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, 1996.
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _______to _______.
Commission file number 0-15237
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HARLEYSVILLE NATIONAL CORPORATION
---------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2210237
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
483 Main Street, Harleysville, Pennsylvania 19438
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (215) 256-8851
Securities registered pursuant to Section 12(b) of the Act: N/A
Name of each exchange
Title of each class on which registered
. N/A . . N/A .
----------------------------------
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1.00 par value
-----------------------------
Title of Class
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes X . No.
---
Indicate by check mark 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. (X)
PAGE 1
State the aggregate market value of the voting stock held by nonaffiliates of
the registrant. The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of a specified date within 60 days prior to the date of filing.
$146,695,854 as of February 21, 1997
Indicate the number of shares outstanding of each class of the registrant's
classes of common stock, as of the latest practicable date.
6,657,001 shares of Common Stock, $1 par value per share, were outstanding
as of February 21, 1997.
DOCUMENTS INCORPORATED BY REFERENCE:
1. Portions of the Registrant's Annual Report to Shareholders for the
fiscal year ended December 31, 1996 are incorporated by reference into Parts
I, II and IV of this report.
2. Portions of the Registrant's Definitive Proxy Statement relating to the
Annual Meeting of Shareholders to be held April 8, 1997 are incorporated by
reference into Part III of this report.
PAGE 2
<TABLE>
<CAPTION>
HARLEYSVILLE NATIONAL CORPORATION
INDEX TO FORM 10-K REPORT
PAGE
----
<S> <C> <C> <C>
I. PART I.
Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Item 2. Properties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . 11
II. PART II.
Item 5. Market for Registrant's Common Stock and Related Shareholder Matters. . . . . . . . . 12
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . 12
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 12
III. PART III.
Item 10. Directors and Executive Officers of the Registrant. . . . . . . . . . . . . . . . . . 13
Item 11. Executive Compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 12. Security Ownership of Certain Beneficial Owners and Management. . . . . . . . . . . . 14
Item 13. Certain Relationships and Related Transactions. . . . . . . . . . . . . . . . . . . . 14
IV. PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K . . . . . . . . . . . 15
Signatures . 17
</TABLE>
PAGE 3
PART I
Item 1. Business.
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History and Business
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Harleysville National Corporation, a Pennsylvania corporation (the
"Corporation"), was incorporated in June 1982. On January 1, 1983, the
Corporation became the parent bank holding company of Harleysville National
Bank and Trust Company ("Harleysville"), a wholly-owned subsidiary of the
Corporation. On February 13, 1991, the Corporation acquired all of the
outstanding common stock of The Citizens National Bank of Lansford
("Citizens"). On June 1, 1992, the Corporation acquired all of the
outstanding stock of Summit Hill Trust Company ("Summit Hill"). On September
25, 1992, Summit Hill merged into Citizens and is now operating as a branch
office of Citizens. On July 1, 1994 the Corporation acquired all of the
outstanding stock of Security National Bank ("Security"). On March 1, 1996,
the Corporation acquired all of the outstanding common stock of Farmers &
Merchants Bank ("Farmers"). Farmers was merged into Citizens and is now
operating as a branch office of Citizens. The Corporation is a bank holding
company which provides financial services through its three bank subsidiaries.
Since commencing operations, the Corporation's business has consisted
primarily of managing Harleysville, Citizens and Security (collectively the
"Banks"), and its principal source of income has been dividends paid by the
Banks. The Corporation is registered as a bank holding company under the Bank
Holding Company Act of 1956, as amended (the "Bank Holding Company Act").
Harleysville, which was established in 1909, Citizens, which was
established in 1903, and Security, which was established in 1988,
(collectively the "Banks"), are national banking associations under the
supervision of the Office of the Comptroller of the Currency (the "OCC"). The
Corporation's and Harleysville's legal headquarters are located at 483 Main
Street, Harleysville, Pennsylvania 19438. Citizens' legal headquarters is
located at 13-15 West Ridge Street, Lansford, Pennsylvania 18232. Security's
legal headquarters is located at One Security Plaza, Pottstown, Pennsylvania
19464.
As of December 31, 1996, the Banks had total assets of $1,026,128,000,
total shareholders' equity of $97,631,000 and total deposits of $847,699,000.
The Banks engage in the full-service commercial banking and trust
business, including accepting time and demand deposits, making secured and
unsecured commercial and consumer loans, financing commercial transactions,
making construction and mortgage loans and performing corporate pension and
personal trust services. Their deposits are insured by the Federal Deposit
Insurance Corporation (FDIC) to the extent provided by law.
The Banks enjoy a stable base of core deposits and are leading community
banks in their service areas. The Banks believe they have gained their
position as a result of a customer oriented philosophy and a strong commitment
to service. Senior management has made the development of a sales orientation
throughout the Banks one of their highest priorities and emphasizes this
objective with extensive training and sales incentive programs that the
Company believes are unusual for community banks. The Banks maintain close
contact with the local business community to monitor commercial lending needs
and believe they respond to customer requests quickly and with flexibility.
Management believes these competitive strengths are reflected in the
Corporation's results of operations.
The Banks have twenty-five (25) offices located in Montgomery, Bucks,
Carbon and Wayne counties, Pennsylvania, 15 of which are owned by the Banks
and 10 of which are leased from third parties.
As of December 31, 1996, the Corporation and the Banks employed
approximately 401 full-time equivalent employees. The Corporation provides a
variety of employment benefits and considers its relationships with its
employees to be satisfactory.
PAGE 4
Competition
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The Banks compete actively with other eastern Pennsylvania financial
institutions, many larger than the Banks, as well as with financial and
non-financial institutions headquartered elsewhere. The Banks are generally
competitive with all competing institutions in their service areas with
respect to interest rates paid on time and savings deposits, service charges
on deposit accounts, interest rates charged on loans, and fees and charges for
trust services. At December 31, 1996, Harleysville's legal lending limit to a
single customer was $11,100,000 and Citizens' and Security's legal lending
limits to a single customer were $3,100,000 and $630,000, respectively. Many
of the institutions with which the Banks compete are able to lend
significantly more than these amounts to a single customer.
Supervision and Regulation - The Registrant
- ------------------------------------------------
The Corporation is a registered bank holding company subject to the
provisions of the Bank Holding Company Act of 1956, as amended (the "Bank
----------
Holding Company Act"), and to supervision by the Board of Governors of the
Federal Reserve system (the "Federal Reserve). The Bank Holding Company Act
requires the Registrant to secure the prior approval of the Federal Reserve
Board before it owns or controls, directly or indirectly, more than five
percent (5%) of the voting shares or substantially all of the assets of any
institution, including another bank. In addition, the Bank Holding Company
Act has been amended by the Riegle-Neal Interstate Banking and Branching
Efficiency Act which permits bank holding companies to acquire a bank located
in any state subject to certain limitation and restrictions which are more
fully described below.
A bank holding company is prohibited from engaging in or acquiring
direct or indirect control of more than five percent (5%) of the voting shares
of any company engaged in non-banking activities unless the Federal Reserve,
by order or regulation, has found such activities to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto.
In making this determination, the Federal Reserve considers whether the
performance of these activities by a bank holding company would offer benefits
to the public that outweigh possible adverse effects.
Federal law also prohibits acquisitions of control of a bank holding
company without prior notice to certain federal bank regulators. Control is
defined for this purpose as the power, directly or indirectly, to direct the
management or policies of the bank or bank holding company or to vote
twenty-five percent (25%) or more of any class of voting securities.
Subsidiary banks of a bank holding company are subject to certain
restrictions imposed by the Federal Reserve Act on any extensions of credit to
the bank holding company or any of its subsidiaries, on investments in the
stock or other securities of the bank holding company and on taking of such
stock or securities of the bank holding company and on taking of such stock or
securities as collateral for loans to any borrower.
Permitted Activities
- ---------------------
The Federal Reserve permits bank holding companies to engage in certain
activities so closely related to banking or managing or controlling banks as
to be proper incident thereto. Other than making an equity investment in a
low to moderate income housing limited partnership, the Corporation does not
at this time engage in any other permissible activities, nor does the
Corporation have any current plans to engage in any other permissible
activities in the foreseeable future.
Legislation and Regulatory Changes
- -------------------------------------
From time to time, legislation is enacted which has the effect of
increasing the cost of doing business, limiting or expanding permissible
activities or affecting the competitive balance between banks and other
financial institutions. Proposals to change the laws and regulations governing
the operations and taxation of banks, bank holding companies and other
financial institutions are frequently made in Congress, and before various
bank regulatory agencies. No prediction can be made as to the likelihood of
any major changes or the impact such changes might have on the Corporation and
PAGE 5
its subsidiaries. Certain changes of potential significance to the
Corporation which have been enacted recently and others which are currently
under consideration by Congress or various regulatory or professional agencies
are discussed below.
The passage of the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 and the Riegle Community Development and Regulatory
Improvement Act may have a significant impact upon the Corporation. The key
provisions pertain to interstate banking and interstate branching as well as a
reduction in the regulatory burden on the banking industry. Since September
1995, bank holding companies may acquire banks in other states without regard
to state law. In addition, banks can merge with other banks in another state
beginning in June 1997. States may adopt laws preventing interstate branching
but, if so, no out-of-state bank can establish a branch in such state and no
banks in such state may branch outside the state. Pennsylvania recently
amended the provisions of its banking code to authorize full interstate
banking and branching under Pennsylvania law and to facilitate the operations
of interstate banks in Pennsylvania. As a result of legal and industry
changes, management predicts that consolidation will continue as the financial
services industry strives for greater cost efficiencies and market share.
Management believes that such consolidation may enhance its competitive
position as a community bank.
The Interstate Banking and Branching Act also amends the International
Banking Act to allow a foreign bank to establish and operate a federal branch
or agency upon approval of the appropriate federal and state banking
regulator. As a national bank, the Bank currently can relocate its main
office across state lines by utilizing a provision in the National Bank Act
which permits such relocation to a location not more than thirty miles from
its existing main office. In effect, a national bank can thereby move across
state lines as long as the relocation does not exceed thirty miles and also
retain as branches the offices located in the original state.
The Federal Reserve, the FDIC, and the OCC have issued certain
risk-based capital guidelines. See page 34 of Registrant's 1996 Annual
Report, which is incorporated by reference herein, for information concerning
the Corporation's capital.
Pending Legislation
- --------------------
There are numerous proposals before Congress to modify the financial
services industry and the way commercial banks and other financial
institutions operate. Some of these proposals include changes to the
ownership of financial companies and the types of products and services which
ma be offered by financial institutions. However, it is difficult to
determine at this time what effect such provisions may have until they are
enacted into law. Except as specifically described on page 34 of the 1996
Annual Report to Shareholders, management believes that the effect of the
provisions of the aforementioned legislation on the liquidity, capital
resources, and results of operations of the Corporation will be immaterial.
Management is not aware of any other current specific recommendations by
regulatory authorities or proposed legislation which, if they were
implemented, would have a material adverse effect upon the liquidity, capital
resources, or results of operations, although the general cost of compliance
with numerous and multiple federal and state laws and regulations does have,
and in the future may have, a negative impact on the Corporation's results of
operations.
Effects of Inflation
- ----------------------
Inflation has some impact on the Corporation's and the Banks' operating
costs. Unlike many industrial companies, however, substantially all of the
Banks' assets and liabilities are monetary in nature. As a result, interest
rates have a more significant impact on the Corporation's and the Banks'
performance than the general level of inflation. Over short periods of time,
interest rates may not necessarily move in the same direction or in the same
magnitude as prices of goods and services.
Effect of Government Monetary Policies
- ------------------------------------------
The earnings of the Corporation are and will be affected by domestic
economic conditions and the monetary and fiscal policies of the United States
government and its agencies. An important function of the Federal Reserve is
PAGE 6
to regulate the money supply and interest rates. Among the instruments used
to implement those objectives are open market operations in United States
government securities and changes in reserve requirements against member bank
deposits. These instruments are used in varying combinations to influence
overall growth and distribution of bank loans, investments and deposits, and
their use may also affect rates charged on loans or paid for deposits.
The Banks are members of the Federal Reserve and, therefore, the policies
and regulations of the Federal Reserve have a significant effect on its
deposits, loans and investment growth, as well as the rate of interest earned
and paid, and are expected to affect the Banks' operations in the future. The
effect of such policies and regulations upon the future business and earnings
of the Corporation and the Banks cannot be predicted.
Environmental Regulations
- --------------------------
There are several federal and state statutes which regulate the
obligations and liabilities of financial institutions pertaining to
environmental issues. In addition to the potential for attachment of
liability resulting from its own actions, a bank may be held liable under
certain circumstances for the actions of its borrowers, or third parties, when
such actions result in environmental problems on properties that collateralize
loans held by the bank. Further, the liability has the potential to far
exceed the original amount of a loan issued by the bank. Currently, neither
the Corporation nor the Banks are a party to any pending legal proceeding
pursuant to any environmental statute, nor are the Corporation and the Banks
aware of any circumstances which may give rise to liability under any such
statute.
Supervision and Regulation - Banks
- --------------------------------------
The operations of the Banks are subject to federal and state statutes
applicable to banks chartered under the banking laws of the United States, to
members of the Federal Reserve and to banks whose deposits are insured by the
FDIC. The Banks' operations are also subject to regulations of the OCC, the
Federal Reserve and the FDIC. The primary supervisory authority of the Banks
is the OCC, who regularly examines the Banks. The OCC has authority to
prevent a national bank from engaging in unsafe or unsound practices in
conducting its business.
Federal and state banking laws and regulations govern, among other
things, the scope of a bank's business, the investments a bank may make, the
reserves against deposits a bank must maintain, loans a bank makes and
collateral it takes, the maximum interest rates a bank may pay on deposits,
the activities of a bank with respect to mergers and consolidations and the
establishment of branches.
As a subsidiary bank of a bank holding company, the Banks are subject to
certain restrictions imposed by the Federal Reserve Act on any extensions of
credit to the bank holding company or its subsidiaries, or investments in the
stock or other securities as collateral for loans. The Federal Reserve Act
and Federal Reserve regulations also place certain limitations and reporting
requirements on extensions of credit by a bank to principal shareholders of
its parent holding company, among others, and to related interests of such
principal shareholders. In addition, such legislation and regulations may
affect the terms upon which any person becoming a principal shareholder of a
holding company may obtain credit from banks with which the subsidiary bank
maintains a correspondent relationship.
Under the Federal Deposit Insurance Act, the OCC possesses the power to
prohibit institutions regulated by it (such as the Banks) from engaging in any
activity that would be an unsafe and unsound banking practice or would
otherwise be in violation of the law.
Under the Community Reinvestment Act of 1977, as amended ("CRA"), the OCC
----------
is required to assess the record of all financial institutions regulated by it
to determine if these institutions are meeting the credit needs of the
community (including low and moderate income neighborhoods) which they serve
and to take this record into account in its evaluation of any application made
by any of such institutions for, among other things, approval of a branch or
other deposit facility, office relocation, a merger or an acquisition of bank
shares. The Financial Institutions Reform, Recovery and Enforcement Act of
1989 amended the CRA to require, among other things, that the OCC make
publicly available the evaluation of a bank's record of meeting the credit
PAGE 7
needs of its entire community, including low and moderate income
neighborhoods. This evaluation will include a descriptive rating
("outstanding", "satisfactory", "needs to improve" or "substantial
noncompliance") and a statement describing the basis for the rating. These
ratings are publicly disclosed.
Under the Bank Secrecy Act ("BSA"), banks and other financial
institutions are required to report to the Internal Revenue Service currency
transactions of more than $10,000 or multiple transactions of which the bank
is aware in any one day that aggregate in excess of $10,000. Civil and
criminal penalties are provided under the BSA for failure to file a required
report, for failure to supply information required by the BSA or for filing a
false or fraudulent report.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") requires that institutions must be classified, based on their
risk-based capital ratios into one of five defined categories, as illustrated
below (well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized).
Total Tier 1 Under a
Risk- Risk- Tier 1 Capital
Based Based Leverage Order or
Ratio Ratio Ratio Directive
-------------------------------------------
CAPITAL CATEGORY
- -----------------
Well capitalized >10.0 >6.0 >5.0 NO
- - -
Adequately capitalized > 8.0 >4.0 >4.0*
- - -
Undercapitalized < 8.0 <4.0 <4.0*
Significantly undercapitalized < 6.0 <3.0 <3.0
Critically undercapitalized <2.0
-
*3.0 for those banks having the highest available regulatory rating.
In the event an institution's capital deteriorates to the
undercapitalized category or below, FDICIA prescribes an increasing amount of
regulatory intervention, including: (1) the institution of a capital
restoration plan and a guarantee of the plan by a parent institution; and (2)
the placement of a hold on increases in assets, number of branches or lines of
business. If capital has reached the significantly or critically
undercapitalized levels, further material restrictions can be imposed,
including restrictions on interest payable on accounts, dismissal of
management and (in critically undercapitalized situations) appointment
of a receiver. For well capitalized institutions, FDICIA provides
authority for regulatory intervention where the institution is deemed
to be engaging in unsafe or unsound practices or receives a less than
satisfactory examination report rating for asset quality, management,
earnings or liquidity. All but well capitalized institutions are
prohibited from accepting brokered deposits without prior regulatory
approval. Under FDICIA, financial institutions are subject to increased
regulatory scrutiny and must comply with certain operational,
managerial and compensation standards to be developed by Federal Reserve
Board regulations. FDICIA also requires the regulators to issue new
rules establishing certain minimum standards to which an institution must
adhere including standards requiring a minimum ratio of classified assets to
capital, minimum earnings necessary to absorb losses and minimum ratio of
market value to book value for publicly held institutions. Additional
regulations are required to be developed relating to internal controls, loan
documentation, credit underwriting, interest rate exposure, asset growth and
excessive compensation, fees and benefits.
Annual full-scope, on site regulatory examinations are required for all
the FDIC-insured institutions except institutions with assets under $100
million which are well capitalized, well-managed and not subject to a recent
change in control, in which case, the examination period is every eighteen
(18) months. Banks with total assets of $500 million or more, as of the
beginning of fiscal year 1993, are required to submit to their supervising
federal and state banking agencies a publicly available annual audit report.
The independent accountants of such bank are required to attest to the
accuracy of management's report regarding the internal control structure of
the bank. In addition, such banks also are required to have an independent
audit committee composed of outside directors who are independent of
PAGE 8
management, to review with management and the independent accountants, the
reports that must be submitted to the bank regulatory agencies. If the
independent accountants resign or are dismissed, written notification must be
given to the bank's supervising government banking agencies. These accounting
and reporting reforms do not apply to an institution such as a bank with total
assets at the beginning of its fiscal year of less than $500 million, such as
Citizens or Security.
FDICIA also requires that banking agencies reintroduce loan-to-value
("LTV") ratio regulations which were previously repealed by the 1982 Act.
LTVs limit the amount of money a financial institution may lend to a borrower,
when the loan is secured by real estate, to no more than a percentage, set by
regulation, of the value of the real estate.
A separate subtitle within FDICIA, called the "Bank Enterprise Act of
1991", requires "truth-in-savings" on consumer deposit accounts so that
consumers can make meaningful comparisons between the competing claims of
banks with regard to deposit accounts and products. Under this provision, the
Bank is required to provide information to depositors concerning the terms of
their deposit accounts, and in particular, to disclose the annual percentage
yield. The operational cost of complying with the Truth-In-Savings law had no
material impact on liquidity, capital resources or reported results of
operations.
While the overall impact of fully implementing all provisions of the
FDICIA cannot be accurately calculated, Management believes that full
implementation of the FDICIA had no material impact on liquidity, capital
resources or reported results of operation in future periods.
From time to time, various types of federal and state legislation have
been proposed that could result in additional regulation of, and restriction
on, the business of the Banks. It cannot be predicted whether any such
legislation will be adopted or, if adopted, how such legislation would affect
the business of the Banks. As a consequence of the extensive regulation of
commercial banking activities in the United States, the Banks' business is
particularly susceptible to being affected by federal legislation and
regulations that may increase the costs of doing business.
Statistical Data
- -----------------
The information for this Item is incorporated by reference to pages 22
through 36 of the Company's Annual Report to Shareholders for the year ended
December 31, 1996 which pages are included at Exhibit (13) to this Annual
Report on Form 10-K.
Item 2. Properties.
- ----------------------
The principal executive offices of the Company and of Harleysville are
located in Harleysville, Pennsylvania in a two-story office building owned by
Harleysville, built in 1929. Harleysville also owns the buildings in which
ten of its branches are located and leases space for the other seven branches
from unaffiliated third parties under leases expiring at various times through
2036. The principal executive offices of Citizens are located in Lansford,
Pennsylvania in a two-story office building owned by Citizens. Citizens also
owns the buildings where its branches are located. The principal executive
offices of Security are located in Pottstown, Pennsylvania, in a building
leased by Security. Security leases its East End and North End branches, and
owns its Pottstown Center branch.
<TABLE>
<CAPTION>
Office Office Location Owned/Leased
- ----------------- --------------- ------------
<S> <C> <C>
Harleysville 483 Main Street Owned
Harleysville Pa
Skippack Route 73 Owned
Skippack Pa
PAGE 9
Limerick Ridge Pike Owned
Limerick Pa
North Penn Welsh & North Wales Rd Owned
North Wales Pa
Gilbertsville Gilbertsville Shopping Leased
Gilbertsville Pa
Hatfield Snyder Square Leased
Hatfield Pa
North Broad North Broad Street Owned
Lansdale Pa
Marketplace Marketplace Shopping Leased
Lansdale Pa
Normandy Farms Morris Road Leased
Blue Bell Pa
Horsham Babylon Business Center Leased
Horsham Pa
Meadowood Route 73 Leased
Worcester Pa
Collegeville 364 Main Street Owned
Collegeville Pa
Sellersville 209 North Main St. Owned
Sellersville Pa
Trainers Corner Trainers Corner Center Leased
Quakertown Pa
Quakertown Main 224 West Broad St. Owned
Quakertown PA
Red Hill 400 Main Street Owned
Red Hill PA
Audubon 2624 Egypt Road Owned
Audubon PA
Citizens 13-15 West Ridge Street Owned
Lansford PA
Summit Hill 2 East Ludlow Street Owned
Summit Hill PA
Lehighton 904 Blakeslee Blvd. Owned
Lehighton PA
Farmers & Merchants 1001 Main Street Owned
Honesdale PA
PAGE 10
Pottstown One Security Plaza Leased
Pottstown PA
Pottstown 1450 East High Street Leased
Pottstown PA
Pottstown Charlotte & Mervine Sts. Leased
Pottstown PA
Pottstown Rte. 100 & Shoemaker Road Owned
Pottstown PA
</TABLE>
In management's opinion, all of the above properties are in good
condition and are adequate for the Registrant's and the Banks' purposes.
Item 3. Legal Proceedings.
- ------------------------------
Management, based on consultation with the Corporation's legal counsel,
is not aware of any litigation that would have a material adverse effect on
the consolidated financial position of the Corporation. There are no
proceedings pending other than the ordinary routine litigation incident to the
business of the Corporation and its subsidiaries - Harleysville National Bank
and Trust Company, The Citizens National Bank of Lansford and Security
National Bank. In addition, no material proceedings are pending or are known
to be threatened or contemplated against the Corporation and the Banks by
government authorities.
Item 4. Submission of Matters to a Vote of Security Holders.
- -----------------------------------------------------------------------
No matter was submitted during the fourth quarter of 1996 to a vote of
holders of the Corporation's Common Stock.
PAGE 11
PART II
Item 5. Market for the Registrant's Common Stock and Related Shareholder
- ------------------------------------------------------------------------------
Matters.
- --------
The information required by this Item is incorporated by reference to
pages 7 and 18 of the Corporation's Annual Report to Shareholders for the year
ended December 31, 1996, which pages are included at Exhibit (13) to this
Annual Report on Form 10-K.
Item 6. Selected Financial Data.
- --------------------------------------
The information required by this Item is incorporated by reference to
pages 22 and 36 of the Corporation's Annual Report to Shareholders for the
year ended December 31, 1996, which pages are included at Exhibit (13) to this
Annual Report on Form 10-k.
Item 7. Management's Discussion and Analysis of Financial Condition and
- ------------------------------------------------------------------------------
Results of Operations.
- -----------------------
The information required by this Item is incorporated by reference to
pages 22 through 35 of the Corporation's Annual Report to Shareholders for the
year ended December 31, 1996, which pages are included at Exhibit (13) to
this Annual Report on Form 10-K.
Item 8. Financial Statements and Supplementary Data.
- -----------------------------------------------------------
The information required by this Item is incorporated by reference to
pages 7 through 21 of the Corporation's Annual Report to Shareholders for the
year ended December 31, 1996, which pages are included at Exhibit (13) to this
Annual Report on Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and
- ------------------------------------------------------------------------------
Financial Disclosure.
- ---------------------
None.
PAGE 12
PART III
Item 10. Directors and Executive Officers of the Registrant.
- ---------------------------------------------------------------------
The information required by this Item with respect to the Corporation's
directors is incorporated by reference to pages 3 through 7 of the
Corporation's definitive Proxy Statement relating to the Annual Meeting of
Shareholders to be held April 8, 1997.
Executive Officers of Registrant
- -----------------------------------
<TABLE>
<CAPTION>
Name Age Position
- --------------------- --- --------
<S> <C> <C>
Walter E. Daller, Jr. 57 President and Chief Executive Officer
of the Company and of Harleysville
James W. Hamilton 50 Senior Vice President and Senior Trust
of Harleysville
Demetra M. Takes 46 Executive Vice President and Chief
Operating Officer of Harleysville
Frank J. Lochetto 49 Senior Vice President and Senior
Lending Officer of Harleysville
Vernon L. Hunsberger 48 Treasurer of the Company, Senior Vice
President/CFO and Cashier of Harleysville
Fred C. Reim, Jr. 53 Senior Vice President of Harleysville
since August 1993; Senior Vice
President of First Valley Bank from
December 1990 to August 1993
Dennis L. Detwiler 49 Senior Vice President of Harleysville
Mikkalya W. Brown 41 Senior Vice President of Loan
Administration of Harleysville since
July 1994; Vice President Security
National Bank September 1991 to June
1994; Assistant Vice President Mellon
Bank January 1990 to August 1991
Thomas D. Oleksa 43 President and Chief Executive Officer
of Citizens
Raymond H. Melcher 45 President and Chief Executive Officer
of Security since November 1994;
Executive Vice President, Chief
Operating Officer Hi-Tech Connections
1990 to 1994; Executive Vice President
Keystone Financial 1988 to 1990
</TABLE>
PAGE 13
Item 11. Executive Compensation.
- ------------------------------------
The information required by this Item is incorporated by reference to
pages 7 through 12 of the Corporation's definitive Proxy Statement relating to
the Annual Meeting of Shareholders to be held April 8, 1997.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
- -----------------------------------------------------------------------------
The information required by this Item is incorporated by reference to
pages 3 through 4 of the Corporation's definitive Proxy Statement relating to
the Annual Meeting of Shareholders to be held April 8, 1997.
Item 13. Certain Relationships and Related Transactions.
- ---------------------------------------------------------------
The information required by this Item is incorporated by reference to
page 17 of the Corporation's definitive Proxy Statement relating to the Annual
Meeting of Shareholders to be held April 8, 1997, and to page 15 of the
Corporation's Annual Report to Shareholders for the year ended December 31,
1996, which page is included at Exhibit (13) to this Annual Report on Form
10-K.
PAGE 14
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
- -------------------------------------------------------------------- --------
(a) Financial Statements, Financial Statement Schedules and Exhibits Filed:
(1) Consolidated Financial Statements
Page
----
Harleysville National Corporation and Subsidiary:
Consolidated Balance Sheets as of
December 31, 1996 and 1995 8*
Consolidated Statements of Income for the
Years Ended December 31, 1996, 1995
and 1994 9*
Consolidated Statements of Shareholders'
Equity for the Years Ended
December 31, 1996, 1995 and 1994 10*
Consolidated Statements of Cash Flows
for the Years Ended December 31, 1996,
1995 and 1994 11*
Notes to Consolidated Financial Statements 12-21*
Independent Auditors' Report 7*
(2) Financial Statement Schedules
Financial Statements Schedules are omitted because the required
information is either not applicable, not required, or the information is
included in the consolidated financial statements or notes thereto.
*Refers to the respective page of the Annual Report to Shareholders. The
Consolidated Financial Statements and Notes to Consolidated Financial
Statements and Auditor's Report thereon on pages 7 to 21 of the Annual Report
to Shareholders, are incorporated herein by reference and attached at Exhibit
13 to this Annual Report on Form 10-K. With the exception of the portions of
such Annual Report specifically incorporated by reference in this Item and in
Items 1, 5, 6, 7 and 8, such Annual Report shall not be deemed filed as part
of this Annual Report on Form 10-K or otherwise subject to the liabilities of
Section 18 of the Securities Exchange Act of 1934.
PAGE 15
(3) Exhibits
Exhibit No. Description of Exhibits
- ----------- -------------------------
(3.1) Harleysville National Corporation Articles of Incorporation,
as amended. (Incorporated by reference to Exhibit 3(a)
to the Corporation's Registration Statement No. 33-65021
on Form S-4, as filed on December 14, 1995.)
(3.2) Harleysville National Corporation By-laws. (Incorporated by
reference to Exhibit 3(b) to the Corporation's
Registration Statement No. 33-65021 on Form S-4, as filed
on December 14, 1995.)
(11) Computation of Earnings per Common Share. The information
for this Exhibit is incorporated by reference to page
9 of the Corporation's Annual Report to Shareholders for
the year ended December 31, 1996, which is included as
Exhibit (13) to this Form 10-K Report.
(13) Excerpts from the Corporation's 1996 Annual Report to
Shareholders. (This excerpt includes only pages 7
through 36 which are incorporated in this Report by
reference.)
(21) Subsidiaries of Registrant
(23) (a) Consent of Grant Thornton LLP Independent Certified Public
Accountants
(b) Consent of KPMG Peat Marwick LLP Independent Certified
Public Accountants
(27) Financial Data Schedule.
(99) Additional Exhibits
(a) Report of Independent Certified Public Accountants -
Grant Thornton LLP
(b) Report of Independent Certified Public Accountants -
KPMG Peat Marwick LLP
(b) Reports on Form 8-K
During the quarter ended December 31, 1996, the Registrant did not file
any reports on Form 8-K.
PAGE 16
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.
HARLEYSVILLE NATIONAL CORPORATION
Date: March 13, 1997 By:/s/ Walter E. Daller, Jr.
---------------------------
Walter E. Daller, Jr.
President
Pursuant to the requirements 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.
Signatures Title Date
---------- ----- ----
Director March 13, 1997
- -------------------
John W. Clemens
/s/ Walter E. Daller, Jr. President, Chief March 13, 1997
- -------------------------
Walter E. Daller, Jr. Executive Officer
and Director (Principal
Executive Officer)
/s/ Martin E. Fossler Director March 13, 1997
- -------------------------
Martin E. Fossler
/s/ Harold A. Herr Director March 13, 1997
- ----------------------
Harold A. Herr
/s/ Vernon L. Hunsberger Treasurer (Principal March 13, 1997
- -------------------------
Vernon L. Hunsberger Financial and
Accounting Officer)
PAGE 17
Signatures Title Date
- ---------- ----- ----
Director March 13, 1997
- -----------------------
Thomas S. McCready
/s/ Bradford W. Mitchell Director March 13, 1997
- ----------------------------
Bradford W. Mitchell
/s/ Henry M. Pollak Director March 13, 1997
- -----------------------
Henry M. Pollak
/s/ Palmer E. Retzlaff Director March 13, 1997
- --------------------------
Palmer E. Retzlaff
/s/ Walter F. Vilsmeier Director March 13, 1997
- ---------------------------
Walter F. Vilsmeier
/s/ William M. Yocum Director March 13, 1997
- ------------------------
William M. Yocum
PAGE 18
EXHIBIT INDEX
- --------------
Exhibit
-------
(13) Excerpts from the Corporation's 1996 Annual Report to Shareholders
(This excerpt includes only pages 7 through 36 which are
incorporated in this Report by reference.)
(21) Subsidiaries of Registrant
(23) (a) Consent of Grant Thornton LLP Independent Certified
Public Accountants
(b) Consent of KPMG Peat Marwick LLP Independent
Certified Public Accountants
(99) Additional Exhibits
(a) Report of Independent Certified Public Accountants-
Grant Thornton LLP
(b) Report of Independent Certified Public Accountants-
KPMG Peat Marwick LLP
PAGE 19
DESCRIPTION OF BUSINESS
Harleysville National Corporation, a Pennsylvania corporation (the
"Corporation"), was incorporated in June 1982. On January 1, 1983, the
Corporation became the parent bank holding company of Harleysville National
Bank and Trust Company ("Harleysville"), a wholly-owned subsidiary of the
Corporation. On February 13, 1991, the Corporation acquired all of the
outstanding common stock of The Citizens National Bank of Lansford
("Citizens"). On June 1, 1992, the Corporation acquired all of the
outstanding stock of Summit Hill Trust Company ("Summit Hill"). On September
25, 1992, Summit Hill merged into Citizens and is now operating as a branch
office of Citizens. On July 1, 1994, the Corporation acquired all of the
outstanding stock of Security National Bank ("Security"). On March 1, 1996,
the Corporation acquired all of the outstanding common stock of Farmers &
Merchants Bank ("Farmers"). Farmers was merged into Citizens and is now
operating as a branch office of Citizens. The Corporation is a bank holding
company which provides financial services through its three bank subsidiaries.
Harleysville, which was established in 1909, Citizens, which was
established in 1903, and Security, which was established in 1988,
(collectively the "Banks"), are national banking associations under the
supervision of the Office of the Comptroller of the Currency. The
Corporation's and Harleysville's legal headquarters are located at 483 Main
Street, Harleysville, Pennsylvania 19438. Citizens' legal headquarters is
located at 13-15 West Ridge Street, Lansford, Pennsylvania 18232. Security's
legal headquarters is located at One Security Plaza, Pottstown, Pennsylvania
19464.
As of December 31, 1996, the Banks had total assets of $1,026,128,000,
total shareholders' equity of $97,631,000 and total deposits of $847,699,000.
The Banks engage in full-service commercial banking and trust business,
including accepting time and demand deposits, making secured and unsecured
commercial and consumer loans, financing commercial transactions, making
construction and mortgage loans and performing corporate pension and personal
trust services. Their deposits are insured by the Federal Deposit Insurance
Corporation (FDIC) Bank Insurance Fund to the extent provided by law. The
Banks have 25 branch offices located in Montgomery, Bucks, Carbon and Wayne
counties.
On December 31, 1996, the Banks had 401 full-time equivalent employees.
COMPETITION
The Banks compete actively with other eastern Pennsylvania financial
institutions, many larger than the Banks, as well as with financial and
nonfinancial institutions headquartered elsewhere. The Banks are generally
competitive with all competing institutions in their service area with respect
to interest rates paid on time and savings deposits, service charges on
deposit accounts, interest rates charged on loans, and fees and charges for
trust services.
SUPERVISION AND REGULATION
The operations of the Banks are subject to federal, state and local
statutes applicable to banks chartered under the banking laws of the United
States, to members of the Federal Reserve System and to banks whose deposits
are insured by the FDIC. The Banks' operations are also subject to the
regulations of the Federal Reserve Board, the FDIC and the Office of the
Comptroller of the Currency (who regularly examines the Banks areas such as
asset quality, investments, management practices and other aspects of bank
operations).
The Corporation is subject to federal and state securities laws, certain
rules and regulations of the Securities and Exchange Commission, to the
provisions of the Bank Holding Company Act of 1956, as amended, and to
supervision by the Federal Reserve Board.
MARKET INFORMATION
The following table sets forth quarterly dividend information and the
high and low prices for the Corporation's Common Stock for 1996 and 1995. The
Corporation's stock is traded in the over-the-counter market under the symbol
"HNBC" and commonly quoted under NASDAQ National Market Issues.
PRICE OF COMMON STOCK
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1996 Low Price High Price Dividend
First Quarter * $ 24.76 * $ 27.14 * $ .190 *
Second Quarter 24.50 26.50 .190
Third Quarter 23.50 26.50 .210
Fourth Quarter 23.50 26.00 .250
1995 Low Price* High Price* Dividend*
First Quarter $ 23.81 $ 26.67 $ .171
Second Quarter 23.81 26.67 .171
Third Quarter 23.81 27.14 .181
Fourth Quarter 25.00 27.14 .229
<FN>
*Adjusted for a 5% stock dividend effective 6/28/96.
</TABLE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Harleysville National Corporation and Subsidiaries
To the Board of Directors and Shareholders, Harleysville National Corporation:
We have audited the accompanying consolidated balance sheets of
Harleysville National Corporation and Subsidiaries as of December 31, 1996 and
1995, and the related consolidated statements of income, shareholders' equity
and cash flows for each of the two years in the period ended December 31,
1996. These financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. The consolidated financial statements of
Harleysville National Corporation and Subsidiaries for the year ended December
31, 1994 were audited by other auditors whose report, dated January 31, 1995,
expressed an unqualified opinion on those consolidated financial statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Harleysville National Corporation and Subsidiaries as of December 31, 1996
and 1995, and the consolidated results of their operations and their
consolidated cash flows for the years then ended, in conformity with generally
accepted accounting principles.
As discussed in note 1 to the consolidated financial statements,
Harleysville National Corporation and Subsidiaries changed their method of
accounting for certain investments in debt and equity securities in 1994.
Grant Thornton LLP
Philadelphia, Pennsylvania
January 8, 1997
PAGE 7
CONSOLIDATED BALANCE SHEETS
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
(Dollars in thousands) December 31,
--------------
<S> <C> <C>
ASSETS 1996 1995
-------------- ---------
Cash and due from banks $ 39,407 $ 34,312
Federal funds sold 6,000 16,295
-------------- ---------
Total cash and cash equivalents 45,407 50,607
-------------- ---------
Interest-bearing deposits in banks 8,475 1,703
Investment securities available for sale 209,795 159,326
Investment securities held to maturity
(market value $66,680 and $85,652, respectively) 65,226 83,669
Loans 689,203 638,220
Less: Unearned income (7,793) (9,482)
Allowance for loan losses (10,710) (9,891)
-------------- ---------
Net loans 670,700 618,847
-------------- ---------
Bank premises and equipment, net 14,810 11,995
Accrued interest receivable 6,653 6,150
Other real estate owned 972 1,220
Intangible assets, net 1,658 1,960
Other assets 2,432 1,868
-------------- ---------
Total assets $ 1,026,128 $937,345
============== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing 139,723 117,698
Interest-bearing:
NOW accounts 102,270 91,616
Money market accounts 155,516 155,641
Savings 104,329 101,993
Time under $100,000 294,501 297,923
Time $100,000 or greater 51,360 29,628
-------------- ---------
Total deposits 847,699 794,499
Accrued interest payable 13,927 12,082
U.S. Treasury demand notes 2,572 1,837
Federal Home Loan Bank (FHLB) borrowings 35,000 21,200
Securities sold under agreements to repurchase 21,949 16,714
Other liabilities 7,350 4,651
-------------- ---------
Total liabilities 928,497 850,983
-------------- ---------
Shareholders' equity:
Series preferred stock, par value $1 per share;
authorized 3,000,000 shares, none issued - -
Common stock, par value $1 per share; authorized 30,000,000
shares; issued and outstanding 6,656,770 shares in 1996
and 6,316,208 shares in 1995 6,657 6,316
Additional paid in capital 40,316 30,883
Retained earnings 47,849 47,780
Net unrealized gain on investment securities available for sale 2,809 1,383
-------------- ---------
Total shareholders' equity 97,631 86,362
-------------- ---------
Total liabilities and shareholders' equity $ 1,026,128 $937,345
============== =========
<FN>
See accompanying notes to consolidated financial statements.
</TABLE>
PAGE 8
CONSOLIDATED STATEMENTS OF INCOME
Harleysville National Corporation and Subsidiaries
(Dollars in thousands except weighted average number of
common shares and per share information)
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
1996 1995 1994
------------------------- ----------- ----------
<S> <C> <C> <C>
Interest Income:
Loans, including fees $ 52,873 $ 50,868 $ 42,509
Lease financing 3,811 3,141 2,737
Investment securities:
Taxable 12,110 10,923 10,117
Exempt from federal taxes 4,020 2,671 2,538
Federal Funds sold 622 784 329
Deposits in banks 282 104 151
------------------------- ----------- ----------
Total interest income 73,718 68,491 58,381
------------------------- ----------- ----------
Interest Expense:
Savings deposits 9,616 9,571 9,468
Time, under $100,000 16,830 15,397 10,512
Time, $100,000 or greater 2,024 1,648 717
Borrowed funds 2,406 2,168 404
------------------------- ----------- ----------
Total interest expense 30,876 28,784 21,101
------------------------- ----------- ----------
Net interest income 42,842 39,707 37,280
Provision for loan losses 2,082 2,172 2,665
------------------------- ----------- ----------
Net interest income after provision for loan losses 40,760 37,535 34,615
------------------------- ----------- ----------
Other Operating Income:
Service charges 2,587 2,337 2,341
Security (losses) gains, net (39) (172) 668
Trust income 1,293 1,094 741
Other Income 1,274 1,178 996
------------------------- ----------- ----------
Total other operating income 5,115 4,437 4,746
------------------------- ----------- ----------
Net interest income after provision for loan losses
and other operating income 45,875 41,972 39,361
------------------------- ----------- ----------
Other Operating Expenses:
Salaries, wages and employee benefits 14,398 13,112 11,626
Occupancy 1,873 1,541 1,474
Furniture and equipment 2,083 1,913 1,572
FDIC premium 6 861 1,648
Other expenses 7,514 6,840 6,994
------------------------- ----------- ----------
Total other operating expenses 25,874 24,267 23,314
------------------------- ----------- ----------
Income before income tax expense 20,001 17,705 16,047
Income tax expense 5,593 5,277 4,767
------------------------- ----------- ----------
Net income $ 14,408 $ 12,428 $ 11,280
========================= =========== ==========
Weighted average number of common shares:
Primary 6,660,530 6,646,957 6,602,678
Fully diluted 6,660,530 6,648,976 6,602,678
========================= =========== ==========
Net income per share information:
Primary $ 2.16 $ 1.87 $ 1.71
========================= =========== ==========
Fully diluted $ 2.16 $ 1.87 $ 1.71
========================= =========== ==========
Cash dividends per share $ 0.84 $ 0.75 $ 0.58
========================= =========== ==========
<FN>
See accompanying notes to consolidated financial statements.
</TABLE>
PAGE 9
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Harleysville National Corporation and Subsidiaries
<TABLE>
<CAPTION>
Net Unrealized
Gain (Loss)
(Dollars in thousands) on Investment
Common Stock Securities
------------
Number of Par Additional Retained Available
Shares Value Paid in Capital Earnings For Sale Total
------------ ----- --------------- --------- --------------- -------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1994 5,396 5,396 15,009 42,066 - 62,471
Acquisition of Farmers &
Merchants Bank 438 438 3,281 3,159 - 6,878
Stock options 58 58 1,653 (2,296) - (585)
Stock dividends 274 274 7,085 (7,369) - (10)
Stock awards - - 3 (3) - -
Dividends reinvestment 25 25 666 - - 691
Net income for 1994 - - - 11,280 - 11,280
Cash dividends - - - (3,686) - (3,686)
Net unrealized loss on
investment securities available
for sale - - - - (2,856) (2,856)
------------ ----- --------------- --------- --------------- -------
Balance, December 31, 1994 6,191 6,191 27,697 43,151 (2,856) 74,183
Stock options 125 125 3,183 (2,886) - 422
Stock awards - - 3 (3) - -
Net income for 1995 - - - 12,428 - 12,428
Cash dividends - - - (4,910) - (4,910)
Net unrealized gain
on investment securities
available for sale - - - - 4,239 4,239
------------ ----- --------------- --------- --------------- -------
Balance, December 31, 1995 6,316 6,316 30,883 47,780 1,383 86,362
Stock options 14 14 335 (237) - 112
Stock dividends 316 316 8,171 (8,502) - (15)
Stock awards 11 11 - (16) - (5)
Stock compensation tax benefit - - 927 - - 927
Net income for 1996 - - - 14,408 - 14,408
Cash dividends - - - (5,584) - (5,584)
Net unrealized gain
on investment securities
available for sale - - - - 1,426 1,426
------------ ----- --------------- --------- --------------- -------
Balance, December 31, 1996 6,657 6,657 40,316 47,849 2,809 97,631
============ ===== =============== ========= =============== =======
<FN>
See accompanying notes to consolidated financial statements.
</TABLE>
PAGE 10
CONSOLIDATED STATEMENTS OF CASH FLOWS
Harleysville National Corporation and Subsidiaries
<TABLE>
<CAPTION>
(Dollars in thousands) Year Ended December 31,
-------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES: 1996 1995 1994
------------------------- --------- ---------
Net Income $ 14,408 $ 12,428 $ 11,280
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses 2,082 2,172 2,665
Depreciation and amortization 1,412 1,220 1,060
Net amortization of investment
securities discount/premiums 403 481 696
Deferred income taxes 844 445 104
Net realized securities (loss) gain 39 172 (668)
Increase in accrued income receivable (503) (908) (806)
Increase in accrued interest payable 1,845 3,764 1,376
Net increase in other assets (564) (28) (877)
Net increase in other liabilities 1,984 423 1,043
Decrease in unearned income (1,689) (599) (1,522)
Write-down of other real estate owned 144 190 148
Amortization of intangible assets 302 355 617
------------------------- --------- ---------
Net cash provided by operating activities 20,707 20,115 15,116
------------------------- --------- ---------
INVESTING ACTIVITIES:
Proceeds from sales of investment securities available for sale 64,327 10,887 41,941
Proceeds, maturity or calls of investment securities held to maturity 9,078 26,843 23,725
Proceeds, maturity or calls of investment securities available for sale 29,789 23,304 26,136
Purchases of investment securities held to maturity (5,847) (60,207) (22,105)
Purchases of investment securities available for sale (127,591) (21,155) (40,339)
Net (increase) decrease in interest-bearing deposits in banks (6,772) 301 1,051
Net increase in loans (53,491) (35,023) (96,555)
Net increase in premises and equipment (4,227) (3,469) (1,273)
Proceeds from sales of other real estate 1,348 1,075 1,207
------------------------- --------- ---------
Net cash used in investing activities (93,386) (57,444) (66,212)
------------------------- --------- ---------
FINANCING ACTIVITIES:
Net increase in deposits 53,200 51,175 7,998
(Decrease) increase in U.S. Treasury demand notes 735 (556) 67
(Decrease) increase in federal funds purchased - (12,716) 12,301
Increase in FHLB borrowings 13,800 16,200 5,000
Increase in securities sold under agreement 5,236 1,501 15,213
Cash dividends and fractional shares (5,584) (4,910) (3,705)
Dividends reinvestment (20) - 691
Stock options 112 422 (585)
------------------------- --------- ---------
Net cash provided by financing activities 67,479 51,116 36,980
------------------------- --------- ---------
Net (decrease) increase in cash and cash equivalents (5,200) 13,787 (14,116)
Cash and cash equivalents at beginning of year 50,607 36,820 50,936
------------------------- --------- ---------
Cash and cash equivalents at end of the year $ 45,407 $ 50,607 $ 36,820
========================= ========= =========
Cash paid during the year for:
Interest $ 29,030 $ 25,021 $ 19,725
Income taxes 3,710 4,398 4,315
========================= ========= =========
Supplemental disclosure of noncash investing
and financing activities:
Transfer of assets from loans to
other real estate owned $ 1,243 $ 1,208 $ 859
========================= ========= =========
Transfer of securities from investment securities held to
maturity to investment securities available for sale $ - $ 39,947 $ 6,029
========================= ========= =========
<FN>
See accompanying notes to consolidated financial statements.
</TABLE>
PAGE 11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Harleysville National Corporation (the "Corporation") through its
subsidiary banks, Harleysville National Bank and Trust Company, Citizens
National Bank of Lansford, and Security National Bank (collectively the
"Banks"), provides a full range of banking services to individual and
corporate customers located in eastern Pennsylvania. The Banks compete with
other banking and financial institutions in their primary market communities,
including financial institutions with resources substantially greater than
their own. Commercial banks, savings banks, savings and loan associations,
credit unions and money market funds actively compete for deposits and for
types of loans. Such institutions, as well as consumer finance and insurance
companies, may be considered competitors of the Banks with respect to one or
more of the services they render. In addition to being subject to competition
from other financial institutions, the Banks are subject to federal and state
laws and to regulations of certain federal agencies, and, accordingly, they
are periodically examined by those regulatory authorities.
BASIS OF FINANCIAL STATEMENT PRESENTATION
The accounting and reporting policies of the Corporation and its
Subsidiaries conform with generally accepted accounting principles. All
significant intercompany transactions are eliminated in consolidation and
certain reclassifications are made when necessary to conform with the previous
years' financial statements to the current year's presentation. In preparing
the consolidated financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities as of the dates of the balance sheets and revenues and
expenditures for the periods presented. Therefore, actual results could
differ significantly from those estimates.
INVESTMENT SECURITIES
The Corporation adopted Statement of Financial Accounting Standards
(SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," on January 1, 1994, which requires among other things, that debt
and equity securities classified as available for sale be reported at fair
value with unrealized gains and losses excluded from earnings and reported in
a separate component of shareholders' equity, net of income taxes. The net
effect of unrealized gains or losses, caused by marking an available-for-sale
portfolio to market, could cause fluctuations in the level of shareholders'
equity and equity-related financial ratios as market interest rates cause the
fair value of fixed-rate securities to fluctuate.
Investment securities are classified as held to maturity when the
Corporation and its Subsidiaries have the ability and intent to hold those
securities to maturity. These investment securities are carried at cost,
adjusted for amortization of premiums and accretion of discounts.
Investment securities expected to be held for an indefinite period of
time are classified as available for sale and are stated at the lower of
aggregate cost or market value. Investment securities expected to be held for
an indefinite period of time include securities that management intends to use
as part of its asset/liability strategy (other than securities that are
intended to be held to maturity because they offset core deposits that have
demonstrated stability) or that may be sold in response to changes in interest
rates, changes in prepayment risks, the need to increase regulatory capital or
other similar factors. Realized gains and losses on the sale of investment
securities are recognized using the specific identification method and are
included in the consolidated statements of income.
LOANS
Loans are stated at the principal amount outstanding. Net loans
represent the principal loan amount outstanding reduced by unearned income and
allowance for loan losses. Interest on commercial and industrial, real
estate, consumer loans and direct installment loans is credited to income
based on the principal amount outstanding. Interest on indirect installment
loans is credited to income using the actuarial method.
Lease financing represents automobile and equipment leasing. The lease
financing receivable included in loans is stated at the gross amount of lease
payments receivable plus the residual value less income to be earned over the
life of the leases. Such income is recognized over the term of the leases
using the level yield method.
Loan origination fees and direct loan origination costs of completed
loans are deferred and recognized over the life of the loan as an adjustment
to yield. The net loan origination fees recognized as yield adjustments are
reflected in total interest income in the consolidated statements of income,
and the unamortized balance of such net loan origination fees is reported in
the consolidated balance sheets as part of unearned income.
Income recognition of interest is discontinued when, in the opinion of
management, the collectibility of such interest becomes doubtful. A loan is
generally classified as nonaccrual when principal or interest has consistently
been in default for a period of 90 days or more or because of a deterioration
in the financial condition of the borrower, and payment in full of principal
or interest is not expected. Loans past due 90 days or more and still
accruing interest are loans that are generally well-secured and expected to be
restored to a current status in the near future.
The Corporation adopted SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors
for Impairment of a Loan-Income Recognition and Disclosures," on January 1,
1995. This new standard requires that a creditor measure impairment based on
the present value of expected future cash flows discounted at the loan's
effective interest rate, except that as a practical expedient, a creditor may
measure impairment based on a loan's observable market price, or the fair
value of the collateral if the loan is collateral dependent. Regardless of
the measurement method, a creditor must measure impairment based on the fair
value of the collateral when the creditor determines that foreclosure is
probable. The adoption of SFAS No. 114, as amended by SFAS No. 118, on
January 1, 1995, did not have a material impact on the Corporation's
consolidated financial position or results of operations.
On January 1, 1996, the Corporation adopted SFAS No. 122, "Accounting for
Mortgage Servicing Rights," which requires that a mortgage banking enterprise
recognize as separate assets rights to service mortgage loans for others,
however those servicing rights are acquired. In circumstances where mortgage
loans are originated, separate asset rights to service mortgage loans are only
recorded when the enterprise intends to sell such loans. The adoptions of
SFAS No. 122 did not have a material impact on the Corporation's consolidated
financial position or results of operations.
PAGE 12
The Financial Accounting Standards Board (FASB) issued SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," as amended by SFAS No. 127, which provides
accounting guidance on transfers of financial assets, servicing of financial
assets, and extinguishments of liabilities. This statement is effective for
transfers of financial assets, servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996. Adoption of
this new statement is not expected to have a material impact on the
Corporation's consolidated financial position or results of operations.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level that management
considers adequate to provide for potential losses based upon an evaluation of
known and inherent risks in the loan portfolio. Allowance for loan losses is
based on estimated net realizable value unless it is probable that loans will
be foreclosed, in which case allowance for loan losses is based on fair value
less selling costs. Management's periodic evaluation is based upon evaluation
of the portfolio, past loss experience, current economic conditions and other
relevant factors. While management uses the best information available to
make such evaluations, future adjustments to the allowance may be necessary if
economic conditions differ substantially from the assumptions used in making
the evaluation. In addition, various regulatory agencies, as an integral part
of their examination process, periodically review the Banks' allowances for
loan losses. Such agencies may require the Banks to recognize additions to
the allowance based on their judgment of information available to them at the
time of their examination.
BANK PREMISES AND EQUIPMENT
Bank premises and equipment are stated at cost less accumulated
depreciation. Depreciation is recorded using the straight-line and
accelerated depreciation methods over the estimated useful life of the assets.
Leasehold improvements are amortized over the term of the lease or estimated
useful life, whichever is shorter.
On January 1, 1996, the Corporation adopted SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of",
which provides guidance on when to recognize and how to measure impairment
losses of long-lived assets and certain identifiable intangibles and how to
value long-lived assets to be disposed of. The adoption of SFAS No. 121 did
not have a material impact on the Corporation's consolidated financial
position or results of operations.
OTHER REAL ESTATE OWNED
Other real estate owned includes foreclosed real estate which is carried
at the lower of cost (lesser of carrying value of loan or fair value at date
of acquisition) or estimated fair value less selling costs. Any write-down,
at or prior to the dates the real estate is considered foreclosed, is charged
to the allowance for loan losses. Subsequent write-downs are recorded in
other expenses, and expenses incurred in connection with holding such assets
and any gains or losses upon their sale are included in other income and
expenses.
INTANGIBLE ASSETS
Intangible assets consist of a core deposit intangible which represents
the present value of the difference in costs between the acquired core
deposits and the market alternative funding sources and a covenant not to
compete. The intangibles are being amortized over a 10-year life on an
accelerated basis. The amortization charged to income was $301,560, $355,140
and $617,500 for the years ended December 31, 1996, 1995 and 1994,
respectively.
STOCK OPTIONS
On January 1, 1996, the Corporation adopted SFAS No. 123, "Accounting for
Stock-Based Compensation," which contains a fair value-based method for
valuing stock-based compensation that entities may use, which measures
compensation cost at the grant date based on the fair value of the award.
Compensation is then recognized over the service period, which is usually the
vesting period. Alternatively, the standard permits entities to continue
accounting for employee stock options and similar instruments under Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees." Entities that continue to account for stock options using APB
Opinion No. 25 are required to make pro forma disclosures of net income and
earnings per share, as if the fair value-based method of accounting defined in
SFAS No. 123 had been applied. The Corporation's employee stock option plan
is accounted for under APB Opinion No. 25. Accordingly, the adoption of SFAS
No. 123 did not have an impact on the Corporation's consolidated financial
position or results of operations.
INCOME TAXES
The Corporation accounts for income taxes under the liability method
specified by SFAS No. 109, "Accounting for Income Taxes." Under SFAS 109,
deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
taxes of a change in tax rates is recognized in income in the period that
includes the enactment date. The principal types of accounts, resulting in
differences between assets and liabilities for financial statement and tax
return purposes, are the allowance for possible loan losses, leased assets,
deferred loan fees and compensation.
PENSION PLANS
The Corporation has certain employee benefit plans covering substantially
all employees. The Corporation accrues service cost as incurred.
ADVERTISING COSTS
The Corporation expenses advertising costs as incurred.
RESTRICTIONS ON CASH AND DUE FROM BANKS
Aggregate reserves (in the form of deposits with the Federal Reserve
Bank) of $8,678,000 were maintained to satisfy federal regulatory
requirements at December 31, 1996.
NET INCOME PER SHARE
Net income per share was computed by dividing net income by the weighted
average number of shares of common stock outstanding during the year,
including the effects of dilutive stock options, and after giving retroactive
effect to the following events: the shares issued when Security National Bank
(1994) and Farmers & Merchants Bank (1996) were acquired by the Corporation
and accounted for on a pooling-of-interests basis and the 5% stock dividends
issued in 1996 and 1994.
PAGE 13
STATEMENTS OF CASH FLOWS
For purposes of the consolidated statements of cash flows, the
Corporation considers cash, amounts due from banks and federal funds sold to
be cash equivalents. Generally, federal funds are sold for one-day periods.
2-ACQUISITIONS
On March 1, 1996, the Corporation consummated the acquisition of
Farmers & Merchants Bank (Honesdale, PA) ("Farmers"). The acquisition was
pursuant to an Agreement and Plan of Reorganization and an Agreement and Plan
of Merger (the "Agreements") which were executed on September 7, 1995. The
Agreements delineate the terms of the combination. The shareholders of
Farmers approved the acquisition at a meeting of shareholders on January 31,
1996. For each share of Farmers common stock outstanding, 0.6190 shares of
the Corporation's Common Stock were issued at the effective date on March 1,
1996. As a result of the transaction, 438,126 new shares of the Corporation's
Common Stock, par value $1.00 per share, were issued on March 1, 1996 pursuant
to the Agreements. Farmers' banking operations were merged into those of
Citizens. The Farmers acquisition was accounted for on a pooling-of-interest
basis, and all prior periods have been restated to reflect the combination as
follows:
<TABLE>
<CAPTION>
(Dollars in thousands)
Revenue Net Income
------- ----------
Year Ended December 31, 1996
- -------------------------------------------------
<S> <C> <C>
Harleysville National Corporation 78,115 14,282
Farmers & Merchants Bank, as of February 29, 1996 718 126
------- ----------
Total 78,833 14,408
======= ==========
Year Ended December 31, 1995
- -------------------------------------------------
Harleysville National Corporation 68,650 11,776
Farmers & Merchants Bank 4,278 652
------- ----------
Total 72,928 12,428
======= ==========
Year Ended December 31, 1994
- -------------------------------------------------
Harleysville National Corporation 59,139 10,745
Farmers & Merchants Bank 3,988 535
------- ----------
Total 63,127 11,280
======= ==========
</TABLE>
On July 1, 1994, the Corporation completed the acquisition of Security
National Bank ("Security"). Under the terms of the merger, each share of
Security Common Stock was converted into 0.7483 shares of the Corporation's
Common Stock, par value $1.00 per share, resulting in the issuance of 211,456
shares of the Corporation's Common Stock. Security operates as a wholly-owned
subsidiary of the Corporation. This transaction was accounted for under the
pooling-of-interests method of accounting and all prior periods have been
restated to reflect the combination as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) Revenue Net Income
------- -----------
Year Ended December 31, 1994
- --------------------------------------------
<S> <C> <C>
Harleysville National Corporation 61,771 11,558
Security National Bank, as of June 30, 1994 1,356 (278)
------- -----------
Total 63,127 11,280
======= ===========
</TABLE>
3-INVESTMENT SECURITIES
The amortized cost, unrealized gains and losses, and the estimated
market values of the Corporation's investment securities held to maturity
and available for sale are as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) December 31, 1996
------------------
Held to Maturity
- ---------------------------
<S> <C> <C> <C> <C>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains (Losses) Value
---------- ------------------ ------------ ----------
Obligations of other U.S.
Government agencies
and corporations $ 33,129 $ 481 ($39) $ 33,571
Obligations of states and
political subdivisions 26,701 962 (38) 27,625
Mortgage-backed securities 1,499 - (9) 1,490
Other securities 3,897 100 (3) 3,994
---------- ------------------ ------------ ----------
Totals $ 65,226 $ 1,543 $ (89) $ 66,680
========== ================== ============ ==========
</TABLE>
Available for Sale
- --------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
U.S. Treasury notes $34,964 $ 293 $(130) $ 35,127
Obligations of other U.S.
Government agencies
and corporations 43,656 349 (120) 43,885
Obligations of states and
political subdivisions 61,432 1,154 (163) 62,423
Mortgage-backed securities 55,468 478 (435) 55,511
Other securities 9,954 2,956 (61) 12,849
-------- ------ ------ --------
Totals $205,474 $5,230 $(909) $209,795
======== ====== ====== ========
</TABLE>
December 31, 1995
-------------------
Held to Maturity
- ------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
U.S. Treasury notes $1,494 $ 16 $ - $ 1,510
Obligations of other U.S.
Government agencies
and corporations 49,038 1,008 (7) 50,039
Obligations of states and
political subdivisions 26,246 782 (25) 27,003
Mortgage-backed securities 378 10 - 388
Other securities 6,513 199 - 6,712
------- ------ ----- -------
Totals $83,669 $2,015 $(32) $85,652
======= ====== ===== =======
</TABLE>
Available for Sale
- --------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
U.S. Treasury notes $ 36,181 $ 248 $ (56) $ 36,373
Obligations of other U.S.
Government agencies
and corporations 10,256 10 (122) 10,144
Obligations of states and
political subdivisions 31,820 270 (568) 31,522
Mortgage-backed securities 69,088 547 (497) 69,138
Other securities 9,884 2,282 (17) 12,149
-------- ------ -------- --------
Totals $157,229 $3,357 $(1,260) $159,326
======== ====== ======== ========
</TABLE>
PAGE 14
There are no significant concentrations of securities (greater than
10% of shareholders' equity) in any individual security issuer.
Securities with a carrying value of $91,506,000 and $50,743,000 at
December 31, 1996 and 1995, respectively, were pledged to secure public funds,
government deposits and repurchase agreements.
The amortized cost and estimated market value of investment
securities, at December 31, 1996, by contractual maturities, are shown below.
Actual maturities will differ from contractual maturities because issuers and
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties.
<TABLE>
<CAPTION>
(Dollars in thousands) Held To Maturity Available For Sale
----------------- -------------------
Estimated Estimated
Amortized Market Amortized Market
Cost Value Cost Value
----------------- ---------- ------------------- ----------
<S> <C> <C> <C> <C>
Due in one year or
less $ 5,410 $ 5,422 $ 6,342 $ 6,344
Due after one year
through five years 23,156 23,638 44,739 44,909
Due after five years
through ten years 19,206 19,493 43,989 44,261
Due after ten years 15,955 16,637 54,936 58,770
----------------- ---------- ------------------- ----------
63,727 65,190 150,006 154,284
Mortgage-backed
securities 1,499 1,490 55,468 55,511
----------------- ---------- ------------------- ----------
Totals $ 65,226 $ 66,680 $ 205,474 $ 209,795
================= ========== =================== ==========
</TABLE>
Proceeds from sales of investment securities available for sale during
1996 were $64,327,000. Gross gains of $168,000 and gross losses of $207,000
were realized on these sales. Proceeds from sales of investment securities
available for sale during 1995 were $10,887,000. Gross gains of $27,000 and
gross losses of $199,000 were realized on these sales. Proceeds from sales of
investment securities available for sale during 1994 were $41,941,000. Gross
gains of $1,366,000 and gross losses of $725,000 were realized on these sales.
4-LOANS
Major classifications of loans are as follows:
<TABLE>
<CAPTION>
December 31,
-------------
<S> <C> <C>
(Dollars in thousands) 1996 1995
------------- --------
Real estate $ 237,155 $227,458
Commercial and industrial 164,327 165,491
Installment 190,745 157,806
Student loans 11,999 7,680
Consumer loans 29,527 29,212
Lease financing 49,623 43,942
Other 5,827 6,631
------------- --------
Total loans 689,203 638,220
Less:
Unearned income 7,793 9,482
Allowance for loan losses 10,710 9,891
------------- --------
Net Loans $ 670,700 $618,847
============= ========
</TABLE>
On December 31, 1996, nonaccrual loans were $2,983,000, loans 90 days or
more past due and still accruing interest were $1,848,000 and troubled debt
restructured loans were $1,717,000. On December 31, 1995, nonaccrual loans
were $9,054,000, loans 90 days or more past due and still accruing interest
were $1,553,000 and troubled debt restructured loans were $1,183,000. The
$6,071,000 reduction in nonaccrual loans from December 31, 1995 to December
31, 1996, is primarily due to one loan being upgraded to accrual status during
1996. This loan achieved accrual status after meeting appropriate standards.
The balance of impaired loans was $4,159,000 at December 31, 1996,
compared to $9,278,000 at December 31, 1995. The Banks have identified a loan
as impaired when it is probable that interest and principal will not be
collected according to the contractual terms of the loan agreement. The
December 31, 1996 impaired loan balance included $2,442,000 of nonaccrual
loans and $1,717,000 of troubled debt restructured loans. The December 31,
1995 impaired loan balance included $8,095,000 of nonaccrual loans and
$1,183,000 of troubled debt restructured loans. The allowance for loan loss
associated with the impaired loans was $533,000 at December 31, 1996 and
$1,122,000 at December 31, 1995. The average impaired loan balance was
$9,333,000 in 1996, compared to $3,906,000 in 1995. The income recognized on
impaired loans during 1996 and 1995 was $814,000 and $231,000, respectively.
The Banks' policy for interest income recognition on impaired loans is to
recognize income on restructured loans under the accrual method. The Banks
recognize income on nonaccrual loans under the cash basis when the loans are
both current and the collateral on the loan is sufficient to cover the
outstanding obligation to the Banks. The Banks will not recognize income if
these factors do not exist.
The Banks have no concentration of loans to borrowers engaged in similar
activities which exceeded 10% of total loans at December 31, 1996 and 1995.
The Banks continued to pursue new lending opportunities while seeking to
maintain a portfolio that is diverse as to industry concentration, type and
geographic distribution. The Banks' geographic lending area is primarily
concentrated in Montgomery, Carbon, Bucks and Wayne counties, but also
includes Chester and Berks counties.
Loans to directors, executive officers and their associates, are made in
the ordinary course of business and on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with others. Activity of these loans is as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) Year Ended December 31,
<S> <C> <C> <C>
1996 1995 1994
---------- -------- --------
Balance, January 1 $12,586 $11,618 $ 8,893
New loans 7,721 8,592 9,757
Repayments (12,584) (7,624) (7,032)
---------- -------- --------
Balance, December 31 $ 7,723 $12,586 $11,618
=========== ======== ========
</TABLE>
PAGE 15
5-ALLOWANCE FOR LOAN LOSSES
Transactions in the allowance for loan losses are as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) Year Ended December 31,
-------------------------
<S> <C> <C> <C>
1996 1995 1994
------------------------- ------- --------
Balance, beginning of year $ 9,891 $8,150 $ 6,087
------------------------- ------- --------
Provision charged to
operating expenses 2,082 2,172 2,665
------------------------- ------- --------
Loans charged off:
Commercial and industrial (392) (240) (491)
Installment (614) (277) (387)
Real estate (412) (127) (84)
Lease financing (33) (39) (44)
------------------------- ------- --------
Total charged off (1,451) (683) (1,006)
------------------------- ------- --------
Recoveries:
Commercial and industrial 84 143 170
Installment 56 72 152
Real estate 30 1 56
Lease financing 18 36 26
------------------------- ------- --------
Total recoveries 188 252 404
------------------------- ------- --------
Balance, end of year $ 10,710 $9,891 $ 8,150
========================= ======= ========
</TABLE>
6-BANK PREMISES AND EQUIPMENT
Bank premises and equipment consist of the following:
<TABLE>
<CAPTION>
(Dollars in thousands)
Estimated
Useful December 31,
Lives 1996 1995
----------- ------------- -------
<S> <C> <C> <C>
Land $ 2,539 $ 2,439
Building 15-30 years 13,443 10,490
Furniture, fixtures and equipment 3-10 years 10,308 9,148
------------- -------
Total cost 26,290 22,077
Less accumulated depreciation and
amortization 11,480 10,082
------------- -------
$ 14,810 $11,995
============= =======
</TABLE>
7-DEPOSITS AND BORROWINGS
At December 31, 1996, scheduled maturities of certificates of deposit are
as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) Year Ended December 31,
----------------------
1997 1998 1999 2000 2001 Thereafter Total
------ ------- ------- ------- ------ ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Amount $209,642 $87,668 $25,835 $16,874 $5,456 $ 386 $345,861
======== ======= ======= ======= ====== =========== ========
</TABLE>
Borrowings, primarily advances from the FHLB, consist of the following:
<TABLE>
<CAPTION>
(Dollars in thousands) December 31,
------------
<S> <C> <C>
Description 1996 1995
- --------------------------------------------------- ------------- -------
Notes payable to FHLB, with fixed rates payable
between 4.97% and 6.57% $ 21,500 $ 8,200
Notes payable to FHLB, with variable rates payable
at 3 month Libor 5,500 -
Notes payable to FHLB, with variable rates payable
at 3 month Libor plus 5 basis points - 8,000
Notes payable to FHLB, with variable rates payable
at 3 month Libor plus 3 basis points 3,000 -
Notes payable to FHLB, with variable rates payable
at prime less 205 basis points 5,000 5,000
------------- -------
$ 35,000 $21,200
============= =======
</TABLE>
Advances are made pursuant to several different credit programs offered from
time to time by the FHLB. Unused lines of credit at the FHLB were
$181,417,000 at December 31, 1996 and $216,344,000 at December 31, 1995.
Outstanding borrowings mature as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
1997 $33,000
1998 1,500
1999 -
2000 500
-------
$35,000
=======
</TABLE>
8-FEDERAL INCOME TAXES
Income tax expense from current operations is composed of the
following:
<TABLE>
<CAPTION>
(Dollars in thousands) Year Ended December 31,
------------------------
<S> <C> <C> <C>
1996 1995 1994
---------- ------ ------
Current tax payable $ 4,699 $3,905 $4,663
Deferred income tax 894 445 104
Charge in lieu of income tax - 927 -
---------- ------ ------
Tax expense $ 5,593 $5,277 $4,767
========== ====== ======
</TABLE>
The effective income tax rates of 28.0% for 1996, 29.8% for 1995 and
29.7% for 1994 were less than the applicable federal income tax rate of 35%
for each year. The reason for these differences follows:
<TABLE>
<CAPTION>
(Dollars in thousands) Year Ended December 31,
-------------------------
<S> <C> <C> <C>
1996 1995 1994
---------- ------- -------
Expected tax expense $ 6,800 $6,020 $5,608
Tax-exempt income (net of
expense disallowance) (1,414) (999) (943)
Other 207 256 102
---------- ------- -------
Actual tax expense $ 5,593 $5,277 $4,767
========== ======= =======
</TABLE>
PAGE 16
The tax effect of temporary differences that give rise to
significant portions of deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) 1996 1995
------ ------
<S> <C> <C> <C> <C>
Asset Liability Asset Liability
------ ---------- ------ ----------
Allowance for possible
credit losses $3,742 $ - $3,378 $ -
Lease assets - 7,509 - 6,383
Deferred loan fees 739 - 962 -
Deferred compensation 527 - 460 -
Unrealized gains on securities - 1,512 - 714
Other 227 - 223 20
------ ---------- ------ ----------
Total deferred taxes $5,235 $ 9,021 $5,023 $ 7,117
====== ========== ====== ==========
</TABLE>
The exercise of stock options which have been granted under the
Corporation's various stock option plans gives rise to compensation, which is
includable in the taxable income of the applicable employees and deductible by
the Corporation for income tax purposes. Compensation resulting from
increases in the fair market value of the Corporation's Common Stock
subsequent to the date of grant of the applicable exercised stock options is
not recognized, in accordance with APB Opinion No. 25, as an expense for
financial accounting purposes and the related tax benefits are taken directly
to Additional Paid in Capital. For the year ended December 31, 1995, such
deductions resulted in $926,833 of income tax benefits which increased the
Additional Paid in Capital.
9-PENSION PLANS
The Corporation has noncontributory defined benefit pension plans
covering substantially all employees. Benefits are based on years of service
and the employee's average compensation during any five consecutive years
within the 10-year period preceding retirement.
The plans' funded status and amounts recognized in the financial
statements follow:
<TABLE>
<CAPTION>
<S> <C> <C>
(Dollars in thousands) 1996 1995
------- -------
Plans' assets at fair value $5,436 $4,187
Projected benefit obligation
(including an accumulated benefit obligation of
$3,577 in 1996, $3,220 in 1995, and
a vested benefit obligation of $3,430 in
1996, and $3,083 in 1995) 5,034 4,134
------- -----
Plans' assets in excess (deficit) of
projected benefit obligation 402 53
Unrecognized net gain from past
experience being different from
that which was assumed 801 408
Unrecognized prior service cost 29 33
Unrecognized net assets at January 1, 1987,
being recognized over 15 years (241) (271)
------- -------
Prepaid pension cost $ 991 $ 223
======= =======
</TABLE>
Net pension cost for the years ended December 31, 1996, 1995 and 1994
included the following components:
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Service cost $ 242 $ 280 $ 225
Interest cost 147 93 64
Actual return on plans' assets (30) (204) 37
Net amortization and deferral (38) 156 (47)
------ ------ ------
Net periodic pension cost $ 321 $ 325 $ 279
====== ====== ======
</TABLE>
The weighted average discount rate used in determining the actuarial
present value of the projected benefit obligation was 7.15%, 7.0% and 7.05% in
1996, 1995 and 1994, respectively. The rate of increase in future
compensation levels was 5.35% for all years. The expected long-term rate of
return on assets was 7.50%, 7.85% and 7.90% in 1996, 1995 and 1994,
respectively.
The Banks had a profit sharing plan for eligible employees. The
continuation of the profit sharing plan was voluntary on the part of the
Banks. The Banks expressly reserved the right to amend or terminate the plan
and to reduce, suspend or discontinue contributions at any time. In 1996, the
profit sharing plan was modified to a 401 (K) plan. All employees may
contribute up to a maximum of 15% of salary on a pre-tax basis with a 50%
employer match up to a maximum of 3% of salary. Contributions charged to
earnings were $699,282, $1,081,068, and $971,640 for 1996, 1995 and 1994,
respectively.
The Corporation has a Supplemental Executive Retirement Plan (SERP) for
certain individuals. The SERP provides for payments based on a certain
percentage of salary for a period of 10 years after retirement. As of
December 31, 1996 and 1995, the Corporation had accrued a liability of
$759,950 and $634,882, respectively, for the SERP.
10-SHAREHOLDERS' EQUITY
On June 28, 1996, the Corporation paid a 5% stock dividend on its
common stock to shareholders of record as of June 14, 1996.
On December 30, 1994, the Corporation paid a 5% stock dividend on its
common stock to shareholders of record as of December 16, 1994.
PAGE 17
11-STOCK OPTIONS
The Corporation has fixed stock option plans accounted for under APB
Opinion No. 25 and related Interpretations. The plans allow the Corporation
to grant options to employees for up to 577,671 shares of common stock. The
options have a term of 10 years when issued and are completely vested over a
five-year period. The exercise price of each option equals the market price
of the Corporation's stock on the date of grant. Accordingly, no compensation
cost has been recognized for the plans. Had compensation cost for the plans
been determined based on the fair value of the options at the grant dates
consistent with the method of Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" (SFAS No. 123), the
Corporation's 1996 and 1995 net income and earnings per share would not be
materially different from amounts reported.
Under the Corporation's stock option plans, the exercisable option prices
ranged from $7.98 to $25.60 at December 31, 1996. A summary of the status of
the Corporation's fixed stock option plans as of December 31, 1996, 1995 and
1994, and changes during the years ending on those dates is presented below.
<TABLE>
<CAPTION>
1996 1995 1994
-------- --------- ---------
<S> <C> <C> <C>
Number of Common Shares:
Outstanding, January 1* 68,431 230,516 353,869
Granted - 4,804 -
Exercised (15,977) (166,889) (123,353)
-------- --------- ---------
Outstanding, December 31 52,454 68,431 230,516
======== ========= =========
Exercisable, December 31 52,454 63,627 230,516
======== ========= =========
<FN>
* Adjusted for stock splits and stock dividends.
</TABLE>
12-COMMITMENTS AND CONTINGENT LIABILITIES
Based on consultation with the Corporation's legal counsel, management is
not aware of any litigation that would have a material adverse effect on the
consolidated financial position of the Corporation. There are no proceedings
pending other than the ordinary routine litigation incident to the business of
the Corporation and its Subsidiaries. In addition, no material proceedings
are pending or are known to be threatened or contemplated against the
Corporation or its Subsidiaries by government authorities.
Lease commitments for equipment and banking locations expire
intermittently over the years through 2036. Most banking location leases
require the lessor to pay insurance, maintenance costs and property taxes.
Approximate minimum rental commitments for existing operating leases at
December 31, are as follows:
<TABLE>
<CAPTION>
Total
Operating
Leases
----------
<S> <C>
1997 $1,065,000
1998 $ 976,000
1999 $ 684,000
2000 502,000
2001 443,000
Thereafter 2,061,000
----------
Total $5,731,000
==========
</TABLE>
Total lease expense amounted to $895,000 in 1996, $770,000 in 1995 and
$537,000 in 1994.
13-FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Banks have not entered into any interest rate swaps, caps, floors or
collars and are not a party to any forward or futures transactions. However,
the Banks are a party to various other financial instruments at December 31,
1996 and 1995 which are not included in the consolidated financial statements,
but are required in the normal course of business to meet the financing needs
of its customers and to assist in managing its exposure to changes in interest
rates. Management does not expect any material losses from these
transactions, which include standby letters of credit at December 31, 1996 and
1995 of $6,568,000 and $5,698,000, respectively; commitments to extend credit
of $22,243,000 and $20,516,000, respectively, for revolving home equity lines;
$74,482,000 and $59,540,000, respectively, for commercial and real estate
loans; and $17,931,000 and $17,462,000, respectively, for consumer loans.
The Banks' exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual or notional
amounts of those instruments. The Banks use the same stringent credit
policies in extending these commitments as they do for recorded financial
instruments and control their exposure to loss through credit approval and
monitoring procedures. These commitments are generally issued for one year or
less, often expire without being drawn upon, and often are secured with
appropriate collateral.
The Banks offer commercial, mortgage and consumer credit products to
their customers in the normal course of business, which are detailed in note
4. These products represent a diversified credit portfolio and are generally
issued to borrowers within the Banks' branch office systems in eastern
Pennsylvania. The ability of the customers to repay their credits is, to some
extent, dependent upon the economy in the Banks' market areas.
14-REGULATORY CAPITAL
The Banks 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 financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Banks must meet specific capital guidelines that involve quantitative
measures of the Banks' assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. The Banks' capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.
PAGE 18
Quantitative measures established by regulation to ensure capital
adequacy require the Banks to maintain minimum amounts and ratios (set forth
in the table below) of total and Tier 1 capital to risk-weighted assets.
Management believes, as of December 31, 1996, that the Banks meet all capital
adequacy requirements to which they are subject.
As of December 31, 1996, the Banks met all regulatory requirements for
classification as "well-capitalized" institutions. To be categorized as well
capitalized, the Banks must maintain minimum total risk-based, Tier 1
risk-based, Tier 1 leverage ratios as set forth in the table. There are no
conditions or events which have occurred that management believes have changed
the institutions' category.
<TABLE>
<CAPTION>
(Dollars in thousands) Leverage Ratio
------------------
December 31, 1996 December 31, 1995
------------------ ------------------
Amount Ratio Amount Ratio
---------- ------ --------- ------
<S> <C> <C> <C> <C>
Entity:
Corporation $93,164 9.21% $83,019 8.99%
Subsidiaries:
Harleysville National Bank 67,253 8.34 58,330 7.99
Citizens National Bank 20,031 13.08 19,193 13.10
Security National Bank 3,885 6.81 3,693 8.32
"Well Capitalized" institution
(under FDIC regulations) 5.00 5.00
</TABLE>
<TABLE>
<CAPTION>
(Dollars in thousands) Tier 1 Capital to Risk-Weighted Assets
--------------------------------------
December 31, 1996 December 31, 1995
------------------- ------------------
Amount Ratio Amount Ratio
-------- ------ ------- ------
<S> <C> <C> <C> <C>
Entity:
Corporation $93,164 13.12% $83,019 12.47%
Subsidiaries:
Harleysville National Bank 67,253 11.59 58,330 10.53
Citizens National Bank 20,031 22.60 19,193 23.71
Security National Bank 3,885 9.57 3,693 11.89
"Well Capitalized" institution
(under FDIC regulations) 6.00 6.00
</TABLE>
<TABLE>
<CAPTION>
(Dollars in thousands) Total Capital to Risk-Weighted Asset Ratio
------------------------------------------
December 31, 1996 December 31, 1995
----------------- -----------------
Amount Ratio Amount Ratio
------ ----- ------ -----
<C> <C> <C> <C>
Entity:
Corporation $102,061 14.38% $91,340 13.72%
Subsidiaries:
Harleysville National Bank 74,528 12.85 65,253 11.78
Citizens National Bank 20,993 23.69 20,205 24.96
Security National Bank 4,394 10.83 4,081 13.14
"Well Capitalized" institution
(under FDIC regulations) 10.00 10.00
</TABLE>
The National Banking Laws require the approval of the Office of the
Comptroller of the Currency if the total of all dividends declared by a
national bank in any calendar year exceed the net profits of the bank (as
defined) for that year combined with its retained net profits for the
preceding two calendar years. Under this formula, the Banks may declare
dividends in 1997 of approximately $16,300,000 plus an amount equal to the net
profits of the Banks in 1997 up to the date of any such dividend declaration.
Additionally, banking regulations limit the amount of investments, loans,
extensions of credit and advances that one subsidiary bank can make to the
Corporation at any time to 10% and in the aggregate 20% of the Banks' capital
stock and surplus. These regulations also require that any such investment,
loan, extension of credit or advance be secured by securities having a market
value in excess of the amount thereof. At December 31, 1996, there were no
investments, loans, extensions of credit or advances from any of the
subsidiary banks to the Corporation.
15-FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107 "Disclosures about Fair Values of Financial Instruments,"
requires disclosure of the estimated fair value of an entity's assets and
liabilities considered to be financial instruments. For the Corporation, as
for most financial institutions, the majority of its assets and liabilities
are considered financial instruments as defined in SFAS No. 107. However,
many such instruments lack an available trading market, as characterized by a
willing buyer and seller engaging in an exchange transaction. Also, it is the
Corporation's general practice and intent to hold its financial instruments to
maturity and not to engage in trading or sales activities, except for certain
loans. Therefore, the Corporation had to use significant estimates and
present value calculations to prepare this disclosure.
Changes in the assumptions or methodologies used to estimate fair values
may materially affect the estimated amounts. Also, management is concerned
that there may not be reasonable comparability between institutions due to the
wide range of permitted assumptions and methodologies in the absence of active
markets. This lack of uniformity gives rise to a high degree of subjectivity
in estimating financial instrument fair values.
Estimated fair values have been determined by the Corporation using the
best available data and an estimation methodology suitable for each category
of financial instruments. The estimation methodologies used, the estimated
fair values and recorded book balances at December 31, 1996 and 1995 are
outlined on the next page.
For cash and due from banks, interest-bearing deposits in banks and
federal funds sold, the recorded book values of $45,407,000 and $50,607,000 at
December 31, 1996 and 1995, respectively, approximate fair values. The
estimated fair values of investment securities are based on quoted market
prices, if available. Estimated fair values are based on quoted market prices
of comparable instruments if quoted market prices are not available.
PAGE 19
The loan portfolio, net of unearned income, at December 31, 1996 and 1995
has been valued using a present value discounted cash flow analysis where
market prices were not available. The discount rate used in these
calculations is the estimated current market rate adjusted for credit risk.
The carrying value approximates its fair value.
1996 1995
------------------------ -----------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
----------------------------------------------------
Investment securities $275,021,000 $276,475,000 $242,995,000 $244,978,000
Loans, net $681,410,000 $689,695,000 $628,738,000 $625,495,000
The estimated fair values of demand deposits (i.e., interest and
noninterest bearing checking accounts, savings and certain types of money
market accounts) are, by definition, equal to the amount payable on demand at
the reporting date (i.e., their carrying amounts). The carrying amounts of
variable rate, fixed-term money market accounts and certificates of deposit
approximate their fair values at the reporting date. The carrying amount of
accrued interest receivable and payable approximates fair value.
1996 1995
-------------------------- ---------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
--------------------------------------------------------
Time deposits $345,861,000 $347,382,000 $327,551,000 $329,562,000
The fair values of demand notes, borrowings, and securities sold under
agreements to repurchase of $59,521,000 and $39,751,000 at December 31, 1996
and 1995, respectively, approximate their recorded book balances.
There was no material difference between the notional amount and the
estimated fair value of off-balance-sheet items which totaled approximately
$121,224,000 and $103,216,000 at December 31, 1996 and 1995, respectively, and
primarily comprised unfunded loan commitments which are generally priced at
market at the time of funding.
16-CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY
Condensed financial statements of Harleysville National Corporation
follow:
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
(Dollars in thousands) December 31,
-------------
<S> <C> <C>
1996 1995
------------- -------
Assets:
Cash $ 553 $ 1,544
Investments in subsidiaries 93,724 84,413
Investment securities available for sale 4,809 854
------------- -------
Total assets $ 99,086 $86,811
============= =======
Liabilities and shareholders' equity:
Other liabilities $ 1,455 $ 449
------------- -------
Total liabilities 1,455 449
------------- -------
Shareholders' equity:
Common Stock 6,657 6,316
Additional paid in capital 40,316 30,883
Retained earnings 47,849 47,780
Net unrealized gain on investment
securities available for sale 2,809 1,383
------------- -------
Total shareholders' equity 97,631 86,362
------------- -------
Total liabilities and
shareholders' equity $ 99,086 $86,811
============= =======
</TABLE>
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(Dollars in thousands) Year Ended December 31,
------------------------
<S> <C> <C> <C>
1996 1995 1994
------------------------ ------- -------
Dividends from banks $ 5,584 $ 5,085 $ 3,725
Other income 156 - 1,059
------------------------ ------- -------
Total operating income 5,740 5,085 4,784
------------------------ ------- -------
Operating expense - - -
------------------------ ------- -------
Income before income tax expense and
equity in undistributed net income of banks 5,740 5,085 4,784
Income tax expense 55 - 371
------------------------ ------- -------
Income before equity in undistributed net 5,685 5,085 4,413
income of banks
Equity in undistributed net income of banks 8,723 7,343 6,867
------------------------ ------- -------
Net income $ 14,408 $12,428 $11,280
======================== ======= =======
</TABLE>
PAGE 20
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Dollars in thousands) Year Ended December 31,
-------------------------
<S> <C> <C> <C>
1996 1995 1994
------------------------- -------- --------
Operating activities:
Net income $ 14,408 $12,428 $11,280
Adjustments to reconcile net income
to net cash provided by operating
activities:
Equity in undistributed net income
of banks (8,723) (7,343) (6,967)
Dividends reinvestment - - 691
Realized gain on sale of securities (68) - (1,059)
Net increase in other liabilities 55 - 370
------------------------- -------- --------
Net cash provided by
operating activities 5,672 5,085 4,315
------------------------- -------- --------
Investing activities:
Capital contributions made to the banks - (175) -
Proceeds from sales of securities 405 - 1,084
Purchase of securities
available for sale (1,576) - -
------------------------- -------- --------
Net cash (used in) provided by
investing activities (1,171) (175) 1,084
------------------------- -------- --------
Financing activities:
Cash dividends and fractional shares (5,604) (4,909) (3,697)
Stock options and awards 112 422 (585)
------------------------- -------- --------
Net cash used in financing activities: (5,492) (4,487) (4,282)
------------------------- -------- --------
Net (decrease) increase in cash (991) 423 1,117
Cash and cash equivalents at beginning of year 1,544 1,121 4
------------------------- -------- --------
Cash and cash equivalents at end of year $ 553 $ 1,544 $ 1,121
========================= ======== ========
</TABLE>
17-QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is the summarized (unaudited) consolidated quarterly financial
data of the Corporation which, in the opinion of management, reflects all
adjustments, consisting only of normal recurring adjustments, necessary for
fair presentation of the Corporation's results of operations:
(Dollars in thousands, except per share information)
<TABLE>
<CAPTION>
Three Months Ended
-------------------
<S> <C> <C> <C> <C>
1996: March 31 June 30 Sept. 30 Dec. 31
------------------- -------- --------- --------
Interest income $ 17,967 $ 17,994 $ 18,612 $ 19,145
Net interest income 10,391 10,444 10,840 11,167
Provision for losses 526 529 517 510
Noninterest income 1,229 1,186 1,364 1,336
Operating expenses 6,322 6,076 6,690 6,786
Income before income
tax expense 4,772 5,025 4,997 5,207
Income tax expense 1,388 1,380 1,482 1,343
------------------- -------- --------- --------
Net income $ 3,384 $ 3,645 $ 3,515 $ 3,864
=================== ======== ========= ========
Net income per share $ 0.50 $ 0.55 $ 0.53 $ 0.58
=================== ======== ========= ========
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
1995: March 31 June 30 Sept. 30 Dec. 31
------------------- -------- --------- --------
Interest income $ 16,311 $ 17,180 $ 17,389 $ 17,611
Net interest income 9,765 10,035 9,938 9,969
Provision for losses 536 518 598 520
Noninterest income 912 1,099 1,169 1,257
Operating expenses 5,898 6,055 6,197 6,117
Income before income
tax expense 4,243 4,561 4,312 4,589
Income tax expense 1,248 1,355 1,253 1,421
------------------- -------- --------- --------
Net income $ 2,995 $ 3,206 $ 3,059 $ 3,168
=================== ======== ========= ========
Net income per share $ 0.45 $ 0.48 $ 0.46 $ 0.48
=================== ======== ========= ========
PAGE 21
</TABLE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
CONSOLIDATED SUMMARY OF OPERATIONS
(Dollars in thousands, except per share data and average shares
outstanding)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
<S> <C> <C> <C> <C> <C>
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
INCOME AND EXPENSE:
Interest income $ 73,718 $ 68,491 $ 58,381 $ 53,980 $ 52,584
Interest expense 30,876 28,784 21,101 21,232 24,036
---------- ---------- ---------- ---------- ----------
Net interest income 42,842 39,707 37,280 32,748 28,548
Provision for loan losses 2,082 2,172 2,665 3,085 2,299
---------- ---------- ---------- ---------- ----------
Net interest income after provision for loan losses 40,760 37,535 34,615 29,663 26,249
Noninterest income 5,115 4,437 4,746 4,963 3,552
Noninterest expense 25,874 24,267 23,314 21,436 18,358
---------- ---------- ---------- ---------- ----------
Income before income tax expense and the
cumulative effect of a change in accounting for 20,001 17,705 16,047 13,190 11,443
income taxes
Income tax expense 5,593 5,277 4,767 3,753 3,092
---------- ---------- ---------- ---------- ----------
Income before the cumulative effect of a change
in accounting for income taxes 14,408 12,428 11,280 9,437 8,351
Cumulative effect of a change in accounting for
income taxes - - - 300 92
---------- ---------- ---------- ---------- ----------
Net income $ 14,408 $ 12,428 $ 11,280 $ 9,737 $ 8,443
========== ========== ========== ========== ==========
PER SHARE*:
Primary $ 2.16 $ 1.87 $ 1.71 $ 1.52 $ 1.34
Fully diluted 2.16 1.87 1.71 1.48 1.30
Cash dividends paid 0.84 0.75 0.58 0.47 0.41
Primary average shares outstanding 6,660,530 6,646,957 6,602,678 6,397,995 6,321,360
Diluted average shares outstanding 6,660,530 6,648,976 6,602,678 6,579,304 6,492,320
</TABLE>
*Adjusted for 5% stock dividends effective 6/28/96 and 12/30/94, a two-for-one
stock split effective 12/31/93, and a 5% stock dividend effective 12/31/92.
AVERAGE BALANCE SHEET:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Loans $ 652,157 $607,335 $540,030 $472,319 $414,230
Investments 260,483 226,747 236,319 236,612 207,298
Other interest-earning assets 16,949 14,605 10,351 21,312 30,183
Total assets 978,899 894,350 829,241 776,419 692,912
Deposits 821,387 761,089 738,029 697,993 620,977
Other interest-bearing liabilities 46,813 37,067 8,348 2,372 1,988
Shareholders' equity 91,687 81,788 74,234 66,355 59,246
BALANCE SHEET AT YEAR-END:
Loans $ 681,410 $628,738 $594,754 $498,139 $446,528
Investments 275,021 242,995 216,816 250,608 237,480
Other earning assets 14,475 17,998 2,980 20,351 36,064
Total assets 1,026,128 937,345 862,669 816,314 768,234
Deposits 847,699 794,499 743,326 735,328 693,377
Other interest-bearing liabilities 59,521 39,751 35,322 2,742 3,269
Shareholders' equity 97,631 86,362 74,182 69,357 61,201
</TABLE>
The following discussion and analysis should be read in conjunction with
the detailed information and consolidated financial statements, including
notes thereto, included elsewhere in this report. The consolidated financial
condition and results of operations of the Corporation are essentially those
of the Banks. Therefore, the analysis that follows is directed to the
performance of the Banks. Such financial condition and results of operations
are not intended to be indicative of future performance.
PAGE 22
In addition to historical information, this discussion and analysis
contains forward-looking statements. The forward-looking statements contained
herein are subject to certain risks and uncertainties that could cause actual
results to differ materially from those projected in the forward-looking
statements. Important factors that might cause such a difference include, but
are not limited to, those discussed in the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect management's analysis only as of the date hereof.
The Corporation undertakes no obligation to publicly revise or update these
forward-looking statements to reflect events or circumstances that arise after
the date hereof.
INTRODUCTION
The Corporation's performance for 1996 was highlighted by record
earnings, continued asset growth and improved asset quality. The Corporation
earnings for 1996 were 15.9% higher than 1995 earnings. On March 1, 1996, the
Corporation consummated the acquisition of Farmers & Merchants Bank
("Farmers") and during the third quarter of 1996 the Corporation achieved one
billion dollars in assets. The Farmers acquisition was accounted for on a
pooling-of-interest basis and all prior periods have been restated to reflect
the combination.
Net income amounted to $14,408,000 in 1996, compared to the $12,428,000
reported in 1995. Earnings per share increased 15.5% to $2.16, from $1.87
earned in 1995. Earnings were enhanced by the growth in earning assets,
increase in income from the Trust and Financial Services Department and a
reduction in the FDIC premium expense. Earning assets increased $81,175,000,
or 9.1%, from a year ago.
Continued progress in asset quality was reflected in a decline in
nonperforming assets. During 1996, nonperforming assets excluding loans
over 90 days past due, and still accruing interest were reduced by $5,785,000,
or 50.5%, to $5,672,000. Nonperforming assets as a percentage of total loans
and net assets acquired in foreclosure at December 31, 1996 declined to
0.83%, from 1.82% at December 31, 1995.
INTEREST-EARNING ASSETS AND INTEREST-BEARING LIABILITIES
Average interest-earning assets totaled $929,589,000 in 1996, an increase
of $80,902,000, or 9.5%, compared to 1995. Most of the increase occurred in
the loan and investment portfolios. During 1996, the average balance of the
loan portfolio increased $44,822,000, or 7.4%, while the average balance of
investment securities increased $33,736,000 or 14.9%. Average interest
earning assets were $786,700,000 in 1994.
Average interest-bearing liabilities totaled $745,741,000 in 1996, an
increase of $57,234,000, or 8.3%, compared to 1995. This increase was
attributable to an increase in time, savings and other borrowings of
$27,327,000, $20,161,000 and $9,746,000, respectively. Average interest
bearing liabilities were $640,423,000 in 1994.
The tax-equivalent yield on total interest earning assets amounted to
8.20%, a decline of 7 basis points from 8.27% earned in 1995. The cost of
interest-bearing liabilities decreased 4 basis points from 4.18% in 1995 to
4.14% in 1996. The net interest margin earned of 4.88% was the same in 1996
as it was in 1995. The 1994 tax-equivalent yield on total interest-earning
assets, cost of interest-bearing liabilities and net interest margin were
7.62%, 3.29% and 4.94%, respectively.
PAGE 23
BALANCE SHEET ANALYSIS
The table below presents the major asset and liability categories on
an average daily basis for the periods presented, along with interest
income and expense, and key rates and yields. The assets showing the
greatest increase were loans. On the liability side, the most significant
source of new funds was time deposits.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY, INTEREST RATES
AND INTEREST DIFFERENTIAL:
Year Ended December 31,
-------------------------
<TABLE>
<CAPTION>
(Dollars in thousands) 1996 1995
-------- --------
Average Average Average Average Average
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS Balance Rate Interest Balance Rate Interest Balance
-------- -------- --------- -------- -------- --------- --------
Investment securities:
Taxable investments $186,213 6.50% $ 12,110 $177,583 6.18% $ 10,977 $189,215
Nontaxable investments (1) 74,270 8.33 6,185 49,164 8.36 4,110 47,104
-------- -------- --------- -------- -------- --------- --------
Total investment securities 260,483 7.02 18,295 226,747 6.65 15,087 236,319
Loans (1) (2) 652,157 8.74 57,008 607,335 8.94 54,305 540,030
Other rate-sensitive assets 16,949 5.33 904 14,605 5.72 835 10,351
-------- ----- -------- ------- ---- -------- -------
Total earning assets 929,589 8.20 76,207 848,687 8.27 70,227 786,700
Noninterest-earning assets 49,310 - - 45,663 - - 42,541
-------- -------- --------- -------- -------- --------- --------
Total assets $978,899 7.78% $ 76,207 $894,350 7.85% $ 70,227 $829,241
======== ======== ========= ======== ======== ========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand $122,459 - % $ - $109,649 - % $ - $105,954
Savings 361,890 2.66 9,616 341,729 2.80 9,571 374,976
Time 337,038 5.59 18,854 309,711 5.50 17,045 257,099
-------- -------- --------- -------- -------- --------- --------
Total 821,387 3.47 28,470 761,089 3.50 26,616 738,029
Borrowings and other interest-bearing liabilities 46,813 5.14 2,406 37,067 5.85 2,168 8,348
Other liabilities 19,012 - - 14,406 - - 8,630
-------- -------- --------- -------- -------- --------- --------
Total liabilities 887,212 3.48 30,876 812,562 3.54 28,784 755,007
Shareholders' equity 91,687 - - 81,788 - - 74,234
-------- -------- --------- -------- -------- --------- --------
Total liabilities and shareholders' equity $978,899 3.15% $ 30,876 $894,350 3.22% $ 28,784 $829,241
======== ======== ========= ======== ======== ========= ========
Average effective rate on interest-bearing liabilities $745,741 4.14% $ 30,876 $688,507 4.18% $ 28,784 $640,423
======== ======== ========= ======== ======== ========= ========
Interest Income/Earning Assets $929,589 8.20% $ 76,207 $848,687 8.27% $ 70,227 $786,700
Interest Expense/Earning Assets $929,589 3.32 $ 30,876 $848,687 3.39 $ 28,784 $786,700
-------- --------
Effective Interest Differential 4.88% 4.88%
======== ========
(Dollars in thousands) 1994
--------
Average
<S> <C> <C>
ASSETS Rate Interest
-------- ---------
Investment securities:
Taxable investments 5.37% $ 10,168
Nontaxable investments (1) 8.29 3,904
-------- ---------
Total investment securities 5.95 14,072
Loans (1) (2) 8.42 45,473
Other rate-sensitive assets 4.12 426
-------- ---------
Total earning assets 7.62 59,971
Noninterest-earning assets - -
-------- ---------
Total assets 7.23% $ 59,971
======== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand - % $ -
Savings 2.52 9,468
Time 4.37 11,229
-------- ---------
Total 2.80 20,697
Borrowings and other interest-bearing liabilities 4.84 404
Other liabilities - -
-------- ---------
Total liabilities 2.79 21,101
Shareholders' equity - -
-------- ---------
Total liabilities and shareholders' equity 2.54% $ 21,101
======== =========
Average effective rate on interest-bearing liabilities 3.29% $ 21,101
======== =========
Interest Income/Earning Assets 7.62% $ 59,971
Interest Expense/Earning Assets 2.68 $ 21,101
--------
Effective Interest Differential 4.94%
========
<FN>
(1) The interest earned on nontaxable investment securities and loans
is shown on a tax equivalent basis.
</TABLE>
(2) Nonaccrual loans have been included in the appropriate average loan
balance category, but interest on nonaccrual loans has not been included for
purposes of determining interest income.
PAGE 24
INVESTMENT PORTFOLIO
The following shows the carrying value of the Corporation's investment
securities held to maturity:
<TABLE>
<CAPTION>
December 31,
-----------
<S> <C> <C> <C>
(Dollars in Thousands) 1996 1995 1994
------- ------- -------
U. S. Treasury notes $ - $ 1,494 $ 4,040
Obligations of other U.S. Government agencies
and corporations 33,129 49,038 21,470
Obligations of states and political subdivisions 26,701 26,246 45,585
Mortgage-backed securities 1,499 378 617
Other securities 3,897 6,513 18,657
------- ------- -------
Total $65,226 $83,669 $90,369
======= ======= =======
</TABLE>
The following shows the carrying value of the Corporation's investment
securities available for sale:
<TABLE>
<CAPTION>
December 31,
-----------
<S> <C> <C> <C>
(Dollars in Thousands) 1996 1995 1994
-------- -------- --------
U. S. Treasury notes $ 35,127 $ 36,373 $ 45,832
Obligations of other U.S. Government agencies
and corporations 43,885 10,144 3,810
Obligations of states and political subdivisions 62,423 31,522 974
Mortgage-backed securities 55,511 69,138 69,060
Other securities 12,849 12,149 6,771
-------- -------- --------
Total $209,795 $159,326 $126,447
======== ======== ========
</TABLE>
The Corporation adopted Statement of Financial Accounting (SFAS)
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," on January 1, 1994, which requires, among other things, that
debt and equity securities classified as available for sale be reported at
fair value, with unrealized gains and losses excluded from earnings and
reported in a separate component of shareholders' equity, net of income taxes.
The net effect of unrealized gains or losses, caused by marking an available
for sale portfolio to market, causes fluctuations in the level of
shareholders' equity and equity-related financial ratios as market interest
rates cause the fair value of fixed-rate securities to fluctuate.
Total investment securities at December 31, 1996 of $275,021,000 grew
$32,026,000 over the December 31, 1995 balance of $242,995,000. This growth
was funded by the increase in deposit balances and borrowings during this
period. The investment securities held to maturity decreased $18,443,000
during 1996, as a result of maturities and calls. The investment securities
available for sale increased $50,469,000. The increase in the investments
available for sale were funded by proceeds from the maturities and calls in
the held-to-maturity portfolio and through the increase in deposits and
borrowings during 1996.
In 1995, the Financial Accounting Standards Board gave banks an
opportunity to reassess the appropriateness of the classifications of all
securities held to maturity and account for any resulting reclassifications at
fair value. Reclassifications from the held to maturity category that result
from this one-time reassessment did not call into question the intent of an
enterprise to hold other debt securities to maturity in the future. After
reassessing the investment security portfolio, the Corporation transferred
$39,947,000 from investment securities held to maturity to the investment
securities available for sale on December 21, 1995. This transfer was the
primary reason for the decrease in the balance of investment securities held
to maturity of $6,700,000 from December 31, 1994 to December 31, 1995. The
transfer also contributed to the increase in investment securities available
for sale of $32,879,000 from December 31, 1994 to December 31, 1995.
PAGE 25
There are no significant concentrations of securities (greater than 10% of
shareholders' equity) in any individual security issuer. The maturity
analysis of investment securities held to maturity, including the weighted
average yield for each category, as of December 31, 1996 is as follows:
<TABLE>
<CAPTION>
Under 1 - 5 5 - 10 Over
1 year years years 10 years Total
-------- -------- -------- ---------- -------------
<S> <C> <C> <C> <C> <C>
(Dollars in thousands)
Obligations of other U.S. Government
agencies and corporations:
Carrying value $ 1,200 $13,993 $17,434 $ 502 $ 33,129
Weighted average yield 5.97% 7.25% 7.52% 8.18% 7.36%
Weighted average maturity 6 yrs, 1 mo
Obligations of states and
political subdivisions:
Carrying value 3,210 6,764 1,274 15,453 26,701
Weighted average yield 7.67% 8.53% 8.74% 8.91% 8.65%
Weighted average maturity 9 yrs, 6 mos
Mortgage-backed securities:
Carrying value - - 1,188 311 1,499
Weighted average yield - % - % 6.94% 7.41% 7.39%
Weighted average maturity 7 yrs, 7 mos
Other securities:
Carrying value 1,000 2,399 498 - 3,897
Weighted average yield 6.81% 7.64% 6.81% - % 7.32%
Weighted average maturity 3 yrs, 4 mos
Total:
Carrying value $5,410 $23,156 $20,394 $16,266 $65,226
Weighted average yield 7.13% 7.67% 7.55% 8.85% 7.85%
Weighted average maturity 7 yrs, 4 mos
</TABLE>
The maturity analysis of securities available for sale, including the weighted
average yield for each category, as of December 31, 1996 is as follows:
<TABLE>
<CAPTION>
Under 1 - 5 5 - 10 Over
(Dollars in thousands) 1 year years years 10 years Total
-------- -------- -------- ---------- --------------
<S> <C> <C> <C> <C> <C>
U.S. Treasury notes:
Amortized cost $ 6,007 $28,957 $ - $ - $ 34,964
Weighted average yield 5.50% 6.10% - % - % 5.42%
Weighted average maturity 2 yrs, 5 mos
Obligations of other U.S.
Government agencies and
corporations:
Amortized cost - 3,000 39,655 1,001 43,656
Weighted average yield - % 7.16% 7.22% 7.35% 7.21%
Weighted average maturity 8 yrs, 6 mos
Obligations of states and
political subdivisions:
Amortized cost 335 9,777 4,034 47,286 61,432
Weighted average yield 7.68% 7.33% 7.74% 8.40% 8.18%
Weighted average maturity 12 yrs, 6 mos
Mortgage-backed securities:
Amortized cost 119 11,501 585 43,263 55,468
Weighted average yield 6.86% 6.61% 6.06% 6.77% 6.73%
Weighted average maturity 20 yrs, 0 mos
Other securities:
Amortized cost - 3,005 300 6,649 9,954
Weighted average yield - % 6.00% 6.12% 6.66% 6.44%
Weighted average maturity 5 yrs, 10 mos
Total:
Amortized Cost $6,461 $56,240 $44,574 $98,199 $205,474
Weighted average yield 5.64% 6.47% 7.24% 7.56% 7.13%
Weighted average maturity 11 yrs, 8 mos
</TABLE>
Weighted average yield is computed by dividing the annualized interest
income, including the accretion of discounts and the amortization of premiums,
by the carrying value. Tax-exempt securities were adjusted to a
tax equivalent basis and are based on the federal statutory tax rate of 35%.
PAGE 26
LOANS
The following table shows the composition of the Banks' loans:
<TABLE>
<CAPTION>
December 31,
-------------
<S> <C> <C> <C> <C> <C>
(Dollars in thousands) 1996 1995 1994 1993 1992
------------- -------- -------- -------- --------
Real estate $ 237,155 $227,458 $220,091 $190,684 $176,209
Commercial and industrial 164,327 165,491 156,387 130,525 114,966
Installment 190,745 157,806 148,580 123,076 114,876
Lease financing 49,623 43,942 41,233 32,304 27,399
Other 47,353 43,523 38,590 32,960 28,579
------------- -------- -------- -------- --------
Total $ 689,203 $638,220 $604,881 $509,549 $462,029
============= ======== ======== ======== ========
</TABLE>
Total loans grew $50,983,000, from $638,220,000 at December 31, 1995 to
$689,203,000 at December 31, 1996. The loan growth included increases in
installment, real estate, lease financing and other loans of $32,939,000,
$9,697,000, $5,681,000 and $3,830,000, respectively. The increase in
installment loans included a $16,023,000 increase in indirect installment
loans during 1996. Indirect loans primarily consist of vehicle loans that are
generated through respective dealers.
At December 31, 1996, there were no loan concentrations over 10% of loans
outstanding in any one category or to any one borrower. The Banks have no
foreign loans, and the impact of nonaccrual, restructured troubled debt and
delinquent loans on total interest income was not material.
Management does not believe that there are any trends or uncertainties
which are reasonably expected to materially impact future operating results,
liquidity or capital resources, and management is not aware of any information
not previously disclosed which causes it to have serious doubts as to the
ability of borrowers to comply with the loan repayment terms.
The following table details maturities and interest sensitivity of real
estate, commercial and industrial, installment loans and lease financing at
December 31, 1996:
<TABLE>
<CAPTION>
Within 1 - 5 Over
(Dollars in thousands) 1 year years 5 years Total
------- -------- -------- --------
<S> <C> <C> <C> <C>
Real estate $ 378 $ 10,547 $226,230 $237,155
Commercial and industrial 25,196 71,726 67,405 164,327
Installment 3,205 114,179 73,361 190,745
Lease financing 7,328 42,295 - 49,623
------- -------- -------- --------
Total $36,107 $238,747 $366,996 $641,850
======= ======== ======== ========
Loans with variable or
floating interest rates $21,122 $ 56,419 $142,673 $220,214
Loans with fixed predetermined
interest rates 14,985 182,328 224,323 421,636
------- -------- -------- --------
Total $36,107 $238,747 $366,996 $641,850
======= ======== ======== ========
</TABLE>
A loan is generally classified as nonaccrual when principal or interest
has consistently been in default for a period of 90 days or more or because of
a deterioration in the financial condition of the borrower or payment in full
of principal or interest is not expected. Delinquent loans past due 90 days
or more and still accruing interest are loans that are generally well-secured
and expected to be restored to a current status in the near future. The
following table details those loans that were placed on nonaccrual status,
were accounted for as troubled debt restructurings or were delinquent by 90
days or more and still accruing interest.
<TABLE>
<CAPTION>
December 31,
-------------
<S> <C> <C> <C> <C> <C>
(Dollars in thousands) 1996 1995 1994 1993 1992
------------- ------- ------ ------ ------
Nonaccrual loans $ 2,983 $ 9,055 $2,521 $1,876 $1,385
Trouble debt restructurings 1,717 1,183 1,867 1,548 315
Delinquent loans 1,848 1,553 2,234 2,063 1,408
------------- ------- ------ ------ ------
Total $ 6,548 $11,791 $6,622 $5,487 $3,108
============= ======= ====== ====== ======
</TABLE>
PAGE 27
ALLOWANCE FOR LOAN LOSSES
A summary of the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
December 31,
--------------
<S> <C> <C> <C> <C> <C>
(Dollars in thousands) 1996 1995 1994 1993 1992
-------------- --------- --------- --------- ---------
Average loans $ 652,157 $607,335 $540,030 $472,319 $414,230
============== ========= ========= ========= =========
Allowance, beginning of period $ 9,891 $ 8,150 $ 6,087 $ 4,597 $ 4,131
-------------- --------- --------- --------- ---------
Loans charged off:
Commercial and industrial 392 240 491 1,211 1,010
Installment and other 614 277 387 401 695
Real estate 412 127 84 238 90
Lease financing 33 39 44 92 162
-------------- --------- --------- --------- ---------
Total loans charged off 1,451 683 1,006 1,942 1,957
-------------- --------- --------- --------- ---------
Recoveries:
Commercial and industrial 84 143 170 86 8
Installment and other 56 72 152 160 97
Real estate 30 1 56 76 -
Lease financing 18 36 26 25 19
-------------- --------- --------- --------- ---------
Total recoveries 188 252 404 347 124
-------------- --------- --------- --------- ---------
Net loans charged off 1,263 431 602 1,595 1,833
-------------- --------- --------- --------- ---------
Provision for loan losses 2,082 2,172 2,665 3,085 2,299
-------------- --------- --------- --------- ---------
Allowance, end of period $ 10,710 $ 9,891 $ 8,150 $ 6,087 $ 4,597
============== ========= ========= ========= =========
Ratio of net charge offs to
average loans outstanding 0.19% 0.07% 0.11% 0.34% 0.44%
============== ========= ========= ========= =========
</TABLE>
The Banks' policy is to maintain allowances for loan losses at a level
believed by management to be adequate to absorb potential losses.
Management's determination of the adequacy of the allowance is determined
monthly based on a continuing evaluation of the portfolio, past loss
experience, current and anticipated economic conditions and other factors
deemed relevant. Additions to the allowances are charged to operations. The
ratio of net charge-offs to average loans increased from 0.07% in 1995 to
0.19% in 1996, as a result of an increase in charge-offs associated with
commercial and mortgage loans and an overall increase in installment
loan charge-offs. The charge-offs associated with the commercial and
mortgage loans were done to write down the loan balances to their net
realizable value. The $337,000 rise in the installment loan
charge-offs is due to the overall growth in the installment portfolio as well
as an increased level of nonperforming installment loans. Management has
responded to the increase in the level of installment loan charge-offs by
increasing the amount of the allowance for loan losses allocated to
installment loans. The allowance for loan losses allocated to installment
loans at December 31, 1996 grew $366,000, or 41.4%, compared to December 31,
1995. The amount of the unallocated allowance for loan losses at December 31,
1996 of $5,024,000 represented 46.9% of the total allowance for loan losses,
compared to $3,635,000, or 36.8%, at December 31, 1995. The 1995 ratio of net
charge-offs to average loans of 0.07% decreased from the 1994 ratio of 0.11%.
Management believes that the 1996 ratio of 0.19% compares favorably with peer
group ratios.
The following table sets forth an allocation of the allowance for loan
losses by category. The specific allocations in any particular category may
be reallocated in the future to reflect current conditions. Accordingly,
management considers the entire allowance to be available to absorb losses in
any category.
<TABLE>
<CAPTION>
December 31,
-------------
1996 1995 1994 1993 1992
------------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands) Percent Percent Percent Percent Percent
Amount of Loans Amount of Loans Amount of Loans Amount of Loans Amount of Loans
------------- --------- ------- --------- ------- --------- ------- --------- ------- ---------
Commercial
and industrial $ 2,897 24% $ 3,952 26% $ 2,967 26% $ 2,821 26% $ 1,786 25%
Installment and other 1,251 35% 885 32% 1,063 31% 990 31% 895 31%
Real estate 1,434 34% 1,292 35% 1,010 36% 879 37% 1,163 38%
Lease financing 104 7% 127 7% 139 7% 225 6% 81 6%
Unallocated 5,024 N/A 3,635 N/A 2,971 N/A 1,172 N/A 672 N/A
------------- --------- ------- --------- ------- --------- ------- --------- ------- ---------
Total $ 10,710 100% $ 9,891 100% $ 8,150 100% $ 6,087 100% $ 4,597 100%
============= ========= ======= ========= ======= ========= ======= ========= ======= =========
</TABLE>
PAGE 28
The allowance and the provision for loan losses are based on management's
judgment after considering charge-off history, nonperforming loans and reserve
levels relative to total loans in determining the allowance and the provision
for loan losses. While management uses the best information available to make
such evaluations, future adjustments to the allowance may be necessary if
economic conditions differ substantially from the assumptions used in making
the evaluation. In addition, various regulatory agencies, as an integral part
of their examination process, periodically review the Banks' allowance for
loan losses. Such agencies may require the Banks to recognize additions to
the allowance based on their judgment of information available to them at the
time of their examination.
The Corporation adopted SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors
for Impairment of a Loan-Income Recognition and Disclosures," on January 1,
1995. This standard requires that a creditor measure impairment based on the
present value of expected future cash flows discounted at the loan's effective
interest rate, except that as a practical expedient, a creditor may measure
impairment based on a loan's observable market price, or the fair value of the
collateral if the loan is collateral dependent. Regardless of the measurement
method, a creditor must measure impairment based on the fair value of the
collateral when the creditor determines that foreclosure is probable. The
adoption of SFAS No. 114, as amended by SFAS No. 118, on January 1, 1995 did
not have a material impact on the Corporation's liquidity, results of
operations or capital resources.
DEPOSIT STRUCTURE
The following table is a distribution of average balances and average
rates paid on the deposit categories for the last three years:
<TABLE>
<CAPTION>
December 31,
-------------
1996 1995 1994
------------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands) Amount Rate Amount Rate Amount Rate
------------- ----- -------- ----- -------- -----
Demand -- noninterest-bearing $ 122,459 --% $109,649 --% $105,954 --%
Demand -- NOW 91,856 1.57% 85,101 1.97 87,566 2.06
Money market and savings 270,034 3.03% 256,628 3.08 287,410 2.67
Time -- under $100,000 298,777 5.63% 280,168 5.50 239,238 4.39
Time -- $100,000 or greater 38,261 5.29% 29,543 5.58 17,861 4.01
------------- -------- --------
Total $ 821,387 $761,089 $738,029
============= ======== ========
</TABLE>
The maturity distribution of certificates of deposit of $100,000 and over is
as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------
<S> <C> <C> <C>
(Dollars in thousands) 1996 1995 1994
------------- ------- -------
Three months or less $ 29,919 $14,527 $ 7,707
Over three months to six months 12,850 3,848 7,809
Over six months to twelve months 4,512 8,323 2,792
Over twelve months 4,079 2,930 2,502
------------- -------
Total $ 51,360 $29,628 $20,810
============= ======= =======
</TABLE>
INCOME STATEMENT ANALYSIS
RESULTS OF OPERATIONS
Consolidated net income for 1996 was $14,408,000, an increase of
$1,980,000, or 15.9%, over 1995. On a per share basis, primary and fully
diluted earnings were $2.16 in 1996, compared to primary and fully diluted
earnings per share of $1.87 in 1995. Consolidated net income increased in
1995 by $1,148,000, a 10.2% increase over 1994.
Return on average assets improved to 1.47% for 1996, compared to 1.39%
for 1995 and 1.36% for 1994, and return on average shareholders' equity was
15.71% for 1996, compared to 15.20% for 1995 and 1994.
Net income is affected by five major elements: net interest income, or
the difference between interest income earned on loans and investments and
interest expense paid on deposits and borrowed funds; the provision for loan
losses, or the amount added to the allowance for loan losses to provide
reserves for future losses on loans; other operating income, which is made up
primarily of certain fees and gains and losses from sales of securities; other
operating expenses, which consist primarily of salaries and other operating
expenses; and income taxes. Each of these major elements is reviewed in more
detail in the following discussion.
NET INTEREST INCOME
Net interest income for 1996 increased by $3,135,000, or 7.9%, to
$42,842,000. Net interest income was $39,707,000 during 1995, which was 6.5%
above the $37,280,000 reported in 1994.
For analytical purposes, the following table reflects tax-equivalent net
interest income in recognition of the income tax savings on tax-exempt items
such as interest on municipal securities and tax-exempt loans. Adjustments
are made using a statutory federal tax rate of 35%.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------
<S> <C> <C> <C>
(Dollars in thousands) 1996 1995 1994
------- ------- -------
Interest income $73,718 $68,491 $58,381
Interest expense 30,876 28,784 21,101
------- ------- -------
Net interest income 42,842 39,707 37,280
Tax equivalent adjustment 2,489 1,736 1,590
------- ------- -------
Net interest income
(fully taxable equivalent) $45,331 $41,443 $38,870
======= ======= =======
</TABLE>
PAGE 29
CHANGES IN NET INTEREST INCOME
The rate-volume analysis set forth in the following table, which is
computed on a tax equivalent basis (tax rate of 35%), analyzes changes in net
interest income for the last three years by their rate and volume components.
Tax-equivalent net interest income was $45,331,000 for 1996, compared to
$41,443,000 for 1995, an increase of $3,888,000, or 9.4%. This increase in
tax-equivalent net interest income was primarily due to the net $3,846,000
increase related to the growth in volume of interest-earning assets. Total
interest income increased $5,980,000, primarily, the result of higher yields
on investment securities and increased volumes of interest-earning assets.
The increase in security interest income was attributable to a $2,369,000
increase due to volume and a $839,000 increase related to the increase in the
overall yield of the investment security portfolio. Total interest income on
loans increased $2,703,000, or 5.0%, in 1996, compared to 1995, as a result of
total average loans outstanding increasing $44,822,000, or 7.4%. The increase
in loan interest income related to volume of $3,918,000 was offset by the
$1,215,000 reduction in loan interest income associated with the lower yields
earned on loans. The decrease in the yield earned on loans is primarily due
to the lower market interest rates in 1996, compared to 1995.
Principally, as a result of higher time deposit volumes and rates, total
interest expense rose $2,092,000. The volume of average time deposits
increased $27,327,000, or 8.8% during 1996, compared to 1995 interest expense.
Borrowings and other interest-bearing liabilities also contributed to the
increase in total interest expense primarily due to the increase in average
balances of $9,746,000 during this same period. Borrowings and other
interest-bearing liabilities include federal funds purchased, FHLB borrowings,
securities sold under agreements to repurchase and U.S. Treasury notes.
For the year ended December 31, 1995, net interest income increased
$2,573,000, primarily due to an increase in the volume of loans. Total loan
interest income increased $8,832,000, or 19.4%, in 1995, compared to 1994,
primarily as a result of total average loans increasing $67,305,000, or 12.5%.
This increase in loans was primarily funded by an increase in borrowings and
other interest-bearing liabilities, which also contributed to the rise in
interest expense by increasing $28,719,000 during the same period. Total
interest expense rose $7,683,000, principally as a result of higher time
deposit rates and volumes. The volume of average time deposits increased
$52,612,000, or 20.5%, during 1995, compared to 1994. Nonaccruing loans
are included in the average balance yield calculations, but the average
nonaccruals were insignificant and had no material effect on the results.
The decrease in interest rates during 1996 and 1995, and the rise in
interest rates in 1994, did not have a material effect on net interest income,
as a result of management's ability to properly price earning assets and
deposits.
<TABLE>
<CAPTION>
1996 over (under) 1995 1995 over (under) 1994
----------------------- ----------------------
due to changes in
-----------------
(Dollars in thousands)
<S> <C> <C> <C>
Net Net
Change Rate Volume Change
--------- ------------------- -------
INTEREST INCOME:
Investment securities (1) $ 3,208 $ 839 $ 2,369 $ 1,015
Loans 2,703 (1,215) 3,918 8,832
Other assets 69 (56) 125 409
---------- -------- ------- --------
Total 5,980 (432) 6,412 10,256
---------- -------- ------- --------
INTEREST EXPENSE:
Savings deposits 45 (491) 536 103
Time deposits 1,809 280 1,529 5,816
Borrowings and other interest-
bearing liabilities 238 (263) 501 1,764
----------- -------- ------- -------
Total 2,092 (474) 2,566 7,683
----------- -------- ------- -------
Changes in net interest income $ 3,888 $ 42 $ 3,846 $ 2,573
=========== ======== ======= ========
due to changes in
------------------
(Dollars in thousands)
<S> <C> <C>
Rate Volume
----------- --------
INTEREST INCOME:
Investment securities (1) $ 1,652 $ (637)
Loans 2,814 6,018
Other assets 166 243
----------- --------
Total 4,632 5,624
----------- --------
INTEREST EXPENSE:
Savings deposits 1,034 (931)
Time deposits 2,920 2,896
Borrowings and other interest-
bearing liabilities 83 1,681
---------- --------
Total 4,037 3,646
---------- --------
Changes in net interest income $ 595 $ 1,978
========== ========
<FN>
(1) The interest earned on nontaxable investment securities and
loans is shown on a tax equivalent basis.
</TABLE>
PAGE 30
INTEREST RATE SENSITIVITY
The Banks actively manage their interest rate sensitivity positions. The
objectives of interest rate risk management are to control exposure of net
interest income to risks associated with interest rate movements and to
achieve consistent growth in net interest income. The Asset/Liability
Committee, using policies and procedures set by senior management, is
responsible for managing the Banks' rate sensitivity position. The Banks
manage interest rate sensitivity by changing mix and repricing characteristics
of their assets and liabilities through their investment securities portfolios
and their offering of loan and deposit terms. The Banks utilize three
principal reports to measure interest rate risk: gap analysis reports, net
interest margin reports and asset/liability simulation reports. The table
below shows the interest rate sensitivity gap position as of December 31,
1996. The table presents data at a single point of time and includes
management assumptions estimating the prepayment rate and the interest rate
environment prevailing at December 31, 1996. Money Market, NOW and savings
accounts have always been considered a stable source of funds, and although
the rates are subject to change, rates on these accounts historically have not
changed as quickly or as often as the other deposits included in the following
analysis. On a cumulative basis over the next 12 months, the Bank is in a
negative gap position of (3.90)% of earning assets at December 31, 1996. This
gap position is within the guidelines set by the Banks' Asset/ Liability
policy.
Management also simulates possible economic conditions and interest rate
scenarios in order to quantify the impact on net interest income. The effect
that changing interest rates has on the Banks' net interest income is
simulated by increasing and decreasing interest rates at 200 basis point
increments. This simulation is known as rate shocks. The results of
the December 31, 1996 rate shock simulations show the Banks are within
all guidelines set by the Banks' Asset/Liability policy.
<TABLE>
<CAPTION>
December 31, 1996
-------------------
0 to 90 91 to 365 >1 year >3 years Over 5
(Dollars in thousands) days days <3 years < 5 years years
---------- ----------- ------------------- ----------- ---------
<S> <C> <C> <C> <C> <C>
ASSETS
Other rate-sensitive assets $ 9,367 $ 3,100 $ 2,000 $ 0 $ 8
Loans 204,757 84,416 174,082 84,972 133,183
Investment securities 15,822 38,704 47,661 30,284 138,229
---------- ----------- ------------------- ----------- ---------
Total rate-sensitive assets 229,946 126,220 223,743 115,256 271,420
---------- ----------- ------------------- ----------- ---------
LIABILITIES
Time deposits 68,215 141,689 112,822 22,759 376
Money market savings funds 59,729 - - - 95,787
NOW accounts 32,572 - - - 69,698
Savings accounts 34,164 - - - 70,165
U.S. Treasury demand note 2,572 - - - -
Other borrowings 45,949 9,000 1,500 500 -
---------- ----------- ------------------- ----------- ---------
Total rate-sensitive liabilities 243,201 150,689 114,322 23,259 236,026
---------- ----------- ------------------- ----------- ---------
Incremental gap ($13,255) ($24,469) $ 109,421 $ 91,997 $ 35,394
========== =========== =================== =========== =========
Cumulative gap ($13,255) ($37,724) $ 71,697 $ 163,694 $199,088
========== =========== =================== =========== =========
% of earning assets (1.37)% (3.90)% 7.42% 16.94% 20.60%
========== =========== =================== =========== =========
</TABLE>
NET INTEREST MARGIN
The 1996 net interest margin of 4.88% was the same as the net interest
margin for 1995 . The decrease in the interest income to earning asset ratio,
from 8.27% in 1995 to 8.20% in 1996, was offset by the decrease in the
interest expense to earning asset ratio, from 3.39% in 1995 to 3.32% in 1996.
The decrease in these rates was the result of the lower rate environment in
1996. The net interest margin in 1995 was lower than the 4.94% net interest
margin in 1994, primarily the result of higher rates paid on time deposits
during 1995, compared to 1994. The Banks have been able to effectively match
assets and liabilities and maintain a consistent percentage of earning assets
to total assets.
PROVISION FOR LOAN LOSSES
The provision for loan losses is based on management's analysis of the
adequacy of the allowance for loan losses. In its evaluation, management
considers past loan experience, overall characteristics of the loan portfolio,
current economic conditions and other relevant factors. Based on the latest
monthly evaluation of potential loan losses, the allowance is adequate to
absorb known and inherent losses in the loan portfolio. Ultimately however,
the adequacy of the allowance is largely dependent upon the economy, a factor
beyond the Corporation's control. With this in mind, additions to the
allowance for loan losses may be required in future periods especially if
economic trends worsen or certain borrowers' abilities to repay decline.
PAGE 31
The provision in 1996 was $2,082,000, a decrease of $90,000 or 4.1%,
compared to the 1995 provision of $2,172,000. Management cautiously reduced
the provision in 1996, as a result of the overall improvement in the level of
nonperforming assets. A review of the table below shows an improvement in the
level of nonperforming assets at December 31, 1996, compared to the same
periods in 1995 and 1994. The ratio of the allowance for loan losses to loans
of 1.57% was the same at December 31, 1996 and 1995. The December 31, 1994
ratio was 1.37%
<TABLE>
<CAPTION>
1996 1995 1994
----------- ------------ ------------
<S> <C> <C> <C>
Nonperforming Assets $5,672,000 $11,457,000 $5,657,000
Allowance for loan losses to nonperforming assets 188.8% 86.3% 144.1%
Nonperforming assets to total loans and net .83% 1.82% .95%
assets acquired in foreclosure
Allowance for loan losses to total loans 1.57% 1.57% 1.37%
Unallocated allowance for loan losses to total 46.9% 36.8% 36.5%
allowance for loan losses
</TABLE>
Nonperforming assets (nonaccruing loans, net assets in foreclosure and
troubled debt restructured loans) were 0.83% of total loans, and net assets
acquired in foreclosure at December 31, 1996 compared to 1.82% at December 31,
1995 and 0.95% at December 31, 1994. The ratio of the allowance to
nonperforming assets was 188.8% at December 31, 1996, compared to 86.3% at
December 31, 1995 and 144.1% at December 31, 1994.
Nonaccruing loans of $2,983,000 at December 31, 1996 decreased $6,071,000
from the December 31, 1995 balance of $9,054,000. The $6,071,000 reduction in
nonaccrual loans during this period is primarily due to one loan being
upgraded to accruing status during 1996. This loan achieved accrual status
after meeting appropriate standards. The nonaccruing loans balance at
December 31, 1994 was $2,521,000.
Net assets in foreclosure totaled $972,000 as of December 31, 1996, a
decrease of $248,000, or 20.3%, from the December 31, 1995 balance. During
1996, sales of foreclosed properties totaled $1,348,000, transfers from loans
to assets in foreclosure were $1,244,000 and write-downs of assets in
foreclosure equaled $144,000. Efforts to liquidate assets acquired in
foreclosure are proceeding as quickly as potential buyers can be located and
legal constraints permit. Generally accepted accounting principles require
foreclosed assets to be carried at the lower of cost (lesser of carrying value
of asset or fair value at date of acquisition) or estimated fair value.
Loans past due 90 days or more and still accruing interest are loans that
are generally well-secured and are in the process of collection. As of
December 31, 1996, loans past due 90 days or more and still accruing interest
were $1,848,000, compared to $1,553,000 as of December 31, 1995.
As of December 31, 1996, there were three unrelated commercial borrowers
with troubled debt restructured loans totaling $1,717,000. All three
customers were complying with the restructured terms as of December 31, 1996.
The balance of impaired loans was $4,159,000 at December 31, 1996. The
Banks have identified a loan as impaired when it is probable that interest and
principal will not be collected according to the contractual terms of the loan
agreement. The impaired loan balance included $2,442,000 of nonaccrual loans
and $1,717,000 of troubled debt restructured loans. The allowance for loan
loss associated with the $4,159,000 of impaired loans was $533,000 at December
31, 1996. The average impaired loan balance was $9,333,000 in 1996, and the
income recognized on impaired loans during 1996 was $814,000. The Banks'
policy for interest income recognition on impaired loans is to recognize
income on restructured loans under the accrual method. The Banks recognize
income on nonaccrual loans under the cash basis when the loans are both
current and the collateral on the loan is sufficient to cover the outstanding
obligation to the Banks. The Banks will not recognize income if these factors
do not exist.
OTHER OPERATING INCOME
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------
<S> <C> <C> <C>
(Dollars in thousands) 1996 1995 1994
------- ------- ------
Service charges $2,587 $2,337 $2,341
Securities (losses) gains, net (39) (172) 668
Trust income 1,293 1,094 741
Other 1,274 1,178 996
------- ------- ------
Total other operating income $5,115 $4,437 $4,746
======= ======= ======
</TABLE>
Other operating income for 1996 increased $678,000, or 15.3%,
compared to the 1995 level of $4,437,000. This increase was primarily
due to increases in service charges and trust income. The 1994 other operating
income of $4,746,000 was 6.5% higher than 1995 due to net security gains.
Income from service charges on deposit accounts of $2,587,000 in 1996
increased $250,000 from the 1995 income from service charges on deposit
accounts of $2,337,000. The increase in service charges during 1996 is
primarily attributed to higher overdraft charges collected and the fees
related to the overall increase in the volume of deposits in 1996. The small
decrease in service charges in 1995, compared to 1994, is attributed to lower
service charges on business accounts. This was the result of an increase in
the earnings credit, attributable to the rise in interest rates, which is used
to offset service charges.
The Corporation recorded a $39,000 net security loss in 1996, compared to
a net security loss of $172,000 in 1995. From time to time, the Corporation
sells securities to fund the purchase of other securities in an effort to
enhance the overall return on the portfolio. The Corporation recognized
$668,000 of net securities gains in 1994. During 1994, the Corporation
realized a securities gain of approximately $1,058,000 as a result of the
Corporation selling over 40,000 shares of First Eastern Bank stock to PNC
Corporation on June 24, 1994. Investment securities available for sale were
sold during 1994 to help fund growth in loans and resulted in a net loss of
approximately $418,000.
PAGE 32
The 1996 income from the Trust and Financial Services Department of
$1,293,000 increased $199,000, or 18.2%, compared to the $1,094,000 recorded
in 1995. This increase was the result of both an increase in the book value
of trust assets of 6.6% from December 31, 1995 to December 31, 1996 and the
Corporation's continuing emphasis on marketing the Trust and Financial
Services Department's products and services. The 1994 Trust and Financial
Services Department income was $741,000.
Other income increased $96,000 during 1996, from $1,178,000 in 1995 to
$1,274,000 in 1996. This increase was due to higher leasing fees earned in
1996. Other income in 1995 increased $182,000, compared to 1994, as a result
of higher fees earned on merchant credit card services and a rise in fees
associated with the sale of insurance policies on new loans.
OTHER OPERATING EXPENSES
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------
<S> <C> <C> <C>
(Dollars in thousands) 1996 1995 1994
------- ------- -------
Salaries $11,392 $ 9,848 $ 8,599
Employee benefits 3,006 3,264 3,027
Occupancy 1,873 1,541 1,474
Equipment expense 2,083 1,913 1,572
FDIC premiums 6 861 1,648
Other expenses 7,514 6,840 6,994
------- ------- -------
Total other operating expenses $25,874 $24,267 $23,314
======= ======= =======
</TABLE>
Other operating expenses rose to $25,874,000 for 1996, a 6.6% increase
over the $24,267,000 for 1995. The 1995 amount was 4.1% above the $23,314,000
for 1994. The rise in operating expenses in 1996 was largely due to higher
expenses related to four new branches opened after June 30, 1995 and one that
opened during May 1995. Also contributing to this rise were increases in
legal fees, consulting fees and expenses related to the overall growth of the
Banks. These increases were partially offset by a reduction in the FDIC
premium.
Employee salaries increased $1,544,000, or 15.7%, from $9,848,000 in 1995
to $11,392,000 in 1996. The salary increase directly related to the staffing
of the five new branches was $795,000, or 51.5% of the total salary increase.
The remaining increase in salaries reflects cost-of-living increases, merit
increases and additional staff necessitated by current and planned future
growth. Employee benefits decreased $258,000, or 7.9%, to $3,006,000 in 1996
from the $3,264,000 in employee benefits during 1995. The decrease is the
result of the modification of the Banks' profit-sharing plan into a 401(K)
plan during 1996. The profit-sharing plan was funded entirely by the Bank and
the modified 401(K) plan is both Bank and employee funded. Offsetting this
decrease was a $173,000 increase in benefit expenses related to the new
branches. The 1995 salary expenses and fringe benefit expenses increased
14.5% and 7.8%, respectively, compared to 1994 expenses.
Net occupancy costs increased by $332,000, or 21.5%, in 1996, compared
with a $67,000, or 4.5%, increase in 1995. The five new branches were
responsible for $276,000, or 83.1% of the increase in 1996. Equipment expenses
increased by $170,000, or 8.9%, during 1996, and $341,000, or 21.7%, in 1995.
The five new branches were primarily responsible for the increase in equipment
expenses during 1996. The remainder of this rise is due to both equipment
depreciation and maintenance associated with planned increased data processing
capabilities. The majority of the rise in 1995 is due to depreciation,
maintenance and equipment rental expenses associated with planned increased
data processing capabilities. The increased data processing capabilities
include modernizing our branches through platform automation and teller
terminals, and the ongoing updating of data processing equipment to manage the
rise in volume related to the growth of the Corporation.
During the third quarter of 1995, the FDIC confirmed that the Bank
Insurance Fund (BIF) was fully recapitalized at the end of May 1995. As a
result, the new lower premium rates were made retroactive to June 1, 1995.
The Banks' 1996 FDIC premium expense was $6,000, compared to the 1995 premium
expense of $861,000. On September 30, 1996, the President signed into law the
Deposit Insurance Funds Act of 1996, which included the resolution of the
disparity of insurance premiums paid by savings and loans associations for
deposit insurance under the Savings Association Insurance Fund (SAIF)
administered by the FDIC, in comparison to the premiums paid by banks for
deposit insurance under the BIF, also administered by the FDIC. Beginning
January 1, 1997, for a three-year period, banks will be required to pay a
premium of 1.296 basis points. This premium will not have a material impact
on the Corporation's financial position or results of operations.
Other expenses increased $674,000, or 9.9%, from $6,840,000 in 1995 to
$7,514,000 in 1996. This increase is primarily the result of a $164,000
increase in consulting fees, a $103,000 rise in legal fees and $91,000 in
other expenses associated with the new branches. The rise in consulting fees
was related to franchise expansion, employee benefits and consultation
concerning enhancements to bank operations. The increase in legal fees was
associated with the Farmers merger, the resolution of legal matters and legal
fees related to maintaining the loan portfolio. The remaining increase during
1996 was due to the normal increases in expenses related to the overall growth
of the Corporation. The 1995 other expenses decreased $154,000, compared to
1994. The reduction in other expenses included a decrease in intangible asset
expense of $262,000 and a $134,000 reduction in legal expenses. The reduction
in legal expenses is related to both the 1994 legal expenses associated with
the Security National Bank merger and the recovery of legal expenses in 1995
related to nonperforming assets that were expensed in prior periods. These
reductions in other expenses were partially offset by an increase in printing
and stationery supply expenses related to bank automation, increases in paper
costs and the opening of the three new branches.
INCOME TAXES
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
<S> <C> <C> <C>
(Dollars in thousands) 1996 1995 1994
-------- ------- -------
Expected tax expense $ 6,800 $6,020 $5,608
Tax exempt income, net of
interest disallowance (1,414) (999) (943)
Other 207 256 102
-------- ------- -------
Actual tax expense $ 5,593 $5,277 $4,767
======== ======= =======
</TABLE>
PAGE 33
The Corporation accounts for income taxes under the liability method
specified by SFAS No. 109, "Accounting for Income Taxes." Under SFAS No.
109, deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Under SFAS No. 109, the
effect on deferred taxes of a change in tax rates is recognized in income in
the period that includes the enactment date. The principal types of accounts
resulting in differences between assets and liabilities for financial
statement and tax return purposes are the allowance for loan losses, leased
assets, deferred loan fees and compensation.
The effective income tax rates of 28.0% for 1996, 29.8% for 1995 and
29.7% for 1994 were less than the applicable federal income tax rate of
35.0%, as a result of tax-exempt income.
CAPITAL
Capital formation is critical to the Corporation's well-being and future
growth. Capital at the end of 1996 was $97,631,000, an increase of
$11,269,000, or 13.0%, over the end of 1995. The increase came as a result of
the retention of the Corporation's earnings and from the adjustment for the
net unrealized gains (losses) on the investment securities available for sale.
Management believes that the Corporation's current capital position and
liquidity position are strong and that its capital position is adequate to
support its operations. Except as previously discussed, management is not
aware of any recommendation by any regulatory authority which, if it were to
be implemented, would have a material effect on the Corporation's capital.
The Corporation's capital ratios exceed regulatory requirements.
Existing minimum regulatory capital ratio requirements are 5.0% for primary
capital and 6.0% for total capital. The primary capital ratio was 10.29% at
December 31, 1996, compared with 9.98% at December 31, 1995. Because the
Corporation's only capital is primary capital, the total capital ratios are
the same as the primary capital ratios.
Pursuant to the federal regulators' risk-based capital adequacy
guidelines, the components of capital are called Tier 1 and Tier 2 capital.
For the Corporation, Tier 1 capital is the shareholders' equity, and Tier 2
capital is the allowance for loan losses. The risk-based capital ratios are
computed by dividing the components of capital by risk-adjusted assets.
Risk-adjusted assets are determined by assigning credit risk-weighting factors
from 0% to 100% to various categories of assets and off-balance-sheet
financial instruments. The minimum for the Tier 1 capital ratio is 4.0%, and
the total capital ratio (Tier 1 plus Tier 2 capital divided by risk-adjusted
assets) minimum is 8.0%. At December 31, 1996, the Corporation's Tier 1
risk-adjusted capital ratio was 13.12%, and the total risk-adjusted capital
ratio was 14.38%, both well above regulatory requirements. The risk-based
capital ratios of each of the Corporation's commercial banks also exceeded
regulatory requirements at the end of 1996.
To supplement the risk-based capital adequacy guidelines, the Federal
Reserve Board (FRB) established a leverage ratio guideline. The leverage
ratio consists of Tier 1 capital divided by quarterly average total assets,
excluding intangible assets. The minimum leverage ratio guideline is 3% for
banking organizations that do not anticipate significant growth and that have
well-diversified risk, excellent asset quality, high liquidity, good earnings
and, in general, are considered top-rated, strong banking organizations.
Other banking organizations are expected to have ratios of at least 4% or 5%,
depending upon their particular condition and growth plans. Higher leverage
ratios could be required by the particular circumstances or risk profile of a
given bank organization. The Corporation's leverage ratios were 9.21% and
8.99% at December 31, 1996 and 1995, respectively.
Under FDIC the regulations, a "well capitalized" institution must have a
leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of at least
6% and a total risk-based capital ratio of at least 10% and not be subject to
a capital directive order. To be considered "adequately capitalized," an
institution must generally have a leverage ratio of at least 4%, a Tier 1
risk-based capital ratio of at least 4% and a total risk-based capital ratio
of at least 8%. An institution is deemed to be "critically undercapitalized"
if it has a tangible equity ratio of 2% or less. As illustrated in the chart
below, the Banks are above the regulatory minimum guidelines and meet the
criteria to be categorized as "well capitalized" institutions at December 31,
1996.
<TABLE>
<CAPTION>
(Dollars in thousands) Leverage Ratio
------------------
December 31, 1996 December 31, 1995
------------------ ------------------
Amount Ratio Amount Ratio
---------- ------ --------- ------
<S> <C> <C> <C> <C>
Entity:
Corporation $93,164 9.21% $83,019 8.99%
Subsidiaries:
Harleysville National Bank 67,253 8.34 58,330 7.99
Citizens National Bank 20,031 13.08 19,193 13.10
Security National Bank 3,885 6.81 3,693 8.32
"Well Capitalized" institution
(under FDIC regulations) 5.00 5.00
</TABLE>
<TABLE>
<CAPTION>
(Dollars in thousands) Tier 1 Capital to Risk-Weighted Assets
--------------------------------------
December 31, 1996 December 31, 1995
------------------- ------------------
Amount Ratio Amount Ratio
-------- ------ ------- ------
<S> <C> <C> <C> <C>
Entity:
Corporation $93,164 13.12% $83,019 12.47%
Subsidiaries:
Harleysville National Bank 67,253 11.59 58,330 10.53
Citizens National Bank 20,031 22.60 19,193 23.71
Security National Bank 3,885 9.57 3,693 11.89
"Well Capitalized" institution
(under FDIC regulations) 6.00 6.00
</TABLE>
<TABLE>
<CAPTION>
(Dollars in thousands) Total Capital to Risk-Weighted Asset Ratio
------------------------------------------
December 31, 1996 December 31, 1995
----------------- -----------------
Amount Ratio Amount Ratio
------ ----- ------ -----
<C> <C> <C> <C>
Entity:
Corporation $102,061 14.38% $91,340 13.72%
Subsidiaries:
Harleysville National Bank 74,528 12.85 65,253 11.78
Citizens National Bank 20,993 23.69 20,205 24.96
Security National Bank 4,394 10.83 4,081 13.14
"Well Capitalized" institution
(under FDIC regulations) 10.00 10.00
</TABLE>
PAGE 34
LIQUIDITY
Liquidity is a measure of the ability of the Banks to meet their needs
and obligations on a timely basis. For a bank, liquidity requires the ability
to meet the day-to-day demands of deposit customers, along with the ability to
fulfill the needs of borrowing customers. Generally, the Banks arrange their
mix of cash, money market investments, investment securities and loans in
order to match the volatility, seasonality, interest sensitivity and growth
trends of its deposit funds. Federal funds sold averaged $11,440,000 during
1996, and investment securities available for sale averaged $192,549,000
during 1996, more than sufficient to match normal fluctuations in loan demand
or deposit fund supplies. Backup sources of liquidity are provided by federal
fund lines of credit established with correspondent banks. Additional
liquidity could be generated through borrowings from the Federal Reserve Bank
of Philadelphia, of which Harleysville, Citizens and Security are members and
from the Federal Home Loan Bank of Pittsburgh, of which Harleysville, Citizens
and Security are members. Unused lines of credit at the FHLB were
$181,417,000, as of December 31, 1996.
There are no known trends or any known demands, commitments, events or
uncertainties that will result in, or that are reasonably likely to result in,
liquidity increasing or decreasing in any material way.
OTHER ITEMS
The passage of the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 and the Riegle Community Development and Regulatory
Improvement Act may have a significant impact upon the Corporation. The key
provisions pertain to interstate banking and interstate branching as well as a
reduction in the regulatory burden on the banking industry. States may adopt
laws preventing interstate branching but, if so, no out-of-state bank can
establish a branch in such state and no bank in such state may branch outside
the state. Pennsylvania law authorized full interstate banking and branching
to facilitate the operations of interstate banks in Pennsylvania. As a result
of legal and industry changes, management predicts that consolidation will
continue as the financial services industry strives for greater cost
efficiencies and market share. Management believes that such consolidation
may enhance its competitive position as a community bank.
There are numerous proposals before Congress to modify the financial
services industry and the way commercial banks and other financial
institutions operate. Some of these proposals include changes to the
ownership of financial companies and the types of products and services which
may be offered by financial institutions. However, it is difficult to
determine at this time what effect such provisions may have until they are
enacted into law. Except as specifically described on page 34, management
believes that the effect of the provisions of the aforementioned legislation
on the liquidity, capital resources, and results of operations of the
Corporation will be immaterial. Management is not aware of any other current
specific recommendations by regulatory authorities or proposed legislation
which, if they were implemented, would have a material adverse effect upon the
liquidity, capital resources, or results of operations, although the general
cost of compliance with numerous and multiple federal and state laws and
regulations does have and in the future may have a negative impact on the
Corporation's results of operations.
The Corporation plans to open two new branches during 1997. Harleysville
National Bank is pursuing locations in Spring House and Chalfont. These new
branch sites are contiguous to our current service area and were chosen due to
the demand for additional delivery locations by our customers.
On September 30, 1996, the President signed into law the Deposit
Insurance Funds Act of 1996 to recapitalize the Savings Association Insurance
Fund (SAIF) administered by the Federal Deposit Insurance Corporation
(FDIC) and to provide for repayment of the Financial Institution Collateral
Obligation (FICO) bonds issued by the United States Treasury Department.
Pursuant to this law, the FDIC will levied a one-time special assessment on
SAIF deposits equal to 65.7 cents per $100 of the SAIF-assessable deposit base
as of March 31, 1995. During the years 1997, 1998 and 1999, the Bank
Insurance Funds (BIF) will pay $322 million of FICO debt service, and SAIF
will pay $458 Million.
During 1997, 1998 and 1999, the average regular annual deposit insurance
assessment is estimated to be about 1.296 cents per $100 of deposits for BIF
deposits and 6.44 cents per $100 of deposits for SAIF deposits. Individual
institution's assessments will continue to vary according to their capital and
management ratings. As always, the FDIC will be able to raise the assessments
as necessary to maintain the funds at their target capital ratios provided by
law. After 1999, BIF and SAIF will share the FICO costs equally. Under
current estimates, BIF and SAIF assessment bases would each be assessed at the
rate of approximately 2.4 cents per $100 of deposits.
Based on current projected deposit levels during 1997, management expects
that the increase in the FDIC assessment rate will not have a material impact
on earnings.
PAGE 35
FINANCIAL RATIOS AND SUMMARY OF KEY INFORMATION
Harleysville National Corporation and Subsidiaries
(Dollars in thousands, except per share data and
average shares outstanding)
Year Ended December 31
-------------------------
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
PER SHARE INFORMATION*:
Primary $ 2.16 $ 1.87 $ 1.71
Fully diluted 2.16 1.87 1.71
Cash dividends paid 0.84 0.75 0.58
Book value (at year-end) 14.67 13.67 11.41
MARKET VALUE*:
Bid price of common stock (high) 27.14 27.14 29.93
Bid price of common stock (low) 23.50 23.81 19.05
Average shares outstanding 6,660,530 6,646,957 6,602,678
AVERAGE BALANCE SHEET:
Loans $ 652,157 $ 607,335 $ 540,030
Earning assets 929,589 848,687 784,011
Total assets 978,899 894,350 829,241
Deposits 821,387 761,089 738,029
Interest-bearing liabilities plus demand deposits 868,200 798,156 746,377
Shareholders' equity 91,687 81,788 74,234
SELECTED OPERATING RATIOS:
Return on average assets 1.47% 1.39% 1.36%
Return on average shareholders' equity 15.71% 15.20% 15.20%
Leverage (assets divided by shareholders' equity) 10.51X 10.85X 11.63X
Average shareholders' equity as a percentage of:
Average loans 14.06% 13.47% 13.75%
Average deposits 11.16 10.75 10.06
Average assets 9.37 9.15 8.95
Average earning assets 9.86 9.64 9.47
Dividend payout ratio 38.76 39.51 32.68
Average total loans as a percentage of
average deposits and borrowed funds 75.12 76.09 72.35
Net interest margin on average earning assets:
Interest income** 8.20% 8.27% 7.62%
Interest expense (3.32) (3.39) (2.68)
Net interest margin 4.88 4.88 4.94
Noninterest margin (2.23) (2.34) (2.36)
<FN>
*Adjusted for a 5% stock dividends effective 6/28/96 and 12/30/94.
**Tax Equivalent Basis.
</TABLE>
PAGE 36
Exhibit 21
Registrant owns all of the issued and outstanding capital stock of
Harleysville National Bank and Trust Company, a National banking association
headquartered at 483 Main Street, Harleysville, PA 19438, the Citizens
National Bank of Lansford, a national banking association headquartered at
13-15 West Ridge Street, Lansford, PA 18232 and of Security National Bank, a
national banking association headquartered at One Security Plaza,
Pottstown, PA 19464.
Exhibit 23(a)
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated January 8, 1997, accompanying the consolidated
financial statements incorporated by reference or included in the 1996 Annual
Report of Harleysville National Corporation on Form 10-K for the year ended
December 31, 1996. We hereby consent to the incorporation by reference of
said report in the Registration Statements of Harleysville National
Corporation on Form S-3 (Registration No. 33-57790, effective February 3,
1993) and on Forms S-8 (Registration No. 33-69784, effective October 1, 1993,
and Registration No. 33-17813, effective December 13, 1996).
GRANT THORNTON LLP
Philadelphia, Pennsylvania
March 26, 1997
Exhibit 23(b)
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Harleysville National Corporation
Re: Registration Statement on Form S-3 (Registration No. 33-57790)
Registration Statement on Form S-8 (Registration No. 33-69784)
Registration Statement on Form S-8 (Registration No. 33-17813)
We consent to the incorporation by reference in the above listed registration
statements of Harleysville National Corporation (the Company) of our report
dated January 31, 1995 relating to the consolidated statements of income,
shareholders' equity, and cash flows of Harleysville National Corporation and
subsidiaries for the year ended December 31, which report appears in the
December 31, 1996 Form 10-K of Harleysville National Corporation. Our report
contains an explanatory paragraph which discusses that the Company changed its
method of accounting for investments in 1994.
KPMG PEAT MARWICK LLP
Philadelphia, Pennsylvania
March 26, 1997
Exhibit 99(a)
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
Harleysville National Corporation
We have audited the consolidated balance sheets of Harleysville National
Corporation and Subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of income, shareholders' equity and cash flows for
each of the two years in the period ended December 31, 1996. These financial
statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides
a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Harleysville National Corporation and Subsidiaries at December 31, 1996 and
1995, and the consolidated results of their operations and their consolidated
cash flows for the year then ended, in conformity with generally accepted
accounting principles.
As discussed in note 1 to the consolidated financial
statements, Harleysville National Corporation and Subsidiaries changed their
method of accounting for certain investments in debt and equity securities in
1994.
GRANT THORNTON LLP
Philadelphia, Pennsylvania
January 8, 1997
Exhibit 99(b)
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
Harleysville National Corporation:
We have audited the accompanying consolidated statements of income,
shareholders' equity, and cash flows of Harleysville National Corporation and
subsidiaries for the year ended December 31, 1994. These consolidated
financial statements are the responsibility of the Corporation's management.
Our responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and the
cash flows of Harleysville National Corporation and subsidiaries for the year
ended December 31, 1994, in conformity with generally accepted accounting
principles.
As discussed in note 1 to the consolidated financial statements, the
Corporation changed its method of accounting for investments in 1994.
KPMG PEAT MARWICK LLP
Philadelphia, Pennsylvania
January 31, 1995
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 39,407
<INT-BEARING-DEPOSITS> 8,475
<FED-FUNDS-SOLD> 6,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 209,795
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0
0
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<SECURITIES-GAINS> (39)
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<ALLOWANCE-CLOSE> 10,710
<ALLOWANCE-DOMESTIC> 10,710
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 5,024
</TABLE>
