UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the period ended June 30, 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 August 8, 1997
Common Stock ($5.00 par value) 3,951,583 shares
<PAGE>
KEYSTONE HERITAGE GROUP, INC.
Index
PART I - FINANCIAL INFORMATION Page
Item 1 - Financial Statements
Consolidated Balance Sheets as of
June 30, 1997 and December 31, 1996 (Unaudited) 3
Consolidated Statements of Income for the
Three and Six Months ended June 30, 1997 and
1996 (Unaudited) 4
Consolidated Statements of Stockholders' Equity
for the Six Months ended June 30, 1997 and
1996 (Unaudited) 5
Consolidated Statements of Cash Flows for the
Six Months ended June 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
Item 4 - Submission of Matters To A Vote of Security Holders 17
Signature Page 19
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<PAGE>
KEYSTONE HERITAGE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars In Thousands)
<TABLE>
<CAPTION>
June 30 December 31
1997 1996
<S> <C> <C>
ASSETS
Cash and due from banks $22,008 $22,832
Interest bearing deposits with banks 341 181
Federal funds sold 2,100 0
Investment securities available for sale 68,171 62,596
Investment securities held to maturity
(fair value of $93,472 and $92,079
for 1997 and 1996, respectively) 93,274 91,652
Loans held for sale 1,280 6,019
Loans, net of unearned income of
$1,627 for 1997 and $1,812 for 1996 436,988 422,534
Allowance for loan losses (8,681) (7,736)
--------- ---------
Loans, net 428,307 414,798
Premises and equipment, net 8,537 8,132
Accrued interest receivable 3,720 3,677
Other real estate owned 192 695
Deferred tax asset, net 2,665 2,604
Other assets 3,517 3,121
--------- ---------
Total assets $634,112 $616,307
========= =========
LIABILITIES
Non-interest bearing deposits $70,569 $72,683
Interest bearing deposits 472,188 454,150
--------- ---------
Total deposits 542,757 526,833
Short-term borrowings 12,086 12,478
Other borrowings 6,113 6,438
Accrued interest payable 4,794 5,184
Other liabilities 3,007 3,135
--------- ---------
Total liabilities 568,757 554,068
STOCKHOLDERS' EQUITY
Common stock - $5 par value; 10,000,000
shares authorized; 4,071,683 outstanding
at June 30, 1997 and December 31, 1996 20,358 20,358
Capital surplus 22,078 22,078
Retained earnings 24,881 21,418
Treasury stock - 120,100 shares at June 30,
1997 and 93,700 at December 31, 1996 (2,826) (2,123)
Net unrealized gain on investment securities
available for sale, net of taxes 864 508
--------- ---------
Total stockholders' equity 65,355 62,239
Total liabilities and stockholders'
equity $634,112 $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 Six Months Ended
June 30 June 30
1997 1996 1997 1996
<S> <C> <C> <C> <C>
INTEREST INCOME
Interest and fees on loans $9,785 $8,977 $19,234 $17,730
Interest and dividends on investment
securities available for sale:
Taxable investment securities 922 696 1,751 1,433
Equity investments 67 49 130 104
Interest and dividends on investment
securities held to maturity:
Taxable investment securities 1,073 1,074 2,182 2,219
Non-taxable investment securities 186 126 359 251
------- ------- ------- -------
Total interest and dividends on
investment securities 2,248 1,945 4,422 4,007
Interest on money market investments 123 30 182 67
------- ------- ------- -------
Total interest income 12,156 10,952 23,838 21,804
INTEREST EXPENSE
Interest on deposits 5,084 4,451 9,990 8,954
Interest on short-term borrowings 127 113 249 234
Interest on other borrowings 95 160 192 322
------- ------- ------- -------
Total interest expense 5,306 4,724 10,431 9,510
Net interest income 6,850 6,228 13,407 12,294
Provision for loan losses 0 0 0 0
------- ------- ------- -------
Net interest income after provision
for possible loan losses 6,850 6,228 13,407 12,294
OTHER OPERATING INCOME
Trust income 331 292 648 609
Service charges on deposits 359 331 701 637
Net realized gain on investment
securities available for sale 28 0 202 23
Net gain on sale of mortgage loans 211 249 425 323
Net gain on sale of credit card loans
and merchant processing activity 618 0 618 0
Other income 649 582 1,254 1,065
------- ------- ------- -------
Total other operating income 2,196 1,454 3,848 2,657
OTHER OPERATING EXPENSE
Salaries and employee benefits 2,697 2,486 5,441 4,850
Occupancy expense, net 374 299 735 627
Equipment expense 484 546 938 1,052
Deposit insurance expense 17 0 32 1
Other expense 970 1,350 2,245 2,626
------- ------- ------- -------
Total other operating expense 4,542 4,681 9,391 9,156
Income before income taxes 4,504 3,001 7,864 5,795
Income taxes 1,397 923 2,420 1,794
------- ------- ------- -------
Net income $3,107 $2,078 $5,444 $4,001
======= ======= ======= =======
PER COMMON SHARE
Net income $.78 $.51 $1.37 $.98
======= ======= ======= =======
Cash dividends paid $.25 $.20 $.50 $.40
</TABLE>
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<PAGE>
KEYSTONE HERITAGE GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Six Months Ended June 30
(Dollars in thousands)
<TABLE>
<CAPTION>
Net Unrealized
Gain (Loss) On
Common Capital Retained Treasury Securities Available
Stock Surplus Earnings Stock for Sale Total
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 $20,358 $22,078 $16,107 $0 $336 $58,879
--------
Net Income -0- -0- 4,001 -0- -0- 4,001
--------
Cash dividends ($.40 per share) -0- -0- (1,629) -0- -0- (1,629)
--------
Change in unrealized gain (loss)
on investment securities
available for sale, net of taxes -0- -0- -0- -0- (124) (124)
------- ------- ------- ------- -------- -------
Balance, June 30, 1996 $20,358 $22,078 $18,479 $0 $212 $61,127
======== ======= ======= ======== ======== ========
Balance, December 31, 1996 $20,358 $22,078 $21,418 ($2,123) $508 $62,239
------- ------- ------- ------- -------- -------
Net income -0- -0- 5,444 -0- -0- 5,444
------- ------- ------- ------- -------- -------
Cash dividends ($.50 per share) -0- -0- (1,981) -0- -0- (1,981)
------- ------- ------- ------- -------- -------
Acquisition of 43,300 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- 356 356
------- ------- ------- ------- -------- -------
Balance, June 30, 1997 $20,358 $22,078 $24,881 ($2,826) $864 $65,355
======== ======= ======= ======== ======== ========
</TABLE>
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<PAGE>
KEYSTONE HERITAGE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30
1997 1996
<S> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $5,444 $4,001
Adjustments to reconcile net income to cash:
Depreciation and amortization 631 816
(Increase) decrease in deferred income taxes (250) 249
(Increase) decrease in accrued interest receivable (43) 196
Decrease in accrued interest payable (390) (1,278)
Net gain on sale or credit card loans
and merchant card processing (618) 0
Net gain on sale of other real estate owned (60) 0
Net gain on sale of loans (425) (323)
Originations of residential mortgage loans sold (16,206) (20,763)
Proceeds from sale of residential mortgage loans 17,432 18,900
Net realized gain on investment securities
available for sale (202) (23)
Other, net (850) (796)
-------- --------
Net cash provided by operating activities 4,463 979
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in money market investments (2,260) (3,512)
Maturities of investment securities
held to maturity 15,118 12,447
Maturities of investment securities
available for sale 9,257 13,375
Sale of investment securities available for sale 2,406 63
Funds invested in investment securities
held to maturity (16,667) (9,393)
Funds invested in investment securities
available for sale (16,395) (3,236)
Proceeds from sale of credit card loans and
merchant processing activity 3,051 0
Net increase in loans made to customers (11,894) (15,584)
Net expenditures for premises and equipment (1,036) (600)
Proceeds from sale of other real estate owned 609 206
-------- --------
Net cash used in investing activities (17,811) (6,234)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 15,924 4,905
Net (decrease) increase in short-term borrowings (392) 2,708
Net increase (decrease) in other borrowings (324) (5,479)
Acquisition of treasury stock (703) 0
Cash dividends paid (1,981) (1,629)
-------- --------
Net cash used by financing activities 12,524 505
Net decrease in cash and due from banks (824) (4,750)
Cash and due from banks at beginning of period 22,832 23,766
Cash and due from banks at end of period $22,008 $19,016
SUPPLEMENTAL DISCLOSURES:
Interest paid $5,558 $4,826
Income taxes paid 2,450 1,683
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Loans charged-off 308 575
</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 June 30, 1997 and December
31, 1996, the consolidated statements of income for the three and six
month periods ended June 30, 1997 and 1996 and the consolidated statements
of cash flows for the six months ended June 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 quarter 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
3,955,121 and 4,071,683 for the three month periods ended June 30, 1997
and 1996, respectively, and 3,962,576 and 4,071,683 for the six months
ended June 30, 1997 and 1996, respectively.
3. 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.
-7-
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Keystone Heritage Group, Inc. (the "Company") is a bank holding company
organized under the laws of Pennsylvania and registered under the Federal Bank
Holding Company Act of 1956. The Company's principal subsidiary is Lebanon
Valley National Bank (the "Bank").
Results of Operations
Net income for the Company for the three months ended June 30, 1997 was
$3.107 million or $.78 per share, compared to $2.078 million or $.51 per share
for the three months ended June 30, 1996. Return on average stockholders' equity
and return on average assets for the 1997 period were 19.61 percent and 2.00
percent, respectively.
During the second quarter, the Company sold its $3.1 million credit card
receivables portfolio and its merchant credit card processor portfolio at an
after-tax net gain of approximately $400 thousand or $.10 per share. Net income
was also improved as a result of receiving interest income and recovering legal
expenses previously expended on a charged-off commercial loan. The net after-tax
effect of these commercial loan related items was approximately $320 thousand or
$.08 per share. As part of the settlement, the Company also recovered $500
thousand of loans previously charged-off which contributed to the increase in
the Allowance for Loan Losses to $8.7 million.
Net income for the six months ended June 30, 1997 was $5.444 million or
$1.37 per share, compared to net income of $4.001 million or $.98 per share for
1996. Return on average stockholders' equity and return on average assets for
the 1997 period were 17.41 percent and 1.78 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 June 30, 1997 and 1996, and for the six months ended June 30, 1997 and
1996.
Net interest income for the three months ended June 30, 1997 was $7.0
million, a $660 thousand or 10.4 percent increase from the same period of 1996.
The net interest margin for the second quarter of 1997 was 4.76 percent compared
to 4.71 percent for the same period of 1996. Average earning assets for the
three month period ended June 30, 1997 were $592.4 million, a $47.8 million or
an 8.8 percent increase from the same period of 1996. For the three month
comparative periods, net interest income and the net interest margin increased
in 1997 primarily as a result of an increase in average loans outstanding of
$28.2 million or 7.0 percent and increases in the investment and money market
investment balances of $19.6 million or 14.0 percent. This growth was primarily
funded by increases in average interest bearing deposit balances of $44.9
million, or 10.7 percent and an increase in average non-interest bearing demand
deposits of $3.4 million or 5.4 percent.
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<PAGE>
Net interest income for the six months ended June 30, 1997 was $13.8
million, a $1.2 million or 9.4 percent increase from the same period of 1996.
The net interest margin for the six months ended June 30, 1997 was 4.74 percent
compared to 4.68 percent for the same period of 1996. Average earning assets for
the six month period ended June 30, 1997 were $585.5 million, a $44.4 million or
a 8.2 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
six month period ended June 30, 1997 or 1996.
Net recoveries of $782 thousand were recorded for the three months ended
June 30, 1997 compared to net charge-offs of $122 thousand for the same period
of 1996. For the six month comparative period the Company recorded net
recoveries of $945 thousand for 1997 and recorded net charge-offs of $371
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 six months ended June 30, 1997 were $339 thousand lower than
the same period of 1996 while charge-offs in loans to individuals increased by
$68 thousand for the same comparative periods.
The allowance for loan losses was $8.7 million or 1.99 percent of total
loans outstanding at June 30, 1997 and $7.7 million or 1.83 percent at June 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 six month periods ended June 30, 1997 and 1996:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
(Dollars in thousands) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
Allowance for loan losses
at beginning of period $7,899 $7,776 $7,736 $8,025
Loans charged-off:
Commercial 67 142 67 406
Agriculture 0 0 0 0
Real estate construction 0 0 0 0
Loans to individuals 138 88 237 169
Real estate - residential mortgage 4 0 4 0
------ ------ ------ ------
Total loans charged-off 209 230 308 575
Recoveries of loans previously charged-off:
Commercial 964 90 1,210 171
Agriculture 0 0 0 0
Real estate construction 0 8 0 12
Loans to individuals 26 10 42 21
Real estate - residential mortgage 1 0 1 0
------ ------ ------ ------
Total recoveries of loans previously
charged-off 991 108 1,253 204
Net loans charged-off (782) 122 (945) 371
Current period's provision for
loan losses 0 0 0 0
------ ------ ------ ------
Allowance for loan
losses at end of period $8,681 $7,654 $8,861 $7,654
====== ====== ====== ======
</TABLE>
Other Operating Income and Expense
Other operating income was $2.2 million and $1.5 million for the three
months ended June 30, 1997 and 1996, respectively. Other operating income was
$3.9 million and $2.7 million for the six months ended June 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 our 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 six month period of 1997 compared to the same period of 1996.
In addition, the Company recognized $425 thousand from selling $16.2 million of
mortgages in the secondary market in the six month period of 1997 compared to
recognizing $323 thousand from selling $20.8 million in the secondary market in
the same period of 1996. The increase in the gain on sale of mortgage loans is a
result of an increase in the the amount of government (FHA and VA) loans sold in
1997 compared to 1996. Although total mortgage loan sales have decreased from
1996 the profit margin attributable to FHA and VA loans is significantly higher
than the conventional loans which the Company sold exclusively prior to the
acquisition of Central Mortgage Company during the first quarter of 1996.
Other operating expense for the three months ended June 30, 1997 was $4.5
million, a 3.0 percent decrease from the $4.7 million reported for the same
period of 1996. For the six months ended June 30, 1997 other operating expense
was $9.4 million compared to $9.2 million for the same period of 1996.
Salaries and benefits expense increased by $211 thousand or 8.5 percent and
by $591 thousand or 12.2 percent for the three and six months ended June 30,
1997 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 four months in
1996. In addition merit increases of 3.5 percent were applied to base salaries
as of January 1, 1997. Other expense decreased by approximately $380 thousand
for both the three and six month periods ended June 30, 1997 compared to the
same period of 1996. A portion of the reduction in other operating expense was
attributable to the recovery of previously expended legal fees amounting to $458
thousand for two separate commercial loans.
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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 June 30, 1997 totalled $966 thousand or .22 percent
of total loans outstanding, compared to $973 thousand or .23 percent of loans at
December 31, 1996 and $1.3 million or .31 percent of loans at June 30, 1996.
Non-performing assets at June 30, 1997 were $1.2 million or .27 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 $2.0 million or .49
percent of loans plus other real estate owned at June 30, 1996. The improvement
in non-performing assets at June 30, 1997 as compared to December 31, 1996 was a
result of decreased levels of other real estate owned.
The following is a presentation of non-performing assets as of June 30,
1997, December 31, 1996, and June 30, 1996:
June 30 Dec. 31 June 30
(Dollars in thousands) 1997 1996 1996
Non-performing loans $966 $973 $1,251
Other real estate owned, net 192 695 741
------ ------ ------
Total non-performing assets $1,158 $1,668 $1,992
====== ====== ======
Loans past due 90 days or more as to
principal or interest 579 624 303
Allowance for loan losses to
non-performing loans 8.99x 7.95x 6.12x
Non-performing loans as a
percent of loans outstanding .22% .23% .31%
Non-performing assets as a
percent of loans outstanding
plus other real estate owned .27% .39% .49%
Interest income of approximately $12 thousand and $23 thousand would have
been recognized during the three and six month periods ended June 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 $1 thousand and $2 thousand was recognized during the three and six
months ended June 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 June 30, 1997 totalled $115 million or 26.2
percent of total loans outstanding. These loans may be impacted by adverse
climate or economic conditions not common to other industries. The Company's
exposure to possible loss in the event of nonperformance by these borrowers is
represented by the contractual amount of those instruments. The Company's policy
is to require supporting collateral for these loans which is generally in the
form of agriculture real estate, livestock, and farm equipment. At June 30, 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 six months ended June 30, 1997.
-11-
<PAGE>
Financial Position
Total assets at June 30, 1997 were $634 million compared to $616 million at
December 31, 1996. Total loans outstanding at June 30, 1997 were $431 million
compared to $423 million at December 31, 1996. Total deposits at March 31, 1997
were $543 million compared to $527 million at December 31, 1996.
Capital Adequacy
The Company's stockholders' equity was $65.4 million at June 30, 1997 and
$62.2 million at December 31, 1996. Total stockholders' equity increased by 5.0
percent from December 31, 1996 which was the net effect of the recognition of
$5.4 million in net income for the three month period, cash dividend payments to
stockholders of $1.98 million, a favorable change in net unrealized gains or
losses on investment securities available for sale of $356 thousand, and due to
the acquisition of treasury stock at a cost of $703 thousand. Net unrealized
gains on investment securities available for sale of $864 thousand and $508
thousand were included as a component of stockholders' equity at June 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 will be available for reissuance through the Company's Dividend
Reinvestment or Stock Option Plans or for other general corporate purposes. A
total of 14,000 shares of common stock were re-acquired by the Company during
the second quarter of 1997 with a cumulative total of 120,100 acquired as of
June 30, 1997.
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 June 30, 1997 the
Company's Tier 1 and Total Capital ratios were 13.39 percent and 14.72 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 10.32 percent at June 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 June 30, 1997 the Company had seven interest rate
agreements outstanding having a total notional amount of $70 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 June 30, 1997 and
December 31, 1996:
Contractual Amounts
June 30 December 31
(Dollars in thousands) 1997 1996
Financial instruments whose
contractual amounts represent
credit risk:
Commitments to extend credit $91,156 $93,811
Standby letters of credit 8,028 7,335
Contractual amounts of off-balance
sheet financial instruments not
constituting credit risk:
Interest rate swap, notional
value 70,000 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. The Company will
adopt SFAS 128 as of December 31, 1997. Management does not expect SFAS 128 to
have a material 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 June 30, 1997 Three Months Ended June 30, 1996
Average Average Average Average
Balance Interest Rate Balance Interest Rate
<S> <C> <C> <C> <C> <C> <C>
Assets
Loans $433,412 $9,869 9.13% $405,215 $9,056 8.99%
Money market investments:
Interest bearing deposits with banks 246 4 6.46 189 3 6.37
Federal funds sold 8,652 119 5.52 2,012 27 5.45
Total money market investments 8,898 123 5.54 2,201 30 5.54
Investment securities available for sale
and held to maturity:
Taxable investment securities
available for sale 66,863 989 5.93 56,202 747 5.35
Taxable investment securities
held to maturity 66,603 1,073 6.46 69,092 1,072 6.24
Non-taxable investment securities
held to maturity 16,630 286 6.91 11,926 193 6.52
------- ------- ---- ------- ------- ----
Total investment securities 150,096 2,348 6.27 137,220 2,012 5.90
Total earning assets 592,406 $12,340 8.35% 544,636 $11,098 8.20%
======= ==== ======= ====
Other assets 30,415 29,240
-------- --------
Total assets $622,821 $573,876
======== ========
Liabilities and stockholders' equity
Interest bearing deposits:
Demand $ 54,429 $ 176 1.29% $ 55,008 $ 172 1.26%
Savings 129,240 1,030 4.01 130,755 1,014 3.12
Time 282,488 3,878 5.51 235,446 3,265 5.58
------- ------- ---- ------- ------- ----
Total interest bearing deposits 466,157 5,084 4.37 421,209 4,451 4.25
Short-term borrowings 11,913 127 4.28 10,860 113 4.20
Other Borrowings 6,172 95 6.18 10,966 160 5.87
------- ------- ---- ------- ------- ----
Total interest bearing liabilities 484,242 $ 5,306 4.39% 443,035 $ 4,724 4.29%
======= ==== ======= ====
Non-interest bearing deposits 67,006 63,566
Other liabilities 8,036 6,838
Stockholders' equity 63,537 60,437
-------- --------
Total liabilities and
stockholders' equity $622,821 $573,876
======== ========
Net interest income $ 7,034 $6,374
Total yield on earning assets 8.35% 8.20%
---- ----
Rate on supporting liabilities 3.59% 3.49%
---- ----
Net interest margin 4.76% 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.
-15-
<PAGE>
AVERAGE BALANCE SHEETS, RATES AND INTEREST INCOME AND EXPENSE
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended June 30, 1997 Six Months Ended June 30, 1996
Average Average Average Average
Balance Interest Rate Balance Interest Rate
<S> <C> <C> <C> <C> <C> <C>
Assets
Loans $431,066 $19,401 9.08% $397,782 $17,890 9.04%
Money market investments:
Interest bearing deposits with banks 248 8 6.50 236 7 5.96
Federal funds sold 6,433 174 5.45 2,229 60 5.41
-------- -------- ---- -------- -------- ----
Total money market investments 6,681 182 5.49 2,465 67 5.47
Investment securities available for sale
and held to maturity:
Taxable investment securities
available for sale 64,361 1,881 5.89 57,851 1,537 5.34
Taxable investment securities
held to maturity 67,437 2,182 6.52 71,124 2,219 6.27
Non-taxable investment securities
held to maturity 16,004 552 6.95 11,894 386 6.53
-------- -------- ---- -------- -------- ----
Total investment securities 147,802 4,615 6.30 140,869 4,142 5.91
Total earning assets 585,549 $24,198 8.33% 541,116 $22,099 8.21%
======= ==== ======= ====
Other assets 29,982 28,132
-------- --------
Total assets $615,531 $569,248
======== ========
Liabilities and stockholders' equity
Interest bearing deposits:
Demand $54,248 $346 1.28% $55,035 $362 1.32%
Savings 128,224 2,013 3.17 129,272 1,999 3.11
Time 278,085 7,631 5.53 234,591 6,593 5.65
-------- -------- ---- -------- -------- ----
Total interest bearing deposits 460,557 9,990 4.37 418,898 8,954 4.30
Short-term borrowings 11,990 249 4.18 11,182 234 4.21
Long-term debt 6,255 192 6.19 11,039 322 5.87
-------- -------- ---- -------- -------- ----
Total interest bearing liabilities 478,802 $10,431 4.39% 441,119 $9,510 4.34%
======= ==== ======= ====
Non-interest bearing deposits 65,428 60,813
Other liabilities 8,234 7,488
Stockholders' equity 63,067 59,828
-------- --------
Total liabilities and
stockholders' equity $615,531 $569,248
======== ========
Net interest income $13,767 $12,589
Total yield on earning assets 8.33% 8.21%
Rate on supporting liabilities 3.59% 3.53%
---- ----
Net interest margin 4.74% 4.68%
==== ====
</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
1997 Annual Stockholders' Meeting
The 1997 Annual Meeting of Stockholders' for the Company was held on April
15, 1997. Stockholders' of the Company voted on the following issues: Election
of Directors Raymond M. Dorsch, Jr., Wendie DiMatteo Holsinger, Donald W.
Lesher, Jr. and Mark Randolph Tice; and a proposal to ratify the selection of
KPMG Peat Marwick LLP as the Company's Independent Public Accountants for the
fiscal year ending December 31, 1997. Seventy eight percent of the 3,965,583
shares eligible to vote were voted in either proxy form or in person at the
meeting.
All matters subject to a vote at the Annual Meeting were approved as a
result of the votes cast at the Annual Meeting. The following is a presentation
of the voting results from the April 15, 1997 Annual Stockholders' Meeting:
Election of Directors: FOR Withheld Total
Raymond M. Dorsch, Jr. 3,066,368 29,579 3,095,947
Wendie DiMatteo Holsinger 3,053,073 42,874 3,095,947
Donald W. Lesher, Jr. 3,087,036 8,911 3,095,947
Mark Randolph Tice 3,084,994 10,953 3,095,947
The term of the Directors elected at the Annual Meeting expires in 2000 or
when the director would reach the mandatory retirement age of 72. The following
directors remain on the Company's Board of Directors until the expiration of
their terms in 1998 and 1999 or when the director would reach the mandatory
retirement age of 72:
Directors Term Expiring in 1998:
Charles V. Henry, III
Bruce A. Johnson
John E. Wengert
Directors Term Expiring in 1999:
Harry J. Gensemer
Albert B. Murry
Thomas I. Siegel
Brett H. Tennis
Messrs. Lance M. Frehafer and E.D. Williams, Jr., Directors of the Company,
retired from the Board on April 15, 1997.
The proposal to ratify the selection of KPMG Peat Marwick LLP as the
Company's Independent Public Accountants for the fiscal year ending December 31,
1997 was voted as follows:
For Against Abstain
3,088,774 1,595 5,578
-17-
<PAGE>
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a.) None.
(b.) The Company did not file any reports on Form 8-K during the quarter ended
June 30, 1997.
-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 July 31, 1997 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> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1997
<CASH> 22,008
<INT-BEARING-DEPOSITS> 341
<FED-FUNDS-SOLD> 2,100
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 68,171
<INVESTMENTS-CARRYING> 93,274
<INVESTMENTS-MARKET> 93,472
<LOANS> 430,988
<ALLOWANCE> 8,681
<TOTAL-ASSETS> 634,112
<DEPOSITS> 542,757
<SHORT-TERM> 12,086
<LIABILITIES-OTHER> 6,113
<LONG-TERM> 4,417
<COMMON> 20,358
0
0
<OTHER-SE> 44,997
<TOTAL-LIABILITIES-AND-EQUITY> 634,112
<INTEREST-LOAN> 19,234
<INTEREST-INVEST> 4,422
<INTEREST-OTHER> 182
<INTEREST-TOTAL> 23,838
<INTEREST-DEPOSIT> 9,990
<INTEREST-EXPENSE> 10,431
<INTEREST-INCOME-NET> 13,407
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 202
<EXPENSE-OTHER> 9,391
<INCOME-PRETAX> 7,864
<INCOME-PRE-EXTRAORDINARY> 7,864
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,444
<EPS-PRIMARY> 1.37
<EPS-DILUTED> 1.37
<YIELD-ACTUAL> 4.74
<LOANS-NON> 966
<LOANS-PAST> 579
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 7,899
<CHARGE-OFFS> 308
<RECOVERIES> 1,253
<ALLOWANCE-CLOSE> 8,681
<ALLOWANCE-DOMESTIC> 8,681
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
