SCHEDULE 14A INFORMATION

Proxy Statement Pursuant to Section 14(a) of the

Securities Exchange Act of 1934 (Amendment No.      )

Filed by the Registrant x

Filed by a Party other than the Registrant ¨

Check the appropriate box:

x  Preliminary Proxy Statement

¨ Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2))

¨ Definitive Proxy Statement

¨ Definitive Additional Materials

¨ Soliciting Material Pursuant to §240.14a-12

FIRST COLONIAL GROUP, INC.

(Name of Registrant as Specified In Its Charter)

(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

Payment of Filing Fee (Check the appropriate box):

x  No fee required.

¨ Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.

(1)  Title of each class of securities to which transaction applies:

(2)  Aggregate number of securities to which transaction applies:

(3)  Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined):

(4)  Proposed maximum aggregate value of transaction:

(5)  Total fee paid:

¨ Fee paid previously with preliminary materials:

¨ Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing.

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FIRST COLONIAL GROUP, INC.

76 South Main Street

Nazareth, Pennsylvania 18064

NOTICE OF ANNUAL MEETING OF SHAREHOLDERS

to be held [            ], 2003

To the shareholders of First Colonial Group, Inc.:

The Annual Meeting of Shareholders of First Colonial Group, Inc. (“First Colonial”) will be held on [            ], 2003, at [            ] a.m., prevailing time, at [                                        ] for the purpose of considering and acting upon the following:

1. To elect two Class 3 directors, as more fully described in the accompanying proxy statement/prospectus;

2. To consider and vote upon a proposal to approve the adoption of the Agreement and Plan of Merger between First Colonial and Keystone Savings Bank, a Pennsylvania-chartered mutual savings bank, dated March 5, 2003 (the “Merger Agreement”), pursuant to which First Colonial will merge with and into KNBT Bancorp, Inc. (“KNBT Bancorp”) and each outstanding share of First Colonial will be converted into the right to receive shares of KNBT Bancorp common stock as more fully described in the accompanying proxy statement/prospectus; and

3. To transact such other business as may properly come before the Annual Meeting.

Only shareholders of record, as shown on the transfer books of First Colonial, at the close of business on [            ], 2003, will be entitled to notice of, and to vote at, the Annual Meeting or any adjournment or postponement thereof.

If the Annual Meeting is adjourned for one or more periods aggregating at least 15 days because of the absence of a quorum, those shareholders entitled to vote who attend the reconvened Annual Meeting, if less than a quorum as determined under applicable law, shall nevertheless constitute a quorum for the purpose of acting upon any matter set forth in this Notice of Annual Meeting.

First Colonial shareholders will not be entitled to dissenters’ rights in connection with the merger.

YOU ARE CORDIALLY INVITED TO ATTEND THE ANNUAL MEETING IN PERSON. WHETHER OR NOT YOU EXPECT TO ATTEND THE ANNUAL MEETING IN PERSON, YOU ARE URGED TO SIGN, DATE AND PROMPTLY RETURN THE ENCLOSED PROXY. A SELF-ADDRESSED ENVELOPE IS ENCLOSED FOR YOUR CONVENIENCE; NO POSTAGE IS REQUIRED IF MAILED IN THE UNITED STATES.

By Order of the Board of Directors

SCOTT V. FAINOR

President and Chief Executive Officer

Nazareth, Pennsylvania

[            ], 2003

EXPLANATORY NOTE

The following pages constitute the preliminary proxy statement of First Colonial Group, Inc. Such proxy statement will “wrap-around” the prospectus of KNBT Bancorp, Inc. enclosed in this registration statement.

PROXY STATEMENT

OF

FIRST COLONIAL GROUP, INC.

76 South Main Street

Nazareth, Pennsylvania 18064

(610) 746-7300

FOR THE ANNUAL MEETING OF SHAREHOLDERS

TO BE HELD ON [            ], 2003

PROSPECTUS

OF

KNBT BANCORP, INC.

(Up to [    ] shares of common stock, par value $0.01 per share)

The accompanying proxy is solicited by the board of directors of First Colonial for use at the Annual Meeting of Shareholders to be held on [            ], 2003 at [            ], prevailing time, at [                                        ], and any adjournments or postponements thereof.

This proxy statement/prospectus relates to the election of two Class 3 directors and the proposed merger of First Colonial with and into KNBT Bancorp, Inc., a Pennsylvania corporation, as contemplated by the merger agreement, dated as of March 5, 2003 between First Colonial and Keystone Savings Bank, a Pennsylvania-chartered mutual savings bank. The merger agreement is included as Appendix A hereto and incorporated by reference herein.

Upon consummation of the merger, each share of First Colonial common stock issued and outstanding immediately prior to the merger (other than treasury shares) will be converted into the right to receive a number of shares of KNBT Bancorp common stock equal to $37.00 divided by the initial public offering price for the shares of KNBT Bancorp common stock to be issued in connection with the conversion of Keystone Savings Bank from mutual to stock form and the organization of KNBT Bancorp as the holding company for Keystone Savings Bank. See “The Conversion and the Merger” in the prospectus for a description of Keystone Savings Bank’s conversion. Assuming an initial public offering price of $10.00, each share of First Colonial common stock would be converted into 3.7 shares of KNBT Bancorp common stock in the merger. Immediately after the merger of First Colonial and KNBT Bancorp, First Colonial’s banking subsidiary, Nazareth National Bank and Trust Company, will merge with and into Keystone Savings Bank with Keystone Savings Bank being the survivor of the merger operating under the name of Keystone Nazareth Bank and Trust Company.

This proxy statement/prospectus also constitutes a prospectus of KNBT Bancorp with respect to up to [    ] shares of common stock, par value $0.01 per share, of KNBT Bancorp. The prospectus of KNBT Bancorp begins on page [        ] of this proxy statement/prospectus, is sometimes referred to as the “prospectus” and is a part of this proxy statement/prospectus.

This proxy statement/prospectus provides you with detailed information about the proposed merger and related matters. You should read this proxy statement/prospectus carefully, including the appendices and the risk factors beginning on page [        ].

Neither the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, the Pennsylvania Department Banking, nor any state securities commission has approved or disapproved of the merger described in this proxy statement/prospectus or the KNBT Bancorp common stock to be issued in connection with the merger or determined if this proxy statement/prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

This proxy statement/prospectus is dated [        ], 2003 and is first being mailed to shareholders on or about [        ], 2003.

Table of Contents

Proxy Statement
Available Information	1
Summary	1
The Annual Meeting	1
Security Ownership	1
The Merger	1
Parties to the Merger	2
First Colonial’s Recommendations to Shareholders; Reasons for the Merger	2
Merger Consideration	3
Treatment of First Colonial Stock Options	3
Board of Directors and Management of KNBT Bancorp and Keystone Nazareth Bank and Trust Following the Merger	3
Representations and Warranties	3
Conditions to the Merger	3
Regulatory Approvals	4
Termination of the Merger Agreement	4
Opinion of Financial Advisor	5
Certain Federal Income Tax Consequences of the Merger	5
Accounting Treatment	6
No Dissenters’ Rights of Appraisal	6
Voting Securities and Principal Holders Thereof	7
Annual Meeting of First Colonial Shareholders	9
General	9
Record Date	9
Stock Entitled to Vote	9
Quorum	10
Required Vote	10
Stock Ownership	10
Voting and Revocation of Proxies	11
Solicitation of Proxies	11
No Dissenters’ Rights	11
Proposal One: Election of Directors	11
Board of Directors, Committees and Attendance at Meetings	14
Audit Committee Report	14
Compensation of Directors	15
Section 16(a) Beneficial Ownership Reporting Compliance	15
Executive Compensation	16
Compensation Committee Report	16
Summary Compensation Table	19
Aggregated Option Exercises in 2002 and 2002 Year-End Option Values	20
Option Grants In Last Fiscal Year	21
Stock Option Plans	21
Agreements with Executive Officers	22
Executive Benefit Program	24
Certain Relationships and Related Transactions	25
Compensation Committee Interlocks and Insider Participation	25
Relationship With Independent Public Accountants	26
Proposal Two: Adoption of the Merger Agreement	27
General	27

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Material Terms of the Merger Agreement	27
Background of the Merger	27
First Colonial’s Reasons for the Merger; Recommendation of First Colonial’s Board of Directors	28
Opinion of First Colonial’s Financial Advisor	31
Certain Federal Income Tax Consequences of the Merger	36
No Dissenters’ Rights	38
Comparison of Rights of Shareholders First Colonial and KNBT Bancorp	38
Authorized Capital	38
Cumulative Voting	38
Special Meetings of Shareholders	39
Size, Classification and Qualifications of the Board of Directors	39
Removal of Directors	39
Amendment of Governing Documents	39
First Colonial.	39
KNBT Bancorp.	40
Shareholder Voting Rights	40
Shareholder Acquisition of Stock	41
Shareholder Approval of Business Combinations with Interested Shareholders	42
Anti-Takeover Provisions	42
First Colonial Stock Prices and Dividend Information	44
Other Matters	45
Shareholder Proposals	46
Form 10-K	46

Prospectus

[TABLE OF CONTENTS OF PROSPECTUS TO BE ADDED]

APPENDICES

A. Agreement and Plan of Merger (omitting schedules and exhibits)

B. Fairness Opinion of The Kafafian Group, Inc.

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Available Information

First Colonial files annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy any reports, statements, and other information First Colonial files with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. First Colonial’s SEC filings are also available on the SEC’s website (http://www.sec.gov).

All information contained in this proxy statement/prospectus with respect to KNBT Bancorp and Keystone Savings Bank has been supplied by KNBT Bancorp and Keystone Savings Bank, and all information with respect to First Colonial and Nazareth National Bank has been supplied by First Colonial.

No person is authorized to give any information or to make any representation other than those contained or incorporated by reference in this proxy statement/prospectus, and, if given or made, such information or representation should not be relied upon as having been authorized. This proxy statement/prospectus does not constitute an offer to sell, or a solicitation of an offer to purchase, the securities offered by this proxy statement/prospectus, or the solicitation of a proxy, in any jurisdiction, to or from any person to whom or from whom it is unlawful to make such offer, solicitation of an offer or proxy solicitation in such jurisdiction.

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Summary

The following is a brief summary of certain information contained in this proxy statement/prospectus. This summary is not intended to be a complete description of all material facts regarding First Colonial, Nazareth National Bank, KNBT Bancorp or Keystone Savings Bank or the matters to be considered at the Annual Meeting and is qualified in its entirety by, and reference is made to, the more detailed information contained elsewhere in this proxy statement/prospectus and the accompanying Appendices. All First Colonial share and per share information in this proxy statement/prospectus has been adjusted to reflect First Colonial’s 5% stock dividends paid in May 2002, June 2001, and June 2000.

The Annual Meeting

Meeting Date; Record Date (see page [        ])

The Annual Meeting is scheduled to be held on [        ], 2003 at [        ], prevailing time, at [        ].

Only First Colonial shareholders of record, as shown on the transfer books of First Colonial, at the close of business on [                ], 2003 (“Record Date”) will be entitled to notice of, and to vote at, the Annual Meeting. On the Record Date, there were [            ] shares of First Colonial common stock outstanding.

Matters to Be Considered (see pages [        ] and [        ] )

At the Annual Meeting holders of shares of First Colonial common stock will consider and act upon the following:

• a proposal to elect two Class 3 directors; and

• a proposal to approve the adoption of the merger agreement between First Colonial and Keystone Savings Bank.

Vote Required (see page [        ])

The election of directors will be determined by a plurality vote and the two nominees receiving the most “for” votes will be elected. In the election of directors, First Colonial shareholders are entitled to cumulate their votes. Cumulative voting entitles each shareholder to cast as many votes as is equal to the number of shares held by such shareholder multiplied by the number of directors to be elected; all such votes may be cast for one candidate or they may be distributed among the two candidates in the election.

Approval of the adoption of the merger agreement and any other proposal will require the affirmative vote of a majority of the votes cast on the proposal.

Security Ownership

As of the Record Date, the directors and executive officers of First Colonial and their affiliates beneficially owned in the aggregate [        ] shares, or [    ]% of the then outstanding shares of First Colonial common stock entitled to vote at the Annual Meeting. The directors of First Colonial, who collectively hold [    ]% of First Colonial common stock, have agreed to vote their shares at the Annual Meeting in favor of the adoption of the merger agreement.

The Merger

Pursuant to the merger agreement, First Colonial will be merged with and into KNBT Bancorp and First Colonial common stock will be converted into KNBT Bancorp common stock. Immediately after the merger of First Colonial and KNBT Bancorp, First Colonial’s banking subsidiary, Nazareth National Bank, will merge with and into Keystone Savings Bank with Keystone Savings Bank being the survivor of the merger operating under the name of Keystone Nazareth Bank and Trust Company.

The merger agreement is attached as Appendix A to this proxy statement/prospectus. You should read the merger agreement as it is the legal document that governs the merger.

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Parties to the Merger

First Colonial and Nazareth National Bank.

First Colonial is a Pennsylvania business corporation which is registered as a bank holding company. First Colonial was incorporated in 1982 to become the holding company for Nazareth National Bank. First Colonial is the sole shareholder of three companies including Nazareth National Bank, First C. G. Company, Inc., a Delaware investment subsidiary, and First Colonial Statutory Trust I, a Connecticut business trust formed to issue trust preferred securities. At March 31, 2003, First Colonial had total assets of $620.7 million, total deposits of $483.3 million and total shareholders’ equity of $40.5 million.

Nazareth National Bank was incorporated under the laws of the United States of America as a national bank in 1897 and is a member of the Federal Reserve System. Nazareth National Bank engages in a full service commercial and consumer banking and trust business. Nazareth National Bank’s primary business is attracting deposits from the general public and investing such deposits in loans secured by residential and commercial real property, commercial business loans, consumer loans and investment securities. Nazareth National Bank provides services to its customers through its branch network of 17 full-service branch offices located in Northampton, Monroe and Lehigh Counties in the Greater Lehigh Valley of Pennsylvania.

First Colonial and Nazareth National Bank’s executive offices are located at 76 South Main Street, Nazareth, Pennsylvania 18064 and their telephone number is (610) 746-7300.

For additional information concerning First Colonial and Nazareth National Bank, see [                                         ].

Keystone Savings Bank and KNBT Bancorp.

Keystone Savings Bank is a Pennsylvania-chartered mutual savings bank organized in 1925. Keystone Savings Bank has 19 offices located in Lehigh, Northampton and Carbon Counties in the Greater Lehigh Valley of Pennsylvania. As of March 31, 2003, Keystone Savings Bank had total assets of $1.0 billion, total deposits of $797.4 million and total capital of $114.3 million.

Pursuant to the terms of a plan of conversion, Keystone Savings Bank will convert from a Pennsylvania-chartered mutual savings bank to Pennsylvania-chartered stock savings bank. The merger is dependent upon Keystone Savings Bank’s mutual to stock conversion. If the conversion is not consummated, the merger will not occur.

KNBT Bancorp is a Pennsylvania corporation organized by Keystone Savings Bank for the purpose of becoming the holding company of Keystone Savings Bank in connection with Keystone Savings Bank’s mutual-to-stock conversion. KNBT Bancorp is not an operating company and has not engaged in any significant business to date.

Keystone Savings Bank and KNBT Bancorp’s executive offices are located at 90 Highland Avenue, Bethlehem, Pennsylvania 18017, and their telephone number is (610) 861-5000.

For additional information concerning Keystone Savings Bank and KNBT Bancorp, see [                                        ].

First Colonial’s Recommendations to Shareholders; Reasons for the Merger (see pages [        ])

First Colonial’s board of directors believes that the merger is in your best interest and unanimously recommends that you vote “for” the proposal to adopt the merger agreement.

For a discussion of the factors considered by the First Colonial board of directors in reaching its decision to adopt the merger agreement and approve the transactions contemplated thereby, see “Proposal Two: Adoption of the Merger Agreement—Background of the Merger” and “—First Colonial’s Reasons for the Merger;

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Recommendation of First Colonial’s Board of Directors.”

Merger Consideration (see page [        ])

Each share of First Colonial common stock outstanding immediately prior to the merger (other than treasury shares) will be converted into the right to receive a number of shares of KNBT Bancorp common stock equal to $37.00 divided by the initial public offering price for the shares of KNBT Bancorp common stock to be issued in connection with the conversion, referred to as the merger exchange ratio. Assuming an initial public offering price of $10.00, each share of First Colonial common stock would be converted into 3.7 shares of KNBT Bancorp common stock in the merger. Cash will be paid in lieu of fractional share interests.

Treatment of First Colonial Stock Options (see page [        ])

Each option to purchase First Colonial common stock outstanding immediately prior to consummation of the merger will be converted into options to purchase KNBT Bancorp common stock, with the number of shares subject to the option and the exercise price per share to be adjusted based upon the merger exchange ratio.

Board of Directors and Management of KNBT Bancorp and Keystone Nazareth Bank and Trust Following the Merger (see pages [        ])

The board of directors of the KNBT Bancorp currently consists of nine members, all of whom currently are trustees of Keystone Saving Bank. Upon completion of the merger, Scott V. Fainor, President and Chief Executive Officer of First Colonial, as well as five other current directors of First Colonial will be appointed to the boards of directors of KNBT Bancorp and Keystone Nazareth Bank. In addition, upon completion of the merger, Mr. Fainor will be appointed the President and Chief Executive officer of KNBT Bancorp and Keystone Nazareth Bank & Trust. KNBT Bancorp and Keystone Savings Bank have entered into a three-year employment agreement with Mr. Fainor with respect to his employment as President and Chief Executive Officer of KNBT Bancorp and Keystone Nazareth Bank & Trust, such agreement to be effective upon completion of the merger. KNBT Bancorp and Keystone Savings Bank have entered into a three-year employment agreement with Eugene T. Sobol, executive vice president and Chief Operating Officer of Keystone Savings Bank, with respect to his employment as senior executive vice president and Chief Operating Officer of KNBT Bancorp and Keystone Nazareth Bank & Trust, such agreement to be effective upon completion of the merger. KNBT Bancorp and Keystone Savings Bank also expect to appoint in connection with the completion of the merger Reid L. Heeren, currently the Executive Vice President and Chief Financial Officer of First Colonial and Nazareth National Bank, to the same position at KNBT Bancorp and Keystone Nazareth Bank & Trust.

Representations and Warranties (see pages [        ])

The merger agreement contains representations and warranties of First Colonial. Keystone Savings Bank and KNBT Bancorp which are customary in merger transactions. See “The Conversion and the Merger—Representations and Warranties” in the prospectus.

Conditions to the Merger (see pages [        ])

The respective obligations of the parties to consummate the merger are subject to the satisfaction or waiver of certain conditions specified in the merger agreement including, among other things, the receipt of all necessary regulatory, shareholder and member approvals, the completion of the conversion, the compliance with or satisfaction of all representations, warranties, covenants and conditions set forth therein, the absence of any order, decree or injunction enjoining or prohibiting consummation of either the conversion or the merger, and the receipt by the parties of a tax opinion with respect to certain federal income tax consequences of the merger. There can be no assurance that the conditions to

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consummation of the merger will be satisfied or waived.

Regulatory Approvals (see pages [        ])

Various approvals or non-objections of the Federal Reserve Board, the Federal Deposit Insurance Corporation and Pennsylvania Department of Banking are required in order to consummate the conversion and the merger. The Pennsylvania Department of Banking has approved and the Federal Deposit Insurance Corporation has issued an intent not to object to the plan of conversion, subject to approval by Keystone Savings Bank’s depositors eligible to vote on the plan of conversion. In addition, consummation of the conversion and the merger is subject to approval by the Federal Reserve Board of KNBT Bancorp’s holding company application to acquire all the common stock of Keystone Savings Bank and the approval of the Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking with respect to the merger of Nazareth National Bank with and into Keystone Savings Bank. Notice must also be provided to the Office of the Comptroller of the Currency of the proposed merger of Nazareth National Bank with and into Keystone Savings Bank. Applications for these approvals have been filled and are currently pending. There can be no assurance as to the receipt or timing of such approvals.

Termination of the Merger Agreement (see pages [        ])

The merger agreement may be terminated and the merger abandoned at any time prior to the merger becoming effective, in a limited number of circumstances, including the following:

By either Keystone Savings Bank or First Colonial in the event of:

• failure of First Colonial’s shareholders to approve the merger agreement after a vote taken thereon at a meeting called for such purpose;

• the failure of Keystone’s depositors to approve the conversion after a vote taken thereon at a meeting called for such purpose;

• a material breach by the other party of any material covenant or undertaking that has not been timely cured after notice;

• any material breach of any representation or warranty of the other party that has not been timely cured after notice;

• if any approval, consent or waiver of a governmental authority required to permit consummation of the merger, the conversion or the other transactions contemplated by the merger agreement has been denied;

• the merger not being completed by March 31, 2004; and

By Keystone Savings Bank in the event:

• the board of directors of First Colonial fails to call, give notice of, convene and hold a meeting of its shareholders to consider and vote upon the approval of the merger agreement or has failed to recommend approval of the merger agreement to its shareholders;

• First Colonial has failed to comply with its agreement not to solicit a competing acquisition transaction;

• a tender or exchange offer for 20% or more of the outstanding shares of common stock of First Colonial is started and the board of directors of First Colonial either recommends that First Colonial shareholders tender

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their shares or fails to recommend that its shareholders reject such tender offer or exchange offer within specified time frames; and

By First Colonial in the event:

• the board of trustees of Keystone does not call, give notice of, convene and hold the meeting of depositors to consider and vote on the plan of conversion or does not recommend that depositors approve the plan of conversion; or

• First Colonial has prior to holding the meeting of First Colonial’s shareholders to consider and approve the merger agreement, terminated the merger agreement to enter into an acquisition agreement with another entity with respect to a superior proposal provided, however, that First Colonial may only terminate the merger agreement under this provision in the event that First Colonial has provided written notice of such superior proposal to Keystone and Keystone has not within five business days submitted a proposal to First Colonial that its board of directors believes is at least equal to the superior proposal.

In the event of the termination of the merger agreement, as provided above, the merger agreement shall become void and have no effect, and there will be no liability on the part of any party to the merger agreement or their respective officers or directors, except that certain provisions regarding confidential information, expenses and termination fees shall survive and remain in full force and effect.

See also “The Conversion and the Merger—Completion of the Conversion and the Merger; Termination and Amendment” in the prospectus.

Termination Fees (see pages [        ])

The merger agreement requires First Colonial to pay KNBT Bancorp a termination fee in the amount of $4.0 million, if the merger agreement is terminated under limited circumstances specified in the merger agreement. The merger agreement also requires Keystone Savings Bank to pay First Colonial a termination fee in the amount of $1.0 million plus First Colonial’s documented expenses up to $1.0 million if the merger agreement is terminated under limited circumstances specified in the merger agreement.

Opinion of Financial Advisor (see page [        ])

In deciding to approve the merger, First Colonial’s board considered the opinion from its financial advisor, The Kafafian Group, Inc., that the merger consideration is fair from a financial point of view, to the shareholders of First Colonial. This opinion is attached as Appendix B to this proxy statement/prospectus. First Colonial encourages you to read this opinion.

Certain Federal Income Tax Consequences of the Merger (see page [        ])

The merger has been structured so that as a general matter, neither you, First Colonial nor KNBT Bancorp will recognize any gain or loss for federal income tax purposes. The merger is conditioned on the parties receipt of a legal opinion that the merger constitutes a reorganization under Section 368(a) of the Internal Revenue Code of 1986, as amended (the “Code”).

Tax matters are very complicated and the tax consequences of the merger to you will depend on the facts of your own situation. You should consult your tax advisors for a full understanding of the tax consequences of the merger to you.

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Accounting Treatment (see page [        ])

The merger will be accounted for under the purchase method of accounting in accordance with generally accepted accounting principles. Under this method, First Colonial’s assets and liabilities as of the date of the merger will be recorded at their respective fair values and added to those of KNBT Bancorp. Any difference between the purchase price for First Colonial and the fair value of the identifiable net assets acquired will be recorded as goodwill.

No Dissenters’ Rights of Appraisal

Under Pennsylvania law, First Colonial shareholders will not be entitled to dissenters’ rights in connection with the merger.

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Voting Securities and Principal Holders Thereof

The following table sets forth certain information, as of May 31, 2003, with respect to the beneficial ownership of First Colonial’s common stock by (1) each shareholder known by First Colonial to own beneficially more than five percent of First Colonial’s outstanding common stock, (2) all directors of First Colonial and Nazareth National Bank, (3) all executive officers of First Colonial and/or Nazareth National Bank named in the Summary Compensation Table and (4) all directors and executive officers of First Colonial and Nazareth National Bank as a group. Except as otherwise specified, to the knowledge of First Colonial, the beneficial owners of First Colonial common stock listed below have sole investment and voting power with respect to such shares. The shareholdings set forth below reflect all stock dividends paid and stock splits effected by First Colonial through May 31, 2003, and are rounded to the nearest whole share.

Name	Amount of Common Stock Beneficially Owned(a)	Percent of Class(a)
Employee Stock Ownership Plan (“ESOP”) Trust Nazareth National Bank and Trust Company, Trustee 76 South Main Street, Nazareth, PA 18064(b)	333,162	13.1
Tomas J. Bamberger(c)	15,743	*
Robert J. Bergren(d)	11,137	*
Scott V. Fainor(e)	110,833	4.3
Reid L. Heeren(f)	36,143	1.4
David W. Hughes(g)	8,559	*
Christian F. Martin, IV(h)	29,991	1.2
Robert M. McGovern(i)	10,041	*
Gordon B. Mowrer(j)	10,367	*
Daniel B. Mulholland(k)	9,300	*
Charles J. Peischl(l)	7,667	*
John H. Ruhle, Jr.(m)	9,196	*
Richard Stevens, III(n)	8,588	*
Maria Zumas Thulin(o)	13,143	*
All Directors and Executive Officers as a group (15 persons)(p)	304,283	11.2

* Less than 1%.

(a) The securities “beneficially owned” by an individual are determined as of May 31, 2003 in accordance with the definition of “beneficial ownership” set forth in the regulations of the SEC. Accordingly, they may include securities owned by or for, among others, the spouse and/or minor children of the individual and any other relative who has the same home as such individual, as well as other securities as to which the individual has or shares voting or investment power or has the right to acquire under outstanding stock options within 60 days after May 31, 2003. Beneficial ownership may be disclaimed as to certain of the securities.

(b) Includes 284,219 allocated and 48,943 unallocated shares. Participants in the ESOP have “pass-through” voting rights and are entitled to direct the vote on all shares allocated to their accounts as of May 31, 2003. Unallocated shares, as well as allocated shares for which no voting directions are received, are voted by the plan administrators, who are appointed by the First Colonial board of directors and who have sole investment power

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with respect to all shares held in the plan. Does not include shares held by Nazareth National Bank in various other trusts for which Nazareth National Bank, in its capacity as trustee, has or shares voting or investment power. As of May 31, 2003, Nazareth National Bank had or shared voting or investment power with respect to 22,212 shares held in trust for First Colonial’s Optional Deferred Salary Plan and 109,432 shares held in various other trust accounts.

(c) Includes 2,305 shares allocated to his account under the ESOP and 12,210 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans.

(d) Includes 7,210 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans.

(e) Includes 82,250 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans.

(f) Includes 13,926 shares allocated to his account under the ESOP, 16,039 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans and 461 shares owned by his spouse.

(g) Includes 178 shares allocated to his account under the ESOP and 8,381 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans.

(h) Includes 5,731 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans and 628 shares owned by his spouse.

(i) Includes 1,109 shares allocated to his account under the ESOP and 7,881 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans.

(j) Includes 7,210 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans.

(k) Includes 959 shares owned by his spouse in custody for his son, 701 shares owned jointly with his spouse, 420 shares owned by his spouse and 7,209 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans.

(l) Includes 7,209 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans.

(m) Includes 5,731 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans.

(n) Includes 5,732 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans.

(o) Includes 140 shares owned by her spouse, 4,789 shares owned jointly with her spouse, 482 shares held in trust for her children, and 7,209 shares issuable upon the exercise of options granted pursuant to First Colonial’s stock option plans.

(p) Includes an aggregate of 141,147 shares issuable upon the exercise of options granted to executive officers pursuant to First Colonial’s stock option plans, an aggregate of 53,241 shares issuable upon the exercise of options granted to directors pursuant to First Colonial’s stock option plans and 24,771 shares allocated under the ESOP to the accounts of all executive officers of First Colonial and Nazareth National Bank, as a group.

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Annual Meeting of First Colonial Shareholders

First Colonial is sending you this proxy statement/prospectus in order to provide you with important information regarding the election of two Class 3 directors and the merger and to solicit your proxy for use at the Annual Meeting and at any adjournments or postponements thereof. The Annual Meeting is scheduled to be held at the time and place described below.

General

The First Colonial Annual Meeting is scheduled to be held on [            ], 2003 at [        ], prevailing time at [                                     ]. At the Annual Meeting First Colonial shareholders will have the opportunity to consider and vote upon the election of two Class 3 directors and the adoption of the merger agreement.

Record Date

The close of business on [                    ], has been fixed by the First Colonial board of directors as the record date for the determination of holders of shares of First Colonial common stock entitled to notice of and to vote at the Annual Meeting.

Stock Entitled to Vote

At the close of business on [    ], First Colonial had [    ] shares of First Colonial common stock outstanding. Except for certain restrictions (summarized below) each share of First Colonial common stock is entitled to one vote on each matter which may be brought before the Annual Meeting except that, in the election of directors, shareholders are entitled to cumulate their votes. Cumulative voting entitles each shareholder to cast as many votes as is equal to the number of shares held by such shareholder multiplied by the number of directors to be elected; all such votes may be cast for one candidate or they may be distributed among the two candidates in the election. The persons named in the accompanying proxy may exercise cumulative voting rights in any manner they deem desirable to secure the election of as many as possible of the nominees named in this proxy statement/prospectus.

Article 7 of the First Colonial’s Restated Articles of Incorporation, as amended, restricts the rights of a Person (as hereafter defined) to cast (or execute written consents with respect to) more than 10% of the total votes which all First Colonial shareholders are entitled to cast at a meeting, unless authorized to do so by the First Colonial board of directors and subject to such conditions as First Colonial’s board of directors may impose. The term “Person” includes not only individuals and entities, but also groups of individuals and entities who act together for the purpose of acquiring, holding, disposing of or voting First Colonial common stock.

The restrictions of Article 7 do not apply to the shares of First Colonial common stock held by Nazareth National Bank for itself or as trustee of First Colonial’s Employee Stock Ownership Plan or other trusts. See “Voting Securities and Principal Holders Thereof.”

The casting of votes by a Person as a proxy holder for other First Colonial shareholders is not counted in computing the 10% limitation to the extent that the proxies so voted were revocable and were secured from other shareholders who are not members of a group which includes such Person. Giving a revocable proxy to a Person does not in itself cause the shareholder giving the proxy to be a member of a group which includes such Person. Article 7 provides that the determination by the First Colonial board of

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directors of the existence or membership of a group, and of a number of votes any Person or each member of a group is entitled to cast, is final and conclusive absent clear and convincing evidence of bad faith.

In the event of a violation of Article 7 and in addition to other remedies afforded First Colonial, the judges of election cannot count votes cast in violation of Article 7 and First Colonial or its nominees have an option to acquire from the violator shares of First Colonial common stock in excess of the 10% limit at prices which would in certain situations be lower than the then current market price of such shares.

The foregoing is a brief summary of Article 7 and is qualified and amplified in all respects by the exact provisions of the Restated Articles of Incorporation, as amended, a copy of which can be obtained in the same manner as First Colonial’s Annual Report on Form 10-K for 2002. See ”Form 10-K”.

Quorum

The presence, in person or represented by proxy, of the holders of a majority of the outstanding shares of First Colonial common stock will constitute a quorum for the transaction of business at the Annual Meeting. All shares of the First Colonial common stock present in person or represented by proxy and entitled to vote at the Annual Meeting, no matter how they are voted or whether they abstain from voting, will be counted in determining the presence of a quorum. Abstentions and “broker non-votes,” explained below, will be counted as shares present for purposes of determining whether a quorum is present. Broker non-votes are shares held in the name of a broker or nominee for which an executed proxy is received, but are not voted on the proposal because the voting instructions have not been received from the beneficial owner or persons entitled to vote and the broker or nominee does not have the discretionary power to vote.

If the Annual Meeting is adjourned because of the absence of a quorum, those shareholders entitled to vote who attend the adjourned Annual Meeting, although constituting less than a quorum as provided herein, shall nevertheless constitute a quorum for the purpose of electing directors. If the Annual Meeting is adjourned for one or more periods aggregating at least 15 days because of the absence of a quorum, those shareholders entitled to vote who attend the reconvened Annual Meeting, if less than a quorum as determined under applicable law, shall nevertheless constitute a quorum for the purpose of acting upon any matter set forth in the Notice of Annual Meeting.

Required Vote

The election of directors will be determined by a plurality vote and the two nominees receiving the most “for” votes will be elected.

Approval of the adoption of the merger agreement and any other proposal will require the affirmative vote of a majority of the votes cast on the proposal.

Under the Pennsylvania Business Corporation Law, an abstention, withholding of authority to vote or broker non-vote are not counted as votes cast. Accordingly, abstentions, withholding of authority to vote or broker non-votes will have no effect on the vote and will not be counted in determining whether the proposals at the Annual Meeting receive the required shareholder vote.

Stock Ownership

As of May 31, 2003 the directors and executive officers, as a group, of First Colonial beneficially owned and had the right to vote, in the aggregate, 109,895 shares of First Colonial common stock, representing approximately 4.9% of the total votes entitled to be cast at the Annual Meeting. First

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Colonial’s directors, as a group, who collectively hold 74,730 shares of First Colonial common stock, representing approximately 3.3% of the total votes entitled to be cast at the meeting, have agreed with Keystone Savings Bank to vote their shares at the Annual Meeting in favor of adoption of the merger agreement.

Voting and Revocation of Proxies

Proxies in the accompanying form, properly executed and received in time for voting, and not revoked, will be voted as indicated in accordance with the instructions thereon. If no directions to the contrary are indicated, the persons named in the enclosed proxy will vote all shares of First Colonial common stock “for” the election of all nominees for directors hereinafter named and “for” the adoption of the merger agreement. The First Colonial board of directors is not aware of any business to be acted upon at the Annual Meeting, other than as described in this proxy statement/prospectus. If, however, other matters are brought before the Annual Meeting, including, among other things, a motion to adjourn or postpone the Annual Meeting to another time or place for the purpose of soliciting additional proxies or otherwise, the persons appointed as proxies will have discretion to vote or act on the matters according to their best judgment. However, no proxy which is voted against the adoption of the merger agreement will be voted in favor of any adjournment or postponement.

Sending in a signed proxy will not affect a First Colonial shareholder’s right to attend the Annual Meeting and vote in person since the proxy is revocable. Any First Colonial shareholder giving a proxy has the power to revoke it by, among other methods, giving written notice to the Secretary of First Colonial at any time before the proxy is exercised.

Solicitation of Proxies

The cost of the solicitation will be borne by First Colonial. In addition to solicitation by mail, proxies may be solicited in person or by telephone, facsimile or similar means by officers, directors or employees of First Colonial, without additional compensation. Upon request, First Colonial will pay the reasonable expenses incurred by record holders of First Colonial’s common stock, par value $5.00 per share, who are brokers, dealers, banks or voting trustees, or their nominees, for mailing proxy material and annual shareholder reports to beneficial owners.

No Dissenters’ Rights

Under Pennsylvania law, First Colonial shareholders will not be entitled to dissenters’ rights in connection with the merger.

Proposal One:

Election of Directors

As permitted under Pennsylvania law, First Colonial’s Bylaws provide for staggering the terms of office of First Colonial’s directors by dividing the board of directors into four classes, with members of each class serving four-year terms. First Colonial’s Bylaws further provide that the board of directors shall consist of not fewer than five nor more than 25 directors, with the exact number fixed by the board of directors. First Colonial’s board of directors currently consists of nine members.

At the Annual Meeting, the shareholders will elect two Class 3 directors to serve for the shorter of (i) a term of four years and until their successors are elected and qualified or (ii) the consummation of the merger. As described in “Annual Meeting of First Colonial Shareholders—Stock Entitled to Vote,” shareholders are entitled to cumulative voting rights in the election of directors. Pursuant to the merger agreement, First Colonial and Keystone Savings Bank agreed to the composition of the initial board of

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directors of KNBT Bancorp and Keystone Nazareth Bank and Trust. See “Management—Management of KNBT Bancorp—Board of Directors.”

The following table sets forth information, as of the Record Date, concerning First Colonial’s directors and nominees for election to First Colonial’s board of directors. Unless directed otherwise, the persons named in the enclosed proxy intend to vote such proxy for the election of the listed nominees or, in the event of death, disqualification, refusal or inability of any nominee to serve, for the election of such other persons as the management of First Colonial may recommend in the place of such nominee to fill the vacancy. First Colonial’s board of directors has no reason to believe that any of the nominees will not be a candidate or will be unable to serve.

The director nominees named below were nominated by First Colonial’s board of directors and currently serve as directors. In addition, all of the directors and director nominees named below also serve on the board of directors of Nazareth National Bank.

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Name/Age as of Record Date	Principal Occupation or Employment for Past Five Years	Director Since	Term of Office Expires
	Director Nominees
Robert J. Bergren 77 (1)(2)(3)	Retired; former Vice President Administration Handling Systems, Inc. (manufacturer of materials handling equipment), Easton, Pennsylvania	1983	2003
Richard Stevens, III 70 (1)(2)(3)	Chairman of the Board of First Colonial and Nazareth National Bank since January 199 Retired; former Division Manager (Marketing) for Computer Aid, Inc., Allentown, Pennsylvania	1989	2003
	Continuing Directors
Scott V. Fainor 42 (1)	President and Chief Executive Officer of First Colonial and Nazareth National Bank since January 2002; Executive Vice President, First Union 2001 and President of Lehigh Valley/Northeastern Pennsylvania region, First Union, from 1997 to December 2000	2002	2004
Christian F. Martin, IV 47	Chairman and Chief Executive Officer, C.F. Martin & Co., Inc. (manufacturer of guitars), Nazareth, Pennsylvania	1999	2004
Gordon B. Mowrer 67 (1)(2)(3)	Retired; Former Pastor, Advent Moravian Church, Bethlehem, Pennsylvania; former President, Hampson-Mowrer-Kreitz Insurance Agency, Inc. (insurance sales)	1989	2006
Daniel B. Mulholland 51 (1)(2)	Consultant; Former President, Mallinckrodt Baker, Inc. (chemical manufacturing), Phillipsburg, New Jersey	1994	2005
Charles J Peischl 58	Attorney, Peters, Moritz, Peischl, Zulick & Landes, Nazareth, Pennsylvania	1996	2005
Jon H. Ruhle, Jr. 56 (3)	President and Chairman, Reeb Millwork Corporation (wholesale distributor of windows, doors and affiliated building products for residential market), Bethlehem, Pennsylvania	1999	2004
Maria Zumas Thulin 50	Executive Vice President, Arcadia Development Corporation, (real estate development and management),Bethlehem, Pennsylvania	1994	2006

(1) Member of the Executive Committee.

(2) Member of the Compensation Committee.

(3) Member of the Audit Committee.

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There are no other nominees for director known to First Colonial at this time.

Under First Colonial’s Bylaws, shareholders have the right to nominate directors in accordance with the procedures specified therein. If the merger is not consummated, nominations for directors made by shareholders for the 2004 annual meeting of shareholders must be submitted by [                ] and must contain certain information required by the Bylaws. All late or non-conforming nominations may be rejected. In addition, at any time prior to the election of directors at a meeting of shareholders, First Colonial’s board of directors may designate a substitute nominee to replace any bona fide nominee who was nominated in accordance with the Bylaws and who, for any reason, becomes unavailable for election as a director.

Board of Directors, Committees and Attendance at Meetings

First Colonial’s board of directors held 17 meetings during the fiscal year ended December 31, 2002. The Executive Committee, which held 5 meetings during the fiscal year, makes recommendations to First Colonial’s board of directors with respect to executive compensation and First Colonial’s stock option plans (among other matters). First Colonial’s board of directors has a Compensation Committee which makes decisions concerning executive compensation and stock options and which administers First Colonial’s stock option plans. The Compensation Committee met once during the fiscal year ended December 31, 2002. The report of the Compensation Committee begins on page [    ] of this proxy statement/prospectus. First Colonial’s board of directors has an Audit Committee, which meets at varying intervals. The purpose of the Audit Committee is to review all recommendations made by First Colonial’s independent public accountants with respect to the accounting methods used and the system of internal controls followed by First Colonial and to advise First Colonial’s board of directors with respect thereto. The Audit Committee held 4 meetings during the fiscal year ended December 31, 2002. The report of the Audit Committee begins on page [            ] of this proxy statements/prospectus. First Colonial’s board of directors does not have a nominating committee. During the fiscal year ended December 31, 2002, all directors of First Colonial attended at least 75% of the total number of meetings of First Colonial’s board of directors and of all committees of which they were members.

Audit Committee Report

In the performance of its oversight function and in accordance with its responsibilities under its charter, the Audit Committee has reviewed and discussed with management and our independent auditors, Grant Thornton LLP, our audited financial statements as of and for the fiscal year ended December 31, 2002.

The Audit Committee has also discussed with Grant Thornton LLP, the matters required to be discussed by Statement on Auditing Standards No. 99, Communication with Audit Committees, as amended by the Auditing Standards Board of the American Institute of Certified Public Accountants. In addition, the Audit Committee has, as required by Independence Standards Board Standard No. 1, “Independence Discussion with Audit Committees,” discussed with, and received the required written disclosures and a confirming letter from Grant Thornton LLP regarding its independence and has discussed with Grant Thornton LLP its independence. The Audit Committee has also considered whether the provision of non-audit services by the independent auditors to us is compatible with maintaining the auditor’s independence.

Based upon the review and discussion referred to above, the Audit Committee recommended to the Board of Directors that the financial statements referred to above be included in First Colonial’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002.

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Members of the Audit Committee:

Robert J. Bergren

Gordon B. Mowrer

John H. Ruhle, Jr.

Richard Stevens, III

Compensation of Directors

Directors of First Colonial and Nazareth National Bank were paid at the rate of $300 per board meeting attended, $160 per committee meeting attended and $1,000 as a quarterly retainer fee in 2002. Beginning January 1, 2003, Directors of First Colonial and Nazareth National Bank will be paid $1,750 as a quarterly retainer fee. The rate for board meetings and committee meetings attended will remain the same.

Each director has the option to defer some or all of the annual directors’ fees pursuant to the Deferred Compensation Plan for Directors (the “Directors’ Plan”). Any such deferred amount will be deemed invested in an account paying interest equal to rates paid by Nazareth National Bank on individual retirement accounts. The director may elect the form and timing of the benefits payable under the Directors’ Plan, but, in general, such benefits will be payable commencing at age 65. Benefits to a director under the Directors’ Plan are generally made in installments over a 15 year period. If a director electing installments dies prior to receiving such director’s full benefits under the Directors’ Plan, the remaining benefits will be made to the named beneficiary. Upon establishment to the satisfaction of First Colonial’s board of directors of the existence of a personal financial hardship, a director may obtain an immediate distribution of some or all of such director’s benefits under the Directors’ Plan.

Directors of First Colonial who are not employees of First Colonial or Nazareth National Bank are eligible to receive grants of options to purchase shares of First Colonial common stock pursuant to the 2001 Stock Option Plan. On January 17, 2002, each of the non-employee directors were granted options to purchase 1,050 shares of First Colonial’s common stock at an exercise price of $21.38 per share. The exercise prices were the fair market value of First Colonial common stock on the date of grant. See “Executive Compensation—Stock Option Plans.”

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934 requires First Colonial’s executive officers, directors and persons who beneficially own more than ten percent of First Colonial’s common stock to file with the SEC initial reports of ownership and reports of changes in ownership of common stock and other equity securities of First Colonial. Executive officers, directors and greater than ten percent shareholders are required by SEC regulation to furnish First Colonial with copies of all Section 16(a) forms they file.

To First Colonial’s knowledge, based solely on a review of the copies of such reports furnished to First Colonial and written representations that no other reports were required, all Section 16(a) filing requirements applicable to First Colonial’s executive officers, directors and greater than ten percent beneficial shareholders were complied with during the year ended December 31, 2002 except that David W. Hughes, Executive Vice President of Marketing and Branch Administrator, did not timely file an initial report of beneficial ownership on Form 3.

On January 16, 2003, each of the non-employee directors were granted options to purchase 1,000 shares of First Colonial’s common stock at an exercise price of $23.83 per share.

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Executive Compensation

Compensation Committee Report

The Compensation Committee of First Colonial’s board of directors is composed of directors who are not employees of First Colonial or Nazareth National Bank, and is responsible for developing and making recommendations to First Colonial’s board of directors with respect to First Colonial’s executive compensation programs. In addition, the Compensation Committee, pursuant to authority delegated by First Colonial’s board of directors, determines on an annual basis the compensation to be paid to the Chief Executive Officer and each of the other executive officers of First Colonial. The members of the Compensation Committee of the board of directors during 2002 were Robert J. Bergren, Gordon B. Mowrer, Daniel B. Mulholland, and Richard Stevens, III.

The policies of First Colonial’s executive compensation program are to:

• Provide compensation that will attract and retain superior executive talent;

• Support the achievement of the goals contained in First Colonial’s annual plan by linking a portion of the executive officer’s compensation to the achievement of such goals; and

• Enhance shareholder value by the use of stock options to further align the interests of the executive officers with those of shareholders.

The Compensation Committee believes that its executive compensation program provides an overall level of compensation opportunity that is competitive to that offered within the banking community. Actual compensation levels may be greater or less than competitive levels based on surveys that are reviewed by the Compensation Committee.

First Colonial’s executive officer compensation program is comprised of base salary, annual cash incentive compensation, the executive benefit program consisting of medical reimbursement, salary continuation and supplemental retirement income, long term incentive compensation in the form of stock options, and various benefits generally available to employees of First Colonial, including group medical and life insurance coverage and participation in the ESOP and 401(k) plans. In determining the level of base salary, annual incentive compensation and stock options for executive officers, the Compensation Committee reviews the recommendations made by the Chief Executive Officer with respect to subordinate executive officers, reviews surveys of compensation data for comparable banks and bank holding companies and uses its discretion to set compensation for individual executive officers, including the Chief Executive Officer, at levels where, in its judgment, external, internal or individual circumstances warrant.

Base Salary

Base salary levels for First Colonial’s executive officers are set competitively relative to companies in the banking industry of comparable size within Pennsylvania as well as in the United States. In determining salaries, the Compensation Committee also takes into account individual experience and performance of executive officers as it relates to the particular needs of First Colonial.

Annual Incentive Compensation

Annual incentive compensation is awarded to executive officers and key managers in the form of cash bonuses. The purpose of such cash bonuses is to provide a direct financial incentive to the executives to achieve the annual goals of First Colonial as set forth in the beginning of the year in the

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annual plan. In 2002, the following measures were taken into consideration by the Compensation Committee in evaluating the payment of bonuses:

• Return on equity

• Return on average assets

• Change in net income compared to the prior fiscal year

• Individual performance

If the Compensation Committee determines First Colonial has not achieved its objectives, no bonuses will be awarded.

Stock Options

The Compensation Committee uses the 2001 Stock Option Plan, the 1996 Employee Stock Option Plan and the 1986 Stock Option Plan (collectively the “Plans”) as First Colonial’s long-term incentive plan for executive officers and key managers. Pursuant to the 2001 Stock Option Plan, no new options may be issued under the 1996 Employee Stock Option Plan. No new options have been granted under the 1986 Stock Option Plan since 1996. The objectives of the Plans are to align the long-term interests of executive officers and shareholders by creating a direct link between executive compensation and shareholder return and to enable executives to develop and maintain a significant long-term equity interest in First Colonial. The Plans authorize the Compensation Committee to award stock options to officers, key employees and important consultants. In general, under the Plans, options are granted with an exercise price equal to the fair market value of First Colonial’s common stock on the date of grant (although the Compensation Committee had the authority to grant Non-Qualified Options under the 1996 Employee Stock Option Plan at an exercise price less than the fair market value on the date of grant) and are exercisable beginning one year after the date of the grant (earlier in the event of a “change in control” as defined in the Plans) up to ten years after the date of grant. Awards are made at a level calculated to be competitive within the banking industry based on reviews of industry surveys. In 2002, stock options for an aggregate of 91,876 shares were awarded under the 2001 Stock Option Plan to seven executive officers at an exercise price of $21.02 per share.

On January 16, 2003, stock options for an aggregate of 20,000 shares were granted to 7 executive officers at an exercise price of $23.83 per share.

Determination of Compensation of Chief Executive Officer

During 2002 Mr. Fainor was President and Chief Executive Officer of First Colonial and Nazareth National Bank. The Compensation Committee reviewed base salaries of chief executive officers of peer group companies in determining Mr. Fainor’s base compensation. The committee reviewed Mr. Fainor’s performance with respect to corporate goals and objectives such as return on equity, return on assets and earnings per share and his leadership and overall impact on the growth of First Colonial. Other objective criteria such as community leadership and industry involvement were used in determining his compensation.

In December 2001, the Compensation Committee set Mr. Fainor’s annual salary rate at $250,000. On January 3, 2002, Mr. Fainor was awarded stock options under the 2001 Stock Option Plan for 78,750 shares at an exercise price of $20.95 per share that became exercisable in equal annual installments over seven and one-half years. As a result of the execution of the merger agreement with Keystone Savings

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Bank in March 2003, all outstanding options became immediately exercisable. In addition, First Colonial issued to Mr. Fainor a restricted stock award of 10,500 shares of First Colonial common stock that vests in equal 20% installments on the first five anniversaries of his employment. In January 2003, 2,100 shares vested. As a result of the execution of the merger agreement with Keystone Savings Bank in March 2003, the balance of the shares vested. Mr. Fainor was also awarded a bonus of $88,500 for 2002.

Policy with Respect to Section 162(m) of the Code

Generally, Section 162(m) of the Code and the regulations promulgated thereunder (collectively, “Section 162(m)”), deny a deduction to any publicly held company, such as First Colonial, for certain compensation exceeding $1,000,000 paid to the chief executive officer and four other highest paid executive officers excluding (among other things) certain performance based compensation. The Compensation Committee has considered the impact of Section 162(m) and, based on current compensation levels of the executive officers of First Colonial, believes that it will not have a material adverse effect on First Colonial in 2002.

The Compensation Committee:

Robert J. Bergren

Gordon B. Mowrer

Daniel B. Mulholland

Richard Stevens, III

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Summary Compensation Table

The following table sets forth all cash compensation paid by First Colonial and Nazareth National Bank for services rendered in all capacities to First Colonial and its subsidiaries during the fiscal years ended December 31, 2002, 2001 and 2000 to (1) the Chief Executive Officer of First Colonial and Nazareth National Bank and (2) the four other most highly compensated executive officers of First Colonial and/or Nazareth National Bank whose salary and bonus exceeded $100,000 during the fiscal year ended December 31, 2002.

Name and Principal Position	Fiscal Year	Annual Compensation		Bonus		Long Term Compensation			Securities Underlying Stock Option Grants	All Other Compensation
		Salary				Restricted Stock Award
Scott V. Fainor, President Chief Executive Officer and Director of First Colonial and Nazareth National Bank	2002 2001 2000	$	242,476 —   —	$	88,500 —   —	$	220,000 —   —	(1)	78,750 —   —	$	42,562 —   —	(2)
Tomas J. Bamberger, Executive Vice President, Senior Loan Officer of Nazareth National Bank	2002 2001 2000	$ $ $	141,788 136,248 131,580	$ $	15,000 8,171 —	$ $ $	—   —   —		2,625 2,756 —	$ $ $	74,424 87,353 88,175	(3)
Reid L. Heeren, Executive Vice President, Chief Financial Officer of Nazareth National Bank, Vice President and Treasurer of First Colonial	2002 2001 2000	$ $ $	132,043 126,787 120,234	$ $ $	17,500 7,603 —	$ $ $	—   —   —		2,625 2,756 —	$ $ $	39,136 31,991 24,099	(4)
Robert M. McGovern, Executive Vice President, Senior Trust Officer of Nazareth National Bank	2002 2001 2000	$ $ $	111,963 107,544 103,365	$ $ $	6,700 7,796 5,909	$ $ $	—   —   —		2,625 2,756 —	$ $ $	7,201 7,517 7,846	(5)
David W. Hughes, Executive Vice President, Marketing and Branch Administration of Nazareth National Bank	2002 2001 2000	$ $ $	103,163 69,371 —	$ $ $	15,000 9,000 —	$ $ $	—   —   —		2,625 2,756 —		6,344 —   —	(6)

(1) Represents the value of 10,500 restricted shares of First Colonial common stock awarded to Mr. Fainor in 2002 based on the closing price per share of $20.95 on January 3, 2002, the date that the shares were awarded. As of May 31, 2003, Mr. Fainor held 10,500 restricted shares with a value of $469,980 based upon the closing price per share of $44.76 on such date. The shares vest in equal 20% installments on each of the first five anniversaries of the date that Mr. Fainor began employment, or immediately upon a change in control. Any dividends paid with respect to the restricted shares are held in trust by Nazareth National Bank and paid to Mr. Fainor upon the vesting of such shares. In January 2003, 2,100 shares vested. As a result of the execution of the merger agreement with Keystone Savings Bank in March 2003, the balance of the shares vested.

(2) Includes the payment of life insurance premiums pursuant to First Colonial’s Salary Continuation Program of $12,417, the funding expense pursuant to First Colonial’s Supplemental Retirement Income Program of $27,663 and reimbursement pursuant to First Colonial’s Medical Reimbursement Program of $2,482.

(3) Includes a contribution to his account in First Colonial’s Employee Stock Ownership Plan of $6,013, First Colonial’s matching contribution to his account under the Optional Deferred Salary Plan of $3,438, the payment of life insurance premiums pursuant to First Colonial’s Salary Continuation Program of $29,364, the funding

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expense pursuant to First Colonial’s Supplemental Retirement Income Program of $34,109 and reimbursement pursuant to First Colonial’s Medical Reimbursement Program of $1,500.

(4) Includes a contribution to his account in First Colonial’s Employee Stock Ownership Plan of $5,604, First Colonial’s matching contribution to his account under the Optional Deferred Salary Plan of $3,297, the payment of life insurance premiums pursuant to First Colonial’s Salary Continuation Program of $8,239, the funding expense pursuant to First Colonial’s Supplemental Retirement Income Program of $20,496 and reimbursement pursuant to First Colonial’s Medical Reimbursement Program of $1,500.

(5) Includes a contribution to his account in First Colonial’s Employee Stock Ownership Plan of $4,701 and First Colonial’s matching contribution to his account under the Optional Deferred Salary Plan of $2,500.

(6) Includes a contribution to his account in First Colonial’s Employee Stock Ownership Plan of $4,453 and First Colonial’s matching contribution to his account under the Optional Deferred Salary Plan of $1,891.

Aggregated Option Exercises in 2002 and 2002 Year-End Option Values

The following table sets forth certain information concerning the number of unexercised options and the value of unexercised options at December 31, 2002 held by the executive officers of First Colonial and/or Nazareth National Bank named in the Summary Compensation Table.

Name	Shares Acquired on Exercise	Value Realized(1)	Number of Securities Underlying Unexercised Options at December 31, 2002 Exercisable/Unexercisable	Value of Unexercised In- the-Money Options at December 31, 2002 (2) Exercisable/Unexercisable
Scott V. Fainor	—	—	—/78,750	—/$137,624
Tomas J. Bamberger	—	—	4,518/4,692	$4,753/$17,723
Reid L. Heeren	—	—	8,347/4,692	$21,169/$17,723
Robert M. McGovern	—	—	689/4,692	$4,753/$17,723
David W. Hughes	—	—	689/4,692	$4,753/$17,723

(1) Represents the difference between the last sale price of First Colonial’s common stock on the date of exercise, as reported on the Nasdaq National Market, and the exercise price per share of the options exercised multiplied by the number of options exercised.

(2) Represents the difference between $22.70, the last sale price of First Colonial’s common stock on December 31, 2002, as reported on the Nasdaq National Market, and the exercise price per share of in-the-money options multiplied by the number of exercisable and unexercisable options held, respectively.

As a result of First Colonial entering into the merger agreement with Keystone Savings Bank in March 2003, all outstanding options became immediately exercisable.

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Option Grants In Last Fiscal Year

The following table sets forth information regarding options to purchase shares of First Colonial’s common stock granted to the executive officers of First Colonial and/or Nazareth National Bank named in the Summary Compensation Table. First Colonial’s stock option plans do not provide for the grant of stock appreciation rights.

	Individual Grants
Name	Number of Securities Underlying Options/SARs Granted (#)		% of Total Options/SARs Granted to Employees in Fiscal Year		Exercise or Base Price ($/sh)		Expiration Date	Potential Realized Value at Assumed Annual Rate of Stock  Price Appreciation for Option Term(3)
								5% ($)		10% ($)
Scott V. Fainor, President, Chief Executive Officer and Director of First Colonial and Nazareth National Bank	78,750	(1)	61.3	%	$	20.95	1-3-2012	$	909,588	$	2,240,359
Tomas J. Bamberger, Executive Vice President, Senior Loan Officer of Nazareth National Bank	2,625	(2)	2.0	%	$	21.38	1-17-2012	$	32,071	$	77,340
Reid L. Heeren, Executive Vice President and Chief Financial Officer of Nazareth National Bank and Vice President and Treasurer of First Colonial	2,625	(2)	2.0	%	$	21.38	1-17-2012	$	32,071	$	77,340
Robert M. McGovern, Executive Vice President, Senior Trust Officer of Nazareth National Bank	2,625	(2)	2.0	%	$	21.38	1-17-2012	$	32,071	$	77,340
David W. Hughes, Executive Vice Marketing and Branch Administration	2,625	(2)	2.0	%	$	21.38	1-17-2012	$	32,071	$	77,340

(1) Options have a term of 10 years.

(2) Options have a term of 10 years.

(3) Shows the difference between the market value of First Colonial common stock for which the option may be exercised less the exercise price of the option assuming that the market price of the Common Stock appreciates in value from the date of the grant to the end of the option term at annualized rates of 5% and 10%, respectively. The rates of appreciation used in this table are prescribed by the regulations if the Securities and Exchange Commission and are not intended to forecast future appreciation of the market value of the Common Stock.

As a result of First Colonial entering into the merger agreement with Keystone Savings Bank in March 2003, all outstanding options became immediately exercisable.

Stock Option Plans

First Colonial maintains the following stock option plans, sometimes referred to as the Plans:

• the 2001 Stock Option Plan, also referred to as the 2001 Plan;

• the 1996 Employee Stock Option Plan, also referred to as the 1996 Plan; and

• the 1994 Stock Option Plan for Non-Employee Directors, also referred to as the Director Plan.

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The 2001 Plan replaced the 1996 Plan and the Director Plan and new options will be granted only under the 2001 Plan. Options outstanding under the 1996 Plan and the Director Plan will continue in effect in accordance with the terms of the Plans pursuant to which they were issued.

All officers, key employees and directors of First Colonial or any current or future parent or subsidiary corporation are eligible to receive options under the 2001 Plan. Under the 1996 Plan, officers and key employees were eligible to receive options. Only non-employee directors were eligible to receive options under the Director Plan. The purpose of the Plans is to provide additional incentive to participants in the Plans by encouraging them to invest in First Colonial’s common stock and thereby acquire a proprietary interest in First Colonial and an increased personal interest in First Colonial’s continued success and progress. Pursuant to the Plans, stock options may be granted which are intended to qualify as incentive stock options under the Code, as well as stock options not intended to so qualify; however, directors and consultants are only eligible to receive non-qualified options.

A total of 274,809 shares of First Colonial’s common stock may be issued upon the exercise of options granted under the 2001 Plan. As of May 31, 2003, options to purchase 195,416 shares were outstanding under the 2001 Plan, options to purchase 61,669 shares were outstanding under the 1996 Plan and options to purchase 17,724 shares were outstanding under the Director Plan.

The Plans are administered by the Compensation Committee appointed by First Colonial’s board of directors, except that the Director Plan is administered by First Colonial’s board of directors. Subject to the provisions of the Plans, the Compensation Committee determines, among other things, which individuals will be granted options under the Plans, whether options granted will be incentive options or non-qualified options, the number of shares subject to an option, the time at which an option is granted, the rate of option exercisability, the duration of an option and the exercise price of an option.

The exercise price for options granted under the Plans must be equal to at least 100% of the fair market value of First Colonial’s common stock as of the date of the grant of the option, except that the option price for non-qualified stock options issued under the 1996 Plan, in the sole discretion of the Compensation Committee, could have been issued for less than the fair market value of First Colonial’s common stock on the date of the grant. Options are exercisable according to a vesting schedule established at the time of grant and become immediately exercisable upon a change in control of First Colonial. Payment of the option price on exercise of options may be made in cash, certificates representing shares of First Colonial’s common stock or a combination of both. Options generally expire ten years after the date of grant unless terminated earlier as a result of the participant’s death, disability or termination of employment.

Agreements with Executive Officers

In December 2001, Nazareth National Bank entered into an agreement with Scott V. Fainor employing him as president and chief executive officer of Nazareth National Bank and First Colonial. Under the agreement, Mr. Fainor is entitled to:

• an annual salary of $250,000,

• an annual bonus of up to one-half of his salary depending upon whether First Colonial meets net income targets established by the First Colonial board of directors,

• a restricted stock award of 10,500 shares of First Colonial common stock that vests in equal 20% installments on the first five anniversaries of his employment (as a result of First Colonial entering into the merger agreement with Keystone Savings Bank in March 2003, Mr. Fainor’s restricted stock vested),

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• stock options to purchase 78,750 shares of First Colonial common stock that become exercisable in equal annual installments over seven and one-half years, and (as a result of First Colonial entering into the merger agreement with Keystone Savings Bank in March 2003, Mr. Fainor’s options became immediately exercisable),

• participation in benefits generally available to executive officers.

The term of Mr. Fainor’s agreement ends on December 31, 2006 or the earlier of his death or permanent disability, the termination of his employment for cause, mutual agreement, resignation or otherwise. Unless Mr. Fainor or Nazareth National Bank provides notice of an intention not to renew at least two months prior to the termination date, the agreement will automatically renew for successive one year terms. “Cause” is defined as a conviction for any felony, fraud or embezzlement or failure or refusal to comply with the written policies or directives of the board of directors of Nazareth National Bank or being guilty of misconduct in connection with the performance of his duties for Nazareth National Bank and failing to cure such non-compliance or misconduct within 20 days of receiving written notice from the board of directors of Nazareth National Bank.

The agreement also provides for severance payments in the event that (a) Nazareth National Bank terminates his employment without cause or (b) Mr. Fainor terminates his employment with Nazareth National Bank due to the fact that, without his consent and whether or not a change in control of Nazareth National Bank has occurred: (1) the nature and scope of his duties and authority or his responsibilities with Nazareth National Bank or the surviving or acquiring person are reduced to a level below that which he enjoys on the date of the agreement, (2) his then current base annual salary is reduced to a level below that which he enjoys on the date of the agreement or at any time thereafter (whichever may be greater), (3) Nazareth National Bank fails to grant the restricted stock award and stock options or pay annual bonuses as provided in the agreement, (4) his position or title with Nazareth National Bank or the surviving or acquiring person is reduced from his current position or title with Nazareth National Bank or (5) his principal place of employment with Nazareth National Bank is changed to a location greater than 50 miles from his current principal place of employment with Nazareth National Bank.

In the event that Mr. Fainor is entitled to severance, he will be paid compensation for a severance period of from 12 to 36 months, as determined in the agreement, at a rate equal to his highest annual cash compensation, excluding cash bonuses and other fringe benefits, during the three year period ending on the termination date. The severance payments will be reduced by any income related to employment Mr. Fainor earns during the severance period, except if his termination was within 18 months of a change in control there will be no reduction. Mr. Fainor also will be entitled to certain benefits and reimbursement for reasonable expenses related to the search for new employment and relocation.

The agreement also contains provisions restricting Mr. Fainor’s right to compete with the Nazareth National Bank in Lehigh, Northampton and Monroe Counties, Pennsylvania and Warren County, New Jersey for one year following the termination of his employment or the severance period, whichever is greater.

Nazareth National Bank has entered into Severance Agreements with Tomas J. Bamberger, Reid L. Heeren, Robert M. McGovern and David W. Hughes. In the event that any of these executive officers are entitled to severance payments, the executive officer will be paid annual compensation for one year following the Termination Date at a rate equal to 100% of his base annual salary on the Termination Date, exclusive of cash bonuses and payments under Nazareth National Bank’s bonus plan. The severance payments will be reduced by any income related to employment the executive officer earns during the one year period following the Termination Date. Such executive officers also will be entitled to certain benefits and reimbursement for reasonable expenses related to the search for new employment and relocation.

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In connection with First Colonial entering into the merger agreement with Keystone Savings Bank, Mr. Fainor entered into an employment agreement with Keystone Savings Bank which will become effective upon the consummation of the merger. See “Management—Employment and Retirement and Severance Agreements.”

Executive Benefit Program

In 1985, Nazareth National Bank established an Executive Benefit Program (the “Program”) for certain of its officers. Currently, six officers of Nazareth National Bank are eligible to participate in the Program. Any non-current obligation of Nazareth National Bank under the Program constitutes an unfunded general obligation of Nazareth National Bank. The Program is administered by the Executive Committee of the board of directors of Nazareth National Bank and provides participants with the following benefits:

(1) Medical Reimbursement Program. Subject to a maximum, Nazareth National Bank reimburses participants in the Program for medical or dental expenses which they or their dependents incur and which are not otherwise covered by an existing medical insurance plan or other reimbursement arrangement.

(2) Salary Continuation Program. If a participant in the Program dies while in the employ of the Nazareth National Bank, his designated beneficiary is entitled to receive 70% of his base-year salary (as defined in the Program) for one year after his death and thereafter 35% of his base-year salary until the earlier to occur of the 10th anniversary of his death or the date on which the participant would have attained age 65.

(3) Supplemental Retirement Income Program. If a participant in the Program is continuously employed by Nazareth National Bank through retirement on or after age 65, the participant will be entitled to a “target benefit” equal to a specified percentage of the participant’s average annual compensation during the five years immediately prior to his retirement. The “target benefit” amount is to be provided with reference to the participant’s benefits under (a) the Salary Plan (to the extent of Nazareth National Bank’s contribution only, and excluding employee deferral amounts or voluntary contributions); (b) the ESOP (including amounts transferred to the Program as a result of the termination of Nazareth National Bank’s Defined Benefit Pension Plan); and (c) each participant’s Social Security benefits (to the extent of the participant’s primary insurance amount). If amounts payable to the participant from those three sources are insufficient to fund the “target benefit”, Nazareth National Bank is obligated to provide the shortfall in an annual supplemental benefit. Each participant is entitled to terminate before reaching age 65 and receive the “target benefit” computed as above (with certain modifications and assumptions), reduced by a factor to reflect the participant’s earlier separation from service. However, if the participant’s earlier separation from service is due to dishonesty, collaboration with a competitor, fraud or similar cause, the participant will forfeit all benefits under the Supplemental Retirement Income Program. In general, no separate death benefit is payable under the Program, except with respect to a participant who dies in the active employment of Nazareth National Bank after attaining age 65. Benefits under the Program will be paid in equal monthly installments during the participant’s lifetime, unless an annuity form of payment is selected.

Stock Performance Graph

The following graph shows a comparison of the cumulative total return for First Colonial’s common stock, the Nasdaq Bank Index and the Nasdaq Composite Index, assuming an investment of $100 in each on December 31, 1996 and the reinvestment of dividends.

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TOTAL RETURN TO STOCKHOLDERS

(Assumes $100 investment on 12/31/96)

	12/31/97		12/31/98	12/31/99	12/31/00	12/29/01	12/31/02
Total Return Analysis
First Colonial Group	$	100.00	88.13	57.16	49.08	89.49	98.04
Nasdaq Bank Index	$	100.00	88.23	81.19	93.10	102.48	107.11
Nasdaq Composite	$	100.00	139.63	259.13	57.32	124.20	85.05

Source: Carl Thompson Associates www.ctaonline.com (800) 959-9677. Data from BRIDGE Information Systems, Inc.

Certain Relationships and Related Transactions

Nazareth National Bank has had, and expects to have in the future, banking transactions in the ordinary course of business with many of its directors, officers and their associates. All extensions of credit to such persons have been made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and in the opinion of the management of First Colonial and Nazareth National Bank, do not involve more than a normal risk of collectibility or present other unfavorable features.

Compensation Committee Interlocks and Insider Participation

The members of the Compensation Committee during 2002 were Robert J. Bergren, Gordon B. Mowrer, Daniel B. Mulholland and Richard Stevens, III.

No person who served as a member of the Compensation Committee during 2002 was a current or former officer or employee of First Colonial or Nazareth National Bank or engaged in certain transactions with First Colonial or Nazareth National Bank required to be disclosed by regulations of the SEC. Additionally, there were no compensation committee “interlocks” during 2002, which generally means that no executive officer of First Colonial served as a director or member of the compensation committee of another entity, one of whose executive officers served as a director or member of the Compensation Committee.

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Relationship With Independent Public Accountants

First Colonial’s independent public accountants for the fiscal year ended December 31, 2002 was the firm of Grant Thornton LLP, Philadelphia, Pennsylvania. The Audit Committee of First Colonial’s board of directors has selected Grant Thornton LLP to be First Colonial’s independent accountant for 2003. The selection of First Colonial’s independent accountant is not being submitted to shareholders because there is no legal requirement to do so.

A representative of Grant Thornton LLP is expected to be present at the Annual Meeting and to be available to respond to appropriate questions. The representative will have the opportunity to make a statement if he so desires.

Principal Accountant Fees And Services

Aggregate fees (1) for professional services rendered for First Colonial and its subsidiaries by Grant Thornton LLP as of or for the years ended December 31, 2002 and 2001 were:

	2002			2001
Audit Fees	$	84,250		$	75,000
Audit Related Fees		[	]		[	]
Tax Fees		[	]		[	]
All Other Fees		[	]		[	]
Total		[	]		[	]

The Audit fees for the years ended December 31, 2002 and 2001, respectively, were for professional services rendered for the audits of the consolidated financial statements of First Colonial and its subsidiaries, quarterly reviews, issuance of consents, and review of registration statements filed with the SEC.

Audit Related fees for the years ended December 31, 2002 and 2001, were for employee benefit plan audits, consultations concerning financial accounting and reporting standards, and non-statutory compliance reports.

Tax fees for the years ended December 31, 2002 and 2001, were for services performed in connection with corporate tax services other than those directly related to the audit of the income tax accrual.

There were no other fees for the year ended December 31, 2002. For the year ended December 31, 2001, all other fees related to internal control reviews, employee fraud review and consulting on the new chief executive officer’s compensation.

(1) The aggregate fees included in Audit are fees billed for the fiscal years for the audit of the registrant’s annual financial statements and reviews of financial statements and statutory and regulatory filings or engagements. The aggregate fees included in each of the other categories are fees billed in the fiscal years.

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The Audit Committee has considered and determined that the services provided by Grant Thornton LLP in addition to those services provided in exchange for audit fees, as discussed above, are compatible with Grant Thornton LLP maintaining its independence.

Proposal Two:

Adoption of the Merger Agreement

The information in this proxy statement/prospectus concerning the terms of the merger is qualified in its entirety by reference to the full text of the merger agreement, which is attached hereto as Appendix A and incorporated by reference herein. All shareholders are urged to read the merger agreement in its entirety.

General

Pursuant to the merger agreement, First Colonial will be merged with and into KNBT Bancorp, with KNBT Bancorp being the surviving entity. Under the terms of the merger agreement, upon completion of the merger, each share of First Colonial common stock which is outstanding (other than treasury shares) will be converted into the right to receive shares of KNBT Bancorp common stock with a value of $37.00, or 3.7 shares based on an initial offering price of $10.00. In addition, each option to purchase First Colonial common stock will be converted into the right to acquire shares of KNBT Bancorp common stock equal to the number of shares of First Colonial common stock subject to the First Colonial option multiplied by the merger exchange ratio. In conjunction with the merger, Nazareth National Bank will be merged into Keystone Savings Bank with Keystone Savings Bank as the surviving bank. As part of this transaction, Keystone Savings Bank will change its name to “Keystone Nazareth Bank & Trust Company.”

Completion of the merger is subject to, various conditions, including, receipt of all necessary regulatory approvals, the approval of the merger agreement by the shareholders of First Colonial, approval of the conversion by the voting depositors of Keystone Savings Bank and completion of the conversion. See “—Material Terms of the Merger Agreement.”

Material Terms of the Merger Agreement

For a summary of the material terms of the merger agreement, see the following sections of the prospectus: “The Conversion and the Merger—Conditions to the Merger”; “—Conduct of Business Prior to the Closing Date”; “—Required Approvals”; “—Board of Directors Covenant to Recommend the Merger Agreement; Board of Trustees’ Covenant to Recommend the Plan of Conversion”; “—Shareholder and Depositor Agreements”; “—Acquisition Proposals”; “—Representations and Warranties”; “—Completion of the Conversion and the Merger”; “—Termination and Amendment.”

Background of the Merger

Prior to November 2002 there had been a few informal meetings between the representatives of First Colonial and Keystone Savings Bank regarding a potential business combination but nothing developed as a result of these meetings. In November 2002, representatives of First Colonial and Keystone Savings Bank met to discuss a possible strategic alliance. Based on these initial discussions, First Colonial directed its financial advisor, The Kafafian Group, Inc., referred to as TKG, to evaluate a potential business combination with Keystone Savings Bank. Negotiations on behalf of First Colonial were primarily conducted by Scott V. Fainor, President and Chief Executive Officer of First Colonial and Richard Stevens, Chairman of the Board of First Colonial, First Colonial’s counsel and First Colonial’s

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financial advisor. As a result of these initial discussions, the First Colonial board of directors appointed the Executive Committee of the board, as a special committee of the board, to deal with the proposed business combination with Keystone Savings Bank.

During December 2002 and January and February 2003, representatives of First Colonial and Keystone Savings Bank had several meetings to discuss the proposed business combination and the board of directors of First Colonial and the Executive Committee of the board had several meetings to discuss the progress of these discussions. On December 31, 2002, a confidentiality agreement was executed by both Keystone Savings Bank and First Colonial.

On February 20, 2003 the First Colonial board of directors held a meeting and was updated on the status of the negotiations with Keystone Savings Bank. Based on the progress made to date in these negotiations, the First Colonial Board authorized Messrs. Fainor and Stevens to continue negotiations with Keystone Savings Bank, and try and finalize these negotiations as soon as possible. In the middle part of February 2003 term sheets and draft agreements were exchanged between the parties.

On February 26, 2003, the First Colonial board of directors met to review the draft agreements and heard from its financial advisor, TKG, regarding its analysis of the fairness of the merger consideration. TKG advised the board of directors that it was prepared to deliver its written fairness opinion, as discussed under “—Opinion of Financial Advisor”, and stated that in its opinion the merger consideration was fair to the shareholders of First Colonial, from a financial point of view. TKG’s oral fairness opinion was subject to completion of its due diligence investigation. Legal counsel informed the First Colonial board of directors that there were still a few unresolved issues in the negotiation of the definitive agreement and discussed those issues with the board of directors. The board of directors then unanimously approved the merger with Keystone Savings Bank, subject to (i) final resolution of open issues in negotiations to be undertaken by Messrs. Fainor and Stevens, legal counsel and TKG, and (ii) the delivery of the final written fairness opinion of TKG as of the date the merger agreement was signed.

Following the satisfactory completion of due diligence and the final resolution of open items, on March 5, 2003 the merger agreement was executed by Keystone Savings Bank and First Colonial. Prior to the execution of the merger agreement, TKG updated its fairness analysis and delivered its written fairness opinion to First Colonial on March 5, 2003. The merger was publicly announced prior to the opening of business on March 6, 2003.

Due to the unique nature of a potential business combination with Keystone Savings Bank, First Colonial did not seek other potential bidders and/or partners. In 2002, First Colonial had embarked on a strategy of expansion of its franchise in order to add shareholder value. In addition to branching, an increase in loan offerings, and strengthening the service delivery system were part of First Colonial’s strategy of expansion. First Colonial had not been exploring possible business combinations with other financial institutions and, but for the unique opportunities presented by a combination with Keystone Savings Bank, First Colonial would not have pursued being acquired by a larger financial institution. First Colonial’s board of directors believes that the merger offers unique operating and strategic benefits to First Colonial and its shareholders. See “—First Colonial’s Reasons for the Merger; Recommendation of First Colonial’s Board of Directors.”

First Colonial’s Reasons for the Merger; Recommendation of First Colonial’s Board of Directors

The board of directors of First Colonial believes that the merger will enhance the competitive position of the combined entities and will enable the resulting financial institution to compete more effectively than either Keystone Savings Bank or Nazareth National Bank could on its own. As a result of the merger, Keystone Nazareth Bank & Trust will be a larger more diversified community bank with the management and operating structure that will draw from both the business strategies currently being

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used at Keystone Savings Bank and at Nazareth National Bank. First Colonial’s board of directors believes that the merger offers unique operating and strategic benefits as summarized below:

• A stronger combined management team with increased experience, expertise and depth than either institution had individually.

• An enhanced branch network system with 36 branch offices located in Lehigh, Northampton, Monroe and Carbon counties with six additional branch offices to be opened within the next year.

• Increased deposit market share within the four counties in the Greater Lehigh Valley, particularly in Northampton and Lehigh counties in which KNBT Bancorp will have the largest and second largest, respectively, deposit market share upon completion of the merger. Overall, First Colonial believes KNBT Bancorp will have the second largest deposit share in the four counties combined.

• Focusing on increasing First Colonial’s involvement in lending to small to mid-sized businesses in the Greater Lehigh Valley which First Colonial believes are under served, especially by the super-regional banks that currently dominate the market.

• Develop Nazareth National Bank’s role as a “relationship bank” offering a broad array of deposit and loan products as well as securities and insurance products to Nazareth National Bank’s customers.

• Leverage First Colonial’s capital efficiently through additional growth of First Colonial’s loan and investment portfolios in the areas of commercial real estate and commercial business lending.

The terms of the merger agreement were the results of arms-length negotiations between the representatives of Keystone Savings Bank and First Colonial. The following were the material factors that were considered by the First Colonial board of directors:

• the expected tax-deferred nature of the merger to the shareholders of First Colonial.

• the KNBT Bancorp and Keystone Nazareth Bank & Trust boards of directors or trustees, as applicable will have significant representation by First Colonial directors and that the Chief Executive Officer of First Colonial will become the Chief Executive Officer of both KNBT Bancorp and Keystone Nazareth Bank & Trust.

• the fairness opinion by TKG to the First Colonial Board of Directors, representing an independent assessment of the financial terms of the transactions, stated that the merger consideration is fair to First Colonial shareholders, from a financial point of view.

• the First Colonial board of directors also reviewed and considered the financial analysis and comparative data prepared by TKG in connection with the rendering of its fairness opinion. This review and analysis included consideration of the price to book value ratio, the price to earnings ratio, the price to deposit ratio and the franchise premium to core deposit ratio of the proposed merger compared to comparable transactions identified by TKG. The First Colonial board of directors also reviewed a discounted cash flow analysis prepared by TKG reflecting the estimated present value of the future cash flows that could be expected by a shareholder of First Colonial on both an acquisition and non-acquisition (trading) basis. Detailed information regarding TKG’s analysis provided to

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the First Colonial Board of Directors is set forth under “—Opinion of Financial Advisors”.

• the ability to expand Nazareth National Bank’s presence in the greater Lehigh Valley.

• information concerning the financial condition, results of operations, capital levels, asset quality and prospects of Keystone Savings Bank and First Colonial, separately, and as a combined institution.

• the short-term and long-term impact the merger will have on First Colonial’s consolidated results of operations, including expanded retail banking products and services.

• the general structure of the transaction and the compatibility of the respective managements and business philosophies.

• the enhancement of First Colonial’s franchise value, the ability of the combined enterprise to compete in relevant banking and non-banking markets.

• industry and economic conditions.

• the impact of the merger on the depositors, employees, customers and communities served by Keystone Savings Bank and First Colonial through the expansion of retail banking products and services.

• the potential values at which KNBT Bancorp shares may trade vs. the potential values at which First Colonial may trade.

When evaluating the proposed merger, the First Colonial board of directors also considered the following additional factors:

• the possibility that regulatory approval may not be obtained.

• the decreased likelihood that a competing acquiror would seek to offer a higher price for First Colonial stock because of the break-up fee payable to Keystone Savings Bank and the restrictions on First Colonial’s ability to negotiate with other potential acquirers.

• the uncertainty in the market price of KNBT Bancorp common stock due to the fact that KNBT Bancorp will be a newly formed corporation with no prior trading history.

First Colonial does not intend this discussion of the information and factors considered by the First Colonial board of directors to be exhaustive although this discussion does include all material factors considered by the First Colonial board of directors. In reaching its determination to approve and recommend the merger to the First Colonial’s shareholders for their approval, the First Colonial board of directors did not sign any relative or specific weight to the factors considered and individual directors of First Colonial might have weighed factors differently.

The Board of Directors of First Colonial unanimously recommends that First Colonial shareholders vote “for” the adoption of the merger agreement.

See also “The Conversion and the Merger—Reasons for and Purposes of the Conversion and the Merger” in the prospectus.

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Opinion of First Colonial’s Financial Advisor

First Colonial engaged TKG to serve as financial advisor and to render an opinion to the First Colonial board of directors as to the fairness, from a financial point of view, of the merger consideration offered to First Colonial shareholders. TKG delivered its oral opinion, subject to the satisfactory completion of due diligence, on February 26, 2003 and delivered its written opinion dated March 5, 2003 to First Colonial’s board of directors. TKG’s opinion stated that, as of March 5, 2003, the consideration of 3.7 KNBT Bancorp initial public offering shares per First Colonial share was fair, from a financial point of view, to the holders of First Colonial common stock. Except as discussed herein, no limitations were imposed by First Colonial’s board of directors upon TKG with respect to investigations made or procedures followed in rendering this opinion.

The full text of TKG’s written opinion is included in this proxy statement/prospectus as Appendix B and is incorporated herein by reference. First Colonial shareholders are urged to read the opinion in its entirety for a description of the procedures followed, assumptions made, matters considered, and qualifications and limitations of TKG’s analyses. The merger consideration was determined by negotiation between Keystone Savings Bank and First Colonial and was not determined by TKG.

TKG’S OPINION IS DIRECTED ONLY TO FIRST COLONIAL’S BOARD OF DIRECTORS REGARDING THE FAIRNESS OF THE MERGER CONSIDERATION FROM A FINANCIAL POINT OF VIEW. IT IS NOT A RECOMMENDATION ON HOW A SHAREHOLDER SHOULD VOTE AT THE ANNUAL MEETING.

In rendering its opinion, TKG, among other things:

• Reviewed the merger agreement;

• Analyzed annual reports to stockholders, regulatory filings, and other financial information concerning First Colonial since 1999;

• Analyzed regulatory filings and other financial information concerning Keystone Savings Bank since 1999;

• Discussed past, present, and future financial performance and operating philosophies with Keystone Savings Bank and First Colonial senior managements;

• Reviewed certain internal financial data and projections of Keystone Savings Bank and First Colonial;

• Compared the financial condition, financial performance, and market trading multiples of First Colonial to similar financial institutions;

• Compared the financial condition and financial performance of Keystone Savings Bank to similar financial institutions;

• Reviewed reported price and trading activity for First Colonial and compared it to the price and trading activity for similar financial institutions;

• Reviewed reported price, pricing trends, and trading activity for financial institutions that recently converted from a mutual to a stock form;

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• Compared the consideration to be paid by Keystone Savings Bank pursuant to the merger agreement with the consideration paid in acquisitions of similar financial institutions;

• Reviewed the pro forma impact of the conversion and merger on the earnings and book value of the combined company and compared the contributions of each institution in a number of key financial categories to the combined company;

• Considered other financial studies, analyses, and investigations and reviewed other information deemed appropriate to render this opinion.

TKG met with certain members of senior management and other representatives of Keystone Savings Bank and First Colonial to discuss the foregoing as well as matters TKG deemed relevant. As part of its analyses, TKG took into account its assessment of general economic, market and financial conditions, its experience in similar transactions, as well as its experience in and knowledge of the banking industry. TKG’s opinion is necessarily based upon conditions as they existed and could be evaluated on the respective dates thereof and the information made available to TKG through the respective dates thereof.

TKG relied upon the accuracy and completeness of all of the financial and other information reviewed and/or discussed for the purposes of its opinion. TKG assumed that financial forecasts provided by Keystone Savings Bank and First Colonial for their respective institutions were reasonably prepared on bases reflecting the best currently available estimates and judgments of the respective senior managements. Any estimates contained in the analyses performed by TKG are not necessarily indicative of actual values or future results, which may be significantly more or less favorable than suggested by these analyses. Additionally, estimates of the value of businesses or securities do not purport to be appraisals or to reflect the prices at which such businesses or securities might actually be sold. TKG did not make any independent evaluation or appraisals of the assets or liabilities of Keystone Savings Bank and First Colonial nor was it furnished with any such appraisals. TKG also assumed, without independent verification, that the aggregate allowances for loan losses for Keystone Savings Bank and First Colonial were adequate.

On March 5, 2003, TKG rendered a written fairness opinion to First Colonial’s board. The summary set forth below does not purport to be a complete description of the analyses performed by TKG in connection with the merger. The preparation of a fairness opinion involves various determinations as to the most appropriate and relevant methods of financial analysis and the application of these methods to the particular circumstances and, therefore, the opinion is not readily susceptible to summary description. TKG believes that its analyses must be considered as a whole and that selecting portions of its analyses and of the factors considered by it, without considering all analyses and factors, could create an incomplete view of the evaluation process underlying the opinion. No one component of the analyses performed by TKG was assigned a greater significance than another component. Taken as a whole, TKG believes these analyses support the conclusion that the consideration to be paid to First Colonial shareholders is fair, from a financial point of view.

The following table summarizes the material valuation methodologies and the range of values of First Colonial common stock used by TKG in arriving at its opinion. The values for peer group and comparable transactions were arrived at by applying First Colonial financial data to median peer group trading and comparable transaction acquisition multiples. The valuation methodologies are described below in greater detail.

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	Implied Value per Common Share
Discounted cash flow analysis
on a trading basis	$21.21-$33.12
on an acquisition basis	$31.75-$43.83
Peer group analysis
national peers	$23.73-$32.77
regional peers	$28.78-$32.25
Comparable transaction analysis	$14.50-$52.16
Value of merger consideration	$37.00

Contribution Analysis. Based on discussions held with Keystone Savings Bank and their advisors, TKG estimated a number of financial categories assuming Keystone Savings Bank had undertaken a standard mutual-to-stock conversion at a price to pro forma book ratio similar to that of recent standard conversions. Subsequently, TKG reviewed the contribution made by each of First Colonial and Keystone Savings Bank to various balance sheet items of the combined company based on balance sheet data at December 31, 2002. A similar contribution analysis was prepared for net income and income statement items based on the year ended December 31, 2002. The analysis showed that:

• First Colonial shareholders would own approximately 28.8% of the combined company;

• First Colonial would contribute 34.0% of total assets of the combined company;

• First Colonial would contribute 30.5% of total loans of the combined company;

• First Colonial would contribute 37.8% of total deposits of the combined company;

• First Colonial would contribute 12.5% of shareholders’ equity of the combined company; and

• First Colonial would contribute 20.4% of net income of the combined company.

Discounted Cash Flow Analysis. TKG performed a discounted cash flow analysis of future income streams of First Colonial using projected earnings for 2003-2007 based on management’s forecasts and First Colonial’s historical performance. Using these projections and market trading multiples from comparable institutions between 12.0 and 15.0 times earnings, and discount rates of between 10% and 15%, TKG calculated a range of net present values of First Colonial common stock. This analysis assumed First Colonial was not acquired but remained independent for the projection period. The analysis showed a present value per share of First Colonial common stock between $21.21 and $33.12.

Using the aforementioned projections, TKG used acquisition multiples from comparable merger transactions between 19.0 and 21.0 times earnings and discount rates of between 10% and 15%. TKG then calculated a range of net present values of First Colonial common stock. This analysis assumed First Colonial was to be acquired at similar earnings multiples as comparable merger transactions. The analysis showed a present value per share of First Colonial common stock between $31.75 and $43.83.

Although the discounted cash flow analysis is a widely used valuation methodology, it relies on numerous assumptions, including balance sheet and earnings growth rates, discount rates, and market trading multiples that may ultimately be materially different than those used in the analysis. Therefore,

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this analysis does not purport to be indicative of the actual values or expected values of First Colonial common stock.

Peer Group Analysis: First Colonial. TKG compared selected balance sheet, asset quality, capitalization, profitability, and market trading ratios using financial data at or for the twelve months ended December 31, 2002 and market data as of February 20, 2003 for First Colonial and two groups of similar financial institutions. Group 1 includes 41 commercial banks nationwide with assets between $366.6 million and $995.1 million, deposits between $301.3 million and $589.4 million, and shareholders’ equity between $20.6 million and $81.2 million (the “National Peers”). Group 2 includes 9 commercial banks in the Mid-Atlantic Region with assets between $405.0 million and $995.1 million, deposits between $364.4 million and $587.5 million, and shareholders’ equity between $23.2 million and $81.2 million (the “Regional Peers”). For purposes of this analysis, non-performing assets (“NPAs”) include non-accrual loans, restructured loans, other real estate owned, and loans greater than 90 days past due but still accruing. Peer statistics are medians.

	First Colonial	National Peers	Regional Peers
(financial data at or for the period ended December 31, 2002)
Loans/Deposits (%)	54.11	86.04	93.78
Equity/Assets (%)	6.59	7.54	7.15
NPAs/Assets (%)	0.36	0.45	0.44
Reserves/NPAs (%)	138.61	200.00	200.00
Net Interest Margin (%)	3.36	4.09	3.60
Non-interest Income/Avg. Assets (%)	1.05	0.95	0.70
Non-interest Expense/Avg. Assets (%)	3.27	3.00	2.78
Efficiency Ratio (%)	77.33	64.10	65.67
Return on Avg. Assets (%)	0.74	1.03	0.77
Return on Avg. Equity (%)	10.57	14.15	12.15
Price to Earnings (x)	13.22	11.98	14.92
Price to Book Value (%)	148.29	163.46	158.33
Price to Tangible Book Value (%)	148.79	180.83	164.85
Current Dividend Yield (%)	2.82	1.97	1.61

Peer Group Analysis: Keystone Savings Bank. TKG compared selected balance sheet, asset quality, capitalization, and profitability ratios for Keystone Savings Bank and two groups of similar financial institutions. Group 1 used financial data at or for the twelve months ended December 31, 2002 and market data as of February 20, 2003 and includes 8 publicly-traded thrifts nationwide that have completed a standard mutual-to-stock conversion since 1998 with assets between $703.5 million and $1.6 billion, deposits between $502.6 million and $954.2 million, and shareholders’ equity between $68.3 million and $160.7 million (the “Converted Peers”). Group 2 used financial data at or for the twelve months ended September 30, 2002 and includes 13 mutual thrifts nationwide with assets between $504.6 million and $1.2 billion, deposits between $407.1 million and $976.7 million, and total equity between $50.1 million and $243.8 million (the “Mutual Peers”). For purposes of this analysis, non-performing assets (“NPAs”)include non-accrual loans, restructured loans, other real estate owned, and loans greater than 90 days past due but still accruing. Peer statistics are medians.

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	Keystone Savings Bank	Converted Peers
(financial data at or for the period ended December 31, 2002)
Loans/Deposits (%)	75.05	106.46
Equity/Assets (%)	10.92	11.99
NPAs/Assets (%)	0.15	0.46
Reserves/NPAs (%)	190.44	98.64
Net Interest Margin (%)	3.69	3.81
Non-interest Income/Avg. Assets (%)	0.82	0.69
Non-interest Expense/Avg. Assets (%)	2.46	2.52
Efficiency Ratio (%)	57.99	64.98
Return on Avg. Assets (%)	1.24	0.90
Return on Avg. Equity (%)	11.61	7.42
Price to Earnings (x)	NA	16.10
Price to Book Value (%)	NA	116.70
Price to Tangible Book Value (%)	NA	120.25
Current Dividend Yield (%)	NA	2.27

	Keystone Savings Bank	Mutual Peers
(financial data at or for the period ended September 30, 2002)
Loans/Deposits (%)	77.09	69.04
Equity/Assets (%)	11.01	12.67
NPAs/Assets (%)	0.21	0.23
Reserves/NPAs (%)	145.72	103.92
Net Interest Margin (%)	3.58	2.95
Non-interest Income/Avg. Assets (%)	0.74	0.20
Non-interest Expense/Avg. Assets (%)	2.25	1.53
Efficiency Ratio (%)	55.94	50.14
Return on Avg. Assets (%)	1.21	0.95
Return on Avg. Equity (%)	11.77	7.56

Comparable Transaction Analysis. TKG reviewed the pricing of merger and acquisition transactions announced after June 30, 2001, where the target institution is a profitable commercial bank with assets between $500 million and $1 billion. The criteria resulted in a list of 18 merger and acquisition transactions. For purposes of this analysis, the book-to-book ratio is the amount of book value a target institution shareholder receives for every one dollar of book value that shareholder is relinquishing (a book-to-book of 120% means a target shareholder receives $1.20 for every $1.00 of book value relinquished). Premium as a percent of core deposits equates to the amount paid over book value (premium) divided by the target’s core deposits (all deposits less time deposits greater than $100,000). Transaction multiples are calculated at the time the transactions were announced.

	Keystone-First Colonial	Comparable Transactions
Price/Book (%)	203.52	207.59
Price/Tangible Book (%)	204.19	232.00
Price/LTM Earnings (x)	20.33	19.00
Price/Assets (%)	14.06	19.10
Price/Deposits (%)	18.19	23.93
Premium/Core Deposits (%)	9.74	17.26
Book/Book (%)	271.70	106.74

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No company or transaction in the preceding Peer Group and Comparable Transaction analyses is identical to Keystone Savings Bank, First Colonial, or the contemplated transaction. Accordingly, an analysis of the results of the foregoing is not mathematically precise; rather, it involves complex considerations and judgments concerning differences in financial and operating characteristics of the companies and other factors that could affect the public trading value of the companies to which they are being compared. The ranges of valuation resulting from any particular analysis described above should not be taken to be TKG’s view of the actual value of First Colonial or Keystone Savings Bank.

First Colonial engaged TKG on May 2, 2002 to evaluate certain acquisition opportunities. That engagement was later amended on January 2, 2003 to facilitate this proposed transaction. First Colonial has paid TKG a retainer of $10,000 and an additional fee of $50,000 upon the rendering of the written fairness opinion. First Colonial has agreed to pay TKG a fee of 1.00% of the aggregate consideration to be paid in the merger upon the closing of the transaction. The retainer and the fairness opinion fee will be netted against the 1.00% fee. TKG will be reimbursed for reasonable out of pocket expenses incurred on behalf of First Colonial. First Colonial has agreed to indemnify TKG against certain liabilities.

Certain Federal Income Tax Consequences of the Merger

In the opinion of the following are the material federal income tax consequences of the merger of First Colonial with and into KNBT Bancorp, assuming that the merger is effected as described in the merger agreement and this proxy statement/prospectus. This opinion and the following discussion are based on currently existing provisions of the Code, existing Treasury Regulations thereunder and current administrative rulings and court decisions, all of which are subject to change. Any such change, which may or may not be retroactive, could alter the tax consequences of the transaction to the shareholders of First Colonial.

This discussion does not address all U.S. federal income tax considerations that may be relevant to particular First Colonial shareholders in light of their particular circumstances, including (without limitation):

• banks;

• insurance companies;

• tax-exempt organizations;

• dealers in securities;

• persons that hold their First Colonial common stock as part of a straddle, a hedge against a currency risk or a constructive sale or conversion transaction;

• persons who are subject to the alternative minimum tax provisions of the Code; or

• persons who acquired their First Colonial common stock in connection with a stock option or stock purchase plans or in some other compensatory transaction.

This discussion assumes that First Colonial’s shareholders hold their shares of First Colonial common stock as capital assets. In addition, the following discussion does not address the tax consequences of the merger under foreign, state or local tax laws. Furthermore, the discussion does not address the tax consequences of transactions effected before, after or at the same time as the merger,

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whether or not they are in connection with the merger, including, without limitation, transactions in which First Colonial’s common stock is acquired or KNBT Bancorp shares are disposed of.

It is a condition to the closing under the merger agreement that Blank Rome LLP render a tax opinion to the effect that the merger will constitute a tax-free reorganization within the meaning of Section 368(a) of the Code. The tax opinion and the materials discussed in this section will be subject to certain assumptions, limitations and qualifications, and are based upon the truth and accuracy of certain factual representations made by KNBT Bancorp and First Colonial.

Assuming the merger constitutes a reorganization within the meaning of Section 368(a) of the Code, the following federal income tax consequences will result to First Colonial shareholders:

No Gain or Loss. Subject to the discussion below regarding fractional shares of KNBT Bancorp common stock, each First Colonial shareholder receiving KNBT Bancorp common stock in the merger will not recognize any gain or loss as a result of the receipt of KNBT Bancorp common stock in the merger.

Tax Basis and Holding Period. A shareholder’s aggregate tax basis in the KNBT Bancorp common stock (including any fractional shares deemed received, as described below) will be equal to the aggregate tax basis of the First Colonial common stock surrendered in the exchange. A First Colonial shareholder’s holding period for the KNBT Bancorp common stock received will include the holding period for the First Colonial common stock surrendered in exchange therefor.

Cash Payments Received in Lieu of Fractional Shares. Cash payments received by First Colonial shareholders in lieu of fractional shares of KNBT Bancorp common stock will be treated as if such fractional shares had been issued in the merger and then redeemed by KNBT Bancorp. A First Colonial shareholder receiving such cash will generally recognize capital gain or loss upon such payment, equal to the difference, if any, between such First Colonial shareholder’s tax basis in the fractional share and the amount of cash received.

Other relevant tax considerations in connection with the merger include the following:

Other Consideration. Even if the merger qualifies as a tax-free reorganization pursuant to Section 368(a) of the Code, a First Colonial shareholder who receives shares of KNBT Bancorp common stock could be required to recognize gain to the extent that such shares were considered to be received in exchange for services. Generally, such income would be taxable as ordinary income upon receipt. In addition, to the extent that First Colonial shareholders are treated as receiving, directly or indirectly, consideration other than KNBT Bancorp common stock in exchange for such shareholder’s First Colonial common stock, gain or loss will be required to be recognized.

Backup Withholding. Certain noncorporate First Colonial shareholders may be subject to backup withholding at a rate of 28% on cash payments received in the merger. Backup withholding will not apply, however, to a First Colonial shareholder who: (i) furnishes a correct taxpayer identification number and certifies that he or she is not subject to backup withholding on the substitute Form W-9 included in the letter of transmittal, (ii) provides a certificate of foreign status on an appropriate Form W-8, or (iii) is otherwise exempt from backup withholding.

No ruling from the Internal Revenue Service has been or will be requested in connection with the merger. In addition, shareholders of First Colonial should be aware that the tax opinion discussed in this section is not binding upon the Internal Revenue Service. Moreover, the Internal Revenue Service could adopt a contrary position which could be sustained by a court.

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THE PRECEDING DISCUSSION IS INTENDED ONLY AS A SUMMARY OF CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES OF THE MERGER AND DOES NOT PURPORT TO BE A COMPLETE ANALYSIS OR DISCUSSION OF ALL POTENTIAL TAX EFFECTS RELEVANT THERETO. THUS, FIRST COLONIAL SHAREHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE SPECIFIC TAX CONSEQUENCES TO THEM OF THE MERGER, INCLUDING TAX RETURN REPORTING REQUIREMENTS, THE APPLICABILITY AND EFFECT OF FOREIGN, FEDERAL, STATE, LOCAL, AND OTHER APPLICABLE TAX LAWS AND THE EFFECT OF ANY PROPOSED CHANGES IN THE TAX LAWS.

See “The Conversion and the Merger—Tax Aspects” in the prospectus for a description of other federal income tax consequences of the merger.

No Dissenters’ Rights

Under Pennsylvania law, First Colonial shareholders will not be entitled to dissenters’ rights in connection with the merger.

Comparison of Rights of Shareholders First Colonial and KNBT Bancorp

Both First Colonial and KNBT Bancorp are Pennsylvania corporations governed by their respective articles and bylaws and the Pennsylvania Business Corporation Law of 1988, as amended, referred to as the PBCL. Because First Colonial and KNBT Bancorp are both Pennsylvania corporations, the differences in the rights of First Colonial and KNBT Bancorp shareholders will generally consist of differences found in each company’s articles and bylaws.

The following is a summary of the material differences between the rights of First Colonial shareholders and the rights of KNBT Bancorp shareholders. This summary is not intended to be complete, and is qualified in its entirety by reference to the applicable provisions of the PBCL, First Colonial’s articles and bylaws and KNBT Bancorp’s articles and bylaws.

Authorized Capital

First Colonial. First Colonial is authorized to issue 10,000,000 shares of common stock, par value of $5.00 per share, and 500,000 shares of preferred stock with a par value of $5.00 per share.

KNBT Bancorp. KNBT Bancorp is authorized to issue 100,000,000 shares of common stock, par value $0.01 per share, and 20,000 shares of preferred stock, par value $0.01 per share.

Cumulative Voting

First Colonial. First Colonial’s shareholders are permitted to cumulate their votes for the election of directors. This means that every shareholder entitled to vote in an election of directors may, if he or she desires, multiply his or her number of votes by the number of directors to be elected, and may cast the total number of votes for one candidate or for two or more candidates.

KNBT Bancorp. KNBT Bancorp’s articles do not permit cumulative voting in an election of directors.

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Special Meetings of Shareholders

First Colonial. Special meetings of the First Colonial shareholders can be called by First Colonial’s President, the First Colonial board of directors or the holders of not less than 25% of the shares entitled to vote at the meeting.

KNBT Bancorp. Special meetings of the shareholders can be called only by an affirmative vote of a majority of the directors then in office.

Size, Classification and Qualifications of the Board of Directors

First Colonial. The number of First Colonial directors must not be less than 5 nor more than 25, with the exact number determined by the board. The directors are divided into four classes as nearly equal in number as possible, with one class to be elected annually. Every director of First Colonial must be a shareholder of First Colonial.

KNBT Bancorp. The number of KNBT Bancorp directors must not be less than 9 but not more than 25, as set by resolution of the board of directors. The board of directors of KNBT Bancorp is divided into three classes as nearly equal in number as possible, with one class to be elected annually. No person shall be eligible for election to KNBT Bancorp’s board if such person is 75 years of age or older.

Removal of Directors

First Colonial. First Colonial’s bylaws provide that the entire board, or a class of the board, or any individual director may be removed from office only for cause and only with the vote of shareholders entitled to cast at least 75% or such higher percentage as may be required by law of the votes which all shareholders are entitled to cast at the meeting. “For cause” includes the conviction of the director of a felony, a declaration by order of court that the director is of unsound mind, or a gross abuse of trust committed in bad faith. The board, without shareholder approval, may remove any director for any proper cause (whether or not similar to the foregoing).

KNBT Bancorp. Any director may be removed from office by shareholders only for cause by the affirmative vote not less than a majority of the total votes eligible to be cast at a shareholder meeting called expressly for such purpose. Cause for removal exists when a director is: declared by a court to be of unsound mind; convicted of a felony or an offense punishable by imprisonment for more than one year; or deemed liable by a court for gross negligence or misconduct in the performance of his or her duties to the corporation.

Amendment of Governing Documents

First Colonial.

Amendment to Articles. Any amendment to First Colonial’s articles which is proposed by shareholders and not previously approved by the board of directors requires for its adoption the affirmative vote of at least 75% of the votes which all shareholders are entitled to cast.

Amendment to Bylaws. Any amendment to First Colonial’s bylaws not previously approved by the board of directors must also be approved by the affirmative vote of at least 75% of the votes which all shareholders are entitled to cast.

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KNBT Bancorp.

Amendment to Articles. KNBT Bancorp’s articles provide that the corporation may amend the articles provided it is first approved by board resolution adopted by the affirmative vote of a majority of the directors then in office, and thereafter approved by the holders of a majority (except as provided below) of the shares entitled to vote in an election of directors, as well as any additional vote of the preferred stock as may be required by any series thereof. However, an affirmative vote of 75% of the shares entitled to vote is required to amend any provision in a manner inconsistent with the Articles VI (Directors), VII (Meetings of Shareholders; Action Without a Meeting), VIII (Liability of Directors and Officers), IX (Restrictions on Offers and Acquisitions of the Corporation’s Equity Securities), X (Applicability of the Takeover Provisions of the PBCL), XI (Shareholder Approval of Fundamental Changes) and XII (Amendment of Articles of Incorporation and Bylaws) which has not been approved by the affirmative vote of 80% of the board of directors then in office.

Amendment to Bylaws. KNBT Bancorp’s articles provide that the board of directors may amend the bylaws by an affirmative vote of a majority of the directors then in office at any regular or special meeting of the board. The shareholders may amend the bylaws by an affirmative vote of at least a majority of the shares entitled to vote in an election of directors, as well as any additional vote of the preferred stock as may be required by any series thereof. However, an affirmative vote of 75% of the shares entitled to vote is required to amend any provision in a manner inconsistent with the following sections of the bylaws: 2.10 (Shareholder Proposals), 3.1 (Number and Powers of Directors), 3.2 (Classification, Terms and Qualifications of Directors), 3.3 (Vacancies of Directors), 3.4 (Removal of Directors) and 3.12 (Nominations of Directors), and Article VI (Indemnification) of the bylaws.

Shareholder Voting Rights

First Colonial. Article 7 of First Colonial’s articles restricts the rights of a “person” (as hereafter defined) to cast (or execute written consents with respect to) more than 10% of the total votes which all First Colonial shareholders are entitled to cast at a meeting, unless authorized to do so by the First Colonial board of directors and subject to such conditions as First Colonial’s board of directors may impose. This provision applies to any meetings, whether annual or special or otherwise. The term “person” includes not only individuals and entities, but also “shareholder groups” of individuals and entities who act together for the purpose of acquiring, holding, disposing of or voting First Colonial common stock. The restrictions of Article 7 do not apply to the shares of First Colonial common stock held by Nazareth National Bank for itself or as trustee of First Colonial’s Employee Stock Ownership Plan or other trusts.

The casting of votes by a person as a proxy holder for other First Colonial shareholders is not counted in computing the 10% limitation to the extent that the proxies so voted were revocable and were secured from other shareholders who are not members of a group which includes such person. Giving a revocable proxy to a person does not in itself cause the shareholder giving the proxy to be a member of a group which includes such person. Article 7 provides that the determination by the First Colonial board of directors of the existence or membership of a shareholder group, and of a number of votes any person or each member of a group is entitled to cast, is final and conclusive absent clear and convincing evidence of bad faith.

In the event of a violation of Article 7 and in addition to other remedies afforded First Colonial, including Article 9 remedies as discussed in the section below “—Shareholder Acquisition of Stock,” the judges of election cannot count votes cast in violation of Article 7.

KNBT Bancorp. KNBT Bancorp’s articles provide that any shareholder action required or permitted to be taken under Subchapters C (Merger, Consolidation, Share Exchange, and Sale of Assets),

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D (Division) and F (Voluntary Dissolution and Winding Up) of Chapter 19 of the PBCL requires the approval of at least 75% of the shares entitled to vote in an election of directors, as well as any additional vote of the preferred stock as may be required by any series thereof. However, if at least two-thirds of the board of directors recommends the action taken under the PBCL as described above, then the 75% shareholder vote requirement does not apply and the action will only require such affirmative vote as required by law. The PBCL Subchapters listed above each allow for the adoption of the above actions upon approval by a majority of the total votes cast.

Shareholder Acquisition of Stock

First Colonial. Article 8 of First Colonial’s articles provides that no “person” (as defined above in the section “—Shareholder Voting Rights” with respect to First Colonial shareholders) may have “holdings” (as hereafter defined) that exceed 10% of the Company’s voting securities except as authorized by, and subject to such conditions as may be imposed by, the Company’s Board of Directors. The term “holdings” means the voting securities (1) which the person owns of record, (2) of which the person has direct or indirect beneficial ownership (as such term is used in Section 13(d) of the Securities and Exchange Act of 1934, as amended) and (3) owned of record or beneficially by members of a “shareholder group” (as defined above in the section “—Shareholder Voting Rights” with respect to First Colonial) which includes such person. The restrictions of Article 8 do not apply to the shares of First Colonial common stock held by Nazareth National Bank for itself or as trustee of First Colonial’s Employee Stock Ownership Plan or other trusts.

The board of directors may terminate the voting rights of any person who acquires holdings in violation of this provision of the articles for so long as such violation continues, commence litigation to require divestiture of the holdings in excess of the 10% limit or take such other action as it deems appropriate, including seeking injunctive relief or purchasing such excess shares as described below. The board of directors’ determination with respect to the existence of a violation of this provision will be conclusive in the absence of clear and convincing evidence of bad faith.

Shares acquired in violation of either Article 7 (as discussed above in the section “—Shareholder Voting Rights” with respect to First Colonial) or Article 8 may, among other things, not be voted by the holder thereof or, if any votes are cast in violation of these provisions, such votes will not be counted. In addition, Article 9 grants the company or its nominee an option to purchase all or any part of a person’s holdings that exceed 10% of the company’s issued and outstanding voting securities. If the person is a shareholder group, the company need not exercise its purchase option proportionately with respect to the individual members of the group, but may exercise such option as to any one or more or all of such individuals members.

The purchase price for the voting securities is intended to equal the average market price for such voting securities during the period beginning 65 trading days prior to the date on which the resolution was adopted and ending five trading days prior to the date of adoption of the resolution. However, if the person from whom the voting securities are purchased acquired such securities within one year prior to the date of the resolution, the purchase price cannot exceed the direct cost to acquire such securities (excluding legal, accounting, brokerage, investment advisory or other indirect costs) incurred by the person from whom such securities are purchased. The purpose of this provision is to prevent a person who violates the voting or holdings limitations from making a profit on voting securities held less than one year. The purchase price will be computed by an independent public accounting firm selected by the board of directors and such firm’s computation will be conclusive in the absence of clear and convincing evidence of bad faith.

KNBT Bancorp. KNBT Bancorp’s articles provide that no person may acquire more than 10% of the issued and outstanding shares of any class of KNBT Bancorp’s equity securities. This restriction does

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not apply to any offer or acquisition approved in advance by the affirmative vote of 80% of the board’s directors then in office. In the event that shares are acquired in excess of 10%, such shares will be considered excess shares and will not be counted as shares entitled to vote. The board may cause the shares in excess of 10% to be transferred to an independent trustee for sale. See “Restrictions on Acquisition of KNBT Bancorp and Keystone and Related Anti-Takeover Provisions – Limitations on Acquisitions of Voting Stock and Voting Rights.”

Shareholder Approval of Business Combinations with Interested Shareholders

First Colonial. Under the PBCL, subject to certain exceptions, a business combination between a Pennsylvania corporation that has a class or series of shares registered under the Securities and Exchange Act of 1934, and a beneficial owner of 20% or more such corporation’s voting stock, referred to as an “interested person,” may be accomplished only if:

• The business combination is approved by the corporation’s directors prior to the date on which such person acquired 20% or more of such stock prior to such stock or if the board approved such person’s acquisition of 20% or more of such stock prior to such acquisition;

• The interested person owns shares entitled to cast at least 80% of the votes all shareholders would be entitled to cast in the election of directors, the business combination is approved by the of shareholder entitled to cast a majority of votes that all shareholders would be entitled in an election of directors (excluding shares held by the interested person), which vote may occur no earlier that three months after the interested person acquired its 80% ownership, and the consideration received by shareholders in the business combination satisfies certain minimum conditions;

• The business combination is approved by the affirmative vote of all outstanding shares of common stock;

• The business combination is approved by the vote of shareholders entitled to cast a majority of the votes that all shareholders would be entitled to cast in the election of directors (excluding shares held by the interest person), which vote may occur no earlier than five years after the interested person became an interested person; or

• The business combination that meets certain minimum conditions is approved at a shareholder’s meeting called for such purpose no earlier that five years after the interested person became an interested person.

A corporation may exempt itself from this provision by an amendment to its articles of incorporation that requires shareholder approval. First Colonial’s articles do not provide an exemption from this provision.

KNBT Bancorp. KNBT Bancorp’s articles do not provide an exemption from this provision of the PBCL relating to a business combination between KNBT Bancorp and an “interested person.” Such business combination may only be accomplished if it is in compliance with the PBCL requirements which are discussed above.

Anti-Takeover Provisions

First Colonial. First Colonial’s articles provide that the board of directors may in its discretion oppose a tender or other offer for the corporation’s securities, whether the offer is in cash or in securities of a corporation. When considering whether to oppose an offer, the Board of Directors may in its discretion consider any of the following:

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• Whether the offer price is acceptable based on the historical and present operating results or financial condition of the corporation.

• Whether a more favorable price could be obtained for the corporation’s securities in the future.

• The impact which an acquisition would have on First Colonial’s employees, depositors, and customers and its subsidiaries.

• The reputation and business practices of the offeror, as it would affect the employees, depositors, customers and subsidiaries of First Colonial.

• The value of the securities offered in exchange for First Colonial’s securities.

• Any antitrust or other legal or regulatory issues.

If the Board of Directors determines that a tender offer should be rejected, the Articles provide that it may take any lawful action to accomplish its purpose including, but not limited to, any and all of the following: advising shareholders not to accept the offer; litigation against the offeror; filing complaints with all governmental and regulatory authorities; acquiring the corporation’s securities; selling or otherwise issuing authorized but unissued securities or treasury stock or granting options with respect thereto; acquiring a company to create an antitrust or other regulatory problem for the offeror; and obtaining a more favorable offer form another individual or entity;

In addition, the PBCL establishes other anti-takeover provisions from which a corporation may exempt itself. First Colonial has not exempted itself from the following anti-takeover provisions of the PBCL:

• Any profit realized by any person or group, who is or was a “controlling person or group” with respect to First Colonial, from the disposition of any stock to any person shall be recoverable by First Colonial where the profit is realized by such person or group: (1) from the disposition of the equity security within 18 months after the person or group attained the status of a controlling person or group; and (2) the equity security had been acquired by the controlling person or group within 24 months prior to or 18 months subsequent to the attaining by the person or group of the status of a controlling person or group. A “controlling person or group” is defined generally to mean a person or group who has acquired, offered to acquire or, directly or indirectly, publicly disclosed or caused to be disclosed the intention of acquiring voting power over 20% of the voting shares of a corporation, or person or group who has otherwise, directly or indirectly, publicly disclosed that it may seek to acquire control of a corporation through any means.

• No “control shares” will have voting rights unless the shareholders approve a resolution granting voting power to the control shares by a majority of those entitled to vote in a vote by all of the disinterested shares (those shares owned by holders other than the holder seeking to engage in a control-share acquisition) of the corporation and by all voting shares of the corporation. Control shares are defined generally as those acquired in a control-share acquisition, one in which a person acquires for the first time the authority to cast or direct the casting of the following range shares entitled to vote in an election of directors: (1) 20% to less than 33-1/3%; (2) 33-1/3% to less than 50%; or (3) 50% or more.

First Colonial has exempted itself from the following anti-takeover provision of the PBCL:

• Holders of common stock may object to a control transaction (generally the acquisition by a person or a group of persons acting in concert of at least 20% of the outstanding

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voting stock of a corporation) involving the company and demand that they be paid in cash the fair value of their shares from the controlling person or group.

KNBT Bancorp. In discharging their duties, the board of directors may in considering the best interests of the corporation consider the effects of any action upon employees, upon suppliers and customers of the corporation and upon communities in which offices or other establishments of the corporation are located, and all other pertinent factors.

In addition, KNBT Bancorp has not exempted itself from the following anti-takeover provisions of the PBCL:

• Holders of common stock may object to a control transaction (generally the acquisition by a person or a group of persons acting in concert of at least 20% of the outstanding voting stock of a corporation) involving KNBT Bancorp and demand that they be paid in cash the fair value of their shares from the controlling person or group.

• Any profit realized by any person or group, who is or was a “controlling person or group” with respect to KNBT Bancorp, from the disposition of any stock to any person shall be recoverable by KNBT Bancorp where the profit is realized by such person or group: (1) from the disposition of the equity security within 18 months after the person or group attained the status of a controlling person or group; and (2) the equity security had been acquired by the controlling person or group within 24 months prior to or 18 months subsequent to the attaining by the person or group of the status of a controlling person or group. A “controlling person or group” is defined generally to mean a person or group who has acquired, offered to acquire or, directly or indirectly, publicly disclosed or caused to be disclosed the intention of acquiring voting power over 20% of the voting shares of a corporation, or person or group who has otherwise, directly or indirectly, publicly disclosed that it may seek to acquire control of a corporation through any means.

KNBT Bancorp has exempted itself from the following anti-takeover provision of the PBCL:

• The PBCL includes provisions which generally require that shareholders of a registered corporation approve a “control-share acquisition,” as described above in this section with respect to First Colonial. See “Restrictions on Acquistion of KNBT Bancorp and Keystone and Related Anti-Takeover Provisions — Control-Share Acquisitions” in the prospectus.

First Colonial Stock Prices and Dividend Information

First Colonial common stock is quoted on the Nasdaq National Market under the symbol “FTCG.” KNBT Bancorp and Keystone Savings Bank have never issued capital stock. KNBT Bancorp has applied to have its common stock, to be issued in connection with the conversion and the merger, quoted on the Nasdaq National Market.

The following table sets forth the reported high and low sales prices of shares of First Colonial common stock as reported on the Nasdaq National Market and the quarterly cash dividends per share declared, for the periods indicated. The stock prices do not include retail mark-ups, mark-downs or commissions.

44

	First Colonial Common Stock
	High		Low		Dividends
2001 Calendar Year
First Quarter	$	15.08	$	12.24	$	0.1724
Second Quarter		15.57		13.37		0.1724
Third Quarter		19.29		14.14		0.1810
Fourth Quarter		23.76		16.76		0.1810
TOTAL					$	0.7068
2002 calendar Year
First Quarter		24.00	$	20.24		0.1810
Second Quarter		25.24		21.81		0.1810
Third Quarter		25.81		18.00		0.1900
Fourth Quarter		25.00		22.59		0.1900
TOTAL					$	0.7420
2003 Calendar Year
First Quarter	$	45.00	$	22.95	$	0.1900
Second Quarter (through May 31, 2003)	$	45.29	$	43.82	$	0.1900

The last reported sales prices per share of First Colonial common stock on (i) March 5, 2003, the last business day preceding public announcement of the signing of the merger agreement and (ii) [             , 2003], the last practicable date prior to the mailing of this proxy statement/prospectus were [$            ] and [$            ], respectively.

As of May 31, 2003 2,254,735 outstanding shares of First Colonial common stock were held by approximately 725 record owners.

Assuming an initial public offering price of $10.00 per share for the KNBT common stock in the conversion, the number of shares of KNBT common stock to be received for each share of First Colonial common stock will be 3.7. Accordingly, an increase in the market value of KNBT common stock subsequent to the conversion will increase the market value of the KNBT common stock received in the merger. A decrease in the market value of KNBT common stock will have the opposite effect. The market value of the merger consideration at the time of the merger will depend upon the market value of a share of KNBT common stock at such time. There can be no assurance that the KNBT common stock will trade above the initial public offering price subsequent to the conversion.

See also “Dividends” in the prospectus.

Other Matters

The enclosed proxy confers discretionary authority to vote with respect to any and all of the following matters that may come before the Annual Meeting: (i) matters which First Colonial did not have notice of by [November 25, 2002] are to be presented at the Annual Meeting; (ii) approval of the minutes of a prior annual meeting of shareholders, if such approval does not amount to ratification of the action taken at the annual meeting; (iii) the election of any person to any office for which a bona fide nominee is unable to serve or for good cause will not serve; (iv) any proposal omitted from this proxy statement/prospectus and the form of proxy pursuant to Rules 14a-8 or 14a-9 under the Securities Exchange Act of 1934; and (v) matters incident to the conduct of the Annual Meeting. If any such matters are brought before the Annual Meeting, the persons named in the enclosed proxy will vote in accordance with their best judgment. First Colonial is not presently aware of any matters (other than

45

procedural matters) which will be brought before the Annual Meeting which are not reflected in the attached Notice of the Annual Meeting.

Shareholder Proposals

First Colonial will hold a 2004 annual meeting of shareholders only if the merger is not consummated before the time of such meeting, which is presently expected to be held in [        ].

Under First Colonial’s Bylaws, as amended, shareholder proposals with respect to the 2004 annual meeting of shareholders, including nominations for directors, which have not been previously approved by First Colonial’s board of directors, must be submitted to the Secretary of First Colonial not later than [                        ]. Any such proposals must be in writing and sent either by personal delivery, nationally-recognized express mail or United States mail, postage prepaid to First Colonial Group, Inc, 76 South Main Street, Nazareth, Pennsylvania 18064. Each nomination or proposal must include the information required by the Bylaws. All late or nonconforming nominations and proposals may be rejected by the officer presiding at the meeting.

Shareholder proposals for the 2004 annual meeting of shareholders must be submitted to First Colonial by [                        ] to receive consideration for inclusion in First Colonial’s proxy statement relating to the 2004 annual meeting of shareholders. Any such proposal must also comply with SEC proxy rules, including SEC Rule 14a-8, and any applicable requirements set forth in the Bylaws.

In addition, First Colonial shareholders are notified that the deadline for providing First Colonial timely notice of any shareholder proposal to be submitted outside of the Rule 14a-8 process for consideration at First Colonial’s 2004 annual meeting of shareholders is [                    ]. As to all such matters which First Colonial does not have notice on or prior to [                        ], discretionary authority shall be granted to the persons designated in First Colonial’s proxy related to the 2004 annual meeting of shareholders to vote on such proposal.

Form 10-K

EACH PERSON SOLICITED HEREUNDER CAN OBTAIN A COPY OF FIRST COLONIAL’S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2002 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION, WITHOUT CHARGE EXCEPT FOR EXHIBITS TO THE REPORT, BY SENDING A WRITTEN REQUEST THEREFORE TO FIRST COLONIAL GROUP, INC., 76 SOUTH MAIN STREET, NAZARETH, PENNSYLVANIA 18064, ATTENTION: REID L. HEEREN, VICE PRESIDENT.

By Order of the Board of Directors

SCOTT V. FAINOR

President and Chief Executive Officer

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PROSPECTUS

KNBT BANCORP, INC.

Keystone Savings Bank is converting from the mutual to the stock form of organization. As part of this conversion, KNBT Bancorp, Inc. is offering shares of common stock. KNBT Bancorp’s shares are being offered to certain depositors of Keystone Savings Bank and others who have subscription purchase rights. Keystone Savings Bank will become a wholly owned subsidiary of KNBT Bancorp, Inc. Applicable regulations require KNBT Bancorp to sell its common stock in the offering in an aggregate amount equal to the estimated pro forma market value of Keystone Savings Bank as determined by an independent appraiser.

Price Per Share: $10.00

Minimum Subscription Requirement: 25 Shares or $250

Expected Trading Market and Symbol: Nasdaq National Market “KNBT”

	Minimum		Maximum
Number of shares:		12,983,750		17,566,250
Gross offering proceeds:	$	129,837,500	$	175,662,500
Estimated underwriting commissions:	$	1,164,505	$	1,586,095
Estimated other offering expenses:	$	2,100,000	$	2,100,000
Estimated net proceeds:	$	126,572,995	$	171,976,405
Estimated net proceeds per share:	$	9.75	$	9.79

KNBT Bancorp may increase the maximum number of shares to 20,201,188 shares.

Substantially simultaneously with the completion of the conversion stock offering, KNBT Bancorp will acquire by merger First Colonial Group, Inc., the holding company for Nazareth National Bank and Trust Company, and Nazareth National Bank will merge into Keystone Savings Bank. In addition to the shares KNBT Bancorp is selling in the conversion offering, it will issue up to 9,355,928 additional shares to shareholders of First Colonial in the merger in exchange for their First Colonial shares.

The conversion offering to depositors, officers, trustees and employees of Keystone Savings Bank will end at     :     p.m., Eastern Time, on              , 2003. An offering to the general public may also be held and may end as early as _:     p.m., Eastern Time, on             , 2003. If the offering is not completed by             , 2003 KNBT Bancorp may extend the expiration date without further notice until             , 2003, unless the Federal Deposit Insurance Corporation or the Pennsylvania Department of Banking approves a later date. Once submitted, orders submitted by depositors of Keystone Savings Bank and other subscribers are irrevocable unless the offering is terminated or extended beyond             , 2003. If the offering is extended beyond             , 2003, all subscribers will be able to increase, decrease or cancel their orders. KNBT Bancorp will hold all funds of subscribers in an interest-bearing savings account until the conversion is completed or terminated. Funds will be returned promptly with interest if the conversion is terminated.

Sandler O’Neill & Partners, L.P. will use its best efforts to assist KNBT Bancorp in selling at least the minimum number of shares in the offering but does not guarantee that this number will be sold. Sandler O’Neill is not obligated to purchase any shares of common stock in the offering. Sandler O’Neill intends to make a market in the common stock.

These securities are not deposits or accounts, are not insured or guaranteed by Keystone Savings Bank, KNBT Bancorp, the Federal Deposit Insurance Corporation or any other federal or state government agency. The common stock is subject to investment risk, including the possible loss of money invested.

For a discussion of the material risks that you should consider, see “Risk Factors” beginning on page _.

Neither the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, the Pennsylvania Department of Banking, nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

For assistance, please contact the conversion center at (610)         -         or (888)         -         .

SANDLER O’NEILL & PARTNERS, L.P.

The date of this prospectus is                 , 2003.

TABLE OF CONTENTS

	Page
Map of Office Locations	iii
Summary	1
Risk Factors	8
Forward Looking Statements	14
Operating Strategy of KNBT Bancorp, Inc.	15
Selected Consolidated Financial and Other Data of Keystone	17
Selected Consolidated Financial and Other Data of First Colonial	19
Use of Net Proceeds	21
Dividends	22
Market for KNBT Bancorp Common Stock	23
Regulatory Capital Requirements	23
Capitalization	25
Pro Forma Unaudited Financial Information	27
Comparison of Independent Valuation and Pro Forma Financial Information With and Without the Foundation	44
Management’s Discussion and Analysis of Financial Condition and Results of Operations of Keystone	46
Management’s Discussion and Analysis of Financial Condition and Results of Operations of First Colonial	65
Business of Keystone.	104
Business of First Colonial	129
Regulation	138
Taxation	144
Management	146
Proposed Management Purchases	156
The Conversion and the Merger	158
The Offering	181
Description of KNBT Bancorp Capital Stock	191
Restrictions on Acquisition of KNBT Bancorp and Keystone and Related Anti-Takeover Provisions.	192
Experts	200
Legal and Tax Opinions	200
Additional Information	200
Index to Consolidated Financial Statements	F-1

ii

KEYSTONE SAVINGS BANK

NAZARETH NATIONAL BANK

OFFICE LOCATIONS

iii

SUMMARY

This summary highlights selected information from this document and may not contain all the information that is important to you. To understand the conversion offering and the merger fully, you should read this entire document carefully, including the financial statements and the notes to financial statements of Keystone Savings Bank and First Colonial.

KNBT Bancorp

KNBT Bancorp is a Pennsylvania corporation recently organized by Keystone Savings Bank as part of its mutual-to-stock conversion. KNBT Bancorp will be the holding company for Keystone Savings Bank following the conversion. KNBT Bancorp is not an operating company and has not engaged in any significant business to date. KNBT Bancorp’s executive offices are located at 90 Highland Avenue, Bethlehem, Pennsylvania 18017, and its telephone number is (610) 861-5000.

Keystone Savings Bank

Keystone Savings Bank is a Pennsylvania-chartered mutual savings bank organized in 1925. Keystone Savings Bank’s main office is in Bethlehem, Pennsylvania and, as of the date of this document, it has 19 offices located in Lehigh, Northampton and Carbon Counties, Pennsylvania. As of March 31, 2003, Keystone Savings Bank had total assets of $1.0 billion, total deposits of $797.4 million and retained earnings of $114.3 million.

In recent years, Keystone Savings Bank has concentrated on the evolution of its operations to be more like a full-service community bank. Keystone Savings Bank offers a full range of deposit products, a wide selection of loans and a variety of investment and insurance products. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations of Keystone—Keystone’s Management Strategy” on page     .

First Colonial Group, Inc.

First Colonial is a Pennsylvania corporation and a registered bank holding company. First Colonial’s principal subsidiary is Nazareth National Bank & Trust Company, a national bank engaged in commercial and consumer banking and trust services. Nazareth National Bank operates out of its main office in Nazareth, Pennsylvania and 16 branch offices located in Northampton, Monroe and Lehigh Counties, Pennsylvania. As of March 31, 2003, First Colonial had total assets of $620.7 million, total deposits of $483.4 million and stockholders’ equity of $40.5 million. First Colonial’s executive offices are located at 76 South Main Street, Nazareth, Pennsylvania 18064 and its telephone number is (610) 746-7300.

Conversion from Mutual to Stock Form

The conversion involves a series of transactions by which Keystone Savings Bank will convert from a mutual savings bank to a stock savings bank. Following the conversion, Keystone Savings Bank will become a subsidiary of KNBT Bancorp and will change its name to Keystone Nazareth Bank & Trust Company. (For ease of reference, the term “Keystone” is hereinafter used, which shall mean Keystone in its mutual form or Keystone Nazareth Bank & Trust Company, in the stock form, as the context dictates.) Keystone will continue to be subject to the regulation and supervision of the Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking. KNBT Bancorp will be a registered bank holding company and will be subject to regulation by the Board of Governors of the Federal Reserve System (which we refer to as the Federal Reserve Board). See “The Conversion and the Merger” at page         .

As part of the conversion, KNBT Bancorp is offering for sale between $129.8 million and $175.7 million of its common stock. The offering is being made to Keystone depositors who have subscription purchase rights as well as Keystone’s officers, trustees and employees and its employee stock ownership plan. The purchase price will be $10.00 per share. All investors will pay the same price per share in the offering. Subject to regulatory approval, KNBT Bancorp may increase the amount of stock to be sold to $202.0 million without any further notice if market or financial conditions change before the conversion is completed. If an insufficient number of shares are subscribed for in the subscription offering, KNBT Bancorp may sell shares in a community offering.

1

The conversion will permit Keystone’s customers, management and employees and possibly other members of the local community and of the general public to become equity owners of KNBT Bancorp and to share in its future. The conversion will facilitate the proposed mergers with First Colonial and Nazareth National Bank. The conversion also will provide additional funds for lending and investment activities and enhance Keystone’s ability to diversify and to grow its operations. The conversion to stock form is subject to approval by Keystone’s depositors entitled to vote on the matter and the receipt of all necessary regulatory approvals.

The Merger

On March 6, 2003, Keystone announced that it had entered into a merger agreement with First Colonial under the terms of which First Colonial will merge with KNBT Bancorp and Nazareth National Bank will merge with Keystone. Under the terms of the merger agreement, upon completion of the merger, each share of First Colonial common stock which is outstanding (other than treasury shares) will be converted into the right to receive shares (which are referred to in this document as merger exchange shares) of KNBT Bancorp common stock with a value of $37.00, or 3.7 shares based on the purchase price of $10.00 (which is referred to in this document as the merger exchange ratio). In addition, each option to purchase First Colonial common stock will be converted into the right to acquire shares of KNBT Bancorp common stock equal to the number of shares of First Colonial common stock subject to the First Colonial option multiplied by the merger exchange ratio. Based upon the number of shares of First Colonial common stock outstanding as of March 31, 2003, it is estimated that the total number of merger exchange shares to be issued in connection with the merger will be approximately 8.3 million shares, excluding any adjustment for fractional shares and the issuance of any additional shares of First Colonial common stock upon the exercise of options. In conjunction with the merger, Nazareth National Bank will be merged into Keystone with Keystone as the surviving bank.

Completion of the merger is subject to various conditions, including, receipt of all necessary regulatory approvals, the approval of the merger agreement by the shareholders of First Colonial, approval of the conversion by the voting depositors of Keystone and completion of the conversion. If the conversion is not successfully completed, the merger will be terminated. The merger agreement is being presented to First Colonial’s shareholders for their approval at its annual meeting called for                  , 2003. KNBT Bancorp has applied for all necessary regulatory approvals in order to complete the merger. The completion of the merger is expected to occur substantially simultaneously with the completion of the conversion.

KNBT Bancorp and Keystone Following the Conversion and the Merger

It is expected that, following the conversion and the merger, Keystone will be the largest locally based community savings bank operating in the greater Lehigh Valley region of Pennsylvania. Assuming the conversion and the merger had been consummated as of March 31, 2003, KNBT Bancorp would have had, on a pro forma basis at the maximum of the offering range, total assets of $1.9 billion, total liabilities of $1.5 billion, including $1.3 billion of deposits, and total shareholders’ equity of $353.7 million. See “Pro Forma Unaudited Financial Information.” In addition, at March 31, 2003, Keystone would have had, on a pro forma basis at the maximum of the offering range, Tier 1 leverage capital of $186.2 million or 10.96% of adjusted total assets and Tier 1 risk-based and total risk-based capital of $186.2 million or 20.44% and $193.0 million or 21.19% of total risk-weighted assets, respectively. See “Regulatory Capital Requirements.”

Assuming the conversion and the merger had been consummated as of March 31, 2003, KNBT Bancorp’s net loan portfolio would have amounted to, on a pro forma basis at the maximum of the offering range, $781.9 million or 42.0% of total assets. On a pro forma basis at March 31, 2003 assuming completion of the conversion and the merger, approximately 48.0% of KNBT Bancorp’s total loan portfolio would consist of single-family residential mortgage loans, 8.4% would be construction loans, 25.7% would be consumer loans and 17.9% would be commercial real estate, commercial business and other loans. In addition, KNBT Bancorp’s total deposits would have amounted to $1.3 billion. Moreover, KNBT Bancorp would have had $4.1 million of non-performing assets or 0.2% of total assets (approximately). For additional information with respect to KNBT Bancorp’s pro forma consolidated financial condition and results of operations, see “Selected Pro Forma Unaudited Consolidated Financial Data of KNBT Bancorp” and “Pro Forma Unaudited Financial Information.”

2

The board of directors of KNBT Bancorp currently consists of nine members, all of whom currently are also trustees of Keystone. Upon completion of the conversion and the merger, Scott V. Fainor, President and Chief Executive Officer of First Colonial, as well as five other current directors of First Colonial will be appointed to the boards of directors of KNBT Bancorp and Keystone. In addition, as of the effective time of the merger, Mr. Fainor will be appointed the President and Chief Executive officer of KNBT Bancorp and Keystone. Mr. Eugene T. Sobol, who currently is Executive Vice President and Chief Operating Officer of Keystone, will be Senior Executive Vice President and Chief Operating Officer of KNBT Bancorp and Keystone. Mr. Reid L. Heeren, currently the Executive Vice President and Chief Financial Officer of First Colonial and Nazareth National Bank, will serve in the same positions at KNBT Bancorp and Keystone. See “Management—Management of KNBT Bancorp” and “—Management of Keystone after the Merger.”

KNBT Bancorp’s Operating Strategy

KNBT Bancorp will be the holding company for Keystone after its conversion and merger with Nazareth National Bank. As a result of the merger, Keystone will be a larger, more diversified, well capitalized community savings bank with a management and operating structure that will draw from both the business strategies currently being used at Keystone and at Nazareth National Bank. KNBT Bancorp believes that the proposed merger offers unique operating and strategic benefits. Some of the keys to KNBT Bancorp’s operating strategy are summarized below.

• A stronger combined management team with increased experience, expertise and depth than either institution had individually.

• An enhanced branch network system with 36 branch offices located in Lehigh, Northampton, Monroe and Carbon Counties (which we refer to as the greater Lehigh Valley) with six new branch offices expected to be opened within the next 12 months.

• Increased deposit market share within the greater Lehigh Valley, particularly in Northampton and Lehigh Counties in which Keystone will have the largest and second largest, respectively, deposit market share upon completion of the merger. Overall, it is anticipated that Keystone will have the second largest deposit share in the greater Lehigh Valley.

• Focusing on increased lending to small to mid-sized businesses in the greater Lehigh Valley, which sector is believed to be underserved, especially by the super-regional banks that currently operate in the market.

• Continue to develop as a “relationship bank” offering a broad array of deposit and loan products as well as securities and insurance products and trust and wealth management services.

• Leverage capital efficiently through additional growth of loan and investment portfolios.

Keystone, as a Pennsylvania-chartered savings bank, will continue to be subject to comprehensive regulation and examination by the Pennsylvania Department of Banking, as its chartering authority and primary regulator, and by the Federal Deposit Insurance Corporation as its primary federal regulator. Keystone will be a member of the Federal Home Loan Bank of Pittsburgh, which is one of the 12 regional banks which comprise the Federal Home Loan Bank system. Keystone will be further subject to regulations of the Federal Reserve Board governing reserves required to be maintained against deposits and certain other matters. KNBT Bancorp will be a registered bank holding company and will be subject to examination and regulation by the Federal Reserve Board and subject to various reporting and other requirements of the Securities and Exchange Commission (which we refer to as the SEC).

3

The Offering Range in the Conversion Offering

Regulations of the Federal Deposit Insurance Corporation as well as the policy of the Pennsylvania Department of Banking require that, as part of its mutual to stock conversion, Keystone must sell to its depositors and others an amount of KNBT Bancorp common stock within an offering range established by an independent appraiser. An independent appraisal of Keystone’s pro forma market value has been prepared by RP Financial, LC., an independent appraisal firm experienced in appraisals of savings institutions. The pro forma market value is the estimated market value of Keystone assuming the sale of shares in the offering and the issue of merger exchange shares in the merger. RP Financial has estimated that, in its opinion as of May 30, 2003, the estimated market value of the common stock of KNBT Bancorp being offered for sale in the conversion offering was between $129.8 million and $175.7 million, with a midpoint of $152.8 million.

Subject to regulatory approval, KNBT Bancorp may increase the amount of common stock offered by up to approximately 15%. If this happens, it is referred to as a sale of shares at the maximum of the offering range “as adjusted,” meaning the maximum has been increased by 15%. Accordingly, at the maximum, as adjusted, of the offering range KNBT Bancorp is offering up to 20,201,188 shares in the conversion offering. The appraisal will be updated before the conversion is completed. If the pro forma market value of the common stock at that time is either below $129.8 million or above $202.0 million, KNBT Bancorp will notify subscribers, and subscribers will have the opportunity to confirm, modify or cancel their order. In such event, subscribers would be required to affirmatively confirm or modify their order within a specified period of time or else it would be cancelled. If KNBT Bancorp is unable to sell at least the number of shares at the minimum of the offering range (currently 12,983,750 shares), as the range may be amended, the conversion and offering would be terminated and all subscriptions would be cancelled and funds returned and the merger with First Colonial would not be completed. See “The Offering—How Keystone Determined the Price Per Share and the Offering Range” at page          for a description of the factors and assumptions used in determining the stock price and offering range.

Two measures that some investors use to analyze whether a stock might be a good investment are the ratio of the offering price to the issuer’s “book value” and the ratio of the offering price to the issuer’s annual net income. RP Financial considered these ratios, among other factors, in preparing its appraisal. Book value is the same as total equity and represents the difference between the issuer’s assets and liabilities. The percentage of KNBT Bancorp’s offering price of $10.00 per share to its pro forma book value per share ranges from 71.4% to 79.8% at March 31, 2003, and the offering price represents between 13.9 and 16.7 times its annualized pro forma per share earnings for the three-months ended March 31, 2003. See “Pro Forma Unaudited Financial Data—Additional Pro Forma Data” on page          for a description of the assumptions used in making these calculations.

See also “The Offering—How Keystone Determined the Price Per Share and the Offering Range” at page         .

Use of Net Proceeds from the Sale of KNBT Bancorp Common Stock

KNBT Bancorp will use the net proceeds from the conversion offering as follows:

Use of Net Proceeds	Amount, at the minimum		Amount, at the maximum		Percentage of net offering proceeds at the maximum
Loan to employee stock ownership plan	$	10,387,000	$	14,053,000	8.17	%
Repurchase of shares for recognition and retention plan	$	5,193,500	$	7,026,500	4.09	%
Purchase of Keystone common stock	$	63,286,498	$	85,988,203	50.00	%
General corporate purposes	$	47,705,997	$	64,908,702	37.74	%

4

The net proceeds received from the sale of shares of KNBT Bancorp common stock in the conversion offering will increase the capital of both KNBT Bancorp and Keystone. Half of the net proceeds from the conversion offering will be used by KNBT Bancorp to buy the common stock of Keystone upon its conversion from mutual to stock form. Keystone will use the portion of the cash proceeds it receives for general corporate purposes. The net proceeds received by Keystone will strengthen its capital position, which already exceeds all regulatory requirements, and will provide it with additional flexibility to grow and diversify in the future. The proceeds invested in Keystone may also be used to fund new loan growth and additional investments in investment securities and to other general corporate uses in furtherance of Keystone’s post-merger business strategy. The net proceeds received by Keystone may ultimately be used to finance the expansion of banking operations through acquisitions of other financial institutions or additional branch offices, although no such transactions are specifically being considered at this time other than the proposed merger with First Colonial.

A portion of the net proceeds from the conversion offering retained by KNBT Bancorp will be used to make a loan to its employee stock ownership plan in an amount sufficient to permit it to buy 8.0% of the shares sold in the conversion offering. The remaining portion of the net proceeds after the loan to the employee stock ownership plan and its purchase of Keystone’s common stock will be retained by KNBT Bancorp and will be available for general corporate purposes. KNBT Bancorp may initially use the remaining net proceeds to invest in deposits at Keystone, U.S. Government and federal agency securities of various maturities, federal funds, mortgage-backed securities, or a combination thereof. In addition, assuming shareholder approval of its proposed recognition and retention plan in the period between six months and one year after the conversion is completed, KNBT Bancorp intends to contribute sufficient funds to the trust so that it can purchase a number of shares equal to an aggregate of 4% of the common stock sold in the conversion offering. The net proceeds retained by KNBT Bancorp may ultimately be used to:

• support the operations of Keystone after its merger with Nazareth National Bank;

• support possible additional future expansion of Keystone, including the establishment of new branch offices or other facilities;

• invest in deposits at Keystone or securities; or

• fund repurchases of its common stock or serve as a source of possible payments of cash dividends.

The Amount of Stock That May Be Purchased In the Conversion Offering

Subscription purchases in the conversion offering may be made by certain depositors of Keystone as well as its officers, trustees and employees and its employee stock ownership plan. The minimum purchase is 25 shares. Generally, subscribers may purchase no more than 50,000 shares of common stock. The maximum amount of shares that a subscriber together with any “associate” or person that he or she is acting in concert with may purchase is 100,000 shares. For this purpose, an “associate” of a person includes:

• a person’s spouse or relatives of such person or such person’s spouse living in the same house,

• companies, trusts or other entities in which such person has a controlling interest or holds a specified position, or

• a trust or estate in which such person holds a substantial beneficial interest or serves in a fiduciary capacity.

KNBT Bancorp may decrease or increase the maximum purchase limitation without further notice. See “The Offering—Limitations on Common Stock Purchases” on page         .

5

How Orders in the Conversion Offering Will Be Prioritized

Subscribers in the conversion offering might not receive any or all of the shares they order. If KNBT Bancorp receives orders for more shares than are available, it will allocate stock to the following persons or groups.

Priority 1:	Eligible Account Holders (Keystone’s depositors with a balance of at least $50 at the close of business on December 31, 2001).
Priority 2:	KNBT Bancorp’s employee stock ownership plan.
Priority 3:	Supplemental Eligible Account Holders (Keystone’s depositors with a balance of at least $50 at the close of business on                  , 2003).
Priority 4:	Other Depositors (Keystone’s depositors with an account balance of at least $100 at the close of business on                  , 2003).
Priority 5:	Keystone’s trustees, officers and employees. These individuals also may be entitled to purchase stock in the above categories.

If the above persons do not subscribe for all of the shares offered in the conversion offering, KNBT Bancorp will offer the remaining shares to the general public, giving preference to persons who reside in the counties in which Keystone has a branch office. See “The Offering—Community Offering” on page             .

Subscription Rights Are Not Transferable

Depositors at Keystone and others who have subscription rights may not assign or sell their subscription rights. Any transfer of subscription rights is prohibited by law. If a Keystone depositor, trustee, officer or employee exercises subscription rights, he or she will be required to certify that shares are being purchased solely for the subscriber’s own account and that there is no agreement or understanding regarding the sale or transfer of shares. KNBT Bancorp intends to pursue any and all legal and equitable remedies if it learns of the transfer of any subscription rights. KNBT Bancorp will reject orders that it determines involve the transfer of subscription rights. See “The Offering—Restrictions on Transfer of Subscription Rights and Shares” on page             .

Benefits to Management from the Offering

Employees, officers, directors and trustees of KNBT Bancorp and Keystone will benefit from the offering due to the implementation of various stock-based benefit plans either adopted in connection with the offering or subsequent to its completion.

• Full-time employees (including officers) will be participants in the KNBT Bancorp employee stock ownership plan which will purchase shares of common stock in the conversion offering;

• Subsequent to completion of the conversion, KNBT Bancorp intends to implement a:

•• stock recognition and retention plan; and

•• stock option plan

which will benefit its employees and directors.

KNBT Bancorp’s employee stock ownership plan will buy shares of common stock offered in the conversion with a portion of the net proceeds received in the offering. The shares will be allocated to the employee participants in the employee stock ownership plan over a period of time at no cost to the employees.

The stock recognition plan and stock option plan will be implemented if KNBT Bancorp receives shareholder approval of the plans. Such approval cannot be obtained earlier than six months after the conversion. If

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the stock recognition and retention and stock option plans are approved by KNBT Bancorp shareholders, it intends to grant stock awards and options to its employees and directors. The stock awards will consist of shares of KNBT Bancorp common stock which will be issued at no cost to the recipients. The options will likewise be issued to directors and employees without cost to them but they will be required to pay the applicable exercise price at the time of exercise to receive the shares of common stock covered by the options.

You will find more information about KNBT Bancorp’s employee stock ownership plan and the stock recognition and retention and stock option plans by reading the section of this document entitled “Management—New Stock Benefit Plans” on page         .

The following table summarizes the stock benefits that directors, officers and employees may receive from the conversion at the midpoint of the offering range:

Plan	Individuals Eligible To Receive Awards	% of Shares Issued(1)		Number of Shares Based on Midpoint of Offering Range(2)	Value of Shares Based on Midpoint of Offering Range
Employee stock ownership plan	All full-time employees	4.93	%	1,222,000	$	12,220,000
Stock recognition plan	Directors, officers and selected employees	2.47		611,000		6,110,000
Stock option plan	Directors, officers and selected employees	6.16		1,527,000		—	(3)

(1) Reflects the amount of shares in the respective plan as a percentage of total issued and outstanding shares immediately subsequent to the conversion and merger including shares sold in the conversion offering at the mid-point of the offering range, shares contributed to the Keystone Nazareth Charitable Foundation and the issuance of merger exchange shares (assuming no options for First Colonial common stock are exercised prior to the closing of the conversion and merger).

(2) The shares purchased by the KNBT Bancorp employee stock ownership plan and stock recognition plan will equal 8.0% and 4.0%, respectively, of the amount of shares sold in the conversion offering and the stock option plan will reserve a number of shares equal to 10.0% of the shares sold in the conversion offering.

(3) Stock options will be granted with a per share exercise price at least equal to the market price of KNBT Bancorp common stock on the date of grant. The value of a stock option will depend upon increases, if any, in the price of KNBT Bancorp common stock during the term of the stock option.

Establishment of the Keystone Nazareth Charitable Foundation and Contribution of Shares to It

KNBT Bancorp intends to establish a charitable foundation, the Keystone Nazareth Charitable Foundation, as part of Keystone’s conversion. Shares equal to 8% of the number of shares of KNBT Bancorp common stock sold in the conversion offering, with an initial value of $10.4 million to $14.1 million assuming the contribution of 1,038,700 shares to 1,405,300 shares, will be contributed to the foundation. Assuming the sale of shares at the maximum of the offering range, the contribution of 1,405,300 shares to the foundation and the issuance of 8,287,486 merger exchange shares, KNBT Bancorp will have 27,259,036 shares of common stock issued and outstanding, of which the foundation will own approximately 5.16%. The foundation is being formed as a complement to Keystone’s existing community service activities, including its existing charitable foundation. By funding the foundation with shares of KNBT Bancorp common stock at this time, KNBT Bancorp believes that the foundation will benefit by participating in its growth as a publicly traded company.

The issuance of shares of common stock to the foundation will:

• dilute the voting interest of purchasers of KNBT Bancorp common stock in the conversion offering as well as the voting interest of the merger exchange shares;

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• result in a estimated $12.2 million pre-tax expense (assuming the contribution of 1,222,000 shares based on the conversion offering closing at the mid-point of the offering range) and a reduction in earnings, which will be offset in part by a corresponding tax benefit, during the quarter in which the contribution is made; and

• reduce KNBT Bancorp’s pro forma market value and the number of shares offered for sale.

See “Risk Factors—The Establishment of the Keystone Nazareth Charitable Foundation Will Negatively Impact Profits for the Year Ended December 31, 2003” (page         ), “Comparison of Independent Valuation and Pro Forma Financial Information With and Without the Foundation” (page         ) and “The Conversion and the Merger—Establishment of the Keystone Nazareth Charitable Foundation” (page         ).

Federal and State Income Tax Consequences of the Conversion and the Merger

KNBT Bancorp has received an opinion from its federal income tax counsel, Elias, Matz, Tiernan & Herrick L.L.P., that, under federal income tax law and regulation, the tax basis to the shareholders of the common stock purchased in the conversion will be the amount paid for the common stock, and that the conversion will not be a taxable event for KNBT Bancorp. This opinion, however, is not binding on the Internal Revenue Service. KNBT Bancorp also has received an opinion from Grant Thornton LLP that the conversion will not be a taxable event for it under Pennsylvania income tax laws, see “The Conversion and the Merger—Tax Aspects” (page         ). The full texts of the opinions are filed as exhibits to the Registration Statement of which this document is a part, and copies may be obtained from the SEC. See “Additional Information” on page         .

KNBT Bancorp’s federal tax counsel, Elias, Matz, Tiernan & Herrick L.L.P., believes that it is more likely than not that the nontransferable subscription rights to purchase common stock have no value. If the Internal Revenue Service determines that subscription rights have an ascertainable value, a subscriber may be taxed in the amount equal to the value of those rights.

Elias, Matz, Tiernan & Herrick L.L.P. has also issued an opinion that the merger will constitute a “reorganization” within the meaning of Section 368(a) of the Internal Revenue Code and accordingly, neither KNBT Bancorp nor First Colonial will recognize any taxable gain or loss as a result of the merger. See “The Conversion and The Merger—Tax Aspects” (page         ).

RISK FACTORS

In addition to the other information in this document, you should consider carefully the following risk factors.

KNBT Bancorp’s Success Depends in Part on the Success of the Merger

The merger with First Colonial will be KNBT Bancorp’s first attempted merger. The future growth and profitability of KNBT Bancorp will depend, in part, on its ability to successfully complete the merger with First Colonial which will, in turn, depend, on a number of factors, including:

• Keystone’s ability to integrate Nazareth National Bank’s branches into the current operations of Keystone;

• KNBT Bancorp’s ability to limit the outflow of deposits held by customers in Nazareth National Bank’s branches;

• KNBT Bancorp’s ability to control the non-interest expense resulting from the merger in a manner that enables it to improve its overall operating efficiencies (which merger related expenses to be recognized directly following the merger are expected to be approximately $5.1 million, pre-tax); and

• its ability to retain and integrate the appropriate personnel of Nazareth National Bank into its operations.

There can be no assurance that KNBT Bancorp will be able to integrate Nazareth National Bank successfully, that it will be able to achieve results in the future similar to those achieved by Keystone in the past, or

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that it will be able to manage the growth resulting from the merger effectively. See “Pro Forma Unaudited Financial Information” on page         .

Market Rates of Interest Could Hurt Profitability

Market rates of interest are at historically low levels. The low levels of market rates of interest generally have reduced the yields earned by financial institutions, including Keystone and Nazareth National Bank, on interest-earning assets such as loans and investment securities. Keystone’s average yield on its interest-earning assets was 5.93% during the three months ended March 31, 2003 compared to 6.41% and 7.19% for the years ended December 31, 2002 and 2001, respectively. Similarly, First Colonial’s average yield on its interest-earning assets was 5.48% for the three months ended March 31, 2003 compared to 6.24% and 7.36% for the years ended December 31, 2002 and 2001, respectively. In addition, many institutions, including First Colonial, have experienced a narrowing or “compression” of their net interest spread (the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities) and net interest margin (net interest income as a percentage of average interest-earning assets) and further reductions in market rates of interest would be expected to further narrow the net interest spread. First Colonial’s net interest spread was 3.01% for the three months ended March 31, 2003 compared to 3.27% and 3.46% for the years ended December 31, 2002 and 2001, respectively. First Colonial’s net interest margin was 3.35% for the three months ended March 31, 2003 compared to 3.71% and 4.04% for the years ended December 31, 2002 and 2001, respectively. In addition, a sudden increase in market rates of interest could adversely affect net income because the average yields earned on interest-earning assets at both Keystone and First Colonial adjust more slowly than the average rates paid on interest-bearing liabilities. In the event of an immediate and sustained 300 basis point increase in interest rates, Keystone’s net portfolio value (the present value of expected cash flows from assets, liabilities and off-balance sheet contracts) would decrease by 54.9% while First Colonial’s net portfolio value would decrease by 3.3%

Concentration of Loans

At March 31, 2003, the preponderance of Keystone’s and Nazareth National Bank’s total loans were to individuals and/or secured by properties located in the greater Lehigh Valley. Both Keystone’s and Nazareth National Bank’s loan diversification outside of the greater Lehigh Valley were insignificant at such date. As a result, KNBT Bancorp may have a greater risk of loan defaults and losses in the event of an economic downturn in its primary market area.

KNBT Bancorp’s Loan Portfolio Will Include Loans With a Higher Risk of Loss

In recent years, Keystone has significantly increased its construction and land development loans, commercial real estate loans and consumer loans, both in terms of dollar amounts and as a percentage of its loan portfolio. Likewise, First Colonial has also been actively increasing its investment in commercial real estate, commercial business and consumer loans. KNBT Bancorp’s strategy after the merger is to continue to grow its portfolio of these types of loans, especially in view of its merger with First Colonial. These loans have a higher risk of default and loss than single-family residential mortgage loans. The aggregate of Keystone’s commercial real estate loans, commercial business loans, construction and land development loans and consumer loans have increased from $143.8 million or 24.2 % of its total loan portfolio at December 31, 1998 to $267.1 million or 47.7% of the total loan portfolio at March 31, 2003. First Colonial’s commercial real estate, commercial business and consumer loans have also increased during the same period, increasing from $80.7 million or 37.8% of the total loan portfolio at December 31, 1998 to $143.0 million or 56.6% at March 31, 2003. At the same time, both the dollar amount and the percentage of the loan portfolio comprised of single-family residential mortgage loans has significantly decreased. Single-family residential mortgage loans held by Keystone have decreased from $445.6 million or 74.8% of its total loan portfolio at December 31, 1998 to $288.0 million or 51.4% at March 31, 2003. First Colonial’s investment in such loans has also declined slightly from $119.9 million or 56.2% of the total loan portfolio at December 31, 1998 to $101.8 million or 40.3% at March 31, 2003. Construction and land development loans and commercial real estate loans all generally have a higher risk of loss than single-family residential mortgage loans because repayment of the loans often depends on the successful operation of a business or the underlying property. Consumer loans also are considered to generally involve greater risk of default than single-family residential mortgage loans because they often are secured by rapidly depreciating assets or are unsecured.

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KNBT Bancorp’s Low Return on Equity May Cause Its Common Stock Price to Decline

Net earnings divided by average equity, known as “return on equity,” is a ratio many investors use to analyze the performance of a financial institution. Keystone’s return on equity was 10.5% for the three months ended March 31, 2003 and 11.5%, 8.8% and 9.3% for the years ended December 31, 2002, 2001 and 2000, respectively. These returns are lower than returns on equity for many comparable publicly traded bank holding companies. KNBT Bancorp expects its return on equity to remain low in view of its expected capital level upon completion of the conversion and the merger until it is able to increase its interest-earning assets, thereby increasing net interest income, and increase the level of its non-interest income. The net proceeds from the conversion and the offering, which may be as much as $198.1 million, will significantly increase KNBT Bancorp’s shareholders’ equity. Because of KNBT Bancorp’s increased shareholders’ equity following the conversion and the merger, its initial returns on equity are expected to be even more negatively impacted as compared to peers. On a pro forma basis and based on net income for the three months ended March 31, 2003 on an annualized basis, KNBT Bancorp’s return on equity assuming shares are sold at the maximum of the offering range, would be approximately 4.7%.

An Increase in the Offering Range Would Be Dilutive

KNBT Bancorp can increase the maximum of the offering range by up to approximately 15% to reflect changes in market or financial conditions. Initially, an increase in the offering will decrease KNBT Bancorp’s net income per share and its shareholders’ equity per share. Based on data for the three months ended March 31, 2003, if the maximum of the offering range is increased, KNBT Bancorp’s pro forma net income per share would be $0.15 compared to $0.16 at the maximum of the offering range. If the maximum of the offering range is increased by approximately 15%, its pro forma shareholders’ equity per share at March 31, 2003 would be $12.53 compared to $12.97 at the maximum of the offering range. An increase in the offering range would increase the price per share paid by subscribers in the conversion offering as a percentage of pro forma shareholders’ equity per share.

KNBT Bancorp Will Have Broad Discretion Over the Use of the Proceeds From the Conversion Offering

Although KNBT Bancorp expects to use the net proceeds of the conversion offering to fund a loan to its employee stock ownership plan, to purchase shares of common stock to fund the stock recognition and retention plan and to purchase all of the stock of Keystone, it does not have a specific plan for the use of the remainder of the net proceeds. KNBT Bancorp’s management will have broad discretion with respect to the use of the net proceeds. KNBT Bancorp expects to use the remainder of the net proceeds for general corporate purposes which may include, among other things, purchasing investment securities, funding new loans and further expanding its banking operations.

KNBT Bancorp Common Stock Value May Suffer from Anti-Takeover Provisions That May Impede Potential Takeovers that Management Opposes

Provisions in KNBT Bancorp’s corporate documents and in Pennsylvania corporate law, as well as certain federal regulations, may make it difficult and expensive to pursue a tender offer, change in control or takeover attempt that its board of directors opposes. As a result, KNBT Bancorp shareholders may not have an opportunity to participate in such a transaction, and the trading price of KNBT Bancorp common stock may not rise to the level of other institutions that are more vulnerable to hostile takeovers. Provisions in KNBT Bancorp’s articles of incorporation and bylaws provide, among other things,

• no person can acquire or offer to acquire more than 10% of the issued and outstanding shares of any class of equity securities of KNBT Bancorp;

• that any merger or similar transaction be approved by a super-majority vote of shareholders unless it has previously been approved by at least two-thirds of its directors;

• that its board of directors is divided into classes with only one-third of directors standing for reelection each year;

• that special meetings of shareholders may be called only by the board of directors of KNBT Bancorp;

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• that shareholders generally must provide advance notice of shareholder proposals and director nominations and provide specified related information; and

• that the board of directors of KNBT Bancorp has the authority to issue shares of authorized but unissued common stock and preferred stock and to establish the terms of any one or more series of preferred stock, including voting rights, without additional shareholder approval.

Provisions of the Pennsylvania Business Corporation Law (which we refer to as the PBCL) applicable to KNBT Bancorp as well as its articles of incorporation provide, among other things, that it may not engage in a business combination with an “interested shareholder” (generally a holder of 20% or more of its voting stock) during the five-year period after the interested shareholder became such except under certain specified circumstances. The PBCL also contains provisions providing for the ability of shareholders to object to the acquisition by a person or group of persons acting in concert of 20% or more of its outstanding voting securities and to demand that they be paid a cash payment for the fair value of their shares from the controlling person or group. In addition, there are various regulatory restrictions on takeovers of KNBT Bancorp and Keystone. See “Restrictions on Acquisition of KNBT Bancorp and Keystone and Related Anti-Takeover Provisions” at page         .

These provisions also will make it more difficult for an outsider to remove the current board of directors or management of KNBT Bancorp. See “Restrictions on Acquisition of KNBT Bancorp and Keystone and Related Anti-Takeover Provisions” for a description of anti-takeover provisions in its corporate documents and under Pennsylvania law and federal regulations.

The persons serving and expected to serve as KNBT Bancorp’s directors and executive officers under completion of the merger have indicated that they intend to purchase approximately 446,000 shares of KNBT Bancorp common stock in the conversion offering. In addition, such directors and executive officers are expected to receive an aggregate of 319,961 merger exchange shares which, when added to the amount of shares expected to be subscribed for, will mean that such persons may own up to an aggregate of 815,961 shares or 3.29% of the shares of KNBT Bancorp to issued and outstanding upon completion of the conversion and merger (based upon the mid-point of the offering range). In addition, KNBT Bancorp’s employee stock ownership plan is expected to purchase 8.0% of the shares sold in the conversion offering, or 1,222,000 shares based upon the mid-point of the offering range. The amount of shares owned by the KNBT Bancorp employee stock ownership plan when added to the number of shares expected to be owned by directors and executive officers of KNBT Bancorp upon completion of the conversion and merger will total up to an aggregate of 1,987,961 shares of KNBT Bancorp common stock or 8.02% of the issued and outstanding shares (based upon the mid-point of the offering range).

During the conversion process, regulations prohibit any person from offering, or making and announcing of an intent to offer, to purchase subscription rights or common stock. In addition, KNBT Bancorp as a bank holding company, will be subject to the provisions of the Change in Bank Control Act and the Bank Holding Company Act which provide that no person or company, acting directly or indirectly, can acquire control of a bank holding company unless he or it has received the prior approval of the Federal Reserve Board. See “Restrictions on Acquisition of KNBT Bancorp and Keystone and Related Anti-Takeover Provisions—Regulatory Restrictions” for a discussion of the provisions and applicable Federal Reserve Board regulations regarding acquisitions.

KNBT Bancorp’s Employee Stock Benefit Plans Will Increase Its Costs

KNBT Bancorp anticipates that its employee stock ownership plan will purchase 8.0% of the aggregate common stock sold in the conversion (not including the shares contributed to the Keystone Nazareth Charitable Foundation or merger exchange shares) with funds borrowed from KNBT Bancorp. The cost of acquiring the employee stock ownership plan shares will be between $10.4 million at the minimum of the offering range and approximately $16.2 million at the adjusted maximum of the offering range. KNBT Bancorp will record annual employee stock ownership plan expenses in an amount equal to the fair value of shares committed to be released to employees. If shares of common stock appreciate in value over time, compensation expense relating to the employee stock ownership plan will increase. KNBT Bancorp also intends to submit a stock recognition and retention plan to its shareholders for approval at least six months after completion of the conversion. KNBT Bancorp’s officers, employees and directors could be awarded (at no cost to them) under the stock recognition plan

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up to an aggregate of 4.0% of the shares sold in the conversion offering. Assuming the shares of common stock to be awarded under the stock recognition and retention plan cost the same as the purchase price in the conversion, the reduction in KNBT Bancorp’s net income from the plan would be between $1.0 million and $1.6 million a year at the minimum and maximum, as adjusted, of the offering range, respectively. See “Pro Forma Unaudited Financial Information-Additional Pro Forma Data” for a discussion of the increased benefit costs KNBT Bancorp will incur after the conversion and how these costs could decrease its return on equity.

KNBT Bancorp’s Employee Stock Benefit Plans May Be Dilutive

If the conversion is completed and shareholders subsequently approve a stock recognition and retention plan and a stock option plan, KNBT Bancorp will allocate stock to its officers, employees and directors through these plans. If the shares for the stock recognition and retention plan are issued from its authorized but unissued stock, the ownership percentage of outstanding shares of KNBT Bancorp could be diluted by approximately 2.51% (taking into account the merger exchange shares and assuming the conversion offering closes at the maximum of the offering range). However, it is KNBT Bancorp’s intention to repurchase shares of its common stock in the open market to fund the stock recognition plan. Assuming the shares of common stock to be awarded under the stock recognition plan are repurchased at a price equal to the offering price in the conversion, the reduction to shareholders’ equity from the stock recognition and retention plan would be between $5.2 million and $8.1 million at the minimum and the maximum, as adjusted, of the offering range. The ownership percentage of KNBT Bancorp shareholders would also decrease by approximately 6.05% if all potential stock options under the proposed KNBT Bancorp stock option plan are exercised and shares issued from authorized but unissued stock (taking into account the merger exchange shares and assuming the conversion offering closes at the maximum of the offering range). In addition, options to purchase shares of First Colonial common stock that remain unexercised upon completion of the merger will be converted into options to purchase KNBT Bancorp common stock. At March 31, 2003, options to purchase 289,031 shares of First Colonial common stock were outstanding. Assuming that none of these are exercised prior to completion of the merger, such options will become options to purchase 1,069,436 shares of KNBT Bancorp common stock. If all such options were exercised, the ownership interest of KNBT Bancorp shareholders would be diluted by an additional 3.77% (assuming the conversion offering closes at the maximum of the offering range). See “Pro Forma Unaudited Financial Information-Additional Pro Forma Data” for data on the dilutive effect of the stock recognition and retention plan and the stock option plan and “Management—New Stock Benefit Plans” for a description of the plans.

Subscribers Who Purchase Shares In the Conversion Offering Will Have Their Interests Diluted By the Issuance of Merger Exchange Shares

Upon completion of the merger, each issued and outstanding share of First Colonial common stock will be converted into 3.7 shares of KNBT Bancorp common stock or an aggregate of 9,355,928 shares assuming all outstanding First Colonial options have been exercised. The issuance of the merger exchange shares would dilute the interests of purchasers in the conversion offering by approximately 41.8% and 32.9% at the minimum and the maximum, as adjusted, respectively, of the offering range.

The Valuation Is Not Indicative of the Future Price of KNBT Bancorp Common Stock

There can be no assurance that shares of KNBT Bancorp common stock will be able to be sold in the market at or above the $10.00 per share initial offering price in the future. The final aggregate purchase price of the common stock in the conversion will be based upon an independent appraisal. The appraisal is not intended, and should not be construed, as a recommendation of any kind as to the advisability of purchasing shares of common stock or accepting merger exchange shares in the proposed merger with First Colonial. The valuation is based on estimates and projections of a number of matters, all of which are subject to change from time to time. See “The Offering—How Keystone Determined the Price Per Share and the Offering Range” for the factors considered by RP Financial in determining the appraisal.

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There is No Guarantee That an Active Trading Market for KNBT Bancorp Common Stock Will Develop; No Determination Has Been Made As to Dividends

Because KNBT Bancorp has never issued stock, there is no current trading market for its common stock. Consequently, KNBT Bancorp cannot assure or guarantee that an active and liquid trading market for its common stock will develop or that, if developed, will continue. An active and liquid trading market will depend on the existence and individual decisions of willing buyers and sellers at any given time over which neither KNBT Bancorp nor any market maker will have any control. If an active trading market does not develop or is sporadic, this may hurt the market value of KNBT Bancorp’s common stock and make it difficult to buy or sell shares on short notice. While KNBT Bancorp intends to consider a policy of paying dividends after the conversion, no determination on the payment of dividends has been made. No assurance can be given that any dividends will be paid by KNBT Bancorp.

The Establishment of the Keystone Nazareth Charitable Foundation Will Negatively Impact KNBT Bancorp’s Profits for the Year Ending December 31, 2003.

KNBT Bancorp intends to contribute to the Keystone Nazareth Charitable Foundation shares equal to 8% of the number of shares of common stock sold in the conversion offering. This contribution will negatively impact net earnings during the year in which the contribution is made, which is expected to be 2003. Based on the pro forma assumptions, the contribution to the Keystone Nazareth Charitable Foundation would reduce KNBT Bancorp’s net earnings by up to $10.2 million, after tax, in 2003.

KNBT Bancorp Believes That Subscription Rights Have No Value and That Subscibers’ Tax Basis in KNBT Bancorp Common Stock Will Be the Purchase Price, But the Internal Revenue Service May Disagree

KNBT Bancorp’s federal tax counsel, Elias, Matz, Tiernan & Herrick L.L.P., has opined that it is more likely than not that the nontransferable subscription rights to purchase common stock have no value. If the Internal Revenue Service determines that subscription rights have ascertainable value, subscribers could be taxed for an amount equal to the value of those rights.

Strong Competition Within the Market Area

Competition in the banking and financial services industry is intense. In the greater Lehigh Valley, both Keystone and Nazareth National Bank compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Many of these competitors have substantially greater resources and lending limits than Keystone or Nazareth National Bank, either individually or on a combined basis, and may offer certain services that Keystone does not or will not provide. The profitability of Keystone depends upon its continued ability to successfully compete in its market area.

KNBT Bancorp’s Contribution to the Keystone Nazareth Charitable Foundation will Dilute the Ownership Interests of Other Shareholders

KNBT Bancorp intends to contribute shares of its common stock to the Keystone Nazareth Charitable Foundation, a newly formed charitable foundation organized by Keystone in connection with the conversion. It is expected that KNBT Bancorp will contribute shares of its common stock equal to 8.0% of the shares sold in the conversion offering to the foundation upon completion of the conversion. Assuming the conversion offering closes at the maximum of the offering range, the contribution would equal 1.4 million shares, with a value of $14.1 million. As a result of such contribution, other shareholders of KNBT Bancorp, including those receiving merger exchange shares, would have their ownership interests diluted by approximately 5.2% (assuming 8,287,486 merger exchange shares are issued and the conversion offering closes at the maximum of the offering range).

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FORWARD LOOKING STATEMENTS

This document contains forward-looking statements, which can be identified by the use of such words as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and similar expressions. These forward-looking statements include:

• statements of goals, intentions and expectations;

• statements regarding prospects and business strategy;

• statements regarding asset quality and market risk; and

• estimates of future costs, benefits and results.

These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following important factors that could affect the actual outcome of future events:

• factors discussed under the caption “Risk Factors” beginning on page _;

• KNBT Bancorp’s ability to successfully complete its merger with First Colonial and integrate their operations;

• changes in demand for loans, deposits and other financial services in KNBT Bancorp’s market area;

• changes in interest rates;

• changes in general economic conditions;

• changes in the monetary and fiscal policies of the U.S. Government;

• legislative or regulatory changes that adversely affect KNBT Bancorp’s business;

• changes in KNBT Bancorp’s asset quality;

• changes in accounting policies and practices, as may be adopted by the bank regulatory agencies and the Financial Accounting Standards Board; and

• changes in KNBT Bancorp’s organization, compensation and benefit plans.

Because of these and other uncertainties, KNBT Bancorp’s actual future results may be materially different from the results indicated by these forward-looking statements. KNBT Bancorp has no obligation to update or revise any forward-looking statements to reflect any changed assumptions, any unanticipated events or any changes in the future.

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OPERATING STRATEGY OF KNBT BANCORP, INC.

KNBT Bancorp will be the parent bank holding company for Keystone. Substantially simultaneously with the mutual-to-stock conversion of Keystone, First Colonial will merge with and into KNBT Bancorp and Nazareth National Bank will merge with and into Keystone. The combined bank will be known as “Keystone Nazareth Bank & Trust Company.” As a result of this merger between the two banks, Keystone will be a larger, more diversified, well capitalized community savings bank with a management and operating structure that will draw from both the models currently used at the two banks. Certain keys of KNBT Bancorp’s proposed operating strategy are outlined below.

• Strong Management Team. KNBT Bancorp will be under the direction of its Board of Directors which will be comprised of nine current trustees of Keystone, including Jeffrey P. Feather who will serve as Chairman of the Board, and six current directors of First Colonial and Nazareth National Bank. KNBT Bancorp’s directors will be comprised of community leaders in northeastern Pennsylvania who bring significant experience and business contacts. The officers of Keystone after the conversion and merger also will be comprised of representatives from both banks and will include Scott Fainor, the current President and Chief Executive Officer of First Colonial and Nazareth National Bank, who will serve as President and Chief Executive Officer, and Eugene T. Sobol, currently Executive Vice President, Chief Operating Officer and Treasurer of Keystone, who will be Senior Executive Vice President and Chief Operating Officer.

• Expanded Branch Network. The combined bank will have 36 offices covering Lehigh, Northampton, Monroe and Carbon Counties, Pennsylvania. No office closings are planned in connection with the merger. In addition, KNBT Bancorp will proceed with the three additional in-store supermarket branch offices as currently planned by Keystone as well as three new branch offices currently proposed by Nazareth National Bank. The combined institution also will have over 45 ATMs in the region. KNBT Bancorp believes that the expanded branch network will bring enhanced convenience to its customers in the greater Lehigh Valley.

• Stronger Market Share. Based on deposit data as of June 30, 2002, Keystone had the third largest market share in Northampton County, with a 12.3% deposit market share, while Nazareth National Bank had the fifth largest market share in Northampton County, with a 9.6% market share at such date. Combined, the two banks would have the largest market share in Northampton County with approximately 21.9% of all deposits. In Lehigh County, Keystone’s current position of second largest market share, with a 7.2% deposit market share, again based on deposit data as of June 30, 2002, will be solidified by the addition of Nazareth National Bank’s deposits which constituted 0.5% of that county’s deposit market share at such date. Nazareth National Bank has five branch offices and a 5.1% deposit market share in Monroe County, Pennsylvania, where Keystone currently has no offices. Keystone has one branch office in Carbon County with a 4.3% deposit market share while Nazareth National Bank currently has no offices in Carbon County, Pennsylvania. Combined, the two banks will have a stronger market share in the greater Lehigh Valley which, KNBT Bancorp believes, will facilitate its efforts to attract and retain additional customer relationships.

• Focus on Increased Business and Commercial Lending Opportunities. While Keystone expects to continue its strong origination efforts for single-family residential mortgage loans, KNBT Bancorp believes that there is significant opportunity in the greater Lehigh Valley for increased lending to small to mid-sized businesses that are looking for alternatives to the super-regional banks that currently compete in the market. KNBT Bancorp also believes that its local decisionmaking together with the better customer service and convenience that it expects, will be incentives for more business customers to seek its banking services. KNBT Bancorp will draw on the resources of both banks to create what it believes will be a stronger, combined lending function. David Kennedy, currently Senior Vice President of Commercial Lending at Nazareth National Bank, will be the Senior Vice President, Corporate Banking/Government Banking and Commercial Real Estate. Mr. Kennedy will focus on commercial loans to companies with annual revenues of at least $10.0 million and non-owner occupied commercial real estate loans. Mr. Kennedy has over 20 years of banking experience, all in the Lehigh Valley. James Higgins, currently Senior Vice President, Commercial Lending at Keystone, will be Senior Vice President, Private Banking/Commercial and Small Business Banking. Mr. Higgins, who has over 19 years banking experience in Pennsylvania including the

15

last nine years in the Lehigh Valley, will concentrate on business and commercial lending relationships to companies with annual revenues under $10.0 million as well as private banking for high net worth individuals. Karen Whitehill, currently Senior Vice President, Retail Lending at Keystone, will be Senior Vice President, Retail/Mortgage Banking. Ms. Whitehill, who has over 29 years of banking experience including 28 years with Keystone, will continue to focus on single-family residential lending, single-family builder/developer loans and consumer loans. Thomas Bamberger, currently Senior Loan Officer at Nazareth National Bank, will serve as Executive Vice President and Chief Credit Policy Officer. Mr. Bamberger, who has 36 years of banking experience including 21 years in the Lehigh Valley, will focus on ensuring continued high levels of credit quality at the combined bank.

• Being a “Relationship Bank.” KNBT Bancorp’s goal will be to provide a wide range of banking services that will permit Keystone to be known as a “relationship bank.” It is anticipated that the complementary nature of the geographic markets served by Keystone and Nazareth National Bank and the business products and employee skills will result in greater efficiencies as products are cross-marketed and offered to a wider, combined customer base. KNBT Bancorp is excited about the opportunity to offer securities and insurance products to Nazareth National Bank’s current customers through the brokerage services currently maintained by Keystone. Similarly, KNBT Bancorp will continue the trust services offered by Nazareth National Bank but not currently available to customers of Keystone. KNBT Bancorp will provide its customers the availability of securities and insurance brokerage and trust and personal wealth management services at the combined institution. KNBT Bancorp believes the combined bank will offer greater opportunities to cross-sell products and services.

• Leverage Capital Efficiently. Upon consummation of the conversion and the merger, KNBT Bancorp will have total assets of $1.9 billion and stockholders’ equity of $353.7 million (based on financial data at March 31, 2003 and assuming the conversion offering closes at the mid-point of the offering range). The increase in size will permit additional leveraging of KNBT Bancorp’s balance sheet to facilitate additional growth. In addition, the increase in capital will raise KNBT Bancorp loan-to-one borrower limit and facilitate KNBT Bancorp ability to make larger commercial and business loans. It is anticipated that Keystone’s current loan-to-one borrower limit of approximately $16.0 million will be increased to at least $46.9 million as a result of the conversion and merger. Nevertheless, KNBT Bancorp expects that it will continue to concentrate on loans ranging from $500,000 to $2.5 million and, in any event, will continue to maintain high credit quality by emphasizing sound underwriting and credit quality control.

Keystone is a community based, Pennsylvania chartered mutual savings bank which was organized in 1925. Keystone, which is headquartered in Bethlehem, Pennsylvania, offers its banking services primarily in Lehigh, Northampton and Carbon Counties, Pennsylvania. Nazareth National Bank, which was originally chartered in 1897, offers a full service commercial and consumer banking and trust business. Nazareth National Bank is headquartered in Nazareth, Pennsylvania and its primary market area is comprised of Northampton, Lehigh and Monroe Counties, Pennsylvania. In recent years, Keystone began a transition of its operations from a traditional thrift to those of a full service community bank. Such efforts included the hiring of two commercial lending officers with significant experience in the Lehigh Valley. Similarly, Nazareth National Bank has increased its commercial and business lending activities in recent periods. In January 2002, Scott Fainor, who has over 24 years of experience as a banker including service as the President of the Lehigh Valley region of a large super-regional bank, was hired as the new President and Chief Executive Officer of Nazareth National Bank. Both Keystone and Nazareth National Bank were, in many respects, pursuing a similar business strategy of being full service community banks in the Lehigh Valley and surrounding areas. Keystone and First Colonial believe that by combining their operations they will accelerate their ability to more effectively compete as a full service locally based community bank. KNBT Bancorp believes that it has a significant opportunity on a combined basis to be a community bank offering a full range of business and consumer banking products. KNBT Bancorp expects to offer its customers an alternative to the super regional banks in its market area with its local decision making, convenient, full service branch network and its commitment to quality customer service.

16

SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA OF KEYSTONE

The following selected financial and other data of Keystone does not purport to be complete and is qualified in its entirety by the more detailed financial information contained elsewhere in this document. The statement of operations as of and for the three-months ended March 31, 2003 and 2002, are unaudited and are derived from our interim condensed consolidated financial statements. The statement of operations and balance sheet data for the years ended and as of December 31, 2002, 2001, 2000, 1999 and 1998 are derived from Keystone’s audited consolidated financial statements. In the opinion of Keystone’s management, financial information at March 31, 2003 and for the three months ended March 31, 2003 and 2002 reflect all adjustments (consisting only of normal recurring accruals) which are necessary to present fairly the results for such periods. Results for the three-month period ended March 31, 2003 may not be indicative of results for the year ending December 31, 2003.

	At March 31, 2003		At December 31,
			2002		2001		2000		1999		1998
	(Dollars in Thousands)
Selected Financial and Other Data:
Total assets	$	1,039,659	$	1,015,906	$	922,045	$	824,736	$	773,953	$	716,549
Cash and cash equivalents		49,781		86,293		51,844		28,880		35,798		33,375
Investment securities:
Held-to-maturity		—		—		—		—		—		56,796
Available-for-sale		400,154		294,150		156,785		114,077		103,092		39,449
Loans receivable, net		532,425		579,322		668,046		657,107		611,108		565,259
Deposits		797,361		771,825		772,226		713,520		665,369		625,134
FHLB advances and other borrowings		113,513		122,404		46,252		14,629		25,000		14,950
Retained earnings, substantially restricted		114,295		111,049		95,788		86,204		78,687		70,664
Full service offices		19		19		16		16		15		15

	Three Months Ended March 31,						Year Ended December 31,
	2003			2002			2002			2001			2000			1999			1998
	(Dollars in Thousands)
Selected Operating Data:
Total interest income	$	14,139		$	14,927		$	59,479		$	60,493		$	57,603		$	52,181		$	50,291
Total interest expense		5,303			7,155			26,416			34,064			31,141			26,846			27,989
Net interest income		8,836			7,772			33,063			26,429			26,462			25,335			22,302
Provision (recovery) for loan losses		62			(445	)		111			391			442			421			281
Net interest income after provision (recovery) for loan losses		8,774			8,217			32,952			26,038			26,020			24,914			22,021
Total non-interest income(1)		2,181			2,643			8,814			5,013			3,214			2,955			2,048
Total non-interest expense		6,906			5,182			24,568			19,613			17,999			16,372			15,453
Income before income taxes		4,049			5,678			17,198			11,438			11,235			11,497			8,616
Income taxes		1,100			1,782			5,188			3,326			3,718			3,898			3,317
Net income	$	2,949		$	3,896		$	12,010		$	8,112		$	7,517		$	7,599		$	5,299
Selected Operating Ratios(2):
Average yield on interest-earning assets		5.93	%		6.78	%		6.41	%		7.19	%		7.36	%		7.19	%		7.31	%
Average rate on interest-bearing liabilities		2.48			3.60			3.22			4.50			4.49			4.15			4.65
Average interest rate spread(3)		3.45			3.18			3.19			2.69			2.87			3.04			2.66
Net interest margin(3)		3.70			3.53			3.57			3.14			3.38			3.50			3.24
Average interest-earning assets to average interest-bearing liabilities		111.51			110.85			113.15			111.26			112.82			111.68			114.37
Net interest income after provision for loan losses to noninterest expense		127.05			158.57			134.13			132.76			144.56			152.17			142.50
Total non-interest expense to average assets		2.74			2.24			2.56			2.24			2.25			2.20			2.22
Efficiency ratio(4)		62.68			49.76			58.67			62.38			60.65			57.87			63.46
Return on average assets		1.17			1.69			1.25			0.92			0.94			1.02			0.76
Return on average equity		10.46			15.88			11.46			8.79			9.27			9.93			7.79
Average equity to average assets		11.19			10.61			10.91			10.52			10.14			10.30			9.75

(Footnotes on next page)

17

	At or For the Three  Months Ended March 31,				At or For the Year Ended December 31,
	2003		2002		2002		2001		2000		1999		1998
Asset Quality Ratios(5):
Non-performing loans as a percent of total loans(6)	0.36	%	0.23	%	0.41	%	0.38	%	0.11	%	0.24	%	0.17	%
Non-performing assets as a percent of total assets(6)	0.20		0.21		0.26		0.31		0.12		0.27		0.15
Allowance for loan losses as a percent of non-performing loans	133.32		207.98		117.31		125.87		418.17		195.15		298.00
Net charge-offs to average loans	0.05		0.02		0.10		0.06		0.04		0.05		0.02
Capital Ratios(5):
Tier 1 leverage ratio	10.78	%	10.50	%	10.78	%	10.50	%	10.45	%	9.97	%	10.08	%
Tier 1 risk-based capital ratio	18.44		18.39		18.19		17.09		16.99		16.67		16.87
Total risk-based capital ratio	18.89		18.91		18.69		17.71		17.65		17.34		17.58

(1) For the three months ended March 31, 2003 and 2002 and for the years ended December 31, 2002, 2001, 2000 and 1998, non-interest income includes net gains on sales of investment securities of zero, $1.2 million, $1.2 million, $35,000, $82,000 and zero, respectively. For the year ended December 31, 1999, non-interest income includes net losses on sales of investment securities of $295,000. For the three months ended March 31, 2003 and 2002 and for the years ended December 31, 2002, 2001, 1999 and 1998, non-interest income includes net gains on sales of mortgage loans of $264,000, $64,000, $900,000, $108,000, $52,000 and $305,000, respectively. For the year ended December 31, 2000, non-interest income includes net losses on sales of mortgage loans of $23,000. For the year ended December 31, 1999, non-interest income includes an $844,000 gain associated with Keystone’s conversion from a single-employer defined benefit pension plan to a multiple employer defined benefit plan.

(2) With the exception of end of period ratios, all ratios are based on average monthly balances during the indicated periods and, for the three-month periods ended March 31, 2003 and 2002, are annualized where appropriate.

(3) Average interest rate spread represents the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities, and net interest margin represents net interest income as a percentage of average interest-earning assets.

(4) The efficiency ratio represents the ratio of non-interest expense divided by the sum of net interest income and non-interest income.

(5) Asset quality ratios and capital ratios are end of period ratios, except for net charge-offs to average loans receivable.

(6) Non-performing assets consist of non-performing loans and real estate owned. Non-performing loans consist of all loans 90 days or more past due or more than 90 days past due and still accruing interest. It is KNBT Bancorp’s policy, with certain exceptions, to cease accruing interest on all loans 90 days or more past due. Real estate owned consists of real estate acquired through foreclosure and repossessed automobiles.

18

SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA OF FIRST COLONIAL GROUP, INC.

The following selected financial and other data of First Colonial does not purport to be complete and is qualified in its entirety by the more detailed financial information contained elsewhere herein. The statement of operations as of and for the three-months ended March 31, 2003 and 2002, are unaudited and are derived from our interim condensed consolidated financial statements. The statement of operations and balance sheet data for the years ended and as of December 31, 2002, 2001, 2000, 1999 and 1998 are derived from First Colonial’s audited consolidated financial statements. In the opinion of First Colonial’s management, financial information at March 31, 2003 and for the three months ended March 31, 2003 and 2002 reflect all adjustments (consisting only of normal recurring accruals) which are necessary to present fairly the results for such periods. Results for the three-month period ended March 31, 2003 may not be indicative of results for the year ending December 31, 2003.

	At March 31, 2003		At December 31,
			2002		2001		2000		1999		1998
			(Dollars in Thousands, Except Per Share Data)
Selected Financial and Other Data:
Total Assets	$	620,718	$	611,592	$	465,144	$	443,051	$	391,889	$	358,496
Cash and cash equivalents		20,698		22,741		17,270		17,738		16,272		14,259
Investment Securities:
Held-to-maturity		69,461		30,297		23,004		19,972		19,887		17,723
Available-for-sale		254,930		283,481		181,302		164,029		132,356		98,389
Loans, net		252,624		255,844		225,757		226,944		202,258		212,437
Mortgage loans held-for-sale		848		1,263		3,808		—		—		603
Deposits		483,377		472,798		379,886		353,190		324,480		294,549
FHLB advances and other borrowings		75,813		76,722		43,184		46,910		31,730		25,094
Guaranteed preferred beneficial interest in the company’s subordinated debentures		15,000		15,000		—		—		—		—
Shareholders’ equity		40,488		40,314		35,326		33,521		28,243		31,717
Book value per share		18.08		18.18		16.96		17.08		15.28		18.17
Full service offices		17		17		17		17		15		13

	Three Months Ended March 31,						Year Ended December 31,
	2003			2002			2002			2001			2000			1999			1998
							(Dollars in Thousands, Except Per Share Data)
Selected Operating Data:
Total interest income	$	7,579		$	7,110		$	29,530		$	30,035		$	29,287		$	26,353		$	25,367
Total interest expense		3,077			3,035			12,410			13,969			13,947			11,449			10,871
Net interest income		4,502			4,075			17,120			16,066			15,340			14,904			14,496
Provision for loan losses		200			400			1,541			580			375			375			450
Net interest income after provision for loan losses		4,302			3,675			15,579			15,486			14,965			14,529			14,046
Total non-interest income (1)		2,266			1,557			6,907			5,607			4,322			4,355			4,580
Total non-interest expense		5,501			4,278			17,611			16,728			16,945			14,673			14,563
Income before income taxes		1,067			954			4,875			4,365			2,342			4,211			4,063
Income Taxes		135			143			877			808			270			929			1,031
Net income	$	932		$	811		$	3,998		$	3,557		$	2,072		$	3,282		$	3,032
Cash dividends paid	$	412		$	388		$	1,597		$	1,489		$	1,406		$	1,321		$	1,275
Cash dividends paid per share		0.19			0.18			0.74			0.70			0.67			0.64			0.61
Dividends paid to net income		44.21	%		47.84	%		39.95	%		41.86	%		67.86	%		40.25	%		42.05	%
Per Share Data:
Basic income	$	0.43		$	0.37		$	1.85		$	1.69		$	0.99		$	1.59		$	1.45
Diluted net income		0.41			0.37			1.82			1.68			0.99			1.58			1.44
Basic average common shares outstanding		2,177,482			2,144,552			2,169,410			2,109,821			2,094,421			2,067,540			2,089,572
Dilutive average common shares outstanding		2,274,995			2,178,154			2,216,049			2,115,510			2,096,759			2,071,352			2,098,656

(Footnotes on next page)

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	At or For the Three Months Ended March 31,				At or For the Year Ended December 31,
	2003		2002		2002		2001		2000		1999		1998
Selected Operating Ratios(2):
Average yield on interest-earning assets	5.48	%	6.59	%	6.24	%	7.36	%	7.84	%	7.68	%	7.95	%
Average rate on interest-bearing liabilities	2.47		3.21		2.97		3.90		4.16		3.76		3.89
Average interest rate spread(3)	3.01		3.38		3.27		3.46		3.68		3.92		4.06
Net interest margin(3)	3.35		3.87		3.71		4.04		4.21		4.44		4.63
Average interest-earning assets to average interest-bearing liabilities	116.02		117.88		117.67		117.48		114.72		116.13		117.16
Net interest income after provision for loan losses to non-interest expense	78.20		85.90		88.46		92.58		88.32		99.02		96.45
Total non-interest expense to average assets	3.62		3.61		3.39		3.71		4.07		3.83		4.13
Efficiency ratio(4)	77.48		72.88		70.00		73.91		82.56		73.07		73.72
Return on average assets	0.62		0.69		0.77		0.79		0.50		0.86		0.86
Return on average equity	9.30		9.46		10.62		10.10		7.04		10.90		9.79
Average equity to average assets	6.68		7.34		7.24		7.81		7.07		7.87		8.78
Asset Quality Ratios(5):
Non-performing loans as a percent of total loans(6)	0.72	%	1.15	%	0.87	%	1.42	%	1.11	%	1.39	%	1.07	%
Non-performing assets as a percent of total assets(6)	0.33		0.56		0.36		0.71		0.64		0.86		0.81
Allowance for loan losses as a percent of non-performing loans	170.33		88.05		138.61		70.66		95.79		86.97		118.76
Net charge-offs to average loans	0.07		0.14		0.29		0.32		0.19		0.30		0.19
Capital Ratios(5):
Tier 1 leverage ratio	8.58	%	7.62	%	8.81	%	7.65	%	8.00	%	8.32	%	8.60	%
Tier 1 risk-based capital ratio	17.00		14.22		16.66		14.46		14.13		15.48		15.64
Total risk-based capital ratio	18.64		15.15		18.45		15.38		15.16		16.67		16.97

(1) For the three months ended March 31, 2003 and 2002 and for the years ended December 31, 2002, 2001, 2000, 1999 and 1998, non-interest income includes net gains on sales of investment securities of $765,000, $369,000, $1.3 million, $929,000, $174,000, $563,000 and $722,000, respectively. For the three months ended March 31, 2003 and 2002 and for the years ended December 31, 2002, 2001, 2000, 1999 and 1998, non-interest income includes net gains on sales of mortgage loans of $417,000, $76,000, $1.1 million, $346,000, $59,000, $157,000 and $398,000, respectively.

(2) With the exception of end of period ratios, all ratios are based on average daily balances during the indicated periods and, for the three-month periods ended March 31, 2003 and 2002, are annualized where appropriate.

(3) Average interest rate spread represents the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities, and net interest margin represents net interest income as a percentage of average interest-earning assets.

(4) The efficiency ratio represents the ratio of non-interest expense divided by the sum of taxable equivalent net interest income before loan loss provision and non-interest income.

(5) Asset quality ratios and capital ratios are end of period ratios, except for net charge-offs to average loans.

(6) Non-performing assets consist of non-performing loans and other real estate owned. Non-performing loans consist of all loans 90 days or more past due.

20

USE OF NET PROCEEDS

Although the actual net proceeds from the sale of KNBT Bancorp common stock cannot be determined until the conversion is completed, it is presently anticipated that the net proceeds from the sale of the common stock will be between $126.6 million at the minimum of the offering range and $172.0 million at the maximum of the offering range ($198.1 million assuming an increase in the offering range by approximately 15%). See “Pro Forma Unaudited Financial Information—Additional Pro Forma Data” and “The Offering—How Keystone Determined the Price Per Share and the Offering Range” as to the assumptions used to arrive at such amounts.

KNBT Bancorp will use the net proceeds from the offering as follows:

Use of Net Proceeds	Amount, at the minimum		Amount, at the maximum		Percentage of net offering proceeds at the maximum
Loan to employee stock ownership plan	$	10,387,000	$	14,053,000	8.17	%
Repurchase of shares for recognition and retention plan	$	5,193,500	$	7,026,500	4.09	%
Purchase of Keystone Common Stock	$	63,286,498	$	85,988,203	50.0	%
General corporate purposes	$	47,705,997	$	64,908,702	37.74	%

The loan to the KNBT Bancorp employee stock ownership plan will be $10.4 million and approximately $14.1 million at the minimum and maximum of the offering range. The KNBT Bancorp employee stock ownership plan will allocate the shares it purchases to employees as the loan is repaid. In addition, if the KNBT Bancorp recognition and retention plan is adopted by the board of directors and approved by shareholders, KNBT Bancorp intends to contribute sufficient funds to the trust so that KNBT Bancorp can purchase a number of shares equal to an aggregate of 4% of the shares sold in the conversion offering (not including shares contributed to the Keystone Nazareth Charitable Foundation) which would amount to 702,650 shares at the maximum of the range or $7.0 million based on a per share price of $10.00. Depending on market conditions, shares repurchased for the recognition and retention plan may not be repurchased at $10.00 per share. In the event that the price of KNBT Bancorp common stock has increased, the cost of the shares purchased for the recognition and retention plan will be greater. See “Management—New Stock Benefit Plans—Employee Stock Ownership Plan” and “—Recognition and Retention Plan.”

The net proceeds received from the sale of shares of KNBT Bancorp common stock in the conversion offering will increase the capital of both KNBT Bancorp and Keystone. Half of the net proceeds from the conversion offering will be used by KNBT Bancorp to buy the common stock of Keystone. While KNBT Bancorp has not identified specific uses for the portion of the net proceeds to be invested in Keystone, it is anticipated that the savings bank will use the portion of the cash proceeds it receives for general corporate purposes. On a short-term basis, Keystone may purchase investment securities. The net proceeds received by Keystone will further strengthen its capital position, which already exceeds all regulatory requirements. At March 31, 2003, Keystone’s Tier 1 capital ratio was 10.8%. After the conversion and the merger, Keystone’s Tier 1 leverage capital ratio will be 10.96%, based upon the maximum of the offering range. As a result, Keystone will continue to be a well-capitalized institution and will have additional flexibility to grow and diversify. The proceeds invested in Keystone, in addition to funding new loans and being invested in equity securities, may also be used to finance the further expansion of Keystone’s banking operations. In addition, the net proceeds may ultimately be used in the future to support further expansion of Keystone’s operations through acquisitions of other financial institutions or branch offices, although no such transactions are specifically being considered at this time other than the proposed mergers with First Colonial and Nazareth National Bank.

A portion of the net proceeds from the conversion offering retained by KNBT Bancorp will be used to make a loan to its employee stock ownership plan in an amount sufficient to permit it to buy 8.0% of the shares sold

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in the conversion offering. The remaining portion of the net proceeds after the loan to the employee stock ownership plan and its purchase of Keystone’s common stock will be retained by KNBT Bancorp and will be available for general corporate purposes. KNBT Bancorp may initially use the remaining net proceeds to invest in deposits at Keystone, U.S. Government and federal agency securities of various maturities, federal funds, mortgage-backed securities, or a combination thereof. In addition, assuming shareholder approval of its proposed recognition and retention plan in the year after the conversion is completed, KNBT Bancorp intends to contribute sufficient funds to the trust so that it can purchase a number of shares equal to an aggregate of 4% of the common stock sold in the conversion offering. The net proceeds retained by KNBT Bancorp may ultimately be used to:

• support the operations of Keystone after its merger with Nazareth National Bank;

• support possible additional future expansion of operations of Keystone through establishment of additional branch offices or other customer facilities for Keystone, acquisition of other financial institutions or branch offices, expansion into other lending markets or diversification into other banking-related businesses, although no such transactions are specifically being considered at this time;

• invest in deposits at Keystone or securities; or

• fund repurchases of its common stock or serve as a source of possible payments of cash dividends to shareholders.

Applicable conversion regulations require KNBT Bancorp to sell common stock in the conversion in an amount equal to its estimated pro forma market value, as determined by an independent appraisal. See “The Offering—How Keystone Determined the Price Per Share and the Offering Range.” To the extent KNBT Bancorp has excess capital upon completion of the conversion and merger, it intends to consider stock repurchases and dividends. However, without nonobjection from the Federal Deposit Insurance Corporation, KNBT Bancorp cannot conduct any stock repurchases during the first year after it completes the conversion.

KNBT Bancorp’s net proceeds may vary because total expenses of the conversion may be more or less than those estimated. The net proceeds also will vary if the number of shares to be issued in the conversion is adjusted to reflect a change in KNBT Bancorp’s estimated pro forma market value. Payments for shares purchased in the subscription offering made through withdrawals from existing deposit accounts at Keystone will not result in the receipt of new funds for investment but will result in a reduction of KNBT Bancorp interest expense and liabilities as funds are transferred from interest-bearing certificates or other deposit accounts.

DIVIDENDS

After the conversion is completed, KNBT Bancorp’s board of directors will have the authority to declare dividends on the common stock, subject to statutory and regulatory requirements. KNBT Bancorp intends to consider a policy of paying cash dividends on the common stock of KNBT Bancorp; however, no decision on the timing or the possible amount of any dividend payments has been made. The rate of such dividends and the initial or continued payment thereof will depend upon a number of factors, including the amount of net proceeds retained by KNBT Bancorp in the conversion, investment opportunities available, capital requirements, KNBT Bancorp’s financial condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic conditions. No assurances can be given that any dividends will be paid or that, if paid, will not be reduced or eliminated in future periods.

Dividends from KNBT Bancorp may eventually depend, in part, upon receipt of dividends from Keystone because KNBT Bancorp initially will have no source of income other than dividends from Keystone, earnings from the investment of the net proceeds from the sale of common stock retained by KNBT Bancorp, and interest payments with respect to the loan by KNBT Bancorp to its employee stock ownership plan.

Any payment of dividends by Keystone to KNBT Bancorp which would be deemed to be drawn out of the savings bank’s bad debt reserves would require a payment of taxes at the then-current tax rate on the amount of

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earnings deemed to be removed from the reserves for such distribution. Keystone does not intend to make any distribution that would create such a federal tax liability. See “Taxation.”

KNBT Bancorp is not subject to the above regulatory restrictions on the payment of dividends to its shareholders, although the source of such dividends may eventually depend, in part, upon dividends from Keystone. KNBT Bancorp is, however, subject to the requirements of Pennsylvania law, which generally limit the payment of dividends to amounts that will not have the effect of making a corporation unable to pay its debts as they become due in the ordinary course of business or if the corporation’s total assets would be less than its total liabilities plus the amount, if any, needed to satisfy any preferential rights that shareholders may have if the corporation were dissolved.

KNBT Bancorp has committed to the Federal Deposit Insurance Corporation that, during the one-year period following Keystone’s conversion, it will take no action to declare an extraordinary dividend that would be treated as a tax-free return of capital without the prior approval of the Federal Deposit Insurance Corporation.

MARKET FOR KNBT BANCORP COMMON STOCK

Because this is KNBT Bancorp’s initial public offering, there is no market for KNBT Bancorp common stock at this time. KNBT Bancorp has applied to have its common stock listed for quotation on the Nasdaq National Market under the symbol “KNBT,” and expects that such application will be approved.

There can be no assurance that an active and liquid trading market will develop for KNBT Bancorp common stock. The development of an active and liquid public market depends upon the existence of willing buyers and sellers, the presence of which is not within KNBT Bancorp control or the control of any market maker. You should not view KNBT Bancorp common stock as a short-term investment. Furthermore, there can be no assurance that you will be able to sell your shares at or above the $10.00 per share purchase price of the conversion offering. Sandler O’Neill & Partners, L.P. has agreed to make a market in KNBT Bancorp common stock upon completion of the conversion and the merger and will assist KNBT Bancorp in encouraging additional market makers to establish and maintain a market for KNBT Bancorp common stock.

REGULATORY CAPITAL REQUIREMENTS

At March 31, 2003, Keystone, First Colonial and Nazareth National Bank exceeded all of their respective regulatory capital requirements. The table on the following page sets forth historical capital amounts of Keystone, First Colonial and Nazareth National Bank under accounting principles generally accepted in the United States of America and regulatory capital at March 31, 2003, and the pro forma capital of KNBT Bancorp and Keystone after giving effect to the conversion and the merger, based upon the sale of the number of shares shown in the table. The pro forma capital amounts reflect the receipt by Keystone of 50% of the net conversion proceeds. The pro forma risk-based capital amounts assume the investment of the net proceeds received by Keystone in assets which have a risk-weight of 20% under applicable regulations, as if such net proceeds had been received and so applied at March 31, 2003.

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													Pro Forma at March 31, 2003 Based on
	KNBT Bancorp and Keystone Historical at March 31, 2003				First Colonial and Nazareth National Bank Historical at March 31, 2003				Pro Forma Combined Historical at March 31, 2003				12,983,750 Shares Sold at $10.00 Per Share				15,275,000 Shares Sold at $10.00 Per Share				17,566,250 Shares Sold at $10.00 Per Share				20,201,188 Shares Sold at $10.00 Per Share
	Amount		Percent of Assets(1)		Amount		Percent of Assets(1)		Amount		Percent of Assets(1)		Amount		Percent of Assets(1)		Amount		Percent of Assets(1)		Amount		Percent of Assets(1)		Amount		Percent of Assets(1)
	(Dollars in Thousands)
Capital at Holding Company Level:
GAAP capital	$	—	—	%	$	40,488	6.52	%	$	201,215	11.79	%	$	312,447	17.18	%	$	333,078	18.11	%	$	353,709	19.02	%	$	377,434	20.04	%
Tier 1 leverage capital:
Actual	$	—	—	%	$	52,230	8.58	%	$	112,819	6.96	%	$	224,051	12.93	%	$	244,682	13.96	%	$	265,312	14.97	%	$	289,037	16.10	%
Requirement	$	—	—	%	$	24,341	4.00	%	$	64,864	4.00	%	$	69,304	4.00	%	$	70,102	4.00	%	$	70,900	4.00	%	$	71,818	4.00	%
Excess	$	—	—	%	$	27,889	4.58	%	$	47,955	2.96	%	$	154,747	8.93	%	$	174,580	9.96	%	$	194,412	10.97	%	$	217,220	12.10	%
Tier 1 risk-based capital:
Actual	$	—	—	%	$	52,230	17.00	%	$	112,819	12.54	%	$	224,051	24.31	%	$	224,682	26.43	%	$	265,312	28.54	%	$	289,037	30.94	%
Requirement	$	—	—	%	$	12,290	4.00	%	$	35,977	4.00	%	$	36,865	4.00	%	$	37,025	4.00	%	$	37,184	4.00	%	$	37,368	4.00	%
Excess	$	—	—	%	$	39,940	13.00	%	$	76,842	8.54	%	$	187,186	20.31	%	$	207,657	22.43	%	$	228,128	24.54	%	$	251,669	26.94	%
Total risk-based capital:
Actual	$	—	—	%	$	57,284	18.64	%	$	120,562	13.40	%	$	231,794	25.15	%	$	252,425	27.27	%	$	273,055	29.37	%	$	296,780	31.77	%
Requirement	$	—	—	%	$	24,580	8.00	%	$	71,955	8.00	%	$	73,731	8.00	%	$	74,050	8.00	%	$	74,369	8.00	%	$	74,736	8.00	%
Excess	$	—	—	%	$	32,704	10.64	%	$	48,607	5.40	%	$	158,063	17.15	%	$	178,375	19.27	%	$	198,686	21.37	%	$	222,044	23.77	%
Capital at Bank Level:
GAAP capital	$	114,295	11.0	%	$	44,529	7.22	%	$	205,367	12.06	%	$	265,050	15.04	%	$	276,402	15.59	%	$	287,752	16.12	%	$	300,805	16.73	%
Tier 1 leverage capital:
Actual	$	109,186	10.8	%	$	43,214	7.16	%	$	103,803	6.42	%	$	163,486	9.75	%	$	174,838	10.36	%	$	186,188	10.96	%	$	199,241	11.64	%
Requirement	$	40,514	4.0	%	$	24,152	4.00	%	$	64,656	4.00	%	$	67,043	4.00	%	$	67,498	4.00	%	$	67,952	4.00	%	$	68,474	4.00	%
Excess	$	68,672	6.8	%	$	19,057	3.16	%	$	39,147	2.42	%	$	96,443	5.75	%	$	107,340	6.36	%	$	118,237	6.96	%	$	130,768	7.64	%
Tier 1 risk-based capital:
Actual	$	109,186	18.4	%	$	43,214	14.27	%	$	103,803	11.61	%	$	163,486	18.04	%	$	174,838	19.24	%	$	186,188	20.44	%	$	199,241	21.81	%
Requirement	$	23,685	4.0	%	$	12,111	4.00	%	$	35,776	4.00	%	$	36,254	4.00	%	$	36,344	4.00	%	$	36,435	4.00	%	$	36,540	4.00	%
Excess	$	85,501	14.4	%	$	31,103	10.27	%	$	68,027	7.61	%	$	127,233	14.04	%	$	138,493	15.24	%	$	149,753	16.44	%	$	162,702	17.81	%
Total risk-based capital:
Actual	$	111,875	18.9	%	$	47,326	15.63	%	$	110,604	12.37	%	$	170,287	18.79	%	$	181,639	19.99	%	$	192,989	21.19	%	$	206,042	22.56	%
Requirement	$	47,369	8.0	%	$	24,222	8.00	%	$	71,552	8.00	%	$	72,507	8.00	%	$	72,689	8.00	%	$	72,870	8.00	%	$	73,079	8.00	%
Excess	$	64,506	10.9	%	$	23,104	7.63	%	$	39,052	4.37	%	$	97,780	10.79	%	$	108,950	11.99	%	$	120,119	13.19	%	$	132,963	14.56	%

(1) Adjusted total or adjusted risk-weighted assets, as appropriate.

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CAPITALIZATION

The following table presents the historical capitalization of Keystone and First Colonial at March 31, 2003, and KNBT Bancorp’s pro forma consolidated capitalization after giving effect to the merger without the conversion offering proceeds and with the conversion offering proceeds, based upon the sale of the number of shares shown below and the other assumptions set forth under “Pro Forma Unaudited Financial Information Data—Additional Pro Forma Data.”

	Keystone —Historical Capitalization		First Colonial Historical Capitalization			Pro Forma Keystone, KNBT Bancorp and First Colonial Combined without conversion offering proceeds			KNBT Bancorp—Pro Forma Based Upon Sale at $10.00 Per Share
									12,983,750 Shares (Minimum of Offering Range)			15,275,000 Shares (Midpoint of Offering Range)			17,566,250 Shares (Maximum of Offering Range)			20,201,188 Shares(1) (15% above Maximum of Offering Range)
												(In Thousands)
Deposits(2)	$	797,361	$	483,377		$	1,280,738		$	1,280,738		$	1,280,738		$	1,280,738		$	1,280,738
FHLB advances and other borrowings		113,513		90,813			204,326			204,326			204,326			204,326			204,326
Total deposits and borrowings	$	910,874	$	574,190		$	1,485,064		$	1,485,064		$	1,485,064		$	1,485,064		$	1,485,064
Shareholders’ equity:
Preferred stock, $.01 par value, 20,000,000 shares authorized; none to be issued	$	—	$	—		$	—		$	—		$	—		$	—		$	—
Common stock, $.01 par value, 100,000,000 shares authorized; shares to be issued as reflected(3)		—		11,199			11,199			223			248			273			301
Additional paid-in capital(3)		—		21,154			21,154			223,160			247,630			272,140			300,326
Retained earnings(4)(5)		109,275		8,950			118,225			105,672			105,672			105,672			105,672
Cumulative other comprehensive income		5,020		278			5,298			5,557			5,557			5,557			5,557
Less:
Foundation contribution expense, net(6)		—		—			—			(6,544	)		(7,699	)		(8,853	)		(10,181	)
Common stock acquired by KNBT Bancorp ESOP or held by First Colonial ESOP(7)		—		(1,093	)		(1,093	)		(10,387	)		(12,220	)		(14,053	)		(16,161	)
Common stock to be acquired by KNBT Bancorp recognition and retention plan(8)		—		—			—			(5,194	)		(6,110	)		(7,027	)		(8,080	)
Total equity	$	114,295	$	40,488		$	154,783		$	312,447		$	333,078		$	353,709		$	377,434

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(1) As adjusted to give effect to an increase in the number of shares which could occur due to an increase in the offering range of up to approximately 15% to reflect changes in market and financial conditions before the conversion is completed.

(2) Does not reflect withdrawals from deposit accounts for the purchase of common stock in the conversion. Such withdrawals would reduce pro forma deposits by the amount of such withdrawals.

(3) The sum of the par value (including the shares to be contributed to the Keystone Nazareth Charitable Foundation) and additional paid-in capital accounts equals the net conversion proceeds. No effect has been given to the issuance of additional shares of common stock pursuant to the proposed KNBT stock option plan. KNBT Bancorp intends to adopt a stock option plan and to submit such plan to shareholders at a meeting of shareholders to be held at least six months following completion of the conversion and the merger. If the plan is approved by shareholders, an amount equal to 10% of the shares of common stock sold in the conversion offering (not including shares contributed to the Keystone Nazareth Charitable Foundation) will be reserved for future issuance under such plan. Your ownership percentage would decrease by approximately 6.4% if all potential stock options are exercised from KNBT Bancorp’s authorized but unissued stock and if 17,566,250 shares were sold in the conversion. See “Pro Forma Unaudited Financial Information—Additional Pro Forma Data” and “Management—New Stock Benefit Plans—Stock Option Plan.”

(4) The retained earnings of Keystone will be substantially restricted after the conversion. See “The Conversion and the Merger—Liquidation Rights of Certain Depositors.”

(5) Pro forma shareholder’s equity includes the effects of estimated one-time charges of approximately $5.1 ($3.6 million net of tax) expected to be incurred shortly following the conversion and the merger. Since the estimated changes are none-recurring, they have not been reflected on the pro forma combined income statements and related per share calculations.

(6) Represents the expense, net of tax, of the contribution of common stock to the Keystone Nazareth Charitable Foundation based on an estimated tax rate of 38.0%. The realization of the tax benefit is limited annually to 10% of KNBT Bancorp’s annual taxable income. However, for federal and state tax purposes, KNBT Bancorp can carry forward any unused portion of the deduction for five years following the year in which the contribution is made.

(7) Assumes that 8% of the common stock sold in the conversion offering (not including shares contributed to the Keystone Nazareth Charitable Foundation) will be purchased by the KNBT Bancorp employee stock ownership plan. The common stock acquired by the employee stock ownership plan is reflected as a reduction of shareholders’ equity. Assumes the funds used to acquire the employee stock ownership plan shares will be borrowed from KNBT Bancorp. See Note 2 to the table set forth under “Pro Forma Unaudited Financial Information—Additional Pro Forma Data” and “Management—New Stock Benefit Plans—Employee Stock Ownership Plan.”

(8) Gives effect to the recognition plan which KNBT Bancorp expects to adopt after the conversion and the merger and present to shareholders for approval at a meeting of shareholders to be held at least six months after the conversion and the merger are completed. No shares will be purchased by the recognition plan in the conversion, and such plan cannot purchase any shares until shareholder approval has been obtained. If the recognition plan is approved by KNBT Bancorp’s shareholders, the plan intends to acquire an amount of common stock equal to 4% of the shares of common stock sold in the conversion offering (not including shares contributed to the Keystone Nazareth Charitable Foundation), or 519,350, 611,000, 702,650 and 808,048 shares at the minimum, midpoint, maximum and 15% above the maximum of the offering range, respectively. The table assumes that shareholder approval has been obtained and that such shares are purchased in the open market at $10.00 per share. The common stock so acquired by the recognition plan is reflected as a reduction in shareholders’ equity. If the shares are purchased at prices higher or lower than the initial purchase price of $10.00 per share, such purchases would have a greater or lesser impact, respectively, on shareholders’ equity. If the recognition and retention plan purchases authorized but unissued shares from KNBT Bancorp, such issuance would dilute the voting interests of existing shareholders by approximately 2.7% if 17,566,250 shares were sold in the conversion. See “Pro Forma Unaudited Financial Information—Additional Pro Forma Data” and “Management—New Stock Benefit Plans—Recognition and Retention Plan.”

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PRO FORMA UNAUDITED FINANCIAL INFORMATION

The following Pro Forma Unaudited Consolidated Statement of Financial Condition at March 31, 2003 and December 31, 2002 and the Pro Forma Unaudited Consolidated Statements of Income for the three months ended March 31, 2003 and the year ended December 31, 2002 give effect to the proposed conversion and the merger based on the assumptions set forth below. The pro forma unaudited financial statements are based on the unaudited consolidated financial statements of Keystone and First Colonial for the three months ended March 31, 2003 and the audited consolidated financial statements of Keystone and First Colonial for the year ended December 31, 2002. The pro forma unaudited financial statements give effect to the conversion and the merger using purchase accounting as required by generally accepted accounting principles used in the United States.

The pro forma adjustments in the tables assume the sale of 17,566,250 shares in the conversion offering at a price of $10.00 per share, which is the maximum of the offering range. In addition, the pro forma adjustments in the tables assume the issuance of 9,355,928 merger exchange shares in the merger and the contribution of 1,405,300 shares of KNBT Bancorp common stock to the Keystone Nazareth Charitable Foundation. The net proceeds are based upon the following assumptions:

• KNBT Bancorp will sell all shares of common stock offered in the conversion in the subscription offering;

• KNBT Bancorp’s employee stock ownership plan will purchase 8% of the shares of common stock sold in the conversion offering (not including shares contributed to the Keystone Nazareth Charitable Foundation) with a loan from KNBT Bancorp;

• KNBT Bancorp will make a contribution to the charitable foundation amounting to 8% of the shares of its common stock sold in the conversion offering with an assumed value of $10.00 per share;

• expenses of the conversion offering, other than the fees to be paid to Sandler O’Neill & Partners, L.P., are estimated to be $2.1 million;

• 300,000 shares of common stock will be purchased by KNBT Bancorp’s executive officers and directors, and their immediate families; and

• Sandler O’Neill & Partners, L.P. will receive fees equal to 1.0% of the aggregate purchase price of the shares of stock sold in the conversion offering, excluding any shares purchased by any of employee benefit plans, and any of KNBT Bancorp’s directors, officers or employees or members of their immediate families.

In addition, the expenses of the conversion and the merger may vary from those estimated, and the fees paid to Sandler O’Neill & Partners, L.P. will vary from the amounts estimated if the amount of shares of KNBT Bancorp common stock sold in the different categories varies from the amounts assumed above or if a syndicated community offering becomes necessary. Additionally, certain one-time charges to operating results are expected to occur following the conversion and the merger, which expenses are currently estimated to be approximately $5.1 million, pre-tax. These items, net of income tax effects, are shown as a reduction in shareholders’ equity in the following tables but are not shown as a reduction in net income for the periods shown in the following tables.

Pro forma net income has been calculated for the three months ended March 31, 2003 and for the year ended December 31, 2002 as if the shares of KNBT Bancorp common stock to be issued in the offering had been sold and the merger exchange shares issued as of the beginning of each period. Historical and pro forma per share amounts have been calculated by dividing historical and pro forma amounts by the indicated number of shares of KNBT Bancorp common stock.

The pro forma unaudited consolidated statement of financial condition assumes the conversion and the merger were consummated on March 31, 2003 or December 31, 2002. The pro forma unaudited consolidated statements of income assume that the conversion and merger were consummated on January 1 of each indicated period.

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The pro forma unaudited statements are provided for informational purposes only. The pro forma financial information presented is not necessarily indicative of the actual results that would have been achieved had the conversion and the merger been consummated on March 31, 2003 or December 31, 2002 or at the beginning of the periods presented, and is not indicative of future results. The pro forma unaudited financial statements should be read in conjunction with the consolidated financial statements and the notes thereto of Keystone and First Colonial contained elsewhere in this document.

The shareholders’ equity represents the combined book value of the common shareholders’ ownership of Keystone and First Colonial computed in accordance with generally accepted accounting principles used in the United States. This amount is not intended to represent fair market value nor does it represent amounts, if any, that would be available for distribution to shareholders in the event of liquidation. The book value for Keystone and First Colonial on a historical and pro forma basis has not been changed to reflect any difference between the carrying value of investments held to maturity or loans held in portfolio and their market value.

The unaudited pro forma net income and common shareholders’ equity derived from the above assumptions are qualified by the statements set forth under this caption and should not be considered indicative of the market value of KNBT Bancorp common stock or the actual results of operations of Keystone and First Colonial for any period. Such pro forma data may be materially affected by the actual gross proceeds from the sale of shares of KNBT Bancorp in the conversion and the actual expenses incurred in connection with the conversion and the merger. See “Use of Net Proceeds.”

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KNBT Bancorp, Inc.

Condensed Combined Pro Forma Balance Sheet

At March 31, 2003

	Keystone, Historical Actual		Pro Forma Conversion Adjustments			Keystone, As Converted			First Colonial			Pro Forma Merger Adjustments			Pro Forma Consolidated
ASSETS
Cash and due from banks	$	9,382				$	9,382		$	20,698		$	—		$	30,080
Interest bearing deposits		40,399		150,897	(1)		191,296			10,547			(3,603	)(6)		195,970
													(1,100	)(5)
													(1,170	)(5)
Federal funds sold		—					—			—						—
Total cash and cash equivalents		49,781		150,897			200,678			31,245			(5,873	)		226,050
Total mortgage-backed securities		—					—									—
Total investment securities—Available for Sale		400,154					400,154			250,374			—			650,528
Total investment securities—Held to Maturity		—					—			69,461			370	(5)		69,831
Mortgage Held for Sale		—					—			848			—			848
Federal Home Loan Bank Stock, at cost		8,516					8,516			4,556			—			13,072
Loans receivable, net		532,425					532,425			249,512			—			781,937
Bank Owned Life Insurance		26,688					26,688			—			—			26,688
Accrued interest receivable		5,239					5,239			2,914			—			8,153
Premises and equipment, net		12,883					12,883			6,399			—			19,282
Other assets		3,973		5,200	(2)		9,173			5,409			(154	)(5)		14,428
Other Intangible Assets—Core Deposit Intangible		—					—			—			16,918	(5)		16,918
Goodwill		—					—			—			31,525	(5)
													154	(5)		31,679
													—
Total assets	$	1,039,659	$	156,097		$	1,195,756		$	620,718		$	42,940		$	1,859,414
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits	$	797,361				$	797,361		$	483,377		$	—		$	1,280,738
Securities sold under agreements to repurchase		10,013					10,013			8,774			—			18,787
Borrowings		103,500					103,500			67,039			—			170,539
Advanced Payments by Borrowers for Taxes and Insurance		2,426					2,426			—			—			2,426
Accrued interest payable		863					863			3,167			—			4,030
Other liabilities		11,201					11,201			2,873			111	(5)		14,185
Guaranteed Preferred Benefical Interest in the Company’s Subordinated Debt		—					—			15,000			—			15,000
Total liabilities		925,364		—			925,364			580,230			111			1,505,705
Stockholders’ equity
Preferred Stock, par value $5.00; authorized 500,000 shares, none issued		—					—			—			—			—
Common stock, par value $5.00; authorized 10,000,000 shares, 2,239,861 issued		—					—			11,199			(11,199	)(4)		—
Common stock, par value $.01; authorized 100,000,000 shares, 28,287,486 issued pro forma		—		176	(1)		190			—			83	(4)		273
				14	(3)
Additional paid-in capital		—		171,801	(1)		185,840			21,154			3,509	(4)		272,140
				14,039	(3)								(21,154	)(4)
													82,792	(4)
Accumulated other comprehensive income, net		5,020					5,020			278			259	(5)		5,557
Retained earnings		109,275		(8,853	)(3)		100,422			8,950			(8,950	)(4)		96,819
													(3,603	)(6)
Common stock to be acquired by management recognition plan, 800,000 shares		—		(7,027	)(1)		(7,027	)		—						(7,027	)
Employee Stock Ownership Debt—First Colonial		—					—			(1,093	)		1,093	(4)		—
Employee Stock Ownership Debt—Keystone, 1,600,000 shares		—		(14,053	)(1)		(14,053	)		—						(14,053	)
													—
													—
Total stockholders’ equity		114,295		156,097			270,392			40,488			42,829			353,709
	$	1,039,659	$	156,097		$	1,195,756		$	620,718		$	42,940		$	1,859,414

Footnotes continued on next page

29

(1) Reflects gross proceeds of $175.7 million from the sale of shares of KNBT Bancorp common stock in the conversion, less estimated expenses of the conversion equal to $3.7 million, the purchase of $14.1 million of shares by the KNBT Bancorp employee stock ownership plan funded internally by a loan from KNBT Bancorp and the proposed purchase of $7.0 million of KNBT Bancorp common stock by KNBT Bancorp recognition and retention plan funded internally by KNBT Bancorp.

(2) Adjustment to record the federal tax benefit of the contribution of 1,405,300 shares of KNBT Bancorp common stock to the Keystone Nazareth Charitable Foundation.

(3) Reflects the issuance of 1,405,300 shares of KNBT Bancorp common stock as a contribution to the Keystone Nazareth Charitable Foundation.

(4) Reflects the merger with First Colonial, includes the issuance of 8,287,486 shares of KNBT Bancorp Stock, and the related reclassification necessary to reflect the exchange of each share of First Colonial common stock previously held for 3.7 shares of KNBT Bancorp’s common stock with a par value of $0.01. Repayment of $1.1 million associated with the First Colonial employee stock ownership plan, and the assignment of $3.5 million of value related to the conversion of 288,768 of First Colonial options into 1,068,442 KNBT Bancorp common stock options.

(5) Reflects purchase accounting adjustments related to merger related expenses of $2.3 million, reclassification of First Colonial investment securities held to maturity to available for sale, estimated core deposit intangible of $16.7 million to be amortized over an estimated 10 years, estimated goodwill of $31.7 million which is not subject to amortization but instead is subject to annual impairment testing.

(6) Adjustment to record the effects of estimated one-time charges of approximately $5.1 million, $3.6 million net of tax effect, which will be charged to earnings as incurred. Since the estimated charges are non-recurring, they have not been reflected in the pro forma consolidated income statements and related per share calculations. The charges are expected to be incurred shortly following the conversion and the merger.

The estimated non-recurring charges (in thousands) consist of the following:

Merger related professional fees	$	1,100	*
Employee severance and contract costs		1,895
Data processing, marketing and occupancy costs		2,078
		5,073
Tax benefit		1,470
Total estimated non-recurring charges	$	3,603

* Amount not tax effected as it is not deductible for federal and state income tax purposes.

30

Pro Forma Unaudited Consolidated Statement of Financial Condition

At December 31, 2002

(Dollars in thousands, except per share data)

	Keystone, Historical Actual		Pro Forma Conversion Adjustments			Keystone, As Converted			First Colonial			Pro Forma Merger Adjustments			Pro Forma Consolidated
ASSETS
Cash and due from banks	$	33,535				$	33,535		$	22,741		$	—		$	56,276
Interest bearing deposits		52,758		150,897	(1)		203,655			5,002			(3,603	)(6)		202,784
													(1,100	)(5)
													(1,170	)(5)
Federal funds sold		—					—			—						—
Total cash and cash equivalents		86,293		150,897			237,190			27,743			(5,873	)		259,060
Total mortgage-backed securities		—					—									—
Total investment securities—Available for Sale		294,150					294,150			279,263			—			573,413
Total investment securities—Held to Maturity		—					—			30,297			494	(5)		30,791
Mortgage Held for Sale		—					—			1,263			—			1,263
Federal Home Loan Bank Stock, at cost		8,011					8,011			4,218			—			12,229
Loans receivable, net		579,322					579,322			252,760			—			832,082
Bank Owned Life Insurance		26,334					26,334			—			—			26,334
Accrued interest receivable		4,964					4,964			3,142			—			8,106
Premises and equipment, net		12,178					12,178			6,375			—			18,553
Other assets		4,654		5,200	(2)		9,854			6,531			(154	)(5)		16,231
Other Intangible Assets—Core Deposit Intangible		—					—			—			16,548	(5)		16,548
Goodwill		—					—			—			31,797	(5)
													154	(5)		31,951
Total assets	$	1,015,906	$	156,097		$	1,172,003		$	611,592		$	42,966		$	1,826,560
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits	$	780,729				$	780,729		$	472,798		$	—		$	1,253,527
Securities sold under agreements to repurchase		—					—			8,801			—			8,801
Borrowings		113,500					113,500			67,921			—			181,421
Advanced Payments by Borrowers for Taxes and Insurance		2,283					2,283			—			—			2,283
Accrued interest payable		711					711			3,129			—			3,840
Other liabilities		7,634					7,634			3,629			148	(5)		11,411
Guaranteed Preferred Beneficial Interest in the Company’s Subordinated Debt		—					—			15,000			—			15,000
Total liabilities		904,857		—			904,857			571,278			148			1,476,283
Stockholders’ equity
Preferred Stock, par value $5.00; authorized 500,000 shares, none issued		—					—			—			—			—
Common stock, par value $5.00; authorized 10,000,000 shares, 2,239,861 issued		—					—			11,090			(11,090	)(4)		—
Common stock, par value $.01; authorized 100,000,000 shares, 28,097,193 issued pro forma		—		176	(1)		190			—			82	(4)		272
				14	(3)
Additional paid-in capital		—		171,801	(1)		185,840			20,786			3,003			270,825
				14,039	(3)								(20,786	)(4)
													81,983	(4)
													(4	)
Accumulated other comprehensive income, net		4,723					4,723			1,321			346	(5)		6,390
Retained earnings		106,326		(8,853	)(3)		97,473			8,430			(8,430	)(4)		93,870
													(3,603	)(6)
Deferred Compensation		—		—			—			(220	)		220	(4)		—
Common stock to be acquired by management recognition plan, 800,000 shares		—		(7,027	)(1)		(7,027	)								(7,027	)
Employee Stock Ownership Debt—First Colonial		—					—			(1,093	)		1,093	(4)		—
Employee Stock Ownership Debt—Keystone, 1,600,000 shares		—		(14,053	)(1)		(14,053	)		—						(14,053	)
													—
													—
Total stockholders’ equity		111,049		156,097			267,146			40,314			42,818			350,277
	$	1,015,906	$	156,097		$	1,172,003		$	611,592		$	42,966		$	1,826,560

Footnotes continued on next page.

31

(1) Reflects gross proceeds of $175.7 million from the sale of shares of KNBT Bancorp common stock in the conversion, less estimated expenses of the conversion equal to $3.7 million, the purchase of $14.1 million of shares by the KNBT Bancorp employee stock ownership plan funded internally by a loan from KNBT Bancorp and the proposed purchase of $7.0 million of KNBT Bancorp common stock by the KNBT Bancorp recognition and retention plan funded internally by KNBT Bancorp.

(2) Adjustment to record the federal tax benefit of the contribution of 1,405,300 shares of KNBT Bancorp common stock to the Keystone Nazareth Charitable Foundation.

(3) Reflects the issuance of 1,405,300 shares of KNBT Bancorp common stock as a contribution to the Keystone Nazareth Charitable Foundation.

(4) Reflects the merger with First Colonial, includes the issuance of 8,206,493 shares of KNBT Bancorp Stock, and the related reclassification necessary to reflect the exchange of each share of First Colonial common stock previously held for 3.7 shares of KNBT Bancorp’s common stock with a par value of $0.01, the repayment of $1.1 million associated with the First Colonial employee stock ownership plan funded extensively and the assignment of $3.0 million of value related to 247,147 of First Colonial common stock options converted into 914,444 of KNBT Bancorp common stock options.

(5) Reflects purchase accounting adjustments related to merger related expenses of $2.3 million, reclassification of First Colonial investment securities held to maturity to available for sale, estimated core deposit intangible of $16.6 million to be amortized over an estimated 10 years, estimated goodwill of $31.9 million which is not subject to amortization but instead is subject to annual impairment testing.

(6) Adjustment to record the effects of estimated one-time charges of approximately $5.1 million, $3.6 million net of tax effect, which will be charged to earnings as incurred. Since the estimated charges are non-recurring, they have not been reflected in the pro forma consolidated income statements and related per share calculations. The charges are expected to be incurred shortly following the conversion and the merger.

The estimated non-recurring charges (in thousands) consist of the following:

Merger related professional fees	$	1,100	*
Employee severance and contract costs		1,895
Data processing, marketing and occupancy costs		2,078
		5,073
Tax benefit		1,470
Total estimated non-recurring charges	$	3,603

* Amount not tax effected as it is not deductible for federal and state income tax purposes.

32

Pro Forma Unaudited Consolidated Statements of Income

(Dollars in thousands, except per share data)

	Keystone 3/31/2003			First Colonial 3/31/2003		Adjustments			Pro Forma 3/31/2003
Interest Income
Loans, including fees	$	10,133		$	4,176	$	—		$	14,309
Investment securities		—			—		—			—
Taxable		3,363			2,758		1,543	(1)		7,664
Tax-Exempt		575			610					1,185
Other		68			35		—			103
Total interest income		14,139			7,579		1,543			23,261
Interest Expense
Deposits		4,163			2,139		—			6,302
FHLB borrowings		1,108			730		—			1,838
Trust preferred securities		—			181		—
Other		32			27		—			59
Total interest expense		5,303			3,077		—			8,380
Net Interest Income		8,836			4,502		1,543			14,881
Provision for loan losses		62			200		—			262
Net Interest Income after Provision for Loan Losses		8,774			4,302		1,543			14,619
Non-Interest Income										—
Service fees		1,583			619		—			2,202
Trust revenue		—			285		—
Net gains on sales of investment securities		—			765		—			765
Bank owned life insurance		355			—		—			355
Net gains on sales of mortgages		264			417		—			681
Other income		(21	)		180		—			159
Total non-interest income		2,181			2,266		—			4,447
Non-Interest Expense
Salaries and employee benefits		3,735			2,576		—			6,311
							—
							—
Net occupancy expense		851			643		—			1,494
Data processing expense		431			242		—			673
Advertising		307			139		—			446
Impairment of mortgage servicing rights		—			637		—			637
Foundation contribution		—			—		14,053	(3)		14,053
Amortization of intangables		—			—		423	(3)		423
Other		1,582			1,264		—			2,846
Total non-interest expense		6,906			5,501		14,476			26,883
Income before provision for taxes		4,049			1,067		(12,933	)		(7,817	)
Provision for income taxes		1,100			135		(5,200	)(3)		(3,965	)
Net income	$	2,949		$	932	$	(7,733	)	$	(3,852	)
Net income per share:
Basic		nm			0.43					(0.14	)
Diluted		nm			0.41					(0.14	)
Shares Out—Basic					2,177,482		(2,177,482	)(1)		27,028,233
							27,028,233	(2)
Shares Out—Diluted					2,274,995		(2,274,995	)(1)		27,389,032
							27,389,032	(2)

33

	Keystone 12/31/2002			First Colonial 12/31/2002		Adjustments			Pro Forma 12/31/2002
Interest Income
Loans, including fees	$	44,188		$	17,452	$	—		$	61,640
Investment securities		—			—					—
Taxable		13,459			9,847		7,183	(3)		30,489
Tax-Exempt		1,611			2,074		—			3,685
Other		221			157		—			378
Total interest income		59,479			29,530		7,183			96,192
Interest Expense
Deposits		23,099			9,723		—			32,822
FHLB borrowings		3,162			2,082		—			5,244
Trust preferred securities		—			416		—			416
Other		155			189		—			344
Total interest expense		26,416			12,410		—			38,826
Net Interest Income		33,063			17,120		7,183			57,366
Provision for loan losses		111			1,541		—			1,652
Net Interest Income after Provision for Loan Losses		32,952			15,579		7,183			55,714
Non-Interest Income										—
Service fees		5,404			2,586		—			7,990
Trust revenue		—			1,197		—			1,197
Net gains on sales of investment securities		1,202			1,253		—			2,455
Bank owned life insurance		1,435			—		—			1,435
Net gains on sales of mortgages		900			1,122		—			2,022
Other income		(127	)		749		—			622
Total non-interest income		8,814			6,907		—			15,721
Non-Interest Expense
Salaries and employee benefits		13,217			9,055		—			22,272
							—
							—
Net occupancy expense		2,686			2,463		—			5,149
Data processing expense		1,712			767		—			2,479
Advertising		840			479		—			1,319
Impairment of mortgage servicing rights		—			—		—			—
Foundation contribution							14,053	(3)		14,053
Amortization of intangables		—			—		1,692	(2)		1,692
Other		6,113			4,847		—			10,960
Total non-interest expense		24,568			17,611		15,745			57,924
Income before provision for taxes		17,198			4,875		(8,562	)		13,511
Provision for income taxes		5,188			877		(5,200	)(3)		865
Net income	$	12,010		$	3,998	$	(3,363	)	$	12,645
Net income per share:
Basic		nm			1.85					0.47
Diluted		nm			1.82					0.47
Shares Out—Basic					2,169,410		(2,169,410	)(1)		26,998,367
							26,998,367	(2)
Shares Out—Diluted					2,216,049		(2,216,049	)(1)		27,170,931
							27,170,931	(2)

(1) First Colonial historical weighted average number of shares outstanding as adjusted for the 3.7:1 merger exchange ratio used in the calculation of earnings per share are as follows:

34

Period	Historical First Colonial Weighted Average Shares Outstanding— Basic EPS	Historical First Colonial Weighted Average Shares Outstanding—   Diluted Earnings Per Share	Adjusted First Colonial Weighted Average Shares Outstanding—   Basic Earnings Per Share	Adjusted First Colonial Weighted Average Shares Outstanding— Diluted EPS
Three months ended March 31, 2003	2,177,482	2,274,995	8,056,683	8,417,482
Year ended December 31, 2002	2,169,410	2,216,049	8,026,817	8,199,381

(2) The weighted average number of shares outstanding used to calculate pro forma consolidated earnings per share are as follows:

Period	Pro Forma Weighted Average Shares Outstanding—Basic Earnings Per Share	Pro Forma Weighted Average Shares Outstanding—Diluted Earning Per Share
Three months ended March 31, 2003	27,028,233	27,389,032
Year ended December 31, 2002	26,998,367	27,170,931

The number of shares in this table has been computed by increasing the weighted average number of shares of First Colonial Common Stock outstanding, adjusted for the 3.7:1 merger exchange ratio, as shown in footnote (1) above, by 17,566,250 shares of KNBT Bancorp common stock issued in the conversion and 1,405,300 shares of KNBT Bancorp common stock issued to the Keystone Nazareth Charitable Foundation.

(3) To record: estimated interest income assuming the net proceeds of $150.9 million from the conversion offering are invested at an average yield of 4.09% and 4.76% for the three months ended March 31, 2003 and the year ended December 31, 2002, respectively; contribution of 1,405,800 shares of KNBT Bancorp common stock as a contribution to the Keystone Nazareth Charitable Foundation and the related tax benefit of such contribution at 37%; and amortization of core deposit intangible over an estimated 10 years.

Additional Pro Forma Data

The actual net proceeds from the sale of KNBT Bancorp common stock in the conversion offering cannot be determined until the conversion is completed. However, the conversion offering net proceeds are currently estimated to be between $126.6 million and $172.0 million (or $198.1 million in the event the offering range is increased by approximately 15%) based upon the following assumptions:

• KNBT Bancorp will sell all shares of common stock in the subscription offering;

• KNBT Bancorp’s employee stock ownership plan will purchase 8% of the shares of common stock sold in the conversion offering (not including shares contributed to the Keystone Nazareth Charitable Foundation) with a loan from KNBT Bancorp;

• KNBT Bancorp will make a contribution to the charitable foundation consisting of shares of its common stock equal to 8% of the shares issued in the conversion with an assumed value of $10.00 per share;

• expenses of the conversion offering, other than the fees to be paid to Sandler O’Neill & Partners, L.P., are estimated to be $2.1 million;

35

• 300,000 shares of common stock will be purchased by KNBT Bancorp’s executive officers and directors, and their immediate families; and

• Sandler O’Neill & Partners, L.P. will receive fees equal to 1.0% of the aggregate purchase price of the shares of stock sold in the conversion offering, excluding any shares purchased by any of employee benefit plans, and any of KNBT Bancorp’s trustees, officers or employees or members of their immediate families.

• KNBT Bancorp will contribute shares to the Keystone Nazareth Charitable Foundation in an amount equal to 8% of the shares sold in the conversion offering and that 8,287,486 merger exchange shares are issued in the merger.

• One-time expenses incurred in connection with the merger total $5.1 million, pre-tax.

KNBT Bancorp has prepared the following tables, which set forth Keystone’s historical consolidated net income and shareholders’ equity prior to the conversion and the merger and KNBT Bancorp’s pro forma consolidated net income and shareholders’ equity following the conversion and the merger. In preparing these tables and in calculating pro forma data, the following assumptions have been made:

• Pro forma earnings have been calculated assuming the stock had been sold at the beginning of the period and the net proceeds had been invested at an average yield of 4.09% and 4.76% for the three months ended March 31, 2003 and the year ended December 31, 2002, respectively, which equals the arithmetic average of Keystone’s average yield on interest-earning assets and the average rate paid on deposits for the three months ended March 31, 2003 and the year ended December 31, 2002, respectively.

• The pro forma after-tax yield on the net proceeds from the conversion offering is assumed to be 2.58% and 3.00% for the three months ended March 31, 2003 and the year ended December 31, 2002, respectively, based on an effective tax rate of 37.00%.

• No withdrawals were made from Keystone’s deposit accounts for the purchase of shares in the conversion offering.

• Historical and pro forma per share amounts have been calculated by dividing historical and pro forma amounts by the indicated number of shares of stock, as adjusted in the pro forma net income per share to give effect to the purchase of shares by the employee stock ownership plan.

• Pro forma shareholders’ equity amounts have been calculated as if KNBT Bancorp common stock had been sold in the conversion offering on March 31, 2003 and December 31, 2002, respectively, and, accordingly, no effect has been given to the assumed earnings effect of the transactions.

The following pro forma information may not be representative of the financial effects of the conversion at the date on which the conversion and the merger actually occur and should not be taken as indicative of future results of operations. Pro forma shareholders’ equity represents the difference between the stated amount of KNBT Bancorp assets and liabilities computed in accordance with generally accepted accounting principles. Shareholders’ equity does not give effect to intangible assets in the event of a liquidation. The pro forma shareholders’ equity is not intended to represent the fair market value of the common stock and may be different than amounts that would be available for distribution to shareholders in the event of liquidation.

The tables do not reflect the possible issuance of additional shares equal to 10% of the common stock sold in the conversion to be reserved for future issuance pursuant to KNBT Bancorp proposed stock option plan or shares of which may be issued upon the exercise of options to purchase First Colonial common stock which are outstanding upon completion of the merger and are converted into options to purchase KNBT Bancorp common stock, nor does book value give any effect to the liquidation account to be established for the benefit of eligible account holders and supplemental eligible account holders or to Keystone’s bad debt reserve. See “Management—New Stock Benefit Plans” and “The Conversion and the Merger—Liquidation Rights of Certain Depositors.” The tables do give effect to the recognition and retention plan, which KNBT Bancorp expects to adopt following the conversion and present

36

(together with the stock option plan) to its shareholders for approval at a meeting to be held at least six months after the conversion and the merger is completed. If approved by shareholders, the recognition and retention plan intends to acquire an amount of common stock equal to 4% of the shares of common stock sold in the conversion offering (not including the shares contributed to the Keystone Nazareth Charitable Foundation), either through open market purchases, if permissible, or from authorized but unissued shares of common stock. The table assumes that shareholder approval has been obtained and that the shares acquired by the recognition and retention plan are purchased in the open market at $10.00 per share. There can be no assurance that shareholder approval of the recognition plan will be obtained, that the shares will be purchased in the open market or that the purchase price will be $10.00 per share.

The tables on the following pages summarize historical consolidated data of Keystone and First Colonial, and KNBT Bancorp’s pro forma data at or for the dates and periods indicated based on the assumptions set forth above and in the table and should not be used as a basis for projection of the market value of the common stock following the conversion and the merger.

37

	At or For the Three Months Ended March 31, 2003
	12,983,750 shares sold at $10.00 per share (Minimum of range)			15,275,000 shares sold at $10.00 per share (Midpoint of range)			17,566,250 shares sold at $10.00 per share (Maximum of range)			20,201,188 shares sold at $10.00 per share (15% above Maximum)
	(Dollars in thousands, except per share amounts)
Pro forma market capitalization	$	140,225		$	164,970		$	189,716		$	218,173
Less shares issued to foundation		(10,387	)		(12,220	)		(14,053	)		(16,161	)
Gross proceeds of public offering		129,838			152,750			175,663			202,012
Less offering expenses		(3,265	)		(3,475	)		(3,686	)		(3,929	)
Estimated net conversion proceeds		126,573			149,275			171,977			198,083
Less ESOP shares		(10,387	)		(12,220	)		(14,053	)		(16,161	)
Less recognition and retention plan shares		(5,194	)		(6,110	)		(7,027	)		(8,080	)
Less one-time cash merger related expenses(1)		(5,073	)		(5,073	)		(5,073	)		(5,073	)
Estimated net proceeds available for Investment	$	105,919		$	125,872		$	145,824		$	168,769
Consolidated net income(1):
Historical combined	$	3,615		$	3,615		$	3,615		$	3,615
Pro forma adjustments:
Net income from proceeds		682			811			939			1,087
ESOP(2)		(109	)		(128	)		(148	)		(170	)
Recognition and retention plan(3)		(164	)		(192	)		(221	)		(255	)
Pro forma net income(1)	$	4,024		$	4,106		$	4,185		$	4,277
Net income per share(1):
Historical combined	$	0.17		$	0.15			0.14			0.13
Pro forma adjustments:
Net income from proceeds		0.03			0.03			0.04			0.04
ESOP(2)		(0.01	)		(0.01	)		(0.01	)		(0.01	)
Recognition and retention plan(3)		(0.01	)		(0.01	)		(0.01	)		(0.01	)
Pro forma net income per share(1)(4)	$	0.18		$	0.16		$	0.16		$	0.15
Shareholders’ equity:
Historical combined	$	201,215		$	201,215		$	201,215		$	201,215
Estimated net conversion proceeds		126,573			149,275			171,977			198,083
Plus shares issued to foundation		10,387			12,220			14,053			16,161
Less after tax cost of foundation		(6,544	)		(7,699	)		(8,853	)		(10,181	)
Less common stock acquired by:
ESOP(2)		(10,387	)		(12,220	)		(14,053	)		(16,161	)
Recognition and retention plan(3)		(5,194	)		(6,110	)		(7,027	)		(8,080	)
Less merger-related non-recurring expenses, net of tax		(3,603	)		(3,603	)		(3,603	)		(3,603	)
Pro forma shareholders’ equity(3)(4)(5)	$	312,447		$	333,078		$	353,709		$	377,434
Shareholders’ equity per share(6):
Historical combined	$	9.02		$	8.12		$	7.38		$	6.68
Estimated net conversion proceeds		5.67			6.02			6.31			6.58
Plus shares issued to foundation		0.47			0.49			0.52			0.54
Less after tax cost of foundation		(0.30	)		(0.31	)		(0.33	)		(0.34	)
Less common stock acquired by:
ESOP(2)		(0.47	)		(0.49	)		(0.52	)		(0.54	)
Recognition and retention plan(3)		(0.23	)		(0.25	)		(0.26	)		(0.27	)
Less merger-related non-recurring expenses, net of tax		(0.16	)		(0.15	)		(0.13	)		(0.12	)
Pro forma shareholders’ equity per share(3)(4)(5)	$	14.00		$	13.43		$	12.97		$	12.53
Pro forma price to earnings per share (P/E ratio)(7)		13.89	x		15.63	x		15.63	x		16.67	x
Pro forma price to pro forma shareholders’ equity per share(7)		71.43	%		74.46	%		77.10	%		79.1	%

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(1) Does not give effect to the non-recurring expense that will be recognized in 2003 as a result of the establishment of the charitable foundation and the completion of the merger. KNBT Bancorp will recognize an after-tax expense for the amount of the aggregate contribution to the foundation which is expected to range from $6.5 million to $8.9 million. For the purposes of this presentation, one-time cash merger-related expenses of $5.1 million (pre-tax) which are expected to be paid upon consummation of the conversion and the merger or shortly thereafter are reflected as an adjustment to net proceeds for purposes of the pro forma net income and pro forma net income per share information. For purposes of pro forma shareholders’ equity and pro forma shareholders’ equity per share, $3.6 million of merger-related non-recurring expenses, net of tax are deducted. Per share net income data is based on 21,288,548, 23,582,853, 25,877,158 and 28,515,608 shares outstanding at the minimum, midpoint, maximum and adjusted maximum of the estimated offering range, respectively, which represents shares sold in the conversion offering, shares contributed to the foundation, merger exchange shares issued in the merger and shares to be allocated or distributed under KNBT Bancorp’s employee stock ownership plan (“ESOP”) and recognition and retention plan for the period presented.

(2) It is assumed that 8% of the aggregate shares sold in the conversion offering will be purchased by KNBT Bancorp’s ESOP. The funds used to acquire such shares are assumed to have been borrowed by the ESOP from KNBT Bancorp. The amount to be borrowed is reflected as a reduction to shareholders’ equity. Annual contributions are expected to be made to the ESOP in an amount at least equal to the principal and interest requirement of the debt. The pro forma net income assumes: (i) that the contribution to the ESOP is equivalent to the debt service requirement for the three months ended March 31, 2003, at an average fair value of $10.00 per share; and (ii) only the ESOP shares committed to be released were considered outstanding for purposes of the net income per share calculations.

(3) Gives effect to the recognition and retention plan KNBT Bancorp expects to adopt following completion of the conversion and the merger. This plan is expected to acquire a number of shares of common stock equal to an aggregate of 4% of the shares of common stock sold in the conversion offering, or 519,350, 611,000, 702,650 and 808,098 shares of common stock at the minimum, midpoint, maximum and adjusted maximum of the estimated offering range, respectively, either through open market purchases or directly from KNBT Bancorp. In calculating the pro forma effect of the recognition and retention plan, it is assumed that the shares were acquired by the plan at the beginning of the period presented in open market purchases at $10.00 per share and that 20% of the amount contributed was an amortized expense during such period. The issuance of authorized but unissued shares of KNBT Bancorp common stock to the recognition and retention plan instead of open market purchases would dilute the voting interests of existing shareholders by approximately 2.4%.

(4) No effect has been given to the issuance of additional shares of common stock pursuant to the stock option plan that KNBT Bancorp expects to adopt following the conversion. Under the stock option plan, an amount equal to the aggregate 10% of the common stock sold in the conversion offering, or 1,293,875, 1,527,500, 1,756,625 and 2,020,119 shares at the minimum, midpoint, maximum and adjusted maximum of the estimated offering range, respectively, will be reserved for future issuance upon the exercise of options to be granted under the stock option plan. The issuance of common stock pursuant to the exercise of options under the KNBT Bancorp stock option plan will result in the dilution of existing shareholders’ voting power by approximately 5.8%. No effect has been given to the issuance of additional shares pursuant to the options to purchase First Colonial common stock which will be outstanding upon completion of the merger which will be converted to options to purchase KNBT Bancorp common stock.

(5) The retained earnings of Keystone will continue to be substantially restricted after the conversion.

(6) Shareholders’ equity per share data is based upon 22,309,936, 24,784,486, 27,259,036 and 30,104,769 shares outstanding at the minimum, midpoint, maximum and adjusted maximum of the estimated offering range, respectively, representing shares issued in the offering, shares purchased by KNBT Bancorp ESOP and the recognition and retention plan, shares contributed to the charitable foundation and merger exchange shares issued in the merger.

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(7) Based on pro forma net income for the three months ended March 31, 2003.

(8) As adjusted to give effect to an increase in the number of shares which could occur due to an increase in the estimated offering range of up to 15% as a result of regulatory considerations, demand for the shares, or changes in market or general financial and economic conditions following the commencement of the offering.

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	At or For the Year Ended December 31, 2002
	12,983,750 shares sold at $10.00 per share (Minimum of range)			15,275,000 shares sold at $10.00 per share (Midpoint of range)			17,566,250 shares sold at $10.00 per share (Maximum of range)			20,201,188 shares sold at $10.00 per share (15% above Maximum)
	(Dollars in thousands, except per share amounts)
Pro forma market capitalization	$	140,225		$	164,970		$	189,716		$	218,173
Less shares issued to foundation		(10,387	)		(12,220	)		(14,053	)		(16,161	)
Gross proceeds of public offering		129,838			152,750			175,663			202,012
Less offering expenses		(3,265	)		(3,475	)		(3,686	)		(3,929	)
Estimated net conversion proceeds		126,573			149,275			171,977			198,083
Less ESOP shares		(10,387	)		(12,220	)		(14,053	)		(16,161	)
Less recognition and retention plan shares		(5,194	)		(6,110	)		(7,027	)		(8,080	)
Less one-time cash merger-related expenses(1)		(5,073	)		(5,073	)		(5,073	)		(5,073	)
Estimated net proceeds available for investment	$	105,919		$	125,872		$	145,824		$	168,769
Consolidated net income(1):
Historical combined	$	14,942		$	14,942		$	14,942		$	14,942
Pro forma adjustments:
Net income from proceeds		3,176			3,775			4,373			5,061
ESOP(2)		(436	)		(513	)		(590	)		(679	)
Recognition and retention plan(3)		(654	)		(770	)		(885	)		(1,018	)
Pro forma net income(1)	$	17,028		$	17,434		$	17,840		$	18,306
Net income per share(1):
Historical combined	$	0.70		$	0.63			0.58			0.52
Pro forma adjustments:
Net income from proceeds		0.15			0.16			0.17			0.18
ESOP(2)		(0.02	)		(0.02	)		(0.02	)		(0.02	)
Recognition and retention plan(3)		(0.03	)		(0.03	)		(0.03	)		(0.03	)
Pro forma net income per share(1)(4)	$	0.80		$	0.74		$	0.70		$	0.65
Shareholders’ equity:
Historical combined	$	197,784		$	197,784		$	197,784		$	197,784
Estimated net conversion proceeds		126,573			149,275			175,663			202,012
Plus shares issued to foundation		10,387			12,220			14,053			16,161
Less after tax cost of foundation		(6,544	)		(7,699	)		(8,853	)		(10,181	)
Less common stock acquired by:
ESOP(2)		(10,387	)		(12,220	)		(14,053	)		(16,161	)
Recognition and retention plan(3)		(5,194	)		(6,110	)		(7,027	)		(8,080	)
Less merger-related non-recurring expenses, net of taxes		(3,603	)		(3,603	)		(3,603	)		(3,603	)
Pro forma shareholders’ equity(3)(4)(5)	$	309,016		$	329,647		$	350,278		$	374,003
Shareholders’ equity per share(6):
Historical (retained earnings)	$	8.87		$	7.98		$	7.26		$	6.57
Estimated net conversion proceeds		5.67			6.02			6.31			6.58
Plus shares issued to foundation		0.47			0.49			0.52			0.54
Less after tax cost of foundation		(0.30	)		(0.31	)		(0.33	)		(0.34	)
Less common stock acquired by:
ESOP(2)		(0.47	)		(0.49	)		(0.52	)		(0.54	)
Recognition and retention plan(3)		(0.23	)		(0.25	)		(0.26	)		(0.27	)
Less merger-related non-recurring expenses, net of taxes		(0.16	)		(0.15	)		(0.13	)		(0.12	)
Pro forma shareholders’ equity per share(3)(4)(5)	$	13.85		$	13.29		$	12.85		$	12.42
Pro forma price to earnings per share (P/E ratio)(7)		12.50	x		13.51	x		14.29	x		15.48	x
Pro forma price to pro forma shareholders’ equity per share(7)		72.20	%		75.24	%		77.82	%		80.52	%

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(1) Does not give effect to the non-recurring expense that will be recognized in 2003 as a result of the establishment of the charitable foundation and the completion of the merger. KNBT Bancorp will recognize an after-tax expense for the amount of the aggregate contribution to the foundation which is expected to range from $6.5 million to $8.9 million. For the purposes of this presentation, one-time cash merger-related expenses of $5.1 million (pre-tax) which are expected to be paid upon consummation of the conversion and the merger or shortly thereafter are reflected as an adjustment to net proceeds for purposes of the pro forma net income and pro forma net income per share information. For purposes of pro forma shareholders’ equity and pro forma shareholders’ equity per share, $3.6 million of merger-related non-recurring expenses, net of tax are deducted. Per share net income data is based on 21,340,483, 23,643,453, 25,947,423 and 28,596,413 shares outstanding at the minimum, midpoint, maximum and adjusted maximum of the estimated offering range, respectively, which represents shares sold in the conversion offering, shares contributed to the foundation, merger exchange shares issued in the merger and shares to be allocated or distributed under KNBT Bancorp’s employee stock ownership plan (“ESOP”) and recognition and retention plan for the period presented.

(2) It is assumed that 8% of the aggregate shares sold in the conversion offering will be purchased by KNBT Bancorp’s ESOP. The funds used to acquire such shares are assumed to have been borrowed by the ESOP from KNBT Bancorp. The amount to be borrowed is reflected as a reduction to shareholders’ equity. Annual contributions are expected to be made to the ESOP in an amount at least equal to the principal and interest requirement of the debt. The pro forma net income assumes: (i) that the contribution to the ESOP is equivalent to the debt service requirement for the year ended December 31, 2002, at an average fair value of $10.00; and (ii) only the ESOP shares committed to be released were considered outstanding for purposes of the net income per share calculations.

(3) Gives effect to the recognition and retention plan KNBT Bancorp expects to adopt following the offering. This plan is expected to acquire a number of shares of common stock equal to an aggregate of 4% of the shares of common stock sold in the conversion offering, or 519,350, 611,000, 702,250 and 808,098 shares of common stock at the minimum, midpoint, maximum and adjusted maximum of the estimated offering range, respectively, either through open market purchases or directly from KNBT Bancorp. In calculating the pro forma effect of the recognition and retention plan, it is assumed that the shares were acquired by the plan at the beginning of the period presented in open market purchases at $10.00 per share and that 20% of the amount contributed was an amortized expense during such period. The issuance of authorized but unissued shares of KNBT Bancorp common stock to the recognition and retention plan instead of open market purchases would dilute the voting interests of existing shareholders by approximately 2.4%.

(4) No effect has been given to the issuance of additional shares of common stock pursuant to the stock option plan that KNBT Bancorp expects to adopt following the conversion. Under the stock option plan, an amount equal to the aggregate 10% of the common stock sold in the conversion offering, or 1,293,875, 1,527,500, 1,756,625 and 2,020,119 shares at the minimum, midpoint, maximum and adjusted maximum of the estimated offering range, respectively, will be reserved for future issuance upon the exercise of options to be granted under the stock option plan. The issuance of common stock pursuant to the exercise of options under the KNBT Bancorp stock option plan will result in the dilution of existing shareholders’ voting power by approximately 5.8%. No effect has been given to the issuance of additional shares pursuant to the options to purchase First Colonial common stock which will be outstanding upon completion of the merger which will be converted to options to purchase KNBT Bancorp common stock.

(5) The retained earnings of Keystone will continue to be substantially restricted after the conversion.

(6) Shareholders’ equity per share data is based upon 22,309,936, 24,784,486, 27,259,036 and 30,104,769 shares outstanding at the minimum, midpoint, maximum and adjusted maximum of the estimated offering range, respectively, representing shares issued in the offering, shares purchased by KNBT Bancorp ESOP and the recognition and retention plan, shares contributed to the charitable foundation and merger exchange shares issued in the merger.

(7) Based on pro forma net income for the year ended December 31, 2002.

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(8) As adjusted to give effect to an increase in the number of shares which could occur due to an increase in the estimated offering range of up to 15% as a result of regulatory considerations, demand for the shares, or changes in market or general financial and economic conditions following the commencement of the offering.

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COMPARISON OF INDEPENDENT VALUATION AND PRO FORMA

FINANCIAL INFORMATION WITH AND WITHOUT THE FOUNDATION

As set forth in the following table, if KNBT Bancorp was not making a contribution to the Keystone Nazareth Charitable Foundation as part of the conversion, RP Financial estimates that the pro forma valuation of KNBT Bancorp would be greater, which would increase the amount of common stock offered for sale in the conversion offering. Without the foundation, the amount of common stock offered for sale in the conversion offering at the maximum of the offering range would be approximately $25.6 million greater. If the foundation were not established, there is no assurance that the appraisal prepared at the time of conversion would conclude that the pro forma market value of KNBT Bancorp would be the same as the estimate set forth in the table below. Any appraisal prepared at the time of conversion would be based on the facts and circumstances existing at that time, including, among other things, market and economic conditions.

The information presented in the following table is for comparative purposes only. It assumes that the conversion was completed at March 31, 2003, based on the assumptions set forth under “ Pro Forma Unaudited Financial Information—Additional Pro Forma Data.”

	At the Minimum of Offering Range						At the Maximum of Offering Range						At the Maximum, as Adjusted, of Offering Range
	With Foundation			No Foundation			With Foundation			No Foundation			With Foundation			No Foundation
	(Dollars in thousands, except per share amounts)
Estimated pro forma valuation	$	129,838		$	148,750		$	175,663		$	201,250		$	202,012		$	231,438
Pro forma market capitalization(1)		140,225			148,750			189,716			201,250			218,173			231,438
Pro forma total assets(2)		1,816,682			1,829,308			1,857,944			1,875,025			1,881,669			1,901,313
Pro forma total liabilities(3)		1,505,705			1,505,705			1,505,705			1,505,705			1,505,705			1,505,705
Pro forma shareholders’ equity		312,447			325,073			353,709			370,790			377,434			397,078
Pro forma net earnings		4,024			4,091			4,185			4,275			4,277			4,381
Pro forma shareholders’ equity per share		14.00			14.03			12.97			13.05			12.53			12.64
Pro forma net earnings per share		0.18			0.18			0.16			0.15			0.15			0.14
Pro forma shares outstanding for earnings calculation		21,288,548						25,877,158						28,515,608
Pro Forma Pricing Ratios:
Offering price as a percentage of pro forma shareholders’ equity		71.43	%		71.28	%		77.10	%		76.63	%		79.81	%		79.11	%
Offering price as a multiple of pro forma net earnings per share(4)		13.89	x		13.89	x		15.63	x		16.67	x		16.67	x		17.86	x
Offering price to assets(5)		7.72	%		8.13	%		10.21	%		10.73	%		11.59	%		12.17	%
Pro Forma Financial Ratios:
Return on assets (6)		0.89	%		0.89	%		0.90	%		0.91	%		0.91	%		0.92	%
Return on shareholders’ equity(7)		5.15			5.03			4.73			4.61			4.53			4.41
Shareholders’ equity to total assets		17.20			17.77			19.04			19.78			20.06			20.88
Total shares issued		22,309,936			23,162,486			27,259,036			28,412,486			30,104,769			31,431,286

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(1) Pro forma market capitalization is equal to the amount of the gross proceeds plus the value of the common stock issued to the Keystone Nazareth Charitable Foundation.

(2) Pro forma assets are equal to Keystone’s total assets at March 31, 2003 plus estimated net proceeds and the tax benefit created by the Keystone Nazareth Charitable Foundation.

(3) Pro forma total liabilities are equal to Keystone’s total liabilities at March 31, 2003.

(4) Annualized. If the contribution to the foundation had been expensed during the three-months ended March 31, 2003, KNBT Bancorp would have incurred a net loss.

(5) Offering price to assets is equal to pro forma market capitalization as a percent of total assets.

(6) Annualized. If the contribution to the foundation had been expensed during the three-months ended March 31, 2003, pro forma return on assets would have been a negative 0.55%, negative 1.01% and negative 1.26% at the minimum maximum and maximum, as adjusted, respectively.

(7) Annualized. If the contribution to the foundation had been expensed during the three-months ended March 31, 2002, return on shareholders’ equity would have been a negative 3.23%, negative 5.28% and a negative 6.26% at the minimum, maximum and maximum, as adjusted, respectively.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF KEYSTONE

General

Keystone’s results of operations depend, to a large extent, on net interest income, which is the difference between the income earned on its loan and investment portfolios and interest expense on deposits and borrowings. Results of operations are also affected by fee income from its banking and non-banking operations, provisions for loan losses, loan servicing and other noninterest income. Non-interest expense principally consists of compensation and employee benefits, office occupancy and equipment expense, data processing, advertising and business promotion and other expense. Keystone’s results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially impact Keystone’s financial conditions and results of operations. See “Risk Factors” beginning on page         .

Keystone’s Operating Strategy

Keystone historically operated as a traditional savings bank primarily providing single-family residential mortgage loans and a variety of retail deposit products and services to its customers.

Highlights of Keystone’s management strategy in recent periods are as follows:

• Repositioning of the Loan Portfolio. In recent years, Keystone has undertaken to transform its loan portfolio to be more like a community bank. In this respect, Keystone has significantly increased its originations of commercial real estate loans, consumer loans, construction and land development loans and commercial business loans. In addition, as part of its interest-rate risk management strategy, while Keystone has continued to be a leading originator of single-family mortgage loans in Lehigh and Northampton Counties, it has significantly reduced the amount of its single-family residential mortgage loans in its portfolio in recent periods through two securitizations of seasoned residential mortgage loans in 2002 and the first quarter of 2003 for an aggregate of $162.6 million as well as the sale in the secondary market during the same period of aggregate of approximately $47.7 million of newly originated single-family residential mortgage loans. These actions, which were part of Keystone’s efforts to increase the yield on its loan portfolio and reduce its exposure to interest rate risk, have resulted in a reduction in the ratio of Keystone’s single-family residential mortgage loans as a percentage of total loans has been reduced from 73.3% at December 31, 2001 to 51.4% at March 31, 2003. The loan securitizations also have been a primary reason for the decrease in Keystone’s total loan portfolio from $700.7 million at December 31, 2001 to $560.0 million at March 31, 2003.

• Increasing Noninterest Income. Keystone has increased its noninterest income in recent periods by recognizing gains upon the sale of certain residential mortgage loans and mortgage-backed securities, introducing additional fee generating services, such as overdraft protection on checking accounts, revising its fee structure for deposit accounts and other services, investing in bank owned life insurance (“BOLI”) and through fees from retail sales of securities and insurance products. Noninterest income at Keystone increased by 75.8% for the year ended December 31, 2002 compared to the year ended December 31, 2001. While noninterest income decreased in the first quarter of 2003 compared to the first quarter of 2002, on an annualized basis, the amount of noninterest income at Keystone in the first quarter of 2003 was substantially consistent for the year ended December 31, 2002.

• Continuing Growth and Expanding Banking Franchise. Keystone has increased its total assets in each of the past five full years. During this five-year period, total assets at Keystone increased by 41.8%, or 8.4% on an annualized basis. In addition, Keystone has increased the number of its full service offices from 15 at December 31, 1998 to 19 at December 31, 2002. Keystone’s branch network includes both “stand-alone” branches and branches located inside local supermarkets, which offer expanded hours of operation and increased customer convenience. In addition to the

46

additional offices to be acquired from Nazareth National Bank, Keystone plans to open at least three new full service supermarket branch offices in 2003.

• Maintaining Asset Quality. While Keystone has grown its franchise, it has continued to focus on maintaining a high level of asset quality in its efforts to ensure long-term financial success. At March 31, 2003, the ratio of total non-performing assets to total assets at Keystone was 0.20%, and the average of this ratio at year-end over the five-years ended December 31, 2002 was 0.22%. Keystone attributes its relatively low amounts of non-performing assets over this period to careful underwriting pursuant to standards which it believes are prudent.

• Increasing Core Deposits. Keystone has increased the amount of its core deposits, consisting of savings accounts, checking accounts and money market accounts, from $272.6 million, or 38.2% of total deposits, at December 31, 2000 to $408.6 million, or 51.2% of total deposits, at March 31, 2003. Keystone has reduced its reliance on certificates of deposit, which generally are higher costing than core deposits and more susceptible to being moved to other institutions offering higher rates. As part of this strategy, Keystone also has increased its utilization of borrowings in order to supplement its deposit base as a source of funds.

Critical Accounting Policies

Keystone has identified the calculation of the allowance for loan losses as a critical accounting policy, due to the higher degree of judgment and complexity than its other significant accounting policies. Provisions for loan losses will continue to be based upon management’s periodic valuation and assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions and other relevant factors in order to maintain the allowance for loan losses at a level believed by management to be sufficient to absorb estimated, probable losses. Although management uses the best information available, the level of the allowance for loan losses remains an estimate which is subject to significant judgment and short-term change. For additional information, see “Business of Keystone—Asset Quality—Allowance for Loan Losses.”

How Keystone Manages Market Risk

Market risk is the risk of loss from adverse changes in market prices and rates. Keystone’s market risk arises primarily from the interest rate risk which is inherent in its lending and deposit taking activities. To that end, management actively monitors and manages interest rate risk exposure. In addition to market risk, Keystone’s primary risk is credit risk on its loan portfolio. Keystone attempts to manage credit risk through its loan underwriting and oversight policies. See “Business of Keystone—Lending Activities.”

The principal objective of Keystone’s interest rate risk management function is to evaluate the interest rate risk embedded in certain balance sheet accounts, determine the level of risk appropriate given its business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with approved guidelines. Through such management, Keystone seeks to reduce the exposure of its operations to changes in interest rates. Keystone monitors interest rate risk as such risk relates to its operating strategies. Keystone has established an Asset/Liability Committee, responsible for reviewing its asset/liability policies and interest rate risk position. The Asset/Liability Committee meets on a quarterly basis. The extent of the movement of interest rates is an uncertainty that could have a negative impact on future earnings of Keystone.

In recent years, Keystone primarily has utilized the following strategies in its efforts to manage interest rate risk:

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• it has emphasized originations for portfolio of shorter term loans, particularly construction loans, commercial real estate and land loans and consumer loans;

• it has reduced its reliance on certificates of deposit as a funding source;

• it has been an active seller in the secondary market of its newly originated, agency eligible long-term fixed-rate residential mortgage loans and it securitized an aggregate of $162.6 million of single-family residential mortgage loans in 2002 and the first quarter of 2003; and

• it has invested in securities with relatively short anticipated lives, generally three to five years.

Gap Analysis. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring a bank’s interest rate sensitivity “gap.” An asset and 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 the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period. At March 31, 2003, Keystone’s cumulative one-year interest rate gap (which is the difference between the amount of interest-earning assets maturing or repricing within one year and interest-bearing liabilities maturing or repricing within one year) as a percentage of total assets, was a negative 0.19%. 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 the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to affect adversely net interest income while a positive gap would tend to result in an increase in net interest income. Conversely, 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 adversely net interest income.

The following table sets forth the amounts of Keystone’s interest-earning assets and interest-bearing liabilities outstanding at March 31, 2003, which are expected, based upon certain assumptions, to reprice or mature in each of the future time periods shown (the “GAP Table”). Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual maturity of the asset or liability. The table sets forth an approximation of the projected repricing of assets and liabilities at March 31, 2003, on the basis of contractual maturities, anticipated prepayments, and scheduled rate adjustments within a three-month period and subsequent selected time intervals. The loan amounts in the table reflect principal balances expected to be repaid and/or repriced as a result of contractual amortization and anticipated prepayments of adjustable-rate loans and fixed-rate loans, and as a result of contractual rate adjustments on adjustable-rate loans. Annual prepayment rates for adjustable-rate and fixed-rate single-family and multi-family mortgage loans are assumed to range from 6.0% to 54.0%. The annual prepayment rate for mortgage-backed securities is assumed to range from 6.0% to 54.0%. Money market deposit accounts, savings accounts and interest-bearing checking accounts are assumed to have annual rates of withdrawal, or “decay rates,” of 20%, 15% and 15%, respectively. See “Business of Keystone—Lending Activities,” “—Investment Activities” and “—Sources of Funds.”

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	3 Months or Less			More than 3 Months to 6 Months			More than 6 Months to 1 Year			More than 1 Year to 3 Years			More than 3 Years to 5 Years			More than 5 Years			Total Amount
	(Dollars in Thousands)
Interest-earning assets(1):
Deposits at other institutions	$	40,399		$	—		$	—		$	—		$	—		$	—		$	40,399
Investment securities		16,590			15,894			18,522			66,222			53,669			229,257			400,154
Loans receivable(2)		94,625			40,181			62,172			140,602			82,119			140,307			560,006
FHLB stock		8,516			—			—			—			—			—			8,516
Total interest-earning assets	$	160,130		$	56,075		$	80,694		$	206,824		$	135,788		$	369,564		$	1,009,075
Cumulative total interest- earning assets	$	160,130		$	216,205		$	296,899		$	503,723		$	639,511		$	1,009,075
Interest-bearing liabilities:
Savings accounts		4,629			4,612			9,869			36,618			36,618			29,920			122,266
Checking accounts		3,406			3,406			6,812			27,246			27,246			22,705			90,821
Money market accounts		7,895			7,895			15,791			63,164			63,002			—			157,747
Certificate accounts		70,036			59,584			78,419			139,682			40,199			903			388,823
FHLB advances and other Borrowings		10,013			—			16,500			8,000			23,500			55,500			113,513
Total interest-bearing liabilities	$	95,979		$	75,497		$	127,391		$	274,710		$	190,565		$	109,028		$	873,170
Cumulative total interest- bearing liabilities	$	95,579		$	171,476		$	298,867		$	573,579		$	764,142		$	873,170
Interest-earning assets less interest-bearing liabilities	$	64,151		$	(19,422	)	$	(46,697	)	$	(67,886	)	$	(54,777	)	$	260,536		$	135,905
Cumulative interest-rate sensitivity gap(3)	$	64,151		$	44,729		$	(1,968	)	$	(69,854	)	$	(124,631	)	$	135,905
Cumulative interest-rate gap as a percentage of total assets at March 31, 2003		6.17	%		4.30	%		(0.19	)%		(6.72	)%		(11.99	)%		13.07	%
Cumulative interest- earning assets as a percentage of cumulative interest- bearing liabilities at March 31, 2003		166.84	%		126.08	%		99.34	%		87.82	%		83.69	%		115.56	%

(1) Interest-earning assets are included in the period in which the balances are expected to be redeployed and/or repriced as a result of anticipated prepayments, scheduled rate adjustment and contractual maturities.

(2) For purposes of the gap analysis, loans receivable includes non-performing loans, gross of the allowance for loan losses, undisbursed loan funds and deferred loan fees.

(3) Interest-rate sensitivity gap represents the difference between net interest-earning assets and interest-bearing liabilities.

Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features which restrict changes in interest rates both on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating

49

the table. Finally, the ability of many borrowers to service their adjustable-rate loans may decrease in the event of an interest rate increase.

Interest Rate Risk. Keystone’s interest rate sensitivity is monitored by management through the use of models which generate estimates of the change in its net portfolio value (“NPV”) and net interest income (“NII”) over a range of interest rate scenarios. NPV is the present value of expected cash flows from assets, liabilities, and off-balance sheet contracts. The NPV ratio, under any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario. The following table sets forth Keystone’s NPV as of March 31, 2003 and reflects the changes to NPV as a result of immediate and sustained changes in interest rates as indicated.

Change in Interest Rates In Basis Points (“bp”) (Rate Shock)	Net Portfolio Value							NPV as % of Portfolio Value of Assets
	Amount		% Change		$ Change			NPV Ratio		Change
	(Dollars in Thousands)
300bp	$	69,883	(54.85	)%	$	(84,899	)	7.18	%	(8.72	)%
200		99,338	(35.82	)		(55,444	)	9.83		(5.48	)
100		129,074	(16.61	)		(25,708	)	12.31		(2.45	)
Static		154,782	—			—		14.29		—
(100)		166,065	7.29			11,283		15.07		1.02

The above table indicates that Keystone has a degree of interest rate risk exposure under rapidly rising rates. Due to Keystone’s recognition of the need to control its interest rate exposure, Keystone, commencing in 2002, has securitized an aggregate of $162.6 of its seasoned single-family residential mortgage loans and also sold an aggregate of $47.7 million of single-family residential mortgage loans. During 2002 and the first quarter of 2003, Keystone’s policy was to sell to Fannie Mae all newly originated, agency eligible single-family residential mortgage loans with interest rates of 6.5% or less. Such loans are sold on a non-recourse basis with servicing retained. Keystone also completed securitizations of single-family residential mortgage loans in the first quarter of each of 2003 and 2002. In such transactions, loans which did not meet Fannie Mae’s eligibility standards at the time of origination, due to the lack of private mortgage insurance or other criteria, were able to be securitized after being in Keystone’s portfolio for certain stipulated periods of time, generally 18 to 24 months. The average interest rate of the loans securitized was 6.19% and 6.65% for the transactions in the first quarter of 2003 and 2002, respectively. In recent years, Keystone also has emphasized the origination of construction loans, commercial real estate and land loans and consumer loans. Keystone plans to continue these lending strategies.

In addition to modeling changes in NPV, Keystone also analyzes potential changes to NII for a twelve-month period under rising and falling interest rate scenarios. The following table shows Keystone’s NII model as of March 31, 2003.

Change in Interest Rates in Basis Points (“bp”) (Rate Shock)	Net Interest Income	$ Change			% Change
300bp	$34,252	$	(4,211	)	(10.95	)%
200	35,789		(2,674	)	(6.95	)
100	37,235		(1,228	)	(3.19	)
Static	38,463		—		—
(100)	38,892		429		1.12	%

The above table indicates that as of March 31, 2003, in the event of an immediate and sustained 200 basis point increase in interest rates, Keystone’s net interest income for the 12 months ending March 31, 2004 would be expected to decrease by $2.7 million or 6.95% to $35.8 million.

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As is the case with the GAP Table, certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV and NII 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 models presented assume that the composition of Keystone’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. Accordingly, although the NPV measurements and net interest income models provide an indication of 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 net interest income and will differ from actual results.

Quantitative and Qualitative Disclosures About Market Risk

A derivative financial instrument includes futures, forwards, interest rate swaps, option contracts, and other financial instruments with similar characteristics. Keystone currently does not enter into futures, forwards, swaps, or options. However, it is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of Keystone’s customers. These financial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. Commitments generally have fixed expiration dates and may require additional collateral from the borrower if deemed necessary. Commitments to extend credit are not recorded as an asset or liability by Keystone until the instrument is exercised.

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Table of Market Risk Sensitive Instruments. The following table shows Keystone’s financial instruments that are sensitive to change in interest rates, categorized by expected maturity, and the instruments’ fair values at March 31, 2003. Market risk sensitive instruments are generally defined as on-and off-balance sheet derivatives and other financial instruments.

			Expected Maturity/Principal Repayment March 31,
	Average Interest Rate		2004		2005		2006		2007		2008		Thereafter		Total(1)		Fair Value(1)
	(Dollars in Thousands)
Interest Sensitive Assets:
Deposits at other institutions	0.96	%	$	40,399	$	—	$	—	$	—	$	—	$	—	$	40,399	$	40,399
Investment securities	4.78			20,324		12,068		10,025		17,733		1,495		338,509		400,154		425,839
Loans receivable	7.04			102,560		45,086		37,736		38,498		36,825		299,300		560,006		580,469
FHLB stock	3.32			8,516		—		—		—		—		—		8,516		8,516
Total			$	171,799	$	57,154	$	47,761	$	56,231	$	38,320	$	637,809	$	1,009,075	$	1,055,213
Interest Sensitive Liabilities:
Savings accounts	1.04	%	$	19,110	$	18,309	$	18,309	$	18,309	$	18,309	$	29,920	$	122,266	$	122,266
Checking accounts	0.53			13,623		13,623		13,623		13,623		13,623		22,706		90,821		90,821
Money market accounts	1.63			31,582		31,582		31,582		31,582		31,419		—		157,747		157,747
Certificate accounts	3.22			205,870		101,772		40,078		13,366		26,832		905		388,823		393,026
FHLB advances and other borrowings	4.11			26,513		3,000		5,000		8,500		15,000		55,500		113,513		114,378
Total			$	296,698	$	168,286	$	108,592	$	85,380	$	105,183	$	109,031	$	873,170	$	878,238
Interest-Sensitive Off-Balance Sheet Items:
Loans serviced for others	6.03	%													$	228,668	$	228,668
Commitments to extend credit	6.36															53,964		53,964
Unused consumer lines of credit	4.75															82,508		82,508

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Keystone is subject to certain market risks and interest rate risks from the time it issues commitments to originate new loans. In recent periods, Keystone has reduced its exposure to interest rate risk by focusing on loans with shorter terms and has sold certain of its newly originated, agency-eligible fixed-rate single-family residential mortgage loans into the secondary market.

Analysis of Net Interest Income

Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income also depends upon the relative amounts of interest-earnings assets and interest-bearing liabilities and the interest rate earned or paid on them.

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Average Balances, Net Interest Income, and Yields Earned and Rates Paid. The following table shows for the periods indicated the total dollar amount of interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. Tax-exempt income and yields have not been adjusted to a tax-equivalent basis. All average balances are based on monthly balances. Management does not believe that the monthly averages differ significantly from what the daily averages would be.

	Three Months Ended March 31,
	2003						2002
	Average Balance		Interest		Average Yield/Rate		Average Balance		Interest		Average Yield/Rate
	(Dollars in Thousands)
Interest-earning assets:
Deposits at other institutions	$	54,776	$	131	0.96	%	$	39,617	$	138	1.39	%
Investment securities(1)		324,053		3,875	4.78			177,202		2,527	5.70
Loans receivable(2)		575,374		10,133	7.04			664,336		12,262	7.38
Total interest-earning assets		954,203		14,139	5.93			881,155		14,927	6.78
Non-interest-earning assets		54,427						43,342
Total assets	$	1,008,630					$	924,497
Interest-bearing liabilities:
Deposits:
Savings accounts	$	118,604	$	307	1.04		$	106,009	$	392	1.48
Checking accounts(3)		85,801		113	0.53			78,798		111	0.56
Money market accounts		153,238		626	1.63			125,851		695	2.21
Certificate accounts		387,253		3,117	3.22			435,287		5,362	4.93
Total deposits		744,896		4,163	2.24			745,945		6,560	3.52
FHLB advances and other borrowings		110,842		1,140	4.11			48,954		595	4.86
Total interest-bearing liabilities		855,738		5,303	2.48			794,899		7,155	3.60
Non-interest-bearing liabilities:
Deposits		34,416						25,041
Other		5,657						6,428
Total liabilities		895,811						826,368
Retained earnings		112,819						98,129
Total liabilities and retained earnings	$	1,008,630					$	924,497
Net interest-earning assets	$	98,465					$	86,256
Net interest income; average interest rate spread			$	8,836	3.45	%			$	7,772	3.18	%
Net interest margin(4)					3.70	%					3.53	%
Average interest-earning assets to average interest-bearing liabilities					111.51	%					110.85	%

(Footnotes on next page.)

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	Year Ended December 31,
	2002						2001						2000
	Average Balance		Interest		Average Yield/ Rate(1)		Average Balance		Interest		Average Yield/ Rate		Average Balance		Interest		Average Yield/ Rate
	(Dollars in Thousands)
Interest-earning assets:
Deposits at other institutions	$	30,577	$	408	1.33	%	$	30,475	$	1,011	3.32	%	$	13,825	$	602	4.35	%
Investment securities(1)		272,704		14,883	5.46			135,356		8,536	6.31			121,628		7,976	6.56
Loans receivable(2)		623,980		44,188	7.08			675,856		50,946	7.54			647,448		49,025	7.57
Total interest-earning assets		927,261		59,479	6.41			841,687		60,493	7.19			782,901		57,603	7.36
Non-interest-earning assets		33,531						35,352						16,779
Total assets	$	960,792					$	877,039					$	799,680
Interest-bearing liabilities:
Deposits:
Savings accounts	$	111,689	$	1,680	1.50		$	97,778	$	2,127	2.18		$	104,801	$	2,353	2.25
Checking accounts(3)		81,609		466	0.57			76,090		846	1.11			75,384		968	1.28
Money market accounts		134,456		2,784	2.07			100,327		3,512	3.50			70,845		3,096	4.37
Certificate accounts		417,073		18,169	4.36			447,171		25,679	5.74			417,542		23,235	5.56
Total deposits		744,827		23,099	3.10			721,366		32,164	4.46			668,572		29,652	4.44
FHLB advances and other borrowings		74,688		3,317	4.44			35,133		1,900	5.41			25,377		1,489	5.87
Total interest-bearing liabilities		819,515		26,416	3.22			756,499		34,064	4.50			693,949		31,141	4.49
Non-interest-bearing liabilities:
Deposits		28,881						19,890						15,965
Other		7,603						8,356						8,655
Total liabilities		855,999						784,745						718,569
Retained earnings		104,793						92,294						81,111
Total liabilities and retained earnings	$	960,792					$	877,039					$	799,680
Net interest-earning assets	$	107,746					$	85,188					$	88,952
Net interest income; average interest rate spread			$	33,063	3.19	%			$	26,429	2.69	%			$	26,462	2.87	%
Net interest margin(4)					3.57	%					3.14	%					3.38	%
Average interest-earning assets to average interest-bearing liabilities					113.15	%					111.26	%					112.82	%

(1) Includes securities available-for-sale and held-to-maturity. Investment securities also include Federal Home Loan Bank stock.

(2) Includes nonaccrual loans during the respective periods. Calculated net of deferred fees and discounts, loans in process and allowance for loan losses.

(3) Includes non-interest-bearing checking accounts.

(4) Equals net interest income divided by average interest-earning assets.

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Rate/Volume Analysis. The following table shows the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities affected Keystone’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 (1) changes in rate (change in rate multiplied by prior year volume), and (2) changes in volume (change in volume multiplied by prior year rate). 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.

	Three Months Ended March 31, 2003 vs. Three Months Ended March 31, 2002									2002 vs. 2001									2001 vs. 2000
	Increase (Decrease) Due to						Total Increase (Decrease)			Increase (Decrease) Due to						Total Increase (Decrease)			Increase (Decrease) Due to						Total Increase (Decrease)
	Rate			Volume						Rate			Volume						Rate			Volume
	(In Thousands)
Interest income:
Cash and cash equivalents	$	32		$	(39	)	$	(7	)	$	(606	)	$	3		$	(603	)	$	(101	)	$	510		$	409
Investment securities		(326	)		1,674			1,348			(971	)		7,318			6,347			(288	)		848			560
Loans receivable, net		(543	)		(1,586	)		(2,129	)		(2,980	)		(3,778	)		(6,758	)		(219	)		2,140			1,921
Total interest-earning assets		(837	)		49			(788	)		(4,557	)		3,543			(1,014	)		(608	)		3,498			2,890
Interest expense:
Savings accounts		(141	)		56			(85	)		(830	)		383			(447	)		(72	)		(154	)		(226	)
Checking accounts		(5	)		7			2			(447	)		67			(380	)		(131	)		9			(122	)
Money market accounts		(421	)		352			(69	)		(4,353	)		3,625			(728	)		(381	)		797			416
Certificate accounts		(1,703	)		(542	)		(2,245	)		(5,873	)		(1,637	)		(7,510	)		759			1,685			2,444
Total deposits		(2,270	)		(127	)		(2,397	)		(11,503	)		2,438			(9,065	)		175			2,336			2,512
FHLB advances and other borrowings		(75	)		620			545			(267	)		1,684			1,417			(105	)		516			411
Total interest-bearing liabilities		(2,345	)		493			(1,852	)		(11,770	)		4,122			(7,648	)		70			2,853			2,923
Increase (decrease) in net interest income	$	1,508		$	(444	)	$	1,064		$	7,213		$	(579	)	$	6,634		$	(676	)	$	645		$	(33	)

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Comparison of Financial Condition at March 31, 2003 and December 31, 2002

Total assets at Keystone amounted to $1.0 billion at March 31, 2003. During the first quarter of 2003, total assets increased by $23.8 million or 2.3% compared to total assets at December 31, 2002. Such increase was due primarily to an increase in Keystone’s holdings of investment securities which was partially offset by reductions in net loans receivable and cash and cash equivalents. During the quarter, Keystone used a portion of its excess cash as well as certain cash proceeds from loan sales and repayments to purchase additional investment securities. Keystone’s investment securities amounted to $400.2 million at March 31, 2003, an increase of $106.0 million or 36.0% compared to investment securities of $294.2 million at December 31, 2002. As part of its asset/liability management strategy, Keystone has actively acquired mortgage-backed securities in recent periods. It has focused on purchasing mortgage-backed securities with relatively short estimated average lives, generally three to five years. All of Keystone’s securities are classified as available for sale. This classification allows management to sell such securities in response to changes in interest rates or other factors. Keystone had $532.4 million of net loans receivable at March 31, 2003, a $46.9 million or 8.1% decrease from its net loans receivable at December 31, 2002. The decrease in net loans receivable reflects Keystone’s securitization of $47.3 million of single-family residential mortgage loans in the quarter ended March 31, 2003 as well as the sale of $10.5 million of newly originated single-family residential mortgage loans. In addition, given the continuing low interest rate environment, Keystone, like other institutions, continues to experience relatively high repayment levels on its loans as borrowers continue to refinance significant amounts of mortgage and other loans. Cash and cash equivalents at Keystone amounted to $49.8 million at March 31, 2003, a $36.5 million or 42.3% decrease from $86.3 million of cash and cash equivalents at December 31, 2002. The primary reason for the decrease in cash was the redeployment of cash for securities purchases as well as the repayment of $10.0 million in Federal Home Loan Bank (“FHLB”) advances.

Total liabilities of Keystone at March 31, 2003 amounted to $925.4 million, a $20.5 million increase from $904.9 of total liabilities at December 31, 2002. The reason for the increase in total liabilities was an increase in deposits. Deposits at Keystone amounted to $797.4 million at March 31, 2003, an increase of $25.6 million or 3.3% compared to $771.8 million in total deposits at December 31, 2002. The increase in Keystone’s total deposits in the first quarter of 2003 was due to an increase in core deposits, defined as savings, checking and money market accounts, which more than offset a slight decrease in the balance of certificate of deposit accounts. Keystone has concentrated on decreasing its reliance on certificates of deposit, which generally have higher rates paid than its core deposit products. At March 31, 2003, Keystone’s savings accounts amounted to $122.3 million, a $7.0 million or 6.1% increase from December 31, 2002. At March 31, 2003, total checking accounts amounted to $128. 5 million, a $10.5 million or 8.9% increase from $118.0 million in checking accounts at December 31, 2002. Money market accounts at Keystone increased to $157.7 million at March 31, 2003, a $8.5 million or 5.7% increase from $149.2 million in money market accounts at December 31, 2002. FHLB advances decreased in the first quarter of 2003 to $103.5 million at March 31, 2003 compared to $113.5 million at December 31, 2002. Keystone utilized a portion of its excess cash in the first quarter to repay FHLB advances. However, Keystone intends to continue, and possibly increase, its utilization of FHLB advances as an additional source of funds to leverage its balance sheet.

Total retained earnings at Keystone increased to $114.3 million at March 31, 2003 from $111.0 million at December 31, 2002. The primary reason for the $3.3 million or 3.0% increase was the $2.9 million in net income in the first quarter of 2003.

Comparison of Financial Condition at December 31, 2002 and December 31, 2001

Total assets at Keystone amounted to $1.0 billion at December 31, 2002, a $93.9 million or 10.2% increase from total assets of $922.0 million at December 31, 2001. The primary reason for the increase in total assets in 2002 was a $137.4 million increase in investment securities which more than offset a $88.7 million decrease in net loans receivable. During 2002, Keystone sold an aggregate of $37.2 million of its newly originated single-family residential mortgage loans into the secondary market with servicing retained. In addition, in the first quarter of 2002 Keystone securitized $115.3 million of seasoned single-family residential mortgage loans, which also reduced the balance of net loans receivable. Keystone retained in its investment securities portfolio $53.9 million of the mortgage-backed securities from its 2002 securitization and sold the remaining $61.4 million of mortgage-backed securities. Due to the proceeds from its loan and securities sales as well as increases in FHLB advances, cash and cash equivalents increased by $34.4 million to $86.3 million at December 31, 2002 compared to $51.8 million at December 31, 2001. The value of Keystone’s investment in bank owned life insurance (“BOLI”) increased by $5.4

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million, due primarily to an additional investment of $4.0 million, to $26.3 million at December 31, 2002 compared to $20.9 million at December 31, 2001.

Total liabilities at Keystone amounted to $904.9 million at December 31, 2002, a $78.6 million or 9.5% increase from total liabilities of $826.3 million at December 31, 2001. The primary reason for the increase in total liabilities in 2002 was a $73.0 million increase in FHLB advances to $113.5 million at December 31, 2002 compared to $40.5 million at December 31, 2001. Keystone increased the amount of its outstanding FHLB advances in 2002 as a result of its determination to increase its use of borrowings as an additional source of funds while reducing its reliance on certificate of deposit accounts by being less aggressive in the rates paid on its certificate accounts. In addition, Keystone determined to increase its use of borrowings as a means to more effectively leverage its balance sheet. Total deposits decreased at Keystone by $401,000 to $771.8 million at December 31, 2002 compared to $772.2 million at December 31, 2001, such decrease was due to a $52.8 million decrease in certificate of deposit accounts which was partially offset by a $52.4 million increase in core deposit accounts.

Total retained earnings at Keystone amounted to $111.0 million at December 31, 2002, a $15.2 million or 15.9% increase from $95.8 million of retained earnings at December 31, 2001. The primary reason for the increase in retained earnings was net income of $12.0 million in the year ended December 31, 2002.

Comparison of Operating Results for the Three Months Ended March 31, 2003 and 2002

General. Keystone reported net income of $2.9 million for the quarter ended March 31, 2003 compared to $3.9 million for the quarter ended March 31, 2002. The primary reasons for the decrease in net income was the recognition of $1.2 million in net gains on sales of investment securities in the first quarter of 2002 compared to no gains in the first quarter of 2003 as well as a $445,000 recovery on the provision for loan losses primarily as a result of the securitization of $115.3 million of loans in the first quarter of 2002 compared to a $62,000 provision for loan losses in the first quarter of 2003. Net interest income at Keystone was $8.8 million for the quarter ended March 31, 2003, a $1.0 million or 13.7% increase from the $7.8 million in net interest income for the first quarter of 2002. Keystone’s interest rate spread increased by 27 basis points to 3.45% for the first quarter of 2003 compared to 3.18% for the first quarter of 2002. Net interest margin increased by 17 basis points to 3.70% for the first quarter of 2003 compared to 3.53% for the first quarter of 2002.

Interest Income. Keystone’s total interest income was $14.1 million for the quarter ended March 31, 2003 compared to $14.9 million for the three months ended March 31, 2002, a decrease of $788,000 or 5.3%. The primary reason for the decrease in total interest income was a $2.1 million decrease in interest earned by Keystone on its net loans receivable which was partially offset by a $1.3 million increase in interest earned on its investment securities portfolio. The primary reason for the decrease in interest earned on loans was an $89.0 million or 13.4% decrease in the average balance in loans receivable in the quarter ended March 31, 2003 compared to the quarter ended March 31, 2002 reflecting the effect of the loan securitization undertaken by Keystone in the first quarter of 2002. Similarly, the increase in interest earned on investment securities was due primarily to a $146.9 million or 82.9% increase in the average balance in the first quarter of 2003 compared to the first quarter of 2002 reflecting Keystone’s retaining in its investment portfolio $53.9 million of the loan securitization in 2002 as well as continuing purchases of mortgage-backed and other investment securities. Interest income in the first quarter of 2003 was adversely affected by declines in the average rates earned on both loans receivable and investment securities reflecting the continuing effects of relatively low market rates of interest. The average yield earned by Keystone on loans receivable was 7.04% for the quarter ended March 31, 2003 compared to 7.38% for the quarter ended March 31, 2002 while the average yield earned on investment securities was 4.78% in the 2003 period compared to 5.70% in the 2002 period.

Interest Expense. Keystone’s total interest expense was $5.3 million for the quarter ended March 31, 2003 compared to $7.2 million for the quarter ended March 31, 2002, a decrease of $1.9 million or 25.9%. The primary reason for the improvement in interest expense was a 171 basis point reduction in the average rate paid on certificate of deposit accounts to 3.22% for the quarter ended March 31, 2003 compared to 4.93% for the quarter ended March 31, 2002 together with a $48.0 million or 11.0% reduction in the average balance of certificate accounts in the first quarter of 2003 compared to the first quarter of 2002. The changes in the average rate and average balance of Keystone’s certificate of deposit accounts in this period reflects, among other factors, the maturity of a significant

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amount of two-year certificate of deposit accounts which Keystone attracted primarily in the year ended December 31, 2000 by paying rates which were higher than the market average at that time and the bank’s subsequent determination to be less aggressive in its pricing in an effort to reduce its reliance on certificate of deposit accounts. In addition to the effect of the changes in its certificate of deposit accounts, Keystone’s total interest expense improved in the first quarter of 2003 compared to the first quarter of 2002 due to reductions in the average rates paid on its savings, checking and money market accounts, reflecting declining market rates of interest, which more than offset increases in the average balances in such accounts. The reductions in interest paid on deposits in the first quarter of 2003 compared to the first quarter of 2002 were partially offset by a $545,000 increase in interest paid on FHLB advances and other borrowings due primarily to a $61.9 million or 126.4% increase in the average balance. The average rate paid by Keystone on FHLB advances and other borrowings was 4.11% in the first quarter of 2003 compared to 4.86% in the first quarter of 2002.

Provision (Recovery) for Loan Losses. Keystone made a provision for loan losses of $62,000 during the first quarter of 2003 compared to a recovery of $445,000 during the first quarter of 2002. Keystone’s allowance for loan losses was $2.7 million at March 31, 2003 compared to $2.8 million at March 31, 2002. The recovery in the first quarter of 2002 primarily reflects Keystone’s assessment of the reduction in its credit risk due to its securitization and sale of loans without recourse in the quarter. Keystone has identified the evaluation of the allowance for loan losses as a critical accounting policy where amounts are sensitive to material variation. This policy is significantly affected by its judgment and uncertainties and there is a likelihood that materially different amounts would be reported under different, but reasonably plausible, conditions or assumptions. Keystone’s activity in the provision for loan losses, which are charges or recoveries to operating results, is undertaken in order to maintain a level of total allowance for losses that management believes covers all known and inherent losses that are both probable and reasonably estimable at each reporting date. Management performs reviews no less than quarterly in order to identify these inherent losses and to assess the overall collection probability for the loan portfolio. Such reviews consist of a quantitative analysis by loan category, using historical loss experience, and consideration of a series of qualitative loss factors. Keystone’s evaluation process includes, among other things, an analysis of delinquency trends, non-performing loan trends, the levels of charge-offs and recoveries, prior loss experience, total loans outstanding, the volume of loan originations, the type, size, terms and geographic concentration of loans held, the value of collateral securing loans, the number of loans requiring heightened management oversight, general economic conditions and loan loss information for other institutions. In recent periods consideration has been given to the declining balance of the overall loan portfolio and the attendant reduction in risk as well as Keystone’s increasing portfolios of construction, commercial real estate, consumer and commercial business loans, which generally are considered to have higher degrees of risk than single-family residential mortgage loans. The amount of the allowance for loan losses is only an estimate and actual losses may vary from these estimates. Keystone assesses its allowance for loan losses at least quarterly, and makes any necessary provision or recovery for loan losses.

Noninterest Income. Keystone’s noninterest income is comprised primarily of fees and service changes on customer accounts, gains on investment securities and residential mortgage loans sold, and other operating income. Total noninterest income at Keystone amounted to $2.2 million for the quarter ended March 31, 2003 compared to $2.6 million for the quarter March 31, 2002, a $462,000 or 17.5% decrease. The primary reason for the decrease in noninterest income in the first quarter of 2003 compared to the first quarter of 2002 was the absence of any gains on sales of investment securities in the 2003 period compared to $1.2 million in gains in the 2002 period. Such change in the gain on sale of investment securities was partially offset by a $556,000 increase in service fees in the first quarter of 2003 compared to the first quarter of 2002 as well as a $200,000 increase in gains recognized on the sale of residential mortgage loans. The increase in service fees was due primarily to a $360,000 increase in overdraft fees primarily as a result of the introduction in the second half of 2002 of an overdraft option on checking accounts for which the bank charges a fee. In addition, the increasing number of Keystone’s checking accounts as well as the amount of loans serviced for others contributed to the increase in service fees.

Noninterest Expense. Noninterest expense is comprised primarily of salaries and employee benefit expense, occupancy and data processing costs, advertising and various other operating expenses. Total noninterest expense at Keystone amounted to $6.9 million for the quarter ended March 31, 2003, a $1.7 million or 33.3% increase from a $5.2 million of noninterest expense for the quarter ended March 31, 2002. The increase was due primarily to a $755,000 increase in compensation and employee benefits costs, a $167,000 increase in occupancy costs, a $157,000 increase in advertising and a $578,000 increase in other noninterest expenses. The increase in

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compensation and employee benefits costs was due to normal salary increases as well as an increased number of employees due to the opening of three additional branch offices in 2002, as well as increased costs for funding the bank’s retirement plan and increased health insurance costs. The increase in occupancy expenses in the first quarter of 2003 compared to the first quarter of 2002 was due primarily to the increased number of branch offices. The increase in advertising costs for the first quarter of 2003 compared to the first quarter of 2002 was due primarily to Keystone’s increased marketing efforts generally and, in particular, to promote its core deposit accounts and its home equity loans. The increase in other noninterest expenses in the first quarter of 2003 compared to the first quarter of 2002 was due primarily to a $375,000 charge due to impairment of mortgage servicing rights and various other increased costs.

Income Tax Expense. Keystone’s income tax expense was $1.1 million for the quarter ended March 31, 2003 compared to $1.8 million for the quarter ended March 31, 2002. The primary reason for the $682,000 or 38.3% decrease in income tax expense was the reduction in net income. In addition, Keystone’s investments in BOLI and municipal securities have reduced its effective tax rates. Keystone’s effective Federal tax rate was 27.2% for the quarter ended March 31, 2003 compared to 31.4% for the quarter ended March 31, 2002.

Comparison of Operating Results for the Years Ended December 31, 2002 and December 31, 2001

General. Keystone reported net income of $12.0 million for the year ended December 31, 2002 compared to $8.1 million for the year ended December 31, 2001. The primary reason for the increase was a $6.6 million or 25.1% increase in net interest income to $33.1 million for the year ended December 31, 2002 compared to $26.4 million for the year ended December 31, 2001. In addition, increases in service fees and gains on sales of investment securities and loans contributed to the increase in net income in 2002 compared to 2001. Keystone’s average interest rate spread increased by 50 basis points to 3.19% for 2002 compared to 2.69% for 2001 while net interest margin increased by 43 basis points to 3.57% in 2002 compared to 3.14% in 2001.

Interest Income. Total interest income at Keystone amounted to $59.5 million for the year ended December 31, 2002 compared to $60.5 million for the year ended December 31, 2001. The primary reason for the decrease in interest income in 2002 compared to 2001 was a decrease in the average balance of net loans receivable as well as decreases in the average yields earned on interest-earning assets which was partially offset by an increase in the average balance of investment securities. Interest income on net loans receivable amounted to $44.2 million in 2002 compared to $50.9 million in 2001. The $6.8 million or 13.3% decrease was due to a $51.9 million or 7.7% decline in the average balance of loans receivable together with a 46 basis point decrease in the average yield earned to 7.08% in 2002 compared to 7.54% in 2001. The decline in the average balance of Keystone’s loans receivable in 2002 compared to 2001 primarily reflects the securitization of $115.3 million in residential mortgage loans in the first quarter of 2002 while the decline in the average yield earned primarily reflects the continuing low market rates of interest during the period.

Interest Expense. Keystone’s total interest expense amounted to $26.4 million for the year ended December 31, 2002 compared to $34.1 million for the year ended December 31, 2001, a decrease of $7.6 million or 22.5%. The reason for the decrease in interest expense in 2002 compared to 2001 was a decrease in the average rates paid on all of Keystone’s interest-bearing liabilities as well as a decline in the average balance of its certificate of deposit accounts which more than offset the effects of increases in the average balances in its other interest-bearing liabilities. Interest paid on deposit accounts decreased by $9.1 million in 2002 compared to 2001. The average rate paid on total deposits was 3.10% in 2002 compared to 4.46% in 2001. While the average balance for total deposits increased by $23.5 million in 2002 compared to 2001, such increase was due to increases in the average balances of Keystone’s core deposit accounts as the average balance of certificate of deposit accounts decreased by $30.1 million during the period.

Noninterest Income. Total noninterest income at Keystone increased by $3.8 million or 75.8% to $8.8 million for the year ended December 31, 2002 compared to $5.0 million for the year ended December 31, 2001. The primary reason for the increase in noninterest income in 2002 compared to 2001 was an increase in service fees, as well as increased net gains on sales of investment securities and residential mortgage loans and increased income from BOLI. Service fees at Keystone increased by $1.4 million or 35.7% to $5.4 million in 2002 compared to $4.0 million in 2001. The primary reason for the increase in service fees was a $634,000 increase in checking overdraft fees due to the introduction of the bank’s overdraft checking feature in the second half of 2002. Net gains on sales

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of investment securities amounted to $1.2 million in the year ended December 31, 2002, due primarily to the sale of $61.4 million in mortgage-backed securities from Keystone’s securitization in the first quarter of 2002, compared to $35,000 in gains on sales of investment securities in the year ended December 31, 2001. Net gains on sales of residential mortgage loans increased by $792,000 to $900,000 for the year ended December 31, 2002 compared to $108,000 for the year ended December 31, 2001. The increase primarily reflects Keystone’s determination, as part of its asset/liability management strategy and its efforts to reduce interest rate risk, to sell some of its newly originated single-family residential mortgage loans. Income from BOLI increased by $536,000 to $1.4 million for the year ended December 31, 2002 compared to $899,000 for the year ended December 31, 2001. The increase reflects the increase in the carrying value of Keystone’s investment in BOLI.

Noninterest Expense. Keystone’s noninterest expense increased by $5.0 million or 25.3% to $24.6 million for the year ended December 31, 2002 compared to $19.6 million for the year ended December 31, 2001. The primary reason for the increase in noninterest expense was a $2.8 million increase in compensation and employee benefit expense and a $1.6 million increase in other noninterest expense. In addition to normal salary increases, salary expense increased as the result of Keystone’s opening and staffing of three additional branch offices in 2002. At December 31, 2002, Keystone had 329 full-time equivalent employees compared to 294 full-time equivalent employees at December 31, 2001. In addition to an increase in salary expense, compensation and employee benefit expense increased in 2002 compared to 2001 due to a $793,000 increase in retirement expense due to a $290,000 increase in the bank’s funding obligation to its multiple employer defined benefit pension plan, a $55,000 increase in matching contributions to its 401(k) plan and $425,000 in expense in 2002 due to the funding of supplemental executive retirement plans for certain executive officers. Other noninterest expenses increased in 2002 compared to 2001 primarily due to a $676,000 charge due to the impairment of mortgage servicing rights.

Income Tax Expense. Keystone’s income tax expense increased by $1.9 million or 56.0% to $5.2 million for the year ended December 31, 2002 compared to $3.3 million for the year ended December 31, 2001. The increase in income tax expense was due to the increase in net income. Keystone’s effective Federal tax rate was 30.2% for the year ended December 31, 2002 compared to 29.1% for the year ended December 31, 2001.

Comparison for Operating Results for the Years Ended December 31, 2001 and December 31, 2000

General. Keystone’s net income increased by $595,000 or 7.9% to $8.1 million for the year ended December 31, 2001 compared to $7.5 million for the year ended December 31, 2000. Net interest income amounted to $26.4 million in 2001 compared to $26.5 million in 2000. Keystone’s average interest rate spread declined to 2.69% for 2001 compared to 2.87% for 2000 while its net interest margin was 3.14% in 2001 compared to 3.38% in 2000. The increase in net income in 2001 compared to 2000 was due primarily to a $1.8 million increase in noninterest income which was partially offset by a $1.6 million increase in noninterest expenses.

Interest Income. Total interest income at Keystone amounted to $60.5 million for the year ended December 31, 2001 compared to $57.6 million for the year ended December 31, 2000. The primary reason for the $2.9 million or 5.0% increase in interest income in 2001 compared to 2000 was a $1.9 million increase in interest income on loans receivable together with a $560,000 increase in interest earned on investment securities. Increases in the average balances of both investment securities and loans receivable in 2001 compared to 2000 offset declines in the average yields. The average balance of net loans receivable increased by $28.4 million in 2001 compared to 2000 while the average yield declined by three basis points to 7.54% in 2001 compared to 7.57% in 2000. The average balance of Keystone’s investment securities increased by $13.7 million in 2001 compared to 2000 while the average yield declined by 25 basis points to 6.31% in 2001 compared to 6.56% in 2000.

Interest Expense. Keystone’s interest expense increased by $2.9 million or 9.4% to $34.1 million for the year ended December 31, 2001 compared to $31.1 million for the year ended December 31, 2000. Interest expense on deposits increased by $2.5 million in 2001 compared to 2000 while interest expense on FHLB advances and other borrowings increased by $411,000. The average balance of Keystone’s total deposits increased by $52.8 million in 2001 compared to 2000 due primarily to a $29.5 million increase in the average balance of money market accounts and a $29.6 million increase in the average balance of certificate of deposit accounts. The increase in certificate of deposit accounts in 2001 compared to 2000 primarily reflects Keystone’s efforts in 2000 to increase its deposit balances by aggressively pricing its certificate of deposit accounts, primarily for two year terms to maturity.

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Noninterest Income. Keystone’s noninterest income increased by $1.8 million to $5.0 million for the year ended December 31, 2001 compared to $3.2 million for the year ended December 31, 2000. The primary reason for the increase in noninterest income in 2001 compared to 2000 was the recognition of $899,000 in income from BOLI, which was purchased in March and April 2001, and a $823,000 increase in service fees due primarily to increases in the fee schedule as well as an increase in the number of deposit accounts in 2001 compared to 2000.

Noninterest Expense. Noninterest expense at Keystone increased by $1.6 million to $19.6 million for the year ended December 31, 2001 compared to $18.0 million for the year ended December 31, 2000. The primary reason for such increase was a $1.1 million increase in compensation and employee benefit expenses due primarily to normal merit adjustments and an increase in the number of employees. Keystone had 294 full time equivalent employees at December 31, 2001 compared to 273 at December 31, 2000. In addition, Keystone’s occupancy expense increased by $280,000 in 2001 compared to 2000 due primarily to a $93,000 increase in rental expense and its data processing expense increased by $237,000 in 2001 compared to 2000 primarily as a result of an increase in the number of ATM/check card transactions.

Income Tax Expense. Keystone’s income tax expense was $3.3 million in 2001 compared to $3.7 million in 2000. The primary reason for the decrease in income tax expense in 2001 compared to 2000 was the effect of Keystone’s purchase of BOLI, which resulted $899,000 of tax-free income in 2001, as well as an increase in the amount of municipal securities held by the bank. Keystone’s effective Federal tax rate was 29.1% in 2001 compared to 33.1% in 2000.

Liquidity and Commitments

Keystone’s primary sources of funds are from deposits, amortization of loans, loan prepayments and the maturity of loans, mortgage-backed securities and other investments, and other funds provided from operations. While scheduled payments from the amortization of loans and mortgage-backed securities and maturing investment securities are relatively predictable sources of funds, deposit flows and loan prepayments can be greatly influenced by general interest rates, economic conditions and competition. Keystone also maintains excess funds in short-term, interest-bearing assets that provide additional liquidity and also utilizes outside borrowings, primarily from the Federal Home Loan Bank of Pittsburgh, as an additional funding source.

Keystone uses its liquidity to fund existing and future loan commitments, to fund maturing certificates of deposit and demand deposit withdrawals, to invest in other interest-earning assets, and to meet operating expenses. At March 31, 2003, Keystone had the following contractual obligations and commercial commitments:

	Total		Due In
			1 Year		1-3 Years		3-5 Years		After 5 Years
	(Dollars in Thousands)
Contractual Obligations:
Total borrowings	$	113,513	$	26,513	$	8,000	$	23,500	$	55,500
Annual rental commitments under non-cancelable operating leases		4,918,926		613,763		1,377,996		414,442		2,512,725
	$	5,032,439	$	640,276	$	1,385,996	$	437,942	$	2,568,225

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	Total		Due In
			1 Year		1-3 Years		3-5 Years		After 5 Years
	(Dollars in Thousands)
Commitments:
Commitments to extend credit	$	53,964	$	4,265	$	14,569	$	3,634	$	31,496
Undisbursed portion of loans in process and unused portions of lines of credit		82,508		26,245		14,693		36,955		4,615
	$	136,472	$	30,510	$	29,262	$	40,589	$	36,111

At March 31, 2003, Keystone also had certificates of deposit maturing within the next 12 months amounting to $206.2 million. Based upon historical experience, Keystone anticipates that a not insignificant portion of the maturing certificates of deposit will be redeposited with Keystone.

In addition to cash flow from loan and securities payments and prepayments as well as from sales of available for sale securities and mortgage loans, Keystone has significant borrowing capacity available to fund liquidity needs. Keystone has increased its utilization of borrowings in recent years as a cost efficient addition to deposits as a source of funds. The average balance of borrowings was $110.8 million for the three months ended March 31, 2003 compared to $74.7 million, $35.1 million and $25.4 million for the years ended December 31, 2002, 2001 and 2000, respectively. To date, KNBT Bancorp borrowings have consisted primarily of advances from the Federal Home Loan Bank of Pittsburgh, of which Keystone is a member. Under terms of the collateral agreement with the Federal Home Loan Bank, Keystone pledges residential mortgage loans and mortgage-backed securities as well as KNBT Bancorp stock in the Federal Home Loan Bank as collateral for such advances.

Keystone has not used, and has no intention to use, any significant off-balance sheet financing arrangements for liquidity purposes. Its primary financial instruments with off-balance sheet risk are limited to loan servicing for others, obligations to fund loans to customers pursuant to existing commitments and commitments to sell mortgage loans. In addition, Keystone has not had, and has no intention to have, any significant transactions, arrangements or other relationships with any unconsolidated, limited purpose entities that could materially affect its liquidity or capital resources. Keystone has not, and does not intend to, trade in commodity contracts.

Keystone anticipates that it will continue to have sufficient funds and alternative funding sources to meet its current commitments.

Impact of Inflation and Changing Prices. The financial statements, accompanying notes, and related financial data of Keystone 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 the changes in purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations. Most of Keystone’s assets and liabilities are monetary in nature; therefore, the impact of interest rates has a greater impact on its performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Recent Accounting Pronouncements

In April of 2002, the FASB issued Statement No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” This Statement rescinds FASB Statement No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” and an amendment of that Statement, FASB Statement No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements.” This Statement also rescinds FASB Statement No. 44, “Accounting for Intangible Assets of Motor Carriers.” This Statement amends FASB Statement No. 13, “Accounting for Leases,” to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic

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effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The adoption of Statement No. 145 is not expected to have a material effect on Keystone’s financial position or results of operation.

Keystone adopted FASB Interprestation Number 45 (“FIN 45”) Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others, on January 1, 2003. FIN 45 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. Keystone has financial and performance letters of credit. Financial letters of credit require Keystone to make payment if the customer’s financial condition deteriorates, as defined in the agreements. Performance letters of credit require Keystone to make payments if the customer fails to perform certain non-financial contractual obligations. Keystone previously did not record a liability when guaranteeing obligations unless it became probable that Keystone would have to perform under the guarantee. FIN 45 applies prospectively to guarantees Keystone issues or modifies subsequent to December 31, 2002.

In January 2003, the FASB issued FASB Interpretation Number 46 (“FIN 46”), Consolidation of Variable Interest Entities. FIN 46 clarifies the application of Accounting Research Bulletin 51, Consolidated Financial Statements, for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest (“variable interest entities”). Variable interest entities within the scope of FIN 46 will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected returns, or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. Keystone is in the process of determining what impact, if any, the adoption of the provisions of FIN 46 will have upon its financial condition or results of operations. Keystone does not anticipate FIN 46 to have a material impact on the consolidated financial position or results of operations.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF FIRST COLONIAL

The following financial review and analysis are intended to assist in understanding and evaluating the major changes in the financial condition and earnings performance of First Colonial. First Colonial’s consolidated earnings are derived primarily from the operations of First Colonial’s subsidiaries, Nazareth National Bank, First C. G. Company, Inc. (“First C. G.”) and First Colonial Statutory Trust I (the “Statutory Trust I”). The information below should be read in conjunction with First Colonial’s consolidated financial statements and accompanying notes thereto, and other detailed information appearing elsewhere in this document. The information concerning First Colonial’s share and per share data included in this discussion have been restated to reflect the 5% stock dividends paid in May 2002, June 2001 and June 2000.

Critical Accounting Policies, Judgments and Estimates

The accounting and reporting policies of First Colonial conform with accounting principles generally accepted in the United States of America and general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and the assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.

First Colonial considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan losses is calculated with the objective of maintaining a reserve level believed by management to be sufficient to absorb estimated probable credit losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material estimates, including, among others, expected default probabilities, loss given default, expected commitment usage, the amounts and timing of expected future cash flows on impaired loans, mortgages, and general amounts for historical loss experience. The process also considers economic conditions, uncertainties in estimating losses and inherent risks in the loan portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that would adversely impact earnings in future periods.

With the adoption of SFAS No. 142 on January 1, 2002, First Colonial discontinued the amortization of goodwill resulting from acquisition. Goodwill is now subject to impairment testing at least annually to determine whether write-downs of the recorded balances are necessary. First Colonial tests for impairment based on the goodwill maintained at each defined reporting unit. A fair value is determined for each reporting unit based on at least one of three various market valuation methodologies. If the fair values of the reporting units exceed their book values, no write-down of recorded goodwill is necessary. If the fair value of the reporting unit is less, an expense may be required on First Colonial’s books to write down the related goodwill to the proper carrying value. As of December 31, 2002, First Colonial determined that no impairment write-offs were necessary.

In August, 2001, the FASB issued SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS No. 144 retains the existing requirements to recognize and measure the impairment of long-lived assets to be held and used or to be disposed of by sale. However, SFAS 144 makes changes to the scope and certain measurement requirements of existing accounting guidance. SFAS 144 also changes the requirements relating to reporting the effects of a disposal or discontinuation of a segment of a business. SFAS 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The adoption of this statement is not expected to have a significant impact on the financial condition or results of operations of First Colonial.

First Colonial recognizes deferred tax assets and liabilities for future tax effects of temporary differences, net operating loss carryforwards and tax credits. Deferred tax assets are subject to management’s judgment based upon available evidence that future realization is more likely than not. If management determines that First Colonial may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the expected realizable amount. For further

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information, see Note A—Summary of Accounting Policies in the First Colonial “Notes to Consolidated Financial Statements.”

Financial Performance Summary

Three months ended March 31, 2003 and March 31, 2002. First Colonial’s basic earnings per share for the three months ended March 31, 2003 were $0.43 as compared to $0.37 for the corresponding period in 2002. First Colonial’s diluted earnings per share for the three months ended March 31, 2003 were $0.41 as compared to $0.37 for the same period in 2002. First Colonial’s average basic shares outstanding during this three-month period were 2,177,482 in 2003 and 2,144,552 in 2002. Average diluted shares outstanding during the three-month period were 2,274,995 in 2003 and 2,178,154 in 2002.

First Colonial’s net income for the three months ended March 31, 2003 was $932,000 compared to $811,000 for the same period in 2002, an increase of $121,000 or 14.9%. First Colonial’s earnings increase was due in part to an increase in net interest income of $427,000 or 10.5%, a $396,000 increase in net gains on the sale of available-for-sale securities, a $341,000 increase in the gains on the sales of mortgage loans, a decrease of $200,000 in the provision for loan losses, a decrease of $8,000 in Federal income taxes and a $1,000 increase in trust and wealth management revenues. These earnings increases were offset in part by an increase of total other operating expenses of $1.2 million or 28.6%. This increase in First Colonial’s total other operating expense included a charge of $637,000 for the impairment of mortgage servicing rights in 2003 with no similar expense in 2002. Also affecting earnings was a $49,000 decrease in other operating income.

First Colonial’s return on average assets for the three months ended March 31 was 0.62% in 2003 and 0.69% in 2002. The return on average equity was 9.30% and 9.46% for the first quarter of 2003 and 2002, respectively.

Years Ended December 31, 2002, 2001 and 2000. In 2002, First Colonial recorded net income of $4.0 million. The 2002 net income was $441,000 or 12.4% higher than 2001 net income of $3.6 million. First Colonial’s net income in 2000 was $2.1 million.

First Colonial’s basic earnings per share were $1.85, $1.69 and $0.99 in 2002, 2001 and 2000, respectively. Diluted earnings per share were $1.82 in 2002, $1.68 in 2001 and $0.99 in 2000. Diluted earnings per share include the effect of common stock equivalents such as options (see Note Q of First Colonial’s “Notes to Consolidated Financial Statements”).

First Colonial’s return on average assets was 0.77% in 2002 as compared to 0.79% in 2001 and 0.50% in 2000. The return on average equity was 10.62%, 10.10% and 7.04% in 2002, 2001 and 2000, respectively.

The principal factors affecting the increase in First Colonial’s earnings in 2002 were a $1.1 million or 6.6% increase in net interest income, an increase of $776,000 or 224.3% on the gains on the sale of residential real estate loans, an increase of $324,000 or 34.9% on the net gains on the sale of investment securities available-for-sale, an increase of $251,000 or 10.8% in service charges on deposit accounts and an increase of $39,000 or 5.5% in other fee income. These increases in income were offset in part by a decrease in trust and wealth management fees of $90,000 or 7.0%, and increases of $961,000 or 165.7% in the provision for possible loan losses, $883,000 or 5.3% in total other expenses and $69,000 or 8.5% in Federal income taxes.

The increase in First Colonial’s 2001 earnings was the result of a $726,000 or 4.7% increase in net interest income, an increase of $755,000 or 433.9% in net gains on the sale of securities, an increase of $287,000 or 486.4% on the gains on the sale of residential real estate loans and an increase of $243,000 or 5.9% in all other income including trust and wealth management fees, deposit service charges and other fees. Also affecting First Colonial’s earnings was a $217,000 or 1.3% decrease in total other expenses. These factors improving earnings were offset in part by increases of $205,000 or 54.7% in the provision for possible loan losses and $538,000 or 199.3% in Federal income taxes.

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Financial Condition Summary

First Colonial has continued to achieve growth in total assets and deposits. First Colonial’s total assets at March 31, 2003 were $620.7 million compared to $611.6 million at December 31, 2002 and $465.1 million at December 31, 2001. First Colonial’s deposits increased by $10.6 million or 2.2% in the first quarter of 2003 and amounted to $483.4 million at March 31, 2003 compared to $472.8 million at December 31, 2002. During 2002, First Colonial’s total deposits grew by 24.5% or $92.9 million to a year-end total of $472.8 million. Total deposits at December 31, 2001 were $379.9 million. First Colonial’s total loans at March 31, 2003 were $252.6 million, a decrease of $3.2 million from December 31, 2002. First Colonial’s total loans amounted to $255.8 million and $225.8 million at December 31, 2002 and 2001, respectively. The loan increase in 2002 was $30.1 million or 13.3%. In addition, First Colonial had residential real estate loans held-for-sale of $848,000 at March 31, 2003 and $1.3 million at December 31, 2002. There were $3.8 million such loans at year-end 2001. The allowance for possible loan losses was $3.1 million at March 31, 2003 and December 31, 2002 as compared to $2.3 million at December 31, 2001. The increase in the allowance for possible loan losses in 2000 was $820,000 or 36.2%. In 2002, First Colonial’s long-term debt to the Federal Home Loan Bank of Pittsburgh increased by $33.1 million or 95.2%. The total long-term debt outstanding to the Federal Home Loan Bank was $67.0 million, $67.9 million and $34.8 million at March 31, 2003 and at December 31, 2002 and 2001, respectively. First Colonial also had $15.0 million of guaranteed preferred beneficial interest in First Colonial’s subordinated debentures at March 31, 2003 and at December 31, 2002. There was no such debt at December 31, 2001.

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Average Balances

The “Consolidated Comparative Statement Analysis” tables below set forth a comparison of average daily balances, interest income and interest expense on a fully taxable equivalent basis and interest rates calculated for each major category of interest-earning assets and interest-bearing liabilities of First Colonial. For purposes of this analysis, the computations in the “Consolidated Comparative Statement Analysis” were prepared using the Federal statutory rate of 34%; there are no state or local taxes on income applicable to First Colonial. For further information relating to the effective income tax rate of First Colonial, see Note K of First Colonial’s “Notes to Consolidated Financial Statements.” Interest income on loans included loan (expenses) and fees of $(49,000) and $(14,000) for the three months ended March 31, 2003 and 2002, respectively, and $(279,000), $(162,000), and $285,000 for the years ended December 31, 2002, 2001 and 2000, respectively.

CONSOLIDATED COMPARATIVE STATEMENT ANALYSIS

	For the Three Months Ended March 31,
	2003							2002
	Average Balance			Interest Income/ Expense		Average Yield/ Rate		Average Balance			Interest Income/ Expense		Average Yield/ Rate
	(Dollars in Thousands)
ASSETS
INTEREST-EARNING ASSETS
Interest-Bearing Balances with Banks	$	13,298		$	34	1.02	%	$	10,523		$	40	1.52	%
Federal Funds Sold		333			1	1.01			178			—	—
Investment Securities
Taxable		258,259			2,758	4.27			168,379			2,368	5.63
Non-Taxable(1)		53,898			925	6.86			36,872			664	7.20
Loans(1)(2)		254,925			4,193	6.58			232,172			4,276	7.37
Allowance for Loan Losses		(3,184	)		—	—			(2,337	)		—	—
Net Loans		251,741			4,193	6.66			229,835			4,276	7.44
Total Interest-Earning Assets		577,529			7,911	5.48			445,787			7,348	6.59
Non-Interest Earning Assets		31,111			—	—			28,250			—	—
TOTAL ASSETS, INTEREST INCOME	$	608,640			7,911	5.20		$	474,037			7,348	6.20
LIABILITIES
INTEREST-BEARING LIABILITIES
Interest-Bearing Deposits
Demand Deposits	$	61,987			69	0.44		$	57,265			100	0.70
Money Market Deposits		89,979			365	1.62			38,419			269	2.80
Savings & Club Deposits		76,206			165	0.86			67,751			246	1.45
CDs over $100,000		5,138			39	3.02			7,242			67	3.70
All Other Time Deposits		172,273			1,501	3.49			162,706			1,797	4.42
Total Interest-Bearing Deposits		405,583			2,139	2.11			333,383			2,479	2.97
Securities Sold Under Agreements to Repurchase		9,637			27	1.12			9,951			58	2.33
Other Short-Term Debt		51			—	1.43			8			—	—
Long-Term Debt		67,523			730	4.32			34,842			498	5.72
Guaranteed Preferred Beneficial Interests in First Colonial’s Subordinated Debentures		15,000			181	4.84			—			—	—
Total Interest-Bearing Liabilities		497,794			3,077	2.47			378,184			3,035	3.21

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CONSOLIDATED COMPARATIVE STATEMENT ANALYSIS CONTINUED

	For the Three Months March 31,
	2003						2002
	Average Balance		Interest Income/ Expense		Average Yield/ Rate		Average Balance		Interest Income/ Expense		Average Yield/ Rate
	(Dollars in Thousands)
NON-INTEREST-BEARING LIABILITIES
Non-Interest-Bearing Deposits		63,211		—	—			53,775		—	—
Other Liabilities		7,007		—	—			7,304		—	—
TOTAL LIABILITIES		568,012		3,077	2.17			439,263		3,035	2.76
SHAREHOLDERS’ EQUITY		40,628		—	—			34,774		—	—
TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY, INTEREST EXPENSE	$	608,640		3,077	2.02		$	474,037		3,035	2.56
NET INTEREST INCOME			$	4,834					$	4,313
Net Interest Spread(3)					3.01						3.38
Effect of Interest-Free Sources Used to Fund Earning Assets					0.34						0.49
NET INTEREST MARGIN(4)					3.35	%					3.87	%

(1) The indicated interest income and average yields are presented on a taxable equivalent basis. The taxable equivalent adjustments included above are $131,000 and $239,000 for the three months ended March 31, 2003 and 2002, respectively. The effective tax rate used for the taxable equivalent adjustment was 34%.

(2) Loan fees (expenses) of $(49,000) and $(14,000) for the three months ended March 31, 2003 and 2002, respectively, are included in interest income. Average loan balances include non-accruing loans of $1.4 million and $875,000 for the three months ended March 31, 2003 and 2002, respectively, and average loans held-for-sale of $2.5 million and $4.3 million for the three months ended March 31, 2003 and 2002, respectively.

(3) Net interest spread is the arithmetic difference between yield on interest-earning assets and the rate paid on interest-bearing liabilities.

(4) Net interest margin is computed by dividing net interest income by average interest-earning assets.

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CONSOLIDATED COMPARATIVE STATEMENT ANALYSIS

	For the Year Ended December 31,
	2002							2001							2000
	Average Balance			Interest Income/ Expense		Average Yield/ Rate		Average Balance			Interest Income/ Expense		Average Yield/ Rate		Average Balance			Interest Income/ Expense		Average Yield/ Rate
	(Dollars in Thousands)
ASSETS
INTEREST-EARNING ASSETS
Interest-Bearing Balances with Banks	$	9,743		$	146	1.50	%	$	4,787		$	154	3.22	%	$	2,281		$	141	6.18	%
Federal Funds Sold		729			11	1.51			427			14	3.28			328			23	7.01
Investment Securities
Taxable		192,816			9,847	5.11			152,604			9,516	6.24			139,283			9,440	6.78
Non-Taxable(1)		44,458			3,143	7.07			37,232			2,661	7.15			30,142			2,374	7.88
Loans(1)(2)		246,113			17,513	7.12			228,458			18,651	8.16			214,856			18,171	8.46
Allowance for Loan Losses		(2,590	)		—	—			(2,394	)		—	—			(2,474	)		—	—
Net Loans		243,523			17,513	7.19			226,065			18,651	8.25			212,382			18,171	8.56
Total Interest-Earning Assets		491,269			30,660	6.24			421,115			30,996	7.36			384,416			30,149	7.84
Non-Interest Earning Assets		28,643			—	—			29,395			—	—			31,926			—	—
TOTAL ASSETS, INTEREST INCOME	$	519,912			30,660	5.90		$	450,510			30,996	6.88		$	416,342			30,149	7.24
LIABILITIES
INTEREST-BEARING LIABILITIES
Interest-Bearing Deposits
Demand Deposits	$	58,496			373	0.64		$	55,087			492	0.89		$	53,151			536	1.01
Money Market Deposits		62,752			1,553	2.47			20,041			619	3.09			13,461			375	2.79
Savings & Club Deposits		72,259			965	1.34			65,079			1,362	2.09			62,834			1,392	2.22
CDs over $100,000		6,519			215	3.30			7,334			356	4.86			5,886			305	5.18
All Other Time Deposits		162,228			6,617	4.08			162,303			8,692	5.36			157,164			8,806	5.60
Total Interest-Bearing Deposits		362,254			9,723	2.68			309,844			11,521	3.72			292,496			11,414	3.90
Securities Sold Under Agreements to Repurchase		10,500			185	1.76			12,591			366	2.90			7,226			332	4.59
Other Short-Term Debt		243			4	1.65			1,919			93	4.85			3,994			256	6.41
Long-Term Debt		36,810			2,082	5.66			34,104			1,989	5.83			31,377			1,945	6.20
Guaranteed Preferred Beneficial Interests in First Colonial’s Subordinated Debentures		7,685			416	5.41			—			—	—			—			—	—
Total Interest-Bearing Liabilities		417,492			12,410	2.97			358,458			13,969	3.90			335,093			13,947	4.16

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CONSOLIDATED COMPARATIVE STATEMENT ANALYSIS CONTINUED

	For the Year Ended December 31,
	2002						2001						2000
	Average Balance		Interest Income/ Expense		Average Yield/ Rate		Average Balance		Interest Income/ Expense		Average Yield/ Rate		Average Balance		Interest Income/ Expense		Average Yield/ Rate
	(Dollars in Thousands)
NON-INTEREST-BEARING LIABILITIES
Non-Interest-Bearing Deposits		57,938		—	—			48,959		—	—			43,893		—	—
Other Liabilities		6,838		—	—			7,887		—	—			7,913		—	—
TOTAL LIABILITIES		482,268		12,410	2.57			415,303		13,969	3.36			386,899		13,947	3.60
SHAREHOLDERS’ EQUITY		37,644		—	—			35,207		—	—			29,443		—	—
TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY, INTEREST EXPENSE	$	519,912		12,410	2.39		$	450,510		13,969	3.10		$	416,432		13,947	3.35
NET INTEREST INCOME			$	18,250					$	17,027					$	16,202
Net Interest Spread(3)					3.27						3.46						3.68
Effect of Interest-Free Sources Used to Fund Earning Assets					0.44						0.58						0.53
NET INTEREST MARGIN(4)					3.71	%					4.04	%					4.21	%

(1) The indicated interest income and average yields are presented on a taxable equivalent basis. The taxable equivalent adjustments included above are $1.1 million, $961,000 and $862,000 for the years 2002, 2001 and 2000, respectively. The effective tax rate used for the taxable equivalent adjustment was 34%.

(2) Loan fees (expenses) of $(279,000), $(162,000) and $285,000 for the years 2002, 2001 and 2000, respectively, are included in interest income. Average loan balances include non-accruing loans of $1.4 million, $1.0 million and $1.0 million and average loans held-for-sale of $2.7 million, $1.9 million and $90,000 for the years 2002, 2001 and 2000, respectively.

(3) Net interest spread is the arithmetic difference between yield on interest-earning assets and the rate paid on interest-bearing liabilities.

(4) Net interest margin is computed by dividing net interest income by average interest-earning assets.

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Net Interest Income

Net interest income is the difference between the interest income on loans, investments and other interest-earning assets, and the interest paid on deposits and other interest-bearing liabilities. Net interest income is the primary source of earnings for First Colonial. Therefore, changes in this category can be essential to the overall net income of First Colonial.

First Colonial’s net interest income amounted to $4.5 million for the three months ended March 31, 2003 compared to $4.1 million for the three months ended March 31, 2002, an increase of $427,000 or 10.5%. This increase was primarily the result of an increase in interest earned on investments, a decrease in interest paid on deposits reduced in part by a decrease in interest earned on loans and an increase in interest paid on debt. The total interest income earned by First Colonial on loans and investments amounted to $7.6 million for the first quarter of 2003, an increase of $469,000 or 6.6% over the $7.1 million earned in the same period in 2002. The total interest expense paid by First Colonial on deposits and debt was $3.1 million and $3.0 million for the three-month period ended March 31, 2003 and 2002, respectively. This increase in first quarter of 2003 from 2002 was $42,000 or 1.4%. The increase in interest income was primarily due to higher volume of loans and investments reduced in part by declining interest rates. The increase in interest expense was primarily the result of higher volumes of deposits reduced in part by declining interest rates.

First Colonial’s fully taxable-equivalent net interest income was $4.8 million for the first three months of 2003, compared to $4.3 million for the same period in 2002, a 12.1% or $521,000 increase. This increase in taxable-equivalent net interest income was primarily due to a $877,000 increase related to volume partially reduced by a $356,000 decrease due to lower interest rates.

First Colonial’s total taxable-equivalent interest income for the three months ended March 31, 2003 increased by $563,000 or 7.7% compared to the same period in 2002. This increase was primarily the result of higher volumes of investments and loans reduced in part by lower interest rates earned on these investments and loans. Interest income on investments on a fully taxable equivalent basis was $651,000 or 21.5% higher during the first quarter of 2003 as compared to the same period in 2002. This increase was comprised of a $1.6 million increase due to a higher volume of investment securities reduced in part by a decrease of $928,000 due to lower interest rates. The interest income earned on loans on a fully taxable equivalent basis decreased by $83,000 or 1.9% for the three months ended March 31, 2003 as compared to the same period in 2002. This decrease was comprised of a $502,000 decrease due to lower interest rates reduced in part by a $419,000 increase due to growth in First Colonial’s average loans outstanding. First Colonial’s average year-to-date earning assets increased to $577.5 million at March 31, 2003 from $445.8 million at March 31, 2002. This was an increase of $131.7 million or 29.5%

First Colonial total interest expense increased by $42,000 or 1.4% during the first three months of 2003, over the same period in 2002. The increase was the result of growth in deposits, long-term debt and the subordinated debentures, reduced in part by lower interest rates paid on deposits and debt. The interest expense on long-term debt increased by $232,000 or 46.6% during the first three months of 2003 as compared to the first three months of 2002. This was comprised of an increase of $467,000 due to higher levels of long-term debt offset in part by a $235,000 decrease due to lower interest rates. Also affecting the increase in First Colonial’s interest expense was the $181,000 of interest paid on the $15.0 million of subordinated debentures issued in June 2002. The increase in interest expense were offset in part by a decrease of $340,000 or 13.7% on the interest paid on interest-bearing deposits and $31,000 or 53.4% on the interest paid on the securities sold under agreements to repurchase. The reduction of the interest paid on interest-bearing deposits was comprised of a decrease of $826,000 due to lower interest rates partially offset by an increase of $486,000 due to growth in deposits. The change in interest paid on securities sold under agreements to repurchase was due to a $29,000 decrease related to lower interest rates and a $2,000 decrease due to lower volume.

First Colonial’s net interest income, on a fully taxable equivalent basis, amounted to $18.3 million for 2002, an increase of $1.2 million or 7.2% over $17.0 million in 2001. As shown in the “Rate/Volume Analysis” table, the increase in net interest income in 2002 was attributable to higher net interest income of $2.8 million due to changes in volume and a reduction in net interest income of $1.6 million due to changes in rates. The volume-related change resulted primarily from increases in First Colonial’s investment securities and average balances for loans, partially offset by an increase in money market deposits, debt and demand, savings and club deposits. The rate-related

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change was primarily the result of the decrease of interest earned on First Colonial’s investment securities and loans being greater than the decrease of interest rates paid on deposits and debt.

First Colonial’s net interest income, on a fully taxable equivalent basis, in 2001 increased $825,000 or 5.1% over the 2000 figure of $16.2 million. This increase was the result of growth in First Colonial’s investments and loans, reduced in part by increases in time deposits and debt. Also affecting First Colonial’s 2000 net income was the decrease in interest rates earned on loans and investments being greater than the decrease on the interest rates paid on deposits and debt.

The net interest margin, a measure of net interest income performance, is determined by dividing net interest income by total interest-earning assets. First Colonial’s net interest margin was 3.35% for the three months ended March 31, 2003 compared to 3.87% for the three months ended March 31, 2002. First Colonial’s net interest margin was 3.71% for 2002, 4.04% for 2001 and 4.21% for 2000. The yield on First Colonial’s interest earning assets was 5.48% during the first three months of 2003 as compared to 6.59% in 2002. The average interest rate paid on First Colonial’s interest bearing deposits and other borrowings was 2.47% for the first three months of 2003 as compared to 3.21% in 2002. The decrease in 2002 was the result of the 1.12% decrease in the average rate earned on First Colonial’s interest-earning assets being greater than the 0.93% decrease in the average interest rate paid on First Colonial’s interest-bearing liabilities. The result was a decline in the interest spread, the difference of interest earned on assets less the interest paid on deposits and debt. First Colonial’s interest spread was 3.27%, 3.46% and 3.68% for 2002, 2001 and 2000, respectively. The impact on earnings by the reduction in First Colonial’s interest spread was diminished in part by the $9.0 million or 18.3% increase in 2002 of First Colonial’s average non-interest-bearing deposits.

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The following table sets forth a “Rate/Volume Analysis”, which segregates in detail the major factors that contributed to the changes in First Colonial’s net interest income for the three months ended March 31, 2003 and the years ended December 31, 2002 and 2001, as compared to the respective previous periods, into amounts attributable to both rate and volume variances. In calculating the variances, the changes were first segregated into (1) changes in volume (change in volume times the old rate), (2) changes in rates (change in rate times the old volume) and (3) changes in rate/volume (changes in rate times the change in volume). The changes in rate/volume have been allocated in their entirety to the change in rates. The interest income included in the “Rate/Volume Analysis” table has been adjusted to a fully taxable equivalent amount using the Federal statutory tax rate of 34%. Non-accruing loans have been used in the daily average balances to determine changes in interest income due to volume. Loan fees included in the interest income calculation are not material.

Rate/Volume Analysis

(Fully Taxable Equivalent)

	Increase (Decrease) in the Three Months Ended March 31, 2003 to 2002 Change Due To:									Increase (Decrease) in Year Ended December 31,
										2002 to 2001 Change Due To:									2001 to 2000 Change Due To:
	TOTAL			RATE			VOLUME			TOTAL			RATE			VOLUME			TOTAL			RATE			VOLUME
	(Dollars in Thousands)
Interest Income
Interest-Bearing Balances With Banks	$	(6	)	$	(17	)	$	11		$	(8	)	$	(167	)	$	159		$	13		$	(142	)	$	155
Federal Funds Sold		1			1			—			(3	)		(13	)		10			(9	)		(16	)		7
Investment Securities		651			(928	)		1,579			814			(2,229	)		3,043			363			(1,060	)		1,423
Loans		(83	)		(502	)		419			(1,139	)		(2,580	)		1,441			480			(670	)		1,150
Total Interest Income	$	563		$	(1,446	)	$	2,009		$	(336	)	$	(4,989	)	$	4,653		$	847		$	(1,888	)	$	2,735
Interest Expense
Demand Deposits	$	(31	)	$	(39	)	$	8		$	(119	)	$	(131	)	$	12		$	(44	)	$	(64	)	$	20
Money Market Deposits		96			(265	)		361			934			(385	)		1,319			244			60			184
Savings & Club Deposits		(81	)		(112	)		31			(397	)		(548	)		151			(30	)		(80	)		50
CD’s Over $100,000		(28	)		(9	)		(19	)		(141	)		(101	)		(40	)		51			(24	)		75
All Other Time Deposits		(296	)		(401	)		105			(2,075	)		(2,068	)		(7	)		(114	)		(402	)		288
Total Interest-Bearing Deposits		(340	)		(826	)		486			(1,798	)		(3,233	)		1,435			107			(510	)		617
Securities Sold Under Agreements to Repurchase		(31	)		(29	)		(2	)		(181	)		(120	)		(61	)		34			(213	)		247
Short-Term Debt											(89	)		(8	)		(81	)		(163	)		(30	)		(133	)
Long-Term Debt		232			(235	)		467			93			(65	)		158			44			(125	)		169
Guaranteed Preferred Beneficial Interest in Company’s Subordinated Debentures		181			—			181			416			—			416			—			—			—
Total Interest Expense	$	42		$	(1,090	)	$	1,132		$	(1,559	)	$	(3,426	)	$	1,867		$	22		$	(878	)	$	900
Increase in Net Interest Income	$	521		$	(356	)	$	877		$	1,223		$	(1,563	)	$	2,786		$	825		$	(1,010	)	$	1,835

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Market Risk

As a financial institution, First Colonial’s primary component of market risk is interest rate volatility. Fluctuations in interest will ultimately impact both the level of income and expense recorded on a large portion of First Colonial’s assets and liabilities, and the market value of all interest-earning assets, other than those which possess a short term to maturity. Since most of First Colonial’s interest-bearing assets and liabilities are located at Nazareth National Bank, the majority of First Colonial’s interest rate risk is at Nazareth National Bank level. As a result, most interest rate risk management procedures are performed at Nazareth National Bank level (see discussion on “Interest Rate Sensitivity”).

First Colonial and Nazareth National Bank operate as a community banking institution primarily in the counties of Northampton, Lehigh and Monroe, Pennsylvania. As a result of its location and nature of operations, First Colonial is not subject to foreign currency exchange or commodity price risk. Nazareth National Bank makes real estate loans primarily in the counties adjacent to its operations and thus is subject to risks associated with those local economies. At December 31, 2002, Nazareth National Bank held a concentration of residential real estate loans (42.4% of total loans) and commercial loans supported by real estate (24.8% of total loans) and consumer/installment loans (23.0% of total loans) in its loan portfolio. Loans for recreational vehicles represent 48% of the consumer/installment loans and 11% of First Colonial’s total loans. (see Note R of First Colonial’s “Notes to Consolidated Financial Statements”). Nazareth National Bank’s loans are subject to interest and economic risks. Nazareth National Bank also originates residential real estate loans for sale in the secondary market. Such loans are identified as “Mortgage Loans Held-for-Sale” on First Colonial’s Balance Sheet and are subject to interest rate risk (see discussion on “Mortgage Loans Held-for-Sale”). First Colonial does not own any trading assets and does not have any hedging transactions in place such as interest rate swaps (see discussions on “Investment Securities” and “Securities Available-for-Sale”).

Interest Rate Sensitivity

Interest rate sensitivity is a measure of the extent to which net interest income would change due to changes in the level of interest rates. The objective of interest rate sensitivity management is to reduce First Colonial’s vulnerability to future interest rate fluctuations and to enhance consistent growth of net interest income. Nazareth National Bank’s Asset/Liability Management Committee meets semi-monthly to examine, among other subjects, interest rates for various products and interest sensitivity.

Rate sensitivity arises from the difference between the volumes of assets which are rate-sensitive as compared to the volumes of liabilities which are rate-sensitive. A comparison of interest-rate-sensitive assets to interest-rate-sensitive liabilities is monitored by Nazareth National Bank on a regular basis using several time periods. The mismatch of assets and liabilities in a specific time frame is referred to as interest sensitivity gap. Generally, in an environment of rising interest rates, a negative gap (interest sensitive liabilities being greater than interest sensitive assets in a given period of time) will decrease net interest income, and in an environment of falling interest rates, a negative gap will increase net interest income.

At March 31, 2003, First Colonial had assets of $208.7 million which were subject to interest rate change within one year. First Colonial’s liabilities subject to rate change within one year at March 31, 2003 were $205.5 million. First Colonial had a positive one-year gap position of $3.1 million at March 31, 2003. First Colonial’s ratio of rate sensitive assets to rate sensitive liabilities was 1.02% at March 31, 2003.

Assets and liabilities are allocated to a specific time period based on their scheduled repricing date or on an historical basis. At December 31, 2002, $207.1 million of First Colonial’s assets (33.9% of total assets) were subject to interest rate changes within one year. This compares to First Colonial’s assets subject to interest rate changes within one year of $149.9 million (32.2% of total assets) at the end of 2001 and $162.2 million (36.6% of total assets) at the end of 2000. Liabilities of First Colonial subject to rate change within one year were $189.4 million, $151.9 million and $169.6 million in 2002, 2001 and 2000, respectively. First Colonial had a positive one-year gap position of $17.6 million as of December 31, 2002. The gap positions at December 31, 2001 and 2000 were negative $2.0 million and negative $7.4 million, respectively. The ratio of First Colonial’s rate-sensitive assets to rate-sensitive liabilities for the one-year time frame was 1.09 at the end of 2002, compared to 0.99 at the end of 2001 and 0.96 at the end of 2000. First Colonial’s positive gap position for the one-year time frame in 2002 was the result

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of an increase in interest-bearing deposits with banks, Federal Funds sold, shorter maturities in investment securities and loans and an increase in some longer-term deposits. The change in First Colonial’s deposit mix was due to the growth of non-interest bearing deposits and some longer-term certificates of deposits. The change in First Colonial’s loan maturities was due in part to the sale of residential mortgage loans and increases in shorter-term commercial loans. The change in First Colonial’s investment securities was the result of sales of longer-term securities and the reinvestment in shorter-term securities. Management of First Colonial intends to continue to purchase short-term rate securities, make adjustable rate and short-term commercial loans, market longer-term certificates of deposit and sell fixed-rate mortgage loans to maintain an acceptable gap position. The “Interest Sensitivity Analysis” in the following table presents a sensitivity gap analysis of First Colonial’s assets and liabilities at March 31, 2003.

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INTEREST SENSITIVITY ANALYSIS

as of March 31, 2003

	0 – 90 Days			91 – 180 Days			181 – 365 Days			1 – 5 Years			Over 5 Years			Total
	(Dollars in Thousands)
Interest bearing Deposits with Banks	$	10,547		$	—		$	—		$	—		$	—		$	10,547
Federal Funds Sold		2,000			—			—			—			—			2,000
Investment Securities		27,841			21,962			43,743			175,594			55,251			324,391
Loans Held-for-Sale		848			—			—			—			—			848
Loans		40,974			13,651			28,389			122,361			44,137			249,512
Other Assets		18,698			—			—			—			14,722			33,420
TOTAL ASSETS	$	100,908		$	35,613		$	72,132		$	297,955		$	114,110		$	620,718
Non-Interest-Bearing Deposits(1)	$	—		$	—		$	—		$	—		$	69,115		$	69,115
Interest-Bearing Deposits		122,172			24,643			41,363			103,192			122,892			414,262
Securities Sold Under Agreements to Repurchase		8,774			—			—			—			—			8,774
Short Term Debt		—			—			—			—			—			—
Long Term Debt		5,888			895			1,809			37,266			21,181			67,039
Guaranteed Preferred Beneficial Interests In Company’s Subordinated Debentures		—			—			—			—			15,000			15,000
Other		—			—			—			—			6,040			6,040
Capital		—			—			—			—			40,488			40,488
TOTAL LIABILITIES AND CAPITAL	$	136,834		$	25,538		$	43,172		$	140,458		$	274,716		$	620,718
Net Interest Sensitivity gap	$	(35,926	)	$	10,075		$	28,960		$	157,497		$	(160,606	)		—
Cumulative Interest Sensitivity gap	$	(35,926	)	$	(25,851	)	$	3,109		$	160,606		$	—			—
Cumulative Gap RSA/RSL		73.7	%		84.1	%		101.5	%		146.4	%		100.0	%

(1) Historically, non-interest-bearing deposits reflect insignificant change in deposit trends and, therefore, the Company classifys these deposits over five years.

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While using the interest sensitivity gap analysis is a useful management tool because it considers the quantity of assets and liabilities subject to repricing in a given time period, it does not consider the relative sensitivity to market interest-rate changes that are characteristic of various interest-rate-sensitive assets and liabilities. Consequently, even though First Colonial currently has a positive gap position because of the unequal sensitivity of these assets and liabilities, management believes that this position will not materially impact earnings in a changing rate environment. For example, changes in the prime rate on variable commercial loans may not result in an equal change in the rate of money market deposits or short-term certificates of deposit. A simulation model is therefore used by First Colonial to estimate the impact of various changes, both upward and downward, in market interest rates and volumes of assets and liabilities on Nazareth National Bank’s net income. This model produces an interest rate exposure report that forecasts changes in the market value of portfolio equity under alternative interest rate environments. The market value of portfolio equity is defined as the present value of First Colonial’s existing assets, liabilities and off-balance sheet instruments. The calculated estimates of changes in the market value of portfolio equity for First Colonial at March 31, 2003 are as follows:

Changes in Rate	Percent of Change in Market Value of Portfolio Equity
+300 basis points	(3.3	)%
+200 basis points	(0.8	)
+100 basis points	(0.1	)
Flat Rate	—
-100 basis points	(0.7	)
-200 basis points	(5.0	)
-300 basis points	(4.0	)

The assumptions used in evaluating the vulnerability of First Colonial’s earnings and capital to changes in interest rates are based on management’s consideration of past experience, current position and anticipated future economic conditions. The interest rate sensitivity of First Colonial’s assets and liabilities as well as the estimated effect of changes in interest rates on the market value of portfolio equity could vary substantially if different assumptions are used or actual experience differs from the assumptions on which the calculations were based.

Service Charges and Other Income

First Colonial’s other income for the three months ended March 31, 2003, including service charges, trust and wealth management revenues, gains on the sale of mortgage loans, net securities gains and other miscellaneous income, was $2.3 million as compared to $1.6 million for the same period in 2002. This was an increase of $709,000 or 45.5%. This increase was the result of the increased gains on the sale of securities available-for-sale, increased gains on the sale of mortgage loans, increases in service charges, and an increase in trust and wealth management revenues, reduced in part by a decrease in and other miscellaneous income. First Colonial’s net gains on securities available-for-sale for the three-month period ended March 31 was $765,000 in the first quarter of 2003 and $369,000 in the first quarter of 2002. This was an increase of $396,000 or 107.3%. In the three month period ended March 31, 2003, First Colonial’s gains on the sale of mortgage loans amounted to $417,000 as compared to gains of $76,000 for the same period in 2002. This was an increase of $341,000. First Colonial’s mortgage loan sales amounted to $16.2 million during the three-month period ended March 31, 2003 as compared to $9.7 million during the same period in 2002. Service charges were $619,000, during the three months ended March 31, 2003, a $20,000 or 3.3% increase over the 2002 amount of $599,000. The increase in First Colonial’s service charges was due to higher volumes of debit card transactions. First Colonial’s other miscellaneous income for the three months ended March 31, 2003 was $180,000, a decrease of $49,000 or 21.4% compared to $229,000 for the same period in 2002.

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First Colonial’s service charge income on deposit accounts amounted to $2.6 million in 2002 compared to $2.3 million in 2001 and $2.0 million in 2000. In 2002, the service charges on deposit accounts increased by $251,000 or 10.7% over 2001 and the 2001 increase over 2000 was $316,000 or 15.7%. The increases in 2002 and 2001 were primarily the result of increases in the number of deposit accounts and increases in the usage of Nazareth National Bank’s debit card.

In 2002, First Colonial had gains on the sale of mortgage loans of $1.1 million as compared to gains of $346,000 in 2001. In 2000, First Colonial reported gains on the sale of mortgage loans of $59,000 (see discussion on “Mortgage Loans Held-for-Sale”).

First Colonial’s other operating income was $749,000 in 2002, as compared to $710,000 in 2001, an increase of $39,000 or 5.5%. Other operating income for 2000 was $825,000.

Trust and Wealth Management Division

For the three months ended March 31, 2003, Nazareth National Bank’s Trust and Wealth Management Division’s revenues were $285,000 compared to $284,000 for the same period in 2002.

Revenue from Nazareth National Bank’s Trust and Wealth Management Division operations was $1.2 million in 2002, as compared to $1.3 million in 2001. This was a decrease of $90,000 or 7.0%. The reduction in the Trust and Wealth Management revenue was the result of a reduction in the market values of the securities on which fees are assessed offset in part by growth in the assets held by Nazareth National Bank for its customers. Revenue for the Nazareth National Bank Trust and Wealth Management Division for 2000 was $1.2 million. Trust assets are held by Nazareth National Bank for its customers in a fiduciary or agency capacity, and thus, are not included in the financial statements of First Colonial. Fees are assessed by the Trust Division to some customers based on the market value of the assets held in the customers’ account. As a result, changing market values will materially impact the revenues earned from Trust operations.

Other Expenses

First Colonial’s total other expenses for the three-month period ended March 31, 2003 were $5.5 million as compared to $4.3 million for the same period in 2002. This was an increase of $1.2 million or 28.6%. A major factor affecting the increase in First Colonial’s total other expenses was an expense of $637,000 for the impairment of mortgage servicing rights due to a larger than normal number of customers prepaying their residential mortgage loans as a result of lower interest rates. Also affecting the increase in total other expenses was an increase of $529,000 or 25.8% in salary and benefit expenses, which were $2.6 million in the first quarter of 2003 as compared to $2.0 million in the first quarter of 2002. This increase was primarily the result of a charge of $175,000 due to accelerated vesting and distribution of the deferred stock compensation as a result of the execution of the merger agreement with Keystone, general salary increases of approximately 4%, the payment of higher commissions and incentives to certain loan officers as a result of increased new loan business and the addition of staff during the third and fourth quarters of 2002 in the commercial loan, and trust and wealth management areas. Other operating expenses for the three-month period ended March 31, 2003 were $1.6 million, an increase of $80,000 or 5.1% from the same period in 2002. Partially offsetting these increases was a decrease in occupancy and equipment expenses of $23,000 or 3.5%. First Colonial’s occupancy and equipment expenses were $643,000 and $666,000 for the three months ended March 31, 2003 and 2002, respectively.

Salaries and employee benefits represent a significant portion of First Colonial’s non-interest expense. These expenses, amounting to $9.1 million, increased by $831,000 or 10.1% in 2002 compared to $8.2 million in 2001. These expenses in 2001 amounted to an increase of $787,000 or 10.6% over the $7.4 million reported in 2000. The increase in 2002 was primarily due to salary increases of approximately 4%, increases in Lending and Trust division’s staff and an increase in cash bonuses paid to all employees. Salary expense in 2001 increased due to normal salary increases of approximately 3%, cash bonuses paid to all employees and the full year’s expense related to the opening of new Nazareth National Bank branches in Mount Pocono, Whitehall and Trexlertown.

Occupancy and equipment expenses for First Colonial were $2.5 million in 2002 which was $65,000 or 2.6% lower than the 2001 amount of $2.6 million. The 2001 amount was $136,000 or 5.7% greater than First

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Colonial’s 2000 occupancy and equipment expense of $2.4 million. The decrease in 2002 was primarily due to expense reductions in building and equipment maintenance. The increase in 2001 was the result of a full year’s expenses at branches in Mount Pocono, Whitehall and Trexlertown.

First Colonial’s other operating expenses (such as advertising, publicity, deposit insurance premiums, data processing fees, legal, accounting, supplies, postage and telephone) in 2002 were $6.1 million, compared to $6.0 million in 2001 and $7.1 million in 2000. These expenses increased in 2002 as compared to 2001 by $117,000 or 2.0%. Contributing to the increase of First Colonial’s expenses in 2002 was an increase of $88,000 in printing and supplies, a $90,000 increase in loan origination and appraisal expenses, and a $40,000 increase in public relations expenses. These increases were offset in part by decreases in: legal fees of $325,000, unrealized losses on residential real estate loans held-for-sale of $93,000, deposit service fees of $40,000, and director fees of $24,000. The decrease in First Colonial’s other expenses in 2001 was $1.1 million or 16.0%. Included in First Colonial’s 2000 expenses was a provision of $1.0 million to the special reserve for Funeral Trust litigation, a $184,000 write-down of other real estate owned and $100,000 on losses due to theft. There were no expenses incurred by First Colonial for these items in 2001. Also contributing to the reduction of First Colonial’s expenses in 2001 were reductions of $188,000 in legal fees, $83,000 in advertising and $74,000 in public relations. These reductions were offset in part by increases in professional fees of $313,000, loan origination costs of $114,000 and unrealized losses on residential real estate loans held for sale of $93,000. Advertising costs were $479,000, $463,000 and $546,000 for the years ended December 31, 2002, 2001 and 2000, respectively (see Notes A.14 and J of First Colonial’s “Notes to Consolidated Financial Statements”).

Investment Securities

First Colonial classifies its debt and marketable securities into three categories: trading, available-for-sale, and held-to-maturity as provided by the Financial Accounting Standards Board Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities”. Trading securities are measured at fair value, with unrealized holding gains and losses included in income. First Colonial had no trading securities in 2002 and 2001. Available-for-sale securities are stated separately on the financial statements and are discussed in the following section “Securities Available-for-Sale”. Held-to-maturity securities are carried at amortized cost and identified as investment securities in the financial statements (see Notes A.2 and B of First Colonial’s “Notes to Consolidated Financial Statements”).

First Colonial’s held-to-maturity securities totaled $69.5 million at March 31, 2003, $30.3 million at December 31, 2002 and $23.0 million at December 31, 2001. First Colonial has the intent and ability to hold these securities until maturity. The fair value of these securities was $69.8 million at March 31, 2003, and $30.8 million and $23.2 million at December 31, 2002 and 2001, respectively.

First Colonial, at December 31, 2002 and 2001, did not hold any securities identified as derivatives in the form of Collateralized Mortgage Obligations (CMOs), Planned Amortization Class (PAC), Real Estate Mortgage Investment Conduits (REMICs), Stripped-Mortgage-Backed Securities, interest rate swaps, futures or options. First Colonial held adjustable rate mortgage-backed securities issued by U. S. Government Agencies totaling $20.7 million at December 31, 2002 ($19.5 million in available-for-sale and $1.2 million in held-to-maturity) and $7.8 million at December 31, 2001 ($5.8 million in available-for-sale and $2.0 million in held-to-maturity). The interest rates on most of these securities are tied to various indexes, are subject to various caps, and are adjusted annually. First Colonial also held fixed rate mortgage-backed securities issued by U. S. Government Agencies totaling $181.8 million at December 31, 2002 ($167.6 million in available-for-sale and $14.2 million in held-to-maturity) and $86.0 million at December 31, 2001 ($81.5 million in available-for-sale and $4.5 million in held-to-maturity).

Securities Available-for-Sale

First Colonial had $254.9 million in available-for-sale securities at March 31, 2003 with a net unrealized gain of $278,000. At December 31, 2002, First Colonial’s available-for-sale securities amounted to $283.5 million with a net unrealized gain of $1.3 million.

During the three-month period ended March 31, 2003, First Colonial sold $50.9 million of securities available-for-sale for a net gain of $765,000 as compared to sales of $28.1 million of securities available-for-sale

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sold for a net gain of $369,000 for the same time period in 2002. Most of the securities sold were longer term agency mortgage-backed bonds and fixed rate agency bonds. These securities were replaced with shorter-term agency mortgage-backed securities. The purpose of these sales was to shorten the investment portfolio and reduce First Colonial’s interest rate risk.

First Colonial had $283.5 million of securities available-for-sale at December 31, 2002, as compared to $181.3 million at December 31, 2001. At December 31, 2002, the net unrealized gain on these securities was $1.3 million, net of the tax effect of $681,000. There was a net unrealized loss of $694,000, net of the tax effect of $359,000 on the available-for-sale securities at December 31, 2001. The net unrealized gain or loss is included in First Colonial’s shareholders’ equity (see Notes A.2, A.6 and B of the “Notes to Consolidated Financial Statements”).

These securities are being held to meet the liquidity needs of First Colonial and to provide flexibility to support earnings in changing interest rate environments. The tax-free municipal securities in the available-for-sale category will also be used to assist in managing First Colonial’s Federal tax position. While First Colonial’s management has the intent and the ability to hold available-for-sale securities on a long-term basis or to maturity, they may sell these securities under certain circumstances. Such occurrences could include, but are not limited to, meeting current liquidity needs, adjusting maturities or repricing periods to reduce interest rate risk, reducing Federal Income Tax liability, improving current or future interest income, adjusting risk-based capital position, changing portfolio concentrations, and providing funds for increased loan demand or deposit withdrawals. Upon the sale of an available-for-sale security, the actual gain or loss is included in income.

A summary of First Colonial’s available-for-sale and held-to-maturity securities at March 31, 2003, and at December 31, 2002, 2001 and 2000 are as follows:

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AVAILABLE-FOR-SALE SECURITIES

	At March 31, 2003				At December 31,
					2002				2001				2000
	Amortized Cost		Carrying Amount at Fair Value		Amortized Cost		Carrying Amount at Fair Value		Amortized Cost		Carrying Amount at Fair Value		Amortized Cost		Carrying Amount at Fair Value
	(Dollars in Thousands)
U. S. Treasury	$	4,206	$	4,248	$	5,244	$	5,287	$	5,074	$	5,108	$	4,011	$	4,022
U. S. Government Agencies		15,297		15,395		25,315		25,670		43,977		43,704		79,145		79,099
States and Political Subdivisions		46,414		47,341		44,315		45,182		31,450		31,127		28,210		28,253
Mortgage Backed Securities		166,357		167,091		186,209		188,338		87,461		87,253		44,110		44,129
Corporate Bonds		3,500		3,500		2,000		1,998		456		422		—		—
Equity Securities		18,734		17,355		18,396		17,006		13,937		13,688		8,496		8,526
Total Available-for-Sale Securities	$	254,508	$	254,930	$	281,479	$	283,481	$	182,355	$	181,302	$	163,972	$	164,029

HELD-TO-MATURITY SECURITIES

	At March 31, 2003				At December 31,
					2002				2001				2000
	Carrying Amount at Amortized Cost		Approximate Fair Value		Carrying Amount at Amortized Cost		Approximate Fair Value		Carrying Amount at Amortized Cost		Approximate Fair Value		Carrying Amount at Amortized Cost		Approximate Fair Value
	(Dollars in Thousands)
U. S. Government  Agencies	$	12,808	$	12,871	$	6,414	$	6,562	$	8,622	$	8,819	$	7,937	$	7,903
States and Political  Subdivisions		8,009		8,116		8,507		8,615		7,885		7,811		8,016		7,991
Mortgage Backed Securities		48,644		48,844		15,376		15,614		6,497		6,530		4,019		4,012
Total Held-to-Maturity Securities	$	69,461	$	69,831	$	30,297	$	30,791	$	23,004	$	23,160	$	19,972	$	19,906

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The maturity distribution and weighted average yield of the investment portfolio of First Colonial at March 31, 2003 are presented in the following table. Weighted average yields on tax-exempt obligations have been computed on a fully taxable equivalent basis assuming a tax rate of 34%. All average yields were calculated on the book value of the related securities. Equity and other securities having no stated maturity have been included in the “After 10 Years” category.

AVAILABLE-FOR-SALE INVESTMENT SECURITIES YIELD BY MATURITY AT MARCH 31, 2003

AVAILABLE-FOR-SALE AT FAIR VALUE

	Within 1 Year				After 1 But Within 5 Years				After 5 But Within 10 Years				After 10 Years				Total
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield
	(Dollars in Thousands)
U.S. Treasury	$	—	—		$	2,023	1.68	%	$	2,225	2.72	%	$	—	—		$	4,248	2.23	%
U.S. Government Agency		—	—			2,017	2.68	%		9,412	3.43	%		3,966	5.09	%		15,395	3.76	%
Mortgage-Backed Securities		25	6.00	%		—	—			—	—			167,067	4.39	%		167,092	4.39	%
State and Political Subdivisions		104	4.86	%		1,235	4.22	%		13,617	4.39	%		32,384	4.62	%		47,340	4.54	%
Other Debt Securities		—	—			—	—			—	—			3,500	—			3,500	2.08	%
Equity Securities		—	—			—	—			—	—			17,355	3.31	%		17,355	3.31	%
TOTAL AVAILABLE-FOR-SALE SECURITIES		129	5.09	%		5,275	2.66	%		25,254	3.88	%		224,272	4.32	%		254,930	4.24	%
Average of Available-for-Sale Securities in Years		0.87				3.32				8.05				18.16				16.81

HELD TO MATURITY SECURITIES YIELD BY MATURITY AT MARCH 31, 2003

HELD-TO-MATURITY AT AMORITIZED COST

	Within 1 Year				After 1 But Within 5 Years				After 5 But Within 10 Years				After 10 Years				Total
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield
	(Dollars in Thousands)
U.S. Government Agency	$	—	—		$	999	5.86	%	$	6,411	4.69	%	$	5,398	3.93	%	$	12,808	4.46	%
Mortgage-Backed Securities		1	6.40	%		253	7.00	%		—	7.85	%		48,389	4.06	%		48,643	4.07	%
State and Political Subdivisions		—	—			460	4.62	%		3,212	4.74	%		4,338	4.61	%		8,010	4.67	%
Equity Securities		—	—			—	—			—	—			—	—			—	—
TOTAL HELD-TO-MATURITY SECURITIES	$	1	6.40	%	$	1,712	5.69	%	$	9,623	4.71	%	$	58,125	4.09	%	$	69,461	4.21	%
Average of Held-to-Maturity Securities in Years		0.25				3.30				8.52				18.52				16.76

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During 2002, First Colonial sold $90.2 million of securities available-for-sale, resulting in a total net gain of $1.3 million, which was recorded in First Colonial’s income and includes net gains on equity securities sold by First C. G. of $26,000. The securities sold were primarily U. S. Government Agency Bonds, U. S. Agency mortgage-backed bonds, municipal bonds, and corporate bonds held by Nazareth National Bank and equity securities held by First C. G. The sales by Nazareth National Bank were executed to provide liquidity, reduce future interest rate risk, and to recognize gains that would be lost as a result of calls and prepayments. The sales of equity securities by First C. G. were made to recognize certain gains, and to reposition the equity portfolio. Securities purchased by First Colonial in 2002 totaled $310.6 million. Included in these purchases were $60.7 million in U. S. Agency bonds, $212.8 million in U. S. Agency mortgage-backed bonds, $24.9 million in municipal securities, $4.3 million in U. S. Treasury bonds, $30.0 million in trust preferred bonds, $1.8 million in agency preferred stock, and $1.7 million in equity securities. The securities sold in 2001 totaling $34.3 million were primarily U. S. Agency, mortgage-backed bonds and municipal bonds held by Nazareth National Bank and equity securities held by First C. G. The 2001 sales resulted in net gains of $929,000. These gains include net gains of $146,000 on equity securities sold by First C. G. The sales made by Nazareth National Bank were to provide liquidity and to reduce future interest rate risk. The sales by First C. G. were made to recognize certain gains. Security purchases by First Colonial in 2001 amounted to $143.5 million which were primarily U. S. Agency mortgage-backed bonds, U. S. Agency fixed rate bonds, municipal securities, U. S. Treasury bonds, corporate bonds, agency preferred stock and other equity securities. In 2000, a net gain on security transactions of $174,000 was recorded by First Colonial on sales of $8.1 million.

Loan Portfolio

First Colonial’s loans outstanding at March 31, 2003 amounted to $252.6 million compared to $255.8 million at December 31, 2002. This was a decrease of $3.2 million or 1.3%. The decrease in First Colonial’s loans was primarily the result of a decrease of $4.1 million or 8.3% in residential real estate loans and a decrease of $2.4 million or 2.3% in consumer loans. These decreases were offset in part by an increase in First Colonial’s commercial loans of $3.3 million or 3.2%. The reduction in residential real estate loans primarily was the result of the sale of $16.2 million of these loans during the three-month period of 2003.

At December 31, 2002, total loans at First Colonial (net of unearned discounts of $138,000 in 2002 and $250,000 in 2001) amounted to $255.8 million, an increase of $30.1 million, or 13.3% compared to the 2001 amount of $225.8 million. The increase in First Colonial’s loans in 2002 was primarily the result of an increase of $31.0 million or 96.0% in real estate commercial loans, an increase of $3.8 million or 27.6% in other commercial loans and an increase of $103,000 or 6.1% in municipal loans, partially offset by an decrease of $4.5 or 4.0% in residential real estate loans (see “Mortgage Loans Held for Sale”), a decrease of $413,000 or 0.7% in consumer loans and a decrease of $51,000 or 0.8% in real estate construction loans.

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First Colonial’s loans outstanding by major category are as follows:

	At March 31, 2003			At December 31
				2002			2001			2000			1999			1998
	(Dollars in Thousands)
Real Estate—Residential	$	101,783		$	108,372		$	112,871		$	128,862		$	112,870		$	119,914
Real Estate—Construction		6,263			6,076			6,127			5,923			6,737			11,689
Real Estate—Commercial		70,215			63,350			32,317			27,206			26,809			29,587
Consumer/Installment		55,935			58,792			59,205			53,062			45,886			40,184
Commercial (Non-Real Estate) and Agricultural		16,812			17,560			13,762			10,214			9,538			10,900
States and Political Subdivisions		1,724			1,805			1,702			2,089			1,096			1,178
Other		17			27			23			19			13			10
Total Gross Loans		252,749			255,982			226,007			227,375			202,949			213,462
Unearned Income		(125	)		(138	)		(250	)		(431	)		(691	)		(1,025	)
Total Loans		252,624			255,844			225,757			226,944			202,258			212,437
Allowance for Possible Losses		(3,112	)		(3,084	)		(2,264	)		(2,411	)		(2,437	)		(2,691	)
Net Loans	$	249,512		$	252,760		$	223,493		$	224,533		$	199,821		$	209,746

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The maturity ranges of items in the loan portfolio (excluding residential mortgages of 1 to 4 family residences and consumer loans) of Nazareth National Bank and the amount of loans with predetermined interest rates and floating interest rates due after one year, as of March 31, 2003, are summarized in the table set forth below. The determination of maturities included in the table are based upon contract terms. Demand loans that do not have a defined repayment term are reported as maturing within one year. In situations where a rollover is appropriate, Nazareth National Bank’s policy in this regard is to evaluate the credit for collectibility consistent with the normal loan evaluation process. This policy is used primarily in evaluating ongoing customers’ use of their lines of credit with Nazareth National Bank that are at floating interest rates. Management continues to emphasize the granting of floating interest rate loans to better match the interest sensitivity of deposits.

LOAN MATURITY AND INTEREST SENSITIVITY

As of March 31, 2003

	One Year or Less		One to Five Years		Over Five Years		Total
	(Dollars in Thousands)
Real Estate—Construction	$	437	$	795	$	5,031	$	6,263
Real Estate—Commercial		9,913		14,318		45,984		70,215
Commercial (Non-Real Estate) and Agricultural		5,259		7,545		4,008		16,812
	$	15,609	$	22,658	$	55,023	$	93,290
Loan Maturity After 1 Year With:
Predetermined Interest Rate			$	9,008	$	20,847
Floating Interest Rate				13,650		34,176
			$	22,658	$	55,023

First Colonial’s primary geographic area for its lending activities includes Monroe, Northampton and Lehigh Counties, Pennsylvania.

Making loans to businesses and individuals entails risks to First Colonial, including ascertaining cash flows, evaluating the credit history, assets and liabilities of a potential borrower, and determining the value of the various types of collateral pledged as security. Lending involves determining risks, managing those risks and charging an appropriate interest rate to compensate for taking such risks, and to cover the cost of funds (see previous discussion on “Market Risk”).

First Colonial’s loan to deposit ratio was 52.3% at March 31, 2003, 54.1% at December 31, 2002 and 59.4% at December 31, 2001. Additional information concerning loans is shown in Note C of First Colonial’s “Notes to Consolidated Financial Statements”.

Mortgage Loans Held-for-Sale

Mortgage loans originated by First Colonial and intended for sale in the secondary market are carried at the lower of aggregate cost or estimated fair value. Gains and losses on sales of loans are also accounted for in accordance with SFAS No. 134, “Accounting for Mortgage Securities Retained After the Securitizations of Mortgage Loans Held-for-Sale by a Mortgage Banking Enterprise.” SFAS No. 134 requires that an entity engaged in mortgage banking activities classify the retained mortgage-backed security or other interest, which resulted from the securitizations of a mortgage loan held-for-sale based upon its ability and intent to sell or hold these investments.

Management of First Colonial continued a program to sell most of its newly originated residential real estate loans in the secondary market. In both 2002 and 2001, First Colonial also sold a group of residential real

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estate loans originated in prior years. The purpose of these sales was to reduce First Colonial’s interest rate risk and to provide funds to support a higher level of loan originations.

In the three month period ended March 31, 2003, First Colonial sold $16.2 million of residential real estate loans in the secondary market resulting in a net gain of $417,000. During the first quarter of 2002, $9.7 million of these loans were sold by First Colonial for a net gain of $76,000. At March 31, 2003, $848,000 of residential real estate loans were identified by First Colonial as held-for-sale. There was no unrealized loss on these loans held-for-sale at March 31, 2003. During the first quarter of 2003, First Colonial recognized an expense of $637,000 for the impairment of mortgage servicing rights previously booked as an asset as a result of retaining servicing of sold mortgage loans. This expense was recognized because of the increase in prepayments of these sold mortgage loans.

The sales of residential real estate loans in the secondary market for 2002 amounted to $52.9 million. In 2002, Nazareth National Bank originated $33.1 million of the loans sold. The remaining $19.9 million of loans sold in 2002 were originated in prior years. A net gain of $1.1 million was recorded by First Colonial on the total amount of loans sold. At December 31, 2002, there First Colonial had $1.3 million of residential real estate loans identified as held-for-sale. There was no unrealized loss on these loans held-for-sale at December 31, 2002.

Nazareth National Bank sold $44.7 million of residential real estate loans during 2001 in the secondary market. Nazareth National Bank originated $26.4 million of these loans in 2001 and $18.3 million in prior years. A net gain of $346,000 was recognized by First Colonial on the total loans sold in 2001. At December 31, 2001, there were $3.8 million residential real estate loans identified as held-for-sale.

During 2000, First Colonial had a net gain of $59,000 on the sale of $7.7 million of residential real estate loans.

First Colonial intends to continue to originate residential real estate loans in 2003 and to sell some of these loans in the secondary market. First Colonial services all of the residential mortgage loans sold and plans to continue this practice.

Non-Performing Loans

The following discussion relates to Nazareth National Bank’s non-performing loans, which consist of loans on a non-accrual basis and accruing loans which are past due ninety days or more.

Accrual of interest is discontinued on a loan when management believes that the borrower’s financial condition is such that the collection of interest is in doubt. First Colonial recognizes these loans as non-accrual, but considers the principal to be substantially collectible because the loans are protected by adequate collateral or other resources. Payments received on non-accrual loans are applied to principal until such time as the principal is paid off. Any additional payments are then recognized as interest income.

First Colonial’s total non-performing loans (non-accruing loans and loans past due over 90 days) amounted to $1.8 million at March 31, 2003 as compared to $2.2 million at December 31, 2002 and $2.7 million at March 31, 2002. The ratio of First Colonial’s non-performing loans to total loans was 0.72%, 0.87% and 1.15% at March 31, 2003, December 31, 2002 and March 31, 2002, respectively. The decrease in this ratio was primarily the result of a decrease in total non-performing loans due to collection efforts.

First Colonial’s non-accruing loans at March 31, 2003 amounted to $1.4 million, a $44,000 increase from the amount at December 31, 2002. This increase was primarily the result of the poor performance of certain consumer and residential real estate loans. At the present time, management of First Colonial is of the opinion that these loans present a minimal amount of exposure to First Colonial.

First Colonial’s loans past due 90 days or more and still accruing interest are loans that are generally well secured and expected to be restored to a current status in the near future. As of March 31, 2003, First Colonial’s loans past due 90 days or more and still accruing interest amounted to $432,000 compared to $874,000 at December 31, 2002. The $442,000 decrease in loans past due 90 days from December 31, 2002 to March 31, 2003 was the result of decreases in commercial, mortgage and consumer loans past due 90 days or more.

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First Colonial’s other real estate owned at March 31, 2003 was $180,000 as compared to none at December 31, 2002. This increase resulted from the foreclosure of a residential real estate property.

First Colonial’s loans on non-accrual status totaled $1.4 million at December 31, 2002. This balance represented a $332,000 increase in non-accrual loans during 2002 due to the poor performance of certain additional mortgage loans. Management of First Colonial believes there is sufficient reserves and/or collateral to cover any possible losses on these loans.

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The table “Non-Accrual Loans” shows the balance and the effect non-accrual loans have had on interest income at First Colonial for each of the periods indicated.

Non-Accrual Loans

	At March 31, 2003			At December 31,
				2002			2001			2000			1999			1998
	(Dollars in Thousands)
Non-accrual loans	$	1,395		$	1,351		$	1,019		$	1,048		$	1,311		$	1,245
Non-accrual loans as a percentage of total loans		0.55	%		0.53	%		0.45	%		0.46	%		0.65	%		0.59	%
Interest which would have been recorded at original rate	$	2		$	10		$	22		$	38		$	56		$	144
Interest that was reflected in income		—			5			33			42			35			23
Net impact on interest income	$	(5	)	$	(5	)	$	11		$	4		$	(21	)	$	(121	)

Set forth below are the amounts of loans outstanding at First Colonial as of the end of each of the periods indicated that are 90 days and over past due and are on an accrual basis and are not included in the table above. Management of First Colonial continues to accrue interest on these loans since they are secured and in the process of collection and are expected to be eventually paid in full.

Accruing Loans Past Due 90 Days Or More

	At March 31, 2003			At December 31,
				2002			2001			2000			1999			1998
	(Dollars in Thousands)
Accruing loans past due 90 days or more	$	432		$	874		$	2,185		$	1,469		$	1,491		$	1,021
Accruing loans past due 90 days or more as a percentage of total loans		0.17	%		0.34	%		0.97	%		0.65	%		0.74	%		0.48	%

The following table shows the balance of First Colonial’s non-performing loans and non-performing assets for the period indicated.

Non-Performing Assets

	At March 31, 2003		At December 31,
			2002		2001		2000		1999		1998
	(Dollars in Thousands)
Non-accrual loans	$	1,395	$	1,351	$	1,019	$	1,048	$	1,311	$	1,245
Accruing loans past due 90 days or more		432		874		2,185		1,469		1,491		1,021
Total non-performing loans	$	1,827	$	2,225	$	3,204	$	2,517	$	2,802	$	2,266
Other real estate owned	$	180	$	—	$	93	$	325	$	571	$	636
Total non-performing assets	$	2,007	$	2,225	$	3,297	$	2,842	$	3,373	$	2,902

First Colonial measures impairment of a loan based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, impairment may be measured based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral

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when the creditor determines that foreclosure is probable. SFAS No. 118 allows creditors to use existing methods for recognizing interest income on impaired loans.

First Colonial identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. The accrual of interest is discontinued in such loans and no income is recognized until all recorded amounts of interest and principal are recovered in full.

Loan impairment is measured by estimating the expected future cash flows and discounting them at the respective effective interest rate or by valuing the underlying collateral. The total principal amount of impaired loans at First Colonial was $65,000 at March 31, 2003 and $65,000 and $103,000 at December 31, 2002 and 2001, respectively. The recorded investment at First Colonial in these loans and the valuation for credit losses related to loan impairment at March 31, 2003 and at December 31, 2002 and 2001 are as follows:

Impaired Loans

	At March 31, 2003			At December 31,
				2002			2001
	(Dollars in Thousands) at:
Principal amount of impaired loans	$	65		$	65		$	103
Accrued interest		—			—			—
Deferred loan costs		—			—			—
		65			65			103
Less valuation allowance		(6	)		(8	)		(43	)
	$	59		$	57		$	60

The activity in the allowance account for credit losses at First Colonial related to impaired loans is as follows:

	For the Three Months Ending March 31, 2003			For the Years Ending December 31,
				2002			2001
	(Dollars in Thousands)
Valuation allowance at January 1,	$	8		$	43		$	78
Provision for loan impairment		—			—			22
Direct charge-offs		—			(15	)		(17	)
Transfers from (to) Unallocated Reserve		(2	)		(20	)		(40	)
Valuation allowance at end of period	$	6		$	8		$	43

There was no cash collected on impaired loans by First Colonial during the three months ended March 31, 2003. Total cash collected on impaired loans at First Colonial during the year ended December 31, 2002 was $16,000.

Total cash collected on impaired loans during 2001 at First Colonial was $128,000, of which $95,000 was credited to the principal balance outstanding on such loans and $33,000 was recognized as interest income. Interest that would have been accrued on impaired loans at First Colonial was $10,000 and $22,000 in 2002 and 2001, respectively. First Colonial’s valuation allowance for impaired loans of $6,000 at March 31, 2003, $8,000 at December 31, 2002 and $43,000 at December 31, 2001 is included in First Colonial’s “Allowance for Possible Loan Losses” which amounts to $3.1 million at March 31, 2003 and at December 31, 2002, and $2.3 million at December 31, 2001. The reduction in the valuation allowance for impaired loans was the result of the decline in the principal amount of impaired loans.

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Allowance and Provision for Possible Loan Losses

First Colonial’s provision for possible loan losses was $200,000 for the first three months of 2003 as compared to $400,000 for the same period in 2002. Net charge offs were $172,000 for the three months ended March 31, 2003 compared with $314,000 for the three months ended March 31, 2002. The ratio of First Colonial’s allowance for loan losses to total loans was 1.23% at March 31, 2003 and 1.21% at December 31, 2002. First Colonial’s allowance for possible loan losses at March 31, 2003 totaled $3.1 million, an increase of $28,000 or 0.9% over the December 31, 2002 amount of $3.1 million.

As of December 31, 2002, First Colonial’s allowance for possible loan losses was $3.1 million as compared to the December 31, 2001 amount of $2.3 million and the December 31, 2000 amount of $2.4 million. First Colonial’s allowance for possible loan losses as a percentage of total loans outstanding as of December 31, 2002 was 1.21%, compared to 1.00% at the end of 2001 and 1.06% at the end of 2000. The increase in First Colonial’s allowance for possible loan losses of $820,000 was the result of First Colonial’s management’s review of loans outstanding (see discussion on “Loan Portfolio”) and non-performing loans (the sum of non-accrual loans and accruing loans past due 90 days or more). Included in First Colonial’s review was an analysis of the related collateral of specific loans and the assignment of a risk factor to all non-performing loans. First Colonial’s non-performing loans totaled $2.3 million at December 31, 2002 as compared to $3.2 million at December 31, 2001 (see tables on “Non-Accrual Loans” and “Accruing Loans Past Due 90 Days or More”). Loan charge-offs at First Colonial are detailed in the table “Allowance for Possible Loan Losses” were $954,000 in 2002 as compared to $904,000 in 2001 and $561,000 in 2000. Net charge-offs at First Colonial were $721,000 in 2002 or $6,000 less than the 2001 amount of $727,000. The 2002 and 2001 charge-offs were the result of losses on commercial, consumer and residential real estate loans. Net loans charged-off in 2000 were $401,000. The ratio of net loan charge-offs to average loans outstanding was .29%, .32% and .19% in 2002, 2001 and 2000, respectively.

First Colonial’s provision for possible loan losses was $1.5 million for the year ended December 31, 2002, $580,000 for the year ended December 31, 2001 and $375,000 for the year ended December 31, 2000. In 2002, the increase in the provision was $961,000 due to the continued high level of loan losses in 2002 and management’s analysis of the risks related to the loan portfolio.

The allowance for possible loan losses is established through a provision for possible loan losses charged to expenses. Loans are charged against the allowance for possible loan losses when management believes that the collectibility of the principal is unlikely. The risk characteristics of the loan portfolio are managed through various control processes, including credit evaluations of individual borrowers, periodic reviews, diversification by industry, and the establishment of lending targets to various segments of the portfolio. Risk is further mitigated through the application of lending procedures such as the holding of adequate collateral and the establishment of contractual guarantees. First Colonial’s management believes that these procedures provide adequate assurances against the adverse impact from any event or set of conditions, and that the level of the allowance for possible loan losses is sufficient to meet the present and potential risk characteristics of the loan portfolio, including the current level of non-performing and past-due loans.

First Colonial’s allowance for loan losses is evaluated based on an assessment of the losses inherent in the loan portfolio. This assessment results in an allowance consisting of two components, allocated and unallocated. The allocated component of the allowance for loan losses reflects possible losses resulting from the analysis of individual loans, pools of loans and commitments. The specific allowance allocations for individual loans are based on an analysis of individual loans where the internal credit rating is at or below a predetermined classification. The general allocation for pools of loans and commitments is based on historical loss experience adjusted for current trends in areas such as lending policies, economic conditions, delinquencies and concentrations. The historical loss factor is determined using actual loss experience and the related internal risk rating of loans charged off. The unallocated portion of the allowance is a function of the total allowance and the allocated portion of the allowance. The analysis of the allowance is performed quarterly and historical factors are updated periodically based on actual experience.

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Allowance For Possible Loan Losses

	For the Three Months Ended March 31, 2003			For the Year Ended December 31,
				2002			2001			2000			1999			1998
	(Dollars in Thousands)
Allowance for Loan Losses at Beginning of Year	$	3,084		$	2,264		$	2,411		$	2,437		$	2,691		$	2,664
Loans Charged-Off by Category:
Commercial		29			32			25			17			255			133
Real Estate—Construction		—			—			—			—			—			—
Real Estate—Residential		61			243			171			219			147			59
Consumer/Installment		101			679			708			325			330			348
Other		—			—			—			—			—			—
Total Loans Charged-Off		191			954			904			561			732			540
Loans Recovered by Category:
Commercial		3			—			60			5			30			42
Real Estate—Construction		—			—			—			—			—			—
Real Estate—Residential		—			150			66			100			29			1
Consumer/Installment		16			83			51			55			44			74
Other		—			—			—			—			—			—
Total Loans Recovered		19			233			177			160			103			117
Net Loans Charged-Off		172			721			727			401			629			423
Provision Charged to Expense		200			1,541			580			375			375			450
Allowance for Loan Losses at End of Period	$	3,112		$	3,084		$	2,264		$	2,411		$	2,437		$	2,691
Total Loans
Average Loans	$	254,925		$	246,113		$	228,458		$	214,856		$	212,993		$	217,191
At End of Period	$	252,624		$	255,844		$	225,757		$	226,944		$	202,258		$	212,437
Net Loans Charged-Off to:
Average Loans		0.07	%		0.29	%		0.32	%		0.19	%		0.30	%		0.19	%
Loans at End of Period		0.07	%		0.28	%		0.32	%		0.18	%		0.31	%		0.20	%
Allowance for Possible Loan Losses at End of Period		5.53	%		23.38	%		32.11	%		16.63	%		25.81	%		15.72	%
Provision for Possible Loan Losses		86.00	%		46.79	%		125.34	%		106.93	%		167.73	%		94.00	%
Allowance for Possible Loan Losses at End of Period to:
Average Loans		1.22	%		1.25	%		0.99	%		1.12	%		1.14	%		1.24	%
Loans at End of Period		1.23	%		1.21	%		1.00	%		1.06	%		1.20	%		1.27	%

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The following table details First Colonial’s Allocation of the Allowance for Possible Loan Losses by the various loan categories. The allocation is not necessarily indicative of the categories in which future loan losses will occur, and the entire allowance is available to absorb losses in any category of loans.

Allocation Of The Allowance For Possible Loan Losses

	At March 31, 2003		At December 31,
			2002		2001		2000		1999		1998
	(Dollars in Thousands)
Loan Categories
Commercial	$	594	$	803	$	567	$	779	$	901	$	1,350
Real Estate—Construction		—		—		—		—		—		4
Real Estate—Residential		399		333		312		281		212		128
Consumer/Installment		1,433		1,256		1,182		964		764		738
Unallocated		686		692		203		387		560		471
TOTAL	$	3,112	$	3,084	$	2,264	$	2,411	$	2,437	$	2,691

Percentage Of Total Loans In Each Category To Total Loans

	At March 31, 2003		At December 31,
			2002		2001		2000		1999		1998
Loan Categories
Commercial	35.12	%	32.32	%	21.15	%	17.38	%	18.46	%	19.52	%
Real Estate—Construction	2.48	%	2.37	%	2.71	%	2.61	%	3.32	%	5.48	%
Real Estate—Residential	40.27	%	42.34	%	49.94	%	56.67	%	55.61	%	56.18	%
Consumer/Installment	22.13	%	22.97	%	26.20	%	23.34	%	22.61	%	18.82	%
TOTAL	100.00	%	100.00	%	100.00	%	100.00	%	100.00	%	100.00	%

Deposits

Deposits are the primary source of First Colonial’s funds. At March 31, 2003, First Colonial’s deposits increased by $10.6 million or 2.2% from $472.8 million on December 31, 2002 to $483.4 million. Contributing to this increase in total deposits were increases in certificates of deposit over $100,000 of $5.7 million, non-interest bearing checking deposits of $5.0 million, savings deposits of $4.6 million and interest bearing checking deposits of $3.0 million, partially offset by a decrease in money market deposits of $6.7 million, and certificates of deposit under $100,000 of $1.0 million.

During 2002, First Colonial’s deposits increased by $92.9 million or 24.5% to a total of $472.8 million at December 31, 2002, from a total of $379.8 million at December 31, 2001. Average deposits at First Colonial for 2002 were $420.2 million, an increase of $61.4 million or 17.1% over the average total deposits for 2001 of $358.8 million. Contributing to the increase in deposits at First Colonial were increases in savings, money market and checking products in response to marketing campaigns to attract these types of deposits, and the effects of lower interest rates, a slowing economy and a general trend of consumers moving their funds from equity markets to bank deposits. The continued growth of deposits held by First Colonial and Nazareth National Banking industry in general could be adversely affected by the flow of funds into other banks, credit unions, mutual funds, equity markets and other investment options.

First Colonial’s average money market deposits increased in 2002 with average balances of $72.3 million, which was $52.2 million or 260.6% higher than the 2001 average balance of $20,041,000. Non-interest bearing deposits averaged $57.9 million in 2002 as compared to $49.0 million in 2001, an increase of $9.0 million or 18.3%.

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In addition, there was an increase in average interest-bearing demand deposits at First Colonial of $3.4 million or 6.2% to $58.5 million in 2002 from $55.1 million in 2001. These deposit increases were partially offset by decreases in average savings and club deposits which averaged $62.8 million in 2002 as compared to $65.1 million in 2001, a decrease of $2.3 million or 3.6%, an $815,000 or 11.1% decrease in certificates of deposit over $100,000 and a decrease of $75,000 in other time deposits. First Colonial’s average certificates of deposit over $100,000 were $6.5 million and $7.3 million in 2002 and 2001, respectively. First Colonial’s average other time deposits were $162.2 million in 2002 as compared to $162.3 million in 2001.

The average balances of First Colonial’s deposits for the three months ended March 31, 2003 and for each of the years ended December 31, 2002, 2001 and 2000 are presented in the following table:

Average Deposit Balances By Major Classification

	For the Three Months Ended March 31,			For the Year Ended December 31,
	2003			2002				2001				2000
	Average Balance		Rate	Average Balance		Rate		Average Balance		Rate		Average Balance		Rate
	(Dollar in Thousands)
Demand Deposits
Non-Interest Bearing	$	63,211	—	$	57,939	—	%	$	48,959	—	%	$	43,893	—	%
Interest Bearing		61,987	0.44		58,496	0.64			55,087	0.89			53,151	1.01
Money Market Deposits		89,979	1.62		62,751	1.34			20,041	3.09			13,461	2.79
Savings & Club Accounts		76,206	0.86		72,259	2.47			65,079	2.09			62,834	2.22
Certificates of Deposits under $100,000		172,273	3.49		161,764	4.08			162,303	5.36			157,164	5.60
Certificates of Deposits of $100,000 or more		5,138	3.02		6,983	3.30			7,334	4.86			5,886	5.18
Total Deposits	$	468,794		$	420,192			$	358,803			$	336,389

Maturities Of Certificates Of Deposit Of $100,000 Or More

	At March 31, 2003		At December 31,
			2002		2001
	(Dollars in Thousands)
Three Months or Less	$	1,424	$	1,167	$	7,493
Over Three, Through Six Months		658		1,322		2,015
Over Six, Through Twelve Months		349		873		1,352
Over Twelve Months		7,303		657		732
Total	$	9,734	$	4,019	$	11,592

There were no brokered deposits at First Colonial at March 31, 2003, December 31, 2002 or 2001.

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Short-Term Debt

Nazareth National Bank had securities sold under agreements to repurchase totaling $8.7 million at March 31, 2003, $8.8 million at December 31, 2002 and $8.4 million at December 31, 2001. Nazareth National Bank had no short-term (overnight) debt at March 31, 2003, December 31, 2002 and 2001 from the Federal Home Loan Bank against a line of credit of $25.0 million. At March 31, 2003 and at December 31, 2002 and 2001, First Colonial had no short-term debt in the form of Federal funds purchased, or Federal Reserve Bank discount borrowings. Additional information relating to short-term debt can be found in Note G of First Colonial’s “Notes to Consolidated Financial Statements”.

Short-term debt at First Colonial consists of the following Federal Home Loan Bank advances:

	For the Three Months Ended March 2003			For the Year Ended December 31,
				2002			2001			2000
	(Dollars in Thousands)
Balance outstanding at end of period	$	—		$	—		$	—		$	5,695
Maximum amount outstanding at any month-end during the period	$	—		$	—		$	6,415		$	11,255
Average amount outstanding	$	51		$	243		$	1,919		$	3,994
Average interest rate during the period		1.43	%		1.65	%		4.85	%		6.41	%

Securities sold under agreements to repurchase at First Colonial consist of the following:

	For the Three Months Ended March 31, 2003			For the Year Ended December 31,
				2002			2001			2000
	(Dollars in Thousands)
Balance outstanding at end of period	$	8,774		$	8,801		$	8,380		$	7,215
Maximum amount outstanding at any month-end during the period	$	13,647		$	13,110		$	18,519		$	12,950
Average amount outstanding	$	9,637		$	10,500		$	12,591		$	7,226
Average interest rate during the period		1.12	%		1.76	%		2.90	%		4.59	%

Long Term Debt

Nazareth National Bank had ten long-term loans from the Federal Home Loan Bank of Pittsburgh totaling $67.0 million at March 31, 2003 and $67.9 million at December 31, 2002 and five long-term loans totaling $34.8 million at December 31, 2001. The proceeds of these loans were used to fund residential real estate loans, community reinvestment projects and securities in the First Colonial investment portfolio. (See Note H of the First Colonial “Notes to Consolidated Financial Statements”.)

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First Colonial’s loans outstanding to the Federal Home Loan Bank of Pittsburgh at March 31, 2003 and at December 31, 2002 and 2001 are as follows:

Date Originated	Original Amount		Balance at: March 31, 2003		Balance at: December 31, 2002		Balance at: December 31, 2001		Due Date	Interest Rate at: March 31, 2003		Interest Rate at: December 31, 2002
	(Dollars in Thousands)
October 1998	$	7,000	$	7,000	$	7,000	$	7,000	October 2008	4.86	%	4.86	%(1)
August 1999		10,000		10,000		10,000		10,000	August 2004	6.06	%	6.06	%(2)
August 2000		12,000		12,000		12,000		12,000	August 2010	6.23	%	6.23	%(3)
November 2001		805		793		795		804	November 2016	6.43	%	6.43	%(5)
December 2001		5,000		5,000		5,000		5,000	January 2007	4.45	%	4.45	%(4)
February 2002		90		89		89		—	February 2017	5.65	%	5.65	%(5)
October 2002		3,050		3,016		3,037		—	October 2007	3.18	%	3.18	%(5)
December 2002		15,000		14,300		15,000		—	December 2007	2.90	%	2.90	%(5)
December 2002		10,000		10,000		10,000		—	December 2007	3.21	%	3.21	%(6)
December 2002		5,000		4,841		5,000		—	December 2009	3.40	%	3.40	%(5)
	$	67,945	$	67,039	$	67,921	$	34,804

(1) The interest rate on this loan is fixed until October 2003, after which the interest rate may, on any quarter, be converted at the option of the lender to a variable rate of three-month LIBOR plus 15 basis points. If the lender elects to convert to a variable rate, Nazareth National Bank may pre-pay the loan without a penalty.

(2) The interest rate on this loan may, on any quarter, be converted at the option of the lender to a variable rate of three-month LIBOR plus 15 basis points if the three-month LIBOR is 7.5% or higher. If the lender elects to convert to a variable rate, Nazareth National Bank may pre-pay the loan without a penalty.

(3) The interest rate on this loan may, on any quarter, be converted at the option of the lender to a variable rate of three-month LIBOR plus 15 basis points if the three-month LIBOR is 8% or higher. If the lender elects to convert to a variable rate, Nazareth National Bank may pre-pay the loan without a penalty.

(4) The interest rate on this loan was fixed until December, 2002, after which the interest rate may, on any quarter, be converted at the option of the lender to a variable rate of three-month LIBOR plus 15 basis points if the three-month LIBOR is 7.5% or higher. If the lender elects to convert to a variable rate, Nazareth National Bank may pre-pay the loan without a penalty.

(5) The interest rate on this loan is fixed until maturity. This loan amortizes with monthly principal and interest payments.

(6) The interest rate on this loan is fixed until December, 2003, after which the interest rate may, on any quarter, be converted at the option of the lender to a variable rate of three-month LIBOR plus 15 basis points if the three-month LIBOR is 7.5% or higher. If the lender elects to convert to a variable rate, Nazareth National Bank may pre-pay the loan without a penalty.

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First Colonial also has an obligation as a party to the First Colonial Employee Stock Ownership Plan (ESOP) debt. There were four loans to the First Colonial ESOP as of March 31, 2003 and December 31, 2002 and 2001. The total outstanding on these loans was $1.1 million at March 31, 2003 and December 31, 2002 and $1.2 million at December 31, 2001. (See Note L of the First Colonial “Notes to Consolidated Financial Statements”.)

The First Colonial ESOP loans outstanding at March 31, 2003, December 31, 2002 and 2001 are as follows:

Date Originated	Original Amount		Balance at March 31, 2003		Balance at December 31,				Due Date	Interest Rate at March 31, 2003 and December 31, 2002
					2002		2001
					(Dollars in Thousands)
April 1998	$	500	$	175	$	175	$	240	October 2005	4.25	%
February 1999		1,000		800		800		850	October 2018	4.25	%
October 2000		72		58		58		65	October 2010	4.25	%
December 2000		100		60		60		80	October 2005	4.25	%
	$	1,672	$	1,093	$	1,093	$	1,235

The interest rates on these loans are variable at the Bank’s prime rate.

On June 3, 2002, First Colonial formed a statutory trust company, First Colonial Statutory Trust I (the “Statutory Trust I”), a wholly-owned Connecticut statutory business trust subsidiary of First Colonial, for the sole purpose of issuing trust preferred securities that are fully and unconditionally guaranteed by First Colonial. On June 26, 2002, First Colonial issued $15,000,000 of subordinated debentures to Statutory Trust I and the Statutory Trust I issued $15.0 million in pooled trust preferred securities. The subordinated debentures are the sole asset of the Statutory Trust. The Trust Preferred securities are classified as long-term debt for the financial statements, but are included as Tier I capital for regulatory purposes. The interest rate on this security (4.74% at March 31, 2003, and 4.85% at December 31, 2002) is variable, adjusting quarterly at three-month LIBOR plus 3.45%. The interest is payable quarterly. The trust preferred securities mature in June 2007, or may be redeemed at any time in the event that the deduction of related interest for federal income tax purposes is prohibited, treatment as Tier I capital is no longer permitted, or certain other contingencies arise. The net proceeds of the trust preferred securities are to be used to support First Colonial’s growth and expansion plans and other general corporate purposes.

First Colonial has non-cancelable operating lease obligations with respect to various buildings and equipment. These obligations totaled $4.6 million at March 31, 2003, $2.8 million at December 31, 2002 and $3.3 million at December 31, 2001. (See Note P of the First Colonial “Notes to Consolidated Financial Statements”.)

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First Colonial’s contractual obligations as of March 31, 2003 are as follows:

CONTRACTUAL OBLIGATIONS

	at March 31, 2003
			Payments Due by Period:
	Total		Less Than 1 Year		1-3 Years		3-5 Years		More Than 5 Years
	(Dollars in Thousands)
Long-Term Federal
Home Loan Debt	$	67,039	$	3,591	$	17,516	$	24,750	$	21,812
Trust Preferred		15,000		—		—		—		15,000
ESOP Debt		1,093		142		284		114		553
Operating Leases		4,635		434		1,137		812		2,252
Total Obligations	$	87,767	$	4,167	$	18,937	$	25,676	$	38,987

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Off-Balance-Sheet Obligations

First Colonial is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. First Colonial’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. First Colonial uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. (See Note R of the First Colonial “Notes to Consolidated Financial Statements”.)

First Colonial’s Contingent Liabilities and Commitments are as follows:

Contingent Liabilities and Commitments

	At March 31, 2003
	Total		Less Than 1 Year		1-3 Years		3-5 Years		More Than 5 Years
	(Dollars in Thousands)
Lines of credit	$	42,789	$	26,503	$	6,144	$	8,965	$	1,177
Standby letters of credit		1,344		1,317		27		—		—
Other commitments to make loans		17,703		17,703		—		—		—
Total	$	61,836	$	45,523	$	6,171	$	8,965	$	1,177

Liquidity and Capital Resources

Liquidity is a measure of First Colonial’s ability to raise funds to support asset growth, meet deposit withdrawals and other borrowing needs, maintain reserve requirements and otherwise operate First Colonial on an ongoing basis. First Colonial manages its assets and liabilities to maintain liquidity and earnings stability. Among the sources of asset liquidity are money market investments, short-term investment securities, and funds received from the repayment of loans and short-term debt. At March 31, 2003, First Colonial’s cash, due from banks, Federal Funds sold and interest bearing deposits with banks totaled $31.2 million and securities maturing within one year totaled $126,000. At year-end 2002, cash, due from banks, Federal funds sold and interest-bearing deposits with banks totaled $27.7 million, and securities maturing within one year totaled $1.0 million. At year-end 2001, cash, due from banks, Federal funds sold and interest-bearing deposits with banks totaled $18.2 million, and securities maturing within one year were $8.1 million.

Nazareth National Bank is a member of the Federal Home Loan Bank of Pittsburgh, Pennsylvania. Nazareth National Bank had interest-bearing deposits at the Federal Home Loan Bank of Pittsburgh in the amount of $10.5 million at March 31, 2003, $5.0 million at December 31, 2002, and $891,000 at December 31, 2001. These deposits are included in interest-bearing deposits with banks on First Colonial’s financial statements. As a result of this relationship, Nazareth National Bank places most of its short-term funds at the Federal Home Loan Bank of Pittsburgh in place of other banks. The Federal Home Loan Bank of Pittsburgh provides Nazareth National Bank with a line of credit in the amount of $25.0 million, all of which was available at March 31, 2003 and at December 31, 2002.

First Colonial’s cash flows for the three months ended March 31, 2003 consisted of cash used in investing activities of $22.9 million offset in part by cash provided by operating activities of $10.9 million and cash provided by financing activities of $10.0 million. The result was a net decrease in cash and cash equivalents of $2.0 million.

Cash was used by First Colonial in investing activities for the purchase of securities available-for-sale and held-to-maturity of $47.0 million and $43.8 million, respectively, a net increase in loans of $5.2 million, an increase in interest bearing deposits with banks of $5.5 million and purchase of premises and equipment of $223,000. These

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were partially offset by First Colonial’s proceeds from the sales of securities available-for-sale of $50.9 million, proceeds from calls and maturities of securities available-for-sale of $23.4 million, and proceeds from calls and maturities of securities held-to-maturity of $4.6 million.

Cash provided by operating activities was the result of net income of $932,000, proceeds from the sale of residential real estate loans of $16.2 million, a decrease in other assets of $1.2 million, amortization of security premiums of $562,000, depreciation and amortization of $370,000, the provision for possible loan losses of $200,000, and amortization of deferred fees on loans of $109,000. These were offset in part by mortgage loans originated for sale of $7.4 million, net gains on the sale of investment securities of $765,000, gains on the sale of residential real estate loans of $417,000, and deferred taxes of $226,000.

Cash provided by First Colonial’s financing activities consisted principally of a net increase in interest and non-interest bearing demand deposits, and savings accounts and money market accounts of $5.9 million, an increase in certificates of deposit of $4.7 million, proceeds from the issuance of stock of $477,000, and a decrease in deferred stock compensation of $220,000. These were partially offset by payments on long-term debt of $882,000, the payment of cash dividends of $412,000, and a decrease in repurchase agreements of $27,000.

First Colonial recognizes the importance of maintaining adequate capital levels to support sound, profitable growth and to encourage depositor and investor confidence. First Colonial’s shareholders’ equity at March 31, 2003 was $40.5 million as compared to $40.3 million at December 31, 2002, for an increase of $174,000 or 0.4%. This increase resulted from net income of $932,000, the proceeds from the sale of stock of $477,000, the distribution of the deferred stock compensation of $220,000, reduced in part by a decrease in accumulated other comprehensive income related to a reduction in the unrealized gains in securities available-for-sale of $1.0 million and the payment of dividends of $412,000.

On February 14, 2003, First Colonial paid its 2003 first quarter cash dividend on its common stock of $0.19 per share to shareholders of record on January 31, 2003.

First Colonial maintained a dividend reinvestment and stock purchase plan. This plan was suspended as of March 5, 2003 as a result of the merger agreement with Keystone. During the first quarter of 2003, 3,771 shares of First Colonial common stock were purchased from authorized and unissued shares at an average price of $25.99 per share for proceeds of approximately $98,000.

First Colonial has a stock option plan adopted in 2001, which provides for the granting of options to acquire First Colonial’s common stock for officers, key employees and directors of First Colonial. In January of 2003, options to purchase 59,950 shares of First Colonial’s common stock at an average price of $23.83 per share were granted to certain officers and First Colonial’s directors. During the first three months of 2003, options for 18,119 shares of First Colonial’s common stock issued pursuant to the plan were exercised at an average price of $20.90 per share.

Cash flows at First Colonial for the year ended December 31, 2002, consisted of cash provided by operating activities of $23.5 million and cash provided by financing activities of $140.4 million offset in part by cash used in investing activities of $158.4 million, resulting in a net increase in cash and cash equivalents of $5.5 million.

The cash provided by operating activities at First Colonial was comprised principally of the proceeds from mortgage loan sales of $52.9 million, net income of $4.0 million, the provision for possible loan losses of $1.5 million, depreciation and amortization of $1.4 million, amortization of security premiums of $1.3 million, and amortizations of deferred fees on loans of $552,000, reduced in part by mortgage loans originated for sale of $33.1 million, an increase in other assets of $1.6 million, net investment securities gains of $1.3 million, net gains on the sale of mortgage loans of $1.1 million, an increase in accrued interest payable of $820,000, accretion of security discounts of $261,000 and a decrease in accrued interest income of $254,000.

The cash provided by financing activities at First Colonial was comprised of a net increase in interest and non-interest bearing demand and savings deposits of $89.6 million, the issuance of long-term debt of $33.1 million, proceeds from the issuance of Guaranteed Preferred Beneficial Interest in First Colonial’s subordinated debt of $15.0

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million, a net increase in certificates of deposit of $3.3 million, a net increase in repurchase agreements of $421,000, proceeds from the sale of common stock of $389,000 and a decrease in ESOP debt of $142,000. Partially offsetting these increases were the payment of cash dividends of $1.6 million, the purchase of treasury stock of $142,000 and the repayment of long-term debt of $9,000.

The cash used in investing activities at First Colonial was primarily for the purchase of securities available-for-sale in the amount of $276.2 million, the purchase of securities held-to-maturity in the amount of $34.4 million, a net increase in loans of $47.8 million, a net increase in interest-bearing deposits with banks of $4.1 million and the purchase of premises and equipment in the amount of $703,000. These cash uses were partially offset by the proceeds from the maturities of securities available-for-sale of $85.8 million, proceeds from the sales of securities available-for-sale of $91.4 million, proceeds from the maturities of securities held-to-maturity of $27.2 million and proceeds from the sale of other real estate owned of $340,000.

First Colonial recognizes the importance of maintaining adequate capital levels to support sound, profitable growth and to encourage depositor and investor confidence. Shareholders’ equity at First Colonial at December 31, 2002 was $40.3 million as compared to $35.3 million at December 31, 2001, an increase of $5.0 million or 14.1%. This increase was attributable to an increase of $2.5 million in paid in capital, an increase of $661,000 in common stock, an increase of $2.0 million in accumulated comprehensive income (see Note A.6 of the First Colonial “Notes to Consolidated Financial Statements”), a decrease of $142,000 in ESOP debt and a decrease due to the issuance of $220,000 in deferred stock compensation to the Chief Executive Officer. The increases in paid in capital and common stock were the result of the sale of common shares pursuant to the First Colonial Dividend Reinvestment Plan and the 5% stock dividend. Total shareholders’ equity, exclusive of accumulated other comprehensive income was $39.0 million and $36.0 million at December 31, 2002 and 2001, respectively, an increase of $3.0 million or 8.3%. The accumulated other comprehensive income was comprised of the unrealized gains or losses on securities available-for-sale. The unrealized gains on securities available-for-sale at December 31, 2002 amounted to $1.3 million (net of tax effect of $681,000). Included in First Colonial’s shareholders’ equity at December 31, 2001 was $694,000 (net of tax effect of $359,000) of unrealized losses on securities available-for-sale.

First Colonial paid a 5% stock dividend on its common stock from authorized but unissued shares on May 31, 2002 to all shareholders of record at the close of business on May 17, 2002. On June 22, 2001, First Colonial paid a 5% stock dividend on its common stock from authorized but unissued shares to all shareholders of record at the close of business on June 4, 2001. First Colonial also paid a 5% stock dividend on June 22, 2000 to shareholders of record on June 2, 2000. Fractional shares on the stock dividends were paid in cash. The number of average shares and per share information of First Colonial has been restated to reflect these 5% stock dividends.

First Colonial maintains a Dividend Reinvestment and Stock Purchase Plan. In 2002, 7,287 new common shares were purchased pursuant to this Plan at an average price of $23.47 for total proceeds of $171,000. Also in 2002, 8,681 Treasury shares were purchased pursuant to the Dividend Reinvestment and Stock Purchase Plan at an average cost of $22.12 per share for total proceeds of $192,000. In 2001, 21,447 new common shares were purchased pursuant to the Plan at an average price of $15.28 per share. The total proceeds were $328,000.

First Colonial adopted the “2001 Stock Option Plan” during 2001. This plan provides for the awarding of stock options to key employees, officers and directors of First Colonial. During 2002, options to purchase 128,375 shares of First Colonial’s common stock at an average price of $21.12 per share were granted to certain officers and directors. In 2001, options to purchase 21,873 shares of First Colonial’s common stock at an average price of $15.70 per share were issued to certain officers and directors under this plan. In January 2003, options to purchase 59,950 shares of First Colonial’s common stock at an average price of $23.83 per share were issued under the 2001 Stock Option Plan to certain officers and directors.

A Non-Employee Directors Stock Option Plan was adopted by First Colonial in 1994. This plan provides for the awarding of stock options to First Colonial’s non-employee directors. There were no options awarded under this plan in 2002 and 2001.

First Colonial also has a Stock Option Plan that was adopted in 1986 and the 1996 Stock Option Plan that was adopted in 1996 which provide for the granting of options to acquire First Colonial’s common stock for officers and key employees. No new options may be issued under the 1986 Stock Option Plan or the 1996 Stock Option

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Plan. In January 2001, options to purchase 43,553 shares of First Colonial’s common stock at an average price of $15.80 per share were granted to certain officers under the 1996 Stock Option Plan. During 2002, options for 10,549 shares of First Colonial’s common stock issued pursuant to the plan were exercised at an average price of $17.07 per share. In 2001, options for 4,927 shares of First Colonial’s common stock were exercised at an average price of $11.90. In 2000, no options were issued under the 1996 Stock Option Plan. No options were exercised under these plans in 2000.

In January 2002, a grant of 10,500 shares of First Colonial’s common stock was awarded to First Colonial’s Chief Executive Officer in the form of deferred stock compensation. The total value of this award was $220,000 or $20.95 per share. This grant originally was to vest over five years, but all unvested shares became fully vested upon the execution of the merger agreement with Keystone. A charge for the cost of the vesting shares in the amount of $45,000 is included in the benefit expenses for the year ended December 31, 2002.

First Colonial and Nazareth National Bank are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on First Colonial’s financial statements. Additional information relating to First Colonial’s and Bank’s capital requirements and capital ratios can be found in Note S of the First Colonial “Notes to Consolidated Financial Statements”.

First Colonial, in March 2001, settled claims by a group of funeral directors, against Nazareth National Bank in connection with certain pre-need funeral trusts which were allegedly directed by funeral directors to be invested in a private placement annuity. In 1998, First Colonial established a reserve of $1.5 million against these possible claims. First Colonial added an additional $1.0 million to this reserve in 2000. The reserve balance, as of December 31, 2002 and 2001 equaled $253,000 and $336,000, respectively. Payments made from this reserve by First Colonial amounted to $83,000 in 2002 and $2.0 million in 2001. In addition, the reserve was reduced in 2001 by $119,000 with a corresponding credit to operating expenses. This reduction in the reserve was the result of an analysis by First Colonial management of the funds required to meet the remaining commitments. There were no additions to this reserve in 2002. First Colonial expects the reserve to be sufficient to cover the remaining liabilities. First Colonial has incurred legal expenses in regard to these claims during 2002, 2001 and 2000. First Colonial will continue to incur legal expenses in regard to these claims during 2003.

Impact of Inflation and Changing Prices

The majority of assets and liabilities of a financial institution are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets in Nazareth National Banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. Another significant effect of inflation is on other expenses, which tend to rise during periods of general inflation.

Management of First Colonial believes the most significant impact on financial results is First Colonial’s ability to react to changes in interest rates.

Market for First Colonial’s Common Stock and Related Stockholder Matters

First Colonial’s common stock trades on the Nasdaq National Market under the trading symbol FTCG. In newspaper listings, First Colonial shares are frequently listed as “First Colnl” or “First Col Group”. At the close of business on December 31, 2002, there were 750 shareholders of record. At the close of business on March 31, 2003, there were 725 shareholders of record.

The declaration and payment of dividends is at the sole discretion of First Colonial’s Board of Directors, and their amount depends upon the earnings, financial condition, and capital needs of First Colonial and certain other factors including restrictions arising from Federal banking laws and regulations (see “Note S—Regulatory Matters” in First Colonial’s “Notes to Consolidated Financial Statements”).

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The following table sets forth for the periods indicated high and low sale prices reported for First Colonial’s common stock and the respective dividends declared per common share. The last sale price of First Colonial’s common stock on March 5, 2003, the day prior to the public announcement of the proposed merger with Keystone, was $28.75. Stock prices and dividends per share have been restated to reflect the 5% stock dividends of May 2002 and June 2001 (see “Note T—Equity Transactions” in First Colonial’s “Notes to Consolidated Financial Statements”).

	High		Low		Cash Dividends Declared
2001
First Quarter	$	15.08	$	12.24	$	0.1724
Second Quarter		15.57		13.37		0.1724
Third Quarter		19.29		14.14		0.1810
Fourth Quarter		23.76		16.76		0.1810
TOTAL					$	0.7068
2002
First Quarter	$	24.00	$	20.24	$	0.1810
Second Quarter		25.24		21.81		0.1810
Third Quarter		25.81		18.00		0.1900
Fourth Quarter		25.00		22.59		0.1900
TOTAL					$	0.7420
2003
First Quarter	$	45.50	$	22.95	$	0.1900
Second Quarter

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BUSINESS OF KNBT BANCORP, INC.

KNBT Bancorp, Inc. is a Pennsylvania corporation that was organized by Keystone to be the holding company for Keystone upon its conversion and its substantially simultaneous merger with Nazareth National Bank. KNBT Bancorp has not engaged in any business to date. Upon completion of the conversion, KNBT Bancorp will own all of the issued and outstanding stock of Keystone. KNBT Bancorp will retain up to 50% of the net proceeds from the offering and invest 50% of the remaining net proceeds in Keystone as additional capital in exchange for 100% of the outstanding common stock of Keystone. KNBT Bancorp will use a portion of its net proceeds to make a loan to the KNBT Bancorp ESOP. At a later date, KNBT Bancorp may use the net proceeds to pay dividends to stockholders and may repurchase shares of common stock, subject to regulatory limitations. KNBT Bancorp will invest its initial capital as discussed in “Use of Net Proceeds.”

In the future, KNBT Bancorp, as the holding company of Keystone, will be authorized to pursue other business activities permitted by applicable laws and regulations for bank holding companies. See “Regulation- Regulation of KNBT Bancorp” for a discussion of the activities that are permitted for bank holding companies.

KNBT Bancorp’s cash flow will depend on earnings from the investment of the net proceeds it retains, and any dividends received from Keystone. Initially, KNBT Bancorp will neither own nor lease any property, but will instead use the premises, equipment and furniture of Keystone. At the present time, KNBT Bancorp intends to employ only persons who are officers of Keystone, including certain current officers of Nazareth National Bank, to serve as officers of KNBT Bancorp. KNBT Bancorp will however, use the support staff of Keystone from time to time. These persons will not be separately compensated by KNBT Bancorp. KNBT Bancorp may hire additional employees, as appropriate, to the extent it expands its business in the future.

The executive offices of KNBT Bancorp are located at 90 Highland Avenue, Bethlehem, Pennsylvania and its telephone number is (610) 861-5000.

BUSINESS OF KEYSTONE

General

Keystone is a community-oriented savings bank which was organized in 1925 and is headquartered in Bethlehem, Pennsylvania. Keystone operates out of nine full service offices in each of Lehigh and Northampton Counties, Pennsylvania and one office in Carbon County, Pennsylvania. Keystone’s office network includes seven full service, in-store supermarket branch offices which offer expanded hours of operation and enhanced customer convenience. Keystone has ATMs in each of its banking offices and also maintains two off-site ATMs. As of June 30, 2002, Keystone had the second largest deposit market share in Lehigh County, at 7.2%, and the third largest in Northampton County, at 12.3%.

Keystone is primarily engaged in attracting deposits from the general public and using those funds to invest in loans and securities. Keystone’s principal sources of funds are deposits, repayments of loans and mortgage-backed securities, maturities of investments and interest-bearing deposits, funds provided from operations and funds borrowed from outside sources such as the Federal Home Loan Bank of Pittsburgh. These funds are primarily used for the origination of various loan types including single-family residential mortgage loans, non-residential or commercial real estate mortgage loans, consumer loans, such as home equity loans and automobile loans, and commercial business loans. Keystone is a recognized leader in the origination of residential home mortgage loans and home construction loans in its market area. In recent years, Keystone has increased it efforts to originate commercial real estate, consumer and commercial business loans in its market area.

The executive offices of Keystone are located at Route 512 and Highland Avenue, Bethlehem, Pennsylvania and its telephone number is (610) 861-5000.

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Market Area and Competition

Keystone’s market area consists of Lehigh, Northampton, and portions of Bucks and Carbon Counties, Pennsylvania. The greater Lehigh Valley area, which is in eastern Pennsylvania approximately 60 miles north of Philadelphia, is anchored by the cities of Bethlehem, Allentown and Easton. The combined population of Lehigh and Northampton Counties is in excess of 500,000 and the market includes a mix of urban, suburban and rural areas. Between 1990 and 2002, the combined population of Lehigh and Northampton Counties grew by approximately 8.3% compared to 3.4% for Pennsylvania as a whole. Major employers in the area include Federal, State and local governments, local healthcare providers, including Lehigh Valley Hospital and St. Luke’s Hospital, Air Products & Chemicals, PPL, Binney & Smith, Agere Systems and Mack Trucks.

Keystone faces significant competition in originating loans and attracting deposits. This competition stems primarily from commercial banks, other savings banks and savings associations and mortgage-banking companies. Within Keystone’s market area, more than 50 other banks savings institutions and credit unions are operating. Many of the financial service providers operating in Keystone’s market area are significantly larger, and have greater financial resources, than Keystone. Keystone faces additional competition for deposits from short-term money market funds and other corporate and government securities funds, mutual funds and from other non-depository financial institutions such as brokerage firms and insurance companies.

Lending Activities

General. Historically, Keystone’s principal lending activity has been the origination of loans collateralized by one-to four-family (or single-family) residential real estate located in its market area. In addition, Keystone traditionally has been actively involved in construction and land development loans, with an emphasis on construction/permanent single-family residential mortgage loans and loans to local homebuilders, and consumer loans, primarily home equity loans and lines of credit. Primarily as a result of its two loan securitizations, Keystone’s total loan portfolio has declined from $700.7 million at December 31, 2001 to $560.0 million at March 31, 2003. Keystone’s one-to four-family residential real estate loans amounted to $288.0 million or 51.4% of the total loan portfolio at March 31, 2003. At such date, commercial real estate and land loans amounted to $39.7 million or 7.1% of the total loan portfolio, construction and land development loans were $62.7 million or 11.2% of the total portfolio, commercial business loans were $12.2 million or 2.2% of the portfolio and consumer loans were $152.5 million or 27.2% of Keystone’s total loan portfolio.

In the second half of 2001, Keystone determined to change its lending emphasis by decreasing the amount of single-family residential mortgage loans in its portfolio and increasing its efforts to originate commercial business loans, commercial real estate and land loans, construction and development loans and consumer loans. In November 2001, Keystone hired an experienced commercial lending officer from a large super-regional bank operating in Keystone’s market area. Keystone reorganized its lending function into retail lending, with primary responsibility for residential mortgage and construction loans and consumer loans, and commercial lending, with primary responsibility for new commercial business and commercial real estate loans. In addition, in order to increase its consumer loans, Keystone initiated indirect automobile lending after it hired an experienced lender from another bank. These efforts have been undertaken by Keystone in order to reduce its interest rate risk exposure while increasing the yield on its loan portfolio by originating loans with interest rates that are generally higher, and terms to maturity that are generally shorter, than single-family residential mortgage loans. These efforts have been a part of Keystone’s planned transformation from a traditional thrift to a full service community banking institution.

The types of loans that Keystone may originate are subject to federal and state law and regulations. Interest rates charged by Keystone on loans are affected principally by the demand for such loans and the supply of money available for lending purposes and the rates offered by its competitors. These factors are, in turn, affected by general and economic conditions, the monetary policy of the federal government, including the Federal Reserve Board, legislative tax policies and governmental budgetary matters.

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Loan Portfolio Composition. The following table shows the composition of Keystone’s loan portfolio by type of loan at the dates indicated.

	March 31, 2003					December 31,
						2002					2001					2000					1999					1998
	Amount			%		Amount			%		Amount			%		Amount			%		Amount			%		Amount			%
	(Dollars in Thousands)
Real estate loans:
One- to four-family residential	$	288,007		51.43	%	$	361,842		59.34	%	$	513,352		73.27	%	$	509,188		73.20	%	$	472,874		72.52	%	$	445,570		74.84	%
Multi-family residential		4,909		0.88			5,377		0.88			3,823		0.54			4,020		0.58			3,607		0.55			6,024		1.01
Commercial real estate		39,718		7.09			29,385		4.82			12,839		1.83			6,715		0.97			3,442		0.54			1,517		0.25
Construction and land development		62,732		11.20			59,363		9.74			54,092		7.72			59,687		8.58			63,404		9.72			44,765		7.52
Total real estate loans		395,366		70.60			455,967		74.78			584,106		83.36			579,610		83.33			543,327		83.33			497,876		83.62
Commercial business loans		12,159		2.17			10,050		1.65			4,399		0.63			4,166		0.60			3,535		0.54			2,803		0.47
Consumer loans:
Home equity loans and lines of credit		107,657		19.22			102,275		16.77			96,702		13.80			94,317		13.56			90,867		13.94			80,948		13.60
Automobile		35,827		6.40			31,956		5.24			5,887		0.84			8,901		1.28			7,906		1.21			8,489		1.42
Other		8,997		1.61			9,500		1.56			9,572		1.37			8,585		1.23			6,407		0.98			5,283		0.89
Total consumer loans		152,481		27.23			143,731		23.57			112,161		16.01			111,803		16.07			105,180		16.13			94,720		15.91
Total loans		560,006		100.00	%		609,748		100.00	%		700,666		100.00	%		695,579		100.00	%		652,042		100.00	%		595,399		100.00	%
Less:
Undisbursed portion of construction loans in process		(22,111	)				(24,263	)				(23,552	)				(28,972	)				(31,743	)				(21,209	)
Deferred loan fees		(2,781	)				(3,236	)				(5,682	)				(6,163	)				(6,090	)				(5,944	)
Allowance for loan losses		(2,689	)				(2,927	)				(3,386	)				(3,337	)				(3,101	)				(2,986	)
Net loans	$	532,425				$	579,322				$	668,046				$	657,107				$	611,108				$	565,260

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Contractual Terms to Final Maturities. The following table shows the scheduled contractual maturities of Keystone’s loans as of March 31, 2003, before giving effect to net items. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. The amounts shown below do not take into account loan prepayments.

	One-to Four- Family Residential		Multi- family Residential		Commercial Real Estate		Construction and Land Development		Commercial Business Loans		Consumer		Total
	(In Thousands)
Amounts due after March 31, 2003 in:
One year or less	$	549	$	—	$	1,879	$	49,214	$	6,000	$	7,968	$	65,610
After one year through three years		1,097		117		1,436		7,554		2,469		9,318		21,567
After three years through five years		5,336		831		1,009		639		1,058		71,715		80,757
After five years through fifteen years		61,369		1,205		9,336		4,414		2,485		63,480		143,003
After fifteen		219,656		2,756		26,058		911		147		—		249,069
Total(1)	$	288,007	$	4,909	$	39,718	$	62,732	$	12,159	$	152,481	$	560,006

The following table shows the amount of Keystone’s loans at March 31, 2003 which are due after March 31, 2004 and indicates whether they have fixed-rates of interest or which are floating or adjustable-rates.

	Fixed-Rate		Floating or Adjustable-Rate		Total
	(In Thousands)
One-to four-family residential	$	263,198	$	24,260	$	287,458
Multi-family residential		3,821		1,088		4,909
Commercial real estate		31,973		5,866		37,839
Construction and land development		13,003		515		13,518
Commercial business		4,045		2,114		6,159
Consumer		121,997		22,516		144,513
Total	$	438,037	$	56,359	$	494,396

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Loan Originations, Sales and Servicing. Keystone’s lending activities are subject to underwriting standards and loan origination procedures established by it board of trustees and management. Keystone relies on its staff of four retail lending representatives and five commercial lenders to originate new loans. These employees travel throughout Keystone’s market area and meet with customers at their homes, place of business or in the bank’s offices, to take loan applications. Keystone has designated certain employees at each of its branch offices who can take consumer loan applications. Keystone Savings has centralized its underwriting function and all new loans are received and underwritten by staff at Keystone’s main office.

Keystone’s single-family residential mortgage loans generally are written on standardized documents used by the Federal National Mortgage Association (“FNMA” or “Fannie Mae”). Commencing in 2002, in its efforts to manage interest rate risk, Keystone began to sell into the secondary market all of its newly originated single-family residential mortgage loans with interest rates of 6.5% or below and which are agency eligible. Keystone sells such newly originated loans on a loan-by-loan or “flow” basis as the loans close. Excluding the effect of two loan securitizations, Keystone sold an aggregate of $10.5 million and $37.2 million of its newly originated single-family residential mortgage loans in the quarter ended March 31, 2003 and the year ended December 31, 2002, respectively. At the time of sale, Keystone recognizes a gain or loss on the sale based on the difference between the net proceeds received and the carrying value of the loans sold. Keystone generally retains the right to continue to provide servicing for all loans sold, with the income therefrom included in noninterest income as service fees, and without recourse.

At March 31, 2003, Keystone was servicing $228.0 million of loans for others. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagees, supervising foreclosures and property dispositions in the event of unremedied defaults, remitting certain insurance and tax payments on behalf of the borrowers and generally administering the loans. The gross servicing fee income from loans sold is generally 25 to 37.5 basis points of the total balance of each loan serviced. Due to the continuing low interest rate environment and a higher level of loan repayments than originally estimated, Keystone recognized impairments of its mortgage servicing rights of $365,000 and $676,000, during the quarter ended March 31, 2003 and the year ended December 31, 2002, respectively. Such impairments are recorded as non-interest expense.

In addition to loan sales, Keystone “securitized” $115.3 million and $47.3 million of seasoned, single-family residential mortgage loans in the year ended December 31, 2002 and the quarter ended March 31, 2003, respectively. Securitization is the process of packaging and transferring residential mortgage loans to issuers of mortgage-backed securities, such as Fannie Mae, in return for mortgage-backed securities backed by the mortgage loans which are transferred. As there is an active market for mortgage-backed securities, they generally can be sold more readily than the underlying loans in response to changes in interest rates or other factors. Keystone retained all of the securities from its 2003 securitization and it sold $61.4 million of the $115.3 million securitization in 2002.

Keystone is limited in the amount of loans that it can make to any one borrower. This amount is equal to 15% of Keystone Saving Bank’s unimpaired capital and surplus, or approximately $16.8 million at March 31, 2003. Keystone’s loans to one borrower generally have been within these limits. The mutual-to-stock conversion of Keystone and merger with Nazareth National Bank are expected to significantly increase Keystone’s loan-to-one borrower limit. At March 31, 2003, Keystone’s largest credit relationship to an individual borrower and related entities consisted of an aggregate of $14.4 million in construction and development and investment property loans to a local builder in which Keystone has sold an aggregate of $2.0 million in participation interests to another financial institution. At March 31, 2003, an aggregate of $3.7 million was outstanding on these loans and all of such loans were performing in accordance with their terms.

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The following table shows total loans originated, securitized, sold and repaid at Keystone during the periods indicated.

	Three Months Ended March 31,						Year Ended December 31,
	2003			2002			2002			2001		2000
	(In Thousands)
Loan originations:
One-to four-family residential	$	21,047		$	20,816		$	109,029		$	100,204	$	71,887
Consumer		33,124			20,622			114,188			58,784		47,870
Other(1)		22,989			11,445			73,605			17,291		54,551
Total loan originations		77,160			52,883			296,822			176,279		174,308
Sales, securitizations and loan principal repayments:
Loans sold:
One-to four-family residential		10,528			8,370			37,178			12,127		15,079
Other		472			—			—			—		—
Total sold:		11,000			8,370			37,178			12,127		15,079
Loans securitized:
Securitized and retained		47,250			53,897			53,897			—		—
Securitized and sold		—			61,438			61,438			—		—
Total securitized		47,250			115,335			115,335			—		—
Loans principal repayments		40,916			20,733			205,534			123,979		95,783
Total loans sold, securitized and principal repayments		99,166			144,438			358,047			136,106		110,862
Decrease due to other items, net(2)		24,891			25,360			27,499			29,234		17,446
Net increase (decrease) in loan portfolio	$	(46,897	)	$	(116,915	)	$	(88,724	)	$	10,939	$	46,000

(1) Consists of commercial real estate, construction and land development loans and commercial business loans.

(2) Other items consist of loans in process, deferred fees and the allowance for loan losses.

Single-Family Residential Mortgage Lending. A primary lending activity of Keystone is the origination of loans secured by first mortgages on one-to four-family residences in its Lehigh Valley market area. Traditionally, Keystone has been a leading originator of single-family residential mortgage loans in Lehigh and Northampton Counties, and the bank expects to continue its single-family loan origination efforts. At March 31, 2003, single-family residential mortgage loans amounted to $288.0 million or 51.4% of Keystone’s total loan portfolio which, due to its loan sales and securitizations, was a significant decline from the $513.4 million of single-family residential mortgage loans at December 31, 2001.

Keystone originates fixed-rate, fully amortizing mortgage loans with maturities ranging between 10 and 30 years. Management establishes interest rates charged on loans based on market conditions. Keystone also offers adjustable-rate mortgage loans with terms of up to 30 years, with an interest rate based on the one year Constant Maturity Treasury Bill index, which adjust annually from the outset of the loan or which adjust annually after a three or five year initial fixed period. Interest rate adjustments on such loans are typically limited to no more than 2% during any adjustment period or 6% over the life of the loan. Due to local market conditions and the current interest rate environment, Keystone has originated very few ARM loans during the past three years. At March 31, 2003, 91.6% of Keystone’s single-family residential mortgage loans maturing after March 31, 2004 had fixed rates of interest and 8.4% had adjustable interest rates.

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Keystone underwrites one-to four-family residential mortgage loans with loan-to-value ratios of up to 95%, provided that a borrower obtains private mortgage insurance on loans that exceed 85% of the appraised value or sales price, whichever is less, of the secured property. Keystone also requires that title insurance, hazard insurance and, if appropriate, flood insurance be maintained on all properties securing real estate loans. A licensed appraiser appraises all properties securing one-to four-family first mortgage loans. Mortgage loans originated by Keystone generally include due-on-sale clauses which provide it with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property without Keystone’s consent. Due-on-sale clauses are an important means of adjusting the yields of fixed-rate mortgage loans in portfolio and Keystone generally exercised its rights under these clauses.

During 2002 and the first quarter of 2003, Keystone’s policy was to sell to Fannie Mae all newly originated, agency eligible single-family residential mortgage loans with interest rates of 6.5% or less. Such loans are sold on a non-recourse basis with servicing retained. During the quarter ended March 31, 2003 and the year ended December 31, 2002, Keystone, excluding sales made as a part of its two securitizations, sold an aggregate of $10.5 million and $37.2 million, respectively, of single-family residential mortgage loans.

Consumer Loans. At March 31, 2003, Keystone’s consumer loans amounted to $152.5 million or 27.2% of the total loan portfolio. Keystone’s consumer loans are comprised primarily of home equity loans and lines of credit and automobile loans. Keystone also offers a variety of other consumer loans including personal loans and lines of credit, home improvement loans and credit card loans. At March 31, 2003, Keystone’s home equity loans and lines of credit amounted to $107.7 million or 19.2% of the total loan portfolio. Of such amount, $85.2 million were loans and $22.5 million were lines of credit. In addition, at such date the unadvanced portion of home equity lines of credit was $27.9 million. Home equity loans and lines of credit, like single-family residential mortgage loans, are secured by the underlying equity in the borrower’s residence. However, the bank generally obtains a second mortgage position on a home equity loan or line of credit. Keystone’s home equity loans typically are structured as fixed-rate fully amortizing loans with terms of up to 15 years and loan-to-value ratios, when combined with any senior liens, of up to 100%. Keystone charges higher interest rates for loan-to-value ratios exceeding 80%. Keystone’s home equity lines of credit have adjustable rates of interest which are indexed to the prime rate as reported in The Wall Street Journal. Generally, the maximum loan-to-value ratio on home equity lines of credit, including the outstanding amount of any first mortgage loan, is 80%. A home equity line of credit may be drawn down by the borrower for a period of five years from the date of the loan agreement. During this period, the borrower has the option of paying, on a monthly basis, either principal and interest or only the interest.

Keystone’s automobile loans amounted to $35.8 million and have increased significantly since the bank commenced its indirect automobile lending function in January 2002. Keystone originates indirect auto loans through a network of auto dealers located in its market area and was actively doing business with approximately 17 dealers at March 31, 2003. Keystone hired an experienced indirect automobile lender to head its program and has grown its dealer network by emphasizing quality service and the development of long term relationships with the owners and managers of dealerships.

Keystone makes indirect auto loans to purchase both new and used cars. The loans have terms up to six years for loans secured by new and used vehicles. As of March 31, 2003, approximately 22.0% of Keystone’s indirect auto loans were secured by new cars and 78.0% were secured by used cars. Keystone originated $32.9 million and $7.0 million of indirect auto loans during 2002 and the first three months of 2003, respectively.

To underwrite its indirect auto loans, Keystone reviews the credit history of applicants and determines appropriate debt to income and loan to value ratios. Keystone also believes that the quality of its indirect auto loan portfolio is positively affected by its efforts to build and maintain relationships with auto dealers who attract creditworthy customers. Keystone Saving Bank tries to identify such dealers based on Keystone Saving Bank’s knowledge of car dealers in its market area.

Indirect auto lending entails greater risks than owner-occupied residential mortgage lending. Although Keystone has not experienced significant delinquencies in this portfolio to date, borrowers are more likely to default on an auto loan than on a residential mortgage loan secured by their primary residence. Moreover, automobiles depreciate rapidly and, in the event of a default, principal loss as a percent of the loan balance depends upon the mileage and condition of the vehicle at the time of repossession, over which Keystone has no control.

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Consumer loans entail greater risk than residential mortgage loans, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as automobiles. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections depend on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.

Construction and Land Development Loans. Keystone has been an active originator of construction and land development loans in its market area for many years. At March 31, 2003, Keystone’s construction and land development loans amounted to $62.7 million or 11.2% of the total loan portfolio. Keystone’s construction lending includes both construction loans to individuals to construct personal residences, which amounted to approximately $40.3 million at March 31, 2003, and loans to building contractors and developers, which amounted to approximately $22.5 million at March 31, 2003. At March 31, 2003, the unadvanced portion of construction loans in process amounted to $22.1 million.

Keystone’s construction loans to individuals to build their residences typically are structured as construction/permanent loans whereby there is one closing for both the construction loan and the permanent financing. During the construction phase, which typically lasts for six to nine months, employees of Keystone make periodic inspections of the construction site and loan proceeds are disbursed directly to the contractors as construction progresses. Typically, disbursements are made in five draws during the construction period. Construction loans require payment of interest only during the construction phase and are structured to be converted to fixed-rate permanent loans at the end of the construction phase. Prior to making a commitment to fund a construction loan, Keystone requires an appraisal of the property by independent fee appraisers or the bank’s in-house appraisers. The bank’s staff also reviews and inspects each project prior to every disbursement of funds during the term of the construction loan. Loan proceeds are disbursed based on a percentage of completion.

Keystone also originates construction and site development loans to contractors and builders primarily to finance the construction of single-family homes and subdivisions and, to a lesser extent, the construction of commercial development projects, and site development projects. Loans to finance the construction of single-family homes and subdivisions are generally offered to experienced builders in the Lehigh Valley with whom Keystone has an established relationship. Residential development loans are typically offered with terms of up to 24 months. The maximum loan-to-value limit applicable to these loans is 80% of the appraised post construction value. Construction loan proceeds are disbursed periodically in increments as construction progresses and as inspection by Keystone’s approved appraisers warrants. At March 31, 2003, Keystone’s largest construction and site development loan totaled to $1.7 million and was secured by a first mortgage lien. This loan was performing according to its original terms at March 31, 2003. At March 31, 2003, Keystone estimates that the average balance of its construction loans to contractors and developers was approximately $417,000.

Keystone also makes construction loans for commercial development projects. The projects include multi-family, apartment, industrial, retail and office buildings. These loans generally have an interest-only phase during construction, and generally convert to permanent financing when construction is completed. Disbursement of funds is at the sole discretion of Keystone and is based on the progress of construction. The maximum loan-to-value limit applicable to these loans is 80% of the appraised post-construction value.

Keystone also originates land loans to local contractors and developers for the purpose of improving the property, or for the purpose of holding or developing the land for sale. Such loans are secured by a lien on the property, are limited to 65% of the lower of the acquisition price or the appraised value of the land, and have a term of up to two years with a floating interest rate based on Keystone’s internal base rate. Keystone’s land loans are generally secured by property in its primary market area. Keystone requires title insurance and, if applicable, a hazardous waste survey reporting that the land is free of hazardous or toxic waste.

Construction financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction compared to the estimated cost

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(including interest) of construction and other assumptions. Additionally, if the estimate of value proves to be inaccurate, Keystone may be confronted with a project, when completed, having a value less than the loan amount. Keystone has attempted to minimize these risks by generally concentrating on residential construction loans in its market area to contractors with whom it has established relationships.

Commercial Real Estate Loans and Multi-Family Residential Real Estate Loans. At March 31, 2003, Keystone’s commercial real estate loans amounted to $39.7 million or 7.1% of the total loan portfolio. The amount of Keystone’s commercial real estate loans increased significantly in 2002 and the first quarter of 2003. Keystone’s commercial real estate loans are secured by mortgages on various commercial income producing properties including office buildings, retail and industrial properties. All of Keystone’s commercial real estate loans are secured by properties in Pennsylvania and substantially all are located in the bank’s market area.

Keystone offers both adjustable-rate and fixed-rate commercial real estate loans. Such loans typically have terms of five or seven years with one or two renewal options and amortize over 15 to 20 years. Loan-to-value ratios cannot exceed 90%, although they generally are 85% or less, and a debt service coverage of 1.10 times or better generally is required. Personal guarantees often are required.

Keystone performs more extensive diligence in underwriting commercial real estate loans than loans secured by owner occupied one-to four-family residential properties due to the larger loan amounts and the riskier nature of such loans. Keystone attempts to understand and control the risk in several ways including inspection of all such properties and the review of the overall financial condition of the borrower, which may include, for example, the review of the rent rolls and the verification of income. Keystone reviews two years of tax returns and financial statements of the borrower in its underwriting of commercial real estate loans and these documents must be updated and provided to the bank an annual basis. Keystone’s commercial lending staff undertakes an extensive credit review of each commercial real estate loan in excess of $1.5 million at least annually. Keystone’s largest commercial real estate loan at March 31, 2003, was a $3.9 million loan secured by commercial real estate in Bethlehem, Pennsylvania. Such loan was performing in accordance with its terms at March 31, 2003.

Commercial real estate loans have interest rates which are generally higher than interest rates on residential mortgage loans, and are more rate sensitive to changes in market interest rates. Commercial real estate loans, however, entail significant additional credit risk as compared with one-to four-family residential mortgage lending, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on commercial real estate loans secured by income producing properties is typically dependent on the successful operation of the related real estate project and thus may be more significantly impacted by adverse conditions in the real estate market or in the economy generally.

At March 31, 2003, Keystone’s multi-family residential mortgage loans amounted to $4.9 million or 0.9% of the loan portfolio. Such loans are secured by apartment buildings with five or more units. Keystone has not emphasized the origination of multi-family residential mortgage loans but, when originated, they are underwritten pursuant to the same policies and procedures as commercial real estate loans.

Commercial Business Loans. Keystone’s commercial business loans amounted to $12.2 million or 2.2% of the total loan portfolio at March 31, 2003. Commercial business loans have increased since late 2001. Keystone expects that its commercial loan portfolio will continue to grow.

Keystone’s commercial business loans typically are to small to mid-sized businesses (annual revenues generally not exceeding $20.0 million) in its market area and may be for working capital, inventory financing or accounts receivable financing. Small business loans may have adjustable or fixed rates and generally have terms of three years or less but may go up to 10 years. Keystone’s commercial business loans generally are secured by equipment, machinery, real property or other corporate assets. In addition, Keystone generally obtains personal guarantees from the principals of the borrower with respect to all commercial business loans. Keystone’s commercial loans structured as advances are made upon perfected security interests in accounts receivable and/or inventory. Generally Keystone will advance amounts up to 75% of accounts receivable and 50% of the value of inventory.

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At March 31, 2003, Keystone’s largest commercial business loan was a $2.5 million working capital line of credit to a local steel distributor on which $1.5 million was outstanding at such date. Such loan was performing in accordance with its terms at March 31, 2003.

Commercial business loans generally are deemed to involve a greater degree of risk than single-family residential mortgage loans. While commercial business lending is relatively new to Keystone and Keystone is attempting to aggressively increase its originations of commercial business loans, Keystone has hired experienced commercial loan officers and has implemented policies and procedures for commercial business lending which are deemed to be prudent.

Loan Approval Procedures and Authority. Keystone’s Board of Trustees establishes its lending policies and procedures. Keystone’s Lending Policy Manual is reviewed on at least an annual basis by its Senior Vice Presidents of Commercial Lending and Retail Lending in order to propose modifications as a result of market conditions, regulatory changes and other factors. All modifications must be approved by the Board of Trustees of Keystone.

Various officers or combinations of officers of Keystone have the authority within specifically identified limits to approve new loans. The largest individual lending authority is $350,000. Amounts in excess of $350,000 must be approved by at least two officers and, for loans in excess of $500,000, by at least three officers including one of the President, the Executive Vice President or one of its Senior Vice Presidents of Lending. Loans in excess of $1.0 million must be approved by the Board of Trustees of Keystone.

Asset Quality

General. One of Keystone’s key objectives has been, and continues to be, maintaining a high level of asset quality. In addition to maintaining credit standards for new originations which it believes are sound, Keystone is proactive in its loan monitoring, collection and workout processes in dealing with delinquent or problem loans.

When a borrower fails to make a scheduled payment, Keystone attempts to cure the deficiency by making personal contact with the borrower. Initial contacts are generally made 15 days after the date the payment is due. In most cases, deficiencies are promptly resolved. If the delinquency continues, late charges are assessed and additional efforts are made to collect the deficiency. All loans delinquent 60 days or more are reported to the Board of Trustees of Keystone. Keystone generally works with borrowers to resolve such problems, however, when the account becomes 90 days delinquent, an additional notice is sent to the borrower and, thereafter, foreclosure or other proceedings are instituted, as necessary, to minimize any potential loss.

On loans where the collection of principal or interest payments is doubtful, the accrual of interest income ceases (“non-accrual” loans). On loans 90 days or more past due, as to principal and interest payments, Keystone’s policy, with certain limited exceptions, is to discontinue accruing additional interest and reverse any interest currently accrued. On occasion, this action may be taken earlier if the financial condition of the borrower raises significant concern with regard to his/her ability to service the debt in accordance with the terms of the loan agreement. Interest income is not accrued on these loans until the borrower’s financial condition and payment record demonstrate an ability to service the debt.

Real estate which is acquired as a result of foreclosure is classified as real estate owned until sold. Real estate owned is recorded at the lower of cost or fair value less estimated selling costs. Costs associated with acquiring and improving a foreclosed property are usually capitalized to the extent that the carrying value does not exceed fair value less estimated selling costs. Holding costs are charged to expense. Gains and losses on the sale of real estate owned are charged to operations, as incurred.

Keystone accounts for its impaired loans under generally accepted accounting principles. An impaired loan generally is one for which it is probable, based on current information, that the lender will not collect all the amounts due under the contractual terms of the loan. Keystone Saving Bank had no loans which were deemed to be impaired as of March 31, 2003 or at December 31, 2002 or 2001.

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Federal regulations and Keystone’s policies require that it utilize an internal asset classification system as a means of reporting problem and potential problem assets. Keystone has incorporated an internal asset classification system, consistent with Federal banking regulations, as a part of its credit monitoring system. Keystone currently classifies problem and potential problem assets as “substandard,” “doubtful” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated “special mention.”

When an insured institution classifies one or more assets, or portions thereof, as “substandard” or “doubtful”, it is required that a general valuation allowance for loan losses be established for loan losses in an amount deemed prudent by management. General valuation allowances represent loss allowances which have been established to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies one or more assets, or portions thereof, as “loss,” it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount.

A savings institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by Federal and state bank regulators which can order the establishment of additional general or specific loss allowances. The Federal banking agencies, have adopted an interagency policy statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management analyze all significant factors that affect the collectibility of the portfolio in a reasonable manner; and that management establish acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. In July 2001, the SEC issued Staff Accounting Bulletin (“SAB”) No. 102, “Selected Loan Loss Allowance Methodology and Documentation Issues.” The guidance contained in the SAB focuses on the documentation the SEC staff normally expects registrants to prepare and maintain in support of the allowance for loan and lease losses. Concurrent with the SEC’s issuance of SAB No. 102, the federal banking agencies, represented by the Federal Financial Institutions Examination Council (“FFIEC”), issued an interagency policy statement entitled “Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Institutions” (Policy Statement). The SAB and Policy Statement were the result of an agreement between the SEC and the federal banking agencies in March 1999 to provide guidance on allowance for loan and lease losses methodologies and supporting documentation. Keystone’s management believes that, based on information currently available, its allowance for loan losses is maintained at a level which covers all known and inherent losses that are both probable and reasonably estimable at each reporting date. However, actual losses are dependent upon future events and, as such, further additions to the level of allowances for loan losses may become necessary.

Keystone reviews and classifies assets on a monthly basis and the Board of Trustees is provided with monthly and quarterly reports on Keystone’s classified assets. Keystone classifies assets in accordance with the management guidelines described above. At March 31, 2003 and at December 31, 2002 and 2001, Keystone had $2.0 million, $2.5 million and $2.7 million, respectively, of assets classified as “substandard” which consisted of non-accrual single-family residential mortgage and consumer loans, and non-accrual commercial real estate and residential construction loans. Non-accrual loans are those loans 90 days or more delinquent and on which Keystone has ceased accruing interest. At March 31, 2003 and at December 31, 2002 and 2001, Keystone had no loans classified as “doubtful” or “loss.” In addition, as of March 31, 2003 and as of December 31, 2002 and 2001, Keystone had $4.2 million, $4.2 million and $1.0 million, respectively, of loans designated “special mention.”

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Delinquent Loans. The following table shows the delinquencies in Keystone’s loan portfolio as of the dates indicated.

	March 31, 2003								December 31, 2002								December 31, 2001
	30-89 Days Overdue				90 or More Days Overdue				30-89 Days Overdue				90 or More Days Overdue				30-89 Days Overdue				90 or More Days Overdue
	Number of Loans	Principal Balance			Number of Loans	Principal Balance			Number of Loans	Principal Balance			Number of Loans	Principal Balance			Number of Loans	Principal Balance			Number of Loans	Principal Balance
	(Dollars in Thousands)
One-to four-family Residential	41	$	2,252		33	$	1,848		49	$	2,197		34	$	2,306		14	$	606		18	$	1,559
Multi-family residential	1		5		—		—		1		5		—		—		2		9		—		—
Commercial real estate	—		—		—		—		—		—		—		—		—		—		—		—
Construction and land Development	1		46		—		—		1		272		—		—		—		—		5		938
Commercial business	2		166		2		15		1		283		2		15		2		18		—		—
Consumer loans	83		852		31		154		97		752		42		174		66		239		21		193
Total delinquent loans	128	$	3,321		66	$	2,017		149	$	3,509		78	$	2,495		84	$	872		44	$	2,690
Delinquent loans to total net loans			0.62	%			0.38	%			0.61	%			0.43	%			0.13	%			0.40	%
Delinquent loans to total Loans			0.59	%			0.36	%			0.58	%			0.41	%			0.12	%			0.38	%

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Non-Performing Loans and Real Estate Owned. The following table sets forth information regarding Keystone’s non-performing loans and real estate owned. At March 31, 2003, non-performing loans consisted of 33 single-family residential loans with an average balance of $56,000, 31 consumer loans with an average balance of $5,000 and $156,000 of real estate owned. Keystone’s general policy is to cease accruing interest on loans 90 days or more past due and to charge off all accrued interest. Keystone occasionally will continue to accrue interest on loans more than 90 days past due. Since December 31, 1999, this has happened on six occasions with respect to interest only loans which, although due in full according to their contractual terms, were not repaid on the maturity date but the borrower continued to pay and, the bank continued to accept, interest payments until the loan was subsequently repaid.

For the three months ended March 31, 2003 and the year ended December 31, 2002 and 2001, the amount of additional interest income that would have been recognized on non-accrual loans if such loans had continued to perform in accordance with their contractual terms was $25,000 , $66,000 and $81,000, respectively.

The following table shows the amounts of Keystone’s non-performing assets (defined as non-accruing loans, accruing loans 90 days or more past due and real estate owned) at the dates indicated. Keystone did not have troubled debt restructurings at any of the dates indicated

	March 31, 2003			December 31,
				2002			2001			2000			1999			1998
	(Dollars in Thousands)
Non-accruing loans:
One-to four-family residential	$	1,848		$	2,023		$	1,559		$	746		$	1,089		$	842
Multi-family residential		—			—			—			—			—			—
Commercial real estate and land		—			—			—			4			6			—
Construction and land development		—			—			—			—			—			—
Commercial business		—			—			—			—			—			—
Consumer		154			174			193			13			8			44
Total non-accruing loans		2,002			2,197			1,752			763			1,103			886
Accruing loans 90 days or more past due:
One-to four-family residential		—			283			—			35			486			116
Multi-family residential		—			—			—			—			—			—
Commercial real estate		—			—			—			—			—			—
Construction and land development		—			—			938			—			—			—
Commercial business		15			15			—			—			—			—
Consumer		—			—			—			—			—			—
Total accruing loans 90 days or more past due		15			298			938			35			486			116
Total non-performing loans(1)		2,017			2,495			2,690			798			1,589			1,002
Real estate owned, net(2)		156			115			200			151			488			62
Total non-performing assets	$	2,073		$	2,610		$	2,890		$	949		$	2,077		$	1,064
Total non-performing loans as a percentage of loans, net		0.38	%		0.43	%		0.40	%		0.12	%		0.26	%		0.18	%
Total non-performing loans as a percentage of total assets		0.19	%		0.25	%		0.29	%		0.10	%		0.21	%		0.14	%
Total non-performing assets as a percentage of total assets		0.20	%		0.26	%		0.31	%		0.12	%		0.27	%		0.15	%

(1) Non-performing loans consist of non-accruing loans plus accruing loans 90 days or more past due.

(2) Real estate owned balances are shown net of related loss allowances and include both real property and

other repossessed collateral consisting primarily of automobiles.

Property acquired by Keystone through foreclosure is initially recorded at the lower of cost (the lesser of the carrying value of the loan or fair value at the date of acquisition) or the fair value of the related assets at the date of foreclosure, less estimated costs to sell. Thereafter, if there is a further deterioration in value, Keystone charges earnings for the diminution in value. Keystone’s policy is to obtain an appraisal on all real estate subject to foreclosure proceedings prior to the time of foreclosure and to require appraisals on a periodic basis on foreclosed properties and conduct inspections on foreclosed properties.

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Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses. Keystone maintains the allowance at a level believed, to the best of management’s knowledge, to cover all known and inherent losses in the portfolio that are both probable and reasonable to estimate at each reporting date. Management reviews all loans which are delinquent 60 days or more on a monthly basis and performs regular reviews of the allowance no less than quarterly in order to identify those inherent losses and to assess the overall collection probability for the loan portfolio. Such reviews consist of a quantitative analysis by loan category, using historical loss experience, and consideration of a series of qualitative loss factors. Keystone’s evaluation process includes, among other things, an analysis of delinquency trends, non-performing loan trends, the level of charge-offs and recoveries, prior loss experience, total loans outstanding, the volume of loan originations, the type, size and geographic concentration of its loans, the value of collateral securing the loan, the borrower’s ability to repay and repayment performance, the number of loans requiring heightened management oversight, local economic conditions and industry experience. In addition, in establishing the allowance for loan losses, Keystone’s management considers a ten point internal rating system for all loans originated by the Commercial Lending department. At the time of origination, each loan, other than single-family residential mortgage loans, construction and development loans and consumer loans, is assigned a rating based on the assumed risk elements of the loan. Such risk ratings are periodically reviewed by management and revised as deemed appropriate. The establishment of the allowance for loan losses is significantly affected by management judgment and uncertainties and there is a likelihood that different amounts would be reported under different conditions or assumptions. Various regulatory agencies, as an integral part of their examination process, periodically review Keystone’s allowance for loan losses. Such agencies may require it to make additional provisions for estimated loan losses based upon judgments different from those of management. As of March 31, 2003, Keystone’s allowance for loan losses was 0.48 % of total loans receivable.

Keystone will continue to monitor and modify its allowances for loan losses as conditions dictate. No assurances can be given that its level of allowance for loan losses will cover all of the inherent losses on its loans or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses.

The following table shows changes in Keystone’s allowance for loan losses during the periods presented.

	At or For the Months Ended March 31,						At or For the Year Ended December 31,
	2003			2002			2002			2001			2000			1999			1998
	(Dollars in Thousands)
Total loans outstanding at end of period	$	560,006		$	579,281		$	609,748		$	700,666		$	695,579		$	652,042		$	595,399
Average loans outstanding		575,374			664,336			623,980			675,856			647,448			588,184			553,195
Allowance for loan losses, beginning of period		2,927			3,386			3,386			3,337			3,101			2,986			2,808
Provision (recovery) for loan losses		62			(445	)		111			391			442			421			281
Charge-offs:
One-to four-family residential		7			89			229			154			100			88			78
Multi-family		—			—			—			—			—			115			—
Commercial real estate		—			—			—			—			—			—			—
Construction and land development		—			—			—			—			—			—			—
Commercial business		—			—			—			—			—			—			—
Consumer		304			68			394			224			146			108			28
Total charge-offs		311			157			623			378			246			311			106
Recoveries on loans previously charged off		11			5			53			36			40			5			3
Allowance for loan losses, end of period	$	2,689		$	2,789		$	2,927		$	3,386		$	3,337		$	3,101		$	2,986
Allowance for loan losses as a percent of non-performing loans		133.32	%		207.98	%		117.31	%		125.87	%		418.17	%		195.15	%		298.00	%
Ratio of net charge-offs during the period to average loans outstanding during the period		0.05	%		0.02	%		0.10	%		0.06	%		0.04	%		0.05	%		0.02	%

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The following table shows how Keystone’s allowance for loan losses has been allocated by type of loan at each of the dates indicated.

	March 31, 2003				December 31,
					2002				2001				2000				1999				1998
	Amount of Allowance		Loan Category as a % of Total Loans		Amount of Allowance		Loan Category as a % of Total Loans		Amount of Allowance		Loan Category as a % of Total Loans		Amount of Allowance		Loan Category as a % of Total Loans		Amount of Allowance		Loan Category as a % of Total Loans		Amount of Allowance		Loan Category as a % of Total Loans
	(Dollars in Thousands)
One-to-four family residential	$	864	51.43	%	$	1,086	59.34	%	$	2,053	73.27	%	$	2,291	73.20	%	$	2,128	72.52	%	$	2,005	74.84	%
Multi-family residential		32	0.88			33	0.88			35	0.55			48	0.58			36	0.55			60	1.01
Commercial real estate		64	7.09			145	4.82			39	1.83			43	0.97			5	0.54			3	0.25
Construction and land development		488	11.20			451	9.74			291	7.72			106	8.58			102	9.72			71	7.52
Commercial business		523	2.17			500	1.65			464	0.63			115	0.60			22	0.54			15	0.47
Consumer		18	27.23			590	23.57			303	16.01			123	16.07			150	16.13			135	15.51
Unallocated		—	—			122	—			201	—			611	—			658	—			697	—
Total	$	2,689	100.00	%	$	2,927	100.00	%	$	3,386	100.00	%	$	3,337	100.00	%	$	3,101	100.00	%	$	2,986	100.00	%

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Investment Activities

General. Keystone invests in securities pursuant to its Investment Policy, which has been approved by its Board of Trustees. Keystone’s President and Executive Vice President/Chief Operating Officer have been designated as investment officers and are authorized by the Board to make the bank’s investments consistent with the Investment Policy. The Board of Trustees of Keystone reviews all investment activity on a monthly basis.

Keystone’s investment policy is designed primarily to manage the interest rate sensitivity of its assets and liabilities, to generate a favorable return without incurring undue interest rate and credit risk, to complement its lending activities and to provide and maintain liquidity while minimizing Keystone’s tax liability. Keystone also uses a leveraged investment strategy for the purpose of enhancing returns. Pursuant to this strategy, Keystone has increased the size of its investment portfolio by utilizing borrowings to support such investments.

At March 31, 2003, Keystone’s investment securities amounted to $400.2 million or 38.5% of total assets at such date. At such date, there were $8.6 million in gross unrealized gains and $978,000 in unrealized losses with respect to the investment securities portfolio of Keystone, resulting in a net of tax unrealized gain of $5.0 million. The largest component of Keystone’s investment securities in recent periods has been mortgage-backed securities, which amounted to $287.8 million or 71.9% of the investment securities portfolio at March 31, 2003. In addition, Keystone invests in municipal securities, corporate debt obligations, U.S. government and agency obligations and other securities. In recent periods, Keystone has increased the amount of its investment in municipal securities due to the tax advantages they provide. Under Keystone’s investment policy, municipal bonds must be rated in the top three investment rating categories at the time of purchase.

In order to achieve maximum flexibility with its investment securities, all of Keystone’s investment securities have been classified as available for sale, pursuant to SFAS No. 115, for more than the past three years. This accounting pronouncement requires a security to be classified as available for sale, held to maturity, or trading, at the time of acquisition. Securities classified as held to maturity must be purchased with the intent and ability to hold that security until its final maturity, and can be sold prior to maturity only under rare circumstances. Held to maturity securities are accounted for based upon the historical cost of the security. Available for sale securities can be sold at any time based upon needs or market conditions. Available for sale securities are accounted for at fair value, with unrealized gains and losses on these securities, net of income tax provisions, reflected in retained earnings as accumulated other comprehensive income.

Currently, Keystone is not participating in hedging programs, interest rate swaps, caps, collars or other activities involving the use of off-balance sheet financial derivatives. Also, Keystone does not purchase mortgage-backed derivative instruments that would be characterized “high-risk” under Federal banking regulations at the time of purchase, nor does it purchase corporate obligations which are not rated investment grade.

Keystone’s mortgage-backed securities include mortgage pass-through certificates issued by the GNMA, FNMA and FHLMC as well as collateralized mortgage obligations (“CMOs”) issued by such agencies or private issuers. Investments in mortgage-backed securities involve a risk that actual prepayments will be greater than estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby changing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities or in the event such securities are redeemed by the issuer. In addition, the market value of such securities may be adversely affected by changes in interest rates.

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 loans insured by the Federal Housing Administration, or guaranteed by the Veterans Administration. The timely payment of principal and interest on GNMA securities is guaranteed by GNMA and backed by the full faith and credit of the U.S. Government. Freddie Mac is a private corporation chartered by the U.S. Government. Freddie Mac issues participation certificates backed principally by conventional mortgage loans. Freddie Mac guarantees the timely payment of interest and the ultimate return of principal on participation certificates. Fannie Mae is a private corporation chartered by the U.S. Congress with a mandate to establish a secondary market for mortgage loans. Fannie Mae guarantees the timely payment of principal and interest on Fannie Mae securities. Freddie Mac and

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Fannie Mae securities are not backed by the full faith and credit of the U.S. Government, but because Freddie Mac and Fannie Mae are U.S. Government-sponsored enterprises, these securities are considered to be among the highest quality investments with minimal credit risks.

Collateralized mortgage obligations are typically issued by a special-purpose entity (in Keystone’s case, private issuers or government agencies), which may be organized in a variety of legal forms, such as a trust, a corporation, or a partnership. Substantially all of the collateralized mortgage obligations held in Keystone’s portfolio consist of senior sequential tranches, primarily investments in the first tranche of the collateralized mortgage obligations. By purchasing senior sequential tranches, management attempts to ensure the cash flow associated with such an investment. While non-agency private issues are somewhat less liquid than collateralized mortgage obligations issued by GNMA, Fannie Mae or Freddie Mac, they generally have a higher yield than agency insured or guaranteed collateralized mortgage obligations, such higher yield reflecting in part the lack of such guarantee or protection and, thus, the potentially higher risk of loss or default associated with such assets. Keystone’s Investment Policy requires that all privately issued CMOs be rated AAA by Standard & Poors at the time of purchase.

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The following table sets forth certain information relating to Keystone’s investment securities portfolio at the dates indicated.

	March 31, 2003				December 31,
					2002				2000				2000
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In Thousands)
U.S. government and agency obligations	$	22,661	$	22,860	$	30,677	$	31,075	$	8,445	$	8,437	$	9,040	$	9,017
Corporate securities		32,563		33,668		34,053		35,172		36,937		38,153		39,567		39,903
Municipal obligations		48,840		50,887		38,935		41,039		29,040		29,560		14,812		15,559
Mortgage-backed securities:
GNMA		3,000		3,081		3,234		3,327		563		608		794		829
FHLMC		18,814		19,179		17,963		18,348		3,063		3,140		4,753		4,831
FNMA		112,489		116,302		73,743		76,101		6,845		6,867		3,286		3,248
Other		149,243		149,277		83,449		84,174		64,849		65,101		35,688		35,802
Total mortgage-backed securities		283,546		287,839		178,389		181,950		75,320		75,716		44,521		44,710
ARM Fund		4,939		4,910		4,939		4,914		4,938		4,909		4,937		4,878
Other		—		—		—		—		10		10		10		10
Total investment securities		392,549		400,154		286,993		294,150		154,690		156,785		112,877		114,077
FHLB stock		8,516		8,516		8,011		8,011		6,099		6,099		5,705		5,705
Total investment securities and FHLB stock	$	401,065	$	408,670	$	295,004	$	302,161	$	160,789	$	162,884	$	118,582	$	119,782

The following table sets forth the amount of investment securities, at amortized cost, which mature during each of the periods indicated and the weighted average yields for each range of maturities at March 31, 2003. No tax-exempt yields have been adjusted to a tax-equivalent basis.

	Amounts at March 31, 2003 Which Mature In
	One Year or Less		Weighted Average Yield		Over One Year Through Five Years		Weighted Average Yield		Over Five Through Ten Years		Weighted Average Yield		Over Ten Years		Weighted Average Yield
	(Dollars in Thousands)
Bonds and other debt securities:
U.S. government and agency obligations	$	—	—	%	$	22,023	4.53	%	$	—	—	%	$	638	4.22	%
Corporate securities		12,408	7.13			20,155	6.28			—	—			—	—
Municipal obligations		—	—			626	3.34			3,600	3.90			44,614	4.82
Mortgage-backed securities		—	—			1,495	4.78			65,530	5.17			216,521	5.56
Equity securities:
ARM Fund		4,939	2.24			—	—			—	—			—	—
FHLB stock(1)		8,516	3.25			—	—			—	—			—	—
Total investment securities and FHLB Stock	$	25,863	4.92	%	$	44,299	5.32	%	$	69,130	5.11	%	$	261,773	5.43	%

1) As a member of the Federal Home Loan Bank of Pittsburgh, Keystone is required to maintain an investment in FHLB stock, which has no stated maturity.

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The following table sets forth the purchases, sales and principal repayments of mortgage-backed securities, at amortized cost, for Keystone during the periods indicated.

	At or For the Three Months Ended March 31,						At or For the Year Ended December 31,
	2003			2002			2002			2001			2000
	(Dollars in Thousands)
Mortgage-backed securities at beginning of period	$	178,389		$	75,320		$	75,320		$	44,521		$	50,220
Purchases		100,702			60,011			140,911			53,160			5,455
Securitizations(1)		47,250			115,335			115,335			—			—
Repayments		(42,424	)		(11,379	)		(88,850	)		(22,403	)		(11,183	)
Sales		—			61,438			63,844			—			—
Amortizations of premiums and discounts, net		(371	)		4			(483	)		42			29
Mortgage-backed securities at end of period	$	283,546		$	177,853		$	178,389		$	75,320		$	44,521
Weighted average yield at end of period		5.46	%		6.22	%		5.85	%		6.09	%		6.12	%

(1) Reflects amounts retained by Keystone.

Sources of Funds

General. Deposits, loan repayments and prepayments, proceeds from sales of loans, cash flows generated from operations and Federal Home Loan Bank advances are the primary sources of Keystone’s funds for use in lending, investing and for other general purposes.

Deposits. Keystone offers a variety of deposit accounts with a range of interest rates and terms. Keystone’s deposits consist of checking (both interest-bearing and non-interest-bearing), money market, savings and certificate of deposit accounts. More than 51% of the funds deposited with Keystone are in core deposits (deposits other than certificates of deposit).

The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition. Keystone’s deposits are obtained predominantly from the areas where its branch offices are located. Keystone has historically relied primarily on customer service and long-standing relationships with customers to attract and retain these deposits; however, market interest rates and rates offered by competing financial institutions significantly affect its ability to attract and retain deposits.

Keystone uses traditional means of advertising its deposit products, including broadcast and print media and generally does not solicit deposits from outside its market area. In recent years, Keystone has emphasized the origination of core deposits. This strategy has resulted in a significant increase in core deposits, particularly money market and checking accounts, as well as increased fee income and new customer relationships.

Keystone does not actively solicit certificate accounts in excess of $100,000 or use brokers to obtain deposits. At March 31, 2003, the weighted average remaining maturity of Keystone’s certificate of deposit accounts was 15.4 months.

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The following table shows the distribution of, and certain other information relating to, Keystone’s deposits by type of deposit, as of the dates indicated.

	March 31, 2003				December 31,
					2002				2001				2000
	Amount		%		Amount		%		Amount		%		Amount		%
	(Dollars in Thousands)
Certificate accounts:
1.00% - 1.99%	$	51,517	6.46	%	$	18,289	2.37	%	$	1,373	0.17	%	$	—	—	%
2.00% - 2.99%		151,278	18.97			166,878	21.62			42,956	5.56			278	0.04
3.00% - 3.99%		88,967	11.16			85,676	11.10			61,515	7.97			1,109	0.16
4.00% - 4.99%		67,811	8.50			70,808	9.17			95,604	12.38			67,402	9.45
5.00% - 5.99%		25,251	3.17			34,144	4.42			74,658	9.67			142,582	19.98
6.00% - 6.99%		3,999	0.50			13,480	1.76			148,784	19.27			213,150	29.87
7.00% or more		—	—			—	—			17,155	2.22			16,366	2.29
Total certificate accounts		388,823	48.76			389,275	50.44			442,045	57.24			440,887	61.79
Transaction accounts:
Savings		122,266	15.33			115,289	14.94			102,940	13.33			94,529	13.25
Checking:
Interest bearing		90,821	11.39			85,448	11.07			80,589	10.44			76,015	10.65
Noninterest bearing		37,704	4.73			32,588	4.22			25,239	3.27			18,413	2.58
Money market		157,747	19.78			149,225	19.33			121,413	15.72			83,676	11.73
Total transaction accounts		408,538	51.24			382,550	49.56			330,181	42.76			272,633	38.21
Total deposits	$	797,361	100.00	%	$	771,825	100.00	%	$	772,226	100.00	%	$	713,520	100.00	%

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The following table shows for Keystone the average balance of each type of deposit and the average rate paid on each type of deposit for the periods indicated.

	Three Months Ended March 31,												Year Ended December 31,
	2003						2002						2002						2001						2000
	Average Balance		Interest Expense		Average Rate Paid		Average Balance		Interest Expense		Average Rate Paid		Average Balance		Interest Expense		Average Rate Paid		Average Balance		Interest Expense		Average Rate Paid		Average Balance		Interest Expense		Average Rate Paid
	(Dollars in Thousands)
Savings	$	118,604	$	307	1.04	%	$	106,009	$	392	1.48	%	$	111,689	$	1,680	1.50	%	$	97,778	$	2,127	2.18	%	$	104,801	$	2,353	2.25	%
Checking		85,801		113	0.53			78,798		111	0.56			81,609		466	0.57			76,090		846	1.11			75,384		968	1.28
Money market		153,238		626	1.63			125,851		695	2.21			134,456		2,784	2.07			100,327		3,512	3.50			70,845		3,096	4.37
Certificates of deposit		387,253		3,117	3.22			435,287		5,362	4.93			417,073		18,169	4.36			447,171		25,679	5.74			417,542		23,235	5.56	%
Total interest-bearing deposits		744,896		4,163	2.24	%		745,945		6,560	3.52	%		744,827		23,099	3.10	%		721,366		32,164	4.46	%		668,572		29,652	4.44	%
Total deposits	$	779,312	$	4,163	2.14	%	$	770,986	$	6,560	3.40	%	$	773,708	$	23,099	2.99	%	$	741,256	$	32,164	4.34	%	$	684,537	$	29,652	4.33	%

The following table shows Keystone’s savings flows during the periods indicated.

	Three Months Ended March 31,				Year Ended December 31,
	2003		2002		2002			2001		2000
	(In Thousands)
Total deposits	$	1,131,276	$	895,950	$	4,352,478		$	2,616,347	$	1,783,656
Total withdrawals		1,109,600		887,191		4,373,968			2,587,038		1,762,530
Interest credited		3,860		6,044		21,089			29,397		27,025
Total increase (decrease) in deposits	$	25,536	$	14,803	$	(401	)	$	58,706	$	48,151

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The following table presents, by various interest rate categories and maturities, the amount of certificates of deposit at March 31, 2003.

	Balance at March 31, 2003 Maturing in the 12 Months Ending March 31,
Certificates of Deposit	2004		2005		2006		Thereafter		Total
	(In Thousands)
Less than 2.00%	$	48,546	$	2,971	$	—	$	—	$	51,517
2.00%-2.99%		101,512		39,546		8,611		1,609		151,278
3.00%-3.99%		18,459		45,797		17,871		6,840		88,967
4.00%-4.99%		22,015		10,002		12,363		23,431		67,811
5.00%-5.99%		11,822		3,528		1,173		8,728		25,251
6.00%-6.99%		3,821		81		97		—		3,999
7.00% or more		—		—		—		—		—
Total certificate accounts	$	206,175	$	101,925	$	40,115	$	40,608	$	388,823

The following table shows the maturities of Keystone’s certificates of deposit of $100,000 or more at March 31, 2003 by time remaining to maturity.

Quarter Ending:	Amount		Weighted Average Rate
	(Dollars in Thousands)
June 30, 2003	$	5,939	3.19	%
September 30, 2003		5,053	2.65
December 31, 2003		5,916	2.73
March 31, 2004		2,130	2.72
After March 31, 2004		27,442	3.81
Total certificates of deposit with balances of $100,000 or more	$	46,460	3.42	%

Borrowings. Keystone utilizes advances from the Federal Home Loan Bank of Pittsburgh as an alternative to retail deposits to fund its operations as part of its operating strategy. These Federal Home Loan Bank advances are collateralized primarily by certain of Keystone’s mortgage loans and mortgage-backed securities and secondarily by its investment in capital stock of the Federal Home Loan Bank of Pittsburgh. Federal Home Loan Bank advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The maximum amount that the Federal Home Loan Bank of Pittsburgh will advance to member institutions, including Keystone, fluctuates from time to time in accordance with the policies of the Federal Home Loan Bank. At March 31, 2003, Keystone had $103.5 million in outstanding Federal Home Loan Bank advances. At such date, $16.5 million of Keystone’s FHLB advances were short-term (maturities of one year or less).

In addition to FHLB advances, Keystone’s borrowings include securities sold under agreements to repurchase (“repurchase agreements”). Repurchase agreements are contracts for the sale of securities owned or borrowed by Keystone, with an agreement to repurchase those securities at an agreed upon price and date. Keystone uses repurchase agreements as an investment vehicle for its commercial sweep checking product. Keystone enters into securities repurchase agreements only with primary dealers recognized by, and reporting to, the Federal Reserve Bank of New York. The collateral for such repurchase agreements are U.S. Treasury securities and municipal securities. At March 31, 2003, Keystone’s securities repurchase agreements amounted to $10.0 million and all of such borrowings were short-term (maturities of one year or less). The average balance of Keystone’s securities sold under repurchase agreements for the quarter ended March 31, 2003 was $7.9 million.

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The following table shows certain information regarding Keystone’s borrowings at or for the dates indicated:

	At or For the Three Months Ended March 31,						At or For the Year Ended December 31,
	2003			2002			2002			2001			2000
	(Dollars in Thousands)
FHLB advances:
Average balance outstanding	$	102,962		$	43,371		$	67,358		$	32,703		$	24,437
Maximum amount outstanding at any month-end during the period	$	103,500		$	50,500		$	113,500		$	40,500		$	36,500
Balance outstanding at end of period	$	103,500		$	50,500		$	113,500		$	40,500		$	13,000
Average interest rate during the period		4.03	%		5.06	%		4.25	%		5.52	%		6.12	%
Weighted average interest rate at end of period		4.31	%		4.98	%		3.87	%		5.28	%		6.19	%
Repurchase Agreements:
Average balance outstanding	$	7,880		$	5,583		$	7,330		$	2,431		$	940
Maximum amount outstanding at any month-end during the period	$	10,013		$	6,211		$	10,051		$	5,752		$	1,629
Balance outstanding and end of period	$	10,013		$	6,211		$	8,904		$	5,752		$	1,629
Average interest rate during the period		1.63	%		2.38	%		2.08	%		3.79	%		5.38	%
Weighted average interest rate at end of period		1.63	%		2.38	%		2.08	%		3.79	%		5.38	%

At March 31, 2003, $16.5 million of Keystone’s borrowings were short-term (maturities of one year or less). Such short-term borrowings had a weighted average interest rate of 3.54% at March 31, 2003.

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Properties

Keystone currently conducts its business from its main office and 18 full-service banking offices. The following table sets forth the net book value of the land, building and leasehold improvements and certain other information with respect to Keystone’s offices at March 31, 2003. In addition to the properties listed below, in May 2003, Keystone entered into an agreement to purchase a 46,000 square foot building in Bethlehem, Pennsylvania to be used as its new operations center. The purchase price for the property is $5.3 million and Keystone anticipates spending an additional $2.2 million in improvements. Keystone expects to close on this purchase in June 2003.

Description/Address	Leased/Owned	Date of Lease Expiration	Net Book Value of Property		Amount of Deposits
			(In Thousands)
KSB Broad St 920 W. Broad St. Bethlehem, PA 18016	Owned		$	473	$	156,310
KSB Hellertown 741 Main St. Hellertown, PA 18055	Owned			663		90,652
KSB South Whitehall 4200 Tilghman St. Allentown, PA 18104	Owned			456		78,150
KSB Palmerton 330 Delaware Avenue Palmerton, PA 18071	Owned			215		39,304
KSB Northampton 1862 Main St. Northampton, PA 18017	Owned			438		59,150
KSB Easton Avenue 2515 Easton Avenue Bethlehem, PA 18017	Owned			502		126,624
KSB Main Office 90 Highland Avenue Bethlehem, PA 18017	Owned			3,334		89,993
KSB Nazareth 859 Nazareth Pk. Nazareth, PA 18064	Leased	8/1/2016		2		16,234
KSB Coopersburg 216 E. Fairmont St. Coopersburg, PA 18036	Leased	8/1/2016		—		25,455

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Description/Address	Leased/Owned	Date of Lease Expiration	Net Book Value of Property		Amount of Deposits
KSB Forks Township 301 Town Center Blvd. Easton, PA 18040	Leased	8/1/2016	$	98		16,571
KSB William Penn Plaza 3091 William Penn Highway Easton, PA 18045	Leased	7/1/2005		90	$	18,380
KSB Coplay 202 Chestnut St. Coplay, PA 18037	Leased	8/1/2016		—		14,806
KSB Schnecksville 4933 Route 873 Schnecksville, PA 18078	Owned			763		14,920
KSB Wescosville 5700 Hamilton Blvd. Wescosville, PA 18106	Owned			882		17,158
KSB Miller Heights 3933 Freemansburg Avenue Bethlehem, PA 18020	Owned			480		16,706
KSB Village West 3100 Tilghman St. Allentown, PA 18104	Leased	2/1/2015		—		9,659
KSB Hellertown Giant 1880 Leithsville Road Hellertown, PA 18055	Leased	4/1/2017		93		2,665
KSB Emmaus Avenue 3015 W. Emmaus Avenue Allentown, PA 18103	Leased	3/1/2017		114		2,926
KSB Emmaus Main St. 235 Main St. Emmaus, PA 18049	Leased	3/1/2020		58		1,876

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Securities Brokerage Activities

Keystone offers a wide selection of investment and insurance products, including equity securities, mutual funds and annuities, to its customers in its branch offices. Keystone conducts such activities under the name KSB Financial Services. Such products are sold by four registered representatives who are dual employees of both Keystone and a third-party, registered broker-dealer. Keystone’s total revenue from securities sales activities was $87,000 for the quarter ended March 31, 2003 and $420,000, $100,000 and $82,000 for the years ended December 31, 2002, 2001 and 2000, respectively.

Subsidiaries

Keystone has two subsidiaries, KLV, Inc. and KLVI, Inc. KLV, Inc. is inactive. KLVI, Inc., a Delaware corporation, is a wholly owned subsidiary of Keystone formed in 1997 to hold and manage certain securities investments.

Employees

At March 31, 2003, Keystone had 300 full-time employees, and 74 part-time employees. None of such employees are represented by a collective bargaining group, and Keystone believes that its relationship with its employees is good.

Legal Proceedings

Keystone is not presently involved in any legal proceedings of a material nature. From time to time, Keystone is a party to legal proceedings incidental to its business to enforce its security interest in collateral pledged to secure loans made by Keystone.

BUSINESS OF FIRST COLONIAL

General

First Colonial is a Pennsylvania business corporation which is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “Holding Company Act”). First Colonial was incorporated on December 30, 1982 for the purpose of acquiring Nazareth National Bank and thereby enabling Nazareth National Bank to operate within a bank holding company structure. First Colonial became an active bank holding company on November 25, 1983 when it acquired Nazareth National Bank. Nazareth National Bank is a wholly-owned subsidiary of First Colonial. In July, 1986, First Colonial established it’s wholly-owned subsidiary, First C. G. Company, Inc. This subsidiary is a Delaware business corporation formed for the purpose of investing in various types of securities. On June 26, 2002, First Colonial established its subsidiary, First Colonial Statutory Trust I. This subsidiary is a Connecticut business trust formed for the purpose of issuing a Trust Preferred Security.

First Colonial’s principal activities consist of owning and supervising Nazareth National Bank, which engages in a full service commercial and consumer banking and trust business. First Colonial, through Nazareth National Bank, derives substantially all of its income from the furnishing of banking and banking-related services. Nazareth National Bank has its principal banking office as well as eight branch offices in Northampton County, five branch offices in Monroe County and three branch offices in Lehigh County, Pennsylvania.

First Colonial is a legal entity separate and distinct from Nazareth National Bank. The rights of First Colonial, and thus the rights of First Colonial’s creditors and shareholders, to participate in distributions of the assets or earnings of Nazareth National Bank, are necessarily subject to the prior claims of creditors of Nazareth National Bank, except to the extent that claims of First Colonial itself as a creditor may be recognized. Such claims on Nazareth National Bank by creditors other than First Colonial include obligations relating to federal funds purchased and certain other borrowings, as well as deposit liabilities.

First Colonial directs the policies and coordinates the financial resources of Nazareth National Bank. First Colonial provides and performs various technical, advisory and auditing services for Nazareth National Bank, coordinates Nazareth National Bank’s general policies and activities, and participates in Nazareth National Bank’s major business decisions.

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As of March 31, 2003 First Colonial, on a consolidated basis, had total assets of $620.7 million, total deposits of $483.4 million, and total shareholders’ equity of $40.5 million.

Nazareth National Bank

History and Business. Nazareth National Bank was incorporated under the laws of the United States of America as a national bank in 1897 under its present name. Since that time, Nazareth National Bank has operated as a banking institution doing business at several locations in Northampton County, Monroe County and Lehigh County, Pennsylvania. Nazareth National Bank is a member of the Federal Reserve System.

As of March 31, 2003, Nazareth National Bank had total assets of $616.5 million, total deposits of $489.3 million and total shareholders’ equity of $44.5 million. Its deposits are insured by Nazareth National Bank Insurance Fund (“BIF”) maintained by the Federal Deposit Insurance Corporation (the “FDIC”) to the maximum extent permitted by law.

Nazareth National Bank engages in a full service commercial and consumer banking and trust business. Nazareth National Bank, with its main office at 76 South Main Street, Nazareth, Pennsylvania, also provides services to its customers through its branch network of seventeen full service banks, which includes drive-in facilities at most locations, ATMs at each branch office (except the Main Street Nazareth branch) and bank-by-mail services. Nine of Nazareth National Bank’s full service offices are located in Northampton County, Pennsylvania. Five offices are located in Monroe County, Pennsylvania. Three offices are located in Lehigh County, Pennsylvania. Nazareth National Bank is currently constructing a new full service branch at the site of the free-standing ATM’s at Northampton Crossings Shopping Center. In addition, Nazareth National Bank has signed a lease and received regulatory approval to establish a new branch at 9^th and Hamilton Streets, Allentown, Lehigh County, Pennsylvania and Nazareth National Bank has acquired land at Hope Road and Freemansburg Avenue, Bethlehem Township, Northampton County, Pennsylvania for a branch location. Nazareth National Bank is also considering other branch locations.

Nazareth National Bank’s services include accepting time, demand and savings deposits, including NOW accounts (Flex Checking), regular savings accounts, money market accounts, super money market accounts (an account that pays a higher rate of interest for high balances), fixed rate certificates of deposit and club accounts, including the Vacation Club, the College Club^® and the Christmas Club. Nazareth National Bank offers Mastercard^® and VISA^®, as well as a Constant Cash account (a pre-approved line of credit activated by writing checks against a checking account) and the First Colonial Club^® and Quality Checking^® (deposit package programs which provide checking accounts with other services including credit card protection, discount travel, shopping services and other related financial services). Its services also include making secured and unsecured commercial and consumer loans, financing commercial transactions either directly or through regional industrial development corporations, making construction and mortgage loans, and renting safe deposit facilities. Additional services include making residential mortgage loans (both fixed rate and variable rate), home equity lines of credit, revolving credit loans with overdraft checking protection, small business loans, student loans, recreational vehicles and new and used car and truck loans.

Nazareth National Bank’s business loans include seasonal credit and collateral loans and term loans as well as accounts receivable and inventory financing. Most of Nazareth National Bank’s commercial customers are small to medium size businesses operating in Northampton, Lehigh and Monroe Counties, Pennsylvania, with concentrations in the Nazareth, Allentown, Bethlehem, Brodheadsville, Easton, and Stroudsburg areas of Pennsylvania.

Trust and wealth management services provided by Nazareth National Bank include services as executor and trustee under wills and deeds, as guardian, custodian and as trustee and agent for pension, profit sharing and other employee benefit trusts as well as various investment, pension and estate planning services.

Nazareth National Bank has a relatively stable deposit base and no material amount of deposits is obtained from a single depositor or group of depositors (including Federal, state and local governments). Nazareth National Bank has not experienced any significant seasonal fluctuations in the amount of its deposits.

130

Competition. All phases of Nazareth National Bank’s business are highly competitive. Nazareth National Bank’s market area is the primary trade area of Northampton and Lehigh Counties (known as the Lehigh Valley), and Monroe County, Pennsylvania with concentrations in the Nazareth, Allentown, Bethlehem, Brodheadsville, Easton, and Stroudsburg areas. In order to keep pace with its competition and the continuing growth of these areas, Nazareth National Bank will be establishing several new branches in 2003 and may, in the future, consider establishing additional new branches, although no assurance can be given that any new branches will be opened or if opened, that they will be successful. Nazareth National Bank competes with local commercial banks as well as other commercial banks with branches in Nazareth National Bank’s market area. Nazareth National Bank considers its major competition to be Ambassador/Lafayette Bank, headquartered in Easton, Pennsylvania, with branches in Nazareth, Bethlehem and Allentown, Pennsylvania, Keystone Savings Bank, headquartered in Bethlehem, Pennsylvania with branches in Nazareth, Easton and Allentown, Pennsylvania, United Trust Bank, headquartered in Bridgewater, New Jersey with branches in Easton, Pennsylvania, and Bethlehem Pennsylvania; Wachovia Bank, NA, headquartered in Charlotte, North Carolina, with branch offices in Easton, Bethlehem, Stroudsburg and Allentown, Pennsylvania; Fleet National Bank, headquartered in Providence, Rhode Island, with branches in Bethlehem, Easton and Allentown, Pennsylvania; and PNC Bank headquartered in Pittsburgh, Pennsylvania, with branches in Nazareth, Brodheadsville, Stroudsburg, Easton and Allentown, Pennsylvania.

Nazareth National Bank, along with other commercial banks, competes with respect to its lending activities, as well as in attracting demand deposits, with savings banks, savings and loan associations, insurance companies, regulated small loan companies, credit unions and the issuers of commercial paper and other securities, such as shares in money market funds. Nazareth National Bank also competes with insurance companies, investment counseling firms, mutual funds and other business firms and individuals in the corporate trust and investment management services. Many of Nazareth National Bank’s competitors have financial resources larger than Nazareth National Bank’s.

As a result of the recent repeal of the Glass-Steagall Act which separated the commercial and investment banking industries, all banking organizations are likely to face an increase in competition. See “Supervision and Regulation”—“Recent Regulation.”

Management believes that Nazareth National Bank is generally competitive with all competing financial institutions in its service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.

First C. G. Company, Inc.

In July 1986, First Colonial established a wholly-owned subsidiary, First C. G. Company, Inc., a Delaware corporation, for the purpose of investing in various types of securities. As of March 31, 2003, First C. G. Company, Inc. had total assets of $4.4 million, of which $3.1 million was invested in common stocks and $1.1 million in loans to Nazareth National Bank’s ESOP and most of the remaining assets were in interest-bearing bank deposits. The total shareholders’ equity at March 31, 2002 was $4.4 million.

First Colonial Statutory Trust I

On June 26, 2002, First Colonial established its subsidiary, First Colonial Statutory Trust I, a Connecticut business trust for the purpose of issuing $15.0 million of Trust Preferred Securities. First Colonial Statutory Trust I had total assets of $15.5 million at March 31, 2003. At March 31, 2003 the trust had trust preferred debt outstanding of $15.0 million and total equity of $464,000.

Supervision and Regulation

Bank holding companies and banks are extensively regulated under both federal and state law. The regulatory framework is intended primarily for the protection of depositors, other customers and the federal deposit insurance funds and not for the protection of shareholders. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws or regulations may have a material effect on the business and prospects of First Colonial and Nazareth National Bank.

131

First Colonial. First Colonial is registered as a “bank holding company” under the National Bank Holding Act of 1956, as amended (the “Holding Company Act”), and is, therefore, subject to supervision and regulation by the Board of Governors of the Federal Reserve Board (the “Federal Reserve Board”). First Colonial is also regulated by the Pennsylvania Department of Banking.

Under the Holding Company Act, First Colonial is required to secure the prior approval of the Federal Reserve Board before it can merge or consolidate with any other bank holding company or acquire all or substantially all of the assets of any bank or acquire direct or indirect ownership or control of any voting shares of any bank that is not already majority owned by it, if after such acquisition, it would directly or indirectly own or control more than 5% of the voting shares of such bank.

First Colonial is generally prohibited under the Holding Company Act from engaging in, or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company engaged in non-banking activities unless the Federal Reserve Board, by order or regulation, has found such activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In making such determination, the Federal Reserve Board considers whether the performance of these activities by a bank holding company can reasonably be expected to produce benefits to the public, which outweigh possible adverse effects.

Satisfactory financial condition, particularly with regard to capital adequacy, and satisfactory Community Reinvestment Act ratings are generally prerequisites to obtaining federal regulatory approval to make acquisitions. Nazareth National Bank currently is rated “outstanding” under the Community Reinvestment Act.

Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (the “1991 Act”), a bank holding company is required to guarantee that any “undercapitalized” (as such term is defined in the statute) insured depository institution subsidiary will comply with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards as of the time the institution failed to comply with such capital restoration plan.

The Financial Institutions Reform, Recovery and Enforcement Act (“FIRREA”) contains a “cross-guarantee” provision that could result in any insured depository institution owned by First Colonial being assessed for losses incurred by the FDIC in connection with assistance provided to, or the failure of, any other depository institution owned by First Colonial. Also, under Federal Reserve Board policy, First Colonial is expected to act as a source of financial strength to each of its banking subsidiaries and to commit resources to support each such bank in circumstances where such bank might not be in a financial position to support itself. Consistent with the “source of strength” policy for subsidiary banks, the Federal Reserve Board has stated that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears to be consistent with the corporation’s capital needs, asset quality and overall financial condition.

Under the Holding Company Act, First Colonial is required to file periodic reports and other information concerning its operations with, and is subject to examination by, the Federal Reserve Board. In addition, under the National Banking Code of 1965, the Pennsylvania Department of Banking has the authority to examine the books, records and affairs of any Pennsylvania bank holding company or to require any documentation deemed necessary to ensure compliance with the National Banking code.

First Colonial is under the jurisdiction of the Securities and Exchange Commission and various state securities commissions for matters relating to the offering and sale of its securities, and is subject to the Securities and Exchange Commission’s rules and regulations relating to periodic reporting, reporting to shareholders, proxy solicitation and insider trading.

There are various legal restrictions on the extent to which First Colonial and its non-bank subsidiary can borrow or otherwise obtain credit from its banking subsidiary. In general, these restrictions require that any such extensions of credit must be secured by designated amounts of specified collateral and are limited, as to any one of First Colonial or such non-bank subsidiary, to ten percent of the lending bank’s capital stock and surplus, and as to First Colonial and its non-bank subsidiary in the aggregate, to 20 percent of such lending bank’s capital stock and surplus. Further, a bank holding company

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and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.

Nazareth National Bank. Nazareth National Bank, as a national bank, is subject to The National Bank Act. Nazareth National Bank is also subject to the supervision of, and is regularly examined by, the Office of the Comptroller of the Currency of the United States (the “OCC”) and is required to furnish quarterly reports to the OCC. The approval of the OCC is required for the establishment of additional branch offices by any national bank, subject to applicable state law restrictions. Under current Pennsylvania law, banking institutions located in Pennsylvania, such as Nazareth National Bank, may establish branches within any county in the Commonwealth, subject to the prior regulatory approval.

Under the Community Reinvestment Act, as amended (“CRA”), a bank 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. 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 CRA. CRA requires the applicable regulatory agency to assess an institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. The CRA requires public disclosure of an institution’s CRA rating and requires that the applicable regulatory agency provide a written evaluation of an institution’s CRA performance utilizing a four-tiered descriptive rating system. An institution’s CRA rating is considered in determining whether to grant charters, branches and other deposit facilities, relocations, mergers, consolidations and acquisitions. Performance less than satisfactory may be the basis for denying an application. In addition, under applicable regulations a bank having a less than satisfactory rating is not entitled to participate on the bid list for FDIC offerings. For its most recent examination, Nazareth National Bank received an “outstanding” rating.

As a national bank, Nazareth National Bank is a member of the FDIC and a member of the Federal Reserve System and, therefore, is subject to additional regulation by these agencies. Some of the aspects of the lending and deposit business of Nazareth National Bank which are regulated by these agencies include personal lending, mortgage lending and reserve requirements. The operations of Nazareth National Bank are also subject to numerous Federal, state and local laws and regulations which set forth specific restrictions and procedural requirements with respect to interest rates on loans, the extension of credit, credit practices, the disclosure of credit terms and discrimination in credit transactions.

Nazareth National Bank is subject to certain limitations on the amount of cash dividends it can pay. See “Note S—Regulatory Matters” in the First Colonial Notes to Consolidated Financial Statements which appear elsewhere herein.

The OCC has authority under the Financial Institutions Supervisory Act to prohibit national banks from engaging in any activity which, in the OCC’s opinion, constitutes an unsafe or unsound practice in conducting their businesses. The Federal Reserve Board has similar authority with respect to First Colonial and First Colonial’s non-bank subsidiary.

Substantially all of the deposits of Nazareth National Bank are insured up to applicable limits by the National Bank Insurance Fund (“BIF”) of the FDIC and are subject to deposit insurance assessments to maintain the BIF. The insurance assessments are based upon a matrix that takes into account a bank’s capital level and supervisory rating. Effective January 1, 1996, the FDIC reduced the insurance premiums it charged on bank deposits insured by the BIF to the statutory minimum of $2,000 annually for “well-capitalized” banks.

Capital Regulation. First Colonial and Nazareth National Bank are 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 First Colonial’s financial condition and results of operation. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, First Colonial and Nazareth National Bank must meet specific capital guidelines that involve quantitative measures of First Colonial’s and Nazareth National Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. First Colonial’s and Nazareth National Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require First Colonial and Nazareth National Bank to maintain minimum amounts and ratios of Tier 1 capital of at least 4% and total capital, Tier 1 and Tier 2, of 8% of risk-adjusted assets and of Tier 1 capital from 3% to 5% of average assets (leverage ratio). The 3% leverage ratio is a minimum for the top-rated banking organizations without any supervisory, financial or operational weaknesses or

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deficiencies and other banking organizations are expected to maintain leverage capital ratios 100 to 200 basis points above the minimum depending on their financial condition. Tier 1 capital includes common shareholders’ equity and qualifying perpetual preferred stock together with related surpluses and retained earnings. Tier 2 capital may be comprised of limited life preferred stock, qualifying debt instruments, and the allowance for possible loan losses. First Colonial’s management believes, as of March 31, 2003, that First Colonial and Nazareth National Bank meet all capital adequacy requirements to which they are subject.

The following tables provide a comparison of First Colonial’s and Nazareth National Bank’s capital amounts, risk-based capital ratios and leverage ratios for the periods indicated.

	Actual				Required For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in Thousands)
At March 31, 2003
Total Capital
(To Risk-Weighted Assets)
First Colonial, (Consolidated)	$	57,284	18.64	%	$	24,580	8.00	%	$	—	—
Nazareth National Bank	$	47,326	15.63	%	$	24,222	8.00	%	$	30,278	10.00	%
Tier I Capital
(To Risk-Weighted Assets)
First Colonial, (Consolidated)	$	52,230	17.00	%	$	12,290	4.00	%	$	—	—
Nazareth National Bank	$	43,214	14.27	%	$	12,111	4.00	%	$	18,167	6.00	%
Tier I Capital
(To Average Assets, Leverage)
First Colonial (Consolidated)	$	52,230	8.58	%	$	24,341	4.00	%	$	—	—
Nazareth National Bank	$	43,214	7.16	%	$	24,157	4.00	%	$	30,196	5.00	%

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	Actual				Required For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in Thousands)
At December 31, 2002
Total Capital
(To Risk-Weighted Assets)
First Colonial, (Consolidated)	$	56,032	18.45	%	$	24,301	8.00	%	$	—	—
Nazareth National Bank	$	46,767	15.63	%	$	23,935	8.00	%	$	29,918	10.00	%
Tier I Capital
(To Risk-Weighted Assets)
First Colonial, (Consolidated)	$	50,598	16.66	%	$	12,151	4.00	%	$	—	—
Nazareth National Bank	$	42,683	14.27	%	$	11,967	4.00	%	$	17,951	6.00	%
Tier I Capital
(To Average Assets, Leverage)
First Colonial (Consolidated)	$	50,598	8.81	%	$	22,978	4.00	%	$	—	—
Nazareth National Bank	$	42,683	7.48	%	$	22,833	4.00	%	$	28,541	5.00	%

	Actual				Required For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in Thousands)
At December 31, 2001
Total Capital
(To Risk-Weighted Assets)
First Colonial, (Consolidated)	$	37,926	15.38	%	$	19,738	8.00	%	$	—	—
Nazareth National Bank	$	32,931	13.50	%	$	19,515	8.00	%	$	24,393	10.00	%
Tier I Capital
(To Risk-Weighted Assets)
First Colonial, (Consolidated)	$	35,662	14.46	%	$	9,869	4.00	%	$	—	—
Nazareth National Bank	$	30,667	12.58	%	$	9,757	4.00	%	$	14,636	6.00	%
Tier I Capital
(To Average Assets, Leverage)
First Colonial (Consolidated)	$	35,662	7.65	%	$	18,661	4.00	%	$	—	—
Nazareth National Bank	$	30,667	6.61	%	$	18,575	4.00	%	$	23,218	5.00	%

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Gramm-Leach-Bliley Act. On November 12, 1999 the Gramm-Leach-Bliley Act (the “Act”) became law, repealing the 1933 Glass-Steagall Act’s separation of the commercial and investment banking industries. The Act expands the range of nonbanking activities a bank holding company may engage in, while preserving existing authority for bank holding companies to engage in activities that are closely related to banking. The new legislation creates a new category of holding company called a “Financial Holding Company”, a subset of bank holding companies that satisfy the following criteria: (1) all of the depository institution subsidiaries must be well capitalized and well managed; and (2) the holding company must have made an effective election to be a financial holding company to engage in activities that would not have been permissible before the Act. In order for the election to be effective, all of the depository institution subsidiaries must have a CRA rating of “satisfactory” or better at its most recent examination. First Colonial has not elected to be a financial holding company. Financial holding companies may engage in any activity that (i) is financial in nature or incidental to such financial activity or (ii) is complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. The Act specifies certain activities that are financial in nature. These activities include—acting as principal, agent or broker for insurance;—underwriting, dealing in or making a market in securities; and—providing financial and investment advice. The Federal Reserve Board and the Secretary of the Treasury have authority to decide whether other activities are also financial in nature or incidental to financial activity, taking into account changes in technology, changes in Nazareth National Banking marketplace, competition for banking services and so on.

The financial activities authorized by the Act may also be engaged in by a “financial subsidiary” of a national or state bank, except for insurance or annuity underwriting, insurance company portfolio investments, real estate investment and development, and merchant banking, which must be conducted in a financial holding company. In order for the new financial activities to be engaged in by a financial subsidiary of a national or state bank, the Act requires each of the parent bank (and its sister-bank affiliates) to be well capitalized and well managed; the aggregate consolidated assets of all of that bank’s financial subsidiaries may not exceed the lesser of 45% of its consolidated total assets or $50 billion; Nazareth National Bank must have at least a satisfactory CRA rating; and, if that bank is one of the 100 largest national banks, it must meet certain financial rating or other comparable requirements.

The Act establishes a system of financial regulation, under which the federal banking agencies will regulate Nazareth National Banking activities of financial holding companies and bank’s financial subsidiaries, the Securities and Exchange Commission will regulate their securities activities and state insurance regulators will regulate their insurance activities. The Act also provides new protections against the transfer and use by financial institutions of consumers’ nonpublic, personal information.

National Monetary Policy. In addition to being affected by general economic conditions, the earnings and growth of Nazareth National Bank and, therefore, the earnings and growth of First Colonial, are affected by the policies of regulatory authorities, including the OCC, the Federal Reserve Board and the FDIC. An important function of the Federal Reserve Board is to regulate the money supply, credit conditions and interest rates. Among the instruments used to implement these objectives are open market operations in United States Government securities, setting the discount rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall growth and distribution of credit, bank loans, investments and deposits, and their use may also affect interest rates charged on loans or paid on deposits.

The monetary policies and regulations of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon the future business, earnings and growth of First Colonial and Nazareth National Bank cannot be predicted.

Fair Value of Financial Instruments. The Financial Accounting Standards Board (“FASB”) issued statement of financial accounting standards (SFAS) No. 107, “Disclosures About Fair Value of Financial Instruments”, which requires all entities to disclose the estimated fair value of its assets and liabilities considered to be financial instruments. Financial instruments consist primarily of securities, loans and deposits. First Colonial has provided these disclosures as of December 31, 2002 and 2001 in Note U of the First Colonial Notes to Consolidated Financial Statements contained elsewhere herein.

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Accounting for Investment Securities. First Colonial classifies its debt and marketable securities into three categories: trading, available-for-sale, and held-to-maturity as provided by the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (SFAS No. 115). Trading securities are measured at fair value with unrealized holding gains and losses included in income. First Colonial had no trading securities in the first quarter of 2003 or in 2002 and 2001. Available-for-sale securities are stated separately on the financial statements and are discussed in the following section “Securities Available-for-Sale”. Held-to-maturity securities are carried at amortized cost and identified as investment securities in the financial statements. The classification of securities can be found in Note B of the First Colonial Notes to Consolidated Financial Statements contained elsewhere herein.

Employees.

As of March 31, 2003, First Colonial had approximately 233 employees, of whom 47 were part-time. First Colonial considers its relationship with its employees to be good.

Description of Property

The principal banking office of Nazareth National Bank and the Trust and Wealth Management offices of Nazareth National Bank and First Colonial are located at 76 South Main Street in the Borough of Nazareth, Northampton County, Pennsylvania, which building is owned by the Nazareth National Bank. In addition, Nazareth National Bank owns additional properties located at 29 South Broad Street, Nazareth, Pennsylvania (Mortgage and Installment Loan Center); 553 Nazareth Drive, Nazareth, Pennsylvania (Branch Office); 33 S. Broad Street, Nazareth (Branch Office), 47 Belvidere Street, Nazareth, Pennsylvania (garage and parking lot), 2000 Sullivan Trail, Easton, Pennsylvania (Branch Office), 3864 Adler Place, Bethlehem Business Park, Bethlehem, Pennsylvania (First Colonial Building, Executive and Commercial Lending and Operations offices), Rt. 209 Brodheadsville, Pennsylvania (Branch Office), 3856 Easton-Nazareth Highway (Route 248), Lower Nazareth Township, Easton, Pennsylvania (free-standing, drive-up ATM location), and 4261 Freemansburg Avenue, Bethlehem Township, Easton, Pennsylvania (future branch location).

Nazareth National Bank also leases facilities for its branch office located at 44 East Broad Street, Bethlehem, Pennsylvania; its branch office located at 4510 Bath Pike in Hanover Township (Bethlehem), Pennsylvania; its branch office located at 101 South Third Street, Easton, Pennsylvania; its branch office located at 1125 N. Ninth Street, Stroudsburg, Pennsylvania; its branch office located at 713 Main Street, Stroudsburg, Pennsylvania; its branch office located in the Hall Square Retirement Center, 175 W. North Street, Nazareth, Pennsylvania; its branch office located within Redner’s Supermarket, Airport Road, Allentown, Pennsylvania; and its branch office located within Redner’s Supermarket, Northampton Crossings Shopping Center, Lower Nazareth Township, Pennsylvania; its branch office located within Wal-Mart’s at 355 Lincoln Avenue, East Stroudsburg, Pennsylvania; its branch office located within Wal-Mart’s at 500 Route 940, Mt. Pocono, Pennsylvania; its branch office located within the Giant Supermarket, 2540 McArthur Road, Whitehall, Pennsylvania; its branch office located within the Giant Supermarket, 6900 Hamilton Boulevard, Trexlertown, Pennsylvania; and 9^th and Hamilton Streets, Allentown, Pennsylvania (future branch location).

Legal Proceedings

From time-to-time, First Colonial Group and Nazareth National Bank are parties to routine litigation incidental to their business.

Neither First Colonial Group, Nazareth National Bank nor any of their properties is subject to any material legal proceedings, nor are any such proceedings known to be contemplated by any governmental authorities.

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REGULATION

Set forth below is a brief description of certain laws relating to the regulation of KNBT Bancorp and Keystone after the proposed conversion. This description does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations.

General

Keystone as a Pennsylvania-chartered savings bank with deposits insured by the Savings Association Insurance Fund administered by the Federal Deposit Insurance Corporation, is subject to extensive regulation and examination by the Pennsylvania Department of Banking and by the Federal Deposit Insurance Corporation. The federal and state laws and regulations applicable to banks regulate, among other things, the scope of their business, their investments, the reserves required to be kept against deposits, the timing of the availability of deposited funds and the nature and amount of and collateral for certain loans. This regulatory structure also gives the federal and state banking agencies extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. The laws and regulations governing Keystone generally have been promulgated to protect depositors and not for the purpose of protecting shareholders.

Federal law provides the federal banking regulators, including the Federal Deposit Insurance Corporation and the Federal Reserve Board, with substantial enforcement powers. 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 against banking organizations and institution-affiliated parties, as defined. 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 regulatory authorities. Any change in such regulation, whether by the Pennsylvania Department of Banking, the Federal Deposit Insurance Corporation or the United States Congress, could have a material impact on KNBT Bancorp and its operations.

Upon completion of the conversion, KNBT Bancorp will register as a bank holding company under the Bank Holding Company Act of 1956, as amended, and KNBT Bancorp will be subject to regulation and supervision by the Federal Reserve Board and by the Pennsylvania Department of Banking. KNBT Bancorp will also be required to file annually a report of its operations with, and will be subject to examination by, the Federal Reserve Board and the Pennsylvania Department of Banking. This regulation and oversight is generally intended to ensure that KNBT Bancorp limits its activities to those allowed by law and that it operates in a safe and sound manner without endangering the financial health of its subsidiary bank.

In connection with the conversion, KNBT Bancorp intends to register its common stock with the SEC under Section 12(g) of the Securities Exchange Act of 1934. KNBT Bancorp will then be subject to the proxy and tender offer rules, insider trading reporting requirements and restrictions, and certain other requirements under the Securities Exchange Act of 1934. KNBT Bancorp also intends to list its common stock on the Nasdaq Stock Market national market system. The Nasdaq Stock Market listing requirements will impose additional requirements on KNBT Bancorp, including, among other things, corporate governance and the composition and independence of its board of directors and various committees of the Board, including the audit committee.

Regulation of KNBT Bancorp

Bank Holding Company Act Activities and Other Limitations. Under the Bank Holding Company Act, KNBT Bancorp must obtain the prior approval of the Federal Reserve Board before it may acquire control of another bank or bank holding company, merge or consolidate with another bank holding company, acquire all or substantially all of the assets of another bank or bank holding company, or acquire direct or indirect ownership or control of any voting shares of any bank or bank holding company if, after such acquisition, the bank holding company would directly or indirectly own or control more than 5% of such shares.

Federal statutes impose restrictions on the ability of a bank holding company and its nonbank subsidiaries to obtain extensions of credit from its subsidiary bank, on the subsidiary bank’s investments in the stock or securities

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of the holding company, and on the subsidiary bank’s taking of the holding company’s stock or securities as collateral for loans to any borrower. A bank holding company and its subsidiaries are also prevented from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property, or furnishing of services by the subsidiary bank.

A bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the policy of the Federal Reserve Board that a bank holding company should stand ready to use available resources to provide adequate capital to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board regulations, or both.

Non-Banking Activities. The business activities of KNBT Bancorp, as a bank holding company, are restricted by the Bank Holding Company Act. Under the Bank Holding Company Act and the Federal Reserve Board’s bank holding company regulations, KNBT Bancorp may only engage in, or acquire or control voting securities or assets of a company engaged in,

• banking or managing or controlling banks and other subsidiaries authorized under the Bank Holding Company Act; and

• any Bank Holding Company Act activity the Federal Reserve Board has determined to be so closely related that it is incidental to banking or managing or controlling banks.

The Federal Reserve Board has by regulation determined that certain activities are closely related to banking including operating a mortgage company, finance company, credit card company, factoring company, trust company or savings association; performing certain data processing operations; providing limited securities brokerage services; acting as an investment or financial advisor; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full-payout, non-operating basis; providing tax planning and preparation services; operating a collection agency; and providing certain courier services. However, as discussed below, certain other activities are permissible for a bank holding company that becomes a financial holding company.

Financial Modernization. The Gramm-Leach-Bliley Act, which became effective in November 1999, permits greater affiliation among banks, securities firms, insurance companies, and other companies under a new type of financial services company known as a “financial holding company.” A financial holding company essentially is a bank holding company with significantly expanded powers. Financial holding companies are authorized by statute to engage in a number of financial activities previously impermissible for bank holding companies, including securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; and merchant banking activities. The act also permits the Federal Reserve Board and the Treasury Department to authorize additional activities for financial holding companies if they are “financial in nature” or “incidental” to financial activities. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized, well managed, and has at least a “satisfactory” CRA rating. A financial holding company must provide notice to the Federal Reserve Board within 30 days after commencing activities previously determined by statute or by the Federal Reserve Board and Department of the Treasury to be permissible. KNBT Bancorp has not submitted notice to the Federal Reserve Board of its intent to be deemed a financial holding company. However, it is not precluded from submitting a notice in the future should it wish to engage in activities only permitted to financial holding companies.

Regulatory Capital Requirements. The Federal Reserve Board has adopted capital adequacy guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a bank holding company and in analyzing applications to it under the Bank Holding Company Act. The Federal Reserve Board’s capital adequacy guidelines for us (on a consolidated basis) are similar to those imposed on Keystone by the Federal Deposit Insurance Corporation. See “-Regulation of Keystone—Regulatory Capital Requirements.”

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Restrictions on Dividends. KNBT Bancorp’s ability to declare and pay dividends may depend in part on dividends received from Keystone. The Pennsylvania Banking Code regulates the distribution of dividends by savings banks and states, in part, that dividends may be declared and paid only out of accumulated net earnings and may not be declared or paid unless surplus (retained earnings) is at least equal to contributed capital. In addition, dividends may not be declared or paid if Keystone is in default in payment of any assessment due the Federal Deposit Insurance Corporation.

The Federal Reserve Board issued a policy statement in 1985 on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve Board’s view that a bank holding company should pay cash dividends only to the extent that the holding company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. The Federal Reserve Board also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the federal prompt corrective action regulations, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.” See “-Regulation of Keystone—Prompt Corrective Action,” below.

Federal Securities Laws. KNBT Bancorp has filed with the SEC a registration statement under the Securities Act of 1933, of which this prospectus is a part, for the registration of the common stock to be issued in the conversion and the merger. In connection with the completion of the conversion, KNBT Bancorp intends to register its common stock with the SEC under Section 12(g) of the Securities Exchange Act of 1934. KNBT Bancorp will then be subject to the proxy and tender offer rules, insider trading reporting requirements and restrictions, and certain other requirements under the Securities Exchange Act of 1934. Under the terms of the plan of conversion, KNBT Bancorp has undertaken to maintain such registration for a minimum of three years following the conversion.

Sarbanes-Oxley Act of 2002. On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 implementing legislative reforms intended to address corporate and accounting fraud. In addition to the establishment of a new accounting oversight board which will enforce auditing, quality control and independence standards and will be funded by fees from all publicly traded companies, the bill restricts provision of both auditing and consulting services by accounting firms. To ensure auditor independence, any non-audit services being provided to an audit client will require preapproval by the company’s audit committee members. In addition, the audit partners must be rotated. The bill requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement. In addition, under the Sarbanes-Oxley Act, counsel will be required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to its chief executive officer or its chief legal officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the board of directors or the board itself.

Longer prison terms will also be applied to corporate executives who violate federal securities laws, the period during which certain types of suits can be brought against a company or its officers has been extended, and bonuses issued to top executives prior to restatement of a company’s financial statements are now subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirement plan “blackout” periods, and loans to company executives are restricted. In addition, a provision directs that civil penalties levied by the SEC as a result of any judicial or administrative action under the Sarbanes-Oxley Act be deposited to a fund for the benefit of harmed investors. The Federal Accounts for Investor Restitution (“FAIR”) provision also requires the SEC to develop methods of improving collection rates. The legislation accelerates the time frame for disclosures by public companies, as they must immediately disclose any material changes in their financial condition or operations. Directors and executive officers must also provide information for most changes in ownership in a company’s securities within two business days of the change.

The Sarbanes-Oxley Act also increases the oversight of, and codifies certain requirements relating to audit committees of public companies and how they interact with the company’s “registered public accounting firm” (“RPAF”). Audit Committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer. In addition, companies must disclose whether at least one member of the committee is a “financial expert” (as such term is defined by the SEC) and if not, why not. Under the Sarbanes-

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Oxley Act, a RPAF is prohibited from performing statutorily mandated audit services for a company if such company’s chief executive officer, chief financial officer, comptroller, chief accounting officer or any person serving in equivalent positions has been employed by such firm and participated in the audit of such company during the one-year period preceding the audit initiation date. The Sarbanes-Oxley Act also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the company’s financial statements for the purpose of rendering the financial statement’s materially misleading. The Sarbanes-Oxley Act also requires the SEC to prescribe rules requiring inclusion of an internal control report and assessment by management in the annual report to shareholders. The Sarbanes-Oxley Act requires the RPAF that issues the audit report to attest to and report on management’s assessment of the company’s internal controls. In addition, the Sarbanes-Oxley Act requires that each financial report required to be prepared in accordance with (or reconciled to) generally accepted accounting principles and filed with the SEC reflect all material correcting adjustments that are identified by a RPAF in accordance with generally accepted accounting principles and the rules and regulations of the SEC.

Regulation of Keystone

Pennsylvania Savings Bank Law. The Pennsylvania Banking Code contains detailed provisions governing the organization, location of offices, rights and responsibilities of trustees, officers, and employees, as well as corporate powers, savings and investment operations and other aspects of Keystone and its affairs. The code delegates extensive rule-making power and administrative discretion to the Pennsylvania Department of Banking so that the supervision and regulation of state-chartered savings banks may be flexible and readily responsive to changes in economic conditions and in savings and lending practices.

The Pennsylvania Banking Code also provides that state-chartered savings banks may engage in any activity permissible for a federal savings association, subject to regulation by the Pennsylvania Department of Banking. The Federal Deposit Insurance Corporation Act, however, will prohibit Keystone from making new investments, loans, or becoming involved in activities as principal and equity investments which are not permitted for national banks unless:

• the Federal Deposit Insurance Corporation determines the activity or investment does not pose a significant risk of loss to the Savings Association Insurance Fund; and

• Keystone meets all applicable capital requirements.

Accordingly, the additional operating authority provided to Keystone by the Pennsylvania Banking Code is significantly restricted by the Federal Deposit Insurance Act.

Insurance of Accounts. The deposits of Keystone are insured to the maximum extent permitted by the Savings Association Insurance Fund, which is administered by the Federal Deposit Insurance Corporation, and are backed by the full faith and credit of the U.S. Government. As insurer, the Federal Deposit Insurance Corporation is authorized to conduct examinations of, and to require reporting by, insured institutions. It also may prohibit any insured institution from engaging in any activity the Federal Deposit Insurance Corporation determines by regulation or order to pose a serious threat to the Federal Deposit Insurance Corporation. The Federal Deposit Insurance Corporation also has the authority to initiate enforcement actions against savings institutions.

Under current Federal Deposit Insurance Corporation regulations, Savings Association Insurance Fund-insured institutions are assigned to one of three capital groups which are based solely on the level of an institution’s capital—“well capitalized,” “adequately capitalized” and “undercapitalized”—which are defined in the same manner as the regulations establishing the prompt corrective action system discussed below. These three groups are then divided into three subgroups which reflect varying levels of supervisory concern, from those which are considered to be healthy to those which are considered to be of substantial supervisory concern. The matrix so created results in nine assessment risk classifications, with rates during the first six months of 2003 ranging from zero for well capitalized, healthy institutions, such as Keystone, to 27 basis points for undercapitalized institutions with substantial supervisory concerns.

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In addition, all institutions with deposits insured by the Federal Deposit Insurance Corporation are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize the predecessor to the Savings Association Insurance Fund. The assessment rate for the first quarter of 2003 was .0168% of insured deposits and is adjusted quarterly. These assessments will continue until the Financing Corporation bonds mature in 2019.

The Federal Deposit Insurance Corporation may terminate the deposit insurance of any insured depository institution, including Keystone, 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 Federal Deposit Insurance Corporation. 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 Federal Deposit Insurance Corporation. Management is aware of no existing circumstances which would result in termination of Keystone’s deposit insurance.

Regulatory Capital Requirements. The Federal Deposit Insurance Corporation has promulgated capital adequacy requirements for state-chartered banks that, like Keystone, are not members of the Federal Reserve Board System. The capital regulations establish a minimum 3% Tier 1 leverage capital requirement for the most highly rated state-chartered, non-member banks, with an additional cushion of at least 100 to 200 basis points for all other state-chartered, non-member banks, which effectively increases the minimum Tier 1 leverage ratio for such other banks to 4% to 5% or more. Under the Federal Deposit Insurance Corporation’s regulations, the highest-rated banks are those that the Federal Deposit Insurance Corporation determines are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and, in general, which are considered a strong banking organization, rated composite 1 under the Uniform Financial Institutions Rating System. Tier 1, or leverage capital, is defined as the sum of common shareholders’ equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, and minority interests in consolidated subsidiaries, minus all intangible assets other than certain purchased mortgage servicing rights and purchased credit card relationships.

The Federal Deposit Insurance Corporation’s regulations also require that state-chartered, non- member banks meet a risk-based capital standard. The risk-based capital standard requires the maintenance of total capital, defined as Tier 1 capital and supplementary (Tier 2) capital, to risk weighted assets of 8%. In determining the amount of risk-weighted assets, all assets, plus certain off balance sheet assets, are multiplied by a risk-weight of 0% to 100%, based on the risks the Federal Deposit Insurance Corporation believes are inherent in the type of asset or item. The components of Tier 1 capital for the risk-based standards are the same as those for the leverage capital requirement. The components of supplementary (Tier 2) capital include cumulative perpetual preferred stock, mandatory subordinated debt, perpetual subordinated debt, intermediate-term preferred stock, up to 45% of unrealized gains on equity securities and a portion of a bank’s allowance for loan losses. Allowance for loan losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital that may be included in total capital is limited to 100% of Tier 1 capital.

A bank that has less than the minimum leverage capital requirement is subject to various capital plan and activities restriction requirements. The Federal Deposit Insurance Corporation’s regulations also provide that any insured depository institution with a ratio of Tier 1 capital to total assets that is less than 2.0% is deemed to be operating in an unsafe or unsound condition pursuant to Section 8(a) of the Federal Deposit Insurance Act and could be subject to potential termination of deposit insurance.

Keystone is also subject to minimum capital requirements imposed by the Pennsylvania Department of Banking on Pennsylvania-chartered depository institutions. Under the Pennsylvania Department of Banking’s capital regulations, a Pennsylvania bank or savings association must maintain a minimum leverage ratio of Tier 1 capital (as defined under the Federal Deposit Insurance Corporation’s capital regulations) to total assets of 4%. In addition, the Pennsylvania Department of Banking has the supervisory discretion to require a higher leverage ratio for any institution or association based on inadequate or substandard performance in any of a number of areas. The Pennsylvania Department of Banking incorporates the same Federal Deposit Insurance Corporation risk-based capital requirements in its regulations.

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At March 31, 2003, Keystone exceeded all of its regulatory capital requirements, with leverage and risk-based capital ratios of 10.8% and 18.9%, respectively.

Prompt Correction Action. The following table shows the amount of capital associated with the different capital categories set forth in the prompt correction action regulations.

Capital Category	Total Risk-Based Capital	Tier 1 Risk-Based Capital	Tier 1 Leverage Capital
Well capitalized	10% or more	6% or more	5% or more
Adequately capitalized	8% or more	4% or more	4% or more
Undercapitalized	Less than 8%	Less than 4%	Less than 4%
Significantly undercapitalized	Less than 6%	Less than 3%	Less than 3%

In addition, an institution is “critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Under specified circumstances, a federal banking agency 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 Federal Deposit Insurance Corporation may not reclassify a significantly undercapitalized institution as critically undercapitalized).

An institution generally must file a written capital restoration plan which meets specified requirements within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. A federal banking agency must provide the institution with written notice of approval or disapproval within 60 days after receiving a capital restoration plan, subject to extensions by the agency. An institution which is required to submit a capital restoration plan must concurrently submit a performance guaranty by each company that controls the institution. In addition, undercapitalized institutions are subject to various regulatory restrictions, and the appropriate federal banking agency also may take any number of discretionary supervisory actions.

At March 31, 2003, Keystone was deemed a well capitalized institution for purposes of the above regulations and as such is not subject to the above mentioned restrictions.

Affiliate Transaction Restrictions. Federal laws strictly limit the ability of banks to engage in transactions with their affiliates, including their bank holding companies. Such transactions between a subsidiary bank and its parent company or the nonbank subsidiaries of the bank holding company are limited to 10% of a bank subsidiary’s capital and surplus and, with respect to such parent company and all such nonbank subsidiaries, to an aggregate of 20% of the bank subsidiary’s capital and surplus. Further, loans and extensions of credit generally are required to be secured by eligible collateral in specified amounts. Federal law also requires that all transactions between a bank and its affiliates be on terms as favorable to the bank as transactions with non-affiliates.

Federal Home Loan Bank System. Keystone is a member of the Federal Home Loan Bank of Pittsburgh, which is one of 12 regional Federal Home Loan Banks. Each Federal Home Loan Bank serves as a reserve or central bank for its members within its assigned region. It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the Federal Home Loan Bank system. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the Federal Home Loan Bank. At March 31, 2003, Keystone had $103.5 million in Federal Home Loan Bank advances.

As a member, Keystone is required to purchase and maintain stock in the Federal Home Loan Bank of Pittsburgh in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of its outstanding advances from the

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Federal Home Loan Bank. At March 31, 2003, Keystone had $8.5 million in stock of the Federal Home Loan Bank of Pittsburgh which was in compliance with this requirement.

Federal Reserve Board System. The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking and NOW accounts) and non-personal time deposits. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy the liquidity requirements that are imposed by the Pennsylvania Department of Banking. At March 31, 2003, Keystone was in compliance with these reserve requirements.

TAXATION

Federal Taxation

General. KNBT Bancorp and Keystone will be subject to federal income taxation in the same general manner as other corporations with some exceptions listed below. The following discussion of federal, state and local income taxation is only intended to summarize certain pertinent income tax matters and is not a comprehensive description of the applicable tax rules applicable to KNBT Bancorp and Keystone. Keystone’s federal and state income tax returns for taxable years through December 31, 1998 have been closed for purposes of examination by the Internal Revenue Service or the Pennsylvania Department of Revenue.

Upon completion of the conversion, KNBT Bancorp will file a consolidated federal income tax return with Keystone. Accordingly, it is anticipated that any cash distributions made by KNBT Bancorp to its shareholders would be treated as cash dividends and not as a non-taxable return of capital to shareholders for federal and state tax purposes.

Method of Accounting. For federal income tax purposes, Keystone reports income and expenses on the accrual method of accounting and file its federal income tax return on a calendar year basis.

Bad Debt Reserves. The Small Business Job Protection Act of 1996 eliminated the use of the reserve method of accounting for bad debt reserves by savings institutions, effective for taxable years beginning after 1995. Prior to that time, Keystone was permitted to establish a reserve for bad debts and to make additions to the reserve. These additions could, within specified formula limits, be deducted in arriving at taxable income. As a result of the Small Business Job Protection Act of 1996, savings associations must use the specific charge-off method in computing their bad debt deduction beginning with their 1996 federal tax return. In addition, federal legislation required the recapture (over a six year period) of the excess of tax bad debt reserves at December 31, 1995 over those established as of December 31, 1987.

Taxable Distributions and Recapture. Prior to the Small Business Job Protection Act of 1996, bad debt reserves created prior to January 1, 1988 were subject to recapture into taxable income if Keystone failed to meet certain thrift asset and definitional tests. New federal legislation eliminated these thrift related recapture rules. However, under current law, pre-1988 reserves remain subject to recapture should Keystone make certain non-dividend distributions or cease to maintain a bank charter.

At March 31, 2003, the total federal pre-1988 reserve was approximately $9.8 million. The reserve reflects the cumulative effects of federal tax deductions by Keystone for which no federal income tax provisions have been made.

Alternative Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences. The alternative minimum tax is payable to the extent such alternative minimum tax income is in excess of an exemption amount. Net operating losses, of which Keystone has none, can offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. Keystone has not been subject to the alternative minimum tax or any such amounts available as credits for carryover.

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Net Operating Loss Carryovers. For net operating losses in tax years beginning before August 6, 1997, Keystone may carry back net operating losses to the three years preceding the loss year and then forward to fifteen years following the loss years. For net operating losses in years beginning after August 5, 1997, net operating losses can be carried back to the two years preceding the loss year and forward to the 20 years following the loss year. At March 31, 2003, Keystone had no net operating loss carry forwards for federal income tax purposes.

Corporate Dividends-Received Deduction. KNBT Bancorp may exclude from its income 100% of dividends received from Keystone as a member of the same affiliated group of corporations. The corporate dividends received deduction is 80% in the case of dividends received from corporations which a corporate recipient owns less than 80%, but at least 20% of the distribution corporation. Corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct only 70% of dividends received.

State And Local Taxation

Pennsylvania Taxation. KNBT Bancorp will be subject to the Pennsylvania Corporate Net Income Tax, Capital Stock and Franchise Tax. The Corporation Net Income Tax rate for 2003 is 9.99% and is imposed on unconsolidated taxable income for federal purposes with certain adjustments. In general, the Capital Stock Tax is a property tax imposed on a corporation’s capital stock value at a statutorily defined rate, such value being determined in accordance with a fixed formula based upon average net income and net worth.

Keystone is subject to (and will remain subject to such provision after the merger) tax under the Pennsylvania Mutual Thrift Institutions Tax Act, as amended to include thrift institutions having capital stock. Pursuant to the Mutual Thrift Institutions Tax, the tax rate is 11.5%. The Mutual Thrift Institutions Tax exempts Keystone from 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 Mutual Thrift Institutions Tax is a tax upon net earnings, determined in accordance with generally accepted accounting principles with certain adjustments. The Mutual Thrift Institutions Tax, in computing income according to generally accepted accounting principles, allows for the deduction of interest earned on state and federal obligations, 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 Keystone. Net operating losses, if any, thereafter can be carried forward three years for Mutual Thrift Institutions Tax purposes.

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MANAGEMENT

Management of KNBT Bancorp

Board of Directors. The Board of Directors of KNBT Bancorp is divided into three classes, each of which contains one-third of the Board. The directors will be elected by KNBT Bancorp’s shareholders for staggered three year terms, or until their successors are elected and qualified. One class of directors, consisting of Messrs. Paul, Smith and Stehly, has a term of office expiring at the first annual meeting of shareholders, a second class, consisting of Messrs. Mountain, Scholl and Strain, has a term of office expiring at the second annual meeting of shareholders and a third class, consisting of Messrs. Feather and Gausling and Ms. Holton has a term of office expiring at the third annual meeting of shareholders. In connection with the consummation of the merger, under the terms of the merger agreement KNBT Bancorp and Keystone agreed to appoint to KNBT Bancorp’s board and that of Keystone the following six existing directors of First Colonial: Messrs. Fainor and Martin for terms expiring at KNBT Bancorp’s first annual meeting of shareholders, Messrs. Mulholland and Peischl for terms expiring at its second annual meeting and Mr. Stevens and Ms. Thulin for terms expiring at its third annual meeting.

The following table sets forth certain information regarding KNBT Bancorp’s current directors, all of whom are also trustees of Keystone. Ages are reflected as of March 31, 2003.

Name	Age	Principal Occupation During the Past Five Years	Year Term Expires
Jeffrey P. Feather	60	Chairman and Chief Executive Officer, SunGard Pentamation, Inc., Bethlehem, Pennsylvania; serves as Chairman of the Board of KNBT Bancorp and Keystone.	2006
Michael J. Gausling	45	President and Chief Executive Officer, OraSure Technologies, Inc. since 2002; previously, President and Chief Operating Officer since September 2000; and prior thereto, Chairman, President and Chief Executive Officer of STC Technologies, Inc.	2006
Donna D. Holton	57	President and Chief Operating Officer, Turn of the Century Solution, Inc., an intellectual property company.	2006
John A. Mountain	75	Retired Chief Financial Officer, Air Products & Chemicals, Inc.	2005
R. Chadwick Paul, Jr.	49	Chief Executive Officer, Ben Franklin Technology Partners, Northeastern Pennsylvania since 2002; prior thereto, Vice President of Nextlink from 1997 to 2000.	2004
Robert R. Scholl	74	Financial Consultant, Prudential Financial.	2005
Kenneth R. Smith	63	Vice President, Lehigh University, Bethlehem, Pennsylvania; previously director of community and regional affairs.	2004
R. Charles Stehly	46	Director of Business Relations, Corporate Environments Group.	2004
Richard L. Strain	73	Retired President, Bethlehem Area Chamber of Commerce.	2005

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Upon consummation of the merger, Messrs. Fainor, Martin, Mulholland, Peischl and Stevens and Ms. Thulin will be appointed as directors of KNBT and of Keystone. Set forth in the table below is certain biographical information with respect to such persons. Ages are reflected as of March 31, 2003.

Name	Age	Principal Occupation During the Past Five Years	Year Term Expires
Scott V. Fainor	41	President and Chief Executive Officer of First Colonial and Nazareth National Bank since January 2002; previously served as Executive Vice President of First Union from 2001 until January 2002 and President of the Lehigh Valley/Northeastern Pennsylvania Region, First Union from 1997 to December 2000.	2004
Christian F. Martin	46	Chairman and Chief Executive Officer of C.F. Martin & Co., Inc., Nazareth, Pennsylvania, a guitar manufacturer, since 1975.	2004
Daniel B. Mulholland	50	Consultant for and formerly President of Mallinckrodt Baker, Inc., Phillipsburg, New Jersey, a chemical manufacturer, since 1974.	2005
Charles J. Peischl	58	Partner in the law firm Peters, Moritz, Peischl, Zulick & Landers, LLP, Nazareth, Pennsylvania.	2005
Richard Stevens, III	70	Prior to his retirement, served as Division Manager of Marketing for Computer Aid, Inc., Allentown, Pennsylvania; currently serves as Chairman of the Board of First Colonial and Nazareth National Bank.	2006
Maria Zumas Thulin	49	Executive President of Arcadia Development Corporation, Bethlehem, Pennsylvania, a real estate development and management company.	2006

Director Compensation. Directors of KNBT Bancorp initially will not be compensated by KNBT Bancorp but will serve and be compensated by Keystone. It is not anticipated that separate compensation will be paid to KNBT Bancorp’s directors until such time as such persons devote significant time to the separate management of its affairs, which is not expected to occur until it becomes actively engaged in additional businesses other than holding the stock of Keystone. KNBT Bancorp may determine that such compensation is appropriate in the future.

Committees of the Board of Directors. KNBT Bancorp’s board of directors has not yet established various committees. In connection with the completion of the conversion and the merger, KNBT Bancorp’s board of directors will establish an audit committee, a nominating and corporate governance committee and a compensation Committee. It is expected that all of such committees will be composed solely of independent directors as defined by the regulations of the Nasdaq Stock Market or the SEC (as a result of the implementation of the provisions of the Sarbanes-Oxley Act). Such committees will operate in accordance with written charters. The board of directors of KNBT Bancorp also expects to adopt codes of conduct and ethics.

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Executive Officers Who Are Not Directors. The following individual currently serves as KNBT Bancorp’s executive officer and also serves as an executive officer of Keystone but does not serve on KNBT Bancorp’s board of directors or the board of trustees of Keystone. Age is as of March 31, 2003.

Name	Age	Principal Occupation During the Past Five Years
Eugene T. Sobol	58	Senior Executive Vice President and Chief Operating Officer of KNBT Bancorp since 2003; Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer of Keystone since February 2003; prior thereto, Executive Vice President, Chief Financial Officer and Treasurer.

In connection with the consummation of the merger, Mr. Fainor, currently President of First Colonial and Nazareth National Bank, will be elected as KNBT Bancorp’s President and Chief Executive Officer and Mr. Reid Heeren, currently Treasurer and Vice President of First Colonial, as Executive Vice President and Chief Financial Officer. In accordance with KNBT Bancorp’s Bylaws, KNBT Bancorp’s executive officers are elected annually and hold office until their respective successors have been elected and qualified or until death, resignation or removal by the board of directors.

Management of Keystone after the Merger

All of KNBT Bancorp’s executive officers will also serve as executive officers of Keystone. In addition, in connection with the completion of the merger, Messrs. Scott V. Fainor and Reid L. Heeren, currently executive officers of First Colonial and Nazareth National Bank, will be appointed President and Chief Executive Officer and Executive Vice President-Chief Financial Officer, respectively, of Keystone. Set forth below is information with respect to Mr. Heeren’s principal occupations during the past five years. For information regarding Mr. Fainor, see “—Management of KNBT Bancorp—Board of Directors.”

Reid L. Heeren. Mr. Heeren, age 62 years (as of March 31, 2003), currently serves as Treasurer and Vice President of First Colonial, since January 1987 and April 1985, respectively. Mr. Heeren also has served as Executive Vice President and Chief Financial Officer of Nazareth National Bank, since August 1997.

Trustees’ Compensation

Members of Keystone’s board of trustees receive $1,700 per meeting attended of the Board and $600 per committee meeting attended. Board fees are subject to periodic adjustment by the board of trustees.

Executive Compensation

Summary Compensation Table. The following table sets forth a summary of certain information concerning the compensation paid by Keystone (including amounts deferred to future periods by the officers) for services rendered in all capacities during the fiscal year ended December 31, 2002, to the President and Chief Executive Officer and the two executive officers of Keystone whose salary plus bonus exceeded $100,000.

		Annual Compensation(1)
Name and Principal Position	Fiscal Year	Salary(2)		Bonus(2)(3)		All Other Compensation(4)
Frederick E. Kutteroff, President and Chief Executive Officer	2002	$	274,000	$	57,540	$	5,500
Eugene T. Sobol, Executive Vice President, Chief Operating Officer and Treasurer	2002		149,000		31,290		4,301
Richard L. Meares, Executive Vice President and Chief Operating Officer(5)	2002		175,000		36,750		4,714

(footnotes on following page)

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(1) Keystone provides various miscellaneous benefits to the named executive officers. The costs of providing such benefits to the named executive officers did not exceed the lesser of $50,000 or 10% of the total annual salary and bonus reported for each of such individuals.

(2) Also includes amounts deferred pursuant to Keystone’s Trustee and Executive Deferred Compensation Plan and/or pursuant to its 401(k) plan.

(3) Represents bonuses earned in 2002 which were paid in 2003. Such bonuses were paid pursuant to the terms of the Keystone Senior Management Variable Compensation Program.

(4) Under Keystone’s 401(k) plan for fiscal 2002, $5,500, $4,301 and $4,714 was allocated to the accounts of Messrs. Kutteroff, Sobol and Meares, respectively. Does not include amounts allocated to Keystone’s Supplemental Executive Retirement Plan on behalf of Messrs. Kutteroff, Sobol and Meares. See “-Supplemental Executive Retirement Plan.” Does not include payments to be made pursuant to a retirement and severance agreement entered into with Mr. Kutteroff in March 2003. Does not include payments to be made to Mr. Meares pursuant to a severance agreement entered into with him as of January 2003. See “—Employment, Retirement and Severance Agreements.”

(5) Retired effective as of January 2003.

Employment, Retirement and Severance Agreements. In connection with the execution of the merger agreement, Keystone entered into employment agreements with Messrs. Fainor and Sobol, such agreements to become effective upon completion of the merger. KNBT Bancorp joined in such agreements subsequent to its formation. Mr. Fainor’s employment agreement has a term of three years, beginning on the date the merger is completed. On each annual anniversary date of the effective date of the employment agreement, the term will be extended for one additional year thereafter unless either KNBT Bancorp or Keystone, on the one hand, or Mr. Fainor on the other, give notice 30 days prior to the annual anniversary date that the term will not be extended. Extension of the term also will cease automatically if Mr. Fainor’s employment with either KNBT Bancorp or Keystone is terminated for any reason. Mr. Fainor’s employment agreement will provide that he will serve as the President and Chief Executive Officer of KNBT Bancorp and Keystone during the term of his employment agreement. As President and Chief Executive Officer, he will have the authority and responsibilities prescribed by KNBT Bancorp’s and Keystone’s bylaws and that are customary for such positions.

Under the terms of the employment agreement, Mr. Fainor will receive a base salary of $335,000. Mr. Fainor will also be entitled to participate in KNBT Bancorp’s and Keystone’s benefit plans and programs, receive an automobile allowance and reimbursement of country club dues. The terms of the employment agreement provide that payments will be allocated between KNBT Bancorp and Keystone in proportion to the level of activity and the time expended on such activities by Mr. Fainor. In no event, however, shall he receive duplicate payments or benefits from KNBT Bancorp and Keystone.

In the event that, during the term of his employment agreement, Mr. Fainor’s employment is terminated by KNBT Bancorp or Keystone without cause or for other than death or disability, or if Mr. Fainor resigns for any of the reasons specified below, he will be entitled to receive as liquidated damages earned but unpaid base salary, benefits as to which he is entitled under plans maintained by KNBT Bancorp and Keystone through the date of termination, continued group life, health, dental, accident and disability benefits for a specified period of time, a cash lump sum payment to compensate him for the loss of salary (on a present value basis), cash bonus and incentive compensation and qualified and non-qualified retirement plan benefits (on a present value basis) for the period of the remaining term of his employment agreement, but not more than two years. In addition, Mr. Fainor will be reimbursed for reasonable expenses incurred by him in searching for new employment not to exceed $75,000. To the extent that Mr. Fainor earns salary, cash bonus or incentive compensation, fees or comparable fringe benefits from another employer during this period and a change in control of KNBT Bancorp has occurred within one year of the date of Mr. Fainor’s termination, the liquidated damages for loss of this type of compensation will be subject to repayment by Mr. Fainor. In addition, if Mr. Fainor surrenders his then outstanding options and shares of restricted stock within 30 days of the termination of his employment, KNBT Bancorp and Keystone will pay him the value of the excess of the fair market value of the KNBT Bancorp common stock covered by options

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granted to him over the exercise price of his outstanding options and the fair market value of his shares of restricted stock.

The reasons specified in Mr. Fainor’s employment agreement that would justify his resigning and receiving the liquidated damages described above are a material breach of the agreement by KNBT Bancorp or Keystone (including a reduction in his salary or a material reduction in his fringe benefits) and such breach remains uncured after 30 days written notice, a failure to appoint him to the positions in which he has a right to serve under his employment agreement, a failure to vest in him the authority and responsibilities associated with those positions and such failure is not cured after 30 days written notice, a change in his principal place of employment to a location more than 25 miles from KNBT Bancorp’s and Keystone’s corporate headquarters in Bethlehem, Pennsylvania, or the liquidation, dissolution, bankruptcy or insolvency of KNBT Bancorp or Keystone, KNBT Bancorp’s or Keystone’s notice to him that the employment period is not being extended as of any annual anniversary date of the agreement or a termination of his employment by KNBT Bancorp or Keystone for other than cause, voluntary resignation or retirement, death or disability.

If a change in control of KNBT Bancorp (as defined in the employment agreement) occurs prior to the end of the term of his employment agreement, Mr. Fainor will be entitled to receive, in addition to any liquidated damages due to Mr. Fainor as described above, a severance benefit in a lump sum payment equal to the greater of (1) the salary and cash bonus or incentive compensation he would have received if his employment had continued until the expiration of the term of his employment agreement or (2) three times his average annual gross income from KNBT Bancorp, Keystone or either entity’s predecessors during the past five full calendar years before the change in control less $1.00. In the event that due to a change in control, any amount paid or payable to Mr. Fainor is subject to the 20% excise tax under Section 4999 of the Internal Revenue Code, then he will be entitled to an additional payment such that on an after-tax basis, he is indemnified for the excise tax.

Mr. Fainor’s employment agreement contains a covenant not to compete, under which he agrees that if his employment terminates before the expiration of the term of his employment agreement other than a termination within 30 days of a change in control of KNBT Bancorp, he will not compete with Keystone in any county in which it maintains an office as of the date of Mr. Fainor’s termination until the expiration of the earlier of two years from the date on which his employment terminates or the date on which the term of his employment agreement would otherwise expire. In addition, for two years after his employment terminates, he agrees to not solicit Keystone’s customers or solicit its employees to accept other employment in the counties where it maintains offices.

The terms of the employment agreement with Mr. Sobol provides that he will serve as Senior Executive Vice President and Chief Operating Officer of KNBT Bancorp and Keystone at an initial annual salary of $220,000. The provisions of Mr. Sobol’s contract, including the non-duplication provisions and payment upon a change in control of KNBT Bancorp, are substantially identical to Mr. Fainor’s.

In the event of a change in control, as defined, of KNBT Bancorp the total payment that would be due under the employment agreements of Messrs. Fainor and Sobol, based solely on the current annual compensation to be paid to such officers, and assuming the change in control occurs in 2003, the remaining term of the agreements at the time of the change in control is three years, the bonuses earned in 2003 are not larger than those earned in 2002 and that such individuals do not meet the requirements to receive liquidated damages, and excluding any tax indemnification payments or benefits under any employee benefit plan which may be payable, would be approximately $2.0 million. Such payments may tend to discourage takeover attempts by increasing the costs to be incurred in the event of a takeover.

In March 2003, Keystone entered into a retirement and severance agreement with Mr. Kutteroff. Under the terms of the agreement, Mr. Kutteroff will be paid an aggregate of approximately $788,000 during 2003, 2004 and 2005. The agreement also provides that upon completion of the conversion and the merger, in the sole discretion of Keystone’s board of trustees, a payment of $250,000 will be made to the Supplemental Executive Retirement Plan maintained for the benefit of Mr. Kutteroff. In addition, Mr. Kutteroff will be paid approximately $192,000 in full settlement of his interest in the Keystone Performance Unit Plan which is being terminated in connection with the completion of the conversion and the merger. See “—Benefit Plans—Management Incentive Compensation Plans.” In addition, under the terms of the agreement, Keystone contributed $350,000 to Keystone’s Supplemental Executive Retirement Plan maintained on Mr. Kutteroff’s behalf for the year ended December 31, 2002. Under the terms of the

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retirement agreement, Mr. Kutteroff is also entitled to continued participation through May 2005 in the Keystone Saving Bank Trustee and Executive Deferred Compensation Plan and in various health and welfare benefit plans as well as being provided various miscellaneous fringe benefits including an automobile allowance. The agreement also provides that Mr. Kutteroff will continue to participate in Keystone’s 401(k) plan and retirement plan through May 2005. If Mr. Kutteroff is not able to continue to participate in Keystone’s defined benefit plan or 401(k) plan, Keystone will make payments to the Supplemental Executive Retirement Plan maintained for Mr. Kutteroff equal to the benefits he would have received in the 401(k) plan and the retirement plan. Mr. Kutteroff’s agreement contains a covenant not to compete under which he agreed that during the term during which compensation is being paid under the retirement agreement, he will not compete with Keystone within a radius of 100 miles of its headquarters. In addition, during the same period, he agreed to not solicit Keystone’s employees to accept other employment.

Keystone entered into a severance agreement with Mr. Meares dated as of January 2, 2003. Under the terms of the agreement, Mr. Meares will be paid an aggregate of approximately $438,000. The first payment was made in January 2003 and the remaining amount will be paid in January 2004. Mr. Meares was also paid in March 2003 in accordance with the agreement an amount equal to the bonus he earned for 2002 under the Keystone’s Senior Management Variable Compensation Plan. In addition, Keystone contributed approximately $12,000 to the Supplemental Executive Retirement Plan maintained on his behalf for the year ended December 31, 2002. He may also be entitled to a payment with respect to his interest in the Performance Unit Plan. Keystone also agreed to allow Mr. Meares to participate in Keystone’s retirement plan through December 31, 2004 and to provide a 50% match of Mr. Meares contributions to Keystone’s 401(k) plan in 2003 and 2004. To the extent that Mr. Meares cannot make contributions to the 401(k) plan, Keystone will pay such matching amount directly to Mr. Meares. Keystone also agreed to pay for out placement services in an amount not to exceed $18,000. Mr. Meares agreed that for the duration of his agreement and for a period of one year thereafter, he would not solicit Keystone’s employees to accept other employment.

Keystone entered into a letter agreement with Mr. Sobol as of May 2003 with respect to his employment at Keystone. Under the terms of the letter agreement, Keystone will agree to pay Mr. Sobol approximately $105,000 in full settlement of his interest in Keystone’s Performance Unit Plan. In addition, Keystone will contribute $250,000 to the Supplemental Executive Retirement Plan maintained on behalf of Mr. Sobol. The letter agreement also provides that in the event the conversion and the merger are not completed, Keystone will enter into an employment agreement with Mr. Sobol with terms essentially identical to the terms of the agreement Mr. Sobol and Keystone entered into in connection with the execution of the merger agreement.

Benefit Plans

Retirement Plan. Keystone participates in the Financial Institutions Retirement Fund, a multiple employer defined benefit plan intended to satisfy the tax-qualification requirements of Section 401(a) of the Internal Revenue Code. Employees become eligible to participate in the retirement plan upon the attainment of age 21 and the completion of one year of eligibility service. Following the conversion, Keystone may freeze the future accrual of benefits under the retirement plan or may terminate the plan in connection with the adoption or amendment of other qualified employee benefit plans. For purposes of the retirement plan, an employee earns one year of eligibility service when he completes 1,000 hours of service within a one-year eligibility computation period. An employee’s first eligibility computation period is the one-year period beginning on the employee’s date of hire. Subsequent eligibility computation periods begin on January 1 and end on December 31.

The retirement plan provides for a monthly benefit upon a participant’s retirement at the age of 65, or if later, the fifth anniversary of the participant’s initial participation in the retirement plan (i.e., the participant’s “normal retirement date”). A participant may also receive a benefit on his early retirement date, which is the date on which he attains age 55 and is partially or fully vested under the terms of the retirement plan. Benefits received prior to a participant’s normal retirement date are reduced by certain factors set forth in the retirement plan. Participants become fully vested in their benefits under the retirement plan upon the completion of five years of vesting service as well as upon the attainment of normal retirement age (age 65).

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The following table sets forth the estimated annual benefits payable upon retirement at age 65 for the period ended December 31, 2002.

Years of Benefit Service
Final Average Earnings	15		20		25		30		35
$  50,000	$	12,600	$	17,000	$	21,300	$	25,700	$	30,100
75,000		19,900		27,200		34,500		41,900		49,200
100,000		27,200		37,500		47,700		58,000		68,300
125,000		34,500		47,700		60,900		74,100		87,300
150,000		41,800		58,000		74,100		90,200		106,400
175,000		49,100		68,200		87,300		106,400		125,500
200,000		56,400		78,500		100,500		122,500		144,500
225,000		63,700		88,700		113,700		138,600		163,600
250,000		71,100		99,000		126,800		154,700		182,600
300,000		85,700		119,500		153,200		187,000		220,800
400,000		114,900		160,500		206,000		251,500		297,000
450,000		129,600		181,000		232,300		283,700		335,100
500,000(1)		144,200		201,500		258,700		316,000		373,000

(1) The maximum amount of annual compensation which the retirement plan can consider in computing benefits is $200,000 (as adjusted for subsequent years pursuant to the Internal Revenue Code provisions). Benefits in excess of the limitation are provided through the Supplemental Executive Retirement Plan, discussed below.

The approximate full years of credited service, as of December 31, 2002, for the named executive officers are as follows:

Name	Years of Service
Frederick E. Kutteroff	17
Eugene T. Sobol	7
Richard L. Meares	20

Supplemental Executive Retirement Plan. Keystone has adopted a Supplemental Executive Retirement Plan to provide for eligible employee benefits that would be due under its retirement plan if such benefits were not limited under the Internal Revenue Code. Supplemental Executive Retirement Plan benefits provided with respect to the retirement plan are reflected in the pension table. Messrs. Kutteroff, Sobol and Meares are participants in the Supplemental Executive Retirement Plan. For the year ended December 31, 2002, Keystone contributed approximately $398,000, $75,000 and $12,000 on behalf of Messrs. Kutteroff, Sobol and Meares, respectively.

Management Incentive Compensation Plans. Keystone maintains the Senior Management Variable Compensation Program. The plan is administered by the Personnel Committee of the board of directors of Keystone. The Senior Management Variable Compensation Program is designed to give senior management an incentive for effectively operating Keystone and to further its earning power by providing cash payments, equal to a certain percentage of their base salaries, based on corporate performance objectives. Eligibility in the Management Variable Compensation Program is limited to individuals that the board believes have a significant opportunity to improve Keystone’s profits and growth. Individuals participating in this plan are Keystone’s Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. Payments under the plan range from 5% to 30% of the individual’s base compensation. Performance goals composed of loan growth, deposit growth and return on equity are tied to Keystone’s business plan and determine the actual percentage for payment under the plan. The business plan is developed with consideration given to a peer group of financial institutions. No awards may be made if Keystone does not achieve certain capital ratio and non-performing loan thresholds.

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Keystone also maintains the Performance Unit Plan, which is a long-term incentive plan. Currently, nine trustees and seven senior officers are participants in the plan. In connection with the completion of the conversion and the merger, the Performance Unit Plan will be terminated. Participants will receive payments amounting to an average of approximately 60% of the maximum amount that can be earned under the plan. Each trustee participant will receive approximately $15,600, and Messrs. Kutteroff and Sobol will receive approximately $192,000 and $105,000, respectively. Total payments upon termination of the Performance Unit Plan will aggregate approximately $870,000. As of March 31, 2003, Keystone had accrued approximately $350,000 and will accrue the remaining $520,000 prior to completion of the conversion.

New Stock Benefit Plans

Employee Stock Ownership Plan. KNBT Bancorp has established an employee stock ownership plan for its and Keystone’s employees to become effective upon the conversion. Employees, other than those paid solely on a retainer or fee basis, who have been credited with at least 1,000 hours of service during a 12-month period and who have attained age 21 are eligible to participate in KNBT Bancorp’s employee stock ownership plan.

As part of the conversion, in order to fund the purchase of up to 8% of the common stock sold in the offering, not including the shares to be contributed to the Keystone Nazareth Charitable Foundation (1,405,300 shares or 1,616,095 shares based on the maximum and 15% above the maximum of the offering range, respectively), KNBT Bancorp anticipates that the employee stock ownership plan will borrow funds from KNBT Bancorp. It is anticipated that such loan will equal 100% of the aggregate purchase price of the common stock acquired by the KNBT Bancorp employee stock ownership plan. The loan to the employee stock ownership plan will be repaid principally from Keystone’s contributions to the employee stock ownership plan and the collateral for the loan will be the common stock purchased by the employee stock ownership plan. The interest rate for the employee stock ownership plan loan will be fixed and is expected to be at Keystone’s prime rate at the date the loan is entered into with the employee stock ownership plan. KNBT Bancorp may, in any plan year, make additional discretionary contributions for the benefit of plan participants in either cash or shares of common stock, which may be acquired through the purchase of outstanding shares in the market or from individual shareholders, upon the original issuance of additional shares by KNBT Bancorp or upon the sale of treasury shares by KNBT Bancorp. Such purchases, if made, would be funded through additional borrowings by the employee stock ownership plan or additional contributions from KNBT Bancorp or from Keystone. The timing, amount and manner of future contributions to the employee stock ownership plan will be affected by various factors, including prevailing regulatory policies, the requirements of applicable laws and regulations and market conditions.

Shares purchased by the KNBT Bancorp employee stock ownership plan with the loan proceeds will be held in a suspense account and released for allocation to participants on a pro rata basis as debt service payments are made. Shares released from the employee stock ownership plan will be allocated to each eligible participant’s employee stock ownership plan account based on the ratio of each such participant’s base compensation to the total base compensation of all eligible employee stock ownership plan participants. Forfeitures may be used for several purposes such as the payments of expenses or be reallocated among remaining participating employees. Upon the completion of [five] years of service, the account balances of participants within the employee stock ownership plan will become 100% vested. Credit is given for years of service with Keystone prior to adoption of the employee stock ownership plan. In the case of a “change in control,” as defined in the employee stock ownership plan, however, participants will become immediately fully vested in their account balances. Participants will also become fully vested in their account balances upon death, disability or retirement. Benefits may be payable upon retirement or separation from service.

It is currently expected that an independent corporate trustee will be appointed by KNBT Bancorp to serve as the trustee of the KNBT Bancorp employee stock ownership plan. Under the terms of the employee stock ownership plan, the trustees must generally vote all allocated shares held in the employee stock ownership plan in accordance with the instructions of the participating employees, and unallocated shares will generally be voted in the same manner as the majority of the allocated shares for which instructions are given are voted, in each case subject to the requirements of applicable law and the fiduciary duties of the trustees.

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Generally accepted accounting principles require that any third party borrowing by the KNBT Bancorp employee stock ownership plan be reflected as a liability on KNBT Bancorp’s statement of financial condition. Since the employee stock ownership plan is borrowing from KNBT Bancorp, the loan will not be treated as a liability but instead will be excluded from shareholders’ equity. If the employee stock ownership plan purchases newly issued shares from KNBT Bancorp, total shareholders’ equity would neither increase nor decrease, but per share shareholders’ equity and per share net earnings would decrease as the newly issued shares are allocated to the employee stock ownership plan participants.

KNBT Bancorp’s employee stock ownership plan will be subject to the requirements of the Employee Retirement Income Security Act of 1974, as amended, and the applicable regulations of the IRS and the Department of Labor.

Stock Option Plan. Following completion of the conversion and the merger, KNBT Bancorp intends to adopt a stock option plan, which will be designed to attract and retain qualified personnel in key positions, provide directors, officers and key employees with a proprietary interest in KNBT Bancorp as an incentive to contribute to its success and reward key employees for outstanding performance. The stock option plan will provide for the grant of incentive stock options intended to comply with the requirements of Section 422 of the Internal Revenue Code and non-incentive or compensatory stock options. Options may be granted to KNBT Bancorp’s directors and key employees as well as those of Keystone. The stock option plan will be administered and interpreted by a committee of the board of directors. Unless terminated earlier, the stock option plan shall continue in effect for a period of 10 years from the date the stock option plan is adopted by the board of directors.

Under the stock option plan, the committee will determine which directors, officers and key employees will be granted options, whether options will be incentive or compensatory options, the number of shares subject to each option, the exercise price of each option, whether options may be exercised by delivering other shares of common stock and when such options become exercisable. The per share exercise price of an incentive stock option must at least equal the fair market value of a share of common stock on the date the option is granted (110% of fair market value in the case of incentive stock options granted to employees who are 10% shareholders).

At a meeting of KNBT Bancorp’s shareholders after the conversion and the merger, KNBT Bancorp intends to present the stock option plan to shareholders for their approval and to reserve an amount equal to 10% of the shares of common stock sold in the conversion, not including shares contributed to the Keystone Nazareth Charitable Foundation (1,756,625 shares or 2,020,119 shares based on the maximum and 15% above the maximum of the offering range, respectively), for issuance under the stock option plan. Federal Deposit Insurance Corporation policies provide that, in the event such plan is implemented within one year after the conversion, no individual officer or employee may receive more than 25% of the options granted under the stock option plan and non-employee directors may not receive more than 5% individually, or 30% in the aggregate of the options granted under the stock option plan. Federal Deposit Insurance Corporation policies also provide that the exercise price of any options granted under any such plan must be at least equal to the fair market value of the common stock as of the date of grant. Further, options under such plan generally are required to vest over a five year period at 20% per year. Each stock option or portion thereof will be exercisable at any time on or after it vests and will be exercisable until 10 years after its date of grant or for periods of up to five years following the death, disability or other termination of the optionee’s employment or service as a director. However, failure to exercise incentive stock options within three months after the date on which the optionee’s employment terminates may result in the loss of incentive stock option treatment for federal income tax purposes.

At the time an option is granted pursuant to the stock option plan, the recipient will not be required to make any payment in consideration for such grant. With respect to incentive or compensatory stock options, the optionee will be required to pay the applicable exercise price at the time of exercise in order to receive the underlying shares of common stock. The shares reserved for issuance under the stock option plan may be authorized but previously unissued shares, treasury shares, or shares purchased by KNBT Bancorp on the open market or from private sources. In the event of a stock split, reverse stock split or stock dividend, the number of shares of common stock under the stock option plan, the number of shares to which any option relates and the exercise price per share under any option shall be adjusted to reflect such increase or decrease in the total number of shares of common stock outstanding. If KNBT Bancorp declares a special cash dividend or return of capital after it implements the stock option plan in an amount per share which exceeds 10% of the fair market value of a share of common stock as of the date of

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declaration, the per share exercise price of all previously granted options which remain unexercised as of the date of such declaration shall, subject to certain limitations, be proportionately adjusted to give effect to the special cash dividend or return of capital as of the date of payment of such special cash dividend or return of capital.

Under current provisions of the Internal Revenue Code, the federal income tax treatment of incentive stock options and compensatory stock options is different. A holder of incentive stock options who meets certain holding period requirements will not recognize income at the time the option is granted or at the time the option is exercised, and a federal income tax deduction generally will not be available to KNBT Bancorp at any time as a result of such grant or exercise. With respect to compensatory stock options, the difference between the fair market value on the date of exercise and the option exercise price generally will be treated as compensation income upon exercise, and KNBT Bancorp will be entitled to a deduction in the amount of income so recognized by the optionee.

Recognition and Retention Plan. After completion of the conversion and the merger, KNBT Bancorp also intends to adopt a stock recognition and retention plan for its directors, officers and employees. The objective of the recognition plan will be to enable KNBT Bancorp to provide directors, officers and employees with a proprietary interest in KNBT Bancorp as an incentive to contribute to its success. KNBT Bancorp intends to present the recognition plan to its shareholders for their approval at a meeting of shareholders. Currently, Federal Deposit Insurance Corporation policies provide that, in the event such plan is implemented within one year after the conversion, shares granted under the plan generally are required to vest over a five year period at 20% per year.

The recognition and retention plan will be administered by a committee of KNBT Bancorp’s board of directors, which will have the responsibility to invest all funds contributed to the trust created for the recognition plan. KNBT Bancorp will contribute sufficient funds to the trust so that it can purchase, following the receipt of shareholder approval, a number of shares equal to an aggregate of 4% of the common stock sold in the conversion, not including shares contributed to the Keystone Nazareth Charitable Foundation (702,650 shares or 808,048 shares based on the maximum and 15% above the maximum of the offering range, respectively). Shares of common stock granted pursuant to the recognition plan generally will be in the form of restricted stock vesting as described above. For accounting purposes, compensation expense in the amount of the fair market value of the common stock at the date of the grant to the recipient will be recognized pro rata over the period during which the shares are payable. A recipient will be entitled to all voting and other shareholder rights, except that the shares, while restricted, may not be sold, pledged or otherwise disposed of and are required to be held in the trust. Under the terms of the recognition and retention plan, recipients of awards will be entitled to instruct the trustees of the recognition and retention plan as to how the underlying shares should be voted, and the trustees will be entitled to vote all unallocated shares in their discretion. If a recipient’s employment is terminated as a result of death or disability, all restrictions will expire and all allocated shares will become unrestricted. KNBT Bancorp will be able to terminate the recognition and retention plan at any time, and if it does so, any shares not allocated will revert to KNBT Bancorp. Recipients of grants under the recognition and retention plan will not be required to make any payment at the time of grant or when the underlying shares of common stock become vested, other than payment of withholding taxes.

Compensation Committee Interlocks and Insider Participation

Determinations regarding compensation of Keystone’s employees are made by the Personnel Committee of the board of trustees. Ms. Holton and Messrs. Gausling, Mountain, Scholl and Paul who is Chairman, serve as members of the Personnel Committee.

Indebtedness of Management and Related Party Transactions

In accordance with applicable federal laws and regulations, Keystone offers mortgage loans to its directors, officers and employees as well as members of their immediate families for the financing of their primary residences and certain other loans. These loans are generally made on substantially the same terms as those prevailing at the time for comparable transactions with non-affiliated persons. It is the belief of management that these loans neither involve more than the normal risk of collectibility nor present other unfavorable features.

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PROPOSED MANAGEMENT PURCHASES

The following table sets forth, for each of KNBT Bancorp’s and Keystone’s directors or trustees, as the case may be, and executive officers (and their associates) and for all of KNBT Bancorp’s directors, Keystone’s trustees and their executive officers as a group, the proposed purchases of KNBT Bancorp common stock, assuming sufficient shares are available to satisfy their subscriptions. The amounts include shares that may be purchased through individual retirement accounts. Amounts reflected also include merger exchange shares that may be acquired in connection with the completion of the merger due to ownership by such persons of First Colonial common stock with respect to those directors, trustees or executive officers and their associates who are shareholders of First Colonial.

Name	Amount		Number of Shares	Number of Merger Exchange Shares	Percent (1)
Directors:
Jeffrey P. Feather	$	1,000,000	100,000	9,342	*
Michael J. Gausling		250,000	25,000	—	*
Donna D. Holton		500,000	50,000	—	*
Frederick E. Kutteroff(2)		750,000	75,000	—	*
John A. Mountain		35,000	3,500	—	*
R. Chadwick Paul, Jr.		250,000	25,000	—	*
Robert R. Scholl		100,000	10,000	—	*
Kenneth R. Smith		500,000	50,000	—	*
R. Charles Stehly		500,000	50,000	—	*
Richard L. Strain		75,000	7,500	—	*
Other Executive Officer:
Eugene T. Sobol		500,000	50,000	—
All Directors, Trustees and Executive Officers as a Group (11 persons)(3)		4,460,000	446,000	9,342	1.84	%

* Amounts to less than 1.0%.

(1) Based on the midpoint of the offering range and assuming 8,287,486 merger exchange shares are issued in the merger and 1,220,000 shares are contributed to the Keystone Nazareth Charitable Foundation.

(2) Serves solely on the board of trustees of Keystone.

(3) Does not reflect shares of KNBT Bancorp common stock to be issued to current directors or executive officers of First Colonial and/or Nazareth National Bank who will become directors and/or executive officers of KNBT Bancorp and/or Keystone upon completion of the conversion and the merger. Except as set forth in the table below none of such persons are eligible account holders, supplemental eligible account holders or other depositors for purposes of purchasing shares of KNBT Bancorp common stock in the conversion. If such persons’ shares of First Colonial common stock (assuming none of the First Colonial options held by them are exercised prior to the completion of the merger) are included, based on the merger exchange ratio, all directors and executive officers of KNBT Bancorp and/or Keystone following completion of the merger (18 persons) would be deemed to own 815,961 shares of KNBT Bancorp common stock, or 3.29% at the midpoint of the offering range and assuming 8,287,486 merger exchange shares are issued in the merger and 1,220,000 shares are contributed to the Keystone Nazareth Charitable Foundation. The table set forth below includes information with respect to the number of merger exchange shares to be received by the directors and executive officers of First Colonial and Nazareth National Bank who will become directors or executive officers of KNBT Bancorp and/or Keystone after completion of the merger. Also includes the number of shares proposed to be purchased in the conversion by such persons if they have subscription rights as a result of being depositors of Keystone. For purposes of this table, all options to purchase First Colonial common stock held by directors and executive officers of First Colonial are assumed to be exercised prior to the merger.

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Name	Number of Merger Exchange Shares	Number of Shares Proposed to be Purchased in the Conversion	Percent at Midpoint of Offering Range
Directors:
Scott V. Fainor	105,757	—	*
Christian F. Martin	89,762	50,000	*
Daniel B. Mulholland	7,736	—	*
Charles J. Peischl	458	—	*
Richard Stevens, III	10,567	—	*
Maria Zumas Thulin	21,955	—	*
Other Executive Officer:
Reid L. Heeren	74,384	—	*

* Amounts to less than 1.0%.

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THE CONVERSION AND THE MERGER

[The board of directors of KNBT Bancorp and the board of trustees of Keystone have approved the plan of conversion, as has the Pennsylvania Department of Banking, subject to approval by depositors of Keystone and the satisfaction of certain other conditions. The Federal Deposit Insurance issued its conditional non-objection to the plan of conversion.] The approval by the Pennsylvania Department of Banking and the non-objection of the Federal Deposit Insurance Corporation, however, does not constitute a recommendation or endorsement of the plan by such agencies. In addition, the board of directors of KNBT Bancorp and the board of trustees of Keystone have adopted the merger agreement.

General

In connection with the approval of the merger agreement, on March 5, 2003, the board of trustees of Keystone unanimously adopted the plan, pursuant to which Keystone will be converted from a Pennsylvania-chartered mutual savings bank to a Pennsylvania-chartered stock savings bank and KNBT Bancorp will offer and sell the shares of common stock to be sold in the conversion. It is intended that all of the common stock of Keystone following the conversion will be held by KNBT Bancorp, which is incorporated under Pennsylvania law. [The plan of conversion has been approved by the Pennsylvania Department of Banking and Federal Deposit Insurance Corporation has provided notice to Keystone of its intent not to object to the plan of conversion,] subject to, among other things, approval of the plan by the depositors of Keystone as of             , 2003. A special meeting has been called for this purpose to be held on             , 2003.

Substantially simultaneously with the completion of the conversion, First Colonial will merge with and into KNBT Bancorp with KNBT Bancorp being the survivor thereof. Immediately thereafter, Nazareth National Bank will merge with and into Keystone with Keystone being the survivor of the merger operating under the name Keystone Nazareth Bank & Trust Company. The merger is governed by the merger agreement, which was unanimously adopted by the respective boards of trustees or directors, as the case may be, of Keystone and First Colonial and upon its formation, by the board of directors of KNBT Bancorp.

In adopting the plan of conversion, the board of trustees of Keystone determined that the conversion and the merger were advisable and in the best interests of its depositors and borrowers of Keystone and further determined that the interests of certain holders of its deposit accounts in the net worth of Keystone would be equitably provided for and that the conversion would not have any adverse impact on the reserves and net worth of Keystone.

The merger will not occur unless the conversion is completed. In the event the conditions to the merger are not satisfied or waived, the offering will be terminated and the funds received in connection therewith returned to subscribers. However, the approval of the plan of conversion by depositors will remain valid. In such event, Keystone may determine to proceed with the conversion. In such event, a new appraisal will be prepared and a new offering will be conducted. The completion of the merger is expected to occur substantially simultaneously with the completion of the conversion.

KNBT Bancorp has applied for approval from Federal Reserve Board for KNBT Bancorp to become a bank holding company and to acquire (1) all of the common stock of Keystone to be issued in connection with the conversion and (2) all the common stock of First Colonial. Keystone must also provide notice to the Office of the Comptroller of the Currency of the intended merger with Nazareth National Bank. One-half of the net proceeds from the sale of the common stock in the offering will be transferred to Keystone with the remaining net proceeds being retained by KNBT Bancorp for its general corporate purposes. Based on the minimum and maximum of the offering range, KNBT Bancorp intends to use approximately $10.4 million, and approximately $14.1 million, respectively, of the net proceeds retained by it to loan funds to its employee stock ownership plan to enable the plan to purchase up to 8% of the common stock. The conversion will not be completed unless KNBT Bancorp sells shares of common stock equal to the minimum of its appraised value.

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The plan of conversion provides generally that KNBT Bancorp will offer shares of common stock for sale in the Subscription Offering to eligible account holders, its employee stock ownership plan, supplemental eligible account holders, certain other depositors and Keystone’s officers, trustees and employees. In addition, subject to the prior rights of holders of subscription rights, KNBT Bancorp and Keystone may elect to offer the shares of common stock not subscribed for in the subscription offering, if any, for sale in a community offering commencing prior to or upon completion of the subscription offering. See “The Offering—Subscription Offering and Subscription Rights” and “The Offering—Community Offering.” KNBT Bancorp and Keystone have the right to accept or reject, in whole or in part, any orders to purchase shares of common stock received in the Community Offering.

The aggregate price of the shares of common stock to be issued in the conversion will be within the offering range, which was determined based upon an independent appraisal of the estimated pro forma market value of the common stock. The offering range is currently $129.8 million to $175.7 million. All shares of common stock to be issued and sold in the conversion will be sold at the same price. The independent appraisal will be affirmed or, if necessary, updated before the conversion is completed. The appraisal has been performed by RP Financial, a consulting firm experienced in the valuation and appraisal of savings institutions. See “The Offering—How Keystone and KNBT Bancorp Determined the Price Per Share and the Offering Range” for more information as to how the estimated pro forma market value of the common stock was determined.

In furtherance of Keystone’s commitment to the community which it serves, the plan of conversion provides for the establishment of the Keystone Nazareth Charitable Foundation as part of the conversion. As is described in greater detail below, the foundation is intended to complement Keystone’s existing community reinvestment activity (Keystone has an existing charitable foundation) and is a means of establishing a common bond between Keystone and the communities that it serves. Consistent with Keystone’s goal, KNBT Bancorp intends to donate to the foundation immediately following the conversion a number of shares of its authorized, but unissued common stock in an amount equal to 8% of the number of shares issued in the conversion.

The following discussion of the conversion and the merger summarizes the material aspects of the plan of conversion as well as the merger agreement. The summary is qualified in its entirety by reference to the provisions of the plan of conversion and the merger agreement. A copy of the plan of conversion is available for inspection at the offices of Keystone and at the offices of the Pennsylvania Department of Banking. The plan of conversion and the merger agreement are also filed as exhibits to the Registration Statement of which this document is a part, copies of which may be obtained from the SEC. See “Additional Information.”

Keystone’s Reasons for and Purposes of the Conversion and the Merger

As a mutual savings bank, Keystone does not have shareholders and it has no authority to issue capital stock. By converting to the capital stock form of organization, Keystone will be structured in the form used by commercial banks, most business entities and a growing number of savings institutions. The conversion will result in an increase in Keystone’s capital base, which will support its operations. The conversion also allows Keystone to complete the merger with First Colonial.

The conversion will permit Keystone’s customers and possibly other members of the local community and of the general public to become equity owners and to share in its future. The conversion also will provide additional funds for lending and investment activities, especially the expansion of Keystone’s commercial real estate and business loan activities, to finance its planned branch expansion, facilitate future access to the capital markets and enhance its ability to diversify and expand into other markets through acquisitions or otherwise.

The holding company form of organization will provide additional flexibility to diversify Keystone’s business activities through existing or newly formed subsidiaries, or through acquisition of or mergers with other financial institutions, as well as other companies. Although there are no current arrangements, understandings or agreements regarding any such opportunities other than the merger with First Colonial, Keystone and KNBT Bancorp will be in a position after the conversion, subject to regulatory limitations and their financial position, to take advantage of any such opportunities that may arise.

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After the conversion, the unissued common and preferred stock authorized by KNBT Bancorp’s articles of incorporation will permit it, subject to market conditions and applicable regulatory approvals, to raise additional equity capital through further sales of securities, and to issue securities in connection with possible acquisitions. At the present time, KNBT Bancorp has no plans with respect to additional offering of securities, other than the shares to be issued to the shareholders of First Colonial in the merger and other than the possible issuance of additional shares to the recognition and retention plan or upon exercise of stock options. After the conversion, KNBT Bancorp also will be able to use stock-related incentive programs to attract and retain executive and other personnel for itself, Keystone and their respective subsidiaries. See “Management—New Stock Benefit Plans.”

The board of trustees of Keystone and the board of directors of KNBT Bancorp believe that the merger will enhance the competitive position of the combined entities and will enable the resulting institution to compete more effectively than either Keystone or Nazareth National Bank could on its own. The combined entity will have greater financial resources and, as a result of the offering, increased capital levels. KNBT Bancorp’s pro forma shareholders’ equity will amount to 19.0% of pro forma total assets at March 31, 2003, assuming the shares of common stock are sold at the maximum of the offering range. The conversion and the merger will result in increased funds being available for lending purposes and greater resources for expansion of services. Keystone also believes that the conversion and the merger will provide it with better opportunities for attracting and retaining qualified personnel.

The terms of the merger agreement were the result of arm’s length negotiations between the representatives of Keystone and First Colonial. Among the factors considered by the board of trustees of Keystone were:

• the ability to expand Keystone’s presence in the greater Lehigh Valley;

• information concerning the financial condition, results of operations, capital levels, asset quality and prospects of Keystone and First Colonial;

• the short-term and long-term impact the conversion and the merger will have on Keystone’s consolidated results of operations, including expanded commercial real estate and commercial business lending as well as expanded retail banking products and services;

• the general structure of the transaction and the compatibility of the respective managements and business philosophies;

• the enhancement of Keystone’s franchise value, the ability of the combined enterprise to compete in relevant banking and non-banking markets;

• industry and economic conditions; and

• the impact of conversion and the merger on the depositors, employees, customers and communities served by Keystone and First Colonial through the contemplated expansion of commercial real estate and commercial business lending as well as the expansion of retail banking products and services.

Keystone and Nazareth National Bank currently serve overlapping market areas in Lehigh, Northhampton, Monroe and Carbon Counties in the greater Lehigh Valley. As a result of merger and taking into account the planned branch office expansion both financial institutions are pursuing, Keystone will operate 42 full-service branch offices upon completion of the merger or shortly thereafer.

In light of the foregoing, the board of trustees of Keystone and the board of directors of KNBT Bancorp believe that the conversion and the merger are in the best interest of Keystone and KNBT Bancorp and Keystone’s customers.

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Description of the Conversion and the Merger

On March 5, 2003, the board of trustees of Keystone adopted the plan of conversion and the merger agreement. In May 2003, Keystone incorporated KNBT Bancorp under Pennsylvania law for the purpose of holding all of the capital stock of Keystone and in order to facilitate the conversion and the merger. Pursuant to the plan and the merger agreement:

• Keystone will convert to the stock form of organization and simultaneously issue all of its to be outstanding shares of common stock to KNBT Bancorp in exchange for one-half of the net proceeds of the offering (net of expenses and the anticipated loan to be made to KNBT Bancorp’s employee stock ownership plan); and

• KNBT Bancorp is offering shares of common stock in the offering as part of the conversion. Substantially simultaneously with the completion of the conversion, First Colonial will merge with KNBT Bancorp and Nazareth National Bank will merge with Keystone. As a result of the merger of First Colonial with KNBT Bancorp, each share of common stock of First Colonial will be converted into the right to receive 3.7 shares of KNBT Bancorp common stock.

Effects of the Conversion and the Merger

General. Before the conversion, each of Keystone’s depositors has both a deposit account and a pro rata ownership interest in its net worth, which interest may only be realized in the event of a liquidation of Keystone. However, this ownership interest is tied to the depositor’s account and has no tangible market value separate from such deposit account. A depositor who reduces or closes his account receives nothing for his ownership interest in the net worth of Keystone, which is lost to the extent that the balance in the account is reduced.

Consequently, Keystone’s depositors normally cannot realize the value of their ownership interest, which has realizable value only in the unlikely event that Keystone was liquidated. In such event, the depositors of record at that time, as owners, would share pro rata in any residual surplus and reserves of Keystone after other claims, including claims of depositors to the amount of their deposits, are paid.

When Keystone converts to stock form, permanent nonwithdrawable capital stock will be created to represent the ownership of the net worth of Keystone, and Keystone will become a wholly owned subsidiary of KNBT Bancorp. Additional shares of common stock will be issued to the shareholders of First Colonial in connection with the completion of the merger. In connection with the merger, Nazareth National Bank will be merged with Keystone with Keystone as the survivor operating under the name Keystone Nazareth Bank & Trust Company. KNBT Bancorp common stock will be separate and apart from deposit accounts of Keystone and cannot be and will not be insured by the Federal Deposit Insurance Corporation or any other governmental agency. Certificates will be issued to evidence ownership of KNBT Bancorp common stock. The certificates representing KNBT Bancorp common stock will be transferable, and therefore the stock may be sold or traded if a purchaser is available with no effect on any account the seller may hold in Keystone.

Continuity. While the conversion is being accomplished, Keystone’s normal banking business as well as that of Nazareth National Bank of accepting deposits and making loans will continue without interruption. Keystone and Nazareth National Bank will continue to be subject to regulation by the various regulators including the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency. After the conversion and the merger are completed, Keystone will continue to provide services for depositors and borrowers under substantially identical policies by our present management and staff as augmented by the addition of the Nazareth National Bank management and staff.

Nine of Keystone’s current trustees and all of its officers (other than Mr. Kutteroff who will be retiring) will continue to serve as trustees and officers of Keystone after the conversion and merger. The directors and executive officers of KNBT Bancorp consist of individuals currently serving as trustees and officers of Keystone, and it is

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currently expected that they will continue to serve KNBT Bancorp after the conversion and the merger. In addition, six directors of First Colonial will become directors of KNBT Bancorp and trustees of Keystone. The officers of First Colonial and Nazareth National Bank will also become officers of KNBT Bancorp and/or Keystone.

Effect on Deposit Accounts. Under the plan of conversion, each depositor in Keystone and Nazareth National Bank at the time of the conversion and the merger will automatically continue as a depositor after the conversion and the merger, and each such deposit account will remain the same with respect to deposit balance, interest rate and other terms, except to the extent that funds in the account are withdrawn to purchase shares of common stock in the conversion and except with respect to liquidation rights. Each such account will be insured by the Federal Deposit Insurance Corporation to the same extent as before the conversion except to the extent that as a result of the merger, an account holder in both institutions before the merger has an account at Keystone after the merger which exceeds the individual deposit account insurance limits. Depositors will continue to hold their existing certificates, passbooks and other evidences of their accounts.

Effect on Loans. No loan outstanding from Keystone or Nazareth National Bank will be affected by the conversion and the merger, and the amount, interest rate, maturity and security for each loan will remain as they were contractually fixed prior to the conversion and merger.

Effect on Voting Rights of Depositors. At present, voting rights and control of Keystone are vested exclusively in the board of trustees. After the conversion, KNBT Bancorp will be the sole shareholder of Keystone and will have all of the voting rights in Keystone. Exclusive voting rights with respect to KNBT Bancorp will be vested in the holders of its common stock.

Tax Effects. To complete the conversion, Keystone and KNBT Bancorp must receive rulings or opinions with regard to certain federal and Pennsylvania income tax matters which state that the conversion will not be taxable for federal or Pennsylvania income tax purposes to Keystone or the Eligible Account Holders or Supplemental Eligible Account Holders, except as discussed below. Keystone and KNBT Bancorp have received favorable opinions regarding the federal and Pennsylvania income tax consequences of the conversion. See “—Tax Aspects.”

Effect on Liquidation Rights. If Keystone were to liquidate, all claims of its creditors (including those of depositors, to the extent of their deposit balances) would be paid first. Thereafter, if there were any assets remaining, depositors of Keystone would receive such remaining assets, pro rata, based upon the deposit balances in their deposit accounts at Keystone immediately prior to liquidation. In the unlikely event that Keystone was to liquidate after the conversion, all claims of creditors (including those of depositors, to the extent of their deposit balances) would also be paid first, followed by distribution of the “liquidation account” to certain depositors (see “—Liquidation Rights of Certain Depositors”), with any assets remaining thereafter distributed to KNBT Bancorp as the sole shareholder of Keystone.

Conditions to the Merger

The merger agreement provides that consummation of the merger is subject to the satisfaction of certain conditions, or the waiver of certain of such conditions by Keystone and KNBT Bancorp, on the one hand, and First Colonial on the other, as the case may be, at or prior to the date the merger is completed. Keystone, KNBT Bancorp and First Colonial are referred to in the following discussion individually as a “party” and collectively as the “parties.” Each of the parties’ obligations under the merger agreement are subject to the following conditions, among others:

• the receipt of all necessary regulatory approvals required to complete the transactions contemplated by the merger agreement, and the expiration of all waiting periods with respect to such approvals;

• the conversion shall have been completed;

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• the approval of the merger agreement by the shareholders of First Colonial;

• compliance with or satisfaction of all representations, warranties, covenants and conditions set forth in the merger agreement, unless waived by the other party to the merger agreement entitled to the benefit of such condition;

• the filing of a certificate of merger with the Pennsylvania Secretary of State with respect to the merger of First Colonial with and into KNBT Bancorp;

• the filing of articles of merger with the Pennsylvania Department of Banking with respect to the merger of Keystone and Nazareth National Bank;

• the approval for listing of the shares of KNBT Bancorp common stock on the Nasdaq Stock Market;

• the absence of any order, decree or injunction of a court or agency of competent jurisdiction which prohibits, restricts or makes illegal consummation of the merger or the transactions contemplated by the merger agreement; and

• the receipt by the parties of an opinion that the merger will be treated for federal income tax purposes as constituting a reorganization within the meaning of Section 368(a) of the Code.

• the performance and compliance in all material respects by each party to the merger agreement of all covenants and obligations required to be performed by it at or prior to the completion of the merger;

• the accuracy in all material respects as of March 5, 2003 and as of the date of the completion of the merger the representations and warranties of each party except:

•• as to any representation or warranty which specifically relates to an earlier date; or

•• (subject to exceptions set forth in the merger agreement) any inaccuracies in the representations and warranties shall not prevent the satisfaction of this condition unless the cumulative effect of all such inaccuracies, taken in the aggregate, represent a material adverse change to the financial condition, results of operation or business of the affected party; and

• the receipt from Keystone and KNBT Bancorp, on the one hand, and First Colonial on the other of such certificates of its officers or others and such other documents to evidence fulfillment of the conditions set forth in the merger agreement as the party receiving the certificates may reasonably request.

Conduct of Business Prior to the Closing Date

Under the terms of the merger agreement, KNBT Bancorp, Keystone and First Colonial have agreed to conduct their respective businesses and engage in transactions only in the ordinary course and consistent with past practice except as expressly contemplated or permitted under the merger agreement, except with the prior written consent of KNBT Bancorp and Keystone or First Colonial, as the case may be. Each of KNBT Bancorp, Keystone and First Colonial have also agreed to use its reasonable efforts to preserve its respective business organization intact, to keep available to itself and the other parties the present services of its employees, and to preserve to itself and to the other parties the goodwill of its customers and others with whom business relationships exist.

In addition, under the terms of the merger agreement, each of KNBT Bancorp, Keystone and First Colonial has agreed that, except as otherwise agreed to or as permitted, contemplated or required by the merger agreement, it will not, and will not cause each of its subsidiaries not to:

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• with respect to First Colonial, declare, set aside, make or pay any dividend or other distribution (whether in cash, stock or property or any combination) in respect of the First Colonial common stock, except for regular quarterly cash dividends at a rate not in excess of $.19 per share and except, in the event the completion of the merger occurs more than 45 days after the start of any calendar quarter but prior to the normal dividend payment date for such calendar quarter, a pro rata cash dividend based on First Colonial’s normal quarterly cash dividend rate;

• issue any shares of its capital stock, other than upon exercise of options existing as of March 5, 2003 to purchase shares of First Colonial common stock or issue, grant, modify or authorize any warrants, options, rights or convertible securities or other arrangements or commitments which would obligate First Colonial to issue or dispose of any of its capital stock or other ownership rights; purchase any shares of First Colonial common stock; or effect any recapitalization, reclassification, stock dividend, stock split or like change in capitalization;

• amend its articles of incorporation, articles of association, bylaws or similar organizational documents; impose, or suffer the imposition, on any share of stock or other ownership interest held in a subsidiary thereof, of any lien, charge or encumbrance or permit any such lien, charge or encumbrance to exist; or waive or release any material right or cancel or compromise any material debt or claim;

• increase the rate of compensation of any of its directors, officers or employees, or pay or agree to pay any bonus or severance to, or provide any other new employee benefit or incentive to, any of its directors, officers or employees, except:

•• as may be required pursuant to previously disclosed commitments existing on March 5, 2003,

•• as may be required by law; and

•• merit increases made in accordance with past practices, normal cost-of-living increases and normal increases related to promotions or increased job responsibilities;

• enter into or, except as may be required by law, modify any pension, retirement, stock option, stock purchase, stock appreciation right, savings, profit-sharing, deferred compensation, supplemental retirement, consulting, bonus, group insurance or other employee benefit, incentive or welfare contract, plan or arrangement, or any trust agreement related thereto, in respect of any of its directors, officers or employees; or make any contributions to any qualified defined benefit or contribution plans other than as required by law or regulation or in a manner and amount consistent with past practices and except as specifically provided in the merger agreement;

• enter into:

•• any transaction, agreement, arrangement or commitment not made in the ordinary course of business;

•• any agreement, indenture or other instrument relating to the borrowing of money or guarantee of any such obligation, except in the case of Nazareth National Bank or Keystone for deposits, borrowings from the Federal Home Loan Bank of Pittsburgh, federal funds purchased and securities sold under agreements to repurchase in the ordinary course of business consistent with past practice;

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•• any agreement, arrangement or commitment relating to the employment of an employee or consultant, or amend any such existing agreement, arrangement or commitment, provided that First Colonial, Nazareth National Bank and Keystone may employ an employee or consultant in the ordinary course of business if the employment of such employee or consultant is terminable by First Colonial, Nazareth National Bank or Keystone, as the case may be, at will without liability, other than as required by law; or

•• any contract, agreement or understanding with a labor union;

• change its method of accounting in effect for the year ended December 31, 2001, except as required by changes in laws or regulations or generally accepted accounting principles, or change any of its methods of reporting income and deductions for federal income tax purposes from those employed in the preparation of its federal income tax return for such year, except as required by changes in laws or regulations;

• make any capital expenditures in excess of $75,000 individually or $150,000 in the aggregate, other than pursuant to binding commitments existing on March 5, 2003 and other than expenditures necessary to maintain existing assets in good repair; or enter into any new lease of real property or any new lease of personal property providing for annual payments exceeding $50,000;

• file any applications or make any contract with respect to branching or site location or relocation;

• acquire in any manner whatsoever (other than to realize upon collateral for a defaulted loan) control over or any equity interest in any business or entity, except for investments in marketable equity securities in the ordinary course of business and not exceeding 5% of the outstanding shares of any class;

• enter or agree to enter into any agreement or arrangement granting any preferential right to purchase any of its assets or rights or requiring the consent of any party to the transfer and assignment of any such assets or rights;

• change or modify in any material respect any of its lending or investment policies, except to the extent required by law or an applicable regulatory authority;

• take any action that would prevent or impede the merger or the conversion from qualifying as a reorganization within the meaning of Section 368 of the Code;

• enter into any futures contract, option contract, interest rate caps, interest rate floors, interest rate exchange agreement or other agreement for purposes of hedging the exposure of its interest-earning assets and interest-bearing liabilities to changes in market rates of interest;

• take any action that would result in any of the representations and warranties contained in the merger agreement not to be true and correct in any material respect at the date of completion of the merger or that would cause any of the conditions to consummation of the merger from being satisfied;

• materially increase or decrease the rate of interest paid on time deposits or certificates of deposit except in a manner and pursuant to policies consistent with past practices; or

• agree to do any of the foregoing.

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Required Approvals

Various approvals or non-objections of the Federal Reserve Board, the Federal Deposit Insurance Corporation and Pennsylvania Department of Banking are required in order to consummate the conversion and the merger. [The Pennsylvania Department of Banking has approved and the Federal Deposit Insurance Corporation has issued an intent not to object to the plan of conversion], subject to approval by Keystone’s depositors eligible to vote on the plan of conversion. In addition, consummation of the conversion and the merger is subject to approval by the Federal Reserve Board of KNBT Bancorp’s holding company application to acquire (1) all the common stock of Keystone and (2) all of the common stock of First Colonial and the approval of the Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking with respect to the merger of Nazareth National Bank with and into Keystone. Notice must also be provided to the Office of the Comptroller of the Currency of the proposed merger of Nazareth National Bank with and into Keystone. Applications for these approvals have been filed and are currently pending. There can be no assurance that the requisite approvals will be received in a timely manner, in which event the completion of the conversion and the merger may be delayed beyond the expiration of the offering. In the event the conversion and the merger are not consummated on or before March 31, 2004, the merger agreement may be terminated by either KNBT Bancorp and Keystone or First Colonial.

Pursuant to regulations of the Federal Deposit Insurance Corporation, the plan of conversion must be approved by at least a majority of the total number of votes eligible to be cast by Keystone’s depositors eligible to vote on the plan of conversion. In addition, the completion of the conversion and the merger cannot occur unless the merger agreement is approved by the shareholders of First Colonial at its annual meeting called for             , 2003. Under Pennsylvania law, the merger agreement must be approved by a majority of the votes cast at the special meeting of First Colonial’s shareholders.

Board of Directors’ Covenant to Recommend the Merger Agreement; Board of Trustee’s Covenant to Recommend the Plan of Conversion

Pursuant to the merger agreement, the First Colonial board of directors is required to recommend that First Colonial shareholders approve the merger agreement at all times prior to and during the meeting of First Colonial shareholders at which the merger agreement is to be considered by them. However, nothing in the merger agreement prevents the First Colonial board of directors from withholding, withdrawing, amending or modifying its recommendation if it determines, after consultation with its outside counsel, that such action is legally required in order for the directors of First Colonial to comply with their fiduciary duties to the First Colonial shareholders under applicable law, provided that any such action in connection with an “acquisition proposal” must comply with the requirements described under “—Acquisition Proposals” below.

Likewise, Keystone’s board of trustees is required to recommend that the Keystone depositors eligible to vote on the plan of conversion approve the plan of conversion and the transactions contemplated by such plan.

Shareholder and Depositor Agreements

In connection with the execution of the merger agreement, each director of First Colonial entered into a shareholder agreement with Keystone pursuant to which each director agreed that at any meeting of the shareholders of First Colonial, or in connection with any written consent of the shareholders of First Colonial, the director shall:

• appear at such meeting or otherwise cause all shares of First Colonial common stock owned by him or her to be counted as present thereat for purposes of calculating a quorum; and

• vote (or cause to be voted), in person or by proxy, or deliver a written consent (or cause a consent to be delivered) covering, all shares of First Colonial common stock beneficially owned by him or her or as to which he or she has, directly or indirectly, the right to direct the voting:

•• in favor of adoption and approval of the merger agreement and the merger,

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•• against any action or agreement that would result in a breach of any covenant, representation or warranty or any other obligation or agreement of First Colonial contained in the merger agreement or of the director contained in the shareholder agreement and

•• against any acquisition proposal (as defined in the merger agreement) or any other action, agreement or transaction that is intended, or could reasonably be expected, to materially impede, interfere or be inconsistent with, delay, postpone, discourage or materially and adversely affect consummation of the merger or the shareholder agreement.

Pursuant to the shareholder agreement, each director also agreed not to, directly or indirectly, sell, transfer, pledge, assign or otherwise dispose of, or enter into any contract, option, commitment or other arrangement or understanding with respect to the sale, transfer, pledge, assignment or other disposition of, any of the shares of First Colonial common stock owned by him or her prior to the meeting at which shareholders of First Colonial will consider the merger agreement.

The shareholder agreements will remain in effect until the earlier of the effective time of the merger or the termination of the merger agreement in accordance with its terms.

Likewise, in connection with the execution of the merger agreement, each trustee of Keystone entered into a depositor agreement with First Colonial pursuant to which each trustee agreed that at the special meeting of depositors of Keystone to vote on the plan of conversion, each trustee would vote all votes conferred upon such trustee’s deposits in favor of the approval of the plan of conversion and any other action requested by Keystone in furtherance of such approval.

Acquisition Proposals

The merger agreement provides that neither First Colonial nor any of its subsidiaries shall, and that First Colonial shall direct and use its reasonable best efforts to cause its and each such subsidiary’s directors, officers, employees, agents and representatives not to, directly or indirectly, initiate, solicit, encourage or otherwise facilitate any inquiries or the making of any proposal or offer with respect to an “acquisition proposal,” which is defined to mean any proposal or offer with respect to any of the following (other than the transactions contemplated by the merger agreement):

• any merger, consolidation, share exchange, business combination, or other similar transaction involving First Colonial or any of its subsidiaries;

• any sale, lease, exchange, mortgage, pledge, transfer or other disposition of 20% or more of the consolidated assets, in a single transaction or series of transactions, of First Colonial or any of its subsidiaries;

• any tender offer to exchange offer for 20% or more of the outstanding shares of capital stock of First Colonial or any of its subsidiaries or the filing of a registration statement in connection with such transaction; or

• any public announcement of a proposal, plan or intention to do any of these things or any agreement to engage in any of these things.

In the merger agreement, First Colonial also agreed that neither it nor any of its subsidiaries shall, and that First Colonial shall direct and use its reasonable best efforts to cause its and each such subsidiary’s directors, officers, employees, agents and representatives not to, directly or indirectly, engage in any negotiations concerning, or provide any confidential information or data to, or have any discussions with, any person relating to an acquisition

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proposal, or otherwise knowingly facilitate any effort or attempt to make or implement an acquisition proposal. However, nothing in the merger agreement prevents First Colonial or its board of directors from:

• complying with its disclosure obligations under federal or state law;

• providing information in response to a request therefor by a person who has made an unsolicited bona fide written acquisition proposal if the First Colonial board of directors receives from the person so requesting such information an executed confidentiality agreement the terms of which are substantially similar to the confidentiality agreement that Keystone and First Colonial entered into;

• engaging in any negotiations or discussions with any person who has made an unsolicited bona fide written acquisition proposal; or

• recommending such an acquisition proposal to the shareholders of First Colonial;

if and only to the extent that in each of the last three cases referred to above, (1) the First Colonial board of directors determines in good faith after consultation with outside legal counsel that such action would be required in order for its directors to comply with their respective fiduciary duties under applicable law and (2) the First Colonial board of directors determines in good faith after consultation with its financial advisor that such acquisition proposal, if accepted, is reasonably likely to be consummated, taking into account all legal, financial and regulatory aspects of the proposal and the person making the proposal and would, if consummated, result in a transaction more favorable to First Colonial’s shareholders from a financial point of view than the merger with Keystone. An acquisition proposal which is received and considered by First Colonial in compliance with these requirements is referred to as a “superior proposal.” First Colonial is required to notify Keystone immediately if any such inquiries, proposals or offers are received by, any such information is requested from, or any such discussions or negotiations are sought to be initiated or continued with, First Colonial or any of its representatives.

In the event First Colonial does receive a superior proposal, First Colonial has to notify Keystone in writing of its intent to terminate the merger agreement and to enter an acquisition agreement with respect to or recommend acceptance of the superior proposal. Keystone shall have five business days to evaluate and respond to First Colonial’s notice. If Keystone notifies First Colonial prior to the expiration of the five day period that it will increase the value of the consideration to be paid in the merger to an amount at least equal to that of the superior proposal, then First Colonial cannot terminate the merger agreement to accept the superior proposal or recommend its shareholders accept the superior proposal.

Representations and Warranties

The merger agreement contains representations and warranties of Keystone and First Colonial which are customary in merger transactions, including, but not limited to, representations and warranties concerning the organization and capitalization of Keystone and First Colonial and their respective subsidiaries; the due authorization, execution, delivery and enforceability of the merger agreement; the consents or approvals required, and the lack of conflicts or violations under applicable articles of incorporation, articles of association, bylaws, instruments and laws, with respect to the transactions contemplated by the merger agreement; the absence of material adverse changes, the documents to be filed with the SEC and other regulatory agencies; the conduct of business in the ordinary course and absence of certain changes; the financial statements; the compliance with laws; and the allowance for loan losses and other real estate owned. The representations and warranties of Keystone and First Colonial will not survive beyond the completion of the merger. If the merger agreement is terminated without completion of the merger, there will be no liability on the part of any parties to the merger agreement except that no party shall be relieved from any liability arising out of a willful misrepresentation in the merger agreement.

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Completion of the Conversion and the Merger; Termination and Amendment

The time and date at which the conversion and the merger are completed will be the date specified in the certificate of merger to be filed with the Pennsylvania Secretary of State with respect to the merger of First Colonial with and into KNBT Bancorp unless a later date and time is specified as the effective time in such certificate of merger. KNBT Bancorp will not make such filing until receiving all requisite regulatory approvals, approval of the merger agreement by the requisite vote of the shareholders of First Colonial and approval of the plan of conversion by the requisite vote of the depositors of Keystone, and the satisfaction or waiver of all other conditions to the conversion and the merger.

The merger agreement may be terminated prior to the completion of the merger by the mutual written consent of KNBT Bancorp, Keystone and First Colonial or, subject to certain exceptions set forth in the merger agreement, by:

• Either Keystone or First Colonial in the event of:

•• failure of First Colonial’s shareholders to approve the merger agreement after a vote taken thereon at a meeting called for such purpose;

•• the failure of Keystone’s depositors to approve the conversion after a vote taken thereon at a meeting called for such purpose;

•• a material breach by the other party of any material covenant or undertaking has not been timely cured after notice;

•• any material breach of any representation or warranty of the other party if such breach would have a material adverse affect to the financial condition, results of operations or business of the party or materially impairs the ability of the other party to consummate the merger or any transactions contemplated by the merger agreement and such breach has not been timely cured after notice;

•• if any approval, consent or waiver of a governmental authority required to permit consummation of the merger, the conversion or the other transactions has been denied or any governmental authority of competent jurisdiction has issued a final unappealable order prohibiting completion of the merger, the conversion or the other transactions contemplated by the merger agreement; or

•• in the event that the merger is not completed by March 31, 2004;

• by Keystone in the event:

•• the board of directors of First Colonial fails to call, give notice of, convene and hold a meeting of its shareholders to consider and vote upon the approval of the merger agreement or has failed to recommend approval of the merger agreement or has modified or changed its recommendation in a manner adverse to Keystone;

•• First Colonial has failed to comply with its agreement not to solicit a competing acquisition transaction; or

•• a tender or exchange offer for 20% or more of the outstanding shares of common stock of First Colonial is started and the board of directors of First Colonial either recommends

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that First Colonial shareholders tender their shares or fails to recommend that its shareholders reject such tender offer or exchange offer within specified time frames; and

• by First Colonial in the event:

•• the board of trustees of Keystone does not call, give notice of, convene and hold the meeting of depositors to consider and vote on the plan of conversion, does not recommend that depositors approve the plan of conversion or has withdrawn or modified its recommendation in a manner adverse to First Colonial; or

•• First Colonial has, prior to holding the meeting of First Colonial’s shareholders to consider and approve the merger agreement, terminated the merger agreement to enter into an acquisition agreement with another entity with respect to a superior proposal; provided, however, that First Colonial may only terminate the merger agreement under this provision in the event that First Colonial has provided written notice of such superior proposal to Keystone and Keystone has not within five business days submitted a proposal to First Colonial that its board of directors believes is at least equal to the superior proposal (see “—Acquisition Proposals”).

In the event of the termination of the merger agreement, as provided above, the merger agreement shall become void and have no effect, and there will be no liability on the part of any party to the merger agreement or their respective officers or directors, except that certain provisions regarding confidential information, expenses and termination fees shall survive and remain in full force and effect; and no party shall be relieved from any liability arising out of the willful breach by such party of any covenant or agreement of it or the willful misrepresentation in the merger agreement of any material fact. First Colonial must pay Keystone a $4.0 million termination fee if the merger agreement is terminated by:

• Keystone because First Colonial breached its covenant not to solicit a competing acquisition transaction, or First Colonial’s board of directors failed to recommend approval of the merger agreement, withdrew such recommendation or changed its recommendation in a manner adverse to Keystone or First Colonial failed to call, give notice of, convene and hold a meeting of its shareholders to consider and vote upon the approval of the merger agreement;

• Keystone because a tender or exchange offer for First Colonial common stock is commenced and First Colonial’s board of directors either recommends that shareholders of First Colonial tender their shares or otherwise fails to recommend that shareholders reject such tender or exchange offer;

• Keystone due to a material breach of the merger agreement by First Colonial and such breach would have a material adverse effect on First Colonial and such breach is not timely cured after notice or by Keystone or First Colonial because the merger is either not completed by March 31, 2004; or the merger agreement is not approved by First Colonial’s shareholders after a vote thereof at a meeting called for such purpose and at the time of such termination (or prior to the holding of the First Colonial meeting to consider the merger agreement in the case of termination as a result of First Colonial’s shareholders not approving the merger agreement) an acquisition proposal (or the intention to make an acquisition proposal) has been publicly announced or otherwise made known to First Colonial’s senior management or its board of directors; or

• the merger agreement is terminated by First Colonial to enter into an acquisition agreement with respect to a superior proposal.

If the termination fee becomes payable by First Colonial pursuant to a termination any one of the first three bullets above, First Colonial must pay Keystone $1.5 million on the first business day following termination and if within 24 months after such termination, First Colonial or one of its subsidiaries enters into an agreement with

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respect to or consummates an acquisition transaction, First Colonial must pay Keystone the remaining $2.5 million on the date of execution of such agreement or the consummation of such acquisition transaction. If the termination fee becomes payable due to the fourth bullet, the entire termination fee is due within two business days following the termination of the merger agreement.

Under the terms of the merger agreement, Keystone must pay a $1.0 million termination fee if the merger agreement is terminated by First Colonial because Keystone and KNBT Bancorp do not receive all regulatory approvals required to complete the merger or any regulatory authority shall have issued a final nonappealable order enjoining or prohibiting completion of the merger, the conversion or other transactions contemplated by the merger agreement, the depositors of Keystone do not approve the plan of conversion after a vote thereon at a meeting called for such purpose or Keystone’s board of trustees fails to recommend approval of the plan of conversion by depositors or withdraws or modifies such recommendation in a manner adverse to First Colonial or if Keystone does not call, give notice of, convene and hold a meeting of its depositors to consider and approve the plan of conversion. In addition, if the merger agreement is terminated by First Colonial for the reasons set forth in this paragraph, Keystone must pay First Colonial’s documented out-of-pocket expenses up to $1.0 million. However, Keystone shall not be required to pay such fee if at the time of termination of the merger agreement, First Colonial had materially breached its representations, warranties or covenants or if the failure to obtain any required regulatory approvals, waivers or authorizations was the result of facts or circumstances relating to First Colonial or its subsidiaries.

The merger agreement may be amended or supplemented at any time by mutual agreement of KNBT Bancorp, Keystone and First Colonial, subject to certain limitations.

Interests of Certain Persons in the Conversion and the Merger

Boards of Directors. Upon consummation of the conversion and the merger, KNBT Bancorp and Keystone will also take all necessary action to appoint Messrs. Scott V. Fainor, Christian F. Martin, Daniel B. Mulholland, Charles J. Peischl and Richard Stevens, III and Ms. Maria Zumas Thulin, currently members of First Colonial’s and Nazareth National Bank’s boards of directors, to KNBT Bancorp’s board of directors and Keystone’s board of trustees. Messrs. Fainor and Martin will be appointed to the class of directors whose term expires in 2004, Messrs. Mulholland and Peischl to the class whose term expires in 2005 and Mr. Stevens and Ms. Thulin to the class whose term expires in 2006.

Executive Officers. In connection with the execution of the merger agreement, Keystone entered into three-year employment agreements with Messrs. Fainor and Eugene T. Sobol, to be effective upon completion of the merger. KNBT Bancorp joined in such employment agreements subsequent to its formation in May 2003. Under the terms of the employment agreements, Mr. Fainor will be employed as the president and chief executive officer of KNBT Bancorp and Keystone while Mr. Sobol will be employed as the senior executive vice president and chief operating officer. Mr. Sobol currently serves as executive vice president and chief operating officer of Keystone. Under the terms of Mr. Fainor’s employment agreement with Keystone and KNBT Bancorp, Mr. Fainor waived any entitlement to payments or benefits under his existing employment agreement with Nazareth National Bank, which agreement will be terminated upon completion of the merger. With respect to other executive officers of First Colonial and/or Nazareth National Bank who have entered into employment or severance agreements with Nazareth National Bank, each agreement will be honored and assumed by Keystone or KNBT Bancorp, as the case may be. In addition, under the terms of Mr. Sobol’s existing letter agreement with Keystone, upon the completion of the conversion and the merger, Keystone, in its discretion, may contribute $250,000 to a supplemental executive retirement plan maintained for the benefit of Mr. Sobol. Mr. Kutteroff, the current president and chief executive officer of Keystone, entered into a retirement and severance agreement with Keystone in March 2003. Under the terms of such agreement, Keystone, in its discretion, may also make a payment upon completion of the conversion and the merger in the amount of $250,000 to a supplemental executive retirement plan maintained for the benefit of Mr. Kutteroff. See “Management—Employment, Retirement and Severance Agreements.”

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Existing Benefit Plans and Employment Agreements. As of March 31, 2003, there were options to purchase First Colonial common stock covering an aggregate of 289,031 shares outstanding under the 1999 Stock Option Plan for Non-Employee Directors, the 1996 Employee Stock Option Plan and 2001 Stock Option Plan (collectively, the “First Colonial option plans”). All of such shares are exercisable as of the date of this prospectus. If any of the First Colonial options remain outstanding immediately prior to consummation of the conversion and the merger, they will be converted into options to purchase KNBT Bancorp common stock, with the number of shares subject to the option and the exercise price per share to be adjusted based upon the merger exchange ratio so that the aggregate exercise price remains unchanged, and with the duration of the option remaining unchanged.

In addition, Mr. Fainor was granted 10,500 restricted shares of First Colonial common stock in connection with entering into his employment agreement in 2001 with Nazareth National Bank. Such restricted shares vest pro rata over five years. Upon execution of the merger agreement, the unvested shares became fully vested and eligible to receive the merger consideration.

As of March 31, 2003, the First Colonial employee stock ownership plan held 48,943 shares of First Colonial common stock which had not yet been allocated to participants and which were pledged as collateral for loans aggregating $1.0 million at March 31, 2003 made to the First Colonial employee stock ownership plan. The aggregate loan balance is expected to be repaid immediately prior to consummation of the conversion and the merger. At such time the remaining unallocated shares will be allocated to the participants and the First Colonial employee stock ownership plan will be terminated.

Pursuant to the merger agreement, Keystone has agreed to retain employees of First Colonial and its subsidiaries after the completion of the merger provided that KNBT Bancorp and Keystone shall not have any obligation to continue the employment of such persons. The merger agreement provides that officers and employees of First Colonial and its subsidiaries who become employees of KNBT Bancorp or Keystone after the merger will be entitled to participate in Keystone’s or KNBT Bancorp’s employee benefit plans maintained generally for the benefit of employees. KNBT and Keystone shall treat employees of First Colonial and its subsidiaries who become employees of Keystone as new employees, but shall amend its employee benefit plans to provide credit, for purposes of vesting and eligibility to participate, for service with First Colonial and its subsidiaries to the extent that such service was recognized for similar purposes under First Colonial’s plans. KNBT Bancorp and Keystone have agreed to honor all benefit obligations and contractual rights of current and former employees of First Colonial and Nazareth National Bank as well as the employment, severance, deferred compensation or similar agreements that First Colonial and/or Nazareth National Bank have entered into with its officers. In the event such officers terminate their employment or are terminated in connection with merger, they will be entitled to minimum cash severance payments aggregating approximately $525,000 plus the continuation of certain benefits for a period of one year (excluding from such calculation Mr. Fainor whose new employment agreement supersedes his existing agreement with Nazareth National Bank upon completion of the merger). As of the date hereof, KNBT Bancorp and Keystone are not aware that any of such officers whose employment will be terminated in connection with the completion of the merger. In addition, with respect to employees of First Colonial, Nazareth National Bank or Keystone who are terminated without cause within six months of the completion of the merger and who are not subject to individual severance or similar agreements, Keystone and KNBT Bancorp have agreed to provide cash severance to such persons in amounts as mutually agreed to by First Colonial, Keystone and KNBT Bancorp.

Keystone currently maintains the Performance Unit Plan, a long-term incentive compensation plan, in which nine trustees and seven senior officers (including Messrs. Kutteroff and Sobol) of Keystone are participants. The plan will be terminated in connection with the completion of the conversion and the merger in view of the KNBT Bancorp’s intention to implement the stock option plan and the recognition and retention plan. It is expected that each Keystone trustee participating in the Performance Unit Plan will receive a cash payment in settlement of the amount due thereunder amounting to approximately $15,600 and that Messrs. Kutteroff and Sobol will receive payments of approximately $192,000 and $105,000, respectively. See “Management—Executive Compensation—Benefit Plans—Management Incentive Compensation Plans.”

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Keystone Plans to Establish the Keystone Nazareth Charitable Foundation

General. To continue Keystone’s commitment to the communities that Keystone serves, the plan of conversion provides that it will establish the Keystone Nazareth Charitable Foundation, as a non-stock Delaware corporation. The foundation will be funded with its common stock of KNBT Bancorp. By increasing Keystone’s visibility and reputation in the communities that it serves, Keystone believes that the foundation will enhance the long-term value of its community banking franchise and will be an extension of its existing community development and charitable activities that it conduct in part through its existing foundation. The foundation will be dedicated to charitable purposes within the communities Keystone serves, including areas currently served by Nazareth National Bank which will become part of Keystone’s expanded market area as a result of the merger, which purposes will include community development activities.

Purpose of the Foundation. The purpose of the foundation is to provide funding to support charitable causes and community development activities. Traditionally, Keystone has emphasized community lending and community development activities within the communities that it served. The foundation is being formed as a complement to Keystone’s existing community activities. While Keystone intends to continue to emphasize community lending and community development activities following the conversion, such activities are not its sole corporate purpose. The Keystone Nazareth Charitable Foundation, conversely, will be completely dedicated to community activities and the promotion of charitable causes, and may be able to support such activities in ways that are not currently available to Keystone. Keystone believes that the foundation will enable it to assist the local community in areas beyond community development and lending.

The board of trustees believes the establishment of a charitable foundation is consistent with Keystone’s commitment to community reinvestment activities. The board further believes that the funding of the foundation with shares of KNBT Bancorp common stock is a means of enabling the communities served by Keystone to share in its growth and success long after completion of the conversion. The foundation will accomplish that goal by providing for continued ties between the foundation and Keystone, forming a partnership with its community. The establishment of the foundation also will enable Keystone to develop a unified charitable donation strategy. However, Keystone does not expect the contribution to the foundation to take the place of its traditional community lending activities. In this respect, Keystone may continue to make contributions to other charitable organizations and/or may make additional contributions to the foundation.

Structure of the Foundation. Keystone expects the initial board of directors of the foundation to consist primarily of trustees and officers of Keystone as well as at least one outside director. There are no plans to change the size or composition of the foundation’s board of directors during the one-year period after the completion of the conversion. Following the first anniversary of the offering, the foundation may alter the size and composition of its board of directors.

The board of directors of the foundation will have the authority for the affairs of the foundation. Among the responsibility of the foundation directors is the establishment of the policies of the foundation with respect to its grants or donations, consistent with the purposes of the foundation. Although no formal policy governing foundation grants exists at this time, the foundation’s board of directors will adopt a policy upon establishment of the foundation. As directors of a nonprofit corporation, directors of the foundation will at all times be bound by their fiduciary duty to advance the foundation’s charitable goals, to protect the assets of the foundation and to act in a manner consistent with its charitable purpose. The directors of the foundation will also be responsible for directing the activities of the foundation, including the management of the shares of KNBT Bancorp common stock held by the foundation. However, it is expected that as a condition to receiving the non-obligation of the Federal Deposit Insurance Corporation to Keystone’s conversion, that the foundation will be required to commit to the Federal Deposit Insurance Corporation that all shares of KNBT Bancorp common stock held by the foundation will be voted in the same ratio as all other shares of its common stock, on all proposals considered by its shareholders.

Initially the foundation’s place of business is expected to be located at Keystone’s administrative offices. Initially, Keystone does not expect that the foundation will have any employees. Eventually, the foundation is expected to have a staff director and may also utilize some of Keystone’s staff and may pay Keystone for the value

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of these services. The board of directors of the foundation will appoint such officers as may be necessary to manage the operations of the foundation. In this regard, it is expected that Keystone will be required to provide the Federal Deposit Insurance Corporation with a commitment that, to the extent applicable, it will comply with the affiliate restrictions set forth in Sections 23A and 23B of the Federal Reserve Act with respect to any transactions between Keystone and the foundation.

KNBT Bancorp intends to capitalize the foundation with shares of its common stock in an amount equal to 8.0% of the total amount of its common stock to be sold in connection with the conversion. At the minimum, midpoint and maximum of the offering range, the contribution to the foundation would equal 1,038,700, 1,222,000 and 1,405,300 shares, which would nave a market value of $10.4 million, $12.2 million and $14.1 million, respectively, assuming the purchase price of $10.00 per share. The contribution of shares of KNBT Bancorp common stock to the foundation will dilute your ownership interest by approximately 4.7% (taking into account the shares of KNBT Bancorp common stock to be issued in the merger). According to RP Financial, if the foundation was not established and funded as part of Keystone’s conversion, KNBT Bancorp’s pro forma market capitalization would be approximately $11.5 million greater and the amount of its stock offered for sale would be approximately $25.6 million greater at the maximum of the offering range. See “Comparison of Independent Valuation and Pro Forma Financial Information With and Without The Foundation.”

The foundation will receive working capital from any dividends paid on the common stock, and subject to applicable federal and state laws, loans collateralized by the common stock or from the proceeds of the sale of any of the common stock in the open market permitted from time to time to provide the foundation with additional liquidity. As a private foundation under Section 501(c)(3) of the Internal Revenue Code, the foundation will be required to distribute annually in grants or donations, a minimum of 5.0% of the average fair market value of its net investment assets. Upon completion of the conversion, the contribution of shares of common stock to the foundation and completion of the merger, KNBT Bancorp would have 22,309,936, 24,784,486, 27,259,036 and 30,104,769 shares issued and outstanding based on the minimum, midpoint, maximum and maximum, as adjusted, of the estimated offering range.

Tax Considerations. Keystone has been advised that an organization created and operated for the above charitable purposes would generally qualify as a Section 501(c)(3) exempt organization under the Code, and that this type of an organization would likely be classified as a private foundation as determined in Section 501 of the Code. The foundation will submit a timely request to the Internal Revenue Service to be recognized as an exempt organization. As long as the foundation files its application for recognition of tax-exempt status within 15 months from the date of its organization, and provided the Internal Revenue Service approves the application, the effective date of the foundation’s status as a Section 501(c)(3) organization will be the date of its organization. Keystone’s outside tax advisor, however, has not advised it on the regulatory condition to the contribution which is expected to require that all shares of KNBT Bancorp common stock held by the foundation must be voted in the same ratio as all other outstanding shares of KNBT Bancorp common stock on all proposals considered by KNBT Bancorp’s shareholders. See “—Regulatory Conditions Imposed on the Foundation.”

The Internal Revenue Code generally allows a deduction for charitable contributions made to qualifying donees within the taxable year of up to 10% of its taxable income of the consolidated group of corporations (with certain modifications) for that year. Charitable contributions made by KNBT Bancorp in excess of the annual deductible amount will be deductible over each of the five succeeding taxable years, subject to certain limitations. Keystone believes that the conversion presents a unique opportunity to establish and fund a charitable foundation given the substantial amount of additional capital being raised in the conversion. In making such a determination, Keystone considered the dilutive impact of the contribution of common stock to the foundation on the amount of common stock available to be offered for sale in the offering. Based on such consideration, Keystone believes that the contribution to the foundation in excess of the 10% annual deduction limitation is justified given Keystone’s capital position and its earnings, the substantial additional capital being raised in the offering and the potential benefits of the foundation to the communities it serves. In this regard, assuming the sale of shares at the maximum of the estimated offering range, KNBT Bancorp would have pro forma shareholders’ equity of $353.7 million or 19.04% of pro forma consolidated assets and Keystone’s pro forma leverage, Tier 1 risk-based and total risk-based ratios would be approximately 11.6%, 21.8% and 22.6%, respectively. See “Keystone Meets All of It’s Regulatory

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Capital Requirements,” “KNBT Bancorp’s Capitalization,” “Comparison of Independent Valuation and Pro Forma Financial Information With and Without the Foundation” and “Pro Forma Unaudited Financial Data—Additional Pro Forma Data.” Keystone believes that the amount of the charitable contribution is reasonable given Keystone’s and KNBT Bancorp’s pro forma capital position. As such, Keystone does not believe that the contribution raises any safety and soundness concerns.

KNBT Bancorp should, more likely than not be entitled to a deduction in the amount of the fair market value of the stock at the time of the contribution less the nominal par value that the foundation is required to pay to KNBT Bancorp for such stock, subject to the annual deduction limitation described above. However, KNBT Bancorp would be able to carry forward any unused portion of the deduction for five years following the contribution, subject to certain limitations. KNBT Bancorp’s outside tax advisor, however, has not rendered advice as to fair market value for purposes of determining the amount of the tax deduction. Assuming the close of the stock offering at the maximum of the estimated price range, KNBT Bancorp estimates that all of the contribution should be deductible over the six-year period. KNBT Bancorp or Keystone may make further contributions to the foundation following the initial contribution. In addition, Keystone also may continue to make charitable contributions to other qualifying organizations. Any of these future contributions would be based on an assessment of, among other factors, KNBT Bancorp’s and/or Keystone’s financial condition at that time, the interests of KNBT Bancorp’s shareholders and Keystone’s depositors, and the financial condition and operations of the foundation.

There can be no assurances that the Internal Revenue Service will recognize the foundation as a Section 501(c)(3) exempt organization or that a deduction for the charitable contribution will be allowed. In either case, KNBT Bancorp’s contribution to the foundation would be expensed without tax benefit, resulting in a reduction in earnings in the year in which the Internal Revenue Service makes the determination.

As a private foundation, earnings and gains, if any, from the sale of common stock or other assets are generally exempt from federal and state corporate income taxation. However, investment income, such as interest, dividends and capital gains, of a private foundation will generally be subject to a federal excise tax of 2.0%. The foundation will be required to make an annual filing with the Internal Revenue Service within five and one-half months after the close of the foundation’s fiscal year. The foundation also will be required to publish a notice that the annual information return will be available for public inspection for a period of 180 days after the date of the public notice. The information return for a private foundation must include, among other things, an itemized list of all grants made or approved, showing the amount of each grant, the recipient, any relationship between a grant recipient and the foundation’s managers and a concise statement of the purpose of each grant. Numerous other restrictions exist in the operation of the foundation including transactions with related entities, level of investment and distributions for charitable purposes.

Regulatory Conditions Imposed on the Foundation. Establishment of the Keystone Nazareth Charitable Foundation is expected to be subject to the following conditions being agreed to in writing by the foundation as a condition to receiving the Federal Deposit Insurance Corporation’s non-objection to the conversion, including the following:

• the foundation will be subject to examination by the Federal Deposit Insurance Corporation;

• the foundation must comply with supervisory directives imposed by the Federal Deposit Insurance Corporation;

• the foundation will operate in accordance with written policies adopted by its board of directors, including a conflict of interest policy and an operating plan; and

• any shares of KNBT Bancorp common stock held by the foundation must be voted in the same ratio as all other shares of its common stock, voting on all proposals considered by its shareholders.

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Delivery of Certificates

Shares Issued in the Conversion. Certificates representing common stock issued in the conversion will be mailed by KNBT Bancorp’s transfer agent to the persons entitled thereto at the addresses of such persons appearing on the stock order form as soon as practicable following completion of the conversion. Any certificates returned as undeliverable will be held by KNBT Bancorp until claimed by persons legally entitled thereto or otherwise disposed of in accordance with applicable law. Until certificates for common stock are available and delivered to subscribers, such subscribers may not be able to sell the shares of common stock for which they have subscribed, even though trading of the common stock may have commenced.

Shares Issued in the Merger. After completion of the conversion and the merger, each holder of a certificate or certificates previously evidencing issued and outstanding shares of First Colonial common stock, upon surrender of the shares of First Colonial common stock to an exchange agent appointed by Keystone shall be entitled to receive in exchange therefore a certificate or certificates representing the number of full shares of KNBT Bancorp common stock for which the shares of First Colonial common stock surrendered shall have been converted based on the merger exchange ratio. No later than seven business days following the consummation of the merger, the exchange agent will mail to each holder of record of an outstanding certificate which immediately prior to the completion of the merger evidenced shares of First Colonial common stock, and which is to be exchanged for KNBT Bancorp common stock based on the merger exchange ratio as provided in the merger agreement, a form of letter of transmittal (which shall specify that delivery shall be effected, and risk of loss and title to such certificate shall pass, only upon delivery of such certificate to the exchange agent) advising such holder of the terms of the exchange effected by the merger and of the procedure for surrendering to the exchange agent such certificate in exchange for a certificate or certificates evidencing KNBT Bancorp common stock. The shareholders of First Colonial should not forward First Colonial common stock certificates to Keystone or the exchange agent until they have received the transmittal letter.

No holder of a certificate representing shares of First Colonial common stock shall be entitled to receive any dividends in respect of KNBT Bancorp common stock into which such shares shall have been converted by virtue of the merger until the certificate representing such shares of First Colonial common stock is surrendered in exchange for certificates representing shares of KNBT Bancorp common stock. In the event that dividends are declared and paid by KNBT Bancorp in respect of KNBT Bancorp common stock after the consummation of the conversion and the merger but prior to surrender of certificates representing shares of First Colonial common stock, dividends payable in respect of shares of KNBT Bancorp common stock not then issued shall accrue without interest. Any such dividends will be paid without interest upon surrender of the certificates representing such shares of First Colonial common stock. KNBT Bancorp shall be entitled, after the consummation of the conversion and the merger, to treat certificates representing shares of First Colonial common stock as evidencing ownership of the number of full shares of KNBT Bancorp common stock into which the shares of First Colonial common stock represented by such certificates shall have been converted even if the holder of the shares of First Colonial common stock has failed to surrender such certificates.

KNBT Bancorp and Keystone shall not be obligated to deliver a certificate or certificates representing shares of KNBT Bancorp common stock to which a holder of First Colonial common stock would otherwise be entitled as a result of the conversion and the merger until such holder surrenders the certificate or certificates representing the shares of First Colonial common stock for exchange as discussed above, or, in default thereof, an appropriate affidavit of loss and indemnity agreement and/or a bond as may be required in each case by KNBT Bancorp and Keystone. If any certificate evidencing shares of KNBT Bancorp common stock is to be issued in a name other than that in which the certificate evidencing First Colonial common stock being surrendered in exchange is registered, KNBT Bancorp and Keystone shall require that the certificate so surrendered shall be properly endorsed and otherwise in proper form for transfer and that the person requesting such exchange pay to the exchange agent any transfer tax due or other tax required by reason of the issuance of a certificate for shares of KNBT Bancorp common stock in any name other than that of the registered holder of the certificate surrendered or otherwise establish to the satisfaction of the exchange agent that such tax has been paid or is not payable.

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Resale of Shares of KNBT Bancorp Common Stock Issued in the Merger

The KNBT Bancorp common stock issued in connection with the merger will be freely transferable under the Securities Act of 1933, except for shares issued to any First Colonial shareholder who may be deemed to be an affiliate of KNBT Bancorp for purposes of Rule 144 promulgated under the Securities Act of 1933 or an affiliate of First Colonial for purposes of Rule 145 promulgated under the Securities Act of 1933. Affiliates will include persons (generally executive officers, directors and 10% shareholders) who control, are controlled by or are under common control with (1) KNBT Bancorp or First Colonial at the time of the special meeting of First Colonial or (2) KNBT Bancorp at or after the completion of the merger.

The ability of affiliates to resell shares of KNBT Bancorp common stock received in the merger under Rule 145 generally will be subject to KNBT Bancorp’s having satisfied its reporting requirements under the Securities Exchange Act of 1934 for specified periods prior to the time of sale. Affiliates also would be permitted to resell KNBT Bancorp common stock received in the merger pursuant to an effective registration statement under the Securities Act of 1933 or another available exemption from the Securities Act of 1933 registration requirements. Neither the registration statement of which this prospectus is a part nor this prospectus cover any resales of KNBT Bancorp common stock received by persons who may be deemed to be affiliates of KNBT Bancorp or First Colonial in the merger.

First Colonial agreed in the merger agreement to use its reasonable best efforts to cause each person who may be deemed to be an affiliate of it for purposes of Rule 145 to deliver to Keystone a letter agreement intended to ensure compliance with the Securities Act of 1933. All of such persons have delivered executed letter agreements addressing this matter.

Certain Restrictions on Purchase or Transfer of Shares After the Conversion and the Merger

All shares of common stock purchased in connection with the conversion by any of Keystone’s trustees or executive officers will be subject to a restriction that the shares not be sold for a period of one year following the conversion, except in the event of the death of such trustee or executive officer or pursuant to a merger or similar transaction approved by the Pennsylvania Department of Banking. Each certificate for restricted shares will bear a legend giving notice of this restriction on transfer, and appropriate stop-transfer instructions will be issued to KNBT Bancorp’s transfer agent. Any shares of common stock issued at a later date within this one year period as a stock dividend, stock split or otherwise with respect to such restricted stock will be subject to the same restrictions. KNBT Bancorp’s directors and executive officers will also be subject to the insider trading rules promulgated pursuant to the Securities Exchange Act of 1934 as long as the common stock is registered pursuant to Section 12(g) of the Securities Exchange Act of 1934.

Purchases of KNBT Bancorp common stock by its directors, executive officers and their associates during the three-year period following completion of the conversion may be made only through a broker or dealer registered with the SEC, except with the prior written approval of the Pennsylvania Department of Banking. This restriction does not apply, however, to negotiated transactions involving more than 1% of its outstanding common stock or to certain purchases of stock pursuant to an employee stock benefit plan, such as its employee stock ownership plan, or by any non-tax-qualified employee stock benefit plan, such as the recognition and retention plan.

Any repurchases of common stock by KNBT Bancorp in the future may be subject to the receipt of any necessary regulatory approvals or non-objections during the first year after the conversion.

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Liquidation Rights of Certain Depositors

In the unlikely event of a complete liquidation of Keystone in its present mutual form, each of Keystone’s depositors would receive his pro rata share of any of Keystone’s assets remaining after payment of claims of all creditors (including the claims of all depositors to the withdrawal value of their accounts). Each depositor’s pro rata share of such remaining assets would be in the same proportion as the value of his deposit account was to the total value of all deposit accounts at the time of liquidation. After the conversion, each depositor, in the event of a complete liquidation of Keystone, would have a claim as a creditor of the same general priority as the claims of all other general creditors of Keystone. However, except as described below, his claim would be solely in the amount of the balance in his deposit account plus accrued interest. The depositor would not have an interest in the value or assets of Keystone above that amount.

The plan of conversion provides for the establishment, upon the completion of the conversion, of a special “liquidation account” for the benefit of depositors of Keystone as of December 31, 2001 or             , 2003 with aggregate account balances of $50.00 or more (such depositors are referred to in this document as Eligible Account Holders and Supplemental Eligible Account Holders) in an amount equal to Keystone’s net worth as of the date of the latest statement of financial condition contained in the final prospectus utilized in the conversion. As of March 31, 2003, the initial balance of the liquidation account would be approximately $109.2 million. Each Eligible Account Holder and Supplemental Eligible Account Holder, if he were to continue to maintain his deposit account at Keystone, would be entitled, upon a complete liquidation of Keystone after the conversion, to an interest in the liquidation account prior to any payment to KNBT Bancorp as the sole shareholder of Keystone. Each Eligible Account Holder and Supplemental Eligible Account Holder would have an initial interest in such liquidation account for each deposit account, including passbook accounts, interest-bearing checking accounts, money market deposit accounts, and certificates of deposit, held in Keystone at the close of business on December 31, 2001 or [            ,] 2003, as the case may be. Each Eligible Account Holder and Supplemental Eligible Account Holder will have a pro rata interest in the total liquidation account for each of his deposit accounts based on the proportion that the balance of each such deposit account on the December 31, 2001, eligibility record date (or the [             ,] 2003 supplemental eligibility record date, as the case may be) bore to the balance of all deposit accounts in Keystone on such dates. For deposit accounts in existence at both the December 31, 2001 eligibility record date and the [            ,] 2003 supplemental eligibility record date, separate initial sub account balances will be determined for such accounts on each of the respective dates. The liquidation account will be an off balance sheet memorandum account. The balance of the liquidation account will not be reflected in KNBT Bancorp’s published financial statements.

If, however, on any December 31 annual closing date, commencing December 31, 2003, the amount in any deposit account is less than the amount in such deposit account on December 31, 2001 or [            ,] 2003, as the case may be, or any other annual closing date, then the interest in the liquidation account relating to such deposit account would be reduced by the proportion of any such reduction, and such interest will cease to exist if such deposit account is closed. In addition, no interest in the liquidation account would ever be increased despite any subsequent increase in the related deposit account. Any assets remaining after the claims of general creditors (including the claims of all depositors to the withdrawal value of their accounts) and the above liquidation rights of Eligible Account Holders and Supplemental Eligible Account Holders are satisfied would be distributed to KNBT Bancorp as the sole shareholder of Keystone.

Tax Aspects

Completion of the conversion and merger is expressly conditioned upon prior receipt of either a ruling or an opinion of counsel with respect to federal tax laws, and either a ruling or an opinion with respect to Pennsylvania tax laws, to the effect that consummation of the transactions contemplated hereby will not result in a taxable reorganization under the provisions of the applicable codes or otherwise result in any adverse tax consequences to Keystone or to account holders receiving subscription rights, except to the extent, if any, that subscription rights are deemed to have fair market value on the date such rights are issued.

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Elias, Matz, Tiernan & Herrick L.L.P., Washington, D.C., has issued an opinion to KNBT Bancorp and Keystone that, for federal income tax purposes:

(1) Keystone’s change in form from mutual to stock ownership will constitute a reorganization under Section 368(a)(1)(F) of the Internal Revenue Code and Keystone will not recognize any gain or loss as a result of the conversion;

(2) no gain or loss will be recognized by Keystone upon the purchase of Keystone’s capital stock by KNBT Bancorp;

(3) no gain or loss will be recognized by Eligible Account Holders and Supplemental Eligible Account Holders upon the issuance to them of deposit accounts in Keystone in its stock form plus their interests in the liquidation account in exchange for their deposit accounts in the mutual savings bank;

(4) the tax basis of the depositors’ deposit accounts in Keystone immediately after the conversion will be the same as the basis of their deposit accounts immediately prior to the conversion;

(5) the tax basis of each Eligible Account Holder’s and Supplemental Eligible Account Holder’s interest in the liquidation account will be zero;

(6) the tax basis to the shareholders of the common stock purchased in the conversion will be the amount paid therefor;

(7) the holding period for shares of common stock will begin on the date of the exercise of the subscription right and on the day after the date of purchase if purchased in the community offering or syndicated community offering; and

(8) it is more likely than not that the Eligible Account Holders and Supplemental Eligible Account Holders will not recognize gain upon the issuance to them of withdrawable savings accounts in Keystone following the conversion, interests in the liquidation account and nontransferable subscription rights to purchase KNBT Bancorp common stock in exchange for their savings accounts and proprietary interests in Keystone.

In reaching their conclusions in opinions (4), (5) and (8) above, Elias, Matz, Tiernan & Herrick L.L.P. has noted that the subscription rights will be granted at no cost to the recipients, will be legally nontransferable and of short duration, and will provide the recipients with the right only to purchase shares of common stock at the same price to be paid by depositors of the general public in any community offering. Elias, Matz, Tiernan & Herrick L.L.P. has also noted that RP Financial has issued a letter dated June 6, 2003, as described below, stating that the subscription rights will have no ascertainable market value. In addition, no cash or property will be given to recipients of the subscription rights in lieu of such rights or to those recipients who fail to exercise such rights. In addition, the IRS was requested in 1993 in a private letter ruling to address the federal tax treatment of the receipt and exercise of nontransferable subscription rights in another conversion and declined to express any opinion. Elias, Matz, Tiernan & Herrick L.L.P. believes because of the factors noted above in this paragraph that it is more likely than not that the nontransferable subscription rights to purchase common stock will have no ascertainable value at the time the rights are granted.

Grant Thornton LLP, Philadelphia, Pennsylvania, has also advised Keystone and KNBT Bancorp that the tax effects of the conversion under Pennsylvania law are substantially the same as they are under federal law.

In the opinion of RP Financial, the subscription rights will have no ascertainable value at the time of distribution or exercise, based on the fact that such rights will be acquired by the recipients without cost, will be nontransferable and of short duration, and will afford the recipients the right only to purchase the common stock at the same price as will be paid by depositors of the general public in any community offering.

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The issue of whether or not the subscription rights have value is dependent upon all of the facts and circumstances that occur. If the nontransferable subscription rights to purchase common stock are subsequently found to have an ascertainable market value greater than zero, income may be recognized by various recipients of the nontransferable subscription rights (in certain cases, whether or not the rights are exercised) and Keystone may be taxed on the distribution of the nontransferable subscription rights under Section 311 of the Code. In this event, the nontransferable subscription rights may be taxed partially or entirely at ordinary income tax rates.

Unlike private rulings, an opinion is not binding on the IRS, and the IRS could disagree with conclusions reached therein. In the event of such disagreement, there can be no assurance that the IRS would not prevail in a judicial or administrative proceeding. Eligible subscribers are encouraged to consult with their own tax advisor as to their own tax consequences in the event that such subscription rights are deemed to have an ascertainable value.

In addition, Elias, Matz, Tiernan & Herrick L.L.P. has issued an opinion to the effect that for federal income tax purposes the merger will constitute a reorganization within the meaning of Section 368(a) of the Code.

Accounting Treatment of the Merger

The merger will be accounted for under the purchase method of accounting under accounting principles generally accepted in the United States of America. Under this method, First Colonial’s assets and liabilities as of the date of the merger will be recorded at their respective fair values and added to those of KNBT Bancorp. Any difference between the purchase price for First Colonial and the fair value of the identifiable net assets acquired (including core deposit intangibles) will be recorded as goodwill. In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” issued in July 2001, the goodwill resulting from the merger will not be amortized to expense, but instead will be reviewed for impairment at least annually and to the extent goodwill is impaired, its carrying value will be written down to its implied fair value and a charge will be made to earnings. Core deposit and other intangibles with definite useful lives recorded by KNBT Bancorp in connection with the merger will be amortized to expense in accordance with the new rules. The financial statements of KNBT Bancorp issued after the merger will reflect the results attributable to the acquired operations of First Colonial beginning on the date of completion of the merger.

Expenses of the Conversion and the Merger

The merger agreement provides, in general, that Keystone and First Colonial shall each bear and pay all their respective costs and expenses incurred by it in connection with the transactions contemplated by the merger agreement, including fees and expenses of their respective financial consultants, investment banking accountants and counsel except under certain circumstances when a termination fee is required to be paid. See “—Completion of the Conversion and the Merger; Termination and Amendment.”

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THE OFFERING

Subscription Offering and Subscription Rights

In accordance with the plan of conversion, rights to subscribe for the purchase of common stock have been granted under the plan of conversion to the following persons in the following order of descending priority:

(1) “Eligible Account Holders,” that is, depositors at Keystone with aggregate account balances of $50.00 or more as of December 31, 2001;

(2) the KNBT Bancorp employee stock ownership plan,

(3) “Supplemental Eligible Account Holders,” that is, persons who are not Eligible Account Holders but who are depositors at Keystone with aggregate account balances of $50.00 or more as of [            ,] 2003;

(4) “Other Depositors,” that is, persons who are not Eligible Account Holders or Supplemental Eligible Account Holders but who are depositors with deposit balances of $100 or more at Keystone as of              , 2003; and

(5) trustees, officers and employees of Keystone.

All subscriptions received will be subject to the availability of common stock after satisfaction of all subscriptions of all persons having prior rights in the Subscription Offering and to the maximum and minimum purchase limitations set forth in the plan of conversion and as described below under “—Limitations on Common Stock Purchases.”

Priority 1: Eligible Account Holders. Each Eligible Account Holder will receive, without payment, first priority, nontransferable subscription rights to purchase up to the greater of:

(1) $500,000 (50,000 shares) of common stock offered,

(2) one-tenth of one percent (.01%) of the total shares sold in the Subscription Offering, or

(3) 15 times the product (rounded down to the next whole number) obtained by multiplying the total number of shares of common stock to be issued by a fraction, of which the numerator is the amount of the Eligible Account Holder’s qualifying deposit and the denominator of which is the total amount of qualifying deposits of all Eligible Account Holders,

in each case as of the close of business on December 31, 2001 (the “Eligibility Record Date”), subject to the overall purchase limitations. See “—Limitations on Common Stock Purchases.”

If there are not sufficient shares available to satisfy all subscriptions, shares first will be allocated among subscribing Eligible Account Holders so as to permit each such Eligible Account Holder, to the extent possible, to purchase a number of shares sufficient to make his total allocation equal to the lesser of the number of shares subscribed for or 100 shares. Any shares remaining after each subscribing Eligible Account Holder has been allocated the lesser of the number of shares subscribed for or 100 shares will be allocated among the subscribing Eligible Account Holders whose subscriptions remain unfilled in the proportion that the amounts of their respective qualifying deposits bear to the total amount of qualifying deposits of all subscribing Eligible Account Holders whose subscriptions remain unfilled, provided that no fractional shares will be issued. Subscription Rights of Eligible Account Holders who are also Keystone’s trustees or officers and their associates will be subordinated to the subscription rights of Eligible Account Holders to the extent attributable to increased deposits during the one year period preceding December 31, 2001.

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To ensure proper allocation of stock, each Eligible Account Holder must list on his subscription order form all accounts in which he has an ownership interest. Failure to list an account could result in fewer shares being allocated than if all accounts had been disclosed.

Priority 2: Employee Stock Ownership Plan. KNBT Bancorp’s employee stock ownership plan will receive, without payment, second priority, nontransferable subscription rights to purchase, in the aggregate, up to 8% of the common stock to be issued in the conversion, including any increase in the number of shares of common stock after the date hereof as a result of an increase of up to 15% in the maximum of the offering range. The employee stock ownership plan intends to purchase 8% of the shares of common stock, or 1,038,700 shares and 1,405,300 shares based on the minimum and maximum of the offering range, respectively. Subscriptions by the employee stock ownership plan will not be aggregated with shares of common stock purchased directly by or which are otherwise attributable to any other participants in the offering, including subscriptions of any of Keystone’s trustees, officers, employees or associates thereof. In the event the KNBT Bancorp employee stock ownership plan is unable to purchase 8.0% of the shares of the common stock in the subscription offering, it is anticipated that the employee stock ownership plan will consider purchasing an amount of shares in the open market sufficient to increase its ownership to 8% of the number of shares of KNBT Bancorp common stock sold in the conversion. See “—Limitations on Common Stock Purchases” and “Risk Factors—An Increase in the Offering Range Would Be Dilutive.”

Priority 3: Supplemental Eligible Account Holders. To the extent that there are sufficient shares remaining after satisfaction of subscriptions by Eligible Account Holders and KNBT Bancorp’s employee stock ownership plan, each Supplemental Eligible Account Holder will receive, without payment, third priority, nontransferable subscription rights to purchase up to the greater of:

(1) $500,000 (50,000 shares) of common stock offered,

(2) one-tenth of one percent (.01%) of the total shares sold in the Subscription Offering, or

(3) 15 times the product (rounded down to the next whole number) obtained by multiplying the total number of shares of common stock to be issued by a fraction, of which the numerator is the amount of the Supplemental Eligible Account Holder’s qualifying deposit and the denominator of which is the total amount of qualifying deposits of all Supplemental Eligible Account Holders, in each case as of the close of business on [            ,] 2003 (the “Supplemental Eligibility Record Date”), subject to the overall purchase limitations. See “—Limitations on Common Stock Purchases.”

If there are not sufficient shares available to satisfy all subscriptions of all Supplemental Eligible Account Holders, available shares first will be allocated among subscribing Supplemental Eligible Account Holders so as to permit each such Supplemental Eligible Account Holder, to the extent possible, to purchase a number of shares sufficient to make his total allocation equal to the lesser of the number of shares subscribed for or 100 shares. Any shares remaining available will be allocated among the Supplemental Eligible Account Holders whose subscriptions remain unfilled in the proportion that the amounts of their respective eligible deposits bear to the total amount of eligible deposits of all subscribing Supplemental Eligible Account Holders whose subscriptions remain unfilled, provided that no fractional shares will be issued.

Priority 4: Other Depositors. To the extent that there are sufficient shares remaining after satisfaction of subscriptions by Eligible Account Holders, KNBT Bancorp’s employee stock ownership plan and Supplemental Eligible Account Holders, each Other Depositor will receive, without payment, fourth priority, nontransferable subscription rights to purchase up to $500,000 (50,000 shares) of common stock offered or one-tenth of one percent (.01%) of the total shares sold, subject to the overall purchase limitations. See “—Limitations on Common Stock Purchases.”

In the event the Other Depositors subscribe for a number of shares which, when added to the shares subscribed for by Eligible Account Holders, the employee stock ownership plan and Supplemental Eligible Account

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Holders, is in excess of the total number of shares of common stock offered in the conversion, shares first will be allocated so as to permit each subscribing Other Depositor, to the extent possible, to purchase a number of shares sufficient to make his total allocation equal to the lesser of the number of shares subscribed for or 100 shares. Any remaining shares will be allocated among such subscribing Other Depositors on an equal number of shares basis per order until all orders have been filled or the remaining shares have been allocated, provided that no fractional shares will be issued.

Priority 5: Trustees, Officers and Employees. To the extent that there are sufficient shares remaining after satisfaction of all subscriptions by Eligible Account Holders, KNBT Bancorp’s employee stock ownership plan, Supplemental Eligible Account Holders and Other Depositors, then Keystone’s trustees, officers and employees will receive, without payment, fifth priority, nontransferable subscription rights to purchase in this category, an aggregate of up to $500,000 (50,000 shares) of common stock offered in the subscription offering. The ability of trustees, officers and employees to purchase common stock under this category is in addition to rights which are otherwise available to them under the plan of conversion if they fall within higher priority categories, and the plan of conversion generally allows such persons in the aggregate to purchase in the aggregate up to 25% of common stock sold in the conversion. See “—Limitations on Common Stock Purchases.” For information as to the number of shares proposed to be purchased by the trustees and executive officers, see “Proposed Management Purchases.”

Expiration Date for the Subscription Offering. The Subscription Offering will expire at             .m., Eastern Time, on             , 2003 (the “Expiration Date”), unless extended by Keystone and KNBT Bancorp, with any required regulatory approval or non-objection. The Subscription Offering may not be extended beyond             , 2005. Subscription rights which have not been exercised prior to the Expiration Date (unless extended) will become void.

KNBT Bancorp and Keystone will not execute orders until at least the minimum number of shares of common stock (12,983,750 shares) have been subscribed for or otherwise sold. If all shares have not been subscribed for or sold within 45 days after the Expiration Date, unless such period is extended, with any required regulatory approval or non-objection, all funds delivered to Keystone pursuant to the Subscription Offering will be returned promptly to the subscribers with interest and all withdrawal authorizations will be canceled. If an extension beyond the 45-day period following the Expiration Date is granted, KNBT Bancorp and Keystone will notify subscribers of the extension of time and of any rights of subscribers to modify or rescind their subscriptions.

Community Offering

To the extent that shares remain available for purchase after satisfaction of all subscriptions of Eligible Account Holders, the employee stock ownership plan, Supplemental Eligible Account Holders, Other Depositors and Keystone’s trustees, officers and employees, KNBT Bancorp and Keystone may elect to offer such shares either prior to or upon completion of the Subscription Offering to certain members of the general public, with preference given to natural persons residing in the counties in Pennsylvania in which Keystone has branch offices (such natural persons referred to as “Preferred Subscribers”). If KNBT Bancorp and Keystone conduct a community offering, such persons, together with their associates, or a group of persons acting in concert may purchase up to $500,000 (50,000 shares) of common stock offered in the Community Offering, subject to the maximum purchase limitations. See “—Limitations on Common Stock Purchases.”

If there are not sufficient shares available to fill the orders of Preferred Subscribers after completion of the Subscription and Community Offering, such stock will be allocated first to each Preferred Subscriber whose order is accepted by KNBT Bancorp and Keystone, in an amount equal to the lesser of 100 shares or the number of shares subscribed for by each such Preferred Subscriber, if possible. Thereafter, unallocated shares will be allocated among the Preferred Subscribers whose accepted orders remain unsatisfied on an equal number of shares basis per order until all orders have been filled or the remaining shares have been allocated, provided that no fractional shares shall be issued. Orders for common stock in the Community Offering will first be filled to a maximum of 2% of the total number of shares of common stock sold in the conversion and thereafter any remaining shares will be allocated on an equal number of shares basis per order until all orders have been filled, provided no fractional shares will be

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issued. If there are any shares remaining, shares will be allocated to other members of the general public who subscribe in the Community Offering applying the same allocation described above for Preferred Subscribers.

The opportunity to subscribe for shares of common stock in the Community Offering category is subject to KNBT Bancorp’s and Keystone’s right, in their sole discretion, to accept or reject any such orders in whole or in part either at the time of receipt of an order or as soon as practicable following the Expiration Date.

Syndicated Community Offering

The plan of conversion provides that, if necessary, all shares of common stock not purchased in the Subscription and Community Offering, if any, may be offered for sale to the general public in a Syndicated Community Offering through selected dealers managed by Sandler O’Neill, acting as KNBT Bancorp’s agent in the sale of the common stock. KNBT Bancorp and Keystone have the right to reject orders, in whole or in part, in their sole discretion in the Syndicated Community Offering. Neither Sandler O’Neill nor any registered broker-dealer shall have any obligation to take or purchase any shares of common stock in the Syndicated Community Offering; however, Sandler O’Neill has agreed to use its best efforts in the sale of shares in the Syndicated Community Offering. Common stock sold in the Syndicated Community Offering will be sold at a purchase price per share which is the same price as all other shares being offered in the conversion. Orders for common stock in the Syndicated Community Offering will first be filled to a maximum of 2% of the total number of shares sold in the conversion and thereafter any remaining shares will be allocated on an equal number of shares basis per order until all orders have been filled, provided no fractional shares will be issued.

It is estimated that the selected dealers will receive a negotiated commission based on the amount of common stock sold by the selected dealer, payable by KNBT Bancorp. During the Syndicated Community Offering, selected dealers may only solicit indications of interest from their customers to place orders with KNBT Bancorp as of a certain date (the “Order Date”) for the purchase of shares of common stock. When and if KNBT Bancorp, Keystone and Sandler O’Neill believe that enough indications and orders have been received in the offering to consummate the conversion, Sandler O’Neill will request, as of the Order Date, selected dealers to submit orders to purchase shares for which they have received indications of interest from their customers. Selected dealers will send confirmations of the orders to such customers on the next business day after the Order Date. Selected dealers will debit the accounts of their customers on a date which will be three business days from the Order Date (“Debit Date”). Customers who authorize selected dealers to debit their brokerage accounts are required to have the funds for payment in their account on but not before the Debit Date. On the next business day following the Debit Date, select dealers will remit funds to the account that KNBT Bancorp will establish for each selected dealer. In the event that the selected dealers’ customers submit checks for the purchase price, such checks must be made payable to KNBT Bancorp. Such checks will be sent directly by noon of the next business day after receipt to the escrow accounts which KNBT Bancorp will establish. After payment has been received by KNBT Bancorp from selected dealers, funds will earn interest at Keystone’s passbook savings rate until the conversion is completed. In the event the conversion is not completed, funds will be returned promptly with interest to the selected dealers, who, in turn, will promptly credit their customers’ brokerage account.

The Syndicated Community Offering may close at any time after the Expiration Date at KNBT Bancorp’s and Keystone’s discretion, but in no case later than 45 days after the Expiration Date, unless further extended with any required regulatory approval or non-objection. The offering may not be extended beyond             , 2005.

How Keystone and KNBT Bancorp Determined the Price Per Share and the Offering Range

The plan of conversion requires that the purchase price of KNBT Bancorp common stock must be based on the appraised pro forma market value of the common stock, as determined on the basis of an independent valuation. Keystone retained RP Financial to make such valuation. For its services in making such appraisal and assistance in preparing a business plan, RP Financial’s fees and out-of-pocket expenses are estimated to be $150,000. Keystone agreed to indemnify RP Financial and any employees of RP Financial in connection with the appraisal and the business plan, unless RP Financial is determined to be negligent or otherwise at fault.

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RP Financial made its appraisal in reliance upon the information contained in this document, including the financial statements. RP Financial also considered the following factors, among others:

• the present and projected operating results and financial condition of Keystone and First Colonial and the economic and demographic conditions in Keystone’s and First Colonial’s existing marketing areas;

• certain historical, financial and other information relating to Keystone and First Colonial;

• a comparative evaluation of the operating and financial statistics of Keystone and First Colonial with those of other similarly situated publicly traded savings institutions located in Pennsylvania and other regions of the United States;

• the aggregate size of the offering of KNBT Bancorp common stock as determined by RP Financial;

• the impact of the conversion and the merger on Keystone’s net worth and earnings potential as determined by RP Financial;

• the pro forma impact of the acquisition of First Colonial, including the issuance of the merger exchange shares to First Colonial shareholders in accordance with the terms of the merger agreement;

• the proposed dividend policy of KNBT Bancorp and Keystone; and

• the trading market for securities of comparable institutions and general conditions in the market for such securities.

In its review of the appraisal provided by RP Financial, the board of trustees of Keystone reviewed the methodologies and the appropriateness of the assumptions used by RP Financial in addition to the factors listed above, and the board of trustees believes that such assumptions are reasonable. The projected operating results reviewed by RP Financial covered periods through December 31, 2006.

On the basis of the foregoing, RP Financial gave its opinion, dated May 30, 2003, that the estimated pro forma market value of the common stock ranged from a minimum of $129.8 million to a maximum of $175.7 million, with a midpoint of $152.8 million. KNBT Bancorp and Keystone determined that the common stock should be sold at $10.00 per share, resulting in a range of 12,983,750 to 17,566,250 shares of common stock being offered in the subscription offering. The offering range may be amended with the approval of the Federal Deposit Insurance Corporation, if required or if necessitated by subsequent developments in Keystone’s financial condition or market conditions generally. In the event the offering range is updated to amend the value of Keystone below $129.8 million or above $202.0 million (the maximum of the offering range, as adjusted by 15%), the new appraisal will be filed with the SEC by post-effective amendment.

In the event KNBT Bancorp and Keystone receive orders for common stock in excess of $175.7 million (the maximum of the offering range) and up to $202.0 million (the maximum of the offering range, as adjusted by 15%), KNBT Bancorp and Keystone may be required by the Federal Deposit Insurance Corporation to accept all such orders. No assurances, however, can be made that KNBT Bancorp and Keystone will receive orders for common stock in excess of the maximum of the offering range or that, if such orders are received, that all such orders will be accepted because the final valuation and number of shares to be issued are subject to the receipt of an updated appraisal from RP Financial which reflects the increase in the valuation and the approval of such increase by the Federal Deposit Insurance Corporation. There is no obligation or understanding on the part of management to take and/or pay for any shares in order to complete the conversion.

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RP Financial’s valuation is not a recommendation as to the advisability of purchasing shares of KNBT Bancorp. RP Financial did not independently verify the financial statements and other information provided by Keystone or First Colonial, nor did RP Financial value independently the assets or liabilities of Keystone or First Colonial. The valuation considers Keystone as a going concern and should not be considered as an indication of the liquidation value of Keystone. Moreover, because such valuation is necessarily based upon estimates and projections of a number of matters, all of which are subject to change from time to time, no assurance can be given that persons purchasing common stock in the conversion or receiving merger exchange shares in the merger will thereafter be able to sell such shares at prices at or above the initial purchase price in the conversion of $10.00 per share.

Before Keystone completes the conversion, the maximum of the offering range may be increased up to 15% and the number of shares of common stock may be increased to up to 20,201,188 shares to reflect changes in market and financial conditions without the resolicitation of subscribers. See “—Limitations on Common Stock Purchases” as to the method of distribution and allocation of additional shares that may be issued in the event of an increase in the offering range to fill unfilled orders in the Subscription Offering.

No sale of shares of common stock in the conversion or issuance of the merger exchange shares in the merger may be consummated unless RP Financial first confirms that nothing of a material nature occurred which, taking into account all relevant factors, would cause it to conclude that the purchase price is materially incompatible with the estimate of the pro forma market value of a share of common stock upon completion of the conversion and the mergers. If such is not the case, a new offering range may be set and a new subscription offering may be held or such other action may be taken as KNBT Bancorp and Keystone determine and the Pennsylvania Department of Banking or Federal Deposit Insurance Corporation may permit or require.

Depending upon market or financial conditions, the total number of shares of common stock may be increased or decreased without a resolicitation of subscribers, provided that the aggregate gross proceeds are not below the minimum or more than 15% above the maximum of the offering range. In the event market or financial conditions change so as to cause the aggregate purchase price of the shares to be below the minimum of the offering range or more than 15% above the maximum of such range, purchasers will be resolicited. In any resolicitation, purchasers will be permitted to continue, modify or rescind their orders. If no election is made by a purchaser prior to the expiration of the resolicitation offering, the purchaser’s order will be rescinded and any funds paid will be promptly refunded with interest at Keystone’s passbook rate of interest, and withdrawal authorizations will be cancelled. Any change in the offering range must be approved by the Federal Deposit Insurance Corporation. If the number of shares of common stock issued in the conversion is increased due to an increase of up to 15% in the offering range to reflect changes in market or financial conditions, persons who subscribed for the maximum number of shares will be given the opportunity to subscribe for the adjusted maximum number of shares. See “—Limitations on Common Stock Purchases.”

An increase in the number of shares of common stock as a result of an increase in the estimated pro forma market value would decrease both a subscriber’s ownership interest and KNBT Bancorp’s pro forma net income and shareholders’ equity on a per share basis while increasing pro forma net income and shareholders’ equity on an aggregate basis. A decrease in the number of shares of common stock would increase both a subscriber’s ownership interest and KNBT Bancorp’s pro forma net income and shareholders’ equity on a per share basis while decreasing pro forma net income and shareholders’ equity on an aggregate basis. See “Pro Forma Unaudited Combined Consolidated Financial Information.”

The appraisal report of RP Financial was filed as an exhibit to Keystone’s Application for Conversion and is available for inspection in the manner set forth under “Additional Information.”

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Persons Who Cannot Exercise Subscription Rights

KNBT Bancorp will make reasonable efforts to comply with the securities laws of all states in the United States in which persons entitled to subscribe for stock pursuant to the plan of conversion reside. However, KNBT Bancorp and Keystone are not required to offer stock in the Subscription Offering to any person who resides in a foreign country or resides in a state of the United States with respect to which:

• the number of persons otherwise eligible to subscribe for shares under the plan of conversion who reside in such jurisdiction is small;

• the granting of subscription rights or the offer or sale of shares of common stock to such persons would require KNBT Bancorp, or its officers, trustees or employees, under the laws of such jurisdiction, to register as a broker, dealer, salesman or selling agent or to register or otherwise qualify its securities for sale in such jurisdiction or to qualify as a foreign corporation or file a consent to service of process in such jurisdiction; or

• such registration, qualification or filing in KNBT Bancorp’s and Keystone’s judgment would be impracticable or unduly burdensome for reasons of costs or otherwise.

Where the number of persons eligible to subscribe for shares in one state is small, Keystone and KNBT Bancorp will base their decision as to whether or not to offer the common stock in such state on a number of factors, including but not limited to the size of accounts held by account holders in the state, the cost of registering or qualifying the shares or the need to register KNBT Bancorp, or its officers, directors or employees as brokers, dealers or salesmen.

Limitations on Common Stock Purchases

The plan of conversion includes the following limitations on the number of shares of common stock which may be purchased in the conversion:

(1)     No fewer than 25 shares of common stock may be purchased, to the extent such shares are available;

(2)     Each Eligible Account Holder may subscribe for and purchase in the Subscription Offering up to the greater of (a) $500,000 (50,000 shares) of common stock, (b) one-tenth of one percent (.01%) of the total shares offered, or (c) 15 times the product (rounded down to the next whole number) obtained by multiplying the total number of shares of common stock offered by a fraction, of which the numerator is the amount of the qualifying deposit of the Eligible Account Holder and the denominator is the total amount of qualifying deposits of all Eligible Account Holders, in each case as of the close of business on the Eligibility Record Date, with clause (a) above subject to the overall limitation in clause (7) below;

(3)     The employee stock ownership plan may purchase up to 8% of the aggregate number of shares of common stock sold in the conversion, including any additional shares issued in the event of an increase in the offering range;

(4)     Each Supplemental Eligible Account Holder may subscribe for and purchase in the Subscription Offering up to the greater of (a) $500,000 (50,000 shares) of common stock, (b) one-tenth of one percent (.01%) of the total shares offered, or (c) 15 times the product (rounded down to the next whole number) obtained by multiplying the total number of shares of common stock offered by a fraction, of which the numerator is the amount of the qualifying deposit of the Supplemental Eligible Account Holder and the denominator is the total amount of qualifying deposits of all Supplemental Eligible Account Holders, in each case as of the close of business on

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the Supplemental Eligibility Record Date, with clause (a) above subject to the overall limitation in clause (7) below;

(5)     Each Other Depositor may subscribe for and purchase up to the greater of (a) $500,000 (50,000 shares) of common stock or, (b) one-tenth of one percent (.01%) of total shares offered in the Subscription Offering, subject to the overall limitation in clause (7) below;

(6)     Persons purchasing shares in the Community Offering or Syndicated Community Offering may subscribe for and purchase up to $500,000 (50,000 shares) of common stock offered, subject to the overall limitation in clause (7) below;

(7)     Except for the employee stock ownership plan, the maximum number of shares of common stock subscribed for or purchased in all categories of the conversion by any person, together with associates of and groups of persons acting in concert with such persons, shall not exceed $1.0 million (100,000 shares); and

(8)     No more than 25% of the total number of shares offered for sale in the conversion may be purchased by Keystone’s trustees and officers and their associates in the aggregate, excluding purchases by the employee stock ownership plan.

Subject to any required regulatory approval and the requirements of applicable laws and regulations, but without further approval of the depositors of Keystone, Keystone and KNBT Bancorp may increase or decrease any individual amount permitted to be subscribed for and the overall purchase limitations. If either of such amounts is increased, subscribers for the maximum amount will be given the opportunity to increase their subscriptions up to the then applicable limit. If either of such amounts is decreased, subscribers for the maximum amount will be decreased by the minimum amount necessary so that the subscriber will be in compliance with the new maximum limitation.

The term “associate” of a person is defined to include the following:

(1)     any corporation or other organization (other than KNBT Bancorp, Keystone or a majority-owned subsidiary of Keystone) of which such person is a director, officer or partner or is directly or indirectly the beneficial owner of 10% or more of any class of equity securities;

(2)      any trust or other estate in which such person has a substantial beneficial interest or as to which such person serves as trustee or in a similar fiduciary capacity, provided, however, that such term shall not include any tax-qualified employee stock benefit plan or non-tax-qualified employee stock benefit plan of KNBT Bancorp or Keystone in which such person has a substantial beneficial interest or serves as a trustee or in a similar fiduciary capacity; and

(3)     any relative or spouse of such person, or any relative of such spouse, who either has the same home as such person or who is a trustee, director or officer of Keystone, KNBT Bancorp or any of our subsidiaries.

The term “acting in concert” is defined to mean (1) knowing participation in a joint activity or interdependent conscious parallel action towards a common goal whether or not pursuant to an express agreement, or (2) a combination or pooling of voting or other interests in the securities of an issuer for a common purpose pursuant to any contract, understanding, relationship, agreement or other arrangement, whether written or otherwise. Keystone and KNBT Bancorp may presume that certain persons are acting in concert based upon, among other things, joint account relationships, common addresses on Keystone’s records and the fact that such persons have filed joint Schedules 13D or 13G with the SEC with respect to other companies.

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Marketing Arrangements

Offering materials for the offering have been distributed to certain persons by mail, with additional copies made available through Keystone’s conversion center and Sandler O’Neill. All prospective purchasers are to send payment directly to Keystone, where such funds will be held in a segregated savings account and not released until the offering is completed or terminated.

To assist in the marketing of the common stock, Keystone and KNBT Bancorp have retained Sandler O’Neill, which is a broker-dealer registered with the NASD. Sandler O’Neill will assist Keystone and KNBT Bancorp in the offering as follows: (a) in training and educating Keystone’s employees regarding the mechanics and regulatory requirements of the offering; (b) in conducting informational meetings for employees, customers and the general public; (c) in coordinating the selling efforts in Keystone’s local communities; and (d) in soliciting orders for common stock. For these services (including any expenses incurred in connection therewith), Sandler O’Neill will receive a fee of 1.0% of the aggregate dollar amount of the common stock sold in the offering, excluding shares sold to the KNBT Bancorp employee stock ownership plan and to Keystone’s officers, employees and trustees, and their immediate families. If there is a syndicated community offering, Sandler O’Neill will receive a management fee of 1.0% of the aggregate dollar amount of the common stock sold in the syndicated community offering. The total fees payable to Sandler O’Neill and other NASD member firms in the syndicated community offering shall not exceed 7.0% of the aggregate dollar amount of the common stock sold in the syndicated community offering.

Keystone and KNBT Bancorp also will reimburse Sandler O’Neill for its legal fees and expenses associated with its marketing effort, up to a maximum of $50,000. KNBT Bancorp and Keystone will indemnify Sandler O’Neill, against liabilities and expenses (including legal fees) incurred in connection with certain claims or litigation arising out of or based upon untrue statements or omissions contained in the offering material for the common stock, including liabilities under the Securities Act of 1933.

Sandler O’Neill will also perform proxy solicitation services, conversion agent services and records management services for Keystone in the conversion and will receive a fee of $50,000 for these services plus reimbursement for its reasonable out-of pocket expenses.

Keystone’s trustees and executive officers may participate in the solicitation of offers to purchase common stock. Other trained employees may participate in the offering in ministerial capacities, providing clerical work in effecting a sales transaction or answering questions of a ministerial nature. Other questions of prospective purchasers will be directed to executive officers or registered representatives. Keystone and KNBT Bancorp will rely on Rule 3a4-1 of the Securities Exchange Act of 1934, as amended, so as to permit officers, trustees, and employees to participate in the sale of the common stock. No officer, trustee, director, or employee will be compensated for his participation by the payment of commissions or other remuneration based either directly or indirectly on the transactions in the common stock.

Procedure for Purchasing Shares in the Subscription and Community Offering

To ensure that each purchaser receives a prospectus at least 48 hours before the Expiration Date (unless extended) in accordance with Rule 15c2-8 of the Securities Exchange Act of 1934, no prospectus will be mailed any later than five days prior to such date or hand delivered any later than two days prior to such date. Execution of the order form will confirm receipt or delivery in accordance with Rule 15c2-8. Order forms will only be distributed with a prospectus.

To purchase shares in the Subscription and Community Offering, an executed order form with the required payment for each share subscribed for, or with appropriate authorization for withdrawal from a deposit account at Keystone (which may be given by completing the appropriate blanks in the order form), must be received by Keystone by _:00 _.m., Eastern Time, on the Expiration Date (unless extended). Order forms which are not received by such time or are executed defectively or are received without full payment (or appropriate withdrawal instructions) are not required to be accepted. Copies of order forms, order forms unaccompanied by an executed acknowledgement form, payments from other private third parties and wire transfers are also not required to be

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accepted. Keystone and KNBT Bancorp have the right to waive or permit the correction of incomplete or improperly executed forms, but do not represent that they will do so. Once received, an executed order form may not be modified, amended or rescinded without Keystone’s and KNBT Bancorp’s consent, unless the conversion has not been completed within 45 days after the end of the Subscription Offering, unless such period has been extended.

In order to ensure that Eligible Account Holders, Supplemental Eligible Account Holders and Other Depositors are properly identified as to their stock purchase priority, depositors as of the close of business on the Eligibility Record Date (December 31, 2001) or the Supplemental Eligibility Record Date [            ,] 2003) and depositors as of the close of business on the Voting Record Date (            , 2003) must list all accounts on the stock order form giving all names in each account and the account numbers. Failure to list all of your accounts may result in fewer shares being allocated to you than if all of your accounts had been disclosed.

Payment for Common Stock

Payment for subscriptions may be made (1) in cash only if delivered in person at any branch office of Keystone, (2) by check or money order, or (3) by authorization of withdrawal from deposit accounts maintained with Keystone. Interest will be paid on payments made by cash, check or money order at Keystone’s passbook rate of interest from the date payment is received until the conversion is completed or terminated. If payment is made by authorization of withdrawal from deposit accounts, the funds authorized to be withdrawn from a deposit account will continue to accrue interest at the contractual rates until completion or termination of the conversion, but a hold will be placed on such funds, thereby making them unavailable to the depositor until completion or termination of the conversion. Payment may not be made by wire transfer of funds.

If a subscriber authorizes Keystone to withdraw the amount of the purchase price from his deposit account, Keystone will do so as of the effective date of the conversion. Keystone will waive any applicable penalties for early withdrawal from certificate accounts. If the remaining balance in a certificate account is reduced below the applicable minimum balance requirement at the time that the funds actually are transferred under the authorization, the certificate will be canceled at the time of the withdrawal, without penalty, and the remaining balance will earn interest at the passbook rate.

The KNBT Bancorp employee stock ownership plan will not be required to pay for the shares subscribed for at the time it subscribes. Instead, the employee stock ownership plan may pay for the shares of common stock subscribed for by it at the purchase price upon completion of the Subscription and Community Offering, provided that there is a valid loan commitment in force from the time of its subscription until such time. The loan commitment may be from an unrelated financial institution or KNBT Bancorp to lend to the employee stock ownership plan, at the completion of the conversion, the aggregate purchase price of the shares for which the employee stock ownership plan subscribed.

Owners of self-directed IRAs may use the assets of such IRAs to purchase shares of common stock in the Subscription and Community Offering, provided that such IRAs are not maintained at Keystone. Persons with IRAs maintained at Keystone must have their accounts transferred to an unaffiliated institution or broker to purchase shares of common stock in the Subscription and Community Offering. In addition, applicable regulations require that Keystone’s officers, trustees and 10% shareholders who use self-directed IRA funds to purchase shares of common stock in the Subscription and Community Offering make such purchases for the exclusive benefit of the IRAs. Any interested parties wishing to use IRA funds for stock purchases are advised to contact the Conversion Center for additional information and allow sufficient time for the account to be transferred as required.

Certificates representing shares of common stock purchased will be mailed to purchasers at the last address of such persons appearing on Keystone’s records, or to such other address as may be specified in properly completed order forms, as soon as practicable following consummation of the conversion. Any certificates returned as undeliverable will be disposed of in accordance with applicable law.

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Restrictions on Transfer of Subscription Rights and Shares

You may not transfer or enter into any agreement or understanding to transfer the legal or beneficial ownership of your subscription rights issued under the plan of conversion or the shares of common stock to be issued upon their exercise. You may exercise your subscription rights only for your own account. If you exercise your subscription rights, you will be required to certify that you are purchasing shares solely for your own account and that you have no agreement or understanding regarding the sale or transfer of such shares. Federal regulations also prohibit any person from offering or making an announcement of an offer or intent to make an offer to purchase such subscription rights or shares of common stock prior to the completion of the conversion.

Keystone and KNBT Bancorp will pursue any and all legal and equitable remedies in the event they become aware of the transfer of subscription rights and will not honor orders known by them to involve the transfer of such rights.

DESCRIPTION OF KNBT BANCORP CAPITAL STOCK

General

KNBT Bancorp’s articles of incorporation provide for the authority to issue up to 100,000,000 shares of common stock and 20,000,000 shares of preferred stock. KNBT Bancorp currently expects to issue up to a maximum of 28,327,478 shares of common stock, (including 1,405,300 shares contributed to the Keystone Nazareth Charitable Foundation), and no shares of preferred stock in the conversion and the merger. Each share of common stock will have the same relative rights as, and will be identical in all respects with, each other share of common stock. Upon payment of the purchase price for the conversion stock in accordance with the plan of conversion, all such stock will be duly authorized, fully paid and nonassessable.

The common stock will represent nonwithdrawable capital, will not be an account of an insurable type and will not be insured by the Federal Deposit Insurance Corporation or any other governmental authority.

Common Stock

Dividends. KNBT Bancorp can pay dividends if, as and when declared by its board of directors, subject to compliance with limitations which are imposed by law. See “Dividends.” The holders of common stock will be entitled to receive such dividends as may be declared by KNBT Bancorp’s board of directors out of funds legally available therefor. If KNBT Bancorp issues preferred stock, the holders thereof may have a priority over the holders of the common stock with respect to dividends.

Voting Rights. Upon completion of the conversion, the holders of KNBT Bancorp’s common stock will possess exclusive voting rights in KNBT Bancorp. They will elect KNBT Bancorp’s board of directors and act on such other matters as are required to be presented to them under Pennsylvania law or KNBT Bancorp’s articles of incorporation or as are otherwise presented to them by the board of directors. Except as discussed in “Restrictions on Acquisition of KNBT Bancorp and Keystone and Related Anti-Takeover Provisions—Limitations on Acquisitions of Voting Stock and Voting Rights,” each holder of common stock will be entitled to one vote per share and will not have any right to cumulate votes in the election of directors. If KNBT Bancorp issues preferred stock, holders of the preferred stock may also possess voting rights.

Liquidation. In the event of any liquidation, dissolution or winding up of KNBT Bancorp, the holders of the then-outstanding common stock would be entitled to receive, after payment or provision for payment of all its debts and liabilities, all of KNBT Bancorp’s assets available for distribution. If preferred stock is issued, the holders thereof may have a priority over the holders of the common stock in the event of liquidation or dissolution.

Preemptive Rights. Holders of the common stock will not be entitled to preemptive rights with respect to any shares which may be issued in the future. The common stock is not subject to redemption.

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Preferred Stock

None of the shares of KNBT Bancorp’s authorized preferred stock will be issued in the conversion. Such stock may be issued with such preferences and designations as the board of directors may from time to time determine. The board of directors can, without shareholder approval, issue preferred stock with voting, dividend, liquidation and conversion rights which could dilute the voting strength of the holders of the common stock and may assist management in impeding an unfriendly takeover or attempted change in control.

Transfer Agent and Registrar and Exchange Agent

The transfer agent and registrar and exchange agent for the common stock of KNBT Bancorp is [            .]

RESTRICTIONS ON ACQUISITION OF KNBT BANCORP AND KEYSTONE

AND RELATED ANTI-TAKEOVER PROVISIONS

Restrictions in KNBT Bancorp’s Articles of Incorporation and Bylaws and Pennsylvania Law

Certain provisions of KNBT Bancorp’s articles of incorporation and bylaws and Pennsylvania law which deal with matters of corporate governance and rights of shareholders might be deemed to have a potential anti-takeover effect. Provisions in KNBT Bancorp’s articles of incorporation and bylaws provide, among other things:

• that KNBT Bancorp’s board of directors shall be divided into classes with only one-third of its directors standing for reelection each year;

• that special meetings of shareholders may only be called by KNBT Bancorp’s board of directors;

• that shareholders generally must provide KNBT Bancorp advance notice of shareholder proposals and nominations for director and provide certain specified related information in the proposal;

• that any merger or similar transaction be approved by a super-majority vote (75%) of shareholders entitled to vote unless it has previously been approved by at least two-thirds of KNBT Bancorp’s directors;

• that no person may acquire more than 10% of the issued and outstanding shares of any class of KNBT Bancorp’s equity securities; and

• the board of directors shall have the authority to issue shares of authorized but unissued common stock and preferred stock and to establish the terms of any one or more series of preferred stock, including voting rights.

Provisions of the Pennsylvania Business Corporation Law, which is referred to as the PBCL in this document, applicable to KNBT Bancorp provide, among other things, that

• KNBT Bancorp may not engage in a business combination with an “interested shareholder” (generally a holder of 20% of a corporation’s voting stock) during the five-year period after the interested shareholder became such except under certain specified circumstances;

• holders of common stock may object to a “control transaction” involving KNBT Bancorp (generally the acquisition by a person or group of persons acting in concert of at least 20% of the outstanding voting stock of a corporation) and demand that they be paid a cash payment for the “fair value” of their shares from the “controlling person or group;” and

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• any “profit,” as defined, realized by any person or group who is or was a “controlling person or group” with respect to KNBT Bancorp from the disposition of any of KNBT Bancorp’s equity securities to any person shall belong to and be recoverable by KNBT Bancorp when the profit is realized in a specified manner.

Pennsylvania-chartered corporations may exempt themselves from these anti-takeover provisions. KNBT Bancorp’s articles of incorporation do not provide for exemption from the applicability of these provisions. The PBCL includes additional anti-takeover provisions from which KNBT Bancorp has elected to exempt itself from as provided in its articles of incorporation.

The provisions noted above as well as others discussed below may have the effect of discouraging a future takeover attempt which is not approved by KNBT Bancorp’s board of directors but which individual shareholders may consider to be in their best interests or in which shareholders may receive a substantial premium for their shares over the then current market price. As a result, shareholders who might wish to participate in such a transaction may not have an opportunity to do so. The provisions may also render the removal of KNBT Bancorp’s board of directors or management more difficult. Furthermore, such provisions could render KNBT Bancorp being deemed less attractive to a potential acquiror and/or could result in KNBT Bancorp’s shareholders receiving a lesser amount of consideration for their shares of KNBT Bancorp common stock than otherwise could have been available either in the market generally and/or in a takeover.

A more detailed discussion of these and other provisions of KNBT Bancorp’s articles of incorporation and bylaws and the PBCL is set forth below.

Board of Directors. KNBT Bancorp’s articles of incorporation and bylaws require the board of directors to be divided into three classes as nearly equal in number as possible and that the members of each class will be elected for a term of three years and until their successors are elected and qualified, with one class being elected annually. Holders of KNBT Bancorp common stock will not have cumulative voting in the election of directors.

Under KNBT Bancorp’s articles of incorporation, any vacancy occurring in its board of directors, including any vacancy created by reason of an increase in the number of directors, may be filled by a majority vote of the remaining directors, whether or not a quorum is present, or by a sole remaining director. Any director so chosen shall hold office for the remainder of the term to which the director has been elected and until his or her successor is elected and qualified.

KNBT Bancorp’s articles of incorporation provide that any director may be removed by shareholders only for cause at a duly constituted meeting of shareholders called expressly for that purpose upon the vote of the holders of not less than a majority of the total votes eligible to be cast by shareholders. Cause for removal shall exist only if the director whose removal is proposed has been either declared incompetent by order of a court, convicted of a felony or an offense punishable by imprisonment for a term of more than one year by a court of competent jurisdiction, or deemed liable by a court of competent jurisdiction for gross negligence or misconduct in the performance of such directors’ duties to KNBT Bancorp.

Consideration of Interests. The PBCL provides that in discharging the duties of their respective positions, including in the context of evaluating an offer to acquire KNBT Bancorp, the board of directors, committees of the board and individual directors of a business corporation may, in considering KNBT Bancorp’s best interests, consider the following:

• the effects of any action upon KNBT Bancorp’s employees, suppliers and customers;

• the effects of the action upon communities in which offices or other establishments of the corporation are located; and

• any other factors KNBT Bancorp may consider important.

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Limitations on Liability. KNBT Bancorp’s articles of incorporation provide that the personal liability of its directors and officers for monetary damages shall be eliminated to the fullest extent permitted by the PBCL as it exists on the effective date of the articles of incorporation or as such law may be thereafter in effect. Section 1713 of the PBCL currently provides that directors (but not officers) of corporations that have adopted such a provision will not be so liable, unless:

• the director has breached or failed to perform the duties of his office in accordance with the PBCL; and

• the breach or failure to perform constitutes self-dealing, willful misconduct or recklessness.

This provision would absolve directors of personal liability for monetary damages for negligence in the performance of their duties, including gross negligence. It would not permit a director to be exculpated, however, for liability for actions involving conflicts of interest or breaches of the traditional “duty of loyalty” to KNBT Bancorp and its shareholders, and it would not affect the availability of injunctive or other equitable relief as a remedy.

If Pennsylvania law is amended in the future to provide for greater limitations on the personal liability of directors or to permit corporations to limit the personal liability of officers, the provision in KNBT Bancorp’s articles of incorporation limiting the personal liability of directors and officers would automatically incorporate such amendments to the law without further action by shareholders. Similarly, if Pennsylvania law is amended in the future to restrict the ability of a corporation to limit the personal liability of directors, KNBT Bancorp’s articles of incorporation would automatically incorporate such restrictions without further action by shareholders.

The provision limiting the personal liability of KNBT Bancorp’s directors does not eliminate or alter the duty of KNBT Bancorp’s directors; it merely limits personal liability for monetary damages to the extent permitted by the PBCL. Moreover, it applies only to claims against a director arising out of his role as a director; it currently does not apply to claims arising out of his role as an officer (if he is also an officer) or arising out of any other capacity in which he serves because the PBCL does not authorize such a limitation of liability. Such limitation also does not apply to the responsibility or liability of a director pursuant to any criminal statute, or the liability of a director for the payment of taxes pursuant to federal, state or local law.

The provision in KNBT Bancorp’s articles of incorporation which limits the personal liability of directors is designed to ensure that the ability of KNBT Bancorp’s directors to exercise their best business judgment in managing its affairs is not unreasonably impeded by exposure to the potentially high personal costs or other uncertainties of litigation. The nature of the tasks and responsibilities undertaken by directors of publicly-held corporations often require such persons to make difficult judgments of great importance which can expose such persons to personal liability, but from which they will acquire no personal benefit. In recent years, litigation against publicly-held corporations and their directors and officers challenging good faith business judgments and involving no allegations of personal wrongdoing has become common. Such litigation regularly involves damage claims in huge amounts which bear no relationship to the amount of compensation received by the directors or officers, particularly in the case of directors who are not employees of the corporation. The expense of such litigation, whether it is well-founded or not, can be enormous. The provision of KNBT Bancorp’s articles of incorporation relating to director liability is intended to reduce, in appropriate cases, the risk incident to serving as a director and to enable KNBT Bancorp to elect and retain the persons most qualified to serve as directors.

Indemnification of Directors, Officers, Employees and Agents. KNBT Bancorp’s bylaws provide that KNBT Bancorp shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that he is or was director or officer of KNBT Bancorp, or is or was serving at KNBT Bancorp’s request as a representative of another domestic or foreign corporation for profit or non-profit, partnership, joint venture, trust or other enterprise, against expenses (including attorney’s fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with the action or proceeding if he acted in good faith and in a manner he reasonably believed to be in, or not opposed to, KNBT Bancorp’s best interests and, with respect to any criminal proceeding, had no reasonable cause to believe his conduct was unlawful. Similar rights to

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indemnification are provided in the case of derivative and other actions by or in the right of KNBT Bancorp. Indemnification shall not be made with respect to an action by or in the right of KNBT Bancorp as to which the person has been adjudged to be liable to KNBT Bancorp unless and only to the extent that the proper court determines upon application that, despite the adjudication of liability but in view of all the circumstances of the case, the person is fairly and reasonably entitled to indemnity for the expenses that the court deems proper. KNBT Bancorp’s bylaws further provide that to the extent that KNBT Bancorp’s representative has been successful on the merits or otherwise in defense of any action or proceeding or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred by him in connection therewith. Unless otherwise ordered by a court, any indemnification shall be made by KNBT Bancorp only as authorized in the specific case upon a determination that indemnification is proper in the circumstance because such person has met the applicable standard of conduct set forth in the bylaws. Expenses (including attorney’s fees) incurred in defending any action or proceeding shall be paid by KNBT Bancorp in advance of the final disposition of the action or proceeding upon receipt of an undertaking by or on behalf of the director or officer to repay the amount if it is ultimately determined that he is not entitled to be indemnified by KNBT Bancorp.

Special Meetings of Shareholders. KNBT Bancorp’s articles of incorporation contain a provision pursuant to which, except as otherwise provided by law, special meetings of its shareholders may be called only by the board of directors pursuant to a resolution approved by a majority of the directors then in office.

Shareholder Nominations and Proposals. KNBT Bancorp’s bylaws provide that, subject to the rights of the holders of any class or series of stock having a preference over the common stock as to dividends or upon liquidation, all nominations for election to the board of directors, other than those made by the board or a committee thereof, shall be made by a shareholder who has complied with the notice provisions in the bylaws. Written notice of a shareholder nomination must be communicated to the attention of the secretary and either delivered to, or mailed and received at, KNBT Bancorp’s principal executive offices not later than (a) with respect to an annual meeting of shareholders, 120 days prior to the anniversary date of the mailing of proxy materials by KNBT Bancorp in connection with the immediately preceding annual meeting of shareholders, or in the case of the first annual meeting following the conversion and the merger, by December 15, 2003.

KNBT Bancorp’s bylaws also provide that only such business as shall have been properly brought before an annual meeting of shareholders shall be conducted at the annual meeting. To be properly brought before an annual meeting, business must be specified in the notice of the meeting (or any supplement thereto) given by or at the direction of the board of directors, or otherwise properly brought before the meeting by a shareholder. For business to be properly brought before an annual meeting by a shareholder, the shareholder must have given timely notice thereof in writing to KNBT Bancorp’s secretary. To be timely, a shareholder’s notice must be delivered to or mailed and received at KNBT Bancorp’s principal executive offices not later than 120 days prior to the anniversary date of the mailing of proxy materials by KNBT Bancorp in connection with the immediately preceding annual meeting of shareholders, or, in the case of the first annual meeting of shareholders following the conversion and reorganization, by December 15, 2003. KNBT Bancorp’s bylaws also require that the notice must contain certain information in order to be considered. The board of directors may reject any shareholder proposal not made in accordance with the bylaws. The presiding officer of an annual meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting in accordance with KNBT Bancorp’s bylaws, and if he should so determine, he shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted.

The procedures regarding shareholder proposals and nominations are intended to provide KNBT Bancorp’s board of directors with the information deemed necessary to evaluate a shareholder proposal or nomination and other relevant information, such as existing shareholder support, as well as the time necessary to consider and evaluate such information in advance of the applicable meeting. The proposed procedures, however, will give incumbent directors advance notice of a business proposal or nomination. This may make it easier for the incumbent directors to defeat a shareholder proposal or nomination, even when certain shareholders view such proposal or nomination as in the best interests of KNBT Bancorp or its shareholders.

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Shareholder Action Without a Meeting. KNBT Bancorp’s articles of incorporation provide that any action permitted to be taken by the shareholders at a meeting may be taken without a meeting if a consent in writing setting forth the action so taken is signed by all of the shareholders entitled to vote.

Limitations on Acquisitions of Voting Stock and Voting Rights. KNBT Bancorp’s articles of incorporation provide that no person shall directly or indirectly offer to acquire or acquire the beneficial ownership of (a) more than 10% of the issued and outstanding shares of any class of an equity security of KNBT Bancorp or (b) any securities convertible into, or exercisable for, any equity securities of KNBT Bancorp if, assuming conversion or exercise by such person of all securities of which such person is the beneficial owner which are convertible into, or exercisable for such equity securities, such person would be the beneficial owner of more than 10% of any class of an equity security of KNBT Bancorp. The term “person” is broadly defined in KNBT Bancorp’s articles of incorporation to prevent circumvention of this restriction.

The foregoing restrictions do not apply to (a) any offer with a view toward public resale made exclusively to KNBT Bancorp by underwriters or a selling group acting on its behalf, (b) any employee benefit plan established by KNBT Bancorp or Keystone, (c) any charitable foundation established by KNBT Bancorp or Keystone and (d) any other offer or acquisition approved in advance by the affirmative vote of 80% of KNBT Bancorp’s board of directors. In the event that shares are acquired in violation of this restriction, all shares beneficially owned by any person in excess of 10% will not be counted as shares entitled to vote and will not be voted by any person or counted as voting shares in connection with any matters submitted to shareholders for a vote, and KNBT Bancorp’s board of directors may cause the excess shares to be transferred to an independent trustee for sale.

Mergers, Consolidations and Sales of Assets. The PBCL generally requires the approval of the board of directors and the affirmative vote of the holders of a majority of the votes cast by all shareholders entitled to vote thereon. KNBT Bancorp’s articles of incorporation provide that any merger, consolidation, share exchange, sale of assets, division or voluntary dissolution shall require approval of 75% of the eligible voting shares unless the transaction has been previously approved by at least two-thirds of its board of directors (in which case the majority of the votes cast standard would apply). In addition, if any class or series of shares is entitled to vote thereon as a class, the PBCL requires the affirmative vote of a majority of the votes cast in each class for any plan of merger or consolidation. The PBCL also provides that unless otherwise required by a corporation’s governing instruments, a plan of merger or consolidation shall not require the approval of the shareholders if:

• whether or not the constituent corporation is the surviving corporation (a) the surviving or new corporation is a Pennsylvania business corporation and the articles of the surviving or new corporation are identical to the articles of the constituent corporation, except for specified changes which may be adopted by a board of directors without shareholder action, (b) each share of the constituent corporation outstanding immediately prior to the effective date of the merger or consolidation is to continue as or to be converted into, except as may be otherwise agreed by the holder thereof, an identical share of the surviving or new corporation after the effective date of the merger or consolidation, and (c) the plan provides that the shareholders of the constituent corporation are to hold in the aggregate shares of the surviving or new corporation to be outstanding immediately after the effectiveness of the plan entitled to cast at least a majority of the votes entitled to be cast generally for the election of directors;

• immediately prior to adoption of the plan and at all times prior to its effective date, another corporation that is a party to the merger or consolidation owns directly or indirectly 80% or more of the outstanding shares of each class of the constituent corporation; or

• no shares of the constituent corporation have been issued prior to the adoption of the plan of merger or consolidation by the board of directors.

As holder of all of the outstanding Keystone common stock after consummation of the conversion, KNBT Bancorp generally will be able to authorize a merger, consolidation or other business combination involving Keystone without the approval of KNBT Bancorp’s shareholders.

196

Business Combinations with Interested Shareholders. Under the PBCL, a registered corporation may not engage in a business combination with an interested shareholder except for certain types of business combinations as enumerated under Pennsylvania law. The PBCL defines a “business combination” generally to include, with respect to a corporation, certain sales, purchases, exchanges, leases, mortgages, pledges, transfers or dispositions of assets, mergers or consolidations, certain issuances or reclassifications of securities, liquidations or dissolutions or certain loans, guarantees or financial assistance, pursuant to an agreement or understanding between such corporation or any subsidiaries, on the one hand, and an interested shareholder or an “affiliate” or “associate” thereof, on the other hand. An “interested shareholder” is defined generally to include any individual, partnership, association or corporation which is the beneficial owner (as defined) of at least 20% of the outstanding voting stock of the corporation or which is an affiliate or associate of such corporation and at any time within the five-year period prior to the date in question was the beneficial owner of at least 20% of the outstanding voting stock.

Control Transactions. The PBCL includes provisions which allow holders of voting shares of a registered corporation that becomes the subject of a “control transaction” to object to such transaction and demand that they be paid a cash payment for the “fair value” of their shares from the “controlling person or group.” A “control transaction” for purposes of these provisions means the acquisition by a person or group of persons acting in concert of at least 20% of the outstanding voting stock of the registered corporation. “Fair value” for purposes of these provisions means an amount not less than the highest price per share paid by the controlling person or group at any time during the 90-day period ending on and including the date of the control transaction, plus an increment representing any value, including without limitation any proportion of any value payable for acquisition of control of the corporation, that may not be reflected in such price.

Control-Share Acquisitions. The PBCL includes provisions which generally require that shareholders of a registered corporation approve a “control-share acquisition,” as defined. Pursuant to authority contained in the Pennsylvania Business Corporation Law, KNBT Bancorp’s articles of incorporation contain a provision which provides that the control-share acquisition provisions of the PBCL shall not be applicable to KNBT Bancorp. The effect of this exclusion is to also exempt KNBT Bancorp from certain provisions of the PBCL which provide statutory rights to severance compensation to any “eligible employee” of a registered corporation whose employment is terminated other than for willful misconduct, (a) within 90 days before shareholders’ approval of voting rights for the “control shares” of an “acquiring person” (generally, a “control share approval”), if the termination was pursuant to a formal or informal agreement, arrangement or understanding with such acquiring person or (b) within 24 months after a “control share approval.”

Disgorgement by Certain Controlling Shareholders. The PBCL includes provisions which generally provide that any “profit” realized by any person or group who is or was a “controlling person or group” with respect to a registered corporation from the disposition of any equity security of the corporation to any person shall belong to and be recoverable by the corporation where the profit is realized by such person or group: (1) from the disposition of the equity security within 18 months after the person or group attained the status of a controlling person or group; and (2) the equity security had been acquired by the controlling person or group within 24 months prior to or 18 months subsequent to the attaining by the person or group of the status of a controlling person or group.

A “controlling person or group” for purposes of these provisions of the PBCL is defined to mean (1) a person or group who has acquired, offered to acquire or, directly or indirectly, publicly disclosed or caused to be disclosed the intention of acquiring voting power over voting shares of a registered corporation that would entitle the holder thereof to cast at least 20% of the votes that all shareholders would be entitled to cast in an election of directors of the corporation or (2) a person or group who has otherwise, directly or indirectly, publicly disclosed or caused to be disclosed that it may seek to acquire control of a corporation through any means. The definition of “controlling person or group” also includes terms which are designed to facilitate a corporation’s determination of the existence of a group and members of a controlling group.

The PBCL excludes certain persons and holders from the definition of a controlling person or group, absent “significant other activities” indicating that a person or group should be deemed a controlling person or group. The

197

PBCL similarly provides that, absent a person or group’s direct or indirect disclosure or causing to be disclosed that it may seek to acquire control of the corporation through any means, a person or group will not be deemed to be a controlling person or group if such person or group holds voting power, among other ways, as a result of the solicitation of proxies or consents if such proxies or consents are (a) given without consideration in response to a solicitation pursuant to the Securities Exchange Act of 1934 and the regulations thereunder and (b) do not empower the holder thereof to vote such shares except on the specific matters described in such proxy or consent and in accordance with the instructions of the giver of such proxy or consent. The disgorgement provisions of the PBCL applicable to registered corporations also do not apply to certain specified transfers of equity securities, including certain acquisitions and dispositions which are approved by a majority vote of both the board of directors and shareholders of the corporation in the prescribed manner.

Actions to recover any profit due to a registered corporation under the disgorgement provisions of the PBCL may be commenced by the corporation in any court of competent jurisdiction within two years from the date any recoverable profit was realized. Such an action also may be commenced by a shareholder on behalf of the corporation if the corporation refuses to bring the action within 60 days after written request by a shareholder or the corporations fail to prosecute the action diligently. Although any recovery of profits would be due the corporation, the shareholder would be entitled to reimbursement of all costs incurred in connection with the bringing of any such action in the event that such action results in a judgment recovering profits for the corporation.

Amendment of Governing Instruments. KNBT Bancorp’s articles of incorporation generally provide that no amendment of the articles of incorporation may be made unless it is first approved by its board of directors and thereafter approved by the holders of a majority of the shares entitled to vote generally in an election of directors, voting together as a single class, as well as such additional vote of the preferred stock as may be required by the provisions of any series thereof, provided, however, any amendment which is inconsistent with Articles VI (directors), VII (meetings of shareholders, actions without a meeting), VIII (liability of directors and officers), IX (restrictions on offers and acquisitions), X (applicability of certain provisions of the PBCL), XI (shareholder approval of mergers and other actions) and XII (amendments to the articles of incorporation) must be approved by the affirmative vote of the holders of not less than 75% of the voting power of the shares entitled to vote thereon unless approved by the affirmative vote of 80% of KNBT Bancorp’s directors then in office.

KNBT Bancorp’s bylaws may be amended by the majority vote of the full board of directors at a regular or special meeting of the board of directors or by a majority vote of the shares entitled to vote generally in an election of directors, voting together as a single class, as well as such additional vote of the preferred stock as may be required by the provisions of any series thereof, provided, however, that the shareholder vote requirement for any amendment to the bylaws which is inconsistent with Sections 2.10 (shareholder proposals), 3.1 (number of directors and powers), 3.2 (classifications and terms of directors), 3.3 (director vacancies), 3.4 (director removals) and 3.12 (director nominations) and Article VI (indemnification) is the affirmative vote of the holders of not less than 75% of the voting power of the shares entitled to vote thereon.

Authorized Capital Stock. KNBT Bancorp authorized capital stock consists of 100,000,000 shares of common stock and 20,000,000 shares of preferred stock. The number of KNBT Bancorp’s authorized shares of stock is greater than what it will issue in the conversion. This will provide its board of directors with greater flexibility to effect, among other things, financings, acquisitions, stock dividends, stock splits and employee stock options.

Issuance of Capital Stock to Directors, Officers and Controlling Persons. KNBT Bancorp’s articles of incorporation do not contain restrictions on the issuance of shares of capital stock to its directors, officers or controlling persons. Thus, KNBT Bancorp could adopt stock-related compensation plans such as stock option plans without shareholder approval and shares of KNBT Bancorp capital stock could be issued directly to directors or officers without shareholder approval. The Marketplace Rules of the NASD, however, generally require corporations like KNBT Bancorp with securities which will be quoted on the Nasdaq National Market to obtain shareholder approval of most stock compensation plans for directors, officers and key employees of the corporation. Moreover, although generally not required, shareholder approval of stock-related compensation plans may be sought in certain instances in order to qualify such plans for favorable federal income tax law treatment under current laws

198

and regulations. KNBT Bancorp plans to submit the proposed stock option and recognition and retention plans discussed herein to its shareholders for their approval.

The foregoing provisions of KNBT Bancorp’s article of incorporation and bylaws and Pennsylvania law could have the effect of discouraging an acquisition of KNBT Bancorp or stock purchases in furtherance of an acquisition, and could accordingly, under certain circumstances, discourage transactions which might otherwise have a favorable effect on the price of the common stock.

In addition, certain provisions expected to be included in the proposed stock option plan and recognition and retention plan, each of which will not be implemented prior to the receipt of shareholder approval, provide for accelerated benefits to participants in the event of a change in control of KNBT Bancorp or Keystone, as applicable. See “Management—New Stock Benefit Plans.” In addition, certain employment agreements to which KNBT Bancorp is a party provide for specified benefits in the event of a change in control. See “Management—Executive Compensation—Employment, Retirement and Severance Agreements.” The foregoing provisions and limitations may make it more costly for companies or persons to acquire control of KNBT Bancorp.

The board of directors of KNBT Bancorp believes that the provisions described above are prudent and will reduce vulnerability to takeover attempts and certain other transactions that are not negotiated with and approved by its board of directors. KNBT Bancorp’s board of directors believes that these provisions are in the best interests of KNBT Bancorp and its future shareholders. In the board of directors’ judgment, KNBT Bancorp’s board of directors is in the best position to determine KNBT Bancorp’s true value and to negotiate more effectively for what may be in the best interests of its shareholders. Accordingly, the board of directors believes that it is in KNBT Bancorp’s best interests and the best interests of its future shareholders to encourage potential acquirers to negotiate directly with the board of directors and that these provisions will encourage such negotiations and discourage hostile takeover attempts. It is also the board of directors’ view that these provisions should not discourage persons from proposing a merger or other transaction at prices reflective of KNBT’s Bancorp’s true value and where the transaction is in the best interests of all shareholders.

Regulatory Restrictions

The Change in Bank Control Act provides that no person, acting directly or indirectly or through or in concert with one or more other persons, may acquire control of a bank holding company unless the Federal Reserve Board has been given 60 days’ prior written notice. The Bank Holding Company Act provides that no company may acquire “control” of a bank holding company without the prior approval of the Federal Reserve Board. Any company that acquires such control becomes a bank holding company subject to registration, examination and regulation by the Federal Reserve Board. Pursuant to federal regulations, control of a bank holding company is conclusively deemed to have been acquired by, among other things, the acquisition of more than 25% of any class of voting stock of the institution or the ability to control the election of a majority of the directors of an institution. The Federal Reserve Board:

• may prohibit an acquisition if the acquisition would result in a monopoly, or would be in furtherance of one, or substantially lessen competition, or be in restraint of trade, unless it finds that the anti-competitive effects are clearly outweighed in the public interest by the probable effect of the transaction in meeting the convenience and needs of the community to be served;

• in every case, must take into consideration the financial and managerial resources, including the competence, experience, and integrity of the officers, directors, and principal shareholders of the acquiring company, and the future prospects of KNBT Bancorp and Keystone, and the convenience and needs of the community to be served; and

• must disapprove any application if the acquiring company fails to assure the Federal Reserve Board that it will provide the information necessary for the Federal Reserve Board to enforce banking laws respecting the acquiror or, if the application involves a foreign bank, the foreign bank is not subject to

199

comprehensive supervision or regulation on a consolidated basis by the appropriate authorities in the foreign bank’s home country.

In addition to the foregoing, the plan of conversion prohibits any person, prior to the completion of the conversion, from offering, or making an announcement of an intent to make an offer, to purchase subscription rights or common stock. See “The Conversion and the Merger—Restrictions on Transfer of Subscription Rights and Shares.”

EXPERTS

The consolidated financial statements of Keystone Savings Bank as of December 31, 2002 and 2001, and for each of the years in the three-year period ended December 31, 2002, have been included herein in reliance upon the report of Grant Thornton LLP, independent accountants, appearing elsewhere herein and upon the authority of said firm as experts in accounting and auditing.

The consolidated financial statements of First Colonial Group, Inc. as of December 31, 2002 and 2001, and for each of the years in the three-year period ended December 31, 2002, have been included herein in reliance upon the report of Grant Thornton LLP, independent accountants, appearing elsewhere herein and upon the authority of said firm as experts in accounting and auditing.

RP Financial has consented to the publication in this document of the summary of its report to KNBT Bancorp and Keystone setting forth its opinion as to the estimated pro forma market value of the common stock to be outstanding upon completion of the conversion and its opinion with respect to subscription rights.

LEGAL AND TAX OPINIONS

The legality of the common stock and the federal income tax consequences of the conversion and the merger has been passed upon for KNBT Bancorp and Keystone by Elias, Matz, Tiernan & Herrick L.L.P., Washington, D.C., special counsel to KNBT Bancorp and Keystone. The Pennsylvania income tax consequences of the conversion has been passed upon for KNBT Bancorp and Keystone by Grant Thornton LLP. Certain legal matters will be passed upon for Sandler O’Neill & Partners, L.P. by Muldoon Murphy & Faucette LLP, Washington, D.C.

ADDITIONAL INFORMATION

KNBT Bancorp has filed with the SEC a Registration Statement on Form S-1 under the Securities Act with respect to the shares of its common stock offered in this document. As permitted by the rules and regulations of the SEC, this prospectus does not contain all the information set forth in the Registration Statement. Such information can be examined without charge at the public reference facilities of the SEC located at 450 Fifth Street, N.W., Washington, D.C. 20549, and copies of such material can be obtained from the SEC at prescribed rates. The registration statement also is available through the SEC’s world wide web site on the internet at http://www.sec.gov. The statements contained in this prospectus as to the contents of any contract or other document filed as an exhibit to the Registration Statement are, of necessity, brief descriptions thereof and are not necessarily complete.

Keystone has filed an application for conversion with the Pennsylvania Department of Banking with respect to the conversion. KNBT Bancorp has also filed an application with the Pennsylvania Department of Banking for approval to acquire First Colonial. This prospectus omits certain information contained in those applications. The applications may be examined at the principal office of the Pennsylvania Department of Banking at 333 Market Street, 16^th Floor, Harrisburg, Pennsylvania.

In connection with the conversion, KNBT Bancorp will register its common stock with the SEC under Section 12(g) of the Securities Exchange Act of 1934, and, upon such registration, KNBT Bancorp and the holders of its stock will become subject to the proxy solicitation rules, reporting requirements and restrictions on stock purchases and sales by directors, officers and greater than 10% shareholders, the annual and periodic reporting

200

requirements and certain other requirements of the Securities Exchange Act of 1934. Under the plan of conversion, KNBT Bancorp has undertaken that it will not terminate such registration for a period of at least three years following the conversion.

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INDEX TO FINANCIAL STATEMENTS

	Page
Financial Statements of Keystone Savings Bank
Report of Independent Certified Public Accountants	F-2
Financial Statements:
Consolidated Balance Sheets (As of March 31, 2003 (unaudited) and December 31, 2002 and 2001)	F-3
Consolidated Statements of Income (For the three months ended March 31, 2003 and 2002 (unaudited) and the years ended December 31, 2002, 2001 and 2000)	F-4
Consolidated Statement of Retained Earnings (For the three months ended March 31, 2003 (unaudited) and the years ended December 31, 2002, 2001 and 2000)	F-5
Consolidated Statements of Cash Flows (For the three months ended March 31, 2003 and 2002 (unaudited) and the years ended December 31, 2002, 2001 and 2000)	F-6
Notes to Consolidated Financial Statements	F-7

All financial statement schedules are omitted because the required information either is not applicable or is shown in the financial statements or in the notes thereto.

The registrant, KNBT Bancorp, Inc., a Pennsylvania corporation, which was incorporated on May 22, 2003, has not yet commenced operations to date; accordingly, the financial statements of KNBT Bancorp, Inc. have been omitted because of their immateriality.

Financial Statements of First Colonial Group, Inc.
Report of Independent Certified Public Accountants	F-24
Financial Statements:
Consolidated Balance Sheets as of March 31, 2003 (unaudited) and December 31, 2002 and 2001	F-25
Consolidated Statements of Income (For the three months ended March 31, 2003 and 2002 (unaudited) and the years ended December 2002, 2001 and 2000)	F-26
Consolidated Statement of Changes in Shareholder’s Equity (For the three months ended March 31, 2003 (unaudited) and the years ended December 2002, 2001, and 2000)	F-27
Consolidated Statements of Cash Flows (For the three months ended March 31, 2003 and 2002 (unaudited) and the years ended December 31 2002, 2001 and 2000)	F-29
Notes to Consolidated Financial Statements	F-30

All financial statement schedules are omitted because the required information either is not applicable or is shown in the financial statements or in the notes thereto.

F-1

Report of Independent Certified Public Accountants

Board of Trustees

Keystone Savings Bank

We have audited the accompanying consolidated balance sheets of Keystone Savings Bank and Subsidiary as of December 31, 2002 and 2001, and the related consolidated statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits 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, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Keystone Savings Bank and Subsidiary as of December 31, 2002 and 2001, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.

/s/ Grant Thornton LLP

Philadelphia, Pennsylvania

January 27, 2003 (except for note O,

  as to which the date is March 6, 2003)

F-2

Keystone Savings Bank and Subsidiary

Consolidated Balance Sheets (in thousands)

	March 31 2003		December 31,
			2002		2001
	(unaudited)
ASSETS
Cash and due from banks	$	9,382	$	33,535	$	16,100
Interest-bearing deposits with banks		40,399		52,758		35,744
Total cash and cash equivalents		49,781		86,293		51,844
Investment securities available for sale		400,154		294,150		156,785
Federal Home Loan Bank of Pittsburgh stock		8,516		8,011		6,099
Loans receivable, net		532,425		579,322		668,046
Bank owned life insurance		26,688		26,334		20,899
Premises and equipment, net		12,883		12,178		12,118
Accrued interest receivable		5,239		4,964		4,599
Other assets		3,973		4,654		1,655
Total assets	$	1,039,659	$	1,015,906	$	922,045
LIABILITIES AND RETAINED EARNINGS
Liabilities
Deposits	$	797,361	$	771,825	$	772,226
Securities sold under agreements to repurchase		10,013		8,904		5,752
Advances from the Federal Home Loan Bank		103,500		113,500		40,500
Advance payments by borrowers for taxes and insurance		2,426		2,283		2,276
Accrued interest payable		863		711		639
Other liabilities		11,201		7,634		4,864
Total liabilities		925,364		904,857		826,257
Retained earnings—substantially restricted		109,275		106,326		94,316
Accumulated other comprehensive income		5,020		4,723		1,472
Total retained earnings		114,295		111,049		95,788
Total liabilities and retained earnings	$	1,039,659	$	1,015,906	$	922,045

The accompanying notes are an integral part of these statements.

F-3

Keystone Savings Bank and Subsidiary

Consolidated Statements of Income (in thousands)

	Three months ended March 31,						Year ended December 31,
	2003			2002			2002			2001			2000
	(unaudited)
Interest income
Loans receivable, including amortization of origination fees	$	10,133		$	12,262		$	44,188		$	50,946		$	49,025
Investment securities		3,875			2,527			14,883			8,536			7,976
Other interest		131			138			408			1,011			602
Total interest income		14,139			14,927			59,479			60,493			57,603
Interest expense
Deposits		4,163			6,560			23,099			32,164			29,652
Advances from the Federal Home Loan Bank		1,108			562			3,162			1,806			1,464
Other expense		32			33			155			94			25
Total interest expense		5,303			7,155			26,416			34,064			31,141
Net interest income		8,836			7,772			33,063			26,429			26,462
Provision (recovery) for loan losses		62			(445	)		111			391			442
Net interest income after provision (recovery) for loan losses		8,774			8,217			32,952			26,038			26,020
Noninterest income
Deposit charges and service fees		1,583			1,027			5,404			3,981			3,158
Net gains on sales of investment securities		—			1,202			1,202			35			82
Bank owned life insurance		355			350			1,435			899			—
Net gains (losses) on sales of residential mortgages		264			64			900			108			(23	)
Net losses on disposition of fixed assets		—			—			(99	)		—			—
Net losses on sales of other real estate owned		(21	)		—			(28	)		(10	)		(3	)
Total noninterest income		2,181			2,643			8,814			5,013			3,214
Noninterest expense
Compensation and employee benefits		3,735			2,980			13,217			10,414			9,285
Occupancy expenses		470			303			1,369			1,194			914
FDIC insurance premiums		32			34			135			137			138
Advertising		307			150			840			728			653
Data processing		431			435			1,712			1,603			1,366
Depreciation and amortization		381			308			1,317			1,137			1,025
Other		1,550			972			5,978			4,400			4,618
Total noninterest expense		6,906			5,182			24,568			19,613			17,999
Income before income taxes		4,049			5,678			17,198			11,438			11,235
Income taxes		1,100			1,782			5,188			3,326			3,718
Net income	$	2,949		$	3,896		$	12,010		$	8,112		$	7,517

The accompanying notes are an integral part of these statements.

F-4

Keystone Savings Bank and Subsidiary

Consolidated Statement of Retained Earnings

Three months ended March 31, 2003 and the years ended December 31, 2002, 2001 and 2000 (in thousands)

	Retained earnings		Accumulated other comprehensive income (loss)			Comprehensive income		Total
Balance at January 1, 2000	$	78,687	$	(1,284	)			$	77,403
Net income		7,517		—		$	7,517		7,517
Other comprehensive income, net of reclassification adjustments and taxes		—		2,016			2,016		2,016
Total comprehensive income						$	9,533
Balance at December 31, 2000		86,204		732					86,936
Net income		8,112		—			8,112		8,112
Other comprehensive income, net of reclassification adjustments and taxes		—		740			740		740
Total comprehensive income						$	8,852
Balance at December 31, 2001		94,316		1,472					95,788
Net income		12,010		—			12,010		12,010
Other comprehensive income, net of reclassification adjustments and taxes		—		3,251			3,251		3,251
Total comprehensive income						$	15,261
Balance at December 31, 2002		106,326		4,723					111,049
Net income (unaudited)		2,949		—			2,949		2,949
Other comprehensive income, net of reclassification adjustments and taxes (unaudited)		—		297			297		297
Total comprehensive income (unaudited)						$	3,246
Balance at March 31, 2003 (unaudited)	$	109,275	$	5,020				$	114,295

The accompanying notes are an integral part of this statement.

F-5

Keystone Savings Bank and Subsidiary

Consolidated Statements of Cash Flows (in thousands)

	Three months ended March 31,						Year ended December 31,
	2003			2002			2002			2001			2000
	(unaudited)
Operating activities
Net income	$	2,949		$	3,896		$	12,010		$	8,112		$	7,517
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		381			308			1,317			1,137			1,025
Amortization of discounts on investment securities, net		—			(14	)		(521	)		82			50
Provision for loan losses		62			(445	)		111			391			442
Net gains on sales of investment securities		—			(1,202	)		(1,202	)		(35	)		(82	)
Net (gains) losses on sales of residential mortgages		(264	)		(64	)		(900	)		(108	)		23
Loss on disposition of fixed assets		—			—			99			—			—
Net losses on sale of real estate owned		21			—			28			10			3
Increase in accrued interest receivable		(629	)		(584	)		(1,805	)		(1,063	)		(893	)
(Increase) decrease in other assets		529			(1,609	)		(4,113	)		1,667			(759	)
Increase (decrease) in advance payments by borrowers for taxes and insurance		143			326			7			101			(121	)
Increase (decrease) in other liabilities and accrued interest payable		3,719			7,419			2,842			(1,973	)		3,591
Net cash provided by operating activities		6,911			8,031			7,873			8,321			10,796
Investing activities
Proceeds from sales of real estate owned		84			—			791			337			411
Proceeds from sales of investment securities available for sale		362			61,438			63,844			1,625			3,378
Proceeds from maturities, calls and principal repayments of investment securities available for sale		52,217			18,697			104,037			46,102			20,068
Purchases of investment securities available for sale		(111,556	)		(68,480	)		(184,848	)		(89,818	)		(31,203	)
Purchases of premises and equipment		(1,086	)		(439	)		(1,376	)		(2,208	)		(1,051	)
Purchases of Federal Home Loan Bank of Pittsburgh stock		(505	)		—			(1,912	)		(394	)		(301	)
Net decrease (increase) in loans		416			2,022			(25,711	)		(11,330	)		(46,796	)
Purchase of bank-owned life insurance		—			(4,000	)		(4,000	)		(20,000	)		—
Net cash provided by (used in) investing activities		(60,068	)		9,238			(49,175	)		(75,686	)		(55,494	)
Financing activities
Net increase (decrease) in deposits		25,536			14,803			(401	)		58,706			48,151
Net increase in repurchase agreements		1,109			459			3,152			4,123			1,629
Federal Home Loan Bank borrowings		—			10,000			73,000			30,500			—
Federal Home Loan Bank repayments		(10,000	)		—			—			(3,000	)		(12,000	)
Net cash provided by financing activities		16,645			25,262			75,751			90,329			37,780
Net increase (decrease) in cash and cash equivalents		(36,512	)		42,531			34,449			22,964			(6,918	)
Cash and cash equivalents at beginning of year		86,293			51,844			51,844			28,880			35,798
Cash and cash equivalents at end of year	$	49,781		$	94,375		$	86,293		$	51,844		$	28,880
Supplemental disclosure of cash flow information
Cash paid during the year for
Income taxes	$	95		$	500		$	4,075		$	3,450		$	4,660
Interest on deposits, advances and other borrowed money	$	5,558		$	—		$	26,344		$	33,956		$	31,773
Supplemental disclosure of noncash activities
Mortgage loan securitizations	$	47,250		$	115,335		$	115,335		$	—		$	—
Reclassification of loans receivable to other real estate owned	$	—		$	—		$	998		$	342		$	204

The accompanying notes are an integral part of these statements.

F-6

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE A—ORGANIZATION

Keystone Savings Bank (the Bank) is a Pennsylvania-chartered mutual savings bank. The Bank provides a range of financial services to individual and corporate customers through its branches in the greater Lehigh Valley area of eastern Pennsylvania. Although the Bank offers numerous financial services, its lending activity is concentrated primarily on residential first mortgage and equity loans secured by real estate located in the greater Lehigh Valley.

The Bank competes with other banking and financial institutions in its primary market areas. Commercial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for savings and time certificates of deposit and all types of loans. Such institutions, as well as consumer financial and insurance companies, may be considered competitors of the Bank with respect to one or more of the services it renders.

The Bank is subject to regulations of certain state and federal agencies and, accordingly, the Bank is periodically examined by such regulatory authorities. As a consequence of the regulation of commercial banking activities, the Bank’s business is particularly susceptible to future state and federal legislation and regulations.

NOTE B—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1. Basis of Consolidated Financial Statement Presentation

The accounting and reporting policies of the Bank conform to accounting principles generally accepted in the United States of America and predominant practices within the banking industry. The accompanying consolidated financial statements include the accounts of the Bank and its wholly-owned subsidiary, KLVI, Inc. All intercompany balances and transactions have been eliminated.

The consolidated balance sheet at March 31, 2003, and the consolidated statements of income and cash flows for the three month periods ended March 31, 2003 and 2002, and the consolidated statement of retained earnings for the three month period ended March 31, 2003 are unaudited and, in the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for a fair presentation have been made. Amounts appearing in the accompanying notes as of March 31, 2003 and for the three month periods ended March 31, 2003 and 2002 are unaudited. The results of operations for the three months ended March 31, 2003 and 2002 are not necessarily indicative of the results that may be attained for an entire fiscal year.

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America (US GAAP), management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The principal estimate that is particularly susceptible to significant change in the near term relates to the allowance for loan losses. The evaluation of the adequacy of the allowance for loan losses includes an analysis of the individual loans and overall risk characteristics and size of the different loan portfolios, and takes into consideration current economic and market conditions, the capability of specific borrowers to pay specific loan obligations, as well as current loan collateral values. However, actual losses on specific loans, which also are encompassed in the analysis, may vary from estimated losses.

Statement of Financial Accounting Standards (SFAS) No. 131, “Disclosures About Segments of an Enterprise and Related Information,” redefines how operating segments are determined and requires disclosures of certain financial and descriptive information about the Bank’s operating segments. Management has determined that the Bank has one operating segment and, accordingly, one reportable segment, “Community Banking.” All of the Bank’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Bank supports

(Continued)

F-7

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE B—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—Continued

the others. For example, consumer and residential mortgage lending is dependent upon the ability of the Bank to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. All significant operating decisions are based upon analysis of the Bank as one operating segment.

2. Cash and Cash Equivalents

For reporting cash flows, cash and cash equivalents include cash and due from banks and interest-bearing deposits with banks. The Bank maintains cash deposits in other depository institutions that occasionally exceed the amount of deposit insurance available. Management periodically assesses the financial condition of these institutions and believes that the risk of any possible credit loss is minimal. Interest-bearing deposits in other financial institutions consist of short-term investments generally having maturities of less than 30 days.

3. Investment Securities

The Bank accounts for its investment securities in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” This standard requires, among other things, that debt and equity securities classified as available for sale be reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of retained earnings, net of income taxes. The net effect of unrealized gains or losses, caused by marking an available for sale portfolio to market, could cause fluctuations in the level of retained earnings and equity-related financial ratios as market interest rates cause the fair value of fixed-rate securities to fluctuate.

Investment securities expected to be held for an indefinite period of time are classified as available for sale and are stated at fair value. Gains or losses on the sales of securities available for sale are recognized upon realization utilizing the specific identification method.

The Bank follows SFAS No. 133 as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities.” SFAS No. 138 requires that entities recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. The Bank does not have any derivative instruments as of March 31, 2003, December 31, 2002, 2001 or 2000.

SFAS No. 119 “Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments,” requires disclosures about financial instruments, which are defined as futures, forwards, swap and option contracts and other financial instruments with similar characteristics. On-balance-sheet receivables and payables are excluded from this definition. The Bank did not hold any derivative financial instruments as defined by SFAS No. 119 at March 31, 2003, December 31, 2002, 2001 or 2000.

4. Loans and Allowance for Loan Losses

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal and reduced by an allowance for loan losses. Interest on loans is accrued and credited to operations based upon the principal amounts outstanding. The allowance for loan losses is established through a provision for possible loan losses charged to operations. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely.

Income recognition of interest is discontinued when, in the opinion of management, the collectibility of such interest becomes doubtful. A loan is generally classified as nonaccrual when the loan is 90 days or more delinquent. Loan origination fees and certain direct origination costs are deferred and amortized over the life of the related loans as an adjustment to the yield on loans receivable in a manner which approximates the interest method.

(Continued)

F-8

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE B—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—Continued

The allowance for loan losses is maintained at an amount management deems adequate to cover estimated losses. In determining the level to be maintained, management evaluates many factors, including current economic trends, industry experience, historical loss experience, industry loan concentrations, the borrowers’ ability to repay and repayment performance, and estimated collateral values. In the opinion of management, the present allowance is adequate to absorb reasonable, foreseeable loan losses. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary based on changes in economic conditions or any of the other factors used in management’s determination. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for losses on loans. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. Charge-offs to the allowance are made when the loan is transferred to real estate owned or other determination of impairment.

The Bank accounts for its impaired loans in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFAS No. 118, “Accounting by Creditors for Impairment of a Loan—Income Recognition and Disclosures.” This standard requires that a creditor measure impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable. At March 31, 2003 and December 31, 2002, 2001 and 2000, the Bank had no loans that would be defined as impaired under SFAS No. 114.

The Bank follows SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” which revised the standards for accounting for the securitizations and other transfers of financial assets and collateral. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001.

In November 2002, FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN No. 45), was issued. The disclosure requirements of FIN No. 45 are effective for the year ended December 31, 2002 and require disclosure of the nature of the guarantee, the maximum potential amount of future payments that that the guarantor could be required to make under the guarantee, and the current amount of the liability, if any, for the guarantor’s obligations under the guarantee. Significant guarantees that have been entered into by the Bank include standby letters of credit, which totaled approximately $2.7 million as of March 31, 2003. The adoption of FIN No. 45 did not have a material impact on the consolidated financial statements.

5. Premises and Equipment

Premises and equipment are carried at cost less accumulated depreciation, and include expenditures for new facilities, major betterments and renewals. Expenditures for maintenance and repairs are charged to expense as incurred. Depreciation is computed using the straight-line method based upon the estimated useful lives of the related assets.

On January 1, 2002, the Bank adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 retains the existing requirements to recognize and measure the impairment of long-lived assets to be held and used or to be disposed of by sale. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001. The adoption of this statement did not have an impact on the financial condition or results of operations of the Bank.

(Continued)

F-9

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE B—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—Continued

6. Other Real Estate Owned

Real estate acquired through foreclosure is classified as other real estate owned (OREO). OREO is carried at the lower of cost (lesser of carrying value of loan or fair value at date of acquisition) or fair value less estimated costs to sell. Any reductions in value, at or prior to the dates the real estate is considered foreclosed, is charged to the allowance for loan losses. Any subsequent reductions in value are charged through earnings. Costs relating to the development or improvement of the property are capitalized; holding costs are charged to expense.

7. Income Taxes

Under the liability method deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these temporary differences are estimated to reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities. The principal types of accounts resulting in differences between assets and liabilities for financial statement and tax return purposes are allowance for loan losses, deferred loan fees and accumulated depreciation.

The Bank and KLVI, Inc. file separate state income tax returns. Management of the Bank anticipates that it will be able to recover the undistributed earnings of KLVI, Inc., the Bank’s wholly-owned Delaware Investment Subsidiary, free of state income taxes, and therefore does not provide for state income taxes on these earnings.

8. Advertising Costs

The Bank expenses advertising costs as incurred.

9. Employee Benefit Plans

The Bank follows SFAS No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” which revised employers’ disclosures about pension and other postretirement benefit plans. It eliminated certain current disclosures and requires additional information about changes in the benefit obligation and the fair values of plan assets. It also standardized the requirements for pensions and other postretirement benefit plans to the extent possible, and illustrates combined formats for the presentation of pension plan and other postretirement benefit plan disclosures. The Bank has certain employee benefit plans covering substantially all employees. The Bank expenses such costs as incurred.

10. Bank Owned Life Insurance (BOLI)

The Bank enters into investments of bank owned life insurance (BOLI). BOLI involves the purchasing of life insurance by the corporation on a chosen group of employees. The Bank is the owner and beneficiary of the policies. This pool of insurance, due to tax advantages to the Bank, is profitable to the corporation. This profitability is used to offset a portion of future benefit cost increases. Earnings from BOLI are recognized as interest income.

11. Financial Instruments

SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” requires the Bank to disclose the estimated fair value of their assets and liabilities considered to be financial instruments. Financial instruments requiring disclosure consist primarily of investment securities, loans and deposits.

(Continued)

F-10

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE B—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—Continued

12. Comprehensive Income

SFAS No. 130, “Reporting Comprehensive Income,” established new standards for reporting comprehensive income, which includes net income as well as certain other items which result in a change to equity during the period.

The income tax effects allocated to comprehensive income for the three months ended March 31, 2003 and the years ended December 31, 2002, 2001 and 2000 is as follows (in thousands):

	March 31, 2003 (unaudited)
	Before tax amount			Tax benefit (expense)			Net of tax amount
Unrealized gains on securities
Unrealized holding gains arising during period	$	448		$	(151	)	$	297
Less reclassification adjustment for gains realized in net income		—			—			—
Other comprehensive income, net	$	448		$	(151	)	$	297
	December 31, 2002
	Before tax amount			Tax benefit (expense)			Net of tax amount
Unrealized gains on securities
Unrealized holding gains arising during period	$	6,266		$	(2,222	)	$	4,044
Less reclassification adjustment for gains realized in net income		(1,202	)		(409	)		(793	)
Other comprehensive income, net	$	5,064		$	(1,813	)	$	3,251
	December 31, 2001
	Before tax amount			Tax benefit (expense)			Net of tax amount
Unrealized gains on securities
Unrealized holding gains arising during period	$	938		$	(174	)	$	764
Less reclassification adjustment for gains realized in net income		(35	)		(11	)		(24	)
Other comprehensive income, net	$	903		$	(163	)	$	740

(Continued)

F-11

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE B—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—Continued

	December 31, 2000
	Before tax amount		Tax benefit (expense)			Net of tax amount
Unrealized gains on securities
Unrealized holding gains arising during period	$	3,359	$	(1,293	)	$	2,066
Less reclassification adjustment for gains realized in net income		82		(32	)		50
Other comprehensive income, net	$	3,277	$	(1,261	)	$	2,016

13. Reclassifications

Certain 2002, 2001 and 2000 amounts have been reclassified to conform to the March 31, 2003 consolidated financial statement presentation.

NOTE C—INVESTMENT SECURITIES

The amortized cost, gross unrealized gains and losses, and fair value of the Bank’s investment securities available for sale are as follows:

	March 31, 2003 (unaudited)
	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
	(in thousands)
Available for sale
U.S. Government and agencies	$	22,661	$	199	$	—		$	22,860
Obligations of states and political subdivisions		48,840		2,241		(204	)		50,877
Asset-managed funds
Adjusted rate mortgage portfolio		4,939		—		(29	)		4,910
Mortgaged-backed securities
GNMA		3,000		81		—			3,081
FHLMC		18,814		380		(15	)		19,179
FNMA		112,489		3,821		(8	)		116,302
Other CMO’s		149,243		736		(702	)		149,277
		283,546		5,018		(725	)		287,839
Corporate and other debt securities		32,563		1,125		(20	)		33,668
	$	392,549	$	8,583	$	(978	)	$	400,154

(Continued)

F-12

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE C—INVESTMENT SECURITIES—Continued

	December 31, 2002
	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
	(in thousands)
Available for sale
U.S. Government and agencies	$	30,677	$	398	$	—		$	31,075
Obligations of states and political subdivisions		38,935		2,148		(44	)		41,039
Asset-managed funds
Adjusted rate mortgage portfolio		4,939		—		(25	)		4,914
Mortgaged-backed securities
GNMA		3,234		93		—			3,327
FHLMC		17,963		390		(5	)		18,348
FNMA		73,743		2,382		(24	)		76,101
Other CMO’s		83,449		862		(137	)		84,174
		178,389		3,727		(166	)		181,950
Corporate and other debt securities		34,053		1,132		(13	)		35,172
	$	286,993	$	7,405	$	(248	)	$	294,150
	December 31, 2001
	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
	(in thousands)
Available for sale
U.S. Government and agencies	$	8,445	$	13	$	(21	)	$	8,437
Obligations of states and political subdivisions		29,040		811		(291	)		29,560
Asset-managed funds
Adjusted rate mortgage portfolio		4,938		—		(29	)		4,909
Mortgaged-backed securities
GNMA		563		45		—			608
FHLMC		3,063		82		(5	)		3,140
FNMA		6,845		28		(6	)		6,867
Other CMO’s		64,849		733		(481	)		65,101
		75,320		888		(492	)		75,716
Corporate and other debt securities		36,937		1,261		(45	)		38,153
Other		10		—		—			10
	$	154,690	$	2,973	$	(878	)	$	156,785

The amortized cost and fair value of the Bank’s investment and mortgage-backed securities available for sale at March 31, 2003, by contractual maturity, are shown below (unaudited). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

(Continued)

F-13

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE C—INVESTMENT SECURITIES—Continued

	Available for sale
	Amortized cost		Fair value
	(in thousands)
Investment securities
Due in one year or less	$	12,408	$	12,640
Due after one year through five years		42,804		43,901
Due after five years through ten years		3,600		3,639
Due after ten years		45,252		47,225
		104,064		107,405
Asset managed funds		4,939		4,910
Mortgage-backed securities		283,546		287,839
		288,485		292,749
	$	392,549	$	400,154

Gross gains of $-0- and losses of $-0- were realized on sales of investment securities classified as available for sale during the three months ended March 31, 2003. Gross gains of $1,202,000 and losses of $-0- were realized on sales of investment securities classified as available for sale during the three months ended March 31, 2002, and for the year ended December 31, 2002. Gross gains of $37,000 and losses of $2,000 were realized on sales of investment securities classified as available for sale for the year ended December 31, 2001. Gross gains of $82,000 and losses of $-0- were realized on sales of investment securities classified as available for sale for the year ended December 31, 2000.

As of March 31, 2003, securities having a book value of $17,500,000 were pledged to secure public deposits, outstanding advances and for other purposes as required by law.

NOTE D—LOANS

A summary of loans receivable follows (in thousands):

	March 31, 2003			December 31,
				2002			2001
	(unaudited)
Real estate
Mortgage	$	332,634		$	396,604		$	530,014
Construction		62,732			59,363			54,092
Total real estate loans		395,366			455,967			584,106
Commercial business loans		12,159			10,050			4,399
Consumer loans		152,481			143,731			112,161
Total loans		560,006			609,748			700,666
Less
Loans in process		(22,111	)		(24,263	)		(23,552	)
Deferred fees		(2,781	)		(3,236	)		(5,682	)
Allowance for loan losses		(2,689	)		(2,927	)		(3,386	)
Net loans	$	532,425		$	579,322		$	668,046

(Continued)

F-14

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE D—LOANS—Continued

Loans whose borrowers were contractually delinquent 90 days or more totaled $2,017,000, $2,495,000 and $2,690,000 at March 31, 2003 and December 31, 2002 and 2001, respectively. The amount of interest income not recognized on loans more than 90 days delinquent was approximately $25,000, $24,000, $66,000, $81,000 and $56,000 for the three months ended March 31, 2003 and 2002 and the years ended December 31, 2002, 2001 and 2000, respectively. At March 31, 2003, there were no commitments to lend additional funds to borrowers whose loans are classified as nonaccrual.

Activity in the allowance for loan losses is as follows (in thousands):

	Three months ended March 31,						Year ended December 31,
	2003			2002			2003			2002			2001
	(unaudited)
Balance, beginning	$	2,927		$	3,386		$	3,386		$	3,337		$	3,101
Provision charged to operations		62			(445	)		111			391			442
Loans charged off		(312	)		(157	)		(623	)		(378	)		(246	)
Recoveries of loans previously charged off		12			5			53			36			40
Balance, end	$	2,689		$	2,789		$	2,927		$	3,386		$	3,337

NOTE E—PREMISES AND EQUIPMENT

Premises and equipment are summarized as follows (in thousands):

	Estimated useful lives	March 31, 2003			December 31,
					2002			2001
		(unaudited)
Land	Indefinite	$	1,829		$	1,829		$	1,829
Buildings and leasehold improvements	30—50 years		10,560			10,559			9,979
Furniture and fixtures	3—10 years		12,295			11,210			10,469
			24,684			23,598			22,277
Less accumulated depreciation and amortization			(11,801	)		(11,420	)		(10,159	)
		$	12,883		$	12,178		$	12,118

NOTE F—DEPOSITS

Deposits are as follows (in thousands):

	March 31, 2003		December 31,
			2002		2001
	(unaudited)
Savings and club accounts	$	122,266	$	115,289	$	102,940
Checking accounts		128,525		118,036		105,828
Money market deposits		157,747		149,225		121,413
Time deposits		342,363		352,477		394,708
Time deposits $100,000 or more		46,460		36,798		47,337
	$	797,361	$	771,825	$	772,226

(Continued)

F-15

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE F—DEPOSITS—Continued

Maturities of time deposits at March 31, 2003 are as follows (unaudited) (in thousands):

2004	$    206,175
2005	101,925
2006	40,115
2007	13,418
Thereafter	27,190
	$    388,823

Interest expense on deposits is as follows (in thousands):

	Three months ended March 31,				Year ended December 31,
	2003		2002		2002		2001		2000
	(unaudited)
Savings and club accounts	$	307	$	392	$	1,680	$	2,127	$	2,353
Checking accounts		113		111		466		846		968
Money market deposits		626		695		2,784		3,512		3,096
Time deposits		3,117		5,362		18,169		25,679		23,235
	$	4,163	$	6,560	$	23,099	$	32,164	$	29,652

NOTE G—BORROWINGS

1. Federal Home Loan Bank (FHLB) Advances

Federal Home Loan Bank (FHLB) advances at March 31, 2003, December 31, 2002 and 2001 totaled $103,500,000, $113,500,000 and $40,500,000, respectively. The advances are collateralized by FHLB stock and otherwise unencumbered qualified assets. The fair value of such collateral for these advances totaled approximately $547,402,000. These advances had a weighted average interest rate of 4.31%, 3.87% and 5.28% for the three months ended March 31, 2003 and for the years ended December 31, 2002 and 2001, respectively. Advances are made pursuant to several different credit programs offered from time to time by the FHLB. At December 31, 2002 or 2001, the Bank did not have a line of credit with the FHLB.

Outstanding borrowings at March 31, 2003 mature as follows (unaudited) (in thousands):

2004	$    16,500
2005	3,000
2006	5,000
2007	8,500
2008	15,000
Thereafter	55,500
	$  103,500

(Continued)

F-16

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE G—BORROWINGS—Continued

2. Securities Sold Under Agreements to Repurchase

The Bank, pursuant to a designated cash management agreement, utilizes securities sold under agreements to repurchase as vehicles for customers’ sweep and term investment products. Securitization under these cash management agreements are in U.S. Treasury Securities and obligations of states and political subdivisions securities.

These securities are held in a third party custodian’s account, designated by the Banks under a written custodial agreement that explicitly recognizes the Banks’ interest in the securities.

Detail of securities sold under agreements to repurchase are as follows (in thousands, except percentages):

	Three months ended March 31,						Year ended December 31,
	2003			2002			2002			2001			2000
	(unaudited)
Average balance outstanding	$	8,906		$	6,176		$	9,033		$	5,743		$	1,014
Maximum amount outstanding any month-end during the period		10,013			6,211			10,051			5,752			1,629
Balance outstanding at end of period		10,013			6,211			8,904			5,752			1,629
Average interest rate during the period		1.63	%		2.38	%		2.08	%		3.79	%		5.38	%
Weighted-average interest rate at end of period		1.63	%		2.38	%		2.08	%		3.79	%		5.38	%

NOTE H—INCOME TAXES

The components of income taxes are as follows for the years ended (in thousands):

	Three months ended March 31,					Year ended December 31,
	2003			2002		2002			2001			2000
	(unaudited)
Current
Federal	$	1,142		$	1,268	$	5,232		$	3,280		$	3,931
State		37			268		128			(56	)		—
		1,179			1,536		5,360			3,224			3,931
Deferred
Federal		(79	)		246		(172	)		102			(213	)
	$	1,100		$	1,782	$	5,188		$	3,326		$	3,718

(Continued)

F-17

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE H—INCOME TAXES—Continued

The reconciliation of the tax computed at the statutory rate is as follows (in thousands):

	Three months ended March 31,						Year ended December 31,
	2003			2002			2002			2001			2000
	(unaudited)
Tax expense at statutory rate of 35%	$	1,417		$	1,990		$	6,019		$	3,888		$	3,820
Increase (decrease) resulting from
Tax-exempt income		(316	)		(246	)		(1,036	)		(657	)		—
State tax expense, net of federal benefit		16			174			84			19			(196	)
Other, net		(17	)		(136	)		121			76			94
Income tax expense	$	1,100		$	1,782		$	5,188		$	3,326		$	3,718

Deferred tax assets and liabilities consist of the following (in thousands):

	March 31, 2003			December 31,
				2002			2001
	(unaudited)
Deferred tax assets
Deferred compensation	$	775		$	773		$	221
Allowance for loan losses		942			1,025			1,132
Other		355			286			—
		2,072			2,084			1,353
Deferred tax liabilities
Depreciation		844			819			670
Mortgage service rights		304			412			—
Unrealized gains on securities available for sale		2,585			2,434			623
		3,733			3,665			1,293
Net deferred tax (liability) asset	$	(1,661	)	$	(1,581	)	$	60

The Bank is not required to recapture approximately $9,800,000 of its tax bad debt reserve, attributable to bad debt deductions taken by it prior to 1988, as long as the Bank continues to operate as a bank under federal tax law and does not use the reserve for any other purpose. In accordance with SFAS No. 109, the Bank has not recorded any deferred tax liability on this portion of its tax bad debt reserve. The tax that would be paid were the Bank ultimately required to recapture that portion of the reserve would amount to approximately $3,400,000.

The Bank and KLVI, Inc. file separate state income tax returns. Because management of the Bank anticipates that it will be able to recover the undistributed earnings of KLVI, Inc., the Bank’s wholly-owned subsidiary, free of state income taxes, the Bank does not provide for state income taxes on these earnings.

F-18

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE I—RETIREMENT PLANS

1. Defined Benefit Plans

The Bank participates in multiple employer defined benefit pension plan, which covers substantially all employees with 1,000 hours of services during the plan year. Benefits are generally based on years of service and the highest average compensation of five consecutive years of employment. It is the bank’s policy to fund the amount which satisfies the statutory requirements under the Employee Retirement Income Security Act. Bank contributions to the multiple employee pension plan for the three months ended March 31, 2003 and 2002 and the years ended December 31, 2002, 2001 and 2000 were approximately $215,000, $-0-, $529,000, $239,000 and $34,000, respectively.

2. Defined Contribution Plan

The Bank also has a 401(k) plan which covers substantially all employees. Employees may elect to defer 1% to 20% of their compensation per year. The Bank will match 50% of contributions up to 6% of compensation per year. Contributions to the 401(k) plan totaled approximately $69,000, $50,000, $222,000, $167,000 and $184,000 for three months ended March 31, 2003 and 2002 and the years ended December 31, 2002, 2001 and 2000, respectively.

NOTE J—FAIR VALUE OF FINANCIAL INSTRUMENTS

SFAS No. 107 requires disclosure of the estimated fair value of an entity’s assets and liabilities considered to be financial instruments. For the Bank, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in SFAS No. 107. However, many such instruments lack an available trading market, as characterized by a willing buyer and seller engaging in an exchange transaction. Therefore, the Bank had to use significant estimates and present value calculations to prepare this disclosure, as required by SFAS No. 107. Accordingly, the information presented below does not purport to represent the aggregate net fair value of the Bank.

Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.

Estimated fair values have been determined by the Bank using what management believes to be the best available data and an estimation methodology suitable for each category of financial instruments. The estimation methodologies used, the estimated fair values, and recorded book balances at December 31, 2002 and 2001 are set forth below.

For cash and due from banks and interest-bearing deposits with banks, the recorded book values of approximately $86,293,000 and $51,844,000 are deemed to approximate fair values at December 31, 2002 and 2001, respectively. The estimated fair values of investment and mortgage-backed securities are based on quoted market prices, if available. If quoted market prices are not available, the estimated fair values are based on quoted market prices of comparable instruments.

(Continued)

F-19

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE J—FAIR VALUE OF FINANCIAL INSTRUMENTS—Continued

The fair values of loans are estimated based on a discounted cash flow analysis using interest rates currently offered for loans with similar terms to borrowers of similar credit quality. The carrying value of accrued interest is deemed to approximate fair value.

	2002				2001
	Carrying amount		Estimated fair value		Carrying amount		Estimated fair value
	(in thousands)
Investment and mortgage-backed securities	$	294,150	$	294,150	$	156,785	$	156,785
Federal Home Loan Bank of Pittsburgh stock		8,011		8,011		6,099		6,099
Loans receivable		582,249		604,159		671,432		688,831

The estimated fair values of demand deposits (i.e., interest- and noninterest-bearing checking accounts, passbook savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. The fair values of fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected monthly time deposit maturities. The carrying amount of accrued interest payable approximates its fair value.

	2002				2001
	Carrying amount		Estimated fair value		Carrying amount		Estimated fair value
	(in thousands)
Time deposits	$	398,179	$	393,111	$	442,045	$	446,785

The fair values of the FHLB advances totaling approximately $113,500,000 and $40,500,000 are estimated to approximate their recorded book balances at December 31, 2002 and 2001, respectively.

The fair value of commitments to extend credit is estimated based on the amount of unamortized deferred loan commitment fees. The fair value of letters of credit is based on the amount of unearned fees plus the estimated cost to terminate the letters of credit. Fair values of unrecognized financial instruments including commitments to extend credit and the fair value of letters of credit are considered immaterial.

NOTE K—FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

(Continued)

F-20

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE K—FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK—Continued

The Bank had the following approximate off-balance-sheet financial instruments whose contract amounts represent credit risk (in thousands):

	March 31, 2003		December 31,
			2002		2001
	(unaudited)
Commitments to extend credit
Residential mortgages	$	22,065	$	19,007	$	11,517
Other mortgages		26,730		1,663		1,075
Home equity lines of credit, secured by mortgages		27,886		26,590		23,206
Commercial lines of credit		45,553		48,880		22,354
Unsecured lines of credit, including credit cards		9,069		8,712		7,650
Letters of credit		2,738		3,366		2,852
Consumer (auto personal)		2,327		—		—
Commercial unsecured		103		—		—
	$	136,471	$	108,218	$	68,654

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies but may include guarantees, personal or commercial real estate, accounts receivable, inventory and equipment.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support contracts entered into by customers. Most guarantees extend for one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds collateral to support these commitments.

Substantially all of the Bank’s loans are secured by real estate in the Lehigh Valley area of eastern Pennsylvania. Loans purchased from other financial institutions or participation in loans originated by other financial institutions constitute less than 1% of the Bank’s loans outstanding. Accordingly, the Bank’s primary concentration of credit risk is related to the real estate market in the Lehigh Valley and the ultimate collectibility of this portion of the Bank’s loan portfolio is susceptible to changes in economic conditions in that area.

NOTE L—LEASE COMMITMENTS

The Bank has entered into several noncancellable operating lease agreements for its branch banking facilities. The Bank is responsible for pro rata operating expense escalations. The approximate minimum annual rental payments at March 31, 2003 under these leases are as follows (unaudited) (in thousands):

2004	$	614
2005		559
2006		468
2007		351
2008		227
Thereafter		2,700
	$	4,919

Lease expense for the three months ended March 31, 2003 and 2002 and the years ended December 31, 2002, 2001 and 2000 was $157,000, $95,000, $474,000, $339,000 and $218,000, respectively.

F-21

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE M—REGULATORY MATTERS

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 Bank’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-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of March 31, 2003, management believes that the Bank meets all capital adequacy requirements to which it is subject.

As of March 31, 2003, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as “well-capitalized” under the regulatory framework for prompt corrective action. To be categorized as “adequately-capitalized,” the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as 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.

	Actual				For capital adequacy purposes					To be well-   capitalized under prompt corrective action provisions
	Amount		Ratio		Amount		Ratio			Amount		Ratio
	(in thousands, except percentages)
As of March 31, 2003 (unaudited)
Total capital (to risk-weighted assets)	$	111,875	18.89	%	$	47,369	³	8.00	%	$	59,212	³	10.00	%
Tier I capital (to risk-weighted assets)		109,186	18.44			23,685	³	4.00			35,527	³	6.00
Tier I capital (to average assets)		109,186	10.78			40,514	³	3.00			40,514	³	4.00
As of December 31, 2002
Total capital (to risk-weighted assets)	$	109,137	18.69	%	$	46,702	³	8.00	%	$	58,378	³	10.00	%
Tier I capital (to risk-weighted assets)		106,210	18.19			23,351	³	4.00			35,027	³	6.00
Tier I capital (to average assets)		106,210	10.78			29,557	³	3.00			39,410	³	4.00

(Continued)

F-22

Keystone Savings Bank and Subsidiary

Notes to Consolidated Financial Statements—Continued

March 31, 2003 (Unaudited), December 31, 2002, 2001 and 2000

NOTE M—REGULATORY MATTERS—Continued

	Actual				For capital adequacy purposes					To be well- capitalized under prompt corrective action provisions
	Amount		Ratio		Amount		Ratio			Amount		Ratio
	(in thousands, except percentages)
As of December 31, 2001
Total capital (to risk-weighted assets)	$	97,616	17.71	%	$	44,100	³	8.00	%	$	55,125	³	10.00	%
Tier I capital (to risk-weighted assets)		94,230	17.09			22,050	³	4.00			33,075	³	6.00
Tier I capital (to average assets)		94,230	10.50			26,932	³	3.00			35,909	³	4.00

NOTE N—PLAN OF MHC REORGANIZATION

On August 26, 2002, the Board of Trustees of Keystone Savings Bank, Bethlehem, Pennsylvania (the Bank), a Pennsylvania-chartered mutual savings bank adopted a Plan of Reorganization from a Mutual Savings Bank to a Mutual Holding Company (the MHC Plan), pursuant to which the Bank proposed to reorganize into the mutual holding company form of organization and operate as an indirect subsidiary of a mutual holding company (the MHC Reorganization).

NOTE O—MUTUAL TO STOCK CONVERSION AND MERGER

On March 6, 2003, the Bank and First Colonial Group, Inc. (First Colonial) (NASDAQ: FTCG), the parent company of Nazareth National Bank and Trust Company entered into a definitive merger agreement (the Merger Agreement). The transaction involves the conversion of Keystone Savings Bank from a mutual savings bank to a stock savings bank, the formation of a holding company, KNBT Bancorp, Inc. (KNBT); and the mergers of First Colonial into KNBT and Nazareth National Bank and Trust Company into the Bank. Each issued and outstanding share of First Colonial common stock will be valued at $37.00 and exchanged for shares of KNBT common stock based on the initial public offering (IPO) price of KNBT common stock. The Merger Agreement is subject to both regulatory and shareholder approval as well as the successful completion of the Bank’s consummation of its mutual-to-stock conversion as well as KNBT’s IPO. The transaction is anticipated to close in the fourth quarter of 2003. Upon execution of the Merger Agreement, the Bank terminated its previously adopted MHC Plan discussed in Note N.

F-23

Report of Independent Certified Public Accountants

Board of Directors and Shareholders

First Colonial Group, Inc.

We have audited the accompanying consolidated balance sheets of First Colonial Group, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Colonial Group, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.

/s/    Grant Thornton LLP

Philadelphia, Pennsylvania

January 16, 2003 (except for Note X as to which

the date is March 6, 2003)

F-24

FIRST COLONIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	At March 31,			At December 31,
	2003			2002			2001
(Dollars in Thousands)	(Unaudited)
ASSETS
Total Cash and Cash Equivalents	$	20,698		$	22,741		$	17,270
Interest-Bearing Deposits With Banks		10,547			5,002			919
Investments Securities Held-to-Maturity (Fair Value: March 31, 2003 (unaudited) $69,831; Dec. 31, 2002—$30,791; Dec. 31, 2001—$23,160)		69,461			30,297			23,004
Investment Securities Available-for-Sale		254,930			283,481			181,302
Mortgage Loans Held-for-Sale		848			1,263			3,808
Loans		252,624			255,844			225,757
Less: Allowance for Possible Loan Losses		(3,112	)		(3,084	)		(2,264	)
Net Loans		249,512			252,760			223,493
Premises and Equipment, Net		6,399			6,375			6,562
Accrued Interest Income		2,914			3,142			2,888
Other Real Estate Owned		180			—			93
Other Assets		5,229			6,531			5,805
TOTAL ASSETS	$	620,718		$	611,592		$	465,144
LIABILITIES
Deposits
Non-Interest-Bearing Deposits	$	69,115		$	64,150		$	57,931
Interest-Bearing Deposits (Includes Certificates of Deposit in Excess of $100: March 31, 2003 (unaudited)—$9,734; Dec. 31, 2002—$4,019; Dec. 31, 2001—$11,592)		414,262			408,648			321,955
Total Deposits		483,377			472,798			379,886
Securities Sold Under Agreements to Repurchase		8,774			8,801			8,380
Long-Term Debt		67,039			67,921			34,804
Guaranteed Preferred Beneficial Interest in the Company’s Subordinated Debentures		15,000			15,000			—
Accrued Interest Payable		3,167			3,129			3,949
Other Liabilities		2,873			3,629			2,799
TOTAL LIABILITIES		580,230			571,278			429,818
SHAREHOLDERS’ EQUITY
Preferred Stock, Par Value $5.00 a share Authorized: 500,000 shares, none issued		—			—			—
Common Stock, Par Value $5.00 a share Authorized: 10,000,000 shares Issued and Outstanding: 2,239,861 shares at March 31, 2003 (unaudited); 2,217,971 shares at Dec. 31, 2002 and 2,085,778 shares at Dec. 31, 2001		11,199			11,090			10,429
Additional Paid-In Capital		21,154			20,786			18,304
Retained Earnings		8,950			8,430			8,581
Less: Treasury Stock at Cost:
No shares at March 31, 2003 (unaudited) and Dec. 31, 2002; 2,463 shares at Dec. 31, 2001		—			—			(59	)
Less: Deferred Stock Compensation:
No shares at March 31, 2003 (unaudited); 10,500 shares at Dec. 31, 2002 and no shares at Dec. 31, 2001		—			(220	)		—
Employee Stock Ownership Plan Debt		(1,093	)		(1,093	)		(1,235	)
Accumulated Other Comprehensive Income (Loss)		278			1,321			(694	)
TOTAL SHAREHOLDERS’ EQUITY		40,488			40,314			35,326
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	620,718		$	611,592		$	465,144

See accompanying notes to consolidated financial statements.

F-25

FIRST COLONIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

	Three Months Ended				Year Ended December 31,
	March 31, 2003		March 31, 2002		2002		2001		2000
	(Unaudited)
(Dollars in Thousands, except per share data)
INTEREST INCOME
Interest and Fees on Loans	$	4,176	$	4,264	$	17,452	$	18,596	$	18,116
Interest on Investment Securities
Taxable		2,758		2,368		9,847		9,515		9,440
Tax-Exempt		610		438		2,074		1,756		1,567
Interest on Deposits with Banks and Federal Funds Sold		35		40		157		168		164
Total Interest Income		7,579		7,110		29,530		30,035		29,287
INTEREST EXPENSE
Interest on Deposits		2,139		2,479		9,723		11,521		11,414
Interest on Short-Term Debt		27		58		189		459		588
Interest on Long-Term Debt		730		498		2,082		1,989		1,945
Interest on Trust-Preferred Securities		181		—		416		—		—
Total Interest Expense		3,077		3,035		12,410		13,969		13,947
NET INTEREST INCOME		4,502		4,075		17,120		16,066		15,340
Provision for Possible Loan Losses		200		400		1,541		580		375
Net Interest Income After Provision for Possible Loan Losses		4,302		3,675		15,579		15,486		14,965
OTHER INCOME
Trust Revenue		285		284		1,197		1,287		1,245
Service Charges on Deposit Accounts		619		599		2,586		2,335		2,019
Investment Securities Gains, Net		765		369		1,253		929		174
Gains on Sales of Mortgage Loans		417		76		1,122		346		59
Other Operating Income		180		229		749		710		825
Total Other Income		2,266		1,557		6,907		5,607		4,322
OTHER EXPENSES
Salaries and Employee Benefits		2,576		2,047		9,055		8,224		7,437
Net Occupancy and Equipment Expense		643		666		2,463		2,528		2,392
Impairment of Mortgage Servicing Rights		637		—		—		—		—
Other Operating Expenses		1,645		1,565		6,093		5,976		7,116
Total Other Expenses		5,501		4,278		17,611		16,728		16,945
Income Before Income Taxes		1,067		954		4,875		4,365		2,342
Income Taxes		135		143		877		808		270
NET INCOME	$	932	$	811	$	3,998	$	3,557	$	2,072
PER SHARE DATA(1)
Net Income—Basic	$	0.43	$	0.37	$	1.85	$	1.69	$	0.99
Net Income—Diluted	$	0.41	$	0.37	$	1.82	$	1.68	$	0.99
Cash Dividends	$	0.19	$	0.18	$	0.74	$	0.70	$	0.67

⁽¹⁾ Per share data has been adjusted to reflect the 5% stock dividends of May 2002, June 2001 and June 2000.

See accompanying notes to consolidated financial statements.

F-26

FIRST COLONIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

	Common Stock		Additional Paid-In Capital			Retained Earnings			Deferred Stock Compensation		Treasury Stock			ESOP Debt			Accumulated Other Comprehensive Income (Loss)			Total
	(Dollars in Thousands)
Balance at December 31, 1999	$	9,242	$	15,674		$	8,968		$	—	$	—		$	(1,320	)	$	(4,321	)	$	28,243
2000
Comprehensive Income
Net Income							2,072														2,072
Other Comprehensive Income
Net of Reclassification Adjustments and Taxes																		4,358			4,358
Total Comprehensive Income																					6,430
Sale of Common Stock under Dividend Reinvestment Plan (21,177 shares)		106		207																	313
Sale of Common Stock under Directors Stock Option Plan (332 shares)		2																			2
Cash Dividends Paid							(1,406	)													(1,406	)
Stock Dividend of 5% (92,752 shares)		464		1,078			(1,542	)													—
Cash Paid in Lieu of Fractional Shares							(2	)													(2	)
ESOP Loan Payment															115						115
Loan to ESOP															(172	)					(172	)
Unallocated ESOP Shares Committed to Employees (6,334 shares)				(2	)																(2	)
Balance at December 31, 2000		9,814		16,957			8,090			—		—			(1,377	)		37			33,521
2001
Comprehensive Income
Net Income							3,557														3,557
Other Comprehensive Income
Net of Reclassification Adjustments and Taxes																		(731	)		(731	)
Total Comprehensive Income																					2,826
Sale of Common Stock under Dividend Reinvestment Plan (19,907 shares)		100		228																	328
Sale of Common Stock under Stock Option Plan (4,692 shares)		23		36																	59
Purchase of Treasury Shares (2,463 shares)												(59	)								(59	)
Cash Dividends Paid							(1,489	)													(1,489	)
Stock Dividend of 5% (98,480 shares)		492		1,083			(1,575	)													—
Cash Paid in Lieu of Fractional Shares							(2	)													(2	)
ESOP Loan Payment															142						142
Unallocated ESOP Shares Committed to Employees (9,000 shares)				—																	—
Balance at December 31, 2001		10,429		18,304			8,581			—		(59	)		(1,235	)		(694	)		35,326

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	Common Stock		Additional Paid-In Capital			Retained Earnings			Deferred Stock Compensation			Treasury Stock			ESOP Debt			Accumulated Other Comprehensive Income (Loss)			Total
	(Dollars in Thousands)
2002
Comprehensive Income
Net Income							3,998															3,998
Other Comprehensive Income
Net of Reclassification Adjustments and Taxes																			2,015			2,015
Total Comprehensive Income																						6,013
Deferred Stock Compensation Issued (10,500 shares)		50		170						(220	)											—
Sale of Common Stock under Dividend Reinvestment Plan (7,287 shares)		37		134																		171
Sale of Common Stock under Stock Option Plan (10,063 shares)		50		130																		180
Purchase of Treasury Shares (5,850 shares)													(146	)								(146	)
Sale of Treasury Shares under Dividend Reinvestment Plan (8,313 shares)				(13	)								205									192
Cash Dividends Paid							(1,597	)														(1,597	)
Stock Dividend of 5% (104,843 shares)		524		2,023			(2,547	)														—
Cash Paid in Lieu of Fractional Shares							(5	)														(5	)
ESOP Loan Payment																142						142
Unallocated ESOP Shares Committed to Employees (8,300 shares)				38																		38
Balance at December 31, 2002		11,090		20,786			8,430			(220	)		—			(1,093	)		1,321			40,314
2003
Comprehensive Income (Loss)
Net Income							932															932
Change in Unrealized Securities Gains, Net																			(1,043	)		(1,043	)
Total Comprehensive Income (Loss)																						(111	)
Distribution of Stock Compensation (10,000 shares)										220												220
Sale of Common Stock under Dividend Reinvestment Plan (3,771 shares)		18		80																		98
Sale of Common Stock under Stock Option Plans (18,119 shares)		91		288																		379
Cash Dividends Paid							(412	)														(412	)
Balance at March 31, 2003	$	11,199	$	21,154		$	8,950		$	—		$	—		$	(1,093	)	$	278		$	40,488

See accompanying notes to consolidated financial statements.

F-28

FIRST COLONIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Three Months Ended						Year Ended December 31,
	March 31, 2003			March 31, 2002			2002			2001			2000
	(Unaudited)
(Dollars in Thousands)
OPERATING ACTIVITIES
Net Income	$	932		$	811		$	3,998		$	3,557		$	2,072
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Provision for Possible Loan Losses		200			400			1,541			580			375
Depreciation and Amortization		370			352			1,378			1,259			1,120
Accretion of Security Discounts		(29	)		(69	)		(261	)		(365	)		(430	)
Amortization of Security Premiums		562			206			1,282			426			239
Deferred Taxes		(226	)		—			(103	)		185			(389	)
Amortization of Deferred Fees on Loans		109			58			552			359			479
Gain on Sale of Other Real Estate Owned		—			(6	)		(2	)		(33	)		(119	)
Loss from Writedown of Other Real Estate Owned		—			—			—			—			184
Investment Securities Gains, Net		(765	)		(369	)		(1,253	)		(929	)		(174	)
Gain on Sale of Mortgage Loans		(417	)		(76	)		(1,122	)		(346	)		(59	)
Mortgage Loans Originated for Sale		(7,406	)		(4,889	)		(33,053	)		(30,190	)		(7,718	)
Mortgage Loan Sales		16,154			9,672			52,909			44,678			7,718
Changes in Assets and Liabilities
(Increase) Decrease in Accrued Interest Income		228			(108	)		(254	)		938			(781	)
(Decrease) Increase in Accrued Interest Payable		38			(81	)		(820	)		(1,053	)		794
Decrease (Increase) in Other Assets		1,168			(792	)		(1,589	)		(213	)		(439	)
Increase (Decrease) in Other Liabilities		(30	)		82			270			(1,611	)		1,181
Net Cash Provided by Operating Activities		10,888			5,191			23,473			17,242			4,053
INVESTING ACTIVITIES
Proceeds from Calls and Maturities of Securities Available-for-Sale		23,366			15,464			85,796			75,806			13,747
Proceeds from Calls and Maturities of Securities Held-to-Maturity		4,555			4,491			27,182			11,843			1,128
Proceeds from Sales of Securities Available-for-Sale		50,908			28,053			91,433			35,263			8,294
Purchase of Securities Available-for-Sale		(47,022	)		(30,789	)		(276,235	)		(128,424	)		(45,625	)
Purchase of Securities Held-to-Maturity		(43,768	)		(15,959	)		(34,362	)		(15,033	)		(2,334	)
Net (Increase) Decrease in Interest-Bearing Deposits With Banks		(5,545	)		(18,482	)		(4,084	)		(824	)		5,494
Net Increase in Loans		(5,157	)		(11,196	)		(47,794	)		(18,288	)		(25,949	)
Purchase of Premises and Equipment		(223	)		(21	)		(703	)		(706	)		(703	)
Proceeds from Sale of Other Real Estate Owned		—			98			340			704			623
Net Cash Used in Investing Activities		(22,886	)		(28,341	)		(158,427	)		(39,659	)		(45,325	)
FINANCING ACTIVITIES
Net Increase in Interest and Non-Interest Bearing Demand Deposits, Savings and Money Market Accounts		5,867			24,813			89,591			27,548			12,074
Net Increase (Decrease) in Certificates of Deposit		4,712			(4,524	)		3,321			(852	)		16,636
Proceeds from Long-Term Debt		—			90			33,126			5,804			12,000
Payments on Long-Term Debt		(882	)		(2	)		(9	)		(5,000	)		(8,000	)
Net Decrease (Increase) in ESOP Debt		—			—			142			142			(57	)
Net (Decrease) Increase in Repurchase Agreements		(27	)		3,399			421			1,165			5,485
(Decrease) Increase in Short-Term Debt		—			—			—			(5,695	)		5,695
Proceeds from Issuance of Common Stock		477			164			389			387			313
Purchase of Treasury Stock		—			(146	)		(146	)		(59	)		—
Proceeds from the Sale of Treasury Stock		—			80			192			—			—
Proceeds from the Issuance of Guaranteed Preferred Beneficial Interest in Company’s Subordinated Debentures		—			—			15,000			—			—
Distribution of Deferred Stock Compensation		220			—
Cash Dividends Paid		(412	)		(388	)		(1,597	)		(1,489	)		(1,406	)
Cash Paid in Lieu of Fractional Shares		—			—			(5	)		(2	)		(2	)
Net Cash Provided by Financing Activities		9,955			23,486			140,425			21,949			42,738
Increase (Decrease) in Cash and Cash Equivalents		(2,043	)		336			5,471			(468	)		1,466
Cash and Cash Equivalents, January 1,		22,741			17,270			17,270			17,738			16,272
Cash and Cash Equivalents, End of Period	$	20,698		$	17,606		$	22,741		$	17,270		$	17,738

See accompanying notes to consolidated financial statements.

F-29

FIRST COLONIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All dollar amounts presented in the tables are in thousands, except per share data.)

NOTE A—SUMMARY OF ACCOUNTING POLICIES

First Colonial Group, Inc. (“First Colonial”) is a one-bank holding company of Nazareth National Bank and Trust Company (the “Nazareth National Bank”), First C. G. Company, Inc. (“First C. G.”) and First Colonial Statutory Trust I (“Statutory Trust I”). Nazareth National Bank is an independent community bank providing retail and commercial banking services through its 19 offices in Northampton, Lehigh, and Monroe counties in northeastern Pennsylvania.

Nazareth National Bank competes with other banking and financial institutions in its primary market communities, including financial institutions with resources substantially greater than its own. Commercial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for savings and time deposits and for various types of loans. Such institutions, as well as consumer finance and insurance companies, may be considered competitors of Nazareth National Bank with respect to one or more of the services it renders.

First Colonial and the Nazareth National Bank are subject to regulations of certain state and Federal agencies and, accordingly, they are periodically examined by those regulatory agencies. As a consequence of the extensive regulation of commercial banking activities, Nazareth National Bank’s business is particularly susceptible to being affected by state and Federal legislation and regulation which may have the effect of increasing the cost of doing business.

1. BASIS OF FINANCIAL STATEMENT PRESENTATION

The consolidated financial statements include the accounts of First Colonial and its wholly-owned subsidiaries, Nazareth National Bank, First C. G., and Statutory Trust I. All significant inter-company balances and transactions have been eliminated.

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the balance sheets and revenues and expenditures for the periods. Therefore, actual results could differ significantly from those estimates.

The consolidated balance sheet at March 31, 2003, and the consolidated statements of income and cash flows for the three month periods ended March 31, 2003 and 2002, and the consolidated statement of changes in shareholders’ equity for the three month period ended March 31, 2003 are unaudited and, in the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for a fair presentation have been made. Amounts appearing in the accompanying notes as of March 31, 2003 and for the three month periods ended March 31, 2003 and 2002 are unaudited. The results of operations for the three months ended March 31, 2003 and 2002 are not necessarily indicative of the results that may be attained for an entire fiscal year.

The principal estimate that is particularly susceptible to significant change in the near term relates to the allowance for loan losses. The evaluation of the adequacy of the allowance for loan losses includes an analysis of the individual loans and overall risk characteristics and size of the different loan portfolios, and takes into consideration current economic and market conditions, the capability of specific borrowers to pay specific loan obligations, as well as current loan collateral values. However, actual losses on specific loans, which also are encompassed in the analysis, may vary from estimated losses.

First Colonial has one reportable segment, “Community Banking”. All of First Colonial’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities

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of First Colonial supports the others. For example, commercial lending is dependent upon the ability of Nazareth National Bank to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential mortgage lending. Accordingly, all significant operating decisions are based upon analysis of First Colonial as one operating segment or unit. First Colonial has also identified several operating segments. These operating segments within First Colonial’s operations do not have similar characteristics to the community banking operations and do not meet the quantitative thresholds requiring separate disclosure. These non-reportable segments include First C. G. and the Parent.

2. INVESTMENT SECURITIES

As required by Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, First Colonial classifies debt and marketable equity securities in three categories: trading, available-for-sale and held-to-maturity. Trading securities are measured at fair value, with unrealized holding gains and losses included in income. First Colonial does not have any securities classified as trading securities. Available-for-sale securities are measured at fair value, with unrealized gains and losses, net of tax effect, reported in equity. Investment securities held-to-maturity are principally debt securities and are carried at cost, net of un-amortized premiums and discounts, which are recognized in interest income using the interest method over the period to maturity. First Colonial has the positive intent and ability to hold such securities until maturity. Gains or losses on disposition are based on the net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method.

3. MORTGAGE LOANS HELD-FOR-SALE

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or estimated fair value. Gains and losses on the sales of loans are also accounted for in accordance with SFAS No. 134, “Accounting for Mortgage Securities Retained after the Securitizations of Mortgage Loans Held-for-Sale by a Mortgage Banking Enterprise”. This statement requires that an entity engaged in mortgage banking activities classify the retained mortgage-backed security or other interest, which resulted from the securitizations of a mortgage loan held-for-sale based upon its ability and intent to sell or hold these investments.

4. LOANS AND ALLOWANCE FOR POSSIBLE LOAN LOSSES

Loans receivable that First Colonial has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, reduced by unearned discount and an allowance for possible loan losses. Interest income on loans is accrued using various methods which approximate a constant yield.

Certain origination and commitment fees, and certain direct loan origination costs are deferred and amortized over the contractual life of the related loans. This results in an adjustment of the yield on the related loan.

Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. Upon such discontinuance, all unpaid accrued interest is reversed.

F-31

The allowance for possible loan losses is established through a provision for loan losses charged to expenses. Loans are charged against the allowance for possible loan losses when management believes that the collectibility of principal is unlikely. The allowance is an amount that management believes will be adequate to absorb possible loan losses on existing loans that may become uncollectible, based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower’s ability to pay.

As required by SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”, as amended by SFAS No. 118, “Accounting by Creditors for Impairment of a Loan—Income Recognition and Disclosures”, First Colonial measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that, as a practical expedient, impairment may be measured based on the observable market price of a loan, or the fair value of the collateral if the loan is collateral dependent. First Colonial measures impairment based on the fair value of the collateral when it determines that foreclosure is probable.

In November 2002, FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN No. 45), was issued. The disclosure requirements of FIN No. 45 are effective for the year ended December 31, 2002 and require disclosure of the nature of the guarantee, the maximum potential amount of future payments that that the guarantor could be required to make under the guarantee, and the current amount of the liability, if any, for the guarantor’s obligations under the guarantee. Significant guarantees that have been entered into by the Bank include standby letters of credit, which totaled approximately $ 1.3 million as of March 31, 2003. The adoption of FIN No. 45 did not have a material impact on the consolidated financial statements.

The Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) 102, Selected Loan Loss Allowance Methodology and Documentation Issues. SAB 102 provides guidance on the development, documentation, and application of a systematic methodology for determining the allowance for loans and leases in accordance with US GAAP. The issuance of SAB No. 102 did not have a material impact on First Colonial’s financial position or results of operations.

5. PREMISES AND EQUIPMENT

Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation of buildings and land improvements is computed principally on the straight-line method, and for equipment, principally on an accelerated method, over the estimated useful lives of the assets.

On January 1, 2002, we adopted SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS No. 144 supercedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of”, but it retains many of the fundamental provisions of that statement. The adoption of this statement did not have a significant impact on the financial condition or the results of operations of First Colonial.

6. COMPREHENSIVE INCOME

First Colonial follows SFAS No. 130, “Reporting Comprehensive Income”. Comprehensive income consists of net income or loss for the current period and income, expenses, gains, and losses that bypass the income statement and are reported directly in a separate component of equity.

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The income tax effects allocated to comprehensive income (loss) are as follows:

	Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount
For the Three Months Ended March 31, 2003
Unrealized Losses on Securities:
Unrealized Holding Losses Arising During Period	$	(2,345	)	$	797		$	(1,548	)
Less: Reclassification Adjustment for Gains Realized in Net Income		(765	)		260			(1,025	)
Other Comprehensive Loss, Net	$	(1,580	)	$	537		$	(1,043	)
For the Year Ended December 31, 2002
Unrealized Gains on Securities:
Unrealized Holding Gains Arising During Period	$	1,802		$	(615	)	$	1,187
Less: Reclassification Adjustment for Gains Realized in Net Income		(1,253	)		425			(828	)
Other Comprehensive Income, Net	$	3,055		$	(1,040	)	$	2,015
For the Year Ended December 31, 2001
Unrealized Losses on Securities:
Unrealized Holding Losses Arising During Period	$	(2,039	)	$	695		$	(1,344	)
Less: Reclassification Adjustment for Gains Realized in Net Income		(929	)		316			(613	)
Other Comprehensive Loss, Net	$	(1,110	)	$	379		$	(731	)
For the Year Ended December 31, 2000
Unrealized Gains on Securities:
Unrealized Holding Gains Arising During Period	$	6,431		$	(2,188	)	$	4,243
Less: Reclassification Adjustment for Gains Realized in Net Income		(174	)		59			(115	)
Other Comprehensive Income, Net	$	6,605		$	(2,247	)	$	4,358

F-33

7. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Statement of Financial Accounting Standards No. 119, “Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments” (“SFAS 119”) requires disclosures about financial instruments, which are defined as futures, forwards, swap and option contracts and other financial instruments with similar characteristics. On balance sheet receivables and payables are excluded from this definition. First Colonial did not hold any derivative financial instruments as defined by SFAS 119 at March 31, 2003, December 31, 2002, 2001 or 2000.

8. INCOME TAXES

First Colonial calculates deferred income taxes under the liability method whereby deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities.

9. STOCK BASED COMPENSATION

Under First Colonial’s Stock Option Plans, options to acquire shares of common stock are granted to certain officers, key employees and directors.

First Colonial’s Stock Option Plans are accounted for under SFAS No. 123, “Accounting for Stock-Based Compensation”. This standard contains a fair value-based method for valuing stock-based compensation which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, the standard permits entities to continue accounting for employee stock options and similar instruments under APB Opinion No. 25. Entities that continue to account for stock options using APB Opinion No. 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied. First Colonial’s stock option plans are accounted for under APB Opinion No. 25. Had compensation cost for the Plans been determined based on the fair value of the options at the grant dates consistent with the method required by SFAS No. 123, “Accounting for Stock-Based Compensation”, First Colonial’s net income and earnings per share would have been reduced to the pro forma amounts indicated below.

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		Three Months Ended, March 31,
		2003			2002
		(Unaudited)
Net Income (Loss)	As reported	$	932		$	811
	Stock-based Compensation Cost Determined under Fair Value Method for all Awards		(1,161	)		(95	)
	Pro forma	$	(229	)	$	716
Basic earnings (loss)	As reported	$	0.43		$	0.37
per share	Pro forma	$	(0.11	)	$	0.33
Diluted earnings (loss)	As reported	$	0.41		$	0.37
per share	Pro forma	$	(0.11	)	$	0.33

		Year Ended December 31,
		2002			2001			2000
Net Income	As reported	$	3,998		$	3,557		$	2,072
	Stock-based Compensation Cost Determined under Fair Value Method for all Awards		(380	)		(144	)		(135	)
	Pro forma	$	3,618		$	3,413		$	1,937
Basic earnings	As reported	$	1.85		$	1.69		$	0.99
per share	Pro forma	$	1.67		$	1.62		$	0.92
Diluted earnings	As reported	$	1.82		$	1.68		$	0.99
per share	Pro forma	$	1.63		$	1.61		$	0.92

The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted-average assumptions used for grants in the three months ended March 31, 2003 and 2002, respectively: dividend yield of 1.8% and 3.3%; expected volatility of 53.5% and 43.5%; risk-free interest rates of 4.1% and 4.9%; and expected lives of 7.7 years and 10 years. The assumptions for the years ended December 31, 2002, 2001 and 2000, respectively were: dividend yield of 3.3%, 4.4% and 2.8%; expected volatility of 43.5%, 26.0% and 27.0%; risk-free interest rates of 4.9%, 5.2% and 6.07%; and expected lives of 10 years. The stock-based compensation cost for the three months ended March 31, 2003 was affected by the accelerated vesting of all stock options as a result of the execution of the merger agreement with Keystone Savings Bank.

10. EMPLOYEE BENEFIT PLANS

First Colonial has established an Employee Stock Ownership Plan (ESOP) covering eligible employees with one year of service as defined by the ESOP. First Colonial accounts for its ESOP in accordance with Statement of Position (SOP) 93-6, “Employer’s Accounting for Employee Stock Ownership Plans”, issued by the Accounting Standards Division of the

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American Institute of Certified Public Accountants (AICPA). SOP 93-6 is applied to shares acquired by the ESOP after December 31, 1992.

Employees who qualify may elect to participate in a deferred salary savings 401(k) plan. First Colonial contributes $.50 for each $1.00 up to the first 5% that each employee contributes. First Colonial also has an executive compensation plan which provides additional death, medical and retirement benefits to certain officers.

First Colonial has a deferred compensation plan involving the Directors of First Colonial. This plan provides defined annual payments for 15 years beginning at age 65 or death in exchange for the Directors deferring the payment of a portion of their fees.

First Colonial records the cost of post-retirement medical benefits on the accrual basis as employees render service to earn the benefits and records a liability for the unfunded accumulated post-retirement benefit obligation. The transition obligation, representing the unfunded and unrecognized accumulated past-service benefit obligation for all plan participants, will be amortized on a straight-line basis over a 20-year period.

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11. TRUST ASSETS AND REVENUE

Assets held by the Trust Department of Nazareth National Bank in fiduciary or agency capacities for its customers are not included in the accompanying consolidated balance sheets since such assets are not assets of First Colonial. Operating revenue and expenses of the Trust Department are included under their respective captions in the accompanying consolidated statements of income and are recorded on the accrual basis.

12. PER SHARE INFORMATION

First Colonial follows the provisions of SFAS No. 128, “Earnings Per Share”. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. Share and per share amounts have been retroactively restated to reflect the three 5% stock dividends in May 2002, June 2001 and June 2000.

13. STATEMENT OF CASH FLOWS

First Colonial considers cash, due from banks and Federal funds sold as cash equivalents for the purposes of the Consolidated Statements of Cash Flows.

Cash paid for interest was $13,230,000, $15,022,000 and $13,153,000, for the years ended December 31, 2002, 2001 and 2000, respectively. Cash paid for taxes was $1,175,000 in 2002, $610,000 in 2001 and $500,000 in 2000.

14. ADVERTISING COSTS

First Colonial expenses advertising costs as incurred.

15. TRANSFER AND SERVICING OF ASSETS AND EXTINGUISHMENTS OF LIABILITIES

In September, 2000, SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, was issued. SFAS No. 140 replaces SFAS No. 125, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, and revises the standards for accounting for the securitizations and other transfers of financial assets and collateral. This new standard also requires certain disclosures, but carries over most of the provisions of SFAS 125. SFAS 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. However, for recognition and reclassification of collateral and for disclosures relating to securitizations transactions and collateral, this statement is effective for fiscal years ending after December 15, 2000 with earlier application not allowed and is to be applied prospectively. The adoption of this statement did not have a material impact on First Colonial’s consolidated financial statements.

16. NEW ACCOUNTING PRONOUNCEMENTS

On January 1, 2002, First Colonial adopted SFAS 141, “Business Combinations”, and SFAS 142, “Goodwill and Intangible Assets”. Upon adoption, goodwill and intangible assets

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with indefinite lives are not amortized but are tested for impairment annually. The adoption of these statements did not impact First Colonial’s financial position or results of operations.

17. RECLASSIFICATIONS

Certain reclassifications of prior years amounts have been made to conform to the March 31, 2003 presentation.

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NOTE B—INVESTMENT SECURITIES

The amortized cost, unrealized gains and losses, and fair value of First Colonial’s available-for-sale and held-to-maturity securities at March 31, 2003, December 31, 2002 and December 31, 2001 are summarized as follows:

Available–for–Sale Securities
	at March 31, 2003									at December 31,
	(unaudited)									2002									2001
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U. S. Treasury	$	4,206	$	42	$	—		$	4,248	$	5,244	$	43	$	—		$	5,287	$	5,074	$	34	$	—		$	5,108
U. S. Government Agency		15,297		124		(26	)		15,395		25,315		360		(5	)		25,670		43,977		127		(400	)		43,704
States and Political Subdivisions		46,414		1,027		(100	)		47,341		44,315		948		(81	)		45,182		31,450		130		(453	)		31,127
Mortgage-Backed Securities		166,357		869		(135	)		167,091		186,209		2,167		(38	)		188,338		87,461		438		(646	)		87,253
Corporate Bonds		3,500		—		—			3,500		2,000		—		(2	)		1,998		456		2		(36	)		422
Equity Securities		18,734		166		(1,545	)		17,355		18,396		172		(1,562	)		17,006		13,937		269		(518	)		13,688
Total	$	254,508	$	2,228	$	(1,806	)	$	254,930	$	281,479	$	3,690	$	(1,688	)	$	283,481	$	182,355	$	1,000	$	(2,053	)	$	181,302
Held-to-Maturity Securities
	at March 31, 2003									at December 31,
	(unaudited)									2002									2001
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U. S. Government Agency	$	12,808	$	94	$	(31	)	$	12,871	$	6,414	$	148	$	—		$	6,562	$	8,622	$	197	$	—		$	8,819
States and Political Subdivisions		8,009		160		(53	)		8,116		8,507		165		(57	)		8,615		7,885		38		(112	)		7,811
Mortgage-Backed Securities		48,644		201		(1	)		48,844		15,376		239		(1	)		15,614		6,497		56		(23	)		6,530
Total	$	69,461	$	455	$	(85	)	$	69,831	$	30,297	$	552	$	(58	)	$	30,791	$	23,004	$	291	$	(135	)	$	23,160

At December 31, the equity securities in the available-for-sale category include Federal Reserve Bank stock in the amount of $564,000 in 2002 and $258,000 in 2001, and Federal Home Loan Bank stock in the amount of $4,218,000 in 2002 and $2,204,000 in 2001 which are carried at cost.

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The following tables lists the maturities of debt securities at March 31, 2003 and December 31, 2002, classified as available-for-sale and held-to-maturity. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

MATURITIES OF DEBT SECURITIES

	At March 31, 2003 (Unaudited)
	Available-for-Sale				Held-to-Maturity
	Amortized Cost		Carrying Value at Fair Value		Carrying Value at Amortized Cost		Fair Value
Due in one year or less	$	100	$	104	$	—	$	—
Due after one year through five years		5,228		5,275		1,459		1,474
Due after five years through ten years		24,846		25,254		9,623		9,082
Due after ten years		39,241		39,850		9,736		9,710
		69,415		70,483		20,818		20,266
Mortgage-Backed Securities		166,359		167,092		48,643		48,845
Equity Securities		18,734		17,355		—		—
Total Investments	$	254,508	$	254,930	$	69,461	$	69,111

Investment securities with a carrying amount of $14,776,000, $15,926,000 and $11,568,000 at March 31, 2003, December 31, 2002 and 2001, respectively, were pledged to secure public deposits, to qualify for fiduciary powers and for other purposes required or permitted by law. There were no securities held other than U. S. Treasury or U. S. Agencies from a single issuer which represented more than 10% of shareholders’ equity. Proceeds from the sales of investments in debt and equity securities available-for-sale during the three months ended March 31, 2003 and 2002 were $50,908,000 and $28,053,000, respectively. During the first quarter of 2003 gross gains on the securities sales were $790,000 and gross losses were $25,000. Gross gains of $400,000 and gross losses of $31,000 were realized on the sales in the first quarter of 2002. Proceeds from sales of investments in debt and equity securities available-for-sale during years ended 2002, 2001 and 2000 were $91,433,000, $35,263,000 and $8,294,000, respectively. Gross gains of $1,318,000 and gross losses of $65,000 were realized on those sales in the year 2002. Gross gains of $1,015,000 and gross losses of $86,000 were realized on the sales in the year 2001. In the year 2000, gross realized gains were $252,000 and gross realized losses were $78,000.

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NOTE C—LOANS

Major classifications of loans at are as follows:

	at March 31, 2003			at December 31,
				2002			2001
	(Unaudited)
	(Dollars in Thousands)
Real Estate/Residential	$	101,783		$	108,372		$	112,871
Real Estate/Construction		6,263			6,076			6,127
Real Estate/Commercial		70,215			63,350			32,317
Consumer/Installment		55,935			58,792			59,205
Commercial (Non-Real Estate) and Agricultural		16,812			17,560			13,762
States and Political Subdivisions		1,724			1,805			1,702
Other		17			27			23
Total Gross Loans		252,749			255,982			226,007
Less: Unearned Discount		(125	)		(138	)		(250	)
Total Loans	$	252,624		$	255,844		$	225,757

Nazareth National Bank makes loans to its directors and executive officers. These loans were made in the ordinary course of business at substantially the same terms and conditions as those with other borrowers.

An analysis of the activity of these loans follows:

	For the Three Months Ended March 31, 2003
	(Unaudited)
Balance, January 1, 2003	$	2,085
New Loans		93
Repayments		(131	)
Balance, March 31, 2003	$	2,047
	For the Year Ended December 31, 2002
Balance, January 1, 2002	$	976
New Loans		1,265
Repayments		(156	)
Balance, December 31, 2002	$	2,085

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NOTE D—ALLOWANCE FOR POSSIBLE LOAN LOSSES

Transactions in the allowance for possible loan losses were as follows:

	Three Months Ended March 31, 2003			March 31, 2002			Year Ended December 31,
							2002			2001			2000
	(unaudited)
Beginning Balance	$	3,084		$	2,264		$	2,264		$	2,411		$	2,437
Provisions charged to operating expenses		200			400			1,541			580			375
Recoveries		19			45			233			177			160
Loans charged-off		(191	)		(359	)		(954	)		(904	)		(561	)
Ending Balance	$	3,112			2,350		$	3,084		$	2,264		$	2,411

At March 31, 2003 the loans on non-accrual totaled $1,395,000 and the average loans on non-accrual for the first quarter of 2003 were $1,402,000. There were loans totaling $1,351,000 on which the accrual of interest has been discontinued or reduced at December 31, 2002. During 2002, an average of $1,035,000 of loans was on non-accrual status. Non-accrual loans at December 31, 2001 amounted to $1,019,000 and averaged $943,000 during 2001. Loans 90 days and over past due and still accruing totaled $432,000 at March 31, 2003, $874,000 at December 31, 2002 and $2,185,000 at December 31, 2001.

The recorded investment in impaired loans was $65,000 at March 31, 2003 and $65,000, $103,000 and $339,000 at December 31, 2002, 2001 and 2000, respectively. The valuation allowance for credit losses related to impaired loans is a part of the allowance for possible loan losses. The total valuation allowance was $6,000, $8,000, $43,000 and $78,000 at March 31, 2003, December 31, 2002, 2001 and 2000, respectively. The average recorded approximate investment in impaired loans in the three months ended March 3, 2003 was $65,000. The average recorded investment in impaired loans during the years ended December 31, 2002, 2001 and 2000 was approximately $78,000, $201,000 and $317,000, respectively. All impaired loans were on a non-accrual status. Income on impaired loans is recognized by First Colonial on a cash basis. There was no income recognized on impaired loans by First Colonial during the three months ended March 31, 2003. First Colonial recognized interest income of approximately $5,000, $33,000 and $42,000 on impaired loans in the years 2002, 2001 and 2000, respectively.

NOTE E—PREMISES AND EQUIPMENT

Major classifications of these assets are summarized as follows:

	Estimated Useful Lives	at March 31, 2003			at December 31,
					2002			2001
		(unaudited)
Land	—	$	1,509		$	1,509		$	1,324
Premises	10-20 years		7,874			7,742			7,550
Equipment	3-10 years		7,058			7,045			7,168
			16,441			16,296			16,042
Accumulated depreciation and amortization			(10,042	)		(9,921	)		(9,480	)
Total Premises and Equipment		$	6,399		$	6,375		$	6,562

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Depreciation and amortization expense amounted to $199,000 for the three months ended March 31, 2003 as compared to $243,000 for the three months ended March 31, 2002. Depreciation and amortization for the years of 2002, 2001 and 2000 was $890,000, $975,000 and $987,000, respectively.

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NOTE F—DEPOSIT MATURITIES

The schedule of maturities of certificates of deposit is as follows:

	at March 31, 2003
	(Unaudited)
2003	$	76,400
2004		35,793
2005		35,700
2006		15,941
2007		13,410
Thereafter		3,157
	$	180,401

NOTE G—SHORT-TERM DEBT

The Federal Home Loan Bank of Pittsburgh provides Nazareth National Bank with a line of credit in the amount of $25,000,000. There were no short-term borrowings against this line at March 31, 2003, December 31, 2002 and 2001. There was short-term borrowings in the amount of $5,695,000 against this line at December 31, 2000.

There was no short-term debt in the form of Federal Reserve Discount borrowings and Federal Funds purchased at March 31, 2003, December 31, 2002, 2001 and 2000.

There were securities sold under agreements to repurchase totaling $8,774,000 at March 31, 2003, $8,801,000 at December 31, 2002, $8,380,000 at December 31, 2001 and $7,215,000 at December 31, 2000.

NOTE H—LONG-TERM DEBT

Nazareth National Bank had long-term debt from the Federal Home Loan Bank of Pittsburgh totaling $67,039,000 at March 31, 2003, $67,921,000 at December 31, 2002 and $34,804,000 at December 31, 2001. These loans will mature in one to ten years. The weighted average interest rate on these loans was 4.4%, 4.4% and 5.8% at March 31, 2003, December 31, 2002 and 2001, respectively.

First Colonial also has an obligation as a party to the Employee Stock Ownership Plan debt.

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The principal payments due on First Colonial’s debt at March 31, 2003 are as follows:

	ESOP Debt		FHLB Debt		Total
2003	$	142	$	84	$	226
2004		142		10,096		10,238
2005		142		100		242
2006		57		103		160
2007		57		32,717		32,774
2008 and beyond		553		23,939		24,492
Total	$	1,093	$	67,039	$	68,132

NOTE I—GUARANTEED PREFERRED BENEFICIAL INTEREST IN FIRST COLONIAL’S SUBORDINATED DEBENTURES

On June 3, 2002, First Colonial formed the statutory trust company, First Colonial Statutory Trust I (the “Statutory Trust I”), a wholly-owned Connecticut statutory business trust subsidiary of First Colonial, for the sole purpose of issuing trust preferred securities that are fully and unconditionally guaranteed by First Colonial. On June 26, 2002, First Colonial issued $15,000,000 of subordinated debentures to Statutory Trust I and the Statutory Trust I issued $15,000,000 in pooled trust preferred securities. The subordinated debentures are the sole asset of the Statutory Trust. The Trust Preferred securities are classified as long-term debt for the financial statements, but are included as Tier I capital for regulatory purposes. The interest rate on this security (4.74% at March 31, 2003 and 4.85% at December 31, 2002) is variable, adjusting quarterly at three-month LIBOR plus 3.45%. The interest is payable quarterly. The trust preferred securities mature in June 2007, or may be redeemed at any time in the event that the deduction of related interest for federal income tax purposes is prohibited, treatment as Tier I capital is no longer permitted, or certain other contingencies arise. The net proceeds of the trust preferred securities are to be used to support First Colonial’s growth and expansion plans and other general corporate purposes.

NOTE J—OTHER OPERATING EXPENSES

Other operating expenses consist of the following:

	For the Three Months Ended March 31,				For the Year Ended December 31,
	2003		2002		2002		2001			2000
	(unaudited)
Advertising	$	139	$	141	$	479	$	463		$	546
Consulting Fees		238		231		892		894			588
Data Processing Services		242		184		767		739			813
Litigation Costs and Legal Fees		73		55		210		535			723
Mortgage Servicing Amortization		171		109		488		265			116
Printing, Stationery and Supplies		66		63		442		354			320
Provisions for Trust Reserve		—		—		—		(110	)		1,012
All Other		716		782		2,815		2,836			2,998
Total Other Operating Expenses	$	1,645	$	1,565	$	6,093	$	5,976		$	7,116

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NOTE K—INCOME TAXES

Income tax expense (benefit) is as follows:

	Three Months Ended March 31, 2003			Three Months Ended March 31, 2002		Year Ended December 31,
						2002			2001		2000
	(unaudited)
Federal
Current	$	105		$	111	$	980		$	352	$	659
Change in lieu of tax relating to stock compensation		87			—
Deferred (benefit)		(57	)		32		(103	)		456		(389	)
Total	$	135		$	143	$	877		$	808	$	270

The income tax provision reconciled to the tax computed statutory Federal rate is as follows:

	Three Months Ended March 31, 2003			Three Months Ended March 31, 2002			Year Ended December 31,
							2002			2001			2000
	(unaudited)
Federal tax expense at statutory rate	$	362		$	324		$	1,657		$	1,484		$	796
Increase (decrease) in taxes resulting from:
Tax-exempt investment securities income		(212	)		(182	)		(730	)		(645	)		(582	)
Tax-exempt interest on loans		(11	)		(8	)		(41	)		(37	)		(37	)
Other, net		(4	)		9			(9	)		6			93
Applicable Income Taxes	$	135		$	143		$	877		$	808		$	270

F-46

Deferred tax assets and liabilites consist of the following:

	at March 31, 2003		at December 31,
			2002		2001
	(Unaudited)
Deferred Tax Assets:
Tax Credits	$	—	$	—	$	200
Unrealized Securities Losses		—		—		359
Loan Loss Reserve		835		772		464
Deferred Compensation		464		465		449
Post-Retirement Benefits		24		88		81
Depreciation		227		213		139
Miscellaneous Reserves		193		134		243
Other		134		148		142
Total	$	1,877	$	1,820	$	2,077
Deferred Tax Liability:
Unrealized Securities Gains	$	143	$	681	$	—
Total	$	143	$	681	$	—
Net	$	1,734	$	1,139	$	2,077

NOTE L—EMPLOYEE STOCK OWNERSHIP PLAN

First Colonial maintains an Employee Stock Ownership Plan (ESOP) for the benefit of eligible employees.

In October, 2000, the ESOP borrowed $71,875 from First Colonial’s subsidiary, First C. G., payable over ten years. The proceeds from this loan were used to purchase shares of First Colonial’s common stock on the market. In December, 2000, the ESOP borrowed an additional $100,000 from First Colonial’s subsidiary, First C. G., payable over five years. The proceeds from this loan were used to purchase the shares from the account of a former employee pursuant to the provisions of the Plan. The interest on these loans is at Nazareth National Bank’s prime rate (an interest rate of 4.25% at March 31, 2003 and December 31, 2002, and 4.75% at December 31, 2001). The balance on these loans was $57,500 and $60,000, respectively at March 31, 2003 and December 31, 2002, and $64,688 and $80,000, respectively at December 31, 2001.

In 1999, the ESOP borrowed $1,000,000 from First Colonial’s subsidiary, First C. G., payable over six years. The interest rate on this loan is at Nazareth National Bank’s prime rate (an interest rate of 4.25% at March 31, 2003 and December 31, 2002, and 4.75% at December 31, 2001). The balance outstanding on this loan was $800,000 at March 31, 2003 and December 31, 2002, and $850,000 at December 31, 2001. The proceeds from this loan were used to purchase shares of First Colonial’s common stock on the market.

In 1998, the ESOP borrowed $500,000 from First Colonial’s subsidiary, First C. G. The interest rate on this loan is at Nazareth National Bank’s prime rate (an interest rate of 4.25% at

F-47

March 31, 2003 and December 31, 2002, and 4.75% at December 31, 2001). The balance outstanding on this loan was $175,000 at March 31, 2003 and December 31, 2002, and $240,000 at December 31, 2001.

These obligations have been recorded as a liability on the books of First Colonial and are collateralized by stock of Nazareth National Bank. Interest expense represents the actual interest paid by the ESOP. The interest expense on the ESOP debt was $11,000 and $14,000 for the three months ended March 31, 2003 and 2002, respectively. The interest incurred on ESOP debt was $56,000, $108,000 and $121,000 for the years ended December 31, 2002, 2001 and 2000, respectively.

As a result of the merger agreement with Keystone Savings Bank there was no compensation expense incurred by Nazareth National Bank related to the ESOP during the first three months of 2003. During the first three months of 2002 Nazareth National Bank’s compensations expense for the ESOP was $68,000. Nazareth National Bank’s compensation expense related to the ESOP amounted to $322,000, $225,000 and $238,000 for the years ended December 31, 2002, 2001 and 2000, respectively. As provided by SOP 93-6, the ESOP compensation expense includes an amount which is the fair market value of the shares related to the loans that were allocated to the employees during these years. The amount related to the release of shares included in compensation expense was $38,000 in 2002, none in 2001 and a $2,000 credit in 2000. The number of shares released was 8,300 in 2002, 9,000 in 2001 and 6,651 in 2000.

Dividends on unallocated shares used for debt service were $9,000 for the three months ended March 31, 2003 and $41,000, $46,000 and $41,000 for the years ended December 31, 2002, 2001 and 2000, respectively.

The total shares held by the ESOP were 333,162 at March 31, 2003, and 333,162 and 336,484 at December 31, 2002 and 2001, respectively. ESOP shares have been restated to reflect the three 5% stock dividends of May, 2002, June, 2001 and June, 2000.

NOTE M—OTHER BENEFIT PLANS

Employees who qualify may elect to participate in a deferred salary savings 401(k) plan. A participating employee may contribute a maximum of 12% of his or her compensation. First Colonial will contribute $.50 for each $1.00 up to the first 5% that each employee contributes. Company payments are charged to current operating expenses. These contributions were $104,000, $101,000 and $91,000 in 2002, 2001 and 2000, respectively.

First Colonial also has an executive compensation plan (the “Officers’ Supplemental Retirement Plan”) which provides additional death, medical and retirement benefits to certain officers.

First Colonial has a deferred compensation plan (the “Deferred Directors’ Plan”) involving Directors of First Colonial. The plan requires defined annual payments for five to

F-48

fifteen years beginning at age 65 or death. The annual benefit is based upon the amount deferred plus interest. First Colonial has recorded the deferred compensation liabilities using the present value method.

The following table sets forth the changes in benefit obligations and plan assets of the Officers’ Supplemental Retirement Plan and the Deferred Directors’ Plan.

Actuarial present value of benefit obligations is as follows:

	At December 31,
	Officers’ Supplemental Retirement Plan						Deferred Directors’ Plan
	2002			2001			2002			2001
Change in benefit obligation:
Benefit obligation at beginning of year	$	661		$	388		$	417		$	443
Service cost		74			57			—			—
Interest cost		26			39			27			28
Change due to change in assumptions		34			—			—			—
Change due to plan amendment		70			—			—			—
Actual (gain) loss		(363	)		177			(2	)		(1	)
Benefits paid		—			—			(53	)		(53	)
Benefits obligation at end of year		502			661			389			417
Change in plan assets:
Fair value of plan assets at beginning of year		—			—			—			—
Actual return on plan assets		—			—			—			—
Employer contribution		—			—			53			53
Benefits paid		—			—			(53	)		(53	)
Fair value of plan assets at end of year		—			—			—			—
Funded status		(502	)		(661	)		(389	)		(417	)
Unrecognized net transition asset		(2	)		(3	)		—			—
Unrecognized net actuarial (gain) loss		(278	)		16			32			33
Unrecognized prior service cost		52			—			—			—
Adjustment to recognize additional minimum liability		—			—			(32	)		(33	)
Accrued benefit cost	$	(730	)	$	(648	)	$	(389	)	$	(417	)

The weighted average assumed discount rates used in determining the actuarial present value of the projected benefit obligation were 6.5% in 2002 and 7.0% in 2001 and 2000 for the Officers’ Supplemental Retirement Plan, and 7.0% in 2002, 2001 and 2000 for the Deferred Directors’ Plan. The weighted average expected long-term rate of return on assets was 9.0% for 2002 and 2001, and 8.0% for 2000 for the Officers’ Supplemental Retirement Plan and 9.0% in each of those years for the Deferred Directors’ Plan. The weighted average rate of increase in future compensation levels used in determining the actuarial present value for the Officers’ Supplemental Retirement Plan was 6.0% in 2002, 2001 and 2000.

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Components of the net periodic benefit costs is as follows for both plans:

OFFICERS’ SUPPLEMENTAL RETIREMENT PLAN

	Year Ended December 31,
	2002			2001		2000
Service cost	$	74		$	57	$	46
Interest cost		26			39		27
Net amortization and deferral of prior service costs		(18	)		—		(12	)
Net Periodic Benefit Cost	$	82		$	96	$	61

DEFERRED DIRECTORS’ PLAN

	Year Ended December 31,
	2002		2001		2000
Service cost	$	—	$	—	$	—
Interest cost		27		28		30
Net amortization and deferral of prior service costs		—		—		—
Net Periodic Benefit Cost	$	27	$	28	$	30

In January 2002, a grant of 10,500 shares of First Colonial’s common stock was awarded to First Colonial’s Chief Executive Officer in the form of deferred stock compensation. The total value of this award was $220,000 or $20.95 per share. This grant will vest over a five-year period at the rate of 20% per year or earlier upon a change in control. A charge for the cost of the vesting shares in the amount of $45,000 is included in the benefit expenses for the year ending December 31, 2002

NOTE N—POST-RETIREMENT BENEFIT

First Colonial sponsors a post-retirement plan that covers a certain number of retired employees and a limited group of current employees. This plan generally provides medical insurance benefits to a group of previously qualified retirees and spouses and to current full-time employees who were 60 years of age or older on January 1, 1992 and who have retired from First Colonial after attaining age 65 and are fully vested in the ESOP at the time of retirement. This plan is currently unfunded.

As permitted by SFAS No. 106, First Colonial elected to delay the recognition of the transition obligation by aggregating $308,000, which arose from adopting SFAS No. 106, and amortize this amount on a straight-line basis over 20 years. This election is recorded in the financial statements as a component of net periodic post-retirement benefit cost.

The components of the net periodic post-retirement benefit cost are as follows:

POST-RETIREMENT PLAN

	Year Ended December 31,
	2002		2001		2000
Interest cost	$	11	$	11	$	9
Amortization of transition obligation		9		8		3
Net Periodic Benefit Cost	$	20	$	19	$	12

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The assumptions used to develop the net periodic post-retirement benefit cost are as follows:

	2002		2001		2000
Discount Rate	6.50	%	7.00	%	7.00	%
Medical care cost trend rate	7.50	%	8.00	%	8.50	%

The medical care cost trend rate used in the actuarial computation ultimately is reduced to 7.5% in the year 2002 and 6.0% in 2005 and subsequent years. This was accomplished using 0.5% decrements through the year 2005 and later.

The table of actuarially computed plan assets and benefit obligations for First Colonial is presented below:

	2002			2001
POST-RETIREMENT PLAN
Change in benefit obligation:
Benefit obligation at beginning of year	$	158		$	128
Service cost		—			—
Interest cost		11			11
Actual gain		—			—
Change due to change in experience		7			37
Change due to change in assumption		4			—
Benefits paid		(17	)		(18	)
Benefits obligation at end of year		163			158
Change in plan assets:
Fair value of plan assets at beginning of year		—			—
Actual return on plan assets		—			—
Employer contribution		—			—
Benefits paid		—			—
Fair value of plan assets at end of year		—			—
Funded status		(163	)		(158	)
Unrecognized net transition obligation		154			170
Unrecognized net gain		(61	)		(78	)
Accrued benefit cost	$	(70	)	$	(66	)

The effect of a one percentage point increase in each future year’s assumed medical care cost trend rate, holding all other assumptions constant, would have been to increase the accumulated post-retirement benefit obligation by $11,131 and the net post-retirement benefit cost by $695. Decreasing the assumed health care cost trend rates by one percentage point in each year would decrease the accumulated post-retirement benefit obligation by $10,130 and the net post-retirement benefit cost by $633.

F-51

Health care benefits are provided to certain retired employees. The cost of providing these benefits was approximately $17,000, $18,000 and $13,000 in 2002, 2001 and 2000, respectively. The cost is accrued over the service periods of employees expected to receive benefits.

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NOTE O—STOCK OPTIONS

First Colonial adopted the “2001 Stock Option Plan” during 2001. Under the 2001 Stock Option Plan, options to acquire shares of common stock may be granted to key employees, officers and directors of First Colonial. The 2001 Stock Option Plan provides for the granting of options at the fair market value of First Colonial’s common stock at the time the options are granted. Each option granted under this plan may be exercised within a period of ten years from the date of grant. However, no option may be exercised within one year of grant. In 2002, options to purchase 128,375 shares of First Colonial’s common stock at an average price of $21.12 per share were issued to certain officers and directors under this plan. In 2001, options to purchase 21,873 shares of First Colonial’s common stock at an average price of $15.70 per share were issued to certain officers and directors under this plan. The aggregate number of shares which may be issued under this plan are 330,750 shares of common stock. In January, 2003, options to purchase 59,950 shares of First Colonial’s common stock at an average price of $23.83 per share were issued under the 2001 Stock Option Plan to certain officers and directors.

First Colonial adopted a Stock Option Plan in 1996 that was similar to the Stock Option Plan established in 1986. Under the Stock Option Plans, options to acquire shares of common stock may be granted to the officers and key employees. The Stock Option Plans provide for the granting of options at the fair market value of First Colonial’s common stock at the time the options are granted. Each option granted under the Stock Option Plans may be exercised within a period of ten years from the date of grant. However, no option may be exercised within one year from date of grant. In January, 2001, options to purchase 43,553 shares of First Colonial’s common stock at a price of $15.80 per share were issued to certain officers under this plan. No new options may be issued under the 1996 or the 1986 Stock Option Plans. There were no options awarded under this plan in 2000. The aggregate number of shares which may be issued under these plans are 363,884 shares of common stock.

The Non-Employee Directors Stock Option Plan provides for the awarding of stock options to First Colonial’s Directors. Pursuant to this Plan, on May 1, 1994, each non-employee director of First Colonial was automatically granted an option to purchase 1,477 shares of First Colonial’s common stock at the fair market value of First Colonial’s common stock of $11.51 per share. In addition, on May 1, 1999, the fifth anniversary of the initial option grant, persons who continue to be non-officer directors were each granted additional options to purchase 1,477 shares of First Colonial’s common stock at a price of $18.21. The Plan additionally provides that any non-employee director who is first elected or appointed as a director of First Colonial or any subsidiary after May 1, 1994, shall, as of that date of such election or appointment, automatically be granted an option to purchase 1,477 shares of First Colonial’s common stock. Such persons who continue to be non-officer directors shall also be granted additional options to purchase 1,477 shares of First Colonial’s common stock on the fifth anniversary of the date they were first elected or appointed to the Board of Directors. There were no options awarded under this plan in 2001. In 2000, options to purchase 2,955 shares of First Colonial’s common stock at a price of $14.90 per share were granted to certain non-employee directors pursuant to the provisions of

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this plan. The aggregate number of shares which may be issued under the Non-Employee Directors Stock Option Plan is 29,547 shares of common stock.

A summary of the 2001 Stock Option Plan as of December 31, 2002 and 2001 and changes during the years are presented below.

2001 EMPLOYEE STOCK OPTION PLAN

	Year Ended December 31,
	2002			2001
	Shares	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
Outstanding at beginning of year	21,873	$	15.70	—	$	—
Granted	128,375		21.12	21,873		15.70
Exercised	—		—	—		—
Expired	578		21.38	—		—
Outstanding at end of year	149,670	$	20.33	21,873	$	15.70
Options exercisable at year-end	5,466	$	15.70	—	$	—
Weighted average fair value of options granted during the year		$	8.45		$	4.18

The following table summarizes information concerning the 2001 Stock Option Plan at December 31, 2002.

	Options outstanding				Options exercisable
Range of Exercise Price	Number Outstanding	Weighted Average Remaining Contractual Life (years)	Weighted Average Exercise Price		Number Exercisable	Weighted Average Exercise Price
$11.60-$14.50	1,477	8.6	$	14.38	369	$	14.38
$14.51-$17.39	20,396	8.5	$	15.80	5,097	$	15.80
$20.29-$23.19	127,797	9.0	$	21.12	—		—
	149,670				5,466

A summary of the status of First Colonial’s 1996 and 1986 Employee Stock Option Plans as of December 31, 2002, 2001 and 2000, and changes during the years ending on those dates is presented below.

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1996/1986 EMPLOYEE STOCK OPTION PLANS

	Year Ended December 31,
	2002				2001				2000
	Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
Outstanding at beginning of year	95,671		$	20.65	66,804		$	23.19	66,804	$	23.19
Granted	—			—	43,553			15.80	—		—
Exercised	(10,549	)		17.07	(4,927	)		11.90	—		—
Expired	(6,847	)		26.87	(9,759	)		21.15	—		—
Outstanding at end of year	78,275			20.63	95,671		$	20.65	66,804	$	23.19
Options exercisable at year-end	48,897		$	23.52	49,033		$	23.44	42,870	$	21.50
Weighted average fair value of options granted during the year			$	—			$	4.18		$	—

The following table summarizes information concerning the 1996 and 1986 Employee Stock Option Plans outstanding at December 31, 2002:

Options outstanding					Options exercisable
Range of Exercise Price	Number Outstanding	Weighted Average Remaining Contractual Life (years)	Weighted Average Exercise Price		Number Exercisable	Weighted Average Exercise Price
$11.60-$14.50	1,055	2.0	$	11.90	1,055	$	11.90
$14.51-$17.39	37,013	8.1	$	15.80	7,635	$	15.80
$17.40-$20.29	14,041	4.4	$	18.41	14,041	$	18.41
$26.09-$28.99	26,166	5.0	$	28.99	26,166	$	28.99
	78,275				48,897

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A summary of the status of First Colonial’s Non-Employee Directors Stock Option Plan as of December 31, 2002, 2001, and 2000 and changes during the years ending on those dates are presented below.

NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN

	Year Ended December 31,
	2002			2001			2000
	Shares	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price		Shares		Weighted Average Exercise Price
Outstanding at beginning of year	19,202	$	15.02	19,202	$	15.02	19,202		$	15.02
Granted	—		—	—		—	2,955			14.90
Exercised	—		—	—		—	(1,477	)		11.51
Expired	—		—	—		—	(1,478	)		18.21
Outstanding at end of year	19,202	$	15.02	19,202	$	15.02	19,202		$	15.02
Options exercisable at year-end	15,878	$	14.58	13,297	$	13.95	10,200		$	13.03
Weighted average fair value of options granted during the year		$	—		$	—			$	5.83

The following table summarizes information concerning non-employee director options outstanding at December 31, 2002.

Options outstanding					Options exercisable
Range of Exercise Price	Number Outstanding	Weighted Average Remaining Contractual Life (years)	Weighted Average Exercise Price		Number Exercisable	Weighted Average Exercise Price
$8.70-$11.60	7,390	1.7	$	11.38	7,390	$	11.38
$11.61-$14.50	1,477	3.6	$	13.81	1,477	$	13.81
$14.51-$17.39	2,952	7.3	$	14.90	1,476	$	14.90
$17.40-$20.29	7,383	6.4	$	18.96	5,535	$	18.96
	19,202				15,878

In January 2003, options to purchase 59,950 shares of First Colonial’s common stock at a price of $23.83 per share were granted to certain officers and non-employee directors. The vesting of all stock options was accelerated on March 5, 2003 as a result of the execution of the merger agreement with Keystone Savings Bank.

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NOTE P—COMMITMENTS AND CONTINGENCIES

First Colonial has non-cancelable operating lease agreements in excess of one year with respect to various buildings and equipment. The minimum annual rental commitments at December 31, 2002 are payable as follows:

	Operating Leases
	at March 31, 2003
	(Unaudited)
2003	$	434
2004		593
2005		544
2006		460
2007		352
2008 and beyond		2,252
Total	$	4,635

The total rental expense was $145,000 and $143,000 for the three months ended March 31, 2003 and 2002, respectively. Total rental expense for the years 2002, 2001 and 2000 was $575,000, $560,000 and $397,000, respectively.

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NOTE Q — EARNINGS PER SHARE

	For the Three Months Ended March 31, (unaudited)
	Income (numerator)		Average Shares (denominator)	Per Share Amount
2003
Net Income	$	932
Basic Earnings Per Share
Income Available to Common Shareholders	$	932	2,177,482	$	0.43
Effect of Dilutive Securities
Stock Options			97,513	$	(0.02	)
Diluted Earnings Per Share
Income Available to Common Shareholders plus Assumed Exercise of Options	$	932	2,274,995	$	0.41
	For the Three Months Ended March 31, (unaudited)
2002
Net Income	$	811
Basic Earnings Per Share
Income Available to Common Shareholders	$	811	2,144,552	$	0.37
Effect of Dilutive Securities
Stock Options			33,602		—
Diluted Earnings Per Share
Income Available to Common Shareholders plus Assumed Exercise of Options	$	811	2,178,154	$	0.37
	For the Year Ended December 31,
	Income (numerator)		Average Shares (denominator)	Per Share Amount
2002
Net Income	$	3,998
Basic Earnings Per Share
Income Available to Common Shareholders	$	3,998	2,169,410	$	1.85
Effect of Dilutive Securities
Stock Options			46,639		(0.03	)
Diluted Earnings Per Share
Income Available to Common Shareholders plus Assumed Exercise of Options	$	3,998	2,216,049	$	1.82

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	For the Year Ended December 31, 2001
	Income (numerator)		Average Shares (denominator)	Per Share Amount
Net Income	$	3,557
Basic Earnings Per Share
Income Available to Common Shareholders	$	3,557	2,109,821	$	1.69
Effect of Dilutive Securities
Stock Options			5,689		(0.01	)
Diluted Earnings Per Share
Income Available to Common Shareholders plus Assumed Exercise of Options	$	3,557	2,115,510	$	1.68
	For the Year Ended December 31, 2000
Net Income	$	2,072
Basic Earnings Per Share
Income Available to Common Shareholders	$	2,072	2,094,421	$	0.99
Effect of Dilutive Securities
Stock Options			2,338		—
Diluted Earnings Per Share
Income Available to Common Shareholders plus Assumed Exercise of Options	$	2,072	2,096,759	$	0.99

Not included in average common shares outstanding are average weighted unallocated shares held by the ESOP of 48,943 for the three months ended March 31, 2003 and 57,413 for the three months ended March 31, 2002. Average common shares outstanding in the years of 2002, 2001 and 2000 do not include 54,197, 63,642 and 60,830, respectively, of average weighted unallocated shares held by the ESOP. The exclusion of these unallocated shares held by the ESOP is due to First Colonial’s adoption of SOP 93-6. Share and per share information have been retroactively restated to reflect the three 5% stock dividends of May, 2002, June, 2001 and June, 2000.

NOTE R—FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK

Nazareth National Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. Nazareth National Bank’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit

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and standby letters of credit is represented by the contractual notional amount of those instruments. Nazareth National Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

First Colonial’s contingent liabilities and commitments as of March 31, 2003 are $42,789,000 for lines of credit, $1,344,000 for standby letters of credit and $17,703,000 for other commitments to make loans.

First Colonial’s contingent liabilities and commitments as of December 31, 2002 are $37,249,000 for lines of credit, $1,715,000 for standby letters of credit and $12,239,000 for other commitments to make loans.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Nazareth National Bank evaluates each customer’s credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Nazareth National Bank upon extension of credit, is based on management’s credit evaluation.

Standby letters of credit are conditional commitments issued by Nazareth National Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support contracts entered into by customers. Most guarantees extend for one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

When deemed necessary, collateral held by Nazareth National Bank for financial instruments varies, but may include personal or commercial real estate, accounts receivable, inventory, equipment, certificates of deposit or marketable securities. The extent of collateral held for any one financial instrument ranges up to 100%. The average collateral held on financial instruments was 69.5% as of December 31, 2002.

Nazareth National Bank grants commercial, real estate and installment loans to customers primarily in Northampton, Monroe and Lehigh Counties, Pennsylvania. Although Nazareth National Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon the economy of Northampton, Monroe and Lehigh Counties.

At December 31, 2002, Nazareth National Bank had residential real estate loans outstanding totaling $108,372,000, which was 42.4% of total loans. Nazareth National Bank also had real estate related commercial loans outstanding at December 31, 2001 totaling $63,350,000, which was 24.8% of total loans. Loans to various borrowers for non-residential buildings totaling $33,213,000 are included in Nazareth National Bank’s total real estate commercial loans. These loans for non-residential buildings represented 52.4% of the total real estate related commercial loans. Nazareth National Bank’s consumer and installment loans totaled $58,792,000 at December 31, 2002. These loans were 23% of total loans. Loans to individuals for recreational vehicles totaled $28,192,000 at December 31, 2002 or 11% of total loans and

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48% of Nazareth National Bank’s consumer installment loans. Loans to individuals for automobiles totaled $23,536,000 at December 31, 2002, or 9.2% of total loans and 40% of Nazareth National Bank’s consumer installment loans.

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NOTE S—REGULATORY MATTERS

Nazareth National Bank, as a National Bank, is subject to the dividend restrictions set forth by the Comptroller of the Currency. Under such restrictions, Nazareth National Bank may not, without the prior approval of the Comptroller of the Currency, declare dividends in excess of the sum of the current year’s earnings (as defined) plus the retained earnings (as defined) from the prior two years. The dividends, as of December 31, 2002, that Nazareth National Bank could declare, without the approval of the Comptroller of the Currency, amounted to approximately $4,380,000.

The Federal Reserve Bank places restrictions on cash and due from bank accounts upon Nazareth National Banking subsidiary. Certain amounts of reserve balances are required to be on hand or on deposit at the Federal Reserve Bank based upon deposit levels and other factors. The average and year-end amount of the reserve balance for 2002 was approximately $1,232,000 and $2,175,000, respectively. For 2001, the average reserve balance was $3,364,000 and the year-end amount was $977,000.

First Colonial and Nazareth National Bank are 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 First Colonial’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, First Colonial and Nazareth National Bank must meet specific capital guidelines that involve quantitative measures of First Colonial’s and Nazareth National Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. First Colonial’s and Nazareth National Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require First Colonial and Nazareth National Bank to maintain minimum amounts and ratios of Tier 1 capital of at least 4% and total capital, Tier 1 and Tier 2, of 8% of risk-adjusted assets and of Tier 1 capital of at least 4% of average assets (leverage ratio). Tier 1 capital includes common shareholders’ equity and qualifying perpetual preferred stock together with related surpluses and retained earnings. Tier 2 capital may be comprised of limited life preferred stock, qualifying subordinated debt instruments, and the allowance for possible loan losses. Management believes that, as of March 31, 2003 and December 31, 2002, First Colonial and Nazareth National Bank met all capital adequacy requirements to which they were subject.

As of December 14, 2001, the most recent notification from the Federal Deposit Insurance Corporation categorized Nazareth National Bank as adequately capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately capitalized, Nazareth National Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution’s category.

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The following table provides a comparison of First Colonial’s and Nazareth National Bank’s capital amounts, risk-based capital ratios and leverage rations for the periods indicated.

CAPITAL RATIOS

	at March 31, 2003 (Unaudited)
	Actual				Required For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total Capital
(To Risk-Weighted Assets)
First Colonial, (Consolidated)	$	57,284	18.64	%	$	24,580	8.00	%	$	—	—
Nazareth National Bank	$	47,326	15.63	%	$	24,222	8.00	%	$	30,278	10.00	%
Tier I Capital
(To Tier I Capital)
First Colonial, (Consolidated)	$	52,230	17.00	%	$	12,290	4.00	%	$	—	—
Nazareth National Bank	$	43,214	14.27	%	$	12,111	4.00	%	$	18,167	6.00	%
Tier I Capital
(To Average Assets, Leverage)
First Colonial, (Consolidated)	$	52,230	8.58	%	$	24,341	4.00	%	$	—	—
Nazareth National Bank	$	43,214	7.16	%	$	24,157	4.00	%	$	30,196	5.00	%
	at December 31, 2002
	Actual				Required For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total Capital
(To Risk-Weighted Assets)
First Colonial, (Consolidated)	$	56,032	18.45	%	$	24,301	8.00	%	$	—	—
Nazareth National Bank	$	46,767	15.63	%	$	23,935	8.00	%	$	29,918	10.00	%
Tier I Capital
(To Risk-Weighted Assets)
First Colonial, (Consolidated)	$	50,598	16.66	%	$	12,151	4.00	%	$	—	—
Nazareth National Bank	$	42,683	14.27	%	$	11,967	4.00	%	$	17,951	6.00	%
Tier I Capital
(To Average Assets, Leverage)
First Colonial, (Consolidated)	$	50,598	8.81	%	$	22,978	4.00	%	$	—	—
Nazareth National Bank	$	42,683	7.48	%	$	22,833	4.00	%	$	28,541	5.00	%
	at December 31, 2001
	Actual				Required For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total Capital
(To Risk-Weighted Assets)
First Colonial, (Consolidated)	$	37,926	15.38	%	$	19,738	8.00	%	$	—	—
Nazareth National Bank	$	32,931	13.50	%	$	19,515	8.00	%	$	24,393	10.00	%
Tier I Capital
(To Risk-Weighted Assets)
First Colonial, (Consolidated)	$	35,662	14.46	%	$	9,869	4.00	%	$	—	—
Nazareth National Bank	$	30,667	12.58	%	$	9,757	4.00	%	$	14,636	6.00	%
Tier I Capital
(To Average Assets, Leverage)
First Colonial, (Consolidated)	$	35,662	7.65	%	$	18,661	4.00	%	$	—	—
Nazareth National Bank	$	30,667	6.61	%	$	18,575	4.00	%	$	23,218	5.00	%

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NOTE T—EQUITY TRANSACTIONS

First Colonial paid a 5% stock dividend on its common stock from authorized but unissued shares on May 31, 2002 to all shareholders of record at the close of business on May 17, 2002. On June 22, 2001, First Colonial paid a 5% stock dividend on its common stock from authorized but unissued shares to all shareholders of record at the close of business on June 4, 2001. First Colonial also paid a 5% stock dividend on June 22, 2000 to shareholders of record on June 2, 2000. Fractional shares on these stock dividends were paid in cash. The number of shares and earnings per share as stated in the following discussion of the shares issued under the Dividend Reinvestment and Stock Purchase Plan have been restated to reflect these 5% stock dividends.

The Dividend Reinvestment and Stock Purchase Plan provides the holders of common stock with a method to invest their cash dividends and voluntary cash payments of not less than $100 or more than $1,000 per quarter in additional shares of First Colonial’s common stock. Under this plan, shares are sold, in general, at a discounted price of 5% below the average of the high bid and asked price for First Colonial’s common stock on the trading day immediately preceding the investment date. This plan was suspended as of March 5, 2003 as a result of the merger agreement with Keystone Savings Bank. During the first quarter of 2003, 3,771, shares of common stock were purchased from authorized but un-issued shares at an average price of $25.99 per share for proceeds of approximately $98,000. In the year 2002, 7,287 new common shares were purchased pursuant to the Dividend Reinvestment and Stock Purchase Plan at an average cost of $23.47 per share for total proceeds of $171,000. Also, in 2002, 8,681 Treasury shares were purchased pursuant to the Dividend Reinvestment and Stock Purchase Plan at an average cost of $22.12 per share for total proceeds of $192,000. In 2001, 21,447 common shares were purchased pursuant to the Dividend Reinvestment and Stock Purchase Plan at an average cost of $15.28 for proceeds of $328,000.

NOTE U—FAIR VALUE OF FINANCIAL INSTRUMENTS

SFAS No. 107, “Disclosures About Fair Value of Financial Instruments”, requires disclosure of the estimated fair value of their assets and liabilities considered to be financial instruments. For First Colonial, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in SFAS No. 107. However, many such instruments lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. Also, it is First Colonial’s general practice and intent to hold its financial instruments (other than available-for-sale) to maturity and to not engage in trading or sales activities. Therefore, First Colonial had to use significant estimations and present value calculations to prepare this disclosure.

Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.

Fair values have been estimated using data which management considered the best available and estimation methodologies deemed suitable for the pertinent category of financial

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instrument. The estimation methodologies and resulting fair values, and recorded carrying amounts at December 31, 2002 and 2001 were as follows.

Fair value of loans and deposits with floating interest rates is generally presumed to approximate the recorded carrying amounts. Fair value of financial instruments actively traded in a secondary market has been estimated using quoted market prices.

	2002				2001
	Estimated Fair Value		Carrying Amount		Estimated Fair Value		Carrying Amount
Cash and cash equivalents	$	22,741	$	22,741	$	17,270	$	17,270
Investment securities		314,272		313,778		204,462		204,306

Fair value of financial instruments with stated maturities has been estimated using present value cash flow, discounted at a rate approximating current market for similar assets and liabilities. Fair value of financial instrument liabilities with no stated maturities has been estimated to equal the carrying amount (the amount payable on demand).

	2002				2001
	Estimated Fair Value		Carrying Amount		Estimated Fair Value		Carrying Amount
Assets:
Interest-bearing deposits with banks	$	5,002	$	5,002	$	919	$	919
Mortgage loans held-for-sale		1,263		1,263		3,808		3,808
Liabilities:
Deposits with stated maturities		182,735		175,689		176,539		172,368
Deposits with no stated maturities		283,453		297,109		184,473		207,518
Securities sold under agreements to repurchase		8,801		8,801		8,380		8,380
Long-term debt		68,311		67,921		41,148		34,804

The fair value of the net loan portfolio has been estimated using present value cash flow, discounted at the approximate current market rates adjusted for non-interest operating costs and giving consideration to estimated prepayment risk and credit loss factors.

	2002				2001
	Estimated Fair Value		Carrying Amount		Estimated Fair Value		Carrying Amount
Total loans	$	261,620	$	255,844	$	229,673	$	225,757

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The fair value of commitments to extend credit is estimated based on the amount of unamortized deferred loan commitment fees. The fair value of letters of credit is based on the amount of unearned fees plus the estimated costs to terminate the letters of credit. Fair values of unrecognized financial instruments including commitments to extend credit and fair value of letters of credit are considered immaterial.

First Colonial’s remaining assets and liabilities are not considered financial instruments. No disclosure of the relationship value of First Colonial’s deposits is required by SFAS No. 107.

NOTE V—QUARTERLY FINANCIAL DATA (Unaudited)

The following represents summarized quarterly financial data of First Colonial, which, in the opinion of management, reflects all adjustments (comprising only normal recurring accruals) necessary for a fair presentation. Net income per share of common stock has been restated to reflect retroactively the 5% stock dividends of May, 2002, June, 2001 and June, 2000.

QUARTERLY FINANCIAL DATA

	Three Months Ended
	Dec. 31		Sept. 30		June 30		March 31
	(Dollars in Thousands) except per share data
2003
Interest Income							$	7,579
Net interest income								4,502
Provision for possible loan losses								200
Net gain on sale of securities and mortgages								1,182
Income before income taxes								1,067
Net income							$	932
Basic net income per share							$	0.43
Diluted net income per share							$	0.41
	Dec. 31		Sept. 30		June 30		March 31
2002
Interest Income	$	7,495	$	7,698	$	7,227	$	7,110
Net interest income		4,303		4,548		4,194		4,075
Provision for possible loan losses		305		475		361		400
Net gain on sale of securities and mortgages		636		879		415		445
Income before income taxes		1,403		1,323		1,195		954
Net income	$	1,125	$	1,082	$	980	$	811
Basic net income per share	$	0.52	$	0.51	$	0.45	$	0.37
Diluted net income per share	$	0.51	$	0.50	$	0.44	$	0.37
	Dec. 31		Sept. 30		June 30		March 31
2001
Interest Income	$	7,216	$	7,460	$	7,724	$	7,635
Net interest income		3,998		3,961		4,179		3,928
Provision for possible loan losses		125		125		230		100
Net gain on sale of securities and mortgages		656		291		191		137
Income (loss) before income taxes		1,098		1,158		1,126		983
Net income	$	903	$	937	$	912	$	805
Basic net income per share	$	0.43	$	0.44	$	0.43	$	0.39
Diluted net income per share	$	0.42	$	0.44	$	0.43	$	0.39

F-66

NOTE W—FIRST COLONIAL GROUP, INC.

(PARENT COMPANY ONLY)

CONDENSED BALANCE SHEETS

	December 31,
	2002		2001
ASSETS
Cash and Due from Banks	$	165	$	17
Interest-Bearing Deposits with Banks		5,183		851
Loan to Banking Subsidiary		1,000		1,000
Investment in Banking Subsidiary		45,049		30,264
Investment in Other Subsidiaries		4,915		4,411
Other Assets		655		34
TOTAL ASSETS	$	56,967	$	36,577
LIABILITIES
Long-Term Debt	$	1,093	$	1,235
Guaranteed Benficial Interest in the Company’s Subordinated Debentures		15,464		—
Other Liabilities		96		16
TOTAL LIABILITIES		16,653		1,251
SHAREHOLDERS’ EQUITY		40,314		35,326
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	56,967	$	36,577

F-67

CONDENSED STATEMENT OF INCOME

	For the Year Ended December 31,
	2002		2001			2000
INCOME
Dividends from Subsidiaries	$	2,302	$	1,489		$	1,405
Interest on Loan to Subsidiary		52		74			97
Interest on Deposits with Banks		41		19			13
Statutory Trust Income		12		—			—
TOTAL INCOME		2,407		1,582			1,515
EXPENSES
Interest on Long-Term Debt		56		94			121
Interest on Trust Preferred Securities		428		—			—
Other Expenses		191		87			39
TOTAL EXPENSES		675		181			160
Income Before Taxes and Equity in Undistributed Net Earnings of Subsidiaries		1,732		1,401			1,355
Federal Income Tax (Credit)		194		(30	)		(17	)
Income Before Equity in Undistributed Net Earnings of Subsidiaries		1,538		1,431			1,372
Equity in Undistributed Net Earnings of Subsidiaries		2,460		2,126			700
NET INCOME	$	3,998	$	3,557		$	2,072

F-68

CONDENSED STATEMENT OF CASH FLOWS

	For the Year Ended December 31,
	2002			2001			2000
OPERATING ACTIVITIES
Net Income	$	3,998		$	3,557		$	2,072
Adjustments to Reconcile
Net Income to Net Cash Provided by Operating Activities:
Distribution in Excess of Undistributed Net Earnings of Subsidiaries		(3,279	)		(2,125	)		(687	)
Changes in Assets and Liabilities:
Increase in Interest-Bearing Deposits with Banks		(4,332	)		(242	)		(240	)
(Increase) Decrease in Other Assets		(621	)		(14	)		15
Increase (Decrease) in Other Liabilities		80			(27	)		(48	)
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES		(4,154	)		1,149			1,112
INVESTING ACTIVITIES
Additional Investment in Banking Subsidiary		(10,200	)		—			—
Additional Investment in Non-Banking Subsidiary		(500	)		—			—
NET CASH USED IN INVESTING ACTIVITIES		(10,700	)		—			—
FINANCING ACTIVITIES
Net (Decrease) Increase in Long-Term Debt		(142	)		(142	)		57
Net Decrease (Increase) in ESOP Debt		142			142			(57	)
Purchase of Treasury Stock		(146	)		(59	)		—
Proceeds from Sale of Treasury Stock		192			—			—
Proceeds from Issuance of Common Stock		389			387			313
Proceeds from Issuance of Guaranteed
Preferred Beneficial Interest in Company’s Subordinated Debentures		15,464			—			—
Dividends Received from Banking Subsidiary		205			—			—
Dividends Received from Non-Banking Subsidiary		500			—			—
Cash Dividends Paid		(1,597	)		(1,489	)		(1,406	)
Cash Paid in Lieu of Fractional Shares		(5	)		(2	)		(2	)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES		15,002			(1,163	)		(1,095	)
Increase (Decrease) in Cash and Cash Equivalents		148			(14	)		17
Cash and Cash Equivalents, January 1,		17			31			14
Cash and Cash Equivalents, December 31,	$	165		$	17		$	31

F-69

NOTE X—MERGER AGREEMENT

On March 6, 2003, First Colonial Group, Inc. and Keystone Savings Bank announced that they had signed an Agreement and Plan of Merger to combine into a new bank holding company, KNBT Bancorp, Inc. In addition, First Colonial’s subsidiary bank, Nazareth National Bank and Trust Company and Keystone Savings Bank will combine into a new bank, Keystone Nazareth Bank & Trust Company.

The transaction involves the conversion of Keystone Savings Bank from a mutual savings bank to a stock institution and the formation of a holding company, KNBT Bancorp, Inc. Each share of First Colonial Group, Inc. common stock will be valued at $37.00 and exchanged for shares of KNBT Bancorp, Inc. common stock based on the initial public offering (“IPO”) price of KNBT Bancorp, Inc.’s common stock.

The transaction is subject to certain conditions, including the receipt of various regulatory approvals, the approval of First Colonial Group’s shareholders and the approval of Keystone Savings Bank’s depositors.

F-70

You should rely only on the information contained in this prospectus. KNBT Bancorp has not authorized anyone to provide you with information that is different. If the laws of your state or other jurisdiction prohibit KNBT Bancorp from offering its common stock to you, then this prospectus does not constitute an offer to sell or a solicitation of an offer to buy any of its common stock. Neither the delivery of this prospectus nor any sale hereunder shall imply that there has been no change in KNBT Bancorp’s affairs since any of the dates as of which information is furnished herein or since the date hereof.

The Table of Contents is located on the inside of the front cover page of this document.

[KNBT Bancorp, Inc. Logo]

(Proposed Holding Company for Keystone Nazareth Bank & Trust Company)

17,566,250 Shares for Sale

(Anticipated Maximum, Subject to Increase)

COMMON STOCK

PROSPECTUS

Sandler O’Neill & Partners, L.P.

                     , 2003

Until             , 2003 or 25 days after commencement of the Syndicated Community Offering, if any, whichever is later, all dealers effecting transactions in KNBT Bancorp common stock may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to any unsold allotments or subscriptions.

                                                                    Appendix A

                          AGREEMENT AND PLAN OF MERGER

                                     between

                              KEYSTONE SAVINGS BANK

                                       and

                           FIRST COLONIAL GROUP, INC.

                            dated as of March 5, 2003

                              (Appendixes Omitted)

                          AGREEMENT AND PLAN OF MERGER

                                TABLE OF CONTENTS

                                                                          Page
                                                                          ----

ARTICLE I       DEFINITIONS...............................................  1

ARTICLE II      THE MERGER................................................  6

    2.1         The Merger................................................  6
    2.2         Effective Time; Closing...................................  7
    2.3         Treatment of Capital Stock................................  7
    2.4         Shareholder Rights; Stock Transfers.......................  8
    2.5         Fractional Shares.........................................  8
    2.6         Options...................................................  8
    2.7         Exchange Procedures.......................................  9
    2.8         Additional Actions........................................ 10

ARTICLE III     REPRESENTATIONS AND WARRANTIES OF THE COMPANY............. 11

    3.1         Capital Structure......................................... 11
    3.2         Organization, Standing and Authority of the Company....... 11
    3.3         Ownership of the Company Subsidiaries..................... 11
    3.4         Organization, Standing and Authority of
                  the Company Subsidiaries................................ 12
    3.5         Authorized and Effective Agreement........................ 12
    3.6         Securities Documents and Regulatory Reports............... 13
    3.7         Financial Statements...................................... 14
    3.8         Material Adverse Change................................... 14
    3.9         Environmental Matters..................................... 14
    3.10        Tax Matters............................................... 15
    3.11        Legal Proceedings......................................... 16
    3.12        Compliance with Laws...................................... 16
    3.13        Certain Information....................................... 16
    3.14        Employee Benefit Plans.................................... 17
    3.15        Certain Contracts......................................... 18
    3.16        Brokers and Finders....................................... 19
    3.17        Insurance................................................. 19
    3.18        Properties................................................ 19
    3.19        Labor..................................................... 19
    3.20        Affiliates................................................ 19
    3.21        Allowance for Loan Losses................................. 20
    3.22        Fairness Opinion.......................................... 20
    3.23        Disclosures............................................... 20

ARTICLE IV      REPRESENTATIONS AND WARRANTIES OF KEYSTONE................ 20

    4.1         Capital Structure......................................... 20

                                        i

    4.2         Organization, Standing and Authority of Keystone and the
                  Holding Company ........................................ 20
    4.3         Ownership of the Keystone Subsidiaries.................... 21
    4.4         Organization, Standing and Authority
                  of the Keystone Subsidiaries............................ 21
    4.5         Authorized and Effective Agreement........................ 21
    4.6         Regulatory Reports........................................ 23
    4.7         Financial Statements...................................... 23
    4.8         Material Adverse Change................................... 23
    4.9         Environmental Matters..................................... 23
    4.10        Tax Matters............................................... 24
    4.11        Legal Proceedings......................................... 25
    4.12        Compliance with Laws...................................... 25
    4.13        Certain Information....................................... 25
    4.14        Employee Benefit Plans.................................... 26
    4.15        Certain Contracts......................................... 27
    4.16        Brokers and Finders....................................... 28
    4.17        Insurance................................................. 28
    4.18        Properties................................................ 28
    4.19        Labor..................................................... 28
    4.20        Ownership of Company Common Stock......................... 28
    4.21        Allowance for Losses on Loans............................. 29
    4.22        Disclosures............................................... 29

ARTICLE V       COVENANTS................................................. 29

    5.1         Reasonable Best Efforts................................... 29
    5.2         Shareholder and Depositor Meetings........................ 29
    5.3         Regulatory Matters........................................ 30
    5.4         Investigation and Confidentiality......................... 31
    5.5         Press Releases............................................ 31
    5.6         Business of the Parties................................... 32
    5.7         Certain Actions........................................... 34
    5.8         Current Information....................................... 36
    5.9         Indemnification; Insurance................................ 36
    5.10        Directors and Executive Officers.......................... 38
    5.11        Employees and Employee Benefit Plans...................... 38
    5.12        Bank Merger............................................... 40
    5.13        Organization of the Holding Company....................... 41
    5.14        Shareholder and Depositor Agreements...................... 41
    5.15        Integration of Policies................................... 41
    5.16        Disclosure Supplements.................................... 41
    5.17        Failure to Fulfill Conditions............................. 42
    5.18        Section 16 Matters........................................ 42

ARTICLE VI      CONDITIONS PRECEDENT...................................... 42

    6.1         Conditions Precedent - Keystone and the Company........... 42
    6.2         Conditions Precedent - The Company........................ 43
    6.3         Conditions Precedent - Keystone........................... 44

                                       ii

ARTICLE VII     TERMINATION, WAIVER AND AMENDMENT......................... 45

    7.1         Termination............................................... 45
    7.2         Effect of Termination..................................... 46
    7.3         Survival of Representations, Warranties
                  and Covenants........................................... 46
    7.4         Waiver.................................................... 47
    7.5         Amendment or Supplement................................... 47

ARTICLE VIII MISCELLANEOUS................................................ 47

    8.1         Expenses; Termination Fees................................ 47
    8.2         Entire Agreement.......................................... 48
    8.3         No Assignment............................................. 49
    8.4         Notices................................................... 49
    8.5         Alternative Structure..................................... 50
    8.6         Interpretation............................................ 50
    8.7         Counterparts.............................................. 50
    8.8         Governing Law............................................. 50

Appendix A      Form of Shareholder Agreement
Appendix B      Form of Depositor Agreement
Appendix C      Articles of Incorporation of KNBT Bancorp, Inc.
Appendix D      Bylaws of KNBT Bancorp, Inc.
Appendix E      Form of Employment Agreement with Scott V. Fainor
Appendix F      Form of Employment Agreement with Eugene  T. Sobol
Appendix G      Form of Accession to Agreement
Appendix H      Form of Affiliate's Letter

                                       iii

                          AGREEMENT AND PLAN OF MERGER

         Agreement and Plan of Merger (the "Agreement"), dated as of March 5,
2003, between Keystone Savings Bank ("Keystone"), a Pennsylvania-chartered
mutual savings bank, and First Colonial Group, Inc. (the "Company"), a
Pennsylvania corporation.

                              W I T N E S S E T H:

         WHEREAS, the Boards of Directors of Keystone and the Company have
determined to consummate the business combination transactions provided for
herein, subject to the terms and conditions set forth herein;

         WHEREAS, the parties desire to provide for certain undertakings,
conditions, representations, warranties and covenants in connection with the
transactions contemplated hereby;

         WHEREAS, as an inducement to Keystone to enter into this Agreement and
simultaneously with the execution of this Agreement, each director of the
Company and the Bank is entering into an agreement (the "Shareholder
Agreement"), in the form of Appendix A hereto pursuant to which they have
agreed, among other things, to vote their shares of Company Common Stock in
favor of this Agreement; and

         WHEREAS, as an inducement to the Company to enter into this Agreement
and simultaneously with the execution of this Agreement, each Trustee of
Keystone is entering into an agreement (the "Depositor Agreement"), in the form
of Appendix B hereto, pursuant to which they have agreed to vote, to the extent
they are depositors of Keystone eligible to vote on the Plan of Conversion, in
favor of the Plan of Conversion.

         NOW, THEREFORE, in consideration of the premises and of the mutual
covenants and agreements herein contained, the parties hereto do hereby agree as
follows:

                                    ARTICLE I
                                   DEFINITIONS

         The following terms shall have the meanings ascribed to them for all
purposes of this Agreement.

         "Acquisition Proposal" means any proposal or offer with respect to any
of the following (other than the transactions contemplated hereunder) involving
the Company or any of its Subsidiaries: (i) any merger, consolidation, share
exchange, business combination or other similar transaction; (ii) any sale,
lease, exchange, mortgage, pledge, transfer or other disposition of 20% or more
of its consolidated assets in a single transaction or series of transactions;
(iii) any tender offer or exchange offer for 20% or more of the outstanding
shares of its capital stock or the filing of a registration statement under the
Securities Act in connection therewith; or (iv) any public announcement of a
proposal, plan or intention to do any of the foregoing or any agreement to
engage in any of the foregoing.

         "Acquisition Transaction" means any of the following (other than the
transaction contemplated hereunder) involving the Company or any of its
Subsidiaries: (i) any merger, consolidation, share exchange, business
combination or other similar transaction; (ii) any sale, lease, exchange,
mortgage, pledge, transfer or other disposition of 20% or more of its

consolidated assets in a single transaction or series of transactions; or (iii)
any tender offer or exchange offer for 20% or more of the outstanding shares of
its capital stock or the filing of a registration statement under the Securities
Act in connection therewith.

         "Application for Conversion" shall mean the application submitted by
Keystone to the FDIC and the Department pursuant to the regulations of the FDIC
and the Banking Law and the regulations, if any, promulgated thereunder in
connection with the Conversion, as amended and supplemented.

         "Bank" shall mean Nazareth National Bank and Trust Company, a national
bank and a wholly owned subsidiary of the Company.

         "Banking Law" shall mean the Pennsylvania Banking Code of 1965, as
amended.

         "Bank Merger" shall have the meaning set forth in Section 5.12 hereof.

         "Bank Merger Agreement" shall have the meaning set forth in Section
5.12 hereof.

         "BCL" shall mean the Business Corporation Law of the Commonwealth of
Pennsylvania, as amended.

         "BIF" shall mean the Bank Insurance Fund administered by the FDIC or
any successor thereto.

         "Certificate of Merger" shall have the meaning set forth in Section 2.2
hereof.

         "Closing" shall have the meaning set forth in Section 2.2 hereof.

         "Closing Date" shall have the meaning set forth in Section 2.2 hereof.

         "Code" shall mean the Internal Revenue Code of 1986, as amended.

         "Commission" shall mean the Securities and Exchange Commission.

         "Company Affiliate" shall mean any person who is deemed, for purposes
of Rule 145 under the Securities Act, to be an "affiliate" of the Company.

         "Company Common Stock" shall mean the common stock, par value $5.00 per
share, of the Company.

         "Company Employee Plans" shall have the meaning set forth in Section
3.14(a) hereof.

         "Company Financial Statements" shall mean (i) the consolidated
statements of financial condition (including related notes and schedules, if
any) of the Company as of December 31, 2001 and 2000 and the consolidated
statements of income, changes in shareholders' equity and cash flows (including
related notes and schedules, if any) of the Company for each of the three years
ended December 31, 2001, 2000 and 1999 as filed by the Company in its Securities
Documents, and (ii) the consolidated statements of financial condition of the
Company (including related notes and schedules, if any) and the consolidated
statements of income, changes in shareholders' equity and cash flows (including
related notes and schedules, if any) of the Company included in the Securities
Documents filed by the Company with respect to the periods ended subsequent to
December 31, 2001.

                                        2

         "Company Options" shall mean options to purchase shares of Company
Common Stock granted pursuant to the Company Option Plans.

         "Company Option Plan" shall mean each of the following stock option
plans of the Company, as amended and as in effect as of the date hereof: the
First Colonial Group, Inc. Stock Option Plan, the 1994 Stock Option Plan for
Non-Employee Directors, the 1996 Stock Option Plan and the 2001 Stock Option
Plan (collectively, the "Company Option Plans").

         "Company Preferred Stock" shall mean the shares of preferred stock, par
value $5.00 per share, of the Company.

         "Conversion" shall mean (i) the amendment of Keystone's Articles of
Incorporation to authorize the issuance of capital stock and otherwise to
conform to the requirements of a stock savings bank chartered under the laws of
the Commonwealth of Pennsylvania, (ii) the issuance of Holding Company Common
Stock to eligible depositors of Keystone and others in connection therewith and
(iii) the purchase by the Holding Company of all of the capital stock of
Keystone to be sold by Keystone in connection with its conversion from mutual to
stock form.

         "Department" means the Pennsylvania Department of Banking.

         "DOJ" shall mean the United States Department of Justice.

         "Effective Time" shall mean the date and time specified pursuant to
Section 2.2 hereof as the effective time of the Merger.

         "Environmental Claim" means any written notice from any Governmental
Entity or third party alleging potential liability (including, without
limitation, potential liability for investigatory costs, cleanup costs,
governmental response costs, natural resources damages, property damages,
personal injuries or penalties) arising out of, based on, or resulting from the
presence, or release into the environment, of any Materials of Environmental
Concern.

         "Environmental Laws" means any federal, state or local law, statute,
ordinance, rule, regulation, code, license, permit, authorization, approval,
consent, order, judgment, decree, injunction or agreement with any governmental
entity relating to (i) the protection, preservation or restoration of the
environment (including, without limitation, air, water vapor, surface water,
groundwater, drinking water supply, surface soil, subsurface soil, plant and
animal life or any other natural resource), and/or (ii) the use, storage,
recycling, treatment, generation, transportation, processing, handling,
labeling, production, release or disposal of Materials of Environment Concern.
The term Environmental Law includes without limitation (i) the Comprehensive
Environmental Response, Compensation and Liability Act, as amended, 42 U.S.C.
Section 9601, et seq; the Resource Conservation and Recovery Act, as amended, 42
U.S.C. Section 6901, et seq; the Clean Air Act, as amended, 42 U.S.C. Section
7401, et seq; the Federal Water Pollution Control Act, as amended, 33 U.S.C.
Section 1251, et seq; the Toxic Substances Control Act, as amended, 15 U.S.C.
Section 9601, et seq; the Emergency Planning and Community Right to Know Act, 42
U.S.C. Section 1101, et seq; the Safe Drinking Water Act, 42 U.S.C. Section
300f, et seq; and all comparable state and local laws, and (ii) any common law
(including without limitation common law that may impose strict liability) that
may impose liability or obligations for injuries or damages due to, or
threatened as a result of, the presence of or exposure to any Materials of
Environmental Concern.

         "ERISA" shall mean the Employee Retirement Income Security Act of 1974,
as amended.

                                        3

         "ESOP" shall mean the Bank's Employee Stock Ownership Plan and Trust.

         "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended.

         "Exchange Ratio" shall have the meaning set forth in Section 2.3
hereof.

         "FDIA" shall mean the Federal Deposit Insurance Act, as amended.

         "FDIC" shall mean the Federal Deposit Insurance Corporation or any
successor thereto.

         "FHLB" shall mean Federal Home Loan Bank.

         "Final Purchase Price" shall mean the price per share at which Holding
Company Common Stock is ultimately sold by the Holding Company to eligible
depositors of Keystone and others in connection with the Conversion.

         "FRB" shall mean the Board of Governors of the Federal Reserve System.

         "Form S-1" shall mean the registration statement on Form S-1 (or on any
successor or other appropriate form) to be filed by the Holding Company in
connection with the issuance of shares of Holding Company Common Stock in
connection with the Merger and the Conversion, as amended and supplemented.

         "Governmental Entity" shall mean any federal or state court,
administrative agency or commission or other governmental authority or
instrumentality.

         "Holding Company" shall mean KNBT Bancorp, Inc., a business corporation
which shall be organized by Keystone under the BCL for the purposes of becoming
the holding company of Keystone upon consummation of the Conversion and
acquiring the Company pursuant to the terms of this Agreement.

         "Holding Company Common Stock" shall mean the common stock, par value
$.01 per share, of the Holding Company.

         "Holding Company Preferred Stock" shall mean the preferred stock, par
value $.01 per share, of the Holding Company.

         "Keystone Employee Plans" shall have the meaning set forth in Section
4.14(a) hereof.

         "Keystone Financial Statements" shall mean (i) the consolidated
statements of condition (including related notes and schedules, if any) of
Keystone as of December 31, 2001 and 2000 and the consolidated statements of
income, retained income and cash flows (including related notes and schedules,
if any) of Keystone for each of the three years ended December 31, 2001, 2000
and 1999, and (ii) the consolidated statements of condition of Keystone
(including related notes and schedules, if any) and the consolidated statements
of income, retained income and cash flows (including related notes and
schedules, if any) of Keystone with respect to the periods ended subsequent to
December 31, 2001.

         "Material Adverse Effect" shall mean, (i) with respect to the Company,
any effect that is material and adverse to the financial condition, results of
operations or business of the Company and its Subsidiaries taken as whole, (ii)
with respect to Keystone, any effect that is material and adverse to the
financial condition, results of operations, or business of Keystone and its

                                        4

Subsidiaries taken as a whole, or (iii) materially impairs the ability of either
the Company or the Bank, on the one hand, or the Holding Company or Keystone, on
the other hand, to consummate the Merger or any of the other transactions
contemplated by this Agreement, provided, however, that Material Adverse Effect
shall not be deemed to include the impact of (a) changes in laws and regulations
or interpretations thereof that are generally applicable to the banking or
savings industries, (b) changes in generally accepted accounting principles or
regulatory accounting requirements that are generally applicable to the banking
or savings industries, (c) expenses incurred in connection with the transactions
contemplated hereby, (d) actions or omissions of a party (or any of its
Subsidiaries) taken with the prior written consent of the other party or parties
in contemplation of the transactions contemplated hereby or (e) changes
attributable to or resulting from changes in general economic conditions,
including changes in the prevailing level of interest rates.

         "Materials of Environmental Concern" means pollutants, contaminants,
wastes, toxic substances, petroleum and petroleum products and any other
materials regulated under Environmental Laws.

         "Merger" shall have the meaning set forth in Section 2.1(a) hereof.

         "Merger Consideration" shall have the meaning set forth in Section
2.3(iii) hereof.

         "NASD" shall mean the National Association of Securities Dealers, Inc.

         "OCC" shall mean the Office of the Comptroller of the Currency of the
U.S. Department of the Treasury or any successor thereto.

         "PBGC" shall mean the Pension Benefit Guaranty Corporation, or any
successor thereto.

         "Party" shall mean either Keystone or the Company, whichever is
applicable.

         "Person" shall mean any individual, bank, corporation, partnership,
association, joint stock company, business trust, limited liability company or
unincorporated organization.

         "Plan of Conversion" shall mean the written plan adopted by the Board
of Trustees of Keystone pursuant to which the Conversion will be
effected.

         "Previously Disclosed" shall mean disclosed (i) in a disclosure
schedule dated the date hereof delivered from the disclosing party to the other
party specifically referring to the appropriate section of this Agreement and
describing in reasonable detail the matters contained therein, or (ii) a
supplement to the disclosure schedule dated after the date hereof from the
disclosing party specifically referring to this Agreement and describing in
reasonable detail the matters contained therein and delivered by the other party
pursuant to Section 5.16 hereof.

         "Prospectus" shall mean the prospectus to be delivered to (i)
shareholders of the Company in connection with the offering of Holding Company
Common Stock in connection with the Merger pursuant to this Agreement and (ii)
eligible depositors of Keystone and others in connection with the offering of
Holding Company Common Stock in connection with the Conversion, as amended and
supplemented.

         "Proxy Statements" shall mean the proxy statements to be delivered to
(i) shareholders of the Company in connection with the solicitation of their
approval of this Agreement and the transactions contemplated hereby and (ii)
depositors of Keystone in connection with the

                                        5

solicitation of their approval of the Conversion and the transactions
contemplated thereby, as amended and supplemented.

         "Rights" shall mean warrants, options, rights, convertible securities
and other arrangements or commitments which obligate an entity to issue or
dispose of any of its capital stock or other ownership interests.

         "SAIF" shall mean the Savings Association Insurance Fund administered
by the FDIC or any successor thereto.

         "Securities Act" shall mean the Securities Act of 1933, as amended.

         "Securities Documents" shall mean all reports, offering circulars,
proxy statements, registration statements and all similar documents filed, or
required to be filed, pursuant to the Securities Laws.

         "Securities Laws" shall mean the Securities Act; the Exchange Act; the
Investment Company Act of 1940, as amended; the Investment Advisers Act of 1940,
as amended; the Trust Indenture Act of 1939, as amended, and the rules and
regulations of the Commission promulgated thereunder.

         "Subsidiary" and "Significant Subsidiary" shall have the meanings set
forth in Rule 1-02 of Regulation S-X of the Commission.

         "Surviving Bank" shall have the meaning set forth in section 5.12
hereof.

         Other terms used herein are defined in the preamble and elsewhere in
this Agreement.

                                   ARTICLE II
                                   THE MERGER

2.1      The Merger

         (a)      Subject to the terms and conditions of this Agreement, at the
Effective Time (as defined in Section 2.2 hereof), the Company shall be merged
with and into the Holding Company (the "Merger") in accordance with the
provisions of Section 1921 et. seq. of the BCL. The Holding Company shall be the
surviving corporation (hereinafter sometimes called the "Surviving Corporation")
of the Merger, and shall continue its corporate existence under the laws of the
Commonwealth of Pennsylvania. The name of the Surviving Corporation shall be
"KNBT Bancorp, Inc." as stated in the Articles of Incorporation of the Holding
Company immediately prior to the Effective Time. Upon consummation of the
Merger, the separate corporate existence of the Company shall terminate.

         (b)      From and after the Effective Time, the Merger shall have the
effects set forth in Section 1929 of the BCL.

         (c)      The Articles of Incorporation and Bylaws of the Holding
Company in the forms attached hereto as Appendices C and D hereto, respectively,
as in effect as of the Effective Time, shall be the Articles of Incorporation
and Bylaws of the Surviving Corporation, respectively, until altered, amended or
repealed in accordance with their terms and applicable law.

         (d)      The authorized capital stock of the Surviving Corporation
shall be as stated in the

                                        6

Articles of Incorporation of the Holding Company immediately prior to the
Effective Time.

         (e)      The directors and officers of the Holding Company immediately
prior to the Effective Time, together with the directors and officers elected
pursuant to Section 5.10 hereof, shall be the directors and officers of the
Surviving Corporation, each to hold office in accordance with the Articles of
Incorporation and Bylaws of the Surviving Corporation as well as the provisions
hereof.

2.2      Effective Time; Closing

         The Merger shall become effective upon the occurrence of the filing of
articles of merger with the Secretary of State of the Commonwealth of
Pennsylvania (the "Articles of Merger"), unless a later date and time is
specified as the effective time in such Articles of Merger (the "Effective
Time"). The Effective Time will occur simultaneously with, or immediately after,
the consummation of the Conversion. A closing (the "Closing") shall take place
immediately prior to the Effective Time at 10:00 a.m., Eastern Time, following
the satisfaction or waiver, to the extent permitted hereunder, of the conditions
to the consummation of the Merger specified in Article VI of this Agreement
(other than the delivery of certificates, opinions and other instruments and
documents to be delivered at the Closing) (the "Closing Date"), at such place
and at such time as the parties may mutually agree upon. At the Closing, there
shall be delivered to Keystone and the Holding Company, on the one hand, and the
Company, on the other hand, the opinions, certificates and other documents
required to be delivered under Article VI hereof.

2.3      Treatment of Capital Stock

         Subject to the provisions of this Agreement, at the Effective Time,
automatically by virtue of the Merger and without any action on the part of any
shareholder:

                  (i)     each share of Holding Company Common Stock issued and
         outstanding immediately prior to the Effective Time (consisting of
         shares issued or to be issued by the Holding Company in connection with
         the Conversion or contributed to the charitable foundation to be
         established by Keystone in connection with the Conversion) shall be
         unchanged and shall remain issued and outstanding;

                  (ii)    each share of Company Common Stock owned by the
         Company (including treasury shares) or the Holding Company or any of
         their respective Subsidiaries (other than shares held in a fiduciary
         capacity for the benefit of third parties or as a result of debts
         previously contracted) shall be cancelled and retired and shall not
         represent capital stock of the Holding Company and shall not be
         exchanged for shares of Holding Company Common Stock, or other
         consideration; and

                  (iii)   each share of Company Common Stock which under the
         terms of Section 2.7 hereof is to be converted into the right to
         receive shares of Holding Company Common Stock shall, subject to
         Section 2.5 hereof, be converted into and become the right to receive a
         number of shares of Holding Company Common Stock equal to the quotient
         (calculated to the nearest one-thousandth) determined by dividing
         $37.00 by the Final Purchase Price (or 3.7 shares assuming an Final
         Purchase Price of $10.00 per share) (the "Merger Consideration" or the
         "Exchange Ratio").

                                        7

2.4      Shareholder Rights; Stock Transfers

         At the Effective Time, holders of Company Common Stock shall cease to
be and shall have no rights as shareholders of the Company, other than to
receive the consideration provided under Sections 2.3 and 2.5 hereof. After the
Effective Time, there shall be no transfers on the stock transfers books of the
Company or the Surviving Corporation of shares of Company Common Stock and if
certificates evidencing such shares are presented for transfer after the
Effective Time, they shall be cancelled against delivery of certificates for
whole shares of Holding Company Common Stock (plus cash in lieu of any
fractional share interest) as herein provided.

2.5      Fractional Shares

         Notwithstanding any other provision hereof, no fractional shares of
Holding Company Common Stock shall be issued to holders of Company Common Stock.
In lieu thereof, each holder of shares of Company Common Stock entitled to a
fraction of a share of Holding Company Common Stock shall, at the time of
surrender of the certificate or certificates representing such holder's shares,
receive an amount of cash (without interest) equal to the amount determined by
multiplying the fractional share interest to which such holder would otherwise
be entitled by the Final Purchase Price. No such holder shall be entitled to
dividends, voting rights or any other rights in respect of fractional shares.

2.6      Options

         (a)      At the Effective Time, each Company Option which is then
outstanding, whether or not exercisable, shall cease to represent a right to
acquire shares of Company Common Stock and shall be converted automatically into
a right to purchase shares of Holding Company Common Stock, and the Holding
Company shall assume each Company Option, in accordance with the terms of the
applicable Company Option Plan and stock option or other agreement by which it
is evidenced, except that from and after the Effective Time, (i) the Holding
Company and either its Board of Directors or a committee consisting solely of
two or more Non-Employee Directors, as defined in Rule 16b-3(b)(3) under the
Exchange Act, shall be substituted for the Company and the committee of the
Company's Board of Directors (including, if applicable, the entire Board of
Directors of the Company) administering such Company Option Plan, (ii) the
number of shares of Holding Company Common Stock subject to such Company Option
shall be equal to the number of shares of Company Common Stock subject to such
Company Option immediately prior to the Effective Time multiplied by the
Exchange Ratio, provided that any fractional shares of Holding Company Common
Stock resulting from such multiplication shall be rounded up or down, as the
case may be, to the nearest whole share, and (iii) the per share exercise price
under each such Company Option shall be adjusted by dividing the per share
exercise price under each such Company Option by the Exchange Ratio, provided
that such exercise price shall be rounded up to the nearest cent.
Notwithstanding clauses (ii) and (iii) of the preceding sentence, each Company
Option which is an "incentive stock option" shall be adjusted as required by
Section 424 of the Code, and the regulations promulgated thereunder, so as not
to constitute a modification, extension or renewal of the option within the
meaning of Section 424(h) of the Code. The Holding Company and the Company shall
take all necessary steps to effect the foregoing provisions of this Section
2.6(a).

         (b)      As soon as practicable after the Effective Time, the Holding
Company shall deliver to each participant in each Company Option Plan an
appropriate notice setting forth such participant's rights pursuant thereto and
the grants subject to such Company Option Plan shall

                                        8

continue in effect on the same terms and conditions, including without
limitation the duration thereof, subject to the adjustments required by Section
2.6(a) hereof after giving effect to the Merger. Within 30 days after the
Effective Time, the Holding Company shall file a registration statement on Form
S-8 (or any successor or other appropriate forms), with respect to the shares of
Holding Company Common Stock subject to such Company Options and shall maintain
the current status of the prospectus or prospectuses contained therein for so
long as such options remain outstanding.

2.7      Exchange Procedures

         (a)      The Holding Company shall designate an exchange agent,
reasonably acceptable to the Company, to act as agent (the "Exchange Agent") for
purposes of conducting the exchange procedure as described herein. No later than
seven business days following the Effective Time, the Holding Company shall
cause the Exchange Agent to mail or make available to each holder of record of a
certificate or certificates which immediately prior to the Effective Time
represented issued and outstanding shares of Company Common Stock (i) a notice
and letter of transmittal (which shall specify that delivery shall be effected
and risk of loss and title to the certificates theretofore representing shares
of Company Common Stock shall pass only upon proper delivery of such
certificates to the Exchange Agent) advising such holder of the effectiveness of
the Merger and the procedure for surrendering to the Exchange Agent such
certificate or certificates which immediately prior to the Effective Time
represented issued and outstanding shares of Company Common Stock in exchange
for the consideration set forth in Section 2.3 hereof deliverable in respect
thereof pursuant to this Agreement.

         (b)      At the Effective Time, the Holding Company shall issue to the
Exchange Agent the number of shares of Holding Company Common Stock issuable in
the Merger, which shall be held by the Exchange Agent in trust for the holders
of Company Common Stock, as well as an amount of cash sufficient to fund any
amounts to be distributed pursuant to Section 2.5 hereof. The Exchange Agent
shall promptly distribute Holding Company Common Stock (and cash in lieu of
fractional shares pursuant to Section 2.5 hereof) as provided herein. The
Exchange Agent shall not be entitled to vote or exercise any rights of ownership
with respect to the shares of Holding Company Common Stock held by it from time
to time hereunder, except that it shall receive and hold all dividends or other
distributions paid or distributed with respect to such shares for the account of
the persons entitled thereto.

         (c)      Each holder of an outstanding certificate or certificates
which prior thereto represented shares of Company Common Stock who surrenders
such certificate or certificates to the Exchange Agent will, upon acceptance
thereof by the Exchange Agent, be entitled to a certificate or certificates
representing the number of full shares of Holding Company Common Stock into
which the aggregate number of shares of company Common Stock previously
represented by such certificate or certificates surrendered shall have been
converted pursuant to this Agreement and any other distribution theretofore paid
with respect to Holding Company Common Stock issuable in the Merger, in each
case without interest. The Exchange Agent shall accept such certificates upon
compliance with such reasonable terms and conditions as the Exchange Agent may
impose to effect an orderly exchange thereof in accordance with normal exchange
practices. Each outstanding certificate which prior to the Effective Time
represented Company Common Stock and which is not surrendered to the Exchange
Agent in accordance with the procedures provided for herein shall, except as
otherwise herein provided, until duly surrendered to the Exchange Agent be
deemed to evidence ownership of the number of shares of Holding Company Common
Stock into which the aggregate number of shares of Company Common Stock
previously represented by such certificate shall have been converted pursuant to
the terms of this Agreement. After the Effective Time, there shall be no further
transfer on the

                                        9

records of the Company of certificates representing shares of Company Common
Stock and if such certificates are presented to the Company for transfer, they
shall be cancelled against delivery of certificates for Holding Company Common
Stock and cash as hereinabove provided. No dividends which have been declared
will be remitted to any person entitled to receive shares of Holding Company
Common Stock under this Section 2.7 until such person surrenders the certificate
or certificates representing Company Common Stock, at which time such dividends
shall be remitted to such person, without interest.

         (d)      The Holding Company shall not be obligated to deliver a
certificate or certificates representing shares of Holding Company Common Stock
to which a holder of Company Common Stock would otherwise be entitled as a
result of the Merger until such holder surrenders the certificate or
certificates representing the shares of Company Common Stock for exchange as
provided in this Section 2.7, or, in default thereof, an appropriate affidavit
of loss and indemnity agreement and/or a bond as may be required in each case by
the Holding Company. If any certificates evidencing shares of Holding Company
Common Stock are to be issued in a name other than that in which the certificate
evidencing Company Common Stock surrendered in exchange therefor is registered,
it shall be a condition of the issuance thereof that the certificate so
surrendered shall be properly endorsed or accompanied by an executed form of
assignment separate from the certificate and otherwise in proper form for
transfer and that the person requesting such exchange pay to the Exchange Agent
any transfer or other tax required by reason of the issuance of a certificate
for shares of Holding Company Common Stock in any name other than that of the
registered holder of the certificate surrendered or otherwise establish to the
satisfaction of the Exchange Agent that such tax has been paid or is not
payable.

         (e)      Any portion of the shares of Holding Company Common Stock
delivered to the Exchange Agent by the Holding Company pursuant to Section
2.7(b) that remains unclaimed by the shareholders of Company for six months
after the Effective Time shall be delivered by the Exchange Agent to the Holding
Company. Any shareholders of the Company who have not theretofore complied with
Section 2.7(c) shall thereafter look only to the Holding Company for the
consideration deliverable in respect of each share of Company Common Stock such
shareholder holds as determined pursuant to this Agreement without any interest
thereon. If outstanding certificates for shares of Company Common Stock are not
surrendered or the payment for them is not claimed prior to the date on which
such shares of Holding Company Common Stock or cash would otherwise escheat to
or become the property of any governmental unit or agency, the unclaimed items
shall, to the extent permitted by abandoned property and any other applicable
law, become the property of the Holding Company (and to the extent not in its
possession shall be delivered to it), free and clear of all claims or interest
of any person previously entitled to such property. Neither the Exchange Agent
nor any party to this Agreement shall be liable to any holder of Company Common
Stock represented by any certificate for any consideration paid to a public
official pursuant to applicable abandoned property, escheat or similar laws. The
Holding Company and the Exchange Agent shall be entitled to rely upon the stock
transfer books of the Company to establish the identity of those persons
entitled to receive consideration specified in this Agreement, which books shall
be conclusive with respect thereto. In the event of a dispute with respect to
ownership of stock represented by any certificate, the Holding Company and the
Exchange Agent shall be entitled to deposit any consideration represented
thereby in escrow with an independent third party and thereafter be relieved
with respect to any claims thereto.

2.8      Additional Actions

         If, at any time after the Effective Time, the Surviving Corporation
shall consider that any further assignments or assurances in law or any other
acts are necessary or desirable to (i) vest,

                                       10

perfect or confirm, of record or otherwise, in the Surviving Corporation its
right, title or interest in, to or under any of the rights, properties or assets
of the Company acquired or to be acquired by the Surviving Corporation as a
result of, or in connection with, the Merger, or (ii) otherwise carry out the
purposes of this Agreement, the Company and its proper officers and directors
shall be deemed to have granted to the Surviving Corporation an irrevocable
power of attorney to execute and deliver all such proper deeds, assignments and
assurances in law and to do all acts necessary or proper to vest, perfect or
confirm title to and possession of such rights, properties or assets in the
Surviving Corporation and otherwise to carry out the purposes of this Agreement;
and the proper officers and directors of the Surviving Corporation are fully
authorized in the name of the Company or otherwise to take any and all such
action.

                                   ARTICLE III
                  REPRESENTATIONS AND WARRANTIES OF THE COMPANY

         The Company represents and warrants to Keystone as follows, except as
Previously Disclosed:

3.1      Capital Structure

         The authorized capital stock of the Company consists of 10,000,000
shares of Company Common Stock and 500,000 shares of Company Preferred Stock. As
of the date hereof, 2,224,239 shares of Company Common Stock are issued and
outstanding, no shares of Company Common Stock are held in treasury, and no
shares of Company Preferred Stock are issued and outstanding. All outstanding
shares of Company Common Stock have been duly authorized and validly issued and
are fully paid and nonassessable, and none of the outstanding shares of Company
Common Stock has been issued in violation of the preemptive rights of any
person, firm or entity. Except for Company Options to acquire not more than
304,600 shares of Company Common Stock as of the date hereof and grants of
restricted shares of Company Common Stock covering 8,400 shares, a schedule of
each of which has been Previously Disclosed, there are no Rights authorized,
issued or outstanding with respect to the capital stock of the Company.

3.2      Organization, Standing and Authority of the Company

         The Company is a corporation duly organized and, validly existing under
the laws of the Commonwealth of Pennsylvania with full corporate power and
authority to own or lease all of its properties and assets and to carry on its
business as now conducted and the Company is duly licensed or qualified to do
business and is in good standing in each jurisdiction in which its ownership or
leasing of property or the conduct of its business requires such licensing or
qualification, except where the failure to be so licensed, qualified or in good
standing would not have a Material Adverse Effect on the Company. The Company is
duly registered as a bank holding company under the Bank Holding Company Act of
1956, as amended, and the regulations of the FRB thereunder. The Company has
heretofore delivered to Keystone true and complete copies of the Articles of
Incorporation and Bylaws of the Company as in effect as of the date hereof.

3.3      Ownership of the Company Subsidiaries

         The Company has Previously Disclosed the name, jurisdiction of
incorporation and percentage ownership of each direct or indirect Company
Subsidiary and identified the Bank as its only Significant Subsidiary. Except
for (x) capital stock of the Company Subsidiaries, (y)

                                       11

securities and other interests held in a fiduciary capacity and beneficially
owned by third parties or taken in consideration of debts previously contracted
and (z) securities and other interests which are Previously Disclosed, the
Company does not own or have the right to acquire, directly or indirectly, any
outstanding capital stock or other voting securities or ownership interests of
any corporation, bank, savings association, savings bank, partnership, joint
venture or other organization, other than investment securities representing not
more than 5% of any entity. The outstanding shares of capital stock or other
ownership interests of each Company Subsidiary have been duly authorized and
validly issued, are fully paid and nonassessable, and are directly or indirectly
owned by the Company free and clear of all liens, claims, encumbrances, charges,
pledges, restrictions or rights of third parties of any kind whatsoever. No
rights are authorized, issued or outstanding with respect to the capital stock
or other ownership interests of the Company Subsidiaries and there are no
agreements, understandings or commitments relating to the right of the Company
to vote or to dispose of such capital stock or other ownership interests.

3.4      Organization, Standing and Authority of the Company Subsidiaries

         Each of the Company Subsidiaries is a corporation or partnership duly
organized, validly existing and in good standing under the laws of the
jurisdiction in which it is organized. Each of the Company Subsidiaries (i) has
full power and authority to own or lease all of its properties and assets and to
carry on its business as now conducted, and (ii) is duly licensed or qualified
to do business and is in good standing in each jurisdiction in which its
ownership or leasing of property or the conduct of its business requires such
qualification, except where the failure to be so licensed, qualified or in good
standing would not have a Material Adverse Effect on the Company. The deposit
accounts of the Bank are insured by the BIF to the maximum extent permitted by
the FDIA and the Bank has paid all deposit insurance premiums and assessments
required by the FDIA and the regulations thereunder. The Company has heretofore
delivered or made available to Keystone true and complete copies of the Articles
of Association and Bylaws of the Bank as in effect as of the date hereof.

3.5      Authorized and Effective Agreement

         (a)      The Company has all requisite corporate power and authority to
enter into this Agreement and (subject to receipt of all necessary governmental
approvals and the approval of the Company's shareholders of this Agreement) to
perform all of its obligations under this Agreement. The execution and delivery
of this Agreement and the consummation of the transactions contemplated hereby
have been duly and validly authorized by all necessary corporate action in
respect thereof on the part of the Company, except for the approval of this
Agreement by the Company's shareholders. This Agreement has been duly and
validly executed and delivered by the Company and, assuming due authorization,
execution and delivery by Keystone, constitutes a legal, valid and binding
obligation of the Company which is enforceable against the Company in accordance
with its terms, subject, as to enforceability, to bankruptcy, insolvency and
other laws of general applicability relating to or affecting creditors' rights
and to general equity principles.

         (b)      Neither the execution and delivery of this Agreement, nor
consummation of the transactions contemplated hereby (including the Merger and
the Bank Merger), nor compliance by the Company with any of the provisions
hereof (i) does or will conflict with or result in a breach of any provisions of
the Articles of Incorporation or Bylaws of the Company or the equivalent
documents of any Company Subsidiary, (ii) violate, conflict with or result in a
breach of any term, condition or provision of, or constitute a default (or an
event which, with notice or lapse of time, or both, would constitute a default)
under, or give rise to any right of termination, cancellation or acceleration
with respect to, or result in the creation of any lien, charge or

                                       12

encumbrance upon any property or asset of the Company or a Company Subsidiary
pursuant to, any material note, bond, mortgage, indenture, deed of trust,
license, lease, agreement or other instrument or obligation to which the Company
or a Company Subsidiary is a party, or by which any of their respective
properties or assets may be bound or affected, or (iii) subject to receipt of
all required governmental and shareholder approvals, violate any order, writ,
injunction, decree, statute, rule or regulation applicable to the Company or a
Company Subsidiary.

         (c)      To the best knowledge of the Company, except for (i) the
filing of applications with and the approvals of the FDIC, FRB and the
Department, (ii) the filing and effectiveness of the Form S-1 and the Proxy
Statement relating to the meeting of shareholders of the Company to be held
pursuant to Section 5.2 hereof with the Commission, (iii) the approval of this
Agreement by the requisite vote of the shareholders of the Company, (iv) the
filing of the Articles of Merger with the Secretary of Commonwealth of
Pennsylvania pursuant to the BCL in connection with the Merger and, (v) the
filing of Articles of Merger with the Department and a notice with the OCC in
connection with the Bank Merger, (vi) review of the Merger by the DOJ under
federal antitrust laws, no consents or approvals of or filings or registrations
with any Governmental Entity or with any third party are necessary on the part
of the Company or the Bank in connection with (x) the execution and delivery by
the Company of this Agreement and the consummation by the Company of the
transactions contemplated hereby and (y) the execution and delivery by the Bank
of the Bank Merger Agreement and the consummation of the transactions
contemplated thereby.

         (d)      As of the date hereof, neither the Company nor the Bank is
aware of any reasons relating to the Company or the Bank (including without
limitation Community Reinvestment Act compliance) why all consents and approvals
shall not be procured from all regulatory agencies having jurisdiction over the
transactions contemplated by this Agreement and the Bank Merger Agreement as
shall be necessary for (i) consummation of the transactions contemplated by this
Agreement and the Bank Merger Agreement and (ii) the continuation by the Holding
Company and Keystone after the Effective Time of the business of the Company and
the Bank, respectively, as such business is carried on immediately prior to the
Effective Time, free of any conditions or requirements which in the reasonable
opinion of the Company could have a Material Adverse Effect on the Company or
the Bank or materially impair the value of the Company and the Bank to the
Holding Company and Keystone, respectively.

3.6      Securities Documents and Regulatory Reports

         (a)      Since January 1, 2000, the Company has timely filed with the
Commission and the NASD all Securities Documents required by the Securities Laws
and such Securities Documents complied in all material respects with the
Securities Laws and did not contain any untrue statement of a material fact or
omit to state any material fact required to be stated therein or necessary in
order to make the statements therein, in light of the circumstances under which
they were made, not misleading.

         (b)      Since January 1, 2000, each of the Company and the Bank has
duly filed with the OCC and any other applicable federal or state banking
authority, as the case may be, the reports required to be filed under applicable
laws and regulations and such reports were in all material respects complete and
accurate and in compliance with the requirements of applicable laws and
regulations. In connection with the most recent examinations of the Company and
the Bank by the OCC, neither the Company nor the Bank was required to correct or
change any action, procedure or proceeding which the Company or the Bank
believes has not been corrected or changed as required as of the date hereof and
which could have a Material Adverse Effect on the Company.

                                       13

3.7      Financial Statements

         (a)      The Company has previously delivered or made available to
Keystone accurate and complete copies of the Company Financial Statements which,
in the case of the consolidated statements of financial condition of the Company
as of December 31, 2001 and 2000 and the consolidated statements of income,
changes in shareholders' equity and cash flows for each of the three years ended
December 31, 2001, 2000 and 1999, are accompanied by the audit reports of Grant
Thornton LLP, independent certified public accountants with respect to the
Company. The Company Financial Statements referred to herein, as well as the
Company Financial Statements to be delivered pursuant to Section 5.8 hereof,
fairly present or will fairly present, as the case may be, the consolidated
financial condition of the Company as of the respective dates set forth therein,
and the consolidated income, changes in stockholders' equity and cash flows of
the Company for the respective periods or as of the respective dates set forth
therein.

         (b)      Each of the Company Financial Statements referred to in
Section 3.7(a) has been or will be, as the case may be, prepared in accordance
with generally accepted accounting principles consistently applied during the
periods involved, except as stated therein. The audits of the Company and the
Company Subsidiaries have been conducted in all material respects in accordance
with generally accepted auditing standards. The books and records of the Company
and the Company Subsidiaries are being maintained in material compliance with
applicable legal and accounting requirements, and such books and records
accurately reflect in all material respects all dealings and transactions in
respect of the business, assets, liabilities and affairs of the Company and its
Subsidiaries.

         (c)      Except as Previously Disclosed or to the extent (i) reflected,
disclosed or provided for in the consolidated statement of financial condition
of the Company as of December 31, 2001 (including related notes), (ii) of
liabilities incurred since December 31, 2001 in the ordinary course of business
and (iii) of liabilities incurred in connection with consummation of the
transactions contemplated by this Agreement, neither the Company nor any Company
Subsidiary has any liabilities, whether absolute, accrued, contingent or
otherwise, material to the financial condition, results of operations or
business of the Company on a consolidated basis.

3.8      Material Adverse Change

         Since September 30, 2002, (i) the Company and its Subsidiaries have
conducted their respective businesses in the ordinary and usual course
(excluding the incurrence of expenses in connection with this Agreement and the
transactions contemplated hereby) and (ii) no event has occurred or circumstance
arisen that, individually or in the aggregate, has had or is reasonably likely
to have a Material Adverse Effect on the Company.

3.9      Environmental Matters

         (a)      To the best of the Company's knowledge, the Company and its
Subsidiaries are in compliance with all Environmental Laws, except for any
violations of any Environmental Law which would not, singly or in the aggregate,
have a Material Adverse Effect on the Company. Neither the Company nor a Company
Subsidiary has received any communication alleging that the Company or a Company
Subsidiary is not in such compliance and, to the best knowledge of the Company,
there are no present circumstances that would prevent or interfere with the
continuation of such compliance.

         (b)      To the best of the Company's knowledge, none of the properties
owned, leased or operated by the Company or a Company Subsidiary has been or is
in violation of or liable under

                                       14

any Environmental Law, except any such violations or liabilities which would not
singly or in the aggregate have a Material Adverse Effect on the Company.

         (c)      To the best of the Company's knowledge, there are no past or
present actions, activities, circumstances, conditions, events or incidents that
could reasonably form the basis of any Environmental Claim or other claim or
action or governmental investigation that could result in the imposition of any
liability arising under any Environmental Law against the Company or a Company
Subsidiary or against any person or entity whose liability for any Environmental
Claim the Company or a Company Subsidiary has or may have retained or assumed
either contractually or by operation of law, except such which would not have a
Material Adverse Effect on the Company.

         (d)      The Company has not conducted any environmental studies during
the past five years with respect to any properties owned by it or a Company
Subsidiary as of the date hereof.

3.10     Tax Matters

         (a)      The Company and its Subsidiaries have timely filed all
federal, state and local (and, if applicable, foreign) income, franchise, bank,
excise, real property, personal property and other tax returns required by
applicable law to be filed by them (including, without limitation, estimated tax
returns, income tax returns, information returns and withholding and employment
tax returns) and have paid, or where payment is not required to have been made,
have set up an adequate reserve or accrual for the payment of, all taxes
required to be paid in respect of the periods covered by such returns and, as of
the Effective Time, will have paid, or where payment is not required to have
been made, will have set up an adequate reserve or accrual for the payment of,
all material taxes for any subsequent periods ending on or prior to the
Effective Time. Neither the Company nor a Company Subsidiary will have any
material liability for any such taxes in excess of the amounts so paid or
reserves or accruals so established.

         (b)      All federal, state and local (and, if applicable, foreign)
income, franchise, bank, excise, real property, personal property and other tax
returns filed by the Company and its Subsidiaries are complete and accurate in
all material respects. Neither the Company nor any Company Subsidiary is
delinquent in the payment of any tax, assessment or governmental charge or has
requested any extension of time within which to file any tax returns in respect
of any fiscal year or portion thereof which have not since been filed. The
federal, state and local income tax returns of the Company and its Subsidiaries
have been examined by the applicable tax authorities (or are closed to
examination due to the expiration of the applicable statute of limitations) and
no deficiencies for any tax, assessment or governmental charge have been
proposed, asserted or assessed (tentatively or otherwise) against the Company or
a Company Subsidiary as a result of such examinations or otherwise which have
not been settled and paid. There are currently no agreements in effect with
respect to the Company or a Company Subsidiary to extend the period of
limitations for the assessment or collection of any tax. As of the date hereof,
no audit, examination or deficiency or refund litigation with respect to such
return is pending or, to the best of the Company's knowledge, threatened.

         (c)      Neither the Company nor any Company Subsidiary (i) is a party
to any agreement providing for the allocation or sharing of taxes, (ii) is
required to include in income any adjustment pursuant to Section 481(a) of the
Code by reason of a voluntary change in accounting method initiated by the
Company or a Company Subsidiary (nor does the Company have any knowledge that
the Internal Revenue Service has proposed any such adjustment or change of
accounting method) or (iii) has filed a consent pursuant to Section 341(f) of
the Code or agreed to have Section 341(f)(2) of the Code apply.

                                       15

3.11     Legal Proceedings

         There are no actions, suits, claims, governmental investigations or
proceedings instituted, pending or, to the best knowledge of the Company,
threatened against the Company or a Company Subsidiary or against any asset,
interest or right of the Company or a Company Subsidiary, or against any
officer, director or employee of any of them that in any such case, if decided
adversely, would have a Material Adverse Effect on the Company. Neither the
Company nor any Company Subsidiary is a party to any order, judgment or decree
which has or could reasonably be expected to have a Material Adverse Effect on
the Company.

3.12     Compliance with Laws

         (a)      Each of the Company and the Company Subsidiaries has all
permits, licenses, certificates of authority, orders and approvals of, and has
made all filings, applications and registrations with, federal, state, local and
foreign governmental or regulatory bodies that are required in order to permit
it to carry on its business as it is presently being conducted and the absence
of which could reasonably be expected to have a Material Adverse Effect on the
Company; all such permits, licenses, certificates of authority, orders and
approvals are in full force and effect; and to the best knowledge of the
Company, no suspension or cancellation of any of the same is threatened.

         (b)      Neither the Company nor any Company Subsidiary is in violation
of its respective Articles of Incorporation, Articles of Association or Bylaws,
or of any applicable federal, state or local law or ordinance or any order, rule
or regulation of any federal, state, local or other governmental agency or body
(including, without limitation, all banking (including all regulatory capital
requirements), securities, municipal securities, safety, health, environmental,
zoning, anti-discrimination, antitrust, and wage and hour laws, ordinances,
orders, rules and regulations), or in default with respect to any order, writ,
injunction or decree of any court, or in default under any order, license,
regulation or demand of any governmental agency, any of which violations or
defaults could reasonably be expected to have a Material Adverse Effect on the
Company; and neither the Company nor any Company Subsidiary has received any
notice or communication from any federal, state or local governmental authority
asserting that the Company or any Company Subsidiary is in violation of any of
the foregoing which could reasonably be expected to have a Material Adverse
Effect on the Company. Neither the Company nor a Company Subsidiary is subject
to any regulatory or supervisory cease and desist order, agreement, written
directive, memorandum of understanding or written commitment (other than those
of general applicability to national banks or holding companies thereof issued
by governmental authorities), and neither of them has received any written
communication requesting that it enter into any of the foregoing.

3.13     Certain Information

         None of the information relating to the Company and its Subsidiaries
supplied or to be supplied by them for inclusion in (i) the Form S-1, including
the Prospectus, at the time the Form S-1 and any amendment thereto becomes
effective under the Securities Act, will contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
therein, in light of the circumstances under which they were made, not
misleading, (ii) the Application for Conversion, at the time the Application for
Conversion and any amendment thereto is not objected to by the FDIC under the
regulations thereof and approved by the Department under the Banking Law and the
regulations, if any, promulgated thereunder, will contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements therein, in light of the circumstances under which they were made,
not misleading,

                                       16

and (iii) the Proxy Statements, as of the date or dates such Proxy Statements
are mailed to shareholders of the Company and depositors of Keystone and up to
and including the date or dates of the meetings of shareholders and depositors
to which such Proxy Statements relate, will contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
therein, in light of the circumstances under which they were made, not
misleading, provided that information as of a later date shall be deemed to
modify information as of an earlier date.

3.14     Employee Benefit Plans

         (a)      The Company has Previously Disclosed all stock option,
restricted stock, employee stock purchase and stock bonus plans, qualified
pension or profit-sharing plans, any deferred compensation, consultant, bonus or
group insurance contract or any other incentive, health and welfare or employee
benefit plan or agreement maintained for the benefit of employees or former
employees of the Company or any Company Subsidiary (the "Company Employee
Plans"), whether written or oral, and the Company has previously furnished or
made available to Keystone accurate and complete copies of the same together
with, in the case of qualified plans, (i) the most recent actuarial and
financial reports prepared with respect thereto, (ii) the most recent annual
reports filed with any governmental agency with respect thereto, and (iii) all
rulings and determination letters and any open requests for rulings or letters
that pertain thereto.

         (b)      None of the Company, any Company Subsidiary, any Company
Employee Plan constituting an "employee pension benefit plan" within the meaning
of Section 3(2) of ERISA ("Company Pension Plan") or, to the best of the
Company's knowledge, any fiduciary of such Company Pension Plan, has incurred
any material liability to the PBGC or the Internal Revenue Service with respect
to any such Company Pension Plan. To the best of the Company's knowledge, no
reportable event under Section 4043(b) of ERISA has occurred with respect to any
Company Pension Plan.

         (c)      Except as Previously Disclosed, neither the Company nor any
Company Subsidiary participates in or has incurred any liability under Section
4201 of ERISA for a complete or partial withdrawal from a multiemployer plan (as
such term is defined in ERISA).

         (d)      A favorable determination letter has been issued by the
Internal Revenue Service with respect to each Company Pension Plan which is
intended to qualify under Section 401 of the Code to the effect that such
Company Pension Plan is qualified under Section 401 of the Code, and the trust
associated with such Company Pension Plan is tax exempt under Section 501 of the
Code. No such letter has been revoked or, to the best of the Company's
knowledge, is threatened to be revoked, and the Company does not know of any
ground on which such revocation may be based. Neither the Company nor any
Company Subsidiary has any liability under any such Company Pension Plan that is
not reflected on the consolidated statement of financial condition of the
Company at December 31, 2001 or the notes thereto included in the Company
Financial Statements, other than liabilities incurred in the ordinary course of
business in connection therewith subsequent to the date thereof.

         (e)      To the best of the Company's knowledge, no prohibited
transaction (which shall mean any transaction prohibited by Section 406 of ERISA
and not exempt under Section 408 of ERISA or Section 4975 of the Code) has
occurred with respect to any Company Employee Plan which would result in the
imposition, directly or indirectly, of a material excise tax under Section 4975
of the Code or otherwise have a Material Adverse Effect on the Company.

                                       17

         (f)      Full payment has been made (or proper accruals have been
established) of all contributions which are required for periods prior to the
date hereof, and full payment will be so made (or proper accruals will be so
established) of all contributions which are required for periods after the date
hereof and prior to the Effective Time, under the terms of each Company Employee
Plan or ERISA; no accumulated funding deficiency (as defined in Section 302 of
ERISA or Section 412 of the Code), whether or not waived, exists with respect to
any Company Pension Plan, and there is no "unfunded current liability" (as
defined in Section 412 of the Code) with respect to any Company Pension Plan.

         (g)      To the best of the Company's knowledge, the Company Employee
Plans have been operated in compliance in all material respects with the
applicable provisions of ERISA, the Code, all regulations, rulings and
announcements promulgated or issued thereunder and all other applicable
governmental laws and regulations.

         (h)      There are no pending or, to the best knowledge of the Company,
threatened claims (other than routine claims for benefits) by, on behalf of or
against any of the Company Employee Plans or any trust related thereto or any
fiduciary thereof.

3.15     Certain Contracts

         (a)      Neither the Company nor a Company Subsidiary is a party to, is
bound or affected by, receives, or is obligated to pay, benefits under (i) any
agreement, arrangement or commitment, including without limitation any
agreement, indenture or other instrument, relating to the borrowing of money by
the Company or a Company Subsidiary (other than in the case of the Bank
deposits, FHLB advances, federal funds purchased and securities sold under
agreements to repurchase in the ordinary course of business) or the guarantee by
the Company or a Company Subsidiary of any obligation, other than by the Bank in
the ordinary course of its banking business, (ii) any agreement, arrangement or
commitment relating to the employment of a consultant or the employment,
election or retention in office of any present or former director, officer or
employee of the Company or a Company Subsidiary, (iii) any agreement,
arrangement or understanding pursuant to which any payment (whether of severance
pay or otherwise) became or may become due to any director, officer or employee
of the Company or a Company Subsidiary upon execution of this Agreement or upon
or following consummation of the transactions contemplated by this Agreement
(either alone or in connection with the occurrence of any additional acts or
events); (iv) any agreement, arrangement or understanding pursuant to which the
Company or a Company Subsidiary is obligated to indemnify any director, officer,
employee or agent of the Company or a Company Subsidiary; (v) any agreement,
arrangement or understanding to which the Company or a Company Subsidiary is a
party or by which any of the same is bound which limits the freedom of the
Company or a Company Subsidiary to compete in any line of business or with any
person, (vi) any assistance agreement, supervisory agreement, memorandum of
understanding, consent order, cease and desist order or condition of any
regulatory order or decree with or by the Department, the FDIC, the FRB, the OCC
or any other regulatory agency, or (vii) any other agreement, arrangement or
understanding which would be required to be filed as an exhibit to the Company's
Annual Report on Form 10-K under the Exchange Act and which has not been so
filed.

         (b)      Neither the Company nor any Company Subsidiary is in default
or in non-compliance, which default or non-compliance could reasonably be
expected to have a Material Adverse Effect on the Company, under any contract,
agreement, commitment, arrangement, lease, insurance policy or other instrument
to which it is a party or by which its assets, business or operations may be
bound or affected, whether entered into in the ordinary course of business

                                       18

or otherwise and whether written or oral, and there has not occurred any event
that with the lapse of time or the giving of notice, or both, would constitute
such a default or non-compliance.

3.16     Brokers and Finders

         Except for The Kafafian Group, Inc., neither the Company nor any
Company Subsidiary nor any of their respective directors, officers or employees,
has employed any broker or finder or incurred any liability for any broker or
finder fees or commissions in connection with the transactions contemplated
hereby.

3.17     Insurance

         Each of the Company and its Subsidiaries is insured for reasonable
amounts with financially sound and reputable insurance companies against such
risks as companies engaged in a similar business would, in accordance with good
business practice, customarily be insured and has maintained all insurance
required by applicable laws and regulations.

3.18     Properties

         All real and personal property owned by the Company or its Subsidiaries
or presently used by any of them in its respective business is in an adequate
condition (ordinary wear and tear excepted) and is sufficient to carry on the
business of the Company and its Subsidiaries in the ordinary course of business
consistent with their past practices. The Company has good and marketable title
free and clear of all liens, encumbrances, charges, defaults or equities (other
than equities of redemption under applicable foreclosure laws) to all of its
material properties and assets, real and personal, except (i) liens for current
taxes not yet due or payable (ii) pledges to secure deposits and other liens
incurred in the ordinary course of its banking business, (iii) such
imperfections of title, easements and encumbrances, if any, as are not material
in character, amount or extent and (iv) as reflected on the consolidated
statement of condition of the Company as of September 30, 2002 included in the
Company Financial Statements. All real and personal property which is material
to the Company's business on a consolidated basis and leased or licensed by the
Company or a Company Subsidiary is held pursuant to leases or licenses which are
valid and enforceable in accordance with their respective terms and such leases
will not terminate or lapse prior to the Effective Time.

3.19     Labor

         No work stoppage involving the Company or a Company Subsidiary is
pending or, to the best knowledge of the Company, threatened. Neither the
Company nor a Company Subsidiary is involved in or affected by, or, to the best
knowledge of the Company, threatened with any labor dispute, arbitration,
lawsuit or administrative proceeding involving the employees of the Company or a
Company Subsidiary which could have a Material Adverse Effect on the Company.
Employees of the Company and the Company Subsidiaries are not represented by any
labor union nor are any collective bargaining agreements otherwise in effect
with respect to such employees, and to the best of the Company's knowledge,
there have been no efforts to unionize or organize any employees of the Company
or any of the Company Subsidiaries during the past five years.

3.20     Affiliates

         The Company has Previously Disclosed to Keystone a schedule of each
person that, to the best of its knowledge, is deemed to be a Company Affiliate.

                                       19

3.21     Allowance for Loan Losses

         The allowance for possible loan losses reflected on the Company's
consolidated statements of financial condition included in the September 30,
2002 Company Financial Statements is, or will be in the case of subsequently
delivered Company Financial Statements, as the case may be, in the opinion of
the Company's management, adequate in all material respects as of their
respective dates under the requirements of generally accepted accounting
principles to provide for reasonably anticipated losses on outstanding loans net
of recoveries. The other real estate owned reflected on the consolidated
statements of financial condition included in the September 30, 2002 Company
Financial Statements is, or will be in the case of subsequently delivered
Company Financial Statements, as the case may be, carried at the lower of cost
or fair value, less estimated costs to sell, as required by generally accepted
accounting principles.

3.22     Fairness Opinion

         The Company has received the opinion from The Kafafian Group, Inc. to
the effect that, as of the date hereof, the consideration to be received by
shareholders of the Company pursuant to this Agreement is fair, from a financial
point of view, to such shareholders.

3.23     Disclosures

         None of the representations and warranties of the Company or any of the
written information or documents furnished or to be furnished by the Company to
Keystone in connection with or pursuant to this Agreement or the consummation of
the transactions contemplated hereby, when considered as a whole, contains or
will contain any untrue statement of a material fact, or omits or will omit to
state any material fact required to be stated or necessary to make any such
information or document, in light of the circumstances, not misleading.

                                   ARTICLE IV
                   REPRESENTATIONS AND WARRANTIES OF KEYSTONE

         Keystone represents and warrants to the Company as follows, except as
Previously Disclosed:

4.1      Capital Structure

         As of the date hereof, Keystone is a Pennsylvania-chartered savings
bank in mutual form and, as a result, has no authorized or outstanding capital
stock. Upon consummation of the Conversion, Keystone will be a duly organized
Pennsylvania-chartered savings bank in stock form and will have authorized
capital stock as set forth in its Articles of Incorporation.

4.2      Organization, Standing and Authority of Keystone and the Holding
         Company

         (a)      Keystone is a savings bank duly organized, validly existing
and in good standing under the laws of the Commonwealth of Pennsylvania, with
full corporate power and authority to own or lease all of its properties and
assets and to carry on its business as now conducted, and Keystone is duly
licensed or qualified to do business and is in good standing in each
jurisdiction in which its ownership or leasing of property or the conduct of its
business requires such licensing or qualification, except where the failure to
be so licensed, qualified or in good standing would not have a Material Adverse
Effect on Keystone. The deposit accounts of Keystone are

                                       20

insured by the SAIF to the maximum extent permitted by the FDIA, and Keystone
has paid all deposit insurance premiums and assessments required by the FDIA and
the regulations thereunder. Keystone has heretofore delivered to the Company
true and complete copies of the Articles of Incorporation and Bylaws of Keystone
as in effect as of the date hereof.

         (b)      At the Effective Time, the Holding Company will be duly
organized, and validly existing under the BCL.

4.3      Ownership of the Keystone Subsidiaries

         Keystone has Previously Disclosed the name, jurisdiction of
incorporation and percentage ownership of each direct or indirect Keystone
Subsidiary. Except for (x) capital stock of the Keystone Subsidiaries, (y)
securities and other interests held in a fiduciary capacity and beneficially
owned by third parties or taken in consideration of debts previously contracted
and (z) securities and other interests which are Previously Disclosed, Keystone
does not own or have the right to acquire, directly or indirectly, any
outstanding capital stock or other voting securities or ownership interests of
any corporation, bank, savings association, savings bank, partnership, joint
venture or other organization, other than investment securities representing not
more than 5% of any entity. The outstanding shares of capital stock or other
ownership interests of each Keystone Subsidiary have been duly authorized and
validly issued, are fully paid and nonassessable, and are directly owned by
Keystone free and clear of all liens, claims, encumbrances, charges, pledges,
restrictions or rights of third parties of any kind whatsoever.

4.4      Organization, Standing and Authority of the Keystone Subsidiaries

         Each of the Keystone Subsidiaries is a corporation or partnership duly
organized, validly existing and in good standing under the laws of the
jurisdiction in which it is organized. Each of the Keystone Subsidiaries (i) has
full power and authority to own or lease all of its properties and assets and to
carry on its business as now conducted, and (ii) is duly licensed or qualified
to do business and is in good standing in each jurisdiction in which its
ownership or leasing of property or the conduct of its business requires such
qualification, except where the failure to be so licensed, qualified or in good
standing would not have a Material Adverse Effect on Keystone.

4.5      Authorized and Effective Agreement

         (a)      Keystone has, and following its organization the Holding
Company will have, all requisite corporate power and authority to enter into
this Agreement and (subject to receipt of all necessary governmental approvals
and the approval of the Conversion by the depositors of Keystone) to perform all
of its respective obligations under this Agreement. The execution and delivery
of this Agreement and the consummation of the transactions contemplated hereby
have been duly and validly authorized by all necessary corporate action in
respect thereof on the part of Keystone, except for the approval of the
Conversion by the depositors of Keystone, and promptly following organization of
the Holding Company and its execution and delivery of an instrument of accession
pursuant to Section 5.13 of this Agreement, the execution and delivery of this
Agreement by the Holding Company and the consummation of the transactions
contemplated hereby will have been duly and validly authorized by all necessary
corporate action in respect thereof on the part of the Holding Company. This
Agreement has been duly and validly executed and delivered by Keystone and upon
its execution and delivery of an instrument of accession pursuant to Section
5.13 of this Agreement, this Agreement will have been duly and validly executed
and delivered by the Holding Company and, assuming due authorization, execution
and delivery by the Company, this Agreement constitutes or will constitute, as
applicable, a legal, valid and binding obligation of Keystone and the Holding
Company which is enforceable against

                                       21

Keystone and the Holding Company in accordance with its terms, subject, as to
enforceability, to bankruptcy, insolvency and other laws of general
applicability relating to or affecting creditors' rights and to general equity
principles.

         (b)      Neither the execution and delivery of this Agreement, nor
consummation of the transactions contemplated hereby (including the Merger and
the Bank Merger) nor compliance by Keystone or upon its organization the Holding
Company with any of the provisions hereof (i) does or will conflict with or
result in a breach of any provisions of the Articles of Incorporation, Bylaws or
similar organizational documents of Keystone, any Keystone Subsidiary or upon
its organization the Holding Company, except that Keystone will not be
authorized to issue capital stock until consummation of the Conversion, (ii)
violate, conflict with or result in a breach of any term, condition or provision
of, or constitute a default (or an event which, with notice or lapse of time, or
both, would constitute a default) under, or give rise to any right of
termination, cancellation or acceleration with respect to, or result in the
creation of any lien, charge or encumbrance upon any property or asset of
Keystone, any Keystone Subsidiary or upon its organization the Holding Company
pursuant to, any material note, bond, mortgage, indenture, deed of trust,
license, lease, agreement or other instrument or obligation to which Keystone,
any Keystone Subsidiary or upon its organization the Holding Company is a party,
or by which any of their respective properties or assets may be bound or
affected, or (iii) subject to receipt of all required governmental and depositor
approvals, violate any order, writ, injunction, decree, statute, rule or
regulation applicable to Keystone, any Keystone Subsidiary or upon its
organization the Holding Company.

         (c)      To the best knowledge of Keystone, except for (i) the filing
of applications and notices with and the approvals of the Department, the FDIC
and the FRB, (ii) the filing and effectiveness of the Form S-1 with the
Commission, (iii) compliance with applicable state securities or "blue sky" laws
and the NASD Bylaws in connection with the issuance of Holding Company Common
Stock in connection with the Merger and the Conversion, (iv) the approval of the
Conversion by the requisite vote of the depositors of Keystone, (v) the filing
of the Articles of Merger with the Secretary of State of the Commonwealth of
Pennsylvania pursuant to the BCL in connection with the Merger, (vi) review of
the Merger by the DOJ under federal antitrust laws and (vii) the filing of
Articles of Merger with the Department and notice with the OCC in connection
with the Bank Merger, no consents or approvals of or filings or registrations
with any Governmental Entity or with any third party are necessary on the part
of Keystone or the Holding Company in connection with the (x) execution and
delivery by Keystone of this Agreement, the execution and delivery by the
Holding Company of an instrument of accession to this Agreement pursuant to
Section 5.13 hereof and the consummation by Keystone and the Holding Company of
the transactions contemplated hereby and (y) the execution and delivery by
Keystone of the Bank Merger Agreement and the consummation by Keystone of the
transactions contemplated thereby.

         (d)      As of the date hereof, Keystone is not aware of any reasons
relating to Keystone (including without limitation Community Reinvestment Act
compliance) why all consents and approvals shall not be procured from all
regulatory agencies having jurisdiction over the transactions contemplated by
this Agreement and the Bank Merger Agreement as shall be necessary for (i)
consummation of the transactions contemplated by this Agreement and the Bank
Merger Agreement and (ii) the continuation by the Holding Company and Keystone
after the Effective Time of the business of each of the Company and the Bank as
such business is carried on immediately prior to the Effective Time, free of any
conditions or requirements which in the reasonable opinion of Keystone could
have a Material Adverse Effect on the Holding Company or Keystone or materially
impair the value of the Company and the Bank to the Holding Company and
Keystone, respectively.

                                       22

4.6      Regulatory Reports

         Since January 1, 2000, Keystone has duly filed with the FDIC and the
Department the reports required to be filed under applicable laws and
regulations and such reports were in all material respects complete and accurate
and in compliance with the requirements of applicable laws and regulations. In
connection with the most recent examinations of Keystone by the FDIC and the
Department, Keystone was not required to correct or change any action, procedure
or proceeding which Keystone believes has not been corrected or changed as
required as of the date hereof and which could have a Material Adverse Effect on
Keystone.

4.7      Financial Statements

         (a)      Keystone has previously delivered or made available to the
Company accurate and complete copies of the Keystone Financial Statements, which
are accompanied by the audit reports of Grant Thornton LLP, independent
certified public accountants with respect to Keystone. The Keystone Financial
Statements, as well as the Keystone Financial Statements to be delivered
pursuant to Section 5.8 hereof, fairly present or will fairly present, as the
case may be, the consolidated financial condition of Keystone as of the
respective dates set forth therein, and the consolidated income, changes in
retained income and cash flows of Keystone for the respective periods or as of
the respective dates set forth therein.

         (b)      Each of the Keystone Financial Statements and the Keystone
Financial Statements to be delivered pursuant to Section 5.8 hereof has been or
will be, as the case may be, prepared in accordance with generally accepted
accounting principles consistently applied during the periods involved, except
as stated therein. The audits of Keystone and the Keystone Subsidiaries have
been conducted in all material respects in accordance with generally accepted
auditing standards. The books and records of Keystone and the Keystone
Subsidiaries are being maintained in material compliance with applicable legal
and accounting requirements, and all such books and records accurately reflect
in all material respects all dealings and transactions in respect of the
business, assets, liabilities and affairs of Keystone and the Keystone
Subsidiaries.

         (c)      Except as Previously Disclosed or to the extent (i) reflected,
disclosed or provided for in the consolidated statement of condition of Keystone
as of December 31, 2001 (including related notes), (ii) of liabilities incurred
since December 31, 2001 in the ordinary course of business and (iii) of
liabilities in connection with consummation of the transactions contemplated by
this Agreement, neither Keystone nor any Keystone Subsidiary has any
liabilities, whether absolute, accrued, contingent or otherwise, material to the
financial condition, results of operations or business of Keystone on a
consolidated basis.

4.8      Material Adverse Change

         Since September 30, 2002, (i) Keystone and its Subsidiaries have
conducted their respective businesses in the ordinary and usual course
(excluding the incurrence of expenses in connection with the Conversion and with
this Agreement and the transactions contemplated hereby) and (ii) no event has
occurred or circumstance arisen that, individually or in the aggregate, has had
or is reasonably likely to have a Material Adverse Effect on Keystone.

4.9      Environmental Matters

         (a)      To the best of Keystone's knowledge, Keystone and its
Subsidiaries are in compliance with all Environmental Laws, except for any
violations of any Environmental Law which would not, singly or in the aggregate,
have a Material Adverse Effect on Keystone.

                                       23

Neither Keystone nor any of its Subsidiaries have received any communication
alleging that Keystone or any of is Subsidiaries is not in such compliance and,
to the best knowledge of Keystone, there are no present circumstances that would
prevent or interfere with the continuation of such compliance.

         (b)      To the best of Keystone's knowledge, none of the properties
owned, leased or operated by Keystone or any of its Subsidiaries has been or is
in violation of or liable under any Environmental Law, except any such
violations or liabilities which would not singly or in the aggregate have a
Material Adverse Effect on Keystone.

         (c)      To the best of Keystone's knowledge, there are no past or
present actions, activities, circumstances, conditions, events or incidents that
could reasonably form the basis of any Environmental Claim or other claim or
action or governmental investigation that could result in the imposition of any
liability arising under any Environmental Law against Keystone or any of its
Subsidiaries or against any person or entity whose liability for any
Environmental Claim Keystone and its Keystone Subsidiaries has or may have
retained or assumed either contractually or by operation of law, except such
which would not have a Material Adverse Effect on Keystone.

         (d)      Keystone has not conducted any environmental studies during
the past five years with respect to any properties owned by it or a Keystone
Subsidiary as of the date hereof.

4.10     Tax Matters

         (a)      Keystone and its Subsidiaries have timely filed all federal,
state and local (and, if applicable, foreign) income, franchise, bank, excise,
real property, personal property and other tax returns required by applicable
law to be filed by them (including, without limitation, estimated tax returns,
income tax returns, information returns and withholding and employment tax
returns) and have paid, or where payment is not required to have been made, have
set up an adequate reserve or accrual for the payment of, all taxes required to
be paid in respect of the periods covered by such returns and, as of the
Effective Time, will have paid, or where payment is not required to have been
made, will have set up an adequate reserve or accrual for the payment of, all
material taxes for any subsequent periods ending on or prior to the Effective
Time. Neither Keystone nor any of its Subsidiaries will have any material
liability for any such taxes in excess of the amounts so paid or reserves or
accruals so established.

         (b)      All federal, state and local (and, if applicable, foreign)
income, franchise, bank, excise, real property, personal property and other tax
returns filed by Keystone and its Subsidiaries are complete and accurate in all
material respects. Neither Keystone nor any of its Subsidiaries is delinquent in
the payment of any tax, assessment or governmental charge or has requested any
extension of time within which to file any tax returns in respect of any fiscal
year or portion thereof which have not since been filed. The federal, state and
local income tax returns of Keystone and its Subsidiaries have been examined by
the applicable tax authorities (or are closed to examination due to the
expiration of the applicable statute of limitations) and no deficiencies for any
tax, assessment or governmental charge have been proposed, asserted or assessed
(tentatively or otherwise) against Keystone or any of its Subsidiaries as a
result of such examinations or otherwise which have not been settled and paid.
There are currently no agreements in effect with respect to Keystone or any of
its Subsidiaries to extend the period of limitations for the assessment or
collection of any tax. As of the date hereof, no audit, examination or
deficiency or refund litigation with respect to such return is pending or, to
the best of Keystone's knowledge, threatened.

                                       24

         (c)      Neither Keystone nor any of its Subsidiaries (i) is a party to
any agreement providing for the allocation or sharing of taxes, (ii) is required
to include in income any adjustment pursuant to Section 481(a) of the Code by
reason of a voluntary change in accounting method initiated by Keystone or any
of its Subsidiaries (nor does Keystone have any knowledge that the Internal
Revenue Service has proposed any such adjustment or change of accounting method)
or (iii) has filed a consent pursuant to Section 341(f) of the Code or agreed to
have Section 341(f)(2) of the Code apply.

4.11     Legal Proceedings

         There are no actions, suits, claims, governmental investigations or
proceedings instituted, pending or to the best knowledge of Keystone threatened
against Keystone or any of its Subsidiaries or against any asset, interest or
right of Keystone or any of its Subsidiaries, or against any officer, director
or employee of them that in any such case, if decided adversely, would have a
Material Adverse Effect on Keystone. Neither Keystone nor any Keystone
Subsidiary is a party to any order, judgment or decree which has or could
reasonably be expected to have a Material Adverse Effect on Keystone.

4.12     Compliance with Laws

         (a)      Keystone and each of its Subsidiaries have all permits,
licenses, certificates of authority, orders and approvals of, and has made all
filings, applications and registrations with, federal, state, local and foreign
governmental or regulatory bodies that are required in order to permit them to
carry on their business as it is presently being conducted and the absence of
which could reasonably be expected to have a Material Adverse Effect on
Keystone; all such permits, licenses, certificates of authority, orders and
approvals are in full force and effect; and to the best knowledge of Keystone,
no suspension or cancellation of any of the same is threatened.

         (b)      Neither Keystone nor any of its Subsidiaries is in violation
of its Articles of Incorporation or Bylaws, or of any applicable federal, state
or local law or ordinance or any order, rule or regulation of any federal,
state, local or other governmental agency or body (including, without
limitation, all banking (including all regulatory capital requirements),
securities, municipal securities, safety, health, environmental, zoning,
anti-discrimination, antitrust, and wage and hour laws, ordinances, orders,
rules and regulations), or in default with respect to any order, writ,
injunction or decree of any court, or in default under any order, license,
regulation or demand of any governmental agency, any of which violations or
defaults could reasonably be expected to have a Material Adverse Effect on
Keystone; and neither Keystone nor any of its Subsidiaries has received any
notice or communication from any federal, state or local governmental authority
asserting that Keystone or any of its Subsidiaries is in violation of any of the
foregoing which could reasonably be expected to have a Material Adverse Effect
on Keystone. Neither Keystone nor any of its Subsidiaries is subject to any
regulatory or supervisory cease and desist order, agreement, written directive,
memorandum of understanding or written commitment (other than those of general
applicability to all savings banks, savings associations or holding companies
thereof, as applicable, issued by governmental authorities), and neither
Keystone nor any of its Subsidiaries have received any written communication
requesting that it enter into any of the foregoing.

4.13     Certain Information

         None of the information relating to Keystone or the Holding Company
supplied by them and to be included in (i) the Form S-1, including the
Prospectus, will, at the time the Form S-1 and any amendment thereto becomes
effective under the Securities Act, contain any untrue

                                       25

statement of a material fact or omit to state a material fact necessary to make
the statements therein, in light of the circumstances under which they were
made, not misleading, (ii) the Application for Conversion, at the time the
Application for Conversion and any amendment thereto is not objected to by the
FDIC under the regulations thereof and approved by the Department under the
Banking Law and the regulations, if any, promulgated thereunder, will contain
any untrue statement of a material fact or omit to state a material fact
necessary to make the statements therein, in light of the circumstances under
which they were made, not misleading, and (iii) the Proxy Statements, as of the
date or dates such Proxy Statements are mailed to shareholders of the Company
and depositors of Keystone and up to and including the date or dates of the
meetings of shareholders and depositors to which such Proxy Statements relate,
will contain any untrue statement of a material fact or omit to state a material
fact necessary to make the statements therein, in light of the circumstances
under which they were made, not misleading, provided that information as of a
later date shall be deemed to modify information as of an earlier date.

4.14     Employee Benefit Plans

         (a)      Keystone has Previously Disclosed all qualified pension or
profit-sharing plans, any deferred compensation, consultant, bonus or group
insurance contract or any other incentive, health and welfare or employee
benefit plan or agreement maintained for the benefit of employees or former
employees of Keystone or any of its Subsidiaries(the "Keystone Employee Plans"),
whether written or oral.

         (b)      None of Keystone, any of its Subsidiaries, any Keystone
Employee Plan constituting an "employee pension benefit plan" within the meaning
of Section 3(2) of ERISA ("Keystone Pension Plan") or to the best of Keystone's
knowledge, any fiduciary of a Keystone Pension Plan has incurred any material
liability to the PBGC or the Internal Revenue Service with respect to any such
Keystone Pension Plan. To the best of Keystone's knowledge, no reportable event
under Section 4043(b) of ERISA has occurred with respect to any Keystone Pension
Plan.

         (c)      Except as Previously Disclosed, neither Keystone nor any of
its Subsidiaries participate in and have not incurred any liability under
Section 4201 of ERISA for a complete or partial withdrawal from a multi-employer
plan (as such term is defined in ERISA).

         (d)      A favorable determination letter has been issued by the
Internal Revenue Service with respect to each Keystone Pension Plan which is
intended to qualify under Section 401 of the Code to the effect that the
Keystone Pension Plan is qualified under Section 401 of the Code and the trust
associated with such Keystone Pension Plan is tax exempt under Section 501 of
the Code. No such letter has been revoked or, to the best of Keystone's
knowledge, is threatened to be revoked and Keystone does not know of any ground
on which such revocation may be based. Neither Keystone nor any of its
Subsidiaries have any liability under any such Keystone Pension Plan that is not
reflected on the statement of condition of Keystone at December 31, 2001 or the
notes thereto included in the Keystone Financial Statements, other than
liabilities incurred in the ordinary course of business in connection therewith
subsequent to the date thereof.

         (e)      To the best of Keystone's knowledge, no prohibited transaction
(which shall mean any transaction prohibited by Section 406 of ERISA and not
exempt under Section 408 of ERISA or Section 4975 of the Code) has occurred with
respect to any Employee Plan which would result in the imposition, directly or
indirectly, of a material excise tax under Section 4975 of the Code or otherwise
have a Material Adverse Effect on Keystone.

                                       26

         (f)      Except as Previously Disclosed, full payment has been made (or
proper accruals have been established) of all contributions which are required
for periods prior to the date hereof, and full payment will be so made (or
proper accruals will be so established) of all contributions which are required
for periods after the date hereof and prior to the Effective Time, under the
terms of each Keystone Employee Plan or ERISA; no accumulated funding deficiency
(as defined in Section 302 of ERISA or Section 412 of the Code), whether or not
waived, exists with respect to any Keystone Pension Plan, and there is no
"unfunded current liability" (as defined in Section 412 of the Code) with
respect to any Keystone Pension Plan. Keystone has not incurred and does not
expect to incur any withdrawal liability with respect to a multiemployer plan
under Subtitle of Title IV of ERISA.

         (g)      To the best of Keystone's knowledge, the Keystone Employee
Plans have been operated in compliance in all material respects with the
applicable provisions of ERISA, the Code, all regulations, rulings and
announcements promulgated or issued thereunder and all other applicable
governmental laws and regulations.

         (h)      There are no pending or, to the best knowledge of Keystone,
threatened claims (other than routine claims for benefits) by, on behalf of or
against any of the Keystone Employee Plans or any trust related thereto or any
fiduciary thereof.

4.15     Certain Contracts

         (a)      Neither Keystone nor a Keystone Subsidiary is a party to, is
bound or affected by, receives, or is obligated to pay, benefits under (i) any
agreement, arrangement or commitment, including without limitation any
agreement, indenture or other instrument, relating to the borrowing of money by
Keystone or a Keystone Subsidiary (other than in the case of Keystone deposits,
FHLB advances, federal funds purchased and securities sold under agreements to
repurchase in the ordinary course of business) or the guarantee by Keystone or a
Keystone Subsidiary of any obligation, other than by Keystone in the ordinary
course of its banking business, (ii) any agreement, arrangement or commitment
relating to the employment of a consultant or the employment, election or
retention in office of any present or former director, officer or employee of
Keystone or a Keystone Subsidiary, (iii) any agreement, arrangement or
understanding pursuant to which any payment (whether of severance pay or
otherwise) became or may become due to any director, officer or employee of
Keystone or a Keystone Subsidiary upon execution of this Agreement or upon or
following consummation of the transactions contemplated by this Agreement
(either alone or in connection with the occurrence of any additional acts or
events); (iv) any agreement, arrangement or understanding pursuant to which
Keystone or a Keystone Subsidiary is obligated to indemnify any director,
officer, employee or agent of Keystone or a Keystone Subsidiary; (v) any
agreement, arrangement or understanding to which Keystone or a Keystone
Subsidiary is a party or by which any of the same is bound which limits the
freedom of Keystone or a Keystone Subsidiary to compete in any line of business
or with any person, (vi) any assistance agreement, supervisory agreement,
memorandum of understanding, consent order, cease and desist order or condition
of any regulatory order or decree with or by the Department, the FDIC or any
other regulatory agency, or (vii) any other agreement, arrangement or
understanding which would be required to be filed as an exhibit to the Annual
Report on Form 10-K under the Exchange Act (assuming Keystone was required to
file such reports under the Exchange Act).

         (b)      Neither Keystone nor any of its Subsidiaries is in default or
in non-compliance, which default or non-compliance could reasonably be expected
to have a Material Adverse Effect on Keystone, under any contract, agreement,
commitment, arrangement, lease, insurance policy or other instrument to which it
is a party or by which its assets, business or operations may be

                                       27

bound or affected, whether entered into in the ordinary course of business or
otherwise and whether written or oral, and there has not occurred any event that
with the lapse of time or the giving of notice, or both, would constitute such a
default or non-compliance.

4.16     Brokers and Finders

         Except Sandler O'Neill & Partners, L.P., none of Keystone, any of its
Subsidiaries, the Holding Company, nor any of their respective directors,
officers or employees, has employed any broker or finder or incurred any
liability for any broker or finder fees or commissions in connection with the
transactions contemplated hereby.

4.17     Insurance

         Keystone and each of its Subsidiaries is insured for reasonable amounts
with financially sound and reputable insurance companies against such risks as
companies engaged in a similar business would, in accordance with good business
practice, customarily be insured and has maintained all insurance required by
applicable laws and regulations.

4.18     Properties

         All real and personal property owned by Keystone or any of its
Subsidiaries or presently used by them in their business is in an adequate
condition (ordinary wear and tear excepted) and is sufficient to carry on their
respective business in the ordinary course of business consistent with its past
practices. Keystone has good and marketable title free and clear of all liens,
encumbrances, charges, defaults or equities (other than equities of redemption
under applicable foreclosure laws) to all of its material properties and assets,
real and personal, except (i) liens for current taxes not yet due or payable
(ii) pledges to secure deposits and other liens incurred in the ordinary course
of its banking business, (iii) such imperfections of title, easements and
encumbrances, if any, as are not material in character, amount or extent and
(iv) as reflected on the statement of condition of Keystone as of September 30,
2002 included in the Keystone Financial Statements. All real and personal
property which is material to Keystone's business on a consolidated basis and
leased or licensed by Keystone or any of its Subsidiaries is held pursuant to
leases or licenses which are valid and enforceable in accordance with their
respective terms and such leases will not terminate or lapse prior to the
Effective Time.

4.19     Labor

         No work stoppage involving Keystone or any of its Subsidiaries is
pending or, to the best knowledge of Keystone, threatened. Neither Keystone nor
any of its Subsidiaries is involved in or to the best knowledge of Keystone
threatened with or affected by, any labor dispute, arbitration, lawsuit or
administrative proceeding involving the employees of Keystone or any of its
Subsidiaries which could have a Material Adverse Effect on Keystone. Employees
of Keystone and its Subsidiaries are not represented by any labor union nor are
any collective bargaining agreements otherwise in effect with respect to such
employees, and to the best of Keystone's knowledge, there have been no efforts
to unionize or organize any employees of Keystone or any of its Subsidiaries
during the past five years.

4.20     Ownership of Company Common Stock

         As of the date hereof, neither Keystone nor, to its best knowledge, any
of its affiliates or associates (as such terms are defined under the Exchange
Act), (i) beneficially own, directly or indirectly, or (ii) are parties to any
agreement, arrangement or understanding for the purpose of

                                       28

acquiring, holding, voting or disposing of, in each case, shares of Company
Common Stock which in the aggregate represent 5% or more of the outstanding
shares of Company Common Stock (other than shares held in a fiduciary capacity
and beneficially owned by third parties or shares taken in consideration of
debts previously contracted).

4.21     Allowance for Losses on Loans

         The allowance for losses on loans reflected on Keystone's consolidated
statements of condition included in the September 30, 2002 Keystone Financial
Statements is, or will be in the case of subsequently delivered Keystone
Financial Statements, as the case may be, in the opinion of Keystone's
management adequate in all material respects as of their respective dates under
the requirements of generally accepted accounting principles to provide for
reasonably anticipated losses on outstanding loans, net of recoveries. The other
real estate owned reflected on the consolidated statements of condition included
in the September 30, 2002 Keystone Financial Statements is, or will be in the
case of subsequently delivered Keystone Financial Statements, as the case may
be, carried at the lower of cost or fair value, less estimated costs to sell, as
required by generally accepted accounting principles.

4.22     Disclosures

         None of the representations and warranties of Keystone or any of the
written information or documents furnished or to be furnished by Keystone to the
Company in connection with or pursuant to this Agreement or the consummation of
the transactions contemplated hereby, when considered as a whole, contains or
will contain any untrue statement of a material fact, or omits or will omit to
state any material fact required to be stated or necessary to make any such
information or document, in light of the circumstances, not misleading.

                                    ARTICLE V
                                    COVENANTS

5.1      Reasonable Best Efforts

         Subject to the terms and conditions of this Agreement, each of the
Company and Keystone (i) shall use its reasonable best efforts in good faith to
take, or cause to be taken, all actions, and to do, or cause to be done, all
things necessary or advisable under applicable laws and regulations so as to
permit and otherwise enable consummation of the Conversion and the Merger as
promptly as reasonably practicable, it being the intention of the parties that
the Conversion be consummated prior to the Effective Time and that the Bank
Merger be consummated immediately following the Effective Time in accordance
with Section 5.12 hereof, and (ii) shall cooperate fully with each other to that
end.

5.2      Shareholder and Depositor Meetings

         (a)      The Company agrees to take, in accordance with applicable law
and the Company's Articles and Incorporation and Bylaws, all action necessary to
convene as soon as reasonably practicable an annual or a special meeting of its
shareholders to consider and vote upon the approval of this Agreement and any
other matters required to be approved by the Company's shareholders for
consummation of the transactions contemplated hereby (including any adjournment
or postponement, the "Company Meeting"). Except with the prior approval of
Keystone, no other matters shall be submitted for the approval of the Company
shareholders at the Company Meeting except, if the Company Meeting is an annual
meeting, the election of directors. The Company Board shall at all times prior
to and during such meeting recommend

                                       29

such approval and shall take all reasonable lawful action to solicit such
approval by its shareholders; provided that nothing in this Agreement shall
prevent the Company Board from withholding, withdrawing, amending or modifying
its recommendation if the Company Board determines, after consultation with its
outside counsel, that such action is legally required in order for the directors
to comply with their fiduciary duties to the Company shareholders under
applicable law; provided, further, that Section 5.7 shall govern the
withholding, withdrawing, amending or modifying of such recommendation in the
circumstances described therein.

         (b)      Keystone shall take all action necessary to properly call and
convene a meeting of its depositors as soon as practicable to consider and vote
upon the Conversion and the transactions contemplated thereby after receipt of
all necessary approvals or non-objections of Governmental Entities. The Board of
Directors of Keystone will recommend that the depositors of Keystone approve the
Conversion and the transactions contemplated thereby.

5.3      Regulatory Matters

         (a)      The parties hereto shall promptly cooperate with each other in
the preparation and filing of the Form S-1, the Prospectus and the Proxy
Statements relating to the meetings of shareholders of the Company and the
depositors of Keystone to be held pursuant to Section 5.2 of this Agreement (the
"Company Proxy Statement" and the "Keystone Proxy Statement," respectively)
under the Securities Act and the Exchange Act, as applicable. Each of the
Holding Company, Keystone and the Company shall use its reasonable best efforts
to have the Form S-1 declared effective under the Securities Act, the Company
Proxy Statement approved for mailing in definitive form under the Exchange Act
and the Keystone Proxy Statement approved or not objected to under the Banking
Law and the regulations of the FDIC as promptly as practicable after such
filings and the receipt of non-objection or approval, as the case may be, of the
Application for Conversion by the FDIC and the Department, and thereafter the
Company shall promptly mail to its shareholders the Company Proxy Statement and
Prospectus and Keystone shall promptly mail, or in the case of the Prospectus
make available, to its depositors the Keystone Proxy Statement and the
Prospectus. The Holding Company also shall use its reasonable best efforts to
obtain all necessary state securities law or "blue sky" permits and approvals
required to carry out the issuance of Holding Company Common Stock in connection
with the Merger and the Conversion. The Company shall furnish all information
concerning the Company and the holders of the Company Common Stock as may be
reasonably requested in connection with any of the foregoing actions. In the
event that the Company has issued any securities, through its employee benefits
plans or otherwise, in any offering which should have been registered or
qualified under Federal or state securities laws which were not so registered or
qualified, the Company shall promptly take such action as the parties hereto
mutually agree in order to eliminate, reduce or mitigate, to the extent
possible, any contingent or other liability which the Company may have as a
result of such offering.

         (b)      The parties hereto shall cooperate with each other and use
their reasonable best efforts to promptly prepare and file all necessary
documentation, to effect all applications, notices, petitions and filings, and
to obtain as promptly as practicable all permits, consents, approvals and
authorizations of all Governmental Entities and third parties which are
necessary or advisable to consummate the transactions contemplated by this
Agreement (including without limitation the Conversion, the Merger and the Bank
Merger). Keystone and the Company shall have the right to review in advance, and
to the extent practicable each will consult with the other on, in each case
subject to applicable laws relating to the exchange of information, all the
information which appears in any filing made with or written materials submitted
to any third party or any Governmental Entity in connection with the
transactions contemplated by this Agreement. In exercising the foregoing right,
each of the parties hereto shall act reasonably and

                                       30

as promptly as practicable. The parties hereto agree that they will consult with
each other with respect to the obtaining of all permits, consents, approvals and
authorizations of all third parties and Governmental Entities necessary or
advisable to consummate the transactions contemplated by this Agreement and each
party will keep the other apprised of the status of matters relating to
completion of the transactions contemplated herein.

         (c)      Keystone and the Company shall, upon request, furnish each
other with all information concerning themselves, their respective Subsidiaries,
directors and officers and shareholders of the Company and such other matters as
may be reasonably necessary or advisable in connection with the Form S-1 or any
other statement, filing, notice or application made by or on behalf of Keystone,
the Holding Company, the Company or the Bank to any Governmental Entity in
connection with the Conversion, the Merger, the Bank Merger and the other
transactions contemplated hereby.

         (d)      Keystone and the Company shall promptly furnish each other
with copies of written communications received by Keystone or the Company, as
the case may be, or any of their respective Subsidiaries from, or delivered by
any of the foregoing to, any Governmental Entity in respect of the transactions
contemplated hereby.

5.4      Investigation and Confidentiality

         (a)      Each party shall permit the other party and its
representatives reasonable access to its properties and personnel, and shall
disclose and make available to such other party all books, papers and records
relating to the assets, stock ownership, properties, operations, obligations and
liabilities of it and its Subsidiaries, including, but not limited to, all books
of account (including the general ledger), tax records, minute books of meetings
of boards of directors (and any committees thereof) and shareholders,
organizational documents, bylaws, material contracts and agreements, filings
with any regulatory authority, accountants' work papers, litigation files, loan
files, plans affecting employees, and any other business activities or prospects
in which the other party may have a reasonable interest, provided that such
access shall be reasonably related to the transactions contemplated hereby and,
in the reasonable opinion of the respective parties providing such access, not
unduly interfere with normal operations. Each party and its Subsidiaries shall
make their respective directors, officers, employees and agents and authorized
representatives (including counsel and independent public accountants) available
to confer with the other party and its representatives, provided that such
access shall be reasonably related to the transactions contemplated hereby and
shall not unduly interfere with normal operations.

         (b)      All information furnished previously in connection with the
transactions contemplated by this Agreement or pursuant hereto shall be treated
as the sole property of the party furnishing the information until consummation
of the transactions contemplated hereby and, if such transactions shall not
occur, the party receiving the information shall either destroy or return to the
party which furnished such information all documents or other materials
containing, reflecting or referring to such information, shall use its best
efforts to keep confidential all such information, and shall not directly or
indirectly use such information for any competitive or other commercial
purposes. The obligation to keep such information confidential shall continue
for five years from the date the proposed transactions are abandoned but shall
not apply to (i) any information which (x) the party receiving the information
can establish was already in its possession prior to the disclosure thereof by
the party furnishing the information; (y) was then generally known to the
public; or (z) became known to the public through no fault of the party
receiving the information; or (ii) disclosures pursuant to a legal requirement
or in accordance with an order of a court of competent jurisdiction, provided
that the party which is the subject of any such legal requirement or order shall
use its best efforts to give the other party

                                       31

at least ten business days prior notice thereof.

5.5      Press Releases

         Keystone and the Company shall agree with each other as to the form and
substance of any press release related to this Agreement or the transactions
contemplated hereby, and consult with each other as to the form and substance of
other public disclosures which may relate to the transactions contemplated by
this Agreement, provided, however, that nothing contained herein shall prohibit
either party, following prior notification to the other party, from making any
disclosure which is required by law or regulation.

5.6      Business of the Parties

         (a)      During the period from the date of this Agreement and
continuing until the Effective Time, except as expressly contemplated or
permitted by this Agreement or with the prior written consent of the other
Party, each Party shall carry on their respective businesses in the ordinary
course consistent with past practice. During such period, each Party also will
use, and will cause each of is subsidiaries to use, all reasonable efforts to
(x) preserve its business organization intact, (y) keep available to itself and
the other Party the present services of its respective employees and (z)
preserve for itself and the other Party the goodwill of its respective customers
and others with whom business relationships exist. Without limiting the
generality of the foregoing, except as Previously Disclosed or with the prior
written consent of the other Party hereto, between the date hereof and the
Effective Time, the Parties shall not, and shall cause each of their respective
Subsidiaries not to:

                  (i)     declare, set aside, make or pay any dividend or other
         distribution (whether in cash, stock or property or any combination
         thereof) in respect of the Company Common Stock, except for regular
         quarterly cash dividends at a rate per share of Company Common Stock
         not in excess of $.19 per share and except, in the event the Effective
         Time occurs more than 45 days after the commencement of any calendar
         quarter but prior to the normal dividend payment date for such calendar
         quarter, a pro rata cash dividend based on the Company's normal
         quarterly cash dividend rate; provided, however, that nothing contained
         herein shall be deemed to affect the ability of a Company Subsidiary to
         pay dividends on its capital stock to the Company;

                  (ii)    issue any shares of its capital stock, other than upon
         exercise of the Company Options referred to in Section 3.1 hereof, or
         issue, grant, modify or authorize any Rights; purchase any shares of
         Company Common Stock; or effect any recapitalization, reclassification,
         stock dividend, stock split or like change in capitalization;

                  (iii)   amend its Articles of Incorporation, Articles of
         Association, Bylaws or similar organizational documents; impose, or
         suffer the imposition, on any share of stock or other ownership
         interest held by a Party in a Party Subsidiary of any lien, charge or
         encumbrance or permit any such lien, charge or encumbrance to exist; or
         waive or release any material right or cancel or compromise any
         material debt or claim;

                  (iv)    increase the rate of compensation of any of its
         directors, officers or employees, or pay or agree to pay any bonus or
         severance to, or provide any other new employee benefit or incentive
         to, any of its directors, officers or employees,

                                       32

         except (i) as may be required pursuant to Previously Disclosed
         commitments existing on the date hereof, (ii) as may be required by law
         and (iii) merit increases in accordance with past practices, normal
         cost-of-living increases and normal increases related to promotions or
         increased job responsibilities;

                  (v)     enter into or, except as may be required by law,
         modify any pension, retirement, stock option, stock purchase, stock
         appreciation right, savings, profit sharing, deferred compensation,
         supplemental retirement, consulting, bonus, group insurance or other
         employee benefit, incentive or welfare contract, plan or arrangement,
         or any trust agreement related thereto, in respect of any of its
         directors, officers or employees; or make any contributions to any of
         the Company's or Keystone's Pension Plans or the Company's ESOP (other
         than as required by law or regulation or in a manner and amount
         consistent with past practices) and except as specifically provided
         herein;

                  (vi)    enter into (w) any transaction, agreement, arrangement
         or commitment not made in the ordinary course of business, (x) any
         agreement, indenture or other instrument relating to the borrowing of
         money by the Party or a Party Subsidiary or guarantee by a Party or any
         Party Subsidiary of any such obligation, except in the case of the Bank
         or Keystone for deposits, FHLB advances, federal funds purchased and
         securities sold under agreements to repurchase in the ordinary course
         of business consistent with past practice, (y) any agreement,
         arrangement or commitment relating to the employment of an employee or
         consultant, or amend any such existing agreement, arrangement or
         commitment, provided that the Company, the Bank and Keystone may employ
         an employee or consultant in the ordinary course of business if the
         employment of such employee or consultant is terminable by the Company,
         the Bank or Keystone, as the case may be, at will without liability,
         other than as required by law; or (z) any contract, agreement or
         understanding with a labor union;

                  (vii)   change its method of accounting in effect for the year
         ended December 31, 2001, except as required by changes in laws or
         regulations or generally accepted accounting principles, or change any
         of its methods of reporting income and deductions for federal income
         tax purposes from those employed in the preparation of its federal
         income tax return for such year, except as required by changes in laws
         or regulations;

                  (viii)  make any capital expenditures in excess of $75,000
         individually or $150,000 in the aggregate, other than pursuant to
         binding commitments existing on the date hereof and other than
         expenditures necessary to maintain existing assets in good repair; or
         enter into any new lease of real property or any new lease of personal
         property providing for annual payments exceeding $50,000;

                  (ix)    file any applications or make any contract with
         respect to branching or site location or relocation;

                  (x)     acquire in any manner whatsoever (other than to
         realize upon collateral for a defaulted loan) control over or any
         equity interest in any business or entity, except for investments in
         marketable equity securities in the ordinary course of business and not
         exceeding 5% of the outstanding shares of any class;

                  (xi)    enter or agree to enter into any agreement or
         arrangement granting

                                       33

         any preferential right to purchase any of its assets or rights or
         requiring the consent of any party to the transfer and assignment of
         any such assets or rights;

                  (xii)   change or modify in any material respect any of its
         lending or investment policies, except to the extent required by law or
         an applicable regulatory authority;

                  (xiii)  take any action that would prevent or impede the
         Merger or the Conversion from qualifying as a reorganization within the
         meaning of Section 368 of the Code;

                  (xiv)   enter into any futures contract, option contract,
         interest rate caps, interest rate floors, interest rate exchange
         agreement or other agreement for purposes of hedging the exposure of
         its interest-earning assets and interest-bearing liabilities to changes
         in market rates of interest;

                  (xv)    take any action that would result in any of the
         representations and warranties contained in this Agreement not to be
         true and correct in any material respect at the Effective Time or that
         would cause any of the conditions of Sections 6.1, 6.2 or 6.3 hereof
         not to be satisfied;

                  (xvi)   materially increase or decrease the rate of interest
         paid on time deposits, or certificates of deposit, except in a manner
         and pursuant to policies consistent with past practices, or

                  (xvii)  agree to do any of the foregoing.

         (b)      Each of the Company and Keystone shall promptly notify the
other Party in writing of the occurrence of any matter or event known to and
directly involving it or any of its Subsidiaries, other than any changes in
conditions that affect the banking or savings institution industry generally,
that would have, either individually or in the aggregate, a Material Adverse
Effect on it.

5.7      Certain Actions

         (a)      The Company agrees that neither it nor any of its Subsidiaries
shall, and that it shall direct and use its reasonable best efforts to cause its
and each such Subsidiary's directors, officers, employees, agents and
representatives not to, directly or indirectly, initiate, solicit, knowingly
encourage or otherwise facilitate any inquiries or the making of any proposal or
offer with respect to an Acquisition Proposal. The Company further agrees that
neither the Company nor any of its Subsidiaries shall, and that it shall direct
and use its reasonable best efforts to cause its and each such Subsidiary's
directors, officers, employees, agents and representatives not to, directly or
indirectly, engage in any negotiations concerning, or provide any confidential
information or data to, or have any discussions with, any Person relating to an
Acquisition Proposal, or otherwise knowingly facilitate any effort or attempt to
make or implement an Acquisition Proposal; provided, however, that nothing
contained in this Agreement shall prevent the Company or the Board of Directors
of the Company from (A) complying with its disclosure obligations under federal
or state law; (B) providing information in response to a request therefor by a
Person who has made an unsolicited bona fide written Acquisition Proposal if the
Board of Directors of the Company receives from the Person so requesting such
information an executed confidentiality agreement the terms of which are
substantially identical to those of the confidentiality agreement entered into
by the Company and Keystone dated December 31, 2002;

                                       34

(C) engaging in any negotiations or discussions with any Person who has made an
unsolicited bona fide written Acquisition Proposal or (D) recommending such an
Acquisition Proposal to the shareholders of the Company, if and only to the
extent that, in each such case referred to in clause (B), (C) or (D) above, (i)
the Company Board determines in good faith (after consultation with outside
legal counsel) that such action would be required in order for its directors to
comply with their respective fiduciary duties under applicable law and (ii) the
Board of Directors of the Company determines in good faith (after consultation
with its financial advisor) that such Acquisition Proposal, if accepted, is
reasonably likely to be consummated, taking into account all legal, financial
and regulatory aspects of the proposal and the Person making the proposal and
would, if consummated, result in a transaction more favorable to the Company's
shareholders from a financial point of view than the Merger. An Acquisition
Proposal which is received and considered by the Company in compliance with this
Section 5.7 and which meets the requirements set forth in clause (D) of the
preceding sentence is herein referred to as a "Superior Proposal." The Company
agrees that it will immediately cease and cause to be terminated any existing
activities, discussions or negotiations with any parties conducted heretofore
with respect to any Acquisition Proposals. The Company agrees that it will
notify Keystone immediately if any such inquiries, proposals or offers are
received by, any such information is requested from, or any such discussions or
negotiations are sought to be initiated or continued with, the Company or any of
its representatives.

         (b)      In the event that the Board of Directors of the Company
determines in good faith, after consultation with its financial advisor and upon
advice from outside counsel, that it has received a Superior Proposal, it shall
notify Keystone in writing of its intent to terminate this Agreement and
concurrently with or after such termination cause the Company to enter into an
acquisition agreement with respect to, or recommend acceptance of, the Superior
Proposal. Such notice shall specify all of the terms and conditions of such
Superior Proposal and identify the Person making such Superior Proposal.
Keystone shall have five business days to evaluate and respond to the Company's
notice. If Keystone notifies the Company in writing prior to the expiration of
the five business day period provided above that it shall increase the Merger
Consideration to an amount at least equal to that of such Superior Proposal (the
"Keystone Proposal"), then the Company shall not be permitted to enter into an
acquisition agreement with respect to, or permit its Board to recommend
acceptance to its shareholders of, such Superior Proposal. Such notice by
Keystone shall specify the new Merger Consideration. The Company shall have five
business days to evaluate the Keystone Proposal.

         (c)      In the event the Superior Proposal involves consideration to
the Company's shareholders consisting of securities, in whole or in part, a
Keystone Proposal shall be deemed to be at least equal to the Superior Proposal,
if the Keystone Proposal offers Merger Consideration that equals or exceeds the
consideration being offered to the Company's shareholders in the Superior
Proposal valuing any securities forming a part of the Superior Proposal at its
cash equivalent based upon (a) the average trading price of such securities for
the 20 trading days immediately preceding the date of the Keystone Proposal or
(b) the written valuation of such securities by a nationally recognized
investment banking firm selected if such securities are not traded on a
nationally recognized exchange or will be newly issued securities that are not
of a class then trading on a nationally recognized exchange. Any written
valuation shall be attached as an exhibit to the Keystone Proposal.

         (d)      In the event that the Board of the Company determines in good
faith, upon the advice of its financial advisor and outside counsel, that the
Keystone Proposal is not at least equal to the Superior Proposal, the Company
can terminate this Agreement in order to execute an acquisition agreement with
respect to, or to allow its Board to adopt a resolution recommending acceptance
to the Company's shareholders of, the Superior

                                       35

Proposal as provided in Section 7.1(h).

5.8      Current Information

         During the period from the date of this Agreement to the Effective
Time, each of Keystone and the Company shall, upon the request of the other
party, cause one or more of its designated representatives to confer on a
monthly or more frequent basis with representatives of the other party regarding
its financial condition, operations and business and matters relating to the
completion of the transactions contemplated hereby. As soon as reasonably
available, but in no event more than 45 days after the end of each calendar
quarter ending after the date of this Agreement, the Company will deliver to
Keystone its quarterly report on Form 10-Q under the Exchange Act, and, as soon
as reasonably available, but in no event more than 90 days after December 31,
2002, the Company will deliver to Keystone its Annual Report on Form 10-K for
2002. As soon as reasonably available, but in no event more than 90 days after
December 31, 2002, Keystone will deliver to the Company audited statements of
condition (including related notes and schedules, if any) of Keystone as of
December 31, 2002 and 2001 and statements of income, changes in retained income
and cash flows (including related notes and schedules, if any) of Keystone for
each of the years in the three-year period ended December 31, 2002. Keystone
also will deliver to the Company each Call Report report filed by Keystone with
the FDIC concurrently with the filing of such call report. Within 25 days after
the end of each month, the Company and Keystone will deliver to the other party
an unaudited consolidated statement of condition and an unaudited consolidated
statement of income, without related notes, for such month prepared in
accordance with generally accepted accounting principles.

5.9      Indemnification; Insurance

         (a)      From and after the Effective Time, the Holding Company (the
"Indemnifying Party") shall provide indemnification to any present or former
director, officer or employee of the Company and each Company Subsidiary, in
each case determined as of the Effective Time (the "Indemnified Parties"), with
respect to any costs or expenses (including reasonable attorneys' fees),
judgments, fines, losses, claims, damages or liabilities incurred in connection
with any claim, action, suit, proceeding or investigation, whether, civil,
criminal, administrative or investigative, arising out of matters existing or
occurring at or prior to the Effective Time, if first asserted or claimed prior
to the date hereof and Previously Disclosed, if first asserted or claimed
between the date hereof and the Effective Time and disclosed pursuant to Section
5.16 hereof or if first asserted or claimed after the Effective Time, to the
fullest extent, if any, that such Indemnified Party would have been entitled to
indemnification by the Company or any Company Subsidiary under the Articles of
Incorporation, Articles of Association or Bylaws of the Company or any Company
Subsidiary as Previously Disclosed, provided, however, that all rights to
indemnification in respect of any claim asserted or made within such period
shall continue until the final disposition of such claim, and provided, further,
that nothing contained herein shall extend or be deemed a waiver of any
applicable statute of limitations in respect of any claim or claim for
indemnification. Without limiting the foregoing, all limitations of liability
existing in favor of the Indemnified Parties in the Articles of Incorporation,
Articles of Association or Bylaws of the Company or any Company Subsidiary,
arising out of matters existing or occurring at or prior to the Effective Time
shall survive the Merger and shall continue in full force and effect.

         (b)      Any Indemnified Party wishing to claim indemnification under
Section 5.9(a), upon learning of any such claim, action, suit, proceeding or
investigation, shall promptly notify the Indemnifying Party, but the failure to
so notify shall not relieve the Indemnifying Party of any

                                       36

liability it may have to such Indemnified Party if such failure does not
materially prejudice the Indemnifying Party. In the event of any such claim,
action, suit, proceeding or investigation (whether arising before or after the
Effective Time), (i) the Indemnifying Party shall have the right to assume the
defense thereof and the Indemnifying Party shall not be liable to such
Indemnified Parties for any legal expenses of other counsel or any other
expenses subsequently incurred by such Indemnified Parties in connection with
the defense thereof, except that if the Indemnifying Party elects not to assume
such defense or counsel for the Indemnified Parties advises that there are
issues which raise conflicts of interest between the Indemnifying Party and the
Indemnified Parties, the Indemnified Parties may retain counsel which is
reasonably satisfactory to the Indemnifying Party, and the Indemnifying Party
shall pay, promptly as statements therefor are received, the reasonable fees and
expenses of such counsel for the Indemnified Parties (which may not exceed one
firm in any jurisdiction unless the use of one counsel for such Indemnified
Parties would present such counsel with a conflict of interest) in accordance
with the obligations set forth in Section 5.9(a) hereof, (ii) the Indemnified
Parties will cooperate in the defense of any such matter, (iii) the Indemnifying
Party shall not be liable for any settlement effected without its prior written
consent, which consent shall not be unreasonably withheld, and (iv) the
Indemnifying Party shall have no obligation hereunder in the event a federal
banking agency or a court of competent jurisdiction shall ultimately determine,
and such determination shall have become final and nonappealable, that
indemnification of an Indemnified Party in the manner contemplated hereby is
prohibited by applicable law.

         (c)      The Holding Company shall maintain the Company's existing
directors' and officers' liability insurance policy (or purchase an insurance
policy providing coverage on substantially the same terms and conditions) for
acts or omissions occurring prior to the Effective Time by persons who are
currently covered by such insurance policy maintained by the Company and the
Company Subsidiaries for a period of six years following the Effective Time,
provided, however, that in no event shall the Holding Company be required to
expend on an annual basis more than 150% of the amount paid by the Company and
the Company Subsidiaries as of the date hereof for such insurance coverage (the
"Insurance Amount") to maintain or procure such insurance coverage, and further
provided that if the Holding Company is unable to maintain or obtain the
insurance called for hereby, the Holding Company shall use all reasonable
efforts to obtain as much comparable insurance as is available for the Insurance
Amount. At the request of the Holding Company, the Company shall use reasonable
efforts to procure the insurance coverage referred to in the preceding sentence
prior to the Effective Time.

         (d)      In the event that the Holding Company or any of its respective
successors or assigns (i) consolidates with or merges into any other person and
shall not be the continuing or surviving corporation or entity of such
consolidation or merger or (ii) transfers all or substantially all of its
properties and assets to any person, then, and in each such case the successors
and assigns of such entity shall assume the obligations set forth in this
Section 5.9, which obligations are expressly intended to be for the irrevocable
benefit of, and shall be enforceable by, each director and officer covered
hereby and the heirs and estates thereof.

                                       37

5.10     Directors and Executive Officers

         (a)      On or prior to the Effective Time, each of Keystone and the
Holding Company agrees to take all action necessary to increase the size of
their respective Boards of Directors to 15 members, nine of whom shall be
selected by Keystone directors and six of whom shall be selected by the Company.
Furthermore, each of Keystone and the Holding Company shall take all action to
appoint or elect, effective as of the Effective Time such persons in the classes
as set forth below.

           Class I                    Class II                  Class III
   (Term expiring in 2004)    (Term expiring in 2005)    (Term expiring in 2006)
   -----------------------    -----------------------    -----------------------
    R. Chadwick Paul, Jr.         John A. Mountain        Jeffrey P. Feather
      Kenneth R. Smith            Robert R. Scholl          Michael J. Gausling
      R. Charles Stehly           Richard L. Strain           Donna D. Holton
       Scott V. Fainor          Daniel B. Mulholland        Maria Zumas Thulin
     Christian F. Martin         Charles J. Peischl        Richard Stevens, III

         (b)      On or prior to the Effective Time, each of Keystone and the
Holding Company agrees to take all action necessary to elect Jeffrey P. Feather
as Chairman of the Board, Scott V. Fainor as the President and Chief Executive
Officer and Eugene T. Sobol as the Senior Executive Vice President and Chief
Operating Officer of Keystone and the Holding Company.

5.11     Employees and Employee Benefit Plans

         (a)      All employees of the Company, the Bank or any other Company
Subsidiary as of the Effective Time (collectively, "Company Employees") shall
become employees of the Holding Company or a Holding Company Subsidiary as of
the Effective Time, provided that, other than as provided by Section 5.11(g)
hereof, the Holding Company or a Holding Company Subsidiary shall have no
obligation to continue the employment of any such person and nothing contained
in this Agreement shall give any employee of the Holding Company or a Holding
Company Subsidiary a right to continuing employment with the Holding Company or
a Holding Company Subsidiary after the Effective Time. To the extent that the
Holding Company or a Holding Company Subsidiary terminates the employment of any
Company, Bank or Keystone Employee (other than those employees, if any, who
receive payments pursuant to Section 5.11(d) hereof), other than for cause,
within six months following the Effective Time, the Holding Company shall, or
shall cause a Holding Company Subsidiary to, provide severance benefits in a
cash amount as mutually agreed to by Keystone and the Company, provided, however
that in no event shall the Holding Company or a Holding Company Subsidiary have
any obligation to provide severance benefits to any Company Employee whose
termination of employment occurs due to resignation or discharge for cause or
who is entitled to severance benefits or the equivalent thereof under the terms
of an individual contract with the Company or the Bank.

         (b)      With the exception of those individuals who are expected to
enter into new employment agreements pursuant to Section 5.11(g) hereof, each
Company Employee who remains employed by the Holding Company or a Holding
Company Subsidiary following the Effective Time (each, a "Continuing Employee")
shall be entitled to participate in (i) such of the employee benefit plans,
deferred compensation arrangements, bonus or incentive plans and other
compensation and benefit plans that the Holding Company or a Holding Company
Subsidiary may continue for the benefit of Continuing Employees following the
Effective Time and (ii)

                                       38

whatever employee benefit plans and other compensation and benefit plans (other
than any stock option or restricted stock grant plan implemented by the Holding
Company) that the Holding Company or a Holding Company Subsidiary may maintain
for the benefit of its similarly situated employees on an equitably equivalent
basis, if such Continuing Employee is not otherwise then participating in a
similar plan described in Section 5.11(c) hereof. The parties hereto acknowledge
that Continuing Employees shall be eligible to participate in the stock option
plan implemented by the Holding Company within one year subsequent to the
Effective Time ("New Option Plan") (subject to receipt of necessary corporate,
regulatory and stockholder approval) based upon the same criteria as other
employees of Keystone or the Holding Company and the level of grants shall give
due regard to, among other factors, relative levels of title, duties, salary and
other compensation and benefits.

         (c)      (i)     At the Effective Time, the Holding Company or a
Holding Company Subsidiary shall become the plan sponsor of each Company
Employee Plan. The Company agrees to take or cause to be taken such actions as
the Holding Company or a Holding Company Subsidiary may reasonably request to
give effect to such assumption. The Holding Company or a Holding Company
Subsidiary shall have the right and power at any time following the Effective
Time to amend or terminate or cease benefit accruals under any Company Employee
Plan or cause it to be merged with or its assets and liabilities to be
transferred to a similar plan maintained by it.

                  (ii)    For purposes of its employee benefit plans, the
Holding Company and a Holding Company Subsidiary shall treat Continuing
Employees as new employees, but shall amend its plans to provide credit for
purposes of vesting and eligibility to participate (but not for benefit
accrual), for each Continuing Employee's service with the Company, the Bank and
any other Subsidiary of the Company to the extent that such service was
recognized for similar purposes under the Company Employee Plans immediately
prior to the Effective Time. Continuing Employees and their covered dependents
will not be deprived of any partial or complete coverage under any employee
benefit plan of the Holding Company or a Holding Company Subsidiary (which
provides the type of benefits similar to benefits under any Company Employee
Plan) because of any waiting period or pre-existing condition or previous
medical treatments, except to the extent that such pre-existing condition or
previous medical treatments were excluded from coverage under a Company Employee
Plan, in which case this Section 5.11(c)(ii) shall not require coverage for such
pre-existing condition or previous medical treatments to the same extent such
coverage was excluded under a Company Employee Plan. To the extent that the
initial period of coverage for Continuing Employees under any employee benefit
plan of the Holding Company or a Holding Company Subsidiary that is an "employee
welfare benefit plan" as defined in Section 3(1) of ERISA overlaps with the 12
months coverage period of an applicable Company Employee Plan, Continuing
Employees shall be given credit during the initial period of coverage for any
deductibles and coinsurance payments made by Continuing Employees under any
Company Employee Plan during any partial period.

         (d)      At and following the Effective Time, Keystone shall honor, and
the Holding Company shall continue to be obligated to perform, in accordance
with their terms, all benefit obligations to, and contractual rights of, current
and former employees of the Company and the Bank existing as of the Effective
Time, as well as all employment, severance, deferred compensation or
"change-in-control" agreements, plans or policies of the Company which are
Previously Disclosed. Keystone acknowledges that the consummation of the Merger
will constitute a "change-in-control" of the Company for purposes of any
employee benefit plans, agreements and arrangements of the Company and the Bank.

                                       39

         (e)      The ESOP shall be terminated effective as of the Effective
Time. As soon as practicable after the Effective Time (but not prior to the
publication of financial results covering at least 30 days of combined
operations after the Merger), the trustees of the ESOP shall, if necessary,
convert to cash a portion of the Holding Company Common Stock received by the
ESOP in the Merger with respect to unallocated Company Common Stock in order to
repay the entire outstanding balances of the ESOP loans in accordance with
ERISA, the rules and regulations promulgated thereunder, the Code, the rules,
regulations promulgated thereunder, and any precedential rulings issued by the
Internal Revenue Service ("IRS"). As soon as practicable after the retirement of
the ESOP loans (but not later than 90 days after the publication of financial
results covering at least 30 days of combined operations after the Merger), the
trustees of the ESOP shall allocate the remaining Holding Company Common Stock
received by the ESOP in the Merger with respect to unallocated shares of Company
Common Stock to the accounts of all ESOP participants (whether or not such
participants are then actively employed) and beneficiaries in proportion to the
account balance of such participants and beneficiaries as they existed as of the
Effective Time (and, if required, to the accounts of former participants or
their beneficiaries) as investment earnings of the ESOP except as restricted by
applicable law. The Company and/or Keystone and the Holding Company shall
exercise best efforts to implement procedures that will assure the full
allocation of the remaining suspense account to such participants or their
beneficiaries. Upon the election of any participant, his or her benefit that
constitutes an "eligible rollover distribution" (as defined in Section
402(f)(2)(A) of the Code) under the ESOP may (i) in the sole discretion of
Keystone and the Holding Company, be rolled over to any qualified Keystone or
Holding Company (or any Subsidiary thereof) benefit plan, other than an employee
stock ownership plan of the Holding Company or Keystone, or (ii) be rolled over
to any individual retirement account and, provided further, that any such
distribution shall not occur until receipt of a favorable termination ruling
from the IRS.

         The foregoing actions relating to termination of the ESOP will be
adopted conditioned upon the consummation of the Merger and upon receiving (i) a
favorable determination letter from the IRS with regard to the continued
qualification of the ESOP after any required amendments necessary to implement
the actions thereof set forth above and (ii) the receipt of a favorable
termination letter as to the termination of the ESOP. The Company, the Bank, and
the Holding Company will cooperate in submitting appropriate requests for any
such determination and termination letters to the IRS and will use their best
efforts to seek the issuance of such letters as soon as practicable following
the date hereof. The Bank and the Holding Company will adopt such additional
amendments to the ESOP as may be reasonably required by the IRS as a condition
to granting such favorable determination and termination letters provided that
such amendments do not substantially change the terms outlined herein or would
result in a material adverse change in the business, operations, assets,
financial condition or prospects of the Company or the Bank or result in an
additional material liability to the Holding Company or Keystone.

         (g)      Concurrently with the execution of this Agreement by Keystone
and the Company, Keystone shall enter into employment agreements with Messrs.
Scott V. Fainor and Eugene T. Sobol in the forms attached hereto as Appendices E
and F, respectively. Upon execution of the Accession Agreement (as hereinafter
defined) by the Holding Company, it shall join in the employment agreements with
Messrs. Fainor and Sobol.

5.12     Bank Merger

         Keystone, the Holding Company and the Company shall take, and the
Company shall cause the Bank to take, all necessary and appropriate actions,
including causing the Bank and Keystone to enter into a merger agreement (the
"Bank Merger Agreement"), to cause the Bank to

                                       40

merge with and into Keystone (the "Bank Merger") immediately after the Effective
Time in accordance with the requirements of all applicable laws of the
Commonwealth of Pennsylvania and regulations of the Department thereunder.
Keystone shall be the surviving corporation in the Bank Merger (the "Surviving
Bank"), and shall continue its corporate existence under the laws of the
Commonwealth of Pennsylvania as a wholly-owned subsidiary of the Holding
Company. The name of the Surviving Bank shall be "Keystone Nazareth Bank & Trust
Company." The directors and executive officers of the Surviving Bank upon
consummation of the Bank Merger shall be the directors and executive officers of
Keystone immediately prior to the consummation of the Bank Merger, except as
provided in Section 5.10 of this Agreement. Upon consummation of the Bank
Merger, the separate corporate existence of the Bank shall cease.

5.13     Organization of the Holding Company

         Prior to the Effective Time, Keystone shall cause the Holding Company
to be organized under the BCL. Following the organization of the Holding Company
and prior to the Effective Time, the Board of Directors shall approve this
Agreement and the transactions contemplated hereby, and Keystone shall cause the
Holding Company to execute and deliver an appropriate instrument of accession to
this Agreement in the form attached hereto as Appendix G ("Accession
Agreement"), whereupon the Holding Company shall become a party to, and be bound
by, this Agreement.

5.14     Shareholder and Depositor Agreements

         Shareholder Agreements, in the form attached as Appendix A hereto,
shall have been executed and delivered by each director of the Company and the
Bank in connection with the Company's execution and delivery of this Agreement.
Furthermore, the Company shall use its reasonable best efforts to cause such
person who is a Company Affiliate to execute and deliver to the Holding Company
within 60 days of the date hereof an agreement in the form of Appendix H hereto.
In addition, the Depositor Agreements, in the form attached as Appendix B
hereto, shall have been executed and delivered by each director of Keystone in
connection with Keystone's execution and delivery of this Agreement.

5.15     Integration of Policies

         During the period from the date of this Agreement to the Effective
Time, the Company and the Bank shall, and shall cause their directors, officers
and employees to, cooperate and assist Keystone in the formulation of a plan of
integration for Keystone and the Company and the Bank with respect to their
combined operations subsequent to the Effective Time.

5.16     Disclosure Supplements

         From time to time prior to the Effective Time, each party shall
promptly supplement or amend any materials Previously Disclosed and delivered to
the other party pursuant hereto with respect to any matter hereafter arising
which, if existing, occurring or known at the date of this Agreement, would have
been required to be set forth or described in materials Previously Disclosed to
the other party or which is necessary to correct any information in such
materials which has been rendered materially inaccurate thereby; no such
supplement or amendment to such materials shall be deemed to have modified the
representations, warranties and covenants of the parties for the purpose of
determining whether the conditions set forth in Article VI hereof have been
satisfied.

                                       41

5.17     Failure to Fulfill Conditions

         In the event that either of the Parties hereto determines that a
condition to its respective obligations to consummate the transactions
contemplated may not be fulfilled on or prior to the termination of this
Agreement, it will promptly notify the other party. Each Party will promptly
inform the other party of any facts applicable to it that would be likely to
prevent or materially delay approval of the Merger, the Conversion or any of the
other transactions contemplated hereby by any Governmental Entity or third party
or which would otherwise prevent or materially delay consummation of such
transactions.

5.18.    Section 16 Matters.

         Prior to the Effective Time, the Holding Company and the Company shall
take all such steps as may be required to cause any dispositions of Company
Common Stock (including derivative securities with respect to Company Common
Stock) or acquisitions of Holding Company Common Stock resulting from the
transactions contemplated by this Agreement by each individual who is subject to
the reporting requirements of Section 16(a) of the Exchange Act with respect to
the Company to be exempt under Rule 16b-3 promulgated under the Exchange Act.

                                   ARTICLE VI
                              CONDITIONS PRECEDENT

6.1      Conditions Precedent - Keystone and the Company

         The respective obligations of Keystone and the Company to effect the
Merger shall be subject to satisfaction of the following conditions at or prior
to the Effective Time.

         (a)      All corporate action necessary to authorize the execution and
delivery of this Agreement and consummation of the Merger, the Bank Merger and
the other transactions contemplated hereby shall have been duly and validly
taken by Keystone, the Holding Company, and the Company, including without
limitation approval of this Agreement by the requisite vote of the shareholders
of the Company.

         (b)      All approvals and consents from any Governmental Entity the
approval or consent of which is required for the consummation of the Merger, the
Bank Merger and the other transactions contemplated hereby shall have been
received and all statutory waiting periods in respect thereof shall have
expired; and Keystone, the Holding Company, the Company and the Bank shall have
procured all other approvals, consents and waivers of each person (other than
the Governmental Entities referred to above) whose approval, consent or waiver
is necessary to the consummation of the Merger and the other transactions
contemplated hereby and the failure of which to obtain would have the effects
set forth in the following proviso clause; provided, however, that no approval
or consent referred to in this Section 6.1(b) shall be deemed to have been
received if it shall include any condition or requirement that, individually or
in the aggregate, would so materially reduce the economic or business benefits
of the transactions contemplated by this Agreement to Keystone that had such
condition or requirement been known, Keystone, in its reasonable judgment, would
not have entered into this Agreement.

         (c)      None of Keystone, the Holding Company, the Company or the Bank
shall be subject to any statute, rule, regulation, injunction or other order or
decree which shall have been enacted, entered, promulgated or enforced by any
governmental or judicial authority which prohibits, restricts or makes illegal
consummation of the Merger or the other transactions contemplated hereby.

                                       42

         (d)      The Form S-1 shall have become effective under the Securities
Act, and Keystone shall have received all state securities laws or "blue sky"
permits and other authorizations or there shall be exemptions from registration
requirements necessary to issue the Holding Company Common Stock in connection
with the Merger, and neither the Form S-1 nor any such permit, authorization or
exemption shall be subject to a stop order or threatened stop order by the
Commission or any state securities authority.

         (e)      The shares of Holding Company Common Stock to be issued in
connection with the Merger and the Conversion shall have been approved for
listing on the Nasdaq Stock Market's National Market. In addition, Keystone and
the Holding Company shall use their reasonable best efforts to have the trading
symbol of the Holding Company Common Stock be "KNBT" or such other available
symbol mutually agreed to by the Parties and the Holding Company.

         (f)      Each of Keystone and the Company shall have received the
written opinion of Elias, Matz, Tiernan & Herrick L.L.P., in form and substance
reasonably satisfactory to both the Company and Keystone, dated as of the
Effective Time, substantially to the effect that, on the basis of the facts,
representations and assumptions set forth in such opinion which are consistent
with the state of facts existing at the Effective Time, the Merger will be
treated for Federal income tax purposes as constituting a reorganization within
the meaning of Section 368(a) of the Code. If such legal counsel does not render
such opinion, this condition may be satisfied if Grant Thornton LLP, independent
auditors of Keystone and the Company, renders such opinion, relying on such
facts, representations and assumptions. In rendering such opinion, such counsel
or auditors may require and rely upon representations and covenants, including
those contained in certificates of officers of Keystone, the Company and others,
reasonably satisfactory in form and substance to such counsel.

         (g)      The Conversion shall have been consummated.

6.2      Conditions Precedent - The Company

         The obligations of the Company to effect the Merger shall be subject to
satisfaction of the following conditions at or prior to the Effective Time
unless waived by the Company pursuant to Section 7.4 hereof.

         (a)      The representations and warranties of Keystone set forth in
Article IV hereof shall be true and correct in all material respects as of the
date of this Agreement and as of the Closing Date as though made on and as of
the Closing Date, or on the date when made in the case of a representation and
warranty which specifically relates to an earlier date. Notwithstanding the
preceding sentence, except for the representations and warranties contained in
the first sentence of Section 4.13, any inaccuracies in the representations and
warranties of Keystone shall not prevent the satisfaction of the condition
contained in this Section 6.2(a) unless the cumulative effect of all such
inaccuracies, taken in the aggregate, represent a Material Adverse Effect on
Keystone. In applying the preceding sentence, the determination of whether a
representation and warranty of Keystone is inaccurate shall be made without
regard to any language in Article IV which would otherwise qualify such
representation and warranty individually by reference to materiality or a
Material Adverse Effect.

         (b)      Keystone shall have performed in all material respects all
obligations and complied with all covenants required to be performed and
complied with by it pursuant to this Agreement on or prior to the Effective
Time.

                                       43

         (c)      Keystone shall have delivered to the Company a certificate,
dated the date of the Closing and signed by its Chairman and by its Chief
Financial Officer, to the effect that the conditions set forth in Sections
6.2(a) and 6.2(b) have been satisfied.

         (d)      No proceeding initiated by any Governmental Entity seeking an
order, injunction or decree issued by any court or agency of competent
jurisdiction or other legal restraint or prohibition preventing the consummation
of the Merger or the other transactions contemplated hereby shall be pending.

         (e)      Keystone shall have furnished the Company with such
certificates of its respective officers or others and such other documents to
evidence fulfillment of the conditions set forth in Sections 6.1 and 6.2 as such
conditions relate to Keystone as the Company may reasonably request.

6.3      Conditions Precedent - Keystone

         The obligations of Keystone to effect the Merger shall be subject to
satisfaction of the following conditions at or prior to the Effective Time
unless waived by Keystone pursuant to Section 7.4 hereof.

         (a)      The representations and warranties of the Company set forth in
Article III hereof shall be true and correct in all material respects as of the
date of this Agreement and as of the Closing Date as though made on and as of
the Closing Date, or on the date when made in the case of a representation and
warranty which specifically relates to an earlier date. Notwithstanding the
preceding sentence, except for the representations and warranties contained in
the second and fourth sentences of Section 3.1 and the first sentence of Section
3.13, any inaccuracies in the representations and warranties of the Company
shall not prevent the satisfaction of the condition contained in this Section
6.3(a) unless the cumulative effect of all such inaccuracies, taken in the
aggregate, represent a Material Adverse Effect on the Company. In applying the
preceding sentence, the determination of whether a representation and warranty
of the Company is inaccurate shall be made without regard to any language in
Article III which would otherwise qualify such representation and warranty
individually by reference to materiality or a Material Adverse Effect.

         (b)      The Company shall have performed in all material respects all
obligations and covenants required to be performed by it pursuant to this
Agreement on or prior to the Effective Time.

         (c)      The Company shall have delivered to Keystone a certificate,
dated the date of the Closing and signed by its President and Chief Executive
Officer and by its Chief Financial Officer, to the effect that the conditions
set forth in Sections 6.3(a) and 6.3(b) have been satisfied.

         (d)      No proceeding initiated by any Governmental Entity seeking an
order, injunction or decree issued by any court or agency of competent
jurisdiction or other legal restraint or prohibition preventing the consummation
of the Merger or the other transactions contemplated hereby shall be pending.

         (e)      The Company shall have furnished Keystone with such
certificates of its officers or others and such other documents to evidence
fulfillment of the conditions set forth in Sections 6.1 and 6.3 as such
conditions relate to the Company as Keystone may reasonably request.

                                       44

                                   ARTICLE VII
                        TERMINATION, WAIVER AND AMENDMENT

7.1      Termination

         This Agreement may be terminated:

         (a)      at any time on or prior to the Effective Time, by the mutual
consent in writing of the parties hereto;

         (b)      at any time on or prior to the Effective Time, by Keystone in
writing if the Company has, or by the Company in writing if Keystone has, in any
material respect, breached (i) any material covenant or undertaking contained
herein or (ii) any representation or warranty contained herein, in any case if
such breach would have a Material Adverse Effect on the party and has not been
cured by the earlier of 30 days after the date on which written notice of such
breach is given to the party committing such breach or the Effective Time;

         (c)      at any time, by either Keystone or the Company in writing, (i)
if any application for prior approval of a Governmental Entity which is
necessary to consummate the Merger, the Conversion or the other transactions
contemplated hereby is denied or withdrawn at the request or recommendation of
the Governmental Entity which must grant such approval, unless within the 25-day
period following such denial or withdrawal a petition for rehearing or an
amended application has been filed with the applicable Governmental Entity,
provided, however, that no party shall have the right to terminate this
Agreement pursuant to this Section 7(c)(i) if such denial or request or
recommendation for withdrawal shall be due to the failure of the party seeking
to terminate this Agreement to perform or observe the covenants and agreements
of such party set forth herein, or (ii) if any Governmental Entity of competent
jurisdiction shall have issued a final nonappealable order enjoining or
otherwise prohibiting the consummation of the Merger, the Conversion or the
other transactions contemplated by this Agreement;

         (d)      at any time, by either Keystone or the Company in writing, if
(i) the shareholders of the Company do not approve this Agreement after a vote
taken thereon at a meeting duly called for such purpose (or at any adjournment
thereof) or (ii) the depositors of Keystone do not approve the Conversion after
a vote taken thereon at a meeting duly called for such purpose (or at any
adjournment thereof), unless in either case the failure of such occurrence shall
be due to the failure of the party seeking to terminate to perform or observe in
any material respect its agreements set forth herein to be performed or observed
by such party at or before the Effective Time; and

         (e)      by either Keystone or the Company in writing if the Effective
Time has not occurred by the close of business on March 31, 2004, of the date
hereof, provided that this right to terminate shall not be available to any
party whose failure to perform an obligation in breach of such party's
obligations under this Agreement has been the cause of, or resulted in, the
failure of the Merger to be consummated by such date.

         (f)      At any time prior to the Company Meeting, by Keystone if (i)
the Company shall have breached Section 5.7, (ii) the Company Board shall have
failed to make its recommendation referred to in Section 5.2(a), withdrawn such
recommendation or modified or changed such recommendation in a manner adverse in
any respect to the interests of Keystone or (iii) the Company shall have
materially breached its obligations under Section 5.2(a) by failing to call,
give notice of, convene and hold the Company Meeting in accordance with Section
5.2(a).

                                       45

         (g)      By Keystone if a tender offer or exchange offer for 20% or
more of the outstanding shares of Company Common Stock is commenced (other than
by Keystone or a Subsidiary thereof), and the Company Board recommends that the
shareholders of the Company tender their shares in such tender or exchange offer
or otherwise fails to recommend that such shareholders reject such tender offer
or exchange offer within the ten-Business Day period specified in Rule 14e-2(a)
under the Exchange Act.

         (h)      At any time prior to the Company Meeting, by the Company in
order to concurrently enter into an acquisition agreement or similar agreement
(each, an "Acquisition Agreement") with respect to a Superior Proposal which has
been received and considered by the Company and the Company Board in compliance
with Section 5.7 hereof, provided, however, that this Agreement may be
terminated by the Company pursuant to this Section 7.1(h) only after the fifth
Business Day following Keystone's receipt of written notice from the Company in
accordance with Section 5.7(b) advising Keystone that the Company is prepared to
enter into an Acquisition Agreement with respect to a Superior Proposal, and
only if, during such five-Business Day period, Keystone does not, in its sole
discretion, make an offer to the Company that the Company Board determines in
good faith, after consultation with its financial and legal advisors, is at
least equal to the Superior Proposal.

         (i)      At any time prior to the Depositor Meeting, by the Company if
(i) the Keystone Board shall have failed to make its recommendation referred to
in Section 5.2(b), withdrawn such recommendation or modified or changed such
recommendation in a manner adverse in any respect to the interests of the
Company or (ii) Keystone shall have materially breached its obligations under
Section 5.2(b) by failing to call, give notice of, convene and hold the
Depositor Meeting in accordance with Section 5.2(b).

         For purposes of this Section 7.1, termination by Keystone also shall be
deemed to be a termination on behalf of the Holding Company.

7.2      Effect of Termination

         In the event that this Agreement is terminated pursuant to Section 7.1
hereof, this Agreement shall become void and have no effect, except that (i) the
provisions relating to confidentiality set forth in Section 5.4(b) and expenses
and the termination fees set forth in Section 8.1, and this Section 7.2, shall
survive any such termination and (ii) a termination pursuant to Section 7.1(b),
(c), (d), (e), (f), (g) or (h) shall not relieve the breaching party from
liability for willful breach of any covenant, undertaking, representation or
warranty giving rise to such termination.

7.3      Survival of Representations, Warranties and Covenants

         All representations, warranties and covenants in this Agreement or in
any instrument delivered pursuant hereto or thereto shall expire on, and be
terminated and extinguished at, the Effective Time other than covenants that by
their terms are to be performed after the Effective Time (including without
limitation the covenants set forth in Sections 5.9, 5.10, 5.11 and 5.12 hereof),
provided that no such representations, warranties or covenants shall be deemed
to be terminated or extinguished so as to deprive Keystone or the Company (or
any director, officer or controlling person of either thereof) of any defense at
law or in equity which otherwise would be available against the claims of any
person, including, without limitation, any shareholder or former shareholder of
either Keystone or the Company.

                                       46

7.4      Waiver

         Each party hereto by written instrument signed by an executive officer
of such party, may at any time (whether before or after approval of this
Agreement by the shareholders of the Company) extend the time for the
performance of any of the obligations or other acts of the other party hereto
and may waive (i) any inaccuracies of the other party in the representations or
warranties contained in this Agreement or any document delivered pursuant
hereto, (ii) compliance with any of the covenants, undertakings or agreements of
the other party, (iii) to the extent permitted by law, satisfaction of any of
the conditions precedent to its obligations contained herein or (iv) the
performance by the other party of any of its obligations set forth herein,
provided that any such waiver granted, or any amendment or supplement pursuant
to Section 7.5 hereof executed after shareholders of the Company have approved
this Agreement shall not modify either the amount or form of the consideration
to be provided hereby to the holders of Company Common Stock upon consummation
of the Merger or otherwise materially adversely affect such shareholders without
the approval of the shareholders who would be so affected.

7.5      Amendment or Supplement

         This Agreement may be amended or supplemented at any time by mutual
agreement of the parties hereto, subject to the proviso to Section 7.4 hereof.
Any such amendment or supplement must be in writing and authorized by or under
the direction of their respective Boards of Directors.

                                  ARTICLE VIII
                                  MISCELLANEOUS

8.1      Expenses; Termination Fees

         (a)      Each party hereto shall bear and pay all costs and expenses
incurred by it in connection with the transactions contemplated by this
Agreement, including fees and expenses of its own financial consultants,
investment bankers, accountants and counsel, provided that notwithstanding
anything to the contrary contained in this Agreement, neither Keystone nor the
Company shall be released from any liabilities or damages arising out of its
willful breach of any provision of this Agreement.

         (b)      In recognition of the efforts, expenses and other
opportunities foregone by Keystone while structuring and pursuing the Merger,
the parties hereto agree that the Company shall pay to Keystone a termination
fee of $4.0 million (the "Termination Fee") in the manner set forth below if:

                  (i)     this Agreement is terminated by Keystone pursuant to
         Section 7.1(f) or (g);

                  (ii)    this Agreement is terminated by (A) Keystone pursuant
         to Section 7.1(b), (B) by either Keystone or the Company pursuant to
         Section 7.1(e), or (C) by either Keystone or the Company pursuant to
         Section 7.1(d)(i) (other than by reason of any breach by Keystone or
         the Company, respectively), and in the case of any termination pursuant
         to clause (A), (B) or (C) an Acquisition Proposal shall have been
         publicly announced or otherwise communicated or made known to the
         senior management of the Company or the Board of Directors of the
         Company (or any Person shall have publicly announced, communicated or
         made known an intention, whether or not conditional, to

                                       47

         make an Acquisition Proposal) at any time after the date of this
         Agreement and prior to the taking of the vote of the shareholders of
         the Company contemplated by this Agreement at the Company Meeting, in
         the case of clause (C), or the date of termination of this Agreement,
         in the case of clause (A) or (B); or

                  (iii)   this Agreement is terminated by the Company pursuant
         to Section 7.1(h).

         In the event the Termination Fee shall become payable pursuant to
Section 8.1(b)(i) or (ii), (x) the Company shall pay to Keystone an amount equal
to $1.5 million on the first Business Day following termination of this
Agreement, and (y) if within 24 months after such termination the Company or a
Subsidiary of the Company enters into any agreement with respect to, or
consummates, any Acquisition Transaction, the Company shall pay to Keystone the
Termination Fee (net of any payment made pursuant to clause (x) above) on the
date of execution of such agreement or consummation of the Acquisition
Transaction. In the event the Termination Fee shall become payable pursuant to
Section 8.1(b)(iii), the Company shall pay to Keystone the entire Termination
Fee within two Business Days following the date of termination of this
Agreement. Any amount that becomes payable pursuant to this Section 8.1(b) shall
be paid by wire transfer of immediately available funds to an account designated
by Keystone.

         (c)      The Company and Keystone agree that the agreements contained
in paragraphs (b) and (d) of this Section 8.1 are an integral part of the
transactions contemplated by this Agreement, that without such agreement either
Party would not have entered into this Agreement and that such amounts do not
constitute a penalty or liquidated damages in the event of a breach of this
Agreement by either Party. If either Party fails to pay the other Party hereto
the amounts due thereto under paragraphs (b) and (d) above, as the case may be,
within the time periods specified therein, such Party shall pay the costs and
expenses (including reasonable legal fees and expenses) incurred by the other
Party in connection with any action in which the other Party prevails, including
the filing of any lawsuit, taken to collect payment of such amounts, together
with interest on the amount of any such unpaid amounts at the prime lending rate
prevailing during such period as published in The Wall Street Journal,
calculated on a daily basis from the date such amounts were required to be paid
until the date of actual payment.

         (d)      In the event that this Agreement is terminated by the Company
pursuant to Section 7.1(c), 7.1(d)(ii) or 7.1(i), then Keystone shall pay to the
Company, within five business days of such termination, a termination fee of
$1.0 million plus the documented out-of pocket expenses incurred by the Company
in connection with the transactions contemplated by this Agreement not to exceed
$1.0 million in the aggregate; provided, however, that Keystone shall not be
required to pay the termination fee or to reimburse the Company for such
expenses if at the time of such termination the Company had materially breached
its representations, warranties or covenants or if the failure to obtain such
approvals, waivers or authorizations of any Governmental Entity resulted as a
consequence of facts or circumstances relating to the Company or its
Subsidiaries.

8.2      Entire Agreement

         This Agreement contains the entire agreement among the parties with
respect to the transactions contemplated hereby and supersedes all prior
arrangements or understandings with respect thereto, written or oral, other than
documents referred to herein and therein. The terms and conditions of this
Agreement shall inure to the benefit of and be binding upon the parties hereto
and thereto and their respective successors. Nothing in this Agreement,
expressed or implied, is intended to confer upon any party, other than the
parties hereto, and their respective

                                       48

successors, any rights, remedies, obligations or liabilities other than as set
forth in Sections 5.9, 5.10 and 5.11 hereof.

8.3      No Assignment

         None of the parties hereto may assign any of its rights or obligations
under this Agreement to any other person.

8.4      Notices

         All notices or other communications which are required or permitted
hereunder shall be in writing and sufficient if delivered personally, telecopied
(with confirmation) or sent by overnight mail service or by registered or
certified mail (return receipt requested), postage prepaid, addressed as
follows:

         If to Keystone:

              Keystone Savings Bank
              Route 512 and Highland Avenue
              Bethlehem, Pennsylvania 18017
              Attn:  Jeffrey P. Feather
                     Chairman
              Fax:   (610) 861-5000

         With a required copy to:

              Elias, Matz, Tiernan & Herrick L.L.P.
              734 15th Street, N.W.
              Washington, DC  20005
              Attn:  Raymond A. Tiernan, Esq. or Philip R. Bevan, Esq.
              Fax:   (202) 347-2172

         If to the Company:

              First Colonial Group, Inc.
              76 South Main Street
              Nazareth, Pennsylvania 18064
              Attn:  Scott V. Fainor
                     President and Chief Executive Officer
              Fax:   (610) 746-7300

         With a required copy to:

              Blank Rome LLP
              One Logan Square
              Philadelphia, Pennsylvania 19103
              Attn:  Lawrence J. Wiseman, Esq.
              Fax:   (215) 569-5549

                                       49

8.5      Alternative Structure

         Notwithstanding any provision of this Agreement to the contrary,
Keystone may, with the written consent of the Company, which shall not be
unreasonably withheld, elect, subject to the filing of all necessary
applications and the receipt of all required regulatory approvals, to modify the
structure of the acquisition of the Company set forth herein, provided that (i)
such modification will not adversely affect the tax treatment of the Company's
shareholders as a result of receiving shares of Company Common Stock (ii)
consideration to be paid to the holders of the Company Common Stock is not
thereby changed in kind or reduced in amount as a result of such modification
and (iii) such modification will not materially delay or jeopardize receipt of
any required regulatory approvals or impair or prevent the satisfaction of any
other condition to the obligations of Keystone set forth in Sections 6.1 and 6.3
hereof.

8.6      Interpretation

         The captions contained in this Agreement are for reference purposes
only and are not part of this Agreement.

8.7      Counterparts

         This Agreement may be executed in any number of counterparts, and each
such counterpart shall be deemed to be an original instrument, but all such
counterparts together shall constitute but one agreement.

8.8      Governing Law

         This Agreement shall be governed by and construed in accordance with
the laws of the Commonwealth of Pennsylvania applicable to agreements made and
entirely to be performed within such jurisdiction. Any dispute arising hereunder
shall be brought before a court located in the Commonwealth of Pennsylvania.
Each of the Parties hereto waives all rights to a trial by jury in any action,
proceeding or counteraction related to or arising out of this Agreement and the
transactions contemplated hereby.

                                       50

         IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed in counterparts by their duly authorized officers and their corporate
seal to be hereunto affixed and attested by their officers thereunto duly
authorized, all as of the day and year first above written.

                                            KEYSTONE SAVINGS BANK

Attest:

/s/  Michele A. Linsky                      By: /s/  Jeffrey P. Feather
- --------------------------                      --------------------------------
Name:  Michele A. Linsky                    Name:  Jeffrey P. Feather
Title: Corporate Secretary                  Title: Chairman of the Board

                                            FIRST COLONIAL GROUP, INC

Attest:

/s/ Joy Betz                                By: /s/ Scott V. Fainor
- --------------------------                      --------------------------------
Name:  Joy Betz                             Name:  Scott V. Fainor
Title: Corporate Secretary                  Title: President and Chief Executive
                                                   Officer

                                       51

                                                                      Appendix B


                  [The Kafafian Group Letterhead Appears Here]

March 5, 2003

Board of Directors
First Colonial Group, Inc.
3864 Adler Place
Bethlehem, PA 18017

Members of the Board:

         You have requested our opinion as to the fairness, from a financial
point of view, to the holders of First Colonial Group, Inc. (the "Company")
common stock of the consideration to be paid pursuant to the Agreement and Plan
of Merger dated March 5, 2003 (the "Agreement") by and between the Company and
Keystone Savings Bank (the "Buyer"). Pursuant to the Agreement, the Company will
be merged into a newly formed bank holding company and Nazareth National Bank
will be merged into Keystone Savings Bank (collectively, the transaction is the
"Merger") and as a result of the Merger, as defined in the Agreement, each share
of the Company's Common Stock held shall cease to be outstanding and shall be
converted to the right to receive 3.7 initial public offering shares of the
newly formed holding company's Common Stock (the "Merger Consideration").

         The Kafafian Group, Inc. ("TKG"), as part of our financial advisory
business, is regularly engaged in the valuation of businesses and their
securities in connection with mergers and acquisitions and valuations for
corporate and other purposes. In the ordinary course of business TKG provides
consulting services to financial institutions, including profitability
outsourcing, strategic planning and various other services. TKG currently
provides profitability outsourcing services and has been engaged from time to
time in other consulting engagements for the Company.

         In arriving at our opinion, we have among other things:

     -    Reviewed the Agreement and Plan of Merger dated March 5, 2003;
     -    Analyzed annual reports to stockholders, regulatory filings and other
          financial information concerning First Colonial since 1999;
     -    Analyzed regulatory filings and other financial information concerning
          Keystone since 1999;
     -    Discussed past, present, and future financial performance and
          operating philosophies with Keystone and First Colonial senior
          managements;
     -    Reviewed certain internal financial data and projections of Keystone
          and First Colonial;
     -    Compared the financial condition, financial performance, and market
          trading multiples of First Colonial to similar financial institutions;
     -    Compared the financial condition and financial performance of Keystone
          to similar financial institutions;

Board of Directors
Page 2


     -    Reviewed reported price and trading activity for First Colonial and
          compared it to the price and trading activity for similar financial
          institutions;
     -    Reviewed reported price and trading activity for financial
          institutions that recently converted from a mutual to a stock form;
     -    Compared the consideration to be paid by Keystone pursuant to the
          Agreement with the consideration paid in acquisitions of financial
          institutions similar to the Company;
     -    Reviewed the pro forma impact of the conversion and merger on the
          earnings and book value of the combined company and compared the
          contributions of each institution in a number of key financial
          categories to the combined company;
     -    Considered other financial studies, analyses, and investigations and
          reviewed other information deemed appropriate to render our opinion.

         TKG met with certain members of senior management and other
representatives of Keystone and First Colonial to discuss the foregoing as well
as matters TKG deemed relevant. As part of its analyses, TKG took into account
our assessment of general economic, market and financial conditions, our
experience in similar transactions, as well as our experience in, and knowledge
of, the banking industry. TKG's opinion is necessarily based upon conditions as
they existed and could be evaluated on the respective dates thereof and the
information made available to TKG through the respective dates hereof.

         TKG assumed and relied upon, without independent verification, the
accuracy and completeness of all of the financial and other information reviewed
and/or discussed for the purposes of our opinion. TKG assumed that financial
forecasts provided by Keystone and First Colonial for their respective
institutions were reasonably prepared on bases reflecting the best currently
available estimates and judgments of the respective senior managements. Any
estimates contained in the analyses performed by us are not necessarily
indicative of actual values or future results, which may be significantly more
or less favorable than suggested by these analyses. Additionally, estimates of
the value of businesses or securities do not purport to be appraisals or to
reflect the prices at which such businesses or securities might actually be
sold. TKG did not make any independent evaluation or appraisals of the assets or
liabilities of Keystone and First Colonial nor was it furnished with any such
appraisals. TKG also assumed, without independent verification, that the
aggregate allowances for loan losses for Keystone and First Colonial were
adequate.

         This opinion is being furnished for the use and benefit of the Board of
Directors of the Company and is not a recommendation to shareholders.

         Based upon and subject to the foregoing, it is our opinion that, as of
the date hereof, the Merger Consideration is fair from a financial point of view
to the holders of First Colonial Group, Inc. common stock.

                            Very truly yours,


                            The Kafafian Group, Inc.

                                  FORM OF PROXY

                                 REVOCABLE PROXY

                           FIRST COLONIAL GROUP, INC.

                         ANNUAL MEETING OF SHAREHOLDERS
                                 [        ], 2003

                  SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
                          OF FIRST COLONIAL GROUP, INC.

     The undersigned hereby constitutes and appoints [   ] and [   ], and each
of them, as attorneys and proxies of the undersigned, with full power of
substitution, for and in the name, place and stead of the undersigned, to appear
at the Annual Meeting of Shareholders of First Colonial Group, Inc. ("First
Colonial") to be held on the [ ] day of [    ], 2003, and at any postponement or
adjournment thereof, and to vote all of the shares of First Colonial which the
undersigned is entitled to vote, with all the powers and authority the
undersigned would possess if personally present.

                 [X]     PLEASE MARK VOTES AS IN THIS EXAMPLE


PROPOSAL 1. The election of Robert J. Bergren and Richard Stevens, III as
Class 3 directors of First Colonial to hold office for the shorter of (i) four
years and until their successors are duly elected and qualified or (ii) the
consummation of the merger between First Colonial and KNBT Bancorp, Inc., a
Pennsylvania corporation and a registered bank holding company ("KNBT Bancorp").

                          FOR             WITHHOLD          NUMBER OF VOTES

Robert J. Bergren         [ ]               [ ]             -------------------

Richard Stevens, III      [ ]               [ ]             -------------------

     INSTRUCTION: To withhold authority to vote for any indicated nominee, check
the box labeled "Withhold" next to that nominee's name. You may choose to
cumulate your votes for the election of directors. Your cumulative vote total is
determined by multiplying (i) the number of shares that you own by (ii) the
number of directors nominated (two). If you wish to cumulate your votes, please
indicate the number of votes that you wish to cast for each nominee on the line
next to each nominee's name above (the number of votes you cast in the aggregate
cannot exceed your cumulative vote total).

PROPOSAL 2. The adoption of the Agreement and Plan of Merger between First
Colonial and Keystone Savings Bank, a Pennsylvania-chartered mutual savings
bank, dated March 5, 2003, pursuant to which First Colonial will merge with and
into KNBT Bancorp, and each outstanding share of First Colonial will be
converted into the right to receive shares of KNBT Bancorp common stock, as more
fully described in the accompanying proxy statement/prospectus.

                          [ ]              [ ]                [ ]

                          FOR             AGAINST           ABSTAIN


PROPOSAL 3. To transact such other business as may properly come before the
Annual Meeting.

     THIS PROXY WILL BE VOTED AS DIRECTED. IF NO DIRECTIONS TO THE CONTRARY ARE
INDICATED, THE PROXY AGENTS INTEND TO VOTE FOR THE ELECTION OF ALL THE NOMINEES
LISTED IN PROPOSAL 1 AND FOR APPROVAL OF PROPOSAL 2.

     BOTH PROXY AGENTS PRESENT AND ACTING IN PERSON OR BY THEIR SUBSTITUTES (OR,
IF ONLY ONE IS PRESENT AND ACTING, THEN THAT ONE), MAY EXERCISE ALL THE POWERS
CONFERRED BY THIS PROXY. THIS PROXY CONFERS DISCRETIONARY AUTHORITY AS TO
CERTAIN MATTERS DESCRIBED IN FIRST COLONIAL'S PROXY STATEMENT/PROSPECTUS
RELATING TO FIRST COLONIAL'S 2003 ANNUAL MEETING OF SHAREHOLDERS.

The undersigned hereby acknowledges receipt of First Colonial's Notice of First
Colonial's 2003 Annual Meeting of Shareholders and the Proxy
Statement/Prospectus relating thereto.

Dated: ________________________________________, 2003


- --------------------------------------------------
                    Signature


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              Signature if held jointly

Please sign your name exactly as it appears on your stock certificate(s),
indicating any official position or representative capacity. If shares are
registered in more than one name, all owners should sign.

PLEASE DATE AND SIGN THIS PROXY AND RETURN IT PROMPTLY IN THE ENCLOSED POSTAGE
PAID ENVELOPE.

IF YOUR ADDRESS HAS CHANGED, PLEASE CORRECT THE ADDRESS IN THE SPACE PROVIDED
BELOW AND RETURN THIS PORTION WITH THE PROXY IN THE ENVELOPE PROVIDED.


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