2009 ANNUAL REPORT

ON FORM 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(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 name of registrant as specified in its charter)

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

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 check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

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 check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit 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 check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

The aggregate market value of the Registrant’s Common Stock held by non-affiliates is $188,566,927 based 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:

None.

HARLEYSVILLE NATIONAL CORPORATION

FORM 10-K

INDEX

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

Signatures

168

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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.”

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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 bank holding company of Harleysville National Bank and Trust Company (the Bank or Harleysville National Bank), established in 1909, a wholly owned subsidiary of the Corporation. The Corporation is registered as a bank holding 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 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 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, 2009, the Bank had 83 branch offices located in Montgomery, Bucks, Chester, Berks, Carbon, Lehigh, Monroe, Northampton and Philadelphia counties, Pennsylvania.

The Bank has maintained a stable base of core deposits and is a leading community bank in 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 relocated its Pottstown East End branch in Montgomery County during 2008. The Conshohocken branch in Montgomery County was opened in February 2009.

Pending Merger

On July 26, 2009, the Corporation entered into an agreement and plan of merger with First Niagara Financial Group, Inc. (“First Niagara”), pursuant to which the Corporation will merger with and into First Niagara (the “Merger”). The Merger was approved by the Corporation’s shareholders at a special meeting of shareholders held on January 22, 2010. Pending and subject to the receipt of all required regulatory approvals, the Merger is expected to close in the second quarter of 2010. See “Item 1A—Risk Factors—Risk Related to the Merger with First Niagara.”

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Acquisitions

Effective after the market close on December 5, 2008, the Corporation completed its acquisition of Willow Financial Bancorp, Inc. and its subsidiary, Willow Financial Bank, a $1.6 billion bank with 29 banking offices in Southeastern Pennsylvania. Headquartered in Wayne, PA, Willow Financial Bank branch offices were located in Philadelphia, Montgomery, Chester, and Bucks Counties. On the acquisition date, Willow Financial had approximately $1.6 billion in assets, $1.1 billion in loans and $946.7 million in deposits. The merger delivers a significant market share in Chester County, one of the fastest 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 Corporation also acquired BeneServ, Inc., a respected provider of employee benefits services from Willow Financial.

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.

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.

Dispositions

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.

Segments

The 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, 2009, the Corporation had total assets of $5.2 billion, total shareholders’ equity of $261.6 million and total deposits of $3.9 billion.

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

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Competition

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.

Concentrations/Seasonality

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, 2009. The businesses of the Corporation and its subsidiaries are not typically seasonal in nature.

Supervision and Regulation—The Registrant

The Gramm-Leach-Bliley Financial Modernization Act of 1999 (Modernization Act) allows bank holding companies meeting management, capital, and Community Reinvestment 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.

The Modernization 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.

Pending Legislation

Other 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.

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Effect of Government Monetary Policies

The earnings of the Corporation are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. An important function of the Federal Reserve is to regulate the money supply and interest rates. Among the instruments used to implement those objectives are open market operations in United States government securities and changes in reserve requirements 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.

The Bank is a member of the Federal Reserve and, therefore, the policies and regulations of the Federal Reserve have a significant effect on its deposits, loans and investment growth, as well as the rate of interest earned and paid, and are expected to affect the Bank’s operations in the future. The effect of such policies and regulations upon the future business and earnings of the Corporation and the Bank cannot be predicted.

Environmental Regulations

There are several federal and state statutes which regulate the obligations and liabilities of financial institutions pertaining to environmental issues. In addition to the potential for attachment of liability resulting from its own actions, a bank may be held liable under certain circumstances for the actions of its borrowers, or third parties, when such actions result in environmental problems on properties that collateralize loans held by the bank. Further, the liability has the potential to far exceed the original amount of a loan issued by the bank. Currently, neither the Corporation nor the Bank are a party to any pending legal proceeding pursuant to any environmental statute, nor are the Corporation and the Bank aware of any circumstances that may give rise to liability under any such statute.

Supervision and Regulation—Bank

The operations 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 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 and state banking laws and regulations govern, among other things, the scope of a bank’s business, the investments a bank may make, the reserves against deposits a bank must maintain, loans a bank makes and collateral it takes, the activities of a bank with respect to mergers and consolidations and the establishment of branches.

The 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.

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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.

Community Reinvestment Act

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 Secrecy Act

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 Requirements / FDICIA

The 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.

Total

Risk

Based

Ratio

Tier 1

Risk

Based

Ratio

Tier 1

Leverage

Ratio

Under a

Capital

Order

Directive

Capital category

Well capitalized

³10.0%

³6.0%

³5.0

YES

Adequately capitalized

³8.0%

³4.0%

³4.0

%(1)

Undercapitalized

<8.0%

<4.0%

<4.0

%(1)

Significantly undercapitalized

<6.0%

<3.0%

<3.0

Critically undercapitalized

Tangible equity capital ratio that is ≤ 2%

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

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capitalized," banks generally must maintain a Tier 1 leverage ratio of at least 5%, a Tier 1 risk based capital ratio of at least 6% and a total risk-based capital ratio of at least 10%. In the case of the Bank, however, the OCC established higher “individual minimum capital ratios “ (IMCR) requiring a Tier 1 leverage ratio of at least eight percent (8%) of adjusted total assets, a Tier 1 risk-based capital ratio of at least ten percent (10%) and a total risk-based capital ratio of at least twelve percent (12%) which the Bank was required to achieve by June 30, 2009. The Corporation’s efforts to raise capital prior to the deadline ultimately resulted in the planned merger with First Niagara, which was announced on July 28, 2009. In addition, the Corporation elected to reduce and subsequently suspend its cash dividends on its common stock beginning with the third quarter of 2009 and to defer quarterly interest payments on its outstanding subordinated debentures until further notice, beginning with the interest payments that were due on September 15, 2009. These actions were taken to conserve capital.

During December 2009, First Niagara entered into a loan transaction to recapitalize the Bank. As of December 31, 2009, the Corporation borrowed the full $50.0 million available under the credit facility from First Niagara which was contributed to the Bank as Tier 1 capital, allowing it to meet the general regulatory capital ratios of a “well capitalized” bank for the first time since September 2008. The Corporation’s regulatory capital ratios as of December 31, 2009 included total risk-based capital of 10.64%, Tier 1 risk-based capital of 9.38% and a Tier 1 leverage capital of 6.33%. The Bank’s regulatory capital ratios as of December 31, 2009 included total risk-based capital of 11.65%, Tier 1 risk-based capital of 10.39% and a Tier 1 leverage capital of 7.01%. While these capital ratios are above the “well capitalized” requirements, they are below 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 March 31, 2010, subject to continued compliance with “well capitalized” ratios achieved upon receipt of the First Niagara loan proceeds. Effective March 4, 2010, this deadline was further extended to May 31, 2010. First Niagara is also prepared to buy up to $80 million in commercial and commercial real estate loan participations from the Corporation and 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.

In 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.

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.

Annual 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.

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A separate 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 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.

Capital Distributions

The Corporation is a legal entity separate and distinct from its banking and other subsidiaries. The majority of the Corporation’s revenue is from dividends paid to the Corporation by the Bank. The Bank is subject to various regulatory policies and requirements relating to the amount and frequency of dividend declarations. Future dividend payments to the Corporation by the Bank will be dependent on a number of factors, including the earnings and financial condition of the Bank, and are subject to limitations and other statutory powers of bank regulatory 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.

Deposit Insurance and Premiums

The 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.

As 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.

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-based deposit insurance assessment system mandated by the Deposit Insurance Reform Act of 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.

In December 2008, the FDIC approved a final rule which raised assessment rates uniformly by seven basis points for the first quarter of 2009 only. The FDIC established new assessment rates effective April 1, 2009. As a result, the assessment rates subsequent to the first quarter of 2009 were significantly higher than in 2008. The Bank estimates that its FDIC assessment for the first quarter of 2010 will be approximately $3.2 million.

On November 12, 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

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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 will continue until the bonds mature in the year 2019. The Bank paid FICO premiums of $424,000 in 2009.

Any significant increases in assessment rates or additional special assessments by the FDIC could have an adverse impact on the results of operations and capital of the Bank and the Corporation.

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 implemented a broad range of corporate governance, accounting and reporting measures for companies that have securities registered under the Exchange Act, including publicly-held bank holding companies. The more significant reforms of the Sarbanes-Oxley Act of 2002 included: (1) new requirements for audit committees, including independence, expertise, and responsibilities; (2) certification of financial statements by the Chief Executive Officer and Chief Financial Officer of the reporting company; (3) new standards for auditors and regulation of audits, including independence provisions that restrict non-audit services 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 accelerated reporting of stock transactions and a 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.

USA Patriot Act

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 anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.

Supervision and Regulation - Cornerstone Companies

The Cornerstone Companies (Cornerstone Financial Consultants, Ltd. (CFC), Cornerstone Institutional Investors, 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 of the securities and other financial markets and with protecting the interests of customers participating in those markets. The SEC is the federal agency that is primarily responsible for the regulation of broker-dealers and investment 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 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. 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, 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.

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In the 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. The imposition 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.

CII is 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.

Changes in Regulations

From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restriction on, the business of the Corporation and the Bank. It cannot be predicted whether any such legislation will be adopted or, if adopted, how such legislation would affect the business of the Corporation or the Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, the Corporation and the Bank are particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business.

Additional Information

The Corporation’s Annual Report on Form 10-K, Quarterly Reports on Form 10-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 1A.

Risk Factors

The business of the Corporation and the Bank involve significant risks as described below. Additional risks may arise in the future or risks that are currently not considered significant may also impact the operations of the Corporation and the Bank. The Corporation may amend or supplement the risk factors described below from time to time by reports filed with the SEC in the future. Management’s ability to analyze and manage these and other risks could affect the future financial results of the Corporation. If any of the events or circumstances described in the following risks occurs, the financial condition or results of operations of the Corporation could suffer and the trading price of the Corporation’s common stock could decline.

Interest rate movements impact the earnings of the Corporation.

The Corporation is exposed to interest rate risk, through the operations of its banking subsidiary, since substantially all of the Bank’s assets and liabilities are monetary in nature. Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and value of financial instruments.

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The Bank’s earnings, like 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 more rapidly than the interest earned on the loans and securities because the primary 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 Corporation is exposed to risks in connection with loans the Bank makes and if the allowance for loan losses is not sufficient to cover actual loan losses, the Corporation’s earnings could decrease.

A 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.

The Corporation maintains an allowance for loan losses at a level management believes is sufficient to absorb estimated probable credit losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires significant estimates by management. Consideration is given to a variety of factors in establishing these estimates including historical losses, current and anticipated economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers’ perceived financial and management strengths, the adequacy of underlying collateral, the dependence on collateral, or the strength of the present value of future cash flows and other relevant factors. These factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required which may adversely affect the Corporation’s results of operations in the future. 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 recognize additions to the allowance based on their judgment of information available to them at the 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’s ability to pay dividends is subject to limitations.

The Corporation is a bank holding company and its operations are conducted by direct and indirect subsidiaries, each of which is a separate and distinct legal entity. Substantially all of the Corporation’s assets are held by its direct and indirect subsidiaries.

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. Additionally, beginning in the third quarter of 2009, the Corporation stopped paying dividends on its common stock in order to conserve capital. 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.

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The Corporation may fail to realize the anticipated benefits from mergers.

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 to combine 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 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 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.

Future acquisitions by the Corporation could dilute shareholder ownership of the Corporation and may cause the Corporation to become more susceptible to adverse economic events.

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 stock. While there is no 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 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.

An economic downturn in eastern Pennsylvania or a general decline in economic conditions could adversely affect the Corporation’s financial results.

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

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 be exacerbated when the collateral held by the Corporation cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Corporation. Such losses could have a material adverse affect on the Corporation’s financial condition and results of operations.

Current levels of market volatility may have materially adverse effects on the Corporation’s liquidity, financial condition and/or profitability.

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

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disruption and volatility 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.

Strong competition within the Corporation’s market area may limit its growth and profitability.

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.

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

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.

If 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.

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.

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.

Harleysville National Corporation at times utilizes the Federal Home Loan Bank (FHLB) of Pittsburgh for overnight borrowings and term advances; Harleysville National Corporation also has the ability to borrow from the Federal Reserve through the discount window and from correspondent banks under our federal funds lines of

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credit. The amount loaned to Harleysville National Corporation is generally dependent on the value of the collateral pledged. These lenders could reduce the percentages loaned against various collateral categories, could eliminate certain types of collateral and could otherwise modify or even terminate their loan programs. Any change or termination would have an adverse affect on Harleysville National Corporation’s liquidity and profitability.

Risks related to the Merger with First Niagara Financial Group, Inc. (“First Niagara”)

The Merger Agreement May Be Terminated in Accordance With Its Terms and The Merger May Not Be Completed.

The agreement and plan of merger (the “Merger Agreement” by and between Harleysville National Corporation and First Niagara is subject to a number of 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 share 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.

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

First Niagara may 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:

	•		Harleysville National Corporation’s businesses may have been adversely impacted by the failure to pursue other beneficial opportunities due to the focus of management on the merger, without realizing any of the anticipated benefits of completing the merger; and
	•		the market price of Harleysville National Corporation common stock might decline to the extent that the current market price reflects a market assumption that the merger will be completed.

If the Merger Agreement is terminated and Harleysville National Corporation’s board of directors seeks another merger or business combination, Harleysville National Corporation shareholders cannot be certain that Harleysville National Corporation will be able to find a party willing to pay an equivalent or more attractive price than the price First Niagara has agreed to pay in the merger.

Regulatory Approvals for the Merger May Not be Received, May Take Longer Than Expected or May Impose Conditions That are Not Presently Anticipated or Cannot be Met.

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

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effect on First Niagara following the merger. There can be no assurance as to whether the regulatory approvals will be received, the timing of those approvals, or whether any conditions will be imposed.

If 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.

On May 28, 2009, 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).

If Harleysville National Corporation cannot repay the loan by 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 Harleysville National Corporation will be able to raise funds sufficient to repay the loan from First Niagara if the merger agreement is terminated. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Overview.”

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.

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.

Harleysville National Corporation’s Asset Quality May Deteriorate Prior to Completion of the Merger.

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.

First 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.

Harleysville National Corporation’s investment portfolio of securities available for sale includes trust preferred securities, private label collateralized mortgage obligations, collateralized debt obligations and equity securities. Harleysville National Corporation recognized other than temporary impairment charges totaling

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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.

First Niagara May Fail to Realize the Anticipated Benefits of the Merger.

The success of the merger will depend on, among other things, First Niagara’s ability to 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 may not be realized fully or at all or may take longer to realize than expected.

First 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.

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

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.

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

Harleysville 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

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First Niagara common stock will become a shareholder of First Niagara with a percentage ownership of the combined organization that is much smaller than the shareholder’s percentage ownership of Harleysville National Corporation. Because of this, Harleysville National Corporation’s shareholders will have less influence on the management and policies of First Niagara than they now have on the management and policies of Harleysville National Corporation.

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

The Merger Agreement contains “no shop” provisions that, subject to limited exceptions, limit Harleysville National Corporation’s ability to discuss, facilitate or commit to competing third-party proposals to acquire all or a significant part of Harleysville National Corporation. In addition, Harleysville National Corporation has agreed to pay First Niagara a termination fee in the amount of $10.0 million in the event that Harleysville National Corporation terminates the merger agreement for certain reasons. These provisions might discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of Harleysville National Corporation from considering or proposing that acquisition even if it were prepared to pay consideration with a higher per share market price than that proposed in the merger, or might result in a potential competing acquiror’s proposing to pay a lower per share price to acquire Harleysville National Corporation than it might otherwise have proposed to pay. Harleysville National Corporation can consider and participate in discussions and negotiations with respect to an alternative proposal so long as the Harleysville National Corporation board of directors determines in good faith (after consultation with legal counsel) that failure to do so would be reasonably likely to result in a violation of its fiduciary duties to Harleysville National Corporation shareholders under applicable law. Moreover, the Merger Agreement restricts the Corporation’s ability to solicit additional capital, which may be needed to meet certain regulatory requirements or to fund day-to-day operations.

The Merger is Subject to the Receipt of Consents and Approvals From Government Entities that May Impose Conditions that Could Have an Adverse Effect on the Combined Company Following the Merger.

Before the merger may be completed, various approvals or consents must be obtained from the Office of Thrift Supervision and other governmental entities. These government entities, including the Office of the Comptroller of the Currency, may impose conditions on the completion of the merger or require changes to the terms of the merger. Although First Niagara and Harleysville National Corporation do not currently expect that any such material 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 merger or imposing additional costs on or limiting the revenues of First Niagara following the merger, any of which might have a material adverse effect on First Niagara following the merger.

The 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.

The merger is subject to closing conditions that, if not satisfied, will prevent the merger from being completed. In addition to the required approvals and consents from governmental, the merger is subject to other conditions beyond First Niagara’s and Harleysville National Corporation’s control that may prevent, delay or otherwise materially adversely affect its completion. First Niagara and Harleysville National Corporation cannot predict whether and when these other conditions will be satisfied.

The Shares of First Niagara Common Stock to be Received by Harleysville National Corporation Shareholders as a Result of the Merger Will Have Different Rights From the Shares of Harleysville National Corporation Common Stock.

Upon completion of the merger, Harleysville National Corporation shareholders will become First Niagara shareholders and their rights as shareholders will be governed by the certificate of incorporation and bylaws of

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

Several 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.

Harleysville National Corporation and the members of the Harleysville National Corporation board of directors are named as defendants in purported class action lawsuits brought by Harleysville National Corporation shareholders challenging the proposed merger, seeking, among other things, to enjoin the defendants from consummating the merger on the agreed-upon terms. First Niagara is also named as a defendant in some, but not all, of these lawsuits. Additionally, the directors of Harleysville National Corporation have been named as defendants in four shareholder derivative lawsuits that also seek, among other things, to enjoin the consummation of the merger. One of the conditions to the closing of the merger is that no order, decree or injunction issued by a court or agency of competent jurisdiction that enjoins or prohibits the consummation of the merger shall be in effect. As such, if the plaintiffs are successful in obtaining an injunction prohibiting the defendants from consummating the merger on the agreed upon terms, then such injunction may prevent the merger from becoming effective, or from becoming effective within the expected timeframe.

Item 1B.

Unresolved Staff Comments

None.

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Item 2.

Properties

The principal executive offices of the Corporation and of the Bank 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 are located and leases space for the other sixty-four branches from unaffiliated third parties under leases expiring at various times through 2037.

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

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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

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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

___________

(1)	Locations include Millennium Wealth Management and Private Banking offices.

(2)	Branch buildings are owned by the Bank and the land is leased.

(3)	The branch facility at this location is owned. There is also a drive-up facility at this location that is leased.

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

(5)	Branch buildings are rented but land is owned.

In management's opinion, all of the above properties are in good condition and are adequate for the Registrant's and the Bank’s purposes.

Item 3. Legal Proceedings

In 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:

In connection with the Corporation’s proposed merger with First Niagara, the Corporation has been named as a defendant in seven, substantially similar actions currently pending in the Court of Common Pleas of Montgomery County, Pennsylvania (the Seibert, McAuvic and Shoemaker matters) and the Court of Common Pleas of Philadelphia County, Pennsylvania (the Davis, Forbes, Silver and Valerius matters). These complaints each charge that the Corporation and its directors breached their fiduciary duties to the Corporation’s shareholders by failing to negotiate a fair price for the Corporation’s stock in the merger. In addition, the plaintiffs claim that the process leading to the proposed merger was unfair. The Seibert and McAuvic complaints also allege that First Niagara aided and abetted the breaches of fiduciary duty by the Corporation and its directors. The complaints seek to enjoin the proposed merger and to recover money damages. The Corporation believes the claims in the complaints are without merit. All seven state cases are currently stayed.

On January 6, 2010, the plaintiffs in the Seibert and McAuvic cases moved to lift the stay of proceedings previously stipulated by the parties, and sought an order granting expedited discovery and scheduling a preliminary injunction hearing. On January 7, 2010, the Court denied plaintiffs’ motions in their entirety.

In December 2009 and 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 District 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 proxy statement sent to shareholders in connection with the proposed merger was incomplete and materially misleading. On 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.

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Item 4.

(Removed and Reserved)

PART II

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The following table sets forth high and low closing sales prices for the Corporation’s common stock and quarterly 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.”

Price of Common Stock and Cash Dividends

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

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.

The Corporation has a stock repurchase program that permits the repurchase of up to five percent of its outstanding common stock. The repurchased shares will be used for general corporate purposes. The Corporation did not repurchase any shares of its stock under the Corporation’s stock repurchase programs during 2009. The maximum number of shares that may yet be purchased under the plans was 731,761 as of December 31, 2009. The repurchased shares are used for general corporate purposes. On May 12, 2005, the Board of Directors authorized a plan to purchase up to 1,416,712 shares (restated for five percent stock dividend paid on September 15, 2006 and September 15, 2005) or 4.9% of its outstanding common stock. The Corporation is precluded from purchasing its outstanding common stock under the terms of the merger agreement with First Niagara.

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Equity Compensation Plan Information

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:

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

(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.

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.

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Performance Graph

The following 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.

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.

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Item 6. Selected Financial Data

	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 results of operations include a non-cash goodwill impairment charge of $214.5 million during the second quarter of 2009 resulting from the decrease in the market value of the Corporation’s stock.

(2)	The results of operations include the acquisition of the Willow Financial effective December 5, 2008.

(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.

(4)	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.

(5)	Adjusted for a five percent stock dividend effective September 15, 2006 and September 15, 2005.

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Item 7.

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

The following is management’s discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for Harleysville National Corporation (the Corporation), and its wholly owned subsidiaries—Harleysville National Bank 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 Bank’s 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.

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 the 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.

When we use words such as “believes”, “expects”, “anticipates”, “estimates”, or “intends” or similar expressions, we are making forward-looking statements. Investors are cautioned not to place undue reliance on these forward-looking statements and are also advised to review the risk factors that may affect Harleysville National Corporation’s operating results in documents filed by Harleysville National Corporation with the Securities and Exchange Commission, including this document, the Annual Report on Form 10-K, the Quarterly Report on Form 10-Q and other required filings. Harleysville National Corporation assumes no duty to update the forward-looking statements made in this document.

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Critical Accounting Estimates

The accounting and reporting policies of the Corporation and its subsidiaries conform with U.S. generally accepted accounting principles (GAAP). The Corporation’s significant accounting policies are described in Note 2 of the consolidated financial statements and are essential in understanding Management’s Discussion and Analysis of Financial Condition and Results of Operations. In applying accounting policies and preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities as of the dates of the balance sheets and the income and expense in the income statements for the periods presented. Therefore, actual results could differ significantly from those estimates. Judgments and assumptions required by management, which have, or could have a material impact on the Corporation’s financial condition or results of operations are considered critical accounting estimates. The following is a summary of the policies the Corporation recognizes as involving critical accounting estimates: Allowance for Loan Loss, Goodwill and Other Intangible Asset Impairment, Stock-Based Compensation, Fair Value Measurement of Investment Securities Available for Sale, inclusive of other-than-temporary impairment, and Deferred Taxes.

Allowance for Loan Losses: The Corporation maintains an allowance for loan losses at a level management believes is sufficient to absorb estimated probable credit losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires significant estimates by management. Consideration is given to a variety of factors in establishing these estimates including historical losses, current and anticipated economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers’ perceived financial and management strengths, the adequacy of underlying collateral, the dependence on collateral, or the strength of the present value of future cash flows and other relevant factors. These factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required which may adversely affect the Corporation’s results of operations in the future.

Goodwill and Other Intangible Asset Impairment: Goodwill and other intangible assets are reviewed for potential impairment on an annual basis, or more often if events or circumstances indicate that there may be impairment. Goodwill is tested for impairment at the reporting unit level and an impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The Corporation employs general industry practices in evaluating the fair value of its goodwill and other intangible assets. The Corporation calculates the fair value, with the assistance of a third party specialist, using a combination of the following valuation methods: dividend discount analysis under the income approach, which calculates the present value of all excess cash flows plus the present value of a terminal value and market multiples (pricing ratios) under the market approach. In 2009, management performed its annual review of goodwill and other identifiable intangibles. Management performed its review by reporting unit and identified goodwill impairment for the 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 announced sale price of the Corporation to First Niagara Financial Group for $5.50 per share. As the Corporation’s annual analysis is performed using March 31 balances, the subsequent stock price decline and a June 2009 communication of Individual Minimum Capital Ratio requirements from the Office of the Comptroller of the Currency resulted in a subsequent impairment evaluation. This analysis was superseded as the announced merger with First Niagara provided an actual fair value for the Corporation. No impairment was identified relating to the Corporation’s Wealth Management segment or other identifiable intangible assets as a part of this annual review. No assurance can be given that future impairment tests will not result in a charge to earnings.

-29-

Stock-based Compensation: The Corporation recognizes compensation expense for stock options over the requisite service period based on the grant-date fair value of those awards expected to ultimately vest. Forfeitures are estimated on the date of grant and revised if actual or expected forfeiture activity differs materially from original estimates. For grants subject to a service condition, the Corporation utilizes the Black-Scholes option-pricing model to estimate the fair value of each option on the date of grant. The Black-Scholes model takes into consideration the exercise price and expected life of the options, the current price of the underlying stock and its expected volatility, the expected dividends on the stock and the current risk-free interest rate for the expected life of the option. For grants subject to a market condition, the Corporation utilizes a Monte Carlo simulation to estimate the fair value and determine the derived service period. Compensation is recognized over the derived service period with any unrecognized compensation cost immediately recognized when the market condition is met. The Corporation’s estimate of the fair value of a stock option is based on expectations derived from historical experience and may not necessarily equate to its market value when fully vested.

Fair 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.

Deferred Taxes: The Corporation recognizes deferred tax assets and liabilities for the future effects of temporary differences, net operating loss carryforwards, and tax credits. Deferred tax assets are subject to management’s judgment based upon available evidence that future realizations are likely. If management determines that the Corporation may not be able to realize some or all of the net deferred tax asset in the future, a charge to income tax expense may be required to reduce the value of the net deferred tax asset to the expected realizable value. The Corporation evaluated its deferred tax asset balance at December 31, 2009 for realizability. Management’s process included the analysis of prior carryback years and the evaluation of future income projections. Based upon this analysis, management believes that the deferred tax asset balance at December 31, 2009 is fully realizable.

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.

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Financial Overview

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.

The 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.

During December 2009, First Niagara entered into a loan transaction with the Corporation to recapitalize the Bank. As of December 31, 2009, the Corporation borrowed the full $50.0 million available under the credit facility from First Niagara which was contributed to the Bank as Tier 1 capital, allowing it to meet the general regulatory capital ratios of a “well capitalized” bank for the first time since September 2008. The Corporation’s regulatory capital ratios as of December 31, 2009 included total risk-based capital of 10.64%, Tier 1 risk-based capital of 9.38% and a Tier 1 leverage capital of 6.33%. The general regulatory minimums for well capitalized designation are 10% for total risk-based capital, 6% for Tier 1 risk-based capital and 5% for a Tier 1 leverage capital. In connection with the capital infusion, the Office of the Comptroller of the Currency extended the deadline for compliance with higher “individual minimum capital ratios” (IMCR) from June 30, 2009 to March 31, 2010, subject to continued compliance with “well capitalized” ratios achieved upon receipt of the First Niagara loan proceeds. Effective March 4, 2010, this deadline was further extended to May 31, 2010, subject to the same conditions.

The following is an overview of the key financial highlights for 2009:

Total assets were $5.2 billion at December 31, 2009, a decrease of $302.7 million, or 5.5%, over $5.5 billion in total assets reported at December 31, 2008. Loans were $3.0 billion, a decrease of $712.6 million or 19.4% from $3.7 billion at December 31, 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 a net loss of $1.8 million. Total deposits were $3.9 billion at both December 31, 2009 and 2008.

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.

Net interest income on a tax-equivalent basis increased $26.5 million, or 23.8%, for the year ending December 31, 2009, over the prior year. The net interest margin for 2009 decreased to 2.78% compared to 3.04% for 2008. The net interest margin decreased as a 102 basis point decrease in the yield on average earning assets of $5.0 billion was offset by a 87 basis point decrease in the cost of interest bearing liabilities of $4.4 billion.

Nonperforming assets increased $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.

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

Noninterest income increased $17.4 million or 37.7% during 2009. Gains from mortgage banking loan sales increased $8.5 million and service charges on deposits increased $3.8 million over 2008 mainly due to the Willow Financial acquisition. Net gains on sales of investment securities increased $8.8 million as compared to 2008. Other income increased $4.1 million during 2009 driven by increases in ATM and point of sale fee income and a $1.7 million gain recorded in the first quarter of 2009 on the sale of the Bank’s merchant credit card business. These increases were partially offset by an increase in other-than-temporary impairment charges on available for sale securities of $7.5 million from 2008.

Noninterest 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.

Pending Merger 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 ratio 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 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 Merger Agreement. 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. See Note 9 – Goodwill and Other intangibles for further information.

The Boards of 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.

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.

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Dispositions/Acquisitions

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.

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.

On December 27, 2007, the Bank settled and closed an agreement to sell fifteen properties to affiliates of American Realty Capital, LLC (“ARC”) in a sale-leaseback transaction. The properties are located throughout Berks, 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. 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.

Effective November 16, 2007, the Corporation completed its acquisition of East Penn Financial Corporation and its wholly owned subsidiary, East Penn Bank (collectively, “East Penn Financial”). 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. 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

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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.

For a five-year summary of financial information, see Item 6, “Selected Financial Data,” which is incorporated herein by reference.

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.

Investment Securities

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 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.

Investment securities and other investments decreased 10.0% to $1.1 billion at December 31, 2009 from $1.2 billion at December 31, 2008. The investment securities available for sale decreased $103.8 million and the investment securities held to maturity decreased $25.1 million. The majority of the decrease in available for sale securities is due to the sales of mortgage-backed securities and maturities of certain securities. During 2009, securities available for sale totaling $470.8 million were sold which generated a pre-tax gain of $11.2 million. Other-than-temporary impairment charges totaling $9.4 million were recognized during 2009 primarily related to collateralized debt obligation investments in pooled trust preferred securities, private label collateralized mortgage obligations and several equity securities.

The increase in available for sale securities at December 31, 2008 compared to December 31, 2007 of $231.6 million was mainly due to the securities acquired from 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.

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

Table 1—Investment 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

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The maturity analysis of investment securities including the weighted average yield for each category as of 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.

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

	December 31, 2009
	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	%

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

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Loans

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.

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

	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	%

The following table details outstanding loans by type as of December 31, 2009, in terms of contractual maturity date:

Table 4—Selected Loan Maturity Data

	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

The Bank had no concentration of loans to individual borrowers which exceeded 10% of total loans at December 31, 2009 and 2008. The Bank actively monitors the risk of loan concentration.

Nonperforming Assets

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

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Nonperforming assets (including 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.

Non-accruing loans increased $54.8 million to $129.9 million at December 31, 2009, as compared to $75.1 million at December 31, 2008. The higher 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 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 suburban counties of Philadelphia 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 from approximately 1.36% of outstanding loans at December 31, 2008, to 2.23% at December 31, 2009. The Bank continues to evaluate appraisals, financial reviews and inspections. 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.

Non-accruing loans increased $54.0 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.

The Bank’s policy for interest income recognition on nonaccrual loans is to recognize income under the cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Bank. The Bank will not recognize income if these factors do not exist. During 2009, interest accrued on non-accruing loans and not recognized as interest income was $6.2 million and interest paid on non-accruing loans of $817,000 was recognized as interest income. During 2008, interest accrued on nonaccruing loans and not recognized as interest income was $1.9 million and interest paid on nonaccruing loans of $299,000 was recognized as interest income. During 2007, interest accrued on nonaccruing loans and not recognized as interest income was $982,000 and interest paid on nonaccruing loans of $331,000 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, 2009 loans past due 90 days or more and still accruing interest were $1.4 million, compared to $1.8 million at December 31, 2008 and $857,000 at December 31, 2007. The lower level of loans past due 90 days or more at December 31, 2009 from December 31, 2008 is largely attributable to a decrease in home equity lines of credit. The higher level of loans past due 90 days or more at December 31, 2008 from December 31, 2007 was primarily in the home equity revolving lines and residential first mortgage loans.

Net assets in foreclosure at December 31, 2009 were $2.3 million compared to $1.6 million at December 31, 2008 and $28,000 at December 31, 2007. During 2009, transfers from loans to assets in foreclosure were $2.6 million, disposals of foreclosed properties were $1.7 million, and charge-offs of $260 thousand were recorded. Efforts to liquidate assets acquired in foreclosure proceed as quickly as potential buyers can be located and legal constraints permit. Foreclosed assets are carried at the lower of cost (lesser of carrying value of the asset or fair value at date of acquisition) or estimated fair value.

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

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Table 5—Nonperforming Assets

	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	%

Local real estate secures many of the nonperforming loans.

Allowance for Loan Losses

The Corporation uses the reserve method of accounting for loan losses. The balance in the allowance for loan losses is determined based on management’s review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions, and other pertinent factors, including management’s assumptions as to future delinquencies, recoveries and losses. Increases to the allowance for loan losses are made by charges to the provision for loan losses. Credit exposures deemed to be uncollectible are charged against the allowance for loan losses. Recoveries of previously charged-off amounts are credited to the allowance for loan losses.

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

The Corporation performs periodic evaluations of the allowance for loan losses that include both historical, internal and external factors. The actual allocation of reserve is a function of the application of these factors to arrive at a reserve for each portfolio type and an additional component of the reserve allocated against the portfolio as a whole. Management assigns historical factors and environmental factors to homogeneous groups of loans that are grouped by loan type and credit rating. Changes in concentrations and quality are captured in the analytical metrics used in the calculation of the reserve. The components of the allowance for credit losses consist of both historical losses and estimates. Management bases its recognition and estimation of each allowance component on certain observable data that it believes is the most reflective of the underlying loan losses being estimated. The observable data and accompanying analysis is directionally consistent, based upon trends, with the resulting component amount for the allowance for loan losses. The Corporation’s allowance for loan losses components 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.

The historical loss components of the allowance represent the results of analyses of historical charge-offs and recoveries within pools of homogeneous loans, within each risk rating and broken down further by segment,

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within the portfolio. Criticized assets are further assessed based on trends, relative to migrations in delinquency, risk rating and nonaccrual status, by credit product (collectively expressed as the product level environmental factor).

The historical loss components of the allowance for commercial and industrial loans and commercial real estate loans (collectively “commercial loans”) are based principally on current risk ratings 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 industry concentration component is recognized as a possible factor in the estimation of loan losses. Two industries represent possible concentrations: commercial real estate and consumer loans relying on residential home equity. No specific loss-related observable data is recognized by management currently, therefore no specific factor is calculated in the reserve solely for the impact of these concentrations, although management continues to carefully consider relevant data for possible future sources of observable data.

The historic loss model includes two judgmental components (product level and portfolio level environmental factors) that reflect management’s belief that there are additional inherent credit losses based on loss attributes not adequately captured in the lagging indicators. The judgmental components are allocated to the specific segments of the portfolio based on the historic loss component of each segment under review as well as an additional assessment applied to the at the portfolio level.

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.

The provision for loan losses increased $42.8 million to $58.3 million during 2009 compared to 2008 mostly as a result of a decrease in the overall quality of the loan portfolio which caused an increase in the amount of the required reserve. Credit quality continued to be a challenge in the Bank’s commercial real estate, commercial and industrial and home equity portfolio in the fourth quarter of 2009. Nonperforming assets as a percentage of total assets were 2.58% at December 31, 2009, compared to 1.43% at December 31, 2008. Net loans charged-off increased $35.8 million for 2009 compared to 2008 principally due to charge-offs of several unrelated commercial real estate and commercial and industrial borrowers and increased charge-offs of consumer loans, specifically home equity lines of credit and loans and other direct installment loans. The profile of the Bank’s customer base has remained relatively constant and management believes that the current deterioration in credit quality has been caused by the economic pressures being felt by borrowers due to general economic conditions

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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 in 2008 compared to 2007 primarily as a result of a decrease in the quality of the loan portfolio which caused an increase in the amount of the required reserve. Net loans charged-off decreased $1.8 million during 2008 compared to 2007 principally due to prior-year charge-offs for real estate construction loans for one borrower combined with an increase in recoveries both related to commercial and industrial loans and real estate loans.

The allowance 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.

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

Table 6—Allowance for Loan Losses

	December 31,
	2009			2008			2007			2006			2005
	(Dollars in thousands)
Average loans	$	3,411,383		$	2,585,101		$	2,123,170		$	2,014,420		$	1,900,023
Allowance, beginning of year	$	49,955		$	27,328		$	21,154		$	19,865		$	18,455
Loans charged off:
Real estate		30,259			3,770			4,847			1,047			383
Commercial and industrial		9,178			1,079			1,551			1,141			353
Consumer		3,493			1,964			1,693			1,481			2,123
Lease financing		168			16			51			42			188
Total loans charged off		43,098			6,829			8,142			3,711			3,047
Recoveries:
Real estate		552			389			72			138			326
Commercial and industrial		374			240			142			55			66
Consumer		515			329			283			519			586
Lease financing		1			6			19			88			78
Total recoveries		1,442			964			516			800			1,056
Net loans charged off		41,656			5,865			7,626			2,911			1,991
Reserve from acquisitions		—			12,925			3,250			—			—
Provision for loan losses		58,321			15,567			10,550			4,200			3,401
Allowance, end of year	$	66,620		$	49,955		$	27,328		$	21,154		$	19,865
Ratio of net charge offs to average loans outstanding		1.22	%		0.23	%		0.36	%		0.14	%		0.10	%

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

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Table 7—Allocation of the Allowance for Loan Losses by Loan Type

	December 31,
	2009					2008				2007					2006				2005
	Amount		Percent of Allowance			Amount		Percent of Allowance		Amount		Percent of Allowance			Amount		Percent of Allowance		Amount		Percent of Allowance
	(Dollars in thousands)
Real estate	$	29,283		44	%	$	22,051	44	%	$	10,491		38	%	$	7,918	38	%	$	6,422		32	%
Commercial and industrial		29,659		44	%		20,898	42	%		12,340		45	%		9,119	43	%		8,534		43	%
Consumer		7,677		12	%		6,996	14	%		4,485		17	%		4,041	19	%		4,596		23	%
Lease financing		1		−	%		10	−	%		12		−	%		76	−	%		313		2	%
Total	$	66,620		100	%	$	49,955	100	%	$	27,328		100	%	$	21,154	100	%	$	19,865		100	%

The factors affecting the allocation of the allowance during 2009 were decreases in credit quality primarily related to real estate loans and commercial and industrial loans. The allocation of the allowance for real estate loans at December 31, 2009 increased $7.2 million as compared to December 31, 2008 principally due to an increase in criticized real estate loans, a decline in collateral values related to these loans and an increase in the loss ratio used to calculate the reserve for commercial mortgage and commercial construction loans. The allocation of the allowance for commercial and industrial loans at December 31, 2009 increased $8.8 million from December 31, 2008 mostly due to a decrease in credit quality and an increase in impairment related to commercial and industrial loans. In addition, the allocation of the allowance for consumer loans at December 31, 2009 increased slightly by $881,000 primarily due to adjustments in the loss ratios as well as some increases in criticized consumer loans. There were no material changes in the allocation of the allowance for lease financing at December 31, 2009 compared to December 31, 2008. Management enhanced its allowance methodology in 2009 to place a heavier emphasis on more recent charge-off history, and has implemented more comprehensive economic analysis attributable to the portfolio level environmental factors. Minor adjustments have been made to account for additional segmentations of the portfolio (e.g., first and second lien positions on home equity products, loans with interest reserves, and troubled debt restructures). It is expected that the negative trends will continue to affect credit quality in 2010.

The factors affecting the allocation of the allowance during 2008 were changes in credit quality resulting from increases in criticized real estate construction loans and increases in loan volume from the Willow Financial acquisition. The allocation of the allowance for real estate loans at December 31, 2008 increased $11.6 million as compared to December 31, 2007 principally due to an increase in criticized real estate construction loans including loans to two borrowing relationships totaling $34.9 million. Both relationships were syndicated credits for local borrowers that were negatively affected by the decline in area home sales. The allocation of the allowance for commercial and industrial loans at December 31, 2008 increased $8.6 million from December 31, 2007 mostly due to an increase in commercial loan volume from the Willow Financial acquisition. In addition, the allocation of the allowance for consumer loans at December 31, 2008 increased $2.5 million primarily due to the increased level of consumer loans related to the Willow Financial acquisition.

Investment in Bank

The Corporation acquired an investment in Berkshire Bancorp, the holding company of Berkshire Bank, through the East Penn Financial acquisition. As of December 31, 2009, 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 and Borrowings

Deposits and borrowings are the primary funding sources of the Corporation. Core deposits increased 1.9%, or $45.7 million, to $2.4 billion at December 31, 2009, up from $2.3 billion at December 31, 2008. Total deposits

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totaled $3.9 billion at December 31, 2009, an increase of $6.4 million from December 31, 2008. Core deposits increased 31.8%, or $567.1 million at December 31, 2008 compared to December 31, 2007 due to $685.4 million acquired from Willow Financial at December 5, 2008 and an organic decrease of approximately $118.3 million. Total deposits increased $953.4 million, or 31.9% during 2008 primarily from deposits associated with the acquisition of Willow Financial of $946.7 million.

Deposit Structure

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

Table 8—Average Deposits

	December 31,
	2009					2008					2007
	Amount		Rate			Amount		Rate			Amount		Rate
	(Dollars in thousands)
Demand—noninterest-bearing	$	497,159		—	%	$	345,717		—	%	$	312,011		—	%
Demand—interest-bearing		604,535		0.92	%		431,138		1.55	%		517,520		3.52	%
Money market and savings		1,301,586		1.11	%		978,803		1.89	%		864,062		3.45	%
Time deposits		1,618,014		3.21	%		1,248,412		4.31	%		863,953		4.78	%
Total interest-bearing deposits	$	3,524,135		2.04	%	$	2,658,353		2.97	%	$	2,245,535		3.98	%
Total deposits	$	4,021,294				$	3,004,070				$	2,557,546

The maturity distribution of certificates of deposit of $100,000 and over as of December 31, 2009 is as follows:

Table 9—Maturity Distribution of Certificates of Deposit $100,000 and Over

	(Dollars in thousands)
Three months or less	$	154,399
Over three months to six months		88,183
Over six months to twelve months		148,423
Over twelve months		87,280
Total	$	478,285

Borrowings

Borrowings decreased $93.9 million to $896.6 million at December 31, 2009 from $990.5 million at December 31, 2008. The Corporation decreased long term debt with the Federal Home Loan Bank by $61.6 million due to maturities as increased cash levels reduced the Bank’s reliance on borrowings. Long-term securities sold under agreement to repurchase decreased by $15.0 million due to maturities during 2009. Fed funds purchased and short-term securities sold under repurchase agreements decreased by $64.6 million primarily due to maturities during 2009. During December 2009, First Niagara entered into a loan transaction with the Corporation to recapitalize the Bank. As of December 31, 2009, the Corporation borrowed the full $50.0 million available under the credit facility from First Niagara which was contributed to the Bank as Tier 1 capital. The loan is secured by a pledge of all of the stock of the Bank, and is payable by the Corporation 30 to 90 days after the merger agreement between the Corporation and First Niagara is terminated, depending on the reason for the termination. The interest rate charged on the loan is 5.25% per annum.

Borrowings increased $482.2 million to $990.5 million at December 31, 2008 from $508.3 million at December 31, 2007. The Corporation increased long term debt with the Federal Home Loan Bank by $305.9 million due to $362.6 million in advances from the Willow Financial acquisition offset by paydowns during 2008. Long-term securities sold under agreement to repurchase increased by $132.0 million due to $82.0 million

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assumed in the Willow Financial acquisition and $50.0 million in new borrowings during 2008. Subordinated debt increased $10.8 million at December 31, 2008 as compared to December 31, 2007 due to the acquisition of $10.7 million of subordinated debt from Willow Financial. Fed funds purchased and short-term securities sold under repurchase agreements increased by $34.6 million primarily due to the Willow Financial acquisition.

The Bank, pursuant to a designated cash management agreement, utilizes securities sold under agreements to repurchase as vehicles for customers’ sweep and term investment products. Securitization under these cash management agreements are in U.S. Government agency securities and obligations of states and political subdivisions securities. Securities sold under agreements to repurchase are generally overnight transactions. These securities are held in a third-party custodian’s account, designated by the Bank under a written custodial agreement that explicitly recognizes the Bank’s interest in the securities.

Table 10—Securities Sold under Agreements to Repurchase

	At or for the year ended December31,
Securities sold under agreements to repurchase(1):	2009			2008			2007
	(Dollars in thousands)
Balance at year-end	$	71,471		$	103,813		$	101,493
Weighted average rate at year-end		0.50	%		0.42	%		3.60	%
Maximum month-end balance	$	93,186		$	97,526		$	105,205
Average balance during the year	$	111,356		$	109,092		$	121,392
Weighted average rate during the year		0.50	%		1.55	%		4.46	%

(1)	Excludes long-term securities sold under agreements to repurchase with private entities of $218.9 million and $237.0 million at December 31, 2009 and 2008, respectively.

Results of Operations

Net income is affected by five major elements: (1) net interest income, or the difference between interest income earned on loans and investments and interest expense paid on deposits and borrowed funds; (2) the provision for loan losses, or the amount added to the allowance for loan losses to provide reserves for inherent losses on loans; (3) noninterest income, which is made up primarily of certain fees, wealth management income and gains and losses from sales of securities or other transactions; (4) noninterest expense, which consists primarily of salaries, employee benefits and other operating expenses; and (5) income taxes. Each of these major elements is reviewed in more detail in the following discussion.

Net Interest Income

Net interest income 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.

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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 11—Analysis of Changes in Net Interest Income—Fully Taxable-Equivalent Basis

	2009 compared to 2008								2008 compared to 2007
	Net			Due to Change in					Net			Due to change in
	Change			Volume		Rate			Change			Volume			Rate
Increase (decrease) in interest income:
Investment securities(1)	$	1,188		$	5,469	$	(4,281	)	$	6,653		$	5,027		$	1,626
Federal funds sold, securities purchased under agreements to resell and deposits in banks		(70	)		1,681		(1,751	)		(2,479	)		(931	)		(1,548	)
Loans(1)(2)		24,193			45,085		(20,892	)		9,047			29,406			(20,359	)
Total		25,311			52,235		(26,924	)		13,221			33,502			(20,281	)
Increase (decrease) in interest expense:
Savings and money market deposits		(5,104	)		7,150		(12,254	)		(22,840	)		965			(23,805	)
Time deposits		(1,785	)		13,792		(15,577	)		12,462			16,859			(4,397	)
Borrowed funds		5,673			10,896		(5,223	)		405			4,985			(4,580	)
Total		(1,216	)		31,838		(33,054	)		(9,973	)		22,809			(32,782	)
Net increase (decrease) in net interest income	$	26,527		$	20,397	$	6,130		$	23,194		$	10,693		$	12,501

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

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

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

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

	Year Ended December 31,
	2009					2008					2007
	Average Balance	Interest	Rate			Average Balance	Interest	Rate			Average Balance	Interest	Rate
	(Dollars in thousands)
Assets
Earning Assets:
Investment securities:
Taxable investments	$ 842,534	$39,254		4.66	%	$ 738,640	$ 39,195		5.31	%	$ 681,788	$ 34,803		5.10	%
Nontaxable investments(1)	296,725	19,239		6.48		298,472	18,110		6.07		262,676	15,849		6.03
Total investment securities	1,139,259	58,493		5.13		1,037,112	57,305		5.53		944,464	50,652		5.36
Federal funds sold, securities purchased under agreements to resell and deposits in banks	417,011	1,027		0.25		48,474	1,097		2.26		72,087	3,576		4.96
Loans(1)(2)	3,411,383	179,640		5.27		2,585,101	155,447		6.01		2,123,170	146,400		6.90
Total earning assets	4,967,653	239,160		4.81		3,670,687	213,849		5.83		3,139,721	200,628		6.39
Noninterest-earning assets	413,817					327,285					231,583
Total assets	$5,381,470					$3,997,972					$3,371,304
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Interest-bearing deposits:
Savings and money market	$1,906,121	20,036		1.05	%	$1,409,941	25,140		1.78	%	$1,381,582	47,980		3.47	%
Time	1,618,014	51,986		3.21		1,248,412	53,771		4.31		863,953	41,309		4.78
Total interest-bearing deposits	3,524,135	72,022		2.04		2,658,353	78,911		2.97		2,245,535	89,289		3.98
Borrowed funds	906,172	28,916		3.19		586,088	23,243		3.97		471,296	22,838		4.85
Total interest-bearing liabilities	4,430,307	100,938		2.28		3,244,441	102,154		3.15		2,716,831	112,127		4.13
Noninterest-bearing liabilities:
Demand deposits	497,159					345,717					312,011
Other liabilities	85,042					71,160					44,069
Total noninterest-bearing liabilities	582,201					416,877					356,080
Total liabilities	5,012,508					3,661,318					3,072,911
Shareholders’ equity	368,962					336,654					298,393
Total liabilities and shareholders’ equity	$5,381,470					$3,997,972					$3,371,304
Net interest spread				2.53					2.68					2.26
Effect of noninterest-bearing sources				0.25					0.36					0.56
Net interest income/margin on earning assets		$138,222		2.78	%		$111,695		3.04	%		$ 88,501		2.82	%
Less tax equivalent adjustment		8,349					7,555					6,067
Net interest income		$129,873					$104,140					$ 82,434

(1)	The interest earned on nontaxable investment securities and loans is shown on a tax-equivalent basis, net of deductions (tax rate of 35%).

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

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

Net interest income on a tax-equivalent basis increased $26.5 million, or 23.8%, for the year ending December 31, 2009 over the same period in 2008 mainly due to the Willow Financial acquisition. Net interest income on a tax equivalent basis in 2008 increased $23.2 million, or 26.2%, in comparison to 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.

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Interest income on a tax equivalent basis in 2009 increased $25.3 million, or 11.8% over 2008. This increase was primarily due to higher average loans of $826.3 million and higher average investment securities of $102.1 million which was partially offset by a 102 basis points reduction in the average rate earned on loans and a 40 basis point reduction in the average rate earned on investments. The growth in average loans of 32.0% over last year was mainly as a result of the Willow Financial acquisition.

Interest income on a tax-equivalent basis for 2008 increased $13.2 million as average loans receivable grew $461.9 million or 21.8% and average investment securities increased $92.6 million or 9.8%. The increases in average balances of loans receivable and investment securities attributed $34.4 million to the increase in interest income in 2008. The rates earned on average loan receivables as well as federal funds sold and deposits in banks decreased 89 basis points and 270 basis points, respectively. These changes in rates decreased interest income $21.9 million during 2008.

Interest expense decreased $1.2 million, or 1.2% during 2009 versus 2008. A 97 basis point reduction in the average rate paid on interest-bearing liabilities was offset by a $1.2 billion increase in average interest-bearing liabilities mostly as a result of the Willow Financial acquisition.

Interest expense decreased $10.0 million for 2008 as average interest-bearing deposits and average borrowed funds increased $412.8 million and $114.8 million, or 18.4% and 24.4%, respectively. The increases in these average balances attributed $22.8 million in an increase to interest expense. Offsetting this was a decrease in the cost of average interest-bearing deposits and borrowed funds of 101 and 88 basis points, respectively. These changes in rates decreased interest expense $32.8 million during 2008.

Net Interest Margin

The 2009 net interest margin of 2.78% was lower than the net interest margins for 2008 and 2007 of 3.04% and 2.82%, respectively. The decrease in the net interest margin during 2009 was mainly attributable to decreases in yields on interest-earning assets mainly reflected in the lower yielding cash balances being maintained for liquidity purposes, which outpaced declines in the customer deposit costs. The increase in the net interest margin during 2008 and compared to 2007 was primarily due to decreases in yields on interest-bearing liabilities which outpaced declines in the yield on loans.

Interest Rate Sensitivity Analysis

In the normal course of conducting business activities, the Corporation is exposed to market risk, principally interest rate risk through the operations of its banking subsidiary. Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and value of financial instruments.

The Corporation actively manages its interest rate sensitivity positions. The objectives of interest rate risk management are to control exposure of net interest income to risks associated with interest rate movements and to achieve consistent growth in net interest income. The Asset/Liability Committee, using policies and procedures approved by the Corporation’s Board of Directors, is responsible for managing the rate sensitivity position. The Corporation manages interest rate sensitivity by changing the mix and repricing characteristics of its assets and liabilities through the management of its investment securities portfolio, its offering of loan and deposit terms and through wholesale borrowings from several providers, but primarily the Federal Home Loan Bank (FHLB). The nature of the Corporation’s current operations is such that it is not subject to foreign currency exchange or commodity price risk.

The Corporation only utilizes derivative instruments for asset/liability management. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations and payments are based. The notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Interest rate swaps are contracts in which a series of interest-rate flows (fixed and floating) are exchanged over a prescribed period. The notional amounts on which the interest payments are based are not exchanged. Interest rate caps are purchased contracts that limit the exposure from the repricing of liabilities in a rising rate environment.

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The Bank is exposed to changes in the fair value of certain of its fixed rate assets due to changes in benchmark interest rates. The Bank uses interest rate swaps to manage its exposure to changes in fair value on these instruments attributable to changes in the benchmark interest rate. Interest rate swaps designated as fair value hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Bank making fixed-rate payments over the life of the agreements without the exchange of the underlying notional amount. As of December 31, 2009, the Bank had a fair value hedge in the form of an interest rate swap with a notional amount of $1.8 million which matures in 2017. In addition, four fair value hedges with current notional amounts totaling $7.0 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 operations. As such, based on the increase in the market value of these interest rate swaps, the Corporation recognized a gain of $349,000 in other income in the consolidated statement of operations for 2009. The Corporation also recognized a reduction of interest income of $294,000 for 2009.

For derivatives designated and that qualify as fair value hedges, during 2009 and 2008, the Bank recognized a reduction of interest income of $93,000 and $81,000, respectively, on the consolidated statements of operations.

Derivatives not designated as hedges are not speculative and result from a service the Bank provides to certain customers. The Bank executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Bank executes with a third party, such that the Bank minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of December 31, 2009, the Bank had 48 interest rate swaps with an aggregate current notional amount of $199.2 million related to this program with maturity dates ranging from 2010 to 2018. For these derivatives, during 2009 and 2008, the Bank recognized a loss of $12,000 and $18,000, respectively in other income on the consolidated statements of operations.

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

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

As of December 31, 2009, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $3.9 million. As of December 31, 2009, the Bank has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of $4.1 million against its obligations under these agreements.

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The Corporation uses three principal reports to measure interest rate risk: (1) asset/liability simulation reports; (2) gap analysis reports; and (3) net interest margin reports. The Corporation’s interest rate sensitivity, as measured by the repricing of its interest sensitive assets and liabilities at December 31, 2009, is presented in the following table. The data in the table was based in part on assumptions that are regularly reviewed for accuracy. The table presents data at a single point in time and includes management assumptions estimating the prepayment rate and the interest rate environment prevailing at December 31, 2009. The table indicates an asset sensitive one-year cumulative gap position of 16.94% of total earning assets.

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Table 13—Contractual Repricing Data of Interest Sensitive Assets and Liabilities

	December 31, 2009
	0 to 90 days			91 to 365 days				After 1 year through 5 years			Over 5 years			Total
	(Dollars in thousands)
Earning assets
Investment securities	$	94,942			$	60,245		$	261,606		$	691,151		$	1,108,124
Deposits in banks		787,722				—			—			—			787,722
Loans		1,042,377				319,976			1,023,982			607,043			2,993,378
Total earning assets	$	1,925,041			$	380,401		$	1,285,588		$	1,298,194		$	4,889,224
Interest-bearing liabilities
Interest-bearing checking accounts	$	20,918			$	58,887		$	463,946		$	121,288		$	665,039
Money market funds		27,912				78,579			374,179			406,753			887,423
Savings accounts		10,043				28,272			153,809			127,169			319,293
Time deposits		403,566				786,173			357,024			2,854			1,549,617
Borrowed funds		115,549				109,694			525,360			145,974			896,577
Total interest-bearing liabilities	$	577,988			$	1,061,605		$	1,874,318		$	804,038		$	4,317,949
Interest rate swaps	$	207,820			$	(45,200	)	$	(127,617	)	$	(35,003	)	$	—
Incremental gap	$	1,554,873			$	(726,404	)	$	(716,347	)	$	459,153
Cumulative gap(1)	$	1,554,873			$	828,469		$	112,122		$	571,275
Cumulative gap as a percentage of earning assets		31.80	%			16.94	%		2.29	%		11.68	%

(1)

The information is based upon significant assumptions, including the following: loans and leases are repaid by contractual maturity and repricing; securities are repaid according to contractual maturity adjusted for call features; interest-bearing demand, regular savings, and money market savings deposits are estimated to exhibit some rate sensitivity; and time deposits are shown in the table based on contractual maturity.

Management also simulates possible economic conditions and interest rate scenarios in order to quantify the impact on net interest income. The effect that changing interest rates have on the Corporation’s net interest income is simulated by increasing and decreasing interest rates. This simulation is known as rate shocking.

The results of the December 31, 2009 net interest income rate shock simulations show that the Corporation is within guidelines set by the Corporation's Asset/Liability Policy. The Corporation constantly monitors this position and takes steps to minimize any reduction in net interest income.

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The following table forecasts changes in the Corporation’s market value of equity under alternative interest rate environments as of December 31, 2009. The market value of equity is defined as the net present value of the Corporation’s existing assets and liabilities. The Corporation is within guidelines set by the Corporation’s Asset/Liability Policy for the percentage change in the market value of equity when modeled rates increase 100 basis points or decrease 100, 200 and 300 basis points. When modeled rates increase 200 and 300 basis points, the Corporation is not within guidelines mainly due to the non-cash goodwill impairment write-off of $214.5 million, resulting from the decrease in market value related to the First Niagara merger agreement previously discussed.

Table 14—Market Value of Equity

	December 31, 2009
	Market Value of Equity		Change in Market Value of Equity		Percentage Change		Asset/Liability Approved Percent Change
	(Dollars in thousands)
+300 Basis Points	$	113,575	$(96,547	)	−45.95	%	+/−35	%
+200 Basis Points		149,838	(60,284	)	−28.69		+/−25
+100 Basis Points		182,934	(27,187	)	−12.94		+/−15
Flat Rate		210,122	—		0.00		—
−100 Basis Points		240,889	30,768		14.64		+/−15
−200 Basis Points		231,586	21,465		10.22		+/−25
−300 Basis Points		210,594	473		0.23		+/−35

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

Provision for Loan Losses

The provision for loan losses increased $42.8 million during 2009 compared to 2008 mostly as a result of a decrease in the credit quality of the loan portfolio which caused an increase in the amount of the required reserve. The provision for loan losses increased $5.0 million during 2008 compared to 2007 mostly as a result of decreased quality of the loan portfolio. Total net loans charged off in 2009, 2008 and 2007 were $41.7 million, $5.9 million and $7.6 million, respectively.

Noninterest Income

Noninterest income for 2009 was $63.7 million, an increase of $17.4 million or 37.7% from $46.2 million in 2008. Net gains on the sale of investment securities increased by $8.8 million over 2008, mostly the result of the sale of mortgage-backed securities. Service charges on deposits increased $3.8 million, or 27.9% during 2009 as compared to 2008 from the acquired Willow Financial deposit accounts in December 2008. In addition, as a result of the Willow Financial acquisition, gains from mortgage banking loan sales were $9.0 million during 2009, an increase of $8.5 million over 2008. Other income increased $4.1 million during 2009 over the prior year primarily from increases in automated teller machine and point of sale revenue and an increase in the cash surrender value of keyman life insurance. Other income also included a $1.7 million gain recorded in the first quarter of 2009 on the sale of the Bank’s merchant credit card business. These increases were partially offset by non-cash OTTI charges of $9.4 million during 2009 on several collateralized debt obligation investments in pooled trust preferred securities, private label collateralized mortgage obligations and certain bank equity securities. OTTI charges were $1.9 million during 2008 as a result of a fourth quarter 2008 OTTI charges on a collateralized debt obligation investment in pooled trust preferred securities.

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For the year ended December 31, 2008, noninterest income was $46.2 million, an increase of $2.9 million, or 6.6%, from 2007. During the second half of 2007, the Bank revised its return check and overdraft charge process and in 2008, the Bank experienced an increase in service 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 $1.9 million to $10.0 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 a collateralized debt obligation investment in pooled trust preferred securities. In addition, noninterest income in 2007 included $2.8 million in gains on sale leaseback transactions.

Noninterest Expense

Noninterest expense was $367.7 million for 2009, an increase of $263.1 million from $104.6 million in 2008 primarily due to the previously aforementioned goodwill impairment charge of $214.5 million recorded in the second quarter of 2009 and a full year of additional expenses from Willow Financial which was acquired in December 2008. Salaries and benefits expense rose $15.0 million during 2009 primarily due to higher staffing levels resulting from the Willow Financial acquisition. Occupancy expenses increased $5.4 million in 2009 as compared to 2008, mainly due to the addition of the Willow Financial branches. Professional fees in 2009 included $5.3 million associated with recent corporate finance activities, including the pending merger with First Niagara. FDIC insurance assessments increased $11.4 million in 2009 mostly due to the Bank’s higher premium rate assessed by the FDIC and the FDIC’s one-time uniform special assessment of 5 basis points of assets minus Tier 1 capital applicable to all insured depositary institutions resulting in a $2.6 million one-time charge recorded during the second quarter of 2009. In addition, insurance premiums were higher as a result of the deposits from the Willow Financial acquisition. Other expense increased $11.2 million for 2009 over 2008 mostly due to the Willow Financial acquisition, including additional data processing expenses.

On November 12, 2009, the FDIC promulgated assessment regulations requiring insured depository institutions to prepay, on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. Although the prepayment of these assessments is mandatory for all insured depository institutions, the FDIC retains the discretion to exempt any institution from the prepayment requirement under certain circumstances as set forth in its regulations. In accordance with the discretion provided to the FDIC under its regulations, the Bank has been informed by the FDIC, that the FDIC is exempting the Bank from prepaying its quarterly risk-based assessments for the fourth quarter of 2009 and 2010, 2011 and 2012. The FDIC is also increasing its annual assessment rates uniformly by three-basis points beginning in 2011.

For the year ended December 31, 2008, noninterest expense was $104.6 million, an increase of $23.3 million, or 28.6%, as compared to 2007. Driving this increase was a full year of additional expenses from East Penn Financial which was acquired in November 2007. Salary and benefits expense increased $7.3 million in 2008 primarily due to the higher staffing levels from the East Penn Financial acquisition, one month of expenses for Willow Financial which was acquired in December 2008, normal salary increases and non-merger related severance costs. Occupancy expense increased $3.1 million in 2008 mainly due to increased rent expense on the bank properties included in the sale-leaseback transaction completed in the fourth quarter of 2007 as well as the addition of the East Penn Financial branches. Intangibles expense increased $3.0 million primarily due to a $1.4 million valuation adjustment on mortgage servicing rights recorded in the fourth quarter of 2008 and amortization of intangibles related to the East Penn Financial acquisition. Merger charges increased $2.6 million and were directly related to the December 2008 Willow Financial acquisition. Other increases for 2008 as compared to the prior year included FDIC insurance costs of $3.0 million, professional fees of $2.0 million and other expenses of $2.6 million.

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Income Taxes

The effective income tax rates for 2009, 2008 and 2007 were 5.6%, 16.8% and 21.5%, respectively, versus the applicable federal statutory rate of 35% and the applicable state tax rates. The Corporation’s effective rate in 2009 was lower than the statutory tax rate primarily as a result of the $214.5 million goodwill impairment charge, which is not deductible for income tax purposes, as well as tax-exempt income earned from state and municipal securities, loans and bank-owned life insurance. The effective tax rate for 2008 was lower than 2007 primarily due to a higher level of tax exempt income recognized during 2008. Tax exempt income increased by $2.9 million from 2007 to 2008 despite an overall decrease in taxable income for the same period.

Capital

Capital formation is important to the Corporation’s well being and future growth. Capital, at the end of 2009, was $261.6 million, a decrease of $213.1 million from the capital balance at the end of 2008 of $474.7 million. The reduction in capital was primarily due to a goodwill impairment charge of $214.5 million recorded in the second quarter of 2009. Also, contributing to the decrease in capital was cash dividends paid of $4.7 million during 2009 offset by an increase of $9.2 million in other comprehensive income. Capital, at December 31, 2008, was $474.7 million, an increase of $135.4 million over December 31, 2007. The increase was mainly due to the issuance of $160.8 million in common stock in connection with the acquisition of Willow Financial partially offset by the increase of $26.5 million in the accumulated other comprehensive loss related to investment securities available for sale.

On May 28, 2009, the Bank was advised that the OCC established higher minimum capital ratios for the Bank than the “well capitalized” ratios generally applicable to banks under current regulations. To be "well capitalized," banks generally must maintain a Tier 1 leverage ratio of at least 5%, a Tier 1 risk based capital ratio of at least 6% and a total risk-based capital ratio of at least 10%. In the case of the Bank, however, the OCC established higher “individual minimum capital ratios “ (IMCR) requiring a Tier 1 leverage ratio of at least eight percent (8%) of adjusted total assets, a Tier 1 risk-based capital ratio of at least ten percent (10%) and a total risk-based capital ratio of at least twelve percent (12%) which the Bank was required to achieve by June 30, 2009. The Corporation’s efforts to raise capital prior to the deadline ultimately resulted in the planned merger with First Niagara, which was announced on July 28, 2009. In addition, the Corporation elected to reduce and subsequently suspend its cash dividends on its common stock beginning with the third quarter of 2009 and to defer quarterly interest payments on its outstanding subordinated debentures until further notice, beginning with the interest payments that were due on September 15, 2009. These actions were taken to conserve capital.

During December 2009, First Niagara entered into a loan transaction to recapitalize the Bank. As of December 31, 2009, the Corporation borrowed the full $50.0 million available under the credit facility from First Niagara which was contributed to the Bank as Tier 1 capital, allowing it to meet the general regulatory capital ratios of a “well capitalized” bank for the first time since September 2008. The Corporation’s regulatory capital ratios as of December 31, 2009 included total risk-based capital of 10.64%, Tier 1 risk-based capital of 9.38% and a Tier 1 leverage capital of 6.33%. The Bank’s regulatory capital ratios as of December 31, 2009 included total risk-based capital of 11.65%, Tier 1 risk-based capital of 10.39% and a Tier 1 leverage capital of 7.01%. While these capital ratios are above the “well capitalized” requirements, they are below 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 March 31, 2010, subject to continued compliance with “well capitalized” ratios achieved upon receipt of the First Niagara loan proceeds. Effective March 4, 2010, this deadline was further extended to May 31, 2010, subject to the same conditions. First Niagara is also prepared to buy up to $80 million in commercial and commercial real estate loan participations from the Corporation and 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.

Management continues to analyze and evaluate the Corporation’s current capital position relative to the Corporation’s ongoing business operations, current economic conditions, the regulatory environment, including

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the higher minimum capital ratio requirements for the Bank established by the Office of the Comptroller of the Currency, and future capital requirements.

Pursuant to the federal regulators’ risk-based capital adequacy guidelines, the components of capital are called Tier 1 and Tier 2 capital. For the Corporation, Tier 1 capital is generally common stockholder’s equity and retained earnings adjusted to exclude disallowed goodwill and identifiable intangibles as well as the inclusion of qualifying trust preferred securities. Tier 2 capital for the Corporation is the allowance for loan losses. The risk-based capital ratios are computed by dividing the components of capital by risk-adjusted assets. Risk-adjusted assets are determined by assigning credit risk-weighting factors from 0% to 200% to various categories of assets and off-balance sheet financial instruments. The minimum for the Tier 1 capital ratio is 4.0%, and the total capital ratio (Tier 1 plus Tier 2 capital divided by risk-adjusted assets) minimum is 8.0%. Purchase accounting adjustments related to the acquisition of Willow Financial in December 2008 contributed to the reduction of the Corporation’s total risk-based capital ratio below the regulatory threshold for a “well capitalized” bank during the first three quarters of 2009 and at the end of 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. At December 31, 2009, the Corporation’s Tier 1 risk-adjusted capital ratio increased to 9.38% from 7.73% at December 31, 2008, and the total risk-adjusted capital ratio at December 31, 2009 increased to 10.64% from 8.88% at December 31, 2008. Both of these ratios are above regulatory “well capitalized” requirements at December 31, 2009; however, they are below the Bank’s IMCR requirements of 10.00% and 12.00%, respectively.

To supplement the risk-based capital adequacy guidelines, the Federal Reserve Board (FRB) established a leverage ratio guideline. The leverage ratio consists of Tier 1 capital divided by quarterly average total assets, excluding goodwill and identifiable intangibles. The minimum leverage ratio guideline is 3% for banking organizations that do not anticipate significant growth and that have well-diversified risk, excellent asset quality, high liquidity, good earnings and, in general, are considered top-rated, strong banking organizations. Other banking organizations are expected to have ratios of at least 4% or 5%, depending upon their particular condition and growth plans. Higher leverage ratios could be required by the particular circumstances or risk profile of a given banking organization. At December 31, 2009, the Corporation’s leverage ratio decreased to 6.33% from 8.19% at December 31, 2008. The leverage ratio at December 31, 2009 is above the regulatory “well capitalized” requirements but below the Bank’s IMCR requirement of 8.00%. The lower leverage ratio of the Corporation at December 31, 2009 was mainly due to an increase in average loans and average assets from the acquisition of Willow Financial in December 2008.

Under FDIC regulations, a “well capitalized” institution must have a leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 6% and a total risk-based capital ratio of at least 10% and not be subject to a capital directive order. To be considered “adequately capitalized” an institution must generally have a leverage ratio of at least 4%, a Tier 1 risk-based capital ratio of at least 4% and a total risk-based capital ratio of at least 8% and not be subject to a capital directive order. An institution is deemed to be “critically under capitalized” if it has a tangible equity ratio of 2% or less. As of December 31, 2009, the Bank is above the regulatory minimum guidelines and meets the criteria to be categorized as a “well capitalized” institution for the risk-based capital and leverage ratios. However, the December 31, 2009 capital ratios are below the Bank’s IMCR requirements.

After a detailed analysis of dividend yields by the Corporation, the cash dividend paid on its common shares in the first quarter of 2009 was reduced to $0.10 per share from $0.20 per share for each quarter in 2008. The Corporation further reduced the second quarter 2009 cash dividend to $.01 per share. On August 17, 2009, the Board of Directors of the Corporation elected to suspend payment of regular quarterly dividends on its common shares beginning with the dividend for the third quarter of 2009. These actions were taken to conserve capital in light of the impact of continued weak economic conditions. This resulted in a reduction of cash dividends of approximately $20.4 million for 2009 as compared to 2008. Activity in both the Corporation’s dividend reinvestment and stock purchase plan did not have a material impact on capital during 2009.

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Liquidity

Liquidity is a measure of the ability of the Corporation to meet its current cash needs and obligations on a timely basis. For a bank, liquidity provides the means to meet the day-to-day demands of deposit customers and the needs of borrowing customers. Generally, the Bank arranges its mix of cash, money market investments, investment securities and loans in order to match the volatility, seasonality, interest sensitivity and growth trends of its deposit funds. The Corporation’s decisions with regard to liquidity are based on the projections of potential sources and uses of funds for the next 120 days under the Corporation’s asset/liability model.

The resulting projections as of December 31, 2009, show the potential sources of funds exceeding the potential uses of funds. The accuracy of this prediction can be affected by limitations inherent in the model and by the occurrence of future events not anticipated when the projections were made. The Corporation has external sources of funds which can be drawn upon when funds are required. As of December 31, 2009, the Bank had borrowings outstanding with the FHLB of $448.6 million, all of which were long-term. At December 31, 2009, the Bank had a borrowing capacity of $65.0 million at the FHLB. In addition, the Corporation’s funding sources include investment and loan portfolio cash flows, cash balances of approximately $844.0 million and short-term investments, as well as repurchase agreements. The Corporation could also increase its liquidity through its pricing on certificates of deposit products. At December 31, 2009, the Corporation has pledged available for sale investment securities with a carrying value of $674.7 million and held to maturity securities of $12.7 million. Securities with a carrying value of $680.7 million were pledged to secure public funds, customer trust funds, government deposits and repurchase agreements as of December 31, 2009. During July 2009, the FHLB required the Corporation’s outstanding borrowings with the FHLB be fully collateralized. Any future borrowings with the FHLB are also required to be fully collateralized. Loans with a carrying value of $736.1 million and cash of $145.0 million were pledged as collateral for FHLB borrowings as of December 31, 2009.

The Corporation believes it has adequate funding sources to maintain sufficient liquidity given its current business conditions. Except as discussed herein, management believes that there are no known trends or any known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in liquidity increasing or decreasing in any material way. Despite the anticipated market volatility and rate environment for much of 2010, the Corporation expects to be able to retain most of these deposits. In the event that additional funds are required, the Corporation believes its short-term liquidity is adequate as outlined above.

Recent Developments

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

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

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years, the consent of the U.S. Treasury will be required for participating institutions to increase their common stock dividend or repurchase their common stock, other than in connection with benefit plans consistent with past practice. The minimum subscription amount available to a participating institution is one percent of total risk-weighted assets. The maximum subscription amount is three percent of risk-weighted assets.

In November 2008, the Corporation filed an application to participate in the CPP as part of the TARP. On April 28, 2009, after discussion with its regulators, the Corporation withdrew its application.

The EESA included a provision for a temporary increase in the Federal Deposit Insurance (FDIC) from $100,000 to $250,000 per depositor effective October 3, 2008 through December 31, 2009. On May 20, 2009, the $250,000 FDIC insurance limit was extended through December 31, 2013. In addition, the FDIC announced the Temporary Liquidity Guarantee Program effective October 14, 2008, enabling the FDIC to temporarily provide a 100% guarantee of newly issued senior unsecured debt of all FDIC-insured institutions and their holding companies issued before June 30, 2009, as well as deposits in non-interest bearing transaction deposit accounts through December 31, 2009. Coverage under the Temporary Liquidity Guarantee Program was available for 30 days without charge and thereafter at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for non-interest bearing transaction deposits. The Corporation determined it would continue to participate in the Temporary Liquidity Guarantee Program for non-interest bearing deposit accounts after the 30 day initial period but did not participate in the issuance of unsecured debt. On August 26, 2009, the FDIC adopted a final rule extending the FDIC’s guarantee of qualifying noninterest-bearing transaction accounts under the Transaction Account Guarantee program (TAG) for six months until June 30, 2010 in order to assure an orderly phase-out of the TAG. Each insured institution that continues to participate in the extended TAG program will be subject to increased fees ranging from 15 basis points to 25 basis points, depending on its risk category rating. The Corporation decided to continue to participate in the TAG program during the extension period. It is not clear at this time what impact these programs announced by the Treasury and other bank regulatory agencies and any additional programs that may be initiated in the future, will have on the Corporation or the financial markets as a whole.

Table 15—Contractual Obligations and Other Commitments

The following table sets forth contractual obligations and other commitments representing required and potential cash outflows as of December 31, 2009:

	December 31, 2009
	Total	One year or less		After one year through three years	After three years through five years	After five years
	(Dollars in thousands)
Minimum annual operating leases	$ 101,273	$	9,919	$ 18,247	$ 16,447	$ 56,660
Remaining contractual maturities of time deposits	1,549,617		1,192,166	345,232	11,115	1,104
Long-term borrowings	679,889		72,513	274,213	185,525	147,638
Subordinated debt	93,828		—	—	—	93,828
Unfunded home equity lines of credit(1)	337,391		10,335	41,294	29,546	256,216
Unfunded other loan lines of credit	339,997		257,349	72,083	10,565	—
Standby letters of credit	40,040		34,669	2,399	69	2,903
Total	$3,142,035	$	1,576,951	$753,468	$253,267	$558,349

(1)	Home equity lines of credit in the after five years category have no stated expiration.

The Bank also had commitments with customers to extend mortgage loans at a specified rate at December 31, 2009 and December 31, 2008 of $31.1 million and $36.4 million , respectively, and commitments to sell mortgage loans at a specified rate at December 31, 2009 and December 31, 2008 of $69.0 million and $53.1 million, respectively. The commitments are accounted for as a derivative and recorded at fair value. The Bank estimates the fair value of these commitments by comparing the secondary market price at the reporting date to the price specified in the contract to extend or sell the loan initiated at the time of the loan commitment. At

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December 31, 2009, the Corporation had commitments with a positive fair value of $1.4 million and negative fair value of $38,000 which was recorded as other income At December 31, 2008, the Corporation had commitments with a positive fair value of $274,000 and negative fair value of $48,000 which was recorded as other income.

During January 2006, the Bank completed its acquisition of the Cornerstone Companies. The purchase price consisted of $15.0 million in cash paid at closing and a contingent payment of up to $7.0 million to be paid post-closing. The contingent payment is based upon the Cornerstone Companies meeting certain minimum operating results during a five-year earn-out period with a maximum payout of $7.0 million over this period. For 2009, an earn-out payment was not made as the minimum operating results were not met. For 2008, 2007 and 2006, the minimum operating results were met resulting in earn-out payments totaling $3.6 million which was recorded as additional goodwill. At December 31, 2009, the remaining maximum payout is $3.4 million through 2010.

For information on known uncertainties, see Item 1, “Business.”

Fourth Quarter 2009 Results (Unaudited)

Net income for the fourth quarter of 2009 was $2.8 million, or $0.07 per diluted share, as compared to $3.8 million or $0.11 per diluted share for the fourth quarter of 2008.

During the fourth quarter of 2009, the provision for loan losses was $4.5 million, compared to $7.9 million in the fourth quarter of 2008. The decrease in provision for loan losses is due to significant provisions recorded in prior quarters. As a result of the provision for loan losses recorded from December 31, 2008 through December 31, 2009, the ratio of the allowance for loan losses to total loans has increased from 1.36% to 2.23% during that period.

Net interest income on a tax-equivalent basis in the fourth quarter 2009 remained relatively flat as compared to the same period in the prior year. The net interest margin decreased to 2.56% in the fourth quarter of 2009 compared to 3.16% for 2008. The net interest margin decreased as a 132 basis point decrease in the yield on average earning assets of $4.9 billion was only partially offset by a 77 basis point decrease in the cost of interest bearing liabilities of $4.3 billion.

Noninterest income of $13.5 million for the fourth quarter of 2009 remained relatively flat as compared to $13.3 million in the fourth quarter of 2008. There was a $721,000 increase in gains on sales of investment securities in the fourth quarter of 2009 which was offset by an increase of $952,000 in other-than-temporary impairment charges on collateralized debt obligation investments in pooled trust preferred securities and equity securities. Deposit service charge income increased $759,000 or 20.7% over 2008 mainly due to the Willow Financial acquisition. Wealth management income declined 29.6% to $4.1 million driven by poor market conditions during 2009. Other income decreased $809,000 or 33.2% primarily to due to higher prior year fees on derivative instruments.

Noninterest expense increased $4.9 million for the fourth quarter of 2009 over the same period in the prior year. Salaries and benefits expense increased $753,000 primarily due to higher staffing levels resulting from the Willow Financial acquisition which closed in December 2008. Occupancy expenses increased $1.2 million over the prior period due to the Willow Financial acquisition. Intangible asset expense decreased $1.2 million primarily due to a prior year $1.4 million valuation adjustment on mortgage servicing rights. Merger costs decreased $2.5 million due to the Willow Financial acquisition in December 2008. FDIC deposit insurance expense increased $1.2 million due to increased premiums. Other expenses increased $2.0 million primarily due to the Willow Financial acquisition.

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The following is the summarized (unaudited) consolidated quarterly financial data of the Corporation which, in the opinion of management, reflects all adjustments, consisting only of normal recurring adjustments, necessary for fair presentation of the Corporation’s results of operations:

Table 16—Selected Quarterly Financial Data (Unaudited)

	Three Months Ended 2009 (1) (2)								Three Months Ended 2008 (2)
	Dec. 31		Sept. 30		June 30		March 31		Dec. 31			Sept. 30	June 30		March 31
Interest income	$	52,123	$	55,005	$	60,045	$	63,638		$	54,583	49,942	$	49,353	$	52,416
Interest expense		22,445		23,567		26,592		28,334			25,136	24,645		24,164		28,209
Net interest income		29,678		31,438		33,453		35,304			29,447	25,297		25,189		24,207
Provision for loan losses		4,450		14,750		32,000		7,121			7,920	2,580		3,107		1,960
Net interest income after provision for loan losses		25,228		16,688		1,453		28,183			21,527	22,717		22,082

HARLEYSVILLE NATIONAL CORP 10-K