10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One):

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

For the fiscal year ended: December 31, 2006

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

For the transition period from: ___________ to ___________

Commission File Number: 000-18464

EMCLAIRE FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

Pennsylvania		25-1606091
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
612 Main Street, Emlenton, PA		16373
(Address of principal executive office)		(Zip Code)
Registrant’s telephone number: (724) 867-2311
Securities registered pursuant to Section 12(b) of the Act:	None.	OTC Electronic Bulletin Board (OTCBB) Name of exchange on which registered
Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $1.25 per share

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

YES o NO x.

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

YES o NO x.

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 o.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer.

Large accelerated filer oAccelerated filer oNon-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES o NO x.

As of June 30, 2006, the aggregate value of the 1,267,835 shares of Common Stock of the Registrant issued and outstanding on such date, which excludes 130,582 shares held by the directors and officers of the Registrant as a group, was approximately $30.7 million. This figure is based on the last sales price of $27.00 per share of the Registrant’s Common Stock on June 30, 2006.

DOCUMENTS INCORPORATED BY REFERENCE

1. Portions of the Annual Report to Stockholders for the Fiscal Year ended December 31, 2006 (Parts I, II, and IV).

2. Portions of the Proxy Statement for the April 25, 2007 Annual Meeting of Stockholders (Part III).

EMCLAIRE FINANCIAL CORP.

TABLE OF CONTENTS

PART I
Item 1.	Business	1
Item 1A.	Risk Factors	16
Item 1B.	Unresolved Staff Comments	17
Item 2.	Properties	18
Item 3.	Legal Proceedings	18
Item 4.	Submission of Matters to a Vote of Security Holders	18
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	19
Item 6.	Selected Financial Data	20
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation	20
Item 7A.	Quantitative and Qualitative Disclosure about Market Risk	20
Item 8.	Financial Statements and Supplementary Data	21
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	21
Item 9A.	Controls and Procedures	21
Item 9B.	Other Information	21
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	22
Item 11.	Executive Compensation	22
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	22
Item 13.	Certain Relationships, Related Transactions and Director Independence	22
Item 14.	Principal Accounting Fees and Services	22
Item 15.	Exhibits and Financial Statement Schedules	22
Signatures		24

PART I

Item 1. Business

General

Emclaire Financial Corp. (the Corporation) is a Pennsylvania corporation and financial holding company that provides a full range of retail and commercial financial products and services to customers in western Pennsylvania through its wholly owned subsidiary bank, the Farmers National Bank of Emlenton (the Bank). The Bank also provides investment advisory services through its Farmers National Financial Services division.

The Bank was organized in 1900 as a national banking association and is a financial intermediary whose principal business consists of attracting deposits from the general public and investing such funds in real estate loans secured by liens on residential and commercial property, consumer loans, commercial business loans, marketable securities and interest-earning deposits. The Bank operates through a network of eleven retail branch offices in Venango, Butler, Clarion, Clearfield, Elk and Jefferson counties, Pennsylvania. The Corporation and the Bank are headquartered in Emlenton, Pennsylvania.

The Corporation and the Bank are subject to examination and comprehensive regulation by the Office of the Comptroller of the Currency (OCC), which is the Bank’s chartering authority, and the Federal Deposit Insurance Corporation (FDIC), which insures customer deposits held by the Bank to the full extent provided by law. The Bank is a member of the Federal Reserve Bank of Cleveland (FRB) and the Federal Home Loan Bank of Pittsburgh (FHLB). The Corporation is a registered financial holding company pursuant to the Bank Holding Company Act of 1956 (BHCA), as amended.

During January 2006, the Bank submitted an application to the OCC for a new branch location in Cranberry, Pennsylvania. This office opened with OCC approval in November 2006.

At December 31, 2006, the Corporation had $300.6 million in total assets, $23.9 million in stockholders’ equity, $213.3 million in loans and $244.5 million in deposits.

Lending Activities

General. The principal lending activities of the Bank are the origination of residential mortgage, commercial mortgage, commercial business and consumer loans. Significantly all of the Bank’s loans are secured by property in the Bank’s primary market area.

One-to-Four Family Mortgage Loans. The Bank offers first mortgage loans secured by one-to-four family residences located in the Bank’s primary lending area. Typically such residences are single-family owner occupied units. The Bank is an approved, qualified lender for the Federal Home Loan Mortgage Corporation (FHLMC). As a result, the Bank may sell loans to and service loans for the FHLMC in market conditions and circumstances where this is advantageous in managing interest rate risk.

Home Equity Loans. The Bank originates home equity loans secured by single-family residences. These loans may be either a single advance fixed-rate loan with a term of up to 20 years, or a variable rate revolving line of credit. These loans are made only on owner-occupied single-family residences.

Commercial Business and Commercial Real Estate Loans. Commercial lending constitutes a significant portion of the Bank’s lending activities. Commercial business and commercial real estate loans amounted to 44.4% of the total loan portfolio at December 31, 2006. Commercial real estate loans generally consist of loans granted for commercial purposes secured by commercial or other nonresidential real estate. Commercial loans consist of secured and unsecured loans for such items as capital assets, inventory, operations and other commercial purposes.

1

Consumer Loans. Consumer loans generally consist of fixed-rate term loans for automobile purchases, home improvements not secured by real estate, capital and other personal expenditures. The Bank also offers unsecured revolving personal lines of credit and overdraft protection.

Loans to One Borrower. National banks are subject to limits on the amount of credit that they can extend to one borrower. Under current law, loans to one borrower are limited to an amount equal to 15% of unimpaired capital and surplus on an unsecured basis, and an additional amount equal to 10% of unimpaired capital and surplus if the loan is secured by readily marketable collateral. At December 31, 2006, the Bank’s loans to one borrower limit based upon 15% of unimpaired capital was $3.4 million. At December 31, 2006, the Bank’s largest single lending relationship had an outstanding balance of $4.5 million, which consisted of a loan to a municipality and was not subject to the legal lending limit. The Bank had one additional lending relationship exceeding the legal lending limit totaling $3.8 million at December 31, 2006. Credit granted to this borrower in excess of the legal lending limit is part of the Pilot Program approved by the OCC which allows the Bank to exceed its legal lending limit within certain parameters. The next largest borrower had loans which totaled $3.3 million and consisted of loans secured by commercial real estate and business property in the Bank’s lending area. At December 31, 2006, all of such loans were performing in accordance with their terms.

Loan Portfolio. The following table sets forth the composition and percentage of the Corporation’s loans receivable in dollar amounts and in percentages of the portfolio as of December 31:

(Dollar amounts in thousands)	2006					2005					2004					2003					2002
	Dollar Amount		%			Dollar Amount		%			Dollar Amount		%			Dollar Amount		%			Dollar Amount		%
Mortgage loans on real estate:
Residential first mortgages	$	64,662		30.0	%	$	66,011		34.0	%	$	69,310		38.2	%	$	76,396		39.7	%	$	82,449		48.2	%
Home equity loans and lines of credit		47,330		22.0	%		39,933		20.5	%		31,548		17.4	%		30,316		15.8	%		19,136		11.2	%
Commercial		61,128		28.4	%		52,990		27.3	%		48,539		26.8	%		44,935		23.4	%		34,986		20.4	%
Total real estate loans		173,120		80.4	%		158,934		81.8	%		149,397		82.4	%		151,647		78.9	%		136,571		79.8	%
Other loans:
Commercial business		34,588		16.0	%		27,732		14.2	%		23,898		13.2	%		26,470		13.8	%		21,913		12.8	%
Consumer		7,671		3.6	%		7,729		4.0	%		8,090		4.4	%		14,142		7.3	%		12,660		7.4	%
Total other loans		42,259		19.6	%		35,461		18.2	%		31,988		17.6	%		40,612		21.1	%		34,573		20.2	%
Total loans receivable		215,379		100.0	%		194,395		100.0	%		181,385		100.0	%		192,259		100.0	%		171,144		100.0	%
Less:
Allowance for loan losses		2,035					1,869					1,810					1,777					1,587
Net loans receivable	$	213,344				$	192,526				$	179,575				$	190,482				$	169,557

The following table sets forth the scheduled contractual principal repayments or interest repricing of loans in the Corporation’s portfolio as of December 31, 2006. Demand loans having no stated schedule of repayment and no stated maturity are reported as due within one year.

(Dollar amounts in thousands)	Due in one		Due from one		Due from five		Due after
	year or less		to five years		to ten years		ten years		Total
Residential mortgages	$	373	$	3,970	$	10,803	$	49,516	$	64,662
Home equity loans and lines of credit		137		7,230		14,855		25,108		47,330
Commercial mortgages		2,938		4,107		17,509		36,574		61,128
Commercial business		2,727		10,903		5,549		15,409		34,588
Consumer		479		6,042		796		354		7,671
	$	6,654	$	32,252	$	49,512	$	126,961	$	215,379

2

The following table sets forth the dollar amount of the Corporation’s fixed- and adjustable-rate loans with maturities greater than one year as of December 31, 2006:

(Dollar amounts in thousands)	Fixed		Adjustable
	rates		rates
Residential mortgage	$	52,883	$	11,405
Home equity loans and lines of credit		43,588		3,605
Commercial mortgage		23,377		34,813
Commercial business		24,402		7,459
Consumer		7,193		-
	$	151,443	$	57,282

Contractual maturities of loans do not reflect the actual term of the Corporation’s loan portfolio. The average life of mortgage loans is substantially less than their contractual terms because of loan prepayments and enforcement of due-on-sale clauses, which give the Corporation the right to declare a loan immediately payable in the event, among other things, that the borrower sells the real property subject to the mortgage. Scheduled principal amortization also reduces the average life of the loan portfolio. The average life of mortgage loans tends to increase when current market mortgage rates substantially exceed rates on existing mortgages and conversely, decrease when rates on existing mortgages substantially exceed current market interest rates.

Delinquencies and Classified Assets

Delinquent Loans and Real Estate Acquired Through Foreclosure (REO). Typically, a loan is considered past due and a late charge is assessed when the borrower has not made a payment within fifteen days from the payment due date. When a borrower fails to make a required payment on a loan, the Corporation attempts to cure the deficiency by contacting the borrower. The initial contact with the borrower is made shortly after the seventeenth day following the due date for which a payment was not received. In most cases, delinquencies are cured promptly.

If the delinquency exceeds 60 days, the Corporation works with the borrower to set up a satisfactory repayment schedule. Typically loans are considered non-accruing upon reaching 90 days delinquency, although the Corporation may be receiving partial payments of interest and partial repayments of principal on such loans. When a loan is placed in non-accrual status, previously accrued but unpaid interest is deducted from interest income. The Corporation institutes foreclosure action on secured loans only if all other remedies have been exhausted. If an action to foreclose is instituted and the loan is not reinstated or paid in full, the property is sold at a judicial or trustee’s sale at which the Corporation may be the buyer.

Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value at the date of foreclosure establishing a new cost basis. After foreclosure, management periodically performs valuations and the real estate is carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in loss on foreclosed real estate. The Corporation generally attempts to sell its REO properties as soon as practical upon receipt of clear title. The original lender typically handles disposition of those REO properties resulting from loans purchased in the secondary market.

As of December 31, 2006, the Corporation’s non-performing assets, which include non-accrual loans, loans delinquent due to maturity, troubled debt restructuring, repossessions and REO, amounted to $1.9 million or 0.65% of the Corporation’s total assets.

3

Classified Assets. Regulations applicable to insured institutions require the classification of problem assets as “substandard,” “doubtful,” or “loss” depending upon the existence of certain characteristics as discussed below. A category designated “special mention” must also be maintained for assets currently not requiring the above classifications but having potential weakness or risk characteristics that could result in future problems. An asset is classified as substandard if not adequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. A substandard asset is characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all the weaknesses inherent in those classified as substandard. In addition, these weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Assets classified as loss are considered uncollectible and of such little value that their continuance as assets is not warranted.

The Corporation’s classification of assets policy requires the establishment of valuation allowances for loan losses in an amount deemed prudent by management. Valuation allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities. When the Corporation classifies a problem asset as a loss, the portion of the asset deemed uncollectible is charged off immediately.

The Corporation regularly reviews the problem loans and other assets in its portfolio to determine whether any require classification in accordance with the Corporation’s policy and applicable regulations. As of December 31, 2006, the Corporation’s classified and criticized assets amounted to $5.1 million with $3.3 million classified as substandard and $1.8 million identified as special mention.

The following table sets forth information regarding the Corporation’s non-performing assets as of December 31:

(Dollar amounts in thousands)	2006			2005			2004			2003			2002
Non-performing loans	$	1,841		$	1,452		$	840		$	1,329		$	1,160
Total as a percentage of gross loans		0.85	%		0.75	%		0.46	%		0.69	%		0.69	%
Repossessions		-			-			2			45			-
Real estate acquired through foreclosure		98			106			69			-			3
Total as a percentage of total assets		0.03	%		0.04	%		0.03	%		0.00	%		0.00	%
Total non-performing assets	$	1,939		$	1,558		$	911		$	1,374		$	1,163
Total non-performing assets
as a percentage of total assets		0.65	%		0.57	%		0.33	%		0.52	%		0.49	%
Allowance for loan losses as a
percentage of non-performing loans		110.54	%		128.72	%		215.48	%		133.71	%		136.81	%

Allowance for Loan Losses. Management establishes allowances for estimated losses on loans based upon its evaluation of the pertinent factors underlying the types and quality of loans; historical loss experience based on volume and types of loans; trend in portfolio volume and composition; level and trend on non-performing assets; detailed analysis of individual loans for which full collectibility may not be assured; determination of the existence and realizable value of the collateral and guarantees securing such loans and the current economic conditions affecting the collectibility of loans in the portfolio. The Corporation analyzes its loan portfolio each month for valuation purposes and to determine the adequacy of its allowance for losses. Based upon the factors discussed above, management believes that the Corporation’s allowance for losses as of December 31, 2006 of $2.0 million was adequate to cover probable losses inherent in the portfolio.

4

The following table sets forth an analysis of the allowance for losses on loans receivable for the years ended December 31:

(Dollar amounts in thousands)	2006			2005			2004			2003			2002
Balance at beginning of period	$	1,869		$	1,810		$	1,777		$	1,587		$	1,464
Provision for loan losses		358			205			290			330			381
Charge-offs:
Mortgage loans		(154	)		(46	)		(165	)		(25	)		(36	)
Commercial business loans		(18	)		(60	)		(36	)		(26	)		(186	)
Consumer loans		(49	)		(91	)		(117	)		(154	)		(109	)
		(221	)		(197	)		(318	)		(205	)		(331	)
Recoveries:
Mortgage loans		-			-			17			-			26
Commercial business loans		19			18			19			22			20
Consumer loans		10			33			25			43			27
		29			51			61			65			73
Balance at end of period	$	2,035		$	1,869		$	1,810		$	1,777		$	1,587
Ratio of net charge-offs to average loans outstanding		0.09	%		0.08	%		0.14	%		0.08	%		0.15	%
Ratio of allowance to total loans at end of period		0.94	%		0.96	%		1.00	%		0.92	%		0.93	%

The following table provides a breakdown of the allowance for loan losses by major loan category for the years ended December 31:

(Dollar amounts in thousands)	2006					2005					2004					2003					2002
			Percent of					Percent of					Percent of					Percent of					Percent of
			loans in each					loans in each					loans in each					loans in each					loans in each
	Dollar		category to			Dollar		category to			Dollar		category to			Dollar		category to			Dollar		category to
Loan Categories:	Amount		total loans			Amount		total loans			Amount		total loans			Amount		total loans			Amount		total loans
Commercial, financial and agricultural	$	532		26.1	%	$	554		29.6	%	$	503		27.8	%	$	623		35.1	%	$	479		30.2	%
Commercial mortgages		820		40.3	%		841		45.0	%		1,137		62.8	%		798		44.9	%		625		39.4	%
Residential mortgages		239		11.7	%		211		11.3	%		10		0.6	%		20		1.1	%		21		1.3	%
Home equity loans		339		16.7	%		150		8.0	%		39		2.2	%		68		3.8	%		63		4.0	%
Consumer loans		83		4.1	%		106		5.7	%		121		6.7	%		190		10.7	%		119		7.5	%
Unallocated		22		1.1	%		7		0.4	%		-		0.0	%		78		4.4	%		280		17.6	%
	$	2,035		100	%	$	1,869		100	%	$	1,810		100	%	$	1,777		100	%	$	1,587		100	%

Investment Portfolio

General. The Corporation maintains an investment portfolio of securities such as U.S. government and agency securities, state and municipal debt obligations, corporate notes and bonds, and to a lesser extent, mortgage-backed and equity securities. Management generally maintains an investment portfolio with relatively short maturities to minimize overall interest rate risk. However, at December 31, 2006 approximately $14.7 million was invested in longer-term callable municipal securities, as part of a strategy to moderate federal income taxes. The Bank has no investment with any one issuer in an amount greater than 10% of stockholders’ equity.

Investment decisions are made within policy guidelines established by the Board of Directors. This policy is aimed at maintaining a diversified investment portfolio, which complements the overall asset/liability and liquidity objectives of the Bank, while limiting the related credit risk to an acceptable level.

5

The following table sets forth certain information regarding the fair value, weighted average yields and contractual maturities of the Corporation’s securities as of December 31, 2006:

(Dollar amounts in thousands)	Due in 1			Due from 1			Due from 3			Due from 5			Due after			No scheduled
	year or less			to 3 years			to 5 years			to 10 years			10 years			maturity			Total
U.S. Government securities	$	6,423		$	18,445		$	3,926		$	1,954		$	-		$	-		$	30,748
Mortgage-backed securities		-			288			942			1,109			-			-			2,339
Municipal securities		-			-			-			939			14,323			-			15,262
Equity securities		-			-			-			-			-			3,425			3,425
Estimated fair value	$	6,423		$	18,733		$	4,868		$	4,002		$	14,323		$	3,425		$	51,774
Weighted average yield (1)		2.60	%		4.06	%		4.70	%		4.12	%		4.84	%		4.39	%		4.17	%
(1) Weighted average yield is calculated based upon amortized cost.

For additional information regarding the Corporation’s investment portfolio see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Notes to Consolidated Financial Statements” in the Annual Report incorporated herein by reference.

Sources of Funds

General. Deposits are the primary source of the Bank’s funds for lending and investing activities. Secondary sources of funds are derived from loan repayments and investment maturities. Loan repayments can be considered a relatively stable funding source, while deposit activity is greatly influenced by interest rates and general market conditions. The Bank also has access to funds through credit facilities available from the FHLB. In addition, the Bank can obtain advances from the FRB discount window. For a description of the Bank’s sources of funds, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report incorporated herein by reference.

Deposits. The Bank offers a wide variety of retail deposit account products to both consumer and commercial deposit customers, including time deposits, non-interest bearing and interest bearing demand deposit accounts, savings deposits and money market accounts.

Deposit products are promoted in periodic newspaper and radio advertisements, along with notices provided in customer account statements. The Bank’s market strategy is based on its reputation as a community bank that provides quality products and personal customer service.

The Bank pays interest rates on its interest bearing deposit products that are competitive with rates offered by other financial institutions in its market area. Management reviews interest rates on deposits weekly and considers a number of factors, including (1) the Bank’s internal cost of funds; (2) rates offered by competing financial institutions; (3) investing and lending opportunities; and (4) the Bank’s liquidity position.

For additional information regarding the Corporation’s deposit base and borrowed funds, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Notes to Consolidated Financial Statements” in the Annual Report incorporated herein by reference.

Subsidiary Activity

The Corporation has one wholly owned subsidiary, the Bank, a national association. As of December 31, 2006, the Bank had no subsidiaries.

6

Personnel

At December 31, 2006, the Bank had 101 full time equivalent employees. There is no collective bargaining agreement between the Bank and its employees, and the Bank believes its relationship with its employees to be satisfactory.

Competition

The Bank competes for loans, deposits and customers with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions and other nonbank financial service providers.

Supervision and Regulation

General. Bank holding companies and banks are extensively regulated under both federal and state law. Set forth below is a summary description of certain provisions of certain laws that relate to the regulation of the Corporation and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.

The Corporation. The Corporation is a registered bank holding company, and subject to regulation and examination by the FRB under the Bank Holding Company Act of 1956, as amended (the BHCA). The Corporation is required to file with the FRB periodicreports and such additional information as the FRB may require. Recent changes to the Bank Holding Company rating system emphasizes risk management and evaluation of the potential impact of non-depository entities on safety and soundness.

The FRB may require the Corporation to terminate an activity or terminate control of or liquidate or divest certain subsidiaries, affiliates or investments when the FRB believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The FRB also has the authority to regulate provisions of certain bank holding company debt, including the authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Corporation must file written notice and obtain FRB approval prior to purchasing or redeeming its equity securities.

Further, the Corporation is required by the FRB to maintain certain levels of capital. See “Capital Standards.”

The Corporation is required to obtain prior FRB approval for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Prior FRB approval is also required for the merger or consolidation of the Corporation and another bank holding company.

The Corporation is prohibited by the BHCA, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or furnishing services to its subsidiaries. However, subject to the prior FRB approval, the Corporation may engage in any, or acquire shares of companies engaged in, activities that the FRB deems to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

Under FRB regulations, the Corporation is required to serve as a source of financial and managerial strength to the Corporation’s subsidiary bank and may not conduct operations in an unsafe or unsound manner. In addition, it is the FRB’s policy that a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of FRB regulations or both.

The Corporation is also a bank holding company within the meaning of the Pennsylvania Banking Code. As such, the Corporation and its subsidiaries are subject to examination by, and may be required to file reports with, the Pennsylvania Department of Banking.

7

The Corporation’s securities are registered with the SEC under the Exchange Act. As such, the Corporation is subject to the information, proxy solicitation, insider trading, corporate governance, and other requirements and restrictions of the Exchange Act. The public may obtain all forms and information filed with the SEC through their website http://www.sec.gov.

The Bank. As a national banking association, the Bank is subject to primary supervision, examination and regulation by the OCC. The Corporation is also subject to regulations of the FDIC as administrator of the Bank Insurance Fund (BIF) and the FRB. If, as a result of an examination of the Bank, the OCC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of the Corporation’s operations are unsatisfactory or that the Bank is violating or has violated any law or regulation, various remedies are available to the OCC. Such remedies include the power to enjoin “unsafe or unsound practices,” to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the Bank’s growth, to assess civil monetary penalties, and to remove officers and directors. The FDIC has similar enforcement authority, in addition to its authority to terminate the Bank’s deposit insurance in the absence of action by the OCC and upon a finding that the Bank is operating in an unsafe or unsound condition, is engaging in unsafe or unsound activities, or that the Corporation’s conduct poses a risk to the deposit insurance fund or may prejudice the interest of its depositors.

A national bank may have a financial subsidiary engaged in any activity authorized for national banks directly or certain permissible activities. Generally, a financial subsidiary is permitted to engage in activities that are “financial in nature” or incidental thereto, even though they are not permissible for the national bank itself. The definition of “financial in nature” includes, among other items, underwriting, dealing in or making a market in securities, including, for example, distributing shares of mutual funds. The subsidiary may not, however, engage as principal in underwriting insurance, issue annuities or engage in real estate development or investment or merchant banking.

The Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 addresses accounting oversight and corporate governance matters, including:

·   the prohibition of accounting firms from providing various types of consulting services to public clients and requiring accounting firms to rotate partners among public client assignments every five years;

·   increased penalties for financial crimes and forfeiture of executive bonuses in certain circumstances;

·   required executive certification of financial presentations;

·   increased requirements for board audit committees and their members;

·   enhanced disclosure of controls and procedures and internal control over financial reporting;

·   enhanced controls on, and reporting of, insider trading; and

·   statutory separations between investment bankers and analysts.

The new legislation and its implementing regulations have resulted in increased costs of compliance, including certain outside professional costs. To date these costs have not had a material impact on the Corporation’s operations.

USA PATRIOT Act of 2001. The USA PATRIOT Act of 2001 and its implementing regulations significantly expanded the anti-money laundering and financial transparency laws. Under the USA PATRIOT Act, financial institutions are subject to prohibitions regarding specified financial transactions and account relationships, as well as enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures and controls generally require financial institutions to take reasonable steps:

8

·   To conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction,

·   To ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions,

·   To ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner, and

·   To ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.

Under the USA PATRIOT Act, financial institutions are required to establish and maintain anti-money laundering programs which included:

·   The establishment of a customer identification program,

·   The development of internal policies, procedures, and controls,

·   The designation of a compliance officer,

·   An ongoing employee training program, and

·   An independent audit function to test the programs.

The Bank has implemented comprehensive policies and procedures to address the requirements of the USA PATRIOT Act.

Privacy. Federal banking rules limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. Pursuant to these rules, financial institutions must provide:

·   initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates;

·   annual notices of their privacy policies to current customers; and

·   a reasonable method for customers to “opt out” of disclosures to nonaffiliated third parties.

These privacy provisions affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. The Corporation’s privacy policies have been implemented in accordance with the law.

Dividends and Other Transfers of Funds. Dividends from the Bank constitute the principal source of income to the Corporation. The Corporation is a legal entity separate and distinct from the Bank. The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends to the Corporation. In addition, the Bank’s regulators have the authority to prohibit the Bank from paying dividends, depending upon the Bank’s financial condition, if such payment is deemed to constitute an unsafe or unsound practice.

Transactions with Affiliates.The Bank is subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, any affiliates, the purchase of, or investments in, stock or other securities thereof, the taking of such securities as collateral for loans, and the purchase of assets of any affiliates. Such restrictions prevent any affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by the Bank to or in any affiliate are limited, individually, to 10.0% of the Bank’s capital and surplus (as defined by federal regulations), and such secured loans and investments are limited, in the aggregate, to 20.0% of the Bank’s capital and surplus. Some of the entities included in the definition of an affiliate are parent companies, sister banks, sponsored and advised companies, investment companies whereby the Bank or its affiliate serves as investment advisor, and financial subsidiaries of the bank. Additional restrictions on transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of federal law. See “Prompt Corrective Action and Other Enforcement Mechanisms.”

9

Loans to One Borrower Limitations.With certain limited exceptions, the maximum amount that a national bank may lend to any borrower (including certain related entities of the borrower) at one time may not exceed 15% of the unimpaired capital and surplus of the institution, plus an additional 10% of unimpaired capital and surplus for loans fully secured by readily marketable collateral. At December 31, 2006, the Bank’s loans-to-one-borrower limit was $3.4 million based upon the 15% of unimpaired capital and surplus measurement. At December 31, 2006, the Bank’s largest single lending relationship had an outstanding balance of $4.5 million, which consisted of a loan to a municipality and was not subject to the legal lending limit. The Bank had one additional lending relationship exceeding the legal lending limit totaling $3.8 million at December 31, 2006. Credit granted to this borrower in excess of the legal lending limit is part of the Pilot Program approved by the OCC which allows the Bank to exceed its legal lending limit within certain parameters. The next largest borrower had loans which totaled $3.3 million and consisted of loans secured by commercial real estate and business property in the Bank’s lending area. At December 31, 2006, all of such loans were performing in accordance with their terms.

Capital Standards. The federal banking agencies have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets and transactions which are recorded as off-balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off-balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as federal banking agencies, to 100% for assets with relatively high credit risk.

The risk-based capital ratio is determined by classifying assets and certain off-balance sheet financial instruments into weighted categories, with higher levels of capital being required for those categories perceived as representing greater risk. Under the capital guidelines, a banking organization’s total capital is divided into tiers. “Tier I capital” consists of (1) common equity, (2) qualifying noncumulative perpetual preferred stock, (3) a limited amount of qualifying cumulative perpetual preferred stock and (4) minority interests in the equity accounts of consolidated subsidiaries (including trust-preferred securities), less goodwill and certain other intangible assets. Not more than 25% of qualifying Tier I capital may consist of trust-preferred securities. “Tier II capital” consists of hybrid capital instruments, perpetual debt, mandatory convertible debt securities, a limited amount of subordinated debt, preferred stock that does not qualify as Tier I capital, a limited amount of the allowance for loan and lease losses and a limited amount of unrealized holding gains on equity securities. “Tier III capital” consists of qualifying unsecured subordinated debt. The sum of Tier II and Tier III capital may not exceed the amount of Tier I capital.

The guidelines require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risk-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets must be 3%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios.

In addition, federal banking regulators may set capital requirements higher than the minimums described above for financial institutions whose circumstances warrant it. For example, a financial institution experiencing or anticipating significant growth may be expected to maintain capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets.

10

Prompt Corrective Action and Other Enforcement Mechanisms. Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve the problems of insured depository institutions, including but not limited to those institutions that fall below one or more prescribed minimum capital ratios. Each federal banking agency has promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At December 31, 2006, the Bank exceeded the required ratios for classification as “well/adequately capitalized.”

An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat a significantly undercapitalized institution as critically undercapitalized unless its capital ratio actually warrants such treatment.

In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation, or any condition imposed in writing by the agency or any written agreement with the agency. Finally, pursuant to an interagency agreement, the FDIC can examine any institution that has a substandard regulatory examination score or is considered undercapitalized - without the express permission of the institution’s primary regulator.

Safety and Soundness Standards. The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: (i) internal controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) asset growth, (v) earnings, and (vi) compensation, fees and benefits. In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and earnings standards. These guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. Under these standards, an insured depository institution should: (i) conduct periodic asset quality reviews to identify problem assets, (ii) estimate the inherent losses in problem assets and establish reserves that are sufficient to absorb estimated losses, (iii) compare problem asset totals to capital, (iv) take appropriate corrective action to resolve problem assets, (v) consider the size and potential risks of material asset concentrations, and (vi) provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk. These guidelines also set forth standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves.

Premiums for Deposit Insurance. Through the BIF, the FDIC insures the Bank’s customer deposits up to prescribed limits for each depositor. The amount of FDIC assessments paid by each BIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other factors. Specifically, the assessment rate is based on the institution's capitalization risk category and supervisory subgroup category. An institution's capitalization risk category is based on the FDIC's determination of whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. An institution's supervisory subgroup category is based on the FDIC's assessment of the financial condition of the institution and the probability that FDIC intervention or other corrective action will be required.

FDIC-insured depository institutions pay an assessment rate equal to the rate assessed on deposits insured by the Savings Association Insurance Fund (SAIF).
 

11

The assessment rate currently ranges from zero to 27 cents per $100 of domestic deposits. The FDIC may increase or decrease the assessment rate schedule on a semi-annual basis. Due to continued growth in deposits and some recent bank failures, the BIF is nearing its minimum ratio of 1.25% of insured deposits as mandated by law. If the ratio drops below 1.25%, it is likely the FDIC will be required to assess premiums on all banks. Any increase in assessments or the assessment rate could have a material adverse effect on the Corporation's earnings, depending on the amount of the increase. Furthermore, the FDIC is authorized to raise insurance premiums under certain circumstances.

The FDIC is authorized to terminate a depository institution's deposit insurance upon a finding by the FDIC that the institution's financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution's regulatory agency. The termination of deposit insurance for the Bank could have a material adverse effect on the Corporation's earnings, depending on the collective size of the particular institutions involved.

All FDIC-insured depository institutions must pay an annual assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the Federal Housing Finance Board. The bonds, commonly referred to as FICO bonds, were issued to capitalize the Federal Savings and Loan Insurance Corporation. The FICO assessment rates for fourth quarter of fiscal 2006 were 1.24 cents for each $100 of assessable deposits. The FICO assessments are adjusted quarterly to reflect changes in the assessment bases of the FDIC's insurance funds and do not vary depending on a depository institution's capitalization or supervisory evaluations.

Deposit Insurance Reform.On February 8, 2006, President Bush signed into law legislation that merges the BIF and the SAIF, eliminates any disparities in bank and thrift risk-based premium assessments, reduces the administrative burden of maintaining and operating two separate funds and establishes certain new insurance coverage limits and a mechanism for possible periodic increases. The legislation also gives the FDIC greater discretion to identify the relative risks all institutions present to the deposit insurance fund and set risk-based premiums.

Major provisions in the legislation include: maintaining basic deposit and municipal account insurance coverage at $100,000 but providing for a new basic insurance coverage for retirement accounts of $250,000. Insurance coverage for basic deposit and retirement accounts could be increased for inflation every five years in $10,000 increments beginning in 2011; providing the FDIC with the ability to set the designated reserve ratio within a range of between 1.15 percent and 1.50 percent, rather than maintaining 1.25 percent at all times regardless of prevailing economic conditions; providing a one-time assessment credit of $4.7 billion to banks and savings associations in existence on December 31, 1996. The institutions qualifying for the credit may use it to offset future premiums with certain limitations; requiring the payment of dividends of 100% of the amount that the insurance fund exceeds 1.5% of the estimated insured deposits and the payment of 50% of the amount that the insurance fund exceeds1.35% of the estimated insured deposits. (when the reserve is greater than 1.35% but no more than 1.5%); the merger of the SAIF and BIF must occur no later than July 1, 2006. Other provisions will become effective within 90 days of the publication date of the final FDIC regulations implementing the legislation.

Interstate Banking and Branching. Banks have the ability, subject to certain State restrictions, to acquire, by acquisition or merger, branches outside its home state. The establishment of new interstate branches is also possible in those states with laws that expressly permit it. Interstate branches are subject to certain laws of the states in which they are located. Competition may increase further as banks branch across state lines and enter new markets.

Consumer Protection Laws and Regulations. The bank regulatory agencies are focusing greater attention on compliance with consumer protection laws and their implementing regulations. Examination and enforcement have become more intense in nature, and insured institutions have been advised to monitor carefully compliance with such laws and regulations. The bank is subject to many federal consumer protection statutes and regulations, some of which are discussed below.

12

The Community Reinvestment Act (CRA) is intended to encourage insured depository institutions, while operating safely and soundly, to help meet the credit needs of their communities. The CRA specifically directs the federal regulatory agencies, in examining insured depository institutions, to assess a bank’s record of helping meet the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with safe and sound banking practices. The CRA further requires the agencies to take a financial institution’s record of meeting its community credit needs into account when evaluating applications for, among other things, domestic branches, mergers or acquisitions, or holding company formations. The agencies use the CRA assessment factors in order to provide a rating to the financial institution. The ratings range from a high of “outstanding” to a low of “substantial noncompliance.” In its last examination for CRA compliance, as of March 22, 1999, the Bank was rated “satisfactory.”

On February 22, 2005, the federal banking agencies re-proposed amendments to the CRA regulations that would:

·   increase the definition of “small institution” from total assets of $250 million to $1 billion, without regard to any holding company; and

·   take into account abusive lending practices by a bank or its affiliates in determining a bank’s CRA rating.

There can be no assurances such proposal will be adopted or, if adopted, in what form.

The Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act (FACT) requires financial firms to help deter identity theft, including developing appropriate fraud response programs, and give consumers more control of their credit data. It also reauthorizes a federal ban on state laws that interfere with corporate credit granting and marketing practices. In connection with FACT, financial institution regulatory agencies proposed rules that would prohibit an institution from using certain information about a consumer it received from an affiliate to make a solicitation to the consumer, unless the consumer has been notified and given a chance to opt out of such solicitations. A consumer’s election to opt out would be applicable for at least five years.

The Check Clearing for the 21st Century Act (Check 21) facilitates check truncation and electronic check exchange by authorizing a new negotiable instrument called a “substitute check,” which is the legal equivalent of an original check. Check 21, effective October 28, 2004, does not require banks to create substitute checks or accept checks electronically; however, it does require banks to accept a legally equivalent substitute check in place of an original.

The Equal Credit Opportunity Act (ECOA) generally prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act.

The Truth in Lending Act (TILA) is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As a result of the TILA, all creditors must use the same credit terminology to express rates and payments, including the annual percentage rate, the finance charge, the amount financed, the total of payments and the payment schedule, among other things.

The Fair Housing Act (FH Act) regulates many practices, including making it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap or familial status. A number of lending practices have been found by the courts to be, or may be considered, illegal under the FH Act, including some that are not specifically mentioned in the FH Act itself.

13

The Home Mortgage Disclosure Act (HMDA) grew out of public concern over credit shortages in certain urban neighborhoods and provides public information that will help show whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. The HMDA also includes a “fair lending” aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes.

The term “predatory lending,” much like the terms “safety and soundness” and “unfair and deceptive practices,” is far-reaching and covers a potentially broad range of behavior. As such, it does not lend itself to a concise or a comprehensive definition. But typically predatory lending involves at least one, and perhaps all three, of the following elements:

·   making unaffordable loans based on the assets of the borrower rather than on the borrower’s ability to repay an obligation (“asset-based lending”)

·   inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced (“loan flipping”)

·   engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrower.

FRB regulations aimed at curbing such lending significantly widen the pool of high-cost home-secured loans covered by the Home Ownership and Equity Protection Act of 1994, a federal law that requires extra disclosures and consumer protections to borrowers. Lenders that violate the rules face cancellation of loans and penalties equal to the finance charges paid.

Effective April 8, 2005, OCC guidelines require national banks and their operating subsidiaries to comply with certain standards when making or purchasing loans to avoid predatory or abusive residential mortgage lending practices. Failure to comply with the guidelines could be deemed an unsafe and unsound or unfair or deceptive practice, subjecting the bank to supervisory enforcement actions.

Finally, the Real Estate Settlement Procedures Act (RESPA) requires lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements. Also, RESPA prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts. Penalties under the above laws may include fines, reimbursements and other penalties. Due to heightened regulatory concern related to compliance with the CRA, TILA, FH Act, ECOA, HMDA and RESPA generally, the Bank may incur additional compliance costs or be required to expend additional funds for investments in its local community.

Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank of Pittsburgh. Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB makes available loans or advances to its members in compliance with the policies and procedures established by the Board of Directors of the individual FHLB. As an FHLB member, the Bank is required to own a certain amount of capital stock in the FHLB. At December 31, 2006, the Bank was in compliance with the stock requirements.

Federal Reserve System. The FRB requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW, and Super NOW checking accounts) and non-personal time deposits. At December 31, 2006, the Bank was in compliance with these requirements.

14

Forward Looking Statements

Discussions of certain matters in this Form 10-K and other related year end documents may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), and as such, may involve risks and uncertainties. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations, are generally identifiable by the use of words or phrases such as “believe”, “plan”, “expect”, “intend”, “anticipate”, “estimate”, “project”, “forecast”, “may increase”, “may fluctuate”, “may improve” and similar expressions of future or conditional verbs such as “will”, “should”, “would”, and “could”. These forward-looking statements relate to, among other things, expectations of the business environment in which the Corporation operates, projections of future performance, potential future credit experience, perceived opportunities in the market and statements regarding the Corporation’s mission and vision. The Corporation’s actual results, performance and achievements may differ materially from the results, performance, and achievements expressed or implied in such forward-looking statements due to a wide range of factors. These factors include, but are not limited to, changes in interest rates, general economic conditions, the local economy, the demand for the Corporation’s products and services, accounting principles or guidelines, legislative and regulatory changes, monetary and fiscal policies of the U.S. Government, U.S. Treasury, and Federal Reserve, real estate markets, competition in the financial services industry, attracting and retaining key personnel, performance of new employees, regulatory actions, changes in and utilization of new technologies and other risks detailed in the Corporation’s reports filed with the Securities and Exchange Commission (SEC) from time to time. These factors and those discussed under “Risk Factors” should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. The Corporation does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

15

Item 1A. Risk Factors

The following discusses certain factors that may affect the Corporation’s financial condition and results of operations and should be considered in analyzing whether to make or continue an investment in our common stock.

Ability of the Corporation to Execute Its Business Strategy. The financial performance and profitability of the Corporation will depend, in large part, on its ability to favorably execute its business strategy. This execution entails risks in, among other areas, technology implementation, market segmentation, brand identification, banking operations, and capital and human resource investments. Accordingly, there can be no assurance that the Corporation will be successful in its business strategy.

Economic Conditions and Geographic Concentration. The Corporation’s operations are located in western Pennsylvania and are concentrated in Venango, Clarion and Butler Counties, Pennsylvania. Although management has diversified the Corporation’s loan portfolio into other Pennsylvania counties, and to a very limited extent into other states, the vast majority of the Corporation’s credits remain concentrated in the threeprimary counties. As a result of this geographic concentration, the Corporation’s results depend largely upon economic and real estate market conditions in these areas. Deterioration in economic or real estate market conditions in the Corporation’s primary market areas could have a material adverse impact on the quality of the Corporation’s loan portfolio, the demand for its products and services, and its financial condition and results of operations.

Interest Rates. By nature, all financial institutions are impacted by changing interest rates. Among other issues, changes in interest rates may affect the following:

§   the demand for new loans;

§   the value of our interest-earning assets;

§   prepayment speeds experienced on various asset classes, particularly residential mortgage loans;

§   credit profiles of existing borrowers;

§   rates received on loans and securities;

§   our ability to obtain and retain deposits in connection with other available investment alternatives; and

§   rates paid on deposits and borrowings.

As presented previously, the Corporation is financially exposed to parallel shifts in general market interest rates, changes in the relative pricing of the term structure of general market interest rates, and relative credit spreads. Therefore, significant fluctuations in interest rates may have an adverse effect upon the Corporation’s financial condition and results of operations.

Government Regulation And Monetary Policy.The financial services industry is subject to extensive federal and state supervision and regulation. Significant new laws, changes in existing laws, or repeals of present laws could cause the Corporation’s financial results to materially differ from past results. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Corporation, and a material change in these conditions could present an adverse impact on the Corporation’s financial condition and results of operations.

Competition. The financial services business in the Corporation’s market areas is highly competitive, and is becoming more so due to technological advances (particularly Internet based financial services delivery), changes in the regulatory environment, and the enormous consolidation that has occurred among financial services providers. Many of the Corporation’s competitors are much larger in terms of total assets and market capitalization, enjoy greater liquidity in their equity securities, have greater access to capital and funding, and offer a broader array of financial products and services. In light of this environment, there can be no assurance that the Corporation will be able to compete effectively. The results of the Corporation may materially differ in future periods depending upon the nature or level of competition.

16

Credit Quality. A significant source of risk arises from the possibility that losses will be sustained because borrowers, guarantors, and related parties may fail to perform in accordance with the terms of their loans. The Corporation has adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that management believes are appropriate to control this risk by assessing the likelihood of non-performance, tracking loan performance, and diversifying the credit portfolio. Such policies and procedures may not, however, prevent unexpected losses that could have a material adverse effect on the Corporation’s financial condition or results of operations. Unexpected losses may arise from a wide variety of specific or systemic factors, many of which are beyond the Corporation’s ability to predict, influence, or control.

There are increased risks involved with commercial real estate and commercial business and consumer lending activities. Our lending activities include loans secured by existing commercial real estate. Commercial real estate lending generally is considered to involve a higher degree of risk than single-family residential lending due to a variety of factors, including generally larger loan balances and the dependency on successful operation of the project for repayment. Our lending activities also include commercial business loans to small to medium business, which generally are secured by various equipment, machinery and other corporate assets, and a wide variety of consumer loans, including home equity and second mortgage loans, automobile loans and unsecured loans. Although commercial business loans and consumer loans generally have shorter terms and higher interest rates than mortgage loans, they generally involve more risk than mortgage loans because of the nature of, or in certain cases the absence of, the collateral which secures such loans.

Our allowance for loan losses on loans may not be adequate to cover probable losses. We have established an allowance for loan losses which we believe is adequate to offset probable losses on our existing loans. There can be no assurance that any future declines in real estate market conditions, general economic conditions or changes in regulatory policies will not require us to increase our allowance for loan losses, which could adversely affect our results of operations.

Other Risks. From time to time, the Corporation details other risks with respect to its business and financial results in its filings with the SEC.

Item 1B. Unresolved staff comments

Not applicable.

17

Item 2. Properties

The Corporation owns no real property but utilizes the main office of the Bank. The Corporation’s and the Bank’s executive offices are located at 612 Main Street, Emlenton, Pennsylvania. The Corporation pays no rent or other form of consideration for the use of this facility. The following table sets forth information with respect to the Bank’s offices at December 31, 2006:

(Dollar amounts in thousands)			Owned		Lease		Net Book		Deposits
			or		Expiration		Value or		at
Location	County		Leased		Date (1)		Annual Rent		12/31/2006
Corporate and Bank Main Offices:
Headquarters and Main Office		Venango		Owned		--	$	1,913	$	44,998
612 Main Street, Emlenton, Pennsylvania 16373
Data Center		Venango		Owned		--		1,057		--
708 Main Street, Emlenton, Pennsylvania 16373
Bank Branch Offices
Bon Aire Office		Butler		Leased		May 2011		38		40,820
1101 North Main Street, Butler, Pennsylvania 16003
Brookville Office		Jefferson		Owned		--		699		21,543
263 Main Street, Brookville, Pennsylvania 15825
Clarion Office		Clarion		Owned		--		318		36,999
Sixth & Wood Street, Clarion, Pennsylvania 16214
Cranberry Office		Venango		Owned		--		1,219		3,187
7001 Route 322, PO Box 235, Cranberry, PA 16319
DuBois Office		Clearfield		Leased		June 2010		21		14,694
861 Beaver Drive, Dubois, Pennsylvania 15801
East Brady Office		Clarion		Owned		--		50		17,835
323 Kelly's Way, East Brady, Pennsylvania 16028
Eau Claire Office		Butler		Owned		--		156		14,527
207 Washington Street, Eau Claire, Pennsylvania 16030
Grove City Office (2)		Mercer		Owned		--		688		--
1319 West Main Street, Grove City, Pennsylvania 16127
Knox Office		Clarion		Leased		December 2011		27		28,985
Route 338 South, Knox, Pennsylvania 16232
Meridian Office		Butler		Leased		December 2012		26		9,707
101 Meridian Road, Butler, Pennsylvania 16003
Ridgway Office		Elk		Owned		--		161		11,198
173 Main Street, Ridgway, Pennsylvania 15853
									$	244,493
(1)Lease agreements for leased offices typically include renewal options.
(2)Branch office expected to open in early 2008.

Item 3. Legal Proceedings

Neither the Bank nor the Corporation is involved in any material legal proceedings. The Bank, from time to time, is party to litigation that arises in the ordinary course of business, such as claims to enforce liens, claims involving the origination and servicing of loans, and other issues related to the business of the Bank. In the opinion of management, the resolution of any such issues would not have a material adverse impact on the financial position, results of operation, or liquidity of the Bank or the Corporation.

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to stockholders for a vote during the quarter ended December 31, 2006.

18

PART II

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities.

(a)   The information is contained under the section captioned “Stock and Dividend Information” in the Corporation’s Annual Report for the fiscal year ended December 31, 2006, and is incorporated herein by reference. For information with respect to equity compensation plans, see “Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” There were no sales of the Corporation’s unregistered securities during the period covered by this report.

Set forth below is a graph comparing the yearly percentage change in the cumulative total shareholder return on the Corporation’s common stock against the cumulative total return of NASDAQ Composite and SNL $250 million to $500 million Bank Index for the five year period beginning December 31, 2001 and ending December 31, 2006. Each assumes an investment of $100 on December 31, 2001 and reinvestment of dividends when paid. The graph is not necessarily indicative of future price performance.

	Period Ending
Index	12/31/01		12/31/02		12/31/03		12/31/04		12/31/05		12/31/06
Emclaire Financial Corp.		100.00		133.83		165.38		174.91		183.66		210.29
NASDAQ Composite		100.00		68.76		103.67		113.16		115.57		127.58
SNL $250M-$500M Bank Index		100.00		128.95		186.31		211.46		224.51		234.58

(b)   Not applicable.

(c)   Issuer Purchases of Equity Securities. The Corporation did not repurchase any of its equity securities in the year ended December 31, 2006.

19

Item 6. Selected Financial Data

The required information is contained in the section captioned “Selected Consolidated Financial Data” in the Corporation’s Annual Report for the year ended December 31, 2006 and incorporated herein by reference.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The required information is contained in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Corporation’s Annual Report for the year ended December 31, 2006 and is incorporated herein by reference.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Market risk for the Corporation is comprised primarily from interest rate risk exposure and liquidity risk. Since virtually all of the interest-earning assets and paying liabilities are at the Bank, virtually all of the interest rate risk and liquidity risk lies at the Bank level. The Bank is not subject to currency exchange risk or commodity price risk, and has no trading portfolio, and therefore, is not subject to any trading risk. In addition, the Bank does not participate in hedging transactions such as interest rate swaps and caps. Changes in interest rates will impact both income and expense recorded and also the market value of long-term interest-earning assets. Interest rate risk and liquidity risk management is performed at the Bank level. Although the Bank has a diversified loan portfolio, loans outstanding to individuals and businesses depend upon the local economic conditions in the immediate trade area.

One of the primary functions of the Corporation’s asset/liability management committee is to monitor the level to which the balance sheet is subject to interest rate risk. The goal of the asset/liability committee is to manage the relationship between interest rate sensitive assets and liabilities, thereby minimizing the fluctuations in the net interest margin, which achieves consistent growth of net interest income during periods of changing interest rates.

Interest rate sensitivity is the result of differences in the amounts and repricing dates of the bank’s rate sensitive assets and rate sensitive liabilities. These differences, or interest rate repricing “gap”, provide an indication of the extent that the Corporation’s net interest income is affected by future changes in interest rates. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest rate-sensitive liabilities and is considered negative when the amount of interest rate-sensitive liabilities exceeds the amount of interest rate-sensitive assets. Generally, during a period of rising interest rates, a negative gap would adversely affect net interest income while a positive gap would result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would result in an increase in net interest income and a positive gap would adversely affect net interest income. The closer to zero that gap is maintained, generally, the lesser the impact of market interest rate changes on net interest income.

Based on certain assumptions by a federal regulatory agency, which management believes most accurately represents the sensitivity of the Corporation’s assets and liabilities to interest rate changes, at December 31, 2006, the Corporation’s interest-earning assets maturing or repricing within one year totaled $78.5 million while the Corporation’s interest-bearing liabilities maturing or repricing within one-year totaled $92.2 million, providing an excess of interest-bearing liabilities over interest-earning assets of $13.7 million or a negative 4.6% of total assets. At December 31, 2006, the percentage of the Corporation’s assets to liabilities maturing or repricing within one year was 85.1%.

For more information, see “Market Risk Management” in Exhibit 13 to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2006.

20

Item 8. Financial Statements and Supplementary Data

The Corporation’s consolidated financial statements required herein are contained in the Corporation’s Annual Report for the year ended December 31, 2006 and are incorporated herein by reference.

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

On January 19, 2005, the Corporation’s Board of Directors dismissed its independent auditors, Crowe Chizek and Company LLC (Crowe Chizek) to be effective upon filing of the 2004 Form 10-K. Crowe Chizek completed its engagement as independent auditor for the Corporation’s fiscal year ended December 31, 2004 upon the filing of the Corporation’s Form 10-K for the year ended December 31, 2004. Crowe Chizek’s report on the Corporation’s consolidated financial statements during the fiscal years ended December 31, 2004 and 2003 contained no adverse opinion or a disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope or accounting principles. The decision to change accountants was approved by the Corporation’s Audit Committee. During the two fiscal years ended December 31, 2004 and 2003 and the subsequent interim period to the date of their dismissal, there were no disagreements between the Corporation and Crowe Chizek on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or principles, which disagreement(s), if not resolved to the satisfaction of Crowe Chizek, would have caused it to make a reference to the subject matter of the disagreement(s) in connection with its reports. None of the “reportable events” described in Item 304(a)(1)(v) of Regulation S-K occurred with respect to the Corporation within the two fiscal years ended December 31, 2004 and 2003 and the subsequent interim period to the date of their dismissal.

Effective January 19, 2005, the Corporation engaged BEARD MILLER COMPANY LLP (Beard Miller) as its independent auditors for the fiscal year ending December 31, 2005. During the two fiscal years ended December 31, 2004 and 2003 and the subsequent interim period to the date of their engagement, the Corporation did not consult Beard Miller regarding any of the matters or events set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K.

Item 9A. Controls and Procedures.

The Corporation maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports in compliance with the Exchange Act, is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Corporation’s Management, including its Chief Executive Officer and Principal Financial and Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of “disclosure controls and procedures” in Rule 13a-14(c) promulgated under the Exchange Act. As of December 31, 2006, the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s Management, including the Corporation’s Chief Executive Officer and the Corporation’s Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures. Based on the foregoing, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures were effective.

During the fourth quarter of fiscal year 2006, there were no significant changes in the Corporation’s internal control over financial reporting or in other factors that could significantly affect the internal controls subsequent to the date of the evaluation referenced above.

Item 9B. Other Information.

None.

21

PART III

Item 10. Directors, Executive Officers and Corporate Governance

The information contained under the sections captioned “Principal Beneficial Owners of the Corporation’s Common Stock”, “Section 16(a) Beneficial Ownership Reporting Compliance” and “Information With Respect to Nominees For Director, Continuing Director and Executive Officers” is incorporated herein by reference to the Corporation’s definitive proxy statement for the Corporation’s Annual Meeting of Stockholders to be held on April 25, 2007 (the Proxy Statement) which will be filed no later than 120 days following the Corporation’s fiscal year end.

The Corporation maintains a Code of Personal and Business Conduct and Ethics (the Code) that applies to all employees, including the CEO and the CFO. A copy of the Code has previously been filed with the SEC and is posted on our website at www.farmersnb.com. Any waiver of the Code with respect to the CEO and the CFO will be publicly disclosed in accordance with applicable regulations.

Item 11. Executive Compensation

The information contained under the section captioned “Executive Compensation” in the Proxy Statement is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information required by this item is incorporated herein by reference to the section captioned “Principal Beneficial

Owners of the Corporation’s Common Stock” in the Proxy Statement.

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required by this item is incorporated herein by reference to the sections captioned “Information With Respect to Nominees For Director, Continuing Directors and Executive Officers” and “Executive Compensation” in the Proxy Statement.

Item 14. Principal Accounting Fees and Services

The information required by this item is incorporated herein by reference to the section captioned “Relationship With Independent Registered Public Accounting Firm” in the Proxy Statement.

PART IV

Item 15. Exhibits and Financial Schedules

(a)(1)-(2) Financial Statements and Schedules:

(i) Financial statements and schedules included in Exhibit 13 to this Form 10-K are filed as part of this report.

(ii) All other financial statement schedules are omitted because the required information is not applicable, or because the information required is included in the consolidated financial statements and notes thereto.

22

   (3) Management Contracts or Compensatory Plans:

(i) Exhibits 10.1-10.3 listed below in (b) below identify management contracts or compensatory plans or arrangements required to be filed as exhibits to this report, and such listing is incorporated herein by reference.
 

(b) Exhibits are either attached as part of this Report or incorporated herein by reference.

      3.1 Articles of Incorporation of Emclaire Financial Corp. (1)

     3.2 Bylaws of Emclaire Financial Corp. (1)

4 Specimen Stock Certificate of Emclaire Financial Corp. (2)

10.1   Form of Change in Control Agreement between Registrant and two executive officers. (3)

10.2   Form of Group Term Carve-Out Plan between the Farmers National Bank of Emlenton and 20 Officers and Employees. (5)

   10.3 Form of Supplemental Executive Retirement Plan Agreement between the Farmers National Bank of Emlenton and Six Officers. (5)

      11 Statement regarding computation of earnings per share (see Note 1 of the Notes to Consolidated Financial Statements in the Annual Report).

     13 Annual Report to Stockholders for the fiscal year ended December 31, 2006.

14    Code of Personal and Business Conduct and Ethics. (6)

     16 Letter regarding change in certifying accountant

     20 Emclaire Financial Corp. Dividend Reinvestment and Stock Purchase Plan.(4)

     21 Subsidiaries of the Registrant (see information contained herein under “Item 1. Description of Business - Subsidiary Activity”).

31.1   CEO 302 Certification.

   31.2 CFO 302 Certification.

   32.1 Chief Executive Officer 906 Certification.

   32.2 CFO 906 Certification.

_____________________________________________________________________________________________

(1) Incorporated by reference to the Registrant’s Registration Statement on Form SB-2, as amended, (File No. 333-11773) declared effective by the SEC on October 25, 1996.

(2) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1997.

(3) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1996.

(4) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001.

(5) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002.

(6) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004.

23

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

EMCLAIRE FINANCIAL CORP.

Dated: March 23, 2007		By:	/s/ David L. Cox
			David L. Cox President, Chief Executive Officer, and Director (Duly Authorized Representative)
Pursuant to the requirement of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
By:	/s/ David L. Cox	By:	/s/ William C. Marsh
	David L. Cox President Chairman of the Board Chief Executive Officer Director) (Principal Executive Officer)		William C. Marsh Executive Vice President Chief Financial Officer and Treasurer Director (Principal Financial and Accounting Officer)
Date:	March 23, 2007	Date:	March 23, 2007
By:	/s/ Ronald L. Ashbaugh	By:	/s/ Brian C. McCarrier
	Ronald L. Ashbaugh Director		Brian C. McCarrier Director
Date:	March 23, 2007	Date:	March 23, 2007
By:	/s/ James M. Crooks	By:	/s/ George W. Freeman
	James M. Crooks Director		George W. Freeman Director
	Date: March 23, 2007		Date: March 23, 2007
By:	/s/ J. Michael King	By:	/s/ John B. Mason
	J. Michael King Director		John B. Mason Director
Date:	March 23, 2007	Date:	March 23, 2007

24

EX-13

EXHIBIT 13

Annual Report to Stockholders for the fiscal year ended December 31, 2006

EMCLAIRE FINANCIAL CORP.

2006

A N N U A L

R E P O R T

Table of Contents
	Consolidated Financial Highlights	1
	Letter to Stockholders	2
	Marketing Information	5
	Board of Directors and Executive Management	7
	Office Locations and Branch Managers	8
	Selected Consolidated Financial Data	9
	Management’s Discussion and Analysis of
	Financial Condition and Results of Operations	10
	Consolidated Financial Statements	28
	Notes to Consolidated Financial Statements	32
	Report of Independent Registered Public Accounting Firm	56
	Stock and Dividend Information	57
	Corporate Information	58

Corporate Profile

Emclaire Financial Corp. (OTCBB: EMCF), a publicly traded Pennsylvania corporation and bank holding company, provides a wide range of retail and commercial financial products and services to customers in western Pennsylvania through its wholly owned subsidiary bank, the Farmers National Bank of Emlenton.

The Farmers National Bank of Emlenton is an FDIC-insured national banking association, which conducts business through eleven offices in Venango, Butler, Clarion, Clearfield, Elk and Jefferson counties, Pennsylvania. The Bank also provides retail brokerage and other investment services through its Farmers National Financial Services division. To complement retail operations conducted through its bank offices, the Corporation also invests in U.S. Government, municipal, mortgage-backed and corporate marketable securities primarily through its subsidiary bank.

Consolidated Financial Highlights 

(Dollar amounts in thousands, except share data)

	At December 31,
Balance Sheet:	2006		2005		2004		2003		2002
Total assets	$	300,560	$	275,517	$	273,380	$	262,512	$	238,577
Loans receivable, net		213,344		192,526		179,575		190,482		169,557
Deposits		244,492		230,503		232,874		217,110		204,425
Stockholders' equity		23,917		23,615		23,616		22,655		22,680
Stockholders' equity per share	$	18.86	$	18.63	$	18.63	$	17.87	$	17.02
Common shares outstanding		1,267,835		1,267,835		1,267,835		1,267,835		1,332,835

	For the year ended December 31,
Income Statement:	2006		2005		2004		2003		2002
Net interest income	$	9,291	$	9,304	$	8,734	$	9,308	$	9,492
Noninterest income		2,934		3,317		2,535		1,785		1,400
Net income		1,966		2,573		2,557		2,492		2,257
Basic earnings per share	$	1.55	$	2.03	$	2.02	$	1.91	$	1.69
Cash dividends per share	$	1.10	$	1.02	$	0.94	$	1.11	$	1.03

	For the year ended December 31,
Key Ratios:	2006			2005			2004			2003			2002
Return on average assets		0.69	%		0.94	%		0.96	%		0.99	%		0.99	%
Return on average equity		8.28	%		10.69	%		11.08	%		10.96	%		10.21	%
Efficiency ratio		74.18	%		69.72	%		67.11	%		64.16	%		64.98	%

1

Letter to Stockholders

DEAR SHAREHOLDERS AND FRIENDS:

I am pleased to report that during 2006, our company, Emclaire Financial Corp., and its wholly-owned subsidiary bank, the Farmers National Bank of Emlenton, realized significant growth and sought to improve long-term performance and enhance stockholder and franchise value. Although certain of these actions adversely impacted 2006 earnings, our prospects for continued growth and long-term profitability prevail.

GROWTH

Our total assets eclipsed the $300 million threshold by year end for the first time in the Bank’s 107 year history. During the year, total assets increased $25 million or 9% to $301 million at December 31, 2006. This significant asset growth was driven by loan portfolio growth of $21 million funded by increases in customer deposits of $14 million and borrowed funds of $11 million.

The Bank’s loans and deposits, continued to grow for the second consecutive year, and over the past five years total assets, loans and deposits have increased 39%, 33% and 29%, respectively. Equally important, the Corporation continues to increase its capital base through profitable operations, as total stockholders’ equity increased to $23.9 million or approximately 8% of total assets at December 31, 2006. As a result, the Corporation and the Bank are well positioned for continued growth and expansion.

The Board of Directors and management continue to be pleased with the Bank’s steady balance sheet growth, sound lending culture and loan production base. We continue to increase our quality loan portfolio and local deposit base through prudent community banking practices.

Continued infrastructure expansion was realized in 2006 by the opening of a new full-service branch office in the Township of Cranberry, Venango County, Pennsylvania in November 2006. Further, in December 2006, the Bank purchased a full-service bank branch office facility in Grove City, Pennsylvania, which we plan to open in early 2008.

PERFORMANCE

For the year ended December 31, 2006, the Corporation realized consolidated net income of $2.0 million or $1.55 per share versus $2.6 million or $2.03 per share for 2005. This $607,000 reduction in net income was primarily due to charges realized in the fourth quarter associated with reorganization initiatives undertaken during 2006. During mid-2006, the Board of Directors and management initiated a strategic review of all aspects of the Bank’s operations. This ongoing review led to several reorganization programs resulting in changes to the way we are organized and operate.

While it is contrary to our persistent goal of providing increasing operating results and returns, the fourth quarter charges were part of our objectives to improve long-term core profitability. Through these recent efforts, we have enhanced the efficiency of our operations while reducing operating expenses, leveraged available technology investments, and improved core profitability all as part of our focus on providing continued sound returns to our shareholders and providing superior customer service.

2

Letter to Stockholders (continued)

These programs resulted in a pre-tax charge to 2006 earnings totaling $559,000. During the fourth quarter of 2006, certain employees accepted a voluntary early retirement payment, resulting in a pension expense charge of $375,000. In addition to these retirement costs, severance and other costs associated with the reorganization initiatives totaled $184,000. It is anticipated that these initiatives will produce ongoing cost savings and contribute to profitability in future periods.

During 2006, net interest margin management remained a key challenge. While the balance sheet continued the aforementioned steady growth, consolidated net interest income saw a modest decline. This was the result of the flat to inverted yield curve prevailing in the marketplace, and impacting all banking industry earnings, as well as continued competition from community banks and other financial intermediaries.

Even in light of the challenges that we have faced in regards to reorganization initiatives and the interest rate environment, the Corporation experienced positive stock performance during 2006. Your stock closed the year at $29.25 per share, up almost 10% from the prior year end close of $26.60. Further, cash dividends increased as regular dividends paid during 2006 totaled $1.10 per share representing a 7.8% increase in annual dividends from the $1.02 per share paid in 2005.

TEAMWORK

Our employees, along with our customers, remain our most valuable asset. As noted, we made certain management changes during the year. These changes were made to improve the overall quality of the Corporation’s leadership and to position us with the skills and experience necessary to develop a first rate, cohesive team across all departments and offices of the Bank. Our commitment to developing a top rate staff to promote sound customer service and education is one of our top priorities.

In June 2006, William C. Marsh returned to the Corporation in the newly created position of Executive Vice President. Bill was previously Chief Financial Officer with the Corporation and the Bank and has returned to manage finance, accounting and compliance and to assist me in directing a number of corporate-wide strategic initiatives including many of the aforementioned programs. Our familiarity with Bill and his banking, finance and strategic planning experience will prove to be valuable as we continue our efforts to grow the Corporation and maintain our reputation as a first rate organization. It is the Board’s desire for Bill to take on increasing responsibilities as we move forward and be part of our leadership succession plan. I am pleased to welcome Bill back and welcome him to the Board of Directors of the Corporation and the Bank.

Also in June, Paige Kaufman joined the Bank as Vice President of Human Resources. Several years ago Paige performed human resource and training consulting services for the Bank and we are delighted to have her energy, leadership and exemplary training skills.

Kathy Buzzard joined the Bank in January 2007 as Senior Vice President of Retail Banking. In this position, Kathy is responsible for managing the Bank’s branch network, marketing and product development efforts, and the financial services division. Kathy brings to the Bank a broad range of financial services experience having served in leadership positions with other banks and financial services companies. With over 20 years of business experience, Kathy has strong team-building, sales program implementation, system, product development, and project management skills.

Training and setting forth teamwork efforts to encourage open communications between departments, offices and between our staff and customers will be one of senior management’s key objectives as we move forward.

3

FUTURE

As we build on and continue with our long range planning initiatives that we have established and continue to form, we look towards the future. In last year’s Annual Report I noted that we have never wavered from our commitment to providing the very best in community banking. That commitment will continue as we strive towards profitable expansion, involvement in the communities we serve and in pursuing growth opportunities for our employees. As we move forward, our business plan is built on the following goals and objectives:

§ To profitably operate our financial service business for the benefit of retail and business customers in our markets.

§ To be a profitable and growth-oriented entity that is committed to quality and building value for the Corporation’s stockholders.

§ To distinguish the Corporation from competitors through the quality of the products and services offered to our customers.

§ To continually be aware that the Corporation’s success is dependent upon our employees.

§ To conduct our businesses with honor and integrity, and to not assume unreasonable risks, regardless of the possible rewards.

More specifically, 2007 should bring a return to improved core profitability as well as continued exploration of external growth opportunities under our current community banking model and through related financial services businesses. Further, we plan on reviewing all of our current products and services in the interest of offering a more simplified retail product base while expanding into a wider range of commercial products and services, including corporate internet banking, cash management and merchant services, among other possibilities.

CLOSING

We strive to provide the very best in community banking in the markets that we serve and believe strongly that there is a place to operate an independent community bank with long-term stockholder growth prospects. On behalf of your management team, the staff and Board of Directors I thank you for your continued support as we strive for growth and consistent, favorable performance.

Very truly yours,

David L. Cox

Chairman of the Board

President and Chief Executive Officer

February 5, 2007

4

Marketing Information

5

Marketing Information

6

Board of Directors

7

Office Locations and Branch Managers

8

Selected Consolidated Financial Data

(Dollar amounts in thousands, except share data)

	As of December 31,
Financial Condition Data	2006			2005			2004			2003			2002
Total assets	$	300,560		$	275,517		$	273,380		$	262,512		$	238,577
Securities		51,774			56,304			63,362			49,162			48,748
Loans receivable, net		213,344			192,526			179,575			190,482			169,557
Deposits		244,492			230,503			232,874			217,110			204,425
Borrowed funds		30,000			19,500			15,000			20,700			10,000
Stockholders' equity		23,917			23,615			23,616			22,655			22,680
Stockholders' equity per common share	$	18.86		$	18.63		$	18.63		$	17.87		$	17.02
Tangible stockholders' equity per common share	$	17.74		$	17.50		$	17.48		$	16.70		$	15.82
		For the year ended December 31,
Operations Data		2006			2005			2004			2003			2002
Interest income	$	16,259		$	14,877		$	13,953		$	14,209		$	14,653
Interest expense		6,968			5,573			5,219			4,901			5,161
Net interest income		9,291			9,304			8,734			9,308			9,492
Provision for loan losses		358			205			290			330			381
Net interest income after provision for loan losses		8,933			9,099			8,444			8,978			9,111
Noninterest income		2,934			3,317			2,535			1,785			1,400
Noninterest expense		9,409			9,146			7,909			7,522			7,420
Income before income taxes		2,458			3,270			3,070			3,241			3,091
Provision for income taxes		492			697			513			749			834
Net income	$	1,966		$	2,573		$	2,557		$	2,492		$	2,257
Average common shares outstanding		1,267,835			1,267,835			1,267,835			1,301,714			1,332,835
Basic earnings per share	$	1.55		$	2.03		$	2.02		$	1.91		$	1.69
Dividends per share (2)	$	1.10		$	1.02		$	0.94		$	1.11		$	1.03
		As of or for the year ended December 31,
Other Data		2006			2005			2004			2003			2002
Performance Ratios
Return on average assets		0.69	%		0.94	%		0.96	%		0.99	%		0.99	%
Return on average equity		8.28	%		10.69	%		11.08	%		10.96	%		10.21	%
Yield on interest-earning assets (1)		6.30	%		6.00	%		5.81	%		6.28	%		6.93	%
Cost of interest-bearing liabilities		3.23	%		2.70	%		2.57	%		2.56	%		2.99	%
Cost of funds		2.69	%		2.24	%		2.15	%		2.16	%		2.53	%
Interest rate spread (1)		3.08	%		3.30	%		3.24	%		3.72	%		3.94	%
Net interest margin (1)		3.68	%		3.82	%		3.71	%		4.18	%		4.54	%
Efficiency ratio (1) (3)		74.18	%		69.72	%		67.11	%		64.16	%		64.98	%
Noninterest expense to average assets		3.30	%		3.33	%		2.96	%		2.99	%		3.25	%
Interest-earning assets to average assets		92.89	%		92.82	%		92.86	%		92.69	%		94.65	%
Loans to deposits		87.26	%		83.52	%		77.11	%		87.74	%		82.94	%
Dividend payout ratio (2)		70.93	%		50.25	%		46.61	%		57.98	%		60.95	%
Asset Quality Ratios
Non-performing loans to total loans		0.85	%		0.75	%		0.46	%		0.69	%		0.68	%
Non-performing assets to total assets		0.65	%		0.57	%		0.33	%		0.52	%		0.49	%
Allowance for loan losses to total loans		0.94	%		0.96	%		1.00	%		0.92	%		0.93	%
Allowance for loan losses to non-performing loans		110.54	%		128.72	%		215.48	%		133.71	%		136.81	%
Capital Ratios
Stockholders' equity to assets		7.96	%		8.57	%		8.64	%		8.63	%		9.51	%
Tangible stockholders' equity to tangible assets		7.52	%		8.09	%		8.15	%		8.11	%		8.90	%
Average equity to average assets		8.32	%		8.75	%		8.63	%		9.02	%		9.69	%

(1)    Interest income utilized in calculation is on a fully tax equivalent basis.

(2)    Includes $0.25 per share special cash dividend paid in 2003 and 2002.

(3)    The efficiency ratio is calculated by dividing operating expenses (less intangible amortization) by net interest income (on a fully tax equivalent basis) and noninterest income. The efficiency ratio gives a measure of how effectively a financial institution is operating.

9

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

The following discussion and analysis represents a review of Emclaire Financial Corp.’s consolidated financial condition and results of operations. This review should be read in conjunction with the consolidated financial statements presented later in this report.

Business Summary

Emclaire Financial Corp. (the Corporation) is a Pennsylvania corporation and bank holding company that provides a full range of retail and commercial financial products and services to customers in western Pennsylvania through its wholly owned subsidiary bank, the Farmers National Bank of Emlenton (the Bank).

The Bank was organized in 1900 as a national banking association and is a financial intermediary whose principal business consists of attracting deposits from the general public and investing such funds in real estate loans secured by liens on residential and commercial property, consumer loans, commercial business loans, marketable securities and interest-earning deposits. The Bank operates through a network of eleven offices in Venango, Butler, Clarion, Clearfield, Elk and Jefferson counties, Pennsylvania. The Corporation and the Bank are headquartered in Emlenton, Pennsylvania. Farmers National Financial Services, formed in 2004, is a division of the Bank that offers retail brokerage and other investment services to customers in the Bank’s market area.

The Bank is subject to examination and comprehensive regulation by the Office of the Comptroller of the Currency (OCC), which is the Bank’s chartering authority, and the Federal Deposit Insurance Corporation (FDIC), which insures customer deposits held by the Bank to the full extent provided by law. The Bank is a member of the Federal Reserve Bank of Cleveland (FRB) and the Federal Home Loan Bank of Pittsburgh (FHLB). The Corporation, as a registered bank holding company, is subject to regulation by the Federal Reserve Board.

Overview

The Corporation reported a reduction in income for 2006 as consolidated net income was $2.0 million or $1.55 per share for 2006, compared to net income of $2.6 million or $2.03 per share for 2005.

The reduction in net income of $607,000 or 23.6% for the year ended December 31, 2006, compared to the same period in 2005, was primarily due to certain charges associated with strategic reorganization initiatives undertaken in 2006. In addition, net income was adversely impacted by an increase in the provision for loan losses and a decrease in noninterest income, partially offset by a decrease in the provision for income taxes. The increase in the provision for loan losses was primarily due to growth in the loan portfolio, particularly with respect to commercial loans. The decrease in noninterest income for 2006 was primarily due to a reduction in gains on sales of securities. The decrease in the provision for income taxes in 2006 was due to lower pre-tax income.

During the year ended December 31, 2006, the Corporation experienced significant asset growth as total assets increased $25.0 million or 9.1% to $300.6 million at year end from $275.5 million at December 31, 2005. This asset growth was driven by total loan portfolio growth of $20.8 million or 10.8% funded by increases in customer deposits of $14.0 million or 6.1% and borrowed funds of $10.5 million or 53.8%.

10

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

The reorganization charges, all of which were realized in the fourth quarter of 2006, were the result of an ongoing strategic review of all aspects of the Bank’s operations that was initiated by the Board of Directors and executive management in June 2006. This review resulted in certain changes in personnel and a streamlining of back room operations to better utilize technology investments and to improve operating controls. During the fourth quarter of 2006, the Bank offered a voluntary early retirement program to eligible employees resulting in a pension expense charge of $375,000. In addition to these retirement costs, severance and other costs associated with the reorganization totaled $184,000.

Changes in Financial Condition

Total assets increased $25.0 million or 9.1% to $300.6 million at December 31, 2006 from $275.5 million at December 31, 2005. This increase was primarily due to increases in loans receivable and cash and equivalents of $20.8 million and $6.4 million, respectively. Also contributing to the increase in total assets was an increase in premises and equipment of $1.8 million as the Corporation opened a new banking office and purchased an existing bank office facility for future use. Partially offsetting the net increase in assets was a decrease in securities as these funds were utilized, in part, to fund loan growth.

The increase in the Corporation’s total assets was primarily funded by increases in total liabilities of $24.7 million or 9.8% and total stockholders’ equity of $302,000 or 1.3%. The increase in total liabilities was primarily due to increases in customer deposits of $14.0 million or 6.1% and borrowed funds of $10.5 million or 53.8%.

Cash and cash equivalents. These accounts increased a combined $6.4 million to $16.7 million at December 31, 2006 from $10.4 million at December 31, 2005. These accounts are typically increased by net operating results, deposits by customers into savings and checking accounts, loan and security repayments and proceeds from borrowed funds. Decreases result from customer deposit withdrawals, new loan originations or other loan fundings, security purchases, repayments of borrowed funds and cash dividends to stockholders. The Corporation maintained a higher balance of cash at year end December 31, 2006 than at the prior year end primarily as a result of the flat market interest rate yield curve as management determined that investing in overnight funds, rather than longer term bonds or securities, provided greater operational flexibility to reinvest such funds in higher-yielding loan products.

Securities. Securities decreased $4.5 million or 8.0% to $51.8 million at December 31, 2006 from $56.3 million at December 31, 2005. The overall decrease in securities for the year resulted from management deploying funds from securities into loan growth and, as noted above, the lack of higher yielding long term investment opportunities in the prevailing interest rate environment during the period. Further, the Corporation had minimal security purchases during the year.

Loans receivable. Net loans receivable increased $20.8 million or 10.8% to $213.3 million at December 31, 2006 from $192.5 million at December 31, 2005. This increase can be primarily attributed to growth in the Corporation’s commercial loan portfolios. Commercial real estate loans increased $8.1 million or 15.4% and commercial business loans increased $6.9 million or 24.7%. This growth in commercial loans can be attributed to the production success of the Bank’s Corporate Banking Group established during 2004 and the related continued market penetration in larger communities served by the Bank.

11

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Also contributing to the growth in the loan portfolio was an increase in home equity loans of $7.4 million or 18.5% due primarily to home equity loan campaigns put forth during the year. Residential first mortgage loans decreased $1.3 million or 2.0% during the year despite strong residential mortgage production. This strong residential mortgage production was offset by the sale of $4.0 million of fixed-rate conforming 30-year mortgages. These loans were sold to the secondary market in connection with managing interest rate risk. Other consumer loans were flat during the period.

Non-performing assets. Non-performing assets include non-accrual loans and real estate acquired through foreclosure (REO). Non-performing assets increased $381,000 to $1.9 million or 0.65% of total assets at December 31, 2006 from $1.6 million or 0.57% of total assets at December 31, 2005. Non-performing assets consisted of non-performing loans and REO of $1.8 million and $98,000, respectively, at December 31, 2006 and $1.5 million and $106,000, respectively, at December 31, 2005. Non-performing assets at both year end dates were associated primarily with one larger credit relationship.

Federal bank stocks. Federal bank stocks were comprised of FHLB stock and FRB stock of $1.9 million and $333,000, respectively, at December 31, 2006. These stocks are purchased and redeemed at par as directed by the federal banks and levels maintained are based primarily on borrowing and other correspondent relationships between the Corporation and the banks. The increase at December 31, 2006 compared to December 31, 2005 can be attributed to an increase in FHLB borrowings during 2006.

Bank-owned life insurance (BOLI). The Corporation maintains single premium life insurance policies on twenty current and former officers and employees of the Bank. In addition to providing life insurance coverage, whereby the Bank as well as the officers and employees receive life insurance benefits, the appreciation of the cash surrender value of the BOLI will serve to offset and finance existing and future employee benefit costs. Increases in this account during 2006 were associated with the increase in the cash surrender value of the policies, partially offset by certain administrative expenses.

Premises and equipment. Premises and equipment increased $1.8 million or 30.0% to $8.0 million at December 31, 2006 from $6.1 million at December 31, 2005. The net increase resulted from capital expenditures of $2.7 million. During 2006, the Corporation constructed a new branch office at a cost of $1.4 million. This office opened in November 2006. In December 2006, the Corporation purchased a full service banking facility for $690,000. In addition, during the year, the Corporation added a drive-through facility to one of its offices and made certain technology investments totaling $500,000 and $400,000, respectively. The overall increase in premises and equipment during the year was partially offset by normal depreciation of fixed assets and the write-off of certain obsolete equipment of $849,000 and $115,000, respectively.

Deposits. Total deposits increased $14.0 million or 6.1% to $244.5 million at December 31, 2006 from $230.5 million at December 31, 2005. While noninterest-bearing deposits remained flat during the year, interest-bearing deposits increased by 7.5% principally as the result of certain certificate of deposit specials promoted in the latter part of the year to fund loan growth and to market the opening of the new branch office.

Borrowed funds. Borrowed funds, or advances from the FHLB, increased $10.5 million or 53.8% to $30.0 million at December 31, 2006 from $19.5 million at December 31, 2005. The increase in advances was the result of management’s matching long-term borrowed funds with loans originated during the second and third quarters of 2006.

12

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Changes in Results of Operations

The Corporation reported net income of $2.0 million, $2.6 million and $2.6 million in 2006, 2005 and 2004, respectively. The following “Average Balance Sheet and Yield/Rate Analysis” and “Analysis of Changes in Net Interest Income” tables should be utilized in conjunction with the discussion of the net interest income and interest expense components of net income.

Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include non-accrual loans and exclude the allowance for loan losses and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt loans and securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis. The information is based on average daily balances during the periods presented.

(Dollar amounts in thousands)	Year ended December 31,
	2006							2005							2004
	Average				Yield /			Average				Yield /			Average				Yield /
	Balance		Interest		Rate			Balance		Interest		Rate			Balance		Interest		Rate
Interest-earning assets:
Loans, taxable	$	200,499	$	13,554		6.76	%	$	181,109	$	12,011		6.63	%	$	178,998	$	11,414		6.38	%
Loans, tax-exempt		6,781		438		6.46	%		7,052		454		6.44	%		7,376		478		6.48	%
Total loans receivable		207,280		13,992		6.75	%		188,161		12,465		6.62	%		186,374		11,892		6.38	%
Securities, taxable		37,944		1,481		3.90	%		47,075		1,714		3.64	%		40,245		1,396		3.47	%
Securities, tax-exempt		15,250		1,013		6.64	%		15,468		1,012		6.53	%		15,398		1,014		6.59	%
Total securities		53,194		2,494		4.69	%		62,543		2,726		4.36	%		55,643		2,410		4.33	%
Interest-earning deposits with banks		2,608		129		4.95	%		2,978		81		2.72	%		4,405		71		1.61	%
Federal bank stocks		1,945		94		4.83	%		1,633		58		3.55	%		1,753		42		2.40	%
Total interest-earning cash equivalents		4,553		223		4.90	%		4,611		139		3.01	%		6,158		113		1.84	%
Total interest-earning assets		265,027		16,709		6.30	%		255,315		15,330		6.00	%		248,175		14,415		5.81	%
Cash and due from banks		6,922							7,399							7,175
Other noninterest-earning assets		13,376							12,340							11,913
Total Assets	$	285,325						$	275,054						$	267,263
Interest-bearing liabilities:
Interest-bearing demand deposits	$	72,584		770		1.06	%	$	79,063		570		0.72	%	$	77,421		457		0.59	%
Time deposits		120,544		5,197		4.31	%		110,829		4,324		3.90	%		110,456		4,129		3.74	%
Total interest-bearing deposits		193,128		5,967		3.09	%		189,892		4,894		2.58	%		187,877		4,586		2.44	%
Borrowed funds, short-term		1,147		53		4.62	%		1,199		50		4.17	%		504		3		0.60	%
Borrowed funds, long-term		21,521		948		4.40	%		15,000		629		4.19	%		15,000		630		4.20	%
Total borrowed funds		22,668		1,001		4.42	%		16,199		679		4.19	%		15,504		633		4.08	%
Total interest-bearing liabilities		215,796		6,968		3.23	%		206,091		5,573		2.70	%		203,381		5,219		2.57	%
Noninterest-bearing demand deposits		43,556		-		-			42,450		-		-			38,800		-		-
Funding and cost of funds		259,352		6,968		2.69	%		248,541		5,573		2.24	%		242,181		5,219		2.15	%
Other noninterest-bearing liabilities		2,224							2,452							2,005
Total Liabilities		261,576							250,993							244,186
Stockholders' Equity		23,749							24,061							23,077
Total Liabilities and Stockholders' Equity	$	285,325						$	275,054						$	267,263
Net interest income			$	9,741						$	9,757						$	9,196
Interest rate spread (difference between weighted average rate on interest-earning  assets and interest-bearing liabilities)						3.08	%						3.30	%						3.24	%
Net interest margin (net interest income as a percentage of average interest earning assets)						3.68	%						3.82	%						3.71	%

13

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Corporation’s interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior year volume), changes in volume (changes in volume multiplied by prior year rate) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on loans and securities reflect the changes in interest income on a fully tax equivalent basis.

(Dollar amounts in thousands)	2006 versus 2005									2005 versus 2004
	Increase (decrease) due to									Increase (decrease) due to
	Volume			Rate			Total			Volume			Rate		Total
Interest income:
Loans	$	1,287		$	240		$	1,527		$	115		$	458	$	573
Securities		(428	)		196			(232	)		300			16		316
Interest-earning deposits with banks		(11	)		59			48			(28	)		38		10
Federal bank stocks		13			23			36			(3	)		19		16
Total interest-earning assets		861			518			1,379			384			531		915
Interest expense:
Deposits		85			988			1,073			50			258		308
Borrowed funds		284			38			322			29			17		46
Total interest-bearing liabilities		369			1,026			1,395			79			275		354
Net interest income	$	492		$	(508	)	$	(16	)	$	305		$	256	$	561

2006 Results Compared to 2005 Results

The Corporation reported net income of $2.0 million and $2.6 million for 2006 and 2005, respectively. The $607,000 or 23.6% decrease in net income can be attributed to decreases in net interest income and noninterest income of $13,000 and $383,000, respectively, and increases in the provision for loan losses and noninterest expense of $153,000 and $263,000, respectively. Partially offsetting these unfavorable comparisons, the provision for income taxes decreased $205,000.

Net interest income. The primary source of the Corporation’s revenue is net interest income. Net interest income is the difference between interest income on earning assets such as loans and securities, and interest expense on liabilities, such as deposits and borrowed funds, used to fund the earning assets. Net interest income is impacted by the volume and composition of interest-earning assets and interest-bearing liabilities, and changes in the level of interest rates. Tax equivalent net interest income decreased $16,000 to $9.7 million for 2006. This decrease in net interest income can be attributed to an increase in tax equivalent interest income of $1.4 million and a corresponding increase in interest expense.

Interest income. Tax equivalent interest income increased $1.4 million or 9.0% to $16.7 million for 2006, compared to $15.3 million for 2005. This increase can be attributed to an increase in interest earned on loans, interest-earning deposits and federal bank stocks of $1.5 million, $48,000 and $36,000, respectively, partially offset by a $232,000 decrease in interest earned on securities.

14

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Tax equivalent interest earned on loans receivable increased $1.5 million or 12.2% to $14.0 million for 2006, compared to $12.5 million for 2005. During that time, average loans increased $19.1 million or 10.2%, accounting for $1.3 million in additional loan interest income. Additionally, the interest rate earned on loans increased as market interest rates for lending were more favorable in 2006 compared to 2005 and the yield on loans increased 13 basis points to 6.75% for 2006, versus 6.62% for 2005 contributing $240,000 in additional interest income. The increase in average loans outstanding can be attributed to the aforementioned commercial and home equity loan growth experienced during 2006 as well as the positive impact in 2006 of loan growth in 2005.

Tax equivalent interest earned on securities decreased $232,000 or 8.5% to $2.5 million for 2006, compared to $2.7 million for 2005. The average volume of these assets decreased $9.3 million or 14.9% primarily as a result of the utilization of these funds for loan growth. The average yield on securities increased by 33 basis points, as a result of certain lower yielding securities maturing, partially offsetting the decline in interest income associated with the volume decline.

Interest earned on interest-earning deposit accounts increased $48,000 to $129,000 for 2006, compared to $81,000 for 2005, as a result of a higher yield realized partially offset by lower average balances maintained. Interest earned on federal bank stocks increased $36,000 to $94,000 for 2006, compared to $58,000 for 2005 as a result of a higher volume and higher yield.

Interest expense. Interest expense increased $1.4 million or 25.0% to $7.0 million for 2006, compared to $5.6 million for 2005. This increase in interest expense can be attributed to an increase in interest incurred on deposits and borrowed funds of $1.1 million and $322,000, respectively.

Deposit interest expense increased $1.1 million or 21.9% to $6.0 million for 2006, compared to $4.9 million for 2005. This increase in deposit interest expense was principally rate driven as the cost of interest-bearing deposits increased 51 basis points to 3.09% for 2006 versus 2.58% for 2005 contributing $988,000 in additional expense. The average volume of deposits increased modestly by $3.2 million or 1.7% contributing to an additional $85,000 in interest expense. The increase in the interest rate on deposits can be attributed to the increase in short term market interest rates during 2006 and 2005 as well as to the Corporation offering certain higher priced certificate products during 2006.

Interest expense on borrowed funds increased $322,000 to $1.0 million for 2006, compared to $679,000 for 2005 due to $15.0 million of FHLB term borrowings placed in the second and third quarters of 2006.

Provision for loan losses. The Corporation records provisions for loan losses to maintain a level of total allowance for loan losses that management believes, to the best of its knowledge, covers all known and inherent losses that are both probable and reasonably estimable at each reporting date. Management considers historical loss experience, the present and prospective financial condition of borrowers, current conditions (particularly as they relate to markets where the Corporation originates loans), the status of non-performing assets, the estimated underlying value of the collateral and other factors related to the collectibility of the loan portfolio.

The provision for loan losses increased $153,000 to $358,000 for 2006, compared to $205,000 for 2005. The Corporation’s allowance for loan losses amounted to $2.0 million or 0.94% of the Corporation’s total loan portfolio at December 31, 2006, compared to $1.9 million or 0.96% at December 31, 2005. The allowance for loan losses as a percentage of non-performing loans at December 31, 2006 and 2005 was 110.5% and 128.7%, respectively. The increase in the provision for loan losses from 2005 to 2006 was primarily due to the aforementioned growth in the loan portfolio.

15

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Noninterest income. Noninterest income includes items that are not related to interest rates, but rather to services rendered and activities conducted in the financial services industry, including fees on depository accounts, general transaction and service fees, commissions on financial services, security and loan gains and losses, and earnings on BOLI. Noninterest income decreased $383,000 or 11.6% to $2.9 million for 2006, compared to $3.3 million for 2005. This decrease can be primarily attributed to a decrease in gains on the sale of securities of $457,000. This decrease resulted primarily from the 2005 gains realized of $628,000 as management elected to divest a community bank stock investment. In 2006, the Corporation realized $372,000 in gains from the sale of this particular investment. Also contributing to the decrease was a 2005 involuntary transaction that resulted from the sale of a community bank which contributed $198,000 to gains on the sale of securities. Partially offsetting the decrease in noninterest income were increases in fee and service income of $64,000 and gains on the sale of loans of $53,000 as management sold $4.0 million of 30-year fixed rate conforming mortgage loans.

Noninterest expense. Noninterest expense increased $263,000 or 2.9% to $9.4 million for 2006, compared to $9.1 million for 2005. This increase in noninterest expense is comprised of increases in compensation and employee benefits and premises and equipment of $525,000 and $26,000, respectively, partially offset by reductions in intangible amortization expense and other expenses of $24,000 and $264,000, respectively.

The largest component of noninterest expense is compensation and employee benefits. This expense increased $525,000 or 10.2%. This increase was primarily the result of the Corporation realizing charges relating to the aforementioned reorganization. These charges included $375,000 in pension expense for employees who took part in an early retirement program as well as $184,000 for severance, other benefits and legal costs associated with the reorganization.

Premises and equipment expense increased $26,000 or 1.6% as a result of increased occupancy costs related to a new drive-thru facility as well as a new branch location. Also contributing to the increase was the write-off of an asset determined to be obsolete.

Other expense decreased $264,000 or 11.0% primarily due to a decrease in telephone expenses of $155,000 as the Corporation received credit from its telephone vendor for billing errors. Also contributing to this decrease was a $203,000 write-off of amounts related to a correspondent bank reconciliation in 2005, which resulted from inefficiencies related to consolidation of their offices as wells as variances resulting from the Bank’s technology conversions late in 2004.

The provision for income taxes decreased $205,000 or 29.4% to $492,000 for 2006, compared to $697,000 for 2005. Contributing to this change was the decrease in the Corporation’s pre-tax earnings of $812,000.

16

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

2005 Results Compared to 2004 Results

The Corporation reported net income of $2.57 million and $2.56 million for 2005 and 2004, respectively. The $16,000 or 1.0% increase in net income can be attributed to increases in net interest income and noninterest income of $570,000 and $782,000, respectively, and a decrease in the provision for loan losses of $85,000, offset by increases in noninterest expenses and the provision for income taxes of $1.2 million and $184,000, respectively.

Net interest income. Tax equivalent net interest income increased $561,000 or 6.1% to $9.8 million for 2005, compared to $9.2 million for 2004. This increase in net interest income can be attributed to an increase in tax equivalent interest income of $915,000 offset by an increase in interest expense of $354,000.

Interest income. Tax equivalent interest income increased $915,000 or 6.4% to $15.3 million for 2005, compared to $14.4 million for 2004. This increase can be attributed primarily to increases in interest earned on loans and securities of $573,000 and $316,000, respectively.

Tax equivalent interest earned on loans receivable increased $573,000 or 4.8% to $12.5 million for 2005, compared to $11.9 million for 2004. During that time, average loans receivable increased $1.8 million or 1.0%, accounting for $115,000 in additional loan interest income. This volume increase was accompanied by an increase of $458,000 related to the 24 basis point increase in the average interest rate earned on the loan portfolio. The increase in the average balance of loans was primarily due to increased originations of home equity loans and lines of credit, commercial mortgages and commercial business loans while the increases in the average yield primarily reflects the recent upward movement in short-term market interest rates.

Tax equivalent interest earned on securities increased $316,000 or 13.1% to $2.7 million for 2005, compared to $2.4 million for 2004 primarily due to an increase in the average volume. The average volume of these assets increased $6.9 million or 12.4% as a result of the deployment of funds from deposit growth, in excess of loan demand, into short-term commercial paper, U.S. Government agency and related entities, mortgage-backed and equity securities.

Interest earned on interest-earning deposits with banks, including federal funds sold, increased $10,000 or 14.1% to $81,000 for 2005, compared to $71,000 for 2004. The average rate of interest-earning deposits increased 111 basis points during 2005 resulting in an increase in interest income of $38,000. Interest rates earned on interest-earning deposit accounts are influenced by the FRB and generally fluctuate with changes in the discount rate. During 2005, the FRB raised the discount rate 200 basis points to 4.25% at December 31, 2005 from 2.25% at December 31, 2004. The average volume of these assets decreased $1.4 million or 32.4% as a result of investing excess funds into increased loan production and a decline in deposits.

Interest earned on federal bank stocks increased $16,000 or 38.1% to $58,000 for 2005, compared to $42,000 for 2004. The average rate of federal bank stocks increased 115 basis points during 2005 resulting in an increase in interest income of $19,000. The average volume of these assets decreased $120,000 or 6.8% during 2005 resulting in a decrease of interest income of $3,000.

Interest expense. Interest expense increased $354,000 or 6.8% to $5.6 million for 2005, compared to $5.2 million for 2004. This increase in interest expense can be attributed to increases in interest incurred on deposits and borrowed funds of $308,000 and $46,000, respectively.

17

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Deposit interest expense increased $308,000 or 6.7% to $4.9 million for 2005, compared to $4.6 million for 2004. This increase in interest expense can be attributed to the increase in average interest-bearing deposits of $2.0 million or 1.1% between 2005 and 2004 resulting in additional interest expense of $50,000. Contributing to the volume variance was a 14 basis point increase in the average cost of interest-bearing deposits to 2.58% for 2005 versus 2.44% for 2004 resulting in an increase in expense due to rate of $258,000. The increase in the average balance of deposits was primarily due to the general fluctuation in transactional demand deposit accounts while the increase in the average cost was due to the recent upward movement in short-term market interest rates.

Interest expense on borrowed funds increased $46,000 or 7.3% to $679,000 for 2005, compared to $633,000 for 2004. This increase was a result of the increase in the average balance of borrowed funds of $695,000 or 4.5% to $16.2 million in 2005 from $15.5 million in 2004 resulting in additional interest expense of $29,000. In addition to the volume increase, the average rate on borrowed funds increased 11 basis points to 4.19% for 2005 versus 4.08% for 2004 resulting in an increase in interest expense due to rate of $17,000. The increase in the average balance and rate of borrowed funds was primarily a result of the FHLB short-term borrowings incurred throughout 2005 primarily to fund loan demand and the outflow in deposits.

Provision for loan losses. The provision for loan losses decreased $85,000 or 29.3% to $205,000 for 2005, compared to $290,000 for 2004. The Corporation’s allowance for loan losses amounted to $1.9 million or 0.96% of the Corporation’s total loan portfolio at December 31, 2005, compared to $1.8 million or 1.00% at December 31, 2004. The allowance for loan losses as a percentage of non-performing loans at December 31, 2005 and 2004 was 128.72% and 215.48%, respectively. The decrease in the provision for loan losses from 2004 to 2005 was primarily due to the decrease of charge-offs and also qualitative factors such as local economics, portfolio mix and trends.

Noninterest income. Noninterest income includes items that are not related to interest rates, but rather to services rendered and activities conducted in the financial services industry, such as fees on depository accounts, general transaction and service fees, security and loan gains and losses and earnings on BOLI. Noninterest income increased $782,000 or 30.8% to $3.3 million for 2005, compared to $2.5 million for 2004. This can be attributed to increases in fees and service charges, commissions on financial services, gains on securities and other noninterest income of $298,000, $342,000, $156,000 and $19,000, respectively. Offsetting this increase were decreases in gains on the sale of loans and earnings on BOLI of $32,000 and $1,000, respectively.

Earnings on fees and service charges increased $298,000 or 26.6% to $1.4 million for 2005, compared to $1.1 million for 2004. This increase was primarily the result of the addition of the Overdraft Privilege Program to our existing product and service line during April 2005. During the year, the Corporation realized an increase in overdraft charges of $307,000 to $1.2 million for the year ended December 31, 2005 compared to $889,000 for the year ended December 31, 2004.

During July 2004, the Corporation entered into an agreement with Blue Vase Securities, LLC to provide investment advisory services to our customers, and operates as Farmers National Financial Services. Blue Vase Securities, LLC is a nation-wide, full-service, independent broker/dealer that offers various services such as investments, insurances, wealth management, advisory services, estate and retirement planning and account consolidation. This partnership has enabled us to provide our customers with financial solutions that extend outside the Bank’s ordinary deposit products and services. The Corporation earns commissions from providing this service and recognized an increase of $342,000 in commissions to $437,000 for the year ended December 31, 2005 compared to $95,000 in 2004.

18

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

In 2004, management elected to sell its student loan portfolio based on the low interest rate environment and the higher expense associated with the servicing of these loans. The final sale of this portfolio occurred in 2005. Gains on the sale of loans decreased $32,000 or 86.5% to $5,000 for the year ended December 31, 2005 compared to $37,000 for the year ended December 31, 2004.

In 2003, management began to diversify its security portfolio with an emphasis on marketable equity securities of community banks with growth potential, increasing dividend yields and the potential to diversify the Corporation’s business. In 2005, management continued to realize gains on the diversification of the security portfolio. The first investment contributed $628,000 to gains on securities as management elected to divest this investment into other community bank stocks and other funding needs. The second investment, which was an involuntary transaction that resulted from the sale of the community bank, contributed $198,000 to gains on securities. The Bank also realized gains on securities from the sale of other equity investments of $31,000.

Other noninterest income increased $19,000 or 4.9% to $407,000 for 2005, compared to $388,000 for 2004. Other noninterest income consists primarily of miscellaneous customer fees for ATM and debit card privileges, wire transfer fees, commissions on insurance and gains on the sale of foreclosed assets.

Noninterest expense. Noninterest expense increased $1.2 million or 15.6% to $9.1 million for 2005, compared to $7.9 million for 2004. This increase in noninterest expense is comprised of increases in compensation and employee benefits, premises and equipment expenses and other noninterest expenses of $712,000, $225,000 and $305,000, respectively, offset by the reduction in intangible amortization expense of $5,000.

The largest component of noninterest expense is compensation and employee benefits. This expense increased $712,000 or 16.2%. Normal annual salary and wage adjustments, increased health insurance and pension costs, higher director’s fees, and commissions paid to the financial services representative were the major components of this increase. Also contributing to the increase was the addition of a new commercial lender, compliance officer, financial services assistant, trainer and credit analyst. Partially offsetting this increase was an increase in standard loan costs deferred associated with personnel as a result of increased loan production.

Premises and equipment expense increased $225,000 or 16.2% primarily as a result of a change in the estimated useful life of an asset which was replaced during the fourth quarter of 2005 and resulted in additional depreciation expense of $108,000. Also contributing to the increase in premises and equipment expenses were increases in repairs and maintenance, utilities resulting from higher energy costs experienced during the year and maintenance service contracts incurred as a result of new technology.

Other noninterest expense increased $305,000 or 14.6% primarily as a result of increased professional fees, travel and entertainment, loan expenses, collection costs, bad checks and other losses, expenses associated with the overdraft privilege program and losses associated with reconciling items related to a correspondent bank relationship. During 2005, the introduction of the overdraft privilege program to our product and service line accounted for $47,000 of the increase in other noninterest expenses. Also contributing to this increase was the write-off of amounts related to a correspondent bank reconciliation of $203,000 resulting from the inefficiencies related to consolidation of their offices as well as variances resulting from the Bank’s technology conversions late in 2004.

Provision for income taxes increased $184,000 or 35.9% to $697,000 for 2005, compared to $513,000 for 2004. Contributing to this change was the increase in the effective tax rate to 21.3% for 2005 from 16.7% for 2004. During 2004, the Corporation generated tax credits and reduced federal income tax expense primarily as a result of the historical renovations to our headquarters located in Emlenton, Pennsylvania.

19

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Market Risk Management

The primary objective of the Corporation’s asset liability management function is to maximize the Corporation’s net interest income while simultaneously maintaining an acceptable level of interest rate risk given the Corporation’s operating environment, capital and liquidity requirements, balance sheet mix, performance objectives and overall business focus. One of the primary measures of the exposure of the Corporation’s earnings to interest rate risk is the timing difference between the repricing or maturity of interest-earning assets and the repricing or maturity of its interest-bearing liabilities.

The Corporation’s Board of Directors has established a Finance Committee, consisting of four outside directors, the President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, to monitor market risk, including primarily interest rate risk. This committee, which meets at least quarterly, generally establishes and monitors the investment, interest rate risk and asset liability management policies established by the Corporation.

In order to minimize the potential for adverse affects of material and prolonged changes in interest rates on the Corporation’s results of operations, the Corporation’s management has implemented and continues to monitor asset liability management policies to better match the maturities and repricing terms of the Corporation’s interest-earning assets and interest-bearing liabilities. Such policies have consisted primarily of (i) originating adjustable-rate mortgage loans; (ii) originating short-term secured commercial loans with the rate on the loan tied to the prime rate or reset features in which the rate changes at determined intervals; (iii) emphasizing investment in shorter-term (15 years or less) investment securities; (iv) selling longer-term (30-year) fixed-rate residential mortgage loans in the secondary market; (v) maintaining a high level of liquid assets (including securities classified as available for sale) that can be readily reinvested in higher yielding investments should interest rates rise; (vi) emphasizing the retention of lower-costing savings accounts and other core deposits; and (vii) lengthening liabilities and locking in lower borrowing rates with longer terms whenever possible.

Interest Rate Sensitivity Gap Analysis

The implementation of asset and liability initiatives and strategies and compliance with related policies, combined with other external factors such as demand for the Corporation’s products and economic and interest rate environments in general, has resulted in the Corporation maintaining a one-year cumulative interest rate sensitivity gap ranging between a positive and negative 20% of total assets. The one-year interest rate sensitivity gap is identified as the difference between the Corporation’s interest-earning assets that are scheduled to mature or reprice within one year and its interest-bearing liabilities that are scheduled to mature or reprice within one year.

The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities, and is considered negative when the amount of interest rate-sensitive liabilities exceeds the amount of interest rate-sensitive assets. Generally, during a period of rising interest rates, a negative gap would adversely affect net interest income while a positive gap would result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would result in an increase in net interest income and a positive gap would adversely affect net interest income. The closer to zero, or more neutral, that gap is maintained, generally, the lesser the impact of market interest rate changes on net interest income.

20

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Based on certain assumptions provided by a federal regulatory agency, which management believes most accurately represents the sensitivity of the Corporation’s assets and liabilities to interest rate changes, at December 31, 2006, the Corporation’s interest-earning assets maturing or repricing within one year totaled $78.5 million while the Corporation’s interest-bearing liabilities maturing or repricing within one-year totaled $92.2 million, providing an excess of interest-bearing liabilities over interest-earning assets of $13.7 million or a negative 4.6% of total assets. At December 31, 2006, the percentage of the Corporation’s assets to liabilities maturing or repricing within one year was 85.1%.

The following table presents the amounts of interest-earning assets and interest-bearing liabilities outstanding as of December 31, 2006 which are expected to mature, prepay or reprice in each of the future time periods presented:

(Dollar amounts in thousands)	Due in			Due within			Due within			Due within			Due in
	six months			six months			one to			three to			over
	or less			to one year			three years			five years			five years			Total
Total interest-earning assets	$	52,564		$	25,877		$	90,720		$	47,079		$	57,181		$	273,421
Total interest-bearing liabilities		50,515			41,649			53,156			28,421			100,787			274,528
Maturity or repricing gap during the period	$	2,049		$	(15,772	)	$	37,564		$	18,658		$	(43,606	)	$	(1,107	)
Cumulative gap	$	2,049		$	(13,723	)	$	23,841		$	42,499		$	(1,107	)
Ratio of gap during the period to total assets		0.68	%		(5.25	%)		12.50	%		6.21	%		(14.51	%)
Ratio of cumulative gap to total assets		0.68	%		(4.57	%)		7.93	%		14.14	%		(0.37	%)
Total assets																$	300,560

Although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase.

The one-year interest rate sensitivity gap has been the most common industry standard used to measure an institution’s interest rate risk position regarding maturities, repricing and prepayments. In recent years, in addition to utilizing interest rate sensitivity gap analysis, the Corporation has increased its emphasis on the utilization of interest rate sensitivity simulation analysis to evaluate and manage interest rate risk.

21

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued) 

Interest Rate Sensitivity Simulation Analysis

The Corporation also utilizes income simulation modeling in measuring its interest rate risk and managing its interest rate sensitivity. The Finance Committee of the Corporation believes that simulation modeling enables the Corporation to more accurately evaluate and manage the possible effects on net interest income due to the exposure to changing market interest rates, the slope of the yield curve and different loan and security prepayment and deposit decay assumptions under various interest rate scenarios.

As with gap analysis and earnings simulation modeling, assumptions about the timing and variability of cash flows are critical in net portfolio equity valuation analysis. Particularly important are the assumptions driving mortgage prepayments and the assumptions about expected attrition of the core deposit portfolios. These assumptions are based on the Corporation’s historical experience and industry standards and are applied consistently across the different rate risk measures.

The Corporation has established the following guidelines for assessing interest rate risk:

Net interest income simulation. Given a 200 basis point parallel and gradual increase or decrease in market interest rates, net interest income may not change by more than 25% for a one-year period.

Portfolio equity simulation. Portfolio equity is the net present value of the Corporation’s existing assets and liabilities. Given a 200 basis point immediate and permanent increase or decrease in market interest rates, portfolio equity may not correspondingly decrease or increase by more than 30% of stockholders’ equity.

These guidelines take into consideration the current interest rate environment, the Corporation’s financial asset and financial liability product mix and characteristics and liquidity sources among other factors. Given the current rate environment, a drop in short-term market interest rates of 200 basis points immediately or over a one-year horizon would seem unlikely. This should be considered in evaluating modeling results outlined in the table below.

The following table presents the simulated impact of a 100 basis point or 200 basis point upward or downward shift of market interest rates on net interest income, for the years ended December 31, 2006 and 2005, respectively. This analysis was done assuming that the interest-earning asset and interest-bearing liability levels at December 31, 2006 remained constant. The impact of the market rate movements on net interest income was developed by simulating the effects of rates changing gradually during a one-year period from the December 31, 2006 levels for net interest income.

	Increase		Decrease
	+100	+200	-100	-200
	BP	BP	BP	BP
2006 Net interest income - increase (decrease)	1.12%	0.73%	(0.33%)	(3.43%)
2005 Net interest income - increase (decrease)	0.40%	(0.53%)	(1.45%)	(4.75%)

22

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Impact of Inflation and Changing Prices

The consolidated financial statements of the Corporation and related notes presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America which require the measurement of financial condition and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.

Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services since such prices are affected by inflation to a larger degree than interest rates. In the current interest rate environment, liquidity and the maturity structure of the Corporation’s assets and liabilities are critical to the maintenance of acceptable performance levels.

Capital Resources

Total stockholders’ equity increased $302,000 or 1.3% to $23.9 million at December 31, 2006 from $23.6 million at December 31, 2005. Net income of $2.0 million in 2006, represented a decline in earnings of $607,000 or 23.6% compared to last year. Returns on average equity and assets were 8.28% and 0.69%, respectively, for 2006.

The Corporation has maintained a strong capital position with a capital to assets ratio of 8.0% at December 31, 2006, a decline compared to the ratio of 8.6% a year earlier. While continuing to sustain this strong capital position, regular quarterly dividends increased to $1.4 million in 2006 from $1.3 million in 2005. Stockholders have taken part in the Corporation’s dividend reinvestment plan introduced during 2003 with 40% of registered shareholder accounts active in the plan at December 31, 2006.

Capital adequacy is intended to enhance the Corporation’s ability to support growth while protecting the interest of shareholders and depositors and to ensure that capital ratios are in compliance with regulatory minimum requirements. Regulatory agencies have developed certain capital ratio requirements that are used to assist them in monitoring the safety and soundness of financial institutions. At December 31, 2006, the Corporation and the Bank were in excess of all regulatory capital requirements.

Liquidity

The Corporation’s primary sources of funds generally have been deposits obtained through the offices of the Bank, borrowings from the FHLB, and amortization and prepayments of outstanding loans and maturing securities. During 2006, the Corporation used its sources of funds primarily to fund loan commitments. As of December 31, 2006, the Corporation had outstanding loan commitments, including undisbursed loans and amounts available under credit lines, totaling $22.6 million, and standby letters of credit totaling $463,000. The Bank is required by the OCC to establish policies to monitor and manage liquidity levels to ensure the Bank’s ability to meet demands for customer withdrawals and the repayment of short-term borrowings, and the Bank is currently in compliance with all liquidity policy limits.

At December 31, 2006, time deposits amounted to $129.5 million or 53.0% of the Corporation’s total consolidated deposits, including approximately $58.9 million, which are scheduled to mature within the next year. Management of the Corporation believes that they have adequate resources to fund all of its commitments, that all of its commitments will be funded as required by related maturity dates and that, based upon past experience and current pricing policies, it can adjust the rates of time deposits to retain a substantial portion of maturing liabilities.

23

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Aside from liquidity available from customer deposits or through sales and maturities of securities, the Corporation has alternative sources of funds such as a line of credit and term borrowing capacity from the FHLB and, to a limited and rare extent, through the sale of loans. At December 31, 2006, the Corporation’s borrowing capacity with the FHLB, net of funds borrowed, was $110.6 million.

Management is not aware of any conditions, including any regulatory recommendations or requirements, that would adversely impact its liquidity or its ability to meet funding needs in the ordinary course of business.

Critical Accounting Policies

The Corporation’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the industry in which it operates. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates or judgments. Certain policies inherently have a greater reliance on the use of estimates, and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates or judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily though the use of internal cash flow modeling techniques.

The most significant accounting policies followed by the Corporation are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management has identified the following as critical accounting policies.

Allowance for loan losses. The Corporation considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The balance in the allowance for loan losses is determined based on management’s review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions and other pertinent factors, including management’s assumptions as to future delinquencies, recoveries and losses. All of these factors may be susceptible to significant change. Among the many factors affecting the allowance for loan losses, some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all of the potential factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from management’s estimates, additional provisions for loan losses may be required that would adversely impact the Corporation’s financial condition or earnings in future periods.

24

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued) 

Recent Accounting and Regulatory Pronouncements

In March 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 156, Accounting for Servicing of Financial Assets - An Amendment of FASB Statement No. 140 (SFAS 156). SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The statement permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. SFAS 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006, which for the Corporation will be as of the beginning of fiscal 2007. The Corporation does not believe that the adoption of SFAS 156 will have a significant effect on its consolidated financial statements.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes. The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS 109, Accounting for Income Taxes. Specifically, the pronouncement prescribes a recognition threshold and a measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on the related derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. The interpretation is effective for fiscal years beginning after December 15, 2006, which for the Corporation will be as of the beginning of fiscal 2007. The Corporation does not believe that the adoption of this interpretation will have a significant effect on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. The Corporation is currently evaluating the potential impact, if any, of the adoption of SFAS 157 on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (SFAS 158), which amends SFAS 87 and SFAS 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date, the date at which the benefit obligation and plan assets are measured, is required to be the Corporation’s fiscal year end. SFAS 158 is effective for publicly-held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. The Corporation, in accordance with and in connection with the adoption of SFAS 158, recognized $360,000 in accumulated other comprehensive income, net of taxes, as of December 31, 2006.

25

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulleting No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, companies might evaluate the materiality of financial-statement misstatements using either the income statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company’s balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. SAB 108 is effective for fiscal years ending after November 15, 2006. The Corporation in accordance with and in connection with the adoption of SAB 108, adjusted its beginning retained earnings for 2006 by $120,000 in the accompanying consolidated balance sheet.

In September 2006, FASB’s EITF issued EITF Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements (EITF 06-4). EITF 06-4 requires the recognition of a liability related to the postretirement benefits covered by an endorsement split-dollar life insurance arrangement. The consensus highlights that the employer (who is also the policyholder) has a liability for the benefit it is providing to its employee. As such, if the policyholder has agreed to maintain the insurance policy in force for the employee’s benefit during his or her retirement, then the liability recognized during the employee’s active service period should be based on the future cost of insurance to be incurred during the employee’s retirement. Alternatively, if the policy holder has agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized by following the guidance in SFAS 106 or Accounting Principals Board (APB) Opinion No. 12, as appropriate. For transition, an entity can choose to apply the guidance using either of the following approaches: (a) a change in accounting principle through retrospective application to all periods presented or (b) a change in accounting principle through a cumulative-effect adjustment to the balance in retained earnings at the beginning of the year of adoption. The disclosures are required in fiscal years beginning after December 15, 2007, with early adoption permitted. The Corporation is currently evaluating the impact that the implementation of EITF 06-4 may have on its consolidated financial statements.

In October 2006, the FASB issued FSP No. 123(R)-5, Amendment of FASB Staff Position FAS 123(R)-1 (FSP 123(R)-5). FSP 123(R)-5 amends FSP 123(R)-1 for equity instruments that were originally issued as employee compensation and then modified, with such modification made solely to reflect an equity restructuring that occurs when the holders are no longer employees. FSP 123(R)-5 is effective for the Corporation January 1, 2007. The Corporation does not expect the adoption of FSP 123(R)-5 to have a material impact on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS 159 is effective for the Corporation January 1, 2008. The Corporation is evaluating the impact that the adoption of SFAS 159 will have on its consolidated financial statements.

26

Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

Forward Looking Statements

Discussions of certain matters in this Annual Report and other related year end documents may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and as such, may involve risks and uncertainties. These forward-looking statements relate to, among other things, expectations of the business environment in which the Corporation operates, projections of future performance and potential future credit experience. The Corporation’s actual results, performance and achievements may differ materially from the results, performance and achievements expressed or implied in such forward-looking statements due to a wide range of factors. These factors include, but are not limited to, changes in interest rates, general economic conditions, the local economy, accounting principles or guidelines, legislative and regulatory changes, government monetary and fiscal policies, real estate markets, financial services industry competition, attracting and retaining key personnel, regulatory actions and other risks detailed in the Corporation’s reports filed with the SEC from time to time. These factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. The Corporation does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

27

Consolidated Balance Sheets

(Dollar amounts in thousands, except share data)

	December 31,
	2006			2005
Assets
Cash and due from banks	$	7,540		$	9,399
Interest earning deposits with banks		9,177			968
Total cash and cash equivalents		16,717			10,367
Securities:
Available for sale, at fair value		51,774			56,289
Held to maturity		-			15
Total securities		51,774			56,304
Loans receivable, net of allowance for loan losses of $2,035 and $1,869		213,344			192,526
Federal bank stocks, at cost		2,217			1,773
Bank-owned life insurance		4,794			4,623
Accrued interest receivable		1,374			1,271
Premises and equipment, net		7,958			6,123
Goodwill		1,422			1,422
Other intangible assets		-			7
Prepaid expenses and other assets		960			1,101
Total Assets	$	300,560		$	275,517
Liabilities and Stockholders' Equity
Liabilities
Deposits:
Non-interest bearing	$	44,045		$	44,044
Interest bearing		200,447			186,459
Total deposits		244,492			230,503
Borrowed funds:
Short-term		-			4,500
Long-term		30,000			15,000
Total borrowed funds		30,000			19,500
Accrued interest payable		825			607
Accrued expenses and other liabilities		1,326			1,292
Total Liabilities		276,643			251,902
Stockholders' Equity
Preferred stock, $1.00 par value, 3,000,000 shares authorized; none issued		-			-
Common stock, $1.25 par value, 12,000,000 shares authorized; 1,395,852 shares issued, 1,267,835 shares outstanding		1,745			1,745
Additional paid-in capital		10,871			10,871
Treasury stock, at cost; 128,017 shares		(2,653	)		(2,653	)
Retained earnings		14,370			13,678
Accumulated other comprehensive loss		(416	)		(26	)
Total Stockholders' Equity		23,917			23,615
Total Liabilities and Stockholders' Equity	$	300,560		$	275,517

See accompanying notes to consolidated financial statements.

28

Consolidated Statements of Income

(Dollar amounts in thousands, except share data)

	Year ended December 31,
	2006		2005		2004
Interest and dividend income
Loans receivable, including fees	$	13,856	$	12,325	$	11,744
Securities:
Taxable		1,481		1,714		1,396
Exempt from federal income tax		699		699		700
Federal bank stocks		94		58		42
Deposits with banks		129		81		71
Total interest and dividend income		16,259		14,877		13,953
Interest expense
Deposits		5,967		4,894		4,586
Short-term borrowed funds		53		50		3
Long-term borrowed funds		948		629		630
Total interest expense		6,968		5,573		5,219
Net interest income		9,291		9,304		8,734
Provision for loan losses		358		205		290
Net interest income after provision for loan losses		8,933		9,099		8,444
Noninterest income
Fees and service charges		1,484		1,420		1,122
Commissions on financial services		408		437		95
Net gain on sales of loans		58		5		37
Net gain on available for sale securities		400		857		701
Earnings on bank-owned life insurance		195		191		192
Other		389		407		388
Total noninterest income		2,934		3,317		2,535
Noninterest expense
Compensation and employee benefits		5,632		5,107		4,395
Premises and equipment		1,637		1,611		1,386
Intangible amortization expense		7		31		36
Other		2,133		2,397		2,092
Total noninterest expense		9,409		9,146		7,909
Income before provision for income taxes		2,458		3,270		3,070
Provision for income taxes		492		697		513
Net income	$	1,966	$	2,573	$	2,557
Basic earnings per share	$	1.55	$	2.03	$	2.02
Average common shares outstanding		1,267,835		1,267,835		1,267,835

See accompanying notes to consolidated financial statements.

29

Consolidated Statements of Changes in Stockholders’ Equity

(Dollar amounts in thousands, except share data)

Year ended December 31, 2006, 2005 and 2004
											Accumulated
			Additional								Other			Total
	Common		Paid-in		Treasury			Retained			Comprehensive			Stockholders'
	Stock		Capital		Stock			Earnings			Income (Loss)			Equity
Balance at January 1, 2004	$	1,745	$	10,871	$	(2,653	)	$	11,033		$	1,659		$	22,655
Comprehensive income:
Net income									2,557						2,557
Change in net unrealized gains on securities available for sale, net of taxes of ($207)												(404	)		(404	)
Comprehensive income															2,153
Dividends declared, $0.94 per share									(1,192	)					(1,192	)
Balance at December 31, 2004		1,745		10,871		(2,653	)		12,398			1,255			23,616
Comprehensive income:
Net income									2,573						2,573
Change in net unrealized gains (losses) on securities available for sale, net of taxes of ($660)												(1,281	)		(1,281	)
Comprehensive income															1,292
Dividends declared, $1.02 per share									(1,293	)					(1,293	)
Balance at December 31, 2005		1,745		10,871		(2,653	)		13,678			(26	)		23,615
Cumulative effect of adjustments resultingfrom the adoption of SAB No. 108									120						120
Adjusted balance at December 31, 2005		1,745		10,871		(2,653	)		13,798			(26	)		23,735
Comprehensive income:
Net income									1,966						1,966
Change in net unrealized losses on securities available for sale, net of taxes of ($14)												(30	)		(30	)
Comprehensive income															1,936
Adjustment to initially apply SFAS No. 158, net of taxes of ($185)												(360	)		(360	)
Dividends declared, $1.10 per share									(1,394	)					(1,394	)
Balance at December 31, 2006	$	1,745	$	10,871	$	(2,653	)	$	14,370		$	(416	)	$	23,917

See accompanying notes to consolidated financial statements.

30

Consolidated Statements of Cash Flows

(Dollar amounts in thousands)

	Year ended December 31,
	2006			2005			2004
Cash flows from operating activities
Net income	$	1,966		$	2,573		$	2,557
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of premises and equipment		849			855			703
Provision for loan losses		358			205			290
Amortization of premiums and accretion of discounts, net		32			94			223
Amortization of intangible assets and mortgage servicing rights		14			37			36
Realized gain on sales of available for sale securities, net		(400	)		(857	)		(701	)
Net gains on sales of loans		(58	)		(5	)		(37	)
Proceeds from the sale of loans held for sale		-			546			3,541
Earnings on bank-owned life insurance, net		(171	)		(175	)		(176	)
(Increase) decrease in accrued interest receivable		(103	)		(68	)		67
(Increase) decrease in prepaid expenses and other assets		(84	)		572			(6	)
Increase in accrued interest payable		218			30			100
Increase (decrease) in accrued expenses and other liabilities		35			(176	)		(421	)
Net cash provided by operating activities		2,656			3,631			6,176
Cash flows from investing activities
Loan originations and principal collections, net		(25,147	)		(13,286	)		6,628
Proceeds from the sale of loans		3,998			-			-
Available for sale securities:
Sales		1,089			1,646			945
Maturities, repayments and calls		5,848			8,809			13,299
Purchases		(2,076	)		(4,552	)		(28,549	)
Held to maturity securities:
Sales		14			-			-
Maturities, repayments and calls		1			1			1
(Purchase) redemption of federal bank stocks		(444	)		(42	)		251
Purchase of customer relationship intangible		-			-			(20	)
Purchases of premises and equipment		(2,684	)		(1,300	)		(682	)
Net cash used in investing activities		(19,401	)		(8,724	)		(8,127	)
Cash flows from financing activities
Net increase (decrease) in deposits		13,989			(2,371	)		15,764
Increase in long-term borrowed funds		15,000			-			-
Increase (decrease) of overnight borrowed funds		(4,500	)		4,500			(5,700	)
Dividends paid on common stock		(1,394	)		(1,293	)		(1,192	)
Net cash provided by financing activities		23,095			836			8,872
Net increase (decrease) in cash and cash equivalents		6,350			(4,257	)		6,921
Cash and cash equivalents at beginning of period		10,367			14,624			7,703
Cash and cash equivalents at end of period	$	16,717		$	10,367		$	14,624
Supplemental information:
Interest paid	$	6,750		$	5,543		$	5,119
Income taxes paid		686			442			295
Supplemental noncash disclosures:
Transfers from loans to foreclosed real estate		50			106			69

See accompanying notes to consolidated financial statements.

31

Notes to Consolidated Financial Statements

1.Summary of Significant Accounting Policies

Basis of Presentation and Consolidation. The consolidated financial statements include the accounts of Emclaire Financial Corp. (the Corporation) and its wholly owned subsidiary, the Farmers National Bank of Emlenton (the Bank). All significant intercompany balances and transactions have been eliminated in consolidation.

Nature of Operations. The Corporation provides a variety of financial services to individuals and businesses through its offices in western Pennsylvania. Its primary deposit products are checking, savings and term certificate accounts and its primary lending products are residential and commercial mortgages, commercial business loans and consumer loans.

Use of Estimates and Classifications. In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and 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 in the near term relate to the determination of the allowance for loan losses, fair value of financial instruments and the valuation of deferred tax assets. Certain amounts previously reported may have been reclassified to conform to the current year financial statement presentation. Such reclassifications did not affect net income or stockholders’ equity.

Significant Group Concentrations of Credit Risk. Most of the Corporation’s activities are with customers located within the western Pennsylvania region of the country. Note 2 discusses the type of securities that the Corporation invests in. Note 3 discusses the types of lending the Corporation engages in. The Corporation does not have any significant concentrations to any one industry or customer.

Cash Equivalents. For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, cash items, interest-earning deposits with other financial institutions and federal funds sold and due from correspondent banks. Interest-earning deposits mature within one year and are carried at cost. Federal funds are generally sold or purchased for one day periods. Net cash flows are reported for loan and deposit transactions.

Restrictions on Cash. Cash on hand or on deposit with the Federal Reserve Bank of approximately $1.1 million and $2.1 million were required to meet regulatory reserve and clearing requirements at December 31, 2006 and 2005, respectively. Such balances do not earn interest.

Securities. Securities include investments primarily in bonds and notes and are classified as either available for sale or held to maturity at the time of purchase based on management’s intent. Securities for which the Corporation has the positive intent and ability to hold to maturity are classified as held to maturity and are reported at amortized cost. Securities that are not classified as held to maturity, including equity securities with readily determinable fair values, are classified as available for sale and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in accumulated other comprehensive income.

32

Notes to Consolidated Financial Statements (continued)

1.Summary of Significant Accounting Policies (continued)

Securities (continued). Purchase premiums and discounts on securities are recognized in interest income using the interest method over the term of the securities. Declines in the fair value of securities below their cost that are deemed other than temporary result in the security being written down to fair value on an individual basis. Any related write-downs are included in operations. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method and are included in operations in the period sold.

Loans Held for Sale. Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Loans held for sale are generally sold with servicing rights retained. The carrying value of such loans sold is reduced by the cost allocated to the servicing rights. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

Loans Receivable. The Corporation grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans throughout western Pennsylvania. The ability of the Corporation’s debtors to honor their contracts is dependent upon real estate and general economic conditions in this area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or net pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans or premiums or discounts on purchased loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, and premiums and discounts are deferred and recognized as an adjustment of the related loan yield using the interest method.

The accrual of interest on loans is typically discontinued at the time the loan is 90 days past due unless the credit is well secured and in the process of collection. Loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual status or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses. The allowance for loan losses is established for probable credit losses through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are typically credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of loans in light of historic experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

33

Notes to Consolidated Financial Statements (continued)

1.Summary of Significant Accounting Policies (continued)

Allowance for Loan Losses (continued). The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable loses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial loans by either the present value of expected future cash flows discounted at the loans effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of small balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.

Bank-Owned Life Insurance (BOLI). The Bank purchased life insurance policies on certain key officers and employees. BOLI is recorded at its cash surrender value, or the amount that can be realized.

Premises and Equipment. Land is carried at cost. Premises, furniture and equipment, and leasehold improvements are carried at cost less accumulated depreciation or amortization. Depreciation is calculated on a straight-line basis over the estimated useful lives of the related assets, which are twenty-five to fifty years for buildings and three to ten years for furniture and equipment. Amortization of leasehold improvements is computed using the straight-line method over the expected term of the leases. Expected terms include lease option periods to the extent that the exercise of such option is reasonably assured. Premises and equipment are reviewed for impairment when events indicate their carry amount may not be recoverable from future undiscounted cash flows. If impaired, assets are recorded at fair value.

Goodwill and Intangible Assets. Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired assets and liabilities. Core deposit intangible assets arise from whole bank or branch acquisitions and are measured at fair value and then are amortized on a straight-line basis over their estimated lives, generally less than 10 years. Customer relationship intangible assets arise from the purchase of a customer list from another company or individual and then are amortized on a straight-line basis over two years. Goodwill is not amortized and is assessed at least annually for impairment and any such impairment will be recognized in the period identified.

34

Notes to Consolidated Financial Statements (continued)

1.Summary of Significant Accounting Policies (continued)

Servicing Assets. Servicing assets represent the allocated value of retained servicing rights on loans sold. Servicing assets are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the assets, using groupings of the underlying loans as to interest rates. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment of a grouping is reported as a valuation allowance, to the extent that fair value is less than the capitalized amount for a grouping.

Real Estate Acquired Through Foreclosure. Real estate properties acquired through foreclosure are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations of the properties, gains and losses on sales and additions to the valuation allowance are included in operating results. Real estate acquired through foreclosure is classified in prepaid expenses and other assets and totaled $98,000 and $106,000 at December 31, 2006 and 2005, respectively.

Income Taxes. Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rate and laws.

Basic Earnings Per Common Share. The Corporation maintains a simple capital structure with no common stock equivalents. As such earnings per share computations are based on the weighted average number of common shares outstanding for the respective reporting periods. The Corporation’s capital structure contains no potentially dilutive securities.

Comprehensive Income. Comprehensive income includes net income from operating results and the net change in accumulated other comprehensive income. Accumulated other comprehensive income is comprised of unrealized holding gains and losses on securities available for sale and the over funded or under funded status of pension and other postretirement benefit plans on the balance sheet. The effects of other comprehensive income are presented as part of the statement of changes in stockholders’ equity.

Operating Segments. Operations are managed and financial performance is evaluated on a corporate-wide basis. Accordingly, all financial services operations are considered by management to be aggregated in one reportable operating segment.

Retirement Plans. The Corporation maintains a noncontributory defined benefit plan covering substantially all employees and officers. The plan calls for benefits to be paid to eligible employees at retirement based primarily on years of service and compensation rates near retirement. The Corporation also maintains a 401(k) plan, which covers substantially all employees and a supplemental executive retirement plan for key executive officers.

Transfers of Financial Assets. Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

35

Notes to Consolidated Financial Statements (continued)

1.Summary of Significant Accounting Policies (continued)

Advertising. Advertising costs are expensed as incurred.

Off-Balance Sheet Financial Instruments. In the ordinary course of business, the Corporation has entered into off-balance sheet financial instruments, consisting of commitments to extend credit, commitments under line of credit lending arrangements and letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are received.

Fair Value of Financial Instruments. Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Recently Adopted Accounting Standards. The Corporation, in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), adjusted its beginning retained earnings for fiscal 2006 in the accompanying consolidated balance sheet. The provisions of SAB 108 are effective for the Corporation for its December 31, 2006 year end. See Note 12 for additional information on the adoption of SAB 108.

The Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106 and 132(R), (SFAS 158), effective December 31, 2006. The adoption of SFAS 158 resulted in the Corporation recording an additional accrued pension liability of $545,000 and a charge of $360,000, net of taxes, to accumulated other comprehensive income. See Note 13 for additional information on the adoptions of SFAS 158.

Recent Accounting and Regulatory Pronouncements. In March 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 156, Accounting for Servicing of Financial Assets - An Amendment of FASB Statement No. 140 (SFAS 156). SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The statement permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. SFAS 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006, which for the Corporation will be as of the beginning of fiscal 2007. The Corporation does not believe that the adoption of SFAS 156 will have a significant effect on its consolidated financial statements.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes. The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS 109, Accounting for Income Taxes. Specifically, the pronouncement prescribes a recognition threshold and a measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on the related derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. The interpretation is effective for fiscal years beginning after December 15, 2006, which for the Corporation will be as of the beginning of fiscal 2007. The Corporation does not believe that the adoption of this interpretation will have a significant effect on its consolidated financial statements.

36

Notes to Consolidated Financial Statements (continued) 

1.Summary of Significant Accounting Policies (continued)

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. The Corporation is currently evaluating the potential impact, if any, of the adoption of SFAS 157 on its consolidated financial statements.

In September 2006, FASB’s EITF issued EITF Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements (EITF 06-4). EITF 06-4 requires the recognition of a liability related to the postretirement benefits covered by an endorsement split-dollar life insurance arrangement. The consensus highlights that the employer (who is also the policyholder) has a liability for the benefit it is providing to its employee. As such, if the policyholder has agreed to maintain the insurance policy in force for the employee’s benefit during his or her retirement, then the liability recognized during the employee’s active service period should be based on the future cost of insurance to be incurred during the employee’s retirement. Alternatively, if the policy holder has agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized by following the guidance in SFAS 106 or Accounting Principals Board (APB) Opinion No. 12, as appropriate. For transition, an entity can choose to apply the guidance using either of the following approaches: (a) a change in accounting principle through retrospective application to all periods presented or (b) a change in accounting principle through a cumulative-effect adjustment to the balance in retained earnings at the beginning of the year of adoption. The disclosures are required in fiscal years beginning after December 15, 2007, with early adoption permitted. The Corporation is currently evaluating the impact that the implementation of EITF 06-4 may have on its consolidated financial statements.

In October 2006, the FASB issued FSP No. 123(R)-5, Amendment of FASB Staff Position FAS 123(R)-1 (FSP 123(R)-5). FSP 123(R)-5 amends FSP 123(R)-1 for equity instruments that were originally issued as employee compensation and then modified, with such modification made solely to reflect an equity restructuring that occurs when the holders are no longer employees. FSP 123(R)-5 is effective for the Corporation January 1, 2007. The Corporation does not expect the adoption of FSP 123(R)-5 to have a material impact on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS 159 is effective for the Corporation January 1, 2008. The Corporation is evaluating the impact that the adoption of SFAS 159 will have on its consolidated financial statements.

37

Notes to Consolidated Financial Statements (continued)

2.Securities

The following table summarizes the Corporation’s securities as of December 31:

(Dollar amounts in thousands)	Amortized		Unrealized		Unrealized			Fair
	Cost		gains		losses			value
Available for sale:
December 31, 2006:
U.S. Government agencies and related entities	$	31,354	$	-	$	(606	)	$	30,748
Mortgage-backed securities		2,434		-		(95	)		2,339
Municipal securities		14,688		574		-			15,262
Corporate securities		-		-		-			-
Equity securities		3,382		176		(132	)		3,425
	$	51,858	$	750	$	(833	)	$	51,774
December 31, 2005:
U.S. Government agencies and related entities	$	34,353	$	-	$	(818	)	$	33,535
Mortgage-backed securities		3,046		-		(124	)		2,922
Municipal securities		14,685		664		-			15,349
Corporate securities		2,249		4		(4	)		2,249
Equity securities		1,995		383		(144	)		2,234
	$	56,328	$	1,051	$	(1,090	)	$	56,289
Held to maturity:
December 31, 2005:
Mortgage-backed securities	$	15	$	-	$	(1	)	$	14
	$	15	$	-	$	(1	)	$	14
Sales of available for sale securities were as follows:
(Dollar amounts in thousands)		2006		2005		2004
Proceeds	$	1,089	$	1,646	$	945
Gross gains		400		857		701
Tax provision related to gains		136		291		238

The following table summarizes scheduled maturities of the Corporation’s securities as of December 31, 2006:

(Dollar amounts in thousands)	Available for sale
	Amortized cost		Fair value
Due in one year or less	$	6,500	$	6,423
Due after one year through five years		24,127		23,601
Due after five through ten years		4,082		4,002
Due after ten years		13,767		14,323
No scheduled maturity		3,382		3,425
	$	51,858	$	51,774

38

Notes to Consolidated Financial Statements (continued) 

2.Securities (continued)

Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

Securities with carrying values of $12.4 million and $11.4 million as of December 31, 2006 and 2005, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.

Information pertaining to securities with gross unrealized losses at December 31, 2006 and 2005 aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

(Dollar amounts in thousands)	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
December 31, 2006:
U.S. Government agencies and related entities	$	1,224	$	(23	)	$	29,524	$	(583	)	$	30,748	$	(606	)
Mortgage-backed securities		-		-			2,339		(95	)		2,339		(95	)
Municipal securities		-		-			-		-			-		-
Corporate securities		-		-			-		-			-		-
Equity securities		1,262		(57	)		960		(75	)		2,222		(132	)
	$	2,486	$	(80	)	$	32,823	$	(753	)	$	35,309	$	(833	)
December 31, 2005:
U.S. Government agencies and related entities	$	17,031	$	(318	)	$	16,504	$	(500	)	$	33,535	$	(818	)
Mortgage-backed securities		702		(34	)		2,220		(91	)		2,922		(124	)
Municipal securities		-		-			-		-			-		-
Corporate securities		-		-			745		(4	)		745		(4	)
Equity securities		1,126		(139	)		215		(5	)		1,341		(144	)
	$	18,859	$	(491	)	$	19,684	$	(600	)	$	38,543	$	(1,090	)

As of December 31, 2006, there were 38 securities in an unrealized loss position.

Unrealized losses on available for sale securities have not been recognized into income because the issuers’ bonds are of high credit quality (rated AA or higher), management has the intent and ability to hold for the foreseeable future and the decline in the fair value is largely due to an increase in market interest rates. The fair value is expected to recover as the bonds approach maturity dates and/or market rates decline.

39

Notes to Consolidated Financial Statements (continued)

3.Loans Receivable

The following table summarizes the Corporation’s loans receivable as of December 31:

(Dollar amounts in thousands)	2006		2005
Mortgage loans on real estate:
Residential first mortgages	$	64,662	$	66,011
Home equity loans and lines of credit		47,330		39,933
Commercial real estate		61,128		52,990
		173,120		158,934
Other loans:
Commercial business		34,588		27,732
Consumer		7,671		7,729
		42,259		35,461
Total loans, gross		215,379		194,395
Less allowance for loan losses		2,035		1,869
Total loans, net	$	213,344	$	192,526

Following is an analysis of the changes in the allowance for loan losses for the years ended December 31:

(Dollar amounts in thousands)	2006			2005			2004
Balance at the beginning of the year	$	1,869		$	1,810		$	1,777
Provision for loan losses		358			205			290
Charge-offs		(221	)		(197	)		(318	)
Recoveries		29			51			61
Balance at the end of the year	$	2,035		$	1,869		$	1,810

Non-performing loans, which include primarily non-accrual loans, were $1.8 million and $1.5 million at December 31, 2006 and 2005, respectively. The Corporation is not committed to lend significant additional funds to debtors whose loans are on non-accrual status. At December 31, 2006 and 2005, the recorded investment in loans considered to be impaired, requiring an allowance for loan loss, was $461,000 and $999,000, respectively, against which approximately $166,000 and $100,000, respectively, of the allowance for loan losses was allocated. Additionally, in 2006, there was one impaired loan for $452,000 that did not require an allowance for loan loss. During 2006, 2005 and 2004, impaired loans averaged $946,000, $1.2 million and $635,000, respectively. The Corporation recognized interest income on impaired loans of approximately $14,000, $95,000 and $27,000, on a cash basis, during 2006, 2005 and 2004, respectively. Nonperforming loans and impaired loans are defined differently. Some loans may be included in both categories whereas other loans may be included in only one category.

The Corporation is required to maintain qualifying collateral with the FHLB to secure all outstanding loans. Loans with book values of $52.7 million and $52.1 million as of December 31, 2006 and 2005, respectively, are pledged as qualifying collateral. The Corporation is in compliance will all FHLB credit policies at December 31, 2006.

40

Notes to Consolidated Financial Statements (continued)

3.Loans Receivable (continued)

The Corporation was servicing residential mortgage loans with unpaid principal balances of $6.3 million and $2.4 million at December 31, 2006 and 2005, respectively, for a third party investor. In addition, the Corporation was servicing commercial loans with unpaid principle balances of $6.0 million and $5.5 million at December 2006 and 2005, respectively, for third party investors. Such loans are not reflected in the consolidated balance sheet and servicing operations result in the generation of annual fee income of approximately 0.25% of the unpaid principal balances of such loans.

4.Federal Bank Stocks

The Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB) and the Federal Reserve Bank of Cleveland (FRB). As a member of these federal banking systems, the Bank maintains an investment in the capital stock of the respective regional banks, at cost. These stocks are purchased and redeemed at par as directed by the federal banks and levels maintained are based primarily on borrowing and other correspondent relationships. The Bank’s investment in FHLB and FRB stocks was $1.9 million and $333,000, respectively, at December 31, 2006, and $1.4 million and $333,000, respectively, at December 31, 2005.

5.Premises and Equipment

Premises and equipment at December 31 are summarized by major classification as follows:

(Dollar amounts in thousands)	2006		2005
Land	$	1,088	$	349
Buildings and improvements		5,894		4,738
Leasehold improvements		696		696
Furniture, fixtures and equipment		4,279		4,411
Software		1,735		1,389
Construction in progress		688		914
		14,381		12,495
Less accumulated depreciation and amortization		6,423		6,372
	$	7,958	$	6,123

Depreciation and amortization expense for the years ended December 31, 2006, 2005 and 2004 were $849,000, $855,000 and $703,000, respectively.

41

Notes to Consolidated Financial Statements (continued)

5.Premises and Equipment (continued)

Rent expense under non-cancelable operating lease agreements for the years ended December 31, 2006, 2005 and 2004 was $112,000, $109,000 and $108,000, respectively. Rent commitments under non-cancelable long-term operating lease agreements for certain branch offices for the years ended December 31, are as follows, before considering renewal options that are generally present:

(Dollar amounts in thousands)	Amount
2007	$	115
2008		120
2009		122
2010		112
2011		76
Thereafter		29
	$	574

6.Goodwill and Intangible Assets

The following table summarizes the Corporation’s acquired goodwill and intangible assets as of December 31:

(Dollar amounts in thousands)	2006				2005
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Goodwill	$	1,422	$	-	$	1,422	$	-
Core deposit intangibles		1,240		1,240		1,240		1,240
Other customer relationship intangibles		20		20		20		13
Total	$	2,682	$	1,260	$	2,682	$	1,253

Goodwill resulted from two previous branch acquisitions and is no longer amortized. Aggregate amortization expense for 2006, 2005 and 2004 was $7,000, $31,000 and $36,000 respectively.

7.Related Party Balances and Transactions

In the ordinary course of business, the Bank maintains loan and deposit relationships with employees, principal officers and directors. The Bank has granted loans to principal officers and directors and their affiliates amounting to $1.2 million and $1.4 million at December 31, 2006 and 2005, respectively. During 2006, total principal additions and total principal repayments associated with these loans were $172,000 and $363,000, respectively. Deposits from principal officers and directors held by the Bank at December 31, 2006 and 2005 totaled $2.4 million and $3.3 million, respectively.

In addition, directors and their affiliates may provide certain professional and other services to the Corporation and the Bank in the ordinary course of business at market fee rates. During 2006, 2005 and 2004, amounts paid to affiliates for such services totaled $117,000, $55,000 and $104,000, respectively.

42

Notes to Consolidated Financial Statements (continued)

8.Deposits

The following table summarizes the Corporation’s deposits as of December 31:

(Dollar amounts in thousands)	2006				2005
	Weighted				Weighted
Type of accounts	average rate		Amount	%	average rate		Amount	%
Non-interest bearing deposits	-	$	44,045	18.0%	-	$	44,044	19.1%
Interest bearing demand deposits	0.69%		70,951	29.0%	0.70%		74,067	32.1%
Time deposits	4.59%		129,496	53.0%	4.13%		112,392	48.8%
	2.63%	$	244,492	100.0%	2.24%	$	230,503	100.0%

The Corporation had a total of $33.0 million and $25.9 million in time deposits of $100,000 or more at December 31, 2006 and 2005, respectively.

Scheduled maturities of time deposits for the next five years were as follows:

(Dollar amounts in thousands)	Amount		%
2007	$	58,859		45.5%
2008		30,166		23.3%
2009		8,635		6.7%
2010		7,347		5.7%
2011		9,631		7.4%
Thereafter		14,858		11.5%
	$	129,496		100.0%

9.Borrowed Funds

The following table summarizes the Corporation’s borrowed funds as of and for the year ended December 31:

(Dollar amounts in thousands)	2006										2005
								Weighted										Weighted
			Average		Average			average					Average		Average			average
	Balance		Balance		Rate			rate			Balance		Balance		Rate			rate
FHLB advances:
Due within 12 months	$	-	$	1,147		4.90	%		4.62	%	$	4,500	$	1,199		3.75	%		4.17	%
Due beyond 12 months but within 5 years		5,000		5,000		4.61	%		4.68	%		-		-		-			-
Due beyond 5 years but within 10 years		25,000		16,521		4.45	%		4.32	%		15,000		15,000		4.13	%		4.19	%
	$	30,000	$	22,668							$	19,500	$	16,199

43

Notes to Consolidated Financial Statements (continued)

9.Borrowed Funds (continued)

The Corporation had outstanding advances with the FHLB of $30.0 million and $19.5 million at December 31, 2006 and 2005, respectively. The $30.0 million in outstanding borrowed funds at December 31, 2006 consists of six advances with the FHLB. These advances mature between November 2011 and August 2016. Three $5.0 million borrowings have fixed rates of 4.61%, 3.74% and 4.04%, respectively, and are callable quarterly based on a strike rate of 8.0% compared to the three month LIBOR rate. During 2006, the Corporation entered into agreements with the FHLB to borrow three additional $5.0 million 10 year term advances at initial interest rates of 4.98%, 4.83% and 4.68%, respectively. Two of these borrowings in 2006 are fixed for the first two years of the term after which the rates may adjust at the option of the FHLB to the then three month LIBOR rate plus 24 basis points. The third borrowing in 2006 is also fixed for the first two years of the initial term after which the rates may adjust at the option of the FHLB to the then three month LIBOR plus 24 basis points, but only if the three month LIBOR exceeds 6.0%. If these advances convert to an adjustable rate borrowing, the Corporation has the opportunity to repay the advances without penalty at the conversion date.

The Bank maintains a credit arrangement with the FHLB as a source of additional liquidity. The total maximum borrowing capacity with the FHLB, excluding loans outstanding, at December 31, 2006 was $110.6 million.

10.Insurance of Accounts and Regulatory Matters

Insurance of Accounts

The Federal Deposit Insurance Corporation (FDIC) insures deposits of account holders up to $100,000 per insured depositor. In addition, federal law provides up to $250,000 in insurance coverage for deposits held in Individual Retirement Accounts (IRAs). To provide this insurance, the Bank must pay an annual premium. In connection with the insurance of deposits, the Bank is required to maintain certain minimum levels of regulatory capital as outlined below.

Restrictions on Dividends, Loans and Advances

The Bank is subject to a regulatory dividend restriction that generally limits the amount of dividends that can be paid by the Bank to the Corporation. Prior regulatory approval is required if the total of all dividends declared in any calendar year exceeds net profits (as defined in the regulations) for the year combined with net retained earnings (as defined) for the two preceding calendar years. In addition, dividends paid by the Bank to the Corporation would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements. As of December 31, 2006, $2.5 million of undistributed earnings of the Corporation was available for distribution of dividends without prior regulatory approval.

Loans or advances from the Bank to the Corporation are limited to 10 percent of the Bank’s capital stock and surplus on a secured basis. Funds available for loans or advances by the Bank to the Corporation amounted to approximately $1.1 million. The Corporation has a $1.1 million commercial line of credit available at the Bank for the primary purpose of purchasing qualified equity investments. At December 31, 2006, the Corporation had an outstanding balance on this line of $850,000.

44

Notes to Consolidated Financial Statements (continued)

10.Insurance of Accounts and Regulatory Matters (continued)

Minimum Regulatory Capital Requirements

The Corporation (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. 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 Corporation’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation 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 capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). As of December 31, 2006 and 2005, the Corporation and the Bank met all capital adequacy requirements to which they are subject.

As of December 31, 2006, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since the notification that management believes have changed the Bank’s category.

The following table sets forth certain information concerning regulatory capital of the consolidated Corporation and the Bank as of the dates presented:

(Dollar amounts in thousands)	December 31, 2006										December 31, 2005
	Consolidated					Bank					Consolidated					Bank
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
Total capital to risk weighted assets:
Actual	$	24,964		11.34	%	$	23,096		10.62	%	$	24,196		12.36	%	$	22,175		11.44	%
For capital adequacy purposes		17,617		8.00	%		17,401		8.00	%		15,662		8.00	%		15,501		8.00	%
To be well capitalized		N/A		N/A			21,752		10.00	%		N/A		N/A			19,376		10.00	%
Tier 1 capital to risk-weighted assets:
Actual	$	22,910		10.40	%	$	21,060		9.68	%	$	22,212		11.35	%	$	20,312		10.48	%
For capital adequacy purposes		8,809		4.00	%		8,701		4.00	%		7,831		4.00	%		7,751		4.00	%
To be well capitalized		N/A		N/A			13,051		6.00	%		N/A		N/A			11,626		6.00	%
Tier 1 capital to average assets:
Actual	$	22,910		8.07	%	$	21,060		7.14	%	$	22,212		8.13	%	$	20,312		7.51	%
For capital adequacy purposes		11,356		4.00	%		11,793		4.00	%		10,926		4.00	%		10,824		4.00	%
To be well capitalized		N/A		N/A			14,741		5.00	%		N/A		N/A			13,530		5.00	%

45

Notes to Consolidated Financial Statements (continued)

11.Commitments and Legal Contingencies

In the ordinary course of business, the Corporation has various outstanding commitments and contingent liabilities that are not reflected in the accompanying consolidated financial statements. In addition, the Corporation is involved in certain claims and legal actions arising in the ordinary course of business. The outcome of these claims and actions are not presently determinable; however, in the opinion of the Corporation’s management, after consulting legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the consolidated financial statements.

12. Income Taxes

The Corporation and the Bank file a consolidated federal income tax return. The provision for income taxes for the years ended December 31 is comprised of the following:

(Dollar amounts in thousands)	2006		2005		2004
Current	$	445	$	556	$	538
Deferred		47		141		(25	)
	$	492	$	697	$	513

A reconciliation between the provision for income taxes and the amount computed by multiplying operating results before income taxes by the statutory federal income tax rate of 34% for the years ended December 31 is as follows:

(Dollar amounts in thousands)	2006						2005						2004
				% Pre-tax						% Pre-tax						% Pre-tax
	Amount			Income			Amount			Income			Amount			Income
Provision at statutory tax rate	$	836			34.0	%	$	1,112			34.0	%	$	1,044			34.0	%
Increase (decrease) resulting from:
Tax free interest, net of disallowance		(304	)		(12.4	%)		(313	)		(9.6	%)		(319	)		(10.4	%)
Earnings on BOLI		(58	)		(2.4	%)		(59	)		(1.8	%)		(53	)		(1.7	%)
Other, net		18			0.7	%		(43	)		(1.3	%)		(159	)		(5.2	%)
Provision	$	492			20.0	%	$	697			21.3	%	$	513			16.7	%

46

Notes to Consolidated Financial Statements (continued) 

12. Income Taxes (continued)

The tax effects of temporary differences between the financial reporting basis and income tax basis of assets and liabilities that are included in the net deferred tax asset as of December 31 relate to the following:

(Dollar amounts in thousands)	2006		2005
Deferred tax assets:
Provision for loan losses	$	638	$	582
SFAS 158 pension accrual		185		-
Tax credits		148		202
Intangible assets		115		130
Accrued pension cost		77		42
Net unrealized loss on securities		28		13
Loss on securities		-		40
Deferred loan fees		-		10
Other		33		3
Gross deferred tax assets		1,224		1,022
Deferred tax liabilities:
				-
Depreciation		360		318
Stock gain		172		184
Prepaid expenses		58		68
Deferred loan fees		26		-
Loan servicing		19		5
Other		53		64
Gross deferred tax liabilities		688		639
Net deferred tax asset	$	536	$	383

The Corporation determined that it was not required to establish a valuation allowance for deferred tax assets in accordance with SFAS No. 109, Accounting for Income Taxes, since it is more likely than not that the deferred tax asset will be realized through carry-back to taxable income in prior years, future reversals of existing taxable temporary differences, and, to a lesser extent, future taxable income.

As discussed under Recently Adopted Accounting Standards in Note 1, in September 2006, the SEC released SAB 108. The transition provisions of SAB 108 permit the Corporation to adjust for the cumulative effect on retained earnings of immaterial errors relating to prior years. SAB 108 also requires the adjustment of any prior quarterly financial statements within the fiscal year of adoption for the effects of such errors on the quarters when the information is next presented. Such adjustments do not require previously filed reports with the SEC to be amended. In accordance with SAB 108, the Corporation has adjusted beginning retained earnings for fiscal 2006 in the accompanying consolidated balance sheet as described below. The Corporation considers this adjustment to be immaterial to prior periods.

In connection with adopting SAB 108, the Corporation recorded an adjustment to its opening balance sheet for the year ended December 31, 2006. This adjustment, the cumulative effect of which was $120,000, increased retained earnings, reduced accrued income taxes payable and was recorded to properly reflect current taxes payable. During prior year periods, certain tax reserve amounts accumulated in connection with preparing tax provision estimates. These tax reserves were not considered material to prior period consolidated financial statements; however, in evaluating the current tax position of the Corporation, management determined that these reserves were not necessary and, accordingly, made the aforementioned adjustment.

47

Notes to Consolidated Financial Statements (continued)  

13.Employee Benefit Plans

Defined Benefit Plan

The Corporation provides pension benefits for eligible employees through a defined benefit pension plan. Substantially all employees participate in the retirement plan on a non-contributing basis, and are fully vested after five years of service.

The Corporation uses December 31 as the measurement date for its plans.

Information pertaining to changes in obligations and funded status of the defined benefit pension plan is as follows:

(Dollar amounts in thousands)	2006			2005			2004
Change in plan assets:
Fair value of plan assets at beginning of year	$	3,037		$	2,818		$	2,483
Actual return on plan assets		296			164			204
Employer contribution		280			135			209
Benefits paid		(88	)		(80	)		(78	)
Fair value of plan assets at end of year		3,525			3,037			2,818
Change in benefit obligation:
Benefit obligation at beginning of year		3,926			3,276			2,912
Service cost		213			188			158
Interest cost		237			214			187
Actuarial loss		(40	)		154			97
Effect of plan amendment		144			-			-
Effect of change in assumptions		-			174			-
Benefits paid		(88	)		(80	)		(78	)
Benefit obligation at end of year		4,392			3,926			3,276
Funded status (plan assets less benefit obligation)		(867	)		(889	)		(458	)
Unrecognized prior service cost		(303	)		(486	)		(517	)
Unrecognized net actuarial gain		847			1,283			923
Unrecognized transition asset		-			(48	)		(56	)
Accrued pension cost	$	(323	)	$	(140	)	$	(108	)

48

Notes to Consolidated Financial Statements (continued) 

13. Employee Benefit Plans (continued)

Amounts recognized in the year end balance sheet consist of:

(Dollar amounts in thousands)	Pension Benefits
	2006			2005
Prepaid benefit cost	$	-		$	-
Accrued benefit cost		(323	)		(140	)
Intangible assets		-			-
Accumulated other comprehensive loss		(544	)		-
Net amount recognized	$	(867	)	$	(140	)

The accumulated benefit obligation for all defined benefit pension plans was $3.8 million and $3.1 million at year end 2006 and 2005, respectively.

The components of the periodic pension costs are as follows:

(Dollar amounts in thousands)	2006			2005			2004
Service cost	$	213		$	188		$	158
Interest cost		237			214			187
Expected return on plan assets		(268	)		(246	)		(209	)
Transition asset		(8	)		(8	)		(8	)
Prior service costs		32			19			(10	)
Effect of Special Termination Benefits		274			-			-
Net periodic pension cost	$	480		$	167		$	118

Weighted-average actuarial assumptions include the following:

	2006			2005			2004
Discount rate for benefit obligations and net cost		6.00	%		6.30	%		6.30	%
Rate of increase in future compensation levels		4.50	%		4.50	%		4.50	%
Expected rate of return on plan assets		8.50	%		8.50	%		8.50	%

49

Notes to Consolidated Financial Statements (continued)

13.Employee Benefit Plans (continued)

The Corporation’s pension plan asset allocation at year end 2006 and 2005, target allocation for 2007, and expected long-term rate of return by asset category are as follows:

Asset Category	Target Allocation	Percentage of Plan Assets at Year End		Weighted-Average Expected Long-Term Rate of Return
	2007	2006	2005	2006
Equity Securities	52%	52%	55%	6.0%
Debt Securities	18%	12%	14%	2.0%
Other	30%	36%	31%	0.5%
		100%	100%	8.5%

The intent of the Plan is to provide a range of investment options for building a diversified asset allocation strategy that will provide the highest likelihood of meeting the aggregate actuarial projections. In selecting the options and asset allocation strategy the Corporation has determined that the benefits of reduced portfolio risk are best received through asset style diversification. The following asset classes or investment categories are utilized to meet the Plan’s objectives: Small company stock, International stock, Mid-cap stock, Large company stock, Diversified bond, Money Market/Stable Value and Cash.

The Corporation expects to contribute approximately $250,000 to its pension plan in 2007.

Estimated future benefit payments, which reflect expected future service, as appropriate, are as follows:

(Dollar amounts in thousands)
For year ended December 31,	Pension Benefits
2007	$	85
2008		86
2009		104
2010		132
2011		149
2012-2016		1,263
Thereafter		2,573
Benefit Obligation	$	4,392

The Corporation adopted SFAS 158 effective December 31, 2006. SFAS 158 requires an employer to recognize the funded status of its defined benefit pension plan as a net asset or liability in its consolidated balance sheet. With an offsetting amount in accumulated other comprehensive income, and to recognize changes in that funded status in the year in which changes occur through comprehensive income. The provisions of SFAS 158 are to be applied on a prospective basis; therefore, prior periods presented are not restated. The adoption of SFAS 158 resulted in the Corporation recording an additional accrued pension liability of $545,000 and a charge of $360,000, net of taxes, to accumulated other comprehensive income. Additionally, SFAS requires an employer to measure the funded status of its defined benefit pension plan as of the date of its year-end financial statements. The Corporation measures the funded status at December 31.

50

Notes to Consolidated Financial Statements (continued) 

13.Employee Benefit Plans (continued)

Defined Contribution Plan

The Corporation maintains a defined contribution 401(k) Plan. Employees are eligible to participate by providing tax-deferred contributions up to 20% of qualified compensation. Employee contributions are vested at all times. The Corporation provides a matching contribution of up to 4% of the participant’s salary. Matching contributions for 2006, 2005 and 2004 were $76,000, $75,000 and $67,000, respectively.

Supplemental Executive Retirement Plan

During 2003, the Corporation established a Supplemental Executive Retirement Plan (SERP) to provide certain additional retirement benefits to participating executive officers. The SERP was adopted in order to provide benefits to such executives whose benefits are reduced under the Corporation’s tax-qualified benefit plans pursuant to limitations under the Internal Revenue Code. The SERP is subject to certain vesting provisions and provides that the executives shall receive a supplemental retirement benefit if the executive’s employment is terminated after reaching the normal retirement age of 62. As of December 31, 2006 and 2005, the Corporation’s SERP liability was $161,000 and $122,000, respectively. For the years ended December 31, 2006, 2005 and 2004, the Corporation recognized SERP expense of $39,000, $40,000 and $38,000, respectively.

14.Financial Instruments

Fair Value of Financial Instruments

The following table sets forth the carrying amount and fair value of the Corporation’s financial instruments included in the consolidated balance sheet as of December 31:

(Dollar amounts in thousands)	2006				2005
	Carrying		Fair		Carrying		Fair
	amount		value		amount		value
Financial assets:
Cash and cash equivalents	$	16,717	$	16,717	$	10,367	$	10,367
Securities		51,774		51,774		56,304		56,303
Loans receivable		213,344		210,362		192,526		190,596
Federal bank stocks		2,217		2,217		1,773		1,773
Accrued interest receivable		1,374		1,374		1,271		1,271
Financial liabilities:
Deposits		244,492		243,328		230,503		228,720
Borrowed funds		30,000		29,668		19,500		19,039
Accrued interest payable		825		825		607		607

51

Notes to Consolidated Financial Statements (continued)

14.Financial Instruments (continued)

Fair Value of Financial Instruments (continued)

The methods and assumptions used to estimate fair value are described as follows:

Carrying amount is the estimated fair value for cash and cash equivalents, short-term borrowings, federal bank stocks, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of loans held for sale is based on market quotes. Fair value of debt is based on current rates for similar financing. The fair value of off-balance-sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements and is not material.

Off-Balance Sheet Financial Instruments

The Corporation is party to credit related 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 and commercial letters of credit. Commitments to extend credit involve, to a varying degree, elements of credit and interest rate risk in excess of amounts recognized in the consolidated statement of financial condition. The Corporation’s exposure to credit loss in the event of non-performance by the other party for commitments to extend credit is represented by the contractual amount of these commitments, less any collateral value obtained. The Corporation uses the same credit policies in making commitments as for on-balance sheet instruments. The Corporation’s distribution of commitments to extend credit approximates the distribution of loans receivable outstanding.

The following table presents the notional amount of the Corporation’s off-balance sheet commitment financial instruments as of December 31:

(Dollar amounts in thousands)
          
2006
          
2005
          
          
 
Fixed Rate
          
Variable Rate
          
Fixed Rate
          
Variable Rate
          
          
Commitments to make loans
          
$
          
189
          
$
          
3,064
          
$
          
280
          
$
          
143
          
          
Unused lines of credit
          
 
771
          
 
18,588
          
 
1,192
          
 
15,516
          
          
 
$
          
960
          
$
          
21,652
          
$
          
1,472
          
$
          
15,659
          
          

          
          
          
        

Commitments to make loans are generally made for periods of 30 days or less. The fixed rate loan commitments have interest rates ranging from 4.00% to 11.25% and maturities ranging from 5 to 30 years at both year end dates. Commitments to extend credit include agreements to lend to a customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Commitments to extend credit also include unfunded commitments under commercial and consumer lines of credit, revolving credit lines and overdraft protection agreements. These lines of credit may be collateralized and usually do not contain a specified maturity date and may be drawn upon to the total extent to which the Corporation is committed.

52

Notes to Consolidated Financial Statements (continued) 

14.Financial Instruments (continued)

Off-Balance Sheet Financial Instruments (continued)

Standby letters of credit are conditional commitments issued by the Corporation usually for commercial customers 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. The Corporation generally holds collateral supporting those commitments if deemed necessary. Standby letters of credit were $463,000 and $629,000 at December 31, 2006 and 2005, respectively.

15.Emclaire Financial Corp. - Condensed Financial Statements, Parent Corporation Only

Following are condensed financial statements for the parent company as of and for the years ended December 31:

Condensed Statements of Financial Condition	December 31,
(Dollar amounts in thousands)	2006		2005
Assets:
Cash and cash equivalents	$	40	$	306
Securities available for sale		3,235		2,088
Equity in net assets of subsidiary bank		21,828		21,558
Other assets		-		7
Total Assets	$	25,103	$	23,959
Liabilities and Stockholders' Equity:
Accrued expenses and other liabilities	$	1,186	$	344
Stockholders' Equity		23,917		23,615
Total Liabilities and Stockholders' Equity	$	25,103	$	23,959

Condensed Statements of Operations	Year ended December 31,
(Dollar amounts in thousands)	2006		2005		2004
Income:
Dividends from subsidiary	$	1,349	$	721	$	1,192
Investment income		488		917		758
Total income		1,837		1,638		1,950
Expense:
Interest Expense		26		-		-
Noninterest expense		100		83		41
Total expense		126		83		41
Income before income taxes and equity in undistributed
operating results of subsidiary		1,711		1,555		1,909
Equity in undistributed net income of subsidiary		405		1,241		831
Income before income taxes		2,116		2,796		2,740
Income tax expense		150		223		183
Net income	$	1,966	$	2,573	$	2,557

53

Notes to Consolidated Financial Statements (continued) 

15. Emclaire Financial Corp. - Condensed Financial Statements, Parent Corporation Only (continued)

Condensed Statements of Cash Flows	Year ended December 31,
(Dollar amounts in thousands)	2006			2005			2004
Operating activities:
Net income	$	1,966		$	2,573		$	2,557
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed operating results of subsidiary		(405	)		(1,241	)		(831	)
Other, net		(300	)		(803	)		(1,332	)
Net cash provided by operating activities		1,261			529			394
Investing activities:
Purchases of securities		(1,797	)		(99	)		(131	)
Proceeds from the sale of available for sale securities		814			1,060			945
Net cash (used in) provided by investing activities		(983	)		961			814
Financing activities:
Net change in borrowings		850			-			-
Dividends paid		(1,394	)		(1,293	)		(1,192	)
Net cash used in financing activities		(544	)		(1,293	)		(1,192	)
(Decrease) Increase in cash and cash equivalents		(266	)		197			16
Cash and cash equivalents at beginning of period		306			109			93
Cash and cash equivalents at end of period	$	40		$	306		$	109

16.Other Comprehensive Loss

Other comprehensive loss components and related taxes were as follows:

(Dollar amounts in thousands)	2006			2005			2004
Unrealized holding gains (losses) on available for sale securities	$	356		$	(1,084	)	$	90
Reclassification adjustment for gains later recognized in income		(400	)		(857	)		(701	)
Net unrealized losses		(44	)		(1,941	)		(611	)
Tax effect		(14	)		660			207
Other comprehensive loss	$	(30	)	$	(1,281	)	$	(404	)

54

17.   Other Noninterest Income and Expense

Other noninterest income includes customer bank card processing fee income of $232,000, $209,000 and $173,000 for 2006, 2005 and 2004, respectively.

The following summarizes the Corporation’s other noninterest expenses for the years ended December 31:

(Dollar amounts in thousands)	2006		2005		2004
Professional fees	$	323	$	292	$	223
Customer bank card processing		231		241		239
Printing and supplies		214		150		147
Correspondent and courier fees		195		189		190
Postage and freight		162		148		157
Marketing and advertising		154		109		114
Pennsylvania shares and use taxes		148		142		202
Travel, entertainment and conferences		135		140		84
Telephone and data communications		116		272		327
Other		455		714		409
Total other noninterest expenses	$	2,133	$	2,397	$	2,092

18.Quarterly Financial Data (unaudited)

The following is a summary of selected quarterly data for the years ended December 31:

(Dollar amounts in thousands, except share data)	First		Second		Third		Fourth
	Quarter		Quarter		Quarter		Quarter
2006:
Interest income	$	3,744	$	3,931	$	4,240	$	4,344
Interest expense		1,482		1,614		1,855		2,017
Net interest income		2,262		2,317		2,385		2,327
Provision for loan losses		31		47		90		190
Net interest income after provision for loan losses		2,231		2,270		2,295		2,137
Noninterest income		727		769		793		645
Noninterest expense		2,214		2,253		2,264		2,678
Income before income taxes		744		786		824		104
Provision for income taxes		159		184		132		17
Net income	$	585	$	602	$	692	$	87
Basic earnings per share	$	0.46	$	0.47	$	0.55	$	0.07
2005:
Interest income	$	3,544	$	3,782	$	3,733	$	3,818
Interest expense		1,354		1,342		1,405		1,472
Net interest income		2,190		2,440		2,328		2,346
Provision for loan losses		60		45		40		60
Net interest income after provision for loan losses		2,130		2,395		2,288		2,286
Noninterest income		655		757		920		985
Noninterest expense		2,087		2,330		2,386		2,343
Income before income taxes		698		822		822		928
Provision for income taxes		131		168		159		239
Net income	$	567	$	654	$	663	$	689
Basic earnings per share	$	0.45	$	0.52	$	0.52	$	0.54

55

Report of Independent Registered Public Accounting Firm

Audit Committee, Board of Directors and Stockholders

Emclaire Financial Corp.

Emlenton, Pennsylvania

We have audited the accompanying consolidated balance sheets of Emclaire Financial Corp. and its subsidiary as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on the 2006 and 2005 consolidated financial statements based on our audits. The consolidated financial statements of Emclaire Financial Corp. and its subsidiary, as of and for the year ended December 31, 2004 were audited by other auditors whose report, dated March 10, 2005, expressed an unqualified opinion on those statements.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Corporation’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the 2006 and 2005 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Emclaire Financial Corp. and its subsidiary as of December 31, 2006 and 2005, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 13 to the consolidated financial statements, the Corporation changed its method of accounting for defined benefit pension and other postretirement plans in 2006.

As discussed in Note 12 to the financial statements, the Corporation has given retroactive effect to the change to the dual method of quantifying misstatements of prior year financial statements. The dual method is required by SEC Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.”

Beard Miller Company LLP

Pittsburgh, Pennsylvania

March 5, 2007

56

Listings and Markets

Emclaire Financial Corp. common stock is traded on the Over the Counter Bulletin Board (OTCBB) under the symbol “EMCF”. The listed market makers for the Corporation’s common stock include:

Ferris, Baker Watts, Inc.	Boenning and Scattergood	Parker Hunter, Inc.
100 Light Street, 8th Floor	4 Tower Bridge, Suite 300	600 Grant Street - Suite 3100
Baltimore, MD 21202	200 Bar Harbor Drive	Pittsburgh, PA 15219
Telephone: (800) 638-7411	West Conshonhocken, PA 19428	Telephone: (412) 562-8000
	Telephone: (610) 862-5360

Stock Price and Cash Dividend Information

The bid and ask price of the Corporation’s common stock were $28.75 and $30.95, respectively, as of February 14, 2007. The Corporation traditionally has paid regular quarterly cash dividends.

The following table sets forth the high and low sale market prices of the Corporation’s common stock as well as cash dividends paid for the quarterly periods presented:

	Market Price						Cash
	High		Low		Close		Dividend
2006:
Fourth quarter	$	30.00	$	25.30	$	29.25	$	0.29
Third quarter		29.00		25.00		25.90		0.27
Second quarter		29.00		25.75		27.00		0.27
First quarter		27.25		25.05		26.00		0.27
2005:
Fourth quarter	$	30.25	$	26.50	$	26.60	$	0.27
Third quarter		31.00		29.00		30.00		0.25
Second quarter		31.75		28.00		30.25		0.25
First quarter		28.50		26.30		28.50		0.25

Number of Stockholders and Shares Outstanding

As of December 31, 2006, there were approximately 708 stockholders of record and 1,267,835 shares of common stock entitled to vote, receive dividends and considered outstanding for financial reporting purposes. The number of stockholders of record does not include the number of persons or entities who hold their stock in nominee or “street” name.

Dividend Reinvestment and Stock Purchase Plan

Common stockholders may have Corporation dividends reinvested to purchase additional shares. Participants may also make optional cash purchases of common stock through this plan and pay no brokerage commissions or fees. To obtain a plan document and authorization card call 800-757-5755.

57

Corporate Headquarters

Emclaire Financial Corp.

612 Main Street

Emlenton, PA 16373

Phone:724-867-2311

Website:www. emclairefinancial.com or www.farmersnb.com

Subsidiary Bank

The Farmers National Bank of Emlenton

Annual Meeting

The annual meeting of the Corporation’s stockholders will be held at 9:00 a.m., on Wednesday, April 25, 2007, at the main office building in Emlenton, Pennsylvania 16373.

Stockholder and Investor Information

Copies of annual reports, quarterly reports and related stockholder literature are available upon written request without charge to stockholders. Requests should be addressed to William C. Marsh, Executive Vice President and Chief Financial Officer, Emclaire Financial Corp., 612 Main Street, Emlenton, Pennsylvania 16373.

In addition, other public filings of the Corporation, including the Annual Report on Form 10-K, can be obtained from the Securities and Exchange Commission’s web site at http://www.sec.gov.

Independent Registered Public Accounting Firm

Beard Miller Company LLP

P.O. Box 101086

Pittsburgh, PA 15237

Special Counsel

Elias, Matz, Tiernan and Herrick L.L.P.

12^th Floor

734 15^th Street, N.W.

Washington, DC 20005

Registrar and Transfer Agent

Illinois Stock Transfer Company

209 West Jackson Boulevard, Suite 903

Chicago, IL 60606

www.ilstockstransfer.com

800-757-5755

58

EMCLAIRE FINANCIAL CORP.

612 Main Street

Emlenton, Pennsylvania 16373

Phone: (724) 867-2311

EX-31.1

  
    
      Exhibit 31.1






  
    

EX-31.2

EXHIBIT 31.2

CERTIFICATIONS

Certification of the Principal Financial and Accounting Officer

(Section 302 of the Sarbanes-Oxley Act of 2002)

I, William C. Marsh, Executive Vice President, Chief Financial Officer and Treasurer, certify that:

1. I have reviewed this annual report on Form 10-K of Emclaire Financial Corp.;

2. Based on my knowledge, this annual 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 annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual report;

4. The registrant’s other certifying officers 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)) 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) 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

(c) 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 (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

5. The registrant’s other certifying officer(s) 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 (or persons performing the equivalent functions):

(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: March 23, 2007

By:	/s/ William C. Marsh
	William C. Marsh
	Executive Vice President Chief Financial Officer Treasurer

EX-32.1

Exhibit 32.1

CEO 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 Annual Report of Emclaire Financial Corp. (the “Corporation”) on Form 10-K for the year ending December 31, 2006 as filed with the Securities and Exchange Commission on the date here (the “Report”), I, David L. Cox, Chief Executive Officer of the Corporation, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 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; and

2.   The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Corporation.

/s/David L. Cox

David L. Cox

Chief Executive Officer

March 23, 2007

EX-32.2

Exhibit 32.2

CFO 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 Annual Report of Emclaire Financial Corp. (the “Corporation”) on Form 10-K for the year ending December 31, 2006 as filed with the Securities and Exchange Commission on the date here (the “Report”), I, William C. Marsh, Treasurer and Chief Financial Officer of the Corporation, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 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; and

2.   The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Corporation.

/s/William C. Marsh

William C. Marsh

Executive Vice President

Chief Financial Officer

Treasurer

March 23, 2007