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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE YEAR ENDED SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBER: 0-25328
FIRST KEYSTONE FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-0469351
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
22 WEST STATE STREET, MEDIA, PENNSYLVANIA 19063
(Address of principal executive office) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (610) 565-6210
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NOT APPLICABLE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK (PAR VALUE $.01 PER SHARE)
Indicate by check mark whether the Registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 126-2).
Yes [ ] No [X]
The aggregate market value of the shares of Common Stock of the Registrant
issued and outstanding on December 10, 2003, which excludes 369,970 shares held
by all directors and officers of the Registrant as a group, was approximately
$31.8 million. This figure is based on the closing price of $20.98 per share of
the Registrant's Common stock on March 31, 2003, the last business day of the
Registrant's second fiscal quarter.
Number of shares of Common Stock outstanding as of December 10, 2003: 1,886,897
DOCUMENTS INCORPORATED BY REFERENCE
Listed hereunder are the documents incorporated by reference and the Part of the
Form 10-K into which the document is incorporated:
(1) Portions of the definitive proxy statement for the 2003 Annual Meeting of
Stockholders are incorporated into Part III.
FIRST KEYSTONE FINANCIAL, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2003
INDEX
Page
----
PART I
Item 1. Business 1
Item 2. Properties 37
Item 3. Legal Proceedings 38
Item 4. Submission of Matters to a Vote of Security Holders 38
PART II
Item 5. Market for Registrant's Common Stock and Related
Stockholder Matters 38
Item 6. Selected Financial Data 40
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations 42
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 54
Item 8. Financial Statements and Supplementary Data 55
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosures 82
Item 9A. Control and Procedures 82
PART III
Item 10. Directors and Executive Officers of the Registrant 82
Item 11. Executive Compensation 82
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters 83
Item 13. Certain Relationships and Related Transactions 83
Item 14. Principal Accounting Fees and Services 83
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports of Form 8-K 83
SIGNATURES 86
[This page left blank intentionally]
PART I.
ITEM 1. BUSINESS.
GENERAL
First Keystone Financial, Inc. (the "Company") is a Pennsylvania
corporation and sole shareholder of First Keystone Bank, a federally chartered
stock savings bank (the "Bank"), which converted to the stock form of
organization in January 1995. The only significant assets of the Company are the
capital stock of the Bank, the Company's loan to its employee stock ownership
plan, and various equity and other investments. See Note 18 of the Notes to
Consolidated Financial Statements for the fiscal year ended September 30, 2003
set forth in Item 8, "Financial Statements and Supplementary Data." The business
of the Company primarily consists of the business of the Bank.
The Bank is a community oriented bank emphasizing customer service and
convenience. The Bank's primary business is attracting deposits from the general
public and using those funds together with other available sources of funds,
primarily borrowings, to originate loans. A substantial portion of the Bank's
deposits are comprised of core deposits consisting of NOW, non-interest-bearing
accounts, money market ("MMDA") and passbook. Core deposits amounted to $184.1
million or 50.8% of the Bank's total deposits at September 30, 2003. The Bank's
primary lending emphasis is the origination of loans secured by first and second
liens on single-family (one-to-four units) residences located in Delaware and
Chester Counties, Pennsylvania and to a lesser degree, Montgomery County,
Pennsylvania and New Castle County, Delaware. The Bank originates residential
first mortgage loans with either fixed and/or adjustable rates. Adjustable-rate
loans are retained for the Bank's portfolio while fixed-rate loans may be sold
in the secondary market depending on the Bank's asset/liability strategy, cash
flow needs and current market conditions. The Bank also originates for
portfolio, due to their generally shorter terms, adjustable or variable interest
rates and generally higher yields, loans secured by commercial and multi-family
residential real estate properties as well as residential and commercial
construction loans secured by properties located in the Bank's market area. The
Bank's management, however, remains focused on its long-term strategic plan to
continue to shift to its loan composition toward commercial business,
construction and home equity loans and lines of credit in order to provide a
higher yielding portfolio with generally shorter terms. This effort to keep
shorter term loans in portfolio resulted in a $5.9 million increase in
outstanding balances in home equity loans and equity lines of credit at fiscal
year end, representing a 21.3% increase in this category compared to the
previous fiscal year. Multi-family residential and commercial real estate loans
amounted to $59.0 million or 19.7% of the total loan portfolio at September 30,
2003 as compared to $60.4 million or 19.9% at September 30, 2002. The Bank has
on occasion purchased loan participation interests in both residential and
commercial real estate loans depending on market conditions and portfolio needs,
although no such purchases were made during the fiscal year ended September 30,
2003.
In addition to its deposit gathering and lending activities, the Bank
invests in mortgage-related securities, which are issued or guaranteed by U.S.
Government agencies and government sponsored or private enterprises, as well as
U.S. Treasury and federal government agency obligations, corporate bonds and
municipal obligations. At September 30, 2003, the Bank's mortgage-related
securities (both available for sale and held to maturity) amounted to $128.2
million, or 22.9% of the Company's total assets, and investment securities (both
available for sale and held to maturity) amounted to $84.0 million, or 15.0% of
total assets.
1
MARKET AREA AND COMPETITION
The Bank's primary market area is in Delaware and Chester Counties,
which is located in the southeastern corner of Pennsylvania between two
metropolitan areas, Philadelphia, Pennsylvania and Wilmington, Delaware. There
is easy access to I-95, the Philadelphia International Airport and the Delaware
River. The Bank is fortunate to be located in such a desirable geographic area.
New York City is just 92 miles away from the Bank's headquarters in Media,
Pennsylvania, Baltimore, Maryland is only 80 miles away, and the distance to
Washington, DC is just 127 miles.
Through an extensive highway and telecommunications network, the
Delaware County's economy is knitted tightly into a regional economy of more
than 2.5 million workers. Census 2000 lists Delaware County as having 14,394
business establishments with the number of jobs in the County (258,922) at an
all time high. Most of the businesses are in corporate and professional
services, distributive services and the manufacturing sector. Census 2000 shows
Delaware County has a large, well-educated, and skilled local labor force of
258,782. Nearly one quarter of the County's population is 25 years or older and
has earned a four-year college degree. The total number of people employed as
executives, managers, professionals, and technicians is 101,646. Philadelphia's
central location in the Northeast corridor, infrastructure and other factors has
made the Bank's market area attractive to many large corporate employers
including Comcast Corp., Boeing, State Farm Insurance, United Parcel Service,
PECO Energy, SAP America, Inc., Wawa and many others.
The Philadelphia area economy is typical of many large Northeastern
cities where the traditional manufacturing based economy has declined and has
been replaced by the service sector including the health care market.
Crozer/Keystone Health System and Mercy Health Corp are amongst the larger
employers within the Bank's market area. According to the Delaware County
Chamber of Commerce, there are 82 degree-granting institutions and 47,000
graduates annually in the region, representing more colleges and universities
than any other area in the United States. Delaware County also has one of the
nation's lowest unemployment rates and one of the most active Chamber of
Commerce Offices in the State. The U.S. Small Business Administration,
Philadelphia District Office, named the Delaware County Chamber the Eastern
Region Chamber of the Year in 2001. This is the second time the Chamber received
this level of recognition.
According to the 2000 Census, the population of Delaware County is
550,864, a modest 0.6% increase since 1990. During the year 2000, Delaware
County Planning Commission reviewed proposals for almost twice as many
residential units compared to 1997. Due to the availability of land still
suitable for development, the majority of this growth has occurred in the
western part of Delaware County, and its contiguous neighbor Chester County. The
Bank had benefited from this growth with the opening of its Chester Heights
office in December 1999 which has exceeded the Company's deposit and consumer
loan projections. Chester County's continual growth is expected to increase
further in the next decade. The communities in Chester County that are
experiencing growth are East Marlborough Township, New Garden Township and East
Goshen which surround the Bank's Chester County office. As a result of the
continual anticipated growth, the Bank is expanding its Willowdale Branch,
Chester County to a full-service free-standing office to be completed in fiscal
2004.
The Bank faces strong competition both in attracting deposits and
making real estate loans. Its most direct competition for deposits has
historically come from other savings associations, credit unions and commercial
banks located in its market area including many large regional financial
institutions which have greater financial and marketing resources available to
them. The ability of the Bank to attract and retain core deposits depends on its
ability to provide a competitive rate of return, liquidity and risk comparable
to that offered by competing investment opportunities.
The Bank experiences strong competition for real estate loans principally
from other savings associations, commercial banks and mortgage-banking
companies. The Bank competes for loans principally through the interest rates
and loan fees it charges, the efficiency and quality of the services it provides
borrowers and the convenient locations of its branch office network. Recognizing
that convenience, as it relates to branch locations, is still a primary
motivator in attracting new deposits, the Bank is undergoing construction of a
new full-service free-standing branch on a corner property in Aston Township,
Delaware County, a densely populated area in the heart of the Bank's
marketplace.
2
FORWARD LOOKING STATEMENTS
In this Annual Report on Form 10-K, the Company has included certain
forward-looking statements concerning the future operations of the Company. It
is management's desire to take advantage of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. This statement is for the
express purpose of availing the Company of the protections of such safe harbor
with respect to all forward-looking statements contained in this Annual Report.
Such forward-looking statements are subject to risks and uncertainties which
could cause actual results to differ materially from those currently anticipated
due to a number of factors. Such forward-looking statements may be identified by
the use of words such as believe, expect, should, estimated, potential and
similar expressions. Examples of forward-looking statements include, but are not
limited to, estimates with respect to the financial condition, business
strategy, expected or anticipated revenue, results of operations and the
business of the Company that are subject to various factors which could cause
actual results to differ materially from these estimates. Factors that could
affect results include interest rate trends, deposit flows, competition, the
general economic climate in Delaware and Chester counties, the mid-Atlantic
region and the United States as a whole, loan demand, real estate values, loan
delinquency rates, levels of non-performing assets, changes in federal and state
regulation, changes in accounting policies and practices and other uncertainties
described in the Company's filings with the Securities and Exchange Commission,
including its Form 10-K for the year ended September 30, 2003. These factors
should be considered in evaluating the forward-looking statements, and undue
reliance should not be placed on such statements. The Company assumes no
obligation to update or revise forward-looking statements to reflect any changed
assumptions, any unanticipated events or any changes in the future.
3
LENDING ACTIVITIES
Loan Portfolio Composition. The following table sets forth the
composition of the Bank's loan portfolio by type of loan at the dates indicated
(excluding loans held for sale).
September 30,
--------------------------------------------------------------
2003 2002 2001
------------------ ------------------ ------------------
Amount % Amount % Amount %
------------------ ------------------ ------------------
(Dollars in thousands)
Real estate loans:
Single-family $166,042 55.51% $173,736 57.32% $160,289 59.81%
Multi-family and commercial 59,022 19.73 60,379 19.92 43,472 16.22
Construction and land 28,975 9.69 28,292 9.33 29,117 10.86
Home equity loans and lines of credit 33,459 11.19 27,595 9.10 25,847 9.65
-------- ------- -------- ------- -------- -------
Total real estate loans 287,498 96.12 290,002 95.67 258,725 96.54
-------- ------- -------- ------- -------- -------
Consumer:
Deposit 112 .04 144 .05 232 .09
Education -- -- -- -- -- --
Unsecured personal loans 547 .18 322 .11 133 .05
Other(1) 779 .26 736 .24 760 .28
-------- ------- -------- ------- -------- -------
Total consumer loans 1,438 .48 1,202 .40 1,125 .42
-------- ------- -------- ------- -------- -------
Commercial business loans 10,161 3.40 11,919 3.93 8,158 3.04
-------- ------- -------- ------- -------- -------
Total loans receivable(2) 299,097 100.00% 303,123 100.00% 268,008 100.00%
-------- ======= -------- ======= -------- =======
Less:
Loans in process (construction and
land) 10,655 11,384 17,016
Deferred loan origination fees and
discounts 35 605 1,147
Allowance for loan losses 1,986 2,358 2,181
-------- -------- --------
Total loans receivable, net $286,421 $288,776 $247,664
======== ======== ========
September 30,
----------------------------------------
2000 1999
------------------ ------------------
Amount % Amount %
------------------ ------------------
(Dollars in thousands)
Real estate loans:
Single-family $160,143 65.54% $166,802 69.82%
Multi-family and commercial 37,870 15.50 31,188 13.05
Construction and land 17,905 7.33 18,426 7.71
Home equity loans and lines of credit 22,597 9.25 18,624 7.80
-------- ------- -------- -------
Total real estate loans 238,515 97.62 235,040 98.38
-------- ------- -------- -------
Consumer:
Deposit 251 .10 243 .10
Education 285 .12 365 .15
Unsecured personal loans -- -- -- --
Other(1) 807 .33 1,080 .45
-------- ------- -------- -------
Total consumer loans 1,343 .55 1,688 .70
-------- ------- -------- -------
Commercial business loans 4,475 1.83 2,190 .92
-------- ------- -------- -------
Total loans receivable(2) 244,333 100.00% 238,918 100.00%
-------- ======= -------- =======
Less:
Loans in process (construction and
land) 10,330 9,005
Deferred loan origination fees and
discounts 1,298 1,610
Allowance for loan losses 2,019 1,928
-------- --------
Total loans receivable, net $230,686 $226,375
======== ========
- -----------------------------
(1) Consists primarily of credit card loans.
(2) Does not include $4.5 million, $501,000, $225,000, $3.1 million and
$1.8 million of loans held for sale at September 30, 2003, 2002, 2001,
2000 and 1999, respectively.
4
Contractual Principal Repayments. The following table sets forth the
scheduled contractual maturities of the Bank's loans held to maturity at
September 30, 2003. Demand loans, loans having no stated schedule of repayments
and no stated maturity and overdraft loans are reported as due in one year or
less. The amounts shown for each period do not take into account loan
prepayments and normal amortization of the Bank's loan portfolio held to
maturity.
Real Estate Loans
------------------------------------------------------------------------------------
Multi-family Consumer and
Single-family and Construction Commercial
(1) Commercial and Land Total Business Loans Total
------------- ------------ ------------ --------- --------------- ---------
(Dollars in thousands)
Amounts due in:
One year or less $ 9,970 $ 6,597 $ 28,975 $ 45,542 $ 10,839 $ 56,381
After one year through three years 19,971 8,601 -- 28,572 335 28,907
After three years through five years 24,808 10,308 -- 35,116 160 35,276
After five years through ten years 74,564 12,913 -- 87,477 97 87,574
After ten years through fifteen years 43,070 9,619 -- 52,689 23 52,712
Over fifteen years 27,118 10,984 -- 38,102 145 38,247
------------ ------------ ------------ --------- --------------- ---------
Total(2) $ 199,501 $ 59,022 $ 28,975 $ 287,498 $ 11,599 $ 299,097
============ ============ ============ ========= =============== =========
Interest rate terms on amounts due after
one year:
Fixed $ 156,927 $ 463 $ 157,390
Adjustable 85,029 297 85,326
--------- --------------- ---------
Total(2) $ 241,956 $ 760 $ 242,716
========= =============== =========
- ----------------------------
(1) Includes home equity loans and lines of credit.
(2) Does not include adjustments relating to loans in process, allowances
for loan losses and deferred fee income.
5
Scheduled contractual amortization of loans does not reflect the
expected term of the Bank's loan portfolio. The average life of loans is
substantially less than their contractual terms because of prepayments and
due-on-sale clauses, which give the Bank the right to declare a conventional
loan immediately due and payable in the event, among other things, that the
borrower sells the real property subject to the mortgage and the loan is not
repaid. The average life of mortgage loans tends to increase when current
mortgage loan rates are higher than rates on existing mortgage loans and,
conversely, decrease when current mortgage loan rates are lower than rates on
existing mortgage loans (due to refinancings of adjustable-rate and fixed-rate
loans at lower rates). Under the latter circumstances, the weighted average
yield on loans decreases as higher yielding loans are repaid or refinanced at
lower rates.
Loan Origination, Purchase and Sale Activity. The following table shows
the loan origination, purchase and sale activity of the Bank during the periods
indicated.
Year Ended September 30,
--------------------------------------
2003 2002 2001
---------- ---------- ----------
(Dollars in thousands)
Gross loans at beginning of period(1) $ 303,624 $ 268,233 $ 247,532
---------- ---------- ----------
Loan originations for investment:
Real estate:
Residential 80,722 60,719 25,889
Commercial and multi-family 13,890 31,300 11,265
Construction 24,578 28,741 18,503
Home equity and lines of credit 29,920 21,710 10,363
---------- ---------- ----------
Total real estate loans originated for investment 149,110 142,470 66,020
Consumer 2,927 2,825 1,287
Commercial business 17,548 21,555 12,102
---------- ---------- ----------
Total loans originated for investment 169,585 166,850 79,409
Participations purchased(2) -- -- 1,124
Loans originated for resale 30,995 3,712 20,685
---------- ---------- ----------
Total originations 200,580 170,562 101,218
---------- ---------- ----------
Deduct:
Principal loan repayments and prepayments (171,489) (131,374) (56,086)
Transferred to real estate owned (2,122) (361) (872)
Loans sold in secondary market (26,998) (3,436) (23,559)
---------- ---------- ----------
Subtotal (200,609) (135,171) (80,517)
---------- ---------- ----------
Net (decrease) increase in loans(1) (29) 35,391 20,701
---------- ---------- ----------
Gross loans at end of period(1) $ 303,595 $ 303,624 $ 268,233
========== ========== ==========
- -------------------
(1) Includes loans held for sale of $4.5 million, $501,000 and $225,000 at
September 30, 2003, 2002 and 2001, respectively.
(2) Consist of commercial real estate loans.
6
The residential lending activities of the Bank are subject to written
underwriting standards and loan origination procedures established by the Bank's
Board of Directors and management. Loan applications may be taken at all of the
Bank's branch offices by the branch manager or other designated loan officers.
Applications for single-family residential mortgage loans for portfolio
retention are obtained predominately through loan originators who are employees
of the Bank. The Bank's residential loan originators will take loan applications
outside of the Bank's offices at the customer's convenience and are compensated
on a commission basis. The Residential Lending Department supervises the process
of obtaining credit reports, appraisals and other documentation involved with a
loan. In most cases, the Bank requires that a property appraisal be obtained in
connection with all new first mortgage loans. Generally, appraisals are not
required on home equity loans because alternative means of valuation are used
(i.e. tax assessments). Property appraisals generally are performed by an
independent appraiser from a list approved by the Bank's Board of Directors. The
Bank requires that title insurance (other than with respect to home equity
loans) and hazard insurance be maintained on all security properties and that
flood insurance be maintained if the property is within a designated flood
plain.
Residential mortgage loan applications are primarily developed from
referrals from real estate brokers and builders, existing customers and walk-in
customers. Commercial and multi-family real estate loan applications are
obtained primarily from previous borrowers, direct solicitations by Bank
personnel, as well as referrals. Consumer loans originated by the Bank are
obtained primarily through existing and walk-in customers who have been made
aware of the Bank's programs by advertising and other means.
Applications for single-family residential mortgage loans which are
originated for resale in the secondary market or loans designated for portfolio
retention that conform to the requirements for resale into the secondary market
and do not exceed Fannie Mae ("FNMA") or Freddie Mac ("FHLMC") limits are
approved by at least one of the following: the Bank's Senior Vice President of
Residential Lending, the Vice President of Residential Lending, the Senior
Mortgage Loan underwriter or the Loan Committee (a committee comprised of four
directors and the Vice President of Residential Lending). Residential mortgage
loans in excess of FNMA/FHLMC maximum amounts (currently $322,700) but less than
$1.0 million must be approved by the Loan Committee. All mortgage loans in
excess of $1.0 million must be approved by the Bank's Board of Directors or the
Executive Committee thereof. Commercial and multi-family residential real estate
loans in excess of $200,000 and construction loans must be approved by the Board
of Directors. All mortgage loans which do not require approval by the Board of
Directors are submitted to the Board at its next meeting for review and
ratification. Home equity loans and lines of credit up to $150,000 can be
approved by the Vice President of Residential Lending, the Vice President of
Construction Loans, the Vice President of Residential Lending or the Senior
Mortgage Loan Underwriter. Loans in excess of such amount must be approved by
the Loan Committee.
Single-Family Residential Loans. Substantially all of the Bank's
single-family residential mortgage loans consist of conventional loans.
Conventional loans are loans that are neither insured by the Federal Housing
Administration or partially guaranteed by the Department of Veterans Affairs.
The vast majority of the Bank's single-family residential mortgage loans are
secured by properties located in Pennsylvania, primarily in Delaware and Chester
counties, and are originated under terms and documentation which permit their
sale to FHLMC or FNMA. The Bank, consistent with its asset/liability management
strategies, sells some of its newly originated longer term fixed-rate
residential mortgage loans and to a limited degree, existing longer term
fixed-rate residential mortgage loans while retaining adjustable-rate mortgage
loans and shorter term fixed-rate residential mortgage loans. See "-
Mortgage-Banking Activities."
The single-family residential mortgage loans offered by the Bank
currently consist of fixed-rate loans, including bi-weekly and balloon loans and
adjustable-rate loans. Fixed-rate loans generally have maturities ranging from
15 to 30 years and are fully amortizing with monthly loan payments sufficient to
repay the total amount of the loan with interest by the end of the loan term.
The Bank's fixed-rate loans are originated under terms, conditions and
documentation which permit them to be sold to U.S. Government-sponsored
agencies, such as FHLMC or FNMA, and other purchasers in the secondary mortgage
market. The Bank also offers bi-weekly loans under the terms of which the
borrower makes payments every two weeks. Although such loans have a 30 year
amortization schedule, due to the bi-weekly payment schedule, such loans repay
substantially more rapidly than a standard monthly amortizing 30-year fixed-rate
loan. The Bank also offers five and seven year balloon loans which provide that
the borrower can conditionally renew the loan at the fifth or seventh year at a
then to-be-determined interest rate for the remaining 25 or 23 years,
respectively, of the amortization period. At September 30, 2003, $147.8 million,
or 89.0% of the Bank's single-family residential mortgage loans held in
portfolio were fixed-rate loans, including $12.4 million of bi-weekly,
fixed-rate residential mortgage loans.
7
The adjustable-rate loans currently offered by the Bank have interest
rates which adjust every one, three or five years in accordance with a
designated index, such as U.S. Treasury obligations, adjusted to a constant
maturity ("CMT"), plus a stipulated margin. The Bank's adjustable-rate
single-family residential real estate loans generally have a cap of 2% on any
increase or decrease in the interest rate at any adjustment date, and a cap and
floor of 6% on any such increase or decrease over the life of the loan. In order
to increase the originations of adjustable-rate loans, the Bank has been
originating loans which bear a fixed interest rate for a period of three to five
years after which they convert to one-year adjustable-rate loans. The Bank's
adjustable-rate loans require that any payment adjustment resulting from a
change in the interest rate of an adjustable-rate loan be sufficient to result
in full amortization of the loan by the end of the loan term and, thus, do not
permit any of the increased payment to be added to the principal amount of the
loan, creating negative amortization. Although the Bank does offer
adjustable-rate loans with initial rates below the fully indexed rate, loans
tied to the one-year CMT are underwritten using methods approved by FHLMC or
FNMA which require borrowers to be qualified at 2% above the discounted loan
rate under certain conditions. At September 30, 2003, $18.2 million, or 11.0%,
of the Bank's single-family residential mortgage loans held for portfolio were
adjustable-rate loans.
Adjustable-rate loans decrease the risks associated with changes in
interest rates but involve other risks, primarily because in the event interest
rates increase, the loan payment by the borrower also increases to the extent
permitted by the terms of the loan, thereby increasing the potential for
default. In addition, adjustable-rate loans tend to prepay and convert to fixed
rates when the overall interest rate environment is low. Moreover, as with
fixed-rate loans, as interest rates increase, the marketability of the
underlying collateral property may be adversely affected by higher interest
rates. The Bank believes that these risks, which have not had a material adverse
effect on the Bank to date, generally are less than the risks associated with
holding fixed-rate loans in an increasing interest rate environment.
For conventional residential mortgage loans held in portfolio and also
for those loans originated for sale in the secondary market, the Bank's maximum
loan-to-value ("LTV") ratio is 97%, and is based on the lesser of sales price or
appraised value. On loans with a LTV ratio of over 80%, private mortgage
insurance may be required to be obtained or the Bank may lend the excess as a
home equity loan.
Commercial and Multi-Family Residential Real Estate Loans. In fiscal
2003, the Bank has maintained its increased investment in commercial and
multi-family residential lending. Such loans are being made primarily to small-
and medium-sized businesses located in the Bank's primary market area, a segment
of the market that the Bank believes continues to be under served in recent
years. Loans secured by commercial and multi-family residential real estate
amounted to $59.0 million, or 19.7%, of the Bank's total loan portfolio, at
September 30, 2003. The Bank's commercial and multi-family residential real
estate loans are secured primarily by professional office buildings, small
retail establishments, warehouses and apartment buildings (with 36 units or
less) located in the Bank's primary market area.
The Bank's adjustable-rate multi-family residential and commercial real
estate loans generally are either three or five-year adjustable-rate loans
indexed to the CMT plus a margin. In addition, depending on collateral value and
strength of the borrower, fixed-rate balloon loans and longer term fixed-rate
loans may be originated. Generally, fees of 1% to 3% of the principal loan
balance are charged to the borrower upon closing. Although terms for
multi-family residential and commercial real estate loans may vary, the Bank's
underwriting standards generally provide for terms of up to 25 years with
amortization of the principal over the term of the loan and LTV ratios of not
more than 75%. Generally, the Bank obtains personal guarantees of the principals
of the borrower as additional security for any commercial real estate and
multi-family residential loans and requires that the borrower have at least a
25% equity investment in any such property.
8
The Bank evaluates various aspects of commercial and multi-family
residential real estate loan transactions in an effort to mitigate risk to the
extent possible. In underwriting these loans, consideration is given to the
stability of the property's cash flow history, future operating projections,
current and projected occupancy, position in the market, location and physical
condition. In recent periods, the Bank has generally imposed a debt coverage
ratio (the ratio of net cash from operations before payment of debt service to
debt service) of not less than 110%. The underwriting analysis also includes
credit checks and a review of the financial condition of the borrower and
guarantor, if applicable. An appraisal report is prepared by a state-licensed
and certified appraiser (generally an appraiser who is qualified as a Member of
the Appraisal Institute ("MAI")) commissioned by the Bank to substantiate
property values for every commercial real estate and multi-family loan
transaction. All appraisal reports are reviewed by the commercial loan
underwriter prior to the closing of the loan.
Multi-family residential and commercial real estate lending entails
different and significant risks when compared to single-family residential
lending because such loans often involve large loan balances to single borrowers
and because the payment experience on such loans is typically dependent on the
successful operation of the project or the borrower's business. These risks also
can be significantly affected by supply and demand conditions in the local
market for apartments, offices, warehouses or other commercial space. The Bank
attempts to minimize its risk exposure by limiting such lending to proven
developers/owners, only considering properties with existing operating
performance which can be analyzed, requiring conservative debt coverage ratios,
and periodically monitoring the operation and physical condition of the
collateral. During fiscal 2003, the Bank continued to experience difficulties
with two borrowers in its commercial real estate loan portfolio which has
increased non-performing assets. See "-Non-performing Assets" for further
discussion of these non-performing loans.
Construction Loans. Substantially all of the Bank's construction loans
consist of loans for acquisition and development of properties to construct
single-family properties extended either to individuals or to selected
developers with whom the Bank is familiar to build such properties on a pre-sold
or limited speculative basis.
To a lesser extent, the Bank provides financing for construction to
permanent commercial real estate properties. Commercial construction loans have
a maximum term of 24 months during the construction period with interest based
upon the prime rate published in the Wall Street Journal ("Prime Rate") plus a
margin and have LTV ratios of 80% or less of the appraised value upon
completion. The loans convert to permanent commercial real estate loans upon
completion of construction. With respect to construction loans to individuals,
such loans have a maximum term of 12 months, have variable rates of interest
based upon the Prime Rate plus a margin and have LTV ratios of 80% or less of
the appraised value of the property upon completion and generally do not require
the amortization of principal during the term. Upon completion of construction,
the borrower is required to refinance the loan although the Bank may be the
lender of the permanent loan secured by the property.
The Bank also provides construction loans (including acquisition and
development) and revolving lines of credit to developers. The majority of
construction loans consist of loans to selected local developers with whom the
Bank is familiar and who build single-family dwellings on a pre-sold or, to a
significantly lesser extent, on a speculative basis. The Bank generally limits
to two the number of unsold units that a developer may have under construction
in a project. Such loans generally have terms of 36 months or less, have
generally a maximum LTV ratios of 75% of the appraised value of the property
upon completion and do not require the amortization of the principal during the
term. The loans are made with variable rates of interest based on the Prime Rate
plus a margin adjusted on a monthly basis. The Bank also receives origination
fees that generally range from .5% to 3.0% of the loan commitment. The borrower
is required to fund a portion of the project's costs, the exact amount being
determined on a case-by-case basis. Loan proceeds are disbursed by percentage of
completion of the cost of the project after inspections indicate that such
disbursements are for costs already incurred and which have added to the value
of the project. Only interest payments are due during the construction phase and
the Bank may provide the borrower with an interest reserve from which it can pay
the stated interest due thereon.
At September 30, 2003, residential construction loans totaled $16.4
million, or 5.5%, of the total loan portfolio, primarily consisting of
construction loans to developers. At September 30, 2003, commercial construction
loans totaled $2.1 million, or .71%, of the total loan portfolio.
9
The Bank also originates ground or land loans to individuals to
purchase a property on which they intend to build their primary residences, as
well as to developers to purchase lots to build speculative homes at a later
date. Such loans have terms of 36 months or less with a maximum LTV ratio of 75%
of the lower of appraised value or sale price. The loans are made with variable
rates based on the Prime Rate plus a margin. The Bank also receives origination
fees, which generally range between 1.0% and 3.0% of the loan amount. At
September 30, 2003, land loans (including loans to acquire and develop land)
totaled $10.4 million, or 3.5%, of the total loan portfolio.
Loans to developers include both secured and unsecured lines of credit
(which are classified as commercial business loans) with outstanding commitments
totaling $2.2 million. All have personal guaranties of the principals and are
cross-collateralized with existing loans. At September 30, 2003, loans
outstanding under builder lines of credit totaled $1.4 million, or .47%, of the
total loan portfolio, of which $788,000 were unsecured and given only to the
Bank's most creditworthy long standing customers.
Prior to making a commitment to fund a construction loan, the Bank
requires an appraisal of the property by an appraiser approved by the Board of
Directors. In addition, during the term of the construction loan, the project is
inspected by an independent inspector.
Construction financing generally is considered to involve a higher
degree of risk of loss than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development and the estimated cost (including interest) of
construction. During the construction phase, a number of factors could result in
delays and cost overruns. If the estimate of value proves to be inaccurate, the
Bank may be confronted, at or prior to the maturity of the loan, with a project,
when completed, having a value which is insufficient to assure full repayment.
Loans on lots may run the risk of adverse zoning changes as well as
environmental or other restrictions on future use.
Home Equity Loans and Lines of Credit. Home equity loans and home
equity lines of credit are secured by the underlying equity in the borrower's
primary residence or, occasionally, other types of real estate. Home equity
loans are amortizing loans with fixed interest rates and generally maximum terms
of 15 years while equity lines of credit have adjustable interest rates indexed
to the Prime Rate. Generally home equity loans or home equity lines of credit do
not exceed $100,000. The Bank's home equity loans and lines of credit generally
require combined LTV ratios of 80% or less. Loans with higher LTV ratios are
available but with higher interest rates and stricter credit standards. At
September 30, 2003, home equity loans and lines of credit amounted to $33.5
million, or 11.2%, of the Bank's total loan portfolio.
Consumer Lending Activities. The Bank also offers a variety of consumer
loans in order to provide a full range of retail financial services to its
customers. At September 30, 2003, $1.4 million, or .5 %, of the Bank's total
loan portfolio was comprised of consumer loans. The Bank originates
substantially all of such loans in its market area. At September 30, 2003, the
Bank's consumer loan portfolio was comprised of credit card, deposit, unsecured
personal loans and other consumer loans. The Bank's credit card program is
primarily offered to only the Bank's most creditworthy customers. At September
30, 2003, these loans totaled $620,000, or .2%, of the total loan portfolio.
Another component of the consumer loan portfolio is unsecured loans amounting to
$547,000, or .2%, of the Bank's loan portfolio at September 30, 2003.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral.
Commercial Business Loans. The Bank has also emphasized the growth in
commercial business loans by granting such loans directly to business
enterprises that are located in its market area. The majority of such loans are
for less than $1.0 million. The Bank actively targets and markets to small- and
medium-sized businesses. Applications for commercial business loans are obtained
from existing commercial customers, branch and customer referrals, direct
inquiry and those that are obtained by our commercial lending officers. As of
September 30, 2003, commercial business loans amounted to $10.2 million, or
3.4%, of the Bank's total loan portfolio.
10
The commercial business loans consist of a limited number of commercial
lines of credit secured by real estate, securities, some working capital
financings secured by accounts receivable and inventory and, to a limited
extent, unsecured lines of credit. Commercial business loans originated by the
Bank ordinarily have terms of five years or less and fixed rates or adjustable
rates tied to the Prime Rate plus a margin.
Although commercial business loans generally are considered to involve
greater credit risk than other certain types of loans, management intends to
continue to offer commercial business loans to small- and medium-sized
businesses in an effort to better serve our community's needs, obtain core
non-interest-bearing deposits and increase the Bank's interest rate spread.
Mortgage-Banking Activities. Due to customer preference for fixed-rate
loans, the Bank has continued to originate fixed-rate loans. Long-term
(generally 30 years) fixed-rate loans not taken into portfolio for
asset/liability purposes are sold into the secondary market. The Bank's net gain
on sales of mortgage loans amounted to $410,000, $84,000, and $122,000 during
the fiscal years ended September 30, 2003, 2002 and 2001, respectively. Profits
from sales of loans held for sale significantly increased due to the increased
originations in 30-year loans resulting from the low interest rate environment.
The Bank had $4.5 million and $501,000 of mortgage loans held for sale at
September 30, 2003 and 2002, respectively. Subsequent to fiscal year end,
management determined, based on its asset liability position, to retain a
substantial portion of such loans in its loan portfolio.
The Bank's conforming mortgage loans sold to others are sold, generally
with servicing retained, on a loan-by-loan basis primarily to FHLMC or FNMA. A
period of less than five days generally elapses between the closing of the loan
by the Bank and its purchase by the investor. Mortgages with established
interest rates generally will decrease in value during periods of increasing
interest rates. Accordingly, fluctuations in prevailing interest rates may
result in a gain or loss to the Bank as a result of adjustments to the carrying
value of loans held for sale or upon sale of loans. The Bank attempts to protect
itself from these market fluctuations through the use of forward commitments
entered into at the same time of the commitment by the Bank of a loan rate to
the borrower. These commitments are mandatory delivery contracts with FHLMC or
FNMA within a certain time frame and within certain dollar amounts by a price
determined at the commitment date. Market risk does exist as non-refundable
points paid by the borrower may not be sufficient to offset fees associated with
closing the forward commitment contract. See Note 13 of the Notes to
Consolidated Financial Statements set forth in Item 8 hereof.
Loan Origination Fees and Servicing. Borrowers may be charged an
origination fee, which is a percentage of the principal balance of the loan. In
accordance with the provisions of Statement of Financial Accounting Standards
("SFAS") No. 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases," the various
fees received by the Bank in connection with the origination of loans are
deferred and amortized as a yield adjustment over the lives of the related loans
using the interest method. However, when such loans are sold, the remaining
unamortized fees (which is all or substantially all of such fees due to the
relatively short period during which such loans are held) are recognized as
income on the sale of loans held for sale.
The Bank, for conforming loan products, generally retains the servicing
on all loans sold to others. In addition, the Bank services substantially all of
the loans that it retains in its portfolio. Loan servicing includes collecting
and remitting loan payments, accounting for principal and interest, making
advances to cover delinquent payments, making inspections as required of
mortgaged premises, contacting delinquent mortgagors, supervising foreclosures
and property dispositions in the event of unremedied defaults and generally
administering the loans. Funds that have been escrowed by borrowers for the
payment of mortgage-related expenses, such as property taxes and hazard and
mortgage insurance premiums, are maintained in noninterest-bearing accounts at
the Bank.
11
The following table presents information regarding the loans serviced
by the Bank for others at the dates indicated. Substantially all the loans were
secured by properties in Pennsylvania. A small percentage of the loans are
secured by properties located in Delaware, Maryland or New Jersey.
SEPTEMBER 30,
----------------------------------
2003 2002 2001
----------------------------------
(Dollars in thousands)
Loans originated by the Bank and serviced for:
FNMA $ 822 $ 1,054 $ 1,726
FHLMC 50,373 50,405 64,195
Others 352 367 380
------- ------- ------
Total loans serviced for others $ 51,547 $ 51,826 $66,301
======= ======= ======
The Bank receives fees for servicing mortgage loans, which generally
amount to 0.25% per annum on the declining principal balance of mortgage loans.
Such fees serve to compensate the Bank for the costs of performing the servicing
function. Other sources of loan servicing revenues include late charges. The
Bank retains a portion of funds received from borrowers on the loans it services
for others in payment of its servicing fees received on loans serviced for
others. For fiscal years ended September 30, 2003, 2002 and 2001, the Bank
earned gross fees of $140,000, $160,000 and $191,000, respectively, from loan
servicing.
Loans-to-One Borrower Limitations. Regulations impose limitations on
the aggregate amount of loans that a savings institution could make to any one
borrower, including related entities. Under such regulations, the permissible
amount of loans-to-one borrower follows the national bank standard for all loans
made by savings institutions, which generally does not permit loans-to-one
borrower to exceed 15% of unimpaired capital and surplus. Loans in an amount
equal to an additional 10% of unimpaired capital and surplus also may be made to
a borrower if the loans are fully secured by readily marketable securities. At
September 30, 2003, the Bank's six largest loans or groups of loans-to-one
borrower, including related entities, ranged from an aggregate of $4.3 million
to $5.8 million. The Bank's loans-to-one borrower limit was $6.8 million at such
date.
ASSET QUALITY
General. As a part of the Bank's efforts to improve its asset quality,
it has developed and implemented an asset classification system. All of the
Bank's assets are subject to review under the classification system, but
particular emphasis is placed on the review of multi-family residential and
commercial real estate loans, construction loans and commercial business loans.
All assets of the Bank are periodically reviewed and the classification
recommendations submitted to the Asset Classification Committee at least
monthly. The Asset Classification Committee is composed of the President and
Chief Executive Officer, the Chief Financial Officer, the Vice President of Loan
Administration, the Internal Auditor and the Vice President of Construction
Lending. All assets are placed into one of the four following categories: Pass,
Substandard, Doubtful and Loss. The criteria used to review and establish each
asset's classification are substantially identical to the asset classification
system used by the Office of Thrift Supervision (the "OTS") in connection with
the examination process. As of September 30, 2003, the Bank did not have any
assets which it had classified as doubtful or loss. See "- Non-Performing
Assets" and "- Other Classified Assets" for a discussion of certain of the
Bank's assets which have been classified as substandard and regulatory
classification standards generally.
12
When a borrower fails to make a required payment on a loan, the Bank
attempts to cure the deficiency by contacting the borrower and requesting
payment. Contact is generally made after the expiration of the grace period
(usually fifteen days) in the form of telephone calls and/or correspondence. In
most cases, deficiencies are cured promptly. If the delinquency increases, the
Bank will initiate foreclosure actions or legal collection actions if a borrower
fails to enter into satisfactory repayment arrangements. Such actions generally
commence at sixty to ninety days of delinquency.
Loans are placed on non-accrual status when, in the judgment of
management, the probability of collection of interest is deemed to be
insufficient to warrant further accrual. When a loan is placed on non-accrual
status, previously accrued but unpaid interest is deducted from interest income.
As a matter of policy, the Bank does not accrue interest on loans past due 90
days or more. See Note 2 of the Notes to Consolidated Financial Statements set
forth in Item 8 hereof.
Real estate acquired by the Bank as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold. Real
estate owned is initially recorded at the lower of fair value less estimated
costs to sell the property, or cost (generally the balance of the loan on the
property at the date of acquisition). After the date of acquisition, all costs
incurred in maintaining the property are expenses and costs incurred for the
improvement or development of such property are capitalized up to the extent of
their net realizable value.
Under accounting principles generally accepted in the United States of
America ("GAAP"), the Bank is required to account for certain loan modifications
or restructurings as "troubled debt restructurings" under SFAS No. 15. In
general, the modification or restructuring of a debt constitutes a troubled debt
restructuring if the Bank, for economic or legal reasons related to the
borrower's financial difficulties, grants a concession to the borrower that the
Bank would not otherwise consider under current market conditions. Debt
restructuring or loan modifications for a borrower do not necessarily always
constitute troubled debt restructuring, however, and troubled debt restructuring
does not necessarily result in non-accrual loans.
13
Delinquent Loans. The following table sets forth information concerning
delinquent loans at the dates indicated, in dollar amounts and as a percentage
of each category of the Bank's loan portfolio. The amounts presented represent
the total outstanding principal balances of the related loans, rather than the
actual payment amounts which are past due.
September 30, 2003 September 30, 2002
----------------------------------------------------------------------
30-59 Days 60-89 Days 30-59 Days 60-89 Days
----------------------------------------------------------------------
Percent Percent Percent Percent
of of of of
Loan Loan Loan Loan
Amount Category Amount Category Amount Category Amount Category
----------------------------------------------------------------------
(Dollars in thousands)
Real estate loans:
Single-family residential $ 84 .05% $127 .08% $ -- --% $405 .23%
Multi-family and commercial 531 .90 -- -- 246 .41 -- --
Home equity 64 .19 167 .50 -- -- 35 .13
Consumer loans 12 .83 1 .07 18 1.50 23 1.91
Commercial business loans 60 .59 -- -- 33 .28 -- --
---- ---- ---- ----
Total $751 .25% $295 .10% $297 .10% $463 .15%
==== ==== ==== ====
14
Non-performing Assets. The following table sets forth the amounts and
categories of the Bank's non-performing assets and troubled debt restructurings
at the dates indicated.
September 30,
------------------------------------------
2003 2002 2001 2000 1999
------------------------------------------
(Dollars in thousands)
Non-performing loans:
Single-family residential $ 688 $1,237 $1,924 $2,109 $2,312
Commercial and multi-family(1) 381 2,386 33 -- 289
Construction(2) -- -- -- -- 556
Consumer 16 19 314 48 16
Commercial business 268 138 -- 3 6
------ ------ ------ ------ ------
Total non-performing loans 1,353 3,780 2,271 2,160 3,179
------ ------ ------ ------ ------
Accruing loans more than 90 days delinquent (3) 203 1,358 31 355 1
------ ------ ------ ------ ------
Total non-performing loans 1,556 5,138 2,302 2,515 3,180
------ ------ ------ ------ ------
Real estate owned 1,420 248 887 947 297
------ ------ ------ ------ ------
Total non-performing assets $2,976 $5,386 $3,189 $3,462 $3,477
====== ====== ====== ====== ======
Troubled debt restructurings (4) $ -- $ -- $ -- $ -- $ 24
====== ====== ====== ====== ======
Total non-performing loans and
troubled debt restructurings
as a percentage of gross loans
receivable(5) 0.53% 1.76% 0.92% 1.07% 1.39%
====== ====== ====== ====== ======
Total non-performing assets
as a percentage of total assets 0.53% 1.04% 0.65% 0.75% 0.77%
====== ====== ====== ====== ======
Total non-performing assets and
troubled debt restructurings as
percentage of total assets 0.53% 1.04% 0.65% 0.75% 0.78%
====== ====== ====== ====== ======
- ------------------------
(1) Consists of one loan at September 30, 2003, three loans at September 30,
2002, one loan at September 30, 2001 and two loans at September 30, 1999.
(2) Consists of three loans made to two borrowers at September 30, 1999.
(3) Consists of one commercial real estate loan of $1.3 million which returned
to current status subsequent to September 30, 2002
(4) Consists of lease financing receivables at September 30, 1999 from the
Bennett Funding Group of Syracuse, New York ("Bennett Funding"). The
troubled debt restructurings entered into in 1997 performed in accordance
with the terms of the agreements since the restructurings.
(5) Includes loans receivable and loans held for sale, less construction and
land loans in process and deferred loan origination fees and discounts.
15
The $688,000 of non-performing single-family residential loans at
September 30, 2003 consisted of 16 loans with principal balances ranging from
$2,700 to $164,000, with an average balance of approximately $43,000. Included
within the 16 loans are four loans aggregating $291,000 to credit impaired
borrowers.
At September 30, 2003, non-performing commercial real estate loans were
comprised of two commercial real estate loans totaling $381,000 with the largest
of the two having a carrying value of $320,000. The Bank owns a 25%
participation interest in this loan which is secured by a partially completed
storage facility in Clifton Heights, Pennsylvania. Subsequent to fiscal year
end, the loan was paid off.
Non-performing commercial business loans comprised of four loans with
an average balance of approximately $67,000 and the largest loan having a
carrying value of $125,000.
At September 30, 2003, the $1.4 million of real estate owned (including
in-substance foreclosure) consisted of two single-family residential properties
with an average carrying value of $167,600 and a $1.1 million commercial real
estate property. The commercial real estate property is an 18-hole golf course
and golf house, located in Avondale, Pennsylvania. The golf facility is fully
operational and continues to generate revenues. Foreclosure is expected to occur
in December 2003 and the property is currently being marketed. During fiscal
2003, the Bank incurred expenses in the amount of $299,000 relating to the
workout of these loans. Management expects the costs associated with these loans
to continue into the next fiscal year.
Other Classified Assets. Federal banking regulations require that each
insured savings association classify its assets on a regular basis. In addition,
in connection with examinations of insured institutions, federal examiners have
authority to identify problem assets and, if appropriate, classify them. There
are three classifications for problem assets: "substandard," "doubtful" and
"loss." Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full, on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified loss is considered uncollectible and of
such little value that continuance as an asset of the institution is not
warranted.
At September 30, 2003, the Bank had $3.1 million of assets classified
as substandard, and no assets classified as doubtful or loss. Substantially all
classified assets consist of non-performing assets.
Allowance for Loan Losses. The Bank's policy is to establish reserves
for estimated losses on delinquent loans when it determines that losses are
probable. The allowance for losses on loans is maintained at a level believed by
management to cover all known and inherent losses in its loan portfolio.
Management's analysis of the adequacy of the allowance is based on an evaluation
of the loan portfolio, past loss experience, current economic conditions,
volume, growth and composition of the portfolio, and other relevant factors. The
allowance is increased by provisions for loan losses which are charged against
income. The level of provisions increased in fiscal 2002 compared, to a large
part, to the nonperforming commercial assets aggregating $1.5 million as
discussed above. As shown in the table below, at September 30, 2003, the Bank's
allowance for loan losses amounted to 127.63% and .68% of the Bank's
non-performing loans and gross loans receivable, respectively.
Management of the Bank presently believes that its allowance for loan
losses is adequate to cover any probable losses in the Bank's loan portfolio.
However, future adjustments to this allowance may be necessary, and the Bank's
results of operations could be adversely affected if circumstances differ
substantially from the assumptions used by management in making its
determinations in this regard.
16
The following table provides information regarding the changes in the
allowance for loan losses and other selected statistics for the periods
presented.
YEAR ENDING SEPTEMBER 30,
-----------------------------------------------
2003 2002 2001 2000 1999
-----------------------------------------------
(Dollars in thousands)
Allowance for loan losses, beginning of period $ 2,358 $ 2,181 $ 2,019 $ 1,928 $ 1,738
Charged-off loans:
Single-family residential (50) (317) (492) (182) (12)
Multi-family and commercial (941) -- -- -- --
Construction -- -- -- (117) --
Consumer and commercial business (111) (56) (40) (64) (60)
------- ------- ------- ------- -------
Total charged-off loans (1,102) (373) (532) (363) (72)
------- ------- ------- ------- -------
Recoveries on loans previously charged off:
Single-family residential 4 1 11 -- 2
Commercial leases (1) -- -- 134 33 --
Consumer and commercial business 11 9 9 1 1
------- ------- ------- ------- -------
Total recoveries 15 10 154 34 3
------- ------- ------- ------- -------
Net loans charged-off (1,087) (363) (378) (329) (69)
Provision for loan losses 715 540 540 420 259
------- ------- ------- ------- -------
Allowance for loan losses, end of period $ 1,986 $ 2,358 $ 2,181 $ 2,019 $ 1,928
======= ======= ======= ======= =======
Net loans charged-off to average loans outstanding(2) 0.37% 0.13% 0.16% 0.14% 0.03%
======= ======= ======= ======= =======
Allowance for loan losses to gross loans receivable(2) 0.68% 0.81% 0.87% 0.86% 0.84%
======= ======= ======= ======= =======
Allowance for loan losses to total non-performing loans 127.63% 45.89% 94.74% 80.28% 60.63%
======= ======= ======= ======= =======
Net loans charged-off to allowance for loan losses 54.73% 15.39% 17.33% 16.30% 3.58%
======= ======= ======= ======= =======
Recoveries to charge-offs 1.36% 2.68% 28.95% 9.37% 4.17%
======= ======= ======= ======= =======
(1) Relate to commercial lease purchases in prior years.
(2) Gross loans receivable and average loans outstanding include loans
receivable and loans held for sale, less construction and land loans in
process and deferred loan origination fees and discounts.
17
The following table presents the Bank's allocation of the allowance for
loan losses to the total amount of loans in each category listed at the dates
indicated.
SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------- ------------------- ------------------- ------------------- -------------------
% OF LOANS % OF LOANS % OF LOANS % OF LOANS % OF LOANS
IN EACH IN EACH IN EACH IN EACH IN EACH
CATEGORY TO CATEGORY TO CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
Single-family residential $ 733 55.51% $ 815 57.32% $ 615 59.81% $1,098 65.54% $ 572 69.82%
Commercial and multi-
family residential 317 19.73 767 19.92 566 16.22 198 15.50 166 13.05
Construction 329 9.69 304 9.33 249 10.86 171 7.33 320 7.71
Home equity 34 11.19 40 9.10 59 9.65 41 9.25 34 7.80
Consumer 10 .48 10 .40 11 .42 8 .55 8 .70
Commercial business 132 3.40 86 3.93 87 3.04 60 1.83 14 .92
Unallocated 431 -- 336 -- 594 -- 443 -- 814 --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance for
loan losses $1,986 100.00% $2,358 100.00% $2,181 100.00% $2,019 100.00% $1,928 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
18
MORTGAGE-RELATED SECURITIES AND INVESTMENT SECURITIES
Mortgage-Related Securities. Federally chartered savings institutions
have authority to invest in various types of liquid assets, including U.S.
Treasury obligations, securities of various federal agencies and of state and
municipal governments, certificates of deposit at federally insured banks and
savings and loan associations, certain bankers' acceptances and federal funds.
Subject to various restrictions, federally chartered savings institutions also
may invest a portion of their assets in commercial paper, corporate debt
securities and mutual funds, the assets of which conform to the investments that
federally chartered savings institutions are otherwise authorized to make
directly.
The Bank maintains a significant portfolio of mortgage-related
securities (including mortgage-backed securities and collateralized mortgage
obligations ("CMOs") as a means of investing in housing-related mortgage
instruments without the costs associated with originating mortgage loans for
portfolio retention and with limited credit risk of default which arises in
holding a portfolio of loans to maturity. Mortgage-backed securities (which also
are known as mortgage participation certificates or pass-through certificates)
represent a participation interest in a pool of single-family or multi-family
residential mortgages. The principal and interest payments on mortgage-backed
securities are passed from the mortgage originators, as servicer, through
intermediaries (generally U.S. Government agencies and government-sponsored
enterprises) that pool and repackage the participation interests in the form of
securities, to investors such as the Bank. Such U.S. Government agencies and
government sponsored enterprises, which guarantee the payment of principal and
interest to investors, primarily include FHLMC, FNMA and the Government National
Mortgage Association ("GNMA"). The Bank also invests in certain privately
issued, credit enhanced mortgage-related securities rated AAA by national
securities rating agencies.
FHLMC is a public corporation chartered by the U.S. Government. FHLMC
issues participation certificates backed principally by conventional mortgage
loans. FHLMC guarantees the timely payment of interest and the ultimate return
of principal on participation certificates. FNMA is a private corporation
chartered by the U.S. Congress with a mandate to establish a secondary market
for mortgage loans. FNMA guarantees the timely payment of principal and interest
on FNMA securities. FHLMC and FNMA securities are not backed by the full faith
and credit of the United States, but because FHLMC and FNMA are U.S.
Government-sponsored enterprises, these securities are considered to be among
the highest quality investments with minimal credit risks. GNMA is a government
agency within the Department of Housing and Urban Development which is intended
to help finance government-assisted housing programs. GNMA securities are backed
by Federal Housing Administration ("FHA") insured and the Department of Veterans
Affairs ("VA") guaranteed loans, and the timely payment of principal and
interest on GNMA securities are guaranteed by the GNMA and backed by the full
faith and credit of the U.S. Government. Because FHLMC, FNMA and GNMA were
established to provide support for low- and middle-income housing, there are
limits to the maximum size of loans that qualify for these programs which is
currently $322,700.
Mortgage-related securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
underlying pool of mortgages can be composed of either fixed-rate or
adjustable-rate loans. As a result, the risk characteristics of the underlying
pool of mortgages (i.e., fixed-rate or adjustable rate) as well as prepayment
risk, are passed on to the certificate holder. Thus, the life of a
mortgage-backed pass-through security thus approximates the life of the
underlying mortgages.
The Bank's mortgage-related securities include regular interests in
CMOs. CMOs were developed in response to investor concerns regarding the
uncertainty of cash flows associated with the prepayment option of the
underlying mortgagor and are typically issued by governmental agencies,
governmental sponsored enterprises and special purpose entities, such as trusts,
corporations or partnerships, established by financial institutions or other
similar institutions. A CMO can be (but is not required to be) collateralized by
loans or securities which are insured or guaranteed by FNMA, FHLMC or the GNMA.
In contrast to pass-through mortgage-related securities, in which cash flow is
received pro rata by all security holders, the cash flow from the mortgages
underlying a CMO is segmented and paid in accordance with a predetermined
priority to investors holding
19
various CMO classes. By allocating the principal and interest cash flows from
the underlying collateral among the separate CMO classes, different classes of
bonds are created, each with its own stated maturity, estimated average life,
coupon rate and prepayment characteristics.
The short-term classes of a CMO usually carry a lower coupon rate than
the longer term classes and, therefore, the interest differential cash flow on a
residual interest is greatest in the early years of the CMO. As the early coupon
classes are extinguished, the residual income declines. Thus, the longer the
lower coupon classes remain outstanding, the greater the cash flow accruing to
CMO residuals. As interest rates decline, prepayments accelerate, the interest
differential narrows, and the cash flow from the CMO declines. Conversely, as
interest rates increase, prepayments decrease, generating a larger cash flow to
residuals.
A senior-subordinated structure often is used with CMOs to provide
credit enhancement for securities which are backed by collateral which is not
guaranteed by FNMA, FHLMC or the GNMA. These structures divide mortgage pools
into various risk classes: a senior class and one or more subordinated classes.
The subordinated classes provide protection to the senior class. When cash flow
is impaired, debt service goes first to the holders of senior classes. In
addition, incoming cash flows also may go into a reserve fund to meet any future
shortfalls of cash flow to holders of senior classes. The holders of
subordinated classes may not receive any funds until the holders of senior
classes have been paid and, when appropriate, until a specified level of funds
has been contributed to the reserve fund.
Mortgage-related securities generally bear yields which are less than
those of the loans which underlie such securities because of their payment
guarantees or credit enhancements which reduce credit risk to nominal levels.
However, mortgage-related securities are more liquid than individual mortgage
loans and may be used to collateralize certain obligations of the Bank. At
September 30, 2003, $13.1 million of the Bank's mortgage-related securities were
pledged to secure various obligations of the Bank, treasury tax and loan
processing and as collateral for certain municipal deposits.
The Bank's mortgage-related securities are classified as either "held
to maturity" or "available for sale" based upon the Bank's intent and ability to
hold such securities to maturity at the time of purchase, in accordance with
GAAP. As of September 30, 2003, the Bank had an aggregate of $128.1 million, or
22.9%, of total assets invested in mortgage-related securities, net, of which
$3.5 million was held to maturity and $124.6 million was available for sale. The
mortgage-related securities of the Bank which are held to maturity are carried
at cost, adjusted for the amortization of premiums and the accretion of
discounts using a method which approximates a level yield, while
mortgage-related securities available for sale are carried at the current fair
value. See Notes 2 and 4 of the Notes to Consolidated Financial Statements set
forth in Item 8 hereof.
20
The following table sets forth the composition of the Bank's available
for sale (at fair value) and held to maturity (at amortized cost) of the
mortgage-related securities portfolios at the dates indicated.
September 30,
---------------------------------------
2003 2002 2001
---------------------------------------
(Dollars in thousands)
Available for sale:
Mortgage-backed securities:
FHLMC $ 6,950 $ 5,261 $ 9,175
FNMA 46,030 13,463 15,056
GNMA 13,639 33,621 43,907
-------- -------- --------
Total mortgage-backed securities 66,619 52,345 68,138
-------- -------- --------
Collateralized mortgage obligations:
FHLMC 20,239 9,509 10,994
FNMA 5,381 3,751 6,215
GNMA -- -- 17
Other 32,417(1) 20,069(2) 32,244(3)
-------- -------- --------
Total collateralized mortgage obligations 58,037 33,329 49,470
-------- -------- --------
Total mortgage-related securities $124,656 $ 85,674 $117,608
======== ======== ========
Held to maturity:
Mortgage-backed securities:
FHLMC $ 478 $ 1,433 $ 2,285
FNMA 2,123 3,574 4,684
-------- -------- --------
Total mortgage-backed securities 2,601 5,007 6,969
-------- -------- --------
Collateralized mortgage obligations:
FNMA 886 3,848 4,485
-------- -------- --------
Total collateralized mortgage obligations 886 3,848 4,485
-------- -------- --------
Total mortgage-related securities, amortized cost $ 3,487 $ 8,855 $ 11,454
======== ======== ========
Total fair value(4) $ 3,560 $ 9,090 $ 11,550
======== ======== ========
(1) Includes "AAA" rated securities of Countrywide Home Loans, Washington
Mutual, AMAC and First Horizon with book values of $6.5 million, $6.8
million, $4.7 million and $ 3.6 million, respectively, and fair values
of $6.4 million, $6.7 million, $4.8 million and $3.5 million.
(2) Includes "AAA" rated securities of Northwest Asset Securities
Corporation, Credit Suisse First Boston, Washington Mutual and
Countrywide Home Loans with book values of $2.9 million, $4.1 million,
$5.1 million and $2.7 million, respectively, and fair value of $3.0
million, $4.1 million, $5.1 million and $2.8 million, respectively.
(3) Includes "AAA" rated securities of Northwest Asset Securities
Corporation, Chase Mortgage Services, Washington Mutual and Countrywide
Home Loans with book values of $5.5 million, $3.1 million, $4.2 million
and $5.0 million, respectively, and fair values of $5.7 million, $3.1
million, $4.3 million and $5.0 million, respectively.
(4) See Note 4 of the Notes to Consolidated Financial Statements set forth
in Item 8 hereof.
21
The following table sets forth the purchases, sales and principal
repayments of the Bank's mortgage-related securities for the periods indicated.
YEAR ENDED SEPTEMBER 30,
------------------------------------
2003 2002 2001
------------------------------------
(Dollars in thousands)
Mortgage-related securities, beginning of period(1)(2) $ 94,529 $ 129,062 $ 109,313
--------- --------- ---------
Purchases:
Mortgage-backed securities - available for sale 50,199 9,280 24,501
CMOs - available for sale 81,942 18,231 34,162
Sales:
Mortgage-backed securities - available for sale (4,493) -- (6,888)
CMOs - available for sale (3,064) -- --
Repayments and prepayments:
Mortgage-backed securities (32,563) (26,820) (21,568)
CMOs (55,941) (34,554) (14,808)
Decrease in net premium (1,128) (315) (145)
Change in net unrealized (loss) gain on mortgage-related
securities available for sale (1,338) (355) 4,495
--------- --------- ---------
Net increase (decrease) in mortgage-related securities 33,614 (34,533) 19,749
--------- --------- ---------
Mortgage-related securities, end of period(1) (2) $ 128,143 $ 94,529 $ 129,062
========= ========= =========
(1) Includes both mortgage-related securities available for sale and held
to maturity.
(2) Calculated at amortized cost for securities held to maturity and at
fair value for securities available for sale.
At September 30, 2003, the estimated weighted average maturity of the
Bank's fixed-rate mortgage-related securities was approximately 3.27 years. The
actual maturity of a mortgage-backed security is less than its stated maturity
due to prepayments of the underlying mortgages. Prepayments that are faster than
anticipated may shorten the life of the security and adversely affect its yield
to maturity. The yield is based upon the interest income and the amortization of
any premium or discount related to the mortgage-backed security. In accordance
with GAAP, premiums and discounts are amortized over the estimated lives of the
securities, which decrease and increase interest income, respectively. The
prepayment assumptions used to determine the amortization period for premiums
and discounts can significantly affect the yield of the mortgage-backed
security, and these assumptions are reviewed periodically to reflect actual
prepayments. Although prepayments of underlying mortgages depend on many
factors, including the type of mortgages, the coupon rate, the age of mortgages,
the geographical location of the underlying real estate collateralizing the
mortgages and general levels of market interest rates, the difference between
the interest rates on the underlying mortgages and the prevailing mortgage
interest rates generally is the most significant determinant of the rate of
prepayments. During periods of declining mortgage interest rates, such as the
Bank experienced during fiscal 2003 and 2002, if the coupon rates of the
underlying mortgages exceed the prevailing market interest rates offered for
mortgage loans, refinancings generally increase and accelerate the prepayment
rate of the underlying mortgages and the related securities. Conversely, during
periods of increasing mortgage interest rates, if the coupon rates of the
underlying mortgages are less than the prevailing market interest rates offered
for mortgage loans, refinancings generally decrease and decrease the prepayment
rate of the underlying mortgages and the related securities. As a result of the
declining interest rate environment, the Bank experienced high levels of
repayments and accelerated prepayments, and consequently, the Bank reinvested
the proceeds of such repayments and prepayments at a lower yield.
22
Investment Securities. The following table sets forth information
regarding the carrying and fair value of the Company's investment securities,
both held to maturity and available for sale, at the dates indicated.
AT SEPTEMBER 30,
----------------------------------------------------------
2003 2002 2001
----------------------------------------------------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE VALUE VALUE
----------------------------------------------------------
(Dollars in thousands)
FHLB stock $ 8,294 $ 8,294 $ 6,571 $ 6,571 $ 6,917 $ 6,917
U.S. Government and agency
obligations
1 to 5 years 13,020 13,004 11,986 12,114 2,961 3,133
5 to 10 years 4,880 4,988 1,861 2,071 1,843 2,050
Municipal obligations 17,373 17,895 19,012 19,800 21,890 22,626
Corporate bonds 20,621 21,693 14,299 14,720 14,333 14,087
Mutual funds 14,009 13,952 14,009 14,045 5,009 5,004
Asset backed securities 1,911 1,922 2,837 2,853 2,986 2,970
Preferred stocks 5,474 4,984 10,682 10,751 9,474 9,197
Other equity investments 3,126 5,712 3,476 4,269 2,778 3,497
------- ------- ------- ------- ------- -------
Total $88,708 $92,444 $84,733 $87,194 $68,191 $69,481
======= ======= ======= ======= ======= =======
At September 30, 2003, the Company had an aggregate of $92.4 million,
or 16.5%, of its total assets invested in investment securities, of which $8.3
million consisted of FHLB stock, $77.7 million was investment securities
available for sale and $6.5 million held to maturity. Included in U.S.
Government and agency obligations are callable bonds with a remaining term of
approximately four years. The Bank's investment securities (excluding mutual
funds, equity securities and FHLB stock) had a weighted average maturity to the
call date of 6.0 years and a weighted average yield of 6.1% (adjusted to a fully
taxable equivalent yield).
SOURCES OF FUNDS
General. The Bank's principal source of funds for use in lending and
for other general business purposes has traditionally come from deposits
obtained through the Bank's branch offices. The Bank also derives funds from
contractual payments and prepayments of outstanding loans and mortgage-related
securities, from sales of loans, from maturing investment securities and from
advances from the FHLB of Pittsburgh and other borrowings. Loan repayments are a
relatively stable source of funds, while deposits inflows and outflows are
significantly influenced by general interest rates and money market conditions.
The Bank uses borrowings to supplement its deposits as a source of funds.
Deposits. The Bank's current deposit products include passbook
accounts, NOW accounts, MMDA, certificates of deposit ranging in terms from 30
days to five years and non-interest-bearing personal and business checking
accounts. The Bank's deposit products also include Individual Retirement Account
("IRA") certificates and Keogh accounts.
The Bank's deposits are obtained primarily from residents in Delaware
and Chester counties in southeastern Pennsylvania. The Bank attracts local
deposit accounts by offering a wide variety of accounts, competitive interest
rates, and convenient branch office locations and service hours. The Bank
utilizes traditional marketing methods to attract new customers and savings
deposits, including print media, radio advertising and direct mailings. However,
the Bank does not solicit funds through deposit brokers nor does it pay any
brokerage fees if it accepts such deposits.
23
The Bank has been competitive in the types of accounts and interest
rates it has offered on its deposit products but does not necessarily seek to
match the highest rates paid by competing institutions. Even with the
significant decline in interest rates paid on deposit products in fiscal 2003
and 2002, due to generally declining returns on competing investment
opportunities as well as the effects of the stock market decline, the Bank did
not experience disintermediation of deposits into competing investment products
in fiscal 2003 and 2002.
The following table shows the distribution of, and certain information
relating to, the Bank's deposits by type of deposit as of the dates indicated.
SEPTEMBER 30,
------------------------------------------------------------
2003 2002 2001
------------------------------------------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------------------------------------------------------------
(Dollars in thousands)
Passbook $ 47,089 12.99% $ 41,659 12.60% $ 37,806 12.13%
MMDA 55,889 15.41 48,721 14.73 40,781 13.09
NOW 60,221 16.61 48,803 14.75 45,161 14.49
Certificates of deposit 178,489 49.22 176,242 53.28 182,155 58.46
Non-interest-bearing 20,917 5.77 15,340 4.64 5,698 1.83
-------- ------ -------- ------ -------- ------
Total deposits $362,605 100.00% $330,765 100.00% $311,601 100.00%
======== ====== ======== ====== ======== ======
The following table sets forth the net savings flows of the Bank during
the periods indicated.
YEAR ENDED SEPTEMBER 30,
---------------------------
2003 2002 2001
---------------------------
(Dollars in thousands)
Increase before interest credited $25,633 $10,477 $27,876
Interest credited 6,207 8,687 11,163
------- ------- -------
Net savings increase $31,840 $19,164 $39,039
======= ======= =======
The following table sets forth maturities of the Bank's certificates of
deposit of $100,000 or more at September 30, 2003 and 2002 by time remaining to
maturity (amounts in thousands).
SEPTEMBER 30
-----------------
2003 2002
-----------------
Three months or less $11,724 $10,764
Over three months through six months 6,581 5,509
Over six months through twelve months 5,984 6,679
Over twelve months 9,889 9,618
------- -------
$34,178 $32,570
======= =======
24
The following table presents, by various interest rate categories, the
amount of certificates of deposit at September 30, 2003 and 2002 and the amounts
at September 30, 2003 which mature during the periods indicated.
AMOUNTS AT SEPTEMBER 30, 2003
SEPTEMBER 30, MATURING WITHIN
-------------------- ----------------------------------------------
Certificates of Deposit 2003 2002 ONE YEAR TWO YEARS THREE YEARS THEREAFTER
-------------------- ----------------------------------------------
(Dollars in thousands)
2.0% or less $ 61,363 $ 3,475 $ 49,859 $ 11,504 $ -- $ --
2.01% to 3.0% 39,394 63,429 19,527 16,497 2,703 667
3.01% to 4.0% 42,191 66,834 25,240 4,271 788 11,892
4.01% to 5.0% 19,694 23,064 1,882 7,335 1,214 9,263
5.01% to 6.0% 6,219 9,717 713 2,244 3,257 5
6.01% to 7.0% 9,628 9,723 9,410 218 -- --
-------- -------- -------- -------- -------- --------
Total certificate accounts $178,489 $176,242 $106,631 $ 42,069 $ 7,962 $ 21,827
======== ======== ======== ======== ======== ========
The following table presents the average balance of each deposit type
and the average rate paid on each deposit type for the periods indicated.
SEPTEMBER 30,
---------------------------------------------------------
2003 2002 2001
---------------------------------------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE RATE AVERAGE RATE AVERAGE RATE
BALANCE PAID BALANCE PAID BALANCE PAID
---------------------------------------------------------
(Dollars in thousands)
Passbook accounts $ 44,105 1.20% $ 40,300 1.86% $ 37,661 2.41%
MMDA accounts 51,756 1.42 47,245 2.19 31,645 3.86
Certificates of deposit 178,097 3.24 174,844 4.24 177,086 5.87
NOW accounts 55,496 .57 49,235 .81 40,681 1.32
Non-interest-bearing deposits 14,272 -- 7,720 -- 7,658 --
-------- -------- --------
Total deposits $343,726 2.14% $319,344 3.01% $294,731 4.43%
======== ==== ======== ==== ======== ====
25
Borrowings. The Bank may obtain advances from the FHLB of Pittsburgh
upon the security of the common stock it owns in the FHLB and certain of its
residential mortgage loans and securities held to maturity, provided certain
standards related to creditworthiness have been met. Such advances are made
pursuant to several credit programs, each of which has its own interest rate and
range of maturities. During fiscal 2003, the Company funded a portion of its
asset growth with overnight borrowings from FHLB. However, during fiscal 2002,
the increase in core deposits funded asset growth, therefore borrowing from the
FHLB was not necessary. At September 30, 2003, the Bank had $126.4 million in
outstanding FHLB advances. The FHLB advances have certain call features whereby
the FHLB of Pittsburgh can call the borrowings after the expiration of certain
time frames. The time frames on the callable borrowings range from three months
to seven years. See Note 9 of the Notes to Consolidated Financial Statements set
forth in Item 8 hereof.
SUBSIDIARIES
The Bank is permitted to invest up to 2% of its assets in the capital
stock of, or secured or unsecured loans to, service corporations, with an
additional investment of 1% of assets when such additional investment is
utilized primarily for community development purposes. It may invest essentially
unlimited amounts in subsidiaries deemed operating subsidiaries that can only
engage in activities that the Bank is permitted to engage in. Under such
limitations, as of September 30, 2003, the Bank was authorized to invest up to
approximately $11.0 million in the stock of, or loans to, service corporations.
As of September 30, 2003, the net book value of the Bank's investment in stock,
unsecured loans, and conforming loans to its service corporations was $38,100.
At September 30, 2003, in addition to the Bank, the Company has six
direct or indirect subsidiaries: First Keystone Capital Trust I, First Keystone
Capital Trust II, FKF Management Corp., Inc., State Street Services Corp., First
Pointe, Inc. and First Chester Services, Inc.
First Keystone Capital Trust I (the "Trust") is a Delaware statutory
business trust wholly owned by the Company formed in 1997 for the purpose of
issuing trust preferred securities and investing the proceeds there from in
Junior Subordinated Debentures issued by the Company. See Note 17 of the Notes
to Consolidated Financial set forth in Item 8 hereof for further discussion
regarding the issuance of trust preferred securities.
First Keystone Capital Trust II (the "Trust II") is a Delaware
statutory business trust wholly owned by the Company formed in 2001 for the
purpose of issuing trust preferred securities and investing the proceeds in
Junior Subordinated Debentures issued by the Company. See Note 17 of the Notes
to the Consolidated Financial Statements set forth in Item 8 hereof for further
discussion regarding the issuance of trust preferred securities.
FKF Management Corp., Inc., a Delaware corporation, is a wholly owned
operating subsidiary of the Bank established in 1997 for the purpose of managing
certain assets of the Bank. Assets under management totaled $150.5 million at
September 30, 2003 and were comprised principally of investment and
mortgage-related securities.
State Street Services Corp. is a wholly owned subsidiary of the Bank
established in 1999 for the purpose of offering a full array of insurance
products through its ownership of a 51% interest in First Keystone Insurance
Services, LLC. In addition, it holds a 10% equity position in a title company
which offers title services.
The Bank has two remaining subsidiaries, First Chester Services, Inc.
and First Pointe, Inc., which were both involved in real estate management but
are now inactive.
EMPLOYEES
The Bank had 88 full-time employees and 15 part-time employees as of
September 30, 2003. None of these employees is represented by a collective
bargaining agreement. The Bank believes that it enjoys excellent relations with
its personnel.
26
REGULATION
The Company. The Company as a savings and loan holding company within
the meaning of the Home Owners' Loan Act, as amended ("HOLA"), is registered as
such with the OTS and is subject to OTS regulations, examination, supervision
and reporting requirements. As a subsidiary of a savings and loan holding
company, the Bank is subject to certain restrictions in its dealings with the
Company and affiliates thereof.
Federal Activities Restrictions. The Company operates as a unitary
savings and loan holding company. Generally, there are only limited restrictions
on the activities of a unitary savings and loan holding company which applied to
become or was a unitary saving and loan holding company prior to May 4, 1999 and
its non-savings institution subsidiaries. Under the Gramm-Leach-Bliley Act of
1999 (the "GLBA"), companies which apply to the OTS to become unitary savings
and loan holding companies will be restricted to only engaging in those
activities traditionally permitted to multiple saving and loan holding
companies. However, if the Director of the OTS determines that there is
reasonable cause to believe that the continuation by a savings and loan holding
company of an activity constitutes a serious risk to the financial safety,
soundness or stability of its subsidiary savings association, the Director may
impose such restrictions as deemed necessary to address such risk, including
limiting (i) payment of dividends by the savings association; (ii) transactions
between the savings association and its affiliates; and (iii) any activities of
the savings association that might create a serious risk that the liabilities of
the holding company and its affiliates may be imposed on the savings
association. Notwithstanding the above rules regarding permissible business
activities of grandfathered unitary savings and loan holding companies under the
GLBA (such as the Company), if the savings association subsidiary of such a
holding company fails to meet the Qualified Thrift Lender ("QTL") test, then
such unitary holding company also shall become subject to the activities
restrictions applicable to multiple savings and loan holding companies and,
unless the savings association qualifies as a QTL within one year thereafter,
shall register as, and become subject to the restrictions applicable to, a bank
holding company.
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company and
would thereafter be subject to further restrictions on its activities.
The GLBA also imposes financial privacy obligations and reporting
requirements on all financial institutions. The privacy regulations require,
among other things, that financial institutions establish privacy policies and
disclose such policies to its customers at the commencement of a customer
relationship and annually thereafter. In addition, financial institutions are
required to permit customers to opt out of the financial institution's
disclosure of the customer's financial information to non-affiliated third
parties.
The HOLA requires every savings institution subsidiary of a savings and
loan holding company to give the OTS at least 30 days' advance notice of any
proposed dividends to be made on its guarantee, permanent or other
nonwithdrawable stock, or else such dividend will be invalid. See "- The Bank -
Restrictions on Capital Distributions."
Limitations on Transactions with Affiliates. Transactions between
savings associations and any affiliate are governed by Sections 23A and 23B of
the Federal Reserve Act ("FRA") and OTS regulations issued in connection
therewith. Affiliates of a savings institution include, among other entities,
the savings institution's holding company and companies that are controlled by
or under common control with the savings institution. Generally, Sections 23A
and 23B (i) limit the extent to which the savings association or its
subsidiaries may engage in "covered transactions" with any one affiliate to an
amount equal to 10% of such association's capital stock and surplus, and contain
an aggregate limit on all such transactions with all affiliates to an amount
equal to 20% of such capital stock and surplus and (ii) require that all such
transactions be on terms substantially the same, or at least as favorable, to
the association or subsidiary as those provided to a non-affiliate. The term
"covered transaction" includes, among other things, the making of loans or
extension of credit to an affiliate, purchase of assets, issuance of a guarantee
and similar transactions. In addition to the restrictions imposed by Sections
23A and 23B, under OTS regulations no savings association may (i) loan or
otherwise extend credit to an affiliate, except for any affiliate which engages
only in activities which are permissible for bank holding companies, (ii) a
savings association may not purchase or invest in securities of an affiliate
other than shares of a subsidiary; (iii) a savings association and its
subsidiaries may not purchase a low-quality asset from an affiliate; (iv) and
covered transactions and certain other transactions between a savings
association or its subsidiaries and an affiliate must
27
be on terms and conditions that are consistent with safe and sound banking
practices. With certain exceptions, each extension of credit by a savings
association to an affiliate must be secured by collateral with a market value
ranging from 100% to 130% (depending on the type of collateral) of the amount of
the loan or extension of credit.
OTS regulations generally exclude all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve Board decides to treat
such subsidiaries as affiliates. The regulations also require savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail, and provide that certain classes of savings associations may
be required to give the OTS prior notice of affiliate transactions.
Restrictions on Acquisitions. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior approval
of the Director of the OTS, (i) control of any other savings association or
savings and loan holding company or substantially all of the assets thereof; or
(ii) more than 5% of the voting shares of a savings association or holding
company thereof which is not a subsidiary. Except with the prior approval of the
Director of the OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may acquire control of any savings association, other than
a subsidiary savings association, or of any other savings and loan holding
company.
Federal Securities Laws. The Company's Common Stock is registered with
the SEC under the Securities Exchange Act of 1934, as amended ("Exchange Act").
The Company is subject to the information, proxy solicitation, insider trading
restrictions and other requirements under the Exchange Act.
Shares of Common Stock owned by an affiliate of the Company are subject
to the resale restrictions of Rule 144 under the Securities Act of 1933, as
amended ("Securities Act"). As long as the Company meets the current public
information requirements of Rule 144 under the Securities Act, each affiliate of
the Company who complies with the other conditions of Rule 144 (including those
that require the affiliate's sale to be aggregated with those of certain other
persons) generally is able to sell in the public market, without registration, a
number of shares not to exceed, in any three-month period, the greater of (i) 1%
of the outstanding shares of the Company or (ii) the average weekly volume of
trading in such shares during the preceding four calendar weeks.
Sarbanes-Oxley Act of 2002. On July 30, 2002, the President signed into
law the Sarbanes-Oxley Act of 2002 (the "Act") implementing legislative reforms
intended to address corporate and accounting fraud. In addition to the
establishment of a new accounting oversight board which will enforce auditing,
quality control and independence standards and will be funded by fees from all
publicly traded companies, the bill restricts provision of both auditing and
consulting services by accounting firms. To ensure auditor independence, any
non-audit services being provided to an audit client will require preapproval by
the company's audit committee members. In addition, the audit partners must be
rotated. The Act requires chief executive officers and chief financial officers,
or their equivalent, to certify to the accuracy of periodic reports filed with
the SEC, subject to civil and criminal penalties if they knowingly or willfully
violate this certification requirement. In addition, under the Act, counsel will
be required to report evidence of a material violation of the securities laws or
a breach of fiduciary duty by a company to its chief executive officer or its
chief legal officer, and, if such officer does not appropriately respond, to
report such evidence to the audit committee or other similar committee of the
board of directors or the board itself.
Longer prison terms and increased penalties will also be applied to
corporate executives who violate federal securities laws, the period during
which certain types of suits can be brought against a company or its officers
has been extended, and bonuses issued to top executives prior to restatement of
a company's financial statements are now subject to disgorgement if such
restatement was due to corporate misconduct. Executives are also prohibited from
insider trading during retirement plan "blackout" periods, and loans to company
executives are restricted. In addition, a provision directs that civil penalties
levied by the SEC as a result of any judicial or administrative action under the
Act be deposited to a fund for the benefit of harmed investors. The Federal
Accounts for Investor Restitution ("FAIR") provision also requires the SEC to
develop methods of improving collection rates. The legislation accelerates the
time frame for disclosures by public companies, as they must immediately
disclose any material changes in their financial condition or operations.
Directors and executive officers must also provide information for most changes
in ownership in a company's securities within two business days of the change.
28
The Act also increases the oversight of, and codifies certain
requirements relating to audit committees of public companies and how they
interact with the company's "registered public accounting firm" ("RPAF"). Audit
committee members must be independent and are barred from accepting consulting,
advisory or other compensatory fees from the issuer. In addition, companies must
disclose whether at least one member of the committee is a "financial expert"
(as such term is defined by the SEC in regulations promulgated thereby) and if
not, why not. Under the Act, a RPAF is prohibited from performing statutorily
mandated audit services for a company if such company's chief executive officer,
chief financial officer, comptroller, chief accounting officer or any person
serving in equivalent positions has been employed by such firm and participated
in the audit of such company during the one-year period preceding the audit
initiation date. The Act also prohibits any officer or director of a company or
any other person acting under their direction from taking any action to
fraudulently influence, coerce, manipulate or mislead any independent public or
certified accountant engaged in the audit of the company's financial statements
for the purpose of rendering the financial statement's materially misleading.
The Act also requires the SEC to prescribe rules requiring inclusion of an
internal control report and assessment by management in the annual report to
stockholders. The Act requires the RPAF that issues the audit report to attest
to and report on management's assessment of the company's internal controls. In
addition, the Act requires that each financial report required to be prepared in
accordance with (or reconciled to) accounting principles generally accepted in
the United States of America and filed with the SEC reflect all material
correcting adjustments that are identified by a RPAF in accordance with
accounting principles generally accepted in the United States of America and the
rules and regulations of the SEC.
The Bank. The OTS has extensive regulatory authority over the operations
of savings associations such as the Bank. As part of this authority, savings
associations are required to file periodic reports with the OTS and are subject
to periodic examinations by the OTS. The investment and lending authority of
savings associations are prescribed by federal laws and regulations and they are
prohibited from engaging in any activities not permitted by such laws and
regulations. Those laws and regulations generally are applicable to all
federally chartered savings associations and may also apply to state-chartered
savings associations. Such regulation and supervision is primarily intended for
the protection of depositors.
Insurance of Accounts. The deposits of the Bank are insured to the
maximum extent permitted by the SAIF, which is administered by the FDIC, and are
backed by the full faith and credit of the U. S. Government. As insurer, the
FDIC is authorized to conduct examinations of, and to require reporting by,
FDIC-insured institutions. It also may prohibit any FDIC-insured institution
from engaging in any activity the FDIC determines by regulation or order to pose
a serious threat to the FDIC. The FDIC also has the authority to initiate
enforcement actions against savings associations, after giving the OTS an
opportunity to take such action.
Under current Federal Deposit Insurance Corporation regulations, Savings
Association Insurance Fund-insured institutions are assigned to one of three
capital groups which are based solely on the level of an institution's capital -
"well capitalized," "adequately capitalized" and "undercapitalized" - which are
defined in the same manner as the regulations establishing the prompt corrective
action system discussed below. These three groups are then divided into three
subgroups which reflect varying levels of supervisory concern, from those which
are considered to be healthy to those which are considered to be of substantial
supervisory concern. The matrix so created results in nine assessment risk
classifications, with rates during the first six months of 2003 ranging from
zero for well capitalized, healthy institutions, such as the Bank, to 27 basis
points for undercapitalized institutions with substantial supervisory concerns.
In addition, all institutions with deposits insured by the Federal
Deposit Insurance Corporation are required to pay assessments to fund interest
payments on bonds issued by the Financing Corporation, a mixed-ownership
government corporation established to recapitalize the predecessor to the
Savings Association Insurance Fund. The assessment rate for the third quarter of
2003 was .016% of insured deposits and is adjusted quarterly. These assessments
will continue until the Financing Corporation bonds mature in 2019.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process
29
for the permanent termination of insurance, if the institution has no tangible
capital. If insurance of accounts is terminated, the accounts at the institution
at the time of the termination, less subsequent withdrawals, shall continue to
be insured for a period of six months to two years, as determined by the FDIC.
Management is not aware of any existing circumstances which could result in
termination of the Bank's deposit insurance.
Capital requirements. Current OTS capital standards require savings
associations to satisfy three different capital requirements. Under these
standards, savings associations must maintain "tangible" capital equal to 1.5%
of adjusted total assets, "core" capital equal to 4% (3% if the association
receives the OTS' highest rating) of adjusted total assets and "total" capital
(a combination of core and "supplementary" capital) equal to 8.0% of
"risk-weighted" assets. For purposes of the regulation, core capital generally
consists of common stockholders' equity (including retained earnings),
noncumulative perpetual preferred stock and related surplus, minority interests
in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Tangible capital is given the same definition as core capital but
does not include qualifying supervisory goodwill and is reduced by the amount of
all the savings association's intangible assets, with only a limited exception
for purchased mortgage servicing rights ("PMSRs"). Both core and tangible
capital are further reduced by an amount equal to a savings association's debt
and equity investments in subsidiaries engaged in activities not permissible for
national banks (other than subsidiaries engaged in activities undertaken as
agent for customers or in mortgage banking activities and subsidiary depository
institutions or their holding companies). In addition, under the Prompt
Corrective Action provisions of the OTS regulations, all but the most highly
rated institutions must maintain a minimum leverage ratio of 4% in order to be
adequately capitalized. See "- Prompt Corrective Action." At September 30, 2003,
the Bank did not have any investment in subsidiaries engaged in impermissible
activities and required to be deducted from its capital calculation.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") granted the OTS the authority to prescribe rules for the amount of
PMSRs that may be included in a savings association's regulatory capital and
required that the value of readily marketable PMSRs included in the calculation
of a savings association's regulatory capital not exceed 90% of fair market
value and that such value be determined at least quarterly. Under OTS
regulations, (i) PMSRs do not have to be deducted from tangible and core
regulatory capital, provided that they do not exceed 50% of core capital, (ii)
savings associations are required to determine the fair market value and to
review the book value of their PMSRs at least quarterly and to obtain an
independent valuation of PMSRs annually, (iii) savings associations that desire
to include PMSRs in regulatory capital may not carry them at a book value under
GAAP that exceeds the discounted value of their future net income stream and
(iv) for purposes of calculating regulatory capital, the amount of PMSRs
reported as balance sheet assets should amount to the lesser of 90% of their
fair market value, 90% of their original purchase price or 100% of their
remaining unamortized book value. At September 30, 2003, the Bank had PMSRs
totaling $197,600.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital does not exceed the savings association's core capital. Supplementary
capital generally consists of hybrid capital instruments; perpetual preferred
stock which is not eligible to be included as core capital; subordinated debt
and intermediate-term preferred stock; and, subject to limitations, general
allowances for loan losses. Assets are adjusted under the risk-based guidelines
to take into account different risk characteristics, with the categories ranging
from 0% (requiring no additional capital) for assets such as cash to 100% for
repossessed assets or loans more than 90 days past due. Single-family
residential real estate loans which are not past-due or non-performing and which
have been made in accordance with prudent underwriting standards are assigned a
50% level in the risk-weighing system, as are certain privately-issued
mortgage-backed securities representing indirect ownership of such loans.
Off-balance sheet items also are adjusted to take into account certain risk
characteristics.
The OTS amended its risk-based capital requirements that would require
institutions with an "above normal" level of interest rate risk to maintain
additional capital. A savings association is considered to have a "normal" level
of interest rate risk if the decline in the market value of its portfolio equity
after an immediate 200 basis point increase or decrease in market interest rates
(whichever leads to the greater decline) is less than two percent of the current
estimated market value of its assets. The market value of portfolio equity is
defined as the net present value of expected cash inflows and outflows from an
association's assets, liabilities, and off-balance sheet items. The amount of
additional capital, that an institution with an above normal interest rate risk
is required to maintain (the "interest rate risk component") equals one-
30
half of the dollar amount by which its measured interest rate risk exceeds the
normal level of interest rate risk. The interest rate risk component is in
addition to the capital otherwise required to satisfy the risk-based capital
requirement. Implementation of this component has been postponed by the OTS. The
final rule was to be effective as of January 1, 1994, subject however to a three
quarter lag time in implementation. However, because of continuing delays by the
OTS, the interest rate risk component has never been operative.
At September 30, 2003, the Bank exceeded all of its regulatory capital
requirements, with tangible, core and risk-based capital ratios of 8.0%, 8.0%,
and 15.0%, respectively. See Note 11 to the Notes to Consolidated Financial
Statements included set forth in Item 8 hereof.
The OTS and the FDIC generally are authorized to take enforcement action
against a savings association that fails to meet its capital requirements, which
action may include restrictions on operations and banking activities, the
imposition of a capital directive, a cease-and-desist order, civil money
penalties or harsher measures such as the appointment of a receiver or
conservator or a forced merger into another institution. In addition, under
current regulatory policy, an association that fails to meet its capital
requirements is prohibited from paying any dividends.
31
The following is a reconciliation of the Bank's equity
determined in accordance with GAAP to regulatory tangible, core and risk-based
capital at September 30, 2003, 2002 and 2001.
September 30, 2003 September 30, 2002 September 30, 2001
--------------------------------------------------------------------------------------------
Tangible Core Risk-based Tangible Core Risk-based Tangible Core Risk-based
Capital Capital Capital Capital Capital Capital Capital Capital Capital
--------------------------------------------------------------------------------------------
(Dollars in thousands)
GAAP equity $43,852 $43,852 $43,852 $40,873 $40,873 $40,873 $37,211 $37,211 $37,211
Assets required to be deducted (1) -- -- -- -- -- -- -- -- --
General valuation allowances -- -- 1,712 -- -- 2,084 -- -- 1,883
------- ------- ------- ------- ------- ------- ------- ------- -------
Total regulatory capital 43,852 43,852 45,564 40,873 40,873 42,957 37,211 37,211 39,094
Minimum capital requirement 8,240 21,972 24,357 7,597 20,265 21,255 7,189 19,172 18,602
------- ------- ------- ------- ------- ------- ------- ------- -------
Excess $35,612 $21,880 $21,207 $33,276 $20,608 $21,702 $30,022 $18,039 $20,492
======= ======= ======= ======= ======= ======= ======= ======= =======
(1) Consists of an equity investment which was non-includable in regulatory
capital.
These capital requirements are viewed as minimum standards by the OTS,
and most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings association's capital, upon a determination that
circumstances exist that higher individual minimum capital requirements may be
appropriate.
32
Prompt Corrective Action. Under the prompt corrective action regulations
of the OTS, an institution shall be deemed to be (i) "well capitalized" if it
has total risk-based capital of 10% or more, has a Tier I risk-based capital
ratio of 6% or more, has a Tier I leverage capital ratio of 5% or more and is
not subject to any order or final capital directive to meet and maintain a
specific capital level for any capital measure, (ii) "adequately capitalized" if
it has a total risk-based capital ratio of 8% or more, a Tier I risk-based
capital ratio of 4% or more and a Tier I leverage capital ratio of 4% or more
(3% under certain circumstances) and does not meet the definition of "well
capitalized," (iii) "undercapitalized" if it has a total risk-based capital
ratio that is less than 8%, a Tier I risk-based capital ratio that is less than
4% or a Tier I leverage capital ratio that is less than 4% (3% under certain
circumstances), (iv) "significantly undercapitalized" if it has a total
risk-based capital ratio that is less than 6%, a Tier I risk-based capital ratio
that is less than 3% or a Tier I leverage capital ratio that is less than 3%,
and (v) "critically undercapitalized" if it has a ratio of tangible equity to
total assets that is equal to or less than 2%. Under specified circumstances,
the OTS may reclassify a well capitalized institution as adequately capitalized
and may require an adequately capitalized institution or an undercapitalized
institution to comply with supervisory actions as if it were in the next lower
category (except that the FDIC may not reclassify a significantly
undercapitalized institution as critically undercapitalized). At September 30,
2003, the Bank met the requirements of a "well capitalized" institution under
OTS regulations.
Qualified Thrift Lender Test (the "QTL"). A savings association can
comply with the QTL test by either meeting the QTL test set forth in the HOLA
and the implementing regulations or qualifying as a domestic building and loan
association as defined in Section 7701(a)(19) of the Internal Revenue Code of
1986, as amended ("Code"). Currently, the portion of the QTL test that is based
on the HOLA rather than the Code requires that 65% of an institution's
"portfolio assets" (as defined) consist of certain housing and consumer-related
assets on a monthly average basis in nine out of every 12 months. Assets that
qualify without limit for inclusion as part of the 65% requirement are loans
made to purchase, refinance, construct, improve or repair domestic residential
housing and manufactured housing, home equity loans, mortgage-backed securities
(where the mortgages are secured by domestic residential housing or manufactured
housing), stock issued by the FHLB, and direct or indirect obligations of the
FDIC. In addition, small business loans, credit card loans, student loans and
loans for personal, family and household purposes are allowed to be included
without limitation as qualified investments. The following assets, among others,
also may be included in meeting the test subject to an overall limit of 20% of
the savings institution's portfolio assets: 50% of residential mortgage loans
originated and sold within 90 days of origination, 100% loans for personal,
family and household purposes (other then credit card loans and education loans)
(limited to 10% of total portfolio assets) and stock issued by FHLMC or FNMA.
Portfolio assets consist of total assets minus the sum of (i) goodwill and other
intangible assets, (ii) property used by the savings institution to conduct its
business, and (iii) liquid assets up to 20% of the institution's total assets.
A savings institution that does not comply with the QTL test must either
convert to a bank charter or comply with certain restrictions on its operations.
Upon the expiration of three years from the date the association ceases to be a
QTL, it must cease any activity and not retain any investment not permissible
for a national bank and immediately repay any outstanding FHLB advances (subject
to safety and soundness considerations).
At September 30, 2003, approximately 71.6% of the Bank's assets were
invested in qualified thrift investments, which was in excess of the percentage
required to qualify the Bank under the QTL test in effect at that time.
OTS regulations govern capital distributions by savings institutions,
which include cash dividends, stock repurchases and other transactions charged
to the capital account of a savings institution to make capital distributions. A
savings institution must file an application for OTS approval of the capital
distribution if any of the following occur or would occur as a result of the
capital distribution (1) the total capital distributions for the applicable
calendar year exceed the sum of the institution's net income for that year to
date plus the institution's retained net income for the preceding two years, (2)
the institution would not be at least adequately capitalized following the
distribution, (3) the distribution would violate any applicable statute,
regulation, agreement or OTS-imposed condition, or (4) the institution is not
eligible for expedited treatment of its filings. If an application is not
required to be filed, savings institutions which are a subsidiary of a holding
company (as well as certain other institutions) must still file a notice with
the OTS at least 30 days before the Board of Directors declares a dividend or
approves a capital distribution.
33
OTS regulations also prohibit the Bank from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
(or total) capital of the Bank would be reduced below the amount required to be
maintained for the liquidation account established by it for certain depositors
in connection with its conversion from mutual to stock form.
Community Reinvestment. Under the Community Reinvestment Act of 1977, as
amended ("CRA"), as implemented by OTS regulations, a savings association has a
continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with the CRA.
The Bank received a satisfactory CRA rating as a result of its last OTS
evaluation.
Branching by Federal Saving Institutions. OTS policy permits interstate
branching to the full extent permitted by statute (which is essentially
unlimited). Generally, federal law prohibits federal savings institutions from
establishing, retaining or operating a branch outside the state in which the
federal institution has its home office unless the institution meets the IRS'
domestic building and loan test (generally, 60% of a thrift's assets must be
housing-related) ("IRS Test"). The IRS Test requirement does not apply if: (a)
the branch(es) result(s) from an emergency acquisition of a troubled savings
institution (however, if the troubled savings institution is acquired by a bank
holding company, does not have its home office in the state of the bank holding
company bank subsidiary and does not qualify under the IRS Test, its branching
is limited to the branching laws for state-chartered banks in the state where
the savings institution is located); (b) the law of the state where the branch
would be located would permit the branch to be established if the federal
savings institution were chartered by the state in which its home office is
located; or (c) the branch was operated lawfully as a branch under state law
prior to the savings institution's reorganization to a federal charter.
Furthermore, the OTS will evaluate a branching applicant's record of
compliance with the Community Reinvestment Act of 1977. An unsatisfactory
Community Reinvestment Act record may be the basis for denial of a branching
application.
Federal Home Loan Bank System. The Bank is a member of the FHLB of
Pittsburgh, which is one of 12 regional FHLBs that administers the home
financing credit function of savings associations. Each FHLB serves as a reserve
or central bank for its members within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures established by the Board of Directors of the FHLB. As of
September 30, 2003, the Bank has overnight borrowings and advances of $133.2
million from the FHLB or 26.4% of its total liabilities. The Bank currently has
the ability to obtain up to $156.9 million additional advances from FHLB of
Pittsburgh.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Pittsburgh in an amount equal to at least 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year or 5% of its advances from the FHLB of Pittsburgh,
whichever is greater. At September 30, 2003, the Bank had $8.3 million in FHLB
stock, which was in compliance with this requirement.
The FHLBs are required to provide funds for the resolution of troubled
savings institutions and to contribute to affordable housing programs through
direct loans or interest subsidies on advances targeted for community investment
and low- and moderate-income housing projects. These contributions have
adversely affected the level of FHLB dividends paid and could continue to do so
in the future and could also result in the FHLBs imposing higher interest rates
on advances to members. These contributions also could have an adverse effect on
the value of FHLB stock in the future.
Federal Reserve System. The Board of Governors of the Federal Reserve
System ("FRB") requires all depository institutions to maintain reserves against
their transaction accounts (primarily NOW and Super NOW checking accounts) and
non-personal time deposits. At September 30, 2003, the Bank was in compliance
with applicable requirements. However, because required reserves must be
maintained in the form of vault cash or a noninterest-bearing account at a FRB,
the effect of this reserve requirement is to reduce an institution's earning
assets.
34
Savings institutions are authorized to borrow from a Federal Reserve
Bank "discount window," but FRB regulations require savings banks to exhaust
other reasonable alternative sources of funds, including FHLB advances, before
borrowing from a Federal Reserve Bank.
Safety and Soundness Guidelines. The OTS and the other federal banking
agencies have established guidelines for safety and soundness, addressing
operational and managerial, as well as compensation matters for insured
financial institutions. Institutions failing to meet these standards are
required to submit compliance plans to their appropriate federal regulators. The
OTS and the other agencies have also established guidelines regarding asset
quality and earnings standards for insured institutions.
FEDERAL AND STATE TAXATION
General. The Company and the Bank are subject to the corporate tax
provisions of the Code, as well as certain additional provisions of the Code
which apply to thrift and other types of financial institutions. The following
discussion of tax matters is intended only as a summary and does not purport to
be a comprehensive description of the tax rules applicable to the Company and
the Bank.
Fiscal Year. The Company and the Bank and its subsidiaries file a
consolidated federal income tax return on a fiscal year basis ending September
30.
Method of Accounting. The Bank maintains its books and records for
federal income tax purposes using the accrual method of accounting. The accrual
method of accounting generally requires that items of income be recognized when
all events have occurred that establish the right to receive the income and the
amount of income can be determined with reasonable accuracy, and that items of
expense be deducted at the later of (i) the time when all events have occurred
that establish the liability to pay the expense and the amount of such liability
can be determined with reasonable accuracy or (ii) the time when economic
performance with respect to the item of expense has occurred.
Bad Debt Reserves. The Bank is permitted to establish reserves for bad
debts and to make annual additions thereto which qualify as deductions from
taxable income. The Company, as of October 1, 1996, changed its method of
computing reserves for bad debts to the experience method (the "Experience
Method"). The bad debt deduction allowable under this method is available to
small banks with assets less than $500 million. Beginning October 1, 2001, the
Company changed its method of computing reserves for bad debts to the specific
charge-off method. The bad debt deduction allowable under this method is
available to large banks with assets greater than $500 million. Generally, this
method allows the Company to deduct an annual addition to the reserve for bad
debts equal to it its net charge-offs.
The Bank treated such change as a change in a method of accounting
determined solely with respect to the "applicable excess reserves" of the
institution. The amount of applicable excess reserves is taken into account
ratably over a six taxable-year period, beginning with the first taxable year
beginning after December 31, 1995. For financial reporting purposes, the Company
has not incurred any additional tax expense. Amounts that had been previously
deferred will be reversed for financial reporting purposes and will be included
in the income tax return of the Company, increasing income tax payable. The
change from the experience method to the specific charge-off method in the
current year did not result in a recapture of bad debt reserves for tax
purposes.
Prior to the Small Business Protection Act of 1996, bad debt reserves
created prior to January 1, 1988 were subject to recapture into taxable income
if the Bank failed to meet certain thrift asset and definitional tests. New
federal legislation eliminated these thrift-related recapture rules. However, to
the extent that the Bank makes "non-dividend distributions" that are considered
as made (i) from the reserve for losses on qualifying real property loans or
(ii) from the supplemental reserve for losses on loans, then an amount based on
the amount distributed will be included in its taxable income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, distributions in redemption of stock, and
distributions in partial or complete liquidation. Dividends paid out of the
Bank's current or accumulated earnings and profits, as calculated for federal
income tax purposes, will not be considered to result in a distribution from our
bad debt reserve. As a result, any dividends that would reduce amounts
appropriated to bad debt reserve and deducted for federal income tax purposes
would create a tax liability for the Bank.
35
Minimum Tax. The Code imposes an alternative minimum tax at a rate of 20%
on a base of regular taxable income plus certain tax preferences ("alternative
minimum taxable income" or "AMTI"). The alternative minimum tax is payable to
the extent such AMTI is in excess of an exemption amount. The Code provides that
an item of tax preference is the excess of the bad debt deduction allowable for
a taxable year pursuant to the percentage of taxable income method over the
amount allowable under the experience method. The other items of tax preference
that constitute AMTI include (a) tax-exempt interest on newly-issued (generally,
issued on or after August 8, 1986) private activity bonds other than certain
qualified bonds and (b) for taxable years beginning after 1989, 75% of the
excess (if any) of (i) adjusted current earnings as defined in the Code, over
(ii) AMTI (determined without regard to this preference and prior to reduction
by net operating losses). Net operating losses can offset no more than 90% of
AMTI. Certain payments of alternative minimum tax may be used as credits against
regular tax liabilities in future years.
Audit by IRS. The Bank's consolidated federal income tax returns for
taxable years through September 30, 1998 have been closed for the purpose of
examination by the IRS.
STATE TAXATION
The Company and the Bank's subsidiaries are subject to the Pennsylvania
Corporate Net Income Tax and Capital Stock and Franchise Tax. The Corporate Net
Income Tax rate for fiscal 2003 is 9.99% and is imposed on the Company's
unconsolidated taxable income for federal purposes with certain adjustments. In
general, the Capital Stock and Franchise Tax is a property tax imposed at the
rate of 1.1% of a corporation's capital stock value, which is determined in
accordance with a fixed formula.
The Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax
Act (the ("MTIT"), as amended to include thrift institutions having capital
stock. Pursuant to the MTIT, the Bank's tax rate is 11.5%. The MTIT exempts the
Bank from all other taxes imposed by the Commonwealth of Pennsylvania for state
income tax purposes and from all local taxation imposed by political
subdivisions, except taxes on real estate and real estate transfers. The MTIT is
a tax upon net earnings, determined in accordance with GAAP with certain
adjustments. The MTIT, in computing GAAP income, allows for the deduction of
interest earned on state and federal securities, while disallowing a percentage
of a thrift's interest expense deduction in the proportion of interest income on
those securities to the overall interest income of the Bank. Net operating
losses, if any, thereafter can be carried forward three years for MTIT purposes.
36
ITEM 2. PROPERTIES.
At September 30, 2003, the Bank conducted business from its executive
offices located in Media, Pennsylvania and six full-service offices located in
Delaware and Chester Counties, Pennsylvania. See also Note 7 of the Notes to
Consolidated Financial Statements set forth in Item 8 hereof.
The following table sets forth certain information with respect to the
Bank's offices at September 30, 2003.
Net Book Value Amount of
Description/Address Leased/Owned of Property Deposits
- ----------------------------------------------------------------------------------------------------------
(Dollar in thousands)
Executive Offices:
22 West State Street
Media, Pennsylvania 19063 Owned(1) $1,223 $103,141
Branch Offices:
3218 Edgmont Avenue
Brookhaven, Pennsylvania 19015 Owned 400 82,002
Routes 1 and 100
Chadds Ford, Pennsylvania 19318 Leased(2) 63 28,883
23 East Fifth Street
Chester, Pennsylvania 19013 Leased(3) 85 26,984
31 Baltimore Pike
Chester Heights, Pennsylvania 19017 Leased(4) 588 42,406
Route 82 and 926
Kennett Square, Pennsylvania 19348 Leased(5) 34 15,463
330 Dartmouth Avenue
Swarthmore, Pennsylvania 19081 Owned 99 63,726
------ --------
Total $2,492 $362,605
====== ========
- ----------------------------
(1) Also a branch office.
(2) Lease expiration date is September 30, 2005. The Bank has one five-year
renewal option.
(3) Lease expiration date is December 31, 2005. The Bank has one ten-year
renewal option.
(4) Lease expiration date is December 31, 2028. The Bank has options to
cancel on the 15th, 20th and 25th year of the lease.
(5) Lease expiration date is September 30, 2006. The Bank has three
five-year renewal options. The bank exercised its option to move the
branch office to a new leased facility that is within a short distance
away.
37
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in routine legal proceedings occurring in the
ordinary course of business which, in the aggregate, are believed by management
to be immaterial to the financial condition of the Company.
In October 2002, the Bank was served with a Demand for Arbitration from
Impac Funding Corp. before the American Arbitration Association. The arbitration
proceedings are captioned In the Matter of Arbitration between Impac Funding
Corp. and First Keystone Federal Savings Bank, American Arbitration Association,
Arbitration No. 73-148-00498-02-JUBA. In its arbitration demand, Impac asserted
breach of contract claims relating to its purchase of five residential mortgage
loans. Impac Funding is claiming damages of $182,000 plus attorney fees. The
Bank submitted their response to the arbitration demand on November 20, 2002.
The parties have agreed to settle the claims for a payment by the Bank of
$45,000.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
On January 25, 1995 the conversion and reorganization of the Bank and
its mutual holding company parent was completed. In connection with the
consummation of the Conversion, the Holding Company issued 2,720,000 shares of
common stock. As of September 30, 2003, there were 1,925,337 shares of common
stock outstanding. As of September 16, 2003, the Holding Company had 415
stockholders of record not including the number of persons or entities holding
stock in nominee or street name through various brokers and banks.
The following table sets forth the high and low closing stock prices of
the Holding Company's common stock as reported by the Nasdaq Stock Market under
the symbol "FKFS" during the periods presented. Price information appears in a
major newspaper under the symbol "FstKeyst".
YEAR ENDED
--------------------------------------------
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
------------------ ------------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First Quarter $16.45 $13.80 $14.00 $13.31
Second Quarter $21.23 $16.11 $15.32 $14.00
Third Quarter $23.74 $21.16 $18.62 $15.19
Fourth Quarter $26.50 $21.90 $18.87 $14.45
38
The following schedule summarizes the cash dividends per share of
common stock paid by the Holding Company during the periods indicated.
YEAR ENDED
--------------------------------------------
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
------------------ ------------------
First Quarter $0.09 $0.08
Second Quarter 0.10 0.09
Third Quarter 0.10 0.09
Fourth Quarter 0.10 0.09
On November 12, 2003, the Board of Directors declared a quarterly cash
dividend of $0.11 per share of Common Stock, payable on January 2, 2004, to
stockholders of record at the close of business on December 16, 2003.
See "Liquidity, Capital Resources and Commitments" set forth in Item 7
hereof and Notes 11 of the "Notes to Consolidated Financial Statements" set
forth in Item 8 hereof for discussion of restrictions on the Holding Company's
ability to pay dividends.
39
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial and other data of First Keystone
Financial, Inc. set forth below does not purport to be complete and should be
read in conjunction with, and is qualified in its entirety by, the more detailed
information, including the Consolidated Financial Statements and related Notes,
appearing elsewhere herein.
AT OR FOR THE YEAR ENDED SEPTEMBER 30,
-----------------------------------------------------------
(Dollars in thousands, except per share data) 2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
SELECTED FINANCIAL DATA:
Total assets $558,667 $518,346 $489,050 $463,463 $450,126
Loans receivable, net 286,421 288,776 247,664 230,686 226,375
Mortgage-related securities held to maturity 3,487 8,855 11,454 13,056 14,497
Investment securities held to maturity 6,315 -- -- 10,000 16,532
Assets held for sale:
Mortgage-related securities 124,656 85,674 117,608 96,257 113,046
Investment securities 77,700 80,624 62,564 42,215 44,315
Loans 4,498 501 225 3,099 1,792
Real estate owned 1,420 248 887 947 297
Deposits 362,605 330,765 311,601 272,562 260,826
Borrowings 136,272 126,384 126,234 142,902 142,437
Trust preferred securities 20,843 20,880 16,200 16,200 16,200
Stockholders' equity 32,388 32,795 30,621 26,569 23,904
Non-performing assets 2,976 5,386 3,189 3,462 3,477
SELECTED OPERATIONS DATA:
Interest income $ 27,212 $ 30,121 $ 31,860 $ 31,068 $ 28,694
Interest expense 14,336 16,540 20,344 19,231 16,956
-------- -------- -------- -------- --------
Net interest income 12,876 13,581 11,516 11,837 11,738
Provision for loan losses 715 540 540 420 259
-------- -------- -------- -------- --------
Net interest income
after provision for loan losses 12,161 13,041 10,976 11,417 11,479
Service charges and other fees 1,013 1,000 952 941 934
Net gain (loss) on sales of
interest-earning assets 1,010 415 174 (680) 616
Other non-interest income 1,223 808 788 1,013 350
Non-interest expense 12,015 12,090 9,960 9,849 9,614
-------- -------- -------- -------- --------
Income before income taxes 3,392 3,174 2,930 2,842 3,765
Income tax expense 653 448 459 480 917
-------- -------- -------- -------- --------
Net income $ 2,739 $ 2,726 $ 2,471 $ 2,362 $ 2,848
======== ======= ======== ======== ========
PER SHARE DATA:
Basic earnings per share $ 1.44 $ 1.42 $ 1.22 $ 1.14 $ 1.40
Diluted earnings per share 1.35 1.34 1.18 1.11 1.32
Cash dividends per share 0.40 0.36 0.32 0.28 0.24
40
AT OR FOR THE YEAR ENDED SEPTEMBER 30,
--------------------------------------------------------
(Dollars in thousands, except per share data) 2003 2002 2001 2000 1999
------ ------ ------ ------ ------
SELECTED OPERATING RATIOS: (1)
Average yield earned on interest-earning assets 5.48% 6.42% 7.25% 7.47% 7.15%
Average rate paid on interest-bearing
liabilities 3.02 3.70 4.83 4.79 4.49
Average interest rate spread 2.46 2.72 2.42 2.68 2.65
Net interest margin 2.64 2.95 2.68 2.91 2.98
Ratio of interest-earning assets to interest-
bearing liabilities 106.06 106.54 105.87 104.91 107.91
Efficiency ratio (2) 74.52 76.50 74.16 75.12 70.49
Non-interest expense as a percent
of average assets 2.25 2.41 2.11 2.20 2.26
Return on average assets 0.51 0.54 0.52 0.53 0.67
Return on average equity 8.39 8.77 8.42 9.96 11.18
Ratio of average equity to average assets 6.12 6.17 6.22 5.29 5.99
Full-service offices at end of period 7 7 7 7 6
ASSET QUALITY RATIOS:(3)
Non-performing loans as a
percent of gross loans receivable 0.53% 1.76% 0.92% 1.07% 1.39%
Non-performing assets as a
percent of total assets 0.53 1.04 0.65 0.75 0.77
Allowance for loan losses as a
percent of gross loans receivable 0.68 0.81 0.87 0.86 0.84
Allowance for loan losses as a
percent of non-performing loans 127.63 45.89 94.74 80.28 60.63
Net loans charged-off to average
loans receivable 0.37 0.13 0.16 0.14 0.03
CAPITAL RATIOS:(3) (4)
Tangible capital ratio 7.98% 8.07% 7.76% 8.32% 8.17%
Core capital ratio 7.98 8.07 7.76 8.32 8.17
Risk-based capital ratio 14.97 16.17 16.81 17.70 18.80
(1) Adjusted for the effects of tax-free investments. See presentation of
reconciliation of tax-free investments in Management's Discussion and
Analysis - "Average Balances, Net Interest Income and Yield Earned and
Rates Paid."
(2) Reflects non-interest expense as a percent of the aggregate of net interest
income and non-interest income.
(3) Asset Quality Ratios and Capital Ratios are end of period ratios except for
the ratio of loan charge-offs to average loans. With the exception of end
of period ratios, all ratios are based on average daily balances during the
indicated periods. Gross loans receivable are net of loans in process.
(4) Regulatory capital ratios of the Company's wholly owned subsidiary, First
Keystone Bank.
41
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
GENERAL
First Keystone Financial, Inc. (the "Company") is the holding company
for its wholly owned subsidiary, First Keystone Bank (the "Bank"). For purposes
of this discussion, references to the Company will include its wholly owned
subsidiaries, unless otherwise indicated. The Company is a community-oriented
banking organization that focuses on providing customer and business services
within its primary market area, consisting primarily of Delaware and Chester
counties in the Commonwealth of Pennsylvania.
The following discussion should be read in conjunction with the
Company's consolidated financial statements presented in Item 15 of this Annual
Report on Form 10-K. The primary asset of the Company is its investment in the
Bank and, accordingly, the discussion below with respect to results of
operations relates primarily to the operations of the Bank.
The Company's results of operations depend primarily on its net
interest income which is the difference between interest income on
interest-earning assets, which principally consist of loans, mortgage-related
securities and investment securities, and interest expense on interest-bearing
liabilities, which principally consist of deposits and FHLB advances. The
Company's results of operations also are affected by the provision for loan
losses (the amount of which reflects management's assessment of the known and
inherent losses in its loan portfolio that are both probable and reasonably
estimable), the level of its non-interest income, including service charges and
other fees as well as gains and losses from the sale of certain assets, the
level of its operating expenses, and income tax expense.
CRITICAL ACCOUNT POLICIES
Accounting policies involving significant judgments and assumptions by
management, which have, or could have, a material impact on the carrying value
of certain assets or comprehensive income, are considered critical accounting
policies. In management's opinion, the most critical accounting policy affecting
the Company's financial statements is the evaluation of the allowance for loan
losses. The Company maintains an allowance for loan loss at a level management
believes is sufficient to provide for known and inherent losses in the loan
portfolio. The determination of the allowance for loan losses involves
significant judgment and assumptions by management which may have a material
impact on the carrying value of net loans and potentially on the net income we
recognize from period to period. Accordingly, there is likelihood that
materially different amounts would be reported under different, but reasonably
plausible conditions or assumptions. For a description of the methods the
Company uses to determine the Company's allowance for loan losses, see "Results
of Operations - Provisions for Loan Losses."
ASSET AND LIABILITY MANAGEMENT
The principal objectives of the Company's asset and liability
management are to (1) evaluate the interest rate risk existing in certain assets
and liabilities, (2) determine the appropriate level of risk given the Company's
business focus, operating environment, capital and liquidity requirements and
performance objectives, (3) establish prudent asset and liability compositions,
and (4) manage the assessed risk consistent with Board approved guidelines.
Through asset and liability management, the Company seeks to reduce both the
vulnerability and volatility of its operations to changes in interest rates and
to manage the ratio of interest-rate sensitive assets to interest-rate sensitive
liabilities within specified maturities or repricing periods. The Company's
actions in this regard are taken under the guidance of the Asset/Liability
Committee ("ALCO"), which is chaired by the Chief Financial Officer and
comprised of members of the Company's senior management. The ALCO meets no less
than quarterly to review, among other things, liquidity and cash flow needs,
current market conditions and the interest rate environment, the sensitivity to
changes in interest rates of the Company's assets and liabilities, the
historical and market values of assets and liabilities, unrealized gains and
losses, and the repricing and maturity characteristics of loans, investment
securities, deposits and borrowings. The ALCO reports to the Company's Board of
Directors no less than once a quarter. In addition, management reviews at least
weekly the pricing of the Company's commercial loans and customer deposits. The
pricing of residential loans including originated for sale in the secondary
market is reviewed daily.
42
The Company's primary asset/liability monitoring tools consist of
various asset/liability simulation models which are prepared on a quarterly
basis. The models are designed to capture the dynamics of the balance sheet as
well as rate and spread movements and to quantify variations in net interest
income under different interest rate scenarios.
One of the models consists of an analysis of the extent to which assets
and liabilities are interest rate sensitive and measures an institution's
interest rate sensitivity gap. An asset or liability is said to be interest rate
sensitive within a specific time period if it will mature or reprice within that
time period. An institution's interest rate sensitivity gap is defined as the
difference between interest-earning assets and interest-bearing liabilities
maturing or repricing within a given time period. A gap is considered positive
when the amount of interest rate sensitive assets exceeds the amount of interest
rate sensitive liabilities and is considered negative when the amount of
interest rate sensitive liabilities exceeds interest rate sensitive assets.
During a period of falling interest rates, a negative gap would tend to result
in an increase in net interest income, while a positive gap would tend to result
in a decline in net interest income. Conversely, during a period of rising
interest rates, a negative gap would tend to result in a decline in net interest
income, while a positive gap would tend to result in an increase in net interest
income.
For purposes of the gap table, annual prepayment assumptions range from
6% to 40% for fixed-rate mortgage loans and mortgage-related securities and 5%
to 15% for adjustable-rate mortgage loans and mortgage-related securities.
Passbook and statement savings accounts are assumed to decay at a rate of 14.0%
per year. Money market deposit accounts ("MMDA") are assumed to decay at a rate
of 25% per year. Negotiable order of withdrawal ("NOW") accounts are assumed to
decay at a rate of 20% per year.
The Bank's passbook, statement savings, MMDA and NOW accounts are
generally subject to immediate withdrawal. However, management considers a
portion of these deposits to be core deposits (which consists of passbook,
statement saving, MMDA and NOW accounts) having significantly longer effective
maturities based upon the Bank's experience in retaining such deposits in
changing interest rate environments. Borrowed funds are included in the period
in which they can be called or when they mature.
Management believes that the assumptions used to evaluate the
vulnerability of the Bank's operations to changes in interest rates are
considered reasonable. However, certain shortcomings are inherent in the method
of analysis presented in the table below. For example, although certain assets
and liabilities may have similar maturities or periods to repricing, they may
react in different degrees to changes in market interest rates, while interest
rates on other types may lag behind changes in market rates. Additionally,
certain assets, such as adjustable-rate loans, have features which restrict
changes in market rates both on a short-term and over the life of the asset.
Further, in the event of a change in interest rates, prepayments and early
withdrawal levels would likely deviate significantly from those assumed in
calculating the table.
43
The following table summarizes the anticipated maturities or repricing
of the Company's interest-earning assets and interest-bearing liabilities as of
September 30, 2003 based on the information and assumptions set forth above.
More Than More Than
Within Six to One Year Three Over
Six Twelve to Three Years to Five
(Dollars in thousands) Months Months Years Five Years Years Total
--------- -------- -------- ---------- -------- --------
Interest-earning assets:
Loans receivable, net(1) $ 79,161 $ 25,780 $ 84,739 $ 37,420 $ 57,765 $284,865
Mortgage-related securities 31,271 23,023 48,345 22,435 3,069 128,143
Loans held for sale 4,498 -- -- -- -- 4,498
Investment securities(2) 19,401 4,580 5,374 19,585 43,369 92,309
Interest-earning deposits 10,751 -- -- -- -- 10,751
--------- -------- -------- -------- -------- --------
Total interest-earning assets $ 145,082 $ 53,383 $138,458 $ 79,440 $104,203 $520,566
--------- -------- -------- -------- -------- --------
Interest-bearing liabilities:
Deposits $ 104,679 $ 55,765 $115,365 $ 73,331 $ 13,454 $362,594
Borrowed funds 110,684 -- 25,000 259 329 136,272
--------- -------- -------- -------- -------- --------
Total interest-bearing liabilities $ 215,363 $ 55,765 $140,365 $ 73,590 $ 13,783 $498,866
--------- -------- -------- -------- -------- --------
Excess (deficiency) of interest-earning assets
over interest-bearing liabilities $ (70,281) $ (2,382) $ (1,907) $ 5,850 $ 90,420 $21,700
========= ======== ======== ======== ======== ========
Cumulative excess (deficiency) of interest-earning
assets over interest-bearing liabilities $ (70,281) $(72,663) $(74,570) $(68,720) $ 21,700
========= ======== ======== ======== ========
Cumulative excess (deficiency)
of interest-earning assets over
interest-bearing liabilities as a
percentage of total assets (12.58)% (13.01)% (13.35)% (12.30)% 3.88%
========= ======== ======== ======== ========
(1) Balances have been reduced for non-accruing loans, which amounted to $1.6
million at September 30, 2003.
(2) Balance includes Federal Home Loan Bank stock.
Although an analysis of the interest rate sensitivity gap measure may
be useful, it is limited in its ability to predict trends in future earnings. It
makes no presumptions about changes in prepayment tendencies, deposit or loan
maturity preferences or repricing time lags that may occur in response to a
change in the interest rate environment. As a consequence, the Company also
utilizes an analysis of the market value of portfolio equity, which addresses
the estimated change in the value of the Bank's equity arising from movements in
interest rates. The market value of portfolio equity is estimated by valuing the
Bank's assets and liabilities under different interest rate scenarios. The
extent to which assets gain or lose value in relation to gains or losses of
liabilities as interest rates increase or decrease determines the appreciation
or depreciation in equity on a market value basis. Market value analysis is
intended to evaluate the impact of immediate and sustained shifts of the current
yield curve upon the market value of the Bank's current balance sheet.
The Company utilizes reports prepared by the Office of Thrift
Supervision ("OTS") to measure interest rate risk. Using data submitted by the
Bank, the OTS performs scenario analysis to estimate the net portfolio value
("NPV") of the Bank over a variety of interest rate scenarios. The NPV is
defined as the present value of expected cash flows from existing assets less
the present value of expected cash flows from existing liabilities plus the
present value of net expected cash inflows from existing off-balance sheet
contracts.
44
The table below sets forth the Bank's NPV assuming an immediate change
in interest rates of plus and minus 100, 200 and 300 basis points. Due to the
low prevailing interest rate environment, the OTS did not provide a calculation
for the minus 200 and minus 300 basis point change in rates. Dollar amounts are
expressed in thousands as of September 30, 2003.
Net Portfolio Value
Net Portfolio Value as a % of Assets
----------------------------------------------------------------------------------
Changes in Rates Dollar Percentage NPV
in Basis Points Amount Change Change Ratio Change
- ------------------ ------- --------- ---------- ------ --------
300 $25,819 $(21,301) (45)% 4.83% (341) bp
200 34,002 (13,118) (28) 6.22 (202)
100 41,322 (5,798) (12) 7.38 (86)
0 47,120 -- -- 8.24 --
(100) 46,000 (1,120) (2) 7.95 (29)
(200) N/A N/A N/A N/A N/A
(300) N/A N/A N/A N/A N/A
As is the case with interest rate sensitivity gap, certain shortcomings
are inherent in the methodology used in the above interest rate risk
measurements. Modeling changes in NPV require the making of certain assumptions
which may or may not reflect the manner in which actual yields and costs respond
to changes in market interest rates. In this regard, the NPV model presented
assumes that the composition of the Bank's interest sensitive assets and
liabilities existing at the beginning of a period remains constant over the
period being measured and also assumes that a particular change in interest
rates is reflected uniformly across the yield curve regardless of the duration
to maturity or repricing of specific assets and liabilities. Although the NPV
measurements and net interest income models provide an indication of the Bank's
interest rate risk exposure at a particular point in time, such measurements are
not intended to and do not provide a precise forecast of the effect of changes
in market interest rates on the Bank's net interest income and may differ from
actual results.
The Company is aware of its interest rate risk exposure in the event of
rapidly rising rates. Due to the Company's recognition of the need to control
interest rate exposure, the Company's current policy is to sell new 30-year
fixed-rate single-family residential mortgage loans into the secondary market.
In addition, in recent years, the Company has emphasized the origination of
construction and land, multi-family and commercial real estate and consumer
loans which generally have either adjustable interest rates and/or shorter
contractual terms than single-family residential loans. The Company plans to
continue these lending strategies.
Derivative financial instruments include futures, forwards, interest
rate swaps, option contracts, and other financial instruments with similar
characteristics. The Company currently does not enter into futures, forwards,
swaps or options. However, the Company is party to financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of our customers. These financial instruments include commitments to
extend credit. These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the consolidated
statements of financial condition. Commitments generally have fixed expiration
dates and may require additional collateral from the borrower if deemed
necessary. Commitments to extend credit are not recorded as an asset or
liability until the instruments are exercised.
The Company is subject to certain market risks and interest rate risks
from the time a commitment is issued to originate new loans. In an effort to
protect the Company against adverse interest rate movements, at the time an
application is taken for a fixed-rate loan, the Company typically enters into an
agreement to sell the loan, or a loan within the same interest-rate range, into
the secondary market. This is known as a "matched sale" approach and reduces
interest-rate risk with respect to these loans. There is still some portion of
these loans which may never close for various reasons. However, the agencies the
Company sells loans to permit some flexibility in delivering loan product to
them. In certain instances, if the loans delivered for sale do not match the
characteristics outlined in the forward sale commitments, the gain on sale may
be reduced.
45
CHANGES IN FINANCIAL CONDITION
GENERAL. Total assets of the Company increased by $40.3 million, or
7.8%, from $518.3 million at September 30, 2002 to $558.7 million at September
30, 2003. The increase primarily reflected growth of mortgage-related securities
available for sale and to a lesser extent, investment securities held to
maturity, partially offset by a decrease in mortgage-related securities held to
maturity and investment securities available for sale. The asset growth was
primarily funded by increases in customer deposits and advances from the FHLB.
CASH AND CASH EQUIVALENTS. Cash and cash equivalents, which consists of
cash on hand and deposited in other banks in interest-earning and
non-interest-earning accounts, amounted to $21.1 million and $24.6 million at
September 30, 2003 and 2002, respectively. The decrease in cash and cash
equivalents was due to a $9.1 million, or 45.9%, decrease in interest-bearing
deposits as a result of the Company investing the cash into interest-earning
assets offset in part by a $5.7 million increase in cash due to higher reserve
requirements at the Federal Reserve Bank. Cash and cash equivalents are
available as a source of funds for originations of new loans and purchases of
additional securities investments.
INVESTMENT SECURITIES HELD TO MATURITY AND INVESTMENT SECURITIES
AVAILABLE FOR SALE. Total investment securities increased by $3.4 million, or
4.2%, from $80.6 million at September 30, 2002 to $84.0 million at September 30,
2003. The increase in investment securities resulted from reinvesting the cash
flows from the high level of prepayments from the loan and investment portfolios
and the proceeds from the sale of certain investment securities.
MORTGAGE-RELATED SECURITIES HELD TO MATURITY AND MORTGAGE-RELATED
SECURITIES AVAILABLE FOR SALE. Mortgage-related securities held to maturity and
mortgage-related securities available for sale increased in the aggregate by
$33.6 million, or 35.6%, to $128.1 million at September 30, 2003 compared to
$94.5 million at September 30, 2002. The significant increase in
mortgage-related securities was part of the Company's strategy to increase this
portfolio due to high levels of cash flows being experienced by the loan
portfolio coinciding with the limited demand for originations of new loans at
interest rates deemed acceptable to the Company.
LOANS HELD FOR SALE. At September 30, 2003, $4.5 million of fixed-rate
single-family residential loans were classified as held for sale compared to
$501,000 at September 30, 2002. The increase of $4.0 million is related to
increased secondary market activity as a result of the low interest rate
environment. During fiscal year 2003, the Company originated $31.0 million and
sold $27.0 million of such loans. Subsequent to fiscal year end, management
reevaluated its asset liability position and determined to retain in its loan
portfolio the majority of the loans held for sale at September 30, 2003.
LOANS RECEIVABLE, NET. Total loans receivable, net, decreased slightly
to $286.4 million at September 30, 2003 compared to $288.8 million at September
30, 2002. The decrease was primarily due to a $7.7 million, or 4.4%, decrease in
single-family residential loans partially offset by a $5.9 million, or 21.3%,
increase in home equity loans and lines of credit. Although the Company had
significant loan originations in single-family residential loans during fiscal
2003, total loans decreased due to the accelerated prepayments experienced by
the portfolio and the Company's decision to sell 30-year fixed-rate mortgages
bearing low interest rates into the secondary market in order to minimize
interest rate risk in a rising interest rate environment.
NON-PERFORMING ASSETS. The Company's total non-performing loans and
real estate owned decreased to $3.0 million, or 0.53% of total assets, at
September 30, 2003 compared to $5.4 million, or 1.04% of total assets, at the
end of the prior fiscal year. The decrease in non-performing assets in fiscal
2003 was primarily attributable to a $1.3 million commercial real estate loan
returning to current status and a $549,000 decrease in non-accrual single-family
residential loans.
DEPOSITS. Deposits increased by $31.8 million, or 9.6%, from $330.8
million at September 30, 2002 to $362.6 million at September 30, 2003. This
increase was primarily due to a $29.6 million, or 19.2%, increase in the
Company's core accounts (non-interest-bearing, NOW, passbook, and MMDA accounts)
as a result of the Company's continued emphasis on increasing both the amount
and the percentage of the deposit portfolio accounted for by these deposit
accounts. Certificates of deposit increased by $2.2 million, or 1.3%, to $178.5
million in the current fiscal year.
BORROWINGS. The Company's total borrowings increased to $136.3 million
at September 30, 2003 from $126.4
46
million at September 30, 2002 as the Company primarily used deposit inflows in
fiscal 2003 to fund asset growth. The increase was principally due to a $6.8
million increase in FHLB overnight borrowings and to a lesser extent, $2.9
million increase in repurchase agreements. Borrowings had a weighted average
interest rate of 5.20% at September 30, 2003. See Note 9 to the Consolidated
Financial Statements for further information.
EQUITY. At September 30, 2003, total stockholders equity was $32.4
million, or 5.8% of total assets, compared to $32.8 million, or 6.3% of total
assets, at September 30, 2002. The decrease was due to the cost of repurchasing
136,219 shares of common stock at a weighted average cost of $21.92 per share
during fiscal 2003 and the payment of $798,000 in dividends partially offset by
net income for the year of $2.7 million.
AVERAGE BALANCES, NET INTEREST INCOME AND YIELDS EARNED AND RATES PAID.
The following table sets forth, for the periods indicated, information regarding
(i) the total dollar amount of interest income of the Company from
interest-earning assets and the resultant average yields; (ii) the total dollar
amount of interest expense on interest-bearing liabilities and the resultant
average rate; (iii) net interest income; (iv) interest rate spread; and (v) net
interest margin. Information is based on average daily balances during the
indicated periods; yields were adjusted for the effects of tax-free investments
using the statutory tax rate.
The adjustment of tax exempt securities to a tax equivalent yield in
the table below may be considered to include non-GAAP financial information.
Management believes that it is a standard practice in the banking industry to
present net interest margin, net interest rate spread and net interest income on
a fully tax equivalent basis when a significant proportion of interest-earning
assets are tax-free. Therefore, management believes, these measures provide
useful information to investors by allowing them to make peer comparisons. A
GAAP reconciliation also is included below.
YEAR ENDED SEPTEMBER 30,
-----------------------------------------------------------------------------------------
2003 2002 2001
YIELD/COST ------------------------------------------------------------------------------
AT AVERAGE Average Average
SEPT.30, AVERAGE YIELD/ Average Yield/ Average Yield/
2003 BALANCE INTEREST COST Balance Interest Cost Balance Interest Cost
-----------------------------------------------------------------------------------------
(Dollars in thousands)
Interest-earning assets:
Loans receivable(1) (2) 6.08% $290,357 $18,937 6.52% $ 267,208 $ 19,379 7.25% $237,419 18,711 7.88%
Mortgage-related securities(2) 4.37 114,833 4,464 3.89 113,827 6,441 5.66 130,283 8,605 6.60
Investment securities(2) 4.25 84,038 4,094 4.87 76,826 4,509 5.87 63,545 4,396 6.92
Other interest-earning assets 0.86 14,390 120 0.83 17,946 223 1.24 14,165 560 3.95
-------- ------- --------- -------- -------- ------
Total interest-earning assets 5.23 503,618 $27,615 5.48 475,807 $ 30,552 6.42 445,412 32,272 7.25
-------- ------- --------- -------- -------- ------
Non-interest-earning assets 30,411 27,855 26,389
-------- --------- --------
Total assets $534,029 $ 503,662 $471,801
======== ========= --------
Interest-bearing liabilities:
Deposits 1.77 $343,727 $ 7,353 2.14 $ 319,344 $ 9,599 3.01 $294,731 13,062 4.43
FHLB advances and other borrowings 5.20 131,136 6,983 5.33 127,264 6,941 5.44 125,988 7,282 5.77
-------- ------- --------- -------- -------- ------
Total interest-bearing liabilities 2.70 474,863 14,336 3.02 446,608 16,540 3.70 420,719 20,344 4.83
-------- ------- --------- -------- -------- ------
Interest rate spread 2.53% 2.46% 2.72% 2.42%
==== ====== ====== ======
Non-interest-bearing liabilities 26,502 25,977 21,744
-------- --------- --------
Total liabilities 501,365 472,585 442,463
Stockholders' equity 32,664 31,077 29,338
-------- --------- --------
Total liabilities and stockholders' equity $534,029 $ 503,622 $471,801
======== ========= ========
Net interest-earning assets $ 28,755 $ 29,199 $ 24,693
======== ========= ========
Net interest income $13,279 $ 14,012 $11,928
======= ======== =======
Net interest margin(3) 2.64% 2.95% 2.68%
====== ====== ======
Ratio of average interest-earning assets
to average interest-bearing liabilities 106.06% 106.54% 105.87%
====== ====== ======
(1) Includes non-accrual loans.
(2) Includes assets classified as either available for sale or held for sale.
(3) Net interest income divided by interest-earning assets.
47
Although management believes that the above mentioned non-GAAP
financial measures enhance investor's understanding of the Company's business
and performance, these non-GAAP financials measures should not be considered an
alternative to GAAP. The reconciliation of these non-GAAP financials measures
from GAAP to non-GAAP is presented below.
(Dollars in thousands) FOR THE YEAR ENDED SEPTEMBER 30,
---------------------------------------------------------------------------
2003 2002 2001
---------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE
INTEREST YIELD/COST INTEREST YIELD/COST INTEREST YIELD/COST
---------------------------------------------------------------------------
Investment securities - nontaxable $ 3,691 4.39% $ 4,078 5.31% $ 3,984 6.27%
Tax equivalent adjustments 403 431 412
------- ------- -------
Investment securities - nontaxable to a
taxable equivalent yield $ 4,094 4.87% $ 4,509 5.87% $ 4,396 6.92%
======= ======= =======
Net interest income $12,876 $13,581 $11,516
Tax equivalent adjustment 403 431 412
------- ------- -------
Net interest income, tax equivalent $13,279 $14,012 $11,928
======= ======= =======
Net interest rate spread, no tax
adjustment 2.38% 2.63% 2.32%
Net interest margin, no tax adjustment 2.56% 2.86% 2.59%
RATE/VOLUME ANALYSIS. The following table describes the extent to which
changes in interest rates and changes in the volume of interest-related assets
and liabilities have affected the Company's interest income and expense during
the periods indicated. For each category of interest-earning asset and
interest-bearing liability, information is provided on changes attributable to
(i) changes in volume (change in volume multiplied by prior year rate), (ii)
changes in rate (change in rate multiplied by prior year volume), and (iii)
total change in rate and volume. The combined effect of changes in both rate and
volume has been allocated proportionately to the change due to rate and the
change due to volume. The table below has been prepared on a tax-equivalent
basis.
YEAR ENDED SEPTEMBER 30,
--------------------------------------------------------------------------
2003 VS. 2002 2002 VS. 2001
--------------------------------------------------------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
--------------------------------------------------------------------------
TOTAL TOTAL
INCREASE INCREASE
RATE VOLUME (DECREASE) RATE VOLUME (DECREASE)
--------------------------------------------------------------------------
Interest-earnings assets:
Loans receivable(1) $(3,156) $ 2,713 $ (443) $(1,166) $ 1,834 $ 668
Mortgage-related securities(1) (2,035) 58 (1,977) (1,150) (1,014) (2,164)
Investment securities(1) (2) (926) 510 (416) (299) 412 113
Other interest-earning assets (64) (38) (102) (551) 214 (337)
------- ------- ------- ------- ------- -------
Total interest-earning assets (6,181) 3,243 (2,938) (3,166) 1,446 (1,720)
------- ------- ------- ------- ------- -------
Interest-bearing liabilities:
Deposits (3,055) 809 (2,246) (4,677) 1,214 (3,463)
FHLB advances and other borrowings (146) 187 41 (413) 74 (339)
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities (3,201) 996 (2,205) (5,090) 1,288 (3,802)
------- ------- ------- ------- ------- -------
Increase (decrease) in net interest income $(2,980) $ 2,247 $ (733) $ 1,924 $ 158 $ 2,082
======= ======= ======= ======= ======= =======
(1) Includes assets classified as either available for sale or held for sale.
(2) Total increase (decrease) in investment securities on a nontaxable
equivalent basis would be $(388) and $93, resulting in a (decrease) increase
in net interest income of $(705) and $2,065, respectively.
48
RESULTS OF OPERATIONS
GENERAL. The Company reported net income of $2.7 million, $2.7 million
and $2.5 million for the years ended September 30, 2003, 2002 and 2001,
respectively.
The $13,000 increase in net income for the year ended September 30,
2003 compared to the year ended September 30, 2002 was primarily due to a $1.0
million, or 46.0%, increase in non-interest income combined with a $75,000, or
0.6%, decrease in non-interest expense partially offset by a $880,000, or 6.7%,
decrease in net interest income after provision for loan losses.
The $255,000 increase in net income for the year ended September 30,
2002 compared to the year ended September 30, 2001 was primarily due to the $2.1
million, or 17.9%, increase in net interest income combined with a $309,000, or
16.1%, increase in non-interest income partially offset by a $2.1 million, or
21.3%, increase in non-interest expense.
NET INTEREST INCOME. Net interest income is determined by the interest
rate spread (the difference between the yields earned on interest-earning assets
and the rates paid on interest-bearing liabilities) and the relative amounts of
interest-earning assets and interest-bearing liabilities. All percentages are
reported on a fully tax-equivalent basis (see the tables on the prior page for a
recalculation of such percentages). The Company's average interest-rate spread
was 2.46%, 2.72% and 2.42% for the years ended September 30, 2003, 2002, and
2001, respectively. The Company's interest-rate spread was 2.53% at September
30, 2003. The Company's net interest margin (net interest income as a percentage
of average interest-earning assets) was 2.64%, 2.95% and 2.68% for the years
ended September 30, 2003, 2002 and 2001, respectively. Due to the historically
low interest rate environment existing during fiscal 2003, the interest rate
compression experienced by the Company reflects the effects of the accelerated
rate of repayments and prepayments of loans and mortgage-related securities,
requiring the Company to reinvest the resulting proceeds at current lower market
rates of interest without a corresponding decrease in the rates paid on deposits
and borrowings. As the refinancing and prepayment activity comes to an end,
management anticipates that the net interest spread and margin will stabilize or
increase slightly during fiscal 2004 providing the Company can maintain its cost
of funds at levels substantially similar to those existing at the end of fiscal
2003.
Net interest income decreased to $12.9 million in fiscal 2003 as
compared to $13.6 million in fiscal 2002. The $705,000, or 5.2%, decrease came
as a result of a $2.9 million, or 9.7%, decrease in interest income partially
offset by a $2.2 million, or 13.3%, decrease in interest expense. The decrease
in net interest income was primarily due to interest-earning assets repricing
downward due to the prolonged low interest rate environment without a
corresponding decrease in rates paid.
Net interest income increased to $13.6 million in the year ended
September 30, 2002 as compared to $11.5 million in fiscal 2001. The $2.1
million, or 17.9%, increase was the result of lower short-term interest rates
which impacted the rates paid on the Company's interest-bearing core deposits
and shorter term certificates of deposit by repricing downward at a greater
degree than its interest-earning assets.
INTEREST INCOME. The $2.9 million, or 9.7%, decrease in total interest
income during the year ended September 30, 2003 as compared to fiscal 2002 was
primarily due to a $2.0 million, or 30.7%, decrease in interest income from
mortgage-related securities as a result of a 177 basis point decrease in the
yield earned offset, in part, by a $1.0 million, or .9%, increase in the average
balance of the mortgage-related securities portfolio. Interest income on loans
decreased $442,000, or 2.3%, due to a 73 basis point decrease in the average
yield earned offset partially by a $23.1 million, or 8.7%, increase in the
average balance of the loan portfolio. The decline in yield was due to the
declining interest rate environment experienced in fiscal 2003 causing
accelerated repayments of loans with the proceeds being reinvested in lower
yielding assets. In addition, the accelerated prepayments of mortgage-related
securities resulted in significant amortization of premiums. Additionally,
interest income on investment securities and other interest-earning assets
decreased $490,000, or 11.4%, due to a 141 basis point decrease in the average
yield earned offset partially by a $3.7 million, or 3.9%, increase in the
average balance.
Total interest income amounted to $30.1 million for the year ended
September 30, 2002 compared to $31.9 million for the year ended September 30,
2001. The decrease in fiscal 2002 was primarily due to a $2.2 million, or 25.1%,
decrease in interest income from mortgage-related securities as a result of a 94
basis point decrease in the yield earned
49
combined with a $16.5 million, or 12.6%, decrease in the average balance of the
securities portfolio. The decrease was offset, in part, by an increase in
interest income on loans. Interest income on loans increased $668,000, or 3.6%,
due to a $29.8 million, or 12.5%, increase in the average balance thereof
offset, in part, by a 63 basis point decrease in the average yield earned. The
increase in the average balance of loans was due to increases in the amount of
commercial real estate and commercial business loans reflecting the Company's
continued emphasis on expanding its commercial loan portfolio since such loans
generally bear higher rates of interest and have shorter contractual maturities
than single-family residential loans.
INTEREST EXPENSE. Total interest expense amounted to $14.3 million for
the year ended September 30, 2003 as compared to $16.5 million for fiscal 2002.
Total interest expense decreased by $2.2 million, or 13.3%, during the year
ended September 30, 2003 compared to fiscal 2002 due to a $2.2 million decrease
in interest expense on deposits partially offset by a $42,000 increase in
interest expense on borrowings. The decrease in interest expense on deposits was
due to a 87 basis point decrease in the average rate paid thereon partially
offset by a $24.4 million increase in the average balance of deposits. The
increase in interest expense on borrowings was due to a $3.9 million increase in
the average balance of borrowings offset by a 11 basis point decrease in the
average rate paid. Deposits grew due to the Company's continued marketing of its
core deposit products and was used to fund purchases of investment and
mortgage-related securities. The decrease in the rates paid on deposits and
borrowings was due to declining interest rates experienced during the fiscal
year 2003.
Total interest expense decreased by $3.8 million, or 18.7%, during the
year ended September 30, 2002 compared to fiscal 2001 primarily due to a $3.5
million decrease in interest expense on deposits and a $341,000 decrease in
interest expense on borrowings. The decrease in interest expense on deposits was
due to a 142 basis point decrease in the average rate paid offset, in part, by a
$24.6 million increase in the average balance of deposits. The decrease in
interest expense on borrowings was due to a 33 basis point decrease in the
average rate paid off set by a $1.3 million increase in the average balance of
borrowings. The increased level of deposits was due to the decline in the
equities market combined with the marketing efforts of the Company to attract
deposits, particularly core deposits. The deposit inflow was used to fund loan
originations, to purchase investment securities and to repay shorter term
borrowings.
PROVISIONS FOR LOAN LOSSES. Provisions for loan losses are charged to
earnings to maintain the total allowance for loan losses at a level believed by
management to cover all known and inherent losses in the Company's loan
portfolio. Management's analysis includes consideration of the Company's
historical experience, the volume and type of lending conducted by the Company,
the amount of the Company's classified assets, the status of past due principal
and interest payments, general economic conditions, particularly as they relate
to the Company's primary market area, and other factors related to the
collectibility of the Company's loan and loans held for sale portfolios.
Management of the Company assesses the allowance for loan losses on a monthly
basis and makes provisions for loan losses as deemed necessary in order to
maintain the allowance for loan losses at a level management believes covers all
known and inherent losses that are both probable and reasonably estimable. For
the years ended September 30, 2003, the provision for loan loss was $715,000 as
compared to $540,000 for each of fiscal 2002 and 2001. During fiscal 2003, the
Company increased its provision for loan losses as compared to fiscal 2002
primarily due to its assessment of the amount of losses it would incur with
respect to the non-performing commercial real estate loans. At September 30,
2003, the Company's allowance for loan losses totaled $2.0 million which
amounted to 127.63% of total non-performing loans and .53% of gross loans
receivable. The provision for allowance for loan losses for fiscal 2002 remained
at the same level as fiscal 2001 due to the Company's re-evaluation of its
estimate of losses with respect to its non-conforming loans based on its loss
experience and the reallocation of a portion of the allowance to commercial real
estate and commercial business loans due to the continued increased investment
in such loans.
Although management of the Company believes that the Company's
allowance for loan losses was adequate at September 30, 2003, based on facts and
circumstances available to it, there can be no assurance that additions to such
allowance will not be necessary in future periods, which would adversely affect
the Company's results of operations for such periods. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's provision for loan losses and the carrying
value of its other non-performing assets based on their judgments about
information available to them at the time of their examination. Such agencies
may require the Company to make additional provisions for estimated loan losses
based on judgments different from those of management.
50
NON-INTEREST INCOME. For the year ended September 30, 2003, the Company
reported non-interest income of $3.2 million compared to $2.2 million for the
year ended September 30, 2003. The primary reason for the $1.0 million, or
46.0%, increase in non-interest income in fiscal 2003 were a $326,000 and
$269,000 increases in gain on the sale of loans and investments and
mortgage-related securities, respectively. These increases were the result of
the Company's strategy to sell certain single-family fixed rate loans and to
restructure the securities portfolio in order to benefit in this low interest
rate environment. Gain on the sale of loans was partially offset by the
recording of loans held for sale of loans at its fair value. In addition, due to
the overall improvement in the U.S. equities market, the Company experienced a
$303,000 increase in the cash surrender value of certain insurance policies used
to fund certain post-retirement benefits.
The $309,000, or 16.1%, increase in non-interest income for the year
ended September 30, 2002 as compared to fiscal 2001 was primarily due to a
$279,000 increase in the gain on sale of $7.1 million of investment securities
along with a $48,000 increase in service charges and other fees offset, in part,
by a $38,000 decrease in gains on sale of loans held for sale.
NON-INTEREST EXPENSE. Non-interest expense include salaries and
employee benefits, occupancy and equipment expense, Federal Deposit Insurance
Corporation (FDIC) deposit insurance premiums, professional fees, data
processing expense, advertising and other items.
Non-interest expense decreased $75,000, or 0.6%, for the year ended
September 30, 2003 compared to the year ended September 30, 2002 primarily due
to the absence of any litigation expenses which amounted to $570,000 in fiscal
2002 and related to the settlement of a lawsuit in the prior year. In addition,
the Company experienced decreases of $99,000 and $74,000 in professional fees
and advertising expenses, respectively, offset, in part by a $562,000 increase
in salaries and employee benefits. Salaries and employee benefits increased
primarily due to the increased cost of employee stock ownership plan resulting
from the appreciation of the Company's stock price as well as general
compensation increases and costs of medical and retirement plans.
Non-interest expense increased $2.1 million, or 21.3%, for the year
ended September 30, 2002 compared to the year ended September 30, 2001 and
amounted to $12.1 million in fiscal 2002 compared to $10.0 million in fiscal
2001. The primary reasons for the increase were a $708,000 increase in salaries
and employee benefits, a $570,000 expense related to a settlement of a lawsuit
and a $533,000 increase in other operating expense. Salaries and employee
benefits increased primarily due to a $431,000 write-down in the cash surrender
value of certain life insurance policies resulting from the decline in the U.S.
equities market as well as general compensation increases and higher costs of
employee benefit plans. With respect to the settlement expense, it related to a
lawsuit that was instituted by the purchaser of five residential mortgage loans
from the Bank that alleged that it suffered losses in connection with these
loans and that the Bank was required to either purchase the loans or compensate
the purchaser for its alleged losses. Other non-interest expense increased
$533,000 primarily due to a $213,000 expense relating to the workout of three
non-performing commercial real estate loans aggregating $2.4 million combined
with increases in service charges and cash loss. In addition, the increase was
attributable to a $51,000 increase in occupancy and equipment expense, a $77,000
increase in data processing, a $111,000 increase in advertising and a $78,000
increase in minority interest in expense of subsidiaries.
INCOME TAXES. The Company recognized income tax expense of $653,000, or
19.3%, of pre-tax income, for the year ended September 30, 2003, compared to
$448,000, or 14.1%, of pre-tax income, for the year ended September 30, 2002.
The Company recognized income tax expense of $459,000, or 15.7%, of pre-tax
income, for fiscal 2001. The primary reason for the increase in the Company's
effective tax rate for fiscal year 2003 resulted from the reduction in tax-fee
income as well as the increase in income before income taxes. Comparing fiscal
years 2002 and 2001, the decrease in the lower effective tax rate in fiscal 2002
was due to a increase in tax-free income resulting from purchases of tax-exempt
securities and bank owned life insurance as the Company employed various
strategies to reduce taxes.
51
LIQUIDITY, CAPITAL RESOURCES AND COMMITMENTS
The Company's liquidity, represented by cash and cash equivalents, is a
product of its operating, investing and financing activities. The Company's
primary sources of funds are deposits, amortization, prepayments and maturities
of outstanding loans and mortgage-related securities, sales of loans, maturities
of investment securities and other short-term investments, borrowings and funds
provided from operations. While scheduled payments from the amortization of
loans and mortgage-related securities and maturing investment securities and
short-term investments are relatively predictable sources of funds, deposit
flows and loan and mortgage-related securities prepayments are greatly
influenced by general interest rates, economic conditions and competition. In
addition, the Company invests excess funds in overnight deposits and other
short-term interest-earning assets which provide liquidity to meet lending
requirements. The Company has the ability to obtain advances from the FHLB of
Pittsburgh through several credit programs with the FHLB in amounts not to
exceed the Bank's maximum borrowing capacity and subject to certain conditions,
including holding a predetermined amount of FHLB stock as collateral. As an
additional source of funds, the Company has access to the Federal Reserve
discount window, but only after it has exhausted its access to the FHLB of
Pittsburgh. At September 30, 2003, the Company had $126.4 million of outstanding
advances and $6.8 million of overnight borrowings from the FHLB of Pittsburgh.
Liquidity management is both a daily and long-term function of business
management. Excess liquidity is generally invested in short-term investments
such as overnight deposits. On a longer term basis, the Company maintains a
strategy of investing in various lending products and mortgage-related
securities. The Company uses its sources of funds primarily to meet its ongoing
commitments, to pay maturing savings certificates and savings withdrawals, fund
loan commitments and maintain a portfolio of mortgage related and investment
securities. At September 30, 2003, the total of approved loan commitments
outstanding amounted to $5.9 million. At the same date, commitments under unused
lines of credit and loans in process on construction loans amounted to an
aggregate of $40.8 million. Certificates of deposit scheduled to mature in one
year or less at September 30, 2003 totaled $106.8 million. Based upon its
historical experience, management believes that a significant portion of
maturing deposits will remain with the Company.
The Company has not used, and has no intention to use, any significant
off-balance sheet financing arrangements for liquidity purposes. The Company's
primary financial instruments with off-balance sheet risk are limited to loan
servicing for others, its obligations to fund loans to customers pursuant to
existing commitments and commitments to purchase and sell mortgage loans. In
addition, the Company has not had, and has no intention to have, any significant
transactions, arrangements or other relationships with any unconsolidated,
limited purpose entities that could materially affect its liquidity or capital
resources. The Company has not, and does not intend to, trade in commodity
contracts.
The OTS requires that the Bank meet minimum regulatory tangible, core,
tier 1 risk-based and total risk based capital requirements. At September 30,
2003, the Bank exceeded all regulatory capital requirements and was deemed a
well capitalized institution for regulatory purposes. See Note 11 to the
Consolidated Financial Statements.
The Company's assets consist primarily of its investment in the Bank
and investments in various corporate debt and equity instruments. Its only
material source of income consists of earnings from its investment in the Bank
and interest and dividends earned on other investments. The Company, as a
separately incorporated holding company, has no significant operations other
than serving as the sole stockholder of the Bank and paying interest to its
subsidiaries, First Keystone Capital Trust I and II, for junior subordinated
debt issued in conjunction with the issuance of trust preferred securities. See
Note 17 to the Consolidated Financial Statements. On an unconsolidated basis,
the Company has no paid employees. The expenses primarily incurred by the
Company relate to its reporting obligations under the Securities Exchange Act of
1934, related expenses incurred as a publicly traded company, and expenses
relating to the issuance of the trust preferred securities and the junior
subordinated debentures issued in connection therewith. Management believes that
the Company has adequate liquidity available to respond to its liquidity
demands. Under applicable federal regulations, the Bank may pay dividends to the
Company (as sole stockholder) within certain limits after providing written
notice to or obtaining the approval of the OTS. See Note 11 of the Consolidated
Financial Statements.
52
INVESTMENT SECURITIES
At September 30, 2003, the Company's investment securities available
for sale portfolio, including short-term investments, were carried at a fair
value of $77.7 million and had an amortized cost of $74.1 million. The average
credit quality on the portfolio is AA. The net unrealized gain on its investment
assets at September 30, 2003 was $3.6 million, or 4.9% of the amortized cost
basis. The net unrealized gain included gross unrealized gains of $4.6 million
and gross unrealized losses of $1.0 million.
The Company reviews the securities in our fixed income portfolio on a
periodic basis to specifically review individual securities for any meaningful
decline in market value below amortized cost. The analysis addresses all
securities whose fair value is significantly below amortized cost at the time of
the analysis, with additional emphasis placed on securities whose fair value has
been below amortized cost for an extended period of time. As part of the
periodic review process, the Company utilizes the expertise of outside
professional asset managers who provide an updated assessment of each issuer's
current credit situation based on recent issuer activities, such as quarterly
earnings announcements or other pertinent financial news for the issuer, recent
developments in a particular industry, economic outlook for a particular
industry and rating agency actions.
In addition to issuer-specific financial information and general
economic data, the Company also considers the ability and intent of its
operations to hold a particular security to maturity or until the market value
of the security recovers to a level in excess of the carrying value.
Nine securities in portfolio that have been in an unrealized loss
position for a substantial period of time. Eight of these securities have an
unrealized loss of less than $480,000 and/or less than 13% of their amortized
cost. These eight securities have an average unrealized loss per security of
approximately $29,000 and have fair values at September 30, 2003 that are 87% or
more of the amortized cost basis. There is only one security with an unrealized
loss in excess of $500,000 at September 30, 2003 with a market value of $4.5
million and a cost of $5.0 million. The security is an equity security and is
rated AAA. The Company has no current plans to dispose of this security.
For all securities that are in an unrealized loss position for an
extended period of time, an evaluation is performed of the specific events
attributable to the decline in the market value of the security. Factors that
are considered are the length of time and extent to which the security's market
value has been below cost as well as the general market conditions, industry
characteristics and the fundamental operating results of the issuer to determine
if the decline is due to changes in interest rates, changes relating to a
decline in credit quality of the issuer, or general market conditions. An
additional part of the evaluation is the Company's intent and ability to hold
the security until its market value has recovered to a level at least equal to
the amortized cost. If the security's unrealized loss is other than temporary, a
realized loss is recognized in the period in which the decline in value is
determined to be other than temporary.
Based on our evaluation as of September 30, 2003, the Company
determined the declines in market value of securities of these nine securities
were temporary. The Company will continue to review these securities and
evaluate the temporary nature of the impairment on a quarterly basis.
RECENT ACCOUNTING PRONOUNCEMENTS
For discussion of recent accounting pronouncements, see Note 2 of the
Consolidated Financial Statements set forth in Item 8 hereof.
53
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements of the Company and related notes
presented herein have been prepared in accordance with accounting principles
generally accepted in the United States of America which require the measurement
of financial position and operating results in terms of historical dollars,
without considering changes in the relative purchasing power of money over time
due to inflation.
Unlike most industrial companies, substantially all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or in the same magnitude as the
prices of goods and services, since such prices are affected by inflation to a
larger extent than interest rates. In the current interest rate environment,
liquidity and the maturity structure and repricing characteristics of the
Company's assets and liabilities are critical to the maintenance of acceptable
performance levels.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required herein is incorporated by reference to "Asset
and Liability Management" set forth in Item 7 above.
54
[DELOITTE LOGO] Deloitte Touche LLP
22nd Floor
1700 Market Street
Philadelphia, PA 19103-3984
Tel: 215-246-2300
Fax: 215-569-2441
www.deloitte.com
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders of
First Keystone Financial, Inc. and subsidiaries
Media, Pennsylvania 19063
We have audited the accompanying consolidated statements of financial condition
of First Keystone Financial, Inc. and subsidiaries (the "Company") as of
September 30, 2003 and 2002, and the related consolidated statements of income,
stockholders equity and cash flows for each of the three years in the period
ended September 30, 2003. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of First Keystone
Financial, Inc. and subsidiaries as of September 30, 2003 and 2002, and the
results of their operations and their cash flows for each of the three years in
the period ended September 30, 2003 in accordance with accounting principles
generally accepted in the United States of America.
- -s- Deloitte Touche LLP
- -----------------------
December 12, 2003
A member firm of
DELOITTE TOUCHE TOHMATSU
55
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
SEPTEMBER 30
----------------------
2003 2002
----------------------
ASSETS
Cash and amounts due from depository institutions $ 10,439 $ 4,753
Interest-bearing deposits with depository institutions 10,751 19,870
--------- ---------
Total cash and cash equivalents 21,190 24,623
Investment securities available for sale 77,700 80,624
Mortgage-related securities available for sale 124,656 85,674
Loans held for sale 4,498 501
Investment securities held to maturity (approximate fair value of $6,450 at
September 30, 2003) 6,315 --
Mortgage-related securities held to maturity - at amortized cost
(approximate fair value of $3,560 and $9,090 at September 30, 2003
and 2002, respectively) 3,487 8,855
Loans receivable (net of allowance for loan losses of $1,986 and $2,358
at September 30, 2003 and 2002, respectively) 286,421 288,776
Accrued interest receivable 2,654 2,971
Real estate owned 1,420 248
Federal Home Loan Bank stock at cost 8,294 6,571
Office properties and equipment, net 3,427 3,491
Cash surrender value of life insurance 15,365 14,362
Prepaid expenses and other assets 3,240 1,650
--------- ---------
Total Assets $ 558,667 $ 518,346
========= =========
LIABILITIES, MINORITY INTEREST IN SUBSIDIARIES AND STOCKHOLDERS EQUITY
Liabilities:
Deposits $ 362,605 $ 330,765
Advances from Federal Home Loan Bank and other borrowings 136,272 126,384
Accrued interest payable 814 1,000
Advances from borrowers for taxes and insurance 958 832
Deferred income taxes 581 424
Accounts payable and accrued expenses 4,206 5,266
--------- ---------
Total liabilities 505,436 464,671
--------- ---------
Company-obligated mandatory redeemable preferred securities
of subsidiary trusts holding solely junior subordinated
debentures of the Company 20,843 20,880
--------- ---------
Stockholders' Equity:
Preferred stock, $.01 par value, 10,000,000 shares authorized; none issued
Common stock, $.01 par value, 20,000,000 shares authorized; issued
and outstanding: September 30, 2003 and 2002, 1,925,337
and 2,008,611 shares, respectively 14 14
Additional paid-in capital 13,443 13,622
Employee stock ownership plan (830) (995)
Treasury stock at cost: 787,219 and 703,945 shares at September 30, 2003
and 2002, respectively (11,378) (9,175)
Accumulated other comprehensive income 3,069 3,200
Retained earnings-partially restricted 28,070 26,129
--------- ---------
Total stockholders' equity 32,388 32,795
--------- ---------
Total Liabilities, Minority Interest in Subsidiaries and Stockholders' Equity $ 558,667 $ 518,346
========= =========
See notes to consolidated financial statements.
56
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED SEPTEMBER 30
--------------------------------
2003 2002 2001
--------------------------------
INTEREST INCOME
Interest on:
Loans $ 18,937 $ 19,379 $18,711
Mortgage-related securities 4,464 6,441 8,605
Investment securities:
Taxable 2,295 2,445 2,030
Tax-exempt 1,040 1,203 1,370
Dividends 356 430 584
Interest-bearing deposits 120 223 560
-------- -------- -------
Total interest income 27,212 30,121 31,860
-------- -------- -------
INTEREST EXPENSE:
Interest on:
Deposits 7,353 9,599 13,062
Federal Home Loan Bank advances and other borrowings 6,983 6,941 7,282
-------- -------- -------
Total interest expense 14,336 16,540 20,344
-------- -------- -------
Net interest income 12,876 13,581 11,516
Provision for loan losses 715 540 540
-------- -------- -------
Net interest income after provision for loan losses 12,161 13,041 10,976
-------- -------- -------
NON-INTEREST INCOME:
Service charges and other fees 1,013 1,000 952
Net gain on sale of:
Investments and mortgage-related securities 600 331 52
Loans held for sale 410 84 122
Increase in cash surrender value 960 680 664
Other income 263 128 124
-------- -------- -------
Total non-interest income 3,246 2,223 1,914
-------- -------- -------
NON-INTEREST EXPENSE:
Salaries and employee benefits 5,358 4,796 4,088
Occupancy and equipment 1,242 1,229 1,178
Professional fees 679 778 749
Federal deposit insurance premium 55 57 55
Net cost of operation of other real estate 38 (4) 25
Data processing 467 478 401
Advertising 397 471 360
Litigation settlement -- 570 --
Minority interest in expense of subsidiaries 1,615 1,649 1,571
Other 2,164 2,066 1,533
-------- -------- -------
Total non-interest expense 12,015 12,090 9,960
-------- -------- -------
Income before income tax expense 3,392 3,174 2,930
Income tax expense 653 448 459
-------- -------- -------
Net income $ 2,739 $ 2,726 $ 2,471
======== ======== =======
Earnings per common share:
Basic $ 1.44 $ 1.42 $ 1.22
Diluted $ 1.35 $ 1.34 $ 1.18
See notes to consolidated financial statements.
57
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
EMPLOYEE ACCUMULATED RETAINED
ADDITIONAL STOCK OTHER EARNINGS- TOTAL
COMMON PAID-IN OWNERSHIP TREASURY COMPREHENSIVE PARTIALLY STOCKHOLDERS'
STOCK CAPITAL PLAN STOCK INCOME(LOSS) RESTRICTED EQUITY
-------- --------- -------- -------- ------------- ---------- ------------
Balance October 1, 2000 $ 14 $ 13,491 $ (1,287) $ (5,622) $ (2,386) $ 22,359 $ 26,569
-------- --------- -------- -------- ------------- --------- ------------
Comprehensive income:
Net income -- -- -- -- -- 2,471 2,471
Other comprehensive income, net of tax:
Net unrealized gain on securities
net of reclassification adjustment(1) -- -- -- -- 5,050 -- 5,050
-------- --------- -------- -------- ------------- --------- ------------
Comprehensive income -- -- -- -- -- -- 7,521
-------- --------- -------- -------- ------------- --------- ------------
ESOP stock committed to be released -- -- 140 -- -- -- 140
Excess of fair value above cost of ESOP
shares committed to be released -- 111 -- -- -- -- 111
Exercise of stock options -- (66) -- 84 -- -- 18
Purchase of treasury stock -- -- -- (3,045) -- -- (3,045)
Dividends paid -- -- -- -- -- (693) (693)
-------- --------- -------- -------- ------------- --------- ------------
Balance at September 30, 2001 14 13,536 (1,147) (8,583) 2,664 24,137 30,621
-------- --------- -------- -------- ------------- --------- ------------
Comprehensive income:
Net income -- -- -- -- -- 2,726 2,726
Other comprehensive income, net of tax:
Net unrealized gain on securities
net of reclassification adjustment(1) -- -- -- -- 536 -- 536
-------- --------- -------- -------- ------------- --------- ------------
Comprehensive income -- -- -- -- -- -- 3,262
-------- --------- -------- -------- ------------- --------- ------------
ESOP stock committed to be released -- -- 152 -- -- -- 152
Excess of fair value above cost of ESOP
shares committed to be released -- 161 -- -- -- -- 161
Exercise of stock options -- (75) -- 421 -- -- 346
Purchase of treasury stock -- -- -- (1,013) -- -- (1,013)
Dividends paid -- -- -- -- -- (734) (734)
-------- --------- -------- -------- ------------- --------- ------------
Balance at September 30, 2002 14 13,622 (995) (9,175) 3,200 26,129 32,795
-------- --------- -------- -------- ------------- --------- ------------
Comprehensive income:
Net income -- -- -- -- -- 2,739 2,739
Other comprehensive income, net of tax:
Net unrealized loss on securities
net of reclassification adjustment(1) -- -- -- -- (131) -- (131)
-------- --------- -------- -------- ------------- --------- ------------
Comprehensive income -- -- -- -- -- -- 2,608
-------- --------- -------- -------- ------------- --------- ------------
ESOP stock committed to be released -- -- 165 -- -- -- 165
Excess of fair value above cost of ESOP
shares committed to be released -- 231 -- -- -- -- 231
Exercise of stock options -- (410) -- 783 -- -- 373
Purchase of treasury stock -- -- -- (2,986) -- -- (2,986)
Dividends paid -- -- -- -- -- (798) (798)
-------- --------- -------- -------- ------------- ---------- ------------
Balance at September 30, 2003 $ 14 $ 13,443 $ (830) $(11,378) $ 3,069 $ 28,070 $ 32,388
======== ========= ======== ======== ============= ========= ============
2003 2002 2001
------ ------ ------
(1) Disclosure of reclassification amount, net of tax for the years ended:
Net unrealized (depreciation) appreciation arising during the year $ 265 $ 754 $5,084
Less: reclassification adjustment for net gains included in net income 396 218 34
------ ------ ------
Net unrealized (loss) gain on securities $ (131) $ 536 $5,050
====== ====== ======
See notes to consolidated financial statements.
58
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30
-----------------------------------
2003 2002 2001
--------- --------- ---------
OPERATING ACTIVITIES:
Net income $ 2,739 $ 2,726 $ 2,471
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for depreciation and amortization 426 457 429
Amortization of premiums and discounts 1,202 (3) (123)
(Gain) loss on sales of:
Loans held for sale (410) (84) (122)
Investment securities available for sale (660) (331) (14)
Mortgage-related securities available for sale 60 -- (38)
Real estate owned 1 (124) (49)
Provision for loan losses 715 540 540
Provision for real estate owned losses -- 18 --
Amortization of employee stock ownership plan 396 384 251
Deferred income taxes 225 (135) --
Changes in assets and liabilities which provided (used) cash:
Origination of loans held for sale (30,995) (3,712) (20,685)
Loans sold in the secondary market 26,998 3,436 23,559
Accrued interest receivable 317 382 20
Prepaid expenses and other assets (2,593) (455) 5,544
Accrued interest payable (186) (804) (490)
Accrued expenses (1,060) 3,637 (388)
--------- --------- ---------
Net cash (used in) provided by operating activities (2,825) 5,932 10,905
--------- --------- ---------
INVESTING ACTIVITIES:
Loans originated (174,407) (172,860) (70,781)
Purchases of:
Investment securities available for sale (23,334) (37,909) (32,137)
Investment securities held to maturity (6,329) -- --
Mortgage-related securities available for sale (132,141) (27,511) (58,663)
(Purchase) redemption of FHLB stock (1,723) 346 (245)
Proceeds from sales of investment and
mortgage-related securities available for sale 14,600 8,936 14,931
Proceeds from sales of real estate owned 150 1,003 849
Principal collected on loans 175,198 131,402 53,046
Proceeds from maturities, calls or repayments of:
Investment securities available for sale 20,793 12,343 7,000
Mortgage-related securities available for sale 83,135 58,779 34,782
Mortgage-related securities held to maturity 5,369 2,595 1,594
Purchase of property and equipment (362) (258) (495)
Net expenditures on real estate owned -- (11) (180)
--------- --------- ---------
Net cash used in investing activities (39,051) (23,145) (50,299)
--------- --------- ---------
FINANCING ACTIVITIES:
Net increase in deposit accounts 31,840 19,164 39,039
Net increase (decrease) in FHLB advances and other borrowings 9,888 167 (16,832)
Net increase (decrease) in advances from borrowers for taxes and insurance 126 136 (76)
Issuance of trust preferred securities -- 8,000 --
Purchase of trust preferred securities -- (3,290) --
Proceeds from exercise of stock options 373 275 18
Purchase of treasury stock (2,986) (1,013) (3,045)
Cash dividends (798) (734) (693)
--------- --------- ---------
Net cash provided by financing activities 38,443 22,705 18,411
--------- --------- ---------
(Decrease) increase in cash and cash equivalents (3,433) 5,492 (20,983)
Cash and cash equivalents at beginning of year 24,623 19,131 40,114
--------- --------- ---------
Cash and cash equivalents at end of year $ 21,190 $ 24,623 $ 19,131
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash payments for interest on deposits and borrowings $ 14,522 $ 17,331 $ 15,605
Cash payments of income taxes 800 650 125
Transfers of loans receivable into real estate owned 2,122 361 872
See notes to consolidated financial statements.
59
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. NATURE OF OPERATIONS AND ORGANIZATION STRUCTURE
The primary business of First Keystone Financial, Inc. (the "Company") is
to act as a holding company for First Keystone Bank (the "Bank"), a federally
chartered stock savings association founded in 1934, and First Keystone Capital
Trust I and Capital Trust II which are companies that are used to issue trust
preferred securities. The Bank has two active subsidiaries, FKF Management
Corp., Inc. which manages investment securities, and State Street Services
Corporation, which has ownership interest in an insurance agency and title
company. The primary business of the Bank is to offer a wide variety of
commercial and retail products through its branch system located in Delaware and
Chester counties in Pennsylvania. The Bank is primarily supervised and regulated
by the Office of Thrift Supervision ("OTS").
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of the Company, the Bank, and the Company's and the Bank's wholly owned
subsidiaries. Intercompany accounts and transactions have been eliminated in
consolidation.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the dates of the consolidated financial statements and the
reported amounts of income and expense during the reporting periods. Actual
results could differ from those estimates.
SECURITIES HELD TO MATURITY AND SECURITIES AVAILABLE FOR SALE
Securities held to maturity are carried at amortized cost only if the
Company has the positive intent and ability to hold these securities to
maturity. Securities available for sale are carried at fair value with the
resulting unrealized gains or losses recorded in equity, net of tax. For the
years ended September 30, 2003 and 2002, the Company did not maintain a trading
portfolio.
ALLOWANCE FOR LOAN LOSSES
An allowance for loan losses is maintained at a level that management
considers adequate to provide for probable losses based upon an evaluation of
known and inherent losses in the loan portfolio. Management's evaluation of the
portfolio is based upon past loss experience, current economic conditions and
other relevant factors. While management uses the best information available to
make such evaluation, future adjustments to the allowance may be necessary if
conditions differ substantially from the assumptions used in making the
evaluations.
Impaired loans are predominantly measured based on the fair value of the
collateral. The provision for loan losses charged to expense is based upon past
loan loss experience and an evaluation of probable losses and impairment
existing in the current loan portfolio. A loan is considered to be impaired
when, based upon current information and events, it is probable that the Company
will be unable to collect all amounts due in accordance with the original
contractual terms of the loan. An insignificant delay or insignificant shortfall
in amounts of payments does not necessarily result in the loan being identified
as impaired. For this purpose, delays less than 90 days are considered to be
insignificant. Large groups of smaller balance homogeneous loans, including
residential real estate and consumer loans, are collectively evaluated for
impairment, except for loans restructured under a troubled debt restructuring.
MORTGAGE BANKING ACTIVITIES
The Company originates mortgage loans held for investment and for sale.
At origination, the mortgage loan is identified as either held for sale or for
investment. Mortgage loans held for sale are carried at the lower of cost or
forward committed contracts (which approximates market), determined on a net
aggregate basis.
60
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
At September 30, 2003, 2002 and 2001, loans serviced for others totaled
approximately $51,547, $51,826, and $66,301, respectively. Servicing loans for
others consists of collecting mortgage payments, maintaining escrow accounts,
disbursing payments to investors, and processing foreclosures. Loan servicing
income is recorded on a cash basis and includes servicing fees from investors
and certain charges collected from borrowers, such as late payment fees. The
Company has fiduciary responsibility for related escrow and custodial funds
aggregating approximately $603 and $584 at September 30, 2003 and 2002,
respectively.
The Company assesses the retained interest in the servicing asset or
liability associated with the sold loans based on the relative fair values. The
servicing asset or liability is amortized in proportion to and over the period
during which estimated net servicing income or net servicing loss, as
appropriate, will be received. Assessment of the fair value of the retained
interest is performed on a continual basis. At September 30, 2003 and 2002,
mortgage servicing rights of $198 and $89, respectively, were included in other
assets.
TRANSFERS OF FINANCIAL ASSETS
Transfers of financial assets are accounted for as sales when control
over the assets has been surrendered. Control is surrendered when (1) the assets
have been isolated from the Company, (2) the transferee obtains the right (free
of conditions that constrain it from taking advantage of that right) to pledge
or exchange the transferred assets, and (3) the Company does not maintain
effective control over the transferred assets through an agreement to repurchase
them before their maturity.
INCOME RECOGNITION ON LOANS
Interest on loans is credited to income when earned. Accrual of loan
interest is discontinued and a reserve established on existing accruals if
management believes after considering, among other things, economic and business
conditions and collection efforts, that the borrowers financial condition is
such that collection of interest is doubtful.
REAL ESTATE OWNED
Real estate owned consists of properties acquired by foreclosure or deed
in-lieu of foreclosure. These assets are initially recorded at the lower of
carrying value of the loan or estimated fair value less selling costs at the
time of foreclosure and at the lower of the new cost basis or net realizable
value thereafter. The amounts recoverable from real estate owned could differ
materially from the amounts used in arriving at the net carrying value of the
assets at the time of foreclosure because of future market factors beyond the
control of the Company. Costs relating to the development and improvement of
real estate owned properties are capitalized and those relating to holding the
property are charged to expense.
OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are recorded at cost. Depreciation is
computed using the straight-line method over the expected useful lives of the
assets. The costs of maintenance and repairs are expensed as they are incurred,
and renewals and betterments are capitalized.
CASH SURRENDER VALUE OF LIFE INSURANCE
The Bank funded the purchase of insurance policies on the lives of
officers and employees of the Bank. The Company has recognized any increase in
cash surrender value of life insurance, net of insurance costs, in the
consolidated statements of income. The cash surrender value of the insurance
policies is recorded as an asset in the statements of financial condition.
61
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
INTEREST RATE RISK
At September 30, 2003 and 2002, the Company's assets consisted primarily
of assets that earned interest at either adjustable or fixed interest rates and
the average life of which is longer term. These assets were funded primarily
with shorter term liabilities that have interest rates which vary over time with
market rates and, in some cases, certain call features that are affected by
changes in market rates. The shorter duration of the interest-sensitive
liabilities indicates that the Company is exposed to interest rate risk because,
in a rising rate environment, liabilities will be repricing faster at higher
interest rates, thereby reducing the market value of long-term assets and net
interest income.
EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed based on the weighted
average number of shares of common stock outstanding. Diluted earnings per
common share is computed based on the weighted average number of shares of
common stock outstanding increased by the number of common shares that are
assumed to have been purchased with the proceeds from the exercise of stock
options. Weighted average shares used in the computation of earnings per share
were as follows:
YEAR ENDED SEPTEMBER 30
-----------------------------------
2003 2002 2001
--------- --------- ---------
Average common shares outstanding 1,901,682 1,915,818 2,021,332
Increase in shares due to options 127,310 118,100 78,396
--------- --------- ---------
Adjusted shares outstanding - diluted 2,028,992 2,033,918 2,099,728
========= ========== =========
For the year ended September 30, 2003, there were no outstanding options
that were antidilutive. For the years ended September 30, 2002 and 2001, 9,000
shares and 9,600 shares, respectively, related to outstanding options were
excluded from the calculation of diluted EPS because the effect was
antidilutive.
INCOME TAXES
Deferred income taxes are recognized for the tax consequences of
temporary differences by applying enacted statutory tax rates applicable to
future years to differences between the financial statement carrying amounts and
the tax bases of existing assets and liabilities. The effect on deferred taxes
of a change in tax rates is recognized in income in the period that includes the
enactment date.
ACCOUNTING FOR STOCK OPTIONS
The Company accounts for stock options in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," which allows an entity to choose between the intrinsic value
method, as defined in Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees" or the fair value method of
accounting for stock-based compensation described in SFAS No. 123. An entity
using the intrinsic value method must disclose pro forma net income and earnings
per share as if stock-based compensation was accounted for using the fair value
method (see Note 12). The Company continues to account for stock-based
compensation using the intrinsic value method and, accordingly, has not
recognized compensation expense under this method.
OTHER COMPREHENSIVE INCOME
The Company presents as a component of comprehensive income the amounts
from transactions and other events which currently are excluded from the
statement of income and are recorded directly to stockholders' equity.
62
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
ACCOUNTING FOR DERIVATIVE INSTRUMENTS
SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities," as amended by SFAS Nos. 137 and 138 and interpreted by the FASB and
the Derivative Implementation Group through Statement 133 Implementation Issues,
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial condition and measure those
instruments at fair value. Under SFAS No. 133, the accounting for changes in the
fair value of a derivative depends on the intended use of the derivative and the
resulting designation. The Company adopted this statement on October 1, 2000.
The adoption of this statement did not have a material impact on the Company's
financial position or results of operations. Currently, the Company does not
have any embedded derivatives. The Company currently does not employ hedging
activities that require designation as either fair value or cash flow hedges, or
hedges of a net investment in a foreign operation.
STATEMENT OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include
cash and amounts due from depository institutions and interest-bearing deposits
with depository institutions.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board issued FASB
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, including Indirect Guarantees of Indebtedness of Others." This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. This Interpretation also
incorporates, without change, the guidance in FASB Interpretation No. 34,
"Disclosure of Indirect Guarantees of Indebtedness of Others," which is being
superseded. The initial recognition and initial measurement provisions of this
Interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002, irrespective of the guarantor's fiscal
year-end. The disclosure requirements in this Interpretation are effective for
financial statements of interim or annual periods ending after December 15,
2002. The Company currently has no guarantees that would be required to be
recognized, measured or disclosed under this Interpretation.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." The Interpretation clarifies the application of Accounting
Research Bulletin No. 51, "Consolidated Financial Statements," to certain
entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. The Company has participated in the issue of trust
preferred securities through a trust established for such purpose. Currently,
the Company classifies such securities after total liabilities and before
stockholders' equity on the Consolidated Balance Sheet. The Company is currently
assessing the trust preferred securities structure and the continued
consolidation of the related trust pursuant to FIN No. 46. Management does not
believe the results of such assessment will result in a material impact on the
Company's financial statements upon the deferred adoption of FIN No. 46 in the
first quarter of fiscal 2004.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". The standard requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the standard include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity. SFAS
No. 146 is to be applied prospectively to exit or disposal activities initiated
after December 31, 2002. The Company adopted this statement and it did not have
a material impact on the Company's financial statements.
63
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions", which provides guidance on the accounting for the
acquisition of a financial institution. This statement requires that the excess
of the fair value of liabilities assumed over the fair value of tangible and
identifiable intangible assets acquired in a business combination which
represents goodwill be accounted for under SFAS No. 142. Thus, the specialized
accounting guidance in paragraph 5 of SFAS No. 72, will not apply after
September 30, 2002. If certain criteria in SFAS No. 147 are met, the amount of
the unidentifiable intangible asset will be reclassified to goodwill upon
adoption of the statement. Financial institutions meeting the conditions
outlined in SFAS No. 147 will be required to restate previously issued financial
statements. Additionally, the scope of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", is amended to include long-term
customer-relationship intangible assets such as deposit or/and
borrower-relationship intangible assets and credit cardholder intangible assets.
This statement became effective for the Company for its fiscal year beginning
October 1, 2002. This statement did not have any impact on the Company's
financial statements upon adoption.
In December 2002 SFAS" No. 148, "Accounting for Stock-Based Compensation
- --Transition and Disclosure, an amendment of FASB Statement No. 123." SFAS No.
148 amends SFAS No. 123 to provide alternative methods of transition in
connection with a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. This statement is effective for financial statements for fiscal years
ending after December 15, 2002. The Company adopted certain disclosure
provisions for interim periods beginning after December 15, 2002. This statement
did not have a material impact on the Company's financial statements in adopting
this statement.
In April 2003, the SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments and hedging activities under
Statement 133. In addition, this Statement clarifies under what circumstances a
contract with an initial net investment meets the characteristic of a derivative
and when a derivative contains a financing component that warrants special
reporting in the statement of cash flows. This statement is effective for
contracts entered into or modified after June 30, 2003. The Company adopted this
statement as it relates to the Company's loan commitments and it did not have a
material impact on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
statement requires that certain financial instruments, which previously could be
designated as equity, now be classified as liabilities on the balance sheet. The
Company currently classifies its trust preferred securities after total
liabilities and before stockholders' equity on the Consolidated Balance Sheet.
Under the provisions of SFAS No. 150, these securities would be reclassified as
borrowed funds. The effective date of SFAS No. 150 has been indefinitely
deferred by the FASB when certain criteria are met. As the structure of the
Company's trust preferred securities meets such criteria, the Company qualifies
for this limited deferral. Therefore, the Company will assess the classification
of the trust preferred securities in conjunction with adoption of FIN No. 46 in
the first quarter of fiscal 2004, as noted above.
RECLASSIFICATIONS
Certain reclassifications have been made to the September 30, 2002 and
2001 consolidated financial statements to conform with the September 30, 2003
presentation. Such reclassifications had no impact on the reported net income.
64
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
3. INVESTMENT SECURITIES
The amortized cost and approximate fair value of investment
securities available for sale and investment securities held to maturity
are as follows:
SEPTEMBER 30, 2003
-------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED APPROXIMATE
COST GAIN LOSS FAIR VALUE
-------------------------------------------------------
Available for Sale:
U.S. Treasury securities and securities
of U.S. Government agencies:
1 to 5 years $ 13,020 $ 35 $ 51 $ 13,004
5 to 10 years 4,880 139 31 4,988
Municipal obligations 14,112 503 -- 14,615
Corporate bonds 17,567 1,288 332 18,523
Mutual funds 14,009 -- 57 13,952
Asset-backed securities 1,911 11 -- 1,922
Preferred stocks 5,474 34 524 4,984
Other equity investments 3,126 2,586 -- 5,712
--------- ---------- ---------- ----------
Total $ 74,099 $ 4,596 $ 995 $ 77,700
--------- ---------- ---------- ----------
Held to Maturity:
Municipal obligations $ 3,261 $ 19 -- $ 3,280
Corporate bonds 3,054 116 -- 3,170
--------- ---------- ---------- ----------
Total $ 6,315 $ 135 -- $ 6,450
========= ========== ========== ==========
SEPTEMBER 30, 2002
------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED APPROXIMATE
COST GAIN LOSS FAIR VALUE
------------------------------------------------------
Available for Sale:
U.S. Treasury securities and securities
of U.S. Government agencies:
1 to 5 years $ 11,986 $ 128 $ 12,114
5 to 10 years 1,861 210 2,071
Municipal obligations 19,012 788 19,800
Corporate bonds 14,299 827 $ 406 14,720
Mutual funds 14,009 42 6 14,045
Asset-backed securities 2,837 16 2,853
Preferred stocks 10,682 293 224 10,751
Other equity investments 3,476 884 90 4,270
--------- ---------- ---------- ----------
Total $ 78,162 $ 3,188 $ 726 $ 80,624
========= ========== ========== ==========
For the years ended September 30, 2003, 2002 and 2001, proceeds from
sales of investment securities available for sale amounted to $7,309, $7,066 and
$8,005, respectively. For such periods, gross realized gains on sales amounted
to $660, $351 and $34, respectively, while gross realized losses amounted to $0,
$20 and $20, respectively. The tax provision applicable to these net realized
gains and losses amounted to $224, $112 and $5, respectively.
Investment securities with an aggregate carrying value of $4,930 and
$2,986 were pledged as collateral for financings at September 30, 2003 and 2002,
respectively (see Note 8).
65
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
4. MORTGAGE-RELATED SECURITIES
Mortgage-related securities available for sale and mortgage-related
securities held to maturity are summarized as follows:
SEPTEMBER 30, 2003
------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED APPROXIMATE
COST GAIN LOSS FAIR VALUE
-------------------------------------------------------
Available for Sale:
FHLMC pass-through certificates $ 6,862 $ 126 $ 38 $ 6,950
FNMA pass-through certificates 45,740 412 122 46,030
GNMA pass-through certificates 13,043 596 -- 13,639
Collateralized mortgage obligations 57,961 433 357 58,037
--------- ---------- ---------- ----------
Total $ 123,606 $ 1,567 $ 517 $ 124,656
========= ========== ========== ==========
Held to Maturity:
FHLMC pass-through certificates $ 478 $ 22 $ -- $ 500
FNMA pass-through certificates 2,123 40 3 2,160
Collateralized mortgage obligations 886 14 -- 900
--------- ---------- ---------- ----------
Total $ 3,487 $ 76 $ 3 $ 3,560
========= ========== ========== ==========
SEPTEMBER 30, 2002
-------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED APPROXIMATE
COST GAIN LOSS FAIR VALUE
-------------------------------------------------------
Available for Sale:
FHLMC pass-through certificates $ 4,986 $ 275 $ -- $ 5,261
FNMA pass-through certificates 13,009 454 -- 13,463
GNMA pass-through certificates 32,407 1,214 -- 33,621
Collateralized mortgage obligations 32,884 449 4 33,329
--------- ---------- ---------- ----------
Total $ 83,286 $ 2,392 $ 4 $ 85,674
========= ========== ========== ==========
Held to Maturity:
FHLMC pass-through certificates $ 1,433 $ 77 $ -- $ 1,510
FNMA pass-through certificates 3,574 96 -- 3,670
Collateralized mortgage obligations 3,848 62 -- 3,910
--------- ---------- ---------- ----------
Total $ 8,855 $ 235 $ -- $ 9,090
========= ========== ========== ==========
The collateralized mortgage obligations contain both fixed and adjustable
classes of securities which are repaid in accordance with a predetermined
priority. The underlying collateral of the securities are loans which are
primarily guaranteed by FHLMC, FNMA, and GNMA.
For the years ended September 30, 2003 and 2001, proceeds from sales of
mortgage-related securities available for sales amounted to $7,485 and $6,926,
respectively. Gross realized gains amounted to $39 and $38 for the years ended
September 30, 2003 and 2001, respectively. Gross realized losses amounted to $99
for the year ended September 30, 2003. The tax provision (benefit) applicable to
these net realized gains and losses amounted to $(38) and $13 for the years
ended September 30, 2003 and 2001, respectively. During the year ended September
30, 2002, there were no sales of mortgage-related securities.
Mortgage-related securities with aggregate carrying values of $13,059 and
$12,907 were pledged as collateral for municipal deposits and financings at
September 30, 2003 and 2002, respectively (see Note 8).
66
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
5. ACCRUED INTEREST RECEIVABLE
The following is a summary of accrued interest receivable by category:
SEPTEMBER 30
------------------
2003 2002
------------------
Loans $ 1,438 $ 1,689
Mortgage-related securities 513 457
Investment securities 703 825
------- -------
Total $ 2,654 $ 2,971
======= =======
6. LOANS RECEIVABLE
Loans receivable consist of the following:
SEPTEMBER 30
----------------------
2003 2002
----------------------
Single-family $ 166,042 $ 173,736
Construction and land 28,975 28,292
Multi-family and commercial 59,022 60,379
Home equity and lines of credit 33,459 27,595
Consumer loans 1,438 1,202
Commercial loans 10,161 11,919
--------- ---------
Total loans 299,097 303,123
Loans in process (10,655) (11,384)
Allowance for loan losses (1,986) (2,358)
Deferred loan fees (35) (605)
--------- ---------
Loans receivable net $ 286,421 $ 288,776
========= =========
The Company originates loans primarily in its local market area of
Delaware and Chester Counties, Pennsylvania to borrowers that share similar
attributes. This geographic concentration of credit exposes the Company to a
higher degree of risk associated with this economic region.
The Company participated in the origination and sale of fixed-rate single
family residential loans in the secondary market. The Company recognized gains
on sale of loans held for sale on sales of conforming agency loans of $410, $84
and $122 for fiscal years ended September 30, 2003, 2002 and 2001, respectively.
The Company offers loans to its directors and senior officers on terms
permitted by Regulation O. There were approximately $2,068, $1,703 and $1,550 of
loans outstanding to senior officers and directors as of September 30, 2003,
2002 and 2001, respectively. The amount of repayments during the years ended
September 30, 2003, 2002 and 2001, totaled $1,163, $948 and $165 respectively.
There were $1,527, $725 and $772 of new loans granted during fiscal years 2003,
2002 and 2001, respectively.
The Company had undisbursed portions under consumer and commercial lines
of credit as of September 30, 2003 of $30,147 and $10,349, respectively.
The Company originates both adjustable and fixed interest rate loans and
purchases mortgage-related securities in the secondary market. The originated
adjustable-rate loans have interest rate adjustment limitations and are
generally indexed to U.S. Treasury securities plus a fixed margin. Future market
factors may affect the correlation of the interest rate adjustment with rates
the Company pays on the short-term deposits that have been the primary funding
source for these loans. The adjustable-rate mortgage-related securities adjust
to various national indices plus a fixed margin. At September 30, 2003, the
composition of these loans and mortgage-related securities was as follows:
67
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
FIXED-RATE
- -------------------------------------
TERM TO MATURITY BOOK VALUE
- ---------------- ----------
1 month to 1 year $ 5,321
1 year to 3 years 6,451
3 years to 5 years 14,753
5 years to 10 years 58,643
Over 10 years 205,505
--------
Total $290,673
========
ADJUSTABLE-RATE
- -----------------------------------
TERM TO RATE ADJUSTMENT BOOK VALUE
- ----------------------- ----------
1 month to 1 year $ 55,431
1 year to 3 years 25,879
3 years to 5 years 44,602
--------
Total $125,912
========
The following is an analysis of the allowance for loan losses:
YEAR ENDED
SEPTEMBER 30
---------------------------------------
2003 2002 2001
------- ------- -------
Beginning balance $ 2,358 $ 2,181 $ 2,019
Provisions charged to income 715 540 540
Charge-offs (1,102) (373) (532)
Recoveries 15 10 154
------- ------- -------
Total $ 1,986 $ 2,358 $ 2,181
======= ======= =======
At September 30, 2003 and 2002, non-performing loans (which include
loans in excess of 90 days delinquent) amounted to approximately $1,556 and
$5,138, respectively. At September 30, 2001, non-performing loans consisted of
loans that were collectively evaluated for impairment.
As of September 30, 2002, the Company had impaired loans with a total
recorded investment of $2.4 million and an average recorded investment of $2.1
million. There was not any cash basis interest income recognized on these
impaired loans during the year ended September 30, 2002. Interest income of
approximately $150 was not recognized as interest income due to the non-accrual
status of loans during 2002.
7. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are summarized by major classification
as follows:
SEPTEMBER 30
-------------------------
2003 2002
-------- --------
Land and buildings $ 6,082 $ 5,926
Furniture, fixtures and equipment 4,555 4,476
-------- --------
Total 10,637 10,402
Accumulated depreciation and amortization (7,210) (6,911)
-------- --------
Net $ 3,427 $ 3,491
======== ========
68
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The future minimum rental payments required under operating leases that
have initial or remaining non-cancelable lease terms in excess of one year as of
September 30, 2003 are as follows:
September 30
2004 $ 239
2005 267
2006 172
2007 158
2008 167
Thereafter 754
------
Total minimum future rental payments $1,757
======
Leasehold expense was approximately $375, $335 and $329 for the years
ended September 30, 2003, 2002 and 2001, respectively.
Depreciation expense amounted to $426, $457 and $429 for the years
ended September 30, 2003, 2002 and 2001, respectively.
8. DEPOSITS
Deposits consist of the following major classifications:
SEPTEMBER 30
------------------------------------------------------
2003 2002
------------------------------------------------------
AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- -------
Non-interest-bearing $ 20,917 5.8% $ 15,340 4.6%
NOW 60,221 16.6 48,803 14.8
Passbook 47,089 13.0 41,659 12.6
Money Market 55,889 15.4 48,721 14.7
Certificates of Deposit 178,489 49.2 176,242 53.3
-------- ----- -------- -----
Total $362,605 100.0% $330,765 100.0%
======== ===== ======== =====
The weighted average interest rates paid on deposits were 1.77% and
2.44% at September 30, 2003 and 2002, respectively.
Included in deposits as of September 30, 2003 and 2002 are deposits
greater than $100 totaling approximately $103,734 and $81,976, respectively.
Deposits in excess of $100 are not federally insured.
At September 30, 2003 and 2002, the Company pledged certain
mortgage-related securities aggregating approximately $12,867 and $7,371,
respectively, as collateral for municipal deposits.
A summary of scheduled maturities of certificates is as follows:
SEPTEMBER 30
------------------------
2003 2002
-------- --------
Within one year $106,631 $109,694
One to two years 42,069 39,829
Two to three years 7,962 11,852
Thereafter 21,827 14,867
-------- --------
Total $178,489 $176,242
======== ========
69
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
A summary of interest expense on deposits is as follows:
YEAR ENDED SEPTEMBER 30
-------------------------------------
2003 2002 2001
------- ------- -------
NOW $ 316 $ 401 $ 537
Passbook 530 750 907
Money Market 736 1,036 1,223
Certificates of Deposit 5,771 7,412 10,395
------- ------- -------
Total $ 7,353 $ 9,599 $13,062
======= ======= =======
9. BORROWINGS
A summary of borrowings is as follows:
SEPTEMBER 30
------------------------
2003 2002
-------- --------
FHLB advances $126,403 $126,237
Repurchase agreements 2,885 --
FHLB overnight borrowings 6,800 --
Other 184 147
-------- --------
Total borrowings $136,272 $126,384
======== ========
Advances from the FHLB are made at fixed rates with remaining
maturities, summarized as follows:
SEPTEMBER 30
------------------------
2003 2002
-------- --------
Over one year through five years (1) $ 25,704 --
Over five years through ten years (1) 100,500 126,032
Over 10 years 199 205
-------- --------
$126,403 $126,237
======== ========
(1) Although the contractual maturities of these borrowings are
between one and ten years, the FHLB has the right to convert these advances to
adjustable-rate advances. The amount of FHLB advances with the convertible
feature, which are subject to conversion in each of fiscal 2004, 2005, and 2006,
is $101.0 million, $10.0 million and $15.0 million, respectively.
Included in the table above at September 30, 2003 and 2002 are FHLB
advances whereby the FHLB has the option at predetermined times to convert the
fixed interest rate to an adjustable rate tied to the London Interbank Offered
Rate (LIBOR). The Company then has the option to prepay these advances if the
FHLB converts the interest rate. These advances are included in the periods in
which they mature. The average balance of FHLB advances was $126.4 million with
an average cost of 5.4% for the year ended September 20, 2003.
Advances from the FHLB are collateralized by all FHLB stock owned by
the Bank in addition to a blanket pledge of eligible assets in an amount
required to be maintained so that the estimated fair value of such eligible
assets exceeds, at all times, 110% of the outstanding advances.
The Company enters into sales of securities under agreements to
repurchase. These agreements are recorded as financing transactions, and the
obligation to repurchase is reflected as a liability in the consolidated
statements of financial condition. The securities underlying the agreements are
delivered to the dealer with whom each transaction is executed. The dealers, who
may sell, loan or otherwise dispose of such securities to other parties in the
normal course of their operations, agree to resell to the Company substantially
the same securities at the maturities of the agreements. The Company retains the
right of substitution of collateral throughout the terms of the agreement.
At September 30, 2003, outstanding FHLB repurchase agreements were
secured by U.S. Government securities. The average balance of FHLB repurchase
agreements during the year ended September 30, 2003 was $8 with an average cost
of 25 basis points. The maximum amount outstanding at any month end during the
year ended September 30, 2003 was $2.9 million.
70
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
10. INCOME TAXES
The Company and its subsidiaries file a consolidated federal income tax
return. The Company uses the specific charge-off method for computing reserves
for bad debts. The bad debt deduction allowable under this method is available
to large banks with assets greater than $500 million. Generally, this method
allows the Company to deduct an annual addition to the reserve for bad debts
equal to its net charge-offs.
Retained earnings at September 30, 2003 and 2002 included approximately
$2.5 million representing bad debt deductions for which no income tax has been
provided.
Income tax expense is comprised of the following:
YEAR ENDED SEPTEMBER 30
--------------------------------
2003 2002 2001
----- ----- -----
Federal:
Current $ 428 $ 583 $ 456
Deferred 225 (135) --
State -- -- 3
----- ----- -----
Total $ 653 $ 448 $ 459
===== ===== =====
The tax effect of temporary differences that give rise to significant
portions of the deferred tax accounts, calculated at 34%, is as follows:
SEPTEMBER 30
-----------------------
2003 2002
------- -------
Deferred tax assets:
Accelerated depreciation $ 374 $ 346
Allowance for loan losses 840 769
Accrued expenses 146 463
Other -- --
------- -------
Total deferred tax assets 1,360 1,578
======= =======
Deferred tax liabilities:
Deferred loan fees (310) (306)
Unrealized gain on available for sale securities (1,581) (1,649)
Other (50) (47)
------- -------
Total deferred tax liabilities (1,941) (2,002)
------- -------
Net deferred income taxes $ (581) $ (424)
======= =======
71
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The Company's effective tax rate is less than the statutory federal income tax
rate for the following reasons:
YEAR ENDED SEPTEMBER 30
----------------------------------------------------------------------
2003 2002 2001
----------------------------------------------------------------------
PERCENTAGE PERCENTAGE PERCENTAGE
OF PRETAX OF PRETAX OF PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
------ ------ ------ ------ ------ ------
Tax at statutory rate $ 1,153 34.0% $ 1,079 34.0% $ 991 34.0%
Increase (decrease) in taxes resulting from:
Tax exempt interest, net (274) (8.1) (290) (9.1) (281) (9.6)
Increase in cash surrender value (223) (6.5) (231) (7.3) (226) (7.7)
Other (3) (0.1) (110) (3.5) (25) (1.0)
------- ---- ------- ---- ------- ----
Total $ 653 19.3% $ 448 14.1% $ 459 15.7%
======= ==== ======= ==== ======= ====
11. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum regulatory
capital requirements can result in certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth
below) of tangible and core capital (as defined in the regulations) to adjusted
assets (as defined), and of Tier I and total capital (as defined) to average
assets (as defined). Management believes, as of September 30, 2003, that the
Bank meets all capital adequacy requirements to which it is subject.
As of September 30, 2003, the most recent notification from the OTS
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must
maintain minimum total risk-based, Tier-1 risk-based, and Tier-1 core capital
ratios as set forth in the table below. There are no conditions or events since
that notification that management believes have changed the institution's
category.
REQUIRED FOR WELL CAPITALIZED
CAPITAL ADEQUACY UNDER PROMPT
ACTUAL PURPOSE CORRECTIVE ACTION
----------------------------------------------------------------
AMOUNT PERCENTAGE AMOUNT PERCENTAGE AMOUNT PERCENTAGE
------ ---------- ------ ---------- ------ ----------
At September 30, 2003:
Core Capital (to Adjusted Tangible Assets) $43,852 8.0% $21,972 4.0% $27,465 5.0%
Tier I Capital (to Risk-Weighted Assets) 43,852 14.4 N/A N/A 18,268 6.0
Total Capital (to Risk-Weighted Assets) 45,564 15.0 24,357 8.0 30,446 10.0
Tangible Capital (to Tangible Assets) 43,852 8.0 8,240 1.5 N/A N/A
At September 30, 2002:
Core Capital (to Adjusted Tangible Assets) $40,873 8.1% $20,265 4.0% $25,325 5.0%
Tier I Capital (to Risk-Weighted Assets) 40,873 15.4 N/A N/A 15,941 6.0
Total Capital (to Risk-Weighted Assets) 42,957 16.2 21,255 8.0 26,569 10.0
Tangible Capital (to Tangible Assets) 40,873 8.1 7,597 1.5 N/A N/A
72
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The Bank's capital at September 30, 2003 and 2002 for financial
statement purposes differs from tangible, core (leverage), and Tier-1 risk-based
capital amounts by $ and $ , respectively, representing the inclusion of
unrealized gain on securities available for sale and a portion of capital
securities (see Note 17) that qualifies as regulatory capital as well as
adjustments to the Bank's capital that do not affect the parent company.
At September 30, 2003 and 2002, total risk-based capital, for
regulatory requirements, was increased by $1,712 and $2,406, respectively, of
general loan loss reserves, for a total of $45,564 and $42,957, respectively.
At the date of the Bank's conversion from the mutual to stock form in
January 1995 (the "Conversion"), the Bank established a liquidation account in
an amount equal to its retained income as of August 31, 1994. The liquidation
account is maintained for the benefit of eligible account holders and
supplemental eligible account holders who continue to maintain their accounts at
the Bank after the Conversion. The liquidation account is reduced annually to
the extent that eligible account holders (as defined in the Bank's plan of
conversion) and supplemental eligible account holders have reduced their
qualifying deposits as of each anniversary date. Subsequent increases in such
balances will not restore an eligible account holder's or supplemental eligible
account holder's interest in the liquidation account. In the event of a complete
liquidation of the Bank, each eligible account holder and supplemental eligible
account holder will be entitled to receive a distribution from the liquidation
account in an amount proportionate to the current adjusted qualifying balances
for accounts then held.
The principal source of cash flow for the Company is dividends from the
Bank. Various federal banking regulations and capital guidelines limit the
amount of dividends that may be paid to the Company by the Bank. Future payment
of dividends by the Bank is dependent on individual regulatory capital
requirements and levels of profitability. In addition, loans or advances made by
the Bank to the Company are generally limited to 10 percent of the Bank's
capital stock and surplus on a secured basis. Accordingly, funds available for
loans or advances by the Bank to the Company amounted to $4,431.
12. EMPLOYEE BENEFITS
401(k) PROFIT SHARING PLAN
The Bank's 401(k) profit sharing plan covers substantially all
full-time employees of the Company and provides for pre-tax contributions by the
employees with matching contributions at the discretion of the Board of
Directors determined at the beginning of the calendar year. All amounts are
fully vested. For calendar years 2003, 2002 and 2001, the Company matched
twenty-five cents for every dollar contributed up to 5% of a participant's
salary. The profit sharing expense for the plan was $38, $36 and $32 for the
fiscal years ended September 30, 2003, 2002 and 2001, respectively.
EMPLOYEE STOCK OWNERSHIP PLAN
In connection with the Conversion, the Company established an employee
stock ownership plan ("ESOP") for the benefit of eligible employees. At
September 30, 2003, 244,865 shares were committed to be released, of which
19,229 shares have not yet been allocated to participant accounts. The Company
accounts for its ESOP in accordance with AICPA Statement of Position 93-6,
Employers Accounting for Employee Stock Ownership Plans, which requires the
Company to recognize compensation expense equal to the fair value of the ESOP
shares during the periods in which they become committed to be released. To the
extent that the fair value of the ESOP shares released differs from the cost of
such shares, this difference is charged or credited to equity as additional
paid-in capital. Management expects the recorded amount of expense in any given
period to fluctuate from period to period as continuing adjustments are made to
reflect changes in the fair value of the ESOP shares. The Company's ESOP, which
is internally leveraged, does not report the loan receivable extended to the
ESOP as an asset and does not report the ESOP debt due the Company. The Company
recorded compensation and employee benefit expense related to the ESOP of $516,
$395 and $308 for the years ended September 30, 2003, 2002 and 2001,
respectively.
73
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
RECOGNITION AND RETENTION PLAN
Under the 1995 Recognition and Retention Plan and Trust (the "RRP"),
there are 81,600 shares authorized under the RRP. At September 30, 2002, the
Company awarded 79,350 shares to the Company's Board of Directors and executive
officers subject to vesting and other provisions of the RRP. At September 30,
2003, all the shares awarded had been allocated to plan participants.
Compensation expense was recognized ratably over the five year vesting
period for the shares awarded. Since all the shares awarded have been allocated,
no compensation expense was recognized relating to the RRP for fiscal years
ended September 30, 2003, 2002 and 2001.
STOCK OPTION PLANS
Under the 1995 Stock Option Plan (the "Option Plan"), common stock
totaling 272,000 shares has been reserved for issuance pursuant to the exercise
of options. During fiscal year 1999, stockholders approved the adoption of the
1998 Stock Option Plan ("1998 Option Plan") (collectively with the Option Plan,
the "Plans") which reserves an additional 111,200 shares of common stock for
issuance. Options covering an aggregate of 357,106 shares have been granted to
the Company's executive officers, nonemployee directors and other key employees,
subject to vesting and other provisions of the Plans. At September 30, 2003,
2002 and 2001, the number of shares exercisable was 210,209, 261,913 and
271,889, respectively, and the weighted average exercise price of those options
was $9.19, $8.91 and $8.57, respectively.
The following table summarizes transactions regarding the stock option
plans:
Weighted
Number of Average
Option Exercise Exercise Price
Shares Price Range per share
------ ----------- ---------
Outstanding at October 1, 2000 339,140 $ 7.50 - 14.25 $ 9.05
Exercised (14,607) 7.50 - 7.50 7.50
------- -------------- ---------
Outstanding at September 30, 2001 324,533 $ 7.50 - 14.25 $ 9.11
Granted 13,300 14.84 - 16.15 15.73
Exercised (30,856) 7.50 - 12.38 7.97
------- -------------- ---------
Outstanding at September 30, 2002 306,977 $ 7.50 - 16.15 $ 9.52
Granted 3,000 16.15 - 16.15 16.15
Exercised (62,678) 7.50 - 14.25 8.79
------- -------------- ---------
Outstanding at September 20, 2003 247,299 $ 7.50 - 16.15 $ 9.78
======= ============== =========
A summary of the exercise price range at September 30, 2003 is as
follows:
Weighted Average Weighted Average
Number of Remaining Contractual Exercise Price per
Option Shares Exercise Price Range Life Share
- ------------- -------------------- ---- -----
146,769 $ 7.50 - 10.13 2.24 $ 7.63
100,530 12.13 - 16.15 6.41 12.90
------- -------------- ---- ---------
247,299 $ 7.50 - 16.15 3.93 $ 9.78
======= ============== ==== =========
74
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The Company applies APB Opinion No. 25 in accounting for stock options
and, accordingly, no compensation expense has been recognized in the financial
statements. Had the Company determined compensation expense based on the fair
value at the grant date for its stock options under SFAS No. 123, the Company's
net income and income per share would have been reduced to the pro forma amounts
indicated below:
YEAR ENDED SEPTEMBER 30
2003 2002 2001
---- ---- ----
Net income:
As reported $ 2,739 $ 2,726 $ 2,471
Pro forma 2,665 2,649 2,405
Net income per common and common equivalent share:
Earnings per common share
- As reported $ 1.35 $ 1.34 $ 1.18
- Pro forma 1.31 1.30 1.15
Weighted average fair value of options granted during the period $ 4.83 $ 9.67 N/A
The binomial option-pricing model was used to determine the fair value
of options at the grant date. Significant assumptions used to calculate the
above fair value of the awards are as follows:
SEPTEMBER 30
----------------------------
2003 2002 2001
---- ---- ----
Risk-free interest rate of return 3.03% 2.98% 3.77%
Expected option life (months) 100 100 60
Expected Volatility 27% 73% 52%
Expected dividends 1.8% 2.8% 2.3%
OTHER
The Company established an expense accrual in connection with the
anticipated funding of a trust to be created to formalize the Company's deferred
compensation arrangements with four former officers of the Company. A total of
$31 and $85 was included in the Company's liabilities at September 30, 2003 and
2002, respectively.
13. DERIVATIVE FINANCIAL INSTRUMENTS
The Company concurrently adopted the provisions of SFAS No. 133, and
SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities -- an amendment of FASB Statement No. 133" on October 1, 2000. The
Company adopted the provisions of SFAS No. 149 effective July 1, 2003. The
Company's derivative instruments outstanding during fiscal year end September
30, 2003 include commitments to fund loans available-for-sale and forward loan
sale agreements.
The Company adopted new accounting requirements relating to SFAS No.
149 which requires that mortgage loan commitments related to loans originated
for sale be accounted for as derivative instruments. In accordance with SFAS No.
133 and SFAS No. 149, derivative instruments are recognized in the statement of
financial condition at fair value and changes in the fair value thereof are
recognized in the statement of operations. The Company originates single-family
residential loans for sale pursuant to programs with FHLMC. Under the structure
of the programs, at the time the Company initially issues a loan commitment in
connection with such programs, it does not lock in a specific interest rate. At
the time the interest rate is locked in by the borrower, the Company
concurrently enters into a forward loan sale agreement with respect to the sale
of such loan at a set price in an effort to manage the interest rate risk
inherent in the locked loan commitment. The forward loan sale agreement also
meets the definition of a derivative instrument under SFAS No. 133. Any change
in the fair value of the loan commitment after the borrower locks in the
interest rate is substantially offset by the corresponding change in the fair
value of the forward loan sale agreement related to such loan. The period from
the time the borrower locks in the interest rate to the time the Company funds
the loan and sells it to FHLMC is generally 60 days. The fair value of each
instrument will rise or fall in response to changes in market interest
75
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
rates subsequent to the dates the interest rate locks and forward loan sale
agreements are entered into. In the event that interest rates rise after the
Company enters into an interest rate lock, the fair value of the loan commitment
will decline. However, the fair value of the forward loan sale agreement related
to such loan commitment should increase by substantially the same amount,
effectively eliminating the Company's interest rate and price risk.
At September 30, 2003, the Company had $1.5 million of loan commitments
outstanding related to loans being originated for sale. Of such amount, $230
related to loan commitments for which the borrowers had not entered into
interest rate locks and $1.3 million which were subject to interest rate locks.
At September 30, 2003, the Company had $1.3 million of forward loan sale
agreements. Due to the structure of these transactions, the Company concluded
that the derivative instruments involving its loans held for sale were not
material to the consolidated statements of the financial condition and
operations of the Company as of and for the year ended September 30, 2003 since
the Company does not bear any interest rate or price risk with respect to such
transactions.
14. COMMITMENTS AND CONTINGENCIES
The Company has outstanding loan commitments, excluding undisbursed
portion of loans in process and equity lines of credit, of approximately $5,922
and $10,621 as of September 30, 2003 and 2002, respectively, all of which are
expected to be funded within four months. Of these commitments outstanding, the
breakdown between fixed and adjustable-rate loans is as follows:
SEPTEMBER 30
-------------------
2003 2002
---- ----
Fixed-rate (ranging from 4.49% to 6.75%) $ 5,578 $ 4,525
Adjustable-rate 344 6,096
------- -------
Total $ 5,922 $10,621
======= =======
Depending on cash flow, interest rate, risk management and other
considerations, longer term fixed-rate residential loans are sold in the
secondary market. There was approximately $1,307 and $2,936 in outstanding
commitments to sell loans at September 30, 2003 and 2002, respectively.
In the fourth quarter of fiscal 2002, the Company settled a lawsuit
related to certain loan sales. The lawsuit was instituted by the purchaser of
five residential mortgage loans from the Bank that alleged that it suffered
losses in connection with these loans and that the Bank was required to purchase
the loans or compensate the purchaser for its alleged losses. The Bank settled
all the purchaser's claims for $570.
There are various claims and pending actions against the Company and
its subsidiaries arising out of the conduct of its business. In the opinion of
the Company's management and based upon advice of legal counsel, the resolution
of these matters will not have a material adverse impact on the consolidated
financial position or the results of operations of the Company and its
subsidiaries.
15. RELATED PARTY TRANSACTIONS
The Company retains the services of a law firm in which one of the
Company's directors is a member. In addition to providing general legal counsel
to the Company, the firm also prepares mortgage documents and attends loan
closings for which it is paid directly by the borrower.
The Company also utilizes one of the Company's directors as a
consultant on various real estate matters. In addition, one of the Company's
board members has an interest in an insurance agency, First Keystone Insurance
Services, LLC in which one of the Bank's subsidiaries has a majority position.
76
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company
using available market information and appropriate valuation methodologies.
However, considerable judgment is required to interpret market data to develop
the estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
SEPTEMBER 30
------------------------------------------------
2003 2002
------------------------------------------------
CARRYING/ ESTIMATED CARRYING/ ESTIMATED
NOTIONAL FAIR NOTIONAL FAIR
AMOUNT VALUE AMOUNT VALUE
------ ----- ------ -----
Assets:
Cash and cash equivalents $ 21,190 $ 21,190 $ 24,623 $ 24,623
Investment securities 84,015 84,150 80,624 80,624
Loans 286,421 287,996 288,776 293,509
Loans held for sale 4,498 4,498 501 501
Mortgage-related securities 128,143 129,646 94,529 94,764
FHLB stock 8,294 8,294 6,571 6,571
Liabilities:
Passbook deposits 47,089 47,089 41,659 41,659
NOW and money market deposits 116,110 116,110 102,770 102,770
Certificates of deposit 178,489 179,699 176,242 178,404
Borrowings 136,272 137,709 126,237 128,539
Off balance sheet commitments 43,024 43,024 35,732 35,732
The fair value of cash and cash equivalents is their carrying value due
to their short-term nature. The fair value of investments and mortgage-related
securities is based on quoted market prices, dealer quotes, and prices obtained
from independent pricing services. The fair value of loans is estimated, based
on present values using approximate current entry value interest rates,
applicable to each category of such financial instruments. The fair value of
FHLB stock approximates its carrying amount.
The fair value of NOW deposits, money market deposits and passbook
deposits is the amount reported in the financial statements. The fair value of
certificates of deposit and FHLB advances is based on a present value estimate,
using rates currently offered for deposits and borrowings of similar remaining
maturity.
Fair values for off-balance sheet commitments are based on fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the counterparties credit standings.
No adjustment was made to the entry-value interest rates for changes in
credit performing commercial loans, construction loans, and land loans for which
there are no known credit concerns. Management believes that the risk factor
embedded in the entry-value interest rates, along with the general reserves
applicable to the performing commercial, construction, and land loan portfolios
for which there are no known credit concerns, result in a fair valuation of such
loans on an entry-value basis. The fair value of non-performing loans, with a
recorded book value of approximately $1,556 and $5,138 (which are collateralized
by real estate properties with property values in excess of carrying amounts) as
of September 30, 2003 and 2002, respectively, was not estimated because it is
not practicable to reasonably assess the credit adjustment that would be applied
in the marketplace for such loans. The fair value estimates presented herein are
based on pertinent information available to management as of September 30, 2003
and 2002. Although management is not aware of any factors that would
significantly affect the estimated fair value amounts, such amounts have not
been comprehensively revalued for purposes of these financial statements since
September 30, 2003 and 2002 and, therefore, current estimates of fair value may
differ significantly from the amounts presented herein.
77
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
17. CAPITAL SECURITIES
On August 21, 1997, First Keystone Capital Trust I (the "Trust"), a
trust formed under Delaware law, that is a subsidiary of the Company, issued
$16.2 million of preferred securities (the "Preferred Securities") at an
interest rate of 9.7%, with a scheduled maturity of August 15, 2027. The Company
owns all the common stock of the Trust. The proceeds from the issue were
invested in Junior Subordinated Debentures (the "Debentures") issued by the
Company. The Debentures are unsecured and rank subordinate and junior in right
of payment to all indebtedness, liabilities and obligations of the Company. The
Debentures represent the sole assets of the Trust. Interest on the
Preferred Securities is cumulative and payable semiannually in arrears. The
Company has the option, subject to required regulatory approval, if any, to
prepay the securities beginning August 15, 2007.
The securities are shown on the balance sheet as Company-obligated
mandatorily redeemable preferred securities of a subsidiary trust holding solely
junior subordinated debentures of the Company. The Company has, under the terms
of the Debentures and the related Indenture as well as the other operative
corporate documents, agreed to irrevocably and unconditionally guarantee the
Trust's obligations under the Debentures. The Company contributed approximately
$6.0 million of the net proceeds to the Bank to support the Bank's lending
activities. The interest cost associated with this issue is treated as a
non-interest expense on the consolidated statement of income rather than
interest expense.
On November 15, 2001, the Company purchased $3.5 million of the
Preferred Securities.
On November 28, 2001, First Keystone Capital Trust II (the "Trust II"),
a trust formed under Delaware law, that is a subsidiary of the Company, issued
$8.0 million of securities ("Preferred Securities II") in a pooled securities
offering at a floating rate of 375 basis over the six month LIBOR with a
maturity date of December 8, 2031. The Company owns all the common stock of the
Trust II. The proceeds from the issue were invested in Junior Subordinated
Debentures (the "Debentures II") issued by the Company. The Debentures II are
unsecured and rank subordinate and junior in right of payment to all
indebtedness, liabilities and obligations of the Company. The Debentures II
represent the sole assets of the Trust II. Interest on the Preferred Securities
II is cumulative and payable semi-annually in arrears. The Company has the
option, subject to required regulatory approval, if any, to prepay the
securities beginning December 8, 2006.
78
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
18. PARENT COMPANY ONLY FINANCIAL INFORMATION
Condensed financial statements of First Keystone Financial, Inc. are as
follows:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30
-----------------
2003 2002
-----------------
Assets:
Interest-bearing deposits $ 1,800 $ 2,269
Investment securities available for sale 6,246 7,060
Investment in subsidiaries 46,482 44,192
Other assets 1,089 1,798
------- -------
Total assets $55,617 $55,319
======= =======
Liabilities and Stockholders' Equity
Junior subordinated debt $21,593 $21,630
Other liabilities 1,636 894
------- -------
Total liabilities 23,229 22,524
Stockholders' equity 32,388 32,795
------- -------
Total liabilities and stockholders' equity $55,617 $55,319
======= =======
CONDENSED STATEMENTS OF INCOME
YEAR ENDED SEPTEMBER 30
-----------------------------
2003 2002 2001
-----------------------------
Interest and dividend income:
Dividends from subsidiary $ 9 $ 5 $ 4,500
Loan to ESOP 79 92 105
Interest and dividends on investments 286 502 608
Interest on deposits 50 67 7
------- ------- -------
Total Interest and dividend income 424 666 5,220
------- ------- -------
Interest on debt and other borrowed money 1,677 1,723 1,762
Other income 241 44 25
Operating expenses 194 154 403
------- ------- -------
(Loss) income before income taxes and equity
in undistributed income (loss) of subsidiaries (1,206) (1,167) 3,080
Income tax benefit (402) (385) (477)
------- ------- -------
(Loss) income before equity in undistributed (loss) income
of subsidiaries (804) (782) 3,557
Equity in undistributed income (loss) of subsidiaries 3,543 3,508 (1,086)
------- ------- -------
Net income $ 2,739 $ 2,726 $ 2,471
======= ======= =======
79
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
CONDENSED STATEMENTS OF CASH FLOWS
YEAR ENDED SEPTEMBER 30
-----------------------------
2003 2002 2001
-----------------------------
Cash flows from operating activities:
Net income $ 2,739 $ 2,726 $ 2,471
Adjustment to reconcile net income to cash provided by
(used in) operations:
Equity in undistributed (income) loss of subsidiaries (3,543) (3,508) 1,086
Amortization of common stock acquired by stock benefit plans 374 384 251
Gain (loss) on sales of investment securities available for sale (241) 44 (25)
Amortization of premium 26 (22) 29
(Increase) decrease in other assets 709 (1,205) 455
(Increase) decrease in other liabilities 165 145 (459)
------- ------- -------
Net cash (used in) provided by operating activities 229 (1,436) 3,808
------- ------- -------
Cash flows from financing activities:
Purchase of investments available for sale (3,870) (278)
Proceeds from calls or repayments of investment securities 1,100
Proceeds from sale of investments available for sale 1,591 4,956 1,025
------- ------- -------
Net cash provided by (used in) investing activities 2,691 1,086 747
------- ------- -------
Cash flows from financing activities:
Issuance of preferred trust securities -- 8,000 --
Purchase of preferred trust securities -- (3,290) --
Repayment in other borrowed money -- (815) (711)
Purchase of treasury stock (2,986) (1,013) (3,045)
Dividends paid (798) (734) (693)
Proceeds from exercise of stock options 395 275 18
------- ------- -------
Net cash provided by (used in) financing activities (3,389) 2,423 (4,431)
------- ------- -------
Increase (decrease) in cash (469) 2,073 124
Cash at beginning of year 2,269 196 72
------- ------- -------
Cash at end of year $ 1,800 $ 2,269 $ 196
======= ======= =======
80
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
19. QUARTERLY FINANCIAL DATA (UNAUDITED)
Unaudited quarterly financial data for the years ended September 30,
2003 and 2002 is as follows:
2003 2002
------------------------------------------------------------------------
1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
QTR QTR QTR QTR QTR QTR QTR QTR
------------------------------------------------------------------------
Interest income $7,217 $6,973 $6,614 $6,407 $7,757 $7,416 $7,547 $7,403
Interest expense 3,710 3,576 3,579 3,470 4,641 4,157 3,899 3,843
------ ------ ------ ------ ------ ------ ------ ------
Net interest income 3,507 3,397 3,035 2,937 3,116 3,259 3,648 3,560
Provision for loan losses 195 195 195 130 135 135 135 135
------ ------ ------ ------ ------ ------ ------ ------
Net income after
provision for loan losses 3,312 3,202 2,840 2,807 2,981 3,124 3,513 3,425
Non-interest income 614 540 998 1,093 458 450 456 859(1)
Non-interest expense 2,921 2,906 3,020 3,168 2,666 2,753 3,053 3,622(1)
------ ------ ------ ------ ------ ------ ------ ------
Income before income taxes 1,005 836 818 732 773 821 916 662
Income tax expense 224 143 153 132 120 137 173 17
------ ------ ------ ------ ------ ------ ------ ------
Net income $ 781 $ 693 $ 665 $ 600 $ 653 $ 684 $ 743 $ 645
====== ====== ====== ====== ====== ====== ====== ======
Per Share:
Earnings per share - basic $ .41 $ .36 $ .35 $ .32 $ .34 $ .35 $ .39 $ .34
Earnings per share - diluted $ .39 $ .34 $ .33 $ .29 $ .32 $ .34 $ .36 $ .32
Dividend per share $ .10 $ .10 $ .10 $ .10 $ .09 $ .09 $ .09 $ .09
(1) During the fourth quarter, the Company sold and realized a pre-tax net gain
on certain available for sale securities of $331. Additionally, due to a
settlement of a lawsuit concerning certain loan sales, a $570 expense was
incurred.
Certain reclassifications have been made to the quarters presented to
conform with the presentation. Such reclassifications had no impact on the
reported net income.
81
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
ITEM 9-A. CONTROLS AND PROCEDURES.
Under the supervision and with the participation of the Company's
management, including its chief executive officer and chief financial officer,
the Company has evaluated the effectiveness of the design and operation of its
disclosure controls and procedures as of September 30,2003, and based on their
evaluation, the Company's chief executive officer and chief financial officer
have concluded that these controls and procedures are designed to ensure that
the information required to be disclosed by the Company. The reports that it
files or submits under the Exchange Act is recorded, processed, summarized in
the SEC's rules and regulations and are operating in an effective manner. No
change in the Company's internal control over financial reporting (as defined in
Rules 13a-15(f) and 15(d)-15(f) under the Exchange Act) occurred during the
fourth fiscal quarter of fiscal 2003 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required herein with respect to directors and executive
officers of the Company is incorporated by reference from the information
contained in the section captioned "Information with Respect to Nominees for
Director, Directors Whose Terms Continue and Executive Officers" in the
Company's definitive Proxy Statement for the Annual Meeting of Stockholders to
be held January 28, 2004 (the "Proxy Statement"), a copy of which will be filed
with the SEC before the meeting date.
The Company has adopted a Code of Ethics that applies to its principal
executive officer and principal financial officer, as well as other officers and
employees of the Company and the Bank. A copy of the Code of Ethics, included as
an exhibit to this Form 10-K and filed with the Securities and Exchange
Commission, may also be found on the Company's website at www.firstkeystone.com.
ITEM 11. EXECUTIVE COMPENSATION.
The information required herein is incorporated by reference from the
information contained in the section captioned "Executive Compensation" in of
the Registrant's Proxy Statement. The reports of the Audit Committee and the
Compensation Committee included in the Registrant's Proxy Statement should be
deemed filed or incorporated into this filing or any other filing by the Company
under the Exchange Act or the Securities Act of 1933 except to the extent the
Company specifically incorporates said reports herein or therein by reference
thereto.
82
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The information required herein is incorporated by reference from the
information contained in the section captioned "Beneficial Ownership of Common
Stock by Certain Beneficial Owners and Management" in the Registrant's Proxy
Statement.
EQUITY COMPENSATION PLAN INFORMATION. The following table sets forth
certain information for all equity compensation plans and individual
compensation arrangements (whether with employees or non-employees, such as
directors), in effect as of September 30, 2003.
Number of Shares to be issued upon Weighted-Average Number of Shares Remaining Available
the Exercise of Outstanding Options, Exercise Price of for Future Issuance (Excluding Shares
Plan Category Warrants and Rights Outstanding Options Reflected in the First Column)
- ------------------------------------------------------------------------------------------------------------------------------------
Equity Compensation Plans
Approved by Security
Holders 247,299 $9.78 26,094
Equity Compensation Plans Not
Approved by Security
Holders -- -- --
------- ----- ------
Total 247,299 $9.78 26,094
======= ===== ======
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required herein is incorporated by reference from the
information contained in the section captioned "Transactions with Certain
Related Persons" in of the Registrant's Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Not applicable.
PART IV.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this Report.
(1) The following documents are filed as part of this report and
are incorporated herein by reference from the Registrant's
Annual Report.
Report of Independent Auditors.
Consolidated Statements of Financial Condition at September
30, 2003 and 2002.
Consolidated Statements of Income for the Years Ended
September 30, 2003, 2002 and 2001.
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended September 30, 2003, 2002 and 2001.
Consolidated Statements of Cash Flows for the Years Ended
September 30, 2003, 2002 and 2001.
Notes to the Consolidated Financial Statements.
83
(2) All schedules for which provision is made in the applicable accounting
regulation of the SEC are omitted because they are not applicable or the
required information is included in the Consolidated Financial
Statements or notes thereto.
(3) The following exhibits are filed as part of this Form 10-K, and this
list includes the Exhibit Index.
No Description
-- -----------
3.1 Amended and Restated Articles of Incorporation of First Keystone
Financial, Inc. *
3.2 Amended and Restated Bylaws of First Keystone Financial, Inc. *
4 Specimen Stock Certificate of First Keystone Financial, Inc. *
10.1 Employee Stock Ownership Plan and Trust of First Keystone Financial,
Inc. *
10.2 401(K)/ Profit-sharing Plan of First Keystone Federal Savings Bank. *
10.3 Employment Agreement between First Keystone Financial, Inc. and Donald
S. Guthrie dated May 26, 1999. **
10.4 Employment Agreement between First Keystone Financial, Inc. and Stephen
J. Henderson dated May 26, 1999. **
10.5 Employment Agreement between First Keystone Financial, Inc. and Thomas
M. Kelly dated May 26, 1999. **
10.6 Form of Severance Agreement between First Keystone Financial, Inc. and
Elizabeth M. Mulcahy dated May 26, 1999. **
10.8 Form of Severance Agreement between First Keystone Financial, Inc. and
Carol Walsh dated May 26, 1999. **
10.9 1995 Stock Option Plan.***
10.10 1995 Recognition and Retention Plan and Trust Agreement.***
10.11 1998 Stock Option Plan.****
10.12 Employment Agreement between First Keystone Federal Savings Bank and
Donald S. Guthrie dated May 26, 1999. **
10.13 Employment Agreement between First Keystone Federal Savings Bank and
Stephen J. Henderson dated May 26, 1999. **
10.14 Employment Agreement between First Keystone Federal Savings Bank and
Thomas M. Kelly dated May 26, 1999. **
10.15 Form of Severance Agreement between First Keystone Federal Savings Bank
and Elizabeth M. Mulcahy dated May 26, 1999. **
10.16 Form of Severance Agreement between First Keystone Federal Savings Bank
and Carol Walsh dated May 26, 1999. **
84
11 Statement re: computation of per share earnings. See Note 2 to the
Consolidated Financial Statements included in Item 8 hereof.
21 Subsidiaries of the Registrant - Reference is made to Item 1 "Business,"
for the required information.
23 Consent of Deloitte & Touche LLP.
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.1 Codes of Ethics
- ----------
(*) Incorporated by reference from the Registration Statement Form S-1
(Registration No. 33-84824) filed by the Registrant with the SEC on
October 6, 1994, as amended.
(**) Incorporated by reference from the Form 10-K filed by the Registrant
with the SEC on December 29, 1999 (File No. 000-25328).
(***) Incorporated by reference from the Form 10-K filed by the Registrant
with SEC on December 29, 1995 (File No. 000-25328).
(****) Incorporated from Appendix A of the Registrant's definitive proxy
statement dated December 24, 1998 (File No. 000-25328).
(b) Reports filed on Form 8-K.
Date Item and Description
---- --------------------
08/01/03 Item 12 - Filing of press release reporting the Company's results
of operation for the three and nine months ended June 30, 2003.
(c) Exhibits. See the list set forth above under subsection (a) (3)
(d) Financial Statement Schedules.
85
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST KEYSTONE FINANCIAL, INC.
By: /s/ Donald S. Guthrie
-----------------------
Donald S. Guthrie
Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report had been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.
/s/ Donald S. Guthrie December 23, 2003
- --------------------------------------
Donald S. Guthrie
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
/s/ Thomas M. Kelly December 23, 2003
- --------------------------------------
Thomas M. Kelly
President and Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ Donald A. Purdy December 23, 2003
- --------------------------------------
Donald A. Purdy
Director
/s/ Edward Calderoni December 23, 2003
- --------------------------------------
Edward Calderoni
Director
/s/ Edmund Jones December 23, 2003
- --------------------------------------
Edmund Jones
Director
/s/ Donald G. Hosier, Jr. December 23, 2003
- --------------------------------------
Donald G. Hosier, Jr.
Director
/s/ Marshall J. Soss December 23, 2003
- --------------------------------------
Marshall J. Soss
Director
/s/ William J. O'Donnell December 23, 2003
- --------------------------------------
William J. O'Donnell
Director
/s/ Bruce C. Hendrixson December 23, 2003
- --------------------------------------
Bruce C. Hendrixson
Director
86