- Quarterly Report (10-Q)

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, 2009

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the transition period from ___________ to __________

Commission file number 0-15237

___________________

HARLEYSVILLE NATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

___________________

Pennsylvania		23-2210237
(State or other jurisdiction of incorporation or organization)		(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: 43,105,939 shares of Common Stock, $1.00 par value, outstanding on May 4, 2009.

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HARLEYSVILLE NATIONAL CORPORATION


INDEX TO FORM 10-Q REPORT

	PAGE

Part I. Financial Information

Item 1. Financial Statements:

Consolidated Balance Sheets at March 31, 2009 (unaudited) and December 31, 2008		3

Consolidated Statements of Income for the Three Months Ended March 31, 2009 and 2008 (unaudited)		4

Consolidated Statements of Shareholders’ Equity for the Three Months Ended March 31, 2009 and 2008 (unaudited)		5

Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2009 and 2008 (unaudited)		6

Notes to Consolidated Financial Statements		7

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		22

Item 3. Quantitative and Qualitative Disclosures about Market Risk		36

Item 4. Controls and Procedures		36

Part II. Other Information		37

Item 1. Legal Proceedings		37

Item 1A. Risk Factors		37

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		38

Item 3. Defaults Upon Senior Securities		38

Item 4. Submission of Matters to a Vote of Security Holders		38

Item 5. Other Information		38

Item 6. Exhibits		38

Signatures		39

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PART 1. FINANCIAL INFORMATION
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)	March 31, 2009			December 31, 2008
	(Unaudited)
Assets
Cash and due from banks	$	64,227		$	75,305
Interest-bearing deposits in banks		314,095			27,221
Total cash and cash equivalents		378,322			102,526
Residential mortgage loans held for sale (at fair value)		47,960			17,165
Investment securities available for sale (amortized cost, $1,141,701 and $1,186,586, respectively)		1,093,724			1,141,948
Investment securities held to maturity (fair value $40,461 and $50,059, respectively)		41,021			50,434
Federal Home Loan Bank stock, Federal Reserve Bank stock and other investments		44,468			39,279
Loans and leases		3,567,815			3,668,079
Less: Allowance for loan losses		(53,062	)		(49,955	)
Net loans		3,514,753			3,618,124
Premises and equipment, net		51,617			50,605
Accrued interest receivable		19,926			21,120
Goodwill		239,811			240,701
Intangible assets, net		26,864			27,807
Bank-owned life insurance		87,860			87,081
Other assets		99,869			93,719
Total assets	$	5,646,195		$	5,490,509
Liabilities and Shareholders' Equity
Deposits:
Noninterest-bearing	$	497,921		$	479,469
Interest-bearing:
Checking		579,922			556,855
Money market		1,074,892			1,042,302
Savings		309,767			270,885
Time deposits		1,684,916			1,588,921
Total deposits		4,147,418			3,938,432

Federal funds purchased and short-term securities sold under agreements to repurchase		104,196			136,113
Other short-term borrowings		2,009			984
Long-term borrowings		735,810			759,658
Accrued interest payable		35,444			34,495
Subordinated debt		93,763			93,743
Other liabilities		53,842			52,377
Total liabilities		5,172,482			5,015,802
Shareholders' Equity:
Series preferred stock, par value $1 per share;
Authorized 8,000,000 shares, none issued		—			—
Common stock, par value $1 per share; authorized 75,000,000 shares;
issued 43,049,597 and 43,022,387 shares at March 31, 2009 and December 31, 2008, respectively		43,050			43,022
Additional paid in capital		379,218			379,551
Retained earnings		82,630			82,295
Accumulated other comprehensive loss		(31,185	)		(29,017	)
Treasury stock, at cost: 0 and 76,635 shares at March 31, 2009 and
December 31, 2008, respectively		—			(1,144	)
Total shareholders' equity		473,713			474,707
Total liabilities and shareholders' equity	$	5,646,195		$	5,490,509

See accompanying notes to consolidated financial statements.

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HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

	Three Months Ended
	March 31,
(Dollars in thousands, except per share information)	2009			2008

Interest Income:
Loans and leases, including fees	$	48,156		$	38,997
Investment securities:
Taxable		11,786			9,754
Exempt from federal taxes		3,569			2,971
Federal funds sold and securities purchased under agreements to resell		-			658
Deposits in banks		127			36
Total interest income		63,638			52,416

Interest Expense:
Savings and money market deposits		6,171			8,095
Time deposits		14,693			14,501
Short-term borrowings		128			658
Long-term borrowings		7,342			4,955
Total interest expense		28,334			28,209

Net interest income		35,304			24,207
Provision for loan losses		7,121			1,960
Net interest income after provision for loan losses		28,183			22,247

Noninterest Income:
Service charges		4,194			3,113
Gain on sales of investment securities, net		1,952			128
Other-than-temporary impairment of available for sale securities		(1,344	)		-
Gain on sales of loans, net		1,698			207
Wealth management		4,322			4,279
Bank-owned life insurance		778			684
Other income		4,559			2,421
Total noninterest income		16,159			10,832
Net interest income after provision for loan losses and
noninterest income		44,342			33,079

Noninterest Expense:
Salaries, wages and employee benefits		20,279			13,859
Occupancy		4,206			2,585
Furniture and equipment		1,608			1,094
Intangibles expense		948			688
FDIC deposit insurance		2,787			163
Other expense		8,793			5,329
Total noninterest expense		38,621			23,718

Income before income tax expense		5,721			9,361
Income tax expense		1,126			2,057
Net income	$	4,595		$	7,304

Net income per share information:
Basic	$	0.11		$	0.23
Diluted	$	0.11		$	0.23
Cash dividends per share	$	0.10		$	0.20
Weighted average number of common shares:
Basic		42,990,542			31,346,833
Diluted		43,018,233			31,522,736

See accompanying notes to consolidated financial statements.

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HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited)

(Dollars and share information in thousands)

Three Months Ended March 31, 2009


	Common Stock		Treasury Stock					Additional						Accumulated Other
	Number of		Number of			Par		Paid			Retained			Comprehensive			Treasury						Comprehensive
	Shares		Shares			Value		In Capital			Earnings			Loss			Stock			Total			Income (Loss)

Balance, January 1, 2009		43,022		(76	)	$	43,022	$	379,551		$	82,295		$	(29,017	)	$	(1,144	)	$	474,707
Issuance of stock for stock options, net of excess tax benefits		-		36			-		(144	)		-			-			545			401
Issuance of stock under dividend reinvestment and stock purchase plan		28		40			28		(268	)		-			-			599			359
Stock based compensation expense		-		-			-		79			-			-			-			79
Net income		-		-			-		-			4,595			-			-			4,595		$	4,595
Other comprehensive loss, net of reclassifications and tax		-		-			-		-			-			(2,168	)		-			(2,168	)		(2,168	)
Cash dividends		-		-			-		-			(4,260	)		-			-			(4,260	)
Comprehensive income																							$	2,427
Balance, March 31, 2009		43,050		-		$	43,050	$	379,218		$	82,630		$	(31,185	)	$	-		$	473,713

Three Months Ended March 31, 2008


	Common Stock		Treasury Stock					Additional						Accumulated Other
	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


See accompanying notes to consolidated financial statements.

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HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
	Three Months Ended
(Dollars in thousands)	March 31,
	2009			2008
Operating Activities:
Net income	$	4,595		$	7,304
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		7,121			1,960
Depreciation		1,721			1,124
Intangibles expense		948			688
Net amortization of discounts/premiums on investments and borrowings		(1,884	)		309
Deferred income tax benefit		(986	)		(1,965	)
Gain on sales of investment securities, net		(1,952	)		(128	)
Other-than-temporary impairment on investments		1,344			―
Gain on sales of loans, net		(1,698	)		(207	)
Originations of loans held for sale		(146,851	)		(20,279	)
Proceeds from sale of loans originated for sale		118,384			19,407
Bank-owned life insurance income		(778	)		(684	)
Stock based compensation expense		79			47
Net decrease (increase) in accrued interest receivable		1,194			(326	)
Net increase in accrued interest payable		949			1,577
Net increase in other assets		(3,704	)		(970	)
Net increase (decrease) in other liabilities		2,458			(4,898	)
Other, net		47			31
Net cash (used in) provided by operating activities		(19,013	)		2,990
Investing Activities:
Proceeds from sales of investment securities available for sale		102,932			56,691
Proceeds from maturity or calls of investment securities held to maturity		9,441			1,215
Proceeds from maturity or calls of investment securities available for sale		47,213			56,111
Proceeds, redemption Federal Home Bank stock and reduction in other investments		24			339
Purchases of investment securities available for sale		(104,072	)		(173,520	)
Purchases of Federal Home Bank stock, Federal Reserve Bank stock and other investments		(5,213	)		(3,027	)
Net decrease (increase) in loans		95,113			(22,175	)
Net cash paid due to acquisitions, net of cash acquired		(877	)		(1,200	)
Purchases of premises and equipment		(2,458	)		(1,713	)
Proceeds from sales of premises and equipment		10			―
Proceeds from sales of other real estate		658			―
Net cash provided by (used in) investing activities		142,771			(87,279	)
Financing Activities:
Net increase in deposits		208,986			2,849
Decrease in federal funds purchased and short-term securities sold under agreements to repurchase		(31,917	)		(2,154	)
Increase (decrease) in other short-term borrowings		1,025			(1,684	)
Repayments of long-term borrowings		(22,556	)		(8,000	)
Cash dividends		(4,260	)		(6,270	)
Proceeds from the exercise of stock options		401			214
Proceeds from issuance of stock under dividend reinvestment and stock purchase plan		359			―
Excess tax benefits from stock based compensation		―			31
Net cash provided by (used in) financing activities		152,038			(15,014	)
Net increase (decrease) increase in cash and cash equivalents		275,796			(99,303	)
Cash and cash equivalents at beginning of period		102,526			209,403
Cash and cash equivalents at end of the period	$	378,322		$	110,100

Cash paid during the period for:
Interest	$	29,000		$	26,885
Income taxes	$	622		$	8,754
Supplemental disclosure of noncash investing and financing activities:
Transfer of assets from loans to net assets in foreclosure	$	1,080		$	1,508
See accompanying notes to consolidated financial statements.

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HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Summary of Significant Accounting Policies

Principles of Consolidation and Basis of Presentation

The accompanying unaudited consolidated financial statements of Harleysville National Corporation (the Corporation) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with instructions to Form 10-Q, and therefore, do not include all of the information and footnotes necessary for a complete presentation of financial condition, results of operations, changes in shareholders’ equity and cash flows in conformity with GAAP. However, all normal recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the consolidated financial statements, have been included. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the accompanying notes in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2008. The results of operations presented for the three months ended March 31, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

The consolidated financial statements include the Corporation and its wholly owned subsidiaries-Harleysville National Bank (the Bank), HNC Financial Company and HNC Reinsurance Company. Willow Financial Corporation (Willow Financial) and its banking subsidiary are included in the Corporation’s results effective after the market close on December 5, 2008. All significant intercompany accounts and transactions have been eliminated in consolidation and certain prior period amounts have been reclassified to conform to current year presentation.

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the balance sheets and the income and expense in the income statements for the periods presented. Actual results could differ significantly from those estimates. Critical estimates include the determination of the allowance for loan losses, goodwill and other intangible assets impairment, stock-based compensation, fair value measurement for investment securities available for sale, inclusive of other-than-temporary impairment, and deferred income taxes.

For additional information on other significant accounting policies, see Note 1 of the Consolidated Financial Statements of the Corporation’s 2008 Annual Report on Form 10-K.

Recent Accounting Pronouncements

In April 2009, the Financial Accounting Standards Board (FASB) issued FASB Staff Positions No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability has Significantly Decreased and Identifying Transactions That Are Not Orderly,” No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” and No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments.” The FASB issued these three related Staff Positions to clarify the application of SFAS 157, “Fair Value Measurements” (SFAS 157) to fair value measurements in the current economic environment, modify the recognition of other-than-temporary impairments of debt securities, and require companies to disclose the fair values of financial instruments in interim periods. The final Staff Positions are effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009, if all three Staff Positions or both the fair-value measurements and other-than-temporary impairment Staff Positions are adopted simultaneously. The Corporation will evaluate the impact and adopt these Staff Positions in its quarter ended June 30, 2009.

In March 2008, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” SFAS 161 requires enhanced disclosures to enable investors to better understand the effects of derivative instruments and hedging activities on an entity’s financial statements. Specifically, it requires that objectives for using derivative 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. SFAS 161 resulted in expanded disclosures within the Corporation’s financial statements. See Note 11 – Financial Instruments with Off-Balance Sheet Risk for additional information.

In March 2008, the FASB issued Financial Staff Position FAS 157-2, “Effective Date of FASB Statement No. 157” (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). The provisions of FSP FAS 157-2 were applied to the Corporation’s fair value measurement of its goodwill and identifiable intangibles and did not have a material impact on the Corporation’s financial statements although it did result in expanded disclosures. See Note 12 – Fair Value Measurements for additional information.

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Note 2 – Acquisition

Acquisition of Willow Financial Bancorp, Inc.

Effective after the market close on December 5, 2008, the Corporation completed its acquisition of Willow Financial and its wholly owned subsidiary, Willow Financial Bank, a $1.6 billion savings bank with 29 branch offices in Southeastern Pennsylvania, was merged with and into the Bank. In conjunction with this transaction, the Corporation also acquired BeneServ, Inc., a provider of employee benefits services. The Corporation acquired 100% of the outstanding shares of Willow Financial. The Corporation issued 11,515,366 shares of common stock, incurred $7.8 million in acquisition costs which were capitalized and converted stock options with a fair value of $2.0 million for a total purchase price of $168.6 million at the closing on December 5, 2008.

The acquisition of Willow Financial constituted a business combination under SFAS No. 141, “Business Combinations,” and was accounted for using the purchase method. Accordingly, the purchase price was allocated to the respective assets acquired and liabilities assumed based on their estimated fair values on the date of acquisition. The excess of purchase price over the fair value of net assets acquired was recorded as goodwill. Goodwill of $128.1 million was recorded in this transaction with $125.0 million allocated to the Community Banking segment and $3.1 million allocated to the Wealth Management segment. The Corporation also recorded $14.1 million in core deposit intangibles and $2.9 million in other identifiable intangible assets which are being amortized over ten years using the sum of the years digits amortization method. The $2.9 million of other identifiable intangibles were allocated to the Wealth Management segment. The purchase price allocation is subject to revision in future periods, including adjustments that may be necessary upon the filing of final tax returns for Willow Financial . The amount of goodwill recorded at December 31, 2008 was reduced by $890,000 in the first quarter of 2009 as a result of additional information obtained for the valuation analysis. The results of operations of Willow Financial have been included in the Corporation’s results of operations since December 5, 2008, the date of acquisition.

The following are the unaudited pro forma consolidated results of operations of the Corporation for the three months ended March 31, 2008 as though Willow Financial had been acquired on January 1, 2008:

(Dollars in thousands, except for per share data)	Three months ended March 31, 2008

Total interest income	$	75,553
Total interest expense		37,543
Net interest income		38,010

Provision for loan losses		2,784
Net interest income after provision for loan losses		35,226

Total non-interest income		15,333
Total non-interest expense		40,215

Income before income taxes		10,344

Income tax expense (1)		2,928

Net income	$	7,416

Basic earnings per share	$	0.17
Diluted earnings per share	$	0.17

(1)	Tax effects are reflected at an assumed rate of 35%

AICPA Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (SOP 03-3) addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes loans acquired in purchase business combinations. SOP 03-3 does not apply to loans originated by the Corporation. The Corporation’s assessment identified $14.4 million in acquired loans from Willow Financial to which the application of the provisions of SOP 03-3 was required. At March 31, 2009 and December 31, 2008, the Corporation acquired loans within the scope of SOP 03-3 had an unpaid principal balance of $13.1 million and $14.4 million, respectively. At March 31, 2009 and December 31, 2008, these loans had a carrying value of $7.0 million and $8.1 million, respectively. As a result of the application of SOP 03-3, the Corporation’s loan balance reflects net purchase accounting adjustments resulting in a reduction in loans of $6.1 million related to acquired impaired loans at March 31, 2009. Income recognition under this SOP is dependent on having a reasonable expectation about the timing and amount of cash flows expected to be collected. The loans deemed impaired under this SOP were considered collateral dependent, however the timing of the sale of loan collateral is indeterminate and as such the loans will remain on non-accrual status and will have no accretable yield. The Corporation is using the cash basis method of interest income recognition.

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Note 2 – Acquisition - Continued

The following are the loans acquired from Willow Financial for which it was probable at March 31, 2009 that all contractually required payments would not be collected:

	(Dollars in thousands)
Contractually required payments at March 31, 2009:
Real estate	$	6,926
Commercial and industrial		6,204
Total	$	13,130
Cash flows expected to be collected at March 31, 2009	$	7,024

The following is the carrying value by category as of March 31, 2009:

	(Dollars in thousands)
Real estate	$	3,983
Commercial and industrial		3,041
Total carrying value	$	7,024

Note 3 – Goodwill and Other Intangibles

Goodwill and identifiable intangibles were $239.8 million and $25.0 million, respectively at March 31, 2009, and $240.7 million and $26.2 million, respectively at December 31, 2008. The goodwill and identifiable intangibles balances resulted from acquisitions. During the first quarter of 2009, the Corporation recorded purchase accounting adjustments related to the Willow Financial acquisition which reduced goodwill by $890,000. For further information related to the acquisition of Willow Financial which occurred during December 2008, 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, 2009	$	222,381		$	18,320	$	240,701
Purchase accounting adjustments for acquisitions		(890	)		—		(890	)
Balance, March 31, 2009	$	221,491		$	18,320	$	239,811

The gross carrying value and accumulated amortization related to core deposit intangibles and other identifiable intangibles at March 31, 2009 and December 31, 2008 are presented below:

	March 31,						December 31,
	2009						2008
		Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount			Accumulated Amortization
		(Dollars in thousands)
Core deposit intangibles		$	23,256		$	3,690		$	23,256		$	2,692
Other identifiable intangibles			7,209			1,787			7,209			1,524
Total		$	30,465		$	5,477		$	30,465		$	4,216

In 2008, management performed its annual review of goodwill and other identifiable intangibles 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 performed its review by reporting unit and determined that there was no impairment of goodwill and other identifiable intangible assets as a part of this annual review. As part of the first quarter of 2009 closing process, management also evaluated any additional circumstances that may have required an interim impairment test subsequent to June 30, 2008; no such circumstances were noted and no impairment charge was recorded.

The amortization of core deposit intangibles allocated to the Community Banking segment was $998,000 and $405,000 for the first quarter of 2009 and 2008, respectively. Amortization of identifiable intangibles related to the Wealth Management segment totaled $263,000 and $161,000 for the first quarter of 2009 and 2008, respectively. The Corporation estimates that aggregate amortization expense for core deposit and other identifiable intangibles will be $4.1 million, $3.6 million, $3.0 million, $2.5 million and $2.8 million for 2009, 2010, 2011, 2012 and 2103, respectively.

Mortgage servicing rights of $1.9 million and $1.6 million at March 31, 2009 and December 31, 2008, 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 $1.9 million and $1.6 million at March 31, 2009 and December 31, 2008, respectively. In accordance with the provisions of SFAS No.156, “Amending Accounting for Separately Recognized Servicing Assets and Liabilities” and SFAS No.

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Note 3 – Goodwill and Other Intangibles – Continued

140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” the Corporation recorded a reduction of intangibles expense of $487,000 and $88,000 of intangibles expense related to the valuation of its mortgage servicing on the consolidated statements of income for the three months ended March 31, 2009 and 2008, respectively.

Note 4 – Trust Preferred Subordinated Debentures

As of March 31, 2009, the Corporation has six statutory trust affiliates (collectively, the Trusts). These trusts were formed to issue mandatorily redeemable trust preferred securities to investors and loan the proceeds to the Corporation for general corporate purposes. The Trusts hold, as their sole assets, subordinated debentures of the Corporation totaling $105.5 million at March 31, 2009 and December 31, 2008. The trust preferred securities represent undivided beneficial interests in the assets of the Trusts. The financial statement carrying value of the trust preferred subordinated debentures, net of a purchase accounting fair value adjustment of approximately $15.0 million from the acquisition of Willow Financial, is $93.8 million at March 31, 2009 and $93.7 million at December 31, 2008. The Corporation owns all of the trust preferred securities of the Trusts and has accordingly recorded $3.3 million in other assets on the consolidated statements of financial condition at March 31, 2009 and December 31, 2008 representing its investment in the common securities of the Trusts. As the shareholders of the trust preferred securities are the primary beneficiaries, the Trusts qualify as variable interest entities under FIN 46R and are not consolidated in the Corporation’s financial statements.

The trust preferred securities require quarterly distributions to the holders of the trust preferred securities at a rate per annum equal to the interest rate on the debentures held by that trust. The Corporation has the right to defer payment of interest on the debentures, at any time or from time to time for a period not exceeding five years, provided that no extension period may extend beyond the stated maturity of the debentures. During any such extension period, distributions on the trust securities will also be deferred, and the Corporation shall not pay dividends or distributions on, or redeem, purchase or acquire any shares of its capital stock.

The trust preferred securities must be redeemed upon the stated maturity dates of the subordinated debentures. The Corporation may redeem the debentures, in whole but not in part, (except for Harleysville Statutory Trust II and Willow Grove Statutory Trust I which may be redeemed in whole or in part) at any time within 90 days at the specified special event redemption price following the occurrence of a capital disqualification event, an investment company event or a tax event as set forth in the indentures relating to the trust preferred securities and in each case subject to regulatory approval. For HNC Statutory Trust II, III and IV, East Penn Statutory Trust I and Willow Grove Statutory Trust I, the Corporation also may redeem the debentures, in whole or in part, at the stated optional redemption dates (after five years from the issuance date) and quarterly thereafter, subject to regulatory approval if required. The optional redemption price is equal to 100% of the principal amount of the debentures being redeemed plus accrued and unpaid interest on the debentures to the redemption date. For Harleysville Statutory Trust I, the Corporation may redeem the debt securities, in whole or in part, at the stated optional redemption date of February 22, 2011 and semi-annually thereafter, subject to regulatory approval if required. The redemption price on February 22, 2011 is equal to 105.10% of the principal amount, and declines annually to 100.00% on February 22, 2021 and thereafter, plus accrued and unpaid interest on the debentures to the redemption date. The Corporation’s obligations under the debentures and related documents, taken together, constitute a full and unconditional guarantee by the Corporation of the Trust’s obligations under the trust preferred securities.

The following table is a summary of the subordinated debentures as of March 31, 2009 as originated by the Corporation and assumed from the acquisitions of Willow Financial and East Penn Financial:

Trust Preferred Subordinated Debentures	Principal Amount of Subordinated Debentures		Principal Amount of Trust Preferred Securities
	(Dollars in thousands)
Issued to Harleysville Statutory Trust I in February 2001, matures in February 2031, interest rate of 10.20% per annum	$	5,155	$	5,000
Issued to HNC Statutory Trust II in March 2004, matures in April 2034, interest rate of three-month London Interbank Offered Rate (LIBOR) plus 2.70% per annum		20,619		20,000
Issued to HNC Statutory Trust III in September 2005, matures in November 2035, bearing interest at 5.67% per annum through November 2010 and thereafter three-month LIBOR plus 1.40% per annum		25,774		25,000
Issued to HNC Statutory Trust IV in August 2007, matures in October 2037, bearing interest at 6.35% per annum through October 2012 and thereafter three-month LIBOR plus 1.28% per annum		23,196		22,500
Issued to East Penn Statutory Trust I in July 2003, matures in September 2033, interest rate of 6.80% per annum through September 2008 and thereafter at three-month LIBOR plus 3.10% per annum		8,248		8,000
Issued to Willow Grove Statutory Trust I in March 2006, matures in June 2036, interest rate of three-month LIBOR plus 1.31% per annum		25,774		25,000
Total	$	108,766	$	105,500

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Note 5 - 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 benefits upon plan termination. The Corporation recorded a one-time pre-tax charge related to the pension plan curtailment of approximately $1.9 million in 2007. On July 3, 2008, the Corporation purchased $896,000 of terminal funding annuity contracts for participants in pay status at that time. During 2008, the majority of assets were distributed to those participants that elected lump sum payments.

In March 2009, the Corporation made a final contribution of $371,000 to the pension plan, which together with the remaining plan assets, was utilized to purchase $435,000 in terminal funding annuity contracts for any remaining participants entering pay status. No further contributions are required to this pension plan.

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. The Corporation matches 50% of pre-tax employee contributions up to a maximum of 3% and additionally all eligible employees receive a company funded basic contribution to the 401(k) plan equal to 2% of eligible earnings. Contribution charged to earnings for the three months ended March 31, 2009 and 2008, were $588,000 and $436,000, respectively. On March 12, 2009, the Corporation’s Board of Directors approved an amendment to the 401(k) plan providing for the suspension of the Corporation’s basic and matching contributions effective for the April 17, 2009 employee bi-weekly pay period until further notice by the Board of Directors. The Corporation expects suspension of employer contributions will result in retirement-related expense savings of approximately $1.8 million for the remainder of 2009.

Willow Financial Bank Employee Stock Ownership Plan

In connection with the acquisition of Willow Financial on December 5, 2008, the Corporation assumed the Willow Financial Bank 401(k)/ Employee Stock Ownership Plan (ESOP). As of December 5, 2008, the 401(k)/ESOP was frozen with termination and final distributions pending approval by the appropriate regulatory authorities. No additional contributions to the plan will be accepted, but loan repayments by participants are permitted. At December 5, 2008, the ESOP portion of the plan had two outstanding loans with a total principal balance of $4.2 million due to Willow Financial Bancorp, Inc. The shares originally purchased with the loan funds were held in a suspense account for allocation among the participants as the loans are repaid. Shares released from the loan collateral were in an amount proportional to repayment of the original ESOP loans. At March 31, 2009, there were 324,113 unallocated ESOP shares remaining to be utilized to pay down the remaining loan principal balance. Upon repayment of the loans, any remaining shares will be allocated to the participants.

Note 6 – Dividend Reinvestment and Stock Purchase Plan

On March 12, 2009, the Corporation’s Board of Directors approved amendments to the Corporation’s Dividend Reinvestment and Stock Purchase Plan (DRIP) designed to provide additional benefits for existing shareholders. Beginning April 6, 2009, shareholders can reinvest all or part of their dividends in additional shares of common stock or make additional cash investments for a minimum of $100 and up to $100,000 per calendar quarter, an increase from the prior quarterly limitation of $5,000. In addition, beginning April 6, 2009, existing shareholders receive a ten percent discount to the market price of the Corporation’s shares on the date shares are purchased. The ten percent discount to the market price is available for all investments made in the Corporation’s shares through the Corporation’s DRIP. This action is part of the Corporation’s ongoing capital enhancement program. On April 28, 2009, the Board of Directors suspended the DRIP until further notice.

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Note 7 – 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, 2009, 2,653,882 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 options granted during 2008 have a term of three years and vest over seven years. The exercise price of each option is the market price of the Corporation’s stock on the date of grant. Additionally, at March 31, 2009, the Corporation had 556,506 assumed stock options from the Willow Financial acquisition completed in 2008. The options have a term of ten years and are exercisable at prices ranging from $5.19 to $22.34. Also, at March 31, 2009, the Corporation had 25,480 assumed stock options from the East Penn Financial 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 Accounting Principles Board (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, 2009 and 2008, there were no options granted.

Grants subject to a service condition were awarded by the Corporation in 2008 and 2006 while grants subject to a market condition were awarded in 2007. 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 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 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 $79,000 and $47,000, for the three months ended March 31, 2009 and 2008, respectively.

A summary of option activity under the Corporation’s stock option plans as of March 31, 2009, and changes during the three months ended March 31, 2009 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, 2009		1,648,723		$	15.28
Granted		—			—
Exercised		(36,711	)		10.44
Forfeited (unvested)		(1,102	)		24.54
Cancelled (vested)		(28,057	)		17.12

Outstanding at March 31, 2009		1,582,853		$	15.35		3.78	$	55

Exercisable at March 31, 2009		1,320,291		$	15.46		3.16	$	55

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Note 7 – Stock-Based Compensation – Continued

The total intrinsic value of options exercised during the three months ended March 31, 2009 and 2008 were $76,000 and $122,000, 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, 2009 is presented below:

Nonvested Shares	Shares			Weighted-Average Grant-Date Fair Value

Nonvested at January 1, 2009		263,664		$	3.74

Granted		—			—

Vested		—			—

Forfeited		(1,102	)		6.72

Nonvested at March 31, 2009		262,562		$	3.73

As of March 31, 2009, there was a total of $771,000 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 2.6 years. There were no shares which vested during the first quarter of 2009 and the total fair value of shares vested during the three months ended March 31, 2008 was $15,000. The tax benefit realized for the tax deductions from option exercises totaled $27,000 and $41,000 for the three months ended March 31, 2009 and 2008, respectively.

Note 8 – 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 March 31,
(Dollars in thousands, except per share data)	2009		2008

Basic earnings per share
Net income available to common shareholders	$	4,595	$	7,304
Weighted average common shares outstanding		42,990,542		31,346,833
Basic earnings per share	$	.11	$	.23

Diluted earnings per share
Net income available to common shareholders and assumed conversions	$	4,595	$	7,304
Weighted average common shares outstanding		42,990,542		31,346,833
Dilutive potential common shares (1), (2)		27,691		175,903
Total diluted weighted average common shares outstanding		43,018,233		31,522,736
Diluted earnings per share	$	.11	$	.23

(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, 2009 and 2008, there were 1,512,896 antidilutive options at an average price of $15.82 and 538,404 antidilutive options at an average price of $21.20, respectively.

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Note 9 – Comprehensive (Loss) Income and Accumulated Other Comprehensive (Loss) Income

The components of other comprehensive (loss) income are as follows:

Comprehensive ( Loss ) Income

(Dollars in thousands)	Before tax			Tax Benefit			Net of tax
Three months ended March 3 1 , 200 9	Amount			(Expense)			amount
Net unrealized losses on available for sale securities:
Net unrealized holding losses arising during period	$	(2,731	)	$	956		$	(1,775	)
Less reclassification adjustment for net gains realized in net income		1,952			(683	)		1,269
Less reclassification adjustment for other-than-temporary impairment of available for sale securities recognized in net income		(1,344	)		470			(874	)
Net unrealized losses		(3,339	)		1,169			(2,170	)
Change in fair value of derivatives used for cash flow hedges		3			(1	)		2
Other comprehensive loss, net	$	(3,336	)	$	1,168		$	(2,168	)

(Dollars in thousands)	Before tax			Tax (Expense)			Net of tax
Three months ended March 3 1 , 200 8	Amount			Benefit			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

The components of other accumulated other comprehensive loss, net of tax, which is a component of shareholders’ equity were as follows:

(Dollars in thousands)	Net Unrealized Losses on Available For Sale Securities			Net Change in Fair Value of Derivatives Used for Cash Flow Hedges			Accumulated Other Comprehensive Loss
Balance, January 1, 2008	$	(2,452	)	$	(114	)	$	(2,566	)
Net Change		2,601			40			2,641
Balance, March 31, 2008	$	149		$	(74	)	$	75

Balance, January 1, 2009	$	(29,014	)	$	(3	)	$	(29,017	)
Net Change		(2,170	)		2			(2,168	)
Balance, March 31, 2009	$	(31,184	)	$	(1	)	$	(31,185	)

No te 10 – 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 and the Lehigh Valley of 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 and activity 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; employee benefits 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

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Note 10 – Segment Information – Continued

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.

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, 2009

Net interest income (expense)	$	36,599	$	43		$	(1,338	)	$	35,304
Provision for loan losses		7,121		-			-			7,121
Noninterest income (loss)		11,831		4,421			(93	)		16,159
Noninterest expense		33,634		4,835			152			38,621
Income (loss) before income taxes (benefit)		7,675		(371	)		(1,583	)		5,721
Income taxes (benefit)		1,785		(121	)		(538	)		1,126
Net income (loss)	$	5,890	$	(250	)	$	(1,045	)	$	4,595

Assets	$	5,577,426	$	56,522		$	12,247		$	5,646,195

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

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, 2008. Consolidating adjustments reflecting certain eliminations of inter-segment revenues, cash and investment in subsidiaries are included in the “All Other” segment.

Note 11 – 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.

As required by SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), the Bank records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Bank has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Bank may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Bank elects not to apply hedge accounting under SFAS 133.

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

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Note 11 – Financial Instruments with Off-Balance Sheet Risk – Continued

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
Commitments	March 31, 2009		December 31, 2008
(Dollars in thousands)	March 31, 2009		December 31, 2008

Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit	$	959,506	$	995,125
Standby letters of credit and financial guarantees written		47,824		34,806
Financial instruments whose notional or contract amounts exceed the amount of credit risk:
Interest rate swap agreements		179,523		124,214
Interest rate cap agreements		—		200,000

The table below presents the fair value of the Bank’s derivative financial instruments as well as their classification on the consolidated balance sheets as of March 31, 2009 and December 31, 2008:

	Asset Derivatives						Liability Derivatives
(Dollars in thousands)	As of March 31, 2009			As of December 31, 2008			As of March 31, 2009			As of December 31, 2008

	Balance Sheet Classification	Fair Value		Balance Sheet Classification	Fair Value		Balance Sheet Classification	Fair Value		Balance Sheet Classification	Fair Value
Derivatives designated as hedging instruments under SFAS 133
Interest Rate Products	Other Assets	$	—	Other Assets	$	—	Other Liabilities	$	289	Other Liabilities	$	347

Total derivatives designated as hedging instruments under SFAS 133		$	—		$	—		$	289		$	347

Derivatives not designated as hedging instruments under SFAS 133
Interest Rate Products	Other Assets	$	4,747	Other Assets	$	4,523	Other Liabilities	$	5,250	Other Liabilities	$	5,294

Total derivatives not designated as hedging instruments under SFAS 133		$	4,747		$	4,523		$	5,250		$	5,294

The Bank is exposed to changes in the fair value of certain of its fixed rate assets due to changes in benchmark interest rates. The Bank uses interest rate swaps to manage its exposure to changes in fair value on these instruments attributable to changes in the benchmark interest rate. Interest rate swaps designated as fair value hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Bank making fixed-rate payments over the life of the agreements without the exchange of the underlying notional amount. As of March 31, 2009, the Bank had a fair value hedge in the form of an interest rate swap with a notional amount of $1.9 million which matures in 2017. In addition, four fair value hedges with notional amounts totaling $7.3 million were acquired from Willow Financial with maturity dates ranging from 2013 to 2016. These swaps do not qualify for hedge accounting treatment and thus all changes in the fair value of the derivatives is recorded in the consolidated statements of income. As such, based on the increase in the market value of these interest rate swaps, the Corporation recognized a gain of $45,000 in other income in the consolidated statement of operations for the three months ended March 31, 2009.

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Note 11 – Financial Instruments with Off-Balance Sheet Risk – Continued

For derivatives designated and that qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in earnings. The Bank includes the gain or loss on the hedged items in the same line item as the offsetting loss or gain on the related derivatives.

Derivatives not designated as hedges are not speculative and result from a service the Bank provides to certain customers. The Bank executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Bank executes with a third party, such that the Bank minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements of SFAS 133, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of March 31, 2009, the Bank had 40 interest rate swaps with an aggregate notional amount of $170.4 million related to this program.

The tables below present the effect of the Bank’s derivative financial instruments on the Income Statement for the three months ended March 31, 2009 and 2008:

Derivatives in SFAS 133 Fair Value Hedging Relationships	Classification of Gain/(Loss) Recognized on Derivative	Gain/(Loss) Recognized on Derivative
		Three Months Ended March 31,
(Dollars in thousands)		2009			2008

Interest Rate Products	Interest income	$	(23	)	$	(16	)

Total		$	(23	)	$	(16	)

Derivatives Not Designated as Hedging Instruments Under SFAS 133	Classification of Gain/ (Loss) Recognized on Derivative	Amount of Gain/(Loss) Recognized on Derivative
		Three Months Ended March 31,
(Dollars in thousands)		2009			2008
Interest Rate Products	Interest income	$	(80	)	$	—
	Other income		268			33

Total		$	188		$	33

The Bank is exposed to certain risks arising from both its business operations and economic conditions. The Bank principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Bank manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Bank enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Bank’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Bank’s known or expected cash receipts and its known or expected cash payments principally related to certain variable rate loan assets and variable rate borrowings.

The Bank has agreements with each of its derivative counterparties that contain a provision where if the Bank defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Bank could also be declared in default on its derivative obligations. The Bank has agreements with some of its derivative counterparties that contain provisions that require the Bank’s debt to maintain an investment grade credit rating from each of the major credit rating agencies. If the Bank’s credit rating is reduced below investment grade then, the Bank may be required to fully collateralize its obligations under the derivative instrument. Certain of the Bank's agreements with some of its derivative counterparties contain provisions where if a specified event or condition occurs that materially changes the Bank's creditworthiness in an adverse manner, the Bank may be required to fully collateralize its obligations under the derivative instrument. The Bank has agreements with certain of its derivative counterparties that contain a provision where if the Bank fails to maintain its status as a well / adequate capitalized institution, then the Bank could be required to settle its obligation under the agreements.

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Note 11 – Financial Instruments with Off-Balance Sheet Risk – Continued

As of March 31, 2009, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $5.3 million. As of March 31, 2009, the Bank has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of $3.4 million against its obligations under these agreements.

The Bank also had commitments with customers to extend mortgage loans at a specified rate at March 31, 2009 and 2008 of $75.1 million and $5.2 million, respectively, and commitments to sell mortgage loans at a specified rate at March 31, 2009 and 2008 of $120.9 million and $2.3 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, 2009, the Corporation had commitments with a positive fair value of $108,000 and negative fair value of $463,000 which were recorded in other income on the consolidated statements of income. At March 31, 2008, the Corporation had commitments with a positive fair value of $41,000 and negative fair value of $2,000 which was recorded in other income on the consolidated statements of income.

Note 12 – Fair Value Measurements

Effective January 1, 2008, the Corporation adopted SFAS No. 157, which 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. During the fourth quarter of 2008, certain collateralized debt obligation investments in pooled trust preferred securities were transferred from Level 2 into Level 3. During the first quarter of 2009, a private label collateralized mortgage obligation (CMO) was transferred from Level 2 to Level 3. The Corporation obtained a third party cash flow analysis to determine the projected level of uncollected principal and the resulting fair value. The cash flow analysis included market information such as instrument performance and relevant corporate data associated with certain issuers included within the pooled trust and collateral performance and delinquency information for the CMO. Other-than temporary impairment losses of $1.1 million were recorded related to these securities during the first quarter of 2009. Additionally other-than temporary impairment losses of $201,000 on certain equity securities in Level 1 were recorded during the first quarter of 2009 based upon the Corporation’s fair value measurement at March 31, 2009.

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Note 12 – Fair Value Measurements – Continued

Residential Mortgage Loans Held for Sale

Residential mortgage loans originated and intended for sale in the secondary market are carried at 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.

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, 2009, 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.

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, 2009
Assets
Investment securities available for sale	$	21,055	$	1,063,544	$	9,125	$	1,093,724
Residential mortgage loans held for sale		—		47,960		—		47,960
Derivatives		—		4,855		—		4,855
Total assets	$	21,055	$	1,116,359	$	9,125	$	1,146,539
Liabilities
Derivatives	$	—	$	6,002	$	—	$	6,002
Total liabilities	$	—	$	6,002	$	—	$	6,002

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Note 12 – Fair Value Measurements – Continued

Assets and Liabilities Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3)

The table below presents a reconciliation of 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, 2009	$	3,149
Transfers into Level 3		7,119
Total losses realized
Included in earnings(1)		(1,143	)
Included in other comprehensive income		—

Balance, March 31, 2009	$	9,125

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, 2009	$	2,934

(1)	The loss is reported as an other–than-temporary impairment loss on investment

securities available for sale 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.

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, 2009, impaired loans had a carrying amount of $79.3 million with a valuation allowance of $13.7 million. Impaired loans with a carrying amount of $76.7 million were evaluated during the three months of 2009 using the practical expedient fair value measurement which resulted in an additional valuation allowance of $7.3 million as compared to December 31, 2008.

Goodwill and Other Identifiable Intangibles

The Corporation employs general industry practices in evaluating the fair value of its goodwill and other identifiable intangibles. The Corporation calculates the fair value, with the assistance of a third party specialist, 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 market multiples (pricing ratios) under the market approach. In 2008, management performed its annual review of goodwill and other identifiable intangibles 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 performed its review by reporting unit and determined that there was no impairment of goodwill and other identifiable intangible assets as a part of this annual review. As part of the annual review of goodwill, management also evaluated any additional circumstances that may have required an impairment test subsequent to June 30, 2008 which also resulted in no impairment charge. The provisions of FSP FAS 157-2 were applied to the Corporation’s fair value measurement of its goodwill and identifiable intangibles with balances of $239.8 million and $26.9 million, respectively at March 31, 2009. The application of this FSP did not have a material impact on the Corporation’s financial statements although it did result in expanded disclosures.

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Note 12 – Fair Value Measurements – Continued

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, 2009, the Corporation’s mortgage servicing rights had a carrying amount of $1.9 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,” mortgage servicing rights are recorded at lower of cost or market.

Certain assets measured at fair value on a non-recurring basis are presented 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, 2009
Assets
Impaired loans	$	—	$	63,314	$	—	$	63,314
Mortgage servicing rights		—		1,876				1,876
Total assets	$	—	$	65,190			$	65,190

Note 13 – Subsequent Event

On April 21, 2009, THP Properties and its affiliated companies (THP), a significant borrower of the Bank, temporarily suspended its operations and subsequently declared bankruptcy on April 30, 2009. THP Properties is primarily involved in residential land development and home construction. As of March 31, 2009, THP’s outstanding credit was considered performing and adequately reserved. The THP loans have subsequently been placed on non-accrual status and the credit will be reassessed regularly for need for additional reserves. THP is currently exploring its strategic opportunities.

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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.

Within this Form 10-Q, management may make projections and forward-looking statements regarding events or the future financial performance of Harleysville National Corporation. We wish to caution you that these forward-looking statements involve certain risks and uncertainties, including a variety of factors that may cause Harleysville National Corporation’s actual results to differ materially from the anticipated results expressed in these forward-looking statements. Such factors include the possibility that anticipated cost savings may not be realized, estimated synergies may not occur, increased demand or prices for the Corporation’s financial services and products may not occur, changing economic and competitive conditions, technological developments and other risks and uncertainties. Such risks, uncertainties and other factors that could cause actual results and experience to differ from those projected include, but are not limited to, the following: ineffectiveness of the Corporation’s business strategy due to changes in current or future market conditions; the effects of competition, and of changes in laws and regulations on competition, including industry consolidation and development of competing financial products and services; inability to achieve desired increases in capital and improvement in asset quality; merger-related synergies; interest rate movements; difficulties in integrating distinct business operations, including information technology difficulties; disruption from the transaction making it more difficult to maintain relationships with customers and employees, and challenges in establishing and maintaining operations in new markets; volatilities in the securities markets; and deteriorating economic conditions. When we use words such as “believes”, “expects”, “anticipates”, or similar expressions, we are making forward-looking statements. Investors are cautioned not to place undue reliance on these forward-looking statements and are also advised to review the risk factors that may affect Harleysville National Corporation’s operating results in documents filed by Harleysville National Corporation with the Securities and Exchange Commission, including the Quarterly Report on Form 10-Q, the Annual Report on Form 10-K, and other required filings. Harleysville National Corporation assumes no duty to update the forward-looking statements made in this Form 10-Q.

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 2008 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 with U.S. generally accepted accounting principles (GAAP). 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 2008 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 amounts of assets and liabilities as of the dates of the balance sheets and the income and expense in the income statements 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, Fair Value Measurement of Investment 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

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and other intangible assets. The Corporation calculates the fair value, with the assistance of a third party specialist, 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 market multiples (pricing ratios) under the market approach. Management performed its annual review of goodwill and other identifiable intangibles in 2008 and determined there was no impairment of goodwill or other identifiable intangibles as a part of this annual review. As part of the first quarter of 2009 closing process, management also evaluated any additional circumstances that may have required an interim impairment test subsequent to June 30, 2008: no such circumstances were noted and no impairment charge was recorded. 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 123(R)) 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.

Fair Value Measurement of Investment 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 Bank recognized an other-than-temporary impairment charge of $1.3 million during the first quarter of 2009 as a result of deterioration in the individual credits of collateralized debt obligation investments in pooled trust preferred securities as well as certain equity securities. 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, 2009 because the unrealized losses are primarily related to changes in interest rates and current market conditions, however, we do not see any negative effect on the expected cash flows of the underlying collateral or issuer. The unrealized losses are affecting all portfolio sectors with collateralized mortgage obligation securities and preferred securities having the largest reductions.

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

The Corporation’s net income for the first quarter of 2009 was $4.6 million, or $0.11 per diluted share, compared to $7.3 million or $0.23 per diluted share for the first quarter of 2008.

Despite the difficult economic environment and the turmoil in the financial markets, the Corporation’s first quarter 2009 performance was profitable. Loan and deposit growth from March 2009 compared to March 2008 was largely driven by a combination of organic loan growth of $81.3 million and deposit growth of $240.4 million along with the impact of the Willow Financial acquisition, which closed in December 2008. The 2009 year-to-date financial results include the impact on operations from the acquisition of Willow Financial effective December 5, 2008 and the related issuance of 11,515,366 shares of the Corporation’s common stock. The following is an overview of the key financial highlights:

Total assets were $5.6 billion at March 31, 2009, an increase of 45.0% from $3.9 billion at March 31, 2008. Loans were $3.6 billion, an increase of 45.7% from $2.5 billion at March 31, 2008. Deposits were $4.1 billion, up 38.8% from $3.0 billion at March 31, 2008. On the acquisition date, Willow Financial had approximately $1.6 billion in assets, $1.1 billion in loans and $946.7 million in deposits. Total assets at March 31, 2009 increased $155.7 million, or 2.8%, as compared to total assets reported at the year ended December 31, 2008. Loans decreased by $69.5 million and deposits increased by $209.0 million since year-end.

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The annualized return on average shareholders’ equity was 3.88% for the first quarter of 2009 as compared to 8.55% for the same period in 2008. The annualized return on average assets was 0.33% during the first quarter of 2009 in comparison to 0.75% for the first quarter of 2008. The decrease in these ratios was primarily due to the decline in earnings resulting from the challenging economic environment experienced during the past year as well as an increase in average assets and equity resulting from the Willow Financial acquisition.

Net interest income on a tax equivalent basis in the first quarter of 2009 increased $11.6 million or 44.5% from the same period in 2008 mainly as a result of a decrease in customer deposit costs and the Willow Financial acquisition as well as organic loan growth. First quarter 2009 net interest margin was 3.02%, increasing 11 basis points from the comparable period last year and decreasing 14 basis points sequentially from the fourth quarter of 2008.

Nonperforming assets were $89.5 million at March 31, 2009. Nonperforming assets as a percentage of total assets were 1.58% at March 31, 2009, compared to 1.43% at December 31, 2008 and 0.69% at March 31, 2008. Net charge-offs for the first quarter of 2009 were $4.0 million, compared to $798,000 in the same period of 2008. The allowance for credit losses increased to $53.1 million at March 31, 2009, compared to $50.0 million at December 31, 2008, and $28.5 million at March 31, 2008.

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.

Net Interest Income

Net interest income is the difference between interest earned on total interest-earning assets (primarily loans and investment securities), on a fully taxable equivalent basis, where appropriate, and interest paid on total interest-bearing liabilities (primarily deposits and borrowed funds). Fully taxable equivalent basis represents income on total interest-earning assets that is either tax-exempt or taxed at a reduced rate, adjusted to give effect to the prevailing incremental federal tax rate, and adjusted for nondeductible carrying costs and state income taxes, where applicable. Yield calculations, where appropriate, include these adjustments. Net interest income depends on the volume and interest rate earned on interest-earning assets and the volume and interest rate paid on interest-bearing liabilities.

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, 2009 compared to March 31, 2008 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, 2009 compared to March 31, 2008
(Dollars in thousands)
	Total			Due to change in:
	Change			Volume		Rate
Increase (decrease) in interest income:
Investment securities (1)	$	3,001		$	2,226	$	775
Federal funds sold, securities purchased under agreements to resell and deposits in banks		(567	)		367		(934	)
Loans (1) (2)		9,253			16,494		(7,241	)
Total		11,687			19,087		(7,400	)

Increase (decrease) in interest expense:
Savings and money market deposits		(1,924	)		2,226		(4,150	)
Time deposits		192			4,339		(4,147	)
Borrowed funds		1,857			3,888		(2,031	)
Total		125			10,453		(10,328	)

Net increase in net interest income	$	11,562		$	8,634	$	2,928

(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.

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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 3 1 ,							Three Months Ended March 3 1 ,
	200 9							200 8

	Average				Average			Average				Average
Assets	Balance		Interest		Rate			Balance		Interest		Rate
Earning assets:
Investment securities:
Taxable investments	$	885,819	$	11,786		5.40	%	$	753,468	$	9,754		5.21	%
Nontaxable investments (1)		323,193		5,325		6.68			290,098		4,356		6.04
Total investment securities		1,209,012		17,111		5.74			1,043,566		14,110		5.44
Federal funds sold, securities purchased under agreements to resell and deposits in banks		172,010		127		0.30			84,157		694		3.32
Loans (1) (2)		3,666,744		48,658		5.38			2,463,242		39,405		6.43
Total earning assets		5,047,766		65,896		5.29			3,590,965		54,209		6.07
Noninterest-earning assets		532,333							299,994
Total assets	$	5,580,099						$	3,890,959

Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Interest-bearing deposits:
Savings and money market	$	1,906,855		6,171		1.31		$	1,415,450		8,095		2.30
Time		1,683,035		14,693		3.54			1,237,482		14,501		4.71
Total interest-bearing deposits		3,589,890		20,864		2.36			2,652,932		22,596		3.43
Borrowed funds		953,143		7,470		3.18			499,064		5,613		4.52
Total interest bearing liabilities		4,543,033		28,334		2.53			3,151,996		28,209		3.60
Noninterest-bearing liabilities:
Demand deposits		472,687							324,120
Other liabilities		83,888							71,443
Total noninterest-bearing liabilities		556,575							395,563
Total liabilities		5,099,608							3,547,559
Shareholders' equity		480,491							343,400
Total liabilities and shareholders' equity	$	5,580,099						$	3,890,959
Net interest spread						2.76							2.47
Effect of noninterest-bearing sources						0.26							0.44
Net interest income/margin on earning assets			$	37,562		3.02	%			$	26,000		2.91	%

Less tax equivalent adjustment				2,258							1,793
Net interest income			$	35,304						$	24,207

(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.

The dramatic decline in the credit and liquidity markets and overall economic conditions continued in the fourth quarter of 2008 resulting in the Federal Open Market Committee reducing overnight rates by 175 basis points to effectively 0%. The total reduction in overnight rates during 2008 was 400 basis points. As discussed later, the Federal Reserve and U.S. Treasury Department also initiated a wide array of programs to improve liquidity, stabilize the credit markets and stimulate economic growth. These initiatives are continuing into 2009. The Corporation’s lower cost of funds have resulted from the short-term and mid-term rate reductions throughout 2008 in response to the decline in the various market yield curves and resulting reduction in asset yields.

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Interest income on a tax equivalent basis in the first quarter of 2009 increased $11.7 million, or 21.6% over the same period in 2008. This increase was primarily due to higher average loans of $1.2 billion and higher average investment securities of $165.4 million which was partially offset by a 105 basis points reduction in the average rate earned on loans. The growth in average loans of 48.9% over the first quarter of last year was mainly as a result of the Willow Financial acquisition as well as organic loan growth over all loan segments. Interest expense increased $125,000 during the first quarter of 2009 versus the comparable period in 2008 as a 107 basis point reduction in the average rate paid on deposits was partially offset by a $1.4 billion increase in average interest-bearing liabilities primarily as a result of the Willow Financial acquisition.

Net Interest Margin

The first quarter 2009 net interest margin was 3.02%, an increase of 11 basis points compared to the first quarter of 2008. The increase in the net interest margin during 2009 was mainly attributable to decreases in yields on interest-bearing liabilities which outpaced declines in the yield on loans. In addition, yields on investment securities have increased 30 basis points since the prior year.

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.

For derivatives designated and that qualify as fair value hedges, during the three months ended March 31, 2009 and 2008, the Bank recognized a reduction of interest income of $23,000 and $16,000, respectively, on the consolidated statements of income.

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manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Bank’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Bank’s known or expected cash receipts and its known or expected cash payments principally related to certain variable rate loan assets and variable rate borrowings.

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, 2009 net interest income rate shock simulations show that the Corporation is within guidelines set by the Corporation's Asset/Liability Policy when modeled rates increase 100 or 200 basis points and decrease 100 and 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, 2009. 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	$	438,058	$	(137,902	)		-23.94	%		+/- 35	%
+200 Basis Points		492,496		(83,464	)		-14.49	%		+/- 25
+100 Basis Points		544,210		(31,750	)		-5.51	%		+/- 15
Flat Rate		575,960		-			0.00	%
-100 Basis Points		578,921		2,961			0.51	%		+/- 15
-200 Basis Points		566,385		(9,575	)		-1.66	%		+/- 25
-300 Basis Points		576,071		111			0.02	%		+/- 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 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 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

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delinquencies, recoveries and losses and management’s intent with regard to the disposition of loans. In addition, the OCC, as an integral part of their examination process, periodically reviews the 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 and an additional component of the reserve allocated against the portfolio as a whole. Management assigns historical factors and environmental factors to homogeneous groups of loans that are grouped by loan type and credit rating. 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 include the following: historical loss estimation by loan product type and by risk rating within each product type, payment (past due) status, industry concentrations, internal and external variables such as economic conditions, credit policy and underwriting changes and results of the loan review process. The Corporation’s historical loss component is a 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 as well as external factors impacting the portfolio taken as a whole .

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 collectability of loans. All commercial loans with an outstanding balance over $500,000 are subject to review on an annual basis. A sample 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 performed by a third party, 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 or performed on loans otherwise deemed to be at risk of nonpayment. 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 two judgmental components (product level and portfolio level environmental factors) that reflect management’s belief that there are additional inherent credit losses based on loss attributes not adequately captured in the lagging indicators. The judgmental components are allocated to the specific segments of the portfolio based on the historic loss component of each segment under review.

Portfolio level environmental factors included in management’s calculation entail the measurement of a wider array of both internal and external criteria impacting the portfolio as a whole. The portfolio level 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 entire portfolio based upon management’s evaluation of the factors under review.

The provision for loan losses increased $5.2 million during the first quarter of 2009 compared to the same period in 2008 mostly as a result of a decrease in the overall quality of the loan portfolio which caused an increase in the amount of the required reserve. Nonperforming assets as a percentage of total assets were 1.58% at March 31, 2009, compared to 0.69% at March 31, 2008. Net loans

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charged-off increased $3.2 million for the first quarter of 2009 compared to the same period in 2008 principally due to charge-offs related to two unrelated commercial borrowers and increased charge-offs of consumer loans, specifically home equity lines of credit and loans and other direct installment loans. The profile of the Bank’s customer base has remained relatively constant and management believes that the current deterioration in credit quality has been caused by the economic pressures being felt by borrowers due to general economic conditions. The Bank has experienced depressed economic cycles in the past. As the current economic condition deteriorates, management continues to allocate dedicated resources to continue to manage at-risk credits. The Bank has experienced a similar decline in the past and expects that we could experience a similar decline in future economic cycles.

The allowance for loan losses increased $3.1 million to $53.1 million at March 31, 2009 from $50.0 million at December 31, 2008 and $28.5 million at March 31, 2008. The increase in the allowance at March 31, 2009 compared to December 31 2008 was primarily due to increased credit risk in the current economic environment. The increase in the allowance at March 31, 2009 in comparison to March 31, 2008 was mainly due to the addition of the Willow Financial loan loss reserve of $12.9 million in December 2008, and the need to adjust for impacts on the portfolio in light of the current credit environment. Nonperforming loans have increased by $10.6 million as a result of these factors from March 31, 2009 compared to December 31, 2008 and by $61.9 million from March 31, 2008. The impact of the recession continues to be felt as the Bank’s commercial real estate portfolio’s increase in allowance illustrates. It is expected that the negative trends in the real estate industry, both residential and commercial, will continue to affect credit quality throughout at least the first half of 2009, if not for the entire year.

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)	2009			2008

Average loans	$	3,666,744		$	2,463,242

Allowance, beginning of period	$	49,955		$	27,328
Loans charged off:
Real estate		1,644			357
Commercial and industrial		1,664			216
Consumer		1,021			394
Total loans charged off		4,329			967
Recoveries:
Real estate		105			27
Commercial and industrial		125			15
Consumer		85			127
Total recoveries		315			169
Net loans charged off		4,014			798
Provision for loan losses		7,121			1,960
Allowance, end of period	$	53,062		$	28,490
Ratio of net charge offs to average
loans outstanding (annualized)		0.44	%		0.13	%

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, 2009 were decreases in credit quality primarily related to real estate construction loans. The allocation of the allowance for real estate loans at March 31, 2009 increased $4.3 million as compared to December 31, 2008 principally due to an increase in criticized real estate construction loans, a decline in collateral values related to construction loans and an increase in the loss ratio used to calculate the reserve for commercial mortgage and construction loans. The allocation of the allowance for commercial and industrial loans at March 31, 2009 decreased $1.4 million from December 31, 2008 mostly due to a decrease in the loss ratio used to calculate the reserve for commercial and industrial loans. In addition, the allocation of the allowance for consumer loans at March 31, 2009 increased slightly by $219,000 primarily due to adjustments in the loss ratios as well as some increases in criticized consumer loans. There were no material changes in the allocation of the allowance for lease financing at March 31, 2009 compared to December 31, 2008. 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 2009. The interest rate environment as well as weakening in

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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 throughout 2009. 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 3 1 , 200 9					December 31, 200 8
			Percent of					Percent of
(Dollars in thousands)	Amount		Allowance			Amount		Allowance

Real estate	$	26,380		50	%	$	22,051		44	%
Commercial
and industrial		19,458		37	%		20,898		42	%
Consumer		7,215		13	%		6,996		14	%
Lease financing		9		-	%		10		-	%
Total	$	53,062		100	%	$	49,955		100	%

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

Nonperforming assets were 1.58% of total assets at March 31, 2009, compared to 1.43% at December 31, 2008, and 0.69% at March 31, 2008. The increase in nonaccrual loans at March 31, 2009, in relation to December 31, 2008, of $10.3 million was mainly attributable to commercial and industrial, commercial real estate, construction and residential real estate loans. The increase of nonaccrual loans in relation to March 31, 2008 of $61.6 million was largely due to an increase in the nonaccrual status of commercial and residential construction, commercial and industrial, residential first mortgage and commercial mortgage loans during 2008. In addition, the December 5, 2008 acquisition of Willow Financial Bank contributed $12.5 million in non-accrual loans. The borrowers associated with these nonaccrual loans are generally unrelated and are primarily located in our market area and in most cases, for the residential real estate, our collateral is local land that has been subdivided for residential development in the growing counties of the Philadelphia suburbs and the Lehigh Valley. The Bank’s management understands these markets and is confident that it can manage the collateral, if necessary. In response to the situation, the Corporation increased its allowance for loan losses from approximately 1.36% of outstanding loans at December 31, 2008 to 1.47% at March 31, 2009. The Bank continues to evaluate appraisals, financial reviews and inspections. All mortgage loans within the Bank’s portfolio were booked with traditional bank customers through the branch network. The Bank has virtually no exposure to subprime borrowers – a benefit of the historically careful approach to residential mortgage lending. The Bank continues to take a conservative approach to its 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.

As of March 31, 2009, loans past due 90 days or more and still accruing interest were $2.1 million, compared to $1.8 million at December 31, 2008 and $1.7 million at March 31, 2008. The higher level of loans past due 90 days or more at March 31, 2009 was primarily driven by a few unrelated commercial and industrial loans.

Net assets in foreclosure at March 31, 2009 were $2.0 million compared to $1.6 million at December 31, 2008 and $1.5 million at March 31, 2008. During the first quarter of 2009, transfers from loans to assets in foreclosure were $1.1 million, disposals of foreclosed properties were $698,000, and no charge-offs were recorded. Efforts to liquidate assets acquired in foreclosure proceed as quickly as potential buyers can be located and legal constraints permit. Foreclosed assets are carried at the lower of cost (lesser of carrying value of the asset or fair value at date of acquisition) or estimated fair value.

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The following table presents information concerning nonperforming assets:

Table 6—Nonperforming Assets

(Dollars in thousands)	March 31, 2009			December 31, 2008			March 31, 2008

Nonaccrual loans	$	85,393		$	75,060		$	23,819
Loans 90 days or more past due		2,073			1,849			1,702
Total nonperforming loans		87,466			76,909			25,521
Net assets in foreclosure		2,008			1,626			1,536
Total nonperforming assets	$	89,474		$	78,535		$	27,057

Allowance for loan losses to nonperforming loans		60.7	%		65.00	%		111.60	%
Nonperforming loans to total net loans		2.46	%		2.12	%		1.04	%
Allowance for loan and lease losses to total loans		1.47	%		1.36	%		1.15	%
Nonperforming assets to total assets		1.58	%		1.43	%		0.69	%

Locally located real estate, most with loan to value ratios within company policy, 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. The increase in impaired loans at March 31, 2009 compared to December 31, 2008 and March 31, 2008 was mostly due to the previously aforementioned increases in nonaccrual commercial and residential construction, commercial and industrial, residential first mortgage and commercial mortgage loans.

Table 7—Impaired Loans

(Dollars in thousands)	March 31, 2009		December 31, 2008		March 31, 2008

Impaired Loans	$	79,269	$	70,173	$	9,404

Average year-to-date impaired loans	$	71,158	$	23,469	$	10,559

Impaired loans with specific loss allowances	$	53,574	$	38,354	$	9,404

Loss allowances reserved on impaired loans	$	13,681	$	8,420	$	2,172

Year-to-date income recognized on impaired loans	$	100	$	151	$	8

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 $16.2 million for the first quarter of 2009, an increase of $5.3 million or 49.2% from $10.8 million in the first quarter of 2008 primarily as a result of the Willow Financial acquisition. For the three months ended March 31, 2009, net gains on the sale of investment securities increased by $1.8 million. In addition, as a result of the Willow Financial acquisition, there was a $1.5 million increase in net gains on the sale of residential mortgage loans. Service charges on deposits of $4.2 million for the first quarter of 2009 increased by $1.1 million, or 34.7%, as compared to the first quarter of 2008 primarily due to the Willow Financial acquisition. Other income during the first quarter of 2009 also included a $1.7 million gain recorded in the first quarter of 2009 on the sale of the Bank’s merchant credit card business. A non-cash other-than-temporary impairment charge of $1.3 million on collateralized debt obligation investments in pooled trust preferred securities as well as other investments was also recorded during the first quarter of 2009.

Noninterest Expense

Noninterest expense was $38.6 million for the first quarter of 2009, an increase of $14.9 million or 62.8% from $23.7 million in the first quarter of 2008. The increase was primarily driven by the acquisition of Willow Financial. Salaries and benefits expense rose $6.4 million during the first quarter of 2009 primarily due to higher staffing levels resulting from the Willow Financial acquisition as well as severance costs of $1.0 million. Occupancy expenses increased $1.6 million for the three months ended March 31, 2009 over the

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comparable period in 2008, mainly due to the addition of the Willow Financial branches. FDIC insurance assessments increased by $2.6 million mainly as a result of the deposits from the Willow Financial acquisition and the FDIC approval of a final rule in December 2008 which raised assessment rates uniformly by seven basis points for the first quarter of 2009. In addition, the Corporation exhausted its remaining FDIC credits in the first quarter of 2008. Other expense increased $3.5 million for the three month period ended March 31, 2009 over the same period in 2008 mostly due to the Willow Financial acquisition, including additional professional, consulting and data processing expenses.

The FDIC proposes to establish new assessment rates effective April 1, 2009. The Bank expects that the assessment rates for the remainder of 2009 will continue to be significantly higher than in 2008.

Income Taxes

The effective income tax rates for the three months ended March 31, 2009 and 2008 were 19.7% and 22.0%, respectively, versus the applicable federal statutory rate of 35% and the applicable state tax rates. The Corporation’s effective rates during 2009 and 2008 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. The effective income tax rate for the first quarter of 2009 was lower than the same period in 2008 primarily due to a higher level of tax exempt income during 2009.

Balance Sheet Analysis

Total assets at March 31, 2009 increased $155.7 million, or 2.8%, from $5.5 billion at December 31, 2008 to $5.6 billion. Cash and cash equivalents increased by $275.8 million due to increased deposits and the sale of investment securities. Residential mortgage loans held for sale increased $30.8 million due to an increase in refinancing volume driven by historically low mortgage rates. Gross loans decreased by $100.3 million at March 31, 2009 since December 31, 2008 primarily in the commercial mortgage and commercial and industrial portfolios. Investment securities decreased by $57.6 million due to sales and maturities of certain securities.

Total liabilities increased $156.7 million, or 3.1%, from $5.0 billion at December 31, 2008 to $5.2 billion at March 31, 2009. Deposits grew by $209.0 million since December 31, 2008 primarily due to increases in certificates of deposits including public funds accounts. Federal funds purchased and short-term securities sold under agreements to repurchase decreased by $31.9 million due to maturities. Long-term borrowings decreased $23.8 million from December 31, 2008 as increased cash levels reduced the Bank’s reliance on borrowings.

Capital

Capital formation is important to the Corporation's well being and future growth. Total capital at March 31, 2009 was $473.7 million, a decrease of $994,000 from the capital balance at December 31, 2008 of $474.7 million. The reduction in capital was primarily the result of an increase of $2.2 million in the accumulated other comprehensive loss related to investment securities partially offset by the issuance of $760,000 under the Corporation’s dividend reinvestment and stock purchase plan and the exercise of stock options. Management believes that the Corporation's current capital and liquidity positions are adequate to support its operations. Management continues to analyze and evaluate the Corporation’s current capital position relative to the Corporation’s ongoing business operations, current economic conditions, the regulatory environment and future capital requirements. As a part of this analysis, the Corporation’s Board of Directors, in conjunction with Management, is undertaking a comprehensive capital review and is analyzing various capital raising options to increase tangible common equity.

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Table 8—Regulatory Capital

(Dollars in thousands)						For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Program
As of March 31, 2009	Actual Amount		Ratio			Amount		Ratio			Amount		Ratio

Total Capital (to risk weighted assets):
Corporation	$	388,884		9.39	%	$	331,413		8.00	%	$	414,266		10	%
Harleysville National Bank		375,036		9.07	%		330,638		8.00	%		413,298		10	%
Tier 1 Capital (to risk weighted assets):
Corporation		337,084		8.14	%		165,707		4.00	%		248,560		6	%
Harleysville National Bank		323,355		7.82	%		165,319		4.00	%		247,979		6	%
Tier 1 Capital (to average assets):
Corporation		337,084		6.33	%		212,917		4.00	%		266,146		5	%
Harleysville National Bank		323,355		6.09	%		212,425		4.00	%		265,532		5	%

(Dollars in thousands)						For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Program
As of December 31, 2008	Actual Amount		Ratio			Amount		Ratio			Amount		Ratio

Total Capital (to risk weighted assets):
Corporation	$	384,522		8.88	%	$	346,333		8.00	%	$	432,917		10	%
Harleysville National Bank		370,552		8.58	%		345,536		8.00	%		431,920		10	%
Tier 1 Capital (to risk weighted assets):
Corporation		334,467		7.73	%		173,167		4.00	%		259,750		6	%
Harleysville National Bank		320,497		7.42	%		172,768		4.00	%		259,152		6	%
Tier 1 Capital (to average assets):
Corporation		334,467		8.19	%		163,315		4.00	%		204,144		5	%
Harleysville National Bank		320,497		7.88	%		162,689		4.00	%		203,361		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 for the Corporation is the allowance for loan losses. The current 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, 2009, the Corporation’s Tier 1 risk-adjusted capital ratio was 8.14% , and the total risk-adjusted capital ratio was 9.39%. Both are above regulatory “adequately capitalized” requirements, however, the total risk adjusted capital ratio is below the regulatory “well capitalized” standard of 10.00%. Purchase accounting adjustments related to the acquisition of Willow Financial in December 2008 contributed to the reduction of the Corporation’s total risk-based capital ratio below the regulatory threshold for a “well capitalized” bank Company at March 31, 2009 and December 31, 2008. The Corporation does not believe that these mark-to-market valuations reflect a reduction in the realizable value of Willow Financial’s assets and expects to recover the discount through amortization in 2009 and beyond. As of March 31, 2009, the total risk-adjusted capital ratio increased to 9.39% from 8.88% at December 31, 2008. The Corporation continues to execute on its plan targeted to return to the current regulatory “well capitalized” definition within the current year.

The leverage ratio consists of Tier 1 capital divided by quarterly average total assets, excluding goodwill and identifiable intangibles. Currently, 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 6.33% at March 31, 2009 and 8.19% at December 31, 2008. The lower leverage ratio of the Corporation at March 31, 2009 was mainly due to an increase in average loans and average assets from the acquisition of Willow Financial as the acquisition occurred towards the end of the fourth quarter of 2008.

After a detailed analysis of dividend yields by the Corporation, the cash dividend paid in the first quarter of 2009 was reduced to $0.10 per share from $0.20 per share for the fourth quarter of 2008. The Corporation also announced on April 23, 2009, that the second quarter cash dividend will be $.01 per share, enabling the Corporation to conserve approximately $3.9 million of capital per quarter. The Corporation believes it is prudent to build balance sheet strength and liquidity in response to the negative economic outlook for 2009 forecast by many leading economists, especially with respect to the credit markets. The proportion of net income paid out in dividends for the first three months of 2009 was 92.7%, compared to 87.0% for the same period in 2008. Activity in both the Corporation’s dividend reinvestment and stock purchase plan did not have a material impact on capital during the first three months of 2009.

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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, 2009 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, 2009, the Bank had borrowings outstanding with the FHLB of $516.0 million, all of which were long-term. At March 31, 2009, the Bank had a maximum borrowing capacity of $1.1 billion at the FHLB, unused FHLB lines of credit of $572.5 million and unused federal funds lines of credit of $110.0 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 $884.8 million and held to maturity securities of $41.0 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. Despite the anticipated market volatility and rate environment for much of 2009, 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.

Recent Developments

The global and U.S economies are experiencing significantly reduced business activity as a result of, among other factors, disruptions in the financial system in the past year. Dramatic declines in the housing market during the past year, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.

In the third quarter of 2008, the Federal Reserve, the U.S. Treasury and the FDIC initiated measures to stabilize the financial markets and to provide liquidity for financial institutions. In response to the financial crisis, the United States government passed the Emergency Economic Stabilization Act of 2008, (the “EESA”) on October 3, 2008 which provides the United States Treasury Department (the “Treasury”) with broad authority to implement certain actions to help restore stability and liquidity to the U.S. markets. Pursuant to the EESA, the Treasury has the ability to purchase or insure up to $700 billion in troubled assets held by financial institutions under the Troubled Asset Relief Program (“TARP”). On October 14, 2008, the Treasury announced it would purchase equity stakes in financial institutions under a Capital Purchase Program (the “CPP”) of up to $250 billion of the $700 billion authorized under the TARP. The CPP provides direct equity investment of perpetual preferred stock by the Treasury in qualified financial institutions. The program is voluntary and requires an institution to comply with a number of restrictions and provisions, including limits on executive compensation, stock redemptions and declaration of dividends. As a result of additional legislation passed in February 2009, the CPP also requires the Treasury to receive warrants for common stock equal to 15% of the capital invested by the Treasury. For a period of three years, the consent of the U.S. Treasury will be required for participating institutions to increase their common stock dividend or repurchase their common stock, other than in connection with benefit plans consistent with past practice. The minimum subscription amount available to a participating institution is one percent of total risk-weighted assets. The maximum subscription amount is three percent of risk-weighted assets.

In November 2008, the Corporation filed an application to participate in the CPP as part of the TARP. The Executive Committee of the Corporation’s Board of Directors authorized management to apply for participation in the CPP up to the maximum of 3% of total risk-based assets, which was estimated at approximately $120 million. The Corporation’s Board of Directors determined that the Corporation should withdraw its previously-submitted application under the CPP as at this time, as they believe the TARP program is not the best course of action for the Corporation. On April 28, 2009, the Corporation notified its regulators that it has withdrawn its application. The Corporation will explore alternative sources of capital.

The EESA included a provision for a temporary increase in the Federal Deposit Insurance (FDIC) from $100,000 to $250,000 per depositor effective October 3, 2008 through December 31, 2009. In addition, the FDIC announced the Temporary Liquidity Guarantee Program effective October 14, 2008, enabling the FDIC to temporarily provide a 100% guarantee of newly issued senior unsecured debt of all FDIC-insured institutions and their holding companies issued before June 30, 2009, as well as deposits in non-interest bearing transaction deposit accounts through December 31, 2009. Coverage under the Temporary Liquidity Guarantee Program was available for 30 days without charge and thereafter at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for non-interest bearing transaction deposits. The Corporation has determined it will continue to participate in the Temporary Liquidity Guarantee Program for non-interest bearing deposit accounts after the 30 day initial period and is assessing its participation for issuance of unsecured debt.

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It is not clear at this time what impact these programs announced by the Treasury and other bank regulatory agencies and any additional programs that may be initiated in the future, will have on the Corporation or the financial markets as a whole.

Other Information

Pending Legislation

The Corporation continues to monitor and assess legislation and regulatory matters for their impact to the Corporation and their effect on capital, liquidity and the results of operations. Any future legislation or regulatory matters may effect the Corporation’s capital, liquidity and results of operations in a material adverse manner.

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 the first quarter of 2009, the Corporation opened a new branch in Conshohocken, Montgomery County. As the Bank continues to evaluate its retail delivery system to better serve customers’ needs, an opportunity was identified to maintain high touch service while saving cost in the Warminster, Bucks County market. In conjunction with the upcoming expiration of its lease, the Bank has decided to consolidate operations of the Warminster K-Mart Plaza branch into nearby offices. Upon regulatory approval, this will occur at 4 p.m. on Tuesday, June 3, 2009. As the Bank evaluated renewing the branch lease, it identified significant overlap with the Warminster Plaza and Warminster Anne’s Choice locations. Under the consolidation plan, Warminster Square and Warminster Anne’s Choice will be handling the accounts of customers from Warminster K-Mart Plaza beginning on July 1, 2009.

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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 Bank’s Board of Directors, is responsible for managing the rate sensitivity position.

During the fourth quarter of 2008 through 2009, the economy has experienced a continued decline in the housing market, reductions in credit facilities, disruptions in the financial system, and volatility in the financial markets, all resulting in short-term rate reductions by the Federal Open Market Committee and the creation of programs by Congress and the Treasury Department for the purpose of stabilizing and providing liquidity to the U.S. financial markets. 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 26 and 27 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 2009 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

As a result of the acquisition of Willow Financial, the Corporation recorded a liability in purchase accounting of $2.7 million, of which $1.6 million is remaining at March 31, 2009, in connection with certain legal contingencies which existed prior to the acquisition. The amount accrued represents estimated settlement and legal costs on ongoing litigation assumed from Willow Financial. There can be no assurance that any of the outstanding legal proceedings to which the Corporation is a party as a successor in interest to Willow Financial will not be decided adversely to the Corporation’s interests and have a material effect on the financial condition and operations of the Corporation.

Management, based on consultation 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. Except as noted above, 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 the Bank by government authorities.

Item 1A. Risk Factors

Except for the addition of the risk factors detailed below, 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, 2008.

If the Corporation concludes that the decline in value of any of its investment securities is other-than-temporary, the Corporation is required to write down the value of that security through a charge to earnings.

The Corporation reviews its investment securities portfolio at each quarter-end reporting period to determine whether the fair value is below the current carrying value. When the fair value of any of its investment securities has declined below its carrying value, the Corporation is required to assess whether the decline is other-than-temporary. If the Corporation determines that the decline is other-than-temporary, the Corporation is required to write down the value of that security through a charge to earnings. During the three-month period ended March 31, 2009, the Corporation recorded impairment charges totaling $1.3 million on one pooled trust preferred security, one private label collateralized mortgage obligation, and several equity securities with book values totaling $10.5 million. Changes in the expected cash flows of the securities in the Corporation’s investment portfolio and/or prolonged price declines may result in the Corporation’s conclusion in future periods that the impairment is other-than-temporary, which would require a charge to earnings to write down the securities to fair value. Due to the complexity of the calculations and assumptions used in determining whether an asset, such as a pooled trust preferred security, is impaired, the impairment disclosed may not accurately reflect the actual impairment in the future.

The Corporation may likely need or be compelled to raise additional capital in the future, but that capital may not be available when it is needed and on terms favorable to current shareholders.

Federal banking regulators require the Corporation and Bank to maintain adequate levels of capital to support their operations. These capital levels are determined and dictated by law, regulation and banking regulatory agencies. In addition, capital levels are also determined by the Corporation’s management and board of directors based on capital levels that they believe are necessary to support the Corporation’s business operations. At March 31, 2009, two of the Corporation’s three capital ratios were above "well capitalized" levels under current bank regulatory guidelines. However, at March 31, 2009, the Corporation’s total capital to risk weighted assets ratio was 9.39% which is below the current 10% regulatory ratio to be considered “well-capitalized”. In addition, the Corporation is evaluating its present and future capital requirements and needs. The Corporation is also analyzing capital raising alternatives and options. Consequently, the Corporation believes it may need to increase tangible common equity by raising additional capital. As a result, the Corporation will have to reduce its assets so as to increase that ratio, increase its capital or both. Even if the Corporation succeeds in meeting the current regulatory capital requirements, the Corporation may likely need to raise additional capital in the near future to support possible loan losses during future periods or to meet future regulatory capital requirements.

Further, the Corporation’s regulators may require it to increase its capital levels. If the Corporation raises capital through the issuance of additional shares of its common stock or other securities, it would likely dilute the ownership interests of current investors and would likely dilute the per share book value and earnings per share of its common stock. Furthermore, it may have an adverse impact on the Corporation’s stock price. New investors may also have rights, preferences, and privileges senior to the Corporation’s current shareholders, which may adversely impact its current shareholders. The Corporation’s ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside its control, and on its financial performance. Accordingly, the Corporation cannot assure you of its ability to raise additional capital on terms and time frames

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acceptable to it or to raise additional capital at all. If the Corporation cannot raise additional capital in sufficient amounts when needed, its ability to comply with regulatory capital requirements could be materially impaired. Additionally, the inability to raise capital in sufficient amounts may adversely affect the Corporation’s operations, financial condition, and results of operations.

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 three months of 2009. The maximum number of shares that may yet be purchased under the plans was 731,761 as of March 31, 2009. (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

(a)	None to report.

(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).

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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, 2009

/s/ Paul D. Geraghty

Paul D. Geraghty, President, Chief Executive Officer and

	Director
	(Principal executive officer)

Date: May 8, 2009

/s/ George S. Rapp

George S. Rapp, Executive Vice President and Chief Financial Officer

	Principal financial and accounting officer)

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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”). (Incorporated by reference to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007, filed with the Commission on March 14, 2008. 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.)
(2.4)	Merger Agreement, dated as of May 20, 2008, by and among Harleysville National Corporation and Willow Financial Bancorp. (Incorporated by reference to Annex A of the Registrant’s Registration Statement No. 333-152007 on Form S-4, as amended, filed with the Commission on July 31, 2008. 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.)
(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.)

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Exhibit No	Description of Exhibits
(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.)
(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, former Executive Vice President and 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, former 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, former 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)	Complete Settlement Agreement and General Release effective October 17, 2008 by and between Michael B. High, former Executive Vice President and Chief Operating Officer of the Corporation, 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 October 23, 2008.)
(10.15)	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).
(10.16)	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.
(10.17)	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.)
(10.18)	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.)
(10.19)	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.)
(10.20)	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.)
(10.21)	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.)
(10.22)	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.)

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Exhibit No.	Description of Exhibits
(10.23)	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.)
(10.24)	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.)
(10.25)	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.)
(10.26)	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.)
(10.27)	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.)
(10.28)	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.)
(10.29)	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.)
(10.30)	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.)
(10.31)	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.)
(10.32)	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.)
(10.33)	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.)
(10.34)	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.)
(10.35)	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.* (Incorporated by reference to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007, filed with the Commission on March 14, 2008.)
(10.36)	Employment Agreement dated April 17, 2008 between Joseph D. Blair, Executive Vice President and President of the Millennium Wealth Management Division of Harleysville National Bank and Trust Company, and Harleysville Management Services, LLC.* (Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 8, 2008.)
(10.37)	Employment Agreement dated May 20, 2008 and effective December 5, 2008 between Donna M. Coughey, Executive Vice President of the Corporation and the Bank, and Harleysville Management Services, LLC.* (Incorporated by reference to Registrant’s Current Report on Form 8-K filed with the Commission on December 5, 2008.)
(10.38)	Willow Financial Bancorp, Inc. Amended and Restated 2002 Stock Option Plan. (Incorporated by reference to Exhibit 10.1 of Registrant’s Registration Statement No. 333-156956 on Form S-8, filed with the Commission on January 27, 2009.)

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Exhibit No.	Description of Exhibits
(10.39)	Willow Financial Bancorp, Inc. Amended and Restated 1999 Stock Option Plan. (Incorporated by reference to Exhibit 10.2 of Registrant’s Registration Statement No. 333-156956 on Form S-8, filed with the Commission on January 27, 2009.)
(10.40)	Chester Valley Bancorp, Inc. 1997 Stock Option Plan, as amended. (Incorporated by reference to Exhibit 10.3 of Registrant’s Registration Statement No. 333-156956 on Form S-8, filed with the Commission on January 27, 2009.)
(11)	Computation of Earnings per Common Share, incorporated by reference to Part II, Item 8, Footnote 8, “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.

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