UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10Q Quarterly Report Pursuant to Section 13 OR 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 1999 Commission File Number: 2-88927 FIRST KEYSTONE CORPORATION (Exact name of registrant as specified in its charter) Pennsylvania 23-2249083 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) identification No.) 111 West Front Street, Berwick, PA 18603 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (570) 752-3671 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date: Common Stock, $2 Par Value, 2,873,932 shares as of June 30, 1999. PART I. - FINANCIAL INFORMATION Item. 1 Financial Statements FIRST KEYSTONE CORPORATION BALANCE SHEETS (Unaudited) (Amounts in thousands, except per share data) June December 1999 1998 ASSETS Cash and due from banks $ 8,289 $ 7,033 Interest bearing deposits with banks 2,929 22 Available-for-sale securities carried at estimated fair value 127,526 116,701 Investment securities, held to maturity securities, estimated fair value of $12,481 and $14,015 12,665 13,985 Loans, net of unearned income 173,773 161,532, Allowance for loan losses (2,502) (2,421) ________ ________ Net loans $171,271 $159,111 Bank premises and equipment 3,736 3,758 Interest receivable 2,226 2,133 Other assets 1,285 285 Total Assets $329,927 $303,028 LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits Non-interest bearing $ 20,090 $ 22,749 Interest bearing 224,708 224,342 ________ ________ Total deposits $244,798 $247,091 Short-term borrowings 34,882 6,634 Long-term borrowings 17,000 13,000 Accrued expenses 1,647 1,521 Other liabilities 100 1,029 ________ ________ Total Liabilities $298,427 $269,275 STOCKHOLDERS' EQUITY Common stock, par value $2 per share; authorized 10,000,000 shares, issued 2,933,727 shares $ 5,867 $ 5,867 Surplus 9,761 9,761 Retained earnings 18,668 17,123 Accumulated other comprehensive income (loss) (835) 2,193 Treasury stock at cost 59,795 shares in 1999 and 35,134 in 1998 (1,961) (1,191) ________ ________ Total Stockholders' Equity $ 31,500 $ 33,753 ________ ________ Total Liabilities and Stockholders' Equity $329,927 $303,028 See Accompanying Notes to Financial Statements 1 FIRST KEYSTONE CORPORATION STATEMENTS OF INCOME FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND 1998 (Unaudited) (Amounts in thousands except per share data) 1999 1998 INTEREST INCOME Interest and fees on loans $3,585 $3,372 Interest and dividend income on securities 2,079 1,777 Interest on deposits in banks 101 34 ______ ______ Total Interest Income $5,765 $5,183 INTEREST EXPENSE Interest on deposits $2,350 $2,242 Interest on short-term borrowings 411 80 Interest on long-term borrowings 233 209 ______ ______ Total Interest Expense $2,994 $2,531 Net interest income $2,771 $2,652 Provision for loan losses 100 75 ______ ______ Net Interest Income After Provision for Loan Losses $2,671 $2,577 OTHER INCOME Service charges on deposit accounts $ 222 $ 175 Other non-interest income 184 124 Investment securities gains (losses) net 72 25 ______ ______ Total Other Income $ 478 $ 324 OTHER EXPENSES Salaries and employee benefits $ 817 $ 679 Net occupancy and fixed asset expense 236 223 Other non-interest expense 464 406 ______ ______ Total Other Expenses $1,517 $1,308 Income before income taxes $1,632 $1,593 Applicable income tax (benefit) 332 345 ______ ______ Net Income $1,300 $1,248 Net Income Per Weighted Shares Outstanding $ .45 $ .43 See Accompanying Notes to Financial Statements 2 FIRST KEYSTONE CORPORATION STATEMENTS OF INCOME FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (Unaudited) (Amounts in thousands except per share data) 1999 1998 INTEREST INCOME Interest and fees on loans $ 7,022 $ 6,659 Interest and dividend income on securities 4,025 3,338 Interest on deposits in banks 153 138 _______ _______ Total Interest Income $11,200 $10,135 INTEREST EXPENSE Interest on deposits $ 4,726 $ 4,475 Interest on short-term borrowings 594 138 Interest on long-term borrowings 419 364 _______ _______ Total Interest Expense $ 5,739 $ 4,977 Net interest income $ 5,461 $ 5,158 Provision for loan losses 175 125 _______ _______ Net Interest Income After Provision for Loan Losses $ 5,286 $ 5,033 OTHER INCOME Service charges on deposit accounts $ 418 $ 334 Other non-interest income 328 282 Investment securities gains (losses) net 96 60 _______ _______ Total Other Income $ 842 $ 676 OTHER EXPENSES Salaries and employee benefits $ 1,617 $ 1,400 Net occupancy and fixed asset expense 483 451 Other non-interest expense 908 808 _______ _______ Total Other Expenses $ 3,008 $ 2,659 Income before income taxes $ 3,120 $ 3,050 Applicable income tax (benefit) 597 661 _______ _______ Net Income $ 2,523 $ 2,389 Net Income Per Weighted Share Outstanding $ .87 $ .81 See Accompanying Notes to Financial Statements 3 FIRST KEYSTONE CORPORATION STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (Unaudited) (Amounts in thousands) 1999 1998 OPERATING ACTIVITIES Net income $ 2,523 $ 2,389 Adjustments to reconcile net income to net cash provided by operating activities: Provision or loan losses 175 125 Provision for depreciation and amortization 200 175 Premium amortization on investment securities 140 132 Discount accretion on investment securities (85) (64) Gain on sale of mortgage loans (1) (30) Proceeds from sale of mortgage loans 2,627 931 Originations of mortgage loans for resale (4,121) (3,679) (Gain) loss on sales of investment securities (96) (60) Deferred income tax (benefit) 2 0 (Increase) decrease in interest receivable and other assets (407) (323) Increase (decrease) in interest payable, accrued expenses and other liabilities 70 (576) ________ ________ Net Cash Provided by Operating Activities $ 1,027 $ (980) INVESTING ACTIVITIES Purchases of investment securities available for sale $(45,945) $(30,828) Proceeds from sales of investment securities available for sale 19,782 7,693 Proceeds from maturities and redemptions of investment securities available for sale 10,826 7,118 Purchase of investment securities held to maturity 0 (677) Proceeds from maturities and redemption of investment securities held to maturity 1,285 1,895 Net (increase) decrease in loans (10,841) (1,049) Purchase of premises and equipment (178) (137) ________ ________ Net Cash Used by Investing Activities $(25,071) $(15,985) FINANCING ACTIVITIES Net increase (decrease) in deposits $ (2,293) $ 5,475 Net increase (decrease) in short-term borrowings 28,248 1,718 Net increase (decrease)in long-term borrowings 4,000 7,000 Acquisition of treasury stock (770) (90) Cash dividends (978) (821) ________ ________ Net Cash Provided by Financing Activities $ 28,207 $ 13,282 Increase (Decrease) in Cash and Cash Equivalent $ 4,163 $ (3,683) Cash and Cash Equivalents, Beginning 7,055 13,484 ________ ________ Cash and Cash Equivalents, Ending $ 11,218 $ 9,801 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during period for Interest $ 5,705 $ 5,077 Income Taxes 569 627 See Accompanying Notes to Financial Statements 4 FIRST KEYSTONE CORPORATION CONSOLIDATED NOTES TO FINANCIAL STATEMENTS June 30, 1999 (Unaudited) Note 1. The accounting and reporting policies of First Keystone Corporation and Subsidiary conform to generally accepted accounting principles and to general practices within the banking industry. These consolidated interim 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 have been eliminated. Note 2. The accompanying consolidated interim financial statements are unaudited. In management's opinion, the consolidated interim financial statements reflect a fair presentation of the consolidated financial position of First Keystone Corporation and Subsidiary, and the results of their operations and their cash flows for the interim periods presented. Further, the consolidated interim financial statements reflect all adjustments, which are in the opinion of management, necessary to present fairly the consolidated financial condition and consolidated results of operations and cash flows for the interim period presented and that all such adjustments to the consolidated financial statements are of a normal recurring nature. Note 3. The results of operations for the six-month period ended June 30, 1999, are not necessarily indicative of the results to be expected for the full year. Note 4. 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. Note 5. LOANS Loans are stated at their outstanding principal balances, net of any 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 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. 5 Non-Accrual Loans - Generally, a loan (including a loan impaired under Statement of Financial Accounting Standards No. 114) is classified as non-accrual, and the accrual of interest on such a loan is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan currently is performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for credit losses. Potential problem loans are identified by management as a part of its loan review process. Income recognition is in accordance with Statement of Financial Accounting Standards No. 118. 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. The Corporation adheres to the principles provided by Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan as amended by Statement of Financial Accounting Standards No. 118, "Accounting by creditors for Impairment of a Loan - Income Recognition and Disclosure." Under these standards, the allowance for loan losses related to loans that are identified for evaluation in accordance with Statement No. 114 is based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. Statement No. 118 allows the continued use of existing methods for income recognition on impaired loans and amends disclosure requirements to require information about the recorded investment in certain impaired loans and related income recognition on those loans. The allowance for loan losses is maintained at a level by management to be adequate to absorb estimated potential loan losses. Management's periodic evaluation of the adequacy of the allowance for loan losses is based on the Corporation's past loan 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. The following table presents the changes in the allowance for credit losses: (Amounts in Thousands) Balance at January 1, 1999 $2,421 Provisions charged to operations 175 Loans charged off (107) Recoveries 13 ______ Balance at June 30, 1999 $2,502 At June 30, 1999, the recorded investment in loans that are considered to be impaired under Statement No. 114 was $67,090. No additional charge to operations is required since the total allowance for loan losses is estimated by management to be adequate to provide for the loan loss allowance under Statement No. 114 as well as any other potential loan losses. 6 Note 6. (Amounts in thousands, except common share data) Common Common Shares Stock Surplus Balance at January 1, 1999 2,933,727 $5,867 $9,761 Comprehensive Income: Net Income Other comprehensive income (loss) net of tax: Unrealized gain (loss) on investment securities of ($2,965) net of reclassification adjustment for gains included in net income of $63 Total Comprehensive income (loss) Cash dividends - $.34 per share Purchase of 24,661 shares of Treasury Stock _________ ______ ______ Balance at June 30, 1999 2,933,727 $5,867 $9,761 (Amounts in thousands, except common share data) Accumulated Compre- Other hensive Retained Comprehensive Income Earnings Income Balance at January 1, 1999 $17,123 $2,193 Comprehensive Income: Net Income $2,523 2,523 Other comprehensive income (loss) net of tax: Unrealized gain (loss) on investment securities of ($2,965) net of reclassification adjustment for gains included in net income of $63 (3,028) (3,028) ______ Total Comprehensive income (loss) $ (505) Cash dividends - $.34 per share (978) Purchase of 24,661 shares of Treasury Stock _______ ______ Balance at June 30, 1999 $18,668 $ (835) (Amounts in thousands, except common share data) Treasury Stock Total Balance at January 1, 1999 (1,191) $33,753 Comprehensive Income: Net Income 2,523 Other comprehensive income (loss) net of tax: Unrealized gain (loss) on investment securities of ($2,965) net of reclassification adjustment for gains included in net income of $63 (3,028) Total Comprehensive income (loss) Cash dividends - $.34 per share (978) Purchase of 24,661 shares of Treasury Stock (770) (770) ______ _______ Balance at June 30, 1999 (1,961) $31,500 Note 7. As required on January 1, 1996, the Corporation adopted Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." The Statement requires that long-lived assets and certain identifiable intangibles are classified into two categories for the purpose of accounting for an impairment of assets: those to be held and used and those to be disposed of. Assets to be held and used must be reviewed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. An impairment loss is indicated if the sum of the expected future cash flows, undiscounted and without interest charges, is less than the carrying amount of the assets. An impairment loss must be recognized as the amount by which the carrying amount of the asset exceeds the fair value of the asset so determined. Implementation of this Statement did not have any effect on the consolidated financial condition or results of operations of the Corporation. Note 8. The consolidated interim financial statements have been prepared in accordance with requirements of Form 10-Q and therefore does not include all the disclosures normally required by generally accepted accounting principles, or those normally made in the Corporation's annual 10-K filing. The reader of these consolidated interim financial statements may wish to refer to the Corporation's annual report or Form 10-K for the period ended December 31, 1998, filed with the Securities and Exchange Commission. 7 Item 2. First Keystone Corporation Management's Discussion and Analysis of Financial Condition and Results of Operation as of June 30, 1999 RESULTS OF OPERATIONS First Keystone Corporation realized record earnings for the second quarter of 1999 of $1,300,000, an increase of $52,000, or 4.2% over the second quarter of 1998. Six months net income for the period ended June 30, 1999, amounted to $2,523,000, an increase of 5.6% over the $2,389,000 net income reported June 30, 1998. On a per share basis, net income per share increased to $.87 for the six months of 1999 compared to $.81 for the first six months of 1998, while dividends increased to $.34 per share up from $.28 in 1998, or an increase of 21.4%. Year-to-date net income annualized amounts to a return on average common equity of 14.96% and a return on assets of 1.57%. For the six months ended June 30, 1998, these measures were 14.67% and 1.74%, respectively on an annualized basis. NET INTEREST INCOME The major source of operating income for the Corporation is net interest income, defined as interest income less interest expense. In the second quarter of 1999 and year-to-date in 1999, interest income has increased more than interest expense resulting in improved net interest income. In the second quarter of 1999, interest income amounted to $5,765,000, an increase of $582,000 or 11.2% over the second quarter of 1998. Interest expense amounted to $2,994,000 in the second quarter of 1999, an increase of $463,000, or 18.3% over the second quarter of 1998. Accordingly, net interest income amounted to $2,771,000 in the second quarter of 1999, an increase of $119,000, or 4.5% over the second quarter of 1998. Year-to-date for the six months ended June 30, 1999, total interest income increased $1,065,000, or 10.5% over the first six months of 1998. Total interest expense increased $762,000, or 15.3% for the first six months of 1999 over 1998. This resulted in net interest income increasing $303,000, or 5.9% for the six months ended June 30, 1999, over 1998. Our net interest margin for the quarter ended June 30, 1999, was 3.86% compared to 4.46% for the quarter ended June 30, 1998. For the six months ended June 30, 1999, our net interest margin was 3.96% compared to 4.33% for the first six months of 1998. PROVISION FOR LOAN LOSSES The provision for loan losses for the quarter ended June 30, 1999, was $100,000 compared to $75,000 for the second quarter of 1998. Year-to-date, the provision for loan losses amounts to $175,000 in 1999 as compared to the $125,000 provision for the period ended June 30, 1998. The provision for possible loan losses increased in 1999 as loan demand continued to be strong. Our allowance for loan losses of $2,502,000 as of June 30, 1999, compared favorably to our allowance for loan losses of $2,421,000 as of December 31, 1998. Net charge-offs totaled $94,000 for the six months ended June 30, 1999, as compared to $98,000 for the first six months of 1998. The allowance for loan losses as a percentage of loans, net of unearned interest was 1.44% as of June 30, 1999, and 1.54% as of June 30, 1998. 8 NON-INTEREST INCOME Total non-interest or other income was $478,000 for the quarter ended June 30, 1999, as compared to $324,000 for the quarter ended June 30, 1998. Excluding investment security gains and losses, non-interest income was $406,000 for the second quarter of 1999, an increase of $107,000 over the second quarter of 1998. For the six months ended June 30, 1999, total non-interest income was $842,000, an increase of $166,000, or 24.6% over the first six months of 1998. An increase in service charges on deposit accounts and an increase of other non-interest income, primarily fees generated by our trust department, account for the increase in non-interest income. NON-INTEREST EXPENSES Total non-interest, or other expenses, was $1,517,000 for the quarter ended June 30, 1999, as compared to $1,308,000 for the quarter ended June 30, 1998. The increase of $209,000 is comprised of salary and benefits increasing $138,000, occupancy expense increasing $13,000, and other non-interest expense increasing $58,000. For the six months ended June 30, 1999, total non-interest expense was $3,008,000, an increase of $349,000, or 13.1% over the first six months of 1998. Expenses associated with employee (salaried employee benefits) continues to be the largest category of non-interest expenses. Salaries and benefits amount to 53.8% of total non-interest expense for the six months ended June 30, 1999, as compared to 52.7% for the first six months of 1998. Salaries and benefits amounted to $1,617,000 for the six months ended June 30, 1999, an increase of $217,000, or 15.5% over the first six months of 1998. The increase was a result of normal salary adjustments and additional hires as we prepare for the opening of our ninth full service office in the third quarter of 1999. Net occupancy expense amounted to $483,000 for the six-months ended June 30, 1999, an increase of $32,000, or 7.1% over 1998, primarily as a result of our branch office expansion. Other non-interest expenses amounted to $908,000 for the six months ended June 30, 1999, an increase of $100,000, or 12.4% over the first six months of 1998. Our overall non-interest expense of less than 2% of average assets on an annualized basis for 1999 and 1998, places us among the leaders of our peer financial institutions at controlling total non-interest expense. INCOME TAXES Effective tax planning has helped produce favorable net income. The effective total income tax rate was 20.3% for the second quarter of 1999 as compared to 21.7% for the second quarter of 1998. For the six months ended June 30, 1999, our tax liability amounted to $597,000 for an effective tax rate of 19.1% as compared to an effective tax rate of 21.7% for the first six months of 1998. The decrease in our effective tax rate was due primarily to the additional purchase of municipal (tax-free investments) securities at attractive interest rates. ANALYSIS OF FINANCIAL CONDITION ASSETS Total assets increased to $329,927,000 as of June 30, 1999, an increase of $26,899,000, or 8.9% over year-end 1998. Total deposits decreased to $244,798,000 as of June 30, 1999, a decrease of $2,293,000, or 0.9% over year-end 1998. The Corporation used borrowed funds to support asset growth not provided by deposit growth. Short-term borrowings increased to $34,882,000, an increase of $28,248,000 over December 31, 1998. The increase in short-term borrowings was the result of an increase in securities sold under an agreement to repurchase for a cash management account. Long-term borrowings increased somewhat to $17,000,000 as of June 30, 1999, an increase of $4,000,000 over year-end 1998. 9 EARNING ASSETS Our primary earning asset, loan, net of unearned income increased to $173,773,000 as of June 30, 1999, up $12,241,000, or 7.6% since year-end 1998. The loan portfolio is well diversified and increases in the portfolio have been primarily from increased originations of real estate loans and commercial loans secured by real estate. In addition to loans, another primary earning asset is our investment portfolio which increased in size from December 31, 1998, to June 30, 1999. Held-to-maturity securities amounted to $12,665,000 as of June 30, 1999, a decrease of $1,320,000, or 9.4% since year-end 1998. However, available-for-sale securities increased to $127,526,000 as of June 30, 1999, an increase of $10,825,000, or 9.3% from year-end 1998. Interest bearing deposits with banks amounted to $2,929,000 as of June 30, 1999, up from $22,000 as of December 31, 1998. 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 loss is adequate to cover foreseeable future losses. Any loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been disclosed under Industry Guide 3 do not (i) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (ii) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms. The company was required to adopt Financial Accounting Standards Board Statement No. 114, "Accounting by Creditors for Impairment of a Loan" - Refer to Note 5 above for details. NON-PERFORMING ASSETS Non-performing assets consist of non-accrual and restructured loans, other real estate and foreclosed assets, together with the loans past-due 90 days or more and still accruing. As of June 30, 1999, total non-performing assets were $806,000 as compared to $881,000 on December 31, 1998. Non-performing assets to total loans and foreclosed assets was .46% as of June 30, 1999, and .55% as of December 31, 1998. Interest income received on non-performing loans as of June 30, 1999, was $0 compared to $5,610 as of December 31, 1998. Interest income, which would have been recorded on these loans under the original terms as of June 30, 1999, and December 31, 1998, was $39,929 and $96,245, respectively. As of June 30, 1999 and December 31, 1998, there was no outstanding commitments to advance additional funds with respect to these non-performing loans. DEPOSITS AND OTHER BORROWED FUNDS As indicated previously, deposits decreased by $2,293,000 as total deposits declined to $244,798,000 as of June 30, 1999, down from $247,091,000 as of year-end 1998. During 1999, the Corporation experienced a deposit decline in non-interest bearing deposits. 10 CAPITAL STRENGTH Normal increases in capital are generated by net income, less cash dividends paid out. Also, net unrealized gains on investment securities available-for-sale decreased shareholders' equity, or capital by $835,000 as of June 30, 1999, and increased capital by $2,193,000 as of December 31, 1998. Our stock repurchase plan had repurchased 59,795 shares and 35,134 shares as of June 30, 1999 and December 31, 1998, respectively. This had an effect of our reducing our total stockholders' equity by $1,961,000 and $1,191,000 as of June 30, 1999 and December 31, 1998, respectively. Leverage ratio and risk based capital ratios remain very strong. As of June 30, 1999, our leverage ratio was 9.71% compared to 10.50% as of December 31, 1998. In addition, Tier I risk based capital and total risk based capital ratio as of June 30, 1999, were 17.37% and 18.84%, respectively. The same ratios as of December 31, 1998, were 18.62% and 20.11%, respectively. LIQUIDITY The liquidity position of the Corporation remains adequate to meet customer loan demand and deposit fluctuation. Managing liquidity remains an important segment of asset liability management. Our overall liquidity position is maintained by an active asset liability management committee. Management feels its current liquidity position is satisfactorily given a very stable core deposit base which has increased annually. Secondly, our loan payments and principal paydowns on our mortgage backed securities provide and steady source of funds. Also, short-term investments and maturing investment securities 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. YEAR 2000 COMPLIANCE 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. 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 has completed 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. 11 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. 12 PART II - OTHER INFORMATION Item 1. Legal Proceedings None. Item 2. Changes in Securities None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders Annual Meeting of Shareholders of First Keystone Corporation held on Tuesday, April 20, 1999, at 10:00 a.m. Votes Votes Directors Elected Votes For Against Withheld John L. Coates 2,378,426 34,118 0 Dudley P. Cooley 2,385,107 27,437 0 Stanley E. Oberrender 2,385,207 27,337 0 Directors Elected Abstentions Non-Votes John L. Coates 0 0 Dudley P. Cooley 0 0 Stanley E. Oberrender 0 0 Directors Continuing: John E. Arndt, term expires in 2001 J. Gerald Bazewicz, term expires in 2001 Budd L. Beyer, term expires in 2000 Robert E. Bull, term expires in 2001 Frederick E. Crispin, term expires in 2000 Jerome F. Fabian, term expires in 2000 Robert E. Wise, term expires in 2000 Matters Voted Upon: Selection of J. H. Williams & Co., as auditors for the Corporation. Votes For - 2,387,481 Votes Against - 798 Votes Withheld - 0 Abstentions - 24,265 Broker Non-Votes - 0 Item 5. Other Information None 13 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits required by Item 601 Regulation S-K Exhibit Number Description of Exhibit 3(i) Articles of Incorporation, as amended (Incorporated by reference to Exhibit 3(i) to Registrant's Annual Report of Form 10-KSB for the year ended December 31, 1996, and Registrant's Form 10Q for the quarter ended June 30, 1999). 3(ii) Bylaws, as amended (Incorporated by reference to Exhibit 3(ii) to Registrant's Annual Report on Form 10-KSB for the year ended December 31, 1996). 10 Material Contracts 11 Statement RE: Computation of Earnings Per Share. 27 Financial Data Schedule. (b) The Registrant has filed no reports on Form 8-K for this quarter. 14 FIRST KEYSTONE CORPORATION SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly cause this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST KEYSTONE CORPORATION Registrant August 12, 1999 /s/ J. Gerald Bazewicz J. Gerald Bazewicz President and Chief Executive Officer (Principal Executive Officer) August 12, 1999 /s/ David R. Saracino David R. Saracino Treasurer/Assistant Secretary (Principal Accounting Officer) 15 INDEX TO EXHIBITS Exhibit Description 10 Material Contracts Profit Sharing Plan Summary (Incorporated by reference to Exhibit 10 (Page 16) to Registrant's Form 10Q for the quarter ended June 30, 1998) Deferred Compensation (Incorporated by reference to Exhibit 10 (Page 17) to Registrant's Form 10Q for the quarter ended June 30, 1998) Other Executive Benefits (Incorporated by reference to Exhibit 99 (Page 9) of the Corporation's Annual Report on Form 10-KSB for the year ended December 31, 1996) Management Incentive Compensation Plan (Incorporated b reference to Exhibit 10 (Page 18) to Registrant's Form 10Q for the quarter ended June 30, 1998) 11 Compensation of Earning Per Share 27 Financial Data Schedule 16