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2003 ANNUAL REPORT
ON FORM 10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

Commission file number 0-15237

Harleysville National Corporation
(Exact name of registrant as specified in its charter)

(215) 256-8851
Registrant's telephone number, including area code:

Securities registered pursuant to Section 12(b) of the Act: N/A

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $1.00 par value
Title of Class

        Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

        Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.) Yes ý No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

        State the aggregate market value of the voting stock held by nonaffiliates of the registrant. The aggregate market value shall be computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of a specified date within 60 days prior to the date of filing.

$586,042,000 as of February 25, 2004

        Indicate the number of shares outstanding of each class of the registrant's classes of common stock, as of the latest practicable date.

23,971,006 shares of Common Stock, $1 par value per share,
were outstanding as of February 25, 2004

DOCUMENTS INCORPORATED BY REFERENCE:

1.

Portions of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 2003 are incorporated by reference into Part II of this report.

2.

Portions of the Registrant's Definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 13, 2004 are incorporated by reference into Part III of this report.

HARLEYSVILLE NATIONAL CORPORATION

Index

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Form 10-K Cross Reference Sheet of Material Incorporated by Reference

        The following table shows the location in this Annual Report on Form 10-K or the accompanying Proxy Statement of the information required to be disclosed by the United States Securities and Exchange Commission ("SEC") in Form 10-K. Where indicated below, information has been incorporated by reference in this Report from the Proxy Statement. Other portions of the Proxy Statement are not included in this Report. This Report is not part of the Proxy Statement. References are to pages in this report unless otherwise indicated.

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Forward-Looking Statements

        In addition to historical information, this document contains forward-looking statements. We have made forward-looking statements in this document that are subject to risks and uncertainties. Forward-looking statements include the information concerning possible or assumed future results of operations of Harleysville National Corporation and its subsidiaries. When we use words such as "believes," "expects," "anticipates," or similar expressions, we are making forward-looking statements.

        Shareholders should note that many factors, some of which are discussed elsewhere in this document and in the documents that we incorporate by reference, could affect the future financial results of 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 analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful

        The SEC has not approved or disapproved this Report or passed upon its accuracy or adequacy.

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Management's Discussion and Analysis of Financial Condition and Results of Operations

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED SUMMARY OF OPERATIONS

*

Adjusted for a five-for-four common stock split effective 9/15/03, a 5% stock dividend effective 9/16/02, 11/9/00 and 9/30/99, and a 100% stock dividend effective 8/10/01

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HARLEYSVILLE NATIONAL CORPORATION

        The following is management's discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for Harleysville National Corporation (the Corporation), Harleysville National Bank and Trust Company, Citizens National Bank, Security National Bank (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.

Critical Accounting Policies

        The accounting and reporting policies of the Corporation and its subsidiaries conform with accounting principles generally accepted in the United States of America (US GAAP) applicable to banks. All significant inter-company transactions are eliminated in consolidation and certain reclassifications are made when necessary to conform with the previous year's financial statements to the current year's presentation. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities as of the dates of the balance sheets and revenues and expenditures for the periods presented. Therefore, actual results could differ significantly from those estimates.

        The principal estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan losses. The evaluation of the adequacy of the allowance for loan losses includes, among other factors, an analysis of historical loss rates, by category, applied to current loan totals. However, actual losses may be higher or lower than historical trends, which vary. Actual losses on specified problem loans, which also are provided for in the evaluation, may vary from estimated loss percentages, which are established based upon a limited number of potential loss classifications.

        The Corporation accounts for income taxes under the liability method whereby deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The principal types of accounts, resulting in differences between assets and liabilities for financial statement and tax return purposes, are the allowance for loan losses, leased assets, deferred loan fees and compensation.

Introduction

        The Corporation achieved its 28^th consecutive year of record earnings in 2003. Net income in 2003 exceeded 2002 net income by 7.3%. This increase in earnings was driven by a 6.9% growth in average earning assets and our persistent focus on controlling expenses. The increase in net income was also due to the gains on the sale of investments, and an increase in both deposit service charges and gains on the sale of residential mortgages. Asset quality at December 31, 2003, also improved through a reduction in nonperforming loans, compared to December 31, 2002.

        The Corporation's net income of $35,333,000 in 2003, increased 7.3% compared to the $32,927,000 reported in 2002. Diluted earnings of $1.44 per share in 2003 increased 7.5% from $1.34 in 2002. Basic earnings per share in 2003 were $1.48 compared to $1.38 in 2002, a 7.2% increase. Net interest income decreased $899,000, as a result of the continued pressures of interest rates reaching 45-year lows. The Corporation saw an improvement in the net interest margin during the fourth quarter of 2003, compared to the fourth quarter of 2002. Other operating income of $19,906,000 earned in 2003, net of gains on sales of investment securities and income on life insurance, increased $858,000, or 4.5%, compared to 2002, primarily due to both higher service charges and gains on the sale of residential mortgage loans. The 2003 other operating expense, net of a $2.6 million Federal Home Loan Bank

6

(FHLB) borrowing prepayment fee, grew only 1.3% compared to 2002. The ratio of overhead expenses to average assets was 2.42% as of December 31, 2003, improved from 2.44% at December 31, 2002. The 2003 ratio was well below our peer ratio of 3.05% at September 30, 2003.

        The quality of the loan portfolio is a key focus of the Corporation. Loan quality performance ratios at December 31, 2003 reflect the improvement in loan quality, compared to 2002. The ratio of the allowance for loan losses to nonperforming loans and leases of 371.7% at December 31, 2003, improved from the December 31, 2002 and December 31, 2001 ratios of 272.8% and 187.9%, respectively. The ratio of nonperforming loans and leases to total loans outstanding at December 31, 2003 was 0.32%, compared the December 31, 2002 and December 31, 2001 ratios of 0.47% and 0.63%, respectively.

Interest-Earning Assets and Interest-Bearing Liabilities

        Average interest-earning assets of $2,333,134,000 in 2003, increased $151,419,000, or 6.9%, compared to $2,181,715,000 in 2002. The growth in average earning assets was primarily due to the increase in the average investment portfolio. During 2003, the average balance of investments increased $127,221,000, or 15.5%, the average loan portfolio grew $20,827,000, or 1.6% and average other earning assets grew $3,371,000, or 13.3%. Total loans at December 31, 2003 grew 5.7%, compared to the December 31, 2002 balance as a result of stronger loan growth during the last two quarters of 2003. Average interest-earning assets were $1,944,961,000 in 2001.

        Average interest-bearing liabilities totaled $1,932,825,000 in 2003, an increase of $114,893,000, or 6.3%, compared to 2002. This increase was primarily the result of the efforts of the Corporation to grow core deposits. Average interest bearing core deposits grew $131,068,000, or 15.9% in 2003. Higher costing average time deposits decreased $39,279,000, or 5.3% during 2003. Also contributing to this rise in average interest bearing liabilities was an increase in other borrowings of $23,104,000, or 9.3%. Average interest-bearing liabilities were $1,606,394,000 in 2001.

Investment Securities

        SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, requires, among other things, that debt and equity securities classified as available for sale be reported at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. The net effect of unrealized gains or losses, caused by marking an available for sale portfolio to market, causes fluctuations in the level of shareholders' equity and equity-related financial ratios as market interest rates cause the fair value of fixed-rate securities to fluctuate.

        Investment securities decreased 4.8% from $971,467,000 at December 31, 2002 to $924,874,000 at December 31, 2003. This decrease was the result of reduced funding from time deposits over $100,000. During 2003, the Corporation adopted the strategy to be less aggressive in obtaining higher rate time deposits over $100,000 from school districts and municipalities. The investment securities available for sale decreased $44,186,000 and the investment securities held to maturity decreased $2,407,000. During 2003, $1,233,050,000 of securities available for sale were sold which generated a pretax gain of $6,613,000. In comparison, $897,327,000 securities available for sale were sold during 2002 to generate a pretax gain of $3,475,000. 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 interest rate risk within different interest rate environments.

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        Table 1    Investment Portfolio

        The following table shows the carrying value of the Corporation's investment securities held to maturity:

        The following table shows the carrying value of the Corporation's investment securities available for sale:

        Table 2    There are no significant concentrations of securities (greater than 10% of shareholders' equity) in any individual security issuer. The maturity analysis of investment securities held to maturity, including the weighted average yield for each category as of December 31, 2003, is as follows:

8

        The maturity analysis of securities available for sale, including the weighted average yield for each category, as of December 31, 2003 is follows:

Loans

        Loans increased 5.7% in 2003, compared to a 1.4% growth in 2002. The growth in loans during 2003 was impacted by planned declines in both the indirect vehicle loan and vehicle leasing portfolios. Net of these two portfolios, total loans grew 12.3%, led by increases in commercial related and home equity loans.

        Total loans grew $76,114,000 or 5.7%, from $1,331,956,000 at December 31, 2002, to $1,408,070,000 at December 31, 2003. The growth in loans was primarily the result of increases in commercial, consumer and real estate loans. During 2003, real estate, consumer and commercial loans grew $77,404,000, $15,187,000 and $9,158,000 respectively. The growth in real estate loans was in commercial mortgages, partially offset by a reduction in residential mortgages. Due to the continued low mortgage rate-driven refinancing activity during 2003, higher rate mortgages in the Banks' portfolios were refinanced into lower rate mortgages. In an effort to reduce interest rate risk, the banks sold the majority of the fixed rate mortgages settled during 2003 and did not add them to our mortgage portfolio. Residential mortgages sold during 2003 were $196,290,000 compared to $136,202,000 in 2002.

        Consumer loans grew primarily due to the growth in home equity lines of credit, partially offset by a reduction in indirect automobile dealer loans. The reduction in indirect automobile dealer loans was due to the planned reduction in this loan portfolio resulting from the low profit margins currently existing in this market segment.

        Table 3    The following table shows the composition of the Banks' loans (in thousands):

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        Table 4    The following table details maturities and interest sensitivity of real estate, commercial and industrial, consumer loans and lease financing at December 31, 2003:

        Table 5    The following table details those loans that were placed on nonaccrual status, or were delinquent by 90 days or more and still accruing interest (in thousands):

        The Banks had no concentration of loans to individual borrowers which exceeded 10% of total loans at December 31, 2003 and 2002. The Banks actively monitor the risk of this loan concentration. The Banks have no foreign loans, and the impact of nonaccrual and delinquent loans on total interest income was not material.

        A loan is generally classified as nonaccrual when principal or interest has consistently been in default for a period of 90 days or more or because of a deterioration in the financial condition of the borrower or payment in full of principal or interest is not expected. Delinquent loans past due 90 days or more and still accruing interest are loans that are generally well-secured and expected to be restored to a current status in the near future.

        Loan quality performance ratios at December 31, 2003 reflect the improvement in loan quality, compared to 2002. Nonperforming assets (nonaccruing loans, loans 90 days or more past due and net assets in foreclosure) were 0.22% of total assets at December 31, 2003, compared to 0.27% at December 31, 2002, and 0.40% at December 31, 2001. The ratio of nonperforming loans and leases to total net loans and leases was 0.32% at December 31, 2003, compared to 0.47% at December 31, 2002, and 0.63% at December 31, 2001.

        Nonaccruing loans decreased $1,766,000 from $5,109,000 at December 31, 2002, to $3,343,000 at December 31, 2003. All loan categories experienced decreases in nonaccrual loans during 2003. The December 31, 2002, balance of nonaccrual loans was $1,245,000 lower than the December 31, 2001, balance of $6,354,000. During 2003, interest accrued on nonaccruing loans and not recognized as interest income was $227,000, and interest paid on nonaccruing loans of $29,000 was recognized as interest income.

        The December 31, 2003 net assets in foreclosure balance of $935,000, increased from the $390,000 balance at December 31, 2002. During 2003, sales of foreclosed properties totaled $1,232,000, transfers from loans to assets in foreclosure were $1,777,000. There were no write-downs of assets in foreclosure in 2003. 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

10

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, less selling costs.

        Loans past due 90 days or more and still accruing interest are loans that are generally well secured and are in the process of collection. As of December 31, 2003, loans past due 90 days or more and still accruing interest were $1,164,000, a slight decrease compared to $1,193,000 as of December 31, 2002. This decrease was primarily the result of a reduction in commercial real estate related loans past due 90 days, partially offset with higher credit cards past due 90 days. Loans past due as of December 31, 2001 were $1,926,000.

        The Banks use the reserve method of accounting for loan losses. The balance in the allowance for loan and lease losses is determined based on management's review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions, and other pertinent factors, including management's assumptions as to future delinquencies, recoveries and losses. Additions to the allowances are charged to operations. The allowance for loan losses decreased 2.6% from $17,190,000 at December 31, 2002, to $16,753,000 at December 31, 2003. Even though the actual allowance for loan losses decreased during 2003, the allowance for loan losses to nonperforming loans ratio at December 31, 2003 of 371.7%, was significantly higher than the December 31, 2002 ratio of 272.8%.

        Table 6    Analysis of Credit Risk

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Allowance for Loan Losses

        Table 7 A summary of the allowance for loan losses is as follows:

        Table 8    The following table sets forth an allocation of the allowance for loan losses by category. The specific allocations in any particular category may be reallocated in the future to reflect then current conditions. Accordingly, management considers the entire allowance to be available to absorb losses in any category.

Allowance for Loan Losses

        The Banks use the reserve method of accounting for loan losses. The balance in the allowance for loan 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

12

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 Office of the Comptroller of the Currency, 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 judgements about information available to them at the time of their examination.

        The Banks' allowance for loan 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 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 and lease losses. The Banks' 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 Banks' 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 represent the results of analysis 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 are based principally on current risk ratings, historical loss rates adjusted, by adjusting the risk window, to reflect current events and conditions, as well as analysis of other factors that may have affected the collectability of loans. The Banks analyze all commercial loans that have been identified as having potential credit 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 altering 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.

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Deposits and Borrowings and Other Interest-Bearing Liabilities

        Deposits and other borrowings are the primary funding sources of the Corporation. During 2003, the Corporation defined a strategy to reduce higher costing time deposits and grow lower costing core deposit (noninterest-bearing checking, interest-bearing checking, money market accounts and savings accounts). Total deposits of $1,979,081,000 at December 31, 2003, decreased $741,000 from the $1,979,822,000 balance at December 31, 2002. This decrease was primarily the result of a $96,389,000, or 12.5% reduction in time deposits, offset by a $95,648,000, or 7.9% rise in core deposits. Interest bearing checking, non-interest bearing deposits, savings deposits and money market deposits grew $33,961,000, $24,340,000, $19,775,000 and $17,572,000, respectively during 2003. Time deposits under $100,000 decreased $35,145,000 and time deposits greater than $100,000 declined $61,244,000.

Deposit Structure

        Table 9    The following table is a distribution of average balances and average rates paid on the deposit categories for the last three years:

        Table 10    The maturity distribution of certificates of deposit of $100,000 and over as of December 31, 2003 is as follows:

        Other borrowings increased $1,150,000 from $248,906,000 at December 31, 2002 to $250,056,000 at December 31, 2003. This increase was due to a $10,000,000 increase in Federal Home Loan Bank (FHLB) borrowings and a $3,000,000 rise in federal funds purchased. The additional FHLB funding was used to match fund commercial mortgages. These increases in other borrowings were partially offset by a $11,850,000 decrease in securities sold under agreements to repurchase. During 2003, the Corporation paid off $29 million of FHLB borrowings with rates over 6.0% prior to their scheduled maturity dates. This provided the opportunity to lock in historically low rates on new long-term borrowings. The early retirement of these borrowings resulted in a $2,594,000 prepayment fee. Borrowings and other interest-bearing liabilities include federal funds purchased, FHLB borrowings, securities sold under agreements to repurchase and U.S. Treasury demand notes.

        Securities sold under agreements to repurchase are generally overnight transactions. These borrowings had balances of $72,291,000, $84,141,000 and $80,393,000 at December 31, 2003, 2002 and 2001, respectively. Daily average balances and weighted average interest rates for the years ended December 31, 2003, 2002 and 2001 were $83,277,000, $83,750,000 and $88,417,000 and 0.87%, 1.51% and 3.35%, respectively. The maximum amount outstanding at any month-end during 2003, 2002, and 2001 were $101,991,000, $96,665,000, and $96,224,000, respectively.

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Income Statement Analysis

Results of Operations

        The 2003 net income of $35,333,000 increased $2,406,000, or 7.3% from the 2002 net income of $32,927,000. On a per share basis, diluted earnings were $1.44 in 2003 and $1.34 in 2002, a 7.5% increase. Basic earnings per share were $1.48 in 2003 compared to $1.38 in 2002. Net income increased in 2002 by $4,107,000, or 14.3% over 2001.

        The 2003 return on average shareholders' equity of 16.29% was lower than the 16.60% for 2002 and higher than the 15.82% in 2001. The 2003 and 2002 return on average assets were both 1.43% and the 2001 ratio was 1.40%. Excluding accumulated other comprehensive income, the annualized return on average realized shareholders' equity for 2003, 2002 and 2001 were 16.87% and 17.06% and 16.23%, respectively.

        Net income is affected by five major elements: (1) net interest income, or the difference between interest income earned on loans and investments and interest expense paid on deposits and borrowed funds; (2) the provision for loan losses, or the amount added to the allowance for loan losses to provide reserves for future losses on loans; (3) other operating income, which is made up primarily of certain service fees and Investment Management and Trust Services income; (4) other operating expenses, which consist primarily of salaries and other operating expenses; and (5) income taxes. Each of these major elements is reviewed in more detail in the following discussion.

Net Interest Income

        The 2003 net interest income of $79,121,000 decreased $899,000, or 1.1%, from 2002 levels. Net interest income was $80,020,000 in 2002, which was 8.5% higher than the $73,742,000 reported in 2001. The decrease in the 2003 net interest income was the result of the continued pressures of interest rates reaching 45-year lows. The year ended with positive net interest income growth in the fourth quarter of the 2003. The Corporation recognized a 8.4% increase in the net interest income during the fourth quarter of 2003, compared to the fourth quarter of 2002.

Table 11

        For analytical purposes, the following table reflects tax-equivalent net interest income in recognition of the income tax savings on tax-exempt items such as interest on municipal securities and tax-exempt loans. Adjustments are made using a statutory federal tax rate of 35%.

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        Table 12    The rate volume analysis set forth in the following table, which is computed on a tax-equivalent basis (tax rate of 35%), analyzes changes in net interest income for the last three years by their rate and volume components.

(1)

The interest earned on nontaxable investment securities and loans is shown on a tax-equivalent basis using a tax rate of 35%.

        The 2003 tax-equivalent net interest income was $88,710,000 for 2003, compared to $87,345,000 for 2002, an increase of $1,365,000, or 1.6%. This increase in tax-equivalent net interest income was primarily due to the net $6,398,000 increase related to volume, partially offset by a decrease related to interest rates of $5,033,000. Total interest income decreased $11,166,000, the result of lower rates earned within each earning asset category, partially offset by higher volumes. The 2003 higher earning asset volumes were primarily due to a 15.5% increase in average investments. Total average loans grew 1.6% during 2003. The increase in investment securities was primarily funded by the 6.6% growth in average deposits and the 9.3% increase in other borrowings during 2003.

        Total interest expense decreased $12,531,000 during 2003 or 23.8%, compared to 2002. This decrease was the result of the lower interest rate environment experienced during 2003 and the Corporation's strategy of decreasing higher costing time deposits. The decrease related to interest rates was partially offset by higher deposit and other borrowing levels. Average interest bearing core deposits (interest bearing checking accounts, money market accounts and savings accounts) grew 15.9%, while average time deposits decreased 5.3%. Average borrowings and other interest-bearing volumes increased 9.3% during 2003. Borrowings and other interest-bearing liabilities include federal funds purchased, Federal Home Loan Bank (FHLB) borrowings, securities sold under agreements to repurchase and U.S. Treasury notes.

        Tax-equivalent net interest income in 2002 was $87,345,000, a $7,811,000 increase compared to $79,534,000 for 2001. This increase in tax-equivalent net interest income was primarily due to the $8,454,000 increase related to volumes, partially offset by the $643,000 decrease in net interest income related to rates. The growth in earning asset volumes was primarily due to investment securities and loans of 24.5% and 5.4%, respectively. During 2002 average interest-bearing deposit grew 13.8% and average other borrowings increased 9.3%.