SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from............to..........
Commission File Number: 000-25328
FIRST KEYSTONE FINANCIAL, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2576479
- --------------------------------- ----------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
22 West State Street
Media, Pennsylvania 19063
- --------------------------------------- ----------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (610) 565-6210
Indicate by check mark whether the Registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) Yes [ ] No [X]
Number of shares of Common Stock outstanding as of August 8, 2005: 2,023,534
FIRST KEYSTONE FINANCIAL, INC.
CONTENTS
PAGE
----
PART I FINANCIAL INFORMATION:
Item 1. Condensed Financial Statements
Unaudited Consolidated Statements of Financial Condition as of
June 30, 2005 and September 30, 2004 1
Unaudited Consolidated Statements of Income for the Three and Nine
Months Ended June 30, 2005 and 2004 2
Unaudited Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended June 30, 2005 and 2004 3
Unaudited Consolidated Statements of Cash Flows for the Nine Months
Ended June 30, 2005 and 2004 4
Notes to Unaudited Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22
Item 4. Controls and Procedures 22
PART II OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits 23
SIGNATURES 26
FIRST KEYSTONE FINANCIAL, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except share amounts)
June 30, September 30,
2005 2004
--------- -------------
ASSETS
Cash and amounts due from depository institutions $ 4,780 $ 5,185
Interest-bearing deposits with depository institutions 12,418 12,790
--------- ------------
Total cash and cash equivalents 17,198 17,975
Investment securities available for sale 47,380 63,615
Mortgage-related securities available for sale 113,371 97,620
Loans held for sale 24 172
Investment securities held to maturity- at amortized cost
(approximate fair value of $4,337 at June 30, 2005 4,271 5,287
and $5,370 at September 30, 2004)
Mortgage-related securities held to maturity - at amortized cost (approximate
fair value of $49,280 at June 30, 2005 and $37,312 at September 30, 2004) 49,682 37,363
Loans receivable (net of allowance for loan losses of $3,471 at June 30, 2005
and $2,039 at September 30, 2004) 303,558 304,248
Accrued interest receivable 2,589 2,577
Real estate owned 920 1,229
Federal Home Loan Bank stock - at cost 8,718 9,827
Office properties and equipment, net 4,862 4,275
Deferred income taxes 1,052 657
Cash surrender value of life insurance 16,676 16,110
Prepaid expenses and other assets 3,280 10,964
--------- ------------
TOTAL ASSETS $ 573,581 $ 571,919
========= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 358,360 $ 344,880
Advances from Federal Home Loan Bank and other borrowings 155,505 171,149
Junior subordinated debentures 21,529 21,557
Accrued interest payable 1,211 1,095
Advances from borrowers for taxes and insurance 3,086 815
Accounts payable and accrued expenses 4,457 2,725
--------- ------------
Total liabilities 544,148 542,221
--------- ------------
Commitments and contingencies
Stockholders' Equity:
Preferred stock, $.01 par value, 10,000,000 shares authorized; none issued
Common stock, $.01 par value, 20,000,000 shares authorized; issued 2,712,556
shares; outstanding at June 30, 2005 and September 30, 2004, 2,022,378
and 1,927,744 shares, respectively 14 14
Additional paid-in capital 12,895 13,622
Employee stock ownership plan (3,208) (3,189)
Treasury stock at cost: 690,178 shares at June 30, 2005 and 787,219 shares
at September 30, 2004 (10,608) (11,913)
Accumulated other comprehensive income 966 1,734
Retained earnings - partially restricted 29,374 29,430
--------- ------------
Total stockholders' equity 29,433 29,698
--------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 573,581 $ 571,919
========= ============
See notes to unaudited consolidated financial statements.
FIRST KEYSTONE FINANCIAL, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data)
Three months ended Nine months ended
June 30, June 30,
-------------------- -------------------
2005 2004 2005 2004
--------- -------- --------- --------
INTEREST INCOME:
Interest and fees on loans $ 4,446 $ 4,332 $ 13,317 $ 13,155
Interest and dividends on:
Mortgage-related securities 1,662 1,327 4,615 3,852
Investment securities:
Taxable 339 525 1,117 1,680
Tax-Exempt 195 220 568 641
Dividends 105 84 462 200
Interest-bearing deposits 41 17 122 52
--------- -------- --------- --------
Total interest income 6,788 6,505 20,201 19,580
--------- -------- --------- --------
INTEREST EXPENSE:
Interest on:
Deposits 1,625 1,405 4,551 4,481
Federal Home Loan Bank advances and other borrowings 1,888 1,763 5,716 5,265
Junior subordinated debentures 450 418 1,328 1,246
--------- -------- --------- --------
Total interest expense 3,963 3,586 11,595 10,992
--------- -------- --------- --------
NET INTEREST INCOME 2,825 2,919 8,606 8,588
PROVISION FOR LOAN LOSSES 1,645 75 1,735 225
--------- -------- --------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,180 2,844 6,871 8,363
--------- -------- --------- --------
NON-INTEREST INCOME:
Service charges and other fees 379 287 1,176 812
Net gain on sales of:
Loans held for sale 29 11 66 43
Investment and mortgage-related securities 15 6 539 1,471
Increase in cash surrender value of life insurance 155 159 565 628
Other real estate fees -- -- -- 550
Other income 105 112 337 304
--------- -------- --------- --------
Total non-interest income 683 575 2,683 3,808
--------- -------- --------- --------
NON-INTEREST EXPENSE:
Salaries and employee benefits 1,398 1,357 4,639 5,472
Occupancy and equipment 405 297 1,150 923
Professional fees 260 195 789 679
Federal deposit insurance premium 12 13 37 40
Data processing 138 120 402 356
Advertising 106 92 289 274
Net cost of operation of other real estate 4 2 10 179
Deposit processing 158 157 474 462
Other 465 413 1,406 1,289
--------- -------- --------- --------
Total non-interest expense 2,946 2,646 9,196 9,674
--------- -------- --------- --------
(LOSS) INCOME BEFORE INCOME TAX (BENEFIT) EXPENSE (1,083) 773 358 2,497
INCOME TAX (BENEFIT) EXPENSE (470) 146 (190) 501
--------- -------- --------- --------
NET (LOSS) INCOME $ (613) $ 627 $ 548 $ 1,996
========= ======== ========= ========
BASIC EARNINGS (LOSS) PER COMMON SHARE $ (0.33) $ 0.34 $ 0.30 $ 1.09
========= ======== ========= ========
DILUTED EARNINGS (LOSS) PER COMMON SHARE $ ( 0.32) $ 0.32 $ 0.30 $ 1.02
========= ======== ========= ========
See notes to unaudited consolidated financial statements.
2
FIRST KEYSTONE FINANCIAL, INC.
UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(dollars in thousands)
Employee Accumulated Retained
Additional stock other earnings- Total
Common paid-in ownership Treasury comprehensive partially stockholders'
stock capital plan stock income restricted equity
-------- ---------- --------- --------- ------------- ---------- -------------
BALANCE AT OCTOBER 1, 2004 $ 14 $ 13,622 $ (3,189) $ (11,913) $ 1,734 $ 29,430 $ 29,698
Net income -- -- -- -- -- 548 548
Other comprehensive income, net of tax:
Net unrealized loss on securities
net of reclassification adjustment(1) -- -- -- -- (768) -- (768)
-------- ---------- --------- --------- ------------- ---------- -------------
Comprehensive loss -- -- -- -- -- -- (220)
-------- ---------- --------- --------- ------------- ---------- -------------
Common stock acquired by stock benefit plans -- -- (72) -- -- -- (72)
ESOP stock committed to be released -- -- 53 -- -- -- 53
Excess of fair value above cost of
ESOP shares committed to be released -- 40 -- -- -- -- 40
Purchase of treasury stock -- -- -- (110) -- -- (110)
Exercise of stock options -- (767) -- 1,415 -- -- 648
Dividends - $.33 per share -- -- -- -- -- (604) (604)
-------- ---------- --------- --------- ------------- ---------- -------------
BALANCE AT JUNE 30, 2005 $ 14 $ 12,895 $ (3,208) $ (10,608) $ 966 $ 29,374 $ 29,433
======== ========== ========= ========= ============= ========== =============
BALANCE AT OCTOBER 1, 2003 $ 14 $ 13,443 $ (830) $ (11,378) $ 3,069 $ 28,070 $ 32,388
Net income -- -- -- -- -- 1,996 1,996
Other comprehensive income, net of tax:
Net unrealized loss on securities
net of reclassification adjustment(1) -- -- -- -- (2,912) -- (2,912)
-------- ---------- --------- --------- ------------- ---------- -------------
Comprehensive loss -- -- -- -- -- -- (916)
-------- ---------- --------- --------- ------------- ---------- -------------
Common stock acquired by stock benefit plans -- -- (2,359) -- -- -- (2,359)
ESOP shares committed to be released -- -- 213 -- -- -- 213
Excess of fair value above cost of
ESOP shares committed to be released -- 407 -- -- -- -- 407
Purchase of treasury stock -- -- -- (1,339) -- -- (1,339)
Exercise of stock options -- (366) -- 783 -- -- 417
Dividends - $.33 per share -- -- -- -- -- (631) (631)
-------- ---------- --------- --------- ------------- ---------- -------------
BALANCE AT JUNE 30, 2004 $ 14 $ 13,484 $ (2,976) $ (11,934) $ 157 $ 29,435 $ 28,180
======== ========== ========= ========= ============= ========== =============
- -------------
(1) Disclosure of reclassification amount, net of tax:
June 30,
---------------------
2005 2004
-------- ---------
Net unrealized depreciation arising during the period $ (1,124) $ (3.883)
Less: reclassification adjustment for net gains included in net income
(net of tax of $183 and $500, respectively) 356 971
-------- ---------
Net unrealized loss on securities $ (768) $ (2,912)
======== =========
See notes to unaudited consolidated financial statements.
3
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands)
Nine months ended
June 30,
----------------------
2005 2004
-------- --------
OPERATING ACTIVITIES:
Net income $ 548 $ 1,996
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Provision for depreciation and amortization 398 361
Amortization of premiums and discounts 395 418
Increase in cash surrender value of life insurance (566) (647)
(Gain) loss on sales of:
Loans held for sale (66) (43)
Investment securities (539) (1,475)
Mortgage-related securities -- 4
Real estate owned 3 --
Provision for loan losses 1,735 225
Amortization of ESOP 93 620
Changes in assets and liabilities which provided (used) cash:
Origination of loans held for sale (10,659) (7,577)
Loans sold in the secondary market 10,807 7,732
Accrued interest receivable (12) 58
Prepaid expenses and other assets 7,684 1,620
Accrued interest payable 116 (57)
Accounts payable and accrued expenses 1,732 (572)
-------- --------
Net cash provided by operating activities 11,669 2,663
-------- --------
INVESTING ACTIVITIES:
Loans originated (96,703) (96,600)
Purchases of:
Mortgage-related securities available for sale (38,890) (20,210)
Investment securities available for sale (7,700) (3,716)
Mortgage-related securities held to maturity (18,591) (34,991)
Redemption (purchase) of FHLB stock 1,109 (670)
Insurance proceeds on real estate owned 29 --
Proceeds from sales of real estate owned 252 335
Proceeds from sales of investment and mortgage-related securities 26,523 9,474
Principal collected on loans 95,806 89,353
Proceeds from maturities, calls, or repayments of:
Investment securities available for sale 687 9,277
Mortgage-related securities available for sale 18,912 33,222
Mortgage-related securities held to maturity 6,136 2,472
Investment securities held to maturity 1,000 --
Purchase of property and equipment (985) (631)
-------- --------
Net cash used in investing activities (12,415) (12,685)
-------- --------
FINANCING ACTIVITIES:
Net increase (decrease) in deposit accounts 13,480 (12,741)
Net (decrease) increase in FHLB advances (15,644) 21,512
Common stock acquired by ESOP (72) (2,359)
Net increase in advances from borrowers for taxes and insurance 2,271 2,015
Exercise of stock options 648 417
Purchase of treasury stock (110) (1,339)
Cash dividends (604) (631)
-------- --------
Net cash (used in) provided by financing activities (31) 6,874
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (777) (3,148)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 17,975 21,190
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 17,198 $ 18,042
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW AND NON-CASH INFORMATION:
Cash payments for interest on deposits and borrowings $ 11,479 $ 11,049
Transfer of loans held for sale to loan portfolio -- 4,186
Transfers of loans receivable into real estate owned -- 153
Cash payments of income taxes 300 130
See notes to unaudited consolidated financial statements.
4
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with instructions to Form 10-Q. Accordingly, they
do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. However, such information reflects all adjustments
(consisting solely of normal recurring adjustments) which are, in the
opinion of management, necessary for a fair statement of results for the
periods.
The results of operations for the three and nine month periods ended June
30, 2005 are not necessarily indicative of the results to be expected for
the fiscal year ending September 30, 2005 or any other period. The
consolidated financial statements presented herein should be read in
conjunction with the audited consolidated financial statements and related
notes thereto included in the Company's Form 10-K for the year ended
September 30, 2004.
2. INVESTMENT SECURITIES
The amortized cost and approximate fair value of investment securities
available for sale and held to maturity, by contractual maturities, are as
follows:
June 30, 2005
-------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
------------- ---------- ---------- -----------
Available for Sale:
U.S. Government bonds
Less than 1 year $ 1,699 $ -- $ (5) $ 1,694
5 -10 years 1,997 1 -- 1,998
Municipal obligations
5 to 10 years 130 4 -- 134
Over 10 years 12,632 445 -- 13,077
Corporate bonds
Less than 1 year 1,000 5 -- 1,005
1 to 5 years 1,000 93 -- 1,093
5 to 10 years 2,000 -- (19) 1,981
Over 10 years 7,998 377 (19) 8,356
Asset-backed securities
1 to 5 years 731 4 -- 735
Mutual funds 14,009 -- (329) 13,680
Other equity investments 1,756 1,902 (31) 3,627
------------- ---------- ---------- -----------
Total $ 44,952 $ 2,831 $ (403) $ 47,380
============= ========== ========== ===========
Held to Maturity:
Municipal obligations
5 to 10 years $ 3,259 $ 70 $ (--) $ 3,329
Corporate bonds
Less than 1 year 1,012 -- (4) 1,008
------------- ---------- ---------- -----------
Total $ 4,271 $ 70 $ (4) $ 4,337
============= ========== ========== ===========
5
The table below sets forth investment securities which have an unrealized
loss position as of June 30, 2005.
Less than 12 Months 12 Months or Longer Total
------------------- ------------------- --------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------- ---------- ------- ---------- -------- ----------
U.S. Government and
Agency bonds $ 1,694 $ (5) $ -- $ -- $ 1,694 $ (5)
Municipal
obligations -- -- -- -- -- --
Corporate bonds 4,090 (42) -- -- 4,090 (42)
Mutual funds -- -- 13,680 (329) 13,680 (329)
Equity investments 546 (31) -- -- 546 (31)
------- ---------- ------- ---------- -------- ----------
Total $ 6,330 $ (78) $13,680 $ (329) $ 20,010 $ (407)
------- ---------- ------- ========== ======== ==========
At June 30, 2005, investment securities in a gross unrealized loss
position for twelve months or longer consisted of shares in mutual funds
that at such date had an aggregate depreciation of 2.4% from the Company's
amortized cost basis. Management believes that the estimated fair value of
the securities disclosed above is primarily dependent upon the movement in
market interest rates. The Company has the ability and intent to hold
these securities until the anticipated recovery of fair value occurs.
Management does not believe any individual unrealized loss as of June 30,
2005 represents an other-than-temporary impairment.
The amortized cost and approximate fair value of investment securities
available for sale and held to maturity, by contractual maturities, are as
follows:
September 30, 2004
--------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
--------- ---------- ---------- -----------
Available for Sale:
U.S. Government and agency bonds
1 to 5 years $ 14,694 $ -- $ (199) $ 14,495
Municipal obligations
5 to 10 years 130 6 -- 136
Over 10 years 11,833 412 -- 12,245
Corporate bonds
Less than 1 year 1,000 43 -- 1,043
1 to 5 years 4,968 479 -- 5,447
5 to 10 years 2,000 -- (5) 1,995
Over 10 years 5,341 248 -- 5,589
Asset-backed securities
1 to 5 years 1,189 8 -- 1,197
Mutual funds 14,009 -- (205) 13,804
Preferred stocks 3,900 -- -- 3,900
Other equity investments 1,755 2,009 -- 3,764
--------- ---------- ---------- -----------
Total $ 60,819 $ 3,205 $ (409) $ 63,615
========= ========== ========== ===========
Held to Maturity:
Municipal obligations
5 to 10 years $ 3,260 $ 50 $ -- $ 3,310
Corporate bonds
Less than 1 year 1,002 21 -- 1,023
1 to 5 years 1,025 12 -- 1,037
--------- ---------- ---------- -----------
Total $ 5,287 $ 83 $ -- $ 5,370
========= ========== ========== ===========
6
3. MORTGAGE-RELATED SECURITIES
Mortgage-related securities available for sale and mortgage-related
securities held to maturity are summarized as follows:
June 30, 2005
--------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
--------- ---------- ---------- -----------
Available for Sale:
FHLMC pass-through certificates $ 4,926 $ 5 $ (79) $ 4,852
FNMA pass-through certificates 48,683 165 (460) 48,388
GNMA pass-through certificates 4,262 15 (34) 4,243
Collateralized mortgage obligations 56,464 66 (642) 55,888
--------- ---------- ---------- -----------
Total $ 114,335 $ 251 $ (1,215) $ 113,371
========= ========== ========== ===========
Held to Maturity:
FHLMC pass-through certificates $ 18,193 $ 17 $ (188) $ 18,022
FNMA pass-through certificates 31,131 26 (254) 30,903
Collateralized mortgage obligations 358 -- (3) 355
--------- ---------- ---------- -----------
Total $ 49,682 $ 43 $ (445) $ 49,280
========= ========== ========== ===========
The table below sets forth mortgage-related securities which have an
unrealized loss position as of June 30, 2005.
Less than 12 Months 12 Months or Longer Total
-------------------- ------------------- --------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
-------- ---------- ------- ---------- -------- ----------
Pass-through
certificates $ 66,649 $ (663) $17,276 $ (352) $ 83,925 $ (1,015)
Collateralized
mortgage
obligations 34,421 (346) 13,421 (299) 47,842 (645)
-------- ---------- ------- ---------- -------- ----------
Total $101,070 $ (1,009) $30,697 $ (651) $131,767 $ (1,660)
======== ========== ======= ========== ======== ==========
At June 30, 2005, mortgage-related securities in a gross unrealized loss
position for twelve months or longer consist of 18 securities having an
aggregate depreciation of 2.1% from the Company's amortized cost basis.
Management does not believe any individual unrealized loss as of June 30,
2005 represents an other-than-temporary impairment. The unrealized losses
reported for mortgage-related securities relate primarily to securities
issued by the Federal National Mortgage Association, the Federal Home Loan
Mortgage Corporation and private institutions. The majority of the
unrealized losses associated with mortgage-related securities are
primarily attributable to changes in interest rates and not from the
deterioration of the creditworthiness of the issuer.
7
Mortgage-related securities available for sale and mortgage-related
securities held to maturity are summarized as follows:
September 30, 2004
--------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
--------- ---------- ---------- -----------
Available for Sale:
FHLMC pass-through certificates $ 5,838 $ 15 $ (42) $ 5,811
FNMA pass-through certificates 42,805 259 (203) 42,861
GNMA pass-through certificates 1,250 20 -- 1,270
Collateralized mortgage obligations 47,895 141 (358) 47,678
---------- ---------- ---------- -----------
Total $ 97,788 $ 435 $ (603) $ 97,620
========== ========== ========== ===========
Held to Maturity:
FHLMC pass-through certificates $ 16,226 $ 85 $ (101) $ 16,210
FNMA pass-through certificates 20,613 74 (106) 20,581
Collateralized mortgage obligations 524 -- (3) 521
---------- ---------- ---------- -----------
Total $ 37,363 $ 159 $ (210) $ 37,312
========== ========== ========== ===========
4. LOANS RECEIVABLE
Loans receivable consist of the following:
June 30, September 30,
2005 2004
---------- ----------
Real estate loans:
Single-family $ 153,164 $ 163,907
Construction and land 35,380 38,078
Multi-family and commercial 72,469 64,509
Home equity and lines of credit 46,082 43,621
Consumer loans 1,490 1,471
Commercial loans 11,395 10,624
---------- -----------
Total loans 319,980 322,210
Loans in process (12,766) (15,807)
Allowance for loan losses (3,471) (2,039)
Deferred loan fees (185) (116)
---------- -----------
Loans receivable - net $ 303,558 $ 304,248
========== ===========
At June 30, 2005 and September 30, 2004, non-performing loans (which
include loans in excess of 90 days delinquent) amounted to approximately
$4,796 and $2,033, respectively. At June 30, 2005, non-performing loans
primarily consisted of single-family residential mortgage loans
aggregating $767, commercial real estate loans aggregating $3,837 and home
equity lines of credit totaling $167.
At June 30, 2005 and September 30, 2004, the Company had impaired loans
with a total recorded investment of $3,837 and $0, respectively. Interest
income of $39 was recognized on these impaired loans during the nine
months ended June 30, 2005. Interest income of approximately $227 was not
recognized as interest income due to the non-accrual status of loans for
the nine months ended June 30, 2005.
8
The following is an analysis of the allowance for loan losses:
Nine Months Ended
June 30,
------------------------
2005 2004
---------- ----------
Balance beginning of period $ 2,039 $ 1,986
Provisions charged to income 1,735 225
Charge-offs (303) (150)
Recoveries -- 68
---------- ----------
Total $ 3,471 $ 2,129
========== ==========
The Company has identified the evaluation of the allowance for loan losses as a
critical accounting estimate where amounts are sensitive to material variation.
The Company is constantly challenging the methodology, conducting assessments
and redefining the process to determine the appropriate level of allowance for
loan losses. Critical accounting estimates are significantly affected by
management's judgment and uncertainties and there is a likelihood that
materially different amounts would be reported under different, but reasonable,
conditions or assumptions. The allowance for loan losses is considered a
critical accounting estimate because there is a large degree of judgment in (i)
assigning individual loans to specific risk levels (pass, special mention,
substandard, doubtful and loss), (ii) valuing the underlying collateral securing
the loans, (iii) determining the appropriate reserve factor to be applied to
specific risk levels for criticized and classified loans (special mention,
substandard, doubtful and loss) and (iv) determining reserve factors to be
applied to pass loans based upon loan type. Management reviews the allowance for
loan losses generally on a monthly basis, but at least quarterly. To the extent
that loans change risk levels, collateral values change or reserve factors
change, the Company may need to adjust its provision for loan losses which would
impact earnings. In this framework, a series of qualitative factors are used in
a methodology as a measurement of how current circumstances are affecting the
loan portfolio. Included, among other things, in these qualitative factors are
past loss experience, type and volume of loans, changes in lending policies and
procedures, underwriting standards, collections, charge-offs and recoveries,
national and local economic conditions, concentrations of credit, and the effect
of external factors on the level of estimated credit losses in the current
portfolio.
The determination of the allowance for loan losses requires management to make
significant estimates with respect to the amounts and timing of losses and
market and economic conditions. Accordingly, a decline in the economy could
increase loan delinquencies, foreclosures or repossessions resulting in
increased charge-off amounts and the need for additional loan loss allowances in
future periods. The Company will continue to monitor and adjust its allowance
for loan losses through the provision for loan losses as economic conditions and
other factors dictate. Although the Company maintains its allowance for loan
losses at levels considered adequate to provide for the amount of known and
inherent loss in its loan portfolio, there can be no assurance that future
losses will not exceed estimated amounts or that additional provisions for loan
losses will not be required in future periods. In addition, the Company's
determination as to the amount of its allowance for loan losses is subject to
review by the Bank's primary regulator, the Office of Thrift Supervision (the
"OTS"), as part of its examination process, which may require the recognition of
an adjustment to the allowance for loan losses based on its judgment of
information available to it at the time of its examination. To the extent that
actual outcomes differ from management's estimates, additional provisions to the
allowance for loan losses may be required that would adversely impact earnings
in future periods.
For the three and nine months ended June 30, 2005, the Company recorded a
provision of $1,645 and $1,735, respectively.
9
5. DEPOSITS
Deposits consist of the following major classifications:
June 30, September 30,
2005 2004
------------------- -------------------
Amount Percent Amount Percent
-------- ------- -------- -------
Non-interest bearing $ 19,825 5.5% $ 21,046 6.1%
Interest bearing:
NOW 70,345 19.6 55,864 16.2
Passbook 50,891 14.2 51,371 14.9
Money market demand 50,262 14.0 51,682 15.0
Certificates of deposit 167,037 46.7 164,917 47.8
-------- ----- -------- -----
Total $358,360 100.0% $344,880 100.0%
======== ===== ======== =====
6. EARNINGS PER SHARE
Basic net income per share is based upon the weighted average number of
common shares outstanding, while diluted net income per share is based
upon the weighted average number of common shares outstanding and common
share equivalents that would arise from the exercise of dilutive
securities. All dilutive shares consist of options the exercise price of
which is lower than the market price of the common stock covered thereby
at the dates presented. At June 30, 2005, anti-dilutive shares consisted
of options covering 408 shares. No anti-dilutive shares existed at June
30, 2004.
The calculated basic and diluted earnings per share ("EPS") is as follows:
For the Three Months Ended For the Nine Months Ended
June 30, June 30,
---------------------------- ---------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Numerator - Net (loss) income $ (613) $ 627 $ 548 $ 1,996
Denominators:
Basic shares outstanding 1,874,143 1,835,609 1,827,849 1,831,822
Effect of dilutive shares 38,636 120,546 18,472 121,281
------------ ------------ ------------ ------------
Diluted shares outstanding 1,912,779 1,956,155 1,846,321 1,953,103
============ ============ ============ ============
EPS:
Basic $ (0.33) $ 0.34 $ 0.30 $ 1.09
Diluted $ (0.32) $ 0.32 $ 0.30 $ 1.02
10
7. STOCK-BASED COMPENSATION
The Company applies APB Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations in accounting for stock options
and, accordingly, no compensation expense has been recognized in the
financial statements. Had the Company determined compensation expense
based on the fair value at the grant date for its stock options in
accordance with the fair value method in SFAS No. 123, "Accounting for
Stock-Based Compensation," the Company's net (loss) income and earnings
per share would have been reduced to the pro forma amounts indicated
below.
Three Months Ended Nine Months Ended
June 30, June 30,
------------------------ -----------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
Net (loss) income, as reported $ (613) $ 627 $ 548 $ 1,996
Less: Total stock-based employee compensation
expense determined under fair value method
for all options, net of tax 4 5 12 15
---------- ---------- ---------- ----------
Pro forma net (loss) income $ (617) $ 622 $ 536 $ 1,981
========== ========== ========== ==========
(Loss) earnings per share:
Basic - as reported $ (0.33) $ 0.34 $ 0.30 $ 1.09
Basic - pro forma $ (0.33) $ 0.34 $ 0.29 $ 1.08
Diluted - as reported $ (0.32) $ 0.32 $ 0.30 $ 1.02
Diluted - pro forma $ (0.32) $ 0.32 $ 0.29 $ 1.01
In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123 (Revised 2004), "Share-Based Payment" (SFAS 123(R)). This
Statement revises SFAS No. 123 by eliminating the option to account for
employee stock options under APB No. 25 and generally requires companies
to recognize the cost of employee services received in exchange for awards
of equity instruments based on the grant-date fair value of those awards
(the "fair-value-based" method). The provisions of SFAS 123(R) were to be
effective for the Company's financial statements issued for the first
interim period beginning after June 15, 2005. However, the SEC in April
2005 amended the compliance dates such that SFAS 123(R) becomes effective
at the beginning of the fiscal year that begins after June 15, 2005.
Accordingly, the Company will adopt SFAS 123(R) on October 1, 2005 and
plans to use the modified prospective method. In management's opinion, the
impact of adopting SFAS 123(R) will be generally consistent with the
impact disclosed above pursuant to the pro forma disclosure requirements
of SFAS No. 123.
11
8. RECENT ACCOUNTING PRONOUNCEMENTS
In March 2004, the FASB Emerging Issues Task Force ("EITF") reached a
consensus regarding EITF 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments." The consensus
provides guidance for evaluating whether an investment is
other-than-temporarily impaired and was effective for other-than-temporary
impairment evaluations made in reporting periods beginning after June 15,
2004. However, the guidance contained in paragraphs 10-20 of this Issue
has been delayed by FASB Staff Position ("FSP") EITF Issue 03-1-1,
"Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments," posted September 30, 2004. On June 29, 2005, the Board
decided not to provide additional guidance on the meaning of
other-than-temporary impairment, but directed the staff to issue proposed
FSP EITF 03-1-a, "Implementation Guidance for the Application of Paragraph
16 of EITF Issue No. 03-1," as final. The final FSP will supersede EITF
Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments," and EITF Topic No. D-44, "Recognition
of Other-Than-Temporary Impairment upon the Planned Sale of a Security
Whose Cost Exceeds Fair Value." The final FSP (retitled FSP FAS 115-1,
"The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments") will replace the guidance set forth in paragraphs
10-18 of Issue 03-1 with references to existing other-than-temporary
impairment guidance, such as FASB Statement No. 115, "Accounting for
Certain Investments in Debt and Equity Securities", SEC Staff Accounting
Bulletin No. 59, "Accounting for Noncurrent Marketable Equity Securities",
and APB Opinion No. 18, "The Equity Method of Accounting for Investments
in Common Stock." FSP FAS 115-1 will codify the guidance set forth in EITF
Topic D-44 and clarify that an investor should recognize an impairment
loss no later than when the impairment is deemed other than temporary,
even if a decision to sell has not been made.
The Board decided that FSP FAS 115-1 would be effective for
other-than-temporary impairment analysis conducted in periods beginning
after September 15, 2005. The Board directed the staff to proceed to a
draft of a final FSP for vote by written ballot.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In addition to historical information, this Quarterly Report on Form 10-Q
includes certain "forward-looking statements" based on management's
current expectations. The actual results of First Keystone Financial, Inc.
(the "Company") could differ materially, as defined in the Securities Act
of 1933 and the Securities Exchange Act of 1934, from management's
expectations. Such forward-looking statements include statements regarding
management's current intentions, beliefs or expectations as well as the
assumptions on which such statements are based. These forward-looking
statements are subject to significant business, economic and competitive
uncertainties and contingencies, many of which are not subject to the
Company's control. Stockholders and potential stockholders are cautioned
that any such forward-looking statements are not guarantees of future
performance and involve risks and uncertainties, and that actual results
may differ materially from those contemplated by such forward-looking
statements. Factors that could cause future results to vary from current
management expectations include, but are not limited to, general economic
conditions, legislative and regulatory changes, monetary and fiscal
policies of the federal government, changes in tax policies, rates and
regulations of federal, state and local tax authorities, changes in
interest rates, deposit flows, the cost of funds, demand for loan
products, demand for financial services, competition, changes in the
quality or composition of the Company's loan and investment portfolios,
changes in accounting principles, policies or guidelines, availability and
cost of energy resources and other economic, competitive, governmental and
technological factors affecting the Company's operations, markets,
products, services and fees.
The Company undertakes no obligation to update or revise any
forward-looking statements to reflect changed assumptions, the occurrence
of unanticipated events or changes to future operating results that occur
subsequent to the date such forward-looking statements are made.
GENERAL
The Company is a Pennsylvania corporation and sole shareholder of First
Keystone Bank, a federally chartered stock savings bank (the "Bank"),
which converted to the stock form of organization in January 1995. The
Bank is a community oriented bank emphasizing customer service and
convenience. The Bank's primary business is attracting deposits from the
general public and using those funds together with other available sources
of funds, primarily borrowings, to originate loans. The Bank's management
remains focused on its long-term strategic plan to continue to shift its
composition of its loan portfolio towards commercial and multi-family real
estate, commercial business, construction and home equity loans and lines
of credit in order to provide a higher yielding portfolio with generally
shorter terms and/or bearing adjustable interest rates.
CRITICAL ACCOUNTING POLICIES
The Company has identified the evaluation of the allowance for loan losses
as a critical accounting estimate where amounts are sensitive to material
variation. The Company is constantly challenging the methodology,
conducting assessments and redefining the process to determine the
appropriate level of allowance for loan losses. Critical accounting
estimates are significantly affected by management's judgment and
uncertainties and there is a likelihood that materially different amounts
would be reported under different, but reasonable, conditions or
assumptions. The allowance for loan losses is considered a critical
accounting estimate because there is a large degree of judgment in (i)
assigning individual loans to specific risk levels (pass, special mention,
substandard, doubtful and loss), (ii) valuing the underlying collateral
securing the loans, (iii) determining the appropriate reserve factor to be
applied to specific risk levels for criticized and classified loans
(special mention, substandard, doubtful and loss) and (iv) determining
reserve factors to be applied to pass loans based upon loan type.
Management reviews the allowance for loan losses generally on a monthly
basis, but at least quarterly. To the extent that loans change risk
levels, collateral values change or reserve factors change, the Company
may need to adjust its provision for loan losses which would impact
earnings. In this framework, a series of qualitative factors are used in a
methodology as a measurement of how current circumstances are affecting
the loan portfolio. Included, among other things, in these qualitative
factors are past loss experience, type and volume of loans, changes in
lending policies and procedures, underwriting standards, collections,
charge-offs and recoveries, national and local economic conditions,
concentrations of credit, and the effect of external factors on the level
of estimated credit losses in the current portfolio.
13
The determination of the allowance for loan losses requires management to
make significant estimates with respect to the amounts and timing of
losses and market and economic conditions. Accordingly, a decline in the
economy could increase loan delinquencies, foreclosures or repossessions
resulting in increased charge-off amounts and the need for additional loan
loss allowances in future periods. The Company will continue to monitor
and adjust its allowance for loan losses through the provision for loan
losses as economic conditions and other factors dictate. Although the
Company maintains its allowance for loan losses at levels considered
adequate to provide for the amount of known and inherent loss in its loan
portfolio, there can be no assurance that future losses will not exceed
estimated amounts or that additional provisions for loan losses will not
be required in future periods. In addition, the Company's determination as
to the amount of its allowance for loan losses is subject to review by the
Bank's primary regulator, the Office of Thrift Supervision (the "OTS"), as
part of its examination process, which may require the recognition of an
adjustment to the allowance for loan losses based on its judgment of
information available to it at the time of its examination. To the extent
that actual outcomes differ from management's estimates, additional
provisions to the allowance for loan losses may be required that would
adversely impact earnings in future periods.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2005 AND SEPTEMBER 30, 2004
Total assets of the Company increased $1.7 million from $571.9 million at
September 30, 2004 to $573.6 million at June 30, 2005. The
mortgage-related securities held to maturity increased by $12.3 million
from $37.3 million at September 30, 2004 mainly due to implementation of
the Company's asset-liability strategy of reinvesting a portion of the
proceeds from the sale of investment securities available for sale into
the held to maturity portfolio in order to minimize volatility of the
Company's equity in the future as market rates of interest shift. In
addition, mortgage-related securities available for sale increased $15.8
million, or 16.1%, from $97.6 million mainly due to the reinvestment of
cash flows from the loan portfolio. Although loans receivable decreased
slightly to $303.6 million at June 30, 2005, the Company continued to
increase its percentage of its portfolio consisting of commercial real
estate loans and home equity loans and lines of credit, partially offset
by a decrease in single-family residential loans. Prepaid expenses and
other assets decreased $7.7 million primarily due to funds received for
settlement of sales of securities. Deposits increased $13.5 million, or
3.9%, from $344.9 million at September 30, 2004 to $358.4 million at June
30, 2005, while borrowings decreased $15.6 million, or 9.1%, from $171.1
million at September 30, 2004. The increase in deposits resulted from an
increase of $11.4 million, or 6.3%, in core deposits (which consist of
passbook, money market, NOW and non-interest bearing accounts) combined
with an increase of $2.1 million, or 1.3%, in certificates of deposit. The
growth in deposits was attributable to the Company's commitment to focus
on business development and aggressively pursue those relationships.
Stockholders' equity decreased $265,000 to $29.4 million at June 30, 2005
primarily due to the reduction in accumulated other comprehensive income
of $768,000, the cost of repurchasing 4,900 shares of common stock and
dividend payments totaling $604,000, partially offset by net income of
$548,000 as well as a $648,000 increase in equity resulting from the
exercise of stock options during the nine months ended June 30, 2005.
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED
JUNE 30, 2005 AND 2004
NET (LOSS) INCOME.
The Company incurred a net loss for the quarter ended June 30, 2005 of
$(613,000), or $(0.32) per diluted share, as compared to net income of
$627,000, or $.32 per diluted share, for the quarter ended June 30, 2004.
Net income for the nine months ended June 30, 2005 was $548,000, or $.30
per diluted share, a decrease of $1.4 million as compared to $2.0 million,
or $1.02 per diluted share, for the same period in 2004. The primary
reason for the significant decline in the 2005 periods was the $1.6
million provision for loan losses during the third quarter of fiscal 2005.
See "- Provision for Loan Losses."
14
NET INTEREST INCOME.
Net interest income decreased slightly by $94,000, or 3.2%, to $2.8
million and increased slightly by $18,000, or 0.2%, to $8.6 million for
the three and nine months ended June 30, 2005, respectively, compared to
the same periods in 2004. The decrease for the third quarter of 2005 was
primarily due to a $377,000, or 10.5%, increase in interest expense which
was partially offset by an increase in interest income of $283,000, or
4.4%, for the three months ended June 30, 2005, respectively. The $18,000
increase in net interest income for the nine months ended June 30, 2005,
was primarily due to an increase in interest income of $621,000, or 3.2%,
for the nine months ended June 30, 2005, respectively, which was partially
offset by a $603,000, or 5.5%, increase in interest expense during such
period. The average balance of interest-earning assets increased $7.7
million and $10.3 million for the three and nine months ended June 30,
2005, respectively, as compared to the same periods in 2004. Calculated on
a tax-equivalent basis, the weighted average yield earned on
interest-earning assets for the three months ended June 30, 2005 increased
14 basis points to 5.12% compared to the 2004 period and 5 basis points to
5.09% for the nine months ended June 30, 2005. However, offsetting such
improvements in the yield were increases in the weighted average rate paid
on interest-bearing liabilities. The weighted average rate paid on such
liabilities increased 25 basis points to 2.98% during the three months
ended June 30, 2005 from 2.73% for the same period in the prior fiscal
year and 9 basis points to 2.90% for the nine months ended June 30, 2005
as compared to 2.81% for the nine months ended June 30, 2004. The
increases in the cost of funds were primarily a result of the upwards
repricing of certificates of deposit, money market accounts and floating
rate debt due to increases in market rates of interest which outpaced the
increases in the yield on interest-earning assets. In addition, net
interest expense was affected by an increase in the average balance of
interest-bearing liabilities of $6.6 million and $10.7 million for the
three and nine months ended June 30, 2005, respectively, as compared to
the same periods in 2004.
The following tables present the average balances for various categories
of assets and liabilities, and income and expense related to those assets
and liabilities for the three and nine months ended June 30, 2005 and
2004. The adjustment of tax exempt securities to a tax equivalent yield in
the table below may be considered to include non-GAAP financial
information. Management believes that it is a practice followed by many
institutions in the banking industry to present net interest margin, net
interest rate spread and net interest income on a fully tax equivalent
basis when a significant proportion of interest-earning assets are
tax-free. Therefore, management believes, these measures provide useful
information to investors by allowing them to make peer comparisons. A GAAP
reconciliation is included below.
15
FOR THE THREE MONTHS ENDED
-----------------------------------------------------------------------
JUNE 30, 2005 JUNE 30, 2004
---------------------------------- --------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Cost(4) Balance Interest Cost(4)
--------- --------- ---------- --------- -------- ---------
Interest-earning assets:
Loans receivable(1) (2) $ 304,240 $ 4,446 5.85% $ 296,824 $ 4,331 5.84%
Mortgage-related securities(2) 163,818 1,662 4.06 141,377 1,327 3.75
Investment securities(2) 57,514 723 5.03 80,378 917 4.56
Other interest-earning assets 11,802 41 1.39 11,091 17 0.61
--------- --------- --------- --------
Total interest-earning assets 537,374 $ 6,872 5.12 529,670 $ 6,592 4.98
--------- --------- ---------- --------- -------- ---------
Non-interest-earning assets 32,008 34,104
--------- ---------
Total assets $ 569,382 $ 563,774
========= =========
Interest-bearing liabilities:
Deposits $ 357,629 $ 1,625 1.82 $ 347,979 $ 1,405 1.62
FHLB advances and other borrowings 153,418 1,888 4.92 156,429 1,763 4.51
Junior subordinated debentures 21,535 450 8.36 21,572 418 7.75
--------- --------- --------- --------
Total interest-bearing liabilities 532,582 3,963 2.98 525,980 3,586 2.73
--------- --------- ---------- --------- -------- ---------
Interest rate spread 2.14% 2.25%
========== =========
Non-interest-bearing liabilities 7,105 6,715
--------- ---------
Total liabilities 539,687 532,695
Stockholders' equity 29,695 31,079
--------- ---------
Total liabilities and stockholders'
equity $ 569,382 $ 563,774
========= =========
Net interest-earning assets $ 4,792 $ 3,690
========= =========
Net interest income $ 2,909 $ 3,006
========= ========
Net interest margin(3) 2.17% 2.27%
========== =========
Ratio of average interest-earning assets
to average interest-bearing liabilities 100.90% 100.70%
========== =========
- ---------------------
(1) Includes non-accrual loans.
(2) Includes assets classified as either available for sale or held for sale.
(3) Net interest income divided by interest-earning assets.
(4) Presented on a tax-equivalent basis.
16
FOR THE NINE MONTHS ENDED
----------------------------------------------------------------------
JUNE 30, 2005 JUNE 30, 2004
--------------------------------- ----------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Cost(4) Balance Interest Cost(4)
------- --------- --------- ----------- -------- --------
Interest-earning assets:
Loans receivable(1) (2) $ 305,552 $ 13,317 5.81% $ 293,283 $ 13,154 5.98%
Mortgage-related securities(2) 153,983 4,615 4.00 135,129 3,852 3.80
Investment securities(2) 64,444 2,408 4.98 84,992 2,793 4.38
Other interest-earning assets
12,049 122 1.35 12,304 52 0.56
--------- --------- ----------- --------
Total interest-earning assets 536,028 $ 20,462 5.09 525,708 $ 19,851 5.04
--------- --------- --------- ----------- -------- ---------
Non-interest-earning assets 32,457 31,592
--------- -----------
Total assets $ 568,485 $ 557,300
========= ===========
Interest-bearing liabilities:
Deposits $ 348,445 $ 4,551 1.74 $ 348,451 $ 4,481 1.71
FHLB advances and other borrowings 162,720 5,716 4.68 151,941 5,265 4.62
Junior subordinated debentures
21,544 1,328 8.22 21,581 1,246 7.70
--------- --------- ----------- --------
Total interest-bearing liabilities 532,709 11,595 2.90 521,973 10,992 2.81
--------- --------- --------- ----------- -------- ---------
Interest rate spread 2.19% 2.23%
========= =========
Non-interest-bearing liabilities 6,007 3,730
--------- -----------
Total liabilities 538,716 525,703
Stockholders' equity 29,769 31,597
--------- -----------
Total liabilities and stockholders'
equity $ 568,485 $ 557,300
========= ===========
Net interest-earning assets $ 3,319 $ 3,735
========= ===========
Net interest income $ 8,867 $ 8,859
========= ========
Net interest margin(3) 2.21% 2.25%
========= =========
Ratio of average interest-earning
assets to average interest-bearing
liabilities 100.62% 100.72%
========= =========
- ---------------------
(1) Includes non-accrual loans.
(2) Includes assets classified as either available for sale or held for sale.
(3) Net interest income divided by interest-earning assets.
(4) Presented on a tax-equivalent basis.
17
Although management believes that the above mentioned non-GAAP financial
measures enhance investor's understanding of the Company's business and
performance, these non-GAAP financials measures should not be considered as an
alternative to GAAP. The reconciliation of these non-GAAP financials measures
from GAAP to non-GAAP is presented below.
FOR THE THREE MONTHS ENDED
---------------------------------------------------
JUNE 30, 2005 JUNE 30, 2005
---------------------------------------------------
AVERAGE AVERAGE
(Dollars in thousands) INTEREST YIELD/COST INTEREST YIELD/COST
---------------------------------------------------
Investment securities - nontaxable $ 639 4.44% $ 829 4.13%
Tax equivalent adjustments 84 88
------ ------
Investment securities - nontaxable to
a taxable equivalent yield $ 723 5.03% $ 917 4.56%
====== ======
Net interest income $2,825 $2,919
Tax equivalent adjustment 84 88
------ ------
Net interest income, tax equivalent $2,909 $3,007
====== ======
Net interest rate spread, no tax adjustment 2.08% 2.18%
Net interest margin, no tax adjustment 2.10% 2.20%
FOR THE NINE MONTHS ENDED
---------------------------------------------------
JUNE 30, 2005 JUNE 30, 2005
---------------------------------------------------
AVERAGE AVERAGE
(Dollars in thousands) INTEREST YIELD/COST INTEREST YIELD/COST
---------------------------------------------------
Investment securities - nontaxable $2,147 4.44% $2,521 3.95%
Tax equivalent adjustments 261 272
------ ------
Investment securities - nontaxable to
a taxable equivalent yield $2,408 4.98% $2,793 4.38%
====== ======
Net interest income $8,606 $8,588
Tax equivalent adjustment 261 272
------ ------
Net interest income, tax equivalent $8,867 $8,860
====== ======
Net interest rate spread, no tax adjustment 2.12% 2.16%
Net interest margin, no tax adjustment 2.14% 2.18%
PROVISION FOR LOAN LOSSES.
The Company establishes provisions for loan losses, which are charges to its
operating results, in order to maintain a level of total allowance for losses
that management believes covers all known and inherent losses that are both
probable and reasonably estimable at each reporting date. Management performs
reviews generally on a monthly basis, but at least quarterly, in order to
identify these known and inherent losses and to assess the overall collection
probability for the loan portfolio. Management's reviews consist of a
quantitative analysis by loan category, using historical loss experience, and
consideration of a series of qualitative loss factors. For each primary type of
loan, management establishes a loss factor reflecting our estimate of the known
and inherent losses in each loan type using both the quantitative analysis as
well as consideration of the qualitative factors. Management's evaluation
process includes, among other things, an analysis of delinquency trends,
non-performing loan trends, the levels of charge-offs and recoveries, the levels
of classified and special mention assets; prior loss experience, total loans
outstanding, the volume of loan originations, the type, average size, terms and
geographic location and concentration of loans held by the Company, the value
and the nature of the collateral securing loans, the number of loans requiring
heightened management oversight, general economic conditions, particularly as
they relate to the Company's primary market area, and trends in market rates of
interest. The amount of the allowance for loan losses is an estimate and actual
18
losses may vary from these estimates. Furthermore, the Company's primary banking
regulator periodically reviews the Company's allowance for loan losses as an
integral part of the examination process. Such agency may require the Company to
make additional provisions for estimated loan losses based upon judgments
different from those of management.
For the three months ended June 30, 2005 and 2004, the provision for loan losses
amounted to $1.6 million and $75,000, respectively, while for the nine months
ended June 30, 2005 and 2004 the provision for loan losses amounted to $1.7
million and $225,000, respectively. The significant increase in the provision
for loan losses reflected management's assessment of a number of factors,
including, among other things, the significant increase in the level of the
Company's non-performing loans including migration in the Company's
classification of such assets in substandard, doubtful and special mention
categories in the 2005 periods, the increased level of charge-offs, the changing
composition of the commercial and multi-family real estate and commercial
business loan portfolios as well as extensive discussions with the examination
staff in connection with the recent examination of the Company by its primary
banking regulator.
At June 30, 2005, non-performing assets increased to $5.7 million, or 1.0% of
total assets, from $3.3 million at September 30, 2004. The increase in
non-performing assets was primarily the result of a $3.6 million increase in
non-performing commercial real estate loans, combined with $144,000 increase in
single-family residential loans, partially offset by previously non-performing
construction and home equity loans aggregating $770,000 and $76,000,
respectively, returning to current status. Included in non-performing assets at
June 30, 2005 was a $3.8 million non-accrual commercial real estate loan to one
borrower secured by a restaurant in Chesapeake City, Maryland which loan was one
of the primary reasons for the substantial increase in the provision for the
third quarter of fiscal 2005. Although the Company received an updated appraisal
of the property, upon review, during the quarter ended June 30, 2005, of a
number of factors concerning the loan and the unique nature of the property, the
Company determined to classify this loan as "doubtful" and establish a
significant reserve related to it. The Company will continue its foreclosure
proceedings and the borrower is currently marketing the property for sale.
Included in non-performing assets is $920,000 in real estate owned consisted
primarily of one commercial real estate property. The Bank owns a 25%
participation interest in an 18-hole golf course and a golf house located in
Avondale, Pennsylvania. The lead lender collected $1.0 million from an easement
agreement of which $250,000 represented the Bank's portion and reduced the book
value of the property to $875,000. The golf facility is fully operational and
continues to generate revenues. However, in connection with the operations of
the facility, the Company incurred its representative share of expenses totaling
approximately $0 and $150,000 for the three and nine months ended June 30, 2004.
No operating expenses were incurred during the three and nine months ended June
30, 2005. In May 2004, the lead lender entered into an agreement of sale.
Although the agreement of sale has expired, the prospective buyer is operating
and incurring the operating costs of the facility under the expired agreement.
During the three months ended June 30, 2005, the Company also charged-off
$243,000 related to a small commercial loan. In addition, the Company's
portfolios of commercial and multi-family real estate and land loans,
construction loans and commercial business loans, all of which generally are
deemed to have higher levels of known and inherent losses than single-family
residential mortgage loans, continued to grow in the aggregate, both in terms of
total dollar amount and as a percentage of the Company's total loan portfolio,
during the nine months ended June 30, 2005. Furthermore, the composition of the
Company's commercial loan portfolio in particular, much of which is unseasoned,
has shifted in recent periods with respect to the nature of the collateral for
such loans and the type of borrower. Increasingly, such loans' primary
collateral is not real estate but inventory and accounts receivables, collateral
which is, among other things, difficult to value. The borrowers tend to be small
businesses which are more susceptible to adverse changes in business conditions,
including, for example, rising interest rates, since such rate changes result,
due to the adjustable nature of the loans, in increased operating costs for such
borrowers.
The coverage ratio, which is the ratio of the allowance for loan losses to
non-performing loans, was 72.38% and 100.3% at June 30, 2005 and September 30,
2004, respectively, while the ratio of the allowance to gross loans was 1.13%
and 0.67%, respectively, at such dates.
Management continues to review its loan portfolio to determine the extent, if
any, to which further additional loss provisions may be deemed necessary. There
can be no assurance that the allowance for losses will be adequate to cover
losses which may in fact be realized in the future and that additional
provisions for losses will not be required.
19
NON-INTEREST INCOME.
Non-interest income increased $108,000 to $683,000 for the three months ended
June 30, 2005 from the same period last year. The increase in non-interest
income was primarily the result of a $92,000 increase in service charges and
other fees due to additional fee-based deposit services implemented in the
latter part of fiscal 2004. Non-interest income decreased $1.1 million to $2.7
million for the nine months ended June 30, 2005 by comparison to the same period
last year. Non-interest income was substantially higher in the 2004 period due
to gains on sale of investment securities which resulted in gains experienced in
the 2004 period related to the gain on sale of equity securities of a company
that was acquired. Non-interest income for the nine months ended June 30, 2004
also included $550,000 related to a non-recurring real estate fee. By
comparison, gains during the 2005 period only amounted to $539,000 and there
were no real estate fees. The increase in cash surrender value of life insurance
was $565,000 for the nine months ended June 30, 2005 as compared to $628,000 for
the same period in 2004. The reduced rate of increase in the cash surrender
value related to a reduction in the appreciation in the value of equity
securities which form the primary investment of certain insurance policies held
by the Bank to fund certain supplemental retirement benefits. Partially
offsetting such decreases was a $364,000 increase in service charges and other
fees due to the implementation of additional fee-based deposit services.
NON-INTEREST EXPENSE.
Non-interest expense for the quarter ended June 30, 2005 increased $300,000, or
11.3%, from the same period last year primarily due to increases of $108,000, or
36.3%, $65,000, or 33.3%, $52,000, or 12.6% and $41,000, or 3.0% in occupancy
and equipment, professional fees, other non-interest expense and salaries and
employee benefits, respectively. The increase in occupancy and equipment was
related to branch expansion in the first quarter of fiscal 2005 and increased
costs relating to rent, maintenance and taxes. Professional fees increased due
to the additional auditing and legal fees resulting from the increased
regulatory requirements placed on financial institutions. The increase in
non-interest expense was due to the implementation of a training program as well
as increased general administrative expenses.
For the nine months ended June 30, 2005, non-interest expense decreased by
$478,000, or 4.9%, primarily due to a decrease of $833,000, or 15.2%, in salary
and employee benefits. The decrease was primarily the result of expenses
recognized in the 2004 period in connection with the funding of a non-qualified
supplemental retirement plan for certain executive officers and the prepayment
of the outstanding balance of one of the loans to the ESOP. However, during
fiscal 2005, such decreases were partially offset by a $379,000 increase in
salary and employee benefit expense compared to the same period in the prior
year due to merit increases, the hiring of additional personnel and retirement
benefits. In addition, the decrease in non-interest expense was partially offset
by increases of $227,000, or 24.6%, $110,000, or 16.2%, and $117,000, or 9.1%,
in occupancy and equipment, professional fees and other non-interest expenses,
respectively, for the reasons described above. Furthermore, the decrease in
non-interest expense was partially offset by an increase of $46,000 in data
processing costs.
INCOME TAX EXPENSE.
Income tax expense decreased $616,000 and $691,000 from $146,000 and $500,000 to
a benefit of $470,000 and $190,000 for the three and nine months ended June 30,
2005, respectively. The decrease for the three and nine months ended June 30,
2005 was primarily related to the decline in pre-tax income for such periods.
20
LIQUIDITY AND CAPITAL RESOURCES.
The Company's liquidity, represented by cash and cash equivalents, is a product
of its operating, investing and financing activities. The Company's primary
sources of funds are deposits, repayments, prepayments and maturities of
outstanding loans and mortgage-related securities, sales of loans, maturities of
investment securities and other short-term investments, borrowing and funds
provided from operations. While scheduled payments from the amortization of
loans and mortgage-related securities and maturing investment securities and
short-term investments are relatively predictable sources of funds, deposit
flows and loan prepayments are greatly influenced by general interest rates,
economic conditions and competition. In addition, the Company invests excess
funds in overnight deposits and other short-term interest-earning assets which
provide liquidity to meet lending requirements. The Company has been able to
generate sufficient cash through its deposits as well as borrowings to satisfy
its funding commitments. At June 30, 2005, the Company had short-term borrowings
(due within one year or currently callable) outstanding of $155.0 million, all
of which consisted of advances from the Federal Home Loan Bank of Pittsburgh.
Liquidity management is both a daily and long-term function of business
management. Excess liquidity is generally invested in short-term investments
such as overnight deposits. On a longer term basis, the Company maintains a
strategy of investing in various lending products, mortgage-related securities
and investment securities. The Company uses its sources of funds primarily to
meet its ongoing commitments, to fund maturing certificates of deposit and
savings withdrawals, fund loan commitments and maintain a portfolio of
mortgage-related and investment securities. At June 30, 2005, total approved
loan commitments outstanding amounted to $8.8 million, not including loans in
process. At the same date, commitments under unused lines of credit amounted to
$39.7 million. Certificates of deposit scheduled to mature in one year or less
at June 30, 2005 totaled $82.5 million. Based upon its historical experience,
management believes that a significant portion of maturing deposits will remain
with the Company.
As of June 30, 2005, the Bank had regulatory capital which was in excess of
applicable requirements. The Bank is required under applicable federal banking
regulations to maintain tangible capital equal to at least 1.5% of its adjusted
total assets, core capital equal to at least 4.0% of its adjusted total assets
and total capital to at least 8.1% of its risk-weighted assets. At June 30,
2005, the Bank had tangible capital and core capital equal to 8.1% of adjusted
total assets and total capital equal to 15.0% of risk-weighted assets. As of
June 30, 2005, the Bank met the requirements of a "well capitalized" institution
under OTS regulatory framework for prompt corrective action.
IMPACT OF INFLATION AND CHANGING PRICES.
The consolidated financial statements of the Company and related notes presented
herein have been prepared in accordance with generally accepted accounting
principles which requires the measurement of financial position and operating
results in terms of historical dollars, without considering changes in the
relative purchasing power of money over time due to inflation.
Unlike most industrial companies, substantially all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or in the same magnitude as the price
of goods and services, since such prices are affected by inflation to a larger
extent than interest rates. In the current interest rate environment, liquidity
and the maturity structure of the Company's assets and liabilities are critical
to the maintenance of acceptable performance levels.
21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For a discussion of the Company's asset and liability management policies, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operation" in the Company's Annual Report on Form 10-K for the year ended
September 30, 2004. There are no material changes in the Company's
asset-liability management policy from those disclosed in the Form 10-K.
The Company utilizes reports prepared by the OTS to measure interest rate risk.
Using data from the Bank's quarterly thrift financial reports, the OTS models
the net portfolio value ("NPV") of the Bank over a variety of interest rate
scenarios. The NPV is defined as the present value of expected cash flows from
existing assets less the present value of expected cash flows from existing
liabilities plus the present value of net expected cash inflows from existing
off-balance sheet contracts. The model assumes instantaneous, parallel shifts in
the U.S. Treasury Securities yield curve of 100 to 300 basis points up and 200
basis points down, in 100 basis point increments.
The interest rate risk measures used by the OTS include an "Exposure Measure" or
"Post-Shock" NPV ratio and a "Sensitivity Measure." The "Post-Shock" NPV ratio
is the net present value as a percentage of assets over the various yield curve
shifts. A low "Post-Shock" NPV ratio indicates greater exposure to interest rate
risk and can result from a low initial NPV ratio or high sensitivity to changes
in interest rates. The "Sensitivity Measure" is the decline in the NPV ratio, in
basis points, caused by a 2% increase or decrease in rates, whichever produces a
larger decline. The following sets forth the Bank's NPV as of June 30, 2005.
Net Portfolio Value
(Dollars in thousands)
- --------------------------------------------------------------------------------------------------------
Changes in Net
Rates in Dollar Percentage Portfolio Value As
Basis Points Amount Change Change a % of Assets Change
- --------------------------------------------------------------------------------------------------------
300 $46,656 $(21,465) (32)% 8.40% (316) bp
9.70 (179) bp
100 62,707 (5,414) (8) 10.84 (72) bp
0 68,121 -- -- 11.56 --
(100) 68,231 110 0 11.46 (10) bp
(200) 56,033 (12,088) (18) 9.36 (220) bp
As of June 30, 2005, the Company's NPV was $68.1 million or 11.56% of the market
value of assets. Following a 200 basis point decrease in interest rates, the
Company's "post shock" NPV was $56.0 million or 9.36% of the market value of
assets. The change in the NPV ratio or the Company's sensitivity measure was
(2.20)%.
ITEM 4. CONTROLS AND PROCEDURES
Our management evaluated, with the participation of our Chief Executive Officer
and Chief Financial Officer, the effectiveness of our disclosure controls and
procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934) as of the end of the period covered by this report. Based
on such evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures are designed to ensure
that information required to be disclosed by us in the reports that we file or
submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
regulations and are operating in an effective manner.
No change in our internal control over financial reporting (as defined in Rule
13a-15(f) or 15(d)-15(f) under the Securities Exchange Act of 1934) occurred
during the most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
22
PART II OTHER INFORMATION
Item 1. Legal Proceedings
No material changes in the legal proceedings previously disclosed in
Item 3 "Legal Proceedings" of the Company's Annual Report on Form 10-K
for the year ended September 30, 2004.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) - (b) Not applicable
(c) The following table sets forth information with respect to
purchases made by or on behalf of the Company of shares of common
stock of the Company during the indicated periods.
Total Total Number of Maximum Number of
Number Average Shares Purchased as Shares that May Yet Be
of Shares Price Paid Part of Publicly Purchased Under the
Period (1) Purchased per Share Announced Plan Plan
- -------------------------------------------------------------------------------------------------------
April 1-30, 2005 -- -- -- 51,432
May 1-31, 2005 -- -- -- 51,432
June 1-30, 2005 -- -- -- 51,432
Total -- -- -- 51,432
======
- -------------------------
(1) On January 31, 2003, the Company announced its current program to
repurchase up to 101,000 of shares of common stock of the Company.
Subsequent to June 30, 2005, the Company decided to terminate the
repurchase program based on the determination that due to the pricing of
the common stock and the consideration of various other factors, the
completion of the Company's repurchase program was not the best use of the
Company's available funds.
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
(a) None
(b) No changes in procedures.
Item 6. Exhibits
(a) List of Exhibits
Exhibit No. Description
- ---------- ---------------------------------------------------------------------------------
3.1 Amended and Restated Articles of Incorporation of First Keystone Financial, Inc. 1
3.2 Amended and Restated Bylaws of First Keystone Financial, Inc. 1
4.1 Specimen Stock Certificate of First Keystone Financial, Inc. 1
4.2 Instrument defining the rights of security holders **
10.1 Employee Stock Ownership Plan and Trust of First Keystone Financial, Inc. 1, *
23
10.2 401(K)/ Profit-sharing Plan of First Keystone Federal Savings Bank 1, *
10.3 Employment Agreement between First Keystone Financial, Inc. and
Thomas M. Kelly dated December 1, 2004. 2,*
10.4 Severance Agreement between First Keystone Financial, Inc. and
Elizabeth M. Mulcahy dated December 1, 2004. 2,*
10.5 Severance Agreement between First Keystone Financial, Inc. and
Carol Walsh dated December 1, 2004. 2,*
10.6 1995 Stock Option Plan. 3, *
10.7 1995 Recognition and Retention Plan and Trust Agreement 4,*
10.8 1998 Stock Option Plan 4, *
10.9 Employment Agreement between First Keystone Bank and Thomas M. Kelly
dated December 1, 2004 2, *
10.10 Severance Agreement between First Keystone Bank and Elizabeth M. Mulcahy
dated December 1, 2004 2, *
10.11 Severance Agreement between First Keystone Bank and Carol Walsh
dated December 1, 2004 2, *
10.12 First Keystone Bank Supplemental Executive Retirement Plan 5,*
10.13 Consulting Agreement between First Keystone Bank and Edmund Jones 6,*
10.14 Amendment No. 1 to the Employment Agreement between First Keystone Financial, Inc. and
Thomas M. Kelly. 7,*
10.15 Amendment No. 1 to the Employment Agreement between First Keystone Bank and Thomas M.
Kelly. 7,*
10.16 Transition, Consulting, Noncompetition and Retirement Agreement by and between First
Keystone Financial, Inc., First Keystone Bank and Donald S. Guthrie. 8,*
11 Statement re: computation of per share earnings. See Note 2 to the Consolidated
Financial Statements included in Item 8 hereof.
31.1 Section 302 Certification of Chief Executive Officer
31.2 Section 302 Certification of Chief Financial Officer
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.1 Codes of Ethics 9
- ----------------------------
(1) Incorporated by reference from the Registration Statement Form S-1
(Registration No. 33-84824) filed by the Registrant with the SEC on October
6, 1994, as amended.
(2) Incorporated by reference from Exhibit 10.5, 10.6, 10.8, 10.14, 10.15 and
10.16, respectively, in the Form 8-K filed by the Registrant with the SEC
on December 7, 2004 (File No. 000-25328).
(3) Incorporated by reference from Exhibit 10.9 in the Form 10-K filed by the
Registrant with SEC on December 29, 1995 (File No. 000-25328).
(4) Incorporated from Appendix A of the Registrant's definitive proxy statement
dated December 24, 1998 (File No. 000-25328).
(5) Incorporated by reference from Exhibit 10.17 in the Form 10-Q filed by the
Registrant with the SEC on May 17, 2004.
(6) Incorporated by reference from Exhibit 10.18 in the Form 10-K filed by the
Registrant with the SEC on December 29, 2004.
(7) Incorporated by reference from Exhibit 10.19 and 10.20, respectively, in
the Form 8-K filed by the Registrant with the SEC on March 29, 2005.
(8) Incorporated by reference from Exhibit 10.21 in the Form 8-K filed by the
Registrant with the SEC on March 29, 2005.
24
(9) Incorporated by reference from the Form 10-K filed by the Registrant with
the SEC on December 23, 2003.
(*) Consists of a management contract or compensatory plan
(**) The Company has no instruments defining the rights of holders of long-term
debt where the amount of securities authorized under such instrument exceeds 10%
of the total assets of the Company and its subsidiaries on a consolidated basis.
The Company hereby agrees to furnish a copy of any such instrument to the SEC
upon request.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST KEYSTONE FINANCIAL, INC.
Date: August 15, 2005 By: /s/ Thomas M. Kelly
----------------------------------
Thomas M. Kelly
President and Chief Executive Officer
Date: August 15, 2005 By: /s/ Rose M. DiMarco
----------------------------------
Rose M. DiMarco
Chief Financial Officer
26