EX-13 2 rar2000.txt FINANCIAL RATIOS AND SUMMARY OF KEY INFORMATION HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
Year Ended December 31, ------------------------------------- (Dollars in thousands, except per share data and average shares outstanding) 2000 1999 1998 ------------------------------------- Per Share Information Basic* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2.76 $ 2.51 $ 2.24 Diluted* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.76 $ 2.50 $ 2.24 Cash dividends paid* . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.13 1.02 0.90 Book value (at year-end) . . . . . . . . . . . . . . . . . . . . . . . . . . 18.75 16.60 17.69 Market Value Bid price of common stock (high)*. . . . . . . . . . . . . . . . . . . . . . $ 34.69 36.28 39.46 Bid price of common stock (low)* . . . . . . . . . . . . . . . . . . . . . . 22.62 30.00 29.48 Average basic shares outstanding*. . . . . . . . . . . . . . . . . . . . . . 9,268,681 9,273,397 9,262,819 Average Balance Sheet Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,166,684 $1,031,055 $ 894,758 Earning assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,739,068 1,566,194 1,354,306 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,843,525 1,639,041 1,413,772 Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,436,781 1,267,936 1,144,822 Other interest-bearing liabilities and deposits. . . . . . . . . . . . . . . 1,655,592 1,462,823 1,244,238 Shareholder's equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154,547 148,636 142,959 Selected Operating Ratios Return on average assets . . . . . . . . . . . . . . . . . . . . . . . . . . 1.39% 1.42% 1.47% Return on average shareholder's equity . . . . . . . . . . . . . . . . . . . 16.57% 15.63% 14.52% Leverage (assets divided by shareholders' equity). . . . . . . . . . . . . . 11.15 12.05 10.31 Average shareholders' equity as a percentage of: . . . . . . . . . . . . . . Average loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.25% 14.42% 15.98% Average deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.76 11.72 12.49 Average assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.38 9.07 10.11 Average earning assets. . . . . . . . . . . . . . . . . . . . . . . . . 8.89 9.49 10.56 Dividend payout ratio. . . . . . . . . . . . . . . . . . . . . . . . . . . . 40.74 40.34 38.84 Average total loans as a percentage of average deposits and borrowed funds . 70.47 70.48 71.91 Net interest margin on average earning assets: . . . . . . . . . . . . . . . Interest income** . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.92% 7.65% 7.87% Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . (3.78) (3.23) (3.28) Net interest margin . . . . . . . . . . . . . . . . . . . . . . . . . . 4.14 4.42 4.59 Noninterest margin. . . . . . . . . . . . . . . . . . . . . . . . . . . (1.87) (2.01) (2.06) * Adjusted for 5% stock dividends effective 11/9/00 and 9/30/99. ** Tax-Equivalent Basis
PAGE 1 DESCRIPTION OF BUSINESS Harleysville National Corporation, a Pennsylvania corporation (the Corporation), was incorporated in June 1982. On January 1, 1983, the Corporation became the parent bank holding company of Harleysville National Bank and Trust Company (HNB), a wholly-owned subsidiary of the Corporation. On February 13, 1991, the Corporation acquired all of the outstanding common stock of The Citizens National Bank (CNB). On June 1, 1992, the Corporation acquired all of the outstanding stock of Summit Hill Trust Company (Summit Hill). On September 25, 1992, Summit Hill merged into CNB and is now operating as a branch office of CNB. On July 1, 1994, the Corporation acquired all of the outstanding stock of Security National Bank (SNB). On March 1, 1996, the Corporation acquired all of the outstanding common stock of Farmers & Merchants Bank (F&M). F&M was merged into CNB and is now operating as a branch office of CNB. On March 17, 1997, the HNC Financial Company was incorporated as a Delaware Corporation. HNC Financial Company's principal business function is to expand the investment opportunities of the Corporation. On January 20, 1999, the Corporation acquired all of the outstanding stock of Northern Lehigh Bancorp, Inc., parent company of Citizens National Bank of Slatington. Citizens National Bank of Slatington was merged into CNB. On April 28, 2000, the Corporation acquired all of the out-standing common stock of Citizens Bank and Trust Company (CB &T). CB & T was merged into CNB. HNB, which was established in 1909, CNB, which was established in 1903, and SNB, which was established in 1988, (collectively the Banks), are national banking associations under the supervision of the Office of the Comptroller of the Currency. The Corporation's and HNB's legal headquarters are located at 483 Main Street, Harleysville, Pennsylvania 19438. CNB's legal headquarters are located at 13-15 West Ridge Street, Lansford, Pennsylvania 18232. SNB's legal head-quarters are located at One Security Plaza, Pottstown, Pennsylvania 19464. HNC Financial Company's legal headquarters are located at 300 Delaware Avenue, Suite 1704, Wilmington, Delaware 19801. As of December 31, 2000, the Corporation had total assets of $1,935,213,000, total shareholders' equity of $173,536,000 and total deposits of $1,489,050,000. The Banks engage in full-service commercial banking and trust business, including accepting time and demand deposits, making secured and unsecured commercial and consumer loans, financing commercial transactions, making construction and mortgage loans and performing corporate pension and personal investment and trust services. Their deposits are insured by the Federal Deposit Insurance Corporation (FDIC) Bank Insurance Fund to the extent provided by law. The Banks have 40 branch offices located in Montgomery Bucks, Chester, Berks, Carbon, Wayne, Monroe, Lehigh, Northampton and Schuylkill Counties, Pennsylvania. On December 31, 2000, the Banks had 579 full-time equivalent employees. Competition The Banks compete actively with other eastern Pennsylvania financial institutions, many larger than the Banks, as well as with financial and nonfinancial institutions headquartered elsewhere. The Banks are generally competitive with all competing institutions in their service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts, interest rates charged on loans, and fees and charges for trust services. Supervision and Regulation The operations of the Banks are subject to federal, state and local statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System and to banks whose deposits are insured by the FDIC. The Banks' operations are also subject to the regulations of the Federal Reserve Board, the FDIC and the Office of the Comptroller of the Currency (who regularly examines the Banks' areas such as asset quality, investments, management practices and other aspects of bank operations). The Corporation is subject to federal and state securities laws, certain rules and regulations of the Securities and Exchange Commission, to the provisions of the Bank Holding Company Act of 1956, as amended, and to supervision by the Federal Reserve Board. Market Information The following table sets forth quarterly dividend information and the high and low prices for the Corporation's common stock for 2000 and 1999. The Corporation's stock is traded in the over-the-counter market under the symbol "HNBC" and commonly quoted under NASDAQ National Market Systems. Price of Common Stock 2000 Low Price High Price Dividend ----------------------------------------------------- First Quarter* . . . $ 22.62 $ 30.95 $ .26 Second Quarter*. . . 24.46 31,19 .27 Third Quarter* . . . 24.05 32.50 .28 Fourth Quarter . . . 27.25 34.69 .32 1999 Low Price High Price Dividend ------------------------------------------------------ First Quarter** . . . $ 30.00 $ 36.28 $ .23 Second Quarter**. . . 30.84 33.33 .24 Third Quarter*. . . . 31.51 33.57 .25 Fourth Quarter* . . . 30.00 32.27 .30 * Adjusted for a 5% stock dividend effective 11/09/00. **Adjusted for a 5% stock dividend effective 09/30/99. PAGE 5 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES TO THE BOARD OF DIRECTORS AND SHAREHOLDERS, HARLEYSVILLE NATIONAL CORPORATION: We have audited the accompanying consolidated balance sheets of Harleysville National Corporation and Subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the following consolidated financial statements present fairly, in all material respects, the consolidated financial position of Harleysville National Corporation and Subsidiaries as of December 31, 2000 and 1999, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. /s/ Grant Thornton LLP Grant Thornton LLP Philadelphia, Pennsylvania January 10, 2001 PAGE 6 CONSOLIDATED BALANCE SHEETS HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES (Dollars in thousands) December 31 ------------------------ Assets 2000 1999 ------------------------ Cash and due from banks . . . . . . . . . . . . . $ 52,018 $ 49,654 Federal funds sold. . . . . . . . . . . . . . . . - 6,600 ----------- ----------- Total cash and cash equivalents . . . . . . . . 52,018 56,254 ----------- ----------- Interest-bearing deposits in banks. . . . . . . . 3,507 7,237 Investment securities available for sale. . . . . 570,619 505,350 Investment securities held to maturity (fair value $31,601 and $25,094, respectively). . 30,841 25,545 Loans . . . . . . . . . . . . . . . . . . . . . . 1,209,605 1,118,244 Less: Deferred costs, net . . . . . . . . . . . . 2,450 572 Allowance for loan losses . . . . . . . . . (15,210) (14,887) ----------- ----------- Net loans . . . . . . . . . . . . . . . . 1,196,845 1,103,929 ----------- ----------- Bank premises and equipment, net. . . . . . . . . 21,870 21,933 Accrued interest receivable . . . . . . . . . . . 12,391 11,044 Other real estate owned . . . . . . . . . . . . . 288 1,436 Intangible assets, net. . . . . . . . . . . . . . 1,697 2,006 Bank-owned life insurance . . . . . . . . . . . . 37,4712 5,527 Other assets. . . . . . . . . . . . . . . . . . . 7,666 7,406 ----------- ----------- Total assets. . . . . . . . . . . . . . . $1,935,213 $1,767,667 =========== =========== Liabilities and Shareholders' Equity Deposits: Noninterest-bearing. . . . . . . . . . . . . 227,446 214,384 Interest-bearing: Checking accounts . . . . . . . . . . . . 163,807 162,190 Money market accounts . . . . . . . . . . 333,622 259,015 Savings 161,233 163,011 Time, under $100,000. . . . . . . . . . . 430,074 407,858 Time, $100,000 or greater . . . . . . . . 172,868 134,979 ----------- ----------- Total deposits. . . . . . . . . . . . . . 1,489,050 1,341,437 Accrued interest payable. . . . . . . . . . . . . 22,346 17,544 U.S. Treasury demand notes. . . . . . . . . . . . 2,055 3,232 Federal funds purchased . . . . . . . . . . . . . 44,500 9,500 Federal Home Loan Bank (FHLB) borrowings. . . . . 110,750 130,250 Securities sold under agreements to repurchase. . 74,083 108,615 Other liabilities . . . . . . . . . . . . . . . . 18,893 10,426 ----------- ----------- Total liabilities . . . . . . . . . . . . 1,761,677 1,621,004 ----------- ----------- 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 9,253,762 shares in 2000 and 8,835,102 shares in 1999 . . . . . . 9,254 8,835 Additional paid in capital. . . . . . . . . . 79,869 68,260 Retained earnings . . . . . . . . . . . . . . 83,244 80,376 Treasury stock; 2000-8,500 shares at cost . . (253) - Accumulated other comprehensive income (loss) 1,422 (10,808) ----------- ----------- Total shareholders' equity. . . . . . . . 173,536 146,663 ----------- ----------- Total liabilities and shareholders' equity $1,935,213 $1,767,667 =========== =========== =========================================================================== See accompanying notes to consolidated financial statements. PAGE 7>
CONSOLIDATED STATEMENTS OF INCOME HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES (Dollars in thousands except weighted average number of common shares and per share information) Year Ended December 31 ---------------------------------- 2000 1999 1998 ---------------------------------- Interest Income Loans, including fees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 87,131 $ 76,350 $ 70,295 Lease financing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,013 6,960 5,084 Investment securities: Taxable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,205 19,485 16,380 Exempt from federal taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . 10,870 10,570 8,586 Federal funds sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219 552 1,373 Deposits in banks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 373 250 287 ---------- ---------- ---------- Total interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131,811 114,167 102,005 ---------- ---------- ---------- Interest Expense Savings deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,337 14,272 13,837 Time, under $100,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,465 20,695 20,427 Time, $100,000 or greater. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,282 6,017 5,308 Borrowed funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,690 9,665 4,800 ---------- ---------- ---------- Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65,774 50,649 44,372 ---------- ---------- ---------- Net interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,037 63,518 57,633 Provision for loan losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,312 2,153 2,288 ---------- ---------- ---------- Net interest income after provision for loan losses. . . . . . . . . . . . . . 63,725 61,365 55,345 ---------- ---------- ---------- Other Operating Income Service charges. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,832 3,771 3,530 Security gains, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 495 1,621 Trust income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,977 2,643 2,156 Bank-owned life insurance income . . . . . . . . . . . . . . . . . . . . . . . . . 1,944 526 - Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,401 3,100 3,213 ---------- ---------- ---------- Total other operating income . . . . . . . . . . . . . . . . . . . . . . . . . 12,206 10,535 10,520 ---------- ---------- ---------- Net interest income after provision for loan losses and other operating income 75,931 71,900 65,865 ---------- ---------- ---------- Other Operating Expenses Salaries, wages and employee benefits. . . . . . . . . . . . . . . . . . . . . . . 23,745 22,271 20,551 Occupancy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,927 2,684 2,573 Furniture and equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,134 4,774 3,857 Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,871 12,247 11,465 ---------- ---------- ---------- Total other operating expenses . . . . . . . . . . . . . . . . . . . . . . . . 44,677 41,976 38,446 ---------- ---------- ---------- Income before income tax expense . . . . . . . . . . . . . . . . . . . . . . . 31,254 29,924 27,419 Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,650 6,686 6,661 ---------- ---------- ---------- Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 25,604 $ 23,238 $ 20,758 ========== ========== ========== Weighted average number of common shares:* Basic. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,268,681 9,273,397 9,262,819 ========== ========== ========== Diluted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,279,273 9,285,241 9,278,194 ========== ========== ========== Net income per share information:* ========== ========== ========== Basic. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2.76 $ 2.51 $ 2.24 ========== ========== ========== Diluted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2.76 $ 2.50 $ 2.24 ========== ========== ========== Cash dividends per share*. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1.13 $ 1.02 $ 0.90 ========== ========== ========== *Adjusted for 5% stock dividends effective 11/9/00 and 9/30/99. ======================================================================================================================= See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES (Dollars in thousands) Common Stock Accumulated ----------------- Other Number of Par Additional Retained Comprehensive Treasury Comprehensive Shares Value Paid in Capital Earnings Income(Loss) Stock Total Income(Loss) ------------------------------------------------------------------------------------------------ Balance, January 1, 1998 . . . . 7,518 $ 7,518 $ 50,563 $ 55,103 $ 4,462 - $117,646 Acquisition of Citizens Bank and Trust Company. . . . . . . . 920 920 5,180 11,283 186 - 17,569 Stock options. . . . . . . . . . 18 18 331 - - - 349 Stock dividends. . . . . . . . . - - - 1 - - 1 Stock awards . . . . . . . . . . - - 5 - - - 5 Net income for 1998. . . . . . . - - - 20,758 - - 20,758 $ 20,758 Other comprehensive income, net of reclassifications and tax - - - - 1,124 - 1,124 1,124 Purchases of Treasury stock. . . - - - - - - - Cash dividends . . . . . . . . . - - - (8,062) - - (8,062) ------------------------------------------------------------------------------------------------ Comprehensive income . . . . . . $ 21,882 ============= Balance, December 31, 1998 . . . 8,456 8,4565 6,079 79,083 5,772 - 149,390 Stock options. . . . . . . . . . 3 3 28 - - - 31 Stock dividends. . . . . . . . . 376 3761 2,145 (12,570) - - (49) Stock awards . . . . . . . . . . - - 8 - - - 8 Net income for 1999. . . . . . . - - - 23,238 - - 23,238 $ 23,238 Other comprehensive loss, net of reclassifications and tax - - - - (16,580) - (16,580) (16,580) Cash dividends . . . . . . . . . - - - (9,375) - - (9,375) ------------------------------------------------------------------------------------------------ Comprehensive income . . . . . . $ 6,658 ============= Balance, December 31, 1999 . . . 8,835 8,835 68,260 80,376 (10,808) - 146,663 Stock options. . . . . . . . . . 4 4 30 - - - 34 Stock dividends. . . . . . . . . 415 415 11,566 (12,306) - 325 - Stock awards . . . . . . . . . . - - 13 - - - 13 Net income for 2000. . . . . . . - - - 25,604 - - 25,604 $ 25,604 Other comprehensive income, net of reclassifications and tax - - - - 12,230 - 12,230 12,230 Treasury stock . . . . . . . . . - - - - - (578) (578) Cash dividends . . . . . . . . . - - - (10,430) - - (10,430) ------------------------------------------------------------------------------------------------ Comprehensive income . . . . . . $37,834 ============= Balance, December 31, 2000 . . . 9,254 $ 9,254 $ 79,869 $ 83,244 $ 1,422 $ (253) $173,536 ================================================================================================ ================================================================================================================================== See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES (Dollars in thousands) Year Ended December 31 ---------------------------------- 2000 1999 1998 ---------------------------------- Operating Activities Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 25,604 $ 23,238 $ 20,758 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . 2,312 2,153 2,288 Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . 3,043 2,937 2,397 Net amortization of investment securities discount/premiums . . . . . . . . . 391 961 572 Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,337 3,646 1,475 Net realized securities gain. . . . . . . . . . . . . . . . . . . . . . . . . (52) (495) (1,621) Increase in accrued income receivable . . . . . . . . . . . . . . . . . . . . (1,347) (530) (1,457) Increase (decrease) in accrued interest payable . . . . . . . . . . . . . . . 4,802 3,038 (615) Net increase in other assets. . . . . . . . . . . . . . . . . . . . . . . . . (184) (2,106) (1,167) Net (decrease) increase in other liabilities. . . . . . . . . . . . . . . . . (1,431) 517 2,299 Decrease in unearned income . . . . . . . . . . . . . . . . . . . . . . . . . (1,878) (3,381) (1,911) Write-down of other real estate owned . . . . . . . . . . . . . . . . . . . . 86 117 65 Decrease (increase) in intangible assets. . . . . . . . . . . . . . . . . . . 309 (70) (84) ---------- ---------- ---------- Net cash provided by operating activities . . . . . . . . . . . . . . . . 34,992 30,025 22,999 ---------- ---------- ---------- Investing Activities Proceeds from sales of investment securities available for sale . . . . . . . . . 33,208 77,177 67,003 Proceeds, maturity or calls of investment securities held to maturity . . . . . . 6,869 11,214 21,044 Proceeds, maturity or calls of investment securities available for sale . . . . . 32,238 78,403 57,765 Purchases of investment securities held to maturity . . . . . . . . . . . . . . . (19,740) (10,632) (13,083) Purchases of investment securities available for sale . . . . . . . . . . . . . . (204,688) (221,056) (249,143) Net decrease (increase) in interest-bearing deposits in banks . . . . . . . . . . 3,730 (1,827) 806 Net increase in loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (94,783) (161,726) (104,988) Net increase in premises and equipment. . . . . . . . . . . . . . . . . . . . . . (3,056) (3,785) (3,410) Purchase of bank-owned life insurance . . . . . . . . . . . . . . . . . . . . . . (11,944) (25,527) - Proceeds from sales of other real estate. . . . . . . . . . . . . . . . . . . . . 2,495 1,765 1,060 ---------- ---------- ---------- Net cash used in investing activities . . . . . . . . . . . . . . . . . . (155,671) (255,994) (222,946) ---------- ---------- ---------- Financing Activities Net increase in deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147,613 130,112 124,072 (Decrease) increase in U.S. Treasury demand notes . . . . . . . . . . . . . . . . (1,177) 973 110 Increase (decrease) in federal funds purchased. . . . . . . . . . . . . . . . . . 35,000 (1,500) (2,700) (Decrease) increase in FHLB borrowings. . . . . . . . . . . . . . . . . . . . . . (19,500) 36,750 76,500 (Decrease) increase in securities sold under agreement. . . . . . . . . . . . . . (34,532) 63,746 13,320 Cash dividends and fractional shares. . . . . . . . . . . . . . . . . . . . . . . (10,430) (9,375) (8,062) Dividends reinvestment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (49) - Repurchase of common stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . (578) (183) (1,318) Stock options 47 39 354 ---------- ---------- ---------- Net cash provided by financing activities . . . . . . . . . . . . . . . . 116,443 220,513 202,276 ---------- ---------- ---------- Net (decrease) increase in cash and cash equivalents. . . . . . . . . . . . . . . (4,236) (5,456) 2,329 Cash and cash equivalents at beginning of year. . . . . . . . . . . . . . . . . . 56,254 61,710 59,381 ---------- ---------- ---------- Cash and cash equivalents at end of year. . . . . . . . . . . . . . . . . . . . . $ 52,018 $ 56,254 $ 61,710 ========== ========== ========== Cash paid during the year for: Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 60,973 $ 47,611 $ 44,793 ========== ========== ---------- Income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,348 3,356 4,790 ========== ========== ========== Supplemental disclosure of noncash investing and financing activities: Transfer of assets from loans to other real estate owned. . . . . . . . . . . $ 1,433 $ 2,186 $ 1,918 ========== ========== ========== Transfer of securities from investment securities held to maturity to investment securities available for sale. . . . . . . . . . . . . . . . . . . $ 7,574 $ 7,530 $ - ========== ========== ========== ===================================================================================================================== See accompanying notes to consolidated financial statements.
PAGE 10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES 1 / SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business Harleysville National Corporation (the Corporation) through its subsidiary banks, Harleysville National Bank and Trust Company, Citizens National Bank, and Security National Bank (collectively the Banks), provides a full range of banking services to individual and corporate customers located in eastern Pennsylvania. The Banks compete with other banking and financial institutions in their primary market communities, including financial institutions with resources substantially greater than their own. Commer cial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for deposits and for various types of loans. Such institutions, as well as consumer finance and insurance companies, may be considered competitors of the Banks with respect to one or more of the services they render. In addition to being subject to competition from other financial institutions, the Banks are subject to federal and state laws and to regulations of certain federal agencies, and, ac cordingly, they are periodically examined by those regulatory authorities. Basis of Financial Statement Presentation The accounting and reporting policies of the Corporation and its Subsidiaries conform with generally accepted accounting principles applicable to banks. All significant intercompany transactions are eliminated in consolidation and certain reclassifications are made when necessary to conform with the previous years' financial statements to the current year's presentation. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amo unts of assets and liabilities as of the dates of the balance sheets and revenues and expenditures for the periods presented. Therefore, actual results could differ significantly from those estimates. Investment Securities The Corporation accounts for securities under the Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which requires among other things, that debt and equity securities classified as available for sale be reported at fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income, net of income taxes. The net effect of unrealized gains or losses, caused by marking an available for sale portfolio to market, could cause fluctuations in the level of shareholders' equity and equity-related financial ratios as market interest rates cause the fair value of fixed-rate securities to fluctuate. Investment securities are classified as held to maturity when the Corporation and its Subsidiaries have the ability and intent to hold those securities to maturity. These investment securities are carried at cost, adjusted for amortization of premiums and accretion of discounts. Investment securities expected to be held for an indefinite period of time are classified as available for sale and are stated at fair value. Realized gains and losses on the sale of investment securities are recognized using the specific identification method and are included in the consolidated statements of income. Loans Loans are stated at the principal amount outstanding. Net loans represent the principal loan amount outstanding reduced by unearned income and allowance for loan losses. Interest on loans is credited to income based on the principal amount outstanding. Lease financing represents automobile and equipment leasing. The lease financing receivable included in loans is stated at the gross amount of lease payments receivable plus the residual value less income to be earned over the life of the leases. Such income is recognized over the term of the leases using the level yield method. Loan origination fees and direct loan origination costs of completed loans are deferred and recognized over the life of the loan as an adjustment to yield. The net loan origination fees recognized as yield adjustments are reflected in total interest income in the consolidated statements of income, and the unamortized balance of such net loan origination fees is reported in the consolidated balance sheets as part of deferred costs, net. Income recognition of interest is discontinued when, in the opinion of management, the collectibility of such interest becomes doubtful. A loan is generally classified as nonaccrual when principal or interest has consistently been in default for a period of 90 days or more or because of a deterioration in the financial condition of the borrower, and payment in full of principal or interest is not expected. Loans past due 90 days or more and still accruing interest are loans that are generally well-secured and expected to be restored to a current status in the near future. The Corporation accounts for impaired loans under SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures." This standard requires that a creditor measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable. The Corporation adopted SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," as amended by SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125 - An Amendment of FASB Statement No. 125" on January 1, 1997. SFAS No. 125 applies a control-oriented, financial components approach to financial-asset-transfer transactions whereby the Corporation (1) recognizes the financial and servicing assets it controls and the liabilities it has incurred, (2) derecognizes financial assets when control has been surrendered, and (3)derecognizes liabilities once they are extinguished. Under SFAS No. 125, control is considered to have been surrendered only if: (i) the transferred assets have been isolated from the transferor and its creditors, even in bankruptcy or other receivership (ii) the transferee has the right to pledge or exchange the transferred assets, or, is a qualifying special purpose entity (as defined) and the holders of beneficial interests in that entity have the right to pledge or exchange those interests; and (iii) the transferor does not maintain effective control over the transferred assets through an agreement which both entitles and obligates it to repurchase or redeem those assets prior to maturity, or through an agreement which both entitles and obligates it to repurchase or redeem those assets if they were not readily obtainable elsewhere. If any of these conditions are not met, the Corporation accounts for the transfer as a secured borrowing. PAGE 11 SFAS No. 125 also requires that the Corporation derecognize a liability if and when it is extinguished. A liability is considered extinguished under SFAS No. 125 if (1) the Corporation pays the creditor, and thus, is relieved of it obligation for the liability, or (2) is legally released from being the primary obligor under the liability, either judicially or by the creditor. The adoption of this statement did not have a material impact on the Corporation's consolidated financial position or results of operations. In September 2000, the Financial Accounting Standards Board has adopted SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", which replaces SFAS No. 125, "Accounting for Transfers and Servicing of Financial Asset and Extinguishments of Liabilities," revises the standards for accounting for the securitizations and other transfers of financial assets and collateral. This new standard also requires certain disclosures, but carries over most of the provisions of SFAS 125. SFAS 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. However, for recognition and reclassification of collateral and for disclosures relating to securititzation transactions and collateral this statement is effective for fiscal years ending after December 15, 2000, with earlier applications not allowed and is to be applied prospectively. The adoption of this statement is not expected to have a material impact on the Corporation's consolidated financial statements. Allowance for Loan Losses The allowance for loan losses is maintained at a level that management considers adequate to provide for potential losses based upon an evaluation of known and inherent risks in the loan portfolio. Allowance for loan losses is based on estimated net realizable value unless it is probable that loans will be foreclosed, in which case allowance for loan losses is based on fair value less selling costs. Management's periodic evaluation is based upon evaluation of the portfolio, past loss experience, current economic conditions and other relevant factors. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Banks' allowances for loan losses. Such agencies may require the Banks to recognize additions to the allowance based on their judgment of information available to them at the time of their examination. Bank Premises and Equipment Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is recorded using the straight-line and accelerated depreciation methods over the estimated useful life of the assets. Leasehold improvements are amortized over the term of the lease or estimated useful life, whichever is shorter. Other Real Estate Owned Other real estate owned includes foreclosed real estate which is carried at the lower of cost (lesser of carrying value of loan or fair value at date of acquisition) or estimated fair value less selling costs. Any write-down, at or prior to the dates the real estate is considered foreclosed, is charged to the allowance for loan losses. Subsequent write-downs are recorded in other expenses, and expenses incurred in connection with holding such assets and any gains or losses upon their sale are included in other income and expenses. Intangible Assets Intangible assets consist of a core deposit intangible which represents the present value of the difference in costs between the acquired core deposits and the market alternative funding sources. Intangible assets also include mortgage servicing rights. The core deposit intangibles are being amortized over a 10-year life on an accelerated basis. The amortization charged to income related to the core deposit intangibles was $325,000 for each of the years ended December 31, 2000, 1999 and 1998, respectively. The mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income. Stock Options The Corporation adopted SFAS No. 123, "Accounting for Stock-Based Compensation," which contains a fair value-based method for valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, the standard permits entities to continue accounting for employee stock options and similar instruments under Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." Entities that continue to account for stock options using APB Opinion No. 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied. The Corporation's employee stock option plan is accounted for under APB Opinion No. 25. Income Taxes The Corporation accounts for income taxes under the liability method specified by SFAS No. 109, "Accounting for Income Taxes." Under SFAS No. 109, deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The principal types of accounts, resulting in differences between assets and liabilities for financial statement and tax return purposes, are the allowance for possible loan losses, leased assets, deferred loan fees and compensation. Pension Plans The Corporation has certain employee benefit plans covering substantially all employees. The Corporation accrues service cost as incurred. Advertising Costs The Corporation expenses advertising costs as incurred. Restrictions on Cash and Due From Banks As of December 31, 2000, the Banks did not need to maintain reserves (in the form of deposits with the Federal Reserve Bank) to satisfy federal regulatory requirements. Bank Owned Life Insurance (BOLI) During 2000 and 1999, the corporation entered into an investment of bank owned life insurance (BOLI). BOLI involves the purchasing of life insurance by the Corporation on a chosen group of employees. The corporation is the owner and beneficiary of the policies. This pool of insurance, due to tax advantages to the Banks, 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. Net Income Per Share The Corporation adopted the provisions of SFAS No. 128, "Earnings per Share." SFAS No. 128 eliminates primary and fully diluted earnings per share and requires presentation of basic and diluted earnings per share (EPS) in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average common shares outstanding during the period. Diluted earnings per share take into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. PAGE 12 The reconciliation of the numerators and denominators of the basic and diluted EPS follows:
Year Ended December 31, 2000 -------------------------------------------- Income Shares Per Share (Numerator) (Denominator) Amount -------------------------------------------- Net income. . . . . . . . . . . . . . . $ 25,604,000 ============== Basic EPS Income available to common shareholders. . . . . . . . . . $ 25,604,000 9,268,681 $ 2.76 ============== Effect of Dilutive Securities Stock options . . . . . . . . . . . . . - 10,592 -------------- ------------- Diluted EPS Income available to common shareholders. . . . . . . . . . . $ 25,604,000 9,279,273 $ 2.76 ============== ============= ==============
148,977 anti-dilutive weighted shares have been excluded in the computation of 2000 diluted EPS since the options' exercise price was greater than the average market price of the common stock.
Year Ended December 31, 1999 --------------------------------------------- Net income. . . . . . . . . . $ 23,238,000 ============== Basic EPS Income available to common shareholders . . . . . $ 23,238,000 9,273,397 $ 2.51 ============== Effect of Dilutive Securities Stock options . . . . . . . . - 11,844 -------------- ------------- Diluted EPS Income available to common shareholders . . . . . $ 23,238,000 9,285,241 $ 2.50 ============== ============= ==============
4,411 anti-dilutive weighted shares have been excluded in the computation of 1999 diluted EPS since the options' exercise price was greater than the average market price of the common stock.
Year Ended December 31, 1998 ---------------------------------------------- Net income. . . . . . . . . . $ 20,758,000 ============== Basic EPS Income available to common shareholders . . . . . $ 20,758,000 9,262,819 $ 2.24 ============== Effect of Dilutive Securities Stock options . . . . . . . . - 15,375 -------------- ------------- Diluted EPS Income available to common shareholders . . . . . $ 20,758,000 9,278,194 $ 2.24 ============== ============= ==============
3,740 anti-dilutive weighted shares have been excluded in the computation of 1998 diluted EPS since the options' exercise price was greater than the average market price of the common stock. Comprehensive Income The Corporation has adopted the FASB issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards to provide prominent disclosure of comprehensive income items. Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Other comprehensive income consists of net unrealized gains on investment securities available for sale. The components of other comprehensive income are as follows:
(Dollars in thousands) Before tax Tax benefit Net of tax December 31, 2000 amount (expense) amount ----------------- ----------------------------------------------- Unrealized gains on securities: Unrealized holding gains arising during period. . . . $ 18,845 $ (6,581) $ 12,264 Less reclassification adjustment for gains realized in net income . . . 52 (18) 34 -------------- -------------- -------------- Other comprehensive income, net. . . . . . . . . . $ 18,793 $ (6,563) $ 12,230 ============== ============== ============== Before tax Tax benefit Net of tax December 31, 1999. . . . . . . . amount (expense) amount ------------------ ---------------------------------------------- Unrealized losses on securities: Unrealized holding losses arising during period. . . . $ (25,242) $ 8,835 $ (16,407) Less reclassification adjustment for gains realized in net income . . . 495 (322) 173 -------------- -------------- -------------- Other comprehensive losses, net. . . . . . . . . . $ (25,737) $ 9,157 $ (16,580) ============== ============== ============== Before tax Tax benefit Net of tax December 31, 1998. . . . . . . . amount (expense) amount ------------------ ---------------------------------------------- Unrealized gains on securities: Unrealized holding gains arising during period. . . . $ 3,351 $ (1,173) $ 2,178 Less reclassification adjustment for gains realized in net income . . . 1,621 (567) 1,054 -------------- -------------- -------------- Other comprehensive income, net. . . . . . . . . . $ 1,730 $ (606) $ 1,124 ============== ============== ==============
Other Information SFAS No. 131 establishes standards for the way public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in subsequent interim financial reports issued to shareholders. It also establishes standards for related disclosure about products and services, geographic areas, and major customers. The statement requires that a public business enterprise report financial and descripti ve information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. The statement also requires that public enterprises report a measure of segment profit or loss, certain specific revenue and expense items and segment assets. It also requires that information be reported about revenues derived from the enterprises' products or services, or about the countries in which the enterprises earn revenues and holds assets, and about major customers, regardless of whether the information is used in making operating decisions. The company has one reportable segment, "Community Banking." All of the Corporation's activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Corporation supports the others. For example, commercial lending is dependent upon the ability of the Banks to fund themselves with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential mortgage lending. Accordingly, all significant operating decisions are based upon analysis of the Corporation as one operating segment or unit. PAGE 13 In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activity" as amended in June, 1999 by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133," and in June 2000, by SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," (collectively SFAS 133). 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. 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. During July 2000, the Corporation reclassified $7,574,000 of investment securities from the held to maturity category to the available for sale category, due to its acquisition of Citizens Bank and Trust Company. As a result of the reclassification, the Corporation recorded $19,000 net of taxes unrealized holding losses in accumulated other comprehensive income. Statement of Financial Accounting Standards No. 119 "Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments" (SFAS No. 119) requires disclosures about financial instruments, which are defined as futures, forwards, swap and option contracts and other financial instruments with similar characteristics. On balance sheet receivables and payables are excluded from this definition. The Corporation did not hold any derivative financial instruments as defined by SFAS No. 119 at December 31, 2000, 1999 or 1998. 2 / ACQUISITIONS On April 28, 2000, the Corporation consummated its acquisition of Citizens Bank and Trust Company. Under the terms of the merger, accounted for as a pooling-of-interest, Citizens Bank and Trust Company's shareholders received 166 shares of Harleysville National Corporation common stock for each share of common stock of Citizens Bank and Trust Company. Upon the completion of the acquisition, Citizens Bank and Trust Company's banking operations merged into those of Citizens National Bank, a wholly-owned subsidiary of Harleysville National Corporation. On January 20, 1999, the Corporation consummated its acquisition of Northern Lehigh Bancorp, Inc., parent company of Citizens National Bank of Slatington. Northern Lehigh Bancorp, Inc. shareholders received 3.57 shares of Harleysville National Corporation common stock for each share of Northern Lehigh Bancorp common stock. The acquisition was effected 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 Bank North, Inc., under the name Citizens National Bank. The merger was accounted for on a pooling-of-interest basis, and all prior periods have been restated to reflect the combination. 3 / INVESTMENT SECURITIES The amortized cost, unrealized gains and losses, and the estimated market values of the Corporation's investment securities held to maturity and available for sale are as follows:
(Dollars in thousands) December 31, 2000 --------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Market Held to Maturity Cost Gains (Losses) Value ---------------- --------------------------------------------------- U.S. Treasury notes . . . $ 500 $ - $ - $ 500 Obligations of states and political subdivisions. 25,803 701 - 26,504 Mortgage-backed Securities. . . . . . . 3,437 70 - 3,507 Other securities. . . . . 1,101 3 (14) 1,090 ----------- ------------ ----------- ----------- Totals. . . . . . . . . $ 30,841 $ 774 $ (14) $ 31,601 =========== ============ =========== =========== Available for Sale ------------------ U.S. Treasury notes . . . $ 39,692 $ 667 $ - $ 40,359 Obligations of other U.S. Government agencies and corporations. . . . 38,508 214 (112) 38,610 Obligations of states and political subdivisions. 193,269 3,252 (1,448) 195,073 Mortgage-backed securities. . . . . . . 226,578 1,880 (975) 227,483 Other securities. . . . . 70,384 2,086 (3,376) 69,094 ----------- ------------ ----------- ----------- Totals. . . . . . . . . $ 568,431 $ 8,099 $ (5,911) $ 570,619 =========== ============ =========== =========== December 31, 1999 --------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Market Held to Maturity Cost Gains (Losses) Value ---------------- --------------------------------------------------- U.S. Treasury Notes . . . $ 1,000 $ 4 $ - $ 1,004 Obligations of states and political subdivisions. 21,450 164 (585) 21,029 Mortgage-backed securities. . . . . . . 1,792 7 (19) 1,780 Other securities. . . . . 1,303 4 (26) 1,281 ----------- ------------ ----------- ----------- Totals. . . . . . . . . $ 25,545 $ 179 $ (630) $ 25,094 =========== ============ =========== =========== Available for Sale U.S. Treasury notes . . . $ 48,486 $ 134 $ (53) $ 48,567 Obligations of other U.S. Government agencies and corporations. . . . 50,748 - (1,174) 49,574 Obligations of states and political subdivisions. 181,361 699 (9,888) 172,172 Mortgage-backed securities. . . . . . . 168,010 189 (4,128) 164,071 Other securities. . . . . 73,350 1,542 (3,926) 70,966 ----------- ------------ ----------- ----------- Totals. . . . . . . . . $ 521,955 $ 2,564 $ (19,169) $ 505,350 =========== ============ =========== ===========
PAGE 14 There are no significant concentrations of securities (greater than 10% of shareholders' equity) in any individual security issuer. Securities with a carrying value of $393,656,000 and $377,575,000 at December 31, 2000 and 1999, respectively, were pledged to secure public funds, government deposits and repurchase agreements. The amortized cost and estimated market value of investment securities, at December 31, 2000, by contractual maturities, are shown below. Actual maturities will differ from contractual maturities because issuers and borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(Dollars in thousands) Held to Maturity Available for Sale ---------------------------------------------- Estimated Estimated Amortized Market Amortized Market Cost Value Cost Value ---------------------------------------------- Due in one year or less $ 1,342 $ 1,347 $ 13,752 $ 13,792 Due after one year through five years. . 854 844 57,444 57,644 Due after five years through ten years . . 3,670 3,790 52,850 52,621 Due after ten years . . 21,538 22,113 217,807 219,079 ---------- ---------- ---------- ---------- 27,404 28,0943 41,8533 43,136 Mortgage-backed securities. . . . . . 3,437 3,507 226,578 227,483 ---------- ---------- ---------- ---------- Totals. . . . . . . . $ 30,841 $ 31,601 $ 568,431 $ 570,619 ========== ========== ========== ==========
Proceeds from sales of investment securities available for sale during 2000 were $133,208,000. Gross gains of $953,000 and gross losses of $901,000 were realized on these sales. Proceeds from sales of investment securities available for sale during 1999 were $77,177,000. Gross gains of $764,000 and gross losses of $269,000 were realized on these sales. Proceeds from sales of investment securities available for sale during 1998 were $67,003,000. Gross gains of $1,625,000 and gross losses of $4,000 were real ized on these sales. 4 / LOANS Major classifications of loans are as follows:
(Dollars in thousands) December 31, ------------------------ 2000 1999 ------------------------ Real estate . . . . . . . $ 369,831 $ 368,177 Commercial and industrial 296,168 282,799 Consumer loans. . . . . . 427,518 372,359 Lease financing . . . . . 116,088 94,909 ----------- ----------- Total loans. . . . . 1,209,605 1,118,244 Deferred costs, net . . . 2,450 572 Allowance for loan losses (15,210) (14,887) ----------- ----------- Net loans. . . . . . $1,196,845 $1,103,929 =========== ===========
A loan is generally classified as nonaccrual when principal or interest has consistently been in default for a period of 90 days or more or because of a deterioration in the financial condition of the borrower or payment in full of principal or interest is not expected. Delinquent loans past due 90 days or more and still accruing interest are loans that are generally well-secured and expected to be restored to a current status in the near future. On December 31, 2000, nonaccrual loans were $5,370,000, loans 90 days or more past due and still accruing interest were $514,000 and troubled debt restructured loans were $11,000. On December 31, 1999, nonaccrual loans were $3,690,000, loans 90 days or more past due and still accruing interest were $565,000 and troubled debt restructured loans were $465,000. The balance of impaired loans was $3,322,000 at December 31, 2000, compared to $2,582,000 at December 31, 1999. The Banks have identified a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. The December 31, 2000 impaired loan balance included $3,311,000 of nonaccrual loans and $11,000 of troubled debt restructured loans. The December 31, 1999, impaired loan balance included $2,117,000 of nonaccrual loans and $465 ,000 of troubled debt restructured loans. The allowance for loan loss associated with the impaired loans was $377,000 at December 31, 2000, and $262,000 at December 31, 1999. The average impaired loan balance was $2,965,000 in 2000, compared to $3,046,000 in 1999. The income recognized on impaired loans during 2000 and 1999 was $128,000 and $132,000, respectively. The Banks' policy for interest income recognition on impaired loans is to recognize income on restructured loans under the accrual method. The Banks recognize income on nonaccrual loans under the cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Banks. The Banks will not recognize income if these factors do not exist. The Banks have no concentration of loans to individual borrowers which exceeded 10% of total loans at December 31, 2000 and 1999. As of December 31, 2000, the Banks have a concentration of indirect consumer loans (12% of total loans) included in the consumer loan classification. The Banks actively monitor the risk of this loan concentration. The Banks continued to pursue new lending opportunities while seeking to maintain a portfolio that is diverse as to industry concentration, type and geographic distribution. The Banks' geographic lending area is primarily concentrated in Montgomery, Carbon, Bucks, and Wayne counties, but also includes Chester, Berks, Lehigh, Monroe, Northhampton and Schuylkill counties. Loans to directors, executive officers and their associates, are made in the ordinary course of business and on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others. Activity of these loans is as follows:
(Dollars in thousands) Year Ended December 31, ------------------------------- 2000 1999 1998 ------------------------------- Balance, January 1 . $ 9,411 $ 6,162 $ 4,917 New loans. . . . . . 68,009 30,064 12,704 Repayments . . . . . (69,076) (26,815) (11,459) --------- --------- --------- Balance, December 31 $ 8,344 $9,411 $ 6,162 ========= ========= =========
PAGE 15 5 / ALLOWANCE FOR LOAN LOSSES Transactions in the allowance for loan losses are as follows:
(Dollars in thousands) Year Ended December 31, ---------------------------- 2000 1999 1998 ---------------------------- Balance, beginning of year. . $14,887 $14,245 $13,107 -------- -------- -------- Provision charged to operating expenses. 2,312 2,153 2,288 -------- -------- -------- Loans charged off: Commercial and industrial (123) (108) (217) Consumer . . . . . . . . (1,470) (632) (647) Real estate. . . . . . . (610) (833) (442) Lease financing. . . . . (450) (226) (145) -------- -------- -------- Total charged off . (2,653) (1,799) (1,451) -------- -------- -------- Recoveries: Commercial and industrial. . . 60 28 94 Consumer . . . . . . . . 289 112 100 Real estate. . . . . . . 274 96 89 Lease financing. . . . . 41 52 18 -------- -------- -------- Total recoveries. . 664 288 301 -------- -------- -------- Balance, end of year. . . . . $15,210 $14,887 $14,245 ======== ======== ========
6 / BANK PREMISES AND EQUIPMENT Bank premises and equipment consist of the following:
Estimated (Dollars in thousands) Useful December 31, --------------- Lives 2000 1999 ----------------------------- Land $ 3,202 $ 3,060 Buildings . . . . . . . . . . 15-39 years 21,419 20,723 Furniture, fixtures . . . . . 3-10 years and equipment. . . . . . 20,186 18,754 ------- ------- Total cost. . . . . 44,807 42,537 Less accumulated depreciation and amortization . . . . 22,937 20,604 ------- ------- Total . . . . . . . $21,870 $21,933 ======= =======
7 / DEPOSITS AND BORROWINGS At December 31, 2000, scheduled maturities of certificates of deposit are as follows: (Dollars in thousands) Year Ended December 31, Amount ------------------------------------------ 2001 . . . . . . . . . . . . . . $376,858 2002 . . . . . . . . . . . . . . 163,995 2003 . . . . . . . . . . . . . . 47,146 2004 . . . . . . . . . . . . . . 12,138 2005 . . . . . . . . . . . . . . 2,765 Thereafter . . . . . . . . . . . 40 -------- Total. . . . . . . . . . . . . . $602,942 ======== Federal Home Loan Bank (FHLB) advances at December 31, 2000, totaled $110,750,000. The advances are collateralized by FHLB stock and certain first mortgage loans and mortgage-backed securities. First mortgages used as collateral for these advances totaled $86,367,000. These advances had a weighted average interest rate of 5.83%. Advances are made pursuant to several different credit programs offered from time to time by the FHLB. Unused lines of credit at the FHLB were $114,738,000 at December 31, 2000, and $188,657,000 at December 31, 1999. Outstanding borrowings mature as follows: (dollars in thousands) 2001. . . . . . . . . . . . . . .$ 30,000 2002. . . . . . . . . . . . . . . 3,000 2003. . . . . . . . . . . . . . . - 2004. . . . . . . . . . . . . . . 24,000 2005 and thereafter . . . . . . . 53,750 --------- $ 110,750 ========= The Banks, pursuant to a designated cash management agreement, utilize securities sold under agreements to repurchase as vehicles for customers' sweep and term investment products. Securitization under these cash management agreements are in U.S. Treasury Securities and obligations of states and political subdivisions securities. These securities are held in a third party custodian's account, designated by the Banks under a written custodial agreement that explicitly recognizes the Banks' interest in the securities. At December 31, 2000, these agreements matured within one year. The average balance of securities sold under agreements to repurchase for 2000 was $71,973,000, and the maximum amounts outstanding at any month-end during 2000 was $84,888,000. 8 / FEDERAL INCOME TAXES Income tax expense from current operations is composed of the following: (Dollars in thousands) Year Ended December 31, ---------------------- 2000 1999 1998 ---------------------- Current tax payable . . $2,379 $3,282 $5,231 Deferred income tax . . 3,271 3,404 1,430 ------ ------ ------ Tax expense . . . $5,650 $6,686 $6,661 ====== ====== ====== The effective income tax rates of 18.1% for 2000, 22.3% for 1999 and 24.3% for 1998 were less than the applicable federal income tax rate of 35% for each year. The reason for these differences follows:
(Dollars in thousands) Year Ended December 31, ---------------------------- 2000 1999 1998 ---------------------------- Expected tax expense. . . $10,939 $10,464 $ 9,625 Tax-exempt income net of expense disallowance (5,432) (3,885) (3,068) Other . . . . . . . . . . 143 107 104 -------- -------- -------- Actual tax expense . $ 5,650 $ 6,686 $ 6,661 ======== ======== ========
PAGE 16 The tax effect of temporary differences that give rise to significant portions of deferred tax assets and liabilities are as follows:
(Dollars in thousands) 2000 1999 --------------------------------------- Asset Liability Asset Liability --------------------------------------- Allowance for credit losses. . . . $5,184 $ - $ 5,071 $ - Lease assets. . . . . . . - 18,084 - 14,740 Deferred loan fees. . . . 132 - 277 - Deferred compensation . . 1,304 - 1,186 - Unrealized gain on securities. . . . - 766 5,795 - Other . . . . . . . . . . 98 - 148 37 ------ ---------- ------- ---------- Total deferred taxes $6,718 $ 18,850 $12,477 $ 14,777 ====== ========== ======= ==========
The exercise of stock options which have been granted under the Corporation's various stock option plans gives rise to compensation, which is includable in the taxable income of the applicable employees and deductible by the Corporation for income tax purposes. Compensation resulting from increases in the fair market value of the Corp-oration's Common Stock subsequent to the date of grant of the applicable exercised stock options is not recognized, in accordance with APB Opinion No. 25, as an expense for financial accounting purposes and the related tax benefits are taken directly to Additional Paid in Capital. 9 / PENSION PLANS The Corporation has two noncontributory defined benefit pension plans covering substantially all employees. These plans are the Harleysville National Corporation Pension Plan and the Northern Lehigh Bancorp Pension Plan. On January 20, 1999, the Corporation consummated its acquisition of Northern Lehigh Bancorp, Inc. These plans were not consolidated, as of December 31, 2000 and 1999. The Harleysville National Corporation Pension Plan's Benefits are based on years of service and the employee's average compensation during any five consecutive years within the 10-year period preceding retirement. The Harleysville National Corporation Pension Plan's funded status and amounts recognized in the financial statements follow:
(Dollars in thousands) 2000 1999 ---------------- Change in benefit obligation: ----------------------------- Benefit obligation at beginning of year . . . . 5,579 4,976 Service cost. . . . . . . . . . . . . . . . . . 448 365 Interest cost . . . . . . . . . . . . . . . . . 327 291 Actual gain . . . . . . . . . . . . . . . . . . 288 167 Benefits paid . . . . . . . . . . . . . . . . . (275) (220) Change in assumptions . . . . . . . . . . . . . - - ------- ------- Benefits obligation at end of year. . . . . . . $6,367 $5,579 ======= ======= Change in plan assets: ---------------------- Fair value of plan assets at beginning of year . . . . . . . . . . . . $6,155 $5,974 Actual return on plan assets. . . . . . . . . . (136) 401 Employer contribution . . . . . . . . . . . . . - - Benefits paid . . . . . . . . . . . . . . . . . (275) (220) ------- ------- Fair value of plan assets at end of year. . . . $5,744 $6,155 ======= ======= Funded status . . . . . . . . . . . . . . . . . $ (622) $ 575 Unrecognized transition liability (asset) . . . (172) (189) Unrecognized prior service cost . . . . . . . . (439) (550) Unrecognized net (gain) or loss . . . . . . . . 1,536 703 ------- ------- Prepaid (accrued) benefit cost. . . . . . . . . $ 303 $ 539 ======= =======
Weighted-average assumptions ---------------------------- as of December 31, 2000 1999 1998 ------------------ ------ ------ ------ Discount rate. . . . . . . . . . . 6.00% 6.00% 6.00% Expected return on plan assets . . 7.00% 7.00% 7.00% Rate of compensation increase. . . 4.50% 4.50% 4.50% Components of net periodic -------------------------- benefit cost 2000 1999 1998 ------------ ------ ------ ------ Service cost . . . . . . . . . . . $ 447 $ 365 $ 264 Interest cost . . . . . . . . . . 326 291 297 Expected return on plan assets . . (421) (410) (431) Amortization of prior service cost (111) (111) (111) Recognized net actuarial loss. . . (6) (17) (17) ------ ------ ------ Net periodic benefit cost. . $ 235 $ 118 $ 2 ====== ====== ======
As of December 31, 2000, Harleysville National Corporation's Pension Plan's had an investment in the Corporation's stock with a market value of $233,000. The Northern Lehigh Bancorp Pension Plan's Benefits are based primarily upon years of service and compensation rates near retirement. The Northern Lehigh Bancorp Pension Plan's funded status and amounts recognized in the financial statements follows:
(Dollars in thousands) 2000 1999 ------ ------ Change in benefit obligation: ----------------------------- Benefit obligation at beginning of year . $ 744 $ 753 Service cost. . . . . . . . . . . . . . . - 55 Interest cost . . . . . . . . . . . . . . 51 51 Actual gain . . . . . . . . . . . . . . . 21 (13) Benefits paid . . . . . . . . . . . . . . (43) (24) Effect of curtailment . . . . . . . . . . 46 (78) ------ ------ Benefits obligation at end of year. . . . $ 819 $ 744 ====== ====== Change in plan assets: ---------------------- Fair value of plan assets at beginning of year . . . . . . . . . $ 886 $ 855 Actual return on plan assets. . . . . . . 3 67 Employer contribution . . . . . . . . . . - - Plan expenses . . . . . . . . . . . . . . - (12) Benefits paid . . . . . . . . . . . . . . (48) (24) ------ ------ Fair value of plan assets at end of year. $ 841 $ 886 ====== ====== Funded status . . . . . . . . . . . . . . $ 22 $ 143 Unrecognized transition liability (asset) (42) (48) Unrecognized prior service cost . . . . . - - Unrecognized net (gain) or loss . . . . . (112) (262) ------ ------ Prepaid (accrued) benefit cost. . . . . . $(132) $(167) ====== ======
Weighted-average assumptions ---------------------------- as of December 31, 2000 1999 1998 ------------------ ---------------------- Discount rate. . . . . . . . . . . 6.50% 7.00% 7.00% Expected return on plan assets . . 8.00% 8.00% 8.00% Rate of compensation increase. . . 0.00% 5.00% 5.00% Components of net periodic -------------------------- benefit cost 2000 1999 1998 ------------ ---------------------- Service cost . . . . . . . . . . . $ - $ 55 $ 54 Interest cost. . . . . . . . . . . 51 51 59 Expected return on plan assets . . (69) (67) (57) Amortization of prior service cost (16) (15) (5) ------ ------ ------ Net periodic benefit cost . . $ (34) $ 24 $ 51 ====== ====== ======
PAGE 17 A 401(k) deferred savings plan covers eligible employees of the Banks. Employees may contribute up to a maximum of 15% of salary on a pre-tax basis with a 50% employer match up to a maximum of 3% of salary. Contributions charged to earnings were $353,000, $284,000, and $242,000 for 2000, 1999 and 1998, respectively. The Corporation has a Supplemental Executive Retirement Plan (SERP) for certain individuals. The SERP provides for payments based on a certain percentage of salary for a period of 10 years after retirement. As of December 31, 2000, and 1999, the Corporation had accrued a liability of $1,832,000 and $1,528,000, respectively, for the SERP. 10 / SHAREHOLDERS' EQUITY On November 9, 2000, the Corporation paid a 5% stock dividend on its common stock to shareholders of record as of October 26, 2000. On September 30, 1999, the Corporation paid a 5% stock dividend on its common stock to shareholders of record as of September 17, 1999. 11 / STOCK OPTIONS The Corporation has fixed stock option plans that allow the Corporation to grant options up to 833,390 shares of common stock to key employees and directors. The options have a term of ten years when issued and are completely vested over a five-year period. The exercise price of each option equals the market price of the Corporation's stock on the date of grant. The Corporation has elected to account for its stock option plan under APB Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, no compensation cost has been recognized for its stock option plan. Had compensation cost for the plan been determined based on the fair value of the options at the grant dates consistent with the method of SFAS No. 123, "Accounting for Stock-Based Compensation," the Corporation's net income and earnings per share would have been:
2000 1999 1998 -------------------------- Net income As reported $25,604 $23,238 $20,758 (in thousands) Pro forma $23,236 $22,527 $20,261 Earnings per share As reported $2.76 $2.51 $2.24 (Basic) Pro forma $2.51 $2.43 $2.19 Earnings per share As reported $2.76 $2.50 $2.24 (Diluted) Pro forma $2.50 $2.43 $2.18
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2000, 1999 and 1998, respectively: dividend yield of 3.26%, 3.30% and 2.54%; expected volatility of 2.58%, 2.84% and 3.18%; risk-free interest rate of 5.96%, 7.06% and 5.50%; and an expected life of 9.82 years, 9.42 years and 9.50 years. Information about stock options outstanding at December 31, 2000, is summarized as follows:
Weighted-Average Outstanding Exercise Price ------------------------------- Balance 1/1/98 . 42,327 $ 14.12 Granted. . . . . 79,933 32.20 Exercised. . . . (19,270)1 8.10 Cancelled. . . . (1,460) 22.11 ------------ ----------------- Balance 1/1/99 . 101,53 027.49 Granted. . . . . 39,421 31.13 Exercised. . . . (3,936) 7.89 Cancelled. . . . (2,206) 34.73 ------------ ----------------- Balance 1/1/00 . 134,809 29.01 Granted. . . . . 593,183 27.93 Exercised. . . . (3,936) 8.48 Cancelled. . . . (1,654) 31.74 ------------ ----------------- Balance 12/31/00 722,402 $ 28.23 ============ =================
The weighted average fair value of options granted during 2000, 1999 and 1998 were $27.93, $31.13 and $32.20, respectively.
----------------------------------------------------------------------------------------------------------- OPTIONS OUTSTANDING Range of Number Weighted-Average Weighted-Average Number Weighted-Average Exercise-Price Outstanding Remaining Contractual Life Exercise Price Exercisable Exercise Price ----------------------------------------------------------------------------------------------------------- $ 7.74 - $11.62 11,808 1.5 years $ 9.31 11,808 $ 9.31 $19.36 - $23.23 1,915 4.6 years $ 22.11 1,915 $ 22.11 $27.10 - $30.98 560,103 9.9 years $ 27.75 - $ - $30.98 - $34.85 144,165 8.2 years $ 31.41 138,045 $ 31.40 $34.85 - $38.72 4,411 7.3 years $ 38.57 1,764 $ 38.57 ----------- ------------ ---------------- 722,402 153,532 $ 29.67 =========== ============ ================ -----------------------------------------------------------------------------------------------------------
12 / COMMITMENTS AND CONTINGENT LIABILITIES Based on consultation with the Corporation's legal counsel, management is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Corporation. There are no proceedings pending other than the ordinary routine litigation incident to the business of the Corporation and its Subsidiaries. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Corporation or its Subsidiaries by government authorities. Lease commitments for equipment and banking locations expire intermittently over the years through 2036. Most banking location leases require the lessor to pay insurance, maintenance costs and property taxes. Approximate minimum rental commitments for existing operating leases at December 31, 2000, are as follows:
Total Operating Leases ----------------- 2001 . . . . . . $ 1,594,000 2002 . . . . . . 1,340,000 2003 . . . . . . 1,248,000 2004 . . . . . . 1,009,000 2005 . . . . . . 1,003,000 Thereafter . . . . . 4,683,000 ----------------- Total. . . . . . $ 10,877,000 =================
Total lease expense amounted to $1,889,000 in 2000, $1,796,000 in 1999 and $1,670,000 in 1998. PAGE 18 13 / FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Banks have not entered into any interest rate swaps, caps, floors or collars and are not a party to any forward or futures transactions. However, the Banks are a party to various other financial instruments at December 31, 2000 and 1999, which are not included in the consolidated financial statements, but are required in the normal course of business to meet the financing needs of its customers and to assist in managing its exposure to changes in interest rates. Management does not expect any material losses from these transactions, which include standby letters of credit at December 31, 2000 and 1999, of $6,829,000 and $7,254,000, respectively; commitments to extend credit of $51,409,000 and $46,945,000, respectively for revolving home equity lines; $120,610,000 and $103,203,000, respectively for commercial and real estate loans; $33,534,000 and $27,116,000, respectively, for consumer loans. The Banks' exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual or notional amounts of those instruments. The Banks use the same stringent credit policies in extending these commitments as they do for recorded financial instruments and control their exposure to loss through credit approval and monitoring procedures. These commitments are generally issued for one year or less, often expire without being drawn upon, and often are secured with appropriate collateral. The Banks offer commercial, mortgage and consumer credit products to their customers in the normal course of business, which are detailed in note 4. These products represent a diversified credit portfolio and are generally issued to borrowers within the Banks' branch office systems in eastern Pennsylvania. The ability of the customers to repay their credits is, to some extent, dependent upon the economy in the Banks' market areas. 14 / REGULATORY CAPITAL
--------------------------------------------------------------------------------------------------- (Dollars in thousands) To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provision As of December 31, 2000 Amount Ratio Amount Ratio Amount Ratio --------------------------------------------------------------------------------------------------- Total Capital (to risk weighted assets): ---------------------------------------- Corporation . . . . . . . . . . . . . . . $186,989 13.35% $ 112,06 38.00% $ - - Harleysville National Bank. . . . . . . . 106,549 10.46% 81,461 8.00% 101,826 10.00% Citizens National Bank. . . . . . . . . . 37,622 14.36% 20,955 8.00% 26,193 10.00% Security National Bank. . . . . . . . . . 13,553 12.65% 8,572 8.00% 10,715 10.00% Tier 1 Capital (to risk weighted assets): ---------------------------------------- Corporation . . . . . . . . . . . . . . . $171,226 12.22% $ 56,031 4.00% $ - - Harleysville National Bank. . . . . . . . 95,980 9.43% 40,731 4.00% 61,096 6.00% Citizens National Bank. . . . . . . . . . 34,344 13.11% 10,477 4.00% 15,716 6.00% Security National Bank. . . . . . . . . . 12,509 11.67% 4,286 4.00% 6,429 6.00% Tier 1 Capital (to average assets): ----------------------------------- Corporation . . . . . . . . . . . . . . . $171,226 8.97% $ 76,313 4.00% $ - - Harleysville National Bank. . . . . . . . 95,980 7.12% 53,932 4.00% 67,415 5.00% Citizens National Bank. . . . . . . . . . 34,344 8.51% 16,147 4.00% 20,183 5.00% Security National Bank. . . . . . . . . . 12,509 8.70% 5,754 4.00% 7,193 5.00%
(Dollars in thousands) To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provision As of December 31, 2000 Amount Ratio Amount Ratio Amount Ratio -------------------------------------------------------------------------------------------------- Total Capital (to risk weighted assets): --------------------------------------- Corporation . . . . . . . . . . . . . . . $171,548 13.48% $101,772 8.00% $ - - Harleysville National Bank. . . . . . . . 93,993 10.23% 73,484 8.00% 91,855 10.00% Citizens National Bank. . . . . . . . . . 40,305 16.27% 19,822 8.00% 24,777 10.00% Security National Bank. . . . . . . . . . 9,593 10.57% 7,259 8.00% 9,074 10.00% Tier 1 Capital (to risk weighted assets): ---------------------------------------- Corporation . . . . . . . . . . . . . . . $156,326 12.29% $ 50,886 4.00% $ - - Harleysville National Bank. . . . . . . . 83,222 9.06% 36,742 4.00% 55,113 6.00% Citizens National Bank. . . . . . . . . . 37,208 15.02% 9,911 4.00% 14,866 6.00% Security National Bank. . . . . . . . . . 8,532 9.40% 3,629 4.00% 5,444 6.00% Tier 1 Capital (to average assets): ---------------------------------- Corporation . . . . . . . . . . . . . . . $156,326 8.92% $ 70,081 4.00% $ - - Harleysville National Bank. . . . . . . . 83,222 6.76% 49,228 4.00% 61,536 5.00% Citizens National Bank. . . . . . . . . . 37,208 9.35% 15,918 4.00% 19,898 5.00% Security National Bank. . . . . . . . . . 8,532 7.05% 4,844 4.00% 6,055 5.00%
PAGE 19 The Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Banks must meet specific capital guidelines that involve quantitative measures of the Banks' assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Banks to maintain minimum amounts and ratios (set forth in the table) of total and Tier 1 capital to risk-weighted assets. Management believes, as of December 31, 2000, that the Banks meet all capital adequacy requirements to which they are subject. To be categorized as well capitalized, the Banks must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events that have occurred that management believes have changed the institutions' category. The National Banking Laws require the approval of the Office of the Comptroller of the Currency if the total of all dividends declared by a national bank in any calendar year exceed the net profits of the bank (as defined) for that year combined with its retained net profits for the preceding two calendar years. Under this formula, the Banks may declare dividends in 2001 of approximately $29,000,000 plus an amount equal to the net profits of the Banks in 2001 up to the date of any such dividend declaration. Additionally, banking regulations limit the amount of investments, loans, extensions of credit and advances that one subsidiary bank can make to the Corporation at any time to 10% and in the aggregate 20% of the Banks' capital stock and surplus. These regulations also require that any such investment, loan, extension of credit or advance be secured by securities having a market value in excess of the amount thereof. At December 31, 2000, there were no investments, loans, extensions of credit or advances from any of the Banks to the Corporation. 15 / FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107 "Disclosures about Fair Values of Financial Instruments," requires disclosure of the estimated fair value of an entity's assets and liabilities considered to be financial instruments. For the Corporation, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in SFAS No. 107. However, many such instruments lack an available trading market, as characterized by a willing buyer and seller engaging in an exchange transaction. Also, it is the Corporation's general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities, except for certain loans and investments. Therefore, the Corporation had to use significant estimates and present value calculations to prepare this disclosure. Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values. Estimated fair values have been determined by the Corporation using the best available data and an estimation methodology suitable for each category of financial instruments. The estimation methodologies used, the estimated fair values and recorded book balances at December 31, 2000 and 1999 are outlined below. For cash and due from banks, interest-bearing deposits in banks and federal funds sold, the recorded book values of $55,525,000 and $63,491,000 at December 31, 2000 and 1999, respectively, approximate fair values. The estimated fair values of investment securities are based on quoted market prices, if available. Estimated fair values are based on quoted market prices of comparable instruments if quoted market prices are not available. The loan portfolio, net of unearned income, at December 31, 2000 and 1999, has been valued using a present value discounted cash flow analysis where market prices were not available. The discount rate used in these calculations is the estimated current market rate adjusted for credit risk. The carrying value approximates its fair value. 2000 ------------------------------ Carrying Estimated Amount Fair Value ------------------------------ Investment securities $ 601,460,000 $ 602,220,000 Loans, net. . . . . . $1,212,055,000 $1,207,034,000 1999 ------------------------------ Carrying Estimated Amount Fair Value ------------------------------ Investment securities $ 530,895,000 $ 530,444,000 Loans, net. . . . . . $1,118,816,000 $1,121,214,000 The estimated fair values of demand deposits (i.e., interest and noninterest-bearing checking accounts, savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. The carrying amount of accrued interest receivable and payable approximates fair value. 2000 -------------------------- Carrying Estimated Amount Fair Value -------------------------- Time deposits $602,942,000 $604,664,000 1999 -------------------------- Carrying Estimated Amount Fair Value -------------------------- Time deposits $542,837,000 $546,551,000 The fair values of demand notes, borrowings, and securities sold under agreements to repurchase of $231,388,000 and $251,597,000 at December 31, 2000 and 1999, respectively, approximate their recorded book balances. There was no material difference between the notional amount and the estimated fair value of off-balance-sheet items which totaled approximately $212,382,000 and $184,518,000 at December 31, 2000 and 1999, respectively, and primarily comprised unfunded loan commitments which are generally priced at market at the time of funding. PAGE 20 16 / CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY Condensed financial statements of Harleysville National Corporation follow:
CONDENSED BALANCE SHEETS (Dollars in thousands) December 31, --------------------- 2000 1999 --------------------- Assets: Cash . . . . . . . . . . . . . . . $ 651 $ 51 Investments in subsidiaries. . . . 172,880 146,612 --------- --------- Total assets. . . . . . . . . . $173,531 $146,663 ========= ========= Liabilities and shareholders' equity: Other liabilities. . . . . . . . . $ (5) $ - ---------- --------- Total liabilities . . . . . . . $ (5) $ - ---------- --------- Shareholders' equity: Common stock . . . . . . . . . . . $ 9,254 $ 8,835 Additional paid in capital . . . . 79,869 68,260 Retained earnings. . . . . . . . . 83,244 80,376 Treasury stock . . . . . . . . . . (253) - Net unrealized gain on investment securities available for sale . 1,422 (10,808) --------- --------- Total shareholders' equity. . . 173,536 146,663 --------- --------- Total liabilities and shareholders' equity. . . . . $173,531 $146,663 ========= =========
CONDENSED STATEMENTS OF INCOME (Dollars in thousands) Year Ended December 31, ----------------------------- 2000 1999 1998 ----------------------------- Dividends from banks. . . . $14,575 $21,650 $28,875 -------- ------- -------- Total operating income . 14,575 21,650 28,875 -------- ------- -------- Operating expense . . . . . 14 19 8 -------- ------- -------- Income before income tax expense and equity in undistributed net income of banks . . . . . . . . 14,561 21,631 28,867 Income tax expense. . . . . (5) (7) (3) -------- ------- -------- Income before equity in undistributed net income of banks . . . . . . . . 14,566 21,638 28,870 Equity in undistributed net income of banks. . . 11,038 1,600 (8,112) -------- ------- -------- Net income . . . . . . . $25,604 $23,238 $20,758 ======== ======= ========
CONDENSED STATEMENTS OF CASH FLOWS (Dollars in thousands) Year Ended December 31, ------------------------------- 2000 1999 1998 ------------------------------- Operating activities: Net income . . . . . . . . . $ 25,604 $ 23,238 $ 20,758 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of banks . . . (11,038) (1,600) 8,112 Net decrease in other liabilities. . . . (5) (446) (3) --------- -------- -------- Net cash provided by operating activities . . . . 14,561 21,192 28,867 --------- -------- -------- Investing activities: Capital contributions made to the banks. . . . . (3,000) (12,000) (21,663) --------- -------- -------- Net cash (used in) provided by investing activities. . . (3,000) (12,000) (21,663) --------- -------- -------- Financing activities: Cash dividends and fractional shares. . . . . (10,430) (9,375) (8,062) Dividend reinvestment. . . . - (49) - Repurchase of common stock . (578) - - Stock options and awards . . 47 39 354 --------- -------- -------- Net cash used in financing activities . . . . (10,961) (9,385) (7,708) --------- -------- -------- Net increase (decrease) in cash 600 (193) (504) Cash and cash equivalents at beginning of year. . . . . . 51 244 748 --------- -------- -------- Cash and cash equivalents at end of year. . . . . . . . . $ 651 $ 51 $ 244 ========= ======== ========
PAGE 21 17 / QUARTERLY FINANCIAL DATA (UNAUDITED) The following is the summarized (unaudited) consolidated quarterly financial data of the Corporation which, in the opinion of management, reflects all adjustments, consisting only of normal recurring adjustments, necessary for fair presentation of the Corporation's results of operations:
(Dollars in thousands, except per share information) Three Months Ended -------------------------------------- 2000: March 31 June 30 Sept. 30 Dec. 31 -------------------------------------- Interest income $ 31,423 $32,343 $33,593 $34,452 Net interest income 16,343 16,716 16,531 16,447 Provision for losses 506 549 581 676 Noninterest income 2,654 2,857 3,248 3,447 Operating expenses 10,929 11,647 11,004 11,097 Income before income tax expense 7,562 7,377 8,194 8,121 Income tax expense 1,517 1,070 1,454 1,609 -------- ------- ------- ------- Net income $ 6,045 $ 6,307 $ 6,740 $ 6,512 ======== ======= ======= ======= Net income per share Basic $ 0.65 $ 0.68 $ 0.73 $ 0.70 ======== ======= ======= ======= Diluted $ 0.65 $ 0.68 $ 0.73 $ 0.70 ======== ======= ======= ======= 1999: Interest income $ 26,491 $27,782 $29,418 $30,476 Net interest income 15,098 15,961 16,358 16,101 Provision for losses 490 490 489 684 Noninterest income 2,452 2,653 2,493 2,937 Operating expenses 9,813 10,002 10,290 11,871 Income before income tax expense 7,247 8,122 8,072 6,483 Income tax expense 1,697 2,024 1,782 1,183 -------- ------- ------- ------- Net income $ 5,550 $ 6,098 $ 6,290 $ 5,300 ======== ======= ======= ======= Net income per share Basic $ 0.60 $ 0.66 $ 0.68 $ 0.57 ======== ======= ======= ======= Diluted $ 0.60 $ 0.65 $ 0.68 $ 0.57 ======== ======= ======= =======
PAGE 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED SUMMARY OF OPERATIONS Year Ended December 31, (Dollars in thousands, except per share ---------------------------------------------------------- data and average shares outstanding) 2000 1999 1998 1997 1996 ---------------------------------------------------------- INCOME AND EXPENSE Interest income. . . . . . . . . . . . . . . . . . . $ 131,811 $ 114,167 $ 102,005 $ 94,114 $ 86,776 Interest expense . . . . . . . . . . . . . . . . . . 65,774 50,649 44,372 39,989 36,658 ---------- ---------- ---------- ---------- ---------- Net interest income. . . . . . . . . . . . . . . . . 66,037 63,518 57,633 54,125 50,118 Provision for loan losses. . . . . . . . . . . . . . 2,312 2,153 2,288 2,652 2,279 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses. 63,725 61,365 55,345 51,473 47,839 Noninterest income . . . . . . . . . . . . . . . . . 12,206 10,535 10,520 7,961 5,666 Noninterest expense. . . . . . . . . . . . . . . . . 44,677 41,976 38,446 33,522 30,650 ---------- ---------- ---------- ---------- ---------- Income before income tax expense . . . . . . . . . . 31,254 29,924 27,419 25,912 22,855 Income tax expense . . . . . . . . . . . . . . . . . 5,650 6,686 6,661 6,883 6,306 ---------- ---------- ---------- ---------- ---------- Net income . . . . . . . . . . . . . . . . . . . . . $ 25,604 $ 23,238 $ 20,758 $ 19,029 $ 16,549 ========== ========== ========== ========== ========== ---------------------------------------------------------------------------------------------------------------- PER SHARE* Basic. . . . . . . . . . . . . . . . . . . . . . . . $ 2.76 $ 2.51 $ 2.24 $ 2.06 $ 1.79 Diluted. . . . . . . . . . . . . . . . . . . . . . . 2.76 2.50 2.24 2.06 1.79 Cash dividends paid. . . . . . . . . . . . . . . . . 1.13 1.02 0.90 0.82 0.72 Basic average shares outstanding . . . . . . . . . . 9,268,681 9,273,397 9,262,819 9,238,609 9,226,960 Diluted average shares outstanding . . . . . . . . . 9,279,273 9,285,241 9,278,194 9,245,704 9,250,827 *Adjusted for 5% stock dividends effective 11/9/00, 9/30/99, 6/30/97 and 6/28/96. ---------------------------------------------------------------------------------------------------------------- AVERAGE BALANCE SHEET Loans. . . . . . . . . . . . . . . . . . . . . . . . $1,166,684 $1,031,055 $ 894,758 $ 815,891 $ 754,029 Investments. . . . . . . . . . . . . . . . . . . . . 562,508 515,006 427,850 357,749 328,994 Other interest-earning assets. . . . . . . . . . . . 9,876 20,133 31,698 34,477 25,137 Total assets . . . . . . . . . . . . . . . . . . . . 1,843,525 1,639,041 1,413,772 1,271,153 1,165,446 Deposits . . . . . . . . . . . . . . . . . . . . . . 1,436,781 1,267,936 1,144,822 1,045,309 980,733 Other interest-bearing liabilities . . . . . . . . . 218,811 194,887 99,416 71,568 46,814 Shareholders' equity . . . . . . . . . . . . . . . . 154,547 148,636 142,959 129,758 116,191 ---------------------------------------------------------------------------------------------------------------- BALANCE SHEET AT YEAR-END Loans. . . . . . . . . . . . . . . . . . . . . . . . $1,212,055 $1,118,816 $ 956,867 $ 852,386 $ 788,234 Investments. . . . . . . . . . . . . . . . . . . . . 601,460 530,895 491,942 372,760 345,612 Other interest-earning assets. . . . . . . . . . . . 3,507 13,837 23,886 21,463 19,627 Total assets . . . . . . . . . . . . . . . . . . . . 1,935,213 1,767,667 1,541,449 1,313,443 1,217,972 Deposits . . . . . . . . . . . . . . . . . . . . . . 1,489,050 1,341,437 1,211,326 1,087,253 1,012,720 Other interest-bearing liabilities . . . . . . . . . 231,388 251,597 151,628 64,400 59,521 Shareholders' equity . . . . . . . . . . . . . . . . 173,536 146,663 149,572 136,715 122,821 ----------------------------------------------------------------------------------------------------------------
PAGE 23 BALANCE SHEET ANALYSIS The table below presents the major asset and liability categories on an average daily basis for the periods presented, along with interest income and expense, and key rates and yields. Distribution Of Assets, Liabilities And Shareholders' Equity, Interest Rates And Interest Differential
Year Ended December 31, ------------------------------------------------------------------------------------------------ 2000 1999 1998 ------------------------------------------------------------------------------------------------ Average Average Average Average Average Average (Dollars in thousands) Balance Rate Interest Balance Rate Interest Balance Rate Interest ------------------------------------------------------------------------------------------------ Assets Investment securities: Taxable investments. . . . . . $ 348,560 6.94% $ 24,205 $ 305,163 6.39% $ 19,485 $ 261,612 6.26% $ 16,381 Nontaxable investments (1) . . 213,948 7.46 15,962 209,843 7.44 15,613 166,238 7.60 12,642 ---------- --------- ---------- ----------- -------- ----------- ---------- --------- ---------- Total investment securities. 562,508 7.14 40,167 515,006 6.82 35,098 427,850 6.78 29,023 Loans (1) (2). . . . . . . . . . 1,166,684 8.31 96,896 1,031,055 8.14 83,938 894,758 8.49 75,932 Other rate-sensitive assets. . . 9,876 5.99 592 20,133 3.98 802 31,698 5.24 1,660 ---------- --------- ---------- ----------- -------- ----------- ---------- --------- ---------- Total earning assets . . . . 1,739,068 7.92 137,655 1,566,194 7.65 119,838 1,354,306 7.87 106,615 Noninterest-earning assets . . . 104,457 - - 72,847 - - 59,466 - - ---------- --------- ---------- ----------- -------- ----------- ---------- --------- ---------- Total assets . . . . . . . . $1,843,525 7.47% $ 137,655 $1,639,041 7.31% $ 119,838 $1,413,772 7.54% $ 106,615 ========== ========= ========== =========== ======== =========== ========== ========= ========== Liabilities And Shareholders' Equity Deposits: Demand . . . . . . . . . . . . $ 204,778 - % $ - $ 192,659 - % $ - $ 168,462 - % $ - Savings. . . . . . . . . . . . 625,928 2.93 18,337 567,316 2.52 14,272 508,245 2.72 13,837 Time . . . . . . . . . . . . . 606,075 5.73 34,747 507,961 5.26 26,712 468,115 5.50 25,735 ---------- --------- ---------- ----------- -------- ----------- ---------- --------- ---------- Total. . . . . . . . . . . . 1,436,781 3.69 53,084 1,267,936 3.23 40,984 1,144,822 3.46 39,572 Borrowings and other interest-bearing liabilities . 218,811 5.80 12,690 194,887 4.96 9,665 99,416 4.83 4,800 Other liabilities. . . . . . . . 33,386 - - 27,582 - - 26,875 - 44,372 ---------- --------- ---------- ----------- -------- ----------- ---------- --------- ---------- Total liabilities. . . . . . 1,688,978 3.89 65,774 1,490,405 3.40 50,649 1,271,113 3.49 - Shareholders' equity . . . . . . 154,547 - - 148,636 - - 142,659 - - ---------- --------- ---------- ----------- -------- ----------- ---------- --------- ---------- Total liabilities and shareholders' equity . . . $1,843,525 3.57% $ 65,774 $1,639,041 3.09% $ 50,649 $1,413,772 3.14% $ 44,372 ========== ========= ========== =========== ======== =========== ========== ========= ========== Average effective rate on interest-bearing liabilities . $1,450,814 4.53% $ 65,774 $1,270,164 3.99% $ 50,649 $1,075,776 4.12% $ 44,372 ========== ========= ========== =========== ======== =========== ========== ========= ========== ================================================================================================================================== Interest Income/Earning Assets . $1,739,068 7.92% $ 137,655 $1,566,194 7.65% $ 119,838 $1,354,306 7.87% $ 106,615 Interest Expense/Earning Assets. $1,739,068 3.78 $ 65,774 $1,566,194 3.23 $ 50,649 $1,354,306 3.28 $ 44,372 --------- ------- -------- Effective Interest Differential l4.14% 4.42% 4.59% ========= ======= ======== (1) The interest earned on nontaxable investment securities and loans is shown on a tax-equivalent basis. (2) Nonaccrual loans have been included in the appropriate average loan balance category, but interest on nonaccrual loans has not been included for purposes of determining interest income. ----------------------------------------------------------------------------------------------------------------------------------
PAGE 24 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 document contains forward-looking statements. We have made forward-looking statements in this document 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 analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful. Introduction The Corporation continued its strong earnings performance during 2000. Net income increased 10.2% and total assets grew 9.5%. This performance was achieved through an increase in earning assets, growth in other income and the continued strength in loan quality. This performance was also achieved during a period when the Corporation successfully completed the acquisition of Citizens Bank & Trust Company, a community bank with $130 million in assets. The Corporation's net income of $25,604,000 in 2000, increased 10.2% compared to the $23,238,000 reported in 1999. Diluted earnings of $2.76 in 2000 increased 10.4% from $2.50 in 1999. Basic earnings per share in 2000 were $2.76 compared to $2.51 in 1999. The primary sources of this increase in net income were the growth in both net interest income and other income, and lower tax expense. Net interest income grew $2,519,000, as a result of an 11.0% rise in average earning assets. Other operating income rose $1,671,000, due primarily to higher trust fees and bank-owned life insurance income. Offsetting these increases was a rise in other operating expenses, primarily related to the overall growth in the Corporation and acquisition related expenses. A key focus of the Banks is preserving the quality of their loan portfolios. Key loan quality performance ratios at December 31, 2000, improved from the strong ratios recorded at December 31, 1999. The ratio of the allowance for loan losses to nonperforming assets of 268.3% at December 31, 2000, improved from the 266.3% at December 31, 1999. Loans 90 days past due at December 31, 2000, of $514,000 decreased from the $565,000 at December 31, 1999. Interest-Earning Assets and Interest-Bearing Liabilities The level of average interest-earning assets was $1,739,068,000 in 2000, an increase of $172,874,000, or 11.0%, compared to $1,566,194,000 in 1999. The increase was the result of growth in loans and investments. During 2000, the average balance of the loan portfolio increased $135,629,000, or 13.2% and investments grew $47,502,000, or 9.2%. Average interest-earning assets were $1,354,306 in 1998. Average interest-bearing liabilities totaled $1,450,814,000 in 2000, an increase of $180,650,000, or 14.2%, compared to 1999. Contributing to this rise were increases in time deposits, savings deposits and other borrowings of $98,114,000, $58,612,000, and $23,924,000, respectively. Average interest-bearing liabilities were $1,075,776,000 in 1998. Investment Securities Statement of Financial Accounting (SFAS) Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," requires, among other things, that debt and equity securities classified as available for sale be reported at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. The net effect of unrealized gains or losses, caused by marking an available for sale portfolio to market, causes fluctuations in the level of shareholders' equity and equity-related financial ratios as market interest rates cause the fair value of fixed-rate securities to fluctuate. The investment securities total at December 31, 2000, of $601,460,000 grew $70,565,000, or 13.3%, over the December 31, 1999, balance of $530,895,000. The investment securities available for sale increased $65,269,000 and the investment securities held to maturity increased $5,296,000 during 2000. The increase in the investments available for sale was funded by proceeds from the maturities and calls in the investment securities portfolios and through the increase in deposits during 2000. Loans The Banks continued to experience growth in all loan categories during 2000. Total loans grew $91,361,000 or 8.2%, from $1,118,244,000 at December 31, 1999, to $1,209,605,000 at December 31, 2000. During 2000, consumer loans, lease financing, commercial loans and real estate loans grew $55,159,000, $21,179,000, $13,369,000 and $1,654,000, respectively. The majority of the growth in consumer loans was related to the growth in financing indirect automobile dealer loans during 2000. The Corporation has maintained strong relationships with automobile dealers to insure that we offer them the services and products to meet their financing needs. Residential mortgages sold during 2000 were $7,690,000 compared to $38,215,000 in 1999. The Banks have no concentration of loans to individual borrowers which exceeded 10% of total loans at December 31, 2000 and 1999. As of December 31, 2000, the Banks have a concentration of indirect consumer loans (12% of total loans) included in the consumer loans classification. The Banks actively monitor the risk of this loan concentration. The Banks have no foreign loans, and the impact of nonaccrual, restructured troubled debt and delinquent loans on total interest income was not material. A loan is generally classified as nonaccrual when principal or interest has consistently been in default for a period of 90 days or more or because of a deterioration in the financial condition of the borrower or payment in full of principal or interest is not expected. Delinquent loans past due 90 days or more and still accruing interest are loans that are generally well-secured and expected to be restored to a current status in the near future. PAGE 25 The Banks continued to maintain a high quality loan portfolio during 2000. Nonperforming assets (nonaccruing loans, net assets in foreclosure and troubled debt restructured loans) were 0.47% of total loans and net assets acquired in foreclosure at December 31, 2000, compared to 0.50% at December 31, 1999, and 0.57% at December 31, 1998. The ratio of the allowance to nonperforming assets was 268.3% at December 31, 2000, compared to 266.3% at December 31, 1999 and 261.2% at December 31, 1998. The balance of nonaccruing loans of $5,370,000 at December 31, 2000, increased $1,680,000 from the December 31, 1999, balance of $3,690,000. A rise in both nonaccruing commercial loans and indirect consumer loans was responsible for this increase. The December 31, 1999, balance of nonaccrual loans was $51,000 less than the December 31, 1998, balance of $3,741,000. Net assets in foreclosure totaled $288,000 as of December 31, 2000, a decrease of $1,148,000 from the December 31, 1999, balance. During 2000, sales of foreclosed properties totaled $2,495,000, transfers from loans to assets in foreclosure were $1,433,000 and write-downs of assets in foreclosure equaled $86,000. 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, less selling costs. The Banks aggressively manage loan collection efforts. During 2000, the Banks reduced loans past due 90 days or more. Loans past due 90 days or more and still accruing interest are loans that are generally well secured and are in the process of collection. As of December 31, 2000, loans past due 90 days or more and still accruing interest were $514,000, compared to $565,000 as of December 31, 1999. This decrease was a result of a reduction in commercial loans and consumer loans past due 90 days at December 31, 2000. As of December 31, 2000, there was one commercial borrower with a troubled debt restructured loan totaling $11,000. This customer was complying with the restructured terms as of December 31, 2000. The Banks' policy is to maintain allowances for loan losses at a level believed by management to be adequate to absorb potential losses. Management's determination of the adequacy of the allowance is determined monthly based on a continuing evaluation of the portfolio, past loss experience, current and anticipated economic conditions and other factors deemed relevant. Additions to the allowances are charged to operations. The allowance for loan losses grew 2.2% from $14,887,000 at December 31, 1999, to $15,210,000 at December 31, 2000. The allowance for loan losses to nonperforming assets at December 31, 2000, of 268.3% increased from the 266.3% at December 31, 1999.
-------------------------------------------------------------------------------- Year Ended December 31, ------------------------------------- 2000 1999 1998 ------------------------------------- Nonperforming assets. . . . . . . . . . $5,670,000 $5,591,000 $5,455,000 Allowance for loan losses to nonperforming assets. . . . . . . . 268.3% 266.3% 261.2% Nonperforming assets to total loans and net assets acquired in foreclosure. 0.47% 0.50% 0.57% Allowance for loan losses to total loans. . . . . . . . . . . 1.25% 1.33% 1.49% --------------------------------------------------------------------------------
Deposits and Borrowings and Other Interest-Bearing Liabilities The primary funding sources of the Corporation are deposits and other borrowings. Total deposits of $1,489,050,000 at December 31, 2000, increased $147,613,000, or 11.0%, from the $1,341,437,000 balance at December 31, 1999. This increase was primarily due to the growth in money market accounts and time deposits during this period. Money market deposits grew $74,607,000 during this period as a result of the successful introduction of new money market products during 2000. Time deposits under $100,000 increased $22,216,000 and time deposits greater than $100,000 grew $37,889,000. The growth in time deposits over $100,000 provided the banks with a lower cost funding alternative during 2000, compared to the higher level of other borrowings during 1999. Noninterest-bearing deposits grew $13,062,000, interest-bearing checking accounts rose $1,617,000 and savings accounts decreased $1,778,000 at December 31, 2000, compared to December 31, 1999. Other borrowings experienced a decrease of $20,209,000 during 2000. Decreases in securities sold under agreements to repurchase and Federal Home Loan Bank borrowings of $34,532,000 and $19,500,000, respectively, were partially offset by an increase in federal funds purchased of $35,000,000. The decrease in securities sold under agreements to repurchase was primarily the result of a business customer withdrawing funds to be used for general business purposes throughout 2000. U.S. treasury demand notes decreased $1,177,000 during this period. Borrowings and other interest-bearing liabilities include federal funds purchased, FHLB borrowings, securities sold under agreements to repurchase and U.S. Treasury notes. INCOME STATEMENT ANALYSIS Results of Operations The 2000 net income of $25,604,000 increased $2,366,000, or 10.2% from the 1999 net income of $23,238,000. On a per share basis, diluted earnings were $2.76 in 2000 and $2.50 in 1999. Basic earnings per share were $2.76 in 2000 compared to $2.51 in 1999. Net income increased in 1999 by $2,480,000, or 11.9% over 1998. The return on average shareholders' equity was 16.57% for 2000, compared to 15.63% for 1999 and 14.52% in 1998. The 2000 return on average assets of 1.39% decreased from the 1999 return on average asset rate of 1.42% as a result of the asset growth experienced during 2000. The 1998 return on average assets was 1.47%. Net income is affected by five major elements: (1) net interest income, or the difference between interest income earned on loans and investments and interest expense paid on deposits and borrowed funds; (2) the provision for loan losses, or the amount added to the allowance for loan losses to provide reserves for future losses on loans; (3) other operating income, which is made up primarily of certain service fees and Investment Management and Trust Services income; (4) other operating expenses, which consist primarily of salaries and other operating expenses; and (5) income taxes. Each of these major elements is reviewed in more detail in the following discussion. PAGE 26 Net Interest Income The 2000 net interest income of $66,037,000 increased $2,519,000, or 4.0%, from 1999 levels. Net interest income was $63,518,000 in 1999, which was 10.2% higher than the $57,633,000 reported in 1998. The smaller rise experienced in net interest income during 2000, was the result of both the Banks increased level of bank owned life insurance and higher funding costs. Interest income at December 31, 2000, of $131,811,000 grew $17,644,000, or 15.5%, from the $114,167,000 balance at December 31, 1999. The increase in interest income is the result of the growth in both average loans and investment securities during this period. This growth in interest income was partially offset by the $15,125,000, or 29.9%, increase in interest expense at December 31,2000, compared to December 31, 1999. The higher rate of growth in interest expense, compared to the growth in interest income, is the result of both the funding of the bank-owned life insurance (BOLI) with deposits, and the high cost of attracting new deposits. The Banks' investment in BOLI increased from an average of $9,394,000 in 1999 to $25,295,000 in 2000. While the cost of funding BOLI is recorded as interest expense, BOLI income is recorded as other operating income. Net Interest Margin The net interest margin for 2000 of 4.14% was lower than the net interest margins for 1999 and 1998 of 4.42% and 4.59%, respectively. The lower net interest margin experienced in 2000 is related to the funding of the BOLI and the high cost of attracting new funding sources. The impact of funding the additional BOLI purchased during 2000 reduced the net interest margin by 34 basis points. The tax-equivalent yield on total interest-earning assets increased 27 basis points from 7.65% in 1999 to 7.92% in 2000. This increase is primarily due to the impact of the rise in interest rates during this period. The tax-equivalent yield on total interest-earning assets in 1998 was 7.87%. The 2000 average interest rate paid on interest-bearing deposits and other borrowings of 4.53% was higher than the 1999 rate of 3.99%. The Banks' 54 basis point rise in the cost of interest-bearing liabilities outpaced the 27 basis point rise in the tax-equivalent yield on total interest earning assets. The 1998 cost of interest-bearing liabilities was 4.12%. Interest Rate Sensitivity Analysis The Corporation actively manages its interest rate sensitivity positions. The objectives of interest rate risk management are to control exposure of net interest income to risks associated with interest rate movements and to achieve consistent growth in net interest income. The Asset/Liability Committee, using policies and procedures approved by the Banks' Boards of Directors, is responsible for managing the rate sensitivity position. The Banks manage interest rate sensitivity by changing mix and repricing characteristics of their assets and liabilities through their investment securities portfolios, borrowings from the FHLB and their offering of loan and deposit terms. The nature of the Banks' current operations is such that it 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. The table below shows the interest rate sensitivity gap position as of December 31, 2000. The table presents data at a single point in time and includes management assumptions estimating the prepayment rate and the interest rate environment prevailing at December 31, 2000. Money market, interest-bearing checking, and savings accounts are considered stable sources of funds, and although the rates are subject to change, rates on these accounts historically have not changed as quickly or as often as the other deposits included in the following analysis. On a cumulative basis over the next 12 months, the Banks are in a positive gap position of 4.25% of earning assets at December 31, 2000.
Interest Rate Sensitivity Gap Position as of December 31, 2000 --------------------------------------------- (Dollars in thousands) 0 to 90 91 to 365 Over 1 year Over 5 days days Under 5 years years ------------------------------------------- Assets Other rate-sensitive assets. . . . $ 3,507 $ - $ - $ - Loans. . . . . . . . . . . . . . . 320,796 282,794 581,229 27,236 Investment securities. . . . . . . 16,607 61,609 210,514 310,542 --------- ----------- ---------- --------- Total rate-sensitive assets. . . . 340,910 344,403 791,743 337,778 --------- ----------- ---------- --------- Liabilities Time deposits. . . . . . . . . . . 146,510 230,348 226,044 40 Money market savings funds . . . . 10,009 30,026 160,139 133,448 Interest-bearing checking accounts 4,914 14,743 78,627 65,523 Savings accounts . . . . . . . . . 4,837 14,511 77,392 64,493 Other borrowings . . . . . . . . . 150,637 - 80,751 - --------- ----------- ---------- --------- Total rate-sensitive liabilities . $316,907 $ 289,628 $ 622,953 $263,504 --------- ----------- ---------- --------- Incremental gap. . . . . . . . . . $ 24,003 $ 54,775 $ 168,790 $ 74,274 ========= =========== ========== ========= Cumulative gap . . . . . . . . . . $ 24,003 $ 78,778 $ 247,568 $321,842 ========= =========== ========== ========= % of earning assets. . . . . . . . 1.30% 4.25% 13.37% 17.38% ========= =========== ========== =========
PAGE 27
Asset/Liability Change in Policy Market Value Market Value Percentage Approved of Equity of Equity Change Percent Change ----------------------------------------------------------- +200 Basis Points 262,627 (27,189) -9.38% +/- 30% +100 Basis Points 281,252 (8,564) -2.95% +/- 30% Flat Rate . . . . 289,816 - 0.00% +/- 30% -100 Basis Points 279,467 (10,349) -3.57% +/- 30% -200 Basis Points 260,897 (28,919) -9.98% +/- 30%
-------------------------------------------------------------------------------- Management also simulates possible economic conditions and interest rate scenarios in order to quantify the impact on net interest income. The effect that changing interest rates have on the Banks' net interest income is simulated by increasing and decreasing interest rates. This simulation is known as rate shocking. The report above forecasts changes in the Banks' market value of equity under alternative interest rate environments. The market value of equity is defined as the net present value of the Banks' existing assets and liabilities. The results of the December 31, 2000, rate shock simulations show that the Banks are within all guidelines set by the Banks' Asset/Liability policy. In the event the Banks should experience a mismatch in their desired GAP ranges or an excessive decline in their market value of equity resulting from changes in interest rates, they have a number of options which they could utilize to remedy such a mismatch. The Banks could restructure their investment portfolio through the sale or purchase of securities with more favorable repricing attributes. They could also emphasize loan products with appropriate maturities or repricing attributes, or attract deposits or obtain borrowings with desired maturities. Provision for Loan Losses The provision for loan losses is based on management's analysis of the adequacy of the allowance for loan losses. In its evaluation, management considers past loan experience, overall characteristics of the loan portfolio, current economic conditions and other relevant factors. Based on the latest monthly evaluation of potential loan losses, the allowance is adequate to absorb known and inherent losses in the loan portfolio. Ultimately however, the adequacy of the allowance is largely dependent upon the economy, a factor beyond the Corporation's control. With this in mind, additions to the allowance for loan losses may be required in future periods, especially if economic trends worsen or certain borrowers' abilities to repay decline. The 2000 provision of $2,312,000, reflected an increase of $159,000, or 7.4%, compared to the 1999 provision of $2,153,000. The increase in the provision during 2000 is based on management's analysis of the adequacy of the loan portfolio. The allowance for loan losses to nonperforming assets ratio for December 31, 2000, 1999 and 1998 were 268.3%, 266.3%, and 261.2%, respectively. Total loans charged off increased 47.5% from $1,799,000 in 1999 to $2,653,000 in 2000. The increase in the loans charged off was primarily due to consumer loans. Recoveries of $664,000 during 2000 increased from the 1999 recoveries of $288,000. The increase in recoveries is related to consumer and real estate loans. The charged off loans and recoveries for 1998 were $1,451,000 and $301,000, respectively. Other Income The 2000 other operating income of $12,206,000 increased $1,671,000, compared to the 1999 level of $10,535,000. Contributing to this rise in operating income were increases in service charges, trust income, BOLI income and other income of $61,000, $334,000, $1,418,000 and $301,000 respectively. These gains were offset by a decrease in security gains of $443,000 in 2000, compared to 1999. The 2000 other operating income net of security gains increased $2,114,000, or 21.1%, over the 1999 other operating income net of security gains. Income from service charges on deposit accounts of $3,832,000 in 2000 increased $61,000, or 1.6%, from the 1999 income from service charges on deposit accounts of $3,771,000. The increase in service charges during 2000 is attributed to the 9.3% rise in average fee earning deposits, partially offset by a reduction in fees related to merger related promotions. The 1999 service charges grew 6.8% over 1998 service charges. The $52,000 net security gain in 2000 was lower than the 1999 and 1998 net security gains of $495,000 and $1,621,000, respectively. Security gains resulting from the sale of securities at HNC Financial Company during 2000 were partially offset by a net loss on the sale of securities at the Banks. The majority of the security gain in 1998 was the result of the sale of equity securities held at HNC Financial Company. HNC Financial Company did not sell any securities during 1999. From time to time, the Corporation sells investment securities available for sale to fund the purchase of other securities in an effort to enhance the overall return on the portfolio. Fees from the Corporation's Investment Management and Trust Division of $2,977,000 increased $334,000, or 12.6%, compared to the $2,643,000 recorded in 1999. This increase was primarily the result of a 16.4% increase in the market value of trust assets from December 31, 1999 to December 31, 2000. The 1998 Investment Management and Trust Division income was $2,156,000. During 1999, the Corporation entered into a $25,000,000 investment of bank owned life insurance (BOLI). The Corporation entered into an additional $10,000,000 investment of BOLI during the 2000. BOLI involves the purchasing of life insurance by the Corporation on a chosen group of employees. The Corporation is the owner and beneficiary of the policies. This pool of insurance, due to tax advantages to the Banks, 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 $1,944,000 of BOLI income 2000 and $526,000 in 1999. Other income increased $301,000 during 2000, from $3,100,000 in 1999 to $3,401,000 in 2000. Contributing to this increase were increases related to loan servicing fees, loan insurance fees, and ATM/Debit card fees. These increases were partially offset by a decrease in gains on the sale of residential mortgages, resulting from a decrease in new mortgage volumes experienced during 2000. Other income in 1998 was $3,213,000. PAGE 28 Other Expenses The Corporation's total December 31, 2000, overhead expense as a percentage of average assets of 2.52% was well below its peer banks' ratio of 2.95% as of September 30, 2000. Other operating expenses rose to $44,677,000 in 2000, a 6.4% increase over the $41,976,000 recorded in 1999. This increase improved from the 9.2% increase in other operating expenses experienced from 1998 to 1999. Employee salaries and benefits increased $1,474,000, or 6.6%, from $22,271,000 in 1999 to $23,745,000 in 2000. The increase in salaries and benefits reflects cost-of-living increases, merit increases and additional staff necessitated by current and planned growth. The 1999 salaries and benefits expense increased 8.4% over the 1998 salary and benefits expense of $20,551,000. Net occupancy costs increased by $243,000, or 9.1%, in 2000, compared with a $111,000, or 4.3%, increase in 1999. Contributing to the increase in 2000 was the opening of new branches and an off-lease vehicle sales center. Equipment expenses increased by $360,000, or 7.5%, during 2000, and $917,000, or 23.8%, in 1999. These increases are due to equipment depreciation, rental and maintenance associated with planned increases in data processing capabilities used to manage the rise in volume related to the growth of the Corporation and to enhance the products offered to its customers. Other expenses grew $624,000, or 5.1%, from $12,247,000 in 1999 to $12,871,000 in 2000. The 1999 other expenses increased 6.8%, compared to 1998. The increase in 2000 is the result of expenses associated with the overall growth of the Banks, and the acquisition of Citizens Bank and Trust Company. Income Taxes The Corporation accounts for income taxes under the liability method specified by SFAS No. 109, "Accounting for Income Taxes." Under SFAS No. 109, deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The principal types of accounts resulting in differences between assets and liabilities for financial statement and tax return purposes are the allowance for loan losses, leased assets, deferred loan fees and compensation. The effective income tax rates of 18.01% for 2000, 22.3% for 1999 and 24.3% for 1998 were less than the applicable federal income tax rate of 35.0%, as a result of tax-exempt income. -------------------------------------------------------------------------------- CAPITAL Capital, at the end of 2000, was $173,536,000, an increase of $26,873,000, or 18.3%, over the end of 1999. The increase was due to the retention of the Corporation's earnings, and to the adjustment for the net unrealized gains related to the available for sale investment securities. Net unrealized gains and losses on available for sale investment securities are recorded as accumulated other comprehensive income (loss) in the equity section of the balance sheet. The accumulated other comprehensive income at December 31, 2000, was a gain of $1,422,000, compared to a loss of $10,808,000 at December 31, 1999. Management believes that the Corporation's current capital position and liquidity position are strong and that its capital position is adequate to support its operations. Except as previously discussed, management is not aware of any recommendation by any regulatory authority, which, if it were to be implemented, would have a material effect on the Corporation's capital. The Corporation's capital ratios exceed regulatory requirements. Existing minimum regulatory capital ratio requirements are 5.0% for primary capital and 6.0% for total capital. The primary capital ratio was 9.63% December 31, 2000, compared with 9.66% at December 31, 1999. 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 shareholders' equity, and Tier 2 capital is the allowance for loan losses. The risk-based capital ratios are computed by dividing the components of capital by risk-adjusted assets. Risk-adjusted assets are determined by assigning credit risk-weighting factors from 0% to 100% to various categories of assets and off-balance-sheet financial instruments. The minimum for the Tier 1 capital ratio is 4.0%, and the total capital ratio (Tier 1 plus Tier 2 capital divided by risk-adjusted assets) minimum is 8.0%. At December 31, 2000, the Corporation's Tier 1 risk-adjusted capital ratio was 12.22%, and the total risk-adjusted capital ratio was 13.35%, both well above regulatory requirements. The risk-based capital ratios of each of the Corporation's commercial banks also exceeded regulatory requirements at the end of 2000. To supplement the risk-based capital adequacy guidelines, the Federal Reserve Board (FRB) established a leverage ratio guideline. The leverage ratio consists of Tier 1 capital divided by quarterly average total assets, excluding intangible assets. The minimum leverage ratio guideline is 3% for banking organizations that do not anticipate significant growth and that have well-diversified risk, excellent asset quality, high liquidity, good earnings and, in general, are considered top-rated, strong banking or ganizations. Other banking organizations are expected to have ratios of at least 4% or 5%, depending upon their particular condition and growth plans. Higher leverage ratios could be required by the particular circumstances or risk profile of a given banking organization. The Corporation's leverage ratios were 8.97% and 8.92% at December 31, 2000 and 1999, respectively. Under FDIC regulations, a "well capitalized" institution must have a leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 6% and a total risk-based capital ratio of at least 10% and not be subject to a capital directive order. To be considered "adequately capitalized" an institution must generally have a leverage ratio of at least 4%, a Tier 1 risk-based capital ratio of at least 4% and a total risk-based capital ratio of at least 8%. An institution is deemed to be "critically under capitalized" if it has a tangible equity ratio of 2% or less. As of December 31, 2000, the Banks are above the regulatory minimum guidelines and meet the criteria to be categorized as "well capitalized" institutions. PAGE 29 Liquidity Liquidity is a measure of the ability of the Banks to meet their needs and obligations on a timely basis. For a bank, liquidity requires the ability to meet the day-to-day demands of deposit customers, and the ability to fulfill the needs of borrowing customers. Generally, the Banks arrange their mix of cash, money market investments, investment securities and loans in order to match the volatility, seasonality, interest sensitivity and growth trends of its deposit funds. Federal funds sold averaged $3,721,000 during 2000, and investment securities available for sale averaged $530,345,000 during 2000; both are more than sufficient to match normal fluctuations in loan demand or deposit funding. Backup sources of liquidity are provided by federal funds lines of credit established with correspondent banks. Additional liquidity could be generated through borrowings from the Federal Reserve Bank of Philadelphia, of which Harleysville, Citizens and Security are members, and from the Federal Home Loan Bank of Pittsburgh, of which Harleysville, Citizens and Security are members. Unused lines of credit at the FHLB were $114,738,000 as of December 31, 2000. There are no known trends or any known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in liquidity increasing or decreasing in any material way. ================================================================================ PAGE 30