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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE YEAR ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission File Number: 0-25328
FIRST KEYSTONE FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-0469351
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
22 West State Street
Media, Pennsylvania 19063
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (610) 565-6210
Securities registered pursuant to Section 12(b) of the Act:
NOT APPLICABLE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK (PAR VALUE $.01 PER SHARE)
Indicate by check mark whether the Registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
As of December 15, 1998 the aggregate value of the 1,784,090 shares of Common
Stock of the Registrant issued and outstanding on such date, which excludes
485,126 shares held by all directors and officers of the Registrant as a group,
was approximately $26.3 million. This figure is based on the last known trade
price of $14.75 per share of the Registrant's Common stock on December 15, 1998.
Number of shares of Common Stock outstanding as of December 15, 1998: 2,269,216
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents incorporated by reference and the Part of
the Form 10-K into which the document is incorporated:
(1) Portions of the Annual Report to Stockholders for the fiscal year ended
September 30, 1998 are incorporated into Parts II and III.
(2) Portions of the definitive proxy statement for the Annual Meeting of
Stockholders are incorporated into Part III.
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PART I.
Item 1. BUSINESS
GENERAL
First Keystone Financial, Inc. (the "Company") is a Pennsylvania
corporation and sole shareholder of First Keystone Federal Savings Bank (the
"Bank") which converted to the stock form of organization in January 1995. The
only significant assets of the Company are the capital stock of the Bank, the
Company's loans to its employee stock ownership plan, and various equity and
other investments. See Note 20 of the Notes to Consolidated Financial Statements
in the Annual Report to stockholders for the year ended September 30, 1998
setforth as Exhibit 13 hereto ("Annual Report"). The business of the Company
primarily consists of the business of the Bank.
The Bank is a traditional, community oriented federal savings bank
emphasizing customer service and convenience. The Bank's primary business is to
attract deposits from the general public and investing those funds together with
other available sources of funds, such as borrowings, to originate loans. A
substantial portion of the Bank's deposits are comprised of core deposits which
amounted to $90.5 million or 36.6% of the Bank's total deposits at September 30,
1998. The Bank's primary lending emphasis has been, and continues to be, loans
secured by first and second liens on single-family (one-to-four units)
residences located in Delaware and Chester Counties, Pennsylvania and to a
lesser degree, Montgomery County, Pennsylvania and New Castle County, Delaware.
The Bank originates single-family residences secured by first mortgages with
respect to non-conforming jumbo loans and loans to credit impaired borrowers for
sale in the secondary market. The Bank also originates, due to their shorter
terms, adjustable or variable interest rates, higher yields, and as a result of
the Bank's analysis that the markets have become more stable, loans secured by
commercial real estate properties as well as residential construction loans
located in the Bank's market area. The Bank originates mortgage loans for resale
into the secondary market while retaining for its portfolio adjustable-rate
mortgage loans and fixed-rate loans that complement the Bank's asset/liability
strategies. The Bank also originates and sells, servicing released, certain
non-conforming loans. Although the Bank has not purchased either whole loans or
loan participation interests in the past, depending on market conditions and
portfolio needs, the Bank may consider purchasing loans and participation
interests in the future. The Bank's originations of commercial real estate and
multi-family residential loans has continued to increase as a direct result of
the Bank's emphasis on developing business loan products. Commercial real estate
and multi-family residential loans amounted to $20.6 million or 9.9% of the
total loan portfolio at September 30, 1998 as compared to $18.3 million or 9.3%
at September 30, 1997.
To a lesser extent, the Bank also originates consumer loans (consisting
almost entirely of home equity loans and lines of credit), loans secured by
commercial real estate and multi-family (over four units) residential
properties, construction and land loans, commercial business and other mortgage
loans.
In addition to its deposit gathering and lending activities, the Bank
invests in mortgage-related securities, substantially all of which are issued or
guaranteed by U.S. Government agencies and government sponsored enterprises, as
well as U.S. Treasury and federal government agency obligations and municipal
obligations. At September 30, 1998, the Bank's mortgage-related securities
(including mortgage-related securities available for sale) amounted to $135.3
million, or 32.3% of the Company's total assets, and investment securities
(including investment securities available for sale) amounted to $40.6 million,
or 9.8% of total assets.
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MARKET AREA
The Bank's primary market area consists of Delaware and Southern Chester
Counties and to a lesser extent the contiguous counties of Montgomery and
Northern Chester Counties, Pennsylvania and New Castle County, Delaware.
Delaware County is part of the Philadelphia Primary Metropolitan Statistical
Area ("PMSA") which includes besides Delaware County, Bucks, Chester, Montgomery
and Philadelphia Counties (as well as four counties in New Jersey). The
Philadelphia area economy is typical of many large northeast and midwest cities
where the traditional manufacturing based economy has declined to a certain
degree and has been replaced with service sector and specialty area growth. As a
result of such growth, the Philadelphia PMSA's economic diversity has broadened
and employment in the area is derived from a number of different employment
sectors. In particular, Delaware County has experienced the development of
companies providing products and services for the health care market such as
Crozer/Keystone Health System, Wyeth-Ayerst Labs, Inc. and Mercy Health Corp.
Philadelphia's central location in the northeast corridor, its
well-educated and skilled population base, infrastructure and other factors has
made the Bank's market area attractive to many large corporate employers. Such
employers include Comcast Corp., Boeing, State Farm Insurance, Unisys Corp.,,
ARCO Chemical Company, PECO Energy, SAP America, Inc., and many others. There
are over seventy-five Fortune 1,000 companies maintaining a presence here and
approximately twenty Fortune 500 companies headquartered in the region
surrounding the Philadelphia PMSA including CIGNA Corp., E.I. duPont de Nemours,
Bethlehem Steel, Ikon Office Solutions, Sun Company, Crown Cork & Seal and
others.
Delaware County has experienced slower population growth than the
Philadelphia PMSA, although the growth rates in the outlying areas of Delaware
County have been growing at a rate above that of the Philadelphia PMSA. Since
1990, there has been no population growth in Delaware County and it is expected
to increase by less than 1 percent over the next 20 years. Chester County, on
the other hand, has grown over 11 percent since 1990 and expected to increase
further through the millennium. By comparison, median household income in
Delaware County and Chester County is approximately $40,500 and $48,000,
respectively, both of which are near or over the Philadelphia PMSA median of
approximately $41,000 (1996 estimates). Likewise, median home values in Delaware
and Chester Counties were approximately $113,200 and $155,900, respectively, as
compared to approximately $112,000 for the Philadelphia PMSA in 1990.
Unemployment rates in Delaware County have been below those experienced by the
Philadelphia PMSA but higher than some of the other counties comprising the
PMSA. The average annual unemployment rate (not seasonally adjusted) for 1998
through October was 4.0% in Delaware County and 2.8% in Chester County as
compared to 4.4% for the Philadelphia PMSA.
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Lending Activities
Loan Portfolio Composition. The following table sets forth the composition
of the Bank's loan portfolio by type of loan at the dates indicated (excluding
loans held for sale).
<TABLE>
<CAPTION>
September 30,
----------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------- --------------- -------------- -------------- ---------------
Amount % Amount % Amount % Amount % Amount %
------ ----- ------ ---- ------ ---- ------ ---- ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
Single-family $148,088 71.34% $135,168 68.53% $122,270 68.68% $115,225 69.01% $105,728 69.77%
Multi-family and commercial 20,563 9.91 18,305 9.28 11,129 6.25 11,789 7.06 12,700 8.38
Construction and land 15,858 7.64 16,400 8.31 17,682 9.93 16,343 9.79 13,805 9.11
======= ====== ======= ====== ======= ====== ======= ==== ======= =====
Total real estate loans 184,509 88.89 169,873 86.12 151,081 84.86 143,357 85.86 132,233 87.26
------- ------ ------- ------ ------- ------ ------- ------ ------- -----
Consumer:
Home equity loans and lines of credit 19,609 9.45 22,964 11.64 20,444 11.48 18,229 10.92 15,603 10.30
Deposit 181 .09 348 .18 457 .26 350 .21 374 .25
Education 449 .21 365 .19 917 .52 1,010 .60 697 .46
Other (1) 1,429 .69 1,690 .86 2,212 1.24 1,491 .89 332 .22
------- ------ ------- ------ ------- ------ ------- ------ ------- -----
Total consumer loans 21,668 10.44 25,367 12.87 24,030 13.50 21,080 12.62 17,006 11.23
------- ------ ------- ------ ------- ------ ------- ------ ------- -----
Commercial business loans 1,390 .67 2,000 1.01 2,923 1.64 2,533 1.52 2,288 1.51
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total loans receivable (2) 207,567 100.00% 197,240 100.00% 178,034 100.00% 166,970 100.00% 151,527 100.00%
------- ====== ------- ====== ------- ====== ------- ====== ------- ======
Less:
Loans in process (construction
and land) 5,781 5,670 6,368 6,070 6,698
Deferred loan origination fees
and discounts 1,705 1,653 1,512 1,411 1,063
Allowance for loan losses 1,738 1,628 2,624 1,487 1,540
------- ------- ------- ------- -------
9,224 8,951 10,504 8,968 9,301
-------- ------- ------- ------- -------
Total loans receivable, net $198,343 $188,289 $167,530 $158,002 $142,226
======= ======= ======= ======= =======
</TABLE>
- -----------------------------
(1) Consists primarily of purchased consumer lease receivables.
(2) Does not include $2.8 million, $4.6 million, $2.4 million, $57,000, and
$168,000 of loans held for sale at September 30, 1998, 1997, 1996, 1995
and 1994, respectively.
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Contractual Principal Repayments. The following table sets forth the
scheduled contractual maturities of the Bank's loans held to maturity at
September 30, 1998. Demand loans, loans having no stated schedule of repayments
and no stated maturity and overdraft loans are reported as due in one year or
less. The amounts shown for each period do not take into account loan
prepayments and normal amortization of the Bank's loan portfolio held to
maturity.
<TABLE>
<CAPTION>
Real Estate Loans
------------------------------------------------------
Multi-family Consumer and
and Construction Commercial
Single-family Commercial and Land Total Business Loans Total
------------- ----------- ------------ --------- -------------- -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Amounts due in:
One year or less $ 7,461 $ 1,161 $15,858 $ 24,480 $ 6,469 $ 30,949
After one year through three years 10,814 2,642 13,456 5,602 19,058
After three years through five years 9,563 3,136 12,699 3,456 16,155
After five years through ten years 20,537 10,651 31,188 5,214 36,402
After ten years through twenty
years 57,674 2,973 60,647 2,317 62,964
Over twenty years 42,039 42,039 42,039
------- --------- ------- --------- ------- --------
Total(1) $148,088 $ 20,563 $15,858 $ 184,509 $23,058 $207,567
======= ---====== -====== --======= -====== -=======
Interest rate terms on amounts
due after one year:
Fixed $ 121,562 $15,697 $137,259
Adjustable 38,467 892 39,359
--------- ------- --------
Total(1) $ 160,029 $16,589 $176,618
--======= -====== -=======
</TABLE>
- -----------------------------
(1) Does not include adjustments relating to loans in process, allowances
for loan losses and deferred fee income.
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Scheduled contractual amortization of loans does not reflect the expected
term of the Bank's loan portfolio. The average life of loans is substantially
less than their contractual terms because of prepayments and due-on-sale
clauses, which give the Bank the right to declare a conventional loan
immediately due and payable in the event, among other things, that the borrower
sells the real property subject to the mortgage and the loan is not repaid. The
average life of mortgage loans tends to increase when current mortgage loan
rates are higher than rates on existing mortgage loans and, conversely, decrease
when rates on existing mortgage loans are lower than current mortgage loan rates
(due to refinancings of adjustable-rate and fixed-rate loans at lower rates).
Under the latter circumstances, the weighted average yield on loans decreases as
higher yielding loans are repaid or refinanced at lower rates.
Loan Origination, Purchase and Sales Activity. The following table shows
the loan origination, purchase and sale activity of the Bank during the periods
indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------------------------------
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Gross loans at beginning of period(1) $201,817 $180,491 $167,027
------- ------- -------
Loan originations for investment:
Real estate:
Residential 39,226 18,016 23,766
Commercial and multi-family 3,578 8,458 399
Construction 14,662 16,298 15,875
------- ------- -------
Total real estate loans originated
for investment 57,466 42,772 40,040
Consumer 4,819 8,859 9,738
Commercial business 4,231 2,755 875
-------- -------- -------
Total loans originated for
investment 66,516 54,386 50,653
Loans originated for resale 56,398 37,209 30,239
------- ------- -------
Total originations 122,914 91,595 80,892
------- ------- -------
Deduct:
Principal loan repayments and
prepayments (55,982) (34,779) (37,821)
Transferred to real estate owned (207) (411) (1,768)
Loans sold in secondary market (58,176) (35,079) (27,839)
------- ------- -------
Subtotal 114,365 70,269 (67,438)
-------- ------- -------
Net increase in loans(1) 8,549 21,326 13,454
------- ------- -------
Gross loans at end of period(1) $210,366 $201,817 $180,481
======= ======= =======
</TABLE>
- ------------------------------
(1) Includes loans held for sale of $2.8 million, $4.6 million, and $2.4
million at September 30, 1998, 1997 and 1996, respectively.
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The lending activities of the Bank are subject to written underwriting
standards and loan origination procedures established by the Bank's Board of
Directors and management. Applications for all types of loans are taken at all
of the Bank's branch offices by the branch manager or other designated loan
officers. Applications for single-family residential mortgage loans for
portfolio retention also are obtained through loan originators who are employees
of the Bank. The Bank's loan originators will take loan applications outside of
the Bank's offices at the customer's convenience and are compensated on a
commission basis. The Mortgage Lending Department supervises the process of
obtaining credit reports, appraisals and other documentation involved with a
loan. The Bank generally requires that a property appraisal be obtained in
connection with all new mortgage loans. Property appraisals generally are
performed by an independent appraiser from a list approved by the Bank's Board
of Directors. The Bank requires that title insurance (other than with respect to
home equity loans) and hazard insurance be maintained on all security properties
and that flood insurance be maintained if the property is within a designated
flood plain.
Residential mortgage loan applications are primarily developed from
referrals from real estate brokers and builders, existing customers and walk-in
customers. Residential mortgage loans also are originated through
correspondents. Commercial and multi-family real estate loan applications are
obtained primarily from previous borrowers, direct solicitations by Bank
personnel, as well as referrals. Consumer loans originated by the Bank are
obtained primarily through existing and walk-in customers who have been made
aware of the Bank's programs by advertising and other means.
Applications for residential mortgage loans which are originated for resale
in the secondary market or loans designated for portfolio retention that conform
to the requirements for resale into the secondary market and do not exceed
Fannie Mae ("FNMA")/ Freddie Mac ("FHLMC") limits are approved by the Bank's
Chief Lending Officer or in his absence, by the Senior Loan Underwriter or Loan
Committee (a committee comprised of three directors and the Bank's Chief Lending
Officer). All other first mortgage loans (commercial and multi-family
residential real estate and construction loans) and residential mortgage loans
in excess of FNMA/FHLMC maximum amounts (currently $227,150) but less than $1.0
million must be approved by the Loan Committee. All first mortgage loans in
excess of $1.0 million must be approved by the Bank's Board of Directors or the
Executive Committee thereof. All mortgage loans which do not require approval by
the Board of Directors are submitted to the Board at its next meeting for review
and ratification. Home equity loans and lines of credit up to $100,000 can be
approved by the Chief Lending Officer, the Vice President of Construction Loans
or the Administrative Vice President of mortgage lending. Loans in excess of
such amount must be approved by the Loan Committee.
Applications for non-conforming residential real estate loans, submitted by
correspondents and sold servicing released into the secondary market, are
packaged and submitted for pre-approval to the buyer prior to closing. The Bank,
on occasion will originate non-conforming loans in accordance with the buyers'
underwriting standards and sells them in bulk to such buyers. See "-Mortgage
Banking Activities."
Single-Family Residential Loans. Substantially all of the Bank's
single-family residential mortgage loans consist of conventional loans.
Conventional loans are loans that are neither insured by the Federal Housing
Administration or partially guaranteed by the Department of Veterans Affairs.
The vast majority of the Bank's single-family residential mortgage loans are
secured by properties located in Pennsylvania, primarily in Delaware and Chester
Counties, and are originated under terms and documentation which permit their
sale to the FHLMC or FNMA. The Bank, consistent with its asset/liability
management strategies, sells some of its newly originated longer term fixed-rate
residential mortgage loans and to a limited degree, existing longer term
fixed-rate residential mortgage loans while retaining adjustable-rate mortgage
loans and shorter term fixed-rate residential mortgage loans. See "-
Mortgage-Banking Activities."
The single-family residential mortgage loans offered by the Bank currently
consist of fixed-rate loans, including bi-weekly and balloon loans, and
adjustable-rate loans. Fixed-rate loans generally have maturities ranging from
15 to 30 years and are fully amortizing with monthly loan payments sufficient to
repay the total amount of the loan with interest by the end of the loan term.
The Bank's fixed-rate loans are originated under terms, conditions and
documentation which permit them to be sold to U.S. Government-sponsored
agencies, such as the FHLMC and the FNMA, and other investors in the secondary
mortgage market. The Bank also offers bi-weekly loans under the terms of which
the borrower makes payments every two weeks. Although such loans have a 30 year
amortization schedule, due to the bi-weekly payment schedule, such loans repay
substantially more rapidly than a standard monthly
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amortizing 30-year fixed-rate loan. The Bank also offers five and seven year
balloon loans which provide that the borrower can conditionally renew the loan
at a to-be-determined rate for the remaining 25 or 23 years, respectively, of
the amortization period. At September 30, 1998, $104.8 million, or 70.8%, of the
Bank's single-family residential mortgage loans held in portfolio were
fixed-rate loans, including $29.8 million of bi-weekly fixed-rate residential
mortgage loans.
The adjustable-rate loans currently offered by the Bank have interest rates
which adjust every one or three years in accordance with a designated index,
such as U.S. Treasury obligations, adjusted to a constant maturity ("CMT"), plus
a stipulated margin. The Bank's adjustable-rate single-family residential real
estate loans generally have a cap of 2% on any increase or decrease in the
interest rate at any adjustment date, and a cap of 6% over the life of the loan.
In order to increase acceptance of adjustable-rate loans, the Bank recently has
been originating loans which are fixed for a period of three to ten years after
which converts to one-year adjustable-rate loan. The Bank's adjustable-rate
loans require that any payment adjustment resulting from a change in the
interest rate of an adjustable-rate loan be sufficient to result in full
amortization of the loan by the end of the loan term and, thus, do not permit
any of the increased payment to be added to the principal amount of the loan, or
so-called negative amortization. Although the Bank does offer adjustable-rate
loans with initial rates below the fully indexed rate, such loans are
underwritten using methods approved by FHLMC and FNMA which allow borrowers to
be qualified at 2% above the discounted loan rate. At September 30, 1998, $43.3
million or 29.2% of the Bank's single-family residential mortgage loans held for
portfolio were adjustable-rate loans.
Adjustable-rate loans decrease the risks associated with changes in
interest rates but involve other risks, primarily because as interest rates
increase the loan payment by the borrower increases to the extent permitted by
the terms of the loan, thereby increasing the potential for default. Moreover,
as with fixed-rate loans, as interest rates increase, the marketability of the
underlying collateral property may be adversely affected by higher interest
rates. The Bank believes that these risks, which have not had a material adverse
effect on the Bank to date because of the generally stable interest rate
environment in recent years, generally are less than the risks associated with
holding fixed-rate loans in an increasing interest rate environment.
For conventional residential mortgage loans held in portfolio and also for
those loans originated for sale in the secondary market, the Bank's maximum
loan-to-value ratio is 95%, and is based on the lesser of sales price or
appraised value. On all loans with a loan-to-value ratio of over 80%, private
mortgage insurance is required to be obtained.
Commercial and Multi-Family Residential Real Estate Loans. The Bank has
moderately increased its investment in commercial and multi-family lending. Such
loans are being extended primarily to small and medium-sized businesses located
in the Bank's primary market area, a portion of the market that the Bank
believes has been underserved in recent years. Loans secured by commercial and
multi-family real estate amounted to $20.6 million, or 9.9%, of the Bank's total
loan portfolio, at September 30, 1998. The Bank's commercial and multi-family
residential real estate loans are secured primarily by professional office
buildings, small retail establishments, warehouses and apartment buildings (with
36 units or less) located in the Bank's primary market area.
The Bank's adjustable-rate multi-family residential and commercial real
estate loans generally are either one-year or three-year adjustable-rate loans
indexed to the CMT plus a margin. In addition, depending on collateral value and
strength of the borrower, fixed-rate balloon loans and longer term fixed-rate
loans are also originated. Generally, fees of 1% to 3% of the principal loan
balance are charged to the borrower upon closing. Although terms for
multi-family residential and commercial real estate loans may vary, the Bank's
underwriting standards generally provide for terms of up to 25 years with
amortization of principal over the term of the loan and loan-to-value ratios of
not more than 75%. Generally, the Bank obtains personal guarantees of the
principals of the borrower as additional security for any commercial real estate
and multi-family residential loans and requires that the borrower have at least
a 25% equity investment in any such property.
The Bank evaluates various aspects of commercial and multi-family
residential real estate loan transactions in an effort to mitigate risk to the
extent possible. In underwriting these loans, consideration is given to the
stability of the property's cash flow history, future operating projections,
current and projected occupancy, position in the market, location and physical
condition. In recent periods, the Bank has also generally imposed a debt
coverage ratio
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(the ratio of net cash from operations before payment of debt service to debt
service) of not less than 110%. The underwriting analysis also includes credit
checks and a review of the financial condition of the borrower and guarantor, if
applicable. An appraisal report is prepared by a state-licensed and certified
appraiser (generally Member of the Appraisal Institute ("MAI") qualified)
commissioned by the Bank to substantiate property values for every commercial
real estate and multi-family loan transaction. All appraisal reports are
reviewed by the Bank prior to the closing of the loan.
Multi-family residential and commercial real estate lending entails
different and significant risks when compared to single-family residential
lending because such loans often involve large loan balances to single borrowers
and because the payment experience on such loans is typically dependent on the
successful operation of the project or the borrower's business. These risks can
also be significantly affected by supply and demand conditions in the local
market for apartments, offices, warehouses or other commercial space. The Bank
attempts to minimize its risk exposure by limiting such lending to proven
developers/owners, only considering properties with existing operating
performance which can be analyzed, requiring conservative debt coverage ratios,
and periodically monitoring the operation and physical condition of the
collateral.
Construction Loans. Substantially all of the Bank's construction loans have
consisted of loans to construct single-family properties extended either to
individuals or to selected developers with whom the Bank is familiar to build
such properties on a pre-sold or limited speculative basis. With respect to
loans to individuals, such loans have a maximum term of six months, have
variable rates of interest based upon the prime rate published in the Wall
Street Journal ("Prime Rate") plus a margin, have loan-to-value ratios of 80% or
less of the appraised value upon completion and generally do not require the
amortization of principal during the term. Upon completion of construction, the
loans convert to permanent residential mortgage loans.
The Bank also provides construction loans and lines of credit to
developers. The majority of such loans consist of loans to selected local
developers with whom the Bank is familiar to build single-family dwellings on a
pre-sold or, to a significantly lesser extent, on a speculative basis. The Bank
generally limits to two the number of unsold units which a developer may have
under construction in a project. Such loans generally have terms of 24 months or
less, have maximum loan-to-value ratios of 75% of the appraised value upon
completion and generally do not require the amortization of the principal during
the term. The loans are made with floating rates of interest based on the Prime
Rate plus a margin adjusted on a monthly basis. The Bank also receives
origination fees, which generally range from 1.0% to 3.0% of the commitment. The
borrower is required to fund a portion of the project's costs, the exact amount
being determined on a case-by-case basis. Loan proceeds are disbursed in stages
after inspections of the project indicate that such disbursements are for costs
already incurred and which have added to the value of the project. Only interest
payments are due during the construction phase and the Bank may provide the
borrower with an interest reserve from which it can pay the stated interest due
thereon. The Bank's construction loans include loans to the developers to
acquire the necessary land, develop the site and construct the residential units
("ADC loans"). At September 30, 1998, net residential construction loans
totalled $8.0 million, or 3.9%, of the total loan portfolio, which primarily
consisted of construction loans to developers.
Loans to developers include both secured and unsecured lines of credit with
outstanding commitments totalling $2.4 million. All have personal guaranties of
the principals and are cross-collateralized with existing loans. Loans
outstanding under builder lines of credit totalled $536,000 at September 30,
1998. The majority of the loans are secured by real estate and the unsecured
lines, given only to the Bank's most creditworthy and long standing customers,
totalled $391,000, or .19% of the total loan portfolio.
The Bank also will originate ground or land loans, both to individuals to
purchase a building lot on which he intends to build his primary residence, as
well as to developers to purchase lots to build speculative homes at a later
date. Such loans have terms of 36 months or less with a maximum loan-to-value
ratio of 75% of the lower of appraised value or sale price with respect to loans
to individuals and 65% of the lower of appraised value or sales price with
respect to loans to developers. The loans are made with floating rates based on
the Prime Rate plus a margin. The Bank also receives origination fees, which
generally range between 1.0% and 3.0% of the loan amount. At September 30, 1998,
land loans (including loans to acquire and develop land) totalled $3.4 million
or 1.6% of the total loan portfolio.
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Prior to making a commitment to fund a construction loan, the Bank requires
an appraisal of the property by an independent state-licensed and qualified
appraiser approved by the Board of Directors. In addition, during the term of
the construction loan, the project is inspected by an independent inspector.
Construction financing is generally considered to involve a higher degree
of risk of loss than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development and the estimated cost (including interest) of
construction. During the construction phase, a number of factors could result in
delays and cost overruns. If the estimate of value proves to be inaccurate, the
Bank may be confronted, at or prior to the maturity of the loan, with a project,
when completed, having a value which is insufficient to assure full repayment.
Loans on lots may run the risk of adverse zoning changes, environmental or other
restrictions on future use.
Consumer Lending Activities. The Bank offers consumer loans in order to
provide a full range of retail financial services to its customers. At September
30, 1998, $21.7 million, or 10.4%, of the Bank's total loan portfolio was
comprised of consumer loans. The Bank originates substantially all of such loans
in its primary market area.
The largest component of the Bank's consumer loan portfolio consists of
home equity loans and home equity lines of credit (a form of revolving credit),
both of which are secured by the underlying equity in the borrower's primary
residence. Home equity loans are amortizing loans with fixed interest rates and
maximum terms of 15 years while equity lines of credit have adjustable interest
rates indexed to the Prime Rate. Generally home equity loans or home equity
lines do not exceed $100,000. The Bank's home equity loans and lines of credit
generally require combined loan-to-value ratios of 80% or less. At September 30,
1998, home equity loans and lines of credit amounted to $19.6 million, or 9.4%,
of the Bank's total loan portfolio.
At September 30, 1998, the remaining portion of the Bank's consumer loan
portfolio was comprised of education, deposit and other consumer loans. At
September 30, 1998, the Bank had $449,000 or .21% of education loans, all of
which were underwritten to conform with the standards of the Pennsylvania Higher
Education Agency. Deposit loans and other consumer loans (including credit card
loans) totalled $1.6 million, or .78%, of the Bank's total loan portfolio at
September 30, 1998. In April 1995, the Bank introduced its own credit card
program. The credit cards were offered to only the Bank's most creditworthy
customers. At September 30, 1998, these loans totalled $584,000 or .28% of the
total loan portfolio. Consumer loans also included certain consumer leases
totalling $745,000 purchased from a leasing company.
Consumer loans generally have shorter terms and higher interest rates than
mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. These risks are not as prevalent in the case of the
Bank's consumer loan portfolio, however, because a high percentage of the
portfolio is comprised of home equity loans and home equity lines of credit
which are secured by real estate and underwritten in a manner such that they
result in a lending risk which is substantially similar to single-family
residential loans.
Commercial Business Loans. At September 30, 1998, commercial business loans
amounted to $1.4 million or .67% of the Bank's total loan portfolio. The
majority of commercial business loans consist of a limited number of commercial
lines of credit secured by real estate and, to a lesser extent, unsecured lines
of credit.
Mortgage-Banking Activities. Due to customer preference for fixed-rate
loans, especially during the declining mortgage interest rate environment in
1998 and the stable rate environment in 1997, the Bank has continued to
originate fixed-rate loans. Long-term, generally 30 years, fixed-rate loans not
taken into portfolio for asset/liability purposes are sold into the secondary
market. In addition, the Bank has developed for sale in the secondary market
non-conforming (loans not conforming to FHLMC/FNMA underwriting guidelines) and
impaired credit loans. The Bank has substantially increased the origination and
sales of non-conforming mortgage loans during fiscal 1998, 1997 and 1996. The
Bank's net gain on sales of mortgage loans amounted to $526,000, $285,000, and
$209,000 during the years ended September 30, 1998, 1997 and 1996, respectively.
The Bank had $2.8 million and $4.6 million of mortgage loans held for sale at
September 30, 1998 and 1997, respectively.
9
<PAGE> 11
The Bank's conforming mortgage loans sold to others are sold, generally
with servicing retained, on a loan-by-loan basis primarily to the FHLMC and the
FNMA. A period of less than five days generally lapses between the closing of
the loan by the Bank and its purchase by the investor. Mortgages with
established interest rates generally will decrease in value during periods of
increasing interest rates. Accordingly, fluctuations in prevailing interest
rates may result in a gain or loss to the Bank as a result of adjustments to the
carrying value of loans held for sale or upon sale of loans. The Bank attempts
to protect itself from these market fluctuations through the use of forward
commitments at the time of the commitment by the Bank of a loan rate to the
borrower. These commitments are mandatory delivery contracts with FHLMC and FNMA
within a certain time frame and within certain dollar amounts by a price
determined at the commitment date. Market risk does exist as non-refundable
points paid by the borrower may not be sufficient to offset fees associated with
closing the forward commitment contract. Non-conforming mortgage loans sold to
others are sold, servicing released, on a loan-by-loan basis and are generally
pre-approved by the buyer prior to closing.
Borrowers are generally charged an origination fee, which is a percentage
of the principal balance of the loan. In accordance with the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 91, "Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases," the various fees received by the Bank in
connection with the origination of loans are deferred and amortized as a yield
adjustment over the lives of the related loans using the interest method.
However, when such loans are sold, the remaining unamortized fees (which is all
or substantially all of such fees due to the relatively short period during
which such loans are held) are recognized on the sale of loans held for sale.
The Bank, for conforming loan products, generally retains the servicing on
all loans sold to others. In addition, the Bank services substantially all of
the loans which it retains in portfolio. Loan servicing includes collecting and
remitting loan payments, accounting for principal and interest, making advances
to cover delinquent payments, making inspections as required of mortgaged
premises, contacting delinquent mortgagors, supervising foreclosures and
property dispositions in the event of unremedied defaults and generally
administering the loans. Funds that have been escrowed by borrowers for the
payment of mortgage-related expenses, such as property taxes and hazard and
mortgage insurance premiums, are maintained in noninterest-bearing accounts at
the Bank.
The following table presents information regarding the loans serviced by
the Bank for others at the dates indicated. Substantially all the loans were
secured by properties in Pennsylvania. A small percentage of the loans are
secured by properties located in Delaware, Maryland or New Jersey.
<TABLE>
<CAPTION>
September 30,
------------------------------------------------
1998 1997 1996
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Loans originated by the Bank
and serviced for:
FNMA $ 3,796 $ 5,228 $ 5,817
FHLMC 92,065 108,895 121,029
Others 414 431 383
-------- -------- --------
Total loans serviced for others $ 96,275 $114,554 $127,229
-======= -======= -=======
</TABLE>
The Bank receives fees for servicing mortgage loans, which generally amount
to 0.25% per annum on the declining principal balance of mortgage loans. Such
fees serve to compensate the Bank for the costs of performing the servicing
function. Other sources of loan servicing revenues include late charges. For
years ended September 30, 1998, 1997 and 1996, the Bank earned gross fees of
$246,000, $293,000 and $331,000, respectively, from loan servicing. The Bank
retains a portion of funds received from borrowers on the loans it services for
others in payment of its servicing fees received on loans serviced for others.
10
<PAGE> 12
Loans-to-One Borrower Limitations. Regulations impose limitations on the
aggregate amount of loans that a savings institution could make to any one
borrower, including related entities. Under such regulations, the permissible
amount of loans-to-one borrower follows the national bank standard for all loans
made by savings institutions, which generally does not permit loans-to-one
borrower to exceed 15% of unimpaired capital and surplus. Loans in an amount
equal to an additional 10% of unimpaired capital and surplus also may be made to
a borrower if the loans are fully secured by readily marketable securities. At
September 30, 1998, the Bank's five largest loans or groups of loans-to-one
borrower, including related entities, ranged from an aggregate of $1.9 million
to $2.6 million, and the Bank's loans-to-one borrower limit was $4.9 million at
such date.
ASSET QUALITY
General. As a part of the Bank's efforts to improve its asset quality, it
has developed and implemented an asset classification system. All of the Bank's
assets are subject to review under the classification system, but particular
emphasis is placed on the review of multi-family residential and commercial real
estate loans, construction loans and commercial business loans. All assets of
the Bank are periodically reviewed and the classification recommendations
submitted to the Asset Classification Committee at least monthly. The Asset
Classification Committee is composed of the President and Chief Executive
Officer, the Chief Financial Officer, the Chief Lending Officer, the Vice
President of Loan Administration, the Internal Auditor and the Vice President of
Construction Lending. All assets are placed into one of the four following
categories: Pass, Substandard, Doubtful and Loss. The criteria used to review
and establish each asset's classification are substantially identical to the
asset classification system used by the Office of Thrift Supervision (the "OTS")
in connection with the examination process. As of September 30, 1998, the Bank
did not have any assets which it had classified as doubtful, however, the Bank
has classified $250,000 as loss. See "- Non-Performing Assets" and "- Other
Classified Assets" for a discussion of certain of the Bank's assets which have
been classified as substandard and regulatory classification standards
generally.
When a borrower fails to make a required payment on a loan, the Bank
attempts to cure the deficiency by contacting the borrower and seeking payment.
Contacts are generally made 30 days after a payment is due. In most cases,
deficiencies are cured promptly. If a delinquency continues, late charges are
assessed and additional efforts are made to collect the loan. While the Bank
generally prefers to work with borrowers to resolve such problems, when the
account becomes 90 days delinquent, the Bank institutes foreclosure or other
proceedings, as necessary, to minimize any potential loss.
Loans are placed on non-accrual status when, in the judgment of management,
the probability of collection of interest is deemed to be insufficient to
warrant further accrual. When a loan is placed on non-accrual status, previously
accrued but unpaid interest is deducted from interest income. As a matter of
policy, the Bank does not accrue interest on loans past due 90 days or more. See
Note 2 of the Notes to Consolidated Financial Statements included in the
Company's Annual Report.
Real estate acquired by the Bank as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold. Real
estate owned is initially recorded at the lower of fair value less estimated
costs to sell the property, or cost (generally the balance of the loan on the
property at the date of acquisition). After the date of acquisition, all costs
incurred in maintaining the property are expenses and costs incurred for the
improvement or development of such property are capitalized up to the extent of
their net realizable value.
Under generally accepted accounting principles ("GAAP"), the Bank is
required to account for certain loan modifications or restructuring as "troubled
debt restructuring." In general, the modification or restructuring of a debt
constitutes a troubled debt restructuring if the Bank, for economic or legal
reasons related to the borrower's financial difficulties, grants a concession to
the borrower that the Bank would not otherwise consider under current market
conditions. Debt restructuring or loan modifications for a borrower do not
necessarily always constitute troubled debt restructuring, however, and troubled
debt restructuring do not necessarily result in non-accrual loans.
11
<PAGE> 13
Delinquent Loans. The following table sets forth information concerning
delinquent loans at the dates indicated, in dollar amounts and as a percentage
of each category of the Bank's loan portfolio. The amounts presented represent
the total outstanding principal balances of the related loans, rather than the
actual payment amounts which are past due.
<TABLE>
<CAPTION>
September 30, 1998 September 30, 1997
------------------------------------------- ------------------------------------------
30-59 Days 60-89 Days 30-59 Days 60-89 Days
-------------------- --------------------- -------------------- --------------------
Percent Percent Percent Percent
of of of of
Loan Loan Loan Loan
Amount Category Amount Category Amount Category Amount Category
-------- --------- --------- --------- -------- ---------- -------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
Single-family
residential $557 .38% $98 .07% $401 .30% $62 .05%
Construction 86 .54% 39 .25 287 1.80
Consumer loans 1 10 .05 15 .06 33 .13
Commercial
business loans 1 .07 2 .10
---- ---- ---- ----
Total $645 .31% $147 .07% $418 .21% $382 .19%
-=== === -=== === -=== === -=== ===
</TABLE>
12
<PAGE> 14
Non-Performing Assets. The following table sets forth the amounts and
categories of the Bank's non-performing assets and troubled debt restructurings
at the dates indicated.
<TABLE>
<CAPTION>
September 30,
------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------- -------------- ------------- ---------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Non-performing loans:
Single-family residential $ 2,341 $1,661 $1,466 $1,986 $1,907
Commercial and multi-
family(1) 323 22 55 22 2,400
Construction(2) 895 275 888 872
Consumer 43 14 1,666 2 1
Commercial business 83 100 2,165 258 196
------- ------ ------ ----- -----
Total non-performing loans 3,685 2,072 5,352 3,156 5,376
------- ------ ------ ----- -----
Accruing loans greater than
90 days delinquent 19 5
------- ------ ------ ------ -----
Total non-performing loans 3,704 2,077 5,352 3,156 5,376
------- ------ ------ ----- -----
REO 1,663 1,672 1,557 465 503
------- ------ ------ ------ ------
Total non-performing assets $ 5,367 $3,749 $6,909 $3,621 $5,879
--===== -===== -===== -===== -=====
Troubled debt restructurings (3) $ 46 $ 384 $ $2,348
-====== ====== ====== -===== ======
Total non-performing loans and
troubled debt restructurings
as a percentage of gross loans
receivable (4) 1.85% 1.29% 3.10% 3.45% 3.73%
==== ==== ==== ==== ====
Total non-performing assets
as a percentage of total assets 1.29% 1.00% 2.35% 1.29% 2.47%
==== ==== ==== ==== ====
Total non-performing assets and
troubled debt restructurings as
percentage of total assets 1.30% 1.11% 2.35% 2.12% 2.43%
==== ==== ==== ==== ====
</TABLE>
- -------------------------------
(1) Consists of two loans at September 30, 1998 and 1996 and one loan at
September 30, 1997 and 1995, respectively. For fiscal 1994, consisted
primarily of one loan restructured during fiscal 1995.
(2) Consists of six loans from three borrowers at September 30, 1998, two
loans at September 30, 1997 and 1995 and one loan at September 30,
1994.
(3) Consists of lease financing receivables at September 30, 1998 and 1997
from the Bennett Funding Group of Syracuse, New York ("Bennett
Funding") and one loan at September 30, 1995. The troubled debt
restructurings in 1997 and 1995 have been performing in accordance with
the terms of the agreements since the restructurings.
(4) Includes loans receivable and loans held for sale, less construction
and land loans in process and deferred loan origination fees and
discounts.
13
<PAGE> 15
The Bank's total non-performing assets and troubled debt restructurings
have increased from $4.1 million, or 1.00% of total assets, at September 30,
1997 to $5.4 million, or 1.29% of total assets at September 30, 1998. The
primary reason for the $1.3 million increase was due to the inclusion in fiscal
1998 of a $900,000 single-family residence located in Atlanta, Georgia. The
remaining $1.4 million of single-family residential loans at September 30, 1998
consisted of 29 loans with principal balances, ranging from $2,000 to $216,000,
with an average of approximately $50,000.
At September 30, 1998, the $1.7 million of REO consisted of two
single-family residential properties, one with a carrying value of $168,000 and
one former construction loan project with a carrying value of $1.4 million. The
construction loan was for the acquisition and development of a 106-lot
residential townhouse project located in Pennsylvania. The project has all units
substantially completed and has 15 units left to sell, of which seven units have
deposits or agreements of sale. Expected completion of sale of all the remaining
units is approximately six to nine months.
Other Classified Assets. Federal regulations require that each insured
savings association classify its assets on a regular basis. In addition, in
connection with examinations of insured institutions, federal examiners have
authority to identify problem assets and, if appropriate, classify them. There
are three classifications for problem assets: "substandard," "doubtful" and
"loss." Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full, on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified loss is considered uncollectible and of
such little value that continuance as an asset of the institution is not
warranted.
At September 30, 1998, the Bank had $5.7 million and $250,000 of assets
classified as substandard and loss, respectively, and no assets classified as
doubtful. Substantially all classified assets are also non-performing.
Allowance for Loan Losses. The Bank's policy is to establish reserves
for estimated losses on delinquent loans when it determines that losses are
expected to be incurred on such loans and leases. The allowance for losses on
loans is maintained at a level believed adequate by management to absorb
potential losses in the portfolio. Management's determination of the adequacy of
the allowance is based on an evaluation of the portfolio, past loss experience,
current economic conditions, volume, growth and composition of the portfolio,
and other relevant factors. The allowance is increased by provisions for loan
losses which are charged against income. The activity in the Bank's allowance
for loan losses has remained relatively stable (other than the $956,000 Bennett
Funding charge-off in fiscal 1997) and the level of provisions has been
relatively small with the exception in fiscal 1996 of an additional $1.1 million
provision related to Bennett Funding. As shown in the table below, at September
30, 1998, the Bank's allowance for loan losses amounted to 46.92% and .86% of
the Bank's non-performing loans and gross loans receivable, respectively.
14
<PAGE> 16
The following table summarizes changes in the allowance for loan losses
and other selected statistics for the periods presented.
<TABLE>
<CAPTION>
Year Ending September 30,
---------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Allowance for loan losses, beginning of
period $ 1,628 $ 2,624 $ 1,487 $ 1,540 $1,265
Charged-off loans:
Single-family residential (86) (119) (113) (163) (141)
Construction
Commercial lease purchases (956)
Consumer and commercial business (28) (177) (5)
------- ------- ------- ------- -------
Total charged-off loans (114) (1,252) (113) (168) (141)
------- ------- ------- ------- -------
Recoveries on loans previously charged off:
Single-family residential 22 7 12
Construction 14 10 43
Commercial and multi-
family residential 8
Consumer and commercial business 2
------- ------- ------- ------- -------
Total recoveries 38 17 63
------- ------- ------- ------- -------
Net loans charged-off (76) (1,235) (113) (105) (141)
Provision for loan losses 186 239 1,250 52 416
------- ------- ------- ------- -------
Allowance for loan losses, end of
period $ 1,738 $ 1,628 $ 2,624 $ 1,487 $ 1,540
======= ======= ======= ======= =======
Net loans charged-off to average
interest-earning loans(1) .04% .68% .07% .07% .10%
======= ======= ======= ======= =======
Allowance for loan losses
to gross loans receivable(1) .86% .86% 1.54% .93% 1.07%
======= ======= ======= ======= =======
Net loans charged-off to
allowance for loan losses 4.37% 75.86% 4.31% 7.06% 9.16 %
======= ======= ======= ======= =======
Recoveries to charge-offs 33.33% 1.36% % 37.50% %
======= ======= ======= ======= =======
</TABLE>
- ------------
(1) Gross loans receivable and average interest-earning loans receivable
include loans receivable and loans held for sale, less construction and
land loans in process and deferred loan origination fees and discounts.
15
<PAGE> 17
The following table presents the Bank's allocation of the allowance for
loan losses to the total amount of loans in each category listed at the dates
indicated.
<TABLE>
<CAPTION>
September 30,
-------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------- ------------------- ------------------- ------------------- -------------------
% of Loans % of Loans % of Loans % of Loans % of Loans
in Each in Each in Each in Each in Each
Category to Category to Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans
------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Single-family residential $ 446 71.34% $ 439 68.53% $ 204 68.68% $ 226 69.01% $ 280 69.77%
Commercial and multi-
family residential 109 9.91 77 9.28 3 6.25 12 7.06 243 8.38
Construction 382 7.64 300 8.31 290 9.93 615 9.79 481 9.11
Consumer 63 10.44 67 12.87 370 13.50 100 12.62 79 11.23
Commercial business 20 .67 31 1.01 1,152 1.64 55 1.52 45 1.51
Unallocated 718 714 605 479 412
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance for
loan losses $1,738 100.00% $1,628 100.00% $2,624 100.00% $1,487 100.00% $1,540 100.00%
-===== ====== -===== ====== -===== ====== -===== ====== -===== ======
</TABLE>
16
<PAGE> 18
Effective December 21, 1993, the OTS, in conjunction with the Office of
the Comptroller of the Currency, the FDIC and the Federal Reserve Board, issued
a joint policy statement ("Policy Statement") regarding an institution's
allowance for loan and lease losses. The Policy Statement, which reflects the
position of the issuing regulatory agencies and does not necessarily constitute
GAAP, includes guidance (i) on the responsibilities of management for the
assessment and establishment of an adequate allowance and (ii) for the agencies'
examiners to use in evaluating the adequacy of such allowance and the policies
utilized to determine such allowance. The Policy Statement also sets forth
quantitative measures for the allowance with respect to assets classified
substandard and doubtful and with respect to the remaining portion of an
institution's loan portfolio. While the Policy Statement sets forth quantitative
measures, such guidance is not intended as a "floor" or "ceiling." The review of
the Policy Statement did not result in a material adjustment to the Bank's
policy for establishing loan losses.
Management of the Bank presently believes that its allowance for loan
losses is adequate to cover any potential losses in the Bank's loan portfolio.
However, future adjustments to this allowance may be necessary, and the Bank's
results of operations could be adversely affected if circumstances differ
substantially from the assumptions used by management in making its
determinations in this regard.
MORTGAGE-RELATED SECURITIES AND INVESTMENT SECURITIES
Mortgage-Related Securities. Federally chartered savings institutions
have authority to invest in various types of liquid assets, including United
States Treasury obligations, securities of various federal agencies and of state
and municipal governments, certificates of deposit at federally-insured banks
and savings and loan associations, certain bankers' acceptances and Federal
funds. Subject to various restrictions, federally chartered savings institutions
may also invest a portion of their assets in commercial paper, corporate debt
securities and mutual funds, the assets of which conform to the investments that
federally chartered savings institutions are otherwise authorized to make
directly.
The Bank maintains a significant portfolio of mortgage-related
securities as a means of investing in housing-related mortgage instruments
without the costs associated with originating mortgage loans for portfolio
retention and with limited credit risk of default which arises in holding a
portfolio of loans to maturity. Mortgage-related securities (which also are
known as mortgage participation certificates or pass-through certificates)
represent a participation interest in a pool of single-family or multi-family
residential mortgages. The principal and interest payments on mortgage-backed
securities are passed from the mortgage originators, as servicer, through
intermediaries (generally U.S. Government agencies and government-sponsored
enterprises) that pool and repackage the participation interests in the form of
securities, to investors such as the Bank. Such U.S. Government agencies and
government sponsored enterprises, which guarantee the payment of principal and
interest to investors, primarily include the FHLMC, the FNMA and the Government
National Mortgage Association ("GNMA"). The Bank also invests to a limited
degree in certain privately issued, credit enhanced mortgage-related securities
rated AAA by national securities rating agencies.
The FHLMC is a public corporation chartered by the U.S. Government. The
FHLMC issues participation certificates backed principally by conventional
mortgage loans. The FHLMC guarantees the timely payment of interest and the
ultimate return of principal on participation certificates. The FNMA is a
private corporation chartered by the U.S. Congress with a mandate to establish a
secondary market for mortgage loans. The FNMA guarantees the timely payment of
principal and interest on FNMA securities. FHLMC and FNMA securities are not
backed by the full faith and credit of the United States, but because the FHLMC
and the FNMA are U.S. Government-sponsored enterprises, these securities are
considered to be among the highest quality investments with minimal credit
risks. The GNMA is a government agency within the Department of Housing and
Urban Development which is intended to help finance government-assisted housing
programs. GNMA securities are backed by FHA-insured and VA-guaranteed loans, and
the timely payment of principal and interest on GNMA securities are guaranteed
by the GNMA and backed by the full faith and credit of the U.S. Government.
Because the FHLMC, the FNMA and the GNMA were established to provide support for
low- and middle-income housing, there are limits to the maximum size of loans
that qualify for these, programs which limit is currently $227,150.
Mortgage-related securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
underlying pool of mortgages can be composed of either fixed-rate or
adjustable-rate loans. As a result, the risk characteristics of the underlying
17
<PAGE> 19
pool of mortgages, (i.e., fixed-rate or adjustable rate) as well as prepayment
risk, are passed on to the certificate holder. The life of a mortgage-backed
pass-through security thus approximates the life of the underlying mortgages.
The Bank's mortgage-related securities include regular interests in
collateralized mortgage obligations ("CMOs"). CMOs were developed in response to
investor concerns regarding the uncertainty of cash flows associated with the
prepayment option of the underlying mortgagor and are typically issued by
governmental agencies, governmental sponsored enterprises and special purpose
entities, such as trusts, corporations or partnerships, established by financial
institutions or other similar institutions. A CMO can be collateralized by loans
or securities which are insured or guaranteed by the FNMA, the FHLMC or the
GNMA. In contrast to pass-through mortgage-related securities, in which cash
flow is received pro rata by all security holders, the cash flow from the
mortgages underlying a CMO is segmented and paid in accordance with a
predetermined priority to investors holding various CMO classes. By allocating
the principal and interest cash flows from the underlying collateral among the
separate CMO classes, different classes of bonds are created, each with its own
stated maturity, estimated average life, coupon rate and prepayment
characteristics.
The short-term classes of a CMO usually carry a lower coupon rate than
the longer term classes and, therefore, the interest differential cash flow on a
residual interest is greatest in the early years of the CMO. As the early coupon
classes are extinguished, the residual income declines. Thus, the longer the
lower coupon classes remain outstanding, the greater the cash flow accruing to
CMO residuals. As interest rates decline, prepayments accelerate, the interest
differential narrows, and the cash flow from the CMO declines. Conversely, as
interest rates increase, prepayments decrease, generating a larger cash flow to
residuals.
A senior-subordinated structure often is used with CMOs to provide
credit enhancement for securities which are backed by collateral which is not
guaranteed by FNMA, FHLMC or GNMA. These structures divide mortgage pools into
various risk classes: a senior class and one or more subordinated classes. The
subordinated classes provide protection to the senior class. When cash flow is
impaired, debt service goes first to the holders of senior classes. In addition,
incoming cash flows also may go into a reserve fund to meet any future
shortfalls of cash flow to holders of senior classes. The holders of
subordinated classes may not receive any funds until the holders of senior
classes have been paid and, when appropriate, until a specified level of funds
has been contributed to the reserve fund.
Mortgage-related securities generally yield less than the loans which
underlie such securities because of their payment guarantees or credit
enhancements which offer nominal credit risk. In addition, mortgage-related
securities are more liquid than individual mortgage loans and may be used to
collateralize certain obligations of the Bank. At September 30, 1998, $27.8
million of the Bank's mortgage-related securities were pledged to secure various
obligations of the Bank, including reverse repurchase agreements and as
collateral for certain government deposits.
The Bank's mortgage-related securities are classified as either "held
to maturity" or "available for sale" based upon the Bank's intent and ability to
hold such securities to maturity at the time of purchase, in accordance with
GAAP. As of September 30, 1998, the Bank had an aggregate of $134.3 million, or
32.3%, of total assets invested in mortgage-related securities, net, of which
$18.8 million was held to maturity and $115.5 million was available for sale.
The mortgage-related securities of the Bank which are held to maturity are
carried at cost, adjusted for the amortization of premiums and the accretion of
discounts using a method which approximates a level yield, while
mortgage-related securities available for sale are carried at the current fair
value. See Notes 1 and 4 of the Notes to Consolidated Financial Statements in
the Annual Report.
18
<PAGE> 20
In November 1995, the Financial Accounting Standards Board (the "FASB")
issued a special report, "A Guide to Implementation of Statement 115 on
Accounting for Certain Investments in Debt and Equity Securities" (the "Guide"),
which discussed through a question and answer format many of the implementation
questions that have arisen since the adoption of SFAS 115. Concurrent with the
initial adoption of this implementation guidance but no later than December 31,
1995, an enterprise was permitted to reassess the appropriateness of the
classifications of all securities held at that time and account and disclose
resulting reclassifications in accordance with SFAS 115. The Guide provided that
reclassifications from the held-to-maturity category that result from this
one-time assessment will not call into question the intent of an enterprise to
hold other debt securities to maturity in the future. In December 1995, as
permitted under the terms of the Guide, the Company reclassified certain
securities with an aggregated amortized cost of $50.5 million from held to
maturity to available for sale.
The following table sets forth the composition of the Bank's mortgage-related
securities portfolio, both held to maturity and available for sale, at the dates
indicated.
<TABLE>
<CAPTION>
September 30,
------------------------------
1998 1997 1996
-------- -------- --------
Held to maturity:
(In thousands)
<S> <C> <C> <C>
Mortgage-backed securities:
FHLMC $ 4,698 $ 2,747 $ 3,631
FNMA 8,747 10,053 11,383
-------- -------- --------
Total mortgage-backed securities 13,445 12,800 15,014
-------- -------- --------
Collateralized mortgage obligations:
FHLMC 233 2,026 2,238
FNMA 5,091 5,740 5,789
Other 141 180
-------- -------- --------
Total collateralized mortgage obligations 5,324 7,907 8,207
-------- -------- --------
Total mortgage-related securities, amortized cost $ 18,769 $ 20,707 $ 23,221
======== ======== ========
Total fair value(1) $ 18,700 $ 20,200 $ 22,060
======== ======== ========
Available for sale:
Mortgage-backed securities:
FHLMC $ 10,968 $ 17,540 $ 12,852
FNMA 25,600 14,587 11,079
GNMA 41,379 28,938 8,355
-------- -------- --------
Total mortgage-backed securities 77,947 61,065 32,286
-------- -------- --------
Collateralized mortgage obligations:
FHLMC 2,704 5,356 7,298
FNMA 15,284 17,301 18,594
GNMA 994 1,338 1,593
Other 17,040 18,819 1,131
-------- -------- --------
Total collateralized mortgage obligations 36,022 42,814 28,616
-------- -------- --------
Total mortgage-related securities, amortized cost $113,969 $103,879 $ 60,902
======== ======== ========
Total fair value(1) $115,486 $104,472 $ 60,211
======== ======== ========
</TABLE>
- ---------------------------
(1) See Note 4 of the Notes to Consolidated Financial Statements in the
Annual Report.
19
<PAGE> 21
The following table sets forth the purchases, sales and principal
repayments of the Bank's mortgage-related securities for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
-----------------------------------
1998 1997 1996
--------- --------- ---------
(In thousands)
<S> <C> <C> <C>
Mortgage-related securities, beginning of period(1)(2) $ 125,179 $ 83,432 $ 79,832
--------- --------- ---------
Purchases:
Mortgage-backed securities - held to maturity 1,938
CMOs - held to maturity 2,687 2,000
Mortgage-backed securities - available for sale 42,422 33,584 15,471
CMOs - available for sale 10,000 18,069 9,997
Sales:
Mortgage-backed securities - available for sale (13,200) (6,422)
CMOs - available for sale (1,047) (6,374)
Repayments and prepayments:
Mortgage-backed securities (14,456) (7,668) (6,467)
CMOs (18,336) (4,057) (5,788)
Increase in net premium 82 535 169
Change in net unrealized gain (loss) on mortgage-related securities
available for sale 924 1,284 (924)
--------- --------- ---------
Net increase in mortgage-related securities 9,076 41,747 3,600
--------- --------- ---------
Mortgage-related securities, end of period(1) $ 134,255 $ 125,179 $ 83,432
========= ========= =========
</TABLE>
- --------------------------
(1) Includes mortgage-related securities available for sale.
(2) Calculated at amortized cost for securities held to maturity and at
fair value for securities available for sale
At September 30, 1998, the weighted average contractual maturity of the
Bank's fixed-rate mortgage-backed securities was approximately 23.2 years. The
actual maturity of a mortgage-backed security is less than its stated maturity
due to prepayments of the underlying mortgages. Prepayments that are faster than
anticipated may shorten the life of the security and adversely affect its yield
to maturity. The yield is based upon the interest income and the amortization of
any premium or discount related to the mortgage-backed security. In accordance
with GAAP, premiums and discounts are amortized over the estimated lives of the
loans, which decrease and increase interest income, respectively. The prepayment
assumptions used to determine the amortization period for premiums and discounts
can significantly affect the yield of the mortgage-backed security, and these
assumptions are reviewed periodically to reflect actual prepayments. Although
prepayments of underlying mortgages depend on many factors, including the type
of mortgages, the coupon rate, the age of mortgages, the geographical location
of the underlying real estate collateralizing the mortgages and general levels
of market interest rates, the difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates generally is the
most significant determinant of the rate of prepayments. During periods of
rising mortgage interest rates, if the coupon rates of the underlying mortgages
are less than the prevailing market interest rates offered for mortgage loans,
refinancings generally decrease and slow the prepayment of the underlying
mortgages and the related securities. Conversely, during periods of falling
mortgage interest rates, if the coupon rates of the underlying mortgages exceed
the prevailing market interest rates offered for mortgage loans, refinancing
generally increases and accelerates the prepayment of the underlying mortgages
and the related securities. Under such circumstances, the Bank may be subject to
reinvestment risk because to the extent that the Bank's mortgage-related
securities amortize or prepay faster than anticipated, the Bank may not be able
to reinvest the proceeds of such repayments and prepayments at a comparable
yield. At September 30, 1998, of the $18.8 million of mortgage-related
securities held to maturity, an
20
<PAGE> 22
aggregate of $9.3 million were secured by fixed-rate securities and an aggregate
of $9.5 million were secured by adjustable-rate securities.
Investment Securities. The following table sets forth information regarding
the carrying and fair value of the Company's investment securities, both held to
maturity and available for sale, at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
---------------------------------------------------------
1998 1997 1996
------- ------- -------
Carrying Fair Carrying Fair Carrying Fair
Value Value Value Value Value Value
------- ------- ------- ------- ------- -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
FHLB stock $ 5,079 $ 5,079 $ 3,769 $ 3,769 $ 2,337 $ 2,337
U.S. Government and agency
obligations 12,000 12,109 17,000 16,958 16,500 16,388
Municipal securities 18,993 19,477 3,138 3,213 145 144
Mutual funds 2,000 1,992
Preferred stocks 5,500 5,763
Other equity investments 1,390 1,280
------- ------- ------- ------- ------- -------
Total $44,962 $45,700 $23,907 $23,940 $18,982 $18,869
======= ======= ======= ======= ======= =======
</TABLE>
At September 30, 1998, the Company had an aggregate of $45.0 million, or
10.8%, of total assets invested in investment securities, of which $5.1 million
consist of FHLB stock and $39.9 million was investment securities available for
sale. Included in U.S. Government and agency obligations are callable bonds with
a term of three years. The Bank's investment securities (excluding equity
securities and FHLB stock) had a weighted average contractual maturity of 14.92
years and a weighted average yield of 6.97% (adjusted to a fully taxable
equivalent yield).
SOURCES OF FUNDS
General. The Bank's principal source of funds for use in lending and for
other general business purposes has traditionally come from deposits obtained
through the Bank's branch offices. The Bank also derives funds from contractual
payments and prepayments of outstanding loans and mortgage-related securities,
from sales of loans, from maturing investment securities and from advances from
the FHLB of Pittsburgh and other borrowings. Loan repayments are a relatively
stable source of funds, while deposits inflows and outflows are significantly
influenced by general interest rates and money market conditions. The Bank uses
borrowings to supplement its deposits as a source of funds.
Deposits. The Bank's current deposit products include passbook accounts,
NOW accounts, MMDA, certificates of deposit ranging in terms from 30 days to
five years and noninterest-bearing personal and business checking accounts. The
Bank's deposit products also include Individual Retirement Account ("IRA")
certificates and Keogh accounts.
The Bank's deposits are obtained primarily from residents in Delaware and
Chester Counties in southeastern Pennsylvania. The Bank attracts local deposit
accounts by offering a wide variety of accounts, competitive interest rates, and
convenient branch office locations and service hours. The Bank utilizes
traditional marketing methods to attract new customers and savings deposits,
including print media and radio advertising and direct mailings. However, the
Bank does not solicit funds through deposit brokers nor does it pay any
brokerage fees if it accepts such deposits. The Bank participates in the
regional ATM network known as MAC(R).
21
<PAGE> 23
The Bank has been competitive in the types of accounts and in interest
rates it has offered on its deposit products but does not necessarily seek to
match the highest rates paid by competing institutions. With the significant
decline in interest rates paid on deposit products, the Bank in recent years has
experienced disintermediation of deposits into competing investment products.
The following table shows the distribution of, and certain information
relating to, the Bank's deposits by type of deposit as of the dates indicated.
<TABLE>
<CAPTION>
September 30,
--------------------------------------------------------------
1998 1997 1996
---- ---- ----
Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Passbook accounts $ 37,988 15.36% $ 38,035 16.69% $ 41,504 18.93%
MMDA accounts 16,087 6.50 16,429 7.21 16,159 7.37
NOW accounts 28,181 11.40 27,754 12.18 28,085 12.81
Certificates of deposit 156,801 63.40 139,535 61.22 128,747 58.73
Noninterest-bearing
deposits 8,254 3.34 6,165 2.70 4,710 2.16
-------- ------- -------- ------- -------- -------
Total deposits $247,311 100.00% $227,918 100.00% $219,205 100.00%
======== ======= ======== ======= ======== =======
</TABLE>
The following table sets forth the net savings flows of the Bank during the
periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------
1998 1997 1996
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Increase (Decrease) before interest credited $ 9,737 $ 99 $(13,152)
Interest credited 9,656 8,614 8,604
-------- -------- --------
Net savings increase (decrease) $ 19,393 $ 8,713 $ (4,548)
======== ======== ========
</TABLE>
The following table sets forth maturities of the Bank's certificates of
deposit of $100,000 or more at September 30, 1998 by time remaining to maturity.
<TABLE>
<CAPTION>
Amounts in
Thousands
---------
<S> <C>
Three months or less $4,541
Over three months through six months 3,145
Over six months through twelve months 3,185
Over twelve months 5,031
------
$15,902
======
</TABLE>
22
<PAGE> 24
The following table presents, by various interest rate categories, the
amount of certificates of deposit at September 30, 1998 and 1997 and the amounts
at September 30, 1998 which mature during the periods indicated.
<TABLE>
<CAPTION>
Amounts at September 30, 1998
September 30, Maturing Within
------------------------- ------------------------------------------------------
Certificates of
Deposit 1998 1997 One Year Two Years Three Years Thereafter
- ----------------- ---------- ---------- --------- --------- ----------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
4.0% or less $ 647 $ 394 $ 647
4.01% to 6.0% 141,948 116,480 103,226 $20,910 $8,307 $ 9,505
6.01% to 8.0% 13,248 19,705 5,070 8,097 48 33
8.01% to 10.0% 958 2,956 958
---------- ---------- --------- ------- ------ -------
Total certificate
accounts $ 156,801 $ 139,535 $ 109,901 $29,007 $8,355 $ 9,538
---======= ---======= --======= -====== -===== ======
</TABLE>
The following table presents the average balance of each deposit type and the
average rate paid on each deposit type for the periods indicated.
<TABLE>
<CAPTION>
September 30,
-----------------------------------------------------------------
1998 1997 1996
------------------- -------------------- --------------------
Average Average Average
Average Rate Average Rate Average Rate
Balance Paid Balance Paid Balance Paid
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Passbook accounts $ 38,273 2.41% $ 39,199 2.42% $ 42,270 2.44%
MMDA accounts 16,368 2.76 16,350 2.75 18,358 2.65
Certificates of deposit 145,105 5.64 133,091 5.58 128,384 5.82
NOW accounts 29,412 1.28 28,143 1.28 27,098 1.37
Noninterest-bearing
deposits 5,779 4,357 4,193
-------- -------- -------- -------- -------- --------
Total deposits $234,937 4.23% $221,140 4.15% $220,303 4.25%
======== ======== ======== ======== ======== ========
</TABLE>
23
<PAGE> 25
Borrowings. The Bank may obtain advances from the FHLB of Pittsburgh upon
the security of the common stock it owns in the FHLB and certain of its
residential mortgage loans and securities held to maturity, provided certain
standards related to creditworthiness have been met. Such advances are made
pursuant to several credit programs, each of which has its own interest rate and
range of maturities. The Bank, during fiscal 1998 and 1997, increased its FHLB
borrowings to fund asset growth thereby leveraging, in part, the capital raised
as a result of the issuance of trust preferred securities in fiscal 1997. At
September 30, 1998, the Bank had $101.6 million in outstanding FHLB advances.
See Note 10 of the Notes to Consolidated Financial Statements in the Annual
Report.
The Bank has entered into agreements to sell securities under terms which
require it to repurchase the same or substantially similar securities by a
specified date. Repurchase agreements are considered borrowings which are
secured by the sold securities. At September 30, 1998, the Bank had $19.3
million of repurchase agreements outstanding scheduled to mature in 2000. See
Note 11 of the Notes to Consolidated Financial Statements in the Annual Report.
Both the FHLB advances and the repurchase agreements have certain call features
whereby the issuer can call the borrowings after the expiration of certain
timeframes. The timeframes on the callable borrowings range from three months to
three years.
SUBSIDIARIES
The Bank is permitted to invest up to 2% of its assets in the capital stock
of, or secured or unsecured loans to, subsidiary corporations, with an
additional investment of 1% of assets when such additional investment is
utilized primarily for community development purposes. Under such limitations,
as of September 30, 1998, the Bank was authorized to invest up to approximately
$8.8 million in the stock of, or loans to, service corporations. As of September
30, 1998, the net book value of the Bank's investment in stock, unsecured loans,
and conforming loans to its service corporations was $1.2 million.
At September 30, 1998, in addition to the Bank, the Company had five direct
or indirect subsidiaries, First Keystone Capital Trust I, FKF Management
Corporation, Inc., First Pointe, Inc. ("First Pointe"), First Chester Services,
Inc., State Street Development, Inc. and First Media Services, Inc.
First Keystone Capital Trust I (the "Trust") is a Delaware statutory
business trust wholly owned by the Company formed in 1997 for the purpose of
issuing trust preferred securities and investing the proceeds therefrom in
Junior Subordinated Debentures issued by the Company. See Note 20 of the Notes
to Consolidated Financial Statements in the Annual Report.
FKF Management Corp., Inc., a Delaware corporation, is a wholly owned
operating subsidiary of the Bank established in 1997 for the purpose of managing
assets of the Bank. Assets under management totaled $135.5 million comprised
principally of investment and mortgage-related securities.
First Pointe, is a wholly owned subsidiary of the Bank which was formed for
the purpose of developing a real estate parcel received in a deed-in-lieu of
foreclosure action. At September 30, 1998, the Bank's equity investment in First
Pointe was a net deficit of $53,213 and First Pointe had total assets of $1.7
million consisting of 15 units substantially all of which are completed. For the
year ended September 30, 1998, First Pointe had a net loss of $18,339.
The Bank has three remaining subsidiaries, all inactive, which had been
involved in either real estate development or real estate management. With the
Bank's cessation of its involvement in such activities and the resolution of the
various development projects in which the subsidiaries were involved, these
subsidiaries were placed on an inactive status. See "-Asset Quality -
Non-Performing Assets" and Notes 1 and 7 of the Notes to Consolidated Financial
Statements in the Annual Report.
24
<PAGE> 26
COMPETITION
The Bank faces strong competition both in attracting deposits and making
real estate loans. Its most direct competition for deposits has historically
come from other savings associations, credit unions and commercial banks located
in its market area including many large financial institutions which have
greater financial and marketing resources available to them. In addition, during
times of high interest rates, the Bank has faced additional significant
competition for investors' funds from short-term money market securities, mutual
funds and other corporate and government securities. The ability of the Bank to
attract and retain savings deposits depends on its ability to generally provide
a rate of return, liquidity and risk comparable to that offered by competing
investment opportunities.
The Bank experiences strong competition for real estate loans principally
from other savings associations, commercial banks and mortgage banking
companies. The Bank competes for loans principally through the interest rates
and loan fees it charges and the efficiency and quality of services it provides
borrowers and the convenient locations of its branch office network. Competition
may increase as a result of the continuing reduction of restrictions on the
interstate operations of financial institutions.
EMPLOYEES
The Bank had 77 full-time employees and 8 part-time employees as of
September 30, 1998. None of these employees is represented by a collective
bargaining agreement. The Bank believes that it enjoys excellent relations with
its personnel.
25
<PAGE> 27
REGULATION
The Company. The Company as a savings and loan holding company within the
meaning of the Home Owners' Loan Act, as amended ("HOLA"), is required to
register as such with the OTS and is subject to OTS regulations, examinations,
supervision and reporting requirements. As a subsidiary of a savings and loan
holding company, the Bank is subject to certain restrictions in its dealings
with the Company and affiliates thereof.
Federal Activities Restrictions. There are generally no restrictions on the
activities of a savings and loan holding company which holds only one subsidiary
savings association. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings association, the
Director may impose such restrictions as deemed necessary to address such risk,
including limiting (i) payment of dividends by the savings association; (ii)
transactions between the savings association and its affiliates; and (iii) any
activities of the savings association that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings association. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
association subsidiary of such a holding company fails to meet a QTL test, then
such unitary holding company also shall become subject to the activities
restrictions applicable to multiple savings and loan holding companies and,
unless the savings association qualifies as a QTL within one year thereafter,
shall register as, and become subject to the restrictions applicable to, a bank
holding company. See "- The Bank - Qualified Thrift Lender Test."
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings association meets the QTL
test, as set forth below, the activities of the Company and any of its
subsidiaries (other than the Bank or other subsidiary savings associations)
would thereafter be subject to further restrictions. No multiple savings and
loan holding company or subsidiary thereof which is not a savings association
shall commence or continue for a limited period of time after becoming a
multiple savings and loan holding company or subsidiary thereof any business
activity, other than: (i) furnishing or performing management services for a
subsidiary savings association; (ii) conducting an insurance agency or escrow
business; (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary savings association; (iv) holding or managing properties used
or occupied by a subsidiary savings association; (v) acting as trustee under
deeds of trust; (vi) those activities authorized by regulation as of March 5,
1987 to be engaged in by multiple savings and loan holding companies; or (vii)
unless the Director of the OTS by regulation prohibits or limits such activities
for savings and loan holding companies, those activities authorized by the
Federal Reserve Board as permissible for bank holding companies. The activities
described in (i) through (vi) above may only be engaged in after giving the OTS
prior notice and being informed that the OTS does not object to such activities.
In addition, the activities described in (vii) above also must be approved by
the Director of the OTS prior to being engaged in by a multiple savings and loan
holding company.
Limitations on Transactions with Affiliates. Transactions between savings
associations and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act ("FRA") and OTS regulations issued in connection therewith.
An affiliate of a savings association is any company or entity which controls,
is controlled by or is under common control with the savings association. In a
holding company context, the parent holding company of a savings association
(such as the Company) and any companies which are controlled by such parent
holding company are affiliates of the savings association. Generally, Sections
23A and 23B (i) limit the extent to which the savings association or its
subsidiaries may engage in "covered transactions" with any one affiliate to an
amount equal to 10% of such association's capital stock and surplus, and contain
an aggregate limit on all such transactions with all affiliates to an amount
equal to 20% of such capital stock and surplus and (ii) require that all such
transactions be on terms substantially the same, or at least as favorable, to
the association or subsidiary as those provided to a non-affiliate. The term
"covered transaction" includes, among other things, the making of loans or
extension of credit to an affiliate, purchase of assets, issuance of a guarantee
and similar transactions. In addition to the restrictions imposed by Sections
23A and 23B, under OTS regulations no savings association may (i) loan or
otherwise extend
26
<PAGE> 28
credit to an affiliate, except for any affiliate which engages only in
activities which are permissible for bank holding companies, (ii) a savings
association may not purchase or invest in securities of an affiliate other than
shares of a subsidiary; (iii) a savings association and its subsidiaries may not
purchase a low-quality asset from an affiliate; (iv) and covered transactions
and certain other transactions between a savings association or its subsidiaries
and an affiliate must be on terms and conditions that are consistent with safe
and sound banking practices. With certain exceptions, each extension of credit
by a savings association to an affiliate must be secured by collateral with a
market value ranging from 100% to 130% (depending on the type of collateral) of
the amount of the loan or extension of credit.
The OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve Board decides to treat
such subsidiaries as affiliates. The regulation also requires savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail, and provides that certain classes of savings associations may
be required to give the OTS prior notice of affiliate transactions.
In addition, Sections 22(g) and (h) of the FRA place restrictions on loans
to executive officers, directors and principal stockholders. Under Section
22(h), loans to a director, an executive officer and to a greater than 10%
stockholder of a savings institution (a "principal stockholder"), and certain
affiliated interests of either, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the savings
institution's loans to one borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus). Section 22(h) also requires that
loans to directors, executive officers and principal stockholders be made on
terms substantially the same as offered to employees of the Bank and also
requires prior board approval for certain loans. In addition, the aggregate
amount of extensions of credit by a savings institution to all insiders cannot
exceed the institution's unimpaired capital and surplus. Furthermore, Section
22(g) places additional restrictions on loans to executive officers. At
September 30, 1998, the Bank was in compliance with the above restrictions.
Restrictions on Acquisitions. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior approval
of the Director of the OTS, (i) control of any other savings association or
savings and loan holding company or substantially all the assets thereof or (ii)
more than 5% of the voting shares of a savings association or holding company
thereof which is not a subsidiary. Except with the prior approval of the
Director of the OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may acquire control of any savings association, other than
a subsidiary savings association, or of any other savings and loan holding
company.
Federal Securities Laws. The Company's Common Stock is registered with the
Securities and Exchange Commission ("SEC") under the Securities Exchange Act of
1934 ("Exchange Act"). The Company is subject to the information, proxy
solicitation, insider trading restrictions and other requirements under the
Exchange Act.
Shares of common stock owned by an affiliate of the Company are subject to
the resale restrictions of Rule 144 under the Securities Act of 1933, as amended
("Securities Act"). If the Company meets the current public information
requirements of Rule 144 under the Securities Act, each affiliate of the Company
who complies with the other conditions of Rule 144 (including those that require
the affiliate's sale to be aggregated with those of certain other persons) is
able to sell in the public market, without registration, a number of shares not
to exceed, in any three-month period, the greater of (i) 1% of the outstanding
shares of the Company or (ii) the average weekly volume of trading in such
shares during the preceding four calendar weeks.
The Bank. The OTS has extensive regulatory authority over the operations of
savings associations. As part of this authority, savings associations are
required to file periodic reports with the OTS and are subject to periodic
examinations by the OTS. The investment and lending authority of savings
associations are prescribed by federal laws and regulations and they are
prohibited from engaging in any activities not permitted by such laws and
regulations. Those laws and regulations generally are applicable to all
federally chartered savings associations and may also apply to state-chartered
savings associations. Such regulation and supervision is primarily intended for
the protection of depositors.
27
<PAGE> 29
The OTS' enforcement authority over all savings associations and their
holding companies was substantially enhanced by Financial Institutions Reform,
Recovery, and Enforcement Act of 1989 ("FIRREA"). This enforcement authority
includes, among other things, the ability to assess civil money penalties, to
issue cease and desist or removal orders and to initiate injunctive actions. In
general, these enforcement actions may be initiated for violations of laws and
regulations and unsafe or unsound practices. Other actions or inactions may
provide the basis for enforcement action, including misleading or untimely
reports filed with the OTS. FIRREA significantly increased the amount of and
grounds for civil money penalties. FIRREA requires, except under certain
circumstances, public disclosure of final enforcement actions by the OTS.
Insurance of Accounts. The deposits of the Bank are insured to the maximum
extent permitted by the SAIF, which is administered by the FDIC, and are backed
by the full faith and credit of the United States Government. As insurer, the
FDIC is authorized to conduct examinations of, and to require reporting by,
FDIC-insured institutions. It also may prohibit any FDIC-insured institution
from engaging in any activity the FDIC determines by regulation or order to pose
a serious threat to the FDIC. The FDIC also has the authority to initiate
enforcement actions against savings associations, after giving the OTS an
opportunity to take such action.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is not aware of any existing circumstances which could
result in termination of the Bank's deposit insurance.
The BIF fund met its target reserve level in September 1995, but the SAIF
was not expected to meet its target reserve level until at least 2002.
Consequently, in late 1995, the FDIC approved a final rule regarding deposit
insurance premiums which, effective with respect to the semi-annual premium
assessment beginning January 1, 1996, reduced deposit insurance premiums for BIF
member institutions to zero basis points (subject to an annual minimum of
$2,000) for institutions in the lowest risk category. Deposit insurance premiums
for SAIF members were maintained at their existing levels (23 basis points for
institutions in the lowest risk category).
On September 30, 1996, President Clinton signed into law legislation (the
"Deposit Insurance Funds Act of 1996") to eliminate the premium differential
between SAIF-insured institutions and BIF-insured institutions by recapitalizing
the SAIF's reserves to the required ratio. The legislation provided that all
SAIF member institutions pay a one-time special assessment to recapitalize the
SAIF, which in the aggregate was sufficient to bring the reserve ratio in the
SAIF to 1.25% of insured deposits. The legislation also provided for the merger
of the BIF and the SAIF, with such merger being conditioned upon, among other
things, the prior elimination of the federal thrift charter.
Effective October 8, 1996, pursuant to the provision of the Deposit
Insurance Funds Act of 1996, FDIC regulations imposed a one-time special
assessment equal to 65.7 basis points for all SAIF-assessable deposits as of
March 31, 1995, which was collected on November 27, 1996. The Bank's one-time
special assessment amounted to approximately $1.4 million. Net of related tax
benefits, the one-time special assessment amounted to $876,000.
Following the imposition of the one-time special assessment, the FDIC
lowered assessment rates for SAIF members to reduce the disparity in the
assessment rates paid by BIF and SAIF members. Beginning October 1, 1996,
effective BIF and SAIF rates both range from zero basis points to 27 basis
points. From 1997 through 1999, SAIF members will pay 6.4 basis points to fund
the Financing Corporation while BIF member institutions will pay approximately
1.3 basis points.
28
<PAGE> 30
Capital requirements. Federally insured savings associations are required
to maintain minimum levels of regulatory capital. Pursuant to FIRREA, the OTS
has established capital standards applicable to all savings associations. These
standards generally must be as stringent as the comparable capital requirements
imposed on national banks. The OTS also is authorized to impose capital
requirements in excess of these standards on individual associations on a
case-by-case basis.
Current OTS capital standards require savings associations to satisfy three
different capital requirements. Under these standards, savings associations must
maintain "tangible" capital equal to 1.5% of adjusted total assets, "core"
capital equal to 4% of adjusted total assets and "total" capital (a combination
of core and "supplementary" capital) equal to 8.0% of "risk-weighted" assets.
For purposes of the regulation, core capital generally consists of common
stockholders' equity (including retained earnings), noncumulative perpetual
preferred stock and related surplus, minority interests in the equity accounts
of fully consolidated subsidiaries, certain nonwithdrawable accounts and pledged
deposits and "qualifying supervisory goodwill." Tangible capital is given the
same definition as core capital but does not include qualifying supervisory
goodwill and is reduced by the amount of all the savings association's
intangible assets, with only a limited exception for purchased mortgage
servicing rights ("PMSRs"). Both core and tangible capital are further reduced
by an amount equal to a savings association's debt and equity investments in
subsidiaries engaged in activities not permissible for national banks (other
than subsidiaries engaged in activities undertaken as agent for customers or in
mortgage banking activities and subsidiary depository institutions or their
holding companies). In addition, under the Prompt Corrective Action provisions
of the OTS regulations, all but the most highly rated institutions must maintain
a minimum leverage ratio of 4% in order to be adequately capitalized. See "-
Prompt Corrective Action." At September 30, 1998, the Bank did not have any
investment in subsidiaries engaged in impermissible activities and required to
be deducted from its capital calculation.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") granted the OTS the authority to prescribe rules for the amount of
PMSRs that may be included in a savings association's regulatory capital and
required that the value of readily marketable PMSRs included in the calculation
of a savings association's regulatory capital not exceed 90% of fair market
value and that such value be determined at least quarterly. Under final OTS
rules effective March 4, 1994, (i) PMSRs do not have to be deducted from
tangible and core regulatory capital, provided that they do not exceed 50% of
core capital, (ii) savings associations are required to determine the fair
market value and to review the book value of their PMSRs at least quarterly and
to obtain an independent valuation of PMSRs annually, (iii) savings associations
that desire to include PMSRs in regulatory capital may not carry them at a book
value under GAAP that exceeds the discounted value of their future net income
stream and (iv) for purposes of calculating regulatory capital, the amount of
PMSRs reported as balance sheet assets should amount to the lesser of 90% of
their fair market value, 90% of their original purchase price or 100% of their
remaining unamortized book value. At September 30, 1998, the Bank had PMSRs
totalling $148,000.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital does not exceed the savings association's core capital. Supplementary
capital generally consists of hybrid capital instruments; perpetual preferred
stock which is not eligible to be included as core capital; subordinated debt
and intermediate-term preferred stock; and, subject to limitations, general
allowances for loan losses. Assets are adjusted under the risk-based guidelines
to take into account different risk characteristics, with the categories ranging
from 0% (requiring no additional capital) for assets such as cash to 100% for
repossessed assets or loans more than 90 days past due. Single-family
residential real estate loans which are not past-due or non-performing and which
have been made in accordance with prudent underwriting standards are assigned a
50% level in the risk-weighing system, as are certain privately-issued
mortgage-backed securities representing indirect ownership of such loans.
Off-balance sheet items also are adjusted to take into account certain risk
characteristics.
Under OTS regulations, an institution with a greater than "normal" level of
interest rate exposure must deduct an interest rate risk ("IRR") component from
total capital for purposes of calculating risk-based capital requirement.
Interest rate exposure is measured, generally, as the decline in an
institution's net portfolio value that would result from a 200 basis point
increase or decrease in market interest rates (whichever would result in lower
net portfolio value), divided by the estimated economic value of the savings
association's assets. The interest rate risk component
29
<PAGE> 31
to be deducted from total capital is equal to one-half of the difference between
an institution's measured exposure and "normal" IRR exposure (which is defined
as 2%), multiplied by the estimated economic value of the institution's assets.
Although the OTS has decided to delay implementation of this rule, it will
continue to closely monitor the level of interest rate risk at individual
savings associations and it retains the authority, on a case-by-case basis, to
impose additional capital requirements for individual savings associations with
significant interest rate risk. The OTS recently updated its standards regarding
the management of interest rate risk to include summary guidelines to assist
savings associations in determining their exposures to interest rate risk.
30
<PAGE> 32
The following is a reconciliation of the Bank's equity determined in
accordance with GAAP to regulatory tangible, core, and risk-based capital at
September 30, 1998, 1997 and 1996.
<TABLE>
<CAPTION>
September 30, 1998 September 30, 1997 September 30, 1996
----------------------------- ------------------------------ -----------------------------
Tangible Core Risk-based Tangible Core Risk-based Tangible Core Risk-based
Capital Capital Capital Capital Capital Capital Capital Capital Capital
------- ------- ------- ------- ------- ------- ------- ------- --------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
GAAP equity $33,701 $33,701 $33,701 $30,254 $30,254 $30,254 $22,608 $22,608 $22,608
Assets required to be deducted(1) (55)
General valuation allowances 1,688 1,578 1,775
------- ------- ------- ------- ------- ------- ------- ------- -------
Total regulatory capital 33,701 33,701 35,389 30,254 30,254 31,832 22,608 22,608 24,328
Minimum capital requirement per
FIRREA published guidelines 6,113 12,225 13,424 5,594 11,188 12,792 4,421 8,841 11,289
------- ------- ------- ------- ------- ------- ------- ------- -------
Excess $27,588 $21,476 $21,965 $24,660 $19,066 $19,040 $18,187 $13,767 $13,039
-====== -====== -====== -====== -====== -====== -====== -====== -======
</TABLE>
- ----------------------
(1) Consists of equity investment nonincludable in regulatory capital.
These capital requirements are viewed as minimum standards by the OTS, and
most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings association's capital, upon a determination that the
regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others: (1) a
savings association has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities, or similar risks or a high proportion of
off-balance sheet risk; (2) a savings association is growing, either internally
or through acquisitions, at such a rate that supervisory problems are presented
that are not dealt with adequately by OTS regulations; and (3) a savings
association may be adversely affected by the activities or condition of its
holding company, affiliates, subsidiaries or other persons or savings
associations with which it has significant business relationships. The Bank is
not subject to any such individual minimum regulatory capital requirement.
31
<PAGE> 33
Prompt Corrective Action. Under Section 38 of the FDIA as added by FDICIA,
the OTS adopted in 1992 regulations implementing Section 38 of the FDIA. Under
the regulations, an institution shall be deemed to be (i) "well capitalized" if
it has total risk-based capital of 10% or more, has a Tier I risk-based capital
ratio of 6% or more, has a Tier I leverage capital ratio of 5% or more and is
not subject to any order or final capital directive to meet and maintain a
specific capital level for any capital measure, (ii) "adequately capitalized" if
it has a total risk-based capital ratio of 8% or more, a Tier I risk-based
capital ratio of 4% or more and a Tier I leverage capital ratio of 4% or more
(3% under certain circumstances) and does not meet the definition of "well
capitalized," (iii) "undercapitalized" if it has a total risk-based capital
ratio that is less than 8%, a Tier I risk-based capital ratio that is less than
4% or a Tier I leverage capital ratio that is less than 4% (3% under certain
circumstances), (iv) "significantly undercapitalized" if it has a total
risk-based capital ratio that is less than 6%, a Tier I risk-based capital ratio
that is less than 3% or a Tier I leverage capital ratio that is less than 3%,
and (v) "critically undercapitalized" if it has a ratio of tangible equity to
total assets that is equal to or less than 2%. Section 38 of the FDIA and the
OTS regulations promulgated thereunder also specify circumstances under the OTS
may reclassify a well capitalized institution as adequately capitalized and may
require an adequately capitalized institution or an undercapitalized institution
to comply with supervisory actions as if it were in the next lower category
(except that the FDIC may not reclassify a significantly undercapitalized
institution as critically undercapitalized). At September 30, 1998 the Bank meet
the requirements of a "well capitalized" institution under OTS regulations.
Liquidity Requirements. All savings associations are required to maintain
an average daily balance of liquid assets equal to a certain percentage of the
sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings associations. At the present time, the required minimum
liquid asset ratio is 4%. The Bank has consistently exceeded such regulatory
liquidity requirement and, for the quarter ended September 30, 1998, had a
liquidity ratio of 4.98%
Qualified Thrift Lender Test. Under Section 2303 of the Economic Growth and
Regulatory Paper work Reduction Act of 1996, a savings association can comply
with the QTL test by either meeting the QTL test set forth in the HOLA and the
implementing regulations or qualifying as a domestic building and loan
association as defined in Section 7701(a)(19) of the Internal Revenue Code of
1986, as amended ("Code"). The QTL Test set forth in the HOLA requires that
Qualified Thrift Investments ("QTLs") represent 65% of portfolio assets. A
savings institution that does not comply with the QTL test must either convert
to a bank charter or comply with the following restrictions on its operations:
(i) the association may not engage in any new activity or make any new
investment, directly or indirectly, unless such activity or investment is
permissible for a national bank; (ii) the branching powers of the association
shall be restricted to those of a national bank; (iii) the association shall not
be eligible to obtain any advances from its FHLB; and (iv) payment of dividends
by the association shall be subject to the rules regarding payment of dividends
by a national bank. Upon the expiration of three years from the date the
association ceases to be a QTL, it must cease any activity and not retain any
investment not permissible for a national bank and immediately repay any
outstanding FHLB advances (subject to safety and soundness considerations).
Portfolio assets are defined as total assets less intangibles, property
used by a savings association in its business and liquidity investments in an
amount not exceeding 20% of assets. Generally, QTLs are residential housing
related assets, The recent legislation allows small business loans, credit card
loans, student loans and loans for personal, family and household purposes to be
included without limitation as qualified investments. In addition, commercial
loans may be made in an amount up to 10% of total assets. At September 30, 1998,
approximately 86.20% of the Bank's assets were invested in QTLs, which was in
excess of the percentage required to qualify the Bank under the QTL Test in
effect at that time.
Restrictions on Capital Distributions. OTS regulations govern capital
distributions by savings associations, which include cash dividends, stock
redemptions or repurchases, cash-out mergers, interest payments on certain
convertible debt and other transactions charged to the capital account of a
savings association to make capital distributions. Generally, the regulation
creates a safe harbor for specified levels of capital distributions from
associations meeting at least their minimum capital requirements, so long as
such associations notify the OTS and
32
<PAGE> 34
receive no objection to the distribution from the OTS. Savings institutions and
distributions that do not qualify for the safe harbor are required to obtain
prior OTS approval before making any capital distributions.
Generally, savings associations that before and after the proposed
distribution meet or exceed their fully phased-in capital requirements, or Tier
1 associations, may make capital distributions during any calendar year equal to
the higher of (i) 100% of net income for the calendar year-to-date plus 50% of
its "surplus capital ratio" at the beginning of the calendar year or (ii) 75% of
net income over the most recent four-quarter period. The "surplus capital ratio"
is defined to mean the percentage by which the association's ratio of total
capital to assets exceeds the ratio of its fully phased-in capital requirement
to assets. Failure to meet fully phased-in or minimum capital requirements will
result in further restrictions on capital distributions including possible
prohibition without explicit OTS approval. See "- Capital Requirements."
In order to make distributions under these safe harbors, Tier 1 and Tier 2
associations must submit written notice to the OTS 30 days prior to making the
distribution. The OTS may object to the distribution during that 30-day period
based on safety and soundness concerns. In addition, a Tier 1 association deemed
to be in need of more than normal supervision by the OTS may be downgraded to a
Tier 2 or Tier 3 association as a result of such a determination. The Bank
currently is a Tier 1 institution for purposes of the regulation dealing with
capital distributions.
OTS regulations also prohibit the Bank from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
(or total) capital of the Bank would be reduced below the amount required to be
maintained for the liquidation account established by it for certain depositors
in connection with its conversion from mutual to stock form.
The OTS has proposed to amend its capital distribution regulation to
conform its requirements to the OTS prompt corrective action regulation. Under
the proposed regulation, an institution that would remain at least adequately
capitalized after making a capital distribution, and that was owned by a holding
company, would be required to provide notice to the OTS prior to making a
capital distribution. "Troubled" associations and undercapitalized associations
would be allowed to make capital distributions only by filing an application and
receiving OTS approval, and such applications would be approved under certain
limited circumstances.
Community Reinvestment. Under the Community Reinvestment Act of 1977, as
amended ("CRA"), as implemented by OTS regulations, a savings association has a
continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with the CRA.
The Bank received a satisfactory rating as a result of its last OTS evaluation.
Policy Statement on Nationwide Branching. Effective May 11, 1992, the OTS
amended and codified its policy statement on branching by federally chartered
savings associations to delete then-existing regulatory restrictions on the
branching authority of such associations and to permit nationwide branching to
the extent allowed by federal statute. (Prior OTS policy generally permitted
interstate branching for federally chartered savings associations only to the
extent allowed state-chartered savings associations in the states where the
association's home office was located and where the branch was sought or if the
branching resulted from OTS approval of a supervisory interstate acquisition of
a troubled institution.) Current OTS policy generally permits a federally
chartered savings association to establish branch offices outside of its home
state if the association meets the domestic building and loan test in Section
7701(a)(19) of the Code or the asset composition test of subparagraph (c) of
that section, and if, with respect to each state outside of its home state where
the association has established branches, the branches, taken alone, also
satisfy one of the two tax tests. An association seeking to take advantage of
this authority would have to have a branching application approved by the OTS,
which would consider the regulatory capital of the association and its record
under the CRA, as amended, among other things.
33
<PAGE> 35
Federal Home Loan Bank System. The Bank is a member of the FHLB of
Pittsburgh, which is one of 12 regional FHLBs that administers the home
financing credit function of savings associations. Each FHLB serves as a reserve
or central bank for its members within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures established by the Board of Directors of the FHLB.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Pittsburgh in an amount equal to at least 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year or 5% of its advances from the FHLB of Pittsburgh,
whichever is greater. At September 30, 1998, the Bank had $5.1 million in FHLB
stock, which was in compliance with this requirement.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest on
advances to their members. For the years ended September 30, 1998, 1997 and
1996, dividends from the FHLB to the Bank amounted to approximately $261,000,
$196,000 and $106,000, respectively. If dividends were reduced, the Bank's net
interest income would likely also be reduced. Further, there can be no assurance
that the impact of recent or future legislation on the FHLBs will not also cause
a decrease in the value of FHLB stock held by the Bank, if any.
Federal Reserve System. The Federal Reserve Bank ("FRB") requires all
depository institutions to maintain reserves against their transaction accounts
(primarily NOW and Super NOW checking accounts) and non-personal time deposits.
At September 30, 1998, the Bank was in compliance with applicable requirements.
However, because required reserves must be maintained in the form of vault cash
or a noninterest-bearing account at a Federal Reserve Bank, the effect of this
reserve requirement is to reduce an institution's earning assets.
Safety and Soundness Guidelines. The OTS and the other federal banking
agencies have established guidelines for safety and soundness, addressing
operational and managerial, as well as compensation matters for insured
financial institutions. Institutions failing to meet these standards are
required to submit compliance plans to their appropriate federal regulators. The
OTS and the other agencies have also established guidelines regarding asset
quality and earnings standards for insured institutions.
FEDERAL AND STATE TAXATION
General. The Company and the Bank are subject to the corporate tax
provisions of the Code, as well as certain additional provisions of the Code
which apply to thrift and other types of financial institutions. The following
discussion of tax matters is intended only as a summary and does not purport to
be a comprehensive description of the tax rules applicable to the Company and
the Bank.
Fiscal Year. For the year ended September 30, 1995 and thereafter, the
Company and the Bank and its subsidiaries file a consolidated federal income tax
return on a fiscal year basis. Prior to September 30, 1995, the Company and the
Bank and its subsidiaries filed consolidated federal income tax returns on a
calendar year basis.
Method of Accounting. The Bank maintains its books and records for federal
income tax purposes using the accrual method of accounting. The accrual method
of accounting generally requires that items of income be recognized when all
events have occurred that establish the right to receive the income and the
amount of income can be determined with reasonable accuracy, and that items of
expense be deducted at the later of (i) the time when all events have occurred
that establish the liability to pay the expense and the amount of such liability
can be determined with reasonable accuracy or (ii) the time when economic
performance with respect to the item of expense has occurred.
Bad Debt Reserves. The Bank is permitted to establish reserves for bad
debts and to make annual additions thereto which qualify as deductions from
taxable income. The Company, as of October 1, 1996, changed its method of
computing reserves for bad debts to the experience method (the "Experience
Method"). The bad debt deduction
34
<PAGE> 36
allowable under this method is available to small banks with assets less than
$500 million. Generally, this method will allow the Company to deduct an annual
addition to the reserve for bad debts equal to the increase in the balance of
the Company's reserve for bad debts at the end of the year to an amount equal to
the percentage of total loans at the end of the year, computed using the ratio
of the previous six years net charge offs divided by the sum of the previous six
years total outstanding loans at year end.
The Bank treated such change as a change in a method of accounting
determined solely with respect to the "applicable excess reserves" of the
institution. The amount of the applicable excess reserves will be taken into
account ratably over a six-taxable year period, beginning with the first taxable
year beginning after December 31, 1995. The timing of the recapture may be
delayed for a two-year period provided certain residential lending requirements
are met. For financial reporting purposes, the Company will not incur any
additional tax expense. At September 30, 1997, under SFAS No. 109, deferred
taxes were provided on the difference between the book reserve at September 30,
1997 and the applicable excess reserve in an amount equal to the Bank's increase
in the tax reserve from December 31, 1987 to September 30, 1997.
Prior to September 30, 1996, the Bank had the option of electing either the
experience method or the percentage of taxable income method (the "Percentage
Method") for its annual addition to the bad debt reserves.
Under the Experience Method, the deductible annual addition is the amount
necessary to increase the balance of the reserve at the close of the taxable
year to the greater of (i) the amount which bears the same ratio to loans
outstanding at the close of the taxable year as the total net bad debts
sustained during the current and five preceding taxable years bear to the sum of
the loans outstanding at the close of those six years or (ii) the balance in the
reserve account at the close of the Bank's "base year," which was its tax year
ended December 31, 1987.
Under the Percentage Method, the bad debt deduction with respect to
qualifying real property loans is computed as a percentage of the Bank's taxable
income before such deduction, as adjusted for certain items (such as capital
gains and the dividends received deduction). Under this method, a qualifying
institution such as the Bank generally may deduct 8% of its taxable income. In
the absence of other factors, the availability of the Percentage Method has
permitted a qualifying savings institution, such as the Bank, to be taxed at an
effective federal income tax rate of 31.28%, as compared to 34% for corporations
generally.
For taxable years ended on or before December 31, 1988, the Bank has
generally elected to use the Percentage Method to compute the amount of its bad
debt deduction with respect to its qualifying real property loans. For all
taxable years ended after December 31, 1988 with the exception of the September
30, 1996 tax year, the Bank elected to use the Experience Method to compute the
amount of its bad debt deduction with respect to its qualifying real property
loans.
The income of the Company or any non-bank subsidiaries would not be subject
to the bad debt deduction allowed the Bank, whether or not consolidated tax
returns are filed.
Distributions. While the Bank maintains a bad debt reserve, if it were to
distribute cash or property to its sole stockholder having a total fair market
value in excess of its accumulated tax-paid earnings and profits, or were to
distribute cash or property to its stockholder in redemption of its stock, the
Bank would generally be required to recognize as income an amount which, when
reduced by the amount of federal income tax that would be attributable to the
inclusion of such amount in income, is equal to the lesser of: (i) the amount of
the distribution or (ii) the sum of (a) the amount of the accumulated bad debt
reserve of the Bank with respect to qualifying real property loans (to the
extent that additions to such reserve exceed the additions that would be
permitted under the experience method) and (b) the amount of the Bank's
supplemental bad debt reserve.
Minimum Tax. The Code imposes an alternative minimum tax at a rate of 20%
on a base of regular taxable income plus certain tax preferences ("alternative
minimum taxable income" or "AMTI"). The alternative minimum tax is payable to
the extent such AMTI is in excess of an exemption amount. The Code provides that
an item of tax preference is the excess of the bad debt deduction allowable for
a taxable year pursuant to the percentage of
35
<PAGE> 37
taxable income method over the amount allowable under the experience method. The
other items of tax preference that constitute AMTI include (a) tax-exempt
interest on newly-issued (generally, issued on or after August 8, 1986) private
activity bonds other than certain qualified bonds and (b) for taxable years
beginning after 1989, 75% of the excess (if any) of (i) adjusted current
earnings as defined in the Code, over (ii) AMTI (determined without regard to
this preference and prior to reduction by net operating losses). Net operating
losses can offset no more than 90% of AMTI. Certain payments of alternative
minimum tax may be used as credits against regular tax liabilities in future
years.
Audit by IRS. The Bank's consolidated federal income tax returns for
taxable years through December 31, 1994 have been closed for the purpose of
examination by the IRS.
STATE TAXATION
The Company is subject to the Pennsylvania Corporate Net Income Tax and
Capital Stock and Franchise Tax. The Corporate Net Income Tax rate for fiscal
1998 is 9.99% and is imposed on the Company's unconsolidated taxable income for
federal purposes with certain adjustments. In general, the Capital Stock Tax is
a property tax imposed at the rate of 1.3% of a corporation's capital stock
value, which is determined in accordance with a fixed formula.
The Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax Act
(the ("MTIT"), as amended to include thrift institutions having capital stock.
Pursuant to the MTIT, the Bank's tax rate is 11.5%. The MTIT exempts the Bank
from all other taxes imposed by the Commonwealth of Pennsylvania for state
income tax purposes and from all local taxation imposed by political
subdivisions, except taxes on real estate and real estate transfers. The MTIT is
a tax upon net earnings, determined in accordance with GAAP with certain
adjustments. The MTIT, in computing GAAP income, allows for the deduction of
interest earned on state and federal securities, while disallowing a percentage
of a thrift's interest expense deduction in the proportion of interest income on
those securities to the overall interest income of the Bank. Net operating
losses, if any, thereafter can be carried forward three years for MTIT purposes.
36
<PAGE> 38
ITEM 2. PROPERTIES
At September 30, 1998, the Bank conducted business from its executive
offices located in Media, Pennsylvania and five full-service offices
located in Delaware and Chester Counties, Pennsylvania. See also Note 8
of the Notes to Consolidated Financial Statements in the Annual Report.
The following table sets forth certain information with respect to the
Bank's offices at September 30, 1998.
<TABLE>
<CAPTION>
Net Book Value Amount of
Description/Address Leased/Owned of Property Deposits
- ----------------------------- ---------------- ------------------ ------------------------
(In thousands)
<S> <C> <C> <C>
Executive Offices:
22 West State Street
Media, Pennsylvania 19063 Owned(1) $1,018 $ 78,410
Branch Offices:
3218 Edgmont Avenue
Brookhaven, Pennsylvania 19015 Owned 316 79,716
Routes 1 and 100
Chadds Ford, Pennsylvania 19318 Leased(2) 72 24,102
23 East Fifth Street
Chester, Pennsylvania 19013 Leased(3) 242 15,523
330 Dartmouth Avenue
Swarthmore, Pennsylvania 19081 Owned 121 44,831
Route 82 and 926 Leased(4) 72 4,729
Kennett Square, PA 19348 ------ --------
$1,841 $247,311
-===== -=======
</TABLE>
- ----------------------------
(1) Also a branch office.
(2) Lease expiration date is September 30, 2000. The Bank has two five year
renewal options.
(3) Lease expiration date is December 31, 2005. The Bank has one ten year
renewal option.
(4) Lease expiration date is September 30, 2001. The Bank has four five year
renewal options.
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<PAGE> 39
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in routine legal proceedings occurring in the
ordinary course of business which, in the aggregate, are believed by
management to be immaterial to the financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The information required herein is incorporated by reference on page 42
of the Company's Annual Report.
ITEM 6. SELECTED FINANCIAL DATA.
The information required herein is incorporated by reference from pages
1 to 2 of the Registrant's Annual Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANAYLSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
The information required herein is incorporated by reference from pages
7 to 18 of the Registrant's Annual Report.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company's balance sheet consists of interest-earning assets and
interest-bearing liabilities, and is therefore exposed to interest rate
risk. The following additional information is being provided regarding
the exposure to this interest rate risk.
The Company utilizes reports prepared by the OTS to measure interest
rate risk. Using data from the Bank's quarterly thrift financial
reports, the OTS models the net portfolio value ("NPV") of the Bank
over a variety of interest rate scenarios. The NAV is defined as the
present value of expected cash flows from existing assets less the
present value of expected cash flows from existing liabilities plus the
present value of net expected cash inflows from existing off-balance
sheet contracts. The model assumes instantaneous, parallel shifts in
the U.S. Treasury Securities yield curve of 100 to 400 basis points,
either up or down, and in 100 basis point increments.
The interest rate risk measures used by the OTS include an "Exposure
Measure" or "Post-Shock" NPV ratio and a "Sensitivity Measure". The
"Post-Shock" NPV ratio is the net present value as a percentage of
assets over the various yield curve shifts. A low "Post-Shock" NPV
ratio indicates greater exposure to interest rate risk and can result
from a low initial NPV ratio or high sensitivity to changes in interest
rates. The "Sensitivity Measure" is the decline in the NPV ratio, in
basis points, caused by a 2% increase or decrease in rates, whichever
produces a larger decline. The following sets forth the Bank's NPV as
of September 30, 1998.
38
<PAGE> 40
Net Portfolio Value
<TABLE>
<CAPTION>
Changes in Net Portfolio Value
Rates in Dollar Percentage Net Portfolio Value As a Change in
Basis Points Amount Change Change % of Assets Percentage (1)
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
200 $28,808 $(13,106) (31.27)% 7.25% (27.72)%
100 36,444 (5,470) (13.05) 8.92 (11.07)
0 41,914 10.03
(100) 44,519 2,605 6.22 10.49 4.59
(200) 47,110 5,196 12.40 10.92 8.87
</TABLE>
(1) Based on the portfolio value of the Bank's assets in the base
case scenario
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in NPV require the
making of certain assumptions which may or may not reflect the manner
in which actual yields and costs respond to changes in market interest
rates. In this regard, the NPV Table presented assumes that the
composition of the Bank's interest sensitive assets and liabilities
existing at the beginning of a period remains constant over the period
being measured and also assumes that a particular change in interest
rates is reflected uniformly across the yield curve regardless of the
duration to maturity or repricing of specific assets and liabilities.
Also, the model does not take into account the Bank's business or
strategic plans. Accordingly, although the NPV Table provides an
indication of the Bank's interest rate risk exposure at a particular
point in time, such measurements are not intended to and do not
provide a precise forecast of the effect of changes in market interest
rates on the Bank's net interest income and may differ from actual
results. See also discussion on pages 7 to 9 of the Annual Report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements and supplementary data required herein are
incorporated by reference from pages 20 to 42 of the Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL
DISCLOSURE.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required herein is incorporated by reference from
pages 2 to 5 and page 15 of the Registrant's Proxy Statement dated
December 24, 1998 ("Proxy Statement").
39
<PAGE> 41
ITEM 11. EXECUTIVE COMPENSATION.
The information required herein is incorporated by reference from
pages 8 to 13 of the Registrant's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required herein is incorporated by reference from
pages 6 to 8 of the Registrant's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required herein is incorporated by reference from
pages 14 to 15 of the Registrant's Proxy Statement.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this Report.
(1) The following documents are filed as part of this report
and are incorporated herein by reference from the
Registrant's Annual Report.
Report of Independent Auditors.
Consolidated Statements of Financial Condition at
September 30, 1998 and 1997.
Consolidated Statements of Income for the Years Ended
September 30, 1998, 1997 and 1996.
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended September 30, 1998, 1997 and 1996.
Consolidated Statements of Cash Flows for the Years Ended
September 30, 1998, 1997 and 1996.
Notes to the Consolidated Financial Statements.
(2) All schedules for which provision is made in the
applicable accounting regulation of the SEC are omitted
because they are not applicable or the required
information is included in the Consolidated Financial
Statements or notes thereto.
(3) The following exhibits are filed as part of this Form
10-K, and this list includes the Exhibit Index.
40
<PAGE> 42
No Description
3.1 Amended and Restated Articles of Incorporation of First Keystone
Financial, Inc. *
3.2 Amended and Restated Bylaws of First Keystone Financial, Inc. *
4 Specimen Stock Certificate of First Keystone Financial, Inc. *
10.1 Employee Stock Ownership Plan and Trust of First Keystone Financial,
Inc. *
10.2 401(K)/ Profit Sharing Plan of First Keystone Federal Savings Bank *
10.3 Employment Agreement between First Keystone Financial, Inc. and Donald
S. Guthrie (incorporated by reference from Exhibit 10.3 to Registrant's
Form 10-KSB for the year ended September 30, 1995).
10.4 Employment Agreement between First Keystone Financial, Inc. and Stephen
J. Henderson (incorporated by reference from Exhibit 10.4 to
Registrant's Form 10-KSB for the year ended September 30, 1995).
10.5 Employment Agreement between First Keystone Financial, Inc. and Thomas
M. Kelly (incorporated by reference from Exhibit 10.5 to Registrant's
Form 10-KSB for the year ended September 30, 1995).
10.6 Form of Severance Agreement between First Keystone Financial, Inc. and
Elizabeth M. Mulcahy (incorporated by reference from Exhibit 10.6 to
Registrant's Form 10-KSB for the year ended September 30, 1995).
10.8 Form of Severance Agreement between First Keystone Financial, Inc. and
Carol Walsh (incorporated by reference from Exhibit 10.8 to
Registrant's Form 10-KSB for the year ended September 30, 1995).
10.9 1995 Stock Option Plan (incorporated by reference from Exhibit 10.9 to
Registrant's Form 10-KSB for the year ended September 30, 1995).
41
<PAGE> 43
10.10 1995 Recognition and Retention Plan and Trust Agreement, (incorporated
by reference from Exhibit 10.10 to Registrant's Form 10-KSB for the
year ended September 30, 1995).
13 Annual Report to Stockholders.
21 Subsidiaries of the Registrant - Reference is made to Item 1
"Business," for the required information.
23 Consent of Deloitte & Touche LLP.
- -----------------------
(*) Incorporated by reference from the Registration Statement Form S-1
(Registration No. 33- 84824) filed by the Registrant with the SEC on
October 6, 1994, as amended.
(b) Reports filed on Form 8-K.
None.
42
<PAGE> 44
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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.
FIRST KEYSTONE FINANCIAL, INC.
By: /s/ Donald S. Guthrie
---------------------------------
Donald S. Guthrie
President and Chief Executive
Officer
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report had been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.
<TABLE>
<S> <C>
/s/ Donald S. Guthrie December 29, 1998
- ------------------------------------------------
Donald S. Guthrie
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Thomas M. Kelly December 29, 1998
- ------------------------------------------------
Thomas M. Kelly
Executive Vice-President and Chief
Financial Officer
(Principal Financial and Accounting Officer)
/s/ Donald A. Purdy December 29, 1998
- ------------------------------------------------
Donald A. Purdy
Chairman of the Board
/s/ William K. Beats December 29, 1998
- ------------------------------------------------
William K. Beats
Director
/s/ Edward Calderoni December 29, 1998
- ------------------------------------------------
Edward Calderoni
Director
/s/ Silvio F. D'Ignazio December 29, 1998
- ------------------------------------------------
Silvio F. D'Ignazio
</TABLE>
43
<PAGE> 45
<TABLE>
<S> <C>
/s/ Olive J. Faulkner December 29, 1998
- ------------------------------------------------
Olive J. Faulkner
Director
/s/ Edmund Jones December 29, 1998
- ------------------------------------------------
Edmund Jones
Director
/s/ Willard F. Letts December 29, 1998
- ------------------------------------------------
Willard F. Letts
Director
/s/ Walter J. Lewicki December 29, 1998
- ------------------------------------------------
Walter J. Lewicki
Director
/s/ Joan G. Taylor December 29, 1998
- ------------------------------------------------
Joan G. Taylor
Director
</TABLE>
44
<PAGE> 1
EXHIBIT B
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The selected consolidated financial and other data of First Keystone Financial,
Inc. set forth below does not purport to be complete and should be read in
conjunction with, and is qualified in its entirety by, the more detailed
information, including the Consolidated Financial Statements and related Notes,
appearing elsewhere herein.
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED SEPTEMBER 30,
-----------------------------------------------------------------
1998 1997 1996 1995 1994
-----------------------------------------------------------------
(dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
SELECTED FINANCIAL DATA:
Total assets $ 415,863 $ 373,430 $ 294,241 $ 280,979 $ 237,749
- --------------------------------------------------------------------------------------------------------------------
Loans receivable, net 198,343 188,289 167,530 158,002 142,226
- --------------------------------------------------------------------------------------------------------------------
Mortgage-related securities held to maturity 18,769 20,707 23,221 60,294 68,369
- --------------------------------------------------------------------------------------------------------------------
Investment securities held to maturity 10,000 16,532 10,710 12,145
- --------------------------------------------------------------------------------------------------------------------
Assets held for sale:
Mortgage-related securities 115,486 104,472 60,211 19,538 251
- --------------------------------------------------------------------------------------------------------------------
Investment securities 40,621 10,211
- --------------------------------------------------------------------------------------------------------------------
Loans 2,799 4,577 2,447 57 168
- --------------------------------------------------------------------------------------------------------------------
Real estate owned 1,663 1,672 1,557 465 503
- --------------------------------------------------------------------------------------------------------------------
Deposits 247,311 227,918 219,205 223,753 216,065
- --------------------------------------------------------------------------------------------------------------------
Borrowings 120,878 99,987 46,740 28,411 5,267
- --------------------------------------------------------------------------------------------------------------------
Stockholders' equity 26,664 24,752 23,084 24,463 11,622
- --------------------------------------------------------------------------------------------------------------------
Non-performing assets 5,367 3,749 6,909 3,621 5,879
- --------------------------------------------------------------------------------------------------------------------
SELECTED OPERATIONS DATA:
Interest income $ 27,393 $ 22,750 $ 19,837 $ 18,295 $ 15,547
- --------------------------------------------------------------------------------------------------------------------
Interest expense 15,625 12,639 10,932 10,767 9,153
- --------------------------------------------------------------------------------------------------------------------
Net interest income 11,768 10,111 8,905 7,528 6,394
- --------------------------------------------------------------------------------------------------------------------
Provision for loan losses 186 239 1,250 52 416
- --------------------------------------------------------------------------------------------------------------------
Net interest income
after provision for loan losses 11,582 9,872 7,655 7,476 5,978
- --------------------------------------------------------------------------------------------------------------------
Other income (expense):
Service charges and other fees 898 972 1,047 1,029 1,010
- --------------------------------------------------------------------------------------------------------------------
Net gain on sales of interest-earning assets 577 285 203 113 350
- --------------------------------------------------------------------------------------------------------------------
Net gain on sale of other assets 1 46
- --------------------------------------------------------------------------------------------------------------------
Net gain (loss) on real estate activities (25) 7 2 (44) (47)
- --------------------------------------------------------------------------------------------------------------------
Other 57 40 56 89 158
- --------------------------------------------------------------------------------------------------------------------
Operating expenses 9,059 6,921 8,645 7,036 7,728
- --------------------------------------------------------------------------------------------------------------------
Income (Loss) before income taxes,
extraordinary item and cumulative effect of
change in accounting principle 4,031 4,301 318 1,627 (279)
- --------------------------------------------------------------------------------------------------------------------
Income tax expense (benefit) 1,250 1,664 (567) 504 (95)
- --------------------------------------------------------------------------------------------------------------------
Extraordinary item, utilization of state
tax carryforward
- --------------------------------------------------------------------------------------------------------------------
Cumulative effect of change in accounting
for income taxes 600
- --------------------------------------------------------------------------------------------------------------------
Net income $ 2,781 $ 2,637 $ 885(2) $ 1,123 $ 416
- --------------------------------------------------------------------------------------------------------------------
Diluted earnings per common share(1) $ 1.23 $ 1.13 $ .37(2) $ .37 N/A
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Adjusted for the effect of a 2 for 1 stock split declared December 4,
1997.
(2) Includes the effects of the one-time SAIF special assessment. The effects
of the assessment increased operating expenses and decreased income before
income taxes by $1.4 million. The effects of the assessment also decreased
net income and earnings per share by $876,000 and $.74, respectively.
1
<PAGE> 2
<TABLE>
<CAPTION>
At or For the Year Ended September 30,
----------------------------------------------------
1998 1997 1996 1995 1994
----------------------------------------------------
<S> <C> <C> <C> <C> <C>
SELECTED OPERATING RATIOS:
Average yield earned on interest-earning assets 7.40% 7.54% 7.45% 7.37% 6.84%
- ---------------------------------------------------------------------------------------------------------
Average rate paid on interest-bearing liabilities 4.68 4.48 4.42 4.62 4.18
- ---------------------------------------------------------------------------------------------------------
Average interest rate spread 2.72 3.07 3.03 2.75 2.66
- ---------------------------------------------------------------------------------------------------------
Net interest margin 3.18 3.35 3.34 3.03 2.81
- ---------------------------------------------------------------------------------------------------------
Ratio of interest-earning assets to
interest-bearing liabilities 110.80 106.82 107.65 106.55 103.77
- ---------------------------------------------------------------------------------------------------------
Net interest income after provision for loan
losses to operating expenses 127.84 142.64 88.55(3) 106.25 77.36
- ---------------------------------------------------------------------------------------------------------
Operating expenses as a percent of average assets 2.37 2.21 3.14(3) 2.73 3.29
- ---------------------------------------------------------------------------------------------------------
Return on average assets 0.73 0.84 0.32(3) 0.44 .18
- ---------------------------------------------------------------------------------------------------------
Return on average equity 11.13 11.46 3.92(3) 5.59 3.60
- ---------------------------------------------------------------------------------------------------------
Ratio of average equity to average assets 6.54 7.36 8.20 7.80 4.91
- ---------------------------------------------------------------------------------------------------------
Full-service offices at end of period 6 5 5 5 5
- ---------------------------------------------------------------------------------------------------------
ASSET QUALITY RATIOS: (4)
Non-performing loans as a
percent of gross loans receivable 1.85% 1.09% 3.15% 1.98% 3.74%
- ---------------------------------------------------------------------------------------------------------
Non-performing assets as a
percent of total assets 1.29 1.00 2.35 1.29 2.47
- ---------------------------------------------------------------------------------------------------------
Allowance for loan losses as a
percent of gross loans receivable 0.87 0.86 1.54 0.93 1.07
- ---------------------------------------------------------------------------------------------------------
Allowance for loan losses as a
percent of non-performing loans 46.92 78.38 49.03 47.12 28.65
- ---------------------------------------------------------------------------------------------------------
Net loans charged-off to average
interest-earning loans receivable 0.04 0.68 0.07 0.07 0.10
- ---------------------------------------------------------------------------------------------------------
CAPITAL RATIOS: (4) (5)
Tangible capital ratio 8.27% 8.12% 7.67% 8.23% 4.88%
- ---------------------------------------------------------------------------------------------------------
Core capital ratio 8.27 8.12 7.67 8.23 4.88
- ---------------------------------------------------------------------------------------------------------
Risk-based capital ratio 21.09 19.91 17.24 17.82 10.13
- ---------------------------------------------------------------------------------------------------------
</TABLE>
(3) Includes the effects of the one-time SAIF special assessment of $1.4
million. Excluding the one-time effects, the ratio of net interest income
after provision for loan losses to operating expenses and operating
expenses as a percent of average assets ratios were 106.04% and 2.62%,
respectively. In addition, return of average assets and return on average
equity were .64% and 7.79%, respectively, excluding the special
assessment.
(4) Asset Quality Ratios and Capital Ratios are end of period ratios, except
for charge-offs to average loans. With the exception of end of period
ratios, all ratios are based on average daily balances during the
indicated periods.
(5) Regulatory capital ratios of the Company's wholly-owned subsidiary, First
Keystone Federal Savings Bank.
LOANS RECEIVABLE
[PIE CHART]
<TABLE>
<S> <C>
Single Family 148088
Construction 15858
Non-residential 20563
Consumer Equity 19609
Commercial Business 1390
Other 2059
</TABLE>
DEPOSIT ACCOUNTS
[PIE CHART]
<TABLE>
<S> <C>
Non-interest bearing accounts $ 8,254
NOW accounts $ 28,181
Passbook accounts $ 37,988
Money Market demand accounts $ 16,087
Certificate of Deposit accounts $ 156,801
</TABLE>
2
<PAGE> 3
MESSAGE TO OUR
SHAREHOLDERS
[PRESIDENT ANNOUNCES NEW OFFICE GRAPHIC]
First Keystone Federal President and Chief Executive Officer Donald S. Guthrie
announces plans for the Bank's newest office, slated to open in the summer of
1999 in western Delaware County, Pennsylvania.
With the same attributes needed to solve the challenges of a Rubik Cube(R),
patience, foresight, solid analytical thinking and good strategic planning, I am
pleased to report that First Keystone's management team guided your Company to
new record earnings. Despite the challenges in fiscal 1998 arising from a
declining interest rate environment, your Company experienced a significant
increase in its net interest income and an increase in earnings per share.
Recognizing that each piece is an integral part of the whole, and
accomplishments are achieved by remaining focused, the Company earned $2.8
million, or $1.23 diluted earnings per share for the year ended September 30,
1998, compared to $2.6 million, or $1.13 diluted earnings per share for fiscal
1997, reflecting a per share increase of 8.8%.
2 FOR 1 STOCK SPLIT
I am pleased to report that, as a result of your Company's strong financial
performance in the first quarter of fiscal 1998, First Keystone announced a 2
for 1 stock split. The dividend per share was unaffected by the stock split,
thereby effectively increasing the dividend paid by 100%. This split was
intended to recognize solid fundamental achievements, and reward shareholders
with additional stock.
The Company also instituted a dividend reinvestment plan and a stock
purchase program during fiscal 1998, enabling shareholders to make additional
cash purchases during the dividend declaration period directly from the
Company's transfer agent. As evidenced by the nearly 50% of the Company's
shareholders of record who have taken advantage of the program, it has been very
well received.
As our fiscal year came to a close on September 30, 1998, U.S.
financial markets were experiencing great volatility as they reacted to the
financial turbulence throughout the world economy. Major indexes slipped
considerably in August and September from their record breaking highs earlier in
the fiscal year, and like our banking peers, First Keystone's stock price was
impacted by the overall uncertainty in the global economy. I am pleased to
report, however, in accordance with the Company's strategic plan, the Board of
Directors remained focused on building long-term shareholder value. Accordingly,
I am pleased to state that the Company's stock price as of September 30, 1998,
has appreciated over 170% since its initial offering in January 1995. This is a
very healthy annualized rate of return of 31%.
ASSETS GREW
The Company's total assets increased to $415.9 million at September 30,
1998 from $373.4 million at September 30, 1997. The asset growth was primarily
attributable to a $29.5 million increase in investment and mortgage-related
securities available for sale to $174.9 million at fiscal year end from $145.4
million at September 30, 1997. Growth in assets can also be attributed to an
increase in origination of loans receivable. The Company's net loan portfolio
increased by $10.1 million to $198.3 million at September 30, 1998 from $188.3
million at September 30, 1997.
SIGNIFICANT INCREASE IN DEPOSITS
The asset growth was funded through increases in deposit accounts and
borrowed money. I am pleased to report that deposits were up by 8.5% this fiscal
year. Total deposits increased to $247.3 million at year end from $227.9 million
at September 30, 1997. This increase can be attributed to cross-selling efforts
in the branches, increased relationship banking with our commercial customers,
and from new deposits at the Willowdale Office,
<PAGE> 4
the Bank's most recent branch located in Chester County, Pennsylvania.
[WILLOWDALE AD GRAPHIC]
Aggressive advertising, a sales oriented staff, and participation in community
events helped the Bank's Willowdale Office more than double its projected
deposits in the first year.
The Willowdale Office has more than doubled its projected deposits in less
than one year. By capturing this new marketshare and by serving the needs of the
customers, we reaffirm that there is a strong market niche for a progressive
community bank. Although competition in the financial industry is fierce, many
consumers appreciate and seek out the local bank that can make decisions
quickly, provide a wide range of services and show the customer his business is
important to the bank.
CONTINUED EXPANSION
Your Company continues to strategically implement its business plan to
increase its branch operations in southern Chester County and the western part
of Delaware County as these contiguous counties experience a tremendous influx
of commercial and residential development. In the summer of 1999, within the
heart of our market area, the newest free-standing First Keystone office will
open at The Shoppes at Darlington Square in Chester Heights Borough in Delaware
County, Pennsylvania.
STRONG FINANCIAL POSITION
The Company's increase in net interest income is primarily a result of
management's investing and leveraging strategies in conjunction with the
issuance of $16.2 million of trust preferred securities in August 1997. As part
of the on-going capital management plan, these proceeds enabled First Keystone
to continue with its asset liability strategies to leverage its capital,
increase its investments in mortgage-related securities, and continue to
repurchase the Company's common stock throughout the fiscal year.
The Company is well capitalized with a shareholders' equity to assets ratio
of 6.4% at fiscal year end. In addition, the Bank is also considered a well
capitalized institution and exceeds all federal regulatory requirements.
A LOOK AHEAD FOR CONTINUED SUCCESS
Moving forward, our team of experienced professionals will continue to show
good judgment and strong leadership. With the challenges that lie ahead from a
relatively flat yield curve creating pressure on our margins, First Keystone
will remain focused on each piece of its business. We will proceed using similar
skills required in solving a strategic puzzle including patience, foresight and
analytical thinking. Areas of concentration to increase earnings include growing
the Bank's commercial loan portfolio, enhancing consumer loan programs and
expanding fee based services. We will continue to aggressively market
relationship checking accounts and improve the delivery system through
deployment of efficient operational strategies.
We will continue to explore other alternatives that could provide First
Keystone with additional sources of quality assets and increase net income to
enhance shareholder value.
Most importantly, we will continue to do what we do best...serve the
customer; and constantly strive to treat our customers the way we would like to
be treated. Service is the key to our niche market -- a strong, progressive
community bank that makes the customer feel welcomed and important.
On behalf of the employees and the Board of Directors, I wish you a
prosperous and healthy new year. We appreciate the trust that you have placed in
us, and we pledge to work diligently to produce solid results again for this
coming year.
Sincerely,
/s/ Donald S. Guthrie
-----------------------------------
Donald S. Guthrie
President & Chief Executive Officer
<PAGE> 5
1998
THE YEAR
IN REVIEW
COMMERCIAL LENDING SLIDES INTO PLACE
[TECHNOLOGY INDUSTRY GRAPHIC]
Through the commercial loan department, the Bank was able to provide financing
for a local company that holds a patent in the technology industry.
As a locally based financial institution, the Bank's loan officers are
knowledgeable about the community and well acquainted with its business leaders.
As a result, management is able to quickly evaluate and approve an unsecured
loan to the local volunteer fire company for a new ambulance, a real estate loan
to a young couple to renovate a storefront building with upper story offices,
and preliminary financing to a company in the development stage which holds a
patented process in the technology industry. With each loan, a new bond is
formed creating a long-term relationship and additional transaction accounts.
Focusing on developing and maintaining long-term account relationships
contributed to the success of the commercial lending department this fiscal
year. In just its second year, the Bank's commercial lending increased its
number of loan originations by 71%. The Bank's philosophy focusing on small to
moderate businesses minimizes risk, and provides a diversified cross-section of
borrowers throughout First Keystone's market area.
BUILDING A SOLID FRAMEWORK OF CONSTRUCTION LOANS
The construction, development and acquisition department continued to have
a strong presence in the community. Each year additional relationships are
forged with new developers as a result of First Keystone's experience,
reputation and active participation in area trade associations.
Enhancement of the department's computer software has enabled construction
loan officers to offer more innovative loan products, such as construction
revolvers. This loan is similar to a line of credit, but the loan is secured
through the real estate of the development project and the cash flow revolves
throughout the life of the project. The advantage to the builder is that it's
faster and more efficient, enabling the developer to complete his customers'
homes in a very timely manner.
RESIDENTIAL LENDING REMAINS AN INTEGRAL PIECE OF THE BUSINESS
Single-family residential loan originations for fiscal 1998 increased by
$12.9 million. The increase was spurred, in part, by low interest rates creating
a demand for both refinancing and first time homebuyers. The increase in market
share can also be attributed to the Bank's outstanding reputation in the
community, and the fact that many customers seek out the Bank because it is one
of the few area financial institutions that still retains servicing over a
majority of the loans it originates.
Fiscal 1998 marked the first for an affinity program launched by the Bank
with a national retailer. An innovative consumer loan program that rewarded
customers with a gift certificate for The Home Depot(R) was kicked off at the
close of the Company's fiscal year. In the spirit of home improvement, the Bank
aggressively advertised the loan program with in-lobby banners, aprons and hard
hats in addition to its multi-media advertising strategy.
[ARCM CORP. GRAPHIC]
ARCM Corporation's patented truck side view mirror helps prevent blind spots,
right turn crashes and jackknifing.
[HOME DEPOT GRAPHIC]
As part of a home equity loan promotion, the consumer loan department offered
gift certificates for The Home Depot(R).
The Home Depot(R) is not affiliated with First Keystone Federal. The Home
Depot(R) is a Registered Trademark of Homer TLC, Inc.
<PAGE> 6
BLENDING TECHNOLOGY WITH ENHANCED PRODUCTS AND SERVICES
[DEBIT CARD GRAPHIC]
First Keystone introduced its debit card in the fall of 1998, and enhanced its
ATM network to provide customers with on-line real time.
Testing the Bank's computer systems and that of its vendors for the Year
2000 is well underway. First Keystone is testing its software and hardware on a
simulated mainframe and applications are currently being performed on schedule.
The Bank also enhanced its ATM network in fiscal 1998 with on-line real
time. Now the customer can receive faster and more accurate account information
24 hours a day. In conjunction with this ATM enhancement, at the end of fiscal
1998, the Bank introduced its Debit Card, allowing customers to use the
MasterMoney(TM) card wherever the MasterCard(R) logo is accepted. This new
product has been very well received as customers appreciate the flexibility it
provides in managing their money.
The Company's web site at www.firstkeystone.com continued to grow in
popularity with inquiries increasing throughout the year. In addition, the Bank
continues to expand its Internet and Bank-By-Phone services. The Bank can now
offer its commercial customers credit card merchant processing through their
computers which enables the merchant to approve sales through the Internet.
Blending efficient uses of technology with enhanced products and services
will enable First Keystone to offer its customers the services they need
provided by a staff of professionals that make it user-friendly for the
consumer.
THE RIGHT PRODUCT MIX IN A CHANGING MARKET
[ADVERTISING CAMPAIGN GRAPHIC]
Capitalizing on area bank mergers and acquisitions, First Keystone launched
hard-hitting advertising campaigns throughout the year targeting displaced
customers of affected institutions.
Bank mergers and acquisitions continued in fiscal 1998, and First Keystone
geared its marketing efforts to welcome these displaced customers. Throughout
the year, the Bank offered special checking account packages for new customers
and aggressively priced its products accordingly.
In response to the Bank's commercial customers' requests, First Keystone
introduced new products such as "Member Select" which enables business owners to
offer their employees discounted and free banking services. Also, in conjunction
with opening day of minor league baseball, the Bank launched an "All-Star Youth
Savings Club." With each new account, the child received a collectable baseball
embossed with the Wilmington Blue Rocks' logo as well as First Keystone's, a
full-sized baseball pennant, stickers and a birthday gift.
A community bank, as recently reported in the region's largest daily
newspaper, can often deliver both innovative and basic products and services for
less than the larger regional banks.
[MEDIA ARTS AND CRAFTS SHOW GRAPHIC]
The Bank hit a home run at the Annual Media Arts and Craft Show (which it
sponsors), promoting its very popular All Star Savings Club for children.
[ALL STAR SAVINGS CLUB GRAPHIC]
<PAGE> 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
GENERAL
First Keystone Financial, Inc. (the "Company") is the holding company of
its wholly owned subsidiary, First Keystone Federal Savings Bank (the "Bank").
For purposes of this discussion, First Keystone Financial, Inc., including its
wholly owned subsidiaries, will be referred to as the "Company". The Company is
a community oriented banking organization that focuses on providing customer and
business services within its primary market area, consisting of Delaware and
Chester counties.
The following discussion should be read in conjunction with the Company's
consolidated financial statements presented elsewhere herein. Accordingly, the
discussion below with respect to results of operations relates primarily to the
Bank, and the financial data for the periods prior to the conversion of the Bank
to stock completed in January 1995, reflects solely financial data of the Bank
and its subsidiaries.
The Company's results of operations depend primarily on its net interest
income, which is the difference between interest income on interest-earning
assets, which principally consist of loans, mortgage-related securities and
investment securities, and interest expense on interest-bearing liabilities,
which principally consist of deposits and Federal Home Loan Bank ("FHLB")
advances. The Company's results of operations also are affected by the provision
for loan losses, resulting from management's assessment of the adequacy of the
allowance for loan losses, the level of its non-interest income, including
service charges and other fees as well as gains and losses from the sale of
certain assets, the level of its operating expenses, and income tax expense.
ASSET AND LIABILITY MANAGEMENT
The principal objective of the Company's asset and liability management is
to evaluate the interest rate risk existing in certain assets and liabilities,
determine the level of risk appropriate given the Company's business focus,
operating environment, capital and liquidity requirements and performance
objectives, establish prudent asset concentration guidelines, and manage the
risk consistent with Board approved guidelines. Through asset and liability
management, the Company seeks to reduce both the vulnerability and volatility of
its operations to changes in interest rates and to manage the ratio of
interest-rate sensitive assets to interest-rate sensitive liabilities within
specified maturities or repricing periods. The Company's actions in this regard
are taken under the guidance of the Asset/Liability Committee ("ALCO"), which is
chaired by the Chief Financial Officer and comprised of members of the Company's
senior management. The ALCO meets at least quarterly to review, among other
things, liquidity and cash flow needs, current market conditions and interest
rate environment, the sensitivity to interest rate changes of the Company's
assets and liabilities, the book and market values of assets and liabilities,
unrealized gains and losses, and the purchase and sale activity and maturities
of investments, deposits and borrowings. In addition, the pricing of the
Company's residential loans and deposits is reviewed at least weekly while the
pricing of loans originated for sale in the secondary market is reviewed daily.
The ALCO reports to the Company's Board of Directors on at least a quarterly
basis.
The Company's primary asset/liability monitoring tool consists of various
asset/liability simulation models, which are prepared on a quarterly basis and
are designed to capture the dynamics of the balance sheet as well as rate and
spread movements and to quantify variations in net interest income under
different interest rate scenarios. A more conventional but limited
Asset/Liability monitoring tool involves an analysis of the extent to which
assets and liabilities are interest rate sensitive and measures an institution's
interest rate sensitivity gap. An asset or liability is said to be interest rate
sensitive within a specific time period if it will mature or reprice within that
time period. The interest rate sensitivity gap is defined as the difference
between interest-earning assets and interest-bearing liabilities maturing or
repricing within a given time period. A gap is considered positive when the
amount of interest rate sensitive assets exceeds the amount of interest rate
sensitive liabilities. A gap is considered negative when the amount of interest
rate sensitive liabilities exceeds interest rate sensitive assets. During a
period of rising interest rates, a negative gap would tend to adversely affect
net interest income, while a positive gap would tend to result in an increase in
net interest income. During a period of falling interest rates, a negative gap
would tend to result in an increase in net interest income, while a positive gap
would tend to affect net interest income adversely. While a conventional gap
measure may be useful, it
7
<PAGE> 8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (CONTINUED)
ASSET AND LIABILITY MANAGEMENT (CONTINUED)
is limited in its ability to predict trends in future earnings. It makes no
presumptions about changes in prepayment tendencies, deposit or loan maturity
preferences or repricing time lags that may occur in response to a change in the
interest rate environment. For purposes of the table below, annual prepayment
assumptions range from 10% to 40% for fixed-rate mortgage loans and
mortgage-backed securities and 6% to 15% for adjustable rate mortgage loans and
mortgage-backed securities. Passbook and statement savings accounts are assumed
to decay at a rate of 30.0%, 30.0%, and 40.0% in each of the first three years,
respectively. Money market ("MMDA") and negotiable order of withdrawal ("NOW")
accounts are assumed to decay at a rate of 75% and 25%, in one year or less and
over one year, respectively. First Keystone's passbook, statement savings, MMDA
and NOW accounts are generally subject to immediate withdrawal. However,
management considers a portion of these deposits to be core deposits having
significantly longer effective maturities based upon the Bank's retention of
such deposits in changing interest rate environments.
Management believes that the assumptions used by it to evaluate the
vulnerability of the Bank's operations to changes in interest rates are
conservative and consider them reasonable. However, the interest rate
sensitivity of the Bank's assets and liabilities as portrayed in the table below
could vary substantially if different assumptions were used or actual experience
differs from the assumptions used in the table.
The following table summarizes the anticipated maturities or repricing of the
Company's interest-earning assets and interest-bearing liabilities as of
September 30, 1998, based on the information and assumptions set forth above.
<TABLE>
<CAPTION>
More Than More Than
Within Six to One Year Three Over
Six Twelve to Three Years to Five
Months Months Years Five Years Years Total
--------- --------- --------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable(1) $ 52,969 $ 25,765 $ 46,921 $ 28,485 $ 43,896 $ 198,036
Mortgage-related securities 41,186 18,904 49,020 21,130 4,015 134,255
Loans held for sale 2,799 2,799
Investment securities 813 12,000 2,435 30,452 45,700
Interest-earning deposits 21,669 21,669
- -------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets $ 119,436 $ 56,669 $ 95,941 $ 52,050 $ 78,363 $ 402,459
===============================================================================================================================
Interest-bearing liabilities:
Deposits $ 89,459 $ 71,404 $ 76,911 $ 9,537 $ 247,311
Borrowed funds 30,325 5,159 49,425 $ 35,969 120,878
- -------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 119,784 $ 71,404 $ 82,070 $ 58,962 $ 35,969 $ 368,189
===============================================================================================================================
Excess (deficiency) of interest-
earning assets over
interest-bearing liabilities $ (348) $ (14,735) $ 13,871 $ (6,912) $ 42,394 $ 34,270
===============================================================================================================================
Cumulative excess (deficiency) of
interest-earning assets over
interest- bearing liabilities $ (348) $ (15,083) $ (1,212) $ (8,124) $ 34,270
===============================================================================================================================
Cumulative excess (deficiency) of
interest-earning assets over interest-
bearing liabilities as a percentage of
total assets (0.08)% (3.63)% (0.29)% (1.95)% 8.24%
===============================================================================================================================
</TABLE>
(1) Balances have been reduced for non-accruing loans, which amounted $3.8
million at September 30, 1998 and, with respect to construction loans, the
amount of loans in process.
8
<PAGE> 9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (CONTINUED)
ASSET AND LIABILITY MANAGEMENT (CONTINUED)
The Company also utilizes market value analysis, which addresses the
estimated change in the Company's equity value arising from movements in
interest rates. The market value of portfolio equity is estimated by valuing the
Company's assets and liabilities. The extent to which assets gain or lose value
in relation to gains or losses of liabilities determines the appreciation or
depreciation in equity on a market value basis. Market value analysis is
intended to evaluate the impact of immediate and sustained shifts of the current
yield curve upon the market value of the Company's current balance sheet.
CHANGES IN FINANCIAL CONDITION
General. Total assets of the Company increased by $42.4 million, or 11.3%,
from $373.4 million at September 30, 1997 to $415.8 million at September 30,
1998. The increase reflected primarily growth in investment and mortgage-related
securities available for sale and loans receivable. The asset growth was funded
by increases in customer deposits and advances from the FHLB of Pittsburgh.
Asset growth was also funded by a modest increase in stockholders' equity.
Cash and Investments. Cash and investments (including investments
available for sale) increased by $22.9 million, or 55.0%, to $64.7 million at
September 30, 1998 compared to $41.8 million at September 30, 1997. The increase
was primarily due to increases in investment securities available for sale as
the Company increased its securities portfolio with purchases of tax-exempt
municipal securities.
Loans Held For Sale and Loans Receivable, Net. Aggregate loans receivable
(loans receivable, net, and loans held for sale) increased $8.3 million or 4.3%
to $201.1 million at September 30, 1998 compared to $192.9 million at September
30, 1997 despite increasing levels of loan prepayments due to the declining
interest rate environment. Single-family mortgage loans increased $12.9 million,
or 9.6%, while multi-family and commercial mortgages increased $2.3 million, or
12.3%, for the year ended September 30, 1998.
Mortgage-Related Securities and Mortgage-Related Securities Available For
Sale. Mortgage-related securities and mortgage-related securities available for
sale increased in the aggregate by $9.1 million, or 7.3%, to $134.3 million at
September 30, 1998 compared to $125.2 million at September 30, 1997. The
increase was the result of the Company's continued use of leveraging to increase
interest income.
Non-Performing Assets. The Company's total non-performing loans (including
troubled debt restructurings) and real estate owned increased $1.3 million or
31.7% from $4.1 million, or 1.1%, of total assets at September 30, 1997 to $5.4
million, or 1.0%, of total assets at September 30, 1998. The increase in the
non-performing assets was primarily due to the inclusion in fiscal 1998 of one
loan with a principal balance of approximately $900,000 which is collateralized
by a single-family residence. Non-performing assets consist primarily of
single-family residential loans.
Real estate owned decreased modestly by $9,000 to $1.7 million, or .40%,
of total assets at September 30, 1998 as compared to $1.7 million, or .45%, of
total assets at September 30, 1997.
Deposits. Deposits increased by $19.4 million, or 8.5%, from $227.9
million at September 30, 1997 to $247.3 million at September 30, 1998. This
increase was primarily due to a $17.3 million increase in certificates of
deposit and a $2.1 million, or 33.9%, increase in non-interest bearing accounts
as the Company continues its emphasis in the commercial accounts area. Passbook,
NOW and money market accounts remained relatively unchanged from the prior year.
Borrowings. The Company's total borrowings increased $20.9 million to
$120.9 million at September 30, 1998 from $100.0 million at September 30, 1997.
The FHLB advances were used to fund loan and investment growth and had a
weighted average interest rate of 5.6% at September 30, 1998.
TOTAL ASSETS
(DOLLARS IN THOUSANDS)
[BAR GRAPH]
<TABLE>
<S> <C>
1996 $ 294,241
1997 $ 373,430
1998 $ 415,863
</TABLE>
9
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (CONTINUED)
CHANGES IN FINANCIAL CONDITION (CONTINUED)
Equity. At September 30, 1998, total stockholders' equity was $26.7
million or 6.4% of total assets, compared to $24.8 million or 6.6% of total
assets at September 30, 1997. The $1.9 million increase was due to net income
for the year of $2.8 million and an increase of $1.1 million in unrealized gain
on available for sale securities offset in part by the Company's stock
repurchases and dividends paid aggregating $2.5 million. The slight decrease in
the capital ratio was due to the increase in total assets as the Company
continued to leverage its capital.
Average Balances, Net Interest Income and Yields Earned and Rates Paid.
The following table sets forth, for the periods indicated, information regarding
(i) the total dollar amount of interest income of the Company from
interest-earning assets and the resultant average yields; (ii) the total dollar
amount of interest expense on interest-bearing liabilities and the resultant
average rate; (iii) net interest income; (iv) interest rate spread; and (v) net
interest margin. Information is based on average daily balances during the
indicated periods.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------------------------------------------------------
1998 1997
YIELD/COST ------------------------------- -------------------------------
AT AVERAGE Average
SEPT. 30, AVERAGE YIELD/ Average Yield/
1998 BALANCE INTEREST COST Balance Interest Cost
---------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable(1) (2) 8.05% $197,776 $ 16,447 8.32% $179,566 $ 14,737 8.21%
Mortgage-related securities(2) 6.75 123,283 8,029 6.51 92,393 6,197 6.71
Investment securities(2) 5.99 38,475 2,429 6.31 21,774 1,478 6.79
Other interest-earning assets 5.80 10,585 488 4.61 7,793 338 4.34
- --------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 7.27 370,119 $ 27,393 7.40 301,526 $ 22,750 7.54
Noninterest-earning assets 11,608 11,193
- --------------------------------------------------------------------------------------------------------------------------
Total assets $381,727 $312,719
==========================================================================================================================
Interest-bearing liabilities:
Deposits 4.21 $234,937 $ 9,937 4.23 $221,140 $ 9,182 4.15
FHLB advances and other borrowings 5.68 99,092 5,688 5.74 61,124 3,457 5.65
- --------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 4.69 334,029 15,625 4.68 282,264 12,639 4.47
Noninterest-bearing liabilities 22,730 7,453
- --------------------------------------------------------------------------------------------------------------------------
Total liabilities 356,759 289,717
Stockholders' equity 24,968 23,002
- --------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $381,727 $312,719
==========================================================================================================================
Net interest-earning assets $ 36,090 $ 19,262
==========================================================================================================================
Net interest income/interest rate spread 2.58% $ 11,768 2.72% $ 10,111 3.07%
==========================================================================================================================
Net yield on interest-earning assets(3) 3.18% 3.35%
==========================================================================================================================
Ratio of average interest-earning assets to
average interest-bearing liabilities 110.80% 106.82%
==========================================================================================================================
<CAPTION>
---------------------------------
1996
---------------------------------
Average
Average Yield/
Balance Interest Cost
---------- ----------------------
<S> <C> <C> <C>
Interest-earning assets:
Loans receivable(1) (2) $ 164,359 $ 13,459 8.19%
Mortgage-related securities(2) 80,539 5,229 6.49
Investment securities(2) 11,534 715 6.20
Other interest-earning assets 9,930 434 4.37
- -----------------------------------------------------------------------------
Total interest-earning assets 266,362 $ 19,837 7.45
Noninterest-earning assets 9,325
- ------------------------------------------------------------------------------
Total assets $ 275,687
=============================================================================
Interest-bearing liabilities:
Deposits $220,303 $ 9,363 4.25
FHLB advances and other borrowings 27,119 1,569 5.79
- -----------------------------------------------------------------------------
Total interest-bearing liabilities 247,422 10,932 4.42
Noninterest-bearing liabilities 5,210
- -----------------------------------------------------------------------------
Total liabilities 252,632
Stockholders' equity 22,604
- -----------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 275,687
=============================================================================
Net interest-earning assets $ 18,940
=============================================================================
Net interest income/interest rate spread $ 8,905 3.03%
=============================================================================
Net yield on interest-earning assets(3) 3.34%
=============================================================================
Ratio of average interest-earning assets to
average interest-bearing liabilities 107.65%
=============================================================================
</TABLE>
(1) Includes non-accrual loans.
(2) Includes assets classified as either available for sale or held for sale.
(3) Net interest income divided by interest-earning assets.
10
<PAGE> 11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (CONTINUED)
CHANGES IN FINANCIAL CONDITION (CONTINUED)
Rate/Volume Analysis. The following table describes the extent to which
changes in interest rates and changes in volume of interest-related assets and
liabilities have affected the Company's interest income and expense during the
periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (change in volume multiplied by prior year rate), (ii)
changes in rate (change in rate multiplied by prior year volume), and (iii)
total change in rate and volume. The combined effect of changes in both rate and
volume has been allocated proportionately to the change due to rate and the
change due to volume.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------------------------------------------------
1998 VS. 1997 1997 VS. 1996
--------------------------------------------------------------------
INCREASE INCREASE
(DECREASE) DUE TO (DECREASE) DUE TO
--------------------------------------------------------------------
TOTAL INCREASE TOTAL INCREASE
RATE VOLUME (DECREASE) RATE VOLUME (DECREASE)
--------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earnings assets:
Loans receivable(1) $ 198 $1,512 $1,710 $ 30 $ 1,248 $ 1,278
Mortgage-related securities(1) (174) 2,006 1,832 178 790 968
Investment securities(1) (95) 1,046 951 74 689 763
Other interest-earning assets 22 128 150 (3) (93) (96)
- -----------------------------------------------------------------------------------------------------------------
Total interest-earning assets (49) 4,692 4,643 279 2,634 2,913
- -----------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Deposits 174 581 755 (217) 36 (181)
FHLB advances and other borrowings (2) 2,233 2,231 (34) 1,922 1,888
- -----------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 172 2,814 2,986 (251) 1,958 1,707
- -----------------------------------------------------------------------------------------------------------------
Increase (decrease) in net interest income $(221) $1,878 $1,657 $ 530 $ 676 $ 1,206
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes assets classified as either available for sale or held for sale.
RESULTS OF OPERATIONS
NET INCOME
(Dollars in thousands)
[BAR GRAPH]
<TABLE>
<S> <C>
1995 $ 1,123
1996 $ 1,426
1997 $ 2,637
1998 $ 2,781
</TABLE>
General. The Company reported net income of $2.8 million, $2.6 million and
$885,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
The $144,000 increase in net income for the year ended September 30, 1998
compared to the year ended September 30, 1997 was primarily due to a $1.7
million, or 16.4%, increase in net interest income, a $158,000, or 11.7%,
increase in other income, and a $414,000 decrease in income tax expense offset
by a $2.1 million, or 30.9%, increase in operating expenses. The increase in
operating expenses for the year ended September 30, 1998 was primarily due to
the minority interest expense related to the issuance of certain trust preferred
securities.
The $1.7 million increase in net income for the year ended September 30,
1997 compared to the year ended September 30, 1996 was primarily due to a $1.2
million, or 13.5%, increase in net interest income, a $1.7 million, or 19.9%,
decrease in operating expenses and a $1.0 million decrease in the provision for
loan losses offset in part by a $2.2 million increase in income taxes. The
decrease in operating expenses for the year ended September 30, 1997 as compared
to fiscal 1996 was primarily due to the one-time SAIF special assessment
recognized in fiscal 1996. Excluding this assessment, net income increased $1.1
million in fiscal 1997, an increase of 73.1% over that earned in fiscal 1996.
Net Interest Income. Net interest income is determined by interest rate
spread (i.e., the difference between the yields earned on interest-earning
assets and the rates paid on interest-bearing liabilities) and the relative
amounts of interest-earning assets and interest-bearing liabilities. The
Company's average interest-rate spread was 2.72%, 3.07% and 3.03% during the
years ended September 30, 1998, 1997 and 1996, respectively. The Company's
interest-rate spread was 2.58% at September 30, 1998. The Company's net interest
margin (i.e., net interest income as a percentage of average interest-earning
11
<PAGE> 12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
assets) was 3.18%, 3.35% and 3.34% during the years ended September 30, 1998,
1997 and 1996, respectively. In fiscal 1998, the Company's net interest spread
and net interest margin were impacted by the relatively flat yield curve in
which assets have repriced at lower interest rate levels than liabilities.
NET INTEREST INCOME
(DOLLARS IN THOUSANDS)
[BAR GRAPH]
<TABLE>
<S> <C>
1995 $ 7,528
1996 $ 8,905
1997 $ 10,111
1998 $ 11,768
</TABLE>
Net interest income increased by $1.7 million, or 16.4%, in the year ended
September 30, 1998 to $11.8 million compared to $10.1 million in fiscal 1997.
The reason for such increase was a $4.6 million, or 20.4%, increase in interest
income partially offset by a $3.0 million, or 23.6%, increase in interest
expense. Net interest income increased by $1.2 million, or 13.5%, in fiscal 1997
compared to fiscal 1996 due to a $2.9 million, or 14.7%, increase in total
interest income offset in part by a $1.7 million, or 15.6%, increase in total
interest expense.
Interest Income. Total interest income amounted to $27.4 million for the
year ended September 30, 1998 compared to $22.8 million for the year ended
September 30, 1997. The primary reason for the increase in the 1998 period was a
$2.9 million, or 36.6%, increase in interest income from mortgage-related
securities, investments and other interest-earning assets as a result of a $50.4
million, or 41.3%, increase in the average balance thereof. Such increase was
partially offset by a 22 basis point (with 100 basis points being equal to 1.0%)
decrease in the yield earned thereon. The increase in the average balances was
due to increased leveraging of the Company's capital base while the decrease in
the yield reflected the effects of both purchases of lower yielding tax free
municipal obligations as well as the declining interest rate environment
existing during fiscal 1998. In addition, interest income from loans increased
$1.7 million, or 11.6%, due to a $18.2 million, or 10.1%, increase in the
average loan balance and a 11 basis point increase in the yield earned thereon.
The increase in the average balance of the loan portfolio in fiscal 1998
reflected increased originations of primarily fixed-rate loans held in
portfolio.
The $2.9 million, or 14.7%, increase in total interest income during the
year ended September 30, 1997 over 1996 was primarily due to a $1.6 million, or
25.6%, increase in interest income from mortgage-related securities, investments
and other interest-earning assets as a result of a $20.0 million, or 19.6%,
increase in the average balance thereof and a 32 basis point increase in the
yield earned thereon. The increase in the average balances and the yield was due
to increased leveraging of the Company's capital base during fiscal 1997 and
investment in higher yielding assets. Additionally, interest income on loans
increased $1.3 million, or 9.5%, due to a $15.2 million, or 9.3%, increase in
the average balance of the loan portfolio and a 2 basis point increase in the
average yield earned thereon. The increase in the average balance of the loan
portfolio in fiscal 1997 reflects increased originations of both fixed and
adjustable-rate loans held in portfolio.
Interest Expense. Total interest expense increased by $3.0 million, or
23.6%, in the year ended September 30, 1998 compared to fiscal 1997. The reason
for such increase was a $2.2 million increase in interest expense on borrowings
and $755,000 increase in interest expense on deposits. The increase in interest
expense on borrowings was due to a $38.0 million increase in the average balance
of total borrowings and a 9 basis point increase in the average rate paid
thereon. The increase in interest paid on deposits was due to a $13.8 million
increase in the average balance of deposits combined with an 8 basis point
increase in the average rate paid. The increase in the average balances of
deposits and borrowings was used to fund loan originations and purchases of
investment securities. The modest increase in the rates paid on deposits and
borrowings was due to general market interest rate fluctuations.
Total interest expense amounted to $12.6 million for the year ended
September 30, 1997 as compared to $10.9 million for fiscal 1996. The $1.7
million, or 15.6%, increase in interest expense in fiscal 1997 compared to
fiscal 1996 was due to a $1.9 million increase in interest expense on borrowings
offset partially by a $181,000 decrease in interest expense on deposits. The
increase in interest expense on borrowings was due to a $34.0 million increase
in the average balance partially offset by a 14 basis
12
<PAGE> 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
point decline in the average rate paid on borrowings. The decrease in interest
paid on deposits was due to an 10 basis point decline in the average rate paid
on deposits offset in part by a $837,000 increase in the average balance of
deposits. The increase in the average balances of borrowings and deposits was
used to fund mortgage originations and the purchase of mortgage-related and
investment securities. The decrease in the average rate paid on deposits and
borrowings was due to general market interest rate fluctuations.
OTHER INCOME
(DOLLARS IN THOUSANDS)
[BAR GRAPH]
<TABLE>
<S> <C>
1996 $ 1,308
1997 $ 1,350
1998 $ 1,543
</TABLE>
Provisions for Loan Losses. Provisions for loan losses are charged to
earnings to bring the total allowance for loan losses to a level considered
appropriate by management based on historical experience, the volume and type of
lending conducted by the Company, the amount of the Company's classified assets,
the status of past due principal and interest payments, general economic
conditions, particularly as they relate to the Company's primary market area,
and other factors related to the collectibility of the Company's loan and loans
held for sale portfolios. Management of the Company assesses the allowance for
loan losses on a monthly basis and makes provisions for loan losses as deemed
appropriate in order to maintain the adequacy of the allowance for loan losses.
For the year ended September 30, 1998, the provision for loan losses amounted to
$186,000 as compared to $239,000 for fiscal 1997. For the year ended September
30, 1996, the provision for loan losses was $1.2 million. The substantial
provision established for potential losses in fiscal 1996 related to the Bennett
Funding bankruptcies which were resolved in fiscal 1997. At September 30, 1998,
the Company's allowance for loan losses amounted to 46.9% of total
non-performing loans and .87% of gross loans receivable.
Although management of the Company believes that the Company's allowance
for loan losses was adequate at September 30, 1998, based on facts and
circumstances available to it, there can be no assurances that additions to such
allowance will not be necessary in future periods, which would adversely affect
the Company's results of operations for such periods. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's provision for loan losses and the carrying
value of its other non-performing assets based on their judgments about
information available to them at the time of their examination.
Other Income. For the year ended September 30, 1998, the Company reported
other income of $1.5 million compared to $1.4 million for the year ended
September 30, 1997. The primary reason for the $158,000 or 11.7% increase in
other income in fiscal 1998 was a $241,000 increase in net gain on sales of
mortgage loans held for sale and a $51,000 gain on the sale of investments and
mortgage-related securities partially offset by a decrease of $74,000 in service
charges and other fees.
The $42,000, or 3.2%, increase in other income for the year ended
September 30, 1997 as compared to fiscal 1996 was due to increases in gains on
sales of mortgage loans of $76,000 and gain on sale of other assets of $46,000
partially offset by a decrease of $75,000 in service charges and other fees. The
increase in gains on sales of loans for fiscal 1998 and 1997 reflected the
Company's increased emphasis on the origination and sale, servicing released, of
non-conforming loans. See Note 6 to the Consolidated Financial Statements.
Operating Expenses. Operating expenses include compensation and employee
benefits, occupancy and equipment expense, Federal Deposit Insurance Corporation
("FDIC") insurance premiums, data processing expense and other items. Operating
expenses increased $2.1 million, or 30.9%, for the year ended September 30, 1998
compared to the year ended September 30, 1997 and amounted to $9.1 million in
fiscal 1998 compared to $6.9 million in fiscal 1997. The primary reason for the
substantially higher level of operating expenses for fiscal 1998 was the $1.6
million minority interest in expense of subsidiary relating to the issuance of
trust preferred securities by the Company. See Note 20 to the Consolidated
Financial Statements for further information regarding the trust preferred
securities. Also contributing to the increase was a $468,000, or 14.7% increase
in compensation expense, a $241,000, or 30.2% increase in other expenses, and a
$155,000, or 18.1%, increase in occupancy and equipment
13
<PAGE> 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
expense partially offset by a $153,000, or 20.9%, decrease in professional fees
and a $62,000, or 30.0%, decrease in FDIC insurance premiums. Expansion of the
branch network contributed to both the increased occupancy and equipment expense
and compensation expense. Compensation expense also increased due to general
salary increases as well as increased costs associated with the market value
accounting for the employee stock ownership plan in accordance with Statement of
Position 93-6. The increase in other expenses was due to a provision established
for the Company's real estate owned property.
Operating expenses decreased $1.7 million, or 19.9%, to $6.9 million for
the year ended September 30, 1997 compared to the year ended September 30, 1996.
The primary reason for the decrease in operating expenses in fiscal 1997 was the
one-time Savings Association Insurance Fund ("SAIF") special assessment of $1.4
million relating to deposit insurance charged in fiscal 1996. The special
assessment was the result of legislation enacted in the fall of 1996 which was
designed to recapitalize the SAIF insurance fund to the 1.25% of total insured
deposits required by the FDIC. The recapitalization decreased the amount of
insurance that the Company now pays to insure deposit accounts from $.23 per
$100 of deposits to $.065 per $100, which amount effectively reflects the amount
required to be paid by SAIF-insured institutions to pay the debt service on
bonds issued by the Financing Corporation. FDIC insurance premium expense was
reduced by $323,000, or 60.9% for fiscal 1997. Also contributing to the decrease
in operating expenses was a $311,000 charge to earnings in fiscal 1996 for
certain costs relating to the restructuring that the Company effected in fiscal
1996. Offsetting these decreases were modest increases in advertising, other
expenses and a $153,000 expense for minority interests in expense of
subsidiaries which relates to expenses incurred from the issuance of the
Company's trust preferred securities.
Income Taxes. The Company recognized income tax expenses of $1.3 million,
or 31.0%, of pre-tax income, for the year ended September 30, 1998, compared to
$1.7 million, or 38.7%, of pre-tax income, for the year ended September 30,
1997. The primary reason for the decrease in the percentage of tax expense was
the reduction in state income taxes and the increase in tax-free income
resulting from purchases of tax-exempt securities, as the Company employed
various strategies to reduce both federal and state income taxes. The Company
recognized an income tax benefit of $567,000 for fiscal 1996. The benefit in
fiscal 1996 was the result of an adjustment for prior year tax contingencies of
approximately $700,000. Excluding this benefit, the income tax expense would
have been $133,000, or 41.8%, of pre-tax income.
Federal legislation enacted in August 1996 repealed the percentage of
taxable income method of accounting for bad debts for thrift institutions
effective for years beginning after December 31, 1995. The Company was required
as of October 1, 1996 to adopt the experience method computation for bad debts
and to provide for taxes relating to excess bad debts reserves over the base
year of December 1987. As of September 30, 1998, the Company has provided
deferred income taxes totalling $74,000 on its excess bad debt reserves.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity, represented by cash and cash equivalents, is a
product of its operating, investing and financing activities. The Company's
primary sources of funds are deposits, amortization, prepayments and maturities
of outstanding loans and mortgage-related securities, sales of loans, maturities
of investment securities and other short-term investments, borrowings and funds
provided from operations. While scheduled payments from the amortization of
loans and mortgage-related securities and maturing investment securities and
short-term investments are relatively predictable sources of funds, deposit
flows and loan prepayments are greatly influenced by general interest rates,
economic conditions and competition. In addition, the Company invests excess
funds in overnight deposits and other short-term interest-earning assets which
provide liquidity to meet lending
14
<PAGE> 15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
requirements. The Company has the ability to obtain advances from the FHLB of
Pittsburgh through several credit programs and in addition, has established a
line of credit with the FHLB in an amount not to exceed 10% of assets and
subject to certain conditions, including holding a predetermined amount of FHLB
stock as collateral. This line of credit is used from time to time for liquidity
purposes. As an additional source of funds, the Company has access to the
Federal Reserve discount window, but only after it has exhausted its access to
the FHLB of Pittsburgh. At September 30, 1998, the Company had $101.6 million of
outstanding advances from the FHLB of Pittsburgh.
LOANS RECEIVABLE
(DOLLARS IN THOUSANDS)
[BAR GRAPH]
<TABLE>
<S> <C>
1996 $ 167,530
1997 $ 188,289
1998 $ 198,343
</TABLE>
Liquidity management is both a daily and long-term function of business
management. Excess liquidity is generally invested in short-term investments
such as overnight deposits. On a longer term basis, the Company maintains a
strategy of investing in various lending products and mortgage-related
securities. The Company uses its sources of funds primarily to meet its ongoing
commitments, to pay maturing savings certificates and savings withdrawals, fund
loan commitments and maintain a portfolio of mortgage-backed and investment
securities. At September 30, 1998, the total of approved loan commitments
outstanding amounted to $11.8 million. At the same date, commitments under
unused lines of credit and loans in process on construction loans amounted to
$14.6 million. Certificates of deposit scheduled to mature in one year or less
at September 30, 1998 totalled $113.8 million. Based upon its historical
experience, management believes that a significant portion of maturing deposits
will remain with the Company.
The Company is required by the Office of Thrift Supervision ("OTS") to
maintain average daily balances of liquid assets, defined as a ratio of cash and
certain marketable securities that can be readily converted into cash to total
deposits and short-term borrowings, of 4% to assure its ability to meet demand
for withdrawals and repayment of short-term borrowings. The Company's liquidity
ratio under these guidelines was 4.98% for the quarter ended September 30, 1998.
The OTS requires that the Bank meet minimum regulatory tangible, core,
tier 1 risk-based and total risk-based capital requirements. At September 30,
1998, the Bank exceeded all regulatory capital requirements and was deemed a
well capitalized institution for regulatory purposes. See Note 13 to the
Consolidated Financial Statements.
The Company's assets consist primarily of its investment in the Bank and
investments in various corporate debt and equity instruments and its only
material source of income consists of earnings from its investment in the Bank
and interest and dividends earned on other investments. The Company, as a
separately incorporated holding company, has no significant operations other
than serving as the sole stockholder of the Bank and paying interest to its
subsidiary for junior subordinated debt in conjunction with the issuance of
trust preferred securities. On an unconsolidated basis, the Company has no paid
employees. The expenses incurred by the Company relate to its reporting
obligations under the Securities Exchange Act of 1934, related expenses incurred
as a publicly traded company, and expenses relating to the issuance of the trust
preferred securities. Management believes that the Company has adequate
liquidity available to respond to its liquidity demands. Under applicable
federal regulations, the Bank may pay dividends within certain limits after
providing written notice to the OTS. See Note 21 to the Consolidated Financial
Statements.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which requires an entity to present, as a component of comprehensive income, the
amounts from transactions and other events which currently are excluded from the
statement of income and are recorded directly to stockholders' equity.
15
<PAGE> 16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)
Also in June 1997, FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information" which requires an entity to disclose
information in a manner consistent to internally used information and requires
more detailed disclosures of operating and reporting segments than are currently
in practice. In February 1998, the FASB issued SFAS No. 132, "Employers'
Disclosure About Pensions and Other Postretirement Benefits." This statement
revises employers' disclosures about pension and other postretirement benefit
plans. It does not change the measurement or recognition of those plans. These
statements are effective for fiscal years beginning after December 15, 1997.
Management has not completed an analysis of the effect the adoption of the
statements will have on the Company's financial condition or results of
operations.
In June 1998, SFAS No 133, "Accounting for Derivative Instruments and
Hedging Activities," was issued. This statement requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial condition and measure those instruments at fair value. The accounting
for changes in the fair value of a derivative depends on the intended use of the
derivative and the resulting designation. This statement is effective for fiscal
years beginning after June 15, 1999, and will not be applied retroactively to
financial statements of prior periods. Management of the Company does not
believe this statement will have a material impact on the Company financial
position or results of operations when adopted.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements of the Company and related notes
presented herein have been prepared in accordance with generally accepted
accounting principles which require the measurement of financial position and
operating results in terms of historical dollars, without considering changes in
the relative purchasing power of money over time due to inflation.
Unlike most industrial companies, substantially all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or in the same magnitude as the
prices of goods and services, since such prices are affected by inflation to a
larger extent than interest rates. In the current interest rate environment,
liquidity and the maturity structure of the Company's assets and liabilities are
critical to the maintenance of acceptable performance levels.
YEAR 2000 ISSUES
(YEAR 2000 READINESS DISCLOSURE STATEMENT)
In order to be ready for the year 2000 (the "Year 2000 Issue"), the
Company has developed a Year 2000 Policy (the "Policy") which was presented to
the Board of Directors during June 1997. The Policy was developed using the
guidelines outlined in the Federal Financial Institutions Examination's
Council's "The Effect of 2000 on Computer Systems". The Board of Director and
their Executive Committee assigned responsibility for the Policy to the Year
2000 Committee, which reports to the Board of Directors on a monthly basis. The
Policy recognizes that the Company's operating, processing and accounting
operations are computer reliant and could be affected by the Year 2000 Issue.
The Company is primarily reliant on third party vendors for its computer output
and processing, as well as other significant functions and services (i.e.,
securities safekeeping services, securities pricing information, etc.). The Year
2000 Committee is continually working with these third party vendors to assess
their year 2000 readiness. Based upon the initial assessment, management
presently believes that with planned modifications to existing software and
hardware and planned conversions to new software and hardware, the Company's
third party vendors are taking the appropriate steps to ensure critical systems
will function properly. The Company has identified 63 priority 1 (directly
effects customers) and 58 priority 2 (effects employee's ability to service
customers) third party vendors. Of such priority 1 and priority 2 vendors, the
Company has been informed that 33% are already Year 2000 compliant. The
Company's data service processing vendor, which is our major software provider,
has informed the
16
<PAGE> 17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
Financial Conditions and Results of Operations (continued)
YEAR 2000 ISSUES (CONTINUED)
Company that it expects to complete testing of its updated systems (in which
testing the Company has been involved) by the end of April 1999. The initial
phase of testing of the data service processor's updated system will be
completed in February 1999. Substantially all of the Company's vendors of its
priority 1 and priority 2 applications (discussed below) have provided
assurances, written or oral, that they are working to make their products and
services Year 2000 compliant. The Company currently expects the majority of such
modifications and conversions and related testing of such systems to be
completed by December 31, 1998 with any remaining ones being completed by March
31, 1999. While the Company has received assurances from such vendors as to
compliance, such assurances are not guarantees and may not be enforceable. The
Company's existing older contracts with such vendors do not include Year 2000
certifications or warranties. Thus, in the event such vendor's products and/or
services are not Year 2000 compliant, the Company's recourse in the event of
such failure maybe limited. If the required modifications and conversions are
not made, or are not completed on a timely basis, the Year 2000 Issue could have
a material impact on the operations of the Company. There can be no assurance
that potential system interruptions or unanticipated additional expense incurred
to obtain Year 2000 compliance would not have a material adverse effect on the
Company's business, financial condition, results of operations and business
prospects. Nevertheless, the Company does not believe that the cost of
addressing the Year 2000 issues will be a material event or uncertainty that
would cause reported financial information not to be necessarily indicative of
future operating results or financial conditions, nor does it believe that the
costs or the consequences of incomplete or untimely resolution of its Year 2000
issues represents a known material event or uncertainty that is reasonably
likely to affect its future financial results, or cause its reported financial
information not to be necessarily indicative of future operating results or
future financial condition. The Year 2000 issues also affect certain of the
Company's customers, particularly in the areas of access to funds and additional
expenditures to achieve compliance. As of February 28, 1998, the Company had
contacted all of its commercial credit customers (19 borrowers with loans
outstanding aggregating $10.0 million) regarding the customers awareness of the
Year 2000 Issue. While no assurance can be given that the customers will be Year
2000 compliant, management believes, based on representations of such customers
and reviews of their operations (including assessments of the borrowers' level
of sophistication and data and record keeping requirements), that the customers
are either addressing the appropriate issues to insure compliance or that they
are not faced with material Year 2000 issues. In substantially all cases the
credit extended to such borrowers is collateralized by real estate which
inherently minimizes the Company's exposure in the event that such borrowers do
experience problems becoming Year 2000 compliant. The Company has completed its
own company-wide Year 2000 contingency plan. Individual contingency plans
concerning specific software and hardware issues and operational plans for
continuing operations were completed for a substantial majority of its mission
critical hardware and software applications as of September 15, 1998 with the
remainder expected to be completed by the end of 1998. The Year 2000 Committee
has reviewed substantially all mission critical test plans and contingency plans
to ensure the reasonableness of the plans. Testing began on mission critical
systems in August 1998 and planned completion of testing of a majority of such
systems is expected by December 1998 with the remainder by March 31, 1999. The
Company has completed contingency plans for substantially all priority 1 and
priority 2 applications. The Company is working to develop contingency plans for
the remainder by the end of 1998 including working on contingency plans which
address operational policies and procedures in the event of data processing,
electric power supply and/or telephone service failures associated with the Year
2000. Such contingency plans provide documented actions to allow the Company to
maintain
17
<PAGE> 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (CONTINUED)
YEAR 2000 ISSUES (CONTINUED)
and/or resume normal operations in the event of the failure of priority 1 and
priority 2 applications. Such plans identify participants, processes and
equipment that will be necessary to permit the Company to continue operations.
Such plans may include providing off-line system processing, back-up electrical
and telephone systems and other methods to ensure the Company's ability to
continue to operate. The costs of modifications to the existing software is
being primarily absorbed by the third party vendors. The Company recognizes that
the need exists to purchase new hardware and software regardless of year 2000
implications. Based upon current estimates, the Company has identified the
hardware and software that would have to be replaced, and have found the amounts
to not be material and in line with normal expenditures for technology upgrades.
The Company is being charged $25,000 to participate in the data service
processor year 2000 test system. As of September 30, 1998, the Company has
incurred $13,328 of that cost.
FORWARD LOOKING STATEMENTS
In this Report, the Company has included certain "forward looking
statements" concerning the future operations of the Company. It is management's
desire to take advantage of the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995. This statement is for the express
purpose of availing the Company of the protections of such safe harbor with
respect to all "forward looking statements" contained in this Report. The
Company has used "forward looking statements" to describe the future plans and
strategies including management's expectations of the Company's Year 2000
readiness and future financial results. Management's ability to predict results
or the effect of future plans and strategy is inherently uncertain. Factors that
could affect results include interest rate trends, competition, the general
economic climate in Delaware and Chester Counties, the mid-Atlantic region and
the country as a whole, loan delinquency rates, changes in federal and state
regulation, Year 2000 uncertainties and other uncertainties described in the
Company's filings with the Securities and Exchange Commission, including its
Form 10-K for the year ended September 30, 1998. These factors should be
considered in evaluating the "forward looking statements", and undue reliance
should not be placed on such statements.
18
<PAGE> 19
[DELOITTE & TOUCHE LOGO]
Board of Directors
First Keystone Financial, Inc. and Subsidiaries
Media, Pennsylvania 19063
We have audited the accompanying consolidated statements of financial
condition of First Keystone Financial, Inc. and Subsidiaries (the "Company") as
of September 30, 1998 and 1997, and the related consolidated statements of
income, stockholders' equity and cash flows for each of the three years in the
period ended September 30, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
First Keystone Financial, Inc. and Subsidiaries at September 30, 1998 and 1997
and the results of their operations and their cash flows for each of the three
years in the period ended September 30, 1998 in accordance with generally
accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Philadelphia, Pennsylvania
November 6, 1998
DELOITTE TOUCHE TOHMATSU INTERNATIONAL
19
<PAGE> 20
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share data)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SEPTEMBER 30
-----------------------
1998 1997
-----------------------
<S> <C> <C>
ASSETS
Cash and amounts due from depository institutions $ 2,457 $ 1,832
Interest-bearing deposits with depository institutions 21,669 19,729
- ----------------------------------------------------------------------------------------------------
Total cash and cash equivalents 24,126 21,561
Investment securities available for sale 40,621 10,211
Mortgage-related securities available for sale 115,486 104,472
Loans held for sale 2,799 4,577
Investment securities held to maturity--at amortized
cost (approximate fair value of $9,960) 10,000
Mortgage-related securities held to maturity--at
amortized cost (approximate fair value of $18,700
and $20,200 at September 30, 1998 and 1997,
respectively) 18,769 20,707
Loans receivable--net 198,343 188,289
Accrued interest receivable 3,117 2,565
Real estate owned 1,663 1,672
Federal Home Loan Bank stock--at cost 5,079 3,769
Office properties and equipment--net 2,612 2,552
Deferred income taxes 283 680
Prepaid expenses and other assets 2,965 2,375
- ----------------------------------------------------------------------------------------------------
Total Assets $ 415,863 $ 373,430
====================================================================================================
LIABILITIES, MINORITY INTEREST IN SUBSIDIARY
AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 247,311 $ 227,918
Advances from Federal Home Loan Bank 101,578 75,387
Securities sold under agreements to repurchase 19,300 24,600
Accrued interest payable 1,683 1,575
Advances from borrowers for taxes and insurance 1,036 913
Accounts payable and accrued expenses 2,091 2,085
- ----------------------------------------------------------------------------------------------------
Total liabilities 372,999 332,478
- ----------------------------------------------------------------------------------------------------
Guaranteed preferred beneficial interest in
subordinated debt 16,200 16,200
- ----------------------------------------------------------------------------------------------------
Stockholders' Equity:
Preferred stock, $.01 par value, 10,000,000 shares
authorized; none issued
Common stock, $.01 par value, 20,000,000 shares authorized; issued and
outstanding; September 30, 1998 and 1997, 2,329,216
and 2,585,000 shares, respectively 14 14
Additional paid in capital 13,204 12,896
Common stock acquired by stock benefit plans (1,789) (2,038)
Treasury stock at cost, 390,784 and 263,162 shares
at September 30, 1998 and 1997, respectively (4,575) (2,545)
Unrealized gain on available for
sale securities--net of tax 1,487 408
Retained earnings--partially restricted 18,323 16,017
- ----------------------------------------------------------------------------------------------------
Total stockholders' equity 26,664 24,752
- ----------------------------------------------------------------------------------------------------
Total Liabilities, Minority Interest in Subsidiary
and Stockholders' Equity $415,863 $ 373,430
====================================================================================================
</TABLE>
See notes to consolidated financial statements.
20
<PAGE> 21
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(dollars in thousands, except per share data)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30
----------------------------------
1998 1997 1996
----------------------------------
<S> <C> <C> <C>
INTEREST INCOME:
Interest on:
Loans $ 16,447 $ 14,737 $ 13,459
Mortgage-related securities 8,029 6,197 5,229
Investments 2,429 1,478 715
Interest-bearing deposits 488 338 434
- -----------------------------------------------------------------------------------------
TOTAL INTEREST INCOME 27,393 22,750 19,837
- -----------------------------------------------------------------------------------------
INTEREST EXPENSE:
Interest on:
Deposits 9,937 9,182 9,363
Federal Home Loan Bank advances 4,206 3,381 1,569
Securities sold under agreements to repurchase 1,482 76
- -----------------------------------------------------------------------------------------
TOTAL INTEREST EXPENSE 15,625 12,639 10,932
- -----------------------------------------------------------------------------------------
Net interest income 11,768 10,111 8,905
Provision for loan losses 186 239 1,250
- -----------------------------------------------------------------------------------------
Net interest income after provision for loan losses 11,582 9,872 7,655
- -----------------------------------------------------------------------------------------
OTHER INCOME (LOSS):
Service charges and other fees 898 972 1,047
Net gain (loss) on sale of:
Investments and mortgage-related securities 51 (6)
Loans held for sale 526 285 209
Real estate owned 7 32 34
Other assets 1 46
Real estate operations (32) (25) (32)
Other income 57 40 56
- -----------------------------------------------------------------------------------------
TOTAL OTHER INCOME 1,508 1,350 1,308
- -----------------------------------------------------------------------------------------
OPERATING EXPENSES:
Salaries and employee benefits 3,642 3,174 3,236
Occupancy and equipment 1,013 858 1,022
Professional fees 580 733 793
Federal deposit insurance premium 145 207 530
SAIF special assessment 1,426
Bank service charges 417 384 401
Data processing 360 335 337
Advertising 293 280 201
Minority interest in expense of subsidiary 1,571 153
Other 1,038 797 699
- -----------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 9,059 6,921 8,645
- -----------------------------------------------------------------------------------------
Income before income tax expense (benefit) 4,031 4,301 318
Income tax expense (benefit) 1,250 1,664 (567)
- -----------------------------------------------------------------------------------------
NET INCOME $ 2,781 $ 2,637 $ 885
=========================================================================================
EARNINGS PER COMMON SHARE:
Basic $ 1.31 $ 1.20 $ 0.37
Diluted $ 1.23 $ 1.13 $ 0.37
</TABLE>
See notes to consolidated financial statements.
21
<PAGE> 22
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNREALIZED
COMMON GAIN (LOSS)ON
STOCK SECURITIES TOTAL
ADDITIONAL ACQUIRED BY AVAILABLE STOCK-
COMMON PAID-IN STOCK BENEFIT TREASURY FOR SALE RETAINED HOLDERS'
STOCK CAPITAL PLANS STOCK (NET OF TAX) EARNINGS EQUITY
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at October 1, 1995 $ 14 $ 12,568 $(1,006) $ 142 $12,745 $24,463
Common stock acquired
by stock benefit plans (704) (704)
ESOP stock committed
to be released 109 109
Excess of fair value above
cost of ESOP shares
committed to be released 91 91
RRP amortization 164 164
Net unrealized loss relating to
transfer of securities from held
to maturity to available for sale,
net of tax (227) (227)
Net unrealized loss on securities
available for sale, net of tax (409) (409)
Purchase of treasury stock $ (1,288) (1,288)
Net income 885 885
- ------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1996 14 12,659 (1,437) (1,288) (494) 13,630 23,084
Common stock acquired
by stock benefit plans (775) (775)
ESOP stock committed
to be released 33 33
Excess of fair value above
cost of ESOP and RRP shares
committed to be released 237 237
RRP amortization 141 141
Net unrealized gain on securities
available for sale, net of tax 902 902
Exercise of stock options 11 11
Purchase of treasury stock (1,268) (1,268)
Dividends paid (250) (250)
Net income 2,637 2,637
- ------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1997 14 12,896 (2,038) (2,545) 408 16,017 24,752
ESOP stock committed
to be released 108 108
Excess of fair value above
cost of ESOP and RRP shares
committed to be released 308 308
RRP amortization 141 141
Net unrealized gain on securities
available for sale, net of tax 1,079 1,079
Exercise of stock options 6 6
Purchase of treasury stock (2,036) (2,036)
Dividends paid (475) (475)
Net income 2,781 2,781
- ------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1998 $ 14 $ 13,204 $(1,789) $ (4,575) $ 1,487 $18,323 $26,664
==============================================================================================================================
</TABLE>
See notes to consolidated financial statements.
22
<PAGE> 23
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30
------------------------------------
1998 1997 1996
------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 2,781 $ 2,637 $ 885
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for depreciation and amortization 453 364 520
Amortization of discounts (609) (872) (161)
Gain (Loss) on sales of:
Loans held for sale (526) (285) (209)
Investments and mortgage-related
securities available for sale (51) 6
Real estate owned (7) (32) (34)
Other assets (1) (46)
Provision for loan losses 186 239 1,250
Provision for real estate owned losses 200
Amortization of stock benefit plans 563 422 364
Changes in assets and liabilities which provided (used) cash:
Origination of loans held for sale (56,398) (37,209) (30,239)
Loans sold in the secondary market 58,176 35,079 27,849
Deferred income taxes (112) 862 (700)
Accrued interest receivable (552) (161) 3
Prepaid expenses and other assets (590) (740) (297)
Accrued interest payable 108 74 405
Accounts payable and accrued expenses 6 (705) 569
- ---------------------------------------------------------------------------------------------------------
Net cash (used in) provided by operating activities 3,627 (373) 211
- ---------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Loans originated or acquired (64,979) (56,049) (52,056)
Purchases of:
Investments held to maturity (2,000) (12,000)
Investments available for sale (40,892) (6,030) (18,000)
Mortgage-related securities held to maturity (2,687) (4,013)
Mortgage-related securities available for sale (52,422) (51,654) (25,770)
Purchase of FHLB stock (1,310) (1,432) (845)
Proceeds from sales of investment and
mortgage-related securities available for sale 20,299 17,790
Proceeds from sales of real estate owned 1,451 944 1,009
Proceeds from sales of other assets 30 101
Principal collected on loans 55,694 35,418 40,160
Proceeds from maturities, calls or repayments of:
Investment securities available for sale 5,070 12,500 3,065
Mortgage-related securities available for sale 28,129 9,243 3,908
Investment securities held to maturity 12,000 2,000 4,000
Mortgage-related securities held to maturity 4,663 2,483 8,347
Purchase of property and equipment (542) (409) (84)
Net expenditures on real estate acquired through
foreclosure and in development (1,462) (734) (371)
- ---------------------------------------------------------------------------------------------------------
Net cash (used in) investing activities (38,958) (65,619) (22,860)
- ---------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net increase (decrease) in deposit accounts 19,393 8,713 (4,548)
Net proceeds from FHLB and other borrowings 20,891 53,247 18,329
Net increase (decrease) in advances from
borrowers for taxes and insurance 123 (8) (114)
Proceeds from issuance of capital securities 16,200
Common stock acquired by stock benefit plans (775) (704)
Purchase of treasury stock (2,036) (1,268) (1,288)
Cash dividends (475) (250)
- ---------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 37,896 75,859 11,675
- ---------------------------------------------------------------------------------------------------------
Increase (Decrease) in cash and cash equivalents 2,565 9,867 (10,974)
Cash and cash equivalents at beginning of year 21,561 11,694 22,668
- ---------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 24,126 $ 21,561 $ 11,694
- ---------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash payments for interest on deposits and borrowings $ 15,517 $ 12,600 $ 10,500
Cash payments of income taxes 1,150 630 720
Transfers of loans receivable into real estate owned 207 411 1,768
Transfers of investment securities to investment
securities available for sale 6,710
Transfers of mortgage-related securities to
mortgage-related securities available for sale 43,823
=========================================================================================================
</TABLE>
See notes to consolidated financial statements.
23
<PAGE> 24
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
1. NATURE OF OPERATIONS AND ORGANIZATION STRUCTURE
On September 21, 1994, the Board of Directors of First Keystone Federal
Savings Bank (the "Bank") adopted a plan of conversion to convert from a
federally chartered mutual savings bank to a federally chartered capital stock
savings bank with the concurrent formation of a holding company (the
"Conversion").
The Conversion was completed on January 25, 1995 with the issuance by
the holding company, First Keystone Financial, Inc. (the "Company"), of
1,360,000 shares of its common stock in a public offering to the Bank's eligible
depositors and borrowers, members of the general public and the Bank's employee
stock ownership plan (the "ESOP"). In exchange for the net conversion proceeds
of $11.5 million, less $1.0 million retained by the Company, the Company
acquired 100% of the issued and outstanding capital stock of the Bank.
The Bank is principally in the business of attracting deposits through
its branch offices and investing those deposits together with funds from
borrowings and operations in single-family residential, commercial real estate
and commercial business loans. The Bank is primarily supervised and regulated by
the Office of Thrift Supervision ("OTS").
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of the Company, the Bank, and the Bank's wholly-owned subsidiaries. Intercompany
accounts and transactions have been eliminated in consolidation.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of income and expenses during the
reporting period. Actual results could differ from those estimates.
SECURITIES HELD TO MATURITY AND SECURITIES AVAILABLE FOR SALE
Securities held to maturity are carried at amortized cost only if the
Company has the positive intent and ability to hold these securities to
maturity. Securities available for sale are carried at fair value with resulting
unrealized gains or losses recorded to equity, net of tax. At September 30, 1998
and 1997, there were no securities held in a trading account.
In November 1995, the Financial Accounting Standards Board (the "FASB")
issued a special report, "A Guide to Implementation of Statement 115 on
Accounting for Certain Investments in Debt and Equity Securities" (the
"Questions and Answers Guide"). In December 1995, in accordance with the
provisions of the Questions and Answers Guide, the Company reclassified certain
securities with an aggregate amortized cost of $50.5 million from held to
maturity to available for sale. The Questions and Answers Guide provided that
reclassifications from the held-to-maturity category that resulted from this
one-time reassessment would not call into question the intent of an enterprise
to hold other debt securities to maturity in the future.
ALLOWANCE FOR LOAN LOSSES
An allowance for loan losses is maintained at a level that management
considers adequate to provide for probable losses based upon an evaluation of
known and inherent risks in the loan portfolio. Management's evaluation of the
portfolio is based upon past loss experience, current economic conditions and
other relevant factors. While management uses the best information available to
make such evaluation, future adjustments to the allowance may be necessary if
conditions differ substantially from the assumptions used in making the
evaluations.
The Company accounts for impaired loans in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 114 "Accounting by Creditors for
Impairment of a Loan" and No. 118, "Accounting by Creditors for
24
<PAGE> 25
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Impairment of a Loan - Income Recognition and Disclosures." Impaired loans are
predominantly measured based on the fair value of the collateral. The provision
for loan losses charged to expense is based upon past loan loss experience and
an evaluation of possible losses and impairment existing in the current loan and
lease portfolio. A loan is considered to be impaired when, based upon current
information and events, it is probable that the Company will be unable to
collect all amounts due according to the original contractual terms of the loan.
An insignificant delay or insignificant shortfall in amounts of payments does
not necessarily result in the loan being identified as impaired. For this
purpose, delays less than 90 days are considered to be insignificant. Large
groups of smaller balance homogeneous loans, including residential real estate
and consumer loans, are collectively evaluated for impairment, except for loans
restructured under a troubled debt restructuring. The majority of loans
classified as impaired on an individual basis are construction and commercial
loans and commercial loans secured by real estate.
MORTGAGE BANKING ACTIVITIES
The Company originates mortgage loans held for investment and for sale.
At origination, the mortgage loan is identified as either held for sale or for
investment. Mortgage loans held for sale are carried at the lower of cost or
forward committed contracts (which approximates market), determined on a net
aggregate basis.
At September 30, 1998, 1997, and 1996, loans serviced for others
totalled approximately $96,275, $114,554 and $127,229, respectively. Servicing
loans for others consists of collecting mortgage payments, maintaining escrow
accounts, disbursing payments to investors, and processing foreclosures. Loan
servicing income is recorded on the cash basis and includes servicing fees from
investors and certain charges collected from borrowers, such as late payment
fees. The Company has fiduciary responsibility for related escrow and custodial
funds aggregating approximately $824 and $793 at September 30, 1998 and 1997,
respectively.
The Company adopted SFAS No. 125 "Accounting for Transfers and
Servicing of Financial Assets and Extinquishments of Liabilities" at January 1,
1997. This statement requires an entity which sells loans with servicing
retained to assess the retained interest in the servicing asset or liability
associated with the sold loans based on the relative fair values. The servicing
asset or liability is amortized in proportion to and over the period of
estimated net servicing income or net servicing loss, as appropriate. Assessment
of the fair value of the retained interest is performed on a continuing basis.
The adoption of this statement did not have a material impact on the Company's
financial position or results of operations.
INCOME RECOGNITION ON LOANS
Interest on loans is credited to income when earned. Accrual of loan
interest is discontinued and a reserve established on existing accruals if
management believes after considering, among other things, economic and business
conditions and collection efforts, that the borrowers' financial condition is
such that collection of interest is doubtful.
REAL ESTATE OWNED
Real estate owned consists of properties acquired by foreclosure or
deed in-lieu-of foreclosure. These assets are initially recorded at the lower of
carrying value of the loan or estimated fair value less selling costs at the
time of foreclosure and at the lower of the new cost basis or net realizable
value thereafter. The amounts recoverable from real estate owned could differ
materially from the amounts used in arriving at the net carrying value of the
assets at the time of foreclosure because of future market factors beyond the
control of the Company. Costs relating to the development and improvement of
real estate owned properties are capitalized and those relating to holding the
property are charged to expense.
OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are recorded at cost. Depreciation is
computed using the straight-line method over the expected useful lives of the
assets. The costs of maintenance and repairs are expensed as they are incurred,
and renewals and betterments are capitalized.
25
<PAGE> 26
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
Deferred income taxes are recognized for the tax consequences of
"temporary differences" by applying enacted statutory tax rates applicable to
future years to differences between the financial statement carrying amounts and
the tax bases of existing assets and liabilities. The effect on deferred taxes
of a change in tax rates is recognized in income in the period that includes the
enactment date.
INTEREST RATE RISK
At September 30, 1998 and 1997, the Company's assets consist primarily
of assets that earned interest at either adjustable or fixed interest rates and
the average life of which is long term. Those assets were funded primarily with
medium-term liabilities that have interest rates which vary over time with
market rates.
Since the assets and liabilities reprice at different times, the
Company is exposed to interest rate risk.
EARNINGS PER SHARE
In February 1997, the FASB issued SFAS No. 128 "Earnings Per Share."
This statement establishes standards for computing and presenting earnings per
share ("EPS") for financial statements issued for periods ending after December
15, 1997, and requires restatement of all prior-period EPS data presented. The
adoption of this statement did not have a material impact on the Company's
financial statements.
ACCOUNTING FOR STOCK OPTIONS
The Company accounts for stock options in accordance with SFAS No. 123
"Accounting for Stock-Based Compensation," which allows an entity to choose
between the intrinsic value method, as defined in Accounting Principals Board
Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" or the fair
value method of accounting for stock-based compensation described in SFAS No.
123. An entity using the intrinsic value method must disclose pro forma net
income and earnings per share as if the stock-based compensation was accounted
for using the fair value method. The Company continues to account for
stock-based compensation using the intrinsic value method and has not recognized
compensation expense under this method.
STATEMENT OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include
cash and amounts due from depository institutions and interest-bearing deposits
with depository institutions.
NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED
In June 1997, FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which requires an entity to present, as a component of comprehensive
income, the amounts from transactions and other events which currently are
excluded from the statement of income and are recorded directly to stockholders'
equity.
Also in June 1997, FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information" which requires an entity to
disclose information in a manner consistent to internally used information and
requires more detailed disclosures of operating and reporting segments than are
currently in practice. In February 1998, the FASB issued SFAS No. 132,
"Employers' Disclosure About Pensions and Other Postretirement Benefits." This
statement revises employers' disclosures about pension and other postretirement
benefit plans. It does not change the measurement or recognition of those plans.
These statements are effective for fiscal years beginning after December 15,
1997. Management has not completed an analysis of the effect the adoption of the
statements will have on the Company's financial condition or results of
operations.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," was issued. This statement requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial condition and measure those instruments at fair value. The accounting
for changes in the fair value of a derivative depends on the intended use of the
derivative and the resulting designation. This
26
<PAGE> 27
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
statement is effective for fiscal years beginning after June 15, 1999, and
will not be applied retroactively to financial statements of prior periods.
Management of the Company does not believe this statement will have a material
impact on the Company financial position or results of operations when adopted.
RECLASSIFICATIONS
Certain reclassifications have been made to the September 30, 1997 and
1996 consolidated financial statements to conform with the September 30, 1998
presentation. Such reclassifications had no impact on the reported net income.
3. INVESTMENT SECURITIES
The amortized cost and approximate fair value of investment securities
available for sale and held to maturity, by contractual maturities (where
applicable), are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED APPROXIMATE
COST GAIN LOSS FAIR VALUE
------------------------------------------------------
<S> <C> <C> <C> <C>
Available for Sale:
U.S. Treasury securities and securities
of U.S. Government agencies:
5 to 10 years $ 12,000 $ 109 $12,109
Municipal obligations 18,993 484 19,477
Mutual funds 2,000 $ 8 1,992
Preferred stocks 5,500 263 5,763
Other equity investments 1,390 110 1,280
- ---------------------------------------------------------------------------------------------------
Total $ 39,883 $856 $ 118 $40,621
===================================================================================================
</TABLE>
<TABLE>
<CAPTION>
September 30, 1997
------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
------------------------------------------------------
<S> <C> <C> <C> <C>
Available for Sale:
U.S. Treasury securities and securities
of U.S. Government agencies:
1 to 5 years $ 4,000 $ 15 $ 4,015
5 to 10 years 3,000 $ 17 2,983
Municipal obligations 3,138 75 3,213
- ---------------------------------------------------------------------------------------------------
Total $10,138 $ 90 $ 17 $10,211
===================================================================================================
Held to Maturity:
U.S. Treasury securities and securities
of U.S. Government agencies:
Over 10 years $10,000 $ 40 $9,960
- ---------------------------------------------------------------------------------------------------
Total $10,000 $ 40 $9,960
===================================================================================================
</TABLE>
27
<PAGE> 28
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
4. MORTGAGE-RELATED SECURITIES
Mortgage-related securities available for sale and mortgage-related
securities held to maturity are summarized as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED APPROXIMATE
COST GAIN LOSS FAIR VALUE
------------------------------------------------------
<S> <C> <C> <C> <C>
Available for Sale:
FHLMC pass-through certificates $ 10,968 $ 197 $ 11,165
FNMA pass-through certificates 25,600 503 26,103
GNMA pass-through certificates 41,379 562 41,941
Collateralized mortgage obligations 36,022 327 $ 72 36,277
- ---------------------------------------------------------------------------------------------------
Total $ 113,969 $ 1,589 $ 72 $115,486
===================================================================================================
Held to Maturity:
FHLMC pass-through certificates $ 4,698 $ 33 $ 1 $ 4,730
FNMA pass-through certificates 8,747 46 103 8,690
Collateralized mortgage obligations 5,324 1 45 5,280
- ---------------------------------------------------------------------------------------------------
Total $ 18,769 $ 80 $ 149 $ 18,700
===================================================================================================
</TABLE>
<TABLE>
<CAPTION>
September 30, 1997
-------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
-------------------------------------------------------
<S> <C> <C> <C> <C>
Available for Sale:
FHLMC pass-through certificates $ 17,540 $ 213 $ 9 $ 17,744
FNMA pass-through certificates 14,587 149 21 14,715
GNMA pass-through certificates 28,938 133 17 29,054
Collateralized mortgage obligations 42,814 376 231 42,959
- ---------------------------------------------------------------------------------------------------
Total $ 103,879 $ 871 $ 278 $104,472
===================================================================================================
Held to Maturity:
FHLMC pass-through certificates $ 2,747 $ 15 $ 52 $ 2,710
FNMA pass-through certificates 10,053 29 272 9,810
Collateralized mortgage obligations 7,907 17 244 7,680
- ---------------------------------------------------------------------------------------------------
Total $ 20,707 $ 61 $568 $ 20,200
===================================================================================================
</TABLE>
The collateralized mortgage obligations contain both fixed and
adjustable classes of securities which are repaid in accordance with a
predetermined priority. The underlying collateral of the securities are loans
which are primarily insured by FHLMC, FNMA, and GNMA.
Mortgage-related securities with a carrying value of $27,846 and
$21,923 were pledged as collateral for public funds on deposit, treasury tax and
loan processing and financings at September 30, 1998 and 1997, respectively (see
Notes 9 and 11).
5. ACCRUED INTEREST RECEIVABLE
The following is a summary of accrued interest receivable by category:
<TABLE>
<CAPTION>
SEPTEMBER 30
-----------------------------
1998 1997
-----------------------------
<S> <C> <C>
Loans $ 1,542 $ 1,593
Mortgage-related securities 823 726
Investment securities 752 246
- ------------------------------------------------------------------------------------------------
Total $ 3,117 $ 2,565
================================================================================================
</TABLE>
28
<PAGE> 29
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
notes to Consolidated Financial Statements (Continued)
Years Ended September 30, 1998, 1997 and 1996 (dollars in thousands)
6. LOANS RECEIVABLE
Loans receivable consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30
----------------------
1998 1997
----------------------
<S> <C> <C>
Real estate loans:
Single-family $ 148,088 $ 135,168
Construction and land 15,858 16,400
Multi-family and commercial 20,563 18,305
Consumer loans:
Home equity and lines of credit 19,609 22,964
Deposit 181 348
Education 449 365
Other 1,429 1,690
Commercial loans 1,390 2,000
- -----------------------------------------------------------
Total loans 207,567 197,240
Loans in process (5,781) (5,670)
Allowance for loan losses (1,738) (1,628)
Deferred loan fees (1,705) (1,653)
- -----------------------------------------------------------
Loans receivable--net $ 198,343 $ 188,289
===========================================================
</TABLE>
The Company originates loans primarily in its local market area of
Delaware and Chester Counties, Pennsylvania to borrowers that share similar
attributes. This concentration of credit exposes the Company to a higher degree
of risk associated with this economic region.
To a lesser extent, the Company participates in the origination and
sale of nonagency, non-conforming loans to the secondary market. The Company
recognized gains on sale of loans held for sale of $526,000, $281,000 and
$183,000 for fiscal years ended September 30, 1998, 1997 and 1996, respectively.
The Company offers loans to its directors and senior officers on terms
permitted by OTS regulations. There were approximately $388 and $440 of loans
outstanding to senior officers and directors as of September 30, 1998 and 1997,
respectively. The amount of repayments during the years ended September 30, 1998
and 1997 totalled $102 and $266, respectively. There was $50 and $271 of new
loans granted during fiscal year 1998 and 1997, respectively.
The Company has undisbursed portions under consumer and commercial
lines of credit as of September 30, 1998 of $4,587 and $4,238, respectively.
The Company originates both adjustable and fixed interest rate loans
and purchases mortgage-backed securities and collateralized mortgage obligations
in the secondary market. The originated adjustable-rate loans have interest rate
adjustment limitations and are generally indexed to U.S. Treasury securities
plus a fixed margin. Future market factors may affect the correlation of the
interest rate adjustment with rates the Company pays on the short-term deposits
that have been primarily utilized to fund these loans. The adjustable-rate
mortgage-related securities adjust to various national indices plus a fixed
margin. At September 30, 1998, the composition of these loans and
mortgage-related securities follows:
<TABLE>
<CAPTION>
FIXED-RATE
- ---------------------------------------
TERM TO MATURITY BOOK VALUE
- ---------------------------------------
<S> <C>
1 month to 1 year $ 3,102
1 year to 3 years 5,962
3 years to 5 years 7,141
5 years to 10 years 19,123
Over 10 years 203,205
- ---------------------------------------
Total $ 238,533
=======================================
</TABLE>
<TABLE>
<CAPTION>
ADJUSTABLE-RATE
- ---------------------------------------
TERM TO
RATE ADJUSTMENT BOOK VALUE
- ---------------------------------------
<S> <C>
1 month to 1 year $ 76,949
1 year to 3 years 18,583
3 years to 5 years 1,976
- ---------------------------------------
Total $ 97,508
=======================================
</TABLE>
The following is an analysis of the allowance for loan losses:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30
-------------------------
1998 1997 1996
-------------------------
<S> <C> <C> <C>
Beginning balance $1,628 $2,624 $1,487
Provisions charged
to income 186 239 1,250
Charge-offs (114) (1,252) (113)
Recoveries 38 17
- -----------------------------------------------
Total $1,738 $1,628 $2,624
===============================================
</TABLE>
At September 30, 1998 and 1997, non-performing loans (which include
loans in excess of 90 days delinquent) amounted to approximately $3,704 and
$2,077, respectively.
29
<PAGE> 30
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Years Ended September 30, 1998, 1997 and 1996 (dollars in thousands)
7. REAL ESTATE OWNED
Real estate owned is comprised of:
<TABLE>
<CAPTION>
SEPTEMBER 30
----------------
1998 1997
----------------
<S> <C> <C>
Real estate acquired
in settlement of loans $ 196 $ 168
Real estate acquired
and in development 1,467 1,504
- ----------------------------------------------
Total $ 1,663 $1,672
==============================================
</TABLE>
In fiscal year 1996, First Pointe, Inc., a subsidiary of the Company,
accepted a deed in lieu of foreclosure on a construction loan for the
acquisition and improvement of a 106-lot real estate development project located
in Pennsylvania. As of September 30, 1998, 91 of the townhouses were completed
and sold. Work-in-process consists of 15 units of which two consist of a sample
home and a sales office.
8. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are summarized by major classification
as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30
--------------------
1998 1997
--------------------
<S> <C> <C>
Land and buildings $ 4,220 $4,045
Furniture, fixtures
and equipment 3,753 3,448
- ----------------------------------------------
Total 7,973 7,493
Accumulated
depreciation and
amortization (5,361) (4,941)
- ----------------------------------------------
Net $ 2,612 $2,552
==============================================
</TABLE>
The future minimum rental payments required under operating leases that
have initial or remaining noncancelable lease terms in excess of one year as of
September 30, 1998 are as follows:
<TABLE>
<CAPTION>
September 30:
<S> <C>
1999 $ 119
2000 121
2001 53
2002 36
2003 27
Thereafter 59
- ----------------------------------------------
Total minimum
future rental payments $ 415
==============================================
</TABLE>
Leasehold expense was approximately $197, $148 and $155 for the years
ended September 30, 1998, 1997 and 1996, respectively.
9. DEPOSITS
Deposits consist of the following major classifications:
<TABLE>
<CAPTION>
SEPTEMBER 30
--------------------------------------------------
1998 1997
--------------------------------------------------
AMOUNT PERCENT Amount Percent
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Non-interest bearing accounts $ 8,254 3.3% $ 6,165 2.7%
NOW accounts 28,181 11.4 27,754 12.2
Passbook accounts 37,988 15.4 38,035 16.7
Money market demand accounts 16,087 6.5 16,429 7.2
Certificate of deposit accounts 156,801 63.4 139,535 61.2
- --------------------------------------------------------------------------------------------
Total $ 247,311 100.0% $ 227,918 100.0%
============================================================================================
</TABLE>
The weighted average interest rates paid on deposits were 4.21% and
4.26% at September 30, 1998 and 1997, respectively.
Included in deposits as of September 30, 1998 are deposits greater than
$100,000 totalling approximately $30,700.
At September 30, 1998 and 1997, the Company had pledged certain
mortgage-related securities aggregating approximately $1,633 and $2,870,
respectively, as collateral for government deposits.
30
<PAGE> 31
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
9. DEPOSITS (continued)
A summary of scheduled maturities of certificates is as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30
1998
------------
<S> <C>
Within one year $ 109,908
One to two years 26,535
Two to three years 10,821
Thereafter 9,537
- -----------------------------------------
Total $ 156,801
=========================================
</TABLE>
A summary of interest expense on deposits is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30
-------------------------
1998 1997 1996
- ---------------------------------------------
<S> <C> <C> <C>
NOW accounts $ 376 $ 360 $ 372
Passbook accounts 923 949 1,030
Money market
demand accounts 452 450 487
Certificates of
deposit accounts 8,186 7,423 7,474
- ---------------------------------------------
Total $ 9,937 $9,182 $ 9,363
=============================================
</TABLE>
10. ADVANCES FROM FEDERAL HOME LOAN BANK
A summary of advances from the Federal Home Loan Bank ("FHLB") of
Pittsburgh follows:
<TABLE>
<CAPTION>
SEPTEMBER 30
-------------------------------------------------
1998 1997
-------------------------------------------------
WEIGHTED Weighted
AVERAGE average
INTEREST interest
AMOUNT RATE Amount rate
-------------------------------------------------
<S> <C> <C> <C> <C>
Advances from FHLB due by
September 30,
1998 $ 33,200 5.7%
1999 $ 30,325 5.8% 11,325 5.7
2000 5,159 5.4 257 6.0
Thereafter 66,094 5.5 30,605 5.6
- ---------------------------------------------------------------------------------------------
Total $ 101,578 5.6% $ 75,387 5.7%
=============================================================================================
</TABLE>
The advances are collateralized by Federal Home Loan Bank stock and
substantially all first mortgage loans held by the company.
Included in the table above at September 30, 1998 are convertible
advances whereby the FHLB has the option at a predetermined time to convert the
fixed interest rate to an adjustable rate tied to LIBOR. The Company then has
the option to prepay these advances if the FHLB converts the interest rate.
These advances are included in the year in which they mature.
The Company has available an annually renewable line of credit not to
exceed 10% of the Company's maximum borrowing capacity which was $20.5 million
at the time the commitment was executed. At September 30, 1998 and 1997, there
were no balances outstanding on the line of credit.
31
<PAGE> 32
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Years Ended September 30, 1998, 1997 and 1996 (dollars in thousands)
11. SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE
The Company sold, under agreements to repurchase, mortgage-related
securities to broker-dealers. Securities underlying the agreements with
broker-dealers were delivered to the dealer who arranged the transaction.
Securities delivered to broker-dealers may have been sold, loaned, or otherwise
disposed of, such securities to other parties in the normal course of their
operations.
Information concerning securities sold under agreements to repurchase
is summarized as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30
-------------------------------
1998 1997
-------------------------------
<S> <C> <C>
Average balance for months outstanding $24,411 $11,179
- -------------------------------------------------------------------------------------
Average interest rate for months outstanding 6.07% 5.90%
- -------------------------------------------------------------------------------------
Maximum month-end balance during the year $24,600 $24,600
- -------------------------------------------------------------------------------------
Mortgage-related securities underlying the
agreements at year-end:
Carrying value $23,055 $27,255
- -------------------------------------------------------------------------------------
Estimated fair value $23,385 $27,267
- -------------------------------------------------------------------------------------
</TABLE>
12. INCOME TAXES
In August 1996, the Small Business Job Protection Act (the "Act") was
signed into law. The Act repealed the percentage of taxable income method of
accounting for bad debts for thrift institutions effective for years beginning
after December 31, 1995. Prior to October 1, 1996, the Company was permitted
under the Internal Revenue Code (the "Code") to deduct an annual addition to the
reserve for bad debts in determining taxable income, subject to certain
limitations. The Company's deduction was based upon the percentage of taxable
income method as defined by the Code. The bad debt deduction allowable under
this method equaled 8% of taxable income determined without regard to that
deduction and with certain adjustments. This addition differs from the bad debt
experience used for financial accounting purposes. The Act required the Company,
as of October 1, 1996, to change its method of computing reserves for bad debts
to the experience method. The bad debt deduction allowable under this method is
available to small banks with assets less than $500 million. Generally, this
method allowed the Company to deduct an annual addition to the reserve for bad
debts equal to the increase in the balance of the Company's reserve for bad
debts at the end of the year to an amount equal to the percentage of total loans
at the end of the year, computed using the ratio of the previous six years net
chargeoffs divided by the sum of the previous six years total outstanding loans
at year end.
The Company treated such change as a change in a method of accounting
determined solely with respect to the "applicable excess reserves" of the
institution. The amount of the applicable excess reserves will be taken into
account ratably over a six-taxable year period, beginning with the first taxable
year beginning after December 31, 1995. For financial reporting purposes, the
Company will not incur any additional tax expense. At September 30, 1997, under
SFAS No. 109, deferred taxes were provided on the difference between the book
reserve at September 30, 1997 and the applicable excess reserve in the amount
equal to the Bank's increase in the tax reserve from December 31, 1987 to
September 30, 1996. Retained earnings at September 30, 1998, 1997 and 1996
included approximately $2.5 million representing bad debt deductions for which
no deferred income taxes have been provided.
Income tax expense (benefit) is comprised of the following:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30
--------------------------
1998 1997 1996
- ------------------------------------------------
<S> <C> <C> <C>
Current
Federal $1,362 $ 489 $ 30
State 313 103
- ------------------------------------------------
Subtotal 1,362 802 133
Deferred (112) 862 (700)
- ------------------------------------------------
Total $1,250 $1,664 $ (567)
================================================
</TABLE>
32
<PAGE> 33
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
12. INCOME TAXES (CONTINUED)
The Company's effective tax rate is less than the statutory federal
income tax rate for the following reasons:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30
-------------------------------------------------------------
1998 1997 1996
-------------------------------------------------------------
PERCENTAGE Percentage Percentage
OF PRETAX of Pretax of Pretax
AMOUNT INCOME Amount Income Amount Income
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Tax at statutory rate $ 1,370 34.0% $1,462 34.0% $ 108 34.0%
Increase (decrease) in taxes resulting from:
Adjustment for resolution
of tax contingency (700) (220.2)
Tax exempt interest, net (149) (3.7) (24) (.6) (14) (4.3)
State tax--net of federal tax effect 207 4.8 68 21.3
Other 29 .7 19 .5 (29) (9.1)
- --------------------------------------------------------------------------------------------------------------
Total $ 1,250 31.0% $1,664 38.7% $ (567) (178.3)%
==============================================================================================================
</TABLE>
The tax effect of temporary differences that give rise to significant
portions of the deferred tax accounts, calculated at 34%, are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30
------------------
1998 1997
------------------
<S> <C> <C>
Accelerated depreciation $ 249 $ 221
Allowance for loan losses 634 525
Deferred loan fees (61) (43)
Accrued expenses 161 185
Unrealized gain (loss)
on available for sale securities (767) (258)
Other 67 50
- ------------------------------------------------------
Total deferred tax asset $ 283 $ 680
======================================================
</TABLE>
13. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance items as calculated under
regulatory accounting practices. The Bank's capital amounts and classification
are also subject to qualitative judgments by regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in
the table below) of tangible and core capital (as defined in the regulations) to
adjusted assets (as defined), and of Tier I and total capital (as defined) to
average assets (as defined). Management believes, as of September 30, 1998, that
the Bank meets all capital adequacy requirements to which it is subject.
As of September 30, 1998, the most recent notification from the Office
of Thrift Supervision categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum total risk-based, Tier-1 risk-based,
and Tier-1 leveraged-ratios as
33
<PAGE> 34
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Years Ended September 30, 1998, 1997 and 1996 (dollars in thousands)
13. REGULATORY CAPITAL REQUIREMENTS (continued)
set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's category.
The Bank's actual capital amounts and ratios are also presented in the
table. At September 30, 1998 and 1997, risk-based capital, for regulatory
requirements, is increased by $1,688 and $1,578, respectively, of general loan
loss reserves for a total of $35,389 and $31,832, respectively. During fiscal
1997, regulatory capital was increased by a $6.0 million capital contribution by
the holding company in conjunction with the issuance of junior subordinated
debentures (see Note 20).
<TABLE>
<CAPTION>
REQUIRED TO BE
REQUIRED FOR WELL CAPITALIZED
CAPITAL ADEQUACY UNDER PROMPT
ACTUAL PURPOSES CORRECTIVE ACTION
------------------------------------------------------------
AMOUNT PERCENTAGE AMOUNT PERCENTAGE AMOUNT PERCENTAGE
------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AT SEPTEMBER 30, 1998:
Core Capital (to Adjusted Tangible Assets) 33,701 8.3% 16,301 4.0% 20,376 5.0%
- -----------------------------------------------------------------------------------------------------------
Tier I Capital (to Risk Weighted Assets) 33,701 20.1 N/A N/A 24,451 6.0
- -----------------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets) 35,389 21.1 13,424 8.0 16,780 10.0
- -----------------------------------------------------------------------------------------------------------
Tangible Capital (to Tangible Assets) 33,701 8.3 6,113 1.5 N/A N/A
- -----------------------------------------------------------------------------------------------------------
September 30, 1997:
Core Capital (to Adjusted Tangible Assets) 30,254 8.1% 14,902 4.0% 18,627 5.0%
- -----------------------------------------------------------------------------------------------------------
Tier I Capital (to Risk Weighted Assets) 30,254 18.9 N/A N/A 9,594 6.0
- -----------------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets) 31,832 19.9 12,792 8.0 15,990 10.0
- -----------------------------------------------------------------------------------------------------------
Tangible Capital (to Tangible Assets) 30,254 8.1 5,594 1.5 N/A N/A
- -----------------------------------------------------------------------------------------------------------
</TABLE>
At the date of the Conversion, the Bank established a liquidation
account in an amount equal to its retained income as of August 31, 1995. The
liquidation account is maintained for the benefit of eligible account holders
and supplemental eligible account holders who continue to maintain their
accounts at the Bank after the Conversion. The liquidation account is reduced
annually to the extent that eligible account holders and supplemental eligible
account holders have reduced their qualifying deposits as of each anniversary
date. Subsequent increases will not restore an eligible account holder's or
supplemental eligible account holder's interest in the liquidation account. In
the event of a complete liquidation of the Bank, each eligible account holder
and supplemental eligible account holder will be entitled to receive a
distribution from the liquidation account in an amount proportionate to the
current adjusted qualifying balances for accounts then held.
The Bank may not declare or pay cash dividends on or repurchase any of
its shares of common stock if the effect thereof would cause equity to be
reduced below applicable regulatory capital maintenance requirements or if such
declaration and payment would otherwise violate regulatory requirements.
34
<PAGE> 35
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
14. EMPLOYEE BENEFITS
401(k) PROFIT SHARING PLAN
The Bank's 401(k) profit sharing plan covers substantially all
full-time employees of the Company and provides for pre-tax contributions by the
employees with matching contributions at the discretion of the Board of
Directors determined at the beginning of the calendar year. All amounts are
fully vested. For calendar year 1998, there was no contribution to the 401(k)
profit sharing plan. For calendar year 1997, the Board approved an 1% of salary
profit sharing contribution of all contributing participants. For calendar year
1996, a salary match up to 2.5% was approved by the Board. Pension expense was
$35 and $88 for the years ended September 30, 1997, and 1996, respectively.
EMPLOYEE STOCK OWNERSHIP PLAN
In connection with the Conversion, the Company established an ESOP for
the benefit of eligible employees. The ESOP purchased 207,600 shares of common
stock in the Conversion. During November 1996, the ESOP purchased an additional
77,550 shares of common stock. At September 30, 1998, 88,386 shares of the total
number of shares held by the ESOP were committed to be released. The Company
accounts for its ESOP in accordance with AICPA Statement of Position 93-6,
"Employers Accounting for Employee Stock Ownership Plans," which requires the
Company to recognize compensation expense equal to the fair value of the ESOP
shares during the periods in which they become committed to be released. To the
extent that the fair value of the ESOP shares differs from the cost of such
shares, this differential will be charged or credited to equity as additional
paid-in-capital. Management expects the recorded amount of expense to fluctuate
as continuing adjustments are made to reflect changes in the fair value of the
ESOP shares. The Company's ESOP, which is internally leveraged, does not report
the loan receivable from the ESOP as an asset and does not report the ESOP debt
from the employer as a liability. The Company recorded compensation and employee
benefit expense related to the ESOP of $450, $275 and $200 for the years ended
September 30, 1998, 1997 and 1996, respectively.
RECOGNITION AND RETENTION PLAN
Under the 1995 Recognition and Retention Plan and Trust (the "RRP"),
the Company had outstanding awards aggregating 50,590 shares as of September 30,
1998 to the Company's Board of Directors and executive officers subject to
vesting and other provisions of the RRP.
At September 30, 1998 and 1997, the deferred cost of unearned RRP
shares totaled $258 and $399, respectively, and is recorded as a charge against
stockholders' equity. Compensation expense will be recognized ratably over the
five year vesting period for shares awarded. For the fiscal years ended
September 30, 1998, 1997 and 1996, the Company recorded compensation and
employee benefit expense of $141, $141 and $137, respectively, relating to the
RRP.
STOCK OPTION PLAN
Under the 1995 Stock Option Plan (the "Plan"), Common Stock totaling
272,000 shares has been reserved for issuance for the Plan. An aggregate of
251,124 stock options have been granted to the Company's executive officers,
nonemployee directors and other key employees, subject to vesting and other
provisions of the Plan. During the years ended September 30, 1998 and 1997,
1,088 and 544 shares, respectively, were exercised at an exercise price of $7.56
and $7.50.
35
<PAGE> 36
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
14. EMPLOYEE BENEFITS (continued)
The following is a summary of transactions under the Plan:
<TABLE>
<CAPTION>
WEIGHTED
EXERCISE AVERAGE
NUMBER OF PRICE EXERCISE PRICE
OPTION SHARES RANGE PER SHARE
----------------------------------------------
<S> <C> <C> <C>
Outstanding at September 30, 1995 239,360 $ 7.50 - 7.50 $ 7.50
Granted 6,800 8.50 - 8.50 8.50
Canceled (9,792) 7.50 - 7.50 7.50
- ---------------------------------------------------------------------------------------------------
Outstanding at September 30, 1996 236,368 7.50 - 8.50 7.53
Granted 15,720 12.38 - 14.25 13.52
Canceled (5,032) 7.50 - 8.50 7.64
Exercised (1,088) 7.50 - 7.50 7.50
- ---------------------------------------------------------------------------------------------------
Outstanding at September 30, 1997 245,968 $ 7.50 - 14.25 7.91
Granted 5,700 12.88 - 12.88 12.88
Exercised (578) 7.50 - 8.50 7.56
- ---------------------------------------------------------------------------------------------------
Outstanding at September 30, 1998 251,090 $ 7.50 - 14.25 $ 8.02
===================================================================================================
</TABLE>
A summary of the exercise price range at September 30, 1998 is as
follows:
<TABLE>
<CAPTION>
WEIGHTED WEIGHTED
EXERCISE AVERAGE AVERAGE
NUMBER OF PRICE REMAINING EXERCISE PRICE
OPTION SHARES RANGE CONTRACTUAL LIFE PER SHARE
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
229,670 $ 7.50 - 8.50 7.03 $7.53
21,420 12.38 - 14.25 9.27 13.35
- -----------------------------------------------------------------------------
251,090 $ 7.50 - 14.25 7.22 $8.02
=============================================================================
</TABLE>
The Company applies APB Opinion No. 25 in accounting for stock options
and, accordingly, no compensation expense has been recognized in the financial
statements. Had the Company determined compensation expense based on the fair
value at the grant date for its stock options under SFAS 123, the Company's net
income and income per share would have been reduced to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30
-----------------------
1998 1997
-----------------------
<S> <C> <C>
Net income:
As reported $2,781 $2,637
- --------------------------------------------------
Pro forma 2,770 2,598
- --------------------------------------------------
Net income per common and
common equivalent share:
Earnings per
common share
- As reported $ 1.23 $ 1.13
- --------------------------------------------------
- Pro forma 1.22 1.12
- --------------------------------------------------
Weighted average
fair value of
options granted
during the period $ 5.15 $10.55
- --------------------------------------------------
</TABLE>
The binomial option-pricing model was used to determine the grant date
fair value of options. Significant assumptions used to calculate the above fair
value of the awards are as follows:
<TABLE>
<CAPTION>
September 30
--------------------
1998 1997
- ---------------------------------------------
<S> <C> <C>
Risk free interest
rate of return 4.69% 6.12%
- ---------------------------------------------
Expected option
life (months) 60 60
- ---------------------------------------------
Expected volatility 45% 37%
- ---------------------------------------------
Expected Dividends 1.9% 1%
- ---------------------------------------------
</TABLE>
OTHER
The Company established an expense accrual in connection with the
anticipated funding of a trust to be created to formalize the Company's deferred
compensation arrangements with four former officers of the Company. A total of
$377 and $448 was included in the Company's liabilities at September 30, 1998
and 1997.
36
<PAGE> 37
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Years Ended September 30, 1998, 1997 and 1996 (dollars in thousands)
15. COMMITMENTS AND CONTINGENCIES
The Company has outstanding loan commitments, excluding undisbursed
portion of loans in process and equity lines of credit, of approximately $11,759
and $7,651 as of September 30, 1998 and 1997, respectively, which are all
expected to be funded within four months. Of these commitments outstanding, the
breakdown between fixed and adjustable rate loans is as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30
------------------
1998 1997
------------------
<S> <C> <C>
Fixed-rate (ranging
from 5.875% to 13.50%) $ 6,859 $4,073
Adjustable-rate 4,900 3,578
- -----------------------------------------------
Total $11,759 $7,651
===============================================
</TABLE>
Generally, non-conforming loans are sold in the secondary market, depending on
cash flow, interest rate, risk management and other considerations. There were
approximately $6,029 and $5,324 in outstanding commitments to sell loans at
September 30, 1998 and 1997, respectively.
16. RELATED PARTY TRANSACTIONS
The Company retains the services of a law firm in which one of the
Company's Directors is a member. In addition to providing general legal counsel
to the Company, the firm also prepares mortgage documents and attends loan
closings for which it is paid directly by the borrower.
17. SAVINGS ASSOCIATION INSURANCE FUND ASSESSMENT
On September 30, 1996, the Economic Growth and Paperwork Reduction Act
of 1996, which includes the recapitalization of the Savings Association
Insurance Fund ("SAIF"), became law. Accordingly, all depository institutions
with SAIF-insured deposits were charged a one-time special assessment on their
SAIF-assessible deposits as of March 31, 1995 at the rate of 65.7 basis points,
which was paid on November 27, 1996. The Bank accrued $1.4 million for this
special assessment at September 30, 1996.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
"Disclosures about the Fair Value of Financial Instruments." The estimated fair
value amounts have been determined by the Company using available market
information and appropriate valuation methodologies. However, considerable
judgment is required to interpret market data to develop the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
37
<PAGE> 38
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
18. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
<TABLE>
<CAPTION>
SEPTEMBER 30
--------------------------------------------------
1998 1997
--------------------------------------------------
ESTIMATED Estimated
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
<S> <C> <C> <C> <C>
Assets:
Cash and interest-earning deposits $ 24,126 $ 24,126 $ 21,561 $ 21,561
- ---------------------------------------------------------------------------------------------
Investment securities 40,621 40,621 20,211 20,171
- ---------------------------------------------------------------------------------------------
Loans 198,343 214,020 188,289 196,194
- ---------------------------------------------------------------------------------------------
Loans held for sale 2,799 2,799 4,577 4,577
- ---------------------------------------------------------------------------------------------
Mortgage-related securities 134,255 134,146 125,179 124,672
- ---------------------------------------------------------------------------------------------
Liabilities:
Savings deposits 37,988 37,988 38,035 38,035
- ---------------------------------------------------------------------------------------------
NOW and MMDA deposits 52,522 52,522 50,348 50,348
- ---------------------------------------------------------------------------------------------
Certificates of deposit 156,801 158,526 139,535 139,741
- ---------------------------------------------------------------------------------------------
Advances from Federal Home Loan Bank 101,578 120,235 75,387 83,525
- ---------------------------------------------------------------------------------------------
Securities sold under agreements
to repurchase 19,300 19,884 24,600 24,605
- ---------------------------------------------------------------------------------------------
Off balance sheet commitments 26,365 26,365 19,439 19,439
- ---------------------------------------------------------------------------------------------
</TABLE>
The fair value of cash and interest-earning deposits is their carrying
value due to their short term nature. The fair value of investments and
mortgage-related securities is based on quoted market prices, dealer quotes, and
prices obtained from independent pricing services. The fair value of loans is
estimated, based on present values using approximate current entry-value
interest rates, applicable to each category of such financial instruments.
The fair value of NOW deposits, MMDA deposits, and savings deposits is
the amount reported in the financial statements. The fair value of certificates
of deposit and FHLB advances is based on a present value estimate, using rates
currently offered for deposits of similar remaining maturity.
No adjustment was made to the entry-value interest rates for changes in
credit performing commercial loans, construction loans, and land loans for which
there are no known credit concerns. Management believes that the risk factor
embedded in the entry-value interest rates, along with the general reserves
applicable to the performing commercial, construction, and land loan portfolios
for which there are no known credit concerns, result in a fair valuation of such
loans on an entry-value basis. The fair value of non-performing loans, with a
recorded book value of approximately $3,704 and $2,077 (which are collateralized
by real estate properties with property values in excess of carrying amounts) as
of September 30, 1998 and 1997, respectively, was not estimated because it is
not practicable to reasonably assess the credit adjustment that would be applied
in the marketplace for such loans. The fair value estimates presented herein are
based on pertinent information available to management as of September 30, 1998
and 1997. Although management is not aware of any factors that would
significantly affect the estimated fair value amounts, such amounts have not
been comprehensively revalued for purposes of these financial statements since
that date and, therefore, current estimates of fair value may differ
significantly from the amounts presented herein.
38
<PAGE> 39
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
19. EARNINGS PER SHARE
Basic earnings per share is computed based on the weighted average
number of shares of common stock outstanding. Diluted earnings per common share
is computed based on the weighted average number of shares of common stock
outstanding, increased by the number of common shares that are assumed to have
been purchased with the proceeds from the exercise of stock options. The
calculation of the weighted average shares, after giving effect to the stock
split, was as follows:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30
------------------------------------
1998 1997 1996
------------------------------------
<S> <C> <C> <C>
Average common share outstanding 2,130,712 2,198,453 1,191,583
Increase in shares due to options -
diluted basis 135,100 125,316
- ---------------------------------------------------------------------------------
Adjusted shares outstanding - diluted 2,265,812 2,323,769 1,191,583
=================================================================================
</TABLE>
20. CAPITAL SECURITIES
On August 21, 1997, First Keystone Capital Trust I ("the Trust"), a
trust formed under Delaware law, that is a subsidiary of the Company, issued
$16.2 million of preferred securities at an interest rate of 9.7%, with a
scheduled maturity of August 15, 2027. The Company owns all the common stock of
the Trust. The proceeds from the issue were invested in Junior Subordinated
Debentures (the "Debentures") issued by the Company. The Debentures are
unsecured and rank subordinate and junior in right of payment to all
indebtedness, liabilities and obligations of the Company. The Debentures
represent the sole assets of the Trust. Interest on the Preferred Securities is
cumulative and payable semi-annually in arrears. The Company has the option,
subject to required regulatory approval, to prepay the securities beginning
August 15, 2007.
The securities are shown on the liability side of the balance sheet as
"Guaranteed preferred beneficial interest in subordinate debt." The Company has,
under the terms of the Debentures and the related Indenture as well as the other
operative corporate documents, agreed to irrevocably and unconditionally
guarantee the Trust's obligations under the Debentures. The Company contributed
approximately $6.0 million of the net proceeds to the Bank to support the Bank's
lending activities. The interest cost associated with this issue is treated as a
non-interest expense on the consolidated statement of operations rather than
interest expense.
<PAGE> 40
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
21. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial statements of First Keystone Financial, Inc. are as
follows:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
SEPTEMBER 30
-----------------------
1998 1997
-----------------------
<S> <C> <C>
ASSETS
Interest-bearing deposits $ 222 $ 9,832
Investment securities
available for sale 7,043
Investment in subsidiaries 35,622 31,168
Other assets 884 712
- ----------------------------------------------------------------
Total assets $ 43,771 $ 41,712
================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Other borrowed money $ 16,802 $ 16,702
Other liabilities 305 258
- ----------------------------------------------------------------
Total liabilities 17,107 16,960
Stockholders' equity 26,664 24,752
- ----------------------------------------------------------------
Total liabilities and
stockholders' equity $ 43,771 $ 41,712
================================================================
</TABLE>
CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30
-------------------------------------
1998 1997 1996
-------------------------------------
<S> <C> <C> <C>
INCOME:
Dividends from subsidiary $ 5 $ 1,000 $ 1,350
Loan to Employee Stock Ownership Plan 136 129 88
Interest and dividends on investments 502
Interest on deposits 43 48 20
- -------------------------------------------------------------------------------------------------
Total income 686 1,177 1,458
Interest on other borrowed money 1,620 153
Operating expenses 107 26 13
- -------------------------------------------------------------------------------------------------
Income (Loss) before income taxes and equity in
undistributed income of subsidiaries (1,041) 998 1,445
Income tax expense (benefit) (343) 10 39
- -------------------------------------------------------------------------------------------------
Income (Loss) before equity in (return of) undistributed
income of subsidiaries (698) 988 1,406
Equity in (return of) undistributed income
of subsidiaries 3,479 1,649 (521)
- -------------------------------------------------------------------------------------------------
NET INCOME $ 2,781 $ 2,637 $ 885
=================================================================================================
</TABLE>
40
<PAGE> 41
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Years Ended September 30, 1998, 1997 and 1996 (dollars in thousands)
21. PARENT COMPANY FINANCIAL INFORMATION (continued)
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30
--------------------------------
1998 1997 1996
--------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,781 $ 2,637 $ 885
Adjustments to reconcile net income
to cash provided by operations:
(Equity in) Return of undistributed
earnings of subsidiaries (3,479) (1,649) 521
Increase in investment of subsidiaries (48) (1,000) (1,350)
Amortization of common stock acquired
by stock benefit plans 563 411 364
Gain on sale of investment available for sale (5)
Increase in other assets (172) (677)
Increase in other liabilities 47 184 36
- -----------------------------------------------------------------------------------------
Net cash (used in) provided
by operating activities (313) (94) 456
- -----------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments available for sale (8,891) 1,350
Proceeds from sale of
investments available for sale 2,005
Dividends received from subsidiaries 1,000
- -----------------------------------------------------------------------------------------
Net cash provided (used in)
by investing activities (6,886) 1,000 1,350
- ------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of debentures 16,200
Increase in other
borrowed money 100
Capital contribution to subsidiary (6,000)
Common stock acquired by
stock benefit plans (775) (704)
Purchase of treasury stock (2,036) (1,257) (1,288)
Dividends paid (475) (250)
- -----------------------------------------------------------------------------------------
Net cash (used in) provided by
financing activities (2,411) 7,918 (1,992)
- -----------------------------------------------------------------------------------------
Increase (Decrease) in cash (9,610) 8,824 (186)
Cash at beginning of period 9,832 1,008 1,194
- -----------------------------------------------------------------------------------------
Cash at end of period $ 222 $ 9,832 $ 1,008
=========================================================================================
</TABLE>
41
<PAGE> 42
FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Years Ended September 30, 1998, 1997 and 1996 (dollars in thousands)
22. QUARTERLY Unaudited quarterly financial data for the year ended
FINANCIAL September 30, 1998 and 1997 is as follows:
DATA
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
-------------------------------------------------------------------------------------
1ST 2ND 3RD 4TH 1st 2nd 3rd 4th
QTR QTR QTR QTR QTR QTR QTR QTR
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Income $ 6,762 $6,836 $ 6,776 $7,019 $5,305 $5,495 $5,759 $6,191
Interest Expense 3,827 3,834 3,852 4,112 2,929 3,042 3,228 3,440
- -------------------------------------------------------------------------------------------------------------------
Net Interest Income 2,935 3,002 2,924 2,907 2,376 2,453 2,531 2,751
Provision for Loan Losses 75 76 20 15 56 60 56 67
- -------------------------------------------------------------------------------------------------------------------
Net Interest Income after
Provision for Loan Losses 2,860 2,926 2,904 2,892 2,320 2,393 2,475 2,684
Non-Interest Income 385 408 320 407 317 352 325 356
Non-Interest Expense 2,155 2,256 2,363 2,298 1,638 1,682 1,706 1,895
- -------------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 1,090 1,078 861 1,001 999 1,063 1,094 1,145
Provision for Income Taxes 418 394 160 278 384 410 421 449
- -------------------------------------------------------------------------------------------------------------------
Net Income $ 672 $ 684 $ 701 $ 723 $ 615 $ 653 $ 673 $ 696
===================================================================================================================
PER SHARE:
Earnings Per Share -Basic $ .31 $ .32 $ .33 $ .35 $ .27 $ .30 $ .31 $ .32
Earnings Per Share -Diluted $ .29 $ .30 $ .31 $ .33 $ .26 $ .29 $ .30 $ .30
Common Stock Price Range
of the Company
High $ 18.75 $19.00 $ 22.25 $17.75 $10.13 $11.25 $11.69 $16.63
Low $ 14.63 $16.38 $ 17.25 $11.63 $ 8.88 $ 9.50 $10.63 $11.38
</TABLE>
42
<PAGE> 1
Exhibit 23.
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the Registration Statements of
First Keystone Financial, Inc. on Form S-8 (Registration Nos. 333-09565 and
33-97562) of our report dated November 6, 1998, appearing in this Annual Report
on Form 10-K of First Keystone Financial, Inc. for the year ended September 30,
1998.
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Philadelphia, Pennsylvania
December 29, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000856751
<NAME> FIRST KEYSTONE FINANCIAL, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> SEP-30-1998
<CASH> 2,457
<INT-BEARING-DEPOSITS> 21,669
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 156,107
<INVESTMENTS-CARRYING> 18,769
<INVESTMENTS-MARKET> 18,700
<LOANS> 201,142
<ALLOWANCE> 1,738
<TOTAL-ASSETS> 415,863
<DEPOSITS> 247,311
<SHORT-TERM> 30,325
<LIABILITIES-OTHER> 4,810
<LONG-TERM> 90,553
0
0
<COMMON> 6,854
<OTHER-SE> 19,780
<TOTAL-LIABILITIES-AND-EQUITY> 415,863
<INTEREST-LOAN> 4,150
<INTEREST-INVEST> 2,026
<INTEREST-OTHER> 843
<INTEREST-TOTAL> 7,019
<INTEREST-DEPOSIT> 2,585
<INTEREST-EXPENSE> 1,527
<INTEREST-INCOME-NET> 2,907
<LOAN-LOSSES> 15
<SECURITIES-GAINS> (5)
<EXPENSE-OTHER> 2,298
<INCOME-PRETAX> 1,001
<INCOME-PRE-EXTRAORDINARY> 1,001
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 723
<EPS-PRIMARY> .35
<EPS-DILUTED> .33
<YIELD-ACTUAL> 7.59
<LOANS-NON> 3,685
<LOANS-PAST> 19
<LOANS-TROUBLED> 46
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,760
<CHARGE-OFFS> 60
<RECOVERIES> 23
<ALLOWANCE-CLOSE> 1,738
<ALLOWANCE-DOMESTIC> 1,020
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 718
</TABLE>
