EXHIBIT 13
EXCERPT FROM ANNUAL REPORT TO SHAREHOLDERS
FOR FISCAL YEAR ENDED DECEMBER 31, 1998
21
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 and 1997
___________________________________________________________________________
1998 1997
___________________________________________________________________________
ASSETS
Cash and due from banks $ 7,033,112 $ 6,400,261
Interest-bearing deposits
in other banks 22,489 7,083,684
Investment securities Available-
for-Sale 116,700,864 81,650,689
Investment securities Held-to-
Maturity (estimated fair value
1998 $14,015,044; 1997 $16,833,038) 13,984,681 16,808,625
Loans, net of unearned income 161,532,639 152,150,843
Allowance for loan losses (2,421,042) (2,371,194)
____________ ____________
Net loans $159,111,597 $149,779,649
Premises and equipment 3,757,565 3,435,689
Accrued interest receivable 2,133,030 1,997,936
Other assets 285,143 242,053
____________ ____________
TOTAL ASSETS $303,028,481 $267,398,586
LIABILITIES
Deposits:
Non-interest bearing $ 22,749,074 $ 18,397,819
Interest bearing 224,342,445 199,249,365
____________ ____________
Total Deposits $247,091,519 $217,647,184
Short-term borrowings 6,633,646 6,102,160
Long-term borrowings 13,000,000 9,000,000
Accrued interest and other expenses 1,521,029 1,521,832
Other liabilities 1,029,138 1,309,343
____________ ____________
TOTAL LIABILITIES $269,275,332 $235,580,519
STOCKHOLDERS' EQUITY
Preferred stock, par value $10.00
per share; authorized
500,000 shares; no shares issued $ - $ -
Common stock, par value $2.00 per
share; authorized 10,000,000
shares 1998 and 3,000,000 shares
1997; issued 2,933,727 shares
1998 and 977,909 shares 1997 5,867,454 1,955,818
Surplus 9,761,066 9,761,066
Retained earnings 17,123,122 17,873,418
Accumulated other comprehensive
income 2,192,528 2,227,765
Treasury stock at cost
(35,134 shares) (1,191,021) -
____________ ____________
TOTAL STOCKHOLDERS' EQUITY $ 33,753,149 $ 31,818,067
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $303,028,481 $267,398,586
The accompanying notes are an integral part of these consolidated financial
statements.
4 First Keystone Corporation
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 and 1996
___________________________________________________________________________
1998 1997
___________________________________________________________________________
INTEREST INCOME
Interest and fees on loans $13,412,619 $12,923,557
Interest and dividends on
investment securities:
Taxable 4,301,941 3,727,915
Tax-exempt 2,562,325 2,288,362
Dividends 179,521 140,973
Deposits in banks 246,822 264,015
___________ ___________
Total interest income $20,703,228 $19,344,822
INTEREST EXPENSE
Deposits $ 9,208,368 $ 8,437,271
Short-term borrowings 303,467 230,071
Long-term borrowings 817,313 713,710
___________ ___________
Total interest expense $10,329,148 $ 9,381,052
Net interest income 10,374,080 9,963,770
Provision for loan losses 275,000 325,000
Net interest income after
provision for loan losses $10,099,080 $ 9,638,770
NON-INTEREST INCOME
Trust Department $ 524,835 $ 456,880
Service charges and fees 749,705 669,252
Gain on sale of loans 126,409 34,107
Investment securities gains
(losses) - net 178,634 67,957
Other 48,555 33,855
___________ ___________
Total non-interest income $ 1,628,138 $ 1,262,051
NON-INTEREST EXPENSE
Salaries and employee benefits $ 2,887,862 $ 2,626,752
Occupancy, net 403,242 331,962
Furniture and equipment 516,186 487,683
Other 1,727,790 1,486,748
___________ ___________
Total non-interest expense $ 5,535,080 $ 4,933,145
Income before income taxes $ 6,192,138 $ 5,967,676
Income tax expense 1,304,606 1,307,436
___________ ___________
NET INCOME $ 4,887,532 $ 4,660,240
PER SHARE DATA
Net income $ 1.67 $ 1.59
Cash dividends $ .59 $ .47
Weighted average shares
outstanding 2,925,695 2,933,727
___________________________________________________________________________
1996
___________________________________________________________________________
INTEREST INCOME
Interest and fees on loans $11,405,509
Interest and dividends on
investment securities:
Taxable 3,856,431
Tax-exempt 2,317,029
Dividends 115,054
Deposits in banks 91,782
___________
Total interest income $17,785,805
INTEREST EXPENSE
Deposits $ 7,864,665
Short-term borrowings 261,458
Long-term borrowings 541,243
___________
Total interest expense $ 8,667,366
Net interest income 9,118,439
Provision for loan losses 516,584
Net interest income after
provision for loan losses $ 8,601,855
NON-INTEREST INCOME
Trust Department $ 424,740
Service charges and fees 616,487
Gain on sale of loans $ -
Investment securities gains
(losses) - net (37,729)
Other 48,936
Total non-interest income $ 1,052,434
NON-INTEREST EXPENSE
Salaries and employee benefits $ 2,448,234
Occupancy, net 281,222
Furniture and equipment 467,973
Other 1,343,236
___________
Total non-interest expense $ 4,540,665
Income before income taxes $ 5,113,624
Income tax expense 983,339
___________
NET INCOME $ 4,130,285
PER SHARE DATA
Net income $ 1.41
Cash dividends $ .39
Weighted average shares
outstanding 2,933,727
The accompanying notes are an integral part of these consolidated financial
statements.
1998 Annual Report 5
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 and 1996
___________________________________________________________________________
Common Comprehensive
Stock Surplus Income
___________________________________________________________________________
Balance At December 31, 1995 $1,616,858 $3,829,266
Comprehensive Income:
Net income $4,130,285
Other comprehensive income,
net of tax:
Unrealized gains (losses)
on investment securities
of $(938,922), net of
reclassification
adjustment for (losses)
included in net income
of $(24,901) (914,021)
__________
Comprehensive income $3,216,264
10% stock dividend 161,436 2,825,130
Dividends paid in lieu of
fractional shares
Cash dividends - $.39
per share
Balance At December 31, 1996 $1,778,294 $6,654,396
Comprehensive Income:
Net income $4,660,240
Other comprehensive
income, net of tax:
Unrealized gains on
investment securities
of $1,115,453, net of
reclassification
adjustment for gains
included in net
income of $38,070 1,077,383
__________
Comprehensive income $5,737,623
10% stock dividend 177,524 3,106,670
Dividends paid in lieu of
fractional shares
Cash dividends - $.47
per share
Balance At December 31, 1997 $1,955,818 $9,761,066
Comprehensive Income:
Net income $4,887,532
Other comprehensive income,
net of tax:
Unrealized gains (losses)
on investment securities
of $74,935, net of
reclassification
adjustment for gains
included in net
income of $110,172 (35,237)
__________
Comprehensive income $4,852,295
3 for 1 stock split in the
form of a 200% stock
dividend 3,911,636
Cash dividends - $.59
per share
Acquisition of 35,134
shares of treasury stock
Balance At December 31, 1998 $5,867,454 $9,761,066
___________________________________________________________________________
Accumulated
Other
Retained Comprehensive Treasury
Earnings Income Stock
___________________________________________________________________________
Balance At December 31, 1995 $17,888,934 $2,064,403 $ -
Comprehensive Income:
Net income $ 4,130,285
Other comprehensive
income net of tax:
Unrealized gains (losses)
on investment
securities of
$(938,922), net of
reclassification
adjustment for (losses)
included in net income
of $(24,901) (914,021)
Comprehensive income 3,216,264
10% stock dividend (2,986,566)
Dividends paid in lieu of
fractional shares (4,622)
Cash dividends - $.39
per share (1,138,108)
Balance At December 31, 1996 $17,889,923 $1,150,382 $ -
Comprehensive Income:
Net income $ 4,660,240
Other comprehensive income,
net of tax:
Unrealized gains on
investment securities
of $1,115,453, net of
reclassification
adjustment for gains
included in net
income of $38,070 1,077,383
Comprehensive income
10% stock dividend (3,284,194)
Dividends paid in lieu of
fractional shares (5,650)
Cash dividends - $.47
per share (1,386,901)
Balance At December 31, 1997 $17,873,418 $2,227,765 $ -
Comprehensive Income:
Net income $ 4,887,532
Other comprehensive income,
net of tax:
Unrealized gains (losses)
on investment securities
of $74,935, net of
reclassification
adjustment for gains
included in net
income of $110,172 (35,237)
Comprehensive income
3 for 1 stock split in the
form of a 200% stock
dividend (3,911,636)
Cash dividends - $.59
per share (1,726,192)
Acquisition of 35,134 shares
of treasury stock (1,191,021)
Balance At December 31, 1998 $17,123,122 $2,192,528 $(1,191,021)
___________________________________________________________________________
Total
___________________________________________________________________________
Balance At December 31, 1995 $25,399,461
Comprehensive Income:
Net income $ 4,130,285
Other comprehensive income,
net of tax:
Unrealized gains (losses)
on investment securities
of $(938,922), net of
reclassification
adjustment for (losses)
included in net
income of $(24,901) (914,021)
Comprehensive income
10% stock dividend -
Dividends paid in lieu of
fractional shares (4,622)
Cash dividends - $.39
per share (1,138,108)
Balance At December 31, 1996 $27,472,995
Comprehensive Income:
Net income $ 4,660,240
Other comprehensive income,
net of tax:
Unrealized gains on
investment securities
of $1,115,453, net
of reclassification
adjustment for gains
included in net
income of $38,070 1,077,383
Comprehensive income
10% stock dividend -
Dividends paid in lieu of
fractional shares (5,650)
Cash dividends - $.47
per share (1,386,901)
Balance At December 31, 1997 $31,818,067
Comprehensive Income:
Net income $ 4,887,532
Other comprehensive income,
net of tax:
Unrealized gains (losses)
on investment securities
of $74,935, net of
reclassification
adjustment for gains
included in net
income of $110,172 (35,237)
Comprehensive income
3 for 1 stock split in the
form of a 200% stock dividend -
Cash dividends - $.59 per share (1,726,192)
Acquisition of 35,134 shares
of treasury stock (1,191,021)
Balance At December 31, 1998 $33,753,149
The accompanying notes are an integral part of these consolidated financial
statements.
6 First Keystone Corporation
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 and 1996
___________________________________________________________________________
1998 1997
___________________________________________________________________________
OPERATING ACTIVITIES
Net income $ 4,887,532 $ 4,660,240
Adjustments to reconcile net income
to net cash provided by operating
activities:
Provision for loan losses 275,000 325,000
Depreciation 345,566 304,134
Premium amortization on investment
securities 260,911 132,361
Discount accretion on investment
securities (143,293) (131,988)
Deferred income taxes (benefit) 1,586 18,645
Gain on sale of loans (126,409) (34,107)
Proceeds from sale of loans 5,751,429 765,019
Originations of loans held
for resale (7,506,624) (1,675,406)
(Gain) loss on sales of
investment securities (178,634) (67,958)
Gain on sale of premises and
equipment (12,157) (67)
(Gain) on sale of other real
estate owned - (816)
(Increase) in accrued interest
receivable (135,094) (39,054)
(Increase) decrease in other
assets - net (43,090) 65,704
Increase (decrease) in accrued
interest and other expenses (803) 393,798
Increase (decrease) in other
liabilities - net (272,171) 406,418
____________ ____________
NET CASH PROVIDED BY OPERATING
ACTIVITIES $ 3,103,749 $ 5,121,923
____________ ____________
INVESTING ACTIVITIES
Proceeds from sales of investment
securities Available-for-Sale $ 9,799,220 $ 18,369,369
Proceeds from maturities and
redemptions of investment
securities Available-for-Sale 15,869,144 5,119,885
Purchases of investment securities
Available-for-Sale (60,639,364) (21,757,280)
Purchases of investment securities
Held-to-Maturity (676,524) -
Proceeds from maturities and
redemption of investment
securities Held-to-Maturity 3,437,452 2,774,482
Net increase in loans (7,725,344) (18,202,028)
Proceeds from sale of premises
and equipment 22,042 2,001
Purchases of premises and equipment (677,327) (860,581)
Proceeds from sale of other real
estate owned - 47,000
____________ ____________
NET CASH USED IN INVESTING
ACTIVITIES $(40,590,701) $(14,507,152)
____________ ____________
FINANCING ACTIVITIES
Net increase in deposits $ 29,444,335 $ 19,101,401
Net increase in short-term
borrowings 531,486 980,793
Proceeds from long-term borrowings 7,000,000 12,000,000
Repayment of long-term borrowings (3,000,000) (13,000,000)
Acquisition of Treasury Stock (1,191,021) -
Cash dividends paid (1,726,192) (1,386,901)
Dividends paid in lieu of
fractional shares - (5,650)
____________ ____________
NET CASH PROVIDED BY
FINANCING ACTIVITIES $ 31,058,608 $ 17,689,643
____________ ____________
Increase (decrease) in cash
and cash equivalents $ (6,428,344) $ 8,304,414
Cash and cash equivalents
at beginning of year 13,483,945 5,179,531
____________ ____________
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 7,055,601 $ 13,483,945
___________________________________________________________________________
1996
___________________________________________________________________________
OPERATING ACTIVITIES
Net income $4,130,285
Adjustments to reconcile net income
to net cash provided by operating
activities:
Provision for loan losses 516,584
Depreciation 299,274
Premium amortization on investment
securities 158,011
Discount accretion on investment
securities (86,481)
Deferred income taxes (benefit) (32,241)
Gain on sale of loans -
Proceeds from sale of loans 65,000
Originations of loans held for
resale (1,087,313)
(Gain) loss on sales of
investment securities 37,729
Gain on sale of premises and
equipment (804)
(Gain) on sale of other real
estate owned -
(Increase) in accrued interest
receivable (83,514)
(Increase) decrease in other
assets - net 28,687
Increase (decrease) in accrued
interest and other expenses (52,076)
Increase (decrease) in other
liabilities - net (301)
____________
NET CASH PROVIDED BY OPERATING
ACTIVITIES $ 3,892,840
____________
INVESTING ACTIVITIES
Proceeds from sales of investment
securities Available-for-Sale $ 20,076,003
Proceeds from maturities and
redemptions of investment
securities Available-for-Sale 3,998,416
Purchases of investment securities
Available-for-Sale (40,909,754)
Purchases of investment securities
Held-to-Maturity (996,170)
Proceeds from maturities and
redemption of investment
securities Held-to-Maturity 3,254,532
Net increase in loans (4,488,234)
Proceeds from sale of premises
and equipment 1,200
Purchases of premises and equipment (114,846)
Proceeds from sale of other real
estate owned -
____________
NET CASH USED IN INVESTING
ACTIVITIES $(19,178,853)
____________
FINANCING ACTIVITIES
Net increase in deposits $ 11,225,696
Net increase in short-term
borrowings 762,766
Proceeds from long-term borrowings 12,000,000
Repayment of long-term borrowings (9,000,000)
Acquisition of Treasury Stock -
Cash dividends paid (1,138,108)
Dividends paid in lieu of
fractional shares (4,622)
____________
NET CASH PROVIDED BY
FINANCING ACTIVITIES $ 13,845,732
____________
Increase (decrease) in cash
and cash equivalents $ (1,440,281)
Cash and cash equivalents at
beginning of year 6,619,812
____________
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 5,179,531
The accompanying notes are an integral part of these consolidated financial
statements
1998 Annual Report 7
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements for Years Ended December
31, 1998, 1997 and 1996
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting policies of First Keystone Corporation and
Subsidiary (the "Corporation") are in accordance with generally
accepted accounting principles 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. 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 eight full service offices and 11 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.
First Keystone Corporation has a commercial banking operation and
trust department as its major lines of business. The commercial
banking operation includes a commercial services and retail services
area. Commercial services includes lending and related financial
services to small and medium sized corporations and other business
entities. The retail services includes sales and distribution (direct
lending, deposit gathering, and retail mortgage lending) primarily to
individuals. The trust department includes investment management,
estate planning, employee benefit administration, and personal trust
services which produce fee based income. The business units are
identified by the products or services offered by the business unit
and the channel through which the product or service is delivered. The
accounting policies of the individual business units are the same as
those of the Corporation.
Use of Estimates
The preparation of these consolidated financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of 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 in the Statement of Stockholders' Equity.
Management's decision to sell available for sale securities is based
on changes in economic conditions controlling the sources and
applications of funds, terms, availability of and yield of alternative
investments, interest rate risk and the need for liquidity.
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 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. 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. Loan origination fees and certain direct
loan origination costs have been deferred and 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. These loans are sold without recourse to the Corporation.
8 First Keystone Corporation
Non-Accrual Loans - Generally, a loan is classified as non-accrual and
the accrual of interest on such 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 loans effective interest rate
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.
Premises and Equipment
Premises and equipment are stated at cost less accumulated
depreciation computed principally on the straight-line method over the
estimated useful lives of the assets. 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 retains the right to service certain loans. When
originated mortgage loans are sold and servicing is retained, a
servicing asset is capitalized based on relative fair value to 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 balance sheet. In addition, the servicing rights are
periodically evaluated for impairment based on their relative fair
value.
Other Real Estate Owned
Real estate properties acquired through, or in lieu of, loan
foreclosure are to be sold and are initially recorded at fair value at
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. 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.
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.
Per Share Data
Statement of Financial Accounting Standards (SFAS) No. 128,
Earnings Per Share, requires dual presentation of basic and 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 which currently have no effect
on earnings per share.
1998 Annual Report 9
Historical shares outstanding and per share data have been
adjusted retroactively for stock splits and dividends.
Cash Flow Information
For purposes of reporting 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.
Interest paid on deposits and other borrowings was $10,355,156,
$9,275,057 and $8,682,349 in 1998, 1997 and 1996, respectively. Cash
payments for income taxes were $1,314,645, $1,257,115 and $1,125,251
for 1998, 1997 and 1996, respectively. The Corporation transferred
loans to other real estate owned in the amounts of $46,184 in 1996.
Derivative Financial Instruments
The Corporation has no derivative financial instruments requiring
disclosure under Statement of Financial Accounting Standards (SFAS)
No. 119, "Disclosure about Derivative Financial Instruments and Fair
Value of Financial Instruments."
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 recognized on a cash basis
and is not materially different than if it were reported on an accrual
basis.
New Accounting Standards
Statement of Financial Accounting Standards (SFAS) No. 130,
"Reporting Comprehensive Income", is effective and has been
implemented for the year ended December 31, 1998. SFAS 130 establishes
standards for reporting and display of comprehensive income and its
components. The adoption of SFAS 130 did not have a material effect on
the Corporation's financial condition or results of operations.
Statement of Financial Accounting Standards (SFAS) No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities", provides accounting and reporting
standards for sales, securitizations, and servicing of receivables and
other financial assets, for certain serviced borrowings and collateral
transactions, and for extinguishment of liabilities. As a result of
SFAS 127, provisions of SFAS 125 became fully effective in 1998 and
has not had a significant impact on the Corporation's financial
condition or results of operations.
Statement of Financial Accounting Standards (SFAS) No. 131,
"Disclosures about Segments of an Enterprise and Related Information",
became effective for 1998 and establishes standards for the way that
public business enterprises report information about operating
segments in annual financial statements and requires those enterprises
report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes
standards for related disclosures about products and services,
geographic areas and major customers. The Corporation adopted the
provision of this Statement for 1998. The disclosure requirements had
no impact on the financial position or results of operations.
Statement of Financial Accounting Standards (SFAS) No. 133,
"Accounting for Derivative Instruments and Hedging Activities",
becomes effective for years beginning after June 15, 1999. SFAS 133
requires fair value accounting for all stand-alone derivatives and
many derivatives embedded in other instruments and contracts. Since
the Corporation does not enter into transactions involving derivatives
described in the standard and does not engage in hedging activities,
the standard is not expected to have a significant impact on the
Corporation's financial condition or results of operations.
Reporting Format
Certain amounts in the financial statements of prior periods have
been reclassified to conform with presentation used in the 1998
financial statements. Such reclassifications have no effect on the
Corporation's consolidated financial condition or net income.
NOTE 2 RESTRICTED CASH BALANCES
Regulations of the Board of Governors of the Federal Reserve
System impose uniform reserve requirements on all member depository
institutions. The Corporation's banking subsidiary was required to
have aggregate cash reserves of $2,471,000 and $3,105,000 at December
31, 1998, and 1997, respectively.
The Corporation's banking subsidiary also, from time to time,
maintains deposits with the Federal Reserve Bank and other banks for
various services such as check clearing and charge card processing.
Balances maintained for this purpose were $2,330,554 at December 31,
1998.
10 First Keystone Corporation
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, 1998
and 1997:
Available-for-Sale Securities
_________________________________________________
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
_________ __________ _________ ________
December 31, 1998:
U.S. Treasury
securities $ 7,347,041 $ 139,115 $ - $ 7,486,156
Obligations of U.S.
Government
Corporations
and Agencies:
Mortgage-backed 37,317,890 273,585 107,209 37,484,266
Other 15,006,590 143,098 1,563 15,148,125
Obligations of state
and political
subdivisions 50,312,521 2,390,785 333,998 52,369,308
Equity securities 3,304,003 940,948 31,942 4,213,009
____________ __________ ________ ____________
Total $113,288,045 $3,887,531 $474,712 $116,700,864
Held-to-Maturity Securities
________________________________________________
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
________ __________ _________ ________
December 31, 1998:
Obligations of U.S.
Government
Corporations
and Agencies:
Mortgage-backed $10,593,592 $ 48,459 $111,820 $10,530,231
Obligations of state
and political
subdivisions 3,391,089 93,724 - 3,484,813
___________ ________ ________ ___________
Total $13,984,681 $142,183 $111,820 $14,015,044
Available-for-Sale Securities
________________________________________________
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
December 31, 1997:
U.S. Treasury
securities $10,321,983 $ 119,830 $ - $10,441,813
Obligations of U.S.
Government
Corporations
and Agencies:
Mortgage-backed 17,196,705 237,966 32,030 17,402,641
Other 16,754,705 120,138 25,000 16,849,843
Obligations of state
and political
subdivisions 31,782,785 2,213,179 - 33,995,964
Equity securities 2,136,832 823,596 - 2,960,428
___________ __________ _______ ___________
Total $78,193,010 $3,514,709 $57,030 $81,650,689
Held-to-Maturity Securities
________________________________________________
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
_________ _________ ________ ________
December 31, 1997:
Obligations of U.S.
Government
Corporations
and Agencies,
Mortgage-backed $13,611,707 $ - $66,466 $13,545,241
Obligations of state
and political
subdivisions 3,196,918 90,879 - 3,287,797
___________ _______ _______ ___________
Total $16,808,625 $90,879 $66,466 $16,833,038
1998 Annual Report 11
Securities Available-for-Sale with an aggregate fair value of
$42,346,853 in 1998; $29,864,796 in 1997 and securities Held-to-
Maturity with an aggregate unamortized cost of $8,878,530 in 1998 and
$13,611,707 in 1997, were pledged to secure public funds, trust funds,
securities sold under agreements to repurchase and other balances of
$21,062,344 in 1998 and $35,175,394 in 1997 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, 1998. 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.
December 31, 1998
________________________________________
U.S. Government Obligations
U.S. Agency & of State
Treasury Corporation & Political
Securities Obligations Subdivisions
<F2> <F1>
_______ __________ __________
Available-For-Sale:
Within 1 Year:
Amortized Cost $3,013,365 $ - $ -
Estimated Fair Value 3,040,625 - -
Weighted average yield 6.18% - -
1 - 5 Years:
Amortized cost 4,333,676 4,314,838 3,903,316
Estimated fair value 4,445,531 4,346,956 4,269,332
Weighted average yield 6.40% 6.48% 10.72%
5 - 10 Years:
Amortized cost - 12,561,299 1,929,351
Estimated Fair value - 12,652,514 2,101,141
Weighted average yield - 6.78% 10.50%
After 10 Years:
Amortized cost - 35,448,343 44,479,854
Estimated fair value - 35,632,921 45,998,835
Weighted average yield - 6.97% 9.81%
Total:
Amortized cost $7,347,041 $52,324,480 $50,312,521
Estimated fair value 7,486,156 52,632,391 52,369,308
Weighted average yield 6.31% 6.88% 9.91%
December 31, 1998
________________________________
Marketable
Other Equity
Securities Securities
<F3> <F2>
________ __________
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 2,416,000 888,003
Estimated fair value 2,416,000 1,797,009
Weighted average yield 6.42% 4.90%
Total:
Amortized cost $2,416,000 $ 888,003
Estimated fair value 2,416,000 1,797,009
Weighted average yield 6.42% 4.90%
_______________________
<FN>
<F1>
Average yields on tax-exempt obligations of state and political
subdivisions have been computed on a tax-equivalent basis using a 34% tax
rate.
<F2>
Mortgage-backed securities are allocated for maturity reporting at their
original maturity date.
<F3>
Other securities and marketable equity securities are not considered to
have defined maturities and are included in the after ten year category.
</FN>
12 First Keystone Corporation
December 31, 1998
U.S. Government Obligations
U.S. Agency & of State
Treasury Corporation & Political
Securities Obligations Subdivisions
<F2> <F1>
__________ _________ __________
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 - - 750,000
Estimated Fair value - - 759,545
Weighted average yield - - 7.39%
After 10 Years:
Amortized cost - 10,593,592 2,641,089
Estimated fair value - 10,530,231 2,725,268
Weighted average yield - 6.50% 8.02%
__________ ___________ __________
Total:
Amortized cost $ - $10,593,592 $3,391,089
Estimated fair value - 10,530,231 3,484,813
Weighted average yield - 6.50% 7.88%
December 31, 1998
_______________________________
Marketable
Other Equity
Securities Securities
<F3> <F2>
_________ ________
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>
Average yields on tax-exempt obligations of state and political
subdivisions have been computed on a tax-equivalent basis using a 34% tax
rate.
<F2>
Mortgage-backed securities are allocated for maturity reporting at their
original maturity date.
<F3>
Other securities and marketable equity securities are not considered to
have defined maturities and are included in the after ten year category.
</FN>
FHLB stock has no stated maturity; however, it must be owned as
long as the Bank remains a member of the FHLB System. The Bank does
not anticipate that it will discontinue its membership and therefore,
the investment in the amount of $1,938,800 and $1,027,300 in 1998 and
1997, respectively are classified as other securities.
There were no aggregate investments with a single issuer
(excluding U.S. Government and its agencies) which exceeded ten
percent of consolidated shareholders' equity at December 31, 1998. 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 debt and equity securities
during 1998, 1997 and 1996 were $9,799,220, $18,369,369 and
$20,076,003, respectively. Gross gains realized on these sales were
$219,310, $309,956 and $414,239, respectively. Gross losses on these
sales were $40,676, $241,999 and $451,968, respectively. Net
unrealized gains on securities Available-for-Sale net of tax, reported
as Other Comprehensive Income in the Consolidated Statement of
Stockholders' Equity, was $2,192,528, $2,227,765 and $1,150,382, in
1998, 1997 and 1996, respectively.
1998 Annual Report 13
NOTE 4 LOANS
Major classifications of loans at December 31, 1998 and 1997
consisted of:
1998 1997
________ _______
Commercial, Financial, and Agricultural $ 16,579,315 $ 17,240,808
Tax-exempt 2,253,539 2,565,607
Real estate mortgage 121,223,412 114,467,096
Consumer 26,205,802 22,009,000
____________ ____________
Gross loans $166,262,068 $156,282,511
Less: Unearned discount 4,603,479 3,864,710
Unamortized loan fees, net of costs 125,950 266,958
____________ ____________
Loans, net of unearned income $161,532,639 $152,150,843
Mortgage loans held for sale included in loans were $3,952,310
and $2,070,707 at December 31, 1998, and 1997, respectively.
Changes in the allowance for loan losses for the years ended
December 31, 1998, 1997 and 1996, were as follows:
1998 1997 1996
_______ ______ ______
Balance, January 1 $2,371,194 $2,266,983 $2,015,236
Provision charged to
operations 275,000 325,000 516,584
Loans charged off (269,218) (271,406) (302,480)
Recoveries 44,066 50,617 37,643
__________ __________ __________
Balance, December 31 $2,421,042 $2,371,194 $2,266,983
Non-accrual loans at December 31, 1998, 1997 and 1996 were
$854,295, $320,700 and $267,445, 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:
1998 1997 1996
______ ______ ______
Gross interest due under terms $96,425 $30,027 $46,924
Amount included in income 5,610 7,006 3,048
_______ _______ _______
Interest income not recognized $90,815 $23,021 $43,876
At December 31, 1998 and 1997 the recorded investment in loans
that are considered to be impaired as defined by SFAS No. 114 was
$75,068 and $45,531, respectively. No additional charge to operations
was required to provide for the impaired loans since the total
allowance for loan losses is estimated by management to be adequate to
provide for the loan loss allowance required by SFAS No. 114 along
with any other potential losses. The average recorded investment in
impaired loans during the year ended December 31, 1998 and 1997 was
approximately $85,015 and $84,901, respectively.
At December 31, 1998, there were no significant commitments to
lend additional funds with respect to non-accrual and restructured
loans.
NOTE 5 PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 1998 and 1997
follows:
1998 1997
______ ______
Land $ 876,526 $ 876,526
Buildings and improvements 2,798,369 2,773,148
Equipment 3,548,426 3,389,465
__________ __________
$7,223,321 $7,039,139
Less: Accumulated depreciation 3,465,756 3,603,450
__________ __________
Total $3,757,565 $3,435,689
Depreciation amounted to $345,566 for 1998, $304,134 for 1997 and
$299,274 for 1996.
14 First Keystone Corporation
NOTE 6 MORTGAGE SERVICING RIGHTS
The Corporation's banking subsidiary entered into mortgage
servicing in 1997. Mortgage loans serviced for others are not included
in the accompanying Consolidated Statements of Financial Condition.
The unpaid principal balances of mortgage loans serviced for others
was $6,276,477 and $704,673 at December 31, 1998 and 1997.
Custodial escrow balances maintained in connection with the
foregoing loan servicing, and included in demand deposits, was
approximately $3,089 and $777 at December 31, 1998 and 1997.
Mortgage servicing rights of $56,251 and $7,048 were capitalized
in 1998 and 1997. Amortization of mortgage servicing rights was $1,671
in 1998 and $16 in 1997.
Changes in the balances of servicing assets for the year ended
December 31, 1998, are as follows:
1998 1997
______ ______
Balance at January 1 $ 7,032 $ 0
Servicing asset additions 56,251 7,048
Amortization (1,671) (16)
_______ ______
Balance at December 31 $61,612 $7,032
There was no valuation allowance on servicing assets as of
December 31, 1998 and 1997. Additionally, there were no unrecognized
servicing assets or liabilities for which it is not practicable to
estimate fair value. Mortgage servicing rights in the Consolidated
Balance Sheet are included in other assets at December 31, 1998 and
1997.
NOTE 7 DEPOSITS
Major classifications of deposits at December 31, 1998 and 1997
consisted of:
1998 1997
______ ______
Demand - non-interest bearing $ 22,749,074 $ 18,397,819
Demand - interest bearing 61,897,838 51,654,338
Savings 45,217,418 41,651,109
Time, $100,000 and over 27,344,905 25,245,346
Other time 89,882,284 80,698,572
____________ ____________
Total deposits $247,091,519 $217,647,184
The following is a schedule reflecting classification and
remaining maturities of time deposits of $100,000 and over at December
31, 1998:
1999 $23,906,518
2000 2,376,370
2001 272,878
2002 -
2003 789,139
___________
$27,344,905
Interest expense related to time deposits of $100,000 or more was
$1,339,212 in 1998, $1,241,486 in 1997 and $1,066,135 in 1996.
NOTE 8 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, 1998, and
1997:
1998 Annual Report 15
1998
_____________________________
Maximum
Ending Average Month End Average
Balance Balance Balance Rate
______ ______ ______ ______
Federal funds purchased
and securities sold
under agreements
to repurchase $6,409,222 $6,158,768 $ 7,149,313 4.19%
Federal Home Loan Bank 0 196,000 2,300,000 5.10%
U.S. Treasury tax and
loan notes 224,424 653,372 1,704,698 5.38%
__________ __________ ___________ ____
Total $6,633,646 $7,008,140 $11,154,011 5.32%
1997
_____________________________________
Maximum
Ending Average Month End Average
Balance Balance Balance Rate
______ ______ ______ ______
Federal funds purchased
and securities sold
under agreements
to repurchase $4,602,160 $3,992,063 $4,728,459 4.15%
Federal Home Loan Bank 0 456,411 2,275,000 6.50%
U.S. Treasury tax and
loan notes 1,500,000 663,378 1,888,686 5.19%
__________ __________ __________ ____
Total $6,102,160 $5,111,852 $8,892,145 5.75%
NOTE 9 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 are secured by certain qualifying assets of the
Corporation's banking subsidiary which consist principally of first
mortgage loans.
A schedule of long-term borrowings by maturity as of December 31,
1998 and 1997 follows:
1998 1997
______ ______
Due 1998, 5.56% $ - $1,000,000
Due 1999, 6.38% 1,000,000 1,000,000
Due 2000, 5.76% to 6.73% 2,000,000 2,000,000
Due 2001, 4.97% to 5.80% - 1,000,000
Due 2002, 5.48% to 7.77% 3,000,000 4,000,000
Due 2005, 5.55% 2,000,000 -
Due 2008, 5.02% to 5.48% 5,000,000 -
___________ __________
$13,000,000 $9,000,000
NOTE 10 INCOME TAXES
The current and deferred components of the income tax provision
(benefit) consisted of the following:
1998 1997 1996
______ ______ ______
Federal
Current $1,291,313 $1,278,515 $1,013,777
Deferred (benefit) 1,586 18,645 (32,241)
__________ __________ __________
$1,292,899 $1,297,160 $ 981,536
__________ __________ __________
State
Current $ 11,707 $ 10,276 $ 1,803
Deferred (benefit) - - -
$ 11,707 $ 10,276 $ 1,803
__________ __________ __________
Total provision for income
taxes $1,304,606 $1,307,436 $ 983,339
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%:
1998
____________
Amount Rate
______ ____
Provision at statutory rate $2,105,327 34.0%
Tax-exempt income (929,748) (15.0)
Non-deductible expenses 125,925 2.0
Other, net (8,605) (.1)
__________ ____
Applicable federal income tax and rate $1,292,899 20.9%
1997
____________
Amount Rate
______ ____
Provision at statutory rate $2,029,010 34.0%
Tax-exempt income (824,918) (13.8)
Non-deductible expenses 106,425 1.8
Other, net (13,357) (.3)
__________ ____
Applicable federal income tax and rate $1,297,160 21.7%
1996
____________
Amount Rate
_____ ____
Provision at statutory rate $1,738,632 34.0%
Tax-exempt income (859,940) (16.8)
Non-deductible expenses 112,022 2.2
Other, net (9,178) (.2)
__________ _____
Applicable federal income tax and rate $ 981,536 19.2%
16 First Keystone Corporation
Total federal income tax (benefit) attributable to realized
security gains and losses was $60,746 in 1998, $23,105 in 1997 and
($12,828) in 1996.
The deferred tax assets and liabilities resulting from temporary
timing differences have been netted to reflect a net deferred tax
liability included in other liabilities in these consolidated
financial statements. The components of the net deferred tax liability
at December 31, 1998, 1997 and 1996, are as follows:
1998 1997 1996
______ ______ ______
Deferred Tax Assets:
Loan loss Reserve $ 676,251 $ 659,302 $ 623,870
Deferred Compensation 44,307 20,432 -
Contributions 11,240 - -
___________ ___________ _________
Total $ 731,798 $ 679,734 $ 623,870
Deferred Tax Liabilities:
Loan origination fees
and costs $ (171,850) $ (118,427) $ (64,371)
Mortgage servicing rights (576) - -
Accretion (21,883) (41,836) (24,302)
Unrealized investment
securities gains (1,220,294) (1,229,914) (634,604)
Depreciation (189,964) (170,361) (167,442)
___________ ___________ _________
Total $(1,604,567) $(1,560,538) $(890,719)
Net Deferred Tax Asset
(Liability) $ (872,769) $ (880,804) $(266,849)
It is anticipated that all deferred tax assets are to be
realized, accordingly no valuation allowance has been provided.
NOTE 11 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
contributes 100% of the employee contribution up to 3% of compensation
which amounted to $67,377, $59,395, and $52,892 in 1998, 1997 and
1996, respectively. Under the profit sharing feature, contributions at
the discretion of the Board of Directors, funded currently, amounted
to $167,497, $151,574, and $138,818 in 1998, 1997 and 1996,
respectively.
The Bank also has non-qualified deferred compensation agreements
with three of its 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, 1998 and 1997, was
$70,222 and $60,093, respectively.
NOTE 12 LEASE COMMITMENTS AND CONTINGENCIES
The Corporation's banking subsidiary leases three branch banking
facilities, as well as the operations center adjoining the main bank
office, under operating leases. Rent expense for the year ended
December 31, 1998, 1997 and 1996 was $82,804, $49,905 and $48,180,
respectively. The lease commitments, including a new banking facility
opened in 1998 with a base annual rental of $25,000 are: 1999 -
$105,148, 2000 - $97,526, 2001 - $41,190, 2002 - $25,000 and 2003 -
$20,833.
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 13 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, 1998, 1997 and 1996. 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.
1998 Annual Report 17
A summary of the activity on the related party loans, comprised
of 6 directors and 4 executive officers, consists of the following for
the years ended December 31, 1998, 1997 and 1996:
1998 1997 1996
______ ______ ______
Balance at January 1 $2,080,963 $2,553,945 $3,090,030
Additions 738,176 284,044 224,885
Deductions (786,805) (757,026) (760,970)
__________ __________ __________
Balance at December 31 $2,032,334 $2,080,963 $2,553,945
NOTE 14 REGULATORY MATTERS
Dividends are paid by the Corporation to shareholders from its
assets 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 1999, without
prior regulatory approval, the Bank may declare dividends to the
Corporation in the amount of $4,628,579 plus additional amounts equal
to the net income earned in 1999 for the period January 1, 1999,
through the date of declaration, less any dividends which may have
already been paid in 1999. 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.
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, 1998, 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
institution's category.
(Amounts in thousands) Actual
_______
Amount Ratio
______ _____
As of December 31, 1998:
Total Capital
(to Risk Weighted Assets) $34,080 20.17%
Tier I Capital
(to Risk Weighted Assets) 31,554 18.92%
Tier I Capital
(to Average Assets) 31,554 9.95%
As of December 31, 1997:
Total Capital
(to Risk Weighted Assets) $30,073 21.01%
Tier I Capital
(to Risk Weighted Assets) 28,277 19.75%
Tier I Capital
(to Average Assets) 28,277 10.79%
For Capital
(Amounts in thousands) Adequacy Purposes
_________________
Amount Ratio
_______ _____
As of December 31, 1998:
Total Capital
(to Risk Weighted Assets) $13,557 8.00%
Tier I Capital
(to Risk Weighted Assets) 6,779 4.00%
Tier I Capital
(to Average Assets) 11,371 4.00%
As of December 31, 1997:
Total Capital
(to Risk Weighted Assets) $11,450 8.00%
Tier I Capital
(to Risk Weighted Assets) 5,727 4.00%
Tier I Capital
(to Average Assets) 10,483 4.00%
To Be Well
Capitalized Under
Prompt Corrective
(Amounts in thousands) Action Provisions
__________________
Amount Ratio
______ _____
As of December 31, 1998:
Total Capital
(to Risk Weighted Assets) $16,947 10.00%
Tier I Capital
(to Risk Weighted Assets) 10,168 6.00%
Tier I Capital
(to Average Assets) 14,214 5.00%
As of December 31, 1997:
Total Capital
(to Risk Weighted Assets) $14,314 10.00%
Tier I Capital
(to Risk Weighted Assets) 8,590 6.00%
Tier I Capital
(to Average Assets) 13,103 5.00%
The Corporation's capital ratios are not materially different
from those of the Bank.
18 First Keystone Corporation
NOTE 15 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.
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, 1998, and 1997 were as
follows:
1998 1997
____ ____
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit $17,230,239 $15,524,491
Standby letters of credit $ 937,438 $ 522,080
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 the performance of a customer to a third
party. 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. However,
at December 31, 1998, all standby letters of credit are generally
unsecured.
The Corporation grants commercial, agribusiness and residential
loans to customers within the state. It is management's opinion that
the loan portfolio was balanced and diversified at December 31, 1998,
to the extent necessary to avoid any significant concentration of
credit risk.
NOTE 16 STOCKHOLDERS' EQUITY
On January 4, 1996, the Board of Directors declared a 10% stock
dividend paid February 16, 1996, to shareholders of record January 4,
1996. A total of 80,718 shares were issued as a result of this stock
dividend with a total value transferred from retained earnings of
$2,991,188, including cash in lieu of fractional shares.
On April 15, 1997, the Board of Directors declared a 10% stock
dividend paid May 16, 1997, to shareholders of record May 2, 1997. A
total of 88,762 shares were issued as a result of this stock dividend
with a total value transferred from retained earnings of $3,289,844,
including cash in lieu of fractional shares.
On January 27, 1998, the Board of Directors approved a 3 for 1
stock split issued in the form of a 200% stock dividend to be paid
March 2, 1998, to shareholders of record February 10, 1998. A total of
1,955,818 shares were issued resulting in a transfer from retained
earnings in the amount of $3,911,636 at par value.
On February 10, 1998, the Board of Directors adopted a stock
incentive plan and reserved 100,000 shares of common stock for
issuance under the plan for certain employees of the Bank. 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.
On September 28, 1998, 11,000 options were granted to 22
employees of the Bank. The fair market value per share at the grant
date was $33.50 per share.
All data with respect to shares, net income and cash dividends
per share, and weighted average number of shares outstanding was
retroactively adjusted to reflect the additional shares issued.
1998 Annual Report 19
NOTE 17 FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards (SFAS) No. 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
sheet, 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
No. 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
The fair value of investment securities which include
mortgage-backed securities is estimated based on bid prices
published in financial newspapers or bid quotations received from
securities dealers.
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 managements'
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.
DEPOSITS
Under SFAS No. 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, 1998, and 1997.
Fair values for fixed-rate certificates of deposit are
estimated using a discounted cash flow calculation that applies
interest rates currently being offered on certificates to a
schedule of aggregated expected monthly maturities on time
deposits.
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.
20 First Keystone Corporation
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, 1998 and 1997, the carrying values and
estimated fair values of financial instruments of the Corporation
are presented in the table below:
1998
_______________________
Carrying Estimated
Amount Fair Value
______ ___________
FINANCIAL ASSETS:
Cash and due from banks $ 7,033,112 $ 7,033,112
Short-term investments 22,489 22,489
Investment securities 130,685,545 130,715,919
Net loans 159,111,597 161,783,048
Accrued interest receivable 2,133,030 2,133,030
FINANCIAL LIABILITIES:
Deposits 247,091,519 247,738,736
Short-term borrowings 6,633,646 6,635,422
Long-term borrowings 13,000,000 13,240,392
Accrued interest payable 974,367 986,399
OFF-BALANCE SHEET FINANCIAL
INSTRUMENTS:
Commitments to extend credit 17,230,239
Standby letters of credit 937,438
1997
_______________________
Carrying Estimated
Amount Fair Value
_____ __________
FINANCIAL ASSETS:
Cash and due from banks $ 6,400,261 $ 6,400,261
Short-term investments 7,083,684 7,083,684
Investment securities 98,459,314 98,483,727
Net loans 149,779,649 151,403,927
Accrued interest receivable 1,997,936 1,997,936
FINANCIAL LIABILITIES:
Deposits 217,647,184 218,366,085
Short-term borrowings 6,102,160 6,104,781
Long-term borrowings 9,000,000 9,042,986
Accrued interest payable 991,403 991,403
OFF-BALANCE SHEET FINANCIAL
INSTRUMENTS:
Commitments to extend credit 15,524,491
Standby letters of credit 522,080
1998 Annual Report 21
NOTE 18 PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for First Keystone Corporation
(parent company only) was as follows:
BALANCE SHEETS
December 31
__________________
1998 1997
____ ____
ASSETS
Cash in subsidiary bank $994,725 $593,598
Investment in subsidiary bank 31,380,695 30,022,204
Investment in other equity securities 1,797,009 1,573,278
___________ ___________
TOTAL ASSETS $34,172,429 $32,189,080
LIABILITIES
Payable to subsidiary bank $32,294 $3,742
Accrued expenses and other liabilities 386,986 367,271
___________ __________
TOTAL LIABILITIES $419,280 $371,013
___________ __________
STOCKHOLDERS' EQUITY
Preferred stock $ - $ -
Common stock 5,867,454 1,955,818
Surplus 9,761,066 9,761,066
Retained earnings 17,123,122 17,873,418
Accumulated other comprehensive income 2,192,528 2,227,765
Treasury stock, at cost (1,191,021) -
___________ ___________
TOTAL STOCKHOLDERS' EQUITY $33,753,149 $31,818,067
___________ ___________
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $34,172,429 $32,189,080
INCOME STATEMENTS
Year Ended December 31
______________________________
1998 1997 1996
____ ____ ____
INCOME
Dividends from subsidiary bank $3,344,449 $1,386,901 $1,138,110
Dividends - other 41,423 40,173 34,818
Securities gains 117,203 103,145 -
Interest 24,560 16,650 28,810
__________ __________ __________
TOTAL INCOME $3,527,635 $1,546,869 $1,201,738
Operating Expenses 36,999 28,984 21,212
__________ __________ __________
Income Before Taxes and
Equity in Undistributed
Net Income of Subsidiary $3,490,636 $1,517,885 $1,180,526
Income tax expense 47,572 41,756 7,325
__________ __________ __________
Income Before Equity in
Undistributed Net Income
of Subsidiary $3,443,064 $1,476,129 $1,173,201
Equity in undistributed
income of Subsidiary 1,444,468 3,184,111 2,957,084
__________ __________ __________
NET INCOME $4,887,532 $4,660,240 $4,130,285
22 First Keystone Corporation
STATEMENTS OF CASH FLOWS
Year Ended December 31
_____________________________
1998 1997 1996
____ ____ ____
OPERATING ACTIVITIES
Net income $ 4,887,532 $ 4,660,240 $ 4,130,285
Adjustments to reconcile net
income to net cash provided
by operating activities:
Securities gains (117,202) (103,145) -
Equity in undistributed
net income of Subsidiary (1,444,468) (3,184,111) (2,957,084)
Decrease in receivables
from Subsidiary - - 54,681
Decrease in prepaid expenses
and other assets - 11,400 70,994
Increase (decrease) in
advances payable to
Subsidiary 28,552 (3,003) 6,745
Increase (decrease) in
accrued expenses and
other liabilities (14,955) 32,149 (97,721)
___________ ___________ ___________
NET CASH PROVIDED BY
OPERATING ACTIVITIES $ 3,339,459 $ 1,413,530 $ 1,207,900
___________ ___________ ___________
INVESTING ACTIVITIES
Purchase of equity securities $ (201,023) $ (59,431) $ (41,628)
Sale of equity securities 179,904 163,196 -
NET CASH PROVIDED (USED)
IN INVESTING ACTIVITIES $ (21,119) $ 103,765 $ (41,628)
FINANCING ACTIVITIES
Acquisition of treasury stock $(1,191,021) $ - $ -
Cash dividends paid (1,726,192) (1,386,901) (1,138,108)
Dividends paid in lieu of
fractional shares - (5,650) (4,622)
___________ ___________ ___________
NET CASH (USED) BY
FINANCING ACTIVITIES $(2,917,213) $(1,392,551) $(1,142,730)
___________ ___________ ___________
Increase in Cash and Cash
Equivalents $ 401,127 $ 124,744 $ 23,542
Cash and Cash Equivalents
at Beginning of Year 593,598 468,854 445,312
___________ ___________ ___________
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 994,725 $ 593,598 $ 468,854
1998 Annual Report 23
Management's Discussion and Analysis
___________________________________________________________________
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
PURPOSE
The purpose of the Management 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.
RESULTS OF OPERATIONS
Year Ended December 31, 1998 Versus Year Ended
December 31, 1997
Net income increased to $4,887,532 for the year ended December
31, 1998, as compared to $4,660,240 for the prior year. The net
income for 1998 marked the 16th consecutive year that earnings and
earnings per share have increased. Earnings per share, both basic and
diluted, for 1998 were $1.67 as compared to $1.59 in 1997 (adjusted
for a 10% stock dividend paid in May 1997 and a 3 for 1 stock split in
the form of a 200% stock dividend paid in March 1998). The
Corporation's return on average assets declined to 1.72% in 1998 from
1.83% in 1997. Likewise, the return on average equity declined to
14.68% in 1998 from 15.92% in 1997. The increase in net income in
1998 did not keep pace with the increase in average assets and average
equity.
Net interest income, as indicated below in Table 1, increased by
$410,000 to $10,374,000 for the year ended December 31, 1998,
primarily due to the growth in average earning assets. The
Corporation's net interest income on a fully taxable equivalent basis
increased 5.1% in 1998 to $569,000.
Year Ended December 31, 1997 Versus Year Ended
December 31, 1996
Net income increased to $4,660,240 for the year ended December
31, 1997, as compared to $4,130,285 in 1996. Earnings per share, both
basic and diluted, for 1997 was $1.59 as compared to $1.41 in 1996.
The Corporation's return on average assets and return on average
equity was 1.83% and 15.92%, respectively in 1997, as compared to
1.75% and 15.98%, respectively in 1996.
Net interest income increased by $845,000 to $9,964,000 for the
year ended 1997. The Corporation's net interest income on a fully
taxable equivalent basis increased 7.6% in 1997 to $793,000 as
indicated in Table 1.
NET INTEREST INCOME
The major source of operating income for the Corporation is net
interest income, defined as interest income less interest expense. 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 earnings
assets, interest rates paid on deposits and borrowed funds, and
finally, the level of interest free deposits.
Table 2 on the following page provides a summary of average
balances with corresponding interest income and interest expense, as
well as average yield and rate information for the periods presented.
Table 1 - Net Interest Income
(Amounts in thousands) 1998/1997
______________________
Increase/(Decrease)
______________________________
1998 Amount % 1997
____ ______ ___ ____
Interest Income $20,703 $1,358 7.0 $19,345
Interest Expense 10,329 948 10.1 9,381
_______ ______ _______
Net Interest Income 10,374 410 4.1 9,964
Tax Equivalent Adjustment 1,409 159 12.7 1,250
_______ ______ _______
Net Interest Income
(fully tax equivalent) $11,783 $ 569 5.1 $11,214
(Amounts in thousands) 1997/1996
Increase/(Decrease)
1997 Amount % 1996
Interest Income $19,345 $1,559 8.8 $17,786
Interest Expense 9,381 714 8.2 8,667
Net Interest Income 9,964 845 9.3 9,119
Tax Equivalent Adjustment 1,250 (52) (4.0) 1,302
Net Interest Income
(fully tax equivalent) $11,214 $ 793 7.6 $10,421
The yield on earning assets was 8.07% in 1998, 8.37% in 1997, and
8.38% in 1996. The rate paid on interest bearing liabilities decreased
to 4.50% after increasing to 4.56% in 1997 from 4.53% in 1996. A 30
basis point decline in the yield on earning assets, together with just
a 6 basis decrease on the rate paid on interest bearing liabilities in
1998 put additional pressure on the net interest margin. The effect
was a decrease in our net interest margin to 4.30% in 1998 as compared
to 4.56% in 1997 and 4.58% in 1996. The continued maintenance of an
adequate net interest margin is a primary concern being addressed by
management on an ongoing basis.
1998 Annual Report 25
Management's Discussion and Analysis
_____________________________________________________________________
Table 2 - Distribution of Assets, Liabilities and Stockholders' Equity
1998
___________________________________
Avg. Balance Revenue Yield
/Expense /Rate
___________ _______ _____
Interest Earning Assets:
Loans:
Commercial<F1> $ 18,349,551 $ 1,645,311 8.97%
Real Estate<F1> 116,452,691 9,986,605 8.58%
Installment Loans,
Net<F1><F2> 18,989,332 1,861,608 9.80%
Fees on Loans 0 7,819 0%
____________ ___________ ____
Total Loans (Including
Fees)<F3> $153,791,574 $13,501,343 8.78%
Investment Securities:
Taxable $ 70,371,073 $ 4,481,462 6.37%
Tax Exempt<F1> 45,379,362 3,882,311 8.56%
____________ ___________
Total Investment Securities $115,750,435 8,363,773 7.23%
Interest Bearing Deposits
in Banks 4,486,588 246,822 5.50%
____________ ___________
Total Interest-Earning
Assets $274,028,597 $22,111,938 8.07%
Non-Interest Earning Assets:
Cash and Due From Banks $ 6,586,890
Allowance for Loan Losses (2,374,338)
Premises and Equipment 3,531,253
Other Real Estate Owned 14,533
Other Assets 2,387,914
____________
Total Non-Interest Earning
Assets 10,146,252
Total Assets $284,174,849
Interest-Bearing Liabilities:
Savings, NOW Accounts, and
Money Markets $100,617,034 $3,248,282 3.23%
Time Deposits 108,004,662 5,960,085 5.52%
Short-Term Borrowings 849,372 45,149 5.32%
Long-Term Borrowings 13,871,969 817,313 5.89%
Securities Sold U/A to
Repurchase 6,158,768 258,319 4.19%
Total Interest-Bearing
Liabilities $229,501,805 $10,329,148 4.50%
Non-Interest Bearing
Liabilities:
Demand Deposits $18,970,283
Other Liabilities 2,401,369
Stockholders' Equity 33,301,392
____________
Total Liabilities/
Stockholders' Equity $284,174,849
Net Interest Income Tax
Equivalent $11,782,790
Margin Analysis:
Interest Income/Earning
Assets 8.07%
Interest Expense/Earning
Assets 3.77%
Net Interest Income/
Earning Assets 4.30%
26 First Keystone Corporation
Management's Discussion and Analysis
___________________________________________________________________
1997
___________________________________
Avg. Balance Revenue/ Yield/
Expense Rate
__________ _______ ____
Interest Earning Assets:
Loans:
Commercial<F1> $ 18,047,317 $ 1,534,446 8.50%
Real Estate<F1> 109,683,131 9,412,077 8.58%
Installment Loans,
Net<F1><F2> 17,344,819 2,124,094 12.25%
Fees on Loans 0 (76,037) 0%
____________ ___________
Total Loans
(Including Fees)<F3> $145,075,267 $12,994,580 8.96%
Investment Securities:
Taxable $ 57,852,149 $ 3,868,888 6.69%
Tax Exempt<F1> 38,362,932 3,467,215 9.04%
Total Investment Securities $ 96,215,081 $ 7,336,103 7.62%
Interest Bearing Deposits
in Banks 4,776,405 264,015 5.53%
____________ ___________
Total Interest-Earning
Assets $246,066,753 $20,594,698 8.37%
____________ ___________
Non-Interest Earning Assets:
Cash and Due From Banks $ 5,378,688
Allowance for Loan Losses (2,295,089)
Premises and Equipment 3,161,431
Other Real Estate Owned 47,946
Other Assets 2,240,113
____________
Total Non-Interest Earning
Assets 8,533,089
____________
Total Assets $254,599,842
Interest-Bearing Liabilities:
Savings, NOW Accounts, and
Money Markets $ 89,137,426 $ 2,853,898 3.20%
Time Deposits 100,012,779 5,583,373 5.58%
Short-Term Borrowings 1,119,789 64,408 5.75%
Long-Term Borrowings 11,646,849 713,710 6.13%
Securities Sold U/A to
Repurchase 3,992,063 165,663 4.15%
____________ ___________
Total Interest-Bearing
Liabilities $205,908,906 $ 9,381,052 4.56%
____________ ___________
Non-Interest Bearing
Liabilities:
Demand Deposits $ 17,712,235
Other Liabilities 1,712,920
Stockholders' Equity 29,265,781
____________
Total Liabilities/
Stockholders' Equity $254,599,842
Net Interest Income
Tax Equivalent $11,213,646
Margin Analysis:
Interest Income/Earning
Assets 8.37%
Interest Expense/Earning
Assets 3.81%
Net Interest Income/
Earning Assets 4.56%
1996
___________________________________
Avg. Balance Revenue/ Yield/
Expense Rate
____________ _______ ____
Interest Earning Assets:
Loans:
Commercial <F1> $ 15,770,100 $ 1,542,429 9.78%
Real Estate <F1> 93,136,506 8,008,957 8.60%
Installment Loans,
Net <F1><F2> 19,832,168 1,986,279 10.02%
Fees on Loans 0 (22,838) 0%
____________ ___________ _____
Total Loans
(Including Fees) <F3> $128,738,774 $11,514,827 8.94%
Investment Securities:
Taxable $ 58,566,185 $ 3,971,485 6.78%
Tax Exempt <F1> 38,724,074 3,510,650 9.07%
Total Investment Securities $ 97,290,259 $ 7,482,135 7.69%
Interest Bearing Deposits
in Banks 1,690,096 91,782 5.43%
Total Interest - Earning
Assets $227,719,129 $19,088,744 8.38%
____________ ___________
Non-Interest Earning Assets:
Cash and Due From Banks $ 4,589,473
Allowance for Loan Losses (1,956,549)
Premises and Equipment 2,957,176
Other Real Estate Owned 51,253
Other Assets 2,245,001
____________
Total Non-Interest Earning
Assets 7,886,354
____________
Total Assets $235,605,483
Interest-Bearing Liabilities:
Savings, NOW Accounts, and
Money Markets $ 84,434,401 $ 2,601,722 3.08%
Time Deposits 93,521,485 5,262,943 5.63%
Short-Term Borrowings 1,658,914 100,183 6.04%
Long-Term Borrowings 8,021,858 541,243 6.75%
Securities Sold U/A to
Repurchase 3,767,725 161,275 4.28%
____________ ___________
Total Interest-Bearing
Liabilities $191,404,383 $ 8,667,366 4.53%
Non-Interest Bearing
Liabilities:
Demand Deposits $ 16,664,535
Other Liabilities 1,506,985
Stockholders' Equity 26,029,580
____________
Total Liabilities/
Stockholders' Equity $235,605,483
Net Interest Income Tax
Equivalent $10,421,378
Margin Analysis:
Interest Income/Earning
Assets 8.38%
Interest Expense/Earning
Assets 3.81%
Net Interest Income/
Earning Assets 4.58%
______________________
<FN>
<F1>
Tax-exempt income has been adjusted to a tax equivalent basis using an
incremental rate of 34%.
<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>
1998 Annual Report 27
Management's Discussion and Analysis
___________________________________________________________________
Table 3 sets forth certain information regarding 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).
In 1998, the increase in net interest income of $569,000 resulted
from a change in volume of $1,212,000 and a decrease of $643,000 due
to changes in rate. In 1997, there was an increase in net interest
income of $793,000 due to changes in volume of $816,000 and a decrease
of $23,000 due to changes in rate.
Table 3 - Changes in Income and Expense, 1998 and 1997
(Amounts in thousands) 1998 COMPARED TO 1997
________________________________
VOLUME RATE NET
______ ____ ___
Interest Income:
Loans, Net $ 781 $(274) $ 507
Taxable Investment Securities 837 (225) 612
Tax-Exempt Investment Securities 634 (219) 415
Other Short-Term Investments (16) (1) (17)
______ _____ ______
Total Interest Income $2,236 $(719) $1,517
Interest Expense:
Savings, Now, and Money Markets $ 367 $27 $ 394
Time Deposits 446 (69) 377
Short-Term Borrowings (15) (4) (19)
Long-Term Borrowings 136 (33) 103
Securities Sold U/A to Repurchase 90 3 93
______ _____ ______
Total Interest Expense $1,024 $ (76) $ 948
______ _____ ______
Net Interest Income $1,212 $(643) $ 569
(Amounts in thousands) 1997 COMPARED TO 1996
________________________________
VOLUME RATE NET
______ ____ ___
Interest Income:
Loans, Net $1,461 $ 19 $1,480
Taxable Investment Securities (49) (54) (103)
Tax-Exempt Investment Securities (33) (11) (44)
Other Short-Term Investments 168 5 173
______ _____ ______
Total Interest Income $1,547 $ (41) $1,506
Interest Expense:
Savings, Now, and Money Markets $ 145 $ 107 $ 252
Time Deposits 365 (45) 320
Short-Term Borrowings (33) (3) (36)
Long-Term Borrowings 245 (72) 173
Securities Sold U/A to Repurchase 9 (5) 4
______ ____ ______
Total Interest Expense $ 731 (18) $ 713
______ _____ ______
Net Interest Income $ 816 $ (23) $ 793
________________________
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 $2,735,553 in 1998, $2,426,231
in 1997, and $2,529,235 in 1996. Tax-exempt income has been adjusted to a
tax-equivalent basis using an incremental rate of 34%.
PROVISION FOR LOAN LOSSES
For the year ended December 31, 1998, the provision for loan
losses was $275,000 as compared to $325,000 as of December 31, 1997, a
decrease of 15.4%. The Corporation's provision for loan losses for the
year ended December 31, 1997, was down $191,584 over 1996. The
provision was decreased the past two years since the loan growth
experienced by the Corporation has not resulted in significant
increase in delinquencies or charge-offs. Net charge-offs by the
Corporation for the fiscal year end December 31, 1998, 1997, and 1996,
were $225,000, $221,000, and $265,000, respectively.
The allowance for loan losses as a percentage of loans, net of
unearned interest, was 1.50% as of December 31, 1998, 1.56% as of
December 31, 1997, and 1.70% as of December 31, 1996.
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.
28 First Keystone Corporation
Management's Discussion and Analysis
___________________________________________________________________
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, other miscellaneous revenue and the
gain on the sale of mortgage loans. In addition, investment security
gains further increase non-interest income, while investment security
losses reduce non-interest income.
For the year ended December 31, 1998, non-interest income
increased $367,000, or 29.1% as compared to an increase of $210,000
for the year ended December 31, 1997. Table 4 provides the major
categories of non-interest income and each respective change.
Excluding investment security gains, non-interest income in 1998
increased $256,000, or 21.4%. This compares to an increase of
$104,000, or 9.5% in 1997 before investment security gains. Income
from the trust department, which consists of fees generated from
individual and corporate accounts, increased in 1998 by $68,000 after
increasing by $32,000 in 1997. Increased income from the trust
department was due primarily to increasing market value of accounts.
Service charges and fees, consisting primarily of service charges
on deposit accounts, was the largest source of non-interest income in
1998 and 1997. Service charges and fees increased by $81,000, or 12.1%
in 1998 compared to an increase of $53,000, or 8.6% in 1997. Other
income increased by $15,000, or 44.41% in 1998 compared to a decrease
of $15,000, or a 30.6% reduction in 1997. The gain on sale of
mortgages provided $126,000 in 1998, an increase of $92,000 over 1997.
In 1997, we recognized our first gain on the sale of mortgage loans as
we originated mortgages for sale in the secondary market. Since the
Corporation continues to service the mortgages which are sold, this
provides a source for continued non-interest income.
Table 4 - Non-Interest Income
(Amounts in thousands) 1998/1997
__________________________
Increase/(Decrease)
___________________
1998 Amount % 1997
____ _____ __ ____
Trust Department $525 $68 14.9 $ 457
Service Charges and Fees 750 81 12.1 669
Other 49 15 44.1 34
Gain on Sale of Mortgages 126 92 270.6 34
______ ____ ______
Subtotal 1,450 $256 21.4 $1,194
Investment Securities Gains 179 111 163.2 68
______ ____ ______
Total $1,629 $367 29.1 $1,262
(Amounts in thousands) 1997/1996
________________________________
Increase/(Decrease)
__________________
1997 Amount % 1996
____ _____ __ ____
Trust Department $ 457 $ 32 7.5 $ 425
Service Charges and Fees 669 53 8.6 616
Other 34 (15) (30.6) 49
Gain on Sale of Mortgages 34 34 0 0
______ ____ _____ ______
Subtotal $1,194 104 9.5 $1,090
Investment Securities Gains 68 106 278.9 (38)
______ ____ _____ ______
Total $1,262 $210 20.0 $1,052
NON-INTEREST EXPENSES
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 change, amount and percentage.
Total non-interest expense increased by $601,000, or 12.2% in
1998 compared to an increase of $393,000, or 8.6% in 1997. Expenses
associated with employees (salaries and employee benefits) continue to
be the largest non-interest expenditure. Salaries and employee
benefits amounted to 52.2% of total non-interest expense in 1998 and
53.3% in 1997. Salaries and employee benefits increased $261,000, or
9.9% in 1998 and $179,000, or 7.3% in 1997. The increase in both years
were due to an increased number of employees, plus normal salary
adjustments and increased benefit costs. Full time equivalent
employees total 105 as of December 31, 1998, compared to 98 in 1997,
and 91 in 1996.
Net occupancy expense increased $71,000, or 21.4% in 1998 as
compared to $51,000, or 18.1% in 1997. The increases in occupancy in
both 1998 and 1997 relate primarily to the opening of one new full
service branch office in each year. Furniture and equipment expense
increased $28,000, or 5.7% in 1998 compared to an increase of $20,000,
or 4.3% in 1997. Other operating expenses increased $241,000, or 16.2%
in 1998 as compared to an increase of $143,000, or 10.6% in 1997.
The overall level of non-interest expense continues to be low,
relative to our peers. In fact, our total non-interest expense was
less than 2% of average assets in both 1998 and 1997. 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.
1998 Annual Report 29
Management's Discussion and Analysis
___________________________________________________________________
Table 5 - Non-Interest Expense
(Amounts in thousands) 1998/1997
____________________________
Increase/(Decrease)
__________________
1998 Amount % 1997
____ ______ ______ ____
Salaries and Employee Benefits $2,888 $261 9.9 $2,627
Occupancy, Net 403 71 21.4 332
Furniture and Equipment 516 28 5.7 488
Other 1,728 241 16.2 1,487
______ ____ ______
Total $5,535 $601 12.2 $4,934
(Amounts in thousands) 1997/1996
________________________________
Increase/(Decrease)
1997 Amount % 1996
____ _____ __ ____
Salaries and Employee Benefits $2,627 $179 7.3 $2,448
Occupancy, Net 332 51 18.1 281
Furniture and Equipment 488 20 4.3 468
Other 1,487 143 10.6 1,344
Total $4,934 $393 8.6 $4,541
INCOME TAX EXPENSE
Income tax expense for the year ended December 31, 1998, was
$1,304,606 as compared to $1,307,436 and $983,339 for the years ended
December 31, 1997, and December 31, 1996, respectively. In 1998, our
income tax expense decreased even though income before taxes increased
$224,462. An increase in tax exempt interest, derived from both our
tax-free loans and municipal investment securities in 1998, resulted
in a lower income tax liability. The effective income tax rate was
20.9% in 1998, 21.7% in 1997, and 19.2% in 1996. The limited
availability of municipal investments at attractive interest rates may
result in a higher effective tax rate in future years.
FINANCIAL CONDITION
GENERAL
Total assets increased to $303,028,481, at year-end 1998, an
increase of 13.3% over year-end 1997. As of December 31, 1998, total
deposits amounted to $247,091,519, up 13.5%over 1997. Assets as of
December 31, 1997, were $267,398,586, an increase of 10.2% over 1996,
while total deposits as of year-end 1997 amounted to $217,647,184, an
increase of 9.6% over 1996.
The increase in assets primarily reflects the deployment of
proceeds from deposits into loans and investment securities. The
Corporation continues to maintain and manage its asset growth. Our
strong equity capital position provides us an opportunity to leverage
our asset growth. Borrowings did increase in 1998 by $4,531,486. The
Corporation may borrow additional funds to leverage its balance sheet
in 1999 if net income can be incrementally increased without incurring
an excessive amount of interest rate risk.
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 equaled 96.4% as
of December 31, 1998, compared to 96.4% as of December 31, 1997, and
96.7% at December 1, 1996. 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 $161,533,000 as
of December 31, 1998, as compared to $152,151,000 as of December 31,
1997. 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 $9,382,000, or 6.2% in 1998 compared to
an increase of $18,890,000, or 14.2% in 1997 and $5,200,000, or 4.1%
in 1996.
The loan portfolio is well diversified and increases in the
portfolio the last two years have been primarily from real estate
loans and commercial loans secured by real estate. Also, in 1998
consumer loans increased to a new record level. In 1998, approximately
$5,600,000 of residential mortgage loans were sold in the secondary
market. The Corporation will continue to originate and market 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 noted loan growth was achieved without a significant
percentage increase in delinquencies or charge-offs. The Corporation
internally underwrites each of its loans to comply with prescribed
policies and approval levels established by its Board of Directors.
30 First Keystone Corporation
Management's Discussion and Analysis
___________________________________________________________________
Table 6 - Loans Outstanding, Net of Unearned Income
(Amounts in thousands) December 31,
___________________________
1998 1997 1996
____ ____ ____
Commercial, financial and
agricultural:
Commercial secured by real estate $ 43,366 $ 41,566 $ 33,103
Commercial - other 16,579 17,241 13,574
Tax exempt 2,254 2,566 2,263
Real estate (primarily residential
mortgage loans) 77,858 72,901 65,145
Consumer loans 26,205 22,009 23,027
________ ________ ________
Total Gross Loans $166,262 $156,283 $137,112
Less: Unearned income and
unamortized loan fees net
of costs 4,729 4,132 3,851
________ ________ ________
Total Loans, net of unearned income $161,533 $152,151 $133,261
(Amounts in thousands) December 31,
_________________
1995 1994
____ ____
Commercial, financial and
agricultural:
Commercial secured by real estate $ 28,846 $ 30,127
Commercial - other 17,563 16,285
Tax exempt 3,602 3,754
Real estate (primarily residential
mortgage loans) 58,438 52,389
Consumer loans 23,681 19,370
________ ________
Total Gross Loans $132,130 $121,925
Less: Unearned income and
unamortized loan fees
net of costs 4,069 3,741
________ ________
Total Loans, net of unearned income $128,061 $118,184
INVESTMENT SECURITIES
The investment portfolio has been allocated between securities
available for sale and securities held to maturity. No investment
securities were established in a trading account. Available for sale
securities increased to $116,701,000 in 1998, a 42.9% increase over
1997. Held-to-maturity securities declined $2,824,000, or a 16.8%
decrease over 1997. 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 short-term investments, U.S. Treasury
Securities, U.S. Government Agencies, corporate obligations, mortgage
backed securities, state and municipal securities, and other debt
securities. In addition, the investment portfolio includes equity
securities consisting primarily of common stock investments in other
bank holding companies and commercial banks.
During 1998, interest bearing deposits in other banks decreased to
$22,489 from $7,083,684 in 1997, as more funds were invested in
marketable securities to maximize income while still addressing
liquidity needs.
Table 7 - Carrying Value of Investment Securities
(Amounts in thousands) December 31,
__________________
1998
__________________
Available Held to
for Sale Maturity
________ ________
U.S. Treasury $ 7,486 $ 0
U. S. Government Corporations
and Agencies 52,633 10,594
State and Municipal 52,369 3,391
Other Securities 0 0
Equity Securities 4,213 0
________ _______
Total Investment Securities $116,701 $13,985
(Amounts in thousands) December 31,
__________________
1997
___________________
Available Held to
for Sale Maturity
________ ________
U.S. Treasury $10,442 $ 0
U. S. Government Corporations
and Agencies 34,253 13,612
State and Municipal 33,996 3,197
Other Securities 0 0
Equity Securities 2,960 0
_______ _______
Total Investment Securities $81,651 $16,809
December 31,
___________________
1996
___________________
Available Held to
for Sale Maturity
_______ ________
U.S. Treasury $ 3,341 $ 0
U. S. Government Corporations
and Agencies 36,339 16,787
State and Municipal 37,602 3,293
Other Securities 1,266 0
Equity Securities 2,598 0
Total Investment Securities $81,146 $20,080
1998 Annual Report 31
Management's Discussion and Analysis
___________________________________________________________________
ALLOWANCE FOR LOAN LOSSES
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. Management
maintains its loan review and loan classification standards consistent
with those of its regulatory supervisory authority. Management feels,
considering the conservative portfolio composition, which is largely
composed of small retail loans (mortgages and installments) with
minimal classified assets, low delinquencies, and favorable loss
history, 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. In 1998, net charge-offs as a percentage of average loans were
.15% compared to .15% in 1997 and .21% in 1996. Net charge-offs
amounted to $225,000 in 1998 as compared to $221,000 and $265,000 in
1997 and 1996, respectively.
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 1.57% in
1998, 1.63% in 1997, and 1.76% in 1996.
Table 8 - Analysis of Allowance for Loan Losses
(Amounts in thousands) Years Ended December 31,
______________________
1998 1997 1996
____ ____ ____
Balance at beginning of period $2,371 $2,267 $2,015
Charge-offs:
Commercial, financial, and
agricultural 66 107 214
Real estate - mortgage 42 54 0
Installment loans to individuals 161 111 88
_____ _____ _____
269 272 302
Recoveries:
Commercial, financial, and
agricultural 0 7 12
Real estate - mortgage 8 17 8
Installment loans to individuals 36 27 17
44 51 37
Net charge-offs 225 221 265
Additions charged to operations 275 325 517
______ ______ ______
Balance at end of period $2,421 $2,371 $2,267
Ratio of net charge-offs
during the period to average
loans outstanding during the period .15% .15% .21%
Allowance for loan losses to average
loans outstanding during the period 1.57% 1.63% 1.76%
(Amounts in thousands) Years Ended December 31,
______________________
1995 1994
____ ____
Balance at beginning of period $1,802 $1,844
Charge-offs:
Commercial, financial, and
agricultural 18 80
Real estate - mortgage 118 29
Installment loans to individuals 50 72
______ ______
186 181
Recoveries:
Commercial, financial, and
agricultural 6 81
Real estate - mortgage 2 6
Installment loans to individuals 19 21
______ ______
27 108
Net charge-offs 159 73
Additions charged to operations 372 31
______ ______
Balance at end of period $2,015 $1,802
Ratio of net charge-offs during
the period to average loans
outstanding during the period .13% .07%
Allowance for loan losses to average
loans outstanding during the period 1.65% 1.61%
32 First Keystone Corporation
Management's Discussion and Analysis
___________________________________________________________________
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,
_______________________________________
1998 %<F1> 1997 % <F1>
____ ____ ____ ____
Commercial, financial,
and agricultural $ 253 9.8 $ 271 12.1
Real estate - mortgage 1,237 74.3 1,135 73.9
Installments to
individuals 319 15.9 241 14.0
Unallocated 612 N/A 724 N/A
______ ______ ______ _____
$2,421 100.00 $2,371 100.0
December 31,
_____________________________________
1996 % <F1> 1995 % <F1>
____ ____ ____ ____
Commercial, financial,
and agricultural $ 303 10.7 $ 344 17.4
Real estate - mortgage 1,088 72.5 663 66.1
Installments to
individuals 203 16.8 443 16.5
Unallocated 673 N/A 565 N/A
______ _____ ______ _____
$2,267 100.0 $2,015 100.0
December 31,
_______________________________________
1994 % <F1>
____ ____
Commercial, financial,
and agricultural $ 253 15.2
Real estate - mortgage 985 68.9
Installments to
individuals 153 15.9
Unallocated 411 N/A
______ _____
$1,802 100.0
______________________
<FN>
<F1>
Percentage of loans in each category to total loans.
</FN>
NON-PERFORMING ASSETS
The recent growth experienced by the Corporation has not resulted
in a corresponding percentage increase in delinquencies and non-
performing loans. 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. Other real estate owned/foreclosed assets represents
property acquired through foreclosure, or considered to be an in-
substance foreclosure.
The total of non-performing assets did increase to $881,000 as of
December 31, 1998, as compared to $686,000 as of December 31, 1997.
Some of the loans at year-end 1997, which were past-due 90 days or
more and still accruing, were put on non-accrual in 1998. Even though
our total non-performing assets did increase in 1998, our allowance
for loan losses to total non-performing assets remains very strong at
274.8%.
With a full-time loan review officer, loan quality is monitored
closely, and we actively attempt to 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 1998 and 1997
was $5,610 and $7,006, respectively. Interest income, which would have
been recorded on these loans under the original terms in 1998 and 1997
was $96,425 and $30,027, respectively. At December 31, 1998, 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, 1998, 1997, and 1996, management is of the opinion
that there were no loan concentrations exceeding 10% of total loans.
There is a concentration of real estate mortgage loans in the loan
portfolio. Real estate mortgages comprise 72.9% of the loan portfolio
as of December 31, 1998, down slightly from 73.2% in 1997.
1998 Annual Report 33
Management's Discussion and Analysis
___________________________________________________________________
Real estate mortgages consist of both residential and commercial real
estate loans. The real estate loan portfolio is well diversified in
terms of borrowers and collateral. 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.
Table 10 - Non-Performing Assets
(Amounts in thousands) December 31,
____________________________________
1998 1997 1996 1995 1994
____ ____ ____ ____ ____
Non-accrual and restructured loans $854 $321 $267 $557 $620
Other real estate/
foreclosed assets 0 29 84 0 235
Loans past-due 90 days or more
and still accruing 27 336 263 68 49
____ ____ ____ ____ ____
Total non-performing assets $881 $686 $614 $625 $904
Non-performing assets to
period-end loans and
foreclosed assets .55% .45% .46% .48% .76%
Total non-performing assets
to total assets .29% .26% .25% .28% .44%
Total allowance for loan losses
to total non-performing assets 274.8% 345.7% 369.2% 322.4% 199.3%
DEPOSITS AND OTHER BORROWED FUNDS
Consumer and commercial retail deposits are attracted primarily
by First Keystone's subsidiary bank's eight 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 and takes
in account prevailing market interest rates and other economic
factors.
Deposit growth amounted to $29,444,335, or a 13.5% increase when
comparing December 31, 1998, to December 31, 1997. This increase
compares to deposit increases of 9.6% in 1997 and 6.0% in 1996.
During 1998, the Corporation experienced deposit growth in both
non-interest bearing and interest bearing deposits. Non-interest
bearing deposits amounted to $22,749,074 as of December 31, 1998, an
increase of $4,351,255, or 23.7% over 1997. Interest bearing deposits
amounted to $224,342,445 as of December 31, 1998, an increase of
$25,093,080, or 12.6% over 1997. In the area of interest bearing
deposits, transaction type of core deposit (interest checking,
savings, and money market) accounts increased as well as certificates
of deposit.
The Corporation utilizes borrowing from the Federal Home Loan
Bank (FHLB) and collateralized repurchase agreements as a tool to
augment deposits in funding asset growth. Total borrowings were
$19,633,646 as of December 31, 1998, compared to $15,102,160 on
December 31, 1997. The increase in borrowings in 1998 were utilized to
fund loan growth and increase in our investment portfolio. In
connection with FHLB borrowings and repurchase agreements, the
Corporation maintains certain eligible assets as collateral.
CAPITAL STRENGTH
Normal increases in capital are generated by net income, less
cash dividends paid out. Also, the net unrealized gains on investment
securities available for sale increased shareholders' equity or
capital in both 1998 and 1997. The net increase in capital was
$1,935,082 in 1998 and $4,345,072 in 1997. The accumulated other
comprehensive income decreased slightly to $2,192,528 in 1998. Another
factor for the smaller increase in equity capital in 1998 relates to
our stock repurchase plan. The Corporation's Board of Directors
approved repurchasing up to 100,000 shares of common stock. As of
December 31, 1998, the Corporation had repurchased 35,134 shares at a
cost of $1,191,021.
Return on equity (ROE) is computed by dividing net income by
average stockholders' equity. This ratio was 14.68% for 1998, 15.92%
for 1997, and 15.98% for 1996. Refer to Performance Ratios on Page 2 -
Summary of 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 10.50% at December 31,
1998, and 11.23% as of December 31, 1997.
The risk-based capital ratios also decreased in 1998 from 1997
for both the Corporation and the Bank. 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.
The following table indicates capital ratios as of December 31, 1998,
and December 31, 1997, for the Corporation and the Bank.
34 First Keystone Corporation
Management's Discussion and Analysis
___________________________________________________________________
Table 11 - Capital Ratios
December 31, 1998
_________________
Corporation Bank
___________ ____
Risk-Based Capital:
Tier I risk-based capital ratio 18.62% 18.92%
Total risk-based capital ratio
(Tier 1 and Tier 2) 20.11% 20.17%
Leverage Ratio:
Tier I capital to average assets 10.50% 9.95%
December 31, 1997
_________________
Corporation Bank
__________ ____
Risk-Based Capital:
Tier I risk-based capital ratio 19.43% 19.75%
Total risk-based capital ratio
(Tier 1 and Tier 2) 20.68% 21.01%
Leverage Ratio:
Tier I capital to average assets 11.23% 10.79%
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. 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 factors 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, short-term
borrowings are readily accessible at the Federal Reserve Bank discount
window, Atlantic Central Bankers Bank, or the Federal Home Loan Bank.
Finally, while the Corporation does not have access to funds on a
short-term basis from the Federal Reserve Bank discount window, the
Bank can utilize the 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, both short-term
and long-term, are available to help address any liquidity needs.
Table 12 - Loan Maturities and Interest Sensitivity<F1>
(Amounts in thousands) December 31, 1998
_______________________________
One year One thru Over five
or less five years years Total
Commercial, Financial and
Agricultural
Fixed interest rate $ 5,573 $ 7,088 $6,955 $19,616
Variable interest rate 32,270 15,150 689 48,109
_______ _______ ______ _______
Total $37,843 $22,238 $7,644 $67,725
Real Estate Construction
Fixed interest rate $ 100 $ 961 $ 0 $ 1,061
Variable interest rate $ 125 $ 0 $ 0 $ 125
__________________________
<FN>
<F1>
Excludes residential mortgages and consumer loans.
</FN>
FORWARD LOOKING STATEMENTS
The sections that follow, Market Risk Management, Asset/Liability
Management, and Year 2000 Compliance contain certain forward looking
statements. These forward looking statements involve significant risks
and uncertainties, including changes in economic and financial market
conditions. The Corporation's ability to execute its business plans,
including its plan to address the Year 2000 issue, and the ability of
third parties to effectively address their Year 2000 issues are
significant risks. Although First Keystone Corporation believes that
the expectations reflected in such forward looking statements are
reasonable, actual results may differ materially.
1998 Annual Report 35
Management's Discussion and Analysis
___________________________________________________________________
MARKET RISK MANAGEMENT
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.
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. As of December 31, 1998, the
Corporation's securities portfolio included $116,700,864 in securities
classified as available for sale. Accordingly, with the magnitude of
the Corporation's holdings of securities available for sale, changes
in interest rates could produce significant changes in the value of
such securities and could produce significant fluctuations in the
stockholders' equity of the Corporation. The Corporation does not own
any trading assets.
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.
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 2.4% if rates fell gradually by two
percentage points over one year. The model projects a decrease of
approximately 2.4% in net-interest income if rates rise gradually by
two percentage points over one year. While this does indicate a
liability sensitive risk position, both of these forecasts are within
the one year policy guidelines.
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 42.2%. Additionally, net present value is projected to decrease by
38.7% if rates increase immediately by 200 basis points, both within
policy limits restricting these amounts to 50%.
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 ALCO
Change Guidelines
______ _________
Effect on Net Interest Income
1-year Net Income simulation
Projection
200 bp Ramp vs Stable Rate 2.4% (10%)
+200 bp Ramp vs Stable Rate (2.4%) (10%)
Effect on Net Present Value of
Balance Sheet
Static Net Present Value Change
200 bp Shock vs Stable Rate 42.2% (50%)
+200 bp Shock vs Stable Rate (38.7%) (50%)
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. Several techniques are used for measuring interest rate
sensitivity. The traditional maturity "gap" analysis, which reflects
the volume difference between interest rate sensitive assets and
liabilities during a given time period, is reviewed regularly by
management. A positive gap occurs when the amount of interest
sensitive assets exceeds interest sensitive liabilities. This position
would
36 First Keystone Corporation
Management's Discussion and Analysis
___________________________________________________________________
contribute positively to net-interest income in a rising interest rate
environment. Conversely, if the balance sheet has more liabilities
repricing than assets, the balance sheet is liability sensitive or
negatively gapped. In our current sensitivity position, management
continues to monitor sensitivity so we do not become overexposed in a
rising interest rate environment.
Limitations of gap analysis as illustrated in Table 14 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 gaps reflect the Corporation's position on a single day
(December 31, 1998 in the case of the following schedule) while the
Corporation continually adjusts its interest sensitivity throughout
the year.
Another way management reviews its interest sensitivity position
is through dynamic income simulation. A dynamic income simulation
model 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. Management also
evaluates the impact of higher and lower interest rates. Management
cannot predict the direction of interest rates or how the mix of
assets and liabilities will change. The use of this information will
help formulate strategies to minimize the unfavorable effect on net
interest income caused by interest rate changes.
Also in Table 14, the Corporation has elected to incorporate some
interest bearing demand deposits and savings deposits as rate
sensitive in the three months or less time frame. The result is a
negative gap in that time frame of $33,862,000. However, much of our
interest bearing demand deposits and savings deposits are considered
core deposits and are not rate sensitive, especially in the three
months or less time frame. Accordingly, the Corporation feels it is
only slightly negatively gapped with exposure to an increase in
interest rates limited within policy guidelines. As discussed
previously, a negative gap will decrease net interest income should
interest rates rise. Despite the Corporation's negative gap position,
the impact of a rapid rise in interest rates as occurred in 1994, did
not have a significant effect on our net interest income. Accordingly,
even though there are some inherent limitations to gap analysis and
dynamic income simulation, the Corporation believes that the tools
used to manage its interest rate sensitivity provide an appropriate
reflection of interest rate risk exposure.
Table 14 - Interest Rate Sensitivity Analysis
(Amounts in thousands) December 31, 1998
_____________________________
3 Months 3 - 12 1 - 5
or Less Months Years
______ ______ _____
Rate Sensitive Assets:
Cash and cash equivalent $ 22 $ 0 $ 0
Loans 32,975 26,342 57,710
Investments 19,599 9,460 60,559
________ _______ ________
Total Rate Sensitive Assets $ 52,596 $ 35,802 $118,269
Rate Sensitive Liabilities:
Deposits:
Interest-bearing demand/
savings $ 52,035 $ 327 $ 0
Time 28,282 59,472 29,100
Short-term borrowings 6,141 492 0
Long-term borrowings 0 1,000 5,000
________ ________ ________
Total Rate Sensitive
Liabilities $ 86,458 $ 61,291 $ 34,100
Interest Rate Sensitivity:
Current period $(33,862) $(25,489) $ 84,169
Cumulative gap (33,862) (59,351) 24,818
Cumulative gap to total assets (11.17%) (19.59%) 8.19%
(Amounts in thousands) December 31, 1998
_____________________________
Over
5 Years Total
______ _____
Rate Sensitive Assets:
Cash and cash equivalent $ 0 $ 22
Loans 44,506 161,533
Investments 41,068 130,686
_______ ________
Total Rate Sensitive Assets $85,574 $292,241
Rate Sensitive Liabilities:
Deposits:
Interest-bearing demand/
savings $55,119 $107,481
Time 8 116,862
Short-term borrowings 0 6,633
Long-term borrowings 7,000 13,000
_______ ________
Total Rate Sensitive
Liabilities $62,127 $243,976
Interest Rate Sensitivity:
Current period $23,447 $ 48,265
Cumulative gap 48,265
Cumulative gap to total assets 15.93%
1998 Annual Report 37
Management's Discussion and Analysis
___________________________________________________________________
YEAR 2000 COMPLIANCE
Management initiated the process of preparing its computer
systems and applications for the Year 2000 in 1997. The process
involves identifying and remediating date recognition problems in
computer systems and software and other operating equipment that could
be caused by the date change from December 31, 1999, to January 1,
2000.
Management has completed its assessment of all business processes
that could be affected by the Year 2000 issue. Each business process
assessment included a review of the information systems used in that
process, including related hardware and software, the involvement of
any third parties, and any affected operating equipment. To date,
approximately 75% of the mission critical systems determined to be
critical for supporting the core services offered by First Keystone
Corporation have been remediated, unit tested, and returned to
production. Management expects to complete the remediation and testing
of all affected systems within the critical business processes by the
end of the second quarter of 1999.
The Corporation anticipates that its total Year 2000 project cost
will not exceed $100,000. This estimated project cost is based upon
currently available information and includes expenses paid to date.
The expenses for maintenance or modification of software associated
with the Year 2000 will be expensed as incurred. The costs of new
software will be capitalized and amortized over the software's useful
life. The aforementioned Year 2000 project cost estimate also may
change as the Corporation progresses in its Year 2000 program and
obtains additional information associated with and conducts further
testing concerning third parties. At this time, no significant
projects have been delayed as a result of the Corporation's Year 2000
effort.
Financial institution regulators have intensively focused upon
Year 2000 exposures, issuing guidance concerning the responsibilities
of senior management and directors. Year 2000 testing and
certification is being addressed as a key safety and soundness issue
in conjunction with regulatory examinations. In May 1997, the Federal
Financial Institutions Examination Council ("FFIEC") issued an
interagency statement to the chief executive officers of all federally
supervised financial institutions regarding Year 2000 project
management awareness. The FFIEC has highly prioritized Year 2000
compliance in order to avoid major disruptions to the operations of
financial institutions and the country's financial systems when the
new century begins. The FFIEC statement provides guidance to financial
institutions, providers of data services, and all examining personnel
of the federal banking agencies regarding the Year 2000 issue.
Management believes it has an effective plan in place to resolve
the Year 2000 issue in a timely manner and, thus far, activities have
tracked in accordance with the original plan. Management is in the
process of modifying its existing business continuity plans and is
also developing contingency plans to address potential risks in the
event of Year 2000 failures, including non-compliance by third
parties. Despite First Keystone Corporation's efforts to date to
remediate affected systems and develop contingency plans for potential
risks, management has not yet completed all activities associated with
resolving its Year 2000 issues. In addition, non-compliance by third
parties (including loan customers) and disruptions to the economy in
general resulting from Year 2000 issues could also have a negative
impact of undeterminable magnitude on First Keystone Corporation.
38 First Keystone Corporation
Management's Discussion and Analysis
___________________________________________________________________
MARKET PRICE/DIVIDEND HISTORY
First Keystone Corporation's common stock is quoted on the Over
The Counter (OTC) Bulletin Board under the symbol "FKYS." The table
below reports the highest and lowest per share prices known to the
Corporation and the dividends paid during the periods indicated. All
amounts are restated to reflect a 10% stock dividend paid in February
1996, May 1997, and a 3 for 1 split in the form of a 200% dividend
paid in March 1998. These prices do not necessarily reflect any dealer
or retail markup, markdown or commission.
Table 15 - Market Price/Dividend History<F1>
1998
__________________________
Common Stock Dividends
High/Low Paid
_______ ____
First Quarter $30.25/$19.08 $.14
Second Quarter $32.50/$29.50 .14
Third Quarter $36.13/$32.00 .14
Fourth Quarter $34.38/$32.50 .17
1997
__________________________
Common Stock Dividends
High/Low Paid
_______ ____
First Quarter $11.21/$10.74 $.106
Second Quarter $14.33/$10.92 .117
Third Quarter $14.33/$14.33 .117
Fourth Quarter $19.08/$16.63 .133
1996
__________________________
Common Stock Dividends
High/Low Paid
_______ ____
First Quarter $11.21/$10.19 $.094
Second Quarter $11.21/$11.21 .094
Third Quarter $11.21/$11.21 .094
Fourth Quarter $11.21/$11.21 .106
<FN>
<F1>
Reflects adjustment for stock dividends more fully described in Note 1.
</FN>
The following brokerage firms make a market in First Keystone
Corporation stock:
Janney Montgomery Scott, Inc. 1801 Market Street
Philadelphia, PA 19103
(800) 526-6397
Hopper Soliday and Co. 1703 Oregon Pike
Lancaster, PA 17601
(800) 646-8647
Ryan, Beck and Company 150 Monument Road
Suite 106
Bala Cynwyd, PA 19004
(800) 223-8969
1998 Annual Report 39
Management's Discussion and Analysis
___________________________________________________________________
Table 16 - Quarterly Results of Operations (Unaudited)
(Amounts in thousands, except per share)
Three Months Ended
_____________________________________
1998 March June September December
31 30 30 31
_____ ____ ________ _______
Interest income $4,952 $5,183 $5,226 $5,342
Interest expense 2,446 2,531 2,613 2,739
______ ______ ______ ______
Net interest income $2,506 $2,652 $2,613 $2,603
Provision for loan
losses 50 75 50 100
Other non-interest
income 352 324 427 525
Non-interest expense 1,351 1,308 1,379 1,497
______ ______ ______ ______
Income before income
taxes $1,457 $1,593 $1,611 $1,531
Income taxes 316 345 342 302
______ ______ ______ ______
Net income $1,141 $1,248 $1,269 $1,229
Per share<F1> $ .39 $ .43 $ .43 $ .42
(Amounts in thousands, except per share)
Three Months Ended
_______________________________________
1997 March June September December
31 30 30 31
____ ____ ________ _______
Interest income $4,608 $4,745 $4,948 $5,044
Interest expense 2,237 2,276 2,417 2,451
______ ______ ______ ______
Net interest income $2,371 $2,469 $2,531 $2,593
Provision for loan
losses 50 100 50 125
Other non-interest
income 291 273 286 412
Non-interest expense 1,215 1,186 1,223 1,309
______ ______ ______ ______
Income before income
taxes $1,397 $1,456 $1,544 $1,570
Income taxes 274 309 359 365
______ ______ ______ ______
Net income $1,123 $1,147 $1,185 $1,205
Per share <F1> $ .38 $ .39 $ .40 $ .41
<FN>
<F1>
Reflects adjustment for stock dividends more fully described in Note 1.
</FN>
40 First Keystone Corporation