FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from ____________to ______________
Commission File Number 0-11460
KEYSTONE FINANCIAL, INC.
Pennsylvania 23-2289209
(State of Incorporation) (IRS Employer I.D. No.)
ONE KEYSTONE PLAZA
FRONT & MARKET STREETS
P.O. BOX 3660
HARRISBURG, PA 17105-3660
(Address of principal executive offices)
(717) 233-1555
(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 or
No_______
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock ($2 par value): 51,376,000 as of July 31, 1998.
1
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KEYSTONE FINANCIAL, INC.
INDEX PAGE
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Statements of Condition -
June 30, 1998 and December 31, 1997 3
Consolidated Statements of Income - Three months
ended June 30, 1998 and 1997, and six months ended
June 30, 1998 and 1997 4
Consolidated Statements of Comprehensive Income -
Three-months ended June 30, 1998 and 1997, and six
months ended June 30, 1998 and 1997 6
Consolidated Statements of Cash Flows - Six months ended
June 30, 1998 and 1997 7
Notes to Consolidated Financial Statements 8
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
ITEM 3. Quantitative and Qualitative Disclosures about
Market Risk 16
PART II. OTHER INFORMATION
Items 1,2,3, and 5 have been omitted since they are not
applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders 16
ITEM 6. Exhibits and Reports on Form 8-K 17
(a) Exhibits
(b) Reports on Form 8-K
Signatures 18
2
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PART I. ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CONDITION
June 30, 1998 December 31, 1997
________________________________________________________________________________
(in thousands, except share data)
ASSETS
________________________________________________________________________________
Cash and due from banks $189,201 $206,223
Federal funds sold 49,300 25,300
Interest bearing deposits with banks 1,064 1,928
Investment securities available
for sale 1,141,937 1,091,400
Investment securities held to
maturity (market values
1998-$601,255; 1997-$538,218) 592,571 528,388
Loans held for resale 62,957 43,055
Loans and leases 4,616,650 4,712,566
Allowance for credit losses (62,777) (65,091)
________________________________________________________________________________
Net Loans 4,553,873 4,647,475
Premises and equipment 119,622 116,615
Other assets 188,365 180,953
________________________________________________________________________________
TOTAL ASSETS $6,898,890 $6,841,337
================================================================================
LIABILITIES
________________________________________________________________________________
Noninterest-bearing deposits $651,005 $637,164
Interest-bearing deposits 4,527,967 4,596,001
________________________________________________________________________________
Total Deposits 5,178,972 5,233,165
Federal funds purchased and security
repurchase agreements 343,433 399,730
Other short-term borrowings 43,428 26,160
________________________________________________________________________________
Total Short-Term Borrowings 386,861 425,890
FHLB borrowings 379,503 248,150
Long-term debt 131,164 101,793
Other liabilities 153,879 146,854
________________________________________________________________________________
TOTAL LIABILITIES 6,230,379 6,155,852
________________________________________________________________________________
SHAREHOLDERS' EQUITY
________________________________________________________________________________
Preferred stock: $1.00 par value,
authorized 8,000,000 shares;
none issued or outstanding --- ---
Common stock: $2.00 par value,
authorized 100,000,000; issued
52,219,815 - 1998 and
52,029,017 - 1997 104,440 104,058
Surplus 159,767 155,430
Retained earnings 439,147 418,605
Deferred KSOP benefit expense (852) (1,150)
Treasury stock:
1,000,000 shares at cost - 1998 (40,411) ---
Accumulated other comprehensive income 6,420 8,542
________________________________________________________________________________
TOTAL SHAREHOLDERS' EQUITY 668,511 685,485
________________________________________________________________________________
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $6,898,890 $6,841,337
================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
3
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CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data)
________________________________________________________________________________
Three Months Ended
June 30,
1998 1997
________________________________________________________________________________
INCOME
________________________________________________________________________________
Loans and fees on loans $102,190 $100,063
Investments - taxable 23,324 20,048
Investments - tax exempt 2,834 3,184
Federal funds sold & other 1,228 1,674
Loans held for resale 1,249 1,835
________________________________________________________________________________
130,825 126,804
________________________________________________________________________________
INTEREST EXPENSE
________________________________________________________________________________
Deposits 48,661 47,988
Short-term borrowings 4,466 4,423
FHLB borrowings 5,453 3,949
Long-term debt 2,049 981
________________________________________________________________________________
60,629 57,341
________________________________________________________________________________
NET INTEREST INCOME 70,196 69,463
Provision for credit losses 6,679 3,659
________________________________________________________________________________
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES 63,517 65,804
________________________________________________________________________________
NONINTEREST INCOME
________________________________________________________________________________
Trust and investment advisory fees 6,364 5,155
Service charges on deposit accounts 4,545 4,258
Fee income 6,249 4,908
Mortgage banking income 3,526 2,744
Other secondary market income 513 278
Reinsurance income 795 768
Other income 1,987 2,318
Net gains(losses)- equity securities 5,330 (120)
Net gains(losses)- debt securities 52 (324)
________________________________________________________________________________
29,361 19,985
NONINTEREST EXPENSE
________________________________________________________________________________
Salaries 24,362 22,289
Employee benefits 4,310 4,189
Occupancy expense (net) 4,283 4,031
Furniture and equipment expense 5,182 4,408
Special charges ---- 11,410
Other expense 17,331 17,441
________________________________________________________________________________
55,468 63,768
________________________________________________________________________________
Income before income taxes 37,410 22,021
Income tax expense 12,129 7,039
________________________________________________________________________________
NET INCOME $25,281 $14,982
________________________________________________________________________________
PER SHARE DATA
________________________________________________________________________________
Net income:
Basic $0.49 $0.29
Diluted $0.48 $0.29
Dividends $0.28 $0.26
________________________________________________________________________________
The accompanying notes are an integral part of the consolidated financial
statements.
4
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CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data)
________________________________________________________________________________
Six Months Ended
June 30,
1998 1997
________________________________________________________________________________
INCOME
________________________________________________________________________________
Loans and fees on loans $204,063 $194,957
Investments - taxable 45,100 40,024
Investments - tax exempt 5,763 6,310
Federal funds sold & other 2,667 2,508
Loans held for resale 2,291 3,451
________________________________________________________________________________
259,884 247,250
________________________________________________________________________________
INTEREST EXPENSE
________________________________________________________________________________
Deposits 97,878 94,507
Short-term borrowings 9,021 8,515
FHLB borrowings 9,717 7,381
Long-term debt 3,918 995
________________________________________________________________________________
120,534 111,398
________________________________________________________________________________
NET INTEREST INCOME 139,350 135,852
Provision for credit losses 10,436 7,453
________________________________________________________________________________
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES 128,914 128,399
________________________________________________________________________________
NONINTEREST INCOME
________________________________________________________________________________
Trust and investment advisory fees 13,045 9,999
Service charges on deposit accounts 8,750 8,405
Fee income 11,559 9,429
Mortgage banking income 6,271 4,262
Other secondary market income 1,190 801
Reinsurance income 1,426 1,788
Other income 4,414 6,671
Net gains - equity securities 6,850 ----
Net gains(losses) - debt securities 63 (295)
________________________________________________________________________________
53,568 41,060
NONINTEREST EXPENSE
________________________________________________________________________________
Salaries 48,657 43,909
Employee benefits 9,655 8,680
Occupancy expense (net) 8,797 8,143
Furniture and equipment expense 10,254 8,989
Special charges ---- 11,410
Other expense 34,212 33,999
________________________________________________________________________________
111,575 115,130
________________________________________________________________________________
Income before income taxes 70,907 54,329
Income tax expense 21,490 16,576
________________________________________________________________________________
NET INCOME $49,417 $37,753
________________________________________________________________________________
PER SHARE DATA
________________________________________________________________________________
Net income
Basic $0.96 $0.73
Diluted $0.94 $0.72
Dividends $0.56 $0.52
________________________________________________________________________________
The accompanying notes are an integral part of the consolidated financial
statements.
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
______________________________________________________________________________
Three Months Ended June 30,
1998 1997
Before Net of Before Net of
Tax Tax Tax Tax
______________________________________________________________________________
Net Income $25,281 $14,982
Unrealized gains (losses) on
securities:
Unrealized holding
gains(losses)arising
during the period 1,545 1,004 7,116 4,625
Less: Reclassification
adjustment for gains
included in net income (5,382) (3,498) 444 289
______________________________________________________________________________
(2,494) 4,914
______________________________________________________________________________
Comprehensive Income $22,787 $19,896
==============================================================================
______________________________________________________________________________
Six Months Ended June 30,
1998 1997
Before Net of Before Net of
Tax Tax Tax Tax
______________________________________________________________________________
Net Income $49,417 $37,753
Unrealized gains(losses) on
securities:
Unrealized holding
gains(losses)arising 3,648 2,371 (1,021) (664)
during the period
Less: Reclassification
adjustment for gains
included in net income (6,913) (4,493) 295 192
______________________________________________________________________________
(2,122) (472)
______________________________________________________________________________
Comprehensive Income $47,295 $37,281
==============================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
(in thousands) 1998 1997
________________________________________________________________________________
OPERATING ACTIVITIES:
Net Income $49,417 $37,753
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Provision for credit losses 10,436 7,453
Provision for depreciation & amortization 10,224 8,275
Deferred income taxes 590 9,626
Special charges accrual (2,962) 7,751
Sale of loans held for resale 123,403 213,825
Origination of loans held for resale (219,617) (202,932)
(Increase)decrease in interest receivable 559 (1,338)
Increase in interest payable 7,295 6,516
Other (7,895) (6,132)
________________________________________________________________________________
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (28,550) 80,797
________________________________________________________________________________
INVESTING ACTIVITIES:
Net decrease in interest-bearing
deposits with banks 864 28,406
Available for sale securities:
Sales 50,121 129,237
Maturities 521,476 409,746
Purchases (614,757) (406,000)
Held to maturity securities:
Maturities 109,914 27,316
Purchases (174,234) (53,939)
Net (increase) decrease in loans 159,875 (213,866)
Purchases of loans (6,660) ----
Proceeds from sales of loans 3,661 84,521
Purchases of premises and equipment (10,989) (10,676)
Other (6,975) (3,753)
________________________________________________________________________________
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 32,296 (9,008)
________________________________________________________________________________
FINANCING ACTIVITIES:
Net decrease in deposits (54,193) (20,920)
Net decrease in short-term borrowings (39,029) (1,130)
Proceeds from FHLB borrowings 202,542 168,242
Repayments of FHLB borrowings (71,189) (167,358)
Issuance of long-term debt 30,000 100,000
Repayment of long term debt (629) (544)
Acquisition of treasury stock (40,411) (61,349)
Cash dividends (28,875) (27,915)
Other 5,016 5,327
________________________________________________________________________________
NET CASH PROVIDED BY(USED IN) FINANCING ACTIVITIES 3,232 (5,647)
________________________________________________________________________________
INCREASE IN CASH AND CASH EQUIVALENTS 6,978 66,142
Cash and cash equivalents at beginning of period 231,523 251,472
________________________________________________________________________________
CASH AND CASH EQUIVALENTS AT END OF PERIOD $238,501 $317,614
________________________________________________________________________________
The accompanying notes are an integral part of the consolidated financial
statements.
7
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Notes To Consolidated Financial Statements
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, these statements do not include all of the information and
footnotes required by generally accepted accounting principles. However, in the
opinion of management, all adjustments necessary for a fair presentation have
been included, and such adjustments were of a normal recurring nature.
Operating results for the six-month period ended June 30, 1998 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1998.
For further information, refer to the audited consolidated financial statements,
footnotes thereto, and the Financial Review for the year ended December 31,
1997, as contained in the Annual Report to Shareholders.
COMPREHENSIVE INCOME
During 1998, Keystone adopted Financial Accounting Standards Board Statement
130, "Reporting Comprehensive Income". Sources of comprehensive income not
included in net income are limited to unrealized gains and losses on certain
investments in debt and equity securities.
COMMITMENTS AND CONTINGENCIES
Keystone and its subsidiaries are subject to various legal proceedings that
arise in the ordinary course of business. In late 1997, an investment advisor
not affiliated with Keystone ("investment advisor") was accused by the
Securities and Exchange Commission of defrauding its clients, which were
primarily school districts and municipalities, resulting in losses alleged to
approximate $70 million. A Keystone subsidiary had been previously engaged to
maintain custody of certain funds and investments of the unaffiliated investment
advisor. In an effort to recover the alleged losses, legal proceedings were
subsequently initiated by the court-appointed trustee for the investment advisor
and by its clients. These proceedings included individual and class actions
against Keystone, its subsidiaries, and some of its employees alleging that
these entities or individuals were responsible for and contributed to the loss.
Management plans to vigorously contest these actions. The loss, if any, to
Keystone or its subsidiaries resulting from the actions can not be reasonably
estimated at this time. Because of the complexity of these actions, it is
expected that final resolution of these matters will not occur for a number of
years.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
required to be adopted in years beginning after June 15, 1999. Because of
Keystone's minimal use of derivatives, management does not anticipate that the
adoption of the new Statement will have a significant effect on earnings or
Keystone's financial position.
8
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
Keystone Financial, Inc. (Keystone) is the third largest bank holding company
headquartered in Pennsylvania. Keystone offers a wide range of financial
products and services through its seven super-community banks and specialized
nonbank subsidiaries located throughout Pennsylvania, Maryland, West Virginia
and Delaware.
The purpose of this review is to provide additional information necessary to
fully understand the consolidated financial condition and results of operations
of Keystone. Throughout this review, net interest income and the yield on
earning assets are stated on a fully taxable-equivalent basis. Balances
represent daily average balances, unless otherwise indicated. The results of
First Financial Corporation of Western Maryland (First Financial), which was
acquired through a purchase acquisition on May 29, 1997, have been included
herein from the consummation date.
SUMMARY OF FINANCIAL RESULTS
Keystone reported net income of $25.3 million or $0.49 per basic share for the
second quarter of 1998, compared to $15.0 million or $0.29 per basic share for
the same quarter of 1997. Second quarter results in 1997 had been influenced by
special merger and portfolio restructuring charges associated with the merger of
Financial Trust Corp. which aggregated $0.17 per share. Excluding these items,
earnings per share increased 7% and reflected a return on average assets (ROA)
and return on average equity (ROE) of 1.47% and 14.93% versus 1.43% and 14.54%
for the second quarter of 1997.
Earnings for the six months ended June 30, 1998 exhibited similar improvement,
reflecting 7% growth in basic earnings per share to $0.96, and resulting in ROA
of 1.46% and ROE of 14.59% compared with 1.44% and 14.35% for 1997, exclusive of
the special charges.
Operating results for the second quarter and six months ended June 30, 1998 were
influenced by the higher loan loss provision associated with consumer loan
charge-offs. These charge-off's relate to the indirect automobile lending and
leasing programs, which were curtailed in 1997. Results were also affected by
securities gains from the sale of appreciated bank stocks.
Core results included slight growth in net interest income coupled with
continued strong growth in noninterest income and recent improvement in expense
levels. As a result of competitive pressures on loan pricing, as well as an
overall higher cost of funds, the net interest margin declined slightly from the
same period last year. Despite the declining margin and the runoff of existing
indirect automobile loan and lease credits, core loan growth approximating 6%
drove the increase in net interest income. Asset management growth, electronic
banking fee increases and record mortgage banking activities combined to improve
noninterest income 13% for the first half of 1998 compared to 1997. While
noninterest expenses excluding special charges increased 8% year to date over
1997, recent measures, including a decline in the ratio of overhead expense to
revenue from the first quarter of 1998, demonstrated improvement. Operating
efficiency, combined with an expanded fee base, will continue to be an important
management focus.
As a result of the above-mentioned consumer loan charge-offs, the ratio of
annualized net charge-offs expressed as a percentage of average loans increased
to 0.55% for the first six months of 1998 from 0.32% for the same period last
year. The level of charge-off's in the second quarter of 1998 was directly
influenced by indirect automobile and lease programs, which were exited in 1997,
and are not expected to significantly influence future charge-off levels. The
ratio of the allowance for credit losses to total loans remained constant at
1.36%, as the provision for credit loses increased $3 million or 40% over 1997.
Capital management remained a priority, as Keystone purchased 500,000 treasury
shares during the quarter, bringing the year to date total shares purchased to
one million. Regulatory capital measures remained above the threshold for
well-capitalized.
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AVERAGE STATEMENT OF CONDITION
The average balance sheets for the six months ended June 30, 1998 and 1997 were
as follows (in thousands):
Change
1998 1997 Volume %
________________________________________________________________________________
Cash and due from banks $175,234 $179,807 $ (4,573) (3)%
Federal funds sold and other 96,964 93,195 3,769 4
Investments 1,624,132 1,488,280 135,852 9
Loans held for resale 57,725 91,576 (33,851) (37)
Loans 4,658,522 4,448,114 210,408 5
Allowance for credit losses (64,608) (58,294) (6,314) 11
________________________________________________________________________________
Net loans 4,593,914 4,389,820 204,094 5
Intangible assets 61,853 28,615 33,238 116
Other assets 227,986 219,107 8,879 4
________________________________________________________________________________
TOTAL ASSETS $6,837,808 $6,490,400 $347,408 5%
________________________________________________________________________________
Noninterest-bearing deposits $627,849 $598,636 $ 29,213 5%
Interest-bearing deposits 4,578,972 4,465,478 113,494 3
Short-term borrowings 373,639 367,220 6,419 2
FHLB borrowings 336,581 247,474 89,107 36
Other long-term debt 107,638 25,447 82,191 323
Other liabilities 129,996 137,067 (7,071) (5)
________________________________________________________________________________
TOTAL LIABILITIES 6,154,675 5,841,322 313,353 5
________________________________________________________________________________
SHAREHOLDERS' EQUITY 683,133 649,078 34,055 5
________________________________________________________________________________
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $6,837,808 $6,490,400 $347,408 5%
________________________________________________________________________________
Loan growth was strongest in the categories of commercial, commercial real
estate and consumer installment loans. The impact of loans added through the
second quarter 1997 acquisition of First Financial was more than offset by the
run-off of indirect loans and leases occurring in conjunction with the
curtailment of these lines of business.
Intangible assets were impacted by the second quarter 1997 acquisition of First
Financial.
Funding for loan growth was obtained from deposit growth and increased FHLB
borrowings. Long-term debt increased due to the issuance of medium term notes
totaling $100 million in May of 1997 and $30 million in May of 1998, the
proceeds of which were used for general corporate purposes including
acquisitions and share repurchases.
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NET INTEREST INCOME
The following table summarizes, on a fully taxable equivalent basis, changes in
net interest income and net interest margin for the six months ended June 30,
1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
_________________________________________________________________________________________
Increase/
1998 1997 (Decrease)
YIELD/ YIELD/ YIELD/
AMOUNT RATE AMOUNT RATE AMOUNT RATE
_________________________________________________________________________________________
<S> <C> <C> <C> <C> <C> <C>
Interest income $264,226 8.26% $251,627 8.27% $12,599 (0.01)
Interest expense 120,534 4.50 111,398 4.40 9,136 0.10
_________________________________________________________________________________________
Net interest income $143,692 $140,229 $3,463
Interest spread 3.76% 3.87% (0.11)
Impact of noninterest funds 0.73 0.73
_________________________________________________________________________________________
Net interest margin 4.49% 4.60% (0.11)
_________________________________________________________________________________________
*The change in net interest income consisted primarily of favorable volume
variances.
</TABLE>
Keystone's primary source of revenue is net interest income, which constituted
75% of total revenue (excluding securities gains) for the first six months of
1998. Net interest income represents the difference between interest income on
earning assets and interest expense on deposits and other borrowed funds, and is
heavily dependent on the volume and composition of earning assets and interest
bearing liabilities as well as the yield or rate earned or paid on these earning
assets or funding sources.
Net interest income grew $3.5 million or 2% for the first half of 1998 versus
the same period in 1997, despite the decline of eleven basis points in the net
interest margin. The growth in net interest income was primarily due to earning
asset growth.
Interest income grew $12.6 million or 5% in the first half of 1998 compared to
the same period in 1997. Earning asset growth of $316,000 or 5% occurred in both
investments and loans. Improvement occurred in the mix of earning assets as
growth occurred in higher yielding categories of loans such as consumer and
commercial real estate due to Keystone's strategic decision to focus on these
relationship-oriented business segments.
Interest expense grew $9.1 million or 8% as the rate on total cost of funds
increased 10 basis points. The increase occurred due to both a 6% increase in
interest bearing liabilities as well as a shift in the composition of the
liabilities, with higher cost funding sources such as the variable rate
certificate of deposit and borrowings becoming a larger percentage of the total
funding sources.
As a result of the yield on earning assets remaining stable and the cost of
funds increasing 10 basis points, the interest spread dropped from 3.87% in 1997
to 3.76% in 1998. Similarly, the margin decreased from 4.60% to 4.49%, as the
impact of noninterest funds was unchanged.
PROVISION FOR CREDIT LOSSES
The provision for credit losses reached $10.4 million or 0.45% of average loans,
when annualized, for the first six months of 1998 compared with $7.5 million or
0.34% of average loans for the same period of 1997. The increased provision
reflects the higher charge-offs related to the indirect automobile lending and
leasing programs that were exited in 1997.
NONINTEREST INCOME
Noninterest revenues continued to demonstrate significant growth as they
increased $12.5 million or 30% from the first half of 1997 to the same period in
1998. Excluding net securities gains and gains on the sale of branches from both
periods, total noninterest revenues increased 23% in 1998.
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Trust and investment management fees increased $3 million or 30% for the first
six months of 1998 compared to 1997, as assets managed within Keystone's
proprietary mutual funds exceeded the $1 billion mark and total managed funds
exceeded $3.5 billion. During the third quarter of 1997, Keystone also expanded
its retirement benefit services capabilities through the acquisition of MMC&P,
which also contributed to the growth in revenue.
Fee income, which includes revenue from credit card activities and electronic
banking services, increased $2 million or 23% compared to the first six months
of 1997. Such fee increases were driven by increased credit card activity, the
expansion of our convenience store ATM network, and the increased usage and fee
generation from the KeyCheck debit card.
Mortgage banking income reflected an increase of $2 million or 47% compared to
the first half of 1997, as loans serviced for others increased 38% and
originations increased 54%. Mortgage banking activity has benefited from a
relatively low interest rate environment, a strong economy, and increased
housing starts.
As part of Keystone's ongoing review of its delivery channels, community offices
were sold in both years, contributing nearly $1 million to other income in 1998
and $4.3 million in 1997. Excluding these gains from both years, other income
increased 46%, primarily from expanded annuity sales.
For the first six months of the year, 1998 results included net securities gains
of $6.9 million, resulting from a strategic decision to manage our equity
securities exposure, and at the same time, take advantage of favorable market
conditions.
NONINTEREST EXPENSES
Excluding special charges incurred in conjunction with the 1997 merger of
Financial Trust Corp, growth in total noninterest expenses approximated $7.9
million or 8% during the first half of 1998. The May 1997 and August 1997
purchase acquisitions of First Financial and MMC&P, respectively, influenced the
expense increases for the first six months of 1998. These acquisitions had the
largest impact on salaries and benefits, which increased 11%. Salary expense was
also impacted by merit increases, increased telephone center staffing, year 2000
expenses, and the continued expansion of performance-based incentive programs.
Occupancy costs, as well as furniture and equipment expense, increased 8% and
14%, respectively, and were impacted by the acquisition of First Financial, the
expanded ATM network, and the recently completed "state-of-the-art" telephone
banking center.
YEAR 2000
As explained in the Financial Review section of Keystone's 1997 Annual Report,
the approach of the Year 2000 has elevated concerns over its potential impact on
the operations of computer systems. Keystone's computer systems are managed by
its information technology (IT) division, which has the primary responsibility
to meet information processing needs through the acquisition, operation, and
customization of software and hardware acquired from major providers. A limited
portion of data processing needs, estimated at approximately 15%, is met by
various third party providers. Keystone's formal plan to resolve issues
attendant to the approach of the Year 2000 (Y2K) consists of four major phases:
inventory; assessment; distribution; and implementation.
The first, or inventory phase of Keystone's Y2K Plan, provided for
identification of all IT and non-IT components and has been completed. The
resultant inventory of components identified in this phase of the plan has
served as the basis for assessment of all potential Y2K issues.
The second, or assessment phase consisted of an evaluation of the need for
modification, upgrade or replacement of either internally-managed or
service-based systems to meet Y2K compliance standards. This evaluation resulted
in the identification of ten "corporate critical" IT systems which were deemed
to present the highest level of execution risk if such systems were not
adequately safeguarded from failure or malfunction. This stage of the process
has been completed for all significant IT systems. Keystone believes that it has
no significant exposure due to non-IT components, which appear to be limited to
items such as access control systems and vaults.
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During the third, or distribution phase, a decision is made about how to remedy
Y2K problems by retiring, replacing, updating or converting each software or
hardware component that is not Y2K compliant. The distribution phase of
Keystone's Y2K plan has been completed for all "corporate critical" systems.
The final, or implementation phase, includes installation, system testing, and
transition to a production environment. Of the ten "corporate critical" systems,
four systems are currently in production and will require only minor additional
testing. The remaining six systems are in various stages of completion with four
systems scheduled for production by the fourth quarter of 1998 and the two
remaining systems in early 1999.
Management believes that all identified "corporate critical" replacement or
updated systems meet the standards necessary for Y2K compliance. The risk
associated with Y2K compliance, therefore, is limited to the implementation of
these compliant systems and can be remedied, if necessary, via standard vendor
support channels or by redirecting internal or external resources. Management's
current risk assessment is that potential difficulties associated with
implementation are likely to result in only minor delays in transaction
processing or information availability. If delays in either transaction
processing or information availability would occur for extended periods for
"corporate critical" systems, or if timely modification could not be made, Y2K
issues could have a material effect on both customers and on the operations of
Keystone. Failure to achieve Y2K compliance could also subject Keystone or its
subsidiaries to potential sanctions or directives from the various regulatory
agencies responsible for supervisory oversight of financial institutions.
Keystone is also engaged in an effort to survey the readiness of suppliers,
vendors, and major customers. To date, Keystone is not aware of any problems
which would materially impact its results of operations, liquidity, or capital
resources. However, Keystone has no means to determine with absolute assurance
that external parties will be Y2K compliant or that non-compliance would have a
material impact on Keystone.
Keystone has previously reported that the estimate of costs expected to be
incurred to accommodate Y2K compliance was $9 million, including nearly $4 to $5
million of software and system replacements which will be capitalized and
amortized over a three to five year period. Expenditures since the inception of
the project have aggregated $4.2 million and all expenditures will be funded
through operating cash flows.
Keystone's estimate of costs and the time required to complete Y2K
modifications, as well as the assessment of the risk of noncompliance, are
forward-looking information and are dependent upon assumptions regarding future
events. There can be no guarantee that estimates surrounding costs or completion
dates will be achieved or that all risk has been appropriately identified and
assessed. Specific factors that might cause differences include, but are not
limited to, the availability and cost of personnel, satisfactory Year 2000
upgrade execution, the ability to identify all issues, and similar
uncertainties.
INCOME TAXES
Income tax expense for the first half of 1998 reached $21.5 million, resulting
in an effective tax rate of 30%, relatively unchanged from an effective rate of
31% for the same period in 1997.
ASSET QUALITY
Keystone's allowance for credit losses totaled $63 million or 1.36% of
outstanding loans at June 30, 1998, compared to 1.38% of loans at the end of
1997. Annualized net charge-offs expressed as a percentage of average loans
increased from 0.32% in 1997 to 0.55% in 1998, with consumer loans and leases
constituting 93% of 1998 net charge-offs. A majority of the consumer and lease
financing charge-offs during 1998 related to the indirect automobile lending and
leasing programs.
13
<PAGE>
The following table provides a comparative summary of the activity in the
allowance for credit losses for the six-month periods ended June 30, 1998 and
1997 (in thousands).
1998 1997
___________________________________________________________________________
Allowance for Credit Losses:
Balance at beginning of period $65,091 $56,256
Allowance obtained through acquisition ---- 8,311
Loans charged-off:
Commercial (938) (682)
Real estate secured (1,011) (1,305)
Consumer (8,934) (5,061)
Lease financing (3,775) (1,260)
___________________________________________________________________________
Total loans charged-off (14,658) (8,308)
___________________________________________________________________________
Recoveries:
Commercial 141 154
Real estate secured 912 365
Consumer 700 563
Lease financing 155 106
___________________________________________________________________________
Total recoveries 1,908 1,188
___________________________________________________________________________
Net loans charged-off (12,750) (7,120)
Provision for credit losses 10,436 7,453
___________________________________________________________________________
Balance at end of period $62,777 $64,900
___________________________________________________________________________
14
<PAGE>
The following table has been provided to compare nonperforming assets and total
risk elements at June 30, 1998 to the balances at the end of 1997, in both
absolute dollars and as a percentage of loans. This presentation is supplemented
by a comparison of various coverage ratios.
June 30, December 31,
(dollars in thousands) 1998 1997
_________________________________________________________________________
Nonaccrual loans $29,452 $20,520
Restructurings 305 489
_________________________________________________________________________
Nonperforming loans 29,757 21,009
Other real estate 4,630 5,028
_________________________________________________________________________
Nonperforming assets 34,387 26,037
Loans past due 90 days or more 20,633 33,062
_________________________________________________________________________
Total risk elements $55,020 $59,099
_________________________________________________________________________
Ratio to period-end loans:*
Nonperforming assets .74% .55%
90-days past due .45 .70
_________________________________________________________________________
Total risk elements 1.19% 1.25%
_________________________________________________________________________
Coverage Ratios:
Ending allowance to nonperforming loans 211% 310%
Ending allowance to risk elements** 125% 120%
Ending allowance to annualized
net charge-offs 2.4X 4.4X
_________________________________________________________________________
* The denominator consists of period-end loans and ORE.
**Excludes ORE.
Total risk elements decreased from $59 million or 1.25% of loans at the end of
1997 to $55 million or 1.19% of loans at June 30, 1998. A limited number of
large commercial loans moved from the 90 days past due category at the end of
1997 to nonaccrual status, causing the ratio of the allowance to nonperforming
loans to decrease from 310% at the end of 1997 to 211% at June 30, 1998. Such
loans are not expected to experience significant collectability problems. As a
result of the aforementioned consumer loan charge-offs, the coverage ratio of
the allowance to annualized net charge-offs declined from 4.4 for 1997 to 2.4
for the first six months of 1998.
Based upon the evaluation of loan quality and other relevant factors, management
believes that the allowance for credit losses is adequate to absorb credit
losses inherent in the portfolio.
15
<PAGE>
CAPITAL MANAGEMENT
During the first half of 1998, Keystone repurchased one million shares for
treasury at a total cost of $40.4 million.
Keystone's regulatory capital measures, which include the leverage ratio, "Tier
1" capital, and "Total" capital ratios, continued to be well in excess of both
regulatory minimums and the thresholds established for "well capitalized"
institutions. The following comparative presentation of these ratios and
associated regulatory standards is provided:
Regulatory
Standards
___________________________
June 30, December 31, Well Minimum
1998 1997 Capitalized Requirement
___________________________________________________________________________
Leverage ratio 8.80% 9.15% 5.00% 4.00%
Tier 1 12.28% 12.50% 6.00% 4.00%
Total capital ratio 13.53% 13.75% 10.00% 8.00%
The slight decline in the above ratios can be attributed in part to the share
repurchases mentioned above.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Through June 30, 1998 there have been no material changes to the information on
this topic presented in the December 31, 1997 Annual Report.
PART II.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Shareholders was held on May 21, 1998. Proxies were
solicited by management pursuant to Regulation 14A under the Securities and
Exchange Act of 1934. Nominees for the seven director positions were elected.
All other matters submitted to a vote of shareholders were also approved, and
the shareholder vote thereon was as follows:
Election of Directors:
For Withheld
________________________________________________________________________________
Carl L. Campbell 40,007,957 507,966
Paul I. Detwiler, Jr. 39,993,424 522,499
Allan W. Holman, Jr. 40,016,889 499,034
James I. Scheiner 40,002,636 513,287
Molly Dickinson Shepard 39,959,092 556,831
Ronald C. Unterberger 40,016,392 499,531
William Ward 40,019,377 496,546
The ratification of the appointment of Ernst & Young, LLP as independent
Auditors of the Corporation for 1998:
Shares in favor of the proposal 40,195,365
Shares against the proposal, and 140,096
Shares abstaining from voting 180,462
For further information concerning these matters, refer to the definitive proxy
statement dated April 9, 1998 in the registrant's file, which is incorporated
herein by reference.
16
<PAGE>
PART II. ITEM 6(a) EXHIBITS
Exhibit # Description
__________ _____________
11 Statement Re Computation of Per Share Earnings
12 Statement Re Computation of Ratios
27 Financial Data Schedule
ITEM 6(b) Reports on Form 8-K:
During the quarter ended June 30, 1998, the registrant filed the following
reports on Form 8-K:
Date of Report Item Description
_______________ _____ _______________________________________
April 22, 1998 5 Earnings release for the quarter ended
March 31, 1998.
May 28, 1998 5 Press release announcing senior
management changes, dividend
declaration and election of new
directors.
June 19, 1998 5 Press release announcing completion of
Capital Region expansion.
17
<PAGE>
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.
DATE: August 13, 1998
- -----------------------------------
Mark L. Pulaski
- -----------------------------------
President & Chief Operating Officer
DATE: August 13, 1998
- -----------------------------------
Donald F. Holt
- -----------------------------------
Senior Vice President &
Chief Financial Officer
18
<PAGE>
Exhibit 11: Statement Re Computation of Per Share Earnings
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations (in thousands, except per
share data):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
_____________________________________________________________________________________
<S> <C> <C> <C> <C>
Numerator $25,281 $14,982 $49,417 $37,753
Denominators:
Basic shares outstanding 51,429 51,320 51,627 51,475
Dilutive option effect 666 623 698 625
_____________________________________________________________________________________
Dilutive shares outstanding 52,095 51,943 52,325 52,100
_____________________________________________________________________________________
EPS:
Basic $0.49 $0.29 $0.96 $0.73
Diluted $0.48 $0.29 $0.94 $0.72
_____________________________________________________________________________________
</TABLE>
Ratio of Earnings to Fixed Charges:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
(in thousands) June 30, June 30,
1998 1997 1998 1997
___________________________________________________________________________________________________
<C> <C> <C> <C> <C>
1. Income before taxes $37,410 $22,021 $70,907 $54,329
2. Fixed charges:
a. Interest expense $60,629 $57,341 $120,534 $111,398
b. Interest component of rent expense 724 597 1,421 1,173
___________________________________________________________________________________________________
c. Total fixed charges (line 2a.+ line 2b.) 61,353 57,938 121,955 112,571
d. Interest on deposits 48,661 47,988 97,878 94,507
___________________________________________________________________________________________________
e. Fixed charges excluding interest on
deposits (line 2c.-line 2d.) $12,692 $9,950 $24,077 $18,064
___________________________________________________________________________________________________
3. Income before taxes plus fixed charges:
a. Including interest on deposits $98,763 $79,959 $192,862 $166,900
(line 1.+ line 2c.)
b. Excluding interest on deposits 50,102 31,971 94,984 72,393
(line 1.+ line 2e.)
___________________________________________________________________________________________________
4. Ratio of earnings to fixed charges:
a. Including interest on deposits
(line 3a. divided by line 2c.) 1.61x 1.38x 1.58x 1.48x
b. Excluding interest on deposits
(line 3b. divided by line 2e.) 3.95x 3.21x 3.95x 4.01x
___________________________________________________________________________________________________
</TABLE>
19
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
This schedule contains summary financial information extracted from the second
quarter 10-Q and is qualified in its entirety by reference to such 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 189,201
<INT-BEARING-DEPOSITS> 1,064
<FED-FUNDS-SOLD> 49,300
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,141,937
<INVESTMENTS-CARRYING> 592,571
<INVESTMENTS-MARKET> 601,255
<LOANS> 4,616,650
<ALLOWANCE> 62,777
<TOTAL-ASSETS> 6,898,890
<DEPOSITS> 5,178,972
<SHORT-TERM> 386,861
<LIABILITIES-OTHER> 153,879
<LONG-TERM> 510,667
0
0
<COMMON> 104,440
<OTHER-SE> 564,071
<TOTAL-LIABILITIES-AND-EQUITY> 6,898,890
<INTEREST-LOAN> 204,063
<INTEREST-INVEST> 50,863
<INTEREST-OTHER> 4,958
<INTEREST-TOTAL> 259,884
<INTEREST-DEPOSIT> 97,878
<INTEREST-EXPENSE> 120,534
<INTEREST-INCOME-NET> 139,350
<LOAN-LOSSES> 10,436
<SECURITIES-GAINS> 6,913
<EXPENSE-OTHER> 111,575
<INCOME-PRETAX> 70,907
<INCOME-PRE-EXTRAORDINARY> 49,417
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 49,417
<EPS-PRIMARY> .96
<EPS-DILUTED> .94
<YIELD-ACTUAL> 3.76
<LOANS-NON> 29,452
<LOANS-PAST> 20,633
<LOANS-TROUBLED> 305
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 65,091
<CHARGE-OFFS> 14,658
<RECOVERIES> 1,908
<ALLOWANCE-CLOSE> 62,777
<ALLOWANCE-DOMESTIC> 62,777
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
