HARLEYSVILLE NATIONAL CORP - 10-Q Quarterly Report

Third quarter 2003 diluted earnings per share of $.36 increased 5.9% over the third quarter 2002 diluted earnings per share of $.34. Third quarter basic earnings per share in 2003 of $.37 exceeded the third quarter 2002 basic earnings per share of $.35 by 5.7%. Third quarter 2003 net income of $8,795,000 increased 4.5% over the third quarter 2002 net income of $8,413,000. Net income for the first nine months of 2003 was $26,361,000, an 7.1% increase over the $24,604,000 for the comparable period in 2002. Diluted earnings per share of $1.07 were up 7.0% from the $1.00 in 2002. Basic earnings per share of $1.11 for the first nine months of 2003 were 7.8% higher than the $1.03 year-to-date September 30, 2002. The Corporation’s consolidated total assets were $2,523,002,000 at September 30, 2003, 2.1% above the September 30, 2002 level of $2,472,052,000.

For the nine months ended September 30, 2003, the annualized return on average shareholders’ equity and the annualized return on average assets were 16.32% and 1.44%, respectively. For the same period in 2002, the annualized return on average shareholders’ equity was 16.78% and the annualized return on average assets was 1.46%. Excluding accumulated other comprehensive income, the annualized return on average realized shareholders’ equity for the first nine months of 2003 and 2002 were 16.99% and 17.15%, respectively. For the three months ended September 30, 2003, the annualized return on average shareholders’ equity and the annualized return on average assets were 16.11% and 1.44%, respectively. For the same period in 2002, the annualized return on average shareholders' equity was 16.71% and the annualized return on average assets was 1.44%. Excluding accumulated other comprehensive income, the annualized return on average realized shareholders’ equity for the third quarters of 2003 and 2002 were 16.65% and 17.29%, respectively.

Asset quality continued to improve in this economy that is slowly beginning to strengthen, as reflected by the improvement in loan quality ratios at September 30, 2003. Nonperforming loans (nonaccruing loans and loans past due 90 days or more and still accruing interest) were .37% of total loans at September 30, 2003, compared to .47% at December 31, 2002 and .51% at September 30, 2002. The ratio of loan loss reserve to nonperforming loans was 326.5% at September 30, 2003, compared to 272.8% at December 31, 2002 and 248.2% at June 30, 2002. The annualized net loans charged-off to average loans was 0.39% during the third quarter of 2003, compared to 0.20% during the third quarter of 2002.

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 inherent 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 2003 of $58,227,000 was $2,510,000 or 4.1% lower than the same period in 2002 net interest income of $60,737,000. The third quarter 2003 net interest income of $19,223,000 was $456,000 or 2.3% less than the net interest income earned in the same quarter of 2002. As shown in the table below, this decrease in net interest income was primarily the result of the lower net interest margin, partially offset by higher earning asset volumes. Interest income was lower in 2003 compared to 2002 as a result of the impact of lower interest rates and the effect of the growth in the investment portfolio outpacing the growth in the loan portfolio during this period. The yield earned on the investment portfolio is lower than the yield earned on the loan portfolio. The year-to-date and third quarter 2003 interest income was also impacted by the very high level of cash flow from mortgage refinance activity and accelerated premium amortization on mortgage backed securities. However, based on lower mortgage refinance applications received in August and September, refinance lending activity and related cash flows should slow in the fourth quarter. The lower interest income was partially offset by the decrease in interest expense related to the reduction in deposit and other borrowing rates.


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The rate-volume variance analysis in the table below, which is computed on a tax-equivalent basis (tax rate of 35%), analyzes changes in net interest income for the nine and three months ended September 30, 2003 over September 30, 2002 by their rate and volume components.

		Nine Months Ended September 30, 2003 Over/Under September 30, 2002						Three Months Ended September 30, 2003 Over/Under September 30, 2002



(In thousands)

		Total		Caused by:				Total		Caused by:

		Variance		Rate		Volume		Variance		Rate		Volume

Interest Income:
Securities *	$	(3,833)	$	(9,456)	$	5,623	$	(2,619)	$	(3,031)	$	412
Money market instruments		(173)		(179)		6		15		(53)		68
Loans *		(5,935)		(6,440)		505		(1,894)		(2,139)		245

Total		(9,941)		(16,075)		6,134		(4,498)		(5,223)		725


Interest Expense:
Savings deposits		(2,893)		(3,853)		960		(1,496)		(1,710)		214
Time deposits and certificates of deposit		(5,684)		(5,221)		(463)		(2,317)		(1,609)		(708)
Other borrowings		(258)		(788)		530		(409)		(461)		52

Total		(8,835)		(9,862)		1,027		(4,222)		(3,780)		(442)


Net Interest Income	$	(1,106)	$	(6,213)	$	5,107	$	(276)	$	(1,443)	$	1,167

*Tax Equivalent Basis

BALANCE SHEET ANALYSIS

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

DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY,
INTEREST RATES AND INTEREST DIFFERENTIAL:

(Dollars in thousands)	Nine Months Ended Sept. 30, 2003					Nine Months Ended Sept. 30, 2002

		Average	Average				Average	Average
Assets		Balance	Rate		Interest		Balance	Rate		Interest

Investment securities:
Taxable investments	$	613,133	2.81%	$	12,931	$	530,727	5.23%	$	20,827
Nontaxable investments (1)		325,940	6.99		17,081		232,411	7.47		13,018

Total investment securities		939,073	4.26		30,012		763,138	5.91		33,845


Loans (1) (2)		1,342,174	6.47		65,173		1,331,766	7.12		71,108
Other rate-sensitive assets		27,258	1.18		241		26,568	2.08		415

Total earning assets		2,308,505	5.51		95,426		2,121,472	6.62		105,368

Noninterest-earning assets		132,359	-		-		126,634	-		-

Total assets	$	2,440,864	5.21%	$	95,426	$	2,248,106	6.25%	$	105,368


Liabilities And Shareholders' Equity
Deposits:
Demand	$	260,712	-%	$	-	$	245,318	-%		-
Savings		938,308	0.86		6,030		788,937	1.51		8,923
Time		712,461	3.35		17,900		730,890	4.30		23,585

Total		1,911,481	1.67		23,930		1,765,145	2.46		32,508
Borrowings and other
Interest-bearing liabilities		262,483	3.43		6,756		241,883	3.87		7,014
Other liabilities		51,533	-		-		45,525	-		-

Total liabilities		2,225,497	1.84		30,686		2,052,553	2.57		39,522

Shareholders' equity		215,367	-		-		195,553	-		-

Total liabilities and shareholders' equity	$	2,440,864	1.68	$	30,686	$	2,248,106	2.34%		39,522

Average effective rate on
interest-bearing liabilities	$	1,913,252	2.14%	$	30,686	$	1,761,710	2.99%		39,522


Interest Income/Earning Assets	$	2,308,505	5.51%	$	95,426	$	2,121,472	6.62%		105,368
Interest Expense/Earning Assets	$	2,308,505	1.77	$	30,686	$	2,121,472	2.48		39,522

Effective Interest Differential			3.74%					4.14%


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(Dollars in thousands)	Three Months Ended Sept. 30, 2003						Three Months Ended Sept. 30, 2002

Assets		Average Balance	Average Rate			Interest		Average Balance	Average Rate			Interest

Investment securities:
Taxable investments	$	589,321	2.30	%	$	3,388	$	593,451	4.42	%	$	6,555
Nontaxable investments (1)		309,565	6.99			5,408		263,332	7.38			4,860

Total investment securities		898,886	3.91			8,796		856,783	5.33			11,415


Loans (1) (2)		1,354,394	6.38			21,604		1,339,041	7.02			23,498
Other rate-sensitive assets		45,285	0.99			112		17,822	2.18			97

Total earning assets		2,298,565	5.31			30,512		2,213,646	6.33			35,010

Noninterest-earning assets		138,198	-			-		128,579	-			-

Total assets	$	2,436,763	5.01%		$	30,512	$	2,342,225	5.98%		$	35,010


Liabilities And Shareholders' Equity
Deposits:
Demand	$	278,267	-	%		-	$	242,568	-	%	$	-
Savings		940,436	0.67			1,585		813,328	1.52			3,081
Time		687,670	3.23			5,561		775,191	4.06			7,877

Total		1,906,373	1.50			7,146		1,831,087	2.39			10,958
Borrowings and other
Interest-bearing liabilities		260,383	3.18			2,071		253,855	3.91			2,481
Other liabilities		51,611	-			-		55,880	-			-

Total liabilities		2,218,367	1.66			9,217		2,140,822	2.51			13,439

Shareholders' equity		218,396	-			-		201,403	-			-

Total liabilities and shareholders' equity	$	2,436,763	1.51%		$	9,217	$	2,342,225	2.30	%	$	13,439

Average effective rate on
interest-bearing liabilities	$	1,888,489	1.95	%	$	9,217	$	1,842,374	2.92	%	$	13,439


Interest Income/Earning Assets	$	2,298,565	5.31	%	$	30,512	$	2,213,646	6.33	%	$	35,010
Interest Expense/Earning Assets	$	2,298,565	1.60		$	9,217	$	2,213,646	2.43		$	13,439

Effective Interest Differential			3.71	%					3.90	%


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

(2) Nonaccrual loans have been included in the appropriate average loan balance category, but interest on nonaccrual loans have not been included for purposes of determining interest income. 

Taxable-equivalent net interest income was $64,740,000 for the first nine months of 2003, compared to $65,846,000 for the same period in 2002, a 1.7% or $1,106,000 decrease. The reduction in the taxable-equivalent net interest income was the result of the lower interest rate environment experienced during this time period and the higher growth in the investment portfolio, compared to loans. During the first nine months of 2003, the average investment portfolio represented 40.7% of total earning assets compared to 36.0% during the same period in 2002. Average total loans grew $10,408,000 compared to a $175,935,000 rise in average investments in the first nine months of 2003, compared to the first nine months of 2002. The growth in loans during 2003 was impacted by the planned declines in the indirect vehicle and auto leasing portfolios. The reduction in these portfolios was primarily r elated to the financing incentives offered by the vehicle manufacturers and the overall increased competition in this market segment. Net of these two products, average loans grew 9.1%, led by increases in both commercial related and home equity loans.

The year-to-date September 30, 2003 taxable-equivalent net interest income was lower than the same period in 2002 primarily due to a $9,941,000 reduction in interest income, which was partially offset by a decrease in interest expense of $8,835,000. The taxable-equivalent interest income decrease was the result of lower earning asset yields, in part offset by the higher volumes of earning assets. Average year-to-date earning assets grew $187,033,000, or 8.8% at September 30, 2003, compared to the same period in 2002. The yield earned on earning assets decreased 111 basis points from 6.62% in the first nine months of 2002 to 5.51% during the same period in 2003.

The year-to-date September 30, 2003 interest expense was $8,835,000 lower than the same period in 2002. This reduction is the result of a $9,862,000 decrease related to lower rates, partially offset by an increase of $1,027,000 associated with the higher deposit and other borrowing volumes. The average rate paid on interest bearing deposits and other borrowings of 2.14% during the first nine months of 2003 was 85 basis points lower than the 2.99% rate paid during the same period in 2002. The average balance of interest bearing deposits and other borrowings grew $151,542,000 or 8.6% in the first nine months of 2003, compared to the first nine months of 2002. Lower rate savings deposits, which include interest bearing checking accounts, savings accounts and money market accounts, accounted for $149,371,000 or 98.6% of the growth in interest bearing deposits and other borrowings. The ave rage year-to-date higher rate time deposits decreased $18,429,000 or 2.5% during this period and other borrowings grew $20,600,000 or 8.5%. Other borrowings include federal funds purchased, Federal Home Loan Bank (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 2003 of $21,295,000 was $276,000 or 1.3% lower than the third quarter of 2002 net interest income. The $4,498,000 decrease in interest income was partially offset by a $4,222,000 reduction in interest expense. The yield earned on average earning assets during the third quarter of 2003 of 5.31% was 102 basis points lower than the 6.33% earned during the third quarter of 2002. The $42,103,000 growth in lower yielding investment securities outpaced the $15,353,000 growth in loans. The rate paid on average deposits and other borrowings of 1.95% during the third quarter of 2003 was 97 basis points lower than the 2.92% rate paid during the third quarter of 2002. Lower rate average savings deposits grew $127,108,000 and higher rate average time deposits decreased $87,521,000. Other borrowings increased $6,528,000 during t his period.


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Net Interest Margin

The net interest margins for the nine-month periods ending September 30, 2003 and September 30, 2002 were 3.74% and 4.14%, respectively. The third quarter 2003 and 2002 net interest margins were 3.71% and 3.90%, respectively. The third quarter 2003 net interest margin was higher than the first quarter of 2003 and fourth quarter of 2002 net interest margins of 3.68% and 3.64%, respectively. The second quarter of 2003 net interest margin of 3.82% was 11 basis points higher than the third quarter of 2003 net interest margin.

During 2003, the Corporation continued to manage its balance sheet in an effort to position it for the longer term. The Corporation entered into two interest-rate swaps with a notional value totaling $20.0 million during the first quarter of 2003. The purpose of these transactions was to fix the rate on variable rate money market accounts in an effort to reduce interest rate risk within a rising rate environment. During the second quarter of 2003, the Corporation paid off $29 million of Federal Home Loan Bank borrowings prior to their scheduled maturity dates. These borrowings carried rates over 6%. While the decline in the net interest margin impacted earnings during the third quarter of 2003, we have positioned the balance sheet to benefit from rising interest rates once the economy begins to improve.

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 Board of Directors, is responsible for managing the rate sensitivity position. The Corporation manages interest rate sensitivity by changing the mix and repricing characteristics of its assets and liabilities through the management of its investment securities portfolios, its offering of loan and deposit terms and through 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 only utilizes derivative instruments for asset/liability management, specifically, to convert a variable rate debt to a fixed rate. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations and payments are based. The notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Interest rate swaps are contracts in which a series of interest-rate flows (fixed and floating) are exchanged over a prescribed period. The notional amounts on which the interest payments are based are not exchanged.

The Corporation entered into two interest-rate swaps with a notional value totaling $20.0 million and a negative fair value of $145,000 at September 30, 2003. The purpose of these transactions is to fix the rate on variable rate money market accounts in an effort to reduce interest rate risk within a rising rate environment.

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 results of the September 30, 2003 net interest income rate shock simulations show that the Corporation is within guidelines set by the Corporation’s Asset/Liability Policy when rates are shocked up 300 basis points, but is outside of guidelines when rates are shocked down over 200 basis points.

The 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.


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

+ Basis Points	342,082	5,848	1.74%	+/- 45%
+ Basis Points	352,568	16,334	4.86%	+/- 30%
+ Basis Points	349,870	13,636	4.06%	+/- 15%
Flat Rate	336,234	-	0.00%
-100 Basis Points	307,507	(28,727)	-8.54%	+/- 15%
-200 Basis Points	284,692	(51,542)	-15.33%	+/- 30%
-300 Basis Points	255,209	(81,025)	-24.10%	+/- 45%

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

Provision for Loan Losses

The Banks use 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 loan losses. Credit exposures deemed to be uncollectible are charged against the allowance for loan losses. Recoveries of previously charged-off amounts are credited to the allowance for loan losses.

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

The Banks’ 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 loan 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 loan losses being estimated. The observable data and accompanying analysis is directionally consistent, based upon trends, with the resulting component amount for the allowance for loan losses. The Banks allowance for loan 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, c ompetence of the loan review process and other historical loss model imprecision. The Banks historical loss component is the most significant component of the allowance for loan losses, and all other allowance components are based on the inherent loss attributes that management believes exist within the total portfolio that are not captured in the historical loss component.

The AICPA's Accounting Standards Executive Committee has issued an exposure draft of a proposed Statement of Position (SOP), Allowance for Credit Losses . The proposed SOP addresses the recognition and measurement by creditors of the allowance for credit losses related to all loans, as that term is defined in Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan , with certain excep tions. If adopted, the proposed SOP would apply to all creditors other than state and local governmental entities and federal governmental entities. The Corporation is currently reviewing the components of the proposed SOP and the impact it will have on its consolidated financial position and results of operations.


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

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

The industry concentration component is recognized as a possible factor in the estimation of loan losses. Two industries represent possible concentrations: commercial real estate and 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.

The historic loss model includes an imprecision component (soft factors and unallocated portion) that reflects management’s belief that there were additional inherent credit losses based on loss attributes not adequately captured in the lagging indicators. Furthermore, given that past-performance indicators may not adequately capture current risk levels, allowing for a real-time adjustment enhances the validity of the loss recognition process. There are many credit risk management reports that are synthesized by credit management staff to assess the direction of credit risk and its instant affect on losses. These reports include the exception tracking reports, the credit bureau score distribution report, the debt to income summary, etc. These are a few of the many reports that drive the judgmental component. It is important to continue to use experiential data to confirm risk as measurable losses will continue to manifest themselves at higher than normal levels even after the economic cycle has begun an upward swing and lagging indicators begin to show improvement.

For the first nine months of 2003 the provision for loan losses was $2,559,000, compared to $3,401,000 for the same period in 2002. This reduction in the provision for loan losses is reflective of the improvement in key loan quality related ratios. The ratio of the allowance for loan losses to nonperforming loans and leases for September 30, 2003 of 326.5% was higher than the December 31, 2002, and the September 30, 2002, ratios of 272.8% and 248.2%, respectively. The ratio of nonperforming loans and leases to total loans and leases was 0.37% at September 30, 2003, compared to 0.47% and 0.51% at December 31, 2002 and September 30, 2002, respectively. Net loans charged off was $2,895,000 for the nine months ended September 30, 2003, compared to $1,820,000 for the nine months ended September 30, 2002. The increase in the 2003 net charged off loans are related to commercial and industria l loans.


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Allowance for Loan Losses

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

(Dollars in thousands)		September 30,
		2003		2002

Average loans	$	1,342,174	$	1,331,766


Allowance, beginning of period	$	17,190	$	15,558

Loans charged off:
Commercial and industrial		473		91
Consumer		1,568		1,985
Real estate		1,193		323
Lease financing		371		396

Total loans charged off		3,605		2,795

Recoveries:
Commercial and industrial		16		105
Consumer		544		642
Real estate		71		157
Lease financing		79		71

Total recoveries		710		975

Net loans charged off		2,895		1,820

Provision for loan losses		2,559		3,401

Allowance, end of period	$	16,854	$	17,139

Ratio of net charge offs to average loans outstanding (annualized)		0.29%		0.18%

Analysis of Credit Risk		September 30,		December 31,		September 30,

(Dollars in thousands)		2003		2002		2002

Non-accrual loan and leases	$	3,962	$	5,109	$	5,325
Loans and leases 90 days past due		1,200		1,193		1,580

Total nonperforming loans and leases		5,162		6,302		6,905
Net assets in foreclosure		893		390		473

Total nonperforming assets	$	6,055	$	6,692	$	7,378

Allowance for loan and lease losses to
nonperforming loans and leases		326.5%		272.8%		248.2%
Nonperforming loans and leases to total
total loans and leases		0.37%		0.47%		0.51%
Allowance for loan and lease losses
to total loans and leases		1.22%		1.29%		1.28%
Nonperforming assets
to total assets		0.24%		0.27%		0.30%

The following table sets forth an allocation of the allowance for loan losses by loan category:

		September 30, 2003

(Dollars in thousands)		Amount	Percent of Loans


Commercial and industrial	$	4,605	27%
Consumer loans		5,596	33%
Real estate		5,837	35%
Lease financing		816	5%

Total	$	16,854	100%


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Nonperforming assets (nonaccruing loans, loans 90 days past due and net assets in foreclosure) were 0.24% of total assets at September 30, 2003 and 0.27% and 0.30% at December 31, 2002 and September 30, 2002, respectively. The ratio of the allowance for loan losses to loans at September 30, 2003 of 1.22% was lower than the December 31, 2002 ratio of 1.29% and the September 30, 2002 ratios of 1.28.%.

Nonaccruing loans at September 30, 2003 of $3,962,000, decreased $1,147,000 from the December 31, 2002 level of $5,109,000, and decreased $1,363,000 from the September 30, 2002 level of $5,325,000. The decrease in nonaccruing loans at September 30, 2003, compared to both December 31, 2002 and September 30, 2002 was primarily the result of decreases in commercial real estate, commercial and consumer loans.

Net assets in foreclosure were $893,000 as of September 30, 2003, an increase of $503,000 from the December 31, 2002 balance of $390,000. During the first nine months of 2003, transfers from loans to assets in foreclosure were $1,378,000, payments on foreclosed properties were $875,000. There were no write-downs of assets in foreclosure during this period . The loans transferred to assets in foreclosure included vehicle leases of $539,000, equipment leases of $204,000, $163,000 of consumer loans and $473,000 of commercial loans. The balance of net assets in foreclosure at September 30, 2002 was $472,000. Efforts to liquidate assets acquired in foreclosure are proceeding as q uickly as potential buyers can be located and legal constraints permit. Foreclosed assets are carried at the lower of cost (lesser of carrying value of asset or fair value at date of acquisition) or estimated fair value.

Loans past due 90 days or more and still accruing interest are loans that are generally well secured and expected to be restored to a current status in the near future. As of September 30, 2003, loans past due 90 days or more and still accruing interest were $1,200,000 compared to $1,193,000 as of December 31, 2002 and $1,580,000 as of September 30, 2002. The increase in loans past due 90 days at September 30, 2003, compared to December 31, 2002 was due to an increase in consumer loans past due 90 days or more. The reduction from September 30, 2002 is the result of the lower level of commercial real estate loans and commercial loans past due 90 days or more.

The following information concerns impaired loans:

		Sept. 30, 2003		Dec. 31, 2002		Sept. 30, 2002

Impaired Loans	$	2,016,000	$	3,153,000	$	3,015,000


Average year-to-date impaired loans	$	2,322,000	$	2,836,000	$	2,909,000


Impaired loans with specific loss allowances	$	2,016,000	$	3,153,000	$	3,015,000


Loss allowances reserved on impaired loans	$	233,000	$	329,000	$	298,000


Year-to-date income recognized on impaired loans	$	45,000	$	186,000	$	93,000

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.


	20

Other Operating Income

		Nine Months Ended September 30,				Three Months Ended September 30,

		2003		2002		2003		2002

		(Dollars in thousands)				(Dollars in thousands)

Service charges	$	5,774	$	4,993	$	2,007	$	1,846
Security gains, net		6,449		3,193		359		719
Trust and investment services income		2,820		2,809		954		896
Bank-owned life insurance income		1,935		1,900		673		631
Income on Life Insurance		1,119		-		-		-
Other income		4,325		4,188		1,259		1,349

Total other operating income	$	22,422	$	17,083	$	5,252	$	5,441

In the nine months ending September 30, 2003, other operating income of $22,422,000 increased $5,339,000, or 31.3%, from $17,083,000 for the same period in 2002. This rise in other operating income is primarily the result of increases in security gains and income on life insurance of $3,256,000 and $1,119,000, respectively. Net of security gains and income on life insurance, other operating income grew $964,000 or 6.9%. All other operating income categories contributed to this growth. In the third quarter of 2003, other operating income was $189,000 or 3.5% lower than the third quarter of 2002 as a result of lower security gains. Net of security gains, third quarter 2003 other operating income increased $171,000 or 3.6%, compared to the same period in 2002. The increase is primarily the result of higher fees related to deposits, trust and investment services, and bank-owned life insur ance.

Service charges grew $781,000 or 15.6% in the first nine months of 2003, compared to the same period in 2002. This rise is the result of management’s continued effort to institute equitable fees for services performed and to closely manage the collection of these fees. The growth in overdraft fees during the first nine months of 2003 contributed $622,000 of this increase. The remaining increase is related to the fees associated with the 15.9% growth in average fee generating deposit balances.

The Corporation recorded net security gains on the sale of securities available for sale of $6,449,000 in the first nine months of 2003, compared to $3,193,000 during the same period in 2002. The net security gains were $359,000 in the third quarter of 2003 and $719,000 in the third quarter of 2002. The Corporation sold the investment securities available for sale to fund the purchase of other securities in an effort to reduce the interest rate risk and market risk within different interest rate environments.

Income from the Investment Management and Trust Services Division increased $11,000 from $2,809,000 at September 30, 2002 to $2,820,000 at September 30, 2003. The 2003 third quarter Investment Management and Trust Services Division experienced a $58,000, or 6.5% increase in income, compared to the third quarter of 2002. These increases were the result of both the growth in trust assets and the higher market value of trust assets experienced during 2003, compared to 2002.

The Corporation’s bank owned life insurance (BOLI) income increased $35,000 or 1.8% during the first nine months of 2003, compared to the same period in 2002. BOLI involves the purchase 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.

Other income for the first nine months of 2003 increased $137,000 or 3.3%, compared to the same period in 2002. This increase was primarily associated with larger gains on the sale of residential mortgages, partially offset with lower income generated by HNC Reinsurance Company. The year-to-date gain on the sale of residential mortgages was $1,167,000 in 2003, compared to $639,000 in the same period in 2002. The third quarter of 2003 other income was $90,000 lower than the same period in 2002, as a result of lower HNC Reinsurance Company income and a reduction in gains on the sale of residential mortgages.


	21

Other Operating Expenses

		Nine Months Ended September 30,				Three Months Ended September 30,

		2003		2002		2003		2002

		(Dollars in thousands)				(Dollars in thousands)

Salaries	$	19,497	$	18,050	$	6,596	$	6,206
Employee benefits		4,158		4,581		1,342		1,344
Occupancy		2,846		2,902		941		844
Furniture and equipment		4,206		4,035		1,525		1,428
Prepayment fee		2,594		-		-		-
Other expenses		12,437		13,126		2,694		3,679

Total other operating expenses	$	45,738	$	42,694	$	13,098	$	13,501

The first nine months of 2003 other operating expenses of $45,738,000 increased $3,044,000 or 7.1% from $42,694,000 for the same period in 2002. This rise was principally due to a $2,594,000 prepayment fee related to paying off FHLB borrowings prior to their scheduled maturity date during the second quarter of 2003. Net of this prepayment fee, the year to date other operating expenses grew $450,000 or 1.1%. This rise was the result of higher salary and furniture and equipment expenses, partially offset by lower employee benefits, occupancy expenses and other expenses. The third quarter 2003 other operating expenses decreased $403,000 or 3.0% from the third quarter of 2002. This reduction in expenses was primarily due to lower other expenses.

Employee salaries increased $1,447,000 or 8.0% from $18,050,000 for the first nine months of 2002 to $19,497,000 for the same period in 2003. This increase reflects cost of living increases, merit increases and additional staff necessitated by the growth of the Banks. Employee benefits of $4,158,000 expensed in the first nine months of 2003, were $423,000 or 9.2% lower than the $4,581,000 of employee benefits expensed during the same period in 2002. The decrease in employee benefits is the result of lower pension expense experienced during the first nine months of 2003, compared to the first nine months of 2002. The third quarter 2003 salary expense was 6.3% higher than the third quarter of 2002. Employee benefits were $2,000 lower in the third quarter of 2003, compared to the third quarter of 2002.

Net occupancy expense decreased $56,000 or 1.9%, from $2,902,000 in the first nine months of 2002 to $2,846,000 in the first nine months of 2003. This decrease was due to a $365,000 expense related to a branch closure during the first quarter of 2002. Net of the branch closure expense, occupancy expenses grew $309,000 or 12.2% during the first nine months of 2003, compared to the same period in 2002. This increase was primarily the result of the increase in snow removal expenses associated with the harsh winter of 2003 and higher rent expense. The third quarter of 2003 occupancy expense grew 11.5%, compared to the third quarter of 2002. Furniture and equipment expense increased $171,000 or 4.3%, during the first nine months of 2003, compared to the same period in 2002. The third quarter of 2003 furniture and equipment expenses grew 6.8% over the third quarter of 2002. Both of these in creases were related to higher depreciation and maintenance expenses.

Other expenses decreased $689,000, or 5.2%, from $13,126,000 in the first nine months of 2002, compared to $12,437,000 in other expenses recorded during the same period in 2003. This decrease was largely due to the $889,000 reduction in expenses related to HNC Reinsurance Company and the net increase in the market value of mortgage servicing rights of $373,000. Net of these expense reductions, other expenses increased $573,000 or 4.6% during this period, primarily due to an increase in the off-lease vehicle residual reserve expense. The year-to-date off-lease vehicle residual reserve expense in 2003 was $2,600,000 compared to $2,227,000 in 2002. The $2,600,000 year-to-date 2003 off-lease vehicle reserve expense was posted entirely during the first six months of 2003.

The 2003 third quarter other expenses decreased 26.8%, compared to the third quarter of 2002, due to lower off-lease vehicle residual reserve expense, HNC Reinsurance Company expenses and the increase in the market value of mortgage servicing rights. Net of these reductions, other expenses grew 14.2% as a result of higher deferred compensation and marketing expenses. As a result of lower than projected off-lease vehicle residual losses experienced during the third quarter of 2003, the Corporation did not add to the off-lease vehicle residual reserve during the quarter. The lower third quarter losses were a result of enhanced processes to remarket the off-lease vehicles and an improvement in the value of used vehicles. The third quarter of 2002 off-lease vehicle reserve expense was $500,000. The Corporation reviews the off-lease vehicle residual reserve expense on a quarter ly basis.

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.


	22

Balance Sheet Analysis

Total assets increased $32,138,000, or 1.3%, from $2,490,864,000 at December 31, 2002 to $2,523,002,000 at September 30, 2003. This increase in assets was the result of a $41,689,000 increase in cash and cash equivalents, a $23,102,000 growth in loans and a $21,288,000 rise in residential mortgages held for sale. These increases were partially offset by a decrease in investment securities available for sale.

The balance of securities available for sale at September 30, 2003 of $895,126,000 decreased $53,930,000 compared to the December 31, 2002 balance of $949,056,000. During the first nine months of 2003, $965,232,000 of securities available for sale was sold which generated a pretax gain of $6,449,000. In comparison, $568,561,000 securities available for sale were sold during the same period in 2002 to generate a pretax gain of $3,193,000. The Corporation sells investment securities available for sale to fund the purchase of other securities in an effort to reduce the interest rate risk and market risk within different interest rate environments. The balance of investment securities held to maturity decreased $1,705,000 during the first nine months of 2003. Total loans and residential mortgage loans held for sale grew $44,390,000 or 3.3% through September 30, 2003. This growth was prima rily due to increases in both commercial related loans and home equity loans, partially offset by lower indirect vehicle financing and vehicle leases. The loan growth net of both the indirect vehicle and vehicle leasing portfolios was 8.4% during this period.

Total deposits increased $11,010,000, or 0.6% from $1,979,822,000 at December 31, 2002 to $1,990,832,000 at September 30, 2003. During this period, core deposits grew $58,763,000 or 4.9% and certificates of deposits decreased $47,753,000 or 6.2%. The reduction in certificates of deposits was due to a planned run-off of higher costing deposits and the increase in core deposits (noninterest-bearing checking, interest-bearing checking, money market accounts and savings accounts) was the result of the strategy to increase lower costing funding. The September 30, 2003 total core deposit balances grew 11.0%, compared to the September 30, 2002 total core deposits.

Other borrowings increased $9,922,000 or 3.9% during the first nine months of 2003. This increase was the result of a $6,000,000 rise in long-term FHLB borrowings and a $3,974,000 increase in securities sold under agreement to repurchase, offset by lower U.S. Treasury demand notes of $52,000. Other borrowings grew $8,826,000 at September 30, 2003, compared to September 30, 2002. This growth was primarily in long-term FHLB borrowings.

Capital

Capital formation is important to the Corporation's well being and future growth. Capital for the period ending September 30, 2003 was $218,878,000, an increase of $12,672,000 over the end of 2002. The increase is the result of the retention of the Corporation's earnings, partially offset by a decrease in accumulated other comprehensive income and by the purchase of treasury stock during the first nine months of 2003. The accumulated other comprehensive income at September 30, 2003 was a gain of $5,016,000, compared to a gain of $6,937,000 at December 31, 2002. The corporation purchased $2,271,000 of treasury stock during the first nine months of 2003. 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.


	23

(Dollars in thousands)
					For Capital Adequacy Purposes
As of September 30, 2003		Actual			For Capital Adequacy Purposes

		Amount	Ratio			Amount	Ratio

Total Capital (to risk weighted assets):

Corporation	$	236,959	13.49	%	$	140,518	8.00	%
Harleysville National Bank		144,512	11.17	%		103,491	8.00	%
Citizens National Bank		39,648	12.85	%		24,682	8.00	%
Security National Bank		18,110	12.89	%		11,235	8.00	%
Tier 1 Capital (to risk weighted assets):

Corporation	$	218,535	12.44	%	$	70,259	4.00	%
Harleysville National Bank		133,661	10.33	%		51,746	4.00	%
Citizens National Bank		35,791	11.60	%		12,341	4.00	%
Security National Bank		16,350	11.64	%		5,618	4.00	%
Tier 1 Capital (to average assets):

Corporation	$	218,535	8.97	%	$	97,457	4.00	%
Harleysville National Bank		133,661	7.65	%		69,848	4.00	%
Citizens National Bank		35,791	7.52	%		19,043	4.00	%
Security National Bank		16,350	8.21	%		7,963	4.00	%

	To Be Well Capitalized Under Prompt Corrective Action Provision


	Amount			Ratio

Total Capital (to risk weighted assets):

Corporation		$ -		-
Harleysville National Bank			129,364		10.00	%
Citizens National Bank			30,852		10.00	%
Security National Bank			14,044		10.00	%
Tier 1 Capital (to risk weighted assets):

Corporation		$	-		-
Harleysville National Bank			77,619		6.00	%
Citizens National Bank			18,511		6.00	%
Security National Bank			8,427		6.00	%
Tier 1 Capital (to average assets):

Corporation		$	-		-
Harleysville National Bank			87,310		5.00	%
Citizens National Bank			23,804		5.00	%
Security National Bank			9,953		5.00	%

(Dollars in thousands)
						For Capital Adequacy Purposes
As of December 31, 2002	Actual					For Capital Adequacy Purposes
	Amount		Ratio			Amount		Ratio

Total Capital (to risk weighted assets):

Corporation	$	222,217		13.38	%	$	132,866		8.00	%
Harleysville National Bank		133,945		11.16	%		96,034		8.00	%
Citizens National Bank		37,125		12.01	%		24,722		8.00	%
Security National Bank		17,033		12.60	%		10,814		8.00	%
Tier 1 Capital (to risk weighted assets):

Corporation	$	203,896		12.28	%	$	66,433		4.00	%
Harleysville National Bank		122,990		10.25	%		48,017		4.00	%
Citizens National Bank		33,258		10.76	%		12,361		4.00	%
Security National Bank		15,338		11.35	%		5,407		4.00	%
Tier 1 Capital (to average assets):

Corporation	$	203,896		8.19	%	$	99,640		4.00	%
Harleysville National Bank		122,990		6.88	%		71,493		4.00	%
Citizens National Bank		33,258		6.91	%		19,255		4.00	%
Security National Bank		15,338		7.77	%		7,896		4.00	%


	24

	To Be Well Capitalized Under Prompt Corrective Action Provision



	Amount			Ratio

Total Capital (to risk weighted assets):


Corporation		$	-		-
Harleysville National Bank			120,043		10.00	%
Citizens National Bank			30,903		10.00	%
Security National Bank			13,517		10.00	%
Tier 1 Capital (to risk weighted assets):

Corporation		$	-		-
Harleysville National Bank			72,026		6.00	%
Citizens National Bank			18,542		6.00	%
Security National Bank			8,110		6.00	%
Tier 1 Capital (to average assets):

Corporation		$	-		-
Harleysville National Bank			89,366		5.00	%
Citizens National Bank			24,069		5.00	%
Security National Bank			9,869		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, 2003, the Corporation’s Tier 1 risk-adjusted capital ratio was 12.44% , and the total risk-adjusted capital ratio was 13.49%, both well above the regulatory requirements. The risk-based capital ratios of each of the Corporation’s commercial b anks also exceeded regulatory requirements at September 30, 2003.

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 8.97% at September 30, 2003 and 8.19% at December 31, 2002.

The year-to-date September 30, 2003 cash dividend per share of $.464 was 17.2% higher than the cash dividend for the same period in 2002 of $.396. The dividend payout ratio for the first nine months of 2003 was 41.9%, compared to 40.9% for the twelve month period ended December 31, 2002. Activity in both the Corporation’s dividend reinvestment and stock purchase plan and the stock option plan did not have a material impact on capital during the first nine months of 2003.

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 uses of funds for the next 120 days. The resulting projections as of September 30, 2003 show the potential sources of funds exceeding the potential uses of funds. The Corporation has external sources of funds which can be drawn upon when funds are required. The primary source of external liquidity is an available line of credit with the FHLB of Pittsburgh. Unused lines of credit at the FHLB of Pittsburgh were $314,119,000, as of September 30, 2003. The Banks also have unused federal funds lines of credit of $60,000,000 and non-pledged investment securities available for sale of $403,727,000 as of September 30, 2003.


	25

Other Information

Pending Legislation

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

Effects of Inflation

Inflation has some impact on the Corporation and the 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, 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 2003, Security National Bank plans to open a location in North Coventry Township, Chester County, Pennsylvania. This new branch site is contiguous to our current service area and was chosen to expand the Bank’s market area and market share of loans and deposits.

Item 3 – Qualitative and Quantitative Disclosures About Market Risk

In the normal course of conducting business activities, the Corporation is exposed to market risk, principally interest risk, through the operations of its banking 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.


	26

No material changes in market risk strategy occurred during the current period. A detailed discussion of market risk is provided on pages 16 and 17 of this Form 10-Q.

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. 


	27

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

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

None.

Item 5. Other Information

None

Item 6. Exhibits and Reports on Form 8-K

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

Exhibit No. Description of Exhibits

(2) Agreement and Plan of Merger dated October 15, 2003, by and among Harleysville National Corporation,

Harleysville National Bank and Trust Company and Millenium Bank.

(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.)


	28

(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.)

(10.7) 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.

(31) Section 302 Certification. Walter E. Daller, Jr. Chairman, President and Chief Executive Officer and

Gregg J. Wagner, Executive Vice President and Chief Financial Officer.

(32) Section 906 Certification. Walter E. Daller, Jr. Chairman, President and Chief Executive Officer and

Gregg J. Wagner, Executive Vice President and Chief Financial Officer.

(b) Reports on Form 8-K

During the quarter ended September 30, 2003, the Registrant filed a Form 8-K containing the second quarter of 2003 earnings press release.


	29

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

Walter E. Daller, Jr., Chairman, President and Chief Executive Officer

(Principal executive officer)

Gregg J. Wagner, Executive Vice President and Chief Financial Officer

(Principal financial and accounting officer)


	30

EXHIBIT INDEX

Exhibit No. Description of Exhibits

(2) Agreement and Plan of Merger dated October 15, 2003, by and among Harleysville National Corporation,

Harleysville National Bank and Trust Company and Millenium Bank.

(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.)

(10.7) 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.

(31) Section 302 Certification. Walter E. Daller, Jr. Chairman, President and Chief Executive Officer and

Gregg J. Wagner, Executive Vice President and Chief Financial Officer.

(32) Section 906 Certification. Walter E. Daller, Jr. Chairman, President and Chief Executive Officer and

Gregg J. Wagner, Executive Vice President and Chief Financial Officer.


	31

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

PART 1. FINANCIAL INFORMATION HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
		(Unaudited)
(Dollars in thousands)		September 30, 2003		December 31, 2002

Assets
Cash and due from banks	$	52,813	$	62,177
Federal funds sold		88,500		33,500
Interest-bearing deposits in banks		4,463		8,410

Total cash and cash equivalents		145,776		104,087


Residential mortgage loans held for sale		21,288		-
Investment securities available for sale		895,126		949,056
Investment securities held to maturity		20,706		22,411
(fair value $22,365 and $23,650, respectively)
Total loans and leases		1,356,394		1,333,292
Less: Allowance for loan losses		(16,854)		(17,190)

Net loans		1,339,540		1,316,102

Bank premises and equipment, net		22,227		21,645
Accrued interest receivable		10,921		13,140
Net assets in foreclosure		893		390
Intangible assets, net		2,526		1,798
Bank-owned life insurance		50,013		48,631
Other assets		13,986		13,604

Total assets	$	2,523,002	$	2,490,864

Liabilities and Shareholders' Equity
Deposits:
Noninterest-bearing	$	283,886	$	269,781
Interest-bearing:
Checking accounts		276,941		249,646
Money market accounts		490,341		488,944
Savings		217,969		202,003
Time, under $100,000		506,976		526,885
Time, $100,000 or greater		214,719		242,563

Total deposits		1,990,832		1,979,822
Accrued interest payable		20,761		21,991
U.S. Treasury demand notes		1,963		2,015
Long-term borrowings		168,750		162,750
Securities sold under agreements to repurchase		88,115		84,141
Guaranteed preferred beneficial interest in Corporation's
subordinated debentures		5,000		5,000
Other liabilities		28,703		28,939

Total liabilities		2,304,124		2,284,658

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 24,655,569 shares at September
30, 2003 and 19,597,290 shares at December 31, 2002		24,656		19,597
Additional paid in capital		93,077		96,585
Retained earnings		109,990		94,677
Treasury stock, at cost: 822,633 shares in 2003
and 569,107 shares in 2002		(13,861)		(11,590)
Accumulated other comprehensive income		5,016		6,937

Total shareholders' equity		218,878		206,206

Total liabilities and shareholders' equity	$	2,523,002	$	2,490,864


See accompanying notes to consolidated financial statements.

Consolidated Statements of Shareholders' Equity
Harleysville National Corporation and Subsidiaries
(Unaudited)
(Dollars and share information in thousands)

Nine Months Ended September 30, 2003
	Common Stock

	Number of shares		Par Value		Additional Paid in Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock		Total		Comprehensive Income (Loss)

Balance, January 1, 2003	19,597	$	19,597	$	96,585	$	94,677	$	6,937	$	(11,590)	$	206,206	$
Stock options	130		130		1,415		-		-		-		1,545
Stock Dividends	4,929		4,929		(4,929)		-		-		-		-
Net income	-		-		-		26,361		-		-		26,361		26,361
Stock awards	-		-		6		-		-		-		6
Other comprehensive income,
net of reclassifications and tax	-		-		-		-		(1,921)		-		(1,921)		(1,921)
Purchases of Treasury stock	-		-		-		-		-		(2,271)		(2,271)
Cash dividends	-		-		-		(11,048)		-		-		(11,048)

Comprehensive income														$	24,440

Balance, September 30, 2003	24,656	$	24,656	$	93,077	$	109,990	$	5,016	$	(13,861)	$	218,878



For the Year Ended December 31, 2002
	Common Stock

	Number of shares		Par Value		Additional Paid in Capital		Retained Earnings		Accumulated Other Comprehensive Income		Treasury		Total		Comprehensive Income

Balance, January 1, 2002	18,571	$	18,571	$	71,419	$	100,171	$	4,534	$	(5,346)	$	189,349	$
Stock options	94		94		1,166		-		-		-		1,260
Stock dividends	932		932		23,994		(24,942)		-		-		(16)
Stock awards	-		-		6		-		-		-		6
Net income	-		-		-		32,927		-		-		32,927		32,927
Other comprehensive income,
net of reclassifications and tax	-		-		-		-		2,403		-		2,403		2,403
Purchases of Treasury stock	-		-		-		-		-		(6,244)		(6,244)
Cash dividends	-		-		-		(13,479)		-		-		(13,479)

Comprehensive income														$	35,330

Balance, December 31, 2002	19,597	$	19,597	$	96,585	$	94,677	$	6,937	$	(11,590)	$	206,206

See accompanying notes to consolidated financial statements.

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

(Dollars in thousands)		Nine Months Ended September 30,
Operating Activities:		2003		2002

Net Income	$	26,361	$	24,604
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses		2,559		3,401
Depreciation and amortization		2,189		1,961
Net amortization of investment
securities discount/premiums		7,906		2,045
Deferred income taxes		(2,080)		(2,642)
Net realized security gains		(6,449)		(3,193)
Decrease (increase) in accrued income receivable		2,219		(1,589)
Net decrease in accrued interest payable		(1,230)		(4,976)
Net increase in intangible assets		(728)		(288)
Net increase in other assets		(382)		(599)
Net increase in other liabilities		2,655		3,877
Decrease in deferred cost, net		839		906
Write-down of other real estate owned		-		68

Net cash provided by operating activities		33,859		23,575

Investing Activities:
Proceeds from sales of investment securities available for sale		965,232		568,561
Proceeds, maturity or calls of investment securities held to maturity		754		3,408
Proceeds, maturity or calls of investment securities available for sale		522,035		184,988
Purchases of investment securities available for sale		(1,436,573)		(961,328)
Net increase in loans		(49,503)		(31,106)
Net increase in premises and equipment		(2,771)		(2,163)
Net increase in bank-owned life insurance		(1,382)		(1,900)
Proceeds from sales of other real estate		875		857

Net cash used by investing activities		(1,333)		(238,683)

Financing Activities:
Net increase in deposits		11,010		204,337
Net decrease in U.S. Treasury demand notes		(52)		(662)
Increase in FHLB borrowings		6,000		35,000
Increase in securities sold under agreement		3,973		4,844
Cash dividends		(11,048)		(9,480)
Repurchase of common stock		(2,271)		(4,118)
Stock options and stock awards		1,551		1,011

Net cash used by financing activities		9,163		230,932

Net increase in cash and cash equivalents		41,689		15,824
Cash and cash equivalents at beginning of period		104,087		82,624

Cash and cash equivalents at end of the period	$	145,776	$	98,448


Cash paid during the period for:
Interest	$	31,917	$	44,498

Income taxes	$	7,400	$	9,000

Supplemental disclosure of noncash investing and financing activities:
Transfer of assets from loans to other real estate owned	$	1,378	$	789

See accompanying notes to consolidated financial statements.

Comprehensive Income


(Dollars in thousands)		Before tax		Tax		Net of tax
September 30, 2003		Amount		Expense		amount

Unrealized gains on securities:
Unrealized holding gains
Arising during period	$	3,494	$	(1,222)	$	2,272
Less reclassification for
adjustment for gains
realized in net income		6,449		(2,256)		4,193

Other comprehensive income, net	$	(2,955)	$	1,034	$	(1,921)


		Before tax		Tax Benefit		Net of tax
September 30, 2002		Amount		(Expense)		amount

Unrealized gains on securities:
Unrealized holding losses
arising during period	$	14,424	$	(5,048)	$	9,376
Less reclassification for
adjustment for gains
realized in net income		3,193		(1,117)		2,076

Other comprehensive income, net	$	11,231	$	(3,931)	$	7,300

HARLEYSVILLE NATIONAL CORPORATION


INDEX TO FORM 10-Q REPORT

	PAGE


Part I. Financial Information

Item 1. Financial Statements:

Consolidated Balance Sheets – September 30, 2003 and December 31, 2002	3

Consolidated Statements of Income – Nine Months and Three Months Ended Sept. 30, 2003 and 2002	4

Consolidated Statements of Shareholders’ Equity – Nine Months Ended September 30, 2003 and Year	5
Ended December 31, 2002

Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2003 and 2002	6

Notes to Consolidated Financial Statements	7

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	11

Item 3. Quantitative and Qualitative Disclosures about Market Risk	26

Item 4. Controls and Procedures	27

Part II. Other Information

Item 1. Legal Proceedings	28

Item 2. Change in Securities and Use of Proceeds	28

Item 3. Defaults Upon Senior Securities	28

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

Item 5. Other Information	28

Item 6. Exhibits and Reports on Form 8-K	28

Signatures	30

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)
(Dollars in thousands except weighted average number of common shares and per share information)		Nine months ended Sept 30,					Three months ended Sept 30,

		2003		2002			2003		2002

Interest Income:
Loans, including fees	$	59,268	$	63,793		$	19,821	$	21,012
Lease financing		5,097		6,476			1,517		2,188
Investment securities:
Taxable		12,931		20,827			3,387		6,555
Exempt from federal taxes		11,376		8,748			3,602		3,266
Federal funds sold		123		275			48		53
Deposits in banks		118		140			64		44

Total interest income		88,913		100,259			28,439		33,118

Interest Expense:
Savings deposits		6,030		8,923			1,585		3,081
Time, under $100,000		14,513		17,905			4,641		5,982
Time, $100,000 or greater		3,387		5,680			919		1,896
Borrowed funds		6,756		7,014			2,071		2,480

Total interest expense		30,686		39,522			9,216		13,439

Net interest income		58,227		60,737			19,223		19,679
Provision for loan losses		2,559		3,401			630		956

Net interest income after provision for loan losses		55,668		57,336			18,593		18,723

Other Operating Income:
Service charges		5,774		4,993			2,007		1,846
Security gains, net		6,449		3,193			359		719
Trust and investment services income		2,820		2,809			954		896
Bank-owned life insurance income		1,935		1,900			673		631
Income on life insurance		1,119		-			-		-
Other Income		4,325		4,188			1,259		1,349

Total other operating income		22,422		17,083			5,252		5,441

Net interest income after provision for loan losses
and other operating income		78,090		74,419			23,845		24,164

Other Operating Expenses:
Salaries, wages and employee benefits		23,655		22,631			7,938		7,550
Occupancy		2,846		2,902			941		844
Furniture and equipment		4,206		4,035			1,525		1,428
Prepayment fee		2,594		-			-		-
Other expenses		12,437		13,126			2,694		3,679

Total other operating expenses		45,738		42,694			13,098		13,501

Income before income tax expense		32,352		31,725			10,747		10,663
Income tax expense		5,991		7,121			1,952		2,250

Net income	$	26,361	$	24,604		$	8,795	$	8,413


Weighted average number of common shares:
Diluted		24,555,092		24,644,984	*		24,587,614		24,609,988*

Basic		23,793,891		23,926,895	*		23,812,431		23,891,899*

Net income per share information:
Diluted	$	1.07	$	1.00	*	$	0.36	$	0.34*

Basic	$	1.11	$	1.03	*	$	0.37	$	0.35*

Cash dividends per share	$	0.464	$	0.396	*	$	0.160	$	0.137*


* Adjusted for a five-for-four common stock split effective 9/15/03.

See accompanying notes to consolidated financial statements.

		Nine Months Ended
		September 30, 2003			September 30, 2002

Net Income
As reported	$	26,361		$	24,604
Less: Stock-based compensation cost determined
under fair value method for all awards		1,114			1,540

Proforma	$	25,247		$	23,064


Earnings per share (Diluted)
As reported	$	1.07		$	1.00
Proforma	$	1.03		$	0.94

Earnings per share (Basic)
As reported	$	1.11		$	1.03
Proforma	$	1.06		$	0.96

		Three Months Ended
		September 30, 2003			September 30, 2002

Net Income
As reported	$	8,795	$		8,413
Less: Stock-based compensation cost determined
under fair value method for all awards		371			513

Proforma	$	8,424	$		7,900


Earnings per share (Diluted)
As reported	$	0.36	$		0.34
Proforma	$	0.34	$		0.32

Earnings per share (Basic)
As reported	$	0.37	$		0.35
Proforma	$	0.35	$		0.33