~~2008~~ 2009 ANNUAL ~~REPORTON FORM 10-K~~ REPORT

~~UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C.~~ON ~~20549_________________________~~FORM 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)
x		Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2008.
OR
o		Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from to .

(Mark One)

Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 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~~National ~~name of registrant as specified in its charter)~~Corporation

Pennsylvania	23-2210237
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
483 Main Street,
Harleysville, Pennsylvania	19438
(Address of principal executive offices)	(Zip Code)

(Exact name of registrant as specified in its charter)

Securities registered pursuant to Section 12(b) of the Act:
Pennsylvania		23-2210237
Title of Each Class	Name of Each Exchange on Which Registered
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
Common Stock, $1.00 par value	The NASDAQ Stock Market LLC
483 Main Street, Harleysville, Pennsylvania		19438
(Address of principal executive offices)		(Zip Code)
Registrant’s telephone number, including area code: (215) 256-8851
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class	Name of Each Exchange on Which Registered
Common Stock, $1.00 par value	The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act:
None

~~Securities~~Indicate by ~~registered~~check ~~pursuant~~mark toif the registrant is a well-known seasoned issuer, as defined in ~~Section~~Rule ~~12(g)~~405 of the Securities Act~~:None~~.

~~Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.~~ Yes o No x

Indicate by by check mark if the registrant is not required to file reports pursuant to ~~Section~~ Section 13 or Section 15(d) of the Act. ~~Yes o No x~~

Yes o No x

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 o

Indicate by by check mark ifwhether ~~disclosure~~the ofregistrant ~~delinquent~~has ~~filers~~submitted ~~pursuant~~electronically toand ~~Item~~posted ~~405 of Regulation~~on ~~S-K~~its iscorporate ~~not~~Web ~~contained~~site, ~~herein~~if any, ~~and~~every ~~will~~Interactive ~~not~~Data File required to be submitted ~~contained,~~and posted pursuant to ~~the~~Rule ~~best~~405 of ~~registrant’s~~ ~~knowledge,~~Regulation inS-T ~~definitive~~(§232.405 ~~proxy~~of orthis chapter) ~~information~~during ~~statements incorporated~~the bypreceding ~~reference~~12 inmonths ~~Part~~(or ~~III~~for ofsuch ~~this~~shorter ~~Form~~period ~~10-K~~that orthe registrant ~~any~~was ~~amendment~~required to ~~this Form~~submit ~~10-K~~and post such files). Yes o No o

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

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	Smaller reporting company o
		(Do not check if a smaller reporting company)

Indicate by by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ~~Yes o No x~~

~~The~~ Yes ~~aggregate market value of the Registrant’s Common Stock held by non-affiliates~~o No ~~is $317,118,196 based on the June 30, 2008 closing price of the Registrant’s Common Stock of $11.16 per share.~~x

AsThe aggregate market value of ~~March~~the ~~10,~~Registrant’s ~~2009,~~Common ~~there~~Stock ~~were~~held by non-affiliates 42is $188,~~982~~566,~~463~~927 ~~outstanding~~based ~~shares~~on the June 30, 2009 closing price of the Registrant’s Common Stock of $4.71 per share.

As of March 9, 2010, there were 43,138,988 outstanding shares of the Registrant’s Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE:

1None. Portions of the Registrant’s Definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 22, 2009 are incorporated by reference into Part III, Items 10-14 of this report.

HARLEYSVILLE NATIONAL CORPORATION

FORM 10-K

INDEX

		~~Page~~	Page
Part I		4	4
Item 1.	Business	4	4
Item 1A.	Risk Factors	12	12
Item 1B.	Unresolved Staff Comments	15	20
Item 2.	Properties	16	21
Item 3.	Legal Proceedings	18	23
Item 4.	~~Submission~~(Removed ofand ~~Matters to a Vote of Security Holders~~Reserved)	18	24
Part II		19	24
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	19	24
Item 6.	Selected Financial Data	22	27
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23	28
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	49	58
Item 8.	Financial Statements and Supplementary Data	50	59
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	~~109~~	124
Item 9A.	Controls and Procedures	~~109~~	124
Item 9B.	Other Information	~~111~~	126
Part III		~~112~~	127
Item 10.	Directors, Executive Officers and Corporate Governance	~~112~~	127
Item 11.	Executive Compensation	~~112~~	134
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	~~112~~	163
Item 13.	Certain Relationships and Related Transactions, and Director Independence	~~112~~	165
Item 14.	Principal Accountant Fees and Services	~~113~~	166
Part IV		~~113~~	167
Item 15.	Exhibits and Financial Statement Schedules	~~113~~	167
Signatures		114

2Signatures 168

-2-

Forward-Looking Statements

In addition to historical information, this report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We have made forward-looking statements in this report, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include the information concerning possible or assumed future results of operations of Harleysville National Corporation (the Corporation) and its subsidiaries. When we use words such as “believes,” “expects,” “anticipates,” “may,” “estimates,” or “intends” or similar expressions, we are making forward-looking statements. Forward-looking statements are representative only as of the date they are made, and the Corporation undertakes no obligation to update any forward-looking statement.

Shareholders should note that many factors, some of which are discussed elsewhere in this report and in the documents that we incorporate by reference, could affect the future financial results of the Corporation and its subsidiaries and could cause those results to differ materially from those expressed or implied in our forward-looking statements contained or incorporated by reference in this document. These factors include but are not limited to those described in Item 1A, “Risk Factors.”

-3-

PART I

Item 1.

Business

Harleysville National Corporation (the Corporation), a Pennsylvania corporation, was incorporated June 1, 1982. On January 1, 1983, the Corporation became the ~~parent~~ parent bank holding company of Harleysville National Bank and Trust Company (the ~~Bank~~ Bank or Harleysville National Bank), established in 1909, a wholly owned ~~subsidiary~~ subsidiary of the Corporation. The Corporation is registered as a bank holding ~~company~~ company under the Bank Holding Company Act of 1956.

Since commencing operations, the Corporation’s business has consisted primarily of providing financial services through its subsidiaries and has acquired nine financial institutions since 1991 including the recent acquisitions of Willow Financial Bancorp, Inc. (Willow Financial) and its banking subsidiary, Willow Financial Bank in December 2008 and East Penn Financial Corporation (East Penn Financial) and its banking subsidiary, East Penn Bank in November 2007. Additionally, the Corporation completed the acquisition of the Cornerstone Companies (registered investment advisors) in January 2006. The Corporation is also the parent holding company of HNC Financial Company and HNC Reinsurance Company. HNC Financial Company was incorporated on March 17, 1997 as a Delaware Corporation and its principal business function is to expand the investment opportunities of the Corporation. HNC Reinsurance Company was incorporated on March 30, 2001 as an Arizona Corporation and reinsures consumer loan credit life and accident and health insurance.

The Bank is is a national banking association under the supervision of the Office of the Comptroller of the Currency (the OCC). The Corporation’s and the Bank’s legal headquarters are located at 483 Main Street, Harleysville, Pennsylvania 19438. HNC Financial Company’s legal headquarters is located at 2751 Centerville Road, Suite ~~3164~~ 164, Wilmington, Delaware 19808. HNC Reinsurance Company’s legal headquarters is located at 101 North First Avenue, Suite 2460, Phoenix, AZ 85003.

The Bank provides a full range of banking services including loans and deposits, investment management and trust and investment advisory services to individual and corporate customers located primarily in eastern Pennsylvania. The Bank engages in the full-service commercial banking and trust business, including accepting time and demand deposits, making secured and unsecured commercial and consumer loans, financing commercial transactions, making construction and mortgage loans and performing corporate pension and personal investment and trust services. Deposits are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law. As of December 31, ~~2008~~2009, the Bank had 8583 branch offices located in Montgomery, Bucks, Chester, Berks, Carbon, Lehigh, Monroe, Northampton and Philadelphia counties, Pennsylvania.

The Bank ~~has~~ has maintained a stable base of core deposits and is a leading community bank in ~~its~~ its service areas. The Bank believes it has gained its position as a result of strategic acquisitions, a customer-oriented philosophy and a strong commitment to service. Senior management has made the development of a sales orientation throughout the Bank one of their highest priorities and emphasizes this objective with extensive training and sales incentive programs. The Bank maintains close contact with the local business community to monitor commercial lending needs and believes it responds to customer requests quickly and with flexibility.

The Bank opened new branches in Flourtown, Montgomery County and Whitehall, Lehigh County ~~and~~ and relocated its Pottstown East End branch in Montgomery County during 2008. ~~The~~ The Conshohocken branch in Montgomery County was opened in February 2009. ~~The Bank continues to evaluate potential new branch sites that are contiguous to our current service area and will expand the Bank’s market area and market share of loans and deposits.~~

~~Acquisitions~~ Pending Merger

~~Effective after~~On ~~the market close on December 5~~July 26, ~~2008~~2009, the Corporation ~~completed~~entered ~~its acquisition~~into ofan ~~Willow~~agreement ~~Financial Bancorp, Inc.~~ and ~~its~~plan ~~subsidiary,~~of ~~Willow Financial~~merger ~~Bank, a $1.6 billion bank~~ with ~~29 banking offices in Southeastern~~ ~~Pennsylvania.~~First ~~Headquartered~~Niagara ~~in Wayne, PA, Willow~~ Financial ~~Bank branch offices were located in Philadelphia~~Group, ~~Montgomery, Chester, and Bucks Counties~~Inc. On(“First ~~the acquisition date~~Niagara”), ~~Willow~~pursuant ~~Financial~~to ~~had~~which ~~approximately $1.6 billion in assets,~~the ~~$1.1~~Corporation ~~billion~~will inmerger ~~loans~~with and ~~$946.7~~into ~~million~~First inNiagara ~~deposits~~(the “Merger”). The ~~acquisition~~Merger ofwas ~~Willow~~approved ~~Financial~~by ~~is consistent with~~ the Corporation’s ~~plan to~~shareholders ~~strategically~~at ~~grow through disciplined in-market expansion. The merger delivers~~ a ~~significant~~special ~~market~~meeting ~~share in Chester County, one~~ of ~~the~~shareholders ~~fastest~~held ~~growing counties~~on inJanuary ~~Pennsylvania~~22, ~~increases the Corporation’s market presence in Bucks~~ ~~and~~2010. Pending ~~Montgomery counties~~ and ~~establishes~~subject ato ~~new~~the ~~market~~receipt ~~presence~~of inall ~~Philadelphia county.~~required ~~The combined company establishes a stronger presence in eastern~~regulatory ~~Pennsylvania~~approvals, ~~including becoming~~ the ~~third~~Merger ~~largest~~is ~~financial~~expected ~~institution headquartered~~to close in ~~suburban~~the ~~Philadelphia.~~second ~~The~~quarter ~~Corporation also acquired BeneServ,~~of ~~Inc~~2010., See a“Item ~~respected~~1A—Risk ~~provider~~Factors—Risk ofRelated ~~employee~~to ~~benefits services from Willow Financial. The merger drives shareholder value by providing~~ the ~~opportunity~~Merger towith ~~deliver~~First ~~synergies and accretion to earnings~~Niagara. ”

-4-

Effective November 16, 2007, the Corporation completed its acquisition of East Penn Financial and its subsidiary, East Penn Bank. On the acquisition date, East Penn Financial had approximately $451.1 million in assets, $337.7 million in loans and $382.7 million in deposits with nine banking offices located in Lehigh, Northampton and Berks Counties, Pennsylvania. The acquisition expanded the branch network of the Corporation in the Lehigh Valley and its opportunity to provide East Penn customers with a broader mix of products and services. As part of the merger agreement, East Penn Bank continues to operate under the East Penn name and logo, and has become a division of the Bank. Nine of the Bank’s existing branches were transferred to the East Penn division including those in Lehigh, Carbon, Monroe, and Northampton Counties.Acquisitions

OnEffective after ~~March~~the 1market close on December 5, ~~2007~~ 2008, the ~~Cornerstone~~Corporation ~~Companies~~completed its acquisition of Willow Financial Bancorp, aInc. ~~subsidiary~~and ofits ~~the~~subsidiary, Willow Financial Bank, ~~completed~~ a ~~selected asset~~$1.6 ~~purchase~~billion ofbank ~~McPherson~~with ~~Enterprises~~29 ~~and~~banking ~~related~~offices ~~entities~~in ~~(McPherson),~~Southeastern ~~registered~~Pennsylvania. ~~investment~~Headquartered ~~advisors~~in ~~specializing~~Wayne, inPA, ~~estate~~Willow ~~and~~Financial ~~succession~~Bank ~~planning~~branch offices ~~and~~were ~~life~~located ~~insurance~~in ~~for~~Philadelphia, ~~high-net-worth~~Montgomery, ~~construction~~Chester, and ~~aggregate~~Bucks ~~business~~Counties. ~~owners~~On the ~~and~~acquisition ~~families~~date, ~~throughout~~Willow ~~the~~Financial ~~United~~had ~~States~~approximately $1.6 ~~McPherson~~billion ~~became~~in aassets, $1.1 ~~part~~billion ofin ~~the Cornerstone~~loans ~~Companies,~~and a$946.7 ~~component~~million ofin ~~the~~deposits. ~~Bank’s~~The ~~Millennium~~merger ~~Wealth~~delivers ~~Management~~a ~~division.~~significant ~~The~~market ~~acquisition~~share ~~was~~in ~~part~~Chester County, one of the fastest growing counties in Pennsylvania, increases the Corporation’s ~~plan~~market topresence ~~continue~~in toBucks and ~~build~~Montgomery ~~its~~counties ~~fee-based~~and ~~services~~establishes ~~businesses~~a new market presence in Philadelphia county. The ~~consideration~~Corporation ~~for~~also ~~the~~acquired ~~transaction was~~BeneServ, $1Inc.5, ~~million~~a inrespected ~~cash~~provider of employee benefits services from Willow Financial.

Effective November ~~January 1~~16, ~~2006~~2007, the ~~Bank~~ Corporation completed its acquisition of ~~the~~East ~~Cornerstone Companies, registered investment~~Penn ~~advisors~~Financial ~~for~~and ~~high~~its ~~net worth~~subsidiary, ~~privately~~East ~~held~~Penn ~~business owners, wealthy families and institutional clients~~Bank. ~~Located~~On in the ~~Lehigh~~acquisition ~~Valley~~date, ~~Pennsylvania,~~East ~~the firm~~Penn ~~serves~~Financial ~~clients~~had ~~throughout~~approximately ~~Pennsylvania~~$451.1 ~~and~~million ~~other~~in ~~mid-Atlantic~~assets, ~~states~~$337.7 ~~The purchase~~million ~~price~~in ~~consisted~~loans and of $15382.07 million in ~~cash~~deposits ~~paid~~with atnine ~~closing~~banking ~~and~~offices ~~a contingent~~located ~~payment~~in ofLehigh, Northampton upand toBerks $7Counties, Pennsylvania.0 ~~million~~The toacquisition beexpanded ~~paid~~the branch ~~post-closing.~~network ~~The~~of ~~contingent payment~~the isCorporation ~~based~~in ~~upon~~ the ~~Cornerstone~~Lehigh ~~Companies~~Valley ~~meeting~~and ~~certain~~its ~~minimum~~opportunity to ~~operating~~provide ~~results~~East ~~during~~Penn customers with a ~~five-year~~broader ~~earn-out~~mix ~~period~~of ~~with~~products aand ~~maximum~~services. ~~payout~~As ofpart ~~$7.0~~of ~~million~~the ~~over~~merger ~~this~~agreement, ~~period.~~East ~~For~~Penn ~~2006~~Bank ~~through~~continues ~~2008,~~to operate under the ~~minimum~~East ~~operating~~Penn ~~results~~name ~~were~~and ~~met~~logo, ~~resulting~~and inhas ~~earn-out~~become ~~payments~~a ~~totaling~~division $3of the Bank.6 ~~million~~Nine ~~which~~of ~~were~~the Bank’s ~~recorded~~existing asbranches ~~additional~~were ~~goodwill.~~transferred Atto ~~December~~the ~~31,~~East ~~2008,~~Penn ~~the~~division ~~remaining~~including ~~maximum~~those in ~~payout~~Lehigh, isCarbon, ~~$3.4~~Monroe, ~~million~~and ~~through~~Northampton ~~2010~~Counties.

~~Dispositions~~On March 1, 2007, the Cornerstone Companies, a subsidiary of the Bank, completed a selected asset purchase of McPherson Enterprises and related entities (McPherson), registered investment advisors specializing in estate and succession planning and life insurance for high-net-worth construction and aggregate business owners and families throughout the United States. McPherson became a part of the Cornerstone Companies, a component of the Bank’s Millennium Wealth Management division. The acquisition was part of the Corporation’s plan to continue to build its fee-based services businesses. The consideration for the transaction was $1.5 million in cash.

The Corporation completed a sale-leaseback transaction involving fifteen bank properties as well as a separate sale of office space during the fourth quarter of 2007. Under the leases, the Bank continues to utilize the properties in the normal course of business. The Corporation received net proceeds of $39.7 million and recorded a pre-tax gain of $2.8 million. The remaining gain of $17.1 million was deferred and is being amortized through a reduction of occupancy expense over the term of the leases. Dispositions

~~Segments~~The Corporation completed a sale-leaseback transaction involving fifteen bank properties as well as a separate sale of office space during the fourth quarter of 2007. Under the leases, the Bank continues to utilize the properties in the normal course of business. The Corporation received net proceeds of $39.7 million and recorded a pre-tax gain of $2.8 million. The remaining gain of $17.1 million was deferred and is being amortized through a reduction of occupancy expense over the term of the leases.

The Corporation has two reportable operating segments: Community Banking and Wealth Management, as well as certain other non-reportable segments. As of December 31, 2008, the Wealth Management segment had assets under management of $2.6 billion. Statement of Financial Accounting Standards (SFAS) No. 131, “Disclosures about Segments of an Enterprise and Related Information” establishes standards for the way public business enterprises 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. For more detailed financial information pertaining to operating segments, see Item 8— Note 17 of the Consolidated Financial Statements which is herein incorporated by reference.

5The Corporation has two reportable operating segments: Community Banking and Wealth Management, as well as certain other non-reportable segments. As of December 31, 2009, the Wealth Management segment had assets under management of $3.3 billion. The Accounting Standards establish requirements for the way public business enterprises 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. For more detailed financial information pertaining to operating segments, see Item 8— Note 18 of the Consolidated Financial Statements which is herein incorporated by reference.

As of December 31, ~~2008~~2009, the Corporation had total assets of $5.52 billion, total shareholders’ equity of $~~474~~261.76 million and total deposits of $3.9 billion.

As of December 31, ~~2008~~2009, the Corporation and the Bank employed approximately ~~1,169~~ 892 full-time equivalent employees. The Corporation provides a variety of employment benefits and considers its relationships with its employees to be satisfactory.

~~Competition~~ -5-

~~The Bank~~ competes actively with other eastern Pennsylvania financial institutions as well as with financial and non-financial institutions, many larger than the Bank, headquartered elsewhere. Commercial banks, savings banks, savings and loan associations, credit unions, and money market funds actively compete for deposits and loans. Such institutions, as well as consumer finance, insurance companies and brokerage firms, may be considered competitors with respect to one or more services they render. The Bank is generally competitive with all competing institutions in its service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts, interest rates charged on loans and fees for trust and investment advisory services. At December 31, 2008, the Bank’s legal lending limit to a single customer was $55.6 million. Many of the institutions with which the Bank competes are able to lend significantly more than this amount to a single customer. Competition

~~Concentrations/Seasonality~~The Bank competes actively with other eastern Pennsylvania financial institutions as well as with financial and non-financial institutions, many larger than the Bank, headquartered elsewhere. Commercial banks, savings banks, savings and loan associations, credit unions, and money market funds actively compete for deposits and loans. Such institutions, as well as consumer finance, insurance companies and brokerage firms, may be considered competitors with respect to one or more services they render. The Bank is generally competitive with all competing institutions in its service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts, interest rates charged on loans and fees for trust and investment advisory services. At December 31, 2009, the Bank’s legal lending limit to a single customer was $64.0 million. Many of the institutions with which the Bank competes are able to lend significantly more than this amount to a single customer.

The Corporation and its subsidiaries do not have any portion of their businesses dependent on a single or limited number of customers, the loss of which would have a material adverse effect on the Corporation’s business. No substantial portion of investments is concentrated within a single industry or group of related industries. The Corporation had no concentrations of credit extended to any specific industry that exceeded 10% of total loans at December 31, 2008. The businesses of the Corporation and its subsidiaries are not typically seasonal in nature. Concentrations/Seasonality

~~Supervision~~The Corporation and ~~Regulation—~~its subsidiaries do not have any portion of their businesses dependent on a single or limited number of customers, the loss of which would have a material adverse effect on the Corporation’s business. No substantial portion of investments is concentrated within a single industry or group of related industries. The Corporation had no concentrations of credit extended to ~~Registrant~~any specific industry that exceeded 10% of total loans at December 31, 2009. The businesses of the Corporation and its subsidiaries are not typically seasonal in nature.

~~The Gramm-Leach-Bliley~~Supervision ~~Financial Modernization Act of 1999 (Modernization Act) allows bank holding companies meeting management, capital,~~ and ~~Community Reinvestment~~Regulation—The Act standards to engage in a substantially broader range of non-banking activities than permissible before enactment, including underwriting insurance and making merchant banking investments in commercial and financial companies. It allows insurers and other financial services companies to acquire banks, removes various restrictions that currently apply to bank holding company ownership of securities firms and mutual fund advisory companies, and establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations. Registrant

The Gramm-Leach-Bliley Financial Modernization Act ~~also~~of ~~modified~~1999 ~~law~~(Modernization ~~related~~Act) allows bank holding companies meeting management, capital, and Community Reinvestment Act standards to ~~financial~~engage ~~privacy~~in a substantially broader range of non-banking activities than permissible before enactment, including underwriting insurance and ~~community~~making merchant banking investments in commercial and financial ~~reinvestment~~companies. ~~The~~It ~~privacy~~allows ~~provisions~~insurers ~~generally~~and ~~prohibit~~other financial ~~institutions, including~~services ~~the~~companies ~~Corporation~~to acquire banks, ~~from~~removes ~~disclosing~~various ~~nonpublic~~restrictions ~~financial~~that ~~information~~currently apply to bank holding company ~~nonaffiliated~~ownership ~~third~~of ~~parties~~securities ~~unless~~firms ~~customers~~and ~~have~~mutual fund advisory companies, and establishes the ~~opportunity~~overall regulatory structure applicable to ~~“opt~~bank ~~out”~~holding ofcompanies ~~the~~that ~~disclosure.~~also engage in insurance and securities operations.

~~Pending~~The Modernization ~~Legislation~~Act also modified law related to financial privacy and community reinvestment. The privacy provisions generally prohibit financial institutions, including the Corporation, from disclosing nonpublic financial information to nonaffiliated third parties unless customers have the opportunity to “opt out” of the disclosure.

~~Other than~~Pending the FDIC insurance increase for 2009 and other regulatory matters as discussed subsequently, management is not aware of any other current specific recommendations by regulatory authorities or proposed legislation which, if they were implemented, would have a material adverse effect upon the liquidity, capital resources, or results of operations, although the general cost of compliance with numerous federal and state laws and regulations does have, and in the future may have, a negative impact on the Corporation’s results of operations. Legislation

6Other than the FDIC insurance increase for 2009 and other regulatory matters as discussed subsequently, the Corporation’s management is not aware of any other current specific recommendations by regulatory authorities or proposed legislation which, if they were implemented, would have a material adverse effect upon the liquidity, capital resources, or results of operations, although the general cost of compliance with numerous federal and state laws and regulations does have, and in the future may have, a negative impact on the Corporation’s results of operations.

Effects of Inflation

Inflation has some impact on the Corporation’s 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~~ -6-

~~The~~Effect ~~earnings~~ of ~~the~~Government ~~Corporation~~Monetary 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 to 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. Policies

The ~~Bank is~~ aearnings ~~member~~ of the ~~Federal~~Corporation ~~Reserve~~are and, ~~therefore,~~will be affected by domestic economic conditions and the ~~policies~~monetary and ~~regulations~~fiscal policies of the United States government and its agencies. An important function of the Federal Reserve ~~have~~is ato ~~significant~~regulate the ~~effect~~money onsupply ~~its~~and ~~deposits,~~interest ~~loans~~rates. ~~and~~Among the instruments used to implement ~~investment~~those ~~growth,~~objectives asare ~~well~~open asmarket ~~the~~operations ~~rate~~in ofUnited ~~interest~~States ~~earned~~government securities and ~~paid,~~changes ~~and~~in ~~are expected~~reserve requirements to ~~affect~~member ~~the~~bank ~~Bank’s~~deposits. ~~operations~~These instruments are used in ~~the~~varying ~~future.~~combinations ~~The~~to ~~effect~~influence ofoverall ~~such policies~~growth and distribution ~~regulations~~of ~~upon~~bank ~~the~~loans, ~~future~~investments ~~business~~and deposits, and ~~earnings~~their ofuse ~~the~~may also ~~Corporation~~affect ~~and~~rates ~~the~~charged ~~Bank~~on ~~cannot~~loans beor ~~predicted.~~paid for deposits.

~~Environmental~~The ~~Regulations~~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.

~~There~~Environmental 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. Regulations

~~Supervision~~There are several federal and ~~Regulation—~~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.

~~The operations~~Supervision ~~of the Bank are subject to federal~~ and ~~state statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve and to banks whose deposits are insured by the FDIC. The~~ Regulation—Bank’s operations are also subject to regulations of the OCC, the Securities and Exchange Commission (SEC), the Federal Reserve and the FDIC. The primary supervisory authority of the Bank is the OCC, who regularly examines the Bank. The OCC has authority to prevent a national bank from engaging in unsafe or unsound practices in conducting its business.

~~Federal~~The operations of the Bank are subject to federal and state statutes applicable to banks chartered under the banking laws ~~and~~of ~~regulations~~the ~~govern~~United States, ~~among~~to ~~other~~members ~~things,~~of the Federal ~~scope~~Reserve ofand ~~a bank~~to banks whose deposits are insured by the FDIC. The Bank’s operations ~~business,~~are also subject to regulations of the ~~investments~~OCC, athe ~~bank~~Securities ~~may~~and Exchange ~~make~~Commission (SEC), the ~~reserves~~Federal ~~against~~Reserve ~~deposits a~~and ~~bank~~the ~~must~~FDIC. ~~maintain,~~The ~~loans~~primary supervisory aauthority ~~bank~~of ~~makes~~the ~~and~~Bank ~~collateral~~is itthe ~~takes~~OCC, who regularly examines the ~~activities~~Bank. ofThe OCC has authority to prevent a national bank ~~with~~from ~~respect~~engaging toin ~~mergers~~unsafe ~~and~~or unsound ~~consolidations~~practices ~~and~~in ~~the~~conducting ~~establishment~~its ~~of branches~~business.

~~The~~Federal ~~Corporation~~ and ~~the~~state ~~Bank~~banking ~~are~~laws ~~subject~~and to regulations ofgovern, ~~certain~~among ~~state~~other ~~and~~things, ~~federal~~the scope of ~~agencies~~a ~~and,~~bank’s ~~accordingly~~business, ~~these~~the ~~regulatory~~investments ~~authorities~~a ~~periodically~~bank ~~examine~~may ~~the Corporation~~make, ~~and~~ the ~~Bank.~~reserves Asagainst deposits a ~~consequence~~bank ofmust ~~the~~maintain, ~~extensive~~loans ~~regulation~~a ~~of commercial~~bank ~~banking~~makes ~~activities,~~and ~~the~~collateral ~~Corporation’s~~it ~~and~~takes, the activities ~~Bank’s~~of ~~business~~a ~~is susceptible~~bank towith ~~being~~respect ~~affected~~to bymergers ~~state~~ and ~~federal~~consolidations ~~legislation~~ and ~~regulations.~~the establishment of branches.

7The Corporation and the Bank are subject to regulations of certain state and federal agencies and, accordingly, these regulatory authorities periodically examine the Corporation and the Bank. As a consequence of the extensive regulation of commercial banking activities, the Corporation’s and the Bank’s business is susceptible to being affected by state and federal legislation and regulations.

As a subsidiary bank of a bank holding company, the Bank is subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or its subsidiaries, or investments in the stock or other securities as collateral for loans. The Federal Reserve Act and Federal Reserve regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship.

Under the Federal Deposit Insurance Act, the OCC possesses the power to prohibit institutions regulated by it (such as the Bank) from engaging in any activity that would be an unsafe and unsound banking practice or would otherwise be in violation of the law. -7-

~~Community~~Under ~~Reinvestment~~the Federal Deposit Insurance Act, the OCC possesses the power to prohibit institutions regulated by it (such as the Bank) from engaging in any activity that would be an unsafe and unsound banking practice or would otherwise be in violation of the law.

~~Under the~~ Community Reinvestment Act, the OCC is required to assess the record of all financial institutions regulated by it to determine if these institutions are meeting the credit needs of the community, including low and moderate income neighborhoods which they serve and to take this record into account in its evaluation of any application made by any of such institutions for, among other things, approval of a branch or other deposit facility, office relocation, a merger or an acquisition of bank shares. The Financial Institutions Reform, Recovery and Enforcement Act amended the CRA to require, among other things, that the OCC make publicly available the evaluation of a bank’s record of meeting the credit needs of its entire community, including low and moderate income neighborhoods. This evaluation will include a descriptive rating like “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance” and a statement describing the basis for the rating. These ratings are publicly disclosed.

~~Bank~~Under ~~Secrecy~~the Community Reinvestment Act, the OCC is required to assess the record of all financial institutions regulated by it to determine if these institutions are meeting the credit needs of the community, including low and moderate income neighborhoods which they serve and to take this record into account in its evaluation of any application made by any of such institutions for, among other things, approval of a branch or other deposit facility, office relocation, a merger or an acquisition of bank shares. The Financial Institutions Reform, Recovery and Enforcement Act amended the CRA to require, among other things, that the OCC make publicly available the evaluation of a bank’s record of meeting the credit needs of its entire community, including low and moderate income neighborhoods. This evaluation will include a descriptive rating like “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance” and a statement describing the basis for the rating. These ratings are publicly disclosed.

~~Under the~~ Bank Secrecy Act, banks and other financial institutions are required to report to the Internal Revenue Service currency transactions of more than $10,000 or multiple transactions of which a bank is aware in any one day that aggregate in excess of $10,000 and to report suspicious transactions under specified criteria. Civil and criminal penalties are provided under the Bank Secrecy Act for failure to file a required report, for failure to supply information required by the Bank Secrecy Act or for filing a false or fraudulent report.

~~Capital~~Under ~~Requirements~~the Bank /Secrecy ~~FDICIA~~Act, banks and other financial institutions are required to report to the Internal Revenue Service currency transactions of more than $10,000 or multiple transactions of which a bank is aware in any one day that aggregate in excess of $10,000 and to report suspicious transactions under specified criteria. Civil and criminal penalties are provided under the Bank Secrecy Act for failure to file a required report, for failure to supply information required by the Bank Secrecy Act or for filing a false or fraudulent report.

~~The~~Capital ~~Federal Deposit~~Requirements ~~Insurance~~/ ~~Corporation Improvement Act of 1991 (~~FDICIA) requires that institutions be classified, based on their risk-based capital ratios into one of five defined categories, as illustrated below: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under these guidelines, the Bank was considered well capitalized for the Tier 1 risk-based and Tier 1 leverage ratios and adequately capitalized for total risk based capital as of December 31, 2008. Unprecedented upheaval in the economy that has negatively impacted the credit and capital markets caused substantial “mark to market” discounts in connection with the acquisition of Willow Financial in December 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. Purchase accounting adjustments related to the Willow Financial acquisition caused the Bank’s total risk-based capital ratio to fall below the regulatory threshold for a well capitalized bank holding company. The Bank has instituted a plan targeted to return to “well capitalized” before the end of 2009.

8The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) requires that institutions be classified, based on their risk-based capital ratios into one of five defined categories, as illustrated below: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under these guidelines, the Bank was considered well capitalized for the total risk based, Tier 1 risk-based and Tier 1 leverage ratios as of December 31, 2009. Unprecedented upheaval in the economy that has negatively impacted the credit and capital markets caused substantial “mark to market” discounts in connection with the acquisition of Willow Financial in December 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 2010 and beyond. Purchase accounting adjustments related to the Willow Financial acquisition caused the Bank’s total risk-based capital ratio to fall below the regulatory threshold for a well capitalized bank holding company as of December 31, 2008. The Bank has executed on its plan targeted to return to “well capitalized” by December 31, 2009.

Under a

Total Risk Based Ratio

Tier 1 Risk Based Ratio

Tier 1 Leverage Ratio

Under a Capital Order or Directive

Total

Tier 1

Capital

Capital category

Risk

Tier 1

Order

Well capitalized

³10.0%

³6.0%

³5.0

YES

Based

Leverage

Adequately capitalized

³8.0%

³4.0%

³4.0

%(1)

Ratio

Directive

Undercapitalized

<8.0%

<4.0%

<4.0

%(1)

Capital category

Significantly undercapitalized

<6.0%

<3.0%

<3.0

Well capitalized

≥10.0%

≥6.0%

≥5.0%

Critically undercapitalized

Tangible equity capital ratio that is ≤ 2%

Adequately capitalized

≥8.0%

≥4.0%

(1)

Undercapitalized

<8.0%

<4.0%

(1)

Significantly undercapitalized

<6.0%

<3.0%

Critically undercapitalized

Tangible equity capital ratio that is ≤ 2%

(1)	3.0% for those banks having the highest available regulatory rating.

InOn ~~the event~~May ~~an institution’s capital deteriorates to the undercapitalized category or below~~28, ~~FDICIA~~ ~~prescribes an increasing amount of regulatory intervention~~2009, ~~including:~~ the ~~institution~~Bank ofwas aadvised ~~capital~~that ~~restoration~~the ~~plan~~OCC ~~and~~established ahigher ~~guarantee~~minimum ~~of the plan by a~~capital ~~parent~~ratios ~~institution;~~for ~~and~~ the ~~placement~~Bank ofthan ~~a hold on increases in assets, number of branches or lines of business. If capital has reached~~ the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and, in critically undercapitalized situations, appointment of a receiver. For “well capitalized” ~~institutions,~~ratios ~~FDICIA~~generally ~~provides~~applicable ~~authority for regulatory intervention where the institution is deemed~~ to ~~be engaging in unsafe~~ orbanks ~~unsound~~under ~~practices~~current ~~or receives a less than satisfactory examination report rating for asset quality, management, earnings or liquidity~~regulations. ~~All~~To ~~but~~be "well ~~capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval.~~

Under FDICIA, financial institutions are subject to increased regulatory scrutiny and must comply with certain operational, managerial and compensation standards developed by Federal Reserve Board regulations. As required by FDICIA, the regulators have adopted guidelines prescribing safety and soundness standards relating to internal controls, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. -8-

~~Annual full-scope~~capitalized," banks ongenerally ~~site~~must ~~regulatory~~maintain ~~examinations~~a ~~are~~Tier ~~required~~1 ~~for~~leverage ~~all~~ratio ~~FDIC-insured institutions~~of ~~except~~at ~~institutions~~least ~~with~~5%, ~~assets~~a ~~under~~Tier ~~$500~~1 risk ~~million~~based ~~that~~capital ~~meet certain~~ratio ~~other~~of ~~criteria~~at ~~may~~least ~~qualify~~6% ~~for~~and ana 18total ~~month~~risk-based oncapital ~~site~~ratio ~~examination~~of at ~~cycle~~least 10%. ~~Banks~~ ~~with~~In ~~total~~the ~~assets~~case of ~~$500~~the ~~million~~Bank, orhowever, ~~more~~the ~~are~~OCC ~~required~~established tohigher “individual ~~have~~minimum ancapital ~~annual audit~~ratios of“ ~~their~~(IMCR) ~~consolidated~~requiring ~~financial~~a ~~statements~~Tier in1 ~~accordance~~leverage ~~with~~ratio ~~generally~~of ~~accepted~~at ~~auditing~~least ~~standards~~eight bypercent an(8%) ~~independent~~of ~~public~~adjusted ~~accountant.~~total ~~The~~assets, ~~independent~~a Tier 1 risk-based ~~accountants~~capital ratio of ~~banks~~at ~~with~~least ten percent (10%) and a total ~~assets~~risk-based capital ratio of $1at ~~billion~~least ortwelve ~~more~~percent ~~are~~(12%) which the Bank was required to ~~attest~~ toachieve ~~the~~by ~~accuracy~~June 30, of2009. ~~management~~The Corporation’s ~~report~~efforts ~~regarding~~to ~~the~~raise ~~internal~~capital ~~controls~~prior of to the ~~bank.~~deadline ultimately Inresulted ~~addition,~~in ~~such~~the ~~banks~~planned ~~also~~merger ~~are~~with ~~required~~First toNiagara, ~~have~~which ~~an independent audit~~was ~~committee~~announced ~~composed~~on ofJuly ~~outside~~28, ~~directors~~2009. ~~who~~In ~~are~~addition, ~~independent~~the ofCorporation ~~management,~~elected to reduce and ~~review~~subsequently ~~with~~suspend ~~management~~its ~~and~~cash ~~the~~dividends ~~independent~~on ~~accountants,~~its ~~the~~common ~~reports~~stock ~~that~~beginning ~~must~~with bethe ~~submitted~~third toquarter ~~the~~of ~~bank~~2009 ~~regulatory~~and ~~agencies.~~to Ifdefer ~~the~~quarterly ~~independent~~interest ~~accountants~~payments ~~resign~~on its oroutstanding ~~are~~subordinated ~~dismissed~~debentures until further notice, ~~written~~beginning ~~notification~~with ~~must~~the interest bepayments ~~given~~that towere ~~the~~due ~~bank’s~~on ~~supervising government~~September ~~banking~~15, ~~agencies~~2009. These actions were taken to conserve capital.

ADuring December ~~separate~~2009, First Niagara entered into a loan transaction to recapitalize the ~~subtitle~~Bank. ~~within~~As ~~FDICIA~~of December 31, ~~called~~2009, the “Corporation borrowed the full $50.0 million available under the credit facility from First Niagara which was contributed to the Bank ~~Enterprise~~as ~~Act~~Tier of1 ~~1991~~capital,” ~~requires~~allowing it to meet the general regulatory capital ratios of a “~~truth~~well capitalized” bank for the first time since September 2008. The Corporation’s regulatory capital ratios as of December 31, 2009 included total risk-inbased capital of 10.64%, Tier 1 risk-~~savings”~~based oncapital ~~consumer~~of ~~deposit~~9.38% ~~accounts~~and soa ~~that~~Tier ~~consumers~~1 leverage ~~can~~capital ~~make~~of 6.33%. The Bank’s regulatory capital ratios as of December ~~meaningful~~31, ~~comparisons~~2009 ~~between~~included ~~the~~total ~~competing~~risk-based ~~claims~~capital of ~~banks~~11.65%, ~~with~~Tier ~~regard~~1 torisk-based capital ~~deposit~~of ~~accounts~~10.39% and ~~products~~a Tier 1 leverage capital of 7.01%. ~~Under~~While ~~this~~these ~~provision~~capital ratios are above the “well capitalized” requirements, athey ~~bank~~are isbelow ~~required~~the Bank’s higher IMCR requirements established by the OCC. In connection with the capital infusion, the OCC extended the deadline for compliance with the IMCR from June 30, 2009 to ~~provide~~March ~~information~~31, 2010, subject to ~~depositors~~continued ~~concerning~~compliance ~~the~~with ~~terms~~“well capitalized” ratios achieved upon receipt of ~~their~~the ~~deposit~~First Niagara loan proceeds. Effective March 4, ~~accounts~~2010, ~~and~~this indeadline ~~particular~~was further extended to May 31, 2010. First Niagara is also prepared to ~~disclose~~buy up to $80 million in commercial and commercial real estate loan participations from the ~~annual~~Corporation ~~percentage~~and ~~yield~~has purchased $63.2 million as of December 31, 2009. These purchases allow the Corporation to originate loans on behalf of First Niagara via a correspondent relationship, both of which will further enhance the Corporation’s regulatory capital ratios and boost lending activities.

~~Capital~~In ~~Distributions~~the event an institution’s capital deteriorates to the undercapitalized category or below, FDICIA prescribes an increasing amount of regulatory intervention, including: the institution of a capital restoration plan and a guarantee of the plan by a parent institution; and the placement of a hold on increases in assets, number of branches or lines of business. If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and, in critically undercapitalized situations, appointment of a receiver. For well capitalized institutions, FDICIA provides authority for regulatory intervention where the institution is deemed to be engaging in unsafe or unsound practices or receives a less than satisfactory examination report rating for asset quality, management, earnings or liquidity. All but well capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval.

~~The~~Under ~~Corporation~~FDICIA, isfinancial ainstitutions ~~legal~~are ~~entity~~subject ~~separate~~to ~~and~~increased ~~distinct~~regulatory ~~from~~scrutiny ~~its banking~~ and ~~other~~ ~~subsidiaries.~~must ~~The~~comply ~~majority~~with ofcertain ~~the~~operational, ~~Corporation’s~~managerial ~~revenue~~and iscompensation ~~from dividends paid~~standards todeveloped ~~the~~by ~~Corporation~~Federal byReserve ~~the~~Board ~~Bank~~regulations. ~~The~~As ~~Bank~~required isby ~~subject~~FDICIA, ~~to various regulatory~~the ~~policies~~regulators ~~and~~have ~~requirements~~adopted ~~relating~~guidelines toprescribing ~~the~~safety ~~amount~~ and ~~frequency~~soundness ~~of dividend~~standards ~~declarations.~~relating ~~Future dividend payments~~ to ~~the~~internal ~~Corporation~~controls, byloan ~~the~~documentation, ~~Bank~~credit ~~will~~underwriting, beinterest ~~dependent~~rate ~~on a number of factors~~exposure, ~~including~~asset ~~the~~growth ~~earnings~~ and ~~financial condition of the Bank~~compensation, ~~and~~fees ~~are subject to limitations~~ and ~~other statutory powers of bank regulatory agencies~~benefits.

9Annual full-scope, on site regulatory examinations are required for all FDIC-insured institutions except institutions with assets under $500 million that meet certain other criteria may qualify for an 18 month on site examination cycle. Banks with total assets of $500 million or more are required to have an annual audit of their consolidated financial statements in accordance with generally accepted auditing standards by an independent public accountant. The independent accountants of banks with total assets of $1 billion or more are required to attest to the accuracy of management’s report regarding the internal controls of the bank. In addition, such banks also are required to have an independent audit committee composed of outside directors who are independent of management, to review with management and the independent accountants, the reports that must be submitted to the bank regulatory agencies. If the independent accountants resign or are dismissed, written notification must be given to the bank’s supervising government banking agencies.

The National Banking Laws require the approval of the OCC if the total of all dividends declared by a national bank in any calendar year exceed the net profits of the bank for that year combined with its retained net profits for the preceding two calendar years. An insured depository institution is prohibited from making any capital distributions to its owner, including any dividend, if, after making such distribution, the depository institution fails to meet the required minimum level for any relevant capital measure, including the risk-~~based capital adequacy and leverage standards previously discussed in the capital requirements section.~~ 9-

~~Deposit~~A separate ~~Insurance~~subtitle within FDICIA, called the “Bank Enterprise Act of 1991,” requires “truth-in-savings” on consumer deposit accounts so that consumers can make meaningful comparisons between the competing claims of banks with regard to deposit accounts and ~~Premiums~~products. Under this provision, a bank is required to provide information to depositors concerning the terms of their deposit accounts, and in particular, to disclose the annual percentage yield.

~~The~~Capital Bank’s deposits are insured by the Deposit Insurance Fund (DIF) which is administered by the FDIC. The basic insurance limit is $250,000 per depositor per insured institution through December 31, 2009. Certain retirement accounts, such as Individual Retirement Accounts are insured up to $250,000 per depositor per insured institution. The FDIC is authorized to consider inflation adjustments to increase the insurance limits for all deposit accounts every five years, beginning in 2010. The insurance is backed by the full faith and credit of the United States government. Distributions

~~As insurer,~~The ~~the~~Corporation ~~FDIC~~is ~~imposes~~a ~~deposit~~legal ~~insurance~~entity ~~premiums~~separate and isdistinct ~~authorized~~from toits ~~conduct~~banking and other ~~examinations~~subsidiaries. The majority of, ~~and~~the Corporation’s revenue is from dividends paid to ~~require~~the ~~reporting~~Corporation by, ~~FDIC-insured~~the ~~institutions~~Bank. ItThe ~~also may~~Bank ~~prohibit~~is ~~any~~subject ~~FDIC-insured~~to ~~institution~~various ~~from~~regulatory policies ~~engaging~~and inrequirements ~~any~~relating ~~activity~~to the ~~FDIC determines~~amount byand ~~regulation~~frequency orof ~~order~~dividend declarations. toFuture ~~pose~~dividend apayments ~~serious risk~~ to the ~~insurance~~Corporation ~~fund. The~~by ~~FDIC~~the ~~also~~Bank ~~has~~will ~~the~~be dependent ~~authority~~on toa ~~terminate~~number anof ~~institution’s~~factors, ~~deposit~~including ~~insurance if~~the itearnings ~~determines~~and ~~that~~financial condition of the ~~institution~~Bank, ~~has~~and ~~engaged~~are insubject ~~unsafe~~to orlimitations ~~unsound~~and ~~practices or~~other isstatutory inpowers anof ~~unsafe~~bank regulatory ~~or unsound condition~~agencies.

~~On November~~The 2,National ~~2006,~~Banking ~~the~~Laws ~~FDIC~~require ~~set~~ the ~~designated~~approval ~~reserve~~of ~~ratio for~~ the ~~deposit~~OCC ~~insurance fund~~if atthe ~~1.25%~~total of ~~estimated insured deposits and adopted final regulations to~~all ~~implement~~dividends ~~the~~declared ~~risk-based deposit insurance assessment system mandated~~ by ~~the Deposit~~a ~~Insurance~~national ~~Reform Act of 2005, which more closely ties each~~ bank~~'s deposit~~ ~~insurance~~in ~~assessments~~any tocalendar ~~the~~year ~~risk~~exceed ~~it poses to~~ the ~~deposit insurance~~net ~~fund.~~profits ~~Under~~of the ~~new~~bank ~~risk-based assessment system, the FDIC evaluates each institution's risk based on three primary factors -- supervisory ratings~~ for ~~all insured~~that ~~institutions,~~year ~~financial~~combined ~~ratios~~with ~~for~~its ~~most~~retained ~~institutions,~~net ~~and~~profits ~~long-term debt issuer ratings~~ for ~~large institutions that have them and places~~ the ~~institution~~ ~~into~~preceding ~~one~~two ofcalendar ~~four risk categories~~years. ~~Effective~~An ~~January~~insured 1,depository ~~2007,~~institution ~~the~~is ~~rates range~~prohibited from 5making toany 43capital ~~basis~~distributions ~~points. However, the Deposit Insurance Reform Act of 2005 provided credits~~ to ~~institutions~~its ~~that~~owner, ~~paid~~including ~~high~~any ~~premiums~~dividend, ~~in the past to bolster~~if, ~~the~~after ~~FDIC's~~making ~~insurance~~such ~~reserves~~distribution, asthe adepository ~~result~~institution offails ~~which a majority of banks had assessment credits~~ to ~~initially~~meet ~~offset all of their premiums in 2007. The~~the ~~assessment~~required ~~credits~~minimum level for ~~the~~any ~~Bank~~relevant ~~were~~capital ~~fully utilized by December 31~~measure, ~~2008.~~including ~~The Bank was classified in~~ the ~~strongest~~ risk-based ~~category~~capital ~~for~~adequacy ~~2008~~ and ~~its~~leverage ~~assessment rate~~standards ~~was~~previously ~~approximately~~discussed ~~6.3~~in ~~basis points. The Bank paid FDIC premiums of $2.1~~the ~~million~~capital inrequirements ~~2008, including $248,000 for Willow Financial~~section.

InDeposit ~~December 2008,~~Insurance the FDIC approved a final rule which will raise assessment rates uniformly by seven basis points for the first quarter of 2009 only. The FDIC proposes to establish new assessment rates effective April 1, 2009. The Bank expects that the assessment rates subsequent to the first quarter of 2009 will continue to be significantly higher than in 2008. The Bank estimates that its FDIC assessment for the first quarter of 2009 will be approximately $1.3 million. In addition, all insured institutions are required to pay a Financing Corporation (FICO) assessment. FICO is a government agency-sponsored entity that was formed to borrow money necessary to carry out the closing and disposition of failed thrift institutions in the 1980’s. The annual FICO rate for all insured institutions as of December 31, 2008 was 1.14 basis points. These assessments are revised quarterly and will continue until the bonds mature in the year 2019. The Bank paid FICO premiums of $364,000 in 2008. Premiums

~~Any~~The Bank’s deposits are ~~significant~~insured ~~increases~~by inthe ~~assessment~~Deposit ~~rates~~Insurance orFund ~~additional~~(DIF) ~~special~~which ~~assessments~~is administered by the FDIC. The basic insurance limit is $250,000 per depositor per insured institution through December 31, 2009. Certain retirement accounts, such as Individual Retirement Accounts are insured up to $250,000 per depositor per insured institution. The FDIC ~~could~~is ~~have~~authorized anto ~~adverse~~consider ~~impact~~inflation onadjustments to increase the ~~results~~insurance oflimits ~~operations~~for ~~and~~all ~~capital~~deposit accounts every five years, ofbeginning in 2010. The insurance is backed by the ~~Bank~~full faith and credit of the United ~~Corporation.~~States government.

10As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund. The FDIC also has the authority to terminate an institution’s deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

~~Sarbanes~~On November 2, 2006, the FDIC set the designated reserve ratio for the deposit insurance fund at 1.25% of estimated insured deposits and adopted final regulations to implement the risk-~~Oxley~~based deposit insurance assessment system mandated by the Deposit Insurance Reform Act of ~~2002~~2005, which more closely ties each bank's deposit insurance assessments to the risk it poses to the deposit insurance fund. Under the new risk-based assessment system, the FDIC evaluates each institution's risk based on three primary factors -- supervisory ratings for all insured institutions, financial ratios for most institutions, and long-term debt issuer ratings for large institutions that have them and places the institution into one of four risk categories. Effective January 1, 2007, the rates range from 5 to 43 basis points. However, the Deposit Insurance Reform Act of 2005 provided credits to institutions that paid high premiums in the past to bolster the FDIC's insurance reserves, as a result of which a majority of banks had assessment credits to initially offset all of their premiums in 2007. The assessment credits for the Bank were fully utilized by December 31, 2008.

~~The~~In December ~~Sarbanes-Oxley~~2008, ~~Act~~the ofFDIC ~~2002 implemented~~approved a ~~broad~~final ~~range~~rule ofwhich ~~corporate~~raised ~~governance,~~assessment ~~accounting and reporting~~rates ~~measures~~uniformly ~~for~~by ~~companies~~seven ~~that~~basis ~~have~~points ~~securities~~for ~~registered under~~ the ~~Exchange~~first ~~Act, including~~quarter ~~publicly-held~~of ~~bank~~2009 ~~holding companies~~only. The ~~more significant reforms of~~FDIC ~~the~~established ~~Sarbanes-Oxley~~new ~~Act~~assessment ofrates ~~2002~~effective ~~included:~~April (1), ~~new~~2009. ~~requirements~~As ~~for~~a ~~audit committees~~result, ~~including independence, expertise, and~~the ~~responsibilities;~~assessment ~~(2)~~rates ~~certification~~subsequent ofto ~~financial statements by~~ the ~~Chief Executive~~first ~~Officer~~quarter ~~and Chief Financial Officer~~ of ~~the~~2009 ~~reporting~~were ~~company; (3) new~~significantly ~~standards~~higher ~~for~~than ~~auditors~~in ~~and~~2008. ~~regulation~~The ofBank ~~audits,~~estimates ~~including independence provisions~~ that ~~restrict~~its ~~non-audit~~FDIC ~~services~~assessment ~~that accountants may provide to their audit clients; (4) increased disclosure and reporting obligations~~ for the ~~reporting~~ ~~company and their directors and executive officers, including~~first ~~accelerated~~quarter ~~reporting~~ of ~~stock~~2010 ~~transactions~~will ~~and~~be aapproximately ~~prohibition on trading during pension blackout periods; (5) a range of new and increased civil and criminal penalties for fraud and other violations of the securities laws~~$3.2 million.

~~USA~~On November ~~Patriot~~12, ~~Act~~2009, the FDIC adopted a final rule that requires all insured depository institutions, with limited exceptions, to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The Corporation was exempt from the prepayment as a result of the pending merger with First Niagara.

In addition, all insured institutions are required to pay a Financing Corporation (FICO) assessment. FICO is a government agency-sponsored entity that was formed to borrow money necessary to carry out the closing and

The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act) imposes additional obligations on financial institutions, including banks and broker-dealer subsidiaries, to implement policies, procedures and controls which are reasonably designed to detect and report instances of money laundering and the financing of terrorism. In addition, provisions of the USA Patriot Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution’s anti10-~~money laundering activities when reviewing bank mergers and bank holding company acquisitions.~~

~~Supervision~~disposition of failed thrift institutions in the 1980’s. The annual FICO rate for all insured institutions as of December 31, 2009 was 1.04 basis points. These assessments are revised quarterly and ~~Regulation~~will -continue until the bonds mature in ~~Cornerstone~~the ~~Companies~~year 2019. The Bank paid FICO premiums of $424,000 in 2009.

~~The~~Any ~~Cornerstone~~significant ~~Companies~~increases ~~(Cornerstone~~in ~~Financial~~assessment ~~Consultants,~~rates ~~Ltd.~~or ~~(CFC), Cornerstone~~additional ~~Institutional~~special ~~Investors,~~assessments ~~Inc. (CII) and Cornerstone Advisors Asset Management, Inc. (CAAM)) are subject to regulation~~ by ~~a number of federal~~ ~~regulatory agencies that are charged with safeguarding~~ the ~~integrity~~FDIC ofcould ~~the securities~~have ~~and~~an ~~other~~adverse ~~financial~~impact ~~markets~~on ~~and with protecting~~ the ~~interests~~results of ~~customers~~ ~~participating~~operations ~~in those markets. The SEC is the federal agency that is primarily responsible for the regulation of broker-dealers~~ and ~~investment~~capital advisers doing business in the United States. The Federal Reserve Board promulgates regulations applicable to securities credit transactions involving broker-dealers and certain other institutions. Much of the ~~regulation~~Bank of CII, as a registered broker-dealer, however, has been delegated to self-regulatory organizations (SROs), principally FINRA (Financial Industry Regulatory Authority, formerly known as the NASD), its subsidiaries and the ~~national securities exchanges~~Corporation. These SROs, which are subject to oversight by the SEC, adopt rules (which are subject to approval by the SEC) that govern the industry, monitor daily activity and conduct periodic examinations of member broker-dealers.

~~CII,~~Sarbanes-Oxley ~~CFC and CAAM are registered investment advisers with the SEC and are subject to the requirements of the Investment Advisers~~ Act of 1940 and the SEC’s regulations, as well as certain state securities laws and regulations. These requirements relate to limitations on the ability of an investment adviser to charge performance-based or non-refundable fees to clients, record-keeping and reporting requirements, disclosure requirements, limitations on principal transactions between an adviser or its affiliates and advisory clients, as well as general anti-fraud prohibitions. CII, as a broker-dealer registered with the SEC and as a member firm of FINRA, is subject to capital requirements of the SEC and the FINRA. These capital requirements specify minimum levels of capital that CII is required to maintain and also limit the amount of leverage that it is able to obtain in its respective business. 2002

InThe Sarbanes-Oxley ~~the~~Act ~~event~~ of ~~non-compliance~~2002 ~~with~~implemented ana ~~applicable~~broad ~~regulation,~~range ~~governmental~~of ~~regulators~~corporate governance, accounting and reporting measures for companies that have securities registered ~~FINRA,~~under ifthe ~~concerning~~Exchange ~~CII~~Act, ~~may~~including ~~institute~~publicly-held ~~administrative~~bank orholding ~~judicial~~companies. ~~proceedings~~The more ~~that~~significant ~~may~~reforms ~~result~~of inthe ~~censure,~~Sarbanes-Oxley ~~fine~~Act of 2002 included: (1) new requirements for audit committees, ~~civil~~including ~~penalties~~independence, ~~the~~expertise, ~~issuance~~and responsibilities; (2) certification of financial statements by the Chief ~~cease-~~Executive Officer and~~-desist~~ ~~orders~~Chief orFinancial Officer of the ~~deregistration~~reporting orcompany; ~~suspension~~(3) new standards for auditors and regulation of ~~the~~audits, ~~non-compliant~~including independence ~~broker-dealer~~provisions orthat ~~investment~~restrict ~~adviser~~non-audit orservices ~~other~~that ~~adverse~~accountants ~~consequences.~~may ~~The~~provide to ~~imposition~~their ofaudit ~~any~~clients; ~~such~~(4) ~~penalties~~increased ordisclosure ~~orders~~and onreporting obligations for the reporting ~~Cornerstone~~company ~~Companies~~and ~~could~~their directors and executive officers, including ~~have~~accelerated areporting ~~material~~of ~~adverse~~stock ~~effect~~transactions and a prohibition on ~~the~~trading ~~Cornerstone~~during pension ~~Companies’~~blackout periods; (5) a range of new and ~~therefore~~increased ~~the~~civil and criminal ~~Corporation’s)~~penalties ~~operating~~for ~~results~~fraud and ~~financial~~other ~~condition.~~violations of the securities laws.

~~CII~~USA isPatriot ~~a member of the Securities Investor Protection Corporation (SIPC), which is a non-profit corporation that was created by the United States Congress under the Securities Protection~~ Act of 1970. SIPC protects customers of member broker-dealers against losses caused by the financial failure of the broker-dealer but not against a change in the market value of securities in customers’ accounts at the broker-dealer. In the event of the inability of a member broker-dealer to satisfy the claims of its customers in the event of its failure, the SIPC’s funds are available to satisfy the remaining claims up to maximum of $500,000 per customer, including up to $100,000 on claims for cash. In addition, CII’s clearing firm, Pershing LLC, carries private insurance that provides unlimited account protection in excess of SIPC’s protection.

11The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act) imposes additional obligations on financial institutions, including banks and broker-dealer subsidiaries, to implement policies, procedures and controls which are reasonably designed to detect and report instances of money laundering and the financing of terrorism. In addition, provisions of the USA Patriot Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.

~~Changes~~Supervision inand ~~Regulations~~Regulation - Cornerstone Companies

~~From~~The Cornerstone ~~time~~Companies ~~to time,~~(Cornerstone ~~various~~Financial ~~types~~Consultants, ofLtd. ~~federal~~(CFC), Cornerstone ~~and~~Institutional ~~state~~Investors, ~~legislation~~Inc. ~~have~~(CII) ~~been~~and ~~proposed~~Cornerstone ~~that~~Advisors Asset ~~could~~Management, ~~result~~Inc. in(CAAM)) ~~additional~~are subject to regulation by a number of, ~~and~~federal regulatory ~~restriction~~agencies ~~on,~~that are charged with safeguarding the ~~business~~integrity of the securities ~~Corporation~~ and ~~the~~other ~~Bank.~~financial Itmarkets ~~cannot~~and bewith ~~predicted~~protecting ~~whether~~the ~~any~~interests ~~such~~of ~~legislation~~customers ~~will~~participating bein ~~adopted~~those ~~or,~~markets. ifThe ~~adopted,~~SEC ~~how~~is ~~such~~the ~~legislation~~federal ~~would~~agency ~~affect~~that is primarily responsible for the ~~business~~regulation of ~~the~~broker-dealers ~~Corporation~~and orinvestment advisers doing business in the ~~Bank~~United States. AsThe aFederal ~~consequence~~Reserve Board promulgates regulations applicable to securities credit transactions involving broker-dealers and certain other institutions. Much of the ~~extensive~~ regulation of ~~commercial~~CII, ~~banking~~as a ~~activities~~registered inbroker-dealer, ~~the~~however, ~~United~~has ~~States~~been delegated to self-regulatory organizations (SROs), ~~the~~principally FINRA (Financial Industry Regulatory ~~Corporation~~Authority, formerly known as the NASD), its subsidiaries and the ~~Bank~~national securities ~~are~~exchanges. ~~particularly~~These ~~susceptible~~SROs, towhich ~~being~~are ~~affected~~subject to oversight by the SEC, ~~federal~~adopt ~~legislation~~rules (which ~~and~~are ~~regulations~~subject ~~that~~to ~~may~~approval ~~increase~~by the ~~costs~~SEC) that govern the industry, monitor daily activity and conduct periodic examinations of ~~doing~~member ~~business~~broker-dealers.

~~Additional~~CII, ~~Information~~CFC and CAAM are registered investment advisers with the SEC and are subject to the requirements of the Investment Advisers Act of 1940 and the SEC’s regulations, as well as certain state securities laws and regulations. These requirements relate to limitations on the ability of an investment adviser to charge performance-based or non-refundable fees to clients, record-keeping and reporting requirements, disclosure requirements, limitations on principal transactions between an adviser or its affiliates and advisory clients, as well as general anti-fraud prohibitions. CII, as a broker-dealer registered with the SEC and as a member firm of FINRA, is subject to capital requirements of the SEC and the FINRA. These capital requirements specify minimum levels of capital that CII is required to maintain and also limit the amount of leverage that it is able to obtain in its respective business.

~~The Corporation’s Annual Report on Form 10~~-~~K, Quarterly Reports on Form 10~~11-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on the Corporation’s website (www.hncbank.com under “Financial Information & Filings—Documents”) as soon as reasonably practicable after the Corporation electronically files such material with, or furnishes it to the Securities and Exchange Commission. These filings are also accessible on the Securities and Exchange Commission’s website (www.sec.gov). You may also read and copy any materials the Corporation files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the Corporation makes available on www.hncbank.com under “Corporate Governance” the following: 1) Audit Committee Charter, 2) Code of Ethics, which applies to all directors and all employees, 3) Whistleblower Policy, 4) Nominating and Corporate Governance Committee Charter and 5) Compensation Committee Charter.

~~Item~~In 1Athe event of non-compliance with an applicable regulation, governmental regulators and FINRA, if concerning CII, may institute administrative or judicial proceedings that may result in censure, fine, civil penalties, the issuance of cease-and-desist orders or the deregistration or suspension of the non-compliant broker-dealer or investment adviser or other adverse consequences. ~~Risk~~The imposition ~~Factors~~of any such penalties or orders on the Cornerstone Companies could have a material adverse effect on the Cornerstone Companies’ (and therefore the Corporation’s) operating results and financial condition.

~~The~~CII ~~business~~is a member of the Securities Investor Protection Corporation ~~and~~(SIPC), ~~the~~which ~~Bank~~is ~~involve~~a non-profit ~~significant~~corporation ~~risks~~that aswas ~~described~~created ~~below. Additional~~by ~~risks~~the ~~may~~United ~~arise~~States inCongress under the Securities ~~future~~Protection orAct ~~risks~~of ~~that~~1970. ~~are~~SIPC ~~currently~~protects ~~not~~customers of member ~~considered~~broker-dealers ~~significant~~against ~~may~~losses ~~also~~caused ~~impact~~by the ~~operations~~financial failure of the ~~Corporation and the~~ ~~Bank.~~broker-dealer ~~The~~but ~~Corporation~~not ~~may~~against ~~amend~~a orchange ~~supplement~~in the ~~risk~~market ~~factors~~value ~~described~~of ~~below~~securities in ~~from~~customers’ ~~time~~accounts toat ~~time~~the bybroker-dealer. ~~reports~~In ~~filed with~~ the ~~SEC~~event inof the ~~future.~~inability ~~Management’s~~of a ~~ability~~member broker-dealer to ~~analyze~~satisfy ~~and~~the ~~manage~~claims ~~these~~of ~~and~~its ~~other~~customers ~~risks~~in ~~could~~the ~~affect~~event ~~the~~of ~~future~~its ~~financial~~failure, ~~results~~the ofSIPC’s ~~the~~funds ~~Corporation.~~are Ifavailable ~~any~~to ofsatisfy the ~~events~~remaining orclaims ~~circumstances~~up to ~~described~~maximum inof ~~the~~$500,000 ~~following~~per ~~risks occurs~~customer, ~~the~~including ~~financial~~up ~~condition~~to or$100,000 ~~results~~on ofclaims for cash. ~~operations~~In ofaddition, ~~the~~CII’s ~~Corporation~~clearing ~~could~~firm, ~~suffer~~Pershing ~~and~~LLC, carries ~~the~~private ~~trading~~insurance ~~price~~that ofprovides ~~the Corporation’s~~unlimited ~~common~~account ~~stock~~protection ~~could~~in ~~decline.~~excess of SIPC’s protection.

~~Interest~~Changes ~~rate~~in ~~movements impact the earnings of the Corporation.~~ Regulations

~~The Corporation~~From ~~is exposed~~ time to ~~interest rate risk~~time, ~~through~~various ~~the~~types ~~operations~~ of ~~its banking~~federal ~~subsidiary, since substantially all of the Bank’s assets~~ and ~~liabilities are~~state ~~monetary~~legislation inhave ~~nature.~~been ~~Interest~~proposed ~~rate risk arises from market driven fluctuations in interest rates~~ that ~~affect cash flows, income, expense and value~~ ofcould ~~financial~~result ~~instruments.~~in ~~The~~additional ~~Bank’s~~regulation ~~earnings, like that~~ of ~~most financial institutions~~, ~~largely~~and ~~depends~~restriction on ~~net interest income~~, ~~which is~~ the ~~difference between~~business of the ~~interest~~Corporation ~~income earned on interest-earning assets, such as loans~~ and ~~investments,~~ ~~and~~ the ~~interest~~Bank. ~~expense~~It ~~paid~~cannot onbe ~~interest-bearing~~predicted ~~liabilities,~~whether any such aslegislation ~~deposits~~will ~~and~~be ~~borrowings.~~adopted Inor, anif ~~increasing interest rate environment~~adopted, ~~the~~how ~~cost of~~such ~~funds~~legislation iswould ~~expected to increase more rapidly than the interest earned on the~~affect ~~loans and securities because~~ the ~~primary~~business ~~source~~ of ~~funds~~the ~~are~~Corporation ~~deposits~~or ~~with generally shorter maturities than~~ the ~~maturities~~Bank. onAs ~~loans~~a ~~and~~consequence ~~investment securities.~~of ~~This causes~~ the ~~net interest rate spread to compress and negatively~~extensive ~~impacts~~regulation ~~the~~of ~~Bank’s~~commercial ~~profitability.~~banking ~~Changes~~activities in ~~interest~~the ~~rates~~United ~~may~~States, ~~also adversely affect~~ the Corporation’s ~~loan~~ and ~~deposit growth and~~ the ~~quality~~Bank ~~of its loan portfolio. The Corporation actively manages its interest rate sensitivity positions. The objectives of interest rate risk management~~ are toparticularly ~~control exposure~~susceptible ~~of net interest income~~ to ~~risks~~being ~~associated~~affected ~~with~~by federal ~~interest~~legislation ~~rate movements~~ and toregulations ~~achieve~~that ~~consistent~~may ~~growth~~increase inthe ~~net~~costs ~~interest~~of ~~income. Continued aggressive~~doing ~~pricing by competitors for loans and deposits may adversely affect the Corporation’s profitability~~business.

12 Additional Information

The Corporation’s isAnnual ~~exposed~~Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to ~~risks~~those inreports filed or furnished ~~connection~~pursuant ~~with~~to ~~loans~~Section 13(a) or 15(d) of the ~~Bank~~Securities ~~makes~~Exchange ~~and~~Act ifof 1934 are available free of charge on the ~~allowance~~Corporation’s ~~for~~website ~~loan~~(www.hncbank.com ~~losses~~under “Financial isInformation ~~not~~& Filings—Documents”) as soon as reasonably ~~sufficient~~practicable toafter ~~cover~~the ~~actual~~Corporation ~~loan~~electronically ~~losses~~files such material with, or furnishes it to the Securities and Exchange Commission. These filings are also accessible on the Securities and Exchange Commission’s website (www.sec.gov). You may also read and copy any materials the Corporation files with the SEC at the SEC’s Public ~~earnings~~Reference ~~could~~Room at 100 F Street, NE, Washington, DC 20549. You may obtain ~~decrease~~information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the Corporation makes available on www.hncbank.com under “Corporate Governance” the following: 1) Audit Committee Charter, 2) Code of Ethics, which applies to all directors and all employees, 3) Whistleblower Policy, 4) Nominating and Corporate Governance Committee Charter and 5) Compensation Committee Charter.

~~A significant~~Item source of risk for the Corporation arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans1A. ~~The~~Risk Corporation has underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that are believed to be adequate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying loan portfolios. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect the Corporation’s results of operations. Factors

The ~~Corporation~~business ~~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~~Corporation ofand the ~~allowance~~Bank isinvolve ~~based~~significant onrisks ~~periodic~~as ~~evaluations~~described ofbelow. ~~the~~Additional ~~loan~~risks ~~portfolio~~may ~~and~~arise ~~other~~in ~~relevant~~the ~~factors.~~future ~~However,~~or ~~this~~risks ~~evaluation~~that ~~is inherently~~are ~~subjective~~currently asnot considered ~~it requires~~ significant ~~estimates~~may byalso ~~management. Consideration~~impact isthe ~~given~~operations ~~to a variety~~ of ~~factors~~the inCorporation ~~establishing~~and ~~these estimates~~the ~~including~~Bank. ~~historical~~The ~~losses,~~Corporation ~~current~~may ~~and~~amend ~~anticipated~~or ~~economic~~supplement ~~conditions, diversification of~~ the ~~loan~~risk ~~portfolio,~~factors ~~delinquency~~described ~~statistics, results of~~below ~~internal~~from ~~loan~~time ~~reviews,~~to ~~borrowers’~~time ~~perceived~~by ~~financial~~reports ~~and~~filed ~~management~~with ~~strengths,~~ the ~~adequacy~~SEC ofin ~~underlying collateral,~~ the ~~dependence~~future. ~~on collateral, or the~~Management’s ~~strength~~ability ofto ~~the~~analyze ~~present~~and ~~value~~manage ofthese ~~future cash flows~~ and other ~~relevant~~risks ~~factors. These~~could ~~factors~~affect ~~may be susceptible to significant change. To~~ the ~~extent actual~~future ~~outcomes~~financial ~~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~~Corporation. InIf ~~addition,~~any ~~various regulatory agencies, as an integral part~~ of ~~their~~the ~~examination~~events ~~process,~~or ~~periodically review the allowance~~circumstances ~~for~~described ~~loan~~in ~~losses. Such agencies may require~~ the ~~Corporation~~following torisks ~~recognize additions~~occurs, to the ~~allowance~~financial ~~based~~condition onor ~~their~~results ~~judgment~~ of ~~information available to~~ ~~them~~operations atof the ~~time~~Corporation ofcould ~~their~~suffer ~~examination.~~and ~~If economic conditions weaken in~~ the ~~geographic~~ ~~region~~trading ~~served~~price byof the Corporation,’s ~~the~~common ~~allowance~~stock ~~may not be sufficient to cover actual loan losses, which~~ could ~~adversely affect our profitability~~decline.

~~The~~Interest ~~Corporation’s~~rate ~~ability~~movements toimpact ~~pay dividends~~the isearnings ~~subject~~of tothe ~~limitations~~Corporation.

The Corporation is aexposed ~~bank~~to ~~holding~~interest ~~company~~rate ~~and~~risk, ~~its~~through the operations ~~are~~of ~~conducted by direct~~its ~~and~~banking ~~indirect subsidiaries~~subsidiary, ~~each~~since ofsubstantially ~~which~~all isof athe ~~separate~~Bank’s assets and ~~distinct legal~~liabilities ~~entity~~are monetary in nature. ~~Substantially~~Interest ~~all~~rate ofrisk ~~the~~arises ~~Corporation’s~~from ~~assets~~market ~~are~~driven fluctuations ~~held~~in byinterest ~~its~~rates ~~direct~~that affect cash flows, income, expense and value ~~indirect~~of ~~subsidiaries.~~financial instruments.

The Corporation’s ability to pay dividends depends on its receipt of dividends from its direct and indirect subsidiaries. Its principal banking subsidiary, Harleysville National Bank, is its primary source of dividends. Dividend payments from its banking subsidiaries are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking regulatory agencies. The ability of banking subsidiaries to pay dividends is also subject to their profitability, financial condition, capital expenditures and other cash flow requirements. There is no assurance that the Corporation’s subsidiaries will be able to pay dividends in the future or that the Corporation will generate adequate cash flow to pay dividends in the future. The Corporation’s failure to pay dividends on its common stock could have a material adverse effect on the market price of its common stock.-12-

The Bank’s ~~Corporation~~earnings, ~~may~~like ~~fail~~that of most financial institutions, largely depends on net interest income, which is the difference between the interest income earned on interest-earning assets, such as loans and investments, and the interest expense paid on interest-bearing liabilities, such as deposits and borrowings. In an increasing interest rate environment, the cost of funds is expected to increase ~~realize~~more rapidly than the interest earned on the loans and securities ~~anticipated~~because ~~benefits~~the ~~from~~primary ~~mergers~~source of funds are deposits with generally shorter maturities than the maturities on loans and investment securities. This causes the net interest rate spread to compress and negatively impacts the Bank’s profitability. Changes in interest rates may also adversely affect the Corporation’s loan and deposit growth and the quality of its loan portfolio. 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. Continued aggressive pricing by competitors for loans and deposits may adversely affect the Corporation’s profitability.

The ~~success~~ ~~of mergers will depend, in part, on the~~ Corporation’s ~~ability to realize the estimated cost savings or revenue enhancements from combining the businesses of the merged companies. If the Corporation’s estimates are incorrect or the Corporation~~ is ~~unable~~exposed to ~~combine~~risks ~~acquired companies successfully, the anticipated benefits may not be realized fully or at all, or may take longer to realize than expected. The integration process could result~~ in ~~the~~connection ~~loss~~with ofloans ~~key employees,~~ the ~~disruption~~Bank ofmakes ~~ongoing business, inconsistencies in standards, controls, procedures~~ and ~~policies that adversely affect the Corporation’s~~if ~~ability to maintain relationships with clients and employees or achieve~~ the ~~anticipated~~ ~~benefits~~allowance offor ~~the~~loan ~~merger.~~losses Asis ~~with~~not ~~any~~sufficient ~~merger of financial institutions, there also may be disruptions that cause the Bank~~ to ~~lose customers~~cover oractual ~~cause~~loan ~~customers to withdraw their deposits from the Bank~~losses, ~~or other unintended consequences that could have a material adverse effect on~~ the Corporation’s ~~results~~earnings ofcould ~~operations or financial condition~~decrease.

13A significant source of risk for the Corporation arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The Corporation has underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that are believed to be adequate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying loan portfolios. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect the Corporation’s results of operations.

~~Future~~The Corporation ~~acquisitions~~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 ~~Corporation~~loan portfolio, delinquency statistics, results of ~~could~~internal ~~dilute~~loan ~~shareholder~~reviews, ~~ownership~~borrowers’ perceived financial and management strengths, the adequacy of underlying collateral, the ~~Corporation~~dependence on collateral, or the strength of the present value of future cash flows and other relevant factors. These factors may ~~cause~~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. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require the Corporation to ~~become~~recognize additions ~~more~~to ~~susceptible~~the allowance based on their judgment of information available to them ~~adverse~~at ~~economic~~the ~~events~~time of their examination. If economic conditions weaken in the geographic region served by the Corporation, the allowance may not be sufficient to cover actual loan losses, which could materially adversely affect our profitability.

The Corporation has acquired other companies with its common stock in the past and may acquire or make investments in banks and other complementary businesses in the future. The Corporation may issue shares of its common stock in connection with these potential acquisitions and other investments, which would dilute shareholder ownership interest in the Corporation in the event that shareholders receive consideration in the form of the Corporation’s ~~common~~ability ~~stock. While there is no assurance that these transactions will occur, or that they will occur on terms favorable~~ to ~~the~~pay ~~Corporation,~~dividends ~~future~~is ~~business~~subject ~~acquisitions could be material~~ to ~~the Corporation, and the degree of success achieved in acquiring and integrating these businesses into the Corporation could have a material effect on the value of Corporation’s common stock~~limitations. In addition, any such acquisition could require the Corporation to expend substantial cash or other liquid assets or to incur debt, which could cause the Corporation to become more susceptible to economic downturns and competitive pressures.

AnThe Corporation ~~economic~~is ~~downturn~~a inbank ~~eastern~~holding company and its operations are conducted by direct ~~Pennsylvania~~and orindirect asubsidiaries, ~~general~~each ~~decline~~of inwhich ~~economic~~is ~~conditions~~a ~~could~~separate ~~adversely~~and ~~affect~~distinct legal entity. Substantially all of the Corporation’s ~~financial~~assets ~~results.~~are held by its direct and indirect subsidiaries.

The ~~Bank~~ Corporation’s ~~operations~~ ~~are~~ability ~~concentrated~~to inpay ~~eastern~~dividends ~~Pennsylvania~~depends ~~and~~on toits areceipt ~~lesser~~of ~~degree~~dividends from ~~central~~its direct and ~~southern~~indirect ~~New~~subsidiaries. ~~Jersey~~Its ~~and~~principal ~~Delaware.~~banking Assubsidiary, Harleysville aNational ~~result~~Bank, is its primary source of ~~this~~dividends. ~~geographic~~Dividend ~~concentration,~~payments ~~the~~from ~~Corporation’s~~its ~~financial~~banking ~~results~~subsidiaries ~~may~~are ~~correlate~~subject to ~~the~~legal ~~economic~~and regulatory ~~conditions~~limitations, ingenerally ~~this~~based ~~area.~~on ~~Deterioration~~net inprofits ~~economic~~and ~~conditions~~retained inearnings, ~~this~~imposed ~~market~~by ~~area,~~the ~~particularly~~various inbanking ~~the~~regulatory ~~industries~~agencies. onThe ~~which~~ability ~~this~~of ~~geographic~~banking ~~areas~~subsidiaries ~~depend~~to pay dividends is also subject to their profitability, orfinancial acondition, ~~general~~capital ~~decline~~expenditures inand ~~economic~~other ~~conditions~~cash ~~may~~flow ~~adversely~~requirements. ~~affect~~There ~~the~~is ~~quality~~no ofassurance that the ~~loan~~ ~~portfolio~~Corporation’s ~~(including~~subsidiaries ~~the~~will ~~level~~be ofable ~~non-performing~~to ~~assets,~~pay ~~charge~~dividends ~~offs~~in ~~and~~the future ~~provision~~or ~~expense)~~that ~~and~~ the ~~demand~~Corporation ~~for~~will ~~products~~generate ~~and~~adequate ~~services,~~cash ~~and~~flow ~~accordingly,~~to pay dividends in the future. Additionally, beginning in the ~~Corporation’s~~third ~~results~~quarter of ~~operations.~~2009, ~~Inflation~~the Corporation ~~has~~stopped ~~some~~paying ~~impact~~dividends on ~~the~~its common stock in order to conserve capital. The Corporation’s ~~and~~failure to pay dividends on its common stock could have a material adverse effect on the ~~Bank’s~~market ~~operating~~price ~~costs.~~of its common stock.

~~The soundness of other financial institutions may adversely affect the Corporation.~~-13-

~~Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships.~~ The ~~Corporation has exposure to many~~ different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose the Corporation ~~to credit risk in the event of a default by a counterparty or client. In addition, the Corporation’s credit risk~~ may befail ~~exacerbated when the collateral held by the Corporation cannot be realized upon or is liquidated at prices not sufficient~~ to ~~recover~~realize the ~~full amount~~anticipated ofbenefits ~~the credit or derivative exposure due to the Corporation. Such losses~~from ~~could have a material adverse affect on the Corporation’s financial condition and results of operations~~mergers.

~~Current~~The success ~~levels~~ of ~~market~~mergers ~~volatility~~will ~~may~~depend, in part, on the Corporation’s ability to realize ~~have~~the ~~materially~~estimated ~~adverse~~cost ~~effects~~savings onor revenue enhancements from combining the businesses of the merged companies. If the Corporation’s ~~liquidity~~estimates are incorrect or the Corporation is unable to combine acquired companies successfully, ~~financial~~the ~~condition~~anticipated benefits may not be realized fully or at all, or may take longer to realize than expected. The integration process could result in the loss of key employees, the disruption of ongoing business, inconsistencies in standards, controls, procedures and/ policies that adversely affect the Corporation’s ability to maintain relationships with clients and employees or ~~profitability~~achieve the anticipated benefits of the merger. As with any merger of financial institutions, there also may be disruptions that cause the Bank to lose customers or cause customers to withdraw their deposits from the Bank, or other unintended consequences that could have a material adverse effect on the Corporation’s results of operations or financial condition.

~~The capital~~Future ~~and~~acquisitions ~~credit~~by ~~markets have been experiencing volatility and disruption for more than twelve months. In some cases,~~ the ~~markets~~Corporation ~~have~~could ~~exerted~~dilute ~~downward~~shareholder ~~pressure~~ownership ~~on stock~~of ~~prices, security prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength. If~~ the ~~current levels of~~ ~~market~~Corporation ~~disruption~~ and ~~volatility~~may ~~continue~~cause ~~or worsen, there can be no assurance that~~ the Corporation ~~will~~to ~~not~~become ~~experience~~more ~~adverse~~susceptible ~~effects,~~to ~~which may be material,~~adverse oneconomic ~~its liquidity, financial condition and/or profitability~~events.

~~Strong~~The Corporation ~~competition~~has ~~within~~acquired other companies with its common stock in the past and may acquire or make investments in banks and other complementary businesses in the future. The Corporation may issue shares of its common stock in connection with these potential acquisitions and other investments, which would dilute shareholder ownership interest in the Corporation in the event that shareholders receive consideration in the form of the Corporation’s ~~market~~common ~~area~~stock. ~~may~~While ~~limit~~there is ~~its~~no ~~growth~~assurance that these transactions will occur, or that they will occur on terms favorable to the Corporation, future business acquisitions could be material to the Corporation, and ~~profitability~~the degree of success achieved in acquiring and integrating these businesses into the Corporation could have a material effect on the value of Corporation’s common stock. In addition, any such acquisition could require the Corporation to expend substantial cash or other liquid assets or to incur debt, which could cause the Corporation to become more susceptible to economic downturns and competitive pressures.

~~Competition~~An ineconomic ~~the~~downturn ~~banking~~in ~~and financial services industry is intense. The Bank competes actively with other~~ eastern Pennsylvania financial institutions as well as with financial and non-financial institutions, many larger than the Bank, headquartered elsewhere. Commercial banks, savings banks, savings and loan associations, credit unions, and money market funds actively compete for deposits and loans. Such institutions, as well as consumer finance, insurance companies and brokerage firms, may be considered competitors with respect to one or ~~more~~a ~~services~~general ~~they~~decline ~~render. The Bank is generally competitive with all competing institutions~~ in ~~its service areas with respect to interest rates paid~~economic onconditions ~~time~~could ~~and~~adversely ~~savings~~affect ~~deposits, service charges on deposit accounts, interest rates charged on loans and fees for trust and investment advisory services. Many of~~ the ~~institutions with which the Bank competes have substantially greater resources and lending limits and may offer certain services that the Bank does not or cannot provide. The~~ Corporation’s ~~profitability depends upon the Bank’s~~financial ~~ability to successfully compete in its market area~~results.

14The Bank’s operations are concentrated in eastern Pennsylvania and to a lesser degree central and southern New Jersey and Delaware. As a result of this geographic concentration, the Corporation’s financial results may correlate to the economic conditions in this area. Deterioration in economic conditions in this market area, particularly in the industries on which this geographic areas depend, or a general decline in economic conditions may adversely affect the quality of the loan portfolio (including the level of non-performing assets, charge offs and provision expense) and the demand for products and services, and accordingly, the Corporation’s results of operations. The Corporation's market area has been subject to a prolonged economic downturn, which has led to a decline in the quality of the loan portfolio. Economic conditions could continue to adversely effect the Corporation's financial results. Inflation has some impact on the Corporation’s and the Bank’s operating costs.

The ~~Corporation~~soundness ~~operates~~of inother ~~a highly~~financial ~~regulated~~institutions ~~environment and~~ may be adversely ~~affected~~affect bythe ~~changes in laws and regulations~~Corporation.

~~The~~Financial ~~Corporation~~services ~~and~~institutions ~~the Bank~~ are ~~subject~~interrelated ~~to extensive regulation, supervision and examination by certain state and federal agencies including the Federal Deposit Insurance Corporation,~~ as ~~insurer~~a result of ~~the Bank’s deposits~~trading, ~~the Board of Governors~~clearing, ~~of the Federal Reserve System~~counterparty, asor ~~regulator~~other ~~of the holding company and the Office of the Comptroller of Currency~~relationships. ~~Such~~The ~~regulation~~Corporation ~~and~~has ~~supervision~~exposure ~~governs~~to many ~~the~~different ~~activities~~industries ~~in which an institution~~ and ~~its holding company may engage~~counterparties, and ~~are~~ ~~intended~~routinely ~~primarily~~executes ~~to ensure the safety and soundness of financial~~transactions ~~institutions.~~with ~~Regulatory~~counterparties ~~authorities have extensive discretion~~ in ~~their supervisory~~the ~~and~~financial ~~enforcement~~services ~~activities~~industry, including ~~the imposition of restrictions~~commercial ~~on operations~~banks, ~~the~~brokers ~~classification~~and ofdealers, ~~assets~~investment banks, and ~~determination~~other ofinstitutional ~~the~~clients. Many ~~level~~ of ~~the~~ ~~allowance~~these ~~for~~transactions ~~loan~~expose ~~losses.~~the ~~Any~~Corporation ~~change~~to incredit ~~such~~risk ~~regulation and oversight, whether~~ in the ~~form~~event of a ~~regulatory~~default ~~policy,~~by ~~regulations,~~a ~~legislation~~counterparty or ~~supervisory~~ ~~action,~~client. ~~may~~In ~~have~~addition, ~~a material impact on~~ the ~~Bank~~Corporation’s ~~and the~~credit ~~Corporation’s~~risk ~~operations.~~may ~~There~~be ~~are~~exacerbated ~~also~~when ~~several federal and state statutes which regulate~~ the ~~obligation~~collateral ~~and~~held ~~liabilities~~by ~~of financial institutions pertaining to environmental issues. In addition to~~ the ~~potential~~Corporation ~~for~~cannot ~~attachment~~be ofrealized ~~liability~~upon ~~resulting~~or ~~from~~is ~~its~~liquidated ~~own~~at ~~actions,~~prices anot ~~bank~~sufficient ~~may~~to berecover ~~held~~the ~~liable under~~full ~~certain~~amount ~~circumstances~~of ~~for~~ the ~~actions~~credit ~~of its borrowers,~~ or ~~third~~derivative ~~parties,~~exposure ~~when such~~due ~~actions~~to ~~result~~the inCorporation. ~~environmental~~Such ~~problems on properties that collateralize~~losses ~~loans~~could ~~held~~have bya ~~the~~material ~~bank.~~adverse ~~Further,~~affect ~~the~~on ~~liability has~~ the ~~potential~~Corporation’s tofinancial ~~far exceed~~condition ~~the~~and ~~original~~results ~~amount~~ of ~~a loan issued by the bank~~operations.

~~Item~~Current levels ~~1B.~~of ~~Unresolved~~market ~~Staff~~volatility ~~Comments~~may have materially adverse effects on the Corporation’s liquidity, financial condition and/or profitability.

~~None~~The capital and credit markets have been experiencing volatility and disruption for more than two years. In some cases, the markets have exerted downward pressure on stock prices, security prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength. If the current levels of market

15 -14-

~~Item~~disruption and 2.volatility ~~Properties~~continue or worsen, there can be no assurance that the Corporation will not experience adverse effects, which may be material, on its liquidity, financial condition and/or profitability.

~~The principal~~Strong ~~executive~~competition ~~offices~~within of the Corporation’s ~~and~~market ofarea ~~the~~may ~~Bank~~limit ~~are located in Harleysville, Pennsylvania in two, two-story office buildings leased by the Bank, one built in 1929 and the other in 2007. The Bank owns the buildings in which twenty-four of~~ its ~~branches~~growth ~~are located (one branch opened in February 2009)~~ and ~~leases space for the other sixty-four branches from unaffiliated third parties under leases expiring at various times through 2037~~profitability.

Office	Office Location	Owned/Leased
Airport Village	102 Airport Road, Coatesville, PA	Leased
Allentown	1602 Allen Street, Allenton, PA	Leased
Audubon	2624 Egypt Road, Norristown, PA	Owned(2)
Avondale	119 Pennsylvania Avenue, Avondale, PA	Owned
Bethlehem	4510 Bath Pike, Bethlehem, PA	Leased
Blue Bell	20 West Skippack Pike, Ambler PA	Owned(2)
Boyertown	Rt. 100 and Bause Road, Boyertown, PA	Leased
Brandywine Square	82 Quarry Road, Downingtown, PA	Leased
Busleton	9869 Bustleton Avenue, Philadelphia, PA	Leased
Cedar Crest	1251 S Cedar Crest Blvd, Allentown, PA	Leased
Chalfont	251 West Butler Avenue, Chalfont, PA	Leased
Coatesville	112 East Lincoln Highway, Coatesville, PA	Leased
Collegeville	364 East Main Street, Collegeville, PA	Owned
Conshohocken(3)	101 Ridge Pike, Conshohocken, PA	Owned(2)
Devon	414 Lancaster Avenue, Devon, PA	Leased
Dorneyville	3570 Hamilton Boulevard, Allentown, PA	Leased
Douglassville	1191 West Ben Franklin Highway, Douglassville, PA	Leased
Downingtown	100 E. Lancaster Avenue, Downingtown, PA	Leased
Doylestown	500 East Farm Lane, Doylestown, PA	Owned(2)
Dresher	701 Twining Road, Dresher, PA	Leased
Eagle	300 Simpson Drive, Chester Springs, PA	Leased
East Norriton	450 East Germantown Pike, East Norriton, PA	Owned(2)
Emmaus	731 Chestnut St, Emmaus, PA	Owned
Emmaus	502 State Ave, Emmaus, PA	Owned
Emmaus High School	500 Macungie Ave, Emmaus, PA	Leased
Exton	601 N. Pottstown Pike, Exton, PA	Leased
Feasterville	220 East Street Road, Feasterville, PA	Leased
Flourtown	1851 Bethlehem Pike, Flourtown, PA	Leased
Fogelsville	861 N. Rt. 100, Fogelsville, PA	Owned
Foulkeways	1120 Meetinghouse Road, Gwynedd, PA	Leased
Frazer	200 West Lancaster Avenue, Frazer, PA	Leased(4)
Gilbertsville	1050 East Philadelphia Avenue, Gilbertsville, PA	Leased
Harleysville Campus	483 Main Street, Harleysville, PA	Leased
Harleysville-Meadowbrook	278 Main Street, Harleysville, PA	Owned(2)
Hatboro	2 North York Road, Hatboro, PA	Leased
Hatfield	1632 Cowpath Road, Hatfield, PA	Leased
Horsham	955 Horsham Road, Horsham, PA	Leased
Huntington Valley	761 Huntingdon Pike, Huntingdon Valley, PA	Leased
Kennett Square	838 East Baltimore Pike, Kennett Square, PA	Owned(6)
King of Prussia	170 S. Warner Road, Suite 100, Wayne, PA	Leased
Kresgeville	Route 209, Kresgeville, PA	Leased
Lansdale-Marketplace	1551 Valley Forge Road, Lansdale, PA	Owned(2)
Lansdale-North Broad	1804 North Broad Street, Lansdale, PA	Leased
Lansford	13-15 West Ridge Street, Lansford, PA	Leased
Lehigh Township	4421 Lehigh Drive, Walnutport, PA	Leased

Competition in the banking and financial services industry is intense. The Bank competes actively with other eastern Pennsylvania financial institutions as well as with financial and non-financial institutions, many larger than the Bank, headquartered elsewhere. Commercial banks, savings banks, savings and loan associations, credit unions, and money market funds actively compete for deposits and loans. Such institutions, as well as consumer finance, insurance companies and brokerage firms, may be considered competitors with respect to one or more services they render. The Bank is generally competitive with all competing institutions in its service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts, interest rates charged on loans and fees for trust and investment advisory services. Many of the institutions with which the Bank competes have substantially greater resources and lending limits and may offer certain services that the Bank does not or cannot provide. The Corporation’s profitability depends upon the Bank’s ability to successfully compete in its market area.

16The Corporation operates in a highly regulated environment and may be adversely affected by changes in laws and regulations.

Office	Office Location	Owned/Leased
Lehighton	904 Blakeslee Blvd, Lehighton, PA	Leased
Limerick	260 West Ridge Pike, Limerick, PA	Leased
Macungie	201 W Main St, Macungie, PA	Owned(2)
Malvern(1)	30 Valley Stream Parkway, Malvern, PA	Leased
Maple Glen	732 Norristown Road, Maple Glen, PA	Leased
Meadowood	3205 Skippack Pike, Worcester, PA	Leased
Mertztown	951 State Street, Mertztown, PA	Leased
Normandy Farms	Morris Road & Route 202, Blue Bell, PA	Leased
North Wales (North Penn)	1498 North Wales Road, North Wales, PA	Leased
North Wales	122 N. Main Street, North Wales, PA	Leased
Oxford	499 North 3rd Street, Oxford, PA	Leased
Palmerton	372 Delaware Avenue, Palmerton, PA	Leased
Peter Becker Community	815 Maplewood Drive, Harleysville, PA	Leased
Pottstown Center	Rt. 100 and Shoemaker Road, Pottstown, PA	Owned(2)
Pottstown-Coventry	2 Glocker Way, Pottstown, PA	Owned(2)
Pottstown-East End	1450 East High Street, Pottstown, PA	Owned(2)
Pottstown-North End	930 North Charlotte Street, Pottstown, PA	Leased
Pottstown-Train Station	One Security Plaza, Pottstown, PA	Leased
Quakertown Main	224 West Broad Street, Quakertown, PA	Owned
Red Hill	400 Main Street, Red Hill, PA	Leased
Rhawnhurst	8200 Castor Avenue, Philadelphia, PA	Leased
Roslyn Valley	1331 Easton Road, Roslyn, PA	Leased
Royersford	440 W. Linfield-Trappe Road, Royersford, PA	Owned(2)
Sellersville	209 North Main Street, Sellersville, PA	Leased
Skippack	3893 Skippack Pike, Skippack, PA	Leased
Slatington	502 Main Street, Slatington, PA	Leased
Slatington Handi-Bank	701-705 Main Street, Slatington, PA	Leased
Somerton	11730 Bustleton Avenue, Philadelphia, PA	Leased
Souderton	702 Route 113, Souderton, PA	Owned(2)
Southampton	735 Davisville Road, Southampton, PA	Leased
Spring House(1)	1017 North Bethlehem Pike, Spring House, PA	Leased
Summit Hill	2 East Ludlow Street, Summit Hill, PA	Leased
Thorndale	3909 Lincoln Highway, Downingtown, PA	Leased
Trainers Corner	120 North West End Boulevard, Quakertown, PA	Leased
Trexlertown	6890 Hamilton Blvd, Trexlertown, PA	Owned
Warminster	190 Veterans Way, Warminster, PA	Owned(2)
Warminster Kmart Plaza	1141 Ivyland Road, Warminster, PA	Leased
Warminster Square	1555 West Street Road, Warminster, PA	Leased
West Chester	16 E. Market Street, West Chester, PA	Leased
Westtown	1197 Wilmington Pike, West Chester, PA	Leased
Whitehall	2985 MacArthur Rd, Whitehall, PA	Owned
Willow Grove	9 Easton Road, Willow Grove, PA	Owned(5) (6)
Wyomissing(1)	2800 State Hill Road, Wyomissing, PA	Leased
Additional Office Space
Commercial Business
Development	650 Sentry Parkway, Blue Bell, Pa	Leased
Harleysville National Bank
Trust Department(1)	1690 Sumneytown Pike, Lansdale, PA	Leased
Cornerstone Financial
Consultants	1802 Hamilton, Allentown PA	Leased
Cornerstone Financial
Consultants - McPherson	8320 Bellona Ave, Towson, MD	Leased

The Corporation and the Bank are subject to extensive regulation, supervision and examination by certain state and federal agencies including the Federal Deposit Insurance Corporation, as insurer of the Bank’s deposits, the Board of Governors of the Federal Reserve System, as regulator of the holding company and the Office of the Comptroller of Currency. Such regulation and supervision governs the activities in which an institution and its holding company may engage, and are intended primarily to ensure the safety and soundness of financial institutions. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on operations, the classification of assets and determination of the level of the allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on the Bank’s and the Corporation’s operations. There are also several federal and state statutes which regulate the obligation 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.

17If the Corporation concludes that the decline in value of any of its investment securities is other than temporary, the Corporation will be required to write down the credit-related portion of the impairment of that security through a charge to earnings.

Office	Office Location	Owned/Leased
Cornerstone Institutional
Investments	74 West Broad St, Bethlehem, PA	Leased
Cornerstone Advisor Asset
Management	74 West Broad St., Bethlehem, PA	Leased
HNC Financial Company	2751 Centerville Rd, Wilmington, DE	Leased
HNC Reinsurance Company	101 North First Avenue, Phoenix, AZ	Leased
Harleysville Management
Services	474 Main St, Harleysville, Pa	Owned
BeneServ, Inc.	453 Baltimore Pike, Springfield, Pa	Leased

Harleysville National 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 the Corporation’s investment securities has declined below its carrying value, the Corporation is required to assess whether the decline is other than temporary. If the Corporation concludes that the decline is other than temporary, it will be required to write down the credit-related portion of the impairment of that security through a charge to earnings. 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.

(1)		Locations include Millennium Wealth Management and Private Banking offices.
(2)		Branch buildings are owned by the Bank and the land is leased.
(3)		Branch opened for business in February 2009.
(4)		The branch facility at this location is owned. There is also a drive-up facility at this location that is leased.
(5)		Includes the lease of an easement at this location.
(6)		Branch buildings are rented but land is owned.

Harleysville National Corporation borrows from the Federal Home Loan Bank and the Federal Reserve, and there can be no assurance these programs will continue in their current manner.

InHarleysville ~~management's~~National ~~opinion,~~Corporation ~~all~~at oftimes utilizes the ~~above~~Federal ~~properties~~Home ~~are~~Loan inBank ~~good~~(FHLB) ~~condition~~of Pittsburgh for overnight borrowings and ~~are~~term advances; Harleysville National ~~adequate~~Corporation ~~for~~also has the ~~Registrant's~~ability ~~and~~to borrow from the ~~Bank’s~~Federal ~~purposes.~~Reserve through the discount window and from correspondent banks under our federal funds lines of

~~Item 3. Legal Proceedings~~-15-

~~As a result~~credit. ofThe ~~the~~amount ~~acquisition~~loaned ofto ~~Willow~~Harleysville ~~Financial,~~National ~~the~~ Corporation ~~recorded~~is agenerally ~~liability~~dependent inon ~~purchase~~the ~~accounting~~value of ~~$2.7~~the ~~million~~collateral inpledged. ~~connection~~These ~~with~~lenders ~~certain~~could ~~legal contingencies~~reduce ~~which existed prior to~~ the ~~acquisition. The amount accrued~~percentages ~~represents~~loaned ~~estimated~~against ~~settlement~~various ~~and~~collateral ~~legal~~categories, ~~costs~~could oneliminate ~~ongoing~~certain ~~litigation~~types ~~assumed from Willow Financial. There can be no assurance that any~~ of ~~the outstanding~~ ~~legal~~collateral ~~proceedings~~and tocould ~~which~~otherwise ~~the~~modify ~~Corporation~~or iseven aterminate ~~party~~their asloan aprograms. ~~successor in interest~~Any tochange ~~Willow~~or ~~Financial~~termination ~~will~~would ~~not~~have bean ~~decided~~adverse ~~adversely~~affect toon ~~the~~Harleysville National Corporation’s ~~interests and~~liquidity ~~have a material effect on the financial condition~~ and ~~operations of the Corporation~~profitability.

~~Management, based~~Risks onrelated ~~consultation~~to ~~with~~ the ~~Corporation’s legal counsel, is not aware of any~~Merger ~~litigation~~with ~~that~~First ~~would~~Niagara 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~~Group, ~~no material proceedings are pending or are known to be threatened or contemplated against the Corporation and the Bank by government authorities~~Inc. (“First Niagara”)

~~Item~~The 4.Merger ~~Submission~~Agreement ofMay ~~Matters~~Be Terminated toin aAccordance ~~Vote~~With ofIts ~~Security~~Terms ~~Holders~~and The Merger May Not Be Completed.

~~No matter~~The ~~was~~agreement ~~submitted~~and ~~during~~plan of merger (the ~~fourth~~“Merger ~~quarter~~Agreement” ofby ~~2008~~and between Harleysville National Corporation and First Niagara is subject to a ~~vote~~number of ~~holders~~conditions which must be fulfilled in order to close. Those conditions include: regulatory approval, the continued accuracy of certain representations and warranties by both parties and the performance by both parties of certain covenants and agreements. Certain circumstances exist where Harleysville National Corporation may choose to terminate the merger agreement, including the acceptance of a superior proposal or the decline in First Niagara’s ~~Common~~share ~~Stock~~price to below $9.28 as of the first date when all regulatory approvals for the merger have been received combined with such decline being at least 20% greater than a corresponding price decline of the Nasdaq Bank Index, with no adjustment made to the exchange ratio by First Niagara. Under such circumstances, First Niagara may, but is not required to, increase the exchange ratio in order to avoid termination of the merger agreement. First Niagara has not determined whether it would increase the exchange ratio in order to avoid termination of the merger agreement by Harleysville National Corporation. There can be no assurance that the conditions to closing the merger will be fulfilled or that the merger will be completed.

18Termination of the Merger Agreement Could Negatively Impact Harleysville National Corporation.

~~PART~~First Niagara IImay terminate the Merger Agreement for the reasons set forth in the Merger Agreement. If the Merger Agreement is terminated, there may be various consequences including:

~~Item~~• 5.Harleysville ~~Market~~National ~~for Registrant~~Corporation’s ~~Common~~businesses ~~Equity~~may have been adversely impacted by the failure to pursue other beneficial opportunities due to the focus of management on the merger, ~~Related~~without ~~Stockholder~~realizing ~~Matters~~any of the anticipated benefits of completing the merger; and ~~Issuer~~• ~~Purchases~~the market price of ~~Equity~~Harleysville ~~Securities~~National Corporation common stock might decline to the extent that the current market price reflects a market assumption that the merger will be completed.

~~The~~If the ~~following~~Merger ~~table~~Agreement ~~sets~~is ~~forth~~terminated ~~high~~ and ~~low~~Harleysville ~~closing~~National ~~sales prices for the~~ Corporation’s ~~common~~board ~~stock~~of directors ~~and~~seeks ~~quarterly~~another ~~cash~~merger ~~dividends~~or ~~paid~~business ~~per~~combination, ~~share~~Harleysville ~~for 2008~~National ~~and 2007. The~~ Corporation’s ~~stock~~shareholders iscannot ~~traded~~be ~~under~~certain ~~the~~that ~~symbol~~Harleysville ~~“HNBC” on the~~National ~~NASDAQ~~Corporation ~~Global~~will ~~Select~~be ~~Market.~~able ~~All share information has been restated~~ to ~~reflect stock~~find ~~dividends~~a ~~and~~party ~~splits.~~willing ~~For certain limitations on the Bank’s ability~~ to pay ~~dividends~~ toan ~~the~~equivalent ~~Corporation,~~or ~~see~~more attractive ~~Item~~price 1,than ~~“Supervision~~the ~~and~~price ~~Regulation—Bank”~~First ~~and Item~~Niagara 8,has ~~Note~~agreed ~~20, “Notes~~ to ~~Consolidated~~pay ~~Financial~~in ~~Statements—Regulatory~~the ~~Capital~~merger.”

~~Price~~Regulatory ofApprovals ~~Common~~for ~~Stock~~the ~~and~~Merger May ~~Cash~~Not be Received, May Take Longer Than Expected or May Impose Conditions That ~~Dividends~~are Not Presently Anticipated or Cannot be Met.

					Cash dividends
2008	High Price		Low Price		per share
First Quarter		$15.84		$12.50		$0.20
Second Quarter		15.24		11.16		0.20
Third Quarter		19.65		10.77		0.20
Fourth Quarter		16.86		11.27		0.20
					Cash dividends
2007	High Price		Low Price		per share
First Quarter		$20.25		$17.11		$0.20
Second Quarter		18.13		15.54		0.20
Third Quarter		18.58		14.03		0.20
Fourth Quarter		17.17		13.15		0.20

Before the transactions contemplated in the Merger Agreement may be completed, various approvals or consents must be obtained from the Office of the Comptroller of the Currency (the “OCC”), and the Federal Reserve Bank. These governmental entities, including the OCC, may impose conditions on the completion of the merger or the bank merger or require changes to the terms of the Merger Agreement. Although Harleysville National Corporation does not currently expect that any such conditions or changes would be imposed, there can be no assurance that they will not be, and such conditions or changes could have the effect of delaying completion of the transactions contemplated in the Merger Agreement or imposing additional costs on or limiting First Niagara’s revenues, any of which might have a material adverse

At December 31, 2008, there were 4,080 shareholders of record, not including the number of persons or entities whose stock is held in nominee or “street” name through various brokerage firms and banks. -16-

~~The~~effect on ~~Corporation~~First ~~has~~Niagara afollowing ~~stock repurchase program that permits~~ the ~~repurchase of up to five percent of its outstanding common stock~~merger. ~~The~~There ~~repurchased~~can ~~shares will~~ be ~~used~~ ~~for~~no ~~general~~assurance ~~corporate~~as ~~purposes.~~to ~~The~~whether ~~Corporation did not repurchase any shares of its stock under~~ the ~~Corporation’s stock repurchase programs during~~ ~~2008.~~regulatory ~~The~~approvals ~~maximum~~will ~~number of share that may yet~~ be ~~purchased under the plans was 731~~received,~~761~~ ~~as of December 31, 2008. The repurchased shares are used for general corporate purposes. On May 12, 2005,~~ the ~~Board~~timing of ~~Directors~~those ~~authorized a plan to purchase up to 1~~approvals,~~416,712~~ ~~shares~~or ~~(restated for five percent stock dividend paid~~whether onany ~~September~~conditions ~~15,~~will ~~2006~~be ~~and September 15, 2005) or 4~~imposed.~~9% of its outstanding common stock.~~

19If the Merger Agreement is Terminated, Certain Pre-Merger Transactions Between First Niagara and Harleysville National Corporation Designed to Alleviate Regulatory Pressure on Harleysville National Bank May Not Have Their Intended Results.

~~Equity~~On ~~Compensation~~May 28, ~~Plan~~2009, ~~Information~~the OCC imposed an individual minimum capital requirement on Harleysville National Bank, requiring it to increase its regulatory capital ratios. To enable Harleysville National Bank to achieve and maintain capital ratios consistent with those of a “well-capitalized” institution not subject to individual minimum capital ratios pending completion of the merger, and to address the OCC’s supervisory concerns, in the fourth quarter of 2009, First Niagara loaned $50 million to Harleysville National Corporation, the proceeds of which were contributed to Harleysville National Bank as Tier One capital. The loan is secured by a pledge of all of the stock of Harleysville National Bank. If the Merger Agreement is terminated, Harleysville National Corporation will have between 30 and 90 days to repay the loan to First Niagara (subject to immediate acceleration if Harleysville National Bank is “significantly undercapitalized” under regulatory standards).

~~The~~If ~~following~~Harleysville ~~table~~National ~~provides~~Corporation ~~information~~cannot ~~about~~repay ~~shares~~the ofloan ~~the~~by ~~Corporation’s~~its due date, First Niagara could foreclose on the stock of Harleysville National Bank under the pledge security agreement. There can be no assurance that ~~may~~Harleysville National Corporation will be ~~issued~~able ~~under~~to ~~existing~~raise ~~equity~~funds ~~compensation~~sufficient ~~plans~~to asrepay the loan from First Niagara if the merger agreement is terminated. “Management’s Discussion and Analysis of ~~December~~Financial ~~31,~~Condition and Results of ~~2008:~~Operations—Financial Overview.”

Number Of Securities Remaining Available

Number Of Securities To Be Issued

Weighted-Average Exercise Price

For Future Issuance Under Equity

Upon Exercise Of Outstanding

Of Outstanding Options, Warrants

Compensation Plans, Excluding Securities

Plan Category

Options, Warrants And Rights

And Rights

Reflected In Column (A)

(A) (#)

(B) ($)

Equity Compensation Plans

Approved by Stockholders

1,648,723

(1)

$15.28 per share

1,157,625

Equity Compensation Plans

Not Approved by

-0-(2)

-0-

22,695

Stockholders

TOTAL

1,648,723

$15.28 per share

1,180,320

If the Merger is Not Consummated by May 31, 2010, Additional Restrictions May be Imposed Upon Harleysville National Bank and Trust Company by its Regulators.

(1)		Includes options issued under the Corporation’s 1993 and 1998 Stock Incentive Plans, 1998 Independent Director’s Stock Option Plan, 2004 Omnibus Stock Incentive Plan, options assumed pursuant to the merger & acquisition of Millennium Bank on April 30, 2004, options assumed pursuant to acquisition of East Penn Financial on November 16, 2007 and options assumed pursuant to the acquisition of Willow Financial on December 5, 2008.
(2)		On December 13, 1996, the Board of Directors authorized the registration of 70,354 shares of common stock for issuance under the Corporation’s Employee Stock Bonus Plan. On December 24, 1996, in celebration of the Corporation reaching $1 billion in total assets, 41,685 shares were issued to full and part-time employees of the Corporation’s subsidiaries. Annually, since 1996, a total of 5,974 shares in the aggregate, have been awarded under this Plan to employees in recognition of exemplary service during each calendar year. When awarded, the value of shares is based on the closing price of the Corporation’s common stock as of the close of business on the last business day of the most recently completed calendar quarter. Registered shares and available shares under the Plan reflect adjustment for stock dividends.

On May 5, 2009, Harleysville National Bank and Trust Company (the “Bank”) was advised by the OCC that the deadline by which the Bank must meet certain individual minimum capital ratios had been extended from March 31, 2010 to May 31, 2010. If the Merger is not consummated by May 31, 2010 and the Bank cannot meet the individual minimum capital ratios by that date, the OCC could impose additional regulatory restrictions on the Bank, which could materially adversely impact the Bank and, as a result, the operating results and financial condition of the Corporation.

~~Additional information~~Harleysville onNational ~~the~~ Corporation’s ~~equity compensation plans included under Item~~ 8,Asset ~~Note~~Quality 1,May ~~“Notes~~Deteriorate Prior to ~~Consolidated~~Completion ~~Financial~~of ~~Statements—Stock-Based Compensation~~the ~~and Note 14, “Stock-Based Compensation,” is incorporated herein by reference~~Merger.

20 Harleysville National Corporation’s nonperforming assets were $133.6 million at December 31, 2009 compared to $78.5 million at December 31, 2008. Nonperforming assets as a percentage of total assets were 2.58% at December 31 compared to 1.43% at December 31, 2008. Net charge-offs for the fourth quarter of 2009 were $15.1 million compared to $2.6 million in the same period of 2008. The allowance for credit losses increased to $66.6 million at December 31, 2009, compared to $50.0 million at December 31, 2008. Should these adverse trends continue, they may have an adverse effect on Harleysville National Corporation’s financial and capital positions, and may differ from First Niagara’s estimates thereof.

~~Performance~~First ~~Graph~~Niagara Could Record Future Impairment Losses on Harleysville National Corporation’s Holdings of Investment Securities Available For Sale. First Niagara May Not Receive Full Future Interest Payments on These Securities.

~~The following graph contains a comparison of the cumulative total returns on~~ Harleysville National Corporation’s ~~common~~investment ~~stock~~portfolio ~~against the cumulative total returns~~ of ~~the~~securities ~~NASDAQ~~available ~~Stock Market (U.S. companies) Index and the NASDAQ Bank Stocks Index~~ for ~~the period of five fiscal years commencing December 31, 2003,~~sale ~~and~~includes ~~ending~~trust ~~December~~preferred 31securities, ~~2008.~~private ~~The~~label ~~graph~~collateralized ~~assumes that $100 was invested on~~mortgage ~~December 31~~obligations, ~~2003~~collateralized indebt ~~the~~obligations ~~Corporation’s common stock, the NASDAQ Stock Market (US companies)~~ and ~~NASDAQ~~equity ~~Banks~~securities. ~~The cumulative returns assume the reinvestment of~~Harleysville ~~dividends.~~National ~~The~~Corporation ~~shareholder~~recognized ~~return~~other ~~shown~~than ontemporary ~~the~~impairment ~~graph below is not necessarily~~charges ~~indicative of future performance.~~ totaling

~~Zack’s Total Return Annual ComparisonFive~~-~~Year Cumulative Total Return Summary~~17-

	2003	2004	2005	2006	2007	2008
Harleysville National Corporation	100.00	95.41	74.47	82.13	65.01	68.27
NASDAQ Stock Market (US companies)	100.00	108.84	111.16	122.11	132.42	63.80
NASDAQ Banks	100.00	114.45	111.80	125.48	99.46	72.51

approximately $9.4 million for the year ended December 31, 2009 as a result of impairment charges mainly on collateralized debt obligations as well as collateralized mortgage obligations and certain equity securities. If the merger with Harleysville National Corporation is completed, First Niagara will take ownership of these securities. A number of factors or combinations of factors could cause First Niagara to conclude in one or more future reporting periods that an unrealized loss that exists with respect to these securities constitutes an additional impairment that is other than temporary, which could result in material losses to First Niagara. These factors include, but are not limited to, continued failure to make scheduled interest payments, an increase in the severity of the unrealized loss on a particular security, an increase in the continuous duration of the unrealized loss without an improvement in value or changes in market conditions and/or industry or issuer specific factors that would render First Niagara unable to forecast a full recovery in value. In addition, the fair values of these investment securities could decline if the overall economy and the financial condition of some of the issuers continue to deteriorate and there remains limited liquidity for these securities.

~~Notes:Corporate Performance~~First ~~Graph~~Niagara ~~with~~May ~~peer~~Fail ~~group~~to ~~uses peer group only performance (excludes~~Realize ~~only~~the ~~company).Peer~~Anticipated ~~group~~Benefits ~~indices use beginning~~ of ~~period~~the ~~market capitalization weighting~~Merger.

*The success ~~Source:~~of ~~Zack~~the merger will depend on, among other things, First Niagara’s ability ~~Investment~~to ~~Research~~realize anticipated cost savings and to combine the businesses of First Niagara Bank and Harleysville National Bank in a manner that permits growth opportunities and does not materially disrupt the existing customer relationships of Harleysville National Bank nor result in decreased revenues resulting from any loss of customers. If First Niagara is not able to successfully achieve these objectives, the anticipated benefits of the merger ~~Inc~~may not be realized fully or at all or may take longer to realize than expected.

21First Niagara and Harleysville National Corporation have operated and, until the completion of the merger, will continue to operate, independently. Certain employees of Harleysville National Corporation will not be employed by First Niagara after the merger. In addition, employees of Harleysville National Corporation that First Niagara wishes to retain may elect to terminate their employment as a result of the merger which could delay or disrupt the integration process. It is possible that the integration process could result in the disruption of Harleysville National Corporation’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the ability of First Niagara to maintain relationships with customers and employees or to achieve the anticipated benefits of the merger.

~~Item~~Harleysville National 6.Corporation ~~Selected~~Shareholders ~~Financial~~Cannot ~~Data~~Be Certain of the Market Value of The Merger Consideration They Will Receive Because the Market Price of First Niagara Common Stock Will Fluctuate.

	Year Ended December 31,
	2008(1)			2007(2)			2006(3)			2005			2004(4)
	(Dollars in thousands, except per share information)
Income and expense
Interest income	$	206,294		$	194,561		$	178,941		$	151,739		$	127,729
Interest expense		102,154			112,127			95,768			64,618			42,638
Net interest income		104,140			82,434			83,173			87,121			85,091
Provision for loan losses		15,567			10,550			4,200			3,401			2,555
Net interest income after provision for loan
losses		88,573			71,884			78,973			83,720			82,536
Noninterest income		46,217			43,338			45,348			29,990			28,158
Noninterest expense		104,622			81,355			70,830			62,479			59,561
Income before income tax expense		30,168			33,867			53,491			51,231			51,133
Income tax expense		5,075			7,272			14,076			12,403			12,566
Net income	$	25,093		$	26,595		$	39,415		$	38,828		$	38,567
Per share information(5)
Basic earnings	$	0.78		$	0.91		$	1.36		$	1.34		$	1.35
Diluted earnings		0.78			0.90			1.34			1.32			1.31
Cash dividends paid		0.80			0.80			0.75			0.72			0.65
Book value (at year-end)		11.05			10.83			10.18			9.48			9.34
Basic average common shares outstanding		32,201,150			29,218,671			28,946,847			28,891,412			28,505,392
Diluted average common shares
outstanding		32,364,137			29,459,898			29,353,128			29,490,216			29,465,613
Average balance sheet
Loans	$	2,585,101		$	2,123,170		$	2,014,420		$	1,900,023		$	1,625,419
Investments		1,037,112			944,464			925,635			903,063			941,910
Other interest-earning assets		48,474			72,087			79,670			51,740			41,064
Total assets		3,997,972			3,371,304			3,229,224			3,039,186			2,773,405
Deposits		3,004,070			2,557,546			2,469,514			2,259,831			2,094,998
Borrowed funds		586,088			471,296			434,938			456,599			372,141
Shareholders’ equity		336,654			298,393			281,847			272,974			251,963
Balance sheet at year-end
Loans	$	3,685,244		$	2,460,823		$	2,047,355		$	1,985,493		$	1,845,802
Investments		1,231,661			982,915			911,889			901,208			943,563
Other interest-earning assets		27,221			135,473			62,975			37,455			56,291
Total assets		5,490,509			3,903,001			3,249,828			3,117,359			3,024,515
Deposits		3,938,432			2,985,058			2,516,855			2,365,457			2,212,563
Borrowed funds		990,498			508,285			389,495			439,168			488,182
Shareholders’ equity		474,707			339,310			294,751			273,232			270,532
Performance ratios
Return on average assets		0.63	%		0.79	%		1.22	%		1.28	%		1.39	%
Return on average equity		7.45			8.91			13.98			14.22			15.31
Average equity to average assets		8.42			8.85			8.73			8.98			9.08
Dividend payout ratio		100.06			88.82			55.26			53.41			48.16
Net interest margin		3.04			2.82			2.95			3.27			3.55

Upon completion of the merger, each share of Harleysville National Corporation common stock will be converted into merger consideration consisting of 0.474 shares of First Niagara common stock. The market value of the merger consideration may vary from the closing price of First Niagara common stock on the date it announced the merger, on the date of the special meeting of the Harleysville National Corporation shareholders and on the date it completes the merger and thereafter. Any change in the market price of First Niagara common stock prior to completion of the merger will affect the market value of the merger consideration that Harleysville National Corporation shareholders will receive upon completion of the merger. Accordingly, Harleysville National Corporation shareholders will not know or be able to calculate with certainty the market value of the merger consideration they would receive upon completion of the merger. Stock price changes may result from a variety of factors, including general market and economic conditions, changes in its respective businesses, operations and prospects, and regulatory considerations. Many of these factors are beyond First Niagara’s control.

(1)		The results of operations include the acquisition of the Willow Financial effective December 5, 2008.
(2)		The results of operations include the acquisition of the East Penn Financial effective November 16, 2007 and the sale lease-back of bank properties during the fourth quarter of 2007.
(3)		The results of operations include the acquisition of the Cornerstone Companies effective January 1, 2006 and the sale of the Bank’s Honesdale branch effective November 10, 2006.
(4)		The results of operations include the acquisition of Millennium Bank effective April 30, 2004.
(5)		Adjusted for a five percent stock dividend effective September 15, 2006, September 15, 2005 and September 15, 2004.

Harleysville National Corporation Shareholders Will Have a Reduced Ownership and Voting Interest After the Merger and Will Exercise Less Influence Over Management.

22Harleysville National Corporation’s shareholders currently have the right to vote in the election of the Harleysville National Corporation board of directors and on other matters affecting Harleysville National Corporation. When the merger occurs, each Harleysville National Corporation shareholder that receives shares of

~~Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~-18-

~~The~~First ~~following~~Niagara iscommon ~~management’s~~stock ~~discussion~~will ~~and~~become ~~analysis~~a shareholder of ~~the~~First ~~significant~~Niagara ~~changes~~with ina ~~the~~percentage ~~results~~ownership of ~~operations,~~the ~~capital~~combined ~~resources~~organization ~~and~~that ~~liquidity~~is ~~presented~~much insmaller ~~its~~than the ~~accompanying~~shareholder’s ~~consolidated~~percentage ~~financial~~ownership ~~statements~~of ~~for~~ Harleysville National ~~Corporation~~ ~~(the~~ Corporation),. ~~and its wholly owned subsidiaries—Harleysville~~Because ~~National~~of ~~Bank (the Bank)~~this, ~~HNC~~Harleysville ~~Financial~~National ~~Company and HNC Reinsurance Company. The~~ Corporation’s ~~consolidated~~shareholders ~~financial~~will ~~condition~~have ~~and results of operations consist~~less ~~almost~~influence ~~entirely~~on of the ~~Bank’s~~management ~~financial condition~~ and ~~results~~policies of ~~operations. Current~~First ~~performance~~Niagara ~~does~~than ~~not~~they ~~guarantee,~~now ~~and~~have ~~may not be indicative of, similar~~on ~~performance in~~ the ~~future.~~management ~~The information in Management’s Discussion~~ and ~~Analysis~~ ofpolicies ~~Financial Condition and Results~~ of ~~Operations~~Harleysville ~~should~~National ~~be read in conjunction with the~~ Corporation~~’s consolidated financial statements and the accompanying footnotes under Item 8 and the Forward-Looking Statements on page 3 of this report on Form 10-K~~.

~~Critical~~The ~~Accounting~~Merger ~~Estimates~~Agreement Limits Harleysville National Corporation’s Ability to Pursue Alternatives to the Merger and Raise Capital.

The ~~accounting~~Merger ~~and~~Agreement ~~reporting~~contains ~~policies~~“no ofshop” ~~the~~provisions ~~Corporation~~that, ~~and~~subject ~~its~~to ~~subsidiaries~~limited ~~conform~~exceptions, limit Harleysville National Corporation’s ability to ~~accounting~~discuss, facilitate ~~principles~~or ~~generally~~commit ~~accepted~~to incompeting ~~the~~third-party ~~United~~proposals ~~States~~to ~~and general~~acquire ~~practices~~all ~~with~~or ~~the~~a significant ~~financial~~part ~~services~~of ~~industry.~~Harleysville ~~The~~National Corporation’s. In addition, Harleysville ~~significant~~National ~~accounting~~Corporation ~~policies~~has ~~are~~agreed ~~described~~to inpay ~~Note~~First 1Niagara a termination fee in the amount of $10.0 million in the ~~consolidated~~event that Harleysville National Corporation ~~financial~~terminates ~~statements~~the ~~and~~merger ~~are~~agreement ~~essential~~for incertain ~~understanding~~reasons. ~~Management’s~~These ~~Discussion~~provisions might ~~and~~discourage ~~Analysis~~a ofpotential ~~Results~~competing ofacquirer ~~Operations~~that ~~and~~might ~~Financial~~have ~~Condition.~~an Ininterest ~~applying~~in ~~accounting~~acquiring ~~policies~~all ~~and~~or ~~preparing~~a ~~the~~significant ~~consolidated~~part ~~financial~~of ~~statements,~~Harleysville National Corporation from ~~management~~considering isor ~~required~~proposing that acquisition even if it were prepared to ~~make~~pay consideration ~~estimates~~with ~~and~~a ~~assumptions~~higher per share market price than that ~~affect~~proposed in the ~~reported~~merger, ~~amount~~or ofmight ~~assets~~result ~~and~~in ~~liabilities~~a aspotential ofcompeting ~~the~~acquiror’s ~~dates~~proposing ofto ~~the~~pay ~~balance sheets~~a ~~and~~lower ~~revenues~~per ~~and~~share ~~expenditures~~price ~~for~~to ~~the~~acquire ~~periods~~Harleysville ~~presented.~~National ~~Therefore,~~Corporation ~~actual results~~than ~~could~~it ~~differ~~might otherwise ~~significantly~~have ~~from~~proposed ~~those~~to ~~estimates~~pay. ~~Judgments~~Harleysville ~~and assumptions~~National ~~required~~Corporation bycan ~~management,~~consider and ~~which~~participate ~~have,~~in ordiscussions ~~could~~and ~~have~~negotiations awith ~~material~~respect ~~impact~~to an alternative onproposal so long as the Harleysville National Corporation’s ~~financial~~board ~~condition~~of ordirectors determines ~~results~~in ofgood ~~operations~~faith ~~are~~(after ~~considered~~consultation with legal counsel) that failure to ~~critical~~do ~~accounting~~so ~~estimates.~~would ~~The~~be ~~following~~reasonably islikely to result in a ~~summary~~violation of ~~the~~its ~~policies the~~fiduciary ~~Corporation~~duties ~~recognizes~~to asHarleysville ~~involving~~National ~~critical~~Corporation ~~accounting~~shareholders ~~estimates:~~under ~~Allowance~~applicable ~~for~~law. ~~Loan Loss~~Moreover, ~~Goodwill~~the ~~and~~Merger ~~Other~~Agreement ~~Intangible~~restricts ~~Asset~~the ~~Impairment,~~Corporation’s ~~Stock-Based~~ability to solicit ~~Compensation~~additional capital, ~~Unrealized~~which ~~Gains~~may ~~and~~be ~~Losses~~needed onto ~~Securities~~meet ~~Available~~certain ~~for~~regulatory ~~Sale, and~~requirements ~~Deferred~~or ~~Taxes.~~to fund day-to-day operations.

~~Allowance for Loan Losses:~~ The ~~Corporation maintains an allowance for loan losses at a~~ ~~level~~Merger ~~management believes~~ is ~~sufficient~~Subject to ~~absorb estimated probable credit losses. Management’s determination of~~ the ~~adequacy~~Receipt of ~~the~~Consents ~~allowance is based on periodic evaluations of the loan portfolio~~ and ~~other~~Approvals ~~relevant~~From ~~factors. However,~~Government ~~this~~Entities ~~evaluation~~that isMay ~~inherently~~Impose ~~subjective~~Conditions asthat itCould ~~requires~~Have ~~significant~~an ~~estimates~~Adverse ~~by management.~~Effect 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.~~Combined ~~These~~Company ~~factors~~Following ~~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~~Merger.

~~Goodwill and~~Before ~~Other~~the ~~Intangible~~merger ~~Asset~~may ~~Impairment:~~be ~~Goodwill and other intangible assets are reviewed for potential impairment on an annual basis~~completed, orvarious ~~more~~approvals ~~often if events~~ or ~~circumstances~~ ~~indicate~~consents ~~that~~must ~~there may~~ be ~~impairment,~~obtained ~~in accordance with SFAS No.~~from ~~142,~~the ~~“Goodwill~~Office ~~and~~of ~~Other~~Thrift ~~Intangible~~Supervision ~~Assets~~ and ~~SFAS~~other Nogovernmental entities. ~~144~~These government entities, ~~“Accounting~~including ~~for~~ the ~~Impairment~~ orOffice ~~Disposal~~ of ~~Long-Lived~~the ~~Assets.”~~Comptroller ~~Goodwill~~of isthe ~~tested for impairment~~Currency, atmay ~~the~~impose ~~reporting~~conditions ~~unit~~on ~~level~~the ~~and~~completion anof ~~impairment~~the ~~loss~~merger isor ~~recorded~~require changes to the ~~extent~~ ~~that~~terms ~~the carrying amount~~ of ~~goodwill~~the ~~exceeds~~merger. ~~its~~Although ~~implied~~First ~~fair~~Niagara ~~value.~~and ~~The~~Harleysville National Corporation ~~employs~~do ~~general~~not ~~industry~~currently ~~practices~~expect inthat ~~evaluating~~any ~~the~~such ~~fair~~material ~~value~~conditions ofor changes ~~its~~would ~~goodwill~~be ~~and~~imposed, ~~other~~there ~~intangible~~can ~~assets.~~be ~~The~~no ~~Corporation~~assurance ~~calculates~~that ~~the~~they ~~fair value,~~will ~~with~~not ~~the assistance of a third party specialist~~be, ~~using~~and ~~a combination of~~such ~~the~~conditions ~~following~~or ~~valuation~~changes ~~methods:~~could ~~dividend~~have ~~discount analysis under~~ the ~~income approach,~~effect ~~which~~of ~~calculates~~delaying ~~the~~completion ~~present value~~ of ~~all excess cash flows plus~~ the merger ~~present~~or ~~value~~imposing ofadditional acosts ~~terminal~~on ~~value~~or ~~and~~limiting ~~market multiples (pricing ratios) under~~ the ~~market~~revenues ~~approach. Management performed its annual review~~ of ~~goodwill~~First ~~and~~Niagara ~~other~~following ~~identifiable~~the ~~intangibles at June 30~~merger, ~~2008~~any ~~and determined there was no impairment~~ of ~~goodwill~~which ormight ~~other~~have ~~identifiable~~a ~~intangibles.~~material Noadverse ~~assurance~~effect ~~can~~on beFirst ~~given~~Niagara ~~that~~following ~~future~~the ~~impairment tests will not result in a charge to earnings~~merger.

23The Merger is Subject to Closing Conditions, that, if Not Satisfied or Waived, Will Result in the Merger Not Being Completed, Which May Result in Material Adverse Consequences to Harleysville National Corporation’s Business and Operations.

~~Stock-based Compensation:~~ The ~~Corporation recognizes compensation expense for stock options~~ inmerger ~~accordance~~is ~~with~~subject ~~SFAS~~to ~~123~~closing ~~(revised~~conditions ~~2004)~~that, ~~“Share-Based~~if ~~Payment”~~not ~~(SFAS 123(R)) adopted at January 1~~satisfied, ~~2006~~will ~~under~~prevent the ~~modified prospective application method of~~ ~~transition.~~merger ~~The~~from ~~expense~~being ~~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~~completed. ~~For~~In ~~grants~~addition ~~subject~~ to ~~a service condition,~~ the ~~Corporation~~ ~~utilizes~~required ~~the~~approvals ~~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~~consents ~~life~~from ~~of the options~~governmental, the ~~current~~merger ~~price~~is ~~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~~other ~~condition,~~conditions ~~the~~beyond ~~Corporation utilizes a Monte Carlo simulation to estimate~~First ~~the~~Niagara’s ~~fair value~~ and ~~determine~~Harleysville ~~the~~National ~~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~~ ofcontrol ~~the~~that ~~fair~~may ~~value of a stock option is based on expectations derived~~prevent, ~~from~~delay ~~historical~~or ~~experience~~otherwise ~~and~~materially ~~may~~adversely ~~not~~affect ~~necessarily equate to~~ its ~~market value when fully vested~~completion. InFirst ~~accordance~~Niagara ~~with~~and Harleysville ~~SFAS~~National ~~123(R), the~~ Corporation ~~estimates~~cannot ~~the number~~predict ofwhether ~~options~~and ~~for~~when ~~which~~these ~~the~~other conditions ~~requisite~~will ~~service is expected to~~ be ~~rendered~~ satisfied.

~~Unrealized Gains and Losses on Securities Available for Sale:~~ The ~~Corporation~~Shares ~~receives estimated fair values~~ of ~~debt~~First ~~securities~~Niagara ~~from independent valuation services and~~Common ~~brokers.~~Stock Into ~~developing~~be ~~these~~Received ~~fair~~by ~~values,~~Harleysville ~~the~~National 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~~Shareholders 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 $1.9 million during the fourth quarter of 2008 as a ~~result of~~ ~~deterioration~~Result ~~in the individual credits~~ of ~~a collateralized debt obligation investment in a pool of trust preferred securities. The unrealized losses associated with~~ the ~~securities~~Merger ~~portfolio,~~Will ~~that~~Have ~~management~~Different ~~has~~Rights ~~the~~From ~~ability and intent to hold, are not considered to be other-than temporary as of December 31, 2008 because~~ the ~~unrealized~~Shares ~~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~~Harleysville ~~unrealized~~National ~~losses~~Corporation ~~are~~Common ~~affecting all portfolio sectors with collateralized mortgage obligation securities and preferred securities having the largest reductions~~Stock.

~~Deferred~~Upon ~~Taxes:~~completion ~~The~~of ~~Corporation recognizes deferred tax assets and liabilities for~~ the ~~future~~ ~~effects of temporary differences~~merger, ~~net~~Harleysville ~~operating~~National ~~loss~~Corporation ~~carryforwards,~~shareholders ~~and~~will ~~tax~~become ~~credits.~~First ~~Deferred~~Niagara ~~tax~~shareholders ~~assets~~and ~~are~~their ~~subject~~rights toas ~~management’s~~shareholders ~~judgment~~will ~~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~~governed ~~asset~~by in the ~~future,~~certificate ~~a charge to income tax expense may be required to reduce the value~~ of ~~the~~incorporation ~~net~~and ~~deferred~~bylaws ~~tax asset to the expected realizable value.~~ of

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. -19-

24First Niagara. The rights associated with Harleysville National Corporation common stock are different from the rights associated with First Niagara common stock.

~~Financial~~Several ~~Overview~~Lawsuits Have Been Filed Against Harleysville National Corporation and the Members of the Harleysville National Corporation Board of Directors, As Well As First Niagara, Challenging the Merger, and an Adverse Judgment in Such Lawsuits May Prevent the Merger From Becoming Effective or From Becoming Effective Within the Expected Timeframe.

~~For~~Harleysville National ~~the~~Corporation ~~year ended~~and ~~December~~the ~~31,~~members ~~2008,~~of the Harleysville National Corporation’s board ~~diluted~~of ~~earnings~~directors ~~per~~are ~~share~~named ~~were~~as ~~$0.78~~defendants in purported class action lawsuits ~~compared~~brought toby ~~$0.90~~Harleysville ~~for~~National ~~2007.~~Corporation ~~Net~~shareholders ~~income~~challenging inthe proposed ~~2008~~merger, ~~was~~seeking, ~~$25.1~~among ~~million~~other ~~compared~~things, to enjoin the defendants from ~~$26.6~~consummating ~~million~~the inmerger ~~2007.~~on ~~The~~the ~~year~~agreed-~~to-date~~upon ~~financial~~terms. ~~results~~First ~~include~~Niagara ~~the~~is ~~impact~~also onnamed as ~~operations~~a ~~from~~defendant ~~the~~in ~~acquisition~~some, but not all, of these lawsuits. Additionally, the ~~Willow~~directors of ~~Financial~~Harleysville National Corporation ~~effective~~have been named as defendants in four ~~December~~shareholder 5derivative lawsuits that also seek, ~~2008~~among ~~and~~other things, to enjoin the ~~related~~consummation ~~issuance~~of the merger. One of ~~11,515,366~~the ~~shares~~conditions to the closing of the ~~Corporation~~merger ~~common~~is ~~stock.~~that Inno ~~addition~~order, ~~the~~decree ~~Corporation’s~~or ~~2008~~injunction ~~year-to-date results~~issued ~~include~~by a ~~full~~court ~~year~~or agency of competent ~~income~~jurisdiction ~~and~~that ~~expense~~enjoins ~~resulting~~or ~~from~~prohibits the ~~acquisition~~ consummation of ~~East~~the ~~Penn~~merger shall ~~Financial~~be ~~and~~in ~~its~~effect. ~~subsidiary~~As such, ~~East~~if ~~Penn~~the ~~Bank,~~plaintiffs ~~effective~~are ~~November~~successful in obtaining an ~~16,~~injunction ~~2007.~~prohibiting ~~The~~the ~~following~~defendants isfrom anconsummating ~~overview~~the ofmerger on the ~~key~~agreed upon ~~financial~~terms, ~~highlights~~then ~~for~~such injunction may prevent the merger from becoming effective, ~~2008:~~or from becoming effective within the expected timeframe.

~~Consolidated total~~Item ~~assets were $5~~1B.5 ~~billion~~Unresolved atStaff December 31, 2008, an increase of 40.7% or $1.6 billion over $3.9 billion in total assets reported at December 31, 2007. Effective December 5, 2008, the Corporation completed its acquisition of Willow Financial. At the acquisition date, Willow Financial had approximately $1.6 billion in assets, $1.1 billion in gross loans and $946.7 million in deposits.Comments

~~The return on average shareholders’ equity was 7~~None.45% in 2008 compared to 8.91% in 2007. The return on average assets was 0.63% in 2008 compared to 0.79% in 2007. The decrease in these ratios during 2008 was primarily the result of increases in average assets and average equity coupled with lower net income.

Loans increased $1.2 billion and deposits increased $953.4 million. Adjusted for the Willow Financial acquisition, organic loan growth was approximately $125.7 million or 5.1% and deposit growth was approximately $6.7 million or 0.2%.-20-

~~Net~~Item ~~interest income on a tax-equivalent basis increased $23.~~2 ~~million, or 26~~.~~2%,~~ for the year ending December 31, 2008, over the prior year. The net interest margin for 2008 increased to 3.04% compared to 2.82% for 2007. The net interest margin increased as a 56 basis point decrease in the yield on average earning assets of $3.7 billion was offset by a 98 basis point decrease in the cost of interest bearing liabilities of $3.2 billion. Properties

~~Nonperforming assets increased $56.6~~The ~~million~~principal toexecutive ~~$78.5~~offices ~~million~~of atthe ~~December~~Corporation ~~31,~~and ~~2008 from $22.0 million at December 31, 2007. Nonperforming assets as a percentage~~ of ~~total~~the ~~assets~~Bank ~~increased~~are tolocated ~~1.43% at~~in ~~December 31~~Harleysville, ~~2008~~Pennsylvania ~~from~~in ~~0.56% at December 31~~two, ~~2007.~~two-story ~~The~~office ~~provision~~buildings ~~for~~leased ~~loan~~by ~~losses increased $5.0 million mostly as a result of decreased quality of~~ the ~~loan~~ ~~portfolio~~Bank, ~~which~~one ~~caused~~built ~~an increase~~ in ~~the~~1929 ~~amount~~and of the ~~required~~other ~~reserve.~~in ~~Net charge-offs decreased $1~~2007.8 ~~million~~The ~~for~~Bank ~~2008~~owns ~~compared~~the tobuildings ~~2007~~in which ~~principally~~twenty-four ~~due~~of ~~to prior~~its ~~year~~branches ~~charge-offs~~are ~~for~~located ~~real~~and ~~estate~~leases ~~construction~~space ~~loans~~ for ~~one~~the ~~borrower~~other ~~combined~~sixty-four branches ~~with~~from anunaffiliated ~~increase~~third inparties ~~recoveries~~under ~~both~~leases ~~related to commercial and~~expiring ~~industrial~~at ~~loans~~various ~~and~~times ~~real~~through ~~estate loans~~2037.

Noninterest income increased $2.9 million or 6.6% during 2008. Increases in service charges of $3.8 million and gains on investment securities of $1.5 million were partially offset by a fourth quarter 2008 other than temporary impairment of available for sale securities of $1.9 million and a 2007 one-time gain of a sale-leaseback of bank properties transaction of $2.8 million. Other income increased $2.0 million during 2008 driven by increases in ATM and point of sale fee income of $835,000, fees on derivative instruments of $627,000 and a $405,000 death benefit earned on bank owned life insurance.

Office	Office Location	Owned/Leased
Airport Village	102 Airport Road, Coatesville, PA	Leased
Allentown	1602 Allen Street, Allenton, PA	Leased
Audubon	2624 Egypt Road, Norristown, PA	Owned(2)
Avondale	119 Pennsylvania Avenue, Avondale, PA	Owned
Bethlehem	4510 Bath Pike, Bethlehem, PA	Leased
Blue Bell	20 West Skippack Pike, Ambler PA	Owned(2)
Boyertown	Rt. 100 and Bause Road, Boyertown, PA	Leased
Brandywine Square	82 Quarry Road, Downingtown, PA	Leased
Bustleton	9869 Bustleton Avenue, Philadelphia, PA	Leased
Cedar Crest	1251 S Cedar Crest Blvd, Allentown, PA	Leased
Chalfont	251 West Butler Avenue, Chalfont, PA	Leased
Coatesville	112 East Lincoln Highway, Coatesville, PA	Leased
Collegeville	364 East Main Street, Collegeville, PA	Owned
Conshohocken	101 Ridge Pike, Conshohocken, PA	Owned(2)
Devon	414 Lancaster Avenue, Devon, PA	Leased
Dorneyville	3570 Hamilton Boulevard, Allentown, PA	Leased
Douglassville	1191 West Ben Franklin Highway, Douglassville, PA	Leased
Downingtown	100 E. Lancaster Avenue, Downingtown, PA	Leased
Doylestown	500 East Farm Lane, Doylestown, PA	Owned(2)
Dresher	701 Twining Road, Dresher, PA	Leased
Eagle	300 Simpson Drive, Chester Springs, PA	Leased
East Norriton	450 East Germantown Pike, East Norriton, PA	Owned(2)
Emmaus	731 Chestnut St, Emmaus, PA	Owned
Emmaus	502 State Ave, Emmaus, PA	Owned
Emmaus High School	500 Macungie Ave, Emmaus, PA	Leased
Exton	601 N. Pottstown Pike, Exton, PA	Leased
Feasterville	220 East Street Road, Feasterville, PA	Leased
Flourtown	1851 Bethlehem Pike, Flourtown, PA	Leased
Fogelsville	861 N. Rt. 100, Fogelsville, PA	Owned
Foulkeways	1120 Meetinghouse Road, Gwynedd, PA	Leased
Frazer	200 West Lancaster Avenue, Frazer, PA	Leased(3)
Gilbertsville	1050 East Philadelphia Avenue, Gilbertsville, PA	Leased
Harleysville Campus	483 Main Street, Harleysville, PA	Leased
Harleysville-Meadowbrook	278 Main Street, Harleysville, PA	Owned(2)
Hatboro	2 North York Road, Hatboro, PA	Leased
Hatfield	1632 Cowpath Road, Hatfield, PA	Leased
Horsham	955 Horsham Road, Horsham, PA	Leased
Huntington Valley	761 Huntingdon Pike, Huntingdon Valley, PA	Leased
Kennett Square	838 East Baltimore Pike, Kennett Square, PA	Owned(5)
King of Prussia	170 S. Warner Road, Suite 100, Wayne, PA	Leased
Kresgeville	Route 209, Kresgeville, PA	Leased
Lansdale-Marketplace	1551 Valley Forge Road, Lansdale, PA	Owned(2)
Lansdale-North Broad	1804 North Broad Street, Lansdale, PA	Leased
Lansford	13-15 West Ridge Street, Lansford, PA	Leased
Lehigh Township	4421 Lehigh Drive, Walnutport, PA	Leased

Noninterest expense increased $23.3 million or 28.6% in 2008 as compared to 2007. This increase is due primarily to increases of $7.3 million in salaries and benefits, $3.1 million in occupancy, $3.0 million in merger charges, $3.0 million in intangibles expense, $1.8 million in FDIC insurance and increases in consulting and legal fees. The increases in salaries and occupancy are mainly the result of a full year of expenses for East Penn Financial which was acquired in November 2007 as well as one month of expenses for Willow Financial. Intangibles expense in 2008 includes $1.4 million in valuation adjustments of mortgage servicing rights with the remaining increase relating to the acquisitions noted above. FDIC insurance expense increased as the Corporation had applied a one-~~time assessment credit in 2007 which offset most of the expense for the year.~~21-

Acquisitions/Dispositions

Office	Office Location	Owned/Leased
Lehighton	904 Blakeslee Blvd, Lehighton, PA	Leased
Limerick	260 West Ridge Pike, Limerick, PA	Leased
Macungie	201 W Main St, Macungie, PA	Owned(2)
Malvern(1)	30 Valley Stream Parkway, Malvern, PA	Leased
Maple Glen	732 Norristown Road, Maple Glen, PA	Leased
Meadowood	3205 Skippack Pike, Worcester, PA	Leased
Mertztown	951 State Street, Mertztown, PA	Leased
Normandy Farms	Morris Road & Route 202, Blue Bell, PA	Leased
North Wales (North Penn)	1498 North Wales Road, North Wales, PA	Leased
North Wales	122 N. Main Street, North Wales, PA	Leased
Oxford	499 North 3rd Street, Oxford, PA	Leased
Palmerton	372 Delaware Avenue, Palmerton, PA	Leased
Peter Becker Community	815 Maplewood Drive, Harleysville, PA	Leased
Pottstown Center	Rt. 100 and Shoemaker Road, Pottstown, PA	Owned(2)
Pottstown-Coventry	2 Glocker Way, Pottstown, PA	Owned(2)
Pottstown-East End	1450 East High Street, Pottstown, PA	Owned(2)
Pottstown-North End	930 North Charlotte Street, Pottstown, PA	Leased
Pottstown-Train Station	One Security Plaza, Pottstown, PA	Leased
Quakertown Main	224 West Broad Street, Quakertown, PA	Owned
Red Hill	400 Main Street, Red Hill, PA	Leased
Roslyn Valley	1331 Easton Road, Roslyn, PA	Leased
Royersford	440 W. Linfield-Trappe Road, Royersford, PA	Owned(2)
Sellersville	209 North Main Street, Sellersville, PA	Leased
Skippack	3893 Skippack Pike, Skippack, PA	Leased
Slatington	502 Main Street, Slatington, PA	Leased
Slatington Handi-Bank	701-705 Main Street, Slatington, PA	Leased
Somerton	11730 Bustleton Avenue, Philadelphia, PA	Leased
Souderton	702 Route 113, Souderton, PA	Owned(2)
Southampton	735 Davisville Road, Southampton, PA	Leased
Spring House(1)	1017 North Bethlehem Pike, Spring House, PA	Leased
Summit Hill	2 East Ludlow Street, Summit Hill, PA	Leased
Thorndale	3909 Lincoln Highway, Downingtown, PA	Leased
Trainers Corner	120 North West End Boulevard, Quakertown, PA	Leased
Trexlertown	6890 Hamilton Blvd, Trexlertown, PA	Owned
Warminster	190 Veterans Way, Warminster, PA	Owned(2)
Warminster Square	1555 West Street Road, Warminster, PA	Leased
West Chester	16 E. Market Street, West Chester, PA	Leased
Westtown	1197 Wilmington Pike, West Chester, PA	Leased
Whitehall	2985 MacArthur Rd, Whitehall, PA	Owned
Willow Grove	9 Easton Road, Willow Grove, PA	Owned(4) (5)
Wyomissing(1)	2800 State Hill Road, Wyomissing, PA	Leased

Additional Office Space
Commercial Business Development	650 Sentry Parkway, Blue Bell, Pa	Leased
Harleysville National Bank Trust Department(1)	1690 Sumneytown Pike, Lansdale, PA	Leased
Cornerstone Financial Consultants	1802 Hamilton, Allentown PA	Leased
Cornerstone Financial Consultants – McPherson	8320 Bellona Ave, Towson, MD	Leased

Effective after the market close on December 5, 2008, the Corporation completed its acquisition of Willow Financial. Under the terms of the merger agreement, dated as of May 20, 2008, Willow Financial was acquired by the Corporation and Willow Financial’s 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. The merger of the Corporation and Willow Financial resulted in a combined company with approximately $5.5 billion in assets and delivers a significant market share in Chester County, one of the fastest22-growing counties in Pennsylvania, increases the Corporation’s market presence in Bucks and Montgomery counties, and establishes a new market presence in Philadelphia County. The combined company establishes a stronger presence in eastern Pennsylvania, including becoming the third largest financial institution headquartered in suburban Philadelphia. Willow Financial has complementary lines of business, a solid reputation with customers in growing markets, and a branch network that augments the Bank’s traditional footprint. In conjunction with this transaction, the Corporation also acquired BeneServ, Inc., a respected provider of employee benefits services and Carnegie Wealth Advisors, LLC (Carnegie). Carnegie was subsequently sold in December 2008. The Willow Financial merger is expected to be accretive to the Corporation’s earnings for the fiscal year of 2009.

Office	Office Location	Owned/Leased
Cornerstone Institutional Investments	74 West Broad St, Bethlehem, PA	Leased
Cornerstone Advisor Asset Management	74 West Broad St., Bethlehem, PA	Leased
HNC Financial Company	2751 Centerville Rd, Wilmington, DE	Leased
HNC Reinsurance Company	101 North First Avenue, Phoenix, AZ	Leased
Harleysville Management Services	474 Main St, Harleysville, Pa	Owned
BeneServ, Inc.	453 Baltimore Pike, Springfield, Pa	Leased

The Corporation acquired 100% of the outstanding shares of Willow Financial. The transaction was accounted for in accordance with SFAS No. 141, “Business Combinations.” Based on the terms of the merger agreement, Willow Financial shareholders received 0.73 shares of the Corporation’s common stock for each share of Willow Financial common stock they held with cash paid in lieu of fractional shares. The purchase price was $13.79 per common share and was based upon the average of the closing prices for the Corporation’s common stock on the agreement date and for two days before and two days after the agreement date and the agreement date. The Corporation issued 11,515,366 shares of common stock, incurred $2.4 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 $163.2 million at the closing on December 5, 2008. Willow Financial’s results of operations are included in the Corporation’s results from the date of acquisition, December 5, 2008.___________

~~Effective November~~(1) ~~16,~~Locations ~~2007,~~include ~~the~~Millennium ~~Corporation~~Wealth ~~completed~~Management ~~its acquisition of East Penn Financial~~ and ~~its~~Private ~~subsidiary,~~Banking ~~East Penn Bank. At the acquisition date, East Penn Financial had approximately $451.1 million in assets with nine banking~~ offices ~~located in Lehigh, Northampton and Berks Counties~~. The acquisition expanded the branch network of the Corporation in the Lehigh Valley and its opportunity to provide East Penn customers with a broader mix of products and services. As part of the merger agreement, East Penn Bank continues to operate under the East Penn name and logo, and has become a division of the Bank. Nine of the Bank’s existing branches were transferred to the East Penn division including those in Lehigh, Carbon, Monroe, and Northampton Counties. The Corporation acquired 100% of the outstanding shares of East Penn Financial for a total purchase price of $91.3 million. The transaction was accounted for in accordance with SFAS No. 141, “Business Combinations.” East Penn Financial shareholders received 2,432,771 shares of the Corporation’s common stock and $49.9 million for all outstanding common shares. East Penn Financial option holders received $792,000 and options to acquire 25,480 shares of the Corporation’s common stock in exchange for all outstanding options. East Penn Financial’s results of operations are included in the Corporation’s results from the date of acquisition, November 16, 2007.

~~On March 1, 2007, the Cornerstone Companies, a subsidiary of the Bank, completed a selected asset purchase of McPherson Enterprises and related entities~~ (~~McPherson~~2)~~, registered~~ ~~investment~~Branch ~~advisors~~buildings ~~specializing~~are inowned ~~estate~~by ~~and succession planning and life insurance for high-net-worth construction and aggregate business owners and families throughout~~ the ~~United States. McPherson became a part of the Cornerstone Companies, a component of the~~ Bank’s ~~Millennium~~and ~~Wealth Management division. The acquisition was part of~~ the ~~Corporation’s~~land ~~plan~~is ~~to continue to build its fee-based services businesses~~leased. ~~The consideration for the transaction was $1.5 million in cash.~~

~~Effective~~(3) January 1, 2006, the Bank completed its acquisition of the Cornerstone Companies, registered investment advisors for high net worth, privately held business owners, wealthy families and institutional clients. Located in the Lehigh Valley, Pennsylvania, the firm serves clients throughout Pennsylvania and other mid-Atlantic states. The ~~transaction~~ ~~was~~branch ~~accounted~~facility ~~for using the purchase method of accounting. The purchase price consisted of $15.0 million in cash paid~~ at ~~closing~~this ~~and~~location ~~a contingent~~is ~~payment of up to $7~~owned.0 ~~million~~There ~~to be paid post-closing. The contingent payment~~ is ~~based~~also ~~upon the Cornerstone Companies meeting certain minimum operating results during~~ a ~~five~~drive-~~year~~up ~~earn-out~~facility ~~period~~at ~~with a maximum payout of $7.0 million over~~ this ~~period.~~location ~~For~~that 2006 through 2008, the minimum operating results were met resulting in earn-out payments totaling $3.6 million which was recorded as additional goodwill. At December 31, 2008, the remaining maximum payout is $3leased.~~4 million through 2010. The Cornerstone Companies results of operations are included in the Corporation’s results from the effective date of the acquisition, January 1, 2006.~~

26(4) Includes the lease of an easement at this location.

~~On December 27, 2007, the Bank settled and closed an agreement to sell fifteen properties to affiliates of American Realty Capital, LLC~~ (~~“ARC”~~5) inBranch abuildings ~~sale-leaseback transaction. The properties~~ are ~~located~~rented ~~throughout~~but ~~Berks,~~land Bucks, Lehigh, Montgomery, Northampton, and Carbon counties. Under the leases, the Bank continues to utilize the properties in the normal course of business. Lease payments on each property are institution-quality, triple net leases with an initial annual aggregate base rent of $3.0 million with annual rent escalations equal to the lower of CPI-U (Consumer Price Index for all Urban Consumers) or 2.0 percent commencing in the second year of the lease term. As tenant, the Bank is ~~fully responsible for all costs associated with the operation, repair and maintenance of the properties during the lease terms and is recorded as occupancy expense~~owned. The agreement provides that each lease will have a term of 15 years, commencing on the closing date for the Agreement. The agreement also contains options to renew for periods aggregating up to 45 years. Under certain circumstances these renewal options are subject to revocation by the lessor. The Bank received net proceeds of $38.2 million and recorded a gain on sale from the transaction of $2.3 million (pre-tax) representing a portion of the total gain of $18.9 million. The remaining gain was deferred and is being amortized through a reduction of occupancy expense over the 15-year term of the leases an annual amount of $1.1 million. The Corporation also completed a separate sale-leaseback of office in October 2007 receiving net proceeds of $1.5 million with a recognized pre-tax gain of $473,000. The deferred gain of $552,000 is being amortized over the 10-year term of the lease. This strategic initiative was undertaken to help the Corporation translate a large non-earning asset into an earning asset in the form of loans, to help bolster earnings and increase liquidity.

~~For~~In ~~a five-year~~management's ~~summary~~opinion, all of ~~financial~~the above ~~information,~~properties ~~see~~are ~~Item~~in 6,good ~~“Selected~~condition ~~Financial Data,”~~and ~~which~~are isadequate ~~incorporated~~for ~~herein~~the byRegistrant's ~~reference.~~and the Bank’s purposes.

~~For quarterly information for 2008 and 2007, see~~ Item ~~7, “Management’s Discussion~~ ~~and Analysis of Financial Condition and Results of Operations—Fourth Quarter 2008 Results,” and Table 17, “Selected Quarterly Financial Data,” which are incorporated herein by reference~~3. Legal Proceedings

~~Investment~~In ~~Securities~~the ordinary course of business, we are involved in various threatened and pending legal proceedings. We believe that we are not a party to any pending legal, arbitration, or regulatory proceedings that would have a material adverse impact on our financial results or liquidity. Certain legal proceedings in which we are involved are described below:

~~SFAS~~In connection ~~No.~~with the Corporation’s proposed merger with First Niagara, the ~~115~~Corporation has been named as a defendant in seven, ~~“Accounting~~substantially ~~for~~similar actions ~~Certain~~currently ~~Investments~~pending in ~~Debt~~the ~~and~~Court ~~Equity~~of ~~Securities”~~Common ~~requires~~Pleas of Montgomery County, ~~that~~Pennsylvania ~~debt~~(the Seibert, McAuvic and ~~equity~~Shoemaker ~~securities~~matters) and ~~classified~~the asCourt ~~available~~of ~~for~~Common ~~sale~~Pleas beof ~~reported~~Philadelphia ~~at fair value~~County, ~~with~~Pennsylvania ~~unrealized~~(the ~~gains~~Davis, Forbes, Silver and ~~losses~~Valerius matters). These ~~excluded~~complaints ~~from~~each ~~earnings~~charge that the Corporation and ~~reported~~its indirectors ~~other~~breached ~~comprehensive~~their ~~income.~~fiduciary ~~The~~duties ~~net~~to ~~effect~~the ofCorporation’s ~~unrealized~~shareholders ~~gains~~by failing orto ~~losses,~~negotiate a fair price for the Corporation’s stock in the ~~caused~~merger. In byaddition, ~~marking~~the anplaintiffs ~~available~~claim ~~for~~that ~~sale~~the ~~portfolio~~process leading to the ~~market,~~proposed ~~causes~~merger ~~fluctuations~~was unfair. The Seibert and McAuvic complaints also inallege that First Niagara aided and abetted the ~~level~~breaches of ~~shareholders’~~fiduciary ~~equity~~duty by the Corporation and ~~equity-related~~its ~~financial~~directors. The ~~ratios~~complaints asseek to enjoin the ~~market~~proposed ~~interest~~merger ~~rates~~and ~~cause~~to ~~the~~recover ~~fair~~money ~~value~~damages. ofThe ~~fixed-rate~~Corporation ~~securities~~believes tothe ~~fluctuate~~claims in the complaints are without merit. All seven state cases are currently stayed.

~~Investment~~On ~~securities~~January ~~and other investments increased 25.3% to $1.2 billion at December 31~~6, ~~2008~~ ~~from $982.9 million at December 31~~2010, ~~2007. The investment securities available for sale increased $231.6 million and~~ the ~~investment~~plaintiffs ~~securities held to maturity decreased $6.9 million. The majority of the increase~~ in ~~available for sale securities is due to~~ the ~~securities~~Seibert ~~acquired from Willow Financial of $238.3 million on December 5, 2008. The securities acquired from Willow Financial include $165.7 million in securities available for sale~~ and ~~$72.6 million~~McAuvic incases ~~securities~~moved ~~held~~ to ~~maturity. Upon acquisition, the Corporation~~lift ~~recorded~~ the ~~securities~~stay ~~held~~of toproceedings ~~maturity~~previously ~~purchased~~stipulated ~~from~~by ~~Willow~~the ~~as available for sale. During 2008~~parties, ~~$208.5~~and ~~million~~sought ~~of securities available for sale were sold~~an ~~which~~order ~~generated~~granting aexpedited ~~pre-tax~~discovery ~~gain of $2.6 million. The securities sold consisted primarily of bullet~~ and ~~callable~~scheduling ~~agency,~~a ~~tax-exempt~~preliminary ~~municipal and~~injunction ~~mortgage-backed securities~~hearing. ~~The~~On ~~increase~~January ~~in available for sale securities at December 31~~7, ~~2007 compared to December 31~~2010, ~~2006 of $72.6 million was mainly due to~~ the ~~securities~~Court ~~acquired~~denied ~~from~~plaintiffs’ ~~East~~motions ~~Penn~~in ~~Financial of $66.2 million at November~~their ~~16, 2007~~entirety. ~~During 2007, securities available for sale totaling $186.2 million were sold which generated a pretax gain of $1.2 million.~~

~~The~~In December ~~following~~2009 ~~table~~and ~~shows~~January 2010, three lawsuits (Valerius v. Geraghty, et al; Shoemaker v. Geraghty, et al.; and Maffia v. Geraghty et al.) were filed against the Corporation in the United States ~~carrying~~District ~~value~~Court for the Eastern District of Pennsylvania. All three complaints named the Corporation and its directors and First Niagara as defendants and asserted that the Corporation’s ~~investment~~proxy ~~securities~~statement ~~available~~sent ~~for~~to shareholders ~~sale~~in connection with the proposed merger was incomplete and ~~held~~materially tomisleading. On ~~maturity:~~February 8, 2010, the plaintiffs in the Shoemaker action voluntarily dismissed their case with prejudice. On February 26, 2010, plaintiffs in the Valerius and Maffia actions voluntarily dismissed their cases with prejudice. All three cases have been marked as closed.

~~Table 1—Investment Portfolio~~ -23-

	December 31,
(Dollars in thousands)	2008		2007		2006
Investment securities available for sale:
Obligations of U.S. government agencies and corporations	$	93,894	$	98,734	$	119,956
Obligations of states and political subdivisions		286,875		228,436		201,643
Mortgage-backed securities		705,483		515,989		476,107
Other securities		55,696		67,208		37,960
Total investment securities available for sale	$	1,141,948	$	910,367	$	835,666
Investment securities held to maturity:
Obligations of U.S. government agencies and corporations	$	3,880	$	3,868	$	3,856
Obligations of states and political subdivisions		46,554		53,479		55,023
Total investment securities held to maturity	$	50,434	$	57,347	$	58,879

Item 4.

(Removed and Reserved)

27 PART II

~~The~~Item ~~maturity~~5. ~~analysis~~Market ~~of investment securities including the weighted average yield~~ for ~~each~~Registrant’s ~~category~~Common ~~as of December 31~~Equity, ~~2008~~Related isStockholder asMatters ~~follows. Actual maturities may differ from contractual maturities because issuers~~ and ~~borrowers~~Issuer ~~may~~Purchases ~~have~~of ~~the~~Equity ~~right to call or prepay obligations with or without call or prepayment penalties.~~ Securities

~~Table~~The following ~~2—Maturity~~table sets forth high and low closing sales prices for the ~~Tax-Equivalent~~Corporation’s ~~Yield~~common ~~Analysis~~stock ofand ~~Investment~~quarterly ~~Securities~~cash dividends paid per share for 2009 and 2008. The Corporation’s stock is traded under the symbol “HNBC” on the NASDAQ Global Select Market. For certain limitations on the Bank’s ability to pay dividends to the Corporation, see Item 1, “Supervision and Regulation—Bank” and Item 8, Note 21, “Notes to Consolidated Financial Statements—Regulatory Capital.”

	December 31, 2008
				Due after			Due after
	Due in 1 year			1 year through			5 years through			Due after
	or less			5 years			10 years			10 years			Total
	(Dollars in thousands)
Investment securities available for sale:
Obligations of U.S. government agencies
and corporations:
Fair value	$	—		$	58,094		$	21,135		$	14,665		$	93,894
Weighted average yield		—	%		3.13	%		5.18	%		5.39	%		3.95	%
Obligations of states and political
subdivisions:
Fair value		—			2,886			70,782			213,207			286,875
Weighted average yield(1)		—	%		8.75	%		5.97	%		6.62	%		6.48	%
Mortgage-backed securities:
Fair value		—			17,177			94,789			593,517			705,483
Weighted average yield		—	%		4.62	%		4.82	%		5.37	%		5.28	%
Other debt securities:
Fair value		1,507			10,599			6,008			15,917			34,031
Weighted average yield		4.73	%		3.53	%		2.68	%		5.57	%		4.39	%
Equity securities:
Fair value		—			—			—			—			21,665
Weighted average yield		—	%		—	%		—	%		—	%		3.77	%
Total investment securities available for
sale:
Fair value	$	1,507		$	88,756		$	192,714		$	837,306		$	1,141,948
Weighted average yield		4.73	%		3.65	%		5.14	%		5.69	%		5.45	%
Investment securities held to maturity:
Obligations of U.S. government agencies
and corporations:
Amortized cost	$	—		$	—		$	3,880		$	—		$	3,880
Weighted average yield		—	%		—	%		5.41	%		—	%		5.41	%
Obligations of states and political
subdivisions:
Amortized Cost		—			—			13,308			33,246			46,554
Weighted average yield(1)		—	%		—	%		6.18	%		6.68	%		6.54	%
Total investment securities held to
maturity:
Amortized Cost	$	—		$	—		$	17,188		$	33,246		$	50,434
Weighted average yield		—	%		—	%		6.01	%		6.68	%		6.45	%

Price of Common Stock and Cash Dividends

(1) Weighted average yield on nontaxable investment securities is shown on a tax equivalent basis (tax rate of 35%).

2009	High Price		Low Price		Cash dividends per share
First Quarter	$	14.45	$	4.18	$	0.10
Second Quarter		9.86		4.60		0.01
Third Quarter		6.11		3.75		—
Fourth Quarter		6.63		5.47		—

2008	High Price		Low Price		Cash dividends per share
First Quarter	$	15.84	$	12.50	$	0.20
Second Quarter		15.24		11.16		0.20
Third Quarter		19.65		10.77		0.20
Fourth Quarter		16.86		11.27		0.20

~~Loans~~At December 31, 2009, there were 5,474 shareholders of record, not including the number of persons or entities whose stock is held in nominee or “street” name through various brokerage firms and banks.

~~Loans~~ The ~~increased~~Corporation $1has a stock repurchase program that permits the repurchase of up to five percent of its outstanding common stock.2 ~~billion~~The inrepurchased ~~2008~~shares will be used for general corporate purposes. The ~~acquisition~~Corporation ofdid ~~Willow~~not ~~Financial~~repurchase ~~accounted~~any ~~for~~shares $1of its stock under the Corporation’s stock repurchase programs during 2009.1 ~~billion~~The maximum number of shares that may yet be purchased under the ~~increase~~plans was 731,761 as of December 531, ~~2008~~2009. ~~Organic~~The ~~growth~~repurchased ~~was~~shares are used for general ~~approximately~~corporate ~~$125~~purposes.7 ~~million~~On May 12, or2005, 5.the Board of Directors authorized a plan to purchase up to 1%.,416,712 ~~Loans~~shares ~~increased~~(restated ~~$413.5~~for ~~million~~five inpercent ~~2007~~stock ~~primarily~~dividend ~~attributed~~paid toon ~~the~~September ~~acquisition~~15, of2006 ~~East~~and ~~Penn~~September 15, ~~Financial~~2005) ~~resulting~~or in4.9% of its ~~$337~~outstanding common stock.7 ~~million~~The inCorporation ~~additional~~is ~~loans~~precluded ~~with~~from ~~organic~~purchasing ~~growth~~its outstanding common stock under the terms of ~~approximately~~the ~~$81.9 million,~~merger oragreement 4with First Niagara.~~0%.~~

~~The following table shows the composition of the Bank’s loans, net of deferred costs:~~ -24-

~~Table 3—Composition of Loan~~Equity ~~Portfolio~~Compensation Plan Information

	December 31,
	2008				2007				2006				2005				2004
			Percent				Percent				Percent				Percent				Percent
	Amount		of Loans		Amount		of Loans		Amount		of Loans		Amount		of Loans		Amount		of Loans
	(Dollars in thousands)
Real estate	$	1,603,406	43	%	$	959,064	39	%	$	845,880	41	%	$	791,358	40	%	$	693,468	37	%
Commercial
and industrial		980,656	27	%		730,144	30	%		507,899	25	%		479,238	24	%		473,514	26	%
Consumer		1,100,424	30	%		769,051	31	%		685,988	34	%		697,373	35	%		645,718	35	%
Lease
financing		758	—	%		2,564	—	%		7,588	—	%		17,524	1	%		33,102	2	%
Total	$	3,685,244	100	%	$	2,460,823	100	%	$	2,047,355	100	%	$	1,985,493	100	%	$	1,845,802	100	%

The following table provides information about shares of the Corporation’s stock that may be issued under existing equity compensation plans as of December 31, 2009:

At the acquisition date, Willow Financial included $664.1 million in real estate loans, $116.6 million in commercial loans, and $317.5 million in consumer loans. The remaining growth in commercial loans was mainly due to the emphasis on owner-operated businesses. The reduction in lease financing was due to run-off of the existing portfolio. One of the Bank’s strategic objectives is to increase its loan to deposit ratio by growing its loan portfolio at a faster pace than its deposits.

Plan Category	Number Of Securities To Be Issued Upon Exercise Of Outstanding Options, Warrants And Rights (A) (#)	Weighted-Average Exercise Price Of Outstanding Options, Warrants And Rights (B) ($)	Number Of Securities Remaining Available For Future Issuance Under Equity Compensation Plans, Excluding Securities Reflected In Column (A) (C)(#)
Equity Compensation Plans Approved by Stockholders	1,401,561(1)	$15.89 per share	914,752
Equity Compensation Plans Not Approved by Stockholders	-0-(2)	-0-	22,695
TOTAL	1,401,561	$15.89 per share	937,447

~~The following~~(1) ~~table~~Includes ~~details~~options ~~outstanding~~issued ~~loans~~under bythe ~~type~~Corporation’s as1993 and 1998 Stock Incentive Plans, 1998 Independent Director’s Stock Option Plan, 2004 Omnibus Stock Incentive Plan, options assumed pursuant to the merger & acquisition of ~~December~~Millennium 31Bank on April 30, ~~2008~~2004, ~~in terms~~options assumed pursuant to acquisition of ~~contractual~~East ~~maturity~~Penn ~~date:~~Financial on November 16, 2007 and options assumed pursuant to the acquisition of Willow Financial on December 5, 2008.

~~Table~~(2) ~~4—Selected~~On ~~Loan Maturity~~December ~~Data~~13, 1996, the Board of Directors authorized the registration of 70,354 shares of common stock for issuance under the Corporation’s Employee Stock Bonus Plan. On December 24, 1996, in celebration of the Corporation reaching $1 billion in total assets, 41,685 shares were issued to full and part-time employees of the Corporation’s subsidiaries. Annually, since 1996, a total of 5,974 shares in the aggregate, have been awarded under this Plan to employees in recognition of exemplary service during each calendar year. When awarded, the value of shares is based on the closing price of the Corporation’s common stock as of the close of business on the last business day of the most recently completed calendar quarter. Registered shares and available shares under the Plan reflect adjustment for stock dividends.

	December 31, 2008
			Due after
	Due in		1 year		Due after
	1 year or less		through 5 years		5 years		Total
	(Dollars in thousands)
Real estate	$	252,911	$	611,744	$	738,751	$	1,603,406
Commercial and industrial		352,189		389,500		238,967		980,656
Consumer		184,076		441,569		474,779		1,100,424
Lease financing		355		403		—		758
Total	$	789,531	$	1,443,216	$	1,452,497	$	3,658,244
Loans with variable or floating interest
rates	$	269,093	$	805,257	$	767,710	$	1,842,060
Loans with fixed predetermined interest rates		520,438		637,959		684,787		1,843,184
Total	$	789,531	$	1,443,216	$	1,452,497	$	3,685,244

Additional information on the Corporation’s equity compensation plans included under Item 8, Note 2, “Notes to Consolidated Financial Statements—Stock-Based Compensation and Note 15, “Stock-Based Compensation,” is incorporated herein by reference.

The Bank had no concentration of loans to individual borrowers which exceeded 10% of total loans at December 31, 2008 and 2007. The Bank actively monitors the risk of loan concentration. The Bank had no foreign loans, and the impact of nonaccrual and delinquent loans on total interest income continues to be immaterial. -25-

29 Performance Graph

~~Nonperforming~~The following ~~Assets~~graph contains a comparison of the cumulative total returns on Harleysville National Corporation’s common stock against the cumulative total returns of the NASDAQ Stock Market (U.S. companies) Index and the NASDAQ Bank Stocks Index for the period of five fiscal years commencing December 31, 2004, and ending December 31, 2009. The graph assumes that $100 was invested on December 31, 2004 in the Corporation’s common stock, the NASDAQ Stock Market (US companies) and NASDAQ Banks. The cumulative returns assume the reinvestment of dividends. The shareholder return shown on the graph below is not necessarily indicative of future performance.

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.

Zack's Total Return Annual Comparison
Five-Year Cumulative Total Return Summary

	2004		2005		2006		2007		2008		2009

Harleysville National Corporation		100.00		78.06		86.06		68.14		71.57		32.36
NASDAQ Stock Market (US Companies)		100.00		102.13		112.18		121.67		58.64		84.30
NASDAQ Banks Index		100.00		97.69		109.63		86.90		63.36		53.09



Notes:
Corporate Performance Graph with peer group uses peer group only performance (excludes only company).
Peer group indices use beginning of period market capitalization weighting.

* Source: Zacks Investment Research, Inc.

Nonperforming assets (including nonaccrual loans, loans 90 days or more past due and net assets in foreclosure) were 1.43% of total assets at December 31, 2008, compared to 0.56% at December 31, 2007 and 0.54% at December 31, 2006. The ratio of nonperforming loans to total net loans was 2.12% at December 31, 2008, compared to 0.90% at December 31, 2007 and 0.87% at December 31, 2006. -26-

~~Nonaccruing loans increased $54.0~~ ~~million to $75.1 million at December 31, 2008, as compared to $21.1 million at~~Item ~~December 31, 2007~~6. ~~The higher level of nonaccruing loans was mainly due to an~~ Selected 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 the Bank’s market area and in most cases, for the residential real estate, the 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 Bank increased its allowance for loan losses to approximately 1.25% of outstanding loans at June 30, 2008, and to 1.36% at December 31, 2008. 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.Data

Nonaccruing loans increased $5.9 million to $21.1 million at December 31, 2007, as compared to December 31, 2006. The increase in nonaccruing loans was principally due to an increase in non-accrual commercial construction, home equity revolving and installment loans during 2007 offset by a decrease in non-accrual commercial mortgages.

	Year Ended December 31,
	2009(1)			2008(2)			2007(3)			2006(4)			2005
	(Dollars in thousands, except per share information)
Income and expense
Interest income	$	230,811		$	206,294		$	194,561		$	178,941		$	151,739
Interest expense		100,938			102,154			112,127			95,768			64,618
Net interest income		129,873			104,140			82,434			83,173			87,121
Provision for loan losses		58,321			15,567			10,550			4,200			3,401
Net interest income after provision for loan losses		71,552			88,573			71,884			78,973			83,720
Noninterest income		63,658			46,217			43,338			45,348			29,990
Noninterest expense		367.742			104,622			81,355			70,830			62,479
(Loss) income before income taxes		(232,532	)		30,168			33,867			53,491			51,231
Income tax (benefit) expense		(13,057	)		5,075			7,272			14,076			12,403
Net (loss) income	$	(219,475	)	$	25,093		$	26,595		$	39,415		$	38,828
Per share information(5)
Basic (loss) earnings	$	(5.09	)	$	0.78		$	0.91		$	1.36		$	1.34
Diluted (loss) earnings		(5.09	)		0.78			0.90			1.34			1.32
Cash dividends paid		0.11			0.80			0.80			0.75			0.72
Book value (at year-end)		6.06			11.05			10.83			10.18			9.48
Basic average common shares outstanding		43,078,543			32,201,150			29,218,671			28,946,847			28,891,412
Diluted average common shares outstanding		43,078,543			32,364,137			29,459,898			29,353,128			29,490,216
Average balance sheet
Loans	$	3,411,383		$	2,585,101		$	2,123,170		$	2,014,420		$	1,900,023
Investments		1,139,259			1,037,112			944,464			925,635			903,063
Other interest-earning assets		417,011			48,474			72,087			79,670			51,740
Total assets		5,381,470			3,997,972			3,371,304			3,229,224			3,039,186
Deposits		4,021,294			3,004,070			2,557,546			2,469,514			2,259,831
Borrowed funds		906,172			586,088			471,296			434,938			456,599
Shareholders’ equity		368,962			336,654			298,393			281,847			272,974
Balance sheet at year-end
Loans	$	2,993,378		$	3,685,244		$	2,460,823		$	2,047,355		$	1,985,493
Investments		1,108,124			1,231,661			982,915			911,889			901,208
Other interest-earning assets		787,722			27,221			135,473			62,975			37,455
Total assets		5,187,796			5,490,509			3,903,001			3,249,828			3,117,359
Deposits		3,944,847			3,938,432			2,985,058			2,516,855			2,365,457
Borrowed funds		896,577			990,498			508,285			389,495			439,168
Shareholders’ equity		261,571			474,707			339,310			294,751			273,232
Performance ratios
Return on average assets		(4.08	) %		0.63	%		0.79	%		1.22	%		1.28	%
Return on average equity		(59.48	)		7.45			8.91			13.98			14.22
Average equity to average assets		6.86			8.42			8.85			8.73			8.98
Dividend payout ratio		—			100.06			88.82			55.26			53.41
Net interest margin		2.78			3.04			2.82			2.95			3.27
Asset Quality Ratios
Nonperforming loans to total loans		4.39	%		2.12	%		0.90	%		0.87	%		0.42	%
Net charge offs to average loans outstanding		1.22			0.23			0.36			0.14			0.10
Allowance for loan losses to total loans		2.23			1.36			1.11			1.03			1.00
Allowance for loan losses to nonperforming loans		50.73			65.00			124.5			119.9			238.2

(1) The ~~Bank’s policy~~results ~~for~~of ~~interest~~operations ~~income~~include ~~recognition~~a ~~on nonaccrual loans is to recognize income under the~~ non-cash ~~basis~~goodwill ~~when~~impairment ~~the~~charge ~~loans~~of 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. During 2008, interest accrued on nonaccruing loans and not recognized as interest income was $1214.95 million ~~and~~during ~~interest~~the ~~paid~~second onquarter ~~nonaccruing loans~~ of ~~$299,000~~2009 ~~was~~resulting ~~recognized as~~from ~~interest~~the ~~income.~~decrease ~~During~~in ~~2007,~~the ~~interest~~market ~~accrued~~value ~~on nonaccruing loans and not recognized as interest income was $982,000 and interest paid on nonaccruing loans~~ of ~~$331,000~~the ~~was~~Corporation’s ~~recognized as interest income~~stock. ~~During 2006, interest accrued on nonaccruing loans and not recognized as interest income was $788,000 and interest paid on nonaccruing loans of $191,000 was recognized as interest income.~~

Loans past due 90 days or more and still accruing interest are loans that are generally well secured and are in the process of collection. As of December 31, 2008, loans past due 90 days or more and still accruing interest were $1.8 million, compared to $857,000 at December 31, 2007 and $(2.4) ~~million at December 31, 2006.~~ The ~~higher~~results ~~level~~ of ~~loans~~operations ~~past~~include ~~due~~the 90acquisition ~~days or more at December 31, 2008 from December 31, 2007 was primarily driven by home equity revolving lines and residential first mortgage loans. The lower level~~ of ~~loans~~the ~~past~~Willow ~~due~~Financial 90effective ~~days or more at~~ December 315, ~~2007 from December 31, 2006 was primarily in the commercial loans, commercial mortgages, home equity revolving lines and home equity installment loans~~2008.

30(3) The results of operations include the acquisition of East Penn Financial Corporation effective November 16, 2007 and the sale lease-back of bank properties during the fourth quarter of 2007.

~~Net~~(4) ~~assets in~~The ~~foreclosure~~results atof ~~December~~operations ~~31,~~include ~~2008~~the ~~were~~acquisition ~~$1.6~~of ~~million~~the ~~compared~~Cornerstone toCompanies ~~$28,000~~effective ~~at December~~January 311, ~~2007 and $0 at December 31,~~ 2006. ~~During 2008, transfers from loans to assets in foreclosure were $2.4 million, additions from Willow Financial were $426,000, disposals of foreclosed properties were $1.3 million,~~ 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~~sale of ~~cost (lesser of carrying value of~~ the ~~asset~~Bank’s orHonesdale ~~fair~~branch ~~value~~effective atNovember ~~date~~10, ~~of acquisition) or estimated fair value~~2006.

~~The following~~(5) ~~table~~Adjusted ~~presents~~for ~~information~~a ~~concerning~~five ~~nonperforming~~percent ~~assets. Nonperforming~~stock ~~assets~~dividend ~~include~~effective ~~loans~~September ~~that~~15, ~~are~~2006 ~~in nonaccrual status or 90 days or more past due~~ and ~~loans~~September ~~that~~15, ~~are in the process of foreclosure~~2005.

~~Table 5—Nonperforming Assets~~ -27-

	December 31,
	2008			2007			2006			2005			2004
	(Dollars in thousands)
Nonaccrual loans	$	75,060		$	21,091		$	15,201		$	7,493		$	4,705
Loans 90 days or more past due		1,849			857			2,444			846			981
Total nonperforming loans		76,909			21,948			17,645			8,339			5,686
Net assets in foreclosure		1,626			28			—			29			370
Total nonperforming assets	$	78,535		$	21,976		$	17,645		$	8,368		$	6,056
Allowance for loan losses to nonperforming
loans		65.00	%		124.5	%		119.9	%		238.2	%		324.6	%
Nonperforming loans to total loans		2.12	%		0.90	%		0.87	%		0.42	%		0.31	%
Allowance for loan losses to total loans		1.36	%		1.11	%		1.03	%		1.00	%		1.00	%
Nonperforming assets to total assets		1.43	%		0.56	%		0.54	%		0.27	%		0.20	%

Item 7.

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

~~Local~~ The ~~real~~following ~~estate~~is management’s discussion and analysis of the significant changes in the results of operations, capital ~~most~~resources ~~with~~and liquidity presented in its accompanying consolidated ~~acceptable~~financial ~~loan~~statements tofor ~~value~~Harleysville ~~ratios~~National Corporation (the Corporation), and ~~secures~~its ~~many~~wholly owned subsidiaries—Harleysville National Bank and Trust Company (the Bank or Harleysville National Bank), HNC Financial Company and HNC Reinsurance Company. The Corporation’s consolidated financial condition and results of operations consist almost entirely of the ~~nonperforming~~Bank’s ~~loans~~financial condition and results of operations. Current performance does not guarantee, and may not be indicative of, similar performance in the future. The information in Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Corporation’s consolidated financial statements and the accompanying footnotes under Item 8 and the Forward-Looking Statements as described on page 3 of this report on Form 10-K.

~~Allowance~~This document, including information included or incorporated by reference in this document, may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Within this document, 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 risks, uncertainties and other factors that could cause actual results and experience to differ include, but are not limited to, the following: inability to achieve merger-related synergies, the strategic initiatives and business plans may not be satisfactorily completed or executed, if at all; increased demand or prices for ~~Loan~~the ~~Losses~~Corporation’s financial services and products may not occur; changing economic and competitive conditions; technological developments; the effectiveness of the Corporation’s business strategy due to changes in current or future market conditions; effects of deterioration of economic conditions on customers specifically the effect on loan customers to repay loans; inability of the Corporation to raise or achieve desired or required levels of capital; the effects of competition, and of changes in laws and regulations, including industry consolidation and development of competing financial products and services; interest rate movements; relationships with customers and employees; challenges in establishing and maintaining operations; volatilities in the securities markets; and deteriorating economic conditions and other risks and uncertainties, including those detailed in the Corporation’s filing with the Securities and Exchange Commission.

~~The~~When we ~~Corporation~~use ~~uses~~words ~~the~~such ~~reserve~~as ~~method~~“believes”, of“expects”, ~~accounting~~“anticipates”, ~~for~~“estimates”, ~~loan losses. The balance~~or in“intends” ~~the~~or ~~allowance~~similar ~~for~~expressions, ~~loan~~we ~~losses~~are ismaking ~~determined~~forward-looking ~~based on management’s review and~~statements. ~~evaluation~~Investors ofare ~~the~~cautioned ~~loan~~not ~~portfolio in relation~~ to ~~past~~place ~~loss~~undue ~~experience,~~reliance ~~the~~on ~~size~~these forward-looking statements and ~~composition~~are ofalso ~~the~~advised ~~portfolio,~~to ~~current~~review ~~economic~~the ~~events~~risk ~~and~~factors ~~conditions,~~that ~~and~~may affect ~~other~~Harleysville ~~pertinent~~National ~~factors, including management~~Corporation’s ~~assumptions~~operating asresults toin ~~future delinquencies,~~documents ~~recoveries~~filed ~~and~~by Harleysville ~~losses.~~National ~~Increases~~Corporation towith the ~~allowance~~Securities ~~for~~and ~~loan~~Exchange ~~losses~~Commission, ~~are~~including ~~made~~this bydocument, ~~charges to~~ the ~~provision~~Annual ~~for~~Report ~~loan~~on ~~losses.~~Form ~~Credit~~10-K, ~~exposures~~the ~~deemed~~Quarterly toReport on beForm ~~uncollectible~~10-Q ~~are~~and ~~charged~~other ~~against~~required ~~the~~filings. ~~allowance~~Harleysville ~~for~~National ~~loan~~Corporation ~~losses. Recoveries~~assumes ofno ~~previously~~duty ~~charged-off amounts are credited~~ to update the ~~allowance~~forward-looking ~~for~~statements ~~loan~~made ~~losses.~~in this document.

~~While~~Shareholders ~~management~~should ~~considers~~note ~~the~~that ~~allowance~~many ~~for~~factors, ~~loan~~some ~~losses~~of towhich beare ~~adequate~~discussed ~~based~~elsewhere onin this ~~information~~report ~~currently~~and ~~available,~~in ~~future additions to~~ the ~~allowance~~documents ~~may~~that ~~be necessary~~we ~~due~~incorporate toby ~~changes~~reference, incould ~~economic~~affect ~~conditions~~the future orfinancial ~~management’s~~results ~~assumptions~~of ~~as to~~the ~~future~~Corporation ~~delinquencies, recoveries~~ and ~~losses~~its subsidiaries and ~~management’s~~could ~~intent with~~cause ~~regard~~those results to ~~the~~differ ~~disposition~~materially offrom ~~loans.~~those Inexpressed ~~addition,~~or ~~the~~implied ~~OCC,~~in ~~as an integral part of~~our ~~their~~forward-looking ~~examination~~statements ~~process,~~contained ~~periodically~~or ~~reviews~~incorporated ~~the~~by ~~Corporation’s~~reference ~~allowance~~in ~~for~~this ~~loan losses~~document. ~~The~~These ~~OCC~~factors ~~may~~include ~~require~~but ~~the~~are ~~Corporation~~not tolimited ~~recognize additions~~ to ~~the allowance~~those ~~for~~described ~~loan~~in ~~losses based on their judgments about information available~~Item to1A, ~~them~~“Risk ~~at the time of their examination~~Factors”.

31 -28-

~~The Corporation~~Critical ~~performs~~Accounting 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 includes the following: historical loss estimation by loan product type and by risk rating within each product type, payment (past due) status, industry concentrations, internal and external variables such as economic conditions, credit policy and underwriting changes and results of the loan review process. The Corporation’s historical loss component is 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. Estimates

The ~~historical~~accounting ~~loss~~and ~~components~~reporting policies of the ~~allowance~~Corporation ~~represent~~and its subsidiaries conform with U.S. generally accepted accounting principles (GAAP). The Corporation’s significant accounting policies are described in Note 2 of the consolidated ~~results~~financial statements and are essential in understanding Management’s Discussion and Analysis of ~~analyses~~Financial Condition and Results of ~~historical~~Operations. ~~charge-offs~~In applying accounting policies and ~~recoveries~~preparing ~~within~~the ~~pools~~consolidated financial statements, management is required to make estimates and assumptions that affect the reported amount of ~~homogeneous~~assets ~~loans,~~and ~~within~~liabilities as of the dates of the ~~each~~balance ~~risk~~sheets ~~rating~~and the income and ~~broken~~expense ~~down~~in ~~further~~the income statements for the periods presented. Therefore, actual results could differ significantly from those estimates. Judgments and assumptions required by ~~segment~~management, ~~within~~which have, or could have a material impact on the ~~portfolio.~~Corporation’s financial condition or ~~Criticized~~results ~~assets~~of operations are ~~further~~considered ~~assessed~~critical ~~based~~accounting onestimates. ~~trends,~~The following ~~expressed~~is a summary of the policies the Corporation recognizes as involving ~~percentages~~critical accounting estimates: Allowance for Loan Loss, ~~relative~~Goodwill toand ~~delinquency~~Other Intangible Asset Impairment, ~~risk~~Stock-Based ~~rating~~Compensation, ~~and~~Fair ~~nonaccrual~~Value Measurement of Investment Securities Available for Sale, byinclusive ~~credit~~of other-than-temporary ~~product.~~impairment, and Deferred Taxes.

~~The~~Allowance ~~historical~~for ~~loss~~Loan ~~components~~Losses: The ofCorporation ~~the~~maintains an allowance for ~~commercial~~loan losses ~~and~~at ~~industrial~~a ~~loans and~~level ~~commercial~~management ~~real~~believes ~~estate~~is ~~loans~~sufficient ~~(collectively~~to ~~“commercial~~absorb ~~loans”)~~estimated ~~are based~~probable ~~principally~~credit onlosses. ~~current~~Management’s ~~risk~~determination ~~ratings,~~of ~~historical~~the ~~loss~~adequacy ~~rates~~of ~~adjusted,~~the byallowance is ~~adjusting~~based ~~the~~on ~~risk~~periodic ~~window,~~evaluations toof ~~reflect~~the ~~current~~loan ~~events~~portfolio and ~~conditions, as well as analyses of~~ other ~~factors~~relevant ~~that may have affected the collectability of loans~~factors. ~~All~~However, ~~commercial~~this ~~loans~~evaluation ~~with~~is aninherently ~~outstanding~~subjective ~~balance~~as ~~over~~it ~~$500,000~~requires ~~are subject to~~significant ~~review~~estimates onby ~~an annual basis~~management. AConsideration ~~sample~~is ofgiven ~~commercial~~to ~~loans with~~ a ~~“pass”~~variety ~~rating~~of ~~are individually~~factors ~~reviewed annually. Commercial loans that management determines to~~in beestablishing ~~potential~~these ~~problem~~estimates ~~loans~~including ~~are~~historical ~~individually~~losses, ~~reviewed~~current ~~at a minimum annually. The~~and ~~review~~anticipated iseconomic ~~performed by a third party~~conditions, ~~and~~diversification isof ~~designed~~the toloan ~~determine whether such~~portfolio, ~~loans~~delinquency ~~are individually impaired~~statistics, ~~with~~results ~~impairment~~of ~~measured~~internal byloan ~~reference~~reviews, toborrowers’ ~~the~~perceived ~~collateral~~financial ~~coverage~~ and~~/or~~ ~~debt~~management ~~service~~strengths, ~~coverage.~~the ~~Consumer~~adequacy ~~credit~~of ~~and residential~~underlying ~~real~~collateral, ~~estate reviews are limited to those loans reflecting delinquent~~the ~~payment~~dependence ~~status or performed~~ on ~~loans~~collateral, ~~otherwise~~or ~~deemed~~the tostrength ~~be at risk~~ of ~~nonpayment.~~ ~~Homogeneous~~the ~~loan~~present ~~pools,~~value ~~including~~of ~~consumer~~future ~~and 1-4 family~~cash ~~residential~~flows ~~mortgages~~and ~~are~~other ~~not~~relevant ~~subject~~factors. toThese ~~individual~~factors ~~review~~may ~~but~~be ~~are~~susceptible ~~evaluated~~to ~~utilizing~~significant ~~risk~~change. ~~factors~~To ~~such~~the asextent ~~concentration~~actual ofoutcomes ~~one~~differ ~~borrower~~from ~~group. The~~management ~~historical~~estimates, ~~loss~~additional ~~component~~provisions ~~of the allowance~~ for ~~these loans is based principally on~~ loan ~~payment~~losses ~~status,~~may ~~retail~~be ~~classification~~required ~~and~~which ~~historical loss rates,~~may ~~adjusted~~adversely byaffect ~~altering~~ the ~~risk~~Corporation’s ~~window,~~results toof ~~reflect~~operations ~~current~~in ~~events and~~the ~~conditions~~future.

~~The~~Goodwill and ~~industry~~Other Intangible Asset Impairment: Goodwill and other intangible ~~concentration~~assets ~~component~~are reviewed for potential impairment on an annual basis, or more often if events or circumstances indicate that there may be impairment. Goodwill is tested ~~recognized~~for asimpairment aat ~~possible~~the ~~factor~~reporting inunit level and an impairment loss is recorded to the ~~estimation~~extent that the carrying amount of goodwill exceeds its implied ~~loan~~fair ~~losses~~value. ~~Two~~The ~~industries~~Corporation ~~represent~~employs ~~possible~~general ~~concentrations~~industry practices in evaluating the fair value of its goodwill 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: ~~commercial~~dividend ~~real~~discount ~~estate~~analysis under the income approach, which calculates the present value of all excess cash flows plus the present value of a terminal value and ~~consumer~~market multiples ~~loans~~(pricing ~~relying~~ratios) onunder ~~residential~~the ~~home~~market ~~equity~~approach. NoIn ~~specific~~2009, management ~~loss-related~~performed ~~observable~~its ~~data~~annual isreview ~~recognized~~of goodwill and other identifiable intangibles. Management performed its review by ~~management~~reporting ~~currently,~~unit ~~therefore~~and noidentified goodwill ~~specific~~impairment ~~factor~~for isthe ~~calculated~~Community Banking segment of $214.5 million. This impairment resulted from the decrease in market value caused by underlying capital and credit concerns and was determined based upon the ~~reserve~~announced ~~solely~~sale price of the Corporation to First Niagara Financial Group for $5.50 per share. As the Corporation’s ~~impact~~annual analysis is performed using March 31 balances, the subsequent stock price decline and a June 2009 communication of ~~these~~Individual ~~concentrations,~~Minimum ~~although~~Capital ~~management~~Ratio ~~continues~~requirements tofrom ~~carefully~~the ~~consider~~Office ~~relevant~~of the Comptroller of the ~~data~~Currency resulted in a subsequent impairment evaluation. This analysis was superseded as the announced merger with First Niagara provided an actual fair value for ~~possible~~the ~~future~~Corporation. ~~sources~~No impairment was identified relating to the Corporation’s Wealth Management segment or other identifiable intangible assets as a part of ~~observable~~this ~~data~~annual review. No assurance can be given that future impairment tests will not result in a charge to earnings.

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. -29-

~~Portfolio~~Stock-based ~~level~~Compensation: The ~~environmental~~Corporation ~~factors~~recognizes ~~included~~compensation inexpense ~~management’s~~for stock ~~calculation~~options ~~entail~~over the ~~measurement~~ ofrequisite aservice ~~wider~~period ~~array~~based ofon ~~both~~the ~~internal~~grant-date ~~and~~fair value ~~external~~of ~~criteria~~those ~~impacting the~~awards ~~portfolio~~expected asto aultimately ~~whole~~vest. ~~The~~Forfeitures ~~portfolio level environmental factors~~ are ~~based~~estimated on ~~upon~~the ~~management’s~~date ~~review~~ of ~~trends~~grant inand ~~the~~revised ~~Corporation’s~~if ~~primary~~actual ~~market~~or ~~area~~expected ~~as well~~forfeiture asactivity ~~regional~~differs materially ~~and~~from ~~national~~original ~~economic trends~~estimates. ~~Management~~For ~~utilizes~~grants ~~various economic~~subject ~~factors~~to ~~that~~a ~~could~~service ~~impact~~condition, the ~~borrowers’~~Corporation ~~future~~utilizes ~~ability~~the toBlack-Scholes ~~make~~option-pricing ~~loan payments~~model ~~such~~to asestimate ~~changes in~~ the fair ~~interest~~value ~~rate~~of ~~environment,~~each ~~product~~option ~~supply shortages~~on ~~and~~the ~~negative~~date ~~industry~~of ~~specific events~~grant. ~~Management~~The ~~utilizes~~Black-Scholes ~~relevant~~model takes ~~articles~~into ~~from~~consideration ~~newspapers~~the ~~and~~exercise ~~other~~price ~~publications~~and ~~that~~expected ~~describe~~life of the ~~economic~~options, the ~~events~~current ~~affecting~~price ~~specific~~of ~~geographic~~the ~~areas~~underlying ~~and~~stock ~~other published economic reports~~ and ~~data.~~its ~~Furthermore~~expected volatility, ~~given~~the ~~that~~expected dividends ~~past-performance~~on ~~indicators~~the ~~may~~stock ~~not~~and ~~adequately capture~~the current risk-free ~~levels,~~interest ~~allowing~~rate for ~~a real-time adjustment enhances~~ the expected ~~validity~~life of the ~~loss recognition process~~option. ~~There~~For ~~are~~grants ~~many~~subject ~~credit~~to ~~risk~~a ~~management reports~~market ~~that~~condition, ~~are~~the ~~synthesized~~Corporation utilizes bya ~~credit~~Monte ~~risk~~Carlo ~~management~~simulation ~~staff~~ to ~~assess~~estimate the ~~direction~~ offair ~~credit~~value ~~risk~~ and ~~its~~determine ~~instant~~the derived ~~effect~~service ~~on losses~~period. ItCompensation is ~~important~~recognized ~~to continue~~over tothe ~~use~~derived ~~experiential data to confirm risk as measurable losses will~~service ~~continue~~period towith ~~manifest~~any ~~themselves~~unrecognized atcompensation ~~higher~~cost ~~than~~immediately ~~normal~~recognized ~~levels~~when ~~even after~~ the ~~economic~~market ~~cycle~~condition ~~has~~is ~~begun~~met. anThe ~~upward~~Corporation’s ~~swing~~estimate ~~and~~of ~~lagging~~the ~~indicators~~fair ~~begin~~value toof ~~show~~a stock ~~improvement.~~option ~~The~~is ~~judgmental~~based ~~component~~on isexpectations ~~allocated~~derived tofrom ~~the~~historical ~~entire~~experience ~~portfolio~~and ~~based~~may not ~~upon~~necessarily ~~management’s~~equate ~~evaluation~~to ofits ~~the~~market ~~factors~~value ~~under~~when ~~review.~~fully vested.

32Fair Value Measurement of Investment Securities Available for Sale, inclusive of other-than-temporary impairment: 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, collateral adequacy, and the existence of deferrals or defaults. Adverse changes to any of these factors would affect the estimated cash flows of the underlying collateral or issuer. On a quarterly basis, the Corporation formally evaluates its investment securities for other-than-temporary impairment. The Corporation uses various indicators in determining whether a security is other-than-temporarily impaired, such as 1) the length of time and the extent to which the fair value has been less than the amortized cost basis, 2) adverse conditions specifically related to the security, industry, or geographic area, 3) the historical and implied volatility of the fair value of the security, 4) the payment structure of the debt security, 5) failure of the underlying issuers to make scheduled interest or principal payments, 6) any changes to the rating of the security, and 7) recoveries or additional declines in fair value subsequent to the balance sheet date. Effective April 1, 2009, for debt securities deemed to be other than temporarily impaired, the Corporation uses cash flow modeling to determine the credit related portion of the loss. The credit portion of the loss is recognized through earnings and the noncredit portion on securities that the Corporation does not intend to sell and it is more likely than not that the Corporation will not be required to sell the securities prior to recovery is recognized in other comprehensive income, net of tax. The Corporation recognized other-than-temporary impairment charges of $9.4 million during 2009 mainly as a result of deterioration in private label collateralized mortgage obligations, collateralized debt obligation investments in pooled trust preferred securities and several equity securities. The unrealized losses associated with the securities portfolio, that the Company is more likely than not to hold the securities until maturity, are not considered to be other-than temporary as of December 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 pooled trust preferred securities having the largest reductions.

~~The~~Deferred ~~provision~~Taxes: The ~~for~~Corporation ~~loan~~recognizes ~~losses~~deferred ~~increased~~tax ~~$5.0~~assets ~~million~~and ~~during 2008 compared to 2007~~liabilities ~~mostly~~for asthe afuture ~~result~~effects of atemporary ~~decrease~~differences, innet ~~the~~operating ~~quality of the loan portfolio which~~loss ~~caused~~carryforwards, anand ~~increase~~tax ~~in the amount of the required reserve~~credits. ~~Net~~Deferred ~~loans~~tax ~~charged-off decreased~~assets ~~$1.8~~are ~~million~~subject ~~for 2008 compared~~ to ~~2007 principally due to prior year~~management’s ~~charge-offs~~judgment ~~for~~based ~~real~~upon ~~estate~~available ~~construction~~evidence ~~loans~~that ~~for~~future ~~one~~realizations ~~borrower~~are ~~combined~~likely. ~~with an~~If ~~increase~~management indetermines ~~recoveries~~that ~~both~~the ~~related~~Corporation tomay ~~commercial~~not ~~and~~be ~~industrial~~able ~~loans~~to ~~and~~realize ~~real~~some or ~~estate~~all ~~loans. The profile~~ of the ~~Bank’s~~net ~~customer~~deferred ~~base~~tax ~~has~~asset ~~remained relatively constant and management believes that the current deterioration~~ in ~~credit quality has been caused by~~ the ~~economic~~future, ~~pressures~~a ~~being~~charge ~~felt~~to byincome ~~borrowers.~~tax ~~The~~expense ~~Bank~~may ~~has~~be ~~experienced~~required ~~depressed~~to ~~economic~~reduce ~~cycles in~~ the ~~past.~~value Asof the ~~current trough~~net ~~deepens~~deferred ~~management~~tax ~~continues~~asset to ~~allocate dedicated resources to continue~~the toexpected ~~manage~~realizable ~~at-risk credits~~value. The ~~Bank has experienced a similar decline in the~~ ~~past~~Corporation ~~and~~evaluated ~~expects~~its ~~that~~deferred wetax ~~could~~asset ~~experience~~balance aat ~~similar~~December ~~decline~~31, in2009 ~~future economic~~for ~~cycles~~realizability. ~~The~~Management’s ~~provision~~process ~~for~~included ~~loan losses increased $6.4 million in 2007 compared to 2006 primarily as a result of a decrease in~~ the ~~quality~~analysis of ~~the~~prior ~~loan portfolio~~carryback ~~which~~years ~~caused~~and ~~an increase in~~ the ~~amount~~evaluation of ~~the~~future ~~required~~income ~~reserve~~projections. ~~Net~~Based ~~loans charged-off~~upon ~~increased~~this ~~$4.7 million during 2007 compared to 2006 principally from~~analysis, ~~charge-offs~~management ~~related~~believes tothat ~~real~~the ~~estate~~deferred ~~construction~~tax ~~loans~~asset ~~for~~balance ~~one~~at ~~borrower~~December ~~and~~31, ~~four~~2009 is ~~unrelated~~fully ~~commercial and industrial loans~~realizable.

The ~~allowance~~Corporation ~~for~~has ~~loan~~not ~~losses~~substantively ~~increased~~changed ~~$22.6~~its ~~million,~~application ~~or 82.8%, to $50.0 million at December 31, 2008 from $27.3 million at December 31, 2007. The increase in the allowance was primarily due to the addition~~ of the ~~Willow Financial loan loss~~foregoing ~~reserve of $12.9 million in December 2008~~policies, and ~~the~~there ~~need~~have tobeen ~~adjust~~no ~~for~~material ~~impacts~~changes ~~on the portfolio~~ in ~~light~~assumptions ofor ~~the current credit environment. Nonperforming loans~~estimation ~~have~~techniques ~~increased~~used ~~by $55.0 million~~ as ~~a result of these factors from December 31, 2008~~ compared to ~~December~~prior ~~31, 2007~~periods. ~~The allowance for loan losses increased $6.2~~ ~~million,~~ or 29.2%, to $27.3 million at December 31, 2007 from December 31, 2006. The increase in the allowance was mainly due to the addition of the East Penn Financial loan loss reserve in November 2007 as well as the inherent risk related to loan growth and the increase in nonperforming loans of $4.3 million.

~~A summary of the activity in the allowance for loan losses is as follows:~~ -30-

~~Table 6—Allowance for Loan~~Financial ~~Losses~~ Overview

	December 31,
	2008			2007			2006			2005			2004
	(Dollars in thousands)
Average loans	$	2,585,101		$	2,123,170		$	2,014,420		$	1,900,023		$	1,625,419
Allowance, beginning of
year	$	27,328		$	21,154		$	19,865		$	18,455		$	16,753
Loans charged off:
Real estate		3,770			4,847			1,047			383			208
Commercial and industrial		1,079			1,551			1,141			353			522
Consumer		1,964			1,693			1,481			2,123			1,921
Lease financing		16			51			42			188			883
Total loans charged off		6,829			8,142			3,711			3,047			3,534
Recoveries:
Real estate		389			72			138			326			307
Commercial and industrial		240			142			55			66			58
Consumer		329			283			519			586			496
Lease financing		6			19			88			78			143
Total recoveries		964			516			800			1,056			1,004
Net loans charged off		5,865			7,626			2,911			1,991			2,530
Reserve from acquisitions		12,925			3,250			—			—			1,677
Provision for loan losses		15,567			10,550			4,200			3,401			2,555
Allowance, end of year	$	49,955		$	27,328		$	21,154		$	19,865		$	18,455
Ratio of net charge offs to average
loans outstanding		0.23	%		0.36	%		0.14	%		0.10	%		0.16	%

For the year ended December 31, 2009, the Corporation reported a net loss of $219.5 million, or $5.09 per share. This compares to net income of $25.1 million or $0.78 for 2008. The year-to-date 2009 net loss from operations was driven by a non-cash goodwill impairment charge of $214.5 million, resulting from the decrease in market value caused by underlying capital and credit concerns which was valued through the Agreement and Plan of Merger dated July 26, 2009 between First Niagara Financial Group, Inc, (First Niagara) and the Corporation pursuant to which the Corporation will be merged into First Niagara. The impairment effectively constituted the difference between the sale price of the Corporation to First Niagara for $5.50 per share, which established the fair value of the Corporation, compared to the Corporation’s book value per share of $10.75 prior to the impairment charge with further evaluation through the Corporation’s step two goodwill analysis.

33The Corporation’s 2009 year-to-date results include a full year of income and expense resulting from the acquisition of Willow Financial Bancorp, Inc. (Willow Financial) effective December 5, 2008 and the related issuance of 11,515,366 shares of the Corporation common stock. The year-to-date results also included a $58.3 million provision for credit losses; a $9.4 million non-cash other-than–temporary impairment (OTTI) charge on investment securities; as well as professional fees of $5.3 million associated with recent corporate finance activities, including the pending merger with First Niagara Financial Group, Inc. (First Niagara) partially offset by a $11.4 million gain on sale of investment securities. During 2009, the provision for loan losses was $58.3 million, compared to $15.6 million 2008. The increase in the provision for loan losses reflects an increase in nonperforming assets to $133.6 million at December 31, 2009, up from $78.5 million at December 31, 2008.

~~Management~~During ~~has~~December ~~improved~~2009, ~~upon~~First ~~its~~Niagara ~~estimation~~entered ~~methods~~into ~~and~~a ~~assumptions~~loan ~~through~~transaction ~~its~~with ~~inclusion~~the ofCorporation ~~portfolio~~to ~~level~~recapitalize ~~environmental~~the ~~factors~~Bank. asAs ~~previously~~of ~~discussed~~December ~~within~~31, 2009, the Corporation ~~previous~~borrowed ~~Allowance~~the ~~for~~full ~~Loan Losses section~~$50.0 ~~These~~million ~~adjustments~~available ~~provide~~under ~~for greater~~the ~~clarity~~credit ~~and~~facility ~~transparency~~from ofFirst Niagara ~~macro~~which ~~and~~was ~~micro~~contributed ~~economic~~to ~~impacts~~the Bank as ~~well~~Tier as1 capital, allowing it to meet ~~internal~~the ~~credit~~general ~~and~~regulatory ~~operational~~capital ~~impacts~~ratios onof a “well capitalized” bank for the ~~portfolio~~first time since September 2008. The ~~impact~~Corporation’s ofregulatory ~~the~~capital ratios as of ~~recession~~December ~~continues~~31, to2009 beincluded ~~felt~~total asrisk-based ~~the~~capital ~~Bank’s~~of ~~commercial~~10.64%, ~~real~~Tier ~~estate~~1 ~~portfolio’s~~risk-based ~~increase~~capital inof ~~allowance shows~~9.38% Itand isa ~~expected~~Tier ~~that~~1 ~~the~~leverage ~~negative~~capital ~~trends~~of in6.33%. ~~the~~The ~~real~~general regulatory ~~estate~~minimums ~~industry~~for ~~will~~well ~~continue~~capitalized todesignation ~~affect~~are ~~credit~~10% ~~quality~~for ~~throughout~~total atrisk-based ~~least the~~capital, ~~first~~6% ~~half~~for ofTier ~~2009,~~1 ifrisk-based ~~not~~capital and 5% for ~~the~~a ~~entire~~Tier ~~year~~1 leverage capital. ~~The~~In connection ~~growth~~with inthe capital infusion, the ~~loan~~Office ~~portfolio and~~of the ~~change~~Comptroller inof the Currency ~~mix~~extended ~~will~~the ~~result~~deadline infor ancompliance ~~adjustment~~with higher “individual minimum capital ratios” (IMCR) from June 30, 2009 to ~~the~~March ~~amount~~31, 2010, subject to continued compliance with “well capitalized” ratios achieved upon receipt of the ~~allowance~~First ~~allocated~~Niagara toloan ~~each~~proceeds. ~~category~~Effective ~~based~~March ~~the~~4, ~~current~~2010, ~~market~~this ~~environment~~deadline ~~and~~was further ~~recent~~extended ~~historical~~to ~~loss~~May ~~trends~~31, ~~among~~2010, ~~other~~subject ~~factors.~~to the same conditions.

The following ~~table~~is ~~sets forth~~ an ~~allocation~~overview of the ~~allowance~~key ~~for~~financial ~~loan~~highlights ~~losses~~for 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. 2009:

~~Table~~Total assets were $5.2 billion at December 31, 2009, a decrease of $302.7~~—Allocation~~ million, or 5.5%, over $5.5 billion in total assets reported at December 31, 2008. Loans were $3.0 billion, a decrease of ~~the~~$712.6 million or 19.4% from $3.7 billion at December 31, ~~Allowance~~2008. The lower loan levels in all categories resulted mainly from increased refinancing activity and reduced origination volume as well as sales of first mortgage residential loans totaling $106.4 million, commercial loan participations totaling $82.8 million and indirect consumer installment loans totaling $47.3 million for ~~Loan~~a ~~Losses~~net byloss ~~Loan~~of ~~Type~~$1.8 million. Total deposits were $3.9 billion at both December 31, 2009 and 2008.

	December 31,
	2008				2007				2006				2005				2004
			Percent				Percent				Percent				Percent				Percent
			of				of				of				of				of
	Amount		Allowance		Amount		Allowance		Amount		Allowance		Amount		Allowance		Amount		Allowance
	(Dollars in thousands)
Real estate	$	22,051	44	%	$	10,491	38	%	$	7,918	38	%	$	6,422	32	%	$	4,923	27	%
Commercial and
industrial		20,898	42	%		12,340	45	%		9,119	43	%		8,534	43	%		7,456	40	%
Consumer		6,996	14	%		4,485	17	%		4,041	19	%		4,596	23	%		5,515	30	%
Lease financing		10	—	%		12	—	%		76	—	%		313	2	%		561	3	%
Total	$	49,955	100	%	$	27,328	100	%	$	21,154	100	%	$	19,865	100	%	$	18,455	100	%

The return on average shareholders’ equity was -59.5% in 2009 compared to 7.45% in 2008. The return on average assets was -4.08% in 2009 compared to 0.63% in 2008. The decrease in these ratios during 2009 was primarily due to the net loss recorded in 2009.

~~The factors~~Net ~~affecting~~interest ~~the~~income ~~allocation~~on ofa ~~the~~tax-equivalent ~~allowance~~basis ~~during~~increased ~~2008~~$26.5 ~~were~~million, ~~changes~~or ~~in credit quality resulting from increases in criticized real estate construction loans and increases in loan volume from the Willow Financial acquisition~~23.8%, ~~The~~for ~~allocation of~~ the ~~allowance~~year ~~for~~ending ~~real estate loans at~~ December 31, ~~2008 increased $11.6 million as compared to December 31~~2009, ~~2007~~over ~~principally~~the ~~due~~prior toyear. anThe ~~increase~~net ininterest ~~criticized~~margin ~~real~~for ~~estate~~2009 ~~construction~~decreased ~~loans~~to ~~including~~2.78% ~~loans~~compared to ~~two~~3.04% ~~borrowing relationships~~for ~~totaling $34~~2008.9 ~~million.~~The ~~Both~~net ~~relationships~~interest ~~are syndicated credits~~margin ~~for~~decreased ~~local~~as ~~borrowers~~a ~~that~~102 ~~have~~basis ~~been~~point ~~negatively~~decrease ~~affected by the decline~~ in ~~area home sales. The allocation of~~ the ~~allowance~~yield ~~for~~on ~~commercial~~average ~~and~~earning ~~industrial loans~~assets atof ~~December 31, 2008 increased~~ $85.60 ~~million~~billion ~~from~~was ~~December~~offset ~~31,~~by ~~2007~~a ~~mostly~~87 ~~due~~basis ~~to an~~point ~~increase~~decrease in ~~commercial loan volume from~~ the ~~Willow~~cost ~~Financial~~of ~~acquisition. In~~interest ~~addition,~~bearing ~~the~~liabilities ~~allocation~~ of ~~the allowance for consumer loans at December 31, 2008 increased~~ $24.54 ~~million primarily due to the increased level of consumer loans related to the Willow Financial acquisition~~billion.

~~Investment~~Nonperforming assets inincreased ~~Bank~~$55.1 million to $133.6 million at December 31, 2009 from $78.5 million at December 31, 2008. Nonperforming assets as a percentage of total assets increased to 2.58% at December 31, 2009 from 1.43% at December 31, 2008. Net charge-offs increased $12.5 million for 2009 compared to 2008.

~~The Corporation acquired an investment in Berkshire Bancorp, the holding company of Berkshire Bank, through the East Penn Financial acquisition. As of December~~ -31, 2008, the total investment in Berkshire Bancorp, Inc. was $2.6 million represented by 679,728 shares, resulting in a 17.54% ownership in consideration of the combined ownership of the Corporation, its directors and officers. The Corporation is considered to be a passive investor under a Crown X Agreement which imposes certain restrictions on the Corporation. The Corporation is entitled to purchase additional shares of common stock from Berkshire Bank up to 24.9% of the outstanding shares of common stock at any time up to July 3, 2013 at an exercise price of $4.10, which is adjusted for stock splits. The investment is included in other assets at its cost basis. -

~~Deposits~~The allowance ~~and~~for ~~Borrowings~~credit losses increased to $66.6 million at December 31, 2009 compared to $50.0 million at December 31, 2008.

~~Deposits and~~Noninterest ~~borrowings~~income ~~are~~increased ~~the~~$17.4 ~~primary~~million ~~funding~~or ~~sources~~37.7% ofduring ~~the Corporation~~2009. ~~Core~~Gains ~~deposits~~from mortgage banking ~~increased~~loan ~~31.8%,~~sales orincreased $~~567~~8.15 million, toand ~~$2.3~~service ~~billion~~charges aton ~~December~~deposits ~~31,~~increased ~~2008, up from~~ $13.8 million ~~billion~~over at2008 ~~December~~mainly ~~31, 2007. This growth is~~ due to ~~$685.4~~the ~~million acquired from~~ Willow Financial ~~and~~acquisition. anNet ~~organic~~gains ~~decrease~~on sales of ~~approximately~~investment ~~$118.3 million.~~securities ~~Total deposits~~ increased $~~953~~8.48 million, oras ~~31.9%~~compared ~~for the same period, which was primarily attributable~~ to ~~deposits~~2008. ~~associated with the acquisition of~~Other ~~Willow~~income ~~Financial~~increased of $~~946~~4.71 million. ~~The~~during ~~Corporation~~2009 ~~continued~~driven ~~its~~by ~~emphasis~~increases onin ~~government~~ATM ~~banking to provide additional funding sources through relationships with municipalities~~ and ~~school~~point ~~districts~~of ~~resulting~~sale infee ~~both~~income ~~interest-bearing checking accounts~~ and ~~large~~a ~~time deposits~~$1. ~~Core deposits increased~~ 7~~.1%,~~ ~~or $118.1~~ million atgain ~~December~~recorded ~~31,~~in ~~2007 compared~~the tofirst ~~December~~quarter ~~31,~~of ~~2006 due to $185.2 million acquired from East Penn~~2009 ~~Financial~~on atthe ~~November~~sale ~~16, 2007 and an organic decrease~~ of ~~approximately~~the ~~$67.2 million.~~Bank’s ~~Total~~merchant ~~deposits~~credit ~~increased~~card ~~$468~~business.2 ~~million,~~These orincreases ~~18.6%~~were partially ~~during~~offset ~~2007~~by ~~primarily from~~an ~~deposits~~increase ~~associated~~in ~~with~~other-than-temporary ~~the~~impairment ~~acquisition~~charges ofon available ~~East~~for ~~Penn~~sale ~~Financial~~securities of $~~382.~~7 .5 million atfrom ~~acquisition date and growth in time deposits~~2008.

34Noninterest expense increased $263.1 million or 251.5% in 2009 as compared to 2008. This increase was primarily due to the previously aforementioned goodwill impairment charge of $214.5 million and the Willow Financial acquisition. Federal Deposit Insurance Corporation (FDIC) assessments increased $11.4 million mostly due to the Bank’s higher premium rate assessed by the FDIC and the FDIC’s one-time uniform special assessment of $2.6 million during the second quarter of 2009, as well as deposits acquired from Willow Financial. Professional fees increased $7.7 million primarily due to recent corporate finance activities, including the pending merger with First Niagara. Occupancy expense increased $5.4 million due primarily to the Willow Financial acquisition.

~~Deposit~~Pending Merger ~~Structure~~with First Niagara Financial Group, Inc.

On July 27, 2009, the Corporation and First Niagara Financial Group, Inc., the holding company for First Niagara Bank, announced that they had entered into an Agreement and Plan of Merger (the “Merger Agreement”), dated July 26, 2009, which sets forth the terms and conditions pursuant to which the Corporation will merge with and into First Niagara in a transaction valued at approximately $237 million. Under the terms of the Merger Agreement, stockholders of the Corporation will receive 0.474 shares of First Niagara stock for each share of common stock they own, representing a premium of about 37.5% based on the Corporation’s closing price on July 24, 2009 of $4.00 per share. The exchange ~~following~~ratio ~~table~~is based on First Niagara’s five-day average closing stock price of $11.60 on July 22, 2009. The exchange ratio is subject to downward adjustment if loan delinquencies of Harleysville National Bank and Trust Company exceed specified amounts. During the second quarter of 2009, the Corporation recorded a ~~distribution~~goodwill impairment charge of ~~average~~$214.5 ~~balances~~million, resulting from the decrease in market value caused by underlying capital and ~~average~~credit ~~rates~~concerns ~~paid~~which onwas valued through the Merger Agreement. The impairment effectively constituted the ~~deposit~~difference ~~categories~~between the sale price of the Corporation to First Niagara for $5.50 per share, which established the ~~last~~fair ~~three~~value ~~years:~~of the Corporation, compared to the Corporation’s book value per share of $10.75 prior to the impairment charge with further evaluation through the Corporation’s step two goodwill analysis. See Note 9 – Goodwill and Other intangibles for further information.

~~Table~~The Boards ~~8—Average~~of ~~Deposits~~Directors of the Corporation and First Niagara and the Corporation’s shareholders have approved the Merger Agreement and the merger, but the transaction remains subject to regulatory approval and other customary closing conditions. The merger is intended to qualify as reorganization for federal income tax purposes, such that shares of the Corporation exchanged for shares of First Niagara will be issued to the Corporation’s shareholders on a tax-free basis.

	December 31,
	2008				2007				2006
	Amount		Rate		Amount		Rate		Amount		Rate
	(Dollars in thousands)
Demand—noninterest-bearing	$	345,717	—	%	$	312,011	—	%	$	333,406	—	%
Demand—interest-bearing		431,138	1.55	%		517,520	3.52	%		450,256	3.24	%
Money market and savings		978,803	1.89	%		864,062	3.45	%		836,940	2.91	%
Time deposits		1,248,412	4.31	%		863,953	4.78	%		848,912	4.29	%
Total interest-bearing deposits	$	2,658,353	2.97	%	$	2,245,535	3.98	%	$	2,136,108	3.53	%
Total deposits	$	3,004,070			$	2,557,546			$	2,469,514

The Merger Agreement provides for a downward adjustment to the merger consideration to be received by the Corporation’s shareholders if the amount of the Bank’s delinquent loans equals or exceeds $237.5 million as of any month end prior to the closing date of the merger, excluding any month end subsequent to February 28, 2010. For purposes of this calculation, “delinquent loans” is defined as the sum of non-performing assets, loans 30 to 89 days delinquent, and cumulative charge-offs subsequent to the signing of the agreement. By this definition, at February 28, 2010, delinquent loans were $190.8 million.

~~The maturity distribution of certificates of deposit of $100,000 and over as of December 31, 2008 is as follows:~~ -32-

~~Table 9—Maturity Distribution of Certificates of Deposit $100,000 and Over~~ Dispositions/Acquisitions

	(Dollars
	in thousands)
Three months or less	$	191,955
Over three months to six months		105,772
Over six months to twelve months		192,461
Over twelve months		136,028
Total	$	626,216

During 2009, the Corporation sold loans held for investment of approximately $236.5 million for a net loss of $1.8 million. The sales consisted of first mortgage residential loans totaling $106.4 million, commercial loan participations totaling $82.8 million and indirect consumer installment loans totaling $47.3 million. The loans were sold without recourse and subject to customary sale conditions. The loan sales were part of the Corporation’s strategy to reduce assets and thereby build capital and increase liquidity. Additionally, the Corporation decided to exit from the indirect lending business effective June 30, 2009 in order to use capital to build relationship-based business with customers.

~~Borrowings~~Effective December 5, 2008, the Corporation completed its acquisition of Willow Financial Bancorp and its wholly owned subsidiary, Willow Financial Bank (collectively, “Willow Financial”). At the acquisition date, Willow Financial had approximately $1.6 billion in assets with 29 branch offices in southeastern Pennsylvania. In conjunction with this transaction, the Corporation also acquired BeneServ, Inc., a respected provider of employee benefits services. The merger delivered a significant market share in Chester County, increased the Corporation’s market presence in Bucks and Montgomery counties, and established a new market presence in Philadelphia County. The Corporation acquired 100% of the outstanding shares of Willow Financial. Willow Financial shareholders received 0.73 shares of the Corporation’s common stock for each share of Willow Financial common stock they held with cash paid in lieu of fractional shares. The purchase price was $13.79 per common share and was based upon the average of the closing prices for the Corporation’s common stock on the agreement date and for two days before and two days after the agreement date and the agreement date. The Corporation issued 11,515,366 shares of common stock, incurred $8.1 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 $168.9 million. Willow Financial’s results of operations are included in the Corporation’s results from the date of acquisition, December 5, 2008.

~~Borrowings~~On ~~increased~~December ~~$482.2~~27, ~~million~~2007, the Bank settled and closed an agreement to ~~$990.5~~sell ~~million~~fifteen properties atto ~~December~~affiliates 31of American Realty Capital, ~~2008~~LLC ~~from~~(“ARC”) ~~$508~~in a sale-leaseback transaction.3 The properties are located throughout Berks, Bucks, ~~million~~Lehigh, atMontgomery, ~~December~~Northampton, 31and Carbon counties. Under the leases, ~~2007~~the Bank continues to utilize the properties in the normal course of business. ~~The~~Lease payments ~~Corporation~~on ~~increased~~each ~~long~~property ~~term~~are ~~debt~~institution-quality, triple net leases with ~~the~~an ~~Federal~~initial ~~Home~~annual ~~Loan~~aggregate ~~Bank~~base byrent of $~~305~~3.90 million ~~due~~with annual rent escalations equal to ~~$362~~the lower of CPI-U (Consumer Price Index for all Urban Consumers) or 2.60 ~~million~~percent commencing in ~~advances~~the ~~from~~second year of the lease term. As tenant, the Bank is fully responsible for all costs associated with the ~~Willow~~operation, ~~Financial~~repair ~~acquisition~~and maintenance ~~offset~~of bythe ~~paydowns~~properties during ~~2008~~the lease terms and is recorded as occupancy expense. ~~Long-~~The agreement provides that each lease will have a term of 15 ~~securities~~years, ~~sold~~commencing ~~under~~on the closing date for the Agreement. The agreement also contains options to ~~repurchase~~renew ~~increased~~for byperiods ~~$132~~aggregating up to 45 years.0 ~~million~~Under ~~due~~certain circumstances these renewal options are subject to revocation by the lessor. The Bank received net proceeds of $8238.02 million ~~assumed~~and inrecorded ~~the~~a ~~Willow~~gain ~~Financial~~on ~~acquisition~~sale ~~and~~from the transaction of $502.03 million ~~in new~~(pre-tax) ~~borrowings~~representing ~~during~~a ~~2008.~~portion ~~Subordinated~~of ~~debt~~the ~~increased~~total gain of $1018.89 million. ~~at December~~The ~~31,~~remaining ~~2008~~gain aswas ~~compared~~deferred toand ~~December~~is ~~31,~~being ~~2007~~amortized ~~due~~through a toreduction of occupancy expense over the ~~acquisition~~15-year term of the leases an annual amount of $101.71 million. The Corporation also completed a separate sale-leaseback of ~~subordinated~~office ~~debt~~in ~~from~~October ~~Willow~~2007 ~~Financial~~receiving net proceeds of $1.5 ~~Fed~~million ~~funds~~with ~~purchased and~~a ~~short~~recognized pre-~~term~~tax ~~securities~~gain ~~sold~~of ~~under~~$473,000. ~~repurchase~~The deferred ~~agreements~~gain ~~increased~~of by $34552,000 is being amortized over the 10-year term of the lease.6 ~~million~~This ~~primarily~~strategic ~~due~~initiative was undertaken to help the ~~Willow~~Corporation translate ~~Financial~~a ~~acquisition.~~large non-earning asset into an earning asset in the form of loans, to help bolster earnings and increase liquidity.

~~Borrowings~~Effective November ~~increased~~16, ~~$118.8~~2007, ~~million~~the Corporation completed its acquisition of East Penn toFinancial ~~$508~~Corporation and its wholly owned subsidiary, East Penn Bank (collectively, “East Penn Financial”).3 ~~million~~At atthe ~~December~~acquisition 31date, ~~2007~~East ~~from~~Penn Financial had approximately $~~389~~451.51 million atin ~~December~~assets 31with nine banking offices located in Lehigh, ~~2006~~Northampton and Berks Counties. The ~~Corporation~~acquisition ~~decreased~~expanded ~~long~~the branch ~~term~~network ~~debt~~of ~~with~~the Corporation in the ~~Federal~~Lehigh ~~Home~~Valley ~~Loan~~and ~~Bank~~its byopportunity to ~~$23.0~~provide ~~million~~East ~~while~~Penn ~~increasing~~customers ~~long-term~~with ~~securities~~a ~~sold~~broader ~~under~~mix ~~agreement~~of ~~to repurchase~~products byand ~~$105~~services.0 ~~million.~~As ~~Subordinated~~part of ~~debt~~the ~~increased~~merger ~~from~~agreement, East Penn Bank continues to operate under the ~~private~~East Penn ~~placement~~name ofand ~~$22.5~~logo, ~~million~~and inhas ~~aggregate~~become ~~principal~~a ~~amount~~division of ~~fixed/floating~~the ~~rate~~Bank. Nine of the Bank’s ~~preferred~~existing ~~securities~~branches ~~through~~were atransferred ~~newly~~to ~~formed~~the ~~Delaware~~East ~~Trust~~Penn ~~affiliate~~division ~~HNC~~including those in ~~Statutory~~Lehigh, ~~Trust~~Carbon, IVMonroe, and Northampton Counties. The Corporation acquired 100% of the ~~acquisition~~outstanding shares of East Penn Financial for a total purchase price of $891.23 million. East Penn Financial shareholders received 2,432,771 shares of ~~subordinated~~the Corporation’s ~~debt~~common ~~from~~stock and $49.9 million for all outstanding common shares. East Penn Financial onoption ~~November~~holders 16received $792,000 ~~2007.~~and options to acquire 25,480 shares of

35 -33-

~~The Bank,~~the ~~pursuant~~Corporation’s tocommon astock ~~designated~~in ~~cash~~exchange ~~management agreement, utilizes securities sold under agreements to repurchase as vehicles~~ for ~~customers’~~all ~~sweep~~outstanding ~~and term investment products~~options. ~~Securitization~~East ~~under these cash management agreements are~~Penn inFinancial’s ~~U.S.~~results ~~Treasury Securities and obligations~~ of ~~states~~operations ~~and political subdivisions securities. Securities sold under agreements to repurchase~~ are ~~generally overnight~~included ~~transactions. These securities are held~~ in athe ~~third-party custodian~~Corporation’s ~~account,~~ ~~designated~~results ~~by the Bank under a written custodial agreement that~~from ~~explicitly recognizes~~ the ~~Bank’s~~date ~~interest~~of inacquisition, ~~the~~November ~~securities~~16, 2007.

~~Table~~For ~~10—Securities~~a five-year ~~Sold~~summary of financial information, see Item 6, “Selected Financial ~~under~~Data,” ~~Agreements~~which tois ~~Repurchase~~incorporated herein by reference.

	At or for the year ended December 31,
Securities sold under agreements to repurchase(1):	2008			2007			2006
	(Dollars in thousands)
Balance at year-end	$	103,813		$	101,493		$	96,840
Weighted average rate at year-end		0.42	%		3.60	%		4.61	%
Maximum month-end balance	$	97,526		$	105,205		$	100,944
Average balance during the year	$	109,092		$	121,392		$	128,185
Weighted average rate during the year		1.55	%		4.46	%		4.37	%

For quarterly information for 2009 and 2008, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Fourth Quarter 2009 Results,” and Table 16, “Selected Quarterly Financial Data,” which are incorporated herein by reference.

~~(1) Excludes long-term securities sold under agreements to repurchase with private entities of $237.0 million and $105.0 million at December 31, 2008 and 2007, respectively.~~ Investment Securities

~~Results~~Debt and equity securities classified as available for sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income, net of ~~Operations~~tax. The net effect of unrealized gains or losses, caused by marking an available for sale portfolio to market, causes fluctuations in the level of shareholders’ equity and equity-related financial ratios as market interest rates cause the fair value of fixed-rate securities to fluctuate. On a quarterly basis, the Corporation formally evaluates its investment securities for other-than-temporary impairment. Effective April 1, 2009, for debt securities deemed to be other-than-temporarily impaired, the Corporation uses cash flow modeling to determine the credit related portion of the loss. The credit portion of the loss is recognized through earnings and the noncredit portion on securities that the Corporation does not intend to sell and it is more likely than not that the Corporation will not be required to sell the securities prior to recovery is recognized in other comprehensive income, net of tax.

~~Net income~~Investment issecurities ~~affected~~and byother ~~five~~investments ~~major~~decreased ~~elements:~~10.0% (to $1).1 ~~net~~billion ~~interest~~at ~~income,~~December ~~or the difference~~31, ~~between~~2009 ~~interest~~from ~~income~~$1.2 ~~earned~~billion onat ~~loans~~December ~~and~~31, ~~investments~~2008. ~~and~~The ~~interest~~investment ~~expense~~securities available ~~paid~~for onsale ~~deposits~~decreased $103.8 million and ~~borrowed~~the ~~funds;~~investment ~~(2)~~securities ~~the~~held ~~provision~~to maturity ~~for~~decreased ~~loan~~$25.1 ~~losses,~~million. orThe ~~the amount~~majority ~~added~~of to the ~~allowance~~decrease in available for sale ~~loan~~securities ~~losses~~is due to ~~provide~~the ~~reserves~~sales ~~for~~of ~~inherent losses~~mortgage-backed onsecurities ~~loans;~~and ~~(3)~~maturities of ~~noninterest~~certain ~~income,~~securities. ~~which~~During is2009, ~~made~~securities upavailable ~~primarily~~for ofsale ~~certain~~totaling ~~fees,~~$470.8 ~~wealth~~million ~~management~~were ~~income~~sold ~~and~~which ~~gains~~generated ~~and~~a ~~losses~~pre-tax ~~from~~gain ~~sales~~ of ~~securities~~$11.2 ormillion. ~~other~~Other-than-temporary ~~transactions;~~impairment ~~(4)~~charges ~~noninterest~~totaling ~~expense,~~$9.4 ~~which~~million ~~consists~~were ~~primarily of~~recognized ~~salaries,~~during ~~employee~~2009 ~~benefits~~primarily ~~and~~related ~~other~~to ~~operating~~collateralized ~~expenses;~~debt ~~and~~obligation ~~(5)~~investments ~~income taxes.~~in ~~Each~~pooled oftrust ~~these~~preferred ~~major~~securities, ~~elements~~private islabel ~~reviewed~~collateralized inmortgage obligations ~~more~~and ~~detail~~several inequity ~~the following discussion~~securities.

~~Adoption~~The increase in available for sale securities at December 31, 2008 compared to December 31, 2007 of ~~Fair~~$231.6 ~~Value~~million ~~Measurements~~was mainly due to the securities acquired ~~Accounting~~from ~~Standard~~Willow Financial of $238.3 million on December 5, 2008. The securities acquired from Willow Financial included $165.7 million in securities available for sale and $72.6 million in securities held to maturity. Upon acquisition, the Corporation recorded the securities held to maturity purchased from Willow as available for sale. During 2008, securities available for sale totaling $208.5 million were sold which generated a pretax gain of $2.6 million. The securities sold consisted primarily of bullet and callable agency, tax-exempt municipal and mortgage-backed securities. Other-than temporary impairment charges totaling $1.9 million were recognized during 2008 related to a collateralized debt obligation.

Effective January 1, 2008, the Corporation adopted SFAS No. 157, “Fair Value Measurements”. The adoption of SFAS 157 resulted in expanded disclosures as indicated in Note 1 and Note 21 of the Consolidated Financial Statements.-34-

~~Net~~The following ~~Interest~~table ~~Income~~shows the carrying value of the Corporation’s investment securities available for sale and held to maturity:

~~Net interest~~Table ~~income~~1—Investment is the most significant component of the Corporation’s income from operations. 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.Portfolio

	December 31,
(Dollars in thousands)	2009		2008		2007
Investment securities available for sale:
Obligations of U.S. government agencies and corporations	$	503	$	93,894	$	98,734
Obligations of states and political subdivisions		220,260		286,875		228,436
Residential mortgage-backed securities		784,090		705,483		515,989
Trust preferred pools/collateralized debt obligations		9,869		15,864		36,926
Corporate bonds		2,215		18,167		16,454
Equity securities		21,216		21,665		13,828
Total investment securities available for sale	$	1,038,153	$	1,141,948	$	910,367
Investment securities held to maturity:
Obligations of U.S. government agencies and corporations	$	—	$	3,880	$	3,868
Obligations of states and political subdivisions		25,324		46,554		53,479
Total investment securities held to maturity	$	25,324	$	50,434	$	57,347

~~The rate volume analysis in the following table, which is computed on a tax~~-~~equivalent basis (tax rate of~~ 35~~%), analyzes changes in net interest income for the last three years by their volume and rate components. The change attributable to both volume and rate has been allocated proportionately.~~-

~~Table~~The maturity ~~11—Analysis~~analysis of ~~Changes~~investment securities including the weighted average yield infor ~~Net~~each ~~Interest~~category ~~Income—Fully~~as ~~Taxable-Equivalent~~of ~~Basis~~December 31, 2009 is as follows. Actual maturities may differ from contractual maturities because issuers and borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	2008 compared to 2007									2007 compared to 2006
	Net			Due to Change in						Net			Due to Change in
	Change			Volume			Rate			Change			Volume			Rate
	(Dollars in thousands)
Increase (decrease) in interest income:
Investment securities(1)	$	6,653		$	5,027		$	1,626		$	4,935		$	953		$	3,982
Federal funds sold, securities purchased under
agreements to resell and deposits in banks		(2,479	)		(931	)		(1,548	)		(477	)		(376	)		(101	)
Loans(1)(2)		9,047			29,406			(20,359	)		11,203			7,349			3,854
Total		13,221			33,502			(20,281	)		15,661			7,926			7,735
Increase (decrease) in interest expense:
Savings and money market deposits		(22,840	)		965			(23,805	)		9,074			2,992			6,082
Time deposits		12,462			16,859			(4,397	)		4,849			651			4,198
Borrowed funds		405			4,985			(4,580	)		2,436			1,730			706
Total		(9,973	)		22,809			(32,782	)		16,359			5,373			10,986
Net increase (decrease) in net interest income	$	23,194		$	10,693		$	12,501		$	(698	)	$	2,553		$	(3,251	)

Table 2—Maturity and Tax-Equivalent Yield Analysis of Investment Securities

(1)	The interest earned on nontaxable investment securities and loans is shown on a tax-equivalent basis using a tax rate of 35%, net.
	December 31, 2009
(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.
	Due in 1 year or less			Due after 1 year through 5 years			Due after 5 years through 10 years			Due after 10 years		Total
	(Dollars in thousands)
Investment securities available for sale:
Obligations of U.S. government agencies and corporations:
Fair value	$	—		$	503		$	—		$—		$ 503
Weighted average yield		—	%		2.05	%		—	%	—	%	2.05	%
Obligations of states and political subdivisions:
Fair value		1,256			5,037			92,974		120,993		220,260
Weighted average yield(1)		3.67	%		5.71	%		6.05	%	6.26	%	6.15	%
Residential mortgage-backed securities:
Fair value		—			3,720			71,301		709,069		784,090
Weighted average yield		—	%		4.27	%		4.07	%	4.15	%	4.15	%
Trust preferred pools/collateralized debt obligations:
Fair value		—			—			—		9,869		9,869
Weighted average yield		—	%		—	%		—	%	3.11	%	3.11	%
Corporate bonds:
Fair value		251			250			1,714		—		2,215
Weighted average yield		4.26	%		1.53	%		3.73	%	—	%	3.54	%
Equity securities:
Fair value		—			—			—		21,216		21,216
Weighted average yield		—	%		—	%		—	%	4.18	%	4.18	%
Total investment securities available for sale:
Fair value	$	1,507		$	9,510		$	165,989		$861,147		$1,038,153
Weighted average yield		3.77	%		4.84	%		5.18	%	4.44	%	4.57	%
Investment securities held to maturity:
Obligations of states and political subdivisions:
Amortized cost	$	—		$	—		$	9,705		$ 15,619		$ 25,324
Weighted average yield		—	%		—	%		6.17	%	7.11	%	6.75	%
Total investment securities held to maturity:
Amortized Cost	$	—		$	—		$	9,705		$15,619		$25,324
Weighted average yield		—	%		—	%		6.17	%	7.11	%	6.75	%

37(1) Weighted average yield on nontaxable investment securities is shown on a tax equivalent basis (tax rate of 35%).

~~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:~~-36-

~~Table 12—Average Balance Sheets and Interest Rates—Fully Taxable-Equivalent Basis~~Loans

	Year Ended December 31,
	2008							2007							2006
	Average							Average							Average
	Balance		Interest		Rate			Balance		Interest		Rate			Balance		Interest		Rate
	(Dollars in thousands)
Assets
Earning Assets:
Investment securities:
Taxable investments	$	738,640	$	39,195		5.31	%	$	681,788	$	34,803		5.10	%	$	672,648	$	30,296		4.50	%
Nontaxable investments(1)		298,472		18,110		6.07			262,676		15,849		6.03			252,987		15,421		6.10
Total investment securities		1,037,112		57,305		5.53			944,464		50,652		5.36			925,635		45,717		4.94
Federal funds sold, securities purchased
under agreements to resell and deposits
in banks		48,474		1,097		2.26			72,087		3,576		4.96			79,670		4,053		5.09
Loans(1)(2)		2,585,101		155,447		6.01			2,123,170		146,400		6.90			2,014,420		135,197		6.71
Total earning assets		3,670,687		213,849		5.83			3,139,721		200,628		6.39			3,019,725		184,967		6.13
Noninterest-earning assets		327,285							231,583							209,499
Total assets	$	3,997,972						$	3,371,304						$	3,229,224
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Interest-bearing deposits:
Savings and money market	$	1,409,941		25,140		1.78	%	$	1,381,582		47,980		3.47	%	$	1,287,196		38,906		3.02	%
Time		1,248,412		53,771		4.31			863,953		41,309		4.78			848,912		36,460		4.29
Total interest-bearing deposits		2,658,353		78,911		2.97			2,245,535		89,289		3.98			2,136,108		75,366		3.53
Borrowed funds		586,088		23,243		3.97			471,296		22,838		4.85			434,938		20,402		4.69
Total interest-bearing liabilities		3,244,441		102,154		3.15			2,716,831		112,127		4.13			2,571,046		95,768		3.72
Noninterest-bearing liabilities:
Demand deposits		345,717							312,011							333,406
Other liabilities		71,160							44,069							42,925
Total noninterest-bearing liabilities		416,877							356,080							376,331
Total liabilities		3,661,318							3,072,911							2,947,377
Shareholders’ equity		336,654							298,393							281,847
Total liabilities and shareholders’ equity	$	3,997,972						$	3,371,304						$	3,229,224
Net interest spread						2.68							2.26							2.41
Effect of noninterest-bearing sources						0.36							0.56							0.54
Net interest income/margin on
earning assets			$	111,695		3.04	%			$	88,501		2.82	%			$	89,199		2.95	%
Less tax equivalent adjustment				7,555							6,067							6,026
Net interest income			$	104,140						$	82,434						$	83,173

Loans decreased $691.9 million in 2009 due to lower loan levels in all categories resulting mainly from increased refinancing activity and reduced origination volume as well as sales of first mortgage residential loans totaling $106.4 million, commercial loan participations totaling $82.8 million and indirect consumer installment loans totaling $47.3 million for a net loss of $1.8 million. Loans increased $1.2 billion in 2008 primarily attributed to the acquisition of Willow Financial resulting in $1.1 billion in additional loans with organic growth of approximately $125.7 million, or 5.1%. At the acquisition date, Willow Financial included $664.1 million in real estate loans, $116.6 million in commercial loans, and $317.5 million in consumer loans.

(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 following table shows the composition of the Bank’s loans, net of deferred costs:

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 for 2008 was 400 basis points. 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.

	December 31,
	2009				2008				2007				2006				2005
	Amount	Percent of Loans			Amount	Percent of Loans			Amount	Percent of Loans			Amount	Percent of Loans			Amount	Percent of Loans
	(Dollars in thousands)
Real estate	$1,324,060		44	%	$1,603,406		43	%	$ 959,064		39	%	$ 845,880		41	%	$ 791,358		40	%
Commercial and industrial	793,786		27	%	980,656		27	%	730,144		30	%	507,899		25	%	479,238		24	%
Consumer	875,424		29	%	1,100,424		30	%	769,051		31	%	685,988		34	%	697,373		35	%
Lease financing	108		—	%	758		—	%	2,564		—	%	7,588		—	%	17,524		1	%
Total	$2,993,378		100	%	$3,685,244		100	%	$2,460,823		100	%	$2,047,355		100	%	$1,985,493		100	%

~~During 2007, the Corporation continued to manage its balance sheet in an effort to position it for the inverted yield curve and subsequent falling rates scenario.~~ The ~~Corporation~~following ~~sold~~table ~~securities~~details ~~with~~outstanding ~~lower~~loans ~~fixed~~by ~~rates~~type ~~and~~as ~~longer average lives and purchased securities with higher yields to take advantage~~ of ~~specific market sectors and more stable cash flows. As a result~~December 31, ~~the balance sheet is better~~2009, ~~positioned~~in toterms ~~mitigate~~of ~~market~~contractual ~~risk.~~maturity date:

38Table 4—Selected Loan Maturity Data

Net interest income on a tax-equivalent basis increased $23.2 million, or 26.2%, for the year ending December 31, 2008, over the same period in 2007. The net interest margin for 2008 increased to 3.04% compared to 2.82% for 2007. The net interest margin increased as a 56 basis point decrease in the yield on average earning assets of $3.7 billion was offset by a 98 basis point decrease in the cost of interest bearing liabilities of $3.2 billion. Net interest income on a tax equivalent basis in 2007 decreased $698,000, or .8% to $88.5 million, in comparison to 2006. The decrease during 2007 was mostly due to higher deposit costs offset in part by yield increases in loans and investments.

	December 31, 2009
	Due in 1 year or less		Due after 1 year through 5 years	Due after 5 years	Total
	(Dollars in thousands)
Real estate	$	290,911	$ 527,974	$ 505,175	$1,324,060
Commercial and industrial		314,611	322,030	157,145	793,786
Consumer		150,895	366,804	357,725	875,424
Lease financing		53	55	—	108
Total	$	756,470	$1,216,863	$1,020,045	$2,993,378
Loans with variable or floating interest rates	$	515,975	$ 605,411	$ 510,069	$1,631,455
Loans with fixed predetermined interest rates		240,495	611,452	509,976	1,361,923
Total	$	756,470	$1,216,863	$1,020,045	$2,993,378

~~Interest~~The Bank ~~income~~had ~~increased~~no ~~$13.2~~concentration ~~million~~of ~~for 2008 as average~~ loans ~~receivable~~to ~~grew~~individual ~~$461.9 million~~borrowers orwhich ~~21.8%~~exceeded ~~and average investment securities increased $92.6 million or 9.8~~10%. ~~The increases in average balances~~ of total loans ~~receivable~~at ~~and~~December ~~investment securities~~31, ~~attributed~~2009 ~~$34.4~~and ~~million to the increase in interest income in~~ 2008. The ~~rates~~Bank ~~earned~~actively onmonitors ~~average~~the ~~loan receivables as well as federal funds sold and~~risk ~~deposits~~of inloan ~~banks decreased 89 basis points and 270 basis points, respectively~~concentration. ~~These changes in rates decreased interest income $21.9 million during 2008.~~

~~Interest~~Nonperforming income on a tax-equivalent basis in 2007 increased $15.7 million, or 8.5% to $200.6 million, as compared to 2006. The increase was primarily due to higher average loans of $108.8 million, or 5.4%, and a 19 basis point rise in the average rates earned on loans. The average yield on investments also increased 42 basis points.Assets

~~Interest~~Nonperforming ~~expense~~assets ~~decreased~~include ~~$10.0~~loans ~~million~~that ~~for~~are ~~2008~~in asnonaccrual ~~average~~status ~~interest-bearing~~or ~~deposits~~90 days or more past due and ~~average~~loans ~~borrowed~~that ~~funds~~are ~~increased~~in ~~$412.8~~the ~~million~~process ~~and~~of ~~$114~~foreclosure.8 ~~million,~~A orloan ~~18.4% and~~is ~~24.4%,~~generally ~~respectively.~~classified as ~~The~~nonaccrual ~~increases~~when inprincipal ~~these~~or ~~average~~interest ~~balances~~has ~~attributed $22.8~~consistently ~~million~~been in andefault ~~increase~~for toa period ~~interest~~of ~~expense.~~90 days ~~Offsetting~~or ~~this~~more, ~~was~~when athere ~~decrease~~ has been deterioration in the financial ~~cost~~condition of ~~average~~the ~~interest-bearing~~borrower, ~~deposits~~or ~~and~~payment ~~borrowed~~in ~~funds~~full of ~~101~~principal ~~and~~or interest 88is ~~basis~~not ~~points, respectively~~expected. ~~These~~Delinquent ~~changes~~loans inpast ~~rates~~due ~~decreased~~90 days or more and still accruing interest ~~expense~~are loans that are generally well-secured and expected to be ~~$32.8~~restored ~~million~~to ~~during~~a ~~2008~~current status in the near future.

Interest expense increased $16.4 million, to $112.1 million during 2007 mostly attributed to higher deposit rates and an increase in average deposits of $109.4 million. The average rate paid on deposits during 2007 of 3.98% was 45 basis points higher compared to 2006. -37-

~~Net~~Nonperforming assets ~~Interest~~(including ~~Margin~~nonaccrual loans, loans 90 days or more past due and net assets in foreclosure) were 2.58% of total assets at December 31, 2009, compared to 1.43% at December 31, 2008 and 0.56% at December 31, 2007. The ratio of nonperforming loans to total net loans was 4.49% at December 31, 2009, compared to 2.12% at December 31, 2008 and 0.90% at December 31, 2007.

~~The~~Non-accruing loans ~~2008~~increased ~~net~~$54.8 million to $129.9 million at December 31, 2009, as ~~interest~~compared ~~margin~~to of$75.1 3million at December 31, 2008.~~04%~~ ~~was~~The higher ~~than~~level of nonaccruing loans was mainly attributable to commercial real estate, construction and residential real estate loans. The borrowers associated with these nonaccrual loans are generally unrelated and are primarily located in the ~~net~~Bank’s ~~interest~~market area ~~margins~~and in most cases, for ~~2007~~the ~~and~~residential real estate, the collateral is local ~~2006~~land that has been subdivided for residential development in the suburban counties of ~~2.82%~~Philadelphia and 2the Lehigh Valley.~~95%~~ The Bank’s management understands these markets and is confident that it can manage the collateral, ~~respectively~~if necessary. ~~The~~In ~~increase~~response into the ~~net~~situation, ~~interest~~the ~~margin~~Bank increased its allowance for ~~during~~loan ~~2008~~losses ~~was~~from ~~mainly~~approximately ~~attributable~~1.36% of outstanding loans at December 31, 2008, to ~~decreases~~2.23% inat ~~yields~~December on31, ~~interest-bearing~~2009. The Bank continues to evaluate appraisals, ~~liabilities~~financial ~~which~~reviews ~~outpaced~~and ~~declines~~inspections. inThe ~~the~~Bank ~~yield~~continues onto ~~loans~~take a conservative approach to its lending and loan review practices. InWith ~~addition~~the expectation of continued economic pressures, ~~yields~~management continues to provide more resources to onresolve ~~investment~~troubled ~~securities~~credits ~~have~~including an increased ~~slightly~~focus ~~since~~on earlier identification of potential problem loans and a more active approach to managing the ~~prior~~level of ~~year~~criticized loans that have not reached nonaccrual status.

~~Interest~~Non-accruing ~~Rate~~loans increased ~~Sensitivity~~$54.0 ~~Analysis~~million to $75.1 million at December 31, 2008, as compared to $21.1 million at December 31, 2007. The increase in nonaccruing loans was principally 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.

InThe Bank’s ~~the~~policy for interest income recognition on nonaccrual loans is to ~~normal~~recognize ~~course~~income ofunder ~~conducting~~the ~~business~~cash ~~activities,~~basis when the ~~Corporation~~loans are both current and the collateral on the loan is ~~exposed~~sufficient to cover the outstanding obligation to the ~~market~~Bank. ~~risk~~The Bank will not recognize income if these factors do not exist. During 2009, ~~principally~~interest accrued on non-accruing loans and not recognized as interest income ~~rate~~was ~~risk,~~$6.2 ~~through~~million and ~~the~~interest ~~operations~~paid ofon ~~its~~non-accruing loans of ~~banking~~$817,000 ~~subsidiary~~was recognized as interest income. ~~Interest~~During ~~rate~~2008, ~~risk~~interest ~~arises~~accrued ~~from~~on nonaccruing ~~market~~loans ~~driven~~and ~~fluctuations~~not inrecognized as interest income was $1.9 million and interest ~~rates~~paid ~~that~~on ~~affect~~nonaccruing ~~cash~~loans ~~flows~~of $299,000 was recognized as interest income. During 2007, ~~expense~~interest accrued on nonaccruing loans and ~~value~~not recognized as interest income was $982,000 and interest paid on nonaccruing loans of ~~financial~~$331,000 ~~instruments.~~was recognized as interest income.

~~The~~Loans ~~Corporation~~past ~~actively~~due ~~manages~~90 days ~~its~~or ~~interest~~more ~~rate~~and ~~sensitivity~~still ~~positions.~~accruing ~~The objectives~~interest ofare ~~interest~~loans ~~rate~~that ~~risk~~are generally ~~management~~well secured and are toin ~~control~~the ~~exposure~~process of ~~net~~collection. As of ~~interest~~December 31, ~~income~~2009 toloans ~~risks~~past ~~associated~~due ~~with~~90 ~~interest~~days ~~rate~~or ~~movements~~more and tostill ~~achieve~~accruing ~~consistent~~interest ~~growth~~were in$1.4 ~~net~~million, ~~interest~~compared ~~income~~to $1.8 ~~The~~million ~~Asset/Liability~~at ~~Committee~~December 31, ~~using policies~~2008 and $857,000 ~~procedures~~at ~~approved~~December by31, ~~the~~2007. ~~Corporation’s~~The ~~Board~~lower level of ~~Directors, is~~loans ~~responsible~~past ~~for~~due ~~managing~~90 ~~the~~days ~~rate~~or ~~sensitivity~~more ~~position.~~at ~~The~~December ~~Corporation~~31, ~~manages interest~~2009 ~~rate~~from ~~sensitivity~~December by31, ~~changing~~2008 ~~the~~is ~~mix and repricing characteristics of~~largely ~~its~~attributable ~~assets~~to ~~and~~a ~~liabilities~~decrease ~~through~~in ~~the~~home ~~management~~equity lines of ~~its~~credit. ~~investment~~The ~~securities~~higher ~~portfolio,~~level ~~its offering~~ of ~~loan~~loans ~~and~~past ~~deposit~~due ~~terms~~90 ~~and~~days ~~through~~or ~~wholesale borrowings~~more ~~from~~at ~~several~~December ~~providers~~31, ~~but~~2008 ~~primarily~~ from ~~the~~December ~~Federal Home Loan~~31, ~~Bank.~~2007 ~~The~~was ~~nature~~primarily ofin the ~~Corporation’s~~home ~~current~~equity ~~operations~~revolving islines ~~such~~and ~~that~~residential ~~it is not~~first ~~subject~~mortgage ~~to foreign currency exchange or commodity price risk~~loans.

~~The~~Net ~~Corporation~~assets ~~only~~in ~~utilizes~~foreclosure ~~derivative~~at ~~instruments~~December ~~for~~31, ~~asset/liability~~2009 ~~management~~were $2. ~~These~~3 ~~transactions~~million ~~involve~~compared ~~both~~to ~~credit and market risk~~$1.6 million ~~The~~at ~~notional~~December ~~amounts~~31, ~~are amounts~~2008 onand ~~which~~$28,000 ~~calculations~~at ~~and~~December ~~payments~~31, ~~are based~~2007. ~~The~~During ~~notional amounts do~~2009, ~~not~~transfers ~~represent~~from ~~direct~~loans ~~credit~~to ~~exposures.~~assets ~~Direct~~in ~~credit~~foreclosure ~~exposure~~were is$2.6 ~~limited~~million, todisposals ~~the~~of ~~net~~foreclosed ~~difference~~properties ~~between~~were ~~the~~$1.7 ~~calculated~~million, ~~amounts~~and tocharge-offs beof ~~received~~$260 ~~and~~thousand ~~paid, if any.~~were ~~Interest~~recorded. ~~rate~~Efforts ~~swaps~~to ~~are~~liquidate ~~contracts~~assets acquired in ~~which~~foreclosure aproceed ~~series~~as ~~of interest-rate flows~~quickly ~~(fixed~~as ~~and~~potential ~~floating)~~buyers ~~are~~can ~~exchanged~~be ~~over~~located aand ~~prescribed~~legal ~~period~~constraints permit. ~~The notional~~Foreclosed ~~amounts~~assets ~~on which the interest payments~~ are ~~based~~carried ~~are~~at ~~not~~the ~~exchanged.~~lower ~~Interest rate~~of ~~caps~~cost ~~are~~(lesser ~~purchased~~of ~~contracts~~carrying ~~that~~value ~~limit~~of the ~~exposure~~asset or ~~from~~fair ~~the~~value ~~repricing~~at date of ~~liabilities~~ inacquisition) aor ~~rising~~estimated ~~rate~~fair ~~environment~~value.

39The following table presents information concerning nonperforming assets. Nonperforming assets include loans that are in nonaccrual status or 90 days or more past due and loans that are in the process of foreclosure.

~~During 2008, the Corporation had cash flow hedges with notional amounts totaling $45.0 million which matured. These swaps had the effect of converting rates on money market deposit accounts to a fixed~~-rate cost of funds. This strategy was undertaken to allow the Bank to recognize, in a rising rate environment, a larger interest rate spread than it otherwise would have without the swaps in effect. In addition, two cash flow hedges with a notional amount of $10.0 million that had the effect of converting variable debt to a fixed rate matured during 2008. For both of these types of swaps, the Corporation recognized net interest expense of $192,000 for the year ended December 31, 2008 and net interest income of $287,000 and $442,000 for the years ended December 31, 2007, and 2006, respectively. During the first quarter of 2005, the Corporation terminated a cash flow hedge with a notional value of $25.0 million. The gross loss related to the termination of this swap was $310,000 which was amortized through October 2006 in accordance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities.” For the year ended December 31, 2006, the Corporation amortized $151,000 into net interest income related to this swap.38-

~~Periodically,~~Table the Corporation may enter into fair value hedges to limit the exposure to changes in the fair value of loan assets. At December 31, 2008, the Corporation 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 $7.5—Nonperforming 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 decrease in the market value of these interest rate swaps, the Corporation recognized a loss of $183,000 in other expense in the consolidated statements of income in 2008. During 2008, the Corporation terminated a fair value hedge in the form of an interest rate swap with a notional amount of $2.0 million. For fair value hedges, the Corporation recognized net interest expense of $81,000 for the year ended December 31, 2008 and net interest income of $59,000 and $7,000 for the years ended December 31, 2007 and 2006, respectively. At December 31, 2008, the Corporation had swap agreements with a negative fair value of $1.1 million. At December 31, 2007, the Corporation had swap agreements with a positive fair value of $10,000 and with a negative fair value of $366,000. There was no hedge ineffectiveness recognized during 2008, 2007 and 2006.Assets

During March 2007, the Corporation purchased one-month and three-month Treasury bill interest rate cap agreements with notional amounts totaling $200 million to limit its exposure on variable rate NOW deposit accounts. The initial premium related to these caps was $73,000 which is being amortized to interest expense over the life of the cap based on the cap market value. The Corporation recognized amortization of $16,000 and $8,000 for the year ended December 31, 2008 and 2007, respectively. At December 31, 2008, these caps, designated as cash flow hedges, had a fair value of $0. At December 31, 2007, these caps had a positive fair value of $222. The caps mature in March 2009. Due to notional mismatch, $43,000 was recognized in other expense on the consolidated statements of income during the year ended December 31, 2008. During 2007, the Corporation accelerated the reclassification of an immaterial amount in other comprehensive income to earnings as a result of variable-rate interest payments becoming probable not to occur. The accelerated amount was a loss of $7,000 recognized in interest expense on the consolidated statements of income.

	December 31,
	2009			2008			2007			2006			2005
	(Dollars in thousands)
Nonaccrual loans	$	129,932		$	75,060		$	21,091		$	15,201		$	7,493
Loans 90 days or more past due		1,396			1,849			857			2,444			846
Total nonperforming loans		131,328			76,909			21,948			17,645			8,339
Net assets in foreclosure		2,286			1,626			28			-			29
Total nonperforming assets	$	133,614		$	78,535		$	21,976		$	17,645		$	8,368
Allowance for loan losses to nonperforming loans		50.70	%		65.00	%		124.5	%		119.9	%		238.2	%
Nonperforming loans to total loans		4.49	%		2.12	%		0.90	%		0.87	%		0.42	%
Allowance for loan losses to total loans		2.23	%		1.36	%		1.11	%		1.03	%		1.00	%
Nonperforming assets to total assets		2.58	%		1.43	%		0.56	%		0.54	%		0.27	%

~~During 2008,~~Local ~~the~~real ~~Corporation~~estate ~~began~~secures tomany offer certain derivative products directly to qualified commercial borrowers. The Corporation economically hedges derivative transactions executed with commercial borrowers by entering into mirror-image, offsetting derivatives with third parties. Derivative transactions executed as part of ~~this program are not designated in SFAS 133-qualifying hedging relationships and are, therefore, marked-to-market through earnings each period. Because~~ the ~~derivatives~~nonperforming ~~have mirror-image contractual terms, the changes in fair value substantially offset through earnings~~loans. These derivatives have maturity dates ranging from 2010 to 2018. As of December 31, 2008, the fair value of the derivative assets and the fair value of the offsetting derivative liabilities were $4.5 million and $4.5 million, respectively. Fees earned in connection with the execution of derivatives related to this program are recognized in other noninterest fee income. The derivative asset and liability values above include an adjustment related to the consideration of credit risk required under FAS 157 of $18,000, which is also recognized as an adjustment to other income on the consolidated statements of income.

40Allowance for Loan Losses

The Corporation uses ~~three~~the ~~principal~~reserve ~~reports~~method toof ~~measure~~accounting ~~interest~~for ~~rate~~loan ~~risk:~~losses. ~~(1)~~The balance ~~asset/liability~~in ~~simulation~~the ~~reports;~~allowance ~~(2)~~for ~~gap~~loan ~~analysis~~losses ~~reports;~~is ~~and~~determined ~~(3)~~based ~~net interest~~on ~~margin reports. The Corporation~~management’s ~~interest~~review ~~rate sensitivity, as~~and ~~measured~~evaluation byof the ~~repricing~~loan ofportfolio ~~its~~in ~~interest~~relation ~~sensitive~~to ~~assets~~past ~~and~~loss ~~liabilities at December 31~~experience, ~~2008,~~the issize and ~~presented~~composition inof the ~~following~~portfolio, ~~table.~~current ~~The~~economic ~~data~~events inand ~~the~~conditions, ~~table~~and ~~was~~other ~~based~~pertinent infactors, ~~part~~including onmanagement’s assumptions ~~that~~as ~~are~~to ~~regularly~~future delinquencies, ~~reviewed~~recoveries ~~for~~and ~~accuracy~~losses. ~~The table~~Increases ~~presents~~to ~~data~~the atallowance afor ~~single~~loan ~~point~~losses are inmade ~~time~~by ~~and~~charges ~~includes~~to ~~management assumptions estimating~~ the ~~prepayment~~provision ~~rate~~for ~~and~~loan ~~the~~losses. ~~interest~~Credit ~~rate~~exposures ~~environment~~deemed to ~~prevailing~~be atuncollectible ~~December~~are ~~31,~~charged ~~2008.~~against ~~The~~the ~~table~~allowance ~~indicates~~for aloan ~~liability~~losses. ~~sensitive~~Recoveries ~~one-year~~of ~~cumulative~~previously ~~gap~~charged-off ~~position~~amounts ofare ~~6.14%~~credited ofto ~~total~~the ~~earning~~allowance ~~assets~~for loan losses.

~~Table~~While management ~~13—Contractual~~considers the allowance for loan losses to be adequate based on ~~Repricing~~information ~~Data~~currently available, future additions to the allowance may be necessary due to changes in economic conditions or management’s assumptions as to future delinquencies, recoveries and losses and management’s intent with regard to the disposition of ~~Interest~~loans. ~~Sensitive~~In ~~Assets~~addition, the Office of the Comptroller of the Currency (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 and ~~Liabilities~~implement modifications to the allowance for loan losses methodology based on their judgments about information available to them at the time of their examination.

	December 31, 2008
	After 1 year
	0 to			91 to			through			Over
	90 days			365 days			5 years			5 years			Total
	(Dollars in thousands)
Earning assets
Investment securities	$	164,261		$	94,238		$	222,475		$	750,687		$	1,231,661
Deposits in banks		27,221			—			—			—			27,221
Loans		1,169,088			340,841			1,317,399			857,916			3,685,244
Total earning assets	$	1,360,570		$	435,079		$	1,539,874		$	1,608,603		$	4,944,126
Interest-bearing liabilities
Interest-bearing checking accounts	$	17,514		$	49,308		$	196,163		$	293,870		$	556,855
Money market funds		32,784			92,293			435,013			482,212			1,042,302
Savings accounts		8,520			23,986			95,424			142,955			270,885
Time deposits		378,842			748,223			460,435			1,421			1,588,921
Borrowed funds		181,198			83,392			473,564			252,344			990,498
Total interest-bearing liabilities	$	618,858		$	997,202		$	1,660,599		$	1,172,802		$	4,449,461
Interest rate swaps	$	124,138		$	—		$	(8,000	)	$	(116,214	)	$	—
Incremental gap	$	865,925		$	(562,123	)	$	(128,725	)	$	319,588
Cumulative gap(1)	$	865,925		$	303,802		$	175,077		$	494,665
Cumulative gap as a percentage of earning
assets		17.51	%		6.14	%		3.54	%		10.01	%

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 includes the following: historical loss estimation by loan product type and by risk rating within each product type, payment (past due) status, industry concentrations, internal and external variables such as economic conditions, credit policy and underwriting changes and results of the loan review process. The Corporation’s historical loss component is 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.

~~(1)~~ The historical ~~information~~loss iscomponents ~~based~~of ~~upon~~the ~~significant~~allowance ~~assumptions,~~represent ~~including~~ the ~~following:~~results ~~loans~~of ~~and~~analyses ~~leases~~of historical ~~are~~charge-offs ~~repaid by contractual maturity~~ and ~~repricing;~~recoveries ~~securities~~within ~~are~~pools ~~repaid~~of ~~according~~homogeneous ~~to contractual maturity adjusted for call features; interest-bearing demand~~loans, ~~regular~~within each ~~savings,~~risk ~~and~~rating ~~money market savings deposits are estimated to exhibit some rate sensitivity;~~ and ~~time~~broken ~~deposits~~down ~~are~~further ~~shown~~by ~~in the table based on contractual maturity.~~segment,

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.-39-

~~The results~~within of the ~~December~~portfolio. ~~31,~~Criticized ~~2008~~assets ~~net~~are ~~interest~~further ~~income~~assessed ~~rate~~based ~~shock~~on ~~simulations~~trends, ~~show that~~relative ~~the~~to ~~Corporation~~migrations isin ~~within~~delinquency, ~~guidelines~~risk ~~set~~rating ~~by the Corporation's Asset/Liability Policy when modeled rates increase 100~~ and ~~200~~nonaccrual ~~basis~~status, ~~points and decrease~~ by ~~100~~credit ~~and~~product ~~200~~(collectively ~~basis~~expressed ~~points.~~as ~~The~~the ~~Corporation~~product ~~constantly~~level ~~monitors this position and~~environmental ~~takes steps to minimize any reduction in net interest income~~factor).

41The 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 and historical loss rates adjusted by the product level environmental factor. 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 the product level environmental factor to reflect current events and conditions.

The ~~following~~industry ~~table~~concentration ~~forecasts~~component ~~changes~~is inrecognized ~~the~~as ~~Corporation’s~~a ~~market~~possible ~~value~~factor ofin ~~equity~~the ~~under~~estimation ~~alternative~~of ~~interest~~loan ~~rate~~losses. ~~environments~~Two asindustries ofrepresent ~~December~~possible ~~31,~~concentrations: commercial ~~2008.~~real ~~The~~estate ~~market value~~and ofconsumer ~~equity~~loans isrelying ~~defined~~on asresidential ~~the~~home ~~net~~equity. ~~present~~No specific ~~value~~loss-related ofobservable ~~the~~data ~~Corporation’s existing~~is ~~assets~~recognized ~~and~~by ~~liabilities.~~management ~~The~~currently, therefore ~~Corporation~~no isspecific ~~within~~factor ~~guidelines~~is ~~set~~calculated byin the ~~Corporation’s~~ ~~Asset/Liability~~reserve ~~Policy~~solely for the ~~percentage~~impact of ~~change~~these inconcentrations, ~~the~~although ~~market~~management continues to carefully consider ~~value~~relevant data for possible future sources of ~~equity~~observable data.

~~Table~~The historic ~~14—Market~~loss ~~Value~~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 ~~Equity~~component of each segment under review as well as an additional assessment applied to the at the portfolio level.

	December 31, 2008
									Asset/Liability
			Change in						Approved
	Market Value		Market Value			Percentage			Percent
	of Equity		of Equity			Change			Change
	(Dollars in thousands)
+300 Basis Points	$	292,335	$	(130,551	)		–30.87	%		+/–35	%
+200 Basis Points		345,059		(77,826	)		–18.40			+/–25
+100 Basis Points		391,542		(31,344	)		–7.41			+/–15
Flat Rate		422,886		—			0.00			—
–100 Basis Points		407,956		(14,930	)		–3.53			+/–15
–200 Basis Points		382,766		(40,120	)		–9.49			+/–25
–300 Basis Points		387,900		(34,986	)		–8.27			+/–35

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, negative industry specific events, and local economic events. Management utilizes relevant data provided by the Third Federal Reserve District of Philadelphia that describe the economic events affecting specific geographic areas. 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 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.

InThe provision ~~the~~for ~~event~~loan losses increased $42.8 million to $58.3 million during 2009 ~~the~~compared ~~Corporation~~to ~~should~~2008 ~~experience~~mostly as a ~~mismatch~~result of a decrease in ~~its~~the ~~desired~~overall ~~gap~~quality ~~ranges~~of orthe loan portfolio which caused an increase in the amount of the required reserve. ~~excessive~~Credit ~~decline~~quality continued to be a challenge in ~~its~~the ~~market~~Bank’s ~~value~~commercial ofreal ~~equity~~estate, commercial ~~resulting~~and ~~from~~industrial ~~changes~~and home equity portfolio in the fourth quarter of ~~interest~~2009. ~~rates,~~Nonperforming itassets ~~has~~as a ~~number~~percentage of ~~options~~total ~~that~~assets itwere ~~could~~2.58% ~~use~~at December 31, 2009, compared to ~~remedy~~1.43% ~~the~~at December 31, 2008. Net loans charged-off ~~mismatch~~increased $35.8 ~~The~~million ~~Corporation~~for ~~could~~2009 ~~restructure~~compared ~~its~~to ~~investment~~2008 ~~portfolio~~principally ~~through~~due ~~the~~to charge-offs ~~sale~~of orseveral ~~purchase~~unrelated commercial real estate and commercial and industrial borrowers and increased charge-offs of ~~securities~~consumer ~~with~~loans, ~~more~~specifically ~~favorable~~home ~~repricing~~equity lines ~~attributes~~of credit and loans and other direct installment loans. ItThe profile of the ~~could~~Bank’s ~~also~~customer ~~emphasize~~base ~~growth~~has remained relatively constant and management believes that the current deterioration in ~~loan~~credit ~~products~~quality ~~with~~has ~~appropriate~~been ~~maturities~~caused ~~or repricing~~by ~~attributes,~~the oreconomic pressures ~~attract~~being ~~deposits~~felt orby ~~obtain~~borrowers ~~borrowings~~due ~~with~~to ~~desired~~general economic ~~maturities.~~conditions

~~Provision for Loan Losses~~-40-

~~The~~and the continued recession As the current economic conditions deteriorate, management continues to allocate dedicated resources to continue to manage at-risk credits. The provision for loan losses increased $5.0 million ~~during~~in 2008 compared to 2007 ~~mostly~~primarily as a result of a decrease in the ~~credit~~ quality of the loan portfolio ~~which~~ which caused an increase in the amount of the required reserve. ~~The~~Net ~~provision~~loans charged-off ~~for~~decreased ~~loan losses increased~~ $61.48 million during ~~2007~~2008 compared to ~~2006~~2007 ~~mostly~~principally asdue ato ~~result~~prior-year ofcharge-offs ~~decreased~~for ~~quality~~real ofestate ~~the~~construction ~~loan~~loans ~~portfolio.~~for ~~Total~~one ~~net~~borrower combined ~~loans~~with ~~charged~~an ~~off~~ increase in ~~2008,~~recoveries ~~2007~~both ~~and~~related ~~2006~~to ~~were~~commercial ~~$5.9~~and industrial ~~million,~~loans ~~$7.6~~and ~~million~~real ~~and~~estate $2loans.~~9 million, respectively.~~

~~Noninterest~~The allowance ~~Income~~for loan losses increased $16.6 million, or 33.4%, to $66.6 million at December 31, 2009 from $50.0 million at December 31, 2008. The increase in the allowance was primarily due to the decline in credit quality in the current environment. Nonperforming loans have increased by $54.4 million as a result of these factors from December 31, 2009 compared to December 31, 2008. The increase in the allowance for real estate loans, commercial and industrial loans, and consumer loans illustrates the impact of the recession. Management expects the negative trends to continue to impact credit quality in 2010. The allowance for loan losses increased $22.6 million, or 82.8%, to $50.0 million at December 31, 2008 from $27.3 million at December 31, 2007. The increase in the allowance 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 credit environment.

~~For the year~~ ~~ended December 31, 2008, noninterest income was $46.2 million, an increase of~~ ~~$2.9~~A ~~million, or 6.6%, from 2007. Noninterest income in 2007 included $2.8~~summary ~~million in gains on sale leaseback transactions. During the second half~~ of ~~2007,~~ the ~~Bank~~activity ~~revised its return check and overdraft charge process and~~ in ~~2008,~~ the ~~Bank~~ ~~experienced~~allowance anfor ~~increase~~loan inlosses ~~service~~is charge income of $3.8 million, or 39.5%, over 2007. Service charge income attributable to the acquisition of East Penn Financial in November 2007 which included approximately $380 million in deposits also contributed approximately $1.9 million to this 2008 service charge increase. Gains on sale of investment securities were $2.6 million during 2008 as compared to $1.2 million in the prior year. Other income increased $2.0 million to $10.6 million over the prior year driven by a $834,000 increase in automated teller machine and point of sale revenue, fees on derivative instruments of $627,000, a $405,000 death benefit received on bank owned life insurance, and a gain of $302,000 from the mandatory redemption of Visa Class B stock in conjunction with Visa’s initial public offering. Offsetting these increases was a fourth quarter 2008 other than temporary impairment charge of $1.9 million on collateralized debt obligation investments in pooled trust preferred securities.follows:

~~Noninterest income~~Table of6—Allowance $43.3 million during 2007 decreased $2.0 million or 4.4% compared to 2006. Wealth management fee income rose $3.9 million or 26.1% during 2007 primarily driven by a higher level of life insurance business at Cornerstone as well as growth in trust assets. The Bank experienced an increase in deposit service charges of $1.7 million or 21.1% over the prior year mainly from return check and overdraft fees and fees from East Penn deposit accounts. During the fourth quarter of 2007, the Bank recognized a pre-tax gain of $2.3 million on the sale-leaseback of fifteen bank properties representing a portion of the total gain of $18.9 million. The remaining gain was deferred and is being amortized through a reduction of occupancy expense over the 15-year term of the leases an annual amount of approximately $1.1 million. The Corporation also completed a separate sale-leaseback of office space in October with a recognized pre-tax gain of $473,000. The deferred gain of $552,000 is being amortized over the 10-year term of the lease. In addition, gains on sale of investment securities were $1.1 million during 2007 as compared to losses of $674,000 for ~~2006.~~Loan ~~In addition, noninterest income for 2006 included the pre-tax gains on the sales of the Bank’s Honesdale branch and credit card portfolio of $10.7 million and $1.4 million, respectively.~~Losses

December 31,

Filing Compare · HARLEYSVILLE NATIONAL CORP