-----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, AFK3/3qgOJLdW3atqQX/erjUd+Hb3JuBinNURymrO8oN+IULM3kfYWhqH/mZqBsF 3MLc16BIimjv7Gugj5RqAQ== 0000702902-97-000002.txt : 19970328 0000702902-97-000002.hdr.sgml : 19970328 ACCESSION NUMBER: 0000702902-97-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970326 SROS: NASD 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-15237 FILM NUMBER: 97564148 BUSINESS ADDRESS: STREET 1: 483 MAIN ST CITY: HARLEYSVILLE STATE: PA ZIP: 19438 BUSINESS PHONE: 2152568851 MAIL ADDRESS: STREET 1: 483 MAIN STREET CITY: HARLEYSVILLE STATE: PA ZIP: 19438 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996. ----------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from _______to _______. Commission file number 0-15237 ------- HARLEYSVILLE NATIONAL CORPORATION --------------------------------- (Exact name of registrant as specified in its charter) Pennsylvania 23-2210237 ------------ ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 483 Main Street, Harleysville, Pennsylvania 19438 ------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (215) 256-8851 Securities registered pursuant to Section 12(b) of the Act: N/A Name of each exchange Title of each class on which registered . N/A . . N/A . ---------------------------------- Securities registered pursuant to Section 12(g) of the Act: Common Stock, $1.00 par value ----------------------------- Title of Class 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (X) PAGE 1 State the aggregate market value of the voting stock held by nonaffiliates of the registrant. The aggregate market value shall be computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of a specified date within 60 days prior to the date of filing. $146,695,854 as of February 21, 1997 Indicate the number of shares outstanding of each class of the registrant's classes of common stock, as of the latest practicable date. 6,657,001 shares of Common Stock, $1 par value per share, were outstanding as of February 21, 1997. DOCUMENTS INCORPORATED BY REFERENCE: 1. Portions of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1996 are incorporated by reference into Parts I, II and IV of this report. 2. Portions of the Registrant's Definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 8, 1997 are incorporated by reference into Part III of this report. PAGE 2
HARLEYSVILLE NATIONAL CORPORATION INDEX TO FORM 10-K REPORT PAGE ---- I. PART I. Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Item 2. Properties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . 11 II. PART II. Item 5. Market for Registrant's Common Stock and Related Shareholder Matters. . . . . . . . . 12 Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . 12 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 12 III. PART III. Item 10. Directors and Executive Officers of the Registrant. . . . . . . . . . . . . . . . . . 13 Item 11. Executive Compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Item 12. Security Ownership of Certain Beneficial Owners and Management. . . . . . . . . . . . 14 Item 13. Certain Relationships and Related Transactions. . . . . . . . . . . . . . . . . . . . 14 IV. PART IV. Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K . . . . . . . . . . . 15 Signatures . 17
PAGE 3 PART I Item 1. Business. - ------- History and Business - ---------------------- Harleysville National Corporation, a Pennsylvania corporation (the "Corporation"), was incorporated in June 1982. On January 1, 1983, the Corporation became the parent bank holding company of Harleysville National Bank and Trust Company ("Harleysville"), a wholly-owned subsidiary of the Corporation. On February 13, 1991, the Corporation acquired all of the outstanding common stock of The Citizens National Bank of Lansford ("Citizens"). On June 1, 1992, the Corporation acquired all of the outstanding stock of Summit Hill Trust Company ("Summit Hill"). On September 25, 1992, Summit Hill merged into Citizens and is now operating as a branch office of Citizens. On July 1, 1994 the Corporation acquired all of the outstanding stock of Security National Bank ("Security"). On March 1, 1996, the Corporation acquired all of the outstanding common stock of Farmers & Merchants Bank ("Farmers"). Farmers was merged into Citizens and is now operating as a branch office of Citizens. The Corporation is a bank holding company which provides financial services through its three bank subsidiaries. Since commencing operations, the Corporation's business has consisted primarily of managing Harleysville, Citizens and Security (collectively the "Banks"), and its principal source of income has been dividends paid by the Banks. The Corporation is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the "Bank Holding Company Act"). Harleysville, which was established in 1909, Citizens, which was established in 1903, and Security, which was established in 1988, (collectively the "Banks"), are national banking associations under the supervision of the Office of the Comptroller of the Currency (the "OCC"). The Corporation's and Harleysville's legal headquarters are located at 483 Main Street, Harleysville, Pennsylvania 19438. Citizens' legal headquarters is located at 13-15 West Ridge Street, Lansford, Pennsylvania 18232. Security's legal headquarters is located at One Security Plaza, Pottstown, Pennsylvania 19464. As of December 31, 1996, the Banks had total assets of $1,026,128,000, total shareholders' equity of $97,631,000 and total deposits of $847,699,000. The Banks engage in the full-service commercial banking and trust business, including accepting time and demand deposits, making secured and unsecured commercial and consumer loans, financing commercial transactions, making construction and mortgage loans and performing corporate pension and personal trust services. Their deposits are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law. The Banks enjoy a stable base of core deposits and are leading community banks in their service areas. The Banks believe they have gained their position as a result of a customer oriented philosophy and a strong commitment to service. Senior management has made the development of a sales orientation throughout the Banks one of their highest priorities and emphasizes this objective with extensive training and sales incentive programs that the Company believes are unusual for community banks. The Banks maintain close contact with the local business community to monitor commercial lending needs and believe they respond to customer requests quickly and with flexibility. Management believes these competitive strengths are reflected in the Corporation's results of operations. The Banks have twenty-five (25) offices located in Montgomery, Bucks, Carbon and Wayne counties, Pennsylvania, 15 of which are owned by the Banks and 10 of which are leased from third parties. As of December 31, 1996, the Corporation and the Banks employed approximately 401 full-time equivalent employees. The Corporation provides a variety of employment benefits and considers its relationships with its employees to be satisfactory. PAGE 4 Competition - ----------- The Banks compete actively with other eastern Pennsylvania financial institutions, many larger than the Banks, as well as with financial and non-financial institutions headquartered elsewhere. The Banks are generally competitive with all competing institutions in their service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts, interest rates charged on loans, and fees and charges for trust services. At December 31, 1996, Harleysville's legal lending limit to a single customer was $11,100,000 and Citizens' and Security's legal lending limits to a single customer were $3,100,000 and $630,000, respectively. Many of the institutions with which the Banks compete are able to lend significantly more than these amounts to a single customer. Supervision and Regulation - The Registrant - ------------------------------------------------ The Corporation is a registered bank holding company subject to the provisions of the Bank Holding Company Act of 1956, as amended (the "Bank ---------- Holding Company Act"), and to supervision by the Board of Governors of the Federal Reserve system (the "Federal Reserve). The Bank Holding Company Act requires the Registrant to secure the prior approval of the Federal Reserve Board before it owns or controls, directly or indirectly, more than five percent (5%) of the voting shares or substantially all of the assets of any institution, including another bank. In addition, the Bank Holding Company Act has been amended by the Riegle-Neal Interstate Banking and Branching Efficiency Act which permits bank holding companies to acquire a bank located in any state subject to certain limitation and restrictions which are more fully described below. A bank holding company is prohibited from engaging in or acquiring direct or indirect control of more than five percent (5%) of the voting shares of any company engaged in non-banking activities unless the Federal Reserve, by order or regulation, has found such activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In making this determination, the Federal Reserve considers whether the performance of these activities by a bank holding company would offer benefits to the public that outweigh possible adverse effects. Federal law also prohibits acquisitions of control of a bank holding company without prior notice to certain federal bank regulators. Control is defined for this purpose as the power, directly or indirectly, to direct the management or policies of the bank or bank holding company or to vote twenty-five percent (25%) or more of any class of voting securities. Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or any of its subsidiaries, on investments in the stock or other securities of the bank holding company and on taking of such stock or securities of the bank holding company and on taking of such stock or securities as collateral for loans to any borrower. Permitted Activities - --------------------- The Federal Reserve permits bank holding companies to engage in certain activities so closely related to banking or managing or controlling banks as to be proper incident thereto. Other than making an equity investment in a low to moderate income housing limited partnership, the Corporation does not at this time engage in any other permissible activities, nor does the Corporation have any current plans to engage in any other permissible activities in the foreseeable future. Legislation and Regulatory Changes - ------------------------------------- From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial institutions are frequently made in Congress, and before various bank regulatory agencies. No prediction can be made as to the likelihood of any major changes or the impact such changes might have on the Corporation and PAGE 5 its subsidiaries. Certain changes of potential significance to the Corporation which have been enacted recently and others which are currently under consideration by Congress or various regulatory or professional agencies are discussed below. The passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and the Riegle Community Development and Regulatory Improvement Act may have a significant impact upon the Corporation. The key provisions pertain to interstate banking and interstate branching as well as a reduction in the regulatory burden on the banking industry. Since September 1995, bank holding companies may acquire banks in other states without regard to state law. In addition, banks can merge with other banks in another state beginning in June 1997. States may adopt laws preventing interstate branching but, if so, no out-of-state bank can establish a branch in such state and no banks in such state may branch outside the state. Pennsylvania recently amended the provisions of its banking code to authorize full interstate banking and branching under Pennsylvania law and to facilitate the operations of interstate banks in Pennsylvania. As a result of legal and industry changes, management predicts that consolidation will continue as the financial services industry strives for greater cost efficiencies and market share. Management believes that such consolidation may enhance its competitive position as a community bank. The Interstate Banking and Branching Act also amends the International Banking Act to allow a foreign bank to establish and operate a federal branch or agency upon approval of the appropriate federal and state banking regulator. As a national bank, the Bank currently can relocate its main office across state lines by utilizing a provision in the National Bank Act which permits such relocation to a location not more than thirty miles from its existing main office. In effect, a national bank can thereby move across state lines as long as the relocation does not exceed thirty miles and also retain as branches the offices located in the original state. The Federal Reserve, the FDIC, and the OCC have issued certain risk-based capital guidelines. See page 34 of Registrant's 1996 Annual Report, which is incorporated by reference herein, for information concerning the Corporation's capital. Pending Legislation - -------------------- There are numerous proposals before Congress to modify the financial services industry and the way commercial banks and other financial institutions operate. Some of these proposals include changes to the ownership of financial companies and the types of products and services which ma be offered by financial institutions. However, it is difficult to determine at this time what effect such provisions may have until they are enacted into law. Except as specifically described on page 34 of the 1996 Annual Report to Shareholders, management believes that the effect of the provisions of the aforementioned legislation on the liquidity, capital resources, and results of operations of the Corporation will be immaterial. Management is not aware of any other current specific recommendations by regulatory authorities or proposed legislation which, if they were implemented, would have a material adverse effect upon the liquidity, capital resources, or results of operations, although the general cost of compliance with numerous and multiple federal and state laws and regulations does have, and in the future may have, a negative impact on the Corporation's results of operations. Effects of Inflation - ---------------------- Inflation has some impact on the Corporation's and the Banks' operating costs. Unlike many industrial companies, however, substantially all of the Banks' assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on the Corporation's and the Banks' 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 PAGE 6 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 Banks are members 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 Banks' operations in the future. The effect of such policies and regulations upon the future business and earnings of the Corporation and the Banks 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 Banks are a party to any pending legal proceeding pursuant to any environmental statute, nor are the Corporation and the Banks aware of any circumstances which may give rise to liability under any such statute. Supervision and Regulation - Banks - -------------------------------------- The operations of the Banks are subject to federal and state statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve and to banks whose deposits are insured by the FDIC. The Banks' operations are also subject to regulations of the OCC, the Federal Reserve and the FDIC. The primary supervisory authority of the Banks is the OCC, who regularly examines the Banks. The OCC has authority to prevent a national bank from engaging in unsafe or unsound practices in conducting its business. Federal and state banking laws and regulations govern, among other things, the scope of a bank's business, the investments a bank may make, the reserves against deposits a bank must maintain, loans a bank makes and collateral it takes, the maximum interest rates a bank may pay on deposits, the activities of a bank with respect to mergers and consolidations and the establishment of branches. As a subsidiary bank of a bank holding company, the Banks are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or its subsidiaries, or investments in the stock or other securities as collateral for loans. The Federal Reserve Act and Federal Reserve regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship. Under the Federal Deposit Insurance Act, the OCC possesses the power to prohibit institutions regulated by it (such as the Banks) from engaging in any activity that would be an unsafe and unsound banking practice or would otherwise be in violation of the law. Under the Community Reinvestment Act of 1977, as amended ("CRA"), the OCC ---------- is required to assess the record of all financial institutions regulated by it to determine if these institutions are meeting the credit needs of the community (including low and moderate income neighborhoods) which they serve and to take this record into account in its evaluation of any application made by any of such institutions for, among other things, approval of a branch or other deposit facility, office relocation, a merger or an acquisition of bank shares. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 amended the CRA to require, among other things, that the OCC make publicly available the evaluation of a bank's record of meeting the credit PAGE 7 needs of its entire community, including low and moderate income neighborhoods. This evaluation will include a descriptive rating ("outstanding", "satisfactory", "needs to improve" or "substantial noncompliance") and a statement describing the basis for the rating. These ratings are publicly disclosed. Under the Bank Secrecy Act ("BSA"), banks and other financial institutions are required to report to the Internal Revenue Service currency transactions of more than $10,000 or multiple transactions of which the bank is aware in any one day that aggregate in excess of $10,000. Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information required by the BSA or for filing a false or fraudulent report. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") requires that institutions must be classified, based on their risk-based capital ratios into one of five defined categories, as illustrated below (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized). Total Tier 1 Under a Risk- Risk- Tier 1 Capital Based Based Leverage Order or Ratio Ratio Ratio Directive ------------------------------------------- CAPITAL CATEGORY - ----------------- Well capitalized >10.0 >6.0 >5.0 NO - - - Adequately capitalized > 8.0 >4.0 >4.0* - - - Undercapitalized < 8.0 <4.0 <4.0* Significantly undercapitalized < 6.0 <3.0 <3.0 Critically undercapitalized <2.0 - *3.0 for those banks having the highest available regulatory rating. In the event an institution's capital deteriorates to the undercapitalized category or below, FDICIA prescribes an increasing amount of regulatory intervention, including: (1) the institution of a capital restoration plan and a guarantee of the plan by a parent institution; and (2) the placement of a hold on increases in assets, number of branches or lines of business. If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and (in critically undercapitalized situations) appointment of a receiver. For well capitalized institutions, FDICIA provides authority for regulatory intervention where the institution is deemed to be engaging in unsafe or unsound practices or receives a less than satisfactory examination report rating for asset quality, management, earnings or liquidity. All but well capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval. Under FDICIA, financial institutions are subject to increased regulatory scrutiny and must comply with certain operational, managerial and compensation standards to be developed by Federal Reserve Board regulations. FDICIA also requires the regulators to issue new rules establishing certain minimum standards to which an institution must adhere including standards requiring a minimum ratio of classified assets to capital, minimum earnings necessary to absorb losses and minimum ratio of market value to book value for publicly held institutions. Additional regulations are required to be developed relating to internal controls, loan documentation, credit underwriting, interest rate exposure, asset growth and excessive compensation, fees and benefits. Annual full-scope, on site regulatory examinations are required for all the FDIC-insured institutions except institutions with assets under $100 million which are well capitalized, well-managed and not subject to a recent change in control, in which case, the examination period is every eighteen (18) months. Banks with total assets of $500 million or more, as of the beginning of fiscal year 1993, are required to submit to their supervising federal and state banking agencies a publicly available annual audit report. The independent accountants of such bank are required to attest to the accuracy of management's report regarding the internal control structure of the bank. In addition, such banks also are required to have an independent audit committee composed of outside directors who are independent of PAGE 8 management, to review with management and the independent accountants, the reports that must be submitted to the bank regulatory agencies. If the independent accountants resign or are dismissed, written notification must be given to the bank's supervising government banking agencies. These accounting and reporting reforms do not apply to an institution such as a bank with total assets at the beginning of its fiscal year of less than $500 million, such as Citizens or Security. FDICIA also requires that banking agencies reintroduce loan-to-value ("LTV") ratio regulations which were previously repealed by the 1982 Act. LTVs limit the amount of money a financial institution may lend to a borrower, when the loan is secured by real estate, to no more than a percentage, set by regulation, of the value of the real estate. A separate subtitle within FDICIA, called the "Bank Enterprise Act of 1991", requires "truth-in-savings" on consumer deposit accounts so that consumers can make meaningful comparisons between the competing claims of banks with regard to deposit accounts and products. Under this provision, the Bank is required to provide information to depositors concerning the terms of their deposit accounts, and in particular, to disclose the annual percentage yield. The operational cost of complying with the Truth-In-Savings law had no material impact on liquidity, capital resources or reported results of operations. While the overall impact of fully implementing all provisions of the FDICIA cannot be accurately calculated, Management believes that full implementation of the FDICIA had no material impact on liquidity, capital resources or reported results of operation in future periods. From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restriction on, the business of the Banks. It cannot be predicted whether any such legislation will be adopted or, if adopted, how such legislation would affect the business of the Banks. As a consequence of the extensive regulation of commercial banking activities in the United States, the Banks' business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business. Statistical Data - ----------------- The information for this Item is incorporated by reference to pages 22 through 36 of the Company's Annual Report to Shareholders for the year ended December 31, 1996 which pages are included at Exhibit (13) to this Annual Report on Form 10-K. Item 2. Properties. - ---------------------- The principal executive offices of the Company and of Harleysville are located in Harleysville, Pennsylvania in a two-story office building owned by Harleysville, built in 1929. Harleysville also owns the buildings in which ten of its branches are located and leases space for the other seven branches from unaffiliated third parties under leases expiring at various times through 2036. The principal executive offices of Citizens are located in Lansford, Pennsylvania in a two-story office building owned by Citizens. Citizens also owns the buildings where its branches are located. The principal executive offices of Security are located in Pottstown, Pennsylvania, in a building leased by Security. Security leases its East End and North End branches, and owns its Pottstown Center branch.
Office Office Location Owned/Leased - ----------------- --------------- ------------ Harleysville 483 Main Street Owned Harleysville Pa Skippack Route 73 Owned Skippack Pa PAGE 9 Limerick Ridge Pike Owned Limerick Pa North Penn Welsh & North Wales Rd Owned North Wales Pa Gilbertsville Gilbertsville Shopping Leased Gilbertsville Pa Hatfield Snyder Square Leased Hatfield Pa North Broad North Broad Street Owned Lansdale Pa Marketplace Marketplace Shopping Leased Lansdale Pa Normandy Farms Morris Road Leased Blue Bell Pa Horsham Babylon Business Center Leased Horsham Pa Meadowood Route 73 Leased Worcester Pa Collegeville 364 Main Street Owned Collegeville Pa Sellersville 209 North Main St. Owned Sellersville Pa Trainers Corner Trainers Corner Center Leased Quakertown Pa Quakertown Main 224 West Broad St. Owned Quakertown PA Red Hill 400 Main Street Owned Red Hill PA Audubon 2624 Egypt Road Owned Audubon PA Citizens 13-15 West Ridge Street Owned Lansford PA Summit Hill 2 East Ludlow Street Owned Summit Hill PA Lehighton 904 Blakeslee Blvd. Owned Lehighton PA Farmers & Merchants 1001 Main Street Owned Honesdale PA PAGE 10 Pottstown One Security Plaza Leased Pottstown PA Pottstown 1450 East High Street Leased Pottstown PA Pottstown Charlotte & Mervine Sts. Leased Pottstown PA Pottstown Rte. 100 & Shoemaker Road Owned Pottstown PA
In management's opinion, all of the above properties are in good condition and are adequate for the Registrant's and the Banks' purposes. Item 3. Legal Proceedings. - ------------------------------ Management, based on consultation with the Corporation's legal counsel, is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Corporation. There are no proceedings pending other than the ordinary routine litigation incident to the business of the Corporation and its subsidiaries - Harleysville National Bank and Trust Company, The Citizens National Bank of Lansford and Security National Bank. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Corporation and the Banks by government authorities. Item 4. Submission of Matters to a Vote of Security Holders. - ----------------------------------------------------------------------- No matter was submitted during the fourth quarter of 1996 to a vote of holders of the Corporation's Common Stock. PAGE 11 PART II Item 5. Market for the Registrant's Common Stock and Related Shareholder - ------------------------------------------------------------------------------ Matters. - -------- The information required by this Item is incorporated by reference to pages 7 and 18 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1996, which pages are included at Exhibit (13) to this Annual Report on Form 10-K. Item 6. Selected Financial Data. - -------------------------------------- The information required by this Item is incorporated by reference to pages 22 and 36 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1996, which pages are included at Exhibit (13) to this Annual Report on Form 10-k. Item 7. Management's Discussion and Analysis of Financial Condition and - ------------------------------------------------------------------------------ Results of Operations. - ----------------------- The information required by this Item is incorporated by reference to pages 22 through 35 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1996, which pages are included at Exhibit (13) to this Annual Report on Form 10-K. Item 8. Financial Statements and Supplementary Data. - ----------------------------------------------------------- The information required by this Item is incorporated by reference to pages 7 through 21 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1996, which pages are included at Exhibit (13) to this Annual Report on Form 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and - ------------------------------------------------------------------------------ Financial Disclosure. - --------------------- None. PAGE 12 PART III Item 10. Directors and Executive Officers of the Registrant. - --------------------------------------------------------------------- The information required by this Item with respect to the Corporation's directors is incorporated by reference to pages 3 through 7 of the Corporation's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 8, 1997. Executive Officers of Registrant - -----------------------------------
Name Age Position - --------------------- --- -------- Walter E. Daller, Jr. 57 President and Chief Executive Officer of the Company and of Harleysville James W. Hamilton 50 Senior Vice President and Senior Trust of Harleysville Demetra M. Takes 46 Executive Vice President and Chief Operating Officer of Harleysville Frank J. Lochetto 49 Senior Vice President and Senior Lending Officer of Harleysville Vernon L. Hunsberger 48 Treasurer of the Company, Senior Vice President/CFO and Cashier of Harleysville Fred C. Reim, Jr. 53 Senior Vice President of Harleysville since August 1993; Senior Vice President of First Valley Bank from December 1990 to August 1993 Dennis L. Detwiler 49 Senior Vice President of Harleysville Mikkalya W. Brown 41 Senior Vice President of Loan Administration of Harleysville since July 1994; Vice President Security National Bank September 1991 to June 1994; Assistant Vice President Mellon Bank January 1990 to August 1991 Thomas D. Oleksa 43 President and Chief Executive Officer of Citizens Raymond H. Melcher 45 President and Chief Executive Officer of Security since November 1994; Executive Vice President, Chief Operating Officer Hi-Tech Connections 1990 to 1994; Executive Vice President Keystone Financial 1988 to 1990
PAGE 13 Item 11. Executive Compensation. - ------------------------------------ The information required by this Item is incorporated by reference to pages 7 through 12 of the Corporation's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 8, 1997. Item 12. Security Ownership of Certain Beneficial Owners and Management. - ----------------------------------------------------------------------------- The information required by this Item is incorporated by reference to pages 3 through 4 of the Corporation's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 8, 1997. Item 13. Certain Relationships and Related Transactions. - --------------------------------------------------------------- The information required by this Item is incorporated by reference to page 17 of the Corporation's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 8, 1997, and to page 15 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1996, which page is included at Exhibit (13) to this Annual Report on Form 10-K. PAGE 14 PART IV ------- Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. - -------------------------------------------------------------------- -------- (a) Financial Statements, Financial Statement Schedules and Exhibits Filed: (1) Consolidated Financial Statements Page ---- Harleysville National Corporation and Subsidiary: Consolidated Balance Sheets as of December 31, 1996 and 1995 8* Consolidated Statements of Income for the Years Ended December 31, 1996, 1995 and 1994 9* Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1996, 1995 and 1994 10* Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994 11* Notes to Consolidated Financial Statements 12-21* Independent Auditors' Report 7* (2) Financial Statement Schedules Financial Statements Schedules are omitted because the required information is either not applicable, not required, or the information is included in the consolidated financial statements or notes thereto. *Refers to the respective page of the Annual Report to Shareholders. The Consolidated Financial Statements and Notes to Consolidated Financial Statements and Auditor's Report thereon on pages 7 to 21 of the Annual Report to Shareholders, are incorporated herein by reference and attached at Exhibit 13 to this Annual Report on Form 10-K. With the exception of the portions of such Annual Report specifically incorporated by reference in this Item and in Items 1, 5, 6, 7 and 8, such Annual Report shall not be deemed filed as part of this Annual Report on Form 10-K or otherwise subject to the liabilities of Section 18 of the Securities Exchange Act of 1934. PAGE 15 (3) Exhibits Exhibit No. Description of Exhibits - ----------- ------------------------- (3.1) Harleysville National Corporation Articles of Incorporation, as amended. (Incorporated by reference to Exhibit 3(a) to the Corporation's Registration Statement No. 33-65021 on Form S-4, as filed on December 14, 1995.) (3.2) Harleysville National Corporation By-laws. (Incorporated by reference to Exhibit 3(b) to the Corporation's Registration Statement No. 33-65021 on Form S-4, as filed on December 14, 1995.) (11) Computation of Earnings per Common Share. The information for this Exhibit is incorporated by reference to page 9 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1996, which is included as Exhibit (13) to this Form 10-K Report. (13) Excerpts from the Corporation's 1996 Annual Report to Shareholders. (This excerpt includes only pages 7 through 36 which are incorporated in this Report by reference.) (21) Subsidiaries of Registrant (23) (a) Consent of Grant Thornton LLP Independent Certified Public Accountants (b) Consent of KPMG Peat Marwick LLP Independent Certified Public Accountants (27) Financial Data Schedule. (99) Additional Exhibits (a) Report of Independent Certified Public Accountants - Grant Thornton LLP (b) Report of Independent Certified Public Accountants - KPMG Peat Marwick LLP (b) Reports on Form 8-K During the quarter ended December 31, 1996, the Registrant did not file any reports on Form 8-K. PAGE 16 SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15 (d) 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: March 13, 1997 By:/s/ Walter E. Daller, Jr. --------------------------- Walter E. Daller, Jr. President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signatures Title Date ---------- ----- ---- Director March 13, 1997 - ------------------- John W. Clemens /s/ Walter E. Daller, Jr. President, Chief March 13, 1997 - ------------------------- Walter E. Daller, Jr. Executive Officer and Director (Principal Executive Officer) /s/ Martin E. Fossler Director March 13, 1997 - ------------------------- Martin E. Fossler /s/ Harold A. Herr Director March 13, 1997 - ---------------------- Harold A. Herr /s/ Vernon L. Hunsberger Treasurer (Principal March 13, 1997 - ------------------------- Vernon L. Hunsberger Financial and Accounting Officer) PAGE 17 Signatures Title Date - ---------- ----- ---- Director March 13, 1997 - ----------------------- Thomas S. McCready /s/ Bradford W. Mitchell Director March 13, 1997 - ---------------------------- Bradford W. Mitchell /s/ Henry M. Pollak Director March 13, 1997 - ----------------------- Henry M. Pollak /s/ Palmer E. Retzlaff Director March 13, 1997 - -------------------------- Palmer E. Retzlaff /s/ Walter F. Vilsmeier Director March 13, 1997 - --------------------------- Walter F. Vilsmeier /s/ William M. Yocum Director March 13, 1997 - ------------------------ William M. Yocum PAGE 18 EXHIBIT INDEX - -------------- Exhibit ------- (13) Excerpts from the Corporation's 1996 Annual Report to Shareholders (This excerpt includes only pages 7 through 36 which are incorporated in this Report by reference.) (21) Subsidiaries of Registrant (23) (a) Consent of Grant Thornton LLP Independent Certified Public Accountants (b) Consent of KPMG Peat Marwick LLP Independent Certified Public Accountants (99) Additional Exhibits (a) Report of Independent Certified Public Accountants- Grant Thornton LLP (b) Report of Independent Certified Public Accountants- KPMG Peat Marwick LLP PAGE 19 EX-13 2 DESCRIPTION OF BUSINESS Harleysville National Corporation, a Pennsylvania corporation (the "Corporation"), was incorporated in June 1982. On January 1, 1983, the Corporation became the parent bank holding company of Harleysville National Bank and Trust Company ("Harleysville"), a wholly-owned subsidiary of the Corporation. On February 13, 1991, the Corporation acquired all of the outstanding common stock of The Citizens National Bank of Lansford ("Citizens"). On June 1, 1992, the Corporation acquired all of the outstanding stock of Summit Hill Trust Company ("Summit Hill"). On September 25, 1992, Summit Hill merged into Citizens and is now operating as a branch office of Citizens. On July 1, 1994, the Corporation acquired all of the outstanding stock of Security National Bank ("Security"). On March 1, 1996, the Corporation acquired all of the outstanding common stock of Farmers & Merchants Bank ("Farmers"). Farmers was merged into Citizens and is now operating as a branch office of Citizens. The Corporation is a bank holding company which provides financial services through its three bank subsidiaries. Harleysville, which was established in 1909, Citizens, which was established in 1903, and Security, which was established in 1988, (collectively the "Banks"), are national banking associations under the supervision of the Office of the Comptroller of the Currency. The Corporation's and Harleysville's legal headquarters are located at 483 Main Street, Harleysville, Pennsylvania 19438. Citizens' legal headquarters is located at 13-15 West Ridge Street, Lansford, Pennsylvania 18232. Security's legal headquarters is located at One Security Plaza, Pottstown, Pennsylvania 19464. As of December 31, 1996, the Banks had total assets of $1,026,128,000, total shareholders' equity of $97,631,000 and total deposits of $847,699,000. The Banks engage in full-service commercial banking and trust business, including accepting time and demand deposits, making secured and unsecured commercial and consumer loans, financing commercial transactions, making construction and mortgage loans and performing corporate pension and personal trust services. Their deposits are insured by the Federal Deposit Insurance Corporation (FDIC) Bank Insurance Fund to the extent provided by law. The Banks have 25 branch offices located in Montgomery, Bucks, Carbon and Wayne counties. On December 31, 1996, the Banks had 401 full-time equivalent employees. COMPETITION The Banks compete actively with other eastern Pennsylvania financial institutions, many larger than the Banks, as well as with financial and nonfinancial institutions headquartered elsewhere. The Banks are generally competitive with all competing institutions in their service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts, interest rates charged on loans, and fees and charges for trust services. SUPERVISION AND REGULATION The operations of the Banks are subject to federal, state and local statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System and to banks whose deposits are insured by the FDIC. The Banks' operations are also subject to the regulations of the Federal Reserve Board, the FDIC and the Office of the Comptroller of the Currency (who regularly examines the Banks areas such as asset quality, investments, management practices and other aspects of bank operations). The Corporation is subject to federal and state securities laws, certain rules and regulations of the Securities and Exchange Commission, to the provisions of the Bank Holding Company Act of 1956, as amended, and to supervision by the Federal Reserve Board. MARKET INFORMATION The following table sets forth quarterly dividend information and the high and low prices for the Corporation's Common Stock for 1996 and 1995. The Corporation's stock is traded in the over-the-counter market under the symbol "HNBC" and commonly quoted under NASDAQ National Market Issues. PRICE OF COMMON STOCK
1996 Low Price High Price Dividend First Quarter * $ 24.76 * $ 27.14 * $ .190 * Second Quarter 24.50 26.50 .190 Third Quarter 23.50 26.50 .210 Fourth Quarter 23.50 26.00 .250 1995 Low Price* High Price* Dividend* First Quarter $ 23.81 $ 26.67 $ .171 Second Quarter 23.81 26.67 .171 Third Quarter 23.81 27.14 .181 Fourth Quarter 25.00 27.14 .229 *Adjusted for a 5% stock dividend effective 6/28/96.
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Harleysville National Corporation and Subsidiaries To the Board of Directors and Shareholders, Harleysville National Corporation: We have audited the accompanying consolidated balance sheets of Harleysville National Corporation and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity and cash flows for each of the two years in the period ended December 31, 1996. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements of Harleysville National Corporation and Subsidiaries for the year ended December 31, 1994 were audited by other auditors whose report, dated January 31, 1995, expressed an unqualified opinion on those consolidated financial statements. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Harleysville National Corporation and Subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their consolidated cash flows for the years then ended, in conformity with generally accepted accounting principles. As discussed in note 1 to the consolidated financial statements, Harleysville National Corporation and Subsidiaries changed their method of accounting for certain investments in debt and equity securities in 1994. Grant Thornton LLP Philadelphia, Pennsylvania January 8, 1997 PAGE 7 CONSOLIDATED BALANCE SHEETS HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
(Dollars in thousands) December 31, -------------- ASSETS 1996 1995 -------------- --------- Cash and due from banks $ 39,407 $ 34,312 Federal funds sold 6,000 16,295 -------------- --------- Total cash and cash equivalents 45,407 50,607 -------------- --------- Interest-bearing deposits in banks 8,475 1,703 Investment securities available for sale 209,795 159,326 Investment securities held to maturity (market value $66,680 and $85,652, respectively) 65,226 83,669 Loans 689,203 638,220 Less: Unearned income (7,793) (9,482) Allowance for loan losses (10,710) (9,891) -------------- --------- Net loans 670,700 618,847 -------------- --------- Bank premises and equipment, net 14,810 11,995 Accrued interest receivable 6,653 6,150 Other real estate owned 972 1,220 Intangible assets, net 1,658 1,960 Other assets 2,432 1,868 -------------- --------- Total assets $ 1,026,128 $937,345 ============== ========= LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest-bearing 139,723 117,698 Interest-bearing: NOW accounts 102,270 91,616 Money market accounts 155,516 155,641 Savings 104,329 101,993 Time under $100,000 294,501 297,923 Time $100,000 or greater 51,360 29,628 -------------- --------- Total deposits 847,699 794,499 Accrued interest payable 13,927 12,082 U.S. Treasury demand notes 2,572 1,837 Federal Home Loan Bank (FHLB) borrowings 35,000 21,200 Securities sold under agreements to repurchase 21,949 16,714 Other liabilities 7,350 4,651 -------------- --------- Total liabilities 928,497 850,983 -------------- --------- Shareholders' equity: Series preferred stock, par value $1 per share; authorized 3,000,000 shares, none issued - - Common stock, par value $1 per share; authorized 30,000,000 shares; issued and outstanding 6,656,770 shares in 1996 and 6,316,208 shares in 1995 6,657 6,316 Additional paid in capital 40,316 30,883 Retained earnings 47,849 47,780 Net unrealized gain on investment securities available for sale 2,809 1,383 -------------- --------- Total shareholders' equity 97,631 86,362 -------------- --------- Total liabilities and shareholders' equity $ 1,026,128 $937,345 ============== ========= See accompanying notes to consolidated financial statements.
PAGE 8 CONSOLIDATED STATEMENTS OF INCOME Harleysville National Corporation and Subsidiaries (Dollars in thousands except weighted average number of common shares and per share information)
Year Ended December 31, ------------------------- 1996 1995 1994 ------------------------- ----------- ---------- Interest Income: Loans, including fees $ 52,873 $ 50,868 $ 42,509 Lease financing 3,811 3,141 2,737 Investment securities: Taxable 12,110 10,923 10,117 Exempt from federal taxes 4,020 2,671 2,538 Federal Funds sold 622 784 329 Deposits in banks 282 104 151 ------------------------- ----------- ---------- Total interest income 73,718 68,491 58,381 ------------------------- ----------- ---------- Interest Expense: Savings deposits 9,616 9,571 9,468 Time, under $100,000 16,830 15,397 10,512 Time, $100,000 or greater 2,024 1,648 717 Borrowed funds 2,406 2,168 404 ------------------------- ----------- ---------- Total interest expense 30,876 28,784 21,101 ------------------------- ----------- ---------- Net interest income 42,842 39,707 37,280 Provision for loan losses 2,082 2,172 2,665 ------------------------- ----------- ---------- Net interest income after provision for loan losses 40,760 37,535 34,615 ------------------------- ----------- ---------- Other Operating Income: Service charges 2,587 2,337 2,341 Security (losses) gains, net (39) (172) 668 Trust income 1,293 1,094 741 Other Income 1,274 1,178 996 ------------------------- ----------- ---------- Total other operating income 5,115 4,437 4,746 ------------------------- ----------- ---------- Net interest income after provision for loan losses and other operating income 45,875 41,972 39,361 ------------------------- ----------- ---------- Other Operating Expenses: Salaries, wages and employee benefits 14,398 13,112 11,626 Occupancy 1,873 1,541 1,474 Furniture and equipment 2,083 1,913 1,572 FDIC premium 6 861 1,648 Other expenses 7,514 6,840 6,994 ------------------------- ----------- ---------- Total other operating expenses 25,874 24,267 23,314 ------------------------- ----------- ---------- Income before income tax expense 20,001 17,705 16,047 Income tax expense 5,593 5,277 4,767 ------------------------- ----------- ---------- Net income $ 14,408 $ 12,428 $ 11,280 ========================= =========== ========== Weighted average number of common shares: Primary 6,660,530 6,646,957 6,602,678 Fully diluted 6,660,530 6,648,976 6,602,678 ========================= =========== ========== Net income per share information: Primary $ 2.16 $ 1.87 $ 1.71 ========================= =========== ========== Fully diluted $ 2.16 $ 1.87 $ 1.71 ========================= =========== ========== Cash dividends per share $ 0.84 $ 0.75 $ 0.58 ========================= =========== ========== See accompanying notes to consolidated financial statements.
PAGE 9 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Harleysville National Corporation and Subsidiaries
Net Unrealized Gain (Loss) (Dollars in thousands) on Investment Common Stock Securities ------------ Number of Par Additional Retained Available Shares Value Paid in Capital Earnings For Sale Total ------------ ----- --------------- --------- --------------- ------- Balance, January 1, 1994 5,396 5,396 15,009 42,066 - 62,471 Acquisition of Farmers & Merchants Bank 438 438 3,281 3,159 - 6,878 Stock options 58 58 1,653 (2,296) - (585) Stock dividends 274 274 7,085 (7,369) - (10) Stock awards - - 3 (3) - - Dividends reinvestment 25 25 666 - - 691 Net income for 1994 - - - 11,280 - 11,280 Cash dividends - - - (3,686) - (3,686) Net unrealized loss on investment securities available for sale - - - - (2,856) (2,856) ------------ ----- --------------- --------- --------------- ------- Balance, December 31, 1994 6,191 6,191 27,697 43,151 (2,856) 74,183 Stock options 125 125 3,183 (2,886) - 422 Stock awards - - 3 (3) - - Net income for 1995 - - - 12,428 - 12,428 Cash dividends - - - (4,910) - (4,910) Net unrealized gain on investment securities available for sale - - - - 4,239 4,239 ------------ ----- --------------- --------- --------------- ------- Balance, December 31, 1995 6,316 6,316 30,883 47,780 1,383 86,362 Stock options 14 14 335 (237) - 112 Stock dividends 316 316 8,171 (8,502) - (15) Stock awards 11 11 - (16) - (5) Stock compensation tax benefit - - 927 - - 927 Net income for 1996 - - - 14,408 - 14,408 Cash dividends - - - (5,584) - (5,584) Net unrealized gain on investment securities available for sale - - - - 1,426 1,426 ------------ ----- --------------- --------- --------------- ------- Balance, December 31, 1996 6,657 6,657 40,316 47,849 2,809 97,631 ============ ===== =============== ========= =============== ======= See accompanying notes to consolidated financial statements.
PAGE 10 CONSOLIDATED STATEMENTS OF CASH FLOWS Harleysville National Corporation and Subsidiaries
(Dollars in thousands) Year Ended December 31, ------------------------- OPERATING ACTIVITIES: 1996 1995 1994 ------------------------- --------- --------- Net Income $ 14,408 $ 12,428 $ 11,280 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 2,082 2,172 2,665 Depreciation and amortization 1,412 1,220 1,060 Net amortization of investment securities discount/premiums 403 481 696 Deferred income taxes 844 445 104 Net realized securities (loss) gain 39 172 (668) Increase in accrued income receivable (503) (908) (806) Increase in accrued interest payable 1,845 3,764 1,376 Net increase in other assets (564) (28) (877) Net increase in other liabilities 1,984 423 1,043 Decrease in unearned income (1,689) (599) (1,522) Write-down of other real estate owned 144 190 148 Amortization of intangible assets 302 355 617 ------------------------- --------- --------- Net cash provided by operating activities 20,707 20,115 15,116 ------------------------- --------- --------- INVESTING ACTIVITIES: Proceeds from sales of investment securities available for sale 64,327 10,887 41,941 Proceeds, maturity or calls of investment securities held to maturity 9,078 26,843 23,725 Proceeds, maturity or calls of investment securities available for sale 29,789 23,304 26,136 Purchases of investment securities held to maturity (5,847) (60,207) (22,105) Purchases of investment securities available for sale (127,591) (21,155) (40,339) Net (increase) decrease in interest-bearing deposits in banks (6,772) 301 1,051 Net increase in loans (53,491) (35,023) (96,555) Net increase in premises and equipment (4,227) (3,469) (1,273) Proceeds from sales of other real estate 1,348 1,075 1,207 ------------------------- --------- --------- Net cash used in investing activities (93,386) (57,444) (66,212) ------------------------- --------- --------- FINANCING ACTIVITIES: Net increase in deposits 53,200 51,175 7,998 (Decrease) increase in U.S. Treasury demand notes 735 (556) 67 (Decrease) increase in federal funds purchased - (12,716) 12,301 Increase in FHLB borrowings 13,800 16,200 5,000 Increase in securities sold under agreement 5,236 1,501 15,213 Cash dividends and fractional shares (5,584) (4,910) (3,705) Dividends reinvestment (20) - 691 Stock options 112 422 (585) ------------------------- --------- --------- Net cash provided by financing activities 67,479 51,116 36,980 ------------------------- --------- --------- Net (decrease) increase in cash and cash equivalents (5,200) 13,787 (14,116) Cash and cash equivalents at beginning of year 50,607 36,820 50,936 ------------------------- --------- --------- Cash and cash equivalents at end of the year $ 45,407 $ 50,607 $ 36,820 ========================= ========= ========= Cash paid during the year for: Interest $ 29,030 $ 25,021 $ 19,725 Income taxes 3,710 4,398 4,315 ========================= ========= ========= Supplemental disclosure of noncash investing and financing activities: Transfer of assets from loans to other real estate owned $ 1,243 $ 1,208 $ 859 ========================= ========= ========= Transfer of securities from investment securities held to maturity to investment securities available for sale $ - $ 39,947 $ 6,029 ========================= ========= ========= See accompanying notes to consolidated financial statements.
PAGE 11 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS Harleysville National Corporation (the "Corporation") through its subsidiary banks, Harleysville National Bank and Trust Company, Citizens National Bank of Lansford, and Security National Bank (collectively the "Banks"), provides a full range of banking services to individual and corporate customers located in eastern Pennsylvania. The Banks compete with other banking and financial institutions in their primary market communities, including financial institutions with resources substantially greater than their own. Commercial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for deposits and for types of loans. Such institutions, as well as consumer finance and insurance companies, may be considered competitors of the Banks with respect to one or more of the services they render. In addition to being subject to competition from other financial institutions, the Banks are subject to federal and state laws and to regulations of certain federal agencies, and, accordingly, they are periodically examined by those regulatory authorities. BASIS OF FINANCIAL STATEMENT PRESENTATION The accounting and reporting policies of the Corporation and its Subsidiaries conform with generally accepted accounting principles. All significant intercompany transactions are eliminated in consolidation and certain reclassifications are made when necessary to conform with the previous years' financial statements to the current year's presentation. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the balance sheets and revenues and expenditures for the periods presented. Therefore, actual results could differ significantly from those estimates. INVESTMENT SECURITIES The Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities," on January 1, 1994, which requires among other things, that debt and equity securities classified as available for sale be reported at fair value with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders' equity, net of income taxes. The net effect of unrealized gains or losses, caused by marking an available-for-sale portfolio to market, could cause fluctuations in the level of shareholders' equity and equity-related financial ratios as market interest rates cause the fair value of fixed-rate securities to fluctuate. Investment securities are classified as held to maturity when the Corporation and its Subsidiaries have the ability and intent to hold those securities to maturity. These investment securities are carried at cost, adjusted for amortization of premiums and accretion of discounts. Investment securities expected to be held for an indefinite period of time are classified as available for sale and are stated at the lower of aggregate cost or market value. Investment securities expected to be held for an indefinite period of time include securities that management intends to use as part of its asset/liability strategy (other than securities that are intended to be held to maturity because they offset core deposits that have demonstrated stability) or that may be sold in response to changes in interest rates, changes in prepayment risks, the need to increase regulatory capital or other similar factors. Realized gains and losses on the sale of investment securities are recognized using the specific identification method and are included in the consolidated statements of income. LOANS Loans are stated at the principal amount outstanding. Net loans represent the principal loan amount outstanding reduced by unearned income and allowance for loan losses. Interest on commercial and industrial, real estate, consumer loans and direct installment loans is credited to income based on the principal amount outstanding. Interest on indirect installment loans is credited to income using the actuarial method. Lease financing represents automobile and equipment leasing. The lease financing receivable included in loans is stated at the gross amount of lease payments receivable plus the residual value less income to be earned over the life of the leases. Such income is recognized over the term of the leases using the level yield method. Loan origination fees and direct loan origination costs of completed loans are deferred and recognized over the life of the loan as an adjustment to yield. The net loan origination fees recognized as yield adjustments are reflected in total interest income in the consolidated statements of income, and the unamortized balance of such net loan origination fees is reported in the consolidated balance sheets as part of unearned income. Income recognition of interest is discontinued when, in the opinion of management, the collectibility of such interest becomes doubtful. A loan is generally classified as nonaccrual when principal or interest has consistently been in default for a period of 90 days or more or because of a deterioration in the financial condition of the borrower, and payment in full of principal or interest is not expected. Loans past due 90 days or more and still accruing interest are loans that are generally well-secured and expected to be restored to a current status in the near future. The Corporation adopted SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures," on January 1, 1995. This new standard requires that a creditor measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable. The adoption of SFAS No. 114, as amended by SFAS No. 118, on January 1, 1995, did not have a material impact on the Corporation's consolidated financial position or results of operations. On January 1, 1996, the Corporation adopted SFAS No. 122, "Accounting for Mortgage Servicing Rights," which requires that a mortgage banking enterprise recognize as separate assets rights to service mortgage loans for others, however those servicing rights are acquired. In circumstances where mortgage loans are originated, separate asset rights to service mortgage loans are only recorded when the enterprise intends to sell such loans. The adoptions of SFAS No. 122 did not have a material impact on the Corporation's consolidated financial position or results of operations. PAGE 12 The Financial Accounting Standards Board (FASB) issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," as amended by SFAS No. 127, which provides accounting guidance on transfers of financial assets, servicing of financial assets, and extinguishments of liabilities. This statement is effective for transfers of financial assets, servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996. Adoption of this new statement is not expected to have a material impact on the Corporation's consolidated financial position or results of operations. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is maintained at a level that management considers adequate to provide for potential losses based upon an evaluation of known and inherent risks in the loan portfolio. Allowance for loan losses is based on estimated net realizable value unless it is probable that loans will be foreclosed, in which case allowance for loan losses is based on fair value less selling costs. Management's periodic evaluation is based upon evaluation of the portfolio, past loss experience, current economic conditions and other relevant factors. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Banks' allowances for loan losses. Such agencies may require the Banks to recognize additions to the allowance based on their judgment of information available to them at the time of their examination. BANK PREMISES AND EQUIPMENT Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is recorded using the straight-line and accelerated depreciation methods over the estimated useful life of the assets. Leasehold improvements are amortized over the term of the lease or estimated useful life, whichever is shorter. On January 1, 1996, the Corporation adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of", which provides guidance on when to recognize and how to measure impairment losses of long-lived assets and certain identifiable intangibles and how to value long-lived assets to be disposed of. The adoption of SFAS No. 121 did not have a material impact on the Corporation's consolidated financial position or results of operations. OTHER REAL ESTATE OWNED Other real estate owned includes foreclosed real estate which is carried at the lower of cost (lesser of carrying value of loan or fair value at date of acquisition) or estimated fair value less selling costs. Any write-down, at or prior to the dates the real estate is considered foreclosed, is charged to the allowance for loan losses. Subsequent write-downs are recorded in other expenses, and expenses incurred in connection with holding such assets and any gains or losses upon their sale are included in other income and expenses. INTANGIBLE ASSETS Intangible assets consist of a core deposit intangible which represents the present value of the difference in costs between the acquired core deposits and the market alternative funding sources and a covenant not to compete. The intangibles are being amortized over a 10-year life on an accelerated basis. The amortization charged to income was $301,560, $355,140 and $617,500 for the years ended December 31, 1996, 1995 and 1994, respectively. STOCK OPTIONS On January 1, 1996, the Corporation adopted SFAS No. 123, "Accounting for Stock-Based Compensation," which contains a fair value-based method for valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, the standard permits entities to continue accounting for employee stock options and similar instruments under Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." Entities that continue to account for stock options using APB Opinion No. 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied. The Corporation's employee stock option plan is accounted for under APB Opinion No. 25. Accordingly, the adoption of SFAS No. 123 did not have an impact on the Corporation's consolidated financial position or results of operations. INCOME TAXES The Corporation accounts for income taxes under the liability method specified by SFAS No. 109, "Accounting for Income Taxes." Under SFAS 109, deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The principal types of accounts, resulting in differences between assets and liabilities for financial statement and tax return purposes, are the allowance for possible loan losses, leased assets, deferred loan fees and compensation. PENSION PLANS The Corporation has certain employee benefit plans covering substantially all employees. The Corporation accrues service cost as incurred. ADVERTISING COSTS The Corporation expenses advertising costs as incurred. RESTRICTIONS ON CASH AND DUE FROM BANKS Aggregate reserves (in the form of deposits with the Federal Reserve Bank) of $8,678,000 were maintained to satisfy federal regulatory requirements at December 31, 1996. NET INCOME PER SHARE Net income per share was computed by dividing net income by the weighted average number of shares of common stock outstanding during the year, including the effects of dilutive stock options, and after giving retroactive effect to the following events: the shares issued when Security National Bank (1994) and Farmers & Merchants Bank (1996) were acquired by the Corporation and accounted for on a pooling-of-interests basis and the 5% stock dividends issued in 1996 and 1994. PAGE 13 STATEMENTS OF CASH FLOWS For purposes of the consolidated statements of cash flows, the Corporation considers cash, amounts due from banks and federal funds sold to be cash equivalents. Generally, federal funds are sold for one-day periods. 2-ACQUISITIONS On March 1, 1996, the Corporation consummated the acquisition of Farmers & Merchants Bank (Honesdale, PA) ("Farmers"). The acquisition was pursuant to an Agreement and Plan of Reorganization and an Agreement and Plan of Merger (the "Agreements") which were executed on September 7, 1995. The Agreements delineate the terms of the combination. The shareholders of Farmers approved the acquisition at a meeting of shareholders on January 31, 1996. For each share of Farmers common stock outstanding, 0.6190 shares of the Corporation's Common Stock were issued at the effective date on March 1, 1996. As a result of the transaction, 438,126 new shares of the Corporation's Common Stock, par value $1.00 per share, were issued on March 1, 1996 pursuant to the Agreements. Farmers' banking operations were merged into those of Citizens. The Farmers acquisition was accounted for on a pooling-of-interest basis, and all prior periods have been restated to reflect the combination as follows:
(Dollars in thousands) Revenue Net Income ------- ---------- Year Ended December 31, 1996 - ------------------------------------------------- Harleysville National Corporation 78,115 14,282 Farmers & Merchants Bank, as of February 29, 1996 718 126 ------- ---------- Total 78,833 14,408 ======= ========== Year Ended December 31, 1995 - ------------------------------------------------- Harleysville National Corporation 68,650 11,776 Farmers & Merchants Bank 4,278 652 ------- ---------- Total 72,928 12,428 ======= ========== Year Ended December 31, 1994 - ------------------------------------------------- Harleysville National Corporation 59,139 10,745 Farmers & Merchants Bank 3,988 535 ------- ---------- Total 63,127 11,280 ======= ==========
On July 1, 1994, the Corporation completed the acquisition of Security National Bank ("Security"). Under the terms of the merger, each share of Security Common Stock was converted into 0.7483 shares of the Corporation's Common Stock, par value $1.00 per share, resulting in the issuance of 211,456 shares of the Corporation's Common Stock. Security operates as a wholly-owned subsidiary of the Corporation. This transaction was accounted for under the pooling-of-interests method of accounting and all prior periods have been restated to reflect the combination as follows:
(Dollars in thousands) Revenue Net Income ------- ----------- Year Ended December 31, 1994 - -------------------------------------------- Harleysville National Corporation 61,771 11,558 Security National Bank, as of June 30, 1994 1,356 (278) ------- ----------- Total 63,127 11,280 ======= ===========
3-INVESTMENT SECURITIES The amortized cost, unrealized gains and losses, and the estimated market values of the Corporation's investment securities held to maturity and available for sale are as follows:
(Dollars in thousands) December 31, 1996 ------------------ Held to Maturity - --------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains (Losses) Value ---------- ------------------ ------------ ---------- Obligations of other U.S. Government agencies and corporations $ 33,129 $ 481 ($39) $ 33,571 Obligations of states and political subdivisions 26,701 962 (38) 27,625 Mortgage-backed securities 1,499 - (9) 1,490 Other securities 3,897 100 (3) 3,994 ---------- ------------------ ------------ ---------- Totals $ 65,226 $ 1,543 $ (89) $ 66,680 ========== ================== ============ ==========
Available for Sale - --------------------
U.S. Treasury notes $34,964 $ 293 $(130) $ 35,127 Obligations of other U.S. Government agencies and corporations 43,656 349 (120) 43,885 Obligations of states and political subdivisions 61,432 1,154 (163) 62,423 Mortgage-backed securities 55,468 478 (435) 55,511 Other securities 9,954 2,956 (61) 12,849 -------- ------ ------ -------- Totals $205,474 $5,230 $(909) $209,795 ======== ====== ====== ========
December 31, 1995 ------------------- Held to Maturity - ------------------
U.S. Treasury notes $1,494 $ 16 $ - $ 1,510 Obligations of other U.S. Government agencies and corporations 49,038 1,008 (7) 50,039 Obligations of states and political subdivisions 26,246 782 (25) 27,003 Mortgage-backed securities 378 10 - 388 Other securities 6,513 199 - 6,712 ------- ------ ----- ------- Totals $83,669 $2,015 $(32) $85,652 ======= ====== ===== =======
Available for Sale - --------------------
U.S. Treasury notes $ 36,181 $ 248 $ (56) $ 36,373 Obligations of other U.S. Government agencies and corporations 10,256 10 (122) 10,144 Obligations of states and political subdivisions 31,820 270 (568) 31,522 Mortgage-backed securities 69,088 547 (497) 69,138 Other securities 9,884 2,282 (17) 12,149 -------- ------ -------- -------- Totals $157,229 $3,357 $(1,260) $159,326 ======== ====== ======== ========
PAGE 14 There are no significant concentrations of securities (greater than 10% of shareholders' equity) in any individual security issuer. Securities with a carrying value of $91,506,000 and $50,743,000 at December 31, 1996 and 1995, respectively, were pledged to secure public funds, government deposits and repurchase agreements. The amortized cost and estimated market value of investment securities, at December 31, 1996, by contractual maturities, are shown below. Actual maturities will differ from contractual maturities because issuers and borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(Dollars in thousands) Held To Maturity Available For Sale ----------------- ------------------- Estimated Estimated Amortized Market Amortized Market Cost Value Cost Value ----------------- ---------- ------------------- ---------- Due in one year or less $ 5,410 $ 5,422 $ 6,342 $ 6,344 Due after one year through five years 23,156 23,638 44,739 44,909 Due after five years through ten years 19,206 19,493 43,989 44,261 Due after ten years 15,955 16,637 54,936 58,770 ----------------- ---------- ------------------- ---------- 63,727 65,190 150,006 154,284 Mortgage-backed securities 1,499 1,490 55,468 55,511 ----------------- ---------- ------------------- ---------- Totals $ 65,226 $ 66,680 $ 205,474 $ 209,795 ================= ========== =================== ==========
Proceeds from sales of investment securities available for sale during 1996 were $64,327,000. Gross gains of $168,000 and gross losses of $207,000 were realized on these sales. Proceeds from sales of investment securities available for sale during 1995 were $10,887,000. Gross gains of $27,000 and gross losses of $199,000 were realized on these sales. Proceeds from sales of investment securities available for sale during 1994 were $41,941,000. Gross gains of $1,366,000 and gross losses of $725,000 were realized on these sales. 4-LOANS Major classifications of loans are as follows:
December 31, ------------- (Dollars in thousands) 1996 1995 ------------- -------- Real estate $ 237,155 $227,458 Commercial and industrial 164,327 165,491 Installment 190,745 157,806 Student loans 11,999 7,680 Consumer loans 29,527 29,212 Lease financing 49,623 43,942 Other 5,827 6,631 ------------- -------- Total loans 689,203 638,220 Less: Unearned income 7,793 9,482 Allowance for loan losses 10,710 9,891 ------------- -------- Net Loans $ 670,700 $618,847 ============= ========
On December 31, 1996, nonaccrual loans were $2,983,000, loans 90 days or more past due and still accruing interest were $1,848,000 and troubled debt restructured loans were $1,717,000. On December 31, 1995, nonaccrual loans were $9,054,000, loans 90 days or more past due and still accruing interest were $1,553,000 and troubled debt restructured loans were $1,183,000. The $6,071,000 reduction in nonaccrual loans from December 31, 1995 to December 31, 1996, is primarily due to one loan being upgraded to accrual status during 1996. This loan achieved accrual status after meeting appropriate standards. The balance of impaired loans was $4,159,000 at December 31, 1996, compared to $9,278,000 at December 31, 1995. The Banks have identified a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. The December 31, 1996 impaired loan balance included $2,442,000 of nonaccrual loans and $1,717,000 of troubled debt restructured loans. The December 31, 1995 impaired loan balance included $8,095,000 of nonaccrual loans and $1,183,000 of troubled debt restructured loans. The allowance for loan loss associated with the impaired loans was $533,000 at December 31, 1996 and $1,122,000 at December 31, 1995. The average impaired loan balance was $9,333,000 in 1996, compared to $3,906,000 in 1995. The income recognized on impaired loans during 1996 and 1995 was $814,000 and $231,000, respectively. The Banks' policy for interest income recognition on impaired loans is to recognize income on restructured loans under the accrual method. The Banks recognize income on nonaccrual loans under the cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Banks. The Banks will not recognize income if these factors do not exist. The Banks have no concentration of loans to borrowers engaged in similar activities which exceeded 10% of total loans at December 31, 1996 and 1995. The Banks continued to pursue new lending opportunities while seeking to maintain a portfolio that is diverse as to industry concentration, type and geographic distribution. The Banks' geographic lending area is primarily concentrated in Montgomery, Carbon, Bucks and Wayne counties, but also includes Chester and Berks counties. Loans to directors, executive officers and their associates, are made in the ordinary course of business and on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others. Activity of these loans is as follows:
(Dollars in thousands) Year Ended December 31, 1996 1995 1994 ---------- -------- -------- Balance, January 1 $12,586 $11,618 $ 8,893 New loans 7,721 8,592 9,757 Repayments (12,584) (7,624) (7,032) ---------- -------- -------- Balance, December 31 $ 7,723 $12,586 $11,618 =========== ======== ========
PAGE 15 5-ALLOWANCE FOR LOAN LOSSES Transactions in the allowance for loan losses are as follows:
(Dollars in thousands) Year Ended December 31, ------------------------- 1996 1995 1994 ------------------------- ------- -------- Balance, beginning of year $ 9,891 $8,150 $ 6,087 ------------------------- ------- -------- Provision charged to operating expenses 2,082 2,172 2,665 ------------------------- ------- -------- Loans charged off: Commercial and industrial (392) (240) (491) Installment (614) (277) (387) Real estate (412) (127) (84) Lease financing (33) (39) (44) ------------------------- ------- -------- Total charged off (1,451) (683) (1,006) ------------------------- ------- -------- Recoveries: Commercial and industrial 84 143 170 Installment 56 72 152 Real estate 30 1 56 Lease financing 18 36 26 ------------------------- ------- -------- Total recoveries 188 252 404 ------------------------- ------- -------- Balance, end of year $ 10,710 $9,891 $ 8,150 ========================= ======= ========
6-BANK PREMISES AND EQUIPMENT Bank premises and equipment consist of the following:
(Dollars in thousands) Estimated Useful December 31, Lives 1996 1995 ----------- ------------- ------- Land $ 2,539 $ 2,439 Building 15-30 years 13,443 10,490 Furniture, fixtures and equipment 3-10 years 10,308 9,148 ------------- ------- Total cost 26,290 22,077 Less accumulated depreciation and amortization 11,480 10,082 ------------- ------- $ 14,810 $11,995 ============= =======
7-DEPOSITS AND BORROWINGS At December 31, 1996, scheduled maturities of certificates of deposit are as follows:
(Dollars in thousands) Year Ended December 31, ---------------------- 1997 1998 1999 2000 2001 Thereafter Total ------ ------- ------- ------- ------ ----------- -------- Amount $209,642 $87,668 $25,835 $16,874 $5,456 $ 386 $345,861 ======== ======= ======= ======= ====== =========== ========
Borrowings, primarily advances from the FHLB, consist of the following:
(Dollars in thousands) December 31, ------------ Description 1996 1995 - --------------------------------------------------- ------------- ------- Notes payable to FHLB, with fixed rates payable between 4.97% and 6.57% $ 21,500 $ 8,200 Notes payable to FHLB, with variable rates payable at 3 month Libor 5,500 - Notes payable to FHLB, with variable rates payable at 3 month Libor plus 5 basis points - 8,000 Notes payable to FHLB, with variable rates payable at 3 month Libor plus 3 basis points 3,000 - Notes payable to FHLB, with variable rates payable at prime less 205 basis points 5,000 5,000 ------------- ------- $ 35,000 $21,200 ============= =======
Advances are made pursuant to several different credit programs offered from time to time by the FHLB. Unused lines of credit at the FHLB were $181,417,000 at December 31, 1996 and $216,344,000 at December 31, 1995. Outstanding borrowings mature as follows (in thousands):
1997 $33,000 1998 1,500 1999 - 2000 500 ------- $35,000 =======
8-FEDERAL INCOME TAXES Income tax expense from current operations is composed of the following:
(Dollars in thousands) Year Ended December 31, ------------------------ 1996 1995 1994 ---------- ------ ------ Current tax payable $ 4,699 $3,905 $4,663 Deferred income tax 894 445 104 Charge in lieu of income tax - 927 - ---------- ------ ------ Tax expense $ 5,593 $5,277 $4,767 ========== ====== ======
The effective income tax rates of 28.0% for 1996, 29.8% for 1995 and 29.7% for 1994 were less than the applicable federal income tax rate of 35% for each year. The reason for these differences follows:
(Dollars in thousands) Year Ended December 31, ------------------------- 1996 1995 1994 ---------- ------- ------- Expected tax expense $ 6,800 $6,020 $5,608 Tax-exempt income (net of expense disallowance) (1,414) (999) (943) Other 207 256 102 ---------- ------- ------- Actual tax expense $ 5,593 $5,277 $4,767 ========== ======= =======
PAGE 16 The tax effect of temporary differences that give rise to significant portions of deferred tax assets and liabilities are as follows:
(Dollars in thousands) 1996 1995 ------ ------ Asset Liability Asset Liability ------ ---------- ------ ---------- Allowance for possible credit losses $3,742 $ - $3,378 $ - Lease assets - 7,509 - 6,383 Deferred loan fees 739 - 962 - Deferred compensation 527 - 460 - Unrealized gains on securities - 1,512 - 714 Other 227 - 223 20 ------ ---------- ------ ---------- Total deferred taxes $5,235 $ 9,021 $5,023 $ 7,117 ====== ========== ====== ==========
The exercise of stock options which have been granted under the Corporation's various stock option plans gives rise to compensation, which is includable in the taxable income of the applicable employees and deductible by the Corporation for income tax purposes. Compensation resulting from increases in the fair market value of the Corporation's Common Stock subsequent to the date of grant of the applicable exercised stock options is not recognized, in accordance with APB Opinion No. 25, as an expense for financial accounting purposes and the related tax benefits are taken directly to Additional Paid in Capital. For the year ended December 31, 1995, such deductions resulted in $926,833 of income tax benefits which increased the Additional Paid in Capital. 9-PENSION PLANS The Corporation has noncontributory defined benefit pension plans covering substantially all employees. Benefits are based on years of service and the employee's average compensation during any five consecutive years within the 10-year period preceding retirement. The plans' funded status and amounts recognized in the financial statements follow:
(Dollars in thousands) 1996 1995 ------- ------- Plans' assets at fair value $5,436 $4,187 Projected benefit obligation (including an accumulated benefit obligation of $3,577 in 1996, $3,220 in 1995, and a vested benefit obligation of $3,430 in 1996, and $3,083 in 1995) 5,034 4,134 ------- ----- Plans' assets in excess (deficit) of projected benefit obligation 402 53 Unrecognized net gain from past experience being different from that which was assumed 801 408 Unrecognized prior service cost 29 33 Unrecognized net assets at January 1, 1987, being recognized over 15 years (241) (271) ------- ------- Prepaid pension cost $ 991 $ 223 ======= =======
Net pension cost for the years ended December 31, 1996, 1995 and 1994 included the following components:
1996 1995 1994 ------ ------ ------ Service cost $ 242 $ 280 $ 225 Interest cost 147 93 64 Actual return on plans' assets (30) (204) 37 Net amortization and deferral (38) 156 (47) ------ ------ ------ Net periodic pension cost $ 321 $ 325 $ 279 ====== ====== ======
The weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.15%, 7.0% and 7.05% in 1996, 1995 and 1994, respectively. The rate of increase in future compensation levels was 5.35% for all years. The expected long-term rate of return on assets was 7.50%, 7.85% and 7.90% in 1996, 1995 and 1994, respectively. The Banks had a profit sharing plan for eligible employees. The continuation of the profit sharing plan was voluntary on the part of the Banks. The Banks expressly reserved the right to amend or terminate the plan and to reduce, suspend or discontinue contributions at any time. In 1996, the profit sharing plan was modified to a 401 (K) plan. All employees may contribute up to a maximum of 15% of salary on a pre-tax basis with a 50% employer match up to a maximum of 3% of salary. Contributions charged to earnings were $699,282, $1,081,068, and $971,640 for 1996, 1995 and 1994, respectively. The Corporation has a Supplemental Executive Retirement Plan (SERP) for certain individuals. The SERP provides for payments based on a certain percentage of salary for a period of 10 years after retirement. As of December 31, 1996 and 1995, the Corporation had accrued a liability of $759,950 and $634,882, respectively, for the SERP. 10-SHAREHOLDERS' EQUITY On June 28, 1996, the Corporation paid a 5% stock dividend on its common stock to shareholders of record as of June 14, 1996. On December 30, 1994, the Corporation paid a 5% stock dividend on its common stock to shareholders of record as of December 16, 1994. PAGE 17 11-STOCK OPTIONS The Corporation has fixed stock option plans accounted for under APB Opinion No. 25 and related Interpretations. The plans allow the Corporation to grant options to employees for up to 577,671 shares of common stock. The options have a term of 10 years when issued and are completely vested over a five-year period. The exercise price of each option equals the market price of the Corporation's stock on the date of grant. Accordingly, no compensation cost has been recognized for the plans. Had compensation cost for the plans been determined based on the fair value of the options at the grant dates consistent with the method of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123), the Corporation's 1996 and 1995 net income and earnings per share would not be materially different from amounts reported. Under the Corporation's stock option plans, the exercisable option prices ranged from $7.98 to $25.60 at December 31, 1996. A summary of the status of the Corporation's fixed stock option plans as of December 31, 1996, 1995 and 1994, and changes during the years ending on those dates is presented below.
1996 1995 1994 -------- --------- --------- Number of Common Shares: Outstanding, January 1* 68,431 230,516 353,869 Granted - 4,804 - Exercised (15,977) (166,889) (123,353) -------- --------- --------- Outstanding, December 31 52,454 68,431 230,516 ======== ========= ========= Exercisable, December 31 52,454 63,627 230,516 ======== ========= ========= * Adjusted for stock splits and stock dividends.
12-COMMITMENTS AND CONTINGENT LIABILITIES Based on consultation with the Corporation's legal counsel, management is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Corporation. There are no proceedings pending other than the ordinary routine litigation incident to the business of the Corporation and its Subsidiaries. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Corporation or its Subsidiaries by government authorities. Lease commitments for equipment and banking locations expire intermittently over the years through 2036. Most banking location leases require the lessor to pay insurance, maintenance costs and property taxes. Approximate minimum rental commitments for existing operating leases at December 31, are as follows:
Total Operating Leases ---------- 1997 $1,065,000 1998 $ 976,000 1999 $ 684,000 2000 502,000 2001 443,000 Thereafter 2,061,000 ---------- Total $5,731,000 ==========
Total lease expense amounted to $895,000 in 1996, $770,000 in 1995 and $537,000 in 1994. 13-FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Banks have not entered into any interest rate swaps, caps, floors or collars and are not a party to any forward or futures transactions. However, the Banks are a party to various other financial instruments at December 31, 1996 and 1995 which are not included in the consolidated financial statements, but are required in the normal course of business to meet the financing needs of its customers and to assist in managing its exposure to changes in interest rates. Management does not expect any material losses from these transactions, which include standby letters of credit at December 31, 1996 and 1995 of $6,568,000 and $5,698,000, respectively; commitments to extend credit of $22,243,000 and $20,516,000, respectively, for revolving home equity lines; $74,482,000 and $59,540,000, respectively, for commercial and real estate loans; and $17,931,000 and $17,462,000, respectively, for consumer loans. The Banks' exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual or notional amounts of those instruments. The Banks use the same stringent credit policies in extending these commitments as they do for recorded financial instruments and control their exposure to loss through credit approval and monitoring procedures. These commitments are generally issued for one year or less, often expire without being drawn upon, and often are secured with appropriate collateral. The Banks offer commercial, mortgage and consumer credit products to their customers in the normal course of business, which are detailed in note 4. These products represent a diversified credit portfolio and are generally issued to borrowers within the Banks' branch office systems in eastern Pennsylvania. The ability of the customers to repay their credits is, to some extent, dependent upon the economy in the Banks' market areas. 14-REGULATORY CAPITAL The Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Banks must meet specific capital guidelines that involve quantitative measures of the Banks' assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. PAGE 18 Quantitative measures established by regulation to ensure capital adequacy require the Banks to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets. Management believes, as of December 31, 1996, that the Banks meet all capital adequacy requirements to which they are subject. As of December 31, 1996, the Banks met all regulatory requirements for classification as "well-capitalized" institutions. To be categorized as well capitalized, the Banks must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverage ratios as set forth in the table. There are no conditions or events which have occurred that management believes have changed the institutions' category.
(Dollars in thousands) Leverage Ratio ------------------ December 31, 1996 December 31, 1995 ------------------ ------------------ Amount Ratio Amount Ratio ---------- ------ --------- ------ Entity: Corporation $93,164 9.21% $83,019 8.99% Subsidiaries: Harleysville National Bank 67,253 8.34 58,330 7.99 Citizens National Bank 20,031 13.08 19,193 13.10 Security National Bank 3,885 6.81 3,693 8.32 "Well Capitalized" institution (under FDIC regulations) 5.00 5.00
(Dollars in thousands) Tier 1 Capital to Risk-Weighted Assets -------------------------------------- December 31, 1996 December 31, 1995 ------------------- ------------------ Amount Ratio Amount Ratio -------- ------ ------- ------ Entity: Corporation $93,164 13.12% $83,019 12.47% Subsidiaries: Harleysville National Bank 67,253 11.59 58,330 10.53 Citizens National Bank 20,031 22.60 19,193 23.71 Security National Bank 3,885 9.57 3,693 11.89 "Well Capitalized" institution (under FDIC regulations) 6.00 6.00
(Dollars in thousands) Total Capital to Risk-Weighted Asset Ratio ------------------------------------------ December 31, 1996 December 31, 1995 ----------------- ----------------- Amount Ratio Amount Ratio ------ ----- ------ ----- Entity: Corporation $102,061 14.38% $91,340 13.72% Subsidiaries: Harleysville National Bank 74,528 12.85 65,253 11.78 Citizens National Bank 20,993 23.69 20,205 24.96 Security National Bank 4,394 10.83 4,081 13.14 "Well Capitalized" institution (under FDIC regulations) 10.00 10.00
The National Banking Laws require the approval of the Office of the Comptroller of the Currency if the total of all dividends declared by a national bank in any calendar year exceed the net profits of the bank (as defined) for that year combined with its retained net profits for the preceding two calendar years. Under this formula, the Banks may declare dividends in 1997 of approximately $16,300,000 plus an amount equal to the net profits of the Banks in 1997 up to the date of any such dividend declaration. Additionally, banking regulations limit the amount of investments, loans, extensions of credit and advances that one subsidiary bank can make to the Corporation at any time to 10% and in the aggregate 20% of the Banks' capital stock and surplus. These regulations also require that any such investment, loan, extension of credit or advance be secured by securities having a market value in excess of the amount thereof. At December 31, 1996, there were no investments, loans, extensions of credit or advances from any of the subsidiary banks to the Corporation. 15-FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107 "Disclosures about Fair Values of Financial Instruments," requires disclosure of the estimated fair value of an entity's assets and liabilities considered to be financial instruments. For the Corporation, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in SFAS No. 107. However, many such instruments lack an available trading market, as characterized by a willing buyer and seller engaging in an exchange transaction. Also, it is the Corporation's general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities, except for certain loans. Therefore, the Corporation had to use significant estimates and present value calculations to prepare this disclosure. Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values. Estimated fair values have been determined by the Corporation using the best available data and an estimation methodology suitable for each category of financial instruments. The estimation methodologies used, the estimated fair values and recorded book balances at December 31, 1996 and 1995 are outlined on the next page. For cash and due from banks, interest-bearing deposits in banks and federal funds sold, the recorded book values of $45,407,000 and $50,607,000 at December 31, 1996 and 1995, respectively, approximate fair values. The estimated fair values of investment securities are based on quoted market prices, if available. Estimated fair values are based on quoted market prices of comparable instruments if quoted market prices are not available. PAGE 19 The loan portfolio, net of unearned income, at December 31, 1996 and 1995 has been valued using a present value discounted cash flow analysis where market prices were not available. The discount rate used in these calculations is the estimated current market rate adjusted for credit risk. The carrying value approximates its fair value. 1996 1995 ------------------------ ----------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ---------------------------------------------------- Investment securities $275,021,000 $276,475,000 $242,995,000 $244,978,000 Loans, net $681,410,000 $689,695,000 $628,738,000 $625,495,000 The estimated fair values of demand deposits (i.e., interest and noninterest bearing checking accounts, savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. The carrying amount of accrued interest receivable and payable approximates fair value. 1996 1995 -------------------------- --------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value -------------------------------------------------------- Time deposits $345,861,000 $347,382,000 $327,551,000 $329,562,000 The fair values of demand notes, borrowings, and securities sold under agreements to repurchase of $59,521,000 and $39,751,000 at December 31, 1996 and 1995, respectively, approximate their recorded book balances. There was no material difference between the notional amount and the estimated fair value of off-balance-sheet items which totaled approximately $121,224,000 and $103,216,000 at December 31, 1996 and 1995, respectively, and primarily comprised unfunded loan commitments which are generally priced at market at the time of funding. 16-CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY Condensed financial statements of Harleysville National Corporation follow: CONDENSED BALANCE SHEETS
(Dollars in thousands) December 31, ------------- 1996 1995 ------------- ------- Assets: Cash $ 553 $ 1,544 Investments in subsidiaries 93,724 84,413 Investment securities available for sale 4,809 854 ------------- ------- Total assets $ 99,086 $86,811 ============= ======= Liabilities and shareholders' equity: Other liabilities $ 1,455 $ 449 ------------- ------- Total liabilities 1,455 449 ------------- ------- Shareholders' equity: Common Stock 6,657 6,316 Additional paid in capital 40,316 30,883 Retained earnings 47,849 47,780 Net unrealized gain on investment securities available for sale 2,809 1,383 ------------- ------- Total shareholders' equity 97,631 86,362 ------------- ------- Total liabilities and shareholders' equity $ 99,086 $86,811 ============= =======
CONDENSED STATEMENTS OF INCOME
(Dollars in thousands) Year Ended December 31, ------------------------ 1996 1995 1994 ------------------------ ------- ------- Dividends from banks $ 5,584 $ 5,085 $ 3,725 Other income 156 - 1,059 ------------------------ ------- ------- Total operating income 5,740 5,085 4,784 ------------------------ ------- ------- Operating expense - - - ------------------------ ------- ------- Income before income tax expense and equity in undistributed net income of banks 5,740 5,085 4,784 Income tax expense 55 - 371 ------------------------ ------- ------- Income before equity in undistributed net 5,685 5,085 4,413 income of banks Equity in undistributed net income of banks 8,723 7,343 6,867 ------------------------ ------- ------- Net income $ 14,408 $12,428 $11,280 ======================== ======= =======
PAGE 20 CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands) Year Ended December 31, ------------------------- 1996 1995 1994 ------------------------- -------- -------- Operating activities: Net income $ 14,408 $12,428 $11,280 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of banks (8,723) (7,343) (6,967) Dividends reinvestment - - 691 Realized gain on sale of securities (68) - (1,059) Net increase in other liabilities 55 - 370 ------------------------- -------- -------- Net cash provided by operating activities 5,672 5,085 4,315 ------------------------- -------- -------- Investing activities: Capital contributions made to the banks - (175) - Proceeds from sales of securities 405 - 1,084 Purchase of securities available for sale (1,576) - - ------------------------- -------- -------- Net cash (used in) provided by investing activities (1,171) (175) 1,084 ------------------------- -------- -------- Financing activities: Cash dividends and fractional shares (5,604) (4,909) (3,697) Stock options and awards 112 422 (585) ------------------------- -------- -------- Net cash used in financing activities: (5,492) (4,487) (4,282) ------------------------- -------- -------- Net (decrease) increase in cash (991) 423 1,117 Cash and cash equivalents at beginning of year 1,544 1,121 4 ------------------------- -------- -------- Cash and cash equivalents at end of year $ 553 $ 1,544 $ 1,121 ========================= ======== ========
17-QUARTERLY FINANCIAL DATA (UNAUDITED) The following is the summarized (unaudited) consolidated quarterly financial data of the Corporation which, in the opinion of management, reflects all adjustments, consisting only of normal recurring adjustments, necessary for fair presentation of the Corporation's results of operations: (Dollars in thousands, except per share information)
Three Months Ended ------------------- 1996: March 31 June 30 Sept. 30 Dec. 31 ------------------- -------- --------- -------- Interest income $ 17,967 $ 17,994 $ 18,612 $ 19,145 Net interest income 10,391 10,444 10,840 11,167 Provision for losses 526 529 517 510 Noninterest income 1,229 1,186 1,364 1,336 Operating expenses 6,322 6,076 6,690 6,786 Income before income tax expense 4,772 5,025 4,997 5,207 Income tax expense 1,388 1,380 1,482 1,343 ------------------- -------- --------- -------- Net income $ 3,384 $ 3,645 $ 3,515 $ 3,864 =================== ======== ========= ======== Net income per share $ 0.50 $ 0.55 $ 0.53 $ 0.58 =================== ======== ========= ========
1995: March 31 June 30 Sept. 30 Dec. 31 ------------------- -------- --------- -------- Interest income $ 16,311 $ 17,180 $ 17,389 $ 17,611 Net interest income 9,765 10,035 9,938 9,969 Provision for losses 536 518 598 520 Noninterest income 912 1,099 1,169 1,257 Operating expenses 5,898 6,055 6,197 6,117 Income before income tax expense 4,243 4,561 4,312 4,589 Income tax expense 1,248 1,355 1,253 1,421 ------------------- -------- --------- -------- Net income $ 2,995 $ 3,206 $ 3,059 $ 3,168 =================== ======== ========= ======== Net income per share $ 0.45 $ 0.48 $ 0.46 $ 0.48 =================== ======== ========= ======== PAGE 21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONSOLIDATED SUMMARY OF OPERATIONS (Dollars in thousands, except per share data and average shares outstanding)
Year Ended December 31, ----------------------- 1996 1995 1994 1993 1992 ---------- ---------- ---------- ---------- ---------- INCOME AND EXPENSE: Interest income $ 73,718 $ 68,491 $ 58,381 $ 53,980 $ 52,584 Interest expense 30,876 28,784 21,101 21,232 24,036 ---------- ---------- ---------- ---------- ---------- Net interest income 42,842 39,707 37,280 32,748 28,548 Provision for loan losses 2,082 2,172 2,665 3,085 2,299 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 40,760 37,535 34,615 29,663 26,249 Noninterest income 5,115 4,437 4,746 4,963 3,552 Noninterest expense 25,874 24,267 23,314 21,436 18,358 ---------- ---------- ---------- ---------- ---------- Income before income tax expense and the cumulative effect of a change in accounting for 20,001 17,705 16,047 13,190 11,443 income taxes Income tax expense 5,593 5,277 4,767 3,753 3,092 ---------- ---------- ---------- ---------- ---------- Income before the cumulative effect of a change in accounting for income taxes 14,408 12,428 11,280 9,437 8,351 Cumulative effect of a change in accounting for income taxes - - - 300 92 ---------- ---------- ---------- ---------- ---------- Net income $ 14,408 $ 12,428 $ 11,280 $ 9,737 $ 8,443 ========== ========== ========== ========== ========== PER SHARE*: Primary $ 2.16 $ 1.87 $ 1.71 $ 1.52 $ 1.34 Fully diluted 2.16 1.87 1.71 1.48 1.30 Cash dividends paid 0.84 0.75 0.58 0.47 0.41 Primary average shares outstanding 6,660,530 6,646,957 6,602,678 6,397,995 6,321,360 Diluted average shares outstanding 6,660,530 6,648,976 6,602,678 6,579,304 6,492,320
*Adjusted for 5% stock dividends effective 6/28/96 and 12/30/94, a two-for-one stock split effective 12/31/93, and a 5% stock dividend effective 12/31/92. AVERAGE BALANCE SHEET:
Loans $ 652,157 $607,335 $540,030 $472,319 $414,230 Investments 260,483 226,747 236,319 236,612 207,298 Other interest-earning assets 16,949 14,605 10,351 21,312 30,183 Total assets 978,899 894,350 829,241 776,419 692,912 Deposits 821,387 761,089 738,029 697,993 620,977 Other interest-bearing liabilities 46,813 37,067 8,348 2,372 1,988 Shareholders' equity 91,687 81,788 74,234 66,355 59,246 BALANCE SHEET AT YEAR-END: Loans $ 681,410 $628,738 $594,754 $498,139 $446,528 Investments 275,021 242,995 216,816 250,608 237,480 Other earning assets 14,475 17,998 2,980 20,351 36,064 Total assets 1,026,128 937,345 862,669 816,314 768,234 Deposits 847,699 794,499 743,326 735,328 693,377 Other interest-bearing liabilities 59,521 39,751 35,322 2,742 3,269 Shareholders' equity 97,631 86,362 74,182 69,357 61,201
The following discussion and analysis should be read in conjunction with the detailed information and consolidated financial statements, including notes thereto, included elsewhere in this report. The consolidated financial condition and results of operations of the Corporation are essentially those of the Banks. Therefore, the analysis that follows is directed to the performance of the Banks. Such financial condition and results of operations are not intended to be indicative of future performance. PAGE 22 In addition to historical information, this discussion and analysis contains forward-looking statements. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Important factors that might cause such a difference include, but are not limited to, those discussed in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations." Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Corporation undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date hereof. INTRODUCTION The Corporation's performance for 1996 was highlighted by record earnings, continued asset growth and improved asset quality. The Corporation earnings for 1996 were 15.9% higher than 1995 earnings. On March 1, 1996, the Corporation consummated the acquisition of Farmers & Merchants Bank ("Farmers") and during the third quarter of 1996 the Corporation achieved one billion dollars in assets. The Farmers acquisition was accounted for on a pooling-of-interest basis and all prior periods have been restated to reflect the combination. Net income amounted to $14,408,000 in 1996, compared to the $12,428,000 reported in 1995. Earnings per share increased 15.5% to $2.16, from $1.87 earned in 1995. Earnings were enhanced by the growth in earning assets, increase in income from the Trust and Financial Services Department and a reduction in the FDIC premium expense. Earning assets increased $81,175,000, or 9.1%, from a year ago. Continued progress in asset quality was reflected in a decline in nonperforming assets. During 1996, nonperforming assets excluding loans over 90 days past due, and still accruing interest were reduced by $5,785,000, or 50.5%, to $5,672,000. Nonperforming assets as a percentage of total loans and net assets acquired in foreclosure at December 31, 1996 declined to 0.83%, from 1.82% at December 31, 1995. INTEREST-EARNING ASSETS AND INTEREST-BEARING LIABILITIES Average interest-earning assets totaled $929,589,000 in 1996, an increase of $80,902,000, or 9.5%, compared to 1995. Most of the increase occurred in the loan and investment portfolios. During 1996, the average balance of the loan portfolio increased $44,822,000, or 7.4%, while the average balance of investment securities increased $33,736,000 or 14.9%. Average interest earning assets were $786,700,000 in 1994. Average interest-bearing liabilities totaled $745,741,000 in 1996, an increase of $57,234,000, or 8.3%, compared to 1995. This increase was attributable to an increase in time, savings and other borrowings of $27,327,000, $20,161,000 and $9,746,000, respectively. Average interest bearing liabilities were $640,423,000 in 1994. The tax-equivalent yield on total interest earning assets amounted to 8.20%, a decline of 7 basis points from 8.27% earned in 1995. The cost of interest-bearing liabilities decreased 4 basis points from 4.18% in 1995 to 4.14% in 1996. The net interest margin earned of 4.88% was the same in 1996 as it was in 1995. The 1994 tax-equivalent yield on total interest-earning assets, cost of interest-bearing liabilities and net interest margin were 7.62%, 3.29% and 4.94%, respectively. PAGE 23 BALANCE SHEET ANALYSIS The table below presents the major asset and liability categories on an average daily basis for the periods presented, along with interest income and expense, and key rates and yields. The assets showing the greatest increase were loans. On the liability side, the most significant source of new funds was time deposits. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY, INTEREST RATES AND INTEREST DIFFERENTIAL: Year Ended December 31, -------------------------
(Dollars in thousands) 1996 1995 -------- -------- Average Average Average Average Average ASSETS Balance Rate Interest Balance Rate Interest Balance -------- -------- --------- -------- -------- --------- -------- Investment securities: Taxable investments $186,213 6.50% $ 12,110 $177,583 6.18% $ 10,977 $189,215 Nontaxable investments (1) 74,270 8.33 6,185 49,164 8.36 4,110 47,104 -------- -------- --------- -------- -------- --------- -------- Total investment securities 260,483 7.02 18,295 226,747 6.65 15,087 236,319 Loans (1) (2) 652,157 8.74 57,008 607,335 8.94 54,305 540,030 Other rate-sensitive assets 16,949 5.33 904 14,605 5.72 835 10,351 -------- ----- -------- ------- ---- -------- ------- Total earning assets 929,589 8.20 76,207 848,687 8.27 70,227 786,700 Noninterest-earning assets 49,310 - - 45,663 - - 42,541 -------- -------- --------- -------- -------- --------- -------- Total assets $978,899 7.78% $ 76,207 $894,350 7.85% $ 70,227 $829,241 ======== ======== ========= ======== ======== ========= ======== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand $122,459 - % $ - $109,649 - % $ - $105,954 Savings 361,890 2.66 9,616 341,729 2.80 9,571 374,976 Time 337,038 5.59 18,854 309,711 5.50 17,045 257,099 -------- -------- --------- -------- -------- --------- -------- Total 821,387 3.47 28,470 761,089 3.50 26,616 738,029 Borrowings and other interest-bearing liabilities 46,813 5.14 2,406 37,067 5.85 2,168 8,348 Other liabilities 19,012 - - 14,406 - - 8,630 -------- -------- --------- -------- -------- --------- -------- Total liabilities 887,212 3.48 30,876 812,562 3.54 28,784 755,007 Shareholders' equity 91,687 - - 81,788 - - 74,234 -------- -------- --------- -------- -------- --------- -------- Total liabilities and shareholders' equity $978,899 3.15% $ 30,876 $894,350 3.22% $ 28,784 $829,241 ======== ======== ========= ======== ======== ========= ======== Average effective rate on interest-bearing liabilities $745,741 4.14% $ 30,876 $688,507 4.18% $ 28,784 $640,423 ======== ======== ========= ======== ======== ========= ======== Interest Income/Earning Assets $929,589 8.20% $ 76,207 $848,687 8.27% $ 70,227 $786,700 Interest Expense/Earning Assets $929,589 3.32 $ 30,876 $848,687 3.39 $ 28,784 $786,700 -------- -------- Effective Interest Differential 4.88% 4.88% ======== ======== (Dollars in thousands) 1994 -------- Average ASSETS Rate Interest -------- --------- Investment securities: Taxable investments 5.37% $ 10,168 Nontaxable investments (1) 8.29 3,904 -------- --------- Total investment securities 5.95 14,072 Loans (1) (2) 8.42 45,473 Other rate-sensitive assets 4.12 426 -------- --------- Total earning assets 7.62 59,971 Noninterest-earning assets - - -------- --------- Total assets 7.23% $ 59,971 ======== ========= LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand - % $ - Savings 2.52 9,468 Time 4.37 11,229 -------- --------- Total 2.80 20,697 Borrowings and other interest-bearing liabilities 4.84 404 Other liabilities - - -------- --------- Total liabilities 2.79 21,101 Shareholders' equity - - -------- --------- Total liabilities and shareholders' equity 2.54% $ 21,101 ======== ========= Average effective rate on interest-bearing liabilities 3.29% $ 21,101 ======== ========= Interest Income/Earning Assets 7.62% $ 59,971 Interest Expense/Earning Assets 2.68 $ 21,101 -------- Effective Interest Differential 4.94% ======== (1) The interest earned on nontaxable investment securities and loans is shown on a tax equivalent basis.
(2) Nonaccrual loans have been included in the appropriate average loan balance category, but interest on nonaccrual loans has not been included for purposes of determining interest income. PAGE 24 INVESTMENT PORTFOLIO The following shows the carrying value of the Corporation's investment securities held to maturity:
December 31, ----------- (Dollars in Thousands) 1996 1995 1994 ------- ------- ------- U. S. Treasury notes $ - $ 1,494 $ 4,040 Obligations of other U.S. Government agencies and corporations 33,129 49,038 21,470 Obligations of states and political subdivisions 26,701 26,246 45,585 Mortgage-backed securities 1,499 378 617 Other securities 3,897 6,513 18,657 ------- ------- ------- Total $65,226 $83,669 $90,369 ======= ======= =======
The following shows the carrying value of the Corporation's investment securities available for sale:
December 31, ----------- (Dollars in Thousands) 1996 1995 1994 -------- -------- -------- U. S. Treasury notes $ 35,127 $ 36,373 $ 45,832 Obligations of other U.S. Government agencies and corporations 43,885 10,144 3,810 Obligations of states and political subdivisions 62,423 31,522 974 Mortgage-backed securities 55,511 69,138 69,060 Other securities 12,849 12,149 6,771 -------- -------- -------- Total $209,795 $159,326 $126,447 ======== ======== ========
The Corporation adopted Statement of Financial Accounting (SFAS) Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," on January 1, 1994, which requires, among other things, that debt and equity securities classified as available for sale be reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders' equity, net of income taxes. The net effect of unrealized gains or losses, caused by marking an available for sale portfolio to market, causes fluctuations in the level of shareholders' equity and equity-related financial ratios as market interest rates cause the fair value of fixed-rate securities to fluctuate. Total investment securities at December 31, 1996 of $275,021,000 grew $32,026,000 over the December 31, 1995 balance of $242,995,000. This growth was funded by the increase in deposit balances and borrowings during this period. The investment securities held to maturity decreased $18,443,000 during 1996, as a result of maturities and calls. The investment securities available for sale increased $50,469,000. The increase in the investments available for sale were funded by proceeds from the maturities and calls in the held-to-maturity portfolio and through the increase in deposits and borrowings during 1996. In 1995, the Financial Accounting Standards Board gave banks an opportunity to reassess the appropriateness of the classifications of all securities held to maturity and account for any resulting reclassifications at fair value. Reclassifications from the held to maturity category that result from this one-time reassessment did not call into question the intent of an enterprise to hold other debt securities to maturity in the future. After reassessing the investment security portfolio, the Corporation transferred $39,947,000 from investment securities held to maturity to the investment securities available for sale on December 21, 1995. This transfer was the primary reason for the decrease in the balance of investment securities held to maturity of $6,700,000 from December 31, 1994 to December 31, 1995. The transfer also contributed to the increase in investment securities available for sale of $32,879,000 from December 31, 1994 to December 31, 1995. PAGE 25 There are no significant concentrations of securities (greater than 10% of shareholders' equity) in any individual security issuer. The maturity analysis of investment securities held to maturity, including the weighted average yield for each category, as of December 31, 1996 is as follows:
Under 1 - 5 5 - 10 Over 1 year years years 10 years Total -------- -------- -------- ---------- ------------- (Dollars in thousands) Obligations of other U.S. Government agencies and corporations: Carrying value $ 1,200 $13,993 $17,434 $ 502 $ 33,129 Weighted average yield 5.97% 7.25% 7.52% 8.18% 7.36% Weighted average maturity 6 yrs, 1 mo Obligations of states and political subdivisions: Carrying value 3,210 6,764 1,274 15,453 26,701 Weighted average yield 7.67% 8.53% 8.74% 8.91% 8.65% Weighted average maturity 9 yrs, 6 mos Mortgage-backed securities: Carrying value - - 1,188 311 1,499 Weighted average yield - % - % 6.94% 7.41% 7.39% Weighted average maturity 7 yrs, 7 mos Other securities: Carrying value 1,000 2,399 498 - 3,897 Weighted average yield 6.81% 7.64% 6.81% - % 7.32% Weighted average maturity 3 yrs, 4 mos Total: Carrying value $5,410 $23,156 $20,394 $16,266 $65,226 Weighted average yield 7.13% 7.67% 7.55% 8.85% 7.85% Weighted average maturity 7 yrs, 4 mos
The maturity analysis of securities available for sale, including the weighted average yield for each category, as of December 31, 1996 is as follows:
Under 1 - 5 5 - 10 Over (Dollars in thousands) 1 year years years 10 years Total -------- -------- -------- ---------- -------------- U.S. Treasury notes: Amortized cost $ 6,007 $28,957 $ - $ - $ 34,964 Weighted average yield 5.50% 6.10% - % - % 5.42% Weighted average maturity 2 yrs, 5 mos Obligations of other U.S. Government agencies and corporations: Amortized cost - 3,000 39,655 1,001 43,656 Weighted average yield - % 7.16% 7.22% 7.35% 7.21% Weighted average maturity 8 yrs, 6 mos Obligations of states and political subdivisions: Amortized cost 335 9,777 4,034 47,286 61,432 Weighted average yield 7.68% 7.33% 7.74% 8.40% 8.18% Weighted average maturity 12 yrs, 6 mos Mortgage-backed securities: Amortized cost 119 11,501 585 43,263 55,468 Weighted average yield 6.86% 6.61% 6.06% 6.77% 6.73% Weighted average maturity 20 yrs, 0 mos Other securities: Amortized cost - 3,005 300 6,649 9,954 Weighted average yield - % 6.00% 6.12% 6.66% 6.44% Weighted average maturity 5 yrs, 10 mos Total: Amortized Cost $6,461 $56,240 $44,574 $98,199 $205,474 Weighted average yield 5.64% 6.47% 7.24% 7.56% 7.13% Weighted average maturity 11 yrs, 8 mos
Weighted average yield is computed by dividing the annualized interest income, including the accretion of discounts and the amortization of premiums, by the carrying value. Tax-exempt securities were adjusted to a tax equivalent basis and are based on the federal statutory tax rate of 35%. PAGE 26 LOANS The following table shows the composition of the Banks' loans:
December 31, ------------- (Dollars in thousands) 1996 1995 1994 1993 1992 ------------- -------- -------- -------- -------- Real estate $ 237,155 $227,458 $220,091 $190,684 $176,209 Commercial and industrial 164,327 165,491 156,387 130,525 114,966 Installment 190,745 157,806 148,580 123,076 114,876 Lease financing 49,623 43,942 41,233 32,304 27,399 Other 47,353 43,523 38,590 32,960 28,579 ------------- -------- -------- -------- -------- Total $ 689,203 $638,220 $604,881 $509,549 $462,029 ============= ======== ======== ======== ========
Total loans grew $50,983,000, from $638,220,000 at December 31, 1995 to $689,203,000 at December 31, 1996. The loan growth included increases in installment, real estate, lease financing and other loans of $32,939,000, $9,697,000, $5,681,000 and $3,830,000, respectively. The increase in installment loans included a $16,023,000 increase in indirect installment loans during 1996. Indirect loans primarily consist of vehicle loans that are generated through respective dealers. At December 31, 1996, there were no loan concentrations over 10% of loans outstanding in any one category or to any one borrower. The Banks have no foreign loans, and the impact of nonaccrual, restructured troubled debt and delinquent loans on total interest income was not material. Management does not believe that there are any trends or uncertainties which are reasonably expected to materially impact future operating results, liquidity or capital resources, and management is not aware of any information not previously disclosed which causes it to have serious doubts as to the ability of borrowers to comply with the loan repayment terms. The following table details maturities and interest sensitivity of real estate, commercial and industrial, installment loans and lease financing at December 31, 1996:
Within 1 - 5 Over (Dollars in thousands) 1 year years 5 years Total ------- -------- -------- -------- Real estate $ 378 $ 10,547 $226,230 $237,155 Commercial and industrial 25,196 71,726 67,405 164,327 Installment 3,205 114,179 73,361 190,745 Lease financing 7,328 42,295 - 49,623 ------- -------- -------- -------- Total $36,107 $238,747 $366,996 $641,850 ======= ======== ======== ======== Loans with variable or floating interest rates $21,122 $ 56,419 $142,673 $220,214 Loans with fixed predetermined interest rates 14,985 182,328 224,323 421,636 ------- -------- -------- -------- Total $36,107 $238,747 $366,996 $641,850 ======= ======== ======== ========
A loan is generally classified as nonaccrual when principal or interest has consistently been in default for a period of 90 days or more or because of a deterioration in the financial condition of the borrower or payment in full of principal or interest is not expected. Delinquent loans past due 90 days or more and still accruing interest are loans that are generally well-secured and expected to be restored to a current status in the near future. The following table details those loans that were placed on nonaccrual status, were accounted for as troubled debt restructurings or were delinquent by 90 days or more and still accruing interest.
December 31, ------------- (Dollars in thousands) 1996 1995 1994 1993 1992 ------------- ------- ------ ------ ------ Nonaccrual loans $ 2,983 $ 9,055 $2,521 $1,876 $1,385 Trouble debt restructurings 1,717 1,183 1,867 1,548 315 Delinquent loans 1,848 1,553 2,234 2,063 1,408 ------------- ------- ------ ------ ------ Total $ 6,548 $11,791 $6,622 $5,487 $3,108 ============= ======= ====== ====== ======
PAGE 27 ALLOWANCE FOR LOAN LOSSES A summary of the allowance for loan losses is as follows:
December 31, -------------- (Dollars in thousands) 1996 1995 1994 1993 1992 -------------- --------- --------- --------- --------- Average loans $ 652,157 $607,335 $540,030 $472,319 $414,230 ============== ========= ========= ========= ========= Allowance, beginning of period $ 9,891 $ 8,150 $ 6,087 $ 4,597 $ 4,131 -------------- --------- --------- --------- --------- Loans charged off: Commercial and industrial 392 240 491 1,211 1,010 Installment and other 614 277 387 401 695 Real estate 412 127 84 238 90 Lease financing 33 39 44 92 162 -------------- --------- --------- --------- --------- Total loans charged off 1,451 683 1,006 1,942 1,957 -------------- --------- --------- --------- --------- Recoveries: Commercial and industrial 84 143 170 86 8 Installment and other 56 72 152 160 97 Real estate 30 1 56 76 - Lease financing 18 36 26 25 19 -------------- --------- --------- --------- --------- Total recoveries 188 252 404 347 124 -------------- --------- --------- --------- --------- Net loans charged off 1,263 431 602 1,595 1,833 -------------- --------- --------- --------- --------- Provision for loan losses 2,082 2,172 2,665 3,085 2,299 -------------- --------- --------- --------- --------- Allowance, end of period $ 10,710 $ 9,891 $ 8,150 $ 6,087 $ 4,597 ============== ========= ========= ========= ========= Ratio of net charge offs to average loans outstanding 0.19% 0.07% 0.11% 0.34% 0.44% ============== ========= ========= ========= =========
The Banks' policy is to maintain allowances for loan losses at a level believed by management to be adequate to absorb potential losses. Management's determination of the adequacy of the allowance is determined monthly based on a continuing evaluation of the portfolio, past loss experience, current and anticipated economic conditions and other factors deemed relevant. Additions to the allowances are charged to operations. The ratio of net charge-offs to average loans increased from 0.07% in 1995 to 0.19% in 1996, as a result of an increase in charge-offs associated with commercial and mortgage loans and an overall increase in installment loan charge-offs. The charge-offs associated with the commercial and mortgage loans were done to write down the loan balances to their net realizable value. The $337,000 rise in the installment loan charge-offs is due to the overall growth in the installment portfolio as well as an increased level of nonperforming installment loans. Management has responded to the increase in the level of installment loan charge-offs by increasing the amount of the allowance for loan losses allocated to installment loans. The allowance for loan losses allocated to installment loans at December 31, 1996 grew $366,000, or 41.4%, compared to December 31, 1995. The amount of the unallocated allowance for loan losses at December 31, 1996 of $5,024,000 represented 46.9% of the total allowance for loan losses, compared to $3,635,000, or 36.8%, at December 31, 1995. The 1995 ratio of net charge-offs to average loans of 0.07% decreased from the 1994 ratio of 0.11%. Management believes that the 1996 ratio of 0.19% compares favorably with peer group ratios. The following table sets forth an allocation of the allowance for loan losses by category. The specific allocations in any particular category may be reallocated in the future to reflect current conditions. Accordingly, management considers the entire allowance to be available to absorb losses in any category.
December 31, ------------- 1996 1995 1994 1993 1992 ------------- ------- ------- ------- ------- (Dollars in thousands) Percent Percent Percent Percent Percent Amount of Loans Amount of Loans Amount of Loans Amount of Loans Amount of Loans ------------- --------- ------- --------- ------- --------- ------- --------- ------- --------- Commercial and industrial $ 2,897 24% $ 3,952 26% $ 2,967 26% $ 2,821 26% $ 1,786 25% Installment and other 1,251 35% 885 32% 1,063 31% 990 31% 895 31% Real estate 1,434 34% 1,292 35% 1,010 36% 879 37% 1,163 38% Lease financing 104 7% 127 7% 139 7% 225 6% 81 6% Unallocated 5,024 N/A 3,635 N/A 2,971 N/A 1,172 N/A 672 N/A ------------- --------- ------- --------- ------- --------- ------- --------- ------- --------- Total $ 10,710 100% $ 9,891 100% $ 8,150 100% $ 6,087 100% $ 4,597 100% ============= ========= ======= ========= ======= ========= ======= ========= ======= =========
PAGE 28 The allowance and the provision for loan losses are based on management's judgment after considering charge-off history, nonperforming loans and reserve levels relative to total loans in determining the allowance and the provision for loan losses. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Banks' allowance for loan losses. Such agencies may require the Banks to recognize additions to the allowance based on their judgment of information available to them at the time of their examination. The Corporation adopted SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures," on January 1, 1995. This standard requires that a creditor measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable. The adoption of SFAS No. 114, as amended by SFAS No. 118, on January 1, 1995 did not have a material impact on the Corporation's liquidity, results of operations or capital resources. DEPOSIT STRUCTURE The following table is a distribution of average balances and average rates paid on the deposit categories for the last three years:
December 31, ------------- 1996 1995 1994 ------------- -------- -------- (Dollars in thousands) Amount Rate Amount Rate Amount Rate ------------- ----- -------- ----- -------- ----- Demand -- noninterest-bearing $ 122,459 --% $109,649 --% $105,954 --% Demand -- NOW 91,856 1.57% 85,101 1.97 87,566 2.06 Money market and savings 270,034 3.03% 256,628 3.08 287,410 2.67 Time -- under $100,000 298,777 5.63% 280,168 5.50 239,238 4.39 Time -- $100,000 or greater 38,261 5.29% 29,543 5.58 17,861 4.01 ------------- -------- -------- Total $ 821,387 $761,089 $738,029 ============= ======== ========
The maturity distribution of certificates of deposit of $100,000 and over is as follows:
Year Ended December 31, ---------------------- (Dollars in thousands) 1996 1995 1994 ------------- ------- ------- Three months or less $ 29,919 $14,527 $ 7,707 Over three months to six months 12,850 3,848 7,809 Over six months to twelve months 4,512 8,323 2,792 Over twelve months 4,079 2,930 2,502 ------------- ------- Total $ 51,360 $29,628 $20,810 ============= ======= =======
INCOME STATEMENT ANALYSIS RESULTS OF OPERATIONS Consolidated net income for 1996 was $14,408,000, an increase of $1,980,000, or 15.9%, over 1995. On a per share basis, primary and fully diluted earnings were $2.16 in 1996, compared to primary and fully diluted earnings per share of $1.87 in 1995. Consolidated net income increased in 1995 by $1,148,000, a 10.2% increase over 1994. Return on average assets improved to 1.47% for 1996, compared to 1.39% for 1995 and 1.36% for 1994, and return on average shareholders' equity was 15.71% for 1996, compared to 15.20% for 1995 and 1994. Net income is affected by five major elements: net interest income, or the difference between interest income earned on loans and investments and interest expense paid on deposits and borrowed funds; the provision for loan losses, or the amount added to the allowance for loan losses to provide reserves for future losses on loans; other operating income, which is made up primarily of certain fees and gains and losses from sales of securities; other operating expenses, which consist primarily of salaries and other operating expenses; and income taxes. Each of these major elements is reviewed in more detail in the following discussion. NET INTEREST INCOME Net interest income for 1996 increased by $3,135,000, or 7.9%, to $42,842,000. Net interest income was $39,707,000 during 1995, which was 6.5% above the $37,280,000 reported in 1994. For analytical purposes, the following table reflects tax-equivalent net interest income in recognition of the income tax savings on tax-exempt items such as interest on municipal securities and tax-exempt loans. Adjustments are made using a statutory federal tax rate of 35%.
Year Ended December 31, ---------------------- (Dollars in thousands) 1996 1995 1994 ------- ------- ------- Interest income $73,718 $68,491 $58,381 Interest expense 30,876 28,784 21,101 ------- ------- ------- Net interest income 42,842 39,707 37,280 Tax equivalent adjustment 2,489 1,736 1,590 ------- ------- ------- Net interest income (fully taxable equivalent) $45,331 $41,443 $38,870 ======= ======= =======
PAGE 29 CHANGES IN NET INTEREST INCOME The rate-volume analysis set forth in the following table, which is computed on a tax equivalent basis (tax rate of 35%), analyzes changes in net interest income for the last three years by their rate and volume components. Tax-equivalent net interest income was $45,331,000 for 1996, compared to $41,443,000 for 1995, an increase of $3,888,000, or 9.4%. This increase in tax-equivalent net interest income was primarily due to the net $3,846,000 increase related to the growth in volume of interest-earning assets. Total interest income increased $5,980,000, primarily, the result of higher yields on investment securities and increased volumes of interest-earning assets. The increase in security interest income was attributable to a $2,369,000 increase due to volume and a $839,000 increase related to the increase in the overall yield of the investment security portfolio. Total interest income on loans increased $2,703,000, or 5.0%, in 1996, compared to 1995, as a result of total average loans outstanding increasing $44,822,000, or 7.4%. The increase in loan interest income related to volume of $3,918,000 was offset by the $1,215,000 reduction in loan interest income associated with the lower yields earned on loans. The decrease in the yield earned on loans is primarily due to the lower market interest rates in 1996, compared to 1995. Principally, as a result of higher time deposit volumes and rates, total interest expense rose $2,092,000. The volume of average time deposits increased $27,327,000, or 8.8% during 1996, compared to 1995 interest expense. Borrowings and other interest-bearing liabilities also contributed to the increase in total interest expense primarily due to the increase in average balances of $9,746,000 during this same period. Borrowings and other interest-bearing liabilities include federal funds purchased, FHLB borrowings, securities sold under agreements to repurchase and U.S. Treasury notes. For the year ended December 31, 1995, net interest income increased $2,573,000, primarily due to an increase in the volume of loans. Total loan interest income increased $8,832,000, or 19.4%, in 1995, compared to 1994, primarily as a result of total average loans increasing $67,305,000, or 12.5%. This increase in loans was primarily funded by an increase in borrowings and other interest-bearing liabilities, which also contributed to the rise in interest expense by increasing $28,719,000 during the same period. Total interest expense rose $7,683,000, principally as a result of higher time deposit rates and volumes. The volume of average time deposits increased $52,612,000, or 20.5%, during 1995, compared to 1994. Nonaccruing loans are included in the average balance yield calculations, but the average nonaccruals were insignificant and had no material effect on the results. The decrease in interest rates during 1996 and 1995, and the rise in interest rates in 1994, did not have a material effect on net interest income, as a result of management's ability to properly price earning assets and deposits.
1996 over (under) 1995 1995 over (under) 1994 ----------------------- ---------------------- due to changes in ----------------- (Dollars in thousands) Net Net Change Rate Volume Change --------- ------------------- ------- INTEREST INCOME: Investment securities (1) $ 3,208 $ 839 $ 2,369 $ 1,015 Loans 2,703 (1,215) 3,918 8,832 Other assets 69 (56) 125 409 ---------- -------- ------- -------- Total 5,980 (432) 6,412 10,256 ---------- -------- ------- -------- INTEREST EXPENSE: Savings deposits 45 (491) 536 103 Time deposits 1,809 280 1,529 5,816 Borrowings and other interest- bearing liabilities 238 (263) 501 1,764 ----------- -------- ------- ------- Total 2,092 (474) 2,566 7,683 ----------- -------- ------- ------- Changes in net interest income $ 3,888 $ 42 $ 3,846 $ 2,573 =========== ======== ======= ======== due to changes in ------------------ (Dollars in thousands) Rate Volume ----------- -------- INTEREST INCOME: Investment securities (1) $ 1,652 $ (637) Loans 2,814 6,018 Other assets 166 243 ----------- -------- Total 4,632 5,624 ----------- -------- INTEREST EXPENSE: Savings deposits 1,034 (931) Time deposits 2,920 2,896 Borrowings and other interest- bearing liabilities 83 1,681 ---------- -------- Total 4,037 3,646 ---------- -------- Changes in net interest income $ 595 $ 1,978 ========== ======== (1) The interest earned on nontaxable investment securities and loans is shown on a tax equivalent basis.
PAGE 30 INTEREST RATE SENSITIVITY The Banks actively manage their interest rate sensitivity positions. The objectives of interest rate risk management are to control exposure of net interest income to risks associated with interest rate movements and to achieve consistent growth in net interest income. The Asset/Liability Committee, using policies and procedures set by senior management, is responsible for managing the Banks' rate sensitivity position. The Banks manage interest rate sensitivity by changing mix and repricing characteristics of their assets and liabilities through their investment securities portfolios and their offering of loan and deposit terms. The Banks utilize three principal reports to measure interest rate risk: gap analysis reports, net interest margin reports and asset/liability simulation reports. The table below shows the interest rate sensitivity gap position as of December 31, 1996. The table presents data at a single point of time and includes management assumptions estimating the prepayment rate and the interest rate environment prevailing at December 31, 1996. Money Market, NOW and savings accounts have always been considered a stable source of funds, and although the rates are subject to change, rates on these accounts historically have not changed as quickly or as often as the other deposits included in the following analysis. On a cumulative basis over the next 12 months, the Bank is in a negative gap position of (3.90)% of earning assets at December 31, 1996. This gap position is within the guidelines set by the Banks' Asset/ Liability policy. 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 has on the Banks' net interest income is simulated by increasing and decreasing interest rates at 200 basis point increments. This simulation is known as rate shocks. The results of the December 31, 1996 rate shock simulations show the Banks are within all guidelines set by the Banks' Asset/Liability policy.
December 31, 1996 ------------------- 0 to 90 91 to 365 >1 year >3 years Over 5 (Dollars in thousands) days days <3 years < 5 years years ---------- ----------- ------------------- ----------- --------- ASSETS Other rate-sensitive assets $ 9,367 $ 3,100 $ 2,000 $ 0 $ 8 Loans 204,757 84,416 174,082 84,972 133,183 Investment securities 15,822 38,704 47,661 30,284 138,229 ---------- ----------- ------------------- ----------- --------- Total rate-sensitive assets 229,946 126,220 223,743 115,256 271,420 ---------- ----------- ------------------- ----------- --------- LIABILITIES Time deposits 68,215 141,689 112,822 22,759 376 Money market savings funds 59,729 - - - 95,787 NOW accounts 32,572 - - - 69,698 Savings accounts 34,164 - - - 70,165 U.S. Treasury demand note 2,572 - - - - Other borrowings 45,949 9,000 1,500 500 - ---------- ----------- ------------------- ----------- --------- Total rate-sensitive liabilities 243,201 150,689 114,322 23,259 236,026 ---------- ----------- ------------------- ----------- --------- Incremental gap ($13,255) ($24,469) $ 109,421 $ 91,997 $ 35,394 ========== =========== =================== =========== ========= Cumulative gap ($13,255) ($37,724) $ 71,697 $ 163,694 $199,088 ========== =========== =================== =========== ========= % of earning assets (1.37)% (3.90)% 7.42% 16.94% 20.60% ========== =========== =================== =========== =========
NET INTEREST MARGIN The 1996 net interest margin of 4.88% was the same as the net interest margin for 1995 . The decrease in the interest income to earning asset ratio, from 8.27% in 1995 to 8.20% in 1996, was offset by the decrease in the interest expense to earning asset ratio, from 3.39% in 1995 to 3.32% in 1996. The decrease in these rates was the result of the lower rate environment in 1996. The net interest margin in 1995 was lower than the 4.94% net interest margin in 1994, primarily the result of higher rates paid on time deposits during 1995, compared to 1994. The Banks have been able to effectively match assets and liabilities and maintain a consistent percentage of earning assets to total assets. PROVISION FOR LOAN LOSSES The provision for loan losses is based on management's analysis of the adequacy of the allowance for loan losses. In its evaluation, management considers past loan experience, overall characteristics of the loan portfolio, current economic conditions and other relevant factors. Based on the latest monthly evaluation of potential loan losses, the allowance is adequate to absorb known and inherent losses in the loan portfolio. Ultimately however, the adequacy of the allowance is largely dependent upon the economy, a factor beyond the Corporation's control. With this in mind, additions to the allowance for loan losses may be required in future periods especially if economic trends worsen or certain borrowers' abilities to repay decline. PAGE 31 The provision in 1996 was $2,082,000, a decrease of $90,000 or 4.1%, compared to the 1995 provision of $2,172,000. Management cautiously reduced the provision in 1996, as a result of the overall improvement in the level of nonperforming assets. A review of the table below shows an improvement in the level of nonperforming assets at December 31, 1996, compared to the same periods in 1995 and 1994. The ratio of the allowance for loan losses to loans of 1.57% was the same at December 31, 1996 and 1995. The December 31, 1994 ratio was 1.37%
1996 1995 1994 ----------- ------------ ------------ Nonperforming Assets $5,672,000 $11,457,000 $5,657,000 Allowance for loan losses to nonperforming assets 188.8% 86.3% 144.1% Nonperforming assets to total loans and net .83% 1.82% .95% assets acquired in foreclosure Allowance for loan losses to total loans 1.57% 1.57% 1.37% Unallocated allowance for loan losses to total 46.9% 36.8% 36.5% allowance for loan losses
Nonperforming assets (nonaccruing loans, net assets in foreclosure and troubled debt restructured loans) were 0.83% of total loans, and net assets acquired in foreclosure at December 31, 1996 compared to 1.82% at December 31, 1995 and 0.95% at December 31, 1994. The ratio of the allowance to nonperforming assets was 188.8% at December 31, 1996, compared to 86.3% at December 31, 1995 and 144.1% at December 31, 1994. Nonaccruing loans of $2,983,000 at December 31, 1996 decreased $6,071,000 from the December 31, 1995 balance of $9,054,000. The $6,071,000 reduction in nonaccrual loans during this period is primarily due to one loan being upgraded to accruing status during 1996. This loan achieved accrual status after meeting appropriate standards. The nonaccruing loans balance at December 31, 1994 was $2,521,000. Net assets in foreclosure totaled $972,000 as of December 31, 1996, a decrease of $248,000, or 20.3%, from the December 31, 1995 balance. During 1996, sales of foreclosed properties totaled $1,348,000, transfers from loans to assets in foreclosure were $1,244,000 and write-downs of assets in foreclosure equaled $144,000. Efforts to liquidate assets acquired in foreclosure are proceeding as quickly as potential buyers can be located and legal constraints permit. Generally accepted accounting principles require foreclosed assets to be carried at the lower of cost (lesser of carrying value of asset or fair value at date of acquisition) or estimated fair value. Loans past due 90 days or more and still accruing interest are loans that are generally well-secured and are in the process of collection. As of December 31, 1996, loans past due 90 days or more and still accruing interest were $1,848,000, compared to $1,553,000 as of December 31, 1995. As of December 31, 1996, there were three unrelated commercial borrowers with troubled debt restructured loans totaling $1,717,000. All three customers were complying with the restructured terms as of December 31, 1996. The balance of impaired loans was $4,159,000 at December 31, 1996. The Banks have identified a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. The impaired loan balance included $2,442,000 of nonaccrual loans and $1,717,000 of troubled debt restructured loans. The allowance for loan loss associated with the $4,159,000 of impaired loans was $533,000 at December 31, 1996. The average impaired loan balance was $9,333,000 in 1996, and the income recognized on impaired loans during 1996 was $814,000. The Banks' policy for interest income recognition on impaired loans is to recognize income on restructured loans under the accrual method. The Banks recognize income on nonaccrual loans under the cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Banks. The Banks will not recognize income if these factors do not exist. OTHER OPERATING INCOME
Year ended December 31, -------------------------- (Dollars in thousands) 1996 1995 1994 ------- ------- ------ Service charges $2,587 $2,337 $2,341 Securities (losses) gains, net (39) (172) 668 Trust income 1,293 1,094 741 Other 1,274 1,178 996 ------- ------- ------ Total other operating income $5,115 $4,437 $4,746 ======= ======= ======
Other operating income for 1996 increased $678,000, or 15.3%, compared to the 1995 level of $4,437,000. This increase was primarily due to increases in service charges and trust income. The 1994 other operating income of $4,746,000 was 6.5% higher than 1995 due to net security gains. Income from service charges on deposit accounts of $2,587,000 in 1996 increased $250,000 from the 1995 income from service charges on deposit accounts of $2,337,000. The increase in service charges during 1996 is primarily attributed to higher overdraft charges collected and the fees related to the overall increase in the volume of deposits in 1996. The small decrease in service charges in 1995, compared to 1994, is attributed to lower service charges on business accounts. This was the result of an increase in the earnings credit, attributable to the rise in interest rates, which is used to offset service charges. The Corporation recorded a $39,000 net security loss in 1996, compared to a net security loss of $172,000 in 1995. From time to time, the Corporation sells securities to fund the purchase of other securities in an effort to enhance the overall return on the portfolio. The Corporation recognized $668,000 of net securities gains in 1994. During 1994, the Corporation realized a securities gain of approximately $1,058,000 as a result of the Corporation selling over 40,000 shares of First Eastern Bank stock to PNC Corporation on June 24, 1994. Investment securities available for sale were sold during 1994 to help fund growth in loans and resulted in a net loss of approximately $418,000. PAGE 32 The 1996 income from the Trust and Financial Services Department of $1,293,000 increased $199,000, or 18.2%, compared to the $1,094,000 recorded in 1995. This increase was the result of both an increase in the book value of trust assets of 6.6% from December 31, 1995 to December 31, 1996 and the Corporation's continuing emphasis on marketing the Trust and Financial Services Department's products and services. The 1994 Trust and Financial Services Department income was $741,000. Other income increased $96,000 during 1996, from $1,178,000 in 1995 to $1,274,000 in 1996. This increase was due to higher leasing fees earned in 1996. Other income in 1995 increased $182,000, compared to 1994, as a result of higher fees earned on merchant credit card services and a rise in fees associated with the sale of insurance policies on new loans. OTHER OPERATING EXPENSES
Year ended December 31, -------------------------- (Dollars in thousands) 1996 1995 1994 ------- ------- ------- Salaries $11,392 $ 9,848 $ 8,599 Employee benefits 3,006 3,264 3,027 Occupancy 1,873 1,541 1,474 Equipment expense 2,083 1,913 1,572 FDIC premiums 6 861 1,648 Other expenses 7,514 6,840 6,994 ------- ------- ------- Total other operating expenses $25,874 $24,267 $23,314 ======= ======= =======
Other operating expenses rose to $25,874,000 for 1996, a 6.6% increase over the $24,267,000 for 1995. The 1995 amount was 4.1% above the $23,314,000 for 1994. The rise in operating expenses in 1996 was largely due to higher expenses related to four new branches opened after June 30, 1995 and one that opened during May 1995. Also contributing to this rise were increases in legal fees, consulting fees and expenses related to the overall growth of the Banks. These increases were partially offset by a reduction in the FDIC premium. Employee salaries increased $1,544,000, or 15.7%, from $9,848,000 in 1995 to $11,392,000 in 1996. The salary increase directly related to the staffing of the five new branches was $795,000, or 51.5% of the total salary increase. The remaining increase in salaries reflects cost-of-living increases, merit increases and additional staff necessitated by current and planned future growth. Employee benefits decreased $258,000, or 7.9%, to $3,006,000 in 1996 from the $3,264,000 in employee benefits during 1995. The decrease is the result of the modification of the Banks' profit-sharing plan into a 401(K) plan during 1996. The profit-sharing plan was funded entirely by the Bank and the modified 401(K) plan is both Bank and employee funded. Offsetting this decrease was a $173,000 increase in benefit expenses related to the new branches. The 1995 salary expenses and fringe benefit expenses increased 14.5% and 7.8%, respectively, compared to 1994 expenses. Net occupancy costs increased by $332,000, or 21.5%, in 1996, compared with a $67,000, or 4.5%, increase in 1995. The five new branches were responsible for $276,000, or 83.1% of the increase in 1996. Equipment expenses increased by $170,000, or 8.9%, during 1996, and $341,000, or 21.7%, in 1995. The five new branches were primarily responsible for the increase in equipment expenses during 1996. The remainder of this rise is due to both equipment depreciation and maintenance associated with planned increased data processing capabilities. The majority of the rise in 1995 is due to depreciation, maintenance and equipment rental expenses associated with planned increased data processing capabilities. The increased data processing capabilities include modernizing our branches through platform automation and teller terminals, and the ongoing updating of data processing equipment to manage the rise in volume related to the growth of the Corporation. During the third quarter of 1995, the FDIC confirmed that the Bank Insurance Fund (BIF) was fully recapitalized at the end of May 1995. As a result, the new lower premium rates were made retroactive to June 1, 1995. The Banks' 1996 FDIC premium expense was $6,000, compared to the 1995 premium expense of $861,000. On September 30, 1996, the President signed into law the Deposit Insurance Funds Act of 1996, which included the resolution of the disparity of insurance premiums paid by savings and loans associations for deposit insurance under the Savings Association Insurance Fund (SAIF) administered by the FDIC, in comparison to the premiums paid by banks for deposit insurance under the BIF, also administered by the FDIC. Beginning January 1, 1997, for a three-year period, banks will be required to pay a premium of 1.296 basis points. This premium will not have a material impact on the Corporation's financial position or results of operations. Other expenses increased $674,000, or 9.9%, from $6,840,000 in 1995 to $7,514,000 in 1996. This increase is primarily the result of a $164,000 increase in consulting fees, a $103,000 rise in legal fees and $91,000 in other expenses associated with the new branches. The rise in consulting fees was related to franchise expansion, employee benefits and consultation concerning enhancements to bank operations. The increase in legal fees was associated with the Farmers merger, the resolution of legal matters and legal fees related to maintaining the loan portfolio. The remaining increase during 1996 was due to the normal increases in expenses related to the overall growth of the Corporation. The 1995 other expenses decreased $154,000, compared to 1994. The reduction in other expenses included a decrease in intangible asset expense of $262,000 and a $134,000 reduction in legal expenses. The reduction in legal expenses is related to both the 1994 legal expenses associated with the Security National Bank merger and the recovery of legal expenses in 1995 related to nonperforming assets that were expensed in prior periods. These reductions in other expenses were partially offset by an increase in printing and stationery supply expenses related to bank automation, increases in paper costs and the opening of the three new branches. INCOME TAXES
Year Ended December 31, -------------------------- (Dollars in thousands) 1996 1995 1994 -------- ------- ------- Expected tax expense $ 6,800 $6,020 $5,608 Tax exempt income, net of interest disallowance (1,414) (999) (943) Other 207 256 102 -------- ------- ------- Actual tax expense $ 5,593 $5,277 $4,767 ======== ======= =======
PAGE 33 The Corporation accounts for income taxes under the liability method specified by SFAS No. 109, "Accounting for Income Taxes." Under SFAS No. 109, deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The principal types of accounts resulting in differences between assets and liabilities for financial statement and tax return purposes are the allowance for loan losses, leased assets, deferred loan fees and compensation. The effective income tax rates of 28.0% for 1996, 29.8% for 1995 and 29.7% for 1994 were less than the applicable federal income tax rate of 35.0%, as a result of tax-exempt income. CAPITAL Capital formation is critical to the Corporation's well-being and future growth. Capital at the end of 1996 was $97,631,000, an increase of $11,269,000, or 13.0%, over the end of 1995. The increase came as a result of the retention of the Corporation's earnings and from the adjustment for the net unrealized gains (losses) on the investment securities available for sale. Management believes that the Corporation's current capital position and liquidity position are strong and that its capital position is adequate to support its operations. Except as previously discussed, management is not aware of any recommendation by any regulatory authority which, if it were to be implemented, would have a material effect on the Corporation's capital. The Corporation's capital ratios exceed regulatory requirements. Existing minimum regulatory capital ratio requirements are 5.0% for primary capital and 6.0% for total capital. The primary capital ratio was 10.29% at December 31, 1996, compared with 9.98% at December 31, 1995. Because the Corporation's only capital is primary capital, the total capital ratios are the same as the primary capital ratios. Pursuant to the federal regulators' risk-based capital adequacy guidelines, the components of capital are called Tier 1 and Tier 2 capital. For the Corporation, Tier 1 capital is the shareholders' equity, and Tier 2 capital is the allowance for loan losses. The risk-based capital ratios are computed by dividing the components of capital by risk-adjusted assets. Risk-adjusted assets are determined by assigning credit risk-weighting factors from 0% to 100% to various categories of assets and off-balance-sheet financial instruments. The minimum for the Tier 1 capital ratio is 4.0%, and the total capital ratio (Tier 1 plus Tier 2 capital divided by risk-adjusted assets) minimum is 8.0%. At December 31, 1996, the Corporation's Tier 1 risk-adjusted capital ratio was 13.12%, and the total risk-adjusted capital ratio was 14.38%, both well above regulatory requirements. The risk-based capital ratios of each of the Corporation's commercial banks also exceeded regulatory requirements at the end of 1996. To supplement the risk-based capital adequacy guidelines, the Federal Reserve Board (FRB) established a leverage ratio guideline. The leverage ratio consists of Tier 1 capital divided by quarterly average total assets, excluding intangible assets. The minimum leverage ratio guideline is 3% for banking organizations that do not anticipate significant growth and that have well-diversified risk, excellent asset quality, high liquidity, good earnings and, in general, are considered top-rated, strong banking organizations. Other banking organizations are expected to have ratios of at least 4% or 5%, depending upon their particular condition and growth plans. Higher leverage ratios could be required by the particular circumstances or risk profile of a given bank organization. The Corporation's leverage ratios were 9.21% and 8.99% at December 31, 1996 and 1995, respectively. Under FDIC the regulations, a "well capitalized" institution must have a leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 6% and a total risk-based capital ratio of at least 10% and not be subject to a capital directive order. To be considered "adequately capitalized," an institution must generally have a leverage ratio of at least 4%, a Tier 1 risk-based capital ratio of at least 4% and a total risk-based capital ratio of at least 8%. An institution is deemed to be "critically undercapitalized" if it has a tangible equity ratio of 2% or less. As illustrated in the chart below, the Banks are above the regulatory minimum guidelines and meet the criteria to be categorized as "well capitalized" institutions at December 31, 1996.
(Dollars in thousands) Leverage Ratio ------------------ December 31, 1996 December 31, 1995 ------------------ ------------------ Amount Ratio Amount Ratio ---------- ------ --------- ------ Entity: Corporation $93,164 9.21% $83,019 8.99% Subsidiaries: Harleysville National Bank 67,253 8.34 58,330 7.99 Citizens National Bank 20,031 13.08 19,193 13.10 Security National Bank 3,885 6.81 3,693 8.32 "Well Capitalized" institution (under FDIC regulations) 5.00 5.00
(Dollars in thousands) Tier 1 Capital to Risk-Weighted Assets -------------------------------------- December 31, 1996 December 31, 1995 ------------------- ------------------ Amount Ratio Amount Ratio -------- ------ ------- ------ Entity: Corporation $93,164 13.12% $83,019 12.47% Subsidiaries: Harleysville National Bank 67,253 11.59 58,330 10.53 Citizens National Bank 20,031 22.60 19,193 23.71 Security National Bank 3,885 9.57 3,693 11.89 "Well Capitalized" institution (under FDIC regulations) 6.00 6.00
(Dollars in thousands) Total Capital to Risk-Weighted Asset Ratio ------------------------------------------ December 31, 1996 December 31, 1995 ----------------- ----------------- Amount Ratio Amount Ratio ------ ----- ------ ----- Entity: Corporation $102,061 14.38% $91,340 13.72% Subsidiaries: Harleysville National Bank 74,528 12.85 65,253 11.78 Citizens National Bank 20,993 23.69 20,205 24.96 Security National Bank 4,394 10.83 4,081 13.14 "Well Capitalized" institution (under FDIC regulations) 10.00 10.00
PAGE 34 LIQUIDITY Liquidity is a measure of the ability of the Banks to meet their needs and obligations on a timely basis. For a bank, liquidity requires the ability to meet the day-to-day demands of deposit customers, along with the ability to fulfill the needs of borrowing customers. Generally, the Banks arrange their mix of cash, money market investments, investment securities and loans in order to match the volatility, seasonality, interest sensitivity and growth trends of its deposit funds. Federal funds sold averaged $11,440,000 during 1996, and investment securities available for sale averaged $192,549,000 during 1996, more than sufficient to match normal fluctuations in loan demand or deposit fund supplies. Backup sources of liquidity are provided by federal fund lines of credit established with correspondent banks. Additional liquidity could be generated through borrowings from the Federal Reserve Bank of Philadelphia, of which Harleysville, Citizens and Security are members and from the Federal Home Loan Bank of Pittsburgh, of which Harleysville, Citizens and Security are members. Unused lines of credit at the FHLB were $181,417,000, as of December 31, 1996. There are no known trends or any known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way. OTHER ITEMS The passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and the Riegle Community Development and Regulatory Improvement Act may have a significant impact upon the Corporation. The key provisions pertain to interstate banking and interstate branching as well as a reduction in the regulatory burden on the banking industry. States may adopt laws preventing interstate branching but, if so, no out-of-state bank can establish a branch in such state and no bank in such state may branch outside the state. Pennsylvania law authorized full interstate banking and branching to facilitate the operations of interstate banks in Pennsylvania. As a result of legal and industry changes, management predicts that consolidation will continue as the financial services industry strives for greater cost efficiencies and market share. Management believes that such consolidation may enhance its competitive position as a community bank. There are numerous proposals before Congress to modify the financial services industry and the way commercial banks and other financial institutions operate. Some of these proposals include changes to the ownership of financial companies and the types of products and services which may be offered by financial institutions. However, it is difficult to determine at this time what effect such provisions may have until they are enacted into law. Except as specifically described on page 34, management believes that the effect of the provisions of the aforementioned legislation on the liquidity, capital resources, and results of operations of the Corporation will be immaterial. Management is not aware of any other current specific recommendations by regulatory authorities or proposed legislation which, if they were implemented, would have a material adverse effect upon the liquidity, capital resources, or results of operations, although the general cost of compliance with numerous and multiple federal and state laws and regulations does have and in the future may have a negative impact on the Corporation's results of operations. The Corporation plans to open two new branches during 1997. Harleysville National Bank is pursuing locations in Spring House and Chalfont. These new branch sites are contiguous to our current service area and were chosen due to the demand for additional delivery locations by our customers. On September 30, 1996, the President signed into law the Deposit Insurance Funds Act of 1996 to recapitalize the Savings Association Insurance Fund (SAIF) administered by the Federal Deposit Insurance Corporation (FDIC) and to provide for repayment of the Financial Institution Collateral Obligation (FICO) bonds issued by the United States Treasury Department. Pursuant to this law, the FDIC will levied a one-time special assessment on SAIF deposits equal to 65.7 cents per $100 of the SAIF-assessable deposit base as of March 31, 1995. During the years 1997, 1998 and 1999, the Bank Insurance Funds (BIF) will pay $322 million of FICO debt service, and SAIF will pay $458 Million. During 1997, 1998 and 1999, the average regular annual deposit insurance assessment is estimated to be about 1.296 cents per $100 of deposits for BIF deposits and 6.44 cents per $100 of deposits for SAIF deposits. Individual institution's assessments will continue to vary according to their capital and management ratings. As always, the FDIC will be able to raise the assessments as necessary to maintain the funds at their target capital ratios provided by law. After 1999, BIF and SAIF will share the FICO costs equally. Under current estimates, BIF and SAIF assessment bases would each be assessed at the rate of approximately 2.4 cents per $100 of deposits. Based on current projected deposit levels during 1997, management expects that the increase in the FDIC assessment rate will not have a material impact on earnings. PAGE 35 FINANCIAL RATIOS AND SUMMARY OF KEY INFORMATION Harleysville National Corporation and Subsidiaries (Dollars in thousands, except per share data and average shares outstanding) Year Ended December 31 -------------------------
1996 1995 1994 ----------- ----------- ----------- PER SHARE INFORMATION*: Primary $ 2.16 $ 1.87 $ 1.71 Fully diluted 2.16 1.87 1.71 Cash dividends paid 0.84 0.75 0.58 Book value (at year-end) 14.67 13.67 11.41 MARKET VALUE*: Bid price of common stock (high) 27.14 27.14 29.93 Bid price of common stock (low) 23.50 23.81 19.05 Average shares outstanding 6,660,530 6,646,957 6,602,678 AVERAGE BALANCE SHEET: Loans $ 652,157 $ 607,335 $ 540,030 Earning assets 929,589 848,687 784,011 Total assets 978,899 894,350 829,241 Deposits 821,387 761,089 738,029 Interest-bearing liabilities plus demand deposits 868,200 798,156 746,377 Shareholders' equity 91,687 81,788 74,234 SELECTED OPERATING RATIOS: Return on average assets 1.47% 1.39% 1.36% Return on average shareholders' equity 15.71% 15.20% 15.20% Leverage (assets divided by shareholders' equity) 10.51X 10.85X 11.63X Average shareholders' equity as a percentage of: Average loans 14.06% 13.47% 13.75% Average deposits 11.16 10.75 10.06 Average assets 9.37 9.15 8.95 Average earning assets 9.86 9.64 9.47 Dividend payout ratio 38.76 39.51 32.68 Average total loans as a percentage of average deposits and borrowed funds 75.12 76.09 72.35 Net interest margin on average earning assets: Interest income** 8.20% 8.27% 7.62% Interest expense (3.32) (3.39) (2.68) Net interest margin 4.88 4.88 4.94 Noninterest margin (2.23) (2.34) (2.36) *Adjusted for a 5% stock dividends effective 6/28/96 and 12/30/94. **Tax Equivalent Basis.
PAGE 36 EX-21 3 Exhibit 21 Registrant owns all of the issued and outstanding capital stock of Harleysville National Bank and Trust Company, a National banking association headquartered at 483 Main Street, Harleysville, PA 19438, the Citizens National Bank of Lansford, a national banking association headquartered at 13-15 West Ridge Street, Lansford, PA 18232 and of Security National Bank, a national banking association headquartered at One Security Plaza, Pottstown, PA 19464. EX-23 4 Exhibit 23(a) CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our report dated January 8, 1997, accompanying the consolidated financial statements incorporated by reference or included in the 1996 Annual Report of Harleysville National Corporation on Form 10-K for the year ended December 31, 1996. We hereby consent to the incorporation by reference of said report in the Registration Statements of Harleysville National Corporation on Form S-3 (Registration No. 33-57790, effective February 3, 1993) and on Forms S-8 (Registration No. 33-69784, effective October 1, 1993, and Registration No. 33-17813, effective December 13, 1996). GRANT THORNTON LLP Philadelphia, Pennsylvania March 26, 1997 Exhibit 23(b) INDEPENDENT AUDITORS' CONSENT The Board of Directors Harleysville National Corporation Re: Registration Statement on Form S-3 (Registration No. 33-57790) Registration Statement on Form S-8 (Registration No. 33-69784) Registration Statement on Form S-8 (Registration No. 33-17813) We consent to the incorporation by reference in the above listed registration statements of Harleysville National Corporation (the Company) of our report dated January 31, 1995 relating to the consolidated statements of income, shareholders' equity, and cash flows of Harleysville National Corporation and subsidiaries for the year ended December 31, which report appears in the December 31, 1996 Form 10-K of Harleysville National Corporation. Our report contains an explanatory paragraph which discusses that the Company changed its method of accounting for investments in 1994. KPMG PEAT MARWICK LLP Philadelphia, Pennsylvania March 26, 1997 EX-99 5 Exhibit 99(a) REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders Harleysville National Corporation We have audited the consolidated balance sheets of Harleysville National Corporation and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity and cash flows for each of the two years in the period ended December 31, 1996. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Harleysville National Corporation and Subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their consolidated cash flows for the year then ended, in conformity with generally accepted accounting principles. As discussed in note 1 to the consolidated financial statements, Harleysville National Corporation and Subsidiaries changed their method of accounting for certain investments in debt and equity securities in 1994. GRANT THORNTON LLP Philadelphia, Pennsylvania January 8, 1997 Exhibit 99(b) INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders Harleysville National Corporation: We have audited the accompanying consolidated statements of income, shareholders' equity, and cash flows of Harleysville National Corporation and subsidiaries for the year ended December 31, 1994. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and the cash flows of Harleysville National Corporation and subsidiaries for the year ended December 31, 1994, in conformity with generally accepted accounting principles. As discussed in note 1 to the consolidated financial statements, the Corporation changed its method of accounting for investments in 1994. KPMG PEAT MARWICK LLP Philadelphia, Pennsylvania January 31, 1995 EX-27 6
9 1000 YEAR DEC-31-1996 DEC-31-1996 39,407 8,475 6,000 0 209,795 65,226 66,680 681,410 10,710 1,026,128 847,699 57,521 21,277 2,000 0 0 6,657 90,974 1,026,128 56,684 16,130 904 73,718 28,470 2,406 42,842 2,082 (39) 25,874 20,001 20,001 0 0 14,408 2.16 2.16 4.88 2,983 1,848 1,717 0 9,891 1,451 188 10,710 10,710 0 5,024
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