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 September 30, 1997
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 November 10, 1997
Common Stock ($5.00 par value) 3,966,249 shares
<PAGE>
KEYSTONE HERITAGE GROUP, INC.
Index
PART I - FINANCIAL INFORMATION Page
Item 1 - Financial Statements
Consolidated Balance Sheets as of
September 30, 1997 and December 31, 1996 (Unaudited) 3
Consolidated Statements of Income for the
Three and Nine Months ended September 30, 1997 and
1996 (Unaudited) 4
Consolidated Statements of Stockholders' Equity
for the Nine Months ended September 30, 1997 and
1996 (Unaudited) 5
Consolidated Statements of Cash Flows for the
Nine Months ended September 30, 1997 and
1996 (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
Signature Page 18
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<PAGE>
KEYSTONE HERITAGE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars In Thousands)
<TABLE>
<CAPTION>
September 30 December 31
1997 1996
--------- ---------
ASSETS
<S> <C> <C>
Cash and due from banks $21,274 $22,832
Interest bearing deposits with banks 437 181
Term federal funds sold 8,000 0
Investment securities available for sale 63,576 62,596
Investment securities held to maturity
(fair value of $80,624 and $92,079
for 1997 and 1996, respectively) 80,177 91,652
Loans held for sale 1,418 6,019
Loans, net of unearned income of
$1,568 for 1997 and $1,812 for 1996 461,925 422,534
Allowance for loan losses (8,633) (7,736)
--------- ---------
Loans, net 453,292 414,798
Premises and equipment, net 8,272 8,132
Accrued interest receivable 4,161 3,677
Other real estate owned 80 695
Deferred tax asset, net 2,481 2,604
Other assets 3,168 3,121
--------- ---------
Total assets $646,336 $616,307
========= =========
LIABILITIES
Non-interest bearing deposits $74,339 $72,683
Interest bearing deposits 473,695 454,150
--------- ---------
Total deposits 548,034 526,833
Short-term borrowings 19,081 12,478
Other borrowings 3,388 6,438
Accrued interest payable 5,416 5,184
Other liabilities 3,186 3,135
--------- ---------
Total liabilities 579,105 554,068
STOCKHOLDERS' EQUITY
Common stock - $5 par value; 10,000,000
shares authorized; 4,071,683 outstanding
at September 30, 1997 and December 31, 1996 20,358 20,358
Capital surplus 22,078 22,078
Retained earnings 26,148 21,418
Treasury stock - 113,434 shares at September 30,
1997 and 93,700 at December 31, 1996 (2,669) (2,123)
Net unrealized gain on investment securities
available for sale, net of taxes 1,316 508
--------- ---------
Total stockholders' equity 67,231 62,239
Total liabilities and stockholders'
equity $646,336 $616,307
========= =========
</TABLE>
See accompanying notes to financial statements.
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<PAGE>
KEYSTONE HERITAGE GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1997 1996 1997 1996
------- ------- ------- -------
INTEREST INCOME
<S> <C> <C> <C> <C>
Interest and fees on loans $9,902 $9,366 $29,136 $27,096
Interest and dividends on investment
securities available for sale:
Taxable investment securities 899 722 2,650 2,155
Equity investments 66 55 196 159
Interest and dividends on investment
securities held to maturity:
Taxable investment securities 1,025 1,055 3,207 3,274
Non-taxable investment securities 210 131 569 382
------- ------- ------- -------
Total interest and dividends on
investment securities 2,200 1,963 6,622 5,970
Interest on money market investments 192 89 374 156
------- ------- ------- -------
Total interest income 12,294 11,418 36,132 33,222
INTEREST EXPENSE
Interest on deposits 5,296 4,672 15,286 13,626
Interest on short-term borrowings 152 135 401 369
Interest on other borrowings 86 98 278 420
------- ------- ------- -------
Total interest expense 5,534 4,905 15,965 14,415
Net interest income 6,760 6,513 20,167 18,807
Provision for loan losses 0 0 0 0
------- ------- ------- -------
Net interest income after provision
for loan losses 6,760 6,513 20,167 18,807
OTHER OPERATING INCOME
Trust income 356 352 1,004 961
Service charges on deposits 377 341 1,078 978
Net realized gain on investment
securities available for sale 310 35 512 58
Net gain on sale of mortgage loans 239 321 664 644
Net gain on sale of credit card loans
and merchant processing activity 0 0 618 0
Other income 513 559 1,767 1,624
------- ------- ------- -------
Total other operating income 1,795 1,608 5,643 4,265
OTHER OPERATING EXPENSE
Salaries and employee benefits 2,770 2,672 8,211 7,522
Occupancy expense, net 412 340 1,147 967
Equipment expense 481 448 1,419 1,500
Deposit insurance expense 16 1 48 2
Other expense 1,647 1,360 3,892 3,986
------- ------- ------- -------
Total other operating expense 5,326 4,821 14,717 13,977
Income before income taxes 3,229 3,300 11,093 9,095
Income taxes 973 1,001 3,393 2,795
------- ------- ------- -------
Net income $2,256 $2,299 $7,700 $6,300
======= ======= ======= =======
PER COMMON SHARE
Net income $.57 $.57 $1.94 $1.55
======= ======= ======= =======
Cash dividends paid $.25 $.22 $.75 $.62
</TABLE>
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<PAGE>
KEYSTONE HERITAGE GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Nine Months Ended September 30
(Dollars in thousands)
<TABLE>
<CAPTION>
Net Unrealized
Gain (Loss) On
Common Capital Retained Treasury Securities Available
Stock Surplus Earnings Stock for Sale Total
Balance, December 31, 1995 $20,358 $22,078 $16,107 $ -0- $ 336 $58,879
<S> <C> <C> <C> <C> <C> <C>
Net Income -0- -0- 6,300 -0- -0- 6,300
Cash dividends ($.62 per share) -0- -0- (2,524) -0- -0- (2,524)
Acquisition of 43,300 shares of
treasury stock at cost -0- -0- -0- (974) -0- (974)
Change in unrealized gain (loss)
on investment securities
available for sale, net of taxes -0- -0- -0- -0- (124) (124)
------- ------- ------- -------- ---------- --------
Balance, September 30, 1996 $20,358 $22,078 $19,883 $ (974) $ 212 $61,557
======= ======= ======= ======== ========== ========
Balance, December 31, 1996 $20,358 $22,078 $21,418 ($2,123) $ 508 $62,239
Net income -0- -0- 7,700 -0- -0- 7,700
Cash dividends ($.75 per share) -0- -0- (2,968) -0- -0- (2,968)
Re-issuance of 6,666 shares of
treasury stock -0- -0- (2) 157 -0- 155
Acquisition of 26,400 shares of
treasury stock at cost -0- -0- -0- (703) -0- (703)
Change in unrealized gain
(loss) on investment securities
available for sale, net of taxes -0- -0- -0- -0- 808 808
------- ------- ------- -------- --------- -------
Balance, September 30, 1997 $20,358 $22,078 $26,148 ($2,669) $ 1,316 $67,231
======= ======= ======= ======== ========= =======
</TABLE>
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<PAGE>
KEYSTONE HERITAGE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30
1997 1996
CASH FLOW FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income $7,700 $6,300
Adjustments to reconcile net income to cash:
Depreciation and amortization 951 1,108
(Increase) decrease in deferred income taxes (325) 220
(Increase) decrease in accrued interest receivable (484) 106
Increase (decrease) in accrued interest payable 232 (976)
Net gain on sale or credit card loans
and merchant card processing (618) 0
Net gain on sale of other real estate owned (112) 0
Net gain on sale of loans (664) (644)
Originations of residential mortgage loans sold (25,175) (28,135)
Proceeds from sale of residential mortgage loans 26,263 27,175
Net realized gain on investment securities
available for sale (512) (58)
Other, net (585) (401)
-------- --------
Net cash provided by operating activities 6,671 4,695
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in money market investments (8,256) (3,377)
Maturities of investment securities
held to maturity 28,976 27,492
Maturities of investment securities
available for sale 19,523 20,980
Sale of investment securities available for sale 3,037 156
Funds invested in investment securities
held to maturity (17,406) (15,801)
Funds invested in investment securities
available for sale (21,409) (9,289)
Proceeds from sale of credit card loans and
merchant processing activity 3,051 0
Net increase in loans made to customers (36,665) (30,458)
Net expenditures for premises and equipment (1,091) (835)
Proceeds from sale of other real estate owned 773 206
-------- --------
Net cash used in investing activities (29,467) (10,926)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 21,201 12,642
Net increase in short-term borrowings 6,603 4,054
Net decrease in other borrowings (3,050) (9,592)
Acquisition of treasury stock (703) (974)
Re-issuance of treasury stock 155 0
Cash dividends paid (2,968) (2,524)
-------- --------
Net cash provided by financing activities 21,238 3,606
Net decrease in cash and due from banks (1,558) (2,625)
Cash and due from banks at beginning of period 22,832 23,766
Cash and due from banks at end of period $21,274 $21,141
SUPPLEMENTAL DISCLOSURES:
Interest paid $8,416 $8,148
Income taxes paid 3,850 2,183
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Loans charged-off 466 673
</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 September 30, 1997 and
December 31, 1996, the consolidated statements of income for the three and
nine month periods ended September 30, 1997 and 1996, the consolidated
statements of stockholders' equity for the nine months ended September 30,
1997 and 1996 and the consolidated statements of cash flows for the nine
months ended September 30, 1997 and 1996. The accounting policies followed
in the presentation of interim financial results are the same as those
followed on an annual basis or those adopted during the first two quarters
of 1997. 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. Earnings per common share are based upon the weighted average number of
shares outstanding. The weighted average number of shares outstanding was
3,954,184 and 4,053,287 for the three month periods ended September 30,
1997 and 1996, respectively, and 3,959,748 and 4,065,506 for the nine
months ended September 30, 1997 and 1996, respectively.
3. On August 15, 1997, an announcement was made of Keystone Heritage Group,
Inc's. agreement to merge with Fulton Financial Corporation. According to
the terms of this agreement, each share of Keystone Heritage's common stock
outstanding at the time of the merger will be exchanged for 1.83 shares of
Fulton Financial common stock. Under the agreement, Keystone Heritage
Group, Inc. and its banking subsidiary Lebanon Valley National Bank would
be merged into Fulton Financial. Fulton Financial is the fifth largest bank
holding company in Pennsylvania, with assets of $4.2 billion. The merger is
subject to approval by regulatory authorities and stockholders of Keystone
Heritage Group. The merger is expected to be finalized during the first
quarter of 1998.
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<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 September 30, 1997
was $2.256 million or $.57 per share, compared to $2.299 million or $.57 per
share for the three months ended September 30, 1996. Return on average
stockholders' equity and return on average assets for the 1997 period were 13.60
percent and 1.40 percent, respectively. Return on average stockholders' equity
and return on average assets for the 1996 period were 14.91 percent and 1.56
percent, respectively.
During the third quarter, an announcement was made of Keystone Heritage
Group, Inc's. agreement to merge with Fulton Financial Corporation. According to
the terms of this agreement, each share of Keystone Heritage's common stock
outstanding at the time of the merger will be exchanged for 1.83 shares of
Fulton Financial common stock. Under the agreement, Keystone Heritage Group,
Inc. and its banking subsidiary Lebanon Valley National Bank would be merged
into Fulton Financial. Fulton Financial is the fifth largest bank holding
company in Pennsylvania, with assets of $4.2 billion. The merger is subject to
approval by regulatory authorities and stockholders of Keystone Heritage Group.
The merger is expected to be finalized during the first quarter of 1998.
Net income for the nine months ended September 30, 1997 was $7.700 million
or $1.94 per share, compared to net income of $6.300 million or $1.55 per share
for 1996. Return on average stockholders' equity and return on average assets
for the 1997 period were 16.09 percent and 1.65 percent, respectively. Return on
average stockholders' equity and return on average assets for the 1996 period
were 13.95 percent and 1.46 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 15 and 16 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 September 30, 1997 and 1996, and for the nine months ended September 30,
1997 and 1996.
Net interest income for the three months ended September 30, 1997 was $7.0
million, a $287 thousand or 4.3 percent increase from the same period of 1996.
The net interest margin for the third quarter of 1997 was 4.54 percent compared
to 4.77 percent for the same period of 1996. Average earning assets for the
three month period ended September 30, 1997 were $607.2 million, a $51.4 million
or a 9.2 percent increase from the same period of 1996. For the three month
comparative periods, net interest income increased in 1997 primarily as a result
of an increase in average loans outstanding of $30.5 million or 7.3 percent and
increases in the investment and money market investment balances of $20.9
million or 14.9 percent. This growth was primarily funded by increases in
average interest bearing deposit balances of $42.9 million, or 9.9 percent and
an
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<PAGE>
increase in average non-interest bearing demand deposits of $5.6 million or 8.8
percent. The net interest margin decreased to 4.54 percent in 1997. This was a
result of the growth in earning assets being funded by the growth in the higher
costing time deposits and also due to a lower yield earned on loan balances
attributable to a more competitive loan market environment.
Net interest income for the nine months ended September 30, 1997 was $20.7
million, a $1.5 million or 7.6 percent increase from the same period of 1996.
The net interest margin for the nine months ended September 30, 1997 was 4.67
percent compared to 4.71 percent for the same period of 1996. Average earning
assets for the nine month period ended September 30, 1997 were $592.8 million, a
$46.8 million or a 8.6 percent increase from the same period of 1996.
Provision and Allowance for Loan Losses
There was no provision for loan losses charged to net income during the
nine month period ended September 30, 1997 or 1996.
Net charge-offs of $48 thousand were recorded for the three months ended
September 30, 1997 compared to net recoveries of $52 thousand for the same
period of 1996. For the nine month comparative period the Company recorded net
recoveries of $897 thousand for 1997 and recorded net charge-offs of $319
thousand for 1996. During the second quarter or 1997, the Company recovered a
total of $885 thousand on three unrelated commercial loans. A total of $500
thousand which was previously charged off in 1992 was recovered on one
commercial loan though a litigation process. In addition to the recovered
principal balance on this loan, the Company also recovered $490 thousand in
interest income and legal expenses associated with this loan. Commercial loan
charge-offs for the nine month period were $339 thousand lower than the same
period of 1996 while charge-offs in loans to individuals increased by $102
thousand for the same comparative periods.
The allowance for loan losses was $8.6 million or 1.87 percent of total
loans outstanding at September 30, 1997 and $7.7 million or 1.82 percent at
September 30, 1996. The allowance for 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 loan losses. The
allowance for 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 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 loan losses.
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<PAGE>
The following is a summary of the activity in the allowance for loan
losses for the three and nine month periods ended September 30, 1997 and 1996:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
------------------- --------------------
(Dollars in thousands) 1997 1996 1997 1996
------- ------- ------- -------
<S> <C> <C> <C> <C>
Allowance for loan losses
at beginning of period $8,681 $7,654 $7,736 $8,025
Loans charged-off:
Commercial 0 0 67 406
Agriculture 0 0 0 0
Real estate construction 0 0 0 0
Loans to individuals 130 96 367 265
Real estate - residential mortgage 28 2 32 2
------- ------- ------- -------
Total loans charged-off 158 98 466 673
Recoveries of loans previously charged-off:
Commercial 97 128 1,307 299
Agriculture 0 0 0 0
Real estate construction 0 7 0 19
Loans to individuals 13 15 55 36
Real estate - residential mortgage 0 0 1 0
------- ------- ------- -------
Total recoveries of loans previously
charged-off 110 150 1,363 354
Net loans charged-off (recovered) 48 (52) (897) 319
Current period's provision for
loan losses 0 0 0 0
------- ------- ------- -------
Allowance for loan
losses at end of period $8,633 $7,706 $8,633 $7,706
======= ======= ======= =======
</TABLE>
Other Operating Income and Expense
Other operating income was $1.8 million and $1.6 million for the three
months ended September 30, 1997 and 1996, respectively. Other operating income
was $5.6 million and $4.3 million for the nine months ended September 30, 1997
and 1996, respectively. During the second quarter of 1997 the Company completed
the sale of its $3.1 million portfolio of credit card receivables, and in a
separate transaction, completed the sale of its merchant credit card processor
portfolio. The combined effect of these transactions resulted in a $618 thousand
pre-tax gain. The gain on the sale of the credit card portfolio along with gains
recognized on the sale of certain equity investments recorded as investments
available for sale were the primary reasons for the growth in other operating
income during the nine month period of 1997 compared to the same period of 1996.
Other operating expense for the three months ended September 30, 1997 was
$5.3 million, a 10.5 percent increase from the $4.8 million reported for the
same period of 1996. For the nine months ended September 30, 1997 other
operating expense was $14.7 million compared to $14.0 million for the same
period of 1996.
Salaries and benefits expense increased by $98 thousand or 3.7 percent and
by $689 thousand or 9.2 percent for the three and nine months ended September
30, 1997, respectively, compared to the same periods of 1996. The increase in
salary and benefit expense is primarily attributable to the opening of five de
novo branches since September 30, 1996 and the effects of the staffing for
Central Mortgage being present for the full year in 1997, compared to being
present for seven months in 1996. In addition merit increases of 3.5 percent
were applied to base salaries as of January 1, 1997. The increase in occupancy
expense for the three and nine month comparative periods is also attributable to
the aforementioned addition of five de novo branches. Other expense increased by
$287 thousand for the three month period ended September 30, 1997 compared to
the same period of 1996. This was attributable to certain merger related
expenses incurred during the third quarter of 1997.
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<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 September 30, 1997 totalled $801 thousand or .17
percent of total loans outstanding, compared to $973 thousand or .23 percent of
loans at December 31, 1996 and $727 thousand or .17 percent of loans at
September 30, 1996. Non-performing assets at September 30, 1997 were $881
thousand or .19 percent of loans plus other real estate owned compared to $1.7
million or .39 percent of loans plus other real estate owned at December 31,
1996 and $1.5 million or .35 percent of loans plus other real estate owned at
September 30, 1996. The improvement in non-performing assets at September 30,
1997 as compared to December 31, 1996 was a result of a reduction in the levels
of other real estate owned due to the sale of other real estate owned
properties.
The following is a presentation of non-performing assets as of September
30, 1997, December 31, 1996, and September 30, 1996:
Sept. 30 Dec. 31 Sept. 30
(Dollars in thousands) 1997 1996 1996
------ ------ ------
Non-performing loans $801 $973 $727
Other real estate owned, net 80 695 749
------ ------ ------
Total non-performing assets $881 $1,668 $1,476
====== ====== ======
Loans past due 90 days or more as to
principal or interest 762 624 455
Allowance for loan losses to
non-performing loans 10.78x 7.95x 10.60x
Non-performing loans as a
percent of loans outstanding .17% .23% .17%
Non-performing assets as a
percent of loans outstanding
plus other real estate owned .19% .39% .35%
Interest income of approximately $12 thousand and $36 thousand would have
been recognized during the three and nine month periods ended September 30,
1997, 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 $3 thousand and $5 thousand was recognized during the three and
nine months ended September 30, 1997.
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 September 30, 1997 totalled $121 million or
26.3 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 September 30,
1997 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 nine months ended September 30, 1997.
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<PAGE>
Financial Position
Total assets at September 30, 1997 were $646 million compared to $616
million at December 31, 1996. Total loans outstanding at September 30, 1997 were
$462 million compared to $423 million at December 31, 1996. Total deposits at
September 30, 1997 were $548 million compared to $527 million at December 31,
1996.
Capital Adequacy
The Company's stockholders' equity was $67.2 million at September 30, 1997
and $62.2 million at December 31, 1996. Total stockholders' equity increased by
8.0 percent from December 31, 1996 which was the net effect of the recognition
of $7.7 million in net income for the nine month period, cash dividend payments
to stockholders of $2.97 million, a favorable change in net unrealized gains or
losses on investment securities available for sale of $808 thousand, the
acquisition of 26,400 shares of treasury stock at a cost of $703 thousand and
the re-issuance of 6,666 shares of treasury stock which provided $155 thousand
of additional capital. Net unrealized gains on investment securities available
for sale of $1.32 million and $508 thousand were included as a component of
stockholders' equity at September 30, 1997 and December 31, 1996, respectively.
The Company announced its intentions to repurchase up to 5 percent or
203,584 shares of its outstanding common stock in June, 1996. These repurchased
shares are available for reissuance through the Company's Dividend Reinvestment
or Stock Option Plans or for other general corporate purposes. No shares of
common stock were re-acquired by the Company during the third quarter of 1997. A
total of 6,666 shares of treasury stock were reissued as as result of stock
options which were exercised during the third quarter of 1997. At September 30,
1997, the Company's had 113,434 shares in treasury stock.
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 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 September 30, 1997 the
Company's Tier 1 and Total Capital ratios were 12.95 percent and 14.27 percent,
respectively. Tier 1 and Total Capital ratios were 13.12 percent and 14.43
percent respectively, at December 31, 1996. 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. The Company's Leverage
ratio was 10.29 percent at September 30, 1997 and was 10.28 percent at December
31, 1996.
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.
-12-
<PAGE>
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.
The Company has entered into 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 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 swap 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. 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. Gains or losses from
early termination of interest rate 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.
The Company's use of these interest rate swap contracts is closely
monitored by the Company's Board of Directors and is closely controlled as to
levels of exposure. At September 30, 1997 the Company had five interest rate
agreements outstanding having a total notional amount of $50 million. These
agreements consisted of interest rate swap agreements each with a notional
amount of $10 million.
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 following is the amount of financial instruments with off-balance sheet
risk not reflected in the consolidated balance sheets at September 30, 1997 and
December 31, 1996:
Contractual Amounts
===============================================================================
September 30 December 31
(Dollars in thousands) 1997 1996
Financial instruments whose
contractual amounts represent
credit risk:
Commitments to extend credit $96,733 $93,811
Standby letters of credit 8,302 7,335
Contractual amounts of off-balance sheet financial
instruments not constituting
credit risk:
Interest rate swap, notional
value 50,000 70,000
===============================================================================
-13-
<PAGE>
Supervision and Regulation
During the latter part of 1996, Congress agreed on a legislative package to
stabilize the Savings and Loan (S&L) industry's deposit insurance fund (SAIF).
The legislation required the S&L industry to recapitalize its insurance fund
with a one-time assessment. Previous proposals required the bank insurance fund
(BIF) to contribute a substantial amount to help recapitalize SAIF. Under the
current legislation, banks are required to pay an annual rate of 1.29 cents for
every $100 of domestic deposits from 1997 through 1999 and pay 2.43 cents per
$100 of domestic deposits for the years of 2000 through 2017. The amount of FDIC
insurance to be paid under this new legislation will not materially impact the
financial position, equity or the results of operations for the Company in
future periods.
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.
New Accounting Standards
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 (SFAS 128), "Earnings Per Share". SFAS
128, which supersedes APB Opinion No. 15 (APB 15), "Earnings Per Share",
specifies the computation, presentation, and disclosure requirements for
earnings per share (EPS) for entities with publicly held common stock. It
replaces the presentation of primary EPS with a presentation of basic EPS and
fully diluted EPS with diluted EPS, Basic EPS, unlike primary EPS, excludes
dilution and is computed by dividing income available to common stockholders by
the weighted average number of common shares outstanding for the period. Diluted
EPS is computed similarly to fully diluted EPS under APB 15. Had the new
accounting standard been applied for current and prior periods it would of had
no effect on reported EPS. The Company will adopt SFAS 128 as of December 31,
1997. Management does not expect SFAS 128 to have any effect on the EPS of the
Company.
-14-
<PAGE>
AVERAGE BALANCE SHEETS, RATES AND INTEREST INCOME AND EXPENSE
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended September 30, 1997 Three Months Ended September 30, 1996
Average Average Average Average
Balance Interest Rate Balance Interest Rate
Assets
<S> <C> <C> <C> <C> <C> <C>
Loans $446,153 $9,984 8.88% $415,632 $9,451 9.05%
Money market investments:
Interest bearing deposits with banks 380 5 5.22 372 6 6.40
Federal funds sold 13,265 187 5.59 6,314 83 5.22
-------- -------- ---- -------- -------- ----
Total money market investments 13,645 192 5.58 6,686 89 5.31
Investment securities available for sale
and held to maturity:
Taxable investment securities
available for sale 65,034 965 5.89 55,859 777 5.52
Taxable investment securities
held to maturity 63,594 1,025 6.39 65,569 1,055 6.38
Non-taxable investment securities
held to maturity 18,723 324 6.86 12,035 202 6.68
-------- -------- ---- -------- -------- ----
Total investment securities 147,351 2,314 6.23 133,463 2,034 6.06
Total earning assets 607,149 $12,490 8.16% 555,781 $11,574 8.28%
======== ======== ==== ======= ======= ====
Other assets 31,549 29,315
-------- --------
Total assets $638,698 $585,096
======== ========
Liabilities and stockholders' equity
Interest bearing deposits:
Demand $55,421 $181 1.30% $54,109 $171 1.26%
Savings 129,285 1,051 3.23 131,209 1,048 3.18
Time 290,789 4,064 5.54 247,289 3,453 5.56
-------- -------- ---- -------- -------- ----
Total interest bearing deposits 475,495 5,296 4.42 432,607 4,672 4.30
Short-term borrowings 13,224 152 4.58 13,116 135 4.10
Other Borrowings 5,547 86 6.15 6,814 98 5.69
-------- -------- ---- -------- -------- ----
Total interest bearing liabilities 494,266 $5,534 4.44% 452,537 $4,905 4.31%
======== ======== ==== ======= ======= ====
Non-interest bearing deposits 69,550 63,920
Other liabilities 9,072 7,282
Stockholders' equity 65,810 61,357
-------- --------
Total liabilities and
stockholders' equity $638,698 $585,096
======== ========
Net interest income $6,956 $6,669
Total yield on earning assets 8.16% 8.28%
Rate on supporting liabilities 3.62% 3.51%
Net interest margin 4.54% 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.
-15-
<PAGE>
AVERAGE BALANCE SHEETS, RATES AND INTEREST INCOME AND EXPENSE
(Dollars in thousands)
<TABLE>
<CAPTION>
Nine Months Ended September 30, 1997 Nine Months Ended September 30, 1996
Average Average Average Average
Balance Interest Rate Balance Interest Rate
Assets
<S> <C> <C> <C> <C> <C> <C>
Loans $436,150 $29,384 9.01% $403,776 $27,340 9.04%
Money market investments:
Interest bearing deposits with banks 293 13 5.93 282 13 6.16
Federal funds sold 8,735 361 5.52 3,600 143 5.31
------- ------- ---- ------- ------- ----
Total money market investments 9,028 374 5.54 3,882 156 5.38
Investment securities available for sale
and held to maturity:
Taxable investment securities
available for sale 64,588 2,846 5.89 57,193 2,314 5.41
Taxable investment securities
held to maturity 66,142 3,207 6.48 69,247 3,274 6.32
Non-taxable investment securities
held to maturity 16,920 876 6.92 11,942 588 6.58
------- ------- ---- ------- ------- ----
Total investment securities 147,650 6,929 6.27 138,382 6,176 5.96
Total earning assets 592,828 $36,687 8.27% 546,040 $33,672 8.24%
======= ======= ==== ======= ======= ====
Other assets 30,511 28,529
------- -------
Total assets $623,339 $574,569
======= =======
Liabilities and stockholders' equity
Interest bearing deposits:
Demand $54,643 $526 1.29% $54,724 $534 1.30%
Savings 128,582 3,065 3.19 129,923 3,047 3.13
Time 282,366 11,695 5.54 238,854 10,045 5.62
------- ------- ---- ------- ------- ----
Total interest bearing deposits 465,591 15,286 4.39 423,501 13,626 4.30
Short-term borrowings 12,406 401 4.32 11,832 369 4.17
Long-term debt 6,017 278 6.18 9,620 420 5.82
------- ------- ---- ------- ------- ----
Total interest bearing liabilities 484,014 $15,965 4.41% 444,953 $14,415 4.33%
======= ======= ==== ======= ======= ====
Non-interest bearing deposits 66,817 61,856
Other liabilities 8,516 7,418
Stockholders' equity 63,992 60,342
------- -------
Total liabilities and
stockholders' equity $623,339 $574,569
======= =======
Net interest income $20,722 $19,257
Total yield on earning assets 8.27% 8.24%
Rate on supporting liabilities 3.60% 3.53%
---- ----
Net interest margin 4.67% 4.71%
===== ====
</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.
-16-
<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 filed a report on Form 8-K on September 10, 1997. This Form 8-K
was filed in reference to the announcement made on August 15, 1997 of Keystone
Heritage Group, Inc's. agreement to merge with Fulton Financial Corporation.
This agreement is described in Note 3 on page 7 of this 10-Q report.
-17-
<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 November 10, 1997 By
Kurt A. Phillips
Chief Financial and Accounting Officer
-18-
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000715366
<NAME> KEYSTONE HERITAGE GROUP, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 21,274
<INT-BEARING-DEPOSITS> 437
<FED-FUNDS-SOLD> 8,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 63,576
<INVESTMENTS-CARRYING> 80,177
<INVESTMENTS-MARKET> 80,624
<LOANS> 461,925
<ALLOWANCE> 8,633
<TOTAL-ASSETS> 646,336
<DEPOSITS> 548,034
<SHORT-TERM> 19,081
<LIABILITIES-OTHER> 3,186
<LONG-TERM> 3,388
0
0
<COMMON> 20,358
<OTHER-SE> 46,873
<TOTAL-LIABILITIES-AND-EQUITY> 646,336
<INTEREST-LOAN> 29,136
<INTEREST-INVEST> 6,622
<INTEREST-OTHER> 374
<INTEREST-TOTAL> 36,132
<INTEREST-DEPOSIT> 15,286
<INTEREST-EXPENSE> 15,965
<INTEREST-INCOME-NET> 20,167
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 512
<EXPENSE-OTHER> 14,717
<INCOME-PRETAX> 11,093
<INCOME-PRE-EXTRAORDINARY> 11,093
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,700
<EPS-PRIMARY> 1.94
<EPS-DILUTED> 1.94
<YIELD-ACTUAL> 4.67
<LOANS-NON> 801
<LOANS-PAST> 762
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 7,736
<CHARGE-OFFS> 466
<RECOVERIES> 1,363
<ALLOWANCE-CLOSE> 8,633
<ALLOWANCE-DOMESTIC> 8,633
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
