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, 1997.
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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 .
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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. ( )
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.
$261,060,387 as of February 27, 1998
Indicate the number of shares outstanding of each class of the registrant's
classes of common stock, as of the latest practicable date.
7,022,550 shares of Common Stock, $1 par value per share, were outstanding
as of February 27, 1998.
DOCUMENTS INCORPORATED BY REFERENCE:
1. Portions of the Registrant's Annual Report to Shareholders for the
fiscal year ended December 31, 1997 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 14, 1998 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 10
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders . 12
II. PART II.
Item 5. Market for Registrant's Common Stock and Related Shareholder Matters 13
Item 6. Selected Financial Data 13
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 7.A. Quantitative and Qualitative Disclosure about Market Risk 13
Item 8. Financial Statements and Supplementary Data 13
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 13
III. PART III.
Item 10. Directors and Executive Officers of the Registrant 14
Item 11. Executive Compensation 15
Item 12. Security Ownership of Certain Beneficial Owners and Management 15
Item 13. Certain Relationships and Related Transactions 15
IV. PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 16
Signatures . 18
</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 (HNB), 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 (CNB). 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 CNB and is now
operating as a branch office of CNB. On July 1, 1994 the Corporation acquired
all of the outstanding stock of Security National Bank (SNB). On March 1,
1996, the Corporation acquired all of the outstanding common stock of Farmers
& Merchants Bank ("F & M"). F & M was merged into CNB and is now operating as
a branch office of CNB. On March 17, 1997, the HNC Financial Company was
incorporated as a Delaware Corporation. HNC Financial Company's principal
business function is to expand the investment opportunities of the
Corporation. The Corporation is primarily 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 HNB, CNB and SNB (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).
HNB, which was established in 1909, CNB, which was established in 1903,
and SNB, 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 HNB's legal headquarters are
located at 483 Main Street, Harleysville, Pennsylvania 19438. CNB's legal
headquarters is located at 13-15 West Ridge Street, Lansford, Pennsylvania
18232. SNB's legal headquarters is located at One Security Plaza, Pottstown,
Pennsylvania 19464. HNC Financial Company's legal headquarters are located at
300 Delaware Avenue, Suite 1704, Wilmington, Delaware 19801.
In addition to historical information, this Form 10-K 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. Readers should carefully review the risk factors described
in other documents the Corporation files from time to time with the Securities
and Exchange Commission, including the Quarterly reports on Form 10-Q to be
filed by the Corporation in 1998, and any Current Reports on Form 8-K filed by
the Corporation.
The following factors are among the factors that could cause actual
results to differ materially from the forward-looking statements: general
economic conditions, including their impact on capital expenditures; business
conditions in the banking industry; the regulatory environment; rapidly
changing technology and evolving banking industry standards; competitive
factors, including increased competition with community, regional and national
financial institutions; new service and product offerings by competitors and
price pressures; and like items.
As of December 31, 1997, the Banks had total assets of $1,116,254,000,
total shareholders' equity of $109,792,000 and total deposits of $919,071,000.
PAGE 4
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 have 29
branch offices located in Montgomery, Bucks, Carbon, Wayne, Chester and
Schuylkill counties.
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-nine (29) offices located in Montgomery, Bucks,
Carbon and Wayne, Chester and Schuylkill counties, Pennsylvania, 18 of which
are owned by the Banks and 11 of which are leased from third parties.
As of December 31, 1997, the Corporation and the Banks employed
approximately 452 full-time equivalent employees. The Corporation provides a
variety of employment benefits and considers its relationships with its
employees to be satisfactory.
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, 1997, HNB's legal lending limit to a single
customer was $12,422,000 and CNB's and SNB's legal lending limits to a single
customer were $3,329,000 and $1,053,000, 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
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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 limitations 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.
PAGE 5
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
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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
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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
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.
Recently, Pennsylvania enacted a law to permit state chartered banking
institutions to sell insurance. This follows a U.S. Supreme Court decision in
favor of nationwide insurance sales by banks which also bars states from
blocking insurance sales by national banks in towns with population of no more
than 5,000. The Corporation is currently evaluating its options regarding the
sale of insurance.
Congress is currently considering legislative reforms to modernize the
financial services industry, including repealing the Glass-Steagall Act which
prohibits commercial banks from engaging in the securities industry.
Consequently, equity underwriting activities of banks may increase in the near
future. However, the Corporation does not currently anticipate entering into
these activities.
The Corporation has analyzed the recently enacted changes to the federal
tax law. The impact of such changes on liquidity, operating results, and
capital should not be material.
Pending Legislation
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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 37 & 38 of the
1997 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.
PAGE 6
Effects of Inflation
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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
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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
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
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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.
PAGE 7
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
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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
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).
<TABLE>
<CAPTION>
Total Tier 1 Under a
Risk Risk Tier 1 Capital
Based Based Leverage Order or
Ratio Ratio Ratio Directive
----- ------ -------- ---------
<S> <C> <C> <C> <C>
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
-
</TABLE>
*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
PAGE 8
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
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
CNB or SNB.
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
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The information for this Item is incorporated by reference to pages 24
through 38 of the Corporation's Annual Report to Shareholders for the year
ended December 31, 1997 which pages are included at Exhibit (13) to this
Annual Report on Form 10-K.
Year 2000 Issue
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Many existing computer programs use only two digits to identify a year in
the date field. These programs were designed and developed without
considering the impact of the upcoming change in the century. If not
corrected, many computer applications could fail or create erroneous results
by or at the Year 2000. The Year 2000 issue affects virtually all companies
and organizations.
PAGE 9
The corporation has conducted a comprehensive review of its computer
systems to identify the systems that could be affected by the Year 2000 issue
and has developed an implementation plan to resolve the issue. Modifications
or replacements of computer systems to attain Year 2000 compliance have begun,
and the Corporation expects to attain Year 2000 compliance and institute
appropriate testing of is modifications and replacements before the Year 2000
date change. The corporation believes that, with modifications to existing
software and conversions to new software, the Year 2000 problem will not pose
a significant operations problem for the Corporation. The Corporation has
taken steps to communicate with the unrelated parties with whom it deals to
coordinate Year 2000 compliance. The cost in addressing the Year 2000 issues
will be expensed as incurred in compliance with Generally Accepted Accounting
Principles (GAAP).
Item 2. Properties.
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The principal executive offices of the Corporation and of HNB are located
in Harleysville, Pennsylvania in a two-story office building owned by HNB,
built in 1929. HNB also owns the buildings in which twelve of its branches
are located and leases space for the other eight branches from unaffiliated
third parties under leases expiring at various times through 2036. The
principal executive offices of CNB are located in Lansford, Pennsylvania in a
two-story office building owned by CNB. Citizens also owns the buildings
where its branches are located. The principal executive offices of SNB are
located in Pottstown, Pennsylvania, in a building leased by SNB. SNB leases
its East End and North End branches, and owns its Pottstown Center branch.
HNC Investment Company leases an office in Wilmington, Delaware.
<TABLE>
<CAPTION>
Office Office Location Owned/Leased
- ------------------- ------------------------------ ------------
<S> <C> <C>
Harleysville 483 Main Street Owned
Harleysville Pa
Skippack Route 73 Owned
Skippack Pa
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
PAGE 10
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
Spring House 1017-1021 North Bethlehem Pike Owned
Spring House PA
Red Hill 400 Main Street Owned
Red Hill PA
Audubon 2624 Egypt Road Owned
Audubon PA
Chalfont 251 West Butler Avenue Leased
Chalfont PA
Spring City 44 North Main Street Owned
Spring City 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
McAdoo 25 North Kennedy Drive Owned
McAdoo PA
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.
PAGE 11
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, Security National
Bank and HNC Financial Company. 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 1997 to a vote of
holders of the Corporation's Common Stock.
PAGE 12
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 19 of the Corporation's Annual Report to Shareholders for the year
ended December 31, 1997, 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
page 24 of the Corporation's Annual Report to Shareholders for the year ended
December 31, 1997, 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 24 through 38 of the Corporation's Annual Report to Shareholders for the
year ended December 31, 1997, which pages are included at Exhibit (13) to
this Annual Report on Form 10-K.
Item 7.A. Quantitative and Qualitative Disclosure about Market Risk.
- ------------------------------------------------------------------------------
The information required by this Item is incorporated by reference to
pages 33 and 34 of the Corporation's Annual Report to Shareholders for the
year ended December 31, 1997, 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 23 of the Corporation's Annual Report to Shareholders for the
year ended December 31, 1997, 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 13
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 Proxy Statement relating to the Annual Meeting of Shareholders
to be held April 14, 1998.
Executive Officers of Registrant
- -----------------------------------
<TABLE>
<CAPTION>
Name Age Position
- --------------------- --- --------------------------------------------------------------------
<S> <C> <C>
Walter E. Daller, Jr. 58 President and Chief Executive Officer of the Company and of
Harleysville
James W. Hamilton 51 Senior Vice President and Senior Trust Officer of Harleysville
Demetra M. Takes 47 Executive Vice President and Chief Operating Officer of Harleysville
Vernon L. Hunsberger 49 Treasurer of the Company, Senior Vice President/CFO and Cashier of
Harleysville
Frank J. Lochetto 50 Senior Vice President and Senior Lending Officer of Harleysville
Fred C. Reim, Jr. 54 Senior Vice President of Harleysville since August 1993; Senior Vice
President of First Valley Bank from December 1990 to August 1993
Dennis L. Detwiler 50 Senior Vice President of Harleysville
Mikkalya W. Brown 42 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 44 President and Chief Executive Officer of Citizens
Raymond H. Melcher 46 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 14
Item 11. Executive Compensation.
- ------------------------------------
The information required by this Item is incorporated by reference to
pages 7 through 12 of the Corporation's Proxy Statement relating to the Annual
Meeting of Shareholders to be held April 14, 1998.
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 Proxy Statement relating to the Annual
Meeting of Shareholders to be held April 14, 1998.
Item 13. Certain Relationships and Related Transactions.
- ---------------------------------------------------------------
The information required by this Item is incorporated by reference to
page 17 of the Corporation's Proxy Statement relating to the Annual Meeting of
Shareholders to be held April 14, 1998, and to page 17 of the Corporation's
Annual Report to Shareholders for the year ended December 31, 1997, which page
is included at Exhibit (13) to this Annual Report on Form 10-K.
PAGE 15
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, 1997 and 1996 8*
Consolidated Statements of Income for the
Years Ended December 31, 1997, 1996
and 1995 9*
Consolidated Statements of Shareholders'
Equity for the Years Ended
December 31, 1997, 1996 and 1995 10*
Consolidated Statements of Cash Flows
for the Years Ended December 31, 1997,
1996 and 1995 11*
Notes to Consolidated Financial Statements 12-23*
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 23 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 16
(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.)
(10.1) Harleysville National Corporation 1993 Stock Incentive Plan.
(Incorporated by Reference to
Exhibit 4.3 of Registrant's Registration Statement No.
33-57790 on Form S-8, filed with the
Commission of October 1, 1993.)
(10.2) Harleysville National Corporation Stock Bonus Plan.
(Incorporated by Reference to Exhibit
99A of Registrant's Registration Statement No. 33-17813 on
Form S-8, filed with the
Commission on December 13, 1996.)
(10.3) Supplemental Executive Retirement Plan.
(11) Computation of Earnings per Common Share. The information
for this Exhibit is
incorporated by reference to page 14 of the Corporation's
Annual Report to Shareholders for
the year ended December 31, 1997, which is included as
Exhibit (13) to this Form 10-K
Report.
(12) Statements Re: Computation of Ratios. The information for
this exhibit is incorporated by
reference to page 1 of the Corporation's Annual Report to
Shareholders for the year ended
December 31, 1997, which is included as Exhibit (13) to
this Form 10-K Report.
(13) Excerpts from the Corporation's 1997 Annual Report to
Shareholders. (This excerpt includes
only page 1 and pages 7 through 38 which are incorporated
in this Report by reference.)
(21) Subsidiaries of Registrant
(23) Consent of Grant Thornton LLP Independent Certified Public
Accountants
(27) Financial Data Schedule.
(99) Additional Exhibits
(a) Report of Independent Certified Public Accountants -
Grant Thornton LLP
(b) Reports on Form 8-K
During the quarter ended December 31, 1997, the Registrant
did not file any reports on Form 8-K.
PAGE 17
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 16, 1998 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.
<TABLE>
<CAPTION>
<S> <C> <C>
Signature Title Date
- ------------------------ -------------------------------- --------------
/s/ John W. Clemens Director March 12, 1998
- ------------------------
John W. Clemens
/s/ Walter E. Daller President, Chief Executive March 16, 1998
- ------------------------
Walter E. Daller, Jr. Officer and Director (Principal
Executive Officer)
/s/ Martin E. Fossler Director March 12, 1998
- ------------------------
Martin E. Fossler
/s/ Harold A. Herr Director March 12, 1998
- ------------------------
Harold A. Herr
/s/ Vernon L. Hunsberger Treasurer (Principal Financial March 12, 1998
- ------------------------
Vernon L. Hunsberger and Accounting Officer)
PAGE 18
____________________ Director March 12, 1998
Thomas S. McCready
/s/ Bradford W. Mitchell Director March 12, 1998
- ------------------------
Bradford W. Mitchell
___________________ Director March 12, 1998
Henry M. Pollak
/s/ Palmer E. Retzlaff Director March 12, 1998
- ------------------------
Palmer E. Retzlaff
/s/ Walter F. Vilsmeier Director March 12, 1998
- ------------------------
Walter F. Vilsmeier
/s/ William M. Yocum Director March 12, 1998
- ------------------------
William M. Yocum
</TABLE>
PAGE 19
EXHIBIT INDEX
- --------------
Exhibit
-------
(10.3) Supplemental Executive Retirement Plan.
(13) Excerpts from the Corporation's 1997 Annual Report to Shareholders
(This excerpt includes only page 1 and pages 7 through 38 which
are incorporated in this Report by reference.)
(21) Subsidiaries of Registrant
(23) Consent of Grant Thornton LLP Independent Certified
Public Accountants
(99) Additional Exhibits
Report of Independent Certified Public Accountants-
Grant Thornton LLP
PAGE 20
Exhibit 10.3
SUPPLEMENTAL EXECUTIVE RETIREMENT BENEFIT AGREEMENT
Harleysville National Corporation (Harleysville) maintains a
Supplemental Executive Retirement Plan for certain officers and key employees
(Employee) of Harleysville. The Plan provides for payment to the covered
employee of an annual supplemental retirement benefit equal to fifty percent
(50%) of their annual base salary upon retirement, thereafter offset by the
employer's share of social security, defined benefit pension and available
employer's 401(k) matching contribution. There is a lifetime payout in
retirement benefits with a minimum payout of ten years. There is a
pre-retirement death benefit, payable for ten years, of one hundred percent
(100%) of the annual base salary for the first year, and fifty percent (50%)
of the annual base salary for the next nine years.
WHEREAS, certain officers and key employees of Harleysville are making a
significant contribution to Harleysville's effective operations and
profitability, and
WHEREAS, Harleysville desires to retain the Employee's services to
provide a financial incentive for the Employee to continue employment and to
continue making significant contributions to the success of Harleysville;
NOW, THEREFORE, for and in consideration of the premises hereof and the
mutual promises and agreements contained herein, and intending to be legally
bound hereby, Harleysville and the Employee agree as follows:
1. CONTINUATION OF EMPLOYMENT. The Employee shall continue employment
with Harleysville on the same terms and conditions as before this Agreement.
This is not a contract of employment and shall not be construed to modify
Employee's employment relationship with Harleysville or provide any other
benefits related to employment, except as specifically provided for herein.
2. BENEFITS. The benefits to be paid as deferred compensation pursuant
to this Agreement are as follows:
(a) Retirement From Employment by Harleysville at or After Age 65. If
the Employee retires from employment with Harleysville on or after his or her
sixty-fifth (65) birthday, in addition to any other retirement benefits to
which Employee may be entitled whether from Harleysville or otherwise, each
month Harleysville shall pay to him or her a supplemental retirement income
equal to his or her "Monthly Retirement Benefit" as defined below. Said
supplemental retirement income shall be payable in monthly installments
commencing the first day of the first month after the effective date of the
Employee's said retirement, and continuing the first day of each month
thereafter so long as Employee shall live. Notwithstanding the foregoing to
the contrary, Harleysville is obligated hereunder to make a minimum of One
Hundred Twenty (120) such monthly retirement income payments. If Employee
dies before receiving said minimum number of monthly payments, the remaining
payments shall be made to the Employee's Beneficiary as defined below.
(b) Death Before Retirement and While Employed by Harleysville. If
Employee dies while employed by Harleysville and before Employee retires from
employment with Harleysville at or after age 65, in addition to any other
death benefits to which Employee or his or her beneficiaries may be entitled
whether from Harleysville or otherwise, Harleysville shall pay the Monthly
Death Benefit (as defined below) to the Employee's beneficiary (as defined
below) monthly starting with the first day of the month immediately following
Employee's death, and continuing until the first day of the month in which the
Employee would have reach age 65. Notwithstanding the foregoing to the
contrary, Harleysville is obligated hereunder to make a minimum of One Hundred
Twenty (120) such monthly death benefit payments.
PAGE 21
(c) Definition of Monthly Retirement Benefit. For purposes of this
Agreement, the Employee's "Monthly Retirement Benefit" shall be equal to the
Employee's Accrued Benefit Percent (defined below) times his or her Average
Monthly Compensation (defined below) less the following offsets:
(1) Social Security Offset: One half (1/2) of the employee's
monthly social security retirement income calculated as of the first day
of the first month after his or her retirement from employment with
Harleysville for purposes of item 2(a), above,
(2) Defined Benefit Pension Offset: The employee's monthly
retirement income from Harleysville's defined benefit pension plan; and
(3) 401(k) Offset: The employee's projected monthly retirement
income derived from Harleysville's matching contributions to employee's
individual account in Harleysville's section 401(k) plan for calendar years
1996 and later, calculated using actuarial assumptions that are consistent
with Harleysville's defined benefit pension plan calculations especially with
regard to use of an assumed pre-retirement earnings rate to project an account
balance at retirement and an annuity purchase rate to project the employee's
monthly retirement income from said account balance.
(d) Definition of Monthly Death Benefit. For purposes of this
Agreement, the Employee's "Monthly Death Benefit" shall be equal to:
(1) One Hundred percent (100%) of the Employee's Average Monthly
Compensation (defined below) for each of the first twelve (12) monthly
death benefit payments hereunder.
(2) Fifty Percent (50%) of the Employee's Average Monthly
Compensation (defined below) for all other monthly death benefit payments
hereunder.
(e) Definition of Accrued Benefit Percent: The Employee's "Accrued
Benefit Percent" shall be equal to the maximum of Fifty Percent (50%) less
any reductions in such percent determined by Harleysville prior to Employee's
retirement from employment with Harleysville.
(f) Definition of Average Monthly Compensation: For purposes of
calculating the Employee's benefits under this Agreement, the Employee's
Average Monthly Compensation shall be an amount equal to One Sixtieth (1/60)
of the Employee's total annual compensation (including salary, overtime and
bonus) from Harleysville for each of Employee's last Five (5) consecutive
full calendar years of employment with Harleysville immediately preceding:
(1) his or her retirement at or after age 65 in the case of
calculating retirement benefits under this Agreement; or
(2) his or her death in the case of calculating death benefits under
this Agreement.
(g) Beneficiary: The beneficiary referred to in this Agreement shall be
the Employee's surviving spouse, and if none, the Employee's surviving issue
per stirpes, and if none then the Employee's estate.
3. LIFE INSURANCE. If Harleysville decides to purchase insurance on the
Employee's life as keyperson life insurance, or for any other business
purpose, Employee agrees to cooperate fully in completing the appropriate
forms and providing information, including but not limited to medical testing,
as may be required to obtain such coverage. Employee's cooperation in
securing such coverage shall not be construed as giving Employee, the
beneficiary or any other person rights in or to the policy or policies.
Notwithstanding any other provisions of this Agreement to the contrary, if
Harleysville is a named beneficiary of any such aforesaid insurance on
Employee's life, and if the issuer of such policy denies payment of death
benefits under such policy due to misrepresentation or other act or deed by
the Employee, then Harleysville shall be excused from and shall not have any
liability for, any obligation it otherwise might have under this Agreement to
pay the Monthly Death Benefit.
PAGE 22
4. TERMINATION OF AGREEMENT. This Agreement shall terminate on the first to
occur of the following:
(a) Written notice given by either of the parties hereto to the other, or
(b) Termination of Employee's employment with Harleysville.
If this Agreement is terminated prior to the first to occur of: (1)
Employee's death while employed with Harleysville; or (2) Employee's
retirement from employment with Harleysville at or after age 65, Harleysville
shall be excused from, and shall not have liability for, any obligation it
might otherwise have under this Agreement to pay benefits.
5. FORFEITURE OF BENEFITS. Harleysville shall have no further
obligation or liability hereunder to pay benefits to or for the benefit of the
Employee or the Employee's beneficiary if the Employee fails to abide by any
provision or perform any obligation of this Agreement.
6. NO TRUST. Nothing contained in this Agreement and no action taken
pursuant to the provisions of this Agreement shall create or be construed to
create a trust of any kind, or a fiduciary relationship between Harleysville,
its shareholders, officers or directors, and the Employee, his beneficiary or
any other person.
7. NO ASSIGNMENT. Neither Employee nor any beneficiary hereunder has
any right to anticipate, transfer, pledge, convey, encumber or dispose of the
right to receive payments under this Agreement, and those payments and the
right to them are expressly declared to be nonassignable, nontransferable and
not subject to seizure for the payment of any debt or judgment against the
Employee or beneficiary hereunder. None of the benefits under this Agreement
are transferable by operation of law if the Employee becomes insolvent or
bankrupt. In the event of any attempted assignment or transfer of Employee's
(or beneficiary's) rights under this Agreement, Harleysville will have no
further obligation or liability under this Agreement.
8. INCAPACITY OF PAYEE. If the board of directors of Harleysville (the
"Board") shall find that any person to whom any payment is payable under this
Agreement is unable to care for his or her affairs because of illness,
accident or other mental or physical disability, or is a minor, any payment
due (unless a prior claim therefor shall have been made by a duly appointed
guardian, committee or other legal representative) may be paid to the spouse,
a child, parent, brother or sister of said payee, or applied directly for the
payee's benefit, without intervention of a guardian, or to any person deemed
by the Board to have incurred expense for the payee hereunder. Any such
payment shall be a complete discharge of Harleysville's obligations under this
Agreement.
9. BOARD'S POWERS AND LIABILITIES. The Board shall have full power and
authority to interpret and administer this Agreement. The Board's
interpretation of any provision or action taken under this Agreement, or the
amount of recipient of any payment hereunder, shall be binding and conclusive
on all persons for all purposes. No member of the Board shall be liable to
any person for any action taken or omitted in connection with the
interpretation and administration of this Agreement unless attributable to the
member's willful misconduct or bad faith.
10. BINDING EFFECT. This Agreement shall be binding upon and inure to
the benefit of Harleysville, its successors and assigns, and the Employee, his
or her heirs, executors and personal representatives.
11. ENTIRE AGREEMENT. This Agreement is the complete agreement of the
parties hereto and supersedes all agreements previously made between the
parties hereto relating to the subject matter hereof. No modification or
amendment of this Agreement will be valid unless in writing and signed by the
parties hereto.
PAGE 23
12. NOTICE. Any notice required to be given hereunder shall be in
writing and shall be effective when delivered personally, or when sent by
certified mail, postage prepaid, addressed to Harleysville or Employee as its,
his or her last know address.
13. HEADINGS. The headings used in this Agreement are for convenience
of reference and shall not be construed to be a part of this Agreement.
14. GOVERNING LAW. This Agreement was made and entered into in the
Commonwealth of Pennsylvania and it shall be construed in accordance with and
governed by the laws of Pennsylvania.
15. COUNTERPARTS. This Agreement may be executed in two or more
counterparts, each of which shall be deemed an original but all of which
together shall constitute one and the same instrument.
PAGE 24
FINANCIAL RATIOS AND SUMMARY OF KEY INFORMATION
Harleysville National Corporation and Subsidiaries
<TABLE>
<CAPTION>
Year Ended December 31,
(Dollars in thousands, except per share data and average --------------------------------------
shares outstanding) 1997 1996 1995
Per Share Information* ------------- ---------- ----------
<S> <C> <C> <C>
Basic....................................................... $ 2.38 $ 2.06 $ 1.79
Diluted..................................................... 2.38 2.06 1.78
Cash dividends paid......................................... 0.91 0.80 0.71
Book value (at year-end).................................... 15.64 14.67 13.67
Market Value*
Bid price of common stock (high)............................ $ 42.00 $ 25.85 $ 28.50
Bid price of common stock (low)............................. 23.10 22.38 18.14
Average basic shares outstanding............................ 7,005,184 6,993,535 6,949,275
Average Balance Sheet
Loans....................................................... $ 706,643 $ 652,157 $ 607,335
Earning assets.............................................. 1,020,983 929,589 848,687
Total assets................................................ 1,075,702 978,899 894,350
Deposits.................................................... 878,166 821,387 761,089
Interest-bearing liabilities plus demand deposits........... 949,200 868,200 798,156
Shareholders' equity........................................ 103,807 91,687 81,788
Selected Operating Ratios
Return on average assets.................................... 1.55% 1.47% 1.39%
Return on average shareholders' equity...................... 16.05% 15.71% 15.20%
Leverage (assets divided by shareholders' equity)........... 10.17X 10.51X 10.85X
Average shareholders' equity as a percentage of:
Average loans............................................. 14.69% 14.06% 13.47%
Average deposits.......................................... 11.82 11.16 10.75
Average assets............................................ 9.65 9.37 9.15
Average earning assets.................................... 10.17 9.86 9.64
Dividend payout ratio....................................... 38.23 38.76 39.51
Average total loans as a percentage of average deposits
and borrowed funds ........................................ 74.45 75.12 76.09
Net interest margin on average earning assets:
Interest income**......................................... 8.18% 8.20% 8.27%
Interest expense.......................................... (3.31) (3.32) (3.39)
Net interest margin....................................... 4.87 4.88 4.88
Noninterest margin........................................ (2.07) (2.23) (2.34)
</TABLE>
*Adjusted for 5% stock dividends effective 6/30/97 and 6/28/96.
**Tax-Equivalent Basis
1
<PAGE>
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 (HNB), 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 (CNB). 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 CNB and is now operating
as a branch office of CNB. On July 1, 1994, the Corporation acquired all of the
outstanding stock of Security National Bank (SNB). On March 1, 1996, the
Corporation acquired all of the outstanding common stock of Farmers & Merchants
Bank (F&M). F&M was merged into CNB and is now operating as a branch office of
CNB. On March 17, 1997, the HNC Financial Company was incorporated as a Delaware
Corporation. HNC Financial Company's principal business function is to expand
the investment opportunities of the Corporation.
HNB, which was established in 1909, CNB, which was established in 1903,
and SNB, 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 HNB's legal headquarters
are located at 483 Main Street, Harleysville, Pennsylvania 19438. CNB's legal
headquarters are located at 13-15 West Ridge Street, Lansford, Pennsylvania
18232. SNB's legal headquarters are located at One Security Plaza, Pottstown,
Pennsylvania 19464. HNC Financial Company's legal headquarters are located at
300 Delaware Avenue, Suite 1704, Wilmington, Delaware 19801.
As of December 31, 1997, the Banks had total assets of $1,116,254,000,
total shareholders' equity of $109,792,000 and total deposits of
$919,071,000.
The Banks engage in full-service commercial banking and the 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 29 branch offices located in Montgomery, Bucks, Carbon, Wayne,
Chester and Schuylkill counties.
On December 31, 1997, the Banks had 452 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 1997 and 1996. 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
1997 LOW PRICE HIGH PRICE DIVIDEND
- --------------------------------------------------------------------------
FIRST QUARTER*....... $ 23.10 $ 27.38 $ .210
SECOND QUARTER*...... 25.48 32.00 .210
THIRD QUARTER........ 31.25 38.75 .230
FOURTH QUARTER....... 36.50 42.00 .260
*Adjusted for a 5% stock dividend effective 6/30/97.
- --------------------------------------------------------------------------
- --------------------------------------------------------------------------
1996 Low Price* High Price* Dividend*
- --------------------------------------------------------------------------
First Quarter**...... $ 23.58 $ 25.85 $ .181
Second Quarter**..... 23.33 25.24 .181
Third Quarter........ 22.38 25.24 .200
Fourth Quarter....... 22.38 24.76 .238
*Adjusted for a 5% stock dividend effective 6/30/97.
**Adjusted for a 5% stock dividend effective 6/28/96.
- --------------------------------------------------------------------------
<PAGE>
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, 1997 and
1996, and the related consolidated statements of income, shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1997. 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.
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, 1997
and 1996, and the consolidated results of their operations and their
consolidated cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting
principles.
/s/ Grant Thornton LLP
- ------------------------------------
Grant Thornton LLP
Philadelphia, Pennsylvania
January 8, 1998
7
<PAGE>
CONSOLIDATED BALANCE SHEETS
Harleysville National Corporation and Subsidiaries
(Dollars in thousands)
<TABLE>
<CAPTION>
December 31,
---------------------------
Assets 1997 1996
------------- -----------
<S> <C> <C>
Cash and due from banks ...................................... $ 38,471 $ 39,407
Federal funds sold ........................................... 11,050 6,000
----------- -----------
Total cash and cash equivalents ...................... 49,521 45,407
----------- -----------
Interest-bearing deposits in banks ........................... 5,574 8,475
Investment securities available for sale ..................... 257,068 209,795
Investment securities held to maturity (fair value $47,354 and
$66,680, respectively) ...................................... 46,238 65,226
Loans ........................................................ 743,608 689,203
Less: Unearned income ........................................ (4,155) (7,793)
Allowance for loan losses ............................ (11,925) (10,710)
----------- -----------
Net loans ............................................ 727,528 670,700
----------- -----------
Bank premises and equipment, net ............................. 17,934 14,810
Accrued interest receivable .................................. 7,719 6,653
Other real estate owned ...................................... 453 972
Intangible assets, net ....................................... 1,851 1,658
Other assets ................................................. 2,368 2,432
----------- -----------
Total assets ......................................... $ 1,116,254 $ 1,026,128
=========== ===========
Liabilities and Shareholders' Equity
Deposits:
Noninterest-bearing .................................. $ 152,621 $ 139,723
Interest-bearing:
Checking accounts ................................ 108,954 102,270
Money market accounts ............................ 180,949 155,516
Savings .......................................... 108,199 104,329
Time, under $100,000 ............................. 299,794 294,501
Time, $100,000 or greater ........................ 68,554 51,360
----------- -----------
Total deposits ....................................... 919,071 847,699
Accrued interest payable ..................................... 14,388 13,927
U.S. Treasury demand notes ................................... 2,150 2,572
Federal funds purchased ...................................... 13,700 --
Federal Home Loan Bank (FHLB) borrowings ..................... 17,000 35,000
Securities sold under agreements to repurchase ............... 31,288 21,949
Other liabilities ............................................ 8,865 7,350
----------- -----------
Total liabilities .................................... 1,006,462 928,497
----------- -----------
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 7,020,211
shares in 1997 and 6,656,770 shares in 1996 ........ 7,020 6,657
Additional paid in capital ........................... 49,305 40,316
Retained earnings .................................... 48,988 47,849
Net unrealized gain on investment securities
available for sale ................................. 4,479 2,809
----------- -----------
Total shareholders' equity ........................... 109,792 97,631
----------- -----------
Total liabilities and shareholders' equity ........... $ 1,116,254 $ 1,026,128
=========== ===========
</TABLE>
================================================================================
See accompanying notes to consolidated financial statements.
8
<PAGE>
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,
--------------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Interest Income
Loans, including fees ......................................... $ 56,381 $ 52,873 $ 50,868
Lease financing ............................................... 4,531 3,811 3,141
Investment securities:
Taxable ............................................... 12,433 12,110 10,923
Exempt from federal taxes ............................. 5,417 4,020 2,671
Federal funds sold ............................................ 1,035 622 784
Deposits in banks ............................................. 405 282 104
----------- ----------- -----------
Total interest income ................................. 80,202 73,718 68,491
----------- ----------- -----------
Interest Expense
Savings deposits .............................................. 10,149 9,616 9,571
Time, under $100,000 .......................................... 16,550 16,830 15,397
Time, $100,000 or greater ..................................... 3,526 2,024 1,648
Borrowed funds ................................................ 3,626 2,406 2,168
----------- ----------- -----------
Total interest expense ................................ 33,851 30,876 28,784
----------- ----------- -----------
Net interest income ................................... 46,351 42,842 39,707
Provision for loan losses ..................................... 2,500 2,082 2,172
----------- ----------- -----------
Net interest income after provision for loan losses ... 43,851 40,760 37,535
----------- ----------- -----------
Other Operating Income
Service charges ............................................... 2,841 2,587 2,337
Security (losses) gains, net .................................. 1,757 (39) (172)
Trust income .................................................. 1,509 1,293 1,094
Other income .................................................. 1,284 1,274 1,178
----------- ----------- -----------
Total other operating income .......................... 7,391 5,115 4,437
----------- ----------- -----------
Net interest income after provision for loan losses and
other operating income ........................... 51,242 45,875 41,972
----------- ----------- -----------
Other Operating Expenses
Salaries, wages and employee benefits ......................... 15,479 14,398 13,112
Occupancy ..................................................... 1,980 1,873 1,541
Furniture and equipment ....................................... 2,817 2,083 1,913
Other expenses ................................................ 8,253 7,520 7,701
----------- ----------- -----------
Total other operating expenses ........................ 28,529 25,874 24,267
----------- ----------- -----------
Income before income tax expense ...................... 22,713 20,001 17,705
Income tax expense ............................................ 6,051 5,593 5,277
----------- ----------- -----------
Net income .................................................... $ 16,662 $ 14,408 $ 12,428
=========== =========== ===========
Weighted average number of common shares:
Basic ................................................. 7,005,184 6,993,535 6,949,275
Diluted ............................................... 7,012,279 7,017,402 6,983,099
=========== =========== ===========
Net income per share information:
Basic ................................................. $ 2.38 $ 2.06 $ 1.79
=========== =========== ===========
Diluted ............................................... $ 2.38 $ 2.06 $ 1.78
=========== =========== ===========
Cash dividends per share .............................. $ 0.91 $ 0.80 $ 0.71
=========== =========== ===========
================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
9
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Harleysville National Corporation and Subsidiaries
<TABLE>
<CAPTION>
Net Unrealized
Common Stock Gain (Loss) on
(Dollars in thousands) ------------------------ Investment 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, 1995 .................... 5,753 $ 5,753 $ 24,416 $ 39,992 $ (2,856) $ 67,305
Acquisition of Farmers & Merchants Bank ..... 438 438 3,281 3,159 -- 6,878
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)
Change in net unrealized gains 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
STOCK OPTIONS ............................... 29 29 187 -- -- 216
STOCK DIVIDENDS ............................. 333 333 8,785 (9,135) -- (17)
STOCK AWARDS ................................ 1 1 17 (18) -- --
NET INCOME FOR 1997 ......................... -- -- -- 16,662 -- 16,662
CASH DIVIDENDS .............................. -- -- -- (6,370) -- (6,370)
CHANGE IN NET UNREALIZED GAINS ON INVESTMENT
SECURITIES AVAILABLE FOR SALE ........... -- -- -- -- 1,670 1,670
--------- --------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1997 .................. 7,020 $ 7,020 $ 49,305 $ 48,988 $ 4,479 $ 109,792
========= ========= ========= ========= ========= =========
====================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
10
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Harleysville National Corporation and Subsidiaries
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------
Operating Activities 1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Net income ................................................................ $ 16,662 $ 14,408 $ 12,428
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses ............................................. 2,500 2,082 2,172
Depreciation and amortization ......................................... 1,762 1,412 1,220
Net amortization of investment securities discount/premiums ........... 280 403 481
Deferred income taxes ................................................. 1,420 844 445
Net realized securities (gain) loss ................................... (1,757) 39 172
Increase in accrued income receivable ................................. (1,066) (503) (908)
Increase in accrued interest payable .................................. 461 1,845 3,764
Net decrease (increase) in other assets ............................... 64 (564) (28)
Net (decrease) increase in other liabilities .......................... (804) 1,984 423
Decrease in unearned income ........................................... (3,637) (1,689) (599)
Write-down of other real estate owned ................................. 73 144 190
(Increase) decrease in intangible assets .............................. (193) 302 355
--------- --------- ---------
Net cash provided by operating activities ....................... 15,765 20,707 20,115
--------- --------- ---------
Investing Activities
Proceeds from sales of investment securities available for sale ....... 39,571 64,327 10,887
Proceeds, maturity or calls of investment securities held to maturity . 16,210 9,078 26,843
Proceeds, maturity or calls of investment securities available for sale 23,331 29,789 23,304
Purchases of investment securities held to maturity ................... (1,001) (5,847) (60,207)
Purchases of investment securities available for sale ................. (102,351) (127,591) (21,155)
Net decrease (increase) in interest-bearing deposits in banks ......... 2,901 (6,772) 301
Net increase in loans ................................................. (56,709) (53,491) (35,023)
Net increase in premises and equipment ................................ (4,886) (4,227) (3,469)
Proceeds from sales of other real estate .............................. 1,465 1,348 1,075
--------- --------- ---------
Net cash used in investing activities ........................... (81,469) (93,386) (57,444)
--------- --------- ---------
Financing Activities
Net increase in deposits .............................................. 71,372 53,200 51,175
(Decrease) increase in U.S. Treasury demand notes ..................... (422) 735 (556)
Increase (decrease) in federal funds purchased ........................ 13,700 -- (12,716)
(Decrease) increase in FHLB borrowings ................................ (18,000) 13,800 16,200
Increase in securities sold under agreement ........................... 9,339 5,236 1,501
Cash dividends and fractional shares .................................. (6,370) (5,584) (4,910)
Dividends reinvestment ................................................ (17) (20) --
Stock options ......................................................... 216 112 422
--------- --------- ---------
Net cash provided by financing activities ....................... 69,818 67,479 51,116
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents .......................... 4,114 (5,200) 13,787
Cash and cash equivalents at beginning of year ................................ 45,407 50,607 36,820
--------- --------- ---------
Cash and cash equivalents at end of year ...................................... $ 49,521 $ 45,407 $ 50,607
========= ========= =========
Cash paid during the year for:
Interest .............................................................. $ 33,389 $ 29,030 $ 25,021
Income taxes .......................................................... 5,100 3,710 4,398
========= ========= =========
Supplemental disclosure of noncash investing and financing activities:
Transfer of assets from loans to other real estate owned .............. $ 1,019 $ 1,243 $ 1,208
========= ========= =========
Transfer of securities from investment securities held to maturity
to investment securities available for sale ........................ $ -- $ -- $ 39,947
========= ========= =========
===========================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Harleysville National Corporation and Subsidiaries
1 - Summary of Significant Accounting Policies
- --------------------------------------------------------------------------------
Business
Harleysville National Corporation (the Corporation) through its subsidiary
banks, Harleysville National Bank and Trust Company, The 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 accounts for securities under the Statement of Financial
Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," 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 fair 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.
<PAGE>
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 loans is credited to income based on
the principal amount outstanding.
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 man
agement, 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.
(continued)
12
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Harleysville National Corporation and Subsidiaries
The Corporation adopted SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," as amended by
SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB
Statement No. 125 -- An Amendment of FASB Statement No. 125" on January 1, 1997.
SFAS No. 125 applies a control-oriented, financial-components approach to
financial-asset-transfer transactions whereby the Corporation (1) recognizes the
financial and servicing assets it controls and the liabilities it has incurred,
(2) derecognizes financial assets when control has been surrendered, and (3)
derecognizes liabilities once they are extinguished. Under SFAS No. 125, control
is considered to have been surrendered only if: (i) the transferred assets have
been isolated from the transferor and its creditors, even in bankruptcy or other
receivership (ii) the transferee has the right to pledge or exchange the
transferred assets, or, is a qualifying special-purpose entity (as defined) and
the holders of beneficial interests in that entity have the right to pledge or
exchange those interests; and (iii) the transferor does not maintain effective
control over the transferred assets through an agreement which both entitles and
obligates it to repurchase or redeem those assets prior to maturity, or through
an agreement which both entitles and obligates it to repurchase or redeem those
assets if they were not readily obtainable elsewhere. If any of these conditions
are not met, the Corporation accounts for the transfer as a secured borrowing.
SFAS No. 125 also requires that the Corporation derecognize a liability if
and when it is extinguished. A liability is considered extinguished under SFAS
No. 125 if (1) the Corporation pays the creditor, and thus, is relieved of its
obligation for the liability, or (2) is legally released from being the primary
obligor under the liability, either judicially or by the creditor. The adoption
of this statement did not 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.
<PAGE>
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. Intangible assets also include mortgage servicing rights. The core
deposit intangibles are being amortized over a 10-year life on an accelerated
basis. The amortization charged to income related to the core deposit
intangibles was $309,332, $301,560 and $355,140 for the years ended December
31, 1997, 1996 and 1995, respectively. The mortgage servicing rights are
amortized using the level yield method.
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.
(continued)
13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Harleysville National Corporation and Subsidiaries
Income Taxes
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. 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
As of December 31, 1997, the Banks did not need to maintain reserves (in
the form of deposits with the Federal Reserve Bank) to satisfy federal
regulatory requirements.
Net Income Per Share
During 1997, the Corporation adopted the provisions of SFAS No. 128,
"Earnings per Share." SFAS No. 128 eliminates primary and fully diluted
earnings per share and requires presentation of basic and diluted earnings
per share (EPS) in conjunction with the disclosure of the methodology used in
the computing such earnings per share. Basic earnings per share excludes
dilution and is computed by dividing income available to common shareholders
by the weighted-average common shares outstanding during the period. Diluted
earnings per share take into account the potential dilution that could occur if
securities or other contracts to issue common stock were exercised and
converted into common stock. Prior periods' earnings per share
calculations have been restated to reflect the adoption of SFAS No. 128.
<PAGE>
The reconciliation of the numerators and denominators of the basic and
diluted EPS follows:
YEAR ENDED DECEMBER 31, 1997
-------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------ -------------- ------------
NET INCOME........... $16,662,000
===========
Basic EPS
INCOME AVAILABLE TO
COMMON SHAREHOLDERS.. $16,662,000 7,005,184 $ 2.38
=======
Effect of
Dilutive Securities
STOCK OPTIONS........ -- 7,095
----------- ----------
Diluted EPS
INCOME AVAILABLE TO
COMMON SHAREHOLDERS.. $16,662,000 7,012,279 $ 2.38
=========== ========== =======
Year Ended December 31, 1996
-------------------------------------------
Net income........... $14,408,000
===========
Basic EPS
Income available to
common shareholders.. $14,408,000 6,993,535 $ 2.06
=======
Effect of
Dilutive Securities
Stock options........ -- 23,867
------------ ----------
Diluted EPS
Income available to
common shareholders.. $14,408,000 7,017,402 $ 2.06
============ ========== ========
Year Ended December 31, 1995
-------------------------------------------
Net income........... $12,428,000
===========
Basic EPS
Income available to
common shareholders. $12,428,000 6,949,275 $ 1.79
=======
Effect of
Dilutive Securities
Stock options........ -- 33,824
----------- ----------
Diluted EPS
Income available to
common shareholders.. $12,428,000 6,983,099 $ 1.78
============ =========== =======
(continued)
14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Harleysville National Corporation and Subsidiaries
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.
Other Information
In February 1997, the FASB issued SFAS No. 129, "Disclosure Information
about Capital Structure." SFAS No. 129 summarizes previously issued disclosure
guidance contained within APB Opinions No. 10 and 15, as well as SFAS No. 47.
SFAS No. 129 is effective for fiscal years ending after December 15, 1997. The
Banks' current disclosures were not affected by the adoption of SFAS No. 129.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards to provide prominent disclosure
of comprehensive income items. Comprehensive income is the change in equity
of a business enterprise during a period from transactions and other events
and circumstances from non-owner sources. SFAS No. 130 is effective for all
periods beginning after December 15, 1997. Subsequent to the effective date,
all prior-period amounts are required to be restated to conform to the
provisions of SFAS No. 130. The adoption of SFAS No. 130 is not expected to
have a material impact on the Corporation's financial position or results of
operations.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 requires that
public business enterprises report certain information about operating
segments in complete sets of financial statements of the enterprise and in
condensed financial statements of interim periods issued to shareholders. It
also requires that public business enterprises report certain information
about their products and services, the geographic areas in which they operate,
and their major customers. SFAS No. 131 is effective for all periods beginning
after December 15, 1997. The adoption of SFAS No. 131 will have no impact on
the Corporation's financial position or results of operations.
Many existing computer programs use only two digits to identify a year in
the date field. These programs were designed and developed without
considering the impact of the upcoming change in the century. If not
corrected, many computer applications could fail or create erroneous results
by or at the Year 2000. The Year 2000 issue affects virtually all companies and
organizations.
The Corporation has conducted a comprehensive review of its computer
systems to identify the systems that could be affected by the Year 2000
issue and has developed an implementation plan to resolve the issue.
Modifications or replacements of computer systems to attain Year 2000
compliance have begun, and the Corporation expects to attain Year 2000
compliance and institute appropriate testing of its modifications and
replacements before the Year 2000 date change. The Corporation believes that,
with modifications to existing software and conversions to new software, the
Year 2000 problem will not pose a significant operational problem for the
Corporation. The Corporation has taken steps to communicate with the unrelated
parties with whom it deals to coordinate Year 2000 compliance. The cost in
addressing the Year 2000 issues will be expensed as incurred in compliance with
Generally Accepted Accounting Principles (GAAP).
<PAGE>
2 - Acquisitions
- --------------------------------------------------------------------------------
On March 1, 1996, the Corporation consummated the acquisition of Farmers
& Merchants Bank (Honesdale, PA) (F&M). 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 F&M approved the acquisition
at a meeting of shareholders on January 31, 1996. For each share of F&M 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. F&M's banking operations
were merged into those of CNB. The F&M merger was accounted for on a
pooling-of-interest basis, and all prior periods have been restated to reflect
the combination as follows:
(Dollars in thousands) Revenue Net Income
--------- ----------
Year Ended December 31, 1996
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
========= ==========
(continued)
15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Harleysville National Corporation and Subsidiaries
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, 1997
--------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
HELD TO MATURITY COST GAINS (LOSSES) VALUE
- ---------------- --------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Obligations of other U.S.
Government Agencies
and corporations ..... $ 21,707 $ 303 $ (14) $ 21,996
Obligations of states and
political subdivisions 19,589 765 (6) 20,348
Mortgage-backed
securities ........... 2,048 13 -- 2,061
Other securities ......... 2,894 55 -- 2,949
-------- -------- -------- --------
Totals ............... $ 46,238 $ 1,136 $ (20) $ 47,354
======== ======== ======== ========
AVAILABLE FOR SALE
- ------------------
U.S. Treasury notes ...... $ 45,988 $ 634 $ (8) $ 46,614
Obligations of other U.S.
Government Agencies
and corporations ..... 42,211 738 (4) 42,945
Obligations of states and
political subdivisions 92,007 2,508 (210) 94,305
Mortgage-backed
securities ........... 56,455 850 (6) 57,299
Other securities ......... 13,518 2,413 (26) 15,905
-------- -------- -------- --------
Totals ............... $250,179 $ 7,143 $ (254) $257,068
======== ======== ======== ========
HELD TO MATURITY
- ----------------
December 31, 1996
-------------------------------------------------
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
======== ======== ======== ========
AVAILABLE FOR SALE
- ------------------
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>
There are no significant concentrations of securities (greater than 10%
of shareholders' equity) in any individual security issuer.
<PAGE>
Securities with a carrying value of $138,121,000 and $91,506,000 at December
31, 1997 and 1996, 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, 1997, 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 $ 3,096 $ 3,128 $ 4,118 $ 4,137
Due after one year
through five years 14,673 14,940 52,973 53,622
Due after five years
through ten years . 13,189 13,395 47,415 48,386
Due after ten years ... 13,232 13,830 89,218 93,624
-------- -------- -------- --------
44,190 45,293 193,724 199,769
Mortgage-backed
securities ........ 2,048 2,061 56,455 57,299
-------- -------- -------- --------
Totals ............ $ 46,238 $ 47,354 $250,179 $257,068
======== ======== ======== ========
</TABLE>
Proceeds from sales of investment securities available for sale during
1997 were $39,571,000. Gross gains of $2,073,000 and gross losses of $316,000
were realized on these sales. 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.
4 - Loans
- ------------------------------------------------------------------------------
Major classifications of loans are as follows:
(Dollars in thousands) December 31,
-----------------------------
1997 1996
----------- ----------
Real estate .............................. $246,259 $237,155
Commercial and industrial ................ 192,694 164,327
Installment .............................. 198,948 190,745
Student loans ............................ 15,194 11,999
Consumer loans ........................... 29,006 29,527
Lease financing .......................... 55,413 49,623
Other .................................... 6,094 5,827
-------- --------
Total loans ...................... 743,608 689,203
Less:
Unearned income .................. 4,155 7,793
Allowance for loan losses ........ 11,925 10,710
-------- --------
Net loans ........................ $727,528 $670,700
======== ========
(continued)
16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Harleysville National Corporation and Subsidiaries
On December 31, 1997, nonaccrual loans were $2,621,000, loans 90 days or
more past due and still accruing interest were $2,253,000 and troubled debt
restructured loans were $1,099,000. 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.
The balance of impaired loans was $2,441,000 at December 31, 1997, compared
to $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 December 31, 1997 impaired
loan balance included $1,429,000 of nonaccrual loans and $1,012,000 of troubled
debt restructured loans. The December 31, 1996 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 impaired loans was
$341,000 at December 31, 1997 and $533,000 at December 31, 1996. The average
impaired loan balance was $3,538,000 in 1997, compared to $9,333,000 in 1996.
The income recognized on impaired loans during 1997 and 1996 was $135,000 and
$814,000, 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 which exceeded 10%
of total loans at December 31, 1997 and 1996. 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, Berks and
Schuylkill 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:
(Dollars in thousands) Year Ended December 31,
------------------------------------------
1997 1996 1995
-------- -------- --------
Balance, January 1 .......... $ 7,723 $ 12,586 $ 11,618
New loans ........... 9,462 7,721 8,592
Repayments .......... (13,611) (12,584) (7,624)
-------- -------- --------
Balance, December 31 ....... $ 3,574 $ 7,723 $ 12,586
======== ======== ========
<PAGE>
5 - Allowance for Loan Losses
- -------------------------------------------------------------------------------
Transactions in the allowance for loan losses are as follows:
(Dollars in thousands) Year Ended December 31,
--------------------------------------
1997 1996 1995
-------- -------- --------
Balance, beginning of year ........ $ 10,710 $ 9,891 $ 8,150
-------- -------- --------
Provision charged to
operating expenses .......... 2,500 2,082 2,172
-------- -------- --------
Loans charged off:
Commercial
and industrial .......... (66) (392) (240)
Installment ................. (1,038) (614) (277)
Real estate ................. (544) (412) (127)
Lease financing ............. (78) (33) (39)
-------- -------- --------
Total charged off ....... (1,726) (1,451) (683)
-------- -------- --------
Recoveries:
Commercial
and industrial .......... 113 84 143
Installment ................. 104 56 72
Real estate ................. 206 30 1
Lease financing ............. 18 18 36
-------- -------- --------
Total recoveries ........ 441 188 252
-------- -------- --------
Balance, end of year .............. $ 11,925 $ 10,710 $ 9,891
======== ======== ========
6 - Bank Premises and Equipment
- -------------------------------------------------------------------------------
Bank premises and equipment consist of the following:
Estimated December 31,
(Dollars in thousands) Useful --------------------
Lives 1997 1996
---------- ------- -------
Land................ $ 2,851 $ 2,539
Building............. 15-39 years 15,858 13,443
Furniture, fixtures
and equipment 3-10 years 12,250 10,308
------- -------
Total cost... 30,959 26,290
Less accumulated depreciation
and amortization 13,025 11,480
------- -------
$17,934 $14,810
======= =======
7 - Deposits and Borrowings
- -------------------------------------------------------------------------------
At December 31, 1997, scheduled maturities of certificates of deposit are
as follows:
(Dollars in thousands)
Year Ended December 31,
-----------------------------------------------------------------
1998 1999 2000 2001 2002 Thereafter Total
-------- ------- ------- ------- ------ ---------- --------
Amount $249,326 $54,079 $34,638 $23,677 $6,450 $178 $368,348
======== ======= ======= ======= ====== ==== ========
(continued)
17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Harleysville National Corporation and Subsidiaries
Borrowings, primarily advances from the FHLB, consist of the
following:
(Dollars in thousands) December 31,
------------------------
DESCRIPTION 1997 1996
- ----------- --------- -------
Notes payable to FHLB, with fixed rates
payable between 4.97% and 6.57% .......... $ 2,000 $21,500
Notes payable to FHLB, with variable rates
payable at 3 month Libor ................. -- 5,500
Notes payable to FHLB, fixed for one year
and then converts to variable rates
payable at 3 month Libor
plus 8 basis points ...................... 14,000 --
Notes payable to FHLB, fixed for two years
and then converts to variable rates
payable at 3 month Libor
plus 6 basis points ...................... 1,000 --
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
------- -------
$17,000 $35,000
======= =======
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
$201,499,000 at December 31, 1997 and $181,417,000 at December 31, 1996.
Outstanding borrowings mature as follows (in thousands):
1998............................................ $ 1,500
2000............................................ 500
2002............................................ 15,000
-------
$17,000
=======
The Banks, pursuant to a designated cash management agreement, utilize
securities sold under agreements to repurchase as vehicles for customers' sweep
and term investment products. Securitization under these cash management
agreements are in U.S. Treasury Securities.
The U.S. Treasury Securities are held in a third party custodian's account,
designated by the Banks under a written custodial agreement that explicitly
recognizes the Banks' interest in the securities. The U.S. Treasury Securities
are non-deliverable and held in the name of the customer in the custodial
account. At December 31, 1997, these agreements matured within 60 days. The
average securities sold under agreements to repurchase balance for 1997 was
$29,757,000, and the maximum amounts outstanding at any month-end during 1997
was $36,121,000.
<PAGE>
8 - Federal Income Taxes
- -------------------------------------------------------------------------------
Income tax expense from current operations is composed of the
following:
(Dollars in thousands) Year Ended December 31,
--------------------------------------
1997 1996 1995
------ ------ ------
Current tax payable ........... $4,631 $4,699 $3,905
Deferred income tax ........... 1,420 894 445
Charge in lieu of
income tax ............ -- -- 927
------ ------ ------
Tax expense ................... $6,051 $5,593 $5,277
====== ====== ======
The effective income tax rates of 26.6% for 1997, 28.0% for 1996 and
29.8% for 1995 were less than the applicable federal income tax rate of 35%
for each year. The reason for these differences follows:
(Dollars in thousands) Year Ended December 31,
---------------------------------------
1997 1996 1995
------- ------- -------
Expected tax expense .......... $ 7,722 $ 6,800 $ 6,020
Tax-exempt income (net of
expense disallowance) ... (1,893) (1,414) (999)
Other ......................... 222 207 256
------- ------- -------
Actual tax expense .... $ 6,051 $ 5,593 $ 5,277
======= ======= =======
The tax effect of temporary differences that give rise to significant
portions of deferred tax assets and liabilities are as follows:
(Dollars in thousands) 1997 1996
--------------------- -------------------
Asset Liability Asset Liability
------- --------- ------- ---------
Allowance for
loan losses ................ $ 4,174 $ -- $ 3,742 $ --
Lease assets ................... -- 9,330 -- 7,509
Deferred loan fees ............. 628 -- 739 --
Deferred compensation .......... 620 -- 527 --
Unrealized gain
on securities .............. -- 2,410 -- 1,512
Other .......................... 212 -- 227 --
------- ------- ------- -------
Total deferred taxes ....... $ 5,634 $11,740 $ 5,235 $ 9,021
======= ======= ======= =======
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, 1996, such
deductions resulted in $926,833 of income tax benefits which increased the
Additional Paid in Capital.
(continued)
18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Harleysville National Corporation and Subsidiaries
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:
(Dollars in thousands) 1997 1996
------- -------
Plans' assets at fair value ...................... $ 6,295 $ 5,436
Projected benefit obligation (including an
accumulated benefit obligation of
$3,934 in 1997 and $3,577 in 1996,
and a vested benefit obligation of
$3,842 in 1997 and $3,430 in 1996) ............... 4,382 5,034
------- -------
Plans' assets in excess (deficit) of
projected benefit obligation ............. 1,913 402
Unrecognized net gain from past
experience being different from
that which was assumed ........................... (258) 801
Unrecognized prior service cost .................. (772) 29
Unrecognized net assets at January 1, 1987,
being recognized over 15 years ........... (224) (241)
------- -------
Prepaid pension cost ............................. $ 659 $ 991
======= =======
Net pension cost for the years ended December 31, 1997, 1996 and 1995
included the following components:
(Dollars in thousands) 1997 1996 1995
----- ----- -----
Service cost ............................. $ 247 $ 242 $ 280
Interest cost ............................ 203 147 93
Actual return on plans' assets ........... (551) (30) (204)
Net amortization and deferral ............ 220 (38) 156
----- ----- -----
Net periodic pension cost .......... $ 119 $ 321 $ 325
===== ===== =====
The weighted average discount rate used in determining the actuarial
present value of the projected benefit obligation was 7.00%, 7.15% and 7.00% in
1997, 1996 and 1995, respectively. The rate of increase in future
compensation levels was 5.00% in 1997 and 5.35% in 1996 and 1995. The
expected long-term rate of return on assets was 7.00%, 7.50% and 7.85% in
1997, 1996 and 1995, 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 $202,857, $699,282, and $1,081,068 for 1997, 1996 and 1995,
respectively.
<PAGE>
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, 1997 and 1996, the Corporation had accrued a
liability of $992,589 and $759,950, respectively, for the SERP.
10 - Shareholders' Equity
- --------------------------------------------------------------------------------
On June 30, 1997, the Corporation paid a 5% stock dividend on its common
stock to shareholders of record as of June 13, 1997.
On June 28, 1996, the Corporation paid a 5% stock dividend on its common
stock to shareholders of record as of June 14, 1996.
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 101,034 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 SFAS No. 123, "Accounting for Stock-Based
Compensation," the Corporation's 1997 and 1996 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 $19.39 to $24.38 at December 31, 1997. The weighted-average
exercise price and weighted-average remaining contractual life of the stock
option plans are $20.62 and 2 years and 3 months, respectively. A summary of
the status of the Corporation's fixed stock option plans as of December 31,
1997, 1996 and 1995, and changes during the years ending on those dates is
presented below.
1997 1996 1995
-------- -------- --------
Number of Common Shares:
Outstanding, January 1* 55,076 71,853 242,042
Granted ................ -- -- 5,044
Exercised .............. (34,537) (16,777) (175,233)
-------- -------- --------
Outstanding, December 31 20,539 55,076 71,853
======== ======== ========
Exercisable, December 3 20,539 55,076 66,809
======== ======== ========
* Adjusted for stock splits and stock dividends.
(continued)
19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Harleysville National Corporation and Subsidiaries
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, 1997 are as follows:
Total
Operating Leases
----------------
1998......... $ 1,158,033
1999......... 915,312
2000......... 719,355
2001......... 642,634
2002......... 450,195
Thereafter... 3,518,774
-------------
Total...... $ 7,404,303
=============
Total lease expense amounted to $1,259,000 in 1997, $895,000 in 1996 and
$770,000 in 1995.
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,
1997 and 1996 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, 1997 and 1996 of
$5,463,000 and $6,568,000, respectively; commitments to extend credit of
$23,945,000 and $22,243,000, respectively for revolving home equity lines;
$78,715,000 and $74,482,000, respectively for commercial and real estate
loans; $21,059,000 and $17,931,000, respectively, for consumer loans.
<PAGE>
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.
(continued)
20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Harleysville National Corporation and Subsidiaries
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, 1997, that the Banks meet all capital adequacy requirements
to which they are subject.
As of December 31, 1997, 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 Tier 1 Capital to Risk-Weighted Asset Ratio
----------------------------------------- -------------------------------------------
December 31, 1997 December 31, 1996 December 31, 1997 December 31, 1996
----------------- ----------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio Amount Ratio
-------- ------ ------- ------ -------- ------ ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Entity:
Corporation ............... $ 103,600 9.36% $93,164 9.21% $103,600 13.42% $93,164 13.12%
Subsidiaries:
Harleysville National
Bank ................. 72,965 8.42% 67,253 8.34% 72,965 11.71% 67,253 11.59%
Citizens National
Bank ................. 20,811 13.00% 20,031 13.08% 20,811 22.49% 20,031 22.60%
Security National
Bank ................. 6,188 8.20% 3,885 6.81% 6,188 11.13% 3,885 9.57%
"Well Capitalized"
institution (under FDIC
regulations) ............ 5.00% 5.00% 6.00% 6.00%
Tier 2 Total Capital to Risk-Weighted Asset Ratio
-------------------------------------------------
December 31, 1997 December 31, 1996
------------------ ------------------
Amount Ratio Amount Ratio
-------- ------ -------- ------
<C> <C> <C> <C>
Entity:
Corporation .............. $113,276 14.68% $102,061 14.38%
Subsidiaries:
Harleysville National
Bank ................. 80,778 12.96% 74,528 12.85%
Citizens National
Bank ................. 21,971 23.74% 20,993 23.69%
Security National
Bank ................. 6,884 12.39% 4,394 10.83%
"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 1998 of
approximately $19,100,000 plus an amount equal to the net profits of the Banks
in 1998 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, 1997, there were no
investments, loans, extensions of credit or advances from any of the subsidiary
banks to the Corporation.
<PAGE>
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 and investments. 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, 1997 and 1996 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 $49,521,000 and $45,407,000 at December
31, 1997 and 1996, 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.
(continued)
21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Harleysville National Corporation and Subsidiaries
The loan portfolio, net of unearned income, at December 31, 1997 and 1996
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.
1997 1996
--------------------------- ---------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------------ ------------ ------------ ------------
Investment
securities ... $303,306,000 $304,422,000 $275,021,000 $276,475,000
Loans, net ..... $739,453,000 $747,008,000 $681,410,000 $689,695,000
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.
1997 1996
--------------------------- ---------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------------ ------------ ------------ ------------
Time deposits ... $368,348,000 $369,709,000 $345,861,000 $347,382,000
The fair values of demand notes, borrowings, and securities sold under
agreements to repurchase of $64,143,000 and $59,521,000 at December 31, 1997 and
1996, 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
$129,182,000 and $121,224,000 at December 31, 1997 and 1996, 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:
<PAGE>
CONDENSED BALANCE SHEETS
(Dollars in thousands) December 31,
-----------------------------
1997 1996
---------- ---------
Assets:
Cash ............................... $ 748 $ 553
Investments in subsidiaries 109,493 93,724
Investment securities available
for sale ........................... -- 4,809
---------- ---------
Total assets ....................... $ 110,241 $ 99,086
========== =========
Liabilities and shareholders' equity:
Other liabilities .................. $ 449 $ 1,455
---------- ---------
Total liabilities .................. $ 449 $ 1,455
---------- ---------
Shareholders' equity:
Common stock ....................... $ 7,020 $ 6,657
Additional paid in capital 49,305 40,316
Retained earnings .................. 48,988 47,849
Net unrealized gain on investment
securities available for sale ...... 4,479 2,809
---------- ---------
Total shareholders' equity ......... 109,792 97,631
---------- ---------
Total liabilities and
shareholders' equity.. ............. $ 110,241 $ 99,086
========== =========
CONDENSED STATEMENTS OF INCOME
(Dollars in thousands) Year Ended December 31,
------------------------------------
1997 1996 1995
------- ------- -------
Dividends from banks .................. $ 8,371 $ 5,584 $ 5,085
Other income .......................... 71 156 --
------- ------- -------
Total operating income ............ 8,442 5,740 5,085
Operating expense ..................... -- -- --
------- ------- -------
Income before income tax expense
and equity in undistributed
net income of banks ............... 8,442 5,740 5,085
Income tax expense .................... 24 55 --
------- ------- -------
Income before equity in undistributed
net income of banks ............... 8,418 5,685 5,085
Equity in undistributed
net income of banks ............... 8,244 8,723 7,343
------- ------- -------
Net income ........................ $ 16,662 $ 14,408 $ 12,428
======== ======== ========
(continued)
22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Harleysville National Corporation and Subsidiaries
CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands) Year Ended December 31,
-----------------------------------
1997 1996 1995
-------- -------- --------
Operating activities:
Net income ...................... $ 16,662 $ 14,408 $ 12,428
Adjustments to reconcile net
income to net cash
provided by operating
activities:
Equity in undistributed
net income of banks .......... (8,244) (8,723) (7,343)
Realized gain on sale
of securities. ............... (6) (68) --
Net increase in
other liabilities ............ 24 55 --
-------- -------- --------
Net cash provided by
operating activities ............ 8,436 5,672 5,085
-------- -------- --------
Investing activities:
Capital contributions
made to the banks ............... (3,944) -- (175)
Proceeds from sales
of securities ................... 1,874 405 --
Purchase of securities
available for sale .............. -- (1,576) --
-------- -------- --------
Net cash (used in) provided
by investing activities ......... (2,070) (1,171) (175)
-------- -------- --------
Financing activities:
Cash dividends and
fractional shares ............... (6,387) (5,604) (4,909)
Stock options and awards ........ 216 112 422
-------- -------- --------
Net cash used in
financing activities ............ (6,171) (5,492) (4,487)
-------- -------- --------
Net (decrease) increase in cash ..... 195 (991) 423
Cash and cash equivalents at
beginning of year ............... 553 1,544 1,121
-------- -------- --------
Cash and cash equivalents at
end of year ..................... $ 748 $ 553 $ 1,544
======== ======== ========
<PAGE>
17 - Quarterly Financial Data (Unaudited)
- --------------------------------------------------------------------------------
The following is the summarized (unaudited) consolidated quarterly financial
data of the Corporation which, in the opinion of management, reflect s 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)
Three Months Ended
---------------------------------------------
1997: March 31 June 30 Sept. 30 Dec. 31
-------- -------- -------- --------
Interest income ........... $ 19,340 $ 19,795 $ 20,482 $ 20,585
Net interest income ....... 11,366 11,407 11,795 11,783
Provision for losses ...... 540 590 540 830
Noninterest income ........ 1,390 2,126 1,651 2,224
Operating expenses ........ 6,833 6,904 7,149 7,643
Income before income
tax expense ............ 5,383 6,039 5,757 5,534
Income tax expense ........ 1,469 1,669 1,513 1,400
-------- -------- -------- --------
Net income ................ $ 3,914 $ 4,370 $ 4,244 $ 4,134
======== ======== ======== ========
Net income
per share .............. $ 0.57 $ 0.62 $ 0.60 $ 0.59
======== ======== ======== ========
1996:
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 .............. $ 0.48 $ 0.52 $ 0.51 $ 0.55
======== ======== ======== ========
================================================================================
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Harleysville National Corporation and Subsidiaries
<TABLE>
<CAPTION>
Consolidated Summary of Operations
(Dollars in thousands, except per share
data and average shares outstanding) Year Ended December 31,
--------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
INCOME AND EXPENSE
Interest income......................................... $ 80,202 $ 73,718 $ 68,491 $ 58,381 $ 53,980
Interest expense........................................ 33,851 30,876 28,784 21,101 21,232
---------- --------- ---------- ---------- ----------
Net interest income..................................... 46,351 42,842 39,707 37,280 32,748
Provision for loan losses............................... 2,500 2,082 2,172 2,665 3,085
---------- --------- ---------- ---------- ----------
Net interest income after provision for loan losses..... 43,851 40,760 37,535 34,615 29,663
Noninterest income...................................... 7,391 5,115 4,437 4,746 4,963
Noninterest expense..................................... 28,529 25,874 24,267 23,314 21,436
---------- --------- ---------- ---------- ----------
Income before income tax expense and the cumulative
effect of a change in accounting for income taxes... 22,713 20,001 17,705 16,047 13,190
Income tax expense...................................... 6,051 5,593 5,277 4,767 3,753
---------- --------- ---------- ---------- ----------
Income before the cumulative effect of a change
in accounting for income taxes...................... 16,662 14,408 12,428 11,280 9,437
Cumulative effect of a change in accounting
for income taxes.................................... -- -- -- -- 300
---------- --------- ---------- ---------- ----------
Net income.............................................. $ 16,662 $ 14,408 $ 12,428 $ 11,280 $ 9,737
========== ========== ========== ========== ==========
- -----------------------------------------------------------------------------------------------------------------------------
PER SHARE*
Basic................................................... $ 2.38 $ 2.06 $ 1.79 $ 1.66 $ 1.49
Diluted................................................. 2.38 2.06 1.78 1.62 1.46
Cash dividends paid..................................... 0.91 0.80 0.71 0.55 0.45
Basic average shares outstanding........................ 7,005,184 6,993,535 6,949,275 6,789,795 6,533,976
Diluted average shares outstanding...................... 7,012,279 7,017,402 6,983,099 6,948,892 6,654,600
*Adjusted for 5% stock dividends effective 6/30/97, 6/28/96 and 12/30/94, and
a two-for-one stock split effective 12/31/93.
- -----------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCE SHEET
Loans.................................................. $ 706,643 $652,157 $607,335 $540,030 $472,319
Investments............................................ 289,018 260,483 226,747 236,319 236,612
Other interest-earning assets.......................... 25,322 16,949 14,605 10,351 21,312
Total assets........................................... 1,075,702 978,899 894,350 829,241 776,419
Deposits............................................... 878,166 821,387 761,089 738,029 697,993
Other interest-bearing liabilities..................... 71,034 46,813 37,067 8,348 2,372
Shareholders' equity................................... 103,807 91,687 81,788 74,234 66,355
- -----------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET AT YEAR-END
Loans.................................................. $ 739,453 $ 681,410 $628,738 $594,754 $498,139
Investments............................................ 303,306 275,021 242,995 216,816 250,608
Other earning assets................................... 16,624 14,475 17,998 2,980 20,351
Total assets........................................... 1,116,254 1,026,128 937,345 862,669 816,314
Deposits............................................... 919,071 847,699 794,499 743,326 735,328
Other interest-bearing liabilities..................... 64,138 59,521 39,751 35,322 2,742
Shareholders' equity................................... 109,792 97,631 86,362 74,182 69,357
- -----------------------------------------------------------------------------------------------------------------------------
</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.
(continued)
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Harleysville National Corporation and Subsidiaries
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." These factors
include future federal or state regulations, the Year 2000 issue and the state
of the financial services industry. 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 continued its strong earnings performance during 1997. This
performance was accomplished through an increase in assets, efforts to contain
overhead expenses, gains on the sales of securities and the Banks' ability to
manage net interest income. The results of 1997 also included an improvement in
the quality of the loan portfolio.
Net income amounted to $16,662,000 in 1997, compared to the $14,408,000
reported in 1996. Both basic and diluted earnings per share increased 15.5% to
$2.38, from $2.06 earned in 1996. The 1997 net income included security gains,
resulting from the sale of equity securities held at HNC Financial Company. This
gain contributed $1,264,000 to net income during 1997. This gain was partially
offset by a loss on the sale of mortgage loans and net losses on the sales of
securities at the banking subsidiaries that reduced net income by $137,000 and
$104,000. Average earnings were also enhanced by the growth in earning assets
and an increase in income from the Trust and Financial Services Department.
Average earning assets increased $91,394,000, or 9.8%, from a year ago.
An improvement in asset quality in 1997 was evidenced by a decline in
nonperforming assets of $1,500,000, or 26.4%, to $4,172,000. Nonperforming
assets as a percentage of total loans and net assets acquired in foreclosure at
December 31, 1997 declined to 0.56%, from 0.83% at December 31, 1996.
INTEREST-EARNING ASSETS AND
INTEREST-BEARING LIABILITIES
Average interest-earning assets totaled $1,020,983,000 in 1997, an increase
of $91,394,000, or 9.8%, compared to 1996. Most of the increase occurred in the
loan and investment portfolios. During 1997, the average balance of the loan
portfolio increased $54,486,000, or 8.4%, while the average balance of
investment securities increased $28,535,000 or 11.0%. Average interest-earning
assets were $848,687,000 in 1995.
Average interest-bearing liabilities totaled $813,893,000 in 1997, an
increase of $68,152,000, or 9.1%, compared to 1996. This increase was
attributable to an increase in time deposits, other borrowings and savings
deposits of $24,507,000, $24,221,000 and $19,424,000, respectively. Average
interest-bearing liabilities were $688,507,000 in 1995.
The tax-equivalent yield on total interest-earning assets amounted to 8.18%,
a slight decline from 8.20% earned in 1996. The cost of interest-bearing
liabilities increased 2 basis points from 4.14% in 1996 to 4.16% in 1997. The
net interest margin of 4.87% in 1997 was almost even with the 4.88% earned in
1996. The 1995 tax-equivalent yield on total interest-earning assets, cost of
interest-bearing liabilities and net interest margin were 8.27%, 4.18% and
4.88%, respectively.
(continued)
25
<PAGE>
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 and borrowings and other interest-bearing liabilities.
DISTRIBUTION OF ASSETS, LIABILITIES AND
SHAREHOLDERS' EQUITY, INTEREST RATES AND
INTEREST DIFFERENTIAL
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------------------------
1997 1996 1995
---------------------------- --------------------------- ------------------------------
Average Average Average Average Average Average
(Dollars in thousands) Balance Rate Interest Balance Rate Interest Balance Rate Interest
---------- ------- -------- -------- ------- ------- -------- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Investment securities:
Taxable investments ............ $ 188,935 6.58% $ 12,433 $186,213 6.50% $12,110 $177,583 6.18% $10,977
Nontaxable investments(1) 100,083 8.33 8,334 74,270 8.33 6,185 49,164 8.36 4,110
---------- ------- -------- -------- ------- ------- -------- ------- ---------
Total investment securities .. 289,018 7.19 20,767 260,483 7.02 18,295 226,747 6.65 15,087
Loans (1)(2) ..................... 706,643 8.68 61,326 652,157 8.74 57,008 607,335 8.94 54,305
Other rate-sensitive assets ...... 25,322 5.69 1,440 16,949 5.33 904 14,605 5.72 835
---------- ------- -------- -------- ------- ------- -------- ------- ---------
Total earning assets ..... 1,020,983 8.18 83,533 929,589 8.20 76,207 848,687 8.27 70,227
Noninterest-earning assets ....... 54,719 -- -- 49,310 -- -- 45,663 -- --
---------- ------- -------- -------- ------- ------- -------- ------- ---------
Total assets ............. $1,075,702 7.77% $ 83,533 $ 978,899 7.78% 76,207 $894,350 7.85% $70,227
========== ====== ======== ========= ===== ======= ======== ====== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand ......................... $ 135,307 -- % $ -- % $ 122,459 -- % $ -- $109,649 -- % $ --
Savings ........................ 381,314 2.66 10,149 361,890 2.66 9,616 341,729 2.80 9,571
Time ...................... 361,545 5.55 20,076 337,038 5.59 18,854 309,711 5.50 17,045
---------- ------- -------- -------- ------- ------- -------- ------- ---------
Total ................... 878,166 3.44 30,225 821,387 3.47 28,470 761,089 3.50 26,616
Borrowings and other
interest-bearing liabilities ... 71,034 5.10 3,626 46,813 5.14 2,406 37,067 5.85 2,168
Other liabilities ................ 22,695 -- -- 19,012 -- -- 14,406 -- --
---------- ------- -------- -------- ------- ------- -------- ------- ---------
Total liabilities ....... 971,895 3.48% 33,851 887,212 3.48 30,876 812,562 3.54 28,784
Shareholders' equity ............. 103,807 -- -- 91,687 -- -- 81,788 -- --
---------- ------- -------- -------- ------- ------- -------- ------- ---------
Total liabilities and
shareholders' equity ......... $1,075,702 3.15% $33,851 $ 978,899 3.15% $ 30,876 $894,350 3.22% $28,784
========== ====== ======== ========= ===== ======= ======== ====== =========
Average effective rate on
interest-bearing liabilities ... $ 813,893 4.16% $33,851 $ 745,741 4.14% $ 30,876 $688,507 4.18% $28,784
========== ====== ======== ========= ===== ======= ======== ====== =========
====================================================================================================================================
Interest Income/Earning Assets ... $1,020,983 8.18% $83,533 $ 929,589 8.20% $ 76,207 $848,687 8.27% $70,227
Interest Expense/Earning Assets .. $1,020,983 3.31 $33,851 $ 929,589 3.32 $ 30,876 $848,687 3.39 $28,784
------ ------ ------
Effective Interest Differential .. 4.87% 4.88% 4.88%
====== ====== ======
(1) The interest earned on nontaxable investment securities and loans is shown
on a tax-equivalent basis.
(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.
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(continued)
26
<PAGE>
INVESTMENT PORTFOLIO
The following shows the carrying value of the Corporation's investment
securities held to maturity:
<TABLE>
<CAPTION>
December 31,
-----------------------------------
(Dollars in thousands) 1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
U. S. Treasury notes.............................................................. $ -- $ -- $ 1,494
Obligations of other U.S. Government agencies and corporations.................... 21,707 33,129 49,038
Obligations of states and political subdivisions.................................. 19,589 26,701 26,246
Mortgage-backed securities........................................................ 2,048 1,499 378
Other securities.................................................................. 2,894 3,897 6,513
------- ------- -------
Total..................................................................... $46,238 $65,226 $83,669
======= ======= =======
The following shows the carrying value of the Corporation's
investment securities available for sale:
December 31,
-----------------------------------
(Dollars in thousands) 1997 1996 1995
------- -------- --------
U. S. Treasury notes.............................................................. $46,614 $ 35,127 $ 36,373
Obligations of other U.S. Government agencies and corporations.................... 42,945 43,885 10,144
Obligations of states and political subdivisions.................................. 94,305 62,423 31,522
Mortgage-backed securities........................................................ 57,299 55,511 69,138
Other securities.................................................................. 15,905 12,849 12,149
-------- -------- --------
Total..................................................................... $257,068 $209,795 $159,326
</TABLE>
Statement of Financial Accounting (SFAS) Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities,'' 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, 1997 of $303,306,000 grew
$28,285,000, or 10.3% over the December 31, 1996 balance of $275,021,000. This
growth was funded by the increase in deposit balances and borrowings during this
period. The investment securities held to maturity decreased $18,988,000 during
1997, as a result of maturities and calls. The investment securities available
for sale increased $47,273,000. 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
1997.
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.
(continued)
27
<PAGE>
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, 1997 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>
OBLIGATIONS OF OTHER U.S. GOVERNMENT AGENCIES AND CORPORATIONS:
CARRYING VALUE..................................... $ 500 $ 8,011 $ 12,695 $ 501 $21,707
WEIGHTED AVERAGE YIELD............................. 5.50% 7.31% 7.65% 8.18% 7.48%
WEIGHTED AVERAGE MATURITY.......................... 6 yrs, 0 mos
OBLIGATIONS OF STATES AND POLITICAL SUBDIVISIONS:
CARRYING VALUE..................................... 1,795 4,569 494 12,731 19,589
WEIGHTED AVERAGE YIELD............................. 8.79% 8.41% 8.72% 8.88% 8.76%
WEIGHTED AVERAGE MATURITY.......................... 9 yrs, 3 mos
MORTGAGE-BACKED SECURITIES:
CARRYING VALUE..................................... -- 767 1,058 223 2,048
WEIGHTED AVERAGE YIELD............................. -- % 6.70% 6.71% 7.41% 6.78%
WEIGHTED AVERAGE MATURITY.......................... 5 yrs, 7 mos
OTHER SECURITIES:
CARRYING VALUE..................................... 801 2,093 -- -- 2,894
WEIGHTED AVERAGE YIELD............................. 7.53% 7.48% -- % -- % 7.49%
WEIGHTED AVERAGE MATURITY.......................... 3 yrs, 4 mos
TOTAL:
CARRYING VALUE..................................... $ 3,096 $ 15,440 $ 14,247 $ 13,455 $46,238
WEIGHTED AVERAGE YIELD............................. 7.93% 7.63% 7.61% 8.83% 7.88%
WEIGHTED AVERAGE MATURITY.......................... 7 yrs, 2 mos
- -----------------------------------------------------------------------------------------------------------------------------------
The maturity analysis of securities available for sale, including the weighted average yield for each category, as of
December 31, 1997 is as follows:
</TABLE>
<TABLE>
<CAPTION>
Under 1 - 5 5 - 10 Over
(Dollars in Thousands) 1 year years years 10 years Total
------- -------- -------- --------- --------------
U.S. Treasury notes:
<S> <C> <C> <C> <C> <C>
AMORTIZED COST............................................. $2,987 $43,001 $ -- $ -- $ 45,988
WEIGHTED AVERAGE YIELD..................................... 6.09% 6.29% -- % -- % 6.28%
WEIGHTED AVERAGE MATURITY.................................. 2 yrs, 7 mos
OBLIGATIONS OF OTHER U.S. GOVERNMENT AGENCIES AND CORPORATIONS:
AMORTIZED COST............................................. -- 3,000 39,211 -- 42,211
WEIGHTED AVERAGE YIELD..................................... -- % 7.18% 7.21% -- % 7.20%
WEIGHTED AVERAGE MATURITY.................................. 8 yrs, 1 mo
OBLIGATIONS OF STATES AND POLITICAL SUBDIVISIONS:
AMORTIZED COST............................................. 635 4,170 7,139 80,063 92,007
WEIGHTED AVERAGE YIELD..................................... 8.01% 7.47% 7.88% 8.28% 8.04%
WEIGHTED AVERAGE MATURITY.................................. 13 yrs, 10 mos
MORTGAGE-BACKED SECURITIES:
AMORTIZED COST............................................. -- 9,546 2,714 44,195 56,455
WEIGHTED AVERAGE YIELD..................................... -- % 6.53% 6.66% 6.60% 6.59%
WEIGHTED AVERAGE MATURITY.................................. 20 yrs, 8 mos
OTHER SECURITIES:
AMORTIZED COST............................................. 496 2,802 1,065 9,155 13,518
WEIGHTED AVERAGE YIELD..................................... 6.56% 5.92% 7.01% 6.67% 6.54%
WEIGHTED AVERAGE MATURITY.................................. 5 yrs, 1 mo
TOTAL:
AMORTIZED COST............................................. $4,118 $62,519 $50,129 $133,413 $250,179
WEIGHTED AVERAGE YIELD..................................... 6.44% 4.30% 7.27% 7.61% 7.23%
WEIGHTED AVERAGE MATURITY.................................. 11 yrs, 10 mos
- --------------------------------------------------------------------------------------------------------------------------------
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%.
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(continued)
28
<PAGE>
LOANS
The following table shows the composition of the Banks' loans:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------
(Dollars in thousands) 1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Real estate...................... $ 246,259 $ 237,155 $ 227,458 $ 220,091 $ 190,684
Commercial and industrial........ 192,694 164,327 165,491 156,387 130,525
Installment...................... 198,948 190,745 157,806 148,580 123,076
Lease financing.................. 55,413 49,623 43,942 41,233 32,304
Other............................ 50,294 47,353 43,523 38,590 32,960
--------- --------- --------- --------- ---------
Total........................ $ 743,608 $ 689,203 $ 638,220 $ 604,881 $ 509,549
========= ========= ========= ========= =========
</TABLE>
Total loans grew $54,405,000, from $689,203,000 at December 31, 1996 to
$743,608,000 at December 31, 1997. The Banks experienced growth in all loan
categories. During 1997, commercial, real estate, installment, lease financing
and other loans grew $28,367,000, $9,104,000, $8,203,000, $5,790,000 and
$2,941,000, respectively. The increase in installment loans was net of a
$2,535,000 decrease in indirect installment loans during 1997. The competition
for indirect loans increased during 1997, resulting in the downward pressure on
the margins that could be earned on these loans. The Banks' indirect loan
strategy was to book indirect loans only if they met internal margin standards.
Indirect loans primarily consist of vehicle loans that are generated through
local dealers.
At December 31, 1997, 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, 1997:
<PAGE>
<TABLE>
<CAPTION>
Within 1 - 5 Over
1 year years 5 years Total
-------- --------- --------- ---------
<S> <C> <C> <C> <C>
(Dollars in thousands)
Real estate......................................... $ 1,056 $ 20,629 $ 224,574 $ 246,259
Commercial and industrial........................... 32,820 81,551 78,323 192,694
Installment......................................... 3,893 113,403 81,652 198,948
Lease financing..................................... 7,435 47,978 -- 55,413
-------- --------- --------- ---------
Total........................................... $ 45,204 $ 263,561 $ 384,549 $ 693,314
======== ========= ========= =========
Loans with variable or floating interest rates...... $ 27,663 $ 54,986 $ 134,266 $ 216,915
Loans with fixed predetermined interest rates....... 17,541 208,575 250,283 476,399
-------- --------- --------- ---------
Total........................................... $ 45,204 $ 263,561 $ 384,549 $ 693,314
======== ========= ========= =========
</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) 1997 1996 1995 1994 1993
------- ------- -------- ------- -------
Nonaccrual loans.................................... $ 2,621 $ 2,983 $ 9,055 $ 2,521 $ 1,876
Troubled debt restructurings........................ 1,099 1,717 1,183 1,867 1,548
Delinquent loans.................................... 2,253 1,848 1,553 2,234 2,063
------- ------- -------- ------- -------
Total........................................... $ 5,973 $ 6,548 $ 11,791 $ 6,622 $ 5,487
======= ======= ======== ======= =======
</TABLE>
(continued)
29
<PAGE>
ALLOWANCE FOR LOAN LOSSES
A summary of the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------
(Dollars in thousands) 1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Average loans.................................... $ 706,643 $ 652,157 $ 607,335 $ 540,030 $ 472,319
========= ========= ========= ========= =========
Allowance, beginning of period................... $ 10,710 $ 9,891 $ 8,150 $ 6,087 $ 4,597
--------- --------- --------- --------- ---------
Loans charged off:
Commercial and industrial.................... 66 392 240 491 1,211
Installment and other........................ 1,038 614 277 387 401
Real estate.................................. 544 412 127 84 238
Lease financing.............................. 78 33 39 44 92
--------- --------- --------- --------- ---------
Total loans charged off...................... 1,726 1,451 683 1,006 1,942
--------- --------- --------- --------- ---------
Recoveries:
Commercial and industrial.................... 113 84 143 170 86
Installment and other........................ 104 56 72 152 160
Real estate.................................. 206 30 1 56 76
Lease financing.............................. 18 18 36 26 25
--------- --------- --------- --------- ---------
Total recoveries............................. 441 188 252 404 347
--------- --------- --------- --------- ---------
Net loans charged off............................ 1,285 1,263 431 602 1,595
--------- --------- --------- --------- ---------
Provision for loan losses........................ 2,500 2,082 2,172 2,665 3,085
--------- --------- --------- --------- ---------
Allowance, end of period......................... $ 11,925 $ 10,710 $ 9,891 $ 8,150 $ 6,087
========= ========= ========= ========= =========
Ratio of net charge-offs to
average loans outstanding.................... 0.18% 0.19% 0.07% 0.11% 0.34%
========= ========= ========= ========= =========
</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 decreased slightly from 0.19% in 1996 to 0.18% in 1997. The
charge-offs associated with the nonaccrual commercial and mortgage loans were
done to write down the loan balances to their net realizable value. Total loans
charged off grew $275,000 in 1997, compared to 1996. This increase was primarily
attributed to consumer loans (installment, personal credit lines and credit
cards). During 1997, management took steps to control the risk of consumer
charge-offs by tightening credit standards and increasing the reserve for loan
losses for consumer loans. The ratio of nonperforming consumer loans to total
consumer loans decreased 26.1% from December 31, 1996 to December 31, 1997. The
allowance for loan losses allocated to installment loans at December 31, 1997
grew $315,000, or 25.2%, compared to December 31, 1996. Total loans recovered
during 1997 increased $253,000, compared to 1996, primarily due to real estate
recoveries. The amount of the unallocated allowance for loan losses at December
31, 1997 of $5,994,000 represented 50.3% of the total allowance for loan losses,
compared to $5,024,000, or 46.9%, at December 31, 1996. The 1996 ratio of net
charge-offs to average loans of 0.19% increased from the 1995 ratio of 0.07%.
Management believes that the 1997 ratio of 0.18% compares favo rably with peer
group ratios.
<PAGE>
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 then current conditions. Accordingly,
management considers the entire allowance to be available to absorb losses in
any category.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------- -------------------- ------------------- ------------------ ------------------
Percent Percent Percent Percent Percent
(Dollars in thousands) Amount of Loans Amount of Loans Amount of Loans Amount of Loans Amount of Loans
-------- -------- -------- -------- ------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial and industrial.. $ 2,719 28% $ 2,897 24% $ 3,952 26% $ 2,967 26% $ 2,821 26%
Installment and other ..... 1,566 32 1,251 35 885 32 1,063 31 990 31
Real estate................ 1,469 33 1,434 34 1,292 35 1,010 36 879 37
Lease financing............ 177 7 104 7 127 7 139 7 225 6
Unallocated................ 5,994 N/A 5,024 N/A 3,635 N/A 2,971 N/A 1,172 N/A
-------- -------- -------- -------- ------- -------- ------- -------- ------- --------
Total.................. $ 11,925 100% $ 10,710 100 $ 9,891 100 $ 8,150 100 $ 6,087 100%
======== ======== ======== ======== ======= ======== ======= ======== ======= ========
</TABLE>
(continued)
30
<PAGE>
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,
------------------------------------------------------------------
1997 1996 1995
--------------------- -------------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands) Amount Rate Amount Rate Amount Rate
--------- --------- --------- ----- --------- ----
Demand --
noninterest-bearing ..... $ 135,307 -- % $ 122,459 -- % $ 109,649 -- %
Demand -- interest-
bearing checking
accounts................. 98,397 1.54 91,856 1.57 85,101 1.97
Money market
and savings ............. 282,917 3.05 270,034 3.03 256,628 3.08
Time -- under
$100,000... ............. 297,263 5.57 298,777 5.63 280,168 5.50
Time -- $100,000
or greater............... 64,282 5.49 38,261 5.29 29,543 5.58
--------- --------- ---------
Total.................... $ 878,166 $ 821,387 $ 761,089
========= ========= =========
</TABLE>
The maturity distribution of certificates of deposit of $100,000 and over is
as follows:
December 31,
----------------------------------
(Dollars in thousands) 1997 1996 1995
-------- -------- --------
Three months or less.. $ 43,499 $ 29,919 $ 14,527
Over three months to six months 13,505 12,850 3,848
Over six months to twelve months 7,535 4,512 8,323
Over twelve months.... 4,015 4,079 2,930
-------- -------- --------
Total........... $ 68,554 $ 51,360 $ 29,628
======== ======== ========
<PAGE>
INCOME STATEMENT ANALYSIS
Results of Operations
Consolidated net income for 1997 was $16,662,000, an increase of $2,254,000,
or 15.6%, over 1996. On a per share basis, basic and diluted earnings were $2.38
in 1997, compared to basic and diluted earnings per share of $2.06 in 1996.
Consolidated net income increased in 1996 by $1,980,000, a 15.9% increase over
1995.
Return on average assets improved to 1.55% for 1997, compared to 1.47% for
1996 and 1.39% for 1995, and return on average shareholders' equity was 16.05%
for 1997, compared to 15.71% for 1996 and 15.20% in 1995.
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 1997 increased by $3,509,000, or 8.2%, to
$46,351,000. Net interest income was $42,842,000 during 1996, which was 7.9%
above the $39,707,000 reported in 1995.
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%.
Year Ended December 31,
-------------------------------
(Dollars in thousands) 1997 1996 1995
------- ------- -------
Interest income...... $80,202 $73,718 $68,491
Interest expense..... 33,851 30,876 28,784
------- ------- -------
Net interest income.. 46,351 42,842 39,707
Tax-equivalent adjustment 3,331 2,489 1,736
------- ------- -------
Net interest income
(fully taxable equivalent) $49,682 $45,331 $41,443
======= ======= =======
(continued)
31
<PAGE>
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 $49,682,000 for 1997, compared to
$45,331,000 for 1996, an increase of $4,351,000, or 9.6%. This increase in
tax-equivalent net interest income was primarily due to the net $4,139,000
increase related to volume. The increase related to interest rates was $212,000.
Total interest income increased $7,326,000, 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
$2,049,000 growth due to volume and a $423,000 increase related to the rise in
the overall yield of the investment security portfolio. Total interest income on
loans increased $4,318,000, or 7.6%, in 1997, compared to 1996, as a result of
total average loans outstanding increasing $54,486,000, or 8.4%. The increase in
loan interest income related to volume of $4,728,000 was offset by the $410,000
reduction in loan interest income associated with the lower yields earned on
loans. The growth in loans is a result of persistent sales efforts and new
branch openings.
Total interest expense grew $2,975,000 during 1997 or 9.6%, compared to
1996. This growth was principally the result of higher time deposit and
borrowing volumes. The volume of average time deposit and borrowings grew
$24,507,000, or 7.3% and $24,221,000, or 51.7%, respectively. These increases in
volumes were partially offset by reductions in the rates paid for these
interest-bearing liabilities. Borrowings and other interest-bearing liabilities
include federal funds purchased, FHLB borrowings, securities sold under
agreements to repurchase and U.S. Treasury notes. The increase in borrowings was
primarily FHLB borrowings used to finance the earning asset growth.
For the year ended December 31, 1996, net interest income increased
$3,888,000, 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 an $839,000
increase related to the rise 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%. This increase in loan interest income related
to volume was offset by a reduction in loan interest income associated with the
lower yields earned on loans. 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 8.8% during 1996, compared to 1995. Borrowings and other
interest-bearing liabilities also contributed to the increase in total interest
expense primarily due to the increase in average balances of 26.3%. Nonaccruing
loans are included in the average balance yield calculations, but the average
nonaccruals were insignificant and had no material effect on the results.
Variances attributable to both rate and volume are included in the volume
column.
<PAGE>
The stable interest rate environment in 1997 and the decrease in interest
rates during 1996 and 1995 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>
1997 over (under) 1996 1996 over (under) 1995
--------------------------------- --------------------------------
due to changes in due to changes in
------------------- ------------------
(Dollars in thousands) Net Net
Change Rate Volume Change Rate Volume
------- ----- ------- ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Investment securities (1)........ $ 2,472 $ 423 $ 2,049 $ 3,208 $ 839 $ 2,369
Loans............................ 4,318 (410) 4,728 2,703 (1,215) 3,918
Other assets..................... 536 60 476 69 (56) 125
------- ----- ------- ------- ------ -------
Total......................... 7,326 73 7,253 5,980 (432) 6,412
------- ----- ------- ------- ------ -------
INTEREST EXPENSE
Savings deposits................. 533 16 517 45 (491) 536
Time deposits.................... 1,222 (139) 1,361 1,809 280 1,529
Borrowings and other interest-bearing liabilities 1,220 (16) 1,236 238 (263) 501
------- ----- ------- ------- ------ -------
Total......................... 2,975 (139) 3,114 2,092 (474) 2,566
------- ----- ------- ------- ------ -------
Changes in net interest income....... $ 4,351 $ 212 $ 4,139 $ 3,888 $ 42 $ 3,846
======= ===== ======= ======= ====== =======
(1) The interest earned on nontaxable investment securities and loans is
shown on a tax-equivalent basis.
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
</TABLE>
(continued)
32
<PAGE>
INTEREST RATE SENSITIVITY ANALYSIS
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 approved by the Banks' Boards of Directors, is
responsible for managing the 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,
borrowings from the FHLB and their offering of loan and deposit terms. The
nature of the Banks' current operations is such that they are not subject to
foreign currency exchange or commodity price risk. The Banks do not own trading
assets and they do not have any hedging transactions in place such as interest
rate swaps, caps or floors.
The Banks utilize three principal reports to measure interest rate risk: gap
analysis reports, asset/liability simulation reports and net interest margin
reports. The table below shows the interest rate sensitivity gap position as of
December 31, 1997. 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, 1997. Money market accounts,
interest-bearing checking accounts and savings accounts have always been
considered stable sources 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 Banks are in a negative gap position of
(2.94)% of earning assets at December 31, 1997. This gap position is within the
guidelines set by the Banks' Asset/Liability policies.
<TABLE>
<CAPTION>
December 31, 1997
--------------------------------------------------------------------------
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................. $ 13,024 $ 3,500 -- $ 100 $ --
Loans....................................... 213,094 68,601 183,065 106,255 168,438
Investment securities....................... 15,179 47,777 77,312 40,281 115,868
--------- --------- --------- -------- ---------
Total rate-sensitive assets................. 241,297 119,878 260,377 146,636 284,306
--------- --------- --------- -------- ---------
LIABILITIES
Time deposits............................... 113,155 135,818 89,070 30,128 177
Money market savings funds.................. 11,956 21,866 25,579 18,450 103,098
Interest-bearing checking accounts........ 8,840 23,752 29,346 12,270 34,746
Savings accounts............................ 4,538 9,738 14,117 17,007 62,799
U.S. Treasury demand notes.................. 2,150 -- -- -- --
Other borrowings............................ 57,988 2,500 1,500 -- --
--------- --------- --------- -------- ---------
Total rate-sensitive liabilities............ $198,627 $193,674 $ 159,612 $77,855 $200,820
--------- --------- --------- -------- ---------
Incremental gap............................. $ 42,670 $(73,796) $ 100,765 $68,781 $ 83,486
======== ======== ========= ======= ========
Cumulative gap.............................. $ 42,670 $(31,126) $ 69,639 $138,420 $221,906
======== ======== ========= ======= ========
% of earning assets......................... 4.03% (2.94)% 6.57% 13.07% 20.95%
======== ======== ========= ======= ========
</TABLE>
(continued)
33
<PAGE>
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. This simulation is known as rate
shocks. The report below forecasts changes in the Banks' market value of equity
under alternative interest rate environments. The market value of equity is
defined as the net present value of the Banks' existing assets and liabilities.
The results of the December 31, 1997 rate shock simulations show the Banks are
within all guidelines set by the Banks' Asset/Liability policies.
<TABLE>
<CAPTION>
Asset/Liability
Change in Policy
Market Value Market Value Percentage Approved
of Equity of Equity Change Percent Change
------------ ------------ ---------- ----------------
<S> <C> <C> <C> <C>
+200 Basis Points.......... 201,279 (24,584) -10.88% +/- 20%
+150 Basis Points.......... 197,760 (18,102) -8.01% +/- 20%
+100 Basis Points.......... 214,081 (11,782) -5.22% +/- 20%
+50 Basis Points........... 220,149 (5,713) -2.53% +/- 20%
Flat Rate.................. 225,863 -- 0.00% +/- 20%
- -50 Basis Points........... 228,998 3,135 1.39% +/- 20%
- -100 Basis Points.......... 229,220 3,357 1.49% +/- 20%
- -150 Basis Points.......... 228,965 3,191 1.41% +/- 20%
- -200 Basis Points.......... 228,232 2,369 1.05% +/- 20%
</TABLE>
In the event the Banks should experience a mismatch in their desired gap
ranges or an excessive decline in their market value of equity resulting from
changes in interest rate, they have a number of options which they could utilize
to remedy such mismatch. The Banks could restructure their investment portfolio
through sale or purchase of securities with more favorable repricing attributes.
They could also emphasize loan products with appropriate maturities or repricing
attributes, or they could attract deposits or obtain borrowings with desired
maturities.
NET INTEREST MARGIN
The 1997 net interest margin of 4.87% was 1 basis point lower than the net
interest margin for 1996 of 4.88%. The decrease in the interest income to
earning asset ratio, from 8.20% in 1996 to 8.18% in 1997, was attributed to the
lower yield earned on loans during 1997. The interest expense to earning asset
ratio of 3.32% in 1997 was the same as 1996. The net interest margin in 1996 of
4.88% did not change from the 1995 net interest margin. The decline in the
interest income to earning asset ratio in 1996, compared to 1995, was offset by
the decline in the interest expense to earning assets ratio during this period.
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.
(continued)
34
<PAGE>
The provision in 1997 was $2,500,000, an increase of $418,000 or 20.1%,
compared to the 1996 provision of $2,082,000. The increase in the provision
during 1997 is related to the $275,000 increase in charged off loans in 1997,
compared to 1996. This increase was primarily attributed to consumer loans
(installment, personal credit lines and credit cards). During 1997, management
took steps to control the risk of consumer loan charge-offs by tightening credit
standards and increasing the reserve for loan losses for consumer loans. The
ratio of nonperforming consumer loans to total consumer loans decreased 26.1%
from December 31, 1996 to December 31, 1997. Recoveries of $441,000 during 1997,
increased from the 1996 recoveries of $188,000. A review of the table below
illustrates a significant improvement in the level of nonperforming assets at
December 31, 1997, compared to the same periods in 1996 and 1995. The ratio of
the allowance for loan losses to total loans of 1.61% at December 31, 1997
improved, compared to the 1.57% ratio at both December 31, 1996 and 1995.
1997 1996 1995
---------- ---------- -----------
Nonperforming assets........... $4,172,000 $5,672,000 $11,457,000
Allowance for loan losses to
nonperforming assets......... 285.8% 188.8% 86.3%
Nonperforming assets to total
loans and net assets acquired
in foreclosure............... .56% .83% 1.82%
Allowance for loan losses to
total loans.................. 1.61% 1.57% 1.57%
Unallocated allowance for loan
losses to total allowance for
loan losses.................. 50.3% 46.9% 36.8%
Nonperforming assets (nonaccruing loans, net assets in foreclosure and
troubled debt restructured loans) were 0.56% of total loans and net assets
acquired in foreclosure at December 31, 1997, compared to 0.83% at December 31,
1996 and 1.82% at December 31, 1995. The ratio of the allowance to nonperforming
assets was 285.8% at December 31, 1997, compared to 188.8% at December 31, 1996
and 86.3% at December 31, 1995.
Nonaccruing loans of $2,621,000 at December 31, 1997 decreased $362,000 from
the December 31, 1996 balance of $2,983,000. The December 31, 1996 balance of
nonaccrual loans was $6,071,000 less than the December 31, 1995 balance. This
$6,071,000 reduction in nonaccrual loans during this period is primarily due to
one loan being upgraded from nonaccrual status to accruing status during 1996.
This loan achieved accrual status after meeting appropriate standards. The
nonaccruing loan balance at December 31, 1995 was $9,054,000.
Net assets in foreclosure totaled $453,000 as of December 31, 1997, a
decrease of $519,000, or 53.4%, from the December 31, 1996 balance. During 1997,
sales of foreclosed properties totaled $1,465,000, transfers from loans to
assets in foreclosure were $1,019,000 and write-downs of assets in foreclosure
equaled $73,000. 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.
<PAGE>
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, 1997, loans past due 90 days or more and still accruing interest were
$2,253,000, compared to $1,848,000 as of December 31, 1996. This increase was a
result of an increase in commercial loans past due 90 days at December 31, 1997.
As of December 31, 1997, there were two unrelated commercial borrowers with
troubled debt restructured loans totaling $1,012,000. Both customers were
complying with the restructured terms as of December 31, 1997.
The quality of the loan portfolio is also reflected in the fact that the
balance of impaired loans was reduced 41.3%, from $4,159,000 at December 31,
1996, to $2,441,000 at December 31, 1997. 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 $1,429,000 of nonaccrual loans and $1,012,000 of troubled debt
restructured loans. The allowance for loan loss associated with the $2,441,000
of impaired loans was $341,000 at December 31, 1997. The average impaired loan
balance was $3,538,000 in 1997, and the income recognized on impaired loans
during 1997 was $135,000. 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
Year Ended December 31,
----------------------------------
(Dollars in thousands) 1997 1996 1995
------ ------ ------
Services charges................... $2,841 $2,587 $2,337
Security (losses) gains, net....... 1,757 (39) (172)
Trust income....................... 1,509 1,293 1,094
Other.............................. 1,284 1,274 1,178
------ ------ ------
Total other operating income....... $7,391 $5,115 $4,437
====== ====== ======
Other operating income for 1997 of $7,391,000 increased $2,276,000, or
44.5%, compared to the 1996 level of $5,115,000. This increase was primarily due
to the $1,796,000 increase in security gains. Also contributing to this increase
was a $254,000 rise in service charges and a $216,000 growth in trust income.
The 1996 other operating income of $5,115,000 was 15.3% higher than 1995,
primarily due to increases in service charges and trust income.
Income from service charges on deposit accounts of $2,841,000 in 1997
increased $254,000, or 9.8% from the 1996 income from service charges on deposit
accounts of $2,587,000. The increase in service charges during 1997 is
attributed to the 6.66% rise in fee earning deposits and management's continued
focus on growing noninterest income. The 1996 service charges grew 10.7% over
1995 service charges, as a result of the collection of higher overdraft charges
and the fees related to the overall increase in the volume of deposits in 1996.
The Corporation recorded a $1,757,000 net security gain in 1997, compared to
a net security loss of $39,000 in 1996. The majority of the 1997 security gain
is the result of the sale of equity securities held at HNC Financial Company.
From time to time, the Corporation sells investment securities available for
sale to fund the purchase of other securities in an effort to enhance the
overall return on the portfolio. The Corporation recognized $172,000 of net
securities losses in 1995.
(continued)
35
<PAGE>
The 1997 income from the Trust and Financial Services Department of
$1,509,000 increased $216,000, or 16.7%, compared to the $1,293,000 recorded in
1996. This increase was the result of both an increase in the book value of
trust assets of 9.14% from December 31, 1996 to December 31, 1997 and the
Corporation's continuing emphasis on marketing the Trust and Financial Services
Department's products and services. The 1995 Trust and Financial Services
Department's income was $1,178,000.
Other income increased $10,000 during 1997, from $1,274,000 in 1996 to
$1,284,000 in 1997. Included in the 1997 other income figure was a net loss
recognized on the sale of residential mortgages. The Banks used the funds
generated from the sale of residential mortgages to purchase residential
mortgages that currently earn a higher rate of return and reduce the overall
interest rate risk of the residential mortgage portfolio. The Banks continuously
research different strategies they can use to enhance both the interest rate
earned on loans, and to reduce the interest rate risk of the loan portfolios.
Net of the loss on the sale of loans, 1997 other income grew $170,000, or 13.3%,
primarily as a result of higher fees related to loans. Other income in 1996
increased $96,000, compared to 1995, as a result of higher leasing fees.
OTHER OPERATING EXPENSES
Year Ended December 31,
------------------------------------
(Dollars in thousands) 1997 1996 1995
------- ------- -------
Salaries............. $13,191 $11,392 $ 9,848
Employee benefits.... 2,288 3,006 3,264
Occupancy............ 1,980 1,873 1,541
Equipment expense.... 2,817 2,083 1,913
FDIC premiums........ 107 6 861
Other expenses....... 8,146 7,514 6,840
------- ------- -------
Total other operating expenses $28,529 $25,874 $24,267
======= ======= =======
Other operating expenses rose to $28,529,000 for 1997, a 10.3% increase over
the $25,874,000 for 1996. The 1996 amount was 6.6% above the $24,267,000 for
1995. The rise in operating expenses in 1997 was primarily due to higher
expenses related to four new branches opened after September 30, 1996 and to the
overall growth in the Banks.
Employee salaries increased $1,799,000, or 15.8%, from $11,392,000 in 1996
to $13,191,000 in 1997. The salary increase directly related to the staffing of
the four new branches was $369,000, or 20.5% 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 $718,000, or 23.9%, to $2,288,000 in 1997
from the $3,006,000 in employee benefits during 1996. The decrease is the result
of the modification of the Banks' profit-sharing plan into a 401(K) plan during
1996, which resulted in the reduction of profit-sharing plan expenses of
$496,000 in 1997. The profit-sharing plan was funded entirely by the Banks and
the modified 401(K) plan is funded by both the Banks and their employees. A
$523,000 reduction in pension related expenses also contributed to the lower
fringe benefit expenses in 1997. Offsetting this decrease were both a $46,000
increase in benefit expenses related to the new branches and the increase in
fringe benefits related to the additional staff necessitated by current and
planned future growth. The 1996 salary expense was 15.7% higher than 1995, and
the fringe benefit expense in 1996 was 7.9% less than 1995.
<PAGE>
Net occupancy costs increased by $107,000, or 5.7%, in 1997, compared with
a $332,000, or 21.5%, increase in 1996. The four new branches were
responsible for the entire increase in 1997 and the increase in 1996 was the
result of the five new branches opened during 1996. Equipment expenses
increased by $734,000, or 35.2%, during 1997, and $170,000, or 8.9%, in 1996.
The four new branches were responsible for $128,000 of the increase in
equipment expenses during 1997. The remainder of this rise is due to
equipment depreciation, rental and maintenance associated with planned
increased data processing capabilities. The increased data processing
capabilities include equipment used to process check imaging 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' 1997 FDIC
premium expense was $107,000, compared to the 1996 premium expense of $6,000 and
the 1995 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 loan 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 $632,000, or 8.4%, from $7,514,000 in 1996 to
$8,146,000 in 1997. This increase is primarily the result of the $187,000
related to the four new branches, a $146,000 increase in deferred compensation
expenses, and a $93,000 rise in legal fees. The rise in the deferred
compensation expense was related to both a change in the method of accounting
for the deferred compensation and an increase in staff. The increase in legal
fees was associated with the resolution of legal matters and legal fees related
to maintaining the loan portfolio. The remaining increase during 1997 was due to
the normal increases in expenses related to the overall growth of the
Corporation. The 1996 other expenses increased $674,000, compared to 1995. This
increase was primarily the result of a $164,000 rise in consulting fees, a
$103,000 rise in legal fees and $91,000 in other expenses associated with the
new branches.
INCOME TAXES
Year Ended December 31,
---------------------------------------
(Dollars in thousands) 1997 1996 1995
------ ------ ------
Expected tax expense................ $7,722 $6,800 $6,020
Tax exempt income, net of
interest disallowance.............. (1,893) (1,414) (999)
Other............................... 222 207 256
------ ------ ------
Actual tax expense.................. $6,051 $5,593 $5,277
====== ====== ======
(continued)
36
<PAGE>
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 26.6% for 1997, 28.0% for 1996 and 29.8%
for 1995 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 1997 was $109,792,000, an increase of $12,161,000,
or 12.5%, over the end of 1996. 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 10.65% at December 31,
1997, compared with 10.29% at December 31, 1996. 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, 1997, the Corporation's Tier 1 risk-adjusted capital ratio was
13.42%, and the total risk-adjusted capital ratio was 14.68%, both well above
regulatory requirements. The risk-based capital ratios of each of the
Corporation's Banks also exceeded regulatory requirements at the end of 1997.
<PAGE>
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
9.36% and 9.21% at December 31, 1997 and 1996, respectively.
Under FDIC 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, 1997.
<TABLE>
<CAPTION>
(Dollars in thousands) Leverage Ratio Tier 1 Capital to Risk-Weighted Asset Ratio
----------------------------------------- -------------------------------------------
December 31, 1997 December 31, 1996 December 31, 1997 December 31, 1996
------------------ ----------------- ------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio Amount Ratio
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Entity:
Corporation................. $ 103,600 9.36% $ 93,164 9.21% $ 103,600 13.42% $ 93,164 13.12%
Subsidiaries:
Harleysville National.......
Bank.... 72,965 8.42 67,253 8.34 72,965 11.71 67,253 11.59
Citizens National
Bank.................... 20,811 13.00 20,031 13.08 20,811 22.49 20,031 22.60
Security National
Bank.................... 6,188 8.20 3,885 6.81 6,188 11.13 3,885 9.57
"Well Capitalized"
institution (under FDIC
regulations).............. 5.00 5.00 6.00 6.00
Tier 2 Total Capital to Risk-Weighted Asset Ratio
-------------------------------------------------
December 31, 1997 December 31, 1996
--------------------- -----------------------
Amount Ratio Amount Ratio
<C> <C> <C> <C>
Entity: $ 113,276 14.68% $ 102,061 14.38%
Corporation.................
Subsidiaries:
Harleysville National
Bank.... 80,778 12.96 74,528 12.85
Citizens National
Bank.................... 21,971 23.74 20,993 23.69
Security National
Bank.................... 6,884 12.39 4,394 10.83
"Well Capitalized"
institution (under FDIC
regulations).............. 10.00 10.00
</TABLE>
(continued)
37
<PAGE>
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
their deposit funds. Federal funds sold averaged $18,546,000 during 1997, and
investment securities available for sale averaged $233,913,000 during 1997, 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 FRB of Philadelphia and the FHLB of
Pittsburgh, of which the Banks are members. Unused lines of credit at the FHLB
of Pittsburgh were $201,499,000 as of December 31, 1997.
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
There are currently a number of issues before Congress which may affect the
Corporation and its business operations, and the business operations of its
subsidiaries. However, management does not believe these issues will have a
material adverse affect on liquidity, capital resources or the results of
operations.
Recently, Pennsylvania enacted a law to permit state chartered banking
institutions to sell insurance. This follows a U.S. Supreme Court decision in
favor of nationwide insurance sales by banks which also bars states from
blocking insurance sales by national banks in towns with populations of no more
than 5,000. The Corporation is currently evaluating its options regarding the
sale of insurance.
Congress is currently considering legislative reforms to modernize the
financial services industry, including repealing the Glass-Steagall Act which
prohibits commercial banks from engaging in the securities industry.
Consequently, equity underwriting activities of banks may increase in the near
future. However, the Corporation does not currently anticipate entering into
these activities.
The Corporation has analyzed the recently enacted changes to the federal tax
law. The impact of such changes on liquidity, operating results, and capital
should not be material.
The Corporation currently plans to open at least two new branches during
1998. Harleysville National Bank is pursuing locations in Doylestown and
Royersford. These new branch sites are contiguous to our current service area
and were chosen to expand the Banks' market area and market share of loans and
deposits.
Many existing computer programs use only two digits to identify a year in
the date field. These programs were designed and developed without considering
the impact of the upcoming change in the century. If not corrected, many
computer applications could fail or create erroneous results by or at the Year
2000. The Year 2000 issue affects virtually all companies and organizations.
The Corporation has conducted a comprehensive review of its computer systems
to identify any system that could be affected by the Year 2000 issue and has
developed an implementation plan to resolve any problems. Modifications or
replacements of computer systems to attain Year 2000 compliance have begun, and
the Corporation expects to attain Year 2000 compliance and institute appropriate
testing of its modifications and replacements before the Year 2000 date change.
The Corporation believes that, with modifications to existing software and
conversions to new software, the Year 2000 problem will not pose a significant
operational problem for the Corporation. The Corporation has taken steps to
communicate with the unrelated parties with whom it deals to coordinate Year
2000 compliance. The cost of addressing the Year 2000 issues will be expensed,
as incurred, in compliance with GAAP.
From time to time, various types of federal and state legislation have been
proposed that could result in additional regulation of, and restrictions on, the
business of the Corporation and the Banks. It cannot be predicted whether such
legislation will be enacted or, if enacted, how such legislation would affect
the business of the Corporation and the Banks. As a consequence of the extensive
regulation of commercial banking activities in the United States, the
Corporation's and the Banks' business is particularly susceptible to being
affected by federal legislation and regulations that may increase the costs of
doing business. Except as specifically described above, management believes that
the effect of the provisions of the aforementioned legislation on 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.
Further, the business of the Corporation is also affected by the state of
the financial services industry in general. As a result of legal and industry
changes, management predicts that the industry will continue to experience an
increase in consolidations and mergers as the financial services industry
strives for greater cost efficiencies and market share. Management also
expects increased diversification of financial products and services offered
by the Banks and their competitors. Management believes that such
consolidations and mergers, and diversification of products and services may
enhance the Banks' competitive position.
================================================================================
38
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, Security National Bank, a national banking
association headquartered at One Security Plaza, Pottstown,
PA 19464 and of HNC Financial Company, a Delaware
Corporation headquartered at 300 Delaware Avenue, Suite
1704, Wilmington, Delaware 19801
Exhibit 23
Consent of Independent Certified Public Accountants:
We have issued our report dated January 8, 1998,
accompanying the consolidated financial statements
incorporated by reference or included in the 1997 Annual
Report of Harleysville National Corporation on Form 10-K for
the year ended December 31, 1997. 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) and on Forms S-8
(Registration No. 33-69784 and Registration No. 33-17813).
GRANT THORNTON LLP
Philadelphia, Pennsylvania
March 26, 1998
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, 1997 and 1996, and the related consolidated
statements of income, shareholders' equity and cash flows
for each of the three years in the period ended December 31,
1997. 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 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
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 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 at December 31, 1997 and 1996,
and the consolidated results of their operations and their
consolidated cash flows for each of the three years in the
period ended December 31, 1997 in conformity with generally
accepted accounting principles.
GRANT THORNTON LLP
Philadelphia, Pennsylvania
January 8, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996 DEC-31-1995
<PERIOD-END> DEC-31-1997 DEC-31-1996 DEC-31-1995
<CASH> 38,471 39,407 34,312
<INT-BEARING-DEPOSITS> 5,574 8,475 1,703
<FED-FUNDS-SOLD> 11,050 6,000 16,295
<TRADING-ASSETS> 0 0 0
<INVESTMENTS-HELD-FOR-SALE> 257,068 209,795 159,326
<INVESTMENTS-CARRYING> 46,238 65,226 83,669
<INVESTMENTS-MARKET> 47,354 66,680 85,652
<LOANS> 739,453 681,410 628,738
<ALLOWANCE> 11,925 10,710 9,891
<TOTAL-ASSETS> 1,116,254 1,026,128 937,345
<DEPOSITS> 919,071 847,699 794,499
<SHORT-TERM> 48,638 57,521 30,751
<LIABILITIES-OTHER> 23,253 21,277 16,733
<LONG-TERM> 15,500 2,000 9,000
0 0 0
0 0 0
<COMMON> 7,020 6,657 6,316
<OTHER-SE> 102,772 90,974 80,046
<TOTAL-LIABILITIES-AND-EQUITY> 1,116,254 1,026,128 937,345
<INTEREST-LOAN> 60,912 56,684 54,009
<INTEREST-INVEST> 17,850 16,130 13,594
<INTEREST-OTHER> 1,440 904 888
<INTEREST-TOTAL> 80,202 73,718 68,491
<INTEREST-DEPOSIT> 30,225 28,470 26,616
<INTEREST-EXPENSE> 3,626 2,406 2,168
<INTEREST-INCOME-NET> 46,351 42,842 39,707
<LOAN-LOSSES> 2,500 2,082 2,172
<SECURITIES-GAINS> 1,757 (39) (172)
<EXPENSE-OTHER> 28,529 25,874 24,267
<INCOME-PRETAX> 22,713 20,001 17,705
<INCOME-PRE-EXTRAORDINARY> 22,713 20,001 17,705
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 16,662 14,408 12,428
<EPS-PRIMARY> 2.38 2.06 1.79
<EPS-DILUTED> 2.38 2.06 1.78
<YIELD-ACTUAL> 4.87 4.88 4.88
<LOANS-NON> 2,621 2,983 9,054
<LOANS-PAST> 2,253 1,848 1,553
<LOANS-TROUBLED> 1,012 1,717 1,183
<LOANS-PROBLEM> 0 0 0
<ALLOWANCE-OPEN> 10,710 9,891 8,150
<CHARGE-OFFS> 1,726 1,451 683
<RECOVERIES> 441 188 252
<ALLOWANCE-CLOSE> 11,925 10,710 9,891
<ALLOWANCE-DOMESTIC> 11,925 10,710 9,891
<ALLOWANCE-FOREIGN> 0 0 0
<ALLOWANCE-UNALLOCATED> 5,994 5,024 3,635
</TABLE>
