SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998.
---------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from__________________to____________________.
Commission file number 0-15237
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HARLEYSVILLE NATIONAL CORPORATION
---------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2210237
- ------------ ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
483 Main Street, Harleysville, Pennsylvania 19438
- ----------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (215) 256-8851
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.
----- -----
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes ___. No ___.
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 7,031,173 shares of Common
Stock, $1.00 par value, outstanding on July 31, 1998.
PAGE 1
HARLEYSVILLE NATIONAL CORPORATION
INDEX TO FORM 10-Q REPORT
PAGE
----
Part I. Financial Information
Consolidated Balance Sheets - June 30, 1998 and December 31, 1997. . . . . 3
Consolidated Statements of Income - Six Months and Three Months Ended
June 30, 1998 and 1997. . . . . . . . . . . . . . . . . . . . 4
Consolidated Statements of Cash Flows - Six Months Ended
June 30, 1998 and 1997. . . . . . . . . . . . . . . . . . . . 5
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . 6
Management's Discussion and Analysis of Financial Condition and
Results of Operations . . . . . . . . . . . . . . . . . . . . 8
Part II. Other Information. . . . . . . . . . . . . . . . . . . . . . . 19
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
PAGE 2
PART 1. FINANCIAL INFORMATION
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(Unaudited) (Audited)
(Dollars in thousands) June 30, 1998 December 31, 1997
--------------- -------------------
ASSETS
<S> <C> <C>
Cash and due from banks . . . . . . . . . . . . . . . . . . . . . . . $ 36,058 $ 38,471
Federal Funds sold. . . . . . . . . . . . . . . . . . . . . . . . . . 13,170 11,050
--------------- -------------------
Total cash and cash equivalents . . . . . . . . . . . . . . . . . 49,228 49,521
--------------- -------------------
Interest-bearing deposits in banks. . . . . . . . . . . . . . . . . . 5,127 5,574
Investment securities available for sale. . . . . . . . . . . . . . . 312,981 257,068
Investment securities held to maturity
(market value $38,539 and $47,354, respectively) . . . . . . . . . . 37,752 46,238
Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 788,038 743,608
Less: Unearned income . . . . . . . . . . . . . . . . . . . . . . . . (2,898) (4,155)
Allowance for loan losses. . . . . . . . . . . . . . . . . . (12,533) (11,925)
--------------- -------------------
Net loans. . . . . . . . . . . . . . . . . . . . . . . . 772,607 727,528
--------------- -------------------
Bank premises and equipment, net. . . . . . . . . . . . . . . . . . . 18,416 17,934
Accrued income receivable . . . . . . . . . . . . . . . . . . . . . . 8,679 7,719
Other real estate owned . . . . . . . . . . . . . . . . . . . . . . . 792 453
Intangible assets, net. . . . . . . . . . . . . . . . . . . . . . . . 1,887 1,851
Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,647 2,368
--------------- -------------------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . $ 1,211,116 $ 1,116,254
=============== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing. . . . . . . . . . . . . . . . . . . . . . . . $ 162,810 $ 152,621
Interest-bearing:
Checking accounts. . . . . . . . . . . . . . . . . . . . . . . . 110,198 108,954
Money market accounts. . . . . . . . . . . . . . . . . . . . . . 209,690 180,949
Savings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116,986 108,199
Time, under $100,000 . . . . . . . . . . . . . . . . . . . . . . 304,174 299,794
Time, $100,000 or greater. . . . . . . . . . . . . . . . . . . . 84,909 68,554
--------------- -------------------
Total deposits. . . . . . . . . . . . . . . . . . . . . . . 988,767 919,071
Accrued interest payable. . . . . . . . . . . . . . . . . . . . . . . 13,586 14,388
U.S. Treasury demand notes. . . . . . . . . . . . . . . . . . . . . . 2,014 2,150
Federal funds purchased . . . . . . . . . . . . . . . . . . . . . . . - 13,700
Federal Home Loan Bank (FHLB) borrowings. . . . . . . . . . . . . . . 45,000 17,000
Securities sold under agreements to repurchase. . . . . . . . . . . . 34,538 31,288
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 11,109 8,865
--------------- -------------------
Total liabilities . . . . . . . . . . . . . . . . . . . . . 1,095,014 1,006,462
--------------- -------------------
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 7,028,960 shares in 1998 and
7,020,211 shares in 1997 . . . . . . . . . . . . . . . . . . . 7,029 7,020
Additional paid in capital. . . . . . . . . . . . . . . . . . . . 49,479 49,305
Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . 54,390 48,988
Net unrealized gains on investment securities available for sale. 5,204 4,479
--------------- -------------------
Total shareholders' equity. . . . . . . . . . . . . . . . . 116,102 109,792
--------------- -------------------
Total liabilities and shareholders' equity. . . . . . . . . $ 1,211,116 $ 1,116,254
=============== ===================
See accompanying notes to consolidated financial statements.
</TABLE>
PAGE 3
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(Unaudited)
Six months ended Three months Ended
(Dollars in thousands except weighted average number June 30, June 30,
of common shares and per share information) ------------------ -------------------
<S> <C> <C> <C> <C>
1998 1997 1998 1997
------------------ ---------- ------------------- ----------
INTEREST INCOME:
Loans, including fees . . . . . . . . . . . . . . . . . . . . $ 29,812 $ 27,606 $ 15,075 $ 13,903
Lease financing . . . . . . . . . . . . . . . . . . . . . . . 2,370 2,237 1,218 1,129
Investment securities:
Taxable. . . . . . . . . . . . . . . . . . . . . . . . . . 6,291 6,256 3,204 3,131
Exempt from federal taxes. . . . . . . . . . . . . . . . . 3,457 2,501 1,848 1,271
Federal funds sold. . . . . . . . . . . . . . . . . . . . . . 453 316 211 267
Deposits in banks . . . . . . . . . . . . . . . . . . . . . . 155 218 71 94
------------------ ---------- ------------------- ----------
Total interest income . . . . . . . . . . . . . . . . . 42,538 39,134 21,627 19,795
------------------ ---------- ------------------- ----------
INTEREST EXPENSE:
Savings deposits. . . . . . . . . . . . . . . . . . . . . . . 5,625 4,851 2,900 2,523
Time, under $100,000. . . . . . . . . . . . . . . . . . . . . 8,319 8,151 4,203 4,109
Time, $100,000 or greater . . . . . . . . . . . . . . . . . . 2,146 1,440 1,133 800
Borrowed funds. . . . . . . . . . . . . . . . . . . . . . . . 1,990 1,919 1,045 956
------------------ ---------- ------------------- ----------
Total interest expense. . . . . . . . . . . . . . . . . 18,080 16,361 9,281 8,388
------------------ ---------- ------------------- ----------
Net interest income . . . . . . . . . . . . . . . . . . 24,458 22,773 12,346 11,407
Provision for loan losses . . . . . . . . . . . . . . . . . . 1,070 1,130 535 590
------------------ ---------- ------------------- ----------
Net interest income after provision for loan losses . . 23,388 21,643 11,811 10,817
------------------ ---------- ------------------- ----------
OTHER OPERATING INCOME:
Service charges . . . . . . . . . . . . . . . . . . . . . . . 1,525 1,416 769 730
Security gains, net . . . . . . . . . . . . . . . . . . . . . 325 704 119 676
Trust income. . . . . . . . . . . . . . . . . . . . . . . . . 1,001 738 581 355
Other Income. . . . . . . . . . . . . . . . . . . . . . . . . 1,183 658 703 365
------------------ ---------- ------------------- ----------
Total other operating income. . . . . . . . . . . . . . 4,034 3,516 2,172 2,126
------------------ ---------- ------------------- ----------
Net interest income after provision for loan losses
and other operating income . . . . . . . . . . . . . 27,422 25,159 13,983 12,943
------------------ ---------- ------------------- ----------
OTHER OPERATING EXPENSES:
Salaries, wages and employee benefits . . . . . . . . . . . . 8,724 7,438 4,391 3,808
Occupancy . . . . . . . . . . . . . . . . . . . . . . . . . . 1,013 957 486 440
Furniture and equipment . . . . . . . . . . . . . . . . . . . 1,540 1,255 799 652
Other expenses. . . . . . . . . . . . . . . . . . . . . . . . 4,546 4,087 2,343 2,004
------------------ ---------- ------------------- ----------
Total other operating expenses. . . . . . . . . . . . . 15,823 13,737 8,019 6,904
------------------ ---------- ------------------- ----------
Income before income taxes. . . . . . . . . . . . . . . 11,599 11,422 5,964 6,039
Income tax expense. . . . . . . . . . . . . . . . . . . . . . 2,824 3,138 1,439 1,669
------------------ ---------- ------------------- ----------
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . $ 8,775 $ 8,284 $ 4,525 $ 4,370
================== ========== =================== ==========
Weighted average number of common shares:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . 7,023,966 6,994,590 7,026,160 6,999,045
================== ========== =================== ==========
Diluted . . . . . . . . . . . . . . . . . . . . . . . . 7,029,409 7,007,043 7,031,643 7,012,739
================== ========== =================== ==========
Net income per share information:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . $ 1.25 $ 1.18 $ 0.64 $ 0.62
================== ========== =================== ==========
Diluted . . . . . . . . . . . . . . . . . . . . . . . . $ 1.25 $ 1.18 $ 0.64 $ 0.62
================== ========== =================== ==========
Cash dividends per share. . . . . . . . . . . . . . . . . . . $ 0.48 $ 0.42 $ 0.24 $ 0.21
================== ========== =================== ==========
See accompanying notes to consolidated financial statements.
</TABLE>
PAGE 4
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
(Dollars in thousands) Six Months Ended June 30,
<S> <C> <C>
OPERATING ACTIVITIES:. . . . . . . . . . . . . . . . . . . . . . . . . . . 1998 1997
--------------------------- ---------
Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 8,775 $ 8,284
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses. . . . . . . . . . . . . . . . . . . . . . . 1,070 1,130
Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . 937 708
Net amortization of investment
securities discount/premiums . . . . . . . . . . . . . . . . . . . . 194 113
Net realized security gain . . . . . . . . . . . . . . . . . . . . . . (325) (704)
Increase in accrued income receivable. . . . . . . . . . . . . . . . . (960) (810)
(Decrease) increase in accrued interest payable. . . . . . . . . . . . (803) 572
Net increase in other assets . . . . . . . . . . . . . . . . . . . . . (1,279) (250)
Net increase in other liabilities. . . . . . . . . . . . . . . . . . . 1,853 470
Decrease in unearned income. . . . . . . . . . . . . . . . . . . . . . (1,258) (1,582)
Write-down of other real estate owned. . . . . . . . . . . . . . . . . 20 4
(Increase) decrease in intangible assets . . . . . . . . . . . . . . . (36) 151
--------------------------- ---------
Net cash provided by operating activities . . . . . . . . . . . . . 8,188 8,086
--------------------------- ---------
INVESTING ACTIVITIES:
Proceeds from sales of investment securities available for sale. . . . . 27,327 15,199
Proceeds, maturity or calls of investment securities held to maturity. . 8,447 5,261
Proceeds, maturity or calls of investment securities available for sale. 13,703 10,748
Purchases of investment securities available for sale. . . . . . . . . . (95,655) (38,640)
Net decrease in interest-bearing deposits in banks . . . . . . . . . . . 447 2,158
Net increase in loans. . . . . . . . . . . . . . . . . . . . . . . . . . (45,694) (23,218)
Net increase in premises and equipment . . . . . . . . . . . . . . . . . (1,418) (3,064)
Proceeds from sales of other real estate . . . . . . . . . . . . . . . . 443 605
--------------------------- ---------
Net cash used in investing activities . . . . . . . . . . . . . . . (92,400) (30,951)
--------------------------- ---------
FINANCING ACTIVITIES:
Net increase in deposits . . . . . . . . . . . . . . . . . . . . . . . . 69,696 46,310
Decrease in U.S. Treasury demand notes . . . . . . . . . . . . . . . . . (136) (561)
Decrease in federal funds purchased. . . . . . . . . . . . . . . . . . . (13,700) -
Increase in FHLB borrowings. . . . . . . . . . . . . . . . . . . . . . . 28,000 8,750
Increase in securities sold under agreement. . . . . . . . . . . . . . . 3,250 3,403
Cash dividends & fractional shares . . . . . . . . . . . . . . . . . . . (3,373) (2,933)
Dividend reinvestment. . . . . . . . . . . . . . . . . . . . . . . . . . - (17)
Stock awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 -
Stock options. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177 41
Net cash provided by financing activities. . . . . . . . . . . . . . . 83,919 54,993
--------------------------- ---------
(Decrease) increase in cash and cash equivalents . . . . . . . . . . . . . (293) 32,128
Cash and cash equivalents at beginning of period . . . . . . . . . . . . . 49,521 45,407
--------------------------- ---------
Cash and cash equivalents at end of the period . . . . . . . . . . . . . . 49,228 77,535
=========================== =========
Cash paid during the period for:
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 18,883 $ 15,789
Income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,400 $ 2,600
=========================== =========
Supplemental disclosure of noncash investing and financing activities:
Transfer of assets from loans to other real estate owned. . . . . . $ 802 $ 669
=========================== =========
See accompanying notes to consolidated financial statements.
</TABLE>
PAGE 5
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the consolidated financial
position of Harleysville National Corporation (the "Corporation") and its wholly
owned subsidiaries - Harleysville National Bank and Trust Company
("Harleysville"), The Citizens National Bank of Lansford ("Citizens"), Security
National Bank ("Security") (collectively, the "Banks") and HNC Financial Company
- - as of June 30, 1998, the results of its operations for six and three month
periods ended June 30, 1998 and 1997 and the cash flows for the six month
periods ended June 30, 1998 and 1997. It is suggested that these unaudited
consolidated financial statements be read in conjunction with the audited
consolidated financial statements of the Corporation and the notes thereto set
forth in the Corporation's 1997 annual report.
The results of operations for the six and three month periods ended June 30,
1998 and 1997 are not necessarily indicative of the results to be expected for
the full year.
NOTE 2 - Income tax expense is less than the amount calculated using the
statutory tax rate, primarily the result of tax exempt income earned from state
and municipal securities and loans.
NOTE 3 - During 1997, the Corporation adopted the provisions of the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
(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 computing such earnings per share. Basic earnings per share exclude
dilution and are 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.
NOTE 4 - On May 8, 1997, the Board of Directors of Harleysville National
Corporation declared a 5% stock dividend (five shares of common stock for each
100 shares of common stock outstanding held) that was payable June 30, 1997, to
shareholders of record June 13, 1997.
NOTE 5 - On March 17, 1997, the HNC Financial Company, a subsidiary of
Harleysville National Corporation was incorporated as a Delaware Corporation.
HNC Financial Company's principal business function is to expand the investment
opportunities of the Corporation.
NOTE 6 - On January 1, 1998, the Corporation adopted the Financial Accounting
Standards Board issued SFAS No. 129, Disclosure Information about Capital
Structure. SFAS No. 129 summarizes previously issued disclosure guidance
contained within APB Opinion No. 10 and 15, as well as SFAS No. 47. The
Corporation's current disclosures were not affected by the adoption of SFAS No.
129.
NOTE 7 - On January 1, 1998, the Corporation adopted the Financial Accounting
Standards Board 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. Other comprehensive income consists of net unrealized
gains on investment securities available for sale. Subsequent to the adoption
date, all prior-period amounts are required to be restated to conform to the
provision of SFAS No. 130. Comprehensive income for the first six months of
1998 was $9,500,000, compared to $9,170,000 for the first six months of 1997.
The adoption of SFAS No. 130 did not have a material impact on the Corporation's
financial position or results of operation.
PAGE 6
NOTE 8 - On January 1, 1998, the Corporation adopted the Financial Accounting
Standards Board 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.
The adoption of SFAS No. 131 did not have an impact on the Corporation's
financial position or results of operations.
NOTE 9 - The American Institute of Certified Public Accountants (AICPA) issued
Statement of Position (SOP) 98-1 "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." The SOP was issued to provide
authoritative guidance on the subject of accounting for the costs associated
with the purchase or development of computer software. The statement is
effective for fiscal years beginning after December 15, 1998. This statement is
not expected to have a material impact on the Corporation's financial position
or results of operations.
NOTE 10 - In June 1998, the Financial Accounting standard Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activity." SFAS No. 133 establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments imbedded in other contracts, and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as a hedge. The accounting for changes in the fair value of
derivative (gains and losses) depends on the intended use of the derivative and
resulting designation. SFAS No. 133 is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999. Earlier application is permitted
only as of the beginning of any fiscal quarter. The company is currently
reviewing the provisions of SFAS No. 133.
PAGE 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
- -----------------------
The following is management's discussion and analysis of the
significant changes in the results of operations, capital resources and
liquidity presented in its accompanying consolidated financial statements for
the Corporation, the Banks and HNC Financial Company. The Corporation's
consolidated financial condition and results of operations consist almost
entirely of the Banks' financial condition and results of operations. Current
performance does not guarantee, assure, or may not be indicative of similar
performance in the future.
In addition to historical information, this Form 10-Q 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. For example, risks and uncertainties
can arise with changes in: general economic conditions, including their impact
on capital expenditures; business conditions in the financial services 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. 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.
Consolidated net income for the first six months of 1998 was $8,775,000, an
increase of $491,000, or 5.9%, over the first six months of 1997 net income of
$8,284,000. Basic and diluted earnings per share at $1.25 were up 5.9% from
$1.18 in the comparable period last year. Consolidated net income for the
second quarter of 1998 was $4,525,000, an increase of $155,000, or 3.5%, over
the second quarter of 1997 net income of $4,370,000. Basic and diluted earnings
per share for the second quarter of 1998 of $0.64 increased 3.2%, over the
second quarter of 1997 basic and diluted earnings per share of $0.62.
The increase in net income during the first six months of 1998,
compared to the same period in 1997, is the result of both higher net interest
income and other operating income, partially offset by higher other operating
expenses. Lower income tax expense associated with a higher level in nontaxable
income, also contributed to the gain in net income. Net interest income grew
$1,685,000, primarily as a result of an 11.7% rise in average earning assets.
Other operating income rose $518,000, due to higher trust fees, a rise in
service charges on deposit accounts, gains on the sale of mortgages and
increased ATM and debit card fees. Offsetting these increases was a rise in
other operating expenses, primarily related to the overall growth in the Banks.
As of June 30, 1998, the Banks have experienced an improvement in
asset quality, compared to December 31, 1997 and June 30, 1997, respectively.
Nonperforming assets, including nonaccrual loans, restructured loans and other
real estate owned, were $4,358,000, or .55% of total loans and net assets
acquired in foreclosure at June 30, 1998, compared to .56% at December 31, 1997
and .88% at June 30, 1997. The ratio of the allowance for loan losses to
nonperforming assets improved to 287.6% at June 30, 1998, from 285.8% at
December 31, 1997 and 178.2% at June 30, 1997.
For the six months ended June 30, 1998, the annualized return on average
shareholders' equity and the annualized return on average assets were 15.48% and
1.51, respectively. For the same period in 1997, the annualized return on
average shareholders' equity was 16.49% and the annualized return on average
assets was 1.58%. For the three months ended June 30, 1998, the annualized
return on average shareholders' equity and the annualized return on average
assets were 15.75% and 1.53%, respectively. For the same period in 1997, the
annualized return on average shareholders' equity was 17.20% and the annualized
return on average assets was 1.64%.
PAGE 8
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, trust income 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 will be reviewed in
more detail in the following discussion.
NET INTEREST INCOME AND RELATED ASSETS AND LIABILITIES
- -------------------------------------------------------------
Net interest income for the first six months of 1998 of $24,458,000
increased $1,685,000, or 7.4%, over the first six months of 1997 net interest
income of $22,773,000. As illustrated in the table below, the primary source of
this increase was a rise in interest income resulting from increases to earning
asset volumes in the first six months of 1998, compared to the same period in
1997. The increase in interest income was partially offset by a rise in
interest expense, primarily the result of higher volumes. The second quarter
1998 net interest income rose 8.2%, compared to the same period in 1997. This
rise was primarily the result of the interest income generated by an increase in
earning assets, partially offset by higher interest expense related to higher
deposit volumes.
The rate-volume variance analysis set forth in the table below,
which is computed on a tax-equivalent basis (tax rate of 35%), analyzes changes
in net interest income for the six months ended June 30, 1998 over June 30, 1997
and the three months ended June 30, 1998 over June 30, 1997 by their rate and
volume components.
<TABLE>
<CAPTION>
Six Months Ended Three Months Ended
June 30, 1998 June 30, 1998
Over/Under Over/Under
June 30, 1997 June 30, 1997
Total Caused by: Total Caused by:
----------- ------------
Variance Rate Volume Variance Rate Volume
----------------- ----------- ------- -------------------- ------------ --------
<S> <C> <C> <C> <C> <C> <C>
Interest Income:
- -----------------------------------------
Securities *. . . . . . . . . . . . . . . $ 1,506 ($161) $ 1,667 $ 961 $ 15 $ 946
Money market instruments. . . . . . . . . 74 (31) 105 (79) (11) (68)
Loans * . . . . . . . . . . . . . . . . . 2,499 (308) 2,807 1,334 (24) 1,358
----------------- ----------- ------- -------------------- ------------ --------
Total. . . . . . . . . . . . . . . . 4,079 (500) 4,579 2,216 (20) 2,236
----------------- ----------- ------- -------------------- ------------ --------
Interest Expense:
- -----------------------------------------
Savings deposits. . . . . . . . . . . . . 774 139 635 377 51 326
Time deposits and certificates of deposit 874 12 862 427 (7) 434
Other borrowings. . . . . . . . . . . . . 71 (90) 161 89 (61) 150
----------------- ----------- ------- -------------------- ------------ --------
Total . . . . . . . . . . . . . . . 1,719 61 1,658 893 (17) 910
----------------- ----------- ------- -------------------- ------------ --------
Changes in net interest income. . . . . . 2,360 (561) 2,921 1,323 (3) 1,326
================= =========== ======= ==================== ============ ========
* Tax equivalent basis
</TABLE>
Taxable-equivalent net interest income was $26,639,000 for the first six
months of 1998, compared to $24,279,000 for the same period in 1997, a 9.7% or
$2,360,000 increase. This rise in taxable-equivalent net interest income was
primarily due to a $2,921,000 increase related to volume, which was partially
offset by a reduction in interest income, related to rate. Total
taxable-equivalent interest income grew $4,079,000, primarily the result of the
higher volumes in both the security and loan earning asset categories. Average
year-to-date earning assets increased to $1,109,623,000 at June 30, 1998 from
$993,036,000 at June 30, 1997, an 11.7% increase. This increase in earning
PAGE 9
assets was primarily due to the growth in loans, as a result of persistent sales
efforts and new branch openings.
Total interest expense grew $1,719,000 during the first six months
of 1998, compared to the same period in 1997. This growth was principally the
result of both higher rates and volumes associated with savings and time
deposits. The volume of savings and time deposits grew 12.7% and 9.0%,
respectively, compared to the first six months of 1997. The rise in other
borrowings interest expense was due to an 8.8% increase in volume. This
increase was partially offset by the lower rates experienced in other borrowings
during the first six months of 1998, compared to 1997. The increase in deposit
and other borrowing volumes was used to finance the earning asset growth. Other
borrowings include federal funds purchased, Federal Home Loan Bank (FHLB)
borrowings, securities sold under agreements to repurchase and U. S. Treasury
demand notes.
Taxable-equivalent net interest income of $13,500,000 was
$1,322,000 or 10.9% higher in the second quarter of 1998, compared to
$12,178,000 for the same period in 1997. Interest income grew $2,216,000 during
the period, as a result of an increase in security and loan volumes. Second
quarter average securities and loans grew 18.5% and 9.0%, respectively, compared
to the second quarter of 1997. The increase in the interest income was
partially offset by a $893,000 rise in interest expense. Increases in all
deposit category volumes contributed to this increase in interest expense.
Nonaccruing loans are included in the average balance yield calculations, but
the average nonaccruing loans had no material effect on the results.
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 utilize three
principal reports to measure interest rate risk: asset/liability simulation
reports, gap analysis reports and net interest margin reports.
NET INTEREST MARGIN
---------------------
The net interest margin of 4.80% for the six month period ended June 30,
1998, decreased from the 4.89% net interest margin for the first six months of
1997. The yield on earning assets of 8.06% during the first six months of 1998
was lower than the 8.19% earned during the first six months of 1997. This drop
in yield is primarily due to the lower rates experienced throughout the earning
asset portfolio in 1998, compared to 1997. The 4.10% average interest rate
paid on interest-bearing deposits and other borrowings during the first six
months of 1998, decreased slightly from the 4.11% rate paid during the same
period in 1997. The decrease in the rate is due generally to the lower rates
paid on other borrowings. The net interest margin was 4.84% in both the second
quarters of 1998 and 1997. 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 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' ability to repay declines.
For the first six months of 1998 the provision for loan losses was
$1,070,000, compared to $1,130,000 for the same period in 1997. Net loans
charged off were $462,000 for the six months ended June 30, 1998, compared to
$636,000 for the six months ended June 30, 1997. The reduction in net loans
charged off of $174,000 was primarily due to a reduction in consumer loans
charged off. During 1997, management took steps to control the risk of consumer
PAGE 10
loans charged off by tightening credit standards and increasing the reserve for
loan losses for consumer loans. The ratio of the allowance for loan losses to
loans at June 30, 1998 was 1.60%, consistent with the December 31, 1997 and June
30, 1997 ratios of 1.61% and 1.59%, respectively.
Allowance for Loan Losses
- ----------------------------
Transaction in the allowance for loan losses are as follows:
<TABLE>
<CAPTION>
1998 1997
---------------- ---------------
<S> <C> <C> <C>
Balance, Beginning of Year $11,925 $10,710
Provision charged to operating expenses 1,070 1,130
Loans charged off (675) (777)
Recoveries 213 141
---------------- ---------------
Balance, June 30 $12,533 $11,204
================ ===============
Ratios: . . . . . . . . . . . . . . . . . . . . . June 30, 1998 Dec. 31, 1997 June 30, 1997
- ------------------------------------------------- ---------------- --------------- --------------
Allowance for loan losses to nonperforming assets 287.6% 285.8% 178.2%
Nonperforming assets to total loans & net assets
acquired in foreclosure . . . . . . . . . . . . . 0.55% 0.56% 0.88%
Allowance for loan losses to total loans. . . . . 1.60% 1.61% 1.59%
</TABLE>
The following table sets forth an allocation of the allowance for loan losses by
loan category:
<TABLE>
<CAPTION>
June 30, 1998
--------------
Percent
Amount of Loans
-------------- ---------
<S> <C> <C>
Commercial and industrial $ 2,409,000 29%
Installment and other . . 1,523,000 31%
Real estate . . . . . . . 1,274,000 33%
Lease financing . . . . . 249,000 7%
Unallocated . . . . . . . 7,078,000 N/A
-------------- ---------
Total . . . . . . . . . $ 12,533,000 100%
============== =========
</TABLE>
Nonperforming assets (nonaccruing loans, net assets in foreclosure and
troubled debt restructured loans) were 0.55% of total loans and net assets
acquired in foreclosure at June 30, 1998, compared to 0.56% at December 31,
1997 and 0.88% at June 30, 1997. The decline in this ratio from June 30, 1997
to June 30, 1998, is the result of the reduction of nonperforming assets in all
nonperforming asset categories during this period. The ratio of the allowance
for loan losses to non-performing assets was 287.6% at June 30, 1998 compared to
285.8% at December 31, 1997 and 178.2% at June 30, 1997.
Nonaccruing loans at June 30, 1998 of $2,941,000, increased $320,000 from
the December 31, 1997 level of $2,621,000, and decreased $1,276,000 from the
June 30, 1997 level of $4,217,000. The increase from December 31, 1997 was
primarily due to real estate loans. The $1,276,000 reduction in nonaccrual
loans from June 30, 1997 to June 30, 1998, is primarily due to one loan that
paid off during the third quarter of 1997.
Net assets in foreclosure totaled $792,000 as of June 30, 1998, an
increase of $339,000 from the December 31, 1997 balance of $453,000. During the
first six months of 1998, transfers from loans to assets in foreclosure were
$802,000, payments on foreclosed properties totaled $443,000 and write downs of
assets in foreclosure equaled $20,000. The loans transferred to assets in
foreclosure included mortgages of $243,000, commercial loans of $204,000 and
leases of $355,000. The balance of net assets in foreclosure at June 30, 1997
was $1,032,000. Efforts to liquidate assets acquired in foreclosure are
proceeding as quickly as potential buyers can be located and legal constraints
PAGE 11
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.
As of June 30, 1998, there were three unrelated borrowers with troubled
debt restructured loans totaling $624,000, compared with a balance of
$1,012,000 as of December 31, 1997 and $1,037,000 at June 30, 1997. All three
customers were complying with the restructured terms as of June 30, 1998.
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. As of June 30, 1998, loans past due 90 days or more and still
accruing interest were $1,218,000, compared to $2,253,000 as of December 31,
1997 and $2,189,000 as of June 30, 1997. The $1,035,000 decrease in loans past
due 90 days from December 31, 1997 to June 30, 1998 was primarily the result of
a decrease in real estate loans past due 90 days.
The following information concerns impaired loans:
<TABLE>
<CAPTION>
Impaired Loans: June 30, 1998 Dec. 31, 1997 June 30, 1997
-------------- -------------- --------------
<S> <C> <C> <C>
Restructured Loans . . . . . . . . . . . . $ 624,000 $ 1,012,000 $ 1,037,000
Nonaccrual Loans . . . . . . . . . . . . . $ 1,335,000 $ 1,429,000 $ 3,011,000
-------------- -------------- --------------
Total Impaired Loans. . . . . $ 1,959,000 $ 2,441,000 $ 4,048,000
============== ============== ==============
Average year-to-date impaired loans:. . . . . . $ 2,251,000 $ 3,538,000 $ 4,089,000
============== ============== ==============
Impaired loans with specific loss allowances: . $ 1,959,486 $ 2,441,000 $ 4,048,000
============== ============== ==============
Loss allowances reserved on impaired loans: . . $ 219,000 $ 341,000 $ 533,000
============== ============== ==============
Year-to-date income recognized on impaired loans $ 37,000 $ 135,000 $ 75,000
============== ============== ==============
</TABLE>
The Banks' policy for interest income recognition on impaired loans is to
recognize income on restructured loans under the accrual method. The Banks
recognize income on nonaccrual loans under the cash basis when the loans are
both current and the collateral on the loan is sufficient to cover the
outstanding obligation to the Banks. The Banks will not recognize income if
these factors do not exist.
OTHER OPERATING INCOME
- ------------------------
<TABLE>
<CAPTION>
Six Months Ended June 30, Three Months Ended June 30,
-------------------------- ----------------------------
1998 1997 1998 1997
------------------------------------------------------------------
<S> <C> <C> <C> <C>
(Dollars in thousands)
Service charges . . . . . . . . $ 1,525 $1,416 $ 769 $ 730
Securities gains (losses), net. 325 704 119 676
Trust income. . . . . . . . . . 1,001 738 581 355
Other income. . . . . . . . . . 1,183 658 703 365
-------------------------- ------ ---------------------------- ------
Total other operating income. . $ 4,034 $3,516 $ 2,172 $2,126
========================== ====== ============================ ======
</TABLE>
Other operating income for the first six months of 1998 increased $518,000,
or 14.7%, from $3,516,000 at June 30, 1997 to $4,034,000 at June 30, 1998.
This rise in other operating income is the result of a $109,000 growth in
service charges, a $263,000 rise in trust income and a $525,000 increase in
other income. A $379,000 decrease in security gains partially offset these
PAGE 12
increases. The second quarter of 1998 other income of $2,172,000 was $46,000 or
2.2% higher than plan. Increases in service charges, trust income and other
income were partially offset by a decrease in security gains.
The $109,000, or 7.7% increase in service charges is primarily the result
of a $55,000 rise in fees charged on deposit accounts and a $56,000 growth in
check fees during this period. This growth was primarily the result of the
12.7% increase in average deposit transaction accounts, from the first half of
1997 to the first half in 1998. The 1998 second quarter service charge income
of $769,000, increased $39,000, or 5.3% over the second quarter of 1997 service
charge income.
The Corporation recorded a net security gain of $325,000 in the
first six months of 1998, compared to a $704,000 gain in the same period in
1997. The second quarter 1998 net security gain of $119,000 was lower than the
$676,000 gain in the second quarter of 1997. 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 of the portfolio.
Income from the Trust and Financial Services Department increased $263,000
in the first six months of 1998, compared to the same period in 1997. This
increase was the result of both an increase in the book value of trust assets of
19.4% from June 30, 1997 to June 30, 1998, and the Corporation's continuing
emphasis on marketing the Trust and Financial Services Department's products and
services. The second quarter of 1998 trust fees grew 63.7%, compared to the
same period in 1997.
Other income for the first six months of 1998 increase $525,000,
or 79.8%, compared to the same period in 1997. The second quarter of 1998
other income was $338,000, or 92.6% higher than the second quarter of 1997.
These increases were primarily due to gains on the sale of residential
mortgages. During the last half of 1997, the Banks entered into the strategy of
increasing the booking and selling of residential mortgages. This strategy has
resulted in the Banks recognizing gains of $294,000 in the first half of 1998
and $254,000 in the second quarter of 1998. The increases in other income were
also due to higher automated teller machine fees and debit card fees earned by
the Banks.
OTHER OPERATING EXPENSES
- --------------------------
<TABLE>
<CAPTION>
Six Months Ended June 30, Three Months Ended June 30,
-------------------------- ---------------------------
1998 1997 1998 1997
-------------------------- ----------------------- ---------------------------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Salaries . . . . . . . . . . . $ 6,558 $ 5,702 $ 3,349 $2,937
Employee benefits. . . . . . . 2,166 1,736 1,042 871
Net occupancy expense. . . . . 1,013 957 486 440
Equipment expense. . . . . . . 1,540 1,255 799 652
Other expenses . . . . . . . . 4,546 4,087 2,343 2,004
-------------------------- ----------------------- ---------------------------- ------
Total other operating expenses $ 15,823 $ 13,737 $ 8,019 $6,904
========================== ======================= ============================ ======
</TABLE>
Other operating expenses for the first six months of 1998 of $15,823,000
increased $2,086,000, or 15.2%, from $13,737,000 for the same period in 1997.
The second quarter of 1998 other operating expenses grew 16.2%, compared to the
second quarter of 1997. The rise in operating expenses was due to higher
expenses related to four new branches opened after April 30, 1997, increases in
equipment expenses and other expenses related to the overall growth of the
Banks.
Employee salaries increased $856,000, or 15.0% from $5,702,000 for the
first six months of 1997 to $6,558,000 for the same period in 1998. Salaries
grew $412,000, or 14.0% from the second quarter of 1997 to the second quarter of
1998. The year-to-date salary increase directly related to the staffing of the
four new branches was $185,000, or 21.6% of the total salary increase. The
PAGE 13
second quarter increase resulting from the four new branches was $103,000, or
25.0% of the total salary increase. The remaining increase in salaries
reflects cost of living increases, merit increases and additional staff
necessitated by the planned growth of the Banks.
Employee benefits of $2,166,000 expensed in the first six months
of 1998, were $430,000, or 24.8% higher than the $1,736,000 of employee benefits
expensed during the same period in 1997. Employee benefits grew $171,000, or
19.6% from the second quarter of 1997 to the second quarter of 1998. These
increases were primarily the result of the impact of the four new branches,
additions to the staff of the Banks and a change in the timing of expensing the
profit sharing plan throughout the year.
Net occupancy expense increased $56,000, or 5.9%, from $957,000 in the
first six months of 1997 to $1,013,000 in the first six months of 1998. The
occupancy expense in the second quarter of 1998 grew $46,000, or 10.5%, compared
to the second quarter of 1997. The four new branches were responsible for the
majority of the increase in occupancy expense. Equipment expense increased
$285,000, or 22.7%, during the first six months of 1998, compared to the same
period in 1997. The equipment expense grew $147,000, or 22.5%, during the
second quarter of 1998, compared to 1997. The equipment expense related to the
new branches for the first six months of 1998 and the second quarter of 1998
totaled $60,000 and $28,000, respectively. The remainder of this increase is
due to both equipment depreciation and maintenance associated with planned
increased technology capabilities used to manage the rise in volume related to
the growth of the Corporation.
Other expenses increased $459,000, or 11.2%, from $4,087,000 in
the first six months of 1997, compared to $4,546,000 in other expenses recorded
during the same period in 1998. The second quarter 1998 other expenses grew
$339,000, or 16.9%, compared to the second quarter of 1997. This growth is the
result of higher advertising and marketing expenses, expenses associated with
the new branches and the overall growth of the Banks.
INCOME TAXES
- -------------
Income tax expense is less than the amount calculated using the statutory
tax rate primarily as a result of tax exempt income earned from state and
municipal securities and loans.
BALANCE SHEET ANALYSIS
- ------------------------
Total assets grew $94,862,000, or 8.5%, from $1,116,254,000 at December 31,
1997 to $1,211,116,000 at June 30, 1998. This growth was the result of a rise
in interest earning assets, which grew $94,787,000 to $1,154,170,000 at June 30,
1998, from $1,059,383,000 at December 31, 1997. During the first six months of
1998, investment securities, federal funds sold, and loans grew $47,427,000,
$2,120,000, $45,687,000, respectively. Offsetting these increases was a
$447,000 decrease in interest bearing deposits.
Total deposits rose $69,696,000, or 7.6% from $919,071,000 at December 31,
1997 to $988,767,000 at June 30, 1998. This growth was due to a $28,741,000
increase in money market accounts, a $20,735,000 rise in time deposits, a
$8,787,000 increase in savings accounts and a $1,244,000 increase in
interest-bearing checking accounts. Non-interest bearing deposits grew
$10,189,000. Other borrowings increased $17,414,000 during the first six months
of 1998, primarily the result of an increase in Federal Home Loan Bank
borrowings. Other borrowings and deposits are used to fund loan and investment
growth.
CAPITAL
- -------
Capital formation is important to the Corporation's well being
and future growth. Capital for the period ending June 30, 1998 was
$116,102,000, an increase of $6,310,000 over the end of 1997. The increase is
primarily the 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
and liquidity positions are adequate to support its operations. Management is
not aware of any recommendations by any regulatory authority, which, if it were
to be implemented, would have a material effect on the Corporation's capital.
PAGE 14
<TABLE>
<CAPTION>
Tier 1 Capital to Risk- Total Capital to Risk-
Leverage Ratio Weighted Assets Ratio Weighted Asset Ratio
June 30, 1998 June 30,1998 June 30, 1998
--------------- ------------------------ -----------------------
Amount Ratio Amount Ratio Amount Ratio
--------------- ------ ------------------------ ------ ----------------------- ------
<S> <C> <C> <C> <C> <C> <C>
Entity:
Corporation . . . . . . . . . . $ 109,327 9.24% $ 109,327 13.14% $ 119,266 14.40%
Subsidiary Banks:
Harleysville National Bank. . . 77,639 8.48 77,639 11.75 85,921 13.01
Citizens National Bank. . . . . 21,291 12.35 21,291 20.24 22,607 21.49
Security National Bank. . . . . 6,449 7.45 6,449 9.96 7,260 11.21
"Well Capitalized" institution
(under FDIC regulations) 5.00 6.00 10.00
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997 December 31,1997 December 31, 1997
------------------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------------------ ------ ----------------- ------ ------------------ ------
Entity:
<S> <C> <C> <C> <C> <C> <C>
Corporation . . . . . . . . . . $ 103,600 9.36% $ 103,600 13.42% $ 113,276 14.68%
Subsidiary Banks:
Harleysville National Bank. . . 72,965 8.42 72,965 11.71 80,778 12.96
Citizens National Bank. . . . . 20,811 13.00 20,811 22.49 21,971 23.74
Security National Bank. . . . . 6,188 8.20 6,188 11.13 6,884 12.39
"Well Capitalized" institution
(under FDIC regulations) 5.00 6.00 10.00
</TABLE>
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 Corporation's primary capital ratio was 10.40% at
June 30, 1998, compared with 10.65% at December 31, 1997. Since 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 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 June
30, 1998, the Corporation's Tier 1 risk-adjusted capital ratio was 13.14%, and
the total risk-adjusted capital ratio was 14.40%, both well above the regulatory
requirements. The risk-based capital ratios of each of the Corporation's
commercial banks also exceeded regulatory requirements at June 30, 1998.
To supplement the risk-based capital adequacy guidelines, the Federal
Reserve Board 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% and 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 banking organization. The Corporation's leverage ratios were 9.24% at
June 30, 1998 and 9.36% at December 31, 1997.
PAGE 15
The year-to-date June 30, 1998 cash dividend per share of $.48 was 14.3%
higher than the cash dividend for the same period in 1997 of $.42. The
dividend payout ratio for the first six months of 1998 was 38.44%, compared to
38.23% for the twelve month period ended December 31, 1997. On June 30, 1997,
the Corporation paid a 5% stock dividend (five shares of common stock for each
100 shares of common stock outstanding held), to shareholders of record June 13,
1997. Activity in both the Corporation's dividend reinvestment and stock
purchase plan and the stock option plan did not have a material impact on
capital during the first six months of 1998.
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 provides the means to meet
the day-to-day demands of deposit customers and the needs of borrowing
customers. Generally, the Banks arrange their mix of cash, money market
investments, investment securities and loans in order to match the volatility,
seasonality, interest sensitivity and growth trends of its deposit funds.
Federal Funds sold averaged $16,315,000 during the first six months of 1998 and
securities available for sale averaged $285,653,000 during the first six months
of 1998, more than sufficient to meet normal fluctuations in loan demand or
deposit funding. Backup sources of liquidity are provided by federal fund lines
of credit established with correspondent banks. Additional liquidity could be
generated through borrowings from the Federal Reserve Bank of Philadelphia and
the FHLB of Pittsburgh, of which the Banks are members. Unused lines of credit
at the FHLB of Pittsburgh were $173,499,000, as of June 30, 1998.
OTHER ITEMS
- ------------
LEGISLATIVE & REGULATORY
--------------------------
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 effect on liquidity, capital resources or the results of
operations.
Recently, Pennsylvania enacted a law to permit State Chartered
banking institutions to sell insurance. 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.
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 affect 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
PAGE 16
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 its competitors. Management believes that such
consolidations and mergers, and diversification of products and services may
enhance the Banks' competitive position.
YEAR 2000
----------
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 it 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
operations problem for the Corporation. The Corporation has taken steps to
communicate with unrelated parties with whom it deals to coordinate Year 2000
compliance. The cost of addressing Year 2000 issues is not considered material
and will be expensed, as incurred, in compliance with GAAP.
Finally, the Bank has communicated with its commercial borrowers.
These borrowers pose a credit risk to the Bank if they are not Year 2000
compliant and their businesses are disrupted. Responses from commercial
borrowers are being evaluated presently.
As the Year 2000 approaches, regulation of the Corporation and the
Bank with respect to completing Year 2000 modifications is likely to increase.
A brief discussion of the most recent federal banking agency pronouncements that
affect the Corporation and/or the Banks follows.
In December 1997, the Federal Financial Institutions Examination
Council (FFIEC) issued an interagency statement. The statement indicates that
senior management and the board of directors should be actively involved in
managing the Corporation's and the Bank's Year 2000 compliance efforts. The
statement also recommended that institutions obtain Year 2000 compliance
certification from vendors followed by comprehensive internal testing. In
addition, contingency plans should be developed for all vendors that service
mission critical applications, which are applications vital to the successful
continuance of a core business activity.
The OCC issued an advisory indicating that Year 2000 preparedness will
be factored into reviews of de novo charters, conversions, business combinations
and establishment of federal branches and agencies as well as hardware and
software systems integration issues related to business combinations.
In addition, the OCC recently issued an advisory providing guidance in
key milestones and testing methods for institutions to use to prepare their
systems and applications for the Year 2000. Institutions should develop and
implement written testing strategies and plan to test both internal and external
systems. In May 1998, the FFIEC issued two interagency statements with regards
to Year 2000 readiness. The first statement provided guidance for institutions
to design its Year 2000 contingency plan to mitigate the risks associated with
the institutions failure to become Year 2000 compliant or the failure of mission
critical systems at specific dates. The second statement provides suggestions
for developing a customer awareness program and identifies issues that financial
institutions should be prepared to discuss with customers.
PAGE 17
BRANCHING
---------
The Corporation currently plans to open at least two new branches
within the next nine months. Harleysville National Bank is pursuing a location
in Royersford, and Security National Bank plans to open a branch in Amity
Township. 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.
ACQUISITION
-----------
On July 28, 1998, the Corporation entered into a definitive Agreement
and Plan of Reorganization to acquire Northern Lehigh Bancorp, Inc., parent
company of Citizens National Bank of Slatington. Under the terms of the merger,
accounted for as a pooling of interest, Northern Lehigh Bancorp shareholders
will receive 3.57 shares of Harleysville National Corporation common stock for
each share of Northern Lehigh Bancorp stock. The transaction is subject to
obtaining regulatory and shareholder approval and, therefore, the final closing
is not expected until late 1998.
PAGE 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
- ----------------------------
Management, based upon discussions 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 its
subsidiaries by government authorities.
Item 2. Change in Securities.
- ------------------------------
Not applicable.
Item 3. Defaults Upon Senior Securities.
- -----------------------------------------
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
- -------------------------------------------------------------
None.
Item 5. Other Information.
- ---------------------------
None.
Item 6. Exhibits and Reports on Form 8-K.
- ------------------------------------------
(a) Exhibits:
The following exhibit is being filed as part of this Report:
Exhibit No. Description
----------- -----------
27 Financial Data Schedule as of June 30, 1998
(b) Reports on Form 8-K:
On August 4, 1998, a Form 8-K was filed by the Registrant reporting
that effective July 28, 1998, the registrant signed a definitive Agreement and
Plan of Reorganization to acquire Northern Lehigh Bancorp, Inc. ("NLBI"),
located in Slatington, Pennsylvania. NLBI is the Parent company of Citizens
National Bank of Slatington. The transaction is subject to obtaining regulatory
and shareholder approval and, therefore, the final closing is not expected until
late 1998.
Under the terms of the merger, NLBI Shareholders will receive 3.57
shares of Harleysville National Corporation common stock, for each share of NLBI
stock.
The acquisition will be effected by the merger of Harleysville
National Corporation North, Inc., a bank holding company and wholly-owned
subsidiary of Harleysville National Corporation ("HNC"), with NLBI. The
Citizens National Bank of Lansford, a national banking association and a
wholly-owned subsidiary of HNC, will merge with Citizens National Bank of
Slatington, under the name Citizens National Bank.
PAGE 19
SIGNATURES
Pursuant to the requirements 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
________________________________
Walter E. Daller, Jr., President
and Chief Executive Officer
(Principal executive officer)
_______________________________
Vernon L. Hunsberger, Treasurer
(Principal financial and accounting officer)
Date: August 13, 1998
PAGE 20
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