2008 ANNUAL REPORTON FORM 10-K



---

---

---

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,
      2008.                                             
|                     |  |                                                                                                                                                                                           
|OR                  
|                     |  |                                                                                                                                                                                           
|**o**                |  | Transition report pursuant to Section 13 or 15(d) of the Securities
      Exchange Act of 1934 for the transition period
      from                   
      to                   
      .

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. o

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 $317,118,196 based on the June 30, 2008 closing price of the Registrants
Common Stock of $11.16 per share.

As of March 10, 2009, there were
42,982,463 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, 2009 are incorporated by reference into Part III,
      Items 10-14 of this report.
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

---

---

HARLEYSVILLE NATIONAL
CORPORATION

FORM 10-K

INDEX

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

2

---

Forward-Looking Statements

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

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

3

---

PART I

Item 1. Business

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

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

The Bank is
a national banking association under the supervision of the Office of the
Comptroller of the Currency (the OCC). The Corporations and the Banks legal
headquarters are located at 483 Main Street, Harleysville, Pennsylvania 19438.
HNC Financial Companys legal headquarters is located at 2751 Centerville Road,
Suite 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, 2008, the
Bank had 85 branch offices located in Montgomery, Bucks, Chester, Berks, Carbon,
Lehigh, Monroe, Northampton and Philadelphia counties, Pennsylvania.

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

The Bank
opened new branches in Flourtown, Montgomery County and Whitehall, Lehigh County
and relocated its Pottstown East End branch in Montgomery County during 2008.
The Conshohocken branch in Montgomery County was opened in February 2009. 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
after the market close on December 5, 2008, the Corporation completed its
acquisition of Willow Financial Bancorp, Inc. and its subsidiary, Willow
Financial Bank, a $1.6 billion bank with 29 banking offices in Southeastern
Pennsylvania. Headquartered in Wayne, PA, Willow Financial Bank branch offices
were located in Philadelphia, Montgomery, Chester, and Bucks Counties. On the
acquisition date, Willow Financial had approximately $1.6 billion in assets,
$1.1 billion in loans and $946.7 million in deposits. The acquisition of Willow Financial is consistent with the Corporations plan to
strategically grow through disciplined in-market expansion. The merger delivers
a significant market share in Chester County, one of the fastest growing
counties in Pennsylvania, increases the Corporations market presence in Bucks
and Montgomery counties and establishes a new market presence in Philadelphia
county. The combined company establishes a stronger presence in eastern
Pennsylvania, including becoming the third largest financial institution
headquartered in suburban Philadelphia. The Corporation also acquired BeneServ,
Inc., a respected provider of employee benefits services from Willow Financial.
The merger drives shareholder value by providing the opportunity to deliver
synergies and accretion to earnings.

4

---

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

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 2006 through 2008, the minimum operating
results were met resulting in earn-out payments totaling $3.6 million which were
recorded as additional goodwill. At December 31, 2008, the remaining maximum
payout is $3.4 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. Under the leases, the Bank continues to utilize the properties in the
normal course of business. The Corporation received net proceeds of $39.7
million and recorded a pre-tax gain of $2.8 million. The remaining gain of $17.1
million was deferred and is being amortized through a reduction of occupancy
expense over the term of the leases.

Segments

The
Corporation has two reportable operating segments: Community Banking and Wealth
Management, as well as certain other non-reportable segments. As of December 31,
2008, the Wealth Management segment had assets under management of $2.6 billion.
Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures about
Segments of an Enterprise and Related Information establishes standards for the
way public business enterprises report information about operating segments.
Operating segments are components of an enterprise, which are evaluated
regularly by the chief operating decision-maker in deciding how to allocate and
assess resources and performance. The Corporations chief operating
decision-maker is the President and Chief Executive Officer. For more detailed
financial information pertaining to operating segments, see Item 8 Note 17 of
the Consolidated Financial Statements which is herein incorporated by reference.

5

---

As of
December 31, 2008, the Corporation had total assets of $5.5 billion, total
shareholders equity of $474.7 million and total deposits of $3.9
billion.

As of December 31, 2008, the
Corporation and the Bank employed approximately 1,169 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 as well
as with financial and non-financial institutions, many larger than the Bank,
headquartered elsewhere. Commercial banks, savings banks, savings and loan
associations, credit unions, and money market funds actively compete for
deposits and loans. Such institutions, as well as consumer finance, insurance
companies and brokerage firms, may be considered competitors with respect to one
or more services they render. The Bank is generally competitive with all
competing institutions in its service areas with respect to interest rates paid
on time and savings deposits, service charges on deposit accounts, interest
rates charged on loans and fees for trust and investment advisory services. At
December 31, 2008, the Banks legal lending limit to a single customer was $55.6
million. Many of the institutions with which the Bank competes are able to lend
significantly more than this amount to a single customer.

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, 2008. The
businesses of the Corporation and its subsidiaries are not typically seasonal in
nature.

Supervision and RegulationThe
Registrant

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

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

Pending Legislation

Other than
the FDIC insurance increase for 2009 and other regulatory matters as discussed
subsequently, 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.

6

---

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.

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.

7

---

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 regulationsalso 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.

Bank Secrecy Act

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

Capital Requirements / FDICIA

The Federal
Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) requires that
institutions be classified, based on their risk-based capital ratios into one of
five defined categories, as illustrated below: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized. Under these guidelines, the Bank was considered well
capitalized for the Tier 1 risk-based and Tier 1 leverage ratios and adequately
capitalized for total risk based capital as of December 31, 2008.Unprecedented upheaval in the economy that has negatively
impacted the credit and capital markets caused substantial mark to market
discounts in connection with the acquisition of Willow Financial in December
2008. The Corporation does not believe that these mark to market valuations
reflect a reduction in the realizable value of Willow Financials assets and
expects to recover the discount through amortization in 2009 and beyond.
Purchase accounting adjustments related to the Willow Financial acquisition
caused the Banks total risk-based capital ratio to fall below the regulatory
threshold for a well capitalized bank holding company. The Bank has instituted a
plan targeted to return to well capitalized before the end of 2009.

8

---

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.

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.

9

---

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

Deposit Insurance and Premiums

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

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

On November
2, 2006, the FDIC set the designated reserve ratio for the deposit insurance
fund at 1.25% of estimated insured deposits and adopted final regulations to
implement the risk-based deposit insurance assessment system mandated by the
Deposit Insurance Reform Act of 2005, which more closely ties each bank's
deposit insurance assessments to the risk it poses to the deposit insurance
fund. Under the new risk-based assessment system, the FDIC evaluates each
institution's risk based on three primary factors -- supervisory ratings for all
insured institutions, financial ratios for most institutions, and long-term debt
issuer ratings for large institutions that have them and places the institution
into one of four risk categories. Effective January 1, 2007, the rates range
from 5 to 43 basis points. However, the Deposit Insurance Reform Act of 2005
provided credits to institutions that paid high premiums in the past to bolster
the FDIC's insurance reserves, as a result of which a majority of banks had
assessment credits to initially offset all of their premiums in 2007. The
assessment credits for the Bank were fully utilized by December 31, 2008. The
Bank was classified in the strongest risk category for 2008 and its assessment
rate was approximately 6.3 basis points. The Bank paid FDIC premiums of $2.1
million in 2008, including $248,000 for Willow Financial.

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

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.

10

---

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) newrequirements 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.

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.

11

---

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
Financial Information & FilingsDocuments) as soon as reasonably
practicable after the Corporation electronically files such material with, or
furnishes it to the Securities and Exchange Commission. These filings are also
accessible on the Securities and Exchange Commissions website (www.sec.gov). You may also
read and copy any materials the Corporation files with the SEC at the SECs
Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain
information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. In addition, the Corporation makes available onwww.hncbank.comunder
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. This causes the net interest rate spread to compress and negatively
impacts the Banks profitability. Changes in interest rates may also adversely
affect the Corporations loan and deposit growth and the quality of its loan
portfolio. The Corporation actively manages its interest rate sensitivity
positions. The objectives of interest rate risk management are to control
exposure of net interest income to risks associated with interest rate movements
and to achieve consistent growth in net interest income. Continued aggressive
pricing by competitors for loans and deposits may adversely affect the
Corporations profitability.

12

---

The Corporation is exposed to risks in
connection with loans the Bank makes and if the allowance for loan losses is not
sufficient to cover actual loan losses, the Corporations earnings could
decrease.

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

The
Corporation maintains an allowance for loan losses at a level management
believes is sufficient to absorb estimated probable credit losses. Managements
determination of the adequacy of the allowance is based on periodic evaluations
of the loan portfolio and other relevant factors. However, this evaluation is
inherently subjective as it requires significant estimates by management.
Consideration is given to a variety of factors in establishing these estimates
including historical losses, current and anticipated economic conditions,
diversification of the loan portfolio, delinquency statistics, results of
internal loan reviews, borrowers perceived financial and management strengths,
the adequacy of underlying collateral, the dependence on collateral, or the
strength of the present value of future cash flows and other relevant factors.
These factors may be susceptible to significant change. To the extent actual
outcomes differ from management estimates, additional provisions for loan losses
may be required which may adversely affect the Corporations results of
operations in the future. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the allowance
for loan losses. Such agencies may require the Corporation to recognize
additions to the allowance based on their judgment of information available to
them at the time of their examination. If economic conditions weaken in the
geographic region served by the Corporation, the allowance may not be sufficient
to cover actual loan losses, which could 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.

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

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

13

---

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

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

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

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

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

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

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

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

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

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

14

---

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.

15

---

Item 2.Properties

The
principal executive offices of the Corporation and of the Bank are located in
Harleysville, Pennsylvania in two, two-story office buildings leased by the
Bank, one built in 1929 and the other in 2007. The Bank owns the buildings in
which twenty-four of its branches are located (onebranch opened in February
2009) and leases space for the other sixty-fourbranches from unaffiliated
third parties under leases expiring at various times through 2037.

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

16

---

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

17

---

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

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

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

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

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

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

No matter
was submitted during the fourth quarter of 2008 to a vote of holders of the
Corporations Common Stock.

18

---

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 2008
and 2007. 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
      dividends2008
    
    
    High Price
    
    Low Price
    
    per shareFirst
      Quarter
    
    
    $15.84
    
    
    
    $12.50
    
    
    
    $0.20Second Quarter
    
    
    15.24
    
    
    
    11.16
    
    
    
    0.20Third
      Quarter
    
    
    19.65
    
    
    
    10.77
    
    
    
    0.20Fourth Quarter
    
    
    16.86
    
    
    
    11.27
    
    
    
    0.20Cash
      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
    
    
    
    0.20


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

The
Corporation has a stock repurchase program that permits the repurchase of up to
five percent of its outstanding common stock. The repurchased shares will be
used for general corporate purposes. The Corporation did not repurchase any
shares of its stock under the Corporations stock repurchase programs during
2008. The maximum number of share that may yet be purchased under the plans was
731,761 as of December 31, 2008. The repurchased shares are used for general
corporate purposes. On May 12, 2005, the Board of Directors authorized a plan to
purchase up to 1,416,712 shares (restated for five percent stock dividend paid
on September 15, 2006 and September 15, 2005) or 4.9% of its outstanding common
stock.

19

---

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,
2008:

|                          |                                         |           |                                        |  | 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) (#)   |                                        |  |                                               
|Equity Compensation Plans |                                         |           |                                        |  |                                               
|Approved by Stockholders  |                                         | 1,648,723 | (1)                                    |  |                                               
|                          |                                         |           |                                        |  |                                               
|Equity Compensation Plans |                                         |           |                                        |  |                                               
|Not Approved by           |                                         | -0-(2)    |                                        |  |                                               
|Stockholders              |                                         |           |                                        |  |                                               
|                          |                                         |           |                                        |  |                                               
|TOTAL                     |                                         | 1,648,723 |                                        |  |                                               

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

Additional
information on the Corporations equity compensation plans included under Item
8, Note 1, Notes to Consolidated Financial StatementsStock-Based Compensation
and Note 14, Stock-Based Compensation, is incorporated herein by reference.

20

---

Performance Graph

The
following graph contains a comparison of the cumulative total returns on
Harleysville National Corporations common stock against the cumulative total
returns of the NASDAQ Stock Market (U.S. companies) Index and the NASDAQ Bank
Stocks Index for the period of five fiscal years commencing December 31, 2003,
and ending December 31, 2008. The graph assumes that $100 was invested on
December 31, 2003 in the Corporations common stock, the NASDAQ Stock Market (US
companies) and NASDAQ Banks. The cumulative returns assume the reinvestment of
dividends. The shareholder return shown on the graph below is not necessarily
indicative of future performance.



Zacks Total Return Annual
ComparisonFive-Year Cumulative Total Return Summary

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

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

* Source: Zacks Investment Research,
Inc.

21

---

Item 6. Selected Financial Data

|                                                   |  | Year Ended December 31,                                   
|-------------------------------------------------- |  | ----------------------------------------------------------
|                                                   |  | 2008(1)                                                   
|                                                   |  | (Dollars in
      thousands, except per share information)
|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(5)                     |  |                                                           
|Basic
      earnings                               |  | $                                                         
|Diluted earnings                                   |  |                                                           
|Cash
      dividends paid                          |  |                                                           
|Book value (at
      year-end)                     |  |                                                           
|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                              |  |                                                           
|Net interest
    margin                            |  |                                                           

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

22

---

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, with the assistance of a third party specialist, using a combination of
the following valuation methods: dividend discount analysis under the income
approach, which calculates the present value of all excess cash flows plus the
present value of a terminal value and market multiples (pricing ratios) under
the market approach. Management performed its annual review of goodwill and
other identifiable intangibles at June 30, 2008 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.

23

---

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.

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 Bank recognized an other-than-temporary impairment
charge of $1.9 million during the fourth quarter of 2008 as a result of
deterioration in the individual credits of a collateralized debt obligation
investment in a pool of trust preferred securities. The unrealized losses
associated with the securities portfolio, that management has the ability and
intent to hold, are not considered to be other-than temporary as of December 31,
2008 because the unrealized losses are primarily related to changes in interest
rates and current market conditions, however, we do not see any negative effect
on the expected cash flows of the underlying collateral or issuer. The
unrealized losses are affecting all portfolio sectors with collateralized
mortgage obligation securities and preferred securities having the largest
reductions.

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

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

24

---

Financial Overview

For the year
ended December 31, 2008, the Corporations diluted earnings per share were $0.78
compared to $0.90 for 2007. Net income in 2008 was $25.1 million compared to
$26.6 million in 2007. The year-to-date financial results include the impact on
operations from the acquisition of the Willow Financial Corporation effective
December 5, 2008 and the related issuance of 11,515,366 shares of the
Corporation common stock. In addition, the Corporations 2008 year-to-date
results include a full year of income and expense resulting from the acquisition
of East Penn Financial and its subsidiary, East Penn Bank, effective November
16, 2007. The following is an overview of the key financial highlights for
2008:

Consolidated
total assets were $5.5 billion at December 31, 2008, an increase of 40.7% or
$1.6 billion over $3.9 billion in total assets reported at December 31, 2007.
Effective December 5, 2008, the Corporation completed its acquisition of Willow
Financial. At the acquisition date, Willow Financial had approximately $1.6
billion in assets, $1.1 billion in gross loans and $946.7 million in
deposits.

The return
on average shareholders equity was 7.45% in 2008 compared to 8.91% in 2007. The
return on average assets was 0.63% in 2008 compared to 0.79% in 2007. The
decrease in these ratios during 2008 was primarily the result of increases in
average assets and average equity coupled with lower net income.

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

Net interest
income on a tax-equivalent basis increased $23.2 million, or 26.2%, for the year
ending December 31, 2008, over the prior year. The net interest margin for 2008
increased to 3.04% compared to 2.82% for 2007. The net interest margin increased
as a 56 basis point decrease in the yield on average earning assets of $3.7
billion was offset by a 98 basis point decrease in the cost of interest bearing
liabilities of $3.2 billion.

Nonperforming assets increased $56.6
million to $78.5 million at December 31, 2008 from $22.0 million at December 31,
2007. Nonperforming assets as a percentage of total assets increased to 1.43% at
December 31, 2008 from 0.56% at December 31, 2007. The provision for loan losses
increased $5.0 million mostly as a result of decreased quality of the loan
portfolio which caused an increase in the amount of the required reserve. Net
charge-offs decreased $1.8 million for 2008 compared to 2007 principally due to
prior year charge-offs for real estate construction loans for one borrower
combined with an increase in recoveries both related to commercial and
industrial loans and real estate loans.

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

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

Acquisitions/Dispositions

Effective
after the market close on December 5, 2008, the Corporation completed its
acquisition of Willow Financial. Under the terms of the merger agreement, dated
as of May 20, 2008, Willow Financial was acquired by the Corporation and Willow
Financials wholly-owned subsidiary, Willow Financial Bank, a $1.6 billion
savings bank with 29 branch offices in Southeastern Pennsylvania, was merged
with and into the Bank. The merger of the Corporation and Willow Financial
resulted in a combined company with approximately $5.5 billion in assets and
delivers a significant market share in Chester County, one of the
fastest-growing counties in Pennsylvania, increases the Corporations market
presence in Bucks and Montgomery counties, and establishes a new market presence
in Philadelphia County. The combined company establishes a stronger presence in
easternPennsylvania,
including becoming the third largest financial institution headquartered in
suburban Philadelphia. Willow Financial has complementary lines of business, a
solid reputation with customers in growing markets, and a branch network that
augments the Banks traditional footprint. In conjunction with this transaction,
the Corporation also acquired BeneServ, Inc., a respected provider of employee
benefits services and Carnegie Wealth Advisors, LLC (Carnegie). Carnegie was
subsequently sold in December 2008. The Willow Financial merger is expected to
be accretive to the Corporations earnings for the fiscal year of
2009.

25

---

The
Corporation acquired 100% of the outstanding shares of Willow Financial. The
transaction was accounted for in accordance with SFAS No. 141, Business
Combinations. Based on the terms of the merger agreement, Willow Financial
shareholders received 0.73 shares of the Corporations common stock for each
share of Willow Financial common stock they held with cash paid in lieu of
fractional shares. The purchase price was $13.79 per common share and was based
upon the average of the closing prices for the Corporations common stock on the
agreement date and for two days before and two days after the agreement date and
the agreement date. The Corporation issued 11,515,366 shares of common stock,
incurred $2.4 million in acquisition costs which were capitalized and converted
stock options with a fair value of $2.0 million for a total purchase price of
$163.2 million at the closing on December 5, 2008. Willow Financials results of
operations are included in the Corporations results from the date of
acquisition, December 5, 2008.

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

On March 1,
2007, the Cornerstone Companies, a subsidiary of the Bank, completed a selected
asset purchase of McPherson Enterprises and related entities (McPherson),
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
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 2006 through 2008, the minimum operating
results were met resulting in earn-out payments totaling $3.6 million which was
recorded as additional goodwill. At December 31, 2008, the remaining maximum
payout is $3.4 million through 2010. The Cornerstone Companies results of
operations are included in the Corporations results from the effective date of
the acquisition, January 1, 2006.

26

---

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

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

For
quarterly information for 2008 and 2007, see Item 7, Managements Discussion
and Analysis of Financial Condition and Results of OperationsFourth Quarter
2008 Results, and Table 17, Selected Quarterly Financial Data, which are
incorporated herein by reference.

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 and other investments increased 25.3% to $1.2 billion at December 31,
2008 from $982.9 million at December 31, 2007. The investment securities
available for sale increased $231.6 million and the investment securities held
to maturity decreased $6.9 million. The majority of the increase in available
for sale securities is due to the securities acquired from Willow Financial of
$238.3 million on December 5, 2008. The securities acquired from Willow
Financial include $165.7 million in securities available for sale and $72.6
million in securities held to maturity. Upon acquisition, the Corporation
recorded the securities held to maturity purchased from Willow as available for
sale. During 2008, $208.5 million of securities available for sale were sold
which generated a pre-tax gain of $2.6 million. The securities sold consisted
primarily of bullet and callable agency, tax-exempt municipal and
mortgage-backed securities. The increase in available for sale securities at
December 31, 2007 compared to December 31, 2006 of $72.6 million was mainly due
to the securities acquired from East Penn Financial of $66.2 million at November
16, 2007. During 2007, securities available for sale totaling $186.2 million
were sold which generated a pretax gain of $1.2 million.

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

**Table 1Investment Portfolio**

|                                                               | December 31,
|-------------------------------------------------------------- | ------------
|(Dollars in
      thousands)                                   | 2008        
|Investment securities available for sale:                      |             
|Obligations of 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 U.S. government agencies and
      corporations | $           
|Obligations of states and
      political subdivisions         |             
|Total investment securities
      held to maturity             | $           

27

---

The maturity analysis of investment
securities including the weighted average yield for each category as of December
31, 2008 is as follows. Actual maturities may differ from contractual maturities
because issuers and borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.

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

|                                              | December 31, 2008     
|--------------------------------------------- | ----------------------
|                                              |                       
|                                              | Due in 1 year         
|                                              | or less               
|                                              | (Dollars in thousands)
|Investment securities available for sale:     |                       
|Obligations of
      U.S. government agencies |                       
|and corporations:                             |                       
|Fair value                                    | $                     
|Weighted average
    yield                    |                       
|Obligations of states and political           |                       
|subdivisions:                                 |                       
|Fair value                                    |                       
|Weighted average
      yield(1)               |                       
|Mortgage-backed
      securities:             |                       
|Fair value                                    |                       
|Weighted average
    yield                    |                       
|Other debt securities:                        |                       
|Fair value                                    |                       
|Weighted average
    yield                    |                       
|Equity
      securities:                      |                       
|Fair value                                    |                       
|Weighted average
    yield                    |                       
|Total investment securities available for     |                       
|**sale:**                                     |                       
|**Fair
      value**                          | $                     
|**Weighted average
      yield**              |                       
|Investment
      securities held to maturity: |                       
|Obligations of U.S. government agencies       |                       
|and corporations:                             |                       
|Amortized cost                                | $                     
|Weighted average
    yield                    |                       
|Obligations of
      states and political     |                       
|subdivisions:                                 |                       
|Amortized Cost                                |                       
|Weighted average
      yield(1)               |                       
|Total investment securities held to           |                       
|**maturity:**                                 |                       
|**Amortized
      Cost**                      | $                     
|**Weighted average
      yield**              |                       

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

28

---

Loans

Loans
increased $1.2 billion in 2008. The acquisition of Willow Financial accounted
for $1.1 billion of the increase as of December 5, 2008. Organic growth was
approximately $125.7 million, or 5.1%. Loans increased $413.5 million in 2007
primarily attributed to the acquisition of East Penn Financial resulting in
$337.7 million in additional loans with organic growth of approximately $81.9
million, or 4.0%.

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

**Table 3Composition of Loan
Portfolio**

|               | December 31,          
|-------------- | ----------------------
|               | 2008                  
|               |                       
|               | Amount                
|               | (Dollars in thousands)
|Real estate    | $                     
|Commercial     |                       
|and industrial |                       
|Consumer       |                       
|Lease          |                       
|financing      |                       
|Total          | $                     

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

The
following table details outstanding loans by type as of December 31, 2008, in
terms of contractual maturity date:

**Table 4Selected Loan
Maturity Data**

December 31, 2008Due
      afterDue
      in
    
    1
      year
    
    Due
      after1 year or less
    
    through 5 years
    
    5 years
    
    Total(Dollars in
      thousands)Real
      estate
    $
    252,911
    
    $
    611,744
    
    $
    738,751
    
    $
    1,603,406Commercial and
      industrial
    
    352,189
    
    
    389,500
    
    
    238,967
    
    
    980,656Consumer
    
    184,076
    
    
    441,569
    
    
    474,779
    
    
    1,100,424Lease financing
    
    355
    
    
    403
    
    
    
    
    
    758Total
    $
    789,531
    
    $
    1,443,216
    
    $
    1,452,497
    
    $
    3,658,244Loans with variable or
      floating interestrates
    $
    269,093
    
    $
    805,257
    
    $
    767,710
    
    $
    1,842,060Loans
      with fixed predetermined interest rates
    
    520,438
    
    
    637,959
    
    
    684,787
    
    
    1,843,184Total
    $
    789,531
    
    $
    1,443,216
    
    $
    1,452,497
    
    $
    3,685,244


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

29

---

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 1.43% of total assets at December
31, 2008, compared to 0.56% at December 31, 2007 and 0.54% at December 31, 2006.
The ratio of nonperforming loans to total net loans was 2.12% at December 31,
2008, compared to 0.90% at December 31, 2007 and 0.87% at December 31, 2006.

Nonaccruing loans increased $54.0
million to $75.1 million at December 31, 2008, as compared to $21.1 million at
December 31, 2007. The higher level of nonaccruing loans was mainly due to an
increase in the nonaccrual status of commercial and residential construction,
commercial and industrial, residential first mortgage and commercial mortgage
loans during 2008. In addition, the December 5, 2008 acquisition of Willow
Financial Bank contributed $12.5 million in non-accrual loans. The borrowers
associated with these nonaccrual loans are generally unrelated and are primarily
located in the Banks market area and in most cases, for the residential real
estate, the collateral is local land that has been subdivided for residential
development in the growing counties of the Philadelphia suburbs and the Lehigh
Valley. The Banks management understands these markets and is confident that it
can manage the collateral, if necessary. In response to the situation, the Bank
increased its allowance for loan losses to approximately 1.25% of outstanding
loans at June 30, 2008, and to 1.36% at December 31, 2008. The Bank continues to
evaluate appraisals, financial reviews and inspections. All mortgage loans
within the Banks portfolio were booked with traditional bank customers through
the branch network. The Bank has virtually no exposure to subprime borrowers  a
benefit of the historically careful approach to residential mortgage lending.
The Bank continues to take a conservative approach to its lending and loan
review practices. With the expectation of continued economic pressures,
management continues to provide more resources to resolve troubled credits
including an increased focus on earlier identification of potential problem
loans and a more active approach to managing the level of criticized loans that
have not reached nonaccrual status.

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

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 2008,
interest accrued on nonaccruing loans and not recognized as interest income was
$1.9 million and interest paid on nonaccruing loans of $299,000 was recognized
as interest income. During 2007, interest accrued on nonaccruing loans and not
recognized as interest income was $982,000 and interest paid on nonaccruing
loans of $331,000 was recognized as interest income. During 2006, interest
accrued on nonaccruing loans and not recognized as interest income was $788,000
and interest paid on nonaccruing loans of $191,000 was recognized as interest
income.

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

30

---

Net assets
in foreclosure at December 31, 2008 were $1.6 million compared to $28,000 at
December 31, 2007 and $0 at December 31, 2006. During 2008, transfers from loans
to assets in foreclosure were $2.4 million, additions from Willow Financial were
$426,000, disposals of foreclosed properties were $1.3 million, and no
charge-offs were recorded. Efforts to liquidate assets acquired in foreclosure
proceed as quickly as potential buyers can be located and legal constraints
permit. Foreclosed assets are carried at the lower of cost (lesser of carrying
value of the asset or fair value at date of acquisition) or estimated fair
value.

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

**Table 5Nonperforming Assets**

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


Local 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.

31

---

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

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

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

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

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

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

32

---

The
provision for loan losses increased $5.0 million during 2008 compared to 2007
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
decreased $1.8 million for 2008 compared to 2007 principally due to prior year
charge-offs for real estate construction loans for one borrower combined with an
increase in recoveries both related to commercial and industrial loans and real
estate loans. The profile of the Banks customer base has remained relatively
constant and management believes that the current deterioration in credit
quality has been caused by the economic pressures being felt by borrowers. The
Bank has experienced depressed economic cycles in the past. As the current
trough deepens management continues to allocate dedicated resources to continue
to manage at-risk credits. The Bank has experienced a similar decline in the
past and expects that we could experience a similar decline in future economic
cycles. The provision for loan losses increased $6.4 million in 2007 compared to
2006 primarily as a result of a decrease in the quality of the loan portfolio
which caused an increase in the amount of the required reserve. Net loans
charged-off increased $4.7 million during 2007 compared to 2006 principally from
charge-offs related to real estate construction loans for one borrower and four
unrelated commercial and industrial loans.

The
allowance for loan losses increased $22.6 million, or 82.8%, to $50.0 million at
December 31, 2008 from $27.3 million at December 31, 2007. The increase in the
allowance was primarily due to the addition of the Willow Financial loan loss
reserve of $12.9 million in December 2008, and the need to adjust for impacts on
the portfolio in light of the current credit environment. Nonperforming loans
have increased by $55.0 million as a result of these factors from December 31,
2008 compared to December 31, 2007. The allowance for loan losses increased $6.2
million, or 29.2%, to $27.3 million at December 31, 2007 from December 31, 2006.
The increase in the allowance was mainly due to the addition of the East Penn
Financial loan loss reserve in November 2007 as well as the inherent risk
related to loan growth and the increase in nonperforming loans of $4.3
million.

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

**Table 6Allowance for Loan
Losses**

|                                    | December 31,          
|----------------------------------- | ----------------------
|                                    | 2008                  
|                                    | (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
      acquisitions     |                       
|Provision for loan losses           |                       
|Allowance, end
      of year        | $                     
|Ratio of net charge offs to average |                       
|loans outstanding                   |                       

33

---

Management
has improved upon its estimation methods and assumptions through its inclusion
of portfolio level environmental factors as previously discussed within the
previousAllowance for Loan Lossessection. These adjustments provide for
greater clarity and transparency of macro and micro economic impacts as well as
internal credit and operational impacts on the portfolio. The impact of the
recession continues to be felt as the Banks commercial real estate portfolios
increase in allowance shows. It is expected that the negative trends in the real
estate industry will continue to affect credit quality throughout at least the
first half of 2009, if not for the entire year. 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 the current market environment and
recent historical loss trends among other factors.

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

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

|                      | December 31,          
|--------------------- | ----------------------
|                      | 2008                  
|                      |                       
|                      |                       
|                      | Amount                
|                      | (Dollars in thousands)
|Real estate           | $                     
|Commercial
      and  |                       
|industrial            |                       
|Consumer              |                       
|Lease
      financing |                       
|Total                 | $                     

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

Investment in Bank

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

Deposits and Borrowings

Deposits and
borrowings are the primary funding sources of the Corporation. Core deposits
increased 31.8%, or $567.1 million, to $2.3 billion at December 31, 2008, up
from $1.8 billion at December 31, 2007. This growth is due to $685.4 million
acquired from Willow Financial and an organic decrease of approximately $118.3
million. Total deposits increased $953.4 million, or 31.9% for the same period,
which was primarily attributable to deposits associated with the acquisition of
Willow Financial of $946.7 million. 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. Core deposits increased 7.1%, or $118.1 million at December 31, 2007
compared to December 31, 2006 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% during 2007 primarily
from deposits associated with the acquisition of East Penn Financial of $382.7
million at acquisition date and growth in time deposits.

34

---

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,          
|------------------------------------- | ----------------------
|                                      | 2008                  
|                                      | Amount                
|                                      | (Dollars in thousands)
|Demandnoninterest-bearing            | $                     
|Demandinterest-bearing               |                       
|Money market and savings              |                       
|Time
      deposits                   |                       
|Total interest-bearing
      deposits | $                     
|Total deposits                        | $                     

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

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

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


Borrowings

Borrowings
increased $482.2 million to $990.5 million at December 31, 2008 from $508.3
million at December 31, 2007. The Corporation increased long term debt with the
Federal Home Loan Bank by $305.9 million due to $362.6 million in advances from
the Willow Financial acquisition offset by paydowns during 2008. Long-term
securities sold under agreement to repurchase increased by $132.0 million due to
$82.0 million assumed in the Willow Financial acquisition and $50.0 million in
new borrowings during 2008. Subordinated debt increased $10.8 million at
December 31, 2008 as compared to December 31, 2007 due to the acquisition of
$10.7 million of subordinated debt from Willow Financial. Fed funds purchased
and short-term securities sold under repurchase agreements increased by $34.6
million primarily due to the Willow Financial acquisition.

Borrowings increased $118.8 million
to $508.3 million 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 from the private
placement of $22.5 million in aggregate principal amount of fixed/floating rate
preferred securities through a newly formed Delaware Trust affiliate HNC
Statutory Trust IV and the acquisition of $8.2 million of subordinated debt from
East Penn Financial on November 16, 2007.

35

---

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):
    
    
    2008
    
    2007
    
    2006(Dollars in thousands)Balance at year-end
    
    $
    103,813
    
    
    $
    101,493
    
    
    $
    96,840Weighted average rate at year-end
    
    
    0.42
    %
    
    
    3.60
    %
    
    
    4.61
    %Maximum month-end balance
    
    $
    97,526
    
    
    $
    105,205
    
    
    $
    100,944Average balance during the year
    
    $
    109,092
    
    
    $
    121,392
    
    
    $
    128,185Weighted average rate during the year
    
    
    1.55
    %
    
    
    4.46
    %
    
    
    4.37
    %


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

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.

Adoption of Fair Value Measurements
Accounting Standard

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

Net Interest Income

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

36

---

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**

|                                               |  | 2008 compared to
      2007 |         | 2007 compared to
      2006
|---------------------------------------------- |  | --------------------------- | ------- | ---------------------------
|                                               |  | Net                         |         | Due to Change
      in     
|                                               |  | Change                      |         | **Volume**                 
|                                               |  | (Dollars in thousands)     
|Increase (decrease) in interest income:        |  |                             |         |                            
|Investment
    securities(1)                   |  | $                           | 6,653   |                            
|Federal funds sold, securities purchased under |  |                             |         |                            
|agreements to resell and deposits in
    banks |  |                             | (2,479  | )                          
|Loans(1)(2)                                    |  |                             | 9,047   |                            
|Total                                          |  |                             | 13,221  |                            
|Increase
      (decrease) in interest expense: |  |                             |         |                            
|Savings and money market deposits              |  |                             | (22,840 | )                          
|Time deposits                                  |  |                             | 12,462  |                            
|Borrowed funds                                 |  |                             | 405     |                            
|Total                                          |  |                             | (9,973  | )                          
|Net increase (decrease) in net interest income |  | $                           | 23,194  |                            

|(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.

37

---

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

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

|                                                 |  | Year Ended December
  31,
|------------------------------------------------ |  | -------------------------
|                                                 |  | 2008                     
|                                                 |  | Average                  
|                                                 |  | Balance                  
|                                                 |  | (Dollars in thousands)   
|Assets                                           |  |                          
|Earning
      Assets:                            |  |                          
|Investment
      securities:                     |  |                          
|Taxable investments                              |  | $                        
|Nontaxable investments(1)                        |  |                          
|Total investment securities                      |  |                          
|Federal funds sold, securities purchased         |  |                          
|under agreements to resell 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.

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

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.

38

---

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

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

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

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

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.

Net Interest Margin

The 2008 net
interest margin of 3.04% was higher than the net interest margins for 2007 and
2006 of 2.82% and 2.95%, respectively. The increase in the net interest margin
during 2008 was mainly attributable to decreases in yields on interest-bearing
liabilities which outpaced declines in the yield on loans. In addition, yields
on investment securities have increased slightly since the prior
year.

Interest Rate Sensitivity Analysis

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

The
Corporation actively manages its interest rate sensitivity positions. The
objectives of interest rate risk management are to control exposure of net
interest income to risks associated with interest rate movements and to achieve
consistent growth in net interest income. The Asset/Liability Committee, using
policies and procedures approved by the Corporations Board of Directors, is
responsible for managing the rate sensitivity position. The Corporation manages
interest rate sensitivity by changing the mix and repricing characteristics of
its assets and liabilities through the management of its investment securities
portfolio, its offering of loan and deposit terms and through wholesale
borrowings from several providers, but primarily 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.

39

---

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

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, 2008,
the Corporation had a fair value hedge in the form of an interest rate swap with
a notional amount of $1.9 million which matures in 2017. In addition, four fair
value hedges with notional amounts totaling $7.5 million were acquired from
Willow Financial with maturity dates ranging from 2013 to 2016. These swaps do
not qualify for hedge accounting treatment and thus all changes in the fair
value of the derivatives is recorded in the consolidated statements of income.
As such, based on the decrease in the market value of these interest rate swaps,
the Corporation recognized a loss of $183,000 in other expense in the
consolidated statements of income in 2008. During 2008, the Corporation
terminated a fair value hedge in the form of an interest rate swap with a
notional amount of $2.0 million. For fair value hedges, the Corporation
recognized net interest expense of $81,000 for the year ended December 31, 2008
and net interest income of $59,000 and $7,000 for the years ended December 31,
2007 and 2006, respectively. At December 31, 2008, the Corporation had swap
agreements with a negative fair value of $1.1 million. At December 31, 2007, the
Corporation had swap agreements with a positive fair value of $10,000 and with a
negative fair value of $366,000. There was no hedge ineffectiveness recognized
during 2008, 2007 and 2006.

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

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

40

---

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, 2008, 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, 2008. The table indicates a liability sensitive
one-year cumulative gap position of 6.14% of total earning assets.

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

|                                                |  | December 31, 2008     
|----------------------------------------------- |  | ----------------------
|                                                |  | After 1 year          
|                                                |  | 0to                   
|                                                |  | 90 days               
|                                                |  | (Dollars in thousands)
|Earning assets                                  |  |                       
|Investment
      securities                     |  | $                     
|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 are
      repaid according to contractual maturity adjusted for call features;
      interest-bearing demand, regular savings, and money market savings
      deposits are estimated to exhibit some rate sensitivity; and time deposits
      are shown in the table based on contractual
maturity.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

The results
of the December 31, 2008 net interest income rate shock simulations show that
the Corporation is within guidelines set by the Corporation's Asset/Liability
Policy when modeled rates increase 100 and 200 basis points and decrease by 100
and 200 basis points. The Corporation constantly monitors this position and
takes steps to minimize any reduction in net interest income.

41

---

The
following table forecasts changes in the Corporations market value of equity
under alternative interest rate environments as of December 31, 2008. The market
value of equity is defined as the net present value of the Corporations
existing assets and liabilities. The Corporation is within guidelines set by the
Corporations Asset/Liability Policy for the percentage change in the market
value of equity.

**Table 14Market Value of
Equity**

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


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 $5.0 million during 2008 compared to 2007
mostly as a result of a decrease in the credit quality of the loan portfolio
which caused an increase in the amount of the required reserve. The provision
for loan losses increased $6.4 million during 2007 compared to 2006 mostly as a
result of decreased quality of the loan portfolio. Total net loans charged off
in 2008, 2007 and 2006 were $5.9 million, $7.6 million and $2.9 million,
respectively.

Noninterest Income

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

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

42

---

Noninterest Expense

Noninterest
expenses increased $23.3 million, or 28.6%, in 2008 as compared to 2007. Driving
this increase was approximately $9.1 million in 2008 noninterest expenses
stemming from a full year of additional expenses from East Penn Financial which
was acquired in November 2007. Excluding these East Penn related expenses,
noninterest expenses increased $14.2 million. The table below depicts the effect
of the 2007 East Penn Financial acquisition on 2008 noninterest
expense.

**Table 15Noninterest
expense**

|                                      |  | Year Ended   |         | Year Ended   |   |           |  |        |      
|------------------------------------- |  | ------------ | ------- | ------------ | - | --------- |  | ------ | -----
|                                      |  | December 31, |         | December 31, |   | East Penn |  | Net   
|**(Dollars in thousands)**            |  | 2008         |         | 2007         |   | Financial |  | Change
|Salaries, wages and employee benefits |  | $            | 56,108  |              | $ | 48,832    |  | $      | 4,600
|Occupancy                             |  |              | 10,101  |              |   | 7,008     |  |        | 1,122
|Furniture and equipment               |  |              | 4,432   |              |   | 3,941     |  |        | 493  
|Intangibles
      expense             |  |              | 4,208   |              |   | 1,225     |  |        | 1,342
|Merger charges                        |  |              | 3,430   |              |   | 423       |  |        | 423  
|Other
      expenses                  |  |              | 26,343  |              |   | 19,926    |  |        | 1,094
|Total noninterest expense             |  | $            | 104,622 |              | $ | 81,355    |  | $      | 9,074

Excluding
East Penn Financial, the $2.7 million increase in salaries and benefits is
primarily due to one month of expenses for Willow Financial, normal salary
increases and non-merger related severance costs. Occupancy expense increased
$2.0 million due to increased rent expense on the bank properties included in
the sale-leaseback transaction completed in the fourth quarter of 2007.
Intangibles expense increased primarily due to a $1.4 million valuation
adjustment on mortgage servicing rights recorded in the fourth quarter of 2008.
Merger charges increased $2.6 million and were directly related to the December
2008 Willow Financial acquisition. Other expenses increased $5.3 million due
primarily to increases of $1.5 million in FDIC insurance costs, $1.9 million in
professional services, and $1.0 million in data processing costs.

Noninterest
expense of $81.4 million during 2007 increased $10.5 million or 14.9% compared
to 2006. Salaries and benefits expense rose $4.2 million for the year of 2007
over 2006, 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 in 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 $4.2 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 and lower
deferred loan origination costs resulting from lower loan volume. In addition,
East Penn merger costs were approximately $423,000.

43

---

Income Taxes

The
effective income tax rates for 2008, 2007 and 2006 were 16.8%, 21.5% and 26.3%,
respectively, versus the applicable federal statutory rate of 35% and the
applicable state tax rates. 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. The
effective tax rate for 2008 was lower than 2007 primarily due to a higher level
of tax exempt income recognized during 2008. Tax exempt income increased by $2.9
million from 2007 to 2008 despite an overall decrease in taxable income for the
same period. The effective tax rate for 2007 was lower than 2006 primarily due
to the higher level of tax exempt income during 2007 as compared to 2006.

Capital

Capital
formation is important to the Corporations well being and future growth.
Capital, at the end of 2008, was $474.7 million, an increase of $135.4 million
over the end of 2007. The increase was mainly due to the issuance of $160.8
million in common stock in connection with the acquisition of Willow Financial
partially offset by the increase of $26.5 million in the accumulated other
comprehensive loss related to investment securities available for sale. At
December 31, 2007, capital was $339.3 million, an increase of $44.6 million over
December 31, 2006. The increase was primarily due to the issuance of $39.1
million in common stock in connection with the acquisition of East Penn
Financial. Management believes that the Corporations current capital position
and liquidity position are adequate to support its operations.

Pursuant to
the federal regulators risk-based capital adequacy guidelines, the components
of capital are called Tier 1 and Tier 2 capital. For the Corporation, Tier 1
capital is generally common stockholders equity and retained earnings adjusted
to exclude disallowed goodwill and identifiable intangibles as well as the
inclusion of qualifying trust preferred securities. Tier 2 capital for the
Corporation is the allowance for loan losses. The risk-based capital ratios are
computed by dividing the components of capital by risk-adjusted assets.
Risk-adjusted assets are determined by assigning credit risk-weighting factors
from 0% to 200% to various categories of assets and off-balance sheet financial
instruments. The minimum for the Tier 1 capital ratio is 4.0%, and the total
capital ratio (Tier 1 plus Tier 2 capital divided by risk-adjusted assets)
minimum is 8.0%. At December 31, 2008, the Corporations Tier 1 risk-adjusted
capital ratio was 7.73%, and the total risk-adjusted capital ratio was 8.88%.
Both are above regulatory adequately capitalized requirements, however, the
total risk adjusted capital ratio is below the regulatory well capitalized
standard of 10.00%. Purchase accounting adjustments related to the acquisition
of Willow Financial helped to push the Corporations total risk-based capital
ratio below the regulatory threshold for a well capitalized bank Company. The
Corporation does not believe that these mark-to-market valuations reflect a
reduction in the realizable value of Willow Financials assets and expects to
recover the discount through amortization in 2009 and beyond.

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 8.19% and
8.72% at December 31, 2008 and 2007, respectively.The lower leverage ratio of the
Corporation at December 31, 2008 was mainly due to an increase in average assets
from the acquisition of Willow Financial and increase in average loans.

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, 2008, the Bank is above the
regulatory minimum guidelines and meets the criteria to becategorized as a well capitalized institution for the
risk-based capital and leverage ratios. For total risk-based capital, the Bank
is categorized as adequately capitalized. During the fourth quarter of 2008,
the Bank fell below the well capitalized threshold as a result of valuation
adjustments recorded for the Willow Financial acquisition. The Bank has
instituted a plan targeted to return to well capitalized before the end of
2009.

44

---

The cash
dividends paid during 2008 of $.80 per share were the same as the cash dividends
paid in 2007. The proportion of net income paid out in dividends for 2008 was
100.06%, compared to 88.82% for 2007, the increase mainly resulting from lower
net income during 2008. Management is focusing on improving and increasing
earnings so that the dividend payout ratio is within acceptable limits and
believes it prudent to build balance sheet strength and liquidity in response to
the negative economic outlook for 2009 forecast by many leading economists,
especially with respect to the credit markets.Accordingly, the Corporation reduced the
quarterly dividend from $0.20 per share to $0.10 per share for 2009.Activity in both the
Corporations dividend reinvestment and stock purchase plan did not have a
material impact on capital during 2008.

Liquidity

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

The
resulting projections as of December 31, 2008, show the potential sources of
funds exceeding the potential uses of funds. The accuracy of this prediction can
be affected by limitations inherent in the model and by the occurrence of future
events not anticipated when the projections were made.The Corporation has external sources of
funds which can be drawn upon when funds are required. One source of external
liquidity is the available line of credit with the FHLB. As of December 31,
2008, the Bank had borrowings outstanding with the FHLB of $522.7 million, all
of which were long-term. At December 31, 2008, the Bank had a maximum borrowing
capacity of $1.1 billion at the FHLB, unused FHLB lines of credit of $574.7
million and unused federal funds lines of credit of $77.7 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 $953.6 million and held to maturity securities of $50.4 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 2009. Despite the anticipated market
volatility and rate environment for much of 2009, the Corporation expects to be
able to retain most of these deposits. In the event that additional funds are
required, the Corporation believes its short-term liquidity is adequate as
outlined above.

Recent Developments

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

45

---

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

In November
2008, the Corporation filed an application to participate in the CPP as part of
the TARP. The Executive Committee of the Corporations Board of Directors
authorized management to apply for participation in the CPP up to the maximum of
3% of total risk-based assets, which is estimated at approximately $120 million.

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

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

46

---

The
following table sets forth contractual obligations and other commitments
representing required and potential cash outflows as of December 31,
2008:

**Table 16Contractual
Obligations and Other Commitments**

|                                               |  | December 31, 2008     
|---------------------------------------------- |  | ----------------------
|                                               |  |                       
|                                               |  |                       
|                                               |  | 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      |  |                       
|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, 2008 and December 31, 2007 of $36.4 million and $3.4 million,
respectively and commitments to sell mortgage loans at a specified rate at
December 31, 2008 and December 31, 2007 of $53.1 million and $2.4 million,
respectively. The commitments are accounted for as a derivative and recorded at
fair value. The Bank estimates the fair value of these commitments by comparing
the secondary market price at the reporting date to the price specified in the
contract to extend or sell the loan initiated at the time of the loan
commitment. At December 31, 2008, the Corporation had commitments with a
positive fair value of $274,000 and negative fair value of $48,000 which was
recorded as other income. 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.

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 2008, 2007 and 2006, the minimum operating
results were met resulting in earn-out payments totaling $3.6 million which was
recorded as additional goodwill. At December 31, 2008, the remaining maximum
payout is $3.4 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. The Banks total recourse
exposure at December 31, 2008 was $26,000. 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, 2008 was $187,000. At December 31, 2008 and December 31, 2007, the Bank had
$1,000 and $17,000, respectively, on the balance sheet as a recourse
liability.

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

47

---

Fourth Quarter 2008 Results (Unaudited)

Net income
for the fourth quarter of 2008 was $3.8 million, or $0.11 per diluted share, as
compared to $6.2 million or $0.20 per diluted share for the fourth quarter of
2007.

During the
fourth quarter of 2008, the provision for loan losses was $7.9 million, compared
to $4.5 million in the fourth quarter of 2007. The increase in provision for
loan losses reflects an increase in non-performing assets to $78.5 million at
December 31, 2008 from $22.0 million at December 31, 2007.

Net interest income on a
tax-equivalent basis in the fourth quarter 2008 increased $8.3 million, or
36.0%, over the same period in the prior year. The net interest margin increased
to 3.16% in the fourth quarter compared to 2.76% for 2007. The net interest
margin increased as a 59 basis point decrease in the yield on average earning
assets of $4.0 billion was offset by a 120 basis point decrease in the cost of
interest bearing liabilities of $3.6 billion.

Noninterest
income of $13.3 million for the fourth quarter of 2008 decreased $827,000 from
the comparable period in 2007. During the fourth quarter of 2007, the
Corporation recognized gains from sale-leaseback transactions of $2.8 million.
In addition, there was a fourth quarter 2008 other than temporary impairment
charge of $1.9 million on collateralized debt obligation investments in pooled
trust preferred securities. Offsetting these decreases were gains on sale of
investment securities of $2.4 million as compared to $657,000 in the prior
period. Deposit service charge income increased $796,000 or 27.7% over 2007
mainly from return check and overdraft fees as well as the larger deposit base
from East Penn acquisition. Wealth management income rose 20.0% to $6.0 million
driven by higher life insurance business at Cornerstone. Other income increased
$252,000 or 11.6% primarily to due to fees on derivative instruments.

Noninterest
expense increased $7.7 million for the fourth quarter of 2008 over the same
period in the prior year. Salaries and benefits expense increased $1.5 million
primarily due to higher staffing levels resulting from new branch openings, the
East Penn acquisition which occurred during the fourth quarter 2007, and the
Willow Financial acquisition which closed in December 2008. Occupancy expenses
increased $620,000 over the prior period due to new branch openings as well as
the aforementioned acquisitions. Intangible asset expense rose $1.8 million
primarily due to a $1.4 million valuation adjustment on mortgage servicing
rights. Merger costs increased $2.1 million due to the Willow acquisition. Other
expenses increased $1.6 million primarily due to increased FDIC insurance
premiums.

48

---

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 17Selected Quarterly
Financial Data (Unaudited)**

|                           |  | Three Months Ended 2008
      (1)                      |        | Three Months Ended 2007
      (2)
|-------------------------- |  | ------------------------------------------------------ | ------ | ---------------------------------
|                           |  | Dec. 31                                                |        | Sept. 30                         
|                           |  | (Dollars in thousands, except per share
  information)
|Interest income            |  | $                                                      | 54,583 |                                  
|Interest
      expense     |  |                                                        | 25,136 |                                  
|Net interest income        |  |                                                        | 29,447 |                                  
|Provision for
      loan   |  |                                                        |        |                                  
|losses                     |  |                                                        | 7,920  |                                  
|Net interest income after  |  |                                                        |        |                                  
|provision for loan         |  |                                                        |        |                                  
|losses                     |  |                                                        | 21,527 |                                  
|Noninterest
      income   |  |                                                        | 13,344 |                                  
|Noninterest expense        |  |                                                        | 31,293 |                                  
|Income before
      income |  |                                                        |        |                                  
|tax expense                |  |                                                        | 3,578  |                                  
|Income tax (benefit)       |  |                                                        |        |                                  
|expense                    |  |                                                        | (245   | )                                
|Net
      income           |  | $                                                      | 3,823  |                                  
|Net income per share       |  |                                                        |        |                                  
|Basic                      |  | $                                                      | 0.11   |                                  
|Diluted                    |  | $                                                      | 0.11   |                                  

| | (1) |  | The results of operations include
      the acquisition of Willow Financial effective December 5,
  2008.                                                                                           
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     |  |                                                                                                                                                                                                     
| | (2) |  | 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.

**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 through 2008, the economy has experienced a continued
decline in the housing market, reductions in credit facilities, disruptions in
the financial system, and volatility in the financial markets, all resulting in
short-term rate reductions by the Federal Open Market Committee and the creation
of programs by Congress and the Treasury Department for the purpose of
stabilizing and providing liquidity to the U.S. financial markets. This has
created a challenging interest rate environment for the Corporation which has
impacted our interest rate sensitivity exposure. 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.

49

---

Item 8.Financial Statements and
Supplementary Data

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

|                                                                                                      |  | December 31,          
|----------------------------------------------------------------------------------------------------- |  | ----------------------
|                                                                                                      |  | 2008                  
|                                                                                                      |  | (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 (measured at fair value at December 31,
      2008)    |  |                       
|Investment securities available for sale (amortized cost $1,186,586
      and $914,139, respectively) |  |                       
|Investment
      securities held to maturity (fair value $50,059 and $57,518,
      respectively)     |  |                       
|Federal Home Loan Bank stock, Federal Reserve Bank stock and other
      investments                  |  |                       
|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 short-term 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 43,022,387 and       |  |                       
|31,507,021 shares at December 31, 2008 and 2007,
      respectively                                   |  |                       
|Additional paid-in capital                                                                            |  |                       
|Retained earnings                                                                                     |  |                       
|Accumulated other comprehensive loss                                                                  |  |                       
|Treasury stock, at cost: 76,635 and 174,605 shares
      at December 31, 2008 and 2007,               |  |                       
|respectively                                                                                          |  |                       
|Total shareholders equity                                                                            |  |                       
|Total liabilities and shareholders
    equity                                                        |  | $                     

See accompanying notes to consolidated
financial statements.

50

---

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

|                                                                             |  | Year Ended December
  31,                    
|---------------------------------------------------------------------------- |  | ---------------------------------------------
|                                                                             |  | 2008                                         
|                                                                             |  | (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                     |  |                                              
|Other-than-temporary impairment of available for sale
      securities       |  |                                              
|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                                                      |  |                                              
|Intangibles
      expense                                                    |  |                                              
|Merger charges                                                               |  |                                              
|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.

51

---

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

CONSOLIDATED 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 |         | (Loss) Income     |  | Stock        |         | Total       |  | Income (Loss)
|                                      |  | (Dollars and share information in thousands)
|Balance January 1, 2006               |  | 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          |  |                                             |  |             |   |        |   |           |  |          |        |                   |  |              |        |             |  |               | 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 |   |  |   |        
|Issuance of stock for stock           |  |                                              |  |              |   |        |   |            |  |          |         |                   |  |              |         |             |  |               |         |   |  |   |        |   |  |   |         |   |  |   |        
|options, net of excess tax            |  |                                              |  |              |   |        |   |            |  |          |         |                   |  |              |         |             |  |               |         |   |  |   |        |   |  |   |         |   |  |   |        
|benefits                              |  |                                             |  | 165          |   |        |   |           |  |          | (992    | )                 |  |              |        |             |  |               |        |   |  |   | 2,850  |   |  |   | 1,858   |   |  |   |        
|Issuance of
      stock awards        |  |                                             |  |             |   |        |   |           |  |          |        |                   |  |              |        |             |  |               |        |   |  |   | 2      |   |  |   | 2       |   |  |   |        
|Stock-based compensation              |  |                                              |  |              |   |        |   |            |  |          |         |                   |  |              |         |             |  |               |         |   |  |   |        |   |  |   |         |   |  |   |        
|expense                               |  |                                             |  |             |   |        |   |           |  |          | 136     |                   |  |              |        |             |  |               |        |   |  |   |       |   |  |   | 136     |   |  |   |        
|Net
      income                      |  |                                             |  |             |   |        |   |           |  |          |        |                   |  |              | 25,093  |             |  |               |        |   |  |   |       |   |  |   | 25,093  |   |  | $ | 25,093 
|Other comprehensive loss, net         |  |                                              |  |              |   |        |   |            |  |          |         |                   |  |              |         |             |  |               |         |   |  |   |        |   |  |   |         |   |  |   |        
|of reclassifications                  |  |                                              |  |              |   |        |   |            |  |          |         |                   |  |              |         |             |  |               |         |   |  |   |        |   |  |   |         |   |  |   |        
|and tax                               |  |                                             |  |             |   |        |   |           |  |          |        |                   |  |              |        |             |  |               | (26,451 | ) |  |   |       |   |  |   | (26,451 | ) |  |   | (26,451
|Issuance of
      common stock for    |  |                                              |  |              |   |        |   |            |  |          |         |                   |  |              |         |             |  |               |         |   |  |   |        |   |  |   |         |   |  |   |        
|acquisition of Willow                 |  |                                              |  |              |   |        |   |            |  |          |         |                   |  |              |         |             |  |               |         |   |  |   |        |   |  |   |         |   |  |   |        
|Financial                             |  | 11,515                                       |  |             |   |        |   | 11,515     |  |          | 149,277 |                   |  |              |        |             |  |               |        |   |  |   |       |   |  |   | 160,792 |   |  |   |        
|Cash dividends                        |  |                                              |  |              |   |        |   |            |  |          |         |                   |  |              |         |             |  |               |         |   |  |   |        |   |  |   |         |   |  |   |        
|Treasury
      stock received in sale |  |                                              |  |              |   |        |   |            |  |          |         |                   |  |              |         |             |  |               |         |   |  |   |        |   |  |   |         |   |  |   |        
|of subsidiary                         |  |                                             |  | (66          | ) |        |   |           |  |          |        |                   |  |              |        |             |  |               |        |   |  |   | (906   | ) |  |   | (906    | ) |  |   |        
|Cash dividends                        |  |                                             |  |             |   |        |   |           |  |          |        |                   |  |              | (25,109 | )           |  |               |        |   |  |   |       |   |  |   | (25,109 | ) |  |   |        
|Other                                 |  |                                             |  | (1           | ) |        |   |           |  |          |        |                   |  |              |        |             |  |               |        |   |  |   | (18    | ) |  |   | (18     | ) |  |   |        
|Comprehensive loss                    |  |                                              |  |              |   |        |   |            |  |          |         |                   |  |              |         |             |  |               |         |   |  |   |        |   |  |   |         |   |  | $ | (1,358 
|Balance December 31,
    2008         |  | 43,022                                       |  | (76          | ) |        | $ | 43,022     |  | $        | 379,551 |                   |  | $            | 82,295  |             |  | $             | (29,017 | ) |  | $ | (1,144 | ) |  | $ | 474,707 |   |  |   |        

See accompanying notes to consolidated
financial statements.

52

---

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                                                              |  | Year Ended December
  31,
|------------------------------------------------------------------------------------------------------------- |  | -------------------------
|                                                                                                              |  | 2008                     
|                                                                                                              |  | (Dollars in thousands)   
|Operating activities                                                                                          |  |                          
|Net
    income                                                                                                |  | $                        
|Adjustments to reconcile net income to net cash provided by
      operating activities:                       |  |                          
|Provision for loan losses                                                                                     |  |                          
|Depreciation                                                                                                  |  |                          
|Intangibles expense                                                                                           |  |                          
|Net amortization of discounts/premiums on investments and
      borrowings                                    |  |                          
|Deferred income (benefit) expense                                                                             |  |                          
|(Gain) loss on sales of investment securities, net                                                            |  |                          
|Other-than-temporary impairment on investments
      available for sale                                       |  |                          
|Gain on sale-leaseback of bank properties                                                                     |  |                          
|Gain on sale of branch                                                                                        |  |                          
|Gain on sale of credit card portfolio                                                                         |  |                          
|Bank-owned life insurance income                                                                              |  |                          
|Death benefit on bank-owned life insurance                                                                    |  |                          
|Stock-based compensation expense                                                                              |  |                          
|Pension termination expense                                                                                   |  |                          
|Net decrease (increase) in accrued interest
      receivable                                                  |  |                          
|Net increase (decrease) in accrued interest payable                                                           |  |                          
|Net (increase) decrease in other assets                                                                       |  |                          
|Net (decrease) increase 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                             |  |                          
|Proceeds,
      redemption Federal Home Loan Bank stock and reduction in other
      investments              |  |                          
|Purchases of investment securities available for sale                                                         |  |                          
|Purchases of
      Federal Home Loan Bank stock, Federal Reserve Bank stock and other
      investments       |  |                          
|Net increase in loans                                                                                         |  |                          
|Net cash
      acquired (paid) due to acquisitions                                                            |  |                          
|Net cash paid in sale of branch                                                                               |  |                          
|Net proceeds
      from sale of credit card portfolio                                                         |  |                          
|Payments to fund pension plan                                                                                 |  |                          
|Purchases of
      premises and equipment                                                                     |  |                          
|Proceeds from sales of premises and equipment                                                                 |  |                          
|Proceeds from
      sales of other real estate                                                                |  |                          
|Net cash used in investing activities                                                                         |  |                          
|Financing
      activities                                                                                    |  |                          
|Net increase in deposits                                                                                      |  |                          
|Increase
      (decrease) in federal funds purchased and securities sold under agreements
      to repurchase |  |                          
|(Decrease) increase 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 (used in) provided by financing
      activities                                                     |  |                          
|Net (decrease) increase 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                                                |  | $                        
|Acquisitions, common stock issued                                                                             |  | $                        

See accompanying notes to consolidated
financial statements.

53

---

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.
Willow Financial Bancorp, Inc. (Willow Financial) and its banking subsidiary are
included in the Corporations results effective December 5, 2008. East Penn
Financial Corporation (East Penn Financial) and its banking subsidiary are
included in the Corporations results effective November 16, 2007. 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 U.S. generally accepted accounting
principles (GAAP).

The
preparation of financial statements in conformity with GAAP 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
original maturities 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.

54

---

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) Financial Staff
Position (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 could 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.

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
consistent with SFAS No. 91, Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs of
Leases. The net loan origination fees recognized as yield adjustments are
reflected in loan interest income from loans and leases in the consolidated
statements of income and the unamortized balance of the net loan origination
fees is reported in net loans in the consolidated balance sheets.

Income
recognition of interest on loans is discontinued when, in the opinion of
management, the collectability 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.

Loans are
considered past due after one payment has been missed. Loans are charged off
when it becomes evident that such balances are not fully collectible.

55

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

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. Impaired loans aremeasured individually 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.

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

56

---

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. A sample of commercial loans with a pass rating are
individually reviewed annually. Commercial loans that management determines to
be potential problem loans are individually reviewed, at a minimum, annually.
The review is performed by a third-party, and is designed to determine whether
such loans are individually impaired, with impairment measured by reference to
the collateral coverage and/or debt service coverage. Consumer credit and
residential real estate reviews are limited to those loans reflecting delinquent
payment status or performed on loans otherwise deemed to be at risk of
nonpayment. Homogeneous loan pools, including consumer and 1-4 family
residential mortgages are not subject to individual review but are evaluated
utilizing risk factors such as concentration of one borrower group. The
historical loss component of the allowance for these loans is based principally
on loan payment status, retail classification and historical loss rates,
adjusted by altering the risk window, to reflect current events and
conditions.

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

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

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

57

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

Statement of
Position (SOP) 03-3, Accounting for Loans or Certain Debt Securities Acquired
in a Transfer requires loans with evidence of deterioration of credit quality
since origination 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
Corporation evaluates the assets acquired in its acquisitions for applicability
to this statement.

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. As a result of these assessments, the Corporation
recorded valuation adjustments of $1.4 million in 2008 which are recorded in
intangibles expense on the consolidated statements of income.

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.

As of
December 31, 2008, mortgage loans originated and intended for sale in the
secondary market are recorded at estimated fair value in accordance with the
provisions with the provisions of SFAS No. 159, Fair Value Option for Financial
Assets and Financial Liabilities. As a result, in the fourth quarter of 2008, a
fair value adjustment of $215,000 was recognized in other income on the
consolidated statements of income.

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.

58

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

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.

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, money market 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). Identifiable intangible assets
are evaluated 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. 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, with the assistance of a third party specialist, using a combination of
the following valuation methods: dividend discount analysis under the income
approach, which calculates the present value of all excess cash flows plus the
present value of a terminal value and market multiples (pricing ratios) under
the market approach. 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.

59

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 1Summary of Significant
Accounting Policies (Continued)

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 on the consolidated balance sheets and offset in accumulated other
comprehensive income (loss) for the effective portion of the derivatives.
Amounts reclassed into earnings, when the hedged transaction culminates, are
included in net interest income on the consolidated statements of income.
Ineffectiveness of the strategy, as defined under SFAS 133, if any, is also
reported in net interest income. 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 sheets 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 consolidated statements of income. 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.

Stock-Based Compensation

The
Corporation recognizes compensation expense for stock options in accordance with
SFAS No. 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.See Note 14  Stock-Based
Compensation for additional information.

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 more likely than not in accordance with SFAS No. 109, Accounting for
Income Taxes. If management determines that the Corporation is not, more likely
than not, 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.

60

---

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 are 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
accumulated other comprehensive income (loss) in the consolidated balance
sheets. 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 on investment securities 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.

61

---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant Accounting Policies
(Continued)

Securities Sold Under Agreements to Repurchase

The
Corporation accounts for securities sold under agreements to repurchase as
secured borrowings as the Corporation maintains effective control over the
transferred assets. Securities sold under agreements to repurchase are reflected
at the amount of cash received in connection with the transaction. The
Corporation may be required to provide additional collateral based on the fair
value of the underlying securities.

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), East Penn Statutory Trust and
Willow Grove Statutory Trust I, (collectively, the Trusts) are considered
variable interest entities under FASB Interpretation 46, Consolidation of
Variable Interest Entities, as revised in December 2003 (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 2008, the
FASB issued FSP FAS 140-4 and FIN 46(R)-8, Disclosure by Public Entities
(Enterprises) about Transfers of Financial Assets and Interests in Variable
Interest Entities. This FSP amends SFAS 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities to require
public entities to provide additional disclosures about transferors continuing
involvements with transferred financial assets. It also amends FIN 46R to
require public entities, including sponsors that have a variable interest in a
variable interest entity, to provide additional disclosures about their
involvement with variable interest entities. This FSP is effective for reporting
periods that end after December 15, 2008. FSP FAS 140-4 and FIN 46(R)-8 did not
impact the Corporations financial statements, although it did result in
expanded disclosures. See Note 10  Borrowings for additional information.

In October 2008, the
FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When
the Market for That Asset is Not Active. FSP FAS 157-3 clarifies how a
reporting entitys own assumptions should be considered when measuring fair
value when relevant observable inputs do not exist, how available observable
inputs in a market that is not active should be considered when measuring fair
value and how the use of market quotes should be considered when assessing the
relevance of observable and unobservable inputs available to measure fair value.
The provisions of FSP FAS 157-3 were applied in calculating an
other-than-temporary impairment charge on investment securities of $1.9 million
during the fourth quarter of 2008. See Note 4  Investment Securities for
additional information.

In June 2008, the FASB
issued FSP EITF Issue No. 03-6-1, Determining Whether Instruments Granted in
Share-Based Payment Transactions are Participating Securities. This FSP states
that unvested share-based payment awards that contain nonforfeitable rights to
dividends or dividend equivalents (whether paid or unpaid) are participating
securities and shall be included in the computation of earnings per share
pursuant to the two-class method. The FSP is effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim periods
within those years. This staff position is not expected to have a material
impact on the Corporations financial statements.

In May 2008, the FASB
issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting
Principles. SFAS 162 identifies the sources of accounting principles and the
framework for selecting the principles to be used in the preparation of
financial statements of nongovernmental entities that are presented in
conformity with generally accepted accounting principles (GAAP) in the United
States (the GAAP hierarchy). This Statement was effective 60 days following the
SECs approval of the Public Company Accounting Oversight Board amendment to AU
Section 411, The Meaning of Present Fairly in Conformity With Generally
Accepted Accounting Principles. The provisions of SFAS 162 did not have a
significant impact on the Corporations current practice.

62

---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant Accounting Policies
(Continued)

In May 2008, the FASB
issued FSP Accounting Principles Board (APB) 14-1, Accounting for Convertible
Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial
Cash Settlement). This FSP clarifies that convertible debt instruments that may
be settled in cash upon conversion (including partial cash settlement) are not
addressed by paragraph 12 of APB Opinion No. 14, Accounting forConvertible Debt and Debt Issued with Stock
Purchase Warrants,and specifies
that issuers of such instruments should separately account for the liability and
equity components in a manner that will reflect the entity's nonconvertible debt
borrowing rate when interest cost is recognized in subsequent periods. FSP APB
14-1 is effective for financial statements issued in fiscal years beginning
after December 15, 2008, and is not anticipated to have a material impact on the
Corporations financial statements.

In April 2008, the FASB
issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets.
FSP FAS 142-3 amends the factors that should be considered in developing renewal
or extension assumptions used to determine the useful life of a recognized
intangible asset and expands disclosures under SFAS No. 142, Goodwill and Other
Intangible Assets. This FSP is effective for financial statements issued in
fiscal years beginning after December 15, 2008, and is not expected to have a
material impact on the Corporations financials statements.

In March 2008, the FASB
issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging
Activities. SFAS 161 requires enhanced disclosures to enable investors to
better understand the effects of derivative instruments and hedging activities
on an entitys financial statements. Specifically, it requires that objectives
for using derivatives instruments be disclosed in terms of underlying risk and
accounting designation, disclosing the fair values of derivative instruments and
their gains and losses in a tabular format, disclosure about credit-risk-related
contingent features and cross-referencing within the footnotes. It is effective
for financial statements issued for fiscal years and interim periods beginning
after November 15, 2008, with early application encouraged. SFAS 161 will result
in expanded disclosures within the Corporations financial statements.

In February 2008, the
FASB issued FSP FAS 140-3, Accounting for Transfers of Financial Assets and
Repurchase Financing Transactions. This FSP specifies that a transferor and
transferee shall not separately account for a transfer of a financial asset and
a related repurchase financing unless (a) the two transactions have a valid and
distinct business or economic purpose for being entered into separately and (b)
the repurchase financing does not result in the initial transferor regaining
control over the financial asset. The two transactions shall be considered
linked unless they meet all of the specified criteria in this FSP. The linked
transaction should be evaluated to determine whether it meets the requirements
for sale accounting under SFAS No. 140, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities. If the linked
transaction does not meet the requirements for sale accounting, it should be
accounted for based on the economics of the combined transaction which generally
represents a forward contract. FSP FAS 140-3 is effective prospectively for
financial statements issued in fiscal years beginning after November 15, 2008.
Early application is not permitted. FSP FAS 140-3 is not expected to have a
material impact on the Corporations financial statements.

63

---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 1Summary of Significant Accounting Policies
(Continued)

In December 2007, the
FASB issued SFAS No. 141(R), Business Combinations (revised 2007). SFAS 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 businesscombination. 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 provisions of SFAS
141(R) will only impact the Corporation if it is party to a business combination
closing on or after January 1, 2009.

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. SFAS 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 adoption of SFAS 160 is not expected to have a material
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. 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. On
December 5, 2008, the Corporation elected to measure residential mortgage loans
held for sale acquired from Willow Financial at fair value under the provisions
of SFAS 159. The adoption of SFAS 159 did not have a material impact on the
Corporations financial statements.

Effective January 1,
2008, the Corporation adopted 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
does not change existing accounting rules governing what can or what must be
recognized and reported at fair value in the Corporations financial statements,
or disclosed at fair value in the Corporations notes to the financial
statements. As a result, the Corporation was not required to recognize any new
instruments at fair value. See Note 21  Fair Value Measurements for additional
information.

In March 2008, the FASB
issued FSP FAS 157-2, Effective Date of FASB Statement No. 157 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, residential mortgage loans held for
sale and derivatives. Assets reported at fair value on a nonrecurring basis
(lower of costor market) are impaired loans and mortgage
servicing rights. See Note 21  Fair Value Measurements for additional
information.

64

---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 2Acquisitions / Dispositions

Acquisition of Willow Financial Bancorp,
Inc.

Effective
after the market close on December 5, 2008, the Corporation completed its
acquisition of Willow Financial. Under the terms of the merger agreement, dated
as of May 20, 2008, Willow Financial was acquired by the Corporation and Willow
Financials wholly-owned subsidiary, Willow Financial Bank, a $1.6 billion
savings bank with 29 branch offices in Southeastern Pennsylvania, was merged
with and into the Bank. The merger of the Corporation and Willow Financial
resulted in a combined company with approximately $5.5 billion in assets and
delivers a significant market share in Chester County, one of the
fastest-growing counties in Pennsylvania, increases the Corporations market
presence in Bucks and Montgomery counties, and establishes a new market presence
in Philadelphia County. The combined company establishes a stronger presence in
eastern Pennsylvania, including becoming the third largest financial institution
headquartered in suburban Philadelphia. Willow Financial has complementary lines
of business, a solid reputation with customers in growing markets, and a branch
network that augments the Banks traditional footprint. In conjunction with this
transaction, the Corporation also acquired BeneServ, Inc., a respected provider
of employee benefits services and Carnegie Wealth Advisors, LLC (Carnegie).
Carnegie was subsequently sold in December 2008. The merger drives shareholder
value by providing the opportunity to deliver synergies and accretion to
earnings.

The
Corporation acquired 100% of the outstanding shares of Willow Financial. Based
on the terms of the merger agreement, Willow Financial shareholders received
0.73 shares of the Corporations common stock for each share of Willow Financial
common stock they held with cash paid in lieu of fractional shares. The purchase
price was $13.79 per common share and was based upon the average of the closing
prices for the Corporations common stock on the agreement date and for two days
before and two days after the agreement date and the agreement date. The
Corporation issued 11,515,366 shares of common stock, incurred $2.4 million in
acquisition costs which were capitalized and converted stock options with a fair
value of $2.0 million for a total purchase price of $163.2 million at the
closing on December 5, 2008.

Goodwill of
$130.0 million has been recorded in this transaction which will not be
amortizable and is not deductible for tax purposes. The Corporation allocated
$126.9 million of the goodwill resulting from this transaction to the Community
Banking segment and $3.1 million to the Wealth Management segment. The
Corporation also recorded $14.1 million in core deposit intangibles and $2.9
million in other identifiable intangible assets which will be amortized over ten
years using the sum of the years digits amortization method. The $2.9 million of
other identifiable intangibles were allocated to the Wealth Management
segment.

The acquisition of Willow Financial
constituted a business combination under SFAS No. 141, Business Combinations,
and was accounted for using the purchase method. Accordingly, the purchase price
was allocated to the respective assets acquired and liabilities assumed based on
their estimated fair values on the date of acquisition. The excess of purchase
price over the fair value of net assets acquired was recorded as goodwill. The
purchase price allocation, as of December 31, 2008, is subject to revision in
future periods, including adjustments that may be necessary upon the filing of
final tax returns for Willow Financial. The results of operations of Willow
Financial have been included in the Corporations results of operations since
December 5, 2008, the date of acquisition.

65

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 2Acquisitions / Dispositions
(Continued)

The following is the calculation of
the purchase price for the Willow Financial acquisition.

|                                                                      | (Dollars in
|--------------------------------------------------------------------- | -----------
|                                                                      | thousands) 
|Purchase price of Willow Financial:                                   |            
|Market value of the Corporations stock issued                        | $          
|Purchase price assigned to fractional shares exchanged for
      cash |            
|Fair value assigned to converted Willow Financial stock
      options |            
|Capitalized costs                                                     |            
|Total purchase
      price                                            | $          

The
following are the assets acquired and liabilities assumed from Willow Financial
at December 5, 2008 including the adjustments made to record the transaction and
to adjust the assets and liabilities to their estimated fair values.

|                                                   |                        |           | Fair Market |   |         
|-------------------------------------------------- | ---------------------- | --------- | ----------- | - | --------
|                                                   | Willow                 |           | Value       |   | As      
|                                                   | Financial              |           | Adjustments |   | Adjusted
|                                                   | (Dollars in thousands)
|Assets acquired:                                   |                        |           |             |   |         
|Cash and cash equivalents                          | $                      | 45,116    |             | $ | ****   
|Investment securities available for sale           |                        | 165,657   |             |   | ****   
|Investment securities held to maturity             |                        | 84,504    |             |   | (11,861 
|Federal Home Loan Bank stock and other investments |                        | 18,495    |             |   | ****   
|Loans, net                                         |                        | 1,115,145 |             |   | (29,366 
|Premises and equipment, net                        |                        | 9,406     |             |   | 3,702   
|Goodwill                                           |                        | ****     |             |   | 129,958 
|Core
      deposit intangible                      |                        | ****     |             |   | 14,112  
|Other identifiable intangible assets               |                        | ****     |             |   | 2,916   
|Bank-owned life insurance                          |                        | 12,624    |             |   | ****   
|Other assets (includes deferred taxes)             |                        | 29,692    |             |   | 13,968  
|Total
      assets acquired                        |                        | 1,480,639 |             |   | 123,429 
|Liabilities
      assumed:                         |                        |           |             |   |         
|Deposits                                           |                        | 945,876   |             |   | 776     
|Repurchase agreements                              |                        | 100,015   |             |   | 7,120   
|Advances from the FHLB                             |                        | 346,277   |             |   | 16,317  
|Subordinated debentures                            |                        | 25,774    |             |   | (15,030 
|Other liabilities                                  |                        | 8,841     |             |   | 4,903   
|Total liabilities assumed                          |                        | 1,426,783 |             |   | 14,086  
|Assets acquired less liabilities assumed           | $                      | 53,856    |             | $ | 109,343 

66

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 2Acquisitions / Dispositions
(Continued)

The fair
value of certain assets and certain liabilities acquired 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 Corporation determined that there were no
other categories of identifiable intangible assets arising from the Willow
Financial acquisition other than the core deposit and customer intangibles.

AICPA
Statement of Position 03-3, Accounting for Certain Loans or Debt Securities
Acquired in a Transfer (SOP 03-3) addresses accounting for differences between
contractual cash flows and cash flows expected to be collected from an
investors initial investment in loans or debt securities acquired in a transfer
if those differences are attributable, at least in part, to credit quality. It
includes loans acquired in purchase business combinations. SOP 03-3 does not
apply to loans originated by the Corporation. The Corporations assessment
identified $17.3 million in acquired loans from Willow Financial to which the
application of the provisions of SOP 03-3 was required. As a result of the
application of SOP 03-3, the Corporation recorded purchase accounting
adjustments reflecting a reduction in loans of $6.3 million related to acquired
impaired loans, thus reducing the carrying value of these loans to $11.0 million
as of December 31, 2008. Income recognition under this SOP is dependent on
having a reasonable expectation about the timing and amount of cash flows
expected to be collected. The loans deemed impaired under this SOP were
considered collateral dependent, however the timing of the sale of loan
collateral is indeterminate and as such the loans will remain on non-accrual
status and will have no accretable yield. The Corporation will use the cash
basis method of interest income recognition.

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

|                                                         | (Dollars in
|-------------------------------------------------------- | -----------
|                                                         | thousands) 
|Contractually required payments at acquisition:          |            
|Real
      estate                                        | $          
|Commercial and industrial                                |            
|Consumer                                                 |            
|Total                                                    | $          
|Cash flows
      expected to be collected at acquisition | $          

The following is the carrying value
by category as of December 31, 2008:

|                                | (Dollars in
|------------------------------- | -----------
|                                | thousands) 
|Real estate                     | $          
|Commercial and
      industrial |            
|Consumer                        |            
|Total carrying value            | $          

67

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 2Acquisitions / Dispositions
(Continued)

The
following are the unaudited pro forma consolidated results of operations of the
Corporation for the years ended December 31, 2008 and 2007 as though Willow
Financial had been acquired on January 1, 2007:

|                                                          | 2008                                  |         | 2007
|--------------------------------------------------------- | ------------------------------------- | ------- | ----
|                                                          | (Dollars in thousands, except for per
|                                                          | share
      data)                    
|Total interest income                                     | $                                     | 287,402 |     
|Total interest
      expense                              |                                       | 132,274 |     
|Net interest income                                       |                                       | 155,128 |     
|                                                         
|Provision for loan losses                                 |                                       | 23,079  |     
|Net interest
      income after provision for loan losses |                                       | 132,049 |     
|                                                         
|Total non-interest income                                 |                                       | 57,030  |     
|Total
      non-interest expense                          |                                       | 173,973 |     
|                                                         
|Income before income taxes                                |                                       | 15,106  |     
|                                                         
|Income tax expense (1)                                    |                                       | 1,736   |     
|                                                         
|Net income                                                | $                                     | 13,370  |     
|                                                         
|Basic earnings per share                                  | $                                     | 0.31    |     
|Diluted earnings
      per share                          | $                                     | 0.31    |     

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

In
connection with the purchase of Willow Financial, on December 15, 2008, the
Corporation sold the net assets of Carnegie. Carnegie was a wealth management
subsidiary of Willow Financial with approximately $160 million under management
that provided professional investment consulting services to retirement plan
administrators, foundations, corporations and high net worth investors. At the
time of acquisition, this subsidiary had net assets of approximately $22,000.
The assets and liabilities of the subsidiary were recorded at their fair values
as of the acquisition date and the excess of the net assets acquired over the
purchase price of approximately $935,000 was recorded as goodwill and allocated
to this subsidiary. The subsequent sale price of the net assets of Carnegie was
approximately $935,000 in the form of 65,966 shares of Harleysville National
Corporation common stock and $29,000 in cash. The Corporation recorded the
receipt of the common shares as treasury shares and recorded no gain or loss on
the transaction.

68

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 2Acquisitions / Dispositions
(Continued)

On December
27, 2007, the Bank settled and closed an agreement to sell fifteen properties to
affiliates of American Realty Capital, LLC (ARC) in a sale-leaseback
transaction. The properties are located throughout Berks, Bucks, Lehigh,
Montgomery, Northampton, and Carbon counties. Under the leases, the Bank
continues to utilize the properties in the normal course of business. Lease
payments on each property are institution-quality, triple net leases with an
initial annual aggregate base rent of $3.0 million with annual rent escalations
equal to the lower of CPI-U (Consumer Price Index for all Urban Consumers) or
2.0 percent commencing in the second year of the lease term. As tenant, the Bank
is fully responsible for all costs associated with the operation, repair and
maintenance of the properties during the lease terms and is recorded as
occupancy expense. The agreement provides that each lease has a term of 15
years, commencing on the closing date for the agreement. The agreement also
contains options to renew for periods aggregating up to 45 years. Under certain
circumstances these renewal options are subject to revocation by the lessor. The
Bank received net proceeds of $38.2 million and recorded a gain on sale from the
transaction of $2.3 million (pre-tax) representing a portion of the total gain
of $18.9 million. The remaining gain was deferred and is being amortized through
a reduction of occupancy expense over the 15-year term of the leases an annual
amount of 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 is being
amortized over the 10-year term of the lease.

Effective
November 16, 2007, the Corporation completed its acquisition of East Penn
Financial Corporation (East Penn Financial) and its wholly owned subsidiary,
East Penn Bank, a $451 million state chartered, FDIC insured bank, was merged
with and into Harleysville National Bank. Headquartered in Emmaus, Pennsylvania,
East Penn Financial had nine banking offices located in Lehigh, Northampton and
Berks Counties. The acquisition expanded the branch network that the Corporation
had in the Lehigh Valley and its opportunity to provide East Penn customers with
a broader mix of products and services. The aggregate purchase price was $91.3
million in cash and stock. The Corporation acquired 100% of the outstanding
shares of East Penn Financial. The transaction was accounted for using the
purchase method of accounting in accordance with SFAS No. 141, Business
Combinations. East Penn Financial shares of 2,890,125 were exchanged at a
conversion ratio of .8416 for 2,432,771 shares of the Corporation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 a total fair value
of $111,000. 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. Goodwill of $63.9 million and a core deposit intangible of $7.4
million were recorded in connection with the acquisition of East Penn Financial
and allocated to the Community Banking segment. These numbers include the
finalized allocation of the purchase price based upon third party valuation of
goodwill and certain intangible assets which occurred during the first six
months of 2008. East Penn Financials results of operations are included in the
Corporations results from the date of acquisition, November 16, 2007.

On March 1,
2007, the Cornerstone Companies, a subsidiary of the Bank, completed a selected
asset purchase of McPherson Enterprises and related entities (McPherson),
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 $1.2 million and customer relationship intangibles of $380,000 were
recorded in connection with the asset purchase. These numbers include the
finalized allocation of the purchase price based upon third party valuation of
goodwill and certain intangible assets which occurred during the first three
months of 2008.

69

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 2Acquisitions / Dispositions
(Continued)

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 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.

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 2008, 2007 and 2006,
the minimum operating results were met resulting in earn-out payments of $1.4
million, $1.2 million and $1.0 million for each year, respectively, which were
recorded as additional goodwill. At December 31, 2008, the remaining maximum
payout is $3.4 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 $15.0 million (including the
earn-out payments) and customer relationship intangibles of $3.9 million were
recorded in connection with the acquisition and allocated to the Wealth
Management segment.

Note 3Restrictions on Cash and Due
from Banks

As of
December 31, 2008 and 2007, the Bank did not need to maintain reserves (in the
form of deposits with the Federal Reserve Bank) to satisfy federal regulatory
requirements.

70

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

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, 2008Gross
    
    GrossAmortized
    
    Unrealized
    
    **Unrealized**
    
    EstimatedCost
    
    Gains
    
    Losses
    
    Fair Value(Dollars in
      thousands)Available for
      saleObligations of U.S. government
      agenciesand
      corporations
    **$**
    93,501
    
    **$**
    419
    
    $
    (26
    )
    
    $
    93,894Obligations of
      states and political subdivisions
    
    288,415
    
    
    4,798
    
    
    (6,338
    )
    
    
    286,875Mortgage-backed securities
    
    710,385
    
    
    14,389
    
    
    (19,291
    )
    
    
    705,483Other
      securities
    
    94,285
    
    
    1,077
    
    
    (39,666
    )
    
    
    55,696Total investment securities available for sale
    $
    1,186,586
    
    **$**
    20,683
    
    **$**
    **(65,321**
    )
    
    $
    1,141,948Held to
      maturityObligations of U.S. government
      agenciesand corporations
    **$**
    3,880
    
    **$**
    122
    
    **$**
    
    
    
    **$**
    4,002Obligations of
      states and political subdivisions
    
    46,554
    
    
    119
    
    
    (616
    )
    
    
    46,057Total investment securities held to maturity
    **$**
    50,434
    
    **$**
    241
    
    **$**
    (616
    )
    
    **$**
    50,059December 31, 2007Gross
    
    GrossAmortized
    
    **Unrealized**
    
    Unrealized
    
    EstimatedCost
    
    Gains
    
    Losses
    
    Fair Value(Dollars in
      thousands)Available for
      saleObligations of 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
    
    70,528
    
    
    139
    
    
    (3,459
    )
    
    
    67,208Total investment securities available for sale
    $
    914,139
    
    $
    3,869
    
    $
    (7,641
    )
    
    $
    910,367Held to
      maturityObligations of 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
    )
    
    $
    57,518


71

---

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, 2008 and 2007:

|                          | December 31, 2008     
|------------------------- | ----------------------
|                          | Less than 12 months   
|Description
      of      |                       
|Securities                |                       
|                          | (Dollars in thousands)
|Obligations of U.S.       |                       
|government
      agencies |                       
|and
      corporations    | 3                     
|Obligations of states     |                       
|and
      political       |                       
|subdivisions              | 290                   
|Mortgage-backed           |                       
|securities                | 35                    
|Other
      securities    | 17                    
|Totals                    | 345                   
|                         
|                          | December 31, 2007     
|                          | Less than 12 months   
|Description
      of      |                       
|Securities                |                       
|                          | (Dollars in thousands)
|Obligations of U.S.       |                       
|government
      agencies |                       
|and
      corporations    | 3                     
|Obligations of states     |                       
|and
      political       |                       
|subdivisions              | 46                    
|Mortgage-backed           |                       
|securities                | 26                    
|Other
      securities    | 20                    
|Totals                    | 95                    

The
unrealized losses associated with the securities portfolio, are temporary in
nature since they are not related to the underlying credit of the issuers, and
the Corporation has the ability and intent to hold these investments for the
time necessary to recover its cost which may be at maturity (i.e. these
investments have contractual maturities that, absent credit default, ensure a
recovery of cost). In making its other-than temporary evaluation, management
considered the fact that the expected cash flow is not affected by the
underlying collateral or issuer. Other factors considered in evaluating the
securities portfolio for other-than-temporary impairment are the length of time
and the extent to which the fair value has been below the cost, analyst reports,
analysis of the current interest rate environment, anticipated volatility in the
market and the underlying credit rating of the issuers. In certain cases where
sufficient data is not available, a cash flow model is utilized.

The change in the unrealized losses
on securities other than obligations of U.S. government agencies and
corporations, which includes certain collateralized mortgage obligations and
collateralized debt obligations were caused by changes in interest rates, credit
spread and liquidity issues in the marketplace. There were 67 individual
securities in a continuous unrealized loss position for twelve months or longer
as of December 31, 2008. The Corporation recognized an other-than temporary
impairment charge of $1.9 million during the fourth quarter of 2008 as a result
of deterioration in the individual credits of a collateralized debt obligation
investment in a pooled trust preferred security. As relevant observable inputs
did not exist, a cash flow model was utilized to determine the fair value of the
impaired security.

72

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 4Investment Securities
(Continued)

Securities
with a carrying value of $100.4 million and $756.3 million at December 31, 2008
and 2007, respectively, were pledged to secure public funds, customer trust
funds, government deposits and repurchase agreements.

Accrued
interest receivable on investment securities was $8.5 million and $7.1 million
at December 31, 2008 and 2007, respectively.

The
amortized cost and estimated fair value of investment securities, at December
31, 2008, 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, 2008Held to Maturity
    
    Available for SaleEstimated
    
    
    
    EstimatedAmortized
    
    Fair
    
    Amortized
    
    FairCost
    
    Value
    
    Cost
    
    Value(Dollars in thousands)Due in one year or less
    $
    
    
    $
    
    
    $
    1,502
    
    $
    1,507Due after one
      year through five years
    
    
    
    
    
    
    
    72,013
    
    
    71,579Due after five years through ten years
    
    17,188
    
    
    17,183
    
    
    99,594
    
    
    97,925Due after ten
      years
    
    33,246
    
    
    32,876
    
    
    280,095
    
    
    243,78950,434
    
    
    50,059
    
    
    453,204
    
    
    414,800Mortgage-backed
      securities
    
    
    
    
    
    
    
    710,385
    
    
    705,483Equity securities
    
    
    
    
    
    
    
    22,997
    
    
    21,665Totals
    $
    50,434
    
    $
    50,059
    
    $
    1,186,586
    
    $
    1,141,948


Proceeds
from the sales of investment securities available for sale for the years ended
December 31, 2008, 2007 and 2006 were $208.5 million, $186.2 million and $110.8
million, respectively. The components of net realized gains on sales of
investment securities were as follows:

Year Ended December 31,2008
    
    2007
    
    2006(Dollars in thousands)Gross realized gains
    $
    3,238
    
    
    $
    1,329
    
    
    $
    445Gross realized
      losses
    
    (596
    )
    
    
    (142
    )
    
    
    (1,119
    )Net realized gain (loss) on sales of investment securities
    $
    2,642
    
    
    $
    1,187
    
    
    $
    (674
    )


73

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 5Loans

Major classifications of loans are
as follows:

December 31,2008
    
    2007(Dollars in thousands)Real estate (including loans held for sale of $17,165 and
      $1,140)
    $
    1,602,654
    
    
    $
    959,716Commercial and
      industrial
    
    980,190
    
    
    
    728,293Consumer loans
    
    1,099,903
    
    
    
    764,860Lease
      financing
    
    758
    
    
    
    2,564Total
      loans
    
    3,683,505
    
    
    
    2,455,433Deferred costs,
      net
    
    1,739
    
    
    
    5,390Allowance for loan losses
    
    (49,955
    )
    
    
    (27,328
    )Net loans (including loans held for sale)
    $
    3,635,289
    
    
    $
    2,433,495


On December
31, 2008, nonaccrual loans were $75.1 million and loans 90 days or more past due
and still accruing interest were $1.8 million. 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. 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 2008, interest accrued on nonaccruing loans and not
recognized as interest income was $1.9 million and interest paid on nonaccruing
loans of $299,000 was recognized as interest income. During 2007, interest
accrued on nonaccruing loans and not recognized as interest income was $982,000
and interest paid on nonaccruing loans of $331,000 was recognized as interest
income. 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.

The balance
of impaired loans at December 31, 2008 and 2007 was $70.2 million and $9.8
million, respectively. At December 31, 2008 and 2007, impaired loans with
specific loss allowances were $38.4 million and $9.8 million and the related
specific allowance for loan losses were $8.4 million and $2.2 million,
respectively. The average impaired loan balance was $23.5 million in 2008,
compared to $7.5 million and $3.2 million in 2007 and 2006, respectively. The
income recognized on impaired loans during 2008, 2007 and 2006 was $151,000,
$31,000 and $60,000, respectively. Impaired loans are included in the nonaccrual
loan total.

Residential
mortgage loans held for sale at December 31, 2008 and 2007 totaled $17.2 million
and $1.1 million, respectively. Gains on the sale of residential mortgage loans
for the years ended December 31, 2008 and 2007 were $557,000 and $472,000,
respectively (recorded in other income on consolidated statements of income).

Residential
mortgage loans serviced for others totaled $397.5 million at December 31, 2008
(included $16.0 million with recourse) and totaled $335.8 million at December
31, 2007 (included $5.8 million with recourse). The residential mortgage loans
serviced for others with recourse were assumed from acquisitions.

The Bank has
no concentration of loans to individual borrowers which exceeded 10% of total
loans at December 31, 2008 and 2007. The Bank actively monitors the risk of loan
concentration.

Net assets
in foreclosure at December 31, 2008 and 2007 were $1.6 million and $28,000,
respectively, and are recorded in other assets on the consolidated balance
sheets. During 2008, transfers from loans to assets in foreclosure were $2.4
million, additions from Willow Financial were $426,000, disposals of foreclosed
properties were $1.3 million, and no charge-offs were recorded. Gains on the
sale of net assets in foreclosure for the years ended December 31, 2008 and 2007
were $56,000 and $0, respectively, and are recorded in other income on the
consolidated statements of income.

74

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

Note 5Loans (Continued)

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 31,2008
    
    2007 (1)
    
    2006(Dollars in
      thousands)Balance, January 1
    
    $
    12,043
    
    
    $
    17,393
    
    
    $
    22,099New loans
    
    
    2,730
    
    
    
    4,451
    
    
    
    66,666Loans
      acquired through acquisition
    
    
    1,903
    
    
    
    
    
    
    
    Repayments and other
      reductions
    
    
    (3,238
    )
    
    
    (9,801
    )
    
    
    (71,372
    )Balance, December 31
    
    $
    13,438
    
    
    $
    12,043
    
    
    $
    17,393


|(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.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

Note 6Allowance for Loan Losses

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

Year Ended December 31,2008
    
    2007
    
    2006(Dollars in
      thousands)Balance, beginning of year
    
    $
    27,328
    
    
    $
    21,154
    
    
    $
    19,865Provision for loan
      losses
    
    
    15,567
    
    
    
    10,550
    
    
    
    4,200Reserve from Willow
      Financial acquisition
    
    
    12,925
    
    
    
    
    
    
    
    Reserve from East Penn
      Financial acquisition
    
    
    
    
    
    
    3,250
    
    
    
    Loans charged
    off
    
    
    (6,829
    )
    
    
    (8,142
    )
    
    
    (3,711
    )Recoveries
    
    
    964
    
    
    
    516
    
    
    
    800Balance, end of year
    
    $
    49,955
    
    
    $
    27,328
    
    
    $
    21,154


Note 7Premises and Equipment

Premises and equipment consist of the following:

**Estimated**
    
    **December
      31,**Useful Lives
    
    2008
    
    2007**(Dollars in thousands)**Land
    
    Indefinite
    
    $
    5,467
    
    
    $
    3,397Buildings
    
    15-39
      years
    
    
    41,111
    
    
    
    22,146Furniture, fixtures and equipment
    
    3-7 years
    
    
    37,336
    
    
    
    41,357Total cost
    
    
    
    
    83,914
    
    
    
    66,900Less
      accumulated depreciation and amortization
    
    
    
    
    (33,309
    )
    
    
    (34,382
    )Premises and equipment,
      net
    
    
    
    $
    50,605
    
    
    $
    32,518


75

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 7Premises and Equipment
(Continued)

Depreciation
expense for the years ended December 31, 2008, 2007, and 2006 was $4.3 million,
$4.0 million and $3.3 million, respectively. During 2008, the Corporation
disposed of premises and equipment with a cost basis of $6.0 million and
accumulated depreciation of $5.4 million. The net gain on disposal of these
assets of $42,000 is recorded in other income on the consolidated statements of
operations.

Note 8Goodwill and Other Intangibles

Goodwill and
identifiable intangibles were $240.7 million and $26.2 million, respectively at
December 31, 2008, and $111.2 million and $10.6 million, respectively at
December 31, 2007. The goodwill and identifiable intangibles balances resulted
from acquisitions. Goodwill of $130.0 million, core deposit intangible of $14.1
million and customer relationship intangibles of $2.9 million were recorded
related to the acquisition of Willow Financial. An earn-out payment of $1.4
million related to the acquisition of the Cornerstone Companies for meeting
minimum operating results was earned and recorded as additional goodwill at
December 31, 2008. During the first six months of 2008, the Corporation recorded
purchase accounting adjustments related to the East Penn Financial acquisition
which increased the core deposit intangible by $940,000 and reduced goodwill by
$948,000. In addition, goodwill of $935,000 was written off due to the sale of
Carnegie Wealth Advisors LLC which had been acquired in the Willow Financial
merger. For further information related to goodwill and intangible assets, see
Note 2  Acquisitions / Dispositions.

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

Community
    
    WealthBanking
    
    Management
    
    Total(Dollars in thousands)Balance, January 1, 2007
    
    $
    31,552
    
    $
    12,404
    
    
    $
    43,956Net addition to
      goodwill from acquisitions
    
    
    64,874
    
    
    2,325
    
    
    
    67,199Balance, December 31, 2007
    
    
    96,426
    
    
    14,729
    
    
    
    111,155Net addition to
      goodwill from acquisitions
    
    
    125,955
    
    
    4,526
    
    
    
    130,481Goodwill written off due to sale of subsidiary
    
    
    
    
    
    (935
    )
    
    
    Balance, December 31,
      2008
    
    $
    222,381
    
    $
    18,320
    
    
    $
    240,701


The gross
carrying value and accumulated amortization related to core deposit intangibles
and other identifiable intangibles at December 31, 2008 and 2007 are presented
below:

December 31,2008
    
    2007Gross
    
    
    
    
    GrossCarrying
    
    Accumulated
    
    Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Amount
    
    Amortization(Dollars in
  thousands)Core deposit intangibles
    
    $
    23,256
    
    $
    2,692
    
    $
    8,351
    
    $
    1,061Other identifiable
      intangibles
    
    
    7,209
    
    
    1,524
    
    
    4,288
    
    
    927Total
    
    $
    30,465
    
    $
    4,216
    
    $
    12,639
    
    $
    1,988


76

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 8Goodwill and Other Intangibles
(Continued)

In 2008 and
2007, management performed its annual review of goodwill and other identifiable
intangibles in accordance with SFAS No. 142, Goodwill and Other Intangible
Assets and SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. Management performed its review by reporting unit and
determined that there was no impairment of goodwill and other identifiable
intangible assets as a part of this annual review. As part of the annual review
of goodwill, management also evaluated any additional circumstances that may
have required an impairment test subsequent to June 30, 2008 which also resulted
in no impairment charge.

The
amortization of core deposit intangibles allocated to the Community Banking
segment was $1.8 million, $328,000 and $246,000 for the years ended December 31,
2008, 2007 and 2006, respectively. Amortization of identifiable intangibles
related to the Wealth Management segment totaled $596,000, $479,000 and $448,000
for the years ended December 31, 2008, 2007 and 2006, respectively. The
Corporation estimates that aggregate amortization expense for core deposit and
other identifiable intangibles will be $4.1 million, $3.6 million, $3.0 million,
$2.5 million and $2.8 million for 2009, 2010, 2011, 2012 and 2013,
respectively.

Mortgage
servicing rights of $1.6 million and $2.7 million at December 31, 2008 and 2007,
respectively are included on the Corporations balance sheet in other intangible
assets and subsequently measured using the amortization method. The mortgage
servicing rights had a fair value of $1.6 million and $3.3 million at December
31, 2008 and 2007, respectively. In accordance with the provisions of SFAS
No.156, Amending Accounting for Separately Recognized Servicing Assets and
Liabilities and SFAS No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, the Corporation recorded
impairment charges of $1.4 million on its mortgage servicing rights in
intangibles expense on the consolidated statements of income for the year ended
December 31, 2008.

Note 9Deposits

Time
deposits with balances of $100,000 or more were $626.2 million and $483.7
million at December 31, 2008 and 2007, respectively. Deposits from directors and
executive officers of the Corporation were approximately $3.1 million and $2.9
million as of December 31, 2008 and 2007, respectively.

At December 31, 2008, scheduled
maturities of time deposits are as follows:

Amount(Dollars in
      thousands)2009
    $
    1,124,8992010
    
    327,3762011
    
    99,1882012
    
    31,7662013
    
    4,263Thereafter
    
    1,429Total
    $
    1,588,921


Deposit
overdraft balances reclassified to loans totaled $4.9 million and $1.5 million
at December 31, 2008 and 2007, respectively.

77

---

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, 2008 were
$110.0 million, of which $77.7 million was unused. The weighted average rate on
the outstanding balance at December 31, 2008 was 0.62%. Total federal funds
lines of credit with correspondent banks at December 31, 2007 were $195.0
million, all of which was 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, 2008, long- term securities sold under agreements to repurchase
with private entities were $237.0 million. The maturity dates range from 2011
through 2017, with call dates ranging from 2009 to 2012. The weighted average
interest rate was 3.44% as of December 31, 2008. The balance and weighted
average interest rate at December 31, 2008 include the purchase accounting
discount and amortization related to the Willow Financial acquisition.
Additionally, at December 31, 2008, the Corporation had $103.8 million of
short-term securities sold under agreements to repurchase primarily with
commercial customers. As of December 31, 2007, long- term securities sold under
agreements to repurchase with private entities were $105.0 million with a
weighted average interest rate of 4.71% and short-term securities sold under
agreements to repurchase were $101.5 million.

Federal Home Loan Bank Advances

Federal Home
Loan Bank (FHLB) advances at December 31, 2008 totaled $522.7 million, all of
which were long-term with a weighted average interest rate of 3.03%. 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%. The advances are
collateralized by unpledged levels of agency bonds, agency mortgage-backed
securities, 1-4 family first mortgage loans, FHLB stock and other real estate
related collateral net of varying market value haircuts based on the asset.
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 $574.7
million at December 31, 2008 and $363.1 million at December 31, 2007.

At December 31, 2008, scheduled
maturities of long-term borrowings with the FHLB are as follows:

WeightedBalance
    
    Average Rate
      (1)(Dollars in thousands)2009
    
    $
    58,230
    
    
    3.65
    %2010
    
    
    73,115
    
    
    2.98
    %2011
    
    
    87,090
    
    
    3.39
    %2012
    
    
    61,994
    
    
    3.28
    %2013
    
    
    91,289
    
    
    2.75
    %Thereafter
    
    
    150,953
    
    
    2.20
    %Total
    
    $
    522,671
    
    
    3.03
    %


|(1) |  | The FHLB borrowings balance and
      weighted average interest rate include purchase accounting fair value
      adjustments, net of related amortization from the Willow Financial
      acquisition.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

78

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 10Borrowings (Continued)

Trust Preferred Subordinated Debentures

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

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

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

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

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.

79

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 10Borrowings
(Continued)

The
following table is a summary of the subordinated debentures as of December 31,
2008 as originated by the Corporation and assumed from the acquisitions of
Willow Financial and East Penn Financial:

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

Note 11Income Taxes

Uncertain Tax Positions

The
Corporation adopted the provisions of FASB Interpretation 48, Accounting for
Uncertainty in Income Taxes (FIN 48) on January 1, 2007. Previously, the
Corporation had accounted for tax contingencies in accordance with SFAS No. 5,
Accounting for Contingencies. As required by FIN 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 FIN 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.

80

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 11Income Taxes (Continued)

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

(Dollars in thousands)Balance, January 1, 2007
    $
    175Additions based on tax positions related to prior
      years
    
    26Additions based on tax positions related to
      the current year
    
    48Balance, December 31, 2007
    
    249Statute of limitations expiration related to
      prior years
    
    (75
    )Additions based on tax positions related to the current
      year
    
    50Balance, December 31, 2008
    $
    224


The amount
of unrecognized tax benefits at December 31, 2008 and December 31, 2007,
included $224,000 and $249,000, respectively, 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 2005. 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 2009 through 2013.

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 on the
consolidated statements of income. Penalties are recorded in other expenses,
net, and interest paid or received is recorded in interest expense or interest
income, respectively, in the consolidated statements of income. Interest accrued
was $40,000, $43,000 and $17,000 as of December 31, 2008, December 31, 2007 and
January 1, 2007, respectively. No penalties have been accrued to
date.

The components of income tax expense
were as follows:

Year Ended December 31,2008
    
    2007
    
    2006(Dollars in
      thousands)Current income tax expense:Federal
    
    $
    8,473
    
    
    $
    15,943
    
    
    $
    13,221State
    
    
    155
    
    
    
    245
    
    
    
    162Total current income tax expense
    
    
    8,628
    
    
    
    16,188
    
    
    
    13,383Deferred income tax
    
    
    (3,553
    )
    
    
    (8,916
    )
    
    
    693Total income tax expense
    
    $
    5,075
    
    
    $
    7,272
    
    
    $
    14,076


The
effective income tax rates of 16.8% for 2008, 21.5% for 2007 and 26.3% for 2006
were less than the applicable federal income tax rate of 35% for each year. The
reasons for these differences are as follows:

Year Ended December 31,2008
    
    2007
    
    2006(Dollars in
      thousands)Expected income tax expense
    
    $
    10,707
    
    
    $
    12,102
    
    
    $
    18,779Tax-exempt income net of interest disallowance
    
    
    (5,925
    )
    
    
    (4,707
    )
    
    
    (4,740
    )Other
    
    
    293
    
    
    
    (123
    )
    
    
    37Actual income tax
      expense
    
    $
    5,075
    
    
    $
    7,272
    
    
    $
    14,076


81

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 11Income Taxes (Continued)

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

|                                                                 |  | 2008                         |        | 2007     
|---------------------------------------------------------------- |  | ---------------------------- | ------ | ---------
|                                                                 |  | Asset                        |        | Liability
|                                                                 |  | (Dollars in
      thousands)
|Allowance for loan losses                                        |  | $                            | 15,272 |          
|Bad debt
    recapture                                           |  |                              |       |          
|Specific reserves                                                |  |                              | 2,212  |          
|Lease assets                                                     |  |                              |       |          
|Deferred loan fees                                               |  |                              |       |          
|Deferred
      compensation                                      |  |                              | 3,365  |          
|Pension                                                          |  |                              | 162    |          
|Stock-based compensation
      expense                           |  |                              | 54     |          
|Mortgage servicing rights                                        |  |                              |       |          
|Depreciation                                                     |  |                              |       |          
|Unrealized loss on investment securities                         |  |                              | 15,623 |          
|Net unrealized gain on derivative used for
      cash flow hedge |  |                              | 2      |          
|Purchase accounting adjustments                                  |  |                              | 19,800 |          
|Deferred gain on
      sale-leaseback of bank properties         |  |                              | 5,760  |          
|Other                                                            |  |                              | 2,256  |          
|Total deferred
    taxes                                         |  | $                            | 64,506 |          

As a result
of the acquisitions of Willow Financial in 2008, the Corporation recorded a net
deferred tax asset of approximately $32.4 million. 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 Note 2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 were based on years of service
and the employees average compensation during any five consecutive years within
the ten-year period preceding retirement. On October 31, 2007, the Corporation
announced that it formally amended its pension plan to provide for its
termination. Employees ceased to accrue additional pension benefits as of
December 31, 2007, and pension benefits are not being provided under a successor
pension plan. All retirement benefits earned in the pension plan as of December
31, 2007 were preserved and all participants became fully vested in their
benefits upon plan termination. On July 3, 2008, the Corporation purchased
$896,000 of terminal funding annuity contracts for participants in pay status at
that time. During 2008, the majority of assets were distributed to those
participants that elected lump sum payments.

82

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 12Pension Plans (Continued)

The following
table summarizes the effect of the pension plan settlement which occurred in
2008:

Year EndedDecember 31, 2008Before
    
    Effect of
    
    AfterAssets and
      obligations:
    
    Settlement
    
    Settlement
    
    Settlement(Dollars in thousands)Vested
      benefit obligation
    
    $
    12,226
    
    
    $
    (11,831
    )
    
    $
    395Non-vested
      benefits
    
    
    
    
    
    
    
    
    
    
    Accumulated benefit obligation
    
    
    12,226
    
    
    
    (11,831
    )
    
    
    395Effect of future
      compensation levels
    
    
    
    
    
    
    
    
    
    
    Projected benefit obligation
    
    $
    12,226
    
    
    $
    (11,831
    )
    
    $
    395Plan
      assets at fair value
    
    $
    11,695
    
    
    $
    (11,624
    )
    
    $
    71Unrecognized net asset
      at transition
    
    
    (33
    )
    
    
    32
    
    
    
    (1
    )Unrecognized net loss (gain) subsequent to transition
    
    
    1,707
    
    
    
    (1,657
    )
    
    
    50Adjustment required to
      recognize minimum liability
    
    
    (1,674
    )
    
    
    1,625
    
    
    
    (49
    )(Prepaid)/accrued pension cost
    
    
    531
    
    
    
    (207
    )
    
    
    324


The
Corporation recorded a one-time pre-tax charge related to the pension plan
curtailment of approximately $1.9 million in 2007 as detailed in the following
table. The curtailment charge was recorded in other expenses in the consolidated
statements 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


83

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 12Pension Plans (Continued)

The plans funded status for the
years ended December 31, 2008 and 2007 is as follows:

2008
    
    2007(Dollars in
      thousands)Change in benefit obligation:Benefit obligation at
      beginning of year
    
    $
    11,874
    
    
    $
    11,586Service cost
    
    
    
    
    
    
    1,166Interest cost
    
    
    426
    
    
    
    683Actual (gain) loss
    
    
    (281
    )
    
    
    182Benefits paid
    
    
    (11,624
    )
    
    
    (1,433
    )Change in assumptions (plan curtailment)
    
    
    
    
    
    
    (310
    )Benefits obligation at end
      of year
    
    $
    395
    
    
    $
    11,874Change in plan assets:Fair value of plan assets
      at beginning of year
    
    $
    10,200
    
    
    $
    9,575Actual return on plan assets
    
    
    245
    
    
    
    808Employer
      contribution
    
    
    1,250
    
    
    
    1,250Benefits paid
    
    
    (11,624
    )
    
    
    (1,433
    )Fair value of plan assets
      at end of year
    
    $
    71
    
    
    $
    10,200Funded status at end of year
    
    $
    (324
    )
    
    $
    (1,674
    )


The
accumulated benefit obligation for the defined benefit pension plan was $395,000
and $11.9 million at December 31, 2008 and December 31, 2007, respectively.

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

Year
      EndedDecember 31,2008
    
    2007(Dollars in
      thousands)Projected benefit obligation
    
    $
    395
    
    $
    11,874Accumulated benefit
      obligation
    
    
    395
    
    
    11,874Fair
      value of plan assets
    
    
    71
    
    
    10,200


Year
      Ended**Weighted-average assumptions used to
      determine**
    
    
    December 31,pension plan obligations as of December
      31,
    
    
    2008
    
    2007
    
    2006Discount rate
    
    4.75
    %
    
    4.75
    %
    
    6.00
    %Rate of compensation
      increase
    
    0.00
    %
    
    0.00
    %
    
    4.00
    %


Year EndedWeighted-average assumptions used to
      determine
    
    December
    31,**Pension plan net
      periodic benefit cost as of December 31,**
    
    
    2008
    
    2007
    
    2006Discount rate
    
    4.75
    %
    
    6.00
    %
    
    6.00
    %Expected
      return on plan assets
    
    4.75
    %
    
    6.00
    %
    
    6.00
    %Rate of compensation increase
    
    0.00
    %
    
    4.00
    %
    
    4.00
    %


84

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 12Pension Plans (Continued)

Year
      EndedDecember 31,Components of
      net periodic benefit expense
    
    2008
    
    2007
    
    2006(Dollars in
      thousands)Service cost
    
    **$**
    
    
    
    $
    1,166
    
    
    $
    1,041Interest cost
    
    
    426
    
    
    
    683
    
    
    
    654Expected return on plan assets
    
    
    (349
    )
    
    
    (600
    )
    
    
    (551
    )Amortization of
      unrecognized net actuarial losses
    
    
    41
    
    
    
    76
    
    
    
    118Net periodic benefit
      expense
    
    $
    118
    
    
    $
    1,325
    
    
    $
    1,262


The pension
plan assets were previously 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. In 2007, the pension plan equity reduction
strategy was implemented along with a re-allocation of fixed income securities
and cash equivalents in preparation for the third quarter 2008 final
distribution to participants. The reduction in equities began in late August
2007 and accelerated with sales in September 2007. At December 31, 2008, any
remaining undistributed funds have been allocated to cash and cash equivalents.

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 was re-allocated with maturity considerations for final benefits to be
paid in 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.

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

Percentage
      ofPlan Assets
      atDecember 31,2008
    
    2007Asset
      CategoryEquity
securities
    
    
    **%**
    
    
    %Debt
      securities
    
    
    **%**
    
    33.4
    %Cash and cash
      equivalents
    
    100.0
    %
    
    66.6
    %Total
    
    100.0
    %
    
    100.0
    %


In March
2009, the Corporation will process a final contribution of $371,000 to the
pension plan, which together with the remaining plan assets, will be utilized to
purchase $435,000 in terminal funding annuity contracts for any remaining
participants entering pay status. At December 31, 2008, the contribution is
accrued in other liabilities on the consolidated balance sheets.

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 for
10 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, 2008 and 2007 was $5.1 million and $5.4
million, respectively.

85

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 12Pension Plans
(Continued)

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, 2008 and 2007 was $594,000 and $593,000, respectively.

In
connection with the acquisition of Willow Financial in 2008, the Corporation
assumed obligations under the Willow Financial Supplemental Executive Retirement
Plan covering seven executives. Upon the effective date of the Willow Financial
acquisition, each individuals interest in the plan became fully vested. The
accrued obligation as of December 31, 2008 was $724,000, of which $416,000 will
be paid in the first quarter of 2009 to individuals electing a lump-sum payment.
The remaining balance is for one executive who elected to receive five annual
payments commencing in February 2009. As a result of the Willow Financial
acquisition, the Corporation also assumed the Willow Financial Directors
Retirement Plan (Directors Plan) and the Willow Financial Presidents
Supplemental Retirement Agreement (Presidents Plan). The Directors Plan
provides for a fixed monthly payment for a 10-year period beginning in June 2009
to the participating former Willow Financial directors. The Presidents Plan for
a former President provides for a fixed monthly payment through February 2016.
The accrued liabilities of the Directors Plan and Presidents Plan were
$944,000 and $582,000, respectively at December 31, 2008.

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. Prior to
January 1, 2008, the Corporation matched 50% of pre-tax employee contributions
up to a maximum of 3%. Effective January 1, 2008, in addition to the company
match up to a maximum of 3%, all eligible employees began receiving a company
funded basic contribution to the 401(k) plan equal to 2% of eligible earnings.
For 2008, the company funded 401(k) match contribution was $931,000 and the
basic company funded 401(k) contribution was $822,000 for a total of $1.8
million in contributions charged to earnings. Contributions charged to earnings
for 2007 and 2006 were $742,000 and $628,000, respectively.

Willow Financial Bank Employee Stock
Ownership Plan

In
connection with the acquisition of Willow Financial on December 5, 2008, the
Corporation assumed the Willow Financial Bank 401(k)/ Employee Stock Ownership
Plan (ESOP). As of December 5, 2008, the 401(k)/ESOP was frozen with termination
and final distributions pending approval by the appropriate regulatory
authorities. No additional contributions to the plan will be accepted, but loan
repayments by participants are permitted. At December 5, 2008, the ESOP portion
of the plan had two outstanding loans with a total principal balance of $4.2
million due to Willow Financial Bancorp, Inc. The shares originally purchased
with the loan funds were held in a suspense account for allocation among the
participants as the loans are repaid. Shares released from the loan collateral
were in an amount proportional to repayment of the original ESOP loans. At
December 31, 2008, there were 324,113 unallocated ESOP shares remaining to be
utilized to pay down the remaining loan principal balance, representing a fair
value of $4.7 million. Upon repayment of the loans, any remaining shares will be
allocated to the participants.

86

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

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, 2008, 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. All prior period amounts in
the consolidated financial statements and footnotes have been restated to
reflect these stock dividends.

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, 2008,
2,663,395stock options had been granted under the stock option plans. The options
have a term of ten years when issued and typically vest over a five-year period.
The options granted during 2008 have a term of three years and vest over seven
years. The exercise price of each option is the market price of the
Corporations stock on the date of grant. Additionally, at December 31, 2008,
the Corporation had 556,506 assumed stock options from the Willow Financial
acquisition completed in 2008. The options have a term of ten years and are
exercisable at prices ranging from $5.19 to $22.34. Also, at December 31, 2008,
the Corporation had 25,480 assumed stock options from the East Penn Financial
acquisition completed in 2007. The options have a term of ten years and are
exercisable at prices ranging from $5.94 to $13.07.

The
Corporation recognizes compensation expense for stock options in accordance with
SFAS 123 (revised 2004), Share-Based Payment (SFAS 123(R)) adopted at January
1, 2006 under the modified prospective application method of transition. Prior
to January 1, 2006, the Corporation followed SFAS 123 and APB 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. 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. Grants
subject to a service condition were awarded in 2008 and 2006 while grants
subject to a market condition were awarded in 2007. 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.The fair value of options granted with a service condition
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 2008 and 2006, respectively: weighted-average dividend yield of 5.74%
and 3.52%; weighted-average expected volatility of 44.31% and 32.19%, weighted
average risk-free interest rate of 2.40% and 4.64% (4.42% to 5.08%) and a
weighted-average expected life of 6.20 and 7.28 years.

87

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 14Stock-Based Compensation
(Continued)

For grants subject to a market
condition that were awarded in 2007, the Corporation utilized a Monte Carlo
simulation to estimate the fair value and determine the derived service period.
Compensation is recognized over the derived service period with any unrecognized
compensation cost immediately recognized when the market condition is met. These
awards vest when the Corporations common stock reaches targeted average trading
prices for 30 days within five years from the grant date. Vesting cannot
commence before six months from the grant date. The term and exercise price of
the options are the same as previously mentioned. The fair value and derived
service period (the median period in which the market condition is met) were
determined using a Monte Carlo simulation 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).

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

In
accordance with SFAS 123(R), stock based compensation expense is based on awards
that are ultimately expected to vest and therefore has been reduced for
estimated forfeitures. The Corporation estimates forfeitures using historical
data based upon the groups identified by management. Stock-based compensation
expense was $136,000, $118,000 and $440,000 for 2008, 2007, and 2006,
respectively.

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 Willow
Financial in 2008, the Corporation assumed all obligations under the Willow
Financial 1999 and 2002 Stock Option Plans, as well as obligations that remained
open under the Willow Grove Bank and Chester Valley Bank stock option plans at
the effective time of the merger. The Plans provided options grants to
non-employee directors, as well as employees. The change in control accelerated
the vesting of all outstanding stock options to 100%. 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. In connection with the acquisition of
Millennium Bank in 2004, the Corporation assumed all obligations under the
Millennium Bank Stock Compensation Program. 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 2008, no
stock options were granted under the plan. At December 31, 2008, there were
258,564 stock options outstanding under the plan. The plan expired on October 8,
2008; therefore, no further stock options may be awarded 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 23,548 were assumed on the effective date of the merger.
A total of 21,025 stock options remained outstanding under the plan at December
31, 2008. 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, 2008, there were 7,855 stock options outstanding
under the plan.

88

---

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. No stock options were granted during 2008. The plan expired on October 8,
2008; therefore, no future stock options may be awarded under the plan. At
December 31, 2008, there were 561,377 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 2008, there were 210,082 stock options
granted under the plan. As of December, 31, 2008, stock options of 910,468
remained available for grant. At December 31, 2008, there were 247,157 stock
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 proration 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 2005, 36,209
non-qualified performance based stock options were cancelled. No stock option
awards remain outstanding and exercisable under the program at December 31,
2008. 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 proration
parameters outlined in the merger agreement. Stock options totaling 1,932 were
assumed on the effective date of the merger. A total of 1,092 stock options
remained outstanding under the plan at December 31, 2008. No further stock
options may be granted under the plan.

Willow
Financial Bancorp Stock Incentive Plans:In
connection with the acquisition of Willow Financial Bancorp in 2008, the
Corporation assumed all obligations under Willows 1999 and 2002 Stock Option
Plans, as well as obligations that remained open under the Willow Grove Bank and
Chester Valley Bank stock option plans at the effective time of the merger. The
Plans provided stock options grants to non-employee directors, as well as
employees. The change in control accelerated the vesting of all outstanding
stock options to 100%. Upon consummation of the merger, 556,506 stock options
were converted according to proration parameters outlined in the merger
agreement. At December 31, 2008, a total of 551,653 stock options remained
outstanding and exercisable under the plan. No further stock options may be
granted under the plans.

89

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 14Stock-Based Compensation
(Continued)

A summary of
option activity under the Corporations stock option plans as of December 31,
2008 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.

**Options**

|                                                               |           |   |       |           |            |             | Weighted-      |                 |   |      
|-------------------------------------------------------------- | --------- | - | ----- | --------- | ---------- | ----------- | -------------- | --------------- | - | -----
|                                                               |           |   |       |           |            |             | Average        |                 |   |      
|                                                               |           |   |       | Weighted- |            | Remaining   |                |                 |  
|                                                               |           |   |       | Average   |            | Contractual |                | Aggregate      
|                                                               |           |   |       | Exercise  |            | Term        |                | Intrinsic Value
|                                                               | Shares    |   | Price |           | (in years) |             | (in thousands)
|Outstanding at January 1, 2008                                 | 1,113,499 |   |       | $         | 15.74      |             |                |                 |   |      
|Granted                                                        | 210,082   |   |       |           | 14.06      |             |                |                 |   |      
|Options assumed from Willow Financial acquisition (see note 2) | 556,506   |   |       |           | 14.17      |             |                |                 |   |      
|Exercised                                                      | (161,163  | ) |       |           | 9.41       |             |                |                 |   |      
|Forfeited (unvested)                                           | (25,574   | ) |       |           | 21.66      |             |                |                 |   |      
|Cancelled
      (vested)                                       | (44,627   | ) |       |           | 24.72      |             |                |                 |   |      
|Outstanding at December 31, 2008                               | 1,648,723 |   |       | $         | 15.28      |             | 3.94           |                 | $ | 3,204
|                                                              
|Exercisable at December 31, 2008                               | 1,385,057 |   |       | $         | 15.36      |             | 3.34           |                 | $ | 3,125

The
weighted-average grant-date fair value of options granted during the years ended
December 31, 2008, 2007 and 2006 were $3.54, $3.73 and $5.23, respectively. The
total intrinsic value of options exercised during the years ended December 31,
2008, 2007 and 2006 were $890,000, $514,000 and $4.6 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, 2008 is as follows:

Weighted-Average**Nonvested
      Shares**
    Shares
    
    Grant-Date Fair ValueNonvested at January 1, 2008
    108,736
    
    
    $
    5.37Granted
    210,082
    
    
    
    3.54Share obligations assumed fromWillow Financial acquisition
    556,506
    
    
    
    3.59Vested
    (586,086
    )
    
    
    3.73Forfeited
    (25,574
    )
    
    
    6.00Nonvested at December 31, 2008
    263,664
    
    
    $
    3.74


90

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 14Stock-Based Compensation
(Continued)

As of
December 31, 2008, there was a total of $857,000 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 2.8 years. The total fair
value of shares vested during the years ended December 31, 2008, 2007 and 2006
were $2.2 million (includes $2.0 million from Willow Financial acquisition),
$356,000 and $360,000, respectively. The tax benefit realized for the tax
deductions from option exercises totaled $305,000, $119,000 and $1.3 million for
2008, 2007, and 2006, respectively.

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 129 shares during 2008. As of
December 31, 2008, a total of 22,695 shares remained available for awards under
the plan.

Note 15Earnings Per Share

The
calculations of basic 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 31,2008
    
    2007
    
    2006(Dollars in thousands, exceptper share information)Basic earnings per shareNet income
      available to common shareholders
    $
    25,093
    
    $
    26,595
    
    $
    39,415Weighted average common shares outstanding
    
    32,201,150
    
    
    29,218,671
    
    
    28,946,847Basic earnings
      per share
    $
    0.78
    
    $
    0.91
    
    $
    1.36Diluted earnings per shareNet income
      available to common shareholdersand assumed conversions
    $
    25,093
    
    $
    26,595
    
    $
    39,415Weighted average common shares outstanding
    
    32,201,150
    
    
    29,218,671
    
    
    28,946,847Dilutive
      potential common shares(1),(2)
    
    162,987
    
    
    241,227
    
    
    406,281Total diluted weighted average common sharesoutstanding
    
    32,364,137
    
    
    29,459,898
    
    
    29,353,128Diluted earnings
      per share
    $
    0.78
    
    $
    0.90
    
    $
    1.34


|(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 2008, 2007, and 2006, there were 1,037,645,
      475,952 and 416,353 antidilutive options at an average price of $18.79,
      $23.44 and $24.50 per share, respectively.

91

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

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

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

|                                                                      |                        |            |           |           | Tax    |            |   |  |  
|--------------------------------------------------------------------- | ---------------------- | ---------- | --------- | --------- | ------ | ---------- | - |  | -
|                                                                      | Before                 |            | Benefit   |           | Net of
|For the year ended December 31,
      2008                            |                        | tax amount |           | (Expense) |        | tax amount
|                                                                      | (Dollars in thousands)
|Net unrealized losses on available for sale
      securities:         |                        |            |           |           |        |            |   |  |  
|Net unrealized holding losses arising during
      period             | $                      | (40,146    | )         |           | $      | 14,051     |   |  | $
|Less
      reclassification adjustment for net gains on sales of      |                        |            |           |           |        |            |   |  |  
|available for sale securities realized in net
      income            |                        | 2,642      |           |           |        | (925       | ) |  |  
|Less reclassification adjustment for
      other-than-temporary       |                        |            |           |           |        |            |   |  |  
|impairment of available for sale securities recognized
      in net   |                        |            |           |           |        |            |   |  |  
|income                                                                |                        | (1,923     | )         |           |        | 673        |   |  |  
|Net unrealized
      losses                                           |                        | (40,865    | )         |           |        | 14,303     |   |  |  
|Change in fair value of derivatives used for cash flow
      hedges   |                        | 171        |           |           |        | (60        | ) |  |  
|Other
      comprehensive loss, net                                   | $                      | (40,694    | )         |           | $      | 14,243     |   |  | $
|                                                                     
|                                                                     
|                                                                      |                        |            |           |           | Tax    |            |   |  |  
|                                                                      | Before                 |            | (Expense) |           | Net of
|For the year ended December 31,
      2007                            |                        | tax amount |           | Benefit   |        | tax amount
|                                                                      | (Dollars in thousands)
|Net unrealized gains on available for sale
      securities:          |                        |            |           |           |        |            |   |  |  
|Net unrealized holding gains arising during
      period              | $                      | 4,856      |           |           | $      | (1,700     | ) |  | $
|Less
      reclassification adjustment for net gains realized in net  |                        |            |           |           |        |            |   |  |  
|income                                                                |                        | 1,187      |           |           |        | (415       | ) |  |  
|Less reclassification adjustment for
      other-than-temporary       |                        |            |           |           |        |            |   |  |  
|impairment of available for sale securities recognized
      in net   |                        |            |           |           |        |            |   |  |  
|income                                                                |                        | (55        | )         |           |        | 19         |   |  |  
|Net unrealized
      gains                                            |                        | 3,724      |           |           |        | (1,304     | ) |  |  
|Change in fair value of derivatives used for cash flow
      hedges   |                        | (643       | )         |           |        | 225        |   |  |  
|Reversal of FAS 158 adjustment due to defined benefit
      pension   |                        |            |           |           |        |            |   |  |  
|plan
      curtailment                                                |                        | 2,361      |           |           |        | (826       | ) |  |  
|Other comprehensive income, net                                       | $                      | 5,442      |           |           | $      | (1,905     | ) |  | $
|                                                                     
|                                                                     
|                                                                      |                        |            |           |           | Tax    |            |   |  |  
|                                                                      | Before                 |            | (Expense) |           | Net of
|For the year ended December 31,
      2006                            |                        | tax amount |           | Benefit   |        | tax amount
|                                                                      | (Dollars in thousands)
|Net unrealized gains on available for sale
      securities:          |                        |            |           |           |        |            |   |  |  
|Net unrealized holding gains arising during
      period              | $                      | 5,548      |           |           | $      | (1,942     | ) |  | $
|Less
      reclassification adjustment for net losses realized in net |                        |            |           |           |        |            |   |  |  
|income                                                                |                        | (674       | )         |           |        | 236        |   |  |  
|Net unrealized gains                                                  |                        | 6,222      |           |           |        | (2,178     | ) |  |  
|Change in fair
      value of derivatives used for cash flow hedges   |                        | (141       | )         |           |        | 49         |   |  |  
|Amortization of unrealized loss on termination of cash
      flow     |                        |            |           |           |        |            |   |  |  
|hedge                                                                 |                        | 151        |           |           |        | (53        | ) |  |  
|Other
      comprehensive income, net                                 | $                      | 6,232      |           |           | $      | (2,182     | ) |  | $

92

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES

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

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

|                              | **Net Unrealized** |         | **Net
      Change in** |  |                    |      |                           |  |                         |     |                   |  | Transition |        |  
|----------------------------- | ------------------ | ------- | ----------------------- |  | ------------------ | ---- | ------------------------- |  | ----------------------- | --- | ----------------- |  | ---------- | ------ | -
|                              | (Losses) Gains     |         | **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**        |     | **(Loss) Income**
|Balance, December 31, 2005    | $                  | (8,916  | )                       |  | $                  | 396  |                           |  | $                       | (98 | )                 |  | $          |       |  
|Net Change                    |                    | 4,044   |                         |  |                    | (92  | )                         |  |                         | 98  |                   |  |            | (1,579 | )
|Balance, December 31, 2006(1) |                    | (4,872  | )                       |  |                    | 304  |                           |  |                         |    |                   |  |            | (1,579 | )
|Net Change                    |                    | 2,420   |                         |  |                    | (418 | )                         |  |                         |    |                   |  |            | 1,579  |  
|Balance, December 31, 2007    |                    | (2,452  | )                       |  |                    | (114 | )                         |  |                         |    |                   |  |            |       |  
|Net Change                    |                    | (26,562 | )                       |  |                    | 111  |                           |  |                         |    |                   |  |            |       |  
|Balance, December 31, 2008    | $                  | (29,014 | )                       |  | $                  | (3   | )                         |  | $                       |    |                   |  | $          |       |  

|(1) |  | At December 31, 2006,
      the Corporation adopted SFAS No. 158, Employers Accounting for Defined
      Benefit Pension and Other Postretirement Plans and recognized as an
      adjustment to the December 31, 2006 balance of accumulated other
      comprehensive income, 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.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 (SFAS 131) 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; employee benefits services; and the Cornerstone Companies,
registered investment advisors for high net worth, privately held business
owners, wealthy families and institutional clients. Major revenue component
sources include investment management and advisory fees, trust fees, estate and
tax planning fees, brokerage fees, and insurance related fees. Expenses
primarily consist of personnel and support 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.

93

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 17Segment Information (Continued)

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

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

|                                                  | Community              |           |                   |   |           |  |                     |        |   |  |  
|------------------------------------------------- | ---------------------- | --------- | ----------------- | - | --------- |  | ------------------- | ------ | - |  | -
|                                                  | Banking                |           | Wealth Management |   | All Other |  | Consolidated Totals
|                                                  | (Dollars in thousands)
|Year Ended December 31, 2008                      |                        |           |                   |   |           |  |                     |        |   |  |  
|Net interest
      income (expense)               | $                      | 109,030   |                   | $ | 280       |  | $                   | (5,170 | ) |  | $
|Provision for loan losses                         |                        | 15,567    |                   |   |          |  |                     |       |   |  |  
|Noninterest
      income                          |                        | 27,175    |                   |   | 18,689    |  |                     | 353    |   |  |  
|Noninterest expense                               |                        | 86,852    |                   |   | 16,869    |  |                     | 901    |   |  |  
|Income (loss)
      before income taxes (benefit) |                        | 33,786    |                   |   | 2,100     |  |                     | (5,718 | ) |  |  
|Income taxes (benefit)                            |                        | 6,138     |                   |   | 833       |  |                     | (1,896 | ) |  |  
|Net income
      (loss)                           | $                      | 27,648    |                   | $ | 1,267     |  | $                   | (3,822 | ) |  | $
|Assets                                            | $                      | 5,447,646 |                   | $ | 30,437    |  | $                   | 12,426 |   |  | $
|                                                 
|                                                 
|                                                  | Community              |           |                   |   |           |  |                     |        |   |  |  
|                                                  | Banking                |           | Wealth Management |   | All Other |  | Consolidated Totals
|                                                  | (Dollars in thousands)
|Year Ended December 31, 2007                      |                        |           |                   |   |           |  |                     |        |   |  |  
|Net interest
      income (expense)               | $                      | 84,563    |                   | $ | 451       |  | $                   | (2,580 | ) |  | $
|Provision for loan losses                         |                        | 10,550    |                   |   |          |  |                     |       |   |  |  
|Noninterest
      income                          |                        | 23,947    |                   |   | 18,658    |  |                     | 733    |   |  |  
|Noninterest expense                               |                        | 64,751    |                   |   | 15,744    |  |                     | 860    |   |  |  
|Income (loss)
      before income taxes (benefit) |                        | 33,209    |                   |   | 3,365     |  |                     | (2,707 | ) |  |  
|Income taxes (benefit)                            |                        | 6,917     |                   |   | 1,502     |  |                     | (1,147 | ) |  |  
|Net income
      (loss)                           | $                      | 26,292    |                   | $ | 1,863     |  | $                   | (1,560 | ) |  | $
|Assets                                            | $                      | 3,862,378 |                   | $ | 25,572    |  | $                   | 15,051 |   |  | $
|                                                 
|                                                 
|                                                  | Community              |           |                   |   |           |  |                     |        |   |  |  
|                                                  | Banking                |           | Wealth Management |   | All Other |  | Consolidated Totals
|                                                  | (Dollars in thousands)
|**Year Ended December 31, 2006**                  |                       
|Net interest
      income (expense)               | $                      | 84,775    |                   | $ | 470       |  | $                   | (2,072 | ) |  | $
|Provision for loan losses                         |                        | 4,200     |                   |   |          |  |                     |       |   |  |  
|Noninterest
      income                          |                        | 29,735    |                   |   | 14,878    |  |                     | 735    |   |  |  
|Noninterest expense                               |                        | 56,049    |                   |   | 13,553    |  |                     | 1,228  |   |  |  
|Income (loss)
      before income taxes (benefit) |                        | 54,261    |                   |   | 1,795     |  |                     | (2,565 | ) |  |  
|Income taxes (benefit)                            |                        | 14,475    |                   |   | 717       |  |                     | (1,116 | ) |  |  
|Net income
      (loss)                           | $                      | 39,786    |                   | $ | 1,078     |  | $                   | (1,449 | ) |  | $
|Assets                                            | $                      | 3,195,051 |                   | $ | 19,475    |  | $                   | 35,302 |   |  | $

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.

94

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 18Lease Commitments and
Contingent Liabilities

Lease Commitments

Lease
commitments for equipment and banking locations expire intermittently over the
years through 2037. As a part of the acquisition of Willow Financial, the
Corporation assumed 28 additional leases with intermittent expirations through
2027. 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, 2008, the
remaining term of these leases was fourteen years with options to renew for up
to forty additional years.Approximate minimum
rental commitments for non-cancelable operating leases at December 31, 2008, are
as follows:

Minimum LeasePayments(Dollars in thousands)For the year ending:2009
    $
    9,2142010
    
    8,6552011
    
    8,3532012
    
    7,7142013
    
    7,548Thereafter
    
    83,073Total
    $
    124,557


Total rent
expense amounted to $5.6 million, $3.2 million and $2.4 million for the years
ended December 31, 2008, 2007 and 2006, respectively.

Other

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

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. Except as noted above, 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.

95

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

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                                                     |                       

Standby
letters of credit expire as follows: $32.3 million in one year or less, $2.5
million after one year through three years, $69,000 after three years through
five years and $0 after five years.

96

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

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

During 2008,
the Corporation had cash flow hedges with notional amounts totaling $45.0
million which matured. These swaps had the effect of converting rates on money
market deposit accounts to a fixed-rate cost of funds. This strategy was
undertaken to allow the Bank to recognize, in a rising rate environment, a
larger interest rate spread than it otherwise would have without the swaps in
effect. In addition, two cash flow hedges with a notional amount of $10.0
million that had the effect of converting variable debt to a fixed rate matured
during 2008. For both of these types of swaps, the Corporation recognized net
interest expense of 192,000 for the year ended December 31, 2008 and net
interest income of $287,000 and $442,000 for the years ended December 31, 2007,
and 2006, respectively. During the first quarter of 2005, the Corporation
terminated a cash flow hedge with a notional value of $25.0 million. The gross
loss related to the termination of this swap was $310,000 which was amortized
through October 2006 in accordance with SFAS No. 133 Accounting for Derivative
Instruments and Hedging Activities. For the year ended December 31, 2006, the
Corporation amortized $151,000 into net interest income related to this swap.
Periodically, the Corporation may enter into fair value hedges to limit the
exposure tochanges in the fair value of loan assets. At December 31,
2008, the Corporation had a fair value hedge in the form of an interest rate
swap with a notional amount of $1.9 million which matures in 2017. In addition,
four fair value hedges with notional amounts totaling $7.5 million were acquired
from Willow Financial with maturity dates ranging from 2013 to 2016. These swaps
do not qualify for hedge accounting treatment and thus all changes in the fair
value of the derivatives is recorded in the consolidated statements of income.
As such, based on the decrease in the market value of these interest rate swaps
during 2008, the Corporation recognized a loss of $183,000 in other expense in
the consolidated statement of operations. During 2008, the Corporation
terminated a fair value hedge in the form of an interest rate swap with a
notional amount of $2.0 million. For fair value hedges, the Corporation
recognized net interest expense of $81,000 for the year ended December 31, 2008
and net interest income of $59,000 and $7,000 for the years ended December 31,
2007 and 2006, respectively. At December 31, 2008, the Corporation had swap
agreements with a negative fair value of $1.1 million. At December 31, 2007, the
Corporation had swap agreements with a positive fair value of $10,000 and with a
negative fair value of $366,000. There was no hedge ineffectiveness recognized
during 2008, 2007 and 2006.

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
$16,000 and $8,000 for the year ended December 31, 2008 and 2007, respectively.
At December 31, 2008, these caps, designated as cash flow hedges, had a positive
fair value of $0. At December 31, 2007, these caps had a positive fair value of
$222. The caps mature in March 2009. Due to notional mismatch, $43,000 was
recognized in other expense during the year ended December 31, 2008. During
2007, the Corporation accelerated the reclassification of an immaterial amount
in other comprehensive income to earnings as a result of variable-rate interest
payments becoming probable not to occur. The accelerated amount was a loss of
$7,000 recognized in interest expense.

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

The Bank
also had commitments with customers to extend mortgage loans at a specified rate
at December 31, 2008 and December 31, 2007 of $36.4 million and $3.4 million,
respectively and commitments to sell mortgage loans at a specified rate at
December 31, 2008 and December 31, 2007 of $53.1 million and $2.4 million,
respectively. The commitments are accounted for as a derivative and recorded at
fair value. The Bank estimates the fair value of these commitments by comparing
the secondary market price at the reporting date to the price specified in the
contract to extend or sell the loan initiated at the time of the loan
commitment. At December 31, 2008, the Corporation had commitments with a
positive fair value of $274,000 and negative fair value of $48,000 which was
recorded as other income. 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.

97

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

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

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. The Banks total recourse
exposure at December 31, 2008 was $26,000. 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, 2008 was $187,000. At December 31, 2008 and December 31, 2007, the Bank had
$1,000 and $17,000, respectively, on the balance sheet as a recourse liability.

Note 20Regulatory Capital

|                                               |                        |                        |                   |       |                  |        |             |         |            |        |   |       | To
      Be Well
|---------------------------------------------- | ---------------------- | ---------------------- | ----------------- | ----- | ---------------- | ------ | ----------- | ------- | ---------- | ------ | - | ----- | ----------------
|                                               |                        |                        |                   |       |                  |        |             |         |            |        |   |       | Capitalized     
|                                               |                        |                        |                   |       |                  |        |             |         |            |        |   |       | Under Prompt    
|                                               |                        |                        |                   |       |                  |        | For Capital |         | Corrective
|                                               | Actual                 |                        | Adequacy Purposes |       | Action Provision
|As of December 31, 2008                        |                        | Amount                 |                   | Ratio |                  | Amount |             | Ratio   |            | Amount |   | Ratio
|                                               |                        | (Dollars in thousands)
|Total Capital (to risk weighted
      assets): |                        |                        |                   |       |                  |        |             |         |            |        |   |       |                 
|Corporation                                    | $                      | 384,522                |                   | 8.88  | %                |        | $           | 346,333 |            | 8.00   | % |       | $               
|Harleysville National Bank                     |                        | 370,552                |                   | 8.58  | %                |        |             | 345,536 |            | 8.00   | % |       |                 
|Tier 1 Capital (to risk weighted assets):      |                        |                        |                   |       |                  |        |             |         |            |        |   |       |                 
|Corporation                                    |                        | 334,467                |                   | 7.73  | %                |        |             | 173,167 |            | 4.00   | % |       |                 
|Harleysville National Bank                     |                        | 320,497                |                   | 7.42  | %                |        |             | 172,768 |            | 4.00   | % |       |                 
|Tier 1 Capital (to average assets):            |                        |                        |                   |       |                  |        |             |         |            |        |   |       |                 
|Corporation                                    |                        | 334,467                |                   | 8.19  | %                |        |             | 163,315 |            | 4.00   | % |       |                 
|Harleysville National Bank                     |                        | 320,497                |                   | 7.88  | %                |        |             | 162,689 |            | 4.00   | % |       |                 
|                                              
|                                              
|                                               |                        |                        |                   |       |                  |        |             |         |            |        |   |       | 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   | % |       |                 

98

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 20Regulatory Capital (Continued)

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,
2008, 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.

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 2009 of approximately $8.3
million plus an amount equal to the net profits of the Bank in 2009 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, 2008, the Banks investments in the Cornerstone Companies and
BeneServ, Inc. (financial subsidiaries) of $27.5 million were in compliance with
the limitations and not subject to collateral requirements.

Note 21Fair Value
Measurements

Effective
January 1, 2008, the Corporation adopted SFAS No. 157, Fair Value Measurements
(SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring
fair value, and expands disclosure about fair value. SFAS 157 defines fair value
as the price that would be received to sell an asset or paid to transfer a
liability (an exit price) in an orderly transaction between market participants
on the measurement date. SFAS 157 also establishes a fair value hierarchy which
requires an entity to maximize the use of observable inputs and minimize the use
of unobservable inputs when measuring fair value. The standard describes three
levels of inputs that may be used to measure fair value. A financial
instruments level within the fair value hierarchy is based on the lowest level
of input significant to the fair value measurement. There have been no material
changes in valuation techniques as a result of the adoption of SFAS No. 157.

Level 1 -
Quoted prices (unadjusted) in active markets for identical assets or liabilities
that the Corporation has the ability to access at the measurement date.

Level 2 -
Observable inputs other than Level 1 prices, such as quoted prices for similar
assets or liabilities in active markets; quoted prices in markets that are not
active for identical or similar assets or liabilities; or other inputs that are
observable or can be corroborated by observable market data for substantially
the full term of the assets or liabilities.

99

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 21Fair Value Measurements
(Continued)

Level 3 -
Unobservable inputs that are supported by little or no market activity and
significant to the fair value of the assets or liabilities that are developed
using the reporting entities estimates and assumptions, which reflect those
that market participants would use.

Assets and Liabilities Measured at Fair
Value on a Recurring Basis

A
description of the valuation methodologies used for financial instruments
measured at fair value on a recurring basis, as well as the classification of
the instruments pursuant to the valuation hierarchy, are as follows:

Securities Available for Sale

Securities
classified as available for sale are reported using Level 1, Level 2 and Level 3
inputs. Level 1 instruments generally include equity securities valued based on
quoted market prices in active markets. Level 2 instruments include U.S.
government agency obligations, state and municipal bonds, mortgage-backed
securities, collateralized mortgage obligations and corporate bonds. For these
securities, the Corporation obtains fair value measurements from an independent
pricing service. The fair value measurements consider observable data that may
include dealer quotes, market spreads, cash flows, the U.S. Treasury yield
curve, live trading levels, trade execution data, market consensus prepayment
speeds, credit information and the bond's terms and conditions, among other
things. During the fourth quarter of 2008, certain collateralized debt
obligation investments in pooled trust preferred securities were transferred
from Level 2 into Level 3. The Corporation obtained a third party cash flow
analysis to determine the projected level of uncollected principal and the
resulting fair value. The cash flow analysis included market information such as
instrument performance and relevant corporate data associated with certain
issuers included within the pooled trust. The Federal Home Loan Bank stock,
Federal Reserve Bank stock and other investments which were classified as Level
3 securities available for sale in the Corporations previously issued financial
statements were reclassified to a separate line item on the Corporations
consolidated balance sheets as of December 31, 2007 since they do not have
readily determinable fair values for purposes of SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities. These investment securities
are carried at cost and periodically evaluated for impairment. This presentation
change is considered to be immaterial.

Residential Mortgage Loans Held for
Sale

Residential
mortgage loans originated and intended for sale in the secondary market are
carried at estimated fair value. The Corporation estimates the fair value of
mortgage loans held for sale using current secondary loan market rates. The
Corporation has determined that the inputs used to value its mortgage loans held
for sale fall within Level 2 of the fair value hierarchy. The Corporation
elected to apply the provisions of SFAS 159 in December 2008 as a result of the
portfolio of loans held for sale acquired from Willow Financial. This election
resulted in a fair value adjustment of $215,000 recorded in other income on the
consolidated statements of income in the fourth quarter of 2008. Prior to the
fourth quarter of 2008, residential mortgage loans held for sale were carried at
lower of cost or market.

Derivative Financial
Instruments

Currently,
the Corporation uses cash flow hedges, fair value hedges and interest rate caps
to manage its interest raterisk. The valuation of these instruments is determined using
widely accepted valuation techniques including discounted cash flow analysis on
the expected cash flows of each derivative. This analysis reflects the
contractual terms of the derivatives, including the period to maturity, and uses
observable market-based inputs, including interest rate curves, foreign exchange
rates, and implied volatilities. The fair values of interest rate swaps are
determined using the market standard methodology of netting the discounted
future fixed cash receipts (or payments) and the discounted expected variable
cash payments (or receipts). The variable cash payments (or receipts) are based
on an expectation of future interest rates (forward curves) derived from
observable market interest rate curves.

100

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 21Fair Value Measurements
(Continued)

The fair
values of interest rate options are determined using the market standard
methodology of discounting the future expected cash receipts that would occur if
variable interest rates fell below (rise above) the strike rate of the floors
(caps). The variable interest rates used in the calculation of projected
receipts on the floor (cap) are based on an expectation of future interest rates
derived from observable market interest rate curves and volatilities. To comply
with the provisions of SFAS No. 157, the Corporation incorporates credit
valuation adjustments to appropriately reflect both its own nonperformance risk
and the respective counterpartys nonperformance risk in the fair value
measurements. In adjusting the fair value of its derivative contracts for the
effect of nonperformance risk, the Corporation has considered the impact of
netting and any applicable credit enhancements, such as collateral postings,
thresholds, mutual puts, and guarantees.

Although the
Corporation has determined that the majority of the inputs used to value its
derivatives fall within Level 2 of the fair value hierarchy, the credit
valuation adjustments associated with its derivatives utilize Level 3 inputs,
such as estimates of current credit spreads to evaluate the likelihood of
default by itself and its counterparties. However, as of December 31, 2008, the
Corporation has assessed the significance of the impact of the credit valuation
adjustments on the overall valuation of its derivative positions and has
determined that the credit valuation adjustments are not significant to the
overall valuation of its derivatives. As a result, the Corporation has
determined that its derivative valuations in their entirety are classified in
Level 2 of the fair value hierarchy.

The
Corporation also has commitments with customers to extend mortgage loans at a
specified rate and commitments to sell mortgage loans at a specified rate. These
interest rate and forward contracts for mortgage loans originated and intended
for sale in the secondary market are accounted for as derivatives and carried at
estimated fair value. The Corporation estimates the fair value of the contracts
using current secondary loan market rates. The Corporation has determined that
the inputs used to value its interest rate and forward contracts fall within
Level 2 of the fair value hierarchy.

Assets and liabilities measured at
fair value on a recurring basis are summarized below.

|                                               |  | Fair Value Measurement
      Using
|---------------------------------------------- |  | ----------------------------------
|                                               |  | Quoted Prices in                  
|                                               |  | Active Markets for                
|                                               |  | Identical                         
|(Dollars in thousands)                         |  | Assets/Liabilities                
|                                               |  | (Level 1)                         
|Assets                                         |  |                                   
|Investment
      securities available for sale |  | $                                 
|Residential mortgage loans held for sale       |  |                                   
|Derivatives                                    |  |                                   
|Total assets                                   |  | $                                 
|Liabilities                                    |  |                                   
|Derivatives                                    |  | $                                 
|Total liabilities                              |  | $                                 

101

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 21Fair Value Measurements
(Continued)

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

The table
below presents a reconciliation for assets measured at fair value on a recurring
basis for which the Corporate has utilized significant unobservable inputs
(Level 3).

InvestmentSecurities(Dollars in
      thousands)
    
    Available for**Sale**Balance, January 1, 2008
    
    $
    Transfers into
      Level 3
    
    
    5,072Total losses realizedIncluded in earnings(1)
    
    
    (1,923
    )Included in other comprehensive income
    
    
    Balance, December 31, 2008
    
    $
    3,149The amount of total gains or losses for the periodincluded in earnings (or changes in net assets)attributable to the change in unrealized gains orlosses relating to assets still held at December 31,2008
    
    $
    


|(1) | The loss is reported as an
      otherthan-temporary impairment loss on investment securities available
      for sale in the income statement.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------

Assets Measured at Fair Value on a
Nonrecurring Basis

A
description of the valuation methodologies and classification levels used for
financial instruments measured at fair value on a nonrecurring basis are listed
as follows. These listed instruments are subject to fair value adjustments
(impairment) as they are valued at the lower of cost or market.

Impaired Loans

Impaired
loans are evaluated and valued at the time the loan is identified as impaired,
at the lower of cost or market value. Individually impaired loans are measured
based on the fair value of the collateral for collateral dependent loans. The
value of the collateral is determined based on an appraisal by qualified
licensed appraisers hired by the Corporation or other observable market data
which is readily available in the marketplace. Impaired loans are reviewed and
evaluated on at least a quarterly basis for additional impairment and adjusted
accordingly. At December 31, 2008, impaired loans had a carrying amount of $70.2
million with a valuation allowance of $8.4 million. Impaired loans with a
carrying amount of $67.9 million were evaluated during 2008 using the practical
expedient fair value measurement which resulted in an additional valuation
allowance of $6.9 million as compared to December 31, 2007.

Mortgage Servicing
Rights

The
Corporation estimates the fair value of mortgage servicing rights based upon the
present value of future cash flows using a current market discount rate
appropriate for each investor group. Some of the primary components in valuing a
servicing portfolio are estimates of anticipated prepayment, current market
yields for servicing, reinvestment rate, servicing spread retained on the loans,
and the cost to service each loan.

102

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 21Fair Value Measurements
(Continued)

The
Corporations entire portfolio consists of fixed rate loans with a remittance
type of schedule/actual and a weighted average servicing fee of .25%. The market
value calculation was based on long term prepayment assumptions obtained from
Bloomberg for similar pools based on original term, remaining term, and coupon.
Where prepayment assumptions for loan pools could not be obtained, projections
based on current prepayments, secondary loan market, and input from servicing
buyers were used. The Corporation has determined that the inputs used to value
its mortgage servicing rights fall within Level 2 of the fair value hierarchy.
At December 31, 2008, the Corporations mortgage servicing rights had a carrying
amount of $1.6 million. In accordance with the provisions of SFAS No.156,
Amending Accounting for Separately Recognized Servicing Assets and Liabilities
and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities, mortgage servicing rights with a carrying
amount of $3.0 million were written down to their fair value of $1.6 million
resulting in an impairment charge of $1.4 million for the year ended December
31, 2008.

Certain assets measured at fair value on a non-recurring basis are
presented below:

|                          |  | Fair Value Measurement
      Using
|------------------------- |  | ----------------------------------
|                          |  | Quoted Prices in                  
|                          |  | Active Markets for                
|                          |  | Identical                         
|(Dollars in thousands)    |  | Assets/Liabilities                
|                          |  | (Level 1)                         
|Assets                    |  |                                   
|Impaired
      loans      |  | $                                 
|Mortgage servicing rights |  |                                   
|Total assets              |  | $                                 

SFAS No. 157
Fair value measurement implementation for nonfinancial assets including goodwill
and identifiable intangibles with balances of $240.7 million and $26.2 million,
respectively, and nonfinancial liabilities at December 31, 2008 have been
delayed until January 1, 2009 in accordance with SFAS No. 157-2.

Disclosures about Fair Value of
Financial Instruments

SFAS No.
107, Disclosures about Fair Values of Financial Instruments, (SFAS 107)
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.

103

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 21Fair Value Measurements
(Continued)

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, 2008 and 2007 are
outlined below. The methodologies for estimating the fair value of financial
assets and financial liabilities that are measured at fair value on a recurring
or non-recurring basis are discussed in the fair value measurements section
above. The estimated fair value approximates carrying value for cash and cash
equivalents, accrued interest and the cash surrender value of life insurance
policies. The methodologies for other financial assets and financial liabilities
are discussed below:

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 held to maturity

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

Loans

The loan
portfolio, net of unearned income, has been valued by a third party specialist
using quoted market prices, if available. When market prices were not available,
a credit risk based present value discounted cash flow analysis was utilized.
The primary assumptions utilized in this analysis are the discount rate based on
the libor curve, adjusted for credit risk, and prepayment estimates based on
factors such as refinancing incentives, age of the loan and seasonality. These
assumptions were applied by loan category and different spreads were applied
based upon prevailing market rates by category.

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 an
independent third party by discounting contractual cash flows using current
market rates for instruments with similar maturities, using a credit based risk
model. The carrying amount of accrued interest receivable and payable
approximates fair value.

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.

104

---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

HARLEYSVILLE NATIONAL CORPORATION AND
SUBSIDIARIES

Note 21Fair Value Measurements
(Continued)

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

December 31,2008
    
    2007Carrying
    
    Fair
    
    Carrying
    
    FairAmount
    
    Value
    
    Amount
    
    Value(Dollars in thousands)Cash and cash equivalents
    
    $
    102,526
    
    $
    102,526
    
    $
    209,403
    
    $
    209,403Investment
      securities available for sale
    
    
    1,141,948
    
    
    1,141,948
    
    
    910,367
    
    
    910,367Investment securities held to maturity
    
    
    50,434
    
    
    50,059
    
    
    57,347
    
    
    57,518Residential
      mortgage loans held for sale
    
    
    17,165
    
    
    17,165
    
    
    1,140
    
    
    1,140Loans and leases, net
    
    
    3,618,124
    
    
    3,591,202
    
    
    2,432,355
    
    
    2,447,474Bank-owned life
      insurance
    
    
    87,081
    
    
    87,081
    
    
    72,269
    
    
    72,269Time deposits
    
    
    1,588,921
    
    
    1,613,684
    
    
    1,202,690
    
    
    1,195,811Long-term
      borrowings
    
    
    759,658
    
    
    809,618
    
    
    321,785
    
    
    328,084Subordinated debt
    
    
    93,743
    
    
    50,474
    
    
    82,992
    
    
    81,954


105

---

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,          
|------------------------------------------------ |  | ----------------------
|                                                 |  | 2008                  
|                                                 |  | (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,
|------------------------------------------------------------------------------------------------------- |  | -------------------------
|                                                                                                        |  | 2008                     
|                                                                                                        |  | (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 income (losses) of
    subsidiaries                                         |  |                          
|Net income                                                                                              |  | $                        

106

---

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,
|--------------------------------------------------------------------------- |  | -------------------------
|                                                                            |  | 2008                     
|                                                                            |  | (Dollars in thousands)   
|Operating activities:                                                       |  |                          
|Net
      income                                                            |  | $                        
|Adjustments to reconcile net income to net cash provided by
      operating |  |                          
|activities:                                                                 |  |                          
|Equity in undistributed net (income) losses of
      subsidiaries           |  |                          
|Stock-based compensation expense                                            |  |                          
|Net (increase) decrease in other assets                                     |  |                          
|Net (decrease) increase in other
    liabilities                            |  |                          
|Other, net                                                                  |  |                          
|Net cash provided by operating activities                                   |  |                          
|                                                                            |  |                          
|Investing activities:                                                       |  |                          
|Net cash paid acquired (paid) due to acquisition                            |  |                          
|Capital contributions made to the subsidiaries                              |  |                          
|Net cash provided by (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 increase (decrease) in cash                                             |  |                          
|Cash and cash equivalents at beginning of year                              |  |                          
|Cash and cash equivalents at end of year                                    |  | $                        

107

---

REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

Board of Directors and
ShareholdersHarleysville National Corporation

We have
audited the accompanying consolidated balance sheets of Harleysville National
Corporation (a Pennsylvania corporation) and subsidiaries as of December 31,
2008 and 2007, and the related consolidated statements of income, shareholders
equity, and cash flows for each of the three years in the period ended December
31, 2008. 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, 2008 and 2007, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2008 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. As also discussed in Note 1 to the financial statements, the Company
adopted FASB No. 157,Fair Value
Measurements, and No. 159,the Fair Value Option for Financial Assets and Financial
Liabilities-Including an amendment of FASB Statement No. 115, in 2007.

We also have
audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Harleysville National Corporation and
subsidiaries internal control over financial reporting as of December 31, 2008,
based on criteria established inInternal
Control-Integrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our
report dated March 13, 2009 expressed an unqualified opinion.

/s/ Grant Thornton LLPPhiladelphia, PennsylvaniaMarch 13,
2009

108

---

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 2008 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, 2008. 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.

In
accordance with the SECs published guidance, the Corporations management
determined that it would exclude the operations of Willow Financial (acquired on
December 5, 2008) from the scope of its assessment of internal control over
financial reporting as of December 31, 2008. As of December 31, 2008, the
Corporations total reported consolidated assets were $5.5 billion, of which
Willow Financials assets accounted for approximately 29.2%. For the year ended
December 31, 2008, the Corporations consolidated interest and non-interest
income was $252.5 million, of which Willow Financial accounted for approximately
2.5%.

109

---

Item 9A. Controls and Procedures
(Continued)

Management believes that, as of
December 31, 2008, 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, 2008, in accordance with reporting requirements of Section 112 of
the Federal Deposit Insurance Corporation Improvement Act (FDICIA). Management
believes that as of December 31, 2008, 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
ShareholdersHarleysville National Corporation

We have
audited Harleysville National Corporations (a Pennsylvania Corporation) and
subsidiaries internal control over financial reporting as of December 31, 2008,
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 Willow Financial which was acquired in December 2008 and
constituted approximately 29.2% of total consolidated assets as of December 31,
2008 and approximately 2.5% of total consolidated 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 Willow Financial.

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.

110

---

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, 2008,
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 subsidiaries as of December 31, 2008 and 2007, and the
related consolidated statements of income, shareholders equity, and cash flows
for each of the three years in the period ended December 31, 2008 and our report
dated March 13, 2009 expressed an unqualified opinion.

/s/ Grant Thornton LLPPhiladelphia, PennsylvaniaMarch 13,
2009

Item 9B.Other Information

None

111

---

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. Walter R. Bateman,
II, until his retirement on April 22, 2008, was the committee's independent
financial expert, as defined by SEC regulations, and chaired the committee.
James A. Wimmer succeeded Mr. Bateman as the financial expert and chairperson of
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 2009 annual meeting of shareholders (the 2009 Proxy Statement)
and is incorporated herein by reference:

Director Information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 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
2009 Proxy Statement is incorporated herein by reference:

Director Information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
Executive Separation 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 caption, Beneficial Ownership by Directors, Officers and Nominees,
in the 2009 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.

112

---

Information
included under the captions, Related Party Transactions, Corporate
Governance, and Meetings and Committees of the Board of Directors in the 2009
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 2009 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)                                                                                                                                       

113

---

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 11, 2009

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/ LEEANNB. BERGEY           |  | Director                                              |  | March 11,
      2009
|LeeAnn B.
      Bergey        |  |                                                       |  |                     
|                             
|/S/ MICHAELL. BROWNE          |  | Director                                              |  | March 11,
      2009
|Michael L.
      Browne       |  |                                                       |  |                     
|                             
|/S/ JOHNJ. CUNNINGHAM, III    |  | Director                                              |  | March 11,
      2009
|John J.
      Cunningham, III |  |                                                       |  |                     
|                             
|/S/ WALTERE. DALLER, JR.      |  | Chairman and
      Director                           |  | March 11,
      2009
|Walter E.
      Daller, Jr.   |  |                                                       |  |                     
|                             
|/S/ PAULD. GERAGHTY           |  | President, Chief
      Executive Officer and Director |  | March 11,
      2009
|Paul D.
      Geraghty        |  | (Principal
      Executive Officer)                   |  |                     
|                             
|/S/ HAROLDA. HERR             |  | Director                                              |  | March 11,
      2009
|Harold A.
      Herr          |  |                                                       |  |                     
|                             
|/S/ THOMASC. LEAMER           |  | Director                                              |  | March 11,
      2009
|Thomas C.
      Leamer        |  |                                                       |  |                     
|                             
|/S/ JAMESE. MCERLANE          |  | Director                                              |  | March 11,
      2009
|James E.
      McErlane       |  |                                                       |  |                     
|                             
|/S/ STEPHANIES. MITCHELL      |  | Director                                              |  | March 11,
      2009
|Stephanie S.
      Mitchell   |  |                                                       |  |                     
|                             
|/S/ A. ROSSMYERS              |  | Director                                              |  | March 11,
      2009
|A. Ross
      Myers           |  |                                                       |  |                     

114

---

|Signature              |  | Title                                              |  | Date                
|---------------------- |  | -------------------------------------------------- |  | --------------------
|                       |  |                                                    |  |                     
|/S/ BRENTL. PETERS     |  | Director                                           |  | March 11,
      2009
|Brent L.
      Peters  |  |                                                    |  |                     
|                      
|/S/ GEORGES. RAPP      |  | Chief Financial
      Officer                      |  | March 11,
      2009
|George S.
      Rapp   |  | (Principal
      Financial and Accounting Officer) |  |                     
|                      
|/S/ DEMETRAM. TAKES    |  | Director                                           |  | March 11,
      2009
|Demetra M.
      Takes |  |                                                    |  |                     
|                      
|/S/ JAMESA. WIMMER     |  | Director                                           |  | March 11,
      2009
|James A.
      Wimmer  |  |                                                    |  |                     

115

---

EXHIBIT INDEX

|Exhibit |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|No.     |  | Description of
    Exhibits                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(2.1)   |  | Purchase Agreement, dated as of
      November 15, 2005, by and among Harleysville National Bank and Trust
      Company, Cornerstone Financial Consultants, Ltd., Cornerstone Advisors
      Asset Management, Inc., Cornerstone Institutional Investors, Inc.,
      Cornerstone Management Resources, Inc., John R. Yaissle, Malcolm L. Cowen,
      II, and Thomas J. Scalici. (Incorporated by reference to Exhibit 2.1 of
      the Registrants Annual Report on Form 10-K for the year ended December
      31, 2005, filed with the Commission on March 15, 2006. The schedules and
      exhibits to the Purchase Agreement are listed at the end of the Purchase
      Agreement but have been omitted from the exhibit to Form 10-K. The
      Registrant agrees to supplementally furnish a copy of any omitted schedule
      or exhibit to the Securities and Exchange Commission upon request.)
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(2.2)   |  | Merger Agreement, dated as of May
      15, 2007, by and among Harleysville National Corporation, East Penn
      Financial Corporation, East Penn Bank and HNC-EPF, LLC, as amended.
      (Incorporated by reference to Annex A of the Corporations Registration
      Statement No. 333-145820 on Form S-4/A, filed with the Commission on
      September 27, 2007. The schedules and exhibits to the Merger Agreement are
      listed at the end of the Merger Agreement but have been omitted from the
      Annex to Form S-4. The Registrant agrees to supplementally furnish a copy
      of any omitted schedule or exhibit to the Securities and Exchange
      Commission upon request.)                                                                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(2.3)   |  | Agreement for Purchase and Sale of
      Partnership Interests, dated as of December 27, 2007, by and among each of
      the applicable entities (Buyer) and 2007 PA HOLDINGS, LLC (HNB) and PA
      BRANCH HOLDINGS, LLC, (Bank Branch) (HNB and Bank Branch are referred to
      collectively as Seller). (Incorporated by reference to Registrants
      Annual Report on Form 10-K for the year ended December 31, 2007, filed
      with the Commission on March 14, 2008. The schedules and exhibits to the
      Agreement for Purchase and Sale of Partnership Interests are listed at the
      end of the agreement but have been omitted from the Exhibit to Form 10-K.
      The Registrant agrees to supplementally furnish a copy of any omitted
      schedule or exhibit to the Securities and Exchange Commission upon
      request.)                                            
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(2.4)   |  | Merger Agreement, dated as of May
      20, 2008, by and among Harleysville National Corporation and Willow
      Financial Bancorp. (Incorporated by reference to Annex A of the
      Registrants Registration Statement No. 333-152007 on Form S-4, as
      amended, filed with the Commission on July 31, 2008. The schedules and
      exhibits to the Merger Agreement are listed at the end of the Merger
      Agreement but have been omitted from the Annex to Form S-4. The Registrant
      agrees to supplementally furnish a copy of any omitted schedule or exhibit
      to the Securities and Exchange Commission upon request.)                                                                                                                                                                                                                                                            
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(3.1)   |  | Harleysville National Corporation
      Amended and Restated Articles of Incorporation. (Incorporated by reference
      to Exhibit 3.1 to the Corporations Registration Statement No. 333-111709
      on Form S-4, as filed on January 5, 2004.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(3.2)   |  | Harleysville National Corporation
      Amended and Restated By-laws. (Incorporated by reference to Exhibit 3.1 to
      the Corporations Current Report on Form 8-K/A, filed with the Commission
      on August 16, 2007.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(10.1)  |  | Harleysville National Corporation
      1993 Stock Incentive Plan.** (Incorporated by reference to Exhibit 4.3 of
      Registrants Registration Statement No. 33-69784 on Form S-8, filed with
      the Commission on October 1, 1993.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(10.2)  |  | Harleysville National Corporation
      Stock Bonus Plan.*** (Incorporated by reference to Exhibit 99A of
      Registrants Registration Statement No. 333-17813 on Form S-8, filed with
      the Commission on December 13, 1996.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(10.3)  |  | Supplemental Executive Retirement
      Plan.* (Incorporated by reference to Exhibit 10.3 of Registrants Annual
      Report in Form 10-K for the year ended December 31, 1997, filed with the
      Commission on March 27, 1998.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

---

|**Exhibit** |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|**No.**     |  | **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, former Executive Vice President of the
      Corporation, and Harleysville Management Services, LLC.* (Incorporated by
      reference to Registrants Quarterly Report on Form 10-Q, filed with the
      Commission on May 10, 2004.)                                                                                                                                      
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(10.12)     |  | Employment Agreement effective April 1, 2005 between Michael B.
      High, former Executive Vice President and Chief Operating Officer of the
      Corporation, and Harleysville Management Services, LLC.* (Incorporated by
      reference to Registrants Current Report on Form 8-K, filed with the
      Commission on November 16, 2004.)                                                                                                                                       
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(10.13)     |  | Amendment to Supplemental Executive Retirement Benefit Agreement
      dated March 14, 2005 by and among Harleysville Management Services, LLC
      and Michael B. High, former Executive Vice President and Chief Operating
      Officer of the Corporation.* (Incorporated by reference to Registrants
      Current Report on Form 8-K, filed with the Commission on March 14,
      2005.)                                                                                       
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(10.14)     |  | Complete Settlement Agreement and General Release effective October
      17, 2008 by and between Michael B. High, former Executive Vice President
      and Chief Operating Officer of the Corporation, and Harleysville National
      Corporation, Harleysville National Bank and Trust Company and Harleysville
      Management Services, LLC .* (Incorporated by reference to Registrants
      Current Report on Form 8-K, filed with the Commission on October 23,
      2008.)

---

|**Exhibit** |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|**No.**     |  | **Description of
      Exhibits**                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|(10.15)     |  | Harleysville National Corporation 2004 Omnibus Stock Incentive
      Plan, as amended and restated effective November 9, 2006.** (Incorporated
      by reference to Registrants Current Report on Form 8-K, filed with the
      Commission on November 15, 2006).                                                                                                                                                                                                                              
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.16)     |  | Employment Agreement dated August 23, 2004 between James F.
      McGowan, Jr., Executive Vice President & Chief Credit Officer and
      Harleysville Management Services, LLC.* (Incorporated by reference to
      Registrants Current Report on Form 8-K, filed with the Commission on
      August 25, 2004.)                                                                                                                                                                               
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.17)     |  | Supplemental Executive Retirement Benefit Agreement dated August
      23, 2004 between James F. McGowan, Jr., Executive Vice President &
      Chief Credit Officer, and Harleysville Management Services, LLC.*
      (Incorporated by reference to Registrants Current Report on Form 8-K,
      filed with the Commission on August 25, 2004.)                                                                                                                                               
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.18)     |  | Amendment to Supplemental Executive Retirement Benefit Agreement
      dated March 14, 2005 by and among Harleysville Management Services, LLC
      and James F. McGowan, Jr., Executive Vice President & Chief Credit
      Officer.* (Incorporated by reference to Registrants Current Report on
      Form 8-K, filed with the Commission on March 14, 2005.)                                                                                                                                
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.19)     |  | Employment Agreement dated September 27, 2004 between John Eisele,
      former Executive Vice President & President of Millennium Wealth
      Management and Private Banking, and Harleysville Management Services,
      LLC.* (Incorporated by reference to Registrants Current Report on Form
      8-K, filed with the Commission on September 29, 2004.)                                                                                                                                  
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.20)     |  | Supplemental Executive Retirement Benefit Agreement dated September
      27, 2004 between John Eisele, former Executive Vice President &
      President of Millennium Wealth Management and Private Banking, and
      Harleysville Management Services, LLC.* (Incorporated by reference to
      Registrants Current Report on Form 8-K, filed with the Commission on
      September 29, 2004.)                                                                                             
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.21)     |  | Amendment to Supplemental Executive Retirement Benefit Agreement
      dated March 14, 2005 by and among Harleysville Management Services, LLC
      and John Eisele, former Executive Vice President & President of
      Millennium Wealth Management and Private Banking.* (Incorporated by
      reference to Registrants Current Report on Form 8-K, filed with the
      Commission on March 14, 2005.)                                                                                    
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.22)     |  | Separation Agreement and Mutual Release dated June 15, 2007 and
      effective July 19, 2007 between John Eisele, former Executive Vice
      President & President of Millennium Wealth Management and Private
      Banking, Harleysville Management Services, LLC., Harleysville National
      Bank and Trust Company and Harleysville National Corporation.*
      (Incorporated by reference to Registrants Current Report on Form 8-K,
      filed with the Commission on July 19, 2007.)
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.23)     |  | Employment Agreement effective January 1, 2005 between Gregg J.
      Wagner, the former President and Chief Executive Officer of the
      Corporation, and Harleysville Management Services, LLC.* (Incorporated by
      reference to Registrants Current Report on Form 8-K, filed with the
      Commission on November 16, 2004.)                                                                                                                                                          
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.24)     |  | Amendment to Supplemental Executive Retirement Benefit Agreement
      dated March 14, 2005 by and among Harleysville Management Services, LLC
      and Gregg J. Wagner, the former President and Chief Executive Officer of
      the Corporation.* (Incorporated by reference to Registrants Current
      Report on Form 8-K, filed with the Commission on March 14,
  2005.)                                                                                                                
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(10.25)     |  | Complete Settlement Agreement and General Release dated November
      29, 2006 and effective December 8, 2006 between Gregg J. Wagner and
      Harleysville National Corporation, Harleysville National Bank and Trust
      Company and Harleysville Management Services, LLC .* (Incorporated by
      reference to Registrants Current Report on Form 8-K, filed with the
      Commission on December 13, 2006.)                                                                           

---

|Exhibit |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|**No.** |  | Description of
      Exhibits                                                                                                                                                                                                                                                                                                                                                                                                              
|(10.26) |  | Employment Agreement dated May 18, 2005, between George S. Rapp,
      Senior Vice President and Chief Financial Officer, and Harleysville
      Management Services, LLC.* (Incorporated by reference to Registrants
      Current Report on Form 8-K, filed with the Commission on May 20,
      2005.)                                                                                                                                 
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.27) |  | Amended and Restated Declaration of Trust for HNC Statutory Trust
      III by and among Wilmington Trust Company, as Institutional Trustee and
      Delaware Trustee, Harleysville National Corporation, as Sponsor, and the
      Administrators named therein, dated as of September 28, 2005.
      (Incorporated by reference to Registrants Quarterly Report on Form
      10-Q/A, filed with the Commission on November, 9, 2005.)
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.28) |  | Indenture between Harleysville National Corporation, as Issuer, and
      Wilmington Trust Company, as Trustee, for Fixed/Floating Rate Junior
      Subordinated Debt Securities, dated as of September 28, 2005.
      (Incorporated by reference to Registrants Quarterly Report on Form
      10-Q/A, filed with the Commission on November, 9, 2005.)                                                                                
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.29) |  | Guarantee Agreement between Harleysville National Corporation and
      Wilmington Trust Company, dated as of September 28, 2005. (Incorporated by
      reference to Registrants Quarterly Report on Form 10-Q/A, filed with the
      Commission on November, 9, 2005.)                                                                                                                                                                 
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.30) |  | Employment Agreement effective July 12, 2006 between Lewis C. Cyr,
      Chief Lending Officer of the Corporation, and Harleysville Management
      Services, LLC.* (Incorporated by reference to Registrants Current Report
      on Form 8-K, filed with the Commission on July 12, 2006.)                                                                                                                                             
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.31) |  | Employment Agreement dated July 12, 2007 between Paul D. Geraghty,
      President and Chief Executive Officer of the Corporation and Harleysville
      Management Services, LLC* (Incorporated by reference to Registrants
      Current Report on Form 8-K filed with the Commission on July 12,
      2007.)                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.32) |  | Amended and Restated Declaration of Trust for HNC Statutory Trust
      IV by and among Wilmington Trust Company, as Institutional Trustee and
      Delaware Trustee, Harleysville National Corporation, as Depositor, and the
      Administrators named therein, dated as of August 22, 2007. (Incorporated
      by reference to Registrants Quarterly Report on Form 10-Q, filed with the
      Commission on November 8, 2007.)     
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.33) |  | Indenture between Harleysville National Corporation, as Issuer, and
      Wilmington Trust Company, as Trustee, for Fixed/Floating Rate Junior
      Subordinated Debt Securities, dated as of August 22, 2007. (Incorporated
      by reference to Registrants Quarterly Report on Form 10-Q, filed with the
      Commission on November 8, 2007.)                                                                                      
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.34) |  | Guarantee Agreement between Harleysville National Corporation and
      Wilmington Trust Company, dated as of August 22, 2007. (Incorporated by
      reference to Registrants Quarterly Report on Form 10-Q, filed with the
      Commission on November 8, 2007.)                                                                                                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.35) |  | Employment Agreement dated November 16, 2007 between Brent L.
      Peters, Executive Vice President and President of the East Penn Bank
      Division of Harleysville National Bank and Trust Company, and Harleysville
      Management Services, LLC. * (Incorporated by reference to Registrants
      Annual Report on Form 10-K for the year ended December 31, 2007, filed
      with the Commission on March 14, 2008.)          
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.36) |  | Employment Agreement dated April 17, 2008 between Joseph D. Blair,
      Executive Vice President and President of the Millennium Wealth Management
      Division of Harleysville National Bank and Trust Company, and Harleysville
      Management Services, LLC.* (Incorporated by reference to Registrants
      Quarterly Report on Form 10-Q filed with the Commission on August 8,
      2008.)                                   
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(10.37) |  | Employment Agreement dated May 20, 2008 and effective December 5,
      2008 between Donna M. Coughey, Executive Vice President of the Corporation
      and the Bank, and Harleysville Management Services, LLC.* (Incorporated by
      reference to Registrants Current Report on Form 8-K filed with the
      Commission on December 5, 2008.)                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(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                                                                                                                                                                                                                                                                                                                                                         

---

|**Exhibit** |  |                                                                                                                                                                                       
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|No.         |  | 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.
| |    

---