UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                    Form 10-Q


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

For the period ended    September 30, 1996


Commission File Number:  0-13775


                          KEYSTONE HERITAGE GROUP, INC.
                                  (Registrant)


     PENNSYLVANIA                                               23-2219740
(State of incorporation)                                     (I.R.S. Employer
                                                             Identification No.)

              555 WILLOW STREET, LEBANON, PENNSYLVANIA     17046
             (Address of principal executive offices)    (Zip Code)


                                  717-274-6800
              (Registrant's telephone number, including area code)


     Indicate  by check mark  whether the  registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. Yes X   No ___

     Indicate the number of shares  outstanding of each of the issuer's  classes
of common stock, as of the latest practicable date.


           Class                              Outstanding at November 12, 1996
Common Stock ($5.00 par value)                                4,028,383 shares

<PAGE>

                          KEYSTONE HERITAGE GROUP, INC.

                                      Index

PART I - FINANCIAL INFORMATION                                        Page

Item 1 - Financial Statements

          Consolidated  Balance  Sheets as of September  30, 1996
          and December 31, 1995 (Unaudited)                              3

          Consolidated  Statements  of  Income  for the Three and
          Nine  Months   ended   September   30,  1996  and  1995
          (Unaudited)                                                    4

          Consolidated Statements of Stockholders' Equity for the
          Nine  Months   ended   September   30,  1996  and  1995
          (Unaudited)                                                    5

          Consolidated  Statements  of Cash  Flows  for the  Nine
          Months ended September 30, 1996 and 1995 (Unaudited)           6

          Notes to Consolidated Financial Statements                     7


Item 2 - Management's Discussion and Analysis of
         Financial Condition and Results of Operations                   8


PART II - OTHER INFORMATION

Signature Page                                                          20

                                       -2-

<PAGE>

                          KEYSTONE HERITAGE GROUP, INC.

                           CONSOLIDATED BALANCE SHEETS

                             (Dollars In Thousands)
<TABLE>
<CAPTION>

                                                           September 30         December 31
                                                              1996                 1995
<S>                                                         <C>                 <C>      
ASSETS
      Cash and due from banks                               $  21,141           $  23,766
      Interest bearing deposits with banks                        223                 246
      Federal funds sold                                        3,400                   0
      Investment securities available for sale                 53,623              65,799
      Investment securities held to maturity
           (fair value of $75,410 and $88,052
           for 1996 and 1995, respectively)                    75,268              86,885
      Loans, net of unearned income of
         $2,203 for 1996 and $2,830 for 1995                  422,679             391,009
      Allowance for possible loan losses                       (7,706)             (8,025)
                                                            ---------           ---------

           Loans, net                                         414,973             382,984

      Premises and equipment, net                               7,660               7,933
      Accrued interest receivable                               3,738               3,844
      Other real estate owned                                     749                 913
      Deferred tax asset, net                                   2,936               3,100
      Other assets                                              3,103               2,307
                                                            ---------           ---------

           Total assets                                     $ 586,814           $ 577,777
                                                            =========           =========

LIABILITIES
      Non-interest bearing deposits                         $  67,131           $  65,530
      Interest bearing deposits                               433,428             422,387
                                                            ---------           ---------

           Total deposits                                     500,559             487,917

      Short-term borrowings                                    12,694               8,640
      Other borrowings                                          4,417              14,009
      Accrued interest payable                                  4,308               5,284
      Other liabilities                                         3,279               3,048
                                                            ---------           ---------

           Total liabilities                                  525,257             518,898

STOCKHOLDERS' EQUITY
     Common stock - $5 par  value; 10,000,000 shares
        authorized;  4,071,683 outstanding  at
        September  30, 1996 and December 31, 1995,
        of which 43,300 and 0 shares are held as
        treasury stock at September 30, 1996 and
        December 31, 1995, respectively                        20,358              20,358
      Capital surplus                                          22,078              22,078
      Retained earnings                                        19,883              16,107
      Net unrealized gain on investment securities
           available for sale, net of taxes                       212                 336
      Treasury stock                                             (974)                  0
                                                            ---------           ---------

           Total stockholders' equity                          61,557              58,879

           Total liabilities and stockholders'
             equity                                         $ 586,814           $ 577,777
                                                            =========           =========
</TABLE>

See accompanying notes to financial statements.

                                       -3-

<PAGE>

                          KEYSTONE HERITAGE GROUP, INC.
                        CONSOLIDATED STATEMENTS OF INCOME

                  (Dollars in thousands, except per share data)
<TABLE>
<CAPTION>

                                                                           Three Months Ended              Nine Months Ended
                                                                              September 30                   September 30
                                                                           1996           1995            1996           1995
<S>                                                                     <C>            <C>             <C>            <C>     
INTEREST INCOME
              Interest and fees on loans                                $  9,366       $  8,856        $ 27,096       $ 26,080
              Interest on investment securities
                available for sale:
                  Taxable investment securities                              722            670           2,155          1,982
                  Equity investments                                          55             52             159            142
              Interest on investment securities held to maturity:
                  Taxable investment securities                            1,055          1,171           3,274          3,207
                  Non-taxable investment securities                          131            111             382            340
                                                                        --------       --------        --------       --------
                    Total interest on investment
                     securities                                            1,963          2,004           5,970          5,671
              Interest on money market investments                            89            175             156            422
                                                                        --------       --------        --------       --------
                  Total interest income                                   11,418         11,035          33,222         32,173

INTEREST EXPENSE
              Interest on deposits                                         4,672          4,674          13,626         13,126
              Interest on short-term borrowings                              135            119             369            362
              Interest on other borrowings                                    98            177             420            581
                                                                        --------       --------        --------       --------
                  Total interest expense                                   4,905          4,970          14,415         14,069

                  Net interest income                                      6,513          6,065          18,807         18,104

              Provision for possible loan losses                               0              0               0              0
                                                                        --------       --------        --------       --------
                  Net interest income after provision
                   for possible loan losses                                6,513          6,065          18,807         18,104

OTHER OPERATING INCOME
              Trust income                                                   352            324             961            961
              Service charges on deposits                                    341            333             978            972
              Net realized gain on investment
                  securities available for sale                               35             51              58            109
              Net gain on sale of mortgage loans                             321             78             644            156
              Other income                                                   559            517           1,624          1,525
                                                                        --------       --------        --------       --------
                  Total other operating income                             1,608          1,303           4,265          3,723

OTHER OPERATING EXPENSE
              Salaries and employee benefits                               2,672          2,510           7,522          7,255
              Occupancy expense, net                                         340            331             967            974
              Equipment expense                                              448            452           1,500          1,413
              Deposit insurance expense                                        1            (26)              2            492
              Other expense                                                1,360          1,323           3,986          3,661
                                                                        --------       --------        --------       --------
                  Total other operating expense                            4,821          4,590          13,977         13,795

                  Income before income taxes                               3,300          2,778           9,095          8,032
              Income taxes                                                 1,001            857           2,795          2,490
                                                                        --------       --------        --------       --------

                  Net income                                            $  2,299       $  1,921        $  6,300       $  5,542
                                                                        ========       ========        ========       ========

PER COMMON SHARE
                  Net income                                            $    .57       $    .47        $   1.55       $   1.36
                                                                        ========       ========        ========       ========

                  Cash dividends paid                                   $    .22       $    .18        $    .62       $    .53
</TABLE>

                                       -4-

<PAGE>

                          KEYSTONE HERITAGE GROUP, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                         Nine Months Ended September 30

                             (Dollars in thousands)
<TABLE>
<CAPTION>
                                                                                      Net Unrealized
                                                                                      Gain (Loss) On
                                                                                        Securities
                                          Common     Capital     Retained   Treasury    Available
                                           Stock     Surplus     Earnings     Stock      for Sale     Total
<S>                                    <C>         <C>         <C>         <C>        <C>          <C>     
Balance, December 31, 1994               $ 15,231    $ 30,053    $  8,269    $    0     ($ 1,451)    $ 52,102
  Net Income                                  -0-         -0-       5,542        -0-         -0-        5,542
  Cash dividends ($.53 per share)             -0-         -0-      (2,133)       -0-         -0-       (2,133)
  Stock issued under dividend
   reinvestment plan                           38         161         -0-        -0-         -0-          199
  Change in unrealized gain (loss)
   on investment securities
   available for sale, net of taxes           -0-         -0-         -0-        -0-       1,340        1,340
                                         --------    --------    --------   --------    --------     --------

Balance, September 30, 1995              $ 15,269    $ 30,214    $ 11,678    $     0    ($   111)    $ 57,050
                                         ========    ========    ========   ========    ========     ========

Balance, December 31, 1995               $ 20,358    $ 22,078    $ 16,107    $     0     $   336     $ 58,879
  Net income                                                        6,300                               6,300
  Cash dividends ($.62 per share)             -0-         -0-      (2,524)                   -0-       (2,524)
  Acquisition of 43,300 shares of
   treasury stock at cost                                                       (974)                    (974)
  Change in unrealized gain
   (loss) on investment securities
   available for sale, net of taxes           -0-         -0-         -0-        -0-        (124)        (124)
                                         --------    --------    --------   --------    --------     --------

Balance, September 30, 1996              $ 20,358    $ 22,078    $ 19,883   ($   974)   $    212     $ 61,557
                                         ========    ========    ========   ========    ========     ========
</TABLE>

                                       -5-

<PAGE>

                          KEYSTONE HERITAGE GROUP, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (Dollars in thousands)
<TABLE>
<CAPTION>

                                                                          Nine Months Ended
                                                                            September 30
                                                                       1996              1995
<S>                                                                 <C>                <C>     
CASH FLOW FROM OPERATING ACTIVITIES:
    Net income                                                      $  6,300           $  5,542
    Adjustments to reconcile net income to cash:
        Provision for possible loan losses                                 0                  0
        Depreciation and amortization                                  1,108              1,054
        Deferred income taxes                                            220                (96)
        Decrease (increase) in accrued interest receivable               106               (348)
        (Decrease) increase in accrued interest payable                 (976)             1,372
        Net gain on sale of loans                                       (644)              (156)
        Net realized gain on investment
         securities available for sale                                   (58)              (109)
        Other, net                                                      (401)              (561)
                                                                    --------           --------
            Net cash provided by operating activities                  5,655              7,820

CASH FLOWS FROM INVESTING ACTIVITIES:
    Net increase in money market investments                          (3,377)            (3,010)
    Maturities of investment securities
      held to maturity                                                27,492             55,284
    Maturities of investment securities
      available for sale                                              20,980              3,358
    Sale of investment securities available for sale                     156                542
    Funds invested in investment securities
      held to maturity                                               (15,801)           (78,893)
    Funds invested in investment securities
      available for sale                                              (9,289)            (2,818)
    Net (increase) decrease in loans
      made to customers                                              (30,458)             1,865
    Originations of residential mortgage loans sold                  (28,135)           (10,046)
    Proceeds from sale of residential mortgage loans                  27,175              7,481
    Net expenditures for premises and equipment                         (835)            (1,008)
    Proceeds from sale of other real estate owned                        206                894
                                                                    --------           --------
        Net cash used in investing activities                        (11,886)           (21,351)


CASH FLOWS FROM FINANCING ACTIVITIES:
    Net increase in deposits                                          12,642              7,349
    Net increase (decrease) in short-term borrowings                   4,054             (1,272)
    Net (decrease) increase in other borrowings                       (9,592)             1,654
    Acquisition of treasury stock                                       (974)                 0
    Issuance of common stock                                               0                199
    Cash dividends paid                                               (2,524)            (2,133)
                                                                    --------           --------
        Net cash provided by financing activities                      3,606              5,797

    Net decrease in cash and due from banks                           (2,625)            (7,734)

    Cash and due from banks at beginning of period                    23,766             23,568
    Cash and due from banks at end of period                        $ 21,141           $ 15,834

SUPPLEMENTAL DISCLOSURES:
    Interest paid                                                   $  8,148           $  7,779
    Income taxes paid                                                  2,183              2,800

NON-CASH INVESTING AND FINANCING ACTIVITIES:
    Loans charged-off                                                    673                385
</TABLE>

                                       -6-

<PAGE>

                          KEYSTONE HERITAGE GROUP, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   The accompanying  consolidated  financial  statements of Keystone  Heritage
     Group,  Inc.  have  not  been  reviewed  by  independent  certified  public
     accountants.  However, in management's  opinion, the statements reflect all
     adjustments  and  disclosures  necessary  for a  fair  presentation  of the
     consolidated  balance  sheet of the  Company as of  September  30, 1996 and
     December 31, 1995, the consolidated  statements of income for the three and
     nine month periods ended  September 30, 1996 and 1995 and the  consolidated
     statements  of cash flows for the nine months ended  September 30, 1996 and
     1995.  The  accounting  policies  followed in the  presentation  of interim
     financial  results  are the same as those  followed  on an annual  basis or
     those adopted during the first quarter of 1996. The consolidated  financial
     statements of Keystone  Heritage Group,  Inc. and subsidiaries  include the
     accounts of the Company and its wholly owned  subsidiaries,  Lebanon Valley
     National Bank and Keystone Heritage Life Insurance Company. All significant
     intercompany   balances  and  transactions  have  been  eliminated  in  the
     consolidated financial statements.  For purposes of comparability,  certain
     prior year amounts have been reclassified.

2.   On June 12, 1996 the Company announced its intentions to repurchase up to 5
     percent  or  203,584  shares  of  its  outstanding   common  stock.   These
     repurchased  shares will be available for reissuance  through the Company's
     Dividend  Reinvestment or Stock Option Plans or for other general corporate
     purposes.  As of September 30, 1996 the Company has  repurchased a total of
     43,300 shares.

3.   Earnings  per common share are based upon the  weighted  average  number of
     shares  outstanding.  The weighted average number of shares outstanding was
     4,053,287 and  4,064,673  for the three month  periods ended  September 30,
     1996 and 1995,  respectively,  and  4,065,506  and  4,063,154  for the nine
     months ended  September 30, 1996 and 1995,  respectively.  All prior period
     per share data has been restated to give effect for the 4-for-3 stock split
     that was effective for January 1996.


                                       -7-

<PAGE>

                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     Keystone  Heritage  Group,  Inc. (the  "Company") is a bank holding company
organized under the laws of Pennsylvania  and registered  under the Federal Bank
Holding  Company Act of 1956.  The  Company's  principal  subsidiary  is Lebanon
Valley National Bank (the "Bank").

Results of Operations
     Net income for the Company for the three  months ended  September  30, 1996
was $2.299  million or $.57 per share,  compared  to $1.921  million or $.47 per
share  for the  three  months  ended  September  30,  1995.  Return  on  average
stockholders' equity and return on average assets for the 1996 period were 14.91
percent and 1.56 percent, respectively.

     Net income for the nine months ended  September 30, 1996 was $6.300 million
or $1.55 per share,  compared to net income of $5.542 million or $1.36 per share
for 1995.  Return on average  stockholders'  equity and return on average assets
for the 1996 period were 13.95 percent and 1.46 percent, respectively.

Net Interest Income
     Net interest  income is the primary  source of income for the Company.  Net
interest  income  is  the  difference  between  interest  earned  on  loans  and
investments  and interest paid on deposits and other funding  sources.  Deposits
are the primary source of funds for the Company. The factors which influence net
interest  income  include  changes in  interest  rates and  changes in asset and
liability balances.

     For  purposes of this  discussion,  interest  income and the average  yield
earned on loans and  investments  are presented on a taxable  equivalent  basis.
This provides a basis for  comparison of tax exempt loans and  investments  with
taxable loans and  investments by giving effect to interest earned on tax exempt
loans and  investments  by an amount  equivalent  to federal  income taxes which
would have been paid on the assumption  that the interest earned on those assets
was taxable at the Company's statutory tax rate of 35 percent.

     The  tables  presented  on pages 17 and 18 are  comparative  statements  of
average balances of interest  earning assets and interest  bearing  liabilities,
interest  income and interest  expense,  and interest rates for the three months
ended  September 30, 1996 and 1995, and for the nine months ended  September 30,
1996 and 1995.

     Net interest  income for the three months ended September 30, 1996 was $6.7
million,  a $490 thousand or 7.9 percent  increase from the same period of 1995.
The net interest margin for the third quarter of 1996 was 4.77 percent  compared
to 4.57  percent for the same  period of 1995.  Average  earning  assets for the
three month period ended September 30, 1996 were $555.8 million, a $19.6 million
or a 3.7  percent  increase  from the same  period of 1995.  For the three month
comparative  periods,  net interest income and the net interest margin increased
in 1996  primarily as a result of an increase in average  loans  outstanding  of
$33.2 million or 8.7 percent. This loan growth was primarily funded by increases
in average interest  bearing deposit  balances of $12.7 million,  or 3.0 percent
and an increase in average  non-interest bearing demand deposits of $6.5 million
or 11.3  percent  and by  decreases  in the average  balances in the  investment
portfolio and money market investments of $13.6 million or 8.8 percent.

     Net interest  income for the nine months ended September 30, 1996 was $19.3
million,  a $757 thousand or 4.1 percent  increase from the same period of 1995.
The net interest  margin for the nine months ended  September  30, 1996 was 4.71
percent  compared to 4.69 percent for the same period of 1995.  Average  earning
assets for the nine month period ended September 30, 1996 were $546.0 million, a
$19.2 million or a 3.6 percent increase from the same period of 1995.

                                       -8-

<PAGE>

Provision and Allowance for Possible Loan Losses
     There was no  provision  for  possible  loan  losses  charged to net income
during the nine month period ended September 30, 1996 or 1995.

     Net  recoveries  of $52 thousand  were  recorded for the three months ended
September  30, 1996  compared to net  recoveries  of $63  thousand  for the same
period of 1995. For the nine month  comparative  period the Company recorded net
charge-offs  of $319  thousand and $15  thousand for the 1996 and 1995  periods,
respectively.  A charge-off related to a single commercial loan customer was the
primary  reason for the $293 thousand  increase in commercial  loan  charge-offs
from 1995 to 1996.

     The  allowance for possible loan losses was $7.7 million or 1.82 percent of
total loans  outstanding  at September 30, 1996 and $8.0 million or 2.05 percent
at December 31, 1995.  The  allowance  for possible loan losses is a reserve for
estimated  potential loan losses in the loan  portfolio.  Losses occur primarily
from the loan  portfolio,  but may also be derived  from  commitments  to extend
credit and standby  letters of credit.  Loan losses and recoveries of previously
charged-off loans are charged or credited directly to the allowance for possible
loan losses.  The  allowance  for possible  loan losses is an amount  which,  in
management's  judgement,  is  considered  adequate  to absorb  potential  losses
inherent in the loan portfolio.  Management  performs a quarterly  assessment of
the Bank's loan  portfolio to determine the  appropriate  level of the allowance
for possible loan losses. The factors considered in this evaluation include, but
are not necessarily  limited to,  estimated loan losses  identified  through the
review  of  loans  by the  Company's  personnel;  general  economic  conditions;
deterioration  in loan  concentrations  or  pledged  collateral;  historic  loss
experience;  and trends in portfolio  volume,  composition,  delinquencies,  and
non-accruals.  In addition,  various regulatory agencies, as an integral part of
their examination process, periodically review the Bank's allowance for possible
loan losses.


                                       -9-

<PAGE>

     The  following is a summary of the activity in the  allowance  for possible
loan losses for the three and nine month  periods  ended  September 30, 1996 and
1995:
<TABLE>
<CAPTION>

                                                           Three Months Ended                Nine Months Ended
                                                              September 30                      September 30
(Dollars in thousands)                                 1996             1995               1996             1995
<S>                                                  <C>               <C>               <C>              <C>    
Allowance for possible loan losses
 at beginning of period                              $ 7,654           $ 8,062           $ 8,025          $ 8,140
Loans charged-off:
 Commercial                                                0                 0               406              113
 Agriculture                                               0                 0                 0                0
 Real estate construction                                  0                 0                 0                0
 Loans to individuals                                     96                71               265              272
 Real estate - residential mortgage                        2                 0                 2                0
                                                     -------           -------           -------          -------
Total loans charged-off                                   98                71               673              385

Recoveries of loans previously charged-off:
 Commercial                                              128               123               299              306
 Agriculture                                               0                 0                 0                0
 Real estate construction                                  7                 7                19               38
 Loans to individuals                                     15                 4                36               26
 Real estate - residential mortgage                        0                 0                 0                0
                                                     -------           -------           -------          -------
 Total recoveries of loans previously
                          charged-off                    150               134               354              370

 Net loans charged-off                                   (52)              (63)              319               15
 Current period's provision for
 possible loan losses                                      0                 0                 0                0
                                                     -------           -------           -------          -------

 Allowance for possible loan
 losses at end of period                             $ 7,706           $ 8,125           $ 7,706          $ 8,125
                                                     =======           =======           =======          =======
</TABLE>

Other Operating Income and Expense
     Other  operating  income was $1.6  million  and $1.3  million for the three
months ended September 30, 1996 and 1995,  respectively.  Other operating income
was $4.3 million and $3.7 million for the nine months ended  September  30, 1996
and 1995,  respectively.  For the three and nine month  period,  the increase in
other operating income is primarily attributable to mortgage banking operations;
results from this line of business were  increased  significantly  following the
acquisition,  during  the first  quarter  of 1996,  of the  business  assets and
operations of a mortgage  banking  company  located in Lancaster,  Pennsylvania.
Other operating income is generated from mortgage banking activities through the
sale  of  originated  mortgage  loans  in  the  secondary  market.  The  Company
recognized  $644  thousand  from  selling  $27.2  million  of  mortgages  in the
secondary  market in the nine month period of 1996 compared to recognizing  $156
thousand from selling $7.5 million in the secondary market in the same period of
1995.

     Other  operating  expense for the three months ended September 30, 1996 was
$4.8 million, a 5.0 percent increase over the $4.6 million reported for the same
period of 1995.  For the nine months ended  September  30, 1996 and 1995,  other
operating expense was $14.0 million and $13.8, million, respectively.

     Salaries and benefits  expense  increased by $162  thousand or 6.57 percent
for the three months  ended  September  30, 1996  compared to the same period of
1995.  For the nine months  ended  September  30,  1996,  salaries  and benefits
increased by $267 thousand or 3.7 percent,  compared to the same period of 1995.
The  increase  in salary and  benefit  expenses  is a result of adding  staffing
expense for the acquisition of Central  Mortgage's banking operations during the
first quarter of 1996  combined with overall merit  increases of 4 percent which
was applied to base salaries as of January 1, 1996.  The effects of adding these
staffing positions were somewhat offset as a result of an internal  productivity
enhancement  program that has  strengthened  the Company's  sales efforts of the
Bank's products while maximizing its overhead efficiency.  This plan resulted in
a 3 percent  reduction in staffing  positions,  during the first quarter,  which
were realized  through  attrition.  In addition,  a component of the increase in
salary and benefit  expenses  during the third  quarter of 1996  compared to the
same period of 1995 was due to additional  staffing for the Bank's twentieth and
twenty-  first branch  offices in  Lancaster  County,  Pennsylvania.  These full
service branch banking offices opened during October, 1996.


                                      -10-

<PAGE>

     Other expense increased by $37 thousand and $325 thousand for the three and
nine month comparative periods from 1995 to 1996. This increase was attributable
to  increased  expenses  related to the  acquisition  of the  mortgage  company,
increased  marketing  and  advertising  expenses and an increase in advisory and
consulting  fees  related to the  Company's  internal  productivity  enhancement
program. The Company's FDIC deposit insurance  substantially offset the increase
in expenses  for the three and nine month  periods  compared  to 1995.  The Bank
expense  for FDIC  insurance  for the first nine  months of 1995  totalled  $492
thousand  compared  to $2  thousand  for the same  period  of 1996.  The Bank is
currently paying an assessment rate of $500 per quarter.

Non-Performing Assets
     Loans,  other than consumer loans not secured by real estate, are typically
classified  as  non-accrual  at the  time  they  reach  90 days  past  due as to
principal or interest.  Loans may also be placed on non-accrual  status when, in
management's  opinion,  the collectability of principal or interest is doubtful,
or should management  believe that circumstances  warrant such action.  Consumer
loans not secured by residential  real estate are  charged-off  when they become
120 days past due.

     Non-performing  loans at September  30, 1996  totalled  $1.2 million or .28
percent of total loans  outstanding,  compared to $1.5 million or .39 percent of
loans at December 31, 1995 and $2.9 million or .76 percent of loans at September
30, 1995.  Non-performing  assets at September 30, 1996 were $1.9 million or .46
percent of loans plus other real estate  owned  compared to $2.4  million or .62
percent of loans plus other real  estate  owned at  December  31,  1995 and $4.0
million or 1.03 percent of loans plus other real estate  owned at September  30,
1995. The improvement in non-performing assets at September 30, 1996 as compared
to September  30, 1995 was a result of decreased  levels of  non-accrual  loans,
loans past due 90 or more as to  principal  or  interest  and other real  estate
owned.

     The following is a presentation  of  non-performing  assets as of September
30, 1996, December 31, 1995, and September 30, 1995:
<TABLE>
<CAPTION>
                                              Sept. 30          Dec. 31         Sept. 30
(Dollars in thousands)                          1996             1995             1995
<S>                                            <C>              <C>              <C>   
Non-performing loans                           $  727           $  741           $1,665
Loans past due 90 days or more as to
  principal or interest                           455              793            1,235
                                               ------           ------           ------
Total non-performing loans                      1,182            1,534            2,900

Other real estate owned, net                      749              913            1,059
                                               ------           ------           ------
Total non-performing assets                    $1,931           $2,447           $3,959
                                               ======           ======           ======

Allowance for possible loan losses to
  non-performing loans                          6.52x            5.23x            2.80x
Non-performing loans as a
  percent of loans outstanding                    .28%             .39%             .76%
Non-performing assets as a
  percent of loans outstanding
  plus other real estate owned                    .46%             .62%            1.03%
</TABLE>

     Interest income of approximately  $17 thousand and $135 thousand would have
been  recognized  during the three and nine month  periods  ended  September 30,
1996,  had these loans been current in accordance  with their original terms and
been  outstanding  through the period or since  origination.  Interest income on
these loans of $1 thousand and $41 thousand was recognized  during the three and
nine months ended September 30, 1996.

     Group  concentrations  of  credit  are  considered  to exist if a number of
counterparties  are  engaged in similar  activities  and have  similar  economic
characteristics  that would cause their ability to meet contractual  obligations
to  be  similarly   affected  by  changes  in  economic  or  other   conditions.
Agriculture-related  borrowings  at September  30, 1996 totalled $102 million or
24.2 percent of total loans outstanding.  These loans may be impacted by adverse
climate or economic  conditions  not common to other  industries.  The Company's
exposure to possible loss in the event of  nonperformance  by these borrowers is
represented by the contractual amount of those instruments. The Company's policy
is to require  supporting  collateral  for these loans which is generally in the
form of agriculture real estate, livestock, and farm equipment. At September 30,
1996  there  were no  significant  agriculture  related  borrowings  which  were
classified as non-performing assets and there were no charge-offs of agriculture
related loans during the three or nine months ended September 30, 1996.


                                      -11-

<PAGE>

Financial Position
     Total  assets at  September  30,  1996 were $587  million  compared to $578
million at December 31, 1995. Total loans outstanding at September 30, 1996 were
$423 million  compared to $391 million at December 31, 1995.  Total  deposits at
September  30, 1996 were $501  million  compared to $488 million at December 31,
1995. The $32 million or 8.1 percent growth in loans  outstanding  from December
31, 1995 to  September  30, 1996 was funded by a $20  million  reduction  in the
Company's investment  portfolio,  including federal funds sold and a $13 million
increase in deposit  balances.  Loan balances  have  increased as a result of an
increased sales and marketing. The reduction in the investment portfolio,  which
was used to fund the loan growth was achieved through the contractual maturities
of the investment portfolio.

Capital Adequacy
     The Company's  stockholders' equity was $61.6 million at September 30, 1996
and $58.9 million at December 31, 1995. Total stockholders'  equity increased by
4.6 percent from  December 31, 1995 which was the net effect of the  recognition
of $6.3 million in net income for the nine month period,  cash dividend payments
to stockholders of $2.5 million,  an unfavorable  change in net unrealized gains
or losses on investment securities available for sale of $124 thousand,  and due
to the acquisition of treasury stock at a cost of $974 thousand.  Net unrealized
gains on  investment  securities  available  for sale of $212  thousand and $336
thousand were included as a component of  stockholders'  equity at September 30,
1996 and  December 31, 1995,  respectively.  A total of 43,300  shares of common
stock were reacquired by the Company during the third quarter of 1996.

     On June 12, 1996 the Company announced its intentions to repurchase up to 5
percent or 203,584 shares of its  outstanding  common stock.  These  repurchased
shares  will  be  available  for  reissuance   through  the  Company's  Dividend
Reinvestment or Stock Option Plans or for other general corporate purposes.

     The  maintenance  of an  appropriate  level of capital is a priority of the
Company's  management.  The Company's  capital  adequacy and dividend policy are
closely  monitored  by  management  and are  reviewed  regularly by the Board of
Directors of the Company.  The Company  intends to provide an adequate return to
its stockholders while retaining a sufficient capital base to provide for future
growth and to comply with regulatory standards.

     Banking  regulators'  risk-based  capital  guidelines  address  the capital
adequacy of banking  organizations.  These  guidelines  include a definition  of
capital and a framework for calculating risk-weighted assets by assigning assets
and off-balance sheet items to broad risk categories,  as well as minimum ratios
to be maintained by banking  organizations.  The  risk-based  capital ratios are
calculated by dividing qualifying capital by risk-weighted assets.

     Under the risk-based  capital  guidelines,  Total Capital is defined as the
sum of core or "Tier 1" Capital and "Tier 2" Capital. As the guidelines apply to
Keystone Heritage Group, Inc., Tier 1 Capital is total stockholders'  equity and
Tier 2 Capital includes a portion of the allowance for possible loan losses. The
rules  require that banking  organizations  must have ratios of 4.00 percent and
8.00 percent for Tier 1 and Total Capital,  respectively.  At September 30, 1996
the  Company's  Tier 1 and Total  Capital  ratios  were 13.24  percent and 14.55
percent,  respectively.  Tier 1 and Total Capital  ratios were 13.59 percent and
14.93 percent respectively,  at December 31, 1995. In addition to the risk-based
capital ratio, a bank is also required to maintain a "Leverage  ratio" of Tier 1
capital to average  total assets of 3 percent or higher.  At September 30, 1996,
the Company's Leverage ratio was 10.44 percent and was 10.29 percent at December
31, 1995.

Off-Balance Sheet Items

     The  Company's  loan   portfolio   consists  of  loans  to  businesses  and
individuals  primarily  in its  five-county  market area of Lebanon,  Lancaster,
Berks, Dauphin, and Schuylkill counties.

     In the ordinary course of business, the Company enters into agreements with
customers,  such as commitments  to extend credit and standby  letters of credit
which involve, to varying degrees,  elements of credit and interest rate risk in
excess of the amounts presented in the balance sheet. The Company's  exposure to
possible loss in the event of nonperformance by the other party to the financial
instruments for commitments to extend credit and financial guarantees written is
represented by the contractual amount of those instruments.  The Company may not
be obligated to advance funds if the customer's financial condition deteriorates
or if the customer fails to meet certain terms.


                                      -12-

<PAGE>

     Commitments and  conditional  obligations  generally have fixed  expiration
dates or termination clauses and may require payment of a fee. Since many of the
commitments  are expected to expire  without  being used,  the total  commitment
amounts do not  necessarily  represent  future  cash  requirements.  The Company
evaluates each customer's creditworthiness on a case-by-case basis, applying the
same  credit   standards  used  in  the  lending   process,   through   periodic
reassessments  of the  customer's  creditworthiness  and through  ongoing credit
reviews. The amount of collateral  obtained,  if deemed necessary by the Company
upon  extension of credit,  is based on  management's  credit  evaluation of the
counterparty.  Collateral  held  varies  but may  include  accounts  receivable,
inventory,  property,  plant  and  equipment,  and  income-producing  commercial
properties.

     The Bank is presently party to several interest rate swap contracts as part
of its asset-liability management activities. These contracts are used primarily
for the purpose of  managing  interest  rate risk  against  specific  assets and
liabilities  in  order  to  minimize  mismatches  in the  Bank's  interest  rate
sensitivity and interest rate risk positions.

     Interest rate swap  contracts  generally  involve the exchange of fixed and
floating-rate   interest  payment   obligations  without  the  exchange  of  the
underlying principal amounts. Entering into interest rate contracts involves not
only the risk of dealing with counterparties and their ability to meet the terms
of the  contracts  but also the interest  rate risk  associated  with  unmatched
positions should the counterparties fail to perform.  Notional principal amounts
often are used to express the volume of these transactions.

     The interest  income or interest  expense  differential  from interest rate
swap  contracts is  recognized  on the accrual  basis as a component of interest
income or interest  expense over the life of the  contract.  Interest  income or
interest  expense  resulting from the cap and collar  contracts is recognized on
the  accrual  basis  when  the  national  prime  rate  moves  below  or  above a
predetermined  interest rate level.  Gains or losses from early  termination  of
swap  contracts  are  deferred  and  amortized  over the  remaining  term of the
underlying  assets or liabilities.  The Company is not exposed to credit risk in
terms of the  notional  amounts  of these  contracts,  however,  the  receipt of
payments representing the interest differential is based on the creditworthiness
of the counterparty to each contract.

     Interest rate sensitivity is a function of the repricing characteristics of
the Company's assets and liabilities.  Each asset and liability  reprices either
at  maturity or during the life of the  instrument.  Interest  rate  sensitivity
measures the difference  between the volume of assets and  liabilities  that are
subject to repricing at a future period of time. These  differences are known as
interest sensitivity gaps.

     The principal  objectives of  asset-liability  management are to manage the
funding and investment  strategies  necessary to maintain an appropriate balance
of the  sensitivity  between assets and  liabilities  to potential  movements in
interest rates and to provide adequate  liquidity while enhancing  profitability
through returns from managed levels of interest rate risk. The Company  actively
manages the interest rate  sensitivity  of its assets and  liabilities.  Several
techniques are used for measuring  interest rate  sensitivity.  The  traditional
maturity "gap" analysis,  which reflects the volume difference  between interest
rate sensitive  assets and liabilities  during a given time period,  is reviewed
regularly  by  management.  An interest  rate risk  simulation  model is used to
assess the level of  interest  rate risk  inherent in the  Company's  assets and
liabilities  under various interest rate scenarios.  The Company  recognizes the
importance  of  managing  both  assets and  liabilities  simultaneously  for the
purpose of managing interest rate risk, providing  liquidity,  and enhancing the
market value of the Company.

     Managing  interest rate  sensitivity is an inexact  science.  The repricing
intervals  between assets and liabilities  change on a daily basis.  Contractual
maturities  are not  always  the  same  as  actual  maturities  as a  result  of
prepayments prior to scheduled maturities.  Additionally,  demand deposits,  NOW
accounts,  and money  market fund  accounts may be  withdrawn  upon demand,  and
savings  deposits may be withdrawn upon a very short period of notice.  However,
for asset-liability management purposes, the Company considers a portion of each
of these types of deposits to be "core"  amounts which may be considered to have
various maturities.

     The Company  manages its  interest  rate  sensitivity  by changing  mix and
repricing  characteristics of its assets and liabilities  through its investment
securities  portfolio,  its loan  and  deposit  terms,  and  through  the use of
off-balance  sheet  derivatives,  primarily  interest rate swap  contracts.  The
interest rate contracts  presently in effect will have a negative  effect on net
interest  income  in a rising  rate  environment  and a  positive  effect on net
interest income in a decreasing rate environment.


                                      -13-

<PAGE>

     The Company's use of these interest rate contracts is closely  monitored by
the  Company's  Board of  Directors  and is closely  controlled  as to levels of
exposure.  At September  30, 1996 the Company had six interest  rate  agreements
outstanding having a total notional amount of $60 million.  These agreements are
in the form of interest rate swap  agreements each with a notional amount of $10
million having remaining maturities ranging from one to three years.

     The Company entered into two interest rate swap contracts  during the first
quarter of 1996 and one interest rate swap contract  during the third quarter of
1996. On March 4, 1996, the Company  entered into an interest rate swap contract
with a notional  amount of $10 million.  This  contract  states that the Company
would  receive a fixed rate of 8.25 percent and pay a floating  prime rate based
on the  national  prime rate and expires on March 4, 1998.  The Company  entered
into  another  interest  rate swap  contract  on March 14,  1996 with a notional
amount of $10 million.  This  contract  states that the Company  would receive a
fixed rate of 8.65  percent and pay a floating  prime rate based on the national
prime rate and expires on March 15,  1999.  The  Company  entered  into  another
interest  rate swap  contract  on July 10,  1996 with a  notional  amount of $10
million.  This  contract  states that the Company  would receive a fixed rate of
9.15 percent and pay a floating  prime rate based on the national prime rate and
expires on July 10, 1998.

     The  Company  does not  obtain  collateral  or other  security  to  support
financial instruments subject to credit risk but monitors the credit standing of
counterparties. The counterparties of the aforementioned interest rate contracts
are commercial banks having a rating of A1 from Moody's Investor Service.

     The interest rate swap contracts were entered into to protect the Company's
interest  rate  risk  in  a  declining  or  stable  interest  rate  environment.
Specifically, these contracts protect the Company's risk from negative movements
in its prime rate based asset portfolio which would not be perfectly  matched by
repricing  liabilities.  These  contracts  were  entered  into to  minimize  the
negative effects that the Bank would realize, in falling rate environments (e.g.
reduction in prime based rates).

     The following is the amount of financial instruments with off-balance sheet
risk not reflected in the consolidated  balance sheets at September 30, 1996 and
December 31, 1995:
<TABLE>
<CAPTION>
                                               Contractual Amounts
                                            Sept. 30        December 31
(Dollars in thousands)                        1996              1995
<S>                                         <C>              <C>    
Financial instruments whose
contractual amounts represent
 credit risk:
Commitments to extend credit                $95,791          $88,242
Standby letters of credit                     8,076            8,862
Contractual amounts of off-balance
sheet financial instruments not
constituting credit risk:
Interest rate swap, notional
value                                        60,000           30,000
Interest rate cap/collar, notional
value                                           -0-           10,000
</TABLE>


Supervision and Regulation
     During 1994, Congress passed legislation to remove geographic  restrictions
on bank expansion.  The Riegle-Neal Interstate Banking and Branch Efficiency Act
of 1994  will  allow  banks to  expand  across  state  lines  to merge  existing
multi-state  branching  operations  into a single  institution or to acquire new
branches in other states.  Interstate  banking and branching  authority  will be
subject to  certain  conditions  and  restrictions,  such as  capital  adequacy,
management,  CRA compliance and limits on deposit concentrations.  The effective
date for this legislation will be June 1, 1997.  Individual states will have the
option to opt in early or to opt out completely prior to June 1, 1997.

     Although  the  passage  of this  legislation  should  have  the  impact  of
quickening the pace of consolidation  within the banking  industry,  the Company
does not  anticipate  any immediate  impact upon its financial  condition or its
operations as a result of this new law.


                                      -14-

<PAGE>

     Congress has recently agreed on a legislative  package to stabilize the S&L
industry's  deposit  insurance  fund (SAIF).  The  legislation  requires the S&L
industry to recapitalize its insurance fund with a one-time assessment. Previous
proposals  required the bank  insurance  fund (BIF) to  contribute a substantial
amount to help  recapitalize  SAIF.  Under the  current  legislation,  banks are
required to pay an annual rate of 1.29 cents for every $100 of domestic deposits
from 1997 through 1999 and pay 2.43 cents per $100 of domestic  deposits for the
years of 2000  through  2017.  In  addition,  the Bank would be  required to pay
higher  assessment  rate on SAIF deposit.  The Bank does not currently have SAIF
deposits. The Bank is currently paying the mimimum premium of $2,000 per year

     The Bank is a national bank,  chartered under the National Bank Act, and is
subject to the primary  supervision  of, and is examined by, the  Comptroller of
the Currency.  As a member of the Federal Reserve System, the Bank is subject to
provisions of the Federal  Reserve Act, which restricts the ability of a bank to
extend  credit to its parent  holding  company  or to  certain  of the  parent's
subsidiaries,  or to invest in the Company's  common stock or to take such stock
as  collateral  for loans to any borrower.  The  operations of the Bank are also
subject to regulation by the FDIC.

     The Company is affected by the monetary and credit  policies of the Federal
Reserve System. The Federal Reserve System regulates the national supply of bank
credit through open market operations in U. S. Government securities, changes in
the  discount  rate  charged  for  bank   borrowing,   and  changes  in  reserve
requirements on bank deposits.

New Accounting Standards
     On January 1, 1996 the  Company  adopted the  provisions  of  Statement  of
Financial  Accounting  Standards  No.  121  (SFAS  121),   "Accounting  for  the
Impairment of Long-Lived  Assets and for  Long-Lived  Assets to be Disposed Of".
SFAS  provides  guidance  for  recognition  and  measurement  of  impairment  of
long-lived assets, certain identifiable intangibles and goodwill related both to
assets held and used and assets to be disposed of.

     SFAS  121  requires  that  long-lived   assets  and  certain   identifiable
intangibles  held and used by an  entity be  reviewed  for  impairment  whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable.  In performing the review for recoverability,  an entity
should  estimate  the future  cash flows  expected to result from the use of the
asset and its eventual disposition. If the sum of the expected future cash flows
(undiscounted  and without interest charges) is less than the carrying amount of
the asset,  an impairment loss is recognized.  Otherwise,  an impairment loss is
not  recognized.  Measurement of an impairment  loss for  long-lived  assets and
identifiable  intangibles that an entity expects to hold and use should be based
on the fair value of the asset.

     SFAS  121  requires  that  long  lived  assets  and  certain   identifiable
intangibles  to be disposed  of be  reported at the lower of carrying  amount or
fair value less cost to sell. The  implementation of SFAS 121 did not materially
impact the Company's financial condition or results of operation.

     On January 1, 1996, the Company  adopted the provisions of the Statement of
Financial  Accounting  Standards  No. 122,  "Accounting  for Mortgage  Servicing
Rights,  an  amendment  of FASB  Statement  No. 65" (SFAS 122).  SFAS 122 amends
Statement  65 to require an  institution  to  recognize  as separate  assets the
rights to  service  mortgage  loans for others  when a mortgage  loan is sold or
securitized and servicing rights  retained.  SFAS 122 also requires an entity to
measure the impairment of servicing  rights based on the difference  between the
carrying amount of the servicing rights and their current fair value.

     Presently,  the Company  does not sell or  securitize  mortgage  loans with
servicing rights retained. Accordingly, the Company has not been impacted by the
provisions of SFAS 122.

     On January 1, 1996 the  Company  adopted the  provisions  of  Statement  of
Financial   Accounting   Standards   No.  123,   "Accounting   for   Stock-Based
Compensation"  (SFAS 123).  SFAS 123  establishes a new method of accounting for
stock-based  compensation  arrangements with employees. The new method is a fair
value  based  method  rather  than the  intrinsic  value  based  method  that is
currently  utilized.  However,  SFAS 123 does not require an entity to adopt the
new  fair  value  based  method  for  purposes  of  preparing   basic  financial
statements.  If an entity chooses not to adopt the fair value based method, SFAS
123  requires  an entity to  display in the  footnotes  pro forma net income and
earnings  per share  information  as if the fair  value  based  method  had been
adopted.

     The Company has not adopted the fair value method as described in SFAS 123.
The Company will disclose in the footnotes, in the 1996 Annual Report, pro forma
net income and  earnings per share  information  as if the fair value method had
been adopted.


                                      -15-

<PAGE>

     In June 1996, the Financial  Accounting Standards Board issued Statement of
Financial Accounting  Standards No. 125 (SFAS),  Accounting for and Servicing of
Financial  Assets  and  Extinguishment  of  Liabilities  (Statement).  SFAS  125
provides  accounting  and  reporting  standards  for  transfers and servicing of
financial  assets  and   extinguishments  of  liabilities  based  on  consistent
application  of a  financial-components  approach  that  focuses on control.  It
distinguishes  transfers of financial  assets that are sales from transfers that
are secured borrowings.

     Under the  financial-components  approach,  after a transfer  of  financial
assets,  an entity recognizes all financial and servicing assets it controls and
liabilities  it has  incurred  and  derecognizes  financial  assets it no longer
controls and liabilities that have been extinguished.  The  financial-components
approach  focuses on the assets and  liabilities  that exist after the transfer.
Many of these assets and  liabilities  are  components of financial  assets that
existed  prior to the  transfer.  If a transfer does not meet the criteria for a
sale,  the  transfer  is  accounted  for as a secured  borrowing  with pledge of
collateral.

     SFAS 125 extends the  "available-for-sale"  or  "trading"  approach in SFAS
115,  Accounting  for  Certain  Investments  in Debt and Equity  Securities,  to
non-security  financial  assets that can  contractually  be prepaid or otherwise
settled  in  such  a way  that  the  holder  of  the  asset  would  not  recover
substantially  all of its recorded  investment.  Thus,  non- security  financial
assets (no matter how acquired)  that are subject to prepayment  risk that could
prevent recovery of substantially  all of the recorded amount are to be reported
at fair  value  with the change in fair value  accounted  for  depending  on the
asset's  classification  as  "available-for-sale"  or  "trading".  SFAS 125 also
amends SFAS 115 to prevent a security from being classified as  held-to-maturity
if the  security  can be  prepaid  or  otherwise  settled in such a way that the
holder of the  security  would not  recover  substantially  all of its  recorded
investment.

     SFAS 125 requires  that a liability be  derecognized  if and only if either
(a) the debtor  pays the  creditor  and is relieved  of its  obligation  for the
liability or (b) the debtor is legally  released from being the primary  obligor
under the liability either judicially or by the creditor.

     Currently,  management  has not  determined  the  impact  on the  Company's
financial  condition or results of operations upon adoption of the provisions of
SFAS 125. SFAS 125 is effective for transfers and servicing of financial  assets
and extinguishments of liabilities  occurring after December 31, 1996, and is to
be applied prospectively.  Earlier or retroactive  application is not permitted.
Also, the extension of the SFAS 115 approach to certain non- security  financial
assets and the amendment to SFAS 115 is effective  for financial  assets held on
or acquired after January 1, 1997.


                                      -16-

<PAGE>

          AVERAGE BALANCE SHEETS, RATES AND INTEREST INCOME AND EXPENSE
                             (Dollars in thousands)
<TABLE>
<CAPTION>

                                                    Three Months Ended Sept. 30, 1996     Three Months Ended Sept. 30, 1995
                                                  Average                     Average     Average                    Average
                                                  Balance    Interest          Rate       Balance    Interest          Rate
<S>                                              <C>           <C>              <C>      <C>          <C>             <C>  
Assets
    Loans                                        $415,632      $  9,451         9.05%    $382,460     $  8,911        9.24%
    Money market investments                        6,686            89         5.31       12,101          175        5.76
    Investment securities:
        Taxable                                   121,428         1,832         6.00      131,628        1,893        5.70
        Non-taxable                                12,035           202         6.68        9,970          170        6.76
                                                 --------      --------         ----     --------     --------        ---- 
             Total investment securities          133,463         2,034         6.06      141,598        2,063        5.78
             Total earning assets                 555,781      $ 11,574         8.28%     536,159     $ 11,149        8.25%
                                                               ========         ====                  ========        ==== 
    Other assets                                   29,315                                  28,164
                                                 --------                                --------
             Total assets                        $585,096                                $564,323
                                                 ========                                ========

Liabilities and stockholders' equity 
Interest bearing deposits:
        Now accounts                             $ 54,109      $    171         1.26%    $ 55,746     $    202        1.44%
        Savings and money market                  131,209         1,048         3.18      123,734          955        3.06
        Time                                      247,289         3,453         5.56      240,402        3,517        5.80
                                                 --------      --------         ----     --------     --------        ---- 
             Total interest bearing deposits      432,607         4,672         4.30      419,882        4,674        4.42

    Short-term borrowings                          13,116           135         4.10       11,664          119        4.05
    Other Borrowings                                6,814            98         5.69       11,948          177        5.88
                                                 --------      --------         ----     --------     --------        ---- 
        Total interest bearing liabilities        452,537      $  4,905         4.31%     443,494     $  4,970        4.45%
                                                               ========         ====                  ========        ==== 

    Non-interest bearing deposits                  63,920                                 57,427
    Other liabilities                               7,282                                  7,086
    Stockholders' equity                           61,357                                 56,316
                                                 --------                               --------
        Total liabilities and
        stockholders' equity                     $585,096                               $564,323
                                                 ========                               ========

    Net interest income                                        $  6,669                             $  6,179
    Total yield on earning assets                                               8.28%                               8.25%
    Rate on supporting liabilities                                              3.51%                               3.68%
                                                                                ----                                ---- 
    Net interest margin                                                         4.77%                               4.57%
                                                                                ====                                ==== 
</TABLE>

Interest and average interest rates are presented on a fully taxable  equivalent
basis,  using an effective  tax rate of 35%. For  purposes of  calculating  loan
yields,  average loan balances include non-accrual loans. Loan fees are included
in interest income.


                                      -17-

<PAGE>

          AVERAGE BALANCE SHEETS, RATES AND INTEREST INCOME AND EXPENSE
                             (Dollars in thousands)
<TABLE>
<CAPTION>
                                                Nine Months Ended Sept. 30, 1996          Nine Months Ended Sept. 30, 1995
                                                  Average                      Average   Average                    Average
                                                  Balance      Interest         Rate     Balance      Interest       Rate
<S>                                              <C>           <C>              <C>      <C>          <C>             <C>  
Assets
    Loans                                        $403,776      $ 27,340         9.04%    $380,883     $ 26,293        9.23%
    Money market investments                        3,882           156         5.38        9,605          422        5.88
    Investment securities:
        Taxable                                   126,440         5,588         5.90      126,170        5,331        5.65
        Non-taxable                                11,942           588         6.58       10,218          523        6.85
                                                 --------      --------         ----     --------     --------        ---- 
             Total investment securities          138,382         6,176         5.96      136,388        5,854        5.74
             Total earning assets                 546,040      $ 33,672         8.24%     526,875     $ 32,569        8.26%
                                                               ========         ====                  ========        ==== 

    Other assets                                   28,529                                  26,949
                                                 --------                                --------
             Total assets                        $574,569                                $553,825
                                                 ========                                ========

Liabilities and stockholders' equity
Interest bearing deposits:
        Now accounts                             $ 54,724      $    534         1.30%    $ 55,866     $    601        1.44%
        Savings and money market                  129,923         3,047         3.13      120,639        2,666        2.96
        Time                                      238,854        10,045         5.62      236,127        9,859        5.58
                                                 --------      --------         ----     --------     --------        ---- 
             Total interest bearing deposits      423,501        13,626         4.30      412,632       13,126        4.25

    Short-term borrowings                          11,832           369         4.17       11,997          362        4.04
    Long-term debt                                  9,620           420         5.82       11,678          581        6.66
                                                 --------      --------         ----     --------     --------        ---- 
        Total interest bearing liabilities        444,953      $ 14,415         4.33%     436,307     $ 14,069        4.31%
                                                               ========         ====                  ========        ==== 

    Non-interest bearing deposits                  61,856                                  56,320
    Other liabilities                               7,418                                   6,702
    Stockholders' equity                           60,342                                  54,496
                                                 --------                                --------
        Total liabilities and
        stockholders' equity                     $574,569                                $553,825
                                                 ========                                ========

    Net interest income                                        $ 19,257                               $ 18,500
    Total yield on earning assets                                               8.24%                                 8.26%
    Rate on supporting liabilities                                              3.53%                                 3.57%
                                                                                ----                                  ---- 
    Net interest margin                                                         4.71%                                 4.69%
                                                                                ====                                  ==== 
</TABLE>

Interest and average interest rates are presented on a fully taxable  equivalent
basis,  using an effective  tax rate of 35%. For  purposes of  calculating  loan
yields,  average loan balances include non-accrual loans. Loan fees are included
in interest income.


                                      -18-

<PAGE>


PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None.

ITEM 2. CHANGES IN SECURITIES

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.


                                      -19-

<PAGE>

                          KEYSTONE HERITAGE GROUP, INC.

                                   SIGNATURES


     Pursuant to the  requirements  of the Securities  Exchange Act of 1934, the
registrant  has duly  caused  this  report  to be  signed  on its  behalf by the
undersigned thereunto duly authorized.



                                    Keystone Heritage Group, Inc.
                                    (Registrant)


Date  November 12, 1996             By /s/ Kurt A. Phillips
                                       --------------------
                                       Kurt A. Phillips
                                       Chief Financial and Accounting Officer



                                      -20-