FIRST KEYSTONE FINANCIAL INC - 10-K Annual Report

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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, 1999

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
---

As of December 15, 1999 the aggregate value of the 1,897,005 shares of Common
Stock of the Registrant issued and outstanding on such date, which excludes
354,711 shares held by all directors and officers of the Registrant as a group,
was approximately $17.5 million. This figure is based on the last known trade
price of $9.25 per share of the Registrant's Common stock on December 15, 1999.

Number of shares of Common Stock outstanding as of December 15, 1999: 2,251,716

DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents incorporated by reference and the Part of
the Form 10-K into which the document is incorporated:

(1) Portions of the Annual Report to Stockholders for the fiscal year ended
September 30, 1999 are incorporated into Parts II and III.

(2) Portions of the definitive proxy statement for the Annual Meeting of
Stockholders are incorporated into Part III.
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PART I.

Item 1. BUSINESS

GENERAL

First Keystone Financial, Inc. (the "Company") is a Pennsylvania
corporation and sole shareholder of First Keystone Federal Savings Bank (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 loans to its employee stock ownership plan, and various equity and
other investments. See Note 19 of the Notes to Consolidated Financial Statements
in the Annual Report to Stockholders for the year ended September 30, 1999 set
forth as Exhibit 13 hereto ("Annual Report"). The business of the Company
primarily consists of the business of the Bank.

The Bank is a traditional, community oriented federal savings bank
emphasizing customer service and convenience. The Bank's primary business is to
attract deposits from the general public and invest those funds together with
other available sources of funds, primarily borrowings, to originate loans. A
substantial portion of the Bank's deposits are comprised of core deposits
consisting of passbook, money market("MMDA"), NOW and noninterest-bearing
accounts which amounted to $101.1 million or 38.7% of the Bank's total deposits
at September 30, 1999. The Bank's primary lending emphasis has been 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 these first mortgage loans for resale into the secondary
market while retaining for its portfolio adjustable-rate mortgage loans and
fixed-rate loans that complement the Bank's asset/liability strategies. The Bank
also originates, due to their shorter terms, adjustable or variable interest
rates, higher yields, and as a result of the Bank's analysis that the markets
have become more stable, loans secured by commercial and residential
multi-family real estate properties as well as residential and commercial
construction loans secured by properties located in the Bank's market area. The
Bank's originations of commercial, construction and multi-family loans has
continued to increase as a direct result of the Bank's emphasis on developing
business loan products. Multi-family and commercial real estate loans amounted
to $31.2 million or 13.1% of the total loan portfolio at September 30, 1999 as
compared to $20.6 million or 9.9% at September 30, 1998. The Bank also
originates for sale, servicing released, in the secondary market, single-family
residences secured by first and second mortgages with respect to non-conforming
jumbo loans and sub-prime loans to credit impaired borrowers. The Bank also
purchases loan participation interests depending on market conditions and
portfolio needs.

To a lesser extent, the Bank also originates consumer loans (consisting
almost entirely of home equity loans and lines of credit) and other mortgage
loans.

In addition to its deposit gathering and lending activities, the Bank
invests in mortgage-related securities, substantially all of which are issued or
guaranteed by U.S. Government agencies and government sponsored enterprises, as
well as U.S. Treasury and federal government agency obligations and municipal
obligations. At September 30, 1999, the Bank's mortgage-related securities
(including mortgage-related securities available for sale) amounted to $127.5
million, or 28.3% of the Company's total assets, and investment securities
available for sale amounted to $44.3 million, or 9. 8% of total assets.
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MARKET AREA

The Bank's primary market area consists of Delaware and Southern Chester
Counties and to a lesser extent the contiguous counties of Montgomery and
Northern Chester Counties, Pennsylvania and New Castle County, Delaware.
Delaware County is part of the Philadelphia Primary Metropolitan Statistical
Area ("PMSA") which includes besides Delaware County, Bucks, Chester, Montgomery
and Philadelphia Counties (as well as four counties in New Jersey). The
Philadelphia area economy is typical of many large northeast and midwest cities
where the traditional manufacturing based economy has declined to a certain
degree and has been replaced with service sector and specialty area growth. As a
result of such growth, the Philadelphia PMSA's economic diversity has broadened
and employment in the area is derived from a number of different employment
sectors. In particular, Delaware County has experienced the development of
companies providing products and services for the health care market such as
Crozer/Keystone Health System, Wyeth-Ayerst Labs, Inc. and Mercy Health Corp.

Philadelphia's central location in the northeast corridor, its
well-educated and skilled population base, infrastructure and other factors has
made the Bank's market area attractive to many large corporate employers. Such
employers include Comcast Corp., Boeing, State Farm Insurance, Unisys Corp.,
ARCO Chemical Company, PECO Energy, SAP America, Inc., and many others. There
are over seventy-five Fortune 1,000 companies maintaining a presence in this
area and approximately twenty Fortune 500 companies headquartered in the region
surrounding the Philadelphia PMSA including CIGNA Corp., E.I. duPont de Nemours,
Bethlehem Steel, Ikon Office Solutions, Sun Company, Crown Cork & Seal and
others.

Delaware County has experienced slower population growth than the
Philadelphia PMSA, although the growth rates in the outlying areas of Delaware
County have exceeded that of the Philadelphia PMSA. Since 1990, there has been
no population growth in Delaware County and it is expected to increase by less
than 1 percent over the next 20 years. Chester County, on the other hand, has
grown over 11% since 1990 and expected to increase further through the
millennium. By comparison, median household income in Delaware County and
Chester County is approximately $42,300 and $55,100, respectively, both of which
are near or more than the Philadelphia PMSA median of approximately $26,900
(1996 estimates). Likewise, median home values in Delaware and Chester Counties
were approximately $113,200 and $155,900, respectively, as compared to
approximately $112,000 for the Philadelphia PMSA in 1990. Unemployment rates in
Delaware County have been below those experienced by the Philadelphia PMSA but
higher than some of the other counties comprising the PMSA. The average annual
unemployment rate (not seasonally adjusted) for 1999 through October was 3.6% in
Delaware County and 2.5% in Chester County as compared to 4.1% for the
Philadelphia PMSA.

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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,
---------------------------------------------------------------------------------
1999 1998 1997 1996
------------------ ------------------ ------------------ ------------------
Amount % Amount % Amount % Amount %
-------- ------- -------- ------- -------- ------- -------- -------
(Dollars in thousands)

Real estate loans:
Single-family $166,802 69.82% $148,088 71.34% $135,168 68.53% $122,270 68.68%
Multi-family and commercial 31,188 13.05 20,563 9.91 18,305 9.28 11,129 6.25
Construction and land 18,426 7.71 15,858 7.64 16,400 8.31 17,682 9.93
-------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 216,416 90.58 184,509 88.89 169,873 86.12 151,081 84.86
-------- ------ -------- ------ -------- ------ -------- ------

Consumer:
Home equity loans and lines of credit 18,624 7.80 19,609 9.45 22,964 11.64 20,444 11.48
Deposit 243 .10 181 .09 348 .18 457 .26
Education 365 .15 449 .21 365 .19 917 .52
Other (1) 1,080 .45 1,429 .69 1,690 .86 2,212 1.24
-------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans 20,312 8.50 21,668 10.44 25,367 12.87 24,030 13.50
-------- ------ -------- ------ -------- ------ -------- ------
Commercial business loans 2,190 .92 1,390 .67 2,000 1.01 2,923 1.64
-------- ------ -------- ------ -------- ------ -------- ------
Total loans receivable (2) 238,918 100.00% 207,567 100.00% 197,240 100.00% 178,034 100.00%
-------- ====== -------- ====== -------- ====== -------- ======

Less:
Loans in process (construction
and land) 9,005 5,781 5,670 6,368
Deferred loan origination fees
and discounts 1,610 1,705 1,653 1,512
Allowance for loan losses 1,928 1,738 1,628 2,624
-------- -------- -------- --------
12,543 9,224 8,951 10,504
-------- -------- -------- --------
Total loans receivable, net $226,375 $198,343 $188,289 $167,530
======== ======== ======== ========

September 30,
------------------
1995
------------------
Amount %
-------- -------
(Dollars in thousands)

Real estate loans:
Single-family $115,225 69.01%
Multi-family and commercial 11,789 7.06
Construction and land 16,343 9.79
-------- ------
Total real estate loans 143,357 85.86
-------- ------

Consumer:
Home equity loans and lines of credit 18,229 10.92
Deposit 350 .21
Education 1,010 .60
Other (1) 1,491 .89
-------- ------
Total consumer loans 21,080 12.62
-------- ------
Commercial business loans 2,533 1.52
-------- ------
Total loans receivable (2) 166,970 100.00%
-------- ======

Less:
Loans in process (construction
and land) 6,070
Deferred loan origination fees
and discounts 1,411
Allowance for loan losses 1,487
--------
8,968
--------
Total loans receivable, net $158,002
========

- -----------------------------

(1) Consists primarily of credit cards and consumer lease receivables.

(2) Does not include $1.8 million, $2.8 million, $4.6 million, $2.4 million,
and $57,000 of loans held for sale at September 30, 1999, 1998, 1997, 1996,
and 1995, respectively.

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Contractual Principal Repayments. The following table sets forth the
scheduled contractual maturities of the Bank's loans held to maturity at
September 30, 1999. Demand loans, loans having no stated schedule of repayments
and no stated maturity and overdraft loans are reported as due in one year or
less. The amounts shown for each period do not take into account loan
prepayments and normal amortization of the Bank's loan portfolio held to
maturity.

Real Estate Loans
------------------------------------------------------
Multi-family Consumer and
and Construction Commercial
Single-family Commercial and Land Total Business Loans Total
------------- ---------- -------- ----- -------------- -----
(In thousands)

Amounts due in:
One year or less $ 7,037 $ 2,275 $18,426 $ 27,738 $ 5,255 $ 32,993
After one year through three years 12,580 6,287 18,867 4,614 23,481
After three years through five years 12,551 10,147 22,698 3,380 26,078
After five years through ten years 33,599 10,344 43,943 5,743 49,686
After ten years through twenty
years 34,120 1,117 35,237 2,050 37,287
Over twenty years 66,915 1,018 67,933 1,460 69,393
-------- ------- ------- -------- ------- --------
Total(1) $166,802 $31,188 $18,426 $216,416 $22,502 $238,918
======== ======= ======= ======== ======= ========

Interest rate terms on amounts due after
one year:
Fixed $146,625 $15,249 $161,874
Adjustable 42,053 1,998 44,051
-------- ------- --------
Total(1) $188,678 $17,247 $205,925
======== ======= ========

- -----------------------------

(1) Does not include adjustments relating to loans in process, allowances for
loan losses and deferred fee income.

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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 rates on existing mortgage loans are lower than current mortgage loan rates
(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 Sales Activity. The following table shows
the loan origination, purchase and sale activity of the Bank during the periods
indicated.

Year Ended September 30,
---------------------------------------
1999 1998 1997
--------- --------- ---------
(In thousands)

Gross loans at beginning of period(1) $ 210,366 $ 201,817 $ 180,491
--------- --------- ---------
Loan originations for investment:
Real estate:
Residential 49,970 39,226 18,016
Commercial and multi-family 18,031 3,578 8,458
Construction 22,313 14,662 16,298
--------- --------- ---------
Total real estate loans originated
for investment 90,314 57,466 42,772
Consumer 7,309 4,819 8,859
Commercial business 3,594 4,231 2,755
--------- --------- ---------
Total loans originated for
investment 101,217 66,516 54,386
Loans originated for resale 46,199 56,398 37,209
--------- --------- ---------
Total originations 147,416 122,914 91,595
--------- --------- ---------
Deduct:
Principal loan repayments and
prepayments (68,549) (55,982) (34,779)
Transferred to real estate owned (1,317) (207) (411)
Loans sold in secondary market (47,206) (58,176) (35,079)
--------- --------- ---------
Subtotal 117,072 114,365 70,269
--------- --------- ---------
Net increase in loans(1) 30,344 8,549 21,326
--------- --------- ---------
Gross loans at end of period(1) $ 240,710 $ 210,366 $ 201,817
========= ========= =========

- ------------------------------

(1) Includes loans held for sale of $1.8 million, $2.8 million, and $4.6
million at September 30, 1999, 1998 and 1997, respectively.

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The 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. Applications for all types of loans are taken at all
of the Bank's branch offices by the branch manager or other designated loan
officers. Applications for single-family residential mortgage loans for
portfolio retention also are obtained through loan originators who are employees
of the Bank. The Bank's 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 Mortgage Lending Department supervises the process of
obtaining credit reports, appraisals and other documentation involved with a
loan. The Bank generally requires that a property appraisal be obtained in
connection with all new mortgage loans. 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. Residential mortgage loans also are originated through
correspondents. 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")/Freddie Mac ("FHLMC") limits are approved
by the Bank's Chief Lending Officer or in his absence, by the Senior Loan
Underwriter or Loan Committee (a committee comprised of four directors and the
Bank's Chief Lending Officer). All other first mortgage loans (commercial and
multi-family residential real estate and construction loans) and residential
mortgage loans in excess of FNMA/FHLMC maximum amounts (currently $240,000) but
less than $1.0 million must be approved by the Loan Committee. All first
mortgage loans in excess of $1.0 million must be approved by the Bank's Board of
Directors or the Executive Committee thereof. All mortgage loans which do not
require approval by the Board of Directors are submitted to the Board at its
next meeting for review and ratification. Home equity loans and lines of credit
up to $100,000 can be approved by the Chief Lending Officer, the Vice President
of Construction Loans or the Administrative Vice President of Mortgage Lending.
Loans in excess of such amount must be approved by the Loan Committee.

Applications for non-conforming and sub-prime residential real estate
loans, submitted by correspondents and sold servicing released into the
secondary market, are packaged and submitted for pre-approval to the buyer prior
to closing. The Bank, on occasion will originate non-conforming loans in
accordance with the buyers' underwriting standards and sells them in bulk to
such buyers. See "- Mortgage Banking Activities."

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 the 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 the FHLMC and the FNMA, and other investors 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

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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 to-be-determined rate for the remaining 25 or 23 years,
respectively, of the amortization period. At September 30, 1999, $134.2 million,
or 56.2%, of the Bank's single-family residential mortgage loans held in
portfolio were fixed-rate loans, including $29.0 million of bi-weekly fixed-rate
residential mortgage loans.

The adjustable-rate loans currently offered by the Bank have interest rates
which adjust every one or three 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 of 6% over the life of the loan.
In order to increase acceptance of adjustable-rate loans, the Bank recently has
been originating loans which are fixed for a period of one to three 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, or
so-called negative amortization. Although the Bank does offer adjustable-rate
loans with initial rates below the fully indexed rate, such loans are
underwritten using methods approved by FHLMC and FNMA which requires borrowers
to be qualified at 2% above the discounted loan rate under certain conditions.
At September 30, 1999, $43.3 million or 29.2% 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 as interest rates
increase the loan payment by the borrower increases to the extent permitted by
the terms of the loan, thereby increasing the potential for default. 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 because of the generally stable interest rate
environment in recent years, generally are less than the risks associated with
holding fixed-rate loans in an increasing interest rate environment.

For conventional residential mortgage loans held in portfolio and also for
those loans originated for sale in the secondary market, the Bank's maximum
loan-to-value ("LTV") ratio is 97%, and is based on the lesser of sales price or
appraised value. On most loans with a LTV ratio of over 80%, private mortgage
insurance is required to be obtained.

Commercial and Multi-Family Residential Real Estate Loans. The Bank has
moderately increased its investment in commercial and multi-family lending. Such
loans are being extended primarily to small and medium-sized businesses located
in the Bank's primary market area, a portion of the market that the Bank
believes has been underserved in recent years. Loans secured by commercial and
multi-family real estate amounted to $31.2 million, or 13.1%, of the Bank's
total loan portfolio, at September 30, 1999. 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 one-year or three-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 are also originated. Generally, fees of 1% to 3% of the principal loan
balance are charged to the borrower upon closing. Although terms for
multi-family residential and commercial real estate loans may vary, the Bank's
underwriting standards generally provide for terms of up to 25 years with
amortization of principal over the term of the loan and loan-to-value ratios of
not more than 75%. Generally, the Bank obtains personal guarantees of the
principals of the borrower as additional security for any commercial real estate
and multi-family residential loans and requires that the borrower have at least
a 25% equity investment in any such property.

The Bank evaluates various aspects of commercial and multi-family
residential real estate loan transactions in an effort to mitigate risk to the
extent possible. In underwriting these loans, consideration is given to the
stability of the property's cash flow history, future operating projections,
current and projected occupancy, position in the market, location and physical
condition. In recent periods, the Bank has also 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

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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 Member of the Appraisal
Institute ("MAI") qualified) 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 Bank 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 can
also 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.

Construction Loans. Substantially all of the Bank's construction loans
consist of loans 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 loan properties. The loan converts to permanent commercial
term loan upon completion of construction. With respect to construction loans to
individuals, such loans have a maximum term of six months, have variable rates
of interest based upon the prime rate published in the Wall Street Journal plus
a margin and have loan-to-value ratio of 80% or less of the appraised value upon
completion and generally do not require the amortization of principal during the
term. Upon completion of construction, the loans convert to permanent
residential mortgage loans. Commercial construction loans have a maximum term of
12 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 70% or less of the appraised value upon completion. The loans convert
to permanent commercial term loans upon completion of construction.

The Bank also provides construction loans and lines of credit to
developers. The majority of construction loans consist of loans to selected
local developers with whom the Bank is familiar to 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 which a developer may
have under construction in a project. Such loans generally have terms of 24 to
36 months or less, have maximum loan-to-value ratios of 75% of the appraised
value upon completion and generally do not require the amortization of the
principal during the term. The loans are made with floating rates of interest
based on the Prime Rate plus a margin adjusted on a monthly basis. The Bank also
receives origination fees which generally range from 1.0% to 3.0% of the
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 in stages after inspections of the project 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. The Bank's construction loans include loans to
developers to acquire the necessary land, develop the site and construct the
residential units ("ADC loans").

At September 30, 1999, residential construction loans totaled $13.6
million, or 5.7%, of the total loan portfolio, which primarily consisted of
construction loans to developers. At September 30, 1999, commercial construction
loans totaled $585,000, or .25% of the total loan portfolio.

The Bank also will originate ground or land loans, both to individuals to
purchase a building lot on which he intends to build his primary residence, 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 loan-to-value
ratio of 75% of the lower of appraised value or sale price. The loans are made
with floating 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, 1999, land loans (including loans to acquire and
develop land) totaled $4.2 million or 1.8% of the total loan portfolio.

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Loans to developers include both secured and unsecured lines of credit with
outstanding commitments totaling $800,000. All have personal guaranties of the
principals and are cross-collateralized with existing loans. Loans outstanding
under builder lines of credit totaled $592,000, or .25% of the total loan
portfolio at September 30, 1999. These loans were unsecured and given only to
the Bank's most creditworthy and long standing customers.

Prior to making a commitment to fund a construction loan, the Bank requires
an appraisal of the property by an independent state-licensed and qualified
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 is generally 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, environmental or other
restrictions on future use.

Consumer Lending Activities. The Bank offers consumer loans in order to
provide a full range of retail financial services to its customers. At September
30, 1999, $20.3 million, or 8.5%, of the Bank's total loan portfolio was
comprised of consumer loans. The Bank originates substantially all of such loans
in its primary market area.

The largest component of the Bank's consumer loan portfolio consists of
home equity loans and home equity lines of credit (a form of revolving credit),
both of which are secured by the underlying equity in the borrower's primary
residence. Home equity loans are amortizing loans with fixed interest rates and
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 do not exceed $100,000. The Bank's home equity loans and lines of credit
generally require combined loan-to-value ratios of 80% or less. Loans with
higher LTV are available but with higher interest rates and stricter credit
standards. At September 30, 1999, home equity loans and lines of credit amounted
to $18.6 million, or 7.8%, of the Bank's total loan portfolio.

At September 30, 1999, the remaining portion of the Bank's consumer loan
portfolio was comprised of education, deposit and other consumer loans. At
September 30, 1999, the Bank had $365,000 or .15% of the total loan portfolio
invested in education loans, all of which were underwritten to conform with the
standards of the Pennsylvania Higher Education Agency. Deposit loans and other
consumer loans (including credit card loans) totaled $1.3 million, or .55%, of
the Bank's total loan portfolio at September 30, 1999. In April 1995, the Bank
introduced its own credit card program. The credit cards were offered to only
the Bank's most creditworthy customers. At September 30, 1999, these loans
totaled $574,000 or .24% of the total loan portfolio. Consumer loans also
included certain consumer leases totaling $507,000 purchased from a leasing
company.

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. These risks are not as prevalent in the case of the
Bank's consumer loan portfolio, however, because a high percentage of the
portfolio is comprised of home equity loans and home equity lines of credit
which are secured by real estate and underwritten in a manner such that they
result in a lending risk which is substantially similar to single-family
residential loans.

Commercial Business Loans. The Bank grants commercial business loans
directly to business enterprises that are located in its market area. The Bank
actively targets and markets to small and medium sized businesses. The majority
of the loans are for less than $1.0 million. 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
lenders. As of September 30, 1999, commercial business loans amounted to $2.2
million or .92% of the Bank's total loan portfolio.

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The commercial business loans consist of a limited number of commercial lines of
credit secured by real estate, some working capital financing 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 and adjustable rates tied to the Prime Rate plus a
margin. Such loans are generally secured by real estate, receivables, equipment
or inventory and are generally backed by personal guarantees of the borrower.

Although commercial business loans generally are considered to involve increased
credit risk than other certain types of loans, management intends to offer
commercial business loans to small, medium sized businesses in an effort to
better serve our community's needs, obtain core noninterest-bearing deposits and
increase the Bank's interest rate spread.

Mortgage-Banking Activities. Due to customer preference for fixed-rate
loans, especially during the declining mortgage interest rate environment in
early 1999 and 1998 and the stable interest rate environment in 1997, 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. In addition, the Bank has developed for sale in the
secondary market non-conforming (loans not conforming to FHLMC/FNMA underwriting
guidelines) and impaired credit loans. The Bank's net gain on sales of mortgage
loans amounted to $325,000, $526,000, and $285,000 during the years ended
September 30, 1999, 1998 and 1997, respectively. Although originations of
sub-prime loans have slowed from the record level in 1998, the Bank continues to
focus on market penetration for this type of product. The Bank had $1.8 million
and $2.8 million of mortgage loans held for sale at September 30, 1999 and 1998,
respectively.

The Bank's conforming mortgage loans sold to others are sold, generally
with servicing retained, on a loan-by-loan basis primarily to the FHLMC and the
FNMA. A period of less than five days generally elapses between the closing of
the loan by the Bank and its purchase by the investor. Mortgages with
established interest rates generally will decrease in value during periods of
increasing interest rates. Accordingly, fluctuations in prevailing interest
rates may result in a gain or loss to the Bank as a result of adjustments to the
carrying value of loans held for sale or upon sale of loans. The Bank attempts
to protect itself from these market fluctuations through the use of forward
commitments at the time of the commitment by the Bank of a loan rate to the
borrower. These commitments are mandatory delivery contracts with FHLMC and FNMA
within a certain time frame and within certain dollar amounts by a price
determined at the commitment date. Market risk does exist as non-refundable
points paid by the borrower may not be sufficient to offset fees associated with
closing the forward commitment contract. Non-conforming mortgage loans sold to
others are sold, servicing released, on a loan-by-loan basis and are generally
pre-approved by the buyer prior to closing the loan with the borrower.

Borrowers are generally charged an origination fee, which is a percentage
of the principal balance of the loan. In accordance with the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 91, "Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases," the various fees received by the Bank in
connection with the origination of loans are deferred and amortized as a yield
adjustment over the lives of the related loans using the interest method.
However, when such loans are sold, the remaining unamortized fees (which is all
or substantially all of such fees due to the relatively short period during
which such loans are held) are recognized 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 which it retains in 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.

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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,
----------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)

Loans originated by the Bank and serviced for:
FNMA $ 2,752 $ 3,796 $ 5,228
FHLMC 74,031 92,065 108,895
Others 403 414 431
-------- -------- --------
Total loans serviced for others $ 77,186 $ 96,275 $114,554
======== ======== ========

The Bank receives fees for servicing mortgage loans, which generally amount
to 0.25% per annum on the declining principal balance of mortgage loans. Such
fees serve to compensate the Bank for the costs of performing the servicing
function. Other sources of loan servicing revenues include late charges. For
years ended September 30, 1999, 1998 and 1997, the Bank earned gross fees of
$205,000, $246,000 and $293,000, respectively, from loan servicing. The Bank
retains a portion of funds received from borrowers on the loans it services for
others in payment of its servicing fees received on loans serviced for others.

Loans-to-One Borrower Limitations. Regulations impose limitations on the
aggregate amount of loans that a savings institution could make to any one
borrower, including related entities. Under such regulations, the permissible
amount of loans-to-one borrower follows the national bank standard for all loans
made by savings institutions, which generally does not permit loans-to-one
borrower to exceed 15% of unimpaired capital and surplus. Loans in an amount
equal to an additional 10% of unimpaired capital and surplus also may be made to
a borrower if the loans are fully secured by readily marketable securities. At
September 30, 1999, the Bank's five largest loans or groups of loans-to-one
borrower, including related entities, ranged from an aggregate of $2.2 million
to $3.2 million, and the Bank's loans-to-one borrower limit was $5.3 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, 1999, 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.

When a borrower fails to make a required payment on a loan, the Bank
attempts to cure the deficiency by contacting the borrower and seeking payment.
Contacts are generally made 30 days after a payment is due. In most cases,
deficiencies are cured promptly. If a delinquency continues, late charges are
assessed and additional efforts are made

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to collect the loan. While the Bank generally prefers to work with borrowers to
resolve such problems, when the account becomes 90 days delinquent, the Bank
institutes foreclosure or other proceedings, as necessary, to minimize any
potential loss.

Loans are placed on non-accrual status when, in the judgment of management,
the probability of collection of interest is deemed to be insufficient to
warrant further accrual. When a loan is placed on non-accrual status, previously
accrued but unpaid interest is deducted from interest income. As a matter of
policy, the Bank does not accrue interest on loans past due 90 days or more. See
Note 2 of the Notes to Consolidated Financial Statements included in the
Company's Annual Report.

Real estate acquired by the Bank as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold. Real
estate owned is initially recorded at the lower of fair value less estimated
costs to sell the property, or cost (generally the balance of the loan on the
property at the date of acquisition). After the date of acquisition, all costs
incurred in maintaining the property are expenses and costs incurred for the
improvement or development of such property are capitalized up to the extent of
their net realizable value.

Under generally accepted accounting principles ("GAAP"), the Bank is
required to account for certain loan modifications or restructuring as "troubled
debt restructuring." 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 do not necessarily result in non-accrual loans.

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14
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, 1999 September 30, 1998
------------------------------------- -------------------------------------
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 $704 .42% $442 .27% $557 .38% $98 .07%
Construction 86 .54% 39 .25
Consumer loans 10 .05 23 .11 1 10 .05
Commercial
business loans 1 .05 1 .07
---- ---- ---- ----

Total $715 .30% $465 .19% $645 .31% $147 .07%
==== === ==== === ==== === ==== ===

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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,
------------------------------------------------------
1999 1998 1997 1996 1995
------ ------ ------ ------ ------
(Dollars in thousands)

Non-performing loans:
Single-family residential $2,312 $2,341 $1,661 $1,466 $1,986
Commercial and multi-
family(1) 289 323 22 55 22
Construction(2) 556 895 275 888
Consumer 16 43 14 1,666 2
Commercial business 6 83 100 2,165 258
------ ------ ------ ------ ------
Total non-performing loans 3,179 3,685 2,072 5,352 3,156
------ ------ ------ ------ ------

Accruing loans greater than
90 days delinquent 1 19 5
------ ------ ------ ------ ------
Total non-performing loans 3,180 3,704 2,077 5,352 3,156
------ ------ ------ ------ ------

REO 297 1,663 1,672 1,557 465
------ ------ ------ ------ ------
Total non-performing assets $3,477 $5,367 $3,749 $6,909 $3,621
====== ====== ====== ====== ======

Troubled debt restructurings (3) $ 24 $ 46 $ 384 $ $2,348
====== ====== ====== ====== ======

Total non-performing loans and
troubled debt restructurings
as a percentage of gross loans
receivable (4) 1.39% 1.85% 1.29% 3.10% 3.45%
====== ====== ====== ====== ======

Total non-performing assets
as a percentage of total assets .77% 1.29% 1.00% 2.35% 1.29%
====== ====== ====== ====== ======

Total non-performing assets and
troubled debt restructurings as
percentage of total assets .78% 1.30% 1.11% 2.35% 2.12%
====== ====== ====== ====== ======

- -----------------------------

(1) Consists of two loans at September 30, 1999, 1998 and 1996 and one loan at
September 30, 1997 and 1995, respectively.

(2) Consists of three loans from two borrowers at September 30, 1999, six loans
from three borrowers at September 30, 1998 and two loans at September 30,
1997 and 1995.

(3) Consists of lease financing receivables at September 30, 1999, 1998 and
1997 from the Bennett Funding Group of Syracuse, New York ("Bennett
Funding") and one loan at September 30, 1995. The troubled debt
restructurings in 1997 and 1995 have been performing in accordance with the
terms of the agreements since the restructurings.

(4) Includes loans receivable and loans held for sale, less construction and
land loans in process and deferred loan origination fees and discounts.

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16
The Bank's total non-performing assets and troubled debt restructurings
have decreased from $5.4 million, or 1.30% of total assets, at September 30,
1998 to $3.5 million, or .78% of total assets at September 30, 1999. The primary
reason for the $1.9 million decrease was due to the completion of the Bank's
only real estate owned development project.

The $2.3 million of single-family residential loans at September 30,
1999 consisted of 34 loans with principal balances, ranging from $2,000 to
$650,000, with an average balance of approximately $70,000.

At September 30, 1999, the $297,000 of REO consisted of six
single-family residential properties, one with a carrying value of $168,000.

Other Classified Assets. Federal 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, 1999, the Bank had $3.9 million of assets classified
as substandard, respectively, and no assets classified as doubtful or loss.
Substantially all classified assets are also non-performing.

Allowance for Loan Losses. The Bank's policy is to establish reserves
for estimated losses on delinquent loans when it determines that losses are
expected to be incurred on such loans and leases. The allowance for losses on
loans is maintained at a level believed adequate by management to absorb
potential losses in the portfolio. Management's determination of the adequacy of
the allowance is based on an evaluation of the 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 activity in the Bank's allowance
for loan losses has remained relatively stable (other than the $956,000 Bennett
Funding charge-off in fiscal 1997) and the level of provisions has been
relatively small with the exception in fiscal 1996 of an additional $1.1 million
provision related to Bennett Funding. As shown in the table below, at September
30, 1999, the Bank's allowance for loan losses amounted to 60.63% and .84% of
the Bank's non-performing loans and gross loans receivable, respectively.

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17
The following table summarizes changes in the allowance for loan losses
and other selected statistics for the periods presented.

Year Ending September 30,
---------------------------------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
(Dollars in thousands)

Allowance for loan losses, beginning of
period $ 1,738 $ 1,628 $ 2,624 $ 1,487 $ 1,540
Charged-off loans:
Single-family residential (12) (86) (119) (113) (163)
Construction
Commercial lease purchases (956)
Consumer and commercial business (60) (28) (177) (5)
------- ------- ------- ------- -------
Total charged-off loans (72) (114) (1,252) (113) (168)
------- ------- ------- ------- -------
Recoveries on loans previously charged off:
Single-family residential 2 22 7 12
Construction 14 10 43
Commercial and multi-
family residential 8
Consumer and commercial business 1 2
------- ------- ------- ------- -------
Total recoveries 3 38 17 63
------- ------- ------- ------- -------

Net loans charged-off (69) (76) (1,235) (113) (105)
Provision for loan losses 259 186 239 1,250 52
------- ------- ------- ------- -------
Allowance for loan losses, end of period $ 1,928 $ 1,738 $ 1,628 $ 2,624 $ 1,487
======= ======= ======= ======= =======

Net loans charged-off to average
loans outstanding(1) .03% .04% .68% .07% .07%
======= ======= ======= ======= =======

Allowance for loan losses
to gross loans receivable(1) .84% .86% .86% 1.54% .93%
======= ======= ======= ======= =======

Net loans charged-off to
allowance for loan losses 3.58% 4.37% 75.86% 4.31% 7.06%
======= ======= ======= ======= =======

Recoveries to charge-offs 4.17% 33.33% 1.36% % 37.50%
======= ======= ======= ======= =======

- ----------

(1) 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.

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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,
-------------------------------------------------------------------------------
1999 1998 1997
------------------------ ------------------------ -----------------------
% of Loans % of Loans % of Loans
in Each in Each in Each
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)

Single-family residential $ 572 69.82% $ 446 71.34% $ 439 68.53%
Commercial and multi-
family residential 166 13.05 109 9.91 77 9.28
Construction 320 7.71 382 7.64 300 8.31
Consumer 42 8.50 63 10.44 67 12.87
Commercial business 14 .92 20 .67 31 1.01
Unallocated 814 718 714
------ ------ ------ ------ ------ ------
Total allowance for
loan losses $1,928 100.00% $1,738 100.00% $1,628 100.00%
====== ====== ====== ====== ====== ======

September 30,
---------------------------------------------------
1996 1995
------------------------ ------------------------
% of Loans % of Loans
in Each in Each
Category to Category to
Amount Total Loans Amount Total Loans
------ ----------- ------ -----------
(Dollars in thousands)

Single-family residential $ 204 68.68% $ 226 69.01%
Commercial and multi-
family residential 3 6.25 12 7.06
Construction 290 9.93 615 9.79
Consumer 370 13.50 100 12.62
Commercial business 1,152 1.64 55 1.52
Unallocated 605 479
------ ------ ------ ------
Total allowance for
loan losses $2,624 100.00% $1,487 100.00%
====== ====== ====== ======

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Effective December 21, 1993, the OTS, in conjunction with the Office of
the Comptroller of the Currency, the FDIC and the Federal Reserve Board, issued
a joint policy statement ("Policy Statement") regarding an institution's
allowance for loan and lease losses. The Policy Statement, which reflects the
position of the issuing regulatory agencies and does not necessarily constitute
GAAP, includes guidance (i) on the responsibilities of management for the
assessment and establishment of an adequate allowance and (ii) for the agencies'
examiners to use in evaluating the adequacy of such allowance and the policies
utilized to determine such allowance. The Policy Statement also sets forth
quantitative measures for the allowance with respect to assets classified
substandard and doubtful and with respect to the remaining portion of an
institution's loan portfolio. While the Policy Statement sets forth quantitative
measures, such guidance is not intended as a "floor" or "ceiling." The review of
the Policy Statement did not and has not resulted in a material adjustment to
the Bank's policy for establishing loan losses.

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.

MORTGAGE-RELATED SECURITIES AND INVESTMENT SECURITIES

Mortgage-Related Securities. Federally chartered savings institutions
have authority to invest in various types of liquid assets, including United
States 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
may also 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 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-related 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 the FHLMC, the FNMA and the Government
National Mortgage Association ("GNMA"). The Bank also invests to a limited
degree in certain privately issued, credit enhanced mortgage-related securities
rated AAA by national securities rating agencies.

The FHLMC is a public corporation chartered by the U.S. Government. The
FHLMC issues participation certificates backed principally by conventional
mortgage loans. The FHLMC guarantees the timely payment of interest and the
ultimate return of principal on participation certificates. The FNMA is a
private corporation chartered by the U.S. Congress with a mandate to establish a
secondary market for mortgage loans. The 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 the FHLMC
and the FNMA are U.S. Government-sponsored enterprises, these securities are
considered to be among the highest quality investments with minimal credit
risks. The 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 FHA-insured and 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 the FHLMC, the FNMA and the 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 limit is currently $240,000.

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

18

20

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. 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
collateralized mortgage obligations ("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 collateralized by loans
or securities which are insured or guaranteed by the FNMA, the FHLMC or the
GNMA. In contrast to pass-through mortgage-related securities, in which cash
flow is received pro rata by all security holders, the cash flow from the
mortgages underlying a CMO is segmented and paid in accordance with a
predetermined priority to investors holding various CMO classes. By allocating
the principal and interest cash flows from the underlying collateral among the
separate CMO classes, different classes of bonds are created, each with its own
stated maturity, estimated average life, coupon rate and prepayment
characteristics.

The short-term classes of a CMO usually carry a lower coupon rate than
the longer term classes and, therefore, the interest differential cash flow on a
residual interest is greatest in the early years of the CMO. As the early coupon
classes are 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 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 yield less than the loans which
underlie such securities because of their payment guarantees or credit
enhancements which offer nominal credit risk. In addition, mortgage-related
securities are more liquid than individual mortgage loans and may be used to
collateralize certain obligations of the Bank. At September 30, 1999, $37.5
million of the Bank's mortgage-related securities were pledged to secure various
obligations of the Bank, including reverse repurchase agreements, treasury tax
and loan processing, and as collateral for certain government 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, 1999, the Bank had an aggregate of $127.5 million, or
28.3%, of total assets invested in mortgage-related securities, net, of which
$14.5 million was held to maturity and $113.0 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 1 and 4 of the Notes to Consolidated Financial Statements in
the Annual Report.

19

21
The following table sets forth the composition of the Bank's
mortgage-related securities portfolio, both held to maturity and available for
sale, at the dates indicated.

September 30,
--------------------------------------

1999 1998 1997
-------- -------- --------

Held to maturity:
(In thousands)

Mortgage-backed securities:

FHLMC $ 3,156 $ 4,698 $ 2,747
FNMA 6,832 8,747 10,053
-------- -------- --------
Total mortgage-backed securities 9,988 13,445 12,800
-------- -------- --------
Collateralized mortgage obligations:
FHLMC 25 233 2,026
FNMA 4,484 5,091 5,740
Other 141
-------- -------- --------
Total collateralized mortgage obligations 5,324 7,907
-------- --------
Total mortgage-related securities, amortized cost 4,509 $ 18,769 $ 20,707
-------- ======== ========
Total fair value(1) $ 14,100 $ 18,700 $ 20,200
======== ======== ========

Available for sale:

Mortgage-backed securities:
FHLMC $ 11,927 $ 10,968 $ 17,540
FNMA 32,795 25,600 14,587
GNMA 34,639 41,379 28,938
-------- -------- --------
Total mortgage-backed securities 79,361 77,947 61,065
-------- -------- --------
Collateralized mortgage obligations:
FHLMC 6,502 2,704 5,356
FNMA 4,515 15,284 17,301
GNMA 536 994 1,338
Other 24,501(1) 17,040 18,819
-------- -------- --------
Total collateralized mortgage obligations 36,054 36,022 42,814
-------- -------- --------
Total mortgage-related securities, amortized cost $115,415 $113,969 $103,879
======== ======== ========
Total fair value(2) $113,046 $115,486 $104,472
======== ======== ========

- --------

(1) Includes "AAA" rated securities of Norwest Asset Securities
Corporation, Chase Mortgage Services, GE Capital Mortgage Services and
Residential Asset Securitization Trust with book values of $6.9
million, $6.7 million, $3.7 million and $2.5 million, respectively, and
fair values of $6.8 million, $6.5 million, $3.6 million and $2.4
million, respectively.

(2) See Note 4 of the Notes to Consolidated Financial Statements in the
Annual Report.

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22

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,
-------------------------------------------

1999 1998 1997
--------- --------- ---------

(In thousands)

Mortgage-related securities, beginning of period(1)(2) $ 134,255 $ 125,179 $ 83,432
--------- --------- ---------
Purchases:
CMOs - held to maturity 2,687
Mortgage-backed securities - available for sale 21,210 42,422 33,584
CMOs - available for sale 24,685 10,000 18,069
Sales:
Mortgage-backed securities - available for sale (13,200)
CMOs - available for sale (1,047)
Repayments and prepayments:
Mortgage-backed securities (22,759) (14,456) (7,668)
CMOs (25,493) (18,336) (4,057)
Increase (decrease) in net premium (469) 82 535
Change in net unrealized gain (loss) on mortgage-related securities
available for sale (3,886) 924 1,284
--------- --------- ---------
Net (decrease) increase in mortgage-related securities (6,712) 9,076 41,747
--------- --------- ---------
Mortgage-related securities, end of period(1) $ 127,543 $ 134,255 $ 125,179
========= ========= =========

- --------------------------

(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, 1999, the weighted average contractual maturity of the
Bank's fixed-rate mortgage-related securities was approximately 6.4 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
loans, 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
rising 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 slow the prepayment of the underlying
mortgages and the related securities. Conversely, during periods of falling
mortgage interest rates, if the coupon rates of the underlying mortgages exceed
the prevailing market interest rates offered for mortgage loans, refinancing
generally increases and accelerates the prepayment of the underlying mortgages
and the related securities. Under such circumstances, the Bank may be subject to
reinvestment risk because to the extent that the Bank's mortgage-related
securities amortize or prepay faster than anticipated, the Bank may not be able
to reinvest the proceeds of such repayments and prepayments at a comparable
yield. At September 30, 1999, of the $14.5 million of mortgage-related
securities held to maturity, an aggregate of $7.0 million were secured by
fixed-rate securities and an aggregate of $7.5 million were secured by
adjustable-rate securities.

21

23

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,
----------------------------------------------------------------------------------------------

1999 1998 1997
--------------------------- --------------------------- --------------------------

Carrying Fair Carrying Fair Carrying Fair
Value Value Value Value Value Value
---------- ---------- ---------- ---------- ---------- ----------

(In thousands)

FHLB stock $ 6,157 $ 6,157 $ 5,079 $ 5,079 $ 3,769 $ 3,769
U.S. Government and agency
obligations
1 to 5 years 5,746 5,652 4,000 4,015
5 to 10 years 6,994 6,780 12,000 12,109 3,000 2,983
Over 10 years 10,000 9,960
Municipal securities 18,924 17,873 18,993 19,477 3,138 3,213
Corporate bonds 4,909 4,639
Mutual funds 2,000 1,972 2,000 1,992
Preferred stocks 5,534 5,248 5,500 5,763
Other equity investments 2,390 2,151 1,390 1,280
---------- ---------- ---------- ---------- ---------- ----------
Total $ 52,654 $ 50,472 $ 44,962 $ 45,700 $ 23,907 $ 23,940
========== ========== ========== ========== ========== ==========

At September 30, 1999, the Company had an aggregate of $52.7 million, or
11.7%, of total assets invested in investment securities, of which $6.2 million
consist of FHLB stock and $46.5 million was investment securities available for
sale. Included in U.S. Government and agency obligations are callable bonds with
a term of three years. The Bank's investment securities (excluding equity
securities and FHLB stock) had a weighted average maturity to the call date of
5.9 years and a weighted average yield of 6.85% (adjusted to a fully taxable
equivalent yield).

SOURCES OF FUNDS

General. The Bank's principal source of funds for use in lending and for
other general business purposes has traditionally come from deposits obtained
through the Bank's branch offices. The Bank also derives funds from contractual
payments and prepayments of outstanding loans and mortgage-related securities,
from sales of loans, from maturing investment securities and from advances from
the FHLB of Pittsburgh and other borrowings. Loan repayments are a relatively
stable source of funds, while deposits inflows and outflows are significantly
influenced by general interest rates and money market conditions. The Bank uses
borrowings to supplement its deposits as a source of funds.

Deposits. The Bank's current deposit products include passbook accounts,
NOW accounts, MMDA, certificates of deposit ranging in terms from 30 days to
five years and noninterest-bearing personal and business checking accounts. The
Bank's deposit products also include Individual Retirement Account ("IRA")
certificates and Keogh accounts.

The Bank's deposits are obtained primarily from residents in Delaware and
Chester Counties in southeastern Pennsylvania. The Bank attracts local deposit
accounts by offering a wide variety of accounts, competitive interest rates, and
convenient branch office locations and service hours. The Bank utilizes
traditional marketing methods to attract new customers and savings deposits,
including print media and 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. The Bank participates in the
regional ATM network known as MAC(R).

22

24

The Bank has been competitive in the types of accounts and in interest
rates it has offered on its deposit products but does not necessarily seek to
match the highest rates paid by competing institutions. With the significant
decline in interest rates paid on deposit products, the Bank in recent years has
experienced disintermediation of deposits into competing investment products.

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,
--------------------------------------------------------------------------------------------------

1999 1998 1997
---------------------------- ---------------------------- ----------------------------

Amount Percent Amount Percent Amount Percent
---------- ---------- ---------- ---------- ---------- ----------

(Dollars in thousands)

Passbook $ 40,324 15.46% $ 37,988 15.36% $ 38,035 16.69%
MMDA 19,417 7.45 16,087 6.50 16,429 7.21
NOW 33,412 12.81 28,181 11.40 27,754 12.18
Certificates of deposit 159,761 61.25 156,801 63.40 139,535 61.22
Noninterest-bearing
deposits 7,912 3.03 8,254 3.34 6,165 2.70
---------- ---------- ---------- ---------- ---------- ----------
Total deposits $ 260,826 100.00% $ 247,311 100.00% $ 227,918 100.00%
========== ========== ========== ========== ========== ==========

The following table sets forth the net savings flows of the Bank during the
periods indicated.

Year Ended September 30,
--------------------------------------------

1999 1998 1997
---------- ---------- ----------

(In thousands)

Increase before interest credited $ 4,336 $ 9,737 $ 99
Interest credited 9,179 9,656 8,614
---------- ---------- ----------
Net savings increase $ 13,515 $ 19,393 $ 8,713
========== ========== ==========

The following table sets forth maturities of the Bank's certificates of
deposit of $100,000 or more at September 30, 1999 by time remaining to maturity.

Amounts in
Thousands
--------------------

Three months or less $ 9,847
Over three months through six months 2,904
Over six months through twelve months 4,261
Over twelve months 4,048
-------
$21,060
=======

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25
The following table presents, by various interest rate categories, the
amount of certificates of deposit at September 30, 1999 and 1998 and the
amounts at September 30, 1999 which mature during the periods indicated.

Amounts at September 30, 1999
September 30, Maturing Within
------------------------ ---------------------------------------------------------------

Certificates of
Deposit 1999 1998 One Year Two Years Three Years Thereafter
------- ---- ---- -------- --------- ----------- ----------

(In thousands)

4.0% or less $ 741 $ 647 $ 741
4.01% to 5.0% 76,007 141,948 70,767 $ 2,492 $ 554 $ 2,194
5.01% to 6.0% 72,000 43,089 17,565 3,778 7,568
6.01% to 7.0% 11,013 13,248 8,000 2,978 35
Over 7.01% 958
-------- -------- -------- -------- -------- --------
Total certificate
accounts $159,761 $156,801 $122,597 $ 23,035 $ 4,332 $ 9,797
======== ======== ======== ======== ======== ========

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,
---------------------------------------------------------------------------------------------------------

1999 1998 1997
----------------------------- ------------------------------ ----------------------------------

Average Average Average
Average Rate Average Rate Average Rate
Balance Paid Balance Paid Balance Paid
------------ -------------- --------------- --------------- --------------- ---------------

Passbook accounts $ 39,625 2.41% $ 38,273 2.41% $ 39,199 2.42%
MMDA accounts 17,833 2.82 16,368 2.76 16,350 2.75
Certificates of deposit 157,134 5.33 145,105 5.64 133,091 5.58
NOW accounts 34,581 1.27 29,412 1.28 28,143 1.28
Noninterest-bearing
deposits 6,360 5,779 4,357
-------- -------- --------
Total deposits $255,533 4.02% $234,937 4.23% $221,140 4.15%
======== ==== ======== ==== ======== ====

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26

Borrowings. The Bank may obtain advances from the FHLB of Pittsburgh
upon the security of the common stock it owns in the FHLB and certain of its
residential mortgage loans and securities held to maturity, provided certain
standards related to creditworthiness have been met. Such advances are made
pursuant to several credit programs, each of which has its own interest rate and
range of maturities. The Bank, during fiscal 1999 and 1998, increased its FHLB
borrowings to fund asset growth. At September 30, 1999, the Bank had $123.1
million in outstanding FHLB advances. See Note 10 of the Notes to Consolidated
Financial Statements in the Annual Report for additional information.

The Bank has entered into agreements to sell securities under terms which
require it to repurchase the same or substantially similar securities by a
specified date. Repurchase agreements are considered borrowings which are
secured by the sold securities. At September 30, 1999, the Bank had $19.3
million of repurchase agreements outstanding scheduled to mature in 2002. See
Note 11 of the Notes to Consolidated Financial Statements in the Annual Report.

Both the FHLB advances and the repurchase agreements have certain call features
whereby the issuer 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.

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, 1999, the Bank was authorized to invest up to approximately $8.9 million in
the stock of, or loans to, service corporations. As of September 30, 1999, the
net book value of the Bank's investment in stock, unsecured loans, and
conforming loans to its service corporations was $28,300.

At September 30, 1999, in addition to the Bank, the Company has five direct
or indirect subsidiaries: First Keystone Capital Trust I, FKF Management Corp.,
Inc., State Street Services Corp., First Pointe, Inc. ("First Pointe"), and
First Chester Services, Inc.

First Keystone Capital Trust I (the "Trust") is a Delaware statutory
business trust wholly owned by the Company formed in 1997 for the purpose of
issuing trust preferred securities and investing the proceeds therefrom in
Junior Subordinated Debentures issued by the Company. See Note 18 of the Notes
to Consolidated Financial Statements in the Annual Report for further discussion
regarding the issuance of trust preferred securities.

FKF Management Corp., Inc., a Delaware corporation, is a wholly owned
operating subsidiary of the Bank established in 1997 for the purpose of managing
assets of the Bank. Assets under management totaled $135.1 million at September
30, 1999 and comprised principally of investment and mortgage-related
securities.

State Street Services Corp., a wholly owned subsidiary of the Bank
established in 1999 for the purpose of offering a full array of insurance
products by entering in a partnership, as a 51% interest , in First Keystone
Insurance Services, LLC. In addition, it holds a 30% equity position in a title
company which offers title services.

First Pointe, is a wholly owned subsidiary of the Bank which was formed for
the purpose of developing a real estate parcel received in a deed-in-lieu of
foreclosure action. At September 30, 1999, all of the townhomes have been
completed and sold.

The Bank has one remaining subsidiay which was involved in real estate
management. With the Bank's cessation of its involvement in such activities and
the resolution of the various development projects in which the subsidiaries
were involved, this subsidiary was placed on an inactive status. See "-Asset
Quality - Non-Performing Assets" and Notes 1 and 7 of the Notes to Consolidated
Financial Statements in the Annual Report.

25
27

COMPETITION

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 financial institutions which have
greater financial and marketing resources available to them. In addition, during
times of high interest rates, the Bank has faced additional significant
competition for investors' funds from short-term money market securities, mutual
funds and other corporate and government securities. The ability of the Bank to
attract and retain savings deposits depends on its ability to generally provide
a 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 and the efficiency and quality of services it provides
borrowers and the convenient locations of its branch office network. Competition
may increase as a result of the continuing reduction of restrictions on the
interstate operations of financial institutions.

EMPLOYEES

The Bank had 76 full-time employees and 13 part-time employees as of
September 30, 1999. None of these employees is represented by a collective
bargaining agreement. The Bank believes that it enjoys excellent relations with
its personnel.

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28

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 required to
register as such with the OTS and is subject to OTS regulations, examinations,
supervision and reporting requirements. As a subsidiary of a savings and loan
holding company, the Bank is subject to certain restrictions in its dealings
with the Company and affiliates thereof.

Federal Activities Restrictions. There are generally no restrictions on the
activities of a savings and loan holding company which holds only one subsidiary
savings association. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings association, the
Director may impose such restrictions as deemed necessary to address such risk,
including limiting (i) payment of dividends by the savings association; (ii)
transactions between the savings association and its affiliates; and (iii) any
activities of the savings association that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings association. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
association subsidiary of such a holding company fails to meet a QTL test, then
such unitary holding company also shall become subject to the activities
restrictions applicable to multiple savings and loan holding companies and,
unless the savings association qualifies as a QTL within one year thereafter,
shall register as, and become subject to the restrictions applicable to, a bank
holding company. See "- The Bank - Qualified Thrift Lender Test."

If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings association meets the QTL
test, as set forth below, the activities of the Company and any of its
subsidiaries (other than the Bank or other subsidiary savings associations)
would thereafter be subject to further restrictions. No multiple savings and
loan holding company or subsidiary thereof which is not a savings association
shall commence or continue for a limited period of time after becoming a
multiple savings and loan holding company or subsidiary thereof any business
activity, other than: (i) furnishing or performing management services for a
subsidiary savings association; (ii) conducting an insurance agency or escrow
business; (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary savings association; (iv) holding or managing properties used
or occupied by a subsidiary savings association; (v) acting as trustee under
deeds of trust; (vi) those activities authorized by regulation as of March 5,
1987 to be engaged in by multiple savings and loan holding companies; or (vii)
unless the Director of the OTS by regulation prohibits or limits such activities
for savings and loan holding companies, those activities authorized by the
Federal Reserve Board as permissible for bank holding companies. The activities
described in (i) through (vi) above may only be engaged in after giving the OTS
prior notice and being informed that the OTS does not object to such activities.
In addition, the activities described in (vii) above also must be approved by
the Director of the OTS prior to being engaged in by a multiple savings and loan
holding company.

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.
An affiliate of a savings association is any company or entity which controls,
is controlled by or is under common control with the savings association. In a
holding company context, the parent holding company of a savings association
(such as the Company) and any companies which are controlled by such parent
holding company are affiliates of the savings association. 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,

27
29

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 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.

The OTS regulation generally excludes 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 regulation also requires savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail, and provides that certain classes of savings associations may
be required to give the OTS prior notice of affiliate transactions.

In addition, Sections 22(g) and (h) of the FRA place restrictions on loans
to executive officers, directors and principal stockholders. Under Section
22(h), loans to a director, an executive officer and to a greater than 10%
stockholder of a savings institution (a "principal stockholder"), and certain
affiliated interests of either, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the savings
institution's loans to one borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus). Section 22(h) also requires that
loans to directors, executive officers and principal stockholders be made on
terms substantially the same as offered to employees of the Bank and also
requires prior board approval for certain loans. In addition, the aggregate
amount of extensions of credit by a savings institution to all insiders cannot
exceed the institution's unimpaired capital and surplus. Furthermore, Section
22(g) places additional restrictions on loans to executive officers. At
September 30, 1999, the Bank was in compliance with the foregoing restrictions.

Restrictions on Acquisitions. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior approval
of the Director of the OTS, (i) control of any other savings association or
savings and loan holding company or substantially all the assets thereof or (ii)
more than 5% of the voting shares of a savings association or holding company
thereof which is not a subsidiary. Except with the prior approval of the
Director of the OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may acquire control of any savings association, other than
a subsidiary savings association, or of any other savings and loan holding
company.

Federal Securities Laws. The Company's Common Stock is registered with the
Securities and Exchange Commission ("SEC") under the Securities Exchange Act of
1934 ("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"). If 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) 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.

The Bank. The OTS has extensive regulatory authority over the operations of
savings associations. 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.

28
30

The OTS' enforcement authority over all savings associations and their
holding companies was substantially enhanced by Financial Institutions Reform,
Recovery, and Enforcement Act of 1989 ("FIRREA"). This enforcement authority
includes, among other things, the ability to assess civil money penalties, to
issue cease and desist or removal orders and to initiate injunctive actions. In
general, these enforcement actions may be initiated for violations of laws and
regulations and unsafe or unsound practices. Other actions or inactions may
provide the basis for enforcement action, including misleading or untimely
reports filed with the OTS. FIRREA significantly increased the amount of and
grounds for civil money penalties. FIRREA requires, except under certain
circumstances, public disclosure of final enforcement actions by the OTS.

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 United States Government. As insurer, the
FDIC is authorized to conduct examinations of, and to require reporting by,
FDIC-insured institutions. It also may prohibit any FDIC-insured institution
from engaging in any activity the FDIC determines by regulation or order to pose
a serious threat to the FDIC. The FDIC also has the authority to initiate
enforcement actions against savings associations, after giving the OTS an
opportunity to take such action.

The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is not aware of any existing circumstances which could
result in termination of the Bank's deposit insurance.

The BIF fund met its target reserve level in September 1995, but the SAIF
was not expected to meet its target reserve level until at least 2002.
Consequently, in late 1995, the FDIC approved a final rule regarding deposit
insurance premiums which, effective with respect to the semi-annual premium
assessment beginning January 1, 1996, reduced deposit insurance premiums for BIF
member institutions to zero basis points (subject to an annual minimum of
$2,000) for institutions in the lowest risk category. Deposit insurance premiums
for SAIF members were maintained at their existing levels (23 basis points for
institutions in the lowest risk category).

On September 30, 1996, President Clinton signed into law legislation (the
"Deposit Insurance Funds Act of 1996") to eliminate the premium differential
between SAIF-insured institutions and BIF-insured institutions by recapitalizing
the SAIF's reserves to the required ratio. The legislation provided that all
SAIF member institutions pay a one-time special assessment to recapitalize the
SAIF, which in the aggregate was sufficient to bring the reserve ratio in the
SAIF to 1.25% of insured deposits. The legislation also provided for the merger
of the BIF and the SAIF, with such merger being conditioned upon, among other
things, the prior elimination of the federal thrift charter.

Effective October 8, 1996, pursuant to the provision of the Deposit
Insurance Funds Act of 1996, FDIC regulations imposed a one-time special
assessment equal to 65.7 basis points for all SAIF-assessable deposits as of
March 31, 1995, which was collected on November 27, 1996. The Bank's one-time
special assessment amounted to approximately $1.4 million. Net of related tax
benefits, the one-time special assessment amounted to $876,000.

Following the imposition of the one-time special assessment, the FDIC
lowered assessment rates for SAIF members to reduce the disparity in the
assessment rates paid by BIF and SAIF members. Beginning October 1, 1996,
effective BIF and SAIF rates both range from zero basis points to 27 basis
points. From 1997 through 1999, SAIF members will pay 6.4 basis points to fund
the Financing Corporation while BIF member institutions will pay approximately
1.3 basis points.

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Capital requirements. Federally insured savings associations are required
to maintain minimum levels of regulatory capital. Pursuant to FIRREA, the OTS
has established capital standards applicable to all savings associations. These
standards generally must be as stringent as the comparable capital requirements
imposed on national banks. The OTS also is authorized to impose capital
requirements in excess of these standards on individual associations on a
case-by-case basis.

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% 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 Corrrective Action." At September 30, 1999, 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 final OTS
rules effective March 4, 1994, (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, 1999, the Bank had PMSRs
totalling $111,000.

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.

Under OTS regulations, an institution with a greater than "normal" level of
interest rate exposure must deduct an interest rate risk ("IRR") component from
total capital for purposes of calculating risk-based capital requirement.
Interest rate exposure is measured, generally, as the decline in an
institution's net portfolio value that would result from a 200 basis point
increase or decrease in market interest rates (whichever would result in lower
net portfolio value),

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divided by the estimated economic value of the savings association's assets. The
interest rate risk component to be deducted from total capital is equal to
one-half of the difference between an institution's measured exposure and
"normal" IRR exposure (which is defined as 2%), multiplied by the estimated
economic value of the institution's assets. Although the OTS has decided to
delay implementation of this rule, it will continue to closely monitor the level
of interest rate risk at individual savings associations and it retains the
authority, on a case-by-case basis, to impose additional capital requirements
for individual savings associations with significant interest rate risk. The OTS
recently updated its standards regarding the management of interest rate risk to
include summary guidelines to assist savings associations in determining their
exposures to interest rate risk.

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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, 1999, 1998 and 1997.

September 30, 1999 September 30, 1998 September 30, 1997
------------------------------ ---------------------------------- ------------------------------

Tangible Core Risk-based Tangible Core Risk-based Tangible Core Risk-based
Capital Capital Capital Capital Capital Capital Capital Capital Capital
--------- ------- ---------- ----------- -------- --------- -------- -------- ----------

(In thousands)

GAAP equity $36,467 $36,467 $36,467 $33,701 $33,701 $33,701 $30,254 $30,254 $30,254
General valuation allowances 1,813 1,688 1,578
------- ------- ------- ------- ------- ------- ------- ------- -------
Total regulatory capital 36,467 36,467 38,280 33,701 33,701 35,389 30,254 30,254 31,832
Minimum capital requirement per
FIRREA published guidelines 6,696 17,586 16,294 6,113 12,225 13,424 5,594 11,188 12,792
------- ------- ------- ------- ------- ------- ------- ------- -------
Excess $29,771 $18,881 $21,986 $27,588 $21,476 $21,965 $24,660 $19,066 $19,040
======= ======= ======= ======= ======= ======= ======= ======= =======

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 the
regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others: (1) a
savings association has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities, or similar risks or a high proportion of
off-balance sheet risk; (2) a savings association is growing, either internally
or through acquisitions, at such a rate that supervisory problems are presented
that are not dealt with adequately by OTS regulations; and (3) a savings
association may be adversely affected by the activities or condition of its
holding company, affiliates, subsidiaries or other persons or savings
associations with which it has significant business relationships. The Bank is
not subject to any such individual minimum regulatory capital requirement.

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Prompt Corrective Action. Under Section 38 of the FDIA as added by
FDICIA, the OTS adopted in 1992 regulations implementing Section 38 of the FDIA.
Under the regulations, 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%. Section 38 of the FDIA and the
OTS regulations promulgated thereunder also specify circumstances under 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, 1999, the Bank
meet the requirements of a "well capitalized" institution under OTS regulations.

Liquidity Requirements. All savings associations are required to maintain
an average daily balance of liquid assets equal to a certain percentage of the
sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings associations. At the present time, the required minimum
liquid asset ratio is 4%. The Bank has consistently exceeded such regulatory
liquidity requirement and, at September 30, 1999, had a average liquidity ratio
of 6.17%.

Qualified Thrift Lender Test. Under Section 2303 of the Economic Growth and
Regulatory Paper work Reduction Act of 1996, 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"). The QTL Test set forth in the HOLA requires that
Qualified Thrift Investments ("QTLs") represent 65% of portfolio assets. A
savings institution that does not comply with the QTL test must either convert
to a bank charter or comply with the following restrictions on its operations:
(i) the association may not engage in any new activity or make any new
investment, directly or indirectly, unless such activity or investment is
permissible for a national bank; (ii) the branching powers of the association
shall be restricted to those of a national bank; (iii) the association shall not
be eligible to obtain any advances from its FHLB; and (iv) payment of dividends
by the association shall be subject to the rules regarding payment of dividends
by a national bank. 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).

Portfolio assets are defined as total assets less intangibles, property
used by a savings association in its business and liquidity investments in an
amount not exceeding 20% of assets. Generally, QTLs are residential housing
related assets, The recent legislation allows small business loans, credit card
loans, student loans and loans for personal, family and household purposes to be
included without limitation as qualified investments. In addition, commercial
loans may be made in an amount up to 10% of total assets. At September 30, 1999,
approximately 81.10% of the Bank's assets were invested in QTLs, which was in
excess of the percentage required to qualify the Bank under the QTL Test in
effect at that time.

Restrictions on Capital Distributions. OTS regulations govern capital
distributions by savings associations, which include cash dividends, stock
redemptions or repurchases, cash-out mergers, interest payments on certain
convertible debt and other transactions charged to the capital account of a
savings association to make capital distributions. Generally, the regulation
creates a safe harbor for specified levels of capital distributions (as a
percentage of income) from associations meeting at least their minimum capital
requirements, so long as such associations notify the OTS and

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receive no objection to the distribution from the OTS. Savings institutions and
distributions that do not qualify for the safe harbor are required to obtain
prior OTS approval before making any capital distributions.

Generally, savings associations such as the Bank includes in a subsidiary
of a savings and loan holding company can, upon 30 days prior notice, distribute
during each calendar year an amount equal to or less than its net income for the
year to date plus retained net income for the preceding two years. Amounts in
excess of this must be approved by the OTS.

OTS regulations also prohibit the Bank from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
(or total) capital of the Bank would be reduced below the amount required to be
maintained 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 rating as a result of its last OTS evaluation.

Policy Statement on Nationwide Branching. Effective May 11, 1992, the OTS
amended and codified its policy statement on branching by federally chartered
savings associations to delete then-existing regulatory restrictions on the
branching authority of such associations and to permit nationwide branching to
the extent allowed by federal statute. (Prior OTS policy generally permitted
interstate branching for federally chartered savings associations only to the
extent allowed state-chartered savings associations in the states where the
association's home office was located and where the branch was sought or if the
branching resulted from OTS approval of a supervisory interstate acquisition of
a troubled institution.) Current OTS policy generally permits a federally
chartered savings association to establish branch offices outside of its home
state if the association meets the domestic building and loan test in Section
7701(a)(19) of the Code or the asset composition test of subparagraph (c) of
that section, and if, with respect to each state outside of its home state where
the association has established branches, the branches, taken alone, also
satisfy one of the two tax tests. An association seeking to take advantage of
this authority would have to have a branching application approved by the OTS,
which would consider the regulatory capital of the association and its record
under the CRA, as amended, among other things.

Federal Home Loan Bank System. The Bank is a member of the FHLB of
Pittsburgh, which is one of 12 regional FHLBs that administers the home
financing credit function of savings associations. Each FHLB serves as a reserve
or central bank for its members within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures established by the Board of Directors of the FHLB.

As 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, 1999, the Bank had $6.2 million in FHLB
stock, which was in compliance with this requirement.

The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest on
advances to their members. For the years ended September 30, 1999, 1998 and
1997, dividends from the FHLB to the Bank amounted to approximately $375,000,
$261,000 and $196,000, respectively. If dividends were reduced, the Bank's net
interest income would likely also be reduced. Further, there can be no assurance
that the impact of recent or future legislation on the FHLBs will not also cause
a decrease in the value of FHLB stock held by the Bank, if any.

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36

Federal Reserve System. The Federal Reserve Bank ("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, 1999, 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 Federal Reserve Bank, the effect of this
reserve requirement is to reduce an institution's earning assets.

Safety and Soundness Guidelines. The OTS and the other federal banking
agencies have established guidelines for safety and soundness, addressing
operational and managerial, as well as compensation matters for insured
financial institutions. Institutions failing to meet these standards are
required to submit compliance plans to their appropriate federal regulators. The
OTS and the other agencies have also established guidelines regarding asset
quality and earnings standards for insured institutions.

Recent Regulatory Developments. On November 12, 1999, President Clinton
signed into law the Gramm-Leach-Bliley Act (the "Act") which will, effective
March 11, 2000, permit qualifying bank holding companies to become financial
holding companies and thereby affiliate with securities firms and insurance
companies and engage in other activities that are financial in nature. The Act
defines "financial in nature" to include securities underwriting, dealing and
market making; sponsoring mutual funds and investment companies; insurance
underwriting and agency; merchant banking activities; and activities that the
Board has determined to be closely related to banking. A qualifying national
bank also may engage, subject to limitations on investment, in activities that
are financial in nature, other than insurance underwriting, insurance company
portfolio investment, real estate development, and real estate investment,
through a financial subsidiary of the Bank.

The Act also prohibits new unitary thrift holding companies from engaging
in nonfinancial activities or from affiliating with an nonfinancial entity. As a
grandfathered unitary holding company, the Company will retain its authority to
engage in nonfinancial activities.

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. Generally, this method will
allow the Company to deduct an annual addition to the reserve for bad debts
equal to the increase in the balance of the Company's reserve for bad debts at
the end of the year to an amount equal to the percentage of total loans at the
end of the year, computed using the ratio of the previous six years net charge
offs divided by the sum of the previous six years total outstanding loans at
year end.

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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 the applicable excess reserves will be taken into
account ratably over a six-taxable year period, beginning with the first taxable
year beginning after December 31, 1995. The timing of the recapture may be
delayed for a two-year period provided certain residential lending requirements
are met. For financial reporting purposes, the Company will not incur any
additional tax expense. At September 30, 1997, under SFAS No. 109, deferred
taxes were provided on the difference between the book reserve at September 30,
1997 and the applicable excess reserve in an amount equal to the Bank's increase
in the tax reserve from December 31, 1987 to September 30, 1997.

Prior to September 30, 1996, the Bank had the option of electing either the
experience method or the percentage of taxable income method (the "Percentage
Method") for its annual addition to the bad debt reserves.

Under the Experience Method, the deductible annual addition is the amount
necessary to increase the balance of the reserve at the close of the taxable
year to the greater of (i) the amount which bears the same ratio to loans
outstanding at the close of the taxable year as the total net bad debts
sustained during the current and five preceding taxable years bear to the sum of
the loans outstanding at the close of those six years or (ii) the balance in the
reserve account at the close of the Bank's "base year," which was its tax year
ended December 31, 1987.

Under the Percentage Method, the bad debt deduction with respect to
qualifying real property loans is computed as a percentage of the Bank's taxable
income before such deduction, as adjusted for certain items (such as capital
gains and the dividends received deduction). Under this method, a qualifying
institution such as the Bank generally may deduct 8% of its taxable income. In
the absence of other factors, the availability of the Percentage Method has
permitted a qualifying savings institution, such as the Bank, to be taxed at an
effective federal income tax rate of 31.28%, as compared to 34% for corporations
generally.

For taxable years ended on or before December 31, 1988, the Bank has
generally elected to use the Percentage Method to compute the amount of its bad
debt deduction with respect to its qualifying real property loans. For all
taxable years ended after December 31, 1988 with the exception of the September
30, 1996 tax year, the Bank elected to use the Experience Method to compute the
amount of its bad debt deduction with respect to its qualifying real property
loans.

The income of the Company or any non-bank subsidiaries would not be subject
to the bad debt deduction allowed the Bank, whether or not consolidated tax
returns are filed.

Distributions. While the Bank maintains a bad debt reserve, if it were to
distribute cash or property to its sole stockholder having a total fair market
value in excess of its accumulated tax-paid earnings and profits, or were to
distribute cash or property to its stockholder in redemption of its stock, the
Bank would generally be required to recognize as income an amount which, when
reduced by the amount of federal income tax that would be attributable to the
inclusion of such amount in income, is equal to the lesser of: (i) the amount of
the distribution or (ii) the sum of (a) the amount of the accumulated bad debt
reserve of the Bank with respect to qualifying real property loans (to the
extent that additions to such reserve exceed the additions that would be
permitted under the experience method) and (b) the amount of the Bank's
supplemental bad debt reserve.

Minimum Tax. The Code imposes an alternative minimum tax at a rate of 20%
on a base of regular taxable income plus certain tax preferences ("alternative
minimum taxable income" or "AMTI"). The alternative minimum tax is payable to
the extent such AMTI is in excess of an exemption amount. The Code provides that
an item of tax preference is the excess of the bad debt deduction allowable for
a taxable year pursuant to the percentage of taxable income method over the
amount allowable under the experience method. The other items of tax preference
that constitute AMTI include (a) tax-exempt interest on newly-issued (generally,
issued on or after August 8, 1986) private activity bonds other than certain
qualified bonds and (b) for taxable years beginning after 1989, 75% of the
excess (if any) of (i) adjusted current earnings as defined in the Code, over
(ii) AMTI (determined without regard to this preference and prior to reduction

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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, 1995 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 1999 is 9.99% and is imposed on the Company's
unconsolidated taxable income for federal purposes with certain adjustments. In
general, the Capital Stock Tax is a property tax imposed at the rate of 1.2% 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.

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ITEM 2. PROPERTIES

At September 30, 1999, 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 8
of the Notes to Consolidated Financial Statements in the Annual Report.

The following table sets forth certain information with respect to the
Bank's offices at September 30, 1999.

Net Book Value Amount of
Description/Address Leased/Owned of Property Deposits
- --------------------------------------- ------------- ------------------ ------------------------
(In thousands)

Executive Offices:
22 West State Street
Media, Pennsylvania 19063 Owned(1) $1,094 $ 80,775

Branch Offices:
3218 Edgmont Avenue
Brookhaven, Pennsylvania 19015 Owned 498 81,678

Routes 1 and 100
Chadds Ford, Pennsylvania 19318 Leased(2) 204 24,284

23 East Fifth Street
Chester, Pennsylvania 19013 Leased(3) 221 19,677

31 Baltimore Pike
Chester Heights, Pennsylvania 19017 Leased(4) 232

Route 82 and 926
Kennett Square, Pennsylvania 19348 Leased(5) 62 5,287

330 Dartmouth Avenue
Swarthmore, Pennsylvania 19081 Owned 114 49,125
------ --------
$2,425 $260,826
====== ========

- ------------------

(1) Also a branch office.

(2) Lease expiration date is September 30, 2000. The Bank has two five year
renewal options.

(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, 2001. The Bank has four five year
renewal options.

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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.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

Not applicable.

PART II.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

The information required herein is incorporated by reference on page 36
of the Company's Annual Report.

ITEM 6. SELECTED FINANCIAL DATA.

The information required herein is incorporated by reference from pages
5 to 6 of the Registrant's Annual Report.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANAYLSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.

The information required herein is incorporated by reference from pages
7 to 16 of the Registrant's Annual Report.

ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The Company's balance sheet consists of interest-earning assets and
interest-bearing liabilities, and is therefore exposed to interest rate
risk. The following additional information is being provided regarding
the exposure to this interest rate risk.

The Company utilizes reports prepared by the OTS to measure interest
rate risk. Using data from the Bank's quarterly thrift financial
reports, the OTS models the net portfolio value ("NPV") of the Bank
over a variety of interest rate scenarios. The NPV is defined as the
present value of expected cash flows from existing assets less the
present value of expected cash flows from existing liabilities plus the
present value of net expected cash inflows from existing off-balance
sheet contracts. The model assumes instantaneous, parallel shifts in
the U.S. Treasury Securities yield curve of 100 to 300 basis points,
either up or down, and in 100 basis point increments.

The interest rate risk measures used by the OTS include an "Exposure
Measure" or "Post-Shock" NPV ratio and a "Sensitivity Measure". The
"Post-Shock" NPV ratio is the net present value as a percentage of
assets over the various yield curve shifts. A low "Post-Shock" NPV
ratio indicates greater exposure to interest rate risk and can result
from a low initial NPV ratio or high sensitivity to changes in interest
rates. The "Sensitivity Measure" is the decline in the NPV ratio, in
basis points, caused by a 2% increase or decrease in rates, whichever
produces a larger decline. The following sets forth the Bank's NPV as
of September 30, 1999.

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Net Portfolio Value
(Dollars in thousands)
- ---------------------------------------------------------------------------------------------------------
Changes in
Rates in Dollar Percentage Net Portfolio Value As a Change in
Basis Points Amount Change Change % of Assets Percentage (1)
- ---------------------------------------------------------------------------------------------------------

200 $23,774 $(18,739) (44.08)% 5.57% (40.93)%
100 33,479 (9,035) (21.25) 7.62 (19.19)
0 42,513 9.43
(100) 49,347 6,834 16.08 10.73 13.79
(200) 52,254 9,741 22.91 11.22 18.98

(1) Based on the portfolio value of the Bank's assets in the base case
scenario

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 Table 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.
Also, the model does not take into account the Bank's business or
strategic plans. Accordingly, although the NPV table provides 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. See
also discussion on pages 7 to 8 of the Annual Report.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The financial statements and supplementary data required herein are
incorporated by reference from pages 18 to 36 of the Annual Report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required herein is incorporated by reference from
pages 2 to 5 and page 15 of the Registrant's Proxy Statement dated
December 23, 1999 ("Proxy Statement").

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42

ITEM 11. EXECUTIVE COMPENSATION.

The information required herein is incorporated by reference from
pages 8 to 9 of the Registrant's Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The information required herein is incorporated by reference from
pages 6 to 8 of the Registrant's Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information required herein is incorporated by reference from
pages 14 to 15 of the Registrant's Proxy Statement.

PART IV.

ITEM 14. 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, 1999 and 1998.

Consolidated Statements of Income for the Years Ended
September 30, 1999, 1998 and 1997.

Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended September 30, 1999, 1998 and 1997.

Consolidated Statements of Cash Flows for the Years Ended
September 30, 1999, 1998 and 1997.

Notes to the Consolidated Financial Statements.

(2) All schedules for which provision is made in the
applicable accounting regulation of the SEC are omitted
because they are not applicable or the required
information is included in the Consolidated Financial
Statements or notes thereto.

(3) The following exhibits are filed as part of this Form
10-K, and this list includes the Exhibit Index.

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43

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 (incorporated by reference from Exhibit
10.9 to Registrant's Form 10-KSB for the year ended September 30,
1995).

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44
10.10 1995 Recognition and Retention Plan and Trust Agreement,
(incorporated by reference from Exhibit 10.10 to Registrant's
Form 10-KSB for the year ended September 30, 1995).

10.11 1998 Stock Option Plan (incorporated from Appendix A of The
Registrant's definitive proxy statement dated December 24, 1998.

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.

13 Annual Report to Stockholders.

21 Subsidiaries of the Registrant - Reference is made to Item 1
"Business," for the required information.

23 Consent of Deloitte & Touche LLP.

27 Financial Data Schedule

- -----------------------

(*) 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.

(b) Reports filed on Form 8-K.

None.

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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
President 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 29, 1999
- --------------------------------------------------
Donald S. Guthrie
President and Chief Executive Officer
(Principal Executive Officer)

/s/ Thomas M. Kelly December 29, 1999
- -----------------------------------------------
Thomas M. Kelly
Executive Vice-President and Chief
Financial Officer
(Principal Financial and Accounting Officer)

/s/ Donald A. Purdy December 29, 1999
- ------------------------------------------------
Donald A. Purdy
Chairman of the Board

/s/ William K. Betts December 29, 1999
- ------------------------------------------------
William K. Betts
Director

/s/ Edward Calderoni December 29, 1999
- ------------------------------------------------
Edward Calderoni
Director

/s/ Silvio F. D'Ignazio December 29, 1999
- ------------------------------------------------
Silvio F. D'Ignazio
Director

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46

/s/ Olive J. Faulkner December 29, 1999
- ------------------------------------------------
Olive J. Faulkner
Director

/s/ Edmund Jones December 29, 1999
- ------------------------------------------------
Edmund Jones
Director

/s/ Willard F. Letts December 29, 1999
- ------------------------------------------------
Willard F. Letts
Director

/s/ Walter J. Lewicki December 29, 1999
- ----------------------------------------------
Walter J. Lewicki
Director

/s/ Joan G. Taylor December 29, 1999
- -----------------------------------------------
Joan G. Taylor
Director

45