-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C2oUZgkmWe9/EsJojeQvJoMitFHLC4Sh1mv1WaZ4NGbLCfWcgIW7d+5Xivc2zb/g s8zkE6VuXNo6a6WBEuKCXQ== 0000702902-07-000012.txt : 20070509 0000702902-07-000012.hdr.sgml : 20070509 20070509124438 ACCESSION NUMBER: 0000702902-07-000012 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20070331 FILED AS OF DATE: 20070509 DATE AS OF CHANGE: 20070509 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HARLEYSVILLE NATIONAL CORP CENTRAL INDEX KEY: 0000702902 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 232210237 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-15237 FILM NUMBER: 07831345 BUSINESS ADDRESS: STREET 1: 483 MAIN ST STREET 2: P O BOX 195 CITY: HARLEYSVILLE STATE: PA ZIP: 19438 BUSINESS PHONE: 2152568851 MAIL ADDRESS: STREET 1: 483 MAIN STREET CITY: HARLEYSVILLE STATE: PA ZIP: 19438 10-Q 1 form10-q1stqtr07.htm HARLEYSVILLE NATIONAL CORPORATION FORM 10-Q FOR FIRST QUARTER ENDED MARCH 31, 2007 Harleysville National Corporation Form 10-Q for First Quarter Ended March 31, 2007
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, 2007

Or

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

for the transition period from ___________ to __________

Commission file number 0-15237

___________________

HARLEYSVILLE NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)

___________________

 
Pennsylvania
  
23-2210237
(State or other jurisdiction
of 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: 28,967,854  shares of Common Stock, $1.00 par value, outstanding on May 2, 2007.


 
-1-
 


HARLEYSVILLE NATIONAL CORPORATION
  
   
   
INDEX TO FORM 10-Q REPORT
  
   
 
PAGE
   
Part I. Financial Information
  
   
Item 1. Financial Statements:
  
   
Consolidated Balance Sheets at March 31, 2007 (unaudited) and December 31, 2006
    3
   
Consolidated Statements of Income for the Three Months Ended March 31, 2007 and 2006 (unaudited)
    4
   
Consolidated Statements of Shareholders’ Equity for the Three Months Ended March 31, 2007 and 2006 (unaudited)
    5
   
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2007 and 2006 (unaudited)
    6
   
Notes to Consolidated Financial Statements
    7
   
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
    15
   
Item 3. Quantitative and Qualitative Disclosures about Market Risk
    26
   
Item 4. Controls and Procedures
    26
   
Part II. Other Information
    27
   
Item 1. Legal Proceedings
    27
   
Item 1A. Risk Factors
    27
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    27
   
Item 3. Defaults Upon Senior Securities
    27
   
Item 4. Submission of Matters to a Vote of Security Holders
    27
   
Item 5. Other Information
    27
   
Item 6. Exhibits
    27
   
Signatures
    28


 
-2-
 


PART 1. FINANCIAL INFORMATION
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
(Dollars in thousands)
   
March 31, 2007
    
December 31, 2006
 
 
    
(Unaudited) 
        
Assets
              
Cash and due from banks
  
$
56,161
  
$
61,895
  
Federal funds sold and securities purchased under agreements to resell
    
101,000
    
59,000
  
Interest-bearing deposits in banks
    
4,723
    
3,975
  
    Total cash and cash equivalents
    
161,884
    
124,870
  
Residential mortgage loans held for sale
    
1,014
    
1,857
  
Investment securities available for sale
    
869,681
    
853,010
  
Investment securities held to maturity (market value $59,356 and $59,297, respectively)
    
58,866
    
58,879
  
Loans and leases
    
2,064,763
    
2,045,498
  
Less: Allowance for loan losses
    
(20,929
)
  
(21,154
)
        Net loans
    
2,043,834
    
2,024,344
 
Premises and equipment, net
    
36,583
    
33,785
 
Accrued interest receivable
    
15,116
    
14,950
 
Goodwill
    
45,081
    
43,956
  
Intangible assets, net
    
7,459
    
7,282
  
Bank-owned life insurance
    
62,302
    
61,720
  
Other assets
    
23,147
    
25,175
  
        Total assets
  
$
3,324,967
  
$
3,249,828
  
Liabilities and Shareholders' Equity
              
Deposits:
              
   Noninterest-bearing
  
$
328,096
  
$
327,973
  
   Interest-bearing:
              
    Checking accounts
    
524,429
    
539,974
  
    Money market accounts
    
711,969
    
662,966
  
    Savings
    
130,981
    
133,370
  
    Time deposits
    
831,366
    
852,572
  
        Total deposits
    
2,526,841
    
2,516,855
  
Federal funds purchased and short-term securities sold under agreements to repurchase
    
99,103
    
96,840
  
Other short-term borrowings
    
36
    
1,357
  
Long-term borrowings
    
304,750
    
239,750
  
Accrued interest payable
    
30,754
    
31,358
  
Subordinated debt
    
51,548
    
51,548
  
Other liabilities
    
15,689
    
17,369
  
    Total liabilities
    
3,028,721
    
2,955,077
  
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 29,074,250 shares at March 31, 2007 and
              
     December 31, 2006
    
29,074
    
29,074
  
   Additional paid in capital
    
194,743
    
194,713
  
   Retained earnings
    
79,680
    
79,339
  
   Accumulated other comprehensive loss
    
(5,044
)
  
(6,103
)
   Treasury stock, at cost: 106,615 shares at March 31, 2007 and
             
     109,767 shares at December 31, 2006
    
(2,207
)
  
(2,272
)
    Total shareholders' equity
    
296,246
    
294,751
  
    Total liabilities and shareholders' equity
  
$
3,324,967
  
$
3,249,828
  
See accompanying notes to consolidated financial statements.


 
-3-
 
 
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
  
     
 
Three Months Ended 
 
  
March 31, 
(Dollars in thousands, except per share information)
    
2007
 
 
2006
  
 
(Unaudited) 
Interest Income:
              
Loans and leases, including fees
  
$
34,636
  
$
31,796
  
Investment securities:
              
   Taxable
    
8,564
    
7,322
  
   Exempt from federal taxes
    
2,689
    
2,553
  
Federal funds sold and securities purchased under agreements to resell
    
751
    
374
  
Deposits in banks
    
55
    
51
  
    Total interest income
    
46,695
    
42,096
  
               
Interest Expense:
              
Savings and money market deposits
    
12,106
    
7,513
  
Time deposits
    
9,716
    
7,644
  
Short-term borrowings
    
1,256
    
1,420
  
Long-term borrowings
    
3,780
    
4,048
  
    Total interest expense
    
26,858
    
20,625
  
               
Net interest income
    
19,837
    
21,471
  
Provision for loan losses
    
2,425
    
1,200
  
Net interest income after provision for loan losses
    
17,412
    
20,271
  
               
Noninterest Income:
              
Service charges
    
1,918
    
1,890
  
Gain on sales of investment securities, net
    
531
    
—
  
Wealth management
    
4,267
    
4,564
  
Bank-owned life insurance
    
582
    
600
  
Other income
    
1,849
    
1,879
  
    Total noninterest income
    
9,147
    
8,933
  
    Net interest income after provision for loan losses and
             
       noninterest income
    
26,559
    
29,204
  
               
Noninterest Expense:
              
Salaries, wages and employee benefits
    
11,597
    
10,519
  
Occupancy
    
1,546
    
1,498
  
Furniture and equipment
    
917
    
891
  
Marketing
    
407
    
406
  
Other expense
    
4,312
    
3,811
  
    Total noninterest expense
    
18,779
    
17,125
  
               
Income before income tax expense
    
7,780
    
12,079
  
Income tax expense
    
1,646
    
3,128
  
Net income
  
$
6,134
  
$
8,951
  
               
Net income per share information:
              
    Basic
  
$
0.21
  
$
0.31
  
    Diluted
  
$
0.21
  
$
0.30
  
Cash dividends per share
  
$
0.20
  
$
0.18
  
Weighted average number of common shares:
              
    Basic
    
28,965,500
    
28,873,187
  
    Diluted
    
29,255,820
    
29,379,870
  
               
See accompanying notes to consolidated financial statements.

 
-4-
 


HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited)
(Dollars and share information in thousands)


Three Months Ended March 31, 2007
                                                         
   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
 
Treasury Stock
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of
 
 
Number of
 
 
Par
 
 
Additional
Paid
 
 
Retained
 
 
Accumulated Other
Comprehensive
 
 
Treasury
 
 
 
 
 
Comprehensive
 
 
 
 
Shares
 
 
Shares
 
 
Value
 
 
In Capital
 
 
Earnings
 
 
Income (Loss
)
 
Stock
 
 
Total
 
 
Income
 
                                                         
 Balance, January 1, 2007
    
29,074
    
(109
)
$
29,074
  
$
194,713
  
$
79,339
  
$
(6,103
)
$
(2,272
)
$
294,751
        
 Issuance of stock for stock options
    
-
    
3
    
-
    
(37
)
  
-
    
-
    
65
    
28
        
 Stock based compensation expense
    
-
    
-
    
-
    
67
    
-
    
-
    
-
    
67
        
 Net income
    
-
    
-
    
-
    
-
    
6,134
    
-
    
-
    
6,134
  
$
6,134
  
   Other comprehensive income, net of reclassifications and tax
    
-
    
-
    
-
    
-
    
-
    
1,059
    
-
    
1,059
    
1,059
  
 Cash dividends
    
-
    
-
    
-
    
-
    
(5,793
)
  
-
    
-
    
(5,793
)
      
 Comprehensive income
                                                  
$
7,193
  
 Balance, March 31, 2007
    
29,074
    
(106
)
$
29,074
  
$
194,743
  
$
79,680
  
$
(5,044
)
$
(2,207
)
$
296,246
        
                                                         




Three Months Ended March 31, 2006
  
                                                         
 
                                                        
 
    
Common Stock 
    
Treasury Stock
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of 
 
 
Number of
 
 
Par
 
 
Additional
Paid
 
 
Retained
 
 
Accumulated Other
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 excess 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
        
                                                         
 
                                                 
See accompanying notes to consolidated financial statements.


 
-5-
 


HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
  
Three Months Ended  
(Dollars in thousands)
  
March 31,
     
2007
 
 
2006
  
Operating Activities:
              
   Net income
  
$
6,134
  
$
8,951
  
   Adjustments to reconcile net income to net cash provided by operating activities:
              
     Provision for loan losses
    
2,425
    
1,200
  
     Depreciation and amortization
    
1,199
    
1,007
  
     Net amortization of investment securities discounts/premiums
    
460
    
972
  
     Deferred income tax expense (benefit)
    
173
    
(1,398
)
     Gain on sales of investment securities, net
    
(531
)
  
—
  
     Bank-owned life insurance income
    
(582
)
  
(600
)
     Stock based compensation expense
    
67
    
128
  
     Net increase in accrued interest receivable
    
(166
)
  
(526
)
     Net decrease in accrued interest payable
   
(604
)
  
(1,333
)
     Net decrease in other assets
   
888
    
996
  
     Net decrease in other liabilities
    
(610
)
  
(1,794
)
     Other, net
    
—
    
(7
)
     Net cash provided by operating activities
   
8,853
   
7,596
 
Investing Activities:
              
  Proceeds from sales of investment securities available for sale
    
62,097
    
1,121
  
  Proceeds from maturity or calls of investment securities available for sale
    
39,536
    
38,312
  
  Purchases of investment securities available for sale
    
(116,391
)
  
(75,801
)
  Net increase in loans
    
(21,070
)
  
(19,201
)
  Net cash paid due to acquisitions, net of cash acquired
    
(2,500
)
  
(14,485
)
  Purchases of premises and equipment
   
(3,674
)
  
(2,017
)
  Proceeds from sales of premises and equipment
   
—
    
16
  
  Proceeds from sales of other real estate
   
—
    
25
  
    Net cash used in investing activities
   
(42,002
)
  
(72,030
)
Financing Activities:
              
   Net increase in deposits
   
9,986
    
60,216
  
   Increase in federal funds purchased and short-term securities sold under agreements to repurchase
    
2,263
    
15,920
  
   Decrease in other short-term borrowings
    
(1,321
)
  
(1,478
)
   Advances of long-term borrowings
    
80,000
    
—
  
   Repayments of long-term borrowings
    
(15,000
)
  
—
  
   Cash dividends
    
(5,793
)
  
(5,228
)
   Repurchase of common stock
    
—
    
(538
)
   Proceeds from the exercise of stock options
   
28
    
3,259
  
   Excess tax benefits from stock based compensation
    
—
    
426
  
      Net cash provided by financing activities
   
70,163
    
72,577
  
   Net increase in cash and cash equivalents
    
37,014
    
8,143
  
   Cash and cash equivalents at beginning of period
    
124,870
    
95,211
  
   Cash and cash equivalents at end of the period
  
$
161,884
  
$
103,354
  
               
    Cash paid during the period for:
              
      Interest
 
$
27,473
  
$
21,982
  
      Income taxes
  
$
1,225
  
$
654
  
    Supplemental disclosure of noncash investing and financing activities:
              
      Transfer of assets from loans to net assets in foreclosure
 
$
10
  
$
91
  
 
See accompanying notes to consolidated financial statements.
              


 
-6-



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, 2007, the results of its operations for the three month periods ended March 31, 2007 and 2006 and the cash flows for the three month periods ended March 31, 2007 and 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 2006 Annual Report on Form 10-K. The results of operations for the three month periods ended March 31, 2007 and 2006 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.

For additional information on other significant accounting policies, see Note 1 of the Consolidated Financial Statements of the Corporation’s 2006 Annual Report on Form 10-K.

Note 2 - Acquisition/Dispositions

On March 1, 2007, the Cornerstone Companies, a subsidiary of the Bank, completed a selected asset purchase of McPherson Enterprises and related entities (McPherson), registered investment advisors specializing in estate and succession planning and life insurance for high-net-worth construction and aggregate business owners and families throughout the United States. Located in Towson, Maryland, McPherson became a part of the Cornerstone Companies, a component of the Bank’s Millennium Wealth Management division. The Bank paid $1.5 million in cash. Estimated goodwill and identifiable intangibles of approximately $1.5 million was recorded in connection with the asset purchase. Management is in the process of evaluating and finalizing the identifiable intangible assets and purchase accounting adjustments.

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, credit cards for the Bank are issued under the Harleysville National Bank name. The Bank sold $15.3 million in credit card receivables resulting in a gain in the second quarter of 2006 from the sale of these credit cards, net of federal income taxes, of approximately $939,000 or $.03 per diluted share. The Bank continues to earn certain fees from ongoing portfolio activity. The sale agreement stipulates that any credit card accounts delinquent over 30 days, overlimit accounts and petitioned bankruptcies will be guaranteed by the Bank for a period of one year. Of the $15.3 million in credit card receivables sold, $529,000 was sold with full recourse which was the total potential recourse exposure at the time of the sale. During the second quarter of 2006, the Bank recorded a recourse liability of $371,000 which was the entire recourse liability recorded. This estimate was based on our historic losses as experienced on similar credit card receivables. The Bank was subject to the full recourse obligations for a period of one year. At March 31, 2007, the total potential recourse exposure had been reduced to $76,000.

Note 3 - Goodwill and Other Intangibles

Goodwill and identifiable intangibles were $45.1 million and $4.9 million, respectively at March 31, 2007, and $44.0 million and $4.7 million, respectively at December 31, 2006. The carrying amounts of goodwill by business segment at March 31, 2007 and December 31, 2006 for Community Banking was $31.6 million and for Wealth Management was $13.5 million and $12.4 million, respectively. Effective March 1, 2007, the Bank completed the selected asset purchase of McPherson Enterprises and related entities including estimated goodwill of approximately $1.1 million and customer relationship intangibles of approximately $375,000 (with an estimated weighted average amortization period of 10 years) allocated to the Wealth Management segment.


 
-7-
 

Note 3 - Goodwill and Other Intangibles - Continued

Management performed its annual review of goodwill at June 30, 2006 in accordance with SFAS No. 142 and determined there was no impairment of goodwill and other identifiable intangible assets.

The gross carrying value and accumulated amortization related to core deposit intangibles and other identifiable intangibles at March 31, 2007 and December 31, 2006 are presented below:

   
March 31, 
    
December 31, 
   
2007
      
2006
  
 
    
Gross Carrying Amount 
    
Accumulated Amortization
      
 Gross Carrying Amount
Accumulated
Amortization
 
(Dollars in thousands) 
Core deposit intangibles
  
$
1,929
  
$
795
    
$1,929
$ 733
Other identifiable intangibles
    
4,288
    
563
    
3,913
448
Total
  
$
6,217
  
$
1,358
    
$5,842
$1,181

 
The remaining weighted average amortization period of core deposit and other identifiable intangibles was approximately eight years. The amortization of core deposit intangibles allocated to the Community Banking segment were $62,000 and $61,000 for the three months ended March 31, 2007 and 2006, respectively. Amortization of identifiable intangibles related to the Wealth Management segment totaled $115,000 and $94,000 for the three months ended March 31, 2007 and 2006, respectively. The Corporation estimates that aggregate amortization expense for core deposit and other identifiable intangibles will be $710,000, $709,000, $709,000, $709,000 and $596,000 for 2007, 2008, 2009, 2010 and 2011, respectively.

Mortgage servicing rights of $2.6 million at March 31, 2007 and December 31, 2006 are included on the Corporation’s balance sheet in other intangible assets.

Note 4 - 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.
 
The components of net periodic defined benefit pension expense and other amounts recognized in other comprehensive income for the three months ended March 31, 2007 and 2006 are as follows:
 
 
Three Months Ended March 31, 
(Dollars in thousands)
    
2007
 
 
2006
  
               
Net periodic benefit cost
              
Service cost
  
$
291
  
$
260
  
Interest cost
   
171
    
164
  
Expected return on plan assets
   
(150
)
  
(138
)
Amortization of net actuarial loss
   
19
    
29
  
Net periodic benefit expense
 
$
331
  
$
315
  
               

The Corporation has not made any contributions to its pension plan during the first quarter of 2007.

Note 5 - Stock Dividend/Split

On September 15, 2006, the Corporation paid a five percent stock dividend to shareholders of record as of September 1, 2006. All prior period amounts were restated to reflect these stock dividends.

 
-8-
 

Note 6 - 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 3,797,861 shares of common stock to key employees and directors. At March 31, 2007, 2,516,882 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, 2007, the Corporation has an additional 328,327 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 $9.25 to $13.81.

The Corporation recognizes compensation expense for stock options in accordance with SFAS 123 (revised 2004), “Share-Based Payment” (SFAS 123(R)) adopted at January 1, 2006 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 had been applied. 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 utilizes 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 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 for the three months ended March 31, 2006 (no options were granted during the three month period ending March 31, 2007): weighted-average dividend yield of 3.46%; weighted-average expected volatility of 31.78%; weighted average risk-free interest rate of 4.42% and a weighted-average expected life of 7.34 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, 2007 and 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. Stock-based compensation expense was $67,000 and $64,000, net of tax for the first quarter of 2007 and $128,000 and $113,000, net of tax for the first quarter of 2006.

A summary of option activity under the Corporation’s stock option plans as of March 31, 2007, and changes during the three months ended March 31, 2007 is presented in the following table. The number of shares and weighted-average share information have been adjusted to reflect stock dividends.
 
Options
    
Shares
 
 
Weighted-Average Exercise Price
 
 
Weighted-Average Remaining Contractual Term
(in years)
 
Aggregate
Intrinsic Value
(in thousands)
Outstanding at January 1, 2007
    
1,157,484
  
$
15.60
              
Granted
    
-
   
-
             
Exercised
    
(3,152
)
  
9.13
             
Forfeited (unvested)
    
-
   
-
             
Cancelled (vested)
    
-
   
-
             
                           
Outstanding at March 31, 2007
    
1,154,332
  
$
15.62
    
5.16
  
$
5,349
  
                           
Exercisable at March 31, 2007
    
1,025,038
  
$
14.79
    
4.78
  
$
5,349
  
                           

There were no options granted during the three month period ending March 31, 2007. The weighted-average grant-date fair value of options granted during the three months ended March 31, 2006 was $5.04. The total intrinsic value of options exercised during the three months ended March 31, 2007 and 2006 was $31,000 and $2.0 million, respectively. Intrinsic value is measured using the fair market value price of the Corporation’s common stock less the applicable exercise price.

 
-9-
 

Note 6 - Stock-Based Compensation - Continued

A summary of the status of the Corporation’s nonvested shares as of March 31, 2007 is presented below:

Nonvested Shares
    
Shares
 
 
Weighted-Average
Grant-Date Fair Value
  
               
Nonvested at January 1, 2007
    
131,610
  
$
6.15
  
               
Granted
    
-
    
-
  
               
Vested
    
(2,315
)
  
6.63
  
               
Forfeited
    
-
    
-
  
               
Nonvested at March 31, 2007
    
129,295
  
$
6.14
  

As of March 31, 2007, there was a total of $667,000 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 1.6 years. The total fair value of shares vested during the three months ended March 31, 2007 and 2006 was $15,000 and $23,000, respectively.

Note 7 - 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)
    
2007
 
 
2006
  
               
Basic earnings per share
              
Net income available to common shareholders
  
$
6,134
  
$
8,951
  
Weighted average common shares outstanding
    
28,965,500
    
28,873,187
  
Basic earnings per share
  
$
.21
  
$
.31
  
               
Diluted earnings per share
              
Net income available to common shareholders
and assumed conversions
  
$
6,134
  
$
8,951
  
Weighted average common shares outstanding
    
28,965,500
    
28,873,187
  
Dilutive potential common shares (1), (2)
    
290,320
    
506,683
  
Total diluted weighted average common shares outstanding
    
29,255,820
    
29,379,870
  
 Diluted earnings per share
  
$
.21
  
$
.30
  
               

(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, 2007, there were 424,858 antidilutive options at an average price of $24.40. For the three months ended March 31, 2006, there were 372,471 antidilutive options at an average price of $25.65.

 
-10-
 

Note 8 - Comprehensive Income

The components of other comprehensive income are as follows:

Comprehensive Income
                     
(Dollars in thousands)
    
Before tax
 
 
Tax Benefit
 
 
Net of tax
 
Three months ended March 31, 2007
    
Amount
 
 
(Expense)
 
Amount
  
Net unrealized gains on available for sale securities:
                    
   Net unrealized holding gains arising during period
  
$
2,361
  
$
(826
)
$
1,535
  
   Less reclassification adjustment for net gains realized in net income
    
531
    
(186
)
  
345
  
   Net unrealized gains
    
1,830
    
(640
)
  
1,190
  
   Change in fair value of derivatives used for cash flow hedges
    
(202
)
  
71
    
(131
)
   Other comprehensive income, net
  
$
1,628
  
$
(569
)
$
1,059
  
                     
(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
  
   Unrealized loss on termination of cash flow hedge
    
46
    
(16
)
  
30
  
   Other comprehensive income, net
  
$
308
  
$
(108
)
$
200
  

Note 9 - 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.

 
-11-
 

Note 9 - 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, 2007
                          
                           
Net interest income (expense)
  
$
20,256
  
$
112
  
$
(531
)
$
19,837
  
Provision for loan losses
    
2,425
    
-
    
-
    
2,425
  
Noninterest income
    
4,663
    
4,267
    
217
    
9,147
  
Noninterest expense
    
15,085
    
3,387
    
307
    
18,779
  
Income (loss) before income taxes (benefit)
    
7,409
    
992
    
(621
)
  
7,780
  
Income taxes (benefit)
    
1,527
    
396
    
(277
)
  
1,646
  
Net income (loss)
  
$
5,882
  
$
596
  
$
(344
)
$
6,134
  
Assets
  
$
3,268,334
  
$
21,123
  
$
35,510
  
$
3,324,967
  
                           
                           
Three Months Ended March 31, 2006
                          
                           
Net interest income
  
$
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
    
13,586
    
3,343
    
196
    
17,125
  
Income (loss) before income taxes (benefit)
    
11,154
    
1,384
    
(459
)
  
12,079
  
Income taxes (benefit)
    
2,791
    
583
    
(246
)
  
3,128
  
Net income (loss)
  
$
8,363
  
$
801
  
$
(213
)
$
8,951
  
Assets
  
$
3,168,842
  
$
2,460
  
$
33,391
  
$
3,201,693
  

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, 2006. Consolidating adjustments reflecting certain eliminations of inter-segment revenues, cash and investment in subsidiaries are included in the “All Other” segment.

Note 10 - 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 maximum 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. These commitments often expire without being drawn upon and often are secured with appropriate collateral; therefore, the total commitment amount does not necessarily represent the actual risk of loss or future cash requirements.

The approximate contract amounts are as follows:
   
Total Amount Committed at
Commitments
  
March 31,
2007
December
 31, 2006
(Dollars in thousands)
     
Financial instruments whose contract amounts represent credit risk:
    
Commitments to extend credit .......................................................................................................................................
$730,579
$753,825
Standby letters of credit and financial guarantees written ......................................................................................
21,102
25,960
Financial instruments whose notional or contract amounts exceed the amount of credit risk:
    
Interest rate swap agreements ......................................................................................................................................
59,750
59,750
Interest rate cap agreements .........................................................................................................................................
200,000
—


 
-12-
 

Note 10 - Financial Instruments with Off-Balance Sheet Risk - Continued

At March 31, 2007, the Corporation had cash flow hedges in the form of interest rate swaps with a notional amount of $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 cash flow hedges with a notional amount of $10.0 million that have the effect of converting variable debt to a fixed rate. For these swaps, the Corporation recognized net interest income of $138,000 and $78,000 for the three months ended March 31, 2007 and 2006, respectively. 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 was $310,000 which was amortized through October 2006 in accordance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities.” The Corporation amortized into net interest income $45,000 for the first quarter of 2006 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. The Corporation has entered into fair value hedges in the form of interest rate swaps with a notional amount of $4.8 million with $5,000 of interest income recognized for the three months ended March 31, 2007 and $2,000 recorded as a reduction of interest income for the three months ended March 31, 2006. At March 31, 2007, the Corporation had swap agreements with a positive fair value of $397,000 and with a negative fair value of $27,000. At December 31, 2006, the Corporation had swap agreements with a positive fair value of $545,000 and with a negative fair value of $21,000. There was no hedge ineffectiveness recognized during the first quarters of 2007 and 2006.

During March 2007, the Corporation purchased one and three month Treasury bill interest rate cap agreements with notional amounts totaling $200 million to limit its exposure on variable rate now deposit accounts. The initial premium related to these caps was $73,000 which will be amortized to interest expense over the life of the cap based on the cap market value. At March 31, 2007, these caps, designated as cash flow hedges, had a positive fair value of $14,000 with no impact to earnings for the first quarter of 2007. The caps mature in March 2009.

The Bank also had commitments with customers to extend mortgage loans at a specified rate at March 31, 2007 and December 31, 2006 of $3.1 million and $2.3 million, respectively and commitments to sell mortgage loans at a specified rate at March 31, 2007 and December 31, 2006 of $1.4 million and $792,000, 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, 2007, the Corporation had commitments with a positive fair value of $21,000 and a negative fair value of $12,000, the net amount which was recorded as other income. At December 31, 2006, the Corporation had commitments with a positive fair value of $15,000 and a negative fair value of $3,000.

During April 2006, the Bank sold its existing credit card portfolio of $15.3 million. The sale agreement stipulates that any credit card accounts delinquent over 30 days, overlimit accounts and petitioned bankruptcies will be guaranteed by the Bank for a period of one year. Of the $15.3 million in credit card receivables sold, $529,000 was sold with full recourse which was the total potential recourse exposure at the time of the sale. During the second quarter of 2006, the Bank recorded a recourse liability of $371,000 which was the entire recourse liability recorded. This estimate was based on our historic losses as experienced on similar credit card receivables. The Bank will be subject to the full recourse obligations for a period of one year. At March 31, 2007, the total potential recourse exposure had been reduced to $76,000.

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 was 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 Bank 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 85% of the lease financing receivables estimated to be paid down by December 31, 2007. The outstanding balance of these sold leases at March 31, 2007 was $2.4 million with a total recourse exposure of $528,000 and a current recourse liability of $46,000.

Note 11 - Recent Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115.” SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 provides entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The statement also establishes presentation and disclosure requirements. The entity shall report the effect of the first re-measurement to fair value as a cumulative-effective adjustment to the opening balance of retained earnings. At each subsequent reporting date, unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The fair value

 
-13-
 
 
Note 11 - Recent Accounting Pronouncements - Continued

option may be applied instrument by instrument, with a few exceptions, is irrevocable and is applied only to entire instruments. Most of the provisions of SFAS 159 apply only to entities that elect the fair value option. However, the amendment to SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” applies to all entities with available-for-sale and trading securities. If the fair value option is elected for any available-for-sale or held-to-maturity securities at the effective date, the cumulative unrealized gains and losses at that date shall be included in the cumulative-effect adjustment. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided that the entity also elects to apply the provisions of SFAS 157, “Fair Value Measurements.” The Corporation is in the process of assessing the impact of the adoption of this statement on the Corporation’s financial statements.

In June, 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting and reporting for income taxes where interpretation of the tax law may be uncertain. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 applies to fiscal years beginning after December 15, 2006. The Corporation adopted the provisions of FIN 48 on January 1, 2007. As required by Interpretation 48, which clarifies Statement 109,“Accounting for Income Taxes,” the Corporation recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. At the adoption date, the Corporation applied FIN 48 to all tax positions for which the statute of limitations remained open. The Corporation has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions.

As of January 1, 2007, the Corporation has $158,000 of unrecognized tax benefits, which if recognized, would favorably affect the Corporation’s effective tax rate. The Corporation did not record a cumulative effect adjustment related to the adoption of FIN 48. There have been no material changes in unrecognized tax benefits since January 1, 2007.

The Corporation’s policy for recording interest and penalties associated with audits is to record such items as a component of income before income taxes. Penalties are recorded in other expenses, net, and interest paid or received is recorded in interest expense or interest income, respectively, in the statement of income. As of January 1, 2007, interest accrued was $17,000 and no penalties have been accrued.

The Corporation is subject to income taxes in the U.S. federal jurisdiction, and various states and foreign jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. With few exceptions, the Corporation is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for the years before 2004.


 
-14-
 


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 Harleysville National Corporation (the Corporation) and its wholly owned subsidiaries-Harleysville National Bank (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 2006 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 2006 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 historical losses, 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, 2006 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.

 
-15-
 

Stock-based Compensation: The Corporation recognizes compensation expense for stock options in accordance with SFAS 123 (revised 2004), “Share-Based Payment” (SFAS 123R)) adopted at January 1, 2006 under the modified prospective application method of transition. 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. The Corporation utilizes 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 Black-Scholes model 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.

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 as well as tax-exempt municipal bonds and U.S. government agency 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 2007, the Corporation’s diluted and basic earnings per share were $.21 compared to $.30 and $.31, respectively, for the first quarter of 2006. Net income was $6.1 million for the first quarter of 2007 compared to $9.0 million during the same period in 2006.

At March 31, 2007, despite a challenging environment, the Corporation reported loan and deposit growth of 3.1% and 4.2%, respectively from the comparable period in 2006. Additionally, although the Corporation continues to experience net interest margin compression, we were able to increase our net interest margin from 2.75% for the fourth quarter 2006, to 2.82% in the first quarter of this year. The reduction in earnings for the first quarter of 2007 as compared to the same period in 2006 was reflective of the lower net interest income due to the net interest margin compression, an increase in the provision for loan losses as well as higher salaries and benefits expense.

The financial results for 2007 reflect the issuance of 1,382,000 shares of the Corporation’s common stock for a 5% stock dividend payable September 15, 2006. All share and per share information has been restated to reflect this stock dividend.

The Corporation’s consolidated total assets were $3.3 billion at March 31, 2007, an increase of 3.9% or $123.3 million over $3.2 billion in total assets reported at March 31, 2006. This rise was primarily attributable to loan growth of $62.3 million and an increase in cash and investments of $50.4 million. The growth in loans took place mainly in the Bank’s real estate portfolio. Total deposits increased $101.2 million to $2.5 billion at March 31, 2007 from $2.4 billion at March 31, 2006 principally attributable to growth in interest-bearing checking accounts. Total assets at March 31, 2007 were $75.1 million higher compared to December 31, 2006 with increases in cash and investments of $53.7 million and loans of $18.4 million.

For the three months ended March 31, 2007, the annualized return on average shareholders’ equity and the annualized return on average assets were 8.47% and .76%, respectively. For the same period in 2006, the annualized return on average shareholders’ equity was 13.06% and the annualized return on average assets was 1.15%. The decrease in these ratios during 2007 was primarily the result of lower net income.


 
-16-
 

Nonperforming assets (including nonaccrual loans, loans 90 days or more past due and net assets in foreclosure) were .59% of total assets at March 31, 2007, compared to .54% at December 31, 2006, and .33% at March 31, 2006. The increase in nonperforming assets at March 31, 2007, in relation to December 31, 2006, of $1.9 million was mainly due to a construction loan for one borrower and real estate loans for two borrowers placed on nonaccrual of interest, partially offset by the payoff of nonaccrual real estate loans for another borrower. The increase in relation to March 31, 2006 was largely due to an increase in the level of real estate loans on non-accrual of interest as well as 90 days past due. For the first quarter of 2007, the provision for loan losses was $2.4 million, compared to $1.2 million for the same period in 2006. The increase in the provision was primarily a result of inherent risk related to loan growth, the increase in nonperforming loans, as well as a higher level of charge-offs. Management recognizes the increased level of nonperforming assets and charge-offs and has dedicated more resources to resolve troubled credits including an increased focus on earlier identification of potential problem loans and a more active approach to managing the level of criticized loans that have not reached nonaccrual status.

On March 1, 2007, the Cornerstone Companies, a subsidiary of the Bank, completed a selected asset purchase of McPherson Enterprises and related entities (McPherson), registered investment advisors specializing in estate and succession planning and life insurance for high-net-worth construction and aggregate business owners and families throughout the United States. McPherson became a part of the Cornerstone Companies, a component of the Bank’s Millennium Wealth Management division. The acquisition is part of the Corporation’s plan to continue to build its fee-based services businesses.

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 or other transactions; (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 2007 decreased $1.6 million or 7.1% from the same period in 2006. The decrease during the first quarter of 2007 was mainly attributable to higher deposit costs offset in part by increased loan and investment rates. Due to the market conditions, deposit rates increased more quickly than loan rates.

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, 2007 compared to March 31, 2006 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, 2007 compared to 
(Dollars in thousands)
  
March 31, 2006
                     
   
Total
  
Due to change in:
   
Change
    
Volume
 
 
Rate
  
                     
Increase in interest income:
                    
Investment securities *
  
$
1,402
  
$
92
  
$
1,310
  
Federal funds sold and deposits in banks
    
381
    
313
    
68
 
Loans *
    
2,821
    
1,170
    
1,651
 
Total
    
4,604
    
1,575
    
3,029
  
                     
Increase (decrease) in interest expense:
                    
Savings and money market deposits
    
4,593
    
981
    
3,612
  
Time deposits
   
2,072
    
471
    
1,601
  
Borrowed funds
    
(432
)
  
(788
)
  
356
  
Total
    
6,233
    
664
    
5,569
  
                     
Net (decrease) increase in net interest income
  
$
(1,629
)
$
911
  
$
(2,540
)
*Tax equivalent basis using a tax rate of 35%, net
                    


 
-17-
 

The following table 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,
   
2007
2006
                                       
 
    
Average 
          
Average
 
 
Average
 
 
 
 
 
Average
  
Assets
    
Balance
 
 
Interest
 
 
Rate
 
 
Balance
 
 
Interest
 
 
Rate
  
Earning assets:
                                      
   Investment securities:
                                      
  Taxable investments
  
$
684,651
  
$
8,564
    
5.07
%
$
690,204
  
$
7,322
    
4.30
%
     Nontaxable investments (1)
    
260,007
    
3,937
    
6.14
    
246,663
    
3,777
    
6.21
  
    Total investment securities
    
944,658
    
12,501
    
5.37
    
936,867
    
11,099
    
4.80
  
     Federal funds sold and deposits in banks
    
62,837
    
806
    
5.20
    
37,896
    
425
    
4.55
  
     Loans (1) (2)
    
2,059,871
    
34,905
    
6.87
    
1,988,778
    
32,084
    
6.54
  
    Total earning assets
    
3,067,366
    
48,212
    
6.37
    
2,963,541
    
43,608
    
5.97
  
   Noninterest-earning assets
    
213,488
              
200,466
              
        Total assets
  
$
3,280,854
              
$
3,164,007
              
                                       
Liabilities and Shareholders' Equity
                                      
Interest-bearing liabilities:
                                      
   Interest-bearing deposits:
                                      
     Savings and money market
  
$
1,376,074
    
12,106
    
3.57
  
$
1,229,437
    
7,513
    
2.48
  
     Time
    
831,489
    
9,716
    
4.74
    
785,250
    
7,644
    
3.95
  
    Total interest-bearing deposits
    
2,207,563
    
21,822
    
4.01
    
2,014,687
    
15,157
    
3.05
  
     Borrowed funds
    
422,415
    
5,036
    
4.84
    
489,614
    
5,468
    
4.53
  
    Total interest bearing liabilities
    
2,629,978
    
26,858
    
4.14
    
2,504,301
    
20,625
    
3.34
  
 Noninterest-bearing liabilities:
                                      
   Demand deposits
   
308,095
                
338,666
              
   Other liabilities
    
48,986
                
43,148
              
     Total noninterest-bearing liabilities
    
357,081
                
381,814
              
    Total liabilities
    
2,987,059
                
2,886,115
              
  Shareholders' equity
    
293,795
                
277,892
              
       Total liabilities and shareholders' equity
  
$
3,280,854
              
$
3,164,007
              
Net interest spread
                
2.23
                
2.63
  
Effect of noninterest-bearing sources
                
0.59
                
.52
  
Net interest income/margin on earning assets
        
$
21,354
    
2.82
%
      
$
22,983
    
3.15
%
                                       
Less tax equivalent adjustment
          
1,517
                
1,512
        
Net interest income
        
$
19,837
              
$
21,471
        

(1)  
The interest earned on nontaxable investment securities and loans is shown on a tax equivalent basis, net of deductions (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 2007 increased $4.6 million, or 10.6% over the same period in 2006. This increase was primarily due to higher average rates earned on loans and investment securities of 33 basis points and 57 basis points, respectively, as well as increases in average loans of $71.1 million, or 3.6% and federal funds sold to correspondent banks of $27.0 million. Interest expense increased $6.2 million during the first quarter of 2007 versus the comparable period in 2006 mainly attributed to higher deposit rates as well as an increase in average interest-bearing deposits of $192.9 million, or 9.6% partially offset by a decline in average borrowings of $67.2 million, or 13.7%. The average rate paid on deposits during the first quarter of 2007 of 4.01% was 96 basis points higher compared to the same period in 2006 due to higher rates on most deposit products. The decline in average borrowings resulted principally from FHLB maturities in addition to a reduced level of overnight funding replaced by deposit growth.

 
-18-
 

Net Interest Margin

The net interest margin for the first quarter of 2007 was 2.82%, compared to 2.75% for the fourth quarter of 2006 and 3.15% for the first quarter of 2006. Due to market conditions, deposit rates increased faster than loan rates, resulting in a lower net interest margin compared to the first quarter of 2006.

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. Interest rate caps are purchased contracts that limit the exposure from the repricing of liabilities in a rising rate environment.

At March 31, 2007, the Corporation had cash flow hedges in the form of interest rate swaps with a notional amount of $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 Corporation 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 cash flow hedges with a notional amount of $10.0 million that have the effect of converting variable debt to a fixed rate. For these swaps, the Corporation recognized net interest income of $138,000 and $78,000 for the three months ended March 31, 2007 and 2006, respectively. 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 was $310,000 which was amortized through October 2006 in accordance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities.” The Corporation amortized into net interest income $45,000 for the first quarter of 2006 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. The Corporation has entered into fair value hedges with a notional amount of $4.8 million with $5,000 of interest income recognized for the three months ended March 31, 2007 and $2,000 recorded as a reduction of interest income for the three months ended March 31, 2006. At March 31, 2007, the Corporation had swap agreements with a positive fair value of $397,000 and with a negative fair value of $27,000. At December 31, 2006, the Corporation had swap agreements with a positive fair value of $545,000 and with a negative fair value of $21,000. There was no hedge ineffectiveness recognized during the first quarters of 2007 and 2006.

During March 2007, the Corporation purchased one and three month Treasury bill interest rate cap agreements with notional amounts totaling $200 million to limit its exposure on variable rate now deposit accounts. The initial premium related to these caps was $73,000 which will be amortized to interest expense over the life of the cap based on the cap market value. At March 31, 2007, these caps, designated as cash flow hedges, had a positive fair value of $14,000 with no impact to earnings for the first quarter of 2007. The caps mature in March 2009.

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, 2007 net interest income rate shock simulations show that the Corporation is within guidelines set by the Corporation’s Asset/Liability Policy.

 
-19-
 

The report below forecasts changes in the Corporation’s market value of equity under alternative interest rate environments as of March 31, 2007. 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
$297,348
$(105,090)
-26.11%
+/- 35%
+200 Basis Points
333,736
    (68,702)
-17.07%
+/- 25
+100 Basis Points
369,720
    (32,718)
-8.13%
+/- 15
Flat Rate
402,438
     -
0.00%
 
-100 Basis Points
401,433
      (1,005)
-0.25%
+/- 15
-200 Basis Points
389,004
    (13,434)
-3.34%
+/- 25
-300 Basis Points
376,635
    (25,803)
-6.41%
+/- 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 Corporation 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 Corporation’s allowance for loan losses. The OCC may require the Corporation 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 Corporation’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 Corporation’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 results of the loan review process. The Corporation’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 Corporation 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.

-20-
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 risk 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 2007, the provision for loan losses was $2.4 million, compared to $1.2 million for the same period in 2006. The increase in the provision was primarily a result of inherent risk related to loan growth, the increase in nonperforming loans, as well as a higher level of charge-offs. Net loans charged-off increased $1.5 million in the first quarter of 2007 compared to the same quarter in 2006 principally from charge-offs related to real estate construction loans for one borrower and a $700,000 charge-off for a loan to one commercial borrower whose financial condition changed due to internal factors unique to that borrower and to a lesser extent, factors affecting the economy as a whole.

Our customer base has remained relatively constant and we believe that the current deterioration in credit quality has been caused by the economic pressures being felt by our borrowers. We have experienced a similar decline in the past and expect that we could experience a similar decline in future economic cycles.
 
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)
    
2007
    
2006
  
               
Average loans
  
$
2,059,871
  
$
1,988,778
  
               
Allowance, beginning of period
   
21,154
    
19,865
  
Loans charged off:
              
    Commercial and industrial
   
750
    
445
  
    Consumer
    
373
    
581
  
    Real estate
   
1,620
    
436
  
    Lease financing
   
31
    
10
  
        Total loans charged off
   
2,774
    
1,472
  
Recoveries:
              
    Commercial and industrial
   
9
    
3
  
    Consumer
    
93
    
177
  
    Real estate
   
9
    
53
  
    Lease financing
   
13
    
69
  
        Total recoveries
    
124
    
302
  
Net loans charged off
   
2,650
    
1,170
  
Provision for loan losses
   
2,425
    
1,200
  
Allowance, end of period
 
$
20,929
  
$
19,895
  
Ratio of net charge offs to average
              
   loans outstanding (annualized)
   
0.52
%
  
0.24
%
               
 

 
-21-
 

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, 2007 
December 31, 2006
         
Percent of 
          
Percent of
  
(Dollars in thousands)
    
Amount
 
 
Allowance
 
 
Amount
 
 
Allowance
  
                           
Real estate
  
$
8,266
    
40
%
$
7,918
    
38
%
Commercial
                         
     and industrial
    
8,838
   
42
%
  
9,119
    
43
%
Consumer
    
3,793
   
18
%
  
4,041
    
19
%
Lease financing
    
32
   
-
%
  
76
    
-
%
Total
  
$
20,929
    
100
%
$
21,154
    
100
%

Nonperforming Assets

Nonperforming assets (including nonaccruing loans, net assets in foreclosure and loans past due 90 days or more past due) were .59% of total assets at March 31, 2007, compared to .54% at December 31, 2006, and .33% at March 31, 2006. The increase in nonperforming assets at March 31, 2007, in relation to December 31, 2006, of $1.9 million was mainly due to a construction loan for one borrower (after a $1.5 million charge-off) and real estate loans for two borrowers placed on nonaccrual of interest, partially offset by the payoff of nonaccrual real estate loans for another borrower. The increase in relation to March 31, 2006 was largely due to an increase in the level of real estate loans on non-accrual of interest as well as 90 days past due. Management recognizes the increased level of nonperforming assets and charge-offs. The expectation of continued economic pressures resulting in deterioration of credit quality has caused us to provide more resources to resolve troubled credits including an increased focus on earlier identification of potential problem loans and a more active approach to managing the level of criticized loans that have not reached nonaccrual status.

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. Efforts to liquidate assets acquired in foreclosure proceed as quickly as potential buyers can be located and legal constraints permit. 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 following table presents information concerning nonperforming assets. Nonperforming assets include loans that are in nonaccrual status or 90 days or more past due and loans that are in the process of foreclosure.

Table 6—Nonperforming Assets

(Dollars in thousands)
    
March 31, 2007
 
 
December 31, 2006
 
 
March 31, 2006
  
                     
Nonaccrual loans
 
$
17,519
  
$
15,201
  
$
9,430
  
Loans 90 days or more past due
    
2,001
    
2,444
    
1,093
  
Total nonperforming loans
   
19,520
    
17,645
    
10,523
  
Net assets in foreclosure
    
10
    
-
    
78
  
Total nonperforming assets
  
$
19,530
  
$
17,645
  
$
10,601
  
                     
  Allowance for loan losses to nonperforming loans
   
107.2
%
  
119.9
%
  
189.1
%
Nonperforming loans to total net loans
   
0.95
%
  
0.87
%
  
0.53
%
Allowance for loan and lease losses to total loans
   
1.01
%
  
1.03
%
  
0.99
%
Nonperforming assets to total assets
    
0.59
%
  
0.54
%
  
0.33
%

Locally located real estate, most with acceptable loan to value ratios, secures many of the nonperforming loans.


 
-22-
 

The following table presents information concerning impaired loans. Impaired loans are loans for which it is probable that all principal and interest will not be collected according to the contractual terms of the loan agreement.

Table 7—Impaired Loans

(Dollars in thousands)
    
March 31, 2007
 
 
December 31, 2006
 
 
March 31, 2006
  
                     
Impaired Loans
  
$
7,789
  
$
3,946
  
$
4,351
  
                   
Average year-to-date impaired loans
  
$
6,523
  
$
3,222
  
$
3,507
  
                   
Impaired loans with specific loss allowances
  
$
7,789
  
$
3,946
  
$
4,351
  
                     
Loss allowances reserved on impaired loans
  
$
1,279
  
$
678
  
$
686
  
                     
Year-to-date income recognized on impaired loans
  
$
4
  
$
60
  
$
1
  

The Bank’s policy for interest income recognition on impaired 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 $9.1 million for the first quarter of 2007 reflects an increase of $214,000 from the comparable period in 2006. Gains on sales of investment securities for the three months ended March 31, 2007 were $531,000. The net security gains were primarily the result of the sale of mortgage-backed securities and longer duration municipal bonds. During the comparable period in 2006, there were no gains recognized. Additionally, the Bank experienced modest increases in deposit service charges and a slight decline in wealth management revenue of $297,000 due to a higher level of variable life insurance business booked in the first quarter of 2006. Major revenue component sources of wealth management income include investment management and advisory fees, trust fees, estate and tax planning fees, brokerage fees, and insurance related fees.
 
Noninterest Expense

Noninterest expense of $18.8 million for the first quarter of 2007 increased $1.7 million from the first quarter of 2006. Salaries and benefits expense rose $1.1 million during the first quarter of 2007 as compared to the same period in 2006 primarily due to higher staffing levels resulting from growth and increased cost of medical benefits. Other expense increased $501,000 during 2007 mainly as a result of increased computer software costs and professional and consulting expenses.

Income Taxes

The effective income tax rates for the quarters ended March 31, 2007 and 2006 were 21.2% and 25.9%, respectively, versus the applicable federal statutory rate of 35%. The Corporation’s effective rates during 2007 and 2006 were 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 rate for the three months ended March 31, 2007 was lower than the same period in 2006 primarily due to the lower level of net income during the first quarter of 2007.

Balance Sheet Analysis

Total assets at March 31, 2007 of $3.3 billion increased $75.1 million compared to December 31, 2006 with increases in cash and investments of $53.7 million and loans of $18.4 million. Federal funds sold to correspondent banks increased $42.0 million resulting from the net increase in long-term borrowings for interest rate risk purposes and in anticipation of continued loan growth. The balance of investment securities available for sale at March 31, 2007 of $869.7 million increased $16.7 million compared to December 31, 2006 primarily as a result of net additional purchases of mortgage-backed securities. The increases in goodwill and intangible assets of $1.3 were related to the selected asset purchase of McPherson during the first quarter of 2007 and allocated to the Wealth Management segment.

Total deposits of $2.53 billion at March 31, 2007 increased $10.0 million from $2.52 billion at December 31, 2006. Money market accounts increased $49.0 million partially offset by reductions in time deposits of $21.2 million and interest-bearing checking accounts of $15.5 million. Core deposits (total deposits less time deposits) increased $31.2 million or 1.9% to $1.70 billion for the same periods.


 
-23-
 

Total borrowings increased $65.9 million to $455.4 million at March 31, 2007 from $389.5 million at December 31, 2006. The increase was the result of advances of $80.0 million in long-term securities sold under agreements to repurchase partially offset by $15.0 in maturities of long-term Federal Home Loan Bank borrowings.

Capital

Capital formation is important to the Corporation's well being and future growth. Capital for the period ending March 31, 2007 was $296.2 million, an increase of $1.5 million over the end of 2006 primarily the result of a reduction in the accumulated other comprehensive loss related to investment securities. 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, 2007
    
Actual
Amount
 
 
Ratio
 
 
Amount
 
 
Ratio
 
 
Amount
 
 
Ratio
  
                                       
Total Capital (to risk weighted assets):
                                      
Corporation
  
$
322,346
    
12.26
%
$
210,355
    
8.00
%
$
262,944
    
-
  
Harleysville National Bank
    
278,620
    
10.66
%
  
209,119
    
8.00
%
  
261,398
    
10
%
Tier 1 Capital (to risk weighted assets):
                                      
Corporation
    
301,317
    
11.46
%
  
105,177
    
4.00
%
  
157,766
    
-
  
Harleysville National Bank
    
257,591
    
9.85
%
  
104,559
    
4.00
%
  
156,839
    
6
%
Tier 1 Capital (to average assets):
                                      
Corporation
    
301,317
    
9.32
%
  
129,252
    
4.00
%
  
161,566
    
-
  
Harleysville National Bank
    
257,591
    
8.06
%
  
127,844
    
4.00
%
  
159,804
    
5
%


 
 
(Dollars in thousands)
              
 
For Capital
Adequacy Purposes
To Be Well Capitalized
Under Prompt Corrective
Action Program
 
As of December 31, 2006
    
Actual
Amount
 
 
Ratio
 
 
Amount
 
 
Ratio
 
 
Amount
 
 
Ratio
  
                                       
Total Capital (to risk weighted assets):
                                      
Corporation
  
$
323,622
    
12.58
%
$
205,814
    
8.00
%
$
257,268
    
-
  
Harleysville National Bank
    
279,513
    
10.93
%
  
204,529
    
8.00
%
  
255,661
    
10
%
Tier 1 Capital (to risk weighted assets):
                                      
Corporation
    
302,368
    
11.75
%
  
102,907
    
4.00
%
  
154,361
    
-
  
Harleysville National Bank
   
258,259
    
10.10
%
  
102,264
    
4.00
%
  
153,397
    
6
%
Tier 1 Capital (to average assets):
                                      
Corporation
    
302,368
    
9.36
%
  
129,242
    
4.00
%
  
161,553
    
-
  
Harleysville National Bank
    
258,259
    
8.08
%
  
127,877
    
4.00
%
  
159,846
    
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 generally common stockholder’s equity and retained earnings adjusted to exclude disallowed goodwill and identifiable intangibles as well as the inclusion of qualifying trust preferred securities. 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, 2007, the Corporation’s Tier 1 risk-adjusted capital ratio was 11.46%, and the total risk-adjusted capital ratio was 12.26%, both well above the regulatory requirements. The risk-based capital ratios of the Bank also exceeded regulatory requirements at March 31, 2007.

The leverage ratio consists of Tier 1 capital divided by quarterly average total assets, excluding goodwill and identifiable intangibles. Banking organizations are expected to have ratios from 4% to 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 9.32% at March 31, 2007 and 9.36% at December 31, 2006.


 
-24-
 

The year-to-date March 31, 2007 cash dividend per share of $.20 was 11.1% higher than the cash dividend for the same period in 2006 of $.18. The proportion of net income paid out in dividends for the first three months of 2007 was 94.4%, compared to 58.4% for the same period in 2006, the increase mainly resulting from lower net income during the first quarter of 2007. 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 2007.

Liquidity

Liquidity is a measure of the ability of the Corporation to meet its current cash 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 Corporation’s decisions with regard to liquidity are based on projections of potential sources and uses of funds for the next 120 days under the Corporation’s asset/liability model. The resulting projections as of March 31, 2007 show the potential sources of funds exceeding the potential uses of funds. The accuracy of this prediction can be affected by limitations inherent in the model and by the occurrence of future events not anticipated when the projections were made. 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, 2007, the Bank had borrowings outstanding with the FHLB of $224.8 million, all of which were long-term and pledged investment securities available for sale of $634.6 million and held to maturity of $52.8 million. At March 31, 2007, the Bank had unused lines of credit at the FHLB of $332.3 million and unused federal funds lines of credit of $195.0 million.

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.

 
-25-
 

Branching

The Corporation is currently planning to open new locations in Warminster, Bucks County and East Norriton, Montgomery County as well as to relocate its Blue Bell office in Montgomery County during 2007. In addition, the Bank plans to add retail branches in Warrington, Bucks County and Conshohocken and Flourtown, Montgomery County in 2008. These plans are subject to change as management continues to evaluate its market and its business needs. 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 of the Corporation, using policies and procedures approved by the Corporation’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 2007. The Corporation continues to experience a challenging interest rate environment which has impacted our interest rate sensitivity exposure. A detailed discussion of market risk is provided on pages 19 and 20 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 2007 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
 
 
-26-
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

There have been no material changes in risk factors from those disclosed under Item 1A, “Risk Factors.” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2006.


Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
The Corporation did not repurchase any of its common stock during the first quarter of 2007. As of March 31, 2007, the maximum number of shares that may yet be purchased under its stock repurchase program is 872,761 (restated retroactively for the effect of stock dividends and splits). On May 12, 2005, the Board of Directors authorized a plan to purchase up to 1,416,712 shares (restated for five percent stock dividend paid on September 15, 2006 and September 15, 2005) or 4.9%, of its outstanding common stock. Repurchased shares are used for general corporate purposes.

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


The exhibits listed on the Exhibit Index at the end of this Report are filed with or incorporated as part of this Report (as indicated in connection with each Exhibit).


 
-27-
 



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 9, 2007                         /s/ Demetra M. Takes
                        Demetra M. Takes, Interim President, Chief Executive Officer and Director
                                                         (Principal executive officer)


Date: May 9, 2007                        /s/ George S. Rapp
                                  George S. Rapp, Executive Vice President and Chief Financial Officer
                                  (Principal financial and accounting officer)



 
-28-
 

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.)
 
(2.2)
 
Branch Purchase Agreement and Deposit Assumption Agreement, dated as of July 26, 2006, by and among First National Community Bank as Buyer and Harleysville National Bank and Trust Company as Seller. (Incorporated by reference to Exhibit 2.2 to the Corporation’s Quarterly Report filed on Form 10-Q, filed with the Commission on August 9, 2006. The attachments, schedules and exhibits to the Branch Purchase and Deposit Assumption Agreement are listed at the end of the Branch Purchase and Deposit Assumption Agreement but have been omitted from the exhibit to Form 10-Q. The Registrant agrees to supplementally furnish a copy of any omitted attachment, schedule or exhibit to the Securities and Exchange Commission upon request.
 
(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 dated October 26, 1998.* (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, as amended and restated effective February 8, 2001.** (Incorporated by reference to Appendix “A” of Registrant’s Definitive Proxy Statement, filed with the Commission on March 9, 2001.)
 
(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.)
 
 
-29-
(10.14)
 
Employment Agreement dated March 9, 2004 between Mikkalya Murray, former 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, former 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, as amended and restated effective November 9, 2006.** (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on November 15, 2006).
 
(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, the former 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 former 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)
 
Complete Settlement Agreement and General Release dated November 29, 2006 and effective December 8, 2006 between Gregg J. Wagner and Harleysville National Corporation, Harleysville National Bank and Trust Company and Harleysville Management Services, LLC .* (Incorporated by reference to Registrant’s Current Report on Form 8-K, filed with the Commission on December 13, 2006.
 
(10.26)
 
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.)
 
(10.27)
 
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. (Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q/A, filed with the Commission on November, 9, 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. (Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q/A, filed with the Commission on November, 9, 2005.)
 
(10.29)
 
Guarantee Agreement between Harleysville National Corporation and Wilmington Trust Company, dated as of September 28, 2005. (Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q/A, filed with the Commission on November, 9, 2005.)
 
(10.30)
 
Employment Agreement effective July 12, 2006 between Lewis C. Cyr, Chief Lending 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 July 12, 2006.)
 
(11)
 
Computation of Earnings per Common Share, incorporated by reference to Note 7 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, filed herewith.
 
(31.2)
 
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
 
 
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(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, furnished herewith.
 
(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, furnished herewith.
 

* Management contract or compensatory plan arrangement.
** Shareholder approved compensatory plan pursuant to which the Registrant’s Common Stock may be issued to employees of the Corporation.

*** Non-shareholder approved compensatory plan pursuant to which the Registrant’s Common Stock may be issued to employees of the Corporation.
 
 
 
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 EX-31.1 CEOCERT302 2 ceocertification302.htm CHIEF EXECUTIVE OFFICER CERTIFICATION - SECTION 302 Chief Executive Officer Certification - Section 302

Exhibit 31.1
CERTIFICATION

I, Demetra M. Takes , Interim President, Chief Executive Officer and Director, certify, that:

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

2.
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;

4.
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 9, 2007      /s/ Demetra M. Takes    
Demetra M. Takes
Interim President, Chief Executive Officer and Director
                Harleysville National Corporation
 
 
 
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 EX-31.2CFOCERT302 3 cfocertification302.htm CHIEF FINANCIAL OFFICER CERTIFICATION SECTION 302 Chief Financial Officer Certification Section 302

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.

2.
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;

4.
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 9, 2007                  /s/ George S. Rapp     
George S. Rapp
Executive Vice President and Chief Financial Officer
Harleysville National Corporation



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 EX-32.1CEOCERT906 4 ceocertification906.htm CHIEF EXECUTIVE OFFICER CERTIFICATION SECTION 906 Chief Executive Officer Certification Section 906
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, 2007, as filed with the Securities and Exchange Commission (the "Report"), I, Demetra M. Takes, Interim 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/ Demetra M. Takes   
Demetra M. Takes
Interim President, Chief Executive Officer and Director
Harleysville National Corporation

Date: May 9, 2007
 
-34-



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.

 EX-32.2CFOSCERT906 5 cfocertification906.htm CHIEF FINANCIAL OFFICER CERTIFICATION SECTION 906 Chief Financial Officer Certification Section 906
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, 2007, 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 9, 2007




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.


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