2007 ANNUAL REPORT ON FORM
10-K











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UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C.
20549_________________________

Form 10-K

|**(Mark
      One)** |  |                                                                                                                                                                                           
|-------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|**x**                |  | Annual report pursuant to Section 13 or 15(d) of the Securities
      Exchange Act of 1934 for the fiscal year ended December 31,
      2007.                                             
|                     |  |                                                                                                                                                                                           
|OR                  
|                     |  |                                                                                                                                                                                           
|**o**                |  | 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              | (I.R.S. Employer   
|incorporation or organization)               | Identification No.)
|                                             |                    
|**483 Main Street,**                         |                    
|**Harleysville,
    Pennsylvania**           | **19438**          
|(Address of principal executive
    offices) | (Zip Code)         

|                                                                 
|-----------------------------------------------------------------
|Securities
      registered pursuant to Section 12(b) of the Act:
|**Title of Each
    Class**                                      
|Common Stock, $1.00 par value                                    

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 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). YesoNo x

The
aggregate market value of the Registrants Common Stock held by non-affiliates
is $412,935,659 based on the June 30, 2007 closing price of the Registrants
Common Stock of $16.12 per share.

As of March 5, 2008, there were
31,353,724 outstanding shares of the Registrants Common Stock.

DOCUMENTS INCORPORATED BY
REFERENCE:

|1. |  | Portions of the Registrants
      Definitive Proxy Statement relating to the Annual Meeting of Shareholders
      to be held April 22, 2008 are incorporated by reference into Part III,
      Items 10-14 of this report.
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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HARLEYSVILLE NATIONAL
CORPORATION

FORM 10-K

INDEX

|           |  |                                                                                                  | **Page**
|---------- |  | ------------------------------------------------------------------------------------------------ | --------
|Part I     |  |                                                                                                  | 4       
|Item 1.    |  | Business                                                                                         | 4       
|Item 1A.   |  | Risk Factors                                                                                     | 11      
|Item 1B.   |  | Unresolved Staff
      Comments                                                                  | 14      
|Item 2.    |  | Properties                                                                                       | 15      
|Item 3.    |  | Legal
      Proceedings                                                                          | 16      
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                              | 16      
|Part II    |  |                                                                                                  | 17      
|Item 5.    |  | Market for Registrants Common Equity, Related Stockholder Matters
      and Issuer              |         
|           |  | Purchases of Equity Securities                                                                   | 17      
|Item 6.    |  | Selected
      Financial Data                                                                    | 20      
|Item 7.    |  | Managements Discussion and Analysis of Financial Condition and
      Results of Operations      | 21      
|Item 7A.   |  | Quantitative and
      Qualitative Disclosures About Market Risk                                 | 43      
|Item 8.    |  | Financial Statements and Supplementary Data                                                      | 44      
|Item 9.    |  | Changes in and
      Disagreements With Accountants on Accounting and Financial
      Disclosure | 94      
|Item 9A.   |  | Controls and Procedures                                                                          | 94      
|Item 9B.   |  | Other
      Information                                                                          | 96      
|Part III   |  |                                                                                                  | 97      
|Item 10.   |  | Directors,
      Executive Officers and Corporate Governance                                     | 97      
|Item 11.   |  | Executive Compensation                                                                           | 97      
|Item 12.   |  | Security
      Ownership of Certain Beneficial Owners and Management and Related                 |         
|           |  | Stockholder Matters                                                                              | 97      
|Item 13.   |  | Certain Relationships and Related Transactions, and Director
      Independence                  | 97      
|Item 14.   |  | Principal
      Accountant Fees and Services                                                     | 98      
|Part IV    |  |                                                                                                  | 98      
|Item 15.   |  | Exhibits and
      Financial Statement Schedules                                                 | 98      
|Signatures |  | 99                                                                                              

2

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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 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 eight
financial institutions since 1991 including the recent acquisition of 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 3164, 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, 2007, the
Bank had 55 branch offices located in Montgomery, Bucks, Chester, Berks, Carbon,
Lehigh, Monroe, and Northampton 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 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 Warminster, Bucks County and East Norriton, Montgomery
County and relocated its Blue Bell office in Montgomery County during 2007. The
Bank plans to add new retail branches in Warrington, Bucks County, Conshohocken
and Flourtown, Montgomery County and Whitehall, Lehigh County in 2008. The Bank
continues to evaluate potential new branch sites that are contiguous to our
current service area and will expand the Banks market area and market share of
loans and deposits.

Acquisitions

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. Headquartered and founded in Emmaus, PA in 1990,
East Penn Bank, had nine banking offices located in Lehigh, Northampton and
Berks Counties. The acquisition expands the branch network the Corporation has
in the Lehigh Valley and its opportunity to provide East Penn customers with a
broader mix of products and services.

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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.

Effective January 1, 2006, the Bank
completed its acquisition of the Cornerstone Companies, registered investment
advisors for high net worth, privately held business owners, wealthy families
and institutional clients. Located in the Lehigh Valley, Pennsylvania, the firm
serves clients throughout Pennsylvania and other mid-Atlantic states. The
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 2007 and 2006, the minimum operating results
were met resulting in earn-out payments totaling $2.2 million which were
recorded as additional goodwill. At December 31, 2007, the remaining maximum
payout is $4.8 million through 2010.

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. 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 will be
deferred and amortized through a reduction of occupancy expense over the term of
the leases.

The
Corporation has two reportable operating segments: Community Banking and Wealth
Management (including the Cornerstone Companies acquired in January 2006) as
well as certain other non-reportable segments. As of December 31, 2007, the
Wealth Management segment had assets under management of $3.2 billion. Statement
of Financial Accounting Standards (SFAS) No. 131, Disclosures about Segments of
an Enterprise and Related Information establishes standards for the way public
business enterprises report information about operating segments. Operating
segments are components of an enterprise, which are evaluated regularly by the
chief operating decision-maker in deciding how to allocate and assess resources
and performance. The Corporations chief operating decision-maker is the
President and Chief Executive Officer. For more detailed financial information
pertaining to operating segments, see Item 8 Note 17 of the Consolidated
Financial Statements which is herein incorporated by reference.

As of
December 31, 2007, the Corporation had total assets of $3.9 billion, total
shareholders equity of $339.3 million and total deposits of $3.0
billion.

As of December 31, 2007, the
Corporation and the Bank employed approximately 820 full-time equivalent
employees. The Corporation provides a variety of employment benefits and
considers its relationships with its employees to be satisfactory.

Competition

The Bank
competes actively with other eastern Pennsylvania financial institutions, many
larger than the Bank, as well as with financial and non-financial institutions
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, 2007, the Banks legal lending limit to a single customer was $46.9
million. Many of the institutions with which the Bank competes are able to lend
significantly more than this amount to a single customer.

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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, 2007. 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

Management
is not aware of any other current specific recommendations by regulatory
authorities or proposed legislation which, if they were implemented, would have
a material adverse effect upon the liquidity, capital resources, or results of
operations, although the general cost of compliance with numerous federal and
state laws and regulations does have, and in the future may have, a negative
impact on the Corporations results of operations.

Effects of Inflation

Inflation
has some impact on the Corporations and the Banks operating costs. Unlike many
industrial companies, however, substantially all of the Banks assets and
liabilities are monetary in nature. As a result, interest rates have a more
significant impact on the Corporations and the Banks performance than the
general level of inflation. Over short periods of time, interest rates may not
necessarily move in the same direction or in the same magnitude as prices of
goods and services.

Effect of Government Monetary Policies

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.

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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.

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.

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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 as of December 31, 2007.

Under
      aTotal
    
    Tier 1
    
    
    
    
    CapitalRisk
    
    Risk
    
    Tier 1
    
    OrderBased
    
    Based
    
    Leverage
    
    orRatio
    
    Ratio
    
    Ratio
    
    DirectiveCapital categoryWell
      capitalized
    
    ≤10.0
    %
    
    ≥6.0
    %
    
    ≥5.0
    %
    
    NOAdequately capitalized
    
    ≥8.0
    %
    
    ≥4.0
    %
    
    ≥4.0
    %(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.
|--- |  | -------------------------------------------------------------------------

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 $100,000 per depositor per insured
institution. 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.

During 2006,
deposit insurance premiums were assessed based both on the balance of insured
deposits held as well as the degree of risk the institution poses to the
insurance fund with a designated minimum reserve ratio of 1.25% of estimated
insured deposits or such higher reserve ratio as established by the FDIC. The
Bank was classified in the strongest risk category, therefore, had a 0.00%
assessment rate in 2006.

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. The new rates range from 5 to 43 basis points. The new
assessment rates took effect at the beginning of 2007. 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 Bank was classified in the strongest risk category
for 2007 and its assessment rate for 2007 was approximately 5.4 basis points, or
$1.1 million. The Bank did not pay any premiums during 2007 since its one-time
assessment credit of $1.4 million was available to offset the initial assessment
in 2007. As of December 31, 2007, the remaining assessment credit available to
offset future deposit insurance assessments was $343,000.

9

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In addition,
all insured institutions are required to pay a Financing Corporation (FICO)
assessment. FICO is a government agency-sponsored entity that was formed to
borrow money necessary to carry out the closing and disposition of failed thrift
institutions in the 1980s. The annual FICO rate for all insured institutions as
of December 31, 2007 was 1.14 basis points. These assessments are revised
quarterly and will continue until the bonds mature in the year 2019. The Bank
paid FICO premiums of $308,000 in 2007.

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.

10

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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.comunder
Investor Information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). In addition, the
Corporation makes available onwww.hncbank.comunder Investor Information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. 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.

11

---

This causes the net interest rate spread
to compress and negatively impacts the Banks profitability. 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. 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 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. The Corporations failure to pay dividends on its common stock could
have a material adverse effect on the market price of its common
stock.

12

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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. 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. Inflation has some impact
on the Corporations and the Banks operating costs.

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, many larger
than the Bank, as well as with financial and non-financial institutions
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.

13

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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.

Item 1B.Unresolved Staff
Comments

None.

14

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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-two of its branches are located (threebranches to be opened during 2008) and
leases space for the other thirty-sevenbranches (one branch to be opened during 2008)
from unaffiliated third parties under leases expiring at various times through
2036. The Bank leases office space for commercial business development in Blue
Bell and Towamencin, Pennsylvania. The Cornerstone Companies lease office space
in Bethlehem and Allentown, Pennsylvania. (1) HNC Financial Company
leases an office in Wilmington, Delaware. HNC Reinsurance Company leases an
office in Phoenix, Arizona.

|Office                      |  | Office
    Location                                    |  | Owned/Leased
|--------------------------- |  | ------------------------------------------------------ |  | ------------
|Harleysville Campus         |  | 483 Main Street, Harleysville, PA                      |  | Leased      
|Harleysville-Meadowbrook    |  | 278 Main Street,
      Harleysville, PA                |  | Owned(2)    
|Skippack                    |  | 3893 Skippack Pike, Skippack, PA                       |  | Leased      
|Limerick                    |  | 260 West Ridge
      Pike, Limerick, PA                |  | Leased      
|North Wales                 |  | 1498 North Wales Road, North Wales, PA                 |  | Leased      
|Gilbertsville               |  | 1050 East
      Philadelphia Avenue, Gilbertsville, PA |  | Leased      
|Hatfield                    |  | 1632 Cowpath Road, Hatfield, PA                        |  | Leased      
|Lansdale-North
      Broad  |  | 1804 North Broad
      Street, Lansdale, PA            |  | Leased      
|Lansdale-Marketplace        |  | 1551 Valley Forge Road, Lansdale, PA                   |  | Owned(2)    
|Normandy
      Farms        |  | Morris Road
      & Route 202, Blue Bell, PA           |  | Leased      
|Horsham                     |  | 955 Horsham Road, Horsham, PA                          |  | Leased      
|Meadowood                   |  | 3205 Skippack
      Pike, Worcester, PA                |  | Leased      
|Collegeville                |  | 364 East Main Street, Collegeville, PA                 |  | Owned       
|Sellersville                |  | 209 North Main
      Street, Sellersville, PA          |  | Leased      
|Trainers Corner             |  | 120 North West End Boulevard, Quakertown, PA           |  | Leased      
|Quakertown
      Main       |  | 224 West Broad
      Street, Quakertown, PA            |  | Owned       
|Spring House(1)             |  | 1017 North Bethlehem Pike, Spring House, PA            |  | Leased      
|Red
      Hill              |  | 400 Main Street,
      Red Hill, PA                    |  | Leased      
|Doylestown                  |  | 500 East Farm Lane, Doylestown, PA                     |  | Owned(2)    
|Audubon                     |  | 2624 Egypt Road,
      Norristown, PA                  |  | Owned(2)    
|Chalfont                    |  | 251 West Butler Avenue, Chalfont, PA                   |  | Leased      
|Royersford                  |  | 440 W.
      Linfield-Trappe Road, Royersford, PA      |  | Owned(2)    
|Souderton                   |  | 702 Route 113, Souderton, PA                           |  | Owned(2)    
|Foulkeways                  |  | 1120
      Meetinghouse Road, Gwynedd, PA              |  | Leased      
|Malvern(1)                  |  | 30 Valley Stream Parkway, Malvern, PA                  |  | Leased      
|Blue
      Bell             |  | 20 West Skippack
      Pike, Ambler PA                 |  | Owned(2)    
|Wyomissing(1)               |  | 2800 State Hill Road, Wyomissing, PA                   |  | Leased      
|Lansford                    |  | 13-15 West Ridge
      Street, Lansford, PA            |  | Leased      
|Summit Hill                 |  | 2 East Ludlow Street, Summit Hill, PA                  |  | Leased      
|Lehighton                   |  | 904 Blakeslee
      Blvd, Lehighton, PA                |  | Leased      
|Slatington                  |  | 502 Main Street, Slatington, PA                        |  | Leased      
|Slatington
      Handi-Bank |  | 701-705 Main
      Street, Slatington, PA              |  | Leased      
|Lehigh Township             |  | 4421 Lehigh Drive, Walnutport, PA                      |  | Leased      
|Palmerton                   |  | 372 Delaware
      Avenue, Palmerton, PA               |  | Leased      
|Kresgeville                 |  | Route 209, Kresgeville, PA                             |  | Leased      
|Allentown                   |  | 1602 Allen
      Street, Allenton, PA                  |  | Leased      
|Pottstown-Train Station     |  | One Security Plaza, Pottstown, PA                      |  | Leased      
|Pottstown-East
      End    |  | 1450 East High
      Street, Pottstown, PA             |  | Owned       
|Pottstown-North End         |  | 930 North Charlotte Street, Pottstown, PA              |  | Leased      
|Pottstown
      Center      |  | Rt. 100 and
      Shoemaker Road, Pottstown, PA        |  | Owned(2)    
|Pottstown-Coventry          |  | 2 Glocker Way, Pottstown, PA                           |  | Owned(2)    

15

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|Office                 |  | Office Location                                         |  | Owned/Leased
|---------------------- |  | ------------------------------------------------------- |  | ------------
|Boyertown              |  | Rt. 100 and Bause Road, Boyertown, PA                   |  | Leased      
|Douglassville          |  | 1191 West Ben
      Franklin Highway, Douglassville, PA |  | Leased      
|Dorneyville            |  | 3570 Hamilton Boulevard, Allentown, PA                  |  | Leased      
|Warminster             |  | 190 Veterans
      Way, Warminster, PA                  |  | Owned(2)    
|Peter Becker Community |  | 815 Maplewood Drive, Harleysville, PA                   |  | Leased      
|Warrington(3)          |  | Titus and Easton
      Roads, Warrington, PA            |  | Owned(2)    
|East Norriton          |  | 450 East Germantown Pike, East Norriton, PA             |  | Owned(2)    
|Conshohocken(3)        |  | 101 Ridge Pike,
      Conshohocken, PA                  |  | Owned(2)    
|Flourtown(3)           |  | 1851 Bethlehem Pike, Flourtown, PA                      |  | Leased      
|Cedar
      Crest      |  | 1251 S Cedar
      Crest Blvd, Allentown, PA            |  | Leased      
|Mertztown              |  | 951 State Street, Mertztown, PA                         |  | Leased      
|Bethlehem              |  | 4510 Bath Pike,
      Bethlehem, PA                     |  | Leased      
|Macungie               |  | 201 W Main St, Macungie, PA                             |  | Owned(2)    
|Whitehall(3)           |  | 2985 MacArthur
      Rd, Whitehall, PA                  |  | Owned       
|Emmaus                 |  | 731 Chestnut St, Emmaus, PA                             |  | Owned       
|Trexlertown            |  | 6890 Hamilton
      Blvd, Trexlertown, PA               |  | Owned       
|Emmaus                 |  | 502 State Ave, Emmaus, PA                               |  | Owned       
|Fogelsville            |  | 861 N Rt 100,
      Fogelsville, PA                     |  | Owned       
|Emmaus High School     |  | 500 Macungie Ave, Emmaus, 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) |  | These branches are expected to
      open for business in 2008.                  

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

Management,
based on consultation with the Corporations legal counsel, is not aware of any
litigation that would have a material adverse effect on the consolidated
financial position of the Corporation. There are no proceedings pending other
than the ordinary routine litigation incident to the business of the Corporation
and its subsidiariesthe Bank, HNC Financial Company and HNC Reinsurance
Company. In addition, no material proceedings are pending or are known to be
threatened or contemplated against the Corporation and the Bank by government
authorities.

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

No matter
was submitted during the fourth quarter of 2007 to a vote of holders of the
Corporations Common Stock.

16

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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 2007
and 2006. The Corporations stock is traded under the symbol HNBC on the
NASDAQ Global Select Market. All share information has been restated to reflect
stock dividends and splits. 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 20, Notes to Consolidated Financial StatementsRegulatory
Capital.

**Price of Common Stock and
Cash Dividends**

Cash dividends2007
    
    
    High Price
    
    Low Price
    
    per shareFirst Quarter
    
    $
    20.25
    
    $
    17.11
    
    $
    0.20Second
      Quarter
    
    
    18.13
    
    
    15.54
    
    $
    0.20Third Quarter
    
    
    18.58
    
    
    14.03
    
    $
    0.20Fourth
      Quarter
    
    
    17.17
    
    
    13.15
    
    $
    0.20Cash dividends2006
    
    
    High Price
    
    Low Price
    
    per shareFirst Quarter(1)
    
    ****$
    24.90****
    
    $
    18.65****
    
    $
    0.18Second
      Quarter(1)
    
    
    21.80****
    
    
    18.06****
    
    
    0.18Third Quarter
    
    
    20.87****
    
    
    18.82****
    
    
    0.19Fourth
      Quarter
    
    
    21.72****
    
    
    19.22****
    
    
    0.20


|(1) |  | Adjusted for a five percent stock
      dividend effective September 15, 2006.
|--- |  | ------------------------------------------------------------------------------

At December
31, 2007, there were 4,172 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
following table provides information about purchases made by the Corporation of
its common stock during the quarter ended December 31, 2007:

**Issuer Purchases of Common
Stock**

MaximumTotal
      Number
    
    Number
      ofof
      Shares
    
    Shares that
      mayWeighted
    
    Purchased
      as
    
    yet
      beTotal Number
      of
    
    Average
    
    Part of
      Publicly
    
    PurchasedCommon
      Shares
    
    Price
      Paid
    
    Announced
    
    under
      thePurchased
    
    Per Share
    
    Plans
    
    Plans(1)October 1-31, 2007
    
    
    
    $ 
    
    
    
    731,761November 1-30,
      2007
    
    
    
    
    
    
    
    731,761December 1-31, 2007
    
    
    
    
    
    
    
    731,761Total
    
    
    
    
    
    


|(1) |  | On May 12, 2005, the Board of
      Directors authorized a plan to purchase up to 1,416,712 shares (adjusted
      for five percent stock dividend paid on September 15, 2006 and September
      15, 2005) or 4.9%, of its outstanding common
stock.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

17

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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,
2007.

|                          |                                         |                                        | Number Of Securities Remaining
      Available
|------------------------- | --------------------------------------- | -------------------------------------- | ----------------------------------------------
|                          | Number Of
      Securities To Be Issued | Weighted-Average Exercise Price        | For
      Future Issuance Under Equity        
|                          | Upon Exercise
      Of Outstanding      | Of Outstanding
      Options, Warrants | Compensation Plans, Excluding Securities      
|Plan
      Category       | Options,
      Warrants And Rights      | And
      Rights                       | Reflected In Column (A)                       
|                          | (A) (#)                                 | (B) ($)                                | (C)(#)                                        
|Equity Compensation Plans |                                         |                                        |                                               
|Approved by Stockholders  | 1,113,499(1)                            | $15.74 per share                       | 1,266,120                                     
|                          |                                         |                                        |                                               
|Equity Compensation Plans |                                         |                                        |                                               
|Not Approved by           | -0-(2)                                  | -0-                                    | 22,824                                        
|Stockholders              |                                         |                                        |                                               
|                          |                                         |                                        |                                               
|TOTAL                     | 1,113,499                               | $15.74 per
    share                   | 1,288,944                                     

|(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, and options assumed pursuant to the merger &
      acquisition of East Penn Financial Corporation on November 16,
    2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(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 5,845
      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 1, Notes to Consolidated Financial StatementsStock-Based Compensation
and Note 14, Stock-Based Compensation, is incorporated herein by
reference.

18

---

Shareholder Return Performance
Graph

A line graph
comparing the yearly change in the cumulative total shareholder return on the
Corporations common stock against the cumulative total return of the NASDAQ
Stock Market (U.S. Companies) Index and the NASDAQ Bank Stocks Index for the
period of 5 fiscal years commencing January 1, 2003, and ending December 31,
2007, follows. The shareholder return shown on the graph below is not
necessarily indicative of future performance.

**Comparison of Five  Year Cumulative Total
Returns**

**Performance Graph for**

**HARLEYSVILLE NATIONAL
CORP**



14087
    
    Prepared by CRSP
      (www.crsp.uchicago.edu), Center for Research in Security Prices, Graduate
      School of Business, The University of Chicago. Used with permission.
      All rights reserved.
    ©Copyright
  2008


19

---

Item 6.Selected Financial Data

|                                          |  | Year Ended December
  31,
|----------------------------------------- |  | -------------------------
|                                          |  | 2007(1)                  
|                                          |  |                          
|Income and expense                        |  |                          
|Interest
      income                     |  | **$**                    
|Interest expense                          |  |                          
|Net interest
      income                 |  |                          
|Provision for loan losses                 |  |                          
|Net interest
      income after provision |  |                          
|for loan losses                           |  |                          
|Noninterest income                        |  |                          
|Noninterest
      expense                 |  |                          
|Income before income tax expense          |  |                          
|Income tax
      expense                  |  |                          
|Net income                                |  | $                        
|                                          |  |                          
|Per share information(4)                  |  |                          
|Basic earnings                            |  | $                        
|Diluted earnings                          |  |                          
|Cash dividends paid                       |  |                          
|Basic average common shares               |  |                          
|outstanding                               |  |                          
|Diluted average common shares             |  |                          
|outstanding                               |  |                          
|                                          |  |                          
|Average balance sheet                     |  |                          
|Loans                                     |  | $                        
|Investments                               |  |                          
|Other interest-earning assets             |  |                          
|Total assets                              |  |                          
|Deposits                                  |  |                          
|Borrowed funds                            |  |                          
|Shareholders equity                      |  |                          
|                                          |  |                          
|Balance sheet at year-end                 |  |                          
|Loans                                     |  | $                        
|Investments                               |  |                          
|Other interest-earning assets             |  |                          
|Total assets                              |  |                          
|Deposits                                  |  |                          
|Borrowed funds                            |  |                          
|Shareholders equity                      |  |                          
|                                          |  |                          
|Performance ratios                        |  |                          
|Return on average assets                  |  |                          
|Return on average equity                  |  |                          
|Average equity to average                 |  |                          
|assets                                    |  |                          
|Dividend payout
      ratio               |  |                          

|(1) |  | The results of operations include
      the acquisition of the East Penn Financial effective November 16, 2007 and
      the sale lease-back of bank properties during the fourth quarter of
      2007.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |  |                                                                                                                                                                                                         
|(2) |  | 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.       
|   
|(3) |  | The results of operations include
      the acquisition of Millennium Bank effective April 30, 2004                                                                                                     
|   
|(4) |  | Adjusted for a five percent stock
      dividend effective September 15, 2006, September 15, 2005, September 15,
      2004 and a five-for-four stock split effective September 15,
    2003.           

20

---

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 (the Bank), HNC Financial Company and HNC Reinsurance Company. The
Corporations consolidated financial condition and results of operations consist
almost entirely of the Banks financial condition and results of operations.
Current performance does not guarantee, and may not be indicative of, similar
performance in the future. 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 on page 3
of this report on Form 10-K.

Critical Accounting
Estimates

The
accounting and reporting policies of the Corporation and its subsidiaries
conform to accounting principles generally accepted in the United States and
general practices with the financial services industry. The Corporations
significant accounting policies are described in Note 1 of the consolidated
financial statements and are essential in understanding Managements Discussion
and Analysis of Results of Operations and Financial Condition. In applying
accounting policies and preparing the consolidated financial statements,
management is required to make estimates and assumptions that affect the
reported amount of assets and liabilities as of the dates of the balance sheets
and revenues and expenditures for the periods presented. Therefore, actual
results could differ significantly from those estimates. Judgments and
assumptions required by management, which have, or could have a material impact
on the Corporations financial condition or results of operations are considered
critical accounting estimates. The following is a summary of the policies the
Corporation recognizes as involving critical accounting estimates: Allowance for
Loan Loss, Goodwill and Other Intangible Asset Impairment, Stock-Based
Compensation, Unrealized Gains and Losses on Securities Available for Sale, and
Deferred Taxes.

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

Goodwill and
Other Intangible Asset Impairment: Goodwill and other intangible assets are
reviewed for potential impairment on an annual basis, or more often if events or
circumstances indicate that there may be impairment, in accordance with SFAS No.
142, Goodwill and Other Intangible Assets and SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. Goodwill is tested for impairment
at the reporting unit level and an impairment loss is recorded to the extent
that the carrying amount of goodwill exceeds its implied fair value. The
Corporation employs general industry practices in evaluating the fair value of
its goodwill and other intangible assets. The Corporation calculates the fair
value using a combination of the following valuation methods: dividend discount
analysis under the income approach, which calculates the present value of all
excess cash flows plus the present value of a terminal value and price/earnings
multiple under the market approach. Management performed its annual review of
goodwill and other identifiable intangibles at June 30, 2007 and determined
there was no impairment of goodwill or other identifiable intangibles. No
assurance can be given that future impairment tests will not result in a charge
to earnings.

21

---

Stock-based
Compensation: The Corporation recognizes compensation expense for stock options
in accordance with SFAS 123 (revised 2004), Share-Based Payment (SFAS 123(R))
adopted at January 1, 2006 under the modified prospective application method of
transition. The expense of the option is generally measured at fair value at the
grant date with compensation expense recognized over the service period, which
is usually the vesting period. For grants subject to a service condition, the
Corporation utilizes the Black-Scholes option-pricing model (as used under SFAS
123) to estimate the fair value of each option on the date of grant. The
Black-Scholes model takes into consideration the exercise price and expected
life of the options, the current price of the underlying stock and its expected
volatility, the expected dividends on the stock and the current risk-free
interest rate for the expected life of the option. For grants subject to a
market condition, the Corporation utilizes a Monte Carlo simulation to estimate
the fair value and determine the derived service period. Compensation is
recognized over the derived service period with any unrecognized compensation
cost immediately recognized when the market condition is met. The Corporations
estimate of the fair value of a stock option is based on expectations derived
from historical experience and may not necessarily equate to its market value
when fully vested. In accordance with SFAS 123(R), the Corporation estimates the
number of options for which the requisite service is expected to be
rendered.Prior to
January 1, 2006, the Corporation followed SFAS 123 and APB 25 withpro formadisclosures of net income and earnings per share, as if the fair value-based
method of accounting defined in SFAS 123 had been applied.

Unrealized
Gains and Losses on Securities Available for Sale: The Corporation receives
estimated fair values of debt securities from independent valuation services and
brokers. In developing these fair values, the valuation services and brokers use
estimates of cash flows based on historical performance of similar instruments
in similar rate environments. Debt securities available for sale are mostly
comprised of mortgage-backed securities as well as tax-exempt municipal bonds
and U.S. government agency securities. The Corporation uses various indicators
in determining whether a security is other-than-temporarily impaired, including
for equity securities, if the market value is below its cost for an extended
period of time with low expectation of recovery or for debt securities, when it
is probable that the contractual interest and principal will not be collected.
The debt securities are monitored for changes in credit ratings. Adverse changes
in credit ratings would affect the estimated cash flows of the underlying
collateral or issuer. The unrealized losses associated with the securities
portfolio, that management has the ability and intent to hold, are not
considered to be other-than temporary as of December 31, 2007 because the
unrealized losses are related to changes in interest rates and do not affect the
expected cash flows of the underlying collateral or issuer. The Corporation
recognized an other-than temporary charge of $55,000 during the third quarter of
2007 as a result of an equity holding in a financial institution which was
purchased by another institution at a lower than cost share price. In
conjunction with the closing of the merger during the fourth quarter of 2007,
the Corporation exchanged its equity holding in the financial institution for
cash.

Deferred
Taxes: The Corporation recognizes deferred tax assets and liabilities for the
future effects of temporary differences, net operating loss carryforwards, and
tax credits. Deferred tax assets are subject to managements judgment based upon
available evidence that future realizations are likely. If management determines
that the Corporation may not be able to realize some or all of the net deferred
tax asset in the future, a charge to income tax expense may be required to
reduce the value of the net deferred tax asset to the expected realizable
value.

The
Corporation has not substantively changed its application of the foregoing
policies, and there have been no material changes in assumptions or estimation
techniques used as compared to prior periods.

Financial Overview

For the year
ended December 31, 2007, the Corporations diluted earnings per share were $0.90
compared to $1.34 for 2006. Net income in 2007 was $26.6 million compared to
$39.4 million in 2006. The year-to-date financial results include the impact on
operations from the acquisition of the East Penn Financial Corporation effective
November 16, 2007 and the related issuance of 2,432,771 shares of the
Corporation common stock. The following is an overview of the key financial
highlights for 2007:

22

---

Consolidated
total assets were $3.9 billion at December 31, 2007, an increase of 20.1% or
$653.2 million over $3.2 billion in total assets reported at December 31, 2006.
On November 16, 2007, the Corporation completed its acquisition of East Penn
Financial and its subsidiary, East Penn Bank. At the acquisition date, East Penn
Financial had approximately $451.1 million in assets, $337.7 million in loans
and $382.7 million in deposits.

The return
on average shareholders equity was 8.91% in 2007 compared to 13.98% in 2006.
The return on average assets was 0.79% in 2007 compared to 1.22% in 2006. The
decrease in these ratios during 2007 was primarily the result of lower net
income.

Loans
increased $413.5 million and deposits increased $468.2 million. Adjusted for the
East Penn Financial acquisition, organic loan growth was approximately $81.9
million or 4.0% and deposit growth was approximately $63.5 million or
2.5%.

Net interest
income on a tax-equivalent basis decreased $698,000, or .8%, for the year ending
December 31, 2007, over the prior year. The net interest margin for 2007 was
2.82% compared to 2.95% for 2006. The decline in the net interest margin was
mainly attributable to the increased customer deposit costs which outpaced yield
increases in loans and investments.

Nonperforming assets increased $4.3 million to $22.0 million at December
31, 2007 from $17.6 million at the end of 2006. However, nonperforming assets as
a percentage of total assets remained relatively stable at 0.56% compared to
0.54% at the end of 2006. The provision for loan losses increased $6.4 million
mostly as a result of decreased quality of the loan portfolio. Net charge-offs
increased by $4.7 million during 2007 over 2006 largely related to one large
real estate loan charge-off and four other unrelated commercial and industrial
loans.

Noninterest
income decreased $2.0 million or 4.4% during 2007 over 2006, although wealth
management fee income rose $3.9 million or 26.1% and service charges on deposits
increased $1.7 million or 21.1%. During 2007, the Corporation recognized gains
from sale-leaseback transactions of $2.8 million, while during 2006 the
Corporation recognized gains on the sale of the Honesdale branch and credit card
portfolio of $10.7 million and $1.4 million, respectively.

Noninterest
expenses were up $10.5 million or 14.9% in 2007 as compared to 2006. Driving
these increases were salaries and benefits expenses primarily due to higher
staffing levels resulting from new branch openings and the East Penn
acquisition. In addition, occupancy expenses increased due to several new office
locations including the new operations center building in Harleysville and four
new branch openings as well as the addition of the East Penn branches. Other
expenses increased due to a one-time pre-tax charge of $1.9 million related to
the pension plan curtailment and increased professional and consulting fees. The
Corporation changed the structure of its retirement programs by announcing its
intention to terminate the defined benefit pension plan while enhancing the
401(k) defined contribution savings plan. Going forward, management anticipates
that pension and 401(k) expenses will be reduced by approximately $600,000
annually.

Acquisitions/Dispositions

Effective
November 16, 2007, the Corporation completed its acquisition of East Penn
Financial. Under the terms of the Agreement and Plan of Merger dated as of May
15, 2007, as amended August 29, 2007, East Penn Financial was acquired by
Harleysville National Corporation and East Penn Financials wholly owned
subsidiary, East Penn Bank, a $451 million state chartered, FDIC insured bank
offering deposit and lending services throughout the Lehigh Valley, PA merged
with and into the Bank. Headquartered and founded in Emmaus, PA in 1990, East
Penn Bank, had nine banking offices located in Lehigh, Northampton and Berks
Counties. The acquisition expands the branch network that the Corporation has in
the Lehigh Valley and its opportunity to provide East Penn customers with a
broader mix of products and services. As part of the merger agreement, East Penn
Bank continues to operate under the East Penn name and logo, and has become a
division of the Bank. Nine of the Banks existing branches were transferred to
the East Penn division including those in Lehigh, Carbon, Monroe, and
Northampton Counties. The Corporation acquired 100% of the outstanding shares of
East Penn Financial for a total purchase price of $91.3 million. The transaction
was accounted for in accordance with SFAS No. 141, Business Combinations. In
connection therewith, 2,890,125 East Penn Financial shares were exchanged for
2,432,771 shares of the Corporations common stock and 3,444,229 East Penn
Financial shares were exchanged for cash consideration totaling $49.9
million.

23

---

East Penn Financial stock options of
136,906 were exchanged for cash consideration of $792,000 and options of 29,092
were exchanged to acquire 25,480 shares of the Corporations common stock
options. The allocation of the Corporations common stock and cash was such that
the East Penn Financial shareholders did not recognize gain or loss for federal
income tax purposes on those East Penn Financial shares that were exchanged for
the Corporations common stock in the merger. East Penn Financials results of
operations are included in the Corporations results from the date of
acquisition, November 16, 2007. The transaction is expected to be accretive to
the Corporations earnings for the fiscal year of 2008.

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 is 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.

Effective
January 1, 2006, the Bank completed its acquisition of the Cornerstone
Companies, registered investment advisors for high net worth, privately held
business owners, wealthy families and institutional clients. Located in the
Lehigh Valley, Pennsylvania, the firm serves clients throughout Pennsylvania and
other mid-Atlantic states. The transaction was accounted for using the purchase
method of accounting. 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 2007 and 2006, the
minimum operating results were met resulting in earn-out payments totaling $2.2
million which was recorded as additional goodwill. At December 31, 2007, the
remaining maximum payout is $4.8 million through 2010. The Cornerstone Companies
results of operations are included in the Corporations results from the
effective date of the acquisition, January 1, 2006.

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 will
continue 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
will be fully responsible for all costs associated with the operation, repair
and maintenance of the properties during the lease terms and will be 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 will be deferred and 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 will be
amortized over the 10-year term of the lease. This strategic initiative will
help the Corporation translate a large non-earning asset into an earning asset
in the form of loans, which can help bolster earnings and increase
liquidity.

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

For
quarterly information for 2007 and 2006, see Item 7, Managements Discussion
and Analysis of Financial Condition and Results of OperationsFourth Quarter
2007 Results, and Table 16, Selected Quarterly Financial Data, which are
incorporated herein by reference.

24

---

Investment Securities

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

Investment
securities increased 7.8% to $982.9 million at December 31, 2007 from $911.9
million at December 31, 2006. The investment securities available for sale
increased $72.6 million and the investment securities held to maturity decreased
$1.5 million. The majority of the increase in available for sale securities is
due to the securities acquired from East Penn Financial of $66.2 million at
November 16, 2007. During 2007, $186.2 million of securities available for sale
were sold which generated a pre-tax gain of $1.1 million. The securities sold
consisted primarily of bullet and callable agency, tax-exempt municipal and
mortgage-backed securities. In comparison, $110.8 million of securities
available for sale were sold in 2006 which generated a pretax loss of
$674,000.

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,          
|-------------------------------------------------------------------- |  | ----------------------
|                                                                     |  | 2007                  
|                                                                     |  | (Dollars in thousands)
|Investment securities available for sale:                            |  |                       
|Obligations of other U.S. government agencies and
      corporations |  | $                     
|Obligations of states and political subdivisions                     |  |                       
|Mortgage-backed securities                                           |  |                       
|Other securities                                                     |  |                       
|Total investment securities available for
      sale                 |  | $                     
|Investment securities held to maturity:                              |  |                       
|Obligations of other U.S. government agencies and
      corporations |  | $                     
|Obligations of states and political subdivisions                     |  |                       
|Total investment securities held to maturity                         |  | $                     

The maturity
analysis of investment securities including the weighted average yield for each
category as of December 31, 2007 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.

25

---

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

|                                                          |  | December 31, 2007     
|--------------------------------------------------------- |  | ----------------------
|                                                          |  |                       
|                                                          |  | Due in 1 year         
|                                                          |  | or less               
|                                                          |  | (Dollars in thousands)
|Investment securities available for sale:                 |  |                       
|Obligations of other
      U.S. government                |  |                       
|agencies and corporations:                                |  |                       
|Fair value                                                |  | $                     
|Weighted average yield                                    |  |                       
|Weighted average maturity                                 |  |                       
|Obligations of states
      and political                 |  |                       
|subdivisions:                                             |  |                       
|Fair value                                                |  |                       
|Weighted average yield(1)                                 |  |                       
|Weighted average maturity                                 |  |                       
|Mortgage-backed
      securities:                         |  |                       
|Fair value                                                |  |                       
|Weighted average yield                                    |  |                       
|Weighted average maturity                                 |  |                       
|Other debt
      securities:                              |  |                       
|Fair value                                                |  |                       
|Weighted average yield                                    |  |                       
|Weighted average maturity                                 |  |                       
|Equity
      securities:                                  |  |                       
|Fair value                                                |  |                       
|Weighted average yield                                    |  |                       
|**Total
      investment securities available for** sale: |  |                       
|Fair value                                                |  | $                     
|Weighted average
yield                                    |  |                       
|Weighted average maturity                                 |  |                       
|Investment securities held to maturity:                   |  |                       
|Obligations of other
      U.S. government                |  |                       
|agencies and corporations:                                |  |                       
|Amortized cost                                            |  | $                     
|Weighted average yield                                    |  |                       
|Weighted average maturity                                 |  |                       
|Obligations of states
      and political                 |  |                       
|subdivisions:                                             |  |                       
|Amortized Cost                                            |  |                       
|Weighted average yield(1)                                 |  |                       
|Weighted average maturity                                 |  |                       
|Total investment
      securities held to                 |  |                       
|maturity:                                                 |  |                       
|Amortized Cost                                            |  | $                     
|Weighted average yield                                    |  |                       
|Weighted average
    maturity                             |  |                       

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

26

---

Loans

Loans
increased $413.5 million in 2007. The acquisition of East Penn Financial
accounted for $337.7 million as of November 16, 2007. Organic growth was
approximately $81.9 million, or 4.0%. At the acquisition date, East Penn
Financial included $58.7 million in real estate loans, $239.0 million in
commercial loans, and $40.0 million in consumer loans. The growth in commercial
loans and real estate loans was mainly due to the emphasis on owner-operated
businesses and owner occupied commercial mortgage loans in its primary market.
The growth in consumer loans was mainly due to marketing efforts. In addition,
there was also a shift from variable rate home equity lines to fixed rate, fixed
payment home equity loans. The planned reduction in lease financing was due to
run-off. One of the Banks strategic objectives is to increase its loan to
deposit ratio by growing its loan portfolio at a faster pace than its deposits.
Loans increased $61.9 million, or 3.1% in 2006, primarily attributed to growth
in commercial and industrial, commercial real estate and residential mortgage
loans.

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

**Table 3Composition of Loan
Portfolio**

December 31,2007
    
    2006
    
    2005
    
    2004
    
    2003Percent
    
    
    
    
    Percent
    
    
    
    
    Percent
    
    
    
    
    Percent
    
    
    
    
    PercentAmount
    
    of Loans
    
    Amount
    
    of Loans
    
    **Amount**
    
    of Loans
    
    Amount
    
    of Loans
    
    **Amount**
    
    of Loans(Dollars in thousands)Real
      estate
    
    $
    959,064
    
    39
    %
    
    $
    845,880
    
    41
    %
    
    $
    791,358
    
    40
    %
    
    $
    693,468
    
    37
    %
    
    $
    498,135
    
    35
    %Commercial and industrial
    
    
    730,144
    
    30
    %
    
    
    507,899
    
    25
    %
    
    
    479,238
    
    24
    %
    
    
    473,514
    
    26
    %
    
    
    385,554
    
    27
    %Consumer
    
    
    769,051
    
    31
    %
    
    
    685,988
    
    34
    %
    
    
    697,373
    
    35
    %
    
    
    645,718
    
    35
    %
    
    
    463,492
    
    34
    %Lease financing
    
    
    2,564
    
    
    **%**
    
    
    7,588
    
    
    %
    
    
    17,524
    
    1
    %
    
    
    33,102
    
    2
    %
    
    
    61,210
    
    4
    %Total
    
    $
    2,460,823
    
    100
    %
    
    $
    2,047,355
    
    100
    %
    
    $
    1,985,493
    
    100
    %
    
    $
    1,845,802
    
    100
    %
    
    $
    1,408,391
    
    100
    %


The
following table details outstanding loans by type as of December 31, 2007, in
terms of contractual maturity date:

**Table 4Selected Loan
Maturity Data**

December 31, 2007Due afterDue in
    
    1
      year
    
    Due after1 year or less
    
    through 5 years
    
    5 years
    
    Total(Dollars in thousands)Real
      estate
    
    $
    183,969
    
    $
    508,448
    
    $
    266,647
    
    $
    959,064Commercial and
      industrial
    
    
    162,486
    
    
    235,321
    
    
    332,337
    
    
    730,144Consumer
    
    
    224,034
    
    
    219,506
    
    
    325,511
    
    
    769,051Lease
    financing
    
    
    2,220
    
    
    344
    
    
    
    
    
    2,564Total
    
    $
    572,709
    
    $
    963,619
    
    $
    924,495
    
    $
    2,460,823Loans with variable or floating
      interest rates
    
    $
    364,868
    
    $
    260,155
    
    $
    338,674
    
    $
    963,697Loans
      with fixed predetermined interest rates
    
    
    207,841
    
    
    703,464
    
    
    585,821
    
    
    1,497,126Total
    
    $
    572,709
    
    $
    963,619
    
    $
    924,495
    
    $
    2,460,823


The Bank had
no concentration of loans to individual borrowers which exceeded 10% of total
loans at December 31, 2007 and 2006. The Bank actively monitors the risk of loan
concentration. The Bank had no foreign loans, and the impact of nonaccrual and
delinquent loans on total interest income was not material.

27

---

Nonperforming Assets

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

Nonperforming assets (including nonaccrual loans, loans 90 days or more
past due and net assets in foreclosure) were 0.56% of total assets at December
31, 2007, compared to 0.54% at December 31, 2006 and 0.27% at December 31, 2005.
The ratio of nonperforming loans to total net loans was 0.90% at December 31,
2007, compared to 0.87% at December 31, 2006 and 0.42% at December 31,
2005.

Nonaccruing loans increased $5.9
million to $21.1 million at December 31, 2007, as compared to December 31, 2006.
The higher level of nonaccruing loans was mainly due to an increase in
nonaccrual commercial construction, home equity revolving and installment loans
during 2007 offset by a decrease in non-accrual commercial mortgages.
Nonaccruing loans increased $7.7 million to $15.2 million at December 31, 2006,
as compared to December 31, 2005. The increase in nonaccruing loans was
principally due to an increase in non-accrual commercial mortgage loans during
2006. 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
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. During 2006, interest accrued on nonaccruing
loans and not recognized as interest income was $788,000 and interest paid on
nonaccruing loans of $191,000 was recognized as interest income. During 2005,
interest accrued on nonaccruing loans and not recognized as interest income was
$310,000, and interest paid on nonaccruing loans of $250,000 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, 2007,
loans past due 90 days or more and still accruing interest were $857,000,
compared to $2.4 million at December 31, 2006 and $846,000 at December 31, 2005.
The lower level of loans past due 90 days or more at December 31, 2007 from
December 31, 2006 was primarily in the commercial loans, commercial mortgages,
home equity revolving lines and home equity installment loans. The higher level
of loans past due 90 days or more at December 31, 2006 compared to December 31,
2005 was primarily in the commercial and residential real estate loan
portfolio.

The
expectation of continued economic pressures resulting in deterioration of credit
quality has caused us to provide more resources to resolve troubled credits
including an increased focus on earlier identification of potential problem
loans and a more active approach to managing the level of criticized loans that
have not reached nonaccrual status.

Net assets
in foreclosure at December 31, 2007 were $28,000. There were no net assets in
foreclosure at December 31, 2006 and $29,000 at December 31, 2005. 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.

28

---

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

**Table 5Nonperforming
Assets**

December 31,2007
    
    2006
    
    2005
    
    2004
    
    2003(Dollars in thousands)Nonaccrual loans
    
    $
    21,091
    
    
    $
    15,201
    
    
    $
    7,493
    
    
    $
    4,705
    
    
    $
    3,343Loans 90 days or more
      past due
    
    
    857
    
    
    
    2,444
    
    
    
    846
    
    
    
    981
    
    
    
    1,164Total nonperforming loans
    
    
    21,948
    
    
    
    17,645
    
    
    
    8,339
    
    
    
    5,686
    
    
    
    4,507Net assets in
      foreclosure
    
    
    28
    
    
    
    -
    
    
    
    29
    
    
    
    370
    
    
    
    935Total nonperforming assets
    
    $
    21,976
    
    
    $
    17,645
    
    
    $
    8,368
    
    
    $
    6,056
    
    
    $
    5,442Allowance for loan losses to
      nonperforming loans
    
    
    124.5
    %
    
    
    119.9
    %
    
    
    238.2
    %
    
    
    324.6
    %
    
    
    371.7
    %Nonperforming loans to total loans
    
    
    0.90
    %
    
    
    0.87
    %
    
    
    0.42
    %
    
    
    0.31
    %
    
    
    0.32
    %Allowance for loan
      losses to total loans
    
    
    1.11
    %
    
    
    1.03
    %
    
    
    1.00
    %
    
    
    1.00
    %
    
    
    1.19
    %Nonperforming assets to total assets
    
    
    0.56
    %
    
    
    0.54
    %
    
    
    0.27
    %
    
    
    0.20
    %
    
    
    0.22
    %


Locally
located real estate, most with acceptable loan to value ratios, 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 OCC, as an integral part of
their examination process, periodically reviews the Corporations allowance for
loan losses. The OCC may require the Corporation to recognize additions to the
allowance for loan losses based on their judgments about information available
to them at the time of their examination.

The
Corporation performs periodic evaluations of the allowance for loan losses that
include both historical, internal and external factors. The actual allocation of
reserve is a function of the application of these factors to arrive at a reserve
for each portfolio type. Management assigns credit ratings and individual
factors to individual groups of loans. Changes in concentrations and quality are
captured in the analytical metrics used in the calculation of the reserve. The
components of the allowance for credit losses consist of both historical losses
and estimates. Management bases its recognition and estimation of each allowance
component on certain observable data that it believes is the most reflective of
the underlying loan losses being estimated. The observable data and accompanying
analysis is directionally consistent, based upon trends, with the resulting
component amount for the allowance for loan losses. The Corporations allowance
for loan losses components includes the following: historical loss estimation by
loan product type and by risk rating within each product type, payment (past
due) status, industry concentrations, internal and external variables such as
economic conditions, credit policy and underwriting changes and results of the
loan review process. The Corporations historical loss component is the most
significant component of the allowance for loan losses, and all other allowance
components are based on the inherent loss attributes that management believes
exist within the total portfolio that are not captured in the historical loss
component.

29

---

The
historical loss components of the allowance represent the results of analyses of
historical charge-offs and recoveries within pools of homogeneous loans, within
each risk rating and broken down further by segment, within the portfolio.
Criticized assets are further assessed based on trends, expressed as
percentages, relative to delinquency, risk rating and nonaccrual, by credit
product.

The
historical loss components of the allowance for commercial and industrial loans
and commercial real estate loans (collectively commercial loans) are based
principally on current risk ratings, historical loss rates adjusted, by
adjusting the risk window, to reflect current events and conditions, as well as
analyses of other factors that may have affected the collectibility of loans.
All commercial loans with an outstanding balance over $500,000 are subject to
review on an annual basis. Samples of commercial loans with a pass rating are
individually reviewed annually. Commercial loans that management determines to
be potential problem loans are individually reviewed at a minimum annually. The
review is accomplished via Watchlist Memorandum, and is designed to determine
whether such loans are individually impaired, with impairment measured by
reference to the collateral coverage and/or debt service coverage. Consumer
credit and residential real estate reviews are limited to those loans reflecting
delinquent payment status. Homogeneous loan pools, including consumer and 1-4
family residential mortgages are not subject to individual review but are
evaluated utilizing risk factors such as concentration of one borrower group.
The historical loss component of the allowance for these loans is based
principally on loan payment status, retail classification and historical loss
rates, adjusted by altering the risk window, to reflect current events and
conditions.

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

The historic
loss model includes a judgmental component (environmental factors) that reflects
managements belief that there are additional inherent credit losses based on
loss attributes not adequately captured in the lagging indicators. The
environmental factors are based upon managements review of trends in the
Corporations primary market area as well as regional and national economic
trends. Management utilizes various economic factors that could impact
borrowers future ability to make loan payments such as changes in the interest
rate environment, product supply shortages and negative industry specific
events. Management utilizes relevant articles from newspapers and other
publications that describe the economic events affecting specific geographic
areas and other published economic reports and data. Furthermore, given that
past-performance indicators may not adequately capture current risk levels,
allowing for a real-time adjustment enhances the validity of the loss
recognition process. There are many credit risk management reports that are
synthesized by credit risk management staff to assess the direction of credit
risk and its instant effect on losses. It is important to continue to use
experiential data to confirm risk as measurable losses will continue to manifest
themselves at higher than normal levels even after the economic cycle has begun
an upward swing and lagging indicators begin to show improvement. The judgmental
component is allocated to the specific segments of the portfolio based on the
historic loss component.

The
provision for loan losses increased $6.4 million during 2007 compared to 2006
mostly 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
increased $4.7 million for 2007 compared to 2006 principally from charge-offs
related to real estate construction loans for one borrower which were disposed
of subsequent to September 30, 2007 through a sale of the collateral and four
unrelated commercial and industrial loans. The profile of our customer base has
remained relatively constant and we believe that the current deterioration in
credit quality has been caused by the economic pressures being felt by our
borrowers. We have experienced a similar decline in the past and expect that we
could experience a similar decline in future economic cycles. The provision for
loan losses for 2006 reflected an increase of $799,000 compared to the 2005
primarily due to inherent risk related to loan growth and the increase in
non-performing loans of $9.3 million.

30

---

The
allowance for loan losses increased $6.2 million, or 29.2%, to $27.3 million at
December 31, 2007 as compared to December 31, 2006. The increase in the
allowance was primarily due to the addition of the East Penn Financial loan loss
reserve in November 2007 as well as the inherent risk related to loan growth and
the increase in nonperforming loans of $4.3 million. The allowance for loan
losses increased $1.3 million, or 6.5%, to $21.2 million at December 31, 2006
from December 31, 2005. The increase in the allowance was mainly due to inherent
risk related to loan growth and the increase in nonperforming loans of $9.3
million.

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

**Table 6Allowance for Loan
Losses**

|                                          |  | December 31,          
|----------------------------------------- |  | ----------------------
|                                          |  | 2007                  
|                                          |  | (Dollars in thousands)
|Average loans                             |  | $                     
|Allowance, beginning of
      year        |  | $                     
|Loans
      charged off:                  |  |                       
|Real estate                               |  |                       
|Commercial and industrial                 |  |                       
|Consumer                                  |  |                       
|Lease financing                           |  |                       
|Total
      loans charged off             |  |                       
|Recoveries:                               |  |                       
|Real estate                               |  |                       
|Commercial and industrial                 |  |                       
|Consumer                                  |  |                       
|Lease financing                           |  |                       
|Total
      recoveries                    |  |                       
|Net
      loans charged off               |  |                       
|Reserve from East Penn
      Financial    |  |                       
|acquisition                               |  |                       
|Provision for loan losses                 |  |                       
|Allowance, end of year                    |  | $                     
|Ratio
      of net charge offs to average |  |                       
|loans outstanding                         |  |                       

The factors
affecting the allocation of the allowance during 2007 were changes in credit
quality resulting from increases in criticized real estate construction loans
and increases in loan volume from the East Penn Financial acquisition. The
allocation of the allowance for real estate loans at December 31, 2007 increased
$2.6 million as compared to December 31, 2006 principally due to an increase in
criticized real estate construction loans including a loan for one borrower
totaling $7.8 million. The loan is part of a syndicated credit for a local
borrower that has been negatively affected by a decline in home sales. The
allocation of the allowance for commercial and industrial loans at December 31,
2007 increased $3.2 million from December 31, 2006 mostly due to an increase in
commercial loan volume from the East Penn Financial acquisition. In addition,
the allocation of the allowance for consumer loans at December 31, 2007
increased $444,000 primarily due to the increased level of consumer loans
related to the East Penn acquisition. There was no material changes in the
allocation of the allowance for lease financing at December 31, 2007 compared to
December 31, 2006. There were no significant changes in the estimation methods
and assumptions including environmental factors, loan concentrations or terms
that impacted the allowance during 2007. The interest rate environment as well
as weakening in the commercial real estate market has moderately increased our
allowance allocation in concert with the historical trends. It is expected that
the negative trends in the real estate industry will continue to affect credit
quality for the remainder of 2007 and into 2008. The growth in the loan
portfolio and the change in the mix will result in an adjustment to the amount
of the allowance allocated to each category based upon historical loss trends
and other factors.

31

---

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.

**Table 7Allocation of the
Allowance for Loan Losses by Loan Type**

|                                |  | December 31,          
|------------------------------- |  | ----------------------
|                                |  | 2007                  
|                                |  |                       
|                                |  |                       
|                                |  | Amount                
|                                |  | (Dollars in thousands)
|Real
      estate               |  | $                     
|Commercial and
      industrial |  |                       
|Consumer                        |  |                       
|Lease
    financing             |  |                       
|Total                           |  | $                     

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,
2007, the total investment in Berkshire Bancorp, Inc. was $2.6 million
represented by 543,783 shares, resulting in a 17.97% 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 share 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 7.1%, or $118.1 million, to $1.8 billion at December 31, 2007, up from
$1.7 billion at December 31, 2006. This growth is due to $185.2 million acquired
from East Penn Financial at November 16, 2007 and an organic decrease of
approximately $67.2 million. Total deposits increased $468.2 million, or 18.6%
for the same period, which was primarily attributable to deposits associated
with the acquisition of East Penn Financial of $382.7 million at acquisition
date and growth in time deposits. The Corporation continued its emphasis on
government banking to provide additional funding sources through relationships
with municipalities and school districts resulting in both interest-bearing
checking accounts and large time deposits.

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,          
|------------------------------- |  | ----------------------
|                                |  | 2007                  
|                                |  | Amount                
|                                |  | (Dollars in thousands)
|Demandnoninterest-bearing      |  | $                     
|Demandinterest-bearing         |  |                       
|Money
      market and savings  |  |                       
|Time
      deposits             |  |                       
|Total interest-bearing deposits |  | $                     
|Total deposits                  |  | $                     

32

---

The maturity
distribution of certificates of deposit of $100,000 and over as of December 31,
2007 is as follows:

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

(Dollarsin thousands)Three
      months or less
    
    $
    185,640Over three months to
      six months
    
    
    88,555Over
      six months to twelve months
    
    
    95,583Over twelve
      months
    
    
    113,902Total
    
    $
    483,680


Borrowings

Borrowings
increased $118.8 million to $508.3 at December 31, 2007 from $389.5 million at
December 31, 2006. The Corporation decreased long term debt with the Federal
Home Loan Bank by $23.0 million while increasing long-term securities sold under
agreement to repurchase by $105.0 million. Subordinated debt increased to $83.0
million at December 31, 2007. The Corporation completed a private placement of
$22.5 million in aggregate principal amount of fixed/floating rate preferred
securities (subordinated debt) through a newly formed Delaware Trust affiliate
HNC Statutory Trust IV on August 22, 2007. The Corporation acquired $8.2 million
of subordinated debt from East Penn Financial on November 16, 2007.

Borrowings
decreased $49.7 million to $389.5 million at December 31, 2006 from $439.2
million at December 31, 2005. The decrease was the result of reductions of $58.0
million in long-term Federal Home Loan Bank (FHLB) borrowings offset in part by
increases of $8.3 million in short-term borrowings.

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. Treasury 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 December
      31,Securities sold under agreements to
      repurchase(1):
    
    
    2007
    
    2006
    
    2005(Dollars in thousands)Balance at year-end
    
    $
    101,493
    
    
    $
    96,840
    
    
    $
    88,118Weighted
      average rate at year-end
    
    
    3.60
    %
    
    
    4.61
    %
    
    
    3.45
    %Maximum month-end balance
    
    $
    105,205
    
    
    $
    100,944
    
    
    $
    155,239Average
      balance during the year
    
    $
    121,392
    
    
    $
    128,185
    
    
    $
    102,722Weighted average rate during the year
    
    
    4.46
    %
    
    
    4.37
    %
    
    
    2.64
    %


|(1) | Excludes
      long-term securities sold under agreements to repurchase with private
      entities of $105 million at December 31, 2007.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------

Results of Operations

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

33

---

Net Interest Income

Net interest
income on a tax equivalent basis in 2007 decreased $698,000, or .8% to $88.5
million, compared to 2006. During 2007, the Corporation experienced higher
deposit costs offset in part by yield increases in loans and investments. Net
interest income on a tax equivalent basis in 2006 decreased $4.3 million, or
4.6% to $89.2 million, in comparison to 2005. The decrease in 2006 was mostly
due to higher deposit rates, partially offset by higher loan rates and loan
volume.

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**

|                                                 |  | 2007 compared to 2006  |        | 2006 compared to 2005
|------------------------------------------------ |  | ---------------------- | ------ | ---------------------
|                                                 |  | Net                    |        | Due to Change in     
|                                                 |  | **Change**             |        | **Volume**           
|                                                 |  | (Dollars in thousands)
|Increase (decrease) in interest income:          |  |                        |        |                      
|Investment securities(1)                         |  | $                      | 4,935  |                      
|Federal funds sold and deposits in banks         |  |                        | (477   | )                    
|Loans(1)(2)                                      |  |                        | 11,203 |                      
|Total                                            |  |                        | 15,661 |                      
|Increase (decrease) in
      interest expense:   |  |                        |        |                      
|Savings and money market deposits                |  |                        | 9,074  |                      
|Time deposits                                    |  |                        | 4,849  |                      
|Borrowed funds                                   |  |                        | 2,436  |                      
|Total                                            |  |                        | 16,359 |                      
|Net (decrease)
      increase in interest income |  | $                      | (698   | )                    

|(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.

Interest
income on a tax-equivalent basis in 2007 increased $15.7 million, or 8.5% to
$200.6 million, in comparison to 2006. The increase was primarily due to higher
average loans of $108.8 million, or 5.4%, and a 19 basis point rise in the
average rates earned on loans. The growth in average loans during 2007 was
mainly attributable to higher levels of new commercial and industrial
originations and real estate loan originations, including both construction and
consumer and loans acquired from East Penn Financial, partially offset by a
lower level of real estate refinancing loans due to the higher interest rate
environment. The average yield on investments also increased 42 basis points.
Interest expense increased $16.4 million, to $112.1 million during 2007 mostly
attributed to higher deposit rates and an increase in average deposits of $109.4
million. The average rate paid on deposits during 2007 of 3.98% was 45 basis
points higher compared to 2006 primarily due to higher rates on money market
accounts, interest checking accounts and time deposits accounts. The increase in
average deposits was mostly from growth in interest-bearing checking and money
market accounts as well as deposits acquired from East Penn Financial partially
offset by reductions in savings accounts.The Corporation has placed more emphasis on lower
rate deposit products in an effort to improve the net interest
margin.

Interest
income on a tax-equivalent basis in 2006 increased $26.9 million, or 17.0% to
$185.0 million, as compared to 2005. The increase was primarily due to higher
average loans of $114.4 million, or 6.0%, and a 59 basis point rise in the
average rates earned on loans. The average yield on investments also increased
50 basis points. Interest expense increased $31.2 million, to $95.8 million
during 2006 mostly attributed to higher deposit and borrowing rates. The average
rate paid on deposits during 2006 of 3.53% was 111 basis points higher compared
to 2005 primarily due to higher rates on most deposit products. These higher
rates resulted from the continued increase in short-term rates during 2006. The
average rate paid on borrowings for 2006 of 4.69% was 75 basis points higher
than 2005 mainly due to an increase in short-term borrowing rates.

34

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Net Interest Margin

The 2007 net
interest margin of 2.82% was lower than the net interest margins for 2006 and
2005 of 2.95% and 3.27%, respectively. The decline in the net interest margin
during 2007 and 2006 was mainly attributable to the increased customer deposit
costs which outpaced yield increases in loans and investments.

During 2007,
the Corporation continued to manage its balance sheet in an effort to position
it for the inverted yield curve and subsequent falling rates scenario. The
Corporation sold securities with lower fixed rates and longer average lives and
purchased securities with higher yields to take advantage of specific market
sectors and more stable cash flows. As a result, the balance sheet is better
positioned to mitigate market risk.

The table
below 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,
|-------------------------------------------------- |  | -------------------------
|                                                   |  | 2007                     
|                                                   |  | Average                  
|                                                   |  | Balance                  
|                                                   |  | (Dollars in thousands)   
|Assets                                             |  |                          
|Earning
      Assets:                              |  |                          
|Investment securities:                             |  |                          
|Taxable investments                                |  | $                        
|Nontaxable investments(1)                          |  |                          
|Total investment securities                        |  |                          
|Federal funds sold and deposits
      in banks     |  |                          
|Loans(1)(2)                                        |  |                          
|Total earning assets                               |  |                          
|Noninterest-earning
      assets                   |  |                          
|Total
      assets                                 |  | $                        
|Liabilities and
      Shareholders Equity         |  |                          
|Interest-bearing liabilities:                      |  |                          
|Interest-bearing deposits:                         |  |                          
|Savings and money market                           |  | $                        
|Time                                               |  |                          
|Total interest-bearing deposits                    |  |                          
|Borrowed funds                                     |  |                          
|Total interest-bearing liabilities                 |  |                          
|Noninterest-bearing
      liabilities:             |  |                          
|Demand deposits                                    |  |                          
|Other liabilities                                  |  |                          
|Total noninterest-bearing liabilities              |  |                          
|Total
      liabilities                            |  |                          
|Shareholders equity                               |  |                          
|Total liabilities and shareholders equity         |  | $                        
|Net
      interest spread                          |  |                          
|Effect of
      noninterest-bearing sources        |  |                          
|Net interest
      income/margin on earning assets |  |                          
|Less tax equivalent
      adjustment               |  |                          
|Net
      interest income                          |  |                          

|(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.

35

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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 from the Federal Home Loan
Bank. The nature of the Corporations current operations is such that it is not
subject to foreign currency exchange or commodity price risk.

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

At December
31, 2007, the Corporation had cash flow hedges in the form of interest rate
swaps with a notional amount of $45.0 million that have the effect of converting
the rates on money market deposit accounts to a fixed-rate cost of funds. This
strategy will cause the Bank to recognize, in a rising rate environment, a
larger interest rate spread than it otherwise would have without the swaps in
effect. In addition, the Corporation had cash flow hedges with a notional amount
of $10.0 million that have the effect of converting variable debt to a fixed
rate. For these swaps, the Corporation recognized net interest income of
$287,000, $442,000 and $69,000 for the years ended December 31, 2007, 2006 and
2005, respectively and estimates that for 2008, $153,000 will be recognized as a
decrease in net interest income. These swaps mature in 2008. During the first
quarter of 2005, the Corporation terminated a cash flow hedge with a notional
value of $25.0 million. The gross loss related to the termination of this swap
was $310,000 which was amortized through October 2006 in accordance with SFAS
No. 133 Accounting for Derivative Instruments and Hedging Activities. For the
years ended December 31, 2006 and 2005, the Corporation amortized into net
interest income $151,000 and $159,000, respectively related to this swap.
Periodically, the Corporation may enter into fair value hedges to limit the
exposure to changes in the fair value of loan assets. At December 31, 2007, the
Corporation had fair value hedges in the form of interest rate swaps with a
notional amount of $3.9 million. These swaps mature in 2017. The Corporation
recognized net interest income of $59,000 and $7,000 for the years ended
December 31, 2007 and 2006, respectively, which includes $55,000 for 2007
related to two terminated swaps with notional amounts totaling $3.9 million that
were terminated during 2007. At December 31, 2007, the Corporation had swap
agreements with a positive fair value of $10,000 and with a negative fair value
of $366,000. At December 31, 2006, the Corporation had swap agreements with a
positive fair value of $545,000 and with a negative fair value of $21,000. There
was no hedge ineffectiveness recognized during 2007, 2006 and 2005.

During March
2007, the Corporation purchased one and three month Treasury bill interest rate
cap agreements with notional amounts totaling $200 million to limit its exposure
on variable rate now deposit accounts. The initial premium related to these caps
was $73,000 which is being amortized to interest expense over the life of the
cap based on the cap market value. The Corporation recognized amortization of
$8,000 for the year ended December 31, 2007 and estimates that for 2008, $46,000
will be recognized as interest expense. At December 31, 2007, these caps,
designated as cash flow hedges, had a positive fair value of $222. The caps
mature in March 2009. During 2007, the Corporation accelerated the
reclassification of an immaterial amount in other comprehensive income to
earnings as a result of variable-rate interest payments becoming probable not to
occur. The accelerated amount was a loss of $7,000 recognized in interest
expense.

36

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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, 2007, 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, 2007. The table indicates a liability sensitive
one-year cumulative gap position of 6.76% of total earning assets.

**Table 13Contractual
Repricing Data of Interest Sensitive Assets and Liabilities**

|                                                 |  | December 31, 2007     
|------------------------------------------------ |  | ----------------------
|                                                 |  |                       
|                                                 |  | 0
      to            
|                                                 |  | 90 days               
|                                                 |  | (Dollars in thousands)
|Earning assets                                   |  |                       
|Investment
      securities                      |  | $                     
|Federal
      funds sold and deposits in banks   |  |                       
|Loans                                            |  |                       
|Total earning assets                             |  | $                     
|Interest-bearing
      liabilities               |  |                       
|Interest-bearing checking accounts               |  | $                     
|Money market
      funds                         |  |                       
|Savings
      accounts                           |  |                       
|Time
      deposits                              |  |                       
|Borrowed funds                                   |  |                       
|Total interest-bearing liabilities               |  | $                     
|Interest rate swaps                              |  | $                     
|Incremental
    gap                              |  | $                     
|Cumulative gap(1)                                |  | $                     
|Cumulative gap as a percentage of earning assets |  |                       

|(1) |  | The information is based upon
      significant assumptions, including the following: loans and leases are
      repaid by contractual maturity and repricing; securities, except
      mortgage-backed securities, are repaid according to contractual maturity
      adjusted for call features; mortgage-backed security repricing is adjusted
      for estimated early paydowns; interest-bearing demand, regular savings,
      and money market savings deposits are estimated to exhibit some rate
      sensitivity based on managements analysis of deposit withdrawals; 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, 2007 net interest income rate shock simulations show
that the Corporation is within guidelines set by the Corporations
Asset/Liability Policy when rates increase or decrease 100 or 200 basis
points.

37

---

The
following table forecasts changes in the Corporations market value of equity
under alternative interest rate environments as of December 31, 2007. The market
value of equity is defined as the net present value of the Corporations
existing assets and liabilities. The Corporation is within guidelines set by the
Corporations Asset/Liability Policy for the percentage change in the market
value of equity.

Table 14Market Value of Equity

December 31, 2007Asset/LiabilityChange in
    
    
    
    
    
    
    ApprovedMarket
      Value
    
    Market Value
    
    Percentage
    
    Percentof Equity
    
    of Equity
    
    Change
    
    Change(Dollars in thousands)+300
      Basis Points
    
    $416,917
    
    $(116,265
    )
    
    
    21.81
    %
    
    
    
    +/35
    %+200 Basis
    Points
    
    457,103
    
    (76,079
    )
    
    
    14.27
    
    
    
    
    +/25+100
      Basis Points
    
    497,873
    
    (35,309
    )
    
    
    6.62
    
    
    
    
    +/15Flat Rate
    
    533,182
    
    
    
    
    
    0.00
    
    
    
    
    100 Basis Points
    
    538,758
    
    5,576
    
    
    
    1.05
    
    
    
    
    +/15200 Basis Points
    
    528,116
    
    (5,066
    )
    
    
    0.95
    
    
    
    
    +/25300 Basis Points
    
    517,653
    
    (15,529
    )
    
    
    2.91
    
    
    
    
    +/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 $6.4 million during 2007 compared to 2006
mostly as a result of decreased quality of the loan portfolio. The provision for
loan losses for 2006 reflected an increase of $799,000 compared to the 2005
primarily due to inherent risk related to loan growth and the increase in
non-performing loans of $9.3 million. Total net loans charged off in 2007, 2006
and 2005 were $7.6 million, $2.9 million and $2.0 million, respectively.

Noninterest Income

For the year
ended December 31, 2007, noninterest income was $43.3 million, a decrease of
$2.0 million or 4.4% from 2006. Wealth management fee income rose $3.9 million
or 26.1% during 2007 primarily driven by a higher level of life insurance
business at Cornerstone as well as growth in trust assets. Major revenue
component sources of wealth management income include investment management and
advisory fees, trust fees, estate and tax planning fees, brokerage fees, and
insurance related fees. The Bank experienced an increase in deposit service
charges of $1.7 million or 21.1% over the prior year mainly from return check
and overdraft fees and fees from East Penn deposit accounts. During the fourth
quarter of 2007, the Bank recognized a pre-tax gain of $2.3 million on the
sale-leaseback of fifteen bank properties representing a portion of the total
gain of $18.9 million. The remaining gain will be deferred and amortized through
a reduction of occupancy expense over the 15-year term of the leases an annual
amount of approximately $1.1 million. The Corporation also completed a separate
sale-leaseback of office space in October with a recognized pre-tax gain of
$473,000. The deferred gain of $552,000 will be amortized over the 10-year term
of the lease. In addition, gains on sale of investment securities were $1.1
million during 2007 as compared to losses of $674,000 for 2006. The net security
gains during 2007 were primarily the result of the sale of bullet and callable
agency, tax-exempt municipal and mortgage-backed securities. In addition,
noninterest income for 2006 included the pre-tax gains on the sales of the
Banks Honesdale branch and credit card portfolio of $10.7 million and $1.4
million, respectively.

38

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Noninterest
income of $45.3 million during 2006 increased $15.4 million compared to 2005.
During 2006, the Bank recognized a pre-tax gain of $10.7 million on the sale of
its Honesdale branch. The sale of this single Wayne County location included
$74.2 million in deposits, as well as approximately $22.5 million in loans and
other assets, and resulted in a net cash payment of $42.5 million. The
acquisition of the Cornerstone Companies was the primary driver of increases in
wealth management income of $8.1 million for the year of 2006 over 2005,
partially offset by the sale of Cumberland Advisors, which was divested in 2005.
In addition, noninterest income for 2006 included the pre-tax gain of $1.4
million on the sale of the Banks $15.3 million credit card portfolio as well as
increases in fee revenue resulting from credit card operations. Losses on sales
of investment securities for 2006 were $674,000 as compared to gains of $4.8
million for 2005. Noninterest income for 2005 included the gains of $690,000 and
$287,000 on the sales of Harleysville National Banks McAdoo branch and
Cumberland Advisors, Inc, respectively.

Noninterest Expense

Noninterest
expense of $81.4 million for the year ended December 31, 2007 increased $10.5
million or 14.9% in comparison to 2006. Salaries and benefits expense rose $4.2
million during 2007 from the previous year, primarily due to higher staffing
levels resulting from new branch openings and the East Penn Financial
acquisition and higher costs of medical benefits. Occupancy expense increased
$1.3 million for the year ended December 31, 2007, over 2006 mostly due to
several new office locations including the new operations center building in
Harleysville and four new branch openings as well as the addition of the East
Penn branches. Other expense increased $5.0 million during 2007 mainly as a
result of the one-time pre-tax charge of $1.9 million related to the pension
plan curtailment, increased professional and consulting expense as well as East
Penn merger costs of approximately $339,000 and lower deferred loan origination
costs resulting from lower loan volume.

Noninterest
expense of $70.9 million during 2006 increased $8.4 million compared to 2005.
Salaries and benefits expense rose $7.2 million for the year of 2006 over 2005,
primarily related to the acquisition of the Cornerstone Companies, partially
offset by the sale of Cumberland Advisors in the second quarter of 2005, higher
staffing levels resulting from growth, increased incentives, non-recurring
compensation and severance charges primarily related to the former Chief
Executive Officers contract, and compensation expense of $440,000 resulting
from recording the Corporations stock option expense in conformance with FAS
123(R), Stock Based Compensation. Occupancy expense increased $494,000 in 2006
over 2005 mostly due to the Cornerstone Companies acquisition and a new branch
opening. Other expense increased $2.0 million during 2006 mainly as a result of
the Cornerstone Companies acquisition including amortization of intangible
assets of $448,000 partially offset by decreased marketing expenses during 2006.

Income Taxes

The
effective income tax rates for 2007, 2006 and 2005 were 21.5%, 26.3% and 24.2%
were less than the applicable federal statutory rate of 35%. The Corporations
effective rates were lower than the statutory tax rate primarily as a result of
tax-exempt income earned from state and municipal securities and loans and
bank-owned life insurance, as well as for 2005, the non-taxable gain on the sale
of Cumberland Advisors, Inc. The effective tax rate for 2007 was lower than 2006
and 2005 primarily due to the lower level of net income during 2007.

Capital

Capital
formation is important to the Corporations well being and future growth.
Capital, at the end of 2007, was $339.3 million, an increase of $44.6 million
over the end of 2006. The increase was mainly due to the issuance of $39.1
million in common stock in connection with the acquisition of East Penn
Financial. At December 31, 2006, capital was $294.8 million, an increase of
$21.5 million over December 31, 2005. The increase was primarily the result of
the retention of the Corporations earnings and issuances of stock for stock
options including tax benefits partially offset by dividends paid to the
shareholders. Management believes that the Corporations current capital
position and liquidity position are strong and that its capital position is
adequate to support its operations. Management is not aware of any
recommendation by any regulatory authority, which, if it were to be implemented,
would have a material effect on the Corporations capital.

39

---

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 100% 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%. At December 31, 2007, the Corporations Tier 1 risk-adjusted
capital ratio was 9.79%, and the total risk-adjusted capital ratio was 10.67%,
both well above regulatory requirements. The risk-based capital ratios of the
Bank also exceeded regulatory requirements at the end of 2007. At December 31,
2006, the Corporations Tier 1 risk-adjusted capital ratio was 11.75%, and the
total risk-adjusted capital ratio was 12.58%. The lower risk-based capital
ratios of the Corporation at December 31, 2007 compared to December 31, 2006
were primarily attributable to the increase in risk-weighted assets from the
acquisition of East Penn Financial in November 2007 and due to an increase in
loans and federal funds sold.

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. The Corporations leverage ratios were 8.72% and
9.36% at December 31, 2007 and 2006, respectively.The lower leverage ratio of the
Corporation at December 31, 2007 was mainly due to an increase in average assets
from the acquisition of East Penn Financial and increases in average loans and
average federal funds sold.

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%. An
institution is deemed to be critically under capitalized if it has a tangible
equity ratio of 2% or less. As of December 31, 2007, the Bank is above the
regulatory minimum guidelines and meets the criteria to be categorized as a
well capitalized institution.

The cash
dividends paid during 2007 of $.80 per share was 6.7% higher than the cash
dividends in 2006 of $.75. The proportion of net income paid out in dividends
for 2007 was 88.82%, compared to 55.26% for 2006, the increase mainly resulting
from lower net income during 2007. The dividend payout ratios are in compliance
with regulatory guidelines. Management is focusing on improving and increasing
earnings so that the dividend payout ratio remains within acceptable
limits.Activity in both the Corporations dividend reinvestment and stock
purchase plan did not have a material impact on capital during 2007.

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.

40

---

The
resulting projections as of December 31, 2007, 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 externalsources of funds which can be drawn upon when funds are
required. One source of external liquidity is the available line of credit with
the FHLB. As of December 31, 2007, the Bank had borrowings outstanding with the
FHLB of $216.8 million, all of which were long-term. At December 31, 2007, the
Bank had unused lines of credit at the FHLB of $363.1 million and unused federal
funds lines of credit of $195.0 million.In
addition, the Corporationsfunding sources
include investment and loan portfolio cash flows, fed funds sold and short-term
investments, as well as access to the brokered certificate of deposit market and
repurchase agreement borrowings. The Corporation has pledged available for sale
investment securities with a carrying value of $699.0 million and held to
maturity securities of $57.3 million. The Corporation could also increase its
liquidity through its pricing on certificates of deposit products. The
Corporation believes it has adequate funding sources to maintain sufficient
liquidity under varying business conditions.

There are no
known trends or any known demands, commitments, events or uncertainties that
will result in, or that are reasonably likely to result in liquidity increasing
or decreasing in any material way although a significant portion of the
Corporations time deposits mature in 2008. Given the anticipated low rate
environment for much of 2008, we expect to be able to retain most of these
deposits. In the event that additional funds are required, the Corporation
believes its short-term liquidity is adequate as outlined above.

The
following table sets forth contractual obligations and other commitments
representing required and potential cash outflows as of December 31, 2007:

**Table 15Contractual
Obligations and Other Commitments**

|                                                        |  | December 31, 2007     
|------------------------------------------------------- |  | ----------------------
|                                                        |  |                       
|                                                        |  |                       
|                                                        |  | Total                 
|                                                        |  | (Dollars in thousands)
|Minimum
      annual operating leases                   |  | $                     
|Remaining contractual maturities
      of time deposits |  |                       
|Long-term borrowings                                    |  |                       
|Subordinated
    debt                                   |  |                       
|Unfunded home
      equity lines of credit(1)           |  |                       
|Unfunded other loan
      lines of credit               |  |                       
|Unfunded residential mortgages                          |  |                       
|Standby letters of
      credit                         |  |                       
|Total                                                   |  | $                     

|(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, 2007 and December 31, 2006 of $3.4 million and $2.3 million,
respectively and commitments to sell mortgage loans at a specified rate at
December 31, 2007 and December 31, 2006 of $2.4 million and $792,000,
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 December 31, 2007, the Corporation had commitments with a
positive fair value of $19,000 and negative fair value of $19,000 which was
recorded as other income. At December 31, 2006, the Corporation had commitments
with a positive fair value of $15,000 and a negative fair value of $3,000.

During April
2006, the Bank sold its existing credit card portfolio of $15.3 million. The
sale agreement stipulated that any credit card accounts delinquent over 30 days,
overlimit accounts and petitioned bankruptcies would be guaranteed by the Bank
for a period of one year. Of the $15.3 million in credit card receivables sold,
$529,000 was sold with full recourse which was the total potential recourse
exposure at the time of the sale. During the second quarter of 2006, the Bank
recorded a recourse liability of $371,000 which was the entire recourse
liability recorded. This estimate was based on our historic losses as
experienced on similar credit card receivables. The Bank was subject to the full
recourse obligations for a period of one year. At June 30, 2007, the total
potential recourse exposure was reduced to $0 with the expiration of the
one-year recourse period. The Corporations actual loss experience approximated
the initial reserve.

41

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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 2006 and 2007, the minimum operating results
were met resulting in earn-out payments totaling $2.2 million which was recorded
as additional goodwill. At December 31, 2007, the remaining maximum payout is
$4.8 million through 2010.

During
December 2004 and January 2005, the Bank sold lease financing receivables of
$10.5 million. Of these leases, $1.2 million were sold with full recourse and
the remaining leases were sold subject to recourse with a maximum exposure of
ten percent of the outstanding receivable. The total recourse exposure at the
time of the sale of the leases was $2.0 million. During the first quarter of
2005, the Bank recorded a recourse liability of $216,000 which was the entire
recourse liability recorded. This estimate was based on our historic losses as
experienced on similar lease financing receivables. After the first anniversary
of the sale agreement, and on a quarterly basis thereafter, upon written request
by the Bank, the purchaser will review the portfolio performance and may reduce
the total exposure to an amount equal to ten percent of the outstanding net book
value. The Bank will be subject to the full and partial recourse obligations
until all the lease financing receivables have been paid or otherwise been
terminated and all equipment has been sold or disposed of. The final lease
payment is due in 2010. The outstanding balance of these sold leases at December
31, 2007 was $1.0 million with a total recourse exposure of $198,000 and a
current recourse liability of $17,000.

For information on known
uncertainties, see Item 1, Business.

Fourth Quarter 2007 Results (Unaudited)

Net income
for the fourth quarter of 2007 was $6.2 million or $0.20 per diluted share, as
compared to $13.3 million or $0.45 per diluted share for the fourth quarter of
2006.

Net interest
income on a tax equivalent basis in the fourth quarter of 2007 increased $1.8
million, or 8.7%, from the same period in 2006. This increase was mainly
attributable to higher net earning assets from the East Penn Financial
acquisition effective November 16, 2007 and lower interest bearing checking and
money market deposit costs. The net interest margin for the fourth quarter of
2007 of 2.76% remained flat as compared to 2.75% for the fourth quarter of
2006.

Noninterest
income of $14.2 million for the fourth quarter of 2007 decreased $4.0 million
from the comparable period in 2006. Fourth quarter 2007 growth, however, was
achieved over 2006 in wealth management fee income and service charges on
deposits. Wealth management fee income rose $1.5 million or 44.5% primarily
driven by a higher level of life insurance business at Cornerstone as well as
growth in trust assets. Service charges on deposits increased $876,000 or 43.9%
mainly from return check and overdraft fees and fees from East Penn deposit
accounts. During the fourth quarter of 2007, the Corporation recognized gains
from sale-leaseback transactions of $2.8 million and from sales of investment
securities of $657,000, while during 2006 the Corporation recognized a gain on
the sale of the Honesdale branch of $10.7 million and a loss on sale of
investment securities of $674,000.

Noninterest
expense of $23.6 million for the fourth quarter of 2007 increased $5.1 million
from the same period in 2006. Salaries and benefits expense rose $1.3 million
during the fourth quarter of 2007 from the comparable period in 2006, primarily
related to higher staffing levels resulting from new branch openings and the
East Penn acquisition. In addition, occupancy expense increased due to several
new office locations including the new operations center building in
Harleysville and four new branch openings as well as the addition of the East
Penn branches. Other expenses increased mostly due to a one-time pre-tax charge
of $1.9 million related to the pension plan curtailment, merger expenses of
$339,000 and increased professional and consulting fees.

42

---

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 2007
    (1)**                    |        | **Three Months Ended 2006
    (2)**
|----------------------------------- |  | ------------------------------------------------------ | ------ | -----------------------------------
|                                    |  | Dec. 31                                                |        | Sept. 30                           
|                                    |  | (Dollars in thousands, except per share
  information)
|Interest income                     |  | $                                                      | 51,133 |                                    
|Interest
      expense              |  |                                                        | 29,555 |                                    
|Net
      interest income           |  |                                                        | 21,578 |                                    
|**Provision for
      loan** losses |  |                                                        | 4,475  |                                    
|Net
      interest income after     |  |                                                        |        |                                    
|provision for loan losses           |  |                                                        | 17,103 |                                    
|Noninterest
      income            |  |                                                        | 14,171 |                                    
|Noninterest expense                 |  |                                                        | 23,579 |                                    
|Income before
      income          |  |                                                        |        |                                    
|tax expense                         |  |                                                        | 7,695  |                                    
|Income tax expense                  |  |                                                        | 1,514  |                                    
|Net
    income                      |  | $                                                      | 6,181  |                                    
|Net
      income per share          |  |                                                        |        |                                    
|Basic                               |  | $                                                      | 0.20   |                                    
|Diluted                             |  | $                                                      | 0.20   |                                    

| | (1) |  | The results of operations include
      the acquisition of East Penn Financial effective November 16, 2007 and the
      sale lease-back of bank properties during the fourth quarter of
      2007.
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     |  |                                                                                                                                                                                                     
| | (2) |  | The results of operations include
      the sale of the Banks Honesdale branch effective November 10,
    2006.                                                                                    

Item 7A. Quantitative and Qualitative
Disclosures about Market Risk

In the
normal course of conducting business activities, the Corporation is exposed to
market risk, principally interest risk, through the operations of its banking
subsidiary. Interest rate risk arises from market driven fluctuations in
interest rates that affect cash flows, income, expense and values of financial
instruments. The Asset/Liability Committee of the Corporation, using policies
and procedures approved by the Banks Board of Directors, is responsible for
managing the rate sensitivity position.

During the
fourth quarter of 2007, the economy has experienced a continued decline in the
housing market, reductions in credit facilities, rising food and energy prices,
all resulting in short-term rate reductions by the Federal Open Market
Committee. This has created a challenging interest rate environment for the
Corporation which has impacted our interest rate sensitivity exposure.
Information on quantitative and qualitative disclosures about market risk is
incorporated by reference to the discussion contained in Item 7, under the
caption Interest Rate Sensitivity, and Table 13, Contractual Repricing Data
of Interest Sensitive Assets and Liabilities, and Table 14, Market Value of
Equity.

43

---

Item 8.Financial Statements and
Supplementary Data

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIESCONSOLIDATED BALANCE SHEETS

|                                                                                                   |  | December 31,          
|-------------------------------------------------------------------------------------------------- |  | ----------------------
|                                                                                                   |  | 2007                  
|                                                                                                   |  | (Dollars in thousands)
|Assets                                                                                             |  |                       
|Cash and due from
      banks                                                                      |  | $                     
|Federal
      funds sold and securities purchased under agreements to resell                       |  |                       
|Interest-bearing
      deposits in banks                                                           |  |                       
|Total cash and cash equivalents                                                                    |  |                       
|Residential mortgage
      loans held for sale                                                     |  |                       
|Investment securities available for sale                                                           |  |                       
|Investment securities
      held to maturity (market value $57,518 and $59,297,
respectively)      |  |                       
|Loans
      and leases                                                                             |  |                       
|Less: Allowance for
      loan losses                                                              |  |                       
|Net loans                                                                                          |  |                       
|Premises and equipment,
      net                                                                  |  |                       
|Accrued
      interest receivable                                                                  |  |                       
|Goodwill                                                                                           |  |                       
|Intangible assets, net                                                                             |  |                       
|Bank-owned life
      insurance                                                                    |  |                       
|Other
      assets                                                                                 |  |                       
|Total assets                                                                                       |  | $                     
|Liabilities and Shareholders Equity                                                               |  |                       
|Deposits                                                                                           |  |                       
|Noninterest-bearing                                                                                |  | $                     
|Interest-bearing:                                                                                  |  |                       
|Checking                                                                                           |  |                       
|Money market                                                                                       |  |                       
|Savings                                                                                            |  |                       
|Time deposits                                                                                      |  |                       
|Total deposits                                                                                     |  |                       
|Federal funds purchased
      and securities sold under agreements to repurchase                   |  |                       
|Other
      short-term borrowings                                                                  |  |                       
|Long-term
      borrowings                                                                         |  |                       
|Accrued
      interest payable                                                                     |  |                       
|Subordinated
    debt                                                                              |  |                       
|Other
      liabilities                                                                            |  |                       
|Total liabilities                                                                                  |  |                       
|Shareholders equity:                                                                              |  |                       
|Series preferred stock, par value $1 per share; authorized
      8,000,000 shares, none issued     |  |                       
|Common stock, par value $1 per share; authorized
      75,000,000 shares; issued 31,507,021 shares |  |                       
|in 2007 and 29,074,250 shares in 2006                                                              |  |                       
|Additional paid-in capital                                                                         |  |                       
|Retained earnings                                                                                  |  |                       
|Accumulated other comprehensive loss                                                               |  |                       
|Treasury stock, at cost: 174,605 shares in 2007 and
      109,767 shares in 2006                   |  |                       
|Total shareholders equity                                                                         |  |                       
|Total liabilities and shareholders equity                                                         |  | $                     

See accompanying notes to consolidated
financial statements.

44

---

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME

|                                                                             |  | Year Ended December
  31,                    
|---------------------------------------------------------------------------- |  | ---------------------------------------------
|                                                                             |  | 2007                                         
|                                                                             |  | (Dollars in thousands, except per share data)
|Interest income                                                              |  |                                              
|Loans and
      leases, including fees                                       |  | $                                            
|Investment securities:                                                       |  |                                              
|Taxable                                                                      |  |                                              
|Exempt from federal taxes                                                    |  |                                              
|Federal funds sold and
      securities purchased under agreements to resell |  |                                              
|Deposits in banks                                                            |  |                                              
|Total interest income                                                        |  |                                              
|Interest expense                                                             |  |                                              
|Savings and money
      market deposits                                      |  |                                              
|Time
      deposits                                                          |  |                                              
|Short-term
      borrowings                                                  |  |                                              
|Long-term borrowings                                                         |  |                                              
|Total interest expense                                                       |  |                                              
|Net
      interest income                                                    |  |                                              
|Provision for loan
      losses                                              |  |                                              
|Net interest income after provision for loan
      losses                    |  |                                              
|Noninterest
      income                                                     |  |                                              
|Service
      charges                                                        |  |                                              
|Gain (loss) on sales of
      investment securities, net                     |  |                                              
|Gain on
      sale-leaseback of bank properties                              |  |                                              
|Gain on sale of
      branch                                                 |  |                                              
|Gain on
      sale of credit card portfolio                                  |  |                                              
|Wealth
    management                                                        |  |                                              
|Bank-owned life insurance                                                    |  |                                              
|Other income                                                                 |  |                                              
|Total noninterest income                                                     |  |                                              
|Net interest income after provision for loan losses
      and                |  |                                              
|noninterest
      income                                                     |  |                                              
|Noninterest expense                                                          |  |                                              
|Salaries, wages and
      employee benefits                                  |  |                                              
|Occupancy                                                                    |  |                                              
|Furniture and
      equipment                                                |  |                                              
|Marketing                                                                    |  |                                              
|Other expense                                                                |  |                                              
|Total noninterest expense                                                    |  |                                              
|Income before income
      tax expense                                       |  |                                              
|Income
      tax expense                                                     |  |                                              
|Net income                                                                   |  | $                                            
|Net
      income per share information:                                      |  |                                              
|Basic                                                                        |  | $                                            
|Diluted                                                                      |  | $                                            
|Cash dividends per
      share                                               |  | $                                            
|Weighted average number of common shares:                                    |  |                                              
|Basic                                                                        |  |                                              
|Diluted                                                                      |  |                                              

See accompanying notes to consolidated
financial statements.

45

---

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIESCONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY

|                                    |  | Common                                             |  | **Treasury** |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|----------------------------------- |  | -------------------------------------------------- |  | ------------ | - | ------ | - | ---------- |  | ------------ | ------- | ----------------- |  | ------------ | ------- | ----------- |  | ------------- | ------- | ------------- |  | - | ------- | - |  | - | ------- | - |  |  | -----------
|                                    |  | Stock                                              |  | Stock        |   | Common |   |            |  |              |         |                   |  |              |         | Accumulated |  |               |         |               |  |   |         |   |  |   |         |  
|                                    |  | Number                                             |  | **Number**   |   | Stock  |   | Additional |  |              |         |                   |  | Other        |         |             |  |               |         |               |  |   |         |   |  |  
|                                    |  | of                                                 |  | of           |   | Par    |   | Paid in    |  | **Retained** |         | **Comprehensive** |  | **Treasury** |         |             |  |               |         | Comprehensive
|                                    |  | Shares                                             |  | Shares       |   | Value  |   | Capital    |  | Earnings     |         | Income (Loss)     |  | Stock        |         | Total       |  | Income (Loss)
|                                    |  | (Dollars and share
      information in thousands)
|Balance January
      1, 2005       |  | 27,320                                             |  | (1,043       | ) |        | $ | 27,320     |  | $            | 160,039 |                   |  | $            | 99,730  |             |  |               | $ 1,243 |               |  | $ | (17,800 | ) |  | $ | 270,532 |   |  |  |            
|Issuance of stock for
    stock     |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|options, net
      of tax           |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|benefits                            |  | 142                                                |  | 153          |   |        |   | 142        |  |              | 1,284   |                   |  |              |        |             |  |               |        |               |  |   | 3,027   |   |  |   | 4,453   |   |  |  |            
|Issuance of stock
      awards      |  |                                                   |  |             |   |        |   |           |  |              | 5       |                   |  |              |        |             |  |               |        |               |  |   |        |   |  |   | 5       |   |  |  |            
|Stock dividend                      |  | 38                                                 |  | 1,272        |   |        |   | 38         |  |              | 6,090   |                   |  |              | (29,535 | )           |  |               |        |               |  |   | 23,392  |   |  |   | (15     | ) |  |  |            
|Net
      income                    |  |                                                   |  |             |   |        |   |           |  |              |        |                   |  |              | 38,828  |             |  |               |        |               |  |   |        |   |  |   | 38,828  |   |  |  | $38,828    
|Other comprehensive loss,
      net |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|of
      reclassifications and tax  |  |                                                   |  |             |   |        |   |           |  |              |        |                   |  |              |        |             |  |               | (9,861  | )             |  |   |        |   |  |   | (9,861  | ) |  |  | (9,861     
|Purchases of
      treasury stock   |  |                                                   |  | (446         | ) |        |   |           |  |              |        |                   |  |              |        |             |  |               |        |               |  |   | (9,972  | ) |  |   | (9,972  | ) |  |  |            
|Cash dividends                      |  |                                                   |  |             |   |        |   |           |  |              |        |                   |  |              | (20,738 | )           |  |               |        |               |  |   |        |   |  |   | (20,738 | ) |  |  |            
|Comprehensive
      income          |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  | $28,967    
|Balance December 31,
    2005       |  | 27,500                                             |  | (64          | ) |        |   | 27,500     |  |              | 167,418 |                   |  |              | 88,285  |             |  |               | (8,618  | )             |  |   | (1,353  | ) |  |   | 273,232 |   |  |  |            
|Issuance of stock
      for stock   |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|options, net of excess tax          |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|benefits                            |  | 192                                                |  | 220          |   |        |   | 192        |  |              | 1,662   |                   |  |              |        |             |  |               |        |               |  |   | 4,583   |   |  |   | 6,437   |   |  |  |            
|Issuance of stock
awards            |  |                                                   |  |             |   |        |   |           |  |              | 5       |                   |  |              |        |             |  |               |        |               |  |   |        |   |  |   | 5       |   |  |  |            
|Stock-based
      compensation      |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|expense                             |  |                                                   |  |             |   |        |   |           |  |              | 440     |                   |  |              |        |             |  |               |        |               |  |   |        |   |  |   | 440     |   |  |  |            
|Stock dividend                      |  | 1,382                                              |  |             |   |        |   | 1,382      |  |              | 25,188  |                   |  |              | (26,582 | )           |  |               |        |               |  |   |        |   |  |   | (12     | ) |  |  |            
|Net
      income                    |  |                                                   |  |             |   |        |   |           |  |              |        |                   |  |              | 39,415  |             |  |               |        |               |  |   |        |   |  |   | 39,415  |   |  |  | $39,415    
|Other comprehensive
    income,     |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|net of
      reclassifications and  |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|tax
      (1)                       |  |                                                   |  |             |   |        |   |           |  |              |        |                   |  |              |        |             |  |               | 4,050   |               |  |   |        |   |  |   | 4,050   |   |  |  | 4,050      
|Purchases of
      treasury stock   |  |                                                   |  | (265         | ) |        |   |           |  |              |        |                   |  |              |        |             |  |               |        |               |  |   | (5,502  | ) |  |   | (5,502  | ) |  |  |            
|Cash dividends                      |  |                                                   |  |             |   |        |   |           |  |              |        |                   |  |              | (21,779 | )           |  |               |        |               |  |   |        |   |  |   | (21,779 | ) |  |  |            
|Comprehensive
      income          |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  | $43,465    
|Adjustment for adoption
    of      |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|FAS No.
      158, net of tax       |  |                                                   |  |             |   |        |   |           |  |              |        |                   |  |              |        |             |  |               | (1,535  | )             |  |   |        |   |  |   | (1,535  | ) |  |  |            
|Balance December
      31, 2006     |  | 29,074                                             |  | (109         | ) |        |   | 29,074     |  |              | 194,713 |                   |  |              | 79,339  |             |  |               | (6,103  | )             |  |   | (2,272  | ) |  |   | 294,751 |   |  |  |            
|Issuance of stock for
      stock   |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|options, net of tax and             |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|excess tax benefits                 |  |                                                   |  | 76           |   |        |   |           |  |              | (386    | )                 |  |              |        |             |  |               |        |               |  |   | 1,391   |   |  |   | 1,005   |   |  |  |            
|Issuance of
      stock awards      |  |                                                   |  |             |   |        |   |           |  |              | (1      | )                 |  |              |        |             |  |               |        |               |  |   | 5       |   |  |   | 4       |   |  |  |            
|Stock-based
      compensation      |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|expense                             |  |                                                   |  |             |   |        |   |           |  |              | 118     |                   |  |              |        |             |  |               |        |               |  |   |        |   |  |   | 118     |   |  |  |            
|Net
      income                    |  |                                                   |  |             |   |        |   |           |  |              |        |                   |  |              | 26,595  |             |  |               |        |               |  |   |        |   |  | $ | 26,595  |   |  |  | $**26,595**
|Other comprehensive
      income,   |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|net of reclassifications            |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|and tax                             |  |                                                   |  |             |   |        |   |           |  |              |        |                   |  |              |        |             |  |               | 3,537   |               |  |   |        |   |  |   | 3,537   |   |  |  | 3,537      
|Issuance of
      common stock for  |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|acquisition of East Penn            |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  |            
|Financial                           |  | 2,433                                              |  |             |   |        |   | 2,433      |  |              | 36,686  |                   |  |              |        |             |  |               |        |               |  |   |        |   |  |   | 39,119  |   |  |  |            
|Purchases of treasury
      stock   |  |                                                   |  | (141         | ) |        |   |           |  |              |        |                   |  |              |        |             |  |               |        |               |  |   | (2,196  | ) |  |   | (2,196  | ) |  |  |            
|Cash
      dividends                |  |                                                   |  |             |   |        |   |           |  |              |        |                   |  |              | (23,623 | )           |  |               |        |               |  |   |        |   |  |   | (23,623 | ) |  |  |            
|Comprehensive
    income            |  |                                                    |  |              |   |        |   |            |  |              |         |                   |  |              |         |             |  |               |         |               |  |   |         |   |  |   |         |   |  |  | $30,132    
|Balance December 31, 2007           |  | 31,507                                             |  | (174         | ) |        | $ | 31,507     |  | **$**        | 231,130 |                   |  | $            | 82,311  |             |  |               | $(2,566 | )             |  | $ | (3,072  | ) |  | $ | 339,310 |   |  |  |            

See accompanying notes to consolidated
financial statements.

46

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HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                                                        |  | Year Ended December
  31,
|------------------------------------------------------------------------------------------------------- |  | -------------------------
|                                                                                                        |  | 2007                     
|                                                                                                        |  | (Dollars in thousands)   
|Operating activities                                                                                    |  |                          
|Net income                                                                                              |  | $                        
|Adjustments to reconcile net income to net cash provided by
      operating activities:                 |  |                          
|Provision for loan losses                                                                               |  |                          
|Depreciation and amortization                                                                           |  |                          
|Net amortization of investment securities
    discounts/premiums                                        |  |                          
|Deferred income (benefit) expense                                                                       |  |                          
|(Gain) loss on sales of investment securities, net                                                      |  |                          
|Gain on sale-leaseback of bank properties                                                               |  |                          
|Gain on sale of branch                                                                                  |  |                          
|Gain on sale of credit card portfolio                                                                   |  |                          
|Gain on sale of bank subsidiary                                                                         |  |                          
|Bank-owned life insurance income                                                                        |  |                          
|Stock-based compensation expense                                                                        |  |                          
|Pension termination expense                                                                             |  |                          
|Net decrease (increase) in accrued interest receivable                                                  |  |                          
|Net (decrease) increase in accrued interest
      payable                                               |  |                          
|Net decrease (increase) in other assets                                                                 |  |                          
|Net increase (decrease) in other liabilities                                                            |  |                          
|Other, net                                                                                              |  |                          
|Net
      cash provided by operating activities                                                         |  |                          
|Investing
      activities                                                                              |  |                          
|Proceeds from sales of investment securities available for
      sale                                   |  |                          
|Proceeds from maturity
      or calls of investment securities held to maturity                         |  |                          
|Proceeds from maturity or calls of investment securities available
      for sale                       |  |                          
|Purchases of investment
      securities available for sale                                             |  |                          
|Net
      increase in loans                                                                             |  |                          
|Net cash paid due to
      acquisitions, net of cash acquired                                           |  |                          
|Net
      cash paid in sale of branch                                                                   |  |                          
|Net proceeds from sale
      of credit card portfolio                                                   |  |                          
|Net
      cash received from sale of bank subsidiary                                                    |  |                          
|Purchases of premises
      and equipment                                                               |  |                          
|Proceeds from sales of premises and equipment                                                           |  |                          
|Purchase of bank-owned
      life insurance                                                             |  |                          
|Proceeds from sales of other real estate                                                                |  |                          
|Net
      cash used in investing activities                                                             |  |                          
|Financing activities                                                                                    |  |                          
|Net increase in
      deposits                                                                          |  |                          
|(Decrease) increase in federal funds purchased and securities sold
      under agreements to repurchase |  |                          
|Increase (decrease) in
      short-term borrowings                                                      |  |                          
|Advances of long-term borrowings                                                                        |  |                          
|Repayments of long-term
      borrowings                                                                |  |                          
|Proceeds from subordinated debt issuance                                                                |  |                          
|Cash
dividends                                                                                          |  |                          
|Repurchase of common stock                                                                              |  |                          
|Proceeds from the
      exercise of stock options                                                       |  |                          
|Excess
      tax benefits from stock-based compensation                                                 |  |                          
|Other, net                                                                                              |  |                          
|Net
      cash provided by financing activities                                                         |  |                          
|Net increase (decrease)
      in cash and cash equivalents                                              |  |                          
|Cash
      and cash equivalents at beginning of year                                                    |  |                          
|Cash and cash
      equivalents at end of year                                                          |  | $                        
|Cash
      paid during the year for:                                                                    |  |                          
|Interest                                                                                                |  | $                        
|Income taxes                                                                                            |  | $                        
|Supplemental disclosure
      of noncash investing and financing activities:                            |  |                          
|Transfer of assets from loans to other real estate owned                                                |  | $                        
|Acquisition of East Penn Financial, common stock issued                                                 |  | $                        

See accompanying notes to consolidated
financial statements.

47

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies

Harleysville
National Corporation (the Corporation) through its subsidiary bank, Harleysville
National Bank (the Bank), provides a full range of banking services including
loans, deposits, investment management, trust and investment advisory services
to individual and corporate customers primarily located in eastern Pennsylvania.
HNC Financial Company and HNC Reinsurance Company are wholly owned subsidiaries
of the Corporation. HNC Financial Companys principal business function is to
expand the investment opportunities of the Corporation. HNC Reinsurance Company
functions as a reinsurer of consumer loan credit life and accident and health
insurance.

The
Corporation and the Bank are subject to regulations of 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.
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 businesses are susceptible to being
affected by state and federal legislation and regulations.

A summary of
the significant accounting policies consistently applied in the preparation of
the accompanying consolidated financial statements follows.

Principles of Consolidation and Basis
of Presentation

The
consolidated financial statements include the Corporation and its wholly owned
subsidiaries, the Bank, HNC Financial Company, and HNC Reinsurance Company. East
Penn Financial Corporation (East Penn Financial) and its banking subsidiary are
included in the Corporations results effective November 16, 2007. The
Cornerstone Companies (subsidiaries of the Bank) results of operations are
included in the Corporations results effective January 1, 2006. All significant
intercompany accounts and transactions have been eliminated in consolidation and
certain prior period amounts have been reclassified to conform to current year
presentation. The accounting and reporting policies of the Corporation and its
subsidiaries conform with accounting principles generally accepted in the United
States and general practices within the financial services industry.

The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amount of assets and
liabilities as of the dates of the balance sheets and revenues and expenditures
for the periods presented. Actual results could differ from those estimates.

Cash and Cash Equivalents

Cash and
cash equivalents include cash and due from banks, federal funds sold, securities
purchased under agreements to resell and interest-bearing deposits in banks with
an original maturity of generally three months or less.

Investment Securities

The
Corporation accounts for securities under Statement of Financial Accounting
Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity
Securities. Debt securities, which management has the intent and ability to
hold until maturity, are classified as held to maturity and reported at
amortized cost, adjusted for amortization of premiums and accretion of discounts
using the interest method over the life of the securities. Debt and equity
securities expected to be held for an indefinite period of time are classified
as available for sale and are stated at fair value with unrealized gains and
losses excluded from earnings and reported in other comprehensive income, net of
income taxes. 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.

48

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

Amortization
of premiums and accretion of discounts for investment securities available for
sale and held to maturity are included in interest income. Realized gains and
losses on the sale of investment securities are recognized using the specific
identification method and are included in the consolidated statements of income.

The
Corporation follows Financial Accounting Standards Board (FASB) FSP FAS Nos.
115-1 and FAS 124-1 The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments, which provides guidance on determining when
investments in certain debt and equity securities are considered impaired,
whether that impairment is other than temporary, and on measuring such
impairment loss. The Corporation uses various indicators in determining whether
a security is other-than-temporarily impaired, including for equity securities,
if the market value is below its cost for an extended period of time with low
expectation of recovery or for debt securities, when it is probable that the
contractual interest and principal will not be collected. The debt securities
are monitored for changes in credit ratings. Adverse changes in credit ratings
would affect the estimated cash flows of the underlying collateral or issuer.

Loans

Loans that
management intends to hold to maturity are stated at the principal amount
outstanding. Net loans represent the principal loan amount outstanding net of
deferred fees and costs, unearned income and the allowance for loan losses.
Interest on loans is credited to income based on the principal amount
outstanding.

Lease
financing represents automobile and equipment leasing. The lease financing
receivable included in loans is stated at the gross amount of lease payments
receivable, plus the residual value, less income to be earned over the life of
the leases. Income is recognized over the term of the leases using the level
yield method.

Loan
origination fees and direct loan origination costs of completed loans are
deferred and recognized over the life of the loan as an adjustment to the yield.
The net loan origination fees recognized as yield adjustments are reflected in
loan interest income in the consolidated statements of income and the
unamortized balance of the net loan origination fees is reported in loans
outstanding in the consolidated balance sheets.

Income
recognition of interest on loans is discontinued when, in the opinion of
management, the collectibility of principal or interest becomes doubtful. A loan
is generally classified as nonaccrual when principal or interest has
consistently been in default for a period of 90 days or more or because of
deterioration in the financial condition of the borrower, and payment in full of
principal or interest is not expected. When a loan is placed on nonaccrual
status, all accrued but uncollected interest is reversed from income. The
Corporation recognizes income on nonaccrual loans 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 Corporation. The Corporation will not recognize
income if these factors do not exist. 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.

A loan is
considered impaired when, based on current information and events, it is
probable that the Corporation will be unable to collect all amounts due,
including principal and interest, according to the contractual terms of the loan
agreement. The Corporation accounts for impaired loans under SFAS No.
114,Accounting by Creditors for Impairment of a Loan, as amended by SFAS
No. 118, Accounting by Creditors for Impairment of a LoanIncome Recognition
and Disclosures. Individually impaired loans aremeasured based on the present value
of expected future cash flows discounted at the loans effective interest rate,
a loans observable market price, or the fair value of the collateral if the
loan is collateral dependent. Regardless of the measurement method, impairment
is based on the fair value of the collateral when foreclosure is probable. If
the recorded investment in impaired loans exceeds the measure of estimated fair
value, a specific allowance is established as a component of the allowance for
loan losses. The Corporations policy for interest income recognition on
impaired loans is to recognize income on restructured loans under the accrual
method.

49

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

Allowance for Loan Losses

The
allowance for loan losses is maintained at a level that management believes is
sufficient to absorb estimated probable credit losses. The allowance for loan
losses is based on estimated net realizable value unless it is probable that
loans will be foreclosed, in which case the allowance for loan losses is based
on the fair value of the collateral less selling costs. 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 review, borrowers perceived financial and management strengths,
the adequacy of underlying collateral, the dependence on collateral, and the
strength of the present value of future cash flows and other relevant factors.
These factors may be susceptible to significant change. 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. 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.

The
Corporation performs periodic evaluations of the allowance for loan losses that
include both historical, internal and external factors. The actual allocation of
reserve is a function of the application of these factors to arrive at a reserve
for each portfolio type. Management assigns credit ratings and individual
factors to individual groups of loans. Changes in concentrations and quality are
captured in the analytical metrics used in the calculation of the reserve. The
components of the allowance for credit losses consist of both historical losses
and estimates. Management bases its recognition and estimation of each allowance
component on certain observable data that it believes is the most reflective of
the underlying loan losses being estimated. The observable data and accompanying
analysis is directionally consistent, based upon trends, with the resulting
component amount for the allowance for loan losses. The Corporations allowance
for loan losses components includes the following: historical loss estimation by
loan product type and by risk rating within each product type, payment (past
due) status, industry concentrations, internal and external variables such as
economic conditions, credit policy and underwriting changes and results of the
loan review process. The Corporations historical loss component is the most
significant component of the allowance for loan losses, and all other allowance
components are based on the inherent loss attributes that management believes
exist within the total portfolio that are not captured in the historical loss
component.

50

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

The
historical loss components of the allowance represent the results of analyses of
historical charge-offs and recoveries within pools of homogeneous loans, within
each risk rating and broken down further by segment, within the portfolio.
Criticized assets are further assessed based on trends, expressed as
percentages, relative to delinquency, risk rating and nonaccrual, by credit
product.

The
historical loss components of the allowance for commercial and industrial loans
and commercial real estate loans (collectively commercial loans) are based
principally on current risk ratings, historical loss rates adjusted, by
adjusting the risk window, to reflect current events and conditions, as well as
analyses of other factors that may have affected the collectability of loans.
All commercial loans with an outstanding balance over $500,000 are subject to
review on an annual basis. Samples of commercial loans with a pass rating are
individually reviewed annually. Commercial loans that management determines to
be potential problem loans are individually reviewed at a minimum annually. The
review is accomplished via Watchlist Memorandum, and is designed to determine
whether such loans are individually impaired, with impairment measured by
reference to the collateral coverage and/or debt service coverage. Consumer
credit and residential real estate reviews are limited to those loans reflecting
delinquent payment status. Homogeneous loan pools, including consumer and 1-4
family residential mortgages are not subject to individual review but are
evaluated utilizing risk factors such as concentration of one borrower group.
The historical loss component of the allowance for these loans is based
principally on loan payment status, retail classification and historical loss
rates, adjusted by altering the risk window, to reflect current events and
conditions.

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

The historic
loss model includes a judgmental component (environmental factors) that reflects
managements belief that there are additional inherent credit losses based on
loss attributes not adequately captured in the lagging indicators. The
environmental factors are based upon managements review of trends in the
Corporations primary market area as well as regional and national economic
trends. Management utilizes various economic factors that could impact
borrowers future ability to make loan payments such as changes in the interest
rate environment, product supply shortages and negative industry specific
events. Management utilizes relevant articles from newspapers and other
publications that describe the economic events affecting specific geographic
areas and other published economic reports and data. Furthermore, given that
past-performance indicators may not adequately capture current risk levels,
allowing for a real-time adjustment enhances the validity of the loss
recognition process. There are many credit risk management reports that are
synthesized by credit risk management staff to assess the direction of credit
risk and its instant effect on losses. It is important to continue to use
experiential data to confirm risk as measurable losses will continue to manifest
themselves at higher than normal levels even after the economic cycle has begun
an upward swing and lagging indicators begin to show improvement. The judgmental
component is allocated to the specific segments of the portfolio based on the
historic loss component.

Statement of
Position (SOP) 03-3, Accounting for Loans or Certain Debt Securities Acquired in
a Transfer requires impaired loans for which it is probable that the investor
will be unable to collect all contractually required payments receivable to be
recorded at the present value of amounts expected to be received and prohibits
carrying over or creation of valuation allowances in the initial accounting for
these loans. The Company evaluates the assets acquired in its acquisitions for
applicability to this statement.

51

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

Mortgage Servicing

The
Corporation performs various servicing functions on mortgage loans owned by
others. A fee, usually based on a percentage of the outstanding principal
balance of the loan, is received for these services.

The
Corporation accounts for its transfers and servicing financial assets in
accordance with SFAS No. 156, Amending Accounting for Separately Recognized
Servicing Assets and Liabilities and SFAS No. 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities. The
Corporation originates mortgages under a definitive plan to sell or securitize
those loans and service the loans owned by the investor. The Corporation
initially recognizes and measures at fair value its servicing assets and
allocates the carrying amount between the assets sold based on the relative fair
values at the date of transfer. The Corporation recognizes and initially
measures at fair value, a servicing asset each time it undertakes an obligation
to service a financial asset by entering into a servicing contract. The
Corporation uses the amortization method for subsequent measurement of its
servicing assets. Servicing assets are amortized in proportion to and over the
period of net servicing income and assessed for impairment based on fair value
at each reporting period.

The
Corporation estimates the fair value of servicing rights based upon the present
value of expected future cash flows associated with the servicing rights
discounted at a current market rate using the same assumptions used by bidders
of servicing portfolios. The loans are grouped into homogenous pools for
analysis based upon the predominant risk characteristics including origination
date, loan type, interest rate and term. Assumptions are developed that include
estimates of servicing costs, loan defaults, prepayment speeds, discount rates,
market conditions and other factors that impact the value of retained interests.
If the carrying value of mortgage servicing rights for a pool exceeds the
estimated fair value, an impairment loss is recognized through a charge to the
valuation allowance with a corresponding adjustment to earnings.

Mortgage
loans originated and intended for sale in the secondary market are carried at
the lower of aggregate cost or estimated fair value. Gains and losses on sales
of loans are also accounted for in accordance with SFAS No. 134, Accounting for
Mortgage Securities Retained after the Securitization of Mortgage Loans Held for
Sale by a Mortgage Banking Enterprise. This statement requires that an entity
engaged in mortgage banking activities classify the retained mortgage-backed
security or other interest, which resulted from the securitizations of a
mortgage loan held for sale, based upon its ability and intent to sell or hold
these investments.

Premises and Equipment

Premises and
equipment are stated at cost less accumulated depreciation. Depreciation is
recorded using the straight-line and accelerated depreciation methods over the
estimated useful lives of the assets. Leasehold improvements are amortized over
the remaining useful lives of the leases (including renewal options) or
estimated useful lives, whichever is shorter.

Net Assets in Foreclosure

Net assets
in foreclosure include foreclosed real estate which is carried at the lower of
cost (lesser of carrying value of loan or fair value at date of acquisition) or
estimated fair value of the collateral less selling costs. Any write-down, at or
prior to the dates the real estate is considered foreclosed, is charged to the
allowance for loan losses. Subsequent write-downs and expenses incurred in
connection with holding such assets are recorded in other expenses. Any gain or
loss upon the sale of real estate owned is charged to operations as incurred.
Net assets in foreclosure also includes foreclosed leases which are carried at
lower of cost (lesser of carrying value of loan or fair value at date of
acquisition) or estimated fair value less selling costs.

52

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

Goodwill and Other Intangible Assets

Goodwill
represents the excess of the cost of an acquired entity over the fair value of
the identifiable net assets acquired in accordance with the purchase method of
accounting. Goodwill is not amortized but is reviewed for potential impairment
on an annual basis, or more often if events or circumstances indicate that there
may be impairment, in accordance with SFAS No. 142, Goodwill and Other
Intangible Assets. 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. Core deposit intangibles are a
measure of the value of checking and savings deposits acquired in business
combinations accounted for under the purchase method. Core deposit intangibles
and other identified intangible assets with finite useful lives are amortized on
a straight-line basis or sum of the years digits basis over their estimated
lives (ranging from five to ten years) and identifiable intangible assets are
evaluated for impairment if events and circumstances indicate a possible
impairment in accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. The Corporation employs general industry
practices in evaluating the fair value of its goodwill and other intangible
assets. The Corporation calculates the fair value using a combination of the
following valuation methods: dividend discount analysis under the income
approach, which calculates the present value of all excess cash flows plus the
present value of a terminal value and price/earnings multiple under the market
approach. Any impairment loss related to goodwill and other intangible assets is
reflected as other noninterest expense in the statement of operations in the
period in which the impairment was determined. No assurance can be given that
future impairment tests will not result in a charge to earnings. See Note 2 
Acquisitions / Dispositions and Note 8  Goodwill and Other Intangibles for
additional information.

Derivatives

The
Corporation accounts for derivatives in accordance with SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities as amended. The
Statement requires the Corporation to recognize all derivative instruments at
fair value as either assets or liabilities. The accounting for changes in the
fair value of a derivative instrument depends on whether, at inception, it has
been designated and qualifies as part of a hedging relationship. For derivatives
not designated as hedges, the gain or loss is recognized in current earnings.
When the Corporation designates a derivative as hedging, it is required to
establish at the inception of the hedge, the method it will use for assessing
the effectiveness of the hedging derivative and the measurement approach for
determining the ineffective aspect of the hedge. Those methods must be
consistent with the Corporations approach to managing risk.

The
Corporation enters into interest rate swap contracts to modify the interest rate
characteristics from variable to fixed in order to reduce the impact of interest
rate changes on future net interest income. Net amounts payable or receivable
from these contracts are accrued as an adjustment to interest income or interest
expense of the related asset or liability. Interest rate swap agreements are
designated as either cash flow hedges or fair value hedges. For cashflow hedges,
the fair value of these derivatives is reported in other assets or other
liabilities and offset in accumulated other comprehensive income for the
effective portion of the derivatives. Amounts reclassed into earnings, when the
hedged transaction culminates, are included in net interest. Ineffectiveness of
the strategy, as defined under SFAS 133, if any, is reported in net interest. In
a fair value hedge, the fair values of the interest rate swap agreements and
changes in the fair values of the hedged items are recorded in the Corporations
consolidated balance sheet with the corresponding gain or loss being recognized
in current earnings. The difference between changes in the fair values of
interest rate swap agreements and the hedged items represents hedge
ineffectiveness and is recorded in net interest in the Corporations income
statement. The Corporation performs an assessment, both at the inception of the
hedge and quarterly thereafter, to determine whether these derivatives are
highly effective in offsetting changes in the value of the hedged items.

53

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

Stock-Based Compensation

The
Corporation recognizes compensation expense for stock options in accordance with
SFAS 123 (revised 2004), Share-Based Payment (SFAS 123R) adopted at January 1,
2006 under the modified prospective application method of transition. The
expense of the option is generally measured at fair value at the grant date with
compensation expense recognized over the service period, which is usually the
vesting period. For grants subject to a service condition, the Corporation
utilizes the Black-Scholes option-pricing model (as used under SFAS 123) to
estimate the fair value of each option on the date of grant. The Black-Scholes
model takes into consideration the exercise price and expected life of the
options, the current price of the underlying stock and its expected volatility,
the expected dividends on the stock and the current risk-free interest rate for
the expected life of the option. For grants subject to a market condition, the
Corporation utilizes a Monte Carlo simulation to estimate the fair value and
determine the derived service period. Compensation is recognized over the
derived service period with any unrecognized compensation cost immediately
recognized when the market condition is met. The Corporations estimate of the
fair value of a stock option is based on expectations derived from historical
experience and may not necessarily equate to its market value when fully vested.
In accordance with SFAS 123(R), the Corporation estimates the number of options
for which the requisite service is expected to be rendered.Prior to January 1, 2006, the
Corporation followed SFAS 123 and Accounting Principles Board (APB) Opinion No.
25,"Accounting for Stock Issued to
Employees,"withpro formadisclosures of net income
and earnings per share, as if the fair value-based method of accounting defined
in SFAS 123 had been applied. See Note 14  Stock-Based Compensation for
additional information.

In December
2007, the SEC issued Staff Accounting Bulletin (SAB) No. 110, Certain
Assumptions Used in Valuation Methods. SAB 110 expresses the views of the staff
regarding the use of a simplified method as discussed in SAB No. 107,
Share-Based Payment, in developing an estimate of expected term of plain
vanilla share options in accordance with FAS 123(R). The staff stated in SAB
107 that it would not expect a company to use the simplified method for share
option grants after December 31, 2007. Under SAB 110, the SEC staff will
continue to accept, under certain circumstances, the use of the simplified
method beyond December 31, 2007 to help public companies, mostly small firms,
that lack historical data on the exercising of options by employees. SAB 110 is
not expected to have any material impact on the Corporations financial
statements.

Income Taxes

There are
two components of income tax expense: current and deferred. Current income tax
expense approximates cash to be paid or refunded for taxes for the applicable
period. Deferred tax assets and liabilities are recognized due to differences
between the basis of assets and liabilities as measured by tax laws and their
basis as reported in the financial statements. 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. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred taxes of a change in tax rates is recognized in
income in the period that includes the enactment date. Deferred tax expense or
benefit is recognized for the change in deferred tax liabilities or assets
between periods.

54

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

Pension Plans

The
Corporation has certain employee benefit plans covering substantially all
employees. The Corporation accrues service cost as incurred. The Corporations
current measurement date for plan assets and obligations is fiscal year-end. The
Corporations defined benefit pension plan was frozen at the current benefit
levels as of December 31, 2007 at which time the accrual of future benefits for
eligible employees ceased. The Corporation accounts for its Pension Plan in
accordance with SFAS No. 87 Employers Accounting for Pensions, and SFAS No.
88 Employers Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits, as amended by SFAS No. 158
Employers Accounting for Defined Benefit Pension and Other Postretirement
Plans. SFAS 158, effective at the end of fiscal year 2006, requires companies
to recognize the funded status of defined benefit pension plans on the balance
sheet and recognize changes in the funded status of the plan in the year in
which the changes occur. See Note 12  Pension Plans for additional information.

Bank-Owned Life Insurance

The
Corporation invests in bank-owned life insurance (BOLI). BOLI involves the
purchasing of life insurance by the Corporation on a chosen group of employees.
The Corporation is the owner and beneficiary of the policies. This pool of
insurance, due to tax advantages to the Bank, is profitable to the Corporation.
This profitability is used to offset a portion of future benefit cost increases.
The Banks deposits fund BOLI and the earnings from BOLI are recognized as
noninterest income.

Earnings Per Share

The
Corporation follows the provisions of SFAS No. 128, Earnings per Share. Basic
earnings per share exclude dilution and are computed by dividing income
available to common shareholders by the weighted-average common shares
outstanding during the period. Diluted earnings per share take into account the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised and converted into common stock. Proceeds assumed to
have been received on such exercise or conversion are assumed to be used to
purchase shares of the Corporations common stock at the average market price
during the period, as required by the treasury stock method of accounting. The
effects of securities or other contracts to issue common stock are excluded from
the computation of diluted earnings per share in periods in which the effect
would be antidilutive. All weighted average shares, actual shares and per share
information in the financial statements have been adjusted retroactively for the
effect of stock dividends.

Marketing Costs

It is the Corporations policy to
expense marketing costs in the period in which they are incurred.

Comprehensive Income

The
Corporation records unrealized gains and losses on available for sale investment
securities, net of tax and gains and losses on cash flow hedges, net of tax in
other comprehensive income in shareholders equity. Gains and losses on
available for sale investment securities are reclassified to net income as the
gains or losses are realized upon sale of the securities. Other-than-temporary
impairment charges are reclassified to net income at the time of the charge.
Gains or losses on derivatives are reclassified to net income as the hedged item
affects earnings. The Corporation follows the disclosure provisions of SFAS No.
130, Reporting Comprehensive Income.

55

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

Variable Interest Entities

Harleysville
Statutory Trust I (Trust I), HNC Statutory Trust II (Trust II), HNC Statutory
Trust III (Trust III), HNC Statutory Trust IV (Trust IV), and East Penn
Statutory Trust, (collectively, the Trusts) are considered variable interest
entities under FASB Interpretation 46, Consolidation of Variable Interest
Entities, as revised (FIN 46R). Accordingly, the Corporation is not considered
the primary beneficiary and therefore the Trusts are not consolidated in the
Corporations financial statements.

Recent Accounting Pronouncements

In December
2007, the FASB issued SFAS No. 141(R), Business Combinations (revised 2007).
FAS 141(R) will significantly change how entities apply the acquisition method
to business combinations. The new standard requires the acquiring entity in a
business combination to recognize all (and only) the assets acquired and
liabilities assumed in the transaction; establishes the acquisition-date fair
value as the measurement objective for all assets acquired and liabilities
assumed; and requires the acquirer to disclose to investors and other users all
of the information they need to evaluate and understand the nature and financial
effect of the business combination. This Statement is broader than SFAS 141,
which only applied to business combinations in which control was obtained by
transferring consideration. SFAS 141(R) applies to all transactions or other
events in which an entity (the acquirer) obtains control of one or more
businesses including combinations achieved without the transfer of
consideration. SFAS 141(R) requires an acquirer to recognize the assets
acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree at the acquisition date, measured at their fair values as of that date,
with limited exceptions specified in the Statement. This replaces SFAS 141s
cost-allocation process, which required the cost of an acquisition to be
allocated to the individual assets acquired and liabilities assumed based on
their estimated fair values. SFAS 141 required the acquirer to include the costs
incurred to effect the acquisition (acquisition-related costs) in the cost of
the acquisition that was allocated to the assets acquired and the liabilities
assumed. SFAS 141 (R) requires those costs to be recognized separately from the
acquisition. In accordance with SFAS 141, restructuring costs that the acquirer
expected but was not obligated to incur were recognized as if they were a
liability assumed at the acquisition date. SFAS 141(R) requires the acquirer to
recognize those restructuring costs that do not meet the criteria in SFAS No.
146, Accounting for Costs Associated with Exit or Disposal Activities as an
expense as incurred. Acquisition related transaction costs will be expensed as
incurred. SFAS 141(R) requires an acquirer to recognize assets or liabilities
arising from all other contingencies (contractual contingencies) as of the
acquisition date, measured at their acquisition-date fair values only if it is
more likely than not that they meet the definition of an asset or a liability on
the acquisition date. Under SFAS 141(R), changes in deferred tax asset valuation
allowances and acquired income tax uncertainties in a business combination after
the measurement period will impact income tax expense. Additionally, under SFAS
141(R), the allowance for loan losses of an acquiree will not be permitted to be
recognized by the acquirer. SFAS 141(R) is effective for fiscal years beginning
after December 15, 2008. The Corporation is currently assessing the impact of
the adoption of this FAS 141(R) on its financial statements.

In December
2007, the FASB issued SFAS No. 160, Noncontrolling Interest in Consolidated
Financial Statements–an amendment of Accounting Research Bulletin No. 51, Consolidated
Financial Statements. FAS 160 requires all entities to report noncontrolling
(minority) interests in subsidiaries as equity in the consolidated financial
statements. Its intention is to eliminate the diversity in practice regarding
the accounting for transactions between an entity and noncontrolling interests.
SFAS 160 is effective for fiscal years beginning after December 15, 2008. The
Corporation is currently assessing the impact of the adoption of SFAS 160 on its
financial statements.

56

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

In November
2007, the SEC issued SAB 109, Written Loan Commitments Recorded at Fair Value
through Earnings. SAB 109 revises and rescinds portions of SAB 105,
Application of Accounting Principles to Loan Commitments. The SEC staffs
current view is that the expected net future cash flows related to the
associated servicing of a loan should be included in the measurement of
derivative and other written loan commitments that are accounted for at fair
value through earnings. That view is consistent with the guidance in Financial
Accounting Standards Board (FASB) No. 156, Accounting for Servicing of
Financial Assets and FASB No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities. SAB 109 retains the view expressed in SAB 105 that
internally developed intangible assets should not be recorded as part of the
fair value of a derivative loan commitment. The guidance in SAB 109 is effective
for derivative loan commitments issued or modified in fiscal quarters beginning
after December 15, 2007. The adoption of SAB 109 is not expected to have a
material impact on the Corporations financial statements.

In June
2007, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 06-11,
Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.
EITF06-11 requires companies to recognize the income tax benefit realized from
dividends or dividend equivalents that are charged to retained earnings and paid
to employees for nonvested equity-classified employee share-based payment awards
as an increase to additional paid-in capital. EITF 06-11 is effective for fiscal
years beginning after September 15, 2007. The Company does not expect EITF 06-11
will have a material impact on its financial statements.

In April 2007, the FASB issued FASB
Staff Position (FSP) No. FIN 39-1, Amendment of FASBInterpretation No. 39, Offsetting of Amounts Related to Certain
Contracts. FIN 39-1 permits a reporting entity that is party to a master
netting arrangement to offset the receivable or payable recognized upon payment
or receipt of cash collateral against the fair value amounts recognized against
derivative instruments that had been offset under the same master netting
arrangement. This FSP also replaces the terms conditional contracts and
exchange contracts with the broader term derivative instruments. FIN 39-1
applies to fiscal years beginning after November 15, 2007. A reporting entity
also must recognize the effects of initial adoption as a change in accounting
principle through retrospective application for all periods presented, unless it
is impracticable to do so. The Corporation has chosen not to adopt FIN 39-1 due
to the immaterial impact on the Corporations financial statements.

In February
2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities—Including an amendment of FASB Statement No. 115. SFAS 159
permits entities to choose to measure many financial instruments and certain
other items at fair value. SFAS 159 provides entities with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. The Statement also establishes presentation and disclosure
requirements. The entity shall report the effect of the first re-measurement to
fair value as a cumulative-effective adjustment to the opening balance of
retained earnings. At each subsequent reporting date, unrealized gains and
losses on items for which the fair value option has been elected will be
reported in earnings. The fair value option may be applied instrument by
instrument, with a few exceptions, is irrevocable and is applied only to entire
instruments. Most of the provisions of SFAS 159 apply only to entities that
elect the fair value option. However, the amendment to SFAS 115, Accounting for
Certain Investments in Debt and Equity Securities, applies to all entities with
available-for-sale and trading securities. If the fair value option is elected
for any available-for-sale or held-to-maturity securities at the effective date,
the cumulative unrealized gains and losses at that date shall be included in the
cumulative-effect adjustment. SFAS 159 is effective as of the beginning of an
entitys first fiscal year that begins after November 15, 2007. Early adoption
was permitted as of the beginning of a fiscal year that began on or before
November 15, 2007, provided that the entity also elected to apply the provisions
of SFAS 157, Fair Value Measurements. The Corporation is not currently
electing to measure any additional financial instruments at fair value under
this Statement and the adoption of FAS 159 is not expected to have a material
impact on its financial statements.

57

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

In September
2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS 157
clarifies the definition of fair value, establishes a framework for measuring
fair value in generally accepted accounting principles and expands disclosures
about fair value measurements. SFAS 157 defines fair value as the price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. The Statement
will require the Corporation to apply valuation techniques that (1) place
greater reliance on observable inputs and less reliance on unobservable inputs
and (2) are consistent with the market approach, the income approach, and/or the
cost approach. The definition and framework apply to both items recognized and
reported at fair value in the financial statements and items disclosed at fair
value in the notes to the financial statements. The Statement also requires
expanded disclosure in interim and annual financial statements about how the
Corporation uses fair value. The disclosures focus on items measured at fair
value based on significant unobservable inputs and the effect of fair value
measurements on earnings. The disclosures are only required for items recognized
and reported at fair value in the financial statements. The Statement does not
change existing accounting rules governing what can or what must be recognized
and reported at fair value in the Corporations financial statements, or
disclosed at fair value in the Corporations notes to the financial statements.
Additionally, SFAS 157 does not eliminate practicability exceptions that exist
in accounting pronouncements amended by this Statement when measuring fair
value. As a result, the Corporation will not be required to recognize any new
instruments at fair value. SFAS 157 is effective for fiscal years beginning
after November 15, 2007, and interim periods within those fiscal years, although
earlier application was encouraged. Prospective application of the provisions of
SFAS 157 is required as of the beginning of the fiscal year in which it is
initially applied, except for certain circumstances specified in the Statement
that require retrospective application. In March 2008, the FASB issued FSP FAS
157-2 to partially delay the effective implementation of SFAS 157 until fiscal
years beginning after November, 15, 2008 for all nonfinancial assets and
liabilities except those that are recognized or disclosed at fair value in
financial statements on a recurring basis (at least annually). Assets and
liabilities currently reported or disclosed at fair value on a recurring basis
in the Corporations financial statements include investment securities,
impaired loans, residential mortgage loans held for sale, mortgage servicing
rights and derivatives. The Corporation does not anticipate any material impact
on its financial statements upon partial adoption of FAS 157 for its fiscal year
beginning January 1, 2008. The Corporation is in the process of assessing the
impact of the adoption of SFAS 157 for its fiscal year beginning January 1, 2009
relating to nonfinancial assets and liabilities on the Corporations financial
statements including goodwill and other intangible assets.

At its September 2006 meeting, the
EITF reached a final consensus on Issue 06–05, Accounting for Purchases of Life
Insurance–Determining the Amount That Could be Realized in Accordance with FASB
Technical Bulletin No. 854. Issue 06-05 concludes that in determining the
amount that could be realized under an insurance contract accounted for under
FASB Technical Bulletin No. 85–4, Accounting for Purchases of Life Insurance, the
policyholder should (1) consider any additional amounts included in the
contractual terms of the policy; (2) assume the surrender value on a
individual–life by
individual–life
policy basis; and (3) not discount the cash surrender value component of the
amount that could be realized when contractual restrictions on the ability to
surrender a policy exist. Issue 06–05 should be adopted through either (1) a change in accounting
principle through a cumulative–effect adjustment to retained earnings as of the beginning of
the year of adoption or (2) a change in accounting principle through
retrospective application to all prior periods. Issue 06–05 is effective for fiscal years
beginning after December 15, 2006. The application of Issue 06–05 did not have a material
effect on the Companys financial position or results of operations.

58

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

At its
September 2006 meeting, the EITF reached a final consensus on Issue
06–04, Accounting
for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
Split–Dollar Life
Insurance Arrangements. In accordance with the EITF consensus, an agreement by
an employer to share a portion of the proceeds of a life insurance policy with
an employee during the postretirement period is a postretirement benefit
arrangement required to be accounted for under SFAS No. 106, Employers
Accounting for Postretirement Benefits Other than Pensions or APB Opinion No.
12, Omnibus Opinion 1967. Furthermore, the purchase of a split–dollar life insurance policy
does not constitute a settlement under SFAS No. 106 and, therefore, a liability
for the postretirement obligation must be recognized under SFAS No. 106 if the
benefit is offered under an arrangement that constitutes a plan or under APB No.
12 if it is not part of a plan. The provisions of Issue 06–04 are to be applied through
either a cumulative–effect adjustment to retained earnings as of the beginning of the year of
adoption or retrospective application. Issue 06–04 is effective for annual or interim reporting
periods beginning after December 15, 2007. The application of Issue 06-04 is not
expected to have a material effect on the Corporations financial
statements.

In June
2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in
Income Taxes - An Interpretation of FASB Statement No. 109 (FIN 48). FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprises financial statements in accordance with SFAS No. 109, Accounting
for Income Taxes. FIN 48 also prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. The provisions of
FIN 48 are to be applied to all tax positions upon initial adoption of this
standard. Only tax positions that meet a more-likely-than-not recognition
threshold at the effective date may be recognized or continue to be recognized
upon adoption of FIN 48. The cumulative effect of applying the provisions of FIN
48 are to be reported as an adjustment to the opening balance of retained
earnings (or other appropriate components of equity or net assets in the
statement of financial position) for that fiscal year. The new interpretation
also provides guidance on de-recognition, classification, interest and
penalties, accounting in interim periods, disclosure, and transition. The
provisions of FIN 48 are effective for fiscal years beginning after December 15,
2006. The Corporations implementation of this interpretation did not have a
material impact on the Corporations financial position or results of operations
and did not result in an adjustment to opening retained earnings.

In May 2007,
the FASB issued FIN 48-1, Definition of Settlement in FIN 48 to provide
guidance on how an enterprise should determine whether a tax position is
effectively settled for the purpose of recognizing previously unrecognized tax
benefits. FIN 48-1 is effective retroactively to January 1, 2007. The
implementation of this standard did not have any impact on the Corporations
consolidated financial position or results of operations.

59

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 2Acquisitions / Dispositions

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 will
continue 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
will be fully responsible for all costs associated with the operation, repair
and maintenance of the properties during the lease terms and will be 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 will be deferred and amortized through a
reduction of occupancy expense over the 15-year term of the leases an annual
amount of approximately $1.1 million. The properties sold had a carrying value
of $19.5 million. The Corporation also completed a separate sale-leaseback of
office space 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 will be
amortized over 10-year term of the lease.

Effective
November 16, 2007, the Corporation completed its acquisition of East Penn
Financial Corporation (East Penn Financial). Under the terms of the Agreement
and Plan of Merger dated as of May 15, 2007, as amended August 29, 2007, East
Penn Financial was acquired by Harleysville National Corporation and East Penn
Financials wholly owned subsidiary, East Penn Bank, a $451 million state
chartered, FDIC insured bank, offering deposit and lending services throughout
the Lehigh Valley, PA merged with and into Harleysville National Bank. These
transactions were effective on November 16, 2007. Headquartered and founded in
Emmaus, PA in 1990, East Penn Financial had nine banking offices located in
Lehigh, Northampton and Berks Counties. The acquisition expands the branch
network that the Corporation has in the Lehigh Valley and its opportunity to
provide East Penn customers with a broader mix of products and services. East
Penn Financials results of operations are included in the Corporations results
from the date of acquisition, November 16, 2007.

The
Corporation acquired 100% of the outstanding shares of East Penn Financial.
Based on the terms of the merger agreement and stock prices at the effective
time of the merger, the transaction was valued at approximately $85.0 million or
$13.41 per share of East Penn Financial stock. Each shareholder of East Penn
Financial had the right to elect to receive either cash only or the
Corporations shares only for each share of East Penn Financial stock, but could
receive a combination of both in the aggregate, subject to the allocation
provisions set forth in the Merger Agreement. The amount of final per share
consideration was based on a formula that was determined by the average of the
closing prices for the Corporations common stock for the twenty business day
period ending eleven business days before the effective time of the merger.

60

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 2Acquisitions / Dispositions
(Continued)

East Penn Financial shares of 2,890,125
were exchanged at a conversion ratio of .8416 for 2,432,771 shares of theCorporations common stock and East Penn
Financial shares of 3,444,229 were exchanged for cash consideration of $14.50
per share totaling $49.9 million. East Penn Financial stock options of 136,906
were exchanged for cash consideration of $792,000 and options of 29,092 were
exchanged at a conversion ratio of .8416 to acquire 25,480 shares of the
Corporations common stock options, with exercise prices ranging from $5.94 to
$13.07 per share with a total fair value of $111,000. The allocation of the
Corporations common stock and cash was such that the East Penn Financial
shareholders did not recognize gain or loss for federal income tax purposes on
those East Penn Financial shares that were exchanged for the Corporations
common stock in the merger.

The
following table summarizes the fair values of East Penn Financials assets
acquired and liabilities assumed at the date of acquisition. This transaction
was accounted for using the purchase method of accounting in accordance with
SFAS No. 141, Business Combinations.

At November
      16,2007(Dollars in
      thousands)Assets:Cash and cash
      equivalents
    
    $
    18,431Investment securities available for sale
    
    
    66,151Loans
    
    
    337,666Less:
      Allowance for loan losses
    
    
    (3,250
    )Net loans
    
    
    334,416Other
      assets
    
    
    32,139Total
      assets
    
    $
    451,137Liabilities:Noninterest-bearing
      deposits
    
    $
    46,401Interest-bearing deposits
    
    
    336,311Short-term
      borrowings
    
    
    11,082Long-term borrowings
    
    
    19,038Other
      liabilities
    
    
    11,873Total
      liabilities
    
    $
    424,705Net assets
      acquired
    
    $
    26,432


61

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 2Acquisitions / Dispositions
(Continued)

Goodwill of
$64.9 million was recorded in connection with the acquisition of East Penn
Financial and allocated to the Community Banking segment. The following table
provides the calculation of the goodwill. Management is in the process of
evaluating and finalizing the identifiable intangible assets and purchase
accounting adjustments, thus the allocation of the purchase price is subject to
refinement. The following table provides the calculation of the goodwill:

(Dollars
      inthousands)Purchase Price:Purchase price assigned to shares exchanged
      for stock
    $
    39,119Purchase price assigned to shares exchanged
      for cash
    
    49,941Transaction costs
    
    2,246Total
      purchase price
    
    91,306Net Assets
      Acquired:Seller shareholders equity
    
    25,846Estimated adjustments to
      reflect assets acquired at fair value:Investments
    
    (1,102
    )Loans (8 year weighted average
      life)
    
    (4,123
    )Premises and equipment (39 year weighted
      average life)
    
    1,204Core deposit intangible (4 year weighted
      average life)
    
    6,422Estimated amount allocated to liabilities assumed at fair
      value:Time deposits (1 year weighted average
      life)
    
    (703
    )FHLB borrowings (1 year weighted average
      life)
    
    (38
    )Deferred tax liability
    
    (1,074
    )Net
      assets acquired
    
    26,432Goodwill(1)
    $
    64,874


|(1) |  | Goodwill is not
      expected to be deductible for tax purposes.
|--- |  | -----------------------------------------------------------------

The fair
value of certain assets and certain liabilities were based on quoted market
prices from reliable market sources. When quoted market prices were not
available, the estimated fair values were based upon the best information
available, including obtained prices for similar assets and liabilities, and the
results of using other valuation techniques. The prominent other valuation
techniques used were the present value technique and appraisal/third party
valuations. When the present value technique was employed, the associated cash
flow estimates incorporated assumptions that marketplace participants would use
in estimating fair values. In instances where reliable market information was
not available, the Corporation used its own assumptions in an effort to
determine a reasonable fair value. In other instances, the Corporation assumed
the historical book value of certain assets and liabilities represented a
reasonable proxy of fair value. The Coporation determined that there were no
other categories of identifiable intangible assets arising from the East Penn
Financial acquisition other than the core deposit intangible. The Corporation
also determined that there were no material purchase accounting adjustments
needed with respect to SOP 03-3, Accounting for Certain Loans or Debt
Securities Acquired in a Transfer.

62

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 2Acquisitions / Dispositions
(Continued)

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. Located in Towson, Maryland,
McPherson became a part of the Cornerstone Companies, a component of the Banks
Millennium Wealth Management division. The Bank paid $1.5 million in cash.
Goodwill of $1.1 million and customer relationship intangibles of $375,000 (with
a weighted average amortization period of ten years) were recorded in connection
with the asset purchase.

On November
10, 2006, the Bank completed the sale of its Honesdale branch located in Wayne
County, Pennsylvania with deposits of $74.2 million, as well as loans and other
assets of $22.5 million to First National Community Bank. In connection with the
sale, the Bank paid net cash of $42.5 million and recorded a gain in the fourth
quarter of 2006, net of federal income taxes, of $6.9 million or $.24 per
diluted share. The sale of this single Wayne County location allowed the Bank to
focus on expanding within its core markets and also helped to provide the
resources required to support strategic initiatives.

On April 14,
2006, the Bank sold its existing credit card portfolio to Elan Financial
Services, a national credit card issuer and established an agent issuing
relationship with Elan Financial Services. Under the agreement, credit cards for
the Bank are issued under the Harleysville National Bank name. The Bank sold
$15.3 million in credit card receivables resulting in a gain in the second
quarter of 2006 from the sale of these credit cards, net of federal income
taxes, of approximately $939,000 or $.03 per diluted share. The Bank continues
to earn certain fees from ongoing portfolio activity. The sale agreement
stipulated that any credit card accounts delinquent over 30 days, overlimit
accounts and petitioned bankruptcies would be guaranteed by the Bank for a
period of one year. Of the $15.3 million in credit card receivables sold,
$529,000 was sold with full recourse which was the total potential recourse
exposure at the time of the sale. During the second quarter of 2006, the Bank
recorded a recourse liability of $371,000 which was the entire recourse
liability recorded. This estimate was based on our historic losses as
experienced on similar credit card receivables. The Bank was subject to the full
recourse obligations for a period of one year. At June 30, 2007, the total
potential recourse exposure was reduced to $0 with the expiration of the
one-year recourse period. The Corporations actual loss experience approximated
the initial reserve.

Effective
January 1, 2006, the Bank completed its acquisition of the Cornerstone
Companies, registered investment advisors for high net worth, privately held
business owners, wealthy families and institutional clients. Located in the
Lehigh Valley, Pennsylvania, the firm serves clients throughout Pennsylvania and
other mid-Atlantic states. The 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 2007 and 2006, the
minimum operating results were met resulting in earn-out payments of $1.2
million and $1.0 million for each year, respectively, which were recorded as
additional goodwill. At December 31, 2007, the remaining maximum payout is $4.8
million through 2010. The Cornerstone Companies acquisition was accounted for
using the purchase method of accounting in accordance with SFAS No. 141,
Business Combinations. The Cornerstone Companies results of operations are
included in the Corporations results from the effective date of the
acquisition, January 1, 2006. Goodwill of $12.4 million (including the earn-out
payments) and customer relationship intangibles of $3.9 million (with a weighted
average amortization period of nine years) were recorded in connection with the
acquisition and allocated to the Wealth Management segment.

63

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 3Restrictions on Cash and Due
from Banks

As of
December 31, 2007 and 2006, the Bank did not need to maintain reserves (in the
form of deposits with the Federal Reserve Bank) to satisfy federal regulatory
requirements.

Note 4Investment Securities

The
amortized cost, unrealized gains and losses, and the estimated fair value of the
Corporations investment securities available for sale and held to maturity are
as follows:

December 31, 2007Gross
    
    Gross**Amortized**
    
    **Unrealized**
    
    **Unrealized**
    
    EstimatedCost
    
    Gains
    
    Losses
    
    Fair Value(Dollars in
      thousands)Available for saleObligations of other U.S.
      government agenciesand corporations
    
    **$**
    98,926
    
    **$**
    122
    
    $
    (314
    )
    
    **$**
    98,734Obligations of states and political subdivisions
    
    
    228,125
    
    
    1,261
    
    
    (950
    )
    
    
    228,436Mortgage-backed
      securities
    
    
    516,560
    
    
    2,347
    
    
    (2,918
    )
    
    
    515,989Other
      securities
    
    
    85,729
    
    
    139
    
    
    (3,459
    )
    
    
    82,409Total investment securities available for
      sale
    
    **$**
    929,340
    
    **$**
    3,869
    
    **$**
    (7,641
    )
    
    **$**
    925,568Held to maturityObligations of other U.S.
      government agenciesand corporations
    
    **$**
    3,868
    
    **$**
    29
    
    $
    
    
    
    **$**
    3,897Obligations of states and political subdivisions
    
    
    53,479
    
    
    354
    
    
    (212
    )
    
    
    53,621Total investment securities held to
      maturity
    
    **$**
    57,347
    
    **$**
    383
    
    **$**
    (212
    )
    
    **$**
    57,518December 31, 2006Gross
    
    Gross**Amortized**
    
    **Unrealized**
    
    Unrealized
    
    EstimatedCost
    
    Gains
    
    Losses
    
    Fair Value(Dollars in
      thousands)Available for saleObligations of other U.S.
      government agenciesand corporations
    
    $
    122,139
    
    $
    
    
    $
    (2,183
    )
    
    $
    119,956Obligations of states and political subdivisions
    
    
    201,241
    
    
    1,023
    
    
    (621
    )
    
    
    201,643Mortgage-backed
      securities
    
    
    481,126
    
    
    388
    
    
    (5,407
    )
    
    
    476,107Other
      securities
    
    
    55,999
    
    
    163
    
    
    (858
    )
    
    
    55,304Total investment securities available for
      sale
    
    $
    860,505
    
    $
    1,574
    
    $
    (9,069
    )
    
    $
    853,010Held to maturityObligations of other U.S.
      government agenciesand corporations
    
    $
    3,856
    
    $
    
    
    $
    (62
    )
    
    $
    3,794Obligations of states and political subdivisions
    
    
    55,023
    
    
    584
    
    
    (104
    )
    
    
    55,503Total investment securities held to
      maturity
    
    $
    58,879
    
    $
    584
    
    $
    (166
    )
    
    $
    59,297


64

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 4Investment Securities
(Continued)

The tables
below indicate the length of time individual securities have been in a
continuous unrealized loss position at December 31, 2007 and 2006:

|                       |  | December 31, 2007     
|---------------------- |  | ----------------------
|                       |  | Less than 12 months   
|Description
      of   |  |                       
|Securities             |  |                       
|                       |  | (Dollars in thousands)
|Obligations of other   |  |                       
|U.S.
      government  |  |                       
|agencies
      and     |  |                       
|corporations           |  | 3                     
|Obligations of states  |  |                       
|and political          |  |                       
|subdivisions           |  | 46                    
|Mortgage-backed        |  |                       
|securities             |  | 26                    
|Other
      securities |  | 20                    
|Totals                 |  | 95                    

|                       |  | December 31, 2007     
|---------------------- |  | ----------------------
|                       |  | Less than 12 months   
|Description
      of   |  |                       
|Securities             |  |                       
|                       |  | (Dollars in thousands)
|Obligations of other   |  |                       
|U.S.
      government  |  |                       
|agencies
      and     |  |                       
|corporations           |  | 1                     
|Obligations of states  |  |                       
|and political          |  |                       
|subdivisions           |  | 66                    
|Mortgage-backed        |  |                       
|securities             |  | 38                    
|Other
      securities |  | 8                     
|Totals                 |  | 113                   

The
unrealized losses associated with the securities portfolio, that management has
the ability and intent to hold, are not considered to be other-than temporary as
of December 31, 2007 because the unrealized losses are related to changes in
interest rates and do not affect the expected cash flows of the underlying
collateral or issuer. There were 191 individual securities in a continuous
unrealized loss position for twelve months or longer as of December 31, 2007.
The Corporation recognized a other-than temporary charge of $55,000 during the
third quarter of 2007 as a result of an equity holding in a financial
institution which was purchased by another institution at a lower than cost
share price. In conjunction with the closing of the merger during the fourth
quarter of 2007, the Corporation exchanged its equity holding in the financial
institution for cash.

Securities
with a carrying value of $756.3 million and $617.4 million at December 31, 2007
and 2006, respectively, were pledged to secure public funds, customer trust
funds, government deposits and repurchase agreements.

65

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 4Investment Securities
(Continued)

The
amortized cost and estimated fair value of investment securities, at December
31, 2007, by contractual maturities are shown in the following table. Actual
maturities will differ from contractual maturities because issuers and borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.

December 31, 2007Held to Maturity
    
    Available for SaleEstimated
    
    
    
    EstimatedAmortized
    
    Fair
    
    Amortized
    
    FairCost
    
    Value
    
    Cost
    
    Value(Dollars in
      thousands)Due
      in one year or less
    
    $
    
    
    $
    
    
    $
    20,316
    
    $
    20,225Due after one year through
      five years
    
    
    
    
    
    
    
    
    43,301
    
    
    43,278Due
      after five years through ten years
    
    
    3,598
    
    
    3,610
    
    
    102,135
    
    
    101,581Due after ten years
    
    
    53,749
    
    
    53,908
    
    
    216,981
    
    
    215,46657,347
    
    
    57,518
    
    
    382,733
    
    
    380,550Mortgage-backed
      securities
    
    
    
    
    
    
    
    
    516,560
    
    
    515,989Equity securities
    
    
    
    
    
    
    
    
    30,047
    
    
    29,029Totals
    
    $
    57,347
    
    $
    57,518
    
    $
    929,340
    
    $
    925,568


The components of net realized gains
on sales of investment securities were as follows:

Year Ended December 31,2007
    
    2006
    
    2005(Dollars in
      thousands)Gross
      realized gains
    
    **$**
    1,329
    
    
    $
    445
    
    
    $
    5,812Gross realized
      losses
    
    
    (197
    )
    
    
    (1,119
    )
    
    
    (1,018
    )Net
      realized gain (loss) on sales of investment securities
    
    **$**
    1,132
    
    
    $
    (674
    )
    
    $
    4,794


Note 5Loans

Major classifications of loans are
as follows:

December 31,2007
    
    2006(Dollars in
      thousands)Real
      estate (including loans held for sale, at cost of $1,140 and
      $1,857)
    
    **$**
    959,716
    
    
    $
    846,510Commercial and
      industrial
    
    
    728,293
    
    
    
    506,149Consumer loans
    
    
    764,860
    
    
    
    682,307Lease financing
    
    
    2,564
    
    
    
    7,588Total loans
    
    
    2,455,433
    
    
    
    2,042,554Deferred costs, net
    
    
    5,390
    
    
    
    4,801Allowance for loan losses
    
    
    (27,328
    )
    
    
    (21,154
    )Net loans (including loans held for
      sale)
    
    **$**
    2,433,495
    
    
    $
    2,026,201


66

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 5Loans (Continued)

On December
31, 2007, nonaccrual loans were $21.1 million and loans 90 days or more past due
and still accruing interest were $857,000. On December 31, 2006, nonaccrual
loans were $15.2 million and loans 90 days or more past due and still accruing
interest were $2.4 million. 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 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. During 2006, interest
accrued on nonaccruing loans and not recognized as interest income was $788,000
and interest paid on nonaccruing loans of $191,000 was recognized as interest
income. During 2005, interest accrued on nonaccruing loans and not recognized as
interest income was $310,000, and interest paid on nonaccruing loans of $250,000
was recognized as interest income.

The balance
of impaired loans was $9.8 million at December 31, 2007 compared to $3.9 million
at December 31, 2006. At December 31, 2007 and 2006, impaired loans with
specific loss allowances were $9.8 million and $3.9 million and the related
allowance for loan losses were $2.2 million and $678,000, respectively. The
average impaired loan balance was $7.5 million in 2007, compared to $3.2 million
and $1.5 million in 2006 and 2005, respectively. The income recognized on
impaired loans during 2007, 2006 and 2005 was $31,000, $60,000 and $33,000,
respectively. Impaired loans are included in the nonaccrual loan
total.

The Bank has
no concentration of loans to individual borrowers which exceeded 10% of total
loans at December 31, 2007 and 2006. The Bank actively monitors the risk of loan
concentration.

The Bank
continued to pursue new lending opportunities while seeking to maintain a
portfolio that is diverse as to industry concentration, type and geographic
distribution. The Banks geographic lending area is primarily concentrated in
Montgomery, Bucks, Carbon, Chester Berks, Lehigh, Monroe and Northampton
counties.

At December
31, 2007 and 2006, residential mortgage loans serviced for others totaled $335.8
million (of which $5.8 million is with recourse assumed from the East Penn
Financial acquisition in 2007) and $330.6 million, respectively.

Loans to
directors, executive officers and their associates are made in the ordinary
course of business and on substantially the same terms, including interest rates
and collateral, as those prevailing at the time for comparable transactions with
others. Activity of these loans is as follows:

Year Ended December 31,2007 (1)
    
    2006
    
    2005(Dollars in
      thousands)Balance, January 1
    
    **$**
    17,393
    
    
    $
    22,099
    
    
    $
    22,863New loans
    
    
    4,451
    
    
    
    66,666
    
    
    
    75,230Repayments and other reductions
    
    
    (9,801
    )
    
    
    (71,372
    )
    
    
    (75,994
    )Balance, December
      31
    
    **$**
    12,043
    
    
    $
    17,393
    
    
    $
    22,099


|(1) |  | A directors
      affiliation with a borrower ended during the fourth quarter of 2006
      accounting for the majority of the decrease in activity during
    2007.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

67

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 6Allowance for Loan Losses

The table below summarizes the
changes in the allowance for loan losses:

Year Ended December 31,2007
    
    2006
    
    2005(Dollars in
      thousands)Balance, beginning of year
    
    **$**
    21,154
    
    
    $
    19,865
    
    
    $
    18,455Provision for loan losses
    
    
    10,550
    
    
    
    4,200
    
    
    
    3,401Reserve from East Penn Financial
      acquisition
    
    
    3,250
    
    
    
    
    
    
    
    Loans charged off
    
    
    (8,142
    )
    
    
    (3,711
    )
    
    
    (3,047
    )Recoveries
    
    
    516
    
    
    
    800
    
    
    
    1,056Balance, end of
      year
    
    **$**
    27,328
    
    
    $
    21,154
    
    
    $
    19,865


Note 7Premises and Equipment

Premises and equipment consist of
the following:

Estimated
    
    December 31,Useful Lives
    
    2007
    
    2006(Dollars in
      thousands)Land
    
    Indefinite
    
    **$**
    3,397
    
    
    $
    4,446Buildings
    
    15-39 years
    
    
    22,146
    
    
    
    31,963Furniture, fixtures and equipment
    
    3-7 years
    
    
    41,357
    
    
    
    35,958Total cost
    
    
    
    
    66,900
    
    
    
    72,367Less
      accumulated depreciation and amortization
    
    
    
    
    (34,382
    )
    
    
    (38,582
    )Premises and equipment, net
    
    
    
    **$**
    32,518
    
    
    $
    33,785


Depreciation
expense for the years ended December 31, 2007, 2006, and 2005 was $4.0 million,
$3.3 million and $3.4 million, respectively.

Note 8Goodwill and Other Intangibles

Goodwill and
identifiable intangibles were $111.2 million and $10.6 million, respectively at
December 31, 2007, and $44.0 million and $4.7 million, respectively at December
31, 2006.

The changes in the carrying amount of goodwill by business segment were
as follows:

Community
    
    WealthBanking
    
    Management
    
    Total(Dollars in
      thousands)Balance, January 1, 2006
    
    $
    31,552
    
    $
    
    
    $
    31,552Additions to goodwill from
      acquisitions
    
    
    
    
    
    12,404
    
    
    12,404Balance, December 31, 2006
    
    
    31,552
    
    
    12,404
    
    
    43,956Additions to goodwill from
      acquisitions
    
    
    64,874
    
    
    2,325
    
    
    67,199Balance, December 31, 2007
    
    **$**
    96,426
    
    **$**
    14,729
    
    **$**
    111,155


68

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 8Goodwill and Other Intangibles
(Continued)

The gross
carrying value and accumulated amortization related to core deposit intangibles
and other identifiable intangibles at December 31, 2007 and 2006 are presented
below:

December 31,2007
    
    2006Gross
    
    
    
    GrossCarrying
    
    Accumulated
    
    Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Amount
    
    Amortization(Dollars in thousands)Core deposit intangibles
    
    **$**
    8,351
    
    **$**
    1,061
    
    $
    1,929
    
    $
    733Other
      identifiable intangibles
    
    
    4,288
    
    
    927
    
    
    3,913
    
    
    448Total
    
    **$**
    12,639
    
    **$**
    1,988
    
    $
    5,842
    
    $
    1,181


Management
performed its annual review of goodwill at June 30, 2007 in accordance with SFAS
No. 142, Goodwill and Other Intangible Assets and determined that there was no
impairment of goodwill and other identifiable intangible assets. For further
information related to goodwill and intangible assets, see Note 2  Acquisitions
/ Dispositions.

The
remaining weighted average amortization period of core deposit intangibles is
four years, other identifiable intangibles is eight years and the combined
intangibles is five years. The amortization of core deposit intangibles
allocated to the Community Banking segment was $328,000, $246,000 and $246,000
for the years ended December 31, 2007, 2006 and 2005, respectively. Amortization
of identifiable intangibles related to the Wealth Management segment totaled
$479,000 and $448,000 for the years ended December 31, 2007 and 2006,
respectively. The Corporation estimates that aggregate amortization expense for
core deposit and other identifiable intangibles will be $1.9 million, $1.8
million, $1.6 million, $1.4 million and $1.1 million for 2008, 2009, 2010, 2011
and 2012, respectively.

Mortgage
servicing rights of 2.7 million and $2.6 million at December 31, 2007 and 2006,
respectively are included on the Corporations balance sheet in other intangible
assets and subsequently measured using the amortization method. The mortgage
servicing rights had a fair value of $3.3 million and $3.8 million at December
31, 2007 and 2006, respectively. The Corporations mortgage servicing rights are
not considered material to its financial statements and therefore additional
disclosures are not provided.

Note 9Deposits

Time
deposits with balances of $100,000 or more were $483.7 million and $302.0
million at December 31, 2007 and 2006, respectively.

Deposits from directors and executive officers
of the Corporation were approximately $2.9 million and $3.1 million as of December 31, 2007
and 2006, respectively.

At December 31, 2007, scheduled
maturities of certificates of deposit are as follows:

Amount(Dollars in
      thousands)2008
    
    $
    835,4962009
    
    
    243,9252010
    
    
    92,0342011
    
    
    26,1952012
    
    
    4,854Thereafter
    
    
    186Total
    
    $
    1,202,690


69

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 10Borrowings

Federal Funds Lines of Credit with
Correspondent Banks

Total
federal funds lines of credit with correspondent banks at December 31, 2007 were
$195.0 million all of which is unused. These lines of credit are available for
overnight funds and the rate is based on the correspondent banks quoted rate at
the time of the transaction.

Securities Sold under Agreements to
Repurchase

As of
December 31, 2007, long- term securities sold under agreements to repurchase
with private entities were $105.0 million. The maturity dates range from 2011
through 2012, with call dates ranging from 2008 to 2009. The weighted average
interest rate as of December 31, 2007 was 4.71%. Additionally, the Corporation
had $101.5 million of short-term securities sold under agreements to repurchase.
As of December 31, 2006, the Corporations securities sold under agreements to
repurchase were $96.8 million, all of which were short-term.

Federal Home Loan Bank Advances

Federal Home
Loan Bank (FHLB) advances at December 31, 2007 totaled $216.8 million, all of
which were long-term with a weighted average interest rate of 4.37%. FHLB
advances at December 31, 2006 totaled $239.8 million, all of which were
long-term with a weighted average interest rate of 4.32%. The advances are
collateralized by FHLB stock and certain first mortgage loans and
mortgage-backed securities. Advances are made pursuant to several different
credit programs offered from time to time by the FHLB. Unused lines of credit
with the FHLB were $363.1 million at December 31, 2007 and $181.7 million at
December 31, 2006.

At December 31, 2007, scheduled
maturities of long-term borrowings with the FHLB are as follows:

WeightedBalance
    
    Average Rate(Dollars in
      thousands)2008
    
    $
    57,000
    
    4.73
    %2009
    
    
    40,750
    
    4.13
    %2010
    
    
    14,000
    
    4.34
    %2011
    
    
    30,000
    
    4.84
    %2012
    
    
    25,000
    
    4.56
    %Thereafter
    
    
    50,000
    
    3.78
    %Total
    
    $
    216,750
    
    4.37
    %


Trust Preferred Subordinated Debentures

As of
December 31, 2007, the Corporation has five statutory trust affiliates
(collectively, the Trusts). These trusts were formed to issue mandatorily
redeemable trust preferred securities to investors and loan the proceeds to the
Corporation for general corporate purposes. The Trusts hold, as their sole
assets, subordinated debentures of the Corporation. The trust preferred
securities represent undivided beneficial interests in the assets of the Trusts.
The Corporation owns all of the trust preferred securities of the Trusts. The
Trusts qualify as variable interest entities under FIN 46R and are not
consolidated in the Corporations financial statements.

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

70

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 10Borrowings (Continued)

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

The
Corporations obligations under the debentures and related documents, taken
together, constitute a full and unconditional guarantee by the Corporation of
the Trusts obligations under the trust preferred securities.

In March
2005, the Federal Reserve Board adopted a final rule that allows the continued
limited inclusion of outstanding and prospective issuances of trust preferred
securities in Tier 1 capital of bank holding companies. Under the final rule,
trust preferred securities and other restricted core capital elements will be
subject to stricter quantitative limits. The Boards final rule limits
restricted core capital elements to 25% of all core capital elements, net of
goodwill, less any associated deferred tax liability. Amounts of restricted core
capital elements in excess of these limits generally may be included in Tier 2
capital. The final rule provides a five-year transition period ending March 31,
2009, for application of the quantitative limits. In addition, the requirement
for trust preferred securities to include a call option has been eliminated, and
standards for the junior subordinated debt underlying trust preferred securities
eligible for Tier 1 capital treatment have been clarified. Management has
evaluated the effects of the rule and does not anticipate a material impact on
its capital ratios upon implementation.

The
following table is a summary of the subordinated debentures as of December 31,
2007 as originated by the Corporation and assumed from the acquisition of East
Penn Financial during 2007:

PrincipalPrincipal
    
    Amount
      ofAmount
      of
    
    TrustSubordinated
    
    PreferredTrust Preferred Subordinated Debentures
    
    Debentures
    
    Securities(Dollars in
      thousands)Issued to Harleysville Statutory Trust I in February 2001,
      matures in February 2031,interest rate of 10.20% per annum
    
    $
    5,155
    
    $
    5,000Issued to HNC Statutory
      Trust II in March 2004, matures in April 2034, interest rate ofthree-month London
      Interbank Offered Rate (LIBOR) plus 2.70% per annum
    
    
    20,619
    
    
    20,000Issued to HNC Statutory Trust III in September 2005, matures
      in November 2035,bearing interest at 5.67% per annum through November 2010 and
      thereafter three-monthLIBOR
      plus 1.40% per annum
    
    
    25,774
    
    
    25,000Issued to HNC Statutory
      Trust IV in August 2007, matures in October 2037, bearinginterest at 6.35% per
      annum through October 2012 and thereafter three-month LIBORplus 1.28% per
      annum
    
    
    23,196
    
    
    22,500Issued to East Penn Statutory Trust I in July 2003, matures
      in September 2033, interestrate
      of 6.80% per annum through September 2008 and thereafter at three-month
      LIBORplus
      3.10% per annum
    
    
    8,248
    
    
    8,000Total
    
    $
    82,992
    
    $
    80,500


71

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 11Income Taxes

Uncertain Tax Positions

The
Corporation adopted the provisions of FIN 48, Accounting for Uncertainty in
Income Taxes on January 1, 2007. Previously, the Corporation had accounted for
tax contingencies in accordance with SFAS No. 5, Accounting for Contingencies.
As required by Interpretation on 48, which clarifies SFAS No. 109, Accounting
for Income Taxes, the Corporation recognizes the financial statement benefit of
a tax position only after determining that the relevant tax authority would more
likely than not sustain the position following an audit. For tax positions
meeting the more-likely-than-not threshold, the amount recognized in the
financial statements is the largest benefit that has a greater than 50 percent
likelihood of being realized upon ultimate settlement with the relevant tax
authority. At the adoption date, the Corporation applied Interpretation 48 to
all tax positions for which the statute of limitations remained open. The amount
of unrecognized tax benefits as of January 1, 2007, was $175,000.

A reconciliation of the beginning
and ending amount of unrecognized tax benefits is as follows:

Balance at January 1, 2007
    
    $
    175,000Additions based on tax
      positions related to prior years
    
    
    26,000Additions based on tax positions related to the current
      year
    
    
    48,000Balance at December 31,
      2007
    
    $
    249,000


The amount
of unrecognized tax benefits at December 31, 2007, includes $249,000 of
unrecognized tax benefits which, if ultimately recognized, will reduce the
Corporations annual effective tax rate.

The
Corporation is subject to income taxes in the U.S. federal jurisdiction, and
various states, the majority of activity residing in Pennsylvania. The statue of
limitations for Pennsylvania has expired on years prior to 2003. The expiration
of the statute of limitations related to the various state income tax returns
the Corporation and subsidiaries file, varies by state, and are expected to
expire over the term of 2008 through 2012.

The
Corporations policy for recording interest and penalties associated with audits
is to record such items as a component of income before income taxes. Penalties
are recorded in other expenses, net, and interest paid or received is recorded
in interest expense or interest income, respectively, in the statement of
income. Interest accrued was $17,000 and $43,000 as of January 1st and December
31st, 2007, respectively. No penalties have been accrued to date.

The components of
income tax expense were as follows:

Year Ended December 31,2007
    
    2006
    
    2005(Dollars in
      thousands)Current income tax expense:Federal
    
    **$**
    15,943
    
    
    $
    13,221
    
    $
    17,814State
    
    
    245
    
    
    
    162
    
    
    119Total current income tax
      expense
    
    
    16,188
    
    
    
    13,383
    
    
    17,933Deferred income tax
    
    
    (8,916
    )
    
    
    693
    
    
    (5,530
    )Total income tax
      expense
    
    **$**
    7,272
    
    
    $
    14,076
    
    $
    12,403


72

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 11Income Taxes (Continued)

The
effective income tax rates of 21.5% for 2007, 26.3% for 2006 and 24.2% for 2005
were less than the applicable federal income tax rate of 35% for each year. The
reasons for these differences follows:

Year Ended December 31,2007
    
    2006
    
    2005(Dollars in
      thousands)Expected income tax expense
    
    **$**
    12,102
    
    
    $
    18,779
    
    
    $
    18,008Tax-exempt income net of
      interest disallowance
    
    
    (4,707
    )
    
    
    (4,740
    )
    
    
    (5,078
    )Other
    
    
    (123
    )
    
    
    37
    
    
    
    (201
    )Tax benefit from sale of
      Cumberland Advisors, Inc
    
    
    
    
    
    
    
    
    
    
    (326
    )Actual income tax expense
    
    **$**
    7,272
    
    
    $
    14,076
    
    
    $
    12,403


The tax
effect of temporary differences that give rise to significant portions of
deferred tax assets and liabilities are as follows:

2007
    
    2006Asset
    
    Liability
    
    Asset
    
    Liability(Dollars in
      thousands)Allowance for loan losses
    
    **$**
    8,494
    
    **$**
    
    
    $
    7,404
    
    $
    Lease assets
    
    
    
    
    
    1,666
    
    
    
    
    
    3,692Deferred loan fees
    
    
    
    
    
    2,895
    
    
    
    
    
    2,637Deferred
      compensation
    
    
    2,936
    
    
    
    
    
    2,796
    
    
    Pension
    
    
    595
    
    
    
    
    
    
    
    
    102Stock-based compensation
      expense
    
    
    40
    
    
    
    
    
    34
    
    
    Mortgage servicing rights
    
    
    
    
    
    941
    
    
    
    
    
    917Depreciation
    
    
    
    
    
    513
    
    
    
    
    
    288Net
      operating loss carryforward
    
    
    
    
    
    
    
    
    208
    
    
    Unrealized loss on
      investment securities
    
    
    1,320
    
    
    
    
    
    2,623
    
    
    Net
      unrealized gain on derivative used for cash flowhedge
    
    
    62
    
    
    
    
    
    
    
    
    164Unrealized loss on pension liability
    
    
    
    
    
    
    
    
    826
    
    
    Purchase accounting adjustments
    
    
    
    
    
    1,284
    
    
    
    
    
    561Deferred gain on sale-leaseback of bank properties
    
    
    5,979
    
    
    
    
    
    
    
    
    Other
    
    
    
    
    
    1,857
    
    
    
    
    
    989Total
      deferred taxes
    
    **$**
    19,426
    
    **$**
    9,156
    
    $
    13,891
    
    $
    9,350


As a result
of the acquisition of East Penn Financial during 2007, the Corporation recorded
a net deferred tax liability of approximately $1.3 million. For additional
information related to the deferred gain on sale-leaseback of bank properties
during 2007 of $6.0 million, see Item 8, Note 2, Notes to Consolidated
Financial StatementsAcquisitions / Dispositions.

Note 12Pension Plans

Defined Benefit Pension Plan

The
Corporation has a non-contributory defined benefit pension plan covering
substantially all employees. The plans benefits are based on years of service
and the employees average compensation during any five consecutive years within
the ten-year period preceding retirement. On October 31, 2007, the Corporation
announced that it has formally amended its pension plan to provide for its
termination. Employees cease to accrue additional pension benefits as of
December 31, 2007, and pension benefits are not to be provided under a successor
pension plan. All retirement benefits earned in the pension plan as of December
31, 2007, are preserved and all participants became fully vested in their
benefit. During 2008, upon receipt of the appropriate regulatory approvals for
termination of the pension plan, assets will be distributed to those
participants who elect lump sums and nonparticipating annuity contracts will be
purchased to settle the accumulated benefit obligation as of that
date.

73

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 12Pension Plans (Continued)

The
Corporation recorded a one-time pre-tax charge related to the pension plan
curtailment of approximately $1.9 million in the fourth quarter of 2007 as
detailed in the following table. The curtailment charge was recorded in other
expenses in the statement of income and impacted the Community Banking and
Wealth Management segments.

Year
      EndedDecember 31, 2007Before
    
    Effect
      of
    
    AfterAssets and
      obligations:
    
    Curtailment
    
    Curtailment
    
    Curtailment(Dollars in
      thousands)Vested benefit obligation
    
    **$**
    8,786
    
    
    **$**
    2,557
    
    
    **$**
    11,343Non-vested
      benefits
    
    
    383
    
    
    
    148
    
    
    
    531Accumulated benefit obligation
    
    
    9,169
    
    
    
    2,705
    
    
    
    11,874Effect of future
      compensation levels
    
    
    3,015
    
    
    
    (3,015
    )
    
    
    ****Projected benefit obligation
    
    **$**
    12,184
    
    
    **$**
    (310
    )
    
    **$**
    11,874Plan
      assets at fair value
    
    **$**
    10,200
    
    
    **$**
    ****
    
    
    **$**
    10,200Unrecognized net asset at
      transition
    
    
    (51
    )
    
    
    ****
    
    
    
    (51
    )Unrecognized net loss (gain) subsequent to
      transition
    
    
    2,252
    
    
    
    (310
    )
    
    
    1,942Adjustment required to
      recognize minimum liability
    
    
    ****
    
    
    
    1,891
    
    
    
    1,891(Prepaid)/accrued pension cost
    
    
    (217
    )
    
    
    1,891
    
    
    
    1,674


The plans funded status for the
years ended December 31, 2007 and 2006 follow:

2007
    
    2006(Dollars in thousands)Change in benefit obligation:Benefit
      obligation at beginning of year
    
    **$**
    11,586
    
    
    $
    11,052Service cost
    
    
    1,166
    
    
    
    1,041Interest
      cost
    
    
    683
    
    
    
    654Actual gain (loss)
    
    
    182
    
    
    
    (199
    )Benefits
      paid
    
    
    (1,433
    )
    
    
    (962
    )Change in assumptions (plan curtailment)
    
    
    (310
    )
    
    
    ****Benefits
      obligation at end of year
    
    **$**
    11,874
    
    
    $
    11,586Change in plan assets:Fair value of
      plan assets at beginning of year
    
    **$**
    9,575
    
    
    $
    8,584Actual return on plan assets
    
    
    808
    
    
    
    703Employer
      contribution
    
    
    1,250
    
    
    
    1,250Benefits paid
    
    
    (1,433
    )
    
    
    (962
    )Fair value of
      plan assets at end of year
    
    **$**
    10,200
    
    
    $
    9,575Funded status at end of year
    
    **$**
    (1,674
    )
    
    $
    (2,011
    )2007
    
    2006(Dollars in thousands)**Amounts recognized in accumulated other comprehensive loss
      (net of tax) consist of:**Net actuarial loss
    
    
    **$**
    
    
    
    $1,579Transition asset
    
    
    ****
    
    
    
    (44
    )Total amount recognized, net of tax
    
    
    **$**
    
    
    
    $1,535


74

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 12Pension Plans (Continued)

The
accumulated benefit obligation for the defined benefit pension plan was $11.9
million and $8.9 million at December 31, 2007 and December 31, 2006,
respectively.

Information
for the Corporations defined benefit pension plan with an accumulated benefit
obligation in excess of plan assets follows:

**Year
    Ended****December 31,****2007**
    
    **2006****(Dollars in
      thousands)**Projected benefit obligation
    **$**
    11,874
    
    $
    11,586Accumulated
      benefit obligation
    
    11,874
    
    
    8,865Fair value of plan assets
    
    10,200
    
    
    9,575


**Year Ended**Weighted-average assumptions used to determine
    
    **December 31,**pension plan obligations as of
      December 31,
    
    
    **2007**
    
    **2006**
    
    **2005**Discount rate
    
    4.75
    **%**
    
    6.00
    %
    
    6.00
    %Rate
      of compensation increase
    
    0.00
    **%**
    
    4.00
    %
    
    4.00
    %**Year Ended**Weighted-average assumptions used to determine
    
    **December 31,**Pension plan net periodic benefit
      cost as of December 31,
    
    
    **2007**
    
    **2006**
    
    **2005**Discount rate
    
    6.00
    %
    
    6.00
    %
    
    6.00
    %Expected return on plan assets
    
    6.00
    **%**
    
    6.00
    %
    
    6.00
    %Rate of compensation increase
    
    4.00
    **%**
    
    4.00
    %
    
    4.00
    %


Year EndedDecember 31,Components
      of net periodic defined benefit expense
    
    
    2007
    
    2006
    
    **2005**(Dollars in thousands)Service cost
    
    **$**
    1,166
    
    
    $
    1,041
    
    
    $
    1,052Interest cost
    
    
    683
    
    
    
    654
    
    
    
    642Expected return on plan assets
    
    
    (600
    )
    
    
    (551
    )
    
    
    (524
    )Amortization of unrecognized net actuarial losses
    
    
    76
    
    
    
    118
    
    
    
    92Net periodic
      benefit expense
    
    **$**
    1,325
    
    
    $
    1,262
    
    
    $
    1,262


The pension
plan assets were invested with a growth and income strategy with a target asset
allocation of 60% equity and 40% fixed income securities. This allocation was
changed to a preservation of capital objective pursuant to the decision to
terminate the plan. The pension plan equity reduction strategy has been
implemented along with a reallocation of fixed income securities and cash
equivalents in preparation for an expected third quarter 2008 final distribution
to participants. The reduction in equities began in late August 2007 and
accelerated with sales in September 2007 to finish out the third quarter with a
25% allocation to stocks.

During
November 2007, the final sales were initiated to close out the remaining equity
positions, which represented less than 5% of the portfolio. The Fixed Income
portfolio has been re-allocated with maturity considerations for final benefits
to be paid on or after September 30, 2008. Cash has been reinvested into high
quality fixed income instruments and cash equivalents such as, secondary
certificate of deposits, government agencies and insured taxable
municipals.

75

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 12Pension Plans (Continued)

The Corporations pension plan
weighted-average asset allocations by asset category are as follows:

Percentage ofPlan Assets atDecember 31,2007
    
    2006Asset CategoryEquity
      securities
    
    **%**
    
    59.7
    %Debt securities
    33.4
    %
    
    33.1
    %Cash and cash
      equivalents
    66.6
    %
    
    7.2
    %Total
    100.0
    %
    
    100.0
    %


Supplemental Benefit Plans

The
Corporation maintains a Supplemental Executive Retirement Plan for certain
officers and key employees. The plan provides for payment to the covered
employee of an annual supplemental retirement benefit up to 50% of their average
annual compensation upon retirement, thereafter offset by the employers share
of social security, defined benefit pension and available employers 401(k)
matching contribution. There is a lifetime payout in retirement benefits with a
minimum payout of 10 years. There is a pre-retirement death benefit, payable
for10 years, of 100% of the average annual compensation for the first year, and
up to 50% of the average annual compensation for the next 9 years. The
Corporations liability under these agreements is being accrued over the
participants remaining service period. The accrued benefit obligation as of
December 31, 2007 and 2006 was $5.4 million for both years.

In connection with the acquisition
of East Penn Financial in 2007, the Corporation assumed an obligation under the
East Penn Supplemental Executive Retirement Plan which provides for a fixed
payment to the covered employee beginning at age 62 with a 15 year benefit
period. The pre-retirement death benefit is the accrued benefit. The liability
for this agreement has been fully accrued. The accrued benefit obligation as of
December 31, 2007 is $593,000.

Defined Contribution Plan

The
Corporation maintains a 401(k) defined contribution retirement savings plan
which allows employees to contribute a portion of their compensation on a
pre-tax and/or after-tax basis in accordance with specified guidelines. The
Corporation matched 50% of pre-tax employee contributions up to a maximum of 3%
for 2007, 2006 and 2005. Contributions charged to earnings were $742,000,
$628,000 and $569,000 for 2007, 2006 and 2005, respectively. Effective January
1, 2008, in addition to the company match up to a maximum of 3%, all eligible
employees will begin receiving a company funded contribution in the 401(k) plan
equal to 2% of eligible earnings.

Note 13Stock Repurchase Program and
Stock Dividend

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. On May 12, 2005, the Board of Directors
authorized a plan to purchase up to 1,416,712 shares (adjusted for five percent
stock dividend paid on September 15, 2006 and September 15, 2005) or 4.9%, of
its outstanding common stock. As of December 31, 2007, the maximum number of
shares that may yet be purchased under the plan is 731,761.

On September
15, 2006, the Corporation paid a five percent stock dividend on its common stock
to shareholders of record as of September 1, 2006.

On September
15, 2005, the Corporation paid a five percent stock dividend on its common stock
to shareholders of record as of September 1, 2005.

All prior
period amounts in the consolidated financial statements and footnotes have been
restated to reflect these stock dividends.

76

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 14Stock-Based Compensation

The
Corporation has four shareholder approved fixed stock option plans that allow
the Corporation to grant options up to an aggregate of 3,797,861 shares of
common stock to key employees and directors. At December 31, 2007,
2,522,046stock options had been granted under the stock option plans.

The options
have a term of ten years when issued and typically vest over a five-year period.
The exercise price of each option is the market price of the Corporations stock
on the date of grant. Additionally, at December 31, 2007, the Corporation has
328,327 granted stock options as a result of the Millennium Bank acquisition
completed in 2004. The options have a term of ten years and the remaining
exercisable prices range from $9.32 to $13.12. Also, at December 31, 2007, the
Corporation has 25,480 granted stock options as a result of the East Penn Bank
acquisition completed in 2007. The options have a term of ten years and are
exercisable at prices ranging from $5.94 to $13.07.

The
Corporation recognizes compensation expense for stock options in accordance with
SFAS 123 (revised 2004), Share-Based Payment (SFAS 123(R)) adopted at January
1, 2006 under the modified prospective application method of transition. Prior
to January 1, 2006, the Corporation followed SFAS 123 and APB 25 withpro formadisclosures of net income and earnings per share, as if the fair value-based
method of accounting defined in SFAS 123 had been applied. The Corporation
recognizes compensation expense for the portion of outstanding awards at January
1, 2006 for which the requisite service has not yet been rendered, based on the
grant-date fair value of those awards calculated under SFAS 123 for pro forma
disclosures. For grants subject to a service condition that were awarded on or
after January 1, 2006, the Corporation utilizes the Black-Scholes option-pricing
model (as used under SFAS 123) to estimate the fair value of each option on the
date of grant. For grants subject to a market condition that were awarded in
2007, 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.

During 2007,
the Corporation granted stock options which were subject to a market condition.
These awards vest when the Corporations common stock reaches targeted average
trading prices for 30 days within five years from the grant date. Vesting cannot
commence before six months from the grant date. The term and exercise price of
the options are the same as previously mentioned. The fair value and derived
service period (the median period in which the market condition is met) were
determined using a Monte Carlo simulation with the following assumptions:
weighted average dividend yield of 4.59% based on historical data,
weighted-average expected volatility of 32.65% based on historical data,
risk-free rate of 4.54% to 5.17%, weighted average expected life of 6.04 years
and a uniform post-vesting exercise rate (mid-point of vesting and contractual
term).

During 2006
and 2005, all options awarded were subject to a service condition. The fair
value of these options were estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions based on historical data for grants in 2006 and 2005, respectively:
weighted-average dividend yield of 3.52% and 3.27%; weighted-average expected
volatility of 32.19% and 31.15%, weighted average risk-free interest rate of
4.64% (4.42% to 5.08%) and 4.41% (3.79% to 4.57%) and a weighted-average
expected life of 7.28 years and 7.15 years.

Expected
volatility is based on the historical volatility of the Corporations stock over
the expected life of the grant. The risk-free rate for periods within the
expected life of the option is based on the U.S. Treasury strip rate in effect
at the time of the grant. The life of the option is based on historical factors
which include the contractual term, vesting period, exercise behavior and
employee terminations.

In
accordance with SFAS 123(R), stock based compensation expense for the year ended
December 31, 2007 and 2006 is based on awards that are ultimately expected to
vest and therefore has been reduced for estimated forfeitures. The Corporation
estimates forfeitures using historical data based upon the groups identified by
management. Prior to January 1, 2006, under SFAS 123, forfeitures were accounted
for as they occurred. Stock-based compensation expense for 2007 was $118,000 and
$100,000 net of tax and for 2006 was $440,000 and $407,000, net of tax.

77

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 14Stock-Based Compensation
(Continued)

The
following table illustrates the effect on net income and earnings per share if
the Corporation had applied the fair value recognition provisions of SFAS 123(R)
to stock-based employee compensation for the year ended December 31, 2005 (all
per share information has been adjusted retroactively for the effect of stock
dividends). See Note 15, Earnings Per Share, for calculation of earnings per
share.

Year endedDecember 31,**2005**(Dollars inthousands,except per shareinformation)Net incomeAs
      reported
    $
    38,828Stock-based compensation expense determined under fair
      valuebased method for all awards, net of related tax
      effects
    
    (602
    )Pro forma
    $
    38,226Earnings per share (Basic)As
      reported
    $
    1.34Pro forma
    $
    1.32Earnings per share (Diluted)As
      reported
    $
    1.32Pro forma
    $
    1.30


The
Corporation has the following shareholder approved fixed stock option plans that
are maintained to advance the development, growth and financial condition of the
Corporation as described below. In connection with the acquisition of Millennium
Bank in 2004, the Corporation assumed all obligations under the Millennium Bank
Stock Compensation Program. In connection with the acquisition of East Penn
Financial in 2007, the Corporation assumed all obligations under the East Penn
Financial 1999 Independent Director Stock Option Plan and the 1999 Stock
Incentive Plan. All share information has been adjusted to reflect stock
dividends. For additional information on the accounting for share-based
compensation plans, see Note 1, Significant Accounting PoliciesStock-Based
Compensation.

*1998 Independent Directors Stock
Option Plan:*This plan provides that shares
of the Corporations stock be issued to non-employee directors. During 2007, no
options were granted under the plan. As of December 31, 2007, a total of 47,098
stock options remained available for grant under the plan. At December 31, 2007,
there were 261,064 options outstanding under the plan.

East Penn
Financial 1999 Independent Director Stock Option Plan Converted to Harleysville
Stock Options:In connection with the
acquisition of East Penn Financial in 2007, the Corporation assumed all
obligations under the East Penn Financial 1999 Independent Director Stock Option
Plan. The change in control accelerated the vesting of all outstanding stock
options to 100%. Upon consummation of the merger, outstanding stock options were
converted according to pro-ration parameters outlined in the merger agreement.
Stock options totaling 1,932 were assumed on the effective date of the merger. A
total of 1,932 stock options remain outstanding under the plan at December 31,
2007. No further stock options may be granted under the plan.

1993
Stock Incentive Plan:This plan provides that
shares of the Corporations common stock be issued to certain employees of the
Corporation and the Bank. Awards can be made in the form of incentive stock
options, non-qualified stock options, stock appreciation rights or restricted
stock. No stock options remain available for grant under the 1993 Stock
Incentive Plan. At December 31, 2007, there were 21,081 options outstanding
under the plan.

78

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 14Stock-Based Compensation
(Continued)

1998
Stock Incentive Plan:This plan provides that
shares of the Corporations common stock be issued to certain employees of the
Corporation and the Bank. Awards can be made in the form of incentive stock
options, non-qualified stock options, stock appreciation rights or restricted
stock. As of December 31, 2007, a total of 99,297 stock options remained
available for grant under the plan. During 2007, no stock options were granted.
At December 31, 2007, there were 767,260 options outstanding under the plan.

2004
Omnibus Stock Incentive:This plan provides
that shares of the Corporations common stock be issued to certain employees
and/or directors of the Corporation and the Bank. Awards can be made in the form
of incentive stock options, non-qualified stock options, stock appreciation
rights or restricted stock. During 2007, there were 25,000 stock options granted
under the plan. As of December, 31, 2007, stock options of 1,119,725 remain
available for grant. At December 31, 2007, there were 37,900 options outstanding
under the plan.

Millennium Bank Stock Compensation Program Converted to Harleysville
Stock Options:In connection with the
acquisition of Millennium Bank in 2004, the Corporation assumed all obligations
under the Millennium Bank Stock Compensation Program. The change in control
accelerated the vesting of all outstanding stock options to 100%. Upon
consummation of the merger, outstanding stock options were converted according
to pro-ration parameters outlined in the merger agreement. Stock options
totaling 328,327 were assumed on the effective date of the merger. In
conjunction with the sale of Cumberland Advisors, Inc. which took place in the
second quarter of 2005, 36,209 non-qualified performance based stock options
were cancelled. A total of 714 stock options remain outstanding under the
program at December 31, 2007. No further stock options may be granted under the
program.

East Penn
Financial 1999 Stock Incentive Plan Converted to Harleysville Stock Options:In connection with the acquisition of East
Penn Financial in 2007, the Corporation assumed all obligations under the East
Penn Financial 1999 Stock Incentive Plan. The change in control accelerated the
vesting of all outstanding stock options to 100%. Upon consummation of the
merger, outstanding stock options were converted according to pro-ration
parameters outlined in the merger agreement. Stock options totaling 23,548 were
assumed on the effective date of the merger. A total of 23,548 stock options
remain outstanding under the plan at December 31, 2007. No further stock options
may be granted under the plan.

A summary of
option activity under the Corporations stock option plans as of December 31,
2007 and changes during the year then ended is presented in the following table.
The number of shares and weighted-average share information have been adjusted
to reflect stock dividends.

|                                                     |  |           |   |       |           |                | **Weighted-**   |                    |                    
|---------------------------------------------------- |  | --------- | - | ----- | --------- | -------------- | --------------- | ------------------ | -------------------
|                                                     |  |           |   |       |           |                | **Average**     |                    |                    
|                                                     |  |           |   |       | Weighted- |                | **Remaining**   |                    |                    
|                                                     |  |           |   |       | Average   |                | **Contractual** |                    | **Aggregate**      
|                                                     |  |           |   |       | Exercise  |                | **Term**        |                    | **Intrinsic Value**
|**Options**                                          |  | Shares    |   | Price |           | **(in years)** |                 | **(in thousands)**
|Outstanding at January 1, 2007                       |  | 1,157,485 |   |       | $         | 15.60          |                 |                    |                    
|Granted                                              |  | 25,000    |   |       |           | 14.49          |                 |                    |                    
|Options assumed from East Penn Financial acquisition |  |           |   |       |           |                |                 |                    |                    
|(see note 2)                                         |  | 25,480    |   |       |           | 10.14          |                 |                    |                    
|Exercised                                            |  | (75,943   | ) |       |           | 9.29           |                 |                    |                    
|Forfeited (unvested)                                 |  | (9,052    | ) |       |           | 22.77          |                 |                    |                    
|Cancelled (vested)                                   |  | (9,471    | ) |       |           | 25.20          |                 |                    |                    
|Outstanding at December 31, 2007                     |  | 1,113,499 |   |       | $         | 15.74          |                 | 4.60               |                    
|                                                    
|Exercisable at December 31, 2007                     |  | 1,004,763 |   |       | $         | 15.26          |                 | 4.24               |                    

79

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 14Stock-Based Compensation
(Continued)

The
weighted-average grant-date fair value of options granted during the years ended
December 31, 2007, 2006 and 2005 were $3.73, $5.23 and $5.83, respectively. The
total intrinsic value of options exercised during the years ended December 31,
2007, 2006 and 2005 were $514,000, $4.6 million and $3.6 million, respectively.
Intrinsic value is measured using the fair market value price of the
Corporations common stock less the applicable exercise price.

A summary of the status of the
Corporations nonvested shares as of December 31, 2007 is as follows:

Weighted-AverageNonvested Shares
    
    
    Shares
    
    Grant-Date Fair ValueNonvested at January 1, 2007
    
    131,610
    
    
    $
    6.15Granted
    
    25,000
    
    
    
    3.08Share obligations assumed fromEast Penn
      Financial acquisition
    
    25,480
    
    
    
    4.37Vested
    
    (64,302
    )
    
    
    5.54Forfeited
    
    (9,052
    )
    
    
    6.30Nonvested at December 31, 2007
    
    108,736
    
    
    $
    5.37


As of
December 31, 2007, there was a total of $376,000 of unrecognized compensation
cost related to nonvested awards under stock option plans. This cost is expected
to be recognized over a weighted-average period of 2.3 years. The total fair
value of shares vested during the years ended December 31, 2007, 2006 and 2005
were $356,000, $360,000 and $1.1 million, respectively. The tax benefit realized
for the tax deductions from option exercises totaled $119,000, $1.3 million, and
$1.1 million for 2007, 2006, and 2005, respectively.

Prior to the
adoption of SFAS 123(R), the Corporation presented all tax benefits of
deductions resulting from the exercise of stock options as operating cash flows
in the statement of cash flows. Statement 123(R) requires the cash flows
resulting from tax benefits resulting from tax deductions in excess of the
compensation cost recognized for those options (excess tax benefits) to be
classified as financing cash flows. The excess tax benefit of $42,000 for 2007
and $948,000 for 2006 classified as a financing cash inflow would have been
classified as an operating cash inflow if the company had not adopted SFAS
123(R).

In addition,
the Corporation maintains the Harleysville National Corporation Stock Bonus Plan
to award employees in recognition of exemplary service during each calendar
year. The Corporations Board of Directors authorized the registration of 70,354
shares of common stock for issuance under this plan in December 1996. The Stock
Bonus Plan is administered by the Compensation Committee of the Corporation. The
committee annually determines, in its sole discretion, the amount of shares the
Corporation awards. The Corporation awarded 219 shares during 2007. As of
December 31, 2007, a total of 22,824 shares remained available for awards under
the plan.

80

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 15Earnings Per Share

The calculations
of basic earnings per share and diluted earnings per share are presented below.
All weighted average shares, actual shares and per share information in the
financial statements have been adjusted retroactively for the effect of stock
dividends and splits. See Note 1 of the consolidated financial statements for a
discussion on the calculation of earnings per share.

Year Ended December

31,2007
    
    2006
    
    2005(Dollars in thousands, exceptper share information)Basic earnings per shareNet income
      available to common shareholders
    
    **$**
    26,595
    
    $
    39,415
    
    $
    38,828Weighted average common shares outstanding
    
    
    29,218,671
    
    
    28,946,847
    
    
    28,891,412Basic earnings
      per share
    
    **$**
    0.91
    
    $
    1.36
    
    $
    1.34Diluted earnings per shareNet income
      available to common shareholdersand assumed conversions
    
    **$**
    26,595
    
    $
    39,415
    
    $
    38,828Weighted average common shares outstanding
    
    
    29,218,671
    
    
    28,946,847
    
    
    28,891,412Dilutive
      potential common shares(1),(2)
    
    
    241,227
    
    
    406,281
    
    
    598,804Total diluted weighted average common sharesoutstanding
    
    
    29,459,898
    
    
    29,353,128
    
    
    29,490,216Diluted earnings
      per share
    
    **$**
    0.90
    
    $
    1.34
    
    $
    1.32


|(1) |  | Includes
      incremental shares from assumed conversions of stock options.                                                                                                                                                                                                                                                                                                                
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Antidilutive options have been excluded in the computation of
      diluted earnings per share because the options exercise prices were
      greater than the average market price of the common stock. For 2007, 2006,
      and 2005, there were 475,952, 416,353 and 372,471 antidilutive options at
      an average price of $23.44, $24.50 and $25.65 per share,
      respectively.

Note 16Comprehensive Income and
Accumulated Other Comprehensive Income

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

Before
    
    Tax Benefit
    
    Net ofFor the year ended December 31,
      2007
    
    
    tax amount
    
    (Expense)
    
    tax amount(Dollars in thousands)Net unrealized gains on available for sale
      securities:Net unrealized holding gains arising during
      period
    
    **$**
    4,856
    
    
    **$**
    (1,700
    )
    
    **$**
    3,156Less
      reclassification adjustment for net gains realized innet income
    
    
    1,132
    
    
    
    (396
    )
    
    
    736Net unrealized gains
    
    
    3,724
    
    
    
    (1,304
    )
    
    
    2,420Change in fair
      value of derivatives used for cash flowhedges
    
    
    (643
    )
    
    
    225
    
    
    
    (418
    )Reversal of FAS 158 adjustment due to defined benefitpension plan curtailment
    
    
    2,361
    
    
    
    (826
    )
    
    
    1,535Other
      comprehensive income, net
    
    **$**
    5,442
    
    
    **$**
    (1,905
    )
    
    **$**
    3,537


81

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note
16Comprehensive Income and Accumulated Other Comprehensive Income (Continued)

Before
    
    **Tax Benefit**
    
    Net ofFor the
      year ended December 31, 2006(1)
    
    tax amount
    
    **(Expense)**
    
    tax amount(Dollars in thousands)Net unrealized gains on available for sale securities:Net unrealized holding gains arising during
      period
    
    $
    5,548
    
    
    $
    (1,942
    )
    
    $
    3,606Less reclassification adjustment for net losses
      realized in netincome
    
    
    (674
    )
    
    
    236
    
    
    
    (438
    )Net unrealized gains
    
    
    6,222
    
    
    
    (2,178
    )
    
    
    4,044Change in fair value of derivatives used for cash
      flow hedges
    
    
    (141
    )
    
    
    49
    
    
    
    (92
    )Amortization of unrealized loss on termination of cash
      flowhedge
    
    
    151
    
    
    
    (53
    )
    
    
    98Other comprehensive income, net
    
    $
    6,232
    
    
    $
    (2,182
    )
    
    $
    4,050Before
    
    **Tax
      Benefit**
    
    Net ofFor the
      year ended December 31, 2005
    
    tax amount
    
    **(Expense)**
    
    tax amount(Dollars in thousands)Net unrealized losses on available for sale securities:Net unrealized holding losses arising during
      period
    
    $
    (10,783
    )
    
    $
    3,774
    
    
    $
    (7,009
    )Less reclassification adjustment for net gains
      realized in netincome
    
    
    4,794
    
    
    
    (1,678
    )
    
    
    3,116Net unrealized losses
    
    
    (15,577
    )
    
    
    5,452
    
    
    
    (10,125
    )Change in fair value of derivatives used for cash
      flowhedges
    
    
    557
    
    
    
    (195
    )
    
    
    362Unrealized loss on termination of cash flow

hedge
    
    
    (151
    )
    
    
    53
    
    
    
    (98
    )Other comprehensive loss, net
    
    $
    (15,171
    )
    
    $
    5,310
    
    
    $
    (9,861
    )


|(1) |  | At December 31, 2006, the
      Corporation adopted SFAS No. 158, Employers Accounting for Defined
      Benefit Pension and Other Postretirement Plans and recognized as a
      component of accumulated other comprehensive income (OCI), net of tax, the
      net loss and transition asset that had not been included in the net
      periodic benefit cost of its pension plan for $1.5 million. However, the
      $1.5 million transition amount was included in OCI for 2006 rather than as
      an adjustment of the December 31, 2006 balance of accumulated OCI. The
      Corporation previously determined the error was not material and
      comprehensive income reflects corrected disclosures for
  2006.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|                           |  | **Net Unrealized** |         | **Net
      Change in** |  |                    |      |                           |  | Transition              |     |                  
|-------------------------- |  | ------------------ | ------- | ----------------------- |  | ------------------ | ---- | ------------------------- |  | ----------------------- | --- | -----------------
|                           |  | **Gains (Losses)** |         | **Fair
      Value of** |  | Net Change in      |      | **Net Change**            |  | **Asset
      Related** |     | Accumulated      
|                           |  | **on Available**   |         | **Derivatives**         |  | **Termination of** |      | ******Related to**        |  | **to Defined**          |     | Other            
|                           |  | **For Sale**       |         | **Used for
      Cash** |  | Cash Flow          |      | **Defined
      Benefit** |  | Benefit                 |     | **Comprehensive**
|                           |  | Securities         |         | Flow Hedges             |  | Hedge              |      | **Pension Plan**          |  | **Pension Plan**        |     | **Income (Loss)**
|Balance, December 31, 2004 |  | $                  | 1,209   |                         |  | $                  | 34   |                           |  | $                       | -   |                  
|Net Change                 |  |                    | (10,125 | )                       |  |                    | 362  |                           |  |                         | (98 | )                
|Balance, December 31, 2005 |  |                    | (8,916  | )                       |  |                    | 396  |                           |  |                         | (98 | )                
|Net Change                 |  |                    | 4,044   |                         |  |                    | (92  | )                         |  |                         | 98  |                  
|Balance, December 31, 2006 |  |                    | (4,872  | )                       |  |                    | 304  |                           |  |                         | -   |                  
|Net Change                 |  |                    | 2,420   |                         |  |                    | (418 | )                         |  |                         | -   |                  
|Balance, December 31, 2007 |  | $                  | (2,452  | )                       |  | $                  | (114 | )                         |  | $                       | -   |                  

82

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 17Segment Information

The Corporation operates two main
lines of business along with several other operating segments.SFAS No. 131, Disclosures about Segments

of an Enterprise and
Related Information establishes standards for 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. The Corporation has applied the aggregation
criteria set forth in SFAS 131 for operating segments establishing two
reportable segments: Community Banking and Wealth Management.

The
Community Banking segment provides financial services to consumers, businesses
and governmental units primarily in southeastern Pennsylvania. These services
include full-service banking, comprised of accepting time and demand deposits,
making secured and unsecured commercial loans, mortgages, consumer loans, and
other banking services. The treasury function income is included in the
Community Banking segment, as the majority of effort of this function is related
to this segment. Primary sources of income include net interest income and
service fees on deposit accounts. Expenses include costs to manage credit and
interest rate risk, personnel, and branch operational and technical support.

The Wealth
Management segment includes: trust and investment management services, providing
investment management, trust and fiduciary services, estate settlement and
executor services, financial planning, and retirement plan and institutional
investment services; and the Cornerstone Companies, registered investment
advisors for high net worth, privately held business owners, wealthy families
and institutional clients. Major revenue component sources include investment
management and advisory fees, trust fees, estate and tax planning fees,
brokerage fees, and insurance related fees. Expenses primarily consist of
personnel and support charges. Additionally, the Wealth Management segment
includes an inter-segment credit related to trust deposits which are maintained
within the Community Banking segment using a transfer pricing methodology.

The
Corporation has also identified several other operating segments. These
operating segments within the Corporations operations do not have similar
characteristics to the Community Banking or Wealth Management segments and do
not meet the quantitative thresholds requiring separate disclosure. These
non-reportable segments include HNC Reinsurance Company, HNC Financial Company,
and the parent holding company and are included in the Other category.

Information
about reportable segments and reconciliation of the information to the
consolidated financial statements follows:

|                                                  |  | Community              |           |                   |   |           |  |                    
|------------------------------------------------- |  | ---------------------- | --------- | ----------------- | - | --------- |  | -------------------
|                                                  |  | Banking                |           | Wealth Management |   | All Other |  | Consolidated Totals
|                                                  |  | (Dollars in thousands)
|Year Ended December 31, 2007                      |  |                        |           |                   |   |           |  |                    
|Net interest
      income (expense)               |  | **$**                  | 84,563    |                   | $ | 451       |  | **$**              
|Provision for loan losses                         |  |                        | 10,550    |                   |   | -         |  |                    
|Noninterest
      income                          |  |                        | 23,947    |                   |   | 18,658    |  |                    
|Noninterest expense                               |  |                        | 64,751    |                   |   | 15,744    |  |                    
|Income (loss)
      before income taxes (benefit) |  |                        | 33,209    |                   |   | 3,365     |  |                    
|Income taxes (benefit)                            |  |                        | 6,917     |                   |   | 1,502     |  |                    
|Net income
      (loss)                           |  | $                      | 26,292    |                   | $ | 1,863     |  | **$**              
|Assets                                            |  | $                      | 3,862,378 |                   | $ | 25,572    |  | **$**              

83

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 17Segment Information (Continued)

|                                            |  | Community              |           |                   |   |           |  |                    
|------------------------------------------- |  | ---------------------- | --------- | ----------------- | - | --------- |  | -------------------
|                                            |  | Banking                |           | Wealth Management |   | All Other |  | Consolidated Totals
|Year Ended
      December 31, 2006          |  | (Dollars in thousands)
|Net interest income (expense)               |  | $                      | 84,775    |                   | $ | 470       |  | $                  
|Provision for
      loan losses             |  |                        | 4,200     |                   |   | -         |  |                    
|Noninterest income                          |  |                        | 29,735    |                   |   | 14,878    |  |                    
|Noninterest
      expense                   |  |                        | 56,049    |                   |   | 13,553    |  |                    
|Income (loss) before income taxes (benefit) |  |                        | 54,261    |                   |   | 1,795     |  |                    
|Income taxes
      (benefit)                |  |                        | 14,475    |                   |   | 717       |  |                    
|Net income (loss)                           |  | $                      | 39,786    |                   | $ | 1,078     |  | $                  
|Assets                                      |  | $                      | 3,195,051 |                   | $ | 19,475    |  | $                  
|                                           
|                                           
|Year Ended December 31, 2005                |  |                        |           |                   |   |           |  |                    
|Net interest
      income (expense)         |  | $                      | 87,105    |                   | $ | 620       |  | $                  
|Provision for loan losses                   |  |                        | 3,401     |                   |   | -         |  |                    
|Noninterest
      income                    |  |                        | 20,512    |                   |   | 6,690     |  |                    
|Noninterest expense                         |  |                        | 55,129    |                   |   | 7,078     |  |                    
|Income before
      income taxes            |  |                        | 49,087    |                   |   | 232       |  |                    
|Income taxes                                |  |                        | 11,927    |                   |   | 81        |  |                    
|Net
      income                            |  | $                      | 37,160    |                   | $ | 151       |  | $                  
|Assets                                      |  | $                      | 3,084,303 |                   | $ | 51        |  | $                  

The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies disclosed in Note 1 of the
consolidated financial statements. Consolidating adjustments reflecting certain
eliminations of inter-segment revenues, cash and investment in subsidiaries are
included in the All Other segment.

Note 18Lease Commitments and
Contingent Liabilities

Lease Commitments

Lease
commitments for equipment and banking locations expire intermittently over the
years through 2036. Most banking location leases require the lessor to pay
insurance, maintenance costs, and property taxes. In December 2007, the
Corporation sold its headquarters property along with fourteen branch
properties and entered into a sale-leaseback agreement with the purchaser. At
December 31, 2007, the remaining term of these leases was fifteen years with
options to renew for up to forty additional years. See Note 2 - Acquisitions /
Dispositions for additional information. Approximate minimum rental commitments
for non-cancelable operating leases at December 31, 2007, are as follows:

MinimumLeasePayments(Dollarsin
      thousands)For the year ending:2008
    
    $
    6,1192009
    
    
    5,8862010
    
    
    5,7212011
    
    
    5,6072012
    
    
    5,526Thereafter
    
    
    59,078Total
    
    $
    87,937


84

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 18Lease Commitments and
Contingent Liabilities (Continued)

Total rent
expense amounted to $2.9 million for 2007 and $2.4 million for each of the years
ended December 31, 2006 and 2005, respectively.

Other

Based on
consultation with the Corporations legal counsel, management is not aware of
any litigation that would have a material adverse effect on the consolidated
financial position of the Corporation. There are no proceedings pending other
than the ordinary routine litigation incident to the business of the
Corporation. In addition, no material proceedings are pending or are known to be
threatened or contemplated against the Corporation by government authorities.

Note 19Financial Instruments with
Off-Balance Sheet Risk

The Bank is
a party to financial instruments with off-balance-sheet risk in the normal
course of business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit and standby letters of credit.
Such financial instruments are recorded in the financial statements when they
become payable. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
consolidated balance sheets. The contract or notional amounts of those
instruments reflect the extent of involvement the Bank has in particular classes
of financial instruments.

The Banks
maximum exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual or notional amounts of those
instruments. The Bank uses the same stringent credit policies in extending these
commitments as they do for recorded financial instruments and controls exposure
to loss through credit approval and monitoring procedures. These commitments
often expire without being drawn upon and often are secured with appropriate
collateral; therefore, the total commitment amount does not necessarily
represent the actual risk of loss or future cash requirements.

The Bank
offers commercial, mortgage and consumer credit products to its customers in the
normal course of business. These products represent a diversified credit
portfolio and are generally issued to borrowers within the Banks branch office
systems in eastern Pennsylvania. The ability of the customers to repay their
credits is, to some extent, dependent upon the economy in the Banks market
areas.

The approximate contract amounts are
as follows:

|                                                                                 |  | Total Amount          
|-------------------------------------------------------------------------------- |  | ----------------------
|                                                                                 |  | Committed at          
|                                                                                 |  | December 31,          
|Commitments                                                                      |  |                       
|                                                                                 |  | (Dollars in thousands)
|Financial instruments whose contract amounts

represent
      credit risk:       |  |                       
|Commitments to extend credit                                                     |  | **$**                 
|Standby
      letters of credit and financial guarantees written                 |  |                       
|Financial instruments whose notional or contract amounts exceed the
      amount |  |                       
|of credit
      risk:                                                            |  |                       
|Interest
      rate swap agreements                                              |  |                       
|Interest
      rate cap agreements                                               |  |                       

85

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 19Financial Instruments with
Off-Balance Sheet Risk (Continued)

Standby
letters of credit expire as follows: $20.2 million in one year or less, $1.7
million after one year through three years, $0 after three years through five
years and $1.5 million after five years.

At December 31, 2007, the
Corporation had cash flow hedges in the form of interest rate swaps with a
notional amount of $45.0 million that have the effect of converting the rates on
money market deposit accounts to a fixed-rate cost of funds. This strategy will
cause the Bank to recognize, in a rising rate environment, a larger interest
rate spread than it otherwise would have without the swaps in effect. In
addition, the Corporation had cash flow hedges with a notional amount of $10.0
million that have the effect of converting variable debt to a fixed rate. For
these swaps, the Corporation recognized net interest income of $287,000,
$442,000 and $69,000 for the years ended December 31, 2007, 2006 and 2005,
respectively and estimates that for 2008, $153,000 will be recognized as a
decrease in net interest income. These swaps mature in 2008. During the first
quarter of 2005, the Corporation terminated a cash flow hedge with a notional
value of $25.0 million. The gross loss related to the termination of this swap
was $310,000 which was amortized through October 2006 in accordance with SFAS
No. 133 Accounting for Derivative Instruments and Hedging Activities. For the
years ended December 31, 2006 and 2005, the Corporation amortized into net
interest income $151,000 and $159,000, respectively related to this swap.
Periodically, the Corporation may enter into fair value hedges to limit the
exposure to changes in the fair value of loan assets. At December 31, 2007, the
Corporation had fair value hedges in the form of interest rate swaps with a
notional amount of $3.9 million. These swaps mature in 2017. The Corporation
recognized net interest income of $59,000 and $7,000 for the years ended
December 31, 2007 and 2006, respectively, which includes $55,000 for 2007
related to two terminated swaps with notional amounts totaling $3.9 million that
were terminated during 2007. At December 31, 2007, the Corporation had swap
agreements with a positive fair value of $10,000 and with a negative fair value
of $366,000. At December 31, 2006, the Corporation had swap agreements with a
positive fair value of $545,000 and with a negative fair value of $21,000. There
was no hedge ineffectiveness recognized during 2007, 2006 and 2005.

During March
2007, the Corporation purchased one and three month Treasury bill interest rate
cap agreements with notional amounts totaling $200 million to limit its exposure
on variable rate now deposit accounts. The initial premium related to these caps
was $73,000 which is being amortized to interest expense over the life of the
cap based on the cap market value. The Corporation recognized amortization of
$8,000 for the year ended December 31, 2007 and estimates that for 2008, $46,000
will be recognized as interest expense. At December 31, 2007, these caps,
designated as cash flow hedges, had a positive fair value of $222. The caps
mature in March 2009. During 2007, the Corporation accelerated the
reclassification of an immaterial amount in other comprehensive income to
earnings as a result of variable-rate interest payments becoming probable not to
occur. The accelerated amount was a loss of $7,000 recognized in interest
expense.

The Bank
also had commitments with customers to extend mortgage loans at a specified rate
at December 31, 2007 and December 31, 2006 of $3.4 million and $2.3 million,
respectively and commitments to sell mortgage loans at a specified rate at
December 31, 2007 and December 31, 2006 of $2.4 million and $792,000,
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 December 31, 2007, the Corporation had commitments with a
positive fair value of $19,000 and negative fair value of $19,000 which was
recorded as other income. At December 31, 2006, the Corporation had commitments
with a positive fair value of $15,000 and a negative fair value of $3,000.

86

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 19Financial Instruments with
Off-Balance Sheet Risk (Continued)

During April
2006, the Bank sold its existing credit card portfolio of $15.3 million. The
sale agreement stipulated that any credit card accounts delinquent over 30 days,
overlimit accounts and petitioned bankruptcies would be guaranteed by the Bank
for a period of one year. Of the $15.3 million in credit card receivables sold,
$529,000 was sold with full recourse which was the total potential recourse
exposure at the time of the sale. During the second quarter of 2006, the Bank
recorded a recourse liability of $371,000 which was the entire recourse
liability recorded. This estimate was based on our historic losses as
experienced on similar credit card receivables. The Bank was subject to the full
recourse obligations for a period of one year. At June 30, 2007, the total
potential recourse exposure was reduced to $0 with the expiration of the
one-year recourse period. The Corporations actual loss experience approximated
the initial reserve.

During
December 2004 and January 2005, the Bank sold lease financing receivables of
$10.5 million. Of these leases, $1.2 million were sold with full recourse and
the remaining leases were sold subject to recourse with a maximum exposure of
ten percent of the outstanding receivable. The total recourse exposure at the
time of the sale of the leases was $2.0 million. During the first quarter of
2005, the Bank recorded a recourse liability of $216,000 which was the entire
recourse liability recorded. This estimate was based on our historic losses as
experienced on similar lease financing receivables. After the first anniversary
of the sale agreement, and on a quarterly basis thereafter, upon written request
by the Bank, the purchaser will review the portfolio performance and may reduce
the total exposure to an amount equal to ten percent of the outstanding net book
value. The Bank will be subject to the full and partial recourse obligations
until all the lease financing receivables have been paid or otherwise been
terminated and all equipment has been sold or disposed of. The final lease
payment is due in 2010. The outstanding balance of these sold leases at December
31, 2007 was $1.0 million with a total recourse exposure of $198,000 and a
current recourse liability of $17,000.

Note 20Regulatory Capital

|                                               |  |                        |         |                   |       |                   |        |             |         |            |        |   |       | To Be Well  
|---------------------------------------------- |  | ---------------------- | ------- | ----------------- | ----- | ----------------- | ------ | ----------- | ------- | ---------- | ------ | - | ----- | ------------
|                                               |  |                        |         |                   |       |                   |        |             |         |            |        |   |       | Capitalized 
|                                               |  |                        |         |                   |       |                   |        |             |         |            |        |   |       | Under Prompt
|                                               |  |                        |         |                   |       |                   |        | For Capital |         | Corrective
|                                               |  | Actual                 |         | Adequacy Purposes |       | Action

Provision
|As of December 31, 2007                        |  |                        | Amount  |                   | Ratio |                   | Amount |             | Ratio   |            | Amount |   | Ratio
|                                               |  | (Dollars in thousands)
|Total Capital (to risk weighted
      assets): |  |                        |         |                   |       |                   |        |             |         |            |        |   |       |             
|Corporation                                    |  | **$**                  | 329,887 |                   | 10.67 | %                 |        | **$**       | 247,273 |            | 8.00   | % |       | **$**       
|Harleysville National Bank                     |  |                        | 312,880 |                   | 10.16 | %                 |        |             | 246,286 |            | 8.00   | % |       |             
|Tier 1 Capital (to risk weighted assets):      |  |                        |         |                   |       |                   |        |             |         |            |        |   |       |             
|Corporation                                    |  |                        | 302,459 |                   | 9.79  | %                 |        |             | 123,637 |            | 4.00   | % |       |             
|Harleysville National Bank                     |  |                        | 285,452 |                   | 9.27  | %                 |        |             | 123,143 |            | 4.00   | % |       |             
|Tier 1 Capital (to average

assets):           |  |                        |         |                   |       |                   |        |             |         |            |        |   |       |             
|Corporation                                    |  |                        | 302,459 |                   | 8.72  | %                 |        |             | 138,795 |            | 4.00   | % |       |             
|Harleysville National Bank                     |  |                        | 285,452 |                   | 8.29  | %                 |        |             | 137,722 |            | 4.00   | % |       |             

87

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 20Regulatory Capital (Continued)

|                                               |  |                        |         |                   |       |                   |        |             |         |            |        |   |       | To
      Be Well
|---------------------------------------------- |  | ---------------------- | ------- | ----------------- | ----- | ----------------- | ------ | ----------- | ------- | ---------- | ------ | - | ----- | ----------------
|                                               |  |                        |         |                   |       |                   |        |             |         |            |        |   |       | Capitalized     
|                                               |  |                        |         |                   |       |                   |        |             |         |            |        |   |       | Under Prompt    
|                                               |  |                        |         |                   |       |                   |        | For Capital |         | Corrective
|                                               |  | Actual                 |         | Adequacy Purposes |       | Action

Provision
|As of December 31, 2006                        |  |                        | Amount  |                   | Ratio |                   | Amount |             | Ratio   |            | Amount |   | Ratio
|                                               |  | (Dollars in thousands)
|Total Capital (to risk weighted
      assets): |  |                        |         |                   |       |                   |        |             |         |            |        |   |       |                 
|Corporation                                    |  | $                      | 323,622 |                   | 12.58 | %                 |        | $           | 205,814 |            | 8.00   | % |       | $               
|Harleysville National Bank                     |  |                        | 279,513 |                   | 10.93 | %                 |        |             | 204,529 |            | 8.00   | % |       |                 
|Tier 1 Capital (to risk weighted assets):      |  |                        |         |                   |       |                   |        |             |         |            |        |   |       |                 
|Corporation                                    |  |                        | 302,368 |                   | 11.75 | %                 |        |             | 102,907 |            | 4.00   | % |       |                 
|Harleysville National Bank                     |  |                        | 258,259 |                   | 10.10 | %                 |        |             | 102,264 |            | 4.00   | % |       |                 
|Tier 1 Capital (to average

assets):           |  |                        |         |                   |       |                   |        |             |         |            |        |   |       |                 
|Corporation                                    |  |                        | 302,368 |                   | 9.36  | %                 |        |             | 129,242 |            | 4.00   | % |       |                 
|Harleysville National Bank                     |  |                        | 258,259 |                   | 8.08  | %                 |        |             | 127,877 |            | 4.00   | % |       |                 

The Bank is
subject to various regulatory capital requirements administered by the federal
banking agencies. Failure to meet minimum capital requirements can initiate
certain mandatory and possibly additional discretionary actions by regulators
that, if undertaken, could have a direct material affect on the Corporations
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the Banks assets, liabilities,
and certain off-balance-sheet items as calculated under regulatory accounting
practices. The Banks capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.

Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios (set forth in the table) of total and
Tier 1 capital to risk-weighted assets. Management believes, as of December 31,
2007, that the Bank meets all capital adequacy requirements to which it is
subject. To be categorized as well capitalized, the Bank must maintain minimum
total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in
the table. There are no conditions or events that have occurred that management
believes have changed the Banks category.

The National
Banking Laws require the approval of the Office of the Comptroller of the
Currency if the total of all dividends declared by a national bank in any
calendar year exceed the net profits of the bank (as defined) for that year
combined with its retained net profits for the preceding two calendar years.
Under this formula, the Bank may declare dividends in 2008 of approximately
$23.6 million plus an amount equal to the net profits of the Bank in 2008 up to
the date of any such dividend declaration.

Banking
regulations limit the amount of investments, loans, extensions of credit and
advances that a subsidiary bank can make to an affiliate at any time to 10% and
in the aggregate or to a single financial subsidiary, to 20% of the Banks
capital stock and surplus. These regulations also require that certain covered
transactions including a loan, extension of credit or advance to an affiliate be
secured by securities having a market value in excess of the amount thereof. At
December 31, 2007, the Banks investment in the Cornerstone Companies (a
financial subsidiary) of $19.4 million was in compliance with the limitations
and not subject to collateral requirements.

88

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 21Fair Value of Financial
Instruments

SFAS No.
107, Disclosures about Fair Values of Financial Instruments, requires
disclosure of the estimated fair value of an entitys assets and liabilities
considered to be financial instruments. For the Corporation, as for most
financial institutions, the majority of its assets and liabilities are
considered financial instruments as defined in SFAS 107. However, many such
instruments lack an available trading market, as characterized by a willing
buyer and seller engaging in an exchange transaction. Also, it is the
Corporations general practice and intent to hold its financial instruments to
maturity and not to engage in trading or sales activities, except for certain
loans and investments. Therefore, the Corporation had to use significant
estimates and present value calculations to prepare this disclosure.

Changes in
the assumptions or methodologies used to estimate fair values may materially
affect the estimated amounts. Also, management is concerned that there may not
be reasonable comparability between institutions due to the wide range of
permitted assumptions and methodologies in the absence of active markets. This
lack of uniformity gives rise to a high degree of subjectivity in estimating
financial instrument fair values.

Estimated
fair values have been determined by the Corporation using the best available
data and an estimation methodology suitable for each category of financial
instruments. The estimation methodologies used at December 31, 2007 and 2006 are
outlined as follows:

Short-term financial instruments

The carrying
value of short-term financial instruments including cash and due from banks,
federal funds sold and securities purchased under agreements to resell,
interest-bearing deposits in banks and other short-term investments and
borrowings, approximates the fair value of these instruments. These financial
instruments generally expose the Corporation to limited credit risk and have no
stated maturities or have short-term maturities with interest rates that
approximate market rates.

Investment securities

The
estimated fair values of investment securities are based on quoted market
prices, provided by independent third parties that specialize in those
investment sectors. Estimated fair values are based on quoted market prices of
comparable instruments if quoted market prices are not available.

Loans

The loan
portfolio, net of unearned income, has been valued by management using a present
value discounted cash flow analysis where market prices were not available,
using the Sendero Risk model. The discount rate used in these calculations is
the estimated current market rate adjusted for credit risk.

Deposits

The
estimated fair values of demand deposits (i.e., interest and noninterest-bearing
checking accounts, savings and money market accounts) are, by definition, equal
to the amount payable on demand at the reporting date (i.e., their carrying
amounts). The fair value for certificates of deposit was calculated by
management by discounting contractual cash flows using current market rates for
instruments with similar maturities, using the Sendero Risk model. The carrying
amount of accrued interest receivable and payable approximates fair value.

89

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 21Fair Value of Financial
Instruments (Continued)

Long-term borrowings and subordinated
debt

The amounts
assigned to long-term borrowings and subordinated debt were based on quoted
market prices, when available, or were based on discounted cash flow
calculations using prevailing market interest rates for debt of similar terms.

Off-balance sheet instruments

The fair
value of commitments to extend credit is estimated based on the amount of
unamortized deferred loan commitment fees. The fair value of letters of credit
is based on the amount of unearned fees plus the estimated cost to terminate the
letters of credit. Fair values of unrecognized financial instruments including
commitments to extend credit and the fair value of letters of credit are
considered immaterial.

The fair
value of interest rate swaps are based upon the estimated amount the Corporation
would receive or pay to terminate the contracts or agreements, taking into
account current interest rates and, when appropriate, the current
creditworthiness of the counterparties. At December 31, 2007, the Corporation
had swap agreements with a positive fair value of 10,000 and with a negative
fair value of $366,000. At December 31, 2006, the Corporation had swap
agreements with a positive fair value of $545,000 and with a negative fair value
of $21,000.

The carrying and fair values of certain
financial instruments were as follows:

December

31,2007
    
    2006Carrying
    
    Fair
    
    Carrying
    
    FairAmount
    
    Value
    
    Amount
    
    Value(Dollars in thousands)Investment securities
    
    **$**
    982,915
    
    **$**
    983,086
    
    $
    911,889
    
    $
    912,307Loans,
      net
    
    
    2,433,495
    
    
    2,448,614
    
    
    2,047,355
    
    
    2,045,513Time deposits
    
    
    1,202,690
    
    
    1,195,811
    
    
    852,572
    
    
    849,052Long-term borrowings and
      subordinateddebt
    
    
    404,777
    
    
    410,038
    
    
    291,298
    
    
    281,246Bank-owned life insurance
    
    
    72,269
    
    
    72,269
    
    
    61,720
    
    
    61,720


90

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 22Parent-Company Only Financial
Information

Condensed financial statements of
Harleysville National Corporation follow:

CONDENSED BALANCE SHEETS

|                                           |  | December 31,          
|------------------------------------------ |  | ----------------------
|                                           |  | 2007                  
|                                           |  | (Dollars in thousands)
|Assets                                     |  |                       
|Cash                                       |  | **$**                 
|Investments in subsidiaries                |  |                       
|Other investments                          |  |                       
|Other assets                               |  |                       
|Total
      assets                         |  | **$**                 
|                                           |  |                       
|Liabilities and shareholders equity       |  |                       
|Subordinated debt                          |  | **$**                 
|Other liabilities                          |  |                       
|Total liabilities                          |  |                       
|Shareholders equity                       |  |                       
|Total liabilities and shareholders equity |  | **$**                 

CONDENSED STATEMENTS OF INCOME

|                                                                       |  | Year Ended December

31,
|---------------------------------------------------------------------- |  | ------------------------
|                                                                       |  | 2007                    
|                                                                       |  | (Dollars in thousands)  
|Dividends from subsidiaries                                            |  | **$**                   
|Interest from
      subsidiaries                                       |  |                         
|Investment income                                                      |  |                         
|Total income                                                           |  |                         
|Interest on subordinated debt                                          |  |                         
|Noninterest
      expense                                              |  |                         
|Total expense                                                          |  |                         
|Income before
      income tax benefit and equity in undistributed net |  |                         
|income of subsidiaries                                                 |  |                         
|Income tax benefit                                                     |  |                         
|Income before
      equity in undistributed net income of subsidiaries |  |                         
|Equity in undistributed net (losses) income of

subsidiaries           |  |                         
|Net income                                                             |  | **$**                   

91

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued) HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 22Parent-Company Only Financial
Information (Continued)

CONDENSED STATEMENTS OF CASH FLOWS

|                                                                                        |  | Year Ended December 31,
|--------------------------------------------------------------------------------------- |  | -----------------------
|                                                                                        |  | 2007                   
|                                                                                        |  | (Dollars in thousands) 
|Operating activities:                                                                   |  |                        
|Net
      income                                                                        |  | **$**                  
|Adjustments to reconcile net income to net cash provided by
      operating activities: |  |                        
|Equity in undistributed net losses (income) of
      subsidiaries                       |  |                        
|Stock-based compensation expense                                                        |  |                        
|Net (increase) decrease in other assets                                                 |  |                        
|Net increase in other liabilities                                                       |  |                        
|Other, net                                                                              |  |                        
|Net cash provided by operating activities                                               |  |                        
|                                                                                        |  |                        
|Investing activities:                                                                   |  |                        
|Net cash paid due to acquisition                                                        |  |                        
|Capital contributions made to the subsidiaries                                          |  |                        
|Net cash used in investing activities                                                   |  |                        
|                                                                                        |  |                        
|Financing activities:                                                                   |  |                        
|Advances
      of long-term subordinated debt                                           |  |                        
|Cash
      dividends                                                                    |  |                        
|Repurchase of common stock                                                              |  |                        
|Proceeds
      from the exercise of stock options                                       |  |                        
|Excess
      tax benefits from stock-based compensation                                 |  |                        
|Other,
      net                                                                        |  |                        
|Net cash used in financing
      activities                                             |  |                        
|Net (decrease) increase in
      cash                                                   |  |                        
|Cash and cash equivalents at
      beginning of year                                    |  |                        
|Cash and cash equivalents at end
      of year                                          |  | **$**                  

92

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REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
Harleysville National Corporation

We have
audited the accompanying consolidated balance sheets of Harleysville National
Corporation (a Pennsylvania corporation) and its subsidiaries as of December 31,
2007 and 2006, and the related consolidated statements of income, shareholders
equity, and cash flows for each of the three years in the period ended December
31, 2007. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted
our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Harleysville National
Corporation and subsidiaries as of December 31, 2007 and 2006, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2007 in conformity with accounting
principles generally accepted in the United States of America.

As discussed
in Note 12 and 14 to the consolidated financial statements, the Corporation has
adopted Financial Accounting Standards Board Statement(FASB) No. 158,Employers Accounting for Defined Benefit
Pension and Other Postretirement Plans  An Amendment of FASB Statements No. 87,
88, 106 and 132(R)) and FASB No. 123(R),Share Based Paymentsin 2006.

We also have
audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Harleysville National Corporations internal
control over financial reporting as of December 31, 2007, based on criteria
established in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) and our report dated
March 14, 2008 expressed an unqualified opinion.

|/s/ Grant
      Thornton LLP    
|--------------------------------
|Philadelphia,
      Pennsylvania
|March 14,
      2008            

93

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Item 9.Changes in and

Disagreements with
Accountants on Accounting and Financial Disclosure

None

Item 9A.Controls and

Procedures

There have
been no changes in the Corporations internal control over financial reporting
during the fourth quarter of 2007 that have materially affected, or reasonably
likely to materially affect, the Corporations internal control over financial
reporting.

**(i)****Conclusion Regarding the
Effectiveness of Disclosure Controls and Procedures**

Our
management evaluated, with the participation of our Chief Executive Officer and
Chief Financial Officer, the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-15(e) or 15(d)-15(e) under the Securities
Exchange Act of 1934) as of the end of the period covered by this report. Based
upon that evaluation, our Chief Executive Officer and Chief Financial Officer
have concluded that our disclosure controls and procedures are designed to
ensure that information required to be disclosed by us in the reports that we
file or submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized, and reported within the time periods specified in the SECs rules
and regulations and are operating in an effective manner and that such
information is accumulated and communicated to our management, including our
principal executive officer and principal financial officer, as appropriate to
allow timely decisions regarding required disclosure.

**(ii)****Managements Report on
Internal Control Over Financial Reporting and Compliance with Federal Laws and
Regulations**

Management
of the Corporation is responsible for establishing and maintaining adequate
internal control over financial reporting and compliance with federal laws and
regulations. Internal control over financial reporting is defined in Rule
13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended,
as a process designed by, or under the supervision of, the Corporations
principal executive and principal financial officers and effected by the
Corporations board of directors, management and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United States of America and
includes those policies and procedures that:

- Pertain to the maintenance of records that in
  reasonable detail accurately and fairly reflect the transactions and
  dispositions of the assets of the Corporation;
- Provide reasonable assurance that transactions are
  recorded as necessary to permit preparation of financial statements in
  accordance with generally accepted accounting principles, and that receipts
  and expenditures of the Corporation are being made only in accordance with
  authorizations of management and directors of the Corporation;
  and
- Provide reasonable assurance regarding prevention
  or timely detection of unauthorized acquisition, use or disposition of the
  Corporations assets that could have a material effect of the financial
  statements.

Because of
its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Projections of any evaluation of effectiveness
to future periods are subject to the risks that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.

Management
assessed the effectiveness of the Corporations internal control over financial
reporting as of December 31, 2007. In making this assessment, management used
the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) inInternal
Control-Integrated Framework.

94

---

Item 9A. Controls and Procedures
(Continued)

In
accordance with the SECs published guidance, the Corporations management
determined that it would exclude the operations of East Penn Financial (acquired
on November 16, 2007) from the scope of its assessment of internal control over
financial reporting as of December 31, 2007. As of December 31, 2007, the
Corporations total reported consolidated assets were $3.9 billion, of
which East Penn Financials assets accounted for approximately 11.6%. For the
year ended December 31, 2007, the Corporations consolidated interest and
non-interest income was $237.9 million, of which East Penn Financial accounted
for approximately 10.4%.

Management believes that, as of
December 31, 2007, the Corporations internal control over financial reporting
was effective. Management also assessed the effectiveness of the Corporations
internal controls for compliance with federal laws and regulations as of
December 31, 2007, in accordance with reporting requirements of Section 112 of
the Federal Deposit Insurance Corporation Improvement Act (FDICIA). Management
believes that as of December 31, 2007, the Corporations internal controls over
compliance with federal laws and regulations were effective.

The
Corporations independent registered Public Accounting Firm has issued an
attestation report on the Corporations internal control over financial
reporting. This report appears herein in Item 9A, section iii.

(iii)Report of Independent Registered Public Accounting
Firm

Board of Directors and Shareholders
Harleysville National Corporation

We have
audited Harleysville National Corporations (a Pennsylvania Corporation)
internal control over financial reporting as of December 31, 2007, based on
criteria established inInternal
ControlIntegrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Harleysville National Corporations management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting, included in the
accompanyingManagement Report on Internal
Control Over Financial Reporting. Our
responsibility is to express an opinion on Harleysville National Corporations
internal control over financial reporting based on our audit.

As indicated
in Managements Report on Internal Control over Financial Reporting,
managements assessment of and conclusion on the effectiveness of internal
control over financial reporting did not include the internal controls of the
operations of East Penn Financial which was acquired in November 2007 and
constituted approximately 11.6% of total consolidated assets as of December 31,
2007 and approximately 10.4% of total consolidate revenues for the year then
ended. Our audit on internal control over financial reporting of Harleysville
National Corporation and subsidiaries did not include an evaluation of the
internal control over financial reporting of the acquired company.

We conducted
our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.

A companys
internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A companys internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the companys
assets that could have a material effect on the financial statements.

95

---

Because of
its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.

In our
opinion, Harleysville National Corporation maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2007,
based on criteria established inInternal
Control  Integrated Framework issued by COSO.

We also have
audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Harleysville
National Corporation and its subsidiaries as of December 31, 2007 and 2006, and
the related consolidated statements of income, shareholders equity, and cash
flows for each of the three years in the period ended December 31, 2007 and our
report dated March 14, 2008 expressed an unqualified opinion.

|/s/ Grant
      Thornton LLP    
|--------------------------------
|Philadelphia,
      Pennsylvania
|March 14,
      2008            

Item 9B.Other

Information

None

96

---

PART III

Item 10.Directors,

Executive Officers and
Corporate Governance

The
Corporation has a Code of Ethics for directors, officers and employees of the
corporation. It is intended to promote honest and ethical conduct, full and
accurate reporting, and compliance with laws as well as other matters.

The SEC
requires disclosure concerning whether or not the Corporation has at least one
audit committee financial expert on the Audit Committee. During 2007, Walter
R. Bateman, II was the committees independent financial expert, as defined by
SEC regulations, and chaired the committee.

Additional
information regarding directors, executive officers and corporate governance is
included under the following captions in the Corporations proxy statement
relating to its 2008 annual meeting of shareholders (the 2008 Proxy Statement)
and is incorporated herein by reference:

DirectorsExecutive Officers

Corporate Governance Meetings and
Committees of the Board of Directors Section 16(a) Beneficial Ownership
Reporting Compliance

In addition, the Corporation makes
available onwww.hncbank.com(under Investor

InformationCorporate Governance) the
following: 1) Audit Committee Charter, 2) Code of Ethics, 3) Whistleblower
Policy, 4) Nominating and Corporate Governance Committee Charter and 5)
Compensation Committee Charter.

Item 11.Executive

Compensation

Information
regarding executive compensation included under the following captions in the
2008 Proxy Statement is incorporated herein by reference:

Directors Meetings and Committees
of the Board of Directors Director Compensation Compensation
Discussion and Analysis Compensation Committee Report Compensation
Committee Interlocks and Insider Participation Executive Compensation
Potential Payments upon Termination or Change in Control Executive
Employment Agreements and Separations Agreements

|**Item
      12.** |  | **Security Ownership
      of Certain Beneficial Owners and Management and Related Stockholder
      Matters**
|------------------ |  | --------------------------------------------------------------------------------------------------------------

Security
ownership information of certain beneficial owners and management is included
under the captions, Principal Owners and Beneficial Ownership by Directors,
Officers and Nominees, in the 2008 Proxy Statement is incorporated herein by
reference.

The
information required by this item concerning Equity Compensation Plan
information is included in Part II, Item 5, Equity Compensation Plan
Information of this Report on Form 10-K and is incorporated herein by
reference.

Item 13.Certain

Relationships and Related
Transactions, and Director Independence

Information
included in Part II, Item 8, Footnote 5 Loans of this Report on Form 10-K is
incorporated herein by reference.

97

---

Information
included under the captions, Related Party Transactions, Corporate
Governance, and Meetings and Committees of the Board of Directors in the 2008
Proxy Statement is incorporated herein by reference.

Item 14.Principal

Accountant Fees and
Services

Information
included under the caption, Independent Registered Public Accounting Firm, in
the 2008 Proxy Statement is incorporated herein by reference.

PART IV

Item 15.Exhibits and

Financial Statement
Schedules

|(a) |  | The
      following documents are filed as part of this report (see Part II, Item 8,
      Financial Statements and Supplementary Data):
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | (1)                                                                                                                                       
|   
|    |  |                                                                                                                                           
|   
|    |  |                                                                                                                                           
|   
|    |  |                                                                                                                                           
|   
|    |  |                                                                                                                                           
|   
|    |  |                                                                                                                                           
|   
|    |  |                                                                                                                                           
|   
|    |  | (2)                                                                                                                                       
|   
|    |  | (3)                                                                                                                                       

98

---

SIGNATURES

Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.

|                          | HARLEYSVILLENATIONALCORPORATION
|------------------------- | -------------------------------
|                         
|                         
|                          | By:                            
|                          |                                
|                          |                                
|                         
|Date: March 7,
      2008 |                                

Pursuant to
the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

|Signature                   |  | Title                                                 |  | Date               
|--------------------------- |  | ----------------------------------------------------- |  | -------------------
|/s/ PAULD. GERAGHTY         |  | President, Chief
      Executive Officer and Director |  | March 7,
      2008
|Paul D.
      Geraghty      |  | (Principal
      Executive Officer)                   |  |                    
|                            |  |                                                       |  |                    
|/s/ WALTERR. BATEMAN, II    |  | Director                                              |  | March 7,
      2008
|Walter R.
      Bateman, II |  |                                                       |  |                    
|                            |  |                                                       |  |                    
|/s/ LEEANNB. BERGEY         |  | Director                                              |  | March 7,
      2008
|LeeAnn B.
      Bergey      |  |                                                       |  |                    
|                            |  |                                                       |  |                    
|/s/ WALTERE. DALLER, JR.    |  | Chairman and
      Director                           |  | March 7,
      2008
|Walter E.
      Daller, Jr. |  |                                                       |  |                    
|                            |  |                                                       |  |                    
|/s/ HAROLDA. HERR           |  | Director                                              |  | March 7,
      2008
|Harold A.
      Herr        |  |                                                       |  |                    
|                            |  |                                                       |  |                    
|/s/ THOMASC. LEAMER         |  | Director                                              |  | March 7,
      2008
|Thomas C.
      Leamer      |  |                                                       |  |                    
|                            |  |                                                       |  |                    
|/s/ STEPHANIES. MITCHELL    |  | Director                                              |  | March 7,
      2008
|Stephanie S.
      Mitchell |  |                                                       |  |                    
|                            |  |                                                       |  |                    
|/s/ A. ROSSMYERS            |  | Director                                              |  | March 7,
      2008
|                            |  |                                                       |  |                    
|A. Ross
      Myers         |  |                                                       |  |                    
|/s/ BRENTL. PETERS          |  | Director                                              |  | March 7,
      2008
|Brent L.
      Peters       |  |                                                       |  |                    
|                            |  |                                                       |  |                    
|/s/ GEORGES. RAPP           |  | Chief Financial
      Officer                         |  | March 7,
      2008
|George S.
      Rapp        |  | (Principal
      Financial and Accounting Officer)    |  |                    
|                            |  |                                                       |  |                    
|/s/ DEMETRAM. TAKES         |  | Director                                              |  | March 7,
      2008
|Demetra M.
      Takes      |  |                                                       |  |                    
|                            |  |                                                       |  |                    
|/s/ JAMESA. WIMMER          |  | Director                                              |  | March 7,
      2008
|James A.
      Wimmer       |  |                                                       |  |                    

99

---

EXHIBIT INDEX

|**ExhibitNo.** |  | Description of
    Exhibits                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|-------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2.1)          |  | Purchase Agreement, dated as of November 15, 2005, by and among
      Harleysville National Bank and Trust Company, Cornerstone Financial
      Consultants, Ltd., Cornerstone Advisors Asset Management, Inc.,
      Cornerstone Institutional Investors, Inc., Cornerstone Management
      Resources, Inc., John R. Yaissle, Malcolm L. Cowen, II, and Thomas J.
      Scalici. (Incorporated by reference to Exhibit 2.1 of the Registrants
      Annual Report on Form 10-K for the year ended December 31, 2005, filed
      with the Commission on March 15, 2006. The schedules and exhibits to the
      Purchase Agreement are listed at the end of the Purchase Agreement but
      have been omitted from the exhibit to Form 10-K. The Registrant agrees to
      supplementally furnish a copy of any omitted schedule or exhibit to the
      Securities and Exchange Commission upon request.)
|               | 
|(2.2)          |  | Branch Purchase Agreement and Deposit Assumption Agreement, dated
      as of July 26, 2006, by and among First National Community Bank as Buyer
      and Harleysville National Bank and Trust Company as Seller. (Incorporated
      by reference to Exhibit 2.1 to the Registrants Quarterly Report filed on
      Form 10-Q, filed with the Commission on November 8, 2006. The attachments,
      schedules and exhibits to the Branch Purchase and Deposit Assumption
      Agreement are listed at the end of the Branch Purchase and Deposit
      Assumption Agreement but have been omitted from the exhibit to Form 10-Q.
      The Registrant agrees to supplementally furnish a copy of any omitted
      attachment, schedule or exhibit to the Securities and Exchange Commission
      upon request.)                                                                                         
|              
|(2.3)          |  | Merger Agreement, dated as of May 15, 2007, by and among
      Harleysville National Corporation, East Penn Financial Corporation, East
      Penn Bank and HNC-EPF, LLC, as amended. (Incorporated by reference to
      Annex A of the Corporations Registration Statement No. 333-145820 on Form
      S-4/A, filed with the Commission on September 27, 2007. The schedules and
      exhibits to the Merger Agreement are listed at the end of the Merger
      Agreement but have been omitted from the Annex to Form S-4. The Registrant
      agrees to supplementally furnish a copy of any omitted schedule or exhibit
      to the Securities and Exchange Commission upon request.)                                                                                                                                                                                                               
|              
|(2.4)          |  | Agreement for Purchase and Sale of
Partnership Interests, dated as of December 27, 2007, by and among each of the applicable entities (Buyer) and 2007 PA HOLDINGS,
LLC (HNB) and PA BRANCH HOLDINGS, LLC, (Bank Branch) (HNB and Bank
Branch are referred to collectively as Seller ), filed herewith. (The schedules
and exhibits to the Agreement for Purchase and Sale of Partnership Interests are listed at the
end of the agreement but have been omitted from the Exhibit to Form 10-K. The Registrant agrees
to supplementally furnish a copy of any omitted schedule or exhibit to the Securities and Exchange Commision upon request.)                                                                                                                                                                                                                                                      
|              
|(3.1)          |  | Harleysville National Corporation Amended and Restated Articles of
      Incorporation. (Incorporated by reference to Exhibit 3.1 to the
      Corporations Registration Statement No. 333-111709 on Form S-4, as filed
      on January 5, 2004.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|              
|(3.2)          |  | Harleysville National Corporation Amended and Restated By-laws.
      (Incorporated by reference to Exhibit 3.1 to the Corporations Current
      Report on Form 8-K/A, filed with the Commission on August 16,
    2007.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|              
|(10.1)         |  | Harleysville National Corporation 1993 Stock Incentive Plan.**
      (Incorporated by reference to Exhibit 4.3 of Registrants Registration
      Statement No. 33-69784 on Form S-8, filed with the Commission on October
      1, 1993.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|              
|(10.2)         |  | Harleysville National Corporation Stock Bonus Plan.***
      (Incorporated by reference to Exhibit 99A of Registrants Registration
      Statement No. 333-17813 on Form S-8, filed with the Commission on December
      13, 1996.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|              
|(10.3)         |  | Supplemental Executive Retirement Plan.* (Incorporated by reference
      to Exhibit 10.3 of Registrants Annual Report in Form 10-K for the year
      ended December 31, 1997, filed with the Commission on March 27,
      1998.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

---

|**ExhibitNo.** |  | Description of Exhibits                                                                                                                                                                                                                                                                                                                                                                                  
|-------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10.4)         |  | Walter E. Daller, Jr., Chairman and
      former President and Chief Executive Officers Employment Agreement dated
      October 26, 1998.* (Incorporated by reference to Registrants Current
      Report on Form 8-K, filed with the Commission on March 25,
      1999.)                                                                                                                            
|               | 
|(10.5)         |  | Consulting Agreement and General
      Release dated November 12, 2004 between Walter E. Daller, Jr.,
      Harleysville National Corporation and Harleysville National Bank and Trust
      Company.* (Incorporated by reference to Registrants Current Report on
      Form 8-K, filed with the Commission on November 16,
2004.)                                                                     
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                          
|(10.6)         |  | Amendment to Supplemental Executive
      Retirement Benefit Agreement dated March 14, 2005 by and among
      Harleysville Management Services, LLC and Walter E. Daller, Jr.*
      (Incorporated by reference to Registrants Current Report on Form 8-K,
      filed with the Commission on March 14, 2005.)                                                                                         
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                          
|(10.7)         |  | Employment Agreement dated October
      26, 1998 by and among Harleysville National Corporation, Harleysville
      National Bank and Trust Company and Demetra M. Takes, President and Chief
      Executive Officer of Harleysville National Bank and Trust Company.*
      (Incorporated by reference to Registrants Current Report on Form 8-K,
      filed with the Commission on March 25, 1999.)
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                          
|(10.8)         |  | Amendment to Supplemental Executive
      Retirement Benefit Agreement dated March 14, 2005 by and among
      Harleysville Management Services, LLC and Demetra M. Takes, President and
      Chief Executive Officer of Harleysville National Bank and Trust Company.*
      (Incorporated by reference to Registrants Current Report on Form 8-K,
      filed with the Commission on March 14, 2005.)
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                          
|(10.9)         |  | Harleysville National Corporation
      1998 Stock Incentive Plan.** (Incorporated by reference to Registrants
      Registration Statement No. 333-79971 on Form S-8, filed with the
      Commission on June 4, 1999.)                                                                                                                                                                                
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                          
|(10.10)        |  | Harleysville National Corporation
      1998 Independent Directors Stock Option Plan, as amended and restated
      effective February 8, 2001.** (Incorporated by reference to Appendix A
      of Registrants Definitive Proxy Statement, filed with the Commission on
      March 9, 2001.)                                                                                                        
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                          
|(10.11)        |  | Supplemental Executive Retirement
      Benefit Agreement dated February 23, 2004 between Michael B. High,
      Executive Vice President and former Chief Financial Officer, and
      Harleysville Management Services, LLC.* (Incorporated by reference to
      Registrants Quarterly Report on Form 10-Q, filed with the Commission on
      May 10, 2004.)                                        
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                          
|(10.12)        |  | Employment Agreement effective April
      1, 2005 between Michael B. High, Executive Vice President and Chief
      Operating Officer of the Corporation, and Harleysville Management
      Services, LLC.* (Incorporated by reference to Registrants Current Report
      on Form 8-K, filed with the Commission on November 16,
  2004.)                                                             
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                          
|(10.13)        |  | Amendment to Supplemental Executive
      Retirement Benefit Agreement dated March 14, 2005 by and among
      Harleysville Management Services, LLC and Michael B. High, Executive Vice
      President and Chief Operating Officer of the Corporation.* (Incorporated
      by reference to Registrants Current Report on Form 8-K, filed with the
      Commission on March 14, 2005.)               
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                          
|(10.14)        |  | Employment Agreement dated March 9,
      2004 between Mikkalya Murray, former Executive Vice President and
      Harleysville Management Services, LLC.* (Incorporated by reference to
      Registrants Quarterly Report on Form 10-Q, filed with the Commission on
      May 10, 2004.)                                                                                                              
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                          
|(10.15)        |  | Amendment to Supplemental Executive
      Retirement Benefit Agreement dated March 14, 2005 by and among
      Harleysville Management Services, LLC and Mikkalya Murray, former
      Executive Vice President.* (Incorporated by reference to Registrants
      Current Report on Form 8-K, filed with the Commission on March 14, 2005.)                                                             

---

|**ExhibitNo.** |  | Description of Exhibits                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10.16)        |  | Harleysville National Corporation
      2004 Omnibus Stock Incentive Plan, as amended and restated effective
      November 9, 2006.** (Incorporated by reference to Registrants Current
      Report on Form 8-K, filed with the Commission on November 15, 2006).                                                                                                                                                                                                                              
|               | 
|(10.17)        |  | Employment Agreement dated August
      23, 2004 between James F. McGowan, Jr., Executive Vice President &
      Chief Credit Officer and Harleysville Management Services, LLC.*
      (Incorporated by reference to Registrants Current Report on Form 8-K,
      filed with the Commission on August 25, 2004.)                                                                                                                                                                               
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.18)        |  | Supplemental Executive Retirement
      Benefit Agreement dated August 23, 2004 between James F. McGowan, Jr.,
      Executive Vice President & Chief Credit Officer, and Harleysville
      Management Services, LLC.* (Incorporated by reference to Registrants
      Current Report on Form 8-K, filed with the Commission on August 25, 2004.)                                                                                                                                               
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.19)        |  | Amendment to Supplemental Executive
      Retirement Benefit Agreement dated March 14, 2005 by and among
      Harleysville Management Services, LLC and James F. McGowan, Jr., Executive
      Vice President & Chief Credit Officer.* (Incorporated by reference to
      Registrants Current Report on Form 8-K, filed with the Commission on
      March 14, 2005.)                                                                                                                          
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.20)        |  | Employment Agreement dated September
      27, 2004 between John Eisele, former Executive Vice President &
      President of Millennium Wealth Management and Private Banking, and
      Harleysville Management Services, LLC.* (Incorporated by reference to
      Registrants Current Report on Form 8-K, filed with the Commission on
      September 29, 2004.)                                                                                                                            
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.21)        |  | Supplemental Executive Retirement
      Benefit Agreement dated September 27, 2004 between John Eisele, former
      Executive Vice President & President of Millennium Wealth Management
      and Private Banking, and Harleysville Management Services, LLC.*
      (Incorporated by reference to Registrants Current Report on Form 8-K,
      filed with the Commission on September 29, 2004.)                                                                                             
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.22)        |  | Amendment to Supplemental Executive
      Retirement Benefit Agreement dated March 14, 2005 by and among
      Harleysville Management Services, LLC and John Eisele, former Executive
      Vice President & President of Millennium Wealth Management and Private
      Banking.* (Incorporated by reference to Registrants Current Report on
      Form 8-K, filed with the Commission on March 14, 2005.)                                                                                    
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.23)        |  | Separation Agreement and Mutual
      Release dated June 15, 2007 and effective July 19, 2007 between John
      Eisele, former Executive Vice President & President of Millennium
      Wealth Management and Private Banking, Harleysville Management Services,
      LLC., Harleysville National Bank and Trust Company and Harleysville
      National Corporation.* (Incorporated by reference to Registrants Current
      Report on Form 8-K, filed with the Commission on July 19, 2007.)
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.24)        |  | Employment Agreement effective
      January 1, 2005 between Gregg J. Wagner, the former President and Chief
      Executive Officer of the Corporation, and Harleysville Management
      Services, LLC.* (Incorporated by reference to Registrants Current Report
      on Form 8-K, filed with the Commission on November 16, 2004.)                                                                                                                                                          
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.25)        |  | Amendment to Supplemental Executive
      Retirement Benefit Agreement dated March 14, 2005 by and among
      Harleysville Management Services, LLC and Gregg J. Wagner, the former
      President and Chief Executive Officer of the Corporation.* (Incorporated
      by reference to Registrants Current Report on Form 8-K, filed with the
      Commission on March 14, 2005.)                                                                                                            
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.26)        |  | Complete Settlement Agreement and
      General Release dated November 29, 2006 and effective December 8, 2006
      between Gregg J. Wagner and Harleysville National Corporation,
      Harleysville National Bank and Trust Company and Harleysville Management
      Services, LLC .* (Incorporated by reference to Registrants Current Report
      on Form 8-K, filed with the Commission on December 13, 2006.)                                                                           

---

|**ExhibitNo.** |  | Description of Exhibits                                                                                                                                                                                                                                                                                                                                                                                                                    
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10.27)        |  | Employment Agreement dated May 18,
      2005, between George S. Rapp, Senior Vice President and Chief Financial
      Officer, and Harleysville Management Services, LLC.* (Incorporated by
      reference to Registrants Current Report on Form 8-K, filed with the
      Commission on May 20, 2005.)                                                                                                                                 
|               | 
|(10.28)        |  | Amended and Restated Declaration of Trust for HNC Statutory Trust
      III by and among Wilmington Trust Company, as Institutional Trustee and
      Delaware Trustee, Harleysville National Corporation, as Sponsor, and the
      Administrators named therein, dated as of September 28, 2005.
      (Incorporated by reference to Registrants Quarterly Report on Form
      10-Q/A, filed with the Commission on November, 9, 2005.)
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.29)        |  | Indenture between Harleysville
      National Corporation, as Issuer, and Wilmington Trust Company, as Trustee,
      for Fixed/Floating Rate Junior Subordinated Debt Securities, dated as of
      September 28, 2005. (Incorporated by reference to Registrants Quarterly
      Report on Form 10-Q/A, filed with the Commission on November, 9, 2005.)                                                                                
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.30)        |  | Guarantee Agreement between
      Harleysville National Corporation and Wilmington Trust Company, dated as
      of September 28, 2005. (Incorporated by reference to Registrants
      Quarterly Report on Form 10-Q/A, filed with the Commission on November, 9,
      2005.)                                                                                                                                                           
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.31)        |  | Employment Agreement effective July
      12, 2006 between Lewis C. Cyr, Chief Lending Officer of the Corporation,
      and Harleysville Management Services, LLC.* (Incorporated by reference to
      Registrants Current Report on Form 8-K, filed with the Commission on July
      12, 2006.)                                                                                                                                       
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.32)        |  | Employment Agreement dated July 12,
      2007 between Paul D. Geraghty, President and Chief Executive Officer of
      the Corporation and Harleysville Management Services, LLC* (Incorporated
      by reference to Registrants Current Report on Form 8-K filed with the
      Commission on July 12, 2007.)                                                                                                                          
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.33)        |  | Amended and Restated Declaration of
      Trust for HNC Statutory Trust IV by and among Wilmington Trust Company, as
      Institutional Trustee and Delaware Trustee, Harleysville National
      Corporation, as Depositor, and the Administrators named therein, dated as
      of August 22, 2007. (Incorporated by reference to Registrants Quarterly
      Report on Form 10-Q, filed with the Commission on November 8, 2007.)     
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.34)        |  | Indenture between Harleysville
      National Corporation, as Issuer, and Wilmington Trust Company, as Trustee,
      for Fixed/Floating Rate Junior Subordinated Debt Securities, dated as of
      August 22, 2007. (Incorporated by reference to Registrants Quarterly
      Report on Form 10-Q, filed with the Commission on November 8, 2007.)                                                                                      
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.35)        |  | Guarantee Agreement between
      Harleysville National Corporation and Wilmington Trust Company, dated as
      of August 22, 2007. (Incorporated by reference to Registrants Quarterly
      Report on Form 10-Q, filed with the Commission on November 8,
      2007.)                                                                                                                                                                 
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.36)        |  | Employment Agreement dated November 16, 2007 between Brent L.
      Peters, Executive Vice President and President of the East Penn Bank
      Division of Harleysville National Bank and Trust Company, and Harleysville
      Management Services, LLC, filed herewith.*                                                                                                                                                                 
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(11)           |  | Computation of Earnings per Common
      Share, incorporated by reference to Part II, Item 8, Footnote 15,
      Earnings Per Share, of this Report on Form 10-K.                                                                                                                                                                                                                                                                        
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(21)           |  | Subsidiaries of Registrant                                                                                                                                                                                                                                                                                                                                                                                                                 
|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(23)           |  | Consent of Grant Thornton LLP,
      Independent Registered Public Accounting firm                                                                                                                                                                                                                                                                                                                                                         

---

|**ExhibitNo.** |  | Description of Exhibits                                                                                                                                                                     
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(31.1)         |  | Certification of the Chief Executive
      Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed
      herewith.                                                         
|               | 
|(31.2)         |  | Certification of the Chief Financial
      Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed
      herewith.                                                         
|               |  |                                                                                                                                                                                             
|(32.1)         |  | Certification of the Chief Executive
      Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
      906 of the Sarbanes-Oxley Act of 2002, furnished herewith.      
|               |  |                                                                                                                                                                                             
|(32.2)         |  | Certification of the Chief Financial
      Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
      906 of the Sarbanes-Oxley Act of 2002, furnished
      herewith.

|*   |  | Management contract or
      compensatory plan arrangement.                                                                                          
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------
|    |  |                                                                                                                                                      
|**  |  | Shareholder approved compensatory
      plan pursuant to which the Registrants Common Stock may be issued to
      employees of the Corporation.    
|   
|*** |  | Non-shareholder approved
      compensatory plan pursuant to which the Registrants Common Stock may be
      issued to employees of the Corporation.

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