-----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, KCdnvzAmiY7utmtOoXaVDtonzzNeS7kDrdFpsCv5tdU+Sz7yWPEs4zvzjSoADSRv Nst031G1/TWBoecWqD3KOw== 0000702902-99-000008.txt : 19991115 0000702902-99-000008.hdr.sgml : 19991115 ACCESSION NUMBER: 0000702902-99-000008 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HARLEYSVILLE NATIONAL CORP CENTRAL INDEX KEY: 0000702902 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 232210237 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-15237 FILM NUMBER: 99749094 BUSINESS ADDRESS: STREET 1: 483 MAIN ST STREET 2: P O BOX 195 CITY: HARLEYSVILLE STATE: PA ZIP: 19438 BUSINESS PHONE: 2152568851 MAIL ADDRESS: STREET 1: 483 MAIN STREET CITY: HARLEYSVILLE STATE: PA ZIP: 19438 10-Q 1 FORM 10-Q FOR 09/30/99 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999. ------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from__________________to____________________. Commission file number 0-15237 ------- HARLEYSVILLE NATIONAL CORPORATION --------------------------------- (Exact name of registrant as specified in its charter) Pennsylvania 23-2210237 - ------------ ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 483 Main Street, Harleysville, Pennsylvania 19438 - ------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (215) 256-8851 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X. No. - --- APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ___. No ___. APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 7,915,130 shares of Common Stock, $1.00 par value, outstanding on October 31, 1999. PAGE 1 HARLEYSVILLE NATIONAL CORPORATION INDEX TO FORM 10-Q REPORT PAGE ---- Part I. Financial Information Item 1. Financial Statements: Consolidated Balance Sheets - September 30, 1999 and December 31,1998 3 Consolidated Statements of Income - Nine Months and Three Months Ended September 30, 1999 and 1998 5 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 1999 and 1998 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3. Quantitative and Qualitative Disclosures about Market Risk 22 Part II. Other Information Item 1. Legal Proceedings 22 Item 2. Change in Securities and Use of Proceeds 22 Item 3. Defaults Upon Senior Securities 22 Item 4. Submission of Matters to a Vote of Security Holders 22 Item 5. Other Information 22 Item 6. Exhibits and Reports on Form 8-K 22 Signatures 24 PAGE 2 PART 1. FINANCIAL INFORMATION HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(Dollars in thousands) (Unaudited) September 30, 1999 December 31, 1998 -------------------- ------------------- ASSETS Cash and due from banks $ 49,006 $ 40,204 Federal Funds sold - 13,426 -------------------- ------------------- Total cash and cash equivalents 49,006 53,630 -------------------- ------------------- Interest-bearing deposits in banks 4,333 3,707 Investment securities available for sale 470,415 390,438 Investment securities held to maturity (market value $11,621 and $42,202, respectively) 11,673 41,520 Loans 1,029,705 902,884 Less: Unearned income (81) (2,574) Allowance for loan losses (14,348) (13,706) -------------------- ------------------- Net loans 1,015,276 886,604 -------------------- ------------------- Bank premises and equipment, net 20,483 19,542 Accrued income receivable 10,834 9,574 Other real estate owned 202 1,131 Intangible assets, net 2,083 1,936 Bank-owned life insurance 25,170 - Other assets 5,743 4,008 -------------------- ------------------- Total assets $ 1,615,218 $ 1,412,090 ==================== =================== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest-bearing $ 182,891 $ 192,156 Interest-bearing: Checking accounts 137,156 139,133 Money market accounts 251,938 212,156 Savings 146,735 140,797 Time, under $100,000 354,727 329,606 Time, $100,000 or greater 122,342 90,468 -------------------- ------------------- Total deposits 1,195,789 1,104,316 Accrued interest payable 16,566 14,072 U.S. Treasury demand notes 590 1,320 Federal funds purchased 62,000 11,000 Federal Home Loan Bank (FHLB) borrowings 141,250 93,500 Securities sold under agreements to repurchase 58,755 43,158 Other liabilities 10,808 13,771 -------------------- ------------------- Total liabilities 1,485,758 1,281,137 -------------------- ------------------- Shareholders' Equity: Series preferred stock, par value $1 per share; authorized 3,000,000 shares, none issued - - Common stock, par value $1 per share; authorized 30,000,000 shares; issued and outstanding 7,915,168 shares in 1999 and 7,535,683 shares in 1998 7,915 7,536 Additional paid in capital 63,081 50,900 Retained Earnings 65,508 67,133 Accumulated other comprehensive income (7,044) 5,384 -------------------- ------------------- Total shareholders' equity 129,460 130,953 -------------------- ------------------- Total liabilities and shareholders' equity $ 1,615,218 $ 1,412,090 PAGE 3 ==================== =================== See accompanying notes to consolidated financial statements.
PAGE 4 HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) Nine months ended Three months ended (Dollars in thousands except weighted average number September 30, September 30, ------------------ ------------------- of common shares and per share information) 1999 1998 1999 1998 ------------------ ---------- ------------------- ---------- INTEREST INCOME: Loans, including fees $ 52,569 $ 49,011 $ 18,526 $ 16,586 Lease financing 5,008 3,669 1,789 1,299 Investment securities: Taxable 12,479 9,902 4,598 3,399 Exempt from federal taxes 7,117 5,461 2,404 1,997 Federal funds sold 325 903 22 345 Deposits in banks 101 185 49 30 ------------------ ---------- ------------------- ---------- Total interest income 77,599 69,131 27,388 23,656 ------------------ ---------- ------------------- ---------- INTEREST EXPENSE: Savings deposits 9,716 9,532 3,431 3,343 Time, under $100,000 13,565 13,363 4,614 4,519 Time, $100,000 or greater 4,064 3,530 1,488 1,313 Borrowed funds 6,099 3,081 2,586 1,091 ------------------ ---------- ------------------- ---------- Total interest expense 33,444 29,506 12,119 10,266 ------------------ ---------- ------------------- ---------- Net interest income 44,155 39,625 15,269 13,390 Provision for loan losses 1,430 1,680 476 550 ------------------ ---------- ------------------- ---------- Net interest income after provision for loan losses 42,725 37,945 14,793 12,840 ------------------ ---------- ------------------- ---------- OTHER OPERATING INCOME: Service charges 2,611 2,416 903 852 Security gains, net 458 900 7 574 Trust income 1,886 1,520 590 519 Bank-owned life insurance 170 - 170 - Other Income 2,111 2,247 710 999 ------------------ ---------- ------------------- ---------- Total other operating income 7,236 7,083 2,380 2,944 ------------------ ---------- ------------------- ---------- Net interest income after provision for loan losses and other operating income 49,961 45,028 17,173 15,784 ------------------ ---------- ------------------- ---------- OTHER OPERATING EXPENSES: Salaries, wages and employee benefits 14,843 13,864 5,024 4,619 Occupancy 1,851 1,702 640 603 Furniture and equipment 3,126 2,568 1,169 940 Other expenses 7,828 7,316 2,616 2,355 ------------------ ---------- ------------------- ---------- Total other operating expenses 27,648 25,450 9,449 8,517 ------------------ ---------- ------------------- ---------- Income before income taxes 22,313 19,578 7,724 7,267 Income tax expense 5,414 5,023 1,766 1,979 ------------------ ---------- ------------------- ---------- Net income $ 16,899 $ 14,555 $ 5,958 $ 5,288 ================== ========== =================== ========== Weighted average number of common shares: Basic 7,913,004 7,900,124 7,915,168 7,905,222 ================== ========== =================== ========== Diluted 7,926,053 7,900,606 7,928,641 7,905,431 ================== ========== =================== ========== Net income per share information: Basic $ 2.13 $ 1.84 $ 0.75 $ 0.67 ================== ========== =================== ========== Diluted $ 2.13 $ 1.84 $ 0.75 $ 0.67 ================== ========== =================== ========== Cash dividends per share $ 0.75 $ 0.70 $ 0.26 $ 0.24 ================== ========== =================== ========== See accompanying notes to consolidated financial statements.
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands) (Unaudited) Nine Months Ended Sept. 30, OPERATING ACTIVITIES: 1999 1998 ----------------------------- ---------- Net Income $ 16,899 $ 14,555 Adjustments to reconcile net inc. to net cash provided by operating activities: Provision for loan losses 1,430 1,680 Depreciation and amortization 1,863 1,542 Net amortization of investment securities discount/premiums 651 297 Net realized security gain (458) (900) Increase in accrued income receivable (1,260) (1,317) Increase (decrease) in accrued interest payable 2,494 (556) Net increase in other assets (1,735) (1,135) Net increase in other liabilities 3,729 3,078 Decrease in unearned income (2,493) (1,762) Write-down of other real estate owned 81 28 Increase in intangible assets (148) (82) ----------------------------- ---------- Net cash provided by operating activities 21,053 15,428 ----------------------------- ---------- INVESTING ACTIVITIES: Proceeds from sales of investment securities available for sale 42,170 40,572 Proceeds, maturity or calls of investment securities held to maturity 10,032 15,060 Proceeds, maturity or calls of investment securities available for sale 53,966 18,922 Purchases of investment securities held to maturity (3,703) - Purchases of investment securities available for sale (171,908) (150,070) Net (increase) decrease in interest-bearing deposits in banks (626) 2,699 Net increase in loans (128,317) (66,578) Net increase in premises and equipment (2,803) (2,111) Proceeds from sales of other real estate 1,556 756 Purchase of Bank-owned life insurance (25,170) - ----------------------------- ---------- Net cash used in investing activities (224,803) (140,750) ----------------------------- ---------- FINANCING ACTIVITIES: Net increase in deposits 91,473 76,231 Decrease in U.S. Treasury demand notes (730) (287) Increase in federal funds purchased 51,000 900 Increase in FHLB borrowings 47,750 38,000 Increase in securities sold under agreement 15,597 19,888 Cash dividends & fractional shares (6,003) (5,324) Stock options 39 354 ----------------------------- ---------- Net cash provided by financing activities 199,126 129,762 ----------------------------- ---------- Net (decrease) increase in cash and cash equivalents (4,624) 4,440 Cash and cash equivalents at beginning of period 53,630 52,991 ----------------------------- ---------- Cash and cash equivalents at end of the period $ 49,006 $ 57,431 ============================= ========== Cash paid during the period for Interest $ 30,950 $ 30,063 ============================= ========== Supplemental disclosure of noncash investing and financing activities: Transfer of assets from loans to other real estate owned $ 708 $ 925 ============================= ========== See accompanying notes to consolidated financial statements.
PAGE 6 HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the consolidated financial position of Harleysville National Corporation (or the "corporation") and its wholly owned subsidiaries - Harleysville National Bank and Trust Company, Citizens National Bank, Security National Bank and HNC Financial Company - as of September 30, 1999, the results of its operations for nine and three month periods ended September 30, 1999 and 1998 and the cash flows for the nine month periods ended September 30, 1999 and 1998. This quarterly report refers to the corporation's subsidiary banks, collectively as "the banks." It is suggested that these unaudited consolidated financial statements be read in conjunction with the audited consolidated financial statements of the corporation and the notes thereto set forth in the corporation's 1998 annual report. All prior period amounts were restated to reflect the acquisition of Northern Lehigh Bancorp. The results of operations for the nine and three month periods ended September 30, 1999 and 1998 are not necessarily indicative of the results to be expected for the full year. NOTE 2 - Income tax expense is less than the amount calculated using the statutory tax rate, primarily the result of tax exempt income earned from state and municipal securities, loans and bank-owned life insurance. NOTE 3 - On January 1, 1998, the corporation adopted the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards to provide prominent disclosure of comprehensive income items. Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Other comprehensive income consists of net unrealized gains (losses) on available for sale investment securities. Subsequent to the adoption date, all prior-period amounts are required to be restated to conform to the provision of SFAS No. 130. Comprehensive income for the first nine months of 1999 was $4,471,000, compared to $16,366,000 for the first nine months of 1998. The market value of the available for sale investment securities was reduced by the rise in interest rates experienced during 1999. The adoption of SFAS No. 130 did not have a material impact on the corporation's financial position or results of operation. NOTE 4 - On January 1, 1998, the corporation adopted the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 requires that public business enterprises report certain information about operating segments in complete sets of financial statements of the enterprise and in condensed financial statements of interim periods issued to shareholders. It also requires that public business enterprises report certain information about their products and services, the geographic areas in which they operate and their major customers. Management has determined that under current conditions, the corporation will report one business segment. NOTE 5 - In June 1998, the Financial Accounting standard Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activity." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments imbedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge. The accounting for changes in the fair value of derivative (gains and losses) depends on the intended use of the derivative and resulting designation. SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Earlier application is permitted only as of the beginning of any fiscal quarter. On January 1, 1999, the corporation adopted SFAS No. 133. Concurrent with the adoption, the corporation reclassified $7,530,000 of investment securities from the held to maturity category to the available for sale category and recorded $221,000 net of taxes of unrealized holding gains in accumulated other comprehensive income. PAGE 7 NOTE 6 - On January 20, 1999, the corporation consummated its acquisition of Northern Lehigh Bancorp, Inc., parent company of Citizens National Bank of Slatington. Accounted for as a pooling-of-interest, Northern Lehigh Bancorp shareholders received 3.57 shares of Harleysville National Corporation common stock for each share of Northern Lehigh Bancorp common stock. The acquisition was affected by the merger of Northern Lehigh Bancorp, Inc. with Harleysville National Corporation North, Inc., a bank holding company and wholly owned subsidiary of Harleysville National Corporation. Citizens National Bank of Slatington merged with and into The Citizens National Bank of Lansford, a national banking association and wholly owned subsidiary of Harleysville National Corporation North, Inc., under the name Citizens National Bank. PAGE 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS - --------------------- The following is management's discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for the corporation, the banks and HNC Financial Company. The corporation's consolidated financial condition and results of operations consist almost entirely of the banks financial condition and results of operations. Current performance does not guarantee, and may not be indicative of similar performance in the future. In addition to historical information, this Form 10-Q contains forward-looking statements. We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include the information concerning possible or assumed future results of operations of Harleysville National Corporation and its subsidiaries. When we use words such as "believes," "expects," "anticipates," or similar expressions, we are making forward-looking statements. Shareholders should note that many factors, some of which are discussed elsewhere in this document and in the documents that we incorporate by reference, could affect the future financial results of Harleysville National Corporation and its subsidiaries and could cause those results to differ materially from those expressed in our forward-looking statements contained or incorporated by reference in this document. These factors include the following: - - operating, legal and regulatory risks; - - economic, political and competitive forces affecting our banking, securities, asset management and credit services businesses; and - - the risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful. OVERVIEW - -------- The corporation continued its strong earnings performance during the third quarter of 1999. Net income increased 12.7% in the third quarter of 1999, compared to the third quarter of 1998. The year-to-date net income grew 16.1% from the same period in 1998. This performance was achieved through an increase in earning assets and a continuing emphasis on controlling overhead expenses. Consolidated net income for the first nine months of 1999 was $16,899,000, an increase of $2,344,000, or 16.1%, over the first nine months of 1998 net income of $14,555,000. Basic and diluted earnings per share for the first nine months of 1999 of $2.13 increased 15.8%, over the first nine months of 1998 basic and diluted earnings per share of $1.84. Consolidated net income for the third quarter of 1999 was $5,958,000, an increase of $670,000, or 12.7%, over the third quarter of 1998 net income of $5,288,000. For the quarter ended September 30, 1999, basic and diluted earnings per share at $.75 were up 11.9% from $.67 in the comparable period last year. The increase in net income during the first nine months of 1999, compared to the same period in 1998, is the result of both higher net interest income and other operating income, partially offset by higher other operating expenses. Net interest income grew $4,530,000, or 11.4%, primarily as a result of the 16.9% rise in average earning assets. Other operating income increased a modest $153,000 or 2.2%, due to the $442,000 decrease in security gains in 1999, compared 1998. Partially offsetting these increases was an 8.6% rise in other operating expenses, primarily related to the overall growth in the banks. The third quarter of 1999 rise in net income compared to the third quarter of 1998 is primarily the result of a $1,879,000 rise in net interest income related to the 19.5% increase in average earning assets during this period. PAGE 9 For the nine months ended September 30, 1999, the annualized return on average shareholders' equity and the annualized return on average assets were 17.24% and 1.53%, respectively. For the same period in 1998, the annualized return on average shareholders' equity was 15.78% and the annualized return on average assets was 1.55%. For the three months ended September 30, 1999, the annualized return on average shareholders' equity and the annualized return on average assets were 18.36% and 1.54%, respectively. For the same period in 1998, the annualized return on average shareholders' equity was 16.79% and the annualized return on average assets was 1.62%. As of September 30, 1999, the banks have seen an improvement in nonperforming assets, compared to December 31, 1998 and September 30, 1998, respectively. Nonperforming assets, including nonaccrual loans, restructured loans and other real estate owned, were $5,391,000, or .52% of total loans and net assets acquired in foreclosure at September 30, 1999, compared to .60% at December 31, 1998 and .62% at September 30, 1998. The ratio of the allowance for loan losses to nonperforming assets was 266.1% at September 30, 1999, an increase from 253.3% at December 31, 1998 and 249.9% at September 30, 1998. Loans 90 days or more past due were $2,376,000 at September 30, 1999, compared to the December 31, 1998 and September 30, 1998 levels of $1,350,000 and $778,000, respectively. As will be discussed in more detail latter, this increase was primarily due to a rise in commercial loans past due 90 days or more. Net income is affected by five major elements: net interest income, or the difference between interest income earned on loans and investments and interest expense paid on deposits and borrowed funds; the provision for loan losses, or the amount added to the allowance for loan losses to provide reserves for future losses on loans; other operating income, which is made up primarily of certain fees, trust income and gains and losses from sales of securities; other operating expenses, which consist primarily of salaries and other operating expenses; and income taxes. Each of these major elements will be reviewed in more detail in the following discussion. NET INTEREST INCOME AND RELATED ASSETS AND LIABILITIES - ------------------------------------------------------ Net interest income for the first nine months of 1999 was $44,155,000, an increase of $4,530,000, or 11.4%, over the first nine months of 1998 which was $39,625,000. As illustrated in the table below, the primary source of this increase was a rise in interest income resulting from increases to earning asset volumes in the first nine months of 1999, compared to the same period in 1998. The increase in interest income was partially offset by a rise in interest expense, as a result of higher deposit volumes. The third quarter 1999 net interest income rose 14.0% compared to the same period in 1998. This rise primarily resulted from the interest income generated by an increase in earning assets, partially offset by higher interest expense related to higher deposit volumes. The rate-volume variance analysis set forth in the table below, which is computed on a tax-equivalent basis (tax rate of 35%), analyzes changes in net interest income for the nine months ended September 30, 1999 over September 30, 1998 and the three months ended September 30, 1999 over September 30, 1998 by their rate and volume components.
Nine Months Ended Three Months Ended Sept. 30, 1999 Sept. 30, 1999 Over/Under Over/Under Sept. 30, 1998 Sept. 30, 1998 Total Caused by: Total Caused by: ------------ ----------- Variance Rate Volume Variance Rate Volume ---------- ------------ -------- ---------- ----------- -------- Interest Income: Securities * $ 5,125 $ 75 $ 5,050 $ 1,829 ($157) $ 1,986 Money market instruments (662) (187) (475) (304) (8) (296) Loans * 4,751 (2,708) 7,459 2,415 (648) 3,063 ---------- ------------ -------- ---------- ----------- -------- Total 9,214 (2,820) 12,034 3,940 (813) 4,753 ---------- ------------ -------- ---------- ----------- -------- Interest Expense: Savings deposits 184 (889) 1,073 88 (301) 389 Time deposits and certificates of deposit 736 (739) 1,475 270 (287) 557 Other borrowings 3,018 (67) 3,085 1,495 12 1,483 ---------- ------------ -------- ---------- ----------- -------- Total 3,938 (1,695) 5,633 1,853 (576) 2,429 ---------- ------------ -------- ---------- ----------- -------- Net interest income $ 5,276 ($1,125) $ 6,401 $ 2,087 ($237) $ 2,324 ========== ============ ======== ========== =========== ======== *Tax Equivalent Basis
PAGE 10 Taxable-equivalent net interest income was $48,342,000 for the first nine months of 1999, compared to $43,066,000 for the same period in 1998, a 12.3% or $5,276,000 increase. Taxable-equivalent net interest income rose primarily due to a $6,401,000 increase related to securities and loan volumes, which was partially offset by a reduction related to rate. Total taxable-equivalent interest income grew $9,214,000, primarily the result of the higher volumes in both the security and loan earning asset categories. Average year-to-date securities and loans grew $95,484,000 and $122,242,000, respectively at September 30, 1999, compared to the same period in 1998. This increase in securities included securities purchased as part of a capital leverage program. Securities purchased for the capital leverage program during the fourth quarter of 1998 and third quarter of 1999 were $49,000,000 and $25,000,000, respectively. The capital leverage program involves structured transactions in which the banks borrow funds from the Federal Home Loan Bank (FHLB) and invests these borrowed funds in securities that are priced to yield a spread over the FHLB borrowing rate. Total interest expense grew $3,938,000 during the first nine months of 1999, compared to the same period in 1998. This growth was principally the result of higher volumes associated with other borrowings. The average year-to-date other borrowings grew $85,824,000, compared to the first nine months of 1998. This increase in other borrowings is primarily attributable to the funding required for the $74,000,000 capital leverage program. The volume of savings and time deposits grew 12.4% and 9.1%, respectively. The remaining increase in deposit and other borrowing volumes was used to primarily finance the growth in loans. Other borrowings include federal funds purchased, FHLB borrowings, securities sold under agreements to repurchase and U. S. Treasury demand notes. Taxable-equivalent net interest income of $16,695,000 was $2,087,000 or 14.3% higher in the third quarter of 1999, compared to $14,608,000 for the same period in 1998. Interest income grew $3,940,000 during the period, as a result of an increase in security and loan volumes. Third quarter average securities and loans grew 31.5% and 17.6%, respectively, compared to the third quarter of 1998. The increase in the interest income was partially offset by a $1,853,000 rise in interest expense. Increases in all deposit category volumes contributed to this increase in interest expense. Non-accruing loans are included in the average balance yield calculations, but the average non-accruing loans had no material effect on the results. The banks actively manage their interest rate sensitivity positions. The objectives of interest rate risk management are to control exposure of net interest income to risks associated with interest rate movements and to achieve consistent growth in net interest income. The Asset/Liability Committee, using policies and procedures approved by the banks' Boards of Directors, is responsible for managing the rate sensitivity position. The banks manage interest rate sensitivity by changing mix and repricing characteristics of their assets and liabilities through their investment securities portfolio, borrowings from the FHLB and their offering of loan and deposit terms. The nature of the banks current operations is such that is not subject to foreign currency exchange or commodity price risk. The banks do not own trading assets and they do not have any hedging transactions in place such as interest rate swaps, caps or floors. The banks utilize three principal reports to measure interest rate risk: asset/liability simulation reports, gap analysis reports and net interest margin reports. PAGE 11 NET INTEREST MARGIN ------------------- The net interest margin of 4.59% for the nine-month period ended September 30, 1999, decreased from the 4.78% net interest margin for the same period of 1998. The decrease in the net interest margin is primarily due to the institution of the capital leverage programs during the fourth quarter of 1998 and the third quarter of 1999. At September 30, 1999, the capital leverage program was yielding a spread of 1.72%. The reduction in the net interest margin was also affected by the investment in bank owned life insurance from which the income is reported in other income and the cost of funding the investment is included in interest expense. Since the current competitive interest rate environment will continue to place downward pressure on the net interest margin, the banks expect an increase in net interest income through the continued growth in market share of loans and deposits. The yield on earning assets of 7.76% during the first nine months of 1999 was lower than the 8.05% earned during the first nine months of 1998. This drop in yield is primarily due to the capital leverage program and the lower average prime rate experienced in 1999, compared to 1998. The rates of all interest bearing liability categories decreased in the first nine months of 1999, compared to the same period in 1998. The third quarter 1999 net interest margin of 4.52% decreased from the third quarter of 1998 net interest margin of 4.72. PROVISION FOR LOAN LOSSES - ------------------------- The provision is based on management's analysis of the adequacy of the allowance for loan losses. In its evaluation, management considers past loan experience, overall characteristics of the loan portfolio, current economic conditions and other relevant factors. Based on the latest monthly evaluation of potential loan losses, the allowance is adequate to absorb known and inherent losses in the loan portfolio. Ultimately, however, the adequacy of the allowance is largely dependent upon the economy, a factor beyond the corporation's control. With this in mind, additions to the allowance for loan losses may be required in future periods, especially if economic trends worsen or certain borrowers' ability to repay declines. For the first nine months of 1999 the provision for loan losses was $1,430,000, compared to $1,680,000 for the same period in 1998. The lower provision for loan losses during the first nine months of 1999, compared to the same period in 1998 is attributable to the continued stability in the quality of the loan portfolio. Net loans charged-off were $788,000 for the nine months ended September 30, 1999, compared to $791,000 for the nine months ended September 30, 1998. The ratio of the allowance for loan losses to nonperforming assets for September 30, 1999 of 266.1% improved from the December 31, 1998 and the September 30, 1998 ratios of 253.3% and 249.9%, respectively. Allowance for Loan Losses - ------------------------- Transaction in the allowance for loan losses are as follows:
1999 1998 ----------------- ------------ Balance, Beginning of Year $13,706,000 $12,592,000 Provision charged to operating expenses 1,430,000 1,680,000 Loans charged off (991,000) (1,042,000) Recoveries 203,000 251,000 ----------------- ------------- Balance, September 30 14,348,000 13,481,000 ================= ============= Ratios: Sept. 30, 1999 Dec. 31, 1998 Sept. 30, 1998 - ------------------------------------------------- ----------------- --------------- ---------------- Allowance for loan losses to nonperforming assets 266.1% 253.3% 249.9% Nonperforming assets to total loans & net assets acquired in foreclosure 0.52% 0.60% 0.62% Allowance for loan losses to total loans 1.39% 1.52% 1.56%
PAGE 12 The following table sets forth an allocation of the allowance for loan losses by loan category: Sept. 30, 1999 --------------
Percent Amount of Loans ------- --------- Commercial and industrial $ 6,876 27% Consumer loans 3,874 32% Real estate 2,885 33% Lease financing 713 8% ------- --------- Total $14,348 100% ======= =========
Nonperforming assets (nonaccruing loans, net assets in foreclosure and troubled debt restructured loans) were 0.52% of total loans and net assets acquired in foreclosure at September 30, 1999, compared to 0.60% at December 31, 1998 and 0.62% at June 30, 1998. The ratio of the allowance for loan losses to loans at September 30, 1999 of 1.39% was lower than both the December 31, 1998 ratio of 1.52% and the September 30, 1998 ratio of 1.56%. Nonaccruing loans at September 30, 1999 of $4,715,000, increased $1,019,000 from the December 31, 1998 level of $3,696,000, and increased $1,087,000 from the September 30, 1998 level of $3,628,000. The growth during these periods was due to an increase in loans collateralized by commercial real estate. Net assets in foreclosure totaled $202,000 as of September 30, 1999, a decrease of $929,000 from the December 31, 1998 balance of $1,131,000. During the first nine months of 1999, transfers from loans to assets in foreclosure were $708,000, payments on foreclosed properties totaled $1,556,000 and write-downs of assets in foreclosure equaled $81,000. The loans transferred to assets in foreclosure included leases of $403,000, mortgages of $295,000 and consumer loans of $10,000. The balance of net assets in foreclosure at September 30, 1998 was $1,154,000. Efforts to liquidate assets acquired in foreclosure are proceeding as quickly as potential buyers can be located and legal constraints permit. Generally accepted accounting principles require foreclosed assets to be carried at the lower of cost (lesser of carrying value of asset or fair value at date of acquisition) or estimated fair value. As of September 30, 1999, there were two unrelated borrowers with troubled debt restructured loans totaling $473,000, compared with three unrelated borrowers with a balance of $583,000 as of December 31, 1998 and $612,000 at September 30, 1998. The two customers were complying with the restructured terms as of September 30, 1999. Loans past due 90 days or more and still accruing interest are loans that are generally well secured and expected to be restored to a current status in the near future. As of September 30, 1999, loans past due 90 days or more and still accruing interest were $2,376,000 compared to $1,350,000 as of December 31, 1998 and $778,000 as of September 30, 1998. The increase in loans past due 90 days at September 30, 1999, compared to December 31, 1998 and September 30, 1998 was primarily due to a rise in commercial loans past due 90 days or more. The following information concerns impaired loans:
Impaired Loans: Sept. 30, 1999 Dec. 31, 1998 Sept. 30, 1998 --------------- -------------- --------------- Restructured Loans $ 473,000 $ 583,000 $ 612,000 Nonaccrual Loans $ 3,186,000 $ 1,513,000 $ 1,743,000 --------------- -------------- --------------- Total Impaired Loans $ 3,659,000 $ 2,096,000 $ 2,355,000 =============== ============== =============== Average year-to-date impaired loans: $ 2,859,000 $ 2,263,000 $ 2,200,000 =============== ============== =============== Impaired loans with specific loss allowances: $ 3,659,000 $ 2,096,000 $ 2,355,000 =============== ============== =============== Loss allowances reserved on impaired loans: $ 467,000 $ 302,000 $ 335,000 =============== ============== =============== Year-to-date income recognized on impaired loans $ 106,000 $ 103,000 $ 49,000 =============== ============== ===============
PAGE 13 The banks' recognize interest income on impaired loans under the accrual method. The banks recognize income on nonaccrual loans under the cash basis method when the loans are both current and sufficiently collaterlized to cover the outstanding obligations to the banks. The banks will not recognize income if these factors do not exist. OTHER OPERATING INCOME - ----------------------
Nine Months Ended Sept. 30, Three Months Ended Sept. 30, 1999 1998 1999 1998 (Dollars in thousands) Service charges $2,611 $2,416 $ 903 $ 852 Security gains, net 458 900 7 574 Trust income 1,886 1,520 590 519 Bank-owned life insurance 170 - 170 - Other income 2,111 2,247 710 999 ------ ------ ------ ------ Total other operating income $7,236 $7,083 $2,380 $2,944 ====== ====== ====== ======
Other operating income for the first nine months of 1999 increased $153,000, or 2.2%, from $7,083,000 at September 30, 1998 to $7,236,000 at September 30, 1999. This rise in other operating income is the result of a $195,000 growth in service charges, a $170,000 increase due to bank-owned life insurance and a $366,000 rise in trust income. Offsetting these increases were decreases in security gains and other income of $442,000 and $136,000, respectively. In the third quarter of 1999 other income of $2,380,000 was $564,000 or 19.2% lower than the same period in 1998. A reduction in security gains was the primary source of this decrease. The $195,000, or 8.1% increase in service charges is primarily the result of a rise in fees charged on transaction deposit accounts. This increase in fees is due to the 12.4% increase in average deposit transaction accounts in the first nine months of 1999, compared to the first nine months in 1998. The 1999 third quarter service charge income of $903,000, increased $51,000, or 6.0% over the third quarter of 1998. The corporation recorded a net security gain of $458,000 in the first nine months of 1999, compared to a $900,000 gain in the same period in 1998. The third quarter of 1999 net security gain of $7,000 decreased from the $574,000 security gain recognized in the same period in 1998. The majority of the security gains in 1998 were the result of the sale of equity securities held at HNC Financial Company. From time to time, the corporation sells investment securities available for sale to fund the purchase of other securities in an effort to enhance the overall return of the portfolio. PAGE 14 Income from the corporation's Investment Management and Trust Services Division increased $366,000, or 24.1% in the first nine months of 1999, compared to the same period in 1998. The third quarter of 1999 trust income of $590,000, was 13.7% higher than the third quarter of 1998. This increase was the result of both an increase in the book value of trust assets under management of 14.5% from September 30, 1998 to September 30, 1999, and the corporation's continuing emphasis on marketing the Investment Management and Trust Services Division's products and services. During the third quarter of 1999, the corporation entered into a $25,000,000 investment of bank owned life insurance (BOLI). BOLI involves the corporation purchasing life insurance on a chosen group of employees. The corporation pays all premiums and is the owner and beneficiary of the policies. This pool of insurance, due to tax advantages unique to life insurance, is profitable to the corporation. This profitability is used to offset a portion of future benefit cost increases. Bank deposits fund BOLI and the earnings from BOLI are recognized as other income. The corporation recognized $170,000 of BOLI income during the third quarter of 1999. Other income for the first nine months of 1999 decreased $136,000, or 6.1%, compared to the same period in 1998. This decrease was primarily due to a reduction of $213,000 on gains on the sale of residential mortgage loans, resulting from the slowdown in the refinancing of residential mortgages during 1999. Offsetting this decrease were increases in gains on the sale of off lease vehicles and equipment, and a rise in ATM fees. The third quarter of 1999 other income of $710,000 was lower than the third quarter of 1998 other income of $999,000. This $289,000 reduction is attributed to lower gains recognized on the sale of residential mortgages during the third quarter of 1999, compared to the third quarter of 1998. OTHER OPERATING EXPENSES - ------------------------
Nine Months Ended Sept. 30, Three Months Ended Sept. 30, 1999 1998 1999 1998 (Dollars in thousands) Salaries $11,233 $10,561 $3,864 $3,590 Employee benefits 3,610 3,303 1,160 1,029 Net occupancy expense 1,851 1,702 640 603 Equipment expense 3,126 2,568 1,169 940 Other expenses 7,828 7,316 2,616 2,355 ------- ------- ------ ------ Total other operating expenses $27,648 $25,450 $9,449 $8,517 ======= ======= ====== ======
Other operating expenses for the first nine months of 1999 of $27,648,000 increased $2,198,000, or 8.6%, from $25,450,000 for the same period in 1998. The 1999 third quarter other operating expenses grew 10.9% compared to the third quarter of 1998. Our constant focus on controlling expenses and improving efficiencies has held the growth of our other operating expense much lower than our 20.7% growth in total assets and our 16.1% increase in year-to-date income. Employee salaries increased $672,000, or 6.4% from $10,561,000 for the first nine months of 1998 to $11,233,000 for the same period in 1999. Employee benefits of $3,610,000 expensed in the first nine months of 1999, were $307,000, or 9.3% higher than the $3,303,000 of employee benefits expensed during the same period in 1998. Salaries and employee benefits grew 7.6% and 12.7%, respectively in the third quarter of 1999, compared to the third quarter of 1998. The increase in salaries and employee benefits reflects cost of living increases, merit increases and additional staff necessitated by the growth of the banks. PAGE 15 Net occupancy expense increased $149,000, or 8.8%, from $1,702,000 in the first nine months of 1998 to $1,851,000 in the first nine months of 1999. The third quarter of 1999 occupancy expense grew 6.1%, compared to the third quarter of 1998. Two new branches opened after June 1998 were primarily responsible for the increase in occupancy expense. Equipment expense increased $558,000, or 21.7%, during the first nine months of 1999, compared to the same period in 1998. The third quarter of 1999 equipment expense grew 24.4% over the third quarter of 1998. This increase is due to both equipment depreciation and maintenance associated with planned increased technology capabilities used to manage the rise in volume related to the growth of the corporation and to enhanced the products offered to customers. Other expenses increased $512,000, or 7.0%, from $7,316,000 in the first nine months of 1998, compared to $7,828,000 in other expenses recorded during the same period in 1999. The third quarter of 1999 other expenses grew by 11.1% over the third quarter of 1998. This increase is the result of an additional accrual for a residual insurance account for leased automobiles and higher expenses associated with the overall growth of the banks. INCOME TAXES - ------------ Income tax expense is less than the amount calculated using the statutory tax rate primarily as a result of tax exempt income earned from state and municipal securities and loans. BALANCE SHEET ANALYSIS - ---------------------- INVESTMENT SECURITIES Total investment securities at September 30, 1999, of $482,088,000 grew $50,130,000, or 11.6% over the December 31, 1998 balance of $431,958,000. Securities purchased for the leverage program during third quarter of 1999 represented $25,000,000 of this growth. The September 30, 1999 balance grew $91,548,000, or 23.4% compared to the September 30, 1998 balance of $390,540,000. This increase included the $74,000,000 in securities purchased as part of the capital leverage program. LOANS Total loans grew $126,821,000, or 14.0% from the December 31, 1998 balance of $902,884,000 to the September 30, 1999 balance of $1,029,705,000. The September 30, 1999 balance grew $162,043,000, or 18.7% compared to the June 30, 1998 balance of $867,662,000. These increases were primarily due to growth in commercial loans, leases and indirect automobile lending. DEPOSITS & OTHER BORROWINGS The primary funding sources of the corporation is deposits and other borrowings. Total deposits of $1,195,789,000 at September 30, 1999, increased $91,473,000, or 8.3% from the $1,104,316,000 balance at December 31, 1998. This increases occurred primarily in money market accounts and certificates of deposits. The growth in deposits at September 30, 1999, compared to September 30, 1998 was $137,029,000, or 12.9%. All deposit categories increased during this period. Other borrowings of $262,595,000 at September 30, 1999, grew $113,617,000, compared to December 31, 1998. This growth was the result of increases in federal funds purchased and FHLB borrowings. The September 30, 1999 other borrowings increased $139,956,000, compared to the September 30, 1998 balance. This increase in other borrowings was used to fund the leverage program and loan demand. PAGE 16 CAPITAL - ------- Capital formation is important to the corporation's well being and future growth. Capital for the period ending September 30, 1999 was $129,460,000, a decrease of $1,493,000 over the end of 1998. The decrease was due to the adjustment for the net unrealized losses on the available for sale investment securities, partially offset by the retention of the corporation's earnings. Net unrealized gains and losses on available for sale investment securities are recorded as accumulated other comprehensive income in the equity section of the balance sheet. The accumulated other comprehensive income at September 30, 1999 was a loss of $7,044,000, compared to a gain of $5,384,000 at December 31, 1998. The market value of the available for sale investment securities was reduced due to the change in interest rates experienced during 1999. Management believes that the corporation's current capital and liquidity positions are adequate to support its operations. Management is not aware of any recommendations by any regulatory authority, which, if it were to be implemented, would have a material effect on the corporation's capital. (Dollars in thousands)
Capital Level required to Capital Level required As of September 30, 1999 Actual be Adequacy Capitalized to be Well Capitalized - ------------------------------------------ Amount Ratio Amount Ratio Amount Ratio -------- ------ -------------------------- ------ ----------------------- ------ Total Capital (to risk weighted assets): - ------------------------------------------ Corporation $150,110 12.85% $ 93,458 8.00% $ 116,822 10.00% Harleysville National Bank 80,705 9.16% 70,502 8.00% 88,127 10.00% Citizens National Bank 33,361 18.18% 14,679 8.00% 18,349 10.00% Security National Bank 8,324 9.81% 6,791 8.00% 8,489 10.00% Tier 1 Capital (to risk weighted assets): - ------------------------------------------ Corporation 135,279 11.58% 46,729 4.00% 70,093 6.00% Harleysville National Bank 69,874 7.93% 35,251 4.00% 52,876 6.00% Citizens National Bank 31,065 16.93% 7,340 4.00% 11,009 6.00% Security National Bank 7,293 8.59% 3,396 4.00% 5,093 6.00% Tier 1 Capital (to average assets): - ------------------------------------------ Corporation 135,279 8.74% 61,890 4.00% 77,362 5.00% Harleysville National Bank 69,874 6.05% 46,219 4.00% 57,774 5.00% Citizens National Bank 31,065 11.80% 10,533 4.00% 13,166 5.00% Security National Bank 7,293 6.36% 4,587 4.00% 5,734 5.00% (Dollars in thousands) Capital Level required to Capital Level required As of December 31, 1998 Actual be Adequacy Purposes to be Action Provision - ------------------------------------------ Amount Ratio Amount Ratio Amount Ratio -------- ------ -------------------------- ------ ----------------------- ------ Total Capital (to risk weighted assets): - ------------------------------------------ Corporation $137,371 13.77% $ 79,823 8.00% $ 99,778 10.00% Harleysville National Bank 70,733 9.70% 58,316 8.00% 72,895 10.00% Citizens National Bank 32,040 17.90% 14,321 8.00% 17,901 10.00% Security National Bank 7,629 10.74% 5,680 8.00% 7,101 10.00% Tier 1 Capital (to risk weighted assets): - ------------------------------------------ Corporation 124,039 12.43% 39,911 4.00% 59,867 6.00% Harleysville National Bank 61,603 8.45% 29,158 4.00% 43,737 6.00% Citizens National Bank 29,868 16.69% 7,160 4.00% 10,740 6.00% Security National Bank 6,741 9.49% 2,840 4.00% 4,260 6.00% Tier 1 Capital (to average assets): - ------------------------------------------ Corporation 124,039 9.05% 54,817 4.00% 68,521 5.00% Harleysville National Bank 61,603 6.11% 40,191 4.00% 50,238 5.00% Citizens National Bank 29,868 11.64% 10,263 4.00% 12,828 5.00% Security National Bank 6,741 7.10% 3,799 4.00% 4,749 5.00%
PAGE 17 The corporation's capital ratios exceed regulatory requirements. Existing minimum regulatory capital ratio requirements are 5.0% for primary capital and 6.0% for total capital. The corporation's primary capital ratio was 9.25% at September 30, 1999, compared with 9.80% at December 31, 1998. Since the corporation's only capital is primary capital, the total capital ratios are the same as the primary capital ratios. Pursuant to the federal regulators' risk-based capital adequacy guidelines, the components of capital are called Tier 1 and Tier 2 capital. For the corporation, Tier 1 capital is the shareholders' equity, and Tier 2 capital is the allowance for loan losses. The minimum for the Tier 1 ratio is 4.0% and the total capital ratio (Tier 1 plus Tier 2 capital divided by risk-adjusted assets) minimum is 8.0%. At September 30, 1999, the corporation's Tier 1 risk-adjusted capital ratio was 11.58%, and the total risk-adjusted capital ratio was 12.85%, both well above the regulatory requirements. The risk-based capital ratios of each of the corporation's commercial banks also exceeded regulatory requirements at September 30, 1999. The leverage ratio consists of Tier 1 capital divided by quarterly average total assets, excluding intangible assets. Banking organizations are expected to have ratios of at least 4% and 5%, depending upon their particular condition and growth plans. Higher leverage ratios could be required by the particular circumstances or risk profile of a given banking organization. The corporations leverage ratios were 8.74% at September 30, 1999 and 9.05% at December 31, 1998. The year-to-date September 30, 1999 cash dividend per share of $.75 was 7.1% higher than the cash dividend for the same period in 1998 of $.70. The dividend payout ratio for the first nine months of 1999 was 35.23%; compared to 38.91% for the twelve month period ended December 31, 1998. Activity in both the corporation's dividend reinvestment and stock purchase plan and the stock option plan did not have a material impact on capital during the first nine months of 1999. LIQUIDITY - --------- Liquidity is a measure of the ability of the banks to meet their needs and obligations on a timely basis. For a bank, liquidity provides the means to meet the day-to-day demands of deposit customers and the needs of borrowing customers. Generally, the banks arrange their mix of cash, money market investments, investment securities and loans in order to match the volatility, seasonality, interest sensitivity and growth trends of its deposit funds. Federal Funds sold averaged $9,025,000 during the first nine months of 1999 and securities available for sale averaged $427,720,000 during the first nine months of 1999, more than sufficient to meet normal fluctuations in loan demand or deposit funding. Backup sources of liquidity are provided by federal fund lines of credit established with correspondent banks. Additional liquidity could be generated through borrowings from the Federal Reserve Bank of Philadelphia and the FHLB of Pittsburgh, of which the banks are members. Unused lines of credit at the FHLB of Pittsburgh were $118,971,000, as of September 30, 1999. OTHER ITEMS - ----------- LEGISLATIVE & REGULATORY - ------------------------ From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of the corporation and the banks. We cannot predict whether the legislation will be enacted or, if enacted, how the legislation would affect the business of the corporation and the banks. As a consequence of the extensive regulation of commercial banking activities in the United States, the corporation's and the banks' business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business. Except as specifically described herein, management believes that the effect of the provisions of the aforementioned legislation on liquidity, capital resources and results of operations of the corporation will be immaterial. Other than as described below, management is not aware of any other current specific recommendations by regulatory authorities or proposed legislation, which if they were implemented, would have a material adverse effect upon the liquidity, capital resources, or results of operations, although the general cost of compliance with numerous and multiple federal and state laws and regulations does have, and in the future may have, a negative impact on the corporation's results of operations. PAGE 18 Further, the business of the corporation is also affected by the state of the financial services industry in general. As a result of legal and industry changes, management predicts that the industry will continue to experience an increase in consolidations and mergers as the financial services industry strives for greater cost efficiencies and market share. Management also expects increased diversification of financial products and services offered by the banks and its competitors. Management believes that such consolidations and mergers, and diversification of products and services may enhance the banks' competitive position. Pending Legislation ------------------- Congress approved legislation to modify the financial services industry and the way commercial banks and other financial institutions operate. The legislation only needs the President's signature to be enacted. The legislation includes changes to the ownership of financial companies and the types of products and services that may be offered by financial institu- tions. However, it is difficult to determine at this time what effect such provisions may have until they are enacted into law. Management believes that the effect of the provisions of the aforementioned legislation on the liquidity, capital resources, and results of operations of the corporation will be immaterial. Management is not aware of any other current specific recommendations by regulatory authorities or proposed legislation which, if they were implemented, would have a material adverse effect upon the liquidity, capital resources, or results of operations, although the general cost of compliance with numerous and multiple federal and state laws and regulations does have, and in the future may have, a negative impact on the corporation's results of operations. YEAR 2000 The following section contains forward-looking statements, that involve risks and uncertainties. The actual impact on the corporation of the Year 2000 issue could materially differ from that which is anticipated in the forward-looking statements as a result of certain factors identified below. Many existing computer programs use only two digits to identify a year in the date field. These programs were designed and developed without considering the impact of the upcoming century date change. If not corrected, many computer applications could fail or create erroneous results by or at the Year 2000 (Y2K). The Year 2000 issue affects virtually all companies and organizations. CORPORATION'S STATE OF READINESS The corporation began addressing the Y2K issue in August 1997. Management has initiated an enterprise-wide program to prepare the corporation's computer systems and applications for the Year 2000. The corporation developed a Y2K plan to include assessing the impact of the Y2K issue on the corporation, renovating systems to alleviate Y2K problems, validating the new systems and implementing them. The corporation focused on information technology and non-information technology systems. A non-information system could be, for example, a microcontroller in an elevator, which may be subject to Y2K problems. The corporation also reviewed Y2K issues related to material third parties. The assessment phase of the Y2K plan included assigning accountabilities throughout the corporation. An inventory was completed of mainframe and PC based applications, third-party relationships and non-information technology systems. The final step in the assessment phase was to identify non-compliant Y2K systems. The assessment phase was completed in November 1997. The corporation began the renovation phase of the Y2K plan in January 1998. The renovation phase included developing action plans to correct non-compliant Y2K systems. The action plans included either enhancing the current system to resolve the Y2K problem or purchasing a new system that is Y2K compliant. The renovation phase was completed in May 1998. The corporation developed a remediation plan for the non-compliant systems. The remediation phase was completed during the third quarter of 1999. PAGE 19 The next phase of the plan was to validate the Y2K compliance of all of the systems. This phase includes developing written test plans and completing the testing of the systems. The validation phase was completed during the first quarter of 1999. The corporation has reviewed the Y2K issues related to material third parties and completed an analysis on the loan portfolio. The corporation's third parties include its vendors and commercial customers. Our material third party relationships are primarily our commercial borrowers. These borrowers may pose a credit risk to the corporation if they are not Y2K compliant. We have contacted the material commercial customers and their responses were evaluated. We have also performed an analysis on the impact of Y2K issues on the remaining loan portfolio. Because most computer systems are, by their very nature, interdependent, it is possible that noncompliant third-party computers could impact the corporation's computer systems. The corporation could be adversely affected by the Y2K problem if it or unrelated parties fail to successfully address the problem. The corporation has taken steps to communicate with the unrelated parties with whom it deals to coordinate Year 2000 compliance. Additionally, we are dependent on external suppliers, such as, wire transfer systems, telephone systems, electric companies, and other utility companies for continuation of service. COST OF YEAR 2000 The Y2K Committee has prepared a Y2K budget and has tracked expenses related to the Y2K issue. As of September 30, 1999, the corporation has expensed $227,000 and capitalized fixed assets of $116,000 related to the Y2K issue. The corporation has estimated the future Y2K expenditures to be $128,000. The Y2K project is being funded through operating cash flows. The cost of the projects and the date on which the corporation plans to complete both Year 2000 modifications and systems conversions are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third-party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those plans. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties. RISK OF YEAR 2000 At present, management believes its progress in remedying the proprietary programs and installing the Y2K compliant upgrades to the third-party vendor mainframe and PC based computer applications is on target. The Y2K computer problem creates risk for the corporation from unforeseen problems in its own computer systems and from third-party vendors who provide the majority of mainframe and PC based computer applications. Failure of third-party systems relative to the Y2K issue could have a material impact on the corporation's ability to conduct business and on its financial position and results of operation. CONTINGENCY PLANS The corporation has developed a contingency plan to handle the most reasonably likely Y2K worst-case scenario should it occur. The contingency plan involves obtaining back-up service providers, devising specific plans for key operations and assessing the potential adverse risks to the corporation. The contingency plan was completed during the first quarter of 1999. The testing of the contingency plan was completed during the third quarter of 1999. The corporation has also utilized an independent consulting firm to verify and validate the corporation's Y2K plans. PAGE 20 BRANCHING --------- The corporation's subsidiaries currently plan to open at least one new branch. Harleysville National Bank is pursuing a location in Souderton. This new branch site is contiguous to our current service area and was chosen to expand the banks' market area and market share of loans and deposits. ACQUISITION - ----------- On January 20, 1999, the corporation consummated its acquisition of Northern Lehigh Bancorp, Inc., parent company of Citizens National Bank of Slatington. Accounted for as a pooling-of-interest, Northern Lehigh Bancorp shareholders received 3.57 shares of Harleysville National Corporation common stock for each share of Northern Lehigh Bancorp common stock. The acquisition was affected by the merger of Northern Lehigh Bancorp, Inc. with Harleysville National Corporation North, Inc., a bank holding company and wholly owned subsidiary of Harleysville National Corporation. Citizen's National Bank of Slatington merged with and into The Citizens National Bank of Lansford, a national banking association and wholly owned subsidiary of Harleysville National Corporation North, Inc., under the name Citizens National Bank. ITEM 3 - Qualitative and Quantitative Disclosures about Market Risk In the normal course of conducting business activities, the corporation is exposed to market risk, principally interest risk, through the operations of its banking subsidiaries. Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and values of financial instruments. The Asset/Liability Committee, using policies and procedures approved by the banks' Boards of Directors, is responsible for managing the rate sensitivity position. No material changes in market risk strategy occurred during the current period. A detailed discussion of market risk is provided in the SEC Form 10-K for the period ended December 31, 1998. PAGE 21 PART II. OTHER INFORMATION Item 1. Legal Proceedings. - ------- ------------------ Management, based upon discussions with the corporation's legal counsel, is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the corporation. There are no proceedings pending other than the ordinary routine litigation incident to the business of the corporation and its subsidiaries - Harleysville National Bank and Trust Company, Citizens National Bank, Security National Bank and HNC Financial Company. In addition, no material proceedings are pending or are known to be threatened or contemplated against the corporation and its subsidiaries by government authorities. Item 2. Change in Securities and Use of Proceeds - ------------------------------------------------ Not applicable. Item 3. Defaults Upon Senior Securities. - --------------------------------------- Not applicable. Item 4. Submission of Matters to a Vote of Security Holders. - ------------------------------------------------------------ None. Item 5. Other Information. - ------------------------- None. Item 6. Exhibits and Reports on Form 8-K. - ---------------------------------------- (a) Exhibits: The following exhibit is being filed as part of this Report: Exhibit No. Description of Exhibits - -------------------------------------- (3.1) Harleysville National Corporation Articles of Incorporation, as amended. (Incorporated by reference to Exhibit 3(a) to the corporation's Registration Statement No. 33-65021 on Form S-4, as filed on December 14, 1995.) (3.2) Harleysville National Corporation By-laws. (Incorporated by reference to Exhibit 3(b) to the corporation's Registration Statement No. 33-65021 on Form S-4, as filed on December 14, 1995.) (10.1) Harleysville National Corporation 1993 Stock Incentive Plan. (Incorporated by Reference to Exhibit 4.3 of Registrant's Registration Statement No. 33-57790 on Form S-8, filed with the Commission on October 1, 1993.) (10.2) Harleysville National Corporation Stock Bonus Plan. (Incorporated by Reference to Exhibit 99A of Registrant's Registration Statement No. 33-17813 on Form S-8, filed with the Commission on December 13, 1996.) (10.3) Supplemental Executive Retirement Plan. (Incorporated by Reference to Exhibit 10.3 of Registrant's Annual Report in Form 10-K for the year ended December 31, 1997, filed with the Commission on March 27, 1998.) PAGE 22 (10.4) Walter E. Daller, Jr., Chairman, President and Chief Executive Officer's employment agreement. (Incorporated by Reference to Registrant's Registration Statement on Form 8-K, filed with the Commission on March 25, 1999.) (10.5) Demetra M. Takes, President and Chief Operating Officer of Harleysville employment agreement. (Incorporated by Reference to Registrant's Registration Statement on Form 8-K, filed with the Commission on March 25, 1999.) (10.6) Vernon L. Hunsberger Senior Vice President/CFO and Cashier's employment agreement. (Incorporated by Reference to Registrant's Registration Statement on Form 8-K, filed with the Commission on March 25, 1999.) (10.7) Harleysville National Corporation 1998 Stock Incentive Plan. (Incorporated by Reference to Registrant's Registration Statement No.333-79971 on Form S-8 filed with the Commission on June 4, 1999.) (10.8) Harleysville National Corporation 1998 Independent Directors Stock Option Plan. (Incorporated by Reference to Registrant's Registration Statement No. 333-79973 on Form S-8 filed with the Commission on June 4, 1999.) (11) Computation of Earnings per Common Share. The information for this Exhibit is incorporated by reference to page 4 of this Form 10-Q. (27) Financial Data Schedule. (b) Reports on Form 8-K: None. PAGE 23 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HARLEYSVILLE NATIONAL CORPORATION /s/ Walter E. Daller, Jr. ________________________________ Walter E. Daller, Jr., President and Chief Executive Officer (Principal executive officer) /s/ Vernon L. Hunsberger _________________________ Vernon L. Hunsberger, Treasurer (Principal financial and accounting officer) Date: November 12, 1999 PAGE 24 EXHIBIT INDEX ------------- Exhibit No. Description of Exhibits - ---------- ----------------------- (3.1) Harleysville National Corporation Articles of Incorporation, as amended. (Incorporated by reference to Exhibit 3(a) to the corporation's Registration Statement No. 33-65021 on Form S-4, as filed on December 14, 1995.) (3.2) Harleysville National Corporation By-laws. (Incorporated by reference to Exhibit 3(b) to the corporation's Registration Statement No. 33-65021 on Form S-4, as filed on December 14, 1995.) (10.1) Harleysville National Corporation 1993 Stock Incentive Plan. (Incorporated by Reference to Exhibit 4.3 of Registrant's Registration Statement No. 33-57790 on Form S-8, filed with the Commission on October 1, 1993.) (10.2) Harleysville National Corporation Stock Bonus Plan. (Incorporated by Reference to Exhibit 99A of Registrant's Registration Statement No. 33-17813 on Form S-8, filed with the Commission on December 13, 1996.) (10.3) Supplemental Executive Retirement Plan. (Incorporated by Reference to Exhibit 10.3 of Registrant's Annual Report in Form 10-K for the year ended December 31, 1997, filed with the Commission on March 27, 1998.) (10.4) Walter E. Daller, Jr., Chairman, President and Chief Executive Officer's employment agreement. (Incorporated by Reference to Registrant's Registration Statement on Form 8-K, filed with the Commission on March 25, 1999.) (10.5) Demetra M. Takes, President and Chief Operating Officer of Harleysville employment agreement. Incorporated by Reference to Registrant's Registration Statement on Form 8-K, filed with the Commission on March 25, 1999.) (10.6) Vernon L. Hunsberger Senior Vice President/CFO and Cashier's employment agreement. (Incorporated by Reference to Registrant's Registration Statement on Form 8-K, filed with the Commission on March 25, 1999.) (10.7) Harleysville National Corporation 1998 Stock Incentive Plan. (Incorporated by Reference to Registrant's Registration Statement No. 333-79971 on Form S-8 filed with the Commission on June 4, 1999). (10.8) Harleysville National Corporation 1998 Independent Directors Stock Option Plan. (Incorporated by Reference to Registrant's Registration Statement No. 333-79973 on Form S-8 filed with the Commission on June 4, 1999.) (11) Computation of Earnings per Common Share. The information for this Exhibit is incorporated by reference to page 4 of this Form 10-Q. (27) Financial Data Schedule. EX-27 2
9 1,000 9-MOS DEC-31-1999 SEP-30-1999 0 4,333 0 0 470,415 11,673 11,621 1,029,624 14,348 1,615,218 1,195,789 213,845 27,374 48,750 0 0 7,915 121,545 1,615,218 57,577 19,596 426 77,599 27,345 33,444 44,155 1,430 458 27,648 22,313 22,313 0 0 16,899 2.13 2.13 4.59 4,715 2,376 473 0 13,706 991 203 14,348 14,348 0 0
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