The following is management's discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for Harleysville National Corporation (the Corporation) and its wholly owned subsidiaries-Harleysville National Bank (the Bank), HNC Financial Company and HNC Reinsurance Company. The Corporation's consolidated financial condition and results of operations consist almost entirely of the Bank's financial condition and results of operations. Current performance does not guarantee, and may not be indicative, of similar performance in the future. These are unaudited financial statements and, as such, are subject to year-end audit review.

Within this Form 10-Q, management may make projections and forward-looking statements regarding events or the future financial performance of Harleysville National Corporation. We wish to caution you that these forward-looking statements involve certain risks and uncertainties, including a variety of factors that may cause Harleysville National Corporation's actual results to differ materially from the anticipated results expressed in these forward-looking statements. Such factors include the possibility that anticipated cost savings may not be realized, estimated synergies may not occur, increased demand or prices for the Corporation's financial services and products may not occur, changing economic and competitive conditions, technological developments and other risks and uncertainties. Such risks, uncertainties and other factors that could cause actual results and experience to differ from those projected include, but are not limited to, the following: ineffectiveness of the Corporation's business strategy due to changes in current or future market conditions; the effects of competition, and of changes in laws and regulations on competition, including industry consolidation and development of competing financial products and services; inability to achieve desired increases in capital and improvement in asset quality; merger-related synergies; interest rate movements; difficulties in integrating distinct business operations, including information technology difficulties; disruption from the transaction making it more difficult to maintain relationships with customers and employees, and challenges in establishing and maintaining operations in new markets; volatilities in the securities markets; and deteriorating economic conditions. When we use words such as "believes", "expects", "anticipates", or similar expressions, we are making forward-looking statements. Investors are cautioned not to place undue reliance on these forward-looking statements and are also advised to review the risk factors that may affect Harleysville National Corporation's operating results in documents filed by Harleysville National Corporation with the Securities and Exchange Commission, including the Quarterly Report on Form 10-Q, the Annual Report on Form 10-K, and other required filings. Harleysville National Corporation assumes no duty to update the forward-looking statements made in this Form 10-Q.

Shareholders should note that many factors, some of which are discussed elsewhere in this report and in the documents that we incorporate by reference, could affect the future financial results of the Corporation and its subsidiaries and could cause those results to differ materially from those expressed or implied in our forward-looking statements contained or incorporated by reference in this document. These factors include but are not limited to those described in Item 1A, "Risk Factors" in the Corporation's 2008 Annual Report on Form 10-K and in this Form 10-Q.

Critical Accounting Estimates

The accounting and reporting policies of the Corporation and its subsidiaries conform with U.S. generally accepted accounting principles (GAAP). The Corporation's significant accounting policies are described in Note 1 of the consolidated financial statements in this Form 10-Q and in the Corporation's 2008 Annual Report on Form 10-K and are essential in understanding Management's Discussion and Analysis of Results of Operations and Financial Condition. In applying accounting policies and preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported 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. Therefore, actual results could differ significantly from those estimates. Judgments and assumptions required by management, which have, or could have a material impact on the Corporation's financial condition or results of operations are considered critical accounting estimates. The following is a summary of the policies the Corporation recognizes as involving critical accounting estimates: Allowance for Loan Loss, Goodwill and Other Intangible Asset Impairment, Stock-Based Compensation, Fair Value Measurement of Investment Securities Available for Sale, and Deferred Taxes.

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

Goodwill and Other Intangible Asset Impairment: Goodwill and other intangible assets are reviewed for potential impairment on an annual basis, or more often if events or circumstances indicate that there may be impairment, in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets and SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." Goodwill is tested for impairment at the reporting unit level and an impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The Corporation employs general industry practices in evaluating the fair value of its goodwill

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

Fair Value Measurement of Investment Securities Available for Sale: The Corporation receives estimated fair values of debt securities from independent valuation services and brokers. In developing these fair values, the valuation services and brokers use estimates of cash flows based on historical performance of similar instruments in similar rate environments. Debt securities available for sale are mostly comprised of mortgage-backed securities as well as tax-exempt municipal bonds and U.S. government agency securities. The Corporation uses various indicators in determining whether a security is other-than-temporarily impaired, including for equity securities, if the market value is below its cost for an extended period of time with low expectation of recovery or for debt securities, when it is probable that the contractual interest and principal will not be collected. The debt securities are monitored for changes in credit ratings. Adverse changes in credit ratings would affect the estimated cash flows of the underlying collateral or issuer. The Bank recognized an other-than-temporary impairment charge of $1.3 million during the first quarter of 2009 as a result of deterioration in the individual credits of collateralized debt obligation investments in pooled trust preferred securities as well as certain equity securities. The unrealized losses associated with the securities portfolio, that management has the ability and intent to hold, are not considered to be other-than temporary as of March 31, 2009 because the unrealized losses are primarily related to changes in interest rates and current market conditions, however, we do not see any negative effect on the expected cash flows of the underlying collateral or issuer. The unrealized losses are affecting all portfolio sectors with collateralized mortgage obligation securities and preferred securities having the largest reductions.

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

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

Financial Overview

The Corporation's net income for the first quarter of 2009 was $4.6 million, or $0.11 per diluted share, compared to $7.3 million or $0.23 per diluted share for the first quarter of 2008.

Despite the difficult economic environment and the turmoil in the financial markets, the Corporation's first quarter 2009 performance was profitable. Loan and deposit growth from March 2009 compared to March 2008 was largely driven by a combination of organic loan growth of $81.3 million and deposit growth of $240.4 million along with the impact of the Willow Financial acquisition, which closed in December 2008. The 2009 year-to-date financial results include the impact on operations from the acquisition of Willow Financial effective December 5, 2008 and the related issuance of 11,515,366 shares of the Corporation's common stock. The following is an overview of the key financial highlights:

Total assets were $5.6 billion at March 31, 2009, an increase of 45.0% from $3.9 billion at March 31, 2008. Loans were $3.6 billion, an increase of 45.7% from $2.5 billion at March 31, 2008. Deposits were $4.1 billion, up 38.8% from $3.0 billion at March 31, 2008. On the acquisition date, Willow Financial had approximately $1.6 billion in assets, $1.1 billion in loans and $946.7 million in deposits. Total assets at March 31, 2009 increased $155.7 million, or 2.8%, as compared to total assets reported at the year ended December 31, 2008. Loans decreased by $69.5 million and deposits increased by $209.0 million since year-end.

Net interest income on a tax equivalent basis in the first quarter of 2009 increased $11.6 million or 44.5% from the same period in 2008 mainly as a result of a decrease in customer deposit costs and the Willow Financial acquisition as well as organic loan growth. First quarter 2009 net interest margin was 3.02%, increasing 11 basis points from the comparable period last year and decreasing 14 basis points sequentially from the fourth quarter of 2008.

Nonperforming assets were $89.5 million at March 31, 2009. Nonperforming assets as a percentage of total assets were 1.58% at March 31, 2009, compared to 1.43% at December 31, 2008 and 0.69% at March 31, 2008. Net charge-offs for the first quarter of 2009 were $4.0 million, compared to $798,000 in the same period of 2008. The allowance for credit losses increased to $53.1 million at March 31, 2009, compared to $50.0 million at December 31, 2008, and $28.5 million at March 31, 2008.

Results of Operations

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

Net Interest Income

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

The rate volume variance analysis in the table below, which is computed on a tax-equivalent basis (tax rate of 35%), analyzes changes in net interest income for the three months ended March 31, 2009 compared to March 31, 2008 by their volume and rate components. The change attributable to both volume and rate has been allocated proportionately.

Table 1-Analysis of Changes in Net Interest Income-Fully Taxable-Equivalent

Basis

                                                            Three Months Ended
                                                        March 31, 2009 compared to
                                                              March 31, 2008
  (Dollars in thousands)
                                                     Total         Due to change in:
                                                     Change       Volume        Rate
  Increase (decrease) in interest income:
   Investment securities (1)                        $  3,001     $  2,226     $     775
   Federal funds sold, securities purchased under
     agreements to resell and deposits in banks         (567 )        367          (934 )
   Loans (1) (2)                                       9,253       16,494        (7,241 )
     Total                                            11,687       19,087        (7,400 )

  Increase (decrease) in interest expense:
   Savings and money market deposits                  (1,924 )      2,226        (4,150 )
   Time deposits                                         192        4,339        (4,147 )
   Borrowed funds                                      1,857        3,888        (2,031 )
     Total                                               125       10,453       (10,328 )

  Net increase in net interest income               $ 11,562     $  8,634     $   2,928

(1) The interest earned on nontaxable investment securities and loans is shown on a tax equivalent basis, net of deductions (tax rate of 35%).
(2) Nonaccrual loans have been included in the appropriate average loan balance category, but interest on nonaccrual loans has not been included for purposes of determining interest income.

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

Table 2-Average Balance Sheets and Interest Rates†Fully Taxable-Equivalent Basis

(Dollars in thousands)                    Three Months Ended March 31,                  Three Months Ended March 31,
                                                      2009                                          2008

                                       Average                       Average         Average                       Average
Assets                                 Balance        Interest        Rate           Balance        Interest        Rate
Earning assets:
 Investment securities:
  Taxable investments               $     885,819     $  11,786          5.40 %   $     753,468     $   9,754          5.21 %
  Nontaxable investments (1)              323,193         5,325          6.68           290,098         4,356          6.04
   Total investment securities          1,209,012        17,111          5.74         1,043,566        14,110          5.44
 Federal funds sold, securities
purchased under agreements to
resell and deposits in banks              172,010           127          0.30            84,157           694          3.32
 Loans (1) (2)                          3,666,744        48,658          5.38         2,463,242        39,405          6.43
    Total earning assets                5,047,766        65,896          5.29         3,590,965        54,209          6.07
Noninterest-earning assets                532,333                                       299,994
     Total assets                   $   5,580,099                                 $   3,890,959

Liabilities and Shareholders'
Equity
Interest-bearing liabilities:
 Interest-bearing deposits:
  Savings and money market          $   1,906,855         6,171          1.31     $   1,415,450         8,095          2.30
  Time                                  1,683,035        14,693          3.54         1,237,482        14,501          4.71
  Total interest-bearing deposits       3,589,890        20,864          2.36         2,652,932        22,596          3.43
 Borrowed funds                           953,143         7,470          3.18           499,064         5,613          4.52
   Total interest bearing
liabilities                             4,543,033        28,334          2.53         3,151,996        28,209          3.60
Noninterest-bearing liabilities:
 Demand deposits                          472,687                                       324,120
 Other liabilities                         83,888                                        71,443
  Total noninterest-bearing
liabilities                               556,575                                       395,563
    Total liabilities                   5,099,608                                     3,547,559
Shareholders' equity                      480,491                                       343,400
    Total liabilities and
shareholders' equity                $   5,580,099                                 $   3,890,959
Net interest spread                                                      2.76                                          2.47
Effect of noninterest-bearing
sources                                                                  0.26                                          0.44
Net interest income/margin on
earning assets                                        $  37,562          3.02 %                     $  26,000          2.91 %

Less tax equivalent adjustment                            2,258                                         1,793
Net interest income                                   $  35,304                                     $  24,207

(1) The interest earned on nontaxable investment securities and loans is shown on a tax equivalent basis, net of deductions (tax rate of 35%).

(2) Nonaccrual loans have been included in the appropriate average loan balance category, but interest on nonaccrual loans has not been included for purposes of determining interest income.

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

Net interest income on a tax equivalent basis in the first quarter of 2009 increased $11.6 million or 44.5% from the same period in 2008 mainly as a result of a decrease in customer deposit costs and the Willow Financial acquisition as well as organic loan growth.

Interest income on a tax equivalent basis in the first quarter of 2009 increased $11.7 million, or 21.6% over the same period in 2008. This increase was primarily due to higher average loans of $1.2 billion and higher average investment securities of $165.4 million which was partially offset by a 105 basis points reduction in the average rate earned on loans. The growth in average loans of 48.9% over the first quarter of last year was mainly as a result of the Willow Financial acquisition as well as organic loan growth over all loan segments. Interest expense increased $125,000 during the first quarter of 2009 versus the comparable period in 2008 as a 107 basis point reduction in the average rate paid on deposits was partially offset by a $1.4 billion increase in average interest-bearing liabilities primarily as a result of the Willow Financial acquisition.

Net Interest Margin

The first quarter 2009 net interest margin was 3.02%, an increase of 11 basis points compared to the first quarter of 2008. The increase in the net interest margin during 2009 was mainly attributable to decreases in yields on interest-bearing liabilities which outpaced declines in the yield on loans. In addition, yields on investment securities have increased 30 basis points since the prior year.

Interest Rate Sensitivity Analysis

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

The Corporation actively manages its interest rate sensitivity positions. The objectives of interest rate risk management are to control exposure of net interest income to risks associated with interest rate movements and to achieve consistent growth in net interest income. The Asset/Liability Committee, using policies and procedures approved by the Corporation's Board of Directors, is responsible for managing the rate sensitivity position. The Corporation manages interest rate sensitivity by changing the mix and repricing characteristics of its assets and liabilities through the management of its investment securities portfolio, its offering of loan and deposit terms and through wholesale borrowings from several providers, but primarily the Federal Home Loan Bank (the FHLB). The nature of the Corporation's current operations is such that it is not subject to foreign currency exchange or commodity price risk.

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

The Bank is exposed to changes in the fair value of certain of its fixed rate assets due to changes in benchmark interest rates. The Bank uses interest rate swaps to manage its exposure to changes in fair value on these instruments attributable to changes in the benchmark interest rate. Interest rate swaps designated as fair value hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Bank making fixed-rate payments over the life of the agreements without the exchange of the underlying notional amount. As of March 31, 2009, the Bank had a fair value hedge in the form of an interest rate swap with a notional amount of $1.9 million which matures in 2017. In . . .