UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________________
FORM 10-K
[x] ANNUAL REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
Or
[ ] TRANSITION REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________
Commission file Number: 2-88927
FIRST KEYSTONE CORPORATION
(Exact name of registrant as specified in its Charter)
Pennsylvania 23-2249083
______________________ ______________________
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
111 West Front Street,
Berwick, Pennsylvania 18603
______________________ ______________________
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code: (570) 752-3671
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common
Stock, par value $2.00 per share
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. [ ]
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act. [ ]
Indicate by check mark whether the Registrant (1) filed all reports
required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Indicate by check mark if there is no disclosure of delinquent
filers in response to Item 405 of Regulation S-K contained in this
form, and no disclosure will be contained, to the best of
registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer (as defined in Rul 12b-2 of the Exchange Act).
Large accelerated filer [ ] Accelerated filer [X]
Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Act).
Yes [ ] No [X]
The aggregate market value of the voting stock held by non-
affiliates on the Registrant based on the closing price as of March
6, 2007, was approximately $70,115,889.
The number of shares outstanding of the issuer's Common Stock, as
of March 6, 2007 was 4,518,873 shares of Common Stock, par value
$2.00 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's 2007 definitive Proxy Statement
are incorporated by reference in Part III of this Report.
FIRST KEYSTONE CORPORATION
FORM 10-K
Table of Contents
Part I Page
Item 1. Business 1
Item 1A. Risk Factors 7
Item 1B. Unresolved Staff Comments 9
Item 2. Properties 9
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote
of Security Holders 10
Part II
_______
Item 5. Market for Registrant's Common Equity
and Related Shareholder Matters 10
Item 6. Selected Financial Data 13
Item 7. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 14
Item 7A. Quantitative and Qualitative Disclosure
About Market Risk 28
Item 8. Financial Statements and Supplementary
Data 29
Item 9. Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure 63
Item 9A. Controls and Procedures 63
Item 9B. Other Information 63
Part III
________
Item 10. Directors, Executive Officers and
Corporate Governance 64
Item 11. Executive Compensation 64
Item 12. Security Ownership of Certain Beneficial
Owners and Management and
Related Shareholder Matters 64
Item 13. Certain Relationships and Related
Transactions and Director
Independence 64
Item 14. Principal Accountant Fees and Services 64
Part IV
_______
Item 15. Exhibits and Financial Statement
Schedules 65
Signatures 67
Exhibit 21 68
Exhibit 23 69
Exhibit 31.1 70
Exhibit 31.2 71
Exhibit 32.1 72
Exhibit 32.2 73
ii
FIRST KEYSTONE CORPORATION
FORM 10-K
PART I
Forward Looking Statements
__________________________
The management of First Keystone Corporation (Corporation),
has made forward-looking statements in this annual report on Form
10-K. These forward-looking statements may be subject to risks and
uncertainties. Forward-looking statements include the information
concerning possible or assumed future results of operations of the
Corporation and its subsidiary, The First National Bank of Berwick
(Bank). When words such as "believes," "expects," "anticipates" or
similar expressions occur in this annual report, management is
making forward looking statements.
Shareholders should note that many factors, some of which are
discussed elsewhere in this annual report, could affect the future
financial results of the Corporation and its subsidiary, both
individually and collectively, and could cause those results to
differ materially from those expressed in the forward looking
statements contained in this annual report on Form 10-K. These
factors include the following:
* operating, legal and regulatory risks;
* economic, political and competitive forces affecting our
banking, securities, asset management and credit services
businesses; and
* the risk that our analyses of these risks and forces could
be incorrect and or that the strategies developed to
address them could be unsuccessful.
The Corporation undertakes no obligation to publicly revise or
update these forward looking statements to reflect events or
circumstances that arise after the date of this report. Readers
should carefully review the risk factors described in other
documents that are filed periodically with the Securities and
Exchange Commission (SEC).
ITEM 1. BUSINESS
First Keystone Corporation is a Pennsylvania business
corporation, and a bank holding company, registered with and
supervised by the Board of Governors of the Federal Reserve System.
The Corporation was incorporated on July 6, 1983, and commenced
operations on July 2, 1984, upon consummation of the acquisition of
all of the outstanding stock of The First National Bank of Berwick.
The Corporation has one wholly owned subsidiary, the Bank, which
has a commercial banking operation and trust department as its
major lines of business. Since commencing operations, the
Corporation's business has consisted primarily of managing and
supervising the Bank, and its principal source of income has been
dividends paid by the Bank. Greater than 98% of the company's
revenue and profit came from the commercial banking department for
the years ended December 31, 2006, 2005, and 2004, and was the only
reportable segment. At December 31, 2006, the Corporation had
total consolidated assets, deposits and stockholders' equity of
approximately $526 million, $384 million and $53 million,
respectively.
The Bank was organized in 1864. The Bank is a national
banking association that is a member of the Federal Reserve System.
Its deposits are insured by the Federal Deposit Insurance
Corporation (FDIC) to the maximum extent of the law regulated by
The Office of the Comptroller of the Currency (OCC). The Bank, has
ten branch locations (five branches within Columbia County, four
branches within Luzerne County, and one branch in Montour County,
Pennsylvania), and is a full service commercial bank providing a
wide range of services to individuals and small to medium sized
businesses in its Northeastern and Central Pennsylvania market
area. The Bank's commercial banking activities include accepting
time, demand, and savings deposits and making secured and unsecured
commercial, real estate and consumer loans. Additionally, the Bank
also provides personal and corporate trust and agency services to
individuals, corporations, and others, including trust investment
accounts, investment advisory services, mutual funds, estate
planning, and management of pension and profit sharing plans.
Supervision and Regulation
__________________________
The Corporation is subject to the jurisdiction of the SEC and
of state securities laws for matters relating to the offering and
sale of its securities. The Corporation is currently subject to
the SEC's rules and regulations relating to company's whose shares
are registered under Section 12 of the Securities Exchange Act of
1934, as amended.
1
The Corporation is also subject to the provisions of the Bank
Holding Company Act of 1956, as amended , and to supervision by the
Federal Reserve Board. The Bank Holding Company Act requires the
Corporation to secure the prior approval of the Federal Reserve
Board before it owns or controls, directly or indirectly, more than
5% of the voting shares of substantially all of the assets of any
institution, including another bank.
The Bank Holding Company Act also prohibits acquisition of
control of a bank holding company, such as the Corporation, without
prior notice to the Federal Reserve Board. Control is defined for
this purpose as the power, directly or indirectly, to direct the
management or policies of a bank holding company or to vote 25% (or
10%, if no other person or persons acting on concert, holds a
greater percentage of the Common Stock) or more of the
Corporation's Common Stock.
The Corporation is required to file an annual report with the
Federal Reserve Board and any additional information that the
Federal Reserve Board may require pursuant to the Bank Holding
Company Act. The Federal Reserve Board may also make examinations
of the Corporation and any or all of its subsidiaries.
The Bank is subject to federal and state statutes applicable
to banks chartered under the banking laws of the United States, to
members of the Federal Reserve System and to banks whose deposits
are insured by the FDIC. Bank operations are also subject to
regulations of the OCC, the Federal Reserve Board and the FDIC.
The primary supervisory authority of the Bank is the OCC,
which regulates and examines the Bank. The OCC has the authority
under the Financial Institutions Supervisory Act to prevent a
national bank from engaging in an unsafe or unsound practice in
conducting its business.
Federal and state banking laws and regulations govern, among
other things, the scope of a bank's business, the investments a
bank may make, the reserves against deposits a bank must maintain,
loans a bank makes and collateral it takes, and the activities of a
bank with respect to mergers and consolidations and the
establishment of branches.
As a subsidiary of a bank holding company, the Bank is subject
to certain restrictions imposed by the Federal Reserve Act on any
extensions of credit to the bank holding company or its
subsidiaries, on investments in the stock or other securities of
the bank holding company or its subsidiaries and on taking such
stock or securities as collateral for loans. The Federal Reserve
Act and Federal Reserve Board regulations also place certain
limitations and reporting requirements on extensions of credit by a
bank to principal shareholders of its parent holding company, among
others, and to related interests of such principal shareholders.
In addition, such legislation and regulations may affect the terms
upon which any person becoming a principal shareholder of a holding
company may obtain credit from banks with which the subsidiary bank
maintains a correspondent relationship.
Under the Federal Deposit Insurance Act , the OCC possesses
the power to prohibit institutions regulated by it from engaging in
any activity that would be an unsafe or unsound banking practice or
would otherwise be in violation of the law.
Permitted Non-Banking Activities
________________________________
The Federal Reserve Board permits bank holding companies to
engage in non banking activities so closely related to banking,
managing or controlling banks as to be a proper incident thereto.
The Corporation does not at this time engage in any of these non
banking activities, nor does the Corporation have any current plans
to engage in any other permissible activities in the foreseeable
future.
Legislation and Regulatory Changes
__________________________________
From time to time, various types of federal and state
legislation have been proposed that could result in additional
regulations of, and restrictions on, the business of the Bank. It
cannot be predicted whether any such legislation will be adopted or
how such legislation would affect the business of the Bank. As a
consequence of the extensive regulation of commercial banking
activities in the United States, the Bank's business is
particularly susceptible to being affected by federal legislation
and regulations that may increase the costs of doing business.
From time to time, legislation is enacted which has the effect
of increasing the cost of doing business, limiting or expanding
permissible activities or affecting the competitive balance between
banks and other financial institutions. No prediction can be made
as to the likelihood of any major changes or the impact such
changes might have on the Corporation and the Bank. Certain
changes of potential significance to the Corporation which have
been enacted recently and others which are currently under
consideration by Congress or various regulatory agencies are
discussed below.
2
Federal Deposit Insurance Corporation Improvement Act of 1991
_____________________________________________________________
The FDICIA established five different levels of capitalization
of financial institutions, with "prompt corrective actions" and
significant operational restrictions imposed of institutions that
are capital deficient under the categories. The five categories
are:
* well capitalized
* adequately capitalized
* undercapitalized
* significantly undercapitalized, and
* critically undercapitalized.
To be considered well capitalized, an institution must have a
total risk based capital ratio of at least 10%, a Tier 1 risk based
capital ratio of at least 6%, a leverage capital ratio of 5%, and
must not be subject to any order or directive requiring the
institution to improve its capital level. An institution falls
within the adequately capitalized category if it has a total risk
based capital ratio of at least 8%, a Tier 1 risk based capital
ratio of at least 4%, and a leverage capital ratio of at least 4%.
Institutions with lower capital levels are deemed to be
undercapitalized, significantly undercapitalized or critically
undercapitalized, depending on their actual capital levels. In
addition, the appropriate federal regulatory agency may downgrade
an institution to the next lower capital category upon a
determination that the institution is in an unsafe or unsound
condition, or is engaged in an unsafe or unsound practice.
Institutions are required under FDICIA to closely monitor their
capital levels and to notify their appropriate regulatory agency of
any basis for a change in capital category. On December 31, 2006
the Corporation and the Bank exceeded the minimum capital levels of
the well capitalized category.
Regulatory oversight of an institution becomes more stringent
with each lower capital category, with certain "prompt corrective
actions" imposed depending on the level of capital deficiency.
Other Provisions of FDICIA
__________________________
Each depository institution must submit audited financial
statements to its primary regulator and the FDIC, which reports are
made publicly available. In addition, the audit committee of each
depository institution must consist of outside directors and the
audit committee at "large institutions" (as defined by FDIC
regulation) must include members with banking or financial
management expertise. The audit committee at "large institutions"
must also have access to independent outside counsel. In addition,
an institution must notify the FDIC and the institution's primary
regulator of any change in the institutions independent auditor,
and annual management letters must be provided to the FDIC and the
depository institution's primary regulator. The regulations define
a "large institution" as one with over $500 million in assets,
which does include the Bank. Also, under the rule, an
institution's independent auditor must examine the institution's
internal controls over financial reporting and perform agreed-upon
procedures to test compliance with laws and regulations concerning
safety and soundness.
Under FDICIA, each federal banking agency must prescribe
certain safety and soundness standards for depository institutions
and their holding companies. Three types of standards must be
prescribed:
* asset quality and earnings
* operational and managerial, and
* compensation
Such standards would include a ratio of classified assets to
capital, minimum earnings, and, to the extent feasible, a minimum
ratio of market value to book value for publicly traded securities
of such institutions and holding companies. Operational and
managerial standards must relate to:
* internal controls, information systems and
internal audit systems
* loan documentation
* credit underwriting
* interest rate exposure
* asset growth, and
* compensation, fees and benefits
FDICIA also sets forth Truth in Savings disclosure and
advertising requirements applicable to all depository institutions.
3
Real Estate Lending Standards. Pursuant to the FDICIA, the
OCC and other federal banking agencies adopted real estate lending
guidelines which would set loan to value ratios for different types
of real estate loans. A LTV ratio is generally defined as the
total loan amount divided by the appraised value of the property at
the time the loan is originated. If the institution does not hold
a first lien position, the total loan amount would be combined with
the amount of all senior liens when calculating the ratio. In
addition to establishing the LTV ratios, the guidelines require all
real estate loans to be based upon proper loan documentation and a
recent appraisal of the property.
Regulatory Capital Requirements
_______________________________
The federal banking regulators have adopted certain risk based
capital guidelines to assist in the assessment of the capital
adequacy of a banking organization's operations for both
transactions reported on the balance sheet as assets and
transactions, such as letters of credit, and recourse agreements,
which are recorded as off balance sheet items. Under these
guidelines, nominal dollar amounts of assets and credit equivalent
amounts of off balance sheet items are multiplied by one of several
risk adjustment percentages, which range from 0% for assets with
low credit risk, such as certain U.S. Treasury securities, to 100%
for assets with relatively high credit risk, such as business
loans.
The following table presents the Corporation's capital ratios
at December 31, 2006.
(In Thousands)
<s> <c>
Tier I Capital $ 51,891
Tier II Capital 4,089
________
Total Capital $ 55,980
Adjusted Total Average Assets $523,800
Total Adjusted Risk-Weighted Assets <F1> 297,422
Tier I Risk-Based Capital Ratio <F2> 17.45%
Required Tier I Risk-Based Capital Ratio 4.00%
Excess Tier I Risk-Based Capital Ratio 13.45%
Total Risk-Based Capital Ratio <F3> 18.82%
Required Total Risk-Based Capital Ratio 8.00%
Excess Total Risk-Based Capital Ratio 10.82%
Tier I Leverage Ratio <F4> 9.94%
Required Tier I Leverage Ratio 4.00%
Excess Tier I Leverage Ratio 5.94%
_____________________
<FN>
<F1>
Includes off-balance sheet items at credit-equivalent values less
intangible assets.
<F2>
Tier I Risk-Based Capital Ratio is defined as the ratio of Tier I
Capital to Total Adjusted Risk-Weighted Assets.
<F3>
Total Risk-Based Capital Ratio is defined as the ratio of Tier I
and Tier II Capital to Total Adjusted Risk-Weighted Assets.
<F4>
Tier I Leverage Ratio is defined as the ratio of Tier I Capital to
Adjusted Total Average Assets.
</FN>
The Corporation's ability to maintain the required levels of
capital is substantially dependent upon the success of
Corporation's capital and business plans; the impact of future
economic events on the Corporation's loan customers; and the
Corporation's ability to manage its interest rate risk and
investment portfolio and control its growth and other operating
expenses. See also, the information under the caption "Capital
Strength" appearing on page 24 of this 2006 Annual Report on Form
10-K.
Effect of Government Monetary Policies
______________________________________
The earnings of the Corporation are and will be affected by
domestic economic conditions and the monetary and fiscal policies
of the United States government and its agencies.
The Federal Reserve Board have had, and will likely continue
to have, an important impact on the operating results of commercial
banks through its power to implement national monetary policy in
order to, among other things, curb inflation or combat a recession.
The Federal Reserve Board has a major effect upon the levels of
bank loans, investments and deposits through its open market
operations in United States government securities and through its
regulations of, among other things, the discount rate on borrowings
of member banks and the reserve requirements against member bank
deposits. It is not possible to predict the nature and impact of
future changes in monetary and fiscal policies.
4
Effects of Inflation
____________________
Inflation has some impact on the Bank's operating costs.
Unlike industrial companies, however, substantially all of the
Bank's assets and liabilities are monetary in nature. As a result,
interest rates have a more significant impact on the Bank's
performance than the general levels of inflation. Over short
periods of time, interest rates may not necessarily move in the
same direction or in the same magnitude as prices of goods and
services.
Environmental Regulation
________________________
There are several federal and state statutes that regulate the
obligations and liabilities of financial institutions pertaining to
environmental issues. In addition to the potential for attachment
of liability resulting from its own actions, a bank may be held
liable, under certain circumstances, for the actions of its
borrowers, or third parties, when such actions result in
environmental problems on properties that collateralize loans held
by the bank. Further, the liability has the potential to far
exceed the original amount of the loan issued by the Bank.
Currently, neither the Corporation nor the Bank is a party to any
pending legal proceeding pursuant to any environmental statute, nor
are the Corporation and the Bank aware of any circumstances that
may give rise to liability under any such statute.
Interest Rate Risk
__________________
Federal banking agency regulations specify that the Bank's
capital adequacy include an assessment of the Bank's interest rate
risk exposure. The standards for measuring the adequacy and
effectiveness of a banking organization's Interest Rate Risk (IRR)
management includes a measurement of Board of Directors and senior
management oversight, and a determination of whether a banking
organization's procedures for comprehensive risk management are
appropriate to the circumstances of the specific banking
organization. The First National Bank of Berwick has internal IRR
models that are used to measure and monitor IRR. Additionally, the
regulatory agencies have been assessing IRR on an informal basis
for several years. For these reasons, the Corporation does not
expect the addition of IRR evaluation to the agencies' capital
guidelines to result in significant changes in capital requirements
for the Bank.
The Gramm-Leach-Bliley Act of 2000
__________________________________
On November 12, 2000, President Clinton signed into law the
Gramm-Leach-Bliley Act of 2000, which is also known as the
Financial Services Modernization Act. The act repeals some
Depression era banking laws and will permit banks, insurance
companies and securities firms to engage in each others' businesses
after complying with certain conditions and regulations. The act
grants to community banks the power to enter new financial markets
as a matter of right that larger institutions have managed to do on
an ad hoc basis. At this time, our company has no plans to pursue
these additional possibilities.
Our Corporation does not believe that the Financial Services
Modernization Act will have an immediate positive or negative
material effect on our operations. However, the act may have the
result of increasing the amount of competition that our Corporation
faces from larger financial service companies, many of whom have
substantially more financial resources than our Corporation, which
may now offer banking services in addition to insurance and
brokerage services.
The Sarbanes-Oxley Act
______________________
On July 30, 2002, President Bush signed into law the Sarbanes
Oxley Act of 2002. The Act was in response to public concerns
regarding corporate accountability in connection with recent high
visibility accounting scandals. The stated goals of the Sarbanes-Oxley Act are:
* to increase corporate responsibility;
* to provide for enhanced penalties for accounting and
auditing improprieties at publicly traded companies; and
* to protect investors by improving the accuracy and
reliability of corporate disclosures pursuant to the
securities laws.
The Sarbanes-Oxley Act generally applies to all companies,
both U.S. and non-U.S., that file periodic reports with the SEC
under the Securities Exchange Act of 1934. The legislation
includes provisions, among other things:
* governing the services that can be provided by a public
company's independent auditors and the procedures for
approving such services;
5
* requiring the chief executive officer and chief financial
officer to certify certain matters relating to the
company's periodic filings under the Exchange Act;
* requiring expedited filings of reports by insiders of
their securities transactions and containing other
provisions relating to insider conflicts of interest;
* increasing disclosure requirements relating to critical
financial accounting policies and their application;
* increasing penalties for securities law violations; and
* creating a new public accounting oversight board, a
regulatory body subject to SEC jurisdiction with broad
powers to set auditing, quality control and ethics
standards for accounting firms.
The American Jobs Creation Act of 2004
______________________________________
In 2004, the American Jobs Creation Act was enacted as the
first major corporation tax act in years. The act addresses a
number of areas of corporate taxation including executive deferred
compensation restrictions. The impact of the act on the
Corporation is unknown at this time, but management is monitoring
its developments.
History and Business - Bank
___________________________
The Bank's legal headquarters are located at 111 West Front
Street, Berwick, Pennsylvania.
As of December 31, 2006, the Bank had total assets of
$525,920,000, total shareholders' equity of $53,387,000 and total
deposits and other liabilities of $472,533,000.
The Bank engages in a full service commercial banking
business, including accepting time and demand deposits, and making
secured and unsecured commercial and consumer loans. The Bank's
business is not seasonal in nature. Its deposits are insured by
the FDIC to the extent provided by law. The Bank has no foreign
loans or highly leveraged transaction loans, as defined by the
Federal Reserve Board. Substantially all of the loans in the
Bank's portfolio have been originated by the Bank. Policies
adopted by the Board of Directors are the basis by which the Bank
conducts its lending activities.
At December 31, 2006, the Bank had 117 full time employees and
25 part time employees. In the opinion of management, the Bank
enjoys a satisfactory relationship with its employees. The Bank is
not a party to any collective bargaining agreement.
Competition - Bank
__________________
The Bank competes actively with other area commercial banks
and savings and loan associations, many of which are larger than
the Bank, as well as with major regional banking and financial
institutions. The Bank's major competitors in Columbia, Luzerne,
and Montour counties are:
* First Columbia Bank & Trust Co. of Bloomsburg
* PNC Bank, N.A.
* Columbia County Farmers National Bank of Bloomsburg
* M & T Bank
* FNB Bank, NA
* Wachovia Bank
* Sovereign Bank
* Citizens Bank
Credit unions are also competitors, especially in Luzerne and
Montour counties. The Bank is generally competitive with all
competing financial institutions in its service area with respect
to interest rates paid on time and savings deposits, service
charges on deposit accounts and interest rates charged on loans.
Concentration
_____________
The Corporation and the Bank are not dependent for deposits
nor exposed by loan concentrations to a single customer or to a
small group of customers the loss of any one or more of whom would
have a materially adverse effect on the financial condition of the
Corporation or the Bank.
6
Available Information
_____________________
The Corporation's common stock is registered under Section
12(b) of the Securities Exchange Act of 1934. The Corporation is
subject to the informational requirements of the Exchange Act, and,
accordingly, files reports, proxy statements and other information
with the Securities and Exchange Commission. The reports, proxy
statements and other information filed with the SEC are available
for inspection and copying at the SEC's Public Reference Room at
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549.
You may obtain information on the operation of the Public Reference
Room by calling the SEC at 1-800-SEC-0330. The Corporation is an
electronic filer with the SEC. The SEC maintains an Internet site
that contains reports, proxy and information statements, and other
information regarding issuers that file electronically with the
SEC. The SEC's internet site address is www.sec.gov.
A copy of the Corporation's Annual Report on Form 10-K may be
obtained without charge from our website at
www.firstkeystonecorporation.com or via email at fnb@fnbbwk.com.
Information may also be obtained via written request to Investor
Relations at First Keystone Corporation, Attention: J. Gerald
Bazewicz, 111 West Front Street, Berwick, Pennsylvania 18603.
ITEM 1A. RISK FACTORS
Investments in First Keystone Corporation common stock involve
risk. The market price of First Keystone common stock may
fluctuate significantly in response to a number of factors,
including:
The Corporation Is Subject To Interest Rate Risk
________________________________________________
The Corporation's earnings and cash flows are largely
dependent upon its net interest income. Net interest income is the
difference between interest income earned on interest earning
assets such as loans and securities and interest expense paid on
interest bearing liabilities such as deposits and borrowed funds.
Interest rates are highly sensitive to many factors that are beyond
the Corporation's control, including general economic conditions
and policies of various governmental and regulatory agencies and,
in particular, the Board of Governors of the Federal Reserve
System. Changes in monetary policy, including changes in interest
rates, could influence not only the interest the Corporation
receives on loans and securities and the amount of interest it pays
on deposits and borrowings, but such changes could also affect (i)
the Corporation's ability to originate loans and obtain deposits,
(ii) the fair value of the Corporation's financial assets and
liabilities, and (iii) the average duration of the Corporation's
mortgage backed securities portfolio. If the interest rates paid
on deposits and other borrowings increase at a faster rate than the
interest rates received on loans and other investments, the
Corporation's net interest income, and therefore earnings, could be
adversely affected. Earnings could also be adversely affected if
the interest rates received on loans and other investments fall
more quickly than the interest rates paid on deposits and other
borrowings.
Although management believes it has implemented effective
asset and liability management strategies, to reduce the potential
effects of changes in interest rates on the Corporation's results
of operations, any substantial, unexpected, prolonged change in
market interest rates could have a material adverse effect on the
Corporation's financial condition and results of operations.
The Corporation's Profitability Depends Significantly On
Economic Conditions In The Commonwealth of Pennsylvania
_______________________________________________________
The Corporation's success depends primarily on the general
economic conditions of the Commonwealth of Pennsylvania and the
specific local markets in which the Corporation operates. Unlike
larger national or other regional banks that are more
geographically diversified, the Corporation provides banking and
financial services to customers primarily in the Columbia, Luzerne,
and Montour Counties. The local economic conditions in these areas
have a significant impact on the demand for the Corporation's
products and services as well as the ability of the Corporation's
customers to repay loans, the value of the collateral securing
loans and the stability of the Corporation's deposit funding
sources. Also a significant decline in general economic conditions
could impact the local economic conditions and, in turn, have a
material adverse effect on the Corporation's financial condition
and results of operations.
7
The Corporation Operates In A Highly Competitive Industry
_________________________________________________________
The Corporation faces substantial competition in all areas of
its operations from a variety of different competitors, many of
which are larger and may have more financial resources. Such
competitors primarily include national, regional, and community
banks within the various markets the Corporation operates.
Additionally, various out of state banks have begun to enter or
have announced plans to enter the market areas in which the
Corporation currently operates. The Corporation also faces
competition from many other types of financial institutions,
including, without limitation, savings and loans, credit unions,
finance companies, brokerage firms, insurance companies, factoring
companies and other financial intermediaries. Also, technology has
lowered barriers to entry and made it possible for non banks to
offer products and services traditionally provided by banks, such
as automatic transfer and automatic payment systems. Many of the
Corporation's competitors have fewer regulatory constraints and may
have lower cost structures.
The Corporation's ability to compete successfully depends on a
number of factors, including, among other things:
* The ability to develop, maintain and build upon long term
customer relationships based on top quality service, high
ethical standards and safe, sound assets.
* The ability to expand the Corporation's market position.
* The scope, relevance and pricing of products and services
offered to meet customer needs and demands.
* The rate at which the Corporation introduces new products
and services relative to its competitors.
* Customer satisfaction with the Corporation's level of
service.
* Industry and general economic trends.
Failure to perform in any of these areas could significantly
weaken the Corporation's competitive position, which could
adversely affect the Corporation's growth and profitability, which,
in turn, could have a material adverse effect on the Corporation's
financial condition and results of operations.
The Corporation Is Subject To Extensive Government
Regulation and Supervision
__________________________
The Corporation, primarily through the Bank, is subject to
extensive federal and state regulation and supervision. Banking
regulations are primarily intended to protect depositors' funds,
federal deposit insurance funds and the banking system as a whole,
not shareholders. These regulations affect the Corporation's
lending practices, capital structure, investment practices,
dividend policy and growth, among other things. Congress and
federal regulatory agencies continually review banking laws,
regulations and policies for possible changes. Changes to statutes,
regulations or regulatory policies could affect the Corporation in
substantial and unpredictable ways. Such changes could subject the
Corporation to additional costs, limit the types of financial
services and products the Corporation may offer and/or increase the
ability of non-banks to offer competing financial services and
products, among other things. Failure to comply with laws,
regulations or policies could result in sanctions by regulatory
agencies, civil money penalties and/or reputation damage, which
could have a material adverse effect on the Corporation's business,
financial condition and results of operations.
The Corporation Is Subject To Claims and Litigation
Pertaining To Fiduciary Responsibility
______________________________________
From time to time, customers make claims and take legal action
pertaining to the Corporation's performance of its fiduciary
responsibilities. Whether customer claims and legal action related
to the Corporation's performance of its fiduciary responsibilities
are founded or unfounded, if such claims and legal actions are not
resolved in a manner favorable to the Corporation they may result
in significant financial liability and/or adversely affect the
market perception of the Corporation and its products and services
as well as impact customer demand for those products and services.
Any financial liability or reputation damage could have a material
adverse effect on the Corporation's financial condition and results
of operations.
The Trading Volume In The Corporation's Common Stock Is Less
Than That Of Other Larger Financial Services Companies
______________________________________________________
The Corporation's common stock is currently not listed but
traded on the Over The Counter Bulletin Board. As a result,
trading volume is less than that of other larger financial services
companies. A public trading market having the desired
characteristics of depth, liquidity and orderliness depends on the
presence in the marketplace of willing buyers and sellers of the
Corporation's common stock at any given time. This presence
depends on the individual decisions of investors and general
economic and market conditions over which the Corporation has no
control. Given the lower trading volume of the Corporation's
common stock, significant sales of the Corporation's common stock,
or the expectation of these sales, could cause the Corporation's
stock price to fall.
8
The Corporation Is Subject To Lending Risk
__________________________________________
As of December 31, 2006, approximately 57.9% of the
Corporation's loan portfolio consisted of commercial and
industrial, construction and commercial real estate loans. These
types of loans are generally viewed as having more risk of default
than residential real estate loans or consumer loans. These types
of loans are also typically larger than residential real estate
loans and consumer loans. Because the Corporation's loan portfolio
contains a significant number of commercial and industrial,
construction and commercial real estate loans with relatively large
balances, the deterioration of one or a few of these loans could
cause a significant increase in non performing loans. An increase
in non performing loans could result in a net loss of earnings from
these loans, an increase in the provision for possible loan losses
and an increase in loan charge offs, all of which could have a
material adverse effect on the Corporation's financial condition
and results of operations.
If The Corporation's Allowance For loan Losses Is Not Sufficient
To Cover Actual Loan Losses, Its Earnings Could Decrease
_________________________________________________________
The Corporation's loan customers may not repay their loans
according to the terms of their loans, and the collateral securing
the payment of their loans may be insufficient to assure repayment.
The Corporation may experience significant credit losses, which
could have a material adverse effect on its operating results. In
determining the amount of the allowance for loan losses, the
Corporation reviews its loans and its loss and delinquency
experience, and the Corporation evaluates economic conditions. If
its assumptions prove to be incorrect, its allowance for loan
losses may not cover inherent losses in its loan portfolio at the
date of its financial statements. Material additions to the
Corporation's allowance would materially decrease its net income.
At December 31, 2006, its allowance for loan losses totaled $3.67
million, representing 1.50% of its average total loans.
Although the Corporation believes it has underwriting
standards to manage normal lending risks, it is difficult to assess
the future performance of its loan portfolio due to the relatively
recent origination of many of these loans. The Corporation cannot
assure that its non performing loans will not increase or that its
non performing or delinquent loans will not adversely affect its
future performance.
In addition, federal and state regulators periodically review
the Corporation's allowance for loan losses and may require it to
increase its allowance for loan losses or recognize further loan
charge offs. Any increase in its allowance for loan losses or loan
charge offs as required by these regulatory agencies could have a
material adverse effect on its results of operations and financial
condition.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not Applicable.
ITEM 2. DESCRIPTION OF PROPERTIES
The Corporation owns no property other than through the Bank.
These are:
* Main Office located at 111 West Front Street, Berwick,
Pennsylvania 18603;
* Salem Office located at 400 Fowler Avenue, Berwick,
Pennsylvania 18603;
* Freas Avenue Office located at 701 Freas Avenue, Berwick,
Pennsylvania 18603;
* Briar Creek Office located inside the Giant Market at 50
Briar Creek Plaza, Berwick, Pennsylvania 18603;
* Nescopeck Office located at 437 West Third Street,
Nescopeck, Pennsylvania 18635;
* Scott Township Office located at Central Road and Route
11, Bloomsburg, Pennsylvania 17815;
* Mifflinville Office located at Third and Race Streets,
Mifflinville, Pennsylvania 18631;
* Hanover Township Office located at 1540 Sans Souci
Highway, Wilkes-Barre, Pennsylvania 18706;
* Danville Office located at 1519 Bloom Road, Danville,
Pennsylvania 17821;
* Kingston Office located at 179 South Wyoming Avenue,
Kingston, Pennsylvania 18704;
* Vacant lot held for expansion located at 117-119 West
Front Street, Berwick, Pennsylvania 18603;
* Parking lot located at Second and Market Streets, Berwick,
Pennsylvania 18603; and
* 12 ATM's located in Columbia, Luzerne and Montour
Counties.
It is Management's opinion that the facilities currently
utilized are suitable and adequate for the Corporation's current
and immediate future purposes.
9
ITEM 3. LEGAL PROCEEDINGS
The Corporation and/or the Bank are defendants in various
legal proceedings arising in the ordinary course of their business.
However, in the opinion of management of the Corporation and the
Bank, there are no proceedings pending to which the Corporation and
the Bank is a party or to which their property is subject, which,
if determined adversely to the Corporation and the Bank, would be
material in relation to the Corporation's and Bank's individual
profits or financial condition, nor are there any proceedings
pending other than ordinary routine litigation incident to the
business of the Corporation and the Bank. In addition, no material
proceedings are pending or are known to be threatened or
contemplated against the Corporation and the Bank by government
authorities or others.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the
fiscal year covered by this report to a vote of security holders
through the solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY,
RELATED SHAREHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
The Corporation's Common Stock is traded in the over the
counter market on the OTC Bulletin Board under the symbol
"FKYS.OB". The following table sets forth:
* The quarterly high and low prices for a share of the
Corporation's Common Stock during the periods indicated as
reported to the management of the Corporation and
* Quarterly dividends on a share of the Common Stock with
respect to each quarter since January 1, 2005.
The following table reflects the high and low closing sale
prices reported for First Keystone Corporation's common stock, and
the cash dividends declared on First Keystone Corporation's common
stock, for the periods indicated, after giving retroactive effect
to a 5% stock dividend paid December 5, 2006.
MARKET VALUE OF COMMON STOCK
Per Share
High Low Dividend
____ ___ ________
<s> <c> <c> <c>
2006:
First quarter $19.91 $18.57 $.21
Second quarter $19.05 $17.43 $.21
Third quarter $19.33 $16.81 $.21
Fourth quarter $19.20 $17.29 $.22
2005:
First quarter $22.76 $20.48 $.19
Second quarter $20.95 $18.81 $.19
Third quarter $21.67 $19.14 $.19
Fourth quarter $20.81 $19.05 $.21
As of December 31, 2006, the Corporation had approximately 675
shareholders of record.
10
The Corporation has paid dividends since commencement of
business in 1984. It is the present intention of the Corporation's
Board of Directors to continue the dividend payment policy;
however, further dividends must necessarily depend upon earnings,
financial condition, appropriate legal restrictions and other
factors relevant at the time the Board of Directors of the
Corporation considers dividend policy. Cash available for dividend
distributions to shareholders of the Corporation must initially
come from dividends paid by the Bank to the Corporation.
Therefore, the restrictions on the Bank's dividend payments are
directly applicable to the Corporation.
Transfer Agent:
The First National Bank of Berwick (570) 752-3671
111 West Front Street
Berwick, PA 18603
The following brokerage firms make a market in First Keystone
Corporation common stock:
RBC Dain Rauscher (800) 223-4207
Janney Montgomery Scott LLC (800) 526-6397
Ryan, Beck and Company (800) 223-6807
Boenning & Scattergood, Inc. (800) 842-8928
Ferris Baker Watts, Inc. (800) 638-7411
Dividend Restrictions on the Bank
_________________________________
The OCC rules govern the payment of dividends by national
banks. Consequently, the Bank, which is subject to these rules,
may not pay dividends from capital (unimpaired common and preferred
stock outstanding) but only from retained earnings after deducting
losses and bad debts therefrom. To the extent that (1) the Bank
has capital surplus in an amount in excess of common capital and
(2) the Bank can prove that such surplus resulted from prior period
earnings, the Bank, upon approval of the OCC, may transfer earned
surplus to retained earnings and thereby increase its dividend
capacity.
The Bank may not pay any dividends on its capital stock during
a period in which it may be in default in the payment of its
assessment for a deposit insurance premium due to the FDIC, nor may
it pay dividends on Common Stock until any cumulative dividends on
the Bank's preferred stock (if any) have been paid in full. The
Bank has never been in default in the payments of its assessments
to the FDIC; and the Bank has no outstanding preferred stock. In
addition, under the Federal Deposit Insurance Act (912 U.S.C.
Section 1818), dividends cannot be declared and paid if the OCC
obtains a cease and desist order because, in the opinion of the
OCC, such payment would constitute an unsafe and unsound banking
practice. As of December 31, 2006, there was $5,081,000 in
unrestricted retained earnings and net income available at the Bank
that could be paid as a dividend to the Corporation under the
current OCC regulations.
Dividend Restrictions on the Corporation
________________________________________
Under the Pennsylvania Business Corporation Law of 1988, as
amended, the Corporation may not pay a dividend if, after giving
effect thereto, either:
* The Corporation would be unable to pay its debts as they
become due in the usual course of business or;
* The Corporation's total assets would be less than its total
liabilities.
The determination of total assets and liabilities may be based
upon:
* Financial statements prepared on the basis of generally
accepted accounting principles,
* Financial statements that are prepared on the basis of
other accounting practices and principles that are
reasonable under the circumstances, or;
* A fair valuation or other method that is reasonable under
the circumstances.
11
PERFORMANCE GRAPH
The following graph and table compare the cumulative total
shareholder return on the corporation's common stock during the
period December 31, 2001, through and including December 31, 2006,
with
* the cumulative total return on the SNL Securities Corporate
Performance Index <F1> for banks with less than $500
million in total assets in the Middle Atlantic area <F2>,
and
* the cumulative total return for all United States stocks
traded on the NASDAQ Stock Market.
The comparison assumes $100 was invested on December 31, 2001,
in the corporation's common stock and in each of the indices below
and assumes further the reinvestment of dividends into the
applicable securities. The shareholder return shown on the graph
and table below is not necessarily indicative of future
performance.
(Performance Graph omitted)
(The following is a description of the performance graph in tabular
format)
FIRST KEYSTONE CORPORATION
Total Return Performance
Period Ending
______________________________
12/31/01 12/31/02 12/31/03
________ ________ ________
First Keystone Corporation 100.00 144.34 205.94
NASDAQ - Total US 100.00 68.76 103.67
SNL <$500M Bank Index 100.00 128.07 186.94
Period Ending
______________________________
12/31/04 12/31/05 12/31/06
________ ________ ________
First Keystone Corporation 200.31 186.08 181.89
NASDAQ - Total US 113.16 115.57 127.58
SNL <$500M Bank Index 215.79 228.47 240.01
__________________
<FN>
<F1>
SNL Securities is a research and publishing firm specializing in
the collection and dissemination of data on the banking, thrift and
financial services industries.
<F2>
The Middle Atlantic area comprises the states of Delaware,
Pennsylvania, Maryland, New Jersey, New York, the District of
Columbia and Puerto Rico.
</FN>
12
ITEM 6. SELECTED FINANCIAL DATA
(Amounts in thousands, except per share)
Year Ended December 31,
_______________________
2006 2005 2004
____ ____ ____
<s> <c> <c> <c>
SELECTED FINANCIAL DATA:
Total Assets $525,920 $512,399 $497,615
Total Investment securities 243,938 251,536 239,053
Net loans 248,086 230,917 229,972
Total Deposits 384,020 362,796 357,956
Stockholders' equity 53,387 53,443 53,312
SELECTED OPERATING DATA:
Interest income $ 28,577 $ 26,382 $ 25,036
Interest expense 14,972 11,621 10,006
________ ________ ________
Net interest income $ 13,605 $ 14,761 $ 15,030
Provision for loan losses 500 750 1,750
________ ________ ________
Net interest income after
provision for loan and
lease losses $ 13,105 $ 14,011 $ 13,280
Other income 3,788 3,782 4,596
Other expense 9,515 9,583 9,426
________ ________ ________
Income before income taxes $ 7,378 $ 8,210 $ 8,450
Income tax expense 1,188 1,363 1,663
________ ________ ________
Net income $ 6,190 $ 6,847 $ 6,787
======== ======== ========
PER COMMON SHARE DATA:
Net income $ 1.35 $ 1.48 $ 1.47
Cash dividends .85 .78 .70
PERFORMANCE RATIOS:
Return on average assets 1.20% 1.35% 1.37%
Return on average equity 11.76% 12.65% 12.76%
Dividend payout ratio 62.63% 52.61% 47.41%
Average equity to average
assets ratio 10.19% 10.69% 10.76%
Year Ended December 31,
______________________
2003 2002
____ ____
<s> <c> <c>
SELECTED FINANCIAL DATA:
Total Assets $481,840 $439,526
Total Investment securities 231,272 215,755
Net loans 225,549 198,343
Total Deposits 343,020 330,745
Stockholders' equity 51,351 49,096
SELECTED OPERATING DATA:
Interest income $ 25,063 $ 25,862
Interest expense 10,200 11,342
________ ________
Net interest income $ 14,863 $ 14,520
Provision for loan losses 500 550
________ ________
Net interest income after
provision for loan and
lease losses $ 14,363 $ 13,970
Other income 3,275 2,285
Other expense 8,371 7,811
________ ________
Income before income taxes $ 9,267 $ 8,444
Income tax expense 1,950 1,857
________ ________
Net income $ 7,317 $ 6,587
======== ========
PER COMMON SHARE DATA:
Net income $ 1.58 $ 1.41
Cash dividends .62 .54
PERFORMANCE RATIOS:
Return on average assets 1.57% 1.59%
Return on average equity 14.27% 14.93%
Dividend payout ratio 39.41% 38.33%
Average equity to average
assets ratio 11.00% 10.66%
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The purpose of Management's Discussion and Analysis of First
Keystone Corporation, a bank holding company (the Corporation), and
its wholly owned subsidiary, The First National Bank of Berwick
(the Bank), is to assist the reader in reviewing the financial
information presented and should be read in conjunction with the
consolidated financial statements and other financial data
contained herein.
This annual report contains certain forward looking statements
(as defined in the Private Securities Litigation Reform Act of
1995), which reflect management's beliefs and expectations based on
information currently available. These forward looking statements
are inherently subject to significant risks and uncertainties,
including changes in general economic and financial market
conditions, the Corporation's ability to effectively carry out its
business plans and changes in regulatory or legislative
requirements. Other factors that could cause or contribute to such
differences are changes in competitive conditions. Although
management believes the expectations reflected in such forward
looking statements are reasonable, actual results may differ
materially.
RESULTS OF OPERATIONS
Year Ended December 31, 2006 Versus Year Ended December 31, 2005
Net income decreased to $6,190,000 for the year ended December
31, 2006, as compared to $6,847,000 for the prior year, a decrease
of 9.6%. Earnings per share, both basic and diluted, for 2006 were
$1.35 as compared to $1.48 in 2005. Cash dividends per share
increased to $.85 in 2006 from $.78 in 2005, an increase of 9.0%.
The Corporation's return on average assets was 1.20% in 2006
as compared to 1.35% in 2005. Return on average equity decreased to
11.76% in 2006 from 12.65% in 2005. The series of increases in
interest rates in 2005 ended in 2006 and resulted in an overall
increase of interest income to $28,577,000 up 8.3% from 2005.
Likewise, there was the accompanying increase in the cost of funds
which resulted in interest expense of $14,972,000 in 2006, an
increase of 28.8% from 2005. The increases in deposit rates in 2006
and the flattened yield curve resulted in interest expense
increasing faster than interest income.
Net interest income, as indicated below in Table 1, decreased
by $1,156,000 or 7.8% to $13,605,000 for the year ended December
31, 2006. The Corporation's net interest income on a fully taxable
equivalent basis decreased by $1,326,000, or 8.0% to $15,300,000 in
2006 as compared to an increase of $61,000, or 0.4% to $16,626,000
in 2005.
Year Ended December 31, 2005 Versus Year Ended December 31, 2004
Net income increased to $6,847,000 for the year ended December
31, 2005, as compared to $6,787,000 for the prior year, an increase
of 0.9%. Earnings per share, both basic and diluted, for 2005 were
$1.48 as compared to $1.48 and $1.47, respectively in 2004. Cash
dividends per share increased to $.78 in 2005 from $.70 in 2004, an
increase of 11.4%.
Net interest income, as indicated below in Table 1, decreased
by $269,000 or 1.8% to $14,761,000 for the year ended December 31,
2005. The Corporation's net interest income on a fully taxable
equivalent basis increased $61,000, or 0.4% to $16,626,000 in 2005
as compared to $16,565,000 in 2004.
Table 1 - Net Interest Income
(Amounts in thousands)
2006/2005
_______________________________
Increase/(Decrease)
__________________
2006 Amount % 2005
____ ______ __ ____
<s> <c> <c> <c> <c>
Interest Income $28,577 $2,195 8.3 $26,382
Interest Expense 14,972 3,351 28.8 11,621
_______ ______ _______
Net Interest Income 13,605 (1,156) (7.8) 14,761
Tax Equivalent Adjustment 1,695 (170) (9.1) 1,865
_______ ______ _______
Net Interest Income
(fully tax equivalent) $15,300 $(1,326) (8.0) $16,626
======= ======= ==== =======
(Amounts in thousands)
2005/2004
_______________________________
Increase/(Decrease)
__________________
2005 Amount % 2004
____ ______ __ ____
<s> <c> <c> <c> <c>
Interest Income $26,382 $1,346 5.4 $25,036
Interest Expense 11,621 1,615 16.1 10,006
_______ ______ _______
Net Interest Income 14,761 (269) (1.8) 15,030
Tax Equivalent Adjustment 1,865 330 21.5 1,535
_______ ______ _______
Net Interest Income
(fully tax equivalent) $16,626 $ 61 .4 $16,565
======= ====== =======
14
Table 2 - Distribution of Assets, Liabilities and Stockholders' Equity
2006
___________________________________
Average Revenue/ Yield/
Balance Expense Rate
_______ _______ ____
<s> <c> <c> <c>
Interest Earning Assets:
Loans:
Commercial <F1> $ 28,120 $ 2,003 7.12%
Real Estate <F1> 198,854 13,200 6.64%
Installment Loans, Net <F1><F2> 17,681 1,402 7.93%
Fees on Loans 0 (39) 0%
________ _______ _____
Total Loans (Including
Fees) <F3> $244,655 $16,566 6.77%
________ _______ _____
Investment Securities:
Taxable $156,109 $8,488 5.44%
Tax Exempt <F1> 82,669 5,188 6.28%
________ _______ _____
Total Investment Securities $238,778 $13,676 5.73%
________ _______ _____
Interest Bearing Deposits
in Banks 606 31 5.12%
Federal Funds Sold 0 0 0%
________ _______ _____
Total Other Interest-Earning
Assets 606 31 5.12%
________ _______ _____
Total Interest-Earning Assets $484,039 $30,273 6.25%
________ _______ _____
Non-Interest Earning Assets:
Cash and Due From Banks $ 7,437
Allowance for Loan Losses (3,662)
Premises and Equipment 4,991
Foreclosed Assets Held for Sale 229
Other Assets 23,707
________
Total Non-Interest Earning
Assets 32,702
________
Total Assets $516,741
========
Interest-Bearing Liabilities:
Savings, NOW Accounts,
and Money Markets $136,481 $2,921 2.14%
Time Deposits 202,780 8,263 4.07%
Short-Term Borrowings 6,909 352 5.09%
Long-Term Borrowings 62,376 2,895 4.64%
Securities Sold U/A to
Repurchase 13,411 542 4.04%
________ _______ _____
Total Interest-Bearing
Liabilities $421,957 $14,973 3.55%
________ _______ _____
Non-Interest Bearing Liabilities:
Demand Deposits $ 39,076
Other Liabilities 3,074
Stockholders' Equity 52,634
________
Total Liabilities/
Stockholders'Equity $516,741
========
Net Interest Income
Tax Equivalent $15,300
=======
Net Interest Spread 2.70%
Net Interest Margin 3.16%
2005
___________________________________
Average Revenue/ Yield/
Balance Expense Rate
_______ _______ ____
<s> <c> <c> <c>
Interest Earning Assets:
Loans:
Commercial <F1> $ 30,933 $ 1,953 6.31%
Real Estate <F1> 182,019 11,501 6.32%
Installment Loans, Net <F1><F2> 19,706 1,492 7.57%
Fees on Loans 0 (26) 0%
________ _______ _____
Total Loans (Including
Fees) <F3> $232,658 $14,920 6.41%
________ _______ _____
Investment Securities:
Taxable $158,749 $ 7,638 4.81%
Tax Exempt <F1> 87,564 5,635 6.44%
________ _______ _____
Total Investment Securities $246,313 $13,273 5.39%
Interest Bearing Deposits
in Banks 1,784 51 2.85%
Federal Funds Sold 90 3 3.04%
________ _______ _____
Total Other Interest-Earning
Assets 1,874 54 2.86%
________ _______ _____
Total Interest-Earning Assets $480,845 $28,247 5.87%
________ _______ _____
Non-Interest Earning Assets:
Cash and Due From Banks $ 7,006
Allowance for Loan Losses (3,738)
Premises and Equipment 5,230
Foreclosed Assets Held for Sale 150
Other Assets 17,028
________
Total Non-Interest Earning
Assets 25,676
________
Total Assets $506,521
========
Interest-Bearing Liabilities:
Savings, NOW Accounts,
and Money Markets $137,134 $ 1,711 1.25%
Time Deposits 191,455 6,394 3.34%
Short-Term Borrowings 5,039 179 3.56%
Long-Term Borrowings 66,305 3,017 4.55%
Securities Sold U/A to
Repurchase 10,770 320 2.97%
________ _______ _____
Total Interest-Bearing
Liabilities $410,703 $11,621 2.83%
________ _______ _____
Non-Interest Bearing Liabilities:
Demand Deposits $38,177
Other Liabilities 3,511
Stockholders' Equity 54,130
________
Total Liabilities/
Stockholders' Equity $506,521
========
Net Interest Income Tax
Equivalent $16,626
=======
Net Interest Spread 3.04%
Net Interest Margin 3.46%
2004
___________________________________
Average Revenue/ Yield/
Balance Expense Rate
_______ _______ ____
<s> <c> <c> <c>
Interest Earning Assets:
Loans:
Commercial <F1> $ 32,658 $ 2,251 6.89%
Real Estate <F1> 172,314 10,720 6.22%
Installment Loans, Net <F1><F2> 28,123 1,680 5.97%
Fees on Loans 0 (36) 0%
________ _______ _____
Total Loans (Including
Fees) <F3> $233,095 $14,615 6.27%
________ _______ _____
Investment Securities:
Taxable $161,464 $ 7,378 4.57%
Tax Exempt <F1> 70,928 4,519 6.37%
________ _______ _____
Total Investment Securities $232,392 $11,897 5.12%
________ _______ _____
Interest Bearing Deposits
in Banks 4,152 51 1.23%
Federal Funds Sold 328 8 2.37%
________ _______ _____
Total Other Interest-Earning
Assets 4,480 59 1.32%
________ _______ _____
Total Interest-Earning Assets $469,967 $26,571 5.65%
________ _______ _____
Non-Interest Earning Assets:
Cash and Due From Banks $ 6,561
Allowance for Loan Losses (3,744)
Premises and Equipment 5,453
Foreclosed Assets Held for Sale 0
Other Assets 16,268
________
Total Non-Interest Earning
Assets 24,538
________
Total Assets $494,505
========
Interest-Bearing Liabilities:
Savings, NOW Accounts, and
Money Markets $142,385 $ 1,335 .94%
Time Deposits 186,534 5,573 2.99%
Short-Term Borrowings 2,736 41 1.50%
Long-Term Borrowings 64,144 2,932 4.57%
Securities Sold U/A to
Repurchase 7,357 125 1.70%
________ _______ _____
Total Interest-Bearing
Liabilities $403,156 $10,006 2.48%
Non-Interest Bearing Liabilities:
Demand Deposits $ 34,000
Other Liabilities 4,144
Stockholders' Equity 53,205
________
Total Liabilities/
Stockholders' Equity $494,505
Net Interest Income Tax
Equivalent $ 16,565
========
Net Interest Spread 3.17%
Net Interest Margin 3.52%
______________________
<FN>
<F1>
Tax-exempt income has been adjusted to a tax equivalent basis using an
incremental rate of 34%, and statutory interest expense disallowance.
<F2>
Installment loans are stated net of unearned interest.
<F3>
Average loan balances include non-accrual loans. Interest income on non-accrual loans is not included.
</FN>
15
NET INTEREST INCOME
The major source of operating income for the Corporation is
net interest income. Net interest income is the difference between
interest income on earning assets, such as loans and securities,
and the interest expense on liabilities used to fund those assets,
including deposits and other borrowings. The amount of interest
income is dependent upon both the volume of earning assets and the
level of interest rates. In addition, the volume of non performing
loans affects interest income. The amount of interest expense
varies with the amount of funds needed to support earning assets,
interest rates paid on deposits and borrowed funds, and finally,
the level of interest free deposits.
Table 2 on the preceding pages provides a summary of average
outstanding balances of earning assets and interest bearing
liabilities with the associated interest income and interest
expense as well as average tax equivalent rates earned and paid as
of year end 2006, 2005, and 2004.
The yield on earning assets was 6.25% in 2006, 5.87% in 2005,
and 5.65% in 2004. The rate paid on interest bearing liabilities
was 3.55% in 2006, 2.83% in 2005, and 2.48% in 2004. This resulted
in a decrease in our net interest spread to 2.70% in 2006, as
compared to 3.04% in 2005 and 3.17% in 2004. As Table 2
illustrates, our net interest margin also declined in 2006.
The net interest margin, which is interest income less
interest expenses divided by average earnings assets, was 3.16% in
2006 as compared to 3.46% in 2005 and 3.52% in 2004. The net
interest margins are presented on a tax equivalent basis. The
decrease in net interest margin in 2006 was due primarily to the
increased interest paid on interest bearing liabilities. This was
a result of more interest bearing liabilities repricing than
earning assets.
In an effort to maintain or try to increase our net interest
margin, we look to higher earning asset yields in 2007. However, it
is apparent that margin expansion will be limited if the flattened
yield curve environment continues.
Table 3 sets forth changes in interest income and interest
expense for the periods indicated for each category of interest
earning assets and interest bearing liabilities. Information is
provided on changes attributable to (i) changes in volume (changes
in average volume multiplied by prior rate); (ii) changes in rate
(changes in average rate multiplied by prior average volume); and,
(iii) changes in rate and volume (changes in average volume
multiplied by change in average rate).
Table 3 - Changes in Income and Expense, 2006 and 2005
(Amounts in thousands) 2006 COMPARED TO 2005
________________________________
VOLUME RATE NET
______ ____ ___
<s> <c> <c> <c>
Interest Income:
Loans, Net $ 769 $ 877 $ 1,646
Taxable Investment Securities (127) 977 850
Tax-Exempt Investment
Securities (315) (132) (447)
Other Short-Term Investments (37) 14 (23)
_____ _______ _______
TOTAL INTEREST INCOME $ 290 $ 1,736 $ 2,026
_____ _______ _______
Interest Expense:
Savings, Now, and Money Markets $(8) $ 1,218 $ 1,210
Time Deposits 378 1,491 1,869
Short-Term Borrowings 66 107 173
Long-Term Borrowings (179) 57 (122)
Securities Sold U/A to
Repurchase 78 144 222
_____ _______ _______
TOTAL INTEREST EXPENSE $ 335 $ 3,017 $ 3,352
_____ _______ _______
NET INTEREST INCOME $ (45) $(1,281) $(1,326)
===== ======= =======
(Amounts in thousands) 2005 COMPARED TO 2004
________________________________
VOLUME RATE NET
_____ ____ ___
<s> <c> <c> <c>
Interest Income:
Loans, Net $ (27) $ 332 $ 305
Taxable Investment Securities (124) 384 260
Tax-Exempt Investment
Securities 1,060 56 1,116
Other Short-Term Investments (34) 29 (5)
______ ______ ______
TOTAL INTEREST INCOME $ 875 $ 801 $1,676
______ ______ ______
Interest Expense:
Savings, Now, and Money Markets $ (49) $ 425 $ 376
Time Deposits 147 674 821
Short-Term Borrowings 35 103 138
Long-Term Borrowings 98 (13) 85
Securities Sold U/A to
Repurchase 58 137 195
______ ______ ______
TOTAL INTEREST EXPENSE $ 289 $1,326 $1,615
______ ______ ______
NET INTEREST INCOME $ 586 $ (525) $ 61
====== ====== ======
________________________
The change in interest due to both volume and yield/rate has been
allocated to change due to volume and change due to yield/rate in
proportion to the absolute value of the change in each.
Balance on non accrual loans are included for computational purposes.
Interest income on non accrual loans is not included.
Interest income exempt from federal tax was $3,755,000 in 2006,
$4,043,000 in 2005, and $3,260,000 in 2004. Tax exempt income has been
adjusted to a tax equivalent basis using an incremental rate of 34%.
16
In 2006, the decrease in net interest income of $1,326,000
resulted from a decrease in volume of $45,000 and a decrease of
$1,281,000 due to changes in rate.
PROVISION FOR LOAN LOSSES
For the year ended December 31, 2006, the provision for loan
losses was $500,000 as compared to $750,000 as of December 31,
2005. The Corporation's provision for loan losses for the year
ended December 31, 2004, was $1,750,000. The provision in 2006,
decreased primarily because of the reduced net charge offs and
stable loan quality. Net charge offs by the Corporation for the
fiscal year end December 31, 2006, 2005, and 2004, were $505,000,
$902,000, and $1,446,000, respectively.
The allowance for loan losses as a percentage of loans, net of
unearned interest, was 1.46% as of December 31, 2006, 1.57% as of
December 31, 2005, 1.64% as of December 31, 2004.
On a quarterly basis, the Corporation's Board of Directors and
management performs a detailed analysis of the adequacy of the
allowance for loan losses. This analysis includes an evaluation of
credit risk concentration, delinquency trends, past loss
experience, current economic conditions, composition of the loan
portfolio, classified loans and other relevant factors.
The Corporation will continue to monitor its allowance for
loan losses and make future adjustments to the allowance through
the provision for loan losses as conditions warrant. Although the
Corporation believes that the allowance for loan losses is adequate
to provide for losses inherent in the loan portfolio, there can be
no assurance that future losses will not exceed the estimated
amounts or that additional provisions will not be required in the
future.
The Bank is subject to periodic regulatory examination by the
Office of the Comptroller of the Currency (OCC). As part of the
examination, the OCC will assess the adequacy of the bank's
allowance for loan losses and may include factors not considered by
the Bank. In the event that an OCC examination results in a
conclusion that the Bank's allowance for loan losses is not
adequate, the Bank may be required to increase its provision for
loan losses.
NON-INTEREST INCOME
Non interest income is derived primarily from trust department
revenue, service charges and fees, income on bank owned life
insurance, other miscellaneous revenue and the gain on the sale of
mortgage loans. In addition, investment securities gains or losses
also impact total non interest income.
For the year ended December 31, 2006, non interest income
amounted to $3,788,000, an increase of $6,000, or 0.2% as compared
to a decrease of $814,000, or 17.7% for the year ended December 31,
2005. Table 4 provides the major categories of non interest income
and each respective change comparing the past three years.
Excluding investment securities gains, non interest income in
2006 increased $45,000, or 1.3%. This compares to a decrease of
$154,000, or 4.4% in 2005 before investment securities gains.
Income from the trust department, which consists of fees generated
from individual and corporate accounts, increased in 2006 by
$30,000, or 6.3% after decreasing by $48,000, or 9.1% in 2005.
Increased income from the trust department in 2006 was due
primarily to an increase in market value in the trust department
because of the strong equity market performance in 2006.
Service charges and fees, consisting primarily of service
charges on deposit accounts, was the largest source of non interest
income in 2006 and 2005. Service charges and fees decreased by
$14,000, or 0.6% in 2006 compared to an increase of $114,000, or
5.6% in 2005. The decrease in 2006 resulted primarily from slightly
decreased revenue from ATM surcharges.
Income on Bank Owned Life Insurance (BOLI) increased $35,000
to $472,000 in 2006 as compared to a decrease of $9,000 to $437,000
in 2005. The income from BOLI represents the increase in the cash
surrender value of BOLI and is intended to partially cover the
costs of the Bank's employee benefit plan, including group life,
disability, and health insurance.
17
The gain on sale of mortgages provided $39,000 in 2006 as
compared to $63,000 in 2005. The decrease in gains on sale of
mortgages was largely a function of the decreased originations and
the reduced subsequent mortgage sales in the secondary market
during the past year. The Corporation continues to service the
mortgages which are sold, this servicing income provides an
additional source of non interest income on an ongoing basis.
Other income, consisting primarily of safe deposit box
rentals, income from the sale of non deposit products, and
miscellaneous fees amounted to $240,000 for 2006, an increase of
$18,000 or 8.1% over the $222,000 other income reported in 2005.
Table 4 - Non-Interest Income
(Amounts in thousands) 2006/2005
_______________________________
Increase/(Decrease)
___________________
2006 Amount % 2005
____ _____ __ ____
<s> <c> <c> <c> <c>
Trust Department $ 507 $ 30 6.3 $ 477
Service Charges and Fees 2,149 (14) (0.6) 2,163
Income on Bank Owned Life
Insurance 472 35 8.0 437
Gain on Sale of Mortgages 39 (24) (38.1) 63
Other 240 18 8.1 222
______ ____ ______
Subtotal $3,407 $ 45 1.3 $3,362
Investment Securities Gains 381 (39) (9.3) 420
______ ____ ______
Total $3,788 $ 6 0.2 $3,782
====== ==== ======
(Amounts in thousands) 2005/2004
_______________________________
Increase/(Decrease)
___________________
2005 Amount % 2004
____ _____ __ ____
<s> <c> <c> <c> <c>
Trust Department $ 477 $ (48) (9.1) $ 525
Service Charges and Fees 2,163 114 5.6 2,049
Income on Bank Owned Life
Insurance 437 (9) (2.0) 446
Gain on Sale of Mortgages 63 (158) (71.5) 221
Other 222 (53) (19.3) 275
______ _____ ______
Subtotal $3,362 $(154) (4.4) $3,516
Investment Securities Gains 420 (660) (61.1) 1,080
______ _____ ______
Total $3,782 $(814) (17.7) $4,596
====== ===== ======
NON-INTEREST EXPENSE
Non interest expense consists of salaries and benefits,
occupancy, furniture and equipment, and other miscellaneous
expenses. Table 5 provides the yearly non interest expense by
category, along with the amount, dollar changes, and percentage of
change.
Total non interest expense amounted to $9,515,000, a decrease
of $68,000, or 0.7% in 2006 compared to an increase of $157,000, or
1.7% in 2005. Expenses associated with employees (salaries and
employee benefits) continue to be the largest non interest
expenditure. Salaries and employee benefits amounted to 54.5% of
total non interest expense in 2006 and 52.9% in 2005. Salaries and
employee benefits increased $111,000, or 2.2% in 2006 and $192,000,
or 3.9% in 2005. The increases in both years largely reflect normal
salary adjustments and increased benefit costs. The number of full
time equivalent employees was 128 as of December 31, 2006, and 128
as of December 31, 2005.
Net occupancy expense increased $30,000, or 5.2% in 2006 as
compared to a decrease of $78,000, or 11.9% in 2005. Furniture and
equipment expense increased $67,000, or 9.8% in 2006 compared to a
decrease of $98,000, or 12.5% in 2005. The increases in occupancy
and furniture and equipment expense in 2006 relate to increases in
rent and lease payments and new equipment purchases. The decrease
in occupancy and furniture and equipment expense in 2005 relates
primarily to reductions in depreciation expense. Other operating
expenses decreased $276,000, or 8.5% in 2006 as compared to an
increase of $141,000, or 4.5% in 2005. Decreases in professional
fees, marketing, advertising, and miscellaneous expense account for
much of the decrease in other operating expenses in 2006.
The overall level of non interest expense remains low,
relative to our peers. In fact, our total non interest expense was
less than 2% of average assets in both 2006 and 2005. Non interest
expense as a percentage of average assets under 2% places us among
the leaders in our peer financial institution categories in
controlling non interest expense.
18
Table 5 - Non-Interest Expense
(Amounts in thousands) 2006/2005
_______________________________
Increase/(Decrease)
___________________
2006 Amount % 2005
____ _____ ___ ____
<s> <c> <c> <c> <c>
Salaries and Employee Benefits $5,185 $111 2.2 $5,074
Occupancy, Net 608 30 5.2 578
Furniture and Equipment 751 67 9.8 684
Other, Shares Tax, and
Professional Service 2,971 (276) (8.5) 3,247
______ ____ ______
Total $9,515 $(68) (0.7) $9,583
====== ==== ======
(Amounts in thousands) 2005/2004
_______________________________
Increase/(Decrease)
___________________
2005 Amount % 2004
____ _____ ___ ____
<s> <c> <c> <c> <c>
Salaries and Employee Benefits $5,074 $192 3.9 $4,882
Occupancy, Net 578 (78) (11.9) 656
Furniture and Equipment 684 (98) (12.5) 782
Other, Shares Tax, and
Professional Service 3,247 141 4.5 3,106
______ ____ ______
Total $9,583 $157 1.7 $9,426
====== ==== ======
INCOME TAX EXPENSE
Income tax expense for the year ended December 31, 2006, was
$1,188,000 as compared to $1,363,000 and $1,663,000 for the years
ended December 31, 2005, and December 31, 2004, respectively. In
2006, our income tax expense decreased because income before taxes
decreased $832,000 to $7,378,000 from $8,210,000 in 2005. In 2004,
our income before taxes amounted to $8,450,000. The corporation
looks to maximize its tax exempt interest derived from both tax
free loans and tax free municipal investments without triggering
alternative minimum tax. The effective income tax rate was 16.1% in
2006, 16.6% in 2005, and 19.7% in 2004. The limited availability of
tax free municipal investments at attractive interest rates may
result in a higher effective tax rate in future years.
FINANCIAL CONDITION
GENERAL
Total assets increased to $525,920,000, at year end 2006, an
increase of 2.6% over year end 2005. As of December 31, 2006, total
deposits amounted to $384,020,000, an increase of 5.9% over 2005.
Assets as of December 31, 2005, were $512,399,000, an increase of
3.0% over 2004, while total deposits as of year end 2005 amounted
to $362,796,000, an increase of 1.4% from 2004.
In 2006, deposit growth was used principally to fund loan
growth. While in 2005, the increase in assets primarily reflects
the deployment of deposits and borrowings into investment
securities because loan growth was limited. The Corporation
continues to maintain and manage its asset growth. Our strong
equity capital position provides us an opportunity to further
leverage our asset growth. Borrowings decreased in 2006 by
$7,972,000 after increasing in 2005 by $11,264,000. Decreased
borrowings in 2006 resulted in a reduction in investment
securities. Core deposits, which include demand deposits and
interest bearing demand deposits (NOWs), money market accounts,
savings accounts, and time deposits of individuals continues to be
our most significant source of funds. In 2006 and 2005, several
successful sales campaigns attracted new customers and generated
growth in retail certificates of deposit (time deposits of
individuals) as well as savings and money market accounts.
EARNING ASSETS
Earning assets are defined as those assets that produce
interest income. By maintaining a healthy asset utilization rate,
i.e., the volume of earning assets as a percentage of total assets,
the Corporation maximizes income. The earning asset ratio (average
interest earning assets divided by average total assets) equaled
93.7% for 2006, compared to 94.9% for 2005 and 95.0% for 2004. This
indicates that the management of earning assets is a priority and
non earning assets, primarily cash and due from banks, fixed assets
and other assets, are maintained at minimal levels. The primary
earning assets are loans and investment securities.
LOANS
Total loans, net of unearned income, increased to $251,757,000
as of December 31, 2006, as compared to a balance of $234,593,000
as of December 31, 2005. Table 6 provides data relating to the
composition of the Corporation's loan portfolio on the dates
indicated. Total loans, net of unearned income increased
$17,164,000, or 7.3% in 2006 compared to an increase of $793,000,
or 0.3% in 2005.
19
The loan portfolio is well diversified and increases in the
portfolio in 2006 were primarily in commercial loans secured by
real estate and a small increase in consumer loans. In 2005, the
increase in loans was also entirely in commercial real estate.
Outstanding balances on commercial - other loans and consumer loans
declined in both 2006 and 2005. The Corporation continues to
originate and sell certain long term fixed rate residential
mortgage loans which conform to secondary market requirements. The
Corporation derives ongoing income from the servicing of mortgages
sold in the secondary market.
The Corporation continues to internally underwrite each of its
loans to comply with prescribed policies and approval levels
established by its Board of Directors.
Table 6 - Loans Outstanding, Net of Unearned Income
(Amounts in thousands) December 31,
________________________
2006 2005 2004
____ ____ ____
<s> <c> <c> <c>
Commercial, financial and
agricultural:
Commercial secured by
real estate $123,673 $ 92,930 $ 86,735
Commercial - other 22,169 29,284 33,470
Tax exempt 3,264 3,840 3,629
Real estate (primarily
residential mortgage loans) 86,208 92,840 92,408
Consumer loans 18,728 18,467 20,823
________ ________ ________
Total Gross Loans $254,042 $237,361 $237,065
Less: Unearned income and
unamortized loan fees
net of costs 2,285 2,768 3,265
________ ________ ________
Total Loans, net of unearned
income $251,757 $234,593 $233,800
======== ======== ========
(Amounts in thousands) December 31,
________________________
2003 2002
____ ____
<s> <c> <c>
Commercial, financial and
agricultural:
Commercial secured by
real estate $ 73,433 $ 65,352
Commercial - other 33,890 23,639
Tax exempt 3,930 4,393
Real estate (primarily
residential mortgage loans) 96,422 85,145
Consumer loans 25,626 28,640
________ ________
Total Gross Loans $233,301 $207,169
Less: Unearned income and
unamortized loan fees
net of costs 4,228 5,652
________ ________
Total Loans, net of unearned
income $229,073 $201,517
======== ========
INVESTMENT SECURITIES
The Corporation uses investment securities to not only
generate interest and dividend revenue, but also to help manage
interest rate risk and to provide liquidity to meet operating cash
needs.
The investment portfolio has been allocated between securities
available for sale and securities held to maturity. No investment
securities were established in a trading account. Available for
sale securities decreased to $237,009,000 in 2006, a 4.2% decline
from 2005. At December 31, 2006 the net unrealized loss, net of the
tax effect, on these securities was $126,000 and is included in
stockholders' equity as accumulated other comprehensive income
(loss). At December 31, 2005, accumulated other comprehensive
income, net of tax effect, amounted to $807,000. In 2006, held to
maturity securities increased $2,681,000, or 63.1% to $6,929,000
after increasing $887,000, or a 26.4% in 2005. Table 7 provides
data on the carrying value of our investment portfolio on the dates
indicated. The vast majority of investment security purchases are
allocated as available for sale. This provides the Corporation with
increased flexibility should there be a need or desire to
liquidate an investment security.
The investment portfolio includes U.S. Government Corporations
and Agencies, corporate obligations, mortgage backed securities,
state and municipal securities, and other debt securities. In
addition, the investment portfolio includes restricted equity
securities consisting primarily of common stock investments in the
Federal Reserve Bank and the Federal Home Loan Bank. Marketable
equity securities consists of common stock investments in other
commercial banks and bank holding companies.
Securities available for sale may be sold as part of the
overall asset and liability management process. Realized gains and
losses are reflected in the results of operations on our statements
of income. The investment portfolio does not contain any structured
notes, step up bonds, or any off-balance sheet derivatives.
During 2006, interest bearing deposits in other banks
increased to $4,307,000 from $58,000 in 2005. Interest bearing
deposits in other banks are generally kept relatively low as funds
were invested in marketable securities to maximize income while
still addressing liquidity needs.
20
Table 7 - Carrying Value of Investment Securities
(Amounts in thousands) December 31,
_______________________
2006
_______________________
Available Held to
for Sale Maturity
________ ________
<s> <c> <c>
U. S. Government Corporations
and Agencies $153,211 $4,205
State and Municipal 73,456 2,724
Corporate 2,019 0
Marketable Equity Securities 3,711 0
Restricted Equity Securities 4,612 0
________ ______
Total Investment Securities $237,009 $6,929
======== ======
(Amounts in thousands) December 31,
_______________________
2005
_______________________
Available Held to
for Sale Maturity
________ ________
<s> <c> <c>
U. S. Government Corporations
and Agencies $142,403 $1,524
State and Municipal 84,434 2,724
Corporate 12,698 0
Marketable Equity Securities 2,966 0
Restricted Equity Securities 4,787 0
________ ______
Total Investment Securities $247,288 $4,248
======== ======
(Amounts in thousands) December 31,
_______________________
2004
_______________________
Available Held to
for Sale Maturity
_________ ________
<s> <c> <c>
U. S. Government Corporations
and Agencies $111,636 $ 638
State and Municipal 86,593 2,723
Corporate 29,302 0
Marketable Equity Securities 2,695 0
Restricted Equity Securities 5,466 0
________ ______
Total Investment Securities $235,692 $3,361
======== ======
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses constitutes the amount available
to absorb losses within the loan portfolio. As of December 31,
2006, the allowance for loan losses was $3,671,000 as compared to
$3,676,000 and $3,828,000 as of December 31, 2005 and 2004,
respectively. The allowance for loan losses is established through
a provision for loan losses charged to expenses. Loans are charged
against the allowance for possible loan losses when management
believes that the collectibility of the principal is unlikely. The
risk characteristics of the loan portfolio are managed through the
various control processes, including credit evaluations of
individual borrowers, periodic reviews, and diversification by
industry. Risk is further mitigated through the application of
lending procedures such as the holding of adequate collateral and
the establishment of contractual guarantees.
Management performs a quarterly analysis to determine the
adequacy of the allowance for loan losses. The methodology in
determining adequacy incorporates specific and general allocations
together with a risk/loss analysis on various segments of the
portfolio according to an internal loan review process. This
assessment results in an allocated allowance. Management maintains
its loan review and loan classification standards consistent with
those of its regulatory supervisory authority.
Management feels based upon its methodology, that the
allowance for loan losses is adequate to cover foreseeable future
losses. Table 8 contains an analysis of our Allowance for Loan
Losses indicating charge offs and recoveries by the year and annual
additional provisions charged to operations. In 2006, net charge
offs as a percentage of average loans were .21% compared to .39% in
2005 and .62% in 2004. Net charge offs amounted to $505,000 in
2006 compared to $902,000 in 2005 and $1,446,000 in 2004,
respectively. The decrease in net charge offs in 2006 follows the
decrease in net charge offs in 2005. In 2004, the increase in net
charge offs was primarily from part of one large commercial loan
relationship, which was deemed impaired and placed on non accrual,
being charged off.
21
Table 8 - Analysis of Allowance for Loan Losses
(Amounts in thousands) Years Ended December 31,
_______________________
2006 2005 2004
____ ____ ____
<s> <c> <c> <c>
Balance at beginning of period $3,676 $3,828 $3,524
Charge-offs:
Commercial, financial,
and agricultural 493 338 1,209
Real estate 183 497 132
Consumer 110 98 143
______ ______ ______
786 933 1,484
Recoveries:
Commercial, financial,
and agricultural 228 0 0
Real estate 4 1 18
Consumer 49 30 20
______ ______ ______
281 31 38
Net charge-offs 505 902 1,446
Additions charged to operations 500 750 1,750
______ ______ ______
Balance at end of period $3,671 $3,676 $3,828
====== ====== ======
Ratio of net charge-offs during
the period to average loans
outstanding during the period .21% .39% .62%
Allowance for loan losses to
average loans outstanding
during the period 1.50% 1.58% 1.64%
(Amounts in thousands) Years Ended December 31,
_______________________
2003 2002
____ ____
<s> <c> <c>
Balance at beginning of period $3,174 $2,922
Charge-offs:
Commercial, financial,
and agricultural 43 66
Real estate 22 140
Consumer 133 196
______ ______
198 402
Recoveries:
Commercial, financial,
and agricultural 1 0
Real estate 1 77
Consumer 46 27
______ ______
48 104
Net charge-offs 150 298
Additions charged to operations 500 550
______ ______
Balance at end of period $3,524 $3,174
====== ======
Ratio of net charge-offs during
the period to average loans
outstanding during the period .07% .15%
Allowance for loan losses to
average loans outstanding
during the period 1.66% 1.58%
It is the policy of management and the Corporation's Board of
Directors to provide for losses on both identified and
unidentified losses inherent in its loan portfolio. A provision for
loan losses is charged to operations based upon an evaluation of
the potential losses in the loan portfolio. This evaluation takes
into account such factors as portfolio concentrations,
delinquency, trends, trends of non accrual and classified loans,
economic conditions, and other relevant factors.
The loan review process which is conducted quarterly, is an
integral part of our evaluation of the loan portfolio. A detailed
quarterly analysis to determine the adequacy of the Corporation's
allowance for loan losses is reviewed by our Board of Directors.
With our manageable level of net charge offs and the additions
to the reserve from our provision out of operations, the allowance
for loan losses as a percentage of average loans amounted to 1.50%
in 2006, 1.58% to 2005, and 1.64% in 2004.
Table 9 sets forth the allocation of the Bank's allowance for
loan losses by loan category and the percentage of loans in each
category to total loans receivable at the dates indicated. The
portion of the allowance for loan losses allocated to each loan
category does not represent the total available for future losses
that may occur within the loan category, since the total loan loss
allowance is a valuation reserve applicable to the entire loan
portfolio.
Table 9 - Allocation of Allowance for Loan Losses
(Amounts in thousands) December 31,
_________________
2006 % <F1>
____ _____
<s> <c> <c>
Commercial, financial, and agricultural $ 674 19.7
Real estate - mortgage 2,613 76.1
Consumer and other loans 145 4.2
Unallocated 239 N/A
______ _____
$3,671 100.0
====== =====
(Amounts in thousands) December 31,
_________________
2005 % <F1>
____ _____
<s> <c> <c>
Commercial, financial, and agricultural $ 906 25.2
Real estate - mortgage 2,521 70.2
Consumer and other loans 164 4.6
Unallocated 85 N/A
______ _____
$3,676 100.0
====== =====
(Amounts in thousands) December 31,
_________________
2004 % <F1>
____ _____
<s> <c> <c>
Commercial, financial, and agricultural $ 858 14.3
Real estate - mortgage 2,594 77.1
Consumer and other loans 308 8.6
Unallocated 68 N/A
______ _____
$3,828 100.0
====== =====
(Amounts in thousands) December 31,
_________________
2003 % <F1>
____ _____
<s> <c> <c>
Commercial, financial, and agricultural $ 775 15.4
Real estate - mortgage 2,106 72.6
Consumer and other loans 378 12.0
Unallocated 265 N/A
______ _____
$3,524 100.0
====== =====
(Amounts in thousands) December 31,
_________________
2002 % <F1>
____ _____
<s> <c> <c>
Commercial, financial, and agricultural $ 488 12.4
Real estate - mortgage 1,812 75.0
Consumer and other loans 357 12.6
Unallocated 517 N/A
______ _____
$3,174 100.0
====== =====
______________________
<FN>
<F1>
Percentage of loans in each category to total loans.
</FN>
22
NON-PERFORMING ASSETS
Table 10 details the Corporation's non performing assets at
the dates indicated.
Non accrual loans are generally delinquent on which principal
or interest is past due approximately 90 days or more, depending
upon the type of credit and the collateral. When a loan is placed
on non accrual status, any unpaid interest is charged against
income. Restructured loans are loans where the borrower has been
granted a concession in the interest rate or payment amount because
of financial problems. Foreclosed assets held for sale represents
property acquired through foreclosure, or considered to be an in
substance foreclosure.
The total of non performing assets increased to $2,880,000 as
of December 31, 2006, as compared to $2,530,000 as of December 31,
2005. Non accrual and restructured loans decreased to $1,704,000 in
2006 from $2,069,000 in 2005. Foreclosed assets decreased to
$41,000 in 2006 from $397,000 in 2005. Loans past due 90 days or
more and still accruing increased to $1,135,000 in 2006 from
$64,000 in 2005. The $1,135,000 reported past due 90 days or more
in 2006 represents one borrower whose loan is secured by commercial
real estate and presently sold under a sales agreement. The loan is
expected to be paid off in full without loss to the Bank. Our
allowance for loan losses to total non performing assets decreased
to 127.5% in 2006 from 145.3% in 2005. While asset quality is a
priority, the corporation continues to retain an independent
outside loan review consultant to closely tract and monitor overall
loan quality.
Improving loan quality is a priority, and we actively work
with borrowers to resolve credit problems. Excluding the assets
disclosed in Table 10, management is not aware of any information
about borrowers' possible credit problems, which cause serious
doubt as to their ability to comply with present loan repayment
terms.
Should the economic climate no longer continue to be stable or
begin to deteriorate, borrowers may experience difficulty, and the
level of non performing loans and assets, charge offs and
delinquencies could rise and possibly require additional increases
in our allowance for loan losses.
In addition, regulatory authorities, as an integral part of
their examinations, periodically review the allowance for possible
loan and lease losses. They may require additions to allowances
based upon their judgements about information available to them at
the time of examination.
Interest income received on non performing loans in 2006 and
2005 was $14,000 and $57,000, respectively. Interest income, which
would have been recorded on these loans under the original terms in
2006 and 2005 was $133,000 and $149,000, respectively. At December
31, 2006, the Corporation had no outstanding commitments to advance
additional funds with respect to these non performing loans.
A concentration of credit exists when the total amount of
loans to borrowers, who are engaged in similar activities that are
similarly impacted by economic or other conditions, exceed 10% of
total loans. As of December 31, 2006, 2005 and 2004, management is
of the opinion that there were no loan concentrations exceeding 10%
of total loans.
Table 10 - Non-Performing Assets
(Amounts in thousands) December 31,
______________________
2006 2005 2004
____ ____ ____
<s> <c> <c> <c>
Non-accrual and restructured loans $1,704 $2,069 $3,405
Foreclosed assets 41 397 6
Loans past-due 90 days or more
and still accruing 1,135 64 69
______ ______ ______
Total non-performing assets $2,880 $2,530 $3,480
====== ====== ======
Non-performing assets to period-
End loans and foreclosed assets 1.14% 1.08% 1.49%
Total non-performing assets to
total assets .55% .49% .70%
Total allowance for loan losses
to total non-performing assets 127.5% 145.3% 110.0%
(Amounts in thousands) December 31,
______________________
2003 2002
____ ____
<s> <c> <c>
Non-accrual and restructured loans $ 735 $ 458
Foreclosed assets 0 0
Loans past-due 90 days or more
and still accruing 33 0
______ ______
Total non-performing assets $ 768 $ 458
====== ======
Non-performing assets to period-
end loans and foreclosed assets .34% .23%
Total non-performing assets to
total assets .16% .10%
Total allowance for loan losses
to total non-performing assets 458.9% 693.7%
23
Real estate mortgages comprise 83.4% of the loan portfolio as
of December 31, 2006, up from 79.2% in 2005. Real estate mortgages
consist of both residential and commercial real estate loans. The
real estate loan portfolio is well diversified in terms of
borrowers, collateral, interest rates, and maturities. Also, the
real estate loan portfolio has a mix of both fixed rate and
adjustable rate mortgages. The real estate loans are concentrated
primarily in our marketing area and are subject to risks associated
with the local economy.
DEPOSITS AND OTHER BORROWED FUNDS
Consumer and commercial retail deposits are attracted
primarily by First Keystone's subsidiary bank's ten full service
office locations. The Bank offers a broad selection of deposit
products and continually evaluates its interest rates and fees on
deposit products. The Bank regularly reviews competing financial
institutions interest rates along with prevailing market rates,
especially when establishing interest rates on certificates of
deposit.
Deposits increased by $21,224,000, or a 5.9% increase when
comparing December 31, 2006 to December 31, 2005. This increase
compares to a deposit increase of 1.4% in 2005 and an increase of
4.4% in 2004.
During 2006, the Corporation experienced a deposit increase in
both non interest bearing and interest bearing deposits. Non
interest bearing deposits amounted to $41,361,000 as of December
31, 2006, an increase of $1,697,000 or 4.3% over 2005. Interest
bearing deposits amounted to $342,659,000 as of December 31, 2006,
an increase of $19,527,000, or 6.0% over 2005.
During 2006, the Corporation decreased its reliance on
borrowings. Short term borrowings amounted to $28,179,000 as of
year end 2006, a slight increase of $28,000 from 2005. Long term
borrowings decreased $8,000,000 in 2006 to $57,535,000 as of
December 31, 2006. Total borrowings were $85,714,000 as of December
31, 2006, compared to $93,686,000 on December 31, 2005. Short term
borrowings are comprised of federal funds purchased, securities
sold under agreements to repurchase, U.S. Treasury demand notes,
and short term borrowings from the Federal Home Loan Bank (FHLB).
Long term borrowings are typically FHLB term borrowings with a
maturity of one year or more. Short term borrowings from the
Federal Home Loan Bank are commonly used to offset seasonal
fluctuations in deposits. In connection with FHLB borrowings and
securities sold under agreements to repurchase, the Corporation
maintains certain eligible assets as collateral.
CAPITAL STRENGTH
Normal increases in capital are generated by net income, less
cash dividends paid out. Also, the net unrealized gains or losses
on investment securities available for sale, net of taxes, referred
to as accumulated other comprehensive income may increase or
decrease total equity capital. The total net decrease in capital
was $56,000 in 2006 after an increase of $131,000 in 2005. The
accumulated other comprehensive income amounted to $(126,000) in
2006 and $807,000 in 2005. One factor which also decreased total
equity capital in 2006 and 2005 relates to stock repurchase. The
Corporation had 228,900 shares of common stock as of December 31,
2006, and 153,624 shares in 2005, at a cost of $5,910,000 and
$4,544,000, respectively as treasury stock.
Return on equity (ROE) is computed by dividing net income by
average stockholders' equity. This ratio was 11.76% for 2006,
12.65% for 2005, and 12.76% for 2004. Refer to Performance Ratios
on Page 13 - Selected Financial Data for a more expanded listing of
the ROE.
Adequate capitalization of banks and bank holding companies is
required and monitored by regulatory authorities. Table 11 reflects
risk based capital ratios and the leverage ratio for our
Corporation and Bank. The Corporation's leverage ratio was 9.94% at
December 31, 2006, and 10.04% at December 31, 2005.
The Corporation has consistently maintained regulatory capital
ratios at or above the "well capitalized" standards. For additional
information on capital ratios, see Page 4 - Corporations Capital
Ratios or Table 11 - Capital Ratios. The risk based capital ratios
for both the Corporation and the Bank, remained very strong. The
risk based capital calculation assigns various levels of risk to
different categories of bank assets, requiring higher levels of
capital for assets with more risk. Also measured in the risk based
capital ratio is credit risk exposure associated with off balance
sheet contracts and commitments.
24
Table 11 - Capital Ratios
December 31, 2006
_________________
Corporation Bank
__________ ____
<s> <c> <c>
Risk-Based Capital:
Tier I risk-based capital ratio 17.45% 16.17%
Total risk-based capital ratio
(Tier 1 and Tier 2) 18.82% 17.41%
Leverage Ratio:
Tier I capital to average assets 9.94% 9.19%
December 31, 2005
_________________
Corporation Bank
__________ ____
<s> <c> <c>
Risk-Based Capital:
Tier I risk-based capital ratio 17.74% 15.97%
Total risk-based capital ratio
(Tier 1 and Tier 2) 19.16% 17.22%
Leverage Ratio:
Tier I capital to average assets 10.04% 9.03%
LIQUIDITY MANAGEMENT
Effective liquidity management ensures that the cash flow
requirements of depositors and borrowers, as well as the operating
cash needs of the Corporation, are met.
Liquidity is needed to provide the funding requirements of
depositors withdrawals, loan growth, and other operational needs.
Asset liquidity is provided by investment securities maturing in
one year or less, other short term investments, federal funds sold,
and cash and due from banks. At year end 2006, cash and due from
banks and interest bearing deposits in other banks totaled
$10,188,000 as compared to $7,156,000 at year end 2005.
Additionally, maturing loans and repayment of loans are another
source of asset liquidity.
Liability liquidity is accomplished by maintaining a core
deposit base, acquired by attracting new deposits and retaining
maturing deposits. Also, short term borrowings provide funds to
meet liquidity.
Management feels its current liquidity position is
satisfactory given the fact that the Corporation has a very stable
core deposit base which has increased annually. Secondly, our loan
payments and principal paydowns on our mortgage backed securities
provide a steady source of funds. Also, short term investments and
maturing investments represent additional sources of liquidity.
Finally, the Corporation's subsidiary bank does have access to
funds on a short term basis from the Federal Reserve Bank discount
window. Also, Fed funds can be purchased by means of a borrowing
line at the Atlantic Central Bankers Bank. The Corporation has
indirect access to the capital markets through its membership in
the Federal Home Loan Bank. Advances on borrowings, both short term
and long term, are available to help address any liquidity needs.
FORWARD LOOKING STATEMENTS
The sections that follow, Market Risk and Asset/Liability
Management contain certain forward looking statements. These
forward looking statements involve significant risks and
uncertainties, including changes in economic and financial market
conditions. Although First Keystone Corporation believes that the
expectations reflected in such forward looking statements are
reasonable, actual results may differ materially.
MARKET RISK
Market risk is the risk of loss arising from adverse changes
in the fair value of financial instruments due to changes in
interest rates, exchange rates and equity prices. First Keystone
Corporation's market risk is composed primarily of interest rate
risk. The Corporation's interest rate risk results from timing
differences in the repricing of assets, liabilities, off balance
sheet instruments, and changes in relationships between ratio
indices and the potential exercise of explicit or embedded options.
Increases in the level of interest rates also may adversely
affect the fair value of the Corporation's securities and other
earning assets. Generally, the fair value of fixed rate instruments
fluctuates inversely with changes in interest rates. As a result,
increases in interest rates could result in decreases in the fair
value of the Corporation's interest earning assets, which could
adversely affect the Corporation's results of operations if sold,
or, in the case of interest earning assets classified as available
for sale, the Corporation's stockholders' equity, if retained.
Under The Financial Accounting Standards Board (FASB) Statement
115, changes in the unrealized gains and losses, net of taxes, on
securities classified as available for sale will be reflected in
the Corporation's stockholders' equity. The Corporation does not
own any trading assets.
25
ASSET/LIABILITY MANAGEMENT
The principal objective of asset liability management is to
manage the sensitivity of the net interest margin to potential
movements in interest rates and to enhance profitability through
returns from managed levels of interest rate risk. The Corporation
actively manages the interest rate sensitivity of its assets and
liabilities. Table 12 presents an interest sensitivity analysis of
assets and liabilities as of December 31, 2006. Several techniques
are used for measuring interest rate sensitivity. Interest rate
risk arises from the mismatches in the repricing of assets and
liabilities within a given time period, referred to as a rate
sensitivity gap. If more assets than liabilities mature or reprice
within the time frame, the Corporation is asset sensitive. This
position would contribute positively to net interest income in a
rising rate environment. Conversely, if more liabilities mature or
reprice, the Corporation is liability sensitive. This position
would contribute positively to net interest income in a falling
rate environment.
Limitations of interest rate sensitivity gap analysis as
illustrated in Table 12 include: a) assets and liabilities which
contractually reprice within the same period may not, in fact,
reprice at the same time or to the same extent; b) changes in
market interest rates do not affect all assets and liabilities to
the same extent or at the same time, and c) interest rate
sensitivity gaps reflect the Corporation's position on a single day
(December 31, 2006 in the case of the following schedule) while the
Corporation continually adjusts its interest sensitivity throughout
the year. The Corporation's cumulative gap at one year indicates
the Corporation is liability sensitive.
Table 12 - Interest Rate Sensitivity Analysis
(Amounts in thousands)
December 31, 2006
_____________________________
One 1 - 5 Beyond
Year Years 5 Years
______ ______ _____
<s> <c> <c> <c>
Assets $135,489 $212,312 $158,000
Liabilities/Stockholders Equity 347,091 94,846 29,444
________ ________ ________
Interest Rate Sensitivity Gap (211,602) 117,466 128,556
Cumulative Gap (211,602) (94,136) 34,420
(Amounts in thousands)
December 31, 2006
_____________________________
Not Rate
Sensitive Total
______ ______
<s> <c> <c>
Assets $20,119 $525,920
Liabilities/Stockholders Equity 54,539 525,920
Interest Rate Sensitivity Gap
Cumulative Gap
EARNINGS AT RISK
The Bank's Asset/Liability Committee (ALCO) is responsible for
reviewing the interest rate sensitivity position and establishing
policies to monitor and limit exposure to interest rate risk. The
guidelines established by ALCO are reviewed by the Corporation's
Board of Directors. The Corporation recognizes that more
sophisticated tools exist for measuring the interest rate risk in
the balance sheet beyond interest rate sensitivity gap. Although
the Corporation continues to measure its interest rate sensitivity
gap, the Corporation utilizes additional modeling for interest rate
risk in the overall balance sheet. Earnings at risk and economic
values at risk are analyzed.
Earnings simulation modeling addresses earnings at risk and
net present value estimation addresses economic value at risk.
While each of these interest rate risk measurements has
limitations, taken together they represent a reasonably
comprehensive view of the magnitude of interest rate risk in the
Corporation.
EARNINGS SIMULATION MODELING
The Corporation's net income is affected by changes in the
level of interest rates. Net income is also subject to changes in
the shape of the yield curve. For example, a flattening of the
yield curve would result in a decline in earnings due to the
compression of earning asset yields and increased liability rates,
while a steepening would result in increased earnings as earning
asset yields widen.
26
Earnings simulation modeling is the primary mechanism used in
assessing the impact of changes in interest rates on net interest
income. The model reflects management's assumptions related to
asset yields and rates paid on liabilities, deposit sensitivity,
size and composition of the balance sheet. The assumptions are
based on what management believes at that time to be the most
likely interest rate environment. Earnings at risk is the change in
net interest income from a base case scenario under an increase and
decrease of 200 basis points in the interest rate earnings
simulation model.
Table 13 presents an analysis of the changes in net interest
income and net present value of the balance sheet resulting from an
increase or decrease of two percentage points (200 basis points) in
the level of interest rates. The calculated estimates of change in
net interest income and net present value of the balance sheet are
compared to current limits approved by ALCO and the Board of
Directors. The earnings simulation model projects net interest
income would increase by approximately 3.5% if rates fell by two
percentage points over one year. The model projects a decrease of
approximately 27.3% in net interest income if rates rise by two
percentage points over one year. Both of these forecasts are within
the one year policy guidelines.
NET PRESENT VALUE ESTIMATION
The net present value measures economic value at risk and is
used for helping to determine levels of risk at a point in time
present in the balance sheet that might not be taken into account
in the earnings simulation model. The net present value of the
balance sheet is defined as the discounted present value of asset
cash flows minus the discounted present value of liability cash
flows. At year end, a 200 basis point immediate decrease in rates
is estimated to increase net present value by 7.0%. Additionally,
net present value is projected to decrease by 46.0% if rates
increase immediately by 200 basis points. The +2% scenario slightly
exceeds policy limits of 40%.
The computation of the effects of hypothetical interest rate
changes are based on many assumptions. They should not be relied
upon solely as being indicative of actual results, since the
computations do not contemplate actions management could undertake
in response to changes in interest rates.
TABLE 13 - EFFECT OF CHANGE IN INTEREST RATES
Projected Change
________________
<s> <c>
Effect on Net Interest Income
1-year Net Income simulation Projection
-200 bp Shock vs Stable Rate 3.5%
+200 bp Shock vs Stable Rate (27.3%)
Effect on Net Present Value of Balance Sheet
Static Net Present Value Change
-200 bp Shock vs Stable Rate 7.0%
+200 bp Shock vs Stable Rate (46.0%)
MARKET PRICE/DIVIDEND HISTORY
As of December 31, 2006, the corporation had 4,526,664 shares
of $2.00 par value common stock outstanding held by shareholders of
record. First Keystone Corporation's common stock is quoted on the
Over The Counter (OTC) Bulletin Board under the symbol "FKYS.OB".
Table 14 reports the highest and lowest per share prices known
to the Corporation and the dividends paid during the periods
indicated. The market prices and dividend paid have been adjusted
to reflect a 5% stock dividend paid December 5, 2006 and a 3 for 2
stock split in the form of a 50% stock dividend paid May 11, 2004.
These prices do not necessarily reflect any dealer or retail
markup, markdown or commission.
27
TABLE 14 - MARKET PRICE/DIVIDEND HISTORY
2006
_________________________
Common Stock Dividends
High/Low Paid
_______ ____
<s> <c> <c>
First Quarter $19.91/$18.57 $.21
Second Quarter $19.05/$17.43 .21
Third Quarter $19.33/$16.81 .21
Fourth Quarter $19.20/$17.29 .22
2005
_________________________
Common Stock Dividends
High/Low Paid
________ ____
<s> <c> <c>
First Quarter $22.76/$20.48 $.19
Second Quarter $20.95/$18.81 .19
Third Quarter $21.67/$19.14 .19
Fourth Quarter $20.81/$19.05 .21
2004
_________________________
Common Stock Dividends
High/Low Paid
_______ ____
<s> <c> <c>
First Quarter $24.29/$22.85 $.17
Second Quarter $24.29/$23.10 .17
Third Quarter $23.33/$21.67 .17
Fourth Quarter $22.14/$20.48 .19
Table 15 - Quarterly Results of Operations (Unaudited)
(Amounts in thousands, except per share)
Three Months Ended
______________________________________
2006 March June September December
31 30 30 31
_____ ____ ________ _______
<s> <c> <c> <c> <c>
Interest income $6,858 $7,051 $7,236 $7,432
Interest expense 3,343 3,626 3,910 4,093
______ ______ ______ ______
Net interest income $3,515 $3,425 $3,326 $3,339
Provision for loan
losses 100 200 100 100
Other non-interest
income 867 901 952 1,068
Non-interest expense 2,432 2,423 2,380 2,280
______ ______ ______ ______
Income before income
taxes $1,850 $1,703 $1,798 $2,027
Income taxes 284 244 295 365
______ ______ ______ ______
Net income $1,566 $1,459 $1,503 $1,662
====== ====== ====== ======
Per share $ .343 $ .314 $ .333 $ .360
(Amounts in thousands, except per share)
Three Months Ended
______________________________________
2005 March June September December
31 30 30 31
_____ ____ ________ _______
<s> <c> <c> <c> <c>
Interest income $6,441 $6,491 $6,637 $6,813
Interest expense 2,630 2,782 2,981 3,228
______ ______ ______ ______
Net interest income $3,811 $3,709 $3,656 $3,585
Provision for loan
losses 150 200 150 250
Other non-interest
income 803 916 915 1,148
Non-interest expense 2,331 2,389 2,245 2,618
______ ______ ______ ______
Income before income
taxes $2,133 $2,036 $2,176 $1,865
Income taxes 378 339 372 274
______ ______ ______ ______
Net income $1,755 $1,697 $1,804 $1,591
====== ====== ====== ======
Per share $ .380 $ .370 $ .390 $ .340
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK
Information with respect to quantitative and qualitative
disclosures about market risk is included in the information under
Management's Discussion and Analysis in Item 7 hereof.
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
_______________________________________________________
BOARD OF DIRECTORS AND STOCKHOLDERS OF FIRST KEYSTONE CORPORATION:
We have audited the accompanying consolidated balance sheets
of First Keystone Corporation and Subsidiary as of December 31,
2006 and 2005, and the related consolidated statements of income,
changes in stockholders' equity, and cash flows for each of the
years in the three year period ended December 31, 2006. These
consolidated financial statements are the responsibility of the
Corporation's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with the standards of
the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the consolidated financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the
overall consolidated financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the consolidated
financial position of First Keystone Corporation and Subsidiary as
of December 31, 2006 and 2005, and the consolidated results of
their operations and their cash flows for each of the years in the
three-year period ended December 31, 2006, in conformity with
accounting principles generally accepted in the United States of
America.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States) the
effectiveness of First Keystone Corporation and Subsidiary's
internal control over financial reporting as of December 31, 2006,
based on criteria established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO) and our report dated February 28,
2007, expressed an unqualified opinion on management's assessment
of the effectiveness of the Corporation's internal control over
financial reporting and an unqualified opinion on the effectiveness
of the Corporation's internal control over financial reporting.
/s/ J. H. Williams & Co., LLP
_____________________________
J. H. Williams & Co., LLP
Kingston, Pennsylvania
February 28, 2007
29
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
_____________________________________________________________________
(Amounts in thousands) December 31,
__________________
2006 2005
____ ____
<s> <c> <c>
ASSETS
Cash and due from banks $ 5,881 $ 7,098
Interest-bearing deposits in
other banks 4,307 58
Investment securities available-
for-sale 237,009 247,288
Investment securities held-to-
maturity (estimated fair value
2006 - $6,908; 2005 - $4,217) 6,929 4,248
Loans, net of unearned income 251,757 234,593
Allowance for loan losses (3,671) (3,676)
________ ________
Net loans $248,086 $230,917
________ ________
Premises and equipment, net 5,016 5,091
Accrued interest receivable 2,686 2,604
Cash surrender value of bank owned
life insurance 11,942 11,470
Goodwill 1,224 1,224
Other assets 2,840 2,401
________ ________
TOTAL ASSETS $525,920 $512,399
======== ========
LIABILITIES
Deposits:
Non-interest bearing $ 41,361 $ 39,664
Interest bearing 342,659 323,132
________ ________
Total Deposits 384,020 362,796
Short-term borrowings 28,179 28,151
Long-term borrowings 57,535 65,535
Accrued interest and other expenses 2,581 2,372
Other liabilities 218 102
________ ________
TOTAL LIABILITIES $472,533 $458,956
________ ________
STOCKHOLDERS' EQUITY
Preferred stock, par value
$10.00 per share; authorized
and unissued 500,000 shares $ - $ -
Common stock, par value $2.00 per
share; authorized 10,000,000
shares; issued 4,755,564 in 2006
and 4,539,573 shares in 2005 9,511 9,079
Surplus 16,119 12,387
Retained earnings 33,793 35,714
Accumulated other comprehensive
income (loss) (126) 807
Treasury stock, at cost, 228,900
shares in 2006 and 153,624
shares in 2005 (5,910) (4,544)
________ ________
TOTAL STOCKHOLDERS' EQUITY $ 53,387 $ 53,443
________ ________
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $525,920 $512,399
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
30
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
_____________________________________________________________________
(Amounts in thousands, except per share data)
Year Ended December 31,
______________________
2006 2005
____ ____
<s> <c> <c>
INTEREST INCOME
Interest and fees on loans $16,484 $14,834
Interest and dividends on
investment securities:
Taxable 8,104 7,424
Tax-exempt 3,574 3,857
Dividends 384 213
Deposits in banks 31 51
Federal funds sold - 3
_______ _______
Total interest income $28,577 $26,382
_______ _______
INTEREST EXPENSE
Deposits $11,184 $ 8,105
Short-term borrowings 893 499
Long-term borrowings 2,895 3,017
_______ _______
Total interest expense $14,972 $11,621
_______ _______
Net interest income $13,605 $14,761
Provision for loan losses 500 750
_______ _______
Net interest income after
provision for loan losses $13,105 $14,011
_______ _______
NON-INTEREST INCOME
Trust department $ 507 $ 477
Service charges and fees 2,149 2,163
Bank owned life insurance income 472 437
Gain on sale of loans 39 63
Investment securities gains
(losses) - net 381 420
Other 240 222
_______ _______
Total non-interest income $ 3,788 $ 3,782
_______ _______
NON-INTEREST EXPENSE
Salaries and employee benefits $ 5,185 $ 5,074
Occupancy, net 608 578
Furniture and equipment 751 684
Professional services 402 407
State shares tax 520 482
Other 2,049 2,358
_______ _______
Total non-interest expense $ 9,515 $ 9,583
_______ _______
Income before income taxes $ 7,378 $ 8,210
Income tax expense 1,188 1,363
_______ _______
NET INCOME $ 6,190 $ 6,847
======= =======
PER SHARE DATA
Net income per share:*
Basic $ 1.35 $ 1.48
Diluted $ 1.35 $ 1.48
Cash dividends per share* $ .85 $ .78
(Amounts in thousands, except per share data)
Year Ended December 31,
_____________________
2004
<s> <c>
INTEREST INCOME
Interest and fees on loans $14,527
Interest and dividends on
investment securities:
Taxable 7,132
Tax-exempt 3,072
Dividends 246
Deposits in banks 59
Federal funds sold -
_______
Total interest income $25,036
_______
INTEREST EXPENSE
Deposits $ 6,908
Short-term borrowings 166
Long-term borrowings 2,932
_______
Total interest expense $10,006
_______
Net interest income $15,030
Provision for loan losses 1,750
_______
Net interest income after
provision for loan losses $13,280
_______
NON-INTEREST INCOME
Trust department $ 525
Service charges and fees 2,049
Bank owned life insurance income 446
Gain on sale of loans 221
Investment securities gains
(losses) - net 1,080
Other 275
_______
Total non-interest income $ 4,596
_______
NON-INTEREST EXPENSE
Salaries and employee benefits $ 4,882
Occupancy, net 656
Furniture and equipment 782
Professional services 502
State shares tax 447
Other 2,157
_______
Total non-interest expense $ 9,426
_______
Income before income taxes $ 8,450
Income tax expense 1,663
_______
NET INCOME $ 6,787
=======
PER SHARE DATA
Net income per share:*
Basic $ 1.48
Diluted $ 1.47
Cash dividends per share* $ .70
*Adjusted for a 5% stock dividend declared October 24, 2006, to
shareholders of record November 14, 2006, distributed December 5, 2006, and
a 3 for 2 stock split in the form of a 50% stock dividend declared April
13, 2004, to shareholders of record April 27, 2004, distributed May 11,
2004.
The accompanying notes are an integral part of these consolidated financial
statements.
31
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
_____________________________________________________________________
(Amounts in thousands)
Common
Stock Surplus
_____ ______
<s> <c> <c>
Balance At December 31, 2003 $6,154 $12,535
Comprehensive Income:
Net income
Change in net unrealized
(loss) on investment
securities available-for-
sale, net of reclassification
adjustment and tax effects
Total comprehensive income
3 for 2 stock split in the form
of a 50% stock dividend 2,925
Cash paid in lieu of fractional
shares
Issuance of 4,336 shares of
treasury stock upon exercise
of employee stock options (78)
Recognition of stock option
expense 48
Cash dividends - $.73 per share
______ _______
Balance At December 31, 2004 $9,079 $12,505
Comprehensive Income:
Net income
Change in net unrealized
(loss) on investment
securities available-for-
sale, net of reclassification
adjustment and tax effects
Total comprehensive income
Purchase of 11,571 shares of
treasury stock
Issuance of 6,211 shares of
treasury stock upon exercise
of employee stock options (116)
Stock option forfeitures in
excess of stock option expense (2)
Cash dividends - $.82 per share
______ _______
Balance At December 31, 2005 $9,079 $12,387
Comprehensive Income:
Net income
Change in net unrealized
(loss) on investment
securities available-for-
sale, net of reclassification
adjustment and tax effects
Total comprehensive income
Purchase of 79,691 shares of
treasury stock
Issuance of 4,415 shares of
treasury stock upon exercise
of employee stock options (77)
5% stock dividend 432 3,801
Cash paid in lieu of
fractional shares
Recognition of stock option
expense 8
Cash dividends - $.85 per share
______ _______
Balance At December 31, 2006 $9,511 $16,119
====== =======
(Amounts in thousands)
Comprehensive Retained
Income Earnings
______ ________
<s> <c> <c>
Balance At December 31, 2003 $31,828
Comprehensive Income:
Net income $6,787 6,787
Change in net unrealized
(loss) on investment
securities available-for-
sale, net of reclassification
adjustment and tax effects (1,722)
______
Total comprehensive income $5,065
======
3 for 2 stock split in the form of
a 50% stock dividend (2,925)
Cash paid in lieu of fractional
shares (3)
Issuance of 4,336 shares of
treasury stock upon exercise
of employee stock options
Recognition of stock option
expense
Cash dividends - $.73 per share (3,218)
_______
Balance At December 31, 2004 $32,469
Comprehensive Income:
Net income $6,847 6,847
Change in net unrealized
(loss) on investment
securities available-for-
sale, net of reclassification
adjustment and tax effects (2,960)
______
Total comprehensive income $3,887
======
Purchase of 11,571 shares of
treasury stock
Issuance of 6,211 shares of
treasury stock upon exercise
of employee stock options
Stock option forfeitures in
excess of stock option expense
Cash dividends - $.82 per share (3,602)
_______
Balance At December 31, 2005 $35,714
Comprehensive Income:
Net income $6,190 6,190
Change in net unrealized
(loss) on investment
securities available-for-
sale, net of reclassification
adjustment and tax effects (933)
______
Total comprehensive income $5,257
======
Purchase of 79,691 shares of
treasury stock
Issuance of 4,415 shares of
treasury stock upon exercise
of employee stock options
5% stock dividend (4,233)
Cash paid in lieu of fractional
shares (4)
Recognition of stock option
expense
Cash dividends - $.85 per share (3,874)
_______
Balance At December 31, 2006 $33,793
=======
(Amounts in thousands) Accumulated
Other
Comprehensive Treasury
Income (Loss) Stock
_______ _____
<s> <c> <c>
Balance At December 31, 2003 $5,489 $(4,655)
Comprehensive Income:
Net income
Change in net unrealized
(loss) on investment
securities available-for-
sale, net of reclassification
adjustment and tax effects (1,722)
Total comprehensive income
3 for 2 stock split in the form
of a 50% stock dividend
Cash paid in lieu of fractional
shares
Issuance of 4,336 shares of
treasury stock upon exercise
of employee stock options 147
Recognition of stock option
expense
Cash dividends - $.73 per share
Balance At December 31, 2004 $3,767 $(4,508)
Comprehensive Income:
Net income
Change in net unrealized
(loss) on investment
securities available-for-
sale, net of reclassification
adjustment and tax effects (2,960)
Total comprehensive income
Purchase of 11,571 shares of
treasury stock (247)
Issuance of 6,211 shares of
treasury stock upon exercise
of employee stock options 211
Stock option forfeitures in
excess of stock option
expense
Cash dividends - $.82 per share
Balance At December 31, 2005 $ 807 $(4,544)
Comprehensive Income:
Net income
Change in net unrealized
(loss) on investment
securities available-for-
sale, net of reclassification
adjustment and tax effects (933)
Total comprehensive income
Purchase of 79,691 shares of
treasury stock (1,514)
Issuance of 4,415 shares of
treasury stock upon exercise
of employee stock options 148
5% stock dividend
Cash paid in lieu of
fractional shares
Recognition of stock option
expense
Cash dividends - $.85 per share
______ _______
Balance At December 31, 2006 $ (126) $(5,910)
====== =======
(Amounts in thousands)
Total
____
<s> <c>
Balance At December 31, 2003 $51,351
Comprehensive Income:
Net income 6,787
Change in net unrealized
(loss) on investment
securities available-for-
sale, net of reclassification
adjustment and tax effects (1,722)
Total comprehensive income
3 for 2 stock split in the form
of a 50% stock dividend
Cash paid in lieu of fractional
shares (3)
Issuance of 4,336 shares of
treasury stock upon exercise
of employee stock options 69
Recognition of stock option
expense 48
Cash dividends - $.73 per share (3,218)
_______
Balance At December 31, 2004 $53,312
Comprehensive Income:
Net income 6,847
Change in net unrealized
(loss) on investment
securities available-for-
sale, net of reclassification
adjustment and tax effects (2,960)
Total comprehensive income
Purchase of 11,571 shares of
treasury stock (247)
Issuance of 6,211 shares of
treasury stock upon exercise
of employee stock options 95
Stock option forfeitures in
excess of stock option expense (2)
Cash dividends - $.82 per share (3,602)
_______
Balance At December 31, 2005 $53,443
Comprehensive Income:
Net income 6,190
Change in net unrealized
(loss) on investment
securities available-for-
sale, net of reclassification
adjustment and tax effects (933)
Total comprehensive income
Purchase of 79,691 shares of
treasury stock (1,514)
Issuance of 4,415 shares of
treasury stock upon exercise
of employee stock options 71
5% stock dividend 0
Cash paid in lieu of
fractional shares (4)
Recognition of stock option
expense 8
Cash dividends - $.85 per share (3,874)
_______
Balance At December 31, 2006 $53,387
=======
The accompanying notes are an integral part of these consolidated financial
statements.
32
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
_____________________________________________________________________
(Amounts in thousands) Year Ended December 31,
_______________________
2006 2005
<s> <c> <c>
OPERATING ACTIVITIES
Net income $ 6,190 $ 6,847
Adjustments to reconcile net income
to net cash provided by
operating activities:
Provision for loan losses 500 750
Depreciation and amortization 542 551
Stock option expense (Forfeitures
in excess of expense) 8 (2)
Premium amortization on investment
securities 187 411
Discount accretion on investment
securities (537) (681)
Core deposit discount accretion
net of amortization 1 (73)
Deferred income tax benefit (263) (49)
Gain on sale of mortgage loans
originated for resale (39) (63)
Proceeds from sale of mortgage
loans originated for resale 7,470 4,759
Originations of mortgage loans
originated for resale (9,013) (6,271)
Gain on sales of investment securities (381) (420)
Loss on sale of foreclosed real estate 13 -
(Increase) decrease in accrued
interest receivable (38) 108
Increase in cash surrender value
of bank owned life insurance (472) (437)
(Increase) decrease in other
assets - net (82) 410
Increase in accrued interest and
other expenses 208 494
Decrease in other liabilities - net (108) (136)
________ ________
NET CASH PROVIDED BY OPERATING
ACTIVITIES $ 4,186 $ 6,198
________ ________
INVESTING ACTIVITIES
Proceeds from sales of investment
securities available-for-sale $103,736 $119,669
Proceeds from maturities and
redemptions of investment
securities available-for-sale 28,583 34,112
Purchases of investment securities
available-for-sale (122,716) (169,780)
Proceeds from maturities and
redemption of investment
securities held-to-maturity 110 113
Proceeds from sales of investment
securities held-to-maturity 201 -
Purchases of investment securities
held-to-maturity (3,015) (1,000)
Net increase in loans (16,087) (575)
Purchases of premises and equipment (218) (177)
Final settlement on acquisition
of branch - -
Proceeds from sale of foreclosed
real estate 320 60
________ ________
NET CASH (USED IN) INVESTING
ACTIVITIES $ (9,086) $(17,578)
________ ________
FINANCING ACTIVITIES
Net increase in deposits $ 21,225 $ 4,840
Net increase in short-term borrowings 28 12,639
Proceeds from long-term borrowings 5,000 8,000
Repayment of long-term borrowings (13,000) (9,375)
Cash paid in lieu of fractional shares (4) -
Proceeds from sale of treasury stock 71 95
Acquisition of treasury stock (1,514) (247)
Cash dividends paid (3,874) (3,602)
________ ________
NET CASH PROVIDED BY FINANCING
ACTIVITIES $ 7,932 $ 12,350
________ ________
INCREASE IN CASH AND CASH EQUIVALENTS $ 3,032 $ 970
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 7,156 6,186
________ ________
CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 10,188 $ 7,156
======== ========
(Amounts in thousands) Year Ended December 31,
_____________________
2004
<s> <c>
OPERATING ACTIVITIES
Net income $ 6,787
Adjustments to reconcile net income
to net cash provided by
operating activities:
Provision for loan losses 1,750
Depreciation and amortization 666
Stock option expense (Forfeitures
in excess of expense) 48
Premium amortization on
investment securities 787
Discount accretion on investment
securities (350)
Core deposit discount accretion
net of amortization (96)
Deferred income tax benefit (154)
Gain on sale of mortgage loans
originated for resale (221)
Proceeds from sale of mortgage
loans originated for resale 13,543
Originations of mortgage loans
originated for resale (6,137)
Gain on sales of investment
securities (1,080)
Loss on sale of foreclosed real
estate -
(Increase) decrease in accrued
interest receivable 66
Increase in cash surrender value
of bank owned life insurance (446)
(Increase) decrease in other
assets - net (482)
Increase in accrued interest and
other expenses 213
Decrease in other liabilities - net -
________
NET CASH PROVIDED BY OPERATING
ACTIVITIES $ 14,894
________
INVESTING ACTIVITIES
Proceeds from sales of investment
securities available-for-sale $ 68,654
Proceeds from maturities and
redemptions of investment
securities available-for-sale 30,237
Purchases of investment securities
available-for-sale (108,877)
Proceeds from maturities and
redemption of investment
securities held-to-maturity 252
Proceeds from sales of investment
securities held-to-maturity 2,199
Purchases of investment securities
held-to-maturity (1,630)
Net increase in loans (13,358)
Purchases of premises and equipment (885)
Final settlement on acquisition of
branch (414)
Proceeds from sale of foreclosed
real estate -
________
NET CASH (USED IN) INVESTING
ACTIVITIES $(23,822)
________
FINANCING ACTIVITIES
Net increase in deposits $ 4,592
Net increase in short-term borrowings 3,768
Proceeds from long-term borrowings 7,500
Repayment of long-term borrowings (3,535)
Cash paid in lieu of fractional shares (3)
Proceeds from sale of treasury stock 69
Acquisition of treasury stock -
Cash dividends paid (3,218)
________
NET CASH PROVIDED BY FINANCING
ACTIVITIES $ 9,173
________
INCREASE IN CASH AND CASH EQUIVALENTS $ 245
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 5,941
________
CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 6,186
========
The accompanying notes are an integral part of these consolidated financial
statements.
33
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 AND 2004
_________________________________________________________________
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting policies of First Keystone Corporation and
Subsidiary (the "Corporation") are in accordance with accounting
principles generally accepted in the United States of America and
conform to common practices within the banking industry. The more
significant policies follow:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of
First Keystone Corporation and its wholly owned Subsidiary, The
First National Bank of Berwick (the "Bank"). All significant inter
company balances and transactions have been eliminated in
consolidation.
NATURE OF OPERATIONS
The Corporation, headquartered in Berwick, Pennsylvania,
provides a full range of banking, trust and related services
through its wholly owned Bank subsidiary and is subject to
competition from other financial institutions in connection with
these services. The Bank serves a customer base which includes
individuals, businesses, public and institutional customers
primarily located in the Northeast Region of Pennsylvania. The Bank
has 10 full service offices and 12 ATMs located in Columbia,
Luzerne and Montour Counties. The Corporation and its subsidiary
must also adhere to certain federal banking laws and regulations
and are subject to periodic examinations made by various federal
agencies.
SEGMENT REPORTING
The Corporation's banking subsidiary acts as an independent
community financial services provider, and offers traditional
banking and related financial services to individual, business and
government customers. Through its branch and automated teller
machine network, the Bank offers a full array of commercial and
retail financial services, including the taking of time, savings
and demand deposits; the making of commercial, consumer and
mortgage loans; and the providing of other financial services. The
Bank also performs personal, corporate, pension and fiduciary
services through its Trust Department.
Management does not separately allocate expenses, including
the cost of funding loan demand, between the commercial, retail,
trust and mortgage banking operations of the Corporation.
Currently, management measures the performance and allocates the
resources of First Keystone Corporation as a single segment.
USE OF ESTIMATES
The preparation of these consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America, requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of these consolidated financial statements and the
reported amounts of income and expenses during the reporting
periods. Actual results could differ from those estimates.
INVESTMENT SECURITIES
The Corporation classifies its investment securities as either
"Held to Maturity" or "Available for Sale" at the time of purchase.
Debt securities are classified as Held to Maturity when the
Corporation has the ability and positive intent to hold the
securities to maturity. Investment securities Held to Maturity are
carried at cost adjusted for amortization of premium and accretion
of discount to maturity.
Debt securities not classified as Held to Maturity and equity
securities are included in the Available for Sale category and are
carried at fair value. The amount of any unrealized gain or loss,
net of the effect of deferred income taxes, is reported as other
comprehensive income (loss) in the Consolidated Statement of
Changes in Stockholders' Equity. Management's decision to sell
Available for Sale securities is based on changes in economic
conditions controlling the sources and applications of funds,
terms, availability of and yield of alternative investments,
interest rate risk and the need for liquidity.
34
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
The cost of debt securities classified as Held to Maturity or
Available for Sale is adjusted for amortization of premiums and
accretion of discounts to expected maturity. Such amortization and
accretion, as well as interest and dividends is included in
interest income from investments. Realized gains and losses are
included in net investment securities gains and losses.
The cost of investment securities sold, redeemed or matured is
based on the specific identification method.
LOANS
Loans are stated at their outstanding unpaid principal
balances, net of deferred fees or costs, unearned income and the
allowance for loan losses. Interest on installment loans is
recognized as income over the term of each loan, generally, by the
actuarial method. Interest on all other loans is primarily
recognized based upon the principal amount outstanding on an actual
day basis. Loan origination fees and certain direct loan
origination costs have been deferred with the net amount amortized
using the interest method over the contractual life of the related
loans as an interest yield adjustment.
Mortgage loans held for resale are carried at the lower of
cost or market on an aggregate basis. These loans are sold without
recourse to the Corporation.
Past-Due Loans - Generally, a loan is considered to be past due
when scheduled loan payments are in arrears 15 days or more.
Delinquent notices are generated automatically when a loan is 15
days past due, depending on the type of loan. Collection efforts
continue on loans past due beyond 60 days that have not been
satisfied, when it is believed that some chance exists for
improvement in the status of the loan. Past due loans are
continually evaluated with the determination for charge off being
made when no reasonable chance remains that the status of the loan
can be improved.
Non-Accrual Loans - Generally, a loan is classified as non accrual
and the accrual of interest on such a loan is discontinued when the
contractual payment of principal or interest has become 90 days
past due or management has serious doubts about further
collectibility of principal or interest, even though the loan
currently is performing. A loan may remain on accrual status if it
is in the process of collection and is either guaranteed or well
secured. When a loan is placed on non accrual status, unpaid
interest credited to income in the current year is reversed and
unpaid interest accrued in prior years is charged against the
allowance for loan losses. Certain non accrual loans may continue
to perform, that is, payments are still being received. Generally,
the payments are applied to principal. These loans remain under
constant scrutiny and if performance continues, interest income may
be recorded on a cash basis based on management's judgement as to
collectibility of principal.
Allowance for Loan Losses - The allowance for loan losses is
established through provisions for loan losses charged against
income. Loans deemed to be uncollectible are charged against the
allowance for loan losses and subsequent recoveries, if any, are
credited to the allowance.
A principal factor in estimating the allowance for loan losses
is the measurement of impaired loans. A loan is considered impaired
when, based on current information and events, it is probable that
the Corporation will be unable to collect all amounts due according
to the contractual terms of the loan agreement. Under current
accounting standards, the allowance for loan losses related to
impaired loans is based on discounted cash flows using the
effective interest rate of the loan or the fair value of the
collateral for certain collateral dependent loans.
The allowance for loan losses is maintained at a level
estimated by management to be adequate to absorb potential loan
losses. Management's periodic evaluation of the adequacy of the
allowance for loan losses is based on the Corporation's past loan
loss experience, known and inherent risks in the portfolio, adverse
situations that may affect the borrower's ability to repay
(including the timing of future payments), the estimated value of
any underlying collateral, composition of the loan portfolio,
current economic conditions, and other relevant factors. This
evaluation is inherently subjective as it requires material
estimates including the amounts and timing of future cash flows
expected to be received on impaired loans that may be susceptible
to significant change.
35
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
DERIVATIVES
The Bank has outstanding loan commitments that relate to the
origination of mortgage loans that will be held for resale.
Pursuant to Statement of Financial Accounting Standards (SFAS) No.
133, "Accounting for Derivative Instruments and Hedging Activities"
as amended by SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities" and the guidance
contained within the Derivatives Implementation Group Statement 133
Implementation Issue No. C 13, the Bank has accounted for such loan
commitments as derivative instruments. The outstanding loan
commitments in this category did not give rise to any losses for
the years ended December 31, 2006 and 2005, as the fair market
value of each outstanding loan commitment exceeded the Bank's cost
basis in each outstanding loan commitment.
PREMISES AND EQUIPMENT
Premises, improvements and equipment are stated at cost less
accumulated depreciation computed principally on the straight line
method over the estimated useful lives of the assets. Long lived
assets are reviewed for impairment whenever events or changes in
business circumstances indicate that the carrying value may not be
recovered. Maintenance and minor repairs are charged to operations
as incurred. The cost and accumulated depreciation of the premises
and equipment retired or sold are eliminated from the property
accounts at the time of retirement or sale, and the resulting gain
or loss is reflected in current operations.
MORTGAGE SERVICING RIGHTS
The Corporation originates and sells real estate loans to
investors in the secondary mortgage market. After the sale, the
Corporation may retain the right to service these loans. When
originated mortgage loans are sold and servicing is retained, a
servicing asset is capitalized based on relative fair value at the
date of sale. Servicing assets are amortized as an offset to other
fees in proportion to, and over the period of, estimated net
servicing income. The unamortized cost is included in other assets
in the accompanying consolidated balance sheet. The servicing
rights are periodically evaluated for impairment based on their
relative fair value.
FORECLOSED REAL ESTATE
Real estate properties acquired through, or in lieu of, loan
foreclosure are held for sale and are initially recorded at fair
value on the date of foreclosure establishing a new cost basis.
After foreclosure, valuations are periodically performed by
management and the real estate is carried at the lower of carrying
amount or fair value less cost to sell and is included in other
assets. Revenues derived from and costs to maintain the assets and
subsequent gains and losses on sales are included in other non
interest income and expense. The total of foreclosed real estate
properties included in other assets amounted to $41,000 and
$397,000 at December 31, 2006 and 2005, respectively.
BANK OWNED LIFE INSURANCE
The Corporation invests in Bank Owned Life Insurance (BOLI)
with split dollar life provisions. Purchase of BOLI provides life
insurance coverage on certain employees with the Corporation being
owner and beneficiary of the policies.
INVESTMENTS IN REAL ESTATE VENTURES
The Bank is a limited partner in real estate ventures that
own and operate affordable residential low income housing apartment
buildings for elderly residents. The investments are accounted for
under the effective yield method under the Emerging Issues Task
Force (EITF) 94-1, "Accounting for Tax Benefits Resulting from
Investments in Affordable Housing Projects". Under the effective
yield method, the Bank recognizes tax credits as they are allocated
and amortizes the initial cost of the investment to provide a
constant effective yield over the period that the tax credits are
allocated to the Bank. Under this method, the tax credits
allocated, net of any amortization of the investment in the limited
partnerships, are recognized in the consolidated statements of
income as a component of income tax expense. The amount of tax
credits allocated to the Bank were $128,000 in 2006, 2005 and
36
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
2004, and the amortization of the investments in the limited
partnerships were $100,000, $96,000 and $92,000 in 2006, 2005 and
2004, respectively. The carrying value of the investments as of
December 31, 2006, and 2005, was $595,000 and $695,000,
respectively, and is included in other assets in the accompanying
consolidated balance sheets.
INCOME TAXES
The provision for income taxes is based on the results of
operations, adjusted primarily for tax exempt income. Certain items
of income and expense are reported in different periods for
financial reporting and tax return purposes. Deferred tax assets
and liabilities are determined based on the differences between the
consolidated financial statement and income tax bases of assets and
liabilities measured by using the enacted tax rates and laws
expected to be in effect when the timing differences are expected
to reverse. Deferred tax expense or benefit is based on the
difference between deferred tax asset or liability from period to
period.
GOODWILL, OTHER INTANGIBLE ASSETS, AND PREMIUM DISCOUNT
Goodwill resulted from the acquisition of certain fixed and
operating assets acquired and deposit liabilities assumed of the
branch of another financial institution in Danville, Pennsylvania,
in January 2004. Such goodwill represents the excess cost of the
acquired assets relative to the assets fair value at the date of
acquisition. The Corporation accounts for goodwill pursuant to the
Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Intangible Assets". SFAS No. 142 includes
requirements to test goodwill for impairments rather than to
amortize goodwill. The Corporation has tested the goodwill
included in its consolidated balance sheet at December 31, 2006,
and has determined there was no impairment as of that date.
Intangible assets are comprised of core deposit intangibles
and premium discount (negative premium) on certificates of deposit
acquired in January 2004 when the Bank assumed deposit accounts of
the branch of another financial institution. The core deposit
intangible is being amortized over the average life of the deposits
acquired as determined by an independent third party. Premium
discount (negative premium) on acquired certificates of deposit
resulted from the valuation of certificate of deposit accounts by
an independent third party which were part of the deposit accounts
assumed of the branch by another financial institution. The book
value of certificates of deposit acquired was greater than their
fair value at the date of acquisition which resulted in a negative
premium due to higher cost of the certificates of deposit compared
to the cost of similar term financing.
STOCK BASED COMPENSATION
The Corporation sponsors a stock option plan (see Note 20).
Prior to January 1, 2006 the Corporation had accounted for this
Plan under the fair value recognition and measurement provisions of
Statement of Financial Accounting Standards (SFAS) 123, "Accounting
for Stock Based Compensation". Effective January 1, 2006 the
Corporation adopted SFAS 123 (revised 2004), "Share-Based Payment",
using the modified prospective application method. Based on the
terms of the Plan, the Corporation did not have a cumulative effect
related to the Plan. Since the fair value recognition provisions
of SFAS 123 and SFAS 123R are essentially the same as they relate
to the Corporation's Plan, the adoption of SFAS 123R did not and
will not have a material impact on the Corporation's consolidated
financial condition, results of operations or liquidity. The fair
values of the stock awards are determined using the estimated
expected life. The Corporation recognized stock based compensation
expense on the straight line basis over the period the stock award
is earned by the employee.
PER SHARE DATA
Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings Per Share", requires dual presentation of basic and fully
diluted earnings per share. Basic earnings per share is calculated
by dividing net income by the weighted average number of shares of
common stock outstanding at the end of each period. Diluted
earnings per share is calculated by increasing the denominator for
the assumed conversion of all potentially dilutive securities. The
Corporation's dilutive securities are limited to stock options.
37
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
Per share data has been adjusted retroactively for stock
splits and stock dividends. The reconciliation of the numerators
and denominators of the basis and diluted earnings per share
follows:
Year Ended December 31, 2006
________________________________________
Weighted Average
Net Income Number of Shares Per Share
Numerators Denominators Amount
__________ ____________ ______
<s> <c> <c> <c>
Net income $6,190
======
Basic earnings per
share:
Income available
to common
stockholders $6,190 4,571 $1.35
Effect of dilutive
securities:
Stock options 7
_____
Diluted earnings per
share:
Income available
to common
stockholders $6,190 4,578 $1.35
Year Ended December 31, 2005
________________________________________
Weighted Average
Net Income Number of Shares Per Share
Numerators Denominators Amount
__________ ____________ ______
<s> <c> <c> <c>
Net income $6,847
======
Basic earnings per
share:
Income available
to common
stockholders $6,847 4,613 $1.48
Effect of dilutive
securities:
Stock options 9
_____
Diluted earnings per
share:
Income available
to common
stockholders $6,847 4,622 $1.48
Year Ended December 31, 2004
________________________________________
Weighted Average
Net Income Number of Shares Per Share
Numerators Denominators Amount
__________ ____________ ______
<s> <c> <c> <c>
Net income $6,787
======
Basic earnings per
share:
Income available
to common
stockholders $6,787 4,608 $1.48
Effect of dilutive
securities:
Stock options 16
_____
Diluted earnings per
share:
Income available
to common
stockholders $6,787 4,624 $1.47
CASH FLOW INFORMATION
For purposes of reporting consolidated cash flows, cash and
cash equivalents include cash on hand and due from other banks and
interest bearing deposits in other banks. The Corporation considers
cash classified as interest bearing deposits with other banks as a
cash equivalent since they are represented by cash accounts
essentially on a demand basis.
38
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
TRUST ASSETS AND INCOME
Property held by the Corporation in a fiduciary or agency
capacity for its customers is not included in the accompanying
consolidated financial statements since such items are not assets
of the Corporation. Trust Department income is generally
recognized on a cash basis and is not materially different than if
it were reported on an accrual basis.
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards (SFAS)
158 "Employers' Accounting for Defined Benefit Pension and Other
Post Retirement Plans", which requires the Corporation to recognize
the funded status of a benefit plan as either assets or liabilities
in the consolidated balance sheet and to recognize as a component
of other comprehensive income, net of tax, unrecognized actuarial
gains or losses, prior service costs and transition obligations
that arise during the period. The adoption of SFAS 158 for year
ended December 31, 2006 did not have a material impact on the
Corporation's consolidated financial position, results of
operations, or liquidity.
In September 2006, the FASB issued Statement of Financial
Accounting Standards (SFAS) 157, "Fair Value Measurements", which
upon adoption will replace various definitions of fair value in
existing accounting literature with a single definition, will
establish a framework for measuring fair value, and will require
additional disclosures about fair value measurements. The statement
clarifies that fair value is the price that would be received to
sell an asset or the price paid to transfer a liability in the most
advantageous market available to the entity and emphasizes that
fair value is a market based measurement and should be based on the
assumptions market participants would use. The statement also
creates a three-level hierarchy under which individual fair value
estimates are to be ranked based on the relative reliability of the
inputs used in the valuation. This hierarchy is the basis for the
disclosure requirements, with fair value estimates based on the
least reliable inputs requiring more extensive disclosures about
the valuation method used and the gains and losses associated with
those estimates. SFAS 157 is required to be applied whenever
another financial accounting standard requires or permits an asset
or liability to be measured at fair value. The statement does not
expand the use of fair value to any new circumstances. The
Corporation will be required to apply the new guidance beginning
January 1, 2008, and does not expect it to have a material impact
on the Corporation's consolidated financial condition, results of
operations, or liquidity.
In July 2006, the FASB issued FASB Staff Position (FSP) 13-2,
"Accounting for a Change or Projected Change in the Timing of Cash
Flows Related to Income Taxes Generated by a Leveraged Lease
Transaction". This FSP amends SFAS 13, "Accounting for Leases", to
require a lessor in a leveraged lease transaction to recalculate
the leveraged lease for the effects of a change or projected change
in the timing of cash flows relating to income taxes that are
generated by the leveraged lease. The guidance in FSP 13-2 is
required to be applied to fiscal years beginning after December 15,
2006. The application of this FSP is not expected to have a
material impact on the Corporation's consolidated financial
condition, results of operations, or liquidity.
In June 2006, the FASB issued Interpretation No. 48 (FIN 48),
"Accounting for Uncertainty in Income Taxes", an interpretation of
SFAS 109, "Accounting for Income Taxes". FIN 48 prescribes a
comprehensive model for how companies should recognize, measure,
present, and disclose in their financial statements uncertain tax
positions taken or expected to be taken on a tax return. Under FIN
48, tax positions shall initially be recognized in the financial
statements when it is more likely than not the position will be
sustained upon examination by the tax authorities. Such tax
positions shall initially and subsequently be measured as the
largest amount of tax benefit that is greater than 50% likely of
being realized upon ultimate settlement with the tax authority
assuming full knowledge of the position and all relevant facts. FIN
48 also revises disclosure requirements to include an annual
tabular roll forward of unrecognized tax benefits. The provisions
of this interpretation are required to be adopted for fiscal
periods beginning after December 15, 2006. The Corporation will be
required to apply the provisions of FIN 48 to all tax positions
upon initial adoption with any cumulative effect adjustment to be
recognized as an adjustment to retained earnings. The adoption of
FIN 48 is not expected to have a material impact on the
Corporation's consolidated financial condition, result of
operations, or liquidity.
In March 2006, the FASB issued Statement of Financial
Accounting Standards (SFAS) 156, "Accounting for Servicing of
Financial Assets", an amendment of SFAS 140. This standard requires
entities to separately recognize a servicing asset or liability
whenever it undertakes an obligation to service financial assets
and also requires all separately recognized servicing assets or
liabilities to be initially measured at fair value. Additionally,
this standard permits entities to choose among two alternatives,
the amortization method or fair value measurement method, for the
subsequent measurement of each class of separately recognized
39
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
servicing assets and liabilities. Under the amortization method, an
entity shall amortize the value of servicing assets or liabilities
in proportion to and over the period of estimated net servicing
income or net servicing loss and assess servicing assets or
liabilities for impairment or increased obligation based on fair
value at each reporting date. Under the fair value measurement
method, an entity shall measure servicing assets or liabilities at
fair value at each reporting date and report changes in fair value
in earnings in the period in which the changes occur.
Effective January 1, 2006, the Corporation adopted this
statement by electing amortization method as the measurement method
for residential real estate mortgage servicing rights (MSRs).
In February 2006, the FASB issued Statement of Financial
Accounting Standards (SFAS) 155, "Accounting for Certain Hybrid
Financial Instruments", which amends SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities", and SFAS 140,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". SFAS 155 requires entities to
evaluate and identify whether interests in securitized financial
assets are freestanding derivatives, hybrid financial instruments
that contain an embedded derivative requiring bifurcation, or
hybrid financial instruments that contain embedded derivatives that
do not require bifurcation. SFAS 155 also permits fair value
measurement for any hybrid financial instrument that contains an
embedded derivative that otherwise would require bifurcation. This
statement will be effective for all financial instruments acquired
or issued by the Corporation on or after January 1, 2007 and is not
expected to have a material impact on the Corporation's
consolidated financial condition, results of operations, or
liquidity.
In November 2005, the Financial Accounting Standards Board
(FASB) issued FASB Staff Position (FSP) 115 - "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments". This FSP provides additional guidance on when an
investment in a debt or equity security should be considered
impaired and when that impairment should be considered other than
temporary and recognized as a loss in the consolidated statement of
income. Specifically, this guidance clarifies that an investor
should recognize an impairment loss no later than when an
impairment is deemed other than temporary, even if the decision to
sell has not been made. The FSP also requires certain disclosures
about unrealized losses that have not been recognized as other than
temporary impairments. The Corporation has followed the guidance of
this FSP in 2005 and 2006.
In May 2005, the FASB issued Statement of Financial Accounting
Standards (SFAS) 154, "Accounting Charges and Error Corrections",
which modifies the accounting for and reporting of a change in an
accounting principle. This statement applies to all voluntary
changes in accounting principles and changes required by an
accounting pronouncement in the unusual instance that the
pronouncement does not include specified transition provisions.
This statement also requires retrospective application to prior
period financial statements of changes in accounting principles,
unless it is impractical to determine either the period-specific or
cumulative effects of the accounting change. SFAS 154 is effective
for accounting changes made in fiscal years beginning after
December 15, 2005. The adoption of SFAS 154 is not expected to have
a material impact on the Corporation's consolidated financial
condition, results of operations, or liquidity.
In December 2004, the FASB issued Statement of Financial
Accounting Standards (SFAS) 153, "Exchanges of Nonmonetary Assets",
which amends APB Opinion No. 29, "Accounting for Nonmonetary
Transactions". SFAS 153 eliminates the exception from fair value
measurement for nonmonetary exchanges of similar productive assets
in Opinion No. 29 and replaces it with an exception for exchanges
that do not have commercial substance. SFAS 153 specifies that a
nonmonetary exchange has commercial substance if the future cash
flows of the entity are expected to change significantly as a
result of the exchange. SFAS 153 is effective for nonmonetary
exchanges occurring in fiscal periods beginning after June 15,
2005. The adoption of SFAS No. 153 is not expected to have a
material impact on the Corporation's consolidated financial
condition, results of operations, or liquidity.
In December 2004, the FASB issued Statement of Financial
Accounting Standards (SFAS) 123 (revised 2004), "Share-Based
Payment". This Statement is a revision of SFAS 123, "Accounting
for Stock-Based Compensation", and supercedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees", and its related
guidance. SFAS 123 (revised 2004) established standards for the
accounting for transactions in which an entity exchanges its equity
instruments for goods and services. This Statement requires that
the cost resulting from all share based payment transactions be
recognized in the financial statements. This Statement establishes
fair value as the measurement objective in accounting for share
based payment arrangements and requires all entities to apply a
fair value based measurement method in accounting for share based
payment transactions with employees, except for equity instruments
held by employee share ownership plans.
40
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
In addition, this statement amends SFAS 95, "Statement of Cash
Flows", to require that excess tax benefits be reported as
financing cash inflow rather than as a reduction of taxes paid. The
Corporation has adopted these statements as of January 1, 2006.
SFAS 123R requires the Corporation to change its method of
accounting for share based awards to include estimated forfeitures
in the initial estimate of compensation expense and to accelerate
the recognition of compensation expense for retiree eligible
employees. The adoption of these standards did not have a material
effect on the Corporation's consolidated financial condition,
results of operations, or liquidity.
ADVERTISING COSTS
It is the Corporation's policy to expense advertising costs in
the period in which they are incurred. Advertising expense for the
years ended December 31, 2006, 2005 and 2004, was approximately
$246,000, $219,000 and $305,000, respectively.
RECLASSIFICATIONS
Certain amounts in the consolidated financial statements of
prior periods have been reclassified to conform with presentation
used in the 2006 consolidated financial statements. Such
reclassifications have no effect on the Corporation's consolidated
financial condition or net income.
NOTE 2 - RESTRICTED CASH BALANCES
The Bank is required to maintain certain average reserve
balances as established by the Federal Reserve Bank. The amount of
those reserve balances for the reserve computation period which
included December 31, 2006, was $911,000, which was satisfied
through the restriction of vault cash. In addition, the Bank
maintains a clearing balance at the Federal Reserve Bank to offset
specific charges for services. At December 31, 2006, the amount of
this balance was $700,000.
NOTE 3 - INVESTMENT SECURITIES
The amortized cost, related estimated fair value, and
unrealized gains and losses for investment securities classified as
"Available For Sale" or "Held to Maturity" were as follows at
December 31, 2006 and 2005:
(Amounts in thousands) Available-for-Sale Securities
_____________________________
Gross
Amortized Unrealized
Cost Gains
_________ __________
<s> <c> <c>
December 31, 2006:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $133,786 $ 209
Other 20,933 51
Obligations of state and
political subdivisions 73,058 770
Corporate securities 1,936 83
Marketable equity securities 2,782 955
Restricted equity securities 4,612 -
________ ______
Total $237,107 $2,068
======== ======
(Amounts in thousands) Available-for-Sale Securities
_____________________________
Gross Estimated
Unrealized Fair
Losses Value
_________ __________
<s> <c> <c>
December 31, 2006:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $1,514 $132,481
Other 254 20,730
Obligations of state and
political subdivisions 372 73,456
Corporate securities - 2,019
Marketable equity securities 26 3,711
Restricted equity securities - 4,612
______ ________
Total $2,166 $237,009
====== ========
41
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
(Amounts in thousands) Held-to-Maturity Securities
_____________________________
Gross
Amortized Unrealized
Cost Gains
_________ __________
<s> <c> <c>
December 31, 2006:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $ 204 $ -
Other 4,000 14
Obligations of state and
political subdivisions 2,725 -
______ ___
Total $6,929 $14
====== ===
(Amounts in thousands) Held-to-Maturity Securities
_____________________________
Gross Estimated
Unrealized Fair
Losses Value
_________ __________
<s> <c> <c>
December 31, 2006:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $ 2 $ 202
Other 3 4,011
Obligations of state and
political subdivisions 30 2,695
___ ______
Total $35 $6,908
=== ======
(Amounts in thousands) Available-for-Sale Securities
_____________________________
Gross
Amortized Unrealized
Cost Gains
_________ __________
<s> <c> <c>
December 31, 2005:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $129,585 $ 81
Other 15,000 -
Obligations of state and
political subdivisions 82,262 2,369
Corporate securities 12,448 250
Marketable equity securities 1,874 1,120
Restricted equity securities 4,787 -
________ ______
Total $245,956 $3,820
======== ======
(Amounts in thousands) Available-for-Sale Securities
_____________________________
Gross Estimated
Unrealized Fair
Losses Value
_________ __________
<s> <c> <c>
December 31, 2005:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $1,987 $127,679
Other 276 14,724
Obligations of state and
political subdivisions 197 84,434
Corporate securities - 12,698
Marketable equity securities 28 2,966
Restricted equity securities - 4,787
______ ________
Total $2,488 $247,288
====== ========
(Amounts in thousands) Held-to-Maturity Securities
_____________________________
Gross
Amortized Unrealized
Cost Gains
_________ __________
<s> <c> <c>
December 31, 2005:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $ 524 $-
Other 1,000 -
Obligations of state and
political subdivisions 2,724 6
______ __
Total $4,248 $6
====== ==
(Amounts in thousands) Held-to-Maturity Securities
_____________________________
Gross Estimated
Unrealized Fair
Losses Value
_________ __________
<s> <c> <c>
December 31, 2005:
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed $ 6 $ 518
Other 6 994
Obligations of state and
political subdivisions 25 2,705
___ ______
Total $37 $4,217
=== ======
Securities Available for Sale with an aggregate fair value of
$64,191,000 in 2006 and $53,177,000 in 2005; and securities Held to
Maturity with an aggregate fair value of $1,813,000 in 2006 and
$2,138,000 in 2005, were pledged to secure public funds, trust
funds, securities sold under agreements to repurchase, FHLB
advances and other balances of $54,569,000 in 2006 and $36,120,000
in 2005 as required by law.
The amortized cost, estimated fair value and weighted average
yield of debt securities, by contractual maturity, are shown below
at December 31, 2006. Expected maturities will differ from
contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
42
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
(Amounts in thousands)
December 31, 2006
_________________________________
U.S. Government Obligations
Agency & of State
Corporation & Political
Obligations Subdivisions
<F1> <F2>
___________ ____________
<s> <c> <c>
Available-For-Sale:
Within 1 Year:
Amortized cost $ - $ -
Estimated fair value - -
Weighted average yield - -
1 - 5 Years:
Amortized cost 2,424 -
Estimated fair value 2,406 -
Weighted average yield 4.76% -
5 - 10 Years:
Amortized cost 34,663 3,918
Estimated fair value 34,102 3,910
Weighted average yield 4.95% 5.61%
After 10 Years:
Amortized cost 117,632 69,140
Estimated fair value 116,703 69,546
Weighted average yield 5.50% 6.33%
________ _______
Total:
Amortized cost $154,719 $73,058
Estimated fair value 153,211 73,456
Weighted average yield 5.37% 6.29%
(Amounts in thousands)
December 31, 2006
_____________________________
Marketable Restricted
Equity Equity
Securities Securities
<F3> <F3>
__________ __________
<s> <c> <c>
Available-For-Sale:
Within 1 Year:
Amortized cost $ - $ -
Estimated fair value - -
Weighted average yield - -
1 - 5 Years:
Amortized cost - -
Estimated fair value - -
Weighted average yield - -
5 - 10 Years:
Amortized cost - -
Estimated fair value - -
Weighted average yield - -
After 10 Years:
Amortized cost 2,782 4,612
Estimated fair value 3,711 4,612
Weighted average yield 3.83% 5.10%
______ ______
Total:
Amortized cost $2,782 $4,612
Estimated fair value 3,711 4,612
Weighted average yield 3.83% 5.10%
(Amounts in thousands)
December 31, 2006
___________________________
Corporate
Securities
_________
<s> <c>
Available-For-Sale:
Within 1 Year:
Amortized cost $ -
Estimated fair value -
Weighted average yield -
1 - 5 Years:
Amortized cost 1,936
Estimated fair value 2,019
Weighted average yield 7.71%
5 - 10 Years:
Amortized cost -
Estimated fair value -
Weighted average yield -
After 10 Years:
Amortized cost -
Estimated fair value -
Weighted average yield -
_______
Total:
Amortized cost $1,936
Estimated fair value 2,019
Weighted average yield 7.71%
_______________________
<FN>
<F1>
Mortgage-backed securities are allocated for maturity reporting at their
original maturity date.
<F2>
Average yields on tax-exempt obligations of state and political
subdivisions have been computed on a tax equivalent basis using a 34% tax
rate.
<F3>
Marketable equity securities and restricted equity securities are not
considered to have defined maturities and are included in the after ten
year category.
</FN>
43
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
(Amounts in thousands)
December 31, 2006
_________________________________
U.S. Government Obligations
Agency & of State
Corporation & Political
Obligations Subdivisions
<F1> <F2>
___________ ____________
<s> <c> <c>
Held-To-Maturity:
Within 1 Year:
Amortized cost $ - $ -
Estimated fair value - -
Weighted average yield - -
1 - 5 Years:
Amortized cost 1,000 630
Estimated fair value 1,000 612
Weighted average yield 5.24% 4.50%
5 - 10 Years:
Amortized cost 3,000 1,095
Estimated fair value 3,011 1,085
Weighted average yield 6.00% 5.10%
After 10 Years:
Amortized cost 204 1,000
Estimated fair value 202 998
Weighted average yield 5.42% 5.83%
______ ______
Total:
Amortized cost $4,204 $2,725
Estimated fair value 4,213 2,695
Weighted average yield 5.79% 5.23%
(Amounts in thousands)
December 31, 2006
_____________________________
Marketable Restricted
Equity Equity
Securities Securities
<F3> <F3>
__________ __________
<s> <c> <c>
Held-To-Maturity:
Within 1 Year:
Amortized cost $ - $ -
Estimated fair value - -
Weighted average yield - -
1 - 5 Years:
Amortized cost - -
Estimated fair value - -
Weighted average yield - -
5 - 10 Years:
Amortized cost - -
Estimated fair value - -
Weighted average yield - -
After 10 Years:
Amortized cost - -
Estimated fair value - -
Weighted average yield - -
______ ______
Total:
Amortized cost $ - $ -
Estimated fair value - -
Weighted average yield - -
(Amounts in thousands)
December 31, 2006
____________________________
Corporate
Securities
__________
<s> <c>
Held-To-Maturity:
Within 1 Year:
Amortized cost $ -
Estimated fair value -
Weighted average yield -
1 - 5 Years:
Amortized cost -
Estimated fair value -
Weighted average yield -
5 - 10 Years:
Amortized cost -
Estimated fair value -
Weighted average yield -
After 10 Years:
Amortized cost -
Estimated fair value -
Weighted average yield -
______
Total:
Amortized cost $ -
Estimated fair value -
Weighted average yield -
_______________________
<FN>
<F1>
Mortgage-backed securities are allocated for maturity reporting at their
original maturity date.
<F2>
Average yields on tax-exempt obligations of state and political
subdivisions have been computed on a tax equivalent basis using a 34% tax
rate.
<F3>
Marketable equity securities and restricted equity securities are not
considered to have defined maturities and are included in the after ten
year category.
</FN>
Restricted equity securities consist of stock in the Federal
Home Loan Bank of Pittsburgh (FHLB), Federal Reserve Bank (FRB) and
Atlantic Central Bankers Bank (ACBB) and do not have a readily
determinable fair value for purposes of SFAS 115, because their
ownership is restricted and they can be sold back only to the FHLB,
FRB, ACBB or to another member institution. Therefore, these
securities are classified as restricted equity investment
securities, carried at cost, and evaluated for impairment.
There were no aggregate investments with a single issuer
(excluding the U.S. Government and its agencies) which exceeded ten
percent of consolidated shareholders' equity at December 31, 2006.
The quality rating of all obligations of state and political
subdivisions are "A" or higher, as rated by Moody's or Standard and
Poors. The only exceptions are local issues which are not rated,
but are secured by the full faith and credit obligations of the
communities that issued these securities. All of the state and
political subdivision investments are actively traded in a liquid
market.
Proceeds from sale of investments in Available for Sale debt
and equity securities during 2006, 2005 and 2004 were $103,736,000,
$119,669,000 and $68,654,000, respectively. Gross gains realized on
these sales were $1,441,000, $2,242,000 and $2,547,000,
respectively. Gross losses on these sales were $1,054,000,
$1,822,000 and $1,467,000, respectively.
44
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
Proceeds from sale of investments in Held To Maturity debt and
equity securities during 2006, 2005, and 2004 were $201,000, $0 and
$2,199,000, respectively. Gross losses on these sales were $6,000,
$0 and $57,000, respectively and there were no gains realized
during these periods.
In accordance with disclosures required by EITF No. 03-1, the
summary below shows the gross unrealized losses and fair value of
the Bank's investments, aggregated by investment category, that
individual securities have been in a continuous unrealized loss
position for less than 12 months or more than 12 months as of
December 31, 2006 and 2005:
December 31, 2006
Less Than 12 Months
_______________________
Fair Unrealized
(Amounts in thousands) Value Loss
_____ ____
<s> <c> <c>
Direct obligations of the
U.S. Government $ 1,000 $ -
Federal Agency Mortgage
Backed Securities 27,426 145
Municipal Bonds 31,258 313
Equities 381 26
_______ ____
$60,065 $484
======= ====
December 31, 2006
12 Months or More
_____________________
Fair Unrealized
(Amounts in thousands) Value Loss
_____ ____
<s> <c> <c>
Direct obligations of the
U.S. Government $15,743 $ 257
Federal Agency Mortgage
Backed Securities 53,837 1,371
Municipal Bonds 5,113 89
Equities - -
_______ ______
$74,693 $1,717
======= ======
December 31, 2006
Total
_______________________
Fair Unrealized
(Amounts in thousands) Value Loss
_____ ____
<s> <c> <c>
Direct obligations of the
U.S. Government $ 16,743 $ 257
Federal Agency Mortgage
Backed Securities 81,263 1,516
Municipal Bonds 36,371 402
Equities 381 26
________ ______
$134,758 $2,201
======== ======
December 31, 2005
Less Than 12 Months
_______________________
Fair Unrealized
(Amounts in thousands) Value Loss
_____ ____
<s> <c> <c>
Direct obligations of the
U.S. Government $ 15,718 $ 282
Federal Agency Mortgage
Backed Securities 107,756 1,643
Municipal Bonds 14,160 155
Equities 385 24
________ ______
$138,019 $2,104
======== ======
December 31, 2005
12 Months or More
_____________________
Fair Unrealized
(Amounts in thousands) Value Loss
_____ ____
<s> <c> <c>
Direct obligations of the
U.S. Government $ - $ -
Federal Agency Mortgage
Backed Securities 9,148 351
Municipal Bonds 3,039 66
Equities 198 4
_______ ____
$12,385 $421
======= ====
December 31, 2005
Total
_______________________
Fair Unrealized
(Amounts in thousands) Value Loss
_____ ____
<s> <c> <c>
Direct obligations of the
U.S. Government $ 15,718 $ 282
Federal Agency Mortgage
Backed Securities 116,904 1,994
Municipal Bonds 17,199 221
Equities 583 28
________ ______
$150,404 $2,525
======== ======
The Corporation invests in various forms of agency debt
including mortgage backed securities and callable debt. The
mortgage backed securities are issued by FHLMC (Federal Home Loan
Mortgage Corporation) of FNMA (Federal National Mortgage
Association). The municipal securities consist of general
obligations and revenue bonds. The equity securities consist of
FHLMC preferred stocks. The fair market value of the above
securities is influenced by market interest rates, prepayment
speeds on mortgage securities, bid to offer spreads in the market
place and credit premiums for various types of agency debt. These
factors change continuously and therefore the market value of these
securities may be higher or lower that the Corporation's carrying
value at any measurement date. Management does not believe any of
their 117 securities in an unrealized position as of December 31,
2006 represents an other than temporary impairment. The Corporation
has the ability to hold the securities contained in the above table
for a time necessary to recover the cost.
45
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
NOTE 4 - LOANS
Major classifications of loans at December 31, 2006 and 2005
consisted of:
(Amounts in thousands)
2006 2005
____ ____
<s> <c> <c>
Commercial, Financial, and
Agricultural $ 22,169 $ 29,284
Tax-exempt 3,264 3,840
Real estate mortgage - Held-for-sale 3,829 2,247
Real estate mortgage - Other 206,052 183,523
Consumer 18,728 18,467
________ ________
Gross loans $254,042 $237,361
Add (deduct): Unearned discount (2,543) (2,981)
Net deferred loan
fees and costs 258 213
________ ________
Loans, net of unearned income $251,757 $234,593
======== ========
Changes in the allowance for loan losses for the years ended
December 31, 2006, 2005 and 2004, were as follows:
(Amounts in thousands)
2006 2005 2004
____ ____ ____
<s> <c> <c> <c>
Balance, January 1 $3,676 $3,828 $3,524
Provision charged to operations 500 750 1,750
Loans charged off (786) (933) (1,484)
Recoveries 281 31 38
------ ______ ______
Balance, December 31 $3,671 $3,676 $3,828
====== ====== ======
Non-accrual loans at December 31, 2006, 2005 and 2004 were
$1,704,000, $2,069,000 and $3,405,000, respectively. The gross
interest that would have been recorded if these loans had been
current in accordance with their original terms and the amounts
actually recorded in income were as follows:
(Amounts in thousands)
2006 2005 2004
____ ____ ____
<s> <c> <c> <c>
Gross interest due under terms $133 $149 $253
Amount included in income (14) (57) (113)
____ ____ ____
Interest income not recognized $119 $ 92 $140
==== ==== ====
At December 31, 2006, 2005 and 2004 the recorded investment in
loans that are considered to be impaired as defined by SFAS 114 was
$1,704,000, $2,069,000 and $3,405,000, respectively. No additional
charge to operations was required to provide for the impaired loans
allowance of $131,000, $327,000 and $246,000, respectively at
December 31, 2006, 2005 and 2004, since the total allowance for
loan losses is estimated by management to be adequate to provide
for the loan loss allowance required by SFAS 114 along with any
other potential losses. The average recorded investment in impaired
loans during the year ended December 31, 2006, 2005 and 2004 was
approximately $1,937,000, $2,187,000 and $2,397,000, respectively.
Loans past due 90 days or more and still accruing interest
were $1,135,000 at December 31, 2006 and $64,000 at December 31,
2005.
At December 31, 2006, there were no significant commitments to
lend additional funds with respect to non accrual and restructured
loans.
46
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
NOTE 5 - MORTGAGE SERVICING RIGHTS
The mortgage loans sold serviced for others are not included
in the accompanying consolidated balance sheets. The unpaid
principal balances of mortgage loans serviced for others were
$35,966,000 and $34,117,000 at December 31, 2006 and 2005,
respectively. The balances of amortized capitalized mortgage
servicing rights, net of valuation allowances, included in other
assets at December 31, 2006 and 2005, were $254,000 and $255,000,
respectively. A valuation allowance is provided when the carrying
amount exceeds fair value determined by using a discount rate of
7.6% and average lives of generally 3 to 13 years depending on loan
rates.
The following summarizes mortgage servicing rights capitalized
and amortized along with the aggregate activity in the related
valuation allowances:
(Amounts in thousands)
2006 2005 2004
____ ____ ____
<s> <c> <c> <c>
Balance, January 1 $268 $297 $255
Servicing asset additions 43 28 95
Amortization (57) (57) (53)
____ ____ ____
Balance, December 31 $254 $268 $297
____ ____ ____
Valuation Allowances:
Balance, January 1 $ 13 $ 47 $ 53
Additions - - -
Reductions (13) (34) (6)
Writedowns - - -
____ ____ ____
Balance, December 31 $ - $ 13 $ 47
____ ____ ____
Net Mortgage Servicing Rights $254 $255 $250
==== ==== ====
Custodial escrow balances maintained in connection with the
foregoing loan servicing, and included in demand deposits, were
approximately $26,000 and $16,000 at December 31, 2006 and 2005,
respectively.
NOTE 6 - PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 2006 and
2005 follows:
(Amounts in thousands)
2006 2005
____ ____
<s> <c> <c>
Land $ 1,055 $ 1,055
Buildings 4,494 4,472
Leasehold improvements 214 214
Equipment 5,332 5,323
_______ _______
11,095 11,064
Less: Accumulated depreciation 6,079 5,973
_______ _______
Total $ 5,016 $ 5,091
====== ======
Depreciation amounted to $442,000 for 2006, $455,000 for 2005
and $574,000 for 2004.
47
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
NOTE 7 - GOODWILL, OTHER INTANGIBLE ASSETS,
AND PREMIUM DISCOUNTS
Goodwill, other intangible assets, and premium discounts were
comprised of the following at December 31, 2006 and 2005:
(Amounts in thousands)
Gross Carrying Amount
_____________________
2006 2005
____ ____
<s> <c> <c>
Unamortized intangible asset:
Goodwill $1,224 $1,224
====== ======
Core deposit intangible $ 137 $ 137
====== ======
Premium discount (negative
premium) on acquired
certificates of deposit $ (217) $ (217)
====== ======
(Amounts in thousands)
Accumulated
Amortization/(Accretion)
________________________
2006 2005
____ ____
<s> <c> <c>
Unamortized intangible asset:
Goodwill $ - $ -
===== =====
Core deposit intangible $ 48 $ 32
===== =====
Premium discount (negative
premium) on acquired
certificates of deposit $(216) $(201)
===== =====
Amortization expense of the core deposit intangible was
$16,000 for each of the years ended December 31, 2006, 2005 and
2004 and accretion of the premium discount (negative premium) of
the acquired certificates of deposit was $15,000, $89,000 and
$112,000 for the years ended December 31, 2006, 2005 and 2004,
respectively.
Estimated amortization/accretion is as follows for the years
ending December 31:
(Amounts in thousands)
Amortization Accretion of Premium Discount
of Core (Negative Premium)
Deposit Intangible on Certificates of Deposit
__________________ __________________________
<s> <c> <c>
2007 $16 $(1)
2008 16 -
2009 16 -
2010 16 -
2011 16 -
NOTE 8 - DEPOSITS
Major classifications of deposits at December 31, 2006 and
2005 consisted of:
(Amounts in thousands)
2006 2005
____ ____
<s> <c> <c>
Demand - non-interest bearing $ 41,361 $ 39,664
Demand - interest bearing 68,593 55,001
Savings 69,950 67,377
Time, $100,000 and over 47,703 42,203
Other time 156,413 158,551
________ ________
Total deposits $384,020 $362,796
======== ========
48
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
The following is a schedule reflecting classification and
remaining maturities of time deposits of $100,000 and over at
December 31, 2006:
(Amounts in thousands)
<s> <c>
2007 $39,103
2008 4,689
2009 1,463
2010 563
2011 1,885
_______
$47,703
=======
Interest expense related to time deposits of $100,000 or more
was $1,907,000 in 2006, $1,330,000 in 2005, and $1,095,000 in 2004.
In January 2004, approximately $10,350,000 of deposit accounts
were assumed from the branch of another financial institution (See
Note 12).
NOTE 9 - SHORT-TERM BORROWINGS
Federal funds purchased, securities sold under agreements to
repurchase and Federal Home Loan Bank advances generally represent
overnight or less than 30-day borrowings. U.S. Treasury tax and
loan notes for collections made by the Bank are payable on demand.
Short-term borrowings consisted of the following at December 31,
2006 and 2005:
(Amounts in thousands)
2006
_______________________________________
Maximum
Ending Average Month End Average
Balance Balance Balance Rate
______ ______ ______ ____
<s> <c> <c> <c> <c>
Federal funds purchased
and securities sold
under agreements to
repurchase $15,688 $13,411 $16,138 4.04%
Federal Reserve -
Discount Window 0 4 0 6.25%
Federal Home Loan Bank 11,000 6,525 13,325 5.06%
U.S. Treasury tax and
loan notes 1,491 367 1,491 5.83%
_______ _______ _______
Total $28,179 $20,307 $30,954 5.10%
======= ======= =======
(Amounts in thousands)
2005
_______________________________________
Maximum
Ending Average Month End Average
Balance Balance Balance Rate
______ ______ ______ ____
<s> <c> <c> <c> <c>
Federal funds purchased
and securities sold
under agreements to
repurchase $11,295 $10,770 $13,774 2.97%
Federal Home Loan Bank 15,900 4,705 15,900 3.56%
U.S. Treasury tax and
loan notes 956 334 1,092 3.54%
_______ _______ _______
Total $28,151 $15,809 $30,766 3.56%
======= ======= =======
49
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
NOTE 10 - LONG-TERM BORROWINGS
Long-term borrowings are comprised of advances from the
Federal Home Loan Bank (FHLB). Under terms of a blanket agreement,
collateral for the loans is secured by certain qualifying assets of
the Corporation's banking subsidiary. The principal assets are
real estate mortgages with a carrying value of $230,910,000 and
certain investment securities with a carrying value of $91,399,000
at December 31, 2006.
A schedule of long-term borrowings by maturity as of December
31, 2006 and 2005 follows:
(Amounts in thousands)
2006 2005
____ ____
<s> <c> <c>
Due 2006, 2.46% to 4.18% $ - $11,000
Due 2007, 3.09% to 3.91% 10,255 10,255
Due 2008, 3.54% to 5.48% 9,030 9,030
Due 2009, 3.87% to 5.01% 7,000 2,000
Due 2010, 5.45% to 6.76% 15,500 15,500
Due 2011, 4.23% to 5.03% 7,000 9,000
Due 2012, 4.77% 5,000 5,000
Due 2014, 5.41% 3,750 3,750
_______ _______
$57,535 $65,535
======= =======
NOTE 11 - INCOME TAXES
The current and deferred components of the income tax
provision (benefit) consisted of the following:
(Amounts in thousands)
2006 2005 2004
____ ____ ____
<s> <c> <c> <c>
Federal
Current $1,417 $1,389 $1,775
Deferred (benefit) (263) (49) (155)
______ ______ ______
$1,154 $1,340 $1,620
______ ______ ______
State
Current $ 34 $ 23 $ 41
Deferred - - 2
______ ______ ______
$ 34 $ 23 $ 43
______ ______ ______
Total provision for
income taxes $1,188 $1,363 $1,663
====== ====== ======
The following is a reconciliation between the actual provision
for federal income taxes and the amount of federal income taxes
which would have been provided at the statutory rate of 34%:
(Amounts in thousands) 2006
________________
Amount Rate
______ ____
<s> <c> <c>
Provision at statutory rate $2,508 34.0%
Tax-exempt income (1,276) (17.3)
Non-deductible expenses 176 2.4
Tax credit from limited partnership
Less amortization - net (62) (.8)
Bank owned life insurance income - net (160) (2.2)
Other-net (32) (.5)
______ ____
Applicable federal income tax and rate $1,154 15.6%
====== ====
(Amounts in thousands) 2005
________________
Amount Rate
______ ____
<s> <c> <c>
Provision at statutory rate $2,792 34.0%
Tax-exempt income (1,374) (16.7)
Non-deductible expenses 161 2.0
Tax credit from limited partnership
Less amortization - net (64) (.8)
Bank owned life insurance income - net (149) (1.8)
Other-net (26) (.4)
______ ____
Applicable federal income tax and rate $1,340 16.3%
====== ====
(Amounts in thousands) 2004
________________
Amount Rate
______ ____
<s> <c> <c>
Provision at statutory rate $2,873 34.0%
Tax-exempt income (1,107) (13.1)
Non-deductible expenses 125 1.5
Tax credit from limited partnership
Less amortization - net (67) (.8)
Bank owned life insurance income - net (152) (1.8)
Other, net (52) (.6)
______ ____
Applicable federal income tax and rate $1,620 19.2%
====== ====
50
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
Total federal income tax attributable to realized security
gains and losses was $130,000 in 2006, $143,000 in 2005 and
$367,000 in 2004.
The deferred tax assets and liabilities resulting from
temporary timing differences have been netted to reflect a net
deferred tax asset (liability) included in other assets or other
liabilities in these consolidated financial statements. The
components of the net deferred tax asset (liability) at December
31, 2006 and 2005, are as follows:
(Amounts in thousands)
2006 2005
____ ____
<s> <c> <c>
Deferred Tax Assets:
Allowance for loan losses $1,145 $ 1,117
Deferred compensation 339 318
Deferred health benefits 4 6
Contributions 9 12
Non-accrual interest 3 5
Mortgage servicing rights - -
Limited partnership 58 41
Alternative minimum tax credit 85 47
Tax credits from limited partnerships 147 19
______ _______
Total $1,790 $ 1,565
______ _______
Deferred Tax Liabilities:
Loan fees and costs $ (195) $ (205)
Depreciation (229) (279)
Accretion (80) (87)
Mortgage servicing rights (11) (8)
Intangibles (135) (109)
Unrealized investment securities gains (28) (525)
______ _______
Total $ (678) $(1,213)
______ _______
Net Deferred Tax Asset (Liability) $1,112 $ 352
====== =======
It is anticipated that all deferred tax assets are to be
realized and accordingly, no valuation allowance has been provided.
The Corporation and its subsidiary file a consolidated federal
income tax return.
NOTE 12 - SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
During the years ended December 31, 2006, 2005 and 2004, cash
payments for interest expense and income taxes were as follows:
(Amounts in thousands)
2006 2005 2004
____ ____ ____
<s> <c> <c> <c>
Interest paid on deposits
and other borrowings $14,784 $11,401 $9,994
Income taxes paid $ 1,380 $ 921 $2,147
The Corporation transferred loans to foreclosed assets held
for sale in amounts of $28,000, $457,000 and $0 in 2006, 2005 and
2004, respectively.
51
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
NON-CASH INVESTING ACTIVITIES
In January 2004, the Bank acquired certain property and
operating assets and assumed the deposit accounts of the branch of
another financial institution located in Danville, Pennsylvania. A
summary of the estimated fair values of the assets acquired and the
deposit accounts assumed at the date of acquisition were as
follows:
(Amounts in thousands)
<s> <c>
Assets Acquired:
Branch real estate and equipment $ 900
Goodwill and other intangible assets 1,360
_______
Total non-cash assets acquired $ 2,260
_______
Liabilities Assumed:
Deposit accounts $10,344
Premium discount (negative premium)
on certificates of deposit 217
_______
Total liabilities assumed $10,561
_______
Net cash to be received for excess of
liabilities assumed over
non-cash assets acquired $ 8,301
Pre-settlement advance received in
December 2003 8,715
_______
Cash paid at closing of acquisition in
January 2004 $ 414
=======
NOTE 13 - EMPLOYEE BENEFIT PLANS AND DEFERRED
COMPENSATION AGREEMENTS
The Corporation maintains a 401K Plan which has a combined tax
qualified savings feature and profit sharing feature for the
benefit of its employees. Under the savings feature, the
Corporation matches 100% of the employee contribution up to 3% of
compensation which amounted to $102,000, $99,000 and $101,000, in
2006, 2005 and 2004, respectively. Under the profit sharing
feature, contributions, at the discretion of the Board of
Directors, are funded currently and amounted to $263,000, $301,000
and $288,000 in 2006, 2005 and 2004, respectively.
The Bank also has non qualified deferred compensation
agreements with one of its officers and three retired officers.
These agreements are essentially unsecured promises by the Bank to
make monthly payments to the officers over a twenty year period.
Payments begin based upon specific criteria - generally, when the
officer retires. To account for the cost of payments yet to be made
in the future, the Bank recognizes an accrued liability in years
prior to when payments begin based on the present value of those
future payments. The Bank's accrued liability for these deferred
compensation agreements as of December 31, 2006 and 2005, was
$998,000 and $934,000, respectively. The related expense for these
plans amounted to $108,000, $179,000 and $167,000 in 2006, 2005 and
2004, respectively.
NOTE 14 - COMMITMENTS AND CONTINGENCIES
The Corporation's banking subsidiary currently leases three
branch banking facilities, as well as the operations center
adjoining the main bank office, under operating leases. Rent
expense for the years ended December 31, 2006, 2005 and 2004 was
$162,000, $152,000 and $198,000, respectively.
Minimum rental payments required under these operating leases
are: 2007 - $182,000, 2008 - $164,000, 2009 - $131,000, 2010 -
$127,000 and thereafter $127,000.
52
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
In the normal course of business, there are various pending
legal actions and proceedings that are not reflected in the
consolidated financial statements. Management does not believe the
outcome of these actions and proceedings will have a material
effect on the consolidated financial position of the Corporation.
NOTE 15 - RELATED PARTY TRANSACTIONS
Certain directors and executive officers of First Keystone
Corporation and its Subsidiary and companies in which they are
principal owners (i.e., at least 10%) were indebted to the
Corporation at December 31, 2006, 2005 and 2004. These loans were
made on substantially the same terms and conditions, including
interest rates and collateral, as those prevailing at the time for
comparable transactions with unrelated parties. The loans do not
involve more than the normal risk of collectibility nor present
other unfavorable features.
A summary of the activity on the related party loans,
comprised of 8 directors and 4 executive officers and their related
companies consists of the following:
(Amounts in thousands)
2006 2005 2004
____ ____ ____
<s> <c> <c> <c>
Balance at January 1 $1,221 $ 744 $ 1,597
Additions 1,359 1,289 667
Deductions 1,641 (812) (1,520)
______ ______ _______
Balance at December 31 $ 939 $1,221 $ 744
====== ====== =======
The above loans represent funds drawn and outstanding at the
date of the accompanying consolidated financial statement.
Commitments by the Bank to related parties on lines of credit and
letters of credit for 2006, 2005 and 2004, presented an additional
off-balance sheet risk to the extent of undisbursed funds in the
amounts of $1,908,000, $2,785,000 and $2,290,000, respectively, on
the above loans.
Deposits from certain officers and directors and/or their
affiliated companies held by the Bank amounted to $4,996,000 and
$4,691,000 at December 31, 2006 and 2005, respectively.
NOTE 16 - REGULATORY MATTERS
Dividends are paid by the Corporation to shareholders which
are mainly provided by dividends from the Bank. However, national
banking laws place certain restrictions on the amount of cash
dividends allowed to be paid by the Bank to the Corporation.
Generally, the limitation provides that dividend payments may not
exceed the Bank's current year's retained income plus retained net
income for the preceding two years. Accordingly, in 2007, without
prior regulatory approval, the Bank may declare dividends to the
Corporation in the amount of $5,081,000 plus additional amounts
equal to the net income earned in 2007 for the period January 1,
2007, through the date of declaration, less any dividends which may
have already been paid in 2007. Regulations also limit the amount
of loans and advances from the Bank to the Corporation to 10% of
consolidated net assets.
The Corporation is subject to various regulatory capital
requirements administered by the federal banking agencies. Failure
to meet minimum capital requirements can initiate certain mandatory
- - and possibly additional discretionary - actions by regulators
that, if undertaken, could have a direct material effect on the
Corporation's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective
action, the Corporation must meet specific capital guidelines that
involve quantitative measures of the Corporation's assets,
liabilities, and certain off balance sheet items as calculated
under regulatory accounting practices. The Corporation's capital
amounts and classification are also subject to qualitative
judgements by the regulators about components, risk weightings and
other factors. Management believes, as of December 31, 2006 and
2005, that the Corporation and the Bank met all capital adequacy
requirements to which they are subject.
53
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
Quantitative measures established by regulation to ensure
capital adequacy require the Bank to maintain minimum amounts and
ratios (set fourth in the table below) of Total and Tier I Capital
(as defined in the regulations) to Risk Weighted Assets (as
defined), and of Tier I Capital (as defined) to Average Assets (as
defined).
As of December 31, 2006, the most recent notification from the
Office of the Comptroller of the Currency categorized the Bank as
Well Capitalized under the regulatory framework for prompt
corrective action. To be categorized as Well Capitalized, the Bank
must maintain minimum Total Risk Based, Tier I Risked Based and
Tier I Leverage Ratios as set forth in the table. There are no
conditions or events since the notification that management
believes have changed the Bank's category.
(Amounts in thousands)
Actual
___________________
Amount Ratio
______ _____
<s> <c> <c>
As of December 31, 2006:
Total Capital
(to Risk Weighted Assets) $51,320 17.41%
Tier I Capital
(to Risk Weighted Assets) 47,649 16.17%
Tier I Capital
(to Average Assets) 47,649 9.19%
(Amounts in thousands)
For Capital
Adequacy Purposes
____________________
Amount Ratio
______ _____
<s> <c> <c>
As of December 31, 2006:
Total Capital
(to Risk Weighted Assets) $23,578 8.00%
Tier I Capital
(to Risk Weighted Assets) 11,789 4.00%
Tier I Capital
(to Average Assets) 20,731 4.00%
(Amounts in thousands)
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
____________________
Amount Ratio
______ _____
<s> <c> <c>
As of December 31, 2006:
Total Capital
(to Risk Weighted Assets) $29,472 10.00%
Tier I Capital
(to Risk Weighted Assets) 17,683 6.00%
Tier I Capital
(to Average Assets) 25,914 5.00%
(Amounts in thousands)
Actual
___________________
Amount Ratio
______ _____
<s> <c> <c>
As of December 31, 2005:
Total Capital
(to Risk Weighted Assets) $49,484 17.22%
Tier I Capital
(to Risk Weighted Assets) 45,892 15.97%
Tier I Capital
(to Average Assets) 45,892 9.03%
(Amounts in thousands)
For Capital
Adequacy Purposes
____________________
Amount Ratio
______ _____
<s> <c> <c>
As of December 31, 2005:
Total Capital
(to Risk Weighted Assets) $22,984 8.00%
Tier I Capital
(to Risk Weighted Assets) 11,492 4.00%
Tier I Capital
(to Average Assets) 20,321 4.00%
(Amounts in thousands)
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
____________________
Amount Ratio
______ _____
<s> <c> <c>
As of December 31, 2005:
Total Capital
(to Risk Weighted Assets) $28,730 10.00%
Tier I Capital
(to Risk Weighted Assets) 17,238 6.00%
Tier I Capital
(to Average Assets) 25,402 5.00%
The Corporation's capital ratios are not materially different
from those of the Bank.
NOTE 17 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET
RISK AND CONCENTRATIONS OF CREDIT RISK
The Corporation is a party to financial instruments with off
balance sheet risk in the normal course of business to meet the
financing needs of its customers. These financial instruments
include commitments to extend credit and standby letters of credit.
Those instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the
consolidated balance sheets. The contract or notional amounts of
those instruments reflect the extent of involvement the Corporation
has in particular classes of financial instruments. The Corporation
does not engage in trading activities with respect to any of its
financial instruments with off balance sheet risk.
The Corporation's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for
commitments to extend credit and standby letters of credit is
represented by the contractual notional amount of those
instruments.
54
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
The Corporation uses the same credit policies in making
commitments and conditional obligations as it does for on balance
sheet instruments.
The Corporation may require collateral or other security to
support financial instruments with off balance sheet credit risk.
The contract or notional amounts at December 31, 2006 and 2005
were as follows:
(Amounts in thousands)
2006 2005
____ ____
<s> <c> <c>
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit $33,811 $29,228
Financial standby letters of credit $ 1,160 $ 1,151
Performance standby letters of credit $ 2,155 $ 1,170
Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition
established in the contract. Commitments generally have fixed
expiration dates or other termination clauses that may require
payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. The Corporation
evaluates each customer's creditworthiness on a case by case basis.
The amount of collateral obtained, if deemed necessary by the
Corporation upon extension of credit, is based on management's
credit evaluation of the counter party. Collateral held varies but
may include accounts receivable, inventory, property, plant and
equipment, and income producing commercial properties.
Standby letters of credit are conditional commitments issued
by the Corporation to guarantee payment to a third party when a
customer either fails to repay an obligation or fails to perform
some non financial obligation. The credit risk involved in issuing
letters of credit is essentially the same as that involved in
extending loan facilities to customers. The Corporation may hold
collateral to support standby letters of credit for which
collateral is deemed necessary.
The Corporation grants commercial, agricultural, real estate
mortgage and consumer loans to customers primarily in the counties
of Columbia, Luzerne and Montour, Pennsylvania. The concentrations
of credit by type of loan are set forth in Note 4, "Loans". It is
management's opinion that the loan portfolio was well balanced and
diversified at December 31, 2006, to the extent necessary to avoid
any significant concentration of credit risk. However, its debtors
ability to honor their contracts may be influenced by the region's
economy.
NOTE 18 - COMPREHENSIVE INCOME
The components of other comprehensive income and related tax
effects are as follows:
(Amounts in thousands)
Years Ended December 31,
______________________
2006
____
<s> <c>
Unrealized holding (losses) on
available-for-sale investment
securities arising during the period $(1,220)
Less reclassification adjustment for net
gains and losses realized in income 210
_______
Change in unrealized (losses) before
tax effect $(1,430)
Tax effects (497)
_______
Net change in unrealized (losses) $ (933)
=======
(Amounts in thousands)
Years Ended December 31,
______________________
2005
____
<s> <c>
Unrealized holding gains (losses) on
available-for-sale investment
securities arising during the period $(3,300)
Less reclassification adjustment for net
gains and losses realized in income 1,203
_______
Change in unrealized (losses)
before tax effect $(4,503)
Tax effects (1,543)
_______
Net change in unrealized (losses) $(2,960)
=======
(Amounts in thousands)
Years Ended December 31,
_____________________
2004
____
<s> <c>
Unrealized holding gains (losses) on
available-for-sale investment
securities arising during the period $(1,550)
Less reclassification adjustment for net
gains and losses realized in income 1,069
_______
Change in unrealized (losses)
before tax effect $(2,619)
Tax effects (897)
_______
Net change in unrealized (losses) $(1,722)
=======
55
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
NOTE 19 - STOCKHOLDERS' EQUITY
On October 24, 2006 the Board of Directors declared a 5% stock
dividend payable to shareholders of record November 14, 2006 and
distributed December 5, 2006. A total of 215,991 shares were issued
as a result of this stock dividend, with a total value transferred
from retained earnings of $4,237,480, including cash in lieu of
fractional shares.
The Corporation also offers to its shareholders a Dividend
Reinvestment and Stock Purchase Plan. First Keystone Corporation is
authorized to issue up to 100,000 shares of its common stock under
the plan. The plan provides First Keystone shareholders a
convenient and economical way to purchase additional shares of
common stock by reinvesting dividends. A plan participant can elect
full dividend reinvestment or partial dividend reinvestment
provided at least 25 shares are enrolled in the plan. In addition,
plan participants may make additional voluntary cash purchases of
common stock under the plan of not less than $100 per calendar
quarter or more than $2,500 in any calendar quarter.
Shares of First Keystone common stock are purchased for the
plan either in the open market by an independent broker on behalf
of the plan, directly from First Keystone as original issue shares,
or through negotiated transactions. A combination of the previous
methods could also occur.
Participation in this plan by shareholders began in 2001.
Shares transferred under this dividend reinvestment and stock
purchase plan were as follows:
Year Number of Shares
____ ________________
<s> <c>
2001 3,260
2002 7,747
2003 8,000
2004 13,932
2005 21,491
2006 22,964
NOTE 20 - STOCK COMPENSATION PLAN
On February 10, 1998, the Board of Directors adopted a stock
option incentive plan and initially reserved 100,000 shares of
common stock for issuance under the plan for certain employees of
the Bank. After adjustments for the effects of stock dividends,
options exercised and options forfeited there remains 80,604
options for possible issuance. Under the Plan, options are granted
at fair market value and the time period during which any option
granted may be exercised may not commence before six months or
continue beyond the expiration of ten years after the option is
awarded. Upon exercise of the stock options, shares of the
Corporation's stock are issued from Treasury Stock.
The fair value of stock options issued to employees is
measured on the date of the grant and is recognized as compensation
expense over the requisite service period. Expected volatility and
dividend yield are based on historical stock prices and dividend
amounts over past time periods equal in length to the life of the
options. The risk free interest rate is determined using the U.S.
Treasury yield curve in effect at the date of the grant. The
expected life of the options is calculated using the average term
of the vesting period and the maximum term.
Stock based compensation expense was $8,000 for the year ended
December 31, 2006 attributable to stock options granted in 2005.
Forfeitures in excess of stock options expense was ($2,000) for the
year ended December 31, 2005.
The fair value of each option grant is estimated on the date
of grant using the Binomial Option Pricing Model derived from the
Black-Scholes Option Pricing Model with the following weighted
average assumptions used for options granted in 2005 (no options
were granted in 2004 and 2006): dividend yield of 4.05% and 2.89%;
expected volatility of 23.04% and 22.70%; risk free interest rate
of 4.39% and 4.24%; and an expected life of 10 years and 10 years.
56
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
Information about stock options outstanding at December 31,
2006, is summarized as follows:
2006
_____________________
Weighted
Average
Stock Exercise
Options Price
______ _______
<s> <c> <c>
Balance at January 1 60,619 $18.61
Granted - -
Granted due to stock dividend 2,404 17.56
Exercised (4,415) 16.23
Forfeited (7,225) 21.33
______ ______
Balance at December 31 51,383 $17.55
====== ======
Exercisable at December 31 51,383 $17.55
====== ======
Weighted average fair value of
options granted during the year
2005
_____________________
Weighted
Average
Stock Exercise
Options Price
______ _______
<s> <c> <c>
Balance at January 1 66,653 $18.29
Granted 4,000 22.00
Granted due to stock dividend - -
Exercised (6,211) 15.40
Forfeited (3,823) 21.80
______ ______
Balance at December 31 60,619 $18.61
====== ======
Exercisable at December 31 56,619 $18.37
====== ======
Weighted average fair value of
options granted during the year $ 5.02
2004
_____________________
Weighted
Average
Stock Exercise
Options Price
______ _______
<s> <c> <c>
Balance at January 1 47,450 $27.13
Granted - -
Granted due to stock dividend 23,539 16.77
Exercised (4,336) 15.12
Forfeited - -
______ ______
Balance at December 31 66,653 $18.29
====== ======
Exercisable at December 31 66,653 $18.29
====== ======
Weighted average fair value of
options granted during the year
Under the terms of the stock option incentive plan, the stock
options including amendments as to price and terms were adjusted
for the stock dividend in 2006.
Exercise prices of options outstanding as of December 31,
2006, ranged from $10.28 to $21.11 per share. The weighted average
remaining contracted life is approximately 4.56 years.
The 51,383 options outstanding as December 31, 2006 have an
intrinsic value, which is the amount that the value of the
underlying stock exceeds the exercise price of the options of
$94,000. The total intrinsic value of the options exercised during
the years ended December 31, 2006, 2005 and 2004 was $10,000,
$31,000 and $31,000, respectively. Cash received from stock
options exercised for the years ended December 31, 2006, 2005 and
2004 was $72,000, $96,000 and $68,000, respectively.
The following table summarizes information concerning the 1998
Employee Stock Option Plan at December 31, 2006.
Options Outstanding
___________________________________________________
Weighted Weighted
Number Average Average
Outstanding Remaining Exercise
Year <F1> Contractual Life Price
____ _________ _______________ _____
<s> <c> <c> <c>
1998 10,319 1.75 $20.26
1999 10,453 2.75 15.88
2000 5,774 3.75 10.28
2002 9,360 5.75 15.08
2003 11,805 6.75 21.11
2005 3,672 8.75 20.95
______ ______
51,383 $17.55
______ ______
____________________
<FN>
<F1>
As adjusted for stock dividend noted above.
</FN>
Options Exercisable
___________________________
Weighted
Average
Number Exercise
Exercisable Price
___________ _____
<s> <c> <c>
1998 10,319 $20.26
1999 10,453 15.88
2000 5,774 10.28
2002 9,360 15.08
2003 11,805 21.11
2005 3,672 20.95
______ ______
51,383 $17.55
______ ______
57
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
NOTE 21 - FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards (SFAS) 107,
"Disclosures about Fair Value of Financial Instruments", requires
disclosure of fair value information about financial instruments,
whether or not required to be recognized in the consolidated
balance sheets, for which it is practicable to estimate such fair
value. In cases where quoted market prices are not available, fair
values are based on estimates using present value or other
valuation techniques. These techniques are significantly affected
by the assumptions used, including the discount rate and estimates
of future cash flows. Fair value estimates derived through these
techniques cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate
settlement of the instrument. SFAS 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Corporation.
The following methods and assumptions were used by the
Corporation in estimating its fair value disclosures for financial
instruments:
CASH AND DUE FROM BANKS, SHORT-TERM INVESTMENTS, ACCRUED
INTEREST RECEIVABLE AND ACCRUED INTEREST PAYABLE
The fair values are equal to the current carrying values.
INVESTMENT SECURITIES
Fair values have been individually determined based on
currently quoted market prices. If a quoted market price is not
available, fair value is estimated using quoted market prices for
similar securities.
LOANS
Fair values are estimated for categories of loans with
similar financial characteristics. Loans were segregated by type
such as commercial, tax exempt, real estate mortgages and consumer.
For estimation purposes each loan category was further segmented
into fixed and adjustable rate interest terms and also into
performing and non performing classifications.
The fair value of each category of performing loans is
calculated by discounting future cash flows using the current rates
at which similar loans would be made to borrowers with similar
credit ratings and for the same remaining maturities.
Fair value for non performing loans is based on
management's estimate of future cash flows discounted using a rate
commensurate with the risk associated with the estimated future
cash flows. The assumptions used by management are judgmentally
determined using specific borrower information.
CASH SURRENDER VALUE OF BANK OWNED LIFE INSURANCE
Fair value is equal to the cash surrender value of life
insurance policies.
DEPOSITS
Under SFAS 107, the fair value of deposits with no stated
maturity, such as Demand Deposits, Savings Accounts and Money
Market Accounts is equal to the amount payable on demand at
December 31, 2006 and 2005.
Fair values for fixed rate certificates of deposit are
estimated using a discounted cash flow calculation that applies
interest rates currently being offered on similar term borrowings,
FHLB, to a schedule of aggregated expected monthly maturities on
time deposits.
58
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
SHORT-TERM AND LONG-TERM BORROWINGS
The fair values of short term and long term borrowings
are estimated using discounted cash flow analyses based on the
Corporation's incremental borrowing rate for similar instruments.
COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT
Management estimates that there are no material
differences between the notional amount and the estimated fair
value of those off balance sheet items since they are primarily
composed of unfunded loan commitments which are generally priced at
market at the time of funding.
At December 31, 2006 and 2005, the carrying values and
estimated fair values of financial instruments of the Corporation
are presented in the table below:
(Amounts in thousands) 2006
________________________
Carrying Estimated
Amount Fair Value
______ __________
<s> <c> <c>
FINANCIAL ASSETS:
Cash and due from banks $ 5,881 $ 5,881
Short-term investments 4,307 4,307
Investment securities -
available for sale 237,009 237,009
Investment securities -
held to maturity 6,929 6,908
Net loans 248,086 250,989
Accrued interest receivable 2,686 2,686
Cash surrender value of life
insurance 11,942 11,942
FINANCIAL LIABILITIES:
Deposits 384,020 367,952
Short-term borrowings 28,179 28,179
Long-term borrowings 57,535 57,902
Accrued interest and other
expenses 2,581 2,581
OFF-BALANCE SHEET FINANCIAL
INSTRUMENTS:
Commitments to extend credit 33,811
Financial standby letters of
credit 1,160
Performance standby letters
of credit 2,155
(Amounts in thousands) 2005
________________________
Carrying Estimated
Amount Fair Value
______ __________
<s> <c> <c>
FINANCIAL ASSETS:
Cash and due from banks $ 7,098 $ 7,098
Short-term investments 58 58
Investment securities -
available for sale 247,288 247,288
Investment securities -
held to maturity 4,248 4,217
Net loans 230,917 229,100
Accrued interest receivable 2,604 2,604
Cash surrender value of life
insurance 11,470 11,470
FINANCIAL LIABILITIES:
Deposits 362,796 360,807
Short-term borrowings 28,151 28,151
Long-term borrowings 65,535 66,018
Accrued interest and other
expenses 2,372 2,372
OFF-BALANCE SHEET FINANCIAL
INSTRUMENTS:
Commitments to extend credit 29,228
Financial standby letters of
credit 1,151
Performance standby letters
of credit 1,170
59
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
NOTE 22 - PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for First Keystone Corporation
(parent company only) was as follows:
BALANCE SHEETS
(Amounts in thousands) December 31
_________________
2006 2005
____ ____
<s> <c> <c>
ASSETS
Cash in subsidiary bank $ 1,648 $ 3,788
Investment in subsidiary bank 48,594 47,406
Investment in other equity
securities 3,711 2,966
Prepayments and other assets 274 124
_______ _______
TOTAL ASSETS $54,227 $54,284
======= =======
LIABILITIES
Accrued expenses and other
liabilities $ 440 $ 536
Advance from subsidiary bank 400 305
_______ _______
TOTAL LIABILITIES $ 840 $ 841
_______ _______
STOCKHOLDERS' EQUITY
Preferred stock $ - $ -
Common stock 9,511 9,079
Surplus 16,119 12,387
Retained earnings 33,793 35,714
Accumulated other comprehensive
income (loss) (126) 807
Treasury stock, at cost (5,910) (4,544)
_______ _______
TOTAL STOCKHOLDERS' EQUITY $53,387 $53,443
_______ _______
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $54,227 $54,284
======= =======
STATEMENTS OF INCOME
(Amounts in thousands) Year Ended December 31
______________________
2006 2005
____ ____
<s> <c> <c>
INCOME
Dividends from Subsidiary Bank $3,902 $3,607
Dividends - other 89 69
Securities gains 362 252
Interest 33 38
______ ______
TOTAL INCOME $4,386 $3,966
Operating Expenses 84 82
______ ______
Income Before Taxes and Equity
in Undistributed Net Income
of Subsidiary $4,302 $3,884
Income tax expense 137 93
______ ______
Income Before Equity in
Undistributed Net Income of
Subsidiary $4,165 $3,791
Equity in (excess of) Undistributed
Net Income of Subsidiary 2,025 3,056
______ ______
NET INCOME $6,190 $6,847
====== ======
STATEMENTS OF INCOME
(Amounts in thousands) Year Ended December 31
_____________________
2004
____
<s> <c>
INCOME
Dividends from Subsidiary Bank $3,225
Dividends - other 63
Securities gains 459
Interest 30
______
TOTAL INCOME $3,777
Operating Expenses 83
______
Income Before Taxes and Equity
in Undistributed Net Income
of Subsidiary $3,694
Income tax expense 173
______
Income Before Equity in
Undistributed Net Income of
Subsidiary $3,521
Equity in (excess of) Undistributed
Net Income of Subsidiary 3,266
______
NET INCOME $6,787
======
60
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 and 2004 - CONTINUED
_________________________________________________________________
STATEMENTS OF CASH FLOWS
(Amounts in thousands) Year Ended December 31
_____________________
2006 2005
____ ____
<s> <c> <c>
OPERATING ACTIVITIES
Net income $ 6,190 $ 6,847
Adjustments to reconcile net income
to net cash provided by
operating activities:
Deferred income tax - -
Securities gains (362) (252)
Equity in undistributed net
income of subsidiary (2,025) (3,056)
(Increase) decrease in prepaid
expenses and other assets (150) 336
Decrease in advanced receivable
from subsidiary bank - net - -
Increase (decrease) in advances
payable to subsidiary bank - net 102 (342)
Increase (decrease) in accrued
expenses and other liabilities (30) 42
_______ _______
NET CASH PROVIDED BY OPERATING
ACTIVITIES $ 3,725 $ 3,575
_______ _______
INVESTING ACTIVITIES
Purchase of equity securities $(1,403) $ (685)
Proceeds from sale of equity
securities 859 479
_______ _______
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES $ (544) $ (206)
_______ _______
FINANCING ACTIVITIES
Proceeds from sale of treasury stock $ 71 $ 95
Acquisition of treasury stock (1,514) (247)
Cash dividends paid (3,874) (3,602)
Dividends paid in lieu of
fractional shares (4) -
_______ _______
NET CASH (USED IN) FINANCING
ACTIVITIES $(5,321) $(3,754)
_______ _______
INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS $(2,140) $ (385)
CASH AND CASH EQUIVALENTS
AT BEGINNING OF YEAR 3,788 4,173
_______ _______
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 1,648 $ 3,788
======= =======
STATEMENTS OF CASH FLOWS
(Amounts in thousands) Year Ended December 31
______________________
2004
____
<s> <c>
OPERATING ACTIVITIES
Net income $ 6,787
Adjustments to reconcile net income
to net cash provided by
operating activities:
Deferred income tax 1
Securities gains (459)
Equity in undistributed net
income of subsidiary (3,266)
(Increase) decrease in prepaid
expenses and other assets (454)
Decrease in advanced receivable
from subsidiary bank - net 87
Increase (decrease) in advances
payable to subsidiary bank - net 646
Increase (decrease) in accrued
expenses and other liabilities 47
_______
NET CASH PROVIDED BY OPERATING
ACTIVITIES $ 3,389
_______
INVESTING ACTIVITIES
Purchase of equity securities $ (499)
Proceeds from sale of equity
securities 818
_______
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES $ 319
_______
FINANCING ACTIVITIES
Proceeds from sale of treasury stock $ 69
Acquisition of treasury stock -
Cash dividends paid (3,218)
Dividends paid in lieu of
fractional shares (3)
_______
NET CASH (USED IN) FINANCING
ACTIVITIES $(3,152)
_______
INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS $ 556
CASH AND CASH EQUIVALENTS
AT BEGINNING OF YEAR 3,617
_______
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 4,173
=======
61
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
______________________________________________________
BOARD OF DIRECTORS AND STOCKHOLDERS OF FIRST KEYSTONE CORPORATION
We have audited management's assessment, included in the
accompanying Management Report on Internal Control Over Financial
Reporting, that First Keystone Corporation and Subsidiary
maintained effective internal control over financial reporting as
of December 31, 2006, based on criteria established in Internal
Control - Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). The
Corporation's management is responsible for maintaining effective
internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Corporation's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over
financial reporting was maintained in all material respects. Our
audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides
a reasonable basis for our opinion.
A company's internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with accounting
principles generally accepted in the United States of America. A
company's internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with accounting principles generally accepted in the
United States of America and that receipts and expenditures of the
company are being made only in accordance with authorizations of
management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could
have a material effect on the financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
In our opinion, management's assessment that First Keystone
Corporation and Subsidiary maintained effective internal control
over financial reporting as of December 31, 2006, is fairly stated,
in all material respects, based on criteria established in Internal
Control - Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Also,
in our opinion, First Keystone Corporation and Subsidiary
maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2006, based on criteria
established in Internal Control - Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of First Keystone Corporation and
Subsidiary as of December 31, 2006 and 2005 and the related
consolidated statements of income, changes in stockholders' equity
and cash flows for each of the years in the three-year period ended
December 31, 2006 and our report dated February 28, 2007 expressed
an unqualified opinion on those consolidated financial statements.
/s/ J. H. Williams & Co., LLP
_____________________________
J. H. Williams & Co., LLP
Kingston, Pennsylvania
February 28, 2007
62
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Management of First Keystone Corporation (the
"Corporation"), with the participation of the Chief Executive
Officer and Chief Financial Officer, conducted an evaluation of the
effectiveness of our disclosure controls and procedures, pursuant
to Securities Exchange Act Rules 13a-15, as amended, as of December
31, 2006. Based upon such evaluation, the Corporation's Chief
Executive Officer and Chief Financial Officer have concluded that,
as of the end of such period, the Corporation's disclosure controls
and procedures are effective in timely alerting them to material
information relating to the Corporation required to be included in
our periodic SEC filings.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER
FINANCIAL REPORTING
The management of First Keystone Corporation is responsible
for establishing and maintaining adequate internal control over
financial reporting. The Corporation's internal control system was
designed to provide reasonable assurance to the Corporation's
management and Board of Directors regarding the preparation and
fair presentation of published financial statements.
The Corporation's internal control over financial reporting
are supported by written policies that pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect transactions and dispositions of assets; provide reasonable
assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America, and
that receipt and expenditures of the Corporation are being made
only in accordance with authorization of the Corporation's
management and Board of Directors; and provide reasonable assurance
regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Corporation's assets that
could have a material effect on the consolidated financial
statements.
All internal control systems, no matter how well designed,
have inherent limitations. Therefore, even those systems
determined to be effective can provide only reasonable assurance
with respect to financial statement preparation and presentation.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
The management of First Keystone Corporation assessed the
effectiveness of the Corporation's internal control over financial
reporting as of December 31, 2006. In making this assessment, we
used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control
- - Integrated Framework. Based on our assessment we believe that,
as of December 31, 2006, the Corporation's internal control over
financial reporting is effective based on those criteria.
First Keystone Corporation's independent registered public
accounting firm that audited the consolidated financial statements
has issued an audit report on our assessment of, and the effective
operation of, the Corporation's internal control over financial
reporting as of December 31, 2006. This report appears on page 62.
CHANGES IN INTERNAL CONTROLS
The Corporation made no significant changes in its internal
controls or in other factors that could significantly affect these
controls subsequent to the date of the evaluation of the controls
by the Chief Executive and Chief Financial Officers.
ITEM 9B. OTHER INFORMATION
Not Applicable.
63
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information under the captions "Information As To
Directors and Nominees" and "Principal Officers of the Bank and the
Corporation" are incorporated here by reference to First Keystone
Corporation's proxy statement for its 2007 annual meeting of
shareholders scheduled for April 17, 2007. The information under
the caption "Section 16(A) Beneficial Ownership Reporting
Compliance" and "Code of Ethics" are as follows:
SECTION 16(A) BENEFICIAL OWNERSHIP
REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires
the Corporation's directors, executive officers and shareholders
who own more than 10% of the Corporation's outstanding equity stock
to file initial reports of ownership and reports of changes in
ownership of common stock and other equity securities of the
Corporation with the Securities and Exchange Commission. Based
solely on its review of copies of Section 16(a) forms received by
it, or written representations from reporting persons that no Form
5s were required for those persons, the corporation believes that
during the period January 1, 2006 through December 31, 2006, its
officers, directors and reporting shareholders were in compliance
with all filing requirements applicable to them.
CODE OF ETHICS
The Corporation has adopted a Directors and Senior Management
Code of Ethical Conduct, which applies to all members of the Board
of Directors and to senior officers of the Corporation. It can be
found on the Investor Relations section of our website at
www.firstkeystonecorporation.com.
ITEM 11. EXECUTIVE COMPENSATION
The information under the captions "Executive Compensation"
and "Compensation Discussion and Analysis (CD&A)" are incorporated
here by reference to First Keystone Corporation's proxy statement
for its 2007 annual meeting of shareholders scheduled for April 17,
2007.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
The information under the caption "Share Ownership" is
incorporated here by reference to First Keystone Corporation's
proxy statement for its 2007 annual meeting of shareholders
scheduled for April 17, 2007.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,
AND DIRECTOR INDEPENDENCE
The information under the captions "Related Person
Transactions" and "Governance Of The Company" are incorporated here
by reference to First Keystone Corporation's proxy statement for
its 2007 annual meeting of shareholders scheduled for April 17,
2007.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information under the caption "Report of the Audit
Committee" is incorporated here by reference of First Keystone
Corporation's proxy statement for its 2007 annual meeting of
shareholders scheduled for April 17, 2007.
64
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. Financial Statements
____________________
The following consolidated financial statements are
included in Part II, Item 8, of this Report:
First Keystone Corporation and Subsidiary.
Report of Independent Registered
Public Accounting Firm 29
Consolidated Balance Sheets 30
Consolidated Statements of Income 31
Consolidated Statements of
Stockholders' Equity 32
Consolidated Statements of
Cash Flows 33
Notes to Consolidated Financial
Statements 34
Report of Independent Registered
Public Accounting Firm 62
2. Financial Statement Schedules
_____________________________
Financial statements schedules are omitted because the
required information is either not applicable, not required, or is
shown in the financial statements or in their notes.
3. Exhibits
________
Exhibits required by Item 601 of Regulation S:
Exhibit Number Referred to
Item 601 of Regulation S-K Description of Exhibit
__________________________ ______________________
3i Articles of Incorporation, as
amended (Incorporated by
reference to Exhibit 3(i) to
the Registrant's Report on Form
10Q for the quarter ended March
31, 2006).
3ii By Laws, as amended
(Incorporated by reference to
Exhibit 3(ii) to the
Registrant's Report on Form 10Q
for the quarter ended March 31,
2006).
10.1 Supplemental Employee
Retirement Plan (Incorporated
by reference to Exhibit 10 to
Registrant's Annual Report on
Form 10Q for the quarter ended
September 31, 2005).
10.2 Management Incentive
Compensation Plan (Incorporated
by reference to Exhibit 10 to
Registrant's Report on Form 10Q
for the quarter ended September
30, 2006).
10.3 Profit Sharing Plan
(Incorporated by reference to
Exhibit 10 to Registrant's
Report on Form 10Q for the
quarter ended September 30,
2006).
10.4 First Keystone Corporation 1998
Stock Incentive Plan
(Incorporated by reference to
Exhibit 10 to Registrant's
Report on Form 10Q for the
quarter ended September 30,
2006).
65
Exhibit Number Referred to Description of Exhibit
Item 601 of Regulation S-K (Continued)
__________________________ ______________________
14 Code of Ethics (Incorporated by
reference to Exhibit 14 to
Registrant's Report on Form 8K
dated January 9, 2007).
21 List of Subsidiaries of the
Corporation.
23 Consent of Independent
Auditors.
31.1 Rule 13a-14(a)/15d-14(a)
Certification of Chief
Executive Officer.
31.2 Rule 13a-14(a)/15d-14(a)
Certification of Chief
Financial Officer.
32.1 Section 1350 Certification of
Chief Executive Officer.
32.2 Section 1350 Certification of
Chief Financial Officer.
66
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 CORPORATION
/s/ J. Gerald Bazewicz
_____________________________
J. Gerald Bazewicz
President/Chief Executive Officer
Date: March 8, 2007
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates
indicated.
/s/ John Arndt March 8, 2007
_________________________ _________________________
John Arndt, Secretary/Director Date
/s/ J. Gerald Bazewicz March 8, 2007
_________________________ _________________________
J. Gerald Bazewicz, President/ Date
Chief Executive Officer/Director
/s/ Don E. Bower March 8, 2007
_________________________ _________________________
Don E. Bower, Director Date
/s/ Robert A. Bull March 8, 2007
_________________________ _________________________
Robert A. Bull, Director Date
/s/ Robert E. Bull March 8, 2007
_________________________ _________________________
Robert E. Bull, Date
Chairman/Director
/s/ Dudley P. Cooley March 8, 2007
_________________________ _________________________
Dudley P. Cooley, Director Date
/s/ Jerome F. Fabian March 8, 2007
_________________________ _________________________
Jerome F. Fabian, Director Date
/s/ David R. Saracino March 8, 2007
_________________________ _________________________
David R. Saracino, Director Date
/s/ Diane C.A. Rosler March 8, 2007
_________________________ _________________________
Diane C.A. Rosler, Date
Principal Financial Officer
/s/ Robert J. Wise March 8, 2007
_________________________ _________________________
Robert J. Wise, Date
Vice Chairman/Director
67