33
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, 2002.
------------------
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.
---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). 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: 19,041,602 shares of Common
Stock, $1.00 par value, outstanding on November 12, 2002.
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, 2002 and December 31, 2001 . . . . . . . . . . . . . . 3
Consolidated Statements of Income - Nine Months and Three Months Ended September 30, 2002 and 2001 4
Consolidated Statements of Shareholders' Equity - Nine Months Ended September 30, 2002 and Twelve. 5
Months Ended December 31, 2001
Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2002 and 2001. . . . . . . 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 . . . . . . . . . . . . . . . . . . . 23
Item 4. Controls and Procedures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Part II. Other Information
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Item 2. Change in Securities and Use of Proceeds. . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . . . . . . . . . . . . . . . . . 26
Item 5. Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
PAGE 2
PART 1. FINANCIAL INFORMATION
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands) (Unaudited)
September 30, 2002 December 31, 2001
-------------------- -------------------
ASSETS
Cash and due from banks. . . . . . . . . . . . . . . . . . . . . $ 73,428 $ 62,974
Fed funds sold . . . . . . . . . . . . . . . . . . . . . . . . . 19,100 12,500
Interest-bearing deposits in banks . . . . . . . . . . . . . . . 5,920 7,150
-------------------- -------------------
Total cash and cash equivalents. . . . . . . . . . . . . . . 98,448 82,624
-------------------- -------------------
Investment securities available for sale . . . . . . . . . . . . 926,529 706,371
Investment securities held to maturity . . . . . . . . . . . . . 22,747 26,099
(fair value $24,224 and $26,782, respectively)
Total loans and leases . . . . . . . . . . . . . . . . . . . . . 1,344,199 1,316,609
Less: Allowance for loan losses. . . . . . . . . . . . . . . . . (17,139) (15,558)
-------------------- -------------------
Net loans . . . . . . . . . . . . . . . . . . . . . 1,327,060 1,301,051
-------------------- -------------------
Bank premises and equipment, net . . . . . . . . . . . . . . . . 21,641 21,439
Accrued income receivable. . . . . . . . . . . . . . . . . . . . 13,496 11,907
Net assets in foreclosure. . . . . . . . . . . . . . . . . . . . 473 609
Intangible assets, net . . . . . . . . . . . . . . . . . . . . . 1,648 1,360
Bank-owned life insurance. . . . . . . . . . . . . . . . . . . . 47,842 45,942
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . 12,168 11,569
-------------------- -------------------
Total assets. . . . . . . . . . . . . . . . . . . . . . $ 2,472,052 $ 2,208,971
==================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing . . . . . . . . . . . . . . . . . . . . . $ 267,254 $ 254,638
Interest-bearing:
Checking accounts . . . . . . . . . . . . . . . . . . . . . 251,571 169,156
Money market accounts . . . . . . . . . . . . . . . . . . . 427,006 419,890
Savings . . . . . . . . . . . . . . . . . . . . . . . . . . 197,122 179,284
Time, under $100,000. . . . . . . . . . . . . . . . . . . . 534,967 489,345
Time, $100,000 or greater . . . . . . . . . . . . . . . . . 273,279 234,549
-------------------- -------------------
Total deposits . . . . . . . . . . . . . . . . . . . . 1,951,199 1,746,862
Accrued interest payable . . . . . . . . . . . . . . . . . . . . 22,138 27,114
U.S. Treasury demand notes . . . . . . . . . . . . . . . . . . . 2,015 2,677
Federal Home Loan Bank (FHLB) borrowings . . . . . . . . . . . . 162,750 127,750
Securities sold under agreements to repurchase . . . . . . . . . 85,237 80,393
Guaranteed preferred beneficial interest in Corporation's
subordinated debentures. . . . . . . . . . . . . . . . . . . . 5,000 5,000
Other liabilities. . . . . . . . . . . . . . . . . . . . . . . . 35,047 29,826
-------------------- -------------------
Total liabilities. . . . . . . . . . . . . . . . . . . 2,263,386 2,019,622
-------------------- -------------------
Shareholders' Equity:
Series preferred stock, par value $1 per share;
authorized 8,000,000 shares, none issued. . . . . . . . . - -
Common stock, par value $1 per share; authorized 75,000,000
shares; issued and outstanding 19,580,179 shares in 2002
and 18,570,971 shares in 2001 . . . . . . . . . . . . . . 19,580 18,571
Additional paid in capital . . . . . . . . . . . . . . . . . 96,362 71,419
Retained earnings. . . . . . . . . . . . . . . . . . . . . . 90,353 100,171
Treasury stock, at cost: 481,507 shares in 2002
and 287,440 shares in 2001. . . . . . . . . . . . . . . . (9,463) (5,346)
Accumulated other comprehensive income . . . . . . . . . . . 11,834 4,534
-------------------- -------------------
Total shareholders' equity . . . . . . . . . . . . . . 208,666 189,349
-------------------- -------------------
Total liabilities and shareholders' equity . . . . . . $ 2,472,052 $ 2,208,971
==================== ===================
See accompanying notes to consolidated financial statements.
PAGE 3
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) Nine months ended Three months ended
September 30, September 30,
--------------- ---------------
(Dollars in thousands except weighted average number
of common shares and per share information)
2002 2001 2002 2001
----------- ----------- ----------- -----------
INTEREST INCOME:
Loans, including fees . . . . . . . . . . . . . . . . . . $ 63,793 $ 68,008 $ 21,012 $ 22,821
Lease financing . . . . . . . . . . . . . . . . . . . . . 6,476 7,377 2,188 2,439
Investment securities:
Taxable. . . . . . . . . . . . . . . . . . . . . . . . 20,827 19,820 6,555 6,893
Exempt from federal taxes. . . . . . . . . . . . . . . 8,748 8,174 3,266 2,551
Federal funds sold. . . . . . . . . . . . . . . . . . . . 275 449 53 215
Deposits in banks . . . . . . . . . . . . . . . . . . . . 140 227 44 90
----------- ----------- ----------- -----------
Total interest income . . . . . . . . . . . . . . . 100,259 104,055 33,118 35,009
----------- ----------- ----------- -----------
INTEREST EXPENSE:
Savings deposits. . . . . . . . . . . . . . . . . . . . . 8,923 13,939 3,081 4,170
Time, under $100,000. . . . . . . . . . . . . . . . . . . 17,905 19,431 5,982 6,715
Time, $100,000 or greater . . . . . . . . . . . . . . . . 5,680 8,447 1,896 2,773
Borrowed funds. . . . . . . . . . . . . . . . . . . . . . 7,014 8,262 2,480 2,585
----------- ----------- ----------- -----------
Total interest expense. . . . . . . . . . . . . . . 39,522 50,079 13,439 16,243
----------- ----------- ----------- -----------
Net interest income . . . . . . . . . . . . . . . . 60,737 53,976 19,679 18,766
Provision for loan losses . . . . . . . . . . . . . . . . 3,401 2,962 956 1,353
----------- ----------- ----------- -----------
Net interest income after provision for loan losses 57,336 51,014 18,723 17,413
----------- ----------- ----------- -----------
OTHER OPERATING INCOME:
Service charges . . . . . . . . . . . . . . . . . . . . . 4,993 3,878 1,846 1,403
Security gains, net . . . . . . . . . . . . . . . . . . . 3,193 3,923 719 2,140
Trust income. . . . . . . . . . . . . . . . . . . . . . . 2,322 2,541 726 826
Bank-owned life insurance income. . . . . . . . . . . . . 1,900 1,818 631 535
Other Income. . . . . . . . . . . . . . . . . . . . . . . 4,675 3,409 1,519 1,352
----------- ----------- ----------- -----------
Total other operating income. . . . . . . . . . . . 17,083 15,569 5,441 6,256
----------- ----------- ----------- -----------
Net interest income after provision for loan losses
and other operating income . . . . . . . . . . . 74,419 66,583 24,164 23,669
----------- ----------- ----------- -----------
OTHER OPERATING EXPENSES:
Salaries, wages and employee benefits . . . . . . . . . . 22,631 19,644 7,550 6,739
Occupancy . . . . . . . . . . . . . . . . . . . . . . . . 2,902 2,457 844 792
Furniture and equipment . . . . . . . . . . . . . . . . . 4,034 3,776 1,428 1,310
Other expenses. . . . . . . . . . . . . . . . . . . . . . 13,127 13,572 3,679 4,903
----------- ----------- ----------- -----------
Total other operating expenses. . . . . . . . . . . 42,694 39,449 13,501 13,744
----------- ----------- ----------- -----------
Income before income tax expense. . . . . . . . . . 31,725 27,134 10,663 9,925
Income tax expense. . . . . . . . . . . . . . . . . . . . 7,121 5,859 2,250 2,302
----------- ----------- ----------- -----------
Net income. . . . . . . . . . . . . . . . . . . . . . . . $ 24,604 $ 21,275 $ 8,413 $ 7,623
=========== =========== =========== ===========
Weighted average number of common shares:
Diluted * . . . . . . . . . . . . . . . . . . . . 19,715,987 19,682,612 19,687,990 19,629,108
=========== =========== =========== ===========
Basic * . . . . . . . . . . . . . . . . . . . . . 19,141,516 19,227,650 19,113,519 19,174,146
=========== =========== =========== ===========
Net income per share information:
Diluted * . . . . . . . . . . . . . . . . . . . . $ 1.25 $ 1.08 $ 0.43 $ 0.39
=========== =========== =========== ===========
Basic * . . . . . . . . . . . . . . . . . . . . . $ 1.29 $ 1.11 $ 0.44 $ 0.40
=========== =========== =========== ===========
Cash dividends per share *. . . . . . . . . . . . . . . . $ 0.495 $ 0.438 $ 0.171 $ 0.152
=========== =========== =========== ===========
* Adjusted for 5% stock dividend effective September 16, 2002 and 100% stock
dividend effective August 10, 2001.
See accompanying notes to consolidated financial statements.
PAGE 4
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
NINE MONTHS ENDED SEPTEMBER 30, 2002
Accumulated
Common Stock Other
--------------
(Dollars in thousands) Number of Par Additional Retained Comprehensive
Shares Value Paid in Capital Earnings Income
-------------- ----------------- ----------------- ---------- ---------------
Balance, January 1, 2002. . . . . . . 18,571 $ 18,571 $ 71,419 $ 100,171 $ 4,534
Stock options . . . . . . . . . . . . 77 77 944 - -
Stock dividends . . . . . . . . . . . 932 932 23,993 (24,942) -
Stock awards. . . . . . . . . . . . . - - 6 - -
Net income. . . . . . . . . . . . . . - - - 24,604 -
Other comprehensive income,
net of reclassifications and tax. . - - - - 7,300
Purchases of Treasury stock . . . . . (4,117) (4,117)
Cash dividends. . . . . . . . . . . . - - - (9,480) -
-------------- ----------------- ----------------- ---------- ---------------
Comprehensive income. . . . . . . . .
Balance, September 30, 2002 . . . . . 19,580 $ 19,580 $ 96,362 $ 90,353 $ 11,834
============== ================= ================= ========== ===============
FOR THE YEAR ENDED DECEMBER 31, 2001
Accumulated
Common Stock Other
- -------------------------------------
(Dollars in thousands). . . . . . . . Number of Par Additional Retained Comprehensive
Shares Value Paid in Capital Earnings Income
- ------------------------------------- -------------- ----------------- ----------------- ---------- ---------------
Balance, January 1, 2001. . . . . . . 9,254 $ 9,254 $ 79,869 $ 83,244 $ 1,422
Stock options . . . . . . . . . . . . 44 44 812 - -
Stock dividends . . . . . . . . . . . 9,273 9,273 (9,273) -
Stock awards. . . . . . . . . . . . . 11
Net income. . . . . . . . . . . . . . - - - 28,820 -
Other comprehensive income,
net of reclassifications and tax. . - - - - 3,112
Purchases of Treasury stock . . . . .
Cash dividends. . . . . . . . . . . . - - - (11,893) -
-------------- ----------------- ----------------- ---------- ---------------
Comprehensive income. . . . . . . . .
Balance, December 31, 2001. . . . . . 18,571 $ 18,571 $ 71,419 $ 100,171 $ 4,534
============== ================= ================= ========== ===============
(Dollars in thousands) Treasury Comprehensive
Stock Total Income
---------- --------------- -------
Balance, January 1, 2002. . . . . . . $ (5,346) $ 189,349
Stock options . . . . . . . . . . . . - 1,021
Stock dividends (17)
Stock awards. . . . . . . . . . . . . - 6
Net income. . . . . . . . . . . . . . - 24,604 $24,604
Other comprehensive income,
net of reclassifications and tax. . - 7,300 7,300
Purchases of Treasury stock (4,117) (4,117)
Cash dividends. . . . . . . . . . . . - (9,480)
---------- ---------------
Comprehensive income $ 31,904
==============
Balance, September 30, 2002 . . . . . $ (9,463) $ 208,666
========== ===============
FOR THE YEAR ENDED DECEMBER 31, 2001
Accumulated
Common Stock
- -------------------------------------
(Dollars in thousands). . . . . . . . Treasury Comprehensive
Shares. . . . . . . . . . . . . . . Stock Total Income
- ------------------------------------- ---------- ---------------
Balance, January 1, 2001. . . . . . . $ (253) $ 173,536
Stock options . . . . . . . . . . . . - 856
Stock dividends
Stock awards 11
Net income. . . . . . . . . . . . . . - 28,820 $28,820
Other comprehensive income,
net of reclassifications and tax. . - 3,112 3,112
Purchases of Treasury stock (5,093) (5,093)
Cash dividends. . . . . . . . . . . . - (11,893)
---------- ---------------
Comprehensive income $ 31,932
========
Balance, December 31, 2001. . . . . . $ (5,346) $ 189,349
========== ===============
See accompanying notes to consolidated financial statements.
PAGE 5
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands) Nine Months Ended Sept.30,
OPERATING ACTIVITIES: . . . . . . . . . . . . . . . . . . . . . . . . . . 2002
-----------------------
Net Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 24,604
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . 3,401
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . 1,961
Net amortization of investment
securities discount/premiums. . . . . . . . . . . . . . . . . . . . 2,045
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . (2,642)
Net realized security gains . . . . . . . . . . . . . . . . . . . . . (3,193)
Increase in accrued income receivable . . . . . . . . . . . . . . . . (1,589)
(Decrease) increase in accrued interest payable . . . . . . . . . . . (4,976)
(Increase) decrease in other assets . . . . . . . . . . . . . . . . . (599)
Net increase in other liabilities . . . . . . . . . . . . . . . . . . 3,877
Decrease (increase) in deferred cost, net . . . . . . . . . . . . . . 906
Write-down of other real estate owned . . . . . . . . . . . . . . . . 68
(Increase) decrease in intangible assets. . . . . . . . . . . . . . . (288)
-----------------------
Net cash provided by operating activities. . . . . . . . . . . . . $ 23,575
-----------------------
INVESTING ACTIVITIES:
Proceeds from sales of investment securities available for sale . . . . $ 568,561
Proceeds, maturity or calls of investment securities held to maturity . 3,408
Proceeds, maturity or calls of investment securities available for sale 184,988
Purchases of investment securities available for sale . . . . . . . . . (961,328)
Net increase in loans . . . . . . . . . . . . . . . . . . . . . . . . . (31,106)
Net increase in premises and equipment. . . . . . . . . . . . . . . . . (2,163)
Net increase in bank-owned life insurance . . . . . . . . . . . . . . . (1,900)
Proceeds from sales of other real estate. . . . . . . . . . . . . . . . 857
-----------------------
Net cash used in investing activities. . . . . . . . . . . . . . . $ (238,683)
-----------------------
FINANCING ACTIVITIES:
Net increase in deposits. . . . . . . . . . . . . . . . . . . . . . . . $ 204,337
(Decrease) increase in U.S. Treasury demand notes . . . . . . . . . . . (662)
Decrease in federal funds purchased . . . . . . . . . . . . . . . . . . -
Increase in FHLB borrowings . . . . . . . . . . . . . . . . . . . . . . 35,000
Increase in securities sold under agreement . . . . . . . . . . . . . . 4,844
Proceeds from issuance of guaranteed preferred beneficial interest
in Corporation's subordinated debentures. . . . . . . . . . . . . . . -
Cash dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (9,480)
Repurchase of common stock. . . . . . . . . . . . . . . . . . . . . . . (4,117)
Stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,021
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (11)
-----------------------
Net cash provided by financing activities . . . . . . . . . . . . . . $ 230,932
-----------------------
Net increase in cash and cash equivalents . . . . . . . . . . . . . . . . $ 15,824
Cash and cash equivalents at beginning of period. . . . . . . . . . . . . 82,624
-----------------------
Cash and cash equivalents at end of the period. . . . . . . . . . . . . . $ 98,448
=======================
Cash paid during the period for:
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 44,498
=======================
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,000
=======================
Supplemental disclosure of noncash investing and financing activities:
Transfer of assets from loans to other real estate owned . . . . . $ 789
=======================
Nine Months Ended Sept.30,
OPERATING ACTIVITIES: . . . . . . . . . . . . . . . . . . . . . . . . . . 2001
----------------------------
Net Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 21,275
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . 2,962
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . 2,033
Net amortization of investment
securities discount/premiums. . . . . . . . . . . . . . . . . . . . 692
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . 2,091
Net realized security gains . . . . . . . . . . . . . . . . . . . . . (3,923)
Increase in accrued income receivable . . . . . . . . . . . . . . . . (997)
(Decrease) increase in accrued interest payable . . . . . . . . . . . 3,935
(Increase) decrease in other assets . . . . . . . . . . . . . . . . . 113
Net increase in other liabilities . . . . . . . . . . . . . . . . . . 4,113
Decrease (increase) in deferred cost, net . . . . . . . . . . . . . . (624)
Write-down of other real estate owned . . . . . . . . . . . . . . . . 17
(Increase) decrease in intangible assets. . . . . . . . . . . . . . . 122
----------------------------
Net cash provided by operating activities. . . . . . . . . . . . . $ 31,809
----------------------------
INVESTING ACTIVITIES:
Proceeds from sales of investment securities available for sale . . . . $ 282,085
Proceeds, maturity or calls of investment securities held to maturity . 4,051
Proceeds, maturity or calls of investment securities available for sale 88,014
Purchases of investment securities available for sale . . . . . . . . . (473,824)
Net increase in loans . . . . . . . . . . . . . . . . . . . . . . . . . (97,243)
Net increase in premises and equipment. . . . . . . . . . . . . . . . . (1,385)
Net increase in bank-owned life insurance . . . . . . . . . . . . . . . (1,818)
Proceeds from sales of other real estate. . . . . . . . . . . . . . . . 963
----------------------------
Net cash used in investing activities. . . . . . . . . . . . . . . $ (199,157)
----------------------------
FINANCING ACTIVITIES:
Net increase in deposits. . . . . . . . . . . . . . . . . . . . . . . . $ 218,658
(Decrease) increase in U.S. Treasury demand notes . . . . . . . . . . . 429
Decrease in federal funds purchased . . . . . . . . . . . . . . . . . . (44,500)
Increase in FHLB borrowings . . . . . . . . . . . . . . . . . . . . . . 17,000
Increase in securities sold under agreement . . . . . . . . . . . . . . 11,556
Proceeds from issuance of guaranteed preferred beneficial interest
in Corporation's subordinated debentures. . . . . . . . . . . . . . . 5,000
Cash dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,423)
Repurchase of common stock. . . . . . . . . . . . . . . . . . . . . . . (5,049)
Stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 625
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
----------------------------
Net cash provided by financing activities . . . . . . . . . . . . . . $ 195,307
----------------------------
Net increase in cash and cash equivalents . . . . . . . . . . . . . . . . $ 27,959
Cash and cash equivalents at beginning of period. . . . . . . . . . . . . 55,525
----------------------------
Cash and cash equivalents at end of the period. . . . . . . . . . . . . . $ 83,484
============================
Cash paid during the period for:
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 46,144
============================
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,300
============================
Supplemental disclosure of noncash investing and financing activities:
Transfer of assets from loans to other real estate owned . . . . . $ 1,095
============================
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 (the "Corporation") and its wholly
owned subsidiaries - Harleysville National Bank and Trust Company
("Harleysville"), Citizens National Bank ("Citizens"), Security National Bank
("Security") (collectively, the "Banks"), HNC Financial Company and HNC
Reinsurance Company - as of September 30, 2002, the results of its operations
for nine and three month periods ended September 30, 2002 and 2001and the cash
flows for the nine month periods ended September 30, 2002 and 2001. This
quarterly report refers to the corporation's subsidiary banks, collectively as
"the banks." We suggest 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 2001 annual
report.
The results of operations for the nine and three month periods ended September
30, 2002 and 2001 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 and loans.
NOTE 3 - The Corporation has adopted SFAS No. 130, "Reporting Comprehensive
Income" which 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 investment securities available for sale. The
adoption of SFAS No. 130 did not have a material impact on the Corporation's
financial position or results of operation.
The components of other comprehensive income are as follows:
Comprehensive Income
- ---------------------
(Dollars in thousands) . . . . . . BEFORE TAX TAX NET OF TAX
September 30, 2002 . . . . . . . . AMOUNT EXPENSE AMOUNT
- ---------------------------------- ----------- ------------ -----------
Unrealized gains on securities:
Unrealized holding gains
arising during period . . . $ 14,424 $ (5,048) $ 9,376
Less reclassification
adjustment for gains
realized in net income. . . 3,193 (1,117) 2,076
----------- ------------ -----------
Other comprehensive income, net. $ 11,231 $ (3,931) $ 7,300
=========== ============ ===========
BEFORE TAX TAX NET OF TAX
September 30, 2001 . . . . . . . . AMOUNT EXPENSE AMOUNT
- ---------------------------------- ----------- ------------ -----------
Unrealized gains on securities:
Unrealized holding gains
arising during period . . . $ 14,351 $ (5,024) $ 9,327
Less reclassification
adjustment for gains
realized in net income. . . 3,923 (1,373) 2,550
----------- ------------ -----------
Other comprehensive income, net. $ 10,428 $ (3,651) $ 6,777
=========== ============ ===========
PAGE 7
NOTE 4 - On June 29, 2001, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Intangible Assets. SFAS No. 141
requires that all business combinations initiated after June 30, 2001 must be
accounted for under the purchase method of accounting. A plan of combination is
considered to be initiated on the earlier of the date that a combining company
(a) announces publicly or formally makes known to its shareholders the major
terms of the plan, or (b) notifies its shareholders, in writing, of an exchange
offer. SFAS No. 141 was adopted upon issuance. SFAS No. 142 prescribes
accounting for all purchased goodwill and intangible assets. The SFAS supersedes
APB Opinion 17, Intangible Assets, but carries over guidance related to
internally developed intangible assets. SFAS No. 142 states that acquired
goodwill is not amortized, but is tested for impairment at the reporting unit
level annually and whenever an impairment indicator arises. A reporting unit is
at the same level or one level below an operating segment as defined by SFAS No.
131, Disclosures About Segments of an Enterprise and Related Information. SFAS
No. 142 is effective for fiscal years beginning after December 15, 2001. Until
the adoption of SFAS No. 142, existing goodwill continues to be amortized and
tested for impairment under previously existing standards. The adoption of SFAS
No. 141 and SFAS No. 142 did not have a material impact on the Corporation's
financial position, or results of operations.
NOTE 5 - On July 6, 2001, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin (SAB) No. 102, Selected Loan Loss Allowance
Methodology and Documentation Issues. SAB No. 102 provides guidance on the
development, documentation, and application of a systematic methodology for
determining allowances for loans and leases in accordance with US GAAP. The
adoption of SAB No. 102 did not have a material impact on the Corporation's
financial position, or results of operations.
NOTE 6- On January 1, 2002, the Corporation adopted Statement of Position (SOP)
01-6, Accounting by Certain Entities That Lend to or Finance the Activities of
Others, which reconciles and conforms existing differences in the accounting and
financial reporting guidance in the AICPA Audit and Accounting Guides, Banks and
Savings Institutions, Audits of Credit Unions, and Audits of Finance Companies.
It also carries forward accounting guidance for practices deemed to be unique to
certain financial institutions. The adoption of this SOP had no impact on the
Corporation's financial position or results of operations.
NOTE 7 - On February 22, 2001, the Corporation issued $5,000,000 of 10.2% junior
subordinate deferrable interest debentures (the debentures) to Harleysville
Statutory Trust 1 (the Trust), a Connecticut business trust, in which the
Corporation owns all of the common equity. The debentures are the sole asset of
the Trust. The Trust issued $5,000,000 of preferred securities to investors.
The Corporation's obligations under the debentures and related documents, taken
together, constitute a full and unconditional guarantee by the Corporation of
the Trust's obligations under the preferred securities. The preferred
securities must be redeemed upon maturity of the subordinate debentures on
February 22, 2031.
NOTE 8 - The Corporation incorporated HNC Reinsurance Company in March 2001.
HNC Reinsurance Company is a reinsurer of consumer loan credit life and accident
and health risks. Through the reinsurance company, the Corporation will assume
a portion of the credit insurance risk in return for income from insurance
premiums.
NOTE 9 - On September 16, 2002, the Corporation paid a 5% stock dividend on its
common stock to shareholders of record as of September 3, 2002.
On August 10, 2001, the Corporation paid a two-for-one stock
split on its common stock in the form of a 100% stock dividend to shareholders
of record July 27, 2001.
All prior period amounts were restated to reflect these stock
dividends.
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, HNC Financial Company and HNC Reinsurance 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. These are unaudited financial statements and, as such, are
subject to year-end audit review.
In addition to historical information, this Form 10-Q contains
forward-looking statements. 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 the 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 the 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 experienced record third quarter and year-to-date
September 30, 2002 earnings. The increases in third quarter 2002 and
year-to-date 2002 net income over comparable periods in 2001 were 10.4% and
15.6%, respectively. The improved third quarter earnings were the result of a
rise in earning assets, a reduction in the provision for loan losses and lower
other expenses. The rise in the year-to-date earnings were also related to the
increase in earnings assets, and improved other income. The Corporation also
experienced an improvement in loan quality during the first nine months of 2002.
Third quarter 2002 diluted earnings per share of $.43, increased 10.3%
over the third quarter 2001 diluted earnings per share of $.39. Third quarter
basic earnings per share in 2002 of $.44 exceed the third quarter 2001 basic
earnings per share of $.40 by 10.0%. Third quarter 2002 net income of
$8,413,000 increased 10.4% over the third quarter 2001 net income of $7,623,000.
Net income for the first nine months of 2002 was $24,604,000, a 15.6% increase
over the $21,275,000 for the comparable period in 2001. Diluted earnings per
share of $1.25 were up 15.7% from the $1.08 in 2001. Basic earnings per share
of $1.29 for the first nine months of 2002 were 16.2% higher than the $1.11 year
to date September 30, 2001. The Corporation's consolidated total assets were
$2,472,052,000 at September 30, 2002, 13.8% above the September 30, 2001 level
of $2,172,516,000.
The rise in net income during 2002, compared to 2001 is primarily
attributed to higher net interest income levels. This increase was the result
PAGE 9
of an 11.1% rise in average earning asset levels and a rise in other income of
9.7%. The growth in other income was the result of both higher service charges
and other miscellaneous fees. Partially offsetting these increases were higher
provision for loan losses and other operating expenses.
For the nine months ended September 30, 2002, the annualized return on
average shareholder's equity and the annualized return on average assets were
16.78% and 1.46%, respectively. For the same period in 2001, the annualized
return on average shareholder's equity was 15.83% and the annualized return on
average assets was 1.40%. Excluding unrealized gains and losses on securities
available for sale, the annualized return on average realized shareholder's
equity for the first nine months of 2002 and 2001 were 17.15% and 16.17%,
respectively.
For the three months ended June 30, 2002, the annualized return on average
shareholders' equity and the annualized return on average assets were 16.71% and
1.44%, respectively. For the same period in 2001, the annualized return on
average realized shareholders' equity was 16.58% and the annualized return on
average assets was 1.45%. Excluding unrealized gains and losses on securities
available for sale, the annualized return on average realized shareholder's
equity for the third quarter of 2002 and 2001 were 17.29% and 17.05%,
respectively.
Strong third quarter results were also reflected in the corporations loan
quality. Nonperforming assets (nonaccruing loans, loans past due 90 days or
more and still accruing interest and net assets in foreclosure) were .30% of
total assets at September 30, 2002, compared to .40% at December 31, 2001 and
..30% at September 30, 2001.
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, employee benefits
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 2002 of $60,737,000 was
$6,761,000, or 12.5% higher than the same period in 2001 net interest income of
$53,976,000. As illustrated in the table below, this rise in net interest
income was primarily the result of higher earning asset volumes. Interest
income was actually lower in 2002 compared to 2001, as a result of the impact of
lower interest rates. The lower interest income related to lower rates was
partially offset by the increase in interest income related to higher earning
asset volumes. The lower interest income was more than offset by the lower
interest expense related to the lower interest rates paid on deposits and other
borrowings during 2002. The third quarter of 2002 net interest income of
$19,679,000 increased $913,000, or 4.9%, over the third quarter of 2001.
The rate-volume variance analysis in the table below, which is computed
on a tax-equivalent basis (tax rate of 35%), analyzes changes in net interest
PAGE 10
income for the nine month and three month periods ended September 30, 2002 over
September 30, 2001 by their rate and volume components.
Nine Months Ended Three Months Ended
September 30, 2002 September 30, 2002
Over/Under Over/Under
September 30, 2001 September 30, 2001
Total Caused by: Total Caused by:
-------------------- ------------
Variance Rate Volume Variance Rate Volume
-------------------- -------------------- ------- ------------ -------- --------
Interest Income:
Securities *. . . . . . . . . . . . . . . $ 1,450 $ (4,213) $ 5,663 $ 597 $(1,821) $ 2,418
Money market instruments. . . . . . . . . (261) (361) 100 (207) (132) (75)
Loans * . . . . . . . . . . . . . . . . . (5,114) (9,427) 4,313 (2,058) (3,010) 952
-------------------- -------------------- ------- ------------ -------- --------
Total. . . . . . . . . . . . . . . . . (3,925) (14,001) 10,076 (1,668) (4,963) 3,295
-------------------- -------------------- ------- ------------ -------- --------
Interest Expense:
Savings deposits. . . . . . . . . . . . . (5,016) (6,117) 1,101 (1,088) (1,499) 411
Time deposits and certificates of deposit (4,294) (6,689) 2,395 (1,611) (2,343) 732
Other borrowings. . . . . . . . . . . . . (1,248) (1,699) 451 (105) (284) 179
-------------------- -------------------- ------- ----------- -------- -------
Total . . . . . . . . . . . . . . . . (10,558) (14,505) 3,947 (2,804) (4,126) 1,322
-------------------- -------------------- ------- ------------ -------- --------
Net Interest Income . . . . . . . . . . . . $ 6,633 $ 504 $ 6,129 $ 1,136 $ (837) $ 1,973
==================== ==================== ======= ============ ======== ========
*Tax Equivalent Basis
Taxable-equivalent net interest income was $65,847,000 for the first
nine months of 2002, compared to $59,214,000 for the same period in 2001, a
11.2% or $6,633,000 increase. This rise in taxable-equivalent net interest
income was primarily due to a $10,558,000 reduction in interest expense, which
was partially offset by a decrease in interest income, primarily related to
rate. Total taxable-equivalent interest income decreased $3,925,000, the result
of lower earning asset yields, in part offset by the higher volumes of earnings
assets. Average year-to-date securities, loans and money market instrument
volumes grew $127,686,000, $80,785,000 and $6,431,000, respectively, at
September 30, 2002, compared to the same period in 2001. The yield earned on
earning assets decreased 102 basis points from 7.64% in the first nine months of
2001 to 6.62% during the same period in 2002.
The $10,558,000 reduction in interest expense is the result of a
$14,505,000 decrease related to lower rates, partially offset by $3,947,000
related to higher deposit and other borrowing volumes. The average rate paid on
interest bearing deposits and other borrowings of 2.99% during the first nine
months of 2002 was 125 basis points lower than the 4.24% rate paid during the
same period in 2001. The average balance of interest bearing deposits and other
borrowings grew $187,154,000 or 11.9% in the first nine months of 2002, compared
to the first nine months of 2001. The average year-to-date growth in time
deposits and other borrowings were $74,217,000 and $15,563,000, respectively.
The lower rate savings deposits, which include interest bearing checking
accounts, savings accounts and money market accounts, were $97,374,000 or 14.1%
higher than in the first nine months of 2002, compared to the same period in
2001. Other borrowings include federal funds purchased, FHLB borrowings,
securities sold under agreements to repurchase, U. S. Treasury demand notes and
junior subordinate deferrable interest debentures.
The taxable-equivalent net interest income during the third quarter of
2002 of $21,571,000 was $1,136,000 or 5.6% higher than the third quarter of 2001
net interest income. The $1,668,000 decrease in interest income was more than
offset by a $2,804,000 reduction in interest expense. The yield earned on
average earning assets during the third quarter of 2002 of 6.33% was 104 basis
points lower than the 7.37% earned during the third quarter of 2001. Average
earning assets in the third quarter of 2002 were $222,030,000 or 11.1% higher
than the third quarter of 2001. Securities grew $181,499,000 and loans
increased $54,261,000 during this period. Money market instruments declined
$13,730,000. The rate paid on average interest bearing deposits and other
borrowings of 2.92% during the third quarter of 2002 was 103 basis points lower
PAGE 11
than the 3.95% rate paid during the third quarter of 2001. Average interest
bearing deposits and other borrowings grew $198,709,000 or 12.1% during this
period. The largest gains were a $108,379,000 increase in savings deposits and
a $72,022,000 rise in time deposits.
NET INTEREST MARGIN
- ---------------------
The net interest margin for the nine-month periods ending September
30, 2002 and September 30, 2001 were both 4.14%. During the first nine months
of 2002 the rate paid on interest-bearing deposits and other borrowings
decreased 125 basis points, compared to a 102 basis point drop in the yield on
earning assets. The rate paid on deposits was 2.99% during the first nine
months of 2002, compared to 4.24% during the same period in 2001. The yield on
earning assets of 6.62% earned during the first nine months of 2002 was lower
than the 7.64% earned during the first nine months of 2001. The decrease in the
yield earned and rate paid are due to the lower interest rate environment
experienced during the first nine months of 2002, compared to the same period in
2001. The third quarter of 2002 net interest margin of 3.90% was 20 basis
points lower than the third quarter of 2001 net interest margin of 4.10%. This
reduction is the result of the banks investment strategy of investing in short
term lower yielding earning assets during the current interest rate cycle, the
impact on the yield of mortgage backed securities related to the high level of
residential mortgage refinancing during the third quarter of 2002 and a slower
pace of growth in the loan portfolio.
INTEREST RATE SENSITIVITY ANALYSIS
- -------------------------------------
The Corporation actively manages its interest rate sensitivity positions. The
objectives of interest rate risk management are to control exposure of net
interest income to risks associated with interest rate movements and to achieve
consistent growth in net interest income. The Asset/Liability Committee, using
policies and procedures approved by the Corporation's Boards of Directors, is
responsible for managing the rate sensitivity position. The Corporation manages
interest rate sensitivity by changing mix and repricing characteristics of its
assets and liabilities through their investment securities portfolios, its
offering of loan and deposit terms and borrowings from the FHLB. The nature of
the Corporation's current operations is such that it is not subject to foreign
currency exchange or commodity price risk. The Corporation does not own trading
assets and does not have any hedging transactions in place, such as interest
rate swaps, caps or floors.
The Corporation uses three principal reports to measure interest rate risk:
asset/liability simulation reports; gap analysis reports; and net interest
margin reports. Management also simulates possible economic conditions and
interest rate scenarios in order to quantify the impact on net interest income.
The effect that changing interest rates have on the Corporation's net interest
income is simulated by increasing and decreasing interest rates. This
simulation is known as rate shocks. The September 30, 2002 report below
forecasts changes in the Corporation's market value of equity under alternative
interest rate environments. The market value of equity is defined as the net
present value of the Corporation's existing assets and liabilities.
(Dollars in thousands)
CHANGE IN ASSET/LIABILITY
MARKET VALUE MARKET VALUE PERCENTAGE APPROVED
OF EQUITY OF EQUITY CHANGE PERCENT CHANGE
------------ ---------------- ----------- ---------------
+300 Basis Points 347,568 42,154 13.80% +/- 45%
+200 Basis Points 353,288 47,874 15.68% +/- 30%
+100 Basis Points 339,510 34,096 11.16% +/- 15%
Flat Rate . . . . 305,414 - 0.00%
- -100 Basis Points 257,868 (47,546) -15.57% +/- 15%
- -200 Basis Points 219,292 (86,122) -28.20% +/- 30%
- -300 Basis Points 185,954 (119,460) -39.11% +/- 45%
In the event the Corporation should experience an excessive decline in their
market value of equity resulting from changes in interest rates, it has a number
of options that it could use to remedy such a mismatch. The Corporation could
PAGE 12
restructure its investment portfolios through sale or purchase of securities
with more favorable repricing attributes. It could also emphasize loan products
with appropriate maturities or repricing attributes, or attract deposits or
obtain borrowings with desired maturities.
PROVISION FOR LOAN LOSSES
- ----------------------------
The Bank uses the reserve method of accounting for credit losses. The balance
in the allowance for loan and lease losses is determined based on management's
review and evaluation of the loan portfolio in relation to past loss experience,
the size and composition of the portfolio, current economic events and
conditions, and other pertinent factors, including management's assumptions as
to future delinquencies, recoveries and losses. Increases to the allowance for
loan and lease losses are made by charges to the provision for credit losses.
Credit exposures deemed to be uncollectible are charged against the allowance
for credit losses. Recoveries of previously charged-off amounts are credited to
the allowance for credit losses.
While management considers the allowance for loan and lease losses to be
adequate based on information currently available, future additions to the
allowance may be necessary due to changes in economic conditions or management's
assumptions as to future delinquencies, recoveries and losses and management's
intent with regard to the disposition of loans and leases. In addition, the OCC
as an integral part of their examination process, periodically review the Bank's
allowance for loan losses. The OCC may require the Bank to recognize additions
to the allowance for credit losses based on their judgements about information
available to them at the time of their examination.
The Bank's allowance for loan and lease losses is the accumulation of various
components that are calculated based on various independent methodologies. All
components of the allowance for credit losses are an estimation. Management
bases its recognition and estimation of each allowance component on certain
observable data that it believes is the most reflective of the underlying credit
losses being estimated. The observable data and accompanying analysis is
directionally consistent, based upon trends, with the resulting component amount
for the allowance for loan and lease losses. The Bank's allowance for loan and
lease losses components include the following: historical loss estimation by
loan product type and by risk rating within each product type, payment (past
due) status, industry concentrations, internal and external variables such as
economic conditions, credit policy and underwriting changes, competence of the
loan review process and other historical loss model imprecision. The Bank's
historical loss component is the most significant component of the allowance for
loan and lease losses, and all other allowance components are based on the
inherent loss attributes that management believes exist within the total
portfolio that are not captured in the historical loss component.
The historical loss components of the allowance represents the results of
analyses of historical charge-offs and recoveries within pools of homogeneous
loans, within each risk rating and broken down further by segment, within the
portfolio.
The historical loss components of the allowance for commercial loans is based
principally on current risk ratings, historical loss rates adjusted, by
adjusting the risk window, to reflect current events and conditions, as well as
analyses of other factors that may have affected the collectibility of loans in
the commercial portfolio. The Bank analyzes all commercial loans that are being
monitored as potential credit problems, via Watchlist Memorandum, to determine
whether such loans are individually impaired, with impairment measured by
reference to the collateral coverage and / or debt service coverage. The
historical loss component of the allowance for consumer loans is based
principally on loan payment status, retail classification and historical loss
rates adjusted, by adjusting the risk window, to reflect current events and
conditions.
The industry concentration component is recognized as a possible factor in the
estimation of credit losses. Two industries represent possible concentrations:
commercial real estate and automobile dealers. No specific loss-related
observable data is recognized by management currently, therefore no specific
factor is calculated in the reserve solely for the impact of these
concentrations, although management continues to carefully consider relevant
data for possible future sources of observable data.
PAGE 13
The historic loss model imprecision component (soft factors and unallocated
portion) reflects management's belief that there are additional inherent credit
losses based on loss attributes not adequately captured in the statistical /
historical loss component and is an assessment of information delay and its
impact on the timeliness of the risk rating process and loss recognition. The
principal observable data utilized by management as the driver of the loss
recognition and measurement of this component is an internal management measure
of the age of financial information used in the borrower debt service analysis.
This is also a key judgmental component, as experiential data confirms that
measurable losses lag the empirical model as a downward credit cycle begins.
For the first nine months of 2002 the provision for loan losses was
$3,401,000, compared to $2,962,000 for the same period in 2001. Net loans
charged off was $1,820,000 for the nine months ended September 30, 2002,
compared to $2,824,000 for the nine months ended September 30, 2001. The
decrease in net charged off loans is attributed to the increase in the
recoveries of charged off indirect consumer loans and a reduction in commercial
loan and lease charge offs. The ratio of the allowance for loan losses to
nonperforming loans and leases for September 30, 2002 of 248.2% was higher than
the December 31, 2001 and the September 30, 2001 ratios of 187.9% and 249.2%,
respectively.
ALLOWANCE FOR LOAN LOSSES
A summary of the allowance for loan losses is as follows:
(Dollars in thousands) SEPTEMBER 30,
--------------
2002 2001
----------- -----------
Average loans $1,331,766 $1,250,981
----------- -----------
Allowance, beginning of period . . . . $ 15,558 $ 15,210
----------- -----------
Loans charged off:
Commercial and industrial . . . 91 417
Consumer. . . . . . . . . . . . 1,985 2,037
Real estate . . . . . . . . . . 323 398
Lease financing . . . . . . . . 396 794
----------- -----------
Total loans charged off . 2,795 3,646
----------- -----------
Recoveries:
Commercial and industrial . . . 105 20
Consumer. . . . . . . . . . . . 642 440
Real estate . . . . . . . . . . 157 278
Lease financing . . . . . . . . 71 84
----------- -----------
Total recoveries. . . . . 975 822
----------- -----------
Net loans charged off. . . . . . . . . 1,820 2,824
----------- -----------
Provision for loan losses. . . . . . . 3,401 2,962
----------- -----------
Allowance, end of period . . . . . . . $ 17,139 $ 15,348
=========== ===========
Ratio of net charge offs to average
loans outstanding (annualized) 0.18% 0.30%
=========== ===========
PAGE 14
ANALYSIS OF CREDIT RISK SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
- ---------------------------------------
2002 2001 2001
--------------- -------------- ---------------
Non-accrual loan and leases . . . . . . $ 5,325,000 $ 6,354,000 $ 5,446,000
Loans and leases 90 days past due . . . 1,580,000 1,926,000 714,000
--------------- -------------- ---------------
Total nonperforming loans and leases 6,905,000 8,280,000 6,160,000
Other real estate owned . . . . . . . . 473,000 609,000 404,000
--------------- -------------- ---------------
Total nonperforming assets . . . . . $ 7,378,000 $ 8,889,000 $ 6,564,000
--------------- -------------- ---------------
Allowance for loan and lease losses to
nonperforming loans and leases . . . 248.2% 187.9% 249.2%
Nonperforming loans and leases to total
net loans and leases . . . . . 0.51% 0.63% 0.47%
Allowance for loan and lease losses
to total loans and leases. . . . . . 1.28% 1.18% 1.18%
Nonperforming assets
to total assets. . . . . . . . . . . 0.30% 0.40% 0.30%
The following table sets forth an allocation of the allowance for loan losses by
loan category:
September 30, 2002
------------------
Percent
Amount of Loans
-------- ---------
Commercial and industrial $ 4,376 26%
Consumer loans. . . . . . 5,727 33%
Real estate . . . . . . . 5,837 34%
Lease financing . . . . . 1,199 7%
-------- ---------
Total . . . . . . . . . $ 17,139 100%
======== =========
Nonperforming assets (nonaccruing loans, loans 90 days past due and net assets
in foreclosure) were 0.30% of total assets at September 30, 2002, compared to
0.40% at December 31, 2001 and 0.30% at September 30, 2001. The ratio of the
allowance for loan losses to loans at September 30, 2002 of 1.28% was higher
than the 1.18% ratio at both December 31, 2001 and September 30, 2001.
Nonaccruing loans at September 30, 2002 of $5,325,000, decreased $1,029,000 from
the December 31, 2001 level of $6,354,000, and decreased $121,000 from the
September 30, 2001 level of $5,446,000. The decrease in nonaccruing loans at
September 30, 2002, compared to both December 31, 2001 and September 30, 2001
was primarily the result of a decrease in commercial real estate nonaccruing
loans.
Net assets in foreclosure were $473,000 as of September 30, 2002, a decrease of
$136,000 from the December 31, 2001 balance of $609,000. During the first nine
months of 2002, transfers from loans to assets in foreclosure were $789,000,
payments on foreclosed properties were $857,000 and the write-downs of assets in
foreclosure were $68,000 during this period. The loans transferred to assets in
foreclosure included vehicle leases of $387,000, equipment leases of $231,000, a
$15,000 commercial loan and $156,000 of mortgages. The balance of net assets in
foreclosure at September 30, 2001 was $404,000. 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.
PAGE 15
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, 2002, loans past due 90 days or more and still
accruing interest were $1,580,000 compared to $1,926,000 as of December 31, 2001
and $714,000 as of September 30, 2001. The decrease in loans past due 90 days at
June 30, 2002, compared to December 31, 2001 was primarily the result of a
decrease in commercial real estate loans past due 90 days. The increase in
loans past due 90 days or more at September 30, 2002, compared to September 30,
2001 is the result of a rise in commercial real estate loans.
The following information concerns impaired loans:
Sept. 30, 2002 Dec. 31, 2001 Sept. 30, 2001
--------------- -------------- ---------------
Impaired Loans . . . . . . . . . . . . . . . . . $ 3,015,000 $ 3,721,000 $ 3,468,000
=============== ============== ===============
Average year-to-date impaired loans. . . . . . . $ 2,909,000 $ 3,505,000 $ 3,322,000
=============== ============== ===============
Impaired loans with specific loss allowances . . $ 3,015,000 $ 3,721,000 $ 3,468,000
=============== ============== ===============
Loss allowances reserved on impaired loans . . . $ 298,000 $ 429,000 $ 369,000
=============== ============== ===============
Year-to-date income recognized on impaired loans $ 93,000 $ 78,000 $ 69,000
=============== ============== ===============
The banks' policy for interest income recognition on nonaccrual loans is to
recognize income under the cash basis when the loans are both current and the
collateral on the loan is sufficient to cover the outstanding obligation to the
banks. The banks will not recognize income if these factors do not exist.
OTHER OPERATING INCOME
- ------------------------
Nine Months Ended Three Months Ended
September 30, September 30,
-------------------- ------------------
2002 2001 2002 2001
--------------- ------- ------ ------
(Dollars in thousands) (Dollars in thousands)
Service charges . . . . . . . . . . $ 4,993 $ 3,878 $1,846 $1,403
Security gains, net . . . . . . . . 3,193 3,923 719 2,140
Trust income. . . . . . . . . . . . 2,322 2,541 726 826
Bank-owned life insurance income. . 1,900 1,818 631 535
Other income. . . . . . . . . . . . 4,675 3,409 1,519 1,352
--------------- ------- ------ ------
Total other operating income. $ 17,083 $15,569 $5,441 $6,256
=============== ======= ====== ======
The nine month ending September 30, 2002 other operating income increased
$1,514,000, or 9.7%, from $15,569,000 for the same period in 2001. This rise in
other operating income is the result of increases in service charges, bank-owned
life insurance and other income of $1,115,000, $82,000 and $1,266,000,
respectively. Offsetting these gains were reductions in security gains and
trust income. The rise in other operating income was 19.3%, not inclusive of
the securities gains. The third quarter other operating income decreased 13.0%,
compared to the third quarter 2001. Net of security gains, the third quarter of
2002 grew 14.7%, compared to the third quarter of 2001.
Service charges grew $1,115,000 or 28.8% in the first nine months of 2002,
compared to the same period in 2001. This rise is the result of an increase in
fees charged on transaction deposit accounts, attributed to the increase in
average deposit transaction accounts and through the Corporation's strategies to
enhance fee income. The driving force behind the increase in service charges
was the introduction of a new overdraft product in March 2001. The growth in
overdraft fees during the first nine months of 2002 was $820,000, compared to
the same period in 2001. The remaining increase is related to the growth in
average transaction deposits and enhanced fee structures. The third quarter
PAGE 16
2002 service charges grew $443,000 or 31.6% compared to the same period in 2001.
This growth was primarily the result of higher overdraft fees and ATM fees.
The Corporation recorded net security gains on the sale of securities available
for sale of $3,193,000 in the first nine months of 2002, compared to $3,923,000
during the same period in 2001. Third quarter 2002 net security gains on the
sale of securities were $719,000, compared to $2,140,000 in the third quarter of
2001. The Corporation sold the investment securities available for sale to fund
the purchase of other securities in an effort to enhance the overall return of
the portfolio and to reduce the risk within different interest rate
environments.
Income from the Investment Management and Trust Services Division decreased
$219,000 or 8.6% in the first nine months of 2002 and $100,000 or 12.1% in the
third quarter, compared to the same periods in 2001. These decreases were the
result of lower estate fees earned during this period and the lower fees
associated with the decrease in the market value of trust assets.
The Corporation's bank owned life insurance (BOLI) income increased $82,000 or
4.5% during the first nine months of 2002, compared to the same period in 2001.
This higher income level was related to the higher volume of BOLI balances
partially offset by lower rates experienced during 2002. BOLI involves the
purchasing of life insurance by the Corporation on a chosen group of employees.
The corporation is the owner and beneficiary of the policies. This pool of
insurance, due to tax advantages to the Banks, is profitable to the Corporation.
This profitability is used to offset a portion of future employee benefit cost
increases. Bank deposits fund BOLI and the earnings from BOLI are recognized as
other income. The third quarter 2002 BOLI income was 17.9% higher than the third
quarter of 2001.
Other income for the first nine months of 2002 increased $1,266,000 or 37.1%,
compared to the same period in 2001. The third quarter other income grew
$167,000 or 12.4% over the third quarter of 2001. Contributing to these
increases were higher fees earned on the sale of alternative investment products
including mutual funds and annuities, gains on the sale of residential mortgage
loans, loan servicing fees and fees generated from HNC Reinsurance Company.
OTHER OPERATING EXPENSES
- --------------------------
Nine Months Ended Three Months Ended
September 30, September 30,
-------------------- ------------------
2002 2001 2002 2001
--------------- ------- ------ ------
(Dollars in thousands) (Dollars in thousands)
Salaries. . . . . . . . . . . . . . . $ 18,050 $16,350 $ 6,206 $ 5,637
Employee benefits . . . . . . . . . . 4,581 3,294 1,344 1,102
Occupancy . . . . . . . . . . . . . . 2,902 2,457 844 792
Furniture and equipment . . . . . . . 4,034 3,776 1,428 1,310
Other expenses. . . . . . . . . . . . 13,127 13,572 3,679 4,903
----------- ------- ------ ------
Total other operating expenses. $ 42,694 $39,449 $13,501 $13,744
============ ======= ======= =======
The first nine months of 2002 other operating expenses of $42,694,000 increased
$3,245,000 or 8.2% from $39,449,000 for the same period in 2001. This rise was
the result of salary and benefit increases and a one-time occupancy expense
related to a closed branch. The third quarter 2002 other operating expenses
decreased $243,000 or 1.8% compared to the third quarter of 2001. This decrease
was due to the result of lower off-lease vehicle residual reserve expenses
recorded in the third quarter of 2002, compared to the third quarter of 2001.
Employee salaries increased $1,700,000 or 10.4% from $16,350,000 for the first
nine months of 2001 to $18,050,000 for the same period in 2002. Employee
salaries increased $569,000 or 10.1% during the third quarter of 2002, compared
to the third quarter of 2001. These increases reflect cost of living increases,
merit increases, salaries related to the rise in the sale of alternative
investment products and additional staff necessitated by the growth of the
Banks. Employee benefits of $4,581,000 expensed in the first nine months of
2002, were $1,287,000 or 39.1% higher than the $3,294,000 of employee benefits
PAGE 17
expensed during the same period in 2001. Third quarter 2002 employee benefits
of $1,344,000 were 22.0% higher than the third quarter 2001 expense of
$1,102,000. The increase in employee benefits is the result of higher pension
expenses and employee medical insurance coverage. The higher pension expense is
related to the addition of new employees to the plan and the overall performance
of the plan.
Net occupancy expense increased $445,000, or 18.1%, from $2,457,000 in the
first nine months of 2001 to $2,902,000 in the first nine months of 2002. This
increase was primarily due to a $365,000 expense related to a branch closure
during the first quarter of 2002. Net occupancy expenses grew $52,000 or 6.6%
during the third quarter of 2002, compared to the third quarter of 2001.
Furniture and equipment expense increased $258,000 or 6.8%, during the first
nine months of 2002, compared to the same period in 2001. The increase in the
third quarter of 2002 was 9.0% over the third quarter of 2001. These increases
are due to higher equipment maintenance and expenses related to new sales and
application systems for the bank branches to use to enhance loan and deposit
volumes and processing.
Other expenses decreased $445,000, or 3.3%, from $13,572,000 in the first nine
months of 2001, compared to $13,127,000 in other expenses recorded during the
same period in 2002. The decrease during the third quarter of 2002 compared to
the third quarter in 2001 was $1,224,000 or 25.0%. This decrease was primarily
due to lower marketing expense, off-lease vehicle residual reserve expense and
goodwill amortization. The banks also experienced higher deferred loan cost
that offset expenses related to higher volumes of commercial loans. Partially
offsetting these lower other expenses were higher advertising costs, expenses
associated with the addition of employees to the supplemental executive
retirement plan and higher mortgage service rights amortization. The Corporation
reviews the off-lease vehicles residual reserve on a quarterly basis. The total
2002 projected residual reserve expense of $2,800,000 is lower than the total
2001 actual residual reserve expense of $3,705,000.
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
- ------------------------
Total assets increased $263,081,000, or 11.9%, from $2,208,971,000 at December
31, 2001 to $2,472,052,000 at September 30, 2002. Contributing to this increase
were higher investment securities available for sale, loans and fed funds sold.
Total assets at September 30, 2002 grew 13.8%, compared to September 30, 2001.
This gain was primarily due to increases in both investment securities available
for sale and loans.
The balance of securities available for sale at September 30, 2002 of
$926,529,000 increased $220,158,000 compared to the December 31, 2001 balance of
$706,371,000. During the first three quarters of 2002, $568,561,000 of
securities available for sale were sold which generated a pretax gain of
$3,193,000. In comparison, $282,085,000 securities available for sale were sold
during the first three quarters of 2001 to generate a pretax gain of $3,923,000.
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, and to reduce the risk associated within different interest rate
environments. The balance of investment securities held to maturity decreased
$3,352,000 during the first nine months of 2002. Total loans grew $27,590,000
or 2.1% through September 30, 2002. This growth was primarily due to increases
in both commercial loans and home equity loans, partially offset by lower
indirect auto financing and vehicle leases. Total loans grew 2.9% at September
30, 2002, compared to September 30, 2001.
Total deposits grew $204,337,000, or 11.7% from $1,746,862,000 at December 31,
2001 to $1,951,199,000 at September 30, 2002. This growth was due to higher
balances in all deposit categories. Lower rate core deposits
(noninterest-bearing checking, interest-bearing checking, money market accounts
and savings accounts) grew $119,985,000, or 11.7% during this period. Higher
costing time deposits grew $84,352,000 or 11.7% during the first nine months of
PAGE 18
2002. Time deposits under $100,000 grew $45,622,000 and time deposits over
$100,000 rose $38,730,000. The September 30, 2002 total deposit balance grew
14.3%, compared to the September 30, 2001 total deposits.
Other borrowings experienced an increase of $39,182,000 during the nine months
of 2002. A $35,000,000 increase in Federal Home Loan Bank Borrowings was the
primarily contributor to this increase. Securities sold under agreements to
repurchase increased by $4,844,000 and U.S. Treasury demand notes decreased by
$662,000.
CAPITAL
- -------
Capital formation is important to the Corporation's well being and future
growth. Capital for the period ending September 30, 2002 was $208,666,000, an
increase of $19,317,000 over the end of 2001. The increase is the result of
the retention of the Corporation's earnings and the adjustment for the net
unrealized gains on the investment securities available for sale and offset by
the purchase of treasury stock during the first nine months of 2002. 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, 2002
was a gain of $11,834,000, compared to a gain of $4,534,000 at December 31,
2001. The corporation purchased $4,117,000 of treasury stock during the first
nine months of 2002. 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)
For Capital
As of September 30, 2002 Actual Adequacy Purposes
- -----------------------------------------
Amount Ratio Amount Ratio
------------ ------------------ -------- ------
Total Capital (to risk weighted assets):
- -----------------------------------------
Corporation . . . . . . . . . . . . . . . $ 219,652 13.39% $131,210 8.00%
Harleysville National Bank. . . . . . . . 130,754 10.99% 95,139 8.00%
Citizens National Bank. . . . . . . . . . 36,698 12.20% 24,067 8.00%
Security National Bank. . . . . . . . . . 16,633 12.53% 10,623 8.00%
Tier 1 Capital (to risk weighted assets):
- -----------------------------------------
Corporation . . . . . . . . . . . . . . . $ 201,548 12.29% $ 65,605 4.00%
Harleysville National Bank. . . . . . . . 119,731 10.07% 47,570 4.00%
Citizens National Bank. . . . . . . . . . 32,933 10.95% 12,033 4.00%
Security National Bank. . . . . . . . . . 14,969 11.27% 5,312 4.00%
Tier 1 Capital (to average assets):
- -----------------------------------------
Corporation . . . . . . . . . . . . . . . $ 201,548 8.61% $ 93,678 4.00%
Harleysville National Bank. . . . . . . . 119,731 7.20% 66,534 4.00%
Citizens National Bank. . . . . . . . . . 32,933 7.00% 18,819 4.00%
Security National Bank. . . . . . . . . . 14,969 8.03% 7,458 4.00%
PAGE 19
To Be Well Capitalized
Under Prompt Corrective
Action Provision
Amount Ratio
------------------------ ------
Total Capital (to risk weighted assets):
- -----------------------------------------
Corporation . . . . . . . . . . . . . . . $ - -
Harleysville National Bank. . . . . . . . 118,924 10.00%
Citizens National Bank. . . . . . . . . . 30,084 10.00%
Security National Bank. . . . . . . . . . 13,279 10.00%
Tier 1 Capital (to risk weighted assets):
- -----------------------------------------
Corporation . . . . . . . . . . . . . . . $ - -
Harleysville National Bank. . . . . . . . 71,354 6.00%
Citizens National Bank. . . . . . . . . . 18,050 6.00%
Security National Bank. . . . . . . . . . 7,967 6.00%
Tier 1 Capital (to average assets):
- -----------------------------------------
Corporation . . . . . . . . . . . . . . . $ - -
Harleysville National Bank. . . . . . . . 83,168 5.00%
Citizens National Bank. . . . . . . . . . 23,524 5.00%
Security National Bank. . . . . . . . . . 9,322 5.00%
(Dollars in thousands)
For Capital
As of December 31, 2001 Actual Adequacy Purposes
- -----------------------------------------
Amount Ratio Amount Ratio
------------ ------------------ -------- ------
Total Capital (to risk weighted assets):
- -----------------------------------------
Corporation . . . . . . . . . . . . . . . $ 205,743 13.23% $124,445 8.00%
Harleysville National Bank. . . . . . . . 118,782 10.46% 90,862 8.00%
Citizens National Bank. . . . . . . . . . 39,888 13.91% 22,936 8.00%
Security National Bank. . . . . . . . . . 15,132 12.53% 9,661 8.00%
Tier 1 Capital (to risk weighted assets):
- -----------------------------------------
Corporation . . . . . . . . . . . . . . . $ 189,423 12.18% $ 62,222 4.00%
Harleysville National Bank. . . . . . . . 108,939 9.59% 45,431 4.00%
Citizens National Bank. . . . . . . . . . 36,297 12.66% 11,468 4.00%
Security National Bank. . . . . . . . . . 13,622 11.28% 4,830 4.00%
Tier 1 Capital (to average assets):
- -----------------------------------------
Corporation . . . . . . . . . . . . . . . $ 189,423 8.71% $ 87,040 4.00%
Harleysville National Bank. . . . . . . . 108,939 6.91% 63,024 4.00%
Citizens National Bank. . . . . . . . . . 36,297 8.45% 17,182 4.00%
Security National Bank. . . . . . . . . . 13,622 8.44% 6,455 4.00%
PAGE 20
To Be Well Capitalized
Under Prompt Corrective
Action Provision
Amount Ratio
-------- ------
Total Capital (to risk weighted assets):
- -----------------------------------------
Corporation . . . . . . . . . . . . . . . $ - -
Harleysville National Bank. . . . . . . . 113,578 10.00%
Citizens National Bank. . . . . . . . . . 28,669 10.00%
Security National Bank. . . . . . . . . . 12,076 10.00%
Tier 1 Capital (to risk weighted assets):
- -----------------------------------------
Corporation . . . . . . . . . . . . . . . $ - -
Harleysville National Bank. . . . . . . . 68,147 6.00%
Citizens National Bank. . . . . . . . . . 17,202 6.00%
Security National Bank. . . . . . . . . . 7,246 6.00%
Tier 1 Capital (to average assets):
- -----------------------------------------
Corporation . . . . . . . . . . . . . . . $ - -
Harleysville National Bank. . . . . . . . 78,780 5.00%
Citizens National Bank. . . . . . . . . . 21,477 5.00%
Security National Bank. . . . . . . . . . 8,069 5.00%
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, 2002, the Corporation's Tier 1 risk-adjusted
capital ratio was 12.29%, and the total risk-adjusted capital ratio was 13.39%,
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, 2002.
The leverage ratio consists of Tier 1 capital divided by quarterly average
total assets, excluding intangible assets. Banking organizations are expected
to have ratios of at least 4% and 5%, depending upon their particular condition
and growth plans. Higher leverage ratios could be required by the particular
circumstances or risk profile of a given banking organization. The
Corporation's leverage ratios were 8.61% at September 30, 2002 and 8.71% at
December 31, 2001.
The year-to-date September 30, 2002 cash dividend per share of $.495 was 13.0%
higher than the cash dividend for the same period in 2001 of $.438. The
dividend payout ratio for the first nine months of 2002 was 38.5%, compared to
41.3% for the twelve month period ended December 31, 2001. 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 three months of
2002.
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. The
liquidity measurement is based on the asset/liability model's projection of
potential sources and use of funds for the next 120 days. The resulting
projections as of September 30, 2002 show the potential sources of funds
exceeding the potential uses of funds. The Corporation has external sources of
funds, which can be drawn upon when funds are required. The primary source of
PAGE 21
external liquidity is an available line of credit with the FHLB of Pittsburgh.
Unused lines of credit at the FHLB of Pittsburgh were $128,679,000, as of
September 30, 2002. The Banks also have unused federal funds lines of credit of
$50,000,000 and non-pledged investment securities available for sale of
$353,437,000 as of September 30, 2002.
OTHER INFORMATION
- ------------------
Legislative & Regulatory
- --------------------------
In November 1999, the Gramm-Leach-Bliley Financial Modernization Act of 1999
(Modernization Act) became law. The Modernization Act allows bank holding
companies meeting management, capital and Community Reinvestment Act standards
to engage in a substantially broader range of nonbanking activities than was
permissible before enactment, including underwriting insurance and making
merchant banking investments in commercial and financial companies. It allows
insurers and other financial services companies to acquire banks; removes
various restrictions that currently apply to bank holing company ownership of
securities firms and mutual fund advisory companies; and establishes the overall
regulatory structure applicable to bank holding companies that also engage in
insurance and securities operations. The Corporation currently believes it
meets the requirements for the broader range of activities that will be
permitted by the Modernization Act.
The Modernization Act also modifies current law related to financial privacy
and community reinvestment. The new privacy provisions will generally prohibit
financial institutions, including the Corporation, from disclosing nonpublic
financial information to nonaffiliated third parties unless customers have the
opportunity to "opt out" of the disclosure.
Pending Legislation
- --------------------
Management is not aware of any other current specific recommendations by
regulatory authorities or proposed legislation which, if they were implemented,
would have a material adverse effect upon the liquidity, capital resources, or
results of operations, although the general cost of compliance with numerous and
multiple federal and state laws and regulations does have, and in the future may
have, a negative impact on the Corporation's results of operations.
Effects of Inflation
- ----------------------
Inflation has some impact on the Corporation and the 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 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,
PAGE 22
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 that may give rise to
liability under any such statute.
Branching
- ---------
The Corporation's subsidiaries currently plan to open at least one new branch.
During the fourth quarter of 2002, Security National Bank plans to open a
location in Douglassville, Pennsylvania. 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.
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 on page 12 of this Form 10-Q
and in SEC Form 10-K for the period ended December 31, 2001.
ITEM 4 - Controls and Procedures
We maintain a system of controls and procedures designed to provide reasonable
assurance as to the reliability of the financial statements and other
disclosures included in this report, as well as to safeguard assets from
unauthorized use or disposition. We evaluated the effectiveness of the design
and operation of our disclosure controls and procedures under the supervision
and with the participation of management, including our Chief Executive Officer
and Chief Financial Officer, within 90 days prior to the filing date of this
report. Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information required to be
included in our periodic Securities and Exchange Commission filings. No
significant changes were made to our internal controls or other factors that
could significantly affect these controls subsequent to the date of their
evaluation.
CERTIFICATION
I, Walter E. Daller, Jr., Chairman, President and Chief Executive Officer,
certify, that:
1. I have reviewed this quarterly report on Form 10-Q of Harleysville
National Corporation.
2. Based on my knowledge, the quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report.
PAGE 23
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report.
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date.
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of the
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls.
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect the internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002
By: /s/ Walter E. Daller, Jr.
-----------------------------
Chairman, President and Chief
Executive Officer
Harleysville National Corporation
CERTIFICATION
I, Gregg J. Wagner, Executive Vice President and Chief Financial Officer
certify, that:
1. I have reviewed this quarterly report on Form 10-Q of Harleysville
National Corporation.
2. Based on my knowledge, the quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report.
PAGE 24
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report.
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date.
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of the
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls.
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect the internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002
By: /s/ Gregg J. Wagner
-----------------
Executive Vice President and
Chief Financial Officer
Harleysville National Corporation
PAGE 25
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, HNC Financial Company
and HNC Reinsurance Company. In addition, no material proceedings are pending
or are known to be threatened or contemplated against the Corporation and its
subsidiaries by government authorities.
Item 2. Change in Securities and Use of Proceeds
- ------------------------------------------------
Not applicable
Item 3. Defaults Upon Senior Securities
- ---------------------------------------
Not applicable
Submission of Matters to a Vote of Security Holders
- -----------------------------------------------------
Item 4. None
Item 5. Other Information
- ------- --------------------------------
None
Item 6. Exhibits and Reports on Form 8-K
- ------- --------------------------------
(a) Exhibits:
--------------
The following exhibits are 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.)
(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.)
PAGE 26
(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.
(b) Reports on Form 8-K
Current Report on Form 8-K, dated January 10, 2002, filed with the Commission on
February 15, 2002, reporting the Registrant's fourth quarter 2001 press release.
Current Report on Form 8-K, dated April 9, 2002, filed with the Commission on
April 17, 2002, reporting the Registrant's first quarter 2002 press release.
Current Report on Form 8-K, dated May 30, 2002, filed with the Commission on
June 11, 2002, reporting the Registrant's appointment of two new directors.
Current Report on Form 8-K, dated July 10, 2002, filed with the Commission on
July 26, 2002, reporting the Registrant's second quarter 2002 press release.
PAGE 27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HARLEYSVILLE NATIONAL CORPORATION
/s/ Walter E. Daller, Jr.
- -------------------------------------------------------------------------
Walter E. Daller, Jr., Chairman, President and Chief Executive Officer
(Principal executive officer)
/s/ Gregg J. Wagner
- -------------------------------------------------------------------------
Gregg J. Wagner, Executive Vice President and Chief Financial Officer
(Principal financial and accounting officer)
Date: November 12, 2002
PAGE 28
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.
PAGE 29