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 March 31, 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 May 9, 1996
Common Stock ($5.00 par value) 4,071,683 shares
<PAGE>
KEYSTONE HERITAGE GROUP, INC.
Index
PART I - FINANCIAL INFORMATION Page
Item 1 - Financial Statements
Consolidated Balance Sheets as of
March 31, 1996 and December 31, 1995 (Unaudited) 3
Consolidated Statements of Income for the
Three Months ended March 31, 1996 and
1995 (Unaudited) 4
Consolidated Statements of Stockholders' Equity
for the Three Months ended March 31, 1996 and
1995 (Unaudited) 5
Consolidated Statements of Cash Flows for the
Three Months ended March 31, 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 9
PART II - OTHER INFORMATION
Signature Page 19
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<PAGE>
KEYSTONE HERITAGE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars In Thousands)
<TABLE>
<CAPTION>
March 31 December 31
1996 1995
<S> <C> <C>
ASSETS
Cash and due from banks $ 17,023 $ 23,766
Interest bearing deposits with banks 198 246
Federal funds sold 5,000 0
Investment securities available for sale 57,393 65,799
Investment securities held to maturity
(fair value of $82,607 and $88,052
for 1996 and 1995, respectively) 82,142 86,885
Loans, net of unearned income of
$2,530 for 1996 and $2,830 for 1995 392,545 391,009
Allowance for possible loan losses (7,776) (8,025)
---------- ----------
Loans, net 384,769 382,984
Premises and equipment, net 7,675 7,933
Accrued interest receivable 3,946 3,844
Other real estate owned 947 913
Deferred tax asset, net 2,914 3,100
Other assets 2,664 2,307
---------- ---------
Total assets $ 564,671 $ 577,777
========== =========
LIABILITIES
Non-interest bearing deposits $ 60,537 $ 65,530
Interest bearing deposits 417,303 422,387
---------- ---------
Total deposits 477,840 487,917
Short-term borrowings 9,110 8,640
Other borrowings 10,941 14,009
Accrued interest payable 4,006 5,284
Other liabilities 2,897 3,048
---------- ---------
Total liabilities 504,794 518,898
STOCKHOLDERS' EQUITY
Common stock - $5 par value; Authorized
10,000,000 shares; Outstanding
4,071,683 shares at March 31, 1996 and
December 31, 1995, respectively 20,358 20,358
Capital surplus 22,078 22,078
Retained earnings 17,216 16,107
Net unrealized loss on investment securities
available for sale, net of taxes 225 336
---------- ---------
Total stockholders' equity 59,877 58,879
Total liabilities and stockholders'
equity $ 564,671 $ 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
March 31
1996 1995
<S> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 8,753 $ 8,481
Interest on investment securities
available for sale:
Taxable investment securities 737 662
Equity investments 55 43
Interest on investment securities held to maturity:
Taxable investment securities 1,145 856
Non-taxable investment securities 125 116
-------- -------
Total interest on investment
securities 2,062 1,677
Interest on money market investments 37 134
-------- -------
Total interest income 10,852 10,292
INTEREST EXPENSE
Interest on deposits 4,503 3,956
Interest on short-term borrowings 121 131
Interest on other borrowings 162 182
-------- -------
Total interest expense 4,786 4,269
Net interest income 6,066 6,023
Provision for possible loan losses 0 0
-------- -------
Net interest income after provision
for possible loan losses 6,066 6,023
OTHER OPERATING INCOME
Trust income 317 315
Service charges on deposits 306 311
Net realized gain (loss) on investment
securities available for sale 23 (7)
Net gain on sale of loans 74 40
Other income 483 481
-------- -------
Total other operating income 1,203 1,140
OTHER OPERATING EXPENSE
Salaries and employee benefits 2,364 2,437
Occupancy expense, net 328 317
Equipment expense 506 466
Deposit insurance expense 1 259
Other expense 1,276 1,141
-------- -------
Total other operating expense 4,475 4,620
Income before income taxes 2,794 2,543
Income taxes 871 786
-------- -------
Net income $ 1,923 $ 1,757
======== =======
PER COMMON SHARE
Net income $ .47 $ .43
======== =======
Cash dividends paid $ .20 $ .165
</TABLE>
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<PAGE>
KEYSTONE HERITAGE GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Three Months Ended March 31
(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) $52,102
Net Income -0- -0- 1,757 -0- 1,757
Cash dividends ($.165 per share) -0- -0- (670) -0- (670)
Change in unrealized gain (loss) on
investment securities available
for sale, net of taxes -0- -0- -0- 694 694
------- ------- ------- -------- -------
Balance, March 31, 1995 $15,231 $30,053 $ 9,356 ($ 757) $53,883
======= ======= ======= ======== =======
Balance, December 31, 1995 $20,358 $22,078 $16,107 $ 336 $58,879
Net income 1,923 1,923
Cash dividends ($.20 per share) -0- -0- (814) -0- (814)
Change in unrealized gain (loss) on
investment securities available for
sale, net of taxes -0- -0- -0- (111) (111)
------- ------- -------- -------- --------
Balance, March 31, 1996 $20,358 $22,078 $17,216 $ 225 $59,877
======= ======= ======== ======== =======
</TABLE>
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<PAGE>
KEYSTONE HERITAGE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31
1996 1995
<S> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 1,923 $ 1,757
Adjustments to reconcile net income to cash:
Provision for possible loan losses 0 0
Depreciation and amortization 391 344
Deferred income taxes 242 (41)
Increase in accrued interest receivable (102) (100)
Increase (decrease) in
accrued interest payable (1,278) 412
Net gain on sale of loans (74) (40)
Net realized (gain) loss on investment
securities available for sale (23) 7
Other, net (504) (143)
-------- --------
Net cash provided by operating activities 575 2,196
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in money market investments (4,952) (1,300)
Maturities of investment securities
held to maturity 9,726 10,376
Maturities of investment securities
available for sale 11,291 3,128
Sale of investment securities available for sale 63 100
Funds invested in investment securities
held to maturity (4,958) (25,992)
Funds invested in investment securities
available for sale (3,174) (184)
Net (increase) decrease in loans
made to customers (423) 3,520
Originations of residential mortgage loans sold (5,994) (1,617)
Proceeds from sale of residential mortgage loans 4,725 1,862
Net expenditures for premises and equipment (133) (301)
Proceeds from sale of other real estate owned 0 412
-------- -------
Net cash provided from (used by)
investing activities 6,171 (9,996)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in deposits (10,077) (514)
Net increase (decrease) in short-term borrowings 470 (1,274)
Net (decrease) increase in other borrowings (3,068) 2,871
Cash dividends paid (814) (670)
-------- --------
Net cash used by (provided from)
financing activities (13,489) 413
Net decrease in cash and due from banks (6,743) (7,387)
Cash and due from banks at beginning of period 23,766 23,568
Cash and due from banks at end of period $17,023 $16,181
SUPPLEMENTAL DISCLOSURES:
Interest paid $ 2,824 $ 2,451
Income taxes paid 74 300
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Loans charged-off 345 137
</TABLE>
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<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 March 31, 1996 and December
31, 1995, the consolidated statements of income for the three month periods
ended March 31, 1996 and 1995 and the consolidated statements of cash flows
for the three months ended March 31, 1996. The accounting policies followed
in the presentation of interim financial results are the same as those
followed on an annual basis, with the exception of the accounting policies
discussed below, which were adopted during the quarter ended March 31,
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. 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
impact the Company's financial condition or results of operations
3. 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.
-7-
<PAGE>
4. 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.
5. 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 4,061,617 for the three month periods ended March 31,1996 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.
6. On March 1, 1996 the Company acquired the business operations of Central
Mortgage Company, a Lancaster, Pennsylvania mortgage origination company.
As consideration for this transaction, the Company will pay the seller an
amount equal to one-tenth of one percent (.1%) of all mortgages closed and
located in Lancaster County during the next five years, up to a maximum of
$50,000 per year. In addition, the building premises and the equipment are
being leased by the Company from the seller.
-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 March 31, 1996 was
$1.923 million or $.47 per share, compared to $1.757 million or $.43 per share
for the three months ended March 31, 1995. Return on average stockholders'
equity and return on average assets for the 1996 period were 13.06 percent and
1.37 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 table presented on page 17 is a comparative statement of average
balances of interest earning assets and interest bearing liabilities, interest
income and interest expense, and interest rates for the three months ended March
31, 1996 and 1995.
Net interest income for the three months ended March 31, 1996 and March 31,
1995 was $6.2 million, respectively. The net interest margin for the first
quarter of 1996 was 4.65 percent compared to 4.84 percent for the same period of
1995. Average earning assets for the three month period ended March 31, 1996
were $537.6 million, a $21.2 million or a 4.1 percent increase from the same
period of 1995.
For the three month comparative periods, net interest income increased by
$60 thousand, which was comprised of volume associated increases of $290
thousand offset by a $230 thousand decrease which was associated to rate
variances. The volume increases were primarily a result of a $21.2 million
increase in average earning assets from the same period of 1995. The average
investment portfolio grew by $19.2 million and average commercial and
agricultural loans grew by $13.2 million. This was partially offset by decreases
in average mortgage loans of $2.9 million and average personal loans of $2.2
million. The decrease in personal loans outstanding was due to the net effect of
decreases of $6.8 million in indirect auto installment loans and a decrease of
$1.1 million in personal credit line loans offset by a $5.8 million or 15.8
percent increase in direct installment loans. The Company has been able to grow
its commercial loan and direct personal loan portfolios through increased sales
efforts. The credit quality of the Company's loan portfolio continues to remain
strong, as indicated by the low level of non-performing loans presented on page
12 and the low amount of net charge-offs presented on page 11. The Company's
management of credit risk continues to be emphasized as loan volumes increase.
-9-
<PAGE>
The aforementioned asset growth was primarily funded by a $14.8 million
increase in average deposit volumes. This was comprised of increases in average
savings and money market deposits of $8.8 million, a $4.6 million increase in
average time deposits and a $3.5 million increase in average non-interest
bearing demand deposits. The increase in average deposit volume was primarily
due to an increased sales and marketing effort on gathering deposits in order to
support the Company's loan growth. In addition, the Company introduced a
competitive money market product on March 1, 1995 which has a tiered pricing
structure and is tied directly to the prime rate. This was a key factor in the
growth of the money market deposit volumes from the first quarter of 1995 to
1996.
The decline in the net interest margin from the first quarter of 1995 was
due to the fact that higher rates were paid on time deposit and money market
accounts. The cost of time deposits and money market deposits increased by 48
and 93 basis points, respectively. The increase in the money market costs
resulted from the prime rate based money market product which was introduced on
March 1, 1995.
Provision and Allowance for Possible Loan Losses
There was no provision for possible loan losses charged to net income
during the three month period ended March 31, 1996 or 1995. The asset quality
continues to remain strong as indicated by the low level of non-performing loans
indicated on page 11.
Net charge-offs of $249 thousand were recorded for the three months ended
March 31, 1996 compared to net recoveries of $11 thousand for the same period of
1995.
The allowance for possible loan losses was $7.8 million or 1.98 percent of
total loans outstanding at March 31, 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 month periods ended March 31, 1996 and 1995:
<TABLE>
<CAPTION>
Three Months Ended
March 31
(Dollars in thousands) 1996 1995
<S> <C> <C>
Allowance for possible loan losses
at beginning of period $8,025 $8,140
Loans charged-off:
Commercial 264 15
Agriculture 0 0
Real estate construction 0 0
Loans to individuals 81 122
Real estate - residential mortgage 0 0
------ ------
Total loans charged-off 345 137
Recoveries of loans previously charged-off:
Commercial 81 126
Agriculture 0 0
Real estate construction 4 9
Loans to individuals 11 13
Real estate - residential mortgage 0 0
------ ------
Total recoveries of loans previously
charged-off 96 148
Net loans charged-off 249 (11)
Current period's provision for
possible loan losses 0 0
------ ------
Allowance for possible loan
losses at end of period $7,776 $8,151
====== ======
</TABLE>
Other Operating Income and Expense
Other operating income was $1.2 million for the three months ended March
31, 1996 and $1.1 million for the same period of 1995. The increase in other
income was due to a $34 thousand increase in the gain on sale of loans. On March
1, 1996, the Company completed a transaction to purchase Central Mortgage
Company, a mortgage origination company based in Lancaster, Pennsylvania. A
total of $4.7 million in mortgage loans were originated and sold during the
first quarter of 1996 compared to $1.9 million during the same periods of 1995.
The Company plans to continue selling mortgages in the secondary market and
anticipates an increase in gains on the sale of loans, as a result of this
transaction. As consideration for this transaction, the Company will pay the
seller an amount equal to one-tenth of one percent (.1%) of all mortgages closed
and located in Lancaster County during the next five years, up to a maximum of
$50,000 per year. In addition, the building premises and the equipment are being
leased by the Company from the seller.
Other operating expense for the three months ended March 31, 1996 was $4.5
million, a 1.3 percent decrease from the $4.6 million reported for the same
period of 1995. The decrease was due to a $258 thousand decrease in the amount
paid for FDIC insurance and a $73 thousand or 3 percent decrease in the amount
of salary and benefit expenses. The decrease in FDIC insurance expense is due to
the lower premium rate being charged to the Bank by the FDIC. The Bank is
currently paying a quarterly assessment amount of $500. Salaries and benefits
decreased as a result of an internal productivity enhancement program that will
strengthen 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 which were realized through attrition.
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.
-11-
<PAGE>
Non-performing loans at March 31, 1996 totalled $1.5 million or .39 percent
of total loans outstanding, compared to $1.5 million or .39 percent of loans at
December 31, 1995 and $2.6 million or .68 percent of loans at March 31, 1995.
Non-performing assets at March 31, 1996 were $2.5 million or .63 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 $4.2 million or 1.09
percent of loans plus other real estate owned at March 31, 1995. The improvement
in non-performing assets at March 31, 1996 as compared to March 31, 1995 was a
result of decreased levels of non-accrual loans and other real estate owned.
Non-accruing loans increased by $267 thousand from December 31, 1995 as the
result of adding four loans to non-accrual status during the quarter.
The Company has determined that loans with a carrying value of $1.0
million, $1.2 million and $1.9 million at March 31, 1996, December 31, 1995 and
March 31, 1995, respectively, are deemed to be impaired. The specific reserves
related to such loans, although not material, are included in the general
allowance for possible loan losses. The average balance of loans classified as
impaired for the three month comparative periods amounted to $784 thousand at
March 31, 1996 and $1.8 million 1995. Interest income of approximately $13
thousand and $4 thousand was recognized during the three month periods of 1996
and 1995, respectively, on loans classified as impaired loans.
The following is a presentation of non-performing assets as of March 31,
1996, December 31, 1995, and March 31 1995:
<TABLE>
<CAPTION>
March 31 Dec. 31 March 31
(Dollars in thousands) 1996 1995 1995
<S> <C> <C> <C>
Non-accruing loans $ 1,008 $ 741 $ 1,864
Loans past due 90 days of more as to
principal or interest 524 $ 793 $ 724
-------- -------- --------
Total non-performing loans 1,532 1,534 2,588
Other real estate owned, net 947 913 1,560
-------- -------- --------
Total non-performing assets $ 2,479 $ 2,447 $ 4,148
======== ======== ========
Allowance for possible loan losses to
non-performing loans 5.08x 5.23x 3.15x
Non-performing loans as a
percent of loans outstanding .39% .39% .68%
Non-performing assets as a
percent of loans outstanding
plus other real estate owned .63% .62% 1.09%
</TABLE>
Interest income of approximately $21 thousand would have been recognized
during the three month period ended March 31, 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 $13 thousand was
recognized during the three months ended March 31, 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 March 31, 1996 totalled $93 million or 23.7
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 March 31,
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 months ended March 31, 1996.
-12-
<PAGE>
Financial Position
Total assets at March 31, 1996 were $565 million compared to $578 million
at December 31, 1995. Total loans outstanding at March 31, 1996 were $393
million compared to $391 million at December 31, 1995. Total deposits at March
31, 1996 were $478 million compared to $488 million at December 31, 1995. The
change in deposits from December 31, 1995 to March 31, 1996 was the result of
fluctuations non-interest bearing demand deposits and other transaction accounts
and was not due to a continuing downward trend in deposit volumes.
Capital Adequacy
The Company's stockholders' equity was $59.9 million at March 31, 1996 and
$58.9 million at December 31, 1995. Total stockholders' equity increased by 1.7
percent from December 31, 1995 which was the net effect of the recognition of
$1.9 million in net income for the three month period, cash dividend payments to
stockholders of $814 thousand and an unfavorable change in net unrealized gains
or losses on investment securities available for sale of $111 thousand. Net
unrealized gains on investment securities available for sale of $225 thousand
and $336 thousand were included as a component of stockholders' equity at March
31, 1996 and December 31, 1995, respectively.
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 March 31, 1996 the
Company's Tier 1 and Total Capital ratios were 13.88 percent and 15.21 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 March 31, 1996, the
Company's Leverage ratio was 10.52 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 has entered into interest rate swap contracts, and interest rate
cap and interest rate collar 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 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 also 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 reducing 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 swaps and interest rate
cap/collar contracts. These interest rate contracts will have the effect of
decreasing net interest income in a rising rate environment and increasing 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 March 31, 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.
-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. 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.
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 will 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 March 31, 1996 and
December 31, 1995:
<TABLE>
<CAPTION>
Contractual Amounts
March 31 December 31
(Dollars in thousands) 1996 1995
<S> <C> <C>
Financial instruments whose
contractual
amounts represent credit risk:
Commitments to extend credit $92,388 $88,242
Standby letters of credit 7,599 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
</TABLE>
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 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.
-16-
<PAGE>
AVERAGE BALANCE SHEETS, RATES AND INTEREST INCOME AND EXPENSE
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended March 31, 1996 Three Months Ended March 31, 1995
Average Average Average Average
Balance Interest Rate Balance Interest Rate
<S> <C> <C> <C> <C> <C> <C>
Assets
Loans $390,350 $ 8,833 9.10% $381,817 $ 8,552 9.01%
Money market investments 2,729 37 5.42 9,247 134 5.81
Investment securities:
Taxable 132,655 1,938 5.87 114,843 1,559 5.46
Non-taxable 11,863 193 6.54 10,466 179 6.88
-------- -------- ----- -------- -------- ----
Total investment securities 144,518 2,131 5.93 125,309 1,738 5.58
Total earning assets 537,597 $ 11,001 8.23% 516,373 $ 10,424 8.12%
======== ======= ===== ======== ====
Other assets 27,023 26,186
-------- --------
Total assets $564,620 $542,559
======== ========
Liabilities and stockholders' equity
Interest bearing deposits:
Now accounts $ 55,062 $ 191 1.39% $ 57,230 $ 202 1.43%
Savings and money market 127,790 986 3.10 118,960 794 2.71
Time 233,735 3,326 5.72 229,119 2,960 5.24
-------- -------- ----- -------- -------- ----
Total interest bearing deposits 416,587 4,503 4.35 405,309 3,956 3.96
Short-term borrowings 11,505 121 4.22 13,138 131 4.04
Long-term debt 11,111 162 5.85 10,678 182 6.91
-------- -------- ----- -------- -------- ----
Total interest bearing liabilities 439,203 $ 4,786 4.38% 429,125 $ 4,261 4.03%
======== ===== ======== =====
Non-interest bearing deposits 58,060 54,543
Other liabilities 8,138 6,195
Stockholders' equity 59,219 52,696
-------- --------
Total liabilities and
stockholders' equity $564,620 $542,559
======== ========
Net interest income $ 6,215 $ 6,155
Total yield on earning assets 8.23% 8.19%
Rate on supporting liabilities 3.58% 3.35%
----- -----
Net interest margin 4.65% 4.84%
==== =====
</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.
-17-
<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
None.
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
March 31, 1996.
-18-
<PAGE>
KEYSTONE HERITAGE GROUP, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Keystone Heritage Group, Inc.
(Registrant)
Date May 9, 1996 By /s/ Kurt A. Phillips
--------------------------------------
Kurt A. Phillips
Chief Financial and Accounting Officer
-19-
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000715366
<NAME> KEYSTONE HERITAGE GROUP, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> MAR-31-1996
<CASH> 17,023
<INT-BEARING-DEPOSITS> 198
<FED-FUNDS-SOLD> 5,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 57,393
<INVESTMENTS-CARRYING> 82,142
<INVESTMENTS-MARKET> 82,607
<LOANS> 392,545
<ALLOWANCE> 7,776
<TOTAL-ASSETS> 564,671
<DEPOSITS> 477,840
<SHORT-TERM> 9,110
<LIABILITIES-OTHER> 6,903
<LONG-TERM> 10,941
0
0
<COMMON> 20,358
<OTHER-SE> 39,519
<TOTAL-LIABILITIES-AND-EQUITY> 564,671
<INTEREST-LOAN> 8,753
<INTEREST-INVEST> 2,062
<INTEREST-OTHER> 37
<INTEREST-TOTAL> 10,852
<INTEREST-DEPOSIT> 4,503
<INTEREST-EXPENSE> 4,786
<INTEREST-INCOME-NET> 6,066
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 23
<EXPENSE-OTHER> 4,475
<INCOME-PRETAX> 2,794
<INCOME-PRE-EXTRAORDINARY> 2,794
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,923
<EPS-PRIMARY> .47
<EPS-DILUTED> .47
<YIELD-ACTUAL> 4.65
<LOANS-NON> 1,008
<LOANS-PAST> 524
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 8,025
<CHARGE-OFFS> 345
<RECOVERIES> 96
<ALLOWANCE-CLOSE> 7,776
<ALLOWANCE-DOMESTIC> 7,776
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
