-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FUBKODuDzzA/YfOeIeJraKs94QBx1oZ2dLXclOm/gsk5y5wEQLgqfL5VEq1RSQIB m6xnIe1ONgKIXjhvLpTxsA== 0000717809-98-000023.txt : 19981116 0000717809-98-000023.hdr.sgml : 19981116 ACCESSION NUMBER: 0000717809-98-000023 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KEYSTONE FINANCIAL INC CENTRAL INDEX KEY: 0000717809 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 232289209 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-11460 FILM NUMBER: 98747678 BUSINESS ADDRESS: STREET 1: ONE KEYSTONE PLZ - FRONT & MARKET STS STREET 2: P O BOX 3660 CITY: HARRISBURG STATE: PA ZIP: 17105-3660 BUSINESS PHONE: 7172331555 MAIL ADDRESS: STREET 1: ONE KEYSTONE PLZ STREET 2: PO BOX 3660 CITY: HARRISBURG STATE: PA ZIP: 171053660 FORMER COMPANY: FORMER CONFORMED NAME: NCB FINANCIAL CORP DATE OF NAME CHANGE: 19850115 10-Q 1 KEYSTONE FINANCIAL, INC'S FORM 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from ____________to ______________ Commission File Number 0-11460 KEYSTONE FINANCIAL, INC. Pennsylvania 23-2289209 (State of Incorporation) (IRS Employer I.D. No.) ONE KEYSTONE PLAZA FRONT & MARKET STREETS P.O. BOX 3660 HARRISBURG, PA 17105-3660 (Address of principal executive offices) (717) 233-1555 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X or No_______ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock ($2 par value): 51,436,000 as of October 31, 1998. 1 KEYSTONE FINANCIAL, INC. INDEX PAGE PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements Consolidated Statements of Condition - September 30, 1998 and December 31, 1997 3 Consolidated Statements of Income - Three months ended September 30, 1998 and 1997, and nine months ended September 30, 1998 and 1997 4 Consolidated Statements of Comprehensive Income - Three months ended September 30, 1998 and 1997, and nine months ended September 30, 1998 and 1997 6 Consolidated Statements of Cash Flows - Nine months ended September 30, 1998 and 1997 7 Notes to Consolidated Financial Statements 8 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 16 PART II. OTHER INFORMATION Items 1,2,3,4 and 5 have been omitted since they are not applicable. ITEM 6. Exhibits and Reports on Form 8-K 17 (a) Exhibits (b) Reports on Form 8-K Signatures 18 2 PART I. ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED STATEMENTS OF CONDITION (in thousands, except share data) - -------------------------------------------------------------------------------- September 30, December 31, 1998 1997 ASSETS - -------------------------------------------------------------------------------- Cash and due from banks $169,103 $206,223 Federal funds sold 25,150 25,300 Interest bearing deposits with banks 1,641 1,928 Investment securities available for sale 1,107,560 1,091,400 Investment securities held to maturity(fair values 1998-$698,286; 1997-$538,218) 681,426 528,388 Loans held for resale 70,820 43,055 Loans and leases 4,552,173 4,712,566 Allowance for credit losses (61,933) (65,091) - -------------------------------------------------------------------------------- Net Loans 4,490,240 4,647,475 Premises and equipment 122,982 116,615 Other assets 237,482 180,953 - -------------------------------------------------------------------------------- TOTAL ASSETS $6,906,404 $6,841,337 - -------------------------------------------------------------------------------- LIABILITIES - -------------------------------------------------------------------------------- Noninterest-bearing deposits $643,693 $637,164 Interest-bearing deposits 4,502,671 4,596,001 - -------------------------------------------------------------------------------- Total Deposits 5,146,364 5,233,165 Federal funds purchased and security repurchase agreements 355,830 399,730 Other short-term borrowings 21,367 26,160 - -------------------------------------------------------------------------------- Total Short-Term Borrowings 377,197 425,890 FHLB borrowings 401,464 248,150 Long-term debt 130,670 101,793 Other liabilities 162,490 146,854 - -------------------------------------------------------------------------------- TOTAL LIABILITIES 6,218,185 6,155,852 - -------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY - -------------------------------------------------------------------------------- Preferred stock: $1.00 par value, authorized 8,000,000 shares; none issued or outstanding --- --- Common stock: $2.00 par value, authorized 100,000,000; issued 51,386,653 - 1998 and 52,029,017 - 1997 102,773 104,058 Surplus 160,981 155,430 Retained earnings 415,059 418,605 Deferred KSOP benefit expense (702) (1,150) Accumulated other comprehensive income 10,108 8,542 - -------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 688,219 685,485 - -------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $6,906,404 $6,841,337 - -------------------------------------------------------------------------------- The accompanying notes are an integral part of the consolidated financial statements. 3 CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except per share data) - -------------------------------------------------------------------------------- Three Months Ended September 30, 1998 1997 - -------------------------------------------------------------------------------- INTEREST INCOME - -------------------------------------------------------------------------------- Loans and fees on loans $100,729 $104,314 Investments - taxable 24,544 21,422 Investments - tax exempt 2,847 2,986 Federal funds sold & other 1,190 1,485 Loans held for resale 1,498 2,008 - -------------------------------------------------------------------------------- 130,808 132,215 - -------------------------------------------------------------------------------- INTEREST EXPENSE - -------------------------------------------------------------------------------- Deposits 48,677 50,247 Short-term borrowings 4,725 4,676 FHLB borrowings 5,651 3,640 Long-term debt 2,349 1,883 - -------------------------------------------------------------------------------- 61,402 60,446 - -------------------------------------------------------------------------------- NET INTEREST INCOME 69,406 71,769 Provision for credit losses 3,081 4,319 - -------------------------------------------------------------------------------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 66,325 67,450 - -------------------------------------------------------------------------------- NONINTEREST INCOME - -------------------------------------------------------------------------------- Trust and investment advisory fees 6,580 5,442 Service charges on deposit accounts 4,899 4,409 Fee income 6,473 5,303 Mortgage banking income 3,138 2,665 Other secondary market income 849 503 Reinsurance income 720 702 Other income 1,651 1,801 Net gains - equity securities 3,403 2,917 Net gains - debt securities 41 607 - -------------------------------------------------------------------------------- 27,754 24,349 NONINTEREST EXPENSE - -------------------------------------------------------------------------------- Salaries 24,821 24,348 Employee benefits 4,342 4,473 Occupancy expense (net) 4,299 4,166 Furniture and equipment expense 5,160 4,832 Other expense 17,508 17,712 - -------------------------------------------------------------------------------- 56,130 55,531 - -------------------------------------------------------------------------------- Income before income taxes 37,949 36,268 Income tax expense 12,368 11,668 - -------------------------------------------------------------------------------- NET INCOME $25,581 $24,600 - -------------------------------------------------------------------------------- PER SHARE DATA - -------------------------------------------------------------------------------- Net income: Basic $0.50 $0.48 Diluted $0.50 $0.47 Dividends $0.28 $0.26 - -------------------------------------------------------------------------------- The accompanying notes are an integral part of the consolidated financial statements. 4 CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except per share data) - -------------------------------------------------------------------------------- Nine Months Ended September 30, 1998 1997 - -------------------------------------------------------------------------------- INTEREST INCOME - -------------------------------------------------------------------------------- Loans and fees on loans $304,792 $299,271 Investments - taxable 69,644 61,446 Investments - tax exempt 8,610 9,296 Federal funds sold & other 3,857 3,993 Loans held for resale 3,789 5,459 - -------------------------------------------------------------------------------- 390,692 379,465 - -------------------------------------------------------------------------------- INTEREST EXPENSE - -------------------------------------------------------------------------------- Deposits 146,555 144,754 Short-term borrowings 13,746 13,191 FHLB borrowings 15,368 11,021 Long-term debt 6,267 2,878 - -------------------------------------------------------------------------------- 181,936 171,844 - -------------------------------------------------------------------------------- NET INTEREST INCOME 208,756 207,621 Provision for credit losses 13,517 11,772 - -------------------------------------------------------------------------------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 195,239 195,849 - -------------------------------------------------------------------------------- NONINTEREST INCOME - -------------------------------------------------------------------------------- Trust and investment advisory fees 19,625 15,441 Service charges on deposit accounts 13,649 12,814 Fee income 18,032 14,732 Mortgage banking income 9,409 6,927 Other secondary market income 2,039 1,304 Reinsurance income 2,146 2,490 Other income 6,065 8,472 Net gains - equity securities 10,253 2,917 Net gains - debt securities 104 312 - -------------------------------------------------------------------------------- 81,322 65,409 NONINTEREST EXPENSE - -------------------------------------------------------------------------------- Salaries 73,478 68,257 Employee benefits 13,997 13,153 Occupancy expense (net) 13,096 12,309 Furniture and equipment expense 15,414 13,821 Special charges --- 11,410 Other expense 51,720 51,711 - -------------------------------------------------------------------------------- 167,705 170,661 - -------------------------------------------------------------------------------- Income before income taxes 108,856 90,597 Income tax expense 33,858 28,244 - -------------------------------------------------------------------------------- NET INCOME $74,998 $62,353 - -------------------------------------------------------------------------------- PER SHARE DATA - -------------------------------------------------------------------------------- Net income: Basic $1.46 $1.21 Diluted $1.44 $1.19 Dividends $0.84 $0.78 - -------------------------------------------------------------------------------- The accompanying notes are an integral part of the consolidated financial statements. 5 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in thousands) Three Months Ended September 30, 1998 1997 Before Net of Before Net of Tax Tax Tax Tax --------- -------- --------- -------- Net Income $25,581 $24,600 Unrealized gains on securities: Unrealized holding gains arising during the period 9,118 5,927 4,241 2,757 Less: Reclassification adjustment for gains included in net income 3,444 2,239 3,524 2,291 - ---------------------------------------- --------- -------- --------- -------- 5,674 3,688 717 466 - ---------------------------------------- --------- -------- --------- -------- Comprehensive Income $29,269 $25,066 ======================================== ========= ======== ========= ======== Nine Months Ended September 30, 1998 1997 Before Net of Before Net of Tax Tax Tax Tax ---------- -------- --------- -------- Net Income $74,998 $62,353 Unrealized gains on securities: Unrealized holding gains arising during the period 12,766 8,298 3,220 2,093 Less: Reclassification adjustment for gains included in net income 10,357 6,732 3,229 2,099 - ---------------------------------------- ---------- -------- --------- -------- 2,409 1,566 (9) (6) - ---------------------------------------- ---------- -------- --------- -------- Comprehensive Income $76,564 $62,347 ======================================== ========== ======== ========= ======== The accompanying notes are an integral part of the consolidated financial statements. 6 CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) - -------------------------------------------------------------------------------- Nine Months Ended September 30, 1998 1997 - -------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net Income $74,998 $62,353 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for credit losses 13,517 11,772 Provision for depreciation & amortization 16,551 13,758 Deferred income taxes 3,103 16,160 Special charges accrual --- 4,924 Sale of loans held for resale 195,480 295,808 Origination of loans held for resale (350,895) (295,321) (Increase) decrease in interest receivable 2,548 (1,689) Increase in interest payable 13,089 9,266 Other (15,602) 3,642 - -------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (47,211) 120,673 - -------------------------------------------------------------------------------- INVESTING ACTIVITIES: Net (increase)decrease in interest-bearing deposits with banks 287 (6,824) Net cash paid for acquisition --- (24,256) Available for sale securities: Sales 59,165 168,249 Maturities 837,023 665,889 Purchases (895,303) (636,706) Held to maturity securities: Maturities 145,875 67,735 Purchases (299,131) (136,646) Net (increase) decrease in loans 273,095 (277,085) Purchases of loans (8,232) --- Proceeds from sales of loans 4,365 172,028 Purchases of bank-owned life insurance (50,230) --- Purchases of premises and equipment (19,405) (17,896) Other (10,436) (7,908) - -------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN)INVESTING ACTIVITIES 37,073 (33,420) - -------------------------------------------------------------------------------- FINANCING ACTIVITIES: Net decrease in deposits (86,801) (15,730) Net decrease in short-term borrowings (48,693) (4,807) Proceeds from FHLB borrowings 242,542 168,242 Repayments of FHLB borrowings (89,227) (223,167) Issuance of long-term debt 30,000 100,000 Repayment of long-term debt (1,123) (623) Acquisition of treasury stock (40,411) (61,349) Cash dividends (43,260) (41,349) Other 9,841 12,422 - -------------------------------------------------------------------------------- NET CASH USED IN FINANCING ACTIVITIES (27,132) (66,361) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (37,270) 20,892 Cash and cash equivalents at beginning of period 231,523 251,472 - -------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $194,253 $272,364 - -------------------------------------------------------------------------------- The accompanying notes are an integral part of the consolidated financial statements. 7 Notes To Consolidated Financial Statements BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these statements do not include all of the information and footnotes required by generally accepted accounting principles. However, in the opinion of management, all adjustments necessary for a fair presentation have been included, and such adjustments were of a normal recurring nature. Operating results for the nine-month period ended September 30, 1998 are not necessarily indicative of the results that may be expected for the year ended December 31, 1998. For further information, refer to the audited consolidated financial statements, footnotes thereto, and the Financial Review for the year ended December 31, 1997, as contained in the Annual Report to Shareholders. COMPREHENSIVE INCOME During the quarter ended March 31, 1998, Keystone adopted Financial Accounting Standards Board Statement No. 130, "Reporting Comprehensive Income". Sources of comprehensive income not included in net income are limited to unrealized gains and losses on certain investments in debt and equity securities. COMMITMENTS AND CONTINGENCIES Keystone and its subsidiaries are subject to various legal proceedings that arise in the ordinary course of business. In late 1997, an investment advisor not affiliated with Keystone ("investment advisor") was accused by the Securities and Exchange Commission of defrauding its clients, which were primarily school districts and municipalities, resulting in losses alleged to approximate $70 million. A Keystone subsidiary had been previously engaged to maintain custody of certain funds and investments of the unaffiliated investment advisor. In an effort to recover the alleged losses, legal proceedings were subsequently initiated by the court-appointed trustee for the investment advisor and by its clients. These proceedings included individual and class actions against Keystone, its subsidiaries, and some of its employees alleging that these entities or individuals were responsible for, and contributed to, the loss. Management plans to vigorously contest these actions. The loss, if any, to Keystone or its subsidiaries resulting from the actions cannot be reasonably estimated at this time. Because of the complexity of these actions, it is expected that final resolution of these matters will not occur for a number of years. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is required to be adopted in years beginning after June 15, 1999. Due to Keystone's limited use of derivatives, management does not anticipate that the adoption of the new Statement will have a significant effect on earnings or Keystone's financial position. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OVERVIEW Keystone Financial, Inc. (Keystone) is the third largest bank holding company headquartered in Pennsylvania. Keystone offers a wide-range of financial products and services through its seven community banks and through its specialized nonbank subsidiaries located in Pennsylvania, Maryland, West Virginia and Delaware. The purpose of this review is to provide additional information necessary to fully understand the consolidated financial condition and results of operations of Keystone. Throughout this review, net interest income and the yield on earning assets are stated on a fully taxable-equivalent basis. Balances represent average daily balances, unless otherwise indicated. The results of First Financial Corporation of Western Maryland (First Financial), which was acquired through a purchase acquisition, have been included herein from the consummation date of May 29, 1997. Keystone consummated the merger of Financial Trust Corp, which was accounted for as a pooling-of-interests, on May 30, 1997. SUMMARY OF FINANCIAL RESULTS Keystone reported net income of $25.6 million in the third quarter of 1998, resulting in basic earning per share (EPS) of $0.50 and a return on average assets(ROA) and return on average equity (ROE) of 1.47% and 14.99%, respectively. Comparable performance in the third quarter of 1997 reflected EPS of $0.48, ROA of 1.43% and ROE of 14.64%. Year-to-date EPS through the end of September, 1998 reached $1.46 compared to $1.37 in 1997 (excluding second quarter 1997 special charges associated with the merger of Financial Trust Corp). ROA and ROE for the first three quarters of 1998 were 1.46% and 14.72%, respectively. Keystone has experienced continued pressure on both net interest margin and net interest income performance. Balance sheet growth and net interest spread have been constrained by customer reactions to recent economic trends and by the relatively flat interest rate yield curve. As a result of these factors, the net interest margin declined from 4.60% for the nine-month period ended September 30, 1997 to 4.45% for the same period in 1998, while net interest income was constant. Core loan growth, which has been influenced by consumer borrowing patterns, has also been adversely affected by the run-off of indirect loan and lease balances, the sale of consumer mortgages into the secondary market, and the decline in dealer floor plan loans due, in part, to the General Motors strike. Noninterest sources of income continue to improve, reflecting strong growth from asset management, mortgage banking, and electronic banking activities, including increases of 20% or more over the prior year-to-date. Year-to-date 1998 results included securities gains of $10.4 million compared with $3.2 million for 1997. The provision for credit losses reflected a 15% increase in 1998 year-to-date versus 1997. As expected, third quarter charge-offs declined from the second quarter levels, which had higher levels of charge-offs associated with Keystone's exited indirect automobile loan and lease programs. Growth in noninterest expenses excluding special charges has been limited to 5% for the year-to-date period, and 1% for the third quarter of 1998 compared with the same quarter in 1997. The growth is attributable to mid-year 1997 acquisitions and to expenses associated with revenue-expansion efforts. Cost management accomplished through improved operating efficiency will continue to be an important focus of management. Asset quality remained stable as reflected by the ratio of total risk elements to loans, which was 1.26% at September 30, 1998, compared to 1.25% at December 31, 1997. Similarly, the allowance-to-loan ratio remained consistent at 1.36%. 9 AVERAGE STATEMENT OF CONDITION The average balance sheets for the nine months ended September 30, 1998 and 1997 were as follows (in thousands): - --------------------------------------------------------------------------- Change 1998 1997 Volume % - --------------------------------------------------------------------------- Cash and due from banks $174,341 $186,239 $(11,898) (6)% Federal funds sold and other 93,171 95,625 (2,454) (3) Investments 1,675,653 1,502,862 172,791 11 Loans held for resale 62,747 88,535 (25,788) (29) Loans 4,623,575 4,521,902 101,673 2 Allowance for credit losses (64,125) (60,604) (3,521) 6 - --------------------------------------------------------------------------- Net loans 4,559,450 4,461,298 98,152 2 Intangible assets 61,934 39,943 21,991 55 Other assets 234,497 219,254 15,243 7 - --------------------------------------------------------------------------- TOTAL ASSETS $6,861,793 $6,593,756 $268,037 4 % - --------------------------------------------------------------------------- Noninterest-bearing deposits $632,509 $608,493 $ 24,016 4 % Interest-bearing deposits 4,565,495 4,529,347 36,148 1 Short-term borrowings 379,061 373,319 5,742 2 FHLB borrowings 353,670 241,645 112,025 46 Other long-term debt 115,510 51,251 64,259 125 Other liabilities 134,450 134,705 (255) --- - --------------------------------------------------------------------------- TOTAL LIABILITIES 6,180,695 5,938,760 241,935 4 - --------------------------------------------------------------------------- SHAREHOLDERS' EQUITY 681,098 654,996 26,102 4 - --------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $6,861,793 $6,593,756 $268,037 4 % - --------------------------------------------------------------------------- Loan growth of 2% was driven by increases in commercial, commercial real estate and consumer installment loans. Growth was constrained by the sale of consumer mortgages and the run-off of indirect loans and leases associated with the curtailment of this line of business. Intangible assets were impacted by the second quarter 1997 acquisition of First Financial. Funding for asset growth was obtained from both deposit growth as well as increased FHLB borrowings. Long-term debt increased due to the issuance of medium term notes totaling $100 million in May of 1997 and $30 million in May of 1998, the proceeds of which were used for general corporate purposes including acquisitions and share repurchase. 10 NET INTEREST INCOME The following table summarizes, on a fully taxable equivalent basis, changes in net interest income and net interest margin for the nine months ended September 30, 1998 and 1997 (in thousands):
- ------------------------------------------------------------------------------------ Increase/ 1998 1997 (Decrease) YIELD/ YIELD/ YIELD/ AMOUNT RATE AMOUNT RATE AMOUNT RATE - ------------------------------------------------------------------------------------ Interest income $397,212 8.22% $386,160 8.30% $11,052 (0.08) Interest expense 181,936 4.49 171,844 4.42 10,092 (0.07) - ------------------------------------------------------------------------------------ Net interest income $215,276 $214,316 $ 960 Interest spread 3.73% 3.88% (0.15) Impact of noninterest funds 0.72 0.72 --- - ------------------------------------------------------------------------------------ Net interest margin 4.45% 4.60% (0.15) - ------------------------------------------------------------------------------------ *The change in net interest income consisted primarily of favorable volume variances.
Keystone's primary source of revenue is net interest income, which comprised 75% of total revenue (excluding securities gains) for the first nine months of 1998. Net interest income represents the difference between interest income on earning assets and interest expense on deposits and other borrowed funds, and is heavily dependent on the volume and composition of earning assets and interest bearing liabilities as well as the yield or rate earned or paid on these earning assets or funding sources. Net interest income reflected minimal growth of $960,000 for the first nine months of 1998 versus the same period in 1997. The growth in net interest income resulted from 4% earning asset growth which was offset by a fifteen basis point decline in the net interest margin. Interest income grew $11.1 million or 3% for the first nine months of 1998 compared to the same period in 1997. Earning asset growth of $246 million occurred in both investments and loans. The total yield on earning assets dropped from 8.30% for 1997 to 8.22% for 1998 due to intense pricing competition on loans and a decline in the treasury yield curve. Interest expense grew $10.1 million or 6% as interest bearing liabilities increased 4% and the total cost of funds increased 7 basis points. Higher cost funding sources such as certificates of deposit and FHLB borrowings became a larger percentage of the total funding sources, increasing the cost of funds and further compressing net interest spread. As a result of the decline in earning asset yields and the increased cost of funds, the interest spread dropped from 3.88% in 1997 to 3.73% in 1998. Similarly, the margin decreased from 4.60% to 4.45%, as the impact of noninterest funds was unchanged. PROVISION FOR CREDIT LOSSES The provision for credit losses reached $13.5 million or 0.39% of average loans, when annualized, for the first nine months of 1998, compared with $11.8 million or 0.35% of average loans for the same period of 1997. The increased provision was primarily due to second quarter charge-offs related to the exited indirect automobile lending and leasing programs. 11 NONINTEREST INCOME Noninterest revenues continued to demonstrate significant growth as they increased $15.9 million or 24% for the nine-month period ended September 30, 1998, compared to the same period in 1997. Excluding net securities gains and gains on the sale of branches included in both periods, total noninterest revenue increased 21% for the first nine months of 1998. Trust and investment management fees increased $4.2 million or 27% in 1998 year-to-date compared to 1997. Such revenues were benefitted by the successful introduction of KeyPremier mutual funds and the third quarter 1997 acquisition of MMC&P, a retirement benefit services firm. Fee income, which includes revenue from processing merchants' credit card transactions and electronic banking services, increased $3.3 million or 22% year-to-date compared to last year. Such fees were benefitted by increased credit card activity, the expansion of our ATM network into convenience stores, and the increased popularity of the KeyCheck debit card. Mortgage banking income rose $2.5 million or 36% compared to prior year-to-date performance, as average loans serviced for others increased 22% to $983 million and originations for the first nine months of 1998 were $344 million, a 58% increase over the same period in 1997. As part of Keystone's ongoing review of its delivery channels, community offices were sold in both years, contributing nearly $1 million to other income 1998 year-to-date and $4.3 million in 1997. Excluding these gains from both years, other income increased 23%, primarily from higher sales of annuities. Year-to-date results included net securities gains of $10.4 million for 1998 and $3.2 million for 1997, resulting from a strategic decision to reduce our equity securities portfolio, and at the same time, take advantage of favorable market conditions. NONINTEREST EXPENSES Excluding 1997 special charges incurred in conjunction with the merger with Financial Trust Corp, year-to-date total noninterest expenses increased 5% in 1998 compared to 1997. The majority of the increase occurred in salaries and benefits which were impacted by mid-1997 acquisitions, increased staffing at the Telephone Banking Center, merit increases and enhanced incentive programs. Furniture and equipment expense increased 12% due to the expanded ATM network and technological investments in computer hardware and software. YEAR 2000 As explained in the Financial Review section of Keystone's 1997 Annual Report, the approach of the Year 2000 has elevated concerns over its potential impact on the operations of computer systems. Keystone's computer systems are managed by its information technology (IT) division, which has the primary responsibility to meet information processing needs through the acquisition, operation, and customization of software and hardware acquired from major providers. A limited portion of data processing needs, estimated at approximately 15%, is met by various third party service providers. Keystone's formal plan to resolve issues attendant to the approach of the Year 2000 (Y2K) consists of four major phases: inventory; assessment; distribution; and implementation. The four phases of the plan are primarily being performed using internal resources. The first, or inventory phase of Keystone's Y2K Plan, provided for identification of all IT and all non-IT components in facilities owned by Keystone and has been completed. However, we recognize that as a part of doing business, new items will be added to inventory as needed, and those items will be exposed to the process. The resultant inventory of components identified in this phase of the plan has served as the basis for assessment of all potential Y2K issues. The second, or assessment phase, consisted of an evaluation of the need for modification, upgrade or replacement of either internally-managed or service-based systems to become Y2K ready. This evaluation resulted in the identification of ten "corporate critical" IT systems which were deemed to present the highest level of execution risk if such systems were not adequately safeguarded from failure or malfunction. This stage of the process has been completed for all significant IT 12 items. Keystone believes that it has no significant exposure due to non-IT components which appear to be limited to items such as access control systems and vaults. During the third, or distribution phase, a decision is made as to remediation of Y2K problems by retiring, replacing, updating or converting each software or hardware component that is not Y2K compliant. The distribution phase of Keystone's Y2K plan has been completed for all "corporate critical" systems. The final, or implementation phase, includes installation, system testing and transition to a production environment. Of the ten "corporate critical" systems, one system is in production, with testing complete. Three systems are currently in production and will require only minor additional testing. The remaining six systems are in various stages of completion with five systems scheduled for production by the fourth quarter of 1998 and the remaining system in early 1999. It has been determined that all identified "corporate critical" replacement or updated systems meet the standards necessary for Y2K readiness. The risk associated with Y2K readiness, therefore, is primarily associated with the implementation of these systems and can be remedied, if necessary, via standard vendor support channels or by redirecting internal or external resources. Management's current risk assessment is that potential difficulties associated with implementation are likely to result in only minor delays in transaction processing or information availability. If delays in either transaction processing or information availability would occur for extended periods for "corporate critical systems", or if timely modification could not be made, Y2K issues could have a material effect on both customers and on the operations of Keystone. In a worst case scenario, which management does not consider to be likely, Keystone may be unable to clear checks, process payments, or obtain customer account information. In addition, customers' access to funds could be delayed. Failure to achieve Y2K readiness could also subject Keystone or its subsidiaries to potential sanctions or directives from the various regulatory agencies responsible for supervisory oversight of financial institutions. Keystone is also engaged in an effort to survey the readiness of suppliers, vendors, and major customers. To date, Keystone is not aware of any problems which would materially impact its results of operations, liquidity, or capital resources. However, Keystone has no means to determine with absolute assurance that external parties will be Y2K ready or that such parties' failure to be Y2K ready would not have a material impact on Keystone. Keystone has previously reported that the estimate of costs expected to be incurred to accommodate Y2K readiness was $9 million, including nearly $4 to $5 million of software and system replacements which will be capitalized and amortized over a three to five year period. Expenditures since the inception of the project have aggregated $5.2 million, of which $2.6 million were capitalized. All expenditures will be funded through operating cash flows. Keystone's estimate of costs and the time required to complete Y2K modifications, as well as the assessment of readiness to deal with Y2K issues, are based on forward- looking information and are dependent upon assumptions regarding future events. There can be no guarantee that estimates of costs or completion dates will be achieved or that all risk has been appropriately identified and assessed. Specific factors that might cause differences include, but are not limited to, the availability and cost of personnel, satisfactory Year 2000 upgrade execution, the ability to identify all issues, and similar uncertainties. INCOME TAXES Income tax expense for the first nine months of 1998 was $33.9 million, resulting in an effective tax rate of 31%, which was comparable to the same period in 1997. ASSET QUALITY Keystone's allowance for credit losses was $61.9 million or 1.36% of loans at September 30, 1998, compared to 1.38% of loans at the end of 1997. Annualized net charge-offs expressed as a percentage of average loans increased from 0.34% for the first nine months of 1997 to 0.48% in the same period of 1998, with consumer loans and leases constituting 85% of the 1998 net charge-offs. A majority of the consumer loan and lease charge-offs related to the indirect auto loan programs exited in 1997. 13 The following table provides a comparative summary of the activity in the allowance for credit losses for the nine-month periods ended September 30, 1998 and 1997 (in thousands). - ------------------------------------------------------------------------ 1998 1997 - ------------------------------------------------------------------------ Allowance for Credit Losses: Balance at beginning of period $65,091 $56,256 Allowance obtained through merger --- 8,311 Loans charged-off: Commercial (1,790) (1,407) Real estate secured (2,049) (1,802) Consumer (11,516) (7,618) Lease financing (3,848) (2,253) - ------------------------------------------------------------------------ Total loans charged-off (19,203) (13,080) - ------------------------------------------------------------------------ Recoveries: Commercial 230 205 Real estate secured 1,062 525 Consumer 1,054 846 Lease financing 182 171 - ------------------------------------------------------------------------ Total recoveries 2,528 1,747 - ------------------------------------------------------------------------- Net loans charged-off (16,675) (11,333) Provision for credit losses 13,517 11,772 - ------------------------------------------------------------------------- Balance at end of period $61,933 $65,006 - ------------------------------------------------------------------------- 14 The following table has been provided to compare nonperforming assets and total risk elements at September 30, 1998 to the balances at the end of 1997, in both absolute dollars and as a percentage of loans. This presentation is supplemented by a comparison of various coverage ratios. September 30, December 31, (dollars in thousands) 1998 1997 - ------------------------------------------------------------------------- Nonaccrual loans $24,607 $20,520 Restructurings 588 489 - ------------------------------------------------------------------------- Nonperforming loans 25,195 21,009 Other real estate 7,008 5,028 - ------------------------------------------------------------------------- Nonperforming assets 32,203 26,037 Loans past due 90 days or more 25,091 33,062 - ------------------------------------------------------------------------- Total risk elements $57,294 $59,099 - ------------------------------------------------------------------------- Ratio to period-end loans:* Nonperforming assets .71% .55% 90-days past due .55 .70 - ------------------------------------------------------------------------- Total risk elements 1.26% 1.25% - ------------------------------------------------------------------------- Coverage Ratios: Ending allowance to nonperforming loans 246% 310% Ending allowance to risk elements** 123% 120% Ending allowance to annualized net charge-offs 2.8X 4.4X - -------------------------------------------------------------------------- * The denominator consists of period-end loans and ORE. **Excludes ORE. Total risk elements expressed as a percent of loans at September 30, 1998 was consistent with year-end 1997. A large commercial loan in the 90-days past due category at December 31, 1997 was placed on nonaccrual status in 1998, thus driving the increase in nonaccrual loans and decrease in 90-days past due. While the migration of this loan into nonaccrual status caused the ratio of the allowance to nonperforming loans to decrease from 310% at the end of 1997 to 246% at September 30, 1998, the ratio of the allowance to total risk elements is slightly improved. As a result of charge-offs associated with the exited indirect automobile loan and lease programs, the coverage ratio of the ending allowance to annualized year-to-date net charge-offs decreased from 4.4 at September 30, 1997 to 2.8 at September 30, 1998. Based upon the evaluation of loan quality and other relevant factors, management believes that the allowance for credit losses is adequate to absorb credit losses inherent in the portfolio. 15 CAPITAL MANAGEMENT During the first half of 1998, Keystone purchased 1 million shares for treasury at a total cost of $40 million. These shares were retired during the third quarter. Keystone's regulatory capital measures, which include the leverage ratio, "Tier 1" capital, and "Total" capital ratios, continued to be well in excess of both regulatory minimums and the thresholds established for "well capitalized" institutions. The following comparative presentation of these ratios and associated regulatory standards is provided: Regulatory Standards --------------------------- September 30, December 31, Well Minimum 1998 1997 Capitalized Requirement - --------------------------------------------------------------------------- Leverage ratio 9.01% 9.15% 5.00% 4.00% Tier 1 12.65% 12.50% 6.00% 4.00% Total capital ratio 13.90% 13.75% 10.00% 8.00% ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Through September 30, 1998 there have been no material changes to the information on this topic presented in the December 31, 1997 Annual Report. 16 PART II. ITEM 6(a) Exhibits: Exhibit # Description ---------- ------------- 11 Statement Re Computation of Per Share Earnings 12 Statement Re Computation of Ratios 27 Financial Data Schedule ITEM 6(b) Reports on Form 8-K: During the quarter ended September 30, 1998, the registrant filed the following reports on Form 8-K: Date of Report Item Description - --------------- ----- --------------------------------------- July 22, 1998 5 Earnings release for the quarter ended June 30, 1998 July 7, 1998 5 Description of common stock 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DATE: November 13, 1998 Mark L. Pulaski - ------------------------- President & Chief Operating Officer DATE: November 13, 1998 Donald F. Holt - ------------------------- Senior Vice President & Chief Financial Officer 18 EX-11 2 COMPUTATION OF PER SHARE EARNINGS Exhibit 11: Statement Re Computation of Per Share Earnings The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations (in thousands, except per share data):
Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 - ----------------------------- ------------- --------------- --------------- --------------- Numerator $25,581 $24,600 $74,998 $62,353 Denominators: Basic shares outstanding 51,368 51,834 51,540 51,596 Dilutive option effect 507 629 638 625 - ----------------------------- ------------- --------------- --------------- --------------- Dilutive shares out- 51,875 52,463 52,178 52,221 standing - ----------------------------- ------------- --------------- --------------- --------------- EPS: Basic $0.50 $0.48 $1.46 $1.21 Diluted $0.50 $0.47 $1.44 $1.19 - ----------------------------- ------------- --------------- --------------- ---------------
EX-12 3 COMPUTATION OF RATIOS Exhibit 12: Statement Re Computation of Ratios Ratio of Earnings to Fixed Charges: (in thousands)
Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 - ---------------------------------------------- ------------ ------------ ------------ 1. Income before taxes $ 37,949 $ 36,268 $108,856 $ 90,597 2. Fixed charges: a. Interest expense $ 61,402 $ 60,446 $181,936 $171,844 b. Interest component of $ 667 $ 600 $ 2,088 $ 1,773 rent expense - ---------------------------------------------- ------------ ------------ ------------ c. Total fixed charges $ 62,069 $ 61,046 $184,024 $173,617 (line 2a.+ line 2b.) d. Interest on deposits $ 48,677 $ 50,247 $146,555 $144,754 - ---------------------------------------------- ------------ ------------ ------------ e. Fixed charges excluding interest on deposits $ 13,392 $ 10,799 $ 37,469 $ 28,863 (line 2c.-line 2d.) - ---------------------------------------------- ------------ ------------ ------------ 3. Income before taxes plus fixed charges: a. Including interest on deposits (line 1.+ line $100,018 $ 97,314 $292,880 $264,214 2c.) b. Excluding interest on deposits (line 1.+ line $ 51,341 $ 47,067 $146,325 $119,460 2e.) - ---------------------------------------------- ------------ ------------ ------------ 4. Ratio of earnings to fixed charges: a. Including interest on deposits (line 3a. 1.61 1.59 1.59 1.52 divided by line 2c.) b. Excluding interest on deposits (line 3b. 3.83 4.36 3.91 4.14 divided by line 2e.) - ---------------------------------------------- ------------ ------------ ------------
19 EX-27 4 FINANCIAL DATA SCHEDULE
9 This schedule contains summary financial information extracted from the third quarter 10-Q and is qualified in its entirety by reference to such 10-Q. 1,000 9-MOS DEC-31-1998 SEP-30-1998 169,103 1,641 25,150 0 1,107,560 681,426 698,286 4,552,173 61,933 6,906,404 5,146,364 377,197 162,490 532,134 0 0 102,773 585,446 6,906,404 304,792 78,254 7,646 390,692 146,555 181,936 208,756 13,517 10,357 167,705 108,856 74,998 0 0 74,998 1.46 1.44 3.73 25,195 25,091 588 0 65,091 19,203 2,528 61,933 61,933 0 0
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