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 risks, uncertainties and other factors that could cause actual results and experience to differ include, but are not limited to, the following: inability to achieve merger-related synergies, the strategic initiatives and business plans may not be satisfactorily completed or executed, if at all; increased demand or prices for the Corporation's financial services and products may not occur; changing economic and competitive conditions; technological developments; the effectiveness of the Corporation's business strategy due to changes in current or future market conditions; effects of deterioration of economic conditions on customers specifically the effect on loan customers to repay loans; inability of the Corporation to raise or achieve desired or required levels of capital; the effects of competition, and of changes in laws and regulations, including industry consolidation and development of competing financial products and services; interest rate movements; relationships with customers and employees; challenges in establishing and maintaining operations; volatilities in the securities markets; and deteriorating economic conditions and other risks and uncertainties, including those detailed in the Corporation's filing with the Securities and Exchange Commission.

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. Goodwill is tested for impairment at the reporting unit level and an impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value.

The Corporation employs general industry practices in evaluating the fair value of its goodwill and other intangible assets. The Corporation calculates the fair value, with the assistance of a third party specialist, using a combination of the following valuation methods: dividend discount analysis under the income approach, which calculates the present value of all excess cash flows plus the present value of a terminal value and market multiples (pricing ratios) under the market approach. In 2009, management performed its annual review of goodwill and other identifiable intangibles. Management performed its review by reporting unit and identified goodwill impairment for the Community Banking segment of $214.5 million. This impairment resulted from the decrease in market value caused by underlying capital and credit concerns and was determined based upon the announced sale price of the Corporation to First Niagara for $5.50 per share. As the Corporation's annual analysis is performed using March 31 balances, the subsequent stock price decline and a June 2009 communication of Individual Minimum Capital Ratio requirements from the Office of the Comptroller of the Currency resulted in a subsequent impairment evaluation. This analysis was superseded as the announced merger provided an actual fair value for the Corporation. No impairment was identified relating to the Corporation's Wealth Management segment or other identifiable intangible assets as a part of this annual review. No assurance can be given that future impairment tests will not result in a charge to earnings.

Stock-based Compensation: The Corporation recognizes compensation expense for stock options over the requisite service period based on the grant-date fair value of those awards expected to ultimately vest. Forfeitures are estimated on the date of grant and revised if actual or expected forfeiture activity differs materially from original estimates. For grants subject to a service condition, the Corporation utilizes the Black-Scholes option-pricing model 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.

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, collateral adequacy, and the existence of deferrals or defaults. Adverse changes to any of these factors would affect the estimated cash flows of the underlying collateral or issuer. Effective for the three months ended June 30, 2009, for securities deemed to be other than temporarily impaired, the Corporation uses cash flow modeling to determine the credit related portion of the loss. This credit portion is recognized through earnings while the remaining impairment amount is recognized through other comprehensive income. The Corporation recognized other-than-temporary impairment charges of $4.7 million during the third quarter of 2009 mainly as a result of deterioration in two collateralized debt obligation investments in pooled trust preferred securities. The unrealized losses associated with the securities portfolio, that management has the ability and intent to hold, are not considered to be other-than temporary as of September 30, 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 pooled trust 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 evaluated its deferred tax asset balance at September 30, 2009 for realizability. Management's process included the analysis of prior carryback years and the evaluation of future income projections. Based upon this analysis, Management believes that the deferred tax asset balance at September 30, 2009 is fully realizable.

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 reported a net loss of $4.4 million, or $0.10 per diluted share for the third quarter of 2009. This compares to net income of $6.6 million, or $0.21 per diluted share for the third quarter of 2008. For the nine months ended September 30, 2009, the net loss was $222.3 million or $5.16 per diluted share, which included a $214.5 million goodwill impairment charge. This compares to net income of $21.3 million or $0.68 per diluted share during the comparable period in 2008.

The third quarter results included a $14.8 million provision for credit losses; a $4.7 million non-cash other-than-temporary impairment (OTTI) charge on investment securities; as well as professional fees of $2.4 million associated with recent corporate finance activities, including the pending merger with First Niagara Financial Group, Inc. (First Niagara). During the third quarter of 2009, the provision for loan losses was $14.8 million, compared to $2.6 million in the third quarter of 2008. For the nine months ended September 30, 2009, the provision for loan losses was $53.9 million compared to $7.6 million for the same period in 2008. The increase in the provision for loan losses reflects an increase in nonperforming assets to $153.7 million at September 30, 2009, up from $78.5 million at December 31, 2008 and $38.8 million at September 30, 2008. Subsequent to September 30, 2009, the Corporation benefited from the full

The year-to-date 2009 loss was driven by a non-cash goodwill impairment charge of $214.5 million, resulting from the decrease in market value caused by underlying capital and credit concerns which was valued through the Agreement and Plan of Merger dated July 26, 2009 between First Niagara and the Corporation in which the Corporation will be merged into First Niagara. The impairment effectively constituted the difference between the sale price of the Corporation to First Niagara for $5.50 per share, which established the fair value of the Corporation, compared to the Corporation's book value per share of $10.75 prior to the impairment charge with further evaluation through the Corporation's step two goodwill analysis.

The 2009 year-to-date financial results include the impact on operations from the acquisition of Willow Financial Bancorp (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 $5.2 billion at September 30, 2009, an increase of $1.2 billion or 30.7% from $3.9 billion at September 30, 2008. Loans were $3.3 billion, an increase of $711.1 million or 28.0% from $2.5 billion at September 30, 2008. Deposits were $4.0 billion, up $923.6 million or 30.6% from $3.0 billion at September 30, 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 September 30, 2009 decreased $327.2 million, or 6.0%, as compared to total assets reported at the year ended December 31, 2008. Gross loans decreased by $459.7 million due to lower loan levels in all categories resulting mainly from increased refinancing activity and reduced origination volume as well as sales of first mortgage residential loans totaling $106.4 million and indirect consumer installment loans totaling $36.2 million for a net loss of $209,000.

The annualized return on average shareholders' equity was -6.73% for the third quarter of 2009 as compared to 8.20% for the same period in 2008. The annualized return on average assets was -0.34% during the third quarter of 2009 in comparison to 0.68% for the third quarter of 2008. The decrease in these ratios was primarily due to the higher level of loan loss provision as well as OTTI charges on investment securities recognized during the third quarter of 2009.

Net interest income on a tax equivalent basis in the third quarter of 2009 increased $6.3 million or 23.3% from the same period in 2008 mainly as a result of the Willow Financial acquisition. Third quarter 2009 net interest margin was 2.75% compared to 3.02% for the same period in 2008.

Nonperforming assets were $153.7 million at September 30, 2009. Nonperforming assets as a percentage of total assets were 2.98% at September 30, 2009, compared to 1.43% at December 31, 2008 and 0.98% at September 30, 2008. Net charge-offs for the third quarter of 2009 were $7.8 million, compared to $2.1 million in the same period of 2008. The allowance for credit losses increased to $77.3 million at September 30, 2009, compared to $50.0 million at December 31, 2008, and $31.7 million at September 30, 2008.

Pending Merger with First Niagara Financial Group, Inc.

On July 27, 2009, the Corporation and First Niagara Financial Group, Inc., the holding company for First Niagara Bank, announced that they had entered into an Agreement and Plan of Merger (the "Merger Agreement"), dated July 26, 2009, which sets forth the terms and conditions pursuant to which the Corporation will merge with and into First Niagara in a transaction valued at approximately $237 million. Under the terms of the Merger Agreement, stockholders of the Corporation will receive 0.474 shares of First Niagara stock for each share of common stock they own, representing a premium of about 37.5% based on the Corporation's closing price on July 24, 2009 of $4.00 per share. The exchange ratio is based on First Niagara's five-day average closing stock price of $11.60 on July 22, 2009. The exchange ratio is subject to downward adjustment if loan delinquencies of Harleysville National Bank and Trust Company exceed specified amounts. During the second quarter of 2009, the Corporation recorded a goodwill impairment charge of $214.5 million, resulting from the decrease in market value caused by underlying capital and credit concerns which was valued through the Merger Agreement. The impairment effectively constituted the difference between the sale price of the Corporation to First Niagara for $5.50 per share, which established the fair value of the Corporation, compared to the Corporation's book value per share of $10.75 prior to the impairment charge with further evaluation through the Corporation's step two goodwill analysis. See Note 5 - Goodwill and Other intangibles for further information.

The Boards of Directors of the Corporation and First Niagara have approved the Merger Agreement, but the transaction remains subject to regulatory approval and other customary closing conditions, as well as the approval of the Corporation's shareholders at a special meeting. The merger is intended to qualify as reorganization for federal income tax purposes, such that shares of the Corporation exchanged for shares of First Niagara will be issued to the Corporation's shareholders on a tax-free basis. It is expected that the transaction will be completed in the first quarter of 2010.

The Merger Agreement provides for a downward adjustment to the merger consideration to be received by the Corporation's shareholders if the amount of the Bank's delinquent loans equals or exceeds $237.5 million as of any month end prior to the closing date of the merger. For purposes of this calculation, "delinquent loans" is defined as the sum of non-performing assets, loans 30 to 89 days delinquent, and cumulative charge-offs subsequent to the signing of the agreement. By this definition, at September 30, 2009, delinquent loans were $193.3 million.

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 following table, which is computed on a tax-equivalent basis (tax rate of 35%), analyzes changes in net interest income for the three and nine months ended September 30, 2009 compared to September 30, 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                            Nine Months Ended
                              September 30, 2009 compared to                September 30, 2009 compared to
                                    September 30, 2008                            September 30, 2008

                           Total             Due to change in:           Total             Due to change in:
(Dollars in
thousands)                Change            Volume         Rate          Change          Volume         Rate

Increase (decrease)
in interest income:
Investment securities
*                       $      (529 )     $    1,232     $  (1,761 )   $    3,880       $   5,694     $  (1,814 )
Federal funds sold
and deposits in banks            49              389          (340 )         (398 )         1,228        (1,626 )
Loans *                       5,729           10,891        (5,162 )       24,437          41,322       (16,885 )
Total                         5,249           12,512        (7,263 )       27,919          48,244       (20,325 )

Increase (decrease)
in interest expense:
Savings and money
market deposits              (1,408 )          1,762        (3,170 )       (3,658 )         5,958        (9,616 )
Time deposits                  (787 )          3,036        (3,823 )          404          11,997       (11,593 )
Borrowed funds                1,117            2,498        (1,381 )        4,729           9,485        (4,756 )
Total                        (1,078 )          7,296        (8,374 )        1,475          27,440       (25,965 )

Net increase in net
interest income         $     6,327       $    5,216     $   1,111     $   26,444       $  20,804     $   5,640

(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 Rates¾Fully Taxable-Equivalent Basis

(Dollars in thousands)              Three Months Ended                           Three Months Ended
                                    September 30, 2009                           September 30, 2008

                           Average                       Average        Average                       Average
Assets                     Balance        Interest        Rate          Balance        Interest        Rate
Earning assets:
Investment securities:
Taxable investments      $   798,874     $    8,761          4.36 %   $   701,626     $    9,518          5.40 %
Nontaxable investments
(1)                          296,737          4,782          6.41         301,275          4,554          6.01
Total investment
securities                 1,095,611         13,543          4.92       1,002,901         14,072          5.58
Federal funds sold,
securities purchased
under agreements to
resell and deposits in
banks                        417,429            281          0.27          55,519            232          1.66
Loans (1) (2)              3,332,059         43,270          5.17       2,522,034         37,541          5.91
Total earning assets       4,845,099         57,094          4.69       3,580,454         51,845          5.76
Noninterest-earning
assets                       307,925                                      319,139
Total assets             $ 5,153,024                                  $ 3,899,593

Liabilities and
Shareholders' Equity
Interest-bearing
liabilities:
Interest-bearing
deposits:
Savings and money
market                   $ 1,870,632          4,372          0.93     $ 1,350,412          5,780          1.70
Time                       1,556,241         12,189          3.12       1,225,220         12,976          4.21
Total interest-bearing
deposits                   3,426,873         16,561          1.92       2,575,632         18,756          2.90
Borrowed funds               871,649          7,006          3.20         582,832          5,889          4.02
Total interest bearing
liabilities                4,298,522         23,567          2.18       3,158,464         24,645          3.10
Noninterest-bearing
liabilities:
Demand deposits              511,802                                      348,183
Other liabilities             85,265                                       70,869
Total
noninterest-bearing
liabilities                  597,067                                      419,052
Total liabilities          4,895,589                                    3,577,516
Shareholders' equity         257,435                                      322,077
Total liabilities and
shareholders' equity     $ 5,153,024                                  $ 3,899,593
Net interest spread                                          2.51                                         2.66
Effect of
noninterest-bearing
sources                                                      0.24                                         0.36
Net interest
. . .