-----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, RKUkb3rFUCNkOoxpFAIQIAOb7Y7NHOC0tRjn1iSeFAFNmz56sYrL1q2fkgM+SzzD +8aBF+Ip1k4rCGTj2V7zmA== 0000893220-02-001543.txt : 20021230 0000893220-02-001543.hdr.sgml : 20021230 20021230155926 ACCESSION NUMBER: 0000893220-02-001543 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20020930 FILED AS OF DATE: 20021230 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST KEYSTONE FINANCIAL INC CENTRAL INDEX KEY: 0000856751 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 232576479 STATE OF INCORPORATION: PA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-25328 FILM NUMBER: 02872029 BUSINESS ADDRESS: STREET 1: 22 WEST STATE ST CITY: MEDIA STATE: PA ZIP: 19063 BUSINESS PHONE: 6105656210 10-K 1 w67175e10vk.txt FORM 10-K FOR FIRST KEYSTONE FINANCIAL, INC. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED SEPTEMBER 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-25328 FIRST KEYSTONE FINANCIAL, INC. (Exact name of registrant as specified in its charter) Pennsylvania 23-0469351 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 22 West State Street Media, Pennsylvania 19063 (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code: (610) 565-6210 Securities registered pursuant to Section 12(b) of the Act: NOT APPLICABLE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK (PAR VALUE $.01 PER SHARE) Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ------- Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 126-2). Yes [ ] No [X] The aggregate market value of the 1,582,119 shares of Common Stock of the Registrant issued and outstanding on December 16, 2002, which excludes 424,068 shares held by all directors and officers of the Registrant as a group, was approximately $23.6 million. This figure is based on the closing price of $14.90 per share of the Registrant's Common stock on March 28, 2002, the last business day of the Registrant's second fiscal quarter. Number of shares of Common Stock outstanding as of December 16, 2002: 2,006,187 DOCUMENTS INCORPORATED BY REFERENCE Listed hereunder are the documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated: (1) Portions of the Annual Report to Stockholders for the fiscal year ended September 30, 2002 are incorporated into Part II. (2) Portions of the definitive proxy statement for the 2002 Annual Meeting of Stockholders are incorporated into Part III. PART I. ITEM 1. BUSINESS. GENERAL First Keystone Financial, Inc. (the "Company") is a Pennsylvania corporation and sole shareholder of First Keystone Federal Savings Bank, a federally chartered stock savings bank (the "Bank"), which converted to the stock form of organization in January 1995. The only significant assets of the Company are the capital stock of the Bank, the Company's loan to its employee stock ownership plan, and various equity and other investments. See Note 17 of the Notes to Consolidated Financial Statements in the Annual Report to Stockholders for the fiscal year ended September 30, 2002 set forth as Exhibit 13 hereto ("Annual Report"). The business of the Company primarily consists of the business of the Bank. The Bank is a traditional, community oriented bank emphasizing customer service and convenience. The Bank's primary business is to attract deposits from the general public and invest those funds together with other available sources of funds, primarily borrowings, to originate loans. A substantial portion of the Bank's deposits are comprised of core deposits consisting of passbook, money market ("MMDA"), NOW and non-interest-bearing accounts. Core deposits amounted to $154.5 million or 46.7% of the Bank's total deposits at September 30, 2002. The Bank's primary lending emphasis is the origination of loans secured by first and second liens on single-family (one-to-four units) residences located in Delaware and Chester Counties, Pennsylvania and to a lesser degree, Montgomery County, Pennsylvania and New Castle County, Delaware. The Bank originates residential first mortgage loans with either fixed and/or adjustable rates. Adjustable-rate loans are retained for the Bank's portfolio while fixed-rate loans may be sold in the secondary market depending on the Bank's asset/liability strategy, cash flow needs and current market conditions. The Bank also originates for portfolio, due to their generally shorter terms, adjustable or variable interest rates and generally higher yields, loans secured by commercial and multi-family residential real estate properties as well as residential and commercial construction loans secured by properties located in the Bank's market area. The level of the Bank's originations of commercial, construction and multi-family residential loans has remained strong as a direct result of the Bank's continued emphasis on developing business loan products. Multi-family residential and commercial real estate loans amounted to $60.4 million or 19.9% of the total loan portfolio at September 30, 2002 as compared to $43.5 million or 16.2% at September 30, 2001. In addition, the Bank originates for sale in the secondary market, servicing released, non-conforming loans in excess of Fannie Mae ("FNMA") and Freddie Mac ("FHLMC") limits. The Bank has on occasion purchased loan participation interests in both residential and commercial real estate loans depending on market conditions and portfolio needs, although no such purchases were made during the fiscal year ended September 30, 2002. To a lesser extent, the Bank also originates consumer loans (consisting almost entirely of home equity loans and lines of credit) and other mortgage loans. In addition to its deposit gathering and lending activities, the Bank invests in mortgage-related securities, which are issued or guaranteed by U.S. Government agencies and government sponsored or private enterprises, as well as U.S. Treasury and federal government agency obligations, corporate bonds and municipal obligations. At September 30, 2002, the Bank's mortgage-related securities (including mortgage-related securities available for sale) amounted to $94.5 million, or 18.2% of the Company's total assets, and investment securities available for sale amounted to $80.6 million, or 15.6% of total assets. MARKET AREA AND COMPETITION The Bank's primary market area is in Delaware and Chester Counties, which is located in the southeastern corner of Pennsylvania between two metropolitan areas, Philadelphia, PA and Wilmington, DE. There is easy access to I-95, the Philadelphia International Airport and the Delaware River. The Bank is fortunate to be located in such a desirable geographic area. New York City is just 92 miles away from the Bank's headquarters in Media, PA, Baltimore, MD is only 80 miles, and the distance to Washington, DC is just 127 miles. Through an extensive highway and telecommunications network, the Delaware County's economy is knitted tightly into a regional economy of more than 2.5 million workers. Census 2000 lists Delaware County as having 14,394 business establishments with the number of jobs in the County (258,922) at an all time high. Most of the businesses are in corporate and professional services, distributive services and the manufacturing sector. Census 2000 shows Delaware County has a large, well-educated, and skilled local labor force of 258,782. Nearly one quarter of the County's population is 25 years or older and has earned a four-year college degree. The total number of people employed as executives, managers, professionals, and technicians is 101,646. Philadelphia's central location in the Northeast corridor, infrastructure and other factors has made the Bank's market area attractive to many large corporate employers including Comcast Corp., Boeing, State Farm Insurance, United Parcel Service, PECO Energy, SAP America, Inc., Wawa, the Franklin Mint and many others. The Philadelphia area economy is typical of many large Northeastern cities where the traditional manufacturing based economy has declined and has been replaced by the service sector including the health care market. Crozer/Keystone Health System and Mercy Health Corp are amongst the larger employers within the Bank's market area. According to the Delaware County Chamber of Commerce, there are 82 degree-granting institutions and 47,000 graduates annually in the region, representing more colleges and universities than any other area in the United States. Delaware County also has one of the nation's lowest unemployment rates and one of the most active Chamber of Commerce Offices in the State. The U.S. Small Business Administration, Philadelphia District Office, named the Delaware County Chamber the Eastern Region Chamber of the Year in 2001. This is the second time the Chamber received this level of recognition. According to the 2000 Census, the population of Delaware County is 550,864, a modest 0.6% increase since 1990. During the year 2000, Delaware County Planning Commission reviewed proposals for almost twice as many residential units compared to 1997. Due to the availability of land still suitable for development, the majority of this growth has occurred in the western part of Delaware County, and its contiguous neighbor Chester County. The Bank had benefitted from this growth with the opening of its Chester Heights office in December 1999 which has exceeded the Company's deposit and consumer loan projections. Chester County has grown over 15% since 1990 and is expected to increase further in the next decade. The communities in Chester County that are experiencing growth are East Marlborough Township, New Garden Township and East Goshen which surround the Bank's Chester County office. The Bank faces strong competition both in attracting deposits and making real estate loans. Its most direct competition for deposits has historically come from other savings associations, credit unions and commercial banks located in its market area including many large regional financial institutions which have greater financial and marketing resources available to them. The ability of the Bank to attract and retain core deposits depends on its ability to provide a competitive rate of return, liquidity and risk comparable to that offered by competing investment opportunities. The Bank experiences strong competition for real estate loans principally from other savings associations, commercial banks and mortgage-banking companies. The Bank competes for loans principally through the interest rates and loan fees it charges, the efficiency and quality of the services it provides borrowers and the convenient locations of its branch office network. Competition may increase as a result of the continuing reduction of restrictions on the interstate operations of financial institutions. 2 LENDING ACTIVITIES Loan Portfolio Composition. The following table sets forth the composition of the Bank's loan portfolio by type of loan at the dates indicated (excluding loans held for sale).
September 30, --------------------------------------------------------------------- 2002 2001 2000 -------------------- ------------------- -------------------- Amount % Amount % Amount % --------- -------- --------- ------ --------- ------- (Dollars in thousands) Real estate loans: Single-family $ 173,736 57.32% $ 160,289 59.81% $ 160,143 65.54% Multi-family and commercial 60,379 19.92 43,472 16.22 37,870 15.5 Construction and land 28,292 9.33 29,117 10.86 17,905 7.33 Home equity loans and lines of credit 27,595 9.10 25,847 9.65 22,597 9.25 ------- ----- ------- ----- ------- ----- Total real estate loans 290,002 95.67 258,725 96.54 238,515 97.62 ======= ===== ======= ===== ======= ===== Consumer: Deposit 144 .05 232 .09 251 .10 Education -- -- -- -- 285 .12 Unsecured personal loans 322 .11 133 .05 -- -- Other(1) 736 .24 760 .28 807 .33 ------- ----- ------- ----- ------- ----- Total consumer loans 1,202 .40 1,125 .42 1,343 .55 ------- ----- ------- ----- ------- ----- Commercial business loans 11,919 3.93 8,158 3.04 4,475 1.83 ------- ----- ------- ----- ------- ----- Total loans receivable (2) 303,123 100.00% 268,008 100.00% 244,333 100.00% ------- ====== ------- ====== ------- ====== Less: Loans in process (construction and land) 11,384 17,016 10,330 Deferred loan origination fees and discounts 605 1,147 1,298 Allowance for loan losses 2,358 2,181 2,019 -------- -------- -------- Total loans receivable, net $288,776 $247,664 $230,686 ======== ======== ========
(1) Consists primarily of credit card loans. (2) Does not include $501,000, $225,000. $3.1 million, $1.8 million and $2.8 million of loans held for sale at September 30, 2002, 2001, 2000, 1999 and 1998, respectively.
1999 1998 --------- -------- --------- -------- Amount % Amount % --------- -------- --------- -------- Real estate loans: Single-family $166,802 69.82% $ 148,088 71.34% Multi-family and commercial 31,188 13.05 20,563 9.91 Construction and land 18,426 7.71 15,858 7.64 Home equity loans and lines of credit 18,624 7.8 19,609 9.45 -------- ----- ------- ----- Total real estate loans 235,040 98.38 204,118 98.34 -------- ----- ------- ----- Consumer: Deposit 243 .10 181 0.09 Education 365 .15 449 0.21 Unsecured personal loans -- -- -- -- Other (1) 1,080 .45 1,429 0.69 ------- ----- ------- ----- Total consumer loans 1,688 .70 2,059 0.99 ------- ----- ------- ----- Commercial business loans 2,190 .92 1,390 0.67 ------- ----- ------- ----- Total loans receivable (2) 238,918 100.00% 207,567 100.00% ------- ====== ------- ====== Less: Loans in process (construction and land) 9,005 5,781 Deferred loan origination fees and discounts 1,610 1,705 Allowance for loan losses 1,928 1,738 -------- ------- Total loans receivable, net $226,375 $198,343 ======== ========
3 Contractual Principal Repayments. The following table sets forth the scheduled contractual maturities of the Bank's loans held to maturity at September 30, 2002. Demand loans, loans having no stated schedule of repayments and no stated maturity and overdraft loans are reported as due in one year or less. The amounts shown for each period do not take into account loan prepayments and normal amortization of the Bank's loan portfolio held to maturity.
Real Estate Loans ----------------------------------------------------------- Multi-family Consumer and and Construction Commercial Single-family (2) Commercial and Land Total Business Loans Total ----------------- ---------- ------------ ----- -------------- -------- (Dollars in thousands) Amounts due in: One year or less $ 8,893 $ 6,935 $ 28,292 $ 44,120 $ 11,800 $ 55,920 After one year through three years 18,170 10,368 -- 28,538 249 28,787 After three years through five years 21,381 12,340 -- 33,721 132 33,853 After five years through ten years 60,657 12,068 -- 72,725 290 73,015 After ten years through fifteen years 37,663 9,098 -- 46,761 42 46,803 Over fifteen years 54,567 9,570 -- 64,137 608 64,745 -------- -------- -------- -------- -------- -------- Total (1) $201,331 $ 60,379 $ 28,292 $290,002 $ 13,121 $303,123 ======== ======== ======== ======== ======== ======== Interest rate terms on amounts due after one year: Fixed $145,635 $ 15,943 $161,578 Adjustable 74,672 10,953 85,625 -------- -------- -------- Total (1) $220,307 $ 26,896 $247,203 ======== ======== ========
- ---------- (1) Does not include adjustments relating to loans in process, allowances for loan losses and deferred fee income. (2) Includes home equity loans and lines of credit. 4 Scheduled contractual amortization of loans does not reflect the expected term of the Bank's loan portfolio. The average life of loans is substantially less than their contractual terms because of prepayments and due-on-sale clauses, which give the Bank the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan rates are higher than rates on existing mortgage loans and, conversely, decrease when current mortgage loan rates are lower than rates on existing mortgage loans (due to refinancings of adjustable-rate and fixed-rate loans at lower rates). Under the latter circumstances, the weighted average yield on loans decreases as higher yielding loans are repaid or refinanced at lower rates. Loan Origination, Purchase and Sale Activity. The following table shows the loan origination, purchase and sale activity of the Bank during the periods indicated.
Year Ended September 30, ------------------------------------- 2002 2001 2000 --------- --------- --------- (In thousands) Gross loans at beginning of period(1) $ 268,233 $ 247,532 $ 240,710 --------- --------- --------- Loan originations for investment: Real estate: Residential 60,719 25,889 20,002 Commercial and multi-family 31,300 11,265 10,704 Construction 28,741 18,503 15,470 Home equity and lines of credit 21,710 10,363 9,038 --------- --------- --------- Total real estate loans originated for investment 142,470 66,020 55,214 Consumer 2,825 1,287 1,007 Commercial business 21,555 12,102 4,443 --------- --------- --------- Total loans originated for investment 166,850 79,409 60,664 Participations purchased(2) -- 1,124 353 Loans originated for resale 3,712 20,685 39,531 --------- --------- --------- Total originations 170,562 101,218 100,548 --------- --------- --------- Deduct: Principal loan repayments and prepayments (131,374) (56,086) (54,325) Transferred to real estate owned (361) (872) (1,177) Loans sold in secondary market (3,436) (23,559) (38,224) --------- --------- --------- Subtotal (135,171) (80,517) 93,726 --------- --------- --------- Net increase in loans(1) 35,391 20,701 6,822 --------- --------- --------- Gross loans at end of period(1) $ 303,624 $ 268,233 $ 247,532 ========= ========= =========
(1) Includes loans held for sale of $501,000, $225,000 and $3.1 million at September 30, 2002, 2001 and 2000, respectively. (2) Consist of commercial real estate loans. 5 The residential lending activities of the Bank are subject to written underwriting standards and loan origination procedures established by the Bank's Board of Directors and management. Loan applications may be taken at all of the Bank's branch offices by the branch manager or other designated loan officers. Applications for single-family residential mortgage loans for portfolio retention also are obtained through loan originators who are employees of the Bank. The Bank's residential loan originators will take loan applications outside of the Bank's offices at the customer's convenience and are compensated on a commission basis. The Residential Lending Department supervises the process of obtaining credit reports, appraisals and other documentation involved with a loan. In most cases, the Bank requires that a property appraisal be obtained in connection with all new first mortgage loans. Generally, appraisals are not required on home equity loans because alternative means of valuation are used (i.e. tax assessments). Property appraisals generally are performed by an independent appraiser from a list approved by the Bank's Board of Directors. The Bank requires that title insurance (other than with respect to home equity loans) and hazard insurance be maintained on all security properties and that flood insurance be maintained if the property is within a designated flood plain. Residential mortgage loan applications are primarily developed from referrals from real estate brokers and builders, existing customers and walk-in customers. Commercial and multi-family real estate loan applications are obtained primarily from previous borrowers, direct solicitations by Bank personnel, as well as referrals. Consumer loans originated by the Bank are obtained primarily through existing and walk-in customers who have been made aware of the Bank's programs by advertising and other means. Applications for single-family residential mortgage loans which are originated for resale in the secondary market or loans designated for portfolio retention that conform to the requirements for resale into the secondary market and do not exceed FNMA/FHLMC limits are approved by at least one of the following: the Bank's Chief Lending Officer, the Vice President of Mortgage Lending, the Senior Mortgage Loan underwriter or the Loan Committee (a committee comprised of four directors and the Bank's Chief Lending Officer). Residential mortgage loans in excess of FNMA/FHLMC maximum amounts (currently $300,700) but less than $1.0 million must be approved by the Loan Committee. All mortgage loans in excess of $1.0 million must be approved by the Bank's Board of Directors or the Executive Committee thereof. Commercial and multi-family residential real estate loans in excess of $200,000 and construction loans must be approved by the Board of Directors. All mortgage loans which do not require approval by the Board of Directors are submitted to the Board at its next meeting for review and ratification. Home equity loans and lines of credit up to $100,000 can be approved by the Chief Lending Officer, the Vice President of Construction Loans, the Vice President of Mortgage Lending or the Senior Mortgage Loan Underwriter. Loans in excess of such amount must be approved by the Loan Committee. Single-Family Residential Loans. Substantially all of the Bank's single-family residential mortgage loans consist of conventional loans. Conventional loans are loans that are neither insured by the Federal Housing Administration or partially guaranteed by the Department of Veterans Affairs. The vast majority of the Bank's single-family residential mortgage loans are secured by properties located in Pennsylvania, primarily in Delaware and Chester counties, and are originated under terms and documentation which permit their sale to FHLMC or FNMA. The Bank, consistent with its asset/liability management strategies, sells some of its newly originated longer term fixed-rate residential mortgage loans and to a limited degree, existing longer term fixed-rate residential mortgage loans while retaining adjustable-rate mortgage loans and shorter term fixed-rate residential mortgage loans. See "- Mortgage-Banking Activities." The single-family residential mortgage loans offered by the Bank currently consist of fixed-rate loans, including bi-weekly, balloon and adjustable-rate loans. Fixed-rate loans generally have maturities ranging from 15 to 30 years and are fully amortizing with monthly loan payments sufficient to repay the total amount of the loan with interest by the end of the loan term. The Bank's fixed-rate loans are originated under terms, conditions and documentation which permit them to be sold to U.S. Government-sponsored agencies, such as FHLMC and FNMA, and other purchasers in the secondary mortgage market. The Bank also offers bi-weekly loans under the terms of which the borrower makes payments every two weeks. Although such loans have a 30 year amortization schedule, due to the bi-weekly payment schedule, such loans repay substantially more rapidly than a standard monthly amortizing 30-year fixed-rate loan. The Bank also offers five and seven year balloon loans which provide that the borrower can conditionally renew the loan at the fifth or seventh year at a then to-be-determined rate for the remaining 25 or 23 years, respectively, of the amortization period. At September 30, 2002, $168.6 million, or 83.4%, of the Bank's single-family residential mortgage loans held in portfolio were fixed-rate loans, including $19.9 million of bi-weekly, fixed-rate residential mortgage loans. The adjustable-rate loans currently offered by the Bank have interest rates which adjust every one, three or five years in accordance with a designated index, such as U.S. Treasury obligations, adjusted to a constant maturity ("CMT"), plus a stipulated margin. The Bank's adjustable-rate single-family residential real estate loans generally have a cap of 2% 6 on any increase or decrease in the interest rate at any adjustment date, and a cap and floor of 6% on any such increase or decrease over the life of the loan. In order to increase the originations of adjustable-rate loans, the Bank has been originating loans which bear a fixed interest rate for a period of three to five years after which they convert to one-year adjustable-rate loans. The Bank's adjustable-rate loans require that any payment adjustment resulting from a change in the interest rate of an adjustable-rate loan be sufficient to result in full amortization of the loan by the end of the loan term and, thus, do not permit any of the increased payment to be added to the principal amount of the loan, creating negative amortization. Although the Bank does offer adjustable-rate loans with initial rates below the fully indexed rate, such loans are underwritten using methods approved by FHLMC and FNMA which require borrowers to be qualified at 2% above the discounted loan rate under certain conditions. At September 30, 2002, $33.6 million, or 16.6%, of the Bank's single-family residential mortgage loans held for portfolio were adjustable-rate loans. Adjustable-rate loans decrease the risks associated with changes in interest rates but involve other risks, primarily because in the event interest rates increase, the loan payment by the borrower also increases to the extent permitted by the terms of the loan, thereby increasing the potential for default. In addition, adjustable-rate loans tend to prepay and convert to fixed rates when the overall interest rate environment is low. Moreover, as with fixed-rate loans, as interest rates increase, the marketability of the underlying collateral property may be adversely affected by higher interest rates. The Bank believes that these risks, which have not had a material adverse effect on the Bank to date, generally are less than the risks associated with holding fixed-rate loans in an increasing interest rate environment. For conventional residential mortgage loans held in portfolio and also for those loans originated for sale in the secondary market, the Bank's maximum loan-to-value ("LTV") ratio is 97%, and is based on the lesser of sales price or appraised value. On most loans with a LTV ratio of over 80%, private mortgage insurance may be required to be obtained or the Bank may lend the excess as an equity loan. Commercial and Multi-Family Residential Real Estate Loans. The Bank has moderately increased its investment in commercial and multi-family residential lending. Such loans are being made primarily to small- and medium-sized businesses located in the Bank's primary market area, a segment of the market that the Bank believes has been underserved in recent years. Loans secured by commercial and multi-family residential real estate amounted to $60.4 million, or 19.9%, of the Bank's total loan portfolio, at September 30, 2002. The Bank's commercial and multi-family residential real estate loans are secured primarily by professional office buildings, small retail establishments, warehouses and apartment buildings (with 36 units or less) located in the Bank's primary market area. The Bank's adjustable-rate multi-family residential and commercial real estate loans generally are either three or five-year adjustable-rate loans indexed to the CMT plus a margin. In addition, depending on collateral value and strength of the borrower, fixed-rate balloon loans and longer term fixed-rate loans may be originated. Generally, fees of 1% to 3% of the principal loan balance are charged to the borrower upon closing. Although terms for multi-family residential and commercial real estate loans may vary, the Bank's underwriting standards generally provide for terms of up to 25 years with amortization of principal over the term of the loan and LTV ratios of not more than 75%. Generally, the Bank obtains personal guarantees of the principals of the borrower as additional security for any commercial real estate and multi-family residential loans and requires that the borrower have at least a 25% equity investment in any such property. The Bank evaluates various aspects of commercial and multi-family residential real estate loan transactions in an effort to mitigate risk to the extent possible. In underwriting these loans, consideration is given to the stability of the property's cash flow history, future operating projections, current and projected occupancy, position in the market, location and physical condition. In recent periods, the Bank has generally imposed a debt coverage ratio (the ratio of net cash from operations before payment of debt service to debt service) of not less than 110%. The underwriting analysis also includes credit checks and a review of the financial condition of the borrower and guarantor, if applicable. An appraisal report is prepared by a state-licensed and certified appraiser (generally an appraiser who is qualified as a Member of the Appraisal Institute ("MAI")) commissioned by the Bank to substantiate property values for every commercial real estate and multi-family loan transaction. All appraisal reports are reviewed by the commercial loan underwriter prior to the closing of the loan. Multi-family residential and commercial real estate lending entails different and significant risks when compared to single-family residential lending because such loans often involve large loan balances to single borrowers and because 7 the payment experience on such loans is typically dependent on the successful operation of the project or the borrower's business. These risks also can be significantly affected by supply and demand conditions in the local market for apartments, offices, warehouses or other commercial space. The Bank attempts to minimize its risk exposure by limiting such lending to proven developers/owners, only considering properties with existing operating performance which can be analyzed, requiring conservative debt coverage ratios, and periodically monitoring the operation and physical condition of the collateral. During fiscal 2002, the Bank has experienced difficulties with two borrowers in its commercial real estate loan portfolio which has increased non-performing assets. See "-Non-performing Assets" for further discussion of these non-performing non-performing loans. Construction Loans. Substantially all of the Bank's construction loans consist of loans for acquisition and development of properties to construct single-family properties extended either to individuals or to selected developers with whom the Bank is familiar to build such properties on a pre-sold or limited speculative basis. To a lesser extent, the Bank provides financing for construction to permanent commercial real estate properties. Commercial construction loans have a maximum term of 24 months during the construction period with interest based upon the prime rate published in the Wall Street Journal ("Prime Rate") plus a margin and have LTV ratios of 80% or less of the appraised value upon completion. The loans convert to permanent commercial real estate loans upon completion of construction. With respect to construction loans to individuals, such loans have a maximum term of 12 months, have variable rates of interest based upon the Prime Rate plus a margin and have LTV ratios of 80% or less of the appraised value of the property upon completion and generally do not require the amortization of principal during the term. Upon completion of construction, the borrower is required to refinance the loan although the Bank may be the lender of the permanent loan secured by the property. The Bank also provides construction loans and lines of credit to developers. The majority of construction loans consist of loans to selected local developers with whom the Bank is familiar and who build single-family dwellings on a pre-sold or, to a significantly lesser extent, on a speculative basis. The Bank generally limits to two the number of unsold units that a developer may have under construction in a project. Such loans generally have terms of 36 months or less, have generally a maximum LTV ratios of 75% of the appraised value of the property upon completion and do not require the amortization of the principal during the term. The loans are made with variable rates of interest based on the Prime Rate plus a margin adjusted on a monthly basis. The Bank also receives origination fees that generally range from .5% to 3.0% of the loan commitment. The borrower is required to fund a portion of the project's costs, the exact amount being determined on a case-by-case basis. Loan proceeds are disbursed by percentage of completion of the cost of the project after inspections indicate that such disbursements are for costs already incurred and which have added to the value of the project. Only interest payments are due during the construction phase and the Bank may provide the borrower with an interest reserve from which it can pay the stated interest due thereon. At September 30, 2002, residential construction loans totaled $16.7 million, or 5.5%, of the total loan portfolio, primarily consisting of construction loans to developers. At September 30, 2002, commercial construction loans totaled $2.6 million, or .85%, of the total loan portfolio. 8 The Bank also originates ground or land loans to individuals to purchase a property on which they intend to build their primary residences, as well as to developers to purchase lots to build speculative homes at a later date. Such loans have terms of 36 months or less with a maximum LTV ratio of 75% of the lower of appraised value or sale price. The loans are made with variable rates based on the Prime Rate plus a margin. The Bank also receives origination fees, which generally range between 1.0% and 3.0% of the loan amount. At September 30, 2002, land loans (including loans to acquire and develop land) totaled $9.0 million, or 3.0%, of the total loan portfolio. Loans to developers include both secured and unsecured lines of credit (which are classified as commercial business loans) with outstanding commitments totaling $2.2 million. All have personal guaranties of the principals and are cross-collateralized with existing loans. At September 30, 2002, loans outstanding under builder lines of credit totaled $1.2 million, or .39%, of the total loan portfolio, of which $690,300 were unsecured and given only to the Bank's most creditworthy long standing customers. Prior to making a commitment to fund a construction loan, the Bank requires an appraisal of the property by an appraiser approved by the Board of Directors. In addition, during the term of the construction loan, the project is inspected by an independent inspector. Construction financing generally is considered to involve a higher degree of risk of loss than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of value proves to be inaccurate, the Bank may be confronted, at or prior to the maturity of the loan, with a project, when completed, having a value which is insufficient to assure full repayment. Loans on lots may run the risk of adverse zoning changes as well as environmental or other restrictions on future use. Home Equity Loans and Lines of Credit. Home equity loans and home equity lines of credit are secured by the underlying equity in the borrower's primary residence or, occasionally, other types of real estate. Home equity loans are amortizing loans with fixed interest rates and generally maximum terms of 15 years while equity lines of credit have adjustable interest rates indexed to the Prime Rate. Generally home equity loans or home equity lines of credit do not exceed $100,000. The Bank's home equity loans and lines of credit generally require combined LTV ratios of 80% or less. Loans with higher LTV ratios are available but with higher interest rates and stricter credit standards. At September 30, 2002, home equity loans and lines of credit amounted to $27.6 million, or 9.1%, of the Bank's total loan portfolio. Consumer Lending Activities. The Bank offers consumer loans in order to provide a full range of retail financial services to its customers. At September 30, 2002, $1.2 million, or .4 %, of the Bank's total loan portfolio was comprised of consumer loans. The Bank originates substantially all of such loans in its primary market area. At September 30, 2002, the Bank's consumer loan portfolio was comprised of credit card, deposit, unsecured personal loans and other consumer loans. The Bank's credit card program is primarily offered to only the Bank's most creditworthy customers. At September 30, 2002, these loans totaled $581,000, or .2%, of the total loan portfolio. Consumer loans generally have shorter terms and higher interest rates than mortgage loans but generally involve more credit risk than mortgage loans because of the type and nature of the collateral and, in certain cases, the absence of collateral. Commercial Business Loans. The Bank has also emphasized the growth in commercial business loans by granting such loans directly to business enterprises that are located in its market area. The majority of such loans are for less than $1.0 million. The Bank actively targets and markets to small- and medium-sized businesses. Applications for commercial business loans are obtained from existing commercial customers, branch and customer referrals, direct inquiry and those that are obtained by our commercial lending officers. As of September 30, 2002, commercial business loans amounted to $11.9 million, or 3.9%, of the Bank's total loan portfolio. The commercial business loans consist of a limited number of commercial lines of credit secured by real estate, securities, some working capital financings secured by accounts receivable and inventory and, to a limited extent, 9 unsecured lines of credit. Commercial business loans originated by the Bank ordinarily have terms of five years or less and fixed rates or adjustable rates tied to the Prime Rate plus a margin. Although commercial business loans generally are considered to involve greater credit risk than other certain types of loans, management intends to continue to offer commercial business loans to small- and medium-sized businesses in an effort to better serve our community's needs, obtain core noninterest-bearing deposits and increase the Bank's interest rate spread. Mortgage-Banking Activities. Due to customer preference for fixed-rate loans, the Bank has continued to originate fixed-rate loans. Long-term (generally 30 years) fixed-rate loans not taken into portfolio for asset/liability purposes are sold into the secondary market. The Bank's net gain on sales of mortgage loans amounted to $84,000, $122,000, and $206,000 during the fiscal years ended September 30, 2002, 2001 and 2000, respectively. Profits from sales of loans held for sale have declined due to declining profitability on subprime lending and the Bank's decision in fiscal 2001 to exit the subprime line of business. The Bank had $501,000 and $225,000 of mortgage loans held for sale at September 30, 2002 and 2001, respectively. The Bank's conforming mortgage loans sold to others are sold, generally with servicing retained, on a loan-by-loan basis primarily to FHLMC and FNMA. A period of less than five days generally elapses between the closing of the loan by the Bank and its purchase by the investor. Mortgages with established interest rates generally will decrease in value during periods of increasing interest rates. Accordingly, fluctuations in prevailing interest rates may result in a gain or loss to the Bank as a result of adjustments to the carrying value of loans held for sale or upon sale of loans. The Bank attempts to protect itself from these market fluctuations through the use of forward commitments at the time of the commitment by the Bank of a loan rate to the borrower. These commitments are mandatory delivery contracts with FHLMC and FNMA within a certain time frame and within certain dollar amounts by a price determined at the commitment date. Market risk does exist as non-refundable points paid by the borrower may not be sufficient to offset fees associated with closing the forward commitment contract. Loan Origination Fees and Servicing. Borrowers are generally charged an origination fee, which is a percentage of the principal balance of the loan. In accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases," the various fees received by the Bank in connection with the origination of loans are deferred and amortized as a yield adjustment over the lives of the related loans using the interest method. However, when such loans are sold, the remaining unamortized fees (which is all or substantially all of such fees due to the relatively short period during which such loans are held) are recognized as income on the sale of loans held for sale. The Bank, for conforming loan products, generally retains the servicing on all loans sold to others. In addition, the Bank services substantially all of the loans that it retains in its portfolio. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, making advances to cover delinquent payments, making inspections as required of mortgaged premises, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults and generally administering the loans. Funds that have been escrowed by borrowers for the payment of mortgage-related expenses, such as property taxes and hazard and mortgage insurance premiums, are maintained in noninterest-bearing accounts at the Bank. 10 The following table presents information regarding the loans serviced by the Bank for others at the dates indicated. Substantially all the loans were secured by properties in Pennsylvania. A small percentage of the loans are secured by properties located in Delaware, Maryland or New Jersey.
September 30, -------------------------- 2002 2001 2000 ---- ---- ---- (In thousands) Loans originated by the Bank and serviced for: FNMA $ 1,054 $ 1,726 $ 2,140 FHLMC 50,405 64,195 67,858 Others 367 380 392 ------- ------- ------- Total loans serviced for others $51,826 $66,301 $70,390 ======= ======= =======
The Bank receives fees for servicing mortgage loans, which generally amount to 0.25% per annum on the declining principal balance of mortgage loans. Such fees serve to compensate the Bank for the costs of performing the servicing function. Other sources of loan servicing revenues include late charges. For fiscal years ended September 30, 2002, 2001 and 2000, the Bank earned gross fees of $103,000, $148,000 and $150,000, respectively, from loan servicing. The Bank retains a portion of funds received from borrowers on the loans it services for others in payment of its servicing fees received on loans serviced for others. Loans-to-One Borrower Limitations. Regulations impose limitations on the aggregate amount of loans that a savings institution could make to any one borrower, including related entities. Under such regulations, the permissible amount of loans-to-one borrower follows the national bank standard for all loans made by savings institutions, which generally does not permit loans-to-one borrower to exceed 15% of unimpaired capital and surplus. Loans in an amount equal to an additional 10% of unimpaired capital and surplus also may be made to a borrower if the loans are fully secured by readily marketable securities. At September 30, 2002, the Bank's five largest loans or groups of loans-to-one borrower, including related entities, ranged from an aggregate of $4.3 million to $5.4 million. The Bank's loans-to-one borrower limit was $6.2 million at such date. ASSET QUALITY General. As a part of the Bank's efforts to improve its asset quality, it has developed and implemented an asset classification system. All of the Bank's assets are subject to review under the classification system, but particular emphasis is placed on the review of multi-family residential and commercial real estate loans, construction loans and commercial business loans. All assets of the Bank are periodically reviewed and the classification recommendations submitted to the Asset Classification Committee at least monthly. The Asset Classification Committee is composed of the President and Chief Executive Officer, the Chief Financial Officer, the Vice President of Loan Administration, the Internal Auditor and the Vice President of Construction Lending. All assets are placed into one of the four following categories: Pass, Substandard, Doubtful and Loss. The criteria used to review and establish each asset's classification are substantially identical to the asset classification system used by the Office of Thrift Supervision (the "OTS") in connection with the examination process. As of September 30, 2002, the Bank did not have any assets which it had classified as doubtful or loss. See "- Non-Performing Assets" and "- Other Classified Assets" for a discussion of certain of the Bank's assets which have been classified as substandard and regulatory classification standards generally. 11 When a borrower fails to make a required payment on a loan, the Bank attempts to cure the deficiency by contacting the borrower and requesting payment. Contact is generally made after the expiration of the grace period (usually fifteen days) in the form of telephone calls and/or correspondence. In most cases, deficiencies are cured promptly. If the delinquency increases, the Bank will initiate foreclosure actions or legal collection actions if a borrower fails to enter into satisfactory repayment arrangements. Such actions generally commence at sixty to ninety days of delinquency. Loans are placed on non-accrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. When a loan is placed on non-accrual status, previously accrued but unpaid interest is deducted from interest income. As a matter of policy, the Bank does not accrue interest on loans past due 90 days or more. See Note 2 of the Notes to Consolidated Financial Statements included in the Company's Annual Report. Real estate acquired by the Bank as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until sold. Real estate owned is initially recorded at the lower of fair value less estimated costs to sell the property, or cost (generally the balance of the loan on the property at the date of acquisition). After the date of acquisition, all costs incurred in maintaining the property are expenses and costs incurred for the improvement or development of such property are capitalized up to the extent of their net realizable value. Under accounting principles generally accepted in the United States of America ("GAAP"), the Bank is required to account for certain loan modifications or restructurings as "troubled debt restructurings." In general, the modification or restructuring of a debt constitutes a troubled debt restructuring if the Bank, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to the borrower that the Bank would not otherwise consider under current market conditions. Debt restructuring or loan modifications for a borrower do not necessarily always constitute troubled debt restructuring, however, and troubled debt restructuring does not necessarily result in non-accrual loans. 12 Delinquent Loans. The following table sets forth information concerning delinquent loans at the dates indicated, in dollar amounts and as a percentage of each category of the Bank's loan portfolio. The amounts presented represent the total outstanding principal balances of the related loans, rather than the actual payment amounts which are past due.
September 30, 2002 September 30, 2001 ------------------------------------------ ---------------------------------------- 30-59 Days 60-89 Days 30-59 Days 60-89 Days --------------------- ------------------ ------------------ ------------------- Percent Percent Percent Percent of of of of Loan Loan Loan Loan Amount Category Amount Category Amount Category Amount Category ------ -------- ------ -------- ------ -------- ------ -------- (Dollars in thousands) Real estate loans: Single-family residential $ -- --% $405 .23% $526 .33% $ 80 .05% Commercial 246 .41 -- -- -- -- -- -- Home equity -- -- 35 .13 -- -- -- -- Construction -- -- -- -- -- -- -- -- Consumer loans 18 1.50 23 1.91 204 .76 46 .17 Commercial business loans 33 .28 -- -- -- -- -- -- ---- --- ---- --- ---- --- ---- --- Total $297 .10% $463 .15% $730 .27% $126 .05% ==== === ==== === ==== === ==== ===
13 Non-performing Assets. The following table sets forth the amounts and categories of the Bank's non-performing assets and troubled debt restructurings at the dates indicated.
September 30, -------------------------------------------------------------------------- 2002 2001 2000 1999 1998 ------ ------ ------ ------ ------ (Dollars in thousands) Non-performing loans: Single-family residential $1,237 $1,924 $2,109 $2,312 $2,341 Commercial and multi-family(1) 2,386 33 -- 289 323 Construction(2) -- -- -- 556 895 Consumer 19 314 48 16 43 Commercial business 138 -- 3 6 83 ------ ------ ------ ------ ------ Total non-performing loans 3,780 2,271 2,160 3,179 3,685 ------ ------ ------ ------ ------ Accruing loans more than 90 days delinquent (5) 1,358 31 355 1 19 ------ ------ ------ ------ ------ Total non-performing loans 5,138 2,302 2,515 3,180 3,704 ------ ------ ------ ------ ------ Real estate owned 248 887 947 297 1,663 ------ ------ ------ ------ ------ Total non-performing assets $5,386 $3,189 $3,462 $3,477 $5,367 ====== ====== ====== ====== ====== Troubled debt restructurings (3) $ -- $ -- $ -- $ 24 $ 46 ====== ====== ====== ====== ====== Total non-performing loans and troubled debt restructurings as a percentage of gross loans receivable (4) 1.76% .92% 1.07% 1.39% 1.85% ====== ====== ====== ====== ====== Total non-performing assets as a percentage of total assets 1.04% .65% .75% .77% 1.29% ====== ====== ====== ====== ====== Total non-performing assets and troubled debt restructurings as percentage of total assets 1.04% .65% .75% .78% 1.30% ====== ====== ====== ====== ======
- ---------- (1) Consists of three loans at September 30, 2002, one loan at September 30, 2001and two loans at September 30, 1999, and 1998. (2) Consists of three loans made to two borrowers at September 30, 1999, and six loans made to three borrowers at September 30, 1998. (3) Consists of lease financing receivables at September 30, 1999 and 1998 from the Bennett Funding Group of Syracuse, New York ("Bennett Funding"). The troubled debt restructurings entered into in 1997 performed in accordance with the terms of the agreements since the restructurings. (4) Includes loans receivable and loans held for sale, less construction and land loans in process and deferred loan origination fees and discounts. (5) Consists of one commercial real estate loan of $1.3 million which returned to current status subsequent to September 30, 2002. 14 The $1.2 million of non-performing single-family residential loans at September 30, 2002 consisted of 21 loans with principal balances ranging from $5,000 to $219,000, with an average balance of approximately $58,900. Included within the 21 loans, are four loans aggregating $495,000 to credit impaired borrowers. At September 30, 2002, non-performing commercial real estate loans were comprised of three commercial real estate loans totaling $2.4 million. In one relationship, the Bank owns a 25% participation interest in two loans totaling $1.9 million which consist of loans secured by an 18-hole golf course and golf house, located in Avondale, Pennsylvania. The golf facility is fully operational and continues to generate revenues. However, during fiscal 2002, the Bank has incurred expenses in the amount of $213,000 relating to the workout of these loans. Management expects the costs associated with these loans to continue into the next fiscal year. The other relationship is another participating loan of $495,000, which represents a 25% participation interest. The loan is secured by a partially completed storage facility in Clifton Heights, Pennsylvania. The lead lender is in the process of foreclosing on these loans. At September 30, 2002, the $248,000 of real estate owned consisted of four single-family residential properties, with an average carrying value of $62,000 with the largest having a carrying value of $137,000. Other Classified Assets. Federal banking regulations require that each insured savings association classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, federal examiners have authority to identify problem assets and, if appropriate, classify them. There are three classifications for problem assets: "substandard," "doubtful" and "loss." Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. At September 30, 2002, the Bank had $5.5 million of assets classified as substandard, and no assets classified as doubtful or loss. Substantially all classified assets consist of non-performing assets. Allowance for Loan Losses. The Bank's policy is to establish reserves for estimated losses on delinquent loans when it determines that losses are probable. The allowance for losses on loans is maintained at a level believed by management to cover all known and inherent losses in its loan portfolio. Management's analysis of the adequacy of the allowance is based on an evaluation of the loan portfolio, past loss experience, current economic conditions, volume, growth and composition of the portfolio, and other relevant factors. The allowance is increased by provisions for loan losses which are charged against income. The level of provisions remained at the same level in fiscal 2002 and 2001 due to the Bank's re-evaluation of its estimate of losses with respect to its non-conforming loans, which it ceased originating in fiscal 2001, and the reallocation of a portion of the allowance to commercial real estate and commercial business loans. As shown in the table below, at September 30, 2002, the Bank's allowance for loan losses amounted to 45.89% and .81% of the Bank's non-performing loans and gross loans receivable, respectively. On July 6, 2001, the Securities and Exchange Commission (the "SEC") issued Staff Accounting Bulletin ("SAB") No. 102, Selected Loan Loss Allowance Methodology and Documentation Issues. The guidance contained in the SAB was effective immediately. This SAB expresses the views of the SEC staff regarding a registrant's development, documentation, and application of a systematic methodology for determining the allowance for loan and lease losses, as required by SEC Financial Reporting Release No. 28. The guidance in SAB No. 102 focuses on the documentation the SEC staff normally expects registrants to prepare and maintain in support of the allowance for loans and lease losses. Concurrent with the SEC's issuance of SAB No. 102, the federal banking agencies (the Federal Deposit Insurance Corporation (the "FDIC"), the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency and the OTS represented by the Federal Financial Institutions Examination Council issued an interagency policy statement entitled Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Institutions (the "Policy Statement"). SAB No. 102 and the Policy Statement were the result of an agreement between the SEC and the federal banking agencies in March 1999 to provide guidance on allowance for loan and lease methodologies and supporting documentation. 15 The guidance contained in SAB No. 102 does not prescribe specific allowance estimation methodologies registrants should employ in estimating their allowance for loan and lease losses, but rather emphasizes the need for a systematic methodology that is properly designed and implemented by registrants. Management of the Bank presently believes that its allowance for loan losses is adequate to cover any probable losses in the Bank's loan portfolio. However, future adjustments to this allowance may be necessary, and the Bank's results of operations could be adversely affected if circumstances differ substantially from the assumptions used by management in making its determinations in this regard. The following table provides information regarding the changes in the allowance for loan losses and other selected statistics for the periods presented.
Year Ending September 30, ----------------------------------------------------------------------- 2002 2001 2000 1999 1998 ------- ------- -------- ------- ------- (Dollars in thousands) Allowance for loan losses, beginning of $ 2,181 $ 2,019 $ 1,928 $ 1,738 $ 1,628 period Charged-off loans: Single-family residential (317) (492) (182) (12) (86) Construction -- -- (117) -- -- Consumer and commercial business (56) (40) (64) (60) (28) ------- ------- ------- ------- ------- Total charged-off loans (373) (532) (363) (72) (114) ------- ------- ------- ------- ------- Recoveries on loans previously charged off: Single-family residential 1 11 -- 2 22 Construction -- -- -- -- 14 Commercial leases (1) -- 134 33 -- -- Consumer and commercial business 9 9 1 1 2 ------- ------- ------- ------- ------- Total recoveries 10 154 34 3 38 ------- ------- ------- ------- ------- Net loans charged-off (363) (378) (329) (69) (76) Provision for loan losses 540 540 420 259 186 ------- ------- ------- ------- ------- Allowance for loan losses, end of period $ 2,358 $ 2,181 $ 2,019 $ 1,928 $ 1,738 ======= ======= ======= ======= ======= Net loans charged-off to average loans outstanding(2) .13% .16% .14% .03% .04% ======= ======= ======= ======= ======= Allowance for loan losses to gross loans receivable(2) .81% .87% .86% .84% .86% ======= ======= ======= ======= ======= Allowance for loan losses to total non-performing loans 45.89% 94.74% 80.28% 60.63% 46.92% ======= ======= ======= ======= ======= Net loans charged-off to allowance for loan losses 15.39% 17.33% 16.30% 3.58% 4.37% ======= ======= ======= ======= ======= Recoveries to charge-offs 2.68% 28.95% 9.37% 4.17% 33.33% ======= ======= ======= ======= =======
(1) Relate to commercial lease purchases in prior years. (2) Gross loans receivable and average loans outstanding include loans receivable and loans held for sale, less construction and land loans in process and deferred loan origination fees and discounts. 16 The following table presents the Bank's allocation of the allowance for loan losses to the total amount of loans in each category listed at the dates indicated.
September 30, -------------------------------------------------------------------------------------------------------- 2002 2001 2000 1999 1998 -------------------- -------------------- ---------------------- --------------------- ----------------- % of Loans % of Loans % of Loans % of Loans % of Loans in Each in Each in Each in Each in Each Category to Category to Category to Category to Category to Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans ------- ----------- ------ ----------- ------ ----------- ------ ----------- ------ ----------- (Dollars in thousands) Single-family residential $ 815 57.32% $ 615 59.81% $1,098 65.54% $ 572 69.82% $ 446 71.34% Commercial and multi- family 767 19.92 566 16.22 198 15.50 166 13.05 109 9.91 Construction 304 9.33 249 10.86 171 7.33 320 7.71 382 7.64 Home equity 40 9.10 59 9.65 41 9.25 34 7.80 49 9.45 Consumer 10 .40 11 .42 8 .55 8 .70 14 .99 Commercial business 86 3.93 87 3.04 60 1.83 14 .92 20 .67 Unallocated 336 -- 594 -- 443 -- 814 -- 718 -- ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total allowance for loan losses $2,358 100.00% $2,181 100.00% $2,019 100.00% $1,928 100.00% $1,738 100.00% ====== ====== ====== ====== ====== ====== ====== ====== ====== ======
17 MORTGAGE-RELATED SECURITIES AND INVESTMENT SECURITIES Mortgage-Related Securities. Federally chartered savings institutions have authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and of state and municipal governments, certificates of deposit at federally insured banks and savings and loan associations, certain bankers' acceptances and federal funds. Subject to various restrictions, federally chartered savings institutions also may invest a portion of their assets in commercial paper, corporate debt securities and mutual funds, the assets of which conform to the investments that federally chartered savings institutions are otherwise authorized to make directly. The Bank maintains a significant portfolio of mortgage-related securities (including mortgage-backed securities and collateralized mortgage obligations ("CMOs") as a means of investing in housing-related mortgage instruments without the costs associated with originating mortgage loans for portfolio retention and with limited credit risk of default which arises in holding a portfolio of loans to maturity. Mortgage-backed securities (which also are known as mortgage participation certificates or pass-through certificates) represent a participation interest in a pool of single-family or multi-family residential mortgages. The principal and interest payments on mortgage-backed securities are passed from the mortgage originators, as servicer, through intermediaries (generally U.S. Government agencies and government-sponsored enterprises) that pool and repackage the participation interests in the form of securities, to investors such as the Bank. Such U.S. Government agencies and government sponsored enterprises, which guarantee the payment of principal and interest to investors, primarily include FHLMC, FNMA and the Government National Mortgage Association ("GNMA"). The Bank also invests in certain privately issued, credit enhanced mortgage-related securities rated AAA by national securities rating agencies. FHLMC is a public corporation chartered by the U.S. Government. FHLMC issues participation certificates backed principally by conventional mortgage loans. FHLMC guarantees the timely payment of interest and the ultimate return of principal on participation certificates. FNMA is a private corporation chartered by the U.S. Congress with a mandate to establish a secondary market for mortgage loans. FNMA guarantees the timely payment of principal and interest on FNMA securities. FHLMC and FNMA securities are not backed by the full faith and credit of the United States, but because FHLMC and FNMA are U.S. Government-sponsored enterprises, these securities are considered to be among the highest quality investments with minimal credit risks. GNMA is a government agency within the Department of Housing and Urban Development which is intended to help finance government-assisted housing programs. GNMA securities are backed by Federal Housing Administration ("FHA") insured and the Department of Veterans Affairs ("VA") guaranteed loans, and the timely payment of principal and interest on GNMA securities are guaranteed by the GNMA and backed by the full faith and credit of the U.S. Government. Because FHLMC, FNMA and GNMA were established to provide support for low- and middle-income housing, there are limits to the maximum size of loans that qualify for these programs which is currently $300,700. Mortgage-related securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that are within a range and have varying maturities. The underlying pool of mortgages can be composed of either fixed-rate or adjustable-rate loans. As a result, the risk characteristics of the underlying pool of mortgages (i.e., fixed-rate or adjustable rate) as well as prepayment risk, are passed on to the certificate holder. Thus, the life of a mortgage-backed pass-through security thus approximates the life of the underlying mortgages. The Bank's mortgage-related securities include regular interests in CMOs. CMOs were developed in response to investor concerns regarding the uncertainty of cash flows associated with the prepayment option of the underlying mortgagor and are typically issued by governmental agencies, governmental sponsored enterprises and special purpose entities, such as trusts, corporations or partnerships, established by financial institutions or other similar institutions. A CMO can be (but is not required to be) collateralized by loans or securities which are insured or guaranteed by FNMA, FHLMC or the GNMA. In contrast to pass-through mortgage-related securities, in which cash flow is received pro rata by all security holders, the cash flow from the mortgages underlying a CMO is segmented and paid in accordance with a predetermined priority to investors holding various CMO classes. By allocating the principal and interest cash flows from the underlying collateral among the separate CMO classes, different classes of bonds are created, each with its own stated maturity, estimated average life, coupon rate and prepayment characteristics. The short-term classes of a CMO usually carry a lower coupon rate than the longer term classes and, therefore, the interest differential cash flow on a residual interest is greatest in the early years of the CMO. As the early coupon classes are 18 extinguished, the residual income declines. Thus, the longer the lower coupon classes remain outstanding, the greater the cash flow accruing to CMO residuals. As interest rates decline, prepayments accelerate, the interest differential narrows, and the cash flow from the CMO declines. Conversely, as interest rates increase, prepayments decrease, generating a larger cash flow to residuals. A senior-subordinated structure often is used with CMOs to provide credit enhancement for securities which are backed by collateral which is not guaranteed by FNMA, FHLMC or the GNMA. These structures divide mortgage pools into various risk classes: a senior class and one or more subordinated classes. The subordinated classes provide protection to the senior class. When cash flow is impaired, debt service goes first to the holders of senior classes. In addition, incoming cash flows also may go into a reserve fund to meet any future shortfalls of cash flow to holders of senior classes. The holders of subordinated classes may not receive any funds until the holders of senior classes have been paid and, when appropriate, until a specified level of funds has been contributed to the reserve fund. Mortgage-related securities generally bear yields which are less than those of the loans which underlie such securities because of their payment guarantees or credit enhancements which reduce credit risk to nominal levels. However, mortgage-related securities are more liquid than individual mortgage loans and may be used to collateralize certain obligations of the Bank. At September 30, 2002, $12.9 million of the Bank's mortgage-related securities were pledged to secure various obligations of the Bank, treasury tax and loan processing and as collateral for certain municipal deposits. The Bank's mortgage-related securities are classified as either "held to maturity" or "available for sale" based upon the Bank's intent and ability to hold such securities to maturity at the time of purchase, in accordance with GAAP. As of September 30, 2002, the Bank had an aggregate of $94.5 million, or 18.2%, of total assets invested in mortgage-related securities, net, of which $8.9 million was held to maturity and $85.7 million was available for sale. The mortgage-related securities of the Bank which are held to maturity are carried at cost, adjusted for the amortization of premiums and the accretion of discounts using a method which approximates a level yield, while mortgage-related securities available for sale are carried at the current fair value. See Notes 2 and 4 of the Notes to Consolidated Financial Statements in the Company's Annual Report. 19 The following table sets forth the composition of the Bank's available for sale (at fair value) and held to maturity (at amortized cost) of the mortgage-related securities portfolios at the dates indicated.
September 30, ------------------------------------------ 2002 2001 2000 -------- -------- -------- Available for sale: (In thousands) Mortgage-backed securities: FHLMC $ 5,261 $ 9,175 $ 5,771 FNMA 13,463 15,056 23,546 GNMA 33,621 43,907 38,421 -------- -------- -------- Total mortgage-backed securities 52,345 68,138 67,738 -------- -------- -------- Collateralized mortgage obligations: FHLMC 9,509 10,994 9,117 FNMA 3,751 6,215 6,905 GNMA -- 17 309 Other 20,069(1) 32,244(2) 12,188 -------- -------- -------- Total collateralized mortgage obligations 33,329 49,470 28,519 -------- -------- -------- Total mortgage-related securities $ 85,674 $117,608 $ 96,257 ======== ======== ======== Held to maturity: Mortgage-backed securities: FHLMC $ 1,433 $ 2,285 $ 2,898 FNMA 3,574 4,684 5,674 -------- -------- -------- Total mortgage-backed securities 5,007 6,969 8,572 -------- -------- -------- Collateralized mortgage obligations: FNMA 3,848 4,485 4,484 -------- -------- -------- Total collateralized mortgage obligations 3,848 4,485 4,484 -------- -------- -------- Total mortgage-related securities, amortized cost $ 8,855 $ 11,454 $ 13,056 ======== ======== ======== Total fair value(3) $ 9,090 $ 11,550 $ 12,580 ======== ======== ========
- ---------- (1) Includes "AAA" rated securities of Northwest Asset Securities Corporation, Credit Suisse First Boston, Washington Mutual and Countrywide Home Loans with book values of $2.9 million, $4.1 million, $5.1 million and $2.7 million, respectively, and fair value of $3.0 million, $4.1 million, $5.1 million and $2.8 million, respectively. (2) Includes "AAA" rated securities of Northwest Asset Securities Corporation, Chase Mortgage Services, Washington Mutual and Countrywide Home Loans with book values of $5.5 million, $3.1 million, $4.2 million and $5.0 million, respectively, and fair values of $5.7 million, $3.1 million, $4.3 million and $5.0 million, respectively. (3) See Note 4 of the Notes to Consolidated Financial Statements in the Company's Annual Report. 20 The following table sets forth the purchases, sales and principal repayments of the Bank's mortgage-related securities for the periods indicated.
Year Ended September 30, ----------------------------------------- 2002 2001 2000 --------- --------- --------- (In thousands) Mortgage-related securities, beginning of period(1)(2) $ 129,062 $ 109,313 $ 127,543 --------- --------- --------- Purchases: Mortgage-backed securities - available for sale 9,280 24,501 11,873 CMOs - available for sale 18,231 34,162 3,965 Sales: Mortgage-backed securities - available for sale -- (6,888) (13,407) CMOs - available for sale -- -- (5,132) Repayments and prepayments: Mortgage-backed securities (26,820) (21,568) (10,410) CMOs (34,554) (14,808) (5,675) Decrease in net premium (315) (145) (62) Change in net unrealized gain (loss) on mortgage-related securities available for sale (355) 4,495 618 --------- --------- --------- Net increase (decrease) in mortgage-related securities (34,533) 19,749 (18,230) --------- --------- --------- Mortgage-related securities, end of period(1) (2) $ 94,529 $ 129,062 $ 109,313 ========= ========= =========
- ---------- (1) Includes both mortgage-related securities available for sale and held to maturity. (2) Calculated at amortized cost for securities held to maturity and at fair value for securities available for sale. At September 30, 2002, the estimated weighted average maturity of the Bank's fixed-rate mortgage-related securities was approximately 2.89 years. The actual maturity of a mortgage-backed security is less than its stated maturity due to prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and adversely affect its yield to maturity. The yield is based upon the interest income and the amortization of any premium or discount related to the mortgage-backed security. In accordance with GAAP, premiums and discounts are amortized over the estimated lives of the securities, which decrease and increase interest income, respectively. The prepayment assumptions used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed security, and these assumptions are reviewed periodically to reflect actual prepayments. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of declining mortgage interest rates, such as the Bank experienced during fiscal 2002 and 2001, if the coupon rates of the underlying mortgages exceed the prevailing market interest rates offered for mortgage loans, refinancings generally increase and accelerate the prepayment rate of the underlying mortgages and the related securities. Conversely, during periods of increasing mortgage interest rates, if the coupon rates of the underlying mortgages are less than the prevailing market interest rates offered for mortgage loans, refinancings generally decrease and decrease the prepayment rate of the underlying mortgages and the related securities. As a result of the declining interest rate environment, the Bank experienced high levels of repayments and accelerated prepayments, and consequently, the Bank reinvested the proceeds of such repayments and prepayments at a lower yield. Investment Securities. The following table sets forth information regarding the carrying and fair value of the Company's investment securities, both held to maturity and available for sale, at the dates indicated 21
At September 30, ------------------------------------------------------------------- 2002 2001 2000 ------------------- ------------------- ------------------- Carrying Fair Carrying Fair Carrying Fair Value Value Value Value Value Value -------- ------- -------- ------- -------- ------- (In thousands) FHLB stock $ 6,571 $ 6,571 $ 6,917 $ 6,917 $ 6,672 $ 6,672 U.S. Government and agency obligations 1 to 5 years 11,986 12,114 2,961 3,133 2,936 2,970 5 to 10 years 1,861 2,071 1,843 2,050 6,997 6,745 Municipal securities 19,012 19,800 21,890 22,626 18,930 18,153 Corporate bonds 14,299 14,720 14,333 14,087 4,910 4,596 Mutual funds 14,009 14,045 5,009 5,004 2,000 1,970 Asset backed securities 2,837 2,853 2,986 2,970 Preferred stocks 10,682 10,751 9,474 9,197 5,528 4,732 Other equity investments 3,476 4,269 2,778 3,497 2,778 3,049 ------- ------- ------- ------- ------- ------- Total $84,733 $87,194 $68,191 $69,481 $50,751 $48,887 ======= ======= ======= ======= ======= =======
At September 30, 2002, the Company had an aggregate of $87.2 million, or 16.8%, of its total assets invested in investment securities, of which $6.6 million consisted of FHLB stock and $80.6 million was investment securities available for sale. Included in U.S. Government and agency obligations is a callable bond with a remaining term of approximately two years. The Bank's investment securities (excluding mutual funds, equity securities and FHLB stock) had a weighted average maturity to the call date of 5.8 years and a weighted average yield of 6.9% (adjusted to a fully taxable equivalent yield). SOURCES OF FUNDS General. The Bank's principal source of funds for use in lending and for other general business purposes has traditionally come from deposits obtained through the Bank's branch offices. The Bank also derives funds from contractual payments and prepayments of outstanding loans and mortgage-related securities, from sales of loans, from maturing investment securities and from advances from the FHLB of Pittsburgh and other borrowings. Loan repayments are a relatively stable source of funds, while deposits inflows and outflows are significantly influenced by general interest rates and money market conditions. The Bank uses borrowings to supplement its deposits as a source of funds. Deposits. The Bank's current deposit products include passbook accounts, NOW accounts, MMDA, certificates of deposit ranging in terms from 30 days to five years and noninterest-bearing personal and business checking accounts. The Bank's deposit products also include Individual Retirement Account ("IRA") certificates and Keogh accounts. The Bank's deposits are obtained primarily from residents in Delaware and Chester counties in southeastern Pennsylvania. The Bank attracts local deposit accounts by offering a wide variety of accounts, competitive interest rates, and convenient branch office locations and service hours. The Bank utilizes traditional marketing methods to attract new customers and savings deposits, including print media, radio advertising and direct mailings. However, the Bank does not solicit funds through deposit brokers nor does it pay any brokerage fees if it accepts such deposits. 22 The Bank has been competitive in the types of accounts and interest rates it has offered on its deposit products but does not necessarily seek to match the highest rates paid by competing institutions. Even with the significant decline in interest rates paid on deposit products in fiscal 2002, due to generally declining returns on competing investment opportunities as well as the effects of the stock market decline, the Bank did not experience disintermediation of deposits into competing investment products in fiscal 2002. The following table shows the distribution of, and certain information relating to, the Bank's deposits by type of deposit as of the dates indicated.
September 30, ----------------------------------------------------------------------- 2002 2001 2000 -------------------- -------------------- ------------------- Amount Percent Amount Percent Amount Percent -------- ------- -------- ------- -------- ------- (Dollars in thousands) Passbook $ 41,659 12.60% $ 37,806 12.13% $ 37,861 13.89% MMDA 48,722 14.73 40,781 13.09 23,583 8.65 NOW 54,048 16.34 45,161 14.49 38,898 14.27 Certificates of deposit 176,242 53.28 182,155 58.46 165,456 60.71 Noninterest-bearing 10,094 3.05 5,698 1.83 6,764 2.48 -------- ------- -------- ------- -------- ------- Total deposits $330,765 100.00% $311,601 100.00% $272,562 100.00% ======== ======= ======== ======= ======== =======
The following table sets forth the net savings flows of the Bank during the periods indicated.
Year Ended September 30, ---------------------------------- 2002 2001 2000 -------- -------- -------- (In thousands) Increase before interest credited $ 10,477 $ 27,876 $ 1,894 Interest credited 8,687 11,163 9,842 -------- -------- -------- Net savings increase $ 19,164 $ 39,039 $ 11,736 ======== ======== ========
The following table sets forth maturities of the Bank's certificates of deposit of $100,000 or more at September 30, 2002 by time remaining to maturity (amounts in thousands). Three months or less $10,764 Over three months through six months 5,509 Over six months through twelve months 6,679 Over twelve months 9,618 ------- $32,570 =======
23 The following table presents, by various interest rate categories, the amount of certificates of deposit at September 30, 2002 and 2001 and the amounts at September 30, 2002 which mature during the periods indicated.
Amounts at September 30, 2002 September 30, Maturing Within --------------------- --------------------------------------------------- Certificates of Deposit 2002 2001 One Year Two Years Three Years Thereafter - -------------------------- -------- -------- -------- --------- ----------- ---------- (Dollars in thousands) 2.0% or less $ 2,575 $ 131 $ 1,908 $ 667 $ -- $ -- 2.01% to 3.0% 63,105 3,563 58,324 2,505 1,265 1,011 3.01% to 4.0% 68,059 23,209 41,999 24,659 758 643 4.01% to 5.0% 22,664 45,287 3,840 1,913 7,369 9,542 5.01% to 6.0% 10,117 26,107 3,509 709 2,228 3,671 6.01% to 7.0% 9,722 83,858 114 9,376 232 -- -------- -------- -------- -------- -------- -------- Total certificate accounts $176,242 $182,155 $109,694 $ 39,829 $ 11,852 $ 14,867 ======== ======== ======== ======== ======== ========
The following table presents the average balance of each deposit type and the average rate paid on each deposit type for the periods indicated.
September 30, ---------------------------------------------------------------------- 2002 2001 2000 -------------------- -------------------- -------------------- Average Average Average Average Rate Average Rate Average Rate Balance Paid Balance Paid Balance Paid -------- ------- -------- ------- -------- ------- (Dollars in thousands) Passbook accounts $ 40,300 1.86% $ 37,661 2.41% $ 39,498 2.41% MMDA accounts 47,245 2.19 31,645 3.86 17,345 3.44 Certificates of deposit 174,844 4.24 177,086 5.87 164,783 5.61 NOW accounts 49,235 .81 40,681 1.32 39,918 1.40 Noninterest-bearing deposits 7,720 -- 7,658 -- 6,613 -- -------- -------- -------- Total deposits $319,344 3.01% $294,731 4.43% $268,157 4.23% ======== ====== ======== ====== ======== ======
24 Borrowings. The Bank may obtain advances from the FHLB of Pittsburgh upon the security of the common stock it owns in the FHLB and certain of its residential mortgage loans and securities held to maturity, provided certain standards related to creditworthiness have been met. Such advances are made pursuant to several credit programs, each of which has its own interest rate and range of maturities. The increase in core deposits funded asset growth during fiscal 2002, therefore borrowing from the FHLB was not necessary. During fiscal 2001, deposit increases exceeded asset growth which allowed the Bank to repay some of the existing FHLB advances. The Bank, during fiscal 2000 and 1999, increased its FHLB borrowings to fund asset growth. At September 30, 2002, the Bank had $126.2 million in outstanding FHLB advances. The FHLB advances have certain call features whereby the FHLB of Pittsburgh can call the borrowings after the expiration of certain time frames. The time frames on the callable borrowings range from three months to seven years. See Note 9 of the Notes to Consolidated Financial Statements in the Company's Annual Report for additional information. SUBSIDIARIES The Bank is permitted to invest up to 2% of its assets in the capital stock of, or secured or unsecured loans to, service corporations, with an additional investment of 1% of assets when such additional investment is utilized primarily for community development purposes. It may invest essentially unlimited amounts in subsidiaries deemed operating subsidiaries that can only engage in activities that the Bank is permitted to engage in. Under such limitations, as of September 30, 2002, the Bank was authorized to invest up to approximately $10.2 million in the stock of, or loans to, service corporations. As of September 30, 2002, the net book value of the Bank's investment in stock, unsecured loans, and conforming loans to its service corporations was $42,700. At September 30, 2002, in addition to the Bank, the Company has five direct or indirect subsidiaries: First Keystone Capital Trust I, First Keystone Capital Trust II, FKF Management Corp., Inc., State Street Services Corp., First Pointe, Inc. and First Chester Services, Inc. First Keystone Capital Trust I (the "Trust") is a Delaware statutory business trust wholly owned by the Company formed in 1997 for the purpose of issuing trust preferred securities and investing the proceeds therefrom in Junior Subordinated Debentures issued by the Company. See Note 16 of the Notes to Consolidated Financial Statements in the Company's Annual Report for further discussion regarding the issuance of trust preferred securities. First Keystone Capital Trust II (the "Trust II") is a Delaware statutory business trust wholly owned by the Company formed in 2001 for the purpose of issuing trust preferred securities and investing the proceeds in Junior Subordinated Debentures issued by the Company. See Note 16 of the Notes to the Consolidated Financial Statements in the Company's Annual Report for further discussion regarding the issuance of trust preferred securities. FKF Management Corp., Inc., a Delaware corporation, is a wholly owned operating subsidiary of the Bank established in 1997 for the purpose of managing certain assets of the Bank. Assets under management totaled $149.0 million at September 30, 2002 and were comprised principally of investment and mortgage-related securities. State Street Services Corp. is a wholly owned subsidiary of the Bank established in 1999 for the purpose of offering a full array of insurance products through its ownership of a 51% interest in First Keystone Insurance Services, LLC. In addition, it holds a 10% equity position in a title company which offers title services. The Bank has two remaining subsidiaries, First Chester Services, Inc. and First Pointe, Inc., which were both involved in real estate management but are now inactive. EMPLOYEES The Bank had 81 full-time employees and 13 part-time employees as of September 30, 2002. None of these employees is represented by a collective bargaining agreement. The Bank believes that it enjoys excellent relations with its personnel. 25 REGULATION The Company. The Company as a savings and loan holding company within the meaning of the Home Owners' Loan Act, as amended ("HOLA"), is registered as such with the OTS and is subject to OTS regulations, examinations, supervision and reporting requirements. As a subsidiary of a savings and loan holding company, the Bank is subject to certain restrictions in its dealings with the Company and affiliates thereof. Federal Activities Restrictions. The Company operates as a unitary savings and loan holding company. Generally, there are only limited restrictions on the activities of a unitary savings and loan holding company which applied to become or was a unitary saving and loan holding company prior to May 4, 1999 and its non-savings institution subsidiaries. Under the Gramm-Leach-Bliley Act of 1999 (the "GLBA"), companies which apply to the OTS to become unitary savings and loan holding companies will be restricted to only engaging in those activities traditionally permitted to multiple saving and loan holding companies. However, if the Director of the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings association, the Director may impose such restrictions as deemed necessary to address such risk, including limiting (i) payment of dividends by the savings association; (ii) transactions between the savings association and its affiliates; and (iii) any activities of the savings association that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings association. Notwithstanding the above rules as to permissible business activities of grandfathered unitary savings and loan holding companies under the GLBA (such as the Company), if the savings association subsidiary of such a holding company fails to meet the Qualified Thrift Lender ("QTL") test, then such unitary holding company also shall become subject to the activities restrictions applicable to multiple savings and loan holding companies and, unless the savings association qualifies as a QTL within one year thereafter, shall register as, and become subject to the restrictions applicable to, a bank holding company. See "- The Bank - Qualified Thrift Lender Test." If the Company were to acquire control of another savings association, other than through merger or other business combination with the Bank, the Company would thereupon become a multiple savings and loan holding company and would thereafter be subject to further restrictions on its activities. The GLBA also imposes financial privacy obligations and reporting requirements on all financial institutions. The privacy regulations require, among other things, that financial institutions establish privacy policies and disclose such policies to its customers at the commencement of a customer relationship and annually thereafter. In addition, financial institutions are required to permit customers to opt out of the financial institution's disclosure of the customer's financial information to non-affiliated third parties. The HOLA requires every savings institution subsidiary of a savings and loan holding company to give the OTS at least 30 days' advance notice of any proposed dividends to be made on its guarantee, permanent or other nonwithdrawable stock, or else such dividend will be invalid. See "- The Bank - Restrictions on Capital Distributions." Limitations on Transactions with Affiliates. Transactions between savings associations and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act ("FRA") and OTS regulations issued in connection therewith. Affiliates of a savings institution include, among other entities, the savings institution's holding company and companies that are controlled by or under common control with the savings institution. Generally, Sections 23A and 23B (i) limit the extent to which the savings association or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such association's capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus and (ii) require that all such transactions be on terms substantially the same, or at least as favorable, to the association or subsidiary as those provided to a non-affiliate. The term "covered transaction" includes, among other things, the making of loans or extension of credit to an affiliate, purchase of assets, issuance of a guarantee and similar transactions. In addition to the restrictions imposed by Sections 23A and 23B, under OTS regulations no savings association may (i) loan or otherwise extend credit to an affiliate, except for any affiliate which engages only in activities which are permissible for bank holding companies, (ii) a savings association may not purchase or invest in securities of an affiliate other than shares of a subsidiary; (iii) a savings association and its subsidiaries may not purchase a low-quality asset from an affiliate; (iv) and covered transactions and certain other transactions between a savings association or its subsidiaries 26 and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices. With certain exceptions, each extension of credit by a savings association to an affiliate must be secured by collateral with a market value ranging from 100% to 130% (depending on the type of collateral) of the amount of the loan or extension of credit. OTS regulations generally exclude all non-bank and non-savings association subsidiaries of savings associations from treatment as affiliates, except to the extent that the OTS or the Federal Reserve Board decides to treat such subsidiaries as affiliates. The regulations also require savings associations to make and retain records that reflect affiliate transactions in reasonable detail, and provide that certain classes of savings associations may be required to give the OTS prior notice of affiliate transactions. Restrictions on Acquisitions. Except under limited circumstances, savings and loan holding companies are prohibited from acquiring, without prior approval of the Director of the OTS, (i) control of any other savings association or savings and loan holding company or substantially all the assets thereof; or (ii) more than 5% of the voting shares of a savings association or holding company thereof which is not a subsidiary. Except with the prior approval of the Director of the OTS, no director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than 25% of such company's stock, may acquire control of any savings association, other than a subsidiary savings association, or of any other savings and loan holding company. Federal Securities Laws. The Company's Common Stock is registered with the SEC under the Securities Exchange Act of 1934, as amended ("Exchange Act"). The Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Exchange Act. Shares of Common Stock owned by an affiliate of the Company are subject to the resale restrictions of Rule 144 under the Securities Act of 1933, as amended ("Securities Act"). As long as the Company meets the current public information requirements of Rule 144 under the Securities Act, each affiliate of the Company who complies with the other conditions of Rule 144 (including those that require the affiliate's sale to be aggregated with those of certain other persons) generally is able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of (i) 1% of the outstanding shares of the Company or (ii) the average weekly volume of trading in such shares during the preceding four calendar weeks. Sarbanes-Oxley Act of 2002. On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 implementing legislative reforms intended to address corporate and accounting fraud. In addition to the establishment of a new accounting oversight board which will enforce auditing, quality control and independence standards and will be funded by fees from all publicly traded companies, the bill restricts provision of both auditing and consulting services by accounting firms. To ensure auditor independence, any non-audit services being provided to an audit client will require preapproval by the company's audit committee members. In addition, the audit partners must be rotated. The bill requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement. In addition, under the Act, counsel will be required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to its chief executive officer or its chief legal officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the board of directors or the board itself. Longer prison terms and increased penalties will also be applied to corporate executives who violate federal securities laws, the period during which certain types of suits can be brought against a company or its officers has been extended, and bonuses issued to top executives prior to restatement of a company's financial statements are now subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirement plan "blackout" periods, and loans to company executives are restricted. In addition, a provision directs that civil penalties levied by the SEC as a result of any judicial or administrative action under the Act be deposited to a fund for the benefit of harmed investors. The Federal Accounts for Investor Restitution ("FAIR") provision also requires the SEC to develop methods of improving collection rates. The legislation accelerates the time frame for disclosures by public companies, as they must immediately disclose any material changes in their financial condition or operations. Directors and executive officers must also provide information for most changes in ownership in a company's securities within two business days of the change. 27 The Act also increases the oversight of, and codifies certain requirements relating to audit committees of public companies and how they interact with the company's "registered public accounting firm" ("RPAF"). Audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer. In addition, companies must disclose whether at least one member of the committee is a "financial expert" (as such term will be defined by the SEC) and if not, why not. Under the Act, a RPAF is prohibited from performing statutorily mandated audit services for a company if such company's chief executive officer, chief financial officer, comptroller, chief accounting officer or any person serving in equivalent positions has been employed by such firm and participated in the audit of such company during the one-year period preceding the audit initiation date. The Act also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the company's financial statements for the purpose of rendering the financial statement's materially misleading. The Act also requires the SEC to prescribe rules requiring inclusion of an internal control report and assessment by management in the annual report to stockholders. The Act requires the RPAF that issues the audit report to attest to and report on management's assessment of the company's internal controls. In addition, the Act requires that each financial report required to be prepared in accordance with (or reconciled to) accounting principles generally accepted in the United States of America and filed with the SEC reflect all material correcting adjustments that are identified by a RPAF in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the SEC. The Bank. The OTS has extensive regulatory authority over the operations of savings associations such as the Bank. As part of this authority, savings associations are required to file periodic reports with the OTS and are subject to periodic examinations by the OTS. The investment and lending authority of savings associations are prescribed by federal laws and regulations and they are prohibited from engaging in any activities not permitted by such laws and regulations. Those laws and regulations generally are applicable to all federally chartered savings associations and may also apply to state-chartered savings associations. Such regulation and supervision is primarily intended for the protection of depositors. Insurance of Accounts. The deposits of the Bank are insured to the maximum extent permitted by the SAIF, which is administered by the FDIC, and are backed by the full faith and credit of the U. S. Government. As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the OTS an opportunity to take such action. The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is not aware of any existing circumstances which could result in termination of the Bank's deposit insurance. Capital requirements. Current OTS capital standards require savings associations to satisfy three different capital requirements. Under these standards, savings associations must maintain "tangible" capital equal to 1.5% of adjusted total assets, "core" capital equal to 4% (3% if the association receives the OTS' highest rating) of adjusted total assets and "total" capital (a combination of core and "supplementary" capital) equal to 8.0% of "risk-weighted" assets. For purposes of the regulation, core capital generally consists of common stockholders' equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, minority interests in the equity accounts of fully consolidated subsidiaries, certain nonwithdrawable accounts and pledged deposits and "qualifying supervisory goodwill." Tangible capital is given the same definition as core capital but does not include qualifying supervisory goodwill and is reduced by the amount of all the savings association's intangible assets, with only a limited exception for purchased mortgage servicing rights ("PMSRs"). Both core and tangible capital are further reduced by an amount equal to a savings association's debt and equity investments in subsidiaries engaged in activities not permissible for national banks (other than subsidiaries engaged in activities undertaken as agent for customers or in mortgage banking activities and subsidiary 28 depository institutions or their holding companies). In addition, under the Prompt Corrective Action provisions of the OTS regulations, all but the most highly rated institutions must maintain a minimum leverage ratio of 4% in order to be adequately capitalized. See "- Prompt Corrrective Action." At September 30, 2002, the Bank did not have any investment in subsidiaries engaged in impermissible activities and required to be deducted from its capital calculation. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") granted the OTS the authority to prescribe rules for the amount of PMSRs that may be included in a savings association's regulatory capital and required that the value of readily marketable PMSRs included in the calculation of a savings association's regulatory capital not exceed 90% of fair market value and that such value be determined at least quarterly. Under OTS regulations, (i) PMSRs do not have to be deducted from tangible and core regulatory capital, provided that they do not exceed 50% of core capital, (ii) savings associations are required to determine the fair market value and to review the book value of their PMSRs at least quarterly and to obtain an independent valuation of PMSRs annually, (iii) savings associations that desire to include PMSRs in regulatory capital may not carry them at a book value under GAAP that exceeds the discounted value of their future net income stream and (iv) for purposes of calculating regulatory capital, the amount of PMSRs reported as balance sheet assets should amount to the lesser of 90% of their fair market value, 90% of their original purchase price or 100% of their remaining unamortized book value. At September 30, 2002, the Bank had PMSRs totaling $20,600. A savings association is allowed to include both core capital and supplementary capital in the calculation of its total capital for purposes of the risk-based capital requirements, provided that the amount of supplementary capital does not exceed the savings association's core capital. Supplementary capital generally consists of hybrid capital instruments; perpetual preferred stock which is not eligible to be included as core capital; subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics, with the categories ranging from 0% (requiring no additional capital) for assets such as cash to 100% for repossessed assets or loans more than 90 days past due. Single- family residential real estate loans which are not past-due or non-performing and which have been made in accordance with prudent underwriting standards are assigned a 50% level in the risk-weighing system, as are certain privately-issued mortgage-backed securities representing indirect ownership of such loans. Off-balance sheet items also are adjusted to take into account certain risk characteristics. The OTS amended its risk-based capital requirements that would require institutions with an "above normal" level of interest rate risk to maintain additional capital. A savings association is considered to have a "normal" level of interest rate risk if the decline in the market value of its portfolio equity after an immediate 200 basis point increase or decrease in market interest rates (whichever leads to the greater decline) is less than two percent of the current estimated market value of its assets. The market value of portfolio equity is defined as the net present value of expected cash inflows and outflows from an association's assets, liabilities, and off-balance sheet items. The amount of additional capital, that an institution with an above normal interest rate risk is required to maintain (the "interest rate risk component") equals one-half of the dollar amount by which its measured interest rate risk exceeds the normal level of interest rate risk. The interest rate risk component is in addition to the capital otherwise required to satisfy the risk-based capital requirement. Implementation of this component has been postponed by the OTS. The final rule was to be effective as of January 1, 1994, subject however to a three quarter lag time in implementation. However, because of continuing delays by the OTS, the interest rate risk component has never been operative. At September 30, 2002, the Bank exceeded all of its regulatory capital requirements, with tangible, core and risk-based capital ratios of 8.1%, 8.1%, and 16.2%, respectively. See Note 11 to the Notes to Consolidated Financial Statements included in the Company's Annual Report. The OTS and the FDIC generally are authorized to take enforcement action against a savings association that fails to meet its capital requirements, which action may include restrictions on operations and banking activities, the imposition of a capital directive, a cease-and-desist order, civil money penalties or harsher measures such as the appointment of a receiver or conservator or a forced merger into another institution. In addition, under current regulatory policy, an association that fails to meet its capital requirements is prohibited from paying any dividends. 29 The following is a reconciliation of the Bank's equity determined in accordance with GAAP to regulatory tangible, core and risk-based capital at September 30, 2002, 2001 and 2000.
September 30, 2002 September 30, 2001 September 30, 2000 ------------------------------ ------------------------------ ------------------------------ Tangible Core Risk-based Tangible Core Risk-based Tangible Core Risk-based Capital Capital Capital Capital Capital Capital Capital Capital Capital -------- ------- ---------- -------- ------- ---------- -------- ------- ---------- (In thousands) GAAP equity $ 40,873 $40,873 $ 40,873 $ 37,211 $37,211 $ 37,211 $ 38,127 $38,127 $ 38,127 Assets required to be deducted(1) -- -- -- -- -- -- -- -- (511) General valuation allowances -- -- 2,084 -- -- 1,883 -- -- 1,667 -------- ------- -------- -------- ------- -------- -------- ------- -------- Total regulatory capital 40,873 40,873 42,957 37,211 37,211 39,094 38,127 38,127 39,283 Minimum capital requirement 7,597 20,265 21,255 7,189 19,172 18,602 6,874 18,332 17,782 -------- ------- -------- -------- ------- -------- -------- ------- -------- Excess $ 33,276 $20,608 $ 21,702 $ 30,022 $18,039 $ 20,492 $ 31,253 $19,795 $ 21,501 ======== ======= ======== ======== ======= ======== ======== ======= ========
(1) Consists of an equity investment which was non-includable in regulatory capital. These capital requirements are viewed as minimum standards by the OTS, and most institutions are expected to maintain capital levels well above the minimum. In addition, the OTS regulations provide that minimum capital levels higher than those provided in the regulations may be established by the OTS for individual savings association's capital, upon a determination that circumstances exist that higher individual minimum capital requirements may be appropriate. 30 Prompt Corrective Action. Under the prompt corrective action regulations of the OTS, an institution shall be deemed to be (i) "well capitalized" if it has total risk-based capital of 10% or more, has a Tier I risk-based capital ratio of 6% or more, has a Tier I leverage capital ratio of 5% or more and is not subject to any order or final capital directive to meet and maintain a specific capital level for any capital measure, (ii) "adequately capitalized" if it has a total risk- based capital ratio of 8% or more, a Tier I risk-based capital ratio of 4% or more and a Tier I leverage capital ratio of 4% or more (3% under certain circumstances) and does not meet the definition of "well capitalized," (iii) "undercapitalized" if it has a total risk-based capital ratio that is less than 8%, a Tier I risk-based capital ratio that is less than 4% or a Tier I leverage capital ratio that is less than 4% (3% under certain circumstances), (iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6%, a Tier I risk-based capital ratio that is less than 3% or a Tier I leverage capital ratio that is less than 3%, and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2%. Under specified circumstances, the OTS may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized). At September 30, 2002, the Bank met the requirements of a "well capitalized" institution under OTS regulations. Qualified Thrift Lender Test(the "QTL"). A savings association can comply with the QTL test by either meeting the QTL test set forth in the HOLA and the implementing regulations or qualifying as a domestic building and loan association as defined in Section 7701(a)(19) of the Internal Revenue Code of 1986, as amended ("Code"). Currently, the portion of the QTL test that is based on the HOLA rather than the Code requires that 65% of an institution's "portfolio assets" (as defined) consist of certain housing and consumer-related assets on a monthly average basis in nine out of every 12 months. Assets that qualify without limit for inclusion as part of the 65% requirement are loans made to purchase, refinance, construct, improve or repair domestic residential housing and manufactured housing, home equity loans, mortgage-backed securities (where the mortgages are secured by domestic residential housing or manufactured housing), stock issued by the FHLB, and direct or indirect obligations of the FDIC. In addition, small business loans, credit card loans, student loans and loans for personal, family and household purposes are allowed to be included without limitation as qualified investments. The following assets, among others, also may be included in meeting the test subject to an overall limit of 20% of the savings institution's portfolio assets: 50% of residential mortgage loans originated and sold within 90 days of origination, 100% of consumer and educational loans (limited to 10% of total portfolio assets) and stock issued by FHLMC or FNMA. Portfolio assets consist of total assets minus the sum of (i) goodwill and other intangible assets, (ii) property used by the savings institution to conduct its business, and (iii) liquid assets up to 20% of the institution's total assets. A savings institution that does not comply with the QTL test must either convert to a bank charter or comply with certain restrictions on its operations. Upon the expiration of three years from the date the association ceases to be a QTL, it must cease any activity and not retain any investment not permissible for a national bank and immediately repay any outstanding FHLB advances (subject to safety and soundness considerations). At September 30, 2002, approximately 70.7% of the Bank's assets were invested in qualified thrift investments, which was in excess of the percentage required to qualify the Bank under the QTL test in effect at that time. Restrictions on Capital Distributions. OTS regulations govern capital distributions by savings associations, which include cash dividends, stock redemptions or repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the capital account of a savings association to make capital distributions. Generally, the regulation creates a safe harbor for specified levels of capital distributions (as a percentage of income) from savings associations meeting at least their minimum capital requirements, so long as such associations notify the OTS and receive no objection to the distribution from the OTS. Savings institutions and distributions that do not qualify for the safe harbor are required to obtain prior OTS approval before making any capital distributions. Generally, savings associations such as the Bank can, upon 30 days prior notice, distribute during each calendar year an amount equal to or less than its net income for the year to date plus retained net income (which takes into account distributions during such periods) for the preceding two years. Amounts in excess of this must be approved by the OTS. OTS regulations also prohibit the Bank from declaring or paying any dividends or from repurchasing any of its stock if, as a result, the regulatory (or total) capital of the Bank would be reduced below the amount required to be maintained 31 for the liquidation account established by it for certain depositors in connection with its conversion from mutual to stock form. Community Reinvestment. Under the Community Reinvestment Act of 1977, as amended ("CRA"), as implemented by OTS regulations, a savings association has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The Bank received a satisfactory CRA rating as a result of its last OTS evaluation. Policy Statement on Nationwide Branching. OTS policy on branching by federally chartered savings associations permits nationwide branching to the extent allowed by federal statute. Current OTS policy generally permits a federally chartered savings association to establish branch offices outside of its home state if the association meets the domestic building and loan test in Section 7701(a)(19) of the Code or the asset composition test of subparagraph (c) of that section, and if, with respect to each state outside of its home state where the association has established branches, the branches, taken alone, also satisfy one of the two tax tests. An association seeking to take advantage of this authority would have to have a branching application approved by the OTS, which would consider the regulatory capital of the association and its record under the CRA, as amended, among other things. Federal Home Loan Bank System. The Bank is a member of the FHLB of Pittsburgh, which is one of 12 regional FHLBs that administers the home financing credit function of savings associations. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the Board of Directors of the FHLB. As of September 30, 2002, the Bank has advances of $126.2 million from the FHLB or 27.2% of its total liabilities. At such date, the Bank had the ability to obtain up to $148.8 million additional advances from FHLB of Pittsburgh. As a member, the Bank is required to purchase and maintain stock in the FHLB of Pittsburgh in an amount equal to at least 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of its advances from the FHLB of Pittsburgh, whichever is greater. At September 30, 2002, the Bank had $6.6 million in FHLB stock, which was in compliance with this requirement. The FHLBs are required to provide funds for the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the FHLBs pay to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. For the years ended September 30, 2002, 2001 and 2000, dividends from the FHLB to the Bank amounted to approximately $278,000, $471,000 and $428,000, respectively. If dividends were reduced, the Bank's net interest income would likely also be reduced. Further, there can be no assurance that the impact of recent or future legislation on the FHLBs will not also cause a decrease in the value of FHLB stock held by the Bank, if any. Federal Reserve System. The Board of Governors of the Federal Reserve System ("FRB") requires all depository institutions to maintain reserves against their transaction accounts (primarily NOW and Super NOW checking accounts) and non-personal time deposits. At September 30, 2002, the Bank was in compliance with applicable requirements. However, because required reserves must be maintained in the form of vault cash or a noninterest-bearing account at a FRB, the effect of this reserve requirement is to reduce an institution's earning assets. Safety and Soundness Guidelines. The OTS and the other federal banking agencies have established guidelines for safety and soundness, addressing operational and managerial, as well as compensation matters for insured financial institutions. Institutions failing to meet these standards are required to submit compliance plans to their appropriate federal regulators. The OTS and the other agencies have also established guidelines regarding asset quality and earnings standards for insured institutions. 32 FEDERAL AND STATE TAXATION General. The Company and the Bank are subject to the corporate tax provisions of the Code, as well as certain additional provisions of the Code which apply to thrift and other types of financial institutions. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Company and the Bank. Fiscal Year. The Company and the Bank and its subsidiaries file a consolidated federal income tax return on a fiscal year basis ending September 30. Method of Accounting. The Bank maintains its books and records for federal income tax purposes using the accrual method of accounting. The accrual method of accounting generally requires that items of income be recognized when all events have occurred that establish the right to receive the income and the amount of income can be determined with reasonable accuracy, and that items of expense be deducted at the later of (i) the time when all events have occurred that establish the liability to pay the expense and the amount of such liability can be determined with reasonable accuracy or (ii) the time when economic performance with respect to the item of expense has occurred. Bad Debt Reserves. The Bank is permitted to establish reserves for bad debts and to make annual additions thereto which qualify as deductions from taxable income. The Company, as of October 1, 1996, changed its method of computing reserves for bad debts to the experience method (the "Experience Method"). The bad debt deduction allowable under this method is available to small banks with assets less than $500 million. Beginning October 1, 2001, the Company changed its method of computing reserves for bad debts to the specific charge-off method. The bad debt deduction allowable under this method is available to large banks with assets greater than $500 million. Generally, this method allows the Company to deduct an annual addition to the reserve for bad debts equal to it its net charge-offs. The Bank treated such change as a change in a method of accounting determined solely with respect to the "applicable excess reserves" of the institution. The amount of applicable excess reserves is taken into account ratably over a six taxable-year period, beginning with the first taxable year beginning after December 31, 1995. For financial reporting purposes, the Company has not incurred any additional tax expense. Amounts that had been previously deferred will be reversed for financial reporting purposes and will be included in the income tax return of the Company, increasing income tax payable. The change from the experience method to the specific charge-off method in the current year did not result in a recapture of bad debt reserves for tax purposes. Distributions. While the Bank maintains a bad debt reserve, if it were to distribute cash or property to its sole stockholder having a total fair market value in excess of its accumulated tax-paid earnings and profits, or were to distribute cash or property to its stockholder in redemption of its stock, the Bank would generally be required to recognize as income an amount which, when reduced by the amount of federal income tax that would be attributable to the inclusion of such amount in income, is equal to the lesser of: (i) the amount of the distribution or (ii) the sum of (a) the amount of the accumulated bad debt reserve of the Bank with respect to qualifying real property loans (to the extent that additions to such reserve exceed the additions that would be permitted under the experience method) and (b) the amount of the Bank's supplemental bad debt reserve. Minimum Tax. The Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences ("alternative minimum taxable income" or "AMTI"). The alternative minimum tax is payable to the extent such AMTI is in excess of an exemption amount. The Code provides that an item of tax preference is the excess of the bad debt deduction allowable for a taxable year pursuant to the percentage of taxable income method over the amount allowable under the experience method. The other items of tax preference that constitute AMTI include (a) tax-exempt interest on newly-issued (generally, issued on or after August 8, 1986) private activity bonds other than certain qualified bonds and (b) for taxable years beginning after 1989, 75% of the excess (if any) of (i) adjusted current earnings as defined in the Code, over (ii) AMTI (determined without regard to this preference and prior to reduction by net operating losses). Net operating losses can offset no more than 90% of AMTI. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. Audit by IRS. The Bank's consolidated federal income tax returns for taxable years through September 30, 1998 have been closed for the purpose of examination by the IRS. 33 STATE TAXATION The Company and the Bank's subsidiaries are subject to the Pennsylvania Corporate Net Income Tax and Capital Stock and Franchise Tax. The Corporate Net Income Tax rate for fiscal 2002 is 9.99% and is imposed on the Company's unconsolidated taxable income for federal purposes with certain adjustments. In general, the Capital Stock and Franchise Tax is a property tax imposed at the rate of 1.1% of a corporation's capital stock value, which is determined in accordance with a fixed formula. The Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax Act (the ("MTIT"), as amended to include thrift institutions having capital stock. Pursuant to the MTIT, the Bank's tax rate is 11.5%. The MTIT exempts the Bank from all other taxes imposed by the Commonwealth of Pennsylvania for state income tax purposes and from all local taxation imposed by political subdivisions, except taxes on real estate and real estate transfers. The MTIT is a tax upon net earnings, determined in accordance with GAAP with certain adjustments. The MTIT, in computing GAAP income, allows for the deduction of interest earned on state and federal securities, while disallowing a percentage of a thrift's interest expense deduction in the proportion of interest income on those securities to the overall interest income of the Bank. Net operating losses, if any, thereafter can be carried forward three years for MTIT purposes. 34 ITEM 2. PROPERTIES. At September 30, 2002, the Bank conducted business from its executive offices located in Media, Pennsylvania and six full-service offices located in Delaware and Chester Counties, Pennsylvania. See also Note 7 of the Notes to Consolidated Financial Statements in the Annual Report. The following table sets forth certain information with respect to the Bank's offices at September 30, 2002.
Net Book Value Amount of Description/Address Leased/Owned of Property Deposits - -------------------------------- ------------ -------------- --------- (In thousands) Executive Offices: 22 West State Street Media, Pennsylvania 19063 Owned(1) $ 1,297 $ 95,384 Branch Offices: 3218 Edgmont Avenue Brookhaven, Pennsylvania 19015 Owned 422 84,313 Routes 1 and 100 Chadds Ford, Pennsylvania 19318 Leased(2) 78 26,436 23 East Fifth Street Chester, Pennsylvania 19013 Leased(3) 122 26,304 31 Baltimore Pike Chester Heights, Pennsylvania 19017 Leased(4) 625 28,831 Route 82 and 926 Kennett Square, Pennsylvania 19348 Leased(5) 38 11,561 330 Dartmouth Avenue Swarthmore, Pennsylvania 19081 Owned 105 57,936 -------- -------- Total $ 2,687 $330,765 ======== ========
- ---------------------------- (1) Also a branch office. (2) Lease expiration date is September 30, 2005. The Bank has one five-year renewal option. (3) Lease expiration date is December 31, 2005. The Bank has one ten-year renewal option. (4) Lease expiration date is December 31, 2028. The Bank has options to cancel on the 15th, 20th and 25th year of the lease. (5) Lease expiration date is September 30, 2006. The Bank has three five-year renewal options. 35 ITEM 3. LEGAL PROCEEDINGS. The Company is involved in routine legal proceedings occurring in the ordinary course of business which, in the aggregate, are believed by management to be immaterial to the financial condition of the Company. In late September 2001, the Bank was served in the following action: Aurora Loan Services, Inc. v. First Keystone Federal Savings Bank, Civil Action No. 01-CV-4774 (United States District Court for the Eastern District of Pennsylvania). This is a civil action arising out of five residential mortgage loans that Aurora holds in its portfolio. Aurora alleges that it suffered losses in connection with these loans (all of which were purchased by Aurora from the Bank more than 18 months prior to September 2001) and that the Bank is required to purchase the loans or compensate Aurora for its alleged losses. The Complaint asserts claims for breach of contract (Count One), violation of the New York Consumer Protection Law (Count Two) and Unjust Enrichment (Count Three). During September 2002, the lawsuit was settled with the plaintiff in the amount of $570,000. Under the terms of the settlement, the plaintiff will release the Bank from any and all claims it could assert relating to these five mortgage loans. In October 2002, the Bank was served with a Demand for Arbitration from Impac Funding Corp. before the American Arbitration Association. The arbitration proceedings are captioned In the Matter of Arbitration between Impac Funding Corp. and First Keystone Federal Savings Bank, American Arbitration Association, Arbitration No. 73- 148-00498-02-JUBA. In its arbitration demand, Impac asserted breach of contract claims relating to its purchase of five residential mortgage loans. Impac Funding is claiming damages of $182,000 plus attorney fees. The Bank submitted their response to the arbitration demand on November 10, 2002. In the Bank's response, the Bank has asserted all defenses on the merit of the claims and denied liability. The Bank believes that its defenses to these claims are meritorious. As of the date hereof, no discovery has been conducted in this case and no hearing date has been set. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information required herein is incorporated by reference on page 38 of the Registrant's Annual Report and from Part III, Item 12 hereof. ITEM 6. SELECTED FINANCIAL DATA. The information required herein is incorporated by reference from pages 7 to 8 of the Registrant's Annual Report. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION. The information required herein is incorporated by reference from pages 9 to 19 of the Registrant's Annual Report. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The information required herein is incorporated by reference from pages 10 to 12 of the Registrant's Annual Report. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The financial statements and supplementary data required herein are incorporated by reference from pages 20 to 38 of the Company's Annual Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. 36 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required herein is incorporated by reference from pages 3 to 7 and page 17 of the Registrant's Proxy Statement dated December 30, 2002 ("Proxy Statement"). ITEM 11. EXECUTIVE COMPENSATION. The information required herein is incorporated by reference from pages 11 to 16 of the Registrant's Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. The information required herein is incorporated by reference from pages 8 to 10 of the Registrant's Proxy Statement. EQUITY COMPENSATION PLAN INFORMATION. The following table sets forth certain information for all equity compensation plans and individual compensation arrangements (whether with employees or non-employees, such as directors), in effect as of September 30, 2002.
Number of Shares to be Number of Shares Remaining issued upon the Exercise Weighted-Average Available for Future Issuance of Outstanding Options, Exercise Price of (Excluding Shares Reflected Plan Category Warrants and Rights Outstanding Options in the First Column) - ----------------------------- ------------------------ ------------------- ----------------------------- Equity Compensation Plans Approved by Security Holders 306,977 $ 9.52 32,344 Equity Compensation Plans Not Approved by Security Holders -- -- -- ------- ------- ------- Total 306,977 $ 9.52 32,344 ======= ======= =======
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required herein is incorporated by reference from page 17 of the Registrant's Proxy Statement. 37 ITEM 14. CONTROLS AND PROCEDURES. Under the supervision and with the participation of the Company's management, including its chief executive officer and chief financial officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures within 90 days of the filing date of this annual report, and based on their evaluation, the Company's chief executive officer and chief financial officer have concluded that these controls and procedures are effective. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. Disclosure controls and procedures are the Company's controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that the Company files under the Exchange Act is accumulated and communicated to the Company management, including its chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. PART IV. ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Documents filed as part of this Report. (1) The following documents are filed as part of this report and are incorporated herein by reference from the Registrant's Annual Report. Report of Independent Auditors. Consolidated Statements of Financial Condition at September 30, 2002 and 2001. Consolidated Statements of Income for the Years Ended September 30, 2002, 2001 and 2000. Consolidated Statements of Changes in Stockholders' Equity for the Years Ended September 30, 2002, 2001 and 2000. Consolidated Statements of Cash Flows for the Years Ended September 30, 2002, 2001 and 2000. Notes to the Consolidated Financial Statements. (2) All schedules for which provision is made in the applicable accounting regulation of the SEC are omitted because they are not applicable or the required information is included in the Consolidated Financial Statements or notes thereto. 38 (3) The following exhibits are filed as part of this Form 10-K, and this list includes the Exhibit Index.
No Description -- ----------- 3.1 Amended and Restated Articles of Incorporation of First Keystone Financial, Inc. * 3.2 Amended and Restated Bylaws of First Keystone Financial, Inc. * 4 Specimen Stock Certificate of First Keystone Financial, Inc. * 10.1 Employee Stock Ownership Plan and Trust of First Keystone Financial, Inc. * 10.2 401(K)/ Profit-sharing Plan of First Keystone Federal Savings Bank. * 10.3 Employment Agreement between First Keystone Financial, Inc. and Donald S. Guthrie dated May 26, 1999. ** 10.4 Employment Agreement between First Keystone Financial, Inc. and Stephen J. Henderson dated May 26, 1999. ** 10.5 Employment Agreement between First Keystone Financial, Inc. and Thomas M. Kelly dated May 26, 1999. ** 10.6 Form of Severance Agreement between First Keystone Financial, Inc. and Elizabeth M. Mulcahy dated May 26, 1999. ** 10.8 Form of Severance Agreement between First Keystone Financial, Inc. and Carol Walsh dated May 26, 1999. ** 10.9 1995 Stock Option Plan.*** 10.10 1995 Recognition and Retention Plan and Trust Agreement.*** 10.11 1998 Stock Option Plan.**** 10.12 Employment Agreement between First Keystone Federal Savings Bank and Donald S. Guthrie dated May 26, 1999. ** 10.13 Employment Agreement between First Keystone Federal Savings Bank and Stephen J. Henderson dated May 26, 1999. ** 10.14 Employment Agreement between First Keystone Federal Savings Bank and Thomas M. Kelly dated May 26, 1999. ** 10.15 Form of Severance Agreement between First Keystone Federal Savings Bank and Elizabeth M. Mulcahy dated May 26, 1999. ** 10.16 Form of Severance Agreement between First Keystone Federal Savings Bank and Carol Walsh dated May 26, 1999. **
39 11 Statement re: computation of per share earnings. See Note 2 to the Consolidated Financial Statements included in the Annual Report set forth as Exhibit 13 hereto. 13 Annual Report to Stockholders. 21 Subsidiaries of the Registrant - Reference is made to Item 1 "Business," for the required information. 23 Consent of Deloitte & Touche LLP. 99.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
----------------------- (*) Incorporated by reference from the Registration Statement Form S-1 (Registration No. 33-84824) filed by the Registrant with the SEC on October 6, 1994, as amended. (**) Incorporated by reference from the Form 10-K filed by the Registrant with the SEC on December 29, 1999 (File No. 000-25328). (***) Incorporated by reference from the Form 10-K filed by the Registrant with SEC on December 29, 1995 (File No. 000-25328). (****) Incorporated from Appendix A of the Registrant's definitive proxy statement dated December 24, 1998 (File No. 000-25328). (b) Reports filed on Form 8-K. None. 40 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST KEYSTONE FINANCIAL, INC. By: /s/ Donald S. Guthrie -------------------------------- Donald S. Guthrie Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities and Exchange Act of 1934, this report had been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ Donald S. Guthrie December 27, 2002 - -------------------------------------------------- Donald S. Guthrie Chairman of the Board and Chief Executive Officer (Principal Executive Officer) /s/ Thomas M. Kelly December 27, 2002 - -------------------------------------------------- Thomas M. Kelly President and Chief Financial Officer (Principal Financial and Accounting Officer) /s/ Donald A. Purdy December 27, 2002 - -------------------------------------------------- Donald A. Purdy Director /s/ Edward Calderoni December 27, 2002 - -------------------------------------------------- Edward Calderoni Director /s/ Edmund Jones December 27, 2002 - -------------------------------------------------- Edmund Jones Director /s/ Donald G. Hosier, Jr. December 27, 2002 - -------------------------------------------------- Donald G. Hosier, Jr. Director /s/ Marshall J. Soss December 27, 2002 - -------------------------------------------------- Marshall J. Soss Director /s/ William J. O'Donnell December 27, 2002 - -------------------------------------------------- William J. O'Donnell Director
41 CERTIFICATION I, Donald S. Guthrie, Chairman of the Board and Chief Executive Officer of First Keystone Financial, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of First Keystone Financial, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: December 27, 2002 /s/ Donald S. Guthrie ------------------------------------------------- Donald S. Guthrie Chairman of the Board and Chief Executive Officer 42 CERTIFICATION I, Thomas M. Kelly, President and Chief Financial Officer of First Keystone Financial, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of First Keystone Financial, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: December 27, 2002 /s/ Thomas M. Kelly --------------------------------------- Thomas M. Kelly President and Chief Financial Officer 43 EX-13 3 w67175exv13.txt FIRST KEYSTONE FINANCIAL, INC. ANNUAL REPORT 2002 EXHIBIT 13 ANNUAL REPORT 2002 [STREET SCENE GRAPHIC] THE FINE ART OF COMMUNITY BANKING FIRST KEYSTONE FINANCIAL, INC. [FRAMED STREET SCENE GRAPHIC] TRADITION First Keystone Federal Savings Bank has been an integral part of the Delaware and Chester County communities since 1882; its employees have been active participants in the area's development from suburbs and farmland to centers of business and government. With the skill of a master artist, First Keystone Financial blends dedication to its community with a commitment to the company's success. We are proud to present the Company's annual report, "The Fine Art of Community Banking." The portrait above is the main office in Media; First Keystone Federal came to the Delaware County seat in 1968 and built the Victorian-reminiscent headquarters in 1977. [PAINTER'S PALETTE GRAPHIC] A Message to Our Shareholders .............................................. 1 2002 The Year in Review .................................................... 4 Selected Consolidated Financial and Other Data ......................................................... 7 Management's Discussion and Analysis of Financial Condition and Results of Operations .............................................. 9 Report of Independent Auditors ............................................. 20 CONSOLIDATED FINANCIAL STATEMENTS Consolidated Statements of Financial Condition ................................................. 21 Consolidated Statements of Income .............................................................. 22 Consolidated Statements of Stockholders' Equity ................................................ 23 Consolidated Statements of Cash Flows .......................................................... 24 Notes to Consolidated Financial Statements ....................................................... 25 Corporate Information ...................................................... 39 TABLE OF CONTENTS A MESSAGE TO OUR SHAREHOLDERS We are pleased to report that despite a difficult economy, First Keystone Financial has experienced a year of improved profitability and continued growth. In reflecting on our history as a financial institution, we have come to realize that our success has been built as much on our ability to become an integral part of our community as it has been on achieving specific financial goals. As smaller banks have been taken over by larger financial conglomerates, First Keystone Federal Savings Bank, the Company's wholly-owned subsidiary, has profited from maintaining a consistency of service, offering an array of products and providing a personal approach to banking. We have learned that although much of banking may be a science in many respects, it is also an art in that it depends on the understanding of people, their needs, their problems and their goals in order to thrive. To maintain a solid financial position, the challenge is to align the Company's goals of improving earnings and building franchise value with the customers' objectives to satisfy all of their financial needs at one financial center. Our strong performance for fiscal year 2002 indicates that we are meeting that challenge. We made improvements in many of our key financial ratios. Loan originations were outstanding in every category. Our balance sheet reflects a better mix of higher yielding assets and lower costing liabilities. As we reflect on the year, we are encouraged by our strong earnings and solid growth. A few noteworthy highlights include: Core deposits increased 19% from the prior year Commercial real estate and multi-family loans increased 39% Our stock price increased 17% Despite the turbulence on Wall Street, we believe that First Keystone Financial's shareholders had a good year. The Company not only increased its earnings per share, but also [PHOTO] RETIRING CHAIRMAN OF FIRST KEYSTONE FINANCIAL, INC., DONALD A. PURDY (LEFT) SHOWN SHAKING HANDS WITH HIS SUCCESSOR, THE NEW CHAIRMAN AND CEO OF THE COMPANY, DONALD S. GUTHRIE (RIGHT). THOMAS M. KELLY (BACK) IS THE NEWLY APPOINTED PRESIDENT OF FIRST KEYSTONE FINANCIAL, INC. THE HOLDING COMPANY FOR FIRST KEYSTONE FEDERAL SAVINGS BANK. [ARTIST PALETTE GRAPHIC] 1 A MESSAGE TO OUR SHAREHOLDERS CONTINUED [BASEBALL GAME GRAPHIC] TEAM BUILDING When the Aston-Middletown Little League field (shown above) was washed away in a flood two seasons ago, the fathers, mothers and other community supporters gave of themselves and their resources to get the field ready for the following season. This area of Delaware County is home to many depositors and employees of the Bank. As the leadership at First Keystone begins to change hands, team building has become one of the Company's priorities. To help ensure a smooth transition, shared responsibilities and generate new enthusiasm, the Company's senior management team has expanded to include expertise in commercial lending and information technology. [ARTIST PALETTE GRAPHIC] enhanced its dividend rate over 12% from the prior year. The Company's stock closed at $15.50 per share on September 30, 2002, compared to $13.25 the previous fiscal year. Book value per share was $16.33 at the end of fiscal 2002 compared to $15.06, representing an 8% increase from the prior year. We will continue to implement, when appropriate, stock repurchase programs as part of the Company's capital management strategy to enhance shareholder value. We are pleased to report that net income was up over 10% for the year, diluted earnings per share increased by 14% and loan growth continued to be funded primarily through growth in core deposits. As expected, our net interest margin increased during the first half of the year as the Company's interest-bearing liabilities continued to reprice downward to a greater degree than its interest-earning assets. Although this resulted in enhanced net income, the Company experienced compression in its net margin in the fourth quarter of fiscal 2002 as interest rates remained at historic lows spurring the refinance market and accelerating loan and investment security prepayments. To minimize interest rate risk, the Company began to sell a portion of its current production of long-term residential loans in the secondary market while maintaining the income generated from retaining the loan servicing. All areas of lending did a brisk volume of originations throughout the year. Total outstanding loan balances increased 13% despite numerous payoffs indicating that a significant percentage of these originations consisted of new loans rather than just refinancing of existing portfolio loans. Increased loan demand and the prolonged soft economy, however, also raise concerns for asset quality. The Company's ratio of non-performing assets to total assets did increase to 1.04% at September 30, 2002. Non-performing assets included a $1.3 million commercial real estate loan that subsequent to fiscal year-end returned to current status. Excluding this loan, the Company's ratio of non-performing assets to total assets would have been 0.79% at fiscal year 2 A MESSAGE TO OUR SHAREHOLDERS CONTINUED end compared to 0.65% at the prior fiscal year. As we continue to grow the loan portfolio, asset quality remains our number one priority and we continually evaluate our portfolio to minimize future exposure. We improved our delivery channels to our customers by increasing the functionality and the content of our website and expanding our telephone banking system. In addition, by expanding our line of insurance and investment products through affiliate relationships, we can now offer our customers the added convenience of a full service financial center while providing a source of non-interest income for the Company. With our most recent board appointment of a certified public accountant with both financial auditing and information technology experience, we have built a knowledgeable board of directors that can provide the Company with the guidance it needs to be a capable and effective competitor in the financial industry. We have also further strengthened our organization by expanding our senior management team to include expertise in commercial lending and information technology. As we move forward, we are pleased by the numerous opportunities we see for our Company. We will continue to work hard to increase revenue, leverage our capital position, further improve our balance sheet mix, manage expenses and continue to implement sound risk management policies. We firmly believe that our commitment to the communities we serve is critical to the well being of our Company, is consistent with our mission and is the cornerstone upon which we will continue to prosper. We thank you for the trust that you have placed in us. Sincerely, /s/ Donald S. Guthrie Donald S. Guthrie Chairman of the Board /s/ Thomas M. Kelly Thomas M. Kelly President [PHOTO OF TRAIN STATION] GROWTH The recently restored Glen Mills train station resides a few miles to the north of First Keystone Federal's Chester Heights office, established in 1999. On weekends, a narrow gauge train winds its way along a route dotted by 18th century stone homes, barns and outbuildings to West Chester, the Chester County seat. The Chester Heights area is the fastest growing and one of the most historic areas in Delaware County. Since its opening, the branch has well exceeded deposit forecasts. In addition to the continuing growth of core deposits, the number of home equity loans, construction loans, and commercial real estate loans continue to rise with the influx of population. [ARTIST PALETTE GRAPHIC] 3 2002 THE YEAR IN REVIEW LOAN MIX 2002 [GRAPH] SINGLE-FAMILY 57.3% COMMERCIAL BUSINESS 3.9% CONSUMER 0.4% HOME EQUITY & LINES OF CREDIT 9.1% MULTI-FAMILY & COMMERCIAL RE 19.9% CONSTRUCTION & LAND 9.3%
LOAN MIX 2000 [GRAPH] SINGLE-FAMILY 65.5% COMMERCIAL BUSINESS 1.8% CONSUMER 0.5% HOME EQUITY & LINES OF CREDIT 9.2% MULTI-FAMILY & COMMERCIAL RE 15.5% CONSTRUCTION & LAND 7.3%
LENDING TELLS THE STORY Record breaking volume describes the Company's loan originations for fiscal year 2002. As could be expected with prolonged historically low interest rates, the refinance market led the way. First Keystone's reputation for knowledgeable loan officers and a tradition of retaining its loan servicing helped contribute to the Bank's 135% increase in single-family originations from the prior year. Despite the prepayments and payoffs that are part of the equation in this market, single-family loans ended the fiscal year with an 8% increase in outstanding balances. The better part of this story, however, is that even with the deluge of residential refinancing, the Company continues to successfully implement its strategic plan to diversify the Bank's loan composition to include a better mix of higher-yielding assets. Multi-family and commercial real estate loan originations increased by 178% during fiscal year 2002 and such loans now comprise approximately 20% of the Bank's loan portfolio. The Bank ended fiscal 2002 with a 13% increase in outstanding loan balances from the prior year and its loan portfolio reflects a better mix of higher yielding assets. [PHOTO OF HOT AIR BALLOONS] The heritage of the Brandywine Valley is rich in culture, art and historic events. As can be seen from a hot air balloon on a summer evening, this area with its rolling hills, horse farms and stone buildings, is also one of the most beautiful areas in Pennsylvania. In our tradition of serving customers' needs and anticipating growth, First Keystone Federal serves its southern Chester County customers with offices in Chadds Ford and Willowdale and has been one of the corporate sponsors of the Pennsbury Land Trust Hot Air Balloon Festival in that area for many years. 4 2002 YEAR IN REVIEW CONTINUED DEPOSITS CONTINUE TO FUEL LOAN GROWTH An on-going challenge in a very crowded and competitive market is to maintain and generate core deposits. A 77% increase in non-interest bearing checking accounts helped contribute to the 19% growth in the Bank's core deposits. In addition, by capitalizing on the extended low interest rate environment, First Keystone Federal Savings Bank, over time, has incrementally priced its higher costing certificates of deposit less aggressively and has been successful in shifting deposits to money market demand accounts. As a result of this strategy, the Bank's core deposits comprised 47% of the Bank's liability mix at year-end compared to 41% the prior year. As marketing efforts, word of mouth and sales officers continue to promote the suite of business products that the Bank now offers, we look to business checking accounts to maintain the Bank's cost of funds in a rising interest rate environment. In addition, management will continue to focus energy on generating core deposits by proactively adapting transaction products to meet customer's needs like our hybrid money market demand account, a slightly more restrictive but higher yielding account, than a traditional money market account. DEPOSIT MIX 2002 [GRAPH] CERTIFICATES OF DEPOSIT 53.3% PASSBOOK 12.6% NOW 16.3% NON-INTEREST BEARING 3.1% MONEY MARKET 14.7%
DEPOSIT MIX 2000 [GRAPH] CERTIFICATES OF DEPOSIT 60.7% PASSBOOK 13.9% NOW 14.3% NON-INTEREST BEARING 2.5% MONEY MARKET 8.7%
The business district of Swarthmore is quaint and bustling with unique shops and businesses that serve a college population as well as a community that is both sophisticated and down-to-earth. Since the Bank has expanded its full line of services to include commercial loans, lines of credit, business checking accounts and other business services including insurance and investment products, the business community has discovered a friendly, personable resource for their financial needs. [SWARTHMORE BUSINESS DISTRICT GRAPHIC] 5 2002 YEAR IN REVIEW CONTINUED NET INTEREST MARGIN [GRAPH]
2002 2001 2000 ---- ---- ---- 2.95% 2.68% 2.91%
DILUTED EARNINGS PER SHARE [GRAPH]
2002 2001 2000 ---- ---- ---- $1.34 $1.18 $1.11
COMBINING THE RIGHT MIX OF TECHNOLOGY AND CUSTOMER SERVICE The growth of commercial loans and non-interest bearing checking accounts has created a greater customer demand for enhanced delivery systems. First Keystone has responded to that need by offering a variety of convenient on-line banking products and user-friendly technologies such as distributing monthly statements and check images on CD-ROM for easy account reconciliation and the ability to create custom reports. In servicing its business customers, First Keystone Federal Savings Bank strives to exceed customer expectations by providing hands-on assistance to implement Internet services such as automated payroll processing and its cash management system. Our Cash Management product provides businesses with on-line real-time data to make the monitoring of transactions and cash flow simple. By providing a suite of valuable and efficient financial products that are user-friendly with a personal approach to banking, First Keystone expects to remain a strong and effective competitor in the industry. [WOLFE BUILDING GRAPHIC] First Keystone Federal traces its roots to the City of Chester. In the past few years, Chester, situated between Philadelphia, Pennsylvania and Wilmington, Delaware has experienced a revitalization beginning with redevelopment and construction of new buildings. As one of the remaining financial institutions in the City of Chester, First Keystone is proud to continue its support of the city's revitalization. The Wolfe Building, shown in the painting, has been preserved and refurbished to accommodate new business. 6 FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA The selected consolidated financial and other data of First Keystone Financial, Inc. set forth below does not purport to be complete and should be read in conjunction with, and is qualified in its entirety by, the more detailed information, including the Consolidated Financial Statements and related Notes, appearing elsewhere herein.
AT OR FOR THE YEAR ENDED SEPTEMBER 30, ---------------------------------------------------------------------- 2002 2001 2000 1999 1998 --------- --------- --------- --------- --------- (dollars in thousands, except per share data) Selected Financial Data: Total assets $ 518,346 $ 489,050 $ 463,463 $ 450,126 $ 415,863 Loans receivable, net 288,776 247,664 230,686 226,375 198,343 Mortgage-related securities held to maturity 8,855 11,454 13,056 14,497 18,769 Investment securities held to maturity 10,000 16,532 Assets held for sale: Mortgage-related securities 85,674 117,608 96,257 113,046 115,486 Investment securities 80,624 62,564 42,215 44,315 40,621 Loans 501 225 3,099 1,792 2,799 Real estate owned 248 887 947 297 1,663 Deposits 330,765 311,601 272,562 260,826 247,311 Borrowings 126,237 126,070 142,902 142,437 120,878 Trust preferred securities 20,880 16,200 16,200 16,200 16,200 Stockholders' equity 32,795 30,621 26,569 23,904 26,664 Non-performing assets 5,386 3,189 3,462 3,477 5,367 ---------------------------------------------------------------------- Selected Operations Data: Interest income $ 30,121 $ 31,860 $ 31,068 $ 28,694 $ 27,393 Interest expense 16,527 20,329 19,231 16,956 15,625 ---------------------------------------------------------------------- Net interest income 13,594 11,531 11,837 11,738 11,768 Provision for loan losses 540 540 420 259 186 ---------------------------------------------------------------------- Net interest income after provision for loan losses 13,054 10,991 11,417 11,479 11,582 Other income (expense): Service charges and other fees 1,000 952 941 934 898 Net gain (loss) on sales of interest-earning assets 415 174 (680) 616 577 Other 808 788 1,013 350 58 Operating expenses 12,103 9,975 9,849 9,614 9,084 ---------------------------------------------------------------------- Income before income taxes 3,174 2,930 2,842 3,765 4,031 Income tax expense 448 459 480 917 1,250 ---------------------------------------------------------------------- Net income $ 2,726 $ 2,471 $ 2,362 $ 2,848 $ 2,781 ====================================================================== Per Share Data: Basic earnings per share $ 1.42 $ 1.22 $ 1.14 $ 1.40 $ 1.31 Diluted earnings per share 1.34 1.18 1.11 1.32 1.23 Cash dividends per share 0.36 0.32 0.28 0.24 0.20
7 FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
AT OR FOR THE YEAR ENDED SEPTEMBER 30, -------------------------------------------------------------- 2002 2001 2000 1999 1998 -------------------------------------------------------------- Selected Operating Ratios: (1) Average yield earned on interest-earning assets 6.42% 7.25% 7.47% 7.15% 7.40% Average rate paid on interest-bearing liabilities 3.70 4.83 4.79 4.49 4.68 Average interest rate spread 2.72 2.42 2.68 2.65 2.72 Net interest margin 2.95 2.68 2.91 2.98 3.18 Ratio of interest-earning assets to interest-bearing liabilities 106.54 105.87 104.91 107.91 110.80 Net interest income after provision for loan losses to operating expenses 107.66 110.46 116.48 120.82 127.84 Operating expenses as a percent of average assets 2.41 2.11 2.20 2.26 2.38 Return on average assets 0.54 0.52 0.53 0.67 0.73 Return on average equity 8.77 8.42 9.96 11.18 11.13 Ratio of average equity to average assets 6.17 6.22 5.29 5.99 6.54 Full-service offices at end of period 7 7 7 6 6 Asset Quality Ratios: (2) Non-performing loans as a percent of gross loans receivable 1.76% 0.92% 1.07% 1.39% 1.85% Non-performing assets as a percent of total assets 1.04 0.65 0.75 0.77 1.29 Allowance for loan losses as a percent of gross loans receivable 0.81 0.87 0.86 0.84 0.87 Allowance for loan losses as a percent of non-performing loans 45.89 94.74 80.28 60.63 46.92 Net loans charged-off to average loans receivable 0.13 0.16 0.14 0.03 0.04 Capital Ratios: (2) (3) Tangible capital ratio 8.07% 7.76% 8.32% 8.17% 8.27% Core capital ratio 8.07 7.76 8.32 8.17 8.27 Risk-based capital ratio 16.17 16.81 17.70 18.80 21.09
(1) Adjusted for the effects of tax-free investments. (2) Asset Quality Ratios and Capital Ratios are end of period ratios, except for the ratio of loan charge-offs to average loans. With the exception of end of period ratios, all ratios are based on average daily balances during the indicated periods. Gross loans receivable are net of loans in process. (3) Regulatory capital ratios of the Company's wholly owned subsidiary, First Keystone Federal Savings Bank. Stock Market Information
2002 2001 -------------------------------------------------------------------------------------------- 1ST 2ND 3RD 4TH 1st 2nd 3rd 4th QTR QTR QTR QTR QTR QTR QTR QTR -------------------------------------------------------------------------------------------- Common stock price range of the Company: High $14.00 $15.32 $18.62 $18.87 $10.75 $12.75 $14.50 $14.50 Low $13.31 $14.00 $15.19 $14.45 $9.94 $10.38 $11.50 $13.01
8 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL First Keystone Financial, Inc. (the "Company") is the holding company for its wholly owned subsidiary, First Keystone Federal Savings Bank (the "Bank"). For purposes of this discussion, references to the Company will include its wholly owned subsidiaries, unless otherwise indicated. The Company is a community-oriented banking organization that focuses on providing customer and business services within its primary market area, consisting primarily of Delaware and Chester counties in the Commonwealth of Pennsylvania. The following discussion should be read in conjunction with the Company's consolidated financial statements presented in this Annual Report. The primary asset of the Company is its investment in the Bank and, accordingly, the discussion below with respect to results of operations relates primarily to the operations of the Bank. The Company's results of operations depend primarily on its net interest income which is the difference between interest income on interest-earning assets, which principally consist of loans, mortgage-related securities and investment securities, and interest expense on interest-bearing liabilities, which principally consist of deposits and Federal Home Loan Bank ("FHLB") advances. The Company's results of operations also are affected by the provision for loan losses (the amount of which reflects management's assessment of the known and inherent losses in its loan portfolio that are both probable and reasonably estimable), the level of its non-interest income, including service charges and other fees as well as gains and losses from the sale of certain assets, the level of its operating expenses, and income tax expense. FORWARD LOOKING STATEMENTS In this Annual Report, the Company has included certain "forward-looking statements" concerning the future operations of the Company. It is management's desire to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. This statement is for the express purpose of availing the Company of the protections of such safe harbor with respect to all "forward-looking statements" contained in this Annual Report. Such forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those currently anticipated due to a number of factors. Such forward-looking statements may be identified by the use of words such as "believe","expect", "should","estimated","potential and similar expressions." Examples of forward-looking statements include, but are not limited to, estimates with respect to the financial condition, business strategy, expected or anticipated revenue, results of operations and the business of the Company that are subject to various factors which could cause actual results to differ materially from these estimates. Factors that could affect results include interest rate trends, deposit flows, competition, the general economic climate in Delaware and Chester counties, the mid-Atlantic region and the country as a whole, loan demand, real estate values, loan delinquency rates, levels of non-performing assets, changes in federal and state regulation, changes in accounting policies and practices and other uncertainties described in the Company's filings with the Securities and Exchange Commission, including its Form 10-K for the year ended September 30, 2002. These factors should be considered in evaluating the "forward-looking statements", and undue reliance should not be placed on such statements. The Company assumes no obligation to update or revise forward-looking statements to reflect any changed assumptions, any unanticipated events or any changes in the future. CRITICAL ACCOUNT POLICIES Accounting policies involving significant judgements and assumptions by management, which have, or could have, a material impact on the carrying value of certain assets or comprehensive income, are considered critical accounting policies. In management's opinion, the most critical accounting policy affecting the Company's financial statements is the evaluation of the allowance for loan losses. The Company maintains an allowance for loan loss at a level management believes is sufficient to provide for known and inherent losses in the loan portfolio. The determination of the allowance for loan losses involves significant judgement and assumptions by management which may have a material impact on the carrying value of net loans and potentially on the net income we recognize from period to period. Accordingly, there is a likelihood that materially different amounts would be reported under different, but reasonably plausible conditions or assumptions. For a description of the methods the Company uses to determine the Company's allowance for loan losses, see "Results of Operations - Provisions for Loan Losses." 9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ASSET AND LIABILITY MANAGEMENT The principal objectives of the Company's asset and liability management are to (1) evaluate the interest rate risk existing in certain assets and liabilities, (2) determine the appropriate level of risk given the Company's business focus, operating environment, capital and liquidity requirements and performance objectives, (3) establish prudent asset concentration guidelines, and (4) manage the assessed risk consistent with Board approved guidelines. Through asset and liability management, the Company seeks to reduce both the vulnerability and volatility of its operations to changes in interest rates and to manage the ratio of interest-rate sensitive assets to interest-rate sensitive liabilities within specified maturities or repricing periods. The Company's actions in this regard are taken under the guidance of the Asset/Liability Committee ("ALCO"), which is chaired by the Chief Financial Officer and comprised of members of the Company's senior management. The ALCO meets no less than quarterly to review, among other things, liquidity and cash flow needs, current market conditions and the interest rate environment, the sensitivity to changes in interest rates of the Company's assets and liabilities, the historical and market values of assets and liabilities, unrealized gains and losses, and the purchase and sale activity and maturities of investment securities, deposits and borrowings. In addition, the pricing of the Company's residential loans and deposits is reviewed at least weekly while the pricing of loans originated for sale in the secondary market is reviewed daily. The ALCO reports to the Company's Board of Directors no less than once a quarter. The Company's primary asset/liability monitoring tool consists of various asset/liability simulation models, which are prepared on a quarterly basis and are designed to capture the dynamics of the balance sheet as well as rate and spread movements and to quantify variations in net interest income under different interest rate scenarios. One of the models consists of an analysis of the extent to which assets and liabilities are interest rate sensitive and measures an institution's interest rate sensitivity gap. An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities and is considered negative when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Conversely, during a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. Although an interest rate sensitivity gap measure may be useful, it is limited in its ability to predict trends in future earnings. It makes no presumptions about changes in prepayment tendencies, deposit or loan maturity preferences or repricing time lags that may occur in response to a change in the interest rate environment. For purposes of the gap table, annual prepayment assumptions range from 10% to 40% for fixed-rate mortgage loans and mortgage-related securities and 5% to 15% for adjustable-rate mortgage loans and mortgage-related securities. Passbook and statement savings accounts are assumed to decay at a rate of 14.0% per year. Money market deposit accounts ("MMDA") are assumed to decay at a rate of 25% per year. Negotiable order of withdrawal ("NOW") accounts are assumed to decay at a rate of 20% per year. The Bank's passbook, statement savings, MMDA and NOW accounts are generally subject to immediate withdrawal. However, management considers a portion of these deposits to be core deposits (which consists of passbook, statement saving, MMDA and NOW accounts) having significantly longer effective maturities based upon the Bank's experience in retaining such deposits in changing interest rate environments. Borrowed funds are included in the period in which they can be called or when they are due. Management believes that the assumptions used to evaluate the vulnerability of the Bank's operations to changes in interest rates are considered reasonable. However, certain shortcomings are inherent in the method of analysis presented in the table below. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features which restrict changes in market rates both on a short-term and over the life of the asset. Further, in the event of a change in interest rates, prepayments and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table summarizes the anticipated maturities or repricing of the Company's interest-earning assets and interest-bearing liabilities as of September 30, 2002 based on the information and assumptions set forth above.
More Than More Than Within Six to One Year Three Over Six Twelve to Three Years to Five Months Months Years Five Years Years Total --------- --------- --------- ---------- --------- --------- (Dollars in thousands) Interest-earning assets: Loans receivable, net(1) $ 97,648 $ 40,581 $ 57,328 $ 34,965 $ 54,474 $ 284,996 Mortgage-related securities 41,630 22,996 26,713 519 2,671 94,529 Loans held for sale 501 501 Investment securities(2) 27,856 4,886 2,860 3,609 47,984 87,195 Interest-earning deposits 19,870 19,870 --------- --------- --------- --------- --------- --------- Total interest-earning assets $ 187,505 $ 68,463 $ 86,901 $ 39,093 $ 105,129 $ 487,091 --------- --------- --------- --------- --------- --------- Interest-bearing liabilities: Deposits $ 82,629 $ 64,399 $ 110,698 $ 61,126 $ 11,913 $ 330,765 Borrowed funds 81,000 10,000 19,819 15,000 418 126,237 --------- --------- --------- --------- --------- --------- Total interest-bearing liabilities $ 163,629 $ 74,399 $ 130,517 $ 76,126 $ 12,331 $ 457,002 --------- --------- --------- --------- --------- --------- Excess (deficiency) of interest-earning assets over interest-bearing liabilities $ 23,876 $ (5,936) $ (43,616) $ (37,033) $ 92,798 $ 30,089 ========= ========= ========= ========= ========= ========= Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities $ 23,876 $ 17,940 $ (25,676) $ (62,709) $ 30,089 ========= ========= ========= ========= ========= Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities as a percentage of total assets 4.61% 3.46% (4.95)% (12.10)% 5.80% ========= ========= ========= ========= =========
(1) Balances have been reduced for non-accruing loans, which amounted to $3.8 million at September 30, 2002. (2) Balance includes Federal Home Loan Bank stock. The Company also utilizes an analysis of the market value of portfolio equity, which addresses the estimated change in the value of the Bank's equity arising from movements in interest rates. The market value of portfolio equity is estimated by valuing the Bank's assets and liabilities under different interest rate scenarios. The extent to which assets gain or lose value in relation to gains or losses of liabilities as interest rates increase or decrease determines the appreciation or depreciation in equity on a market value basis. Market value analysis is intended to evaluate the impact of immediate and sustained shifts of the current yield curve upon the market value of the Bank's current balance sheet. The Company utilizes reports prepared by the Office of Thrift Supervision ("OTS") to measure interest rate risk. Using data submitted by the Bank, the OTS performs scenario analysis to estimate the net portfolio value ("NPV") of the Bank over a variety of interest rate scenarios. The NPV is defined as the present value of expected cash flows from existing assets less the present value of expected cash flows from existing liabilities plus the present value of net expected cash inflows from existing off-balance sheet contracts. The interest rate risk measures used by the OTS include an "Exposure Measure" or "Post-Shock" NPV ratio and a "Sensitivity Measure". The "Post-Shock" NPV ratio is the net present value as a percentage of assets over the various yield curve shifts. A low "Post-Shock" NPV ratio indicates greater exposure to interest rate risk and can result from a low initial NPV ratio or high sensitivity to changes in interest rates. The "Sensitivity Measure" is the decline in the NPV ratio, in basis points, caused by a 2% increase or decrease in rates, whichever produces a larger decline. 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The table below sets forth the Bank's NPV assuming an immediate change in interest rates of plus and minus 100, 200 and 300 basis points. Due to the low prevailing interest rate environment, the OTS did not provide a calculation for the minus 200 and minus 300 basis point change in rates. Dollar amounts are expressed in thousands as of September 30, 2002.
Net Portfolio Value Net Portfolio Value as a % of Assets Changes in --------------------------------- -------------------- Rates in Dollar Percentage Basis Points Amount Change Change NPV Ratio Change - ------------ ------ ------- ---------- --------- ------ 300 28,137 (13,218) (32)% 5.64% (216) 200 34,849 (6,507) (16) 6.83 (98) 100 40,169 (1,186) (3) 7.70 (11) 0 41,355 7.81 (100) 37,434 (3,921) (9) 7.01 (80) (200) N/A N/A N/A N/A N/A (300) N/A N/A N/A N/A N/A
As is the case with the GAP table, certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV require the making of certain assumptions which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the NPV model presented assumes that the composition of the Bank's interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Although the NPV measurements and net interest income models provide an indication of the Bank's interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on the Bank's net interest income and may differ from actual results. The Company is aware of its interest rate risk exposure in the event of rapidly rising rates. Due to the Company's recognition of the need to control interest rate exposure, the Company's current policy is to sell new fixed-rate single-family residential mortgage loans into the secondary market. In addition, in recent years, the Company has emphasized the origination of the construction and land, multi-family and commercial real estate and consumer loans which generally have either adjustable interest rates and/or shorter contractual terms than single-family residential loans. The Company plans to continue these lending strategies. Derivative financial instruments include futures, forwards, interest rate swaps, option contracts, and other financial instruments with similar characteristics. The Company currently does not enter into futures, forwards, swaps or options. However, the Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. Commitments generally have fixed expiration dates and may require additional collateral from the borrower if deemed necessary. Commitments to extend credit are not recorded as an asset or liability until the instruments is exercised. The Company is subject to certain market risks and interest rate risks from the time a commitment is issued to originate new loans. In an effort to protect the Company against adverse interest rate movements, at the time an application is taken for a fixed-rate loan, the Company typically enters into an agreement to sell the loan, or a loan within the same interest-rate range, into the secondary market. This is known as a "matched sale" approach and reduces interest-rate risk with respect to these loans. There is still some portion of these loans which may never close for various reasons. However, the agencies the Company sells loans to permit some flexibility in delivering loans product to them. In certain instances, if the loans delivered for sale do not match the characteristics outlined in the forward sale commitments the gain on sale may be reduced. 12 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CHANGES IN FINANCIAL CONDITION GENERAL. Total assets of the Company increased by $29.3 million, or 6.0%, from $489.1 million at September 30, 2001 to $518.3 million at September 30, 2002. The increase primarily reflected growth of the loan portfolio and investment securities available for sale and to a lesser extent, cash and cash equivalents, partially offset by a decrease in mortgage-related securities available for sale. The asset growth was primarily funded by increases in customer deposits. CASH AND CASH EQUIVALENTS. Cash and cash equivalents, which consists of cash on hand and in other banks in interest-earning and non-interest-earning accounts, amounted to $24.6 million and $19.1 million at September 31, 2002 and 2001, respectively. Cash and cash equivalents are available as a source of funds for originations of new loans and purchases of additional securities investments. INVESTMENT SECURITIES AVAILABLE FOR SALE. Total investment securities available for sale increased by $18.1 million, or 28.9%, from $62.6 million at September 30, 2001 to $80.6 million at September 30, 2002. The increase in investments was resulted primarily from investing the cash flows from increased deposits and the heavy prepayments of mortgage-related securities experienced during fiscal 2002 as the mortgages collateralizing such securities repaid due to the current low interest rate environment. LOANS HELD FOR SALE AND LOANS RECEIVABLE, NET. Aggregate loans receivable (loans receivable, net and loans held for sale) increased $41.4 million or 16.7% to $289.3 million at September 30, 2002 compared to $247.9 million at September 30, 2001. The increase was primarily the result of the Company's continued emphasis on increasing its investment in multi-family and commercial real estate (including construction) and commercial business loans which increased to $100.6 million, or 33.2% of the aggregate loan portfolio. Such loans increased in the aggregate by $19.8 million, or 24.6%, from the end of the prior fiscal year. In addition, the increase was attributed, in part, to increases in residential loans of $13.4 million, or 8.4%, and home equity loans and lines of credit of $1.7 million, or 6.8%. Loans held for sale increased from $225,000 at September 30, 2001 to $501,000 at September 30, 2002. In the latter part of fiscal 2002, management decided to sell 30 year, fixed-rate single-family residential loans in order to minimize interest rate risk in a rising interest rate environment. MORTGAGE-RELATED SECURITIES AND MORTGAGE-RELATED SECURITIES AVAILABLE FOR SALE. Mortgage-related securities and mortgage-related securities available for sale decreased in the aggregate by $34.5 million, or 26.8%, to $94.5 million at September 30, 2002 compared to $129.1 million at September 30, 2001. The significant decrease in mortgage-related securities was due to the historically low interest rate environment existed in fiscal 2002 which resulted in accelerated prepayments and the reinvestment of cash flows into higher yielding loan products. NON-PERFORMING ASSETS. The Company's total non-performing loans and real estate owned increased to $5.4 million, or 1.0% of total assets, at September 30, 2002 compared to $3.2 million, or 0.7% of total assets, at the end of the prior fiscal year. The increase in non-performing assets in fiscal 2002 was primarily attributable to the placement of four commercial real-estate loans aggregating $3.7 million as non-performing. One of such loans, in the amount of $1.3 million, has subsequently returned to current status in October 2002. DEPOSITS. Deposits increased by $19.2 million, or 6.2%, from $311.6 million at September 30, 2001 to $330.8 million at September 30, 2002. This increase was primarily due to a $25.1 million, or 19.3%, increase in the Company's core accounts (non-interest bearing, NOW, passbook, and MMDA accounts) as a result of the Company's continued emphasis on these deposit accounts. Certificates of deposit decreased by $5.9 million, or 3.2%, to $176.2 million in the current fiscal year. BORROWINGS. The Company's total borrowings increased slightly to $126.2 million at September 30, 2002 from $126.1 million at September 30, 2001 as the Company primarily used deposit inflows to fund asset growth. The FHLB advances have a weighted average interest rate of 5.4% at September 30, 2002. See Note 9 to the Consolidated Financial Statements for further information. EQUITY. At September 30, 2002, total stockholders' equity was $32.8 million, or 6.3% of total assets, compared to $30.6 million, or 6.3% of total assets, at September 30, 2001. The $2.2 million increase was due to net income for the year of $2.7 million and a $536,000 increase in net unrealized gains on available for sale securities partially offset by the cost of the repurchasing of 61,109 shares of common stock during fiscal 2002 and the payment of $734,000 in dividends. 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AVERAGE BALANCES, NET INTEREST INCOME AND YIELDS EARNED AND RATES PAID. The following table sets forth, for the periods indicated, information regarding (i) the total dollar amount of interest income of the Company from interest- earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rate; (iii) net interest income; (iv) interest rate spread; and (v) net interest margin. Information is based on average daily balances during the indicated periods; yields were adjusted for the effects of tax-free investments using the statutory tax rate.
YEAR ENDED SEPTEMBER 30, ------------------------------------------------------------------------------------------------- 2002 2001 2000 YIELD/COST --------------------------- --------------------------- --------------------------- AT AVERAGE Average Average SEPT. 30, AVERAGE YIELD/ Average Yield/ Average Yield/ 2002 BALANCE INTEREST COST Balance Interest Cost Balance Interest Cost ------------------------------------------------------------------------------------------------- (Dollars in Thousands) Interest-earning assets: Loans receivable(1) (2) 6.82% $267,208 $19,379 7.25% $237,419 $ 18,711 7.88% $232,807 $ 18,533 7.96% Mortgage-related securities(2) 5.75 113,827 6,441 5.66 130,283 8,605 6.60 125,246 8,582 6.85 Investment securities(2) 5.18 76,826 4,509 5.87 63,545 4,396 6.92 51,331 3,809 7.42 Other interest-earning assets 1.65 17,946 223 1.24 14,165 560 3.95 11,807 551 4.67 -------- -------- -------- -------- -------- -------- Total interest-earning assets 6.12 475,807 $30,552 6.42 445,412 $ 32,272 7.25 421,191 $ 31,475 7.47 -------- -------- -------- -------- -------- -------- Non-interest-earning assets 27,855 26,389 26,738 -------- -------- -------- Total assets $503,662 $471,801 $447,929 ======== ======== ======== Interest-bearing liabilities: Deposits 2.44 $319,344 $ 9,599 3.01 $294,731 $ 13,062 4.43 $268,157 $ 11,352 4.23 FHLB advances and other borrowings 5.41 127,264 6,928 5.44 125,988 7,267 5.77 133,330 7,879 5.90 -------- -------- -------- -------- -------- -------- Total interest-bearing liabilities 3.26 446,608 16,527 3.70 420,719 20,329 4.83 401,487 19,231 4.79 -------- -------- -------- -------- -------- -------- Interest rate spread 2.86 2.72 2.42 2.68 Non-interest-bearing liabilities 25,977 21,744 22,732 -------- -------- -------- Total liabilities 472,585 442,463 424,219 Stockholders' equity 31,077 29,338 23,710 -------- -------- -------- Total liabilities and stockholders' equity $503,622 $471,801 $447,929 ======== ======== ======== Net interest-earning assets $ 29,199 $ 24,693 $ 19,704 ======== ======== ======== Net interest income/net interest margin(3) 14,025 2.95% 11,943 2.68% 12,244 2.91% ======= ====== ====== Less: tax equivalent adjustments (431) (412) (407) -------- -------- -------- Net interest income $ 13,594 $ 11,531 $ 11,837 ======== ======== ======== Ratio of average interest-earning assets to average interest-bearing liabilities 106.54% 105.87% 104.91% ======== ======== ========
(1) Includes non-accrual loans. (2) Includes assets classified as either available for sale or held for sale. (3) Net interest income divided by interest-earning assets. 14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RATE/VOLUME ANALYSIS. The following table describes the extent to which changes in interest rates and changes in the volume of interest-related assets and liabilities have affected the Company's interest income and expense during the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) changes in rate (change in rate multiplied by prior year volume), and (iii) total change in rate and volume. The combined effect of changes in both rate and volume has been allocated proportionately to the change due to rate and the change due to volume. The table below has been prepared on a tax-equivalent basis.
YEAR ENDED SEPTEMBER 30, -------------------------------------------------------------- 2002 VS.2001 2001 vs.2000 ------------------------------- ----------------------------- INCREASE (DECREASE) DUE TO Increase (Decrease) Due To ------------------------------- ----------------------------- TOTAL Total INCREASE Increase RATE VOLUME (DECREASE) Rate Volume (Decrease) ------- ------- ---------- ------- ------- ---------- Interest-earnings assets: Loans receivable(1) $(1,166) $ 1,834 $ 668 $ (182) $ 360 $ 178 Mortgage-related securities(1) (1,150) (1,014) (2,164) (208) 231 23 Investment securities(1) (2) (299) 412 113 (234) 821 587 Other interest-earning assets (551) 214 (337) (29) 38 9 ------- ------- ------- ------- ------- ------- Total interest-earning assets (3,166) 1,446 (1,720) (653) 1,450 797 ------- ------- ------- ------- ------- ------- Interest-bearing liabilities: Deposits (4,677) 1,214 (3,463) 549 1,161 1,710 FHLB advances and other borrowings (413) 74 (339) (185) (427) (612) ------- ------- ------- ------- ------- ------- Total interest-bearing liabilities (5,090) 1,288 (3,802) 364 734 1,098 ------- ------- ------- ------- ------- ------- Increase (decrease) in net interest income $ 1,924 $ 158 $ 2,082 $(1,017) $ 716 $ (301) ======= ======= ======= ======= ======= =======
(1) Includes assets classified as either available for sale or held for sale. (2) The above table is presented on a tax-equivalent basis. RESULTS OF OPERATIONS GENERAL. The Company reported net income of $2.7 million, $2.5 million and $2.4 million for the years ended September 30, 2002, 2001 and 2000, respectively. The $255,000 increase in net income for the year ended September 30, 2002 compared to the year ended September 30, 2001 was primarily due to the $2.1 million, or 17.9%, increase in net interest income combined with a $309,000, or 16.1%, increase in non-interest income partially offset by a $2.1 million, or 21.3%, increase in non-interest expense. The $109,000 increase in net income for the year ended September 30, 2001 compared to the year ended September 30, 2000 was primarily due to the $640,000, or 50.2%, increase in non-interest income offset by a $426,000, or 3.7%, decrease in net interest income after provision for loan losses combined with a $126,000, or 1.3%, increase in non-interest expense. NET INTEREST INCOME. Net interest income is determined by the interest rate spread (the difference between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. All percentages are reported on a fully tax-equivalent basis. The Company's average interest-rate spread was 2.72%, 2.42% and 2.68% for the years ended September 30, 2002, 2001, and 2000, respectively. The Company's interest-rate spread was 2.86% at September 30, 2002. The Company's net interest margin (net interest income as a percentage of average interest-earning assets) was 2.95%, 2.68% and 2.91% for the years ended September 30, 2002, 2001 and 2000, respectively. In fiscal 2002, the changes in net interest spread and net interest margin were the result of lower short-term interest rates which impacted the rates paid on the Company's interest-bearing core deposits and shorter term certificates of deposit by repricing downward at a greater degree than its interest-earning assets. However, in fiscal 2001, the Company's net interest spread and net interest margin were adversely impacted by the significant interest rate decreases implemented by the Board of Governors of the Federal Reserve System. Due to the repricing characteristics of the Company's interest-earning assets, they repriced downward more rapidly than its interest-bearing liabilities. Net interest income increased to $13.6 million in the year ended September 30, 2002 as compared to 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS $11.5 million in fiscal 2001. The $2.1 million, or 17.9%, increase was primarily due to decreases in rates paid on interest-bearing liabilities. Net interest income decreased to $11.5 million in fiscal 2001 as compared to $11.8 million in fiscal 2000. The $306,000, or 2.6%, decrease came as a result of a $1.1 million increase in interest expense partially offset by a $792,000 increase in interest income. The decrease in net interest income was a result of higher short-term interest rates experienced in calendar year 2000 causing interest-bearing liabilities to reprice more frequently than the Company's interest-earning assets. INTEREST INCOME. Total interest income amounted to $30.1 million for the year ended September 30, 2002 compared to $31.9 million for the year ended September 30, 2001. The decrease in fiscal 2002 was primarily due to a $2.2 million, or 25.1%, decrease in interest income from mortgage-related securities as a result of a 94 basis point decrease in the yield earned combined with a $16.5 million, or 12.6%, decrease in the average balance of the securities portfolio. The decrease was offset, in part, by an increase in interest income on loans. Interest income on loans increased $668,000, or 3.6%, due to a $29.8 million, or 12.5%, increase in the average balance thereof offset, in part, by a 63 basis point decrease in the average yield earned. The increase in the average balances of loans was due to increases in the amount of commercial real estate and commercial business loans reflecting the Company's continued emphasis on expanding its commercial loan portfolio since such loans generally bear higher rates of interest and have shorter contractual maturities than single-family residential loans. The $792,000, or 2.5%, increase in total interest income during the year ended September 30, 2001 as compared to fiscal 2000 was due to a $610,000, or 4.9%, increase in interest income from investments and mortgage-related securities as a result of a $17.3 million, or 9.8%, increase in the average balance of the securities portfolio offset, in part, by a 31 basis point decrease in the yield earned. The increase in the average balance was due to the reinvestment of cash on hand at the end of fiscal 2000 resulting from the sale of $24.3 million of securities as part of the Company's asset/liability management strategy as well as maintaining leverage on the Company's balance sheet to maximize earnings. The decline in yield was due to the declining interest rate environment existing during most of fiscal 2001 as a result of cuts in interest rates implemented by the Federal Reserve. Additionally, interest income on loans increased $178,000, or 1.0%, due to a $4.6 million, or 2.0%, increase in the average balance thereof offset by a 6 basis point decrease in the average yield earned. INTEREST EXPENSE. Total interest expense decreased by $3.8 million, or 18.7%, during the year ended September 30, 2002 compared to fiscal 2001 primarily due to a $3.5 million decrease in interest expense on deposits and a $339,000 decrease in interest expense on borrowings. The decrease in interest expense on deposits was due to a 142 basis point decrease in the average rate paid offset, in part, by a $24.6 million increase in the average balance of deposits. The decrease in interest expense on borrowings was due to a 33 basis point decrease in the average rate paid off-set by a $1.3 million increase in the average balance of borrowings. The increased level of deposits was due to the decline in the equities market combined with the marketing efforts of the Company to attract deposits, particularly core deposits. The deposit inflow was used to fund loan originations, to purchase investment securities and to repay shorter term borrowings. Total interest expense amounted to $20.3 million for the year ended September 30, 2001 as compared to $19.2 million for fiscal 2000. Total interest expense increased by $1.1 million, or 5.7%, during the year ended September 30, 2001 compared to fiscal 2000 due to a $1.7 million increase in interest expense on deposits partially offset by a $612,000 decrease in interest expense on borrowings. The increase in interest expense on deposits was due to a $26.6 million increase in the average balance of deposits and a 20 basis point increase in the average rate paid thereon. The decrease in interest expense on borrowings was due to a $7.3 million decrease in the average balance of borrowings combined with an 13 basis point decrease in the average rate paid. The increased level of deposits was due to the Company's increased marketing of its core deposit products and was used to fund loan originations, purchases of investment and mortgage-related securities and to repay higher rate shorter term borrowings. The increase in the rates paid on deposits was due to rising short-term interest rates experienced during the latter part of calendar year 2000. PROVISIONS FOR LOAN LOSSES. Provisions for loan losses are charged to earnings to maintain the total allowance for loan losses at a level believed by management to cover all known and inherent losses in the Company's loan portfolio. Management's 16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS analysis includes consideration of the Company's historical experience, the volume and type of lending conducted by the Company, the amount of the Company's classified assets, the status of past due principal and interest payments, general economic conditions, particularly as they relate to the Company's primary market area, and other factors related to the collectibility of the Company's loan and loans held for sale portfolios. Management of the Company assesses the allowance for loan losses on a monthly basis and makes provisions for loan losses as deemed necessary in order to maintain the allowance for loan losses at a level management believes covers all known and inherent losses that are both probable and reasonably estimable. For the years ended September 30, 2002 and 2001, the provision for loan losses remained at $540,000 as compared to $420,000 for fiscal 2000. The provision for allowance for loan losses for fiscal 2002 remained at the same level as fiscal 2001 due to the Company's re-evaluation of its estimate of losses with respect to its non-conforming loans based on its loss experience and the reallocation of a portion of the allowance to commercial real estate and commercial business loans due to the continued increased investment in such loans. During fiscal 2001, the Company increased its provision for loan losses as compared to fiscal 2000 primarily due to its assessment of the amount of losses it would incur with respect to the non-conforming loans remaining in its portfolio. Although the Company had ceased origination of this type of loan during fiscal 2000, it had in its portfolio loans that were not sold in the secondary market for a variety of reasons. The provision for fiscal 2001 also increased due to the continued growth of the Company's commercial real estate and commercial business loan portfolios which the Company believed had a greater inherent level of loss than traditional single-family residential loans. At September 30, 2002, the Company's allowance for loan losses totalled $2.4 million which amounted to 45.9% of total non- performing loans and .81% of gross loans receivable. Although management of the Company believes that the Company's allowance for loan losses was adequate at September 30, 2002, based on facts and circumstances available to it, there can be no assurances that additions to such allowance will not be necessary in future periods, which would adversely affect the Company's results of operations for such periods. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's provision for loan losses and the carrying value of its other non-performing assets based on their judgments about information available to them at the time of their examination. Such agencies may require the Company to make additional provisions for estimated loan losses based on judgements different from those of management. NON-INTEREST INCOME. The $309,000, or 16.1%, increase in non-interest income for the year ended September 30, 2002 as compared to fiscal 2001 was primarily due to a $279,000 increase in the gain on sale of $7.1 million of investment securities along with a $48,000 increase in service charges and other fees offset, in part, by a $38,000 decrease in gains on sale of loans held for sale. For the year ended September 30, 2001, the Company reported non-interest income of $1.9 million compared to $1.3 million for the year ended September 30, 2000. The primary reason for the $640,000, or 50.2%, increase in non-interest income in fiscal 2001 was the recognition in the prior fiscal year of a $886,000 loss on the sale of investments and mortgage-related securities offset in part by a $278,000 distribution of common stock included in other income in connection with an insurance company demutualization. The loss on sale was incurred in connection with an asset restructuring undertaken in the fourth quarter of fiscal 2000 as a part of the Company's asset/liability management strategy. In addition, gains on the sale of loans held for sale declined $84,000 during fiscal 2001 due to the Company ceasing the origination of sub-prime loans offset partially by a $51,000 increase in cash surrender value of the Company's Bank Owned Life Insurance ("BOLI"). OPERATING EXPENSES. Operating expenses include compensation and employee benefits, occupancy and equipment expense, Federal Deposit Insurance Corporation ("FDIC") deposit insurance premiums, professional fees, data processing expense, advertising and other items. Operating expenses increased $2.1 million, or 21.3%, for the year ended September 30, 2002 compared to the year ended September 30, 2001 and amounted to $12.1 million in fiscal 2002 compared to $10.0 million in fiscal 2001. The primary reasons for the increase were a $708,000 increase in salaries and employee benefits, a $570,000 expense related to a settlement of a lawsuit and a $531,000 increase in other operating expense. Salaries and employee benefits increased primarily due to a $431,000 writedown in the cash surrender value of certain life insurance policies resulting from the decline in the equities market as well as general compensation 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS increases and higher costs of employee benefit plans. With respect to the settlement expense, it related to a lawsuit that was instituted by the purchaser of five residential mortgage loans from the Bank that alleged that it suffered losses in connection with these loans and that the Bank was required to either purchase the loans or compensate the purchaser for its alleged losses. Other non-interest expense increased $531,000 primarily due to a $213,000 expense relating to the workout of three non-performing commercial real estate loans aggregating $2.4 million along with increases in bank service charges and cash loss. In addition, the increase was attributable to a $51,000 increase in occupancy and equipment expense, a $77,000 increase in data processing, a $111,000 increase in advertising and a $78,000 increase in minority interest in expense of subsidiaries. Management expects the costs relating to the workout of the non-performing commercial real estate loans to continue in fiscal 2003. Operating expenses increased $126,000, or 1.3%, for the year ended September 30, 2001 compared to the year ended September 30, 2000 and amounted to $10.0 million in fiscal 2001 compared to $9.8 million in fiscal 2000. The primary reason for the increase of operating expenses for fiscal 2001 was a $337,000 increase in salaries and employee benefits offset, in part, by a $75,000 and $94,000 decrease in professional fees and advertising expenses, respectively. Salaries and employee benefits increased due to general compensation increases and increased costs of employee benefit plans. INCOME TAXES. The Company recognized income tax expense of $448,000, or 14.1%, of pre-tax income, for the year ended September 30, 2002, compared to $459,000, or 15.7%, of pre-tax income, for the year ended September 30, 2001. The Company recognized income tax expense of $480,000, or 16.9%, of pre-tax income, for fiscal 2000. The primary reason for the decrease in the Company's effective tax rate for fiscal years 2002 and 2001 was the increase in tax-free income resulting from purchases of tax-exempt securities and BOLI as the Company employed various strategies to reduce taxes. LIQUIDITY AND CAPITAL RESOURCES The Company's liquidity, represented by cash and cash equivalents, is a product of its operating, investing and financing activities. The Company's primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans and mortgage-related securities, sales of loans, maturities of investment securities and other short-term investments, borrowings and funds provided from operations. While scheduled payments from the amortization of loans and mortgage-related securities and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan and mortgage-related securities prepayments are greatly influenced by general interest rates, economic conditions and competition. In addition, the Company invests excess funds in overnight deposits and other short-term interest-earning assets which provide liquidity to meet lending requirements. The Company has the ability to obtain advances from the FHLB of Pittsburgh through several credit programs with the FHLB in amounts not to exceed the Bank's maximum borrowing capacity and subject to certain conditions, including holding a predetermined amount of FHLB stock as collateral. As an additional source of funds, the Company has access to the Federal Reserve discount window, but only after it has exhausted its access to the FHLB of Pittsburgh. At September 30, 2002, the Company had $126.2 million of outstanding advances from the FHLB of Pittsburgh. Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in short-term investments such as overnight deposits. On a longer term basis, the Company maintains a strategy of investing in various lending products and mortgage-related securities. The Company uses its sources of funds primarily to meet its ongoing commitments, to pay maturing savings certificates and savings withdrawals, fund loan commitments and maintain a portfolio of mortgage-related and investment securities. At September 30, 2002, the total of approved loan commitments outstanding amounted to $10.2 million. At the same date, commitments under unused lines of credit and loans in process on construction loans amounted to an aggregate of $17.4 million. Certificates of deposit scheduled to mature in one year or less at September 30, 2002 totalled $109.7 million. Based upon its historical experience, management believes that a significant portion of maturing deposits will remain with the Company. The Company has not used, and has no intention to use, any significant off-balance sheet financing arrangements for liquidity purposes. The Company's primary financial instruments with off-balance sheet risk are limited to loan servicing for others, its obligations to fund loans to customers pursuant to 18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS existing commitments and commitments to purchase and sell mortgage loans. In addition, the Company has not had, and has no intention to have, any significant transactions, arrangements or other relationships with any unconsolidated, limited purpose entities that could materially affect its liquidity or capital resources. The Company has not, and does not intend to, trade in commodity contracts. The OTS requires that the Bank meet minimum regulatory tangible, core, tier 1 risk-based and total risk-based capital requirements. At September 30, 2002, the Bank exceeded all regulatory capital requirements and was deemed a well capitalized institution for regulatory purposes. See Note 11 to the Consolidated Financial Statements. The Company's assets consist primarily of its investment in the Bank and investments in various corporate debt and equity instruments. Its only material source of income consists of earnings from its investment in the Bank and interest and dividends earned on other investments. The Company, as a separately incorporated holding company, has no significant operations other than serving as the sole stockholder of the Bank and paying interest to its subsidiaries, First Keystone Capital Trust I and II, for junior subordinated debt issued in conjunction with the issuance of trust preferred securities. See Note 16 to the Consolidated Financial Statements. On an unconsolidated basis, the Company has no paid employees. The expenses primarily incurred by the Company relate to its reporting obligations under the Securities Exchange Act of 1934, related expenses incurred as a publicly traded company, and expenses relating to the issuance of the trust preferred securities and the junior subordinated debentures issued in connection therewith. Management believes that the Company has adequate liquidity available to respond to its liquidity demands. Under applicable federal regulations, the Bank may pay dividends to the Company (as sole stockholder) within certain limits after providing written notice to or obtaining the approval of the OTS. See Note 11 of the Consolidated Financial Statements. RECENT ACCOUNTING PRONOUNCEMENTS For discussion of additional recent accounting pronouncements, see Note 2 of the Consolidated Financial Statements in this Annual Report. Impact of Inflation and Changing Prices The Consolidated Financial Statements of the Company and related notes presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates. In the current interest rate environment, liquidity and the maturity structure and repricing characteristics of the Company's assets and liabilities are critical to the maintenance of acceptable performance levels. 19 Deloitte & Touche LLP Twenty-Second Floor 1700 Market Street Philadelphia, Pennsylvania 19103-3984 Tel: (215) 246 2300 [DELOITTE & TOUCHE LOGO] Fax: (215) 569 2441 www.us.deloitte.com INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders of First Keystone Financial, Inc. and subsidiaries Media, Pennsylvania 19063 We have audited the accompanying consolidated statements of financial condition of First Keystone Financial, Inc. and subsidiaries (the "Company") as of September 30, 2002 and 2001, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended September 30, 2002. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of First Keystone Financial, Inc. and subsidiaries as of September 30, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2002 in accordance with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche, LLP Philadelphia, Pennsylvania November 7, 2002 Deloitte Touche Tohmatsu 20 FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share data) SEPTEMBER 30 ---------------------------- 2002 2001 --------- --------- ASSETS Cash and amounts due from depository institutions $ 4,753 $ 3,753 Interest-bearing deposits with depository institutions 19,870 15,378 --------- --------- Total cash and cash equivalents 24,623 19,131 Investment securities available for sale 80,624 62,564 Mortgage-related securities available for sale 85,674 117,608 Loans held for sale 501 225 Mortgage-related securities held to maturity - at amortized cost (approximate fair value of $9,090 and $11,550 at September 30, 2002 and 2001, respectively) 8,855 11,454 Loans receivable (net of allowance for loan losses of $2,358 and $2,181 at September 30, 2002 and 2001, respectively) 288,776 247,664 Accrued interest receivable 2,971 3,353 Real estate owned 248 887 Federal Home Loan Bank stock--at cost 6,571 6,917 Office properties and equipment--net 3,491 3,690 Cash surrender value of life insurance 14,362 14,021 Prepaid expenses and other assets 1,650 1,536 --------- --------- Total Assets $ 518,346 $ 489,050 ========= ========= LIABILITIES, MINORITY INTEREST IN SUBSIDIARIES AND STOCKHOLDERS' EQUITY Liabilities: Deposits $ 330,765 $ 311,601 Advances from Federal Home Loan Bank 126,237 126,070 Accrued interest payable 1,000 1,804 Advances from borrowers for taxes and insurance 832 696 Deferred income taxes 424 282 Accounts payable and accrued expenses 5,413 1,776 --------- --------- Total liabilities 464,671 442,229 --------- --------- Company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures of the Company 20,880 16,200 --------- --------- Stockholders' Equity: Preferred stock, $.01 par value, 10,000,000 shares authorized; none issued Common stock, $.01 par value, 20,000,000 shares authorized; issued and outstanding: September 30, 2002 and 2001, 2,008,611 and 2,033,707 shares, respectively 14 14 Additional paid-in capital 13,622 13,536 Common stock acquired by stock benefit plans (995) (1,147) Treasury stock at cost: 703,945 and 686,293 shares at September 30, 2002 and 2001, respectively (9,175) (8,583) Accumulated other comprehensive income 3,200 2,664 Retained earnings--partially restricted 26,129 24,137 --------- --------- Total stockholders' equity 32,795 30,621 --------- --------- Total Liabilities, Minority Interest in Subsidiaries and Stockholders' Equity $ 518,346 $ 489,050 ========= =========
See notes to consolidated financial statements. 21 FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(dollars in thousands, except per share data) YEAR ENDED SEPTEMBER 30 ----------------------------------------------- 2002 2001 2000 -------- -------- -------- INTEREST INCOME: Interest on: Loans $ 19,379 $ 18,711 $ 18,533 Mortgage-related securities 6,441 8,605 8,582 Investment securities: Taxable 2,445 2,030 1,523 Tax-exempt 1,203 1,370 1,311 Dividends 430 584 568 Interest-bearing deposits 223 560 551 -------- -------- -------- Total interest income 30,121 31,860 31,068 -------- -------- -------- INTEREST EXPENSE: Interest on: Deposits 9,599 13,062 11,352 Federal Home Loan Bank advances 6,928 7,265 6,758 Securities sold under agreements to repurchase 2 1,121 -------- -------- -------- Total interest expense 16,527 20,329 19,231 -------- -------- -------- Net interest income 13,594 11,531 11,837 Provision for loan losses 540 540 420 -------- -------- -------- Net interest income after provision for loan losses 13,054 10,991 11,417 -------- -------- -------- NON-INTEREST INCOME (LOSS): Service charges and other fees 1,000 952 941 Net gain (loss) on sale of: Investments and mortgage-related securities 331 52 (886) Loans held for sale 84 122 206 Increase in cash surrender value 680 664 613 Other income 128 124 400 -------- -------- -------- Total non-interest income 2,223 1,914 1,274 -------- -------- -------- NON-INTEREST EXPENSE: Salaries and employee benefits 4,796 4,088 3,751 Occupancy and equipment 1,229 1,178 1,117 Professional fees 778 749 824 Federal deposit insurance premium 57 55 80 Net cost of operation of other real estate (4) 25 87 Data processing 478 401 401 Advertising 471 360 454 Litigation settlement 570 Minority interest in expense of subsidiaries 1,649 1,571 1,571 Other 2,079 1,548 1,564 -------- -------- -------- Total non-interest expense 12,103 9,975 9,849 -------- -------- -------- Income before income tax expense 3,174 2,930 2,842 Income tax expense 448 459 480 -------- -------- -------- Net income $ 2,726 $ 2,471 $ 2,362 ======== ======== ======== Earnings per common share: Basic $ 1.42 $ 1.22 $ 1.14 Diluted $ 1.34 $ 1.18 $ 1.11
See notes to consolidated financial statements. 22 FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(dollars in thousands) COMMON STOCK ACCUMULATED RETAINED ADDITIONAL ACQUIRED BY OTHER EARNINGS- TOTAL COMMON PAID-IN STOCK BENEFIT TREASURY COMPREHENSIVE PARTIALLY STOCKHOLDERS' STOCK CAPITAL PLANS STOCK INCOME (LOSS) RESTRICTED EQUITY -------- ---------- ------------- -------- ------------- ---------- ------------- Balance at October 1, 1999 $ 14 $ 13,408 $ (1,531) $ (5,622) $ (2,992) $ 20,627 $ 23,904 -------- -------- -------- -------- -------- -------- -------- Comprehensive income: Net income 2,362 2,362 Other comprehensive income, net of tax: Net unrealized gain on securities net of reclassification adjustment(1) 606 606 -------- -------- -------- -------- -------- -------- -------- Comprehensive income 2,968 -------- -------- -------- -------- -------- -------- -------- ESOP stock committed to be released 127 127 Excess of fair value above cost of ESOP and RRP shares committed to be released 83 83 RRP amortization 117 117 Dividends paid (630) (630) -------- -------- -------- -------- -------- -------- -------- Balance at September 30, 2000 14 13,491 (1,287) (5,622) (2,386) 22,359 26,569 -------- -------- -------- -------- -------- -------- -------- Comprehensive income: Net income 2,471 2,471 Other comprehensive income, net of tax: Net unrealized gain on securities net of reclassification adjustment(1) 5,050 5,050 -------- -------- -------- -------- -------- -------- -------- Comprehensive income 7,521 -------- -------- -------- -------- -------- -------- -------- ESOP stock committed to be released 140 140 Excess of fair value above cost of ESOP shares committed to be released 111 111 Exercise of stock options (66) 84 18 Purchase of treasury stock (3,045) (3,045) Dividends paid (693) (693) -------- -------- -------- -------- -------- -------- -------- Balance at September 30, 2001 14 13,536 (1,147) (8,583) 2,664 24,137 30,621 -------- -------- -------- -------- -------- -------- -------- Net income 2,726 2,726 Other comprehensive income, net of tax: Net unrealized gain on securities net of reclassification adjustment(1) 536 536 -------- -------- -------- -------- -------- -------- -------- Comprehensive income 3,262 -------- -------- -------- -------- -------- -------- -------- ESOP stock committed to be released 152 152 Excess of fair value above cost of ESOP shares committed to be released 161 161 Exercise of stock options (75) 421 346 Purchase of treasury stock (1,013) (1,013) Dividends paid (734) (734) -------- -------- -------- -------- -------- -------- -------- Balance at September 30, 2002 $ 14 $ 13,622 $ (995) $ (9,175) $ 3,200 $ 26,129 $ 32,795 ======== ======== ======== ======== ======== ======== ========
(1) Disclosure of reclassification amount, net of tax for the years ended: 2002 2001 2000 ------- ------- ------- Net unrealized appreciation arising during the year $ 754 $ 5,084 $ 1,191 Less: reclassification adjustment for net gains (losses) included in net income 218 34 (585) ------- ------- ------- Net unrealized gain on securities $ 536 $ 5,050 $ 606 ======= ======= =======
See notes to consolidated financial statements. 23 FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(dollars in thousands) YEAR ENDED SEPTEMBER 30 ------------------------------------------- 2002 2001 2000 --------- --------- --------- OPERATING ACTIVITIES: Net income $ 2,726 $ 2,471 $ 2,362 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for depreciation and amortization 457 429 424 Amortization of discounts (3) (123) (261) (Gain) loss on sales of: Loans held for sale (84) (122) (206) Investment securities available for sale (331) (14) 120 Mortgage-related securities available for sale (38) 766 Real estate owned (124) (49) (52) Provision for loan losses 540 540 420 Provision for real estate owned losses 18 40 Amortization of stock benefit plans 384 251 327 Distribution of policy value in demutualization (278) Changes in assets and liabilities which provided (used) cash: Origination of loans held for sale (3,712) (20,685) (39,531) Loans sold in the secondary market 3,436 23,559 38,224 Deferred income taxes (135) 100 Accrued interest receivable 382 20 (277) Prepaid expenses and other assets (455) 5,544 (6,390) Accrued interest payable (804) (490) (27) Accounts payable and accrued expenses 3,637 (388) (1,328) --------- --------- --------- Net cash provided by (used in) operating activities 5,932 10,905 (5,567) --------- --------- --------- INVESTING ACTIVITIES: Loans originated (172,860) (70,781) (63,434) Purchases of: Investment securities available for sale (37,909) (32,137) (3,033) Mortgage-related securities available for sale (27,511) (58,663) (15,838) Redemption (purchase) of FHLB stock 346 (245) (515) Proceeds from sales of investment and mortgage-related securities available for sale 8,936 14,931 23,401 Proceeds from sales of real estate owned 1,003 849 560 Principal collected on loans 131,402 53,046 58,268 Proceeds from maturities, calls or repayments of: Investment securities available for sale 12,343 7,000 Mortgage-related securities available for sale 58,779 34,782 14,652 Mortgage-related securities held to maturity 2,595 1,594 1,433 Purchase of property and equipment (258) (495) (972) Net expenditures on real estate acquired through foreclosure and in development (11) (180) (253) --------- --------- --------- Net cash (used in) provided by investing activities (23,145) (50,299) 14,269 --------- --------- --------- FINANCING ACTIVITIES: Net increase in deposit accounts 19,164 39,039 11,736 Net increase (decrease) in FHLB advances and other borrowings 167 (16,832) 465 Net increase (decrease) in advances from borrowers for taxes and insurance 136 (76) (174) Issuance of trust preferred securities 8,000 Purchase of trust preferred securities (3,290) Proceeds from exercise of stock options 275 18 Purchase of treasury stock (1,013) (3,045) Cash dividends (734) (693) (630) --------- --------- --------- Net cash provided by financing activities 22,705 18,411 11,397 --------- --------- --------- Increase (decrease) in cash and cash equivalents 5,492 (20,983) 20,099 Cash and cash equivalents at beginning of year 19,131 40,114 20,015 --------- --------- --------- Cash and cash equivalents at end of year $ 24,623 $ 19,131 $ 40,114 ========= ========= ========= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash payments for interest on deposits and borrowings $ 17,331 $ 15,605 $ 19,258 Cash payments of income taxes 650 125 550 Transfers of loans receivable into real estate owned 361 872 1,177
See notes to consolidated financial statements. 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except per share data) 1. NATURE OF OPERATIONS AND ORGANIZATION STRUCTURE The primary business of First Keystone Financial, Inc. (the "Company"), is to act as a holding company for First Keystone Federal Savings Bank (the "Bank"), a federally chartered stock savings association founded in 1934, First Keystone Capital Trust I and Capital Trust II which are companies that are used to issue trust preferred securities. The Bank has two active subsidiaries, FKF Management Corp., Inc. which manages investment securities, and State Street Services Corporation, which has ownership interest in an insurance agency and title company. The primary business of the Bank is to offer a wide variety of commercial and retail products through its branch system located in Delaware and Chester counties in Pennsylvania. The Bank is primarily supervised and regulated by the Office of Thrift Supervision ("OTS"). 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the Company, the Bank, and the Company's and the Bank's wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of income and expense during the reporting periods. Actual results could differ from those estimates. SECURITIES HELD TO MATURITY AND SECURITIES AVAILABLE FOR SALE Securities held to maturity are carried at amortized cost only if the Company has the positive intent and ability to hold these securities to maturity. Securities available for sale are carried at fair value with the resulting unrealized gains or losses recorded in equity, net of tax. For the years ended September 30, 2002 and 2001, the Company did not maintain a trading portfolio. ALLOWANCE FOR LOAN LOSSES An allowance for loan losses is maintained at a level that management considers adequate to provide for probable losses based upon an evaluation of known and inherent losses in the loan portfolio. Management's evaluation of the portfolio is based upon past loss experience, current economic conditions and other relevant factors. While management uses the best information available to make such evaluation, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. Impaired loans are predominantly measured based on the fair value of the collateral. The provision for loan losses charged to expense is based upon past loan loss experience and an evaluation of probable losses and impairment existing in the current loan portfolio. A loan is considered to be impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan. An insignificant delay or insignificant shortfall in amounts of payments does not necessarily result in the loan being identified as impaired. For this purpose, delays less than 90 days are considered to be insignificant. Large groups of smaller balance homogeneous loans, including residential real estate and consumer loans, are collectively evaluated for impairment, except for loans restructured under a troubled debt restructuring. In July 2001, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues". SAB No. 102 expresses the SEC staff's views on the development, documentation, and application of a systematic methodology for determining the allowance for loan losses in accordance with accounting principles generally accepted in the United States of America. Also in July 2001, the federal banking agencies issued guidance on this topic through the Federal Financial Institutions Examination Council interagency guidance, Policy Statement on Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Institutions. In management's opinion, the Company's methodology and documentation of the allowance for loan losses meets the guidance issued. MORTGAGE BANKING ACTIVITIES The Company originates mortgage loans held for investment and for sale. At origination, the mortgage loan is identified as either held for sale or for investment. Mortgage loans held for sale are carried at the lower of cost or forward committed contracts (which approximates market), determined on a net aggregate basis. At September 30, 2002, 2001 and 2000, loans serviced for others totalled approximately $51,826, $66,301, and $70,390, respectively. Servicing loans for others consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors, and processing foreclosures. Loan servicing income is recorded on a cash basis and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees. The Company has fiduciary responsibility for related escrow and custodial funds 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data) aggregating approximately $584 and $995 at September 30, 2002 and 2001, respectively. The Company assesses the retained interest in the servicing asset or liability associated with the sold loans based on the relative fair values. The servicing asset or liability is amortized in proportion to and over the period during which estimated net servicing income or net servicing loss, as appropriate, will be received. Assessment of the fair value of the retained interest is performed on a continual basis. At September 30, 2002 and 2001, mortgage servicing rights of $89 and $109, respectively, were included in other assets. TRANSFERS OF FINANCIAL ASSETS Transfers of financial assets are accounted for as sales, when control over assets has been surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. INCOME RECOGNITION ON LOANS Interest on loans is credited to income when earned. Accrual of loan interest is discontinued and a reserve established on existing accruals if management believes after considering, among other things, economic and business conditions and collection efforts, that the borrowers' financial condition is such that collection of interest is doubtful. REAL ESTATE OWNED Real estate owned consists of properties acquired by foreclosure or deed in-lieu of foreclosure. These assets are initially recorded at the lower of carrying value of the loan or estimated fair value less selling costs at the time of foreclosure and at the lower of the new cost basis or net realizable value thereafter. The amounts recoverable from real estate owned could differ materially from the amounts used in arriving at the net carrying value of the assets at the time of foreclosure because of future market factors beyond the control of the Company. Costs relating to the development and improvement of real estate owned properties are capitalized and those relating to holding the property are charged to expense. OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment are recorded at cost. Depreciation is computed using the straight-line method over the expected useful lives of the assets. The costs of maintenance and repairs are expensed as they are incurred, and renewals and betterments are capitalized. CASH SURRENDER VALUE OF LIFE INSURANCE The Bank funded the purchase of insurance policies on the lives of officers and employees of the Bank. The Company has recognized any increase in cash surrender value of life insurance, net of insurance costs, in the consolidated statements of income and the insurance policies are recorded as an asset in the statements of financial condition. During the year ended September 30, 2000, the Company recognized a gain of $278 from a distribution of shares of common stock in demutualization of an insurance company. INTEREST RATE RISK At September 30, 2002 and 2001, the Company's assets consist primarily of assets that earned interest at either adjustable or fixed interest rates and the average life of which is longer term. These assets were funded primarily with shorter term liabilities that have interest rates which vary over time with market rates and certain call features that are affected by changes in market rates. The shorter duration of the interest-sensitive liabilities indicates that the Company is exposed to interest rate risk because, in a rising rate environment, liabilities will be repricing faster at higher interest rates, thereby reducing the market value of long-term assets and net interest income. EARNINGS PER SHARE Basic earnings per share ("EPS") is computed based on the weighted average number of shares of common stock outstanding. Diluted earnings per common share is computed based on the weighted average number of shares of common stock outstanding increased by the number of common shares that are assumed to have been purchased with the proceeds from the exercise of stock options. Weighted average shares used in the computation of earnings per share were as follows:
YEAR ENDED SEPTEMBER 30 ----------------------------------- 2002 2001 2000 --------- --------- --------- Average common shares outstanding 1,915,818 2,021,332 2,069,925 Increase in shares due to options 118,100 78,396 57,526 --------- --------- --------- Adjusted shares outstanding - diluted 2,033,918 2,099,728 2,127,451 ========= ========= =========
For the years ended September 30, 2002, 2001 and 2000, 9,000 shares, 9,600 shares and 85,680 shares, respectively, attributable outstanding options were excluded from the calculation of diluted EPS because the effect was antidilutive. 26 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data) INCOME TAXES Deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. ACCOUNTING FOR STOCK OPTIONS The Company accounts for stock options in accordance with Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," which allows an entity to choose between the intrinsic value method, as defined in Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" or the fair value method of accounting for stock-based compensation described in SFAS No. 123. An entity using the intrinsic value method must disclose pro forma net income and earnings per share as if stock-based compensation was accounted for using the fair value method (See Note 12). The Company continues to account for stock-based compensation using the intrinsic value method and, accordingly, has not recognized compensation expense under this method. OTHER COMPREHENSIVE INCOME The Company presents as a component of comprehensive income the amounts from transactions and other events which currently are excluded from the statement of income and are recorded directly to stockholders' equity. ACCOUNTING FOR DERIVATIVE INSTRUMENTS SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS Nos. 137 and 138 and interpreted by the FASB and the Derivative Implementation Group through "Statement 133 Implementation Issues" requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. Under SFAS No. 133, the accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. The Company adopted this statement on October 1, 2000. The adoption of this statement did not have a material impact on the Company's financial position or results of operations. Currently, no embedded derivatives require bifurcation. The Company currently does not employ hedging activities that require designation as either fair value or cash flow hedges, or hedges of a net investment in a foreign operation. STATEMENT OF CASH FLOWS For purposes of reporting cash flows, cash and cash equivalents include cash and amounts due from depository institutions and interest-bearing deposits with depository institutions. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB issued two new pronouncements: SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 is effective as follows: (a) use of the pooling-of-interest method is prohibited for business combinations initiated after June 30, 2001; and (b) the provisions of SFAS No. 141 also apply to all business combinations accounted for by the purchase method that are completed after June 30, 2001. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recognized in an entity's statement of financial position at that date, regardless of when those assets were initially recognized. However, SFAS No. 142 did not change the accounting prescribed for certain acquisitions by banking and thrift institutions, resulting in continued amortization of the excess of cost over fair value of net assets acquired under SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions." In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions", which provides guidance on the accounting for the acquisition of a financial institution. This statement requires that the excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired in a business combination which represents goodwill be accounted for under SFAS No. 142. Thus, the specialized accounting guidance in paragraph 5 of SFAS No. 72, will not apply after September 30, 2002. If certain criteria in SFAS No. 147 are met, the amount of the unidentifiable intangible asset will be reclassified to goodwill upon adoption of the statement. Financial institutions meeting the conditions outlined in SFAS No. 147 will be required to restate previously issued financial statements. Additionally, the scope of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", is amended to include long-term customer-relationship intangible assets such as deposit or/and borrower-relationship intangible assets and credit cardholder intangible assets. This statement became effective for the Company for its fiscal year beginning October 1, 2002. This statement did not have any impact of the Company's financial statements upon adoption because the Company has no recorded goodwill. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and the accounting and reporting provisions of the APB No. 30, "Reporting of Operations-Reporting the Effects of Disposal of a Segment of a 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data) Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." This statement is effective for fiscal years beginning after December 15, 2001. The Company does not expect an impact of the Company's financial statements in adopting this statement. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". The provisions of this statement related to the rescission of SFAS No. 4 and are effective for fiscal years beginning after May 15, 2002. Management does not believe the impact of applying these provisions will be material to the Company. Certain provisions of the statement relating to SFAS No. 13 are effective for transactions occurring after May 15, 2002. All other provisions of the statement are effective for financial statements issued on or after May 15, 2002. These provisions had no impact on the Company's financial statements. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. This statement is not expected to have an impact on the Company. Reclassifications Certain reclassifications have been made to the September 30, 2001 and 2000 consolidated financial statements to conform with the September 30, 2002 presentation. Such reclassifications had no impact on the reported net income. 3. INVESTMENT SECURITIES AVAILABLE FOR SALE The amortized cost and approximate fair value of investment securities are as follows:
SEPTEMBER 30, 2002 --------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED APPROXIMATE COST GAIN LOSS FAIR VALUE --------- ---------- ---------- ----------- U.S. Treasury securities and securities of U.S. Government agencies: 1 to 5 years $11,986 $ 128 $12,114 5 to 10 years 1,861 210 2,071 Municipal obligations 19,012 788 19,800 Corporate bonds 14,299 827 $ 406 14,720 Mutual funds 14,009 42 6 14,045 Asset-backed securities 2,837 16 2,853 Preferred stocks 10,682 293 224 10,751 Other equity investments 3,476 884 90 4,270 ------- ------- ------- ------- Total $78,162 $ 3,188 $ 726 $80,624 ======= ======= ======= =======
September 30, 2001 --------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Approximate Cost Gain Loss Fair Value --------- ---------- ---------- ----------- U.S. Treasury securities and securities of U.S. Government agencies: 1 to 5 years $ 2,961 $ 172 $ 3,133 5 to 10 years 1,843 207 2,050 Municipal obligations 21,890 739 $ 3 22,626 Corporate bonds 14,333 277 523 14,087 Mutual funds 5,009 3 8 5,004 Asset-backed securities 2,986 16 2,970 Preferred stocks 9,474 5 282 9,197 Other equity investments 2,778 719 3,497 ------- ------- ------- ------- Total $61,274 $ 2,122 $ 832 $62,564 ======= ======= ======= =======
For the years ended September 30, 2002, 2001 and 2000, proceeds from sales of investment securities available for sale amounted to $7,066, $8,005 and $5,628, respectively. For such periods, gross realized gains on sales amounted to $351, $34 and $0, respectively, while gross realized losses amounted to $20, $20 and $120, respectively. The tax provision (benefit) applicable to these net realized gains and losses amounted to $112, $5 and $(41), respectively. Investment securities with an aggregate carrying value of $2,986 and $2,961 were pledged as collateral for financings at September 30, 2002 and 2001, respectively (see Note 8). 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data) 4. MORTGAGE-RELATED SECURITIES Mortgage-related securities available for sale and mortgage-related securities held to maturity are summarized as follows:
SEPTEMBER 30, 2002 ------------------------------------------------ GROSS GROSS AMORTIZED UNREALIZED UNREALIZED APPROXIMATE COST GAIN LOSS FAIR VALUE --------- ---------- ---------- ----------- Available for Sale: FHLMC pass-through certificates $ 4,986 $ 275 $ 5,261 FNMA pass-through certificates 13,009 454 13,463 GNMA pass-through certificates 32,407 1,214 33,621 Collateralized mortgage obligations 32,884 449 $ 4 33,329 ------- ------- ------- ------- Total $83,286 $ 2,392 $ 4 $85,674 ======= ======= ======= ======= Held to Maturity: FHLMC pass-through certificates $ 1,433 $ 77 $ 1,510 FNMA pass-through certificates 3,574 96 3,670 Collateralized mortgage obligations 3,848 62 3,910 ------- ------- ------- ------- Total $ 8,855 $ 235 $ 9,090 ======= ======= ======= =======
September 30, 2001 ------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Approximate Cost Gain Loss Fair Value --------- ---------- ---------- ----------- Available for Sale: FHLMC pass-through certificates $ 8,832 $ 343 $ 9,175 FNMA pass-through certificates 14,570 486 15,056 GNMA pass-through certificates 42,804 1,103 43,907 Collateralized mortgage obligations 48,658 814 $ 2 49,470 -------- ------- ------- ------- Total $114,864 $ 2,746 $ 2 $117,608 ======== ======= ======= ======= Held to Maturity: FHLMC pass-through certificates $ 2,285 $ 68 $ 3 $ 2,350 FNMA pass-through certificates 4,684 70 54 4,700 Collateralized mortgage obligations 4,485 49 34 4,500 -------- ------- ------- ------- Total $ 11,454 $ 187 $ 91 $ 11,550 ======== ======= ======= =======
The collateralized mortgage obligations contain both fixed and adjustable classes of securities which are repaid in accordance with a predetermined priority. The underlying collateral of the securities are loans which are primarily guaranteed by FHLMC, FNMA, and GNMA. During the year ended September 30, 2002, there were no sales of mortgage-related securities. For the years ended September 30, 2001 and 2000, proceeds from sales of mortgage-related securities available for sales amounted to $6,926 and $17,773, respectively. Gross realized gains amounted to $38 for the year ended September 30, 2001. Gross realized losses amounted to $766 for the year ended September 30, 2000. The tax provision (benefit) applicable to these net realized gains and losses amounted to $13 and ($260) for the years ended September 30, 2001 and 2000, respectively. Mortgage-related securities with aggregate carrying values of $12,907 and $19,861 were pledged as collateral for municipal deposits and financings at September 30, 2002 and 2001, respectively (see Note 8). 29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data) 5. ACCRUED INTEREST RECEIVABLE The following is a summary of accrued interest receivable by category:
SEPTEMBER 30 ----------------- 2002 2001 ------ ------ Loans $1,689 $1,802 Mortgage-related securities 457 709 Investment securities 825 842 ------ ------ Total $2,971 $3,353 ====== ======
6. LOANS RECEIVABLE Loans receivable consist of the following:
SEPTEMBER 30 ------------------------ 2002 2001 --------- --------- Real estate loans: Single-family $ 173,736 $ 160,289 Construction and land 28,292 29,117 Multi-family and commercial 60,379 43,472 Home equity and lines of credit 27,595 25,847 Consumer loans 1,202 1,125 Commercial loans 11,919 8,158 --------- --------- Total loans 303,123 268,008 Loans in process (11,384) (17,016) Allowance for loan losses (2,358) (2,181) Deferred loan fees (605) (1,147) --------- --------- Loans receivable--net $ 288,776 $ 247,664 ========= =========
The Company, originates loans primarily in its local market area of Delaware and Chester Counties, Pennsylvania to borrowers that share similar attributes. This geographic concentration of credit exposes the Company to a higher degree of risk associated with this economic region. The Company, prior to fiscal 2001, participated in the origination and sale of non-agency, non-conforming sub-prime loans in the secondary market. The Company recognized gains on sale of loans held for sale under this program and on sales of conforming agency loans of $84,$122 and $206 for fiscal years ended September 30, 2002, 2001 and 2000, respectively. The Company offers loans to its directors and senior officers on terms permitted by OTS regulations.There were approximately $1,328, $1,550 and $529 of loans outstanding to senior officers and directors as of September 30, 2002, 2001 and 2000, respectively. The amount of repayments during the years ended September 30, 2002,2001 and 2000, totalled $948, $165 and $65 respectively.There were $725, $772 and $19 of new loans granted during fiscal years 2002, 2001 and 2000, respectively. The Company had undisbursed portions under consumer and commercial lines of credit as of September 30,2002 of $11,835 and $5,592, respectively. The Company originates both adjustable and fixed interest rate loans and purchases mortgage-related securities in the secondary market. The originated adjustable-rate loans have interest rate adjustment limitations and are generally indexed to U.S. Treasury securities plus a fixed margin. Future market factors may affect the correlation of the interest rate adjustment with rates the Company pays on the short-term deposits that have been the primary funding source for these loans. The adjustable-rate mortgage-related securities adjust to various national indices plus a fixed margin. At September 30, 2002, the composition of these loans and mortgage-related securities was as follows:
FIXED-RATE - ---------------------------------------------- TERM TO MATURITY BOOK VALUE - -------------------- ---------- 1 month to 1 year $ 5,270 1 year to 3 years 6,602 3 years to 5 years 13,117 5 years to 10 years 28,566 Over 10 years 203,023 --------- Total $ 256,578 =========
ADJUSTABLE-RATE - ---------------------------------------------- TERM TO RATE ADJUSTMENT BOOK VALUE - ----------------------- ---------- 1 month to 1 year $ 55,988 1 year to 3 years 35,600 3 years to 5 years 38,102 --------- Total $ 129,690 =========
The following is an analysis of the allowance for loan losses:
YEAR ENDED SEPTEMBER 30 --------------------------------- 2002 2001 2000 ------- ------- ------- Beginning balance $ 2,181 $ 2,019 $ 1,928 Provisions charged to income 540 540 420 Charge-offs (373) (532) (363) Recoveries 10 154 34 ------- ------- ------- Total $ 2,358 $ 2,181 $ 2,019 ======= ======= =======
At September 30, 2002 and 2001, non-performing loans (which include loans in excess of 90 days delinquent) amounted to approximately $5,138 and $2,302, respectively. At September 30, 2001 and 2000, non-performing loans consisted of loans that were collectively evaluated for impairment. As of September 30, 2002,the Company had impaired loans with a total recorded investment of $2.4 million and an average recorded investment of $2.1 million. There was not any cash basis interest income recognized on these impaired loans during the year ended September 30, 2002.Interest income of approximately $150 was not recognized as interest income due to the non-accrual status of loans during 2002. 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data) 7. OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment are summarized by major classification as follows:
SEPTEMBER 30 ---------------------- 2002 2001 -------- -------- Land and buildings $ 5,926 $ 5,828 Furniture, fixtures and equipment 4,476 4,316 -------- -------- Total 10,402 10,144 Accumulated depreciation and amortization (6,911) (6,454) -------- -------- Net $ 3,491 $ 3,690 ======== ========
The future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of September 30, 2002 are as follows: September 30: 2003 $ 220 2004 221 2005 224 2006 122 2007 102 Thereafter 232 --------- Total minimum future rental payments $ 1,121 =========
Leasehold expense was approximately $335, $329 and $292 for the years ended September 30, 2002, 2001 and 2000, respectively. Depreciation expense amounted to $457, $429 and $424 for the years ended September 30, 2002, 2001 and 2000, respectively. 8. DEPOSITS Deposits consist of the following major classifications:
SEPTEMBER 30 ------------------------------------------ 2002 2001 ------------------- -------------------- AMOUNT PERCENT Amount Percent Non-interest bearing $ 10,094 3.1% $ 5,698 1.8% NOW 54,048 16.3 45,161 14.5 Passbook 41,659 12.6 37,806 12.1 Money market 48,722 14.7 40,781 13.1 Certificates of deposit 176,242 53.3 182,155 58.5 -------- ----- -------- ----- Total $330,765 100.0% $311,601 100.0% ======== ===== ======== =====
The weighted average interest rates paid on deposits were 2.44% and 4.03% at September 30, 2002 and 2001, respectively. Included in deposits as of September 30, 2002 and 2001 are deposits greater than $100 totalling approximately $81,976 and $65,700, respectively. Deposits in excess of $100 are not federally insured. At September 30, 2002 and 2001, the Company pledged certain mortgage-related securities aggregating approximately $7,371 and $11,109, respectively, as collateral for municipal deposits. A summary of scheduled maturities of certificates is as follows:
September 30 2002 ------------ Within one year $ 109,694 One to two years 39,829 Two to three years 11,852 Thereafter 14,867 --------- Total $ 176,242 =========
A summary of interest expense on deposits is as follows:
YEAR ENDED SEPTEMBER 30 ------------------------------- 2002 2001 2000 ------- ------- ------- NOW $ 401 $ 537 $ 557 Passbook 750 907 952 Money market 1,036 1,223 597 Certificates of deposit 7,412 10,395 9,246 ------- ------- ------- Total $ 9,599 $13,062 $11,352 ======= ======= =======
9. ADVANCES FROM FEDERAL HOME LOAN BANK The Company has available borrowings with the Federal Home Loan Bank of Pittsburgh ("FHLB") up to the Company's maximum borrowing capacity which was $275.0 million at September 30, 2002, of which $126.2 million was outstanding at September 30, 2002. A summary of advances from the FHLB follows:
SEPTEMBER 30 ------------------------------------------- 2002 2001 -------------------- ------------------- WEIGHTED Weighted AVERAGE average INTEREST interest AMOUNT RATE Amount rate -------- -------- ------ --------- Advances from FHLB due after September 30, 2007 $126,237 5.4% $126,070 5.4% ======== === ======== ===
The advances are collateralized by FHLB stock and substantially all first mortgage loans held by the Company. Included in the table above at September 30, 2002 and 2001 are convertible advances whereby the FHLB has the option at predetermined times to convert the fixed interest rate to an adjustable rate tied to London Interbank Offered Rate ("LIBOR"). The Company then has the option to prepay these advances if the FHLB converts the interest rate. These advances are included in the periods in which they mature. 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data) 10. INCOME TAXES The Company and its subsidiaries file a consolidated federal income tax return. The Company uses the specific charge-off method for computing reserves for bad debts. The bad debt deduction allowable under this method is available to large banks with assets greater than $500 million. Generally, this method allows the Company to deduct an annual addition to the reserve for bad debts equal to its net charge-offs. Retained earnings at September 30, 2002 and 2001 included approximately $2.5 million representing bad debt deductions for which no income tax has been provided. Income tax expense is comprised of the following:
YEAR ENDED SEPTEMBER 30 --------------------------------- 2002 2001 2000 ------ ------ ------ Federal: Current $ 583 $ 456 $ 380 Deferred (135) 100 State 3 ------ ------ ------ Total $ 448 $ 459 $ 480 ====== ====== ======
The tax effect of temporary differences that give rise to significant portions of the deferred tax accounts, calculated at 34%, is as follows:
SEPTEMBER 30 ------------------------ 2002 2001 -------- -------- Deferred tax assets: Accelerated depreciation $ 346 $ 350 Allowance for loan losses 769 762 Accrued expenses 463 75 Other 125 -------- -------- Total deferred tax assets 1,578 1,312 -------- -------- Deferred tax liabilities: Deferred loan fees (306) (222) Unrealized gain on available for sale securities (1,649) (1,372) Other (47) -------- -------- Total deferred tax liabilities (2,002) (1,594) -------- -------- Net deferred income taxes $ (424) $ (282) ======== ========
The Company's effective tax rate is less than the statutory federal income tax rate for the following reasons:
YEAR ENDED SEPTEMBER 30 ------------------------------------------------------------------ 2002 2001 2000 -------------------- -------------------- -------------------- PERCENTAGE Percentage Percentage OF PRETAX of Pretax of Pretax AMOUNT INCOME Amount Income Amount Income ------ ------ ------ ------ ------ ------ Tax at statutory rate $1,079 34.0% $ 991 34.0% $ 966 34.0% Increase (decrease) in taxes resulting from: Tax exempt interest, net (290) (9.1) (281) (9.6) (278) (9.8) Increase in cash surrender value (231) (7.3) (226) (7.7) (209) (7.4) Other (110) (3.5) (25) (1.0) 1 .1 ------ ---- ------ ---- ------ ---- Total $ 448 14.1% $ 459 15.7% $ 480 16.9% ====== ==== ====== ==== ====== ====
11. REGULATORY CAPITAL REQUIREMENTS The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum regulatory capital requirements can result in certain mandatory,and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth on the following page) of tangible and core capital (as defined in the regulations) to adjusted assets (as defined), and of Tier I and total capital (as defined) to average assets (as defined). Management believes, as of September 30, 2002, that the Bank meets all capital adequacy requirements to which it is subject. As of September 30, 2002, the most recent notification from the OTS categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based,Tier-1 risk-based, and Tier-1 core capital ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the institution's category. 32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data)
REQUIRED FOR WELL CAPITALIZED CAPITAL ADEQUACY UNDER PROMPT ACTUAL PURPOSES CORRECTIVE ACTION ---------------------- ---------------------- ----------------------- AMOUNT PERCENTAGE AMOUNT PERCENTAGE AMOUNT PERCENTAGE ------ ---------- ------ ---------- ------ ---------- At September 30, 2002: Core Capital (to Adjusted Tangible Assets) $ 40,873 8.1% $20,265 4.0% $25,325 5.0% Tier I Capital (to Risk-Weighted Assets) 40,873 15.4 N/A N/A 15,941 6.0 Total Capital (to Risk-Weighted Assets) 42,957 16.2 21,255 8.0 26,569 10.0 Tangible Capital (to Tangible Assets) 40,873 8.1 7,597 1.5 N/A N/A At September 30, 2001: Core Capital (to Adjusted Tangible Assets) $ 37,211 7.8% $19,172 4.0% $23,965 5.0% Tier I Capital (to Risk-Weighted Assets) 37,211 16.0 N/A N/A 13,951 6.0 Total Capital (to Risk-Weighted Assets) 39,094 16.8 18,602 8.0 23,252 10.0 Tangible Capital (to Tangible Assets) 37,211 7.8 7,189 1.5 N/A N/A
The Bank's capital at September 30, 2002 and 2001 for financial statement purposes differs from tangible, core (leverage), and Tier-1 risk-based capital amounts by $8,078 and $6,590, respectively, representing the inclusion of unrealized gain on securities available for sale and a portion of capital securities (see Note 16) that qualifies as regulatory capital as well as adjustments to the Bank's capital that do not affect the parent company. At September 30, 2002 and 2001, total risk-based capital, for regulatory requirements, was increased by $2,406 and $1,883, respectively, of general loan loss reserves, for a total of $42,957 and $39,094, respectively. At the date of the Bank's conversion from the mutual to stock form in January 1995 (the "Conversion"), the Bank established a liquidation account in an amount equal to its retained income as of August 31, 1994. The liquidation account is maintained for the benefit of eligible account holders and supplemental eligible account holders who continue to maintain their accounts at the Bank after the Conversion. The liquidation account is reduced annually to the extent that eligible account holders and supplemental eligible account holders have reduced their qualifying deposits as of each anniversary date. Subsequent increases in such balances will not restore an eligible account holder's or supplemental eligible account holder's interest in the liquidation account. In the event of a complete liquidation of the Bank, each eligible account holder and supplemental eligible account holder will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held. The principal source of cash flow for the Company is dividends from the Bank. Various federal banking regulations and capital guidelines limit the amount of dividends that may be paid to the Company by the Bank. Future payment of dividends by the Bank is dependent on individual regulatory capital requirements and levels of profitability. In addition, loans or advances made by the Bank to the Company are generally limited to 10 percent of the Bank's capital stock and surplus on a secured basis. Accordingly, funds available for loans or advances by the Bank to the Company amounted to $4,087. 12. EMPLOYEE BENEFITS 401(K) PROFIT SHARING PLAN The Bank's 401(k) profit sharing plan covers substantially all full-time employees of the Company and provides for pre-tax contributions by the employees with matching contributions at the discretion of the Board of Directors determined at the beginning of the calendar year. All amounts are fully vested. For calendar years 2002, 2001 and 2000, the Company matched twenty-five cents for every dollar contributed up to 5% of participants' salary. The profit sharing expense for the plan was $36, $32 and $17 for the fiscal years ended September 30, 2002, 2001 and 2000, respectively. EMPLOYEE STOCK OWNERSHIP PLAN In connection with the Conversion, the Company established an employee stock ownership plan ("ESOP") for the benefit of eligible employees. At September 30, 2002, 215,962 shares were committed to be released, of which 19,229 shares have not yet been allocated to participant accounts. The Company accounts for its ESOP in accordance with AICPA Statement of Position 93-6, "Employers Accounting for Employee Stock Ownership Plans," which requires the Company to recognize compensation expense equal to the fair value of the ESOP shares during the periods in which they become committed to be released. To the extent that the fair value of the ESOP shares released differs from the cost of such shares, this difference is charged or credited to equity as additional paid-in capital. Management expects the recorded amount of expense in any given period 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data) to fluctuate from period to period as continuing adjustments are made to reflect changes in the fair value of the ESOP shares. The Company's ESOP, which is internally leveraged, does not report the loan receivable extended to the ESOP as an asset and does not report the ESOP debt due the Company. The Company recorded compensation and employee benefit expense related to the ESOP of $395, $308 and $253 for the years ended September 30, 2002, 2001 and 2000, respectively. RECOGNITION AND RETENTION PLAN Under the 1995 Recognition and Retention Plan and Trust (the "RRP"), there are 81,600 shares authorized under the RRP. At September 30, 2002, the Company awarded 79,350 shares to the Company's Board of Directors and executive officers subject to vesting and other provisions of the RRP. At September 30, 2000, all the shares awarded had been allocated to plan participants. Compensation expense was recognized ratably over the five year vesting period for the shares awarded. Since all the shares awarded have been allocated, no compensation expense was recognized relating to the RRP for fiscal years ended September 30, 2002 and 2001. For the fiscal year ended September 30, 2000, the Company recorded compensation and employee benefit expense of $117 relating to the RRP. STOCK OPTION PLANS Under the 1995 Stock Option Plan (the "Option Plan"), common stock totaling 272,000 shares has been reserved for issuance pursuant to the exercise of options. During fiscal year 1999, stockholders approved the adoption of the 1998 Stock Option Plan ("1998 Option Plan")(collectively with the Option Plan, the "Plans") which reserves an additional 111,200 shares of common stock for issuance. Options covering an aggregate of 368,930 shares have been granted to the Company's executive officers, nonemployee directors and other key employees, subject to vesting and other provisions of the Plans. At September 30, 2002, 2001 and 2000, the number of shares exercisable was 261,913, 271,889 and 262,738, respectively and the weighted average exercise price of those options was $8.91 and $8.57, respectively. The following table summarizes transactions regarding the stock option plans:
Weighted Average Number of Exercise Exercise Option Price Price Shares Range per Share -------- ------------ --------- Outstanding at October 1, 1999 331,840 $ 7.50-14.25 $ 9.02 Granted 7,300 10.13-10.13 10.13 -------- ------------ -------- Outstanding at September 30, 2000 339,140 $ 7.50 -14.25 $ 9.05 Exercised (14,607) 7.50- 7.50 7.50 -------- ------------ -------- Outstanding at September 30, 2001 324,533 $ 7.50-14.25 $ 9.11 GRANTED 13,300 14.84-16.15 15.73 EXERCISED (30,856) 7.50-12.38 7.97 -------- ------------ -------- OUTSTANDING AT SEPTEMBER 30, 2002 306,977 $ 7.50-16.15 $ 9.52 ======== ============ ========
A summary of the exercise price range at September 30, 2002 is as follows:
WEIGHTED WEIGHTED EXERCISE AVERAGE AVERAGE NUMBER OF PRICE REMAINING EXERCISE PRICE OPTION SHARES RANGE CONTRACTUAL LIFE PER SHARE - ------------- ----------- ---------------- -------------- 194,337 $ 7.50-10.13 3.21 $ 7.62 112,640 12.13-16.15 7.13 12.78 ------- ----------- ---- ----- 306,977 $ 7.50-16.15 4.65 $ 9.52 ======= =========== ==== =====
The Company applies APB Opinion No. 25 in accounting for stock options and, accordingly, no compensation expense has been recognized in the financial statements. Had the Company determined compensation expense based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net income and income per share would have been reduced to the pro forma amounts indicated below:
YEAR ENDED SEPTEMBER 30 2002 2001 2000 ---- ---- ---- Net income: As reported $2,726 $2,471 $2,362 Pro forma 2,649 2,405 2,293 Net income per common and common equivalent share: Earnings per common share - As reported $ 1.34 $ 1.18 $ 1.11 - Pro forma 1.30 1.15 1.08 Weighted average fair value of options granted during the period $ 9.67 N/A $ 3.80
34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data) The binomial option-pricing model was used to determine the fair value of options at the grant date. Significant assumptions used to calculate the above fair value of the awards are as follows:
SEPTEMBER 30 ---------------------------- 2002 2001 2000 ---- ---- ---- Risk free interest rate of return 2.98% 3.77% 5.85% Expected option life (months) 100 60 60 Expected volatility 73% 52% 44% Expected dividends 2.8% 2.3% 3.1%
OTHER The Company established an expense accrual in connection with the anticipated funding of a trust to be created to formalize the Company's deferred compensation arrangements with four former officers of the Company. A total of $85 and $186 was included in the Company's liabilities at September 30, 2002 and 2001, respectively. 13. COMMITMENTS AND CONTINGENCIES The Company has outstanding loan commitments, excluding undisbursed portion of loans in process and equity lines of credit, of approximately $10,621 and $8,279 as of September 30, 2002 and 2001, respectively, all of which are expected to be funded within four months. Of these commitments outstanding, the breakdown between fixed and adjustable-rate loans is as follows:
SEPTEMBER 30 ------------------- 2002 2001 ------- ------ Fixed-rate (ranging from 5.50% to 6.99%) $ 4,525 $ 3,244 Adjustable-rate 6,096 5,035 ------- ------ Total $ 10,621 $ 8,279 ======= ======
Depending on cash flow, interest rate, risk management and other considerations, longer term fixed-rate and non-conforming loans are sold in the secondary market. There was approximately $2,936 in outstanding commitments to sell loans at September 30, 2002. There were no outstanding commitments to sell loans at September 30, 2001. In the fourth quarter of fiscal 2002, the Company settled a lawsuit related to certain loan sales. The lawsuit was instituted by the purchaser of five residential mortgage loans from the Bank that alleged that it suffered losses in connection with these loans and that the Bank was required to purchase the loans or compensate the purchaser for its alleged losses. The Bank settled all the purchaser's claims for $570. There are various claims and pending actions against the Company and its subsidiaries arising out of the conduct of its business. In the opinion of the Company's management and based upon advice of legal counsel, the resolution of these matters will not have a material adverse impact on the consolidated financial position or the results of operations of the Company and its subsidiaries. 14. RELATED PARTY TRANSACTIONS The Company retains the services of a law firm in which one of the Company's directors is a member. In addition to providing general legal counsel to the Company, the firm also prepares mortgage documents and attends loan closings for which it is paid directly by the borrower. The Company also utilizes one of the Company's directors as a consultant on various real estate matters. In addition, one of the Company's board members has an interest in an insurance agency, First Keystone Insurance Services, LLC in which one of the Bank's subsidiary has a majority position. 15. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
SEPTEMBER 30 ---------------------------------------------- 2002 2001 -------------------- ---------------------- Carrying/ Estimated Carrying/ Estimated Notional Fair Notional Fair Amount Value Amount Value --------- --------- --------- --------- Assets: Cash and cash equivalents $ 24,623 $ 24,623 $ 19,131 $ 19,131 Investment securities 80,624 80,624 62,564 62,564 Loans 288,776 293,509 247,664 246,498 Loans held for sale 501 501 225 225 Mortgage-related securities 94,529 94,764 129,062 129,158 FHLB stock 6,571 6,571 6,917 6,917 Liabilities: Passbook deposits 41,659 41,659 37,806 37,806 NOW and money market deposits 102,770 102,770 91,639 91,639 Certificates of deposit 176,242 178,404 182,155 185,474 Advances from Federal Home Loan Bank 126,237 128,539 126,070 144,442 Off balance sheet commitments 35,732 35,732 37,983 37,983
The fair value of cash and cash equivalents is their carrying value due to their short-term nature. The fair value of investments and mortgage-related securities is based on quoted market prices, dealer quotes, and prices obtained 35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data) from independent pricing services. The fair value of loans is estimated, based on present values using approximate current entry-value interest rates, applicable to each category of such financial instruments. The fair value of FHLB stock approximates its carrying amount. The fair value of NOW deposits, money market deposits and passbook deposits is the amount reported in the financial statements. The fair value of certificates of deposit and FHLB advances is based on a present value estimate, using rates currently offered for deposits and borrowings of similar remaining maturity. Fair values for off-balance sheet commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standings. No adjustment was made to the entry-value interest rates for changes in credit performing commercial loans, construction loans, and land loans for which there are no known credit concerns. Management believes that the risk factor embedded in the entry-value interest rates, along with the general reserves applicable to the performing commercial, construction, and land loan portfolios for which there are no known credit concerns, result in a fair valuation of such loans on an entry-value basis. The fair value of non-performing loans, with a recorded book value of approximately $5,138 and $2,302 (which are collateralized by real estate properties with property values in excess of carrying amounts) as of September 30, 2002 and 2001, respectively, was not estimated because it is not practicable to reasonably assess the credit adjustment that would be applied in the marketplace for such loans. The fair value estimates presented herein are based on pertinent information available to management as of September 30, 2002 and 2001. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since September 30, 2002 and 2001 and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. 16. CAPITAL SECURITIES On August 21, 1997, First Keystone Capital Trust I ("the Trust"), a trust formed under Delaware law, that is a subsidiary of the Company, issued $16.2 million of preferred securities (the "Preferred Securities") at an interest rate of 9.7%, with a scheduled maturity of August 15, 2027. The Company owns all the common stock of the Trust. The proceeds from the issue were invested in Junior Subordinated Debentures (the "Debentures") issued by the Company. The Debentures are unsecured and rank subordinate and junior in right of payment to all indebtedness, liabilities and obligations of the Company. The Debentures represent the sole assets of the Trust. Interest on the Preferred Securities is cumulative and payable semi-annually in arrears. The Company has the option, subject to required regulatory approval, if any, to prepay the securities beginning August 15, 2007. The securities are shown on the balance sheet as "Company-obligated mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company." The Company has, under the terms of the Debentures and the related Indenture as well as the other operative corporate documents, agreed to irrevocably and unconditionally guarantee the Trust's obligations under the Debentures. The Company contributed approximately $6.0 million of the net proceeds to the Bank to support the Bank's lending activities. The interest cost associated with this issue is treated as a non-interest expense on the consolidated statement of income rather than interest expense. On November 15, 2001, the Company purchased $3.5 million of the Preferred Securities. On November 28, 2001, First Keystone Capital Trust II (the "Trust II"), a trust formed under Delaware law, that is a subsidiary of the Company, issued $8.0 million of securities ("Preferred Securities II") in a pooled securities offering at a floating rate of 375 basis over the six month LIBOR with a maturity date of December 8, 2031. The Company owns all the common stock of the Trust II. The proceeds from the issue were invested in Junior Subordinated Debentures (the "Debentures II") issued by the Company. The Debentures II are unsecured and rank subordinate and junior in right of payment to all indebtedness, liabilities and obligations of the Company. The Debentures II represent the sole assets of the Trust II. Interest on the Preferred Securities II is cumulative and payable semi-annually in arrears. The Company has the option, subject to required regulatory approval, if any, to prepay the securities beginning December 8, 2006. 36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data) 17. PARENT COMPANY ONLY FINANCIAL INFORMATION Condensed financial statements of First Keystone Financial, Inc. are as follows: CONDENSED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30 --------------------- 2002 2001 -------- -------- Assets Interest-bearing deposits $ 2,269 $ 196 Investment securities available for sale 7,060 7,715 Investment in subsidiaries 44,192 40,217 Other assets 1,798 593 -------- -------- Total assets $ 55,319 $ 48,721 ======== ======== Liabilities and Stockholders' Equity Junior subordinated debt $ 21,630 $ 16,702 Other borrowed money 815 Other liabilities 894 583 -------- -------- Total liabilities 22,524 18,100 Stockholders' equity 32,795 30,621 -------- -------- Total liabilities and stockholders' equity $ 55,319 $ 48,721 ======== ========
CONDENSED STATEMENTS OF INCOME
YEAR ENDED SEPTEMBER 30 ------------------------------------ 2002 2001 2000 -------- -------- -------- Interest and dividend income: Dividends from subsidiary $ 5 $ 4,500 $ 1,250 Loan to ESOP 92 105 116 Interest and dividends on investments 502 608 618 Interest on deposits 67 7 16 -------- -------- -------- Total interest and dividend income 666 5,220 2,000 -------- -------- -------- Interest on debt and other borrowed money 1,723 1,762 1,783 Other income 44 25 Operating expenses 154 403 96 -------- -------- -------- (Loss) income before income taxes and equity in undistributed (loss) income of subsidiaries (1,167) 3,080 121 Income tax benefit (385) (477) (374) -------- -------- -------- (Loss) income before equity in undistributed income (loss) of subsidiaries (782) 3,557 495 Equity in undistributed income (loss) of subsidiaries 3,508 (1,086) 1,867 -------- -------- -------- Net income $ 2,726 $ 2,471 $ 2,362 ======== ======== ========
CONDENSED STATEMENTS OF CASH FLOWS
YEAR ENDED SEPTEMBER 30 ------------------------------------ 2002 2001 2000 -------- -------- -------- Cash flows from operating activities: Net income $ 2,726 $ 2,471 $ 2,362 Adjustments to reconcile net income to cash provided by (used in) operations: Equity in undistributed (income) loss of subsidiaries (3,508) 1,086 (1,867) Amortization of common stock acquired by stock benefit plans 384 251 327 Gain (loss) on sales of investment securities available for sale 44 (25) Amortization of premium (22) 29 5 (Increase) decrease in other assets (1,205) 455 (255) Increase (decrease) in other liabilities 145 (459) 339 -------- -------- -------- Net cash (used in) provided by operating activities (1,436) 3,808 911 -------- -------- -------- Cash flows from investing activities: Purchases of investments available for sale (3,870) (278) (109) Proceeds from sale of investments available for sale 4,956 1,025 -------- -------- -------- Net cash provided by (used in) investing activities 1,086 747 (109) -------- -------- -------- Cash flows from financing activities: Issuance of preferred trust securities 8,000 Purchase of preferred trust securities (3,290) Repayment in other borrowed money (815) (711) (706) Purchase of treasury stock (1,013) (3,045) Dividends paid (734) (693) (630) Proceeds from exercise of stock options 275 18 -------- -------- -------- Net cash provided by (used in) financing activities 2,423 (4,431) (1,336) -------- -------- -------- Increase (decrease) in cash 2,073 124 (534) Cash at beginning of year 196 72 606 -------- -------- -------- Cash at end of year $ 2,269 $ 196 $ 72 ======== ======== ========
37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (dollars in thousands, except per share data) 18. QUARTERLY FINANCIAL DATA (UNAUDITED) Unaudited quarterly financial data for the years ended September 30, 2002 and 2001 is as follows:
2002 2001 --------------------------------------- --------------------------------------- 1ST 2ND 3RD 4TH 1st 2nd 3rd 4th QTR QTR QTR QTR QTR QTR QTR QTR ------ ------ ------ ------ ------ ------ ------ ------ Interest income $7,757 $7,416 $7,547 $7,403 $7,978 $7,992 $8,043 $7,847 Interest expense 4,638 4,154 3,896 3,840 5,194 5,047 5,088 5,000 ------ ------ ------ ------ ------ ------ ------ ------ Net interest income 3,119 3,262 3,651 3,563 2,784 2,945 2,955 2,847 Provision for loan losses 135 135 135 135 135 135 135 135 ------ ------ ------ ------ ------ ------ ------ ------ Net interest income after provision for loan losses 2,984 3,127 3,516 3,428 2,649 2,810 2,820 2,712 Non-interest income 458 450 456 859(1) 470 438 529 452 Non-interest expense 2,669 2,756 3,056 3,625(1) 2,382 2,517 2,559 2,492 ------ ------ ------ ------ ------ ------ ------ ------ Income before income taxes 773 821 916 662 737 731 790 672 Income tax expense 120 137 173 17 127 116 129 87 ------ ------ ------ ------ ------ ------ ------ ------ Net income $ 653 $ 684 $ 743 $ 645 $ 610 $ 615 $ 661 $ 585 ====== ====== ====== ====== ====== ====== ====== ====== Per Share: Earnings per share - basic $ .34 $ .35 $ .39 $ .34 $ .29 $ .30 $ .33 $ .31 Earnings per share - diluted $ .32 $ .34 $ .36 $ .32 $ .28 $ .28 $ .31 $ .29 Dividend per share $ .09 $ .09 $ .09 $ .09 $ .08 $ .08 $ .08 $ .08
Earnings per share is computed independently for each period presented. Consequently, the sum of the quarters may not equal the total earnings per share for the year. Certain reclassifications have been made to the quarters presented to conform with the presentation. Such reclassifications had no impact on the reported net income. (1) During the fourth quarter, the Company sold and realized a pre-tax net gain on certain available for sale securities of $331. Additionally, due to a settlement of a lawsuit concerning certain loan sales, a $570 expense was incurred. 38 FIRST KEYSTONE FEDERAL SAVINGS BANK SENIOR MANAGEMENT TEAM [PHOTO OF SENIOR MANAGEMENT TEAM] (standing left to right) Robin G. Otto Carol L. Walsh Thomas M. Kelly Rose Mary DiMarco Robert R. Hosier (sitting left to right) Stephen J. Henderson Donald S. Guthrie Elizabeth M. Mulcahy A. Charles Amentt, Jr. EXECUTIVE OFFICES 22 West State Street Media,PA 19063 (610) 565-6210 INDEPENDENT AUDITORS Deloitte & Touche LLP 24th Floor 1700 Market Street Philadelphia, PA 19103-3984 INVESTOR INFORMATION Thomas M. Kelly President and Chief Financial Officer (610) 565-6210 SHAREHOLDER INFORMATION Carol Walsh Corporate Secretary (610) 565-6210 DIRECTORS Donald S. Guthrie, Esquire Chairman of the Board Chief Executive Officer Donald A. Purdy, Esquire Chairman Emeritus Thomas M. Kelly President and Chief Financial Officer Edward Calderoni Associate Broker of Century-21 Alliance Donald G. Hosier, Jr. Principal in Montgomery Insurance Services, Inc. and President, First Keystone Insurance Services, LLC Edmund Jones, Esquire Member, Jones, Strohm & Guthrie, P.C. William J. O'Donnell CPA,Information Technology Manager, Wawa, Inc. Marshall J. Soss President and Chief Executive Officer KarMar Realty Group, Inc. TRANSFER AGENT Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016-3572 COUNSEL Lawrence G. Strohm, Jr.,Esquire Jones, Strohm & Guthrie, P.C. 10 Beatty Road Media, PA 19063 SPECIAL COUNSEL Elias, Matz, Tiernan and Herrick L.L.P. 12th Floor 734 15th Street, N.W. Washington, DC 20005 STOCK INFORMATION First Keystone Financial, Inc., is traded on the Nasdaq National Market under the symbol of "FKFS." There were approximately 414 shareholders of record as of September 16, 2002, not including the number of persons or entities whose stock is held in nominee or street name through various brokerage firms or banks. The Annual Meeting of Shareholders is scheduled for Wednesday, January 22, 2003, at 2 p.m. to be held at the Towne House Restaurant, 117 Veterans Square, Media, Pennsylvania. [FIRST KEYSTONE LOGO] FIRST KEYSTONE FINANCIAL, INC. 23 WEST STATE STREET MEDIA, PENNSYLVANIA 19063 EX-23 4 w67175exv23.txt INDEPENDENT AUDITORS' CONSENT EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement Nos. 333-88676, 333-09565 and 333-97562 of First Keystone Financial, Inc. on Form S-8 of our report dated November 7, 2002, incorporated by reference in this Annual Report on Form 10-K of First Keystone Financial, Inc. for the year ended September 30, 2002. /s/ DELOITTE & TOUCHE LLP DELOITTE & TOUCHE LLP Philadelphia, Pennsylvania December 27, 2002 EX-99.1 5 w67175exv99w1.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER EXHIBIT 99.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (18 U.S.C. 1350) The undersigned Chairman of the Board and Chief Executive Officer of First Keystone Financial, Inc. (the "Registrant") hereby certifies that the Registrant's Form 10-K for the fiscal year ended September 30, 2002 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained therein fairly presents, in all material respects, the financial condition and results of operations of the Registrant. /s/ Donald S. Guthrie - -------------------------------------------------------- Name: Donald S. Guthrie Title: Chairman of the Board and Chief Executive Officer Date: December 27, 2002 EX-99.2 6 w67175exv99w2.txt CERTIFICATION OF CHIEF FINANCIAL OFFICER EXHIBIT 99.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (18 U.S.C. 1350) The undersigned President and Chief Financial Officer of First Keystone Financial, Inc. (the "Registrant") hereby certifies that the Registrant's Form 10-K for the fiscal year ended September 30, 2002 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained therein fairly presents, in all material respects, the financial condition and results of operations of the Registrant. /s/ Thomas M. Kelly - --------------------------------------------- Name: Thomas M. Kelly Title: President and Chief Financial Officer Date: December 27, 2002 -----END PRIVACY-ENHANCED MESSAGE-----