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    June 30, 1997

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 August 8, 1997
Common Stock ($5.00 par value)                               3,951,583 shares

<PAGE>

                          KEYSTONE HERITAGE GROUP, INC.

                                      Index


PART I - FINANCIAL INFORMATION                                          Page


Item 1 - Financial Statements

         Consolidated Balance Sheets as of
         June 30, 1997 and December 31, 1996 (Unaudited)                  3

         Consolidated Statements of Income for the
         Three and Six Months ended June 30, 1997 and
         1996 (Unaudited)                                                 4

         Consolidated Statements of Stockholders' Equity
         for the Six Months ended June 30, 1997 and
         1996 (Unaudited)                                                 5

         Consolidated Statements of Cash Flows for the
         Six Months ended June 30, 1997 and
         1996 (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

Item 4 - Submission of Matters To A Vote of Security Holders             17

Signature Page                                                           19

                                       -2-

<PAGE>

                          KEYSTONE HERITAGE GROUP, INC.

                           CONSOLIDATED BALANCE SHEETS

                             (Dollars In Thousands)

<TABLE>
<CAPTION>
                                                          June 30      December 31
                                                            1997           1996
<S>                                                       <C>            <C>    
ASSETS
      Cash and due from banks                             $22,008        $22,832
      Interest bearing deposits with banks                    341            181
      Federal funds sold                                    2,100              0
      Investment securities available for sale             68,171         62,596
      Investment securities held to maturity
           (fair value of $93,472 and $92,079
           for 1997 and 1996, respectively)                93,274         91,652
      Loans held for sale                                   1,280          6,019
      Loans, net of unearned income of
         $1,627 for 1997 and $1,812 for 1996              436,988        422,534
      Allowance for loan losses                            (8,681)        (7,736)
                                                        ---------      ---------

           Loans, net                                     428,307        414,798

      Premises and equipment, net                           8,537          8,132
      Accrued interest receivable                           3,720          3,677
      Other real estate owned                                 192            695
      Deferred tax asset, net                               2,665          2,604
      Other assets                                          3,517          3,121
                                                        ---------      ---------

           Total assets                                  $634,112       $616,307
                                                        =========      =========

LIABILITIES
      Non-interest bearing deposits                       $70,569        $72,683
      Interest bearing deposits                           472,188        454,150
                                                        ---------      ---------

           Total deposits                                 542,757        526,833

      Short-term borrowings                                12,086         12,478
      Other borrowings                                      6,113          6,438
      Accrued interest payable                              4,794          5,184
      Other liabilities                                     3,007          3,135
                                                        ---------      ---------

           Total liabilities                              568,757        554,068

STOCKHOLDERS' EQUITY

      Common stock - $5 par value; 10,000,000
           shares authorized; 4,071,683 outstanding
           at June 30, 1997 and December 31, 1996          20,358         20,358
      Capital surplus                                      22,078         22,078
      Retained earnings                                    24,881         21,418
      Treasury stock - 120,100 shares at June 30,
           1997 and 93,700 at December 31, 1996            (2,826)        (2,123)
      Net unrealized gain on investment securities
           available for sale, net of taxes                   864            508
                                                        ---------      ---------

           Total stockholders' equity                      65,355         62,239

           Total liabilities and stockholders'
             equity                                      $634,112       $616,307
                                                        =========      =========
</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     Six Months Ended
                                                                June 30                 June 30
                                                            1997       1996        1997         1996
<S>                                                        <C>         <C>        <C>         <C>    
INTEREST INCOME
              Interest and fees on loans                   $9,785      $8,977     $19,234     $17,730
              Interest and dividends on investment
                securities available for sale:
                  Taxable investment securities               922         696       1,751       1,433
                  Equity investments                           67          49         130         104
              Interest and dividends on investment
                securities held to maturity:
                  Taxable investment securities             1,073       1,074       2,182       2,219
                  Non-taxable investment securities           186         126         359         251
                                                          -------     -------     -------     -------
                    Total interest and dividends on
                     investment securities                  2,248       1,945       4,422       4,007
              Interest on money market investments            123          30         182          67
                                                          -------     -------     -------     -------
                  Total interest income                    12,156      10,952      23,838      21,804

INTEREST EXPENSE
              Interest on deposits                          5,084       4,451       9,990       8,954
              Interest on short-term borrowings               127         113         249         234
              Interest on other borrowings                     95         160         192         322
                                                          -------     -------     -------     -------
                  Total interest expense                    5,306       4,724      10,431       9,510

                  Net interest income                       6,850       6,228      13,407      12,294

              Provision for loan losses                         0           0           0           0
                                                          -------     -------     -------     -------
                  Net interest income after provision
                   for possible loan losses                 6,850       6,228      13,407      12,294

OTHER OPERATING INCOME
              Trust income                                    331         292         648         609
              Service charges on deposits                     359         331         701         637
              Net realized gain on investment
                  securities available for sale                28           0         202          23
              Net gain on sale of mortgage loans              211         249         425         323
              Net gain on sale of credit card loans
                  and merchant processing activity            618           0         618           0
              Other income                                    649         582       1,254       1,065
                                                          -------     -------     -------     -------
                  Total other operating income              2,196       1,454       3,848       2,657

OTHER OPERATING EXPENSE
              Salaries and employee benefits                2,697       2,486       5,441       4,850
              Occupancy expense, net                          374         299         735         627
              Equipment expense                               484         546         938       1,052
              Deposit insurance expense                        17           0          32           1
              Other expense                                   970       1,350       2,245       2,626
                                                          -------     -------     -------     -------
                  Total other operating expense             4,542       4,681       9,391       9,156

                  Income before income taxes                4,504       3,001       7,864       5,795
              Income taxes                                  1,397         923       2,420       1,794
                                                          -------     -------     -------     -------

                  Net income                               $3,107      $2,078      $5,444      $4,001
                                                          =======     =======     =======     =======

PER COMMON SHARE
                  Net income                                 $.78        $.51       $1.37        $.98
                                                          =======     =======     =======     =======

                  Cash dividends paid                        $.25        $.20        $.50        $.40
</TABLE>

                                       -4-

<PAGE>

                          KEYSTONE HERITAGE GROUP, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                            Six Months Ended June 30

                             (Dollars in thousands)
<TABLE>
<CAPTION>

                                                                                                       Net Unrealized
                                                                                                       Gain (Loss) On
                                                        Common       Capital    Retained     Treasury  Securities Available
                                                         Stock       Surplus    Earnings       Stock   for Sale           Total
<S>                                                    <C>          <C>         <C>               <C>         <C>       <C>    
Balance, December 31, 1995                              $20,358      $22,078     $16,107           $0          $336      $58,879
                                                                                                                        --------
 Net Income                                                 -0-          -0-       4,001          -0-           -0-        4,001
                                                                                                                        --------
 Cash dividends ($.40 per share)                            -0-          -0-      (1,629)         -0-           -0-       (1,629)
                                                                                                                        --------
 Change in unrealized gain (loss)
  on investment securities
  available for sale, net of taxes                          -0-          -0-         -0-          -0-         (124)         (124)
                                                        -------      -------     -------      -------      --------      -------

Balance, June 30, 1996                                  $20,358      $22,078     $18,479           $0          $212      $61,127
                                                       ========      =======     =======     ========      ========     ========

Balance, December 31, 1996                              $20,358      $22,078     $21,418      ($2,123)         $508      $62,239
                                                        -------      -------     -------      -------      --------      -------
 Net income                                                 -0-          -0-       5,444           -0-           -0-       5,444
                                                        -------      -------     -------      -------      --------      -------
 Cash dividends ($.50 per share)                            -0-          -0-      (1,981)          -0-           -0-      (1,981)
                                                        -------      -------     -------      -------      --------      -------
 Acquisition of 43,300 shares of
  treasury stock at cost                                    -0-          -0-         -0-         (703)           -0-        (703)
                                                        -------      -------     -------      -------      --------      -------
 Change in unrealized gain
  (loss) on investment securities
  available for sale, net of taxes                          -0-          -0-         -0-          -0-           356          356
                                                        -------      -------     -------      -------      --------      -------

Balance, June 30, 1997                                  $20,358      $22,078     $24,881      ($2,826)         $864      $65,355
                                                       ========      =======     =======     ========      ========     ========
</TABLE>

                                       -5-
<PAGE>

                          KEYSTONE HERITAGE GROUP, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (Dollars in thousands)
<TABLE>
<CAPTION>
                                                                    Six Months Ended
                                                                        June 30
                                                                   1997          1996
<S>                                                              <C>           <C>   
CASH FLOW FROM OPERATING ACTIVITIES:
    Net income                                                   $5,444        $4,001
    Adjustments to reconcile net income to cash:
        Depreciation and amortization                               631           816
        (Increase) decrease in deferred income taxes               (250)          249
        (Increase) decrease in accrued interest receivable          (43)          196
        Decrease in accrued interest payable                       (390)       (1,278)
        Net gain on sale or credit card loans
         and merchant card processing                              (618)            0
        Net gain on sale of other real estate owned                 (60)            0
        Net gain on sale of loans                                  (425)         (323)
        Originations of residential mortgage loans sold         (16,206)      (20,763)
        Proceeds from sale of residential mortgage loans         17,432        18,900
        Net realized gain on investment securities
         available for sale                                        (202)          (23)
        Other, net                                                 (850)         (796)
                                                               --------      --------
            Net cash provided by operating activities             4,463           979

CASH FLOWS FROM INVESTING ACTIVITIES:
    Net increase in money market investments                     (2,260)       (3,512)
    Maturities of investment securities
      held to maturity                                           15,118        12,447
    Maturities of investment securities
      available for sale                                          9,257        13,375
    Sale of investment securities available for sale              2,406            63
    Funds invested in investment securities
      held to maturity                                          (16,667)       (9,393)
    Funds invested in investment securities
      available for sale                                        (16,395)       (3,236)
    Proceeds from sale of credit card loans and
      merchant processing activity                                3,051             0
    Net increase in loans made to customers                     (11,894)      (15,584)
    Net expenditures for premises and equipment                  (1,036)         (600)
    Proceeds from sale of other real estate owned                   609           206
                                                               --------      --------
        Net cash used in investing activities                   (17,811)       (6,234)


CASH FLOWS FROM FINANCING ACTIVITIES:
    Net increase in deposits                                     15,924         4,905
    Net (decrease) increase in short-term borrowings               (392)        2,708
    Net increase (decrease) in other borrowings                    (324)       (5,479)
    Acquisition of treasury stock                                  (703)            0
    Cash dividends paid                                          (1,981)       (1,629)
                                                               --------      --------
        Net cash used by financing activities                    12,524           505

    Net decrease in cash and due from banks                        (824)       (4,750)

    Cash and due from banks at beginning of period               22,832        23,766
    Cash and due from banks at end of period                    $22,008       $19,016

SUPPLEMENTAL DISCLOSURES:
    Interest paid                                                $5,558        $4,826
    Income taxes paid                                             2,450         1,683

NON-CASH INVESTING AND FINANCING ACTIVITIES:
    Loans charged-off                                               308           575
</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 June 30, 1997 and December
      31,  1996,  the  consolidated  statements  of income for the three and six
      month periods ended June 30, 1997 and 1996 and the consolidated statements
      of cash  flows  for the six  months  ended  June 30,  1997 and  1996.  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 1997. 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.    Earnings per common share are based upon the  weighted  average  number of
      shares outstanding.  The weighted average number of shares outstanding was
      3,955,121  and  4,071,683  for the three month periods ended June 30, 1997
      and 1996,  respectively,  and  3,962,576  and 4,071,683 for the six months
      ended June 30, 1997 and 1996, respectively.


3.    During the second  quarter of 1997 the Company  completed  the sale of its
      $3.1  million  portfolio  of credit  card  receivables,  and in a separate
      transaction,  completed  the sale of its  merchant  credit card  processor
      portfolio.  The combined effect of these  transactions  resulted in a $618
      thousand pre-tax gain.


                                       -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 June 30, 1997 was
$3.107  million or $.78 per share,  compared to $2.078 million or $.51 per share
for the three months ended June 30, 1996. Return on average stockholders' equity
and return on average  assets for the 1997  period  were 19.61  percent and 2.00
percent, respectively.

      During the second  quarter,  the Company sold its $3.1 million credit card
receivables  portfolio and its merchant  credit card  processor  portfolio at an
after-tax net gain of approximately  $400 thousand or $.10 per share. Net income
was also improved as a result of receiving  interest income and recovering legal
expenses previously expended on a charged-off commercial loan. The net after-tax
effect of these commercial loan related items was approximately $320 thousand or
$.08 per share.  As part of the  settlement,  the Company  also  recovered  $500
thousand of loans previously  charged-off  which  contributed to the increase in
the Allowance for Loan Losses to $8.7 million.

      Net income for the six months  ended June 30,  1997 was $5.444  million or
$1.37 per share,  compared to net income of $4.001 million or $.98 per share for
1996.  Return on average  stockholders'  equity and return on average assets for
the 1997 period were 17.41 percent and 1.78 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 15 and 16 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 June 30,  1997 and 1996,  and for the six months  ended June 30,  1997 and
1996.

      Net  interest  income for the three  months  ended June 30,  1997 was $7.0
million,  a $660 thousand or 10.4 percent increase from the same period of 1996.
The net interest margin for the second quarter of 1997 was 4.76 percent compared
to 4.71  percent for the same  period of 1996.  Average  earning  assets for the
three month period ended June 30, 1997 were $592.4  million,  a $47.8 million or
an 8.8  percent  increase  from the same  period of 1996.  For the  three  month
comparative  periods,  net interest income and the net interest margin increased
in 1997  primarily as a result of an increase in average  loans  outstanding  of
$28.2  million or 7.0 percent and increases in the  investment  and money market
investment balances of $19.6 million or 14.0 percent.  This growth was primarily
funded by  increases  in average  interest  bearing  deposit  balances  of $44.9
million, or 10.7 percent and an increase in average  non-interest bearing demand
deposits of $3.4 million or 5.4 percent.

                                       -8-

<PAGE>

      Net  interest  income  for the six months  ended  June 30,  1997 was $13.8
million,  a $1.2 million or 9.4 percent  increase  from the same period of 1996.
The net interest  margin for the six months ended June 30, 1997 was 4.74 percent
compared to 4.68 percent for the same period of 1996. Average earning assets for
the six month period ended June 30, 1997 were $585.5 million, a $44.4 million or
a 8.2 percent increase from the same period of 1996.

Provision and Allowance for Loan Losses
      There was no provision  for loan losses  charged to net income  during the
six month period ended June 30, 1997 or 1996.

      Net  recoveries  of $782 thousand were recorded for the three months ended
June 30, 1997 compared to net  charge-offs  of $122 thousand for the same period
of  1996.  For the  six  month  comparative  period  the  Company  recorded  net
recoveries  of $945  thousand  for 1997 and  recorded  net  charge-offs  of $371
thousand for 1996.  During the second quarter or 1997,  the Company  recovered a
total of $885  thousand on three  unrelated  commercial  loans.  A total of $500
thousand  which  was  previously  charged  off  in  1992  was  recovered  on one
commercial  loan though a  litigation  process.  In  addition  to the  recovered
principal  balance on this loan,  the Company also  recovered  $490  thousand in
interest income and legal expenses  associated  with this loan.  Commercial loan
charge-offs for the six months ended June 30, 1997 were $339 thousand lower than
the same period of 1996 while  charge-offs in loans to individuals  increased by
$68 thousand for the same comparative periods.

      The  allowance  for loan losses was $8.7  million or 1.99 percent of total
loans  outstanding at June 30, 1997 and $7.7 million or 1.83 percent at June 30,
1996.  The allowance for 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 loan losses.  The allowance for 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  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 loan losses.


                                       -9-

<PAGE>

      The  following  is a summary of the  activity  in the  allowance  for loan
losses for the three and six month periods ended June 30, 1997 and 1996:
<TABLE>
<CAPTION>
                                                                        Three Months Ended                Six Months Ended
                                                                              June 30                         June 30
(Dollars in thousands)                                                   1997             1996             1997      1996
<S>                                                                     <C>              <C>              <C>        <C>
 Allowance for loan losses
  at beginning of period                                               $7,899           $7,776            $7,736    $8,025
 Loans charged-off:
  Commercial                                                               67              142                67       406
  Agriculture                                                               0                0                 0         0
  Real estate construction                                                  0                0                 0         0
  Loans to individuals                                                    138               88               237       169
  Real estate - residential mortgage                                        4                0                 4         0
                                                                       ------           ------            ------    ------
 Total loans charged-off                                                  209              230               308       575

 Recoveries of loans previously charged-off:
  Commercial                                                              964               90             1,210       171
  Agriculture                                                               0                0                 0         0
  Real estate construction                                                  0                8                 0        12
  Loans to individuals                                                     26               10                42        21
  Real estate - residential mortgage                                        1                0                 1         0
                                                                       ------           ------            ------    ------
  Total recoveries of loans previously
                           charged-off                                    991              108             1,253       204

  Net loans charged-off                                                  (782)             122              (945)      371
  Current period's provision for
  loan losses                                                               0                0                 0         0
                                                                       ------           ------            ------    ------

  Allowance for loan
  losses at end of period                                              $8,681           $7,654            $8,861    $7,654
                                                                       ======           ======            ======    ======
</TABLE>

Other Operating Income and Expense
     Other  operating  income was $2.2  million  and $1.5  million for the three
months ended June 30, 1997 and 1996,  respectively.  Other operating  income was
$3.9  million and $2.7  million for the six months ended June 30, 1997 and 1996,
respectively.  During the second quarter of 1997 the Company  completed the sale
of its $3.1  million  portfolio  of credit card  receivables,  and in a separate
transaction, completed the sale of our merchant credit card processor portfolio.
The combined effect of these  transactions  resulted in a $618 thousand  pre-tax
gain.  The  gain on the sale of the  credit  card  portfolio  along  with  gains
recognized on the sale of certain  equity  investments  recorded as  investments
available  for sale were the primary  reasons for the growth in other  operating
income  during the six month period of 1997 compared to the same period of 1996.
In addition,  the Company recognized $425 thousand from selling $16.2 million of
mortgages in the  secondary  market in the six month period of 1997  compared to
recognizing  $323 thousand from selling $20.8 million in the secondary market in
the same period of 1996. The increase in the gain on sale of mortgage loans is a
result of an increase in the the amount of government (FHA and VA) loans sold in
1997 compared to 1996.  Although  total  mortgage loan sales have decreased from
1996 the profit margin attributable to FHA and VA loans is significantly  higher
than the  conventional  loans which the Company  sold  exclusively  prior to the
acquisition of Central Mortgage Company during the first quarter of 1996.

     Other  operating  expense for the three months ended June 30, 1997 was $4.5
million,  a 3.0 percent  decrease  from the $4.7  million  reported for the same
period of 1996. For the six months ended June 30, 1997 other  operating  expense
was $9.4 million compared to $9.2 million for the same period of 1996.

     Salaries and benefits expense increased by $211 thousand or 8.5 percent and
by $591  thousand or 12.2  percent  for the three and six months  ended June 30,
1997  compared to the same  periods of 1996.  The increase in salary and benefit
expense is primarily  attributable to the opening of five de novo branches since
September  30, 1996 and the effects of the staffing for Central  Mortgage  being
present for the full year in 1997,  compared to being present for four months in
1996. In addition  merit  increases of 3.5 percent were applied to base salaries
as of January 1, 1997. Other expense  decreased by  approximately  $380 thousand
for both the three and six month  periods  ended June 30,  1997  compared to the
same period of 1996. A portion of the reduction in other  operating  expense was
attributable to the recovery of previously expended legal fees amounting to $458
thousand for two separate commercial loans.

                                      -10-

<PAGE>

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 June 30, 1997 totalled $966 thousand or .22 percent
of total loans outstanding, compared to $973 thousand or .23 percent of loans at
December  31, 1996 and $1.3  million or .31  percent of loans at June 30,  1996.
Non-performing assets at June 30, 1997 were $1.2 million or .27 percent of loans
plus other real estate  owned  compared to $1.7  million or .39 percent of loans
plus  other real  estate  owned at  December  31,  1996 and $2.0  million or .49
percent of loans plus other real estate owned at June 30, 1996. The  improvement
in non-performing assets at June 30, 1997 as compared to December 31, 1996 was a
result of decreased levels of other real estate owned.

     The following is a  presentation  of  non-performing  assets as of June 30,
1997, December 31, 1996, and June 30, 1996:

                                        June 30     Dec. 31     June 30
(Dollars in thousands)                    1997        1996        1996

Non-performing loans                       $966        $973      $1,251
Other real estate owned, net                192         695         741
                                         ------      ------      ------
Total non-performing assets              $1,158      $1,668      $1,992
                                         ======      ======      ======

Loans past due 90 days or more as to
  principal or interest                     579         624         303


Allowance for loan losses to
  non-performing loans                    8.99x       7.95x       6.12x
Non-performing loans as a
  percent of loans outstanding              .22%        .23%        .31%
Non-performing assets as a
  percent of loans outstanding
  plus other real estate owned              .27%        .39%        .49%

     Interest income of  approximately  $12 thousand and $23 thousand would have
been recognized  during the three and six month periods ended June 30, 1997, 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 $2 thousand  was  recognized  during the three and six
months ended June 30, 1997.

     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 June 30, 1997  totalled $115 million or 26.2
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 June 30, 1997
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 six months ended June 30, 1997.

                                      -11-

<PAGE>

Financial Position
     Total assets at June 30, 1997 were $634 million compared to $616 million at
December 31, 1996.  Total loans  outstanding  at June 30, 1997 were $431 million
compared to $423 million at December 31, 1996.  Total deposits at March 31, 1997
were $543 million compared to $527 million at December 31, 1996.

Capital Adequacy
     The Company's  stockholders'  equity was $65.4 million at June 30, 1997 and
$62.2 million at December 31, 1996. Total stockholders'  equity increased by 5.0
percent from  December 31, 1996 which was the net effect of the  recognition  of
$5.4 million in net income for the three month period, cash dividend payments to
stockholders  of $1.98 million,  a favorable  change in net unrealized  gains or
losses on investment securities available for sale of $356 thousand,  and due to
the  acquisition of treasury  stock at a cost of $703  thousand.  Net unrealized
gains on  investment  securities  available  for sale of $864  thousand and $508
thousand were included as a component of  stockholders'  equity at June 30, 1997
and December 31, 1996, respectively.

     The Company  announced  its  intentions  to  repurchase  up to 5 percent or
203,584 shares of its outstanding  common stock in June, 1996. These repurchased
shares  will  be  available  for  reissuance   through  the  Company's  Dividend
Reinvestment or Stock Option Plans or for other general  corporate  purposes.  A
total of 14,000 shares of common stock were  re-acquired  by the Company  during
the second  quarter of 1997 with a  cumulative  total of 120,100  acquired as of
June 30, 1997.

     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 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 June  30,  1997 the
Company's  Tier 1 and Total Capital ratios were 13.39 percent and 14.72 percent,
respectively.  Tier 1 and Total  Capital  ratios  were 13.12  percent  and 14.43
percent  respectively,  at December  31,  1996.  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.  The Company's  Leverage
ratio was 10.32  percent at June 30, 1997 and was 10.28  percent at December 31,
1996.


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 Company has entered into  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 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  swap  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.  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.  Gains or losses from
early  termination  of interest  rate 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.

         The  Company's  use of these  interest  rate swap  contracts is closely
monitored by the Company's  Board of Directors  and is closely  controlled as to
levels  of  exposure.  At June 30,  1997 the  Company  had seven  interest  rate
agreements  outstanding  having a total  notional  amount of $70 million.  These
agreements  consisted  of  interest  rate swap  agreements  each with a notional
amount of $10 million.

         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 following is the amount of financial instruments with off-balance sheet
risk not  reflected  in the  consolidated  balance  sheets at June 30,  1997 and
December 31, 1996:

                                        Contractual Amounts
                                        June 30    December 31
(Dollars in thousands)                   1997        1996

Financial instruments whose
contractual amounts represent
 credit risk:
  Commitments to extend credit         $91,156     $93,811
  Standby letters of credit              8,028       7,335
Contractual amounts of off-balance
sheet financial  instruments not
constituting credit risk:
  Interest rate swap, notional
   value                                70,000      70,000



                                      -13-

<PAGE>


Supervision and Regulation

     During the latter part of 1996, Congress agreed on a legislative package to
stabilize the Savings and Loan (S&L) industry's  deposit  insurance fund (SAIF).
The  legislation  required 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. The amount of FDIC
insurance to be paid under this new legislation  will not materially  impact the
financial  position,  equity or the  results of  operations  for the  Company in
future periods.

   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.

New Accounting Standards

     In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 (SFAS 128), "Earnings Per Share". SFAS
128,  which  supersedes  APB  Opinion  No. 15 (APB 15),  "Earnings  Per  Share",
specifies  the  computation,   presentation,  and  disclosure  requirements  for
earnings  per share (EPS) for  entities  with  publicly  held common  stock.  It
replaces the  presentation  of primary EPS with a presentation  of basic EPS and
fully  diluted EPS with diluted EPS,  Basic EPS,  unlike  primary EPS,  excludes
dilution and is computed by dividing income available to common  stockholders by
the weighted average number of common shares outstanding for the period. Diluted
EPS is computed  similarly  to fully  diluted EPS under APB 15. The Company will
adopt SFAS 128 as of December 31, 1997.  Management  does not expect SFAS 128 to
have a material effect on the EPS of the Company.


                                      -14-

<PAGE>

          AVERAGE BALANCE SHEETS, RATES AND INTEREST INCOME AND EXPENSE
                             (Dollars in thousands)
<TABLE>
<CAPTION>
                                                Three Months Ended June 30, 1997        Three Months Ended June 30, 1996
                                                  Average               Average          Average              Average
                                                  Balance    Interest    Rate            Balance    Interest    Rate
<S>                                               <C>          <C>        <C>           <C>          <C>         <C>  
Assets
    Loans                                         $433,412     $9,869     9.13%         $405,215     $9,056      8.99%
    Money market investments:
        Interest bearing deposits with banks           246          4     6.46               189          3      6.37
        Federal funds sold                           8,652        119     5.52             2,012         27      5.45

             Total money market investments          8,898        123     5.54             2,201         30      5.54
    Investment securities available for sale
      and held to maturity:
        Taxable investment securities
         available for sale                         66,863        989     5.93            56,202        747      5.35
        Taxable investment securities
         held to maturity                           66,603      1,073     6.46            69,092      1,072      6.24
        Non-taxable investment securities
         held to maturity                           16,630        286     6.91            11,926        193      6.52
                                                   -------    -------     ----           -------    -------      ---- 
             Total investment securities           150,096      2,348     6.27           137,220      2,012      5.90
             Total earning assets                  592,406    $12,340     8.35%          544,636    $11,098      8.20%
                                                              =======     ====                      =======      ==== 

    Other assets                                    30,415                                29,240
                                                  --------                              --------
             Total assets                         $622,821                              $573,876
                                                  ========                              ========

Liabilities and stockholders' equity 
Interest bearing deposits:
        Demand                                    $ 54,429      $ 176     1.29%         $ 55,008      $ 172      1.26%
        Savings                                    129,240      1,030     4.01           130,755      1,014      3.12
        Time                                       282,488      3,878     5.51           235,446      3,265      5.58
                                                   -------    -------     ----           -------    -------      ---- 
             Total interest bearing deposits       466,157      5,084     4.37           421,209      4,451      4.25

    Short-term borrowings                           11,913        127     4.28            10,860        113      4.20
    Other Borrowings                                 6,172         95     6.18            10,966        160      5.87
                                                   -------    -------     ----           -------    -------      ---- 
        Total interest bearing liabilities         484,242    $ 5,306     4.39%          443,035    $ 4,724      4.29%
                                                              =======     ====                      =======      ==== 

    Non-interest bearing deposits                   67,006                                63,566
    Other liabilities                                8,036                                 6,838
    Stockholders' equity                            63,537                                60,437
                                                  --------                              --------
        Total liabilities and
        stockholders' equity                      $622,821                              $573,876
                                                  ========                              ========

    Net interest income                                       $ 7,034                               $6,374
    Total yield on earning assets                                         8.35%                                  8.20%
                                                                          ----                                   ---- 
    Rate on supporting liabilities                                        3.59%                                  3.49%
                                                                          ----                                   ---- 
    Net interest margin                                                   4.76%                                  4.71%
                                                                          ====                                   ==== 
</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.

                                      -15-

<PAGE>

          AVERAGE BALANCE SHEETS, RATES AND INTEREST INCOME AND EXPENSE
                             (Dollars in thousands)
<TABLE>
<CAPTION>
                                               Six Months Ended June 30, 1997           Six Months Ended June 30, 1996
                                               Average               Average            Average              Average
                                               Balance    Interest    Rate              Balance    Interest    Rate
<S>                                              <C>            <C>             <C>    <C>           <C>            <C>  
Assets
    Loans                                        $431,066       $19,401         9.08%  $397,782      $17,890        9.04%
    Money market investments:
        Interest bearing deposits with banks          248             8         6.50        236            7        5.96
        Federal funds sold                          6,433           174         5.45      2,229           60        5.41
                                                 --------      --------         ----   --------     --------        ----
             Total money market investments         6,681           182         5.49      2,465           67        5.47
    Investment securities available for sale
     and held to maturity:
        Taxable investment securities
         available for sale                        64,361         1,881         5.89     57,851        1,537        5.34
        Taxable investment securities
         held to maturity                          67,437         2,182         6.52     71,124        2,219        6.27
        Non-taxable investment securities
         held to maturity                          16,004           552         6.95     11,894          386        6.53
                                                 --------      --------         ----   --------     --------        ----
             Total investment securities          147,802         4,615         6.30    140,869        4,142        5.91
             Total earning assets                 585,549       $24,198         8.33%   541,116      $22,099        8.21%
                                                                =======         ====                 =======        ==== 

    Other assets                                   29,982                                28,132
                                                 --------                              --------
             Total assets                        $615,531                              $569,248
                                                 ========                              ========

Liabilities and stockholders' equity
Interest bearing deposits:
        Demand                                    $54,248          $346         1.28%   $55,035         $362        1.32%
        Savings                                   128,224         2,013         3.17    129,272        1,999        3.11
        Time                                      278,085         7,631         5.53    234,591        6,593        5.65
                                                 --------      --------         ----   --------     --------        ----
             Total interest bearing deposits      460,557         9,990         4.37    418,898        8,954        4.30

    Short-term borrowings                          11,990           249         4.18     11,182          234        4.21
    Long-term debt                                  6,255           192         6.19     11,039          322        5.87
                                                 --------      --------         ----   --------     --------        ----
        Total interest bearing liabilities        478,802       $10,431         4.39%   441,119       $9,510        4.34%
                                                                =======         ====                 =======        ==== 

    Non-interest bearing deposits                  65,428                                60,813
    Other liabilities                               8,234                                 7,488
    Stockholders' equity                           63,067                                59,828
                                                 --------                              --------
        Total liabilities and
        stockholders' equity                     $615,531                              $569,248
                                                 ========                              ========

    Net interest income                                         $13,767                              $12,589
    Total yield on earning assets                                               8.33%                              8.21%
    Rate on supporting liabilities                                              3.59%                              3.53%
                                                                                ----                               ---- 
    Net interest margin                                                         4.74%                              4.68%
                                                                                ====                               ==== 
</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.

                                      -16-

<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

1997 Annual Stockholders' Meeting

     The 1997 Annual Meeting of Stockholders'  for the Company was held on April
15, 1997.  Stockholders' of the Company voted on the following issues:  Election
of Directors  Raymond M.  Dorsch,  Jr.,  Wendie  DiMatteo  Holsinger,  Donald W.
Lesher,  Jr. and Mark Randolph  Tice;  and a proposal to ratify the selection of
KPMG Peat Marwick LLP as the Company's  Independent  Public  Accountants for the
fiscal year ending  December 31, 1997.  Seventy  eight  percent of the 3,965,583
shares  eligible  to vote were  voted in either  proxy  form or in person at the
meeting.

     All  matters  subject to a vote at the Annual  Meeting  were  approved as a
result of the votes cast at the Annual Meeting.  The following is a presentation
of the voting results from the April 15, 1997 Annual Stockholders' Meeting:

Election of Directors:             FOR           Withheld        Total

Raymond M. Dorsch, Jr.          3,066,368          29,579      3,095,947

Wendie DiMatteo Holsinger       3,053,073          42,874      3,095,947

Donald W. Lesher, Jr.           3,087,036           8,911      3,095,947

Mark Randolph Tice              3,084,994          10,953      3,095,947


     The term of the Directors  elected at the Annual Meeting expires in 2000 or
when the director would reach the mandatory  retirement age of 72. The following
directors  remain on the Company's  Board of Directors  until the  expiration of
their  terms in 1998 and 1999 or when the  director  would  reach the  mandatory
retirement age of 72:

Directors Term Expiring in 1998:
Charles V. Henry, III
Bruce A. Johnson
John E. Wengert

Directors Term Expiring in 1999:
Harry J. Gensemer
Albert B. Murry
Thomas I. Siegel
Brett H. Tennis

     Messrs. Lance M. Frehafer and E.D. Williams, Jr., Directors of the Company,
retired from the Board on April 15, 1997.

     The  proposal  to ratify  the  selection  of KPMG Peat  Marwick  LLP as the
Company's Independent Public Accountants for the fiscal year ending December 31,
1997 was voted as follows:

                For              Against            Abstain

             3,088,774              1,595              5,578


                                      -17-

<PAGE>

ITEM 5.  OTHER INFORMATION

None

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a.)  None.

(b.)  The Company did not file any reports on Form 8-K during the quarter ended
June 30, 1997.




                                      -18-


<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  July 31, 1997                 By /s/ Kurt A. Phillips
                                       Kurt A. Phillips
                                       Chief Financial and Accounting Officer





                                      -19-