UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________
FORM 10-K
[x] ANNUAL REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
Or
[ ] TRANSITION REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ____________
Commission file Number: 2-88927
FIRST KEYSTONE CORPORATION
(Exact name of registrant as specified in its Charter)
Pennsylvania 23-2249083
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
111 West Front Street, 18603
Berwick, Pennsylvania (Zip Code)
(Address of principal
executive offices)
Registrant's telephone number, including area code: (570) 752-3671
__________________________________
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common
Stock, par value $2.00 per share
__________________________________
Indicate by check mark whether the Registrant (1) filed all reports
required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Indicate by check mark if there is no disclosure of delinquent
filers in response to Item 405 of Regulation S-K contained in this
form, and no disclosure will be contained, to the best of
registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10K
or any amendment to this Form 10K. [X]
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rul 12b-2 of the Exchange Act).
Yes [X] No [ ]
The aggregate market value of the voting stock held by non
affiliates on the Registrant based on the closing price as of March
8, 2005, was approximately $79,345,260.
The number of shares outstanding of the issuer's Common Stock, as
of March 8, 2005, was 4,392,846 shares of Common Stock, par value
$2.00 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's 2005 definitive Proxy Statement
are incorporated by reference in Part III of this Report.
FIRST KEYSTONE CORPORATION
FORM 10-K
Table of Contents
Part I Page
______ ____
Item 1. Business 1
Item 2. Properties 8
Item 3. Legal Proceedings 9
Item 4. Submission of Matters to a Vote of
Security Holders 9
Part II
_______
Item 5. Market for Registrant's Common Equity
and Related Shareholder Matters 10
Item 6. Selected Financial Data 12
Item 7. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 13
Item 7A. Quantitative and Qualitative Disclosure
About Market Risk 27
Item 8. Financial Statements and Supplementary Data 28
Item 9. Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure 61
Item 9A. Controls and Procedures 61
Item 9B. Other Information 61
Part III
________
Item 10. Directors and Executive Officers of
the Registrant 62
Item 11. Executive Compensation 62
Item 12. Security Ownership of Certain
Beneficial Owners and Management 62
Item 13. Certain Relationships and Related
Transactions 62
Item 14. Principal Accountant Fees and Services 62
Part IV
_______
Item 15. Exhibits, Financial Statement Schedules 63
Signatures 65
Exhibit 21 68
Exhibit 23 69
Exhibit 31.1 70
Exhibit 31.2 71
Exhibit 32.1 72
Exhibit 32.2 73
i
FIRST KEYSTONE CORPORATION
FORM 10-K
PART I
Forward Looking Statements
__________________________
The management of First Keystone Corporation (Corporation),
has made forward looking statements in this annual report on Form
10 K. These forward looking statements may be subject to risks and
uncertainties. Forward looking statements include the information
concerning possible or assumed future results of operations of the
Corporation and its subsidiary, The First National Bank of Berwick
(Bank). When words such as "believes," "expects," "anticipates" or
similar expressions occur in this annual report, management is
making forward looking statements.
Shareholders should note that many factors, some of which are
discussed elsewhere in this annual report, could affect the future
financial results of the Corporation and its subsidiary, both
individually and collectively, and could cause those results to
differ materially from those expressed in the forward looking
statements contained in this annual report on Form 10 K. These
factors include the following:
* operating, legal and regulatory risks;
* economic, political and competitive forces affecting our
banking, securities, asset management and credit services
businesses; and
* the risk that our analyses of these risks and forces could
be incorrect and or that the strategies developed to
address them could be unsuccessful.
The Corporation undertakes no obligation to publicly revise or
update these forward looking statements to reflect events or
circumstances that arise after the date of this report. Readers
should carefully review the risk factors described in other
documents that are filed periodically with the Securities and
Exchange Commission (SEC).
ITEM 1. BUSINESS
First Keystone Corporation is a Pennsylvania business
corporation, and a bank holding company, registered with and
supervised by the Board of Governors of the Federal Reserve System.
The Corporation was incorporated on July 6, 1983, and commenced
operations on July 2, 1984, upon consummation of the acquisition of
all of the outstanding stock of The First National Bank of Berwick.
The Corporation has one wholly owned subsidiary, the Bank, which
has a commercial banking operation and trust department as its
major lines of business. Since commencing operations, the
Corporation's business has consisted primarily of managing and
supervising the Bank, and its principal source of income has been
dividends paid by the Bank. Greater than 98% of the Corporation's
revenue and profit came from the commercial banking department for
the years ended December 31, 2004, 2003, and 2002, and was the only
reportable segment. At December 31, 2004, the Corporation had
total consolidated assets, deposits and stockholders' equity of
approximately $497.6 million, $358.0 million and $53.3 million,
respectively.
The Bank was organized in 1864. The Bank is a national
banking association that is a member of the Federal Reserve System.
Its deposits are insured by the Federal Deposit Insurance
Corporation (FDIC) to the maximum extent of the law regulated by
The Office of the Comptroller of the Currency (OCC). The Bank, has
ten branch locations (five branches within Columbia County, four
branches within Luzerne County, and one branch in Montour County,
Pennsylvania), and is a full service commercial bank providing a
wide range of services to individuals and small to medium sized
businesses in its Northeastern and Central Pennsylvania market
area. The Bank's commercial banking activities include accepting
time, demand, and savings deposits and making secured and unsecured
commercial, real estate and consumer loans. Additionally, the Bank
also provides personal and corporate trust and agency services to
individuals, corporations, and others, including trust investment
accounts, investment advisory services, mutual funds, estate
planning, and management of pension and profit sharing plans.
1
Supervision and Regulation
__________________________
The Corporation is subject to the jurisdiction of the SEC and
of state securities laws for matters relating to the offering and
sale of its securities. The Corporation is currently subject to
the SEC's rules and regulations relating to company's whose shares
are registered under Section 12 of the Securities Exchange Act of
1934, as amended.
The Corporation is also subject to the provisions of the Bank
Holding Company Act of 1956, as amended , and to supervision by the
Federal Reserve Board. The Bank Holding Company Act requires the
Corporation to secure the prior approval of the Federal Reserve
Board before it owns or controls, directly or indirectly, more than
5% of the voting shares of substantially all of the assets of any
institution, including another bank.
The Bank Holding Company Act also prohibits acquisition of
control of a bank holding company, such as the Corporation, without
prior notice to the Federal Reserve Board. Control is defined for
this purpose as the power, directly or indirectly, to direct the
management or policies of a bank holding company or to vote 25% (or
10%, if no other person or persons acting on concert, holds a
greater percentage of the Common Stock) or more of the
Corporation's Common Stock.
The Corporation is required to file an annual report with the
Federal Reserve Board and any additional information that the
Federal Reserve Board may require pursuant to the Bank Holding
Company Act. The Federal Reserve Board may also make examinations
of the Corporation and any or all of its subsidiaries.
The Bank is subject to federal and state statutes applicable
to banks chartered under the banking laws of the United States, to
members of the Federal Reserve System and to banks whose deposits
are insured by the FDIC. Bank operations are also subject to
regulations of the OCC, the Federal Reserve Board and the FDIC.
The primary supervisory authority of the Bank is the OCC,
which regulates and examines the Bank. The OCC has the authority
under the Financial Institutions Supervisory Act to prevent a
national bank from engaging in an unsafe or unsound practice in
conducting its business.
Federal and state banking laws and regulations govern, among
other things, the scope of a bank's business, the investments a
bank may make, the reserves against deposits a bank must maintain,
loans a bank makes and collateral it takes, and the activities of a
bank with respect to mergers and consolidations and the
establishment of branches.
As a subsidiary of a bank holding company, the Bank is subject
to certain restrictions imposed by the Federal Reserve Act on any
extensions of credit to the bank holding company or its
subsidiaries, on investments in the stock or other securities of
the bank holding company or its subsidiaries and on taking such
stock or securities as collateral for loans. The Federal Reserve
Act and Federal Reserve Board regulations also place certain
limitations and reporting requirements on extensions of credit by a
bank to principal shareholders of its parent holding company, among
others, and to related interests of such principal shareholders.
In addition, such legislation and regulations may affect the terms
upon which any person becoming a principal shareholder of a holding
company may obtain credit from banks with which the subsidiary bank
maintains a correspondent relationship.
Under the Federal Deposit Insurance Act , the OCC possesses
the power to prohibit institutions regulated by it (such as the
Bank) from engaging in any activity that would be an unsafe or
unsound banking practice or would otherwise be in violation of the
law.
Permitted Non-Banking Activities
________________________________
The Federal Reserve Board permits bank holding companies to
engage in non banking activities so closely related to banking,
managing or controlling banks as to be a proper incident thereto.
The Corporation does not at this time engage in any of these non
banking activities, nor does the Corporation have any current plans
to engage in any other permissible activities in the foreseeable
future.
2
Legislation and Regulatory Changes
__________________________________
From time to time, various types of federal and state
legislation have been proposed that could result in additional
regulations of, and restrictions on, the business of the Bank. It
cannot be predicted whether any such legislation will be adopted or
how such legislation would affect the business of the Bank. As a
consequence of the extensive regulation of commercial banking
activities in the United States, the Bank's business is
particularly susceptible to being affected by federal legislation
and regulations that may increase the costs of doing business.
From time to time, legislation is enacted which has the effect
of increasing the cost of doing business, limiting or expanding
permissible activities or affecting the competitive balance between
banks and other financial institutions. No prediction can be made
as to the likelihood of any major changes or the impact such
changes might have on the Corporation and the Bank. Certain
changes of potential significance to the Corporation which have
been enacted recently and others which are currently under
consideration by Congress or various regulatory agencies are
discussed below.
Federal Deposit Insurance Corporation Improvement Act of 1991
_____________________________________________________________
The FDICIA established five different levels of capitalization
of financial institutions, with "prompt corrective actions" and
significant operational restrictions imposed of institutions that
are capital deficient under the categories. The five categories
are:
* well capitalized
* adequately capitalized
* undercapitalized
* significantly undercapitalized, and
* critically undercapitalized.
To be considered well capitalized, an institution must have a
total risk based capital ratio of at least 10%, a Tier 1 risk based
capital ratio of at least 6%, a leverage capital ratio of 5%, and
must not be subject to any order or directive requiring the
institution to improve its capital level. An institution falls
within the adequately capitalized category if it has a total risk
based capital ratio of at least 8%, a Tier 1 risk based capital
ratio of at least 4%, and a leverage capital ratio of at least 4%.
Institutions with lower capital levels are deemed to be
undercapitalized, significantly undercapitalized or critically
undercapitalized, depending on their actual capital levels. In
addition, the appropriate federal regulatory agency may downgrade
an institution to the next lower capital category upon a
determination that the institution is in an unsafe or unsound
condition, or is engaged in an unsafe or unsound practice.
Institutions are required under FDICIA to closely monitor their
capital levels and to notify their appropriate regulatory agency of
any basis for a change in capital category. On December 31, 2004,
the Corporation and the Bank exceeded the minimum capital levels of
the well capitalized category.
Regulatory oversight of an institution becomes more stringent
with each lower capital category, with certain "prompt corrective
actions" imposed depending on the level of capital deficiency.
Other Provisions of FDICIA
__________________________
Each depository institution must submit audited financial
statements to its primary regulator and the FDIC, which reports are
made publicly available. In addition, the audit committee of each
depository institution must consist of outside directors and the
audit committee at "large institutions" (as defined by FDIC
regulation) must include members with banking or financial
management expertise. The audit committee at "large institutions"
must also have access to independent outside counsel. In addition,
an institution must notify the FDIC and the institution's primary
regulator of any change in the institutions independent auditor,
and annual management letters must be provided to the FDIC and the
depository institution's primary regulator. The regulations define
a "large institution" as one with over $500 million in assets,
which does not include the Bank. Also, under the rule, an
institution's independent auditor must examine the institution's
internal controls over financial reporting and perform agreed upon
procedures to test compliance with laws and regulations concerning
safety and soundness.
3
Under FDICIA, each federal banking agency must prescribe
certain safety and soundness standards for depository institutions
and their holding companies. Three types of standards must be
prescribed:
* asset quality and earnings
* operational and managerial, and
* compensation
Such standards would include a ratio of classified assets to
capital, minimum earnings, and, to the extent feasible, a minimum
ratio of market value to book value for publicly traded securities
of such institutions and holding companies. Operational and
managerial standards must relate to:
* internal controls, information systems and
internal audit systems
* loan documentation
* credit underwriting
* interest rate exposure
* asset growth, and
* compensation, fees and benefits
FDICIA also sets forth Truth in Savings disclosure and
advertising requirements applicable to all depository institutions.
Real Estate Lending Standards. Pursuant to the FDICIA, the
OCC and other federal banking agencies adopted real estate lending
guidelines which would set loan to value ratios for different types
of real estate loans. A LTV ratio is generally defined as the
total loan amount divided by the appraised value of the property at
the time the loan is originated. If the institution does not hold
a first lien position, the total loan amount would be combined with
the amount of all senior liens when calculating the ratio. In
addition to establishing the LTV ratios, the guidelines require all
real estate loans to be based upon proper loan documentation and a
recent appraisal of the property.
Regulatory Capital Requirements
_______________________________
The federal banking regulators have adopted certain risk based
capital guidelines to assist in the assessment of the capital
adequacy of a banking organization's operations for both
transactions reported on the balance sheet as assets and
transactions, such as letters of credit, and recourse agreements,
which are recorded as off balance sheet items. Under these
guidelines, nominal dollar amounts of assets and credit equivalent
amounts of off balance sheet items are multiplied by one of several
risk adjustment percentages, which range from 0% for assets with
low credit risk, such as certain U.S. Treasury securities, to 100%
for assets with relatively high credit risk, such as business
loans.
4
The following table presents the Corporation's capital ratios
at December 31, 2004:
(In Thousands)
Tier I Capital $ 48,212
Tier II Capital 4,290
Total Capital 52,502
Adjusted Total Average Assets 501,677
Total Adjusted Risk-Weighted Assets297,048
Tier I Risk-Based Capital Ratio16.23%
Required Tier I Risk-Based Capital Ratio 4.00%
Excess Tier I Risk-Based Capital Ratio 12.23%
Total Risk-Based Capital Ratio17.68%
Required Total Risk-Based Capital Ratio 8.00%
Excess Total Risk-Based Capital Ratio 9.68%
Tier I Leverage Ratio9.61%
Required Tier I Leverage Ratio 4.00%
Excess Tier I Leverage Ratio 5.61%
_______________________
Includes off balance sheet items at credit equivalent values less
intangible assets.
Tier I Risk Based Capital Ratio is defined as the ratio of Tier I
Capital to Total Adjusted Risk Weighted Assets.
Total Risk Based Capital Ratio is defined as the ratio of Tier I
and Tier II Capital to Total Adjusted Risk Weighted Assets.
Tier I Leverage Ratio is defined as the ratio of Tier I Capital to
Adjusted Total Average Assets.
The Corporation's ability to maintain the required levels of
capital is substantially dependent upon the success of
Corporation's capital and business plans; the impact of future
economic events on the Corporation's loan customers; and the
Corporation's ability to manage its interest rate risk and
investment portfolio and control its growth and other operating
expenses. See also, the information under the caption "Capital
Strength" appearing on page 23 of this 2004 Annual Report on Form
10K.
Effect of Government Monetary Policies
______________________________________
The earnings of the Corporation are and will be affected by
domestic economic conditions and the monetary and fiscal policies
of the United States government and its agencies.
The Federal Reserve Board have had, and will likely continue
to have, an important impact on the operating results of commercial
banks through its power to implement national monetary policy in
order to, among other things, curb inflation or combat a recession.
The Federal Reserve Board has a major effect upon the levels of
bank loans, investments and deposits through its open market
operations in United States government securities and through its
regulations of, among other things, the discount rate on borrowings
of member banks and the reserve requirements against member bank
deposits. It is not possible to predict the nature and impact of
future changes in monetary and fiscal policies.
Effects of Inflation
____________________
Inflation has some impact on the Bank's operating costs.
Unlike industrial companies, however, substantially all of the
Bank's assets and liabilities are monetary in nature. As a result,
interest rates have a more significant impact on the Bank's
performance than the general levels of inflation. Over short
periods of time, interest rates may not necessarily move in the
same direction or in the same magnitude as prices of goods and
services.
5
Environmental Regulation
________________________
There are several federal and state statutes that regulate the
obligations and liabilities of financial institutions pertaining to
environmental issues. In addition to the potential for attachment
of liability resulting from its own actions, a bank may be held
liable, under certain circumstances, for the actions of its
borrowers, or third parties, when such actions result in
environmental problems on properties that collateralize loans held
by the bank. Further, the liability has the potential to far
exceed the original amount of the loan issued by the Bank.
Currently, neither the Corporation nor the Bank is a party to any
pending legal proceeding pursuant to any environmental statute, nor
are the Corporation and the Bank aware of any circumstances that
may give rise to liability under any such statute.
Interest Rate Risk
__________________
Federal banking agency regulations specify that the Bank's
capital adequacy include an assessment of the Bank's interest rate
risk exposure. The standards for measuring the adequacy and
effectiveness of a banking organization's Interest Rate Risk (IRR)
management includes a measurement of Board of Directors and senior
management oversight, and a determination of whether a banking
organization's procedures for comprehensive risk management are
appropriate to the circumstances of the specific banking
organization. The First National Bank of Berwick has internal IRR
models that are used to measure and monitor IRR. Additionally, the
regulatory agencies have been assessing IRR on an informal basis
for several years. For these reasons, the Corporation does not
expect the addition of IRR evaluation to the agencies' capital
guidelines to result in significant changes in capital requirements
for the Bank.
The Gramm-Leach-Bliley Act of 2000
__________________________________
On November 12, 2000, President Clinton signed into law the
Gramm Leach Bliley Act of 2000, which is also known as the
Financial Services Modernization Act. The act repeals some
Depression era banking laws and will permit banks, insurance
companies and securities firms to engage in each others' businesses
after complying with certain conditions and regulations. The act
grants to community banks the power to enter new financial markets
as a matter of right that larger institutions have managed to do on
an ad hoc basis. At this time, our company has no plans to pursue
these additional possibilities.
Our Corporation does not believe that the Financial Services
Modernization Act will have an immediate positive or negative
material effect on our operations. However, the act may have the
result of increasing the amount of competition that our Corporation
faces from larger financial service companies, many of whom have
substantially more financial resources than our Corporation, which
may now offer banking services in addition to insurance and
brokerage services.
The Sarbanes-Oxley Act
______________________
On July 30, 2002, President Bush signed into law the Sarbanes
Oxley Act of 2002. The Act was in response to public concerns
regarding corporate accountability in connection with recent high
visibility accounting scandals. The stated goals of the Sarbanes
Oxley Act are:
* to increase corporate responsibility;
* to provide for enhanced penalties for
accounting and auditing improprieties
at publicly traded companies; and
* to protect investors by improving the accuracy
and reliability of corporate disclosures pursuant
to the securities laws.
The Sarbanes Oxley Act generally applies to all companies,
both U.S. and non U.S., that file periodic reports with the SEC
under the Securities Exchange Act of 1934. The legislation
includes provisions, among other things:
* governing the services that can be provided by a
public company's independent auditors and the
procedures for approving such services;
* requiring the chief executive officer and chief
financial officer to certify certain matters
relating to the company's periodic filings under
the Exchange Act;
* requiring expedited filings of reports by insiders
of their securities transactions and containing
other provisions relating to insider conflicts
of interest;
6
* increasing disclosure requirements relating to
critical financial accounting policies and
their application;
* increasing penalties for securities law
violations; and
* creating a new public accounting oversight board,
a regulatory body subject to SEC jurisdiction
with broad powers to set auditing, quality
control and ethics standards for accounting firms.
The American Jobs Creation Act of 2004
______________________________________
In 2004, the American Jobs Creation Act was enacted as the
first major corporation tax act in years. The act addresses a
number of areas of corporate taxation including executive deferred
compensation restrictions. The impact of the act on the
Corporation is unknown at this time, but management is monitoring
its developments.
History and Business - Bank
___________________________
The Bank's legal headquarters are located at 111 West Front
Street, Berwick, Pennsylvania.
As of December 31, 2004, the Bank had total assets of
$497,615,000, total shareholders' equity of $53,312,000 and total
deposits and other liabilities of $444,303,000.
The Bank engages in a full service commercial banking
business, including accepting time and demand deposits, and making
secured and unsecured commercial and consumer loans. The Bank's
business is not seasonal in nature. Its deposits are insured by
the FDIC to the extent provided by law. The Bank has no foreign
loans or highly leveraged transaction loans, as defined by the
Federal Reserve Board. Substantially all of the loans in the
Bank's portfolio have been originated by the Bank. Policies
adopted by the Board of Directors are the basis by which the Bank
conducts its lending activities.
At December 31, 2004, the Bank had 117 full time employees and
32 part time employees. In the opinion of management, the Bank
enjoys a satisfactory relationship with its employees. The Bank is
not a party to any collective bargaining agreement.
Competition - Bank
__________________
The Bank competes actively with other area commercial banks
and savings and loan associations, many of which are larger than
the Bank, as well as with major regional banking and financial
institutions. The Bank's major competitors in Columbia and Luzerne
counties are:
* First Columbia Bank & Trust Co. of Bloomsburg
* PNC Bank, N.A.
* Columbia County Farmers National Bank of Bloomsburg
* M & T Bank
* FNB Bank, NA
* First Federal Bank
In the county of Montour, credit unions are our major
competitors along with M & T Bank, FNB Bank, NA and Sovereign Bank.
The Bank is generally competitive with all competing financial
institutions in its service area with respect to interest rates
paid on time and savings deposits, service charges on deposit
accounts and interest rates charged on loans.
Concentration
_____________
The Corporation and the Bank are not dependent for deposits
nor exposed by loan concentrations to a single customer or to a
small group of customers the loss of any one or more of whom would
have a materially adverse effect on the financial condition of the
Corporation or the Bank.
Available Information
_____________________
The Corporation's common stock is registered under Section
12(b) of the Securities Exchange Act of 1934. The Corporation is
subject to the informational requirements of the Exchange Act, and,
accordingly, files reports, proxy statements and other information
with the Securities and Exchange Commission. The reports, proxy
statements and other information filed with the SEC are available
for inspection and copying at the SEC's Public Reference Room at
Judiciary Plaza, 450 Fifth Street, N.W.,
7
Washington, D.C. 20549. You may obtain information on the
operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. The Corporation is an electronic filer with the SEC.
The SEC maintains an Internet site that contains reports, proxy and
information statements, and other information regarding issuers
that file electronically with the SEC. The SEC's internet site
address is www.sec.gov.
A copy of the Corporation's Annual Report on Form 10K may be
obtained without charge from our website at
www.firstkeystonecorporation.com or via email at fnb@fnbbwk.com.
Information may also be obtained via written request to Investor
Relations at First Keystone Corporation, Attention: J. Gerald
Bazewicz, 111 West Front Street, Berwick, Pennsylvania 18603.
ITEM 2. DESCRIPTION OF PROPERTIES
The Corporation owns no property other than through the Bank.
These are:
Type of Square
Location Ownership Footage Use
________ _________ _______ ___
Columbia County, PA
111 W. Front Street,
Berwick Owned 12,500 Administrative
office, banking and
trust services.
117-119 W. Front Street,
Berwick Owned .1413 No building,
Acres held for expansion.
105 Market Street Leased 4,000 Computer/
(second floor) Annual accounting
Rental department.
$36,780
2nd & Market Streets, Owned 1.45 No buildings,
Berwick Acres Present use,
parking.
701 Freas Avenue,
Berwick Owned 3,744 Banking services.
Giant Market Leased 500 Banking services.
50 Briar Creek Plaza Annual
Rental
$33,419
2301 Columbia Owned 7,000 Banking services.
Boulevard, Bloomsburg
Third & Race Streets, Owned 2,500 Banking services.
Mifflinville
8
Type of Square
Location Ownership Footage Use
________ _________ _______ ___
Luzerne County, PA
Salem Township Owned 3,700 Banking services.
400 Fowler Avenue,
Berwick
West Third Street, Leased 2,300 Banking services.
Nescopeck Annual
Rental
$15,600
1540 Sans Souci Owned 4,000 Banking services.
Highway, Wilkes-Barre
179 South Wyoming Leased 3,000 Banking services.
Avenue, Kingston Annual
Rental
$51,000
Montour County, PA
1519 Bloom Road Owned 6,480 Banking services.
Danville
It is Management's opinion that the facilities currently
utilized are suitable and adequate for the Corporation's current
and immediate future purposes.
ITEM 3. LEGAL PROCEEDINGS
The Corporation and/or the Bank are defendants in various
legal proceedings arising in the ordinary course of their business.
However, in the opinion of management of the Corporation and the
Bank, there are no proceedings pending to which the Corporation and
the Bank is a party or to which their property is subject, which,
if determined adversely to the Corporation and the Bank, would be
material in relation to the Corporation's and Bank's individual
profits or financial condition, nor are there any proceedings
pending other than ordinary routine litigation incident to the
business of the Corporation and the Bank. In addition, no material
proceedings are pending or are known to be threatened or
contemplated against the Corporation and the Bank by government
authorities or others.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the
fiscal year covered by this report to a vote of security holders
through the solicitation of proxies or otherwise.
9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED
SHAREHOLDER MATTERS AND ISSUER PURCHASES OF
EQUITY SECURITIES
The Corporation's Common Stock is traded in the over the
counter market on the OTC Bulletin Board under the symbol "FKYS".
The following table sets forth:
* The quarterly high and low prices for a share of the
Corporation's Common Stock during the periods indicated
as reported to the management of the Corporation and
* Quarterly dividends on a share of the Common Stock with
respect to each quarter since January 1, 2003.
The following table reflects the high and low closing sale
prices reported for First Keystone Corporation's common stock, and
the cash dividends declared on First Keystone Corporation's common
stock, for the periods indicated, after giving retroactive effect
to a 3 for 2 stock split in the form of a 50% stock dividend paid
on May 11, 2004.
MARKET VALUE OF COMMON STOCK
Per Share
High Low Dividend
____ ___ ________
2004:
First quarter $25.50 $24.00 $.17
Second quarter $25.50 $24.25 $.18
Third quarter $24.50 $22.75 $.18
Fourth quarter $23.25 $21.90 $.20
2003:
First quarter $20.77 $17.17 $.16
Second quarter $21.67 $19.50 $.16
Third quarter $22.67 $21.33 $.16
Fourth quarter $24.33 $22.50 $.17
As of December 31, 2004, the Corporation had approximately 628
shareholders of record.
The Corporation has paid dividends since commencement of
business in 1984. It is the present intention of the Corporation's
Board of Directors to continue the dividend payment policy;
however, further dividends must necessarily depend upon earnings,
financial condition, appropriate legal restrictions and other
factors relevant at the time the Board of Directors of the
Corporation considers dividend policy. Cash available for dividend
distributions to shareholders of the Corporation must initially
come from dividends paid by the Bank to the Corporation.
Therefore, the restrictions on the Bank's dividend payments are
directly applicable to the Corporation.
Transfer Agent:
The First National Bank of Berwick (570) 752-3671
111 West Front Street
Berwick, PA 18603
10
The following brokerage firms make a market in First Keystone
Corporation common stock:
Legg Mason Wood Walker Inc. (800) 888-6673
Janney Montgomery Scott LLC (800) 526-6397
Ryan, Beck and Company (800) 223-6807
Boenning & Scattergood, Inc. (800) 842-8928
Ferris Baker Watts, Inc. (800) 638-7411
Dividend Restrictions on the Bank
_________________________________
The OCC rules govern the payment of dividends by national
banks. Consequently, the Bank, which is subject to these rules,
may not pay dividends from capital (unimpaired common and preferred
stock outstanding) but only from retained earnings after deducting
losses and bad debts therefrom. To the extent that (1) the Bank
has capital surplus in an amount in excess of common capital and
(2) the Bank can prove that such surplus resulted from prior period
earnings, the Bank, upon approval of the OCC, may transfer earned
surplus to retained earnings and thereby increase its dividend
capacity.
The Bank may not pay any dividends on its capital stock during
a period in which it may be in default in the payment of its
assessment for a deposit insurance premium due to the FDIC, nor may
it pay dividends on Common Stock until any cumulative dividends on
the Bank's preferred stock (if any) have been paid in full. The
Bank has never been in default in the payments of its assessments
to the FDIC; and the Bank has no outstanding preferred stock. In
addition, under the Federal Deposit Insurance Act (912 U.S.C.
Section 1818), dividends cannot be declared and paid if the OCC
obtains a cease and desist order because, in the opinion of the
OCC, such payment would constitute an unsafe and unsound banking
practice. As of December 31, 2004, there was $3,041,000 in
unrestricted retained earnings and net income available at the Bank
that could be paid as a dividend to the Corporation under the
current OCC regulations.
Dividend Restrictions on the Corporation
________________________________________
Under the Pennsylvania Business Corporation Law of 1988, as
amended, the Corporation may not pay a dividend if, after giving
effect thereto, either:
* The Corporation would be unable to pay its debts as they
become due in the usual course of business or;
* The Corporation's total assets would be less than its total
liabilities.
The determination of total assets and liabilities may be based
upon:
* Financial statements prepared on the basis of generally
accepted accounting principles,
* Financial statements that are prepared on the basis of
other accounting practices and principles that are
reasonable under the circumstances, or;
* A fair valuation or other method that is reasonable under
the circumstances.
11
ITEM 6. SELECTED FINANCIAL DATA
(Amounts in thousands, except per share)
Year Ended December 31,
_______________________________
2003 2002 2001
____ ____ ____
SELECTED FINANCIAL DATA:
Total Assets $497,615 $481,840 $439,526
Total Investment securities 239,053 231,272 215,755
Net loans 229,972 225,549 198,343
Total Deposits 357,956 343,020 330,745
Stockholders' equity 53,312 51,351 49,096
SELECTED OPERATING DATA:
Interest income $ 25,036 $ 25,063 $ 25,862
Interest expense 10,006 10,200 11,342
________ ________ ________
Net interest income $ 15,030 $ 14,863 $ 14,520
Provision for loan losses 1,750 500 550
________ ________ ________
Net interest income after
provision for loan and
lease losses $ 13,280 $ 14,363 $ 13,970
Other income 4,596 3,275 2,285
Other expense 9,426 8,371 7,811
________ ________ ________
Income before income taxes $ 8,450 $ 9,267 $ 8,444
Income tax expense 1,663 1,950 1,857
________ ________ ________
Net income $ 6,787 $ 7,317 $ 6,587
======== ======== ========
PER COMMON SHARE DATA:
Net income $ 1.55 $ 1.66 $ 1.48
Cash dividends .73 .65 .57
PERFORMANCE RATIOS:
Return on average assets 1.37% 1.57% 1.59%
Return on average equity 12.76% 14.27% 14.93%
Dividend payout ratio 47.41% 39.41% 38.33%
Average equity to average
assets ratio 10.76% 11.00% 10.66%
Year Ended December 31,
______________________
2001 2000
____ ____
SELECTED FINANCIAL DATA:
Total Assets $393,472 $360,342
Total Investment securities 184,107 156,438
Net loans 195,302 187,969
Total Deposits 294,681 271,473
Stockholders' equity 39,696 36,658
SELECTED OPERATING DATA:
Interest income $ 26,836 $ 25,650
Interest expense 14,465 13,995
________ ________
Net interest income $ 12,371 $ 11,655
Provision for loan losses 610 425
________ ________
Net interest income after
provision for loan and
lease losses $ 11,761 $ 11,230
Other income 2,346 1,875
Other expense 7,180 6,787
________ ________
Income before income taxes $ 6,927 $ 6,318
Income tax expense 1,494 1,110
________ ________
Net income $ 5,433 $ 5,208
======== ========
PER COMMON SHARE DATA:
Net income $ 1.22 $ 1.43
Cash dividends .51 .49
PERFORMANCE RATIOS:
Return on average assets 1.41% 1.52%
Return on average equity 13.85% 16.55%
Dividend payout ratio 42.24% 41.90%
Average equity to average
assets ratio 10.16% 9.20%
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of Management's Discussion and Analysis of First
Keystone Corporation, a bank holding company (the Corporation), and
its wholly owned subsidiary, The First National Bank of Berwick
(the Bank), is to assist the reader in reviewing the financial
information presented and should be read in conjunction with the
consolidated financial statements and other financial data
contained herein.
This annual report contains certain forward-looking statements
(as defined in the Private Securities Litigation Reform Act of
1995), which reflect management's beliefs and expectations based on
information currently available. These forward-looking statements
are inherently subject to significant risks and uncertainties,
including changes in general economic and financial market
conditions, the Corporation's ability to effectively carry out its
business plans and changes in regulatory or legislative
requirements. Other factors that could cause or contribute to such
differences are changes in competitive conditions. Although
management believes the expectations reflected in such forward
looking statements are reasonable, actual results may differ
materially.
RESULTS OF OPERATIONS
Year Ended December 31, 2004 Versus Year Ended December 31, 2003
Net income increased to $6,787,000 for the year ended December
31, 2004, as compared to $7,317,000 for the prior year, a decrease
of 7.2%. Earnings per share, both basic and diluted, for 2004 were
$1.55 and $1.54, respectively, as compared to $1.66 and $1.65 in
2003. Cash dividends per share increased to $.73 in 2004 from $.65
in 2003, an increase of 12.3%.
The Corporation's return on average assets was 1.37% in 2004
as compared to 1.57% in 2003. Return on average equity decreased to
12.76% in 2004 from 14.27% in 2003. Even though there was an
increase in interest rates in 2004, the continued relatively low
interest rate environment resulted in a small overall decrease of
interest income to $25,036,000 down 0.1% from 2003. Likewise, there
was the accompanying decrease in the cost of funds which resulted
in interest expense of $10,006,000 in 2004, a decrease of 1.9% from
2003.
Net interest income, as indicated below in Table 1, increased
by $167,000 or 1.1% to $15,030,000 for the year ended December 31,
2004. The Corporation's net interest income on a fully taxable
equivalent basis increased $238,000, or 1.5% to $16,565,000 in 2004
as compared to an increase of $452,000, or 2.8% to $16,327,000 in
2003.
Year Ended December 31, 2003 Versus Year Ended December 31, 2002
Net income increased to $7,317,000 for the year ended December
31, 2003, as compared to $6,587,000 in 2002. Earnings per share,
both basic and diluted, for 2003 were $1.66 and $1.65,
respectively, as compared to $1.48 in 2002. The Corporation's
return on average assets and return on average equity was 1.57% and
14.27%, respectively in 2003, as compared to 1.59% and 14.93%,
respectively in 2002.
Net interest income increased by $343,000 or 2.4% to
$14,863,000 for the year ended 2003. The Corporation's net interest
income on a fully taxable equivalent basis increased 2.8% in 2003
or $452,000 to $16,327,000 as indicated in Table 1 as compared to
$15,875,000 for the year ended 2002.
Table 1 - Net Interest Income
(Amounts in thousands)
2004/2003
________________________________
Increase/(Decrease)
__________________
2004 Amount % 2003
____ ______ __ ____
Interest Income $25,036 $(27) (.1) $25,063
Interest Expense 10,006 (194) (1.9) 10,200
_______ _____ _______
Net Interest Income 15,030 167 1.1 14,863
Tax Equivalent Adjustment 1,535 71 4.8 1,464
_______ ____ _______
Net Interest Income
(fully tax equivalent) $16,565 $238 1.5 $16,627
======= ==== =======
(Amounts in thousands) 2003/2002
________________________________
Increase/(Decrease)
_________________
2003 Amount % 2002
____ _____ ___ ____
Interest Income $25,063 $ (799) (3.1) $25,862
Interest Expense 10,200 (1,142) (10.1) 11,342
_______ ______ _______
Net Interest Income 14,863 343 2.4 14,520
Tax Equivalent Adjustment 1,464 109 8.0 1,355
_______ ______ _______
Net Interest Income
(fully tax equivalent) $16,327 $ 452 2.8 $15,875
======= ====== =======
13
Table 2 - Distribution of Assets, Liabilities and Stockholders' Equity
2004
___________________________________
Average Revenue/ Yield/
Balance Expense Rate
_______ _______ ____
Interest Earning Assets:
Loans:
Commercial$ 32,658 $ 2,251 6.89%
Real Estate172,314 10,720 6.22%
Installment Loans, Net28,123 1,680 5.97%
Fees on Loans 0 (36) 0%
________ _______ _____
Total Loans (Including
Fees)$233,095 $14,615 6.27%
________ _______ _____
Investment Securities:
Taxable $161,464 $7,378 4.57%
Tax Exempt70,928 4,519 6.37%
________ _______ _____
Total Investment Securities $232,392 $11,897 5.12%
________ _______ _____
Interest Bearing Deposits
in Banks 4,152 51 1.23%
Federal Funds Sold 328 8 2.37%
________ _______ _____
Total Interest-Earning Assets $469,967 $26,571 5.65%
________ _______ _____
Non-Interest Earning Assets:
Cash and Due From Banks $ 6,561
Allowance for Loan Losses (3,744)
Premises and Equipment 5,453
Foreclosed Assets Held for Sale 0
Other Assets 16,268
________
Total Non-Interest Earning
Assets 24,538
________
Total Assets $494,505
========
Interest-Bearing Liabilities:
Savings, NOW Accounts, and
Money Markets $142,385 $1,335 .94%
Time Deposits 186,534 5,573 2.99%
Short-Term Borrowings 2,736 41 1.50%
Long-Term Borrowings 64,144 2,932 4.57%
Securities Sold U/A to
Repurchase 7,357 125 1.70%
________ _______ _____
Total Interest-Bearing
Liabilities $403,156 $10,006 2.48%
________ _______ _____
Non-Interest Bearing
Liabilities:
Demand Deposits $ 34,000
Other Liabilities 4,144
Stockholders' Equity 53,205
________
Total Liabilities/
Stockholders' Equity $494,505
========
Net Interest Income Tax
Equivalent $16,565
=======
Net Interest Spread 3.17%
Net Interest Margin 3.52%
2003
___________________________________
Average Revenue/ Yield/
Balance Expense Rate
_______ _______ ____
Interest Earning Assets:
Loans:
Commercial$ 30,194 $ 1,839 6.09%
Real Estate158,468 10,575 6.67%
Installment Loans, Net24,169 1,964 8.13%
Fees on Loans 0 72 0%
________ _______ _____
Total Loans (Including
Fees)$212,831 $14,450 6.79%
________ _______ _____
Investment Securities:
Taxable $167,551 $ 7,797 4.65%
Tax Exempt61,188 4,249 6.94%
________ _______ _____
Total Investment Securities $228,739 $12,046 5.27%
________ _______ _____
Interest Bearing Deposits
in Banks 3,105 32 1.03%
Federal Funds Sold 0 0 0%
________ _______ _____
Total Interest-Earning Assets $444,675 $26,528 5.97%
________ _______ _____
Non-Interest Earning Assets:
Cash and Due From Banks $ 6,614
Allowance for Loan Losses (3,309)
Premises and Equipment 3,683
Foreclosed Assets Held for Sale 0
Other Assets 14,751
________
Total Non-Interest Earning
Assets 21,739
________
Total Assets $466,414
========
Interest-Bearing Liabilities:
Savings, NOW Accounts, and
Money Markets $133,138 $ 1,455 1.09%
Time Deposits 183,358 6,015 3.28%
Short-Term Borrowings 4,421 53 1.19%
Long-Term Borrowings 53,272 2,588 4.86%
Securities Sold U/A to
Repurchase 6,016 90 1.50%
________ _______ _____
Total Interest-Bearing
Liabilities $380,205 $10,201 2.68%
________ _______ _____
Non-Interest Bearing
Liabilities:
Demand Deposits $ 30,103
Other Liabilities 4,817
Stockholders' Equity 51,289
________
Total Liabilities/
Stockholders' Equity $466,414
========
Net Interest Income Tax
Equivalent $16,327
=======
Net Interest Spread 3.28%
Net Interest Margin 3.67%
2002
___________________________________
Average Revenue/ Yield/
Balance Expense Rate
_______ _______ ____
Interest Earning Assets:
Loans:
Commercial$ 28,280 $ 1,795 6.35%
Real Estate146,708 10,930 7.45%
Installment Loans, Net26,159 2,269 8.68%
Fees on Loans 0 118 0%
________ _______ _____
Total Loans (Including
Fees)$201,147 $15,112 7.51%
________ _______ _____
Investment Securities:
Taxable $141,884 $ 8,213 5.79%
Tax Exempt52,611 3,814 7.25%
________ _______ _____
Total Investment Securities $194,495 $12,027 6.18%
________ _______ _____
Interest Bearing Deposits
in Banks 5,194 78 1.51%
Federal Funds Sold 0 0 0%
________ _______ _____
Total Interest-Earning Assets $400,836 $27,217 6.79%
________ _______ _____
Non-Interest Earning Assets:
Cash and Due From Banks $ 6,620
Allowance for Loan Losses (3,061)
Premises and Equipment 3,365
Foreclosed Assets Held for Sale 26
Other Assets 6,260
________
Total Non-Interest Earning
Assets 13,210
________
Total Assets $414,046
========
Interest-Bearing Liabilities:
Savings, NOW Accounts, and
Money Markets $123,269 $ 1,845 1.50%
Time Deposits 161,262 6,272 3.89%
Short-Term Borrowings 1,379 25 1.82%
Long-Term Borrowings 46,930 3,078 6.56%
Securities Sold U/A to
Repurchase 6,357 122 1.91%
________ _______ _____
Total Interest-Bearing
Liabilities $339,197 $11,342 3.34%
________ _______ _____
Non-Interest Bearing Liabilities:
Demand Deposits $ 27,401
Other Liabilities 3,318
Stockholders' Equity 44,130
________
Total Liabilities/
Stockholders' Equity $414,046
========
Net Interest Income Tax
Equivalent $15,875
=======
Net Interest Spread 3.45%
Net Interest Margin 3.96%
______________________
Tax-exempt income has been adjusted to a tax equivalent basis using an
incremental rate of 34%, and statutory interest expense disallowance.
Installment loans are stated net of unearned interest.
Average loan balances include non-accrual loans. Interest income on non
accrual loans is not included.
14
NET INTEREST INCOME
The major source of operating income for the Corporation is
net interest income. Net interest income is the difference between
interest income on earning assets, such as loans and securities,
and the interest expense on liabilities used to fund those assets,
including deposits and other borrowings. The amount of interest
income is dependent upon both the volume of earning assets and the
level of interest rates. In addition, the volume of non performing
loans affects interest income. The amount of interest expense
varies with the amount of funds needed to support earning assets,
interest rates paid on deposits and borrowed funds, and finally,
the level of interest free deposits.
Table 2 on the preceding pages provides a summary of average
outstanding balances of earning assets and interest bearing
liabilities with the associated interest income and interest
expense as well as average tax equivalent rates earned and paid as
of year end 2004, 2003, and 2002.
The yield on earning assets was 5.65% in 2004, 5.97% in 2003,
and 6.79% in 2002. The rate paid on interest bearing liabilities
was 2.48% in 2004, 2.68% in 2003, and 3.34% in 2002. This resulted
in a decrease in our net interest spread to 3.17% in 2004, as
compared to 3.28% in 2003, and 3.45% in 2002. As Table 2
illustrates, our net interest margin also declined in 2004.
The net interest margin, which is interest income less
interest expenses divided by average earnings assets, was 3.52% in
2004 as compared to 3.67% in 2003 and 3.96% in 2002. The net
interest margins are presented on a tax equivalent basis. The
decrease in net interest margin in both 2004 and 2003 was due
primarily to the interest rate on earning assets decreasing more
than the interest rate on liabilities.
In an effort to maintain or try to increase our net interest
margin, we look to higher earning asset yields in 2005. However, it
is apparent that margin expansion will be limited by the flattening
of the yield curve.
Table 3 sets forth changes in interest income and interest
expense for 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 (changes
in average volume multiplied by prior rate); (ii) changes in rate
(changes in average rate multiplied by prior average volume); and,
(iii) changes in rate and volume (changes in average volume
multiplied by change in average rate).
Table 3 - Changes in Income and Expense, 2004 and 2003
(Amounts in thousands) 2004 COMPARED TO 2003
______________________________
VOLUME RATE NET
_____ ____ ___
Interest Income:
Loans, Net $1,376 $(1,211) $ 165
Taxable Investment Securities (283) (136) (419)
Tax-Exempt Investment
Securities 676 (405) 271
Other Short-Term Investments 14 13 27
______ _______ _____
TOTAL INTEREST INCOME $1,783 $(1,739) $ 44
______ _______ _____
Interest Expense:
Savings, Now, and Money Markets $ 101 $ (220) $(119)
Time Deposits 104 (546) (442)
Short-Term Borrowings (20) 8 (12)
Long-Term Borrowings 528 (184) 344
Securities Sold U/A to
Repurchase 20 15 35
______ _______ _____
TOTAL INTEREST EXPENSE $ 733 $ (927) $(194)
______ _______ _____
NET INTEREST INCOME $1,050 $ (812) $ 238
====== ======= =====
(Amounts in thousands) 2003 COMPARED TO 2002
______________________________
VOLUME RATE NET
_____ ____ ___
Interest Income:
Loans, Net $ 878 $(1,539) $ (661)
Taxable Investment Securities 1,486 (1,901) (415)
Tax-Exempt Investment
Securities 622 (188) 434
Other Short-Term Investments (32) (15) (47)
______ _______ _______
TOTAL INTEREST INCOME $2,954 $(3,643) $ (689)
______ _______ _______
Interest Expense:
Savings, Now, and Money Markets $ 148 $ (538) $ (390)
Time Deposits 859 (1,116) (257)
Short-Term Borrowings 55 (28) 27
Long-Term Borrowings 416 (906) (490)
Securities Sold U/A to
Repurchase (6) (25) (31)
______ _______ _______
TOTAL INTEREST EXPENSE $1,472 $(2,613) $(1,141)
______ _______ _______
NET INTEREST INCOME $1,482 $(1,030) $ 452
====== ======= =======
__________________
The change in interest due to both volume and yield/rate has been allocated
to change due to volume and change due to yield/rate in proportion to the
absolute value of the change in each.
Balance on non-accrual loans are included for computational purposes.
Interest income on non-accrual loans is not included.
Interest income exempt from federal tax was $3,260,000 in 2004, $3,091,000
in 2003, and $2,928,000 in 2002. Tax-exempt income has been adjusted to a
tax-equivalent basis using an incremental rate of 34%.
15
In 2004, the increase in net interest income of $238,000
resulted from a change in volume of $1,050,000 and a decrease of
$812,000 due to changes in rate. In 2003, there was an increase in
net interest income of $452,000 resulted from a change in volume of
$1,482,000 and a decrease of $1,030,000 due to changes in rate.
PROVISION FOR LOAN LOSSES
For the year ended December 31, 2004, the provision for loan
losses was $1,750,000 as compared to $500,000 as of December 31,
2003. The Corporation's provision for loan losses for the year
ended December 31, 2002, was $550,000. The provision in 2004,
increased primarily because of the additional net charge offs and
an increase in non accrual loans. Net charge offs by the
Corporation for the fiscal year end December 31, 2004, 2003, and
2002, were $1,446,000, $150,000, and $298,000, respectively.
The allowance for loan losses as a percentage of loans, net of
unearned interest, was 1.64% as of December 31, 2004, 1.54% as of
December 31, 2003, and 1.58% as of December 31, 2002.
On a quarterly basis, the Corporation's Board of Directors and
management performs a detailed analysis of the adequacy of the
allowance for loan losses. This analysis includes an evaluation of
credit risk concentration, delinquency trends, past loss
experience, current economic conditions, composition of the loan
portfolio, classified loans and other relevant factors.
The Corporation will continue to monitor its allowance for
loan losses and make future adjustments to the allowance through
the provision for loan losses as conditions warrant. Although the
Corporation believes that the allowance for loan losses is adequate
to provide for losses inherent in the loan portfolio, there can be
no assurance that future losses will not exceed the estimated
amounts or that additional provisions will not be required in the
future.
The Bank is subject to periodic regulatory examination by the
Office of the Comptroller of the Currency (OCC). As part of the
examination, the OCC will assess the adequacy of the bank's
allowance for loan losses and may include factors not considered by
the Bank. In the event that an OCC examination results in a
conclusion that the Bank's allowance for loan losses is not
adequate, the Bank may be required to increase its provision for
loan losses.
NON-INTEREST INCOME
Non interest income is derived primarily from trust department
revenue, service charges and fees, income on bank owned life
insurance, other miscellaneous revenue and the gain on the sale of
mortgage loans. In addition, investment securities gains or losses
also impact total non interest income.
For the year ended December 31, 2004, non interest income
increased $1,321,000, or 40.3% as compared to an increase of
$990,000, or 43.3% for the year ended December 31, 2003. Table 4
provides the major categories of non interest income and each
respective change comparing the past three years.
Excluding investment securities gains, non interest income in
2004 increased $540,000, or 18.1%. This compares to an increase of
$720,000, or 31.9% in 2003 before investment securities gains.
Income from the trust department, which consists of fees generated
from individual and corporate accounts, increased in 2004 by
$39,000 after decreasing by $24,000 in 2003. Decreased income from
the trust department in 2003 was due primarily to the decline in
market value of accounts.
Service charges and fees, consisting primarily of service
charges on deposit accounts, was the largest source of non interest
income in 2004 and 2003. Service charges and fees increased by
$525,000, or 30.5% in 2004 compared to an increase of $351,000, or
25.6% in 2003. The increases in 2004 and 2003 resulted primarily
from increasing revenue from NSF charges generated from a courtesy
overdraft program.
Income on Bank Owned Life Insurance (BOLI) decreased $39,000
to $446,000 in 2004 as compared to an increase of $383,000 to
$485,000 in 2003. In October 2002 the Bank purchased $10 million of
Bank Owned Life Insurance. The income from BOLI represents the
increase in the cash surrender value of BOLI and is intended to
partially cover the costs of the Bank's employee benefit plan,
including group life, disability, and health insurance.
16
The gain on sale of mortgages provided $221,000 in 2004 as
compared to $234,000 in 2003. The slight decrease in gains on sale
of mortgages was largely a function of the decreased volume of
mortgages sold in the secondary market during the past year. Since
the Corporation continues to service the mortgages which are sold,
this provides a source for additional non interest income on an
ongoing basis.
Other income amounted to $75,000 for 2004, an increase of
$28,000 or 59.6% over the $47,000 reported in 2003.
Table 4 - Non-Interest Income
(Amounts in thousands) 2004/2003
_______________________________
Increase/(Decrease)
__________________
2004 Amount % 2003
____ _____ __ ____
Trust Department $ 525 $ 39 8.0 $ 486
Service Charges and Fees 2,249 525 30.5 1,724
Income on Bank Owned Life
Insurance 446 (39) (8.0) 485
Gain on Sale of Mortgages 221 (13) (5.6) 234
Other 75 28 59.6 47
______ ______ ______
Subtotal $3,516 $ 540 18.1 $2,976
Investment Securities Gains 1,080 781 261.2 299
______ ______ ______
Total $4,596 $1,321 40.3 $3,275
====== ====== ======
(Amounts in thousands) 2003/2002
______________________________
Increase/(Decrease)
__________________
2003 Amount % 2002
____ _____ __ ____
Trust Department $ 486 $(24) (4.7) $ 510
Service Charges and Fees 1,724 351 25.6 1,373
Income on Bank Owned Life
Insurance 485 383 375.5 102
Gain on Sale of Mortgages 234 6 2.6 228
Other 47 4 9.3 43
______ ____ ______
Subtotal $2,976 $720 31.9 $2,256
Investment Securities Gains 299 270 931.0 29
______ ____ ______
Total $3,275 $990 43.3 $2,285
====== ==== ======
NON-INTEREST EXPENSE
Non interest expense consists of salaries and benefits,
occupancy, furniture and equipment, and other miscellaneous
expenses. Table 5 provides the yearly non interest expense by
category, along with the amount, dollar changes, and percentage of
change.
Total non interest expense increased by $1,055,000, or 12.6%
in 2004 compared to an increase of $560,000, or 7.2% in 2003.
Expenses associated with employees (salaries and employee benefits)
continue to be the largest non interest expenditure. Salaries and
employee benefits amounted to 51.8% of total non interest expense
in 2004 and 53.1% in 2003. Salaries and employee benefits increased
$436,000, or 9.8% in 2004 and $224,000, or 5.3% in 2003. The
increases in both years were due to an increase in the profit
sharing contribution, plus normal salary adjustments and increased
benefit costs. The number of full time equivalent employees was 130
as of December 31, 2004, and 129 as of December 31, 2003.
Net occupancy expense increased $89,000, or 15.7% in 2004 as
compared to an increase of $81,000, or 16.7% in 2003. Furniture and
equipment expense increased $139,000, or 21.6% in 2004 compared to
an increase of $27,000, or 4.4% in 2003. The increase in occupancy
and furniture and equipment expense in 2004 relates primarily to
increased expenses at our new Danville Office and our new Scott
Township Office. Other operating expenses increased $391,000, or
14.4% in 2004 as compared to an increase of $228,000, or 9.2% in
2003. Increases in professional fees, postage, supplies, insurance,
marketing, advertising, and state shares tax account for much of
the increase in other operating expenses in both 2004 and 2003.
The overall level of non-interest expense remains low,
relative to our peers. In fact, our total non interest expense was
less than 2% of average assets in both 2004 and 2003. Non interest
expense as a percentage of average assets under 2% places us among
the leaders in our peer financial institution categories in
controlling non interest expense.
17
Table 5 - Non-Interest Expense
(Amounts in thousands) 2004/2003
_______________________________
Increase/(Decrease)
__________________
2004 Amount % 2003
____ _____ ___ ____
Salaries and Employee Benefits $4,882 $ 436 9.8 $4,446
Occupancy, Net 656 89 15.7 567
Furniture and Equipment 782 139 21.6 643
Other and State Shares Tax 3,106 391 14.4 2,715
______ ____ ______
Total $9,426 $1,055 12.6 $8,371
====== ====== ======
(Amounts in thousands) 2003/2002
______________________________
Increase/(Decrease)
_________________
2003 Amount % 2002
____ _____ ___ ____
Salaries and Employee Benefits $4,446 $224 5.3 $4,222
Occupancy, Net 567 81 16.7 486
Furniture and Equipment 643 27 4.4 616
Other and State Shares Tax 2,715 228 9.2 2,487
______ ____ ______
Total $8,371 $560 7.2 $7,811
====== ==== ======
INCOME TAX EXPENSE
Income tax expense for the year ended December 31, 2004, was
$1,663,000 as compared to $1,950,000 and $1,857,000 for the years
ended December 31, 2003, and December 31, 2002, respectively. In
2004, our income tax expense decreased because income before taxes
decreased $817,000 to $8,450,000 from $9,267,000 in 2003. In 2003,
our income before taxes increased $823,000 as compared to 2002. The
corporation looks to maximize its tax exempt interest derived from
both tax free loans and tax free municipal investments without
triggering alternative minimum tax. The effective income tax rate
was 19.7% in 2004, 21.0% in 2003, and 22.0% in 2002. The limited
availability of tax free municipal investments at attractive
interest rates may result in a higher effective tax rate in future
years.
FINANCIAL CONDITION
GENERAL
Total assets increased to $497,615,000, at year end 2004, an
increase of 3.3% over year end 2003. As of December 31, 2004, total
deposits amounted to $357,956,000, an increase of 4.4% over 2003.
Assets as of December 31, 2003, were $481,840,000, an increase of
9.6% over 2002, while total deposits as of year end 2003 amounted
to $343,020,000, an increase of 3.7% from 2002.
In 2004, the increase in assets primarily reflects the
deployment of deposits into loans and investment securities. The
Corporation continues to maintain and manage its asset growth. Our
strong equity capital position provides us an opportunity to
further leverage our asset growth. Borrowings increased in 2004 by
$7,733,000 after increasing in 2003 by $19,872,000. Increased
borrowings in 2004 were used primarily to fund investment
securities purchases, while increased borrowings in 2003 funded
principally loan growth. Core deposits, which include demand
deposits and interest bearing demand deposits (NOWs), money market
accounts, savings accounts, and time deposits of individuals
continues to be our most significant source of funds. In 2004 and
2003, several successful sales campaigns attracted new customers
and generated growth in retail certificates of deposit (time
deposits of individuals) as well as savings and money market
accounts.
EARNING ASSETS
Earning assets are defined as those assets that produce
interest income. By maintaining a healthy asset utilization rate,
i.e., the volume of earning assets as a percentage of total assets,
the Corporation maximizes income. The earning asset ratio (average
interest earning assets divided by average total assets) equaled
95.0% for 2004, compared to 95.3% for 2003, and 96.8% for 2002.
This indicates that the management of earning assets is a priority
and non earning assets, primarily cash and due from banks, fixed
assets and other assets, are maintained at minimal levels. The
primary earning assets are loans and investment securities.
LOANS
Total loans, net of unearned income, increased to $233,800,000
as of December 31, 2004, as compared to a balance of $229,073,000
as of December 31, 2003. Table 6 provides data relating to the
composition of the Corporation's loan portfolio on the dates
indicated. Total loans, net of unearned income increased
$4,727,000, or 2.1% in 2004 compared to an increase of $27,556,000,
or 13.7% in 2003. In 2004, loan growth was limited as our
outstanding balances on residential mortgage and consumer loans
declined. This contrasts the low interest rate environment
prevalent during 2003 which resulted in a substantial increase in
residential mortgage loans, commercial loans secured by real estate
and other commercial loans.
18
The loan portfolio is well diversified and increases in the
portfolio in 2004 were only in commercial loans secured by real
estate. In 2003, the increase in loans was diversified primarily in
commercial real estate, commercial loans, and residential mortgage
loans. Outstanding balances on tax exempt loans and consumer loans
declined in both 2004 and 2003. The Corporation continues to
originate and sell certain long term fixed rate residential
mortgage loans which conform to secondary market requirements. The
Corporation derives ongoing income from the servicing of mortgages
sold in the secondary market.
The Corporation continues to internally underwrites each of
its loans to comply with prescribed policies and approval levels
established by its Board of Directors.
Table 6 - Loans Outstanding, Net of Unearned Income
(Amounts in thousands) December 31,
________________________
2004 2003 2002
____ ____ ____
Commercial, financial and
agricultural:
Commercial secured by
real estate $ 86,734 $ 73,433 $ 65,352
Commercial - other 33,470 33,890 23,639
Tax exempt 3,629 3,930 4,393
Real estate (primarily
residential mortgage loans) 92,408 96,422 85,145
Consumer loans 20,824 25,626 28,640
________ ________ ________
Total Gross Loans $237,065 $233,301 $207,169
Less: Unearned income and
unamortized loan fees
net of costs 3,265 4,228 5,652
________ ________ ________
Total Loans, net of unearned
income $233,800 $229,073 $201,517
======== ======== ========
(Amounts in thousands) December 31,
________________________
2001 2000
____ ____
Commercial, financial and
agricultural:
Commercial secured by
real estate $ 61,135 $ 53,608
Commercial - other 24,062 22,674
Tax exempt 7,958 3,798
Real estate (primarily
residential mortgage loans) 79,483 84,330
Consumer loans 32,075 32,845
________ ________
Total Gross Loans $204,713 $197,255
Less: Unearned income and
unamortized loan fees
net of costs 6,489 6,583
________ ________
Total Loans, net of unearned
income $198,224 $190,672
======== ========
INVESTMENT SECURITIES
The Corporation uses investment securities to not only
generate interest and dividend revenue, but also to help manage
interest rate risk and to provide liquidity to meet operating cash
needs.
The investment portfolio has been allocated between securities
available for sale and securities held to maturity. No investment
securities were established in a trading account. Available for
sale securities increased to $235,692,000 in 2004, a 4.3% increase
over 2003. At December 31, 2004, the net unrealized gain, net of
the tax effect, on these securities was $3,767,000 and is included
in stockholders' equity as accumulated other comprehensive gain. At
December 31, 2003, accumulated other comprehensive income, net of
tax effect, amounted to $5,489,000. In 2004, held to maturity
securities declined $1,868,000, or a 35.7% decrease from 2003 after
declining $703,000, or a 11.9% decrease in 2003. Table 7 provides
data on the carrying value of our investment portfolio on the dates
indicated. The vast majority of investment security purchases are
allocated as available for sale. This provides the Corporation with
increased flexibility should there be a need or desire to
liquidate an investment security.
The investment portfolio includes U.S. Government Corporations
and Agencies, corporate obligations, mortgage backed securities,
state and municipal securities, and other debt securities. In
addition, the investment portfolio includes restricted equity
securities consisting primarily of common stock investments in the
Federal Reserve Bank and the Federal Home Loan Bank. Marketable
equity securities consists of common stock investments in other
commercial banks and bank holding companies.
Securities available for sale may be sold as part of the
overall asset and liability management process. Realized gains and
losses are reflected in the results of operations on our statements
of income. The investment portfolio does not contain any structured
notes, step up bonds, or any off balance sheet derivatives.
During 2004, interest bearing deposits in other banks
increased to $36,000 from $28,000 in 2003. Balances in interest
bearing deposits in other banks were kept relatively low as funds
were invested in marketable securities to maximize income while
still addressing liquidity needs.
19
Table 7 - Carrying Value of Investment Securities
(Amounts in thousands) December 31,
_______________________
2004
_______________________
Available Held to
for Sale Maturity
_________ ________
U. S. Government Corporations
and Agencies $111,636 $ 638
State and Municipal 86,593 2,723
Corporate 29,302 0
Marketable Equity Securities 2,695 0
Restricted Equity Securities 5,466 0
________ ______
Total Investment Securities $235,692 $3,361
======== ======
(Amounts in thousands) December 31,
_______________________
2003
_______________________
Available Held to
for Sale Maturity
_________ ________
U. S. Government Corporations
and Agencies $100,486 $3,153
State and Municipal 78,711 2,076
Corporate 36,025 0
Marketable Equity Securities 5,654 0
Restricted Equity Securities 5,167 0
________ ______
Total Investment Securities $226,043 $5,229
======== ======
(Amounts in thousands) December 31,
______________________
2002
_______________________
Available Held to
for Sale Maturity
_________ ________
U. S. Government Corporations
and Agencies $ 77,806 $4,272
State and Municipal 84,809 1,660
Corporate 38,446 0
Marketable Equity Securities 5,310 0
Restricted Equity Securities 3,452 0
________ ______
Total Investment Securities $209,823 $5,932
======== ======
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses constitutes the amount available
to absorb losses within the loan portfolio. As of December 31,
2004, the allowance for loan losses was $3,828,000 as compared to
$3,524,000 and $3,174,000 as of December 31, 2003 and 2002,
respectively. The allowance for loan losses is established through
a provision for loan losses charged to expenses. Loans are charged
against the allowance for possible loan losses when management
believes that the collectibility of the principal is unlikely. The
risk characteristics of the loan portfolio are managed through the
various control processes, including credit evaluations of
individual borrowers, periodic reviews, and diversification by
industry. Risk is further mitigated through the application of
lending procedures such as the holding of adequate collateral and
the establishment of contractual guarantees.
Management performs a quarterly analysis to determine the
adequacy of the allowance for loan losses. The methodology in
determining adequacy incorporates specific and general allocations
together with a risk/loss analysis on various segments of the
portfolio according to an internal loan review process. This
assessment results in an allocated allowance. Management maintains
its loan review and loan classification standards consistent with
those of its regulatory supervisory authority.
Management feels based upon its methodology, that the
allowance for loan losses is adequate to cover foreseeable future
losses. Table 8 contains an analysis of our Allowance for Loan
Losses indicating charge offs and recoveries by the year and annual
additional provisions charged to operations. In 2004, net charge
offs as a percentage of average loans were .62% compared to .07% in
2003 and .15% in 2002. Net charge offs amounted to $1,446,000 in
2004 as compared to $150,000 and $298,000 in 2003 and 2002,
respectively. The increased net charge offs in 2004 resulted
primarily from part of one large commercial loan relationship,
which was deemed impaired and placed on non accrual, being charged
off. The balance of the relationship is on non accrual and included
in Table 10 - Non Performing Assets.
20
Table 8 - Analysis of Allowance for Loan Losses
(Amounts in thousands) Years Ended December 31,
_______________________
2004 2003 2002
____ ____ _____
Balance at beginning of period $3,524 $3,174 $2,922
Charge-offs:
Commercial, financial, and
agricultural 1,209 43 66
Real estate - mortgage 132 22 140
Installment loans to individuals 143 133 196
______ ______ ______
1,484 198 402
Recoveries:
Commercial, financial, and
agricultural 0 1 0
Real estate - mortgage 18 1 77
Installment loans to individuals 20 46 27
______ ______ ______
38 48 104
Net charge-offs 1,446 150 298
Additions charged to operations 1,750 500 550
______ ______ ______
Balance at end of period $3,828 $3,524 $3,174
====== ====== ======
Ratio of net charge-offs during the
period to average loans
outstanding during the period .62% .07% .15%
Allowance for loan losses to
average loans outstanding during
the period 1.64% 1.66% 1.58%
(Amounts in thousands) Years Ended December 31,
_______________________
2001 2000
____ ____
Balance at beginning of period $2,702 $2,600
Charge-offs:
Commercial, financial, and
agricultural 109 79
Real estate - mortgage 111 44
Installment loans to individuals 238 226
______ ______
458 349
Recoveries:
Commercial, financial, and
agricultural 21 0
Real estate - mortgage 3 10
Installment loans to individuals 44 16
______ ______
68 26
Net charge-offs 390 323
Additions charged to operations 610 425
______ ______
Balance at end of period $2,922 $2,702
Ratio of net charge-offs during the
period to average loans
outstanding during the period .20% .17%
Allowance for loan losses to
average loans outstanding during
the period 1.50% 1.44%
It is the policy of management and the Corporation's Board of
Directors to provide for losses on both identified and
unidentified losses inherent in its loan portfolio. A provision for
loan losses is charged to operations based upon an evaluation of
the potential losses in the loan portfolio. This evaluation takes
into account such factors as portfolio concentrations,
delinquency, trends, trends of non accrual and classified loans,
economic conditions, and other relevant factors.
The loan review process which is conducted quarterly, is an
integral part of our evaluation of the loan portfolio. A detailed
quarterly analysis to determine the adequacy of the Corporation's
allowance for loan losses is reviewed by our Board of Directors.
With our manageable level of net charge offs and the additions
to the reserve from our provision out of operations, the allowance
for loan losses as a percentage of average loans amounted to 1.64%
to 2004, 1.66% in 2003, and 1.58% in 2002.
Table 9 sets forth the allocation of the Bank's allowance for
loan losses by loan category and the percentage of loans in each
category to total loans receivable at the dates indicated. The
portion of the allowance for loan losses allocated to each loan
category does not represent the total available for future losses
that may occur within the loan category, since the total loan loss
allowance is a valuation reserve applicable to the entire loan
portfolio.
Table 9 - Allocation of Allowance for Loan Losses
(Amounts in thousands) December 31,
_________________
2004 %
____ _____
Commercial, financial, and agricultural $ 858 14.3
Real estate - mortgage 2,594 77.1
Consumer and other loans 308 8.6
Unallocated 68 N/A
______ ____
$3,828 100.0
====== =====
(Amounts in thousands) December 31,
_________________
2003 %
____ _____
Commercial, financial, and agricultural $ 775 15.4
Real estate - mortgage 2,106 72.6
Consumer and other loans 378 12.0
Unallocated 265 N/A
______ _____
$3,524 100.0
====== =====
(Amounts in thousands) December 31,
_________________
2002 %
____ _____
Commercial, financial, and agricultural $ 488 12.4
Real estate - mortgage 1,812 75.0
Consumer and other loans 357 12.6
Unallocated 517 N/A
______ _____
$3,174 100.0
====== =====
(Amounts in thousands) December 31,
_________________
2001 %
____ _____
Commercial, financial, and agricultural $ 605 14.9
Real estate - mortgage 1,826 71.2
Consumer and other loans 458 13.9
Unallocated 33 N/A
______ _____
$2,922 100.0
====== =====
(Amounts in thousands) December 31,
_________________
2000 %
____ _____
Commercial, financial, and agricultural $ 316 10.7
Real estate - mortgage 1,606 71.1
Consumer and other loans 557 18.2
Unallocated 223 N/A
______ _____
$2,702 100.0
====== =====
______________________
Percentage of loans in each category to total loans.
21
NON-PERFORMING ASSETS
From the continuing economic slowdown in 2003, the Corporation
experienced an increase in delinquencies and non performing loans
in 2004. Table 10 details the Corporation's non performing assets
at the dates indicated.
Non accrual loans are generally delinquent on which principal
or interest is past due approximately 90 days or more, depending
upon the type of credit and the collateral. When a loan is placed
on non accrual status, any unpaid interest is charged against
income. Restructured loans are loans where the borrower has been
granted a concession in the interest rate or payment amount because
of financial problems. Foreclosed assets held for sale represents
property acquired through foreclosure, or considered to be an in
substance foreclosure.
The total of non performing assets increased to $3,480,000 as
of December 31, 2004, as compared to $768,000 as of December 31,
2003. Non accrual and restructured loans increased to $3,405,000 in
2004 from $735,000 in 2003. Foreclosed assets increased slightly to
$6,000 in 2004 from zero in 2003. Loans past due 90 days or more
and still accruing also increased to $69,000 in 2004 from $33,000
in 2003. Our allowance for loan losses to total non performing
assets declined to 110.1% in 2004 as compared to 458.9% in 2003.
With the decline in asset quality, the corporation has retained an
independent outside loan review consultant to closely monitor
overall loan quality.
Improving loan quality is a priority, and we actively work
with borrowers to resolve credit problems. Excluding the assets
disclosed in Table 10, management is not aware of any information
about borrowers' possible credit problems, which cause serious
doubt as to their ability to comply with present loan repayment
terms.
Should the economic climate no longer continue to be stable or
begin to deteriorate, borrowers may experience difficulty, and the
level of non performing loans and assets, charge offs and
delinquencies could rise and possibly require additional increases
in our allowance for loan losses.
In addition, regulatory authorities, as an integral part of
their examinations, periodically review the allowance for possible
loan and lease losses. They may require additions to allowances
based upon their judgements about information available to them at
the time of examination.
Interest income received on non performing loans in 2004 and
2003 was $113,000 and $38,000, respectively. Interest income, which
would have been recorded on these loans under the original terms in
2004 and 2003 was $253,000 and $61,000, respectively. At December
31, 2004, the Corporation had no outstanding commitments to advance
additional funds with respect to these non performing loans.
A concentration of credit exists when the total amount of
loans to borrowers, who are engaged in similar activities that are
similarly impacted by economic or other conditions, exceed 10% of
total loans. As of December 31, 2004, 2003 and 2002, management is
of the opinion that there were no loan concentrations exceeding 10%
of total loans.
Table 10 - Non-Performing Assets
(Amounts in thousands) December 31,
_______________
2004 2003 2002
____ ____ ____
Non-accrual and restructured loans $3,405 $735 $458
Foreclosed assets 6 0 0
Loans past-due 90 days or more and
still accruing 69 33 0
______ ____ ____
Total non-performing assets $3,480 $768 $458
====== ==== ====
Non-performing assets to period-end
loans and foreclosed assets 1.49% .34% .23%
Total non-performing assets to
total assets .70% .16% .10%
Total allowance for loan losses to
total non-performing assets 110.0% 458.9% 693.7%
(Amounts in thousands) December 31,
_______________
2001 2000
____ ____
Non-accrual and restructured loans $1,102 $719
Foreclosed assets 75 13
Loans past-due 90 days or more and
still accruing 217 10
_____ ____
Total non-performing assets $1,394 $742
====== ====
Non-performing assets to period-end
loans and foreclosed assets .70% .39%
Total non-performing assets to
total assets .35% .21%
Total allowance for loan losses to
total non-performing assets 209.6% 364.2%
22
There is a concentration of real estate mortgage loans in the
loan portfolio. Real estate mortgages comprise 76.6% of the loan
portfolio as of December 31, 2004, up from 74.1% in 2003. Real
estate mortgages consist of both residential and commercial real
estate loans. The real estate loan portfolio is well diversified in
terms of borrowers, collateral, interest rates, and maturities.
Also, the real estate loan portfolio has a mix of both fixed rate
and adjustable rate mortgages. The real estate loans are
concentrated primarily in our marketing area and are subject to
risks associated with the local economy.
DEPOSITS AND OTHER BORROWED FUNDS
Consumer and commercial retail deposits are attracted
primarily by First Keystone's subsidiary bank's ten full service
office locations. The Bank offers a broad selection of deposit
products and continually evaluates its interest rates and fees on
deposit products. The Bank regularly reviews competing financial
institutions interest rates along with prevailing market rates,
especially when establishing interest rates on certificates of
deposit.
Deposits increased by $14,936,000, or a 4.4% increase when
comparing December 31, 2004, to December 31, 2003. This increase
compares to a deposit increase of 3.7% in 2003 and an increase of
12.2% in 2002.
During 2004, the Corporation experienced a deposit increase in
both non interest bearing and interest bearing deposits. Non
interest bearing deposits amounted to $35,803,000 as of December
31, 2004, an increase of $5,751,000 over 2003. Interest bearing
deposits amounted to $322,153,000 as of December 31, 2004, an
increase of $9,185,000, or 2.9% over 2003.
During 2004, the Corporation increased its reliance on
borrowings. Short term borrowings amounted to $15,512,000 as of
year end 2004, an increase of $3,768,000 from 2003. Long term
borrowings increased $3,965,000 in 2004 to $66,910,000 as of
December 31, 2004. Total borrowings were $82,422,000 as of December
31, 2004, compared to $74,689,000 on December 31, 2003. Short term
borrowings are comprised of federal funds purchased, securities
sold under agreements to repurchase, U.S. Treasury demand notes,
and short term borrowings from the Federal Home Loan Bank (FHLB).
Long term borrowings are typically FHLB term borrowings with a
maturity of one year or more. Some of the additional term
borrowings were made to take advantage of special rates offered by
the FHLB. In connection with FHLB borrowings and securities sold
under agreements to repurchase, the Corporation maintains certain
eligible assets as collateral.
CAPITAL STRENGTH
Normal increases in capital are generated by net income, less
cash dividends paid out. Also, the net unrealized gains on
investment securities available for sale, net of taxes, increased
shareholders' equity or capital in 2004 and 2003, referred to as
accumulated other comprehensive income. The total net increase in
capital was $1,961,000 in 2004 after an increase of $2,255,000 in
2003. The accumulated other comprehensive income amounted to
$3,767,000 in 2004 and $5,489,000 in 2003. One factor which
decreased total equity capital in 2004 and 2003 relates to stock
repurchase. The Corporation had 148,264 shares of common stock as
of December 31, 2004, and 152,600 shares in 2003, at a cost of
$4,508,000 and $4,655,000, respectively as treasury stock.
Return on equity (ROE) is computed by dividing net income by
average stockholders' equity. This ratio was 12.76% for 2004,
14.27% for 2003, and 14.93% for 2002. Refer to Performance Ratios
on Page 13 - Selected Financial Data for a more expanded listing of
the ROE.
Adequate capitalization of banks and bank holding companies is
required and monitored by regulatory authorities. Table 11 reflects
risk based capital ratios and the leverage ratio for our
Corporation and Bank. The Corporation's leverage ratio was 9.61% at
December 31, 2004, and 9.83% at December 31, 2003.
The Corporation has consistently maintained regulatory capital
ratios at or above the "well capitalized" standards. For additional
information on capital ratios, see Page 6 - Corporations Capital
Ratios or Table 11 - Capital Ratios. The risk based capital ratios
increased somewhat in 2004 from 2003 for both the Corporation and
the Bank, remaining very strong. The risk based capital calculation
assigns various levels of risk to different categories of bank
assets, requiring higher levels of capital for assets with more
risk. Also measured in the risk based capital ratio is credit risk
exposure associated with off balance sheet contracts and
commitments.
23
Table 11 - Capital Ratios
December 31, 2004
_________________
Corporation Bank
__________ ____
Risk-Based Capital:
Tier I risk-based capital ratio 16.23% 14.55%
Total risk-based capital ratio
(Tier 1 and Tier 2) 17.68% 15.80%
Leverage Ratio:
Tier I capital to average assets 9.61% 8.62%
December 31, 2003
_________________
Corporation Bank
__________ ____
Risk-Based Capital:
Tier I risk-based capital ratio 14.82% 13.19%
Total risk-based capital ratio
(Tier 1 and Tier 2) 16.11% 14.34%
Leverage Ratio:
Tier I capital to average assets 9.83% 8.74%
LIQUIDITY MANAGEMENT
Effective liquidity management ensures that the cash flow
requirements of depositors and borrowers, as well as the operating
cash needs of the Corporation, are met.
Liquidity is needed to provide the funding requirements of
depositors withdrawals, loan growth, and other operational needs.
Asset liquidity is provided by investment securities maturing in
one year or less, other short term investments, federal funds sold,
and cash and due from banks. At year end 2004, cash and due from
banks and interest bearing deposits in other banks totaled
$6,186,000 as compared to $5,941,000 at year end 2003.
Additionally, maturing loans and repayment of loans are another
source of asset liquidity.
Liability liquidity is accomplished by maintaining a core
deposit base, acquired by attracting new deposits and retaining
maturing deposits. Also, short term borrowings provide funds to
meet liquidity.
Management feels its current liquidity position is
satisfactory given the fact that the Corporation has a very stable
core deposit base which has increased annually. Secondly, our loan
payments and principal paydowns on our mortgage backed securities
provide a steady source of funds. Also, short term investments and
maturing investments represent additional sources of liquidity.
Finally, the Corporation's subsidiary bank does have access to
funds on a short term basis from the Federal Reserve Bank discount
window. Also, Fed funds can be purchased by means of a borrowing
line at the Atlantic Central Bankers Bank. The Corporation has
indirect access to the capital markets through its membership in
the Federal Home Loan Bank. Advances on borrowings, both short term
and long term, are available to help address any liquidity needs.
FORWARD LOOKING STATEMENTS
The sections that follow, Market Risk and Asset/Liability
Management contain certain forward looking statements. These
forward looking statements involve significant risks and
uncertainties, including changes in economic and financial market
conditions. Although First Keystone Corporation believes that the
expectations reflected in such forward looking statements are
reasonable, actual results may differ materially.
MARKET RISK
Market risk is the risk of loss arising from adverse changes
in the fair value of financial instruments due to changes in
interest rates, exchange rates and equity prices. First Keystone
Corporation's market risk is composed primarily of interest rate
risk. The Corporation's interest rate risk results from timing
differences in the repricing of assets, liabilities, off-balance
sheet instruments, and changes in relationships between ratio
indices and the potential exercise of explicit or embedded options.
Increases in the level of interest rates also may adversely
affect the fair value of the Corporation's securities and other
earning assets. Generally, the fair value of fixed rate instruments
fluctuates inversely with changes in interest rates. As a result,
increases in interest rates could result in decreases in the fair
value of the Corporation's interest earning assets, which could
adversely affect the Corporation's results of operations if sold,
or, in the case of interest earning assets classified as available
for sale, the Corporation's stockholders' equity, if retained.
Under The Financial Accounting Standards Board (FASB) Statement
115, changes in the unrealized gains and losses, net of taxes, on
securities classified as available for sale will be reflected in
the Corporation's stockholders' equity. The Corporation does not
own any trading assets.
24
ASSET/LIABILITY MANAGEMENT
The principal objective of asset liability management is to
manage the sensitivity of the net interest margin to potential
movements in interest rates and to enhance profitability through
returns from managed levels of interest rate risk. The Corporation
actively manages the interest rate sensitivity of its assets and
liabilities. Table 12 presents an interest sensitivity analysis of
assets and liabilities as of December 31, 2004. Several techniques
are used for measuring interest rate sensitivity. Interest rate
risk arises from the mismatches in the repricing of assets and
liabilities within a given time period, referred to as a rate
sensitivity gap. If more assets than liabilities mature or reprice
within the time frame, the Corporation is asset sensitive. This
position would contribute positively to net interest income in a
rising rate environment. Conversely, if more liabilities mature or
reprice, the Corporation is liability sensitive. This position
would contribute positively to net interest income in a falling
rate environment.
Limitations of interest rate sensitivity gap analysis as
illustrated in Table 12 include: a) assets and liabilities which
contractually reprice within the same period may not, in fact,
reprice at the same time or to the same extent; b) changes in
market interest rates do not affect all assets and liabilities to
the same extent or at the same time, and c) interest rate
sensitivity gaps reflect the Corporation's position on a single day
(December 31, 2004 in the case of the following schedule) while the
Corporation continually adjusts its interest sensitivity throughout
the year. The Corporation's cumulative gap at one year is 7.0% of
total assets. At one year, the Corporation is liability sensitive
with the ratio of interest rate sensitive assets to interest rate
sensitive liabilities at .74.
Table 12 - Interest Rate Sensitivity Analysis
(Amounts in thousands)
December 31, 2004
_____________________________
One 1 - 5 Beyond
Year Years 5 Years
______ ______ _____
Assets $ 99,475 $194,429 $188,662
Liabilities/Stockholders Equity 134,266 166,454 112,195
________ ________ ________
Interest Rate Sensitivity Gap (34,791) 27,975 76,467
Cumulative Gap (34,791) (6,816) 69,651
(Amounts in thousands)
December 31, 2004
_____________________________
Not Rate
Sensitive Total
______ ______
Assets $15,049 $497,615
Liabilities/Stockholders Equity 84,700 497,615
Interest Rate Sensitivity Gap
Cumulative Gap
EARNINGS AT RISK
The Bank's Asset/Liability Committee (ALCO) is responsible for
reviewing the interest rate sensitivity position and establishing
policies to monitor and limit exposure to interest rate risk. The
guidelines established by ALCO are reviewed by the Corporation's
Board of Directors. The Corporation recognizes that more
sophisticated tools exist for measuring the interest rate risk in
the balance sheet beyond interest rate sensitivity gap. Although
the Corporation continues to measure its interest rate sensitivity
gap, the Corporation utilizes additional modeling for interest rate
risk in the overall balance sheet. Earnings at risk and economic
values at risk are analyzed.
Earnings simulation modeling addresses earnings at risk and
net present value estimation addresses economic value at risk.
While each of these interest rate risk measurements has
limitations, taken together they represent a reasonably
comprehensive view of the magnitude of interest rate risk in the
Corporation.
EARNINGS SIMULATION MODELING
The Corporation's net income is affected by changes in the
level of interest rates. Net income is also subject to changes in
the shape of the yield curve. For example, a flattening of the
yield curve would result in a decline in earnings due to the
compression of earning asset yields and funds rates, while a
steepening would result in increased earnings as investment margins
widen.
25
Earnings simulation modeling is the primary mechanism used in
assessing the impact of changes in interest rates on net interest
income. The model reflects management's assumptions related to
asset yields and rates paid on liabilities, deposit sensitivity,
size and composition of the balance sheet. The assumptions are
based on what management believes at that time to be the most
likely interest rate environment. Earnings at risk is the change in
net interest income from a base case scenario under an increase and
decrease of 200 basis points in the interest rate earnings
simulation model.
Table 13 presents an analysis of the changes in net interest
income and net present value of the balance sheet resulting from an
increase or decrease of two percentage points (200 basis points) in
the level of interest rates. The calculated estimates of change in
net interest income and net present value of the balance sheet are
compared to current limits approved by ALCO and the Board of
Directors. The earnings simulation model projects net interest
income would increase by approximately .6% if rates fell by two
percentage points over one year. The model projects a decrease of
approximately 6.5% in net interest income if rates rise by two
percentage points over one year. Both of these forecasts are within
the one year policy guidelines.
Net Present Value Estimation
The net present value measures economic value at risk and is
used for helping to determine levels of risk at a point in time
present in the balance sheet that might not be taken into account
in the earnings simulation model. The net present value of the
balance sheet is defined as the discounted present value of asset
cash flows minus the discounted present value of liability cash
flows. At year end, a 200 basis point immediate decrease in rates
is estimated to increase net present value by .4%. Additionally,
net present value is projected to decrease by 18.8% if rates
increase immediately by 200 basis points, both within policy
guidelines. If management is concerned market interest rates may
begin to rise in 2005, it can take steps to reduce liability
sensitivity by attracting long term deposits and reducing short
term borrowings.
The computation of the effects of hypothetical interest rate
changes are based on many assumptions. They should not be relied
upon solely as being indicative of actual results, since the
computations do not contemplate actions management could undertake
in response to changes in interest rates.
Table 13 - Effect of Change in Interest Rates
Projected Change
________________
Effect on Net Interest Income
1-year Net Income simulation Projection
-200 bp Shock vs Stable Rate .6%
+200 bp Shock vs Stable Rate (6.5%)
Effect on Net Present Value of Balance Sheet
Static Net Present Value Change
-200 bp Shock vs Stable Rate .4%
+200 bp Shock vs Stable Rate (18.8%)
MARKET PRICE/DIVIDEND HISTORY
As of December 31, 2004, the corporation had 4,391,309 shares
of $2.00 par value common stock outstanding held by shareholders of
record. First Keystone Corporation's common stock is quoted on the
Over The Counter (OTC) Bulletin Board under the symbol "FKYS".
Table 14 reports the highest and lowest per share prices known
to the Corporation and the dividends paid during the periods
indicated. The market prices and dividend paid have been adjusted
to reflect a 3 for 2 stock split in the form of a 50% stock
dividend paid May 11, 2004, and a 5% stock dividend paid August 6,
2002. These prices do not necessarily reflect any dealer or retail
markup, markdown or commission.
26
Table 14 - Market Price/Dividend History
2004
_________________________
Common Stock Dividends
High/Low Paid
_______ ____
First Quarter $25.50/$24.00 $.17
Second Quarter $25.50/$24.25 .18
Third Quarter $24.50/$22.75 .18
Fourth Quarter $23.25/$21.90 .20
2003
_________________________
Common Stock Dividends
High/Low Paid
_______ ____
First Quarter $20.77/$17.17 $.16
Second Quarter $21.67/$19.50 .16
Third Quarter $22.67/$21.33 .16
Fourth Quarter $24.33/$22.50 .17
2002
_________________________
Common Stock Dividends
High/Low Paid
_______ ____
First Quarter $15.24/$12.38 $.133
Second Quarter $14.92/$13.40 .133
Third Quarter $16.00/$12.79 .14
Fourth Quarter $17.50/$15.97 .16
Table 15 - Quarterly Results of Operations (Unaudited)
(Amounts in thousands, except per share)
Three Months Ended
______________________________________
2004 March June September December
31 30 30 31
_____ ____ ________ _______
Interest income $6,261 $6,246 $6,333 $6,196
Interest expense 2,427 2,444 2,517 2,618
Net interest income $3,834 $3,802 $3,816 $3,578
Provision for loan
losses 150 125 675 800
Other non-interest
income 943 949 1,313 1,391
Non-interest expense 2,255 2,368 2,266 2,538
______ ______ ______ ______
Income before income
taxes $2,372 $2,258 $2,188 $1,631
Income taxes 516 470 398 278
______ ______ ______ ______
Net income $1,856 $1,788 $1,790 $1,353
Per share $ .42 $ .41 $ .41 $ .31
2003 March June September December
31 30 30 31
_____ ____ ________ _______
Interest income $6,257 $6,185 $6,231 $6,390
Interest expense 2,592 2,575 2,575 2,458
______ ______ ______ ______
Net interest income $3,665 $3,610 $3,656 $3,932
Provision for loan
losses 150 125 75 150
Other non-interest
income 745 909 844 777
Non-interest expense 2,019 2,030 2,100 2,222
______ ______ ______ ______
Income before income
taxes $2,241 $2,364 $2,325 $2,337
Income taxes 463 507 491 489
______ ______ ______ ______
Net income $1,778 $1,857 $1,834 $1,848
====== ====== ====== ======
Per share $ .40 $ .42 $ .41 $ .42
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Information with respect to quantitative and qualitative
disclosures about market risk is included in the information under
Management's Discussion and Analysis in Item 7 hereof.
27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
_______________________________________________________
BOARD OF DIRECTORS AND STOCKHOLDERS OF FIRST KEYSTONE CORPORATION:
We have audited the accompanying consolidated balance sheets
of First Keystone Corporation and Subsidiary as of December 31,
2004 and 2003, and the related consolidated statements of income,
changes in stockholders' equity, and cash flows for each of the
years in the three year period ended December 31, 2004. These
consolidated financial statements are the responsibility of the
Corporation'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 the standards of
the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the consolidated financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the
overall consolidated financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the consolidated
financial position of First Keystone Corporation and Subsidiary as
of December 31, 2004 and 2003, and the consolidated results of
their operations and their cash flows for each of the years in the
three-year period ended December 31, 2004, in conformity with
accounting principles generally accepted in the United States of
America.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States) the
effectiveness of First Keystone Corporation and Subsidiary's
internal control over financial reporting as of December 31, 2004,
based on criteria established in Internal Control Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO) and our report dated January 24,
2005, expressed our unqualified opinion of management's assessment
of internal control over financial reporting and an unqualified
opinion on the effectiveness of the internal control over financial
reporting.
/s/ J. H. Williams & Co., LLP
J. H. Williams & Co., LLP
Kingston, Pennsylvania
January 24, 2005
28
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
____________________________________________________________________
(Amounts in thousands except share data)
December 31,
____________________
2004 2003
ASSETS
Cash and due from banks $ 6,150 $ 5,913
Interest-bearing deposits in
other banks 36 28
Investment securities
available-for-sale 235,692 226,043
Investment securities held-to-
maturity (estimated fair value
2004 - $3,364; 2003 - $5,229) 3,361 5,229
Loans, net of unearned income 233,800 229,073
Allowance for loan losses (3,828) (3,524)
________ ________
Net loans $229,972 $225,549
________ ________
Premises and equipment, net 5,369 4,158
Accrued interest receivable 2,727 2,871
Cash surrender value of bank owned
life insurance 11,033 10,587
Goodwill 1,224 -
Other assets 2,051 1,462
________ ________
TOTAL ASSETS $497,615 $481,840
======== ========
LIABILITIES
Deposits:
Non-interest bearing $ 35,803 $ 30,052
Interest bearing 322,153 312,968
________ ________
Total Deposits 357,956 343,020
Short-term borrowings 15,512 11,744
Long-term borrowings 66,910 62,945
Accrued interest and other expenses 1,877 1,664
Pre-settlement advance on
acquisition of branch - 8,715
Other liabilities 2,048 2,401
________ ________
TOTAL LIABILITIES $444,303 $430,489
________ ________
STOCKHOLDERS' EQUITY
Preferred stock, par value $10.00
per share; authorized and
unissued 500,000 shares $ - $ -
Common stock, par value $2.00 per
share; authorized 10,000,000
shares; issued 4,539,573 shares
in 2004 and 3,077,207 shares in 2003 9,079 6,154
Surplus 12,505 12,535
Retained earnings 32,469 31,828
Accumulated other comprehensive income 3,767 5,489
Treasury stock, at cost, 148,264
shares in 2004 and 152,600 shares
in 2003 (4,508) (4,655)
________ ________
TOTAL STOCKHOLDERS' EQUITY $ 53,312 $ 51,351
________ ________
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $497,615 $481,840
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
29
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
____________________________________________________________________
(Amounts in thousands, except per share data)
Year Ended December 31,
______________________
2004 2003
INTEREST INCOME
Interest and fees on loans $14,527 $14,352
Interest and dividends on
investment securities:
Taxable 7,132 7,513
Tax-exempt 3,072 2,882
Dividends 246 284
Deposits in banks 59 32
_______ _______
Total interest income $25,036 $25,063
_______ _______
INTEREST EXPENSE
Deposits $ 6,908 $ 7,469
Short-term borrowings 166 143
Long-term borrowings 2,932 2,588
_______ _______
Total interest expense $10,006 $10,200
_______ _______
Net interest income $15,030 $14,863
Provision for loan losses 1,750 500
_______ _______
Net interest income after
provision for loan losses $13,280 $14,363
_______ _______
NON-INTEREST INCOME
Trust department $ 525 $ 486
Service charges and fees 2,249 1,724
Bank owned life insurance income 446 485
Gain on sale of loans 221 234
Investment securities gains
(losses) - net 1,080 299
Other 75 47
_______ _______
Total non-interest income $ 4,596 $ 3,275
NON-INTEREST EXPENSE
Salaries and employee benefits $ 4,882 $ 4,446
Occupancy, net 656 567
Furniture and equipment 782 643
Professional services 502 372
State shares tax 447 407
Other 2,157 1,936
_______ _______
Total non-interest expense $ 9,426 $ 8,371
_______ _______
Income before income taxes $ 8,450 $ 9,267
Income tax expense 1,663 1,950
_______ _______
NET INCOME $ 6,787 $ 7,317
======= =======
PER SHARE DATA
Net income per share:*
Basic $1.55 $1.66
Diluted $1.54 $1.65
Cash dividends per share* $.73 $.65
(Amounts in thousands, except per share data)
Year Ended December 31,
______________________
2002
INTEREST INCOME
Interest and fees on loans $14,963
Interest and dividends on
investment securities:
Taxable 7,892
Tax-exempt 2,608
Dividends 321
Deposits in banks 78
_______
Total interest income $25,862
INTEREST EXPENSE
Deposits $ 8,117
Short-term borrowings 147
Long-term borrowings 3,078
_______
Total interest expense $11,342
_______
Net interest income $14,520
Provision for loan losses 550
_______
Net interest income after
provision for loan losses $13,970
_______
NON-INTEREST INCOME
Trust department $ 510
Service charges and fees 1,373
Bank owned life insurance income 102
Gain on sale of loans 228
Investment securities gains
(losses) - net 29
Other 43
_______
Total non-interest income $ 2,285
NON-INTEREST EXPENSE
Salaries and employee benefits $ 4,222
Occupancy, net 486
Furniture and equipment 616
Professional services 290
State shares tax 367
Other 1,830
_______
Total non-interest expense $ 7,811
_______
Income before income taxes $ 8,444
Income tax expense 1,857
_______
NET INCOME $ 6,587
=======
PER SHARE DATA
Net income per share:*
Basic $ 1.48
Diluted $ 1.48
Cash dividends per share* $ .57
*Adjusted for 5% stock dividend declared June 25, 2002, to shareholders of
record July 16, 2002, distributed August 6, 2002 and for a 3 for 2 stock
split in the form of a 50% stock dividend declared April 13, 2004, to
shareholders of record April 27, 2004, distributed May 11, 2004.
The accompanying notes are an integral part of these consolidated financial
statements.
30
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
____________________________________________________________________
(Amounts in thousands)
Common
Stock Surplus
_____ ______
Balance At December 31, 2001 $5,867 $ 9,761
Comprehensive Income:
Net income
Change in net unrealized
gain (loss) on investment
securities available-for-sale,
net of reclassification
adjustment and tax effects
Total comprehensive income
5% stock dividend 283 2,829
Dividends paid in lieu
of fractional shares
Purchase of 20,181 shares
of treasury stock
Issuance of 1,000 shares of
treasury stock upon exercise
of employee stock options (6)
Cash dividends - $.85 per share
______ _______
Balance At December 31, 2002 $6,150 $12,584
Comprehensive Income:
Net income
Change in net unrealized
gain (loss) on investment
securities available-for-sale,
net of reclassification
adjustment and tax effects
Total comprehensive income
Purchase of 41,987 shares
of treasury stock
Issuance of 2,027 shares of
common stock under
dividend reinvestment 4 48
Issuance of 8,568 shares of
treasury stock upon exercise
of employee stock options (145)
Recognition of stock option expense 48
Cash dividends - $.98 per share
______ _______
Balance At December 31, 2003 $6,154 $12,535
Comprehensive Income:
Net income
Change in net unrealized
gain (loss) on investment
securities available-for-sale,
net of reclassification
adjustment and tax effects
Total comprehensive income
3 for 2 stock split in the form of
a 50% stock dividend 2,925
Cash paid in lieu of fractional
shares
Issuance of 4,336 shares of
treasury stock upon exercise
of employee stock options (78)
Recognition of stock option expense 48
Cash dividends - $.73 per share
______ _______
Balance At December 31, 2004 $9,079 $12,505
====== =======
(Amounts in thousands)
Comprehensive Retained
Income Earnings
______ ________
Balance At December 31, 2001 $26,450
Comprehensive Income:
Net income $6,587 6,587
Change in net unrealized
gain (loss) on investment
securities available-for-sale,
net of reclassification
adjustment and tax effects 5,829
______
Total comprehensive income $12,416
=======
5% stock dividend (3,112)
Dividends paid in lieu
of fractional shares (5)
Purchase of 20,181 shares
of treasury stock
Issuance of 1,000 shares of
treasury stock upon exercise
of employee stock options
Cash dividends - $.85 per share (2,525)
_______
Balance At December 31, 2002 $27,395
Comprehensive Income:
Net income $7,317 7,317
Change in net unrealized
gain (loss) on investment
securities available-for-sale,
sale, net of reclassification
adjustment and tax effects (1,055)
______
Total comprehensive income $6,262
======
Purchase of 41,987 shares
of treasury stock
Issuance of 2,027 shares of
common stock under
dividend reinvestment
Issuance of 8,568 shares of
treasury stock upon exercise
of employee stock options
Recognition of stock option expense
Cash dividends - $.98 per share (2,884)
_______
Balance At December 31, 2003 $31,828
Comprehensive Income:
Net income $6,787 6,787
Change in net unrealized
gain (loss) on investment
securities available-for-sale,
net of reclassification
adjustment and tax effects (1,722)
______
Total comprehensive income $5,065
======
3 for 2 stock split in the form of
a 50% stock dividend (2,925)
Cash paid in lieu of fractional
shares (3)
Issuance of 4,336 shares of
treasury stock upon exercise
of employee stock options
Recognition of stock option expense
Cash dividends - $.73 per share (3,218)
_______
Balance At December 31, 2004 $32,469
=======
(Amounts in thousands) Accumulated
Other
Comprehensive Treasury
Income Stock
_______ _____
Balance At December 31, 2001 $ 715 $(3,097)
Comprehensive Income:
Net income
Change in net unrealized
gain (loss) on investment
securities available-for-sale,
sale, net of reclassification
adjustment and tax effects 5,829
Total comprehensive income
5% stock dividend
Dividends paid in lieu
of fractional shares
Purchase of 20,181 shares
of treasury stock (504)
Issuance of 1,000 shares of
treasury stock upon exercise
of employee stock options 24
Cash dividends - $.85 per share
______ _______
Balance At December 31, 2002 $6,544 $(3,577)
Comprehensive Income:
Net income
Change in net unrealized
gain (loss) on investment
securities available-for-sale,
net of reclassification
adjustment and tax effects (1,055)
Total comprehensive income
Purchase of 41,987 shares
of treasury stock (1,374)
Issuance of 2,027 shares of
common stock under
dividend reinvestment
Issuance of 8,568 shares of
treasury stock upon exercise
of employee stock options 296
Recognition of stock option expense
Cash dividends - $.98 per share
______ _______
Balance At December 31, 2003 $5,489 $(4,655)
Comprehensive Income:
Net income
Change in net unrealized
gain (loss) on investment
securities available-for-sale,
net of reclassification
adjustment and tax effects (1,722)
Total comprehensive income
3 for 2 stock split in the form of
a 50% stock dividend
Cash paid in lieu of fractional
shares
Issuance of 4,336 shares of
treasury stock upon exercise
of employee stock options 147
Recognition of stock option expense
Cash dividends - $.73 per share
______ _______
Balance At December 31, 2004 $3,767 $(4,508)
====== =======
(Amounts in thousands)
Total
____
Balance At December 31, 2001 $39,696
Comprehensive Income:
Net income 6,587
Change in net unrealized
gain (loss) on investment
securities available-for-sale,
net of reclassification
adjustment and tax effects 5,829
Total comprehensive income
5% stock dividend --
Dividends paid in lieu
of fractional shares (5)
Purchase of 20,181 shares
of treasury stock (503)
Issuance of 1,000 shares of
treasury stock upon exercise
of employee stock options 17
Cash dividends - $.85 per share (2,525)
_______
Balance At December 31, 2002 $49,096
Comprehensive Income:
Net income 7,317
Change in net unrealized
gain (loss) on investment
securities available-for-sale,
net of reclassification
adjustment and tax effects (1,055)
Total comprehensive income
Purchase of 41,987 shares
of treasury stock (1,374)
Issuance of 2,027 shares of
common stock under
dividend reinvestment 52
Issuance of 8,568 shares of
treasury stock upon exercise
of employee stock options 151
Recognition of stock option expense 48
Cash dividends - $.98 per share (2,884)
_______
Balance At December 31, 2003 $51,351
Comprehensive Income:
Net income 6,787
Change in net unrealized
gain (loss) on investment
securities available-for-sale,
net of reclassification
adjustment and tax effects (1,722)
Total comprehensive income
3 for 2 stock split in the form of
a 50% stock dividend
Cash paid in lieu of fractional
shares (3)
Issuance of 4,336 shares of
treasury stock upon exercise
of employee stock options 69
Recognition of stock option expense 48
Cash dividends - $.73 per share (3,218)
_______
Balance At December 31, 2004 $53,312
=======
The accompanying notes are an integral part of these consolidated financial
statements.
31
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
____________________________________________________________________
(Amounts in thousands) Year Ended December 31,
_______________________
2004 2003
OPERATING ACTIVITIES
Net income $ 6,787 $ 7,317
Adjustments to reconcile net income
to net cash provided by
operating activities:
Provision for loan losses 1,750 500
Depreciation and amortization 666 491
Stock option expense 48 48
Premium amortization on
investment securities 787 1,128
Discount accretion on
investment securities (350) (451)
Core deposit discount accretion
net of amortization (96) -
Deferred income tax benefit (154) (116)
Gain on sale of mortgage loans (221) (234)
Proceeds from sale of mortgage
loans originated for resale 13,543 14,800
Originations of mortgage loans
held for resale (6,137) (17,377)
Gain on sales of investment
securities (1,080) (299)
Loss on sale of foreclosed real
estate - 15
(Increase) decrease in accrued
interest receivable 144 198
Increase in cash surrender value
of bank owned life insurance (446) (485)
Increase in other assets - net (560) (157)
Increase (decrease) in accrued
interest and other expenses 213 16
Increase (decrease) in other
liabilities - net - (214)
________ ________
NET CASH PROVIDED BY OPERATING
ACTIVITIES $ 14,894 $ 5,180
________ ________
INVESTING ACTIVITIES
Proceeds from sales of investment
securities available-for-sale $ 68,654 $ 38,223
Proceeds from maturities and
redemptions of investment
securities available-for-sale 30,237 47,828
Purchases of investment securities
available-for-sale (108,877) (104,588)
Proceeds from maturities and
redemption of investment
securities held-to-maturity 252 1,097
Proceeds from sales of investment
securities held-to-maturity 2,199 -
Purchases of investment securities
held-to-maturity (1,630) -
Net increase in loans (13,358) (25,023)
Purchases of premises and equipment (885) (1,154)
Final settlement on acquisition of
branch (414) -
Pre-settlement advance on acquisition
of branch - 8,715
Proceeds from sale of foreclosed
real estate - 114
Purchase of bank owned life insurance
policies - -
________ ________
NET CASH (USED IN) INVESTING
ACTIVITIES $(23,822) $(34,788)
________ ________
FINANCING ACTIVITIES
Net increase in deposits $ 4,592 $ 12,275
Net increase (decrease) in
short-term borrowings 3,768 2,678
Proceeds from long-term borrowings 7,500 18,695
Repayment of long-term borrowings (3,535) (1,500)
Cash paid in lieu of fractional shares (3) -
Proceeds from issuance of common stock - 52
Proceeds from sale of treasury stock 69 151
Acquisition of treasury stock - (1,374)
Cash dividends paid (3,218) (2,884)
________ ________
NET CASH PROVIDED BY FINANCING
ACTIVITIES $ 9,173 $ 28,093
________ ________
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS $ 245 $ (1,515)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 5,941 7,456
________ ________
CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 6,186 $ 5,941
======== ========
(Amounts in thousands) Year Ended December 31,
______________________
2002
OPERATING ACTIVITIES
Net income $ 6,587
Adjustments to reconcile net income
to net cash provided by
operating activities:
Provision for loan losses 550
Depreciation and amortization 446
Stock option expense -
Premium amortization on
investment securities 557
Discount accretion on
investment securities (567)
Core deposit discount accretion
net of amortization -
Deferred income tax benefit (80)
Gain on sale of mortgage loans (228)
Proceeds from sale of mortgage
loans originated for resale 8,322
Originations of mortgage loans
held for resale (10,523)
Gain on sales of investment
securities (29)
Loss on sale of foreclosed real
estate 5
(Increase) decrease in accrued
interest receivable (75)
Increase in cash surrender value
of bank owned life insurance (102)
Increase in other assets - net (304)
Increase (decrease) in accrued
interest and other expenses (434)
Increase (decrease) in other
liabilities - net 128
________
NET CASH PROVIDED BY OPERATING
ACTIVITIES $ 4,253
________
INVESTING ACTIVITIES
Proceeds from sales of investment
securities available-for-sale $ 46,732
Proceeds from maturities and
redemptions of investment
securities available-for-sale 27,015
Purchases of investment securities
available-for-sale (96,558)
Proceeds from maturities and
redemption of investment
securities held-to-maturity 1,036
Proceeds from sales of investment
securities held-to-maturity -
Purchases of investment securities
held-to-maturity (983)
Net increase in loans (1,193)
Purchases of premises and equipment (545)
Final settlement on acquisition of
branch -
Pre-settlement advance on acquisition
of branch -
Proceeds from sale of foreclosed
real estate 100
Purchase of bank owned life insurance
policies (10,000)
________
NET CASH (USED IN) INVESTING
ACTIVITIES $(34,396)
________
FINANCING ACTIVITIES
Net increase in deposits $ 36,065
Net increase (decrease) in
short-term borrowings (2,499)
Proceeds from long-term borrowings 8,000
Repayment of long-term borrowings (7,500)
Cash paid in lieu of fractional shares (5)
Proceeds from issuance of common stock -
Proceeds from sale of treasury stock 17
Acquisition of treasury stock (504)
Cash dividends paid (2,525)
________
NET CASH PROVIDED BY FINANCING
ACTIVITIES $ 31,049
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS $ 906
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 6,550
________
CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 7,456
========
The accompanying notes are an integral part of these consolidated financial
statements.
32
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2004, 2003 AND 2002
________________________________________________________________
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting policies of First Keystone Corporation and
Subsidiary (the "Corporation") are in accordance with accounting
principles generally accepted in the United States of America and
conform to common practices within the banking industry. The more
significant policies follow:
Principles of Consolidation
The consolidated financial statements include the accounts of
First Keystone Corporation and its wholly owned Subsidiary, The
First National Bank of Berwick (the "Bank"). All significant inter
company balances and transactions have been eliminated in
consolidation.
NATURE OF OPERATIONS
The Corporation, headquartered in Berwick, Pennsylvania,
provides a full range of banking, trust and related services
through its wholly owned Bank subsidiary and is subject to
competition from other financial institutions in connection with
these services. The Bank serves a customer base which includes
individuals, businesses, public and institutional customers
primarily located in the Northeast Region of Pennsylvania. The Bank
has 10 full service offices and 14 ATMs located in Columbia,
Luzerne and Montour Counties. The Corporation and its subsidiary
must also adhere to certain federal banking laws and regulations
and are subject to periodic examinations made by various federal
agencies.
SEGMENT REPORTING
The Corporation's banking subsidiary acts as an independent
community financial services provider, and offers traditional
banking and related financial services to individual, business and
government customers. Through its branch and automated teller
machine network, the Bank offers a full array of commercial and
retail financial services, including the taking of time, savings
and demand deposits; the making of commercial, consumer and
mortgage loans; and the providing of other financial services. The
Bank also performs personal, corporate, pension and fiduciary
services through its Trust Department.
Management does not separately allocate expenses, including
the cost of funding loan demand, between the commercial, retail,
trust and mortgage banking operations of the Corporation.
Currently, management measures the performance and allocates the
resources of First Keystone Corporation as a single segment.
USE OF ESTIMATES
The preparation of these consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America, requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of these consolidated financial statements and the
reported amounts of income and expenses during the reporting
periods. Actual results could differ from those estimates.
INVESTMENT SECURITIES
The Corporation classifies its investment securities as either
"Held to Maturity" or "Available for Sale" at the time of purchase.
Debt securities are classified as Held to Maturity when the
Corporation has the ability and positive intent to hold the
securities to maturity. Investment securities Held to Maturity are
carried at cost adjusted for amortization of premium and accretion
of discount to maturity.
Debt securities not classified as Held to Maturity and equity
securities are included in the Available for Sale category and are
carried at fair value. The amount of any unrealized gain or loss,
net of the effect of deferred income taxes, is reported as other
comprehensive income (loss) in the Consolidated Statement of
Stockholders' Equity. Management's decision to sell Available for
Sale securities is based on changes in economic conditions
controlling the sources and applications of funds, terms,
availability of and yield of alternative investments, interest rate
risk and the need for liquidity.
33
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2004, 2003 AND 2002 - CONTINUED
________________________________________________________________
The cost of debt securities classified as Held to Maturity or
Available for Sale is adjusted for amortization of premiums and
accretion of discounts to expected maturity. Such amortization and
accretion, as well as interest and dividends is included in
interest income from investments. Realized gains and losses are
included in net investment securities gains and losses. The cost of
investment securities sold, redeemed or matured is based on the
specific identification method.
LOANS
Loans are stated at their outstanding unpaid principal
balances, net of deferred fees or costs, unearned income and the
allowance for loan losses. Interest on installment loans is
recognized as income over the term of each loan, generally, by the
"actuarial method". Interest on all other loans is primarily
recognized based upon the principal amount outstanding on an actual
day basis. Loan origination fees and certain direct loan
origination costs have been deferred with the net amount amortized
using the interest method over the contractual life of the related
loans as an interest yield adjustment.
Mortgage loans held for resale are carried at the lower of
cost or market on an aggregate basis. These loans are sold without
recourse to the Corporation.
Past-Due Loans - Generally, a loan is considered to be past due
when scheduled loan payments are in arrears 15 days or more.
Delinquent notices are generated automatically when a loan is 15
days past due, depending on the type of loan. Collection efforts
continue on loans past due beyond 60 days that have not been
satisfied, when it is believed that some chance exists for
improvement in the status of the loan. Past due loans are
continually evaluated with the determination for charge off being
made when no reasonable chance remains that the status of the loan
can be improved.
Non-Accrual Loans - Generally, a loan is classified as non accrual
and the accrual of interest on such a loan is discontinued when the
contractual payment of principal or interest has become 90 days
past due or management has serious doubts about further
collectibility of principal or interest, even though the loan
currently is performing. A loan may remain on accrual status if it
is in the process of collection and is either guaranteed or well
secured. When a loan is placed on non accrual status, unpaid
interest credited to income in the current year is reversed and
unpaid interest accrued in prior years is charged against the
allowance for loan losses. Certain non accrual loans may continue
to perform, that is, payments are still being received. Generally,
the payments are applied to principal. These loans remain under
constant scrutiny and if performance continues, interest income may
be recorded on a cash basis based on management's judgement as to
collectibility of principal.
Allowance for Loan Losses - The allowance for loan losses is
established through provisions for loan losses charged against
income. Loans deemed to be uncollectible are charged against the
allowance for loan losses and subsequent recoveries, if any, are
credited to the allowance.
A principal factor in estimating the allowance for loan losses
is the measurement of impaired loans. A loan is considered impaired
when, based on current information and events, it is probable that
the Corporation will be unable to collect all amounts due according
to the contractual terms of the loan agreement. Under current
accounting standards, the allowance for loan losses related to
impaired loans is based on discounted cash flows using the
effective interest rate of the loan or the fair value of the
collateral for certain collateral dependent loans.
The allowance for loan losses is maintained at a level
estimated by management to be adequate to absorb potential loan
losses. Management's periodic evaluation of the adequacy of the
allowance for loan losses is based on the Corporation's past loan
loss experience, known and inherent risks in the portfolio, adverse
situations that may affect the borrower's ability to repay
(including the timing of future payments), the estimated value of
any underlying collateral, composition of the loan portfolio,
current economic conditions, and other relevant factors. This
evaluation is inherently subjective as it requires material
estimates including the amounts and timing of future cash flows
expected to be received on impaired loans that may be susceptible
to significant change.
34
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2004, 2003 AND 2002 - CONTINUED
________________________________________________________________
DERIVATIVES
The Bank has outstanding loan commitments that relate to the
origination of mortgage loans that will be held for resale.
Pursuant to Statement of Financial Accounting Standards (SFAS) No.
133, "Accounting for Derivative Instruments and Hedging Activities"
as amended by SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities" and the guidance
contained within the Derivatives Implementation Group Statement 133
Implementation Issue No. C 13, the Bank has accounted for such loan
commitments as derivative instruments. The outstanding loan
commitments in this category did not give rise to any losses for
the years ended December 31, 2004 and 2003, as the fair market
value of each outstanding loan commitment exceeded the Bank's cost
basis in each outstanding loan commitment.
PREMISES AND EQUIPMENT
Premises, improvements and equipment are stated at cost less
accumulated depreciation computed principally on the straight line
method over the estimated useful lives of the assets. Long lived
assets are reviewed for impairment whenever events or changes in
business circumstances indicate that the carrying value may not be
recovered. Maintenance and minor repairs are charged to operations
as incurred. The cost and accumulated depreciation of the premises
and equipment retired or sold are eliminated from the property
accounts at the time of retirement or sale, and the resulting gain
or loss is reflected in current operations.
MORTGAGE SERVICING RIGHTS
The Corporation originates and sells real estate loans to
investors in the secondary mortgage market. After the sale, the
Corporation may retain the right to service these loans. When
originated mortgage loans are sold and servicing is retained, a
servicing asset is capitalized based on relative fair value at the
date of sale. Servicing assets are amortized as an offset to other
fees in proportion to, and over the period of, estimated net
servicing income. The unamortized cost is included in other assets
in the accompanying consolidated balance sheet. The servicing
rights are periodically evaluated for impairment based on their
relative fair value.
FORECLOSED REAL ESTATE
Real estate properties acquired through, or in lieu of, loan
foreclosure are held for sale and are initially recorded at fair
value on the date of foreclosure establishing a new cost basis.
After foreclosure, valuations are periodically performed by
management and the real estate is carried at the lower of carrying
amount or fair value less cost to sell and is included in other
assets. Revenues derived from and costs to maintain the assets and
subsequent gains and losses on sales are included in other non
interest income and expense.
BANK OWNED LIFE INSURANCE
The Corporation invests in Bank Owned Life Insurance (BOLI)
with split dollar life provisions. Purchase of BOLI provides life
insurance coverage on certain employees with the Corporation being
owner and beneficiary of the policies.
INVESTMENTS IN REAL ESTATE VENTURES
The Bank is a limited partner in real estate ventures that
own and operate affordable residential low income housing apartment
buildings for elderly residents. The investments are accounted for
under the effective yield method under the Emerging Issues Task
Force (EITF) 94-1, "Accounting for Tax Benefits Resulting from
Investments in Affordable Housing Projects". Under the effective
yield method, the Bank recognizes tax credits as they are allocated
and amortizes the initial cost of the investment to provide a
constant effective yield over the period that the tax credits are
allocated to the Bank. Under this method, the tax credits
allocated, net of any amortization of the investment in the limited
partnerships, are recognized in the consolidated statements of
income as a component of income tax expense. The amount of tax
credits allocated to the Bank were $128,000, $91,000 and $81,000 in
2004, 2003 and 2002, respectively, and the amortization of the
investments in the limited partnerships were $92,000, $66,000 and
$55,000 in 2004, 2003 and 2002, respectively. The carrying value
of the investments as of December 31, 2004, and 2003, was $790,000
and $882,000, respectively, and is carried in Other Assets in the
accompanying consolidated balance sheets.
35
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2004, 2003 AND 2002 - CONTINUED
________________________________________________________________
INCOME TAXES
The provision for income taxes is based on the results of
operations, adjusted primarily for tax exempt income. Certain items
of income and expense are reported in different periods for
financial reporting and tax return purposes. Deferred tax assets
and liabilities are determined based on the differences between the
consolidated financial statement and income tax bases of assets and
liabilities measured by using the enacted tax rates and laws
expected to be in effect when the timing differences are expected
to reverse. Deferred tax expense or benefit is based on the
difference between deferred tax asset or liability from period to
period.
GOODWILL, OTHER INTANGIBLE ASSETS, AND PREMIUM DISCOUNT
Goodwill resulted from the acquisition of certain fixed and
operating assets acquired and deposit liabilities assumed of the
branch of another financial institution in Danville, Pennsylvania,
in January 2004. Such goodwill represents the excess cost of the
acquired assets relative to the assets fair value at the date of
acquisition. The Corporation accounts for goodwill pursuant to the
Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Intangible Assets". SFAS No. 142 includes
requirements to test goodwill for impairments rather than to
amortize goodwill. The Corporation has tested the goodwill
included in its consolidated balance sheet at December 31, 2004,
and has determined there was no impairment as of that date.
Intangible assets are comprised of core deposit intangibles
and premium discount (negative premium) on acquired certificates of
deposit acquired in January 2004 when the Bank assumed deposit
accounts of the branch of another financial institution. The core
deposit intangible is being amortized over the average life of the
deposits acquired as determined by an independent third party.
Premium discount (negative premium) on acquired certificates of
deposit resulted from the valuation of certificate of deposit
accounts by an independent third party which were part of the
deposit accounts assumed of the branch by another financial
institution. The book value of certificates of deposit acquired
was greater than their fair value at the date of acquisition which
resulted in a negative premium due to higher cost of the
certificates of deposit compared to the cost of similar term
financing.
STOCK BASED COMPENSATION
The Corporation had accounted for stock options and shares
issued under the Stock Option Incentive Plan through December 31,
2002 in accordance with Accounting Principles Board Opinion (APB)
No. 25, "Accounting for Stock Issued to Employees". Under this
method no compensation expense is recognized for stock options when
the exercise price equals the fair value of the options at the
grant date. Under provisions of Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock Based
Compensation", the fair value of a stock option is required to be
recognized as compensation expense over the service period
(generally the vesting period). As permitted under SFAS No. 123,
"Accounting for Stock Based Compensation", the fair value of a
stock option is required to be recognized as compensation expense
over the service period (generally the vesting period). As
permitted under SFAS No. 123 the Corporation had elected to
continue to account for its stock option plan in accordance with
APB No. 25.
As of the first quarter 2003, the Corporation adopted
Statement of Financial Accounting Standards (SFAS) No. 148,
"Accounting for Stock Based Compensation - Transition and
Disclosures - an amendment of FASB Statement No. 123". The
Corporation elected to use the "prospective method" of accounting
for stock options as allowed by the Standard. Accordingly,
compensation expense was recognized in 2004 and 2003 in the amount
of $48,000 being the vested portion attributable to stock options
granted in 2003 (See Note 20).
PER SHARE DATA
Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings Per Share", requires dual presentation of basic and fully
diluted earnings per share. Basic earnings per share is calculated
by dividing net income by the weighted average number of shares of
common stock outstanding at the end of each period. Diluted
earnings per share is calculated by increasing the denominator for
the assumed conversion of all potentially dilutive securities. The
Corporation's dilutive securities are limited to stock options.
36
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2004, 2003 AND 2002 - CONTINUED
________________________________________________________________
Per share data has been adjusted retroactively for stock
splits and stock dividends. The reconciliation of the numerators
and denominators of the basis and diluted earnings per share
follows:
Year Ended December 31, 2004
________________________________________
Weighted Average
Net Income Number of Shares Per Share
Numerators Denominators Amount
__________ ____________ ______
Net income $6,787
======
Basic earnings per
share:
Income available
to common
stockholders $6,787 4,388 $1.55
Effect of dilutive
securities:
Stock options 16
_____
Diluted earnings per
share:
Income available to
common stockholders $6,787 4,404 $1.54
Year Ended December 31, 2003
________________________________________
Weighted Average
Net Income Number of Shares Per Share
Numerators Denominators Amount
__________ ____________ ______
Net income $7,317
======
Basic earnings per
share:
Income available
to common
stockholders $7,317 4,417 $1.66
Effect of dilutive
securities:
Stock options 12
_____
Diluted earnings per
share:
Income available to
common stockholders $7,317 4,429 $1.65
Year Ended December 31, 2002
________________________________________
Weighted Average
Net Income Number of Shares Per Share
Numerators Denominators Amount
__________ ____________ ______
Net income $6,587
======
Basic earnings per
share:
Income available
to common
stockholders $6,587 4,458 $1.48
Effect of dilutive
securities:
Stock options 4
_____
Diluted earnings per
share:
Income available to
common stockholders $6,587 4,462 $1.48
CASH FLOW INFORMATION
For purposes of reporting consolidated cash flows, cash and
cash equivalents include cash on hand and due from other banks and
interest bearing deposits in other banks. The Corporation considers
cash classified as interest bearing deposits with other banks as a
cash equivalent since they are represented by cash accounts
essentially on a demand basis.
37
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2004, 2003 AND 2002 - CONTINUED
________________________________________________________________
TRUST ASSETS AND INCOME
Property held by the Corporation in a fiduciary or agency
capacity for its customers is not included in the accompanying
consolidated financial statements since such items are not assets
of the Corporation. Trust Department income is generally
recognized on a cash basis and is not materially different than if
it were reported on an accrual basis.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2004, the Financial Accounting Standards Board
(FASB) issued Staff Position No. 106-1, "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003", which allows companies to recognize
or defer recognizing the effects of the Medicare Prescription Drug
Improvement and Modernization Act of 2003, or Medicare Act, for
annual financial statements of fiscal years ending after December
7, 2003. The Medicare Act introduced both a Medicare prescription
drug benefit and a federal subsidy to sponsors of retiree health
care plans that provide a benefit at least "actuarially equivalent"
to the Medicare benefit. These provisions of the Medicare Act
affect accounting measurements. This standard does not have impact
on the Corporation's consolidated financial condition or results of
operations.
In September 2004, the FASB issued Staff Position Emerging
Issues Task Force ("EITF") Issue No. 03-01, "Effective Date of
Paragraphs 10-20 of EITF Issue No. 03-01, The Meaning of Other Than
Temporary Impairment and Its Application to Certain Investments",
which delays the effective date for the measurement and recognition
guidance contained in EITF Issue No. 03-01. EITF Issue No. 03-01
provides guidance for evaluating whether an investment is other
than temporarily impaired and was originally effective for other
than temporarily impairment evaluations made in reporting periods
beginning after June 15, 2004. The delay in the effective date for
the measurement and recognition guidance contained in paragraphs 10
through 20 of EITF Issue No. 03-01 does not suspend the requirement
to recognize other than temporary impairment as required by
existing authoritative literature. The disclosure guidance in
paragraphs 21 and 22 of EITF Issue No. 03-01 remains effective.
The delay will be superseded concurrent with the final issuance of
EITF Issue No. 03-01a, which is expected to provide implementation
guidance on matters such as impairment evaluations for declines in
value caused by increases in interest rates and/or sector spreads.
In December 2004, the FASB issued Statement of Financial
Accounting Standards ("SFAS") No. 153, "Exchanges of Nonmonetary
Assets," which amends APB Opinion No. 29, "Accounting for
Nonmonetary Transactions". SFAS No. 153 eliminates the exception
from fair value measurement for nonmonetary exchanges of similar
productive assets in Opinion No. 29 and replaces it with an
exception for exchanges that do not have commercial substance.
SFAS No. 153 specifies that a nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. SFAS No. 153 is
effective for nonmenetary exchanges occurring in fiscal periods
beginning after June 15, 2005. The adoption of SFAS No. 153 is not
expected to have a material impact on the Corporation's
consolidated financial condition or results of operations.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment". This Statement is a revision of SFAS No.
123, "Accounting for Stock Based Compensation", and supercedes APB
Opinion No. 25, "Accounting for Stock Issued to employees", and its
related guidance. SFAS No. 123 (revised 2004) established
standards for the accounting for transactions in which an entity
exchanges its equity instruments for goods and services. This
Statement requires that the cost resulting from all share based
payment transactions be recognized in the financial statements.
This Statement establishes fair value as the measurement objective
in accounting for share based payment arrangements and requires all
entities to apply a fair value based measurement method in
accounting for share based payment transactions with employees,
except for equity instruments held by employee share ownership
plans. This Statement is effective for public entities that do no
file as small business issuers as of the beginning of the first
interim or annual reporting period that begins after June 15, 2005.
The adoption of SFAS No. 123 (revised 2004) is not expected to have
a material impact on the Corporation's consolidated financial
condition or results of operations.
38
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2004, 2003 AND 2002 - CONTINUED
________________________________________________________________
In May 2003, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 150, "Accounting for Certain Financial
Instruments with characteristics of both Liabilities and Equity"
which is generally effective for financial instruments entered into
or modified after May 31, 2003 and for contracts in existence at
the start of the first interim period beginning after June 15,
2003. This Statement establishes new standards for classification,
measurement and disclosure of certain types of financial
instruments having characteristics of both liabilities and equity,
including instruments that are mandatorily redeemable and that
embody obligations requiring or permitting settlement by
transferring assets or by issuing an entity's own shares. In
December 2003, the FASB deferred for an indefinite period the
application of the guidance in SFAS 150 to noncontrolling interests
that are classified as equity in the financial statements of a
subsidiary but would be classified as a liability in the parent's
financial statement's under SFAS 150. The deferral is limited to
mandatorily redeemable noncontrolling interests associated with
finite-lived subsidiaries. This standard does not have any impact
on the Corporation's consolidated financial position or results of
operations.
In December 2003, the Emerging Issues Task Force (EITF) issued
EITF 03-1, "The Meaning of Other Than Temporary Impairment and its
Application to Certain Investments" which is generally effective
for fiscal years ending after December 15, 2003 and addresses how
to define an "other than temporary impairment" as well as its
application to investments classified as either "available for
sale" and "held to maturity" under SFAS 115. The EITF requires
disclosure of securities in a continuous unrealized loss position
to be stratified based on length of time those securities were
carried in such a position (less than 12 months and 12 months or
more). Additional information is required to be disclosed to
include the nature of the investment, the cause of the decline in
value and the evidence considered in reaching the conclusions that
the investment is not other than temporarily impaired. The
disclosure is required for fiscal years ending after December 15,
2003. Comparative information for earlier periods is not required.
ADVERTISING COSTS
It is the Corporation's policy to expense advertising costs in
the period in which they are incurred. Advertising expense for the
years ended December 31, 2004, 2003 and 2002, was approximately
$305,000, $256,000 and $219,000, respectively.
RECLASSIFICATIONS
Certain amounts in the consolidated financial statements of
prior periods have been reclassified to conform with presentation
used in the 2004 consolidated financial statements. Such
reclassifications have no effect on the Corporation's consolidated
financial condition or net income.
NOTE 2 - RESTRICTED CASH BALANCES
The Bank is required to maintain certain average reserve
balances as established by the Federal Reserve Bank. The amount of
those reserve balances for the reserve computation period which
included December 31, 2004, was $904,000, which was satisfied
through the restriction of vault cash. In addition, the Bank
maintains a clearing balance at the Federal Reserve Bank to offset
specific charges for services. At December 31, 2004, the amount of
this balance was $700,000.
NOTE 3 - INVESTMENT SECURITIES
The amortized cost, related estimated fair value, and
unrealized gains and losses for investment securities classified as
"Available For Sale" or "Held to Maturity" were as follows at
December 31, 2004 and 2003:
39
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2004, 2003 AND 2002 - CONTINUED
________________________________________________________________
(Amounts in thousands) Available-for-Sale Securities
_____________________________
Gross
Amortized Unrealized
Cost Gains
_________ __________
December 31, 2004:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $105,398 $ 552
Other 5,995 10
Obligations of state and
political subdivisions 83,144 3,708
Corporate securities 28,437 865
Marketable equity securities 1,417 1,278
Restricted equity securities 5,466 -
________ ______
Total $229,857 $6,413
======== ======
(Amounts in thousands) Available-for-Sale Securities
_____________________________
Gross Estimated
Unrealized Fair
Losses Value
_________ __________
December 31, 2004:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $300 $105,650
Other 19 5,986
Obligations of state and
political subdivisions 259 86,593
Corporate securities - 29,302
Marketable equity securities - 2,695
Restricted equity securities - 5,466
____ ________
Total $578 $235,692
==== ========
(Amounts in thousands) Held-to-Maturity Securities
_____________________________
Gross
Amortized Unrealized
Cost Gains
_________ __________
December 31, 2004:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $ 638 $-
Obligations of state and
political subdivisions 2,723 9
______ __
Total $3,361 $9
====== ==
(Amounts in thousands) Held-to-Maturity Securities
_____________________________
Gross Estimated
Unrealized Fair
Losses Value
_________ __________
December 31, 2004:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $6 $ 632
Obligations of state and
political subdivisions - 2,732
__ ______
Total $6 $3,364
== ======
(Amounts in thousands) Available-for-Sale Securities
_____________________________
Gross
Amortized Unrealized
Cost Gains
_________ __________
December 31, 2003:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $ 94,357 $ 719
Other 5,997 50
Obligations of state and
political subdivisions 73,691 5,199
Corporate securities 33,724 2,301
Marketable equity securities 4,653 1,378
Restricted equity securities 5,167 -
________ ______
Total $217,589 $9,647
======== ======
(Amounts in thousands) Available-for-Sale Securities
_____________________________
Gross Estimated
Unrealized Fair
Losses Value
_________ __________
December 31, 2003:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $ 629 $ 94,447
Other 8 6,039
Obligations of state and
political subdivisions 179 78,711
Corporate securities - 36,025
Marketable equity securities 377 5,654
Restricted equity securities - 5,167
______ ________
Total $1,193 $226,043
====== ========
(Amounts in thousands) Held-to-Maturity Securities
_____________________________
Gross
Amortized Unrealized
Cost Gains
_________ __________
December 31, 2003:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $3,153 $ 3
Obligations of state and
political subdivisions 2,076 28
______ ___
Total $5,229 $31
====== ===
(Amounts in thousands) Held-to-Maturity Securities
_____________________________
Gross Estimated
Unrealized Fair
Losses Value
_________ __________
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $31 $3,125
Obligations of state and
political subdivisions - 2,104
___ ______
Total $31 $5,229
=== ======
40
Securities Available for Sale with an aggregate fair value of
$55,038,000 in 2004 and $52,927,000 in 2003; and securities Held to
Maturity with an aggregate unamortized cost of $1,638,000 in 2004
and $3,153,000 in 2003, were pledged to secure public funds, trust
funds, securities sold under agreements to repurchase, FHLB
advances and other balances of $37,224,000 in 2004 and $38,210,000
in 2003 as required by law.
The amortized cost, estimated fair value and weighted average
yield of debt securities, by contractual maturity, are shown below
at December 31, 2004. Expected maturities will differ from
contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
(Amounts in thousands)
December 31, 2004
_________________________________
U.S. Government Obligations
Agency & of State
Corporation & Political
Obligations Subdivisions
___________ ____________
Available-For-Sale:
Within 1 Year:
Amortized cost $ - $ -
Estimated fair value - -
Weighted average yield - -
1 - 5 Years:
Amortized cost 21,351 1,108
Estimated fair value 21,308 1,173
Weighted average yield 3.98% 6.01%
5 - 10 Years:
Amortized cost 11,147 9,487
Estimated fair value 11,109 9,899
Weighted average yield 4.11% 6.34%
After 10 Years:
Amortized cost 78,895 72,549
Estimated fair value 79,219 75,522
Weighted average yield 4.88% 7.24%
________ _______
Total:
Amortized cost $111,393 $83,144
Estimated fair value 111,636 86,594
Weighted average yield 4.63% 7.13%
(Amounts in thousands)
December 31, 2004
_____________________________
Marketable Restricted
Equity Equity
Securities Securities
__________ __________
Available-For-Sale:
Within 1 Year:
Amortized cost $ - $ -
Estimated fair value - -
Weighted average yield - -
1 - 5 Years:
Amortized cost - -
Estimated fair value - -
Weighted average yield - -
5 - 10 Years:
Amortized cost - -
Estimated fair value - -
Weighted average yield - -
After 10 Years:
Amortized cost 1,417 5,466
Estimated fair value 2,695 5,466
Weighted average yield 4.69% 2.12%
______ ______
Total:
Amortized cost $1,417 $5,466
Estimated fair value 2,695 5,466
Weighted average yield 4.69% 2.12%
(Amounts in thousands)
December 31, 2004
____________________________
Corporate
Securities
__________
Available-For-Sale:
Within 1 Year:
Amortized cost $13,901
Estimated fair value 14,060
Weighted average yield 6.20%
1 - 5 Years:
Amortized cost -
Estimated fair value -
Weighted average yield -
5 - 10 Years:
Amortized cost 14,536
Estimated fair value 15,241
Weighted average yield 5.87%
After 10 Years:
Amortized cost -
Estimated fair value -
Weighted average yield -
_______
Total:
Amortized cost $28,437
Estimated fair value 29,301
Weighted average yield 6.03%
______________________
Mortgage-backed securities are allocated for maturity reporting at their
original maturity date.