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 September 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): 51,436,000 as of October 31, 1998.
1
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KEYSTONE FINANCIAL, INC.
INDEX PAGE
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Statements of Condition - September 30, 1998
and December 31, 1997 3
Consolidated Statements of Income - Three months
ended September 30, 1998 and 1997, and nine months ended
September 30, 1998 and 1997 4
Consolidated Statements of Comprehensive Income - Three
months ended September 30, 1998 and 1997, and nine months
ended September 30, 1998 and 1997 6
Consolidated Statements of Cash Flows - Nine months ended
September 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 1,2,3,4 and 5 have been omitted since they are not applicable.
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
(in thousands, except share data)
- --------------------------------------------------------------------------------
September 30, December 31,
1998 1997
ASSETS
- --------------------------------------------------------------------------------
Cash and due from banks $169,103 $206,223
Federal funds sold 25,150 25,300
Interest bearing deposits with banks 1,641 1,928
Investment securities available
for sale 1,107,560 1,091,400
Investment securities held to
maturity(fair values
1998-$698,286; 1997-$538,218) 681,426 528,388
Loans held for resale 70,820 43,055
Loans and leases 4,552,173 4,712,566
Allowance for credit losses (61,933) (65,091)
- --------------------------------------------------------------------------------
Net Loans 4,490,240 4,647,475
Premises and equipment 122,982 116,615
Other assets 237,482 180,953
- --------------------------------------------------------------------------------
TOTAL ASSETS $6,906,404 $6,841,337
- --------------------------------------------------------------------------------
LIABILITIES
- --------------------------------------------------------------------------------
Noninterest-bearing deposits $643,693 $637,164
Interest-bearing deposits 4,502,671 4,596,001
- --------------------------------------------------------------------------------
Total Deposits 5,146,364 5,233,165
Federal funds purchased and security
repurchase agreements 355,830 399,730
Other short-term borrowings 21,367 26,160
- --------------------------------------------------------------------------------
Total Short-Term Borrowings 377,197 425,890
FHLB borrowings 401,464 248,150
Long-term debt 130,670 101,793
Other liabilities 162,490 146,854
- --------------------------------------------------------------------------------
TOTAL LIABILITIES 6,218,185 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
51,386,653 - 1998 and 52,029,017 - 1997 102,773 104,058
Surplus 160,981 155,430
Retained earnings 415,059 418,605
Deferred KSOP benefit expense (702) (1,150)
Accumulated other comprehensive income 10,108 8,542
- --------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 688,219 685,485
- --------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $6,906,404 $6,841,337
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
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CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data)
- --------------------------------------------------------------------------------
Three Months Ended
September 30,
1998 1997
- --------------------------------------------------------------------------------
INTEREST INCOME
- --------------------------------------------------------------------------------
Loans and fees on loans $100,729 $104,314
Investments - taxable 24,544 21,422
Investments - tax exempt 2,847 2,986
Federal funds sold & other 1,190 1,485
Loans held for resale 1,498 2,008
- --------------------------------------------------------------------------------
130,808 132,215
- --------------------------------------------------------------------------------
INTEREST EXPENSE
- --------------------------------------------------------------------------------
Deposits 48,677 50,247
Short-term borrowings 4,725 4,676
FHLB borrowings 5,651 3,640
Long-term debt 2,349 1,883
- --------------------------------------------------------------------------------
61,402 60,446
- --------------------------------------------------------------------------------
NET INTEREST INCOME 69,406 71,769
Provision for credit losses 3,081 4,319
- --------------------------------------------------------------------------------
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES 66,325 67,450
- --------------------------------------------------------------------------------
NONINTEREST INCOME
- --------------------------------------------------------------------------------
Trust and investment advisory fees 6,580 5,442
Service charges on deposit accounts 4,899 4,409
Fee income 6,473 5,303
Mortgage banking income 3,138 2,665
Other secondary market income 849 503
Reinsurance income 720 702
Other income 1,651 1,801
Net gains - equity securities 3,403 2,917
Net gains - debt securities 41 607
- --------------------------------------------------------------------------------
27,754 24,349
NONINTEREST EXPENSE
- --------------------------------------------------------------------------------
Salaries 24,821 24,348
Employee benefits 4,342 4,473
Occupancy expense (net) 4,299 4,166
Furniture and equipment expense 5,160 4,832
Other expense 17,508 17,712
- --------------------------------------------------------------------------------
56,130 55,531
- --------------------------------------------------------------------------------
Income before income taxes 37,949 36,268
Income tax expense 12,368 11,668
- --------------------------------------------------------------------------------
NET INCOME $25,581 $24,600
- --------------------------------------------------------------------------------
PER SHARE DATA
- --------------------------------------------------------------------------------
Net income:
Basic $0.50 $0.48
Diluted $0.50 $0.47
Dividends $0.28 $0.26
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
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CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data)
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
1998 1997
- --------------------------------------------------------------------------------
INTEREST INCOME
- --------------------------------------------------------------------------------
Loans and fees on loans $304,792 $299,271
Investments - taxable 69,644 61,446
Investments - tax exempt 8,610 9,296
Federal funds sold & other 3,857 3,993
Loans held for resale 3,789 5,459
- --------------------------------------------------------------------------------
390,692 379,465
- --------------------------------------------------------------------------------
INTEREST EXPENSE
- --------------------------------------------------------------------------------
Deposits 146,555 144,754
Short-term borrowings 13,746 13,191
FHLB borrowings 15,368 11,021
Long-term debt 6,267 2,878
- --------------------------------------------------------------------------------
181,936 171,844
- --------------------------------------------------------------------------------
NET INTEREST INCOME 208,756 207,621
Provision for credit losses 13,517 11,772
- --------------------------------------------------------------------------------
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES 195,239 195,849
- --------------------------------------------------------------------------------
NONINTEREST INCOME
- --------------------------------------------------------------------------------
Trust and investment advisory fees 19,625 15,441
Service charges on deposit accounts 13,649 12,814
Fee income 18,032 14,732
Mortgage banking income 9,409 6,927
Other secondary market income 2,039 1,304
Reinsurance income 2,146 2,490
Other income 6,065 8,472
Net gains - equity securities 10,253 2,917
Net gains - debt securities 104 312
- --------------------------------------------------------------------------------
81,322 65,409
NONINTEREST EXPENSE
- --------------------------------------------------------------------------------
Salaries 73,478 68,257
Employee benefits 13,997 13,153
Occupancy expense (net) 13,096 12,309
Furniture and equipment expense 15,414 13,821
Special charges --- 11,410
Other expense 51,720 51,711
- --------------------------------------------------------------------------------
167,705 170,661
- --------------------------------------------------------------------------------
Income before income taxes 108,856 90,597
Income tax expense 33,858 28,244
- --------------------------------------------------------------------------------
NET INCOME $74,998 $62,353
- --------------------------------------------------------------------------------
PER SHARE DATA
- --------------------------------------------------------------------------------
Net income:
Basic $1.46 $1.21
Diluted $1.44 $1.19
Dividends $0.84 $0.78
- --------------------------------------------------------------------------------
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 September 30,
1998 1997
Before Net of Before Net of
Tax Tax Tax Tax
--------- -------- --------- --------
Net Income $25,581 $24,600
Unrealized gains on securities:
Unrealized holding gains arising
during the period 9,118 5,927 4,241 2,757
Less: Reclassification adjustment for
gains included in net income 3,444 2,239 3,524 2,291
- ---------------------------------------- --------- -------- --------- --------
5,674 3,688 717 466
- ---------------------------------------- --------- -------- --------- --------
Comprehensive Income $29,269 $25,066
======================================== ========= ======== ========= ========
Nine Months Ended September 30,
1998 1997
Before Net of Before Net of
Tax Tax Tax Tax
---------- -------- --------- --------
Net Income $74,998 $62,353
Unrealized gains on securities:
Unrealized holding gains arising during
the period 12,766 8,298 3,220 2,093
Less: Reclassification adjustment for
gains included in net income 10,357 6,732 3,229 2,099
- ---------------------------------------- ---------- -------- --------- --------
2,409 1,566 (9) (6)
- ---------------------------------------- ---------- -------- --------- --------
Comprehensive Income $76,564 $62,347
======================================== ========== ======== ========= ========
The accompanying notes are an integral part of the consolidated financial
statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
1998 1997
- --------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net Income $74,998 $62,353
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Provision for credit losses 13,517 11,772
Provision for depreciation & amortization 16,551 13,758
Deferred income taxes 3,103 16,160
Special charges accrual --- 4,924
Sale of loans held for resale 195,480 295,808
Origination of loans held for resale (350,895) (295,321)
(Increase) decrease in interest receivable 2,548 (1,689)
Increase in interest payable 13,089 9,266
Other (15,602) 3,642
- --------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (47,211) 120,673
- --------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Net (increase)decrease in interest-bearing
deposits with banks 287 (6,824)
Net cash paid for acquisition --- (24,256)
Available for sale securities:
Sales 59,165 168,249
Maturities 837,023 665,889
Purchases (895,303) (636,706)
Held to maturity securities:
Maturities 145,875 67,735
Purchases (299,131) (136,646)
Net (increase) decrease in loans 273,095 (277,085)
Purchases of loans (8,232) ---
Proceeds from sales of loans 4,365 172,028
Purchases of bank-owned life insurance (50,230) ---
Purchases of premises and equipment (19,405) (17,896)
Other (10,436) (7,908)
- --------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN)INVESTING ACTIVITIES 37,073 (33,420)
- --------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net decrease in deposits (86,801) (15,730)
Net decrease in short-term borrowings (48,693) (4,807)
Proceeds from FHLB borrowings 242,542 168,242
Repayments of FHLB borrowings (89,227) (223,167)
Issuance of long-term debt 30,000 100,000
Repayment of long-term debt (1,123) (623)
Acquisition of treasury stock (40,411) (61,349)
Cash dividends (43,260) (41,349)
Other 9,841 12,422
- --------------------------------------------------------------------------------
NET CASH USED IN FINANCING ACTIVITIES (27,132) (66,361)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (37,270) 20,892
Cash and cash equivalents at beginning of
period 231,523 251,472
- --------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $194,253 $272,364
- --------------------------------------------------------------------------------
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 nine-month period ended September 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 the quarter ended March 31, 1998, Keystone adopted Financial Accounting
Standards Board Statement No. 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 cannot 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. Due to Keystone's
limited 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 community banks and through its
specialized nonbank subsidiaries located in 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 average daily balances, unless otherwise indicated. The results of
First Financial Corporation of Western Maryland (First Financial), which was
acquired through a purchase acquisition, have been included herein from the
consummation date of May 29, 1997. Keystone consummated the merger of Financial
Trust Corp, which was accounted for as a pooling-of-interests, on May 30, 1997.
SUMMARY OF FINANCIAL RESULTS
Keystone reported net income of $25.6 million in the third quarter of 1998,
resulting in basic earning per share (EPS) of $0.50 and a return on average
assets(ROA) and return on average equity (ROE) of 1.47% and 14.99%,
respectively. Comparable performance in the third quarter of 1997 reflected EPS
of $0.48, ROA of 1.43% and ROE of 14.64%.
Year-to-date EPS through the end of September, 1998 reached $1.46 compared to
$1.37 in 1997 (excluding second quarter 1997 special charges associated with the
merger of Financial Trust Corp). ROA and ROE for the first three quarters of
1998 were 1.46% and 14.72%, respectively.
Keystone has experienced continued pressure on both net interest margin and net
interest income performance. Balance sheet growth and net interest spread have
been constrained by customer reactions to recent economic trends and by the
relatively flat interest rate yield curve. As a result of these factors, the net
interest margin declined from 4.60% for the nine-month period ended September
30, 1997 to 4.45% for the same period in 1998, while net interest income was
constant.
Core loan growth, which has been influenced by consumer borrowing patterns, has
also been adversely affected by the run-off of indirect loan and lease balances,
the sale of consumer mortgages into the secondary market, and the decline in
dealer floor plan loans due, in part, to the General Motors strike.
Noninterest sources of income continue to improve, reflecting strong growth from
asset management, mortgage banking, and electronic banking activities, including
increases of 20% or more over the prior year-to-date. Year-to-date 1998 results
included securities gains of $10.4 million compared with $3.2 million for 1997.
The provision for credit losses reflected a 15% increase in 1998 year-to-date
versus 1997. As expected, third quarter charge-offs declined from the second
quarter levels, which had higher levels of charge-offs associated with
Keystone's exited indirect automobile loan and lease programs.
Growth in noninterest expenses excluding special charges has been limited to 5%
for the year-to-date period, and 1% for the third quarter of 1998 compared with
the same quarter in 1997. The growth is attributable to mid-year 1997
acquisitions and to expenses associated with revenue-expansion efforts. Cost
management accomplished through improved operating efficiency will continue to
be an important focus of management.
Asset quality remained stable as reflected by the ratio of total risk elements
to loans, which was 1.26% at September 30, 1998, compared to 1.25% at December
31, 1997. Similarly, the allowance-to-loan ratio remained consistent at 1.36%.
9
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AVERAGE STATEMENT OF CONDITION
The average balance sheets for the nine months ended September 30, 1998 and 1997
were as follows (in thousands):
- ---------------------------------------------------------------------------
Change
1998 1997 Volume %
- ---------------------------------------------------------------------------
Cash and due from banks $174,341 $186,239 $(11,898) (6)%
Federal funds sold and other 93,171 95,625 (2,454) (3)
Investments 1,675,653 1,502,862 172,791 11
Loans held for resale 62,747 88,535 (25,788) (29)
Loans 4,623,575 4,521,902 101,673 2
Allowance for credit losses (64,125) (60,604) (3,521) 6
- ---------------------------------------------------------------------------
Net loans 4,559,450 4,461,298 98,152 2
Intangible assets 61,934 39,943 21,991 55
Other assets 234,497 219,254 15,243 7
- ---------------------------------------------------------------------------
TOTAL ASSETS $6,861,793 $6,593,756 $268,037 4 %
- ---------------------------------------------------------------------------
Noninterest-bearing deposits $632,509 $608,493 $ 24,016 4 %
Interest-bearing deposits 4,565,495 4,529,347 36,148 1
Short-term borrowings 379,061 373,319 5,742 2
FHLB borrowings 353,670 241,645 112,025 46
Other long-term debt 115,510 51,251 64,259 125
Other liabilities 134,450 134,705 (255) ---
- ---------------------------------------------------------------------------
TOTAL LIABILITIES 6,180,695 5,938,760 241,935 4
- ---------------------------------------------------------------------------
SHAREHOLDERS' EQUITY 681,098 654,996 26,102 4
- ---------------------------------------------------------------------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $6,861,793 $6,593,756 $268,037 4 %
- ---------------------------------------------------------------------------
Loan growth of 2% was driven by increases in commercial, commercial real estate
and consumer installment loans. Growth was constrained by the sale of consumer
mortgages and the run-off of indirect loans and leases associated with the
curtailment of this line of business.
Intangible assets were impacted by the second quarter 1997 acquisition of First
Financial.
Funding for asset growth was obtained from both deposit growth as well as
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 repurchase.
10
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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 nine months ended September
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 $397,212 8.22% $386,160 8.30% $11,052 (0.08)
Interest expense 181,936 4.49 171,844 4.42 10,092 (0.07)
- ------------------------------------------------------------------------------------
Net interest income $215,276 $214,316 $ 960
Interest spread 3.73% 3.88% (0.15)
Impact of noninterest funds 0.72 0.72 ---
- ------------------------------------------------------------------------------------
Net interest margin 4.45% 4.60% (0.15)
- ------------------------------------------------------------------------------------
*The change in net interest income consisted primarily of favorable volume variances.
</TABLE>
Keystone's primary source of revenue is net interest income, which comprised 75%
of total revenue (excluding securities gains) for the first nine 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 reflected minimal growth of $960,000 for the first nine
months of 1998 versus the same period in 1997. The growth in net interest income
resulted from 4% earning asset growth which was offset by a fifteen basis point
decline in the net interest margin.
Interest income grew $11.1 million or 3% for the first nine months of 1998
compared to the same period in 1997. Earning asset growth of $246 million
occurred in both investments and loans. The total yield on earning assets
dropped from 8.30% for 1997 to 8.22% for 1998 due to intense pricing competition
on loans and a decline in the treasury yield curve.
Interest expense grew $10.1 million or 6% as interest bearing liabilities
increased 4% and the total cost of funds increased 7 basis points. Higher cost
funding sources such as certificates of deposit and FHLB borrowings became a
larger percentage of the total funding sources, increasing the cost of funds and
further compressing net interest spread.
As a result of the decline in earning asset yields and the increased cost of
funds, the interest spread dropped from 3.88% in 1997 to 3.73% in 1998.
Similarly, the margin decreased from 4.60% to 4.45%, as the impact of
noninterest funds was unchanged.
PROVISION FOR CREDIT LOSSES
The provision for credit losses reached $13.5 million or 0.39% of average loans,
when annualized, for the first nine months of 1998, compared with $11.8 million
or 0.35% of average loans for the same period of 1997. The increased provision
was primarily due to second quarter charge-offs related to the exited indirect
automobile lending and leasing programs.
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NONINTEREST INCOME
Noninterest revenues continued to demonstrate significant growth as they
increased $15.9 million or 24% for the nine-month period ended September 30,
1998, compared to the same period in 1997. Excluding net securities gains and
gains on the sale of branches included in both periods, total noninterest
revenue increased 21% for the first nine months of 1998.
Trust and investment management fees increased $4.2 million or 27% in 1998
year-to-date compared to 1997. Such revenues were benefitted by the successful
introduction of KeyPremier mutual funds and the third quarter 1997 acquisition
of MMC&P, a retirement benefit services firm.
Fee income, which includes revenue from processing merchants' credit card
transactions and electronic banking services, increased $3.3 million or 22%
year-to-date compared to last year. Such fees were benefitted by increased
credit card activity, the expansion of our ATM network into convenience stores,
and the increased popularity of the KeyCheck debit card.
Mortgage banking income rose $2.5 million or 36% compared to prior year-to-date
performance, as average loans serviced for others increased 22% to $983 million
and originations for the first nine months of 1998 were $344 million, a 58%
increase over the same period in 1997.
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 1998
year-to-date and $4.3 million in 1997. Excluding these gains from both years,
other income increased 23%, primarily from higher sales of annuities.
Year-to-date results included net securities gains of $10.4 million for 1998 and
$3.2 million for 1997, resulting from a strategic decision to reduce our equity
securities portfolio, and at the same time, take advantage of favorable market
conditions.
NONINTEREST EXPENSES
Excluding 1997 special charges incurred in conjunction with the merger with
Financial Trust Corp, year-to-date total noninterest expenses increased 5% in
1998 compared to 1997. The majority of the increase occurred in salaries and
benefits which were impacted by mid-1997 acquisitions, increased staffing at the
Telephone Banking Center, merit increases and enhanced incentive programs.
Furniture and equipment expense increased 12% due to the expanded ATM network
and technological investments in computer hardware and software.
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 service 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 four phases of the
plan are primarily being performed using internal resources.
The first, or inventory phase of Keystone's Y2K Plan, provided for
identification of all IT and all non-IT components in facilities owned by
Keystone and has been completed. However, we recognize that as a part of doing
business, new items will be added to inventory as needed, and those items will
be exposed to the process. 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 become Y2K ready. 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
12
<PAGE>
items. 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.
During the third, or distribution phase, a decision is made as to remediation of
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,
one system is in production, with testing complete. Three systems are currently
in production and will require only minor additional testing. The remaining six
systems are in various stages of completion with five systems scheduled for
production by the fourth quarter of 1998 and the remaining system in early 1999.
It has been determined that all identified "corporate critical" replacement or
updated systems meet the standards necessary for Y2K readiness. The risk
associated with Y2K readiness, therefore, is primarily associated with the
implementation of these 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. In a worst case scenario, which management does not consider to be
likely, Keystone may be unable to clear checks, process payments, or obtain
customer account information. In addition, customers' access to funds could be
delayed. Failure to achieve Y2K readiness 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 ready or that such parties' failure to be Y2K
ready would not have a material impact on Keystone.
Keystone has previously reported that the estimate of costs expected to be
incurred to accommodate Y2K readiness 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 $5.2 million, of which $2.6 million were
capitalized. 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 readiness to deal with Y2K issues,
are based on forward- looking information and are dependent upon assumptions
regarding future events. There can be no guarantee that estimates of 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 nine months of 1998 was $33.9 million,
resulting in an effective tax rate of 31%, which was comparable to the same
period in 1997.
ASSET QUALITY
Keystone's allowance for credit losses was $61.9 million or 1.36% of loans at
September 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 0.34%
for the first nine months of 1997 to 0.48% in the same period of 1998, with
consumer loans and leases constituting 85% of the 1998 net charge-offs. A
majority of the consumer loan and lease charge-offs related to the indirect auto
loan programs exited in 1997.
13
<PAGE>
The following table provides a comparative summary of the activity in the
allowance for credit losses for the nine-month periods ended September 30, 1998
and 1997 (in thousands).
- ------------------------------------------------------------------------
1998 1997
- ------------------------------------------------------------------------
Allowance for Credit Losses:
Balance at beginning of period $65,091 $56,256
Allowance obtained through merger --- 8,311
Loans charged-off:
Commercial (1,790) (1,407)
Real estate secured (2,049) (1,802)
Consumer (11,516) (7,618)
Lease financing (3,848) (2,253)
- ------------------------------------------------------------------------
Total loans charged-off (19,203) (13,080)
- ------------------------------------------------------------------------
Recoveries:
Commercial 230 205
Real estate secured 1,062 525
Consumer 1,054 846
Lease financing 182 171
- ------------------------------------------------------------------------
Total recoveries 2,528 1,747
- -------------------------------------------------------------------------
Net loans charged-off (16,675) (11,333)
Provision for credit losses 13,517 11,772
- -------------------------------------------------------------------------
Balance at end of period $61,933 $65,006
- -------------------------------------------------------------------------
14
<PAGE>
The following table has been provided to compare nonperforming assets and total
risk elements at September 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.
September 30, December 31,
(dollars in thousands) 1998 1997
- -------------------------------------------------------------------------
Nonaccrual loans $24,607 $20,520
Restructurings 588 489
- -------------------------------------------------------------------------
Nonperforming loans 25,195 21,009
Other real estate 7,008 5,028
- -------------------------------------------------------------------------
Nonperforming assets 32,203 26,037
Loans past due 90 days or more 25,091 33,062
- -------------------------------------------------------------------------
Total risk elements $57,294 $59,099
- -------------------------------------------------------------------------
Ratio to period-end loans:*
Nonperforming assets .71% .55%
90-days past due .55 .70
- -------------------------------------------------------------------------
Total risk elements 1.26% 1.25%
- -------------------------------------------------------------------------
Coverage Ratios:
Ending allowance to nonperforming loans 246% 310%
Ending allowance to risk elements** 123% 120%
Ending allowance to annualized
net charge-offs 2.8X 4.4X
- --------------------------------------------------------------------------
* The denominator consists of period-end loans and ORE.
**Excludes ORE.
Total risk elements expressed as a percent of loans at September 30, 1998 was
consistent with year-end 1997. A large commercial loan in the 90-days past due
category at December 31, 1997 was placed on nonaccrual status in 1998, thus
driving the increase in nonaccrual loans and decrease in 90-days past due. While
the migration of this loan into nonaccrual status caused the ratio of the
allowance to nonperforming loans to decrease from 310% at the end of 1997 to
246% at September 30, 1998, the ratio of the allowance to total risk elements is
slightly improved. As a result of charge-offs associated with the exited
indirect automobile loan and lease programs, the coverage ratio of the ending
allowance to annualized year-to-date net charge-offs decreased from 4.4 at
September 30, 1997 to 2.8 at September 30, 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 purchased 1 million shares for treasury
at a total cost of $40 million. These shares were retired during the third
quarter.
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
---------------------------
September 30, December 31, Well Minimum
1998 1997 Capitalized Requirement
- ---------------------------------------------------------------------------
Leverage ratio 9.01% 9.15% 5.00% 4.00%
Tier 1 12.65% 12.50% 6.00% 4.00%
Total capital ratio 13.90% 13.75% 10.00% 8.00%
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Through September 30, 1998 there have been no material changes to the
information on this topic presented in the December 31, 1997 Annual Report.
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 September 30, 1998, the registrant filed the following
reports on Form 8-K:
Date of Report Item Description
- --------------- ----- ---------------------------------------
July 22, 1998 5 Earnings release for the quarter ended
June 30, 1998
July 7, 1998 5 Description of common stock
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: November 13, 1998
Mark L. Pulaski
- -------------------------
President & Chief
Operating Officer
DATE: November 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 Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
- ----------------------------- ------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Numerator $25,581 $24,600 $74,998 $62,353
Denominators:
Basic shares outstanding 51,368 51,834 51,540 51,596
Dilutive option effect 507 629 638 625
- ----------------------------- ------------- --------------- --------------- ---------------
Dilutive shares out- 51,875 52,463 52,178 52,221
standing
- ----------------------------- ------------- --------------- --------------- ---------------
EPS:
Basic $0.50 $0.48 $1.46 $1.21
Diluted $0.50 $0.47 $1.44 $1.19
- ----------------------------- ------------- --------------- --------------- ---------------
</TABLE>
Exhibit 12: Statement Re Computation of Ratios
Ratio of Earnings to Fixed Charges:
(in thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
- ---------------------------------------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
1. Income before taxes $ 37,949 $ 36,268 $108,856 $ 90,597
2. Fixed charges:
a. Interest expense $ 61,402 $ 60,446 $181,936 $171,844
b. Interest component of $ 667 $ 600 $ 2,088 $ 1,773
rent expense
- ---------------------------------------------- ------------ ------------ ------------
c. Total fixed charges $ 62,069 $ 61,046 $184,024 $173,617
(line 2a.+ line 2b.)
d. Interest on deposits $ 48,677 $ 50,247 $146,555 $144,754
- ---------------------------------------------- ------------ ------------ ------------
e. Fixed charges excluding
interest on deposits $ 13,392 $ 10,799 $ 37,469 $ 28,863
(line 2c.-line 2d.)
- ---------------------------------------------- ------------ ------------ ------------
3. Income before taxes plus
fixed charges:
a. Including interest on
deposits (line 1.+ line $100,018 $ 97,314 $292,880 $264,214
2c.)
b. Excluding interest on
deposits (line 1.+ line $ 51,341 $ 47,067 $146,325 $119,460
2e.)
- ---------------------------------------------- ------------ ------------ ------------
4. Ratio of earnings to fixed
charges:
a. Including interest on
deposits (line 3a. 1.61 1.59 1.59 1.52
divided by line 2c.)
b. Excluding interest on
deposits (line 3b. 3.83 4.36 3.91 4.14
divided by line 2e.)
- ---------------------------------------------- ------------ ------------ ------------
</TABLE>
19
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
This schedule contains summary financial information extracted from the third
quarter 10-Q and is qualified in its entirety by reference to such 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 169,103
<INT-BEARING-DEPOSITS> 1,641
<FED-FUNDS-SOLD> 25,150
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,107,560
<INVESTMENTS-CARRYING> 681,426
<INVESTMENTS-MARKET> 698,286
<LOANS> 4,552,173
<ALLOWANCE> 61,933
<TOTAL-ASSETS> 6,906,404
<DEPOSITS> 5,146,364
<SHORT-TERM> 377,197
<LIABILITIES-OTHER> 162,490
<LONG-TERM> 532,134
0
0
<COMMON> 102,773
<OTHER-SE> 585,446
<TOTAL-LIABILITIES-AND-EQUITY> 6,906,404
<INTEREST-LOAN> 304,792
<INTEREST-INVEST> 78,254
<INTEREST-OTHER> 7,646
<INTEREST-TOTAL> 390,692
<INTEREST-DEPOSIT> 146,555
<INTEREST-EXPENSE> 181,936
<INTEREST-INCOME-NET> 208,756
<LOAN-LOSSES> 13,517
<SECURITIES-GAINS> 10,357
<EXPENSE-OTHER> 167,705
<INCOME-PRETAX> 108,856
<INCOME-PRE-EXTRAORDINARY> 74,998
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 74,998
<EPS-PRIMARY> 1.46
<EPS-DILUTED> 1.44
<YIELD-ACTUAL> 3.73
<LOANS-NON> 25,195
<LOANS-PAST> 25,091
<LOANS-TROUBLED> 588
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 65,091
<CHARGE-OFFS> 19,203
<RECOVERIES> 2,528
<ALLOWANCE-CLOSE> 61,933
<ALLOWANCE-DOMESTIC> 61,933
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
