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, 1999.
-------------
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
-------
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: 7,539,469 shares of Common
Stock, $1.00 par value, outstanding on July 31, 1999.
PAGE 1
HARLEYSVILLE NATIONAL CORPORATION
INDEX TO FORM 10-Q REPORT
PAGE
----
Part I. Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheets - June 30, 1999 and December 31, 1998 3
Consolidated Statements of Income - Six Months and Three Months
Ended June 30, 1999 and 1998 4
Consolidated Statements of Cash Flows - Six Months Ended June 30,
1999 and 1998 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 Disclosures about Market Risk 19
Part II. Other Information
Item 1. Legal Proceedings 20
Item 2. Change in Securities and Use of Proceeds 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
(Unaudited)
<TABLE>
<CAPTION>
(Dollars in thousands) June 30, 1999 December 31, 1998
--------------- -------------------
ASSETS
<S> <C> <C>
Cash and due from banks $ 46,321 $ 40,204
Federal Funds sold - 13,426
--------------- -------------------
Total cash and cash equivalents 46,321 53,630
--------------- -------------------
Interest-bearing deposits in banks 8,411 3,707
Investment securities available for sale 441,383 390,438
Investment securities held to maturity
(market value $12,672 and $42,202, respectively) 12,552 41,520
Loans 976,281 902,884
Less: Unearned income (1,026) (2,574)
Allowance for loan losses (14,312) (13,706)
--------------- -------------------
Net loans 960,943 886,604
--------------- -------------------
Bank premises and equipment, net 20,744 19,542
Accrued income receivable 10,496 9,574
Other real estate owned 413 1,131
Intangible assets, net 2,154 1,936
Other assets 5,743 4,008
--------------- -------------------
Total assets $ 1,509,160 $ 1,412,090
=============== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing $ 193,806 $ 192,156
Interest-bearing:
Checking accounts 138,402 139,133
Money market accounts 236,733 212,156
Savings 150,564 140,797
Time, under $100,000 339,834 329,606
Time, $100,000 or greater 115,279 90,468
--------------- -------------------
Total deposits 1,174,618 1,104,316
Accrued interest payable 15,765 14,072
U.S. Treasury demand notes 2,416 1,320
Federal funds purchased 23,000 11,000
Federal Home Loan Bank (FHLB) borrowings 96,250 93,500
Securities sold under agreements to repurchase 56,813 43,158
Other liabilities 10,916 13,771
--------------- -------------------
Total liabilities 1,379,778 1,281,137
--------------- -------------------
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 7,539,469 shares in 1999 and
7,535,683 shares in 1998 7,539 7,536
Additional paid in capital 50,935 50,900
Retained Earnings 74,155 67,133
Accumulated other comprehensive income (3,247) 5,384
--------------- -------------------
Total shareholders' equity 129,382 130,953
--------------- -------------------
Total liabilities and shareholders' equity $ 1,509,160 $ 1,412,090
=============== ===================
<FN>
See accompanying notes to consolidated financial statements.
</TABLE>
PAGE 3
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
Six months ended Three months ended
(Dollars in thousands except weighted average number June 30, June 30,
----------------- -------------------
<S> <C> <C> <C> <C>
of common shares and per share information) 1999 1998 1999 1998
----------------- ---------- ------------------- ----------
INTEREST INCOME:
Loans, including fees $ 34,042 $ 32,425 $ 17,331 $ 16,406
Lease financing 3,219 2,370 1,705 1,218
Investment securities:
Taxable 7,881 6,502 4,118 3,305
Exempt from federal taxes 4,713 3,464 2,358 1,855
Federal funds sold 304 559 195 275
Deposits in banks 52 155 36 71
----------------- ---------- ------------------- ----------
Total interest income 50,211 45,475 25,743 23,130
----------------- ---------- ------------------- ----------
INTEREST EXPENSE:
Savings deposits 6,285 6,189 3,223 3,182
Time, under $100,000 8,952 8,844 4,507 4,473
Time, $100,000 or greater 2,575 2,217 1,368 1,170
Borrowed funds 3,513 1,990 1,778 1,044
----------------- ---------- ------------------- ----------
Total interest expense 21,325 19,240 10,876 9,869
----------------- ---------- ------------------- ----------
Net interest income 28,886 26,235 14,867 13,261
Provision for loan losses 954 1,130 477 565
----------------- ---------- ------------------- ----------
Net interest income after provision for loan losses 27,932 25,105 14,390 12,696
----------------- ---------- ------------------- ----------
OTHER OPERATING INCOME:
Service charges 1,707 1,564 862 789
Security gains, net 451 326 334 119
Trust income 1,296 1,001 658 581
Other Income 1,402 1,248 687 747
----------------- ---------- ------------------- ----------
Total other operating income 4,856 4,139 2,541 2,236
----------------- ---------- ------------------- ----------
Net interest income after provision for loan losses
and other operating income 32,788 29,244 16,931 14,932
----------------- ---------- ------------------- ----------
OTHER OPERATING EXPENSES:
Salaries, wages and employee benefits 9,819 9,246 5,009 4,659
Occupancy 1,211 1,098 592 526
Furniture and equipment 1,956 1,628 989 848
Other expenses 5,213 4,961 2,588 2,551
----------------- ---------- ------------------- ----------
Total other operating expenses 18,199 16,933 9,178 8,584
----------------- ---------- ------------------- ----------
Income before income taxes 14,589 12,311 7,753 6,348
Income tax expense 3,648 3,044 2,001 1,558
----------------- ---------- ------------------- ----------
Net income $ 10,941 $ 9,267 $ 5,752 $ 4,790
================= ========== =================== ==========
Weighted average number of common shares:
Basic 7,536,206 7,521,834 7,536,566 7,524,029
================= ========== =================== ==========
Diluted 7,549,494 7,542,609 7,547,875 7,543,619
================= ========== =================== ==========
Net income per share information:
Basic $ 1.45 $ 1.24 $ 0.76 $ 0.64
================= ========== =================== ==========
Diluted $ 1.45 $ 1.23 $ 0.76 $ 0.64
================= ========== =================== ==========
Cash dividends per share $ 0.52 $ 0.48 $ 0.26 $ 0.24
================= ========== =================== ==========
<FN>
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: 1999 1998
--------- ---------
Net Income $ 10,941 $ 9,267
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses 954 1,130
Depreciation and amortization 1,147 995
Net amortization of investment
securities discount/premiums 326 194
Net realized security gain (451) (326)
Increase in accrued income receivable (921) (942)
Increase (decrease) in accrued interest payable 1,694 (752)
Net increase in other assets (1,736) (1,314)
Net increase in other liabilities 1,791 1,868
Decrease in unearned income (1,549) (1,303)
Write-down of other real estate owned 66 19
Increase in intangible assets (218) (35)
--------- ---------
Net cash provided by operating activities 12,044 8,801
--------- ---------
INVESTING ACTIVITIES:
Proceeds from sales of investment securities available for sale 29,435 27,327
Proceeds, maturity or calls of investment securities held to maturity 5,447 8,447
Proceeds, maturity or calls of investment securities available for sale 48,607 13,703
Purchases of investment securities available for sale (118,621) (96,856)
Net (increase) decrease in interest-bearing deposits in banks (4,704) 447
Net increase in loans (74,357) (45,006)
Net increase in premises and equipment (2,349) (1,434)
Proceeds from sales of other real estate 1,266 444
---------- ---------
Net cash used in investing activities (115,276) (92,928)
---------- ---------
FINANCING ACTIVITIES:
Net increase in deposits 70,303 72,448
Increase (decrease) in U.S. Treasury demand notes 1,096 (136)
Increase (decrease) in federal funds purchased 12,000 (13,700)
Increase in FHLB borrowings 2,750 28,000
Increase in securities sold under agreement 13,655 3,250
Cash dividends & fractional shares (3,920) (3,497)
Stock options 39 183
----------- ---------
Net cash provided by financing activities 95,923 86,548
------------ ---------
Net (decrease) increase in cash and cash equivalents (7,309) 2,421
Cash and cash equivalents at beginning of period 53,630 52,991
------------ ---------
Cash and cash equivalents at end of the period $ 46,321 $ 55,412
============ =========
Cash paid during the period for:
Interest $ 19,632 $ 19,993
============ =========
Supplemental disclosure of noncash investing and financing activities:
Transfer of assets from loans to other real estate owned $ 614 $ 802
============ =========
</TABLE>
See accompanying notes to consolidated financial statements.
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 (or the "corporation") and its
wholly owned subsidiaries - Harleysville National Bank and Trust Company,
Citizens National Bank, Security National Bank and HNC Financial Company - as
of June 30, 1999, the results of its operations for six and three month periods
ended June 30, 1999 and 1998 and the cash flows for the six month periods ended
June 30, 1999 and 1998. This quarterly report refers to the corporation's
subsidiary banks, collectively as "the banks." 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 1998 annual report. All prior period
amounts were restated to reflect the acquisition of Northern Lehigh Bancorp.
The results of operations for the six and three month periods ended June 30,
1999 and 1998 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 - 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 (losses) on available for sale investment securities. 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 1999 was $2,310,000, compared to $9,999,000 for the first six months of 1998.
The market value of the available for sale investment securities was reduced by
the higher interest rates experienced during the first half of 1999. The
adoption of SFAS No. 130 did not have a material impact on the corporation's
financial position or results of operation.
NOTE 4 - 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.
Management has determined that under current conditions, the corporation will
report one business segment.
NOTE 5 - 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. On January 1, 1999, the
corporation adopted SFAS No. 133. Concurrent with the adoption, the corporation
reclassified $7,530,000 of investment securities from the held to maturity
category to the available for sale category and recorded $221,000 net of taxes
of unrealized holding gains in accumulated other comprehensive income.
PAGE 6
NOTE 6 - On January 20, 1999, the corporation consummated its acquisition of
Northern Lehigh Bancorp, Inc., parent company of Citizens National Bank of
Slatington. Accounted for as a pooling-of-interest, Northern Lehigh Bancorp
shareholders received 3.57 shares of Harleysville National Corporation common
stock for each share of Northern Lehigh Bancorp common stock.
The acquisition was affected by the merger of Northern Lehigh
Bancorp, Inc. with Harleysville National Corporation North, Inc., and a bank
holding company and wholly owned subsidiary of Harleysville National
Corporation. Citizens National Bank of Slatington merged with and into The
Citizens National Bank of Lansford, a national banking association and wholly
owned subsidiary of Harleysville National Corporation North, Inc., under the
name Citizens National Bank.
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, and may not be indicative of similar performance
in the future.
In addition to historical information, this Form 10-Q contains
forward-looking statements. We have made forward-looking statements in this
document, and in documents that we incorporate by reference, that are subject to
risks and uncertainties. Forward-looking statements include the information
concerning possible or assumed future results of operations of Harleysville
National Corporation and its subsidiaries. When we use words such as
"believes," "expects," "anticipates," or similar expressions, we are making
forward-looking statements.
Shareholders should note that many factors, some of which are
discussed elsewhere in this document and in the documents that we incorporate by
reference, could affect the future financial results of Harleysville National
Corporation and its subsidiaries and could cause those results to differ
materially from those expressed in our forward-looking statements contained or
incorporated by reference in this document. These factors include the
following:
- - operating, legal and regulatory risks;
- - economic, political and competitive forces affecting our banking,
securities, asset management and credit services businesses; and
- - the risk that our analyses of these risks and forces could be incorrect
and/or that the strategies developed to address them could be
unsuccessful.
OVERVIEW
- --------
The corporation reported strong earnings performance in the first
six months of 1999 and the second quarter of 1999. Net income increased 18.1%
for the first six months of 1999, compared to the same period in 1998. The
second quarter net income grew 20.1%, compared to the second quarter of 1998.
This performance was achieved through an increase in earning assets and a
continuing emphasis on generating other operating income and containing overhead
expenses.
Consolidated net income for the first six months of 1999 was $10,941,000,
an increase of $1,674,000, or 18.1%, over the first six months of 1998 net
income of $9,267,000. Basic earning per share for the first six months of 1999
of $1.45 increased 16.9%, over the first six months of 1998 basic earnings per
share of $1.24. Diluted earnings per share at $1.45 were up 17.9% from $1.23
at June 30, 1998. Consolidated net income for the second quarter of 1999 was
$5,752,000, an increase of $962,000, or 20.1%, over the second quarter of 1998
net income of $4,790,000. For the quarter ended June 30, 1999, basic and
diluted earnings per share at $.76 were up 18.8% from $.64 in the comparable
period last year.
The increase in net income during the first six months of 1999,
compared to the same period in 1998, is the result of both higher net interest
income and other operating income, partially offset by higher other operating
expenses. Net interest income grew $2,651,000, primarily as a result of a 16.5%
rise in average earning assets. Other operating income rose $717,000, due to
higher trust fees, a rise in service charges on deposit accounts and gains on
the sale of mortgages. Offsetting these increases was a rise in other operating
expenses, primarily related to the overall growth in the banks. The second
quarter of 1999 rise in net income compared to the second quarter of 1998 is
primarily the result of a $1,606,000 rise in net interest income related to the
17.2% increase in average earning assets during this period.
PAGE 8
For the six months ended June 30, 1999, the annualized return on average
shareholders' equity and the annualized return on average assets were 16.70% and
1.53%, respectively. For the same period in 1998, the annualized return on
average shareholders' equity was 15.27% and the annualized return on average
assets was 1.50%. For the three months ended June 30, 1999, the annualized
return on average shareholders' equity and the annualized return on average
assets were 17.57% and 1.58%, respectively. For the same period in 1998, the
annualized return on average shareholders' equity was 15.58% and the annualized
return on average assets was 1.52%.
As of June 30, 1999, the banks have seen an improvement in asset
quality, compared to December 31, 1998 and June 30, 1998, respectively.
Nonperforming assets, including nonaccrual loans, restructured loans and other
real estate owned, were $5,435,000, or .56% of total loans and net assets
acquired in foreclosure at June 30, 1999, compared to .60% at December 31, 1998
and .60% at June 30, 1998. The ratio of the allowance for loan losses to
nonperforming assets was 263.3% at June 30, 1999, an increase from 253.3% at
December 31, 1998 and 259.6% at June 30, 1998.
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 1999 was $28,886,000, an
increase of $2,651,000, or 10.1%, over the first six months of 1998 which was
$26,235,000. 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 1999, compared to the same period in 1998.
The increase in interest income was partially offset by a rise in interest
expense, as a result of higher deposit volumes. The second quarter 1999 net
interest income rose 12.1% compared to the same period in 1998. This rise
primarily resulted from 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, 1999 over June 30, 1998
and the three months ended June 30, 1999 over June 30, 1998 by their rate and
volume components.
<TABLE>
<CAPTION>
Six Months Ended Three Months Ended
June 30, 1999 June 30, 1999
Over/Under Over/Under
June 30, 1998 June 30, 1998
Total Caused by: Total Caused by:
----------- -----------
Variance Rate Volume Variance Rate
------------------ ----------- -------- -------------------- -----------
<S> <C> <C> <C> <C> <C>
Interest Income:
Securities * $ 3,297 ($32) $ 3,329 $ 1,587 ($69)
Money market instruments (358) (189) (169) (115) (101)
Loans * 2,334 (2,052) 4,386 1,321 (1,172)
------------------ ----------- -------- -------------------- -----------
Total 5,273 (2,273) 7,546 2,793 (1,342)
------------------ ----------- -------- -------------------- -----------
Interest Expense:
Savings deposits 96 (592) 688 41 (329)
Time deposits and certificates of deposit 466 (452) 918 232 (281)
Other borrowings 1,523 (478) 2,001 734 (51)
------------------ ----------- -------- -------------------- -----------
Total 2,085 (1,522) 3,607 1,007 (661)
------------------ ----------- -------- -------------------- -----------
Net interest income $ 3,188 ($751) $ 3,939 $ 1,786 ($681)
================== =========== ======== ==================== ===========
*Tax Equivalent Basis
Volume
--------
<S> <C>
Interest Income:
Securities * $ 1,656
Money market instruments (14)
Loans * 2,493
--------
Total 4,135
--------
Interest Expense:
Savings deposits 370
Time deposits and certificates of deposit 513
Other borrowings 786
--------
Total 1,669
--------
Net interest income $ 2,466
========
*Tax Equivalent Basis
</TABLE>
PAGE 9
Taxable-equivalent net interest income was $31,646,000 for the first six
months of 1999, compared to $28,458,000 for the same period in 1998, a 11.2% or
$3,188,000 increase. Taxable-equivalent net interest income rose primarily due
to a $3,939,000 increase related to volume, which was only partially offset by a
reduction related to rate. Total taxable-equivalent interest income grew
$5,273,000, primarily the result of the higher volumes in both the security and
loan earning asset categories. Average year-to-date securities and loans grew
$108,229,000 and $94,682,000, respectively at June 30, 1999, compared to the
same period in 1998. This increase included $53,000,000 securities purchased as
part of a capital leverage program during the fourth quarter of 1998. To more
fully leverage its capital, the corporation entered into $53,000,000 of
structured transactions in which the banks borrows funds from the Federal Home
Loan Bank (FHLB) and invests these borrowed funds in securities that are priced
to yield a spread over the FHLB borrowing rate.
Total interest expense grew $2,085,000 during the first six months
of 1999, compared to the same period in 1998. This growth was principally the
result of higher volumes associated with other borrowings. The average
year-to-date other borrowings grew $60,042,000, compared to the first six months
of 1998. This increase in other borrowings is primarily attributable to the
funding required for the $53,000,000 capital leverage program. The volume of
savings and time deposits grew 12.3% and 8.7%, respectively. The increase in
deposit and other borrowing volumes was used to finance the earning asset
growth. Other borrowings include federal funds purchased, FHLB borrowings,
securities sold under agreements to repurchase and U. S. Treasury demand notes.
Taxable-equivalent net interest income of $16,222,000 was
$1,786,000 or 12.4% higher in the second quarter of 1999, compared to
$14,436,000 for the same period in 1998. Interest income grew $2,793,000 during
the period, as a result of an increase in security and loan volumes. Second
quarter average securities and loans grew 27.2% and 15.0%, respectively,
compared to the second quarter of 1998. The increase in the interest income was
partially offset by a $1,007,000 rise in interest expense. Increases in all
deposit category volumes contributed to this increase in interest expense.
Non-accruing loans are included in the average balance yield calculations, but
the average non-accruing 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 manage
interest rate sensitivity by changing mix and repricing characteristics of their
assets and liabilities through their investment securities portfolio, borrowings
from the FHLB and their offering of loan and deposit terms. The nature of the
banks current operations is such that is not subject to foreign currency
exchange or commodity price risk. The banks do not own trading assets and they
do not have any hedging transactions in place such as interest rate swaps, caps
or floors. The banks utilize three principal reports to measure interest rate
risk: asset/liability simulation reports, gap analysis reports and net interest
margin reports.
NET INTEREST MARGIN
-------------------
The net interest margin of 4.61% for the six-month period ended June 30,
1999, decreased from the 4.83% net interest margin for the same period of 1998.
The decrease in the net interest margin is primarily due to the institution of
the capital leverage program during the fourth quarter of 1998. The actual
leverage program yield spread earned during the first half of 1999 was 1.65%.
Since the current competitive interest rate environment will continue to place
downward pressure on the net interest margin, the banks expect an increase in
PAGE 10
net interest income through the continued growth in market share of loans and
deposits. The yield on earning assets of 7.71% during the first six months of
1999 was lower than the 8.09% earned during the first six months of 1998. This
drop in yield is primarily due to the capital leverage program and the lower
average prime rate experienced in 1999, compared to 1998. The rates of all
interest bearing liability categories decreased in the first half of 1999,
compared to the same period in 1998. The second quarter 1999 net interest
margin of 4.63% decreased from the second quarter of 1998 net interest margin of
4.87.
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 1999 the provision for loan losses was
$954,000, compared to $1,130,000 for the same period in 1998. The lower
provision for loan losses during the first half of 1999, compared to the same
period in 1998 is attributable to the continued stability in the quality of the
loan portfolio. Net loans charged-off were $348,000 for the six months ended
June 30, 1999, compared to $462,000 for the six months ended June 30, 1998. The
ratio of the allowance for loan losses to nonperforming assets for June 30, 1999
of 263.3% did not significantly change from the December 31, 1998 and the June
30, 1998 ratios of 253.3% and 259.6%, respectively.
Allowance for Loan Losses
- -------------------------
Transaction in the allowance for loan losses are as follows:
<TABLE>
<CAPTION>
1999 1998
---------------- ---------------
Balance, Beginning of Year $13,706,000 $12,592,000
Provision charged to operating expenses 954,000 1,130,000
Loans charged off (436,000) (675,000)
Recoveries 88,000 213,000
---------------- ---------------
Balance, June 30 14,312,000 13,260,000
================ ===============
<S> <C> <C> <C>
Ratios: June 30, 1999 Dec. 31, 1998 June 30, 1998
- ------------------------------------------------- ---------------- --------------- ---------------
Allowance for loan losses to nonperforming assets 263.3% 253.3% 259.6%
Nonperforming assets to total loans & net assets
acquired in foreclosure 0.56% 0.60% 0.60%
Allowance for loan losses to total loans 1.47% 1.52% 1.57%
</TABLE>
The following table sets forth an allocation of the allowance for loan losses by
loan category:
<TABLE>
<CAPTION>
June 30, 1999
--------------
Percent
Amount of Loans
-------------- ---------
<S> <C> <C>
Commercial and industrial $ 2,938,000 28%
Consumer loans 1,954,000 31%
Real estate 1,417,000 33%
Lease financing 335,000 8%
Unallocated 7,668,000 N/A
-------------- ---------
Total $ 14,312,000 100%
============== =========
</TABLE>
PAGE 11
Nonperforming assets (nonaccruing loans, net assets in foreclosure and
troubled debt restructured loans) were 0.56% of total loans and net assets
acquired in foreclosure at June 30, 1999, compared to 0.60% at December 31, 1998
and June 30, 1998. The ratio of the allowance for loan losses to loans at June
30, 1999 of 1.47% was lower than both the December 31, 1998 ratio of 1.52% and
the June 30, 1998 ratio of 1.57%.
Nonaccruing loans at June 30, 1999 of $4,541,000, increased $845,000 from
the December 31, 1998 level of $3,696,000, and increased $1,410,000 from the
June 30, 1998 level of $3,131,000. The growth during these periods was due to
an increase in loans collateralized by commercial real estate.
Net assets in foreclosure totaled $413,000 as of June 30, 1999, a
decrease of $718,000 from the December 31, 1998 balance of $1,131,000. During
the first six months of 1999, transfers from loans to assets in foreclosure were
$614,000, payments on foreclosed properties totaled $1,266,000 and write-downs
of assets in foreclosure equaled $66,000. The loans transferred to assets in
foreclosure included mortgages of $260,000 and leases of $354,000. The balance
of net assets in foreclosure at June 30, 1998 was $1,351,000. 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.
As of June 30, 1999, there were two unrelated borrowers with troubled debt
restructured loans totaling $481,000, compared with three unrelated borrowers
with a balance of $583,000 as of December 31, 1998 and $624,000 at June 30,
1998. The two customers were complying with the restructured terms as of June
30, 1999.
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, 1999, loans past due 90 days or more and still
accruing interest were $666,000, compared to $1,350,000 as of December 31, 1998
and $1,218,000 as of June 30, 1998. The decrease in loans past due 90 days at
June 30, 1999, compared to December 31, 1998 and June 30, 1998 was primarily the
result of a decrease in loans collateralized by commercial real estate.
The following information concerns impaired loans:
<TABLE>
<CAPTION>
Impaired Loans: June 30, 1999 Dec. 31, 1998 June 30, 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Restructured Loans $ 481,000 $ 583,000 $ 624,000
Nonaccrual Loans $ 2,766,000 $ 1,513,000 $ 1,335,000
-------------- -------------- --------------
Total Impaired Loans $ 3,247,000 $ 2,096,000 $ 1,959,000
============== ============== ==============
Average year-to-date impaired loans: $ 2,612,000 $ 2,263,000 $ 2,251,000
============== ============== ==============
Impaired loans with specific loss allowances: $ 3,247,000 $ 2,096,000 $ 1,959,486
============== ============== ==============
Loss allowances reserved on impaired loans: $ 433,000 $ 302,000 $ 219,000
============== ============== ==============
Year-to-date income recognized on impaired loans $ 23,000 $ 103,000 $ 37,000
============== ============== ==============
</TABLE>
The banks' recognize interest income on impaired loans under the accrual
method. The banks recognize income on nonaccrual loans under the cash basis
method when the loans are both current and sufficiently collateralized to
cover the outstanding obligations to the banks. The banks will not
recognize income if these factors do not exist.
PAGE 12
<TABLE>
OTHER OPERATING INCOME
- ----------------------
<CAPTION>
Six Months Ended June 30, Three Months Ended June 30,
1999 1998 1999 1998
------------------------ --------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Service charges $1,707 $1,564 $ 862 $ 789
Securities gains (losses), net 451 326 334 119
Trust income 1,296 1,001 658 581
Other income 1,402 1,248 687 747
------ ------ ------ ------
Total other operating income $4,856 $4,139 $2,541 $2,236
====== ====== ====== ======
</TABLE>
Other operating income for the first six months of 1999 increased $717,000,
or 17.3%, from $4,139,000 at June 30, 1998 to $4,856,000 at June 30, 1999.
This rise in other operating income is the result of a $143,000 growth in
service charges, a $125,000 increase in security gains, a $295,000 rise in trust
income and a $154,000 increase in other income. In the second quarter of 1999
other income of $2,541,000 was $305,000 or 13.6% higher than the same period in
1998. Gains in securities were the primary source of this increase.
The $143,000, or 9.1% increase in service charges is primarily the result
of a rise in fees charged on transaction deposit accounts. This increase in
fees is due to the 16.2% increase in average deposit transaction accounts in the
first six months of 1999, compared to the first six months in 1998. The 1999
second quarter service charge income of $862,000, increased $73,000, or 9.3%
over the second quarter of 1998.
The corporation recorded a net security gain of $451,000 in the
first six months of 1999, compared to a $326,000 gain in the same period in
1998. The second quarter of 1999 net security gain of $334,000 increased from
the $119,000 security gain recognized in the same period in 1998. 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 corporation's Investment Management and Trust Services
Division increased $295,000, or 29.5% in the first six months of 1999, compared
to the same period in 1998. The second quarter of 1999 trust income of
$658,000, was 13.3% higher than the second quarter of 1998. This increase was
the result of both an increase in the book value of trust assets under
management of 6.7% from June 30, 1998 to June 30, 1999, and the corporation's
continuing emphasis on marketing the Investment Management and Trust Services
Division's products and services. Other income for the first six months of 1999
increased $154,000, or 12.3%, compared to the same period in 1998. This
increase was primarily due to gains on the sale of off lease vehicles and
equipment, and an increase in ATM fees. The second quarter of 1999 other income
of $687,000 was lower than the second quarter of 1998 other income of $747,000.
This $60,000 reduction is attributed to lower gains recognized on the sale of
residential mortgages during the second quarter of 1999, compared to the second
quarter of 1998.
OTHER OPERATING EXPENSES
- ------------------------
<TABLE>
<CAPTION>
Six Months Ended June 30, Three Months Ended June 30,
<S> <C> <C> <C> <C>
1999 1998 1999 1998
------------------------ ---------------------------
(Dollars in thousands)
Salaries $ 7,369 $ 6,972 $3,849 $3,567
Employee benefits 2,450 2,274 1,160 1,092
Net occupancy expense 1,211 1,098 592 526
Equipment expense 1,956 1,628 989 848
Other expenses 5,213 4,961 2,588 2,551
------- ------- ------ ------
Total other operating expenses $18,199 $16,933 $9,178 $8,584
======= ======= ====== ======
</TABLE>
PAGE 13
Other operating expenses for the first six months of 1999 of $18,199,000
increased $1,266,000, or 7.5%, from $16,933,000 for the same period in 1998.
The 1999 second quarter other operating expenses grew 6.9%, compared to the
second quarter of 1998. Our constant focus on controlling expenses and
improving efficiencies has held the growth of our other operating expense much
lower than our 17.3% growth in total assets and our 18.1% increase in
year-to-date income.
Employee salaries increased $397,000, or 5.7% from $6,972,000 for the
first six months of 1998 to $7,369,000 for the same period in 1999. Employee
benefits of $2,450,000 expensed in the first six months of 1999, were $176,000,
or 7.7% higher than the $2,274,000 of employee benefits expensed during the same
period in 1998. Salaries and employee benefits grew 7.9% and 6.2%, respectively
in the second quarter of 1999, compared to the second quarter of 1998. The
increase in salaries and employee benefits reflects cost of living increases,
merit increases and additional staff necessitated by the growth of the banks.
Net occupancy expense increased $113,000, or 10.3%, from $1,098,000 in the
first six months of 1998 to $1,211,000 in the first six months of 1999. The
second quarter of 1999 occupancy expense grew 12.5%, compared to the second
quarter of 1998. Two new branches opened after June 1998 were primarily
responsible for the increase in occupancy expense. Equipment expense increased
$328,000, or 20.1%, during the first six months of 1999, compared to the same
period in 1998. The second quarter of 1999 equipment expense grew 16.6% over
the second quarter of 1998. 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 and to enhanced the products offered to customers.
Other expenses increased $252,000, or 5.1%, from $4,961,000 in the
first six months of 1998, compared to $5,213,000 in other expenses recorded
during the same period in 1999. The second quarter of 1999 other expenses grew
by a marginal rate of 1.5% over the second quarter of 1998. This increase is the
result of higher 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
- ----------------------
INVESTMENT SECURITIES
Total investment securities at June 30, 1999, of $453,935,000 grew
$21,977,000, or 5.1% over the December 31, 1998 balance of $431,958,000. The
June 30, 1999 balance grew $93,665,000, or 26.0% compared to the June 30, 1998
balance of $360,270,000. This increase included the $53,000,000 in securities
purchased as part of the capital leverage program.
LOANS
Total loans grew $73,397,000, or 8.1% from the December 31, 1998 balance of
$902,884,000 to the June 30, 1999 balance of $976,281,000. This increase was
primarily due to growth in both commercial loans and indirect automobile
lending. The June 30, 1999 balance grew $129,739,000, or 15.3% compared to the
June 30, 1998 balance of $846,542,000. This increase was primarily due to
increases in real estate loans, commercial loans and automobile leases.
PAGE 14
DEPOSITS & OTHER BORROWINGS
The primary funding sources of the corporation is deposits and other
borrowings. Total deposits of $1,174,618,000 at June 30, 1999, increased
$70,302,000, or 6.4% from the $1,104,316,000 balance at December 31, 1998.
These increases occurred primarily in money market accounts and certificates
of deposits. The growth in deposits at June 30, 1999, compared to June 30,
1998 was $119,641,000, or 11.3%. All deposit categories increased during this
period. Other borrowings of $178,479,000 at June 30, 1999, grew $29,501,000,
compared to December 31, 1998. This growth was the result of increases in
federal funds purchased and securities sold under agreements to repurchase. The
June 30, 1999 other borrowings increased $96,927,000, compared to the June 30,
1998 balance. This increase included $53,000,000 in FHLB borrowings related to
the capital leverage program, higher federal funds purchased balances and a rise
in securities sold under agreements to repurchase balances.
CAPITAL
- -------
Capital formation is important to the corporation's well being
and future growth. Capital for the period ending June 30, 1999 was
$129,382,000, a decrease of $1,571,000 over the end of 1998. The decrease was
due to the adjustment for the net unrealized losses on the available for sale
investment securities, partially offset by the retention of the corporation's
earnings. Net unrealized gains and losses on available for sale investment
securities are recorded as accumulated other comprehensive income in the equity
section of the balance sheet. The accumulated other comprehensive income at
June 30, 1999 was a loss of $3,247,000, compared to a gain of $5,384,000 at
December 31, 1998. The market value of the available for sale investment
securities was reduced by the higher interest rates experienced during the first
half of 1999. 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>
(Dollars in thousands)
<CAPTION>
Capital Level required to be Capital Level required to be
As of June 30, 1999 Actual Adequately Capitalized Well Capitalized
Amount Ratio Amount Ratio Amount
- -------------------------------------------------------------------------------------------------------------------------
Total Capital (to risk weighted assets):
- ----------------------------------------
<S> <C> <C> <C> <C> <C>
Corporation $145,530 13.44% $ 86,594 8.00% $108,242
Harleysville National Bank 77,183 9.57% 64,552 8.00% 80,690
Citizens National Bank 32,939 18.52% 14,231 8.00% 17,789
Security National Bank 8,041 10.12% 6,357 8.00% 7,947
Tier 1 Capital (to risk weighted assets):
- ------------------------------------------
Corporation 131,324 12.13% 43,297 4.00% 64,945
Harleysville National Bank 67,087 8.31% 32,276 4.00% 48,414
Citizens National Bank 30,713 17.27% 7,116 4.00% 10,673
Security National Bank 7,047 8.87% 3,179 4.00% 4,768
Tier 1 Capital (to average assets):
- ------------------------------------------
Corporation 131,324 9.00% 58,337 4.00% 72,921
Harleysville National Bank 67,087 6.25% 42,949 4.00% 53,687
Citizens National Bank 30,713 12.01% 10,228 4.00% 12,785
Security National Bank 7,047 6.64% 4,246 4.00% 5,308
</TABLE>
<TABLE>
(Dollars in thousands)
<CAPTION>
Capital Level required to Capital Level required to
As of December 31, 1998 Actual be Adequately Capitalized be Well Capitalized
- ------------------------------------------
Amount Ratio Amount Ratio Amount
-------- ------ ---------- ---------- -----------
Total Capital (to risk weighted assets):
- ------------------------------------------
<S> <C> <C> <C> <C> <C>
Corporation $137,371 13.77% $ 79,823 8.00% $ 99,778
Harleysville National Bank 70,733 9.70% 58,316 8.00% 72,895
Citizens National Bank 32,040 17.90% 14,321 8.00% 17,901
Security National Bank 7,629 10.74% 5,680 8.00% 7,101
Tier 1 Capital (to risk weighted assets):
- ------------------------------------------
Corporation 124,039 12.43% 39,911 4.00% 59,867
Harleysville National Bank 61,603 8.45% 29,158 4.00% 43,737
Citizens National Bank 29,868 16.69% 7,160 4.00% 10,740
Security National Bank 6,741 9.49% 2,840 4.00% 4,260
Tier 1 Capital (to average assets):
- ------------------------------------------
Corporation 124,039 9.05% 54,817 4.00% 68,521
Harleysville National Bank 61,603 6.11% 40,191 4.00% 50,238
Citizens National Bank 29,868 11.64% 10,263 4.00% 12,828
Security National Bank 6,741 7.10% 3,799 4.00% 4,749
As of June 30, 1999 Ratio
- ------------------- -----
<S> <C>
Corporation 10.00%
Harleysville National Bank 10.00%
Citizens National Bank 10.00%
Security National Bank 10.00%
Tier 1 Capital (to risk weighted assets):
- ------------------------------------------
Corporation 6.00%
Harleysville National Bank 6.00%
Citizens National Bank 6.00%
Security National Bank 6.00%
Tier 1 Capital (to average assets):
- ------------------------------------------
Corporation 5.00%
Harleysville National Bank 5.00%
Citizens National Bank 5.00%
Security National Bank 5.00%
As of December 31, 1998 Ratio
- ----------------------- -----
Total Capital (to risk weighted assets):
- ------------------------------------------
Corporation 10.00%
Harleysville National Bank 10.00%
Citizens National Bank 10.00%
Security National Bank 10.00%
Tier 1 Capital (to risk weighted assets):
- ------------------------------------------
Corporation 6.00%
Harleysville National Bank 6.00%
Citizens National Bank 6.00%
Security National Bank 6.00%
Tier 1 Capital (to average assets):
- ------------------------------------------
Corporation 5.00%
Harleysville National Bank 5.00%
Citizens National Bank 5.00%
Security National Bank 5.00%
</TABLE>
PAGE 15
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 9.66% at
June 30, 1999, compared with 9.80% at December 31, 1998. 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 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, 1999, the corporation's Tier 1 risk-adjusted
capital ratio was 12.13%, and the total risk-adjusted capital ratio was 13.44%,
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, 1999.
The leverage ratio consists of Tier 1 capital divided by quarterly
average total assets, excluding intangible assets. 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
corporations leverage ratios were 9.00% at June 30, 1999 and 9.05% at December
31, 1998.
The year-to-date June 30, 1999 cash dividend per share of $.52 was 8.3%
higher than the cash dividend for the same period in 1998 of $.48. The dividend
payout ratio for the first six months of 1999 was 35.86%; compared to 38.91% for
the twelve month period ended December 31, 1998. 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
1999.
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 $12,742,000 during the first six months of 1999 and
PAGE 16
securities available for sale averaged $413,445,000 during the first six months
of 1999, 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 $120,425,000, as of June 30, 1999.
OTHER ITEMS
- -----------
LEGISLATIVE & REGULATORY
- ------------------------
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. We cannot
predict whether the legislation will be enacted or, if enacted, how the
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 herein,
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.
Pending Legislation
-------------------
There are numerous proposals before Congress to modify the financial
services industry and the way commercial banks and other financial institutions
operate. Some of these proposals include changes to the ownership of financial
companies and the types of products and services that may be offered by
financial institutions. However, it is difficult to determine at this time what
effect such provisions may have until they are enacted into law. Management
believes that the effect of the provisions of the aforementioned legislation on
the liquidity, capital resources, and results of operations of the corporation
will be immaterial. Management is not aware of any other current specific
recommendations by regulatory authorities or proposed legislation which, if they
were implemented, would have a material adverse effect upon the liquidity,
capital resources, or results of operations, although the general cost of
compliance with numerous and multiple federal and state laws and regulations
does have, and in the future may have, a negative impact on the corporation's
results of operations.
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 century date change. If not corrected,
PAGE 17
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 include 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 corporation also reviewed 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. As of June 30,
1999, 95% of the remediation phase has been completed. Remediation of all
mission critical systems is completed.
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 was completed
during the first quarter of 1999.
The corporation has reviewed the Y2K issues related to material third
parties and completed an analysis on the loan portfolio. The corporation's
third parties include its vendors and commercial customers. Our material third
party relationships are primarily our commercial borrowers. These borrowers may
pose a credit risk to the corporation if they are not Y2K compliant. We have
contacted the material commercial customers and their responses were evaluated.
We have also performed an analysis on the impact of Y2K issues on the remaining
loan portfolio.
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 June 30, 1999, the corporation has expensed
$160,000 and capitalized fixed assets of $116,000 related to the Y2K issue.
The corporation has estimated the future Y2K expenditures to be $35,000. 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
PAGE 18
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 plan. 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 and on its financial position and
results of operation.
CONTINGENCY PLANS
The corporation has developed a contingency plan to handle the most
reasonably likely Y2K worst-case scenario should it occur. The contingency plan
involves obtaining back-up service providers, devising specific plans for key
operations and assessing the potential adverse risks to the corporation. The
contingency plan was completed during the first quarter of 1999. The majority
of the testing of the contingency plan was completed by June 30, 1999. The
remaining testing will be completed by September 30, 1999. The corporation has
also utilized an independent consulting firm to verify and validate the
corporation's Y2K plans.
BRANCHING
---------
The corporation's subsidiaries currently plan to open at least two
new branches. Harleysville National Bank will open a location in Foulkeways, a
retirement community in Lower Gwynedd, during the third quarter of 1999 and is
pursuing a location in Souderton. 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 January 20, 1999, the corporation consummated its acquisition of
Northern Lehigh Bancorp, Inc., parent company of Citizens National Bank of
Slatington. Accounted for as a pooling-of-interest, Northern Lehigh Bancorp
shareholders received 3.57 shares of Harleysville National Corporation common
stock for each share of Northern Lehigh Bancorp common stock.
The acquisition was affected by the merger of Northern Lehigh
Bancorp, Inc. with Harleysville National Corporation North, Inc., and a bank
holding company and wholly owned subsidiary of Harleysville National
Corporation. Citizen's National Bank of Slatington merged with and into The
Citizens National Bank of Lansford, a national banking association and wholly
owned subsidiary of Harleysville National Corporation North, Inc., under the
name Citizens National Bank.
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, 1998.
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, Citizens National Bank, 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 and Use of Proceeds
- ------------------------------------------------
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 of Exhibits
- --------------------------------------
(3.1) Harleysville National Corporation Articles of Incorporation,
as amended. (Incorporated by reference to Exhibit 3(a) to the
corporation's Registration Statement No. 33-65021 on Form
S-4, as filed on December 14, 1995.)
(3.2) Harleysville National Corporation By-laws. (Incorporated by
reference to Exhibit 3(b) to the corporation's Registration
Statement No. 33-65021 on Form S-4, as filed on December 14,
1995.)
(10.1) Harleysville National Corporation 1993 Stock Incentive Plan.
(Incorporated by Reference to Exhibit 4.3 of Registrant's
Registration Statement No. 33-57790 on Form S-8, filed with
the Commission 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 Exhibit 10.3 of Registrant's Annual Report in
Form 10-K for the year ended December 31, 1997, filed with
the Commission on March 27, 1998.)
(10.4) Walter E. Daller, Jr., Chairman, President and Chief Executive
Officer's employment agreement. (Incorporated by Reference
to Registrant's Registration Statement on Form 8-K, filed with
the Commission on March 25, 1999.)
PAGE 20
(10.5) Demetra M. Takes, President and Chief Operating Officer of
Harleysville employment agreement. (Incorporated by Reference
to Registrant's Registration Statement on Form 8-K, filed with
the Commission on March 25, 1999.)
(10.6) Vernon L. Hunsberger Senior Vice President/CFO and Cashier's
employment agreement. (Incorporated by Reference to Registrant's
Registration Statement on Form 8-K, filed with the Commission
on March 25, 1999.)
(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.
(b) Reports on Form 8-K:
None.
[S] [C]
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: August 11, 1999
PAGE 22
EXHIBIT INDEX
-------------
Exhibit No. Description of Exhibits
- ---------- -----------------------
(3.1) Harleysville National Corporation Articles of Incorporation, as
amended. (Incorporated by reference to Exhibit 3(a) to the
corporation's Registration Statement No. 33-65021 on Form
S-4, as filed on December 14, 1995.)
(3.2) Harleysville National Corporation By-laws. (Incorporated by
reference to Exhibit 3(b) to the corporation's Registration
Statement No. 33-65021 on Form S-4, as filed on December 14,
1995.)
(10.1) Harleysville National Corporation 1993 Stock Incentive Plan.
(Incorporated by Reference to Exhibit 4.3 of Registrant's
Registration Statement No. 33-57790 on Form S-8, filed with the
Commission 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 Exhibit 10.3 of Registrant's Annual Report in Form
10-K for the year ended December 31, 1997, filed with the
Commission on March 27, 1998.)
(10.4) Walter E. Daller, Jr., Chairman, President and Chief Executive
Officer's employment agreement. (Incorporated by Reference to
Registrant's Registration Statement on Form 8-K,filed with the
Commission on March 25, 1999.)
(10.5) Demetra M. Takes, President and Chief Operating Officer of
Harleysville employment agreement. Incorporated by Reference
to Registrant's Registration Statement on Form 8-K, filed with
the Commission on March 25, 1999.)
(10.6) Vernon L. Hunsberger Senior Vice President/CFO and Cashier's
employment agreement. (Incorporated by Reference to
Registrant's Registration Statement on Form 8-K, filed with
the Commission on March 25, 1999.)
(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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