Harleysville National Corporation Form 10-Q for first quarter ended March 31, 2006

10-Q 1 form10q-1stquarter2006.htm HARLEYSVILLE NATIONAL CORPORATION FORM 10-Q FOR FIRST QUARTER ENDED MARCH 31, 2006 Harleysville National Corporation Form 10-Q for first quarter ended March 31, 2006

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

___________________

Form 10-Q

__________________

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended March 31, 2006

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the transition period from ___________ to __________

Commission file number 0-15237

___________________

HARLEYSVILLE NATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

___________________

Pennsylvania		23-2210237
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

483 Main Street

Harleysville, Pennsylvania 19438

(Address of principal executive office and zip code)

(215) 256-8851

(Registrant’s telephone number, including area code)

___________________

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer o Accelerated filer x Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 27,516,962 shares of Common Stock, $1.00 par value, outstanding on May 4, 2006.

HARLEYSVILLE NATIONAL CORPORATION


INDEX TO FORM 10-Q REPORT

	PAGE

Part I. Financial Information

Item 1. Financial Statements:

Consolidated Balance Sheets at March 31, 2006 (unaudited) and December 31, 2005	3

Consolidated Statements of Income for the Three Months Ended March 31, 2006 and 2005 (unaudited)	4

Consolidated Statements of Shareholders’ Equity for the Three Months Ended March 31, 2006 and 2005 (unaudited)	5

Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005 (unaudited)	6

Notes to Consolidated Financial Statements	7

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	16

Item 3. Quantitative and Qualitative Disclosures about Market Risk	27

Item 4. Controls and Procedures	27

Part II. Other Information	28

Item 1. Legal Proceedings	28

Item 1A. Risk Factors	28

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	28

Item 3. Defaults Upon Senior Securities	28

Item 4. Submission of Matters to a Vote of Security Holders	28

Item 5. Other Information	28

Item 6. Exhibits	29

Signatures	31

Certifications	34-37

PART 1. FINANCIAL INFORMATION
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)		March 31, 2006			December 31, 2005
		(Unaudited)
Assets
Cash and due from banks	$	63,874		$	57,756
Federal funds sold and securities purchased under agreements to resell		35,500			35,000
Interest-bearing deposits in banks		3,980			2,455
Total cash and cash equivalents		103,354			95,211
Residential mortgage loans held for sale		2,530			2,028
Investment securities available for sale		877,124			841,653
Investment securities held to maturity (market value $59,906 and $59,753, respectively)		59,541			59,555
Loans and leases		2,000,920			1,983,465
Less: Allowance for loan losses		(19,895	)		(19,865	)
Net loans		1,981,025			1,963,600
Premises and equipment, net		28,852			27,570
Accrued interest receivable		13,808			13,282
Goodwill		46,154			31,552
Intangible assets, net		3,967			4,031
Bank-owned life insurance		59,934			59,334
Other assets		25,404			19,543
Total assets	$	3,201,693		$	3,117,359
Liabilities and Shareholders' Equity
Deposits:
Noninterest-bearing	$	345,118		$	363,440
Interest-bearing:
Checking accounts		382,199			387,374
Money market accounts		678,276			667,952
Savings		187,534			190,033
Time deposits		832,546			756,658
Total deposits		2,425,673			2,365,457
Federal funds purchased and securities sold under agreements to repurchase		104,038			88,118
Other short-term borrowings		274			1,752
Long-term borrowings		297,750			297,750
Accrued interest payable		26,943			28,276
Subordinated debt		51,548			51,548
Other liabilities		15,478			11,226
Total liabilities		2,921,704			2,844,127
Shareholders' Equity:
Series preferred stock, par value $1 per share;
Authorized 8,000,000 shares, none issued		-			-
Common stock, par value $1 per share; authorized 75,000,000
shares; issued 27,581,941 shares at March 31, 2006 and
27,500,407 shares at December 31, 2005		27,582			27,500
Additional paid in capital		168,946			167,418
Retained earnings		92,008			88,285
Accumulated other comprehensive loss		(8,418	)		(8,618	)
Treasury stock, at cost: 5,987 shares at March 31, 2006 and
64,700 shares at December 31, 2005		(129	)		(1,353	)
Total shareholders' equity		279,989			273,232
Total liabilities and shareholders' equity	$	3,201,693		$	3,117,359

See accompanying notes to consolidated financial statements.

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
	Three Months Ended
	March 31,
(Dollars in thousands, except per share information)		2006		2005

Interest Income:
Loans and leases, including fees	$	31,796	$	26,186
Investment securities:
Taxable		7,322		6,054
Exempt from federal taxes		2,553		2,763
Federal funds sold and securities purchased under agreements to resell		374		245
Deposits in banks		51		24
Total interest income		42,096		35,272

Interest Expense:
Savings and money market deposits		7,513		4,280
Time deposits		7,644		5,307
Short-term borrowings		1,420		814
Long-term borrowings		4,048		3,201
Total interest expense		20,625		13,602

Net interest income		21,471		21,670
Provision for loan losses		1,200		750
Net interest income after provision for loan losses		20,271		20,920

Noninterest Income:
Service charges		1,890		1,957
Gain on sales in investment securities, net		-		923
Wealth management income		4,474		1,929
Bank-owned life insurance income		600		493
Other income		1,969		1,641
Total noninterest income		8,933		6,943
Net interest income after provision for loan losses and
Nonterest income		29,204		27,863

Noninterest Expense:
Salaries, wages and employee benefits		10,519		9,500
Occupancy		1,498		1,391
Furniture and equipment		891		1,170
Marketing		406		550
Other expense		3,811		2,892
Total noninterest expense		17,125		15,503

Income before income tax expense		12,079		12,360
Income tax expense		3,128		3,195
Net income	$	8,951	$	9,165

Net income per share information:
Basic	$	0.33	$	0.33
Diluted	$	0.32	$	0.32
Cash dividends per share	$	0.19	$	0.17
Weighted average number of common shares:
Basic		27,498,274		27,559,493
Diluted		27,980,829		28,316,146

See accompanying notes to consolidated financial statements.

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited)

(Dollars and share information in thousands)

Three Months Ended March 31, 2006


	Common Stock	Treasury Stock					Additional					Accumulated Other
	Number of	Number of			Par		Paid		Retained			Comprehensive			Treasury						Comprehensive
	Shares	Shares			Value		In Capital		Earnings			Income (Loss	)		Stock			Total			Income

Balance, January 1, 2006	27,500	(64	)	$	27,500	$	167,418	$	88,285		$	(8,618	)	$	(1,353	)	$	273,232
Issuance of stock for stock options, net of tax benefits	82	83			82		1,400		-			-			1,762			3,244
Stock based compensation expense	-	-			-		128		-			-			-			128
Net income	-	-			-		-		8,951			-			-			8,951		$	8,951
Other comprehensive income, net of reclassifications and tax	-	-			-		-		-			200			-			200			200
Purchases of treasury stock	-	(25	)		-		-		-			-			(538	)		(538	)
Cash dividends	-	-			-		-		(5,228	)		-			-			(5,228	)
Comprehensive income																				$	9,151
Balance, March 31, 2006	27,582	(6	)	$	27,582	$	168,946	$	92,008		$	(8,418	)	$	(129	)	$	279,989

Three Months Ended March 31, 2005


	Common Stock	Treasury Stock					Additional					Accumulated Other
	Number of	Number of			Par		Paid		Retained			Comprehensive			Treasury						Comprehensive
	Shares	Shares			Value		In Capital		Earnings			Income (Loss	)		Stock			Total			Income (Loss	)

Balance, January 1, 2005	27,320	(1,043	)	$	27,320	$	160,039	$	99,730		$	1,243		$	(17,800	)	$	270,532
Issuance of stock for stock options, net of tax benefits	94	-			94		2,331		-			-			-			2,425
Net income	-	-			-		-		9,165			-			-			9,165		$	9,165
Other comprehensive loss, net of reclassifications and tax	-	-			-		-		-			(5,542	)		-			(5,542	)		(5,542	)
Purchases of treasury stock	-	(131	)		-		-		-			-			(3,133	)		(3,133	)
Cash dividends	-	-			-		-		(4,723	)		-			-			(4,723	)
Comprehensive income																				$	3,623
Balance, March 31, 2005	27,414	(1,174	)	$	27,414	$	162,370	$	104,172		$	(4,299	)	$	(20,933	)	$	268,724



See accompanying notes to consolidated financial statements.

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
	Three Months Ended
(Dollars in thousands)	March 31,
		2006			2005
Operating Activities:
Net income	$	8,951		$	9,165
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1,200			750
Depreciation and amortization		1,007			883
Net amortization of investment securities discounts/premiums		972			1,448
Deferred income tax benefit		(1,398	)		(896	)
Gains on sales of investment securities, net		—			(923	)
Stock based compensation expense		128			—
Net increase in accrued interest receivable		(526	)		(869	)
Net increase (decrease) in accrued interest payable		(1,333	)		1,385
Net decrease in other assets		996			204
Net increase (decrease) in other liabilities		(1,794	)		4,722
Net cash provided by operating activities		8,203			15,869
Investing Activities:
Proceeds from sales of investment securities available for sale		1,121			124,955
Proceeds, maturity or calls of investment securities held to maturity		—			4,872
Proceeds, maturity or calls of investment securities available for sale		38,312			33,800
Purchases of investment securities available for sale		(75,801	)		(136,586	)
Net increase in loans		(19,201	)		(20,427	)
Net cash paid due to acquisition, net of cash acquired		(14,485	)		—
Net increase in premises and equipment		(2,008	)		(914	)
Net increase in bank-owned life insurance		(600	)		(484	)
Proceeds from sales of other real estate		25			66
Net cash provided by (used in) investing activities		(72,637	)		5,282
Financing Activities:
Net increase in deposits		60,216			25,004
Increase (decrease) in federal funds purchased and securities sold under agreements to repurchase		15,920			(4,509	)
Decrease in short-term borrowings		(1,478	)		(45,538	)
Cash dividends		(5,228	)		(4,723	)
Repurchase of common stock		(538	)		(3,133	)
Proceeds from the exercise of stock options		3,259			2,425
Excess tax benefits from stock based compensation		426			—
Net cash provided by (used in) financing activities		72,577			(30,474	)
Net increase (decrease) in cash and cash equivalents		8,143			(9,323	)
Cash and cash equivalents at beginning of period		95,211			106,990
Cash and cash equivalents at end of the period	$	103,354		$	97,667

Cash paid during the period for:
Interest	$	21,982		$	12,328
Income taxes	$	500		$	2,052
Supplemental disclosure of noncash investing and financing activities:
Transfer of assets from loans to other real estate owned	$	91		$	138

See accompanying notes to consolidated financial statements.

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 - Summary of Significant Accounting Policies

Principles of Consolidation and Basis of Presentation

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the consolidated financial position of Harleysville National Corporation (the Corporation) and its wholly owned subsidiaries - Harleysville National Bank (the Bank), HNC Financial Company and HNC Reinsurance Company, as of March 31, 2006, the results of its operations for the three month periods ended March 31, 2006 and 2005 and the cash flows for the three month period ended March 31, 2006 and 2005. The Cornerstone’s Companies (subsidiaries of the Bank) results of operations are included in the Corporation’s results beginning January 1, 2006 through March 31, 2006. Certain prior period amounts have been reclassified to conform to current year presentation. All significant intercompany accounts and transactions have been eliminated in consolidation. We recommend that you read these unaudited consolidated financial statements in conjunction with the audited consolidated financial statements of the Corporation and the accompanying notes in the Corporation's 2005 Annual Report on Form 10-K. The results of operations for the three month periods ended March 31, 2006 and 2005 are not necessarily indicative of the results to be expected for the full year.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities as of the dates of the balance sheets and revenues and expenditures for the periods presented. Actual results could differ from those estimates.

Goodwill and Other Intangible Assets

Goodwill was $46.2 million at March 31, 2006 and $31.6 million at December 31, 2005. In January 2006, the Corporation completed the acquisition of the Cornerstone Companies including approximately $15.3 million of goodwill allocated to the Wealth Management segment. The amortization of the identifiable intangibles related to the Wealth Management segment totaled $94,000 for the first quarter of 2006 on an estimated intangible of $3.7 million. Amortization of other intangible assets, primarily core deposit intangible, allocated to the Community Banking segment were $61,000 and $62,000 for the three months ended March 31, 2006 and 2005, respectively. Management performed its annual review of goodwill at June 30, 2005 in accordance with SFAS No. 142 and determined there was no impairment of goodwill and identifiable intangible assets.

Stock Based Compensation

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS 123(R)). SFAS 123(R) replaces SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123(R) establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services and addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. Under SFAS 123(R), all forms of share-based payments to employees, including employee stock options, will be treated the same as other forms of compensation by recognizing the related cost in the income statement. The expense of the award will generally be measured at fair value at the grant date with compensation expense recognized over the service period, which is usually the vesting period. SFAS 123 required that the expense relating to so-called fixed plan employee stock options only be disclosed in the footnotes to the financial statements. SFAS 123(R) eliminates the ability to account for share-based compensation transactions using APB 25.

The Corporation adopted SFAS No. 123(R) on January 1, 2006 using the modified prospective application method of transition. Prior to January 1, 2006, the Corporation followed APB 25 and the disclosure requirements of FAS 123(R) with pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS 123 has been applied. The Corporation’s consolidated financial statements as of and for the first quarter of 2006 reflect the impact of adopting FAS 123(R). In accordance with the modified prospective method, the consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of FAS 123(R). Effective January 1, 2006, the Corporation recognizes compensation expense for the portion of outstanding awards at January 1, 2006 for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under SFAS 123 for pro forma disclosures. For new grants awarded on or after January 1, 2006, the Corporation has chosen to continue the use of the Black-Scholes option-pricing model (as used under SFAS 123) to estimate the fair value of each option on the date of grant. In accordance with SFAS 123(R), commencing January 1, 2006, the Corporation estimates the number of options for which the requisite service is expected to be rendered as compared to accounting for forfeitures as they occur under SFAS 123. The Corporation has chosen to recognize compensation expense for new grants using the straight-line method which spreads compensation expense for shares vesting evenly over the period of vesting. Pro forma disclosures under SFAS 123 have been

Note 1 - Summary of Significant Accounting Policies - Continued

based upon the accrual method which treats each vesting tranche as a separate award and amortizes expense evenly (prorated) from grant date to vest date for each tranche. The Corporation estimates that share-based compensation expense, net of tax, to be recognized during the year of 2006 will be approximately $403,000. The number and timing of options granted during 2006 and vesting criteria may alter this projected number. See Note 5 - Stock Based Compensation for additional information.

In October 2005, the FASB issued Staff Position (FSP) No. 123(R)-2, “Practical Accommodation to the Application of Grant Date as Defined in SFAS No. 123(R).” The FSP stipulates that assuming all other criteria in the grant date definition are met, a mutual understanding of the key terms and conditions of an award to an individual employee is presumed to exist upon the award’s approval in accordance with the relevant corporate governance requirements, provided that the terms and conditions of an award (a) cannot be negotiated by the recipient with the employer and (b) are expected to be communicated to an individual recipient within a relatively short time period from the date of approval. FSP 123(R)-2 applies upon initial adoption of SFAS 123(R). The adoption of this FSP did not have any impact on the Corporation’s financial position or results of operations.

In November 2005, the FASB issued FSP No. 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payments Awards.” The FSP provides an alternative transition method for accounting for the tax effects of share-based payment awards to employees for entities that do not have the necessary information to comply with the transition requirements of SFAS 123(R). An entity may take up to one year from the later of its initial adoption of SFAS 123(R) or the effective date of this FSP (November 10, 2005) to evaluate its available transition alternatives and make its one-time election.

In February 2006, the FASB issued FSP No. 123(R)-4, “Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event” to amend guidance in SFAS 123(R) on classifying options and similar instruments issued as part of employee compensation arrangements. Prior to amendment, SFAS 123(R) required the classification of such instruments as liabilities if the entity could be required under any circumstances to settle the option or similar instrument by transferring cash or other assets. FSP 123(R)-4 amends certain paragraphs of SFAS 123(R) to incorporate a practical accommodation similar to the probability approach provided in footnote 16 of the statement for shares subject to contingent cash settlement features. As a result, SFAS 123(R) requires options issued as compensation to employees to be classified as liabilities if the cash settlement feature can be exercised only upon the occurrence of a contingent event that is outside the employee's control, and such event is deemed probable to occur. Accounting for the modification of the option or similar instrument from equity to liability is similar to accounting for a modification from an equity to liability award. This FSP is applicable upon initial adoption of SFAS 123(R). FSP 123(R)-4 did not have any impact on the Corporation’s financial position or results of operations.

For additional information on other significant accounting policies, see Note 1 of the Consolidated Financial Statements of the Corporation’s 2005 Annual Report on Form 10-K.

Note 2 - Dispositions / Acquisition

On January 13, 2006, the Corporation completed its acquisition of the Cornerstone Companies, registered investment advisors for high net worth, privately held business owners, wealthy families and institutional clients. Located in the Lehigh Valley, Pennsylvania, the firm specializes in providing sophisticated open architecture asset management platforms, business succession and estate planning services, life insurance sales and compensation and benefits consulting. The Cornerstone Companies have assets under management of approximately $1.5 billion at the acquisition date and serve clients throughout Pennsylvania and other mid-Atlantic states.

The acquisition was consummated pursuant to the Purchase Agreement dated November 15, 2005, by and among the Bank and Cornerstone Financial Consultants, Ltd., a Pennsylvania corporation (CFC), Cornerstone Institutional Investors, Inc., a Pennsylvania corporation (CII), Cornerstone Advisors Asset Management, Inc., a Pennsylvania corporation ((CAAM), and together with CFC and CII collectively, the Cornerstone Companies) and Cornerstone Management Resources, Inc., (CMR). Under the Purchase Agreement, the Bank acquired (i) all of the outstanding capital stock of CFC and CII, (ii) substantially all of the assets of CAAM, and (iii) certain limited assets of CMR. The purchase price consisted of $15.0 million in cash paid at closing and a contingent payment of up to $7.0 million to be paid post-closing. The contingent payment is based upon the Cornerstone Companies meeting certain minimum operating results during a five-year earn-out period, with a maximum payout of $7.0 million over this period.

The Cornerstone Companies acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, “Business Combinations.” The Cornerstone’s Companies results of operations are included in the Corporation’s results beginning January 1, 2006 through March 31, 2006. Goodwill of approximately $15.3 million was recorded in connection with the acquisition. Management is in the process of evaluating and finalizing the identifiable intangible assets and purchase accounting adjustments. The amortization of the identifiable intangibles totaled $94,000 for the first quarter of 2006 on an estimated identifiable intangible of $3.9 million included in goodwill.

Note 2 - Dispositions / Acquisition - Continued

On June 30, 2005, the Bank sold its former subsidiary, Cumberland Advisors, Inc., to David R. Kotok and Associates, Inc. in a stock sale. The sale price was $2.0 million cash and resulted in a non-taxable gain of $287,000 recorded in the second quarter of 2005. Cumberland Advisors had assets of $1.8 million. Cumberland Advisors, based in Vineland, New Jersey, is a SEC registered investment advisor specializing in fixed income money management and equities with approximately $700 million in assets under management at June 30, 2005. It was acquired by the Corporation on April 30, 2004 as part of its Millennium Bank acquisition. Based upon management’s analysis of Cumberland Advisors’ results of operations and assets in comparison to the Corporation’s, management determined the impact of the sale of Cumberland Advisors is immaterial, and therefore the transaction is not presented as discontinued operations.

On April 1, 2005, the Bank completed the sale of its McAdoo branch located in Schuylkill County, Pennsylvania with deposits of $13.9 million as well as certain loans and other assets of $5.8 million to The Legacy Bank. In connection with the sale, the Bank paid net cash of $7.4 million and recorded a pre-tax profit of $690,000 during the second quarter of 2005.

Note 3 - Pension Plan

The Corporation has a non-contributory defined benefit pension plan covering substantially all employees. The plan’s benefits are based on years of service and the employee’s average compensation during any five consecutive years within the ten-year period preceding retirement.

Net periodic defined benefit pension expense for the three months ended March 31, 2006 and 2005 included the following components:

	Three Months Ended
	March 31,
(Dollars in thousands)		2006			2005

Service cost	$	260		$	263
Interest cost		164			161
Expected return on plan assets		(138	)		(131	)
Amortization of unrecognized net actuarial loss		29			23
Net periodic benefit expense	$	315		$	316

The Corporation has not made any contributions to its pension plan during the first quarter of 2006.

Note 4 - Stock Dividend/Split

On September 15, 2005, the Corporation paid a five percent stock dividend to shareholders of record as of September 1, 2005. All prior period amounts were restated to reflect these stock dividends.

Note 5 - Stock Based Compensation

The Corporation has four shareholder approved fixed stock option plans that allow the Corporation to grant options up to an aggregate of 3,617,011 shares of common stock to key employees and directors. At March 31, 2006, 2,471,734 stock options had been granted under the stock option plans. The options have a term of ten years when issued and typically vest over a five-year period. The exercise price of each option is the market price of the Corporation’s stock on the date of grant. Additionally, at March 31, 2006, the Corporation has an additional 312,681 granted stock options as a result of the Millennium Bank acquisition. The options have a term of ten years and are exercisable at prices ranging from $9.71 to $14.50.

At January 1, 2006, the Corporation began recognizing compensation expense for stock options with the adoption of SFAS 123(R) under the modified prospective application method of transition. Prior to January 1, 2006, the Corporation followed SFAS 123 and APB 25 with pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS 123 has been applied. Effective January 1, 2006, the Corporation recognizes compensation expense for the portion of outstanding awards at January 1, 2006 for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under SFAS 123 for pro forma disclosures. For new grants awarded on or after January 1, 2006, the Corporation has chosen to continue the use of the Black-Scholes option-pricing model (as used under SFAS 123) to estimate the fair value of each option on the date of grant. See Note 1 - Summary of Significant Accounting Policies for additional information.

Note 5 - Stock Based Compensation - Continued

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 based on historical data used for grants at March 31, 2006 and March 31, 2005, respectively: dividend yield of 3.46% and 2.83%; expected volatility of 31.78% and 29.38%; risk-free interest rate of 4.42% and 4.06%; and an expected life of 7.34 years and 7.06 years. Expected volatility is based on the historical volatility of the Corporation’s stock over the expected life of the grant. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury strip rate in effect at the time of the grant. The life of the option is based on historical factors which include the contractual term, vesting period, exercise behavior and employee terminations. In accordance with SFAS 123(R), stock based compensation expense for the three months ended March 31, 2006 is based on awards that are ultimately expected to vest and therefore has been reduced for estimated forfeitures. The Corporation estimates forfeitures using historical data based upon the groups identified by management. Prior to January 1, 2006, under SFAS 123, forfeitures were accounted for as they occurred. As a result of adopting FAS 123(R) on January 1, 2006, the Corporation’s income before income taxes and net income for the three months ended March 31, 2006 were $128,000 and $113,000 lower, respectively, than if it had continued to account for share based compensation under APB 25.

The following table illustrates the effect on net income and earnings per share if the Corporation had applied the fair value recognition provisions of SFAS 123(R) to stock-based employee compensation for the three months ended March 31, 2005 (all per share information has been adjusted retroactively for the effect of stock dividends).

(Dollars in thousands, except per share amounts)		Three Months Ended March 31,
		2005
Net income
As reported	$	9,165
Stock-based compensation expense included in reported net income, net of related tax effects		-
Stock-based compensation expense determined under fair value based method for all awards, net of related tax effects		(200	)
Pro forma	$	8,965

Earnings per share (Basic)
As reported	$	.33
Pro forma	$	.33

Earnings per share (Diluted)
As reported	$	.32
Pro forma	$	.32

A summary of option activity under the Corporation’s stock option plans as of March 31, 2006, and changes during the period ended March 31, 2006 were as follows:

Options	Shares			Weighted-Average Exercise Price	Weighted-Average Remaining Contractual Term		Aggregate Intrinsic Value (in thousands	)
Outstanding at January 1, 2006	1,571,799		$	14.99
Granted	12,000			19.10
Exercises	(169,980	)		10.06

Outstanding at March 31, 2006	1,413,819		$	15.61	5.95	$	11,299

Exercisable at March 31, 2006	1,186,807		$	14.10	5.35	$	11,105

Note 5 - Stock Based Compensation - Continued

The weighted-average grant-date fair value of options granted during the three months ended March 31, 2006 and 2005 was $5.29 and $6.73, respectively. The total intrinsic value of options exercised during the first quarter of 2006 and 2005 was $2.0 million and $1.2 million, respectively. Intrinsic value is measured using the fair market value price of the Corporation’s common stock less the applicable exercise price.

A summary of the status of the Corporation’s nonvested shares as of March 31, 2006 is presented below:

Nonvested Shares	Shares			Weighted-Average Grant-Date Fair Value

Nonvested at January 1, 2006	218,717		$	6.56

Granted	12,000			5.29

Vested	(3,705	)		6.28

Nonvested at March 31, 2006	227,012		$	6.49

As of March 31, 2006, there was a total of $1.0 million of unrecognized compensation cost related to nonvested awards under stock option plans. This cost is expected to be recognized over a weighted-average period of 1.8 years. The total fair value of shares vested during the three months ended March 31, 2006 and 2005 was $23,000 and $15,000, respectively.

Prior to the adoption of FAS 123(R), the Corporation presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the statement of cash flows. Statement 123(R) requires the cash flows resulting from tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. The $426,000 excess tax benefit classified as a financing cash inflow would have been classified as an operating cash inflow if the company had not adopted FAS 123(R).

Note 6 - Earnings Per Share

Basic earnings per share exclude dilution and are computed by dividing income available to common shareholders by the weighted-average common shares outstanding during the period. Diluted earnings per share take into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. All weighted average, actual shares and per share information in these financial statements have been adjusted retroactively for the effect of stock dividends. The calculations of basic earnings per share and diluted earnings per share are as follows:

	Three Months Ended
	March 31,
(Dollars in thousands, except per share data)		2006		2005

Basic earnings per share
Net income available to common shareholders	$	8,951	$	9,165
Weighted average common shares outstanding		27,498,274		27,559,493
Basic earnings per share	$	.33	$	.33

Diluted earnings per share
Net income available to common shareholders and assumed conversions	$	8,951	$	9,165
Weighted average common shares outstanding		27,498,274		27,559,493
Dilutive potential common shares ^{(1), (2)}		482,555		756,653
Total diluted weighted average common shares outstanding		27,980,829		28,316,146
Diluted earnings per share	$	.32	$	.32

(1)	Includes incremental shares from assumed conversions of stock options.

(2)

Antidilutive options have been excluded in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common stock. For the three months ended March 31, 2006, there were 354,734 antidilutive options at an average price of $26.93. For the three months ended March 31, 2005, there were 363,616 antidilutive options at an average price of $26.92.

Note 7 - Comprehensive Income

The components of other comprehensive income (loss) are as follows:

Comprehensive Income

(Dollars in thousands)		Before tax			Tax Benefit			Net of tax
Three months ended March 31, 2006		Amount			(Expense)			Amount
Net unrealized gains on available for sale securities:
Net unrealized holding gains arising during period	$	59		$	(21	)	$	38
Less reclassification adjustment for net gains realized in net income		-			-			-
Net unrealized gains		59			(21	)		38
Change in fair value of derivatives used for cash flow hedges		203			(71	)		132
Amortization of unrealized loss on termination of cash flow hedge		46			(16	)		30
Other comprehensive income, net	$	308		$	(108	)	$	200

(Dollars in thousands)		Before tax			Tax Benefit			Net of tax
Three months ended March 31, 2005		Amount			(Expense	)		amount
Net unrealized losses on available for sale securities:
Net unrealized holding losses arising during period	$	(7,695	)	$	2,693		$	(5,002	)
Less reclassification adjustment for net gains realized in net income		923			(323	)		600
Net unrealized losses		(8,618	)		3,016			(5,602	)
Change in fair value of derivatives used for cash flow hedges		378			(132	)		246
Unrealized loss on termination of cash flow hedge		(286	)		100			(186	)
Other comprehensive loss, net	$	(8,526	)	$	2,984		$	(5,542	)

Note 8 - Segment Information

The Corporation operates two main lines of business along with several other operating segments. SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” establishes standards for public business enterprises to report information about operating segments. Operating segments are components of an enterprise, which are evaluated regularly by the chief operating decision-maker in deciding how to allocate and assess resources and performance. The Corporation’s chief operating decision-maker is the President and Chief Executive Officer. The Corporation has applied the aggregation criteria set forth in SFAS No. 131 for operating segments establishing two reportable segments: Community Banking and Wealth Management.

The Community Banking segment provides financial services to consumers, businesses and governmental units primarily in southeastern Pennsylvania. These services include full-service banking, comprised of accepting time and demand deposits, making secured and unsecured commercial loans, mortgages, consumer loans, and other banking services. The treasury function income is included in the Community Banking segment, as the majority of effort of this function is related to this segment. Primary sources of income include net interest income and service fees on deposit accounts. Expenses include costs to manage credit and interest rate risk, personnel, and branch operational and technical support.

The Wealth Management segment includes: trust and investment management services, providing investment management, trust and fiduciary services, estate settlement and executor services, financial planning, and retirement plan and institutional investment services; and the Cornerstone Companies, registered investment advisors for high net worth, privately held business owners, wealthy families and institutional clients. Major revenue components sources include investment management and advisory fees, trust fees, estate and tax planning fees, brokerage fees, and insurance related fees. Expenses primarily consist of personnel and support charges. Additionally, the Wealth Management segment includes an inter-segment credit related to trust deposits which are maintained within the Community Banking segment using a transfer pricing methodology.

The Corporation has also identified several other operating segments. These operating segments within the Corporation’s operations do not have similar characteristics to the Community Banking or Wealth Management segments and do not meet the quantitative thresholds requiring separate disclosure. These non-reportable segments include HNC Reinsurance Company, HNC Financial Company, and the parent holding company and are included in the “Other” category.

Note 8 - Segment Information - Continued

Information about reportable segments and reconciliation of the information to the consolidated financial statements follows:

(Dollars in thousands)
		Community Banking		Wealth Management			All Other			Consolidated Totals
Three Months Ended March 31, 2006

Net interest income (expense)	$	21,769	$	140		$	(438	)	$	21,471
Provision for loan losses		1,200		-			-			1,200
Noninterest income		4,171		4,587			175			8,933
Noninterest expense		13,680		3,249			196			17,125
Income (loss) before income taxes (benefit)		11,060		1,478			(459	)		12,079
Income taxes (benefit)		2,758		616			(246	)		3,128
Net income (loss)	$	8,302	$	862		$	(213	)	$	8,951
Assets	$	3,165,842	$	2,460		$	33,391		$	3,201,693

Three Months Ended March 31, 2005

Net interest income	$	21,432	$	172		$	66		$	21,670
Provision for loan losses		750		-			-			750
Noninterest income		3,932		1,933			1,078			6,943
Noninterest expense		13,201		2,192			110			15,503
Income (loss) before income taxes (benefit)		11,413		(87	)		1,034			12,360
Income taxes (benefit)		2,780		(19	)		434			3,195
Net income (loss)	$	8,633	$	(68	)	$	600		$	9,165
Assets	$	2,963,715	$	1,842		$	37,015		$	3,002,572

The accounting policies of the segments are the same as those described in the summary of significant accounting policies disclosed in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2005. Consolidating adjustments reflecting certain eliminations of inter-segment revenues, cash and investment in subsidiaries are included in the “All Other” segment.

Note 9 - Financial Instruments with Off-Balance Sheet Risk

The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.

The Bank’s 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 Bank uses the same stringent credit policies in extending these commitments as they do for recorded financial instruments and controls exposure to loss through credit approval and monitoring procedures.

The approximate contract amounts are as follows:

	Total Amount Committed at
Commitments	March 31, 2006	December 31, 2005
(Dollars in thousands)

Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit .................................................................................................................................................................	$742,415	$722,034
Standby letters of credit and financial guarantees written .................................................................................................................	25,005	21,661
Financial instruments whose notional or contract amounts exceed the amount of credit risk:
Interest rate swap agreements ................................................................................................................................................................	52,100	22,100

Note 9 - Financial Instruments with Off-Balance Sheet Risk - Continued

At March, 31, 2006, the Corporation had cash flow hedges in the form of interest rate swaps totaling $45.0 million that have the effect of converting the rates on money market deposit accounts to a fixed-rate cost of funds. This strategy will cause the Bank to recognize, in a rising rate environment, a larger interest rate spread than it otherwise would have without the swaps in effect. In addition, the Corporation had a cash flow hedge for $5.0 million that has the effect of converting variable debt to a fixed rate. For these swaps, the Corporation recognized $78,000 of net interest income for the three months ended March 31, 2006 and $14,000 of net interest expense for the three months ended March 31, 2005. During the first quarter of 2005, the Corporation terminated a cash flow hedge with a notional value of $25.0 million. The gross loss related to the termination of this swap is $310,000 which is being amortized through October 2006 in accordance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities.” For the three months ended March 31, 2006 and March 31, 2005, the Corporation amortized into net interest income $45,000 and $23,000, respectively, related to this swap. Periodically, the Corporation may enter into fair value hedges to limit the exposure to changes in the fair value of loan assets. During December 2005, the Corporation entered into a fair value hedge for $2.1 million which had no impact to earnings for the first quarter of 2006. The interest rate swap agreements have a positive fair market value of $812,000 at March 31, 2006 and $623,000 at December 31, 2005.

The Bank also had commitments with customers to extend mortgage loans at a specified rate at March 31, 2006 and December 31, 2005 of $3.0 million and $1.8 million, respectively and commitments to sell mortgage loans at a specified rate at March 31, 2006 and December 31, 2005 of $2.2 million and $1.1 million, respectively. The commitments are accounted for as a derivative and recorded at fair value. The Bank estimates the fair value of these commitments by comparing the secondary market price at the reporting date to the price specified in the contract to extend or sell the loan initiated at the time of the loan commitment. At March 31, 2006, the commitments had a negative fair value of $6,000 which was recorded as a reduction of other income. At December 31, 2005, the commitments had a positive fair value of $320 which was recorded as other income.

During December 2004 and January 2005, the Bank sold lease financing receivables of $10.5 million. Of these leases, $1.2 million were sold with full recourse and the remaining leases were sold subject to recourse with a maximum exposure of ten percent of the outstanding receivable. The total recourse exposure at the time of the sale of the leases was $2.0 million. During the first quarter of 2005, the Bank recorded a recourse liability of $216,000 which is the entire recourse liability recorded. This estimate was based on our historic losses as experienced on similar lease financing receivables. After the first anniversary of the sale agreement, and on a quarterly basis thereafter, upon written request by the Bank, the purchaser will review the portfolio performance and may reduce the total exposure to an amount equal to ten percent of the outstanding net book value. The Corporation will be subject to the full and partial recourse obligations until all the lease financing receivables have been paid or otherwise been terminated and all equipment has been sold or disposed of. The final lease payment is due in 2010 with approximately 90% of the lease financing receivables estimated to be paid down by 2007. The outstanding balance of these sold leases at March 31, 2006 was $5.5 million with a total recourse exposure of $1.2 million and a current recourse liability of $175,000.

Note 10 - Recent Accounting Pronouncements

In March 2006, the FASB issued SFAS No. 156, “Amending Accounting for Separately Recognized Servicing Assets and Servicing Liabilities,” to simplify accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 amends SFAS No. 140, “ Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” to require an entity to 1) separately recognize financial assets as servicing assets or servicing liabilities, each time it undertakes an obligation to service a financial asset by entering into certain kinds of servicing contracts, 2) initially measure all separately recognized servicing assets and servicing liabilities at fair value, if practicable and 3) separately present servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. Additionally, SFAS No. 156 permits an entity to choose either the amortization method or the fair value measurement method for measuring each class of separately recognized servicing assets and servicing liabilities. SFAS No. 156 also permits a servicer that uses derivative financial instruments to offset risks on servicing to use fair value measurement when reporting both the derivative financial instrument and related servicing asset or liability. SFAS 156 applies to all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity's fiscal year that begins after September 15, 2006, although early adoption is permitted. The Corporation is in the process of assessing the impact of the adoption of this statement on the Corporation’s financial results.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments¾an amendment of FASB Statements No. 133 and 140,” to simplify and make more consistent the accounting for certain financial instruments. SFAS 155 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” to permit fair value re-measurement for any hybrid financial instrument with an embedded derivative that otherwise would require bifurcation, provided that the whole instrument is accounted for on a fair value basis. Prior to fair value measurement, interests in securitized financial assets must be evaluated to identify interests containing embedded derivatives requiring bifurcation. The amendments to SFAS 133 also clarify which interest-only and principal-only strips are not subject to the requirements of SFAS 133, and that concentrations of credit risk in the form of subordination are not embedded derivatives. SFAS 155 amends SFAS No. 140, “Accounting for the Impairment or Disposal of Long-Lived Assets,” to allow a qualifying special-purpose entity to hold a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 applies to all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006, with earlier application allowed. FAS 155 is not expected to have a material impact on the Corporation’s results of operations or financial condition.

Note 10 - Recent Accounting Pronouncements - Continued

In November 2005, the FASB issued FSP FAS Nos. 115-1 and FAS 124-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” to give guidance on determining when investments in certain debt and equity securities are considered impaired, whether that impairment is other than temporary, and on measuring such impairment loss. This FSP nullifies certain requirements of EITF Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” and supersedes EITF Topic No. D-44, “Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value.” This FSP nullifies the requirements of paragraphs 10-18 of Issue 03-1, carries forward the requirements of paragraphs 8 and 9 of Issue 03-1 with respect to cost-method investments, carries forward the disclosure requirements included in paragraphs 21 and 22 of Issue 03-1 and related examples, and references existing other-than-temporary guidance. The guidance in this FSP will apply to reporting periods beginning after December 15, 2005. The adoption of this FSP did not have a material impact on the Corporation’s results of operations or financial condition.

In November, 2005, the FASB issued FSP FIN 45-3, “Application of FASB Interpretation No. 45 to Minimum Revenue Guarantees Granted to a Business or Its Owners.” The guidance in this FSP amends FIN No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” to explicitly state that the recognition, measurement and disclosure provisions of FIN No. 45 apply to a minimum revenue guarantee. A minimum revenue guarantee is a guarantee granted to a business or its owners that the revenue of the business will be at least a specified minimum amount for a specified period of time. FSP FIN 45-3 is effective for new minimum revenue guarantees issued or modified on or after the beginning of the first fiscal quarter following November 10, 2005 (the date posted to the FASB website). The disclosure requirements are to be applied to all minimum revenue guarantees in financial statements of interim or annual periods ending after the beginning of the first fiscal quarter following November 10, 2005, although earlier application is permitted. FSP FIN 45-3 did not have a material impact on the Corporation’s financial position or results of operations.

Note 11- Subsequent Event

On April 14, 2006, the Bank sold its existing credit card portfolio to Elan Financial Services, a national credit card issuer and established an agent issuing relationship with Elan Financial Services. Under the agreement, Elan Financial Services will issue credit cards for the Bank under the Harleysville name. As of March 31, 2006, the Bank held approximately $14.5 million in credit card receivables. The Corporation anticipates recording a gain in the second quarter of 2006 from the sale of these credit cards, net of federal income taxes, of approximately $900,000 or $.03 per diluted share. The Bank will continue to earn certain fees from ongoing portfolio activity.

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF

RESULTS OF OPERATIONS AND FINANCIAL CONDITION

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 Bank, HNC Financial Company and HNC Reinsurance Company. The Corporation’s consolidated financial condition and results of operations consist almost entirely of the Bank’s financial condition and results of operations. Current performance does not guarantee, and may not be indicative, of similar performance in the future. These are unaudited financial statements and, as such, are subject to year-end audit review.

In addition to historical information, this Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We have made forward-looking statements in this report, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include the information concerning possible or assumed future results of operations of the Corporation and its subsidiaries. When we use words such as “believes,” “expects,” “anticipates,” “may,” “estimates,” or “intends” or similar expressions, we are making forward-looking statements. Forward-looking statements are representative only as of the date they are made, and the Corporation undertakes no obligation to update any forward-looking statement.

Shareholders should note that many factors, some of which are discussed elsewhere in this report and in the documents that we incorporate by reference, could affect the future financial results of the Corporation and its subsidiaries and could cause those results to differ materially from those expressed or implied in our forward-looking statements contained or incorporated by reference in this document. These factors include but are not limited to those described in Item 1A, “Risk Factors” in the Corporation’s 2005 Annual Report on Form 10-K and in this Form 10-Q.

Critical Accounting Estimates

The accounting and reporting policies of the Corporation and its subsidiaries conform to accounting principles generally accepted in the United States and general practices with the financial services industry. The Corporation’s significant accounting policies are described in Note 1 of the consolidated financial statements in this Form 10-Q and in the Corporation’s 2005 Annual Report on Form 10-K and are essential in understanding Management’s Discussion and Analysis of Results of Operations and Financial Condition. In applying accounting policies and preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amount 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. Judgments and assumptions required by management, which have, or could have a material impact on the Corporation’s financial condition or results of operations are considered critical accounting estimates. The following is a summary of the policies the Corporation recognizes as involving critical accounting estimates: Allowance for Loan Loss, Goodwill and Other Intangible Asset Impairment, Stock-Based Compensation, Unrealized Gains and Losses on Debt Securities Available for Sale, and Deferred Taxes.

Allowance for Loan Losses: The Corporation maintains an allowance for loan losses at a level management believes is sufficient to absorb estimated probable credit losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires significant estimates by management. Consideration is given to a variety of factors in establishing these estimates including current and anticipated economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers’ perceived financial and management strengths, the adequacy of underlying collateral, the dependence on collateral, or the strength of the present value of future cash flows and other relevant factors. These factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required which may adversely affect the Corporation’s results of operations in the future.

Goodwill and Other Intangible Asset Impairment: Goodwill and other intangible assets are reviewed for potential impairment on an annual basis, or more often if events or circumstances indicate that there may be impairment, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Goodwill is tested for impairment at the reporting unit level and an impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The Corporation employs general industry practices in evaluating the fair value of its goodwill and other intangible assets. The Corporation calculates the fair value using a combination of the following valuations: deposit premiums based on market deals, current stock pricing tracking as a multiple of book value, discounted cash flow of earnings with a terminal value and market multiple of earnings. Management performed its annual review of goodwill at June 30, 2005 and determined there was no impairment of goodwill. No assurance can be given that future impairment tests will not result in a charge to earnings.

Share-based Compensation: The Corporation adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (FAS 123(R)) on January 1, 2006 using the modified prospective application method of transition. FAS 123(R) was issued by the FASB in December 2004, requiring all forms of share-based payments to employees, including employee stock options, be treated the same as other forms of compensation by recognizing the related cost in the income statement. The expense of the option is generally measured at fair value at the grant date with compensation expense recognized over the service period, which is usually the vesting period. Prior to January 1, 2006, the Corporation followed SFAS 123 and APB 25 with pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS 123 has been applied. Effective January 1, 2006, the Corporation recognizes compensation expense for the portion of outstanding awards at January 1, 2006 for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under SFAS 123 for pro forma disclosures. For new grants awarded on or after January 1, 2006, the Corporation has chosen to continue the use of the Black-Scholes option-pricing model (as used under SFAS 123) to estimate the fair value of each option on the date of grant. The Corporation estimates the fair value of options under the Black-Scholes model which takes into consideration the exercise price and expected life of the options, the current price of the underlying stock and its expected volatility, the expected dividends on the stock and the current risk-free interest rate for the expected life of the option. The Corporation’s estimate of the fair value of a stock option is based on expectations derived from historical experience and may not necessarily equate to its market value when fully vested. In accordance with SFAS 123(R), the Corporation estimates the number of options for which the requisite service is expected to be rendered as compared to accounting for forfeitures as they occur under SFAS 123. The Corporation has chosen to recognize compensation expense for new grants using the straight-line method which spreads compensation expense for shares vesting evenly over the period of vesting. Pro forma disclosures under SFAS 123 have been based upon the accrual method which treats each vesting tranche as a separate award and amortizes expense evenly (prorated) from grant date to vest date for each tranche. The Corporation estimates that share-based compensation expense, net of tax, to be recognized during the year of 2006 will be approximately $403,000. The number and timing of options granted during 2006 and vesting criteria may alter this projected number. During the first quarter of 2006, the Corporation recognized $128,000 of share-based compensation expense ($113,000 net of tax). As of March 31, 2006, there was a total of $1.0 million of unrecognized compensation cost related to nonvested awards under stock option plans ($965,000 net of tax). This cost is expected to be recognized over a weighted-average period of 1.8 years.

Unrealized Gains and Losses on Debt Securities Available for Sale: The Corporation receives estimated fair values of debt securities from independent valuation services and brokers. In developing these fair values, the valuation services and brokers use estimates of cash flows based on historical performance of similar instruments in similar rate environments. Debt securities available for sale are mostly comprised of mortgage-backed securities.

Deferred Taxes: The Corporation recognizes deferred tax assets and liabilities for the future effects of temporary differences, net operating loss carryforwards, and tax credits. Deferred tax assets are subject to management’s judgment based upon available evidence that future realizations are likely. If management determines that the Corporation may not be able to realize some or all of the net deferred tax asset in the future, a charge to income tax expense may be required to reduce the value of the net deferred tax asset to the expected realizable value.

The Corporation has not substantively changed its application of the foregoing policies, and there have been no material changes in assumptions or estimation techniques used as compared to prior periods.

Financial Overview

For the first quarter of 2006, the Corporation’s diluted earnings per share were $.32 and basic earnings per share were $.33, level with the earnings for the same period last year. Net income was $9.0 million compared to $9.2 million for the first quarter of 2005. On a core earnings basis, this year’s first quarter reflected an improvement over the comparable period for last year because the 2005 earnings included the benefit of $.02 per share related to the gain on sales of investment securities of $923,000. The earnings for 2006 reflected increases in loan interest income and wealth management income partially offset by increases in interest expense on deposits and salaries and benefits expense.

The financial results for 2006 include a favorable impact on operations from the acquisition of the Cornerstone Companies effective January 1, 2006. The results were also impacted by the issuance of 1,310,000 shares of the Corporation’s common stock for a 5% stock dividend payable September 15, 2005. All share and per share information has been restated to reflect this stock dividend.

The Corporation’s consolidated total assets were $3.2 billion at March 31, 2006, an increase of 6.6% or $199.1 million over $3.0 billion in total assets reported at March 31, 2005. Of this increase, 4.6% or $137.8 million was attributable to loan growth and 1.2% or $35.0 million was due to a net increase in cash and investments. Total assets at March 31, 2006 increased $84.3 million compared to December 31, 2005 with a $43.6 million net increase in cash and investments and $18.0 million growth in loans.

For the three months ended March 31, 2006, the annualized return on average shareholders’ equity and the annualized return on average assets were 13.06% and 1.15%, respectively. For the same period in 2005, the annualized return on average shareholders’ equity was 13.69% and the annualized return on average assets was 1.25%.

Nonperforming assets (nonaccruing loans, net assets in foreclosure and loans 90 days or more past due) were .33% of total assets at March 31, 2006, compared to .27% at December 31, 2005 and .19% at March 31, 2005. The increase in nonperforming assets at March 31, 2006, in relation to December 31, 2005 was mainly due to commercial mortgage loans for two borrowers totaling $2.3 million. The increase in relation to March 31, 2005, was due to the previously aforementioned loans in addition to commercial mortgage loans for one borrower totaling $1.5 million and commercial business loans for two borrowers totaling $445,000 which were placed on nonaccrual of interest during the fourth quarter of 2005.

Results of Operations

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 inherent losses on loans; (3) noninterest income, which is made up primarily of certain fees, wealth management income and gains and losses from sales of securities; (4) noninterest expense, which consists primarily of salaries, employee benefits and other operating expenses; and (5) income taxes. Each of these major elements will be reviewed in more detail in the following discussion.

Net Interest Income

Net interest income on a tax equivalent basis in the first quarter of 2006 decreased $301,000 or 1.3% compared to the same period in 2005. The decrease during the first quarter of 2006 was mainly attributed to higher deposit and borrowing rates offset in part by higher loan rates and loan volume. Due to market conditions, deposit and short-term borrowing rates have increased more quickly than loan rates have increased.

The rate volume variance analysis in the table below, which is computed on a tax-equivalent basis (tax rate of 35%), analyzes changes in net interest income for the three months ended March 31, 2006 compared to March 31, 2005 by their volume and rate components. The change attributable to both volume and rate has been allocated proportionately.

Table 1—Analysis of Changes in Net Interest Income—Fully Taxable-Equivalent Basis

	Three Months Ended
	March 31, 2006 compared to
(Dollars in thousands)	March 31, 2005

		Total		Due to change in:
		Change			Volume			Rate

Increase (decrease) in interest income:
Investment securities *	$	913		$	295		$	618
Federal funds sold and deposits in banks		156			(51	)		207
Loans *		5,653			2,160			3,493
Total		6,722			2,404			4,318

Increase (decrease) in interest expense:
Savings and money market deposits		3,233			(25	)		3,258
Time deposits		2,337			1,338			999
Borrowed funds		1,453			336			1,117
Total		7,023			1,649			5,374

Net increase (decrease) in interest income	$	(301	)	$	755		$	(1,056	)
*Tax equivalent basis using a tax rate of 35%

The table below presents the major asset and liability categories on an average basis for the periods presented, along with interest income and expense, and key rates and yields.

Table 2—Average Balance Sheets and Interest Rates¾Fully Taxable-Equivalent Basis

(Dollars in thousands)	Three Months Ended March 31,						Three Months Ended March 31,
	2006						2005

		Average			Average			Average			Average
Assets		Balance		Interest	Rate			Balance		Interest	Rate
Earning assets:
Investment securities:
Taxable investments	$	690,204	$	7,322	4.30	%	$	652,314	$	6,054	3.76	%
Nontaxable investments ⁽¹⁾		246,663		3,777	6.21			258,667		4,132	6.48
Total investment securities		936,867		11,099	4.80			910,981		10,186	4.53
Federal funds sold and deposits in banks		37,896		425	4.55			45,428		269	2.40
Loans ^{(1) (2)}		1,988,778		32,084	6.54			1,845,408		26,431	5.81
Total earning assets		2,963,541		43,608	5.97			2,801,817		36,886	5.34
Noninterest-earning assets		200,466						174,544
Total assets	$	3,164,007					$	2,976,361

Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Interest-bearing deposits:
Savings and money market	$	1,229,437		7,513	2.48		$	1,236,536		4,280	1.40
Time		785,250		7,644	3.95			638,136		5,307	3.37
Total interest-bearing deposits		2,014,687		15,157	3.05			1,874,672		9,587	2.07
Borrowed funds		489,614		5,468	4.53			453,897		4,015	3.59
Total interest bearing liabilities		2,504,301		20,625	3.34			2,328,569		13,602	2.37
Noninterest-bearing liabilities:
Demand deposits		338,666						321,912
Other liabilities		43,148						54,349
Total noninterest-bearing liabilities		381,814						376,261
Total liabilities		2,886,115						2,704,830
Shareholders' equity		277,892						271,531
Total liabilities and shareholders' equity	$	3,164,007					$	2,976,361
Net interest spread					2.63						2.97
Effect of noninterest-bearing sources					0.52						.40
Net interest income/margin on earning assets			$	22,983	3.15	%			$	23,284	3.37	%

Less tax equivalent adjustment				1,512						1,614
Net interest income			$	21,471					$	21,670

(1)	The interest earned on nontaxable investment securities and loans is shown on a tax equivalent basis (tax rate of 35%).

(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.

Interest income on a tax equivalent basis in the first quarter of 2006 increased $6.7 million, or 18.2% over the same period in 2005. This increase was primarily due to higher average loans of $143.4 million, or 7.8% and a 73 basis point increase in the average rate earned on loans. Interest expense increased $7.0 million during the first quarter of 2006 versus the comparable period in 2005 mainly attributed to higher deposit and short-term borrowing rates. The average rate paid on deposits during the first quarter of 2006 of 3.05% was 98 basis points higher compared to the same period in 2005 due to higher rates on most deposit products. The average rate paid on borrowings for the first quarter of 2006 of 4.53% was 94 basis points higher than the comparable period in 2005 mainly due to an increase in short-term borrowing rates.

Net Interest Margin

The net interest margin for the first quarter of 2006 was 3.15%, compared to 3.16% for the fourth quarter of 2005 and 3.37% for the first quarter of 2005. Due to market conditions, deposit and short-term borrowing rates have increased more quickly than loan rates resulting in a lower net interest margin.

Interest Rate Sensitivity Analysis

In the normal course of conducting business activities, the Corporation is exposed to market risk, principally interest rate risk through the operations of its banking subsidiary. Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and value of financial instruments.

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 Corporation’s Board of Directors, is responsible for managing the rate sensitivity position. The Corporation manages interest rate sensitivity by changing the mix and repricing characteristics of its assets and liabilities through the management of its investment securities portfolio, its offering of loan and deposit terms and through borrowings from the Federal Home Loan Bank of Pittsburgh (the FHLB). The nature of the Corporation’s current operations is such that it is not subject to foreign currency exchange or commodity price risk.

The Corporation only utilizes derivative instruments for asset/liability management. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations and payments are based. The notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Interest rate swaps are contracts in which a series of interest-rate flows (fixed and floating) are exchanged over a prescribed period. The notional amounts on which the interest payments are based are not exchanged.

The Corporation uses three principal reports to measure interest rate risk: (1) asset/liability simulation reports; (2) gap analysis reports; and (3) net interest margin reports. 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 Corporation’s net interest income is simulated by increasing and decreasing interest rates. This simulation is known as rate shocking. The results of the March 31, 2006 net interest income rate shock simulations show that the Corporation is within guidelines set by the Corporation’s Asset/Liability Policy.

The report below forecasts changes in the Corporation’s market value of equity under alternative interest rate environments as of March 31, 2006. The market value of equity is defined as the net present value of the Corporation’s existing assets and liabilities. The Corporation is within guidelines set by the Corporation’s Asset/Liability Policy for the percentage change in the market value of equity.

Table 3—Market Value of Equity

				Change in				Asset/Liability
		Market Value		Market Value		Percentage		Approved
(Dollars in thousands)		of Equity		of Equity		Change		Percent Change

+300 Basis Points	$	351,635	$	(112,932	)	-24.31	%	+/- 35	%
+200 Basis Points		390,847		(73,720	)	-15.87		+/- 25
+100 Basis Points		429,050		(35,517	)	-7.65		+/- 15
Flat Rate		464,567		-		0.00
-100 Basis Points		470,271		5,704		1.23		+/- 15
-200 Basis Points		461,944		(2,623	)	-0.56		+/- 25
-300 Basis Points		448,618		(15,949	)	-3.49		+/- 35

In the event the Corporation should experience a mismatch in its desired gap ranges or an excessive decline in their market value of equity resulting from changes in interest rates, it has a number of options that it could use to remedy the mismatch. The Corporation could restructure its investment portfolio through the sale or purchase of securities with more favorable repricing attributes. It could also emphasize growth in loan products with appropriate maturities or repricing attributes, or attract deposits or obtain borrowings with desired maturities.

Provision for Loan Losses

The Bank uses the reserve method of accounting for loan losses. The balance in the allowance for loan and lease losses is determined based on management’s review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions, and other pertinent factors, including management’s assumptions as to future delinquencies, recoveries and losses. Increases to the allowance for loan and lease losses are made by charges to the provision for loan losses. Credit exposures deemed to be uncollectible are charged against the allowance for loan losses. Recoveries of previously charged-off amounts are credited to the allowance for loan losses.

While management considers the allowance for loan losses to be adequate based on information currently available, future additions to the allowance may be necessary due to changes in economic conditions or management’s assumptions as to future delinquencies, recoveries and losses and management’s intent with regard to the disposition of loans. In addition, the Office of the Comptroller of the Currency (the OCC), as an integral part of their examination process, periodically reviews the Bank’s allowance for loan losses. The OCC may require the Bank to recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examination.

The Bank’s allowance for loan and lease losses is the accumulation of various components that are calculated based on various independent methodologies. The components of the allowance for credit losses consist of both historical losses and estimates. Management bases its recognition and estimation of each allowance component on certain observable data that it believes is the most reflective of the underlying loan losses being estimated. The observable data and accompanying analysis is directionally consistent, based upon trends, with the resulting component amount for the allowance for loan losses. The Bank’s allowance for loan losses components includes the following: historical loss estimation by loan product type and by risk rating within each product type, payment (past due) status, industry concentrations, internal and external variables such as economic conditions, credit policy and underwriting changes and competence of the loan review process. The Bank’s historical loss component is the most significant component of the allowance for loan losses, and all other allowance components are based on the inherent loss attributes that management believes exist within the total portfolio that are not captured in the historical loss component.

The historical loss components of the allowance represent the results of analyses of historical charge-offs and recoveries within pools of homogeneous loans, within each risk rating and broken down further by segment, within the portfolio. Criticized assets are further assessed based on trends, expressed as percentages, relative to delinquency, risk rating and nonaccrual, by credit product.

The historical loss components of the allowance for commercial loans are based principally on current risk ratings, historical loss rates adjusted, by adjusting the risk window, to reflect current events and conditions, as well as analyses of other factors that may have affected the collectibility of loans. The Bank analyzes all commercial loans that have been identified as having potential risk. The review is accomplished via Watchlist Memoranda, and designed to determine whether such loans are individually impaired, with impairment measured by reference to the collateral coverage and/or debt service coverage. The historical loss component of the allowance for consumer loans is based principally on loan payment status, retail classification and historical loss rates adjusted, by adjusting the risk window, to reflect current events and conditions.

The industry concentration component is recognized as a possible factor in the estimation of loan losses. Two industries represent possible concentrations: commercial real estate and consumer loans relying on residential home equity. No specific loss-related observable data is recognized by management currently, therefore no specific factor is calculated in the reserve solely for the impact of these concentrations, although management continues to carefully consider relevant data for possible future sources of observable data.

The historic loss model includes a judgmental component (environmental factors) that reflects management’s belief that there are additional inherent credit losses based on loss attributes not adequately captured in the lagging indicators. Furthermore, given that past-performance indicators may not adequately capture current risk levels, allowing for a real-time adjustment enhances the validity of the loss recognition process. There are many credit risk management reports that are synthesized by credit management staff to assess the direction of credit risk and its instant effect on losses. It is important to continue to use experiential data to confirm risk as measurable losses will continue to manifest themselves at higher than normal levels even after the economic cycle has begun an upward swing and lagging indicators begin to show improvement. The judgmental component is allocated to the specific segments of the portfolio based on the historic loss component.

For the first quarter of 2006, the provision for loan losses was $1.2 million, compared to $750,000 for the same period in 2005. The increase in the provision was primarily due to inherent risk within the portfolio and the increase in nonperforming loans. Nonperforming assets (nonaccruing loans, net assets in foreclosure and loans past due 90 days or more past due) were .33% of total assets at March 31, 2006, compared to .27% at December 31, 2005 and .19% at March 31, 2005. The increase in nonperforming assets at March 31, 2006, in relation to December 31, 2005 was mainly due to commercial mortgage loans for two borrowers totaling $2.3 million placed on nonaccrual of interest. The increase in relation to March 31, 2005, was due to the previously aforementioned loans in addition to commercial mortgage loans for one borrower totaling $1.5 million and commercial business loans for two borrowers totaling $445,000 which were placed on nonaccrual of interest during the fourth quarter of 2005. Net loans charged off were $1.2 million for the first quarter of 2006 compared to $481,000 for the same quarter in 2005. This increase was mainly due to charge offs of a commercial real estate loan for one borrower of $256,000 and commercial real estate and commercial business loans for another borrower of $101,000 and $232,000, respectively.

A summary of the activity in the allowance for loan losses is as follows:

Table 4—Allowance for Loans Losses

	Three Months Ended
	March 31,
(Dollars in thousands)		2006			2005

Average loans	$	1,988,778		$	1,845,408

Allowance, beginning of period		19,865			18,455
Loans charged off:
Commercial and industrial		445			133
Consumer		581			457
Real estate		436			20
Lease financing		10			6
Total loans charged off		1,472			616
Recoveries:
Commercial and industrial		3			4
Consumer		177			90
Real estate		53			16
Lease financing		69			25
Total recoveries		302			135
Net loans charged off		1,170			481
Provision for loan losses		1,200			750
Allowance, end of period	$	19,895		$	18,724
Ratio of net charge offs to average
loans outstanding (annualized)		0.24	%		0.11	%

The following table sets forth an allocation of the allowance for loan losses by loan category. The specific allocations in any particular category may be reallocated in the future to reflect then current conditions. Accordingly, management considers the entire allowance to be available to absorb losses in any category.

Table 5—Allocation of the Allowance for Loan Losses by Loan Type

	March 31, 2006				December 31, 2005
			Percent of				Percent of
(Dollars in thousands)		Amount	Reserve			Amount	Reserve

Real estate	$	6,562	33	%	$	6,422	32	%
Commercial
and industrial		8,621	44	%		8,534	43	%
Consumer		4,631	23	%		4,596	23	%
Lease financing		81	-	%		313	2	%
Total	$	19,895	100	%	$	19,865	100	%

Table 6—Nonperforming Assets

(Dollars in thousands)		March 31, 2006			December 31, 2005			March 31, 2005

Nonaccrual loans	$	9,430		$	7,493		$	4,572
Loans 90 days or more past due		1,093			846			599
Total nonperforming loans		10,523			8,339			5,171
Net assets in foreclosure		78			29			411
Total nonperforming assets	$	10,601		$	8,368		$	5,582

Allowance for loan losses to nonperforming loans		189.1	%		238.2	%		362.1	%
Nonperforming loans to total net loans		0.53	%		0.42	%		0.28	%
Allowance for loan and lease losses to total loans		0.99	%		1.00	%		1.00	%
Nonperforming assets to total assets		0.33	%		0.27	%		0.19	%

Net assets in foreclosure decreased $333,000 at March 31, 2006 from March 31, 2005 mainly due to proceeds received on disposals of foreclosed properties. Efforts to liquidate assets acquired in foreclosure proceed as quickly as potential buyers can be located and legal constraints permit. Foreclosed assets are carried at the lower of cost (lesser of carrying value of asset or fair value at date of acquisition) or estimated fair value. 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. The increase in loans past due 90 days or more at March 31, 2006 compared to March 31, 2005 was primarily due to a higher level of past due commercial real estate loans.

Table 7—Impaired Loans

(Dollars in thousands)		March 31, 2006		Dec. 31, 2005		March 31, 2005

Impaired Loans	$	4,351	$	3,317	$	1,276

Average year-to-date impaired loans	$	3,507	$	1,542	$	1,278

Impaired loans with specific loss allowances	$	4,351	$	3,317	$	1,276

Loss allowances reserved on impaired loans	$	686	$	675	$	138

Year-to-date income recognized on impaired loans	$	1	$	33	$	15

The Bank’s policy for interest income recognition on nonaccrual loans is to recognize income 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 Bank. The Bank will not recognize income if these factors do not exist.

Noninterest Income

Noninterest income of $8.9 million for the first quarter of 2006 rose $2.0 million or 28.7% from the comparable period in 2005. This increase was primarily due to the acquisition of the Cornerstone Companies which generated an increase of $2.5 million in wealth management income over the same period last year, partially offset by the sale of Cumberland Advisors, which was divested in the second quarter of 2005. Major revenue components sources of wealth management income include investment management and advisory fees, trust fees, estate and tax planning fees, brokerage fees, and insurance related fees. There were no gains on sales of investment securities during the first quarter of 2006 as compared to $923,000 during the same period in 2005. The net security gains during the three months ended March 31, 2005 were primarily the result of the sale of equity securities.

Noninterest Expense

Noninterest expense of $17.1 million for the first quarter of 2006 increased $1.6 million or 10.5% from $15.5 million in the first quarter of 2005. Salaries and benefits expense increased $1.0 million during the first quarter of 2006 from the comparable period in 2005 primarily related to the acquisition of the Cornerstone Companies and compensation expense in 2006 of $128,000 resulting from recording the Corporation’s share based compensation expense in conformance with FAS 123 (R), “Share-Based Payment.” Other expense increased $775,000 mainly due to the Cornerstone Companies acquisition as well as increased computer software expenses.

Federal Income Taxes

The effective federal income tax rate for the quarter ended March 31, 2006 was 24.6% versus the statutory rate of 35%. The Corporation’s effective rate is lower than the statutory tax rate primarily as a result of tax-exempt income earned from state and municipal securities and loans and bank-owned life insurance. The effective income tax rate for the first quarter of 2005 was 25.0%.

Balance Sheet Analysis

Total assets at March 31, 2006 of $3.2 billion increased $84.3 million compared to December 31, 2005 with a $43.6 million net increase in cash and investments and $18.0 million growth in loans. The balance of investment securities available for sale at March 31, 2006 of $877.1 million increased $35.5 million compared to the December 31, 2005. The increase in investment securities was primarily the result of net additional purchases of tax-exempt and mortgage-backed securities. Total deposits increased $60.0 million to $2.43 billion at March 31, 2006 from $2.37 billion at December 31, 2005 primarily attributable to an increase in brokered certificates of deposits. Core deposits remained level at $1.59 billion.

Capital

Capital formation is important to the Corporation's well being and future growth. Capital for the period ending March 31, 2006 was $280.0 million, an increase of $6.8 million over the end of 2005. The increase was primarily the result of the retention of the Corporation's earnings and issuances of stock for stock options including tax benefits partially offset by dividends paid to shareholders. Management believes that the Corporation's current capital and liquidity positions are adequate to support its operations. Management is not aware of any recommendations by any regulatory authority, which, if it were to be implemented, would have a material effect on the Corporation's capital.

Table 8—Regulatory Capital

(Dollars in thousands)					For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Program
As of March 31, 2006		Actual Amount	Ratio			Amount	Ratio			Amount	Ratio

Total Capital (to risk weighted assets):
Corporation	$	310,873	12.54	%	$	198,342	8.00	%	$	247,928	-
Harleysville National Bank		264,148	10.72	%		197,113	8.00	%		246,392	10	%
Tier 1 Capital (to risk weighted assets):
Corporation		290,878	11.73	%		99,171	4.00	%		148,757	-
Harleysville National Bank		244,153	9.91	%		98,557	4.00	%		147,835	6	%
Tier 1 Capital (to average assets):
Corporation		290,878	9.33	%		124,678	4.00	%		155,848	-
Harleysville National Bank		244,153	7.92	%		123,346	4.00	%		154,183	5	%

(Dollars in thousands)			For Capital Adequacy Purposes		To Be Well Capitalized Under Prompt Corrective Action Program
As of December 31, 2005	Actual Amount	Ratio	Amount	Ratio	Amount	Ratio

Total Capital (to risk weighted assets):
Corporation	$318,911	12.98%	$196,563	8.00%	$ 245,703	-
Harleysville National Bank	259,883	10.64%	195,390	8.00%	244,238	10%
Tier 1 Capital (to risk weighted assets):
Corporation	298,946	12.17%	98,281	4.00%	147,422	-
Harleysville National Bank	239,918	9.82%	97,695	4.00%	146,543	6%
Tier 1 Capital (to average assets):
Corporation	298,946	9.69%	123,408	4.00%	154,260	-
Harleysville National Bank	239,918	7.86%	122,154	4.00%	152,693	5%

Pursuant to the federal regulators’ risk-based capital adequacy guidelines, the components of capital are called Tier 1 and Tier 2 capital. For the Corporation, Tier 1 capital is the shareholders’ equity and Tier 2 capital is the allowance for loan losses. The minimum for the Tier 1 ratio is 4.0% and the total capital ratio (Tier 1 plus Tier 2 capital divided by risk-adjusted assets) minimum is 8.0%. At March 31, 2006, the Corporation’s Tier 1 risk-adjusted capital ratio was 11.73%, and the total risk-adjusted capital ratio was 12.54%, both well above the regulatory requirements. The risk-based capital ratios of the Bank also exceeded regulatory requirements at March 31, 2006.

The leverage ratio consists of Tier 1 capital divided by quarterly average total assets, excluding intangible assets. Banking organizations are expected to have ratios of at least 4% and 5%, depending upon their particular condition and growth plans. Higher leverage ratios could be required by the particular circumstances or risk profile of a given banking organization. The Corporation’s leverage ratios were 9.33% at March 31, 2006 and 9.69% at December 31, 2005. The lower leverage ratio of the Corporation at March 31, 2006 was mainly due to the decrease in Tier 1 capital from the additional disallowed goodwill related to the acquisition of the Cornerstone Companies.

The year-to-date March 31, 2006 cash dividend per share of $.19 was 11.8% higher than the cash dividend for the same period in 2005 of $.17. The dividend payout ratio for the first three months of 2006 was 58.4%, compared to 51.5% for the same period in 2005. Activity in both the Corporation’s dividend reinvestment and stock purchase plan did not have a material impact on capital during the first three months of 2006.

Liquidity

Liquidity is a measure of the ability of the Bank to meet its needs and obligations on a timely basis. For a bank, liquidity provides the means to meet the day-to-day demands of deposit customers and the needs of borrowing customers. Generally, the Bank arranges its 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. The liquidity measurement is based on the asset/liability model’s projection of potential sources and uses of funds for the next 120 days. The resulting projections as of March 31, 2006 show the potential sources of funds exceeding the potential uses of funds. The Corporation has external sources of funds which can be drawn upon when funds are required. The primary source of external liquidity is an available line of credit with the FHLB. As of March 31, 2006, the Bank had borrowings outstanding with the FHLB of $297.8 million, all of which were long-term and pledged investment securities available for sale of $380.9 million. At March 31, 2006, the Bank had unused lines of credit at the FHLB of $355.2 million and unused federal funds lines of credit of $115.0 million.

Recent Federal Deposit Insurance Corporation Rules

In March 2006, the Federal Deposit Insurance Corporation (FDIC) Board of Directors adopted interim final rules to implement provisions of the Federal Deposit Insurance Act of 2005 pertaining to deposit insurance coverage. These rules take effect on April 1, 2006. The interim rule: 1) increases the deposit insurance limit for certain retirement plan deposits to $250,000 (the basic insurance limit for other depositors¾individuals, joint accountholders, businesses, government entities and trusts remain at $100,000), provides per-participant insurance coverage to employee benefit plan accounts, even if the depository institution at which the deposits are placed is not authorized to accept employee benefit plan deposits and 3) provides for consideration of inflation adjustments to increase the insurance limits for all deposit accounts every five years, beginning in 2010.

Other Information

Pending Legislation

Management is not aware of any other current specific recommendations by regulatory authorities or proposed legislation which, if they were implemented, would have a material adverse effect upon the liquidity, capital resources, or results of operations, although the general cost of compliance with numerous and multiple federal and state laws and regulations does have, and in the future may have, a negative impact on the Corporation’s results of operations.

Effects of Inflation

Inflation has some impact on the Corporation and the Bank’s operating costs. Unlike many industrial companies, however, substantially all of the Bank’s assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on the Corporation’s and the Bank’s performance than the general level of inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as prices of goods and services.

Effect of Government Monetary Policies

The earnings of the Corporation are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. An important function of the Federal Reserve is to regulate the money supply and interest rates. Among the instruments used to implement those objectives are open market operations in United States government securities and changes in reserve requirements against member bank deposits. These instruments are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may also affect rates charged on loans or paid for deposits.

The Bank is a member of the Federal Reserve and, therefore, the policies and regulations of the Federal Reserve have a significant effect on its deposits, loans and investment growth, as well as the rate of interest earned and paid, and are expected to affect the Bank’s operations in the future. The effect of such policies and regulations upon the future business and earnings of the Corporation and the Bank cannot be predicted.

Environmental Regulations

There are several federal and state statutes, which regulate the obligations and liabilities of financial institutions pertaining to environmental issues. In addition to the potential for attachment of liability resulting from its own actions, a bank may be held liable under certain circumstances for the actions of its borrowers, or third parties, when such actions result in environmental problems on properties that collateralize loans held by the bank. Further, the liability has the potential to far exceed the original amount of a loan issued by the bank. Currently, neither the Corporation nor the Bank are a party to any pending legal proceeding pursuant to any environmental statute, nor are the Corporation and the Bank aware of any circumstances that may give rise to liability under any such statute.

Branching

The Corporation is currently planning to open a new location in Warminster, Bucks County during 2006 and in Plymouth Meeting, Montgomery County during 2007. In addition, the Corporation is planning to relocate its Blue Bell and Collegeville offices both located in Montgomery County during late 2006 or early 2007. The Corporation continues to evaluate potential new branch sites that are contiguous to our current service area and will expand the Bank’s market area and market share of loans and deposits.

Item 3 - Qualitative and Quantitative Disclosures About Market Risk

In the normal course of conducting business activities, the Corporation is exposed to market risk, principally interest risk, through the operations of its banking subsidiary. Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and values of financial instruments. The Asset/Liability Committee, using policies and procedures approved by the Bank’s Board of Directors, is responsible for managing the rate sensitivity position.

No material changes in market risk strategy occurred during the first quarter of 2006. A detailed discussion of market risk is provided on pages 20 and 21 of this Form 10-Q.

Item 4 - Controls and Procedures

(i) Management’s Report on Disclosure Controls

Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15(d)-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and regulations and are operating in an effective manner.

(ii) Changes in Internal Controls

In connection with the ongoing review of the Corporation’s internal controls over financial reporting as defined in rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended, the Corporation regularly assesses the adequacy of its internal control over financial reporting and enhances its controls in response to internal control assessments and internal and external audit and regulatory recommendations. There have been no changes in the Corporation’s internal control over financial reporting during the first quarter of 2006 that have materially affected, or reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Management, based upon discussions with the Corporation's legal counsel, is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Corporation. There are no proceedings pending other than the ordinary routine litigation incident to the business of the Corporation and its subsidiaries - the Bank, HNC Financial Company and HNC Reinsurance Company. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Corporation and its subsidiaries by government authorities.

Item 1A. Risk Factors

No material changes in risk factors occurred during the first quarter of 2006. A detailed discussion of risk factors is provided in Item 1A, “Risk Factors” in the Corporation’s 2005 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table presents the repurchase activity of the Corporation’s stock repurchase programs during the first quarter of 2006 (all share information has been restated retroactively for the effect of stock dividends and splits). The repurchased shares will be used for general corporate purposes.

	Total Number of Common Shares Purchased		Weighted Average Price Paid Per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans	Maximum Number of Shares that may yet be Purchased under the Plans⁽¹⁾

January 1-31, 2006	-	$	-	-	1,088,039
February 1-28, 2006	-		-	-	1,088,039
March 1-31, 2006	25,000		21.53	25,000	1,063,039
Total	25,000	$	21.53	25,000

(1)

On December 14, 2000, the Board of Directors authorized a program to purchase up to 1,311,450 shares (restated for stock dividends and splits), or 5%, of its outstanding common stock. This repurchase plan was completed during the second quarter of 2005. On May 12, 2005, the Board of Directors authorized a plan to purchase up to 1,349,250 shares (restated for five percent stock dividend paid on September 15, 2005) or 4.9%, of its outstanding common stock.

Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. Submission of Matters to a Vote of Security Holders

Not Applicable

Item 5. Other Information

(a)	None to report.

(b)	There were no changes in the manner shareholders may recommend nominees to the Registrant’s Board of Directors.

Item 6. Exhibits

(a) Exhibits:

The following exhibits are being filed as part of this Report:

Exhibit No. Description of Exhibits

(2.1)	Purchase Agreement, dated as of November 15, 2005, by and among Harleysville National Bank and Trust Company, Cornerstone Financial Consultants, Ltd., Cornerstone Advisors Asset Management, Inc., Cornerstone Institutional Investors, Inc., Cornerstone Management Resources, Inc., John R. Yaissle, Malcolm L. Cowen, II, and Thomas J. Scalici. The schedules and exhibits to the Purchase Agreement are listed at the end of the Purchase Agreement but have been omitted from the exhibit to Form 10-K. The Registrant agrees to supplementally furnish a copy of any omitted schedule or exhibit to the Securities and Exchange Commission upon request. (Incorporated by reference to Exhibit 2.1 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005, filed with the Commission on March 15, 2006.)
(3.1)	Harleysville National Corporation Amended and Restated Articles of Incorporation. (Incorporated by reference to Exhibit 3.1 to the Corporation’s Registration Statement No. 333-111709 on Form S-4, as filed on January 5, 2004.)
(3.2)	Harleysville National Corporation Amended and Restated By-laws. (Incorporated by reference to Exhibit 3.1 to the Corporation’s Current Report on Form 8-K, filed with the Commission on February 14, 2005.)
(10.1)	Harleysville National Corporation 1993 Stock Incentive Plan. (Incorporated by reference to Exhibit 4.3 of Registrant’s Registration Statement No. 33-69784 on Form S-8, filed with the Commission on October 1, 1993.)
(10.2)	Harleysville National Corporation Stock Bonus Plan. (Incorporated by reference to Exhibit 99A of Registrant’s Registration Statement No. 333-17813 on Form S-8, filed with the Commission on December 13, 1996.)
(10.3)	Supplemental Executive Retirement Plan. (Incorporated by reference to Exhibit 10.3 of Registrant’s Annual Report in Form 10-K for the year ended December 31, 1997, filed with the Commission on March 27, 1998.)
(10.4)	Walter E. Daller, Jr., Chairman and former President and Chief Executive Officer’s Employment Agreement. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 25, 1999.)
(10.5)	Consulting Agreement and General Release dated November 12, 2004 between Walter E. Daller, Jr., Harleysville National Corporation and Harleysville National Bank and Trust Company. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on November 16, 2004.)
(10.6)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and Walter E. Daller, Jr. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.7)	Employment Agreement dated October 26, 1998 by and among Harleysville National Corporation, Harleysville National Bank and Trust Company and Demetra M. Takes, President and Chief Executive Officer of Harleysville National Bank and Trust Company. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 25, 1999.)
(10.8)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and Demetra M. Takes, President and Chief Executive Officer of Harleysville National Bank and Trust Company. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.9)	Harleysville National Corporation 1998 Stock Incentive Plan. (Incorporated by reference to Registrant’s Registration Statement No. 333-79971 on Form S-8, filed with the Commission on June 4, 1999.)
(10.10)	Harleysville National Corporation 1998 Independent Directors Stock Option Plan. (Incorporated by reference to Registrant’s Registration Statement No. 333-79973 on Form S-8, filed with the Commission on June 4, 1999.)
(10.11)	Supplemental Executive Retirement Benefit Agreement dated February 23, 2004 between Michael B. High, Executive Vice President and former Chief Financial Officer, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q, filed with the Commission on May 10, 2004.)
(10.12)	Employment Agreement effective April 1, 2005 between Michael B. High, Executive Vice President and Chief Operating Officer of the Corporation, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on November 16, 2004.)
(10.13)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and Michael B. High, Executive Vice President and Chief Operating Officer of the Corporation. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.14)	Employment Agreement dated March 9, 2004 between Mikkalya Murray, Executive Vice President and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q, filed with the Commission on May 10, 2004.)

(10.15)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and Mikkalya Murray, Executive Vice President. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.16)	Harleysville National Corporation 2004 Omnibus Stock Incentive Plan. (Incorporated by reference to Exhibit 4 of Registrant’s Registration Statement No. 333-116183 on Form S-8, filed with the Commission on June 4, 2004).
(10.17)	Employment Agreement dated August 23, 2004 between James F. McGowan, Jr., Executive Vice President & Chief Credit Officer and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on August 25, 2004.)
(10.18)	Supplemental Executive Retirement Benefit Agreement dated August 23, 2004 between James F. McGowan, Jr., Executive Vice President & Chief Credit Officer, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on August 25, 2004.)
(10.19)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and James F. McGowan, Jr., Executive Vice President & Chief Credit Officer. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.20)	Employment Agreement dated September 27, 2004 between John Eisele, Executive Vice President & President of Millennium Wealth Management and Private Banking, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on September 29, 2004.)
(10.21)	Supplemental Executive Retirement Benefit Agreement dated September 27, 2004 between John Eisele, Executive Vice President & President of Millennium Wealth Management and Private Banking, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on September 29, 2004.)
(10.22)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and John Eisele, Executive Vice President & President of Millennium Wealth Management and Private Banking. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.23)	Employment Agreement effective January 1, 2005 between Gregg J. Wagner, President and Chief Executive Officer of the Corporation, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on November 16, 2004.)
(10.24)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and Gregg J. Wagner, the current President and Chief Executive Officer of the Corporation. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.25)	Employment Agreement dated May 18, 2005, between George S. Rapp, Senior Vice President and Chief Financial Officer, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on May 20, 2005.)
(10.26)	Stock Purchase Agreement dated June 30, 2005, between David R. Kotok & Associates, Inc., Harleysville National Corporation and Harleysville National Bank and Trust Company. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on July 1, 2005.)
(10.27)	Amended and Restated Declaration of Trust for HNC Statutory Trust III by and among Wilmington Trust Company, as Institutional Trustee and Delaware Trustee, Harleysville National Corporation, as Sponsor, and the Administrators named therein, dated as of September 28, 2005.
(10.28)	Indenture between Harleysville National Corporation, as Issuer, and Wilmington Trust Company, as Trustee, for Fixed/Floating Rate Junior Subordinated Debt Securities, dated as of September 28, 2005.
(10.29)	Guarantee Agreement between Harleysville National Corporation and Wilmington Trust Company, dated as of September 28, 2005.
(11)	Computation of Earnings per Common Share, incorporated by reference to Note 6 of the Consolidated Financial Statements of this Report on Form 10-Q.
(31.1)	Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(31.2)	Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(32.1)	Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(32.2)	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

HARLEYSVILLE NATIONAL CORPORATION

Date: May 8, 2006 ___/s/ Gregg J. Wagner

Gregg J. Wagner, President, Chief Executive Officer and Director

(Principal executive officer)

Date: May 8, 2006 ____/s/ George S. Rapp

George S. Rapp, Executive Vice President and Chief Financial Officer

(Principal financial and accounting officer)

EXHIBIT INDEX

Exhibit No Description of Exhibits

(2.1)	Purchase Agreement, dated as of November 15, 2005, by and among Harleysville National Bank and Trust Company, Cornerstone Financial Consultants, Ltd., Cornerstone Advisors Asset Management, Inc., Cornerstone Institutional Investors, Inc., Cornerstone Management Resources, Inc., John R. Yaissle, Malcolm L. Cowen, II, and Thomas J. Scalici. The schedules and exhibits to the Purchase Agreement are listed at the end of the Purchase Agreement but have been omitted from the exhibit to Form 10-K. The Registrant agrees to supplementally furnish a copy of any omitted schedule or exhibit to the Securities and Exchange Commission upon request. (Incorporated by reference to Exhibit 2.1 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005, filed with the Commission on March 15, 2006.)
(3.1)	Harleysville National Corporation Amended and Restated Articles of Incorporation. (Incorporated by reference to Exhibit 3.1 to the Corporation’s Registration Statement No. 333-111709 on Form S-4, as filed on January 5, 2004.)
(3.2)	Harleysville National Corporation Amended and Restated By-laws. (Incorporated by reference to Exhibit 3.1 to the Corporation’s Current Report on Form 8-K, filed with the Commission on February 14, 2005.)
(10.1)	Harleysville National Corporation 1993 Stock Incentive Plan. (Incorporated by reference to Exhibit 4.3 of Registrant’s Registration Statement No. 33-69784 on Form S-8, filed with the Commission on October 1, 1993.)
(10.2)	Harleysville National Corporation Stock Bonus Plan. (Incorporated by reference to Exhibit 99A of Registrant’s Registration Statement No. 333-17813 on Form S-8, filed with the Commission on December 13, 1996.)
(10.3)	Supplemental Executive Retirement Plan. (Incorporated by reference to Exhibit 10.3 of Registrant’s Annual Report in Form 10-K for the year ended December 31, 1997, filed with the Commission on March 27, 1998.)
(10.4)	Walter E. Daller, Jr., Chairman and former President and Chief Executive Officer’s Employment Agreement. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 25, 1999.)
(10.5)	Consulting Agreement and General Release dated November 12, 2004 between Walter E. Daller, Jr., Harleysville National Corporation and Harleysville National Bank and Trust Company. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on November 16, 2004.)
(10.6)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and Walter E. Daller, Jr. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.7)	Employment Agreement dated October 26, 1998 by and among Harleysville National Corporation, Harleysville National Bank and Trust Company and Demetra M. Takes, President and Chief Executive Officer of Harleysville National Bank and Trust Company. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 25, 1999.)
(10.8)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and Demetra M. Takes, President and Chief Executive Officer of Harleysville National Bank and Trust Company. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.9)	Harleysville National Corporation 1998 Stock Incentive Plan. (Incorporated by reference to Registrant’s Registration Statement No. 333-79971 on Form S-8, filed with the Commission on June 4, 1999.)
(10.10)	Harleysville National Corporation 1998 Independent Directors Stock Option Plan. (Incorporated by reference to Registrant’s Registration Statement No. 333-79973 on Form S-8, filed with the Commission on June 4, 1999.)
(10.11)	Supplemental Executive Retirement Benefit Agreement dated February 23, 2004 between Michael B. High, Executive Vice President and former Chief Financial Officer, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q, filed with the Commission on May 10, 2004.)
(10.12)	Employment Agreement effective April 1, 2005 between Michael B. High, Executive Vice President and Chief Operating Officer of the Corporation, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on November 16, 2004.)
(10.13)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and Michael B. High, Executive Vice President and Chief Operating Officer of the Corporation. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)

(10.14)	Employment Agreement dated March 9, 2004 between Mikkalya Murray, Executive Vice President and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q, filed with the Commission on May 10, 2004.)
(10.15)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and Mikkalya Murray, Executive Vice President. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.16)	Harleysville National Corporation 2004 Omnibus Stock Incentive Plan. (Incorporated by reference to Exhibit 4 of Registrant’s Registration Statement No. 333-116183 on Form S-8, filed with the Commission on June 4, 2004).
(10.17)	Employment Agreement dated August 23, 2004 between James F. McGowan, Jr., Executive Vice President & Chief Credit Officer and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on August 25, 2004.)
(10.18)	Supplemental Executive Retirement Benefit Agreement dated August 23, 2004 between James F. McGowan, Jr., Executive Vice President & Chief Credit Officer, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on August 25, 2004.)
(10.19)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and James F. McGowan, Jr., Executive Vice President & Chief Credit Officer. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.20)	Employment Agreement dated September 27, 2004 between John Eisele, Executive Vice President & President of Millennium Wealth Management and Private Banking, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on September 29, 2004.)
(10.21)	Supplemental Executive Retirement Benefit Agreement dated September 27, 2004 between John Eisele, Executive Vice President & President of Millennium Wealth Management and Private Banking, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on September 29, 2004.)
(10.22)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and John Eisele, Executive Vice President & President of Millennium Wealth Management and Private Banking. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.23)	Employment Agreement effective January 1, 2005 between Gregg J. Wagner, President and Chief Executive Officer of the Corporation, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on November 16, 2004.)
(10.24)	Amendment to Supplemental Executive Retirement Benefit Agreement dated March 14, 2005 by and among Harleysville Management Services, LLC and Gregg J. Wagner, the current President and Chief Executive Officer of the Corporation. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on March 14, 2005.)
(10.25)	Employment Agreement dated May 18, 2005, between George S. Rapp, Senior Vice President and Chief Financial Officer, and Harleysville Management Services, LLC. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on May 20, 2005.)
(10.26)	Stock Purchase Agreement dated June 30, 2005, between David R. Kotok & Associates, Inc., Harleysville National Corporation and Harleysville National Bank and Trust Company. (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on July 1, 2005.)
(10.27)	Amended and Restated Declaration of Trust for HNC Statutory Trust III by and among Wilmington Trust Company, as Institutional Trustee and Delaware Trustee, Harleysville National Corporation, as Sponsor, and the Administrators named therein, dated as of September 28, 2005.
(10.28)	Indenture between Harleysville National Corporation, as Issuer, and Wilmington Trust Company, as Trustee, for Fixed/Floating Rate Junior Subordinated Debt Securities, dated as of September 28, 2005.
(10.29)	Guarantee Agreement between Harleysville National Corporation and Wilmington Trust Company, dated as of September 28, 2005.
(11)	Computation of Earnings per Common Share, incorporated by reference to Note 6 of the Consolidated Financial Statements of this Report on Form 10-Q.
(31.1)	Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(31.2)	Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(32.1)	Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(32.2)	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit 31.1

CERTIFICATION

I, Gregg J. Wagner, President, Chief Executive Officer and Director, certify, that:

1. I have reviewed this quarterly report on Form 10-Q of Harleysville National Corporation.

Based on my knowledge, the quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)	Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonable likely to materially affect, the registrant’s internal control over financial reporting; and

5.	The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: May 8, 2006 /s/ Gregg J. Wagner

Gregg J. Wagner

President, Chief Executive Officer and Director

Harleysville National Corporation

Exhibit 31.2

CERTIFICATION

I, George S. Rapp, Executive Vice President and Chief Financial Officer certify, that:

1. I have reviewed this quarterly report on Form 10-Q of Harleysville National Corporation.

3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

(a)

(b)

(c)	Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)

5.	The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: May 8, 2006 ____/s/ George S. Rapp

George S. Rapp

Executive Vice President and Chief Financial Officer

Harleysville National Corporation

Exhibit 32.1

HARLEYSVILLE NATIONAL CORPORATION

CERTIFICATION

PRINCIPAL EXECUTIVE OFFICER

PURSUANT TO 18 U.S.C. SECTION 1350

In connection with the Harleysville National Corporation (the “Corporation”) Quarterly Report on Form 10-Q for the period ending March 31, 2006, as filed with the Securities and Exchange Commission (the "Report"), I, Gregg J. Wagner, President, Chief Executive Officer and Director of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002, that:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. To my knowledge the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation as of and for the period covered by the Report.

/s/ Gregg J. Wagner

Gregg J. Wagner

President, Chief Executive Officer and Director

Harleysville National Corporation

Date: May 8, 2006

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Harleysville National Corporation and will be retained by the Corporation and furnished to the Securities and Exchange Commission or its staff upon request.

Exhibit 32.2

HARLEYSVILLE NATIONAL CORPORATION

CERTIFICATION

PRINCIPAL FINANCIAL OFFICER

PURSUANT TO 18 U.S.C. SECTION 1350

In connection with the Harleysville National Corporation (the "Corporation") Quarterly Report on Form 10-Q for the period ending March 31, 2006, as filed with the Securities and Exchange Commission (the "Report"), I, George S. Rapp, Executive Vice President and Chief Financial Officer of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as added Section 906 of the Sarbanes-Oxley Act of 2002, that:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. To my knowledge, the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation as of and for the period covered by the Report.

/s/ George S. Rapp

George S. Rapp

Executive Vice President and Chief Financial Officer

Harleysville National Corporation

Date: May 8, 2006