-----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, D4DlI42C7VrqQRC36e4ZUMboY4oP6Ki/5xewyZM1AEF0ZAH0Mg214oqGc41Rs/Rj X4lgt1+xg58wdybMEvqQLQ== 0000717809-98-000019.txt : 19980817 0000717809-98-000019.hdr.sgml : 19980817 ACCESSION NUMBER: 0000717809-98-000019 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 SROS: NASD 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: 98690558 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. 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 June 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): 51,376,000 as of July 31, 1998. 1 KEYSTONE FINANCIAL, INC. INDEX PAGE PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements Consolidated Statements of Condition - June 30, 1998 and December 31, 1997 3 Consolidated Statements of Income - Three months ended June 30, 1998 and 1997, and six months ended June 30, 1998 and 1997 4 Consolidated Statements of Comprehensive Income - Three-months ended June 30, 1998 and 1997, and six months ended June 30, 1998 and 1997 6 Consolidated Statements of Cash Flows - Six months ended June 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, and 5 have been omitted since they are not applicable. ITEM 4. Submission of Matters to a Vote of Security Holders 16 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 June 30, 1998 December 31, 1997 ________________________________________________________________________________ (in thousands, except share data) ASSETS ________________________________________________________________________________ Cash and due from banks $189,201 $206,223 Federal funds sold 49,300 25,300 Interest bearing deposits with banks 1,064 1,928 Investment securities available for sale 1,141,937 1,091,400 Investment securities held to maturity (market values 1998-$601,255; 1997-$538,218) 592,571 528,388 Loans held for resale 62,957 43,055 Loans and leases 4,616,650 4,712,566 Allowance for credit losses (62,777) (65,091) ________________________________________________________________________________ Net Loans 4,553,873 4,647,475 Premises and equipment 119,622 116,615 Other assets 188,365 180,953 ________________________________________________________________________________ TOTAL ASSETS $6,898,890 $6,841,337 ================================================================================ LIABILITIES ________________________________________________________________________________ Noninterest-bearing deposits $651,005 $637,164 Interest-bearing deposits 4,527,967 4,596,001 ________________________________________________________________________________ Total Deposits 5,178,972 5,233,165 Federal funds purchased and security repurchase agreements 343,433 399,730 Other short-term borrowings 43,428 26,160 ________________________________________________________________________________ Total Short-Term Borrowings 386,861 425,890 FHLB borrowings 379,503 248,150 Long-term debt 131,164 101,793 Other liabilities 153,879 146,854 ________________________________________________________________________________ TOTAL LIABILITIES 6,230,379 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 52,219,815 - 1998 and 52,029,017 - 1997 104,440 104,058 Surplus 159,767 155,430 Retained earnings 439,147 418,605 Deferred KSOP benefit expense (852) (1,150) Treasury stock: 1,000,000 shares at cost - 1998 (40,411) --- Accumulated other comprehensive income 6,420 8,542 ________________________________________________________________________________ TOTAL SHAREHOLDERS' EQUITY 668,511 685,485 ________________________________________________________________________________ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $6,898,890 $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 June 30, 1998 1997 ________________________________________________________________________________ INCOME ________________________________________________________________________________ Loans and fees on loans $102,190 $100,063 Investments - taxable 23,324 20,048 Investments - tax exempt 2,834 3,184 Federal funds sold & other 1,228 1,674 Loans held for resale 1,249 1,835 ________________________________________________________________________________ 130,825 126,804 ________________________________________________________________________________ INTEREST EXPENSE ________________________________________________________________________________ Deposits 48,661 47,988 Short-term borrowings 4,466 4,423 FHLB borrowings 5,453 3,949 Long-term debt 2,049 981 ________________________________________________________________________________ 60,629 57,341 ________________________________________________________________________________ NET INTEREST INCOME 70,196 69,463 Provision for credit losses 6,679 3,659 ________________________________________________________________________________ NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 63,517 65,804 ________________________________________________________________________________ NONINTEREST INCOME ________________________________________________________________________________ Trust and investment advisory fees 6,364 5,155 Service charges on deposit accounts 4,545 4,258 Fee income 6,249 4,908 Mortgage banking income 3,526 2,744 Other secondary market income 513 278 Reinsurance income 795 768 Other income 1,987 2,318 Net gains(losses)- equity securities 5,330 (120) Net gains(losses)- debt securities 52 (324) ________________________________________________________________________________ 29,361 19,985 NONINTEREST EXPENSE ________________________________________________________________________________ Salaries 24,362 22,289 Employee benefits 4,310 4,189 Occupancy expense (net) 4,283 4,031 Furniture and equipment expense 5,182 4,408 Special charges ---- 11,410 Other expense 17,331 17,441 ________________________________________________________________________________ 55,468 63,768 ________________________________________________________________________________ Income before income taxes 37,410 22,021 Income tax expense 12,129 7,039 ________________________________________________________________________________ NET INCOME $25,281 $14,982 ________________________________________________________________________________ PER SHARE DATA ________________________________________________________________________________ Net income: Basic $0.49 $0.29 Diluted $0.48 $0.29 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) ________________________________________________________________________________ Six Months Ended June 30, 1998 1997 ________________________________________________________________________________ INCOME ________________________________________________________________________________ Loans and fees on loans $204,063 $194,957 Investments - taxable 45,100 40,024 Investments - tax exempt 5,763 6,310 Federal funds sold & other 2,667 2,508 Loans held for resale 2,291 3,451 ________________________________________________________________________________ 259,884 247,250 ________________________________________________________________________________ INTEREST EXPENSE ________________________________________________________________________________ Deposits 97,878 94,507 Short-term borrowings 9,021 8,515 FHLB borrowings 9,717 7,381 Long-term debt 3,918 995 ________________________________________________________________________________ 120,534 111,398 ________________________________________________________________________________ NET INTEREST INCOME 139,350 135,852 Provision for credit losses 10,436 7,453 ________________________________________________________________________________ NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 128,914 128,399 ________________________________________________________________________________ NONINTEREST INCOME ________________________________________________________________________________ Trust and investment advisory fees 13,045 9,999 Service charges on deposit accounts 8,750 8,405 Fee income 11,559 9,429 Mortgage banking income 6,271 4,262 Other secondary market income 1,190 801 Reinsurance income 1,426 1,788 Other income 4,414 6,671 Net gains - equity securities 6,850 ---- Net gains(losses) - debt securities 63 (295) ________________________________________________________________________________ 53,568 41,060 NONINTEREST EXPENSE ________________________________________________________________________________ Salaries 48,657 43,909 Employee benefits 9,655 8,680 Occupancy expense (net) 8,797 8,143 Furniture and equipment expense 10,254 8,989 Special charges ---- 11,410 Other expense 34,212 33,999 ________________________________________________________________________________ 111,575 115,130 ________________________________________________________________________________ Income before income taxes 70,907 54,329 Income tax expense 21,490 16,576 ________________________________________________________________________________ NET INCOME $49,417 $37,753 ________________________________________________________________________________ PER SHARE DATA ________________________________________________________________________________ Net income Basic $0.96 $0.73 Diluted $0.94 $0.72 Dividends $0.56 $0.52 ________________________________________________________________________________ The accompanying notes are an integral part of the consolidated financial statements. 5 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in thousands) ______________________________________________________________________________ Three Months Ended June 30, 1998 1997 Before Net of Before Net of Tax Tax Tax Tax ______________________________________________________________________________ Net Income $25,281 $14,982 Unrealized gains (losses) on securities: Unrealized holding gains(losses)arising during the period 1,545 1,004 7,116 4,625 Less: Reclassification adjustment for gains included in net income (5,382) (3,498) 444 289 ______________________________________________________________________________ (2,494) 4,914 ______________________________________________________________________________ Comprehensive Income $22,787 $19,896 ============================================================================== ______________________________________________________________________________ Six Months Ended June 30, 1998 1997 Before Net of Before Net of Tax Tax Tax Tax ______________________________________________________________________________ Net Income $49,417 $37,753 Unrealized gains(losses) on securities: Unrealized holding gains(losses)arising 3,648 2,371 (1,021) (664) during the period Less: Reclassification adjustment for gains included in net income (6,913) (4,493) 295 192 ______________________________________________________________________________ (2,122) (472) ______________________________________________________________________________ Comprehensive Income $47,295 $37,281 ============================================================================== The accompanying notes are an integral part of the consolidated financial statements. 6 CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30, (in thousands) 1998 1997 ________________________________________________________________________________ OPERATING ACTIVITIES: Net Income $49,417 $37,753 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for credit losses 10,436 7,453 Provision for depreciation & amortization 10,224 8,275 Deferred income taxes 590 9,626 Special charges accrual (2,962) 7,751 Sale of loans held for resale 123,403 213,825 Origination of loans held for resale (219,617) (202,932) (Increase)decrease in interest receivable 559 (1,338) Increase in interest payable 7,295 6,516 Other (7,895) (6,132) ________________________________________________________________________________ NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (28,550) 80,797 ________________________________________________________________________________ INVESTING ACTIVITIES: Net decrease in interest-bearing deposits with banks 864 28,406 Available for sale securities: Sales 50,121 129,237 Maturities 521,476 409,746 Purchases (614,757) (406,000) Held to maturity securities: Maturities 109,914 27,316 Purchases (174,234) (53,939) Net (increase) decrease in loans 159,875 (213,866) Purchases of loans (6,660) ---- Proceeds from sales of loans 3,661 84,521 Purchases of premises and equipment (10,989) (10,676) Other (6,975) (3,753) ________________________________________________________________________________ NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 32,296 (9,008) ________________________________________________________________________________ FINANCING ACTIVITIES: Net decrease in deposits (54,193) (20,920) Net decrease in short-term borrowings (39,029) (1,130) Proceeds from FHLB borrowings 202,542 168,242 Repayments of FHLB borrowings (71,189) (167,358) Issuance of long-term debt 30,000 100,000 Repayment of long term debt (629) (544) Acquisition of treasury stock (40,411) (61,349) Cash dividends (28,875) (27,915) Other 5,016 5,327 ________________________________________________________________________________ NET CASH PROVIDED BY(USED IN) FINANCING ACTIVITIES 3,232 (5,647) ________________________________________________________________________________ INCREASE IN CASH AND CASH EQUIVALENTS 6,978 66,142 Cash and cash equivalents at beginning of period 231,523 251,472 ________________________________________________________________________________ CASH AND CASH EQUIVALENTS AT END OF PERIOD $238,501 $317,614 ________________________________________________________________________________ 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 six-month period ended June 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 1998, Keystone adopted Financial Accounting Standards Board Statement 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 can not 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. Because of Keystone's minimal 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 super-community banks and specialized nonbank subsidiaries located throughout 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 daily average balances, unless otherwise indicated. The results of First Financial Corporation of Western Maryland (First Financial), which was acquired through a purchase acquisition on May 29, 1997, have been included herein from the consummation date. SUMMARY OF FINANCIAL RESULTS Keystone reported net income of $25.3 million or $0.49 per basic share for the second quarter of 1998, compared to $15.0 million or $0.29 per basic share for the same quarter of 1997. Second quarter results in 1997 had been influenced by special merger and portfolio restructuring charges associated with the merger of Financial Trust Corp. which aggregated $0.17 per share. Excluding these items, earnings per share increased 7% and reflected a return on average assets (ROA) and return on average equity (ROE) of 1.47% and 14.93% versus 1.43% and 14.54% for the second quarter of 1997. Earnings for the six months ended June 30, 1998 exhibited similar improvement, reflecting 7% growth in basic earnings per share to $0.96, and resulting in ROA of 1.46% and ROE of 14.59% compared with 1.44% and 14.35% for 1997, exclusive of the special charges. Operating results for the second quarter and six months ended June 30, 1998 were influenced by the higher loan loss provision associated with consumer loan charge-offs. These charge-off's relate to the indirect automobile lending and leasing programs, which were curtailed in 1997. Results were also affected by securities gains from the sale of appreciated bank stocks. Core results included slight growth in net interest income coupled with continued strong growth in noninterest income and recent improvement in expense levels. As a result of competitive pressures on loan pricing, as well as an overall higher cost of funds, the net interest margin declined slightly from the same period last year. Despite the declining margin and the runoff of existing indirect automobile loan and lease credits, core loan growth approximating 6% drove the increase in net interest income. Asset management growth, electronic banking fee increases and record mortgage banking activities combined to improve noninterest income 13% for the first half of 1998 compared to 1997. While noninterest expenses excluding special charges increased 8% year to date over 1997, recent measures, including a decline in the ratio of overhead expense to revenue from the first quarter of 1998, demonstrated improvement. Operating efficiency, combined with an expanded fee base, will continue to be an important management focus. As a result of the above-mentioned consumer loan charge-offs, the ratio of annualized net charge-offs expressed as a percentage of average loans increased to 0.55% for the first six months of 1998 from 0.32% for the same period last year. The level of charge-off's in the second quarter of 1998 was directly influenced by indirect automobile and lease programs, which were exited in 1997, and are not expected to significantly influence future charge-off levels. The ratio of the allowance for credit losses to total loans remained constant at 1.36%, as the provision for credit loses increased $3 million or 40% over 1997. Capital management remained a priority, as Keystone purchased 500,000 treasury shares during the quarter, bringing the year to date total shares purchased to one million. Regulatory capital measures remained above the threshold for well-capitalized. 9 AVERAGE STATEMENT OF CONDITION The average balance sheets for the six months ended June 30, 1998 and 1997 were as follows (in thousands): Change 1998 1997 Volume % ________________________________________________________________________________ Cash and due from banks $175,234 $179,807 $ (4,573) (3)% Federal funds sold and other 96,964 93,195 3,769 4 Investments 1,624,132 1,488,280 135,852 9 Loans held for resale 57,725 91,576 (33,851) (37) Loans 4,658,522 4,448,114 210,408 5 Allowance for credit losses (64,608) (58,294) (6,314) 11 ________________________________________________________________________________ Net loans 4,593,914 4,389,820 204,094 5 Intangible assets 61,853 28,615 33,238 116 Other assets 227,986 219,107 8,879 4 ________________________________________________________________________________ TOTAL ASSETS $6,837,808 $6,490,400 $347,408 5% ________________________________________________________________________________ Noninterest-bearing deposits $627,849 $598,636 $ 29,213 5% Interest-bearing deposits 4,578,972 4,465,478 113,494 3 Short-term borrowings 373,639 367,220 6,419 2 FHLB borrowings 336,581 247,474 89,107 36 Other long-term debt 107,638 25,447 82,191 323 Other liabilities 129,996 137,067 (7,071) (5) ________________________________________________________________________________ TOTAL LIABILITIES 6,154,675 5,841,322 313,353 5 ________________________________________________________________________________ SHAREHOLDERS' EQUITY 683,133 649,078 34,055 5 ________________________________________________________________________________ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $6,837,808 $6,490,400 $347,408 5% ________________________________________________________________________________ Loan growth was strongest in the categories of commercial, commercial real estate and consumer installment loans. The impact of loans added through the second quarter 1997 acquisition of First Financial was more than offset by the run-off of indirect loans and leases occurring in conjunction with the curtailment of these lines of business. Intangible assets were impacted by the second quarter 1997 acquisition of First Financial. Funding for loan growth was obtained from deposit growth and 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 repurchases. 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 six months ended June 30, 1998 and 1997 (in thousands):
_________________________________________________________________________________________ Increase/ 1998 1997 (Decrease) YIELD/ YIELD/ YIELD/ AMOUNT RATE AMOUNT RATE AMOUNT RATE _________________________________________________________________________________________ Interest income $264,226 8.26% $251,627 8.27% $12,599 (0.01) Interest expense 120,534 4.50 111,398 4.40 9,136 0.10 _________________________________________________________________________________________ Net interest income $143,692 $140,229 $3,463 Interest spread 3.76% 3.87% (0.11) Impact of noninterest funds 0.73 0.73 _________________________________________________________________________________________ Net interest margin 4.49% 4.60% (0.11) _________________________________________________________________________________________ *The change in net interest income consisted primarily of favorable volume variances.
Keystone's primary source of revenue is net interest income, which constituted 75% of total revenue (excluding securities gains) for the first six 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 grew $3.5 million or 2% for the first half of 1998 versus the same period in 1997, despite the decline of eleven basis points in the net interest margin. The growth in net interest income was primarily due to earning asset growth. Interest income grew $12.6 million or 5% in the first half of 1998 compared to the same period in 1997. Earning asset growth of $316,000 or 5% occurred in both investments and loans. Improvement occurred in the mix of earning assets as growth occurred in higher yielding categories of loans such as consumer and commercial real estate due to Keystone's strategic decision to focus on these relationship-oriented business segments. Interest expense grew $9.1 million or 8% as the rate on total cost of funds increased 10 basis points. The increase occurred due to both a 6% increase in interest bearing liabilities as well as a shift in the composition of the liabilities, with higher cost funding sources such as the variable rate certificate of deposit and borrowings becoming a larger percentage of the total funding sources. As a result of the yield on earning assets remaining stable and the cost of funds increasing 10 basis points, the interest spread dropped from 3.87% in 1997 to 3.76% in 1998. Similarly, the margin decreased from 4.60% to 4.49%, as the impact of noninterest funds was unchanged. PROVISION FOR CREDIT LOSSES The provision for credit losses reached $10.4 million or 0.45% of average loans, when annualized, for the first six months of 1998 compared with $7.5 million or 0.34% of average loans for the same period of 1997. The increased provision reflects the higher charge-offs related to the indirect automobile lending and leasing programs that were exited in 1997. NONINTEREST INCOME Noninterest revenues continued to demonstrate significant growth as they increased $12.5 million or 30% from the first half of 1997 to the same period in 1998. Excluding net securities gains and gains on the sale of branches from both periods, total noninterest revenues increased 23% in 1998. 11 Trust and investment management fees increased $3 million or 30% for the first six months of 1998 compared to 1997, as assets managed within Keystone's proprietary mutual funds exceeded the $1 billion mark and total managed funds exceeded $3.5 billion. During the third quarter of 1997, Keystone also expanded its retirement benefit services capabilities through the acquisition of MMC&P, which also contributed to the growth in revenue. Fee income, which includes revenue from credit card activities and electronic banking services, increased $2 million or 23% compared to the first six months of 1997. Such fee increases were driven by increased credit card activity, the expansion of our convenience store ATM network, and the increased usage and fee generation from the KeyCheck debit card. Mortgage banking income reflected an increase of $2 million or 47% compared to the first half of 1997, as loans serviced for others increased 38% and originations increased 54%. Mortgage banking activity has benefited from a relatively low interest rate environment, a strong economy, and increased housing starts. 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 in 1998 and $4.3 million in 1997. Excluding these gains from both years, other income increased 46%, primarily from expanded annuity sales. For the first six months of the year, 1998 results included net securities gains of $6.9 million, resulting from a strategic decision to manage our equity securities exposure, and at the same time, take advantage of favorable market conditions. NONINTEREST EXPENSES Excluding special charges incurred in conjunction with the 1997 merger of Financial Trust Corp, growth in total noninterest expenses approximated $7.9 million or 8% during the first half of 1998. The May 1997 and August 1997 purchase acquisitions of First Financial and MMC&P, respectively, influenced the expense increases for the first six months of 1998. These acquisitions had the largest impact on salaries and benefits, which increased 11%. Salary expense was also impacted by merit increases, increased telephone center staffing, year 2000 expenses, and the continued expansion of performance-based incentive programs. Occupancy costs, as well as furniture and equipment expense, increased 8% and 14%, respectively, and were impacted by the acquisition of First Financial, the expanded ATM network, and the recently completed "state-of-the-art" telephone banking center. 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 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 first, or inventory phase of Keystone's Y2K Plan, provided for identification of all IT and non-IT components and has been completed. 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 meet Y2K compliance standards. 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 systems. 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. 12 During the third, or distribution phase, a decision is made about how to remedy 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, four systems are currently in production and will require only minor additional testing. The remaining six systems are in various stages of completion with four systems scheduled for production by the fourth quarter of 1998 and the two remaining systems in early 1999. Management believes that all identified "corporate critical" replacement or updated systems meet the standards necessary for Y2K compliance. The risk associated with Y2K compliance, therefore, is limited to the implementation of these compliant 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. Failure to achieve Y2K compliance 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 compliant or that non-compliance would have a material impact on Keystone. Keystone has previously reported that the estimate of costs expected to be incurred to accommodate Y2K compliance 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 $4.2 million and 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 the risk of noncompliance, are forward-looking information and are dependent upon assumptions regarding future events. There can be no guarantee that estimates surrounding 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 half of 1998 reached $21.5 million, resulting in an effective tax rate of 30%, relatively unchanged from an effective rate of 31% for the same period in 1997. ASSET QUALITY Keystone's allowance for credit losses totaled $63 million or 1.36% of outstanding loans at June 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 0.32% in 1997 to 0.55% in 1998, with consumer loans and leases constituting 93% of 1998 net charge-offs. A majority of the consumer and lease financing charge-offs during 1998 related to the indirect automobile lending and leasing programs. 13 The following table provides a comparative summary of the activity in the allowance for credit losses for the six-month periods ended June 30, 1998 and 1997 (in thousands). 1998 1997 ___________________________________________________________________________ Allowance for Credit Losses: Balance at beginning of period $65,091 $56,256 Allowance obtained through acquisition ---- 8,311 Loans charged-off: Commercial (938) (682) Real estate secured (1,011) (1,305) Consumer (8,934) (5,061) Lease financing (3,775) (1,260) ___________________________________________________________________________ Total loans charged-off (14,658) (8,308) ___________________________________________________________________________ Recoveries: Commercial 141 154 Real estate secured 912 365 Consumer 700 563 Lease financing 155 106 ___________________________________________________________________________ Total recoveries 1,908 1,188 ___________________________________________________________________________ Net loans charged-off (12,750) (7,120) Provision for credit losses 10,436 7,453 ___________________________________________________________________________ Balance at end of period $62,777 $64,900 ___________________________________________________________________________ 14 The following table has been provided to compare nonperforming assets and total risk elements at June 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. June 30, December 31, (dollars in thousands) 1998 1997 _________________________________________________________________________ Nonaccrual loans $29,452 $20,520 Restructurings 305 489 _________________________________________________________________________ Nonperforming loans 29,757 21,009 Other real estate 4,630 5,028 _________________________________________________________________________ Nonperforming assets 34,387 26,037 Loans past due 90 days or more 20,633 33,062 _________________________________________________________________________ Total risk elements $55,020 $59,099 _________________________________________________________________________ Ratio to period-end loans:* Nonperforming assets .74% .55% 90-days past due .45 .70 _________________________________________________________________________ Total risk elements 1.19% 1.25% _________________________________________________________________________ Coverage Ratios: Ending allowance to nonperforming loans 211% 310% Ending allowance to risk elements** 125% 120% Ending allowance to annualized net charge-offs 2.4X 4.4X _________________________________________________________________________ * The denominator consists of period-end loans and ORE. **Excludes ORE. Total risk elements decreased from $59 million or 1.25% of loans at the end of 1997 to $55 million or 1.19% of loans at June 30, 1998. A limited number of large commercial loans moved from the 90 days past due category at the end of 1997 to nonaccrual status, causing the ratio of the allowance to nonperforming loans to decrease from 310% at the end of 1997 to 211% at June 30, 1998. Such loans are not expected to experience significant collectability problems. As a result of the aforementioned consumer loan charge-offs, the coverage ratio of the allowance to annualized net charge-offs declined from 4.4 for 1997 to 2.4 for the first six months of 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 repurchased one million shares for treasury at a total cost of $40.4 million. 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 ___________________________ June 30, December 31, Well Minimum 1998 1997 Capitalized Requirement ___________________________________________________________________________ Leverage ratio 8.80% 9.15% 5.00% 4.00% Tier 1 12.28% 12.50% 6.00% 4.00% Total capital ratio 13.53% 13.75% 10.00% 8.00% The slight decline in the above ratios can be attributed in part to the share repurchases mentioned above. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Through June 30, 1998 there have been no material changes to the information on this topic presented in the December 31, 1997 Annual Report. PART II. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of the Shareholders was held on May 21, 1998. Proxies were solicited by management pursuant to Regulation 14A under the Securities and Exchange Act of 1934. Nominees for the seven director positions were elected. All other matters submitted to a vote of shareholders were also approved, and the shareholder vote thereon was as follows: Election of Directors: For Withheld ________________________________________________________________________________ Carl L. Campbell 40,007,957 507,966 Paul I. Detwiler, Jr. 39,993,424 522,499 Allan W. Holman, Jr. 40,016,889 499,034 James I. Scheiner 40,002,636 513,287 Molly Dickinson Shepard 39,959,092 556,831 Ronald C. Unterberger 40,016,392 499,531 William Ward 40,019,377 496,546 The ratification of the appointment of Ernst & Young, LLP as independent Auditors of the Corporation for 1998: Shares in favor of the proposal 40,195,365 Shares against the proposal, and 140,096 Shares abstaining from voting 180,462 For further information concerning these matters, refer to the definitive proxy statement dated April 9, 1998 in the registrant's file, which is incorporated herein by reference. 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 June 30, 1998, the registrant filed the following reports on Form 8-K: Date of Report Item Description _______________ _____ _______________________________________ April 22, 1998 5 Earnings release for the quarter ended March 31, 1998. May 28, 1998 5 Press release announcing senior management changes, dividend declaration and election of new directors. June 19, 1998 5 Press release announcing completion of Capital Region expansion. 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: August 13, 1998 - ----------------------------------- Mark L. Pulaski - ----------------------------------- President & Chief Operating Officer DATE: August 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 Six Months Ended June 30, June 30, 1998 1997 1998 1997 _____________________________________________________________________________________ Numerator $25,281 $14,982 $49,417 $37,753 Denominators: Basic shares outstanding 51,429 51,320 51,627 51,475 Dilutive option effect 666 623 698 625 _____________________________________________________________________________________ Dilutive shares outstanding 52,095 51,943 52,325 52,100 _____________________________________________________________________________________ EPS: Basic $0.49 $0.29 $0.96 $0.73 Diluted $0.48 $0.29 $0.94 $0.72 _____________________________________________________________________________________
EX-12 3 COMPUTATION OF RATIOS Ratio of Earnings to Fixed Charges:
Three Months Ended Six Months Ended (in thousands) June 30, June 30, 1998 1997 1998 1997 ___________________________________________________________________________________________________ 1. Income before taxes $37,410 $22,021 $70,907 $54,329 2. Fixed charges: a. Interest expense $60,629 $57,341 $120,534 $111,398 b. Interest component of rent expense 724 597 1,421 1,173 ___________________________________________________________________________________________________ c. Total fixed charges (line 2a.+ line 2b.) 61,353 57,938 121,955 112,571 d. Interest on deposits 48,661 47,988 97,878 94,507 ___________________________________________________________________________________________________ e. Fixed charges excluding interest on deposits (line 2c.-line 2d.) $12,692 $9,950 $24,077 $18,064 ___________________________________________________________________________________________________ 3. Income before taxes plus fixed charges: a. Including interest on deposits $98,763 $79,959 $192,862 $166,900 (line 1.+ line 2c.) b. Excluding interest on deposits 50,102 31,971 94,984 72,393 (line 1.+ line 2e.) ___________________________________________________________________________________________________ 4. Ratio of earnings to fixed charges: a. Including interest on deposits (line 3a. divided by line 2c.) 1.61x 1.38x 1.58x 1.48x b. Excluding interest on deposits (line 3b. divided by line 2e.) 3.95x 3.21x 3.95x 4.01x ___________________________________________________________________________________________________
19 EX-27 4 KEYSTONE FINANCIAL'S FDS
9 This schedule contains summary financial information extracted from the second quarter 10-Q and is qualified in its entirety by reference to such 10-Q. 1,000 6-MOS DEC-31-1998 JUN-30-1998 189,201 1,064 49,300 0 1,141,937 592,571 601,255 4,616,650 62,777 6,898,890 5,178,972 386,861 153,879 510,667 0 0 104,440 564,071 6,898,890 204,063 50,863 4,958 259,884 97,878 120,534 139,350 10,436 6,913 111,575 70,907 49,417 0 0 49,417 .96 .94 3.76 29,452 20,633 305 0 65,091 14,658 1,908 62,777 62,777 0 0
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