Harleysville National 10-Q 2009
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
for the quarterly period ended June 30, 2009
¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934>
for the transition period from ___________ to __________
Commission file number 0-15237
HARLEYSVILLE NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
483 Main Street
Harleysville, Pennsylvania 19438
(Address of principal executive office and zip code)
(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 by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ¨ No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer x
Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 43,090,911 shares of Common Stock, $1.00 par value, outstanding on August 4, 2009.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Dollars and share information in thousands)
HARLEYSVILLE NATIONAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Principles of Consolidation and Basis of Presentation
The accompanying unaudited consolidated financial statements of Harleysville National Corporation (the Corporation) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with instructions to Form 10-Q, and therefore, do not include all of the information and footnotes necessary for a complete presentation of financial condition, results of operations, changes in shareholders’ equity and cash flows in conformity with GAAP. However, all normal recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the consolidated financial statements, have been included. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the accompanying notes in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2008. The results of operations presented for the three and six month periods ended June 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. The Corporation has evaluated subsequent events for recognition and/or disclosure through August 7, 2009, the date the consolidated financial statements included in this Quarterly Report on Form 10-Q were issued. See Note 14 – Subsequent Events for additional information.
The consolidated financial statements include the Corporation and its wholly owned subsidiaries-Harleysville National Bank (the Bank), HNC Financial Company and HNC Reinsurance Company. Willow Financial Corporation (Willow Financial) and its banking subsidiary are included in the Corporation’s results effective after the market close on December 5, 2008. All significant intercompany accounts and transactions have been eliminated in consolidation and certain prior period amounts have been reclassified to conform to current year presentation.
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the balance sheets and the income and expense in the income statements for the periods presented. Actual results could differ significantly from those estimates. Critical estimates include the determination of the allowance for loan losses, goodwill and other intangible assets impairment, stock-based compensation, fair value measurement for investment securities available for sale, inclusive of other-than-temporary impairment, and deferred income taxes.
For additional information on other significant accounting policies, see Note 1 of the Consolidated Financial Statements of the Corporation’s 2008 Annual Report on Form 10-K.
Recent Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 168, “The FASB Accounting Standards CodificationTM (the Codification) and the Hierarchy of Generally Accepted Accounting Principles—a replacement of SFAS No. 162.” The Codification will become the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date of this Statement, the Codification will supersede all existing accounting and reporting standards other than guidance issued by the SEC. All other non-grandfathered non-SEC accounting literature not included in the Codification will become non-authoritative. This Statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. FAS 168 is not expected to have a material impact on the Corporation’s financial statements, although references to specific guidance in financial statements and future filings will be required to be referenced to the Codification.
In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets” and SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” which changes the guidance for off-balance-sheet accounting of financial instruments including the way entities account for securitizations and special-purpose entities. SFAS 166 requires more information about sales of securitized financial assets and similar transactions, particularly if the seller retains some risk to the assets. It eliminates the concept of a “qualifying special purpose entity,” changes the requirement for derecognizing financial assets, and requires sellers of the assets to make additional disclosures about them. SFAS 167 alters how a company determines when an entity that is insufficiently capitalized or is not controlled through voting should be consolidated. A company has to determine whether it should provide consolidated reporting of any entity based upon the entity’s purpose and design and the parent company’s ability to direct the entity’s actions. The standards are effective at the start of the first fiscal year beginning after November 15, 2009 and are not anticipated to have a material impact on the Corporation’s financial statements.
Note 1 – Summary of Significant Accounting Policies – Continued
In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 is effective for interim and annual periods ending after June 15, 2009. The adoption of FAS 165 did not have any impact on the Corporation’s financial statements although it did result in expanded disclosure with regard to the date for which subsequent events have been evaluated. See Note 1 - Summary of Significant Accounting Policies, “Principles of Consolidation and Basis of Presentation” for additional information.
In April 2009, the FASB issued FASB Staff Positions No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability has Significantly Decreased and Identifying Transactions That Are Not Orderly,” No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” and No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments.” The FASB issued these three related Staff Positions to clarify the application of SFAS 157, “Fair Value Measurements” (SFAS 157) to fair value measurements in the current economic environment, modify the recognition of other-than-temporary impairments of debt securities, and require companies to disclose the fair values of financial instruments in interim periods. The final Staff Positions are effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009, if all three Staff Positions or both the fair-value measurements and other-than-temporary impairment Staff Positions are adopted simultaneously. The Corporation adopted the provisions of these Staff Positions in its quarter ended June 30, 2009 and they did not have a material impact on the Corporation’s financial statements although they did result in expanded disclosures.
Note 2 – Acquisition / Dispositions
During the second quarter of 2009, the Corporation sold loans held for investment of approximately $117.2 million for a net loss of $29,000. The sales consisted of first mortgage residential loans totaling $81.0 million and indirect consumer installment loans totaling $36.2 million. The loans were sold without recourse and subject to customary sale conditions. The sales were part of the Corporation’s strategy to build capital. Additionally, the Corporation decided to exit from the indirect lending business effective June 30, 2009 in order to use capital to build relationship-based business with customers.
Acquisition of Willow Financial Bancorp, Inc.
Effective after the market close on December 5, 2008, the Corporation completed its acquisition of Willow Financial and its wholly owned subsidiary, Willow Financial Bank, a $1.6 billion savings bank with 29 branch offices in Southeastern Pennsylvania, was merged with and into the Bank. In conjunction with this transaction, the Corporation also acquired BeneServ, Inc., a provider of employee benefits services. The Corporation acquired 100% of the outstanding shares of Willow Financial. The Corporation issued 11,515,366 shares of common stock, incurred $7.8 million in acquisition costs which were capitalized and converted stock options with a fair value of $2.0 million for a total purchase price of $168.6 million at the closing on December 5, 2008.
The acquisition of Willow Financial constituted a business combination under SFAS No. 141, “Business Combinations,” and was accounted for using the purchase method. Accordingly, the purchase price was allocated to the respective assets acquired and liabilities assumed based on their estimated fair values on the date of acquisition. The excess of purchase price over the fair value of net assets acquired was recorded as goodwill. Goodwill of $129.9 million was recorded in this transaction with $126.8 million allocated to the Community Banking segment and $3.1 million allocated to the Wealth Management segment. The Corporation also recorded $11.9 million in core deposit intangibles and $2.9 million in other identifiable intangible assets which are being amortized over ten years using the sum of the year’s digits amortization method. The $2.9 million of other identifiable intangibles were allocated to the Wealth Management segment. The purchase price allocation is subject to revision in future periods, including adjustments that may be necessary upon the filing of final tax returns for Willow Financial. The amount of goodwill recorded at December 31, 2008 was increased by $866,000 and the core deposit intangible was reduced by $2.2 million in the first six months of 2009 as a result of additional information obtained for the valuation analysis. The results of operations of Willow Financial have been included in the Corporation’s results of operations since December 5, 2008, the date of acquisition.
Note 2 – Acquisition / Dispositions - Continued
The following are the unaudited pro forma consolidated results of operations of the Corporation for the three and six months ended June 30, 2008 as though Willow Financial had been acquired on January 1, 2008:
AICPA Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (SOP 03-3) addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes loans acquired in purchase business combinations. SOP 03-3 does not apply to loans originated by the Corporation. The Corporation’s assessment identified $14.4 million in acquired loans from Willow Financial to which the application of the provisions of SOP 03-3 was required. At June 30, 2009 and December 31, 2008, the Corporation acquired loans within the scope of SOP 03-3 had an unpaid principal balance of $13.1 million and $14.4 million, respectively. At June 30, 2009 and December 31, 2008, these loans had a carrying value of $7.0 million and $8.1 million, respectively. As a result of the application of SOP 03-3, the Corporation’s loan balance reflects net purchase accounting adjustments resulting in a reduction in loans of $6.1 million related to acquired impaired loans at June 30, 2009. Income recognition under this SOP is dependent on having a reasonable expectation about the timing and amount of cash flows expected to be collected. The loans deemed impaired under this SOP were considered collateral dependent, however the timing of the sale of loan collateral is indeterminate and as such the loans will remain on non-accrual status and will have no accretable yield. The Corporation is using the cash basis method of interest income recognition.
The following are the loans acquired from Willow Financial for which it was probable at June 30, 2009 that all contractually required payments would not be collected:
The following is the carrying value by category as of June 30, 2009:
Note 3 – Investment Securities
The amortized cost, unrealized gains and losses, and the estimated fair value of the Corporation’s investment securities available for sale and held to maturity are as follows:
Note 3 – Investment Securities - Continued
The tables below indicate the length of time individual securities have been in a continuous unrealized loss position at June 30, 2009 and December 31, 2008:
Management believes that the unrealized losses associated with the securities portfolio, are temporary in nature since they are not related to the underlying credit of the issuers, and the Corporation has the ability and intent to hold these investments for the time necessary to recover its cost which may be at maturity (i.e. these investments have contractual maturities that, absent credit default, ensure a recovery of cost). In making its other-than temporary evaluation, management considered the fact that the expected cash flow is not affected by the underlying collateral or issuer. Other factors considered in evaluating the securities portfolio for other-than-temporary impairment are the length of time and the extent to which the fair value has been below the cost, analyst reports, analysis of the current interest rate environment, anticipated volatility in the market and the underlying credit rating of the issuers. In certain cases where sufficient data is not available, a cash flow model is utilized.
The change in the unrealized losses on securities other than obligations of U.S. government agencies and corporations, which includes certain collateralized mortgage obligations and collateralized debt obligations were caused by changes in interest rates, credit spread and liquidity issues in the marketplace. As of June 30, 2009 and December 31, 2008, there were 92 and 67 individual securities, respectively, in a continuous unrealized loss position for twelve months or longer. The Corporation recognized other-than temporary impairment (OTTI) charges totaling $530,000 during the second quarter of 2009 as a result of deterioration in two collateralized mortgage obligation investments. As relevant observable inputs did not exist, a cash flow model was utilized to determine the fair value of the impaired securities.
Note 3 – Investment Securities - Continued
On a quarterly basis, the Corporation formally evaluates its investment securities for other than temporary impairment. OTTI losses on individual investment securities were recognized during the six months ended June 30, 2009 according to FSP FAS 115-2 and FAS 124-2. In accordance with this new guidance, credit related OTTI is recognized in earnings and the noncredit portion on securities not expected to be sold is recognized in other comprehensive income. The credit related OTTI recognized in earnings during the three months and six months ended June 30, 2009 was $530,000 and $1.9 million, respectively. These impairment charges related to collateralized debt obligations, collateralized mortgage obligations and equity securities. Noncredit related OTTI recognized in OCI during the three months and six months ended June 30, 2009 was $2.2 million and $7.4 million, respectively.
The following table provides a cumulative roll forward of credit losses recognized in earnings for debt securities held and not intended to be sold:
The Corporation utilizes a third party valuation specialist for those securities which have insufficient observable market data available to determine the fair value. All relevant data inputs and the appropriateness of key model assumptions are reviewed by management. These assumptions include, but were not limited to collateral performance projections, historical and projected defaults, and discounted cash flow modeling.
On a quarterly basis, all pooled trust preferred security investments for which the fair value of the investment is less than its amortized cost basis are reviewed for OTTI. For those securities in a loss position, a detailed analysis is performed by management to assess them for OTTI as described below. Management will also assess if the Corporation has the ability and intent to hold the security until the market recovers or maturity for all securities.
In evaluating the pooled trust preferred securities for credit related OTTI, the Corporation considered the following:
After evaluating the criteria above, if certain ratios such as excess collateral, principal shortfall and interest shortfall conditions suggest an uncertainty of future recovery of principal and interest, a discounted cash flow model is obtained from the third party investment specialist.
For the collateralized mortgage obligation portfolio, a detailed analysis is performed involving a review of delinquency data in relation to projected current credit enhancement and coverage levels based upon certain stress factors. This analysis includes a review of third-party investment summary reports to assess the length of time in a loss position and changes in credit ratings. If the calculated principal loss exceeds the current credit enhancement, additional evaluation is required to determine what, if any impairment would be recorded. In order to determine the existence of OTTI, related data such as foreclosures, bankruptcy and real estate owned is analyzed to calculate a default percentage. Based upon completion of the stressed discounted cash flow analysis performed on two collateralized mortgage obligation investments, credit related OTTI charges on collateralized mortgage obligations totaling $530,000 and $683,000 were recorded for the three and six months ended June 30, 2009, respectively. The OTTI charges were recorded as the full contractual principal due is not expected to be recovered upon maturity of the security. The credit related OTTI charge was recorded for the portion deemed uncollectible.
For the other debt securities in the Corporation’s portfolio, while several are in an unrealized loss position, the analysis supports the Corporation’s assumption that future cashflows will not be impacted and the full amount of contractual principal and interest payments will be realized upon maturity.
Note 3 – Investment Securities – Continued
The following table provides additional information related to the Corporation’s trust preferred pools/collateralized debt obligations:
The pooled trust preferred security portfolios as of June 30, 2009 includes all Class B tranches except for one security which is in a Class C tranche. The number of banks in each pooled trust preferred security issuance at June 30, 2009 ranges from nine to sixty-five.
Securities with a carrying value of $797.9 million and $100.4 million at June 30, 2009 and December 31, 2008, respectively, were pledged to secure public funds, customer trust funds, government deposits and repurchase agreements.
Accrued interest receivable on investment securities was $6.9 million and $8.5 million at June 30, 2009 and December 31, 2008, respectively.
Note 3 – Investment Securities - Continued
The amortized cost and estimated fair value of investment securities, at June 30, 2009, by contractual maturities are shown in the following table. Actual maturities will differ from contractual maturities because issuers and borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.