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, 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: 7,915,130 shares of Common
Stock, $1.00 par value, outstanding on October 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 - September 30, 1999 and
December 31,1998 3
Consolidated Statements of Income - Nine Months and
Three Months Ended September 30, 1999 and 1998 5
Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 1999 and 1998 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk 22
Part II. Other Information
Item 1. Legal Proceedings 22
Item 2. Change in Securities and Use of Proceeds 22
Item 3. Defaults Upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 24
PAGE 2
PART 1. FINANCIAL INFORMATION
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(Dollars in thousands) (Unaudited) September 30, 1999 December 31, 1998
-------------------- -------------------
ASSETS
<S> <C> <C>
Cash and due from banks $ 49,006 $ 40,204
Federal Funds sold - 13,426
-------------------- -------------------
Total cash and cash equivalents 49,006 53,630
-------------------- -------------------
Interest-bearing deposits in banks 4,333 3,707
Investment securities available for sale 470,415 390,438
Investment securities held to maturity
(market value $11,621 and $42,202, respectively) 11,673 41,520
Loans 1,029,705 902,884
Less: Unearned income (81) (2,574)
Allowance for loan losses (14,348) (13,706)
-------------------- -------------------
Net loans 1,015,276 886,604
-------------------- -------------------
Bank premises and equipment, net 20,483 19,542
Accrued income receivable 10,834 9,574
Other real estate owned 202 1,131
Intangible assets, net 2,083 1,936
Bank-owned life insurance 25,170 -
Other assets 5,743 4,008
-------------------- -------------------
Total assets $ 1,615,218 $ 1,412,090
==================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing $ 182,891 $ 192,156
Interest-bearing:
Checking accounts 137,156 139,133
Money market accounts 251,938 212,156
Savings 146,735 140,797
Time, under $100,000 354,727 329,606
Time, $100,000 or greater 122,342 90,468
-------------------- -------------------
Total deposits 1,195,789 1,104,316
Accrued interest payable 16,566 14,072
U.S. Treasury demand notes 590 1,320
Federal funds purchased 62,000 11,000
Federal Home Loan Bank (FHLB) borrowings 141,250 93,500
Securities sold under agreements to repurchase 58,755 43,158
Other liabilities 10,808 13,771
-------------------- -------------------
Total liabilities 1,485,758 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 7,915,168 shares in 1999 and
7,535,683 shares in 1998 7,915 7,536
Additional paid in capital 63,081 50,900
Retained Earnings 65,508 67,133
Accumulated other comprehensive income (7,044) 5,384
-------------------- -------------------
Total shareholders' equity 129,460 130,953
-------------------- -------------------
Total liabilities and shareholders' equity $ 1,615,218 $ 1,412,090
PAGE 3 ==================== ===================
See accompanying notes to consolidated financial statements.
</TABLE>
PAGE 4
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(Unaudited) Nine months ended Three months ended
(Dollars in thousands except weighted average number September 30, September 30,
------------------ -------------------
<S> <C> <C> <C> <C>
of common shares and per share information) 1999 1998 1999 1998
------------------ ---------- ------------------- ----------
INTEREST INCOME:
Loans, including fees $ 52,569 $ 49,011 $ 18,526 $ 16,586
Lease financing 5,008 3,669 1,789 1,299
Investment securities:
Taxable 12,479 9,902 4,598 3,399
Exempt from federal taxes 7,117 5,461 2,404 1,997
Federal funds sold 325 903 22 345
Deposits in banks 101 185 49 30
------------------ ---------- ------------------- ----------
Total interest income 77,599 69,131 27,388 23,656
------------------ ---------- ------------------- ----------
INTEREST EXPENSE:
Savings deposits 9,716 9,532 3,431 3,343
Time, under $100,000 13,565 13,363 4,614 4,519
Time, $100,000 or greater 4,064 3,530 1,488 1,313
Borrowed funds 6,099 3,081 2,586 1,091
------------------ ---------- ------------------- ----------
Total interest expense 33,444 29,506 12,119 10,266
------------------ ---------- ------------------- ----------
Net interest income 44,155 39,625 15,269 13,390
Provision for loan losses 1,430 1,680 476 550
------------------ ---------- ------------------- ----------
Net interest income after provision for loan losses 42,725 37,945 14,793 12,840
------------------ ---------- ------------------- ----------
OTHER OPERATING INCOME:
Service charges 2,611 2,416 903 852
Security gains, net 458 900 7 574
Trust income 1,886 1,520 590 519
Bank-owned life insurance 170 - 170 -
Other Income 2,111 2,247 710 999
------------------ ---------- ------------------- ----------
Total other operating income 7,236 7,083 2,380 2,944
------------------ ---------- ------------------- ----------
Net interest income after provision for loan losses
and other operating income 49,961 45,028 17,173 15,784
------------------ ---------- ------------------- ----------
OTHER OPERATING EXPENSES:
Salaries, wages and employee benefits 14,843 13,864 5,024 4,619
Occupancy 1,851 1,702 640 603
Furniture and equipment 3,126 2,568 1,169 940
Other expenses 7,828 7,316 2,616 2,355
------------------ ---------- ------------------- ----------
Total other operating expenses 27,648 25,450 9,449 8,517
------------------ ---------- ------------------- ----------
Income before income taxes 22,313 19,578 7,724 7,267
Income tax expense 5,414 5,023 1,766 1,979
------------------ ---------- ------------------- ----------
Net income $ 16,899 $ 14,555 $ 5,958 $ 5,288
================== ========== =================== ==========
Weighted average number of common shares:
Basic 7,913,004 7,900,124 7,915,168 7,905,222
================== ========== =================== ==========
Diluted 7,926,053 7,900,606 7,928,641 7,905,431
================== ========== =================== ==========
Net income per share information:
Basic $ 2.13 $ 1.84 $ 0.75 $ 0.67
================== ========== =================== ==========
Diluted $ 2.13 $ 1.84 $ 0.75 $ 0.67
================== ========== =================== ==========
Cash dividends per share $ 0.75 $ 0.70 $ 0.26 $ 0.24
================== ========== =================== ==========
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE 5>
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Dollars in thousands) (Unaudited) Nine Months Ended Sept. 30,
<S> <C> <C>
OPERATING ACTIVITIES: 1999 1998
----------------------------- ----------
Net Income $ 16,899 $ 14,555
Adjustments to reconcile net inc. to net cash provided by operating activities:
Provision for loan losses 1,430 1,680
Depreciation and amortization 1,863 1,542
Net amortization of investment securities discount/premiums 651 297
Net realized security gain (458) (900)
Increase in accrued income receivable (1,260) (1,317)
Increase (decrease) in accrued interest payable 2,494 (556)
Net increase in other assets (1,735) (1,135)
Net increase in other liabilities 3,729 3,078
Decrease in unearned income (2,493) (1,762)
Write-down of other real estate owned 81 28
Increase in intangible assets (148) (82)
----------------------------- ----------
Net cash provided by operating activities 21,053 15,428
----------------------------- ----------
INVESTING ACTIVITIES:
Proceeds from sales of investment securities available for sale 42,170 40,572
Proceeds, maturity or calls of investment securities held to maturity 10,032 15,060
Proceeds, maturity or calls of investment securities available for sale 53,966 18,922
Purchases of investment securities held to maturity (3,703) -
Purchases of investment securities available for sale (171,908) (150,070)
Net (increase) decrease in interest-bearing deposits in banks (626) 2,699
Net increase in loans (128,317) (66,578)
Net increase in premises and equipment (2,803) (2,111)
Proceeds from sales of other real estate 1,556 756
Purchase of Bank-owned life insurance (25,170) -
----------------------------- ----------
Net cash used in investing activities (224,803) (140,750)
----------------------------- ----------
FINANCING ACTIVITIES:
Net increase in deposits 91,473 76,231
Decrease in U.S. Treasury demand notes (730) (287)
Increase in federal funds purchased 51,000 900
Increase in FHLB borrowings 47,750 38,000
Increase in securities sold under agreement 15,597 19,888
Cash dividends & fractional shares (6,003) (5,324)
Stock options 39 354
----------------------------- ----------
Net cash provided by financing activities 199,126 129,762
----------------------------- ----------
Net (decrease) increase in cash and cash equivalents (4,624) 4,440
Cash and cash equivalents at beginning of period 53,630 52,991
----------------------------- ----------
Cash and cash equivalents at end of the period $ 49,006 $ 57,431
============================= ==========
Cash paid during the period for Interest $ 30,950 $ 30,063
============================= ==========
Supplemental disclosure of noncash investing and financing activities:
Transfer of assets from loans to other real estate owned $ 708 $ 925
============================= ==========
See accompanying notes to consolidated financial statements.
</TABLE>
PAGE 6
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 September 30, 1999, the results of its operations for nine and three month
periods ended September 30, 1999 and 1998 and the cash flows for the nine month
periods ended September 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 nine and three month periods ended September
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, loans and bank-owned life insurance.
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 nine
months of 1999 was $4,471,000, compared to $16,366,000 for the first nine months
of 1998. The market value of the available for sale investment securities was
reduced by the rise in interest rates experienced during 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 7
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., 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 8
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 continued its strong earnings performance during
the third quarter of 1999. Net income increased 12.7% in the third quarter of
1999, compared to the third quarter of 1998. The year-to-date net income grew
16.1% from the same period in 1998. This performance was achieved through an
increase in earning assets and a continuing emphasis on controlling overhead
expenses.
Consolidated net income for the first nine months of 1999 was $16,899,000,
an increase of $2,344,000, or 16.1%, over the first nine months of 1998 net
income of $14,555,000. Basic and diluted earnings per share for the first nine
months of 1999 of $2.13 increased 15.8%, over the first nine months of 1998
basic and diluted earnings per share of $1.84. Consolidated net income for the
third quarter of 1999 was $5,958,000, an increase of $670,000, or 12.7%, over
the third quarter of 1998 net income of $5,288,000. For the quarter ended
September 30, 1999, basic and diluted earnings per share at $.75 were up 11.9%
from $.67 in the comparable period last year.
The increase in net income during the first nine 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 $4,530,000, or 11.4%, primarily as a result
of the 16.9% rise in average earning assets. Other operating income increased a
modest $153,000 or 2.2%, due to the $442,000 decrease in security gains in 1999,
compared 1998. Partially offsetting these increases was an 8.6% rise in other
operating expenses, primarily related to the overall growth in the banks. The
third quarter of 1999 rise in net income compared to the third quarter of 1998
is primarily the result of a $1,879,000 rise in net interest income related to
the 19.5% increase in average earning assets during this period.
PAGE 9
For the nine months ended September 30, 1999, the annualized return on
average shareholders' equity and the annualized return on average assets were
17.24% and 1.53%, respectively. For the same period in 1998, the annualized
return on average shareholders' equity was 15.78% and the annualized return on
average assets was 1.55%. For the three months ended September 30, 1999, the
annualized return on average shareholders' equity and the annualized return on
average assets were 18.36% and 1.54%, respectively. For the same period in
1998, the annualized return on average shareholders' equity was 16.79% and the
annualized return on average assets was 1.62%.
As of September 30, 1999, the banks have seen an improvement in
nonperforming assets, compared to December 31, 1998 and September 30, 1998,
respectively. Nonperforming assets, including nonaccrual loans, restructured
loans and other real estate owned, were $5,391,000, or .52% of total loans and
net assets acquired in foreclosure at September 30, 1999, compared to .60% at
December 31, 1998 and .62% at September 30, 1998. The ratio of the allowance
for loan losses to nonperforming assets was 266.1% at September 30, 1999, an
increase from 253.3% at December 31, 1998 and 249.9% at September 30, 1998.
Loans 90 days or more past due were $2,376,000 at September 30, 1999, compared
to the December 31, 1998 and September 30, 1998 levels of $1,350,000 and
$778,000, respectively. As will be discussed in more detail latter, this
increase was primarily due to a rise in commercial loans past due 90 days or
more.
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 nine months of 1999 was $44,155,000, an
increase of $4,530,000, or 11.4%, over the first nine months of 1998 which was
$39,625,000. 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 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 third quarter 1999 net
interest income rose 14.0% 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 nine months ended September 30, 1999 over
September 30, 1998 and the three months ended September 30, 1999 over September
30, 1998 by their rate and volume components.
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
Sept. 30, 1999 Sept. 30, 1999
Over/Under Over/Under
Sept. 30, 1998 Sept. 30, 1998
Total Caused by: Total Caused by:
------------ -----------
Variance Rate Volume Variance Rate Volume
---------- ------------ -------- ---------- ----------- --------
Interest Income:
<S> <C> <C> <C> <C> <C> <C>
Securities * $ 5,125 $ 75 $ 5,050 $ 1,829 ($157) $ 1,986
Money market instruments (662) (187) (475) (304) (8) (296)
Loans * 4,751 (2,708) 7,459 2,415 (648) 3,063
---------- ------------ -------- ---------- ----------- --------
Total 9,214 (2,820) 12,034 3,940 (813) 4,753
---------- ------------ -------- ---------- ----------- --------
Interest Expense:
Savings deposits 184 (889) 1,073 88 (301) 389
Time deposits and certificates of deposit 736 (739) 1,475 270 (287) 557
Other borrowings 3,018 (67) 3,085 1,495 12 1,483
---------- ------------ -------- ---------- ----------- --------
Total 3,938 (1,695) 5,633 1,853 (576) 2,429
---------- ------------ -------- ---------- ----------- --------
Net interest income $ 5,276 ($1,125) $ 6,401 $ 2,087 ($237) $ 2,324
========== ============ ======== ========== =========== ========
*Tax Equivalent Basis
</TABLE>
PAGE 10
Taxable-equivalent net interest income was $48,342,000 for the first nine
months of 1999, compared to $43,066,000 for the same period in 1998, a 12.3% or
$5,276,000 increase. Taxable-equivalent net interest income rose primarily due
to a $6,401,000 increase related to securities and loan volumes, which was
partially offset by a reduction related to rate. Total taxable-equivalent
interest income grew $9,214,000, primarily the result of the higher volumes in
both the security and loan earning asset categories. Average year-to-date
securities and loans grew $95,484,000 and $122,242,000, respectively at
September 30, 1999, compared to the same period in 1998. This increase in
securities included securities purchased as part of a capital leverage program.
Securities purchased for the capital leverage program during the fourth quarter
of 1998 and third quarter of 1999 were $49,000,000 and $25,000,000,
respectively. The capital leverage program involves structured transactions in
which the banks borrow 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 $3,938,000 during the first nine 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 $85,824,000, compared to the first nine
months of 1998. This increase in other borrowings is primarily attributable to
the funding required for the $74,000,000 capital leverage program. The volume
of savings and time deposits grew 12.4% and 9.1%, respectively. The remaining
increase in deposit and other borrowing volumes was used to primarily finance
the growth in loans. 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 $16,695,000 was
$2,087,000 or 14.3% higher in the third quarter of 1999, compared to $14,608,000
for the same period in 1998. Interest income grew $3,940,000 during the period,
as a result of an increase in security and loan volumes. Third quarter average
securities and loans grew 31.5% and 17.6%, respectively, compared to the third
quarter of 1998. The increase in the interest income was partially offset by a
$1,853,000 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.
PAGE 11
NET INTEREST MARGIN
-------------------
The net interest margin of 4.59% for the nine-month period ended September
30, 1999, decreased from the 4.78% 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 programs during the fourth quarter of 1998
and the third quarter of 1999. At September 30, 1999, the capital leverage
program was yielding a spread of 1.72%. The reduction in the net interest
margin was also affected by the investment in bank owned life insurance from
which the income is reported in other income and the cost of funding the
investment is included in interest expense. Since the current competitive
interest rate environment will continue to place downward pressure on the net
interest margin, the banks expect an increase in net interest income through the
continued growth in market share of loans and deposits. The yield on earning
assets of 7.76% during the first nine months of 1999 was lower than the 8.05%
earned during the first nine 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 nine months of 1999, compared to the same
period in 1998. The third quarter 1999 net interest margin of 4.52% decreased
from the third quarter of 1998 net interest margin of 4.72.
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 nine months of 1999 the provision for loan losses was
$1,430,000, compared to $1,680,000 for the same period in 1998. The lower
provision for loan losses during the first nine months 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 $788,000 for the nine months
ended September 30, 1999, compared to $791,000 for the nine months ended
September 30, 1998. The ratio of the allowance for loan losses to nonperforming
assets for September 30, 1999 of 266.1% improved from the December 31, 1998 and
the September 30, 1998 ratios of 253.3% and 249.9%, 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 1,430,000 1,680,000
Loans charged off (991,000) (1,042,000)
Recoveries 203,000 251,000
----------------- -------------
Balance, September 30 14,348,000 13,481,000
================= =============
<S> <C> <C> <C>
Ratios: Sept. 30, 1999 Dec. 31, 1998 Sept. 30, 1998
- ------------------------------------------------- ----------------- --------------- ----------------
Allowance for loan losses to nonperforming assets 266.1% 253.3% 249.9%
Nonperforming assets to total loans & net assets
acquired in foreclosure 0.52% 0.60% 0.62%
Allowance for loan losses to total loans 1.39% 1.52% 1.56%
</TABLE>
PAGE 12
The following table sets forth an allocation of the allowance for loan losses by
loan category:
Sept. 30, 1999
--------------
<TABLE>
<CAPTION>
Percent
Amount of Loans
------- ---------
<S> <C> <C>
Commercial and industrial $ 6,876 27%
Consumer loans 3,874 32%
Real estate 2,885 33%
Lease financing 713 8%
------- ---------
Total $14,348 100%
======= =========
</TABLE>
Nonperforming assets (nonaccruing loans, net assets in foreclosure and
troubled debt restructured loans) were 0.52% of total loans and net assets
acquired in foreclosure at September 30, 1999, compared to 0.60% at December 31,
1998 and 0.62% at June 30, 1998. The ratio of the allowance for loan losses to
loans at September 30, 1999 of 1.39% was lower than both the December 31, 1998
ratio of 1.52% and the September 30, 1998 ratio of 1.56%.
Nonaccruing loans at September 30, 1999 of $4,715,000, increased $1,019,000
from the December 31, 1998 level of $3,696,000, and increased $1,087,000 from
the September 30, 1998 level of $3,628,000. The growth during these periods was
due to an increase in loans collateralized by commercial real estate.
Net assets in foreclosure totaled $202,000 as of September 30,
1999, a decrease of $929,000 from the December 31, 1998 balance of $1,131,000.
During the first nine months of 1999, transfers from loans to assets in
foreclosure were $708,000, payments on foreclosed properties totaled $1,556,000
and write-downs of assets in foreclosure equaled $81,000. The loans transferred
to assets in foreclosure included leases of $403,000, mortgages of $295,000 and
consumer loans of $10,000. The balance of net assets in foreclosure at
September 30, 1998 was $1,154,000. 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 September 30, 1999, there were two unrelated borrowers with troubled
debt restructured loans totaling $473,000, compared with three unrelated
borrowers with a balance of $583,000 as of December 31, 1998 and $612,000 at
September 30, 1998. The two customers were complying with the restructured terms
as of September 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 September 30, 1999, loans past due 90 days or more and
still accruing interest were $2,376,000 compared to $1,350,000 as of December
31, 1998 and $778,000 as of September 30, 1998. The increase in loans past due
90 days at September 30, 1999, compared to December 31, 1998 and September 30,
1998 was primarily due to a rise in commercial loans past due 90 days or more.
The following information concerns impaired loans:
<TABLE>
<CAPTION>
Impaired Loans: Sept. 30, 1999 Dec. 31, 1998 Sept. 30, 1998
--------------- -------------- ---------------
<S> <C> <C> <C>
Restructured Loans $ 473,000 $ 583,000 $ 612,000
Nonaccrual Loans $ 3,186,000 $ 1,513,000 $ 1,743,000
--------------- -------------- ---------------
Total Impaired Loans $ 3,659,000 $ 2,096,000 $ 2,355,000
=============== ============== ===============
Average year-to-date impaired loans: $ 2,859,000 $ 2,263,000 $ 2,200,000
=============== ============== ===============
Impaired loans with specific loss allowances: $ 3,659,000 $ 2,096,000 $ 2,355,000
=============== ============== ===============
Loss allowances reserved on impaired loans: $ 467,000 $ 302,000 $ 335,000
=============== ============== ===============
Year-to-date income recognized on impaired loans $ 106,000 $ 103,000 $ 49,000
=============== ============== ===============
</TABLE>
PAGE 13
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 collaterlized to cover
the outstanding obligations to the banks. The banks will not recognize income
if these factors do not exist.
OTHER OPERATING INCOME
- ----------------------
<TABLE>
<CAPTION>
Nine Months Ended Sept. 30, Three Months Ended Sept. 30,
1999 1998 1999 1998
(Dollars in thousands)
<S> <C> <C> <C> <C>
Service charges $2,611 $2,416 $ 903 $ 852
Security gains, net 458 900 7 574
Trust income 1,886 1,520 590 519
Bank-owned life insurance 170 - 170 -
Other income 2,111 2,247 710 999
------ ------ ------ ------
Total other operating income $7,236 $7,083 $2,380 $2,944
====== ====== ====== ======
</TABLE>
Other operating income for the first nine months of 1999 increased
$153,000, or 2.2%, from $7,083,000 at September 30, 1998 to $7,236,000 at
September 30, 1999. This rise in other operating income is the result of a
$195,000 growth in service charges, a $170,000 increase due to bank-owned life
insurance and a $366,000 rise in trust income. Offsetting these increases were
decreases in security gains and other income of $442,000 and $136,000,
respectively. In the third quarter of 1999 other income of $2,380,000 was
$564,000 or 19.2% lower than the same period in 1998. A reduction in security
gains was the primary source of this decrease.
The $195,000, or 8.1% 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 12.4% increase in average deposit transaction accounts in the
first nine months of 1999, compared to the first nine months in 1998. The 1999
third quarter service charge income of $903,000, increased $51,000, or 6.0% over
the third quarter of 1998.
The corporation recorded a net security gain of $458,000 in the
first nine months of 1999, compared to a $900,000 gain in the same period in
1998. The third quarter of 1999 net security gain of $7,000 decreased from the
$574,000 security gain recognized in the same period in 1998. The majority of
the security gains in 1998 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.
PAGE 14
Income from the corporation's Investment Management and Trust Services
Division increased $366,000, or 24.1% in the first nine months of 1999, compared
to the same period in 1998. The third quarter of 1999 trust income of
$590,000, was 13.7% higher than the third quarter of 1998. This increase was
the result of both an increase in the book value of trust assets under
management of 14.5% from September 30, 1998 to September 30, 1999, and the
corporation's continuing emphasis on marketing the Investment Management and
Trust Services Division's products and services.
During the third quarter of 1999, the corporation entered into a
$25,000,000 investment of bank owned life insurance (BOLI). BOLI involves the
corporation purchasing life insurance on a chosen group of employees. The
corporation pays all premiums and is the owner and beneficiary of the policies.
This pool of insurance, due to tax advantages unique to life insurance, is
profitable to the corporation. This profitability is used to offset a portion
of future benefit cost increases. Bank deposits fund BOLI and the earnings from
BOLI are recognized as other income. The corporation recognized $170,000 of
BOLI income during the third quarter of 1999.
Other income for the first nine months of 1999 decreased $136,000,
or 6.1%, compared to the same period in 1998. This decrease was primarily due
to a reduction of $213,000 on gains on the sale of residential mortgage loans,
resulting from the slowdown in the refinancing of residential mortgages during
1999. Offsetting this decrease were increases in gains on the sale of off lease
vehicles and equipment, and a rise in ATM fees. The third quarter of 1999 other
income of $710,000 was lower than the third quarter of 1998 other income of
$999,000. This $289,000 reduction is attributed to lower gains recognized on
the sale of residential mortgages during the third quarter of 1999, compared to
the third quarter of 1998.
OTHER OPERATING EXPENSES
- ------------------------
<TABLE>
<CAPTION>
Nine Months Ended Sept. 30, Three Months Ended Sept. 30,
1999 1998 1999 1998
(Dollars in thousands)
<S> <C> <C> <C> <C>
Salaries $11,233 $10,561 $3,864 $3,590
Employee benefits 3,610 3,303 1,160 1,029
Net occupancy expense 1,851 1,702 640 603
Equipment expense 3,126 2,568 1,169 940
Other expenses 7,828 7,316 2,616 2,355
------- ------- ------ ------
Total other operating expenses $27,648 $25,450 $9,449 $8,517
======= ======= ====== ======
</TABLE>
Other operating expenses for the first nine months of 1999 of $27,648,000
increased $2,198,000, or 8.6%, from $25,450,000 for the same period in 1998.
The 1999 third quarter other operating expenses grew 10.9% compared to the third
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 20.7% growth in total assets and our 16.1% increase in year-to-date income.
Employee salaries increased $672,000, or 6.4% from $10,561,000 for the
first nine months of 1998 to $11,233,000 for the same period in 1999. Employee
benefits of $3,610,000 expensed in the first nine months of 1999, were $307,000,
or 9.3% higher than the $3,303,000 of employee benefits expensed during the same
period in 1998. Salaries and employee benefits grew 7.6% and 12.7%,
respectively in the third quarter of 1999, compared to the third 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.
PAGE 15
Net occupancy expense increased $149,000, or 8.8%, from $1,702,000 in the
first nine months of 1998 to $1,851,000 in the first nine months of 1999. The
third quarter of 1999 occupancy expense grew 6.1%, compared to the third quarter
of 1998. Two new branches opened after June 1998 were primarily responsible for
the increase in occupancy expense. Equipment expense increased $558,000, or
21.7%, during the first nine months of 1999, compared to the same period in
1998. The third quarter of 1999 equipment expense grew 24.4% over the third
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 $512,000, or 7.0%, from $7,316,000 in the
first nine months of 1998, compared to $7,828,000 in other expenses recorded
during the same period in 1999. The third quarter of 1999 other expenses grew
by 11.1% over the third quarter of 1998. This increase is the result of an
additional accrual for a residual insurance account for leased automobiles and
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 September 30, 1999, of $482,088,000 grew
$50,130,000, or 11.6% over the December 31, 1998 balance of $431,958,000.
Securities purchased for the leverage program during third quarter of 1999
represented $25,000,000 of this growth. The September 30, 1999 balance grew
$91,548,000, or 23.4% compared to the September 30, 1998 balance of
$390,540,000. This increase included the $74,000,000 in securities purchased as
part of the capital leverage program.
LOANS
Total loans grew $126,821,000, or 14.0% from the December 31, 1998 balance
of $902,884,000 to the September 30, 1999 balance of $1,029,705,000. The
September 30, 1999 balance grew $162,043,000, or 18.7% compared to the June 30,
1998 balance of $867,662,000. These increases were primarily due to growth in
commercial loans, leases and indirect automobile lending.
DEPOSITS & OTHER BORROWINGS
The primary funding sources of the corporation is deposits and other
borrowings. Total deposits of $1,195,789,000 at September 30, 1999, increased
$91,473,000, or 8.3% from the $1,104,316,000 balance at December 31, 1998. This
increases occurred primarily in money market accounts and certificates of
deposits. The growth in deposits at September 30, 1999, compared to September
30, 1998 was $137,029,000, or 12.9%. All deposit categories increased during
this period. Other borrowings of $262,595,000 at September 30, 1999, grew
$113,617,000, compared to December 31, 1998. This growth was the result of
increases in federal funds purchased and FHLB borrowings. The September 30,
1999 other borrowings increased $139,956,000, compared to the September 30, 1998
balance. This increase in other borrowings was used to fund the leverage
program and loan demand.
PAGE 16
CAPITAL
- -------
Capital formation is important to the corporation's well being
and future growth. Capital for the period ending September 30, 1999 was
$129,460,000, a decrease of $1,493,000 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
September 30, 1999 was a loss of $7,044,000, compared to a gain of $5,384,000 at
December 31, 1998. The market value of the available for sale investment
securities was reduced due to the change in interest rates experienced during
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.
(Dollars in thousands)
<TABLE>
<CAPTION>
Capital Level required to Capital Level required
As of September 30, 1999 Actual be Adequacy Capitalized to be Well Capitalized
- ------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------ -------------------------- ------ ----------------------- ------
Total Capital (to risk weighted assets):
- ------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Corporation $150,110 12.85% $ 93,458 8.00% $ 116,822 10.00%
Harleysville National Bank 80,705 9.16% 70,502 8.00% 88,127 10.00%
Citizens National Bank 33,361 18.18% 14,679 8.00% 18,349 10.00%
Security National Bank 8,324 9.81% 6,791 8.00% 8,489 10.00%
Tier 1 Capital (to risk weighted assets):
- ------------------------------------------
Corporation 135,279 11.58% 46,729 4.00% 70,093 6.00%
Harleysville National Bank 69,874 7.93% 35,251 4.00% 52,876 6.00%
Citizens National Bank 31,065 16.93% 7,340 4.00% 11,009 6.00%
Security National Bank 7,293 8.59% 3,396 4.00% 5,093 6.00%
Tier 1 Capital (to average assets):
- ------------------------------------------
Corporation 135,279 8.74% 61,890 4.00% 77,362 5.00%
Harleysville National Bank 69,874 6.05% 46,219 4.00% 57,774 5.00%
Citizens National Bank 31,065 11.80% 10,533 4.00% 13,166 5.00%
Security National Bank 7,293 6.36% 4,587 4.00% 5,734 5.00%
(Dollars in thousands)
Capital Level required to Capital Level required
As of December 31, 1998 Actual be Adequacy Purposes to be Action Provision
- ------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------ -------------------------- ------ ----------------------- ------
Total Capital (to risk weighted assets):
- ------------------------------------------
Corporation $137,371 13.77% $ 79,823 8.00% $ 99,778 10.00%
Harleysville National Bank 70,733 9.70% 58,316 8.00% 72,895 10.00%
Citizens National Bank 32,040 17.90% 14,321 8.00% 17,901 10.00%
Security National Bank 7,629 10.74% 5,680 8.00% 7,101 10.00%
Tier 1 Capital (to risk weighted assets):
- ------------------------------------------
Corporation 124,039 12.43% 39,911 4.00% 59,867 6.00%
Harleysville National Bank 61,603 8.45% 29,158 4.00% 43,737 6.00%
Citizens National Bank 29,868 16.69% 7,160 4.00% 10,740 6.00%
Security National Bank 6,741 9.49% 2,840 4.00% 4,260 6.00%
Tier 1 Capital (to average assets):
- ------------------------------------------
Corporation 124,039 9.05% 54,817 4.00% 68,521 5.00%
Harleysville National Bank 61,603 6.11% 40,191 4.00% 50,238 5.00%
Citizens National Bank 29,868 11.64% 10,263 4.00% 12,828 5.00%
Security National Bank 6,741 7.10% 3,799 4.00% 4,749 5.00%
</TABLE>
PAGE 17
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 9.25% at
September 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 September 30, 1999, the corporation's Tier 1 risk-adjusted
capital ratio was 11.58%, and the total risk-adjusted capital ratio was 12.85%,
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, 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 8.74% at September 30, 1999 and 9.05% at
December 31, 1998.
The year-to-date September 30, 1999 cash dividend per share of $.75 was
7.1% higher than the cash dividend for the same period in 1998 of $.70. The
dividend payout ratio for the first nine months of 1999 was 35.23%; 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 nine
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 $9,025,000 during the first nine months of 1999 and
securities available for sale averaged $427,720,000 during the first nine 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 $118,971,000, as of September 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.
Other than as described below, management is not aware of any other
current specific recommendations by regulatory authorities or proposed
legislation, which if they were implemented, would have a material adverse
effect upon the liquidity, capital resources, or results of operations, although
the general cost of compliance with numerous and multiple federal and state laws
and regulations does have, and in the future may have, a negative impact on the
corporation's results of operations.
PAGE 18
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
-------------------
Congress approved legislation to modify the financial services
industry and the way commercial banks and other financial institutions
operate. The legislation only needs the President's signature to be enacted.
The legislation includes changes to the ownership of financial companies and
the types of products and services that may be offered by financial institu-
tions. 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, that
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,
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. The remediation
phase was completed during the third quarter of 1999.
PAGE 19
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 Y2K Committee has prepared a Y2K budget and has tracked expenses
related to the Y2K issue. As of September 30, 1999, the corporation has
expensed $227,000 and capitalized fixed assets of $116,000 related to the Y2K
issue. The corporation has estimated the future Y2K expenditures to be
$128,000. 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 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 testing of
the contingency plan was completed during the third quarter of 1999. The
corporation has also utilized an independent consulting firm to verify and
validate the corporation's Y2K plans.
PAGE 20
BRANCHING
---------
The corporation's subsidiaries currently plan to open at least one
new branch. Harleysville National Bank is pursuing a location in Souderton.
This new branch site is contiguous to our current service area and was 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., 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 21
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.)
PAGE 22
(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.)
(10.7) Harleysville National Corporation 1998 Stock Incentive Plan.
(Incorporated by Reference to Registrant's Registration
Statement No.333-79971 on Form S-8 filed with the Commission
on June 4, 1999.)
(10.8) Harleysville National Corporation 1998 Independent Directors
Stock Option Plan. (Incorporated by Reference to Registrant's
Registration Statement No. 333-79973 on Form S-8 filed with
the Commission on June 4, 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.
PAGE 23
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 12, 1999
PAGE 24
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.)
(10.7) Harleysville National Corporation 1998 Stock Incentive Plan.
(Incorporated by Reference to Registrant's Registration
Statement No. 333-79971 on Form S-8 filed with the Commission
on June 4, 1999).
(10.8) Harleysville National Corporation 1998 Independent Directors
Stock Option Plan. (Incorporated by Reference to Registrant's
Registration Statement No. 333-79973 on Form S-8 filed with
the Commission on June 4, 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.
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