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 September 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: 7,037,814 shares of Common
Stock, $1.00 par value, outstanding on October 31, 1998.
PAGE 1
HARLEYSVILLE NATIONAL CORPORATION
INDEX TO FORM 10-Q REPORT
PAGE
----
Part I. Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheets - September 30, 1998 and
December 31, 1997 . . . . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Income - Nine Months
and Three Months Ended September 30, 1998 and 1997 . . . . . . . 4
Consolidated Statements of Cash Flows - Nine
Months Ended September 30, 1998 and 1997 . . . . . . . . . . . 5
Notes to Consolidated Financial Statements . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . . . 8
Item 3. Quantitative and Qualitative Disclosure about Market Risk . . . 19
Part II. Other Information
Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . 20
Item 2. Change in Securities . . . . . . . . . . . . . . . . . . . . . 20
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . . . . 20
Item 4. Submission of Matters to a Vote of Security Holders . . . . . 20
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . 20
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . 20
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
PAGE 2
PART 1. FINANCIAL INFORMATION
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(Unaudited) (Audited)
(Dollars in thousands) September 30, 1998 December 31, 1997
-------------------- -------------------
ASSETS
<S> <C> <C>
Cash and due from banks . . . . . . . . . . . . . . . . . . . . . . . $ 33,457 $ 38,471
Federal Funds sold. . . . . . . . . . . . . . . . . . . . . . . . . . 13,250 11,050
-------------------- -------------------
Total cash and cash equivalents . . . . . . . . . . . . . . . . . 46,707 49,521
-------------------- -------------------
Interest-bearing deposits in banks. . . . . . . . . . . . . . . . . . 2,875 5,574
Investment securities available for sale. . . . . . . . . . . . . . . 351,067 257,068
Investment securities held to maturity
(market value $31,911 and $47,354, respectively) . . . . . . . . . . 31,118 46,238
Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 810,485 743,608
Less: Unearned income . . . . . . . . . . . . . . . . . . . . . . . . (2,443) (4,155)
Allowance for loan losses. . . . . . . . . . . . . . . . . . (12,738) (11,925)
-------------------- -------------------
Net loans. . . . . . . . . . . . . . . . . . . . . . . . 795,304 727,528
-------------------- -------------------
Bank premises and equipment, net. . . . . . . . . . . . . . . . . . . 18,563 17,934
Accrued income receivable . . . . . . . . . . . . . . . . . . . . . . 8,995 7,719
Other real estate owned . . . . . . . . . . . . . . . . . . . . . . . 595 453
Intangible assets, net. . . . . . . . . . . . . . . . . . . . . . . . 1,933 1,851
Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,462 2,368
-------------------- -------------------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . $ 1,260,619 $ 1,116,254
==================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing. . . . . . . . . . . . . . . . . . . . . . . . $ 153,085 $ 152,621
Interest-bearing:
Checking accounts. . . . . . . . . . . . . . . . . . . . . . . . 112,514 108,954
Money market accounts. . . . . . . . . . . . . . . . . . . . . . 208,566 180,949
Savings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115,132 108,199
Time, under $100,000 . . . . . . . . . . . . . . . . . . . . . . 304,071 299,794
Time, $100,000 or greater. . . . . . . . . . . . . . . . . . . . 97,235 68,554
-------------------- -------------------
Total deposits. . . . . . . . . . . . . . . . . . . . . . . 990,603 919,071
Accrued interest payable. . . . . . . . . . . . . . . . . . . . . . . 13,808 14,388
U.S. Treasury demand notes. . . . . . . . . . . . . . . . . . . . . . 1,863 2,150
Federal funds purchased . . . . . . . . . . . . . . . . . . . . . . . 14,600 13,700
Federal Home Loan Bank (FHLB) borrowings. . . . . . . . . . . . . . . 55,000 17,000
Securities sold under agreements to repurchase. . . . . . . . . . . . 51,176 31,288
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 12,900 8,865
-------------------- -------------------
Total liabilities . . . . . . . . . . . . . . . . . . . . . 1,139,950 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 7,037,814 shares in 1998 and
7,020,211 shares in 1997 . . . . . . . . . . . . . . . . . . . 7,038 7,020
Additional paid in capital. . . . . . . . . . . . . . . . . . . . 49,641 49,305
Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . 57,706 48,988
Net unrealized gains on investment securities available for sale. 6,284 4,479
-------------------- -------------------
Total shareholders' equity. . . . . . . . . . . . . . . . . 120,669 109,792
-------------------- -------------------
Total liabilities and shareholders' equity. . . . . . . . . $ 1,260,619 $ 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)
Nine months ended Three months Ended
September 30, September 30,
------------------- -------------------
<S> <C> <C> <C> <C>
(Dollars in thousands except weighted average number
of common shares and per share information). . . . . . . . . 1998 1997 1998 1997
------------------- ---------- ------------------- ----------
INTEREST INCOME:
Loans, including fees . . . . . . . . . . . . . . . . . . . . $ 45,152 $ 41,939 $ 15,340 $ 14,332
Lease financing . . . . . . . . . . . . . . . . . . . . . . . 3,669 3,376 1,299 1,139
Investment securities:
Taxable. . . . . . . . . . . . . . . . . . . . . . . . . . 9,559 9,294 3,268 3,038
Exempt from federal taxes. . . . . . . . . . . . . . . . . 5,454 3,917 1,997 1,417
Federal funds sold. . . . . . . . . . . . . . . . . . . . . . 701 781 248 465
Deposits in banks . . . . . . . . . . . . . . . . . . . . . . 185 309 30 91
------------------- ---------- ------------------- ----------
Total interest income . . . . . . . . . . . . . . . . . 64,720 59,616 22,182 20,482
------------------- ---------- ------------------- ----------
INTEREST EXPENSE:
Savings deposits. . . . . . . . . . . . . . . . . . . . . . . 8,661 7,436 3,036 2,585
Time, under $100,000. . . . . . . . . . . . . . . . . . . . . 12,558 12,332 4,239 4,182
Time, $100,000 or greater . . . . . . . . . . . . . . . . . . 3,422 2,421 1,276 980
Borrowed funds. . . . . . . . . . . . . . . . . . . . . . . . 3,081 2,859 1,091 940
------------------- ---------- ------------------- ----------
Total interest expense. . . . . . . . . . . . . . . . . 27,722 25,048 9,642 8,687
------------------- ---------- ------------------- ----------
Net interest income . . . . . . . . . . . . . . . . . . 36,998 34,568 12,540 11,795
Provision for loan losses . . . . . . . . . . . . . . . . . . 1,605 1,670 535 540
------------------- ---------- ------------------- ----------
Net interest income after provision for loan losses . . 35,393 32,898 12,005 11,255
------------------- ---------- ------------------- ----------
OTHER OPERATING INCOME:
Service charges . . . . . . . . . . . . . . . . . . . . . . . 2,354 2,122 828 706
Security gains, net . . . . . . . . . . . . . . . . . . . . . 899 1,134 574 430
Trust income. . . . . . . . . . . . . . . . . . . . . . . . . 1,520 1,107 519 369
Other Income. . . . . . . . . . . . . . . . . . . . . . . . . 2,156 804 974 146
------------------- ---------- ------------------- ----------
Total other operating income. . . . . . . . . . . . . . 6,929 5,167 2,895 1,651
------------------- ---------- ------------------- ----------
Net interest income after provision for loan losses
and other operating income . . . . . . . . . . . . . 42,322 38,065 14,900 12,906
------------------- ---------- ------------------- ----------
OTHER OPERATING EXPENSES:
Salaries, wages and employee benefits . . . . . . . . . . . . 13,063 11,349 4,339 3,911
Occupancy . . . . . . . . . . . . . . . . . . . . . . . . . . 1,576 1,467 563 511
Furniture and equipment . . . . . . . . . . . . . . . . . . . 2,432 1,976 893 721
Other expenses. . . . . . . . . . . . . . . . . . . . . . . . 6,693 6,094 2,146 2,006
------------------- ---------- ------------------- ----------
Total other operating expenses. . . . . . . . . . . . . 23,764 20,886 7,941 7,149
------------------- ---------- ------------------- ----------
Income before income taxes. . . . . . . . . . . . . . . 18,558 17,179 6,959 5,757
Income tax expense. . . . . . . . . . . . . . . . . . . . . . 4,709 4,651 1,885 1,513
------------------- ---------- ------------------- ----------
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . $ 13,849 $ 12,528 $ 5,074 $ 4,244
=================== ========== =================== ==========
Weighted average number of common shares:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . 7,026,556 7,000,120 7,031,654 7,011,000
=================== ========== =================== ==========
Diluted . . . . . . . . . . . . . . . . . . . . . . . . 7,027,038 7,006,084 7,031,863 7,019,406
=================== ========== =================== ==========
Net income per share information:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . $ 1.97 $ 1.79 $ 0.72 $ 0.61
=================== ========== =================== ==========
Diluted . . . . . . . . . . . . . . . . . . . . . . . . $ 1.97 $ 1.79 $ 0.72 $ 0.61
=================== ========== =================== ==========
Cash dividends per share. . . . . . . . . . . . . . . . . . . $ 0.73 $ 0.65 $ 0.25 $ 0.23
=================== ========== =================== ==========
See accompanying notes to consolidated financial statements.
PAGE 4
</TABLE>
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
(Dollars in thousands) Nine Months Ended Sept. 30,
<S> <C> <C>
OPERATING ACTIVITIES:. . . . . . . . . . . . . . . . . . . . . . . . . . . 1998 1997
----------------------------- ---------
Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 13,849 $ 12,528
Adjustments to reconcile net income to
Net cash provided by operating activities:
Provision for loan losses. . . . . . . . . . . . . . . . . . . . . . . 1,605 1,670
Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . 1,456 1,172
Net amortization of investment
Securities discount/premiums . . . . . . . . . . . . . . . . . . . . 297 186
Net realized security gain . . . . . . . . . . . . . . . . . . . . . . (899) (1,134)
Increase in accrued income receivable. . . . . . . . . . . . . . . . . (1,276) (1,090)
(Decrease) increase in accrued interest payable. . . . . . . . . . . . (580) 491
Net increase in other assets . . . . . . . . . . . . . . . . . . . . . (1,094) (806)
Net increase in other liabilities. . . . . . . . . . . . . . . . . . . 3,061 1,279
Decrease in unearned income. . . . . . . . . . . . . . . . . . . . . . (1,713) (2,532)
Write-down of other real estate owned. . . . . . . . . . . . . . . . . 28 4
Increase in intangible assets. . . . . . . . . . . . . . . . . . . . . (82) (153)
----------------------------- ---------
Net cash provided by operating activities . . . . . . . . . . . . . 14,652 11,615
----------------------------- ---------
INVESTING ACTIVITIES:
Proceeds from sales of investment securities available for sale. . . . . 40,572 29,047
Proceeds, maturity or calls of investment securities held to maturity. . 15,060 12,904
Proceeds, maturity or calls of investment securities available for sale. 18,922 16,947
Purchases of investment securities held to maturity. . . . . . . . . . . - (1,001)
Purchases of investment securities available for sale. . . . . . . . . . (150,051) (88,045)
Net decrease (increase) in interest-bearing deposits in banks. . . . . . 2,699 (756)
Net increase in loans. . . . . . . . . . . . . . . . . . . . . . . . . . (68,595) (38,764)
Net increase in premises and equipment . . . . . . . . . . . . . . . . . (2,084) (3,684)
Proceeds from sales of other real estate . . . . . . . . . . . . . . . . 755 1,074
----------------------------- ---------
Net cash used in investing activities . . . . . . . . . . . . . . . (142,722) (72,278)
----------------------------- ---------
FINANCING ACTIVITIES:
Net increase in deposits . . . . . . . . . . . . . . . . . . . . . . . . 71,532 48,983
Decrease in U.S. Treasury demand notes . . . . . . . . . . . . . . . . . (287) (556)
Increase in federal funds purchased. . . . . . . . . . . . . . . . . . . 900 14,000
Increase (decrease) in FHLB borrowings . . . . . . . . . . . . . . . . . 38,000 (8,000)
Increase in securities sold under agreement. . . . . . . . . . . . . . . 19,888 6,288
Cash dividends & fractional shares . . . . . . . . . . . . . . . . . . . (5,131) (4,545)
Dividend reinvestment. . . . . . . . . . . . . . . . . . . . . . . . . . - (17)
Stock awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 -
Stock options. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 349 217
----------------------------- ---------
Net cash provided by financing activities. . . . . . . . . . . . . . . 125,256 56,370
----------------------------- ---------
Increase in cash and cash equivalents. . . . . . . . . . . . . . . . . . . (2,814) (4,293)
Cash and cash equivalents at beginning of period . . . . . . . . . . . . . 49,521 45,407
----------------------------- ---------
Cash and cash equivalents at end of the period . . . . . . . . . . . . . . $ 46,707 $ 41,114
============================= =========
Cash paid during the period for:
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 28,303 $ 24,557
============================= =========
Supplemental disclosure of noncash investing and financing activities:
Transfer of assets from loans to other real estate owned. . . . . . $ 925 $ 820
============================= =========
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 September 30, 1998, the results of its operations for nine and three
month periods ended September 30, 1998 and 1997 and the cash flows for the nine
month periods ended September 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 nine and three month periods ended September
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 nine months of
1998 was $15,654,000, compared to $13,627,000 for the first nine 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.
NOTE 11 - 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, Inc.
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 early 1999.
PAGE 7
ITEM 2.
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 nine months of 1998 was $13,849,000,
an increase of $1,321,000, or 10.5%, over the first nine months of 1997 net
income of $12,528,000. Basic and diluted earnings per share at $1.97 were up
10.1% from $1.79 in the comparable period last year. Consolidated net income
for the third quarter of 1998 was $5,074,000, an increase of $830,000, or 19.6%,
over the third quarter of 1997 net income of $4,244,000. Basic and diluted
earnings per share for the third quarter of 1998 of $0.72 increased 18.0%, over
the third quarter of 1997 basic and diluted earnings per share of $0.61.
The increase in net income during the first nine 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. A lower income tax rate associated with a higher level of nontaxable
income, also contributed to the gain in net income. Net interest income grew
$2,430,000, primarily as a result of a 12.1% rise in average earning assets.
Other operating income rose $1,762,000, 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.
For the nine months ended September 30, 1998, the annualized return on
average shareholders' equity and the annualized return on average assets were
16.08% and 1.56%, respectively. For the same period in 1997, the annualized
return on average shareholders' equity was 16.35% and the annualized return on
average assets was 1.57%. For the three months ended September 30, 1998, the
annualized return on average shareholders' equity and the annualized return on
average assets were 17.25% and 1.66%, respectively. For the same period in
1997, the annualized return on average shareholders' equity was 16.08% and the
annualized return on average assets was 1.55%.
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.
PAGE 8
NET INTEREST INCOME AND RELATED ASSETS AND LIABILITIES
- -------------------------------------------------------------
Net interest income for the first nine months of 1998 of $36,998,000
increased $2,430,000, or 7.0%, over the first nine months of 1997 net interest
income of $34,568,000. 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 nine 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 third quarter
1998 net interest income rose 6.3%, 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 nine months ended September 30, 1998 over
September 30, 1997 and the three months ended September 30, 1998 over September
30, 1997 by their rate and volume components.
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, 1998 September 30, 1998
Over/Under Over/Under
September 30, 1997 September 30, 1997
Total Caused by: Total Caused by:
----------- -----------
Variance Rate Volume Variance Rate
-------------------- ----------- -------- -------------------- -----------
<S> <C> <C> <C> <C> <C>
Interest Income:
- -----------------------------------------
Securities *. . . . . . . . . . . . . . . $ 2,629 ($320) $ 2,949 $ 1,122 ($18)
Money market instruments. . . . . . . . . (204) (60) (144) (278) (38)
Loans * . . . . . . . . . . . . . . . . . 3,681 (818) 4,499 1,178 (509)
-------------------- ----------- -------- -------------------- -----------
Total. . . . . . . . . . . . . . . . 6,106 (1,198) 7,304 2,022 (565)
-------------------- ----------- -------- -------------------- -----------
Interest Expense:
- -----------------------------------------
Savings deposits. . . . . . . . . . . . . 1,229 217 1,012 451 76
Time deposits and certificates of deposit 1,230 (28) 1,258 353 (40)
Other borrowings. . . . . . . . . . . . . 223 (128) 351 151 (38)
-------------------- ----------- -------- -------------------- -----------
Total . . . . . . . . . . . . . . . 2,682 61 2,621 955 (2)
-------------------- ----------- -------- -------------------- -----------
Changes in net interest income. . . . . . 3,424 (1,259) 4,683 1,067 (563)
==================== =========== ======== ==================== ===========
* Tax equivalent basis
Volume
--------
<S> <C>
Interest Income:
- -----------------------------------------
Securities *. . . . . . . . . . . . . . . $ 1,140
Money market instruments. . . . . . . . . (240)
Loans * . . . . . . . . . . . . . . . . . 1,687
--------
Total. . . . . . . . . . . . . . . . 2,587
--------
Interest Expense:
- -----------------------------------------
Savings deposits. . . . . . . . . . . . . 375
Time deposits and certificates of deposit 393
Other borrowings. . . . . . . . . . . . . 189
--------
Total . . . . . . . . . . . . . . . 957
--------
Changes in net interest income. . . . . . 1,630
========
* Tax equivalent basis
</TABLE>
Taxable-equivalent net interest income was $40,368,000 for the first nine
months of 1998, compared to $36,944,000 for the same period in 1997, a 9.3% or
$3,424,000 increase. This rise in taxable-equivalent net interest income was
primarily due to a $4,683,000 increase related to volume, which was partially
offset by a reduction in interest income, related to rate. Total
taxable-equivalent interest income grew $6,106,000, primarily the result of the
higher volumes in both the security and loan earning asset categories. Average
year-to-date earning assets increased to $1,131,082,000 at September 30, 1998
from $1,008,643,000 at September 30, 1997, a 12.1% increase. This increase in
earning assets was primarily due to the growth in loans, as a result of
persistent sales efforts and new branch openings.
PAGE 9
Total interest expense grew $2,682,000 during the first nine months
of 1998, compared to the same period in 1997. This growth was principally the
result of higher volumes associated with savings and time deposits. The volume
of average savings and time deposits grew 13.2% and 8.5%, respectively, compared
to the first nine months of 1997. The rise in other borrowings interest expense
was due to a 12.8% increase in volume. This increase was partially offset by
the lower rates experienced in other borrowings during the first nine 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 $13,734,000 was
$1,066,000 or 8.4% higher in the third quarter of 1998, compared to $12,668,000
for the same period in 1997. Interest income grew $2,022,000 during the period,
as a result of an increase in security and loan volumes. Third quarter average
securities and loans grew 21.9% and 11.2%, respectively, compared to the third
quarter of 1997. The increase in the interest income was partially offset by a
$955,000 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 4.75% for the nine-month period ended September
30, 1998, decreased from the 4.88% net interest margin for the first nine months
of 1997. The yield on earning assets of 8.03% during the first nine months of
1998 was lower than the 8.20% earned during the first nine 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 average interest rate
paid on interest-bearing deposits and other borrowings of 4.14% was the same
during the first nine months of 1998 and 1997. The net interest margin was
4.72% in the third quarter of 1998, a .15% decrease from the 4.87% net interest
margin recorded in the third quarter of 1997. This decrease was the result of a
lower yield on earning assets during the third quarter of 1998, compared to the
third quarter of 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.
PAGE 10
For the first nine months of 1998 the provision for loan losses was
$1,605,000, compared to $1,670,000 for the same period in 1997. Net loans
charged off was $792,000 for the nine months ended September 30, 1998, compared
to $691,000 for the nine months ended September 30, 1997. The increase in
net loans charged off of $101,000 was primarily due to an increase in
commercial loans charged off. The ratio of the allowance for loan losses
to loans at September 30, 1998 was 1.58%, consistent with the December 31,
1997 and September 30, 1997 ratios of 1.61% and 1.62%, respectively.
Allowance for Loan Losses
- ----------------------------
Transaction in the allowance for loan losses are as follows:
<TABLE>
<CAPTION>
1998 1997
----------------- ---------------
Balance, Beginning of Year $11,925,000 $10,710,000
Provision charged to operating expenses 1,605,000 1,670,000
Loans charged off (1,041,000) (1,058,000)
Recoveries 249,000 367,000
----------------- ---------------
Balance, September 30 12,738,000 11,689,000
================= ===============
<S> <C> <C> <C>
Ratios: . . . . . . . . . . . . . . . . . . . . . Sept. 30, 1998 Dec. 31, 1997 Sept. 30, 1997
- ------------------------------------------------- ----------------- --------------- ----------------
Allowance for loan losses to nonperforming assets 274.2% 285.8% 255.7%
Nonperforming assets to total loans & net assets
acquired in foreclosure . . . . . . . . . . . . . 0.57% 0.56% 0.63%
Allowance for loan losses to total loans. . . . . 1.58% 1.61% 1.62%
</TABLE>
The following table sets forth an allocation of the allowance for loan losses by
loan category:
<TABLE>
<CAPTION>
September 30, 1998
-------------------
Percent
Amount of Loans
------------------- ---------
<S> <C> <C>
Commercial and industrial $ 2,544,000 27%
Installment and other . . 1,444,000 30%
Real estate . . . . . . . 1,192,000 35%
Lease financing . . . . . 202,000 8%
Unallocated . . . . . . . 7,356,000 N/A
------------------- ---------
Total . . . . . . . . . $ 12,738,000 100%
=================== =========
</TABLE>
Nonperforming assets (nonaccruing loans, net assets in foreclosure and
troubled debt restructured loans) were 0.57% of total loans and net assets
acquired in foreclosure at September 30, 1998, compared to 0.56% at December 31,
1997 and 0.63% at September 30, 1997. The decline in this ratio from September
30, 1997 to September 30, 1998 is the result of a reduction in both net assets
in foreclosure and troubled restructured loans, partially offset by an increase
in nonaccruing loans. The ratio of the allowance for loan losses to
non-performing assets was 274.2% at September 30, 1998 compared to 285.8% at
December 31, 1997 and 255.7% at September 30, 1997.
Nonaccruing loans at September 30, 1998 of $3,438,000, increased $817,000
from the December 31, 1997 level of $2,621,000, and increased $605,000 from the
September 30, 1997 level of $2,833,000. The increase during both of these
periods was primarily due to real estate loans.
Net assets in foreclosure totaled $595,000 as of September 30,
1998, an increase of $142,000 from the December 31, 1997 balance of $453,000.
During the first nine months of 1998, transfers from loans to assets in
foreclosure were $925,000, payments on foreclosed properties totaled $755,000
and write-downs of assets in foreclosure equaled $28,000. The loans transferred
to assets in foreclosure included mortgages of $243,000, commercial loans of
$282,000 and leases of $400,000. The balance of net assets in foreclosure at
September 30, 1997 was $714,000. 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 11
As of September 30, 1998, there were three unrelated borrowers with
troubled debt restructured loans totaling $612,000, compared with a balance of
$1,012,000 as of December 31, 1997 and $1,024,000 at September 30, 1997. All
three customers were complying with the restructured terms as of September 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 September 30, 1998, loans past due 90 days or more and
still accruing interest were $625,000, compared to $2,253,000 as of December 31,
1997 and $1,969,000 as of September 30, 1997. The $1,628,000 decrease in loans
past due 90 days from December 31, 1997 to September 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: Sept. 30, 1998 Dec. 31, 1997 Sept. 30, 1997
--------------- -------------- ---------------
<S> <C> <C> <C>
Restructured Loans . . . . . . . . . . . . $ 612,000 $ 1,012,000 $ 1,025,000
Nonaccrual Loans . . . . . . . . . . . . . $ 1,743,000 $ 1,429,000 $ 1,470,000
--------------- -------------- ---------------
Total Impaired Loans. . . . . $ 2,355,000 $ 2,441,000 $ 2,495,000
=============== ============== ===============
Average year-to-date impaired loans:. . . . . . $ 2,200,000 $ 3,538,000 $ 3,917,000
=============== ============== ===============
Impaired loans with specific loss allowances: . $ 2,355,000 $ 2,441,000 $ 2,495,000
=============== ============== ===============
Loss allowances reserved on impaired loans: . . $ 335,000 $ 341,000 $ 348,000
=============== ============== ===============
Year-to-date income recognized on impaired loans $ 49,000 $ 135,000 $ 110,000
=============== ============== ===============
</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>
Nine Months Ended September 30,
--------------------------------
1998 1997
-------------------------------- ------
<S> <C> <C>
(Dollars in thousands)
Service charges. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,354 $2,122
Securities gains (losses), net . . . . . . . . . . . . . . . . . . . . . . . . 899 1,134
Trust income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,520 1,107
Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,156 804
-------------------------------- ------
Total other operating income . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,929 $5,167
================================ ======
Three Months Ended September 30,
---------------------------------
1998 1997
--------------------------------- ------
<S> <C> <C>
(Dollars in thousands)
Service charges. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 828 $ 706
Securities gains (losses), net . . . . . . . . . . . . . . . . . . . . . . . . 574 430
Trust income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 519 369
Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 974 146
--------------------------------- ------
Total other operating income . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,895 $1,651
================================= ======
</TABLE>
PAGE 12
Other operating income for the first nine months of 1998 increased
$1,762,000, or 34.1%, from $5,167,000 at September 30, 1997 to $6,929,000 at
September 30, 1998. This rise in other operating income is the result of a
$232,000 growth in service charges, a $413,000 rise in trust income and a
$1,352,000 increase in other income, primarily due to gains on the sale of
residential mortgages. A $235,000 decrease in security gains partially offset
these increases. The third quarter of 1998 other income of $2,895,000 was
$1,244,000 or 75.3% higher than the third quarter of 1997. This increase is
the result of growth in all other operating income categories, including a
significant increase in gains on the sale of mortgage loans in the third quarter
of 1998, compared to the third quarter of 1997.
The $232,000, or 10.9% increase in service charges is primarily the result
of a $120,000 rise in fees charged on deposit accounts and a $83,000 growth in
check fees during this period. This growth was primarily the result of the
13.5% increase in average deposit transaction accounts, from the first nine
months of 1997 to the first nine months in 1998. The 1998 third quarter service
charge income of $828,000, increased $122,000, or 17.3% over the third quarter
of 1997 service charge income. Average deposit transaction accounts grew 15.2%
from the third quarter of 1997 to the third quarter of 1998.
The Corporation recorded a net security gain of $899,000 in the
first nine months of 1998, compared to a $1,134,000 gain in the same period in
1997. The third quarter 1998 net security gain of $574,000 was higher than the
$430,000 gain recorded in the third quarter of 1997. The majority of the
security gains in 1998 and 1997 were 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 $413,000,
or 37.3% in the first nine 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 under management of 21.2% from September 30, 1997 to September 30, 1998,
and the Corporation's continuing emphasis on marketing the Trust and Financial
Services Department's products and services. The third quarter of 1998 trust
fees grew 40.7%, compared to the same period in 1997.
Other income for the first nine months of 1998 increased
$1,352,000, or 168.2%, compared to the same period in 1997. The third quarter
of 1998 other income grew $828,000, from $146,000 in the third quarter of 1997
to $974,000 in the third quarter of 1998. 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 $503,000 in the first nine months of 1998, compared to a loss of
$176,000 in the same period in 1997. The Banks used the funds generated from
the 1997 sales to purchase mortgages that earned a higher rate of return and
reduced the overall interest rate risk of the residential mortgage portfolio.
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>
NINE MONTHS ENDED SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
1998 1997 1998
-------------------------------- ----------------------- ------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
SALARIES . . . . . . . . . . . $ 9,913 $ 8,746 $ 3,355
EMPLOYEE BENEFITS. . . . . . . 3,150 2,603 984
NET OCCUPANCY EXPENSE. . . . . 1,576 1,467 563
EQUIPMENT EXPENSE. . . . . . . 2,432 1,976 893
OTHER EXPENSES . . . . . . . . 6,693 6,094 2,146
-------------------------------- ----------------------- ---------------------------------
TOTAL OTHER OPERATING EXPENSES $ 23,764 $ 20,886 $ 7,941
-------------------------------- ----------------------- ---------------------------------
1997
------
<S> <C>
SALARIES . . . . . . . . . . . $3,044
EMPLOYEE BENEFITS. . . . . . . 867
NET OCCUPANCY EXPENSE. . . . . 511
EQUIPMENT EXPENSE. . . . . . . 721
OTHER EXPENSES . . . . . . . . 2,006
------
TOTAL OTHER OPERATING EXPENSES $7,149
------
</TABLE>
PAGE 13
Other operating expenses for the first nine months of 1998 of $23,764,000
increased $2,878,000, or 13.8%, from $20,886,000 for the same period in 1997.
The third quarter of 1998 other operating expenses grew 11.1%, compared to the
third 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 $1,167,000, or 13.3% from $8,746,000 for the
first nine months of 1997 to $9,913,000 for the same period in 1998. Salaries
grew $311,000, or 10.2% from the third quarter of 1997 to the third quarter of
1998. The year-to-date salary increase directly related to the staffing of the
four new branches was $279,000, or 23.9% of the total salary increase. The
third quarter increase resulting from the four new branches was $93,000, or
29.9% 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 $3,150,000 expensed in the first nine months
of 1998, were $547,000, or 21.0% higher than the $2,603,000 of employee benefits
expensed during the same period in 1997. Employee benefits grew $117,000, or
13.5% from the third quarter of 1997 to the third 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 $109,000, or 7.4%, from $1,467,000 in the
first nine months of 1997 to $1,576,000 in the first nine months of 1998. The
occupancy expense in the third quarter of 1998 grew $52,000, or 10.2%, compared
to the third quarter of 1997. The four new branches were responsible for the
majority of the increase in occupancy expense. Equipment expense increased
$456,000, or 23.1%, during the first nine months of 1998, compared to the same
period in 1997. The equipment expense grew $172,000, or 23.9%, during the third
quarter of 1998, compared to 1997. The equipment expense related to the new
branches for the first nine months of 1998 and the third quarter of 1998 totaled
$79,000 and $17,000, 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 $599,000, or 9.8%, from $6,094,000 in the
first nine months of 1997, compared to $6,693,000 in other expenses recorded
during the same period in 1998. The third quarter 1998 other expenses grew
$140,000, or 7.0%, compared to the third quarter of 1997. This increase is the
result of higher advertising and marketing expenses and expenses associated with
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 $144,365,000, or 12.9%, from $1,116,254,000 at December
31, 1997 to $1,260,619,000 at September 30, 1998. This growth was the result of
a rise in interest earning assets, which grew $146,969,000 to $1,206,352,000 at
September 30, 1998, from $1,059,383,000 at December 31, 1997. During the first
nine months of 1998, investment securities, federal funds sold, and loans grew
$78,879,000, $2,200,000, $68,589,000, respectively. Offsetting these increases
was a $2,699,000 decrease in interest bearing deposits.
Total deposits rose $71,532,000, or 7.8% from $919,071,000 at December 31,
1997 to $990,603,000 at September 30, 1998. This growth was due to a
$32,958,000 rise in time deposits, a $27,617,000 increase in money market
accounts, a $6,933,000 growth in savings accounts and a $3,560,000 increase in
interest-bearing checking accounts. Non-interest bearing deposits grew
$464,000. Other borrowings increased $58,501,000 during the first nine months
of 1998, primarily the result of an increase in Federal Home Loan Bank
borrowings and securities sold under agreement to repurchase. Other borrowings
and deposits are used to fund loan and investment growth.
PAGE 14
CAPITAL
- -------
Capital formation is important to the Corporation's well being
and future growth. Capital for the period ending September 30, 1998 was
$120,669,000, an increase of $10,877,000 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.
<TABLE>
<CAPTION>
Tier 1 Capital to Risk- Total Capital to Risk-
Leverage Ratio Weighted Assets Ratio Weighted Asset Ratio
September 30, 1998 September 30, 1998 September 30, 1998
------------------- ------------------------ -----------------------
Amount Ratio Amount Ratio Amount Ratio
------------------- ------ ------------------------ ------ ----------------------- ------
<S> <C> <C> <C> <C> <C> <C>
Entity:
Corporation . . . . . . . . . . $ 112,882 9.22% $ 112,882 12.97% $ 126,615 14.34%
Subsidiary Banks:
Harleysville National Bank. . . 79,658 8.35 79,658 11.49 90,872 12.75
Citizens National Bank. . . . . 21,616 12.18 21,616 20.02 23,514 21.27
Security National Bank. . . . . 6,601 7.18 6,601 9.67 7,617 10.93
"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 10.34% at
September 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
September 30, 1998, the Corporation's Tier 1 risk-adjusted capital ratio was
12.97%, and the total risk-adjusted capital ratio was 14.54%, both well above
the regulatory requirements. The risk-based capital ratios of each of the
Corporation's commercial banks also exceeded regulatory requirements at
September 30, 1998.
PAGE 15
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 9.22% at
September 30, 1998 and 9.36% at December 31, 1997.
The year-to-date September 30, 1998 cash dividend per share of $.73 was
12.3% higher than the cash dividend for the same period in 1997 of $.65. The
dividend payout ratio for the first nine months of 1998 was 37.04%, 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 nine 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 $16,791,000 during the first nine months of 1998
and securities available for sale averaged $302,007,000 during the first nine
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 $157,117,000, as of September 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.
During 1997, 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.
PAGE 16
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 its competitors. Management believes that such
consolidations and mergers, and diversification of products and services may
enhance the Banks' competitive position.
YEAR 2000
- ----------
The following section contains forward-looking statements which involve
risks and uncertainties. The actual impact on the Corporation of the Year 2000
issue could materially differ from that which is anticipated in the
forward-looking statements as a result of certain factors identified below.
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 (Y2K). The Year 2000 issue affects virtually all companies and
organizations.
CORPORATION'S STATE OF READINESS
-----------------------------------
The Corporation began addressing the Y2K issue in August 1997.
Management has initiated an enterprise-wide program to prepare the Corporation's
computer systems and applications for the Year 2000. The Corporation developed
a Y2K plan to included assessing the impact of the Y2K issue on the Corporation,
renovating systems to alleviate Y2K problems, validating the new systems and
implementing them. The Corporation focused on information technology and
non-information technology systems. A non-information system could be, for
example, a microcontroller in an elevator, which may be subject to Y2K problems.
The committee also was responsible for Y2K issues related to material third
parties.
The assessment phase of the Y2K plan included assigning accountabilities
throughout the Corporation. An inventory was completed of mainframe and PC
based applications, third-party relationships and non-information technology
systems. The final step in the assessment phase was to identify non-compliant
Y2K systems. The assessment phase was completed in November 1997.
The Corporation began the renovation phase of the Y2K plan in January
1998. The renovation phase included developing action plans to correct
non-compliant Y2K systems. The action plans included either enhancing the
current system to resolve the Y2K problem or purchasing a new system that is Y2K
compliant. The renovation phase was completed in May 1998. The Corporation
developed a remediation plan for the non-compliant systems. The remediation
phase is scheduled to be completed by year-end 1998. As of September 30, 1998,
25% of the renovation phase has been completed.
PAGE 17
The next phase of the plan was to validate the Y2K compliance of all of
the systems. This phase includes developing written test plans and completing
the testing of the systems. The validation phase is scheduled to be completed
by March 31, 1999. As of September 30, 1998, 25% of the computer applications
have been validated to be Y2K compliant.
The Corporation has reviewed the Y2K issues related to material third
parties. The Corporation's third parties include its vendors and commercial
customers. Our material third party relationships are primarily our commercial
borrowers. These borrowers pose a credit risk to the Corporation if they are
not Y2K compliant and their businesses are disrupted. We have contacted the
material commercial customers and their responses are being evaluated presently.
Because most computer systems are, by their very nature, interdependent,
it is possible that noncompliant third-party computers could impact the
Corporation's computer systems. The Corporation could be adversely affected by
the Y2K problem if it or unrelated parties fail to successfully address the
problem. The Corporation has taken steps to communicate with the unrelated
parties with whom it deals to coordinate Year 2000 compliance. Additionally, we
are dependent on external suppliers, such as, wire transfer systems, telephone
systems, electric companies, and other utility companies for continuation of
service.
COST OF YEAR 2000
--------------------
The Committee has prepared a Y2K budget and has tracked expenses related
to the Y2K issue. As of September 30, 1998, the Corporation has expensed
$125,000 and capitalized $10,000 related to the Y2K issue. The Corporation
has estimated the future Y2K expenditures to be $75,000 and future capitalized
items also to be under $90,000. The Y2K project is being funded through
operating cash flows.
The cost of the projects and the date on which the Corporation plans to
complete both Year 2000 modifications and systems conversions are based on
management's best estimates, which were derived utilizing numerous assumptions
of future events including the continued availability of certain resources,
third-party modification plans and other factors. However, there can be no
guarantee that these estimates will be achieved and actual results could differ
materially from those plans. Specific factors that might cause such material
differences include, but are not limited to, the availability and cost of
personnel trained in this area, the ability to locate and correct all relevant
computer codes, and similar uncertainties.
RISK OF YEAR 2000
--------------------
At present, management believes its progress in remedying the proprietary
programs and installing the Y2K compliant upgrades to the third-party vendor
mainframe and PC based computer applications is on target. The Y2K computer
problem creates risk for the Corporation from unforeseen problems in its own
computer systems and from third-party vendors who provide the majority of
mainframe and PC based computer applications. Failure of third-party systems
relative to the Y2K issue could have a material impact on the Corporation's
ability to conduct business.
CONTINGENCY PLANS
------------------
A contingency plan is being developed to handle the most reasonably
likely Y2K worst-case scenario should it occur. The contingency plan will
involve obtaining back-up service providers, working up contingency plans and
assessing the potential adverse risks to the Corporation. The contingency plan
is scheduled to be completed by year-end 1998. The committee has also utilized
an independent consulting firm to verify and validate the Corporation's Y2K
plans.
PAGE 18
BRANCHING
- ---------
The Corporation's subsidiaries currently plan 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, Inc.
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 early 1999.
ITEM 3 - Qualitative and Quantitative Disclosures About Market Risk
- ------- ----------------------------------------------------------------
In the normal course of conducting business activities, the Corporation
is exposed to market risk, principally interest risk, through the operations
of its banking subsidiaries. Interest rate risk arises from market driven
fluctuations in interest rates that affect cash flows, income, expense and
values of financial instruments. The Asset/Liability Committee, using policies
and procedures approved by the Banks' Boards of Directors, is responsible for
managing the rate sensitivity position.
No material changes in market risk strategy occurred during the
current period. A detailed discussion of market risk is provided in the SEC
Form 10-K for the period ended December 31, 1997.
PAGE 19
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 exhibits are being filed as part of this Report:
(3.1) Harleysville National Corporation Amended Articles of
Incorporation, (Incorporated by reference to Exhibit 4A to
the Corporation's Registration Statement No. 333-17813 on
Form S-8, as filed on December 13, 1996.)
(3.2) Harleysville National Corporation Amended By-laws,
(Incorporated by reference to Exhibit 4B to the Corporation's
Registration Statement No. 333-17813 on Form S-8, as filed on
December 13, 1996.)
(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 on 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. (Incorporated by
Reference to the registrant's 1997 Annual Report, Form 10-K,
Exhibit 10.3, as filed with the Commission on March 27,
1998.)
(11) Computation of Earnings per Common Share. The information for
this Exhibit is incorporated by reference to page 4 of
this Form 10-Q.
PAGE 20
(27) Financial Data Schedule.
(b) Reports on Form 8-K:
On August 4, 1998, a Form 8-K was filed by the Registrant reporting,
at Item 5, 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 NLBI with
Harleysville National Corporation North, Inc., a bank holding company and
wholly-owned subsidiary of Harleysville National Corporation ("HNC"). CNB of
Slatington will merge with and into The Citizens National Bank of Lansford, a
national banking association and a wholly-owned subsidiary of Harleysville
National Bank North, Inc., under the name Citizens National Bank.
PAGE 21
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
/s/ Walter E. Daller, Jr.
_____________________________
Walter E. Daller, Jr., President
and Chief Executive Officer
(Principal executive officer)
/s/ Vernon L. Hunsberger
___________________________
Vernon L. Hunsberger, Treasurer
(Principal financial and accounting officer)
Date: November 5, 1998
PAGE 22
EXHIBIT INDEX
--------------
Exhibit No. Description of Exhibits
- ----------- -------------------------
(3.1) Harleysville National Corporation Amended Articles of
Incorporation. (Incorporated by reference to Exhibit
4A to the Corporation's Registration Statement No. 333-17813
on Form S-8, as filed on December 13, 1996.)
(3.2) Harleysville National Corporation Amended By-laws.
(Incorporated by reference to Exhibit 4B to the
Corporation's Registration Statement No. 333-17813 on Form
S-8, as filed on December 13, 1996.)
(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. (Incorporated by
Reference to the registrant's 1997 Annual Report, Form
10-K, Exhibit 10.3, as filed with the Commission on March 27,
1998.)
(11) Computation of Earnings per Common Share. The information for
this Exhibit is incorporated by reference to page 4
of this Form 10-Q.
(27) Financial Data Schedule.
PAGE 23
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