-----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, P+QElOdH6KullzhknPJgSKNun7lSysRe3SXJn0gyub5i4m/+pidaqRq/LB5dEx/d ZXBBZLip5rLzQSgwY3ccNQ== 0000893220-99-001397.txt : 19991224 0000893220-99-001397.hdr.sgml : 19991224 ACCESSION NUMBER: 0000893220-99-001397 CONFORMED SUBMISSION TYPE: ARS PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991223 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: ARS SEC ACT: SEC FILE NUMBER: 000-25328 FILM NUMBER: 99780208 BUSINESS ADDRESS: STREET 1: 22 WEST STATE ST CITY: MEDIA STATE: PA ZIP: 19063 BUSINESS PHONE: 6105656210 ARS 1 ANNUAL REPORT 1 FIRST KEYSTONE FINANCIAL, INC. [COIN] "NOTHING HAPPENS UNLESS FIRST A DREAM" -CARL SANDBURG ANNUAL REPORT 1999 2 As we approach the millennium, we look to the challenges that lie ahead as opportunities to improve our services, expand our line of products, develop the potential of our employees, and explore the yet unknown expanses of the financial world. Donald S. Guthrie President 3 a Message to Our Shareholders - -------------------------------------------------------------------------------- Dear Shareholders: More than 100 years ago, the founders of First Keystone Financial envisioned a community bank that would serve the needs of the working man by helping him purchase a home, build a business, and save for his family and his own retirement. Today, as we approach the dawn of a new era, we salute our predecessors who had the forethought to develop the building and loan association concept, and all the visionaries who have marked this century with achievements such as television, computers and space exploration. As we stand at the starting line of a new millennium, it is now clearer than ever that mankind is only limited by its imagination and its ability to learn from the lessons of its past. At First Keystone, we have prepared ourselves for the journey into the future by taking on the challenges brought with the rapidly changing times. We began preparations for the Year 2000 upgrade of the Company's computer hardware and software system early in 1998, formed strategic alliances in 1999 to offer our customers more services including a complete line of insurance products, and we plan to introduce Internet Banking in the Year 2000. We challenge our employees to continue to provide the Bank's customers with the products and services needed to make banking more convenient and efficient while providing the Company's shareholders with increased value. [PHOTO] Donald S. Guthrie President and Chief Executive Officer It is with respect for all that has been accomplished in this past century, and with wonder at the possibilities ahead, that I report on the Company's performance for fiscal 1999. [PHOTO] Thomas M. Kelly, Executive Vice President and Chief Financial Officer, reviews a design for the new home page for the Bank's website which will introduce internet banking during the Year 2000. I am pleased to report that for the year ended September 30, 1999, First Keystone continued to achieve record earnings. Net income increased to $2.8 million and diluted earnings per share increased to $1.32 per share as compared to $1.23 per share for the prior fiscal year. Total assets grew to $450 million at year-end compared to $416 million at the previous year-end. Asset growth was attributed primarily to growth of the Company's loan portfolio. The Company's net loan portfolio increased by $28 million to $226 million at 4 September 30, 1999. As we continue to implement our strategic business plan, we are particularly pleased with the impressive growth in the origination of commercial real estate and construction loans. Asset growth was partially funded by an increase in the Bank's core deposits. The increase of 11.7%, or $11 million, in core deposits can be attributed to the Bank's successful efforts to cross-sell existing customers, acquire new households through targeted direct mail campaigns, and open new ancillary deposit accounts by further developing the Bank's commercial business lending relationships. During the first quarter of fiscal year 1999, the Board of Directors unanimously approved to increase the quarterly dividends paid to the Company's shareholders by 20% reflecting First Keystone's commitment to enhancing shareholder value. [PHOTO] Robert Hosier, Vice President of Management Information Services, spearheaded the Bank's Y2K compliance program and alleviated customers' fears of the Big Bad Wolf. I encourage you to read the Company's complete financial review presented in this annual report. One of the highlights includes a 35% reduction in the Company's ratio of non-performing assets and troubled debt restructurings to total assets as a result of the completion of a real estate development project. In addition, I am pleased to report that the Company's financial performance remains strong as evidenced through earnings improvement and the continued repurchase of its stock in the open market. These factors contributed to the Company's slight increase in return on equity at year-end despite a sluggish market in the financial services sector. During the next fiscal year, we plan to introduce internet banking, open the Bank's seventh full service office in Chester Heights, Pennsylvania, and further develop the strategic alliances formed through the Company's subsidiaries to provide insurance services and title insurance. These subsidiaries will provide additional financial services to both bank and non-bank customers and will directly impact the bottom line by contributing to non-interest income. Thank you for the trust and confidence that you have placed in our management team. We will continue to work hard to increase the value of your investment. [PHOTO] With the bank well prepared for the millennium,"Who's afraid of Y2K?" was an appropriate and fun theme for this year's Delaware County Halloween Parade in Media. The parade was sponsored by First Keystone Federal. Sincerely, /s/Donald S. Guthrie Donald S. Guthrie President and Chief Executive Officer 5 YEAR IN REVIEW We're More than Y2K OK Recognizing the importance of upgrading the Bank's computer system to properly read dates in a four-digit system, management began dedicating significant resources to this potential problem in early 1998. In accordance with the Bank's Y2K Compliance Plan, the Bank has run complete diagnostic tests on its computer system, all necessary hardware and software has been updated, and testing with the Bank's primary service provider has produced excellent results. In addition, the Bank has hosted numerous customer informational seminars on the topic, and we are confident that these efforts will result in a seamless transition into the new millennium for its customers. FORMING STRATEGIC ALLIANCES TO MAKE FINANCIAL MATTERS EASIER Understanding that, for many of us, time has become one of our most valuable assets, the Bank has added to the convenience of one-stop shopping for residential and commercial loans by also offering title insurance services through its investment in a title insurance agency. Now, with just one quick telephone call, our customers can feel confident that their title insurance will be completed efficiently and professionally. Another natural extension of services is the ability to offer a full array of insurance products. Through First Keystone Insurance Services, LLC, a subsidiary of the Bank, Bank customers can receive valuable discounts on the purchase of long-term health care, life, automobile, home and commercial insurance products. These strategic alliances enable the Bank to provide its customers with excellent service, competitive prices and time saving convenience on many financial products while providing the Company with a more diversified income stream that is less dependent on interest income. CONCENTRATING ON COMMERCIAL, CONSTRUCTION AND CONSUMER LENDING With a strong economy helping to pave the way, commercial real estate lending and commercial business loans enjoyed a robust year with outstanding balances increasing from $22 million at September 30, 1998 to $33 million at September 30, 1999. This 50% increase in the portfolio helped to provide many small businesses with the financing they needed to [PHOTO] A group of Russian delegates, brought to the United States by Congressman Curt Weldon, attended a meeting with First Keystone Federal Vice President of Lending Elizabeth Gibson to learn mortgage processing and underwriting skills. With the information gathered from this and other meetings with bank officials and business leaders throughout Delaware County, they will use their knowledge to help institute business and economic changes in their country. 6 [PHOTO] Mary Wentz, Vice President of Construction Loans and Bud Amentt, Vice President of Commercial Lending work together to provide commercial real estate lending and commercial business loans throughout Chester and Delaware Counties. Shown above, they are on the construction site of the new Fox Roach Realtor office in Media. expand, while providing the Company with solid returns on its investments. The tremendous growth in this department is a result of increased market penetration, and greater customer awareness that First Keystone is a source for commercial financing. Continued strong activity in new residential construction was spurred by both record low interest rates and the expansion of public sewer and water in many of the markets the Bank serves. In addition, the ability to offer permanent commercial loan financing has also enhanced the construction lending portfolio. First Keystone continues to maintain its market share in this extremely competitive arena because of its proven expertise, active presence in the trade associations and solid reputation with area builders. First mortgage lending remains an important aspect of the Bank's portfolio mix, and management recognizes that traditional residential lending will always be a staple among its lending products. However, increased emphasis is being placed on originating consumer loans, as well as first and second mortgages to subprime borrowers. The origination of consumer loans provides greater interest rate spreads than single-family residential loans while the origination of subprime loans generates increased fee income as they are sold into the capital markets for a premium. BANKING SERVICES DELIVERED IN A MULTITUDE OF MEDIUMS First Keystone is meeting the needs of our customers by providing access to bank products through a multitude of mediums. These include the expansion of branch offices, increased options and services through its telephone banking system, and Internet banking which will be introduced in fiscal year 2000. The Company's goal remains to provide its banking customers with a multitude of financial services while striving to enhance shareholder value. First Keystone continues to face these challenges with foresight and strong leadership. The latest branch office that opened in December 1999 in Chester Heights, Pennsylvania is located in the most explosive growth area in Delaware County. The Bank's 24/7 banking telephone system, Keystone Direct, continues to expand its services and the number of transactions increases monthly. Internet banking will be launched during the new fiscal year, and management recognizes that this new service will not only assist the Bank in remaining competitive in the financial industry, but will serve as an aggressive tool to attract a younger demographic group than its current client base. [PHOTO] The newest branch of First Keystone Federal opened in December 1999 in Chester Heights, PA. 7 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, -------------------------------------------------------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (dollars in thousands, except per share data) SELECTED FINANCIAL DATA: Total assets $ 450,126 $ 415,863 $ 373,430 $ 294,241 $ 280,979 Loans receivable, net 226,375 198,343 188,289 167,530 158,002 Mortgage-related securities held to maturity 14,497 18,769 20,707 23,221 60,294 Investment securities held to maturity 10,000 16,532 10,710 Assets held for sale: Mortgage-related securities 113,046 115,486 104,472 60,211 19,538 Investment securities 44,315 40,621 10,211 Loans 1,792 2,799 4,577 2,447 57 Real estate owned 297 1,663 1,672 1,557 465 Deposits 260,826 247,311 227,918 219,205 223,753 Borrowings 142,437 120,878 99,987 46,740 28,411 Stockholders' equity 23,904 26,664 24,752 23,084 24,463 Non-performing assets 3,477 5,367 3,749 6,909 3,621 ========= ========= ========= =========== ========= SELECTED OPERATIONS DATA: Interest income $ 28,694 $ 27,393 $ 22,750 $ 19,837 $ 18,295 Interest expense 16,956 15,625 12,639 10,932 10,767 --------- --------- --------- --------- --------- Net interest income 11,738 11,768 10,111 8,905 7,528 Provision for loan losses 259 186 239 1,250 52 --------- --------- --------- --------- --------- Net interest income after provision for loan losses 11,479 11,582 9,872 7,655 7,476 Other income (expense): Service charges and other fees 934 898 972 1,047 1,029 Net gain on sales of interest-earning assets 616 577 285 203 113 Net gain on sale of other assets 1 46 Net gain (loss) on real estate activities (113) (25) 7 2 (44) Other 350 57 40 56 89 Operating expenses 9,501 9,059 6,921 8,645 7,036 -------- --------- -------- --------- --------- Income (loss) before income taxes, extraordinary item and cumulative effect of change in accounting principle 3,765 4,031 4,301 318 1,627 Income tax expense (benefit) 917 1,250 1,664 (567) 504 --------- --------- --------- ---------- --------- Net income $ 2,848 $ 2,781 $ 2,637 $ 885(2) $ 1,123 ========= ========= ========= =========== ========= Diluted earnings per common share(1) $ 1.32 $ 1.23 $ 1.13 $ .37(2) $ .37 ========= ========= ========= =========== =========
(1) Adjusted for the effect of a 2 for 1 stock split declared December 4, 1997. (2) Includes the effects of the one-time SAIF special assessment. The effects of the assessment increased operating expenses and decreased income before income taxes by $1.4 million. The effects of the assessment also decreased net income and earnings per share by $876,000 and $.74, respectively. 5 8 First Keystone Financial, Inc. and Subsidiaries SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
AT OR FOR THE YEAR ENDED SEPTEMBER 30, ------------------------------------------------------------ 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- SELECTED OPERATING RATIOS: (3) Average yield earned on interest-earning assets 7.15% 7.40% 7.54% 7.45% 7.37% Average rate paid on interest-bearing liabilities 4.49% 4.68 4.48 4.42 4.62 Average interest rate spread 2.65% 2.72 3.07 3.03 2.75 Net interest margin 2.98% 3.18 3.35 3.34 3.03 Ratio of interest-earning assets to interest-bearing liabilities 107.91 110.80 106.82 107.65 106.55 Net interest income after provision for loan losses to operating expenses 120.82 127.84 142.64 88.55(4) 106.25 Operating expenses as a percent of average assets 2.23 2.37 2.21 3.14(4) 2.73 Return on average assets 0.67 0.73 0.84 0.32(4) 0.44 Return on average equity 11.18 11.13 11.46 3.92(4) 5.59 Ratio of average equity to average assets 5.99 6.54 7.36 8.20 7.80 Full-service offices at end of period 6 6 5 5 5 ====== ====== ====== ======= ====== ASSET QUALITY RATIOS: (5) Non-performing loans as a percent of gross loans receivable 1.39% 1.85% 1.09% 3.15% 1.98% Non-performing assets as a percent of total assets 0.77 1.29 1.00 2.35 1.29 Allowance for loan losses as a percent of gross loans receivable 0.84 0.87 0.86 1.54 0.93 Allowance for loan losses as a percent of non-performing loans 60.63 46.92 78.38 49.03 47.12 Net loans charged-off to average interest-earning loans receivable 0.03 0.04 0.68 0.07 0.07 ====== ====== ====== ======= ====== CAPITAL RATIOS: (5) (6) Tangible capital ratio 8.17% 8.27% 8.12% 7.67% 8.23% Core capital ratio 8.17 8.27 8.12 7.67 8.23 Risk-based capital ratio 18.80 21.09 19.91 17.24 17.82 ====== ====== ====== ======= ======
(3) Adjusted for the effects of tax-free investments (4) Includes the effects of the one-time SAIF special assessment of $1.4 million. Excluding the one-time effects, the ratio of net interest income after provision for loan losses to operating expenses and operating expenses as a percent of average assets ratios were 106.04% and 2.62%, respectively. In addition, return of average assets and return on average equity were .64% and 7.79%, respectively, excluding the special assessment. (5) Asset Quality Ratios and Capital Ratios are end of period ratios, except for charge-offs to average loans. With the exception of end of period ratios, all ratios are based on average daily balances during the indicated periods. (6) Regulatory capital ratios of the Company's wholly-owned subsidiary, First Keystone Federal Savings Bank. LOANS RECEIVABLE Commercial Business 1% Single Family 69% Construction 8% Non-Residential 13% Consumer Equity 8% Other 1% DEPOSIT ACCOUNTS Non-Interest Bearing Accounts 3% Money Market Demand Accounts 7% Passbook Accounts 16% New Accounts 13% Certificates of Deposit 61% 6 9 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, First Keystone Financial, Inc., including its wholly owned subsidiaries, will be referred to as the "Company". The Company is a community oriented banking organization that focuses on providing customer and business services within its primary market area, consisting of Delaware and Chester counties in the state of Pennsylvania. The following discussion should be read in conjunction with the Company's consolidated financial statements presented elsewhere herein. 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 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, resulting from management's assessment of the adequacy of the allowance for loan losses, the level of its non-interest income, including service charges and other fees as well as gains and losses from the sale of certain assets, the level of its operating expenses, and income tax expense. ASSET AND LIABILITY MANAGEMENT The principal objective of the Company's asset and liability management is to evaluate the interest rate risk existing in certain assets and liabilities, determine the level of risk appropriate given the Company's business focus, operating environment, capital and liquidity requirements and performance objectives, establish prudent asset concentration guidelines, and manage the risk consistent with Board approved guidelines. Through asset and liability management, the Company seeks to reduce both the vulnerability and volatility of its operations to changes in interest rates and to manage the ratio of interest-rate sensitive assets to interest-rate sensitive liabilities within specified maturities or repricing periods. The Company's actions in this regard are taken under the guidance of the Asset/Liability Committee ("ALCO"), which is chaired by the Chief Financial Officer and comprised of members of the Company's senior management. The ALCO meets on a monthly basis to review, among other things, liquidity and cash flow needs, current market conditions and interest rate environment, the sensitivity to changes in interest rates of the Company's assets and liabilities, the book and market values of assets and liabilities, unrealized gains and losses, and the purchase and sale activity and maturities of investments, deposits and borrowings. In addition, the pricing of the Company's residential loans and deposits is reviewed at least weekly while the pricing of loans originated for sale in the secondary market is reviewed daily. The ALCO reports to the Company's Board of Directors 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. A more conventional but limited Asset/Liability monitoring tool involves an analysis of the extent to which assets and liabilities are interest rate sensitive and measures an institution's interest rate sensitivity gap. An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets. 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. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. While a conventional gap measure may be useful, it 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. 7 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For purposes of the table below, annual prepayment assumptions range from 9% to 15% 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 ("MMDA") are assumed to decay at a rate of 30% per year. Negotiable order of withdrawal ("NOW") accounts are assumed to decay at a rate of 20% per year. First Keystone's passbook, statement savings, MMDA and NOW accounts are generally subject to immediate withdrawal. However, management considers a portion of these deposits to be core deposits having significantly longer effective maturities based upon the Bank's experience in retaining such deposits in changing interest rate environments. Management believes that the assumptions used by it to evaluate the vulnerability of the Bank's operations to changes in interest rates are conservative and considers them reasonable. However, the interest rate sensitivity of the Bank's assets and liabilities as portrayed in the table below could vary substantially if different assumptions are used or actual experience differs from the assumptions used in the table. The Company also utilizes an analysis of the market value of portfolio equity, which addresses the estimated change in the Company's equity value arising from movements in interest rates. The market value of portfolio equity is estimated by valuing the Company's assets and liabilities 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 Company's current balance sheet. See Item 7A in the Company's Annual Report on Form 10-K. The following table summarizes the anticipated maturities or repricing of the Company's interest-earning assets and interest-bearing liabilities as of September 30, 1999, 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) $ 61,292 $ 35,858 $ 44,010 $ 30,896 $ 51,140 $ 223,196 Mortgage-related securities 13,980 8,890 28,722 24,718 51,233 127,543 Loans held for sale 1,792 1,792 Investment securities 10,645 4,994 34,833 50,472 Interest-earning deposits 17,005 17,005 --------- --------- --------- --------- --------- --------- Total interest-earning assets $ 104,714 $ 44,748 $ 77,726 $ 55,614 $ 137,206 $ 420,008 --------- --------- --------- --------- --------- --------- Interest-bearing liabilities: Deposits $ 85,613 $ 57,271 $ 66,178 $ 36,250 $ 15,514 $ 260,826 Borrowed funds 72,180 34,300 20,500 10,000 5,457 142,437 --------- --------- --------- --------- --------- --------- Total interest-bearing liabilities $ 157,793 $ 91,571 $ 86,678 $ 46,250 $ 20,971 $ 403,263 --------- --------- --------- --------- --------- --------- Excess (deficiency) of interest-earning assets over interest-bearing liabilities $ (53,079) $ (46,823) $ (8,952) $ 9,364 $ 116,235 $ 16,745 ========= ========= ========= ========= ========= ========= Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities $ (53,079) $ (99,902) $(108,854) $ (99,490) $ 16,745 ========= ========= ========= ========= ========= Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities as a percentage of total assets (11.79)% (22.19)% (24.18)% (22.10)% 3.72% ========= ========= ========= ========= =========
(1) Balances have been reduced for non-accruing loans, which amounted $3.2 million at September 30, 1999. 8 11 MD&A management's discussion and analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CHANGES IN FINANCIAL CONDITION GENERAL. Total assets of the Company increased by $34.3 million, or 8.2%, from $415.9 million at September 30, 1998 to $450.1 million at September 30, 1999. The increase reflected primarily growth in loans receivable and, to a lessor extent, prepaid expenses and other assets, which consist primarily of the Bank's purchase of Bank Owned Life Insurance ("BOLI") products. The asset growth was funded by increases in customer deposits and advances from the FHLB of Pittsburgh. Asset growth was also funded by a modest increase in retained earnings. CASH AND INVESTMENTS. Cash and investments (including investments available for sale) decreased by $417,000, or .6%, to $64.3 million at September 30, 1999 compared to $64.7 million at September 30, 1998. The decrease was primarily due to use of the Company's liquid assets and the proceeds from investments to fund increases in the Company's loan portfolio. LOANS HELD FOR SALE AND LOANS RECEIVABLE, NET. Aggregate loans receivable (loans receivable, net, and loans held for sale) increased $27.0 million or 13.4% to $228.2 million at September 30, 1999 compared to $201.1 million at September 30, 1998. Single-family mortgage loans increased $18.7 million, or 12.6%, while an increased focus on the origination of multi-family and commercial real estate mortgages increased the balance of such loans to $11.4 million, or 52.0%, for the year ended September 30, 1999. 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 $6.8 million, or 5.0%, to $127.5 million at September 30, 1999 compared to $134.3 million at September 30, 1998. The decrease was the result of the Company's continued emphasis on loan originations. NON-PERFORMING ASSETS. The Company's total non-performing loans (including troubled debt restructurings) and real estate owned decreased $1.9 million or 35.2% from $5.4 million, or 1.0%, of total assets at September 30, 1998 to $3.5 million, or .8%, of total assets at September 30, 1999. The decrease in the non-performing assets was primarily due to the completion in fiscal 1999 of the Company's only real estate development project. Real estate owned decreased by $1.4 million to $297,000, or .07%, of total assets at September 30, 1999 as compared to $1.7 million, or .40%, of total assets at September 30, 1998. Non-performing assets consist primarily of single-family residential loans. DEPOSITS. Deposits increased by $13.5 million, or 5.5%, from $247.3 million at September 30, 1998 to $260.8 million at September 30, 1999. This increase was primarily due to a $10.6 million, or 11.7%, increase in the Company's core accounts, NOW, passbook, and MMDA accounts, as a result of the Company's continued emphasis on these deposit accounts. Certificates of deposit also increased by $3.0 million, or 1.9%, in the current fiscal year. BORROWINGS. The Company's total borrowings increased $21.6 million to $142.4 million at September 30, 1999 from $120.9 million at September 30, 1998. The FHLB advances were used to fund loan growth and had a weighted average interest rate of 5.4% at September 30, 1999. See Note 10 to the Consolidated Financial Statements for further information. EQUITY. At September 30, 1999, total stockholders' equity was $23.9 million, or 5.3% of total assets, compared to $26.7 million, or 6.4%, of total assets at September 30, 1998. The $2.8 million decrease was due to the combination of a decrease of $4.5 million in unrealized gains on available for sale securities as well as the cost of the Company's stock repurchases and dividends paid aggregating $1.6 million offset, in part, by the Company's net income of $2.8 million. The decrease in the unrealized gains on available for sale securities was due to general increases in market interest rates. 9 12 MD&A 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 and yields were adjusted for the effects of tax-free investments.
YEAR ENDED SEPTEMBER 30, -------------------------------------------------------------------------------- 1999 1998 YIELD/COST ------------------------------------------------------------------- AT AVERAGE Average SEPT. 30, AVERAGE YIELD/ Average Yield/ 1999 BALANCE INTEREST COST Balance Interest Cost -------------------------------------------------------------------------------- (Dollars in Thousands) Interest-earning assets: Loans receivable(1)(2) 7.69% $ 218,784 $ 17,366 7.94% $ 197,776 $ 16,447 8.32% Mortgage-related securities(2) 6.66 127,572 7,965 6.24 123,283 8,029 6.51 Investment securities(2) 6.80 49,273 3,363 6.83 38,475 2,607 6.78 Other interest-earning assets 5.51 11,600 414 3.57 10,585 488 4.61 --------- -------- -------- -------- Total interest-earning assets 7.19 407,229 $ 29,108 7.15 370,119 $27,571 7.45 ---- -------- ---- -------- ---- Noninterest-earning assets 18,261 11,608 --------- --------- Total assets $ 425,490 $ 381,727 ========= ========= Interest-bearing liabilities: Deposits 3.96 $ 255,536 $ 10,265 4.02 $ 234,937 $ 9,937 4.23 FHLB advances and other borrowings 5.50 121,829 6,691 5.49 99,092 5,688 5.74 --------- -------- --------- -------- Total interest-bearing liabilities 4.50 377,365 16,956 4.49 334,029 15,625 4.68 ---- -------- -------- Interest rate spread 2.68 2.65 2.77 ---- ---- ---- Noninterest-bearing liabilities 22,643 22,730 --------- --------- Total liabilities 400,008 356,759 Stockholders' equity 25,482 24,968 --------- --------- Total liabilities and stockholders' equity $ 425,490 $ 381,727 ========= ========= Net interest-earning assets $ 29,864 $ 36,090 ========= ========= Net interest income/net interest margin(3) 12,152 2.98% 11,946 2.23% ==== ==== Less: tax equivalent adjustments (414) (178) -------- -------- Net interest income $ 11,738 $ 11,768 ======== ======== Ratio of average interest-earning assets to average interest-bearing liabilities 107.91% 110.80% ====== ======
YEAR ENDED SEPTEMBER 30, ------------------------------- 1997 ------------------------------- Average Average Yield/ Balance Interest Cost ------- -------- ---- (Dollars in Thousands) Interest-earning assets: Loans receivable(1) (2) $179,566 $ 14,737 8.21% Mortgage-related securities(2) 92,393 6,197 6.71 Investment securities(2) 21,774 1,478 6.79 Other interest-earning assets 7,793 338 4.34 -------- -------- Total interest-earning assets 301,526 $ 22,750 7.54 -------- ---- Noninterest-earning assets 11,193 -------- Total assets $312,719 ======== Interest-bearing liabilities: Deposits $221,140 $ 9,182 4.15 FHLB advances and other borrowings 61,124 3,457 5.65 -------- -------- Total interest-bearing liabilities 282,264 12,639 4.47 -------- Interest rate spread 3.07 ---- Noninterest-bearing liabilities 7,453 -------- Total liabilities 289,717 Stockholders' equity 23,002 -------- Total liabilities and stockholders' equity $312,719 ======== Net interest-earning assets $ 19,262 ======== Net interest income/net interest margin(3) $ 10,111 3.35% ==== Less: tax equivalent adjustments -------- Net interest income $ 10,111 ======== Ratio of average interest-earning assets to average interest-bearing liabilities 106.82% ======
(1) Includes non-accrual loans. (2) Includes assets classified as either available for sale or held for sale. (3) Net interest income divided by interest-earning assets. 10 13 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 volume of interest-related assets and liabilities have affected the Company's interest income and expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) changes in rate (change in rate multiplied by prior year volume), and (iii) total change in rate and volume. The combined effect of changes in both rate and volume has been allocated proportionately to the change due to rate and the change due to volume.
Year Ended September 30, --------------------------------------------------------------------------------- 1999 vs. 1998 1998 vs. 1997 --------------------------------------------------------------------------------- Increase (Decrease) Increase (Decrease) Due To Due To --------------------------------------------------------------------------------- Total Increase Total Increase Rate Volume (Decrease) Rate Volume (Decrease) ---- ------ ---------- ---- ------ ---------- Interest-earnings assets: Loans receivable(1) $ (689) $1,608 $ 919 $ 198 $1,512 $1,710 Mortgage-related securities(1) (409) 345 (64) (174) 2,006 1,832 Investment securities (1) (2) 19 737 756 (3) 1,132 1,129 Other interest-earning assets (129) 55 (74) 22 128 150 ------- ------ ------- ------ ------ ------ Total interest-earning assets (1,208) 2,745 1,537 43 4,778 4,821 ------- ------ ------- ------ ------ ------ Interest-bearing liabilities: Deposits (440) 768 328 174 581 755 FHLB advances and other borrowings (169) 1,172 1,003 (2) 2,233 2,231 ------- ------ ------- ------ ------ ------ Total interest-bearing liabilities (609) 1,940 1,331 172 2,814 2,986 ------- ------ ------- ------ ------ ------ Increase (decrease) in net interest income $ (599) $ 805 $ 206 $(129) $1,964 $1,835 ======= ====== ======= ====== ====== ======
(1) Includes assets classified as either available for sale or held for sale. (2) The above table is presented on a taxable equivalent basis. RESULTS OF OPERATIONS GENERAL. The Company reported net income of $2.8 million, $2.8 million and $2.6 million for the years ended September 30, 1999, 1998 and 1997, respectively. The $67,000 increase in net income for the year ended September 30, 1999 compared to the year ended September 30, 1998 was primarily due to a $279,000, or 18.5%, increase in other income, and a $333,000 decrease in income tax expense offset, in part, by a $442,000, or 4.9%, increase in operating expenses. The $144,000 increase in net income for the year ended September 30, 1998 compared to the year ended September 30, 1997 was primarily due to a $1.7 million, or 16.4%, increase in net interest income, a $158,000, or 11.7%, increase in other income and a $414,000 decrease in income tax expense partially offset by a $2.1 million, or 30.9%, increase in operating expenses. The increase in operating expenses for the year ended September 30, 1998 was primarily due to the minority interest expense related to the issuance of trust preferred securities. 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 ratios are reported on a fully tax equivalent basis. The Company's average interest-rate spread was 2.65%, 2.72% and 3.07% during the years ended September 30, 1999, 1998 and 1997, respectively. The Company's interest-rate spread was 2.68% at September 30, 1999. The Company's net interest margin (net interest income as a percentage of average interest-earning assets) was 2.98%, 3.23% and 3.35% during the years ended September 30, 1999, 1998 and 1997, respectively. In fiscal 1999 and 1998, the Company's net interest spread and net interest margin were impacted by the relatively flat yield curve in which assets have repriced downward to a greater degree than liabilities in the declining interest rate environment that existed. Net interest income declined slightly to $11.7 million in fiscal 1999 as compared to $11.8 million in fiscal 1998. The reason for the decrease was a greater increase in total interest expense than in total interest income. Net interest income increased by $1.7 million, or 16.4%, in the year ended September 30, 1998 to $11.8 million compared to $10.1 million in fiscal 1997. The reason for such increase was a $4.6 million, or 20.4%, increase in interest income partially offset by a $3.0 million, or 23.6%, increase in interest expense. 11 14 management's discussion and analysis - -------------------------------------------------------------------------------- OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTEREST INCOME. The $1.3 million, or 4.7%, increase in total interest income during the year ended September 30, 1999 as compared to fiscal 1998 was primarily due to a $919,000, or 5.6%, increase in interest income from loans as a result of a $21.0 million, or 10.6%, increase in the average balance of the loan portfolio offset, in part, by a 38 basis point (with 100 basis points being equal to 1.0%) decrease in the yield earned thereon. The increase in the average balance was due to increased loan originations in both single-family, commercial business and commercial real estate loans as part of the Company's continued emphasis on expanding its loan portfolio. The decline in yield was due to the low rate environment in fiscal 1999 resulting in the refinancing of higher yielding loans into lower yielding products. Additionally, interest income on mortgage-related securities, investments and other interest-earning assets increased $382,000, or 3.5%, due to a $16.1 million, or 9.3%, increase in the aggregate average balance thereof offset by a 22 basis point decrease in the average yield earned. The increase in the average balances of such assets was due to the ongoing leveraging of the Company's capital base as part of the implementation of its strategic plan and the decrease in the yield earned was due to the declining interest rate environment experienced during fiscal 1999. Total interest income amounted to $27.4 million for the year ended September 30, 1998 compared to $22.8 million for the year ended September 30, 1997. The primary reason for the increase in the 1998 period was a $2.9 million, or 36.6%, increase in interest income from mortgage-related securities, investments and other interest-earning assets as a result of a $50.4 million, or 41.3%, increase in the aggregate average balance thereof. Such increase was partially offset by a 22 basis point decrease in the yield earned thereon. The increase in the average balances was due to increased leveraging of the Company's capital base while the decrease in the yield reflected the declining interest rate environment existing during fiscal 1998 compared to 1997. In addition, interest income from loans increased $1.7 million, or 11.6%, due to a $18.2 million, or 10.1%, increase in the average loan balance and a 11 basis point increase in the yield earned thereon. The increase in the average balance of the loan portfolio in fiscal 1998 reflected increased originations of primarily fixed-rate single family loans held in portfolio. INTEREST EXPENSE. Total interest expense amounted to $17.0 million for the year ended September 30, 1999 as compared to $15.6 million for fiscal 1998. The $1.4 million, or 8.5%, increase in interest expense in fiscal 1999 compared to fiscal 1998 was due to a $1.0 million increase in interest expense on borrowings and a $328,000 increase in interest expense on deposits. The increase in interest expense on borrowings was due to a $22.7 million increase in the average balance partially offset by a 25 basis point decline in the average rate paid on borrowings. The increase in interest paid on deposits was due to a $20.6 million increase in the average balance of deposits offset by a 21 basis point decline in the average rate paid on deposits. The increased level of borrowings and deposits was used to fund loan originations and the purchase of mortgage-related and investment securities. The decrease in the average rate paid on deposits and borrowings was due to general market interest rate fluctuations. Total interest expense increased by $3.0 million, or 23.6%, in the year ended September 30, 1998 compared to fiscal 1997. The reason for such increase was a $2.2 million increase in interest expense on borrowings and $755,000 increase in interest expense on deposits. The increase in interest expense on borrowings was due to a $38.0 million increase in the average balance of total borrowings and a 9 basis point increase in the average rate paid thereon. The increase in interest paid on deposits was due to a $13.8 million increase in the average balance of deposits combined with an 8 basis point increase in the average rate paid. The increased level of deposits and borrowings was used to fund loan originations and purchases of investment securities. The modest increase in the rates paid on deposits and borrowings was due to general market interest rate fluctuations. PROVISIONS FOR LOAN LOSSES. Provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level considered appropriate by management based on historical experience, the volume and type of lending conducted by the Company, the amount of the Company's classified assets, the status of past due principal and interest payments, general economic conditions, particularly as they relate to the Company's primary market area, and other factors related to the collectibility of the Company's loan and loans held for sale portfolios. Management of the Company assesses the allowance for loan losses on a monthly basis and makes provisions for loan losses as deemed appropriate in order to maintain the adequacy of the allowance for loan losses. For the year ended September 30, 1999, the provision for loan losses amounted to $259,000 as compared to $186,000 for fiscal 1998. For the year ended September 30, 1997, the provision for loan losses was $239,000. At September 30, 1999, the Company's allowance for loan losses amounted to 60.6% 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 12 15 management's discussion and analysis - -------------------------------------------------------------------------------- OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS at September 30, 1999, based on facts and circumstances available to it, there can be no assurances that additions to such allowance will not be necessary in future periods, which would adversely affect the Company's results of operations for such periods. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's provision for loan losses and the carrying value of its other non-performing assets based on their judgments about information available to them at the time of their examination. OTHER INCOME. For the year ended September 30, 1999, the Company reported other income of $1.8 million compared to $1.5 million for the year ended September 30, 1998. The primary reason for the $279,000, or 18.5%, increase in other income in fiscal 1999 was a $274,000 increase in other income and a $36,000 increase in service charges and other fees, partially offset by a $106,000 increase in the cost of real estate operations. Also contributing to the increase in other income was a $240,000 increase in the gain on sale of investments and mortgage-related securities as the Company sought to take advantage of certain market opportunities partially offset by a decrease in the gain on sale of loans of $201,000 due to the record refinancings processed in the prior fiscal year. The increase in other income is due to the Bank's purchase of Bank Owned Life Insurance Policies which were purchased to offset current employee benefit plan costs. The $158,000, or 11.7%, increase in other income for the year ended September 30, 1998 as compared to fiscal 1997 was due to a $241,000 increase in net gain on sales of mortgage loans held for sale and a $51,000 gain on the sale of investments and mortgage-related securities partially offset by a decrease of $74,000 in service charges and other fees. The increase in gains on sales of loans for fiscal 1998 reflected the Company's increased emphasis on the origination and sale, servicing released, of non-conforming loans. See Note 6 to the Consolidated Financial Statements. OPERATING EXPENSES. Operating expenses include compensation and employee benefits, occupancy and equipment expense, Federal Deposit Insurance Corporation ("FDIC") deposit insurance premiums, data processing expense and other items. Operating expenses increased $442,000, or 4.9%, to $9.5 million for the year ended September 30, 1999 compared to the year ended September 30, 1998. The primary reason for the increase in operating expenses in fiscal 1999 was a $350,000 provision for real estate owned losses primarily related to the Bank real estate development project. Also contributing to the increase in operating expenses were modest increases in occupancy and equipment, professional fees, bank service charges, data processing and advertising expenses offset in part by a decrease in salaries and employee benefits. Operating expenses increased $2.1 million, or 30.9%, for the year ended September 30, 1998 compared to the year ended September 30, 1997 and amounted to $9.1 million in fiscal 1998 compared to $6.9 million in fiscal 1997. The primary reason for the substantially higher level of operating expenses for fiscal 1998 was the $1.6 million minority interest in expense of subsidiary relating to the issuance of trust preferred securities by the Company. See Note 20 to the Consolidated Financial Statements for further information regarding the trust preferred securities. Also contributing to the increase was a $468,000, or 14.7% increase in compensation expense, a $241,000, or 30.2% increase in other expenses, and a $155,000, or 18.1%, increase in occupancy and equipment expense partially offset by a $153,000, or 20.9%, decrease in professional fees and a $62,000, or 30.0%, decrease in FDIC insurance premiums. Expansion of the branch network, through the opening of a new branch office, contributed to both the increased occupancy and equipment expense and compensation expense. Compensation expense also increased due to general salary increases as well as increased costs associated with the market value accounting for the employee stock ownership plan in accordance with AICPA Statement of Position 93-6. The increase in other expenses was due to a provision established for the Company's real estate owned property. INCOME TAXES. The Company recognized income tax expenses of $917,000, or 24.4%, of pre-tax income, for the year ended September 30, 1999, compared to $1.3 million, or 31.0%, of pre-tax income, for the year ended September 30, 1998. The Company recognized income tax expenses of $1.7 million, or 38.7% of pre-tax income, for fiscal 1997. The primary reason for the decrease in the percentage of tax expense in fiscal 1999 and 1998 was the reduction in state income taxes combined with the increase in tax-free income resulting from purchases of tax-exempt securities and insurance, as the Company employed various strategies to reduce both federal and state income 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. 13 16 management's discussion and analysis - -------------------------------------------------------------------------------- OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS While scheduled payments from the amortization of loans and mortgage-related securities and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. In addition, the Company invests excess funds in overnight deposits and other short-term interest-earning assets which provide liquidity to meet lending 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, 1999, the Company had $123.1 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, 1999, the total of approved loan commitments outstanding amounted to $6.4 million. At the same date, commitments under unused lines of credit and loans in process on construction loans amounted to $22.2 million. Certificates of deposit scheduled to mature in one year or less at September 30, 1999 totalled $122.6 million. Based upon its historical experience, management believes that a significant portion of maturing deposits will remain with the Company. The Company is required by the Office of Thrift Supervision ("OTS") to maintain average daily balances of liquid assets, defined as a ratio of cash and certain marketable securities that can be readily converted into cash to total deposits and short-term borrowings, of 4% to assure its ability to meet demand for withdrawals and repayment of short-term borrowings. The Company's liquidity ratio under these guidelines was 6.32% at September 30, 1999. The OTS requires that the Bank meet minimum regulatory tangible, core, tier 1 risk-based and total risk-based capital requirements. At September 30, 1999, the Bank exceeded all regulatory capital requirements and was deemed a well capitalized institution for regulatory purposes. See Note 13 to the Consolidated Financial Statements. The Company's assets consist primarily of its investment in the Bank and investments in various corporate debt and equity instruments. Its only material source of income consists of earnings from its investment in the Bank and interest and dividends earned on other investments. The Company, as a separately incorporated holding company, has no significant operations other than serving as the sole stockholder of the Bank and paying interest to its subsidiary, First Keystone Capital Trust I, for junior subordinated debt in conjunction with the issuance of trust preferred securities. On an unconsolidated basis, the Company has no paid employees. The expenses 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 within certain limits after providing written notice to the OTS. See Note 21 to the Consolidated Financial Statements. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," was issued. This statement requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. This statement is effective for fiscal years beginning after June 15, 2000, and will not be applied retroactively to financial statements of prior periods. Management of the Company does not believe this statement will have a material impact on the Company's financial position or results of operations when adopted. IMPACT OF INFLATION AND CHANGING PRICES The Consolidated Financial Statements of the Company and related notes presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. 14 17 management's discussion and analysis - -------------------------------------------------------------------------------- OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates. In the current interest rate environment, liquidity and the maturity structure of the Company's assets and liabilities are critical to the maintenance of acceptable performance levels. YEAR 2000 ISSUES (YEAR 2000 READINESS DISCLOSURE STATEMENT) The Year 2000 Issue is the result of computer programs which were written using two digits rather than four to define the applicable year. As a result, such programs may recognize a date using "00" as the year 1900 instead of the year 2000 which could result in system failures or miscalculations. In order to be ready for the year 2000, the Company has developed a Year 2000 Policy (the "Policy") which was presented to the Board of Directors during June 1997. The Policy was developed using the guidelines outlined in the Federal Financial Institutions Examination's Council's "The Effect of Year 2000 on Computer Systems". The Board of Directors and its Executive Committee assigned responsibility for the Policy to the Year 2000 Committee, which reports to the Board of Directors on a monthly basis. The Policy recognizes that the Company's operating, processing and accounting operations are computer reliant and could be affected by the Year 2000 Issue. The Company is primarily reliant on third party vendors for its computer output and processing, as well as other significant functions and services (i.e., securities safekeeping services, securities pricing information, etc.). The Year 2000 Committee is continually working with these third party vendors to assess their year 2000 readiness. Based upon this continual assessment, management presently believes that with planned modifications to existing software and hardware and planned conversions to new software and hardware, the Company's third party vendors are taking the appropriate steps to ensure critical systems will function properly. The Company has identified 74 priority 1 (directly effects customers) and 59 priority 2 (effects employee's ability to service customers) third party vendors. Of such priority 1 and priority 2 vendors, the Company has been informed that 100% are Year 2000 compliant. The Company's data service processing vendor, which is its major software provider, has informed the Company that it has completed testing and updating systems. The initial phase of testing of the data service processor's updated system was successfully completed in January 1999, and the subsequent phase of modifications and conversions and related testing of the system was completed by March 31, 1999. All of the Company's vendors of its priority 1 and priority 2 applications (discussed below) have provided assurances, written or oral, that they are Year 2000 compliant. While the Company has received assurances from such vendors as to compliance, such assurances are not guarantees and may not be enforceable. The Company's existing older contracts with such vendors do not include Year 2000 certifications or warranties. Thus, in the event such vendor's products and/or services are not Year 2000 compliant (notwithstanding their assurances to the contrary), the Company's recourse in the event of such failure may be limited. If the required modifications and conversions are not made, or are not completed on a timely basis, the Year 2000 Issue could have a material impact on the operations of the Company. There can be no assurance that potential system interruptions or unanticipated additional expense incurred to obtain Year 2000 compliance will not have a material adverse effect on the Company's business, financial condition, results of operations and business prospects. Nevertheless, the Company does not believe that the cost of addressing the Year 2000 issues will be a material event or uncertainty that would cause reported financial information not to be necessarily indicative of future operating results or financial conditions, nor does it believe that the costs or the consequences of incomplete or untimely resolution of its Year 2000 issues represents a known material event or uncertainty that is reasonably likely to affect its future financial results, or cause its reported financial information not to be necessarily indicative of future operating results or future financial condition. The Year 2000 issues also affect certain of the Company's customers, particularly in the areas of access to funds and additional expenditures to achieve compliance. As of September 30, 1999, the Company had contacted all of its commercial credit customers (85 borrowers with loans outstanding aggregating $28.2 million) regarding the customers' awareness of the Year 2000 Issue. While no assurance can be given that the customers will be Year 2000 compliant, management believes, based on representations of such customers and reviews of their operations (including assessments of the borrowers' level of sophistication and data and record keeping requirements), that the customers are either addressing the appropriate issues to insure compliance or that they are not faced with material Year 2000 issues. In the majority of cases the credit extended to such borrowers is collateralized by 15 18 management's discussion and analysis - -------------------------------------------------------------------------------- OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS real estate which inherently minimizes the Company's exposure to loss in the event that such borrowers do experience problems becoming Year 2000 compliant. The remaining borrowers have completed their Year 2000 projects or are in the process of completing their projects. The Year 2000 Committee is continually working with its commercial customers to assess their Year 2000 readiness. The Company has completed its own company-wide Year 2000 contingency plan. Individual contingency plans concerning specific software and hardware issues and operational plans for continuing operations were completed by December 1998. The Year 2000 Committee has reviewed all mission critical test plans and contingency plans to ensure the reasonableness of the plans including a Liquidity Contingency Plan to address the potential liquidity issues that federal banking regulations have raised. These plans include ordering extra currency, utilizing lines of credit, holding more liquid investments in order to provide the Bank with the ability to maintain smooth operations in the event of abnormally large withdrawals of funds by consumers concerned with the effect of the advent of the Year 2000. Testing began on mission critical systems in August 1998 and was completed by September 30, 1999. The Company has developed contingency plans for substantially all priority 1 and priority 2 applications which address operational policies and procedures in the event of data processing, electric power supply and/or telephone service failures associated with the Year 2000. Such contingency plans provide documented actions to allow the Company to maintain and/or resume normal operations in the event of the failure of priority 1 and priority 2 applications. Such plans identify participants, processes and equipment that will be necessary to permit the Company to continue operations. The plans include providing off-line system processing, back-up electrical and telephone systems and other methods to ensure the Company's ability to continue to operate. The costs of modifications to the existing software is being primarily absorbed by the third party vendors. The Company recognizes that the need exists to purchase new hardware and software regardless of year 2000 implications. Based upon current estimates, the Company has identified the hardware and software that would have to be replaced, and have found the amounts to not be material and consistent with the Company's normal expenditures for technology upgrades. The Company has paid $25,000 to participate in the data service processor's Year 2000 testing. FORWARD LOOKING STATEMENTS In this Report, the Company has included certain "forward looking statements" concerning the future operations of the Company. It is management's desire to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. This statement is for the express purpose of availing the Company of the protections of such safe harbor with respect to all "forward looking statements" contained in this Report. The Company has used "forward looking statements" to describe the future plans and strategies including management's expectations of the Company's Year 2000 readiness and future financial results. Management's ability to predict results or the effect of future plans and strategy is inherently uncertain. Factors that could affect results include interest rate trends, competition, the general economic climate in Delaware and Chester Counties, the mid-Atlantic region and the country as a whole, loan delinquency rates, changes in federal and state regulation, Year 2000 uncertainties and other uncertainties described in the Company's filings with the Securities and Exchange Commission, including its Form 10-K for the year ended September 30, 1999. These factors should be considered in evaluating the "forward looking statements", and undue reliance should not be placed on such statements. 16 19 [Deloitte & Touche Logo] DELOITTE & TOUCHE LLP Telephone: (215) 246-2300 Twenty-Fourth Floor Facsimile: (215) 569-2441 1700 Market Street Philadelphia, Pennsylvania 19103-3984 INDEPENDENT AUDITORS' REPORT Board of Directors First Keystone Financial, Inc. and Subsidiaries Media, Pennsylvania 19063 We have audited the accompanying consolidated statements of financial condition of First Keystone Financial, Inc. and Subsidiaries (the "Company") as of September 30, 1999 and 1998, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended September 30, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of First Keystone Financial, Inc. and Subsidiaries at September 30, 1999 and 1998 and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1999 in accordance with generally accepted accounting principles. /s/ Deloitte & Touche LLP Philadelphia, Pennsylvania November 5, 1999 - --------------- DELOITTE TOUCHE TOHMATSU 17 20 FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (dollars in thousands, except per share data)
September 30 1999 1998 ---- ---- ASSETS Cash and amounts due from depository institutions $ 3,010 $ 2,457 Interest-bearing deposits with depository institutions 17,005 21,669 --------- --------- Total cash and cash equivalents 20,015 24,126 Investment securities available for sale 44,315 40,621 Mortgage-related securities available for sale 113,046 115,486 Loans held for sale 1,792 2,799 Mortgage-related securities held to maturity -- at amortized cost (approximate fair value of $14,100 and $18,700 at September 30, 1999 and 1998, respectively) 14,497 18,769 Loans receivable -- net 226,375 198,343 Accrued interest receivable 3,096 3,117 Real estate owned 297 1,663 Federal Home Loan Bank stock -- at cost 6,157 5,079 Office properties and equipment -- net 3,076 2,612 Deferred income taxes 2,749 283 Prepaid expenses and other assets 14,711 2,965 --------- --------- Total Assets $ 450,126 $ 415,863 ========= ========= LIABILITIES, MINORITY INTEREST IN SUBSIDIARY AND STOCKHOLDERS' EQUITY Liabilities: Deposits $ 260,826 $ 247,311 Advances from Federal Home Loan Bank 123,137 101,578 Securities sold under agreements to repurchase 19,300 19,300 Accrued interest payable 2,321 1,683 Advances from borrowers for taxes and insurance 946 1,036 Accounts payable and accrued expenses 3,492 2,091 --------- --------- Total liabilities 410,022 372,999 --------- --------- Company-obligated mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company 16,200 16,200 --------- --------- Stockholders' Equity: Preferred stock, $.01 par value, 10,000,000 shares authorized; none issued Common stock, $.01 par value, 20,000,000 shares authorized; issued and outstanding; September 30, 1999 and 1998, 2,251,716 and 2,329,216 shares, respectively 14 14 Additional paid in capital 13,408 13,204 Common stock acquired by stock benefit plans (1,531) (1,789) Treasury stock at cost, 468,284 and 390,784 shares at September 30, 1999 and 1998, respectively (5,622) (4,575) Accumulated other comprehensive (loss) income (2,992) 1,487 Retained earnings -- partially restricted 20,627 18,323 --------- --------- Total stockholders' equity 23,904 26,664 --------- --------- Total Liabilities, Minority Interest in Subsidiary and Stockholders' Equity $ 450,126 $ 415,863 ========= =========
See notes to consolidated financial statements. 18 21 FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except per share data)
YEAR ENDED SEPTEMBER 30 ---------------------------------- 1999 1998 1997 ---- ---- ---- INTEREST INCOME: Interest on: Loans $ 17,366 $ 16,447 $ 14,737 Mortgage-related securities 7,965 8,029 6,197 Investments 2,949 2,429 1,478 Interest-bearing deposits 414 488 338 -------- -------- -------- TOTAL INTEREST INCOME 28,694 27,393 22,750 -------- -------- -------- INTEREST EXPENSE: Interest on: Deposits 10,265 9,937 9,182 Federal Home Loan Bank advances 5,511 4,206 3,381 Securities sold under agreements to repurchase 1,180 1,482 76 -------- -------- -------- TOTAL INTEREST EXPENSE 16,956 15,625 12,639 -------- -------- -------- Net interest income 11,738 11,768 10,111 Provision for loan losses 259 186 239 -------- -------- -------- Net interest income after provision for loan losses 11,479 11,582 9,872 -------- -------- -------- OTHER INCOME (LOSS): Service charges and other fees 934 898 972 Net gain on sale of: Investments and mortgage-related securities 291 51 Loans held for sale 325 526 285 Real estate owned 25 7 32 Other assets 1 46 Real estate operations (138) (32) (25) Other income 350 57 40 -------- -------- -------- TOTAL OTHER INCOME 1,787 1,508 1,350 -------- -------- -------- OPERATING EXPENSES: Salaries and employee benefits 3,567 3,642 3,174 Occupancy and equipment 1,030 1,013 858 Professional fees 617 580 733 Federal deposit insurance premium 147 145 207 Bank service charges 445 417 384 Data processing 386 360 335 Advertising 322 293 280 Provision for real estate owned losses 350 200 Minority interest in expense of subsidiary 1,571 1,571 153 Other 1,066 838 797 -------- -------- -------- TOTAL OPERATING EXPENSES 9,501 9,059 6,921 -------- -------- -------- Income before income tax expense 3,765 4,031 4,301 Income tax expense 917 1,250 1,664 -------- -------- -------- NET INCOME $ 2,848 $ 2,781 $ 2,637 ======== ======== ======== EARNINGS PER COMMON SHARE: Basic $ 1.40 $ 1.31 $ 1.20 Diluted $ 1.32 $ 1.23 $ 1.13 ======== ======== ========
See notes to consolidated financial statements. 19 22 FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (dollars in thousands)
COMMON STOCK ACQUIRED BY ACCUMULATED RETAINED ADDITIONAL STOCK OTHER EARNINGS- TOTAL COMMON PAID-IN BENEFIT TREASURY COMPREHENSIVE PARTIALLY STOCKHOLDERS' STOCK CAPITAL PLANS STOCK INCOME (LOSS) RESTRICTED EQUITY ----- ------- ----- ----- ------------- ---------- ------ Balance at October 1, 1996 $ 14 $ 12,659 $(1,437) $(1,288) $ (494) $ 13,630 $ 23,084 Comprehensive income: Net income 2,637 2,637 Other comprehensive income, net of tax: Net unrealized gain on securities, net of reclassification adjustment(1) 902 902 Comprehensive income 3,539 Common stock acquired by stock benefit plans (775) (775) ESOP stock committed to be released 33 33 Excess of fair value above cost of ESOP and RRP shares committed to be released 237 237 RRP amortization 141 141 Exercise of stock options 11 11 Purchase of treasury stock (1,268) (1,268) Dividends paid (250) (250) ------ -------- ------- ------- -------- -------- -------- Balance at September 30, 1997 14 12,896 (2,038) (2,545) 408 16,017 24,752 Comprehensive income: Net income 2,781 2,781 Other comprehensive income, net of tax: Net unrealized gain on securities, net of reclassification adjustment(1) 1,079 1,079 Comprehensive income 3,860 ESOP stock committed to be released 108 108 Excess of fair value above cost of ESOP and RRP shares committed to be released 308 308 RRP amortization 141 141 Exercise of stock options 6 6 Purchase of treasury stock (2,036) (2,036) Dividends paid (475) (475) ------ -------- ------- ------- -------- -------- -------- Balance at September 30, 1998 14 13,204 (1,789) (4,575) 1,487 18,323 26,664 Comprehensive income: Net income 2,848 2,848 Other comprehensive income, net of tax: Net unrealized loss on securities net of reclassification adjustment(1) (4,479) (4,479) Comprehensive income (loss) (1,631) ESOP stock committed to be released 117 117 Excess of fair value above cost of ESOP and RRP shares committed to be released 204 204 RRP amortization 141 141 Purchase of treasury stock (1,047) (1,047) Dividends paid (544) (544) ------ -------- ------- ------- -------- -------- -------- Balance at September 30, 1999 $ 14 $ 13,408 $(1,531) $(5,622) $ (2,992) $ 20,627 $ 23,904 ====== ======== ======= ======= ======== ======== ========
(1) Disclosure of reclassification amount, net of tax for the years ended: 1999 1998 1997 ------- ------ ----- Net unrealized (depreciation) appreciation arising during the year $(4,671) $1,113 $ 902 Less: Reclassification adjustment for net gains included in net income 192 34 ------- ------ ----- Net unrealized (loss) gain on securities $(4,479) $1,079 $ 902 ======= ====== =====
See notes to consolidated financial statements. 20 23 FIRST KEYSTONE FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
YEAR ENDED SEPTEMBER 30 -------------------------------- 1999 1998 1997 ---- ---- ---- OPERATING ACTIVITIES: Net income $ 2,848 $ 2,781 $ 2,637 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for depreciation and amortization 444 453 364 Amortization of discounts (288) (609) (872) Gain on sales of: Loans held for sale (325) (526) (285) Investment securities available for sale (4) Mortgage-related securities available for sale (291) (47) Real estate owned (25) (7) (32) Other assets (1) (46) Provision for loan losses 259 186 239 Provision for real estate owned losses 350 200 Amortization of stock benefit plans 462 563 422 Changes in assets and liabilities which provided (used) cash: Origination of loans held for sale (46,199) (56,398) (37,209) Loans sold in the secondary market 47,206 58,176 35,079 Deferred income taxes (140) (112) 862 Accrued interest receivable 21 (552) (161) Prepaid expenses and other assets (11,746) (590) (740) Accrued interest payable 638 108 74 Accounts payable and accrued expenses 1,401 6 (705) -------- -------- -------- Net cash (used in) provided by operating activities (5,385) 3,627 (373) -------- -------- -------- INVESTING ACTIVITIES: Loans originated (96,238) (64,979) (56,049) Purchases of: Investment securities held to maturity (2,000) (12,000) Investment securities available for sale (24,949) (40,892) (6,030) Mortgage-related securities held to maturity (2,687) Mortgage-related securities available for sale (45,895) (52,422) (51,654) Purchase of FHLB stock (1,078) (1,310) (1,432) Proceeds from sales of investment and mortgage-related securities available for sale 6,791 20,299 Proceeds from sales of real estate owned 2,373 1,451 944 Proceeds from sales of other assets 30 101 Principal collected on loans 67,481 55,694 35,418 Proceeds from maturities, calls or repayments of: Investment securities available for sale 12,075 5,070 12,500 Mortgage-related securities available for sale 44,031 28,129 9,243 Investment securities held to maturity 12,000 2,000 Mortgage-related securities held to maturity 4,221 4,663 2,483 Purchase of property and equipment (908) (542) (409) Net expenditures on real estate acquired through foreclosure and in development (23) (1,462) (734) -------- -------- -------- Net cash used in investing activities (32,119) (38,958) (65,619) -------- -------- -------- FINANCING ACTIVITIES: Net increase in deposit accounts 13,515 19,393 8,713 Net proceeds from FHLB and other borrowings 21,559 20,891 53,247 Net (decrease) increase in advances from borrowers for taxes and insurance (90) 123 (8) Proceeds from issuance of capital securities 16,200 Common stock acquired by stock benefit plans (775) Purchase of treasury stock (1,047) (2,036) (1,268) Cash dividends (544) (475) (250) -------- -------- -------- Net cash provided by financing activities 33,393 37,896 75,859 -------- -------- -------- (Decrease) increase in cash and cash equivalents (4,111) 2,565 9,867 Cash and cash equivalents at beginning of year 24,126 21,561 11,694 -------- -------- -------- Cash and cash equivalents at end of year $ 20,015 $ 24,126 $ 21,561 ======== ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash payments for interest on deposits and borrowings $ 16,318 $ 15,517 $ 12,600 Cash payments of income taxes 915 1,150 630 Transfers of loans receivable into real estate owned 1,317 207 411 ======== ======== ========
See notes to consolidated financial statements. 21 24 NOTES TO CONSOLIDATED STATEMENTS - -------------------------------------------------------------------------------- 1. NATURE OF OPERATIONS AND ORGANIZATION STRUCTURE - -------------------------------------------------------------------------------- On September 21, 1994, the Board of Directors of First Keystone Federal Savings Bank (the "Bank") adopted a plan of conversion to convert from a federally chartered mutual savings bank to a federally chartered capital stock savings bank with the concurrent formation of a holding company (the "Conversion"). The Conversion was completed on January 25, 1995 with the issuance by the holding company, First Keystone Financial, Inc. (the "Company"), of 1,360,000 shares of its common stock in a public offering to the Bank's eligible depositors and borrowers, members of the general public and the Bank's employee stock ownership plan (the "ESOP"). In exchange for the net conversion proceeds of $11.5 million, less $1.0 million retained by the Company, the Company acquired 100% of the issued and outstanding capital stock of the Bank. The Bank is principally in the business of attracting deposits through its branch offices and investing those deposits together with funds from borrowings and operations in single-family residential, commercial real estate and commercial business loans. The Bank is primarily supervised and regulated by the Office of Thrift Supervision ("OTS"). 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - -------------------------------------------------------------------------------- PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the Company, the Bank, and the 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 generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. SECURITIES HELD TO MATURITY AND SECURITIES AVAILABLE FOR SALE Securities held to maturity are carried at amortized cost only if the Company has the positive intent and ability to hold these securities to maturity. Securities available for sale are carried at fair value with resulting unrealized gains or losses recorded to equity, net of tax. For the years ended September 30, 1999 and 1998, 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 risks in the loan portfolio. Management's evaluation of the portfolio is based upon past loss experience, current economic conditions and other relevant factors. While management uses the best information available to make such evaluation, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. The Company accounts for impaired loans in accordance with Statement of Financial Accounting Standards ("SFAS") No. 114 "Accounting by Creditors for Impairment of a Loan" and No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures." Impaired loans are predominantly measured based on the fair value of the collateral. The provision for loan losses charged to expense is based upon past loan loss experience and an evaluation of probable losses and impairment existing in the current loan and lease portfolio. A loan is considered to be impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the loan. An insignificant delay or insignificant shortfall in amounts of payments does not necessarily result in the loan being identified as impaired. For this purpose, delays less than 90 days are considered to be insignificant. Large groups of smaller balance homogeneous loans, including residential real estate and consumer loans, are collectively evaluated for impairment, except for loans restructured under a troubled debt restructuring. 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. 22 25 NOTES TO CONSOLIDATED STATEMENTS (continued) - -------------------------------------------------------------------------------- At September 30, 1999, 1998, and 1997, loans serviced for others totalled approximately $77,186, $96,275 and $114,554, 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 aggregating approximately $720 and $824 at September 30, 1999 and 1998, 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 of estimated net servicing income or net servicing loss, as appropriate. Assessment of the fair value of the retained interest is performed on a continuing basis. 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. INCOME TAXES Deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. INTEREST RATE RISK At September 30, 1999 and 1998, the Company's assets consist primarily of assets that earned interest at either adjustable or fixed interest rates and the average life of which is long term. Those assets were funded primarily with shorter-term liabilities that have interest rates which vary over time with market rates and certain call features that are impacted by changes in market rates. Since the assets and liabilities reprice at different times, the Company is exposed to interest rate risk. EARNINGS PER SHARE Basic earnings per share is computed based on the weighted average number of shares of common stock outstanding. Diluted earnings per common share is computed based on the weighted average number of shares of common stock outstanding, increased by the number of common shares that are assumed to have been purchased with the proceeds from the exercise of stock options. The calculation of the weighted average shares, after giving effect to the stock split, was as follows:
Year Ended September 30 ------------------------------------------ 1999 1998 1997 ------------------------------------------ Average common share outstanding 2,043,780 2,130,712 2,198,453 Increase in shares due to options - diluted basis 76,724 135,100 125,316 --------- --------- --------- Adjusted shares outstanding - diluted 2,120,504 2,265,812 2,323,769 --------- --------- ---------
ACCOUNTING FOR STOCK OPTIONS The Company accounts for stock options in accordance with SFAS No. 123 "Accounting for Stock-Based Compensation," which allows an entity to choose between the intrinsic value method, as defined in Accounting Principals Board ("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 the stock-based compensation was accounted 23 26 NOTES TO CONSOLIDATED STATEMENTS (continued) - -------------------------------------------------------------------------------- for using the fair value method. The Company continues to account for stock-based compensation using the intrinsic value method and has not recognized compensation expense under this method. OTHER COMPREHENSIVE INCOME In 1999, the Company adopted SFAS No. 130 "Reporting Comprehensive Income." This statement requires the Company to present, as a component of comprehensive income, the amounts from transactions and other events which currently are excluded from the statement of income and are recorded directly to stockholders' equity. STATEMENT OF CASH FLOWS For purposes of reporting cash flows, cash and cash equivalents include cash and amounts due from depository institutions and interest-bearing deposits with depository institutions. NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," was issued. This statement requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. This statement is effective for fiscal years beginning after June 15, 2000, and will not be applied retroactively to financial statements of prior periods. Management of the Company does not believe this statement will have a material impact on the Company's financial position or results of operations when adopted. RECLASSIFICATIONS Certain reclassifications have been made to the September 30, 1998 and 1997 consolidated financial statements to conform with the September 30, 1999 presentation. Such reclassifications had no impact on the reported net income. 3. INVESTMENT SECURITIES - -------------------------------------------------------------------------------- The amortized cost and approximate fair value of investment securities are as follows:
September 30, 1999 ------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Approximate Cost Gain Loss Fair Value ------------------------------------------------------ Available for Sale: U.S. Treasury securities and securities of U.S. Government agencies: 1 to 5 years $ 5,746 $ 94 $ 5,652 5 to 10 years 6,994 214 6,780 Municipal obligations 18,924 $ 1 1,052 17,873 Corporate bonds 4,909 270 4,639 Mutual funds 2,000 28 1,972 Preferred stocks 5,534 286 5,248 Other equity investments 2,390 239 2,151 ------- ---- ------ -------- Total $46,497 $ 1 $2,183 $ 44,315 ======= ==== ====== ========
September 30, 1998 ------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Approximate Cost Gain Loss Fair Value ------------------------------------------------------ Available for Sale: U.S. Treasury securities and securities of U.S. Government agencies: 5 to 10 years $12,000 $ 109 $12,109 Municipal obligations 18,993 484 19,477 Mutual funds 2,000 $ 8 1,992 Preferred stocks 5,500 263 5,763 Other equity investments 1,390 110 1,280 ------- ----- ----- ------- Total $39,883 $ 856 $ 118 $40,621 ======= ===== ===== =======
For the years ended September 30, 1999 and 1998, gross realized gains on sales of investment securities available for sale amounted to $161 and $12, respectively. Gross realized losses on sales of investment securities available for sale amounted to $8 for the year ended September 30, 1998. 24 27 NOTES TO CONSOLIDATED STATEMENTS (continued) - -------------------------------------------------------------------------------- 4. MORTGAGE-RELATED SECURITIES - -------------------------------------------------------------------------------- Mortgage-related securities available for sale and mortgage-related securities held to maturity are summarized as follows:
September 30, 1999 -------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Approximate Cost Gain Loss Fair Value -------------------------------------------------------- Available for Sale: FHLMC pass-through certificates $ 11,927 $ 81 $ 174 $ 11,834 FNMA pass-through certificates 32,795 37 877 31,955 GNMA pass-through certificates 34,639 75 755 33,959 Collateralized mortgage obligations 36,054 111 867 35,298 -------- -------- ------- --------- Total $ 115,415 $ 304 $ 2,673 $ 113,046 ========= ======== ======= ========= Held to Maturity: FHLMC pass-through certificates $ 3,156 $ 11 $ 67 $ 3,100 FNMA pass-through certificates 6,832 232 6,600 Collateralized mortgage obligations 4,509 109 4,400 -------- -------- ------- --------- Total $ 14,497 $ 11 $ 408 $ 14,100 ======== ======== ======= =========
September 30, 1998 ------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Approximate Cost Gain Loss Fair Value ------------------------------------------------------- Available for Sale: FHLMC pass-through certificates $ 10,968 $ 197 $ 11,165 FNMA pass-through certificates 25,600 503 26,103 GNMA pass-through certificates 41,379 562 41,941 Collateralized mortgage obligations 36,022 327 $ 72 36,277 -------- -------- ---- --------- Total $113,969 $ 1,589 $ 72 $ 115,486 ======== ======== ==== ========= Held to Maturity: FHLMC pass-through certificates $ 4,698 $ 33 $ 1 $ 4,730 FNMA pass-through certificates 8,747 46 103 8,690 Collateralized mortgage obligations 5,324 1 45 5,280 -------- -------- ---- --------- Total $ 18,769 $ 80 $149 $ 18,700 ======== ======== ==== =========
The collateralized mortgage obligations contain both fixed and adjustable classes of securities which are repaid in accordance with a predetermined priority. The underlying collateral of the securities are loans which are primarily insured by FHLMC, FNMA, and GNMA. Mortgage-related securities with a carrying value of $37,504 and $27,846 were pledged as collateral for public funds on deposit, treasury tax and loan processing and financings at September 30, 1999 and 1998, respectively (see Notes 9 and 11). For the year ended September 30, 1998, gross realized gains and losses on sales of mortgage-related securities available for sale amounted to $83 and $36, respectively. 25 28 NOTES TO CONSOLIDATED STATEMENTS (continued) 5. ACCRUED INTEREST RECEIVABLE The following is a summary of accrued interest receivable by category:
September 30 ------------------------ 1999 1998 ------ ------ Loans $1,602 $1,542 Mortgage-related securities 755 823 Investment securities 739 752 ------ ------ Total $3,096 $3,117 ====== ======
6. LOANS RECEIVABLE Loans receivable consist of the following:
September 30 ------------------------------- 1999 1998 --------- --------- Real estate loans: Single-family $ 166,802 $ 148,088 Construction and land 18,426 15,858 Multi-family and commercial 31,188 20,563 Consumer loans: Home equity and lines of credit 18,624 19,609 Deposit 243 181 Education 365 449 Other 1,080 1,429 Commercial loans 2,190 1,390 --------- --------- Total loans 238,918 207,567 Loans in process (9,005) (5,781) Allowance for loan losses (1,928) (1,738) Deferred loan fees (1,610) (1,705) --------- --------- Loans receivable -- net $ 226,375 $ 198,343 ========= =========
The Company originates loans primarily in its local market area of Delaware and Chester Counties, Pennsylvania to borrowers that share similar attributes. This concentration of credit exposes the Company to a higher degree of risk associated with this economic region. The Company also participates in the origination and sale of nonagency, non-conforming sub-prime loans to the secondary market. The Company recognized gains on sale of loans held for sale of $325, $526 and $281 for fiscal years ended September 30, 1999, 1998 and 1997, respectively. The Company offers loans to its directors and senior officers on terms permitted by OTS regulations. There were approximately $575 and $388 of loans outstanding to senior officers and directors as of September 30, 1999 and 1998, respectively. The amount of repayments during the years ended September 30, 1999 and 1998 totalled $28 and $102, respectively. There were $215 and $50 of new loans granted during fiscal year 1999 and 1998, respectively. The Company has undisbursed portions under consumer and commercial lines of credit as of September 30, 1999 of $4,323 and $8,891, respectively. The Company originates both adjustable and fixed interest rate loans and purchases mortgage-backed securities and collateralized mortgage obligations in the secondary market. The originated adjustable-rate loans have interest rate adjustment limitations and are generally indexed to U.S. Treasury securities plus a fixed margin. Future market factors may affect the correlation of the interest rate adjustment with rates the Company pays on the short-term deposits that have been the primary source funds for these loans. The adjustable-rate mortgage-related securities adjust to various national indices plus a fixed margin. At September 30, 1999, the composition of these loans and mortgage-related securities follows:
FIXED-RATE - ------------------------------------------------------ TERM TO MATURITY BOOK VALUE - ------------------------------------------------------ 1 month to 1 year $ 3,317 1 year to 3 years 5,290 3 years to 5 years 8,712 5 years to 10 years 23,204 Over 10 years 227,754 --------- Total $ 268,277 =========
ADJUSTABLE-RATE - ------------------------------------------------------ TERM TO RATE ADJUSTMENT BOOK VALUE - ------------------------------------------------------ 1 month to 1 year $ 73,723 1 year to 3 years 12,329 3 years to 5 years 3,127 --------- Total $ 89,179 =========
The following is an analysis of the allowance for loan losses:
YEAR ENDED SEPTEMBER 30 ----------------------------------------------- 1999 1998 1997 ------- ------- ------- Beginning balance $ 1,738 $ 1,628 $ 2,624 Provisions charged to income 259 186 239 Charge-offs (72) (114) (1,252) Recoveries 3 38 17 ------- ------- ------- Total $ 1,928 $ 1,738 $ 1,628 ======= ======= =======
At September 30, 1999 and 1998, non-performing loans (which include loans in excess of 90 days delinquent) amounted to approximately $3,180 and $3,704, respectively. All non-performing loans are collectively evaluated for impairment. 26 29 NOTES TO CONSOLIDATED STATEMENTS (continued) 7. REAL ESTATE OWNED Real estate owned is comprised of:
SEPTEMBER 30 ------------------------ 1999 1998 ------ ------ Real estate acquired in settlement of loans $ 297 $ 196 Real estate acquired and in development 1,467 ------ ------ Total $ 297 $1,663 ====== ======
In fiscal year 1996, First Pointe, Inc., a subsidiary of the Company, accepted a deed in lieu of foreclosure on a construction loan for the acquisition and improvement of a 106-lot real estate development project located in Pennsylvania. As of September 30, 1999, all townhomes have been completed and sold. Remaining items to be completed consist of township improvements under a tri-party agreement. 8. OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment are summarized by major classification as follows:
SEPTEMBER 30 --------------------------- 1999 1998 ------- ------- Land and buildings $ 4,990 $ 4,220 Furniture, fixtures and equipment 3,860 3,753 ------- ------- Total 8,850 7,973 Accumulated depreciation and amortization (5,774) (5,361) ------- ------- Net $ 3,076 $ 2,612 ======= =======
The future minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of September 30, 1999 are as follows:
September 30: 2000 $ 181 2001 125 2002 117 2003 116 2004 120 Thereafter 563 ------ Total minimum future rental payments $1,222 ======
Lease hold expense was approximately $182, $197 and $148 for the years ended September 30, 1999, 1998 and 1997, respectively. 9. DEPOSITS Deposits consist of the following major classifications:
SEPTEMBER 30 -------------------------------------------------------------- 1999 1998 ------------------------ ------------------------- AMOUNT PERCENT Amount Percent ------- ----- -------- ----- Non-interest bearing $ 7,912 3.0% $ 8,254 3.3% NOW 33,412 12.8 28,181 11.4 Passbook 40,324 15.5 37,988 15.4 Money market demand 19,417 7.4 16,087 6.5 Certificates of deposit 159,761 61.3 156,801 63.4 ------- ----- -------- ----- Total 260,826 100.0% $247,311 100.0% ======= ===== ======== =====
The weighted average interest rates on deposits were 3.96% and 4.21% at September 30, 1999 and 1998, respectively. Included in deposits as of September 30, 1999 are deposits greater than $100,000 totalling approximately $41,740. At September 30, 1999 and 1998, the Company had pledged certain mortgage-related securities aggregating approximately $5,849 and $1,633, respectively, as collateral for municipal deposits. A summary of scheduled maturities of certificates is as follows:
SEPTEMBER 30 1999 -------- Within one year $122,597 One to two years 23,036 Two to three years 4,332 Thereafter 9,796 -------- Total $159,761 ========
A summary of interest expense on deposits is as follows:
YEAR ENDED SEPTEMBER 30 --------------------------------------------- 1999 1998 1997 ------- ------- ------- NOW $ 440 $ 376 $ 360 Passbook 955 923 949 Money market demand 502 452 450 Certificates of deposit 8,368 8,186 7,423 ------- ------- ------- Total $10,265 $ 9,937 $ 9,182 ======= ======= =======
27 30 NOTES TO CONSOLIDATED STATEMENTS (continued) 10. ADVANCES FROM FEDERAL HOME LOAN BANK A summary of advances from the Federal Home Loan Bank ("FHLB") of Pittsburgh follows:
SEPTEMBER 30 ------------------------------------------------------------ 1999 1998 ------------------------------------------------------------ WEIGHTED WEIGHTED AVERAGE AVERAGE INTEREST INTEREST AMOUNT RATE AMOUNT RATE -------- --- -------- --- Advances from FHLB due by September 30, 1999 $ 30,325 5.8% 2000 $ 47,055 5.4% 5,159 5.4 2001 Thereafter 76,082 5.4 66,094 5.5 -------- --- -------- --- Total $123,137 5.4 $101,578 5.6% ======== === ======== ===
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, 1999 and 1998 are convertible advances whereby the FHLB has the option at a predetermined time to convert the fixed interest rate to an adjustable rate tied to LIBOR. The Company then has the option to prepay these advances if the FHLB converts the interest rate. These advances are included in the year in which they mature. The Company has available various lines of credit with the FHLB up to the Company's maximum borrowing capacity which was $220.6 million, of which $123.1 million was outstanding, at September 30, 1999. 11. SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE The Company sold, under agreements to repurchase, mortgage-related securities to broker-dealers. Securities underlying the agreements with broker-dealers were delivered to the dealer who arranged the transaction. Securities delivered to broker-dealers may have been sold, loaned, or otherwise disposed of, to other parties in the normal course of their operations. Information concerning securities sold under agreements to repurchase is summarized as follows:
SEPTEMBER 30 --------------------------- 1999 1998 ------- ------- Average balance for months outstanding $19,300 $24,411 Average interest rate for months outstanding 6.11% 6.07% Maximum month-end balance during the year $19,300 $24,600 Mortgage-related securities underlying the agreements at year-end: Carrying value $20,972 $23,055 Estimated fair value $20,681 $23,385
12. INCOME TAXES As of October 1, 1996, the Company changed its method of computing reserves for bad debts to the experience method. The bad debt deduction allowable under this method is available to small banks with assets less than $500 million. Generally, this method allowed the Company to deduct an annual addition to the reserve for bad debts equal to the increase in the balance of the Company's reserve for bad debts at the end of the year to an amount equal to the percentage of total loans at the end of the year, computed using the ratio of the previous six years net chargeoffs divided by the sum of the previous six years total outstanding loans at year end. The Company treated such change as a change in a method of accounting determined solely with respect to the "applicable excess reserves" of the institution. The amount of the applicable excess reserves will be taken into account ratably over a six-taxable year period, beginning with the first taxable year beginning after December 31, 1995. For financial reporting purposes, the Company will not incur any additional tax expense. At September 30, 1997, under SFAS No. 109, deferred taxes were provided on the difference between the book reserve at September 30, 1997 and the applicable excess reserve in the amount equal to the Bank's increase in the tax reserve from December 31, 1987 to September 30, 1996. Retained earnings at September 30, 1999 and 1998 included approximately $2.5 million representing bad debt deductions for which no deferred income taxes have been provided. 28 31 NOTES TO CONSOLIDATED STATEMENTS (continued) Income tax expense (benefit) is comprised of the following:
YEAR ENDED SEPTEMBER 30 1999 1998 1997 ------- ------- ------- Current Federal $ 1,057 $ 1,362 $ 489 State 313 ------- ------- ------- Subtotal 1,057 1,362 802 Deferred (140) (112) 862 ------- ------- ------- Total $ 917 $ 1,250 $ 1,664 ======= ======= =======
The tax effect of temporary differences that give rise to significant portions of the deferred tax accounts, calculated at 34%, are as follows:
SEPTEMBER 30 --------------------------- 1999 1998 ------- ------- Accelerated depreciation $ 326 $ 249 Allowance for loan losses 824 634 Deferred loan fees (135) (61) Accrued expenses 111 161 Unrealized (gain) loss on available for sale securities 1,559 (767) Other 64 67 ------- ------- Total deferred tax asset $ 2,749 $ 283 ======= =======
The Company's effective tax rate is less than the statutory federal income tax rate for the following reasons:
YEAR ENDED SEPTEMBER 30 ------------------------------------------------------------------------------ 1999 1998 1997 PERCENTAGE PERCENTAGE PERCENTAGE OF PRETAX OF PRETAX OF PRETAX AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME ------- ------- ------- ------- ------- ------- Tax at statutory rate $ 1,280 34.0% $ 1,370 34.0% $ 1,462 34.0% Increase (decrease) in taxes resulting from: Tax exempt interest, net (284) (7.5) (149) (3.7) (24) (.6) State tax -- net of federal tax effect 207 4.8 Other (79) (2.1) 29 .7 19 .5 ------- ------- ------- ------- ------- ------- Total $ 917 24.4% $ 1,250 31.0% $ 1,664 38.7% ======= ======= ======= ======= ======= =======
29 32 NOTES TO CONSOLIDATED STATEMENTS (continued) 13. REGULATORY CAPITAL REQUIREMENTS The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of tangible and core capital (as defined in the regulations) to adjusted assets (as defined), and of Tier I and total capital (as defined) to average assets (as defined). Management believes, as of September 30, 1999, that the Bank meets all capital adequacy requirements to which it is subject. As of September 30, 1999, the most recent notification from the Office of Thrift Supervision categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier-1 risk-based, and Tier-1 leveraged-ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. The Bank's actual capital amounts and ratios are also presented in the table. At September 30, 1999 and 1998, risk-based capital, for regulatory requirements, is increased by $1,813 and $1,688, respectively, of general loan loss reserves for a total of $38,280 and $35,389, respectively.
REQUIRED FOR WELL CAPITALIZED CAPITAL ADEQUACY UNDER PROMPT ACTUAL PURPOSES CORRECTIVE ACTION ------------------------------------------------------------------------ AMOUNT PERCENTAGE AMOUNT PERCENTAGE AMOUNT PERCENTAGE ------ ------ ------ ------ ------ ------ At September 30, 1999: Core Capital (to Adjusted Tangible Assets) 36,467 8.2% 17,586 4.0% 22,320 5.0% Tier I Capital (to Risk Weighted Assets) 36,467 17.9 N/A N/A 26,784 6.0 Total Capital (to Risk Weighted Assets) 38,280 18.8 16,294 8.0 20,367 10.0 Tangible Capital (to Tangible Assets) 36,467 8.2 6,696 1.5 N/A N/A At September 30, 1998: Core Capital (to Adjusted Tangible Assets) 33,701 8.3% 16,301 4.0% 20,376 5.0% Tier I Capital (to Risk Weighted Assets) 33,701 20.1 N/A N/A 24,451 6.0 Total Capital (to Risk Weighted Assets) 35,389 21.1 13,424 8.0 16,780 10.0 Tangible Capital (to Tangible Assets) 33,701 8.3 6,113 1.5 N/A N/A
At the date of the Conversion, the Bank established a liquidation account in an amount equal to its retained income as of August 31, 1995. The liquidation account is maintained for the benefit of eligible account holders and supplemental eligible account holders who continue to maintain their accounts at the Bank after the Conversion. The liquidation account is reduced annually to the extent that eligible account holders and supplemental eligible account holders have reduced their qualifying deposits as of each anniversary date. Subsequent increases 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 Bank may not declare or pay cash dividends on or repurchase any of its shares of common stock if the effect thereof would cause equity to be reduced below applicable regulatory capital maintenance requirements or if such declaration and payment would otherwise violate regulatory requirements. 30 33 NOTES TO CONSOLIDATED STATEMENTS (continued) 14. EMPLOYEE BENEFITS 401(k) PROFIT SHARING PLAN The Bank's 401(k) profit sharing plan covers substantially all full-time employees of the Company and provides for pre-tax contributions by the employees with matching contributions at the discretion of the Board of Directors determined at the beginning of the calendar year. All amounts are fully vested. For calendar years 1999 and 1998, there were no contributions to the 401(k) profit sharing plan. For calendar year 1997, the Board approved a 1% of salary profit sharing contribution of all contributing participants. EMPLOYEE STOCK OWNERSHIP PLAN In connection with the Conversion, the Company established an ESOP for the benefit of eligible employees. The ESOP purchased 217,600 shares of common stock in the Conversion. During November 1996, the ESOP purchased an additional 77,550 shares of common stock. At September 30, 1999, 114,022 shares of the total number of shares held by the ESOP were committed to be released. The Company accounts for its ESOP in accordance with AICPA Statement of Position 93-6, "Employers Accounting for Employee Stock Ownership Plans," which requires the Company to recognize compensation expense equal to the fair value of the ESOP shares during the periods in which they become committed to be released. To the extent that the fair value of the ESOP shares 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 to fluctuate as continuing adjustments are made to reflect changes in the fair value of the ESOP shares. The Company's ESOP, which is internally leveraged, does not report the loan receivable from the ESOP as an asset and does not report the ESOP debt from the employer as a liability. The Company recorded compensation and employee benefit expense related to the ESOP of $348, $450 and $275 for the years ended September 30, 1999, 1998 and 1997, respectively. RECOGNITION AND RETENTION PLAN Under the 1995 Recognition and Retention Plan and Trust (the "RRP"), the Company had outstanding awards aggregating 21,216 shares as of September 30, 1999 to the Company's Board of Directors and executive officers subject to vesting and other provisions of the RRP. At September 30, 1999 and 1998, the deferred cost of unearned RRP shares totaled $117 and $258, respectively, and is recorded as a charge against stockholders' equity. Compensation expense will be recognized ratably over the five year vesting period for shares awarded. For the fiscal years ended September 30, 1999, 1998 and 1997, the Company recorded compensation and employee benefit expense of $141 for each fiscal year relating to the RRP. STOCK OPTION PLAN Under the 1995 Stock Option Plan (the "Plan"), Common Stock totaling 272,000 shares has been reserved for issuance for the Plan. During fiscal year 1999, shareholders approved the adoption of the 1998 Stock Option Plan ("1998 Option Plan")(collectively the "Plans") which reserves an additional 111,200 shares of common stock for issuance. An aggregate of 351,050 stock options have been granted to the Company's executive officers, nonemployee directors and other key employees, subject to vesting and other provisions of the Plans. During the year ended September 30, 1998 and 1997, 578 and 1,088 shares were exercised at a weighted average exercise price of $7.56 and $7.50, respectively. The following table summarizes transactions regarding stock option plans:
WEIGHTED AVERAGE EXERCISE EXERCISE NUMBER OF PRICE PRICE OPTION SHARES RANGE PER SHARE ------- ------------- ------------- Outstanding at October 1, 1996 236,368 $7.50 - 8.50 $ 7.53 Granted 15,720 12.38 - 14.25 13.52 Canceled (5,032) 7.50 - 8.50 7.64 Exercised (1,088) 7.50 - 7.50 7.50 ------- ------------- ------------- Outstanding at September 30, 1997 245,968 $7.50 - 14.25 $ 7.91 Granted 5,700 12.88 - 12.88 12.88 Exercised (578) 7.50 - 8.50 7.56 ------- ------------- ------------- Outstanding at September 30, 1998 251,090 $7.50 - 14.25 $ 8.02 Granted 99,960 12.13 - 12.13 12.13 ------- ------------- ------------- Outstanding at September 30, 1999 351,050 $7.50 - 14.25 $ 9.19 ======= ============= =============
A summary of the exercise price range at September 30, 1999 is as follows:
WEIGHTED WEIGHTED EXERCISE AVERAGE AVERAGE NUMBER OF PRICE REMAINING EXERCISE PRICE OPTION SHARES RANGE CONTRACTUAL LIFE PER SHARE - ------------- ----- ---------------- --------- 229,670 $ 7.50 - 8.50 7.03 $ 7.53 121,380 12.38 - 14.25 9.69 12.34 ------- -------------- ---- ------ 351,050 $ 7.50 - 14.25 7.29 $ 9.19 ======= ============== ==== ======
31 34 NOTES TO CONSOLIDATED STATEMENTS(continued) The Company applies APB Opinion No. 25 in accounting for stock options and, accordingly, no compensation expense has been recognized in the financial statements. Had the Company determined compensation expense based on the fair value at the grant date for its stock options under SFAS 123, the Company's net income and income per share would have been reduced to the pro forma amounts indicated below:
Year Ended September 30 ----------------------- 1999 1998 1997 ---- ---- ---- Net income: As reported $ 2,848 $ 2,781 $ 2,637 Pro forma 2,770 2,771 $ 2,598 Net income per common and common equivalent share: Earnings per common share -As report $ 1.32 $ 1.23 $ 1.13 -Pro forma 1.31 1.22 1.12 Weighted average fair value of options granted during the period $ 4.43 $ 5.15 $ 10.55
The binomial option-pricing model was used to determine the grant date fair value of options. Significant assumptions used to calculate the above fair value of the awards are as follows:
September 30 ------------ 1999 1998 1997 ---- ---- ---- Risk free interest rate of return 5.83% 4.69% 6.12% Expected option life (months) 60 60 60 Expected volatility 41% 45% 37% Expected Dividends 2.6% 1.9% 1.0%
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 $308 and $377 was included in the Company's liabilities at September 30, 1999 and 1998, respectively. 15. COMMITMENTS AND CONTINGENCIES The Company has outstanding loan commitments, excluding undisbursed portion of loans in process and equity lines of credit, of approximately $6,405 and $11,759 as of September 30, 1999 and 1998, respectively, which are all expected to be funded within four months. Of these commitments outstanding, the breakdown between fixed and adjustable rate loans is as follows:
September 30 ------------ 1999 1998 ---- ---- Fixed-rate (ranging from 5.875% to 13.50%) $ 6,122 $ 6,859 Adjustable-rate 2,706 4,900 ------- ------- Total $ 8,828 $11,759 ======= =======
Generally, non-conforming loans are sold in the secondary market, depending on cash flow, interest rate, risk management and other considerations. There were approximately $2,733 and $6,029 in outstanding commitments to sell loans at September 30, 1999 and 1998, respectively. 16. RELATED PARTY TRANSACTIONS The Company retains the services of a law firm in which one of the Company's Directors is a member. In addition to providing general legal counsel to the Company, the firm also prepares mortgage documents and attends loan closings for which it is paid directly by the borrower. 17. FAIR VALUE OF FINANCIAL INSTRUMENTS The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosures about the Fair Value of Financial Instruments." The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. 32 35 NOTES TO CONSOLIDATED STATEMENTS(continued)
September 30 1999 1998 ---- ---- Estimated Estimated Carrying Fair Carrying Fair Amount Value Amount Value ------ ----- ------ ----- Assets: Cash and interest-earning deposits $ 20,015 $ 20,015 $ 24,126 $ 24,126 Investment securities 44,315 44,315 40,621 40,621 Loans 226,375 222,007 198,343 214,020 Loans held for sale 1,792 1,792 2,799 2,799 Mortgage-related securities 127,543 127,146 134,255 134,146 FHLB stock 6,157 6,157 5,079 5,079 Liabilities: Passbook deposits 40,324 40,324 37,988 37,988 NOW and MMDA deposits 60,741 60,741 52,522 52,522 Certificates of deposit 159,761 158,165 156,801 158,526 Advances from Federal Home Loan Bank 123,137 121,800 101,578 120,235 Securities sold under agreements to repurchase 19,300 19,226 19,300 19,884 Off balance sheet commitments 31,047 31.047 26,365 26,365
The fair value of cash and interest-earning deposits is their carrying value due to their short-term nature. The fair value of investments and mortgage-related securities is based on quoted market prices, dealer quotes, and prices obtained from independent pricing services. The fair value of loans is estimated, based on present values using approximate current entry-value interest rates, applicable to each category of such financial instruments. The fair value of FHLB stock approximates its carrying amount. The fair value of NOW deposits, MMDA 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 of similar remaining maturity. No adjustment was made to the entry-value interest rates for changes in credit performing commercial loans, construction loans, and land loans for which there are no known credit concerns. Management believes that the risk factor embedded in the entry-value interest rates, along with the general reserves applicable to the performing commercial, construction, and land loan portfolios for which there are no known credit concerns, result in a fair valuation of such loans on an entry-value basis. The fair value of non-performing loans, with a recorded book value of approximately $3,180 and $3,704 (which are collateralized by real estate properties with property values in excess of carrying amounts) as of September 30, 1999 and 1998, 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, 1999 and 1998. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. 18. CAPITAL SECURITIES On August 21, 1997, First Keystone Capital Trust I ("the Trust"), a trust formed under Delaware law, that is a subsidiary of the Company, issued $16.2 million of preferred securities at an interest rate of 9.7%, with a scheduled maturity of August 15, 2027. The Company owns all the common stock of the Trust. The proceeds from the issue were invested in Junior Subordinated Debentures (the "Debentures") issued by the Company. The Debentures are unsecured and rank subordinate and junior in right of payment to all indebtedness, liabilities and obligations of the Company. The Debentures represent the sole assets of the Trust. Interest on the Preferred Securities is cumulative and payable semi-annually in arrears. The Company has the option, subject to required regulatory approval, to prepay the securities beginning August 15, 2007. The securities are shown on the liability side of the balance sheet as "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 operations rather than interest expense. 33 36 NOTES TO CONSOLIDATED STATEMENTS (continued) 19. PARENT COMPANY ONLY FINANCIAL INFORMATION Condensed financial statements of First Keystone Financial, Inc. are as follows: CONDENSED STATEMENTS OF FINANCIAL CONDITION
September 30 ------------ 1999 1998 ---- ---- ASSETS Interest-bearing deposits $ 606 $ 222 Investment securities available for sale 7,400 7,043 Investment in subsidiaries 34,403 35,622 Other assets 793 884 ------- ------- Total assets $43,202 $43,771 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Junior subordinated debt $16,702 $16,702 Other borrowed money 2,232 100 Other liabilities 364 305 ------- ------- Total liabilities 19,298 17,107 Stockholders' equity 23,904 26,664 Total liabilities and stockholders' equity ------- ------- $43,202 $43,771 ======= =======
Condensed Statements of Income
Year Ended September 30 ------------ 1999 1998 1997 ---- ---- ---- Interest and dividend Income: Dividends from subsidiary $ 750 $ 1,000 Loan to Employee Stock Ownership Plan 127 $ 136 129 Interest and dividends on investments 549 502 Interest on deposits 9 43 48 ------ ------ ------ Total interest and dividend income 1,435 681 1,177 Interest on debt and other borrowed money 1,788 1,620 153 Other Income 130 5 Operating expenses 129 107 26 ------ ------ ------ Income (loss) before income taxes and equity in undistributed income of subsidiaries (352) (1,041) 998 Income tax expense (benefit) (374) (343) 10 ------ ------ ------ Income (loss) before equity in undistributed income of subsidiaries 22 (698) 988 Equity in undistributed income of subsidiaries 2,826 3,479 1,649 ----- ----- ----- Net income $ 2,848 $ 2,781 $ 2,637 ======= ======= =======
34 37 NOTES TO CONSOLIDATED STATEMENTS (continued) CONDENSED STATEMENTS OF CASH FLOWS
Year Ended September 30 ----------------------- 1999 1998 1997 ---- ---- ---- Cash flows from operating activities: Net income $ 2,848 $ 2,781 $ 2,637 Adjustments to reconcile net income to cash provided by operations: (Equity in) return of undistributed earnings of subsidiaries (2,826) (3,479) (1,649) Increase in investment of subsidiaries (48) Amortization of common stock acquired by stock benefit plans 462 563 411 Gain on sale of investment available for sale (130) (5) Amortization of premium 1 Decrease (increase) in other assets 91 (172) (677) Increase in other liabilities 302 47 184 --- ---- --- Net cash provided by (used in) operating activities 748 (313) 906 --- ---- --- Cash flows from investing activities: Purchases of investments available for sale (3,535) (8,891) Proceeds from sale of investments available for sale 2,630 2,005 ----- ----- Net cash used in investing activities (905) (6,886) --- ---- Cash flows from financing activities: Proceeds from issuance of debentures 16,200 Increase in other borrowed money 2,132 100 Capital contribution to subsidiary (6,000) Common stock acquired by stock benefit plans (775) Purchase of treasury stock (1,047) (2,036) (1,257) Dividends paid (544) (475) (250) -------- -------- ------- Net cash provided by (used in) financing activities 541 (2,411) 7,918 -------- -------- ------- Increase (decrease) in cash 384 (9,610) 8,824 Cash at beginning of period 222 9,832 1,008 -------- -------- -------- Cash at end of period $ 606 $ 222 $ 9,832 ======== ======== ========
35 38 NOTES TO CONSOLIDATED STATEMENTS(continued) 20. QUARTERLY FINANCIAL DATA (UNAUDITED) Unaudited quarterly financial data for the years ended September 30, 1999 and 1998 is as follows:
1999 1998 1st 2nd 3rd 4th 1st 2nd 3rd 4th QTR QTR QTR QTR QTR QTR QTR QTR --- --- --- --- --- --- --- --- Interest Income $7,165 $7,083 $7,050 $7,396 $6,762 $6,836 $6,776 $7,019 Interest Expense 4,270 4,162 4,146 4,378 3,827 3,834 3,852 4,112 ------ ------ ------ ------ ------ ------ ------ ------ Net Interest Income 2,895 2,921 2,904 3,018 2,935 3,002 2,924 2,907 Provision for Loan Losses 25 75 84 75 75 76 20 15 ------ ------ ------ ------ ------ ------ ------ ------ Net Interest Income after Provision for Loan Losses 2,870 2,846 2,820 2,943 2,860 2,926 2,904 2,892 Non-Interest Income 322 687 372 406 385 408 320 407 Non-Interest Expense 2,336 2,594 2,223 2,348 2,155 2,256 2,363 2,298 ------ ------ ------ ------ ------ ------ ------ ------ Income Before Income Taxes 856 939 969 1,001 1,090 1,078 861 1,001 Provision for Income Taxes 196 228 244 249 418 394 160 278 ------ ------ ------ ------ ------ ------ ------ ------ Net Income $ 660 $ 711 $ 725 $ 752 $ 672 $ 684 $ 701 $ 723 ====== ====== ====== ====== ====== ====== ====== ====== Per Share: Earnings Per Share - Basic $ .32 $ .35 $ .35 $ .37 $ .31 $ .32 $ .33 $ .35 Earnings Per Share - Diluted $ .31 $ .33 $ .34 $ .35 $ .29 $ .30 $ .31 $ .33 Common Stock Price Range of the Company High $16.00 $14.63 $14.25 $14.00 $18.75 $19.00 $22.25 $17.75 Low $12.25 $12.00 $12.00 $12.13 $14.63 $16.38 $17.25 $11.63
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. 36 39 First Keystone Financial, Inc. is a unitary savings and loan holding company conducting business through its wholly-owned subsidiary, First Keystone Federal Savings Bank. The savings bank is a federally chartered SAIF-insured savings institution operating through six full-service offices located in Delaware and Chester Counties, Pennsylvania. The Company's headquarters is located at 22 West State Street, Media, PA 19063. DIRECTORS Donald A. Purdy, Esquire Chairman of the Board William K. Betts; retired Former Senior Vice President of Human Resources First Keystone Federal Savings Bank Edward Calderoni President of Century-21 Alliance Silvio F. D'Ignazio Owner of the Towne House Restaurant Olive J. Faulkner; retired Former Vice President and Corporate Secretary First Keystone Federal Savings Bank Donald S. Guthrie, Esquire President and Chief Executive Officer Edmund Jones, Esquire Chairman Emeritus Member Jones, Strohm, Crain & Guthrie, P.C. Thomas M. Kelly Executive Vice President and Chief Financial Officer Willard F. Letts President and Principal Stockholder Eastern Flame Hardening Company Walter J. Lewicki; retired Former associate of Looker, Lees and Melcher, Inc. Joan G. Taylor; retired Former Executive Director of the Young Women's Christian Association (YWCA) SENIOR OFFICERS Donald S. Guthrie President and Chief Executive Officer Thomas M. Kelly Executive Vice President and Chief Financial Officer Stephen J. Henderson Senior Vice President/Lending Elizabeth M. Mulcahy Senior Vice President/Human Resources Carol Walsh Corporate Secretary EXECUTIVE OFFICES 22 West State Street Media, PA 19063 (610) 565-6210 TRANSFER AGENT Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016 COUNSEL Lawrence G. Strohm, Jr., Esquire Jones, Strohm, Crain & Guthrie, P.C 10 Beatty Road Media, PA 19063 SPECIAL COUNSEL Elias, Matz, Tiernan and Herrick L.L.P. Suite 1200 734 15th Street, N.W. Washington, DC 20005 INDEPENDENT AUDITORS Deloitte & Touche LLP Twenty-Fourth Floor 1700 Market Street Philadelphia, PA 19103-3984 INVESTOR INFORMATION Thomas M. Kelly Executive Vice President and Chief Financial Officer (610) 565-6210 SHAREHOLDER INFORMATION Carol Walsh Corporate Secretary (610) 565-6210 STOCK INFORMATION First Keystone Financial, Inc. is traded on the Nasdaq National Market under the symbol of "FKFS." There were approximately 435 shareholders of record as of October 1, 1999, 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 26, 2000, at 2:00 p.m. to be held at the Towne House Restaurant, 117 Veterans Square, Media, Pennsylvania. [FIRST KEYSTONE FINANCIAL, Inc. LOGO] 40 [FIRST KEYSTONE FINANCIAL, Inc. LOGO] FIRST KEYSTONE FINANCIAL, INC. 22 West State Street - Media, Pennsylvania 19063 - 610.565.6210 http://www.firstkeystone.com -----END PRIVACY-ENHANCED MESSAGE-----