content: 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, 1996
  
  Commission File Number:  0-13775
  
                            KEYSTONE HERITAGE GROUP, INC.
                                    (Registrant)
  
       PENNSYLVANIA                                               23-2219740
  (State of incorporation)                                     (I.R.S. Employer
                                                             Identification No.)
  
            555 WILLOW STREET, LEBANON, PENNSYLVANIA         17046
            (Address of principal executive offices)       (Zip Code)
  
                                    717-274-6800
                (Registrant's telephone number, including area code)
  
       Indicate  by check mark  whether the  registrant  (1) has filed all reports
  required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
  1934  during  the  preceding  12 months  (or for such  shorter  period  that the
  registrant was required to file such reports),  and (2) has been subject to such
  filing requirements for the past 90 days. Yes [X]  No [ ]
  
       Indicate the number of shares  outstanding of each of the issuer's  classes
  of common stock, as of the latest practicable date.
   
             Class                                Outstanding at August 12, 1996
  Common Stock ($5.00 par value)                          4,069,283 shares
  
  
  <PAGE>
  
                            KEYSTONE HERITAGE GROUP, INC.
  
                                        Index
  
  PART I - FINANCIAL INFORMATION                                            Page
  
  Item 1 - Financial Statements
  
       Consolidated Balance Sheets as of
       June 30, 1996 and December 31, 1995 (Unaudited)                        3
  
       Consolidated Statements of Income for the
       Three and Six Months ended June 30, 1996 and
       1995 (Unaudited)                                                       4
  
       Consolidated Statements of Stockholders' Equity
       for the Six Months ended June 30, 1996 and
       1995 (Unaudited)                                                       5
  
       Consolidated Statements of Cash Flows for the
       Six Months ended June 30, 1996 and 1995 (Unaudited)                    6
  
       Notes to Consolidated Financial Statements                             7
  
  Item 2 - Management's Discussion and Analysis of
           Financial Condition and Results of Operations                      8
  
  PART II - OTHER INFORMATION
  
  Item 4 - Submission of Matters To A Vote Of Security Holders               20
  
  Signature Page                                                             22
  
                                         -2-
  
  <PAGE>
  
                            KEYSTONE HERITAGE GROUP, INC.
  
                             CONSOLIDATED BALANCE SHEETS
  
                               (Dollars In Thousands)
  <TABLE>
  <CAPTION>
                                                          June 30      December 31
                                                            1996           1995
  <S>                                                    <C>            <C>      
  ASSETS
        Cash and due from banks                          $  19,016      $  23,766
        Interest bearing deposits with banks                   158            246
        Federal funds sold                                   3,600              0
        Investment securities available for sale            55,269         65,799
        Investment securities held to maturity
             (fair value of $83,944 and $88,052
             for 1996 and 1995, respectively)               83,876         86,885
        Loans, net of unearned income of
        $2,203 for 1996 and $2,830 for 1995                408,393        391,009
        Allowance for possible loan losses                  (7,654)        (8,025)
                                                         ---------      ---------
             Loans, net                                    400,739        382,984
  
        Premises and equipment, net                          7,717          7,933
        Accrued interest receivable                          3,648          3,844
        Other real estate owned                                741            913
        Deferred tax asset, net                              2,907          3,100
        Other assets                                         2,550          2,307
                                                         ---------      ---------
             Total assets                                $ 580,221      $ 577,777
                                                         =========      =========
  
  LIABILITIES
        Non-interest bearing deposits                    $  65,829      $  65,530
        Interest bearing deposits                          426,993        422,387
                                                         ---------      ---------
             Total deposits                                492,822        487,917
  
        Short-term borrowings                               11,348          8,640
        Other borrowings                                     8,530         14,009
        Accrued interest payable                             4,006          5,284
        Other liabilities                                    2,387          3,048
                                                         ---------      ---------
             Total liabilities                             519,094        518,898
  
  STOCKHOLDERS' EQUITY
  
        Common stock - $5 par value;
            Authorized  10,000,000 shares;
            Outstanding 4,071,683 shares at
            June 30, 1996 and
            December 31, 1995, respectively                 20,358         20,358
        Capital surplus                                     22,078         22,078
        Retained earnings                                   18,479         16,107
        Net unrealized gain on investment securities
             available for sale, net of taxes                  212            336
                                                         ---------      ---------
             Total stockholders' equity                     61,127         58,879
  
             Total liabilities and stockholders'
               equity                                    $ 580,221      $ 577,777
                                                         =========      =========
  </TABLE>
  
  See accompanying notes to financial statements.
  
                                         -3-
  
  <PAGE>
  
                            KEYSTONE HERITAGE GROUP, INC.
                          CONSOLIDATED STATEMENTS OF INCOME
  
                    (Dollars in thousands, except per share data)
  <TABLE>
  <CAPTION>
                                                                        Three Months Ended        Six Months Ended
                                                                             June 30                   June 30
                                                                         1996        1995         1996        1995
  <S>                                                                   <C>         <C>         <C>         <C>    
  INTEREST INCOME
                Interest and fees on loans                              $ 8,977     $ 8,743     $17,730     $17,224
                Interest on investment securities
                    available for sale:
                    Taxable investment securities                           696         650       1,433       1,312
                    Equity investments                                       49          47         104          90
                Interest on investment securities held to maturity:
                    Taxable investment securities                         1,074       1,180       2,219       2,036
                    Non-taxable investment securities                       126         113         251         229
                                                                        -------     -------     -------     -------
                      Total interest on investment
                      securities                                          1,945       1,990       4,007       3,667
                Interest on money market investments                         30         113          67         247
                                                                        -------     -------     -------     -------
                    Total interest income                                10,952      10,846      21,804      21,138
  
  INTEREST EXPENSE
                Interest on deposits                                      4,451       4,496       8,954       8,452
                Interest on short-term borrowings                           113         112         234         243
                Interest on other borrowings                                160         222         322         404
                                                                        -------     -------     -------     -------
                    Total interest expense                                4,724       4,830       9,510       9,099
  
                    Net interest income                                   6,228       6,016      12,294      12,039
  
                Provision for possible loan losses                            0           0           0           0
                                                                        -------     -------     -------     -------
                    Net interest income after provision
                    for possible loan losses                              6,228       6,016      12,294      12,039
  
  OTHER OPERATING INCOME
                Trust income                                                292         322         609         637
                Service charges on deposits                                 331         328         637         639
                Net realized gain on investment
                    securities available for sale                             0          65          23          58
                Net gain on sale of mortgage loans                          249          38         323          78
                Other income                                                582         527       1,065       1,008
                                                                        -------     -------     -------     -------
                    Total other operating income                          1,454       1,280       2,657       2,420
  
  OTHER OPERATING EXPENSE
                Salaries and employee benefits                            2,486       2,308       4,850       4,745
                Occupancy expense, net                                      299         326         627         643
                Equipment expense                                           546         495       1,052         961
                Deposit insurance expense                                     0         259           1         518
                Other expense                                             1,350       1,197       2,626       2,338
                                                                        -------     -------     -------     -------
                    Total other operating expense                         4,681       4,585       9,156       9,205
  
                    Income before income taxes                            3,001       2,711       5,795       5,254
                Income taxes                                                923         847       1,794       1,633
                                                                        -------     -------     -------     -------
                    Net income                                          $ 2,078     $ 1,864     $ 4,001     $ 3,621
                                                                        =======     =======     =======     =======
  PER COMMON SHARE
                    Net income                                          $   .51     $   .46     $   .98     $   .89
                                                                        =======     =======     =======     =======
                    Cash dividends paid                                 $   .20     $   .18     $   .40     $   .35
  </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
                                                                                         Investment
                                                                                         Securities
                                                                                        Available for
                                                    Common      Capital      Retained     Sale, Net
                                                    Stock       Surplus      Earnings      of Taxes       Total
  <S>                                              <C>          <C>          <C>           <C>           <C>     
  Balance, December 31, 1994                       $ 15,231     $ 30,053     $  8,269      ($ 1,451)     $ 52,102
       Net Income                                       -0-          -0-        3,621           -0-         3,621
       Cash dividends ($.35 per share)                  -0-          -0-       (1,400)          -0-        (1,400)
       Stock issued under dividend
           reinvestment plan                             20           83          -0-           -0-           103
       Change in unrealized gain (loss) on
           investment securities available
           for sale, net of taxes                       -0-          -0-          -0-         1,373         1,373
                                                   --------     --------     --------      --------      --------
  
  Balance, June 30, 1995                           $ 15,251     $ 30,136     $ 10,490      ($    78)     $ 55,799
                                                   ========     ========     ========      ========      ========
  
  
  Balance, December 31, 1995                       $ 20,358     $ 22,078     $ 16,107      $    336      $ 58,879
       Net income                                                               4,001                       4,001
       Cash dividends ($.40 per share)                  -0-          -0-       (1,629)          -0-        (1,629)
       Change in unrealized gain (loss) on
           investment securities available for
           sale, net of taxes                           -0-          -0-          -0-          (124)         (124)
                                                   --------     --------     --------      --------      --------
  
  Balance, June 30, 1996                           $ 20,358     $ 22,078     $ 18,479      $    212      $ 61,127
                                                   ========     ========     ========      ========      ========
  </TABLE>
  
                                         -5-
  
  <PAGE>
  
                            KEYSTONE HERITAGE GROUP, INC.
                        CONSOLIDATED STATEMENTS OF CASH FLOWS
                               (Dollars in thousands)
  <TABLE>
  <CAPTION>
                                                                 Six Months Ended
                                                                      June 30
                                                                1996           1995
  <S>                                                        <C>           <C>     
  CASH FLOW FROM OPERATING ACTIVITIES:
      Net income                                             $  4,001      $  3,621
      Adjustments to reconcile net income to cash:
          Provision for possible loan losses                        0             0
          Depreciation and amortization                           816           697
          Deferred income taxes                                   249           (37)
          Decrease in accrued interest receivable                 196             9
          (Decrease) increase in
           accrued interest payable                            (1,278)          881
          Net gain on sale of mortgage loans                     (323)          (78)
          Net realized gain on investment
           securities available for sale                          (23)          (58)
              Other, net                                         (796)         (554)
                                                             --------      --------
              Net cash provided by operating activities         2,842         4,481
  
  CASH FLOWS FROM INVESTING ACTIVITIES:
      Net (increase)decrease in money market investments       (3,512)        1,300
      Maturities of investment securities
           held to maturity                                    12,447        32,127
      Maturities of investment securities
           available for sale                                  13,375         3,230
      Sale of investment securities available for sale             63           401
      Funds invested in investment securities
           held to maturity                                    (9,393)      (58,437)
      Funds invested in investment securities
           available for sale                                  (3,236)         (616)
      Net (increase) decrease in loans
           made to customers                                  (15,584)        6,186
      Originations of residential mortgage loans sold         (20,763)       (6,298)
      Proceeds from sale of residential mortgage loans         18,900         3,610
      Net expenditures for premises and equipment                (600)         (566)
      Proceeds from sale of other real estate owned               206           524
                                                             --------      --------
          Net cash used by investing activities                (8,097)      (18,539)
  
  
  CASH FLOWS FROM FINANCING ACTIVITIES:
      Net increase in deposits                                  4,905        10,071
      Net increase (decrease) in short-term borrowings          2,708        (1,769)
      Net (decrease) increase in other borrowings              (5,479)        1,739
      Proceeds from issuance of common stock                        0           103
      Cash dividends paid                                      (1,629)       (1,400)
                                                             --------      --------
          Net cash provided from financing activities             505         8,744
  
      Net decrease in cash and due from banks                  (4,750)       (5,314)
  
      Cash and due from banks at beginning of period           23,766        23,568
      Cash and due from banks at end of period               $ 19,016      $ 18,254
  
  SUPPLEMENTAL DISCLOSURES:
      Interest paid                                          $  4,826      $  5,034
      Income taxes paid                                         1,683         1,900
  
  NON-CASH INVESTING AND FINANCING ACTIVITIES:
      Loans charged-off                                           575           314
  </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, 1996 and December
       31, 1995, the consolidated statements of income for the three and six month
       periods  ended June 30, 1996 and 1995 and the  consolidated  statements  of
       cash flows for the six months ended June 30, 1996 and 1995.  The accounting
       policies  followed in the presentation of interim financial results are the
       same as those followed on an annual basis except for SFAS 121,  "Accounting
       for the  Impairment of Long-Lived  Assets and for  Long-Lived  Assets to be
       Disposed of" and SFAS 122,  "Accounting  for Mortgage  Servicing  Rights an
       Amendment of FASB  statement  No. 65" which were  adopted  during the first
       quarter of 1996,  with the exception of the accounting  policies  discussed
       below,  which were  adopted  during the quarter  ended June 30,  1996.  The
       consolidated  financial  statements of Keystone  Heritage  Group,  Inc. and
       subsidiaries  include the  accounts  of the  Company  and its wholly  owned
       subsidiaries,  Lebanon  Valley  National  Bank and Keystone  Heritage  Life
       Insurance Company. All significant  intercompany  balances and transactions
       have been eliminated in the consolidated financial statements. For purposes
       of comparability, certain prior year amounts have been reclassified.
  
  2.   In June 1996,  the  Financial  Accounting  Standards  Board  (FASB)  issued
       Statement of Financial  Accounting  Standards No. 125,  Accounting  for and
       Servicing  of  Financial  Assets and  Extinguishment  of  Liabilities  (the
       Statement).  This Statement provides accounting and reporting standards for
       transfers  and  servicing  of  financial  assets  and   extinguishments  of
       liabilities  based  on  consistent  application  of a  financial-components
       approach that focuses on control.  It distinguishes  transfers of financial
       assets that are sales from transfers that are secured borrowings.
  
       Under the  financial-components  approach,  after a transfer  of  financial
       assets, an entity recognizes all financial and servicing assets it controls
       and  liabilities it has incurred and  derecognizes  financial  assets it no
       longer controls and liabilities that have been extinguished. The financial-
       components  approach focuses on the assets and liabilities that exist after
       the  transfer.  Many of these  assets and  liabilities  are  components  of
       financial assets that existed prior to the transfer. If a transfer does not
       meet the  criteria for a sale,  the transfer is accounted  for as a secured
       borrowing with pledge of collateral.
  
       This Statement extends the  "available-for-sale"  or "trading"  approach in
       Statement No. 115,  Accounting  for Certain  Investments in Debt and Equity
       Securities,  to non-security  financial  assets that can  contractually  be
       prepaid  or  otherwise  settled  in such a way that the holder of the asset
       would not recover substantially all of its recorded investment.  Thus, non-
       security  financial  assets (no matter how  acquired)  that are  subject to
       prepayment  risk that could prevent  recovery of  substantially  all of the
       recorded  amount are to be  reported  at fair value with the change in fair
       value accounted for depending on the asset's  classification as "available-
       for-sale" or  "trading".  The  Statement  also amends  Statement No. 115 to
       prevent  a  security  from  being  classified  as  held-to-maturity  if the
       security can be prepaid or otherwise  settled in such a way that the holder
       of the  security  would  not  recover  substantially  all  of its  recorded
       investment.
  
       This  Statement  requires that a liability be  derecognized  if and only if
       either (a) the debtor pays the creditor  and is relieved of its  obligation
       for the  liability  or (b) the  debtor is legally  released  from being the
       primary obligor under the liability either judicially or by the creditor.
  
  
                                         -7-
  
  <PAGE>
       Currently,  management  has not  determined  the  impact  on the  Company's
       financial   condition  or  results  of  operations  upon  adoption  of  the
       provisions of the  Statement.  Statement No. 125 is effective for transfers
       and  servicing  of  financial  assets and  extinguishments  of  liabilities
       occurring  after  December  31, 1996,  and is to be applied  prospectively.
       Earlier or retroactive application is not permitted. Also, the extension of
       the Statement No. 115 approach to certain non-security financial assets and
       the amendment to Statement  No. 115 is effective for financial  assets held
       on or acquired after January 1, 1997.
  
  3.   On June 12, 1996 the Company announced its intentions to repurchase up to 5
       percent  or  203,584  shares  of  its  outstanding   common  stock.   These
       repurchased  shares will be available for reissuance  through the Company's
       Dividend  Reinvestment or Stock Option Plans or for other general corporate
       purposes.
  
  4.   Earnings  per common share are based upon the  weighted  average  number of
       shares  outstanding.  The weighted average number of shares outstanding was
       4,071,683 and 4,064,673 for the three month periods ended June 30, 1996 and
       1995,  respectively,  and  4,071,683 and 4,063,154 for the six months ended
       June 30, 1996 and 1995,  respectively.  All prior period per share data has
       been restated to give effect for the 4-for-3 stock split that was effective
       for January 1996.
  
                                         -8-
  
  <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, 1996 was
  $2.078  million or $.51 per share,  compared to $1.864 million or $.46 per share
  for the three months ended June 30, 1995. Return on average stockholders' equity
  and return on average  assets for the 1996  period  were 13.83  percent and 1.46
  percent, respectively.
  
       Net  income for the six months  ended June 30,  1996 was $4.001  million or
  $.98 per share,  compared to net income of $3.621  million or $.89 per share for
  1995.  Return on average  stockholders'  equity and return on average assets for
  the 1996 period were 13.45 percent and 1.41 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 18 and 19 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,  1996 and 1995,  and for the six months  ended June 30,  1996 and
  1995.
  
       Net  interest  income for the three  months  ended  June 30,  1996 was $6.4
  million,  a $196 thousand or 3.2 percent  increase from the same period of 1995.
  The net interest margin for the second quarter of 1996 was 4.71 percent compared
  to 4.69  percent for the same  period of 1995.  Average  earning  assets for the
  three month period ended June 30, 1996 were $544.6 million, a $16.8 million or a
  3.2  percent  increase  from  the  same  period  of 1995.  For the  three  month
  comparative periods, net interest income increased in 1996 primarily as a result
  of an increase in average  loans  outstanding  of $26.9  million or 7.1 percent.
  This loan growth was primarily  funded by increases in average  interest bearing
  deposit  balances  of $8.7  million,  or 2.1  percent,  an  increase  in average
  non-interest  bearing demand deposits of $6.1 million or 11.6 percent and by the
  decrease in the average  balances in the  investment  portfolio and money market
  investments of $10.1 million or 6.7 percent.
  
       Net  interest  income  for the six  months  ended  June 30,  1996 was $12.6
  million,  a $248 thousand or 2.0 percent  increase from the same period of 1995.
  The net interest  margin for the six months ended June 30, 1996 was 4.68 percent
  compared to 4.77 percent for the same period of 1995. Average earning assets for
  the six month period ended June 30, 1996 were $541.1 million, a $19.0 million or
  a 3.6 percent increase from the same period of 1995.
  
                                         -9-
  
  <PAGE>
  
  Provision and Allowance for Possible Loan Losses
       There was no  provision  for  possible  loan  losses  charged to net income
  during the six month period ended June 30, 1996 or 1995.
  
       Net  charge-offs  of $122 thousand were recorded for the three months ended
  June 30, 1996 compared to net charge-offs of $89 thousand for the same period of
  1995. For the six month comparative  period the Company recorded net charge-offs
  of $371 thousand and $78 thousand for the 1996 and 1995  periods,  respectively.
  The primary reason for the increase in net charge-offs from 1995 to 1996 was due
  to a $264  thousand  commercial  loan  which was  charged-off  during  the first
  quarter of 1996.
  
       The  allowance for possible loan losses was $7.7 million or 1.87 percent of
  total loans  outstanding  at June 30, 1996 and $8.0  million or 2.05  percent at
  December  31, 1995.  The  allowance  for  possible  loan losses is a reserve for
  estimated  potential loan losses in the loan  portfolio.  Losses occur primarily
  from the loan  portfolio,  but may also be derived  from  commitments  to extend
  credit and standby  letters of credit.  Loan losses and recoveries of previously
  charged-off loans are charged or credited directly to the allowance for possible
  loan losses.  The  allowance  for possible  loan losses is an amount  which,  in
  management's  judgement,  is  considered  adequate  to absorb  potential  losses
  inherent in the loan portfolio.  Management  performs a quarterly  assessment of
  the Bank's loan  portfolio to determine the  appropriate  level of the allowance
  for possible loan losses. The factors considered in this evaluation include, but
  are not necessarily  limited to,  estimated loan losses  identified  through the
  review  of  loans  by the  Company's  personnel;  general  economic  conditions;
  deterioration  in loan  concentrations  or  pledged  collateral;  historic  loss
  experience;  and trends in portfolio  volume,  composition,  delinquencies,  and
  non-accruals.  In addition,  various regulatory agencies, as an integral part of
  their examination process, periodically review the Bank's allowance for possible
  loan losses.
  
                                        -10-
  
  <PAGE>
       The  following is a summary of the activity in the  allowance  for possible
  loan losses for the three and six month periods ended June 30, 1996 and 1995:
  <TABLE>
  <CAPTION>
                                                   Three Months Ended    Six Months Ended
                                                       June 30                June 30
  (Dollars in thousands)                            1996       1995       1996      1995
  <S>                                              <C>        <C>        <C>        <C>   
   Allowance for possible loan losses
    at beginning of period                         $7,776     $8,151     $8,025     $8,140
   Loans charged-off:
    Commercial                                        142         98        406        113
    Agriculture                                         0          0          0          0
    Real estate construction                            0          0          0          0
    Loans to individuals                               88         79        169        201
    Real estate - residential mortgage                  0          0          0          0
                                                   ------     ------     ------     ------
   Total loans charged-off                            230        177        575        314
  
   Recoveries of loans previously charged-off:
    Commercial                                         90         57        171        183
    Agriculture                                         0          0          0          0
    Real estate construction                            8         22         12         31
    Loans to individuals                               10          9         21         22
    Real estate - residential mortgage                  0          0          0          0
                                                   ------     ------     ------     ------
    Total recoveries of loans previously
                             charged-off              108         88        204        236
  
    Net loans charged-off                             122         89        371         78
    Current period's provision for
    possible loan losses                                0          0          0          0
                                                   ------     ------     ------     ------
    Allowance for possible loan
    losses at end of period                        $7,654     $8,062     $7,654     $8,062
                                                   ======     ======     ======     ======
  </TABLE>
  
  Other Operating Income and Expense
       Other  operating  income was $1.5  million  and $1.3  million for the three
  months ended June 30, 1996 and 1995,  respectively.  Other operating  income was
  $2.7  million and $2.4  million for the six months ended June 30, 1996 and 1995,
  respectively.  For the  three  and six  month  period,  the  increase  in  other
  operating  income is  primarily  attributable  to mortgage  banking  operations;
  results from this line of business were  increased  significantly  following the
  acquisition,  during  the first  quarter  of 1996,  of the  business  assets and
  operations of a mortgage  banking  company  located in Lancaster,  Pennsylvania.
  Other operating income is generated from mortgage banking activities through the
  sale  of  originated  mortgage  loans  in  the  secondary  market.  The  Company
  recognized  $323  thousand  from  selling  $18.9  million  of  mortgages  in the
  secondary  market in the six month period of 1996  compared to  recognizing  $78
  thousand from selling $5.4 million in the secondary market in the same period of
  1995.
  
       Other  operating  expense for the three months ended June 30, 1996 was $4.7
  million,  a 2.1 percent  increase  over the $4.6  million  reported for the same
  period of 1995. For the six months ended June 30, 1996 and 1995, other operating
  expense was $9.2 million.
  
       Salaries and benefits expense increased by $178 thousand or 7.7 percent for
  the three  months ended June 30, 1996  compared to the same period of 1995.  For
  the six months  ended June 30, 1996,  salaries  and  benefits  increased by $105
  thousand or 2.2  percent,  compared to the same period of 1995.  The increase in
  salary and benefit  expenses is a result of adding  staffing for the acquisition
  of the mortgage  banking  operations  during the first  quarter of 1996 combined
  with overall merit  increases of 4 percent which was applied to base salaries as
  of January 1, 1996. The effects of adding these staffing positions were somewhat
  offset as a result of an  internal  productivity  enhancement  program  that has
  strengthened the Company's sales efforts of the Bank's products while maximizing
  its overhead efficiency. This plan resulted in a 3 percent reduction in staffing
  positions, during the first quarter, which were realized through attrition.
  
       Other  expense  increased by $153  thousand and $288 thousand for the three
  and  six  month  comparative  periods  from  1995 to  1996.  This  increase  was
  attributable  to increased  expenses  related to the acquisition of the mortgage
  banking company, increased marketing and advertising expenses and an increase in
  advisory and  consulting  fees related to the  Company's  internal  productivity
  enhancement program.  The Company's FDIC deposit insurance  substantially offset
  the increase in expenses for the three and six month  periods  compared to 1995.
  The Bank expense for FDIC  insurance  for the first six months of 1995  totalled
  $518 thousand  compared to $1 thousand for the same period of 1996.  The Bank is
  currently paying an assessment rate of $500 per quarter.
  
                                        -11-
  <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, 1996 totalled $1.6 million or .38 percent
  of total loans outstanding,  compared to $1.5 million or .39 percent of loans at
  December  31, 1995 and $2.2  million or .58  percent of loans at June 30,  1995.
  Non-performing assets at June 30, 1996 were $2.3 million or .56 percent of loans
  plus other real estate  owned  compared to $2.5  million or .62 percent of loans
  plus  other real  estate  owned at  December  31,  1995 and $3.6  million or .95
  percent of loans plus other real estate owned at June 30, 1995. The  improvement
  in  non-performing  assets at June 30,  1996 as  compared to June 30, 1995 was a
  result of decreased levels of non-accrual loans and other real estate owned.
  
       The following is a  presentation  of  non-performing  assets as of June 30,
  1996, December 31, 1995, and June 30, 1995:
  
                                           June 30     Dec. 31      June 30
  (Dollars in thousands)                     1996        1995        1995
  
  Non-performing loans                      $1,251      $  741      $1,806
  Loans past due 90 days or more as to
    principal or interest                      303         793         384
                                            ------      ------      ------
  Total non-performing loans                 1,554       1,534       2,190
  
  Other real estate owned, net                 741         913       1,448
                                            ------      ------      ------
  Total non-performing assets               $2,295      $2,447      $3,638
                                            ======      ======      ======
  
  Allowance for possible loan losses to
    non-performing loans                     4.93x       5.23x       3.68x
  Non-performing loans as a
    percent of loans outstanding               .38%        .39%        .58%
  Non-performing assets as a
    percent of loans outstanding
    plus other real estate owned               .56%        .62%        .95%
  
       Interest income of  approximately  $18 thousand and $39 thousand would have
  been recognized  during the three and six month periods ended June 30, 1996, had
  these  loans been  current in  accordance  with  their  original  terms and been
  outstanding  through the period or since  origination.  Interest income on these
  loans of $9 thousand and $22 thousand  was  recognized  during the three and six
  months ended June 30, 1996.
  
       Group  concentrations  of  credit  are  considered  to exist if a number of
  counterparties  are  engaged in similar  activities  and have  similar  economic
  characteristics  that would cause their ability to meet contractual  obligations
  to  be  similarly   affected  by  changes  in  economic  or  other   conditions.
  Agriculture-related  borrowings  at June 30, 1996  totalled  $99 million or 24.2
  percent of total  loans  outstanding.  These  loans may be  impacted  by adverse
  climate or economic  conditions  not common to other  industries.  The Company's
  exposure to possible loss in the event of  nonperformance  by these borrowers is
  represented by the contractual amount of those instruments. The Company's policy
  is to require  supporting  collateral  for these loans which is generally in the
  form of agriculture real estate, livestock, and farm equipment. At June 30, 1996
  there were no significant  agriculture  related borrowings which were classified
  as  non-performing  assets and there were no charge-offs of agriculture  related
  loans during the three or six months ended June 30, 1996.
  
  Financial Position
       Total assets at June 30, 1996 were $580 million compared to $578 million at
  December 31, 1995.  Total loans  outstanding  at June 30, 1996 were $408 million
  compared to $391 million at December 31, 1995.  Total  deposits at June 30, 1996
  were $493 million compared to $488 million at December 31, 1995. The $17 million
  or 4.4 percent  growth in loans  outstanding  from December 31, 1995 to June 30,
  1996  was  funded  by a $13.5  million  reduction  in the  Company's  investment
  maturity and a $4.9 million  increase in deposit  balances.  Loan  balances have
  increased as a result of an increased sales and marketing.  The reduction in the
  investment  portfolio,  which  was  used to fund the loan  growth  was  achieved
  through the contractual maturities of the investment portfolio.
  
                                        -12-
  
  <PAGE>
  
  Capital Adequacy
       The Company's  stockholders'  equity was $61.1 million at June 30, 1996 and
  $58.9 million at December 31, 1995. Total stockholders'  equity increased by 3.8
  percent from  December 31, 1995 which was the net effect of the  recognition  of
  $4.0 million in net income for the six month period,  cash dividend  payments to
  stockholders of $1.6 million and an unfavorable  change in net unrealized  gains
  or losses on  investment  securities  available for sale of $124  thousand.  Net
  unrealized  gains on investment  securities  available for sale of $212 thousand
  and $336 thousand were included as a component of  stockholders'  equity at June
  30, 1996 and December 31, 1995, respectively.
  
       On June 12, 1996, the Company  announced its intentions to repurchase up to
  5 percent or 203,584 shares of its outstanding  common stock.  These repurchased
  shares  will  be  available  for  reissuance   through  the  Company's  Dividend
  Reinvestment or Stock Option Plans or for other general corporate purposes.
  
       The  maintenance  of an  appropriate  level of capital is a priority of the
  Company's  management.  The Company's  capital  adequacy and dividend policy are
  closely  monitored  by  management  and are  reviewed  regularly by the Board of
  Directors of the Company.  The Company  intends to provide an adequate return to
  its stockholders while retaining a sufficient capital base to provide for future
  growth and to comply with regulatory standards.
  
       Banking  regulators'  risk-based  capital  guidelines  address  the capital
  adequacy of banking  organizations.  These  guidelines  include a definition  of
  capital and a framework for calculating risk-weighted assets by assigning assets
  and off-balance sheet items to broad risk categories,  as well as minimum ratios
  to be maintained by banking  organizations.  The  risk-based  capital ratios are
  calculated by dividing qualifying capital by risk-weighted assets.
  
       Under the risk-based  capital  guidelines,  Total Capital is defined as the
  sum of core or "Tier 1" Capital and "Tier 2" Capital. As the guidelines apply to
  Keystone Heritage Group, Inc., Tier 1 Capital is total stockholders'  equity and
  Tier 2 Capital includes a portion of the allowance for possible loan losses. The
  rules  require that banking  organizations  must have ratios of 4.00 percent and
  8.00 percent for Tier 1 and Total  Capital,  respectively.  At June 30, 1996 the
  Company's  Tier 1 and Total Capital ratios were 13.65 percent and 14.97 percent,
  respectively.  Tier 1 and Total  Capital  ratios  were 13.59  percent  and 14.93
  percent  respectively,  at December  31,  1995.  In  addition to the  risk-based
  capital ratio, a bank is also required to maintain a "Leverage  ratio" of Tier 1
  capital to average  total assets of 3 percent or higher.  At June 30, 1996,  the
  Company's Leverage ratio was 10.57 percent and was 10.29 percent at December 31,
  1995.
  
  Off-Balance Sheet Items
  
       The  Company's  loan   portfolio   consists  of  loans  to  businesses  and
  individuals  primarily  in its  five-county  market area of Lebanon,  Lancaster,
  Berks, Dauphin, and Schuylkill counties.
  
       In the ordinary course of business, the Company enters into agreements with
  customers,  such as commitments  to extend credit and standby  letters of credit
  which involve, to varying degrees,  elements of credit and interest rate risk in
  excess of the amounts presented in the balance sheet. The Company's  exposure to
  possible loss in the event of nonperformance by the other party to the financial
  instruments for commitments to extend credit and financial guarantees written is
  represented by the contractual amount of those instruments.  The Company may not
  be obligated to advance funds if the customer's financial condition deteriorates
  or if the customer fails to meet certain terms.
  
       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.
  
                                        -13-
  
  <PAGE>
  
       The Bank is presently party to several interest rate swap contracts as part
  of its asset-liability management activities. These contracts are used primarily
  for the purpose of  managing  interest  rate risk  against  specific  assets and
  liabilities  in  order  to  minimize  mismatches  in the  Bank's  interest  rate
  sensitivity and interest rate risk positions.
  
       Interest rate swap  contracts  generally  involve the exchange of fixed and
  floating-rate   interest  payment   obligations  without  the  exchange  of  the
  underlying principal amounts. Entering into interest rate contracts involves not
  only the risk of dealing with counterparties and their ability to meet the terms
  of the  contracts  but also the interest  rate risk  associated  with  unmatched
  positions should the counterparties fail to perform.  Notional principal amounts
  often are used to express the volume of these transactions.
  
       The interest  income or interest  expense  differential  from interest rate
  swap  contracts is  recognized  on the accrual  basis as a component of interest
  income or interest  expense over the life of the  contract.  Interest  income or
  interest  expense  resulting from the cap and collar  contracts is recognized on
  the  accrual  basis  when  the  national  prime  rate  moves  below  or  above a
  predetermined  interest rate level.  Gains or losses from early  termination  of
  swap  contracts  are  deferred  and  amortized  over the  remaining  term of the
  underlying  assets or liabilities.  The Company is not exposed to credit risk in
  terms of the  notional  amounts  of these  contracts,  however,  the  receipt of
  payments representing the interest differential is based on the creditworthiness
  of the counterparty to each contract.
  
       Interest rate sensitivity is a function of the repricing characteristics of
  the Company's assets and liabilities.  Each asset and liability  reprices either
  at  maturity or during the life of the  instrument.  Interest  rate  sensitivity
  measures the difference  between the volume of assets and  liabilities  that are
  subject to repricing at a future period of time. These  differences are known as
  interest sensitivity gaps.
  
       The principal  objectives of  asset-liability  management are to manage the
  funding and investment  strategies  necessary to maintain an appropriate balance
  of the  sensitivity  between assets and  liabilities  to potential  movements in
  interest rates and to provide adequate  liquidity while enhancing  profitability
  through returns from managed levels of interest rate risk. The Company  actively
  manages the interest rate  sensitivity  of its assets and  liabilities.  Several
  techniques are used for measuring  interest rate  sensitivity.  The  traditional
  maturity "gap" analysis,  which reflects the volume difference  between interest
  rate sensitive  assets and liabilities  during a given time period,  is reviewed
  regularly  by  management.  An interest  rate risk  simulation  model is used to
  assess the level of  interest  rate risk  inherent in the  Company's  assets and
  liabilities  under various interest rate scenarios.  The Company  recognizes the
  importance  of  managing  both  assets and  liabilities  simultaneously  for the
  purpose of managing interest rate risk, providing  liquidity,  and enhancing the
  market value of the Company.
  
       Managing  interest rate  sensitivity is an inexact  science.  The repricing
  intervals  between assets and liabilities  change on a daily basis.  Contractual
  maturities  are not  always  the  same  as  actual  maturities  as a  result  of
  prepayments prior to scheduled maturities.  Additionally,  demand deposits,  NOW
  accounts,  and money  market fund  accounts may be  withdrawn  upon demand,  and
  savings  deposits may be withdrawn upon a very short period of notice.  However,
  for asset-liability management purposes, the Company considers a portion of each
  of these types of deposits to be "core"  amounts which may be considered to have
  various maturities.
  
       The Company  manages its  interest  rate  sensitivity  by changing  mix and
  repricing  characteristics of its assets and liabilities  through its investment
  securities  portfolio,  its loan  and  deposit  terms,  and  through  the use of
  off-balance  sheet  derivatives,  primarily  interest rate swap  contracts.  The
  interest rate contracts  presently in effect will have a negative  effect on net
  interest  income  in a rising  rate  environment  and a  positive  effect on net
  interest income in a decreasing rate environment.
  
       The Company's use of these interest rate contracts is closely  monitored by
  the  Company's  Board of  Directors  and is closely  controlled  as to levels of
  exposure.  At June  30,  1996 the  Company  had five  interest  rate  agreements
  outstanding having a total notional amount of $50 million.  These agreements are
  in the form of interest rate swap  agreements each with a notional amount of $10
  million having remaining maturities ranging from one to three years.
  
                                        -14-
  
  <PAGE>
  
       The Company entered into two interest rate swap contracts  during the first
  quarter of 1996.  On March 4, 1996,  the Company  entered into an interest  rate
  swap contract with a notional  amount of $10 million.  This contract states that
  the Company would receive a fixed rate of 8.25 percent and pay a floating  prime
  rate based on the national  prime rate and expires on March 4, 1998. The Company
  entered  into  another  interest  rate swap  contract  on March 14,  1996 with a
  notional  amount of $10 million.  This  contract  states that the Company  would
  receive a fixed rate of 8.65 percent and pay a floating  prime rate based on the
  national prime rate and expires on March 15, 1999.
  
       The  Company  does not  obtain  collateral  or other  security  to  support
  financial instruments subject to credit risk but monitors the credit standing of
  counterparties. The counterparties of the aforementioned interest rate contracts
  are commercial banks having a rating of A1 from Moody's Investor Service.
  
       The interest rate swap contracts were entered into to protect the Company's
  interest  rate  risk  in  a  declining  or  stable  interest  rate  environment.
  Specifically, these contracts protect the Company's risk from negative movements
  in its prime rate based asset portfolio which would not be perfectly  matched by
  repricing  liabilities.  These  contracts  were  entered  into to  minimize  the
  negative effects that the Bank would realize, in falling rate environments (e.g.
  reduction in prime based rates).
  
       The following is the amount of financial instruments with off-balance sheet
  risk not  reflected  in the  consolidated  balance  sheets at June 30,  1996 and
  December 31, 1995:
  
                                            Contractual Amounts
                                          June 30     December 31
  (Dollars in thousands)                    1996         1995
  Financial instruments whose
  contractual
    amounts represent credit risk:
  Commitments to extend credit           $100,300     $ 88,242
  Standby letters of credit                 8,159        8,862
  Contractual amounts of off-balance
  sheet financial instruments not
  constituting credit risk:
     Interest rate swap, notional
  value                                    50,000       30,000
     Interest rate cap/collar,
  notional value                              -0-       10,000
  
  Supervision and Regulation
  
       During 1994, Congress passed legislation to remove geographic  restrictions
  on bank expansion.  The Riegle-Neal Interstate Banking and Branch Efficiency Act
  of 1994  will  allow  banks to  expand  across  state  lines  to merge  existing
  multi-state  branching  operations  into a single  institution or to acquire new
  branches in other states.  Interstate  banking and branching  authority  will be
  subject to  certain  conditions  and  restrictions,  such as  capital  adequacy,
  management,  CRA compliance and limits on deposit concentrations.  The effective
  date for this legislation will be June 1, 1997.  Individual states will have the
  option to opt in early or to opt out completely prior to June 1, 1997.
  
       Although  the  passage  of this  legislation  should  have  the  impact  of
  quickening the pace of consolidation  within the banking  industry,  the Company
  does not  anticipate  any immediate  impact upon its financial  condition or its
  operations as a result of this new law.
  
       The Bank is a national bank,  chartered under the National Bank Act, and is
  subject to the primary  supervision  of, and is examined by, the  Comptroller of
  the Currency.  As a member of the Federal Reserve System, the Bank is subject to
  provisions of the Federal  Reserve Act, which restricts the ability of a bank to
  extend  credit to its parent  holding  company  or to  certain  of the  parent's
  subsidiaries,  or to invest in the Company's  common stock or to take such stock
  as  collateral  for loans to any borrower.  The  operations of the Bank are also
  subject to regulation by the FDIC.
  
       The Company is affected by the monetary and credit  policies of the Federal
  Reserve System. The Federal Reserve System regulates the national supply of bank
  credit through open market operations in U. S. Government securities, changes in
  the  discount  rate  charged  for  bank   borrowing,   and  changes  in  reserve
  requirements on bank deposits.
  
                                        -15-
  
  <PAGE>
  
  New Accounting Standards
  
       On January 1, 1996 the  Company  adopted the  provisions  of  Statement  of
  Financial  Accounting  Standards  No.  121  (SFAS  121),   "Accounting  for  the
  Impairment of Long-Lived  Assets and for  Long-Lived  Assets to be Disposed Of".
  SFAS  provides  guidance  for  recognition  and  measurement  of  impairment  of
  long-lived assets, certain identifiable intangibles and goodwill related both to
  assets held and used and assets to be disposed of.
  
       SFAS  121  requires  that  long-lived   assets  and  certain   identifiable
  intangibles  held and used by an  entity be  reviewed  for  impairment  whenever
  events or changes in circumstances indicate that the carrying amount of an asset
  may not be recoverable.  In performing the review for recoverability,  an entity
  should  estimate  the future  cash flows  expected to result from the use of the
  asset and its eventual disposition. If the sum of the expected future cash flows
  (undiscounted  and without interest charges) is less than the carrying amount of
  the asset,  an impairment loss is recognized.  Otherwise,  an impairment loss is
  not  recognized.  Measurement of an impairment  loss for  long-lived  assets and
  identifiable  intangibles that an entity expects to hold and use should be based
  on the fair value of the asset.
  
       SFAS  121  requires  that  long  lived  assets  and  certain   identifiable
  intangibles  to be disposed  of be  reported at the lower of carrying  amount or
  fair value less cost to sell. The  implementation of SFAS 121 did not materially
  impact the Company's financial condition or results of operation.
  
       On January 1, 1996, the Company  adopted the provisions of the Statement of
  Financial  Accounting  Standards  No. 122,  "Accounting  for Mortgage  Servicing
  Rights,  an  amendment  of FASB  Statement  No. 65" (SFAS 122).  SFAS 122 amends
  Statement  65 to require an  institution  to  recognize  as separate  assets the
  rights to  service  mortgage  loans for others  when a mortgage  loan is sold or
  securitized and servicing rights  retained.  SFAS 122 also requires an entity to
  measure the impairment of servicing  rights based on the difference  between the
  carrying amount of the servicing rights and their current fair value.
  
       Presently,  the Company  does not sell or  securitize  mortgage  loans with
  servicing rights retained. Accordingly, the Company has not been impacted by the
  provisions of SFAS 122.
  
       On January 1, 1996 the  Company  adopted the  provisions  of  Statement  of
  Financial   Accounting   Standards   No.  123,   "Accounting   for   Stock-Based
  Compensation"  (SFAS 123).  SFAS 123  establishes a new method of accounting for
  stock-based  compensation  arrangements with employees. The new method is a fair
  value  based  method  rather  than the  intrinsic  value  based  method  that is
  currently  utilized.  However,  SFAS 123 does not require an entity to adopt the
  new  fair  value  based  method  for  purposes  of  preparing   basic  financial
  statements.  If an entity chooses not to adopt the fair value based method, SFAS
  123  requires  an entity to  display in the  footnotes  pro forma net income and
  earnings  per share  information  as if the fair  value  based  method  had been
  adopted.
  
       The Company has not adopted the fair value method as described in SFAS 123.
  The Company will disclose in the footnotes, in the 1996 Annual Report, pro forma
  net income and  earnings per share  information  as if the fair value method had
  been adopted.
  
       In June 1996,  the  Financial  Accounting  Standards  Board  (FASB)  issued
  Statement  of  Financial  Accounting  Standards  No.  125,  Accounting  for  and
  Servicing of Financial  Assets and  Extinguishment  of Liabilities  (Statement).
  This Statement  provides  accounting  and reporting  standards for transfers and
  servicing  of  financial  assets and  extinguishments  of  liabilities  based on
  consistent  application  of a  financial-components  approach  that  focuses  on
  control.  It  distinguishes  transfers of  financial  assets that are sales from
  transfers that are secured borrowings.
  
       Under the  financial-components  approach,  after a transfer  of  financial
  assets,  an entity recognizes all financial and servicing assets it controls and
  liabilities  it has  incurred  and  derecognizes  financial  assets it no longer
  controls and liabilities that have been extinguished.  The  financial-components
  approach  focuses on the assets and  liabilities  that exist after the transfer.
  Many of these assets and  liabilities  are  components of financial  assets that
  existed  prior to the  transfer.  If a transfer does not meet the criteria for a
  sale,  the  transfer  is  accounted  for as a secured  borrowing  with pledge of
  collateral.
  
                                        -16-
  
  <PAGE>
  
       This Statement extends the  "available-for-sale"  or "trading"  approach in
  Statement  No.  115,  Accounting  for  Certain  Investments  in Debt and  Equity
  Securities,  to non-security  financial assets that can contractually be prepaid
  or  otherwise  settled  in such a way that the  holder  of the  asset  would not
  recover  substantially  all  of  its  recorded  investment.  Thus,  non-security
  financial  assets (no matter how acquired)  that are subject to prepayment  risk
  that could prevent recovery of  substantially  all of the recorded amount are to
  be reported at fair value with the change in fair value  accounted for depending
  on  the  asset's  classification  as  "available-for-sale"  or  "trading".   The
  Statement  also  amends  Statement  No.  115 to  prevent a  security  from being
  classified  as  held-to-maturity  if the  security  can be prepaid or  otherwise
  settled  in such a way  that  the  holder  of the  security  would  not  recover
  substantially all of its recorded investment.
  
       This  Statement  requires that a liability be  derecognized  if and only if
  either (a) the debtor pays the  creditor and is relieved of its  obligation  for
  the  liability  or (b) the debtor is  legally  released  from being the  primary
  obligor under the liability either judicially or by the creditor.
  
       Currently,  management  has not  determined  the  impact  on the  Company's
  financial  condition or results of operations upon adoption of the provisions of
  the  Statement.  Statement  No. 125 is effective  for transfers and servicing of
  financial assets and extinguishments of liabilities occurring after December 31,
  1996, and is to be applied prospectively.  Earlier or retroactive application is
  not permitted.  Also, the extension of the Statement No. 115 approach to certain
  non-security  financial  assets  and  the  amendment  to  Statement  No.  115 is
  effective for financial assets held on or acquired after January 1, 1997.
  
                                        -17-
  
  <PAGE>
  
            AVERAGE BALANCE SHEETS, RATES AND INTEREST INCOME AND EXPENSE
                               (Dollars in thousands)
  <TABLE>
  <CAPTION>
                                                      Three Months Ended June 30, 1996       Three Months Ended June 30, 1995
                                                   Average                       Average     Average                   Average
                                                   Balance      Interest          Rate       Balance      Interest       Rate
  <S>                                              <C>           <C>              <C>       <C>          <C>             <C>  
  Assets 
      Loans                                        $405,215      $  9,056         8.99%     $378,365     $  8,830        9.36%
      Money market investments                        2,201            30         5.54         7,436          113        6.10
      Investment securities:
          Taxable                                   125,294         1,819         5.84       131,853        1,878        5.78
          Non-taxable                                11,926           193         6.52        10,224          174        6.82
                                                    -------      --------         ----       -------     --------        ---- 
               Total investment securities          137,220         2,012         5.90       142,077        2,052        5.79
               Total earning assets                 544,636      $ 11,098         8.20%      527,878     $ 10,995        8.35%
                                                                 ========         ====                   ========        ==== 
  
      Other assets                                   29,240                                   26,476
                                                   --------                                 --------
               Total assets                        $573,876                                 $554,354
                                                   ========                                 ========
  
  Liabilities and stockholders' equity
      Interest bearing deposits:
          Now accounts                             $ 55,008      $    172         1.26%     $ 54,638     $    197        1.45%
          Savings and money market                  130,755         1,014         3.12       119,171          917        3.12
          Time                                      235,446         3,264         5.58       238,735        3,382        5.68
                                                    -------      --------         ----       -------     --------        ---- 
               Total interest bearing deposits      421,209         4,450         4.25       412,544        4,496        4.37
  
      Short-term borrowings                          10,860           114         4.20        11,207          112        4.02
      Long-term debt                                 10,966           160         5.87        12,392          209        6.84
                                                    -------      --------         ----       -------     --------        ---- 
          Total interest bearing liabilities        443,035      $  4,724         4.29%      436,143     $  4,817        4.43%
                                                                 ========         ====                   ========        ====
  
      Non-interest bearing deposits                  63,566                                   56,958
      Other liabilities                               6,838                                    6,817
      Stockholders' equity                           60,437                                   54,436
                                                   --------                                 --------
          Total liabilities and
          stockholders' equity                     $573,876                                 $554,354
                                                   ========                                 ========
  
      Net interest income                                        $  6,374                                $  6,178
      Total yield on earning assets                                               8.20%                                  8.35%
      Rate on supporting liabilities                                              3.49%                                  3.66%
                                                                                  ----                                   ---- 
      Net interest margin                                                         4.71%                                  4.69%
                                                                                  ====                                   ==== 
  </TABLE>
  Interest and average interest rates are presented on a fully taxable  equivalent
  basis,  using an effective  tax rate of 35%. For  purposes of  calculating  loan
  yields,  average loan balances include non-accrual loans. Loan fees are included
  in interest income.
  
                                        -18-
  
  <PAGE>
  
            AVERAGE BALANCE SHEETS, RATES AND INTEREST INCOME AND EXPENSE
                               (Dollars in thousands)
  <TABLE>
  <CAPTION>
                                                    Six Months Ended June 30, 1996             Six Months Ended June 30, 1995
                                                    Average                     Average        Average                    Average
                                                    Balance      Interest         Rate         Balance    Interest         Rate
  <S>                                              <C>           <C>              <C>         <C>          <C>             <C>
  Assets
      Loans                                        $397,782      $ 17,890         9.04%       $380,081     $ 17,381        9.22%
      Money market investments                        2,465            67         5.47           8,337          247        5.97
      Investment securities:
          Taxable                                   128,975         3,756         5.86         123,396        3,438        5.61
          Non-taxable                                11,894           386         6.53          10,344          353        6.88
                                                   --------      --------         ----        --------     --------        ---- 
               Total investment securities          140,869         4,142         5.91         133,740        3,791        5.72
               Total earning assets                 541,116      $ 22,099         8.21%        522,158     $ 21,419        8.27%
                                                                 ========         ====                     ========        ==== 
  
      Other assets                                   28,132                                     26,331
                                                   --------                                   --------
               Total assets                        $569,248                                   $548,489
                                                   ========                                   ========
  
  Liabilities and stockholders' equity
      Interest bearing deposits:
          Now accounts                             $ 55,035      $    362         1.32%       $ 55,927     $    399        1.44%
          Savings and money market                  129,272         1,999         3.11         119,066        1,711        2.90
          Time                                      234,591         6,592         5.65         233,954        6,342        5.47
                                                   --------      --------         ----        --------     --------        ----
               Total interest bearing deposits      418,898         8,953         4.30         408,947        8,452        4.17
  
      Short-term borrowings                          11,182           234         4.21          12,167          243        4.03
      Long-term debt                                 11,039           323         5.87          11,540          383        6.69
                                                   --------      --------         ----        --------     --------        ----
          Total interest bearing liabilities        441,119      $  9,510         4.34%        432,654     $  9,078        4.23%
                                                                 ========         ====                     ========        ====
  
      Non-interest bearing deposits                  60,813                                     55,757
      Other liabilities                               7,488                                      6,507
      Stockholders' equity                           59,828                                     53,571
                                                   --------                                   --------
          Total liabilities and
          stockholders' equity                     $569,248                                   $548,489
                                                   ========                                   ========
  
      Net interest income                                        $ 12,589                                  $ 12,341
      Total yield on earning assets                                               8.21%                                    8.27%
      Rate on supporting liabilities                                              3.53%                                    3.50%
                                                                                  ----                                     ---- 
      Net interest margin                                                         4.68%                                    4.77%
                                                                                  ====                                     ==== 
  </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.
  
                                        -19-
  
  <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
  
  1996 Annual Stockholders' Meeting
  
       The 1996 Annual Meeting of Stockholders'  for the Company was held on April
  16, 1996.  Stockholders' of the Company voted on the following issues:  Election
  of Directors  Harry J.  Gensemer,  Albert B. Murry,  Thomas I. Siegel,  Brett H.
  Tennis  and  Earnest D.  Williams,  Jr.;  a  proposal  to Approve  and Adopt the
  Keystone Heritage Group,  Inc. 1996 Independent  Directors Stock Option Plan for
  non-employee  directors  of the  Company;  to Vote on the  Stockholder  Proposal
  described  on page 6 of the March 7, 1996 proxy  statement;  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, 1996.  Seventy seven
  percent of the 4,071,683 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 16, 1996 Annual Stockholders' Meeting:
  
  Election of Directors:             FOR           Withheld        Total
  
  Harry J. Gensemer               3,060,847          63,572      3,124,419
  
  Albert B. Murry                 2,980,338         144,081      3,124,419
  
  Thomas I. Siegel                3,050,740          73,679      3,124,419
  
  Brett H. Tennis                 2,967,721         156,698      3,124,419
  
  Earnest D. Williams, Jr.        3,063,986          60,433      3,124,419
  
       The term of the Directors  elected at the Annual Meeting expires in 1999 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 1997 and 1998 or when the  director  would  reach the  mandatory
  retirement age of 72:
  
  Directors Term Expiring in 1997:
  Raymond M. Dorsch, Jr.
  Wendie DiMatteo Holsinger
  Donald W. Lesher, Jr.
  Mark Randolph Tice
  
  Directors Term Expiring in 1998:
  Lance M. Frehafer
  Charles V. Henry, III
  Bruce A. Johnson
  John E. Wengert
  
       The proposal to Approve and Adopt the  Keystone  Heritage  Group,  Inc 1996
  Independent  Directors  Stock  Option  Plan for  non-employee  directors  of the
  Company was voted as follows:
  
                  For              Against            Abstain
  
               2,721,554            375,942             26,913
  
                                        -20-
  
  <PAGE>
  
       The proposal to approve the Stockholder Proposal described on page 6 of the
  March 7, 1996 proxy statement was defeated and was voted as follows
  
                                                                       Broker
                  For              Against            Abstain         Non-vote
  
                 365,902          2,465,532           47,932         245,053
  
       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,
  1996 was voted as follows:
  
                  For              Against            Abstain
  
               2,958,958            129,167           36,294
  
  
  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, 1996.
  
                                        -21-
  
  <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  August 12, 1996               By /s/ Kurt A. Phillips
                                         -----------------------------------------
                                         Kurt A. Phillips
                                         Chief Financial and Accounting Officer
  
  
  
                                        -22-
metadata_documents: [{"type": "10-Q", "sequence": "1", "secsgml_size_bytes": 78400}]
metadata_filer: {"company-data": {"conformed-name": "KEYSTONE HERITAGE GROUP INC", "cik": "0000715366", "assigned-sic": "6021", "irs-number": "232219740", "state-of-incorporation": "PA", "fiscal-year-end": "1231"}, "filing-values": {"form-type": "10-Q", "act": "34", "file-number": "000-13775", "film-number": "96613832"}, "business-address": {"street1": "555 WILLOW ST", "street2": "P O BOX 1285", "city": "LEBANON", "state": "PA", "zip": "17042-1285", "phone": "7172746800"}, "mail-address": {"street2": "555 WILLOW ST P O BOX 1285", "city": "LEBANON", "state": "PA", "zip": "17042-1285"}}
text: 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, 1996
  
  Commission File Number:  0-13775
  
                            KEYSTONE HERITAGE GROUP, INC.
                                    (Registrant)
  
       PENNSYLVANIA                                               23-2219740
  (State of incorporation)                                     (I.R.S. Employer
                                                             Identification No.)
  
            555 WILLOW STREET, LEBANON, PENNSYLVANIA         17046
            (Address of principal executive offices)       (Zip Code)
  
                                    717-274-6800
                (Registrant's telephone number, including area code)
  
       Indicate  by check mark  whether the  registrant  (1) has filed all reports
  required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
  1934  during  the  preceding  12 months  (or for such  shorter  period  that the
  registrant was required to file such reports),  and (2) has been subject to such
  filing requirements for the past 90 days. Yes [X]  No [ ]
  
       Indicate the number of shares  outstanding of each of the issuer's  classes
  of common stock, as of the latest practicable date.
   
             Class                                Outstanding at August 12, 1996
  Common Stock ($5.00 par value)                          4,069,283 shares
  KEYSTONE HERITAGE GROUP, INC.
  
                                        Index
  
  PART I - FINANCIAL INFORMATION                                            Page
  
  Item 1 - Financial Statements
  
       Consolidated Balance Sheets as of
       June 30, 1996 and December 31, 1995 (Unaudited)                        3
  
       Consolidated Statements of Income for the
       Three and Six Months ended June 30, 1996 and
       1995 (Unaudited)                                                       4
  
       Consolidated Statements of Stockholders' Equity
       for the Six Months ended June 30, 1996 and
       1995 (Unaudited)                                                       5
  
       Consolidated Statements of Cash Flows for the
       Six Months ended June 30, 1996 and 1995 (Unaudited)                    6
  
       Notes to Consolidated Financial Statements                             7
  
  Item 2 - Management's Discussion and Analysis of
           Financial Condition and Results of Operations                      8
  
  PART II - OTHER INFORMATION
  
  Item 4 - Submission of Matters To A Vote Of Security Holders               20
  
  Signature Page                                                             22
  
                                         -2-
  KEYSTONE HERITAGE GROUP, INC.
  
                             CONSOLIDATED BALANCE SHEETS
  
                               (Dollars In Thousands)
  June 30      December 31
                                                            1996           1995
  ASSETS
        Cash and due from banks                          $  19,016      $  23,766
        Interest bearing deposits with banks                   158            246
        Federal funds sold                                   3,600              0
        Investment securities available for sale            55,269         65,799
        Investment securities held to maturity
             (fair value of $83,944 and $88,052
             for 1996 and 1995, respectively)               83,876         86,885
        Loans, net of unearned income of
        $2,203 for 1996 and $2,830 for 1995                408,393        391,009
        Allowance for possible loan losses                  (7,654)        (8,025)
                                                         ---------      ---------
             Loans, net                                    400,739        382,984
  
        Premises and equipment, net                          7,717          7,933
        Accrued interest receivable                          3,648          3,844
        Other real estate owned                                741            913
        Deferred tax asset, net                              2,907          3,100
        Other assets                                         2,550          2,307
                                                         ---------      ---------
             Total assets                                $ 580,221      $ 577,777
                                                         =========      =========
  
  LIABILITIES
        Non-interest bearing deposits                    $  65,829      $  65,530
        Interest bearing deposits                          426,993        422,387
                                                         ---------      ---------
             Total deposits                                492,822        487,917
  
        Short-term borrowings                               11,348          8,640
        Other borrowings                                     8,530         14,009
        Accrued interest payable                             4,006          5,284
        Other liabilities                                    2,387          3,048
                                                         ---------      ---------
             Total liabilities                             519,094        518,898
  
  STOCKHOLDERS' EQUITY
  
        Common stock - $5 par value;
            Authorized  10,000,000 shares;
            Outstanding 4,071,683 shares at
            June 30, 1996 and
            December 31, 1995, respectively                 20,358         20,358
        Capital surplus                                     22,078         22,078
        Retained earnings                                   18,479         16,107
        Net unrealized gain on investment securities
             available for sale, net of taxes                  212            336
                                                         ---------      ---------
             Total stockholders' equity                     61,127         58,879
  
             Total liabilities and stockholders'
               equity                                    $ 580,221      $ 577,777
                                                         =========      =========
  See accompanying notes to financial statements.
  
                                         -3-
  KEYSTONE HERITAGE GROUP, INC.
                          CONSOLIDATED STATEMENTS OF INCOME
  
                    (Dollars in thousands, except per share data)
  Three Months Ended        Six Months Ended
                                                                             June 30                   June 30
                                                                         1996        1995         1996        1995
  INTEREST INCOME
                Interest and fees on loans                              $ 8,977     $ 8,743     $17,730     $17,224
                Interest on investment securities
                    available for sale:
                    Taxable investment securities                           696         650       1,433       1,312
                    Equity investments                                       49          47         104          90
                Interest on investment securities held to maturity:
                    Taxable investment securities                         1,074       1,180       2,219       2,036
                    Non-taxable investment securities                       126         113         251         229
                                                                        -------     -------     -------     -------
                      Total interest on investment
                      securities                                          1,945       1,990       4,007       3,667
                Interest on money market investments                         30         113          67         247
                                                                        -------     -------     -------     -------
                    Total interest income                                10,952      10,846      21,804      21,138
  
  INTEREST EXPENSE
                Interest on deposits                                      4,451       4,496       8,954       8,452
                Interest on short-term borrowings                           113         112         234         243
                Interest on other borrowings                                160         222         322         404
                                                                        -------     -------     -------     -------
                    Total interest expense                                4,724       4,830       9,510       9,099
  
                    Net interest income                                   6,228       6,016      12,294      12,039
  
                Provision for possible loan losses                            0           0           0           0
                                                                        -------     -------     -------     -------
                    Net interest income after provision
                    for possible loan losses                              6,228       6,016      12,294      12,039
  
  OTHER OPERATING INCOME
                Trust income                                                292         322         609         637
                Service charges on deposits                                 331         328         637         639
                Net realized gain on investment
                    securities available for sale                             0          65          23          58
                Net gain on sale of mortgage loans                          249          38         323          78
                Other income                                                582         527       1,065       1,008
                                                                        -------     -------     -------     -------
                    Total other operating income                          1,454       1,280       2,657       2,420
  
  OTHER OPERATING EXPENSE
                Salaries and employee benefits                            2,486       2,308       4,850       4,745
                Occupancy expense, net                                      299         326         627         643
                Equipment expense                                           546         495       1,052         961
                Deposit insurance expense                                     0         259           1         518
                Other expense                                             1,350       1,197       2,626       2,338
                                                                        -------     -------     -------     -------
                    Total other operating expense                         4,681       4,585       9,156       9,205
  
                    Income before income taxes                            3,001       2,711       5,795       5,254
                Income taxes                                                923         847       1,794       1,633
                                                                        -------     -------     -------     -------
                    Net income                                          $ 2,078     $ 1,864     $ 4,001     $ 3,621
                                                                        =======     =======     =======     =======
  PER COMMON SHARE
                    Net income                                          $   .51     $   .46     $   .98     $   .89
                                                                        =======     =======     =======     =======
                    Cash dividends paid                                 $   .20     $   .18     $   .40     $   .35
  -4-
  KEYSTONE HERITAGE GROUP, INC.
                   CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                              Six Months Ended June 30
  
                               (Dollars in thousands)
  Net
                                                                                         Unrealized
                                                                                       Gain (Loss) on
                                                                                         Investment
                                                                                         Securities
                                                                                        Available for
                                                    Common      Capital      Retained     Sale, Net
                                                    Stock       Surplus      Earnings      of Taxes       Total
  Balance, December 31, 1994                       $ 15,231     $ 30,053     $  8,269      ($ 1,451)     $ 52,102
       Net Income                                       -0-          -0-        3,621           -0-         3,621
       Cash dividends ($.35 per share)                  -0-          -0-       (1,400)          -0-        (1,400)
       Stock issued under dividend
           reinvestment plan                             20           83          -0-           -0-           103
       Change in unrealized gain (loss) on
           investment securities available
           for sale, net of taxes                       -0-          -0-          -0-         1,373         1,373
                                                   --------     --------     --------      --------      --------
  
  Balance, June 30, 1995                           $ 15,251     $ 30,136     $ 10,490      ($    78)     $ 55,799
                                                   ========     ========     ========      ========      ========
  
  Balance, December 31, 1995                       $ 20,358     $ 22,078     $ 16,107      $    336      $ 58,879
       Net income                                                               4,001                       4,001
       Cash dividends ($.40 per share)                  -0-          -0-       (1,629)          -0-        (1,629)
       Change in unrealized gain (loss) on
           investment securities available for
           sale, net of taxes                           -0-          -0-          -0-          (124)         (124)
                                                   --------     --------     --------      --------      --------
  
  Balance, June 30, 1996                           $ 20,358     $ 22,078     $ 18,479      $    212      $ 61,127
                                                   ========     ========     ========      ========      ========
  -5-
  KEYSTONE HERITAGE GROUP, INC.
                        CONSOLIDATED STATEMENTS OF CASH FLOWS
                               (Dollars in thousands)
  Six Months Ended
                                                                      June 30
                                                                1996           1995
  CASH FLOW FROM OPERATING ACTIVITIES:
      Net income                                             $  4,001      $  3,621
      Adjustments to reconcile net income to cash:
          Provision for possible loan losses                        0             0
          Depreciation and amortization                           816           697
          Deferred income taxes                                   249           (37)
          Decrease in accrued interest receivable                 196             9
          (Decrease) increase in
           accrued interest payable                            (1,278)          881
          Net gain on sale of mortgage loans                     (323)          (78)
          Net realized gain on investment
           securities available for sale                          (23)          (58)
              Other, net                                         (796)         (554)
                                                             --------      --------
              Net cash provided by operating activities         2,842         4,481
  
  CASH FLOWS FROM INVESTING ACTIVITIES:
      Net (increase)decrease in money market investments       (3,512)        1,300
      Maturities of investment securities
           held to maturity                                    12,447        32,127
      Maturities of investment securities
           available for sale                                  13,375         3,230
      Sale of investment securities available for sale             63           401
      Funds invested in investment securities
           held to maturity                                    (9,393)      (58,437)
      Funds invested in investment securities
           available for sale                                  (3,236)         (616)
      Net (increase) decrease in loans
           made to customers                                  (15,584)        6,186
      Originations of residential mortgage loans sold         (20,763)       (6,298)
      Proceeds from sale of residential mortgage loans         18,900         3,610
      Net expenditures for premises and equipment                (600)         (566)
      Proceeds from sale of other real estate owned               206           524
                                                             --------      --------
          Net cash used by investing activities                (8,097)      (18,539)
  
  CASH FLOWS FROM FINANCING ACTIVITIES:
      Net increase in deposits                                  4,905        10,071
      Net increase (decrease) in short-term borrowings          2,708        (1,769)
      Net (decrease) increase in other borrowings              (5,479)        1,739
      Proceeds from issuance of common stock                        0           103
      Cash dividends paid                                      (1,629)       (1,400)
                                                             --------      --------
          Net cash provided from financing activities             505         8,744
  
      Net decrease in cash and due from banks                  (4,750)       (5,314)
  
      Cash and due from banks at beginning of period           23,766        23,568
      Cash and due from banks at end of period               $ 19,016      $ 18,254
  
  SUPPLEMENTAL DISCLOSURES:
      Interest paid                                          $  4,826      $  5,034
      Income taxes paid                                         1,683         1,900
  
  NON-CASH INVESTING AND FINANCING ACTIVITIES:
      Loans charged-off                                           575           314
  -6-
  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, 1996 and December
       31, 1995, the consolidated statements of income for the three and six month
       periods  ended June 30, 1996 and 1995 and the  consolidated  statements  of
       cash flows for the six months ended June 30, 1996 and 1995.  The accounting
       policies  followed in the presentation of interim financial results are the
       same as those followed on an annual basis except for SFAS 121,  "Accounting
       for the  Impairment of Long-Lived  Assets and for  Long-Lived  Assets to be
       Disposed of" and SFAS 122,  "Accounting  for Mortgage  Servicing  Rights an
       Amendment of FASB  statement  No. 65" which were  adopted  during the first
       quarter of 1996,  with the exception of the accounting  policies  discussed
       below,  which were  adopted  during the quarter  ended June 30,  1996.  The
       consolidated  financial  statements of Keystone  Heritage  Group,  Inc. and
       subsidiaries  include the  accounts  of the  Company  and its wholly  owned
       subsidiaries,  Lebanon  Valley  National  Bank and Keystone  Heritage  Life
       Insurance Company. All significant  intercompany  balances and transactions
       have been eliminated in the consolidated financial statements. For purposes
       of comparability, certain prior year amounts have been reclassified.
  
  2.   In June 1996,  the  Financial  Accounting  Standards  Board  (FASB)  issued
       Statement of Financial  Accounting  Standards No. 125,  Accounting  for and
       Servicing  of  Financial  Assets and  Extinguishment  of  Liabilities  (the
       Statement).  This Statement provides accounting and reporting standards for
       transfers  and  servicing  of  financial  assets  and   extinguishments  of
       liabilities  based  on  consistent  application  of a  financial-components
       approach that focuses on control.  It distinguishes  transfers of financial
       assets that are sales from transfers that are secured borrowings.
  
       Under the  financial-components  approach,  after a transfer  of  financial
       assets, an entity recognizes all financial and servicing assets it controls
       and  liabilities it has incurred and  derecognizes  financial  assets it no
       longer controls and liabilities that have been extinguished. The financial-
       components  approach focuses on the assets and liabilities that exist after
       the  transfer.  Many of these  assets and  liabilities  are  components  of
       financial assets that existed prior to the transfer. If a transfer does not
       meet the  criteria for a sale,  the transfer is accounted  for as a secured
       borrowing with pledge of collateral.
  
       This Statement extends the  "available-for-sale"  or "trading"  approach in
       Statement No. 115,  Accounting  for Certain  Investments in Debt and Equity
       Securities,  to non-security  financial  assets that can  contractually  be
       prepaid  or  otherwise  settled  in such a way that the holder of the asset
       would not recover substantially all of its recorded investment.  Thus, non-
       security  financial  assets (no matter how  acquired)  that are  subject to
       prepayment  risk that could prevent  recovery of  substantially  all of the
       recorded  amount are to be  reported  at fair value with the change in fair
       value accounted for depending on the asset's  classification as "available-
       for-sale" or  "trading".  The  Statement  also amends  Statement No. 115 to
       prevent  a  security  from  being  classified  as  held-to-maturity  if the
       security can be prepaid or otherwise  settled in such a way that the holder
       of the  security  would  not  recover  substantially  all  of its  recorded
       investment.
  
       This  Statement  requires that a liability be  derecognized  if and only if
       either (a) the debtor pays the creditor  and is relieved of its  obligation
       for the  liability  or (b) the  debtor is legally  released  from being the
       primary obligor under the liability either judicially or by the creditor.
  
                                         -7-
  Currently,  management  has not  determined  the  impact  on the  Company's
       financial   condition  or  results  of  operations  upon  adoption  of  the
       provisions of the  Statement.  Statement No. 125 is effective for transfers
       and  servicing  of  financial  assets and  extinguishments  of  liabilities
       occurring  after  December  31, 1996,  and is to be applied  prospectively.
       Earlier or retroactive application is not permitted. Also, the extension of
       the Statement No. 115 approach to certain non-security financial assets and
       the amendment to Statement  No. 115 is effective for financial  assets held
       on or acquired after January 1, 1997.
  
  3.   On June 12, 1996 the Company announced its intentions to repurchase up to 5
       percent  or  203,584  shares  of  its  outstanding   common  stock.   These
       repurchased  shares will be available for reissuance  through the Company's
       Dividend  Reinvestment or Stock Option Plans or for other general corporate
       purposes.
  
  4.   Earnings  per common share are based upon the  weighted  average  number of
       shares  outstanding.  The weighted average number of shares outstanding was
       4,071,683 and 4,064,673 for the three month periods ended June 30, 1996 and
       1995,  respectively,  and  4,071,683 and 4,063,154 for the six months ended
       June 30, 1996 and 1995,  respectively.  All prior period per share data has
       been restated to give effect for the 4-for-3 stock split that was effective
       for January 1996.
  
                                         -8-
  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, 1996 was
  $2.078  million or $.51 per share,  compared to $1.864 million or $.46 per share
  for the three months ended June 30, 1995. Return on average stockholders' equity
  and return on average  assets for the 1996  period  were 13.83  percent and 1.46
  percent, respectively.
  
       Net  income for the six months  ended June 30,  1996 was $4.001  million or
  $.98 per share,  compared to net income of $3.621  million or $.89 per share for
  1995.  Return on average  stockholders'  equity and return on average assets for
  the 1996 period were 13.45 percent and 1.41 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 18 and 19 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,  1996 and 1995,  and for the six months  ended June 30,  1996 and
  1995.
  
       Net  interest  income for the three  months  ended  June 30,  1996 was $6.4
  million,  a $196 thousand or 3.2 percent  increase from the same period of 1995.
  The net interest margin for the second quarter of 1996 was 4.71 percent compared
  to 4.69  percent for the same  period of 1995.  Average  earning  assets for the
  three month period ended June 30, 1996 were $544.6 million, a $16.8 million or a
  3.2  percent  increase  from  the  same  period  of 1995.  For the  three  month
  comparative periods, net interest income increased in 1996 primarily as a result
  of an increase in average  loans  outstanding  of $26.9  million or 7.1 percent.
  This loan growth was primarily  funded by increases in average  interest bearing
  deposit  balances  of $8.7  million,  or 2.1  percent,  an  increase  in average
  non-interest  bearing demand deposits of $6.1 million or 11.6 percent and by the
  decrease in the average  balances in the  investment  portfolio and money market
  investments of $10.1 million or 6.7 percent.
  
       Net  interest  income  for the six  months  ended  June 30,  1996 was $12.6
  million,  a $248 thousand or 2.0 percent  increase from the same period of 1995.
  The net interest  margin for the six months ended June 30, 1996 was 4.68 percent
  compared to 4.77 percent for the same period of 1995. Average earning assets for
  the six month period ended June 30, 1996 were $541.1 million, a $19.0 million or
  a 3.6 percent increase from the same period of 1995.
  
                                         -9-
  Provision and Allowance for Possible Loan Losses
       There was no  provision  for  possible  loan  losses  charged to net income
  during the six month period ended June 30, 1996 or 1995.
  
       Net  charge-offs  of $122 thousand were recorded for the three months ended
  June 30, 1996 compared to net charge-offs of $89 thousand for the same period of
  1995. For the six month comparative  period the Company recorded net charge-offs
  of $371 thousand and $78 thousand for the 1996 and 1995  periods,  respectively.
  The primary reason for the increase in net charge-offs from 1995 to 1996 was due
  to a $264  thousand  commercial  loan  which was  charged-off  during  the first
  quarter of 1996.
  
       The  allowance for possible loan losses was $7.7 million or 1.87 percent of
  total loans  outstanding  at June 30, 1996 and $8.0  million or 2.05  percent at
  December  31, 1995.  The  allowance  for  possible  loan losses is a reserve for
  estimated  potential loan losses in the loan  portfolio.  Losses occur primarily
  from the loan  portfolio,  but may also be derived  from  commitments  to extend
  credit and standby  letters of credit.  Loan losses and recoveries of previously
  charged-off loans are charged or credited directly to the allowance for possible
  loan losses.  The  allowance  for possible  loan losses is an amount  which,  in
  management's  judgement,  is  considered  adequate  to absorb  potential  losses
  inherent in the loan portfolio.  Management  performs a quarterly  assessment of
  the Bank's loan  portfolio to determine the  appropriate  level of the allowance
  for possible loan losses. The factors considered in this evaluation include, but
  are not necessarily  limited to,  estimated loan losses  identified  through the
  review  of  loans  by the  Company's  personnel;  general  economic  conditions;
  deterioration  in loan  concentrations  or  pledged  collateral;  historic  loss
  experience;  and trends in portfolio  volume,  composition,  delinquencies,  and
  non-accruals.  In addition,  various regulatory agencies, as an integral part of
  their examination process, periodically review the Bank's allowance for possible
  loan losses.
  
                                        -10-
  The  following is a summary of the activity in the  allowance  for possible
  loan losses for the three and six month periods ended June 30, 1996 and 1995:
  Three Months Ended    Six Months Ended
                                                       June 30                June 30
  (Dollars in thousands)                            1996       1995       1996      1995
  Allowance for possible loan losses
    at beginning of period                         $7,776     $8,151     $8,025     $8,140
   Loans charged-off:
    Commercial                                        142         98        406        113
    Agriculture                                         0          0          0          0
    Real estate construction                            0          0          0          0
    Loans to individuals                               88         79        169        201
    Real estate - residential mortgage                  0          0          0          0
                                                   ------     ------     ------     ------
   Total loans charged-off                            230        177        575        314
  
   Recoveries of loans previously charged-off:
    Commercial                                         90         57        171        183
    Agriculture                                         0          0          0          0
    Real estate construction                            8         22         12         31
    Loans to individuals                               10          9         21         22
    Real estate - residential mortgage                  0          0          0          0
                                                   ------     ------     ------     ------
    Total recoveries of loans previously
                             charged-off              108         88        204        236
  
    Net loans charged-off                             122         89        371         78
    Current period's provision for
    possible loan losses                                0          0          0          0
                                                   ------     ------     ------     ------
    Allowance for possible loan
    losses at end of period                        $7,654     $8,062     $7,654     $8,062
                                                   ======     ======     ======     ======
  Other Operating Income and Expense
       Other  operating  income was $1.5  million  and $1.3  million for the three
  months ended June 30, 1996 and 1995,  respectively.  Other operating  income was
  $2.7  million and $2.4  million for the six months ended June 30, 1996 and 1995,
  respectively.  For the  three  and six  month  period,  the  increase  in  other
  operating  income is  primarily  attributable  to mortgage  banking  operations;
  results from this line of business were  increased  significantly  following the
  acquisition,  during  the first  quarter  of 1996,  of the  business  assets and
  operations of a mortgage  banking  company  located in Lancaster,  Pennsylvania.
  Other operating income is generated from mortgage banking activities through the
  sale  of  originated  mortgage  loans  in  the  secondary  market.  The  Company
  recognized  $323  thousand  from  selling  $18.9  million  of  mortgages  in the
  secondary  market in the six month period of 1996  compared to  recognizing  $78
  thousand from selling $5.4 million in the secondary market in the same period of
  1995.
  
       Other  operating  expense for the three months ended June 30, 1996 was $4.7
  million,  a 2.1 percent  increase  over the $4.6  million  reported for the same
  period of 1995. For the six months ended June 30, 1996 and 1995, other operating
  expense was $9.2 million.
  
       Salaries and benefits expense increased by $178 thousand or 7.7 percent for
  the three  months ended June 30, 1996  compared to the same period of 1995.  For
  the six months  ended June 30, 1996,  salaries  and  benefits  increased by $105
  thousand or 2.2  percent,  compared to the same period of 1995.  The increase in
  salary and benefit  expenses is a result of adding  staffing for the acquisition
  of the mortgage  banking  operations  during the first  quarter of 1996 combined
  with overall merit  increases of 4 percent which was applied to base salaries as
  of January 1, 1996. The effects of adding these staffing positions were somewhat
  offset as a result of an  internal  productivity  enhancement  program  that has
  strengthened the Company's sales efforts of the Bank's products while maximizing
  its overhead efficiency. This plan resulted in a 3 percent reduction in staffing
  positions, during the first quarter, which were realized through attrition.
  
       Other  expense  increased by $153  thousand and $288 thousand for the three
  and  six  month  comparative  periods  from  1995 to  1996.  This  increase  was
  attributable  to increased  expenses  related to the acquisition of the mortgage
  banking company, increased marketing and advertising expenses and an increase in
  advisory and  consulting  fees related to the  Company's  internal  productivity
  enhancement program.  The Company's FDIC deposit insurance  substantially offset
  the increase in expenses for the three and six month  periods  compared to 1995.
  The Bank expense for FDIC  insurance  for the first six months of 1995  totalled
  $518 thousand  compared to $1 thousand for the same period of 1996.  The Bank is
  currently paying an assessment rate of $500 per quarter.
  
                                        -11-
  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, 1996 totalled $1.6 million or .38 percent
  of total loans outstanding,  compared to $1.5 million or .39 percent of loans at
  December  31, 1995 and $2.2  million or .58  percent of loans at June 30,  1995.
  Non-performing assets at June 30, 1996 were $2.3 million or .56 percent of loans
  plus other real estate  owned  compared to $2.5  million or .62 percent of loans
  plus  other real  estate  owned at  December  31,  1995 and $3.6  million or .95
  percent of loans plus other real estate owned at June 30, 1995. The  improvement
  in  non-performing  assets at June 30,  1996 as  compared to June 30, 1995 was a
  result of decreased levels of non-accrual loans and other real estate owned.
  
       The following is a  presentation  of  non-performing  assets as of June 30,
  1996, December 31, 1995, and June 30, 1995:
  
                                           June 30     Dec. 31      June 30
  (Dollars in thousands)                     1996        1995        1995
  
  Non-performing loans                      $1,251      $  741      $1,806
  Loans past due 90 days or more as to
    principal or interest                      303         793         384
                                            ------      ------      ------
  Total non-performing loans                 1,554       1,534       2,190
  
  Other real estate owned, net                 741         913       1,448
                                            ------      ------      ------
  Total non-performing assets               $2,295      $2,447      $3,638
                                            ======      ======      ======
  
  Allowance for possible loan losses to
    non-performing loans                     4.93x       5.23x       3.68x
  Non-performing loans as a
    percent of loans outstanding               .38%        .39%        .58%
  Non-performing assets as a
    percent of loans outstanding
    plus other real estate owned               .56%        .62%        .95%
  
       Interest income of  approximately  $18 thousand and $39 thousand would have
  been recognized  during the three and six month periods ended June 30, 1996, had
  these  loans been  current in  accordance  with  their  original  terms and been
  outstanding  through the period or since  origination.  Interest income on these
  loans of $9 thousand and $22 thousand  was  recognized  during the three and six
  months ended June 30, 1996.
  
       Group  concentrations  of  credit  are  considered  to exist if a number of
  counterparties  are  engaged in similar  activities  and have  similar  economic
  characteristics  that would cause their ability to meet contractual  obligations
  to  be  similarly   affected  by  changes  in  economic  or  other   conditions.
  Agriculture-related  borrowings  at June 30, 1996  totalled  $99 million or 24.2
  percent of total  loans  outstanding.  These  loans may be  impacted  by adverse
  climate or economic  conditions  not common to other  industries.  The Company's
  exposure to possible loss in the event of  nonperformance  by these borrowers is
  represented by the contractual amount of those instruments. The Company's policy
  is to require  supporting  collateral  for these loans which is generally in the
  form of agriculture real estate, livestock, and farm equipment. At June 30, 1996
  there were no significant  agriculture  related borrowings which were classified
  as  non-performing  assets and there were no charge-offs of agriculture  related
  loans during the three or six months ended June 30, 1996.
  
  Financial Position
       Total assets at June 30, 1996 were $580 million compared to $578 million at
  December 31, 1995.  Total loans  outstanding  at June 30, 1996 were $408 million
  compared to $391 million at December 31, 1995.  Total  deposits at June 30, 1996
  were $493 million compared to $488 million at December 31, 1995. The $17 million
  or 4.4 percent  growth in loans  outstanding  from December 31, 1995 to June 30,
  1996  was  funded  by a $13.5  million  reduction  in the  Company's  investment
  maturity and a $4.9 million  increase in deposit  balances.  Loan  balances have
  increased as a result of an increased sales and marketing.  The reduction in the
  investment  portfolio,  which  was  used to fund the loan  growth  was  achieved
  through the contractual maturities of the investment portfolio.
  
                                        -12-
  Capital Adequacy
       The Company's  stockholders'  equity was $61.1 million at June 30, 1996 and
  $58.9 million at December 31, 1995. Total stockholders'  equity increased by 3.8
  percent from  December 31, 1995 which was the net effect of the  recognition  of
  $4.0 million in net income for the six month period,  cash dividend  payments to
  stockholders of $1.6 million and an unfavorable  change in net unrealized  gains
  or losses on  investment  securities  available for sale of $124  thousand.  Net
  unrealized  gains on investment  securities  available for sale of $212 thousand
  and $336 thousand were included as a component of  stockholders'  equity at June
  30, 1996 and December 31, 1995, respectively.
  
       On June 12, 1996, the Company  announced its intentions to repurchase up to
  5 percent or 203,584 shares of its outstanding  common stock.  These repurchased
  shares  will  be  available  for  reissuance   through  the  Company's  Dividend
  Reinvestment or Stock Option Plans or for other general corporate purposes.
  
       The  maintenance  of an  appropriate  level of capital is a priority of the
  Company's  management.  The Company's  capital  adequacy and dividend policy are
  closely  monitored  by  management  and are  reviewed  regularly by the Board of
  Directors of the Company.  The Company  intends to provide an adequate return to
  its stockholders while retaining a sufficient capital base to provide for future
  growth and to comply with regulatory standards.
  
       Banking  regulators'  risk-based  capital  guidelines  address  the capital
  adequacy of banking  organizations.  These  guidelines  include a definition  of
  capital and a framework for calculating risk-weighted assets by assigning assets
  and off-balance sheet items to broad risk categories,  as well as minimum ratios
  to be maintained by banking  organizations.  The  risk-based  capital ratios are
  calculated by dividing qualifying capital by risk-weighted assets.
  
       Under the risk-based  capital  guidelines,  Total Capital is defined as the
  sum of core or "Tier 1" Capital and "Tier 2" Capital. As the guidelines apply to
  Keystone Heritage Group, Inc., Tier 1 Capital is total stockholders'  equity and
  Tier 2 Capital includes a portion of the allowance for possible loan losses. The
  rules  require that banking  organizations  must have ratios of 4.00 percent and
  8.00 percent for Tier 1 and Total  Capital,  respectively.  At June 30, 1996 the
  Company's  Tier 1 and Total Capital ratios were 13.65 percent and 14.97 percent,
  respectively.  Tier 1 and Total  Capital  ratios  were 13.59  percent  and 14.93
  percent  respectively,  at December  31,  1995.  In  addition to the  risk-based
  capital ratio, a bank is also required to maintain a "Leverage  ratio" of Tier 1
  capital to average  total assets of 3 percent or higher.  At June 30, 1996,  the
  Company's Leverage ratio was 10.57 percent and was 10.29 percent at December 31,
  1995.
  
  Off-Balance Sheet Items
  
       The  Company's  loan   portfolio   consists  of  loans  to  businesses  and
  individuals  primarily  in its  five-county  market area of Lebanon,  Lancaster,
  Berks, Dauphin, and Schuylkill counties.
  
       In the ordinary course of business, the Company enters into agreements with
  customers,  such as commitments  to extend credit and standby  letters of credit
  which involve, to varying degrees,  elements of credit and interest rate risk in
  excess of the amounts presented in the balance sheet. The Company's  exposure to
  possible loss in the event of nonperformance by the other party to the financial
  instruments for commitments to extend credit and financial guarantees written is
  represented by the contractual amount of those instruments.  The Company may not
  be obligated to advance funds if the customer's financial condition deteriorates
  or if the customer fails to meet certain terms.
  
       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.
  
                                        -13-
  The Bank is presently party to several interest rate swap contracts as part
  of its asset-liability management activities. These contracts are used primarily
  for the purpose of  managing  interest  rate risk  against  specific  assets and
  liabilities  in  order  to  minimize  mismatches  in the  Bank's  interest  rate
  sensitivity and interest rate risk positions.
  
       Interest rate swap  contracts  generally  involve the exchange of fixed and
  floating-rate   interest  payment   obligations  without  the  exchange  of  the
  underlying principal amounts. Entering into interest rate contracts involves not
  only the risk of dealing with counterparties and their ability to meet the terms
  of the  contracts  but also the interest  rate risk  associated  with  unmatched
  positions should the counterparties fail to perform.  Notional principal amounts
  often are used to express the volume of these transactions.
  
       The interest  income or interest  expense  differential  from interest rate
  swap  contracts is  recognized  on the accrual  basis as a component of interest
  income or interest  expense over the life of the  contract.  Interest  income or
  interest  expense  resulting from the cap and collar  contracts is recognized on
  the  accrual  basis  when  the  national  prime  rate  moves  below  or  above a
  predetermined  interest rate level.  Gains or losses from early  termination  of
  swap  contracts  are  deferred  and  amortized  over the  remaining  term of the
  underlying  assets or liabilities.  The Company is not exposed to credit risk in
  terms of the  notional  amounts  of these  contracts,  however,  the  receipt of
  payments representing the interest differential is based on the creditworthiness
  of the counterparty to each contract.
  
       Interest rate sensitivity is a function of the repricing characteristics of
  the Company's assets and liabilities.  Each asset and liability  reprices either
  at  maturity or during the life of the  instrument.  Interest  rate  sensitivity
  measures the difference  between the volume of assets and  liabilities  that are
  subject to repricing at a future period of time. These  differences are known as
  interest sensitivity gaps.
  
       The principal  objectives of  asset-liability  management are to manage the
  funding and investment  strategies  necessary to maintain an appropriate balance
  of the  sensitivity  between assets and  liabilities  to potential  movements in
  interest rates and to provide adequate  liquidity while enhancing  profitability
  through returns from managed levels of interest rate risk. The Company  actively
  manages the interest rate  sensitivity  of its assets and  liabilities.  Several
  techniques are used for measuring  interest rate  sensitivity.  The  traditional
  maturity "gap" analysis,  which reflects the volume difference  between interest
  rate sensitive  assets and liabilities  during a given time period,  is reviewed
  regularly  by  management.  An interest  rate risk  simulation  model is used to
  assess the level of  interest  rate risk  inherent in the  Company's  assets and
  liabilities  under various interest rate scenarios.  The Company  recognizes the
  importance  of  managing  both  assets and  liabilities  simultaneously  for the
  purpose of managing interest rate risk, providing  liquidity,  and enhancing the
  market value of the Company.
  
       Managing  interest rate  sensitivity is an inexact  science.  The repricing
  intervals  between assets and liabilities  change on a daily basis.  Contractual
  maturities  are not  always  the  same  as  actual  maturities  as a  result  of
  prepayments prior to scheduled maturities.  Additionally,  demand deposits,  NOW
  accounts,  and money  market fund  accounts may be  withdrawn  upon demand,  and
  savings  deposits may be withdrawn upon a very short period of notice.  However,
  for asset-liability management purposes, the Company considers a portion of each
  of these types of deposits to be "core"  amounts which may be considered to have
  various maturities.
  
       The Company  manages its  interest  rate  sensitivity  by changing  mix and
  repricing  characteristics of its assets and liabilities  through its investment
  securities  portfolio,  its loan  and  deposit  terms,  and  through  the use of
  off-balance  sheet  derivatives,  primarily  interest rate swap  contracts.  The
  interest rate contracts  presently in effect will have a negative  effect on net
  interest  income  in a rising  rate  environment  and a  positive  effect on net
  interest income in a decreasing rate environment.
  
       The Company's use of these interest rate contracts is closely  monitored by
  the  Company's  Board of  Directors  and is closely  controlled  as to levels of
  exposure.  At June  30,  1996 the  Company  had five  interest  rate  agreements
  outstanding having a total notional amount of $50 million.  These agreements are
  in the form of interest rate swap  agreements each with a notional amount of $10
  million having remaining maturities ranging from one to three years.
  
                                        -14-
  The Company entered into two interest rate swap contracts  during the first
  quarter of 1996.  On March 4, 1996,  the Company  entered into an interest  rate
  swap contract with a notional  amount of $10 million.  This contract states that
  the Company would receive a fixed rate of 8.25 percent and pay a floating  prime
  rate based on the national  prime rate and expires on March 4, 1998. The Company
  entered  into  another  interest  rate swap  contract  on March 14,  1996 with a
  notional  amount of $10 million.  This  contract  states that the Company  would
  receive a fixed rate of 8.65 percent and pay a floating  prime rate based on the
  national prime rate and expires on March 15, 1999.
  
       The  Company  does not  obtain  collateral  or other  security  to  support
  financial instruments subject to credit risk but monitors the credit standing of
  counterparties. The counterparties of the aforementioned interest rate contracts
  are commercial banks having a rating of A1 from Moody's Investor Service.
  
       The interest rate swap contracts were entered into to protect the Company's
  interest  rate  risk  in  a  declining  or  stable  interest  rate  environment.
  Specifically, these contracts protect the Company's risk from negative movements
  in its prime rate based asset portfolio which would not be perfectly  matched by
  repricing  liabilities.  These  contracts  were  entered  into to  minimize  the
  negative effects that the Bank would realize, in falling rate environments (e.g.
  reduction in prime based rates).
  
       The following is the amount of financial instruments with off-balance sheet
  risk not  reflected  in the  consolidated  balance  sheets at June 30,  1996 and
  December 31, 1995:
  
                                            Contractual Amounts
                                          June 30     December 31
  (Dollars in thousands)                    1996         1995
  Financial instruments whose
  contractual
    amounts represent credit risk:
  Commitments to extend credit           $100,300     $ 88,242
  Standby letters of credit                 8,159        8,862
  Contractual amounts of off-balance
  sheet financial instruments not
  constituting credit risk:
     Interest rate swap, notional
  value                                    50,000       30,000
     Interest rate cap/collar,
  notional value                              -0-       10,000
  
  Supervision and Regulation
  
       During 1994, Congress passed legislation to remove geographic  restrictions
  on bank expansion.  The Riegle-Neal Interstate Banking and Branch Efficiency Act
  of 1994  will  allow  banks to  expand  across  state  lines  to merge  existing
  multi-state  branching  operations  into a single  institution or to acquire new
  branches in other states.  Interstate  banking and branching  authority  will be
  subject to  certain  conditions  and  restrictions,  such as  capital  adequacy,
  management,  CRA compliance and limits on deposit concentrations.  The effective
  date for this legislation will be June 1, 1997.  Individual states will have the
  option to opt in early or to opt out completely prior to June 1, 1997.
  
       Although  the  passage  of this  legislation  should  have  the  impact  of
  quickening the pace of consolidation  within the banking  industry,  the Company
  does not  anticipate  any immediate  impact upon its financial  condition or its
  operations as a result of this new law.
  
       The Bank is a national bank,  chartered under the National Bank Act, and is
  subject to the primary  supervision  of, and is examined by, the  Comptroller of
  the Currency.  As a member of the Federal Reserve System, the Bank is subject to
  provisions of the Federal  Reserve Act, which restricts the ability of a bank to
  extend  credit to its parent  holding  company  or to  certain  of the  parent's
  subsidiaries,  or to invest in the Company's  common stock or to take such stock
  as  collateral  for loans to any borrower.  The  operations of the Bank are also
  subject to regulation by the FDIC.
  
       The Company is affected by the monetary and credit  policies of the Federal
  Reserve System. The Federal Reserve System regulates the national supply of bank
  credit through open market operations in U. S. Government securities, changes in
  the  discount  rate  charged  for  bank   borrowing,   and  changes  in  reserve
  requirements on bank deposits.
  
                                        -15-
  New Accounting Standards
  
       On January 1, 1996 the  Company  adopted the  provisions  of  Statement  of
  Financial  Accounting  Standards  No.  121  (SFAS  121),   "Accounting  for  the
  Impairment of Long-Lived  Assets and for  Long-Lived  Assets to be Disposed Of".
  SFAS  provides  guidance  for  recognition  and  measurement  of  impairment  of
  long-lived assets, certain identifiable intangibles and goodwill related both to
  assets held and used and assets to be disposed of.
  
       SFAS  121  requires  that  long-lived   assets  and  certain   identifiable
  intangibles  held and used by an  entity be  reviewed  for  impairment  whenever
  events or changes in circumstances indicate that the carrying amount of an asset
  may not be recoverable.  In performing the review for recoverability,  an entity
  should  estimate  the future  cash flows  expected to result from the use of the
  asset and its eventual disposition. If the sum of the expected future cash flows
  (undiscounted  and without interest charges) is less than the carrying amount of
  the asset,  an impairment loss is recognized.  Otherwise,  an impairment loss is
  not  recognized.  Measurement of an impairment  loss for  long-lived  assets and
  identifiable  intangibles that an entity expects to hold and use should be based
  on the fair value of the asset.
  
       SFAS  121  requires  that  long  lived  assets  and  certain   identifiable
  intangibles  to be disposed  of be  reported at the lower of carrying  amount or
  fair value less cost to sell. The  implementation of SFAS 121 did not materially
  impact the Company's financial condition or results of operation.
  
       On January 1, 1996, the Company  adopted the provisions of the Statement of
  Financial  Accounting  Standards  No. 122,  "Accounting  for Mortgage  Servicing
  Rights,  an  amendment  of FASB  Statement  No. 65" (SFAS 122).  SFAS 122 amends
  Statement  65 to require an  institution  to  recognize  as separate  assets the
  rights to  service  mortgage  loans for others  when a mortgage  loan is sold or
  securitized and servicing rights  retained.  SFAS 122 also requires an entity to
  measure the impairment of servicing  rights based on the difference  between the
  carrying amount of the servicing rights and their current fair value.
  
       Presently,  the Company  does not sell or  securitize  mortgage  loans with
  servicing rights retained. Accordingly, the Company has not been impacted by the
  provisions of SFAS 122.
  
       On January 1, 1996 the  Company  adopted the  provisions  of  Statement  of
  Financial   Accounting   Standards   No.  123,   "Accounting   for   Stock-Based
  Compensation"  (SFAS 123).  SFAS 123  establishes a new method of accounting for
  stock-based  compensation  arrangements with employees. The new method is a fair
  value  based  method  rather  than the  intrinsic  value  based  method  that is
  currently  utilized.  However,  SFAS 123 does not require an entity to adopt the
  new  fair  value  based  method  for  purposes  of  preparing   basic  financial
  statements.  If an entity chooses not to adopt the fair value based method, SFAS
  123  requires  an entity to  display in the  footnotes  pro forma net income and
  earnings  per share  information  as if the fair  value  based  method  had been
  adopted.
  
       The Company has not adopted the fair value method as described in SFAS 123.
  The Company will disclose in the footnotes, in the 1996 Annual Report, pro forma
  net income and  earnings per share  information  as if the fair value method had
  been adopted.
  
       In June 1996,  the  Financial  Accounting  Standards  Board  (FASB)  issued
  Statement  of  Financial  Accounting  Standards  No.  125,  Accounting  for  and
  Servicing of Financial  Assets and  Extinguishment  of Liabilities  (Statement).
  This Statement  provides  accounting  and reporting  standards for transfers and
  servicing  of  financial  assets and  extinguishments  of  liabilities  based on
  consistent  application  of a  financial-components  approach  that  focuses  on
  control.  It  distinguishes  transfers of  financial  assets that are sales from
  transfers that are secured borrowings.
  
       Under the  financial-components  approach,  after a transfer  of  financial
  assets,  an entity recognizes all financial and servicing assets it controls and
  liabilities  it has  incurred  and  derecognizes  financial  assets it no longer
  controls and liabilities that have been extinguished.  The  financial-components
  approach  focuses on the assets and  liabilities  that exist after the transfer.
  Many of these assets and  liabilities  are  components of financial  assets that
  existed  prior to the  transfer.  If a transfer does not meet the criteria for a
  sale,  the  transfer  is  accounted  for as a secured  borrowing  with pledge of
  collateral.
  
                                        -16-
  This Statement extends the  "available-for-sale"  or "trading"  approach in
  Statement  No.  115,  Accounting  for  Certain  Investments  in Debt and  Equity
  Securities,  to non-security  financial assets that can contractually be prepaid
  or  otherwise  settled  in such a way that the  holder  of the  asset  would not
  recover  substantially  all  of  its  recorded  investment.  Thus,  non-security
  financial  assets (no matter how acquired)  that are subject to prepayment  risk
  that could prevent recovery of  substantially  all of the recorded amount are to
  be reported at fair value with the change in fair value  accounted for depending
  on  the  asset's  classification  as  "available-for-sale"  or  "trading".   The
  Statement  also  amends  Statement  No.  115 to  prevent a  security  from being
  classified  as  held-to-maturity  if the  security  can be prepaid or  otherwise
  settled  in such a way  that  the  holder  of the  security  would  not  recover
  substantially all of its recorded investment.
  
       This  Statement  requires that a liability be  derecognized  if and only if
  either (a) the debtor pays the  creditor and is relieved of its  obligation  for
  the  liability  or (b) the debtor is  legally  released  from being the  primary
  obligor under the liability either judicially or by the creditor.
  
       Currently,  management  has not  determined  the  impact  on the  Company's
  financial  condition or results of operations upon adoption of the provisions of
  the  Statement.  Statement  No. 125 is effective  for transfers and servicing of
  financial assets and extinguishments of liabilities occurring after December 31,
  1996, and is to be applied prospectively.  Earlier or retroactive application is
  not permitted.  Also, the extension of the Statement No. 115 approach to certain
  non-security  financial  assets  and  the  amendment  to  Statement  No.  115 is
  effective for financial assets held on or acquired after January 1, 1997.
  
                                        -17-
  AVERAGE BALANCE SHEETS, RATES AND INTEREST INCOME AND EXPENSE
                               (Dollars in thousands)
  Three Months Ended June 30, 1996       Three Months Ended June 30, 1995
                                                   Average                       Average     Average                   Average
                                                   Balance      Interest          Rate       Balance      Interest       Rate
  Assets 
      Loans                                        $405,215      $  9,056         8.99%     $378,365     $  8,830        9.36%
      Money market investments                        2,201            30         5.54         7,436          113        6.10
      Investment securities:
          Taxable                                   125,294         1,819         5.84       131,853        1,878        5.78
          Non-taxable                                11,926           193         6.52        10,224          174        6.82
                                                    -------      --------         ----       -------     --------        ---- 
               Total investment securities          137,220         2,012         5.90       142,077        2,052        5.79
               Total earning assets                 544,636      $ 11,098         8.20%      527,878     $ 10,995        8.35%
                                                                 ========         ====                   ========        ==== 
  
      Other assets                                   29,240                                   26,476
                                                   --------                                 --------
               Total assets                        $573,876                                 $554,354
                                                   ========                                 ========
  
  Liabilities and stockholders' equity
      Interest bearing deposits:
          Now accounts                             $ 55,008      $    172         1.26%     $ 54,638     $    197        1.45%
          Savings and money market                  130,755         1,014         3.12       119,171          917        3.12
          Time                                      235,446         3,264         5.58       238,735        3,382        5.68
                                                    -------      --------         ----       -------     --------        ---- 
               Total interest bearing deposits      421,209         4,450         4.25       412,544        4,496        4.37
  
      Short-term borrowings                          10,860           114         4.20        11,207          112        4.02
      Long-term debt                                 10,966           160         5.87        12,392          209        6.84
                                                    -------      --------         ----       -------     --------        ---- 
          Total interest bearing liabilities        443,035      $  4,724         4.29%      436,143     $  4,817        4.43%
                                                                 ========         ====                   ========        ====
  
      Non-interest bearing deposits                  63,566                                   56,958
      Other liabilities                               6,838                                    6,817
      Stockholders' equity                           60,437                                   54,436
                                                   --------                                 --------
          Total liabilities and
          stockholders' equity                     $573,876                                 $554,354
                                                   ========                                 ========
  
      Net interest income                                        $  6,374                                $  6,178
      Total yield on earning assets                                               8.20%                                  8.35%
      Rate on supporting liabilities                                              3.49%                                  3.66%
                                                                                  ----                                   ---- 
      Net interest margin                                                         4.71%                                  4.69%
                                                                                  ====                                   ====
  Interest and average interest rates are presented on a fully taxable  equivalent
  basis,  using an effective  tax rate of 35%. For  purposes of  calculating  loan
  yields,  average loan balances include non-accrual loans. Loan fees are included
  in interest income.
  
                                        -18-
  AVERAGE BALANCE SHEETS, RATES AND INTEREST INCOME AND EXPENSE
                               (Dollars in thousands)
  Six Months Ended June 30, 1996             Six Months Ended June 30, 1995
                                                    Average                     Average        Average                    Average
                                                    Balance      Interest         Rate         Balance    Interest         Rate
  Assets
      Loans                                        $397,782      $ 17,890         9.04%       $380,081     $ 17,381        9.22%
      Money market investments                        2,465            67         5.47           8,337          247        5.97
      Investment securities:
          Taxable                                   128,975         3,756         5.86         123,396        3,438        5.61
          Non-taxable                                11,894           386         6.53          10,344          353        6.88
                                                   --------      --------         ----        --------     --------        ---- 
               Total investment securities          140,869         4,142         5.91         133,740        3,791        5.72
               Total earning assets                 541,116      $ 22,099         8.21%        522,158     $ 21,419        8.27%
                                                                 ========         ====                     ========        ==== 
  
      Other assets                                   28,132                                     26,331
                                                   --------                                   --------
               Total assets                        $569,248                                   $548,489
                                                   ========                                   ========
  
  Liabilities and stockholders' equity
      Interest bearing deposits:
          Now accounts                             $ 55,035      $    362         1.32%       $ 55,927     $    399        1.44%
          Savings and money market                  129,272         1,999         3.11         119,066        1,711        2.90
          Time                                      234,591         6,592         5.65         233,954        6,342        5.47
                                                   --------      --------         ----        --------     --------        ----
               Total interest bearing deposits      418,898         8,953         4.30         408,947        8,452        4.17
  
      Short-term borrowings                          11,182           234         4.21          12,167          243        4.03
      Long-term debt                                 11,039           323         5.87          11,540          383        6.69
                                                   --------      --------         ----        --------     --------        ----
          Total interest bearing liabilities        441,119      $  9,510         4.34%        432,654     $  9,078        4.23%
                                                                 ========         ====                     ========        ====
  
      Non-interest bearing deposits                  60,813                                     55,757
      Other liabilities                               7,488                                      6,507
      Stockholders' equity                           59,828                                     53,571
                                                   --------                                   --------
          Total liabilities and
          stockholders' equity                     $569,248                                   $548,489
                                                   ========                                   ========
  
      Net interest income                                        $ 12,589                                  $ 12,341
      Total yield on earning assets                                               8.21%                                    8.27%
      Rate on supporting liabilities                                              3.53%                                    3.50%
                                                                                  ----                                     ---- 
      Net interest margin                                                         4.68%                                    4.77%
                                                                                  ====                                     ====
  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.
  
                                        -19-
  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
  
  1996 Annual Stockholders' Meeting
  
       The 1996 Annual Meeting of Stockholders'  for the Company was held on April
  16, 1996.  Stockholders' of the Company voted on the following issues:  Election
  of Directors  Harry J.  Gensemer,  Albert B. Murry,  Thomas I. Siegel,  Brett H.
  Tennis  and  Earnest D.  Williams,  Jr.;  a  proposal  to Approve  and Adopt the
  Keystone Heritage Group,  Inc. 1996 Independent  Directors Stock Option Plan for
  non-employee  directors  of the  Company;  to Vote on the  Stockholder  Proposal
  described  on page 6 of the March 7, 1996 proxy  statement;  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, 1996.  Seventy seven
  percent of the 4,071,683 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 16, 1996 Annual Stockholders' Meeting:
  
  Election of Directors:             FOR           Withheld        Total
  
  Harry J. Gensemer               3,060,847          63,572      3,124,419
  
  Albert B. Murry                 2,980,338         144,081      3,124,419
  
  Thomas I. Siegel                3,050,740          73,679      3,124,419
  
  Brett H. Tennis                 2,967,721         156,698      3,124,419
  
  Earnest D. Williams, Jr.        3,063,986          60,433      3,124,419
  
       The term of the Directors  elected at the Annual Meeting expires in 1999 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 1997 and 1998 or when the  director  would  reach the  mandatory
  retirement age of 72:
  
  Directors Term Expiring in 1997:
  Raymond M. Dorsch, Jr.
  Wendie DiMatteo Holsinger
  Donald W. Lesher, Jr.
  Mark Randolph Tice
  
  Directors Term Expiring in 1998:
  Lance M. Frehafer
  Charles V. Henry, III
  Bruce A. Johnson
  John E. Wengert
  
       The proposal to Approve and Adopt the  Keystone  Heritage  Group,  Inc 1996
  Independent  Directors  Stock  Option  Plan for  non-employee  directors  of the
  Company was voted as follows:
  
                  For              Against            Abstain
  
               2,721,554            375,942             26,913
  
                                        -20-
  The proposal to approve the Stockholder Proposal described on page 6 of the
  March 7, 1996 proxy statement was defeated and was voted as follows
  
                                                                       Broker
                  For              Against            Abstain         Non-vote
  
                 365,902          2,465,532           47,932         245,053
  
       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,
  1996 was voted as follows:
  
                  For              Against            Abstain
  
               2,958,958            129,167           36,294
  
  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, 1996.
  
                                        -21-
  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  August 12, 1996               By /s/ Kurt A. Phillips
                                         -----------------------------------------
                                         Kurt A. Phillips
                                         Chief Financial and Accounting Officer
  
                                        -22-