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, 1999
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): 48,707,000 of October 31, 1999.
<PAGE>
KEYSTONE FINANCIAL, INC.
INDEX
PAGE
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Statements of Condition - September 30, 1999
and December 31, 1998 3
Consolidated Statements of Income - Three months ended
September 30, 1999 and 1998, and nine months ended
September 30, 1999 and 1998 4
Consolidated Statements of Comprehensive Income - Three
months ended September 30, 1999 and 1998, and nine months ended
September 30, 1999 and 1998 6
Consolidated Statements of Cash Flows - Nine months ended
September 30, 1999 and 1998 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 16
(a) Exhibits
(b) Reports on Form 8-K
Signatures 17
<PAGE>
PART I. ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CONDITION (in thousands, except share data)
- --------------------------------------------------------------------------------
September 30, December 31,
1999 1998
ASSETS
- --------------------------------------------------------------------------------
Cash and due from banks $196,322 $190,622
Federal funds sold 122,000 141,700
Interest bearing deposits with banks 1,558 5,978
Investment securities available
for sale 1,158,668 1,129,753
Investment securities held to
maturity(fair values
1999-$593,103; 1998-$670,934) 600,225 659,536
Loans held for resale 101,090 76,423
Loans and leases 4,388,555 4,459,783
Allowance for credit losses (59,110) (60,274)
- --------------------------------------------------------------------------------
Net Loans 4,329,445 4,399,509
Premises and equipment 119,101 124,080
Other assets 249,154 240,626
- --------------------------------------------------------------------------------
TOTAL ASSETS $6,877,563 $6,968,227
- --------------------------------------------------------------------------------
LIABILITIES
- --------------------------------------------------------------------------------
Noninterest-bearing deposits $656,186 $710,161
Interest-bearing deposits 4,257,567 4,521,557
- --------------------------------------------------------------------------------
Total Deposits 4,913,753 5,231,718
Federal funds purchased and security
repurchase agreements 325,845 363,739
Other short-term borrowings 100,000 11,306
- --------------------------------------------------------------------------------
Total Short-Term Borrowings 425,845 375,045
FHLB borrowings 678,399 427,027
Long-term debt 129,938 130,239
Other liabilities 143,784 142,533
- --------------------------------------------------------------------------------
TOTAL LIABILITIES 6,291,719 6,306,562
- --------------------------------------------------------------------------------
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
48,647,898 - 1999 and 51,448,335 - 1998 97,296 102,897
Surplus 166,214 162,350
Retained earnings 333,184 424,873
Deferred KSOP benefit expense (231) (553)
Treasury stock at cost - 1,013,600 shares-1998 --- (34,186)
Accumulated other comprehensive income (loss) (10,619) 6,284
- --------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 585,844 661,665
- --------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $6,877,563 $6,968,227
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except per share data)
- --------------------------------------------------------------------------------
Three Months Ended
September 30,
1999 1998
- --------------------------------------------------------------------------------
INTEREST INCOME
- --------------------------------------------------------------------------------
Loans and fees on loans $ 92,931 $100,729
Investments - taxable 22,253 24,544
Investments - tax exempt 3,156 2,847
Federal funds sold & other 1,547 1,190
Loans held for resale 2,070 1,498
- --------------------------------------------------------------------------------
121,957 130,808
- --------------------------------------------------------------------------------
INTEREST EXPENSE
- --------------------------------------------------------------------------------
Deposits 42,923 48,677
Short-term borrowings 4,174 4,725
FHLB borrowings 7,753 5,651
Long-term debt 1,876 2,349
- --------------------------------------------------------------------------------
56,726 61,402
- --------------------------------------------------------------------------------
NET INTEREST INCOME 65,231 69,406
Provision for credit losses 3,290 3,081
- --------------------------------------------------------------------------------
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES 61,941 66,325
- --------------------------------------------------------------------------------
NONINTEREST INCOME
- --------------------------------------------------------------------------------
Trust and investment advisory fees 6,784 6,580
Service charges on deposit accounts 4,822 4,899
Fee income 7,668 6,473
Mortgage banking income 2,374 3,138
Reinsurance income 856 720
Other income 3,698 2,500
Net gains - equity securities 275 3,403
Net gains - debt securities 454 41
- --------------------------------------------------------------------------------
26,931 27,754
NONINTEREST EXPENSE
- --------------------------------------------------------------------------------
Salaries 22,383 24,821
Employee benefits 3,812 4,342
Occupancy expense (net) 4,378 4,299
Furniture and equipment expense 5,152 5,160
Special charges 2,215 ---
Other expense 18,662 17,508
- --------------------------------------------------------------------------------
56,602 56,130
- --------------------------------------------------------------------------------
Income before income taxes 32,270 37,949
Income tax expense 9,798 12,368
- --------------------------------------------------------------------------------
NET INCOME $22,472 $25,581
- --------------------------------------------------------------------------------
PER SHARE DATA
- --------------------------------------------------------------------------------
Net income:
Basic $0.46 $0.50
Diluted $0.46 $0.50
Dividends $0.29 $0.28
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except per share data)
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
1999 1998
- --------------------------------------------------------------------------------
INTEREST INCOME
- --------------------------------------------------------------------------------
Loans and fees on loans $277,651 $304,792
Investments - taxable 66,509 69,644
Investments - tax exempt 8,808 8,610
Federal funds sold & other 3,414 3,857
Loans held for resale 5,562 3,789
- --------------------------------------------------------------------------------
361,944 390,692
- --------------------------------------------------------------------------------
INTEREST EXPENSE
- --------------------------------------------------------------------------------
Deposits 129,804 146,555
Short-term borrowings 11,679 13,746
FHLB borrowings 19,311 15,368
Long-term debt 6,545 6,267
- --------------------------------------------------------------------------------
167,339 181,936
- --------------------------------------------------------------------------------
NET INTEREST INCOME 194,605 208,756
Provision for credit losses 9,903 13,517
- --------------------------------------------------------------------------------
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES 184,702 195,239
- --------------------------------------------------------------------------------
NONINTEREST INCOME
- --------------------------------------------------------------------------------
Trust and investment advisory fees 20,784 19,625
Service charges on deposit accounts 13,617 13,649
Fee income 20,787 18,032
Mortgage banking income 9,435 9,409
Reinsurance income 2,748 2,146
Other income 13,142 8,104
Net gains - equity securities 714 10,253
Net gains - debt securities 460 104
- --------------------------------------------------------------------------------
81,687 81,322
NONINTEREST EXPENSE
- --------------------------------------------------------------------------------
Salaries 68,166 73,478
Employee benefits 13,414 13,997
Occupancy expense (net) 13,611 13,096
Furniture and equipment expense 15,680 15,414
Special charges 22,013 ---
Other expense 54,598 51,720
- --------------------------------------------------------------------------------
187,482 167,705
- --------------------------------------------------------------------------------
Income before income taxes 78,907 108,856
Income tax expense 23,916 33,858
- --------------------------------------------------------------------------------
NET INCOME $54,991 $74,998
- --------------------------------------------------------------------------------
PER SHARE DATA
- --------------------------------------------------------------------------------
Net income:
Basic $1.12 $1.46
Diluted $1.12 $1.44
Dividends $0.87 $0.84
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
- ----------------------------------------------------------------------------------------------------
Three Months Ended September 30,
1999 1998
- ----------------------------------------------------------------------------------------------------
Before Net of Before Net of
Tax Tax Tax Tax
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
Net Income $ 22,472 $25,581
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising
during the period (5,353) (3,479) 9,118 5,927
Less: Reclassification adjustment for gains
included in net income (729) (474) (3,444) (2,239)
- ----------------------------------------------- ------------ ------------ ------------ -------------
(3,953) 3,688
- ----------------------------------------------- ------------ ------------ ------------ -------------
Comprehensive Income $18,519 $29,269
=============================================== ============ ============ ============ =============
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1999 1998
- ----------------------------------------------- ----------------------- ------------------------------
Before Net of Before Net of
Tax Tax Tax Tax
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net Income $ 54,991 $74,998
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)arising
during the period (24,831) (16,140) 12,766 8,298
Less: Reclassification adjustment for gains
included in net income (1,174) (763) (10,357) (6,732)
- ----------------------------------------------- ------------ ------------- ------------- -------------
(16,903) 1,566
- ----------------------------------------------- ------------ ------------- ------------- -------------
Comprehensive Income $38,088 $76,564
=============================================== ============ ============= ============= =============
The accompanying notes are an integral part of the unaudited consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
- --------------------------------------------------------------------------------------------
Nine Months Ended
September 30,
1999 1998
- --------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
<S> <C> <C>
Net Income $54,991 $74,998
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for credit losses 9,903 13,517
Provision for depreciation & amortization 17,162 16,551
Deferred income taxes 6,916 3,103
Special charges accrual 3,127 ---
Sale of loans held for resale 241,533 195,480
Origination of loans held for resale (266,144) (221,875)
Decrease in interest receivable 4,044 2,548
Increase in interest payable 6,672 13,089
Other (1,116) (15,602)
- ---------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 77,088 81,809
- ---------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Net decrease in interest-bearing deposits with banks 4,420 287
Available for sale securities:
Sales 11,668 59,165
Maturities 921,825 837,023
Purchases (985,308) (895,303)
Held to maturity securities:
Maturities 118,108 145,875
Purchases (59,014) (299,131)
Net decrease in loans 56,067 144,075
Purchases of loans (5,378) (8,232)
Proceeds from sales of loans 10,078 4,365
Purchases of bank-owned life insurance (25,000) (50,230)
Purchases of premises and equipment (7,844) (19,405)
Other (565) (10,436)
- ---------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 39,057 (91,947)
- ---------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net decrease in deposits (317,965) (86,801)
Net increase (decrease) in short-term borrowings 50,800 (48,693)
Proceeds from FHLB borrowings 273,193 242,542
Repayments of FHLB borrowings (21,821) (89,227)
Issuance of long-term debt --- 30,000
Repayment of long-term debt (301) (1,123)
Acquisition of treasury stock (88,701) (40,411)
Cash dividends (42,423) (43,260)
Other 17,073 9,841
- ---------------------------------------------------------------------------------------------
NET CASH USED IN FINANCING ACTIVITIES (130,145) (27,132)
DECREASE IN CASH AND CASH EQUIVALENTS (14,000) (37,270)
Cash and cash equivalents at beginning of period 332,322 231,523
- ---------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $318,322 $194,253
- ---------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the unaudited consolidated financial statements.
</TABLE>
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.
Operating results for the nine-month period ended September 30, 1999 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1999.
For further information, refer to the audited consolidated financial statements,
footnotes thereto, and the Financial Review for the year ended December 31,
1998, as contained in the annual report to shareholders.
SPECIAL CHARGES EXPENSE
Special charges recognized during 1999 are primarily composed of restructuring
expenses related to Keystone's decision to unify its seven banks under a single
charter. Pursuant to this organizational change, Keystone initiated a formal
restructuring plan which provided for the involuntary termination of
approximately 15% of its work force. Under the provisions of the plan,
management established formal benefit arrangements for affected employees and
communicated the specifics of such arrangements to those employees during the
first quarter of 1999. In addition to the expenses associated with these benefit
arrangements, Keystone also incurred expenses associated with the consolidation
of certain operations facilities, lease termination expenses, facility closures,
directors severance, legal expenses, and professional fees.
Of the total $22 million of special charges recognized to date in 1999, $15.7
million consisted of a restructuring accrual recognized in the first quarter.
The remaining $6.3 million of expenses were associated with the bank unification
but did not meet the criteria for classification as a restructuring expense.
The following summarizes the components of the restructuring accrual and the
remaining balance at September 30, 1999 (in thousands). The majority of the
remaining unpaid expenses are expected to be paid by December 31, 1999.
Initial Accrual at
Accrual September 30,1999
- -------------------------------------------- ----------------- -----------------
Employee termination $8,208 $2,671
Asset disposals/write-downs 4,094 ---
Professional fees 1,113 ---
Other 2,320 456
------------------------------------------- ---------------- ------------------
Total restructuring costs $15,735 $3,127
------------------------------------------- ---------------- ------------------
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, which have
been dismissed, and by its clients, which are proceeding. These proceedings
include individual actions and a class action against Keystone, its
subsidiaries, and some of its employees alleging that these entities or
individuals were responsible for, and contributed to, the loss. Management is
vigorously contesting 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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
Keystone Financial, Inc. (Keystone) is the fourth largest financial institution
headquartered in Pennsylvania. Keystone offers a wide-range of financial
products and services through its bank and 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. In addition,
income statement comparisons are based on results for the first nine months of
1999 compared to the same period of 1998 unless otherwise indicated.
FORWARD LOOKING STATEMENTS
From time to time, Keystone has and will continue to make statements which may
include "forward-looking" information. Keystone cautions that "forward-looking"
information disseminated through financial presentations should not be construed
as guarantees of future performance. Furthermore, actual results may differ from
expectations contained in such "forward-looking" information as a result of
factors which are not predictable. Financial institution performance can be
affected by any number of factors, many of which are outside of management's
direct control. Examples include, but are not limited to, the effect of
prevailing economic conditions; the overall direction of government policies;
unforeseen changes in the general interest rate environment; the actions and
policy directives of the Federal Reserve Board; competitive factors in the
marketplace; and business risks associated with the management of the credit
extension function and fiduciary activities. Each of these factors could affect
estimates, assumptions, uncertainties, and risks considered in the development
of "forward-looking" information, and could cause actual results to differ
materially from management's expectations regarding future performance.
SUMMARY OF FINANCIAL RESULTS
Keystone recognized third quarter operating earnings of $0.49 per share,
exclusive of special charges associated with its year-long restructuring effort.
These results included net income of $23.9 million and a return on average
assets (ROA) and return on average equity (ROE) of 1.40% and 16.33%,
respectively.
For the nine months ended September 30, 1999, operating earnings, exclusive of
special charges, were $69.6 million or $1.41 per diluted share, compared with
$75.0 million, or $1.44 per share, for the first nine months of 1998. These
earnings resulted in a 1.38% ROA and a 15.69% ROE, versus 1.46% and 14.72%,
respectively, in the corresponding period last year.
At the end of 1998, Keystone announced plans to combine its separate banks into
a single bank charter in order to reduce operating expenses by 10% and improve
business line execution. This restructuring effort remains on schedule to be
completed by the end of 1999. To date in 1999, Keystone has incurred special
charges of $22 million in connection with the restructuring, related primarily
to employee terminations, fixed asset dispositions, the introduction of the
Keystone Financial Bank name and branding efforts. These charges reduced 1999
diluted earnings per share by $0.25 in the first quarter, $0.01 in the second
quarter and $0.03 in the third quarter.
<PAGE>
Performance to date in 1999 has been influenced by declines in net interest
income associated with a lower earning asset base and reduced margin, growth in
noninterest income, and declining levels of overhead expenses.
Net interest income declined 7% to date in 1999 compared with the same period in
1998, as earning assets declined 2% and the margin declined from 4.45% to 4.26%.
Though commercial loan growth has been strong, declines in various commodity
loan products have made growth in aggregate loan balances difficult. Declines in
commodity loan products were a result of Keystone's strategic decisions to
either curtail activity or to sell originated loans into the secondary market.
Earning asset levels were also adversely affected by the funding of share
repurchase activity. Funding of investments in bank-owned life insurance also
contributed to a decline in net interest income as related earnings are
reclassified as noninterest revenues. The net interest margin was also impacted
by the effect of interest rate increases on funding costs.
Excluding securities gains, noninterest revenues increased 13% to date in 1999
compared with 1998. Noninterest sources of revenue reached 28.6% of total
revenue to date in 1999, compared with 24.8% for the same period in 1998. The
growth is primarily attributable to increased sales of financial products and
electronic banking fees associated with Keystone's expansive ATM network.
Results in 1999 also included the benefit of a pension plan curtailment gain
associated with the reduction in the work force.
Overhead expenses, excluding special charges, were down slightly in 1999
compared with the first nine months of 1998. Substantial improvement occurred in
salary expense due to a 16% reduction in full-time equivalent employees (FTEs),
which declined from 3,010 at September 30, 1998 to 2,517.
Results for 1999 reflected a reduced provision for loan losses from the prior
year when higher levels of consumer charge-offs resulted in a higher provision.
Both risk elements and delinquent loans, expressed as a percentage of total
loans, declined from December 31, 1998 levels.
Keystone repurchased 2.5 million shares to date in 1999 at a total cost of $89
million. During the second quarter, the 2.5 million shares, in addition to
approximately one million shares repurchased in 1998, were retired.
<PAGE>
AVERAGE STATEMENT OF CONDITION
The average balance sheets for the nine months ended September 30, 1999 and 1998
were as follows (in thousands):
- --------------------------------------------------------------------------------
Change
1999 1998 Volume %
- --------------------------------------------------------------------------------
Cash and due from banks $197,489 $174,341 $23,148 13%
Federal funds sold and other 90,028 93,171 (3,143) (3)
Investments 1,702,457 1,675,653 26,804 2
Loans held for resale 90,384 62,747 27,637 44
Loans 4,419,468 4,623,575 (204,107) (4)
Allowance for credit losses (60,453) (64,125) 3,672 6
- --------------------------------------------------------------------------------
Net loans 4,359,015 4,559,450 (200,435) (4)
Intangible assets 58,091 61,934 (3,843) (6)
Other assets 258,712 234,497 24,215 10
- --------------------------------------------------------------------------------
TOTAL ASSETS $6,756,176 $6,861,793 $(105,617) (2)%
- --------------------------------------------------------------------------------
Noninterest-bearing deposits $678,734 $632,509 $ 46,225 7 %
Interest-bearing deposits 4,402,798 4,565,495 (162,697) (4)
Short-term borrowings 357,594 379,061 (21,467) (6)
FHLB borrowings 454,215 353,670 100,545 28
Other long-term debt 130,055 115,510 14,545 13
Other liabilities 146,651 134,450 12,201 9
- --------------------------------------------------------------------------------
TOTAL LIABILITIES 6,170,047 6,180,695 (10,648) ---
- --------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY 586,129 681,098 (94,969) (14)
- --------------------------------------------------------------------------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $6,756,176 $6,861,793 $(105,617) (2)%
- --------------------------------------------------------------------------------
Loan growth totaling $114 million or 3% of total loans occurred in the
categories of commercial and commercial real estate. This growth was offset by
declines attributable to the run-off of indirect automobile loans and leases and
sales of fixed-rate mortgages. As a result, total loans decreased 4%. Increases
in loans held for resale are due to a higher volume of mortgage loan
originations and the timing of loan sales.
While deposit products such as free checking, indexed money market accounts, and
variable-rate certificates of deposits reflected stable growth, total
interest-bearing deposits declined during 1999 as customer demand for mutual
funds, annuity products, and equity investments increased.
The increase in other long-term debt is attributable to the issuance of $30
million of medium-term notes in the second quarter of 1998. The decline in
shareholders equity is attributable to share repurchase activity pursuant to
Keystone's capital management plan.
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, 1999 and 1998 (in thousands):
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
Increase/
1999 1998 (Decrease)
Yield/ Yield/ Yield/
Amount Rate Amount Rate Amount Rate
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest income $368,322 7.81% $397,212 8.22% $(28,890) (0.41)
Interest expense 167,339 4.19 181,936 4.49 (14,597) (0.30)
- ---------------------------------------------------------------------------------------
Net interest income $200,983 $215,276 $(14,293)
Interest spread 3.62% 3.73% (0.11)
Impact of noninterest funds 0.64 0.72 (0.08)
- ---------------------------------------------------------------------------------------
Net interest margin 4.26% 4.45% (0.19)
- ---------------------------------------------------------------------------------------
</TABLE>
Keystone's primary source of revenue is net interest income, which constituted
71% of total revenue (excluding securities gains) in the first nine months of
1999. 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 declined $14 million or 7% in 1999 compared to the same
period in 1998, as earning asset levels declined and the decline in asset yields
outpaced the decline in funding costs. Consequently, the net interest spread
decreased 11 basis points and the net interest margin decreased 19 basis points.
Interest income declined $29 million or 7% during 1999 and was influenced by a
decrease of approximately $149 million in earning assets. Share repurchases and
investments in bank-owned life insurance reduced earning assets and therefore,
interest income. Loans declined from 71.6% of average earning assets in 1998 to
70.1% in 1999, making lower-yielding investment securities a higher portion of
the total portfolio. In addition, the overall yield on loans decreased 42 basis
points in 1999 compared to 1998 due in part to lower interest rates and
continued pricing competition. Similarly, the total yield on investments and
federal funds sold decreased in line with the general decline in overall rates.
Interest expense experienced a decline of $15 million or 8%, as interest bearing
liabilities decreased by $69 million and the total rate paid on all funding
sources decreased 30 basis points. The benefit of a lower interest rate
environment on funding costs was mitigated by an increased utilization of more
costly funding sources such as FHLB borrowings.
PROVISION FOR CREDIT LOSSES
The provision for credit losses was $9.9 million or 0.30% of average loans for
1999, compared with $13.5 million or 0.39% of average loans for 1998. The
reduced provision was responsive to a reduced level of net charge-offs, which
were 0.33% of average loans for 1999, compared to 0.48% for the same period in
1998. Results in 1998 were influenced by higher levels of charge-offs associated
with indirect loans and leases. The ratio of the allowance for credit losses as
a percent of loans outstanding at September 30 remained constant at 1.35%. Refer
to the asset quality section of this report for additional information related
to the allowance for credit losses.
NONINTEREST INCOME
Excluding securities gains from both periods, noninterest income increased $9.5
million or 13% in 1999 compared to 1998. Notable increases occurred in trust and
investment advisory revenue, fee income, and other income. Trust and investment
advisory revenue has been affected by the success of Keystone's Governor Funds
and both full-service and discount brokerage services. Fee income was favorably
impacted by ATM surcharges, increased usage of the Keystone Visa check card, and
increased activity related to the processing of merchants' credit card
transactions. Other income increased by $5 million due to a combination of
factors, including a pension curtailment gain, income earned on bank-owned life
insurance purchased in late 1998 and increased annuity sales volume. The pension
plan curtailment gain arose from reductions in staffing associated with the
restructuring.
NONINTEREST EXPENSES
During 1999, Keystone incurred special charges primarily associated with the
unification of its seven former banks under a single charter. These charges
totaled $22 million to date in 1999 and are described in greater detail in the
footnotes to the financial statements. During the last quarter of 1999, Keystone
expects to incur additional expenses of approximately $1 million to $2 million
associated with the finalization of the charter unification process. Such
expenses are expected to consist primarily of nonrecurring marketing expenses
which will coincide with scheduled bank conversions and related customer
notifications.
Excluding special charges, total noninterest expenses decreased slightly in 1999
compared to the same period in 1998. Salaries declined 7% as a 16% reduction in
FTEs was partially offset by merit increases and higher variable compensation
associated with record levels of mortgage originations and sales of financial
products. Benefit expenses declined 4% from 1998 due to the reduced number of
FTEs.
Occupancy and furniture and equipment expense increased slightly during 1999,
due in part to delivery channel enhancements and Year 2000 compliant software
upgrades.
Other expenses increased 6% or $2.9 million in 1999 compared to 1998. The
increase was in part due to higher levels of activity in processing merchant
credit card transactions and reinsurance, both of which demonstrated
corresponding increases in revenue.
Year 2000
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 were primarily performed using
internal resources and are explained fully in Keystone's 1998 annual report to
its shareholders.
Keystone has completed all phases of its Y2K plan including the implementation
phase of installation, system testing and transition to a production
environment. It has been determined that all identified replacement or updated
systems meet the standards necessary for Y2K readiness. Further risk associated
with Y2K is primarily related to the successful ongoing operations of these
systems and can be remedied, if necessary, via standard vendor support channels
or by redirecting internal or external resources. Keystone has no significant
exposure due to non-IT components with embedded technology. Management's current
risk assessment is that should difficulties be encountered with system
operations, only minor delays in transaction processing or information
availability will occur. 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.
The impact of Year 2000 issues on Keystone will depend not only on steps taken
by Keystone to address and prevent potential Y2K problems but also on the way in
which Y2K issues are addressed by governmental agencies, businesses and other
third parties that provide services or data to, or receive services or data
from, Keystone, or whose financial condition or operational capability is
important to Keystone. Keystone has extensively surveyed the readiness of such
third party suppliers, vendors, and major customers, and to date, Keystone is
not aware of any third party problems which would materially impact Keystone's
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.
Expenditures since the inception of the project have aggregated $6.5 million, of
which $3.6 million were capitalized. Throughout the remainder of 1999, Keystone
expects to spend an additional $700,000, of which $400,000 will be capitalized
and amortized over a five-year period. 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 Y2K
upgrade execution, the ability to identify all issues, and similar
uncertainties.
INCOME TAXES
Income tax expense for 1999 was $23.9 million, resulting in an effective tax
rate of 30%, comparable to Keystone's effective tax rate of 31% for calendar
year 1998.
ASSET QUALITY
Keystone's allowance for credit losses was $59.1 million or 1.35% of loans at
September 30, 1999, comparable to the ratio at the end of 1998. Annualized net
charge-offs expressed as a percentage of average loans decreased from 0.48% for
1998 to 0.33% in the same period of 1999. Consumer loan and lease charge-offs
declined in conjunction with Keystone's curtailment of indirect lending
activities in 1997.
The following table provides a comparative summary of the activity in the
allowance for credit losses for the nine-month periods ended September 30, 1999
and 1998(in thousands).
- ------------------------------------------------------------------------
1999 1998
- ------------------------------------------------------------------------
Allowance for Credit Losses:
Balance at beginning of period $60,274 $65,091
Loans charged-off:
Commercial (1,896) (1,790)
Real estate secured (2,299) (2,049)
Consumer (7,511) (11,516)
Lease financing (1,036) (3,848)
- ------------------------------------------------------------------------
Total loans charged-off (12,742) (19,203)
- ------------------------------------------------------------------------
Recoveries:
Commercial 184 230
Real estate secured 644 1,062
Consumer 737 1,054
Lease financing 110 182
- ------------------------------------------------------------------------
Total recoveries 1,675 2,528
- -------------------------------------------------------------------------
Net loans charged-off (11,067) (16,675)
Provision for credit losses 9,903 13,517
- -------------------------------------------------------------------------
Balance at end of period $59,110 $61,933
- -------------------------------------------------------------------------
The following table has been provided to compare nonperforming assets and total
risk elements at September 30, 1999 to the balances at the end of 1998, 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) 1999 1998
- ------------------------------------------------------------------------
Nonaccrual loans $31,659 $24,675
Restructurings 854 264
Other real estate 3,488 3,982
- -------------------------------------------------------------------------
Nonperforming assets 36,001 28,921
Loans 90 days or more past due 19,290 28,549
- -------------------------------------------------------------------------
Total risk elements $55,291 $57,470
- -------------------------------------------------------------------------
Ratio to period-end loans:*
Nonperforming assets .82% .65%
90-days past due .44 .64
- -------------------------------------------------------------------------
Total risk elements 1.26% 1.29%
- -------------------------------------------------------------------------
Coverage Ratios:
Ending allowance to nonperforming loans 182% 242%
Ending allowance to risk elements** 114% 113%
Ending allowance to annualized
net charge-offs 4.0x 2.9X
- --------------------------------------------------------------------------
* The denominator consists of period-end loans and ORE.
**Excludes ORE.
The ratio of total risk elements expressed as a percent of loans at September
30, 1999 was slightly improved from year-end 1998 levels. The ratio of the
allowance to nonperforming loans declined since December 31, 1998 as a limited
number of loans moved out of the 90 days past due category into nonaccrual
status. Similarly, nonperforming assets increased and loans 90-days past due
decreased. As a result of reduced consumer charge-offs in 1999, the coverage
ratio of the ending allowance to annualized year-to-date net charge-offs
improved from 2.9x for 1998 to 4.0x for 1999.
Management's determination of the adequacy of the allowance is based on periodic
evaluations of the loan portfolio and other relevant factors. This evaluation is
inherently subjective as it requires material estimates, including, but not
limited to, the amounts and timing of expected future cash flows or the fair
value of collateral on impaired loans; estimated losses on installment and
residential mortgage loans; and trends in delinquencies, all of which may be
susceptible to significant change.
In determining the adequacy of the allowance for loan losses, management also
makes allocations to specific problem commercial loans or pools of loans with
consideration given to the above factors. While allocations are made to specific
loans and pools of loans, the allowance is available for all loan losses. Based
on its evaluation of loan quality, management believes that the allowance for
credit losses at September 30, 1999 was adequate to absorb potential losses
within the loan portfolio.
CAPITAL MANAGEMENT
During the first half of 1999, Keystone purchased 2.5 million shares for
treasury at a total cost of $89 million. Keystone currently has board approval
to purchase an additional 500,000 shares.
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
1999 1998 Capitalized Requirement
- ---------------------------------------------------------------------------
Leverage ratio 8.04% 8.66% 5.00% 4.00%
Tier 1 11.33% 12.59% 6.00% 4.00%
Total capital ratio 12.57% 13.84% 10.00% 8.00%
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At September 30, 1999, there have been no material changes to the information
on this topic presented in the December 31, 1998 Annual
Report.
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, 1999, the registrant filed the following
reports on Form 8-K:
Date of Report Item Description
- --------------- ----- ---------------------------------------
July 19, 1999 5 Earnings release for the second quarter
September 29, 1999 5 Press release announcing earnings update
<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 12, 1999
Mark L. Pulaski
- ----------------------------
President & Chief
Operating Officer
DATE: November 12, 1999
Donald F. Holt
- ----------------------------
Executive Vice President &
Chief Financial Officer
<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):
- --------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
- --------------------------------------------------------------------------------
1999 1998 1999 1998
- --------------------------------------------------------------------------------
Numerator $22,472 $25,581 $54,991 $74,998
Denominators:
Basic shares outstanding 48,583 51,368 48,909 51,540
Dilutive option effect 253 507 387 638
- --------------------------------------------------------------------------------
Dilutive shares outstanding 48,836 51,875 49,296 52,178
- --------------------------------------------------------------------------------
EPS:
Basic $0.46 $0.50 $1.12 $1.46
Diluted $0.46 $0.50 $1.12 $1.44
- --------------------------------------------------------------------------------
Exhibit 12: Statement Re Computation of Ratios
Ratio of Earnings to Fixed Charges:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
(in thousands) September 30, September 30,
- ------------------------------------------------------------------------------------------------------------------
1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1. Income before taxes $32,270 $37,949 $78,907 $108,856
2. Fixed charges:
a. Interest expense $56,726 $61,402 $167,339 $181,936
b. Interest component of rent expense 700 667 2,069 2,088
---------------------------------------------------------------------------------------------------------------
c. Total fixed charges (line 2a.+ line 2b.) 57,426 62,069 169,408 184,024
d. Interest on deposits 42,923 48,677 129,804 146,555
---------------------------------------------------------------------------------------------------------------
e. Fixed charges excluding interest on deposits
(line 2c.-line 2d.) $14,503 $13,392 $39,604 $37,469
---------------------------------------------------------------------------------------------------------------
3. Income before taxes plus fixed charges:
a. Including interest on deposits $89,696 $100,018 $248,315 $292,880
(line 1.+ line 2c.)
b. Excluding interest on deposits 46,773 51,341 118,511 146,325
(line 1.+ line 2e.)
---------------------------------------------------------------------------------------------------------------
4. Ratio of earnings to fixed charges:
a. Including interest on deposits
(line 3a. divided by line 2c.) 1.56x 1.61x 1.47x 1.59x
b. Excluding interest on deposits
(line 3b. divided by line 2e.) 3.23x 3.83x 2.99x 3.91x
----------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<CASH> 196,322
<INT-BEARING-DEPOSITS> 1,558
<FED-FUNDS-SOLD> 122,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,158,668
<INVESTMENTS-CARRYING> 600,225
<INVESTMENTS-MARKET> 593,103
<LOANS> 4,388,555
<ALLOWANCE> 59,110
<TOTAL-ASSETS> 6,877,563
<DEPOSITS> 4,913,753
<SHORT-TERM> 425,845
<LIABILITIES-OTHER> 143,784
<LONG-TERM> 808,337
0
0
<COMMON> 97,296
<OTHER-SE> 488,548
<TOTAL-LIABILITIES-AND-EQUITY> 6,877,563
<INTEREST-LOAN> 277,651
<INTEREST-INVEST> 75,317
<INTEREST-OTHER> 8,976
<INTEREST-TOTAL> 361,944
<INTEREST-DEPOSIT> 129,804
<INTEREST-EXPENSE> 167,339
<INTEREST-INCOME-NET> 194,605
<LOAN-LOSSES> 9,903
<SECURITIES-GAINS> 1,174
<EXPENSE-OTHER> 187,482
<INCOME-PRETAX> 78,907
<INCOME-PRE-EXTRAORDINARY> 54,991
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 54,991
<EPS-BASIC> 1.12
<EPS-DILUTED> 1.12
<YIELD-ACTUAL> 3.62
<LOANS-NON> 31,659
<LOANS-PAST> 19,290
<LOANS-TROUBLED> 854
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 60,274
<CHARGE-OFFS> 12,742
<RECOVERIES> 1,675
<ALLOWANCE-CLOSE> 59,110
<ALLOWANCE-DOMESTIC> 59,110
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
