UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
___________________
Form
10-Q
__________________
x
Quarterly Report Pursuant to Section
13 or 15(d) of the Securities Exchange Act of 1934
for
the quarterly period ended March 31, 2008
Or
¨
Transition Report Pursuant to Section
13 or 15(d) of the Securities Exchange Act of 1934
for the
transition period from ___________ to __________
Commission
file number 0-15237
___________________
HARLEYSVILLE
NATIONAL CORPORATION
(Exact
name of registrant as specified in its charter)
___________________
Pennsylvania
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23-2210237
|
(State
or other jurisdiction
of
incorporation or organization)
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|
(IRS
Employer
Identification
No.)
|
483
Main Street
Harleysville,
Pennsylvania 19438
(Address
of principal executive office and zip code)
(215)
256-8851
(Registrant’s
telephone number, including area code)
___________________
Indicate
by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days.
Yes
x
No
¨
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large
accelerated filer
o
Accelerated
filer
x
Non-accelerated
filer
o
(Do not
check if a smaller reporting
company) Smaller reporting
company
o
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes
¨
No
x
Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date: 31,355,492 shares of Common Stock,
$1.00 par value, outstanding on May 1, 2008.
HARLEYSVILLE
NATIONAL CORPORATION
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INDEX
TO FORM 10-Q REPORT
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PAGE
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Part
I. Financial Information
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Item
1. Financial Statements:
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Consolidated
Balance Sheets at March 31, 2008 (unaudited) and December 31,
2007
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3
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Consolidated
Statements of Income for the Three Months Ended March 31, 2008 and 2007
(unaudited)
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4
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Consolidated
Statements of Shareholders’ Equity for the Three Months Ended March 31,
2008 and 2007 (unaudited)
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5
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Consolidated
Statements of Cash Flows for the Three Months Ended March 31, 2008 and
2007 (unaudited)
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6
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Notes
to Consolidated Financial Statements
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7
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Item
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
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18
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Item
3. Quantitative and Qualitative Disclosures about Market
Risk
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30
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Item
4. Controls and Procedures
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31
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Part
II. Other Information
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32
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Item
1. Legal Proceedings
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32
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Item
1A. Risk Factors
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32
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Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
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32
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Item
3. Defaults Upon Senior Securities
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32
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Item
4. Submission of Matters to a Vote of Security Holders
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32
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Item
5. Other Information
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32
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Item
6. Exhibits
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32
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Signatures
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33
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PART
1. FINANCIAL INFORMATION
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HARLEYSVILLE
NATIONAL CORPORATION AND SUBSIDIARIES
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CONSOLIDATED
BALANCE SHEETS
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(Dollars
in thousands)
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March
31, 2008
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December
31, 2007
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|
(Unaudited)
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Assets
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Cash
and due from banks
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$
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71,905
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$
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73,930
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Federal
funds sold and securities purchased under agreements to
resell
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33,900
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131,600
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Interest-bearing
deposits in banks
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4,295
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3,873
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Total
cash and cash equivalents
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110,100
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209,403
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Residential
mortgage loans held for sale
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2,219
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1,140
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Investment
securities available for sale
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992,798
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925,568
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Investment
securities held to maturity
(market
value $56,796 and
$5
7
,
518
, respectively
)
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56,117
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57,347
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Loans
and leases
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2,479,711
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2,459,683
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Less:
Allowance for loan losses
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(28,490
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)
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(27,328
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)
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Net
loans
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2,451,221
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2,432,355
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Premises
and equipment, net
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33,164
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32,518
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Accrued
interest receivable
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16,782
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16,456
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Goodwill
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110,615
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111,155
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Intangible
assets, net
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13,708
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13,340
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Bank-owned
life insurance
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72,953
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72,269
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Other
assets
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34,342
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31,450
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Total
assets
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$
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3,894,019
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$
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3,903,001
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Liabilities
and Shareholders' Equity
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Deposits:
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Noninterest-bearing
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$
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355,027
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$
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358,258
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Interest-bearing:
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Checking
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399,178
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482,104
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Money
market
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854,831
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796,325
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Savings
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171,337
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145,681
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Time
deposits
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1,207,534
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1,202,690
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Total
deposits
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2,987,907
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2,985,058
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Federal
funds purchased and short-term securities sold under agreements
to
repurchase
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99,339
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101,493
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Other
short-term borrowings
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331
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2,015
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Long-term
borrowings
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313,774
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321,785
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Accrued
interest payable
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30,387
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28,810
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Subordinated
debt
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82,992
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82,992
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Other
liabilities
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36,007
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41,538
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Total
liabilities
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3,550,737
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3,563,691
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Shareholders'
Equity:
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Series
preferred stock, par value $1 per share;
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Authorized
8,000,000 shares, none issued
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—
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—
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Common
stock, par value $1 per share; authorized 75,000,000
shares,
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issued
31,507,021 shares at March 31, 2008 and at December
31, 2007
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31,507
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31,507
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Additional
paid in capital
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231,040
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231,130
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Retained
earnings
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83,345
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82,311
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Accumulated
other comprehensive income (loss)
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75
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(2,566
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)
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Treasury
stock, at cost: 152,583 shares at March 31, 2008 and
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174,605
shares at December 31, 2007
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(2,685
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)
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(3,072
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)
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Total
shareholders' equity
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343,282
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339,310
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Total
liabilities and shareholders' equity
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$
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3,894,019
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$
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3,903,001
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See
accompanying notes to consolidated financial statements.
HARLEYSVILLE
NATIONAL CORPORATION AND SUBSIDIARIES
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CONSOLIDATED
STATEMENTS OF INCOME
(Unaudited)
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Three
Months Ended
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March
31,
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(Dollars
in thousands, except per share information)
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2008
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2007
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Interest
Income:
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Loans
and leases, including fees
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$
|
38,997
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$
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34,636
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Investment
securities:
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Taxable
|
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9,754
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|
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8,564
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Exempt
from federal taxes
|
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2,971
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2,689
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Federal
funds sold and securities purchased under agreements to
resell
|
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|
658
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|
751
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Deposits
in banks
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|
36
|
|
|
|
55
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|
Total
interest income
|
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|
52,416
|
|
|
|
46,695
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Interest
Expense:
|
|
|
|
|
|
|
|
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Savings
and money market deposits
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|
8,095
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|
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|
12,106
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|
Time
deposits
|
|
|
14,501
|
|
|
|
9,716
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|
Short-term
borrowings
|
|
|
658
|
|
|
|
1,256
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|
Long-term
borrowings
|
|
|
4,955
|
|
|
|
3,780
|
|
Total
interest expense
|
|
|
28,209
|
|
|
|
26,858
|
|
|
|
|
|
|
|
|
|
|
Net
interest income
|
|
|
24,207
|
|
|
|
19,837
|
|
Provision
for loan losses
|
|
|
1,960
|
|
|
|
2,425
|
|
Net
interest income after provision for loan losses
|
|
|
22,247
|
|
|
|
17,412
|
|
|
|
|
|
|
|
|
|
|
Noninterest
Income:
|
|
|
|
|
|
|
|
|
Service
charges
|
|
|
3,113
|
|
|
|
1,918
|
|
Gain
on sales of investment securities, net
|
|
|
128
|
|
|
|
531
|
|
Wealth
management
|
|
|
4,277
|
|
|
|
4,267
|
|
Bank-owned
life insurance
|
|
|
684
|
|
|
|
582
|
|
Other
income
|
|
|
2,630
|
|
|
|
1,849
|
|
Total
noninterest income
|
|
|
10,832
|
|
|
|
9,147
|
|
Net
interest income after provision for loan losses and
|
|
|
|
|
|
|
|
|
noninterest
income
|
|
|
33,079
|
|
|
|
26,559
|
|
|
|
|
|
|
|
|
|
|
Noninterest
Expense:
|
|
|
|
|
|
|
|
|
Salaries,
wages and employee benefits
|
|
|
13,859
|
|
|
|
11,597
|
|
Occupancy
|
|
|
2,585
|
|
|
|
1,546
|
|
Furniture
and equipment
|
|
|
1,094
|
|
|
|
917
|
|
Marketing
|
|
|
436
|
|
|
|
407
|
|
Other
expense
|
|
|
5,744
|
|
|
|
4,312
|
|
Total
noninterest expense
|
|
|
23,718
|
|
|
|
18,779
|
|
|
|
|
|
|
|
|
|
|
Income
before income tax expense
|
|
|
9,361
|
|
|
|
7,780
|
|
Income
tax expense
|
|
|
2,057
|
|
|
|
1,646
|
|
Net
income
|
|
$
|
7,304
|
|
|
$
|
6,134
|
|
|
|
|
|
|
|
|
|
|
Net
income per share information:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.23
|
|
|
$
|
0.21
|
|
Diluted
|
|
$
|
0.23
|
|
|
$
|
0.21
|
|
Cash
dividends per share
|
|
$
|
0.20
|
|
|
$
|
0.20
|
|
Weighted
average number of common shares:
|
|
|
|
|
|
|
|
|
Basic
|
|
|
31,346,833
|
|
|
|
28,965,500
|
|
Diluted
|
|
|
31,522,736
|
|
|
|
29,255,820
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes to consolidated financial statements.
HARLEYSVILLE
NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited)
(Dollars
and share information in thousands)
Three
Months Ended
March
3
1
, 200
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
Treasury
Stock
|
|
|
|
|
|
Additional
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number
of
|
|
|
Number
of
|
|
|
Par
|
|
|
Paid
|
|
|
Retained
|
|
|
Comprehensive
|
|
|
Treasury
|
|
|
|
|
|
Comprehensive
|
|
|
|
Shares
|
|
|
Shares
|
|
|
Value
|
|
|
In
Capital
|
|
|
Earnings
|
|
|
(Loss)
Income
|
|
|
Stock
|
|
|
Total
|
|
|
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
January 1, 2008
|
|
|
31,507
|
|
|
|
(174
|
)
|
|
$
|
31,507
|
|
|
$
|
231,130
|
|
|
$
|
82,311
|
|
|
$
|
(2,566
|
)
|
|
$
|
(3,072
|
)
|
|
$
|
339,310
|
|
|
|
|
Issuance
of stock for stock options, net of excess tax benefits
|
|
|
-
|
|
|
|
22
|
|
|
|
-
|
|
|
|
(137
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
387
|
|
|
|
250
|
|
|
|
|
Stock
based compensation
expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
47
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
47
|
|
|
|
|
Net
income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
7,304
|
|
|
|
-
|
|
|
|
-
|
|
|
|
7,304
|
|
|
$
|
7,304
|
|
Other
comprehensive income, net of reclassifications and tax
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,641
|
|
|
|
-
|
|
|
|
2,641
|
|
|
|
2,641
|
|
Cash
dividends
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(6,270
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(6,270
|
)
|
|
|
|
|
Comprehensive
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
9,945
|
|
Balance,
March 31, 2008
|
|
|
31,507
|
|
|
|
(152
|
)
|
|
$
|
31,507
|
|
|
$
|
231,040
|
|
|
$
|
83,345
|
|
|
$
|
75
|
|
|
$
|
(2,685
|
)
|
|
$
|
343,282
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended
March
3
1
,
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
Treasury
Stock
|
|
|
|
|
|
Additional
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number
of
|
|
|
Number
of
|
|
|
Par
|
|
|
Paid
|
|
|
Retained
|
|
|
Comprehensive
|
|
|
Treasury
|
|
|
|
|
|
Comprehensive
|
|
|
|
Shares
|
|
|
Shares
|
|
|
Value
|
|
|
In
Capital
|
|
|
Earnings
|
|
|
(Loss)
Income
|
|
|
Stock
|
|
|
Total
|
|
|
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
January 1, 2007
|
|
|
29,074
|
|
|
|
(109
|
)
|
|
$
|
29,074
|
|
|
$
|
194,713
|
|
|
$
|
79,339
|
|
|
$
|
(6,103
|
)
|
|
$
|
(2,272
|
)
|
|
$
|
294,751
|
|
|
|
|
Issuance
of stock for stock options, net of excess tax benefits
|
|
|
-
|
|
|
|
3
|
|
|
|
-
|
|
|
|
(37
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
65
|
|
|
|
28
|
|
|
|
|
Stock
based compensation
expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
67
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
67
|
|
|
|
|
Net
income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6,134
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6,134
|
|
|
$
|
6,134
|
|
Other
comprehensive income, net of reclassifications and tax
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,059
|
|
|
|
-
|
|
|
|
1,059
|
|
|
|
1,059
|
|
Cash
dividends
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(5,793
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(5,793
|
)
|
|
|
|
|
Comprehensive
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
7,193
|
|
Balance,
March 31, 2007
|
|
|
29,074
|
|
|
|
(106
|
)
|
|
$
|
29,074
|
|
|
$
|
194,743
|
|
|
$
|
79,680
|
|
|
$
|
(5,044
|
)
|
|
$
|
(2,207
|
)
|
|
$
|
296,246
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to
consolidated financial statements.
HARLEYSVILLE
NATIONAL CORPORATION AND SUBSIDIARIES
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
(Unaudited)
|
|
|
|
|
|
|
|
|
Three
Months Ended
|
(Dollars
in thousands)
|
|
March
31,
|
|
|
|
2008
|
|
|
|
2007
|
|
Operating
Activities:
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
7,304
|
|
|
$
|
6,134
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
Provision
for loan losses
|
|
|
1,960
|
|
|
|
2,425
|
|
Depreciation
and amortization
|
|
|
1,812
|
|
|
|
1,199
|
|
Net
amortization of investment securities discounts/premiums
|
|
|
320
|
|
|
|
460
|
|
Deferred
income tax benefit
|
|
|
(1,965
|
)
|
|
|
173
|
|
Gain
on sales of investment securities, net
|
|
|
(128
|
)
|
|
|
(531
|
)
|
Bank-owned
life insurance income
|
|
|
(684
|
)
|
|
|
(582
|
)
|
Stock
based compensation expense
|
|
|
47
|
|
|
|
67
|
|
Net
increase in accrued interest receivable
|
|
|
(326
|
)
|
|
|
(166
|
)
|
Net
increase (decrease) in accrued interest payable
|
|
|
1,577
|
|
|
|
(604
|
)
|
Net
(increase) decrease in other assets
|
|
|
(970
|
)
|
|
|
888
|
|
Net
decrease in other liabilities
|
|
|
(4,898
|
)
|
|
|
(610
|
)
|
Other,
net
|
|
|
20
|
|
|
|
―
|
|
Net
cash provided by operating activities
|
|
|
4,069
|
|
|
|
8,853
|
|
Investing
Activities:
|
|
|
|
Proceeds
from sales of investment securities available for sale
|
|
|
56,691
|
|
|
|
62,097
|
|
Proceeds from maturity or calls
of investment securities held to maturity
|
|
|
1,215
|
|
|
|
―
|
|
Proceeds
from maturity or calls of investment securities available for
sale
|
|
|
56,450
|
|
|
|
39,536
|
|
Purchases
of investment securities available for sale
|
|
|
(176,547
|
)
|
|
|
(116,391
|
)
|
Net
increase in loans
|
|
|
(23,254
|
)
|
|
|
(21,070
|
)
|
Net cash paid due to
acquisitions, net of cash acquired
|
|
|
(1,200
|
)
|
|
|
(2,500
|
)
|
Purchases
of premises and equipment
|
|
|
(1,713
|
)
|
|
|
(3,674
|
)
|
Net
cash used in investing activities
|
|
|
(88,358
|
)
|
|
|
(42,002
|
)
|
Financing
Activities:
|
|
|
|
Net
increase in deposits
|
|
|
2,849
|
|
|
|
9,986
|
|
(Decrease)
increase in federal funds purchased and short-term securities sold under
agreements to
repurchase
|
|
|
(2,154
|
)
|
|
|
2,263
|
|
Decrease
in other short-term borrowings
|
|
|
(1,684
|
)
|
|
|
(1,321
|
)
|
Advances
of long-term borrowings
|
|
|
―
|
|
|
|
80,000
|
|
Repayments
of long-term borrowings
|
|
|
(8,000
|
)
|
|
|
(15,000
|
)
|
Cash
dividends
|
|
|
(6,270
|
)
|
|
|
(5,793
|
)
|
Proceeds
from the exercise of stock options
|
|
|
214
|
|
|
|
28
|
|
Excess
tax benefits from stock based compensation
|
|
|
31
|
|
|
|
―
|
|
Net
cash (used in) provided by financing activities
|
|
|
(15,014
|
)
|
|
|
70,163
|
|
Net
(decrease) increase in cash and cash equivalents
|
|
|
(99,303
|
)
|
|
|
37,014
|
|
Cash
and cash equivalents at beginning of period
|
|
|
209,403
|
|
|
|
124,870
|
|
Cash
and cash equivalents at end of the period
|
|
$
|
110,100
|
|
|
$
|
161,884
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
Interest
|
|
$
|
26,885
|
|
|
$
|
27,473
|
|
Income
taxes
|
|
$
|
8,754
|
|
|
$
|
1,225
|
|
Supplemental
disclosure of noncash investing and financing activities:
|
|
|
|
Transfer
of assets from loans to net assets in foreclosure
|
|
$
|
1,508
|
|
|
$
|
10
|
|
|
See
accompanying notes to consolidated financial statements.
|
|
|
|
|
|
|
HARLEYSVILLE
NATIONAL CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1
– Summary of Significant Accounting
Policies
Principles
of Consolidation and Basis of Presentation
In the
opinion of management, the accompanying unaudited consolidated financial
statements contain all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the consolidated financial position of
Harleysville National Corporation (the Corporation) and its wholly owned
subsidiaries-Harleysville National Bank (the Bank), HNC Financial Company and
HNC Reinsurance Company, as of March 31, 2008, the results of its operations for
the three month periods ended March 31, 2008 and 2007 and the cash flows for the
three month periods ended March 31, 2008 and 2007. East Penn Financial
Corporation (East Penn Financial) and its banking subsidiary are included in the
Corporation’s results effective November 16, 2007. Certain prior period amounts
have been reclassified to conform to current year presentation. All significant
intercompany accounts and transactions have been eliminated in consolidation. We
recommend that you read these unaudited consolidated financial statements in
conjunction with the audited consolidated financial statements of the
Corporation and the accompanying notes in the Corporation's 2007 Annual Report
on Form 10-K. The results of operations for the three month periods ended March
31, 2008 and 2007 are not necessarily indicative of the results to be expected
for the full year.
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management 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. Actual results could differ from those
estimates.
For
additional information on other significant accounting policies, see Note 1 of
the Consolidated Financial Statements of the Corporation’s 2007 Annual Report on
Form 10-K.
Recent
Accounting Pronouncements
In March
2008, the Financial Accounting Standards Board (FASB) issued SFAS No. 161,
“Disclosures about Derivative Instruments and Hedging Activities.” SFAS 161
requires enhanced disclosures to enable investors to better understand their
effects on an entity’s financial position, financial performance and cash flows.
Specifically, it requires that objectives for using derivatives instruments be
disclosed in terms of underlying risk and accounting designation, disclosing the
fair values of derivative instruments and their gains and losses in a tabular
format, disclosure about credit-risk-related contingent features and
cross-referencing within the footnotes. It is effective for financial statements
issued for fiscal years and interim periods beginning after November 15, 2008,
with early application encouraged. The Corporation is currently assessing the
impact of the adoption of this statement on its financial statement
disclosures.
In
February 2008, the FASB issued FASB Staff Position (FSP) No. FAS 140-3,
“Accounting for Transfers of Financial Assets and Repurchase Financing
Transactions.” This FSP specifies that a transferor and transferee shall not
separately account for a transfer of a financial asset and a related repurchase
financing unless (a) the two transactions have a valid and distinct business or
economic purpose for being entered into separately and (b) the repurchase
financing does not result in the initial transferor regaining control over the
financial asset. The two transactions shall be considered linked unless they
meet all of the specified criteria in this FSP. The linked transaction should be
evaluated to determine whether it meets the requirements for sale accounting
under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities.” If the linked transaction does not meet the
requirements for sale accounting, it should be accounted for based on the
economics of the combined transaction which generally represents a forward
contract. FAS 140-3 is effective prospectively for financial statements issued
for fiscal years beginning after November 15, 2008, and interim periods within
those fiscal years. Early application is not permitted. The Corporation is
currently assessing the impact of the adoption of SFAS 140-3 on its financial
statements.
In
January 2008, the FASB cleared SFAS 133 Implementation Issue E23, “Clarification
of the Application of the Shortcut Method (Issue E23). Issue E23 amends SFAS
133, “Accounting for Derivative Instruments and Hedging Activities” by
permitting interest rate swaps to have a non-zero fair value at inception, as
long as the difference between the transaction price (zero) and the fair value
(exit price), as defined by SFAS 157, “Fair Value Measurements” is solely
attributable to a bid-ask spread. In addition, entities would not be precluded
from assuming no ineffectiveness in a hedging relationship of interest rate risk
involving an interest bearing asset or liability in situations where the hedged
item is not recognized for accounting purposes until settlement date as long as
the period between trade date and settlement date of the hedged item is
consistent with generally established conventions in the marketplace. Issue E23
is effective for hedging relationships designated on or after January 1, 2008.
The adoption of Issue E23 did not have a material impact on the Corporation’s
consolidated financial statements.
Note 1
– Summary of Significant Accounting
Policies – Continued
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS
157 clarifies the definition of fair value, establishes a framework for
measuring fair value in generally accepted accounting principles and expands
disclosures about fair value measurements. SFAS 157 defines fair value as “the
price that would be received to sell an asset or paid to transfer a liability in
an orderly transaction between market participants at the measurement date.” The
Statement requires the Corporation to apply valuation techniques that (1) place
greater reliance on observable inputs and less reliance on unobservable inputs
and (2) are consistent with the market approach, the income approach, and/or the
cost approach. The definition and framework apply to both items recognized and
reported at fair value in the financial statements and items disclosed at fair
value in the notes to the financial statements. The Statement also requires
expanded disclosure in interim and annual financial statements about how the
Corporation uses fair value. The disclosures focus on items measured at fair
value based on significant unobservable inputs and the effect of fair value
measurements on earnings. The disclosures are only required for items recognized
and reported at fair value in the financial statements. The Statement does not
change existing accounting rules governing what can or what must be recognized
and reported at fair value in the Corporation’s financial statements, or
disclosed at fair value in the Corporation’s notes to the financial statements.
As a result, the Corporation will not be required to recognize any new
instruments at fair value. SFAS 157 was effective for fiscal years beginning
after November 15, 2007, and interim periods within those fiscal years, although
earlier application was encouraged. Prospective application of the provisions of
SFAS 157 was required as of the beginning of the fiscal year in which it was
initially applied. In March 2008, the FASB issued FSP FAS 157-2 to partially
delay the effective implementation of SFAS 157 until fiscal years beginning
after November, 15, 2008 for all nonfinancial assets and liabilities except
those that are recognized or disclosed at fair value in financial statements on
a recurring basis (at least annually). Assets and liabilities currently reported
or disclosed at fair value on a recurring basis in the Corporation’s financial
statements include investment securities and derivatives. Assets reported at
fair value on a nonrecurring basis (lower of cost or market) are impaired loans,
residential mortgage loans held for sale and mortgage servicing rights The
partial adoption of FAS 157 for its fiscal year beginning January 1, 2008 did
not have a material impact on its financial statements. The Corporation is in
the process of assessing the impact of the adoption of SFAS 157 for its fiscal
year beginning January 1, 2009 relating to nonfinancial assets and liabilities
on the Corporation’s financial statements including goodwill, other intangible
assets and net assets in foreclosure. See Note 10 – Fair Value Measurements for
additional information.
Note
2 – Acquisition
Effective
November 16, 2007, the Corporation completed its acquisition of East Penn
Financial Corporation (East Penn Financial) and its wholly owned subsidiary,
East Penn Bank, a $451 million state chartered, FDIC insured bank, was merged
with and into Harleysville National Bank. East Penn Financial’s results of
operations are included in the Corporation’s results from the date of
acquisition, November 16, 2007. The aggregate purchase price was $91.3 million
in cash and stock. The Corporation acquired 100% of the outstanding shares of
East Penn Financial and issued 2,432,771 shares of its common stock.
Goodwill of $64.3 million and core
deposit intangible of $7.4 million were recorded in connection with the
acquisition of East Penn Financial
and allocated to the Community Banking
segment
. These numbers include the finalized allocation of the purchase
price based upon third party valuation of goodwill and certain intangible assets
which occurred during the first quarter of 2008 increasing net assets acquired
by $611,000 and reducing goodwill by $611,000.
Note
3 – Goodwill and Other Intangibles
Goodwill
and identifiable intangibles were $110.6 million and $11.0 million, respectively
at March 31, 2008, and $111.2 million and $10.6 million, respectively at
December 31, 2007. The goodwill and identifiable intangibles balances resulted
from acquisitions. During the first quarter of 2008, the Corporation recorded
purchase accounting adjustments related to the East Penn Financial acquisition
which increased the core deposit intangible by $940,000, reduced goodwill by
$611,000 and increased the deferred tax liability by $329,000. For further
information related to the acquisition of East Penn Financial which occurred
during the fourth quarter of 2007, see Note 2 – Acquisition.
The
changes in the carrying amount of goodwill by business segment were as
follows:
|
|
Community
Banking
|
|
Wealth
Management
|
|
|
Total
|
|
|
|
(Dollars in thousands)
|
|
Balance,
January 1, 2008
|
|
$
|
96,426
|
|
|
$
|
14,729
|
|
|
$
|
111,155
|
|
Purchase
accounting adjustments for acquisitions
|
|
|
(611
|
)
|
|
|
71
|
|
|
|
(540
|
)
|
Balance,
March 31, 2008
|
|
$
|
95,815
|
|
|
$
|
14,800
|
|
|
$
|
110,615
|
|
Note
3 – Goodwill and Other Intangibles – Continued
The gross
carrying value and accumulated amortization related to core deposit intangibles
and other identifiable intangibles at March 31, 2008 and December 31, 2007 are
presented below:
|
March 31,
|
|
December 31,
|
|
2008
|
|
2007
|
|
Gross
Carrying Amount
|
Accumulated
Amortization
|
|
Gross
Carrying Amount
|
|
Accumulated
Amortization
|
|
|
(Dollars in thousands)
|
Core
deposit intangibles
|
|
$
|
9,144
|
|
|
$
|
1,318
|
|
$
|
8,351
|
|
$
|
1,061
|
|
Other
identifiable intangibles
|
|
|
4,293
|
|
|
|
1,089
|
|
|
4,288
|
|
|
927
|
|
Total
|
|
$
|
13,437
|
|
|
$
|
2,407
|
|
$
|
12,639
|
|
$
|
1,988
|
|
Management
performed its annual review of goodwill and identifiable intangibles at June 30,
2007 in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” and
SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
Management determined there was no impairment of goodwill and other identifiable
intangible assets.
The
remaining weighted average amortization period of core deposit intangibles are
four years, other identifiable intangibles are seven years and the combined
intangibles are five years. The amortization of core deposit intangibles
allocated to the Community Banking segment was $405,000 and $62,000 for the
first quarter of 2008 and 2007, respectively. Amortization of identifiable
intangibles related to the Wealth Management segment totaled $161,000 and
$115,000 for the first quarter of 2008 and 2007, respectively. The Corporation
estimates that aggregate amortization expense for core deposit and other
identifiable intangibles will be $2.1 million, $1.9 million, $1.8 million, $1.6
million and $1.2 million for 2008, 2009, 2010, 2011 and 2012,
respectively.
Mortgage
servicing rights of $2.7 million at March 31, 2008 and December 31, 2007,
respectively, are included on the Corporation’s balance sheet in other
intangible assets and subsequently measured using the amortization method. The
mortgage servicing rights had a fair value of $3.0 million and $3.3 million at
March 31, 2008 and December 31, 2007, respectively. The Corporation’s mortgage
servicing rights are not considered material to its financial statements and
therefore additional disclosures are not provided.
Note
4 - Pension Plans
The
Corporation had a non-contributory defined benefit pension plan covering
substantially all employees. The plan’s benefits were based on years of service
and the employee’s average compensation during any five consecutive years within
the ten-year period preceding retirement. On October 31, 2007, the Corporation
announced that it formally amended its pension plan to provide for
its termination. Employees ceased to accrue additional pension
benefits as of December 31, 2007
, and
pension benefits are not being provided under a successor pension plan. All
retirement benefits earned in the pension plan as of December 31, 2007, were
preserved and all participants became fully vested in their benefit upon
plan termination. During 2008, upon receipt of the appropriate regulatory
approvals for termination of the pension plan, it is anticipated that assets
will be distributed to those participants who elect lump sums and
nonparticipating annuity contracts will be purchased to settle the accumulated
benefit obligation as of that date.
The
Corporation recorded a one-time pre-tax charge related to the pension plan
curtailment of approximately $1.9 million in the fourth quarter of 2007. The
curtailment charge was recorded in other expenses in the statement of income and
impacted the Community Banking and Wealth Management segments.
The
components of net periodic defined benefit pension expense for the three months
ended March 31, 2007 were as follows:
(Dollars
in thousands)
|
|
Three
Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Net periodic benefit
cost
|
|
|
|
|
|
|
Service
cost
|
|
$
|
―
|
|
|
$
|
291
|
|
Interest
cost
|
|
|
―
|
|
|
|
171
|
|
Expected
return on plan assets
|
|
|
―
|
|
|
|
(150
|
)
|
Amortization
of net actuarial loss
|
|
|
―
|
|
|
|
19
|
|
Net
periodic benefit expense
|
|
$
|
―
|
|
|
$
|
331
|
|
The
Corporation maintains a 401(k) defined contribution retirement savings plan
which allows employees to contribute a portion of their compensation on a
pre-tax and/or after-tax basis in accordance with specified guidelines. Prior to
January 1, 2008, the Corporation matched 50% of pre-tax employee contributions
up to a maximum of 3% of eligible earnings. Effective January 1, 2008, in
addition to the company match of up to 3%, all eligible employees began
receiving a company funded basic contribution in the 401(k) plan equal to 2% of
eligible earnings. For the three months ended March 31, 2008, the basic company
funded 401(k) contribution was $198,000.
Note 5
–
Stock-Based
Compensation
The
Corporation has four shareholder approved fixed stock option plans that allow
the Corporation to grant options up to an aggregate of 3,797,861 shares of
common stock to key employees and directors. At March 31, 2008, 2,518,265
stock options had been
granted under the stock option plans. The options have a term of ten years when
issued and typically vest over a five-year period. The exercise price of each
option is the market price of the Corporation’s stock on the date of grant.
Additionally,
at
March 31, 2008, the Corporation had 25,480 granted stock options as a result of
the East Penn Bank acquisition completed in 2007. The options have a term of ten
years and are exercisable at prices ranging from $5.94 to
$13.07.
The
Corporation recognizes compensation expense for stock options in accordance with
SFAS 123 (revised 2004), “Share-Based Payment” (SFAS 123(R)) adopted at January
1, 2006 under the modified prospective application method of transition. Prior
to January 1, 2006, the Corporation followed SFAS 123 and APB 25 with
pro forma
disclosures of net
income and earnings per share, as if the fair value-based method of accounting
defined in SFAS 123 had been applied. The Corporation recognizes compensation
expense for the portion of outstanding awards at January 1, 2006 for which the
requisite service has not yet been rendered, based on the grant-date fair value
of those awards calculated under SFAS 123 for pro forma disclosures. For the
three months ended March 31, 2008 and 2007, there were no options
granted.
For
grants subject to a service condition that were awarded on or after January 1,
2006, the Corporation utilizes the Black-Scholes option-pricing model (as used
under SFAS 123) to estimate the fair value of each option on the date of
grant.
The
Black-Scholes model takes into consideration the exercise price and expected
life of the options, the current price of the underlying stock and its expected
volatility, the expected dividends on the stock and the current risk-free
interest rate for the expected life of the option.
For
grants subject to a market condition that were awarded in the third quarter of
2007, the Corporation utilized a Monte Carlo simulation to estimate the fair
value and determine the derived service period. Compensation is recognized over
the derived service period with any unrecognized compensation cost immediately
recognized when the market condition is met. These awards vest when the
Corporation’s common stock reaches targeted average trading prices for 30 days
within five years from the grant date. Vesting cannot commence before six months
from the grant date. The term and exercise price of the options are the same as
previously mentioned. The fair value and derived service period (the median
period in which the market condition is met) were determined using a Monte Carlo
simulation taking into consideration the weighted average dividend yield based
on historical data, weighted-average expected volatility based on historical
data, the risk-free rate, the weighted average expected life of the option and a
uniform post-vesting exercise rate (mid-point of vesting and contractual
term).
Expected
volatility is based on the historical volatility of the Corporation’s stock over
the expected life of the grant. The risk-free rate for periods within the
expected life of the option is based on the U.S. Treasury strip rate in effect
at the time of the grant. The life of the option is based on historical factors
which include the contractual term, vesting period, exercise behavior and
employee terminations.
In
accordance with SFAS 123(R), stock-based compensation expense for the three
months ended March 31, 2008 and 2007 is based on awards that are ultimately
expected to vest and therefore has been reduced for estimated forfeitures. The
Corporation estimates forfeitures using historical data based upon the groups
identified by management. Stock-based compensation expense was $47,000 and
$43,000, net of tax for the first quarter of 2008 and $67,000 and $64,000, net
of tax for the first quarter of 2007.
A summary
of option activity under the Corporation’s stock option plans as of March 31,
2008, and changes during the three months ended March 31, 2008 is presented in
the following table. The number of shares and weighted-average share information
have been adjusted to reflect stock dividends.
Options
|
|
Shares
|
|
|
Weighted-Average
Exercise Price
|
|
|
Weighted-Average
Remaining Contractual Term
(in
years)
|
|
|
Aggregate
Intrinsic
Value
(in
thousands)
|
|
Outstanding
at January 1, 2008
|
|
|
1,113,499
|
|
|
$
|
15.74
|
|
|
|
|
|
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
Exercised
|
|
|
(22,022
|
)
|
|
|
9.52
|
|
|
|
|
|
|
|
Forfeited
(unvested)
|
|
|
(2,395
|
)
|
|
|
20.10
|
|
|
|
|
|
|
|
Cancelled
(vested)
|
|
|
(2,699
|
)
|
|
|
21.91
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at March 31, 2008
|
|
|
1,086,383
|
|
|
$
|
15.84
|
|
|
|
4.37
|
|
|
$
|
2,755
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at March 31, 2008
|
|
|
982,357
|
|
|
$
|
15.39
|
|
|
|
4.02
|
|
|
$
|
2,755
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Note 5
–
Stock-Based Compensation
– Continued
The total
intrinsic value of options exercised during the three months ended March 31,
2008 and 2007 was $122,000 and $31,000, respectively.
Intrinsic value is
measured using the fair market value price of the Corporation’s common stock
less the applicable exercise price.
A summary
of the status of the Corporation’s nonvested shares as of March 31, 2008 is
presented below:
Nonvested
Shares
|
|
Shares
|
|
|
Weighted-Average
Grant-Date
Fair Value
|
|
|
|
|
|
|
|
|
Nonvested
at January 1, 2008
|
|
|
108,736
|
|
|
$
|
5.37
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Vested
|
|
|
(2,315
|
)
|
|
|
6.63
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(2,395
|
)
|
|
|
5.61
|
|
|
|
|
|
|
|
|
|
|
Nonvested
at March 31, 2008
|
|
|
104,026
|
|
|
$
|
5.34
|
|
As of
March 31, 2008, there was a total of $317,000 of unrecognized compensation cost
related to nonvested awards under stock option plans. This cost is expected to
be recognized over a weighted-average period of 2.1 years. The total fair value
of shares vested during the three months ended March 31, 2008 and 2007 was
$15,000 for each period. The tax benefit realized for the tax deductions from
option exercises totaled $41,000 and $0 for the three months ended March 31,
2008 and 2007, respectively.
Note 6
–
Earnings Per
Share
Basic
earnings per share exclude dilution and are computed by dividing income
available to common shareholders by the weighted average common shares
outstanding during the period. Diluted earnings per share take into account the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised and converted into common stock. All weighted
average, actual shares and per share information in these financial statements
have been adjusted retroactively for the effect of stock dividends.
The
calculations of basic earnings per share and diluted earnings per share are as
follows:
|
|
Three
Months Ended
|
|
|
|
|
|
(Dollars
in thousands, except per share data)
|
|
2008
|
|
2007
|
|
|
|
|
|
Basic
earnings per share
|
|
|
|
|
Net
income available to common shareholders
|
|
$
|
7,304
|
|
$
|
6,134
|
|
Weighted
average common shares outstanding
|
|
|
31,346,833
|
|
|
28,965,500
|
|
Basic
earnings per share
|
|
$
|
0.23
|
|
$
|
0.21
|
|
|
|
|
|
|
|
|
|
Diluted
earnings per share
|
|
|
|
|
|
|
|
Net
income available to common shareholders
and
assumed conversions
|
|
$
|
7,304
|
|
$
|
6,134
|
|
Weighted
average common shares outstanding
|
|
|
31,346,833
|
|
|
28,965,500
|
|
Dilutive
potential common shares
(1),
(2)
|
|
|
175,903
|
|
|
290,320
|
|
Total
diluted weighted average common shares outstanding
|
|
|
31,522,736
|
|
|
29,255,820
|
|
Diluted
earnings per share
|
|
$
|
0.23
|
|
$
|
0.21
|
|
|
|
|
|
|
|
|
|
(1)
|
Includes
incremental shares from assumed conversions of stock
options.
|
(2)
|
Antidilutive
options have been excluded in the computation of diluted earnings per
share because the options’ exercise prices were greater than the average
market price of the common stock. For the three months ended March 31,
2008 and 2007, there were 538,404 antidilutive options at an average price
of $21.20 and 424,858 antidilutive options at an average price of $24.40,
respectively.
|
Note
7 – Comprehensive Income and Accumulated Other Comprehensive Income
The
components of other comprehensive income are as follows:
Comprehensive
Income
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars
in thousands)
|
|
Before
tax
|
|
|
Tax
Benefit
|
|
|
Net
of tax
|
|
Three months ended
March 31, 2008
|
|
Amount
|
|
|
(Expense)
|
|
|
amount
|
|
Net
unrealized gains on available for sale securities:
|
|
|
|
|
|
|
|
|
|
Net
unrealized holding gains arising during period
|
|
$
|
4,130
|
|
|
$
|
(1,446
|
)
|
|
$
|
2,684
|
|
Less
reclassification adjustment for net gains realized in net
income
|
|
|
128
|
|
|
|
(45
|
)
|
|
|
83
|
|
Net
unrealized gains
|
|
|
4,002
|
|
|
|
(1,401
|
)
|
|
|
2,601
|
|
Change
in fair value of derivatives used for cash flow hedges
|
|
|
62
|
|
|
|
(22
|
)
|
|
|
40
|
|
Other
comprehensive income, net
|
|
$
|
4,064
|
|
|
$
|
(1,423
|
)
|
|
$
|
2,641
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars
in thousands)
|
|
Before
tax
|
|
|
Tax
Benefit
|
|
|
Net
of tax
|
|
Three
months ended
March
3
1
, 200
7
|
|
Amount
|
|
|
(Expense)
|
|
|
Amount
|
|
Net
unrealized gains on available for sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
unrealized holding gains arising during period
|
|
$
|
2,361
|
|
|
$
|
(826
|
)
|
|
$
|
1,535
|
|
Less
reclassification adjustment for net gains realized in net
income
|
|
|
531
|
|
|
|
(186
|
)
|
|
|
345
|
|
Net
unrealized gains
|
|
|
1,830
|
|
|
|
(640
|
)
|
|
|
1,190
|
|
Change
in fair value of derivatives used for cash flow hedges
|
|
|
(202
|
)
|
|
|
71
|
|
|
|
(131
|
)
|
Other
comprehensive income, net
|
|
$
|
1,628
|
|
|
$
|
(569
|
)
|
|
$
|
1,059
|
|
The
components of other accumulated other comprehensive income (loss), net of tax,
which is a component of shareholders’ equity were as follows:
|
Net
Unrealized (Losses) Gains on Available For Sale
Securities
|
|
|
Net
Change in Fair Value of Derivatives Used for Cash Flow
Hedges
|
|
|
Net
Change Related to Defined Benefit Pension Plan
|
Transition
Asset Related to Defined Benefit Pension Plan
|
Accumulated
Other Comprehensive (Loss) Income
|
Balance,
January 1, 2007
|
$
|
(4,872
|
)
|
|
$
|
304
|
|
|
$
|
(1,579
|
)
|
|
$
|
44
|
|
$
|
(6,103
|
)
|
Net
Change
|
|
1,190
|
|
|
|
(131
|
)
|
|
|
-
|
|
|
|
-
|
|
|
1,059
|
|
Balance,
March 31, 2007
|
$
|
(3,682
|
)
|
|
$
|
173
|
|
|
$
|
(1,579
|
)
|
|
$
|
44
|
|
$
|
(5,044
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
January 1, 2008
|
$
|
(2,452
|
)
|
|
$
|
(114
|
)
|
|
$
|
-
|
|
|
$
|
-
|
|
$
|
(2,566
|
)
|
Net
Change
|
|
2,602
|
|
|
|
39
|
|
|
|
-
|
|
|
|
-
|
|
|
2,641
|
|
Balance,
March 31, 2008
|
$
|
150
|
|
|
$
|
(75
|
)
|
|
$
|
-
|
|
|
$
|
-
|
|
$
|
75
|
|
No
te 8 – Segment
Information
The
Corporation operates two main lines of business along with several other
operating segments. SFAS No. 131, “Disclosures about Segments of an Enterprise
and Related Information,” establishes standards for public business enterprises
to report information about operating segments. Operating segments are
components of an enterprise, which are evaluated regularly by the chief
operating decision-maker in deciding how to allocate and assess resources and
performance. The Corporation’s chief operating decision-maker is the President
and Chief Executive Officer. The Corporation has applied the aggregation
criteria set forth in SFAS No. 131 for operating segments establishing two
reportable segments: Community Banking and Wealth Management.
The
Community Banking segment provides financial services to consumers, businesses
and governmental units primarily in southeastern Pennsylvania. These services
include full-service banking, comprised of accepting time and demand deposits,
making secured and unsecured commercial loans, mortgages, consumer loans, and
other banking services. The treasury function income is included in the
Community Banking segment, as the majority of effort of this function is related
to this segment. Primary sources of income include net interest income and
service fees on deposit accounts. Expenses include costs to manage credit and
interest rate risk, personnel, and branch operational and technical
support.
The
Wealth Management segment includes: trust and investment management services,
providing investment management, trust and fiduciary services, estate settlement
and executor services, financial planning, and retirement plan and institutional
investment services; and the Cornerstone Companies, registered investment
advisors for high net worth, privately held business owners, wealthy families
and institutional clients. Major revenue component sources include investment
management and advisory fees, trust fees, estate and tax planning fees,
brokerage fees, and insurance related fees. Expenses primarily consist of
personnel and support charges. Additionally, the Wealth Management
segment includes an inter-segment credit related to trust deposits which are
maintained within the Community Banking segment using a transfer pricing
methodology.
Note 8 – Segment Information –
Continued
The
Corporation has also identified several other operating segments. These
operating segments within the Corporation’s operations do not have similar
characteristics to the Community Banking or Wealth Management segments and do
not meet the quantitative thresholds requiring separate disclosure. These
non-reportable segments include HNC Reinsurance Company, HNC Financial Company,
and the parent holding company and are included in the “Other”
category.
Information
about reportable segments and reconciliation of the information to the
consolidated financial statements follows:
(Dollars
in thousands)
|
|
Community
Banking
|
|
|
Wealth Management
|
|
|
All
Other
|
|
|
Consolidated
Totals
|
|
Three
Months Ended March 31, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income (expense)
|
|
$
|
25,501
|
|
|
$
|
5
|
|
|
$
|
(1,299
|
)
|
|
$
|
24,207
|
|
Provision
for loan losses
|
|
|
1,960
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,960
|
|
Noninterest
income
|
|
|
6,356
|
|
|
|
4,315
|
|
|
|
161
|
|
|
|
10,832
|
|
Noninterest
expense
|
|
|
19,568
|
|
|
|
3,796
|
|
|
|
354
|
|
|
|
23,718
|
|
Income
(loss) before income taxes (benefit)
|
|
|
10,329
|
|
|
|
524
|
|
|
|
(1,492
|
)
|
|
|
9,361
|
|
Income
taxes (benefit)
|
|
|
2,307
|
|
|
|
199
|
|
|
|
(449
|
)
|
|
|
2,057
|
|
Net
income (loss)
|
|
$
|
8,022
|
|
|
$
|
325
|
|
|
$
|
(1,043
|
)
|
|
$
|
7,304
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
$
|
3,854,858
|
|
|
$
|
24,356
|
|
|
$
|
14,805
|
|
|
$
|
3,894,019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended March 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income (expense)
|
|
$
|
20,256
|
|
|
$
|
112
|
|
|
$
|
(531
|
)
|
|
$
|
19,837
|
|
Provision
for loan losses
|
|
|
2,425
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,425
|
|
Noninterest
income
|
|
|
4,663
|
|
|
|
4,267
|
|
|
|
217
|
|
|
|
9,147
|
|
Noninterest
expense
|
|
|
15,085
|
|
|
|
3,387
|
|
|
|
307
|
|
|
|
18,779
|
|
Income
(loss) before income taxes (benefit)
|
|
|
7,409
|
|
|
|
992
|
|
|
|
(621
|
)
|
|
|
7,780
|
|
Income
taxes (benefit)
|
|
|
1,527
|
|
|
|
396
|
|
|
|
(277
|
)
|
|
|
1,646
|
|
Net
income (loss)
|
|
$
|
5,882
|
|
|
$
|
596
|
|
|
$
|
(344
|
)
|
|
$
|
6,134
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
$
|
3,268,334
|
|
|
$
|
21,123
|
|
|
$
|
35,510
|
|
|
$
|
3,324,967
|
|
The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies disclosed in the Corporation’s Annual
Report on Form 10-K for the year ended December 31, 2007. Consolidating
adjustments reflecting certain eliminations of inter-segment revenues, cash and
investment in subsidiaries are included in the “All Other” segment.
Note
9 – Financial Instruments with Off-Balance Sheet Risk
The Bank
is a party to financial instruments with off-balance-sheet risk in the normal
course of business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit and standby letters of credit.
Such financial instruments are recorded in the financial statements when they
become payable. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
consolidated balance sheets. The contract or notional amounts of those
instruments reflect the extent of involvement the Bank has in particular classes
of financial instruments.
The
Bank’s maximum exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual or notional amounts
of those instruments. The Bank uses the same stringent credit policies in
extending these commitments as they do for recorded financial instruments and
controls exposure to loss through credit approval and monitoring procedures.
These commitments often expire without being drawn upon and often are secured
with appropriate collateral; therefore, the total commitment amount does not
necessarily represent the actual risk of loss or future cash
requirements.
The
approximate contract amounts are as follows:
|
|
Total
Amount Committed at
|
|
|
|
|
|
|
|
|
(Dollars
in thousands)
|
|
|
|
|
|
|
|
Financial
instruments whose contract amounts represent credit risk:
|
|
|
|
|
|
|
Commitments to extend
credit
|
|
$
|
814,146
|
|
|
$
|
822,995
|
|
Standby letters of credit and
financial guarantees written
|
|
|
25,286
|
|
|
|
23,473
|
|
Financial
instruments whose notional or contract amounts exceed the amount of credit
risk:
|
|
|
|
|
|
|
|
|
Interest rate swap
agreements
|
|
|
23,977
|
|
|
|
58,928
|
|
Interest rate cap
agreements
|
|
|
200,000
|
|
|
|
200,000
|
|
Note
9 – Financial Instruments with Off-Balance Sheet Risk – Continued
At March
31, 2008, the Corporation had a cash flow hedge with a notional amount of $5.0
million that has the effect of converting variable debt to a fixed rate. This
swap matures in 2008. During the first quarter of 2008, cash flow hedges matured
with a notional amount of $50.0 million that had the effect of converting rates
on money market deposit accounts to a fixed-rate cost of funds. For both of
these types of swaps, the Corporation recognized net interest expense of
$115,000 and income of $138,000 for the three months ended March 31, 2008 and
2007, respectively. Periodically, the Corporation may enter into fair value
hedges to limit the exposure to changes in the fair value of loan assets. At
March 31, 2008, the Corporation had fair value hedges in the form of interest
rate swaps with a notional amount of $3.9 million. These swaps mature in 2017.
The Corporation recognized net interest expense of $16,000 and income of $5,000
for the three months ended March 31, 2008 and 2007, respectively. At March 31,
2008, the Corporation had swap agreements with a negative fair value of
$496,000. At December 31, 2007, the Corporation had swap agreements with a
positive fair value of $10,000 and with a negative fair value of $366,000. There
was no hedge ineffectiveness recognized during the first quarters of 2008 and
2007.
During
March 2007, the Corporation purchased one and three month Treasury bill interest
rate cap agreements with notional amounts totaling $200 million to limit its
exposure on variable rate now deposit accounts. The initial premium related to
these caps was $73,000 which is being amortized to interest expense over the
life of the cap based on the cap market value. The Corporation recognized
amortization of $1,000 for the three months ended March 31, 2008. At March 31,
2008 and December 31, 2007, these caps, designated as cash flow hedges, had a
positive fair value of $2 and $222, respectively. The caps mature in March 2009.
Hedge ineffectiveness of $40,000 on cash flow hedges due to notional mismatch
was recognized in other expense during the first quarter of 2008. There was no
impact to earnings for the first quarter of 2007 related to the
caps.
During
2008 the Company implemented a program to offer certain derivative products
directly to qualified commercial borrowers. The Corporation
economically hedges derivative transactions executed with commercial borrowers
by entering into mirror-image, offsetting derivatives with a third party.
Derivative transactions executed as part of this program are not designated in
SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”
-qualifying hedging relationships and are, therefore, marked-to-market through
earnings each period. As of March 31, 2008, the fair value of the derivative
assets and the fair value of the derivative liabilities were $152,000 and
$119,000, respectively. The difference between the change
in the fair value of the derivative assets and derivative liabilities of
$33,000, which relates to the credit valuation adjustment in accordance with FAS
157, “Fair Value Measurements” is recognized in other
income.
The Bank
also had commitments with customers to extend mortgage loans at a specified rate
at March 31, 2008 and December 31, 2007 of $5.2 million and $3.4 million,
respectively and commitments to sell mortgage loans at a specified rate at March
31, 2008 and December 31, 2007 of $2.3 million and $2.4 million, respectively.
The commitments are accounted for as a derivative and recorded at fair value.
The Bank estimates the fair value of these commitments by comparing the
secondary market price at the reporting date to the price specified in the
contract to extend or sell the loan initiated at the time of the loan
commitment. At March 31, 2008, the Corporation had commitments with a positive
fair value of $41,000 and a negative fair value of $2,000 the net amount which
was recorded as other income. At December 31, 2007, the Corporation had
commitments with a positive fair value of $19,000 and a negative fair value of
$19,000.
During
December 2004 and January 2005, the Bank sold lease financing receivables of
$10.5 million. Of these leases, $1.2 million were sold with full recourse and
the remaining leases were sold subject to recourse with a maximum exposure of
ten percent of the outstanding receivable. The total recourse exposure at the
time of the sale of the leases was $2.0 million. During the first quarter of
2005, the Bank recorded a recourse liability of $216,000 which was the entire
recourse liability recorded. This estimate was based on our historic losses as
experienced on similar lease financing receivables. After the first anniversary
of the sale agreement, and on a quarterly basis thereafter, upon written request
by the Bank, the purchaser will review the portfolio performance and may reduce
the total exposure to an amount equal to ten percent of the outstanding net book
value. The Bank will be subject to the full and partial recourse obligations
until all the lease financing receivables have been paid or otherwise been
terminated and all equipment has been sold or disposed of. The final lease
payment is due in 2010. The outstanding balance of these sold leases at March
31, 2008 was $751,000 with a total recourse exposure of $137,000 and a current
recourse liability of $16,000.
Note
10 – Fair Value Measurements
Effective
January 1, 2008, the Corporation adopted SFAS No. 157, “Fair Value
Measurements.” SFAS 157 defines fair value, establishes a framework for
measuring fair value, and expands disclosure about fair value. SFAS 157 defines
fair value as the price that would be received to sell an asset or paid to
transfer a liability (an exit price) in an orderly transaction between market
participants on the measurement date. SFAS 157 also establishes a fair value
hierarchy which requires an entity to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair value. The standard
describes three levels of inputs that may be used to measure fair value. A
financial instrument’s level within the fair value hierarchy is based on the
lowest level of input significant to the fair value measurement. There have been
no material changes in valuation techniques as a result of the adoption of SFAS
No. 157.
Level 1 -
Quoted prices (unadjusted) in active markets for identical assets or liabilities
that the Corporation has the ability to access at the measurement
date.
Level 2 -
Observable inputs other than Level 1 prices, such as quoted prices for similar
assets or liabilities in active markets; quoted prices in markets that are not
active for identical or similar assets or liabilities; or other inputs that are
observable or can be corroborated by observable market data for substantially
the full term of the assets or liabilities.
Level 3 -
Unobservable inputs that are supported by little or no market activity and
significant to the fair value of the assets or liabilities that are developed
using the reporting entities’ estimates and assumptions, which reflect those
that market participants would use.
Assets
and Liabilities Measured at Fair Value on a Recurring Basis
A
description of the valuation methodologies used for financial instruments
measured at fair value on a recurring basis, as well as the classification of
the instruments pursuant to the valuation hierarchy, are as
follows:
Securities
Available for Sale
Securities
classified as available for sale are reported using Level 1, Level 2 and Level 3
inputs. Level 1 instruments generally include equity securities valued based on
quoted market prices in active markets. Level 2 instruments include U.S.
government agency obligations, state and municipal bonds, mortgage-backed
securities, collateralized mortgage obligations and corporate bonds. For these
securities, the Corporation obtains fair value measurements from an independent
pricing service. The fair value measurements consider observable data that may
include dealer quotes, market spreads, cash flows, the U.S. Treasury yield
curve, live trading levels, trade execution data, market consensus prepayment
speeds, credit information and the bond's terms and conditions, among other
things. Level 3 securities available for sale consist of instruments that are
not readily marketable and may only be redeemed with the issuer at par such as
Federal Home Loan Bank and Federal Reserve Bank stock. These securities are
stated at par value.
Derivative Financial
Instruments
Currently,
the Corporation uses cash flow hedges, fair value hedges and interest rate caps
to manage its interest rate
risk. The valuation of
these instruments is determined using widely accepted valuation techniques
including discounted cash flow analysis on the expected cash flows of each
derivative. This analysis reflects the contractual terms of the derivatives,
including the period to maturity, and uses observable market-based inputs,
including interest rate curves, foreign exchange rates, and implied
volatilities. The fair values of interest rate swaps are determined using the
market standard methodology of netting the discounted future fixed cash receipts
(or payments) and the discounted expected variable cash payments (or
receipts). The variable cash payments (or receipts) are based on an
expectation of future interest rates (forward curves) derived from observable
market interest rate curves.
The fair
values of interest rate options are determined using the market standard
methodology of discounting the future expected cash receipts that would
occur if variable interest rates fell below (rise above) the strike rate of the
floors (caps). The variable interest rates used in the calculation of
projected receipts on the floor (cap) are based on an expectation of future
interest rates derived from observable market interest rate curves and
volatilities.
To
comply with the provisions of SFAS No. 157, the Corporation incorporates credit
valuation adjustments to appropriately reflect both its own nonperformance risk
and the respective counterparty’s nonperformance risk in the fair value
measurements. In adjusting the fair value of its derivative contracts for the
effect of nonperformance risk, the Corporation has considered the impact of
netting and any applicable credit enhancements, such as collateral postings,
thresholds, mutual puts, and guarantees.
Although
the Corporation has determined that the majority of the inputs used to value its
derivatives fall within Level 2 of the fair value hierarchy, the credit
valuation adjustments associated with its derivatives utilize Level 3 inputs,
such as estimates of current credit spreads to evaluate the likelihood of
default by itself and its counterparties. However, as of March 31, 2008, the
Corporation has assessed the significance of the impact of the credit valuation
adjustments on the overall valuation of its derivative positions and has
determined that the credit valuation adjustments are not significant to the
overall valuation of its derivatives. As a result, the Corporation has
determined that its derivative valuations in their entirety are classified in
Level 2 of the fair value hierarchy.
Note 10 – Fair Value
Measurements
–
Continued
The
Corporation also has commitments with customers to extend mortgage loans at a
specified rate and commitments to sell mortgage loans at a specified rate. These
interest rate and forward contracts for mortgage loans originated and intended
for sale in the secondary market are accounted for as derivatives and carried at
estimated fair value. The Corporation estimates the fair value of the contracts
using current secondary loan market rates. The Corporation has determined that
the inputs used to value its interest rate and forward contracts fall within
Level 2 of the fair value hierarchy.
Assets
and liabilities measured at fair value on a recurring basis are summarized
below.
|
|
Fair
Value Measurement Using
|
|
|
|
|
(Dollars
in thousands)
|
|
Quoted
Prices in Active Markets for Identical Assets/Liabilities
(Level
1)
|
|
|
Significant
Other Observable Inputs
(Level
2)
|
|
|
Significant
Unobservable Inputs
(Level
3)
|
|
|
Balance
March 31, 2008
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment
securities available for sale
|
|
$
|
14,073
|
|
|
$
|
960,835
|
|
|
$
|
17,890
|
|
|
$
|
992,798
|
|
Derivatives
|
|
|
—
|
|
|
|
193
|
|
|
|
—
|
|
|
|
193
|
|
Total
assets
|
|
$
|
14,073
|
|
|
$
|
961,028
|
|
|
$
|
17,890
|
|
|
$
|
992,991
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives
|
|
$
|
—
|
|
|
$
|
618
|
|
|
$
|
—
|
|
|
$
|
618
|
|
Total
liabilities
|
|
$
|
—
|
|
|
$
|
618
|
|
|
$
|
—
|
|
|
$
|
618
|
|
Assets
and Liabilities Measured at Fair Value on a Recurring Basis Using Significant
Unobservable Inputs (Level 3)
The table
below presents a reconciliation for assets measured at fair value on a recurring
basis for which the Corporate has utilized significant unobservable inputs
(Level 3).
(Dollars
in thousands)
|
|
Investment
Securities Available for Sale
|
|
|
|
|
|
Balance,
January 1, 2008
|
|
$
|
15,201
|
|
Total
gains/losses (realized/unrealized)
|
|
|
|
|
Included
in earnings (or changes in net assets)
|
|
|
—
|
|
Included
in other comprehensive income
|
|
|
—
|
|
Purchases
|
|
|
3,026
|
|
Redemptions
|
|
|
(320
|
)
|
Interest
|
|
|
1
|
|
Capital
deductions for operating expenses(1)
|
|
|
(18
|
)
|
Balance,
March 31, 2008
|
|
$
|
17,890
|
|
|
|
|
|
|
The
amount of total gains or losses for the period
included
in earnings (or changes in net assets)
attributable
to the change in unrealized gains or
losses
relating to assets still held at March 31,
2008
|
|
$
|
—
|
|
(1)
Operating expenses are included in earnings in other expenses in the income
statement.
Assets
Measured at Fair Value on a Nonrecurring Basis
A
description of the valuation methodologies and classification levels used for
financial instruments measured at fair value on a nonrecurring basis are listed
below. These listed instruments are subject to fair value adjustments
(impairment) as they are valued at the lower of cost or market.
Mortgage
Loans Held for Sale
Mortgage
loans originated and intended for sale in the secondary market are carried at
the lower of aggregate cost or estimated fair value. The Corporation estimates
the fair value of mortgage loans held for sale using current secondary loan
market rates. The Corporation has determined that the inputs used to value its
mortgage loans held for sale fall within Level 2 of the fair value hierarchy. At
March 31, 2008, loans held for sale were recorded at their carrying amount of
$2.2 million with no impairment recorded during the first quarter of
2008.
Note 10 – Fair Value
Measurements
–
Continued
Impaired
Loans
Impaired
loans are evaluated and valued at the time the loan is identified as impaired,
at the lower of cost or market value. Individually impaired loans are measured
based on the fair value of the collateral for collateral dependent loans. The
value of the collateral is determined based on an appraisal by qualified
licensed appraisers hired by the Corporation or other observable market data
which is readily available in the marketplace. Impaired loans are reviewed and
evaluated on at least a quarterly basis for additional impairment and adjusted
accordingly. At March 31, 2008, impaired loans had a carrying amount of $9.4
million with a valuation allowance of $2.2 million. Impaired loans with a
carrying amount of $8.0 million were evaluated during the first quarter of 2008
using the practical expedient fair value measurement which resulted in an
additional valuation allowance of $434,000.
Mortgage
Servicing Rights
The
Corporation estimates the fair value of mortgage servicing rights based upon the
present value of future cash flows using a current market discount rate
appropriate for each investor group. Some of the primary components in valuing a
servicing portfolio are estimates of anticipated prepayment, current market
yields for servicing, reinvestment rate, servicing spread retained on the loans,
and the cost to service each loan.
The
Corporation’s entire portfolio consists of fixed rate loans with a remittance
type of schedule/actual and a weighted average servicing fee of .25%. The market
value calculation was based on long term prepayment assumptions obtained from
Bloomberg for similar pools based on original term, remaining term, and
coupon. Where prepayment assumptions for loan pools could not be
obtained, projections based on current prepayments, secondary loan market, and
input from servicing buyers were used. The Corporation has determined that the
inputs used to value its mortgage servicing rights fall within Level 2 of the
fair value hierarchy. At March 31, 2008, the Corporation’s mortgage servicing
rights had a carrying amount of $2.8 million. In accordance with the provisions
of SFAS No.156, “Amending Accounting for Separately Recognized Servicing Assets
and Liabilities” and SFAS No. 140, “Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities,” three pools of mortgage
servicing rights with a carrying amount of $952,000 were written down to their
fair value of $864,000 resulting in an impairment charge of $88,000 for the
first quarter of 2008.
Certain
assets measured at fair value on a non-recurring basis are presented
below:
|
|
Fair
Value Measurement Using
|
|
(Dollars
in thousands)
|
|
Balance
March
31, 2008
|
|
|
Quoted
Prices in Active Markets for Identical Assets/Liabilities
(Level
1)
|
|
|
Significant
Other Observable Inputs
(Level
2)
|
|
|
Significant
Unobservable Inputs
(Level
3)
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Impaired
loans
|
|
$
|
6,412
|
|
|
$
|
—
|
|
|
$
|
6,412
|
|
|
$
|
—
|
|
Mortgage
servicing rights
|
|
|
864
|
|
|
|
—
|
|
|
|
864
|
|
|
|
—
|
|
Total
assets
|
|
$
|
7,276
|
|
|
$
|
—
|
|
|
$
|
7,276
|
|
|
$
|
—
|
|
SFAS No. 157 Fair value measurement
implementation for nonfinancial assets including goodwill, identifiable
intangibles
and net assets in foreclosure with balances of $110.6
million, $11.0 million and $1.5 million, respectively at March 31, 2008 have
been delayed until January 1, 2009 in accordance with SFAS No.
157-2.
Item
2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
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) and its wholly owned subsidiaries-Harleysville
National Bank (the Bank), HNC Financial Company and HNC Reinsurance Company. The
Corporation’s consolidated financial condition and results of operations consist
almost entirely of the Bank’s financial condition and results of operations.
Current performance does not guarantee, and may not be indicative, of similar
performance in the future. These are unaudited financial statements and, as
such, are subject to year-end audit review.
In
addition to historical information, this Form 10-Q contains forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. We have made forward-looking statements in this report, and in documents
that we incorporate by reference, that are subject to risks and uncertainties.
Forward-looking statements include the information concerning possible or
assumed future results of operations of the Corporation and its subsidiaries.
When we use words such as “believes,” “expects,” “anticipates,” “may,”
“estimates,” or “intends” or similar expressions, we are making forward-looking
statements. Forward-looking statements are representative only as of the date
they are made, and the Corporation undertakes no obligation to update any
forward-looking statement.
Shareholders
should note that many factors, some of which are discussed elsewhere in this
report 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 or implied in our
forward-looking statements contained or incorporated by reference in this
document
.
These factors include but are not limited to those described in Item 1A,
“Risk Factors” in the Corporation’s 2007 Annual Report on Form 10-K and in this
Form 10-Q.
Critical Accounting
Estimates
The
accounting and reporting policies of the Corporation and its subsidiaries
conform to accounting principles generally accepted in the United States and
general practices with the financial services industry. The Corporation’s
significant accounting policies are described in Note 1 of the consolidated
financial statements in this Form 10-Q and in the Corporation’s 2007 Annual
Report on Form 10-K and are essential in understanding Management’s Discussion
and Analysis of Results of Operations and Financial Condition. In applying
accounting policies and 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. Judgments and
assumptions required by management, which have, or could have a material impact
on the Corporation’s financial condition or results of operations are considered
critical accounting estimates. The following is a summary of the policies the
Corporation recognizes as involving critical accounting estimates: Allowance for
Loan Loss, Goodwill and Other Intangible Asset Impairment, Stock-Based
Compensation, Unrealized Gains and Losses on Debt Securities Available for Sale,
and Deferred Taxes.
Allowance
for Loan Losses: The Corporation maintains an allowance for loan losses at a
level management believes is sufficient to absorb estimated probable credit
losses. Management’s determination of the adequacy of the allowance is based on
periodic evaluations of the loan portfolio and other relevant factors. However,
this evaluation is inherently subjective as it requires significant estimates by
management. Consideration is given to a variety of factors in establishing these
estimates including historical losses, current and anticipated economic
conditions, diversification of the loan portfolio, delinquency statistics,
results of internal loan reviews, borrowers’ perceived financial and management
strengths, the adequacy of underlying collateral, the dependence on collateral,
or the strength of the present value of future cash flows and other relevant
factors. These factors may be susceptible to significant change. To the extent
actual outcomes differ from management estimates, additional provisions for loan
losses may be required which may adversely affect the Corporation’s results of
operations in the future.
Goodwill
and Other Intangible Asset Impairment: Goodwill and other intangible assets are
reviewed for potential impairment on an annual basis, or more often if events or
circumstances indicate that there may be impairment, in accordance with SFAS
No. 142, “Goodwill and Other Intangible Assets” and SFAS No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets.” Goodwill is
tested for impairment at the reporting unit level and an impairment loss is
recorded to the extent that the carrying amount of goodwill exceeds its implied
fair value. The Corporation employs general industry practices in evaluating the
fair value of its goodwill and other intangible assets. The Corporation
calculates the fair value using a combination of the following valuation
methods: dividend discount analysis under the income approach, which calculates
the present value of all excess cash flows plus the present value of a terminal
value and price/earnings multiple under the market approach. Management
performed its annual review of goodwill and other identifiable intangibles at
June 30, 2007 and determined there was no impairment of goodwill or other
identifiable intangibles.
No assurance can be given
that future impairment tests will not result in a charge to
earnings.
Stock-based
Compensation: The Corporation recognizes compensation expense for stock options
in accordance with SFAS 123 (revised 2004), “Share-Based Payment” (SFAS 123R))
adopted at January 1, 2006 under the modified prospective application method of
transition. The expense of the option is generally measured at fair value at the
grant date with compensation expense recognized over the service period, which
is usually the vesting period. The Corporation utilizes the Black-Scholes
option-pricing model (as used under SFAS 123) to estimate the fair value of each
option on the date of grant. The Black-Scholes model takes into consideration
the exercise price and expected life of the options, the current price of the
underlying stock and its expected volatility, the expected dividends on the
stock and the current risk-free interest rate for the expected life of the
option. For grants subject to a market condition, the Corporation utilizes a
Monte Carlo simulation to estimate the fair value and determine the derived
service period. Compensation is recognized over the derived service period with
any unrecognized compensation cost immediately recognized when the market
condition is met. The Corporation’s estimate of the fair value of a stock option
is based on expectations derived from historical experience and may not
necessarily equate to its market value when fully vested. In accordance with
SFAS 123(R), the Corporation estimates the number of options for which the
requisite service is expected to be rendered.
Unrealized Gains and
Losses on Securities Available for Sale:
The Corporation receives
estimated fair values of debt securities from independent valuation services and
brokers. In developing these fair values, the valuation services and brokers use
estimates of cash flows based on historical performance of similar instruments
in similar rate environments. Debt securities available for sale are mostly
comprised of mortgage-backed securities as well as tax-exempt municipal bonds
and U.S. government agency securities. The Corporation uses various indicators
in determining whether a security is other-than-temporarily impaired, including
for equity securities, if the market value is below its cost for an extended
period of time with low expectation of recovery or for debt securities, when it
is probable that the contractual interest and principal will not be collected.
The debt securities are monitored for changes in credit ratings. Adverse changes
in credit ratings would affect the estimated cash flows of the underlying
collateral or issuer. The unrealized losses associated with the securities
portfolio, that management has the ability and intent to hold, are not
considered to be other-than temporary as of March 31, 2008 because the
unrealized losses are related to changes in interest rates and do not affect the
expected cash flows of the underlying collateral or issuer.
Deferred
Taxes: The Corporation recognizes deferred tax assets and liabilities for the
future effects of temporary differences, net operating loss carryforwards, and
tax credits. Deferred tax assets are subject to management’s judgment based upon
available evidence that future realizations are likely. If management determines
that the Corporation may not be able to realize some or all of the net deferred
tax asset in the future, a charge to income tax expense may be required to
reduce the value of the net deferred tax asset to the expected realizable
value.
The
Corporation has not substantively changed its application of the foregoing
policies, and there have been no material changes in assumptions or estimation
techniques used as compared to prior periods.
Financial
Overview
For the
first quarter of 2008, the Corporation’s net income was $7.3 million or $.23 per
diluted share, up 19.1% and 9.5%, respectively, compared to $6.1 million or $.21
per diluted share for the first quarter of 2007. Results were favorably impacted
by an increase in the net interest margin, the impact of cost reduction actions
taken in 2007 as well as the recent acquisition of East Penn Financial
Corporation (East Penn Financial). The year-to-date financial results include
the impact on operations from the acquisition of East Penn Financial effective
November, 16, 2007 and the related issuance of 2,432,771 shares of the
Corporation’s common stock. The following is an overview of the key financial
highlights for the first quarter of 2008:
Total
assets were $3.9 billion at March 31, 2008, an increase of 17.1% or $569.1
million over $3.3 billion in total assets at March 31, 2007. Loans were $2.48
million, an increase of 20.1% from $2.07 million at March 31, 2007. Deposits
were $2.99 million, up 18.2% from $2.53 million last year. East Penn Financial
had assets of $451.1 million, loans of $337.7 million and deposits of $382.7
million at the acquisition date. Total assets at March 31, 2008 were level with
December 31, 2007.
The
annualized return on average shareholders’ equity was 8.55% for the first
quarter of 2008 as compared to 8.47% for the same period in 2007. The annualized
return on average assets was 0.75% during the first quarter of 2008 in
comparison to 0.76% for the first quarter of 2007.
Net
interest income on a tax equivalent basis in the first quarter of 2008 increased
$4.6 million or 21.8% from the same period in 2007 mainly as a result of the
East Penn Financial acquisition as well as organic loan growth and a decrease in
customer deposit costs. First quarter net interest margin of 2.91% was the
highest since the third quarter of 2006, and was up 9 basis points year over
year and 15 basis points sequentially.
Nonperforming
assets were $27.1 million at March 31, 2008. Nonperforming assets as a
percentage of total assets were 0.69% at March 31, 2008, compared to 0.56% at
December 31, 2007, and 0.59% in last year’s first quarter.
Net charge-offs were $0.8
million, compared to $2.7 million in the first quarter of 2007. The provision
for loan losses was $2.0 million, a decrease of 19.2% from $2.4 million in the
first quarter of 2007.
Results of
Operations
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
inherent losses on loans; (3) noninterest income, which is made up primarily of
certain fees, wealth management income and gains and losses from sales of
securities or other transactions; (4) noninterest expense, which consists
primarily of salaries, employee benefits and other operating expenses; and (5)
income taxes. Each of these major elements will be reviewed in more detail in
the following discussion.
Adoption of Fair Value
Measurements Accounting Standard
As
previously discussed in Note 1
–
Summary of Significant
Accounting Policies and Note 10– Fair Value Measurements, the Corporation
adopted SFAS No. 157, “Fair Value Measurements” effective January 1, 2008. The
adoption of SFAS 157 did not have a material impact on the Corporation’s
financial statements. See Note 1 and Note 10 for additional
information.
Net Interest
Income
Net
interest income on a tax equivalent basis in the first quarter of 2008 increased
$4.6 million or 21.8% from the same period in 2007. The increase during 2008 was
mainly as a result of the East Penn Financial acquisition as well as organic
loan growth and a decrease in customer deposit costs.
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 three months ended March 31, 2008 compared to March 31, 2007 by their
volume and rate components. The change attributable to both volume and rate has
been allocated proportionately.
Table
1—Analysis of Changes in Net Interest Income—Fully Taxable-Equivalent
Basis
|
|
Three Months Ended
March 31, 2008 compared to
March 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars
in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
Due to change in:
|
|
|
|
Change
|
|
|
Volume
|
|
|
Rate
|
|
|
|
|
|
|
|
|
|
|
|
Increase
(decrease) in interest income:
|
|
|
|
|
|
|
|
|
|
Investment
securities *
|
|
$
|
1,609
|
|
|
$
|
1,431
|
|
|
$
|
178
|
|
Federal
funds sold and deposits in banks
|
|
|
(112
|
)
|
|
|
230
|
|
|
|
(342
|
)
|
Loans
*
|
|
|
4,500
|
|
|
|
6,787
|
|
|
|
(2,287
|
)
|
Total
|
|
|
5,997
|
|
|
|
8,448
|
|
|
|
(2,451
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
(decrease) in interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
Savings
and money market deposits
|
|
|
(4,011
|
)
|
|
|
349
|
|
|
|
(4,360
|
)
|
Time
deposits
|
|
|
4,785
|
|
|
|
4,846
|
|
|
|
(61
|
)
|
Borrowed
funds
|
|
|
577
|
|
|
|
915
|
|
|
|
(338
|
)
|
Total
|
|
|
1,351
|
|
|
|
6,110
|
|
|
|
(4,759
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
increase in net interest income
|
|
$
|
4,646
|
|
|
$
|
2,338
|
|
|
$
|
2,308
|
|
*Tax
equivalent basis using a tax rate of 35%, net
|
|
|
|
|
|
|
|
|
|
|
|
|
The
following table presents the major asset and liability categories on an average
basis for the periods presented, along with interest income and expense, and key
rates and yields.
Table
2—Average Balance Sheets and Interest Rates
¾
Fully Taxable-Equivalent
Basis
(Dollars
in thousands)
|
|
Three Months Ended March
31,
|
|
|
Three Months Ended March
31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
Average
|
|
Assets
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
Earning
assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
investments
|
|
$
|
753,468
|
|
|
$
|
9,754
|
|
|
|
5.21
|
%
|
|
$
|
684,651
|
|
|
$
|
8,564
|
|
|
|
5.07
|
%
|
Nontaxable
investments
(1)
|
|
|
290,098
|
|
|
|
4,356
|
|
|
|
6.04
|
|
|
|
260,007
|
|
|
|
3,937
|
|
|
|
6.14
|
|
Total
investment securities
|
|
|
1,043,566
|
|
|
|
14,110
|
|
|
|
5.44
|
|
|
|
944,658
|
|
|
|
12,501
|
|
|
|
5.37
|
|
Federal
funds sold and deposits in banks
|
|
|
84,157
|
|
|
|
694
|
|
|
|
3.32
|
|
|
|
62,837
|
|
|
|
806
|
|
|
|
5.20
|
|
Loans
(1)
(2)
|
|
|
2,463,242
|
|
|
|
39,405
|
|
|
|
6.43
|
|
|
|
2,059,871
|
|
|
|
34,905
|
|
|
|
6.87
|
|
Total
earning assets
|
|
|
3,590,965
|
|
|
|
54,209
|
|
|
|
6.07
|
|
|
|
3,067,366
|
|
|
|
48,212
|
|
|
|
6.37
|
|
Noninterest-earning
assets
|
|
|
299,994
|
|
|
|
|
|
|
|
|
|
|
|
213,488
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
3,890,959
|
|
|
|
|
|
|
|
|
|
|
$
|
3,280,854
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Shareholders' Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Savings
and money market
|
|
$
|
1,415,450
|
|
|
|
8,095
|
|
|
|
2.30
|
|
|
$
|
1,376,074
|
|
|
|
12,106
|
|
|
|
3.57
|
|
Time
|
|
|
1,237,482
|
|
|
|
14,501
|
|
|
|
4.71
|
|
|
|
831,489
|
|
|
|
9,716
|
|
|
|
4.74
|
|
Total
interest-bearing deposits
|
|
|
2,652,932
|
|
|
|
22,596
|
|
|
|
3.43
|
|
|
|
2,207,563
|
|
|
|
21,822
|
|
|
|
4.01
|
|
Borrowed
funds
|
|
|
499,064
|
|
|
|
5,613
|
|
|
|
4.52
|
|
|
|
422,415
|
|
|
|
5,036
|
|
|
|
4.84
|
|
Total
interest bearing liabilities
|
|
|
3,151,996
|
|
|
|
28,209
|
|
|
|
3.60
|
|
|
|
2,629,978
|
|
|
|
26,858
|
|
|
|
4.14
|
|
Noninterest-bearing
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand
deposits
|
|
|
324,120
|
|
|
|
|
|
|
|
|
|
|
|
308,095
|
|
|
|
|
|
|
|
|
|
Other
liabilities
|
|
|
71,443
|
|
|
|
|
|
|
|
|
|
|
|
48,986
|
|
|
|
|
|
|
|
|
|
Total
noninterest-bearing liabilities
|
|
|
395,563
|
|
|
|
|
|
|
|
|
|
|
|
357,081
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
3,547,559
|
|
|
|
|
|
|
|
|
|
|
|
2,987,059
|
|
|
|
|
|
|
|
|
|
Shareholders'
equity
|
|
|
343,400
|
|
|
|
|
|
|
|
|
|
|
|
293,795
|
|
|
|
|
|
|
|
|
|
Total
liabilities and shareholders' equity
|
|
$
|
3,890,959
|
|
|
|
|
|
|
|
|
|
|
$
|
3,280,854
|
|
|
|
|
|
|
|
|
|
Net
interest spread
|
|
|
|
|
|
|
|
|
|
|
2.47
|
|
|
|
|
|
|
|
|
|
|
|
2.23
|
|
Effect
of noninterest-bearing sources
|
|
|
|
|
|
|
|
|
|
|
0.44
|
|
|
|
|
|
|
|
|
|
|
|
0.59
|
|
Net
interest income/margin on earning assets
|
|
|
|
|
|
$
|
26,000
|
|
|
|
2.91
|
%
|
|
|
|
|
|
$
|
21,354
|
|
|
|
2.82
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
tax equivalent adjustment
|
|
|
|
|
|
|
1,793
|
|
|
|
|
|
|
|
|
|
|
|
1,517
|
|
|
|
|
|
Net
interest income
|
|
|
|
|
|
$
|
24,207
|
|
|
|
|
|
|
|
|
|
|
$
|
19,837
|
|
|
|
|
|
(1)
|
The
interest earned on nontaxable investment securities and loans is shown on
a tax equivalent basis, net of deductions (tax rate of
35%).
|
(2)
|
Nonaccrual
loans have been included in the appropriate average loan balance category,
but interest on nonaccrual loans has not been included for purposes of
determining interest income.
|
Interest
income on a tax equivalent basis in the first quarter of 2008 increased $6.0
million, or 12.4% over the same period in 2007. This increase was primarily due
to higher average loans of $403.4 million partially offset by a 44 basis points
reduction in the average rate earned on loans. The growth in average loans of
19.6% over the first quarter of last year was mainly as a result of the East
Penn Financial acquisition as well as organic loan growth. Loan rates have
declined from the first quarter of 2007 to the first quarter of 2008 due to
market credit and liquidity conditions resulting in the Federal Open Market
Committee reducing overnight rates 300 basis points and the subsequent change in
the yield curve. Interest expense increased $1.4 million or 5.0% during the
first quarter of 2008 versus the comparable period in 2007 mainly attributed to
higher deposit volume from the East Penn Financial acquisition offset by a 58
basis point reduction in the average rate paid on deposits. The Corporation’s
lower cost of funds have resulted from the short-term rate reductions during the
fourth quarter of 2007 and the first quarter of 2008 by the Federal Open Market
Committee as well as the Corporation’s continued emphasis on lower rate deposit
products.
Net Interest
Margin
The net
interest margin for the first quarter of 2008 of was 2.91% compared to 2.76% for
the fourth quarter of 2007 and 2.82% for the first quarter of 2007. Decreases in
customer deposit costs have outpaced yield decreases in loans and investments.
The steepening of the yield curve and the acquisition of East Penn Bank have
contributed to the improved margin.
Interest Rate Sensitivity
Analysis
In the
normal course of conducting business activities, the Corporation is exposed to
market risk, principally interest rate risk through the operations of its
banking subsidiary. Interest rate risk arises from market driven fluctuations in
interest rates that affect cash flows, income, expense and value of financial
instruments.
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
portfolio, its offering of loan and deposit terms and through wholesale
borrowings from several providers, but primarily the Federal Home Loan Bank (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.
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.
Interest rate caps are purchased contracts that limit the exposure from the
repricing of liabilities in a rising rate environment.
At March
31, 2008, the Corporation had a cash flow hedge with a notional amount of $5.0
million that has the effect of converting variable debt to a fixed rate. This
swap matures in 2008. During the first quarter of 2008, cash flow hedges matured
with a notional amount of $50.0 million that had the effect of converting rates
on money market deposit accounts to a fixed-rate cost of funds. For both of
these types of swaps, the Corporation recognized net interest expense of
$115,000 and income of $138,000 for the three months ended March 31, 2008 and
2007, respectively. Periodically, the Corporation may enter into fair value
hedges to limit the exposure to changes in the fair value of loan assets. At
March 31, 2008, the Corporation had fair value hedges in the form of interest
rate swaps with a notional amount of $3.9 million. These swaps mature in 2017.
The Corporation recognized net interest expense of $16,000 and income of $5,000
for the three months ended March 31, 2008 and 2007, respectively. At March 31,
2008, the Corporation had swap agreements with a negative fair value of
$496,000. At December 31, 2007, the Corporation had swap agreements with a
positive fair value of $10,000 and with a negative fair value of $366,000. There
was no hedge ineffectiveness recognized during the first quarters of 2008 and
2007.
During
March 2007, the Corporation purchased one and three month Treasury bill interest
rate cap agreements with notional amounts totaling $200 million to limit its
exposure on variable rate now deposit accounts. The initial premium related to
these caps was $73,000 which is being amortized to interest expense over the
life of the cap based on the cap market value. The Corporation recognized
amortization of $1,000 for the three months ended March 31, 2008. At March 31,
2008 and December 31, 2007, these caps, designated as cash flow hedges, had a
positive fair value of $2 and $222, respectively. The caps mature in March 2009.
Hedge ineffectiveness of $40,000 on cash flow hedges due to notional mismatch
was recognized in other expense during the first quarter of 2008. There was no
impact to earnings for the first quarter of 2007 related to the
caps.
During
2008 the Company implemented a program to offer certain derivative products
directly to qualified commercial borrowers. The Corporation
economically hedges derivative transactions executed with commercial borrowers
by entering into mirror-image, offsetting derivatives with a third party.
Derivative transactions executed as part of this program are not designated in
SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”
-qualifying hedging relationships and are, therefore, marked-to-market through
earnings each period. As of March 31, 2008, the fair value of the derivative
assets and the fair value of the derivative liabilities were $152,000 and
$119,000, respectively. The difference between the change
in the fair value of the derivative assets and derivative liabilities of
$33,000, which relates to the credit valuation adjustment in accordance with
SFAS 157, “Fair Value Measurements” is recognized in other
income.
The
Corporation uses three principal reports to measure interest rate risk: (1)
asset/liability simulation reports; (2) gap analysis reports; and (3) 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 shocking.
The
results of the March 31, 2008 net interest income rate shock simulations show
that the Corporation is within guidelines set by the Corporation's
Asset/Liability Policy when rates increase 100 or 200 basis points or decrease
100 basis points. In rates shocked down 200 basis points, net
interest income is projected to be -10.04% which is outside the policy guideline
of -8.00%. This is due to the low current interest rate
environment. When rates are shocked down 200 basis points, the rates
on core deposits hit internally established minimums and are unable to reprice
down the full 200 basis points, while interest earning assets can reprice down
the full 200 basis points. The Corporation constantly monitors this
position and takes steps to minimize any reduction in net interest
income.
The
report below forecasts changes in the Corporation’s market value of equity under
alternative interest rate environments as of March 31, 2008. The market value of
equity is defined as the net present value of the Corporation’s existing assets
and liabilities. The Corporation is within guidelines set by the Corporation’s
Asset/Liability Policy for the percentage change in the market value of
equity.
Table
3—Market Value of Equity
|
|
|
|
|
Change
in
|
|
|
|
|
|
Asset/Liability
|
|
|
|
Market
Value
|
|
|
Market
Value
|
|
|
Percentage
|
|
|
Approved
|
|
(Dollars
in thousands)
|
|
of
Equity
|
|
|
Of
Equity
|
|
|
Change
|
|
|
Percent
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
+300
Basis Points
|
|
$
|
385,486
|
|
|
$
|
(98,712
|
)
|
|
|
-20.39
|
%
|
|
|
+/-
35
|
%
|
+200
Basis Points
|
|
|
427,604
|
|
|
|
(56,594
|
)
|
|
|
-11.69
|
%
|
|
|
+/-
25
|
|
+100
Basis Points
|
|
|
470,312
|
|
|
|
(13,886
|
)
|
|
|
-2.87
|
%
|
|
|
+/-
15
|
|
Flat
Rate
|
|
|
484,198
|
|
|
|
-
|
|
|
|
0.00
|
%
|
|
|
|
|
-100
Basis Points
|
|
|
464,854
|
|
|
|
(19,344
|
)
|
|
|
-4.00
|
%
|
|
|
+/-
15
|
|
-200
Basis Points
|
|
|
423,456
|
|
|
|
(60,743
|
)
|
|
|
-12.55
|
%
|
|
|
+/-
25
|
|
-300
Basis Points
|
|
|
373,363
|
|
|
|
(110,835
|
)
|
|
|
-22.89
|
%
|
|
|
+/-
35
|
|
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 portfolio through the
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
Corporation uses 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. 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 Office of the Comptroller
of the Currency (the OCC), as an integral part of their examination process,
periodically reviews the Corporation’s allowance for loan losses. The OCC may
require the Corporation 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
Corporation performs periodic evaluations of the allowance for loan losses that
include both historical, internal and external factors. The actual allocation of
reserve is a function of the application of these factors to arrive at a reserve
for each portfolio type. Management assigns credit ratings and individual
factors to individual groups of loans. Changes in concentrations and quality are
captured in the analytical metrics used in the calculation of the reserve. The
components of the allowance for credit losses consist of both historical losses
and estimates. 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
Corporation’s
allowance
for loan losses components includes 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 and results of the
loan review process. The Corporation’s 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
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 nonaccrual, by credit
product.
The
historical loss components of the allowance for commercial and industrial loans
and commercial real estate loans (collectively “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
analyses of other factors that may have affected the collectibility of loans.
All commercial loans with an outstanding balance over $500,000 are subject to
review on an annual basis. Samples of commercial loans with a “pass” rating are
individually reviewed annually. Commercial loans that management determines to
be potential problem loans are individually reviewed at a minimum annually. The
review is accomplished via Watchlist Memorandum, and is designed to determine
whether such loans are individually impaired, with impairment measured by
reference to the collateral coverage and/or debt service coverage. Consumer
credit and residential real estate reviews are limited to those loans reflecting
delinquent payment status. Homogeneous loan pools, including consumer and 1-4
family residential mortgages are not subject to individual review but are
evaluated utilizing risk factors such as concentration of one borrower group.
The historical loss component of the allowance for these 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 consumer loans relying on residential home equity. 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 a
judgmental component (environmental factors) that reflects management’s belief
that there are additional inherent credit losses based on loss attributes not
adequately captured in the lagging indicators.
The environmental factors are based
upon management’s review of trends in the Corporation’s primary market area as
well as regional and national economic trends. Management utilizes various
economic factors that could impact borrowers’ future ability to make loan
payments such as changes in the interest rate environment, product supply
shortages, and negative industry specific events. Management utilizes relevant
articles from newspapers and other publications that describe the economic
events affecting specific geographic areas and other published economic reports
and data.
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 risk management staff to assess the direction of credit
risk and its instant effect on losses. 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. The judgmental
component is allocated to the specific segments of the portfolio based on the
historic loss component
.
The
provision for loan losses was $2.0 million for the three months ended March 31
2008, a decrease of 19.2% from $2.4 million for the same period in 2007.
N
et loans charged-off were $.8
million during the first quarter of 2008 as compared to $2.7 million in the
first quarter of 2007.
A summary
of the activity in the allowance for loan losses is as follows:
Table
4—Allowance for Loans Losses
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
(Dollars
in thousands)
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Average
loans
|
|
$
|
2,463,242
|
|
|
$
|
2,059,871
|
|
|
|
|
|
|
|
|
|
|
Allowance,
beginning of period
|
|
|
27,328
|
|
|
|
21,154
|
|
Loans
charged off:
|
|
|
|
|
|
|
|
|
Real
estate
|
|
|
357
|
|
|
|
1,620
|
|
Commercial
and industrial
|
|
|
216
|
|
|
|
750
|
|
Consumer
|
|
|
394
|
|
|
|
373
|
|
Lease
financing
|
|
|
—
|
|
|
|
31
|
|
Total
loans charged off
|
|
|
967
|
|
|
|
2,774
|
|
Recoveries:
|
|
|
|
|
|
|
|
|
Real
estate
|
|
|
27
|
|
|
|
9
|
|
Commercial
and industrial
|
|
|
15
|
|
|
|
9
|
|
Consumer
|
|
|
127
|
|
|
|
93
|
|
Lease
financing
|
|
|
—
|
|
|
|
13
|
|
Total
recoveries
|
|
|
169
|
|
|
|
124
|
|
Net
loans charged off
|
|
|
798
|
|
|
|
2,650
|
|
Provision
for loan losses
|
|
|
1,960
|
|
|
|
2,425
|
|
Allowance,
end of period
|
|
$
|
28,490
|
|
|
$
|
20,929
|
|
Ratio
of net charge offs to average
|
|
|
|
|
|
|
|
|
loans
outstanding (annualized)
|
|
|
0.13
|
%
|
|
|
0.52
|
%
|
|
|
|
|
|
|
|
|
|
The
following table sets forth an allocation of the allowance for loan losses by
loan 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.
Table
5—Allocation of the Allowance for Loan Losses by Loan Type
The
factors affecting the allocation of the allowance during the three-month period
ended March 31, 2008 were changes in credit quality resulting from increases in
criticized commercial and industrial loans. The allocation of the allowance for
commercial and industrial loan at March 31, 2008 increased $1.7 million from
December 31, 2007 primarily due to an increase in loans rated special mention
and a slight increase in the loss ratio for substandard loans. T
he allocation of the
allowance for real estate loans decreased $635,000 mostly due to decreased loan
volume combined with an improvement in the loss ratio.
There were no
material changes in the allocation of the allowance for consumer loans and lease
financing at March 31, 2008 compared to December 31, 2007. There were no
significant changes in the estimation methods and assumptions including
environmental factors, loan concentrations or terms that impacted the allowance
during the first three months of 2008. The interest rate environment as well as
weakening in the commercial real estate market has moderately increased our
allowance allocation in concert with the historical trends. It is expected that
the negative trends in the real estate industry will continue to affect credit
quality into 2008. The growth in the loan portfolio and the change in the mix
will result in an adjustment to the amount of the allowance allocated to each
category based upon historical loss trends and other factors.
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.
|
|
March 31, 2008
|
|
|
December 31, 2007
|
|
|
|
|
|
|
Percent
of
|
|
|
|
|
|
Percent
of
|
|
(Dollars
in thousands)
|
|
Amount
|
|
|
Allowance
|
|
|
Amount
|
|
|
Allowance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real
estate
|
|
$
|
9,856
|
|
|
|
35
|
%
|
|
$
|
10,491
|
|
|
|
38
|
%
|
Commercial
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
industrial
|
|
|
14,073
|
|
|
|
49
|
%
|
|
|
12,340
|
|
|
|
45
|
%
|
Consumer
|
|
|
4,547
|
|
|
|
16
|
%
|
|
|
4,485
|
|
|
|
17
|
%
|
Lease
financing
|
|
|
14
|
|
|
|
-
|
%
|
|
|
12
|
|
|
|
-
|
%
|
Total
|
|
$
|
28,490
|
|
|
|
100
|
%
|
|
$
|
27,328
|
|
|
|
100
|
%
|
Nonperforming
Assets
Nonperforming
assets (including nonaccruing loans, net assets in foreclosure and loans past
due 90 days or more past due) were 0.69% of total assets at March 31, 2008,
compared to 0.56% at December 31, 2007, and 0.59% at March 31, 2007. The
increase in nonperforming assets at March 31, 2008, in relation to December 31,
2007, of $5.1 million was substantially concentrated in the commercial real
estate portfolio as well as a higher level of commercial and industrial loans on
nonaccrual of interest. The increase of nonperforming assets in relation to
March 31, 2007 of $7.5 million was largely due to a higher level of commercial
real estate loans on nonaccrual of interest. While the credit quality remained
stable at quarter end, we continue to take a conservative approach to our
lending and loan review practices. With the expectation of continued economic
pressures, management continues to provide more resources to resolve troubled
credits including an increased focus on earlier identification of potential
problem loans and a more active approach to managing the level of criticized
loans that have not reached nonaccrual status.
Net
assets in foreclosure increased $1.5 million due to the foreclosure and
subsequent transfer to OREO of one construction loan which defaulted during the
fourth quarter of 2007. The Bank has assumed the rights to an agreement with a
homebuilder, who has been constructing homes on the site, to purchase remaining
lots in the development at a fixed price which is expected to result in full
payment of the loan. Foreclosed assets are carried at the lower of cost (lesser
of carrying value of asset or fair value at date. 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. Efforts to liquidate assets acquired in
foreclosure proceed as quickly as potential buyers can be located and legal
constraints permit. 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.
The
following table presents information concerning nonperforming assets.
Nonperforming assets include loans that are in nonaccrual status or 90 days or
more past due and loans that are in the process of foreclosure.
Table
6—Nonperforming Assets
(Dollars
in thousands)
|
|
March
31, 2008
|
|
|
December
31, 2007
|
|
|
March
31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
Nonaccrual
loans
|
|
$
|
23,819
|
|
|
$
|
21,091
|
|
|
$
|
17,519
|
|
Loans
90 days or more past due
|
|
|
1,702
|
|
|
|
857
|
|
|
|
2,001
|
|
Total nonperforming
loans
|
|
|
25,521
|
|
|
|
21,948
|
|
|
|
19,520
|
|
Net
assets in foreclosure
|
|
|
1,536
|
|
|
|
28
|
|
|
|
10
|
|
Total nonperforming
assets
|
|
$
|
27,057
|
|
|
$
|
21,976
|
|
|
$
|
19,530
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance
for loan losses to nonperforming loans
|
|
|
111.6
|
%
|
|
|
124.5
|
%
|
|
|
107.2
|
%
|
Nonperforming
loans to total net loans
|
|
|
1.04
|
%
|
|
|
0.90
|
%
|
|
|
0.95
|
%
|
Allowance
for loan and lease losses to total loans
|
|
|
1.15
|
%
|
|
|
1.11
|
%
|
|
|
1.01
|
%
|
Nonperforming
assets to total assets
|
|
|
0.69
|
%
|
|
|
0.56
|
%
|
|
|
0.59
|
%
|
Locally
located real estate, most with acceptable loan to value ratios, secures many of
the nonperforming loans.
The
following table presents information concerning impaired loans. Impaired loans
are loans for which it is probable that all principal and interest will not be
collected according to the contractual terms of the loan agreement. Impaired
loans are included in the nonaccrual loan total.
Table
7—Impaired Loans
(Dollars
in thousands)
|
|
March
31, 2008
|
|
|
December
31, 2007
|
|
|
March
31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
Impaired
Loans
|
|
$
|
9,404
|
|
|
$
|
9,803
|
|
|
$
|
7,789
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
year-to-date impaired loans
|
|
$
|
10,559
|
|
|
$
|
7,539
|
|
|
$
|
6,523
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impaired
loans with specific loss allowances
|
|
$
|
9,404
|
|
|
$
|
9,803
|
|
|
$
|
7,789
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
allowances reserved on impaired loans
|
|
$
|
2,172
|
|
|
$
|
2,229
|
|
|
$
|
1,279
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year-to-date
income recognized on impaired loans
|
|
$
|
8
|
|
|
$
|
31
|
|
|
$
|
4
|
|
The
Bank’s policy for interest income recognition on impaired 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 Bank. The
Bank will not recognize income if these factors do not exist.
Noninterest
Income
Noninterest
income was $10.8 million for the first quarter of 2008, an increase of $1.7
million or 18.4% from $9.1 million in the first quarter of 2007, driven by
growth in service charges on deposits. S
ervice charges on deposits of $3.1
million increased by $1.2 million or 62.3% primarily from increased return check
and overdraft fees as well as East Penn deposit accounts. Wealth management
income of $4.3 million remained level with last year’s first quarter.
Major revenue component sources of wealth management income include
investment management and advisory fees, trust fees, estate and tax planning
fees, brokerage fees, and insurance related fees.
Net security gains were
$128,000 during the first quarter of 2008 compared to $531,000 during the
comparable period in 2007.
Other
income included a gain of $302,000 from the mandatory redemption of Visa Class B
stock in conjunction with Visa’s initial public offering.
Noninterest
Expense
Noninterest
expense was $23.7 million, an increase of $4.9 million or 26.3% from $18.8
million in the first quarter of 2007, driven by the acquisition of East Penn
Financial as well as branch expansion. Salaries and benefits expense rose $2.3
million primarily due to higher staffing levels resulting from the East Penn
Financial acquisition and branch expansion. Occupancy expenses increased $1.1
million mainly due to the addition of the East Penn branches as well as rent
expense on the bank properties in the sale-leaseback transaction completed in
the fourth quarter of 2007. Other expenses increased $1.4 million mostly due to
additional professional and consulting fees and identifiable intangible asset
amortization related to the East Penn acquisition.
Income
Taxes
The
effective income tax rate for the three months ended March 31, 2008 and March
31, 2007 were 22.0% and 21.2%, respectively versus the applicable federal
statutory rate of 35%. The Corporation’s effective rates during 2008 and 2007
were lower than the statutory tax rate primarily as a result of tax-exempt
income earned from state and municipal securities and loans and bank-owned life
insurance.
Balance Sheet
Analysis
Total
assets at March 31, 2008 of $3.9 billion were level with December 31, 2007.
T
he balance of
investment securities available for sale increased by $67.2 million primarily as
a result of net additional purchases
of mortgage-backed
securities and
l
oans grew by $20.0 million. Federal funds sold to correspondent banks
decreased $92.7 million due to the increase in investment securities and loans.
Total deposits remained level with year-end.
Capital
Capital
formation is important to the Corporation's well being and future growth.
Capital for the period ending March 31, 2008 was $343.3 million, an increase of
$4.0 million from the capital balance at December 31, 2007 of $339.3 million.
Increases in capital from the retention of the Corporation’s earnings and a
decrease in the accumulated other comprehensive loss related to investment
securities were partially offset by cash dividends paid to shareholders.
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.
Table
8—Regulatory Capital
(Dollars
in thousands)
|
|
|
|
|
|
|
|
For
Capital
Adequacy
Purposes
|
|
|
To
Be Well Capitalized
Under
Prompt Corrective
Action
Program
|
|
As of March 31, 2008
|
|
Actual
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Capital (to risk weighted assets):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporation
|
|
$
|
332,890
|
|
|
|
10.79
|
%
|
|
$
|
246,812
|
|
|
|
8.00
|
%
|
|
$
|
308,514
|
|
|
|
-
|
|
Harleysville
National Bank
|
|
|
316,519
|
|
|
|
10.30
|
%
|
|
|
245,853
|
|
|
|
8.00
|
%
|
|
|
307,316
|
|
|
|
10
|
%
|
Tier
1 Capital (to risk weighted assets):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporation
|
|
|
304,300
|
|
|
|
9.86
|
%
|
|
|
123,406
|
|
|
|
4.00
|
%
|
|
|
185,109
|
|
|
|
-
|
|
Harleysville
National Bank
|
|
|
287,929
|
|
|
|
9.37
|
%
|
|
|
122,926
|
|
|
|
4.00
|
%
|
|
|
184,389
|
|
|
|
6
|
%
|
Tier
1 Capital (to average assets):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporation
|
|
|
304,300
|
|
|
|
8.07
|
%
|
|
|
150,882
|
|
|
|
4.00
|
%
|
|
|
188,603
|
|
|
|
-
|
|
Harleysville
National Bank
|
|
|
287,929
|
|
|
|
7.66
|
%
|
|
|
150,277
|
|
|
|
4.00
|
%
|
|
|
187,846
|
|
|
|
5
|
%
|
(Dollars
in thousands)
|
|
|
|
|
|
|
|
For
Capital
Adequacy
Purposes
|
|
|
To
Be Well Capitalized
Under
Prompt Corrective
Action
Program
|
|
As of December 31, 2007
|
|
Actual
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Capital (to risk weighted assets):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporation
|
|
$
|
329,887
|
|
|
|
10.67
|
%
|
|
$
|
247,273
|
|
|
|
8.00
|
%
|
|
$
|
309,091
|
|
|
|
10
|
%
|
Harleysville
National Bank
|
|
|
312,880
|
|
|
|
10.16
|
%
|
|
|
246,286
|
|
|
|
8.00
|
%
|
|
|
307,858
|
|
|
|
10
|
%
|
Tier
1 Capital (to risk weighted assets):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporation
|
|
|
302,459
|
|
|
|
9.79
|
%
|
|
|
123,637
|
|
|
|
4.00
|
%
|
|
|
185,455
|
|
|
|
6
|
%
|
Harleysville
National Bank
|
|
|
285,452
|
|
|
|
9.27
|
%
|
|
|
123,143
|
|
|
|
4.00
|
%
|
|
|
184,715
|
|
|
|
6
|
%
|
Tier
1 Capital (to average assets):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporation
|
|
|
302,459
|
|
|
|
8.72
|
%
|
|
|
138,795
|
|
|
|
4.00
|
%
|
|
|
173,494
|
|
|
|
5
|
%
|
Harleysville
National Bank
|
|
|
285,452
|
|
|
|
8.29
|
%
|
|
|
137,722
|
|
|
|
4.00
|
%
|
|
|
172,153
|
|
|
|
5
|
%
|
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 generally common stockholder’s equity and retained earnings
adjusted to exclude disallowed goodwill and identifiable intangibles as well as
the inclusion of qualifying trust preferred securities. 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 March 31, 2008, the Corporation’s Tier 1 risk-adjusted
capital ratio was 9.86%
,
and the total risk-adjusted capital ratio was 10.79%, both well above the
regulatory requirements. The risk-based capital ratios of the Bank also exceeded
regulatory requirements at March 31, 2008.
The
leverage ratio consists of Tier 1 capital divided by quarterly average total
assets, excluding goodwill and identifiable intangibles. Banking organizations
are expected to have ratios from 4% to 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 8.07% at March 31, 2008 and 8.72% at December
31, 2007.
The lower
leverage ratio of the Corporation at March 31, 2008 was mainly due to the
increase in average assets from the purchase of East Penn Bank in November
2007.
The first
quarter 2008 cash dividend per share of $.20 was the same as the cash dividend
for the first quarter of 2007. The proportion of net income paid out in
dividends for the first three months of 2008 was 85.8%, compared to 94.4% for
the same period in 2007. Activity in both the Corporation’s dividend
reinvestment and stock purchase plan did not have a material impact on capital
during the first quarter of 2008.
Liquidity
Liquidity
is a measure of the ability of the Corporation to meet its current cash 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 Bank arranges its 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
Corporation’s decisions with regard to liquidity are based on projections of
potential sources and uses of funds for the next 120 days under the
Corporation’s asset/liability model.
The
resulting projections as of March 31, 2008 show the potential sources of funds
exceeding the potential uses of funds. The accuracy of this prediction can be
affected by limitations inherent in the model and by the occurrence of future
events not anticipated when the projections were made. The Corporation has
external sources of funds which can be drawn upon when funds are required. One
source of external liquidity is an available line of credit with the FHLB. As of
March 31, 2008, the Bank had borrowings outstanding with the FHLB of $208.8
million, all of which were long-term. At March 31, 2008, the Bank had unused
lines of credit at the FHLB of $335.4 million and unused federal funds lines of
credit of $195.0 million.
In addition, the
Corporation’s funding sources include investment and loan portfolio cash flows,
fed funds sold and short-term investments, as well as access to the brokered
certificate of deposit market and repurchase agreement borrowings. The
Corporation has pledged available for sale investment securities with a carrying
value of $680.8 million and held to maturity securities of $56.1 million.
The Corporation could also increase its liquidity through its pricing on
certificates of deposit products.
The Corporation believes
it has adequate funding sources to maintain sufficient liquidity under varying
business conditions.
There are
no known trends or any known demands, commitments, events or uncertainties that
will result in, or that are reasonably likely to result in liquidity increasing
or decreasing in any material way, although a significant portion of the
Corporation’s time deposits mature within the next twelve months. Given the
anticipated low rate environment for much of 2008, we expect to be able to
retain most of these deposits. In the event that additional funds are required,
the Corporation believes its short-term liquidity is adequate as outlined
above.
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 Bank’s operating costs. Unlike many
industrial companies, however, substantially all of the Bank’s assets and
liabilities are monetary in nature. As a result, interest rates have a more
significant impact on the Corporation’s and the Bank’s 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 Bank
is a member 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 Bank’s operations in the future. The effect of such
policies and regulations upon the future business and earnings of the
Corporation and the Bank 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 Bank are a party to any
pending legal proceeding pursuant to any environmental statute, nor are the
Corporation and the Bank aware of any circumstances that may give rise to
liability under any such statute.
Branching
During
2008, the Corporation opened a new branch in Flourtown, Montgomery County. The
Bank plans to add retail branches in Warrington, Bucks County and Whitehall,
Lehigh County and to relocate its Pottstown East End branch, Montgomery County
in 2008 The Bank also plans to add a branch in Conshohocken, Montgomery County
in early 2009. These plans are subject to change as management continues to
evaluate its market and its business needs. The Corporation continues to
evaluate potential new branch sites that are contiguous to our current service
area and will 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
subsidiary. 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 of the Corporation, using policies
and procedures approved by the Corporation’s Board of Directors, is responsible
for managing the rate sensitivity position.
During
the fourth quarter of 2007 and the first quarter of 2008, the economy has
experienced a continued decline in the housing market, reductions in credit
facilities, rising food and energy prices, all resulting in short-term rate
reductions by the Federal Open Market Committee. This has created a challenging
interest rate environment for the Corporation which has impacted our interest
rate sensitivity exposure. A detailed discussion of market risk is provided on
pages 22 and 23 of this Form 10-Q.
Item 4
–
Controls and
Procedures
(i) Management’s
Report on Disclosure Controls
Our
management evaluated, with the participation of our Chief Executive Officer and
Chief Financial Officer, the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-15(e) or 15(d)-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
report. Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures are
designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Securities Exchange Act of 1934 is
recorded, processed, summarized, and reported within the time periods specified
in the SEC’s rules, regulations and forms and are operating in an effective
manner and that such information is accumulated and communicated to our
management, including our principal executive officer and principal financial
officer, as appropriate to allow timely decisions regarding required
disclosure.
(ii) Changes
in Internal Controls
In
connection with the ongoing review of the Corporation’s internal controls over
financial reporting as defined in rule 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934, as amended, the Corporation regularly assesses
the adequacy of its internal control over financial reporting and enhances its
controls in response to internal control assessments and internal and external
audit and regulatory recommendations. There have been no changes in the
Corporation’s internal control over financial reporting during the first quarter
of 2008 that have materially affected, or are reasonably likely to materially
affect, the Corporation’s internal control over financial
reporting.
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 - the 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
1A.
Risk
Factors
There
have been no material changes in risk factors from those disclosed under Item
1A, “Risk Factors.” in the Corporation’s Annual Report on Form 10-K for the year
ended December 31, 2007.
Item
2.
Unregistered Sales of Equity
Securities and Use of Proceeds
The
Corporation did not repurchase any shares of its stock under the Corporation’s
stock repurchase programs during the first quarter of 2008. The maximum number
of share that may yet be purchased under the plans was 731,761 as of March 31,
2008. (1) The repurchased shares are used for general corporate
purposes.
(1)
|
On
May 12, 2005, the Board of Directors authorized a plan to purchase up
to 1,416,712 shares (restated for five percent stock dividend paid on
September 15, 2006 and September 15, 2005) or 4.9%, of its
outstanding common stock.
|
Item
3.
Defaults Upon Senior
Securities
Not applicable
Item
4.
Submission of Matters to a
Vote of Security Holders
None to
report.
Item
5.
Other
Information
(b)
|
There
were no material changes in the manner shareholders may recommend nominees
to the Registrant’s Board of
Directors.
|
Item
6.
Exhibits
|
The
exhibits listed on the Exhibit Index at the end of this Report are filed
with or incorporated as part of this Report (as indicated in connection
with each Exhibit).
|
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
Date: May
8, 2008
|
/s/
Paul D. Geraghty
|
|
Paul
D. Geraghty, President, Chief Executive Officer
and
|
(Principal executive
officer)
Date: May
8,
2008
/s/ George S.
Rapp
George S. Rapp,
Executive Vice President and Chief Financial Officer
(Principal
financial and accounting officer)
EXHIBIT
INDEX
Exhibit No
|
Description of Exhibits
|
(2.1)
|
Purchase
Agreement, dated as of November 15, 2005, by and among Harleysville
National Bank and Trust Company, Cornerstone Financial Consultants, Ltd.,
Cornerstone Advisors Asset Management, Inc., Cornerstone Institutional
Investors, Inc., Cornerstone Management Resources, Inc., John R. Yaissle,
Malcolm L. Cowen, II, and Thomas J. Scalici. (Incorporated by reference to
Exhibit 2.1 of the Registrant’s Annual Report on Form 10-K for the year
ended December 31, 2005, filed with the Commission on March 15,
2006. The schedules and exhibits to the Purchase Agreement are
listed at the end of the Purchase Agreement but have been omitted from the
exhibit to Form 10-K. The Registrant agrees to supplementally furnish a
copy of any omitted schedule or exhibit to the Securities and Exchange
Commission upon request.)
|
(2.2)
|
Merger
Agreement, dated as of May 15, 2007, by and among Harleysville National
Corporation, East Penn Financial Corporation, East Penn Bank and HNC-EPF,
LLC, as amended. (Incorporated by reference to Annex A of the
Corporation’s Registration Statement No. 333-145820 on Form S-4/A, filed
with the Commission on September 27, 2007. The schedules and exhibits to
the Merger Agreement are listed at the end of the Merger Agreement but
have been omitted from the Annex to Form S-4. The Registrant agrees to
supplementally furnish a copy of any omitted schedule or exhibit to the
Securities and Exchange Commission upon request.)
|
(2.3)
|
Agreement
for Purchase and Sale of Partnership Interests, dated as of December 27,
2007, by and among each of the applicable entities (“Buyer”) and 2007 PA
HOLDINGS, LLC (“HNB”) and PA BRANCH HOLDINGS, LLC, (“Bank Branch”) (HNB
and Bank Branch are referred to collectively as “Seller”), filed herewith.
(The schedules and exhibits to the Agreement for Purchase and Sale of
Partnership Interests are listed at the end of the agreement but have been
omitted from the Exhibit to Form 10-K. The Registrant agrees to
supplementally furnish a copy of any omitted schedule or exhibit to the
Securities and Exchange Commission upon request.)
|
(3.1)
|
Harleysville
National Corporation Amended and Restated Articles of Incorporation.
(Incorporated by reference to Exhibit 3.1 to the Corporation’s
Registration Statement No. 333-111709 on Form S-4, as filed on
January 5, 2004.)
|
(3.2)
|
Harleysville
National Corporation Amended and Restated
By-laws. (Incorporated by reference to Exhibit 3.1 to the
Corporation’s Current Report on Form 8-K/A, filed with the Commission on
August 16, 2007.)
|
(10.1)
|
Harleysville
National Corporation 1993 Stock Incentive Plan.** (Incorporated by
reference to Exhibit 4.3 of Registrant’s Registration Statement
No. 33-69784 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. 333-17813
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 and former President and Chief Executive
Officer’s Employment Agreement dated October 26, 1998.* (Incorporated by
reference to Registrant’s Current Report on Form 8-K, filed with the
Commission on March 25, 1999.)
|
(10.5)
|
Consulting
Agreement and General Release dated November 12, 2004 between
Walter E. Daller, Jr., Harleysville National Corporation and
Harleysville National Bank and Trust Company.* (Incorporated by reference
to Registrant’s Current Report on Form 8-K, filed with the Commission
on November 16, 2004.)
|
(10.6)
|
Amendment
to Supplemental Executive Retirement Benefit Agreement dated March 14,
2005 by and among Harleysville Management Services, LLC and Walter E.
Daller, Jr.* (Incorporated by reference to Registrant’s Current
Report on Form 8-K, filed with the Commission on March 14,
2005.)
|
(10.7)
|
Employment
Agreement dated October 26, 1998 by and among Harleysville National
Corporation, Harleysville National Bank and Trust Company and
Demetra M. Takes, President and Chief Executive Officer of
Harleysville National Bank and Trust Company.* (Incorporated by reference
to Registrant’s Current Report on Form 8-K, filed with the Commission
on March 25, 1999.)
|
(10.8)
|
Amendment
to Supplemental Executive Retirement Benefit Agreement dated March 14,
2005 by and among Harleysville Management Services, LLC and Demetra M.
Takes, President and Chief Executive Officer of Harleysville National Bank
and Trust Company.* (Incorporated by reference to Registrant’s
Current Report on Form 8-K, filed with the Commission on March 14,
2005.)
|
(10.9)
|
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.)
|
Exhibit No.
|
Description
of Exhibits
|
(10.10)
|
Harleysville
National Corporation 1998 Independent Directors Stock Option Plan, as
amended and restated effective February 8, 2001.** (Incorporated by
reference to Appendix “A” of Registrant’s Definitive Proxy Statement,
filed with the Commission on March 9, 2001.)
|
(10.11)
|
Supplemental
Executive Retirement Benefit Agreement dated February 23, 2004
between Michael B. High, Executive Vice President and former Chief
Financial Officer, and Harleysville Management Services, LLC.*
(Incorporated by reference to Registrant’s Quarterly Report on
Form 10-Q, filed with the Commission on May 10,
2004.)
|
(10.12)
|
Employment
Agreement effective April 1, 2005 between Michael B. High,
Executive Vice President and Chief Operating Officer of the Corporation,
and Harleysville Management Services, LLC.* (Incorporated by
reference to Registrant’s Current Report on Form 8-K, filed with the
Commission on November 16, 2004.)
|
(10.13)
|
Amendment
to Supplemental Executive Retirement Benefit Agreement dated March 14,
2005 by and among Harleysville Management Services, LLC and Michael B.
High, Executive Vice President and Chief Operating Officer of the
Corporation.* (Incorporated by reference to Registrant’s
Current Report on Form 8-K, filed with the Commission on March 14,
2005.)
|
(10.14)
|
Harleysville
National Corporation 2004 Omnibus Stock Incentive Plan, as amended and
restated effective November 9, 2006.** (Incorporated by reference to
Registrant’s Current Report on Form 8-K, filed with the Commission on
November 15, 2006).
|
(10.15)
|
Employment
Agreement dated August 23, 2004 between James F.
McGowan, Jr., Executive Vice President & Chief Credit Officer and
Harleysville Management Services, LLC.* (Incorporated by reference to
Registrant’s Current Report on Form 8-K, filed with the Commission on
August 25, 2004.
|
(10.16)
|
Supplemental
Executive Retirement Benefit Agreement dated August 23, 2004 between
James F. McGowan, Jr., Executive Vice President & Chief
Credit Officer, and Harleysville Management Services, LLC.*
(Incorporated by reference to Registrant’s Current Report on
Form 8-K, filed with the Commission on August 25,
2004.)
|
(10.17)
|
Amendment
to Supplemental Executive Retirement Benefit Agreement dated March 14,
2005 by and among Harleysville Management Services, LLC and James F.
McGowan, Jr., Executive Vice President & Chief Credit
Officer.* (Incorporated by reference to Registrant’s Current
Report on Form 8-K, filed with the Commission on March 14,
2005.)
|
(10.18)
|
Employment
Agreement dated September 27, 2004 between John Eisele, former
Executive Vice President & President of Millennium Wealth Management
and Private Banking, and Harleysville Management Services, LLC.*
(Incorporated by reference to Registrant’s Current Report on
Form 8-K, filed with the Commission on September 29,
2004.)
|
(10.19)
|
Supplemental
Executive Retirement Benefit Agreement dated September 27, 2004
between John Eisele, former Executive Vice President & President of
Millennium Wealth Management and Private Banking, and Harleysville
Management Services, LLC.* (Incorporated by reference to Registrant’s
Current Report on Form 8-K, filed with the Commission on
September 29, 2004.)
|
(10.20)
|
Amendment
to Supplemental Executive Retirement Benefit Agreement dated March 14,
2005 by and among Harleysville Management Services, LLC and John Eisele,
former Executive Vice President & President of Millennium Wealth
Management and Private Banking.* (Incorporated by reference to
Registrant’s Current Report on Form 8-K, filed with the Commission on
March 14, 2005.)
|
(10.21)
|
Separation
Agreement and Mutual Release dated June 15, 2007 and effective July 19,
2007 between John Eisele, former Executive Vice President & President
of Millennium Wealth Management and Private Banking, Harleysville
Management Services, LLC., Harleysville National Bank and Trust
Company and Harleysville National Corporation.* (Incorporated by reference
to Registrant’s Current Report on Form 8-K, filed with the Commission
on July 19, 2007.)
|
(10.22)
|
Employment
Agreement effective January 1, 2005 between Gregg J. Wagner, the
former President and Chief Executive Officer of the Corporation, and
Harleysville Management Services, LLC.* (Incorporated by reference to
Registrant’s Current Report on Form 8-K, filed with the Commission on
November 16, 2004.)
|
(10.23)
|
Amendment
to Supplemental Executive Retirement Benefit Agreement dated March 14,
2005 by and among Harleysville Management Services, LLC and Gregg J.
Wagner, the former President and Chief Executive Officer of the
Corporation.* (Incorporated by reference to Registrant’s
Current Report on Form 8-K, filed with the Commission on March 14,
2005.)
|
(10.24)
|
Complete
Settlement Agreement and General Release dated November 29, 2006 and
effective December 8, 2006 between Gregg J. Wagner and Harleysville
National Corporation, Harleysville National Bank and Trust Company and
Harleysville Management Services, LLC .* (Incorporated by reference to
Registrant’s Current Report on Form 8-K, filed with the Commission on
December 13, 2006.)
|
(10.25)
|
Employment
Agreement dated May 18, 2005, between George S. Rapp, Senior Vice
President and Chief Financial Officer, and Harleysville Management
Services, LLC.* (Incorporated by reference to Registrant’s Current Report
on Form 8-K, filed with the Commission on May 20,
2005.)
|
Exhibit No.
|
Description
of Exhibits
|
(10.26)
|
Amended
and Restated Declaration of Trust for HNC Statutory Trust III by and among
Wilmington Trust Company, as Institutional Trustee and Delaware Trustee,
Harleysville National Corporation, as Sponsor, and the Administrators
named therein, dated as of September 28, 2005. (Incorporated by reference
to Registrant’s Quarterly Report on Form 10-Q/A, filed with the Commission
on November, 9, 2005.)
|
(10.27)
|
Indenture
between Harleysville National Corporation, as Issuer, and Wilmington Trust
Company, as Trustee, for Fixed/Floating Rate Junior Subordinated Debt
Securities, dated as of September 28, 2005. (Incorporated by reference to
Registrant’s Quarterly Report on Form 10-Q/A, filed with the Commission on
November, 9, 2005.)
|
(10.28)
|
Guarantee
Agreement between Harleysville National Corporation and Wilmington Trust
Company, dated as of September 28, 2005. (Incorporated by reference to
Registrant’s Quarterly Report on Form 10-Q/A, filed with the Commission on
November, 9, 2005.)
|
(10.29)
|
Employment
Agreement effective July 12, 2006 between Lewis C. Cyr, Chief Lending
Officer of the Corporation, and Harleysville Management
Services, LLC.* (Incorporated by reference to Registrant’s Current
Report on Form 8-K, filed with the Commission on July 12,
2006.)
|
(10.30)
|
Employment
Agreement dated July 12, 2007 between Paul D. Geraghty, President and
Chief Executive Officer of the Corporation and Harleysville Management
Services, LLC* (Incorporated by reference to Registrant’s Current Report
on Form 8-K filed with the Commission on July 12,
2007.)
|
(10.31)
|
Amended
and Restated Declaration of Trust for HNC Statutory Trust IV by and among
Wilmington Trust Company, as Institutional Trustee and Delaware Trustee,
Harleysville National Corporation, as Depositor, and the Administrators
named therein, dated as of August 22, 2007. (Incorporated by reference to
Registrant’s Quarterly Report on Form 10-Q, filed with the Commission on
November 8, 2007.)
|
(10.32)
|
Indenture
between Harleysville National Corporation, as Issuer, and Wilmington Trust
Company, as Trustee, for Fixed/Floating Rate Junior Subordinated Debt
Securities, dated as of August 22, 2007. (Incorporated by reference to
Registrant’s Quarterly Report on Form 10-Q, filed with the Commission on
November 8, 2007.)
|
(10.33)
|
Guarantee
Agreement between Harleysville National Corporation and Wilmington Trust
Company, dated as of August 22, 2007. (Incorporated by reference to
Registrant’s Quarterly Report on Form 10-Q, filed with the Commission on
November 8, 2007.)
|
(10.34)
|
Employment
Agreement dated November 16, 2007 between Brent L. Peters, Executive Vice
President and President of the East Penn Bank Division of Harleysville
National Bank and Trust Company, and Harleysville Management Services,
LLC, filed herewith.*
|
(11)
|
Computation
of Earnings per Common Share, incorporated by reference to Part II,
Item 8, Footnote 6, “Earnings Per Share,” of this Report on
Form 10-Q.
|
(31.1)
|
Certification
of the Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002, filed herewith.
|
(31.2)
|
Certification
of the Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002, filed herewith.
|
(32.1)
|
Certification
of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, furnished herewith.
|
(32.2)
|
Certification
of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, furnished
herewith.
|
|
* Management
contract or compensatory plan
arrangement.
|
|
** Shareholder
approved compensatory plan pursuant to which the Registrant’s Common Stock
may be issued to employees of the
Corporation.
|
|
*** Non-shareholder
approved compensatory plan pursuant to which the Registrant’s Common Stock
may be issued to employees of the
Corporation.
|
Harleysville Natl Corp Pa (MM) (NASDAQ:HNBC)
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Harleysville Natl Corp Pa (MM) (NASDAQ:HNBC)
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