SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2005
- OR -
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-25328
FIRST KEYSTONE FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2576479
(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
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NOT APPLICABLE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK (PAR VALUE $.01 PER SHARE)
Indicate by check mark whether the Registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
-----
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 126-2).
Yes No X
----- -----
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
----- -----
The aggregate market value of the shares of Common Stock of the Registrant
issued and outstanding on December 12, 2005, which excludes 448,070 shares held
by all directors and officers of the Registrant as a group, was approximately
$33.5 million. This figure is based on the closing price of $21.23 per share of
the Registrant's Common stock on March 31, 2005, the last business day of the
Registrant's second fiscal quarter.
Number of shares of Common Stock outstanding as of December 12, 2005: 2,023,874
DOCUMENTS INCORPORATED BY REFERENCE
Listed hereunder are the documents incorporated by reference and the Part of the
Form 10-K into which the document is incorporated:
(1) Portions of the definitive proxy statement for the 2006 Annual Meeting of
Stockholders are incorporated into Part III.
FIRST KEYSTONE FINANCIAL, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2005
INDEX
Page
----
PART I
Item 1. Business 1
Item 2. Properties 35
Item 3. Legal Proceedings 36
Item 4. Submission of Matters to a Vote of Security Holders 36
PART II
Item 5. Market for Registrant's Common Stock, Related Stockholder
Matters and Issuer Purchases of Equity Securities 36
Item 6. Selected Financial Data 37
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 39
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 52
Item 8. Financial Statements and Supplementary Data 54
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures 84
Item 9A. Controls and Procedures 84
Item 9B. Other Information 84
PART III
Item 10. Directors and Executive Officers of the Registrant 84
Item 11. Executive Compensation 84
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 85
Item 13. Certain Relationships and Related Transactions 85
Item 14. Principal Accounting Fees and Services 85
PART IV
Item 15. Exhibits, Financial Statement Schedules 85
SIGNATURES 88
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PART I.
ITEM 1. BUSINESS.
GENERAL
First Keystone Financial, Inc. (the "Company") is a Pennsylvania
corporation and the 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 only significant assets of the Company are the
capital stock of the Bank, the Company's loan to its employee stock ownership
plan, and various equity and other investments. See Note 18 of the Notes to
Consolidated Financial Statements for the fiscal year ended September 30, 2005
set forth in Item 8 hereof, "Financial Statements and Supplementary Data." The
business of the Company primarily consists of the business of the Bank.
During the fourth quarter of fiscal 2005, the Company implemented a
deleveraging strategy in order to improve the Company's capital ratios, mitigate
margin compression and enhance future earnings performance. The execution of the
strategy resulted in a decline in total assets from $571.9 million at September
30, 2004 to $518.1 million at September 30, 2005. As part of the deleveraging
strategy, the Company sold approximately $47.5 million of investment and
mortgage-related securities with a weighted average yield of 3.97% resulting in
a pre-tax gain of approximately $168,000. The proceeds from the sales were used
to repay $20 million of Federal Home Loan Bank ("FHLB") fixed-rate convertible
advances with a weighted average cost of approximately 5.44% and a final
maturity of 2008 resulting in a pre-tax prepayment penalty charge of
approximately $486,000. The remaining proceeds were utilized to repay
approximately $26.0 million of floating-rate borrowings from the FHLB. At
September 30, 2005, in large part due to the deleveraging strategy, the capital
ratio increased 25 basis points to 5.44% from 5.19% at September 30, 2004.
Likewise, the Bank's core capital ratio also showed improvement from 8.21% at
the end of fiscal 2004 to 8.85% at September 30, 2005.
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. A substantial portion of the Bank's
deposits are comprised of core deposits consisting of NOW, non-interest-bearing
accounts, money market deposit accounts ("MMDA") and passbook accounts. Core
deposits amounted to $176.6 million or 50.5% of the Bank's total deposits at
September 30, 2005. The Bank's primary lending emphasis is the origination of
loans secured by first and second liens on single-family (one-to-four units)
residences located in Delaware and Chester Counties, Pennsylvania and to a
lesser degree, Montgomery County, Pennsylvania and New Castle County, Delaware.
The Bank originates residential first mortgage loans with either fixed and/or
adjustable rates. Adjustable-rate loans are retained for the Bank's portfolio
while fixed-rate loans are generally sold in the secondary market depending on
the Bank's asset/liability strategy, cash flow needs and current market
conditions. The Bank also originates for portfolio, due to their generally
shorter terms, adjustable or variable interest rates and generally higher
yields, loans secured by commercial and multi-family residential real estate
properties located within the Bank's market area. The Bank's management
continues to remain focused on implementation of its long-term strategic plan of
shifting its loan composition toward commercial real estate and business loans,
construction loans and home equity loans and lines of credit in order to provide
a higher yielding portfolio with generally shorter terms. This effort to keep
shorter term loans in portfolio resulted in a $5.5 million, or 51.4%, increase
in the outstanding balances of commercial business loans as well as a $3.1
million, or 7.2%, increase in home equity loans and lines of credit at September
30, 2005, compared to the end of the previous fiscal year. Multi-family
residential and commercial real estate loans amounted to $72.4 million or 22.6%
of the total loan portfolio at September 30, 2005. The Bank has on occasion
purchased loan participation interests in both residential and commercial real
estate loans depending on market conditions and portfolio needs, although no
such purchases have been made during the past several fiscal years.
In addition to its deposit gathering and lending activities, the Bank
invests in mortgage-related securities, which are issued or guaranteed by U.S.
Government agencies and government sponsored or private enterprises, as well as
U.S. Treasury and federal government agency obligations, corporate bonds and
municipal obligations. At September 30, 2005, the Bank's mortgage-related
securities (both available for sale and held to maturity) amounted to $114.2
million, or 22.0% of the Company's total assets, and investment securities (both
available for sale and held to maturity) amounted to $41.3 million, or 8.0% of
total assets.
1
MARKET AREA AND COMPETITION
The Bank's primary market area is Delaware and Chester Counties, which are
located in the southeastern corner of Pennsylvania between two prominent
metropolitan areas - Philadelphia, Pennsylvania and Wilmington, Delaware. There
is easy access to I-95, the Philadelphia International Airport and the Delaware
River, and the Bank is fortunate to be located in such a desirable geographic
area. New York City is just 92 miles away from the Bank's headquarters in Media,
Pennsylvania, while Baltimore, Maryland and Washington, DC are only 80 miles and
127 miles away, respectively.
Through an extensive highway and telecommunications network, Delaware
County's economy is knitted tightly into a regional economy of more than 2.5
million workers. The most recent census lists Delaware County as having 14,394
business establishments, with most of the businesses in corporate and
professional services, distributive services, and the manufacturing sector. This
census also shows that Delaware County has a large, well-educated, and skilled
labor force, and nearly one quarter of the County's population has earned a
four-year college degree. In addition, Philadelphia's central location in the
Northeast corridor, infrastructure, and other factors have made the Bank's
market area attractive to many large corporate employers including, among
others, Comcast Corp., Boeing, State Farm Insurance, United Parcel Service, PECO
Energy, SAP America, Inc., and Wawa.
The Philadelphia area economy is typical of many large northeastern cities
where the traditional manufacturing-based economy has declined and been replaced
by the service sector, including the health care market. Crozer/Keystone Health
System, Mercy Health Corp., and Astra-Zeneca are among the larger health care
employers within the Bank's market area. According to the Delaware County
Chamber of Commerce, there is more than 65 degree-granting institutions in the
Delaware Valley region, representing a higher density of colleges and
universities than any other area in the United States. Delaware County also has
one of the nation's lowest unemployment rates and one of the most active Chamber
of Commerce Offices in the Commonwealth. In fact, the Delaware County Chamber of
Commerce has been recognized by the U.S. Small Business Administration
(Philadelphia District Office) for its accomplishments several times within the
past few years.
The population of Delaware County is reported at over half a million
residents and is the fifth most populated county in the Commonwealth of
Pennsylvania. Much of the growth and development continues to be in the western
part of the county and adjacent Chester County. In the second calendar quarter
of 2005, unemployment in Chester County was extremely low - at 3.6% - compared
to the rest of the Commonwealth, which was at an average of 5.0%. The Bank
continues to benefit from this growth as its Chester Heights branch, situated in
a prime location in Western Delaware County, has exceeded the Company's deposit
and consumer loan projections year after year. Chester County's growth rate is
expected to increase even further in the next decade, and some of the
communities in Chester County that are experiencing the most rapid growth - East
Marlborough Township, New Garden Township and East Goshen - surround the Bank's
Chester County branch. As a result of the anticipated growth, in fiscal 2004,
the Bank expanded its Willowdale branch to a full-service free-standing branch,
which has provided it with greater visibility and helped increase growth in core
deposits.
The Bank experiences strong competition for real estate loans, principally
from other savings associations, commercial banks, and mortgage-banking
companies. The Bank competes for these and other loans primarily through the
interest rates and loan fees it charges, the efficiency and quality of the
services it provides borrowers, and the convenient locations of its branch
office network. Recognizing that convenience, as it relates to branch locations,
is still a primary motivator in attracting new deposits, the Bank completed
construction of its eighth full-service free-standing branch during the first
quarter of fiscal 2005. This branch is located on a corner commercial property
in Aston Township, Delaware County, which is a densely populated area in the
heart of the Bank's marketplace. The building's design was carefully integrated
into our corporate branding strategy and complements our Chester Heights and
Willowdale branches in both look and feel.
2
The Bank faces strong competition both in attracting deposits and making
real estate and commercial loans. Its most direct competition for deposits has
historically come from other savings associations, credit unions, and commercial
banks located in its market area. This includes many large regional financial
institutions which have even greater financial and marketing resources available
to them. The ability of the Bank to attract and retain core deposits depends on
its ability to provide a competitive rate of return, liquidity, and service
convenience comparable to those offered by competing investment opportunities.
The Bank's management remains focused on attracting core deposits through its
branch network, business development efforts, and commercial business
relationships. Early in 2005, the Business Development Team was expanded to
include an experienced full-time officer, who through her existing network of
relationships and clients, has been able to work closely with and strongly
support the efforts of the branches, in addition to redesigning more competitive
business packages. Core deposits represented 50.5% of the Bank's total deposit
portfolio at September 30, 2005.
FORWARD-LOOKING STATEMENTS
In this Annual Report on Form 10-K, the Company has included certain
forward-looking statements concerning the future operations of the Company. It
is management's desire to take advantage of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. This statement is for the
express purpose of availing the Company of the protections of such safe harbor
with respect to all forward-looking statements contained in this Annual Report.
Such forward-looking statements are subject to risks and uncertainties which
could cause actual results to differ materially from those currently anticipated
due to a number of factors. Such forward-looking statements may be identified by
the use of words such as believe, expect, should, estimated, potential and
similar expressions. Examples of forward-looking statements include, but are not
limited to, estimates with respect to the financial condition, business
strategy, expected or anticipated revenue, results of operations and the
business of the Company that are subject to various factors which could cause
actual results to differ materially from these estimates. Factors that could
affect results include interest rate trends, deposit flows, competition, the
general economic climate in Delaware and Chester counties, the mid-Atlantic
region and the United States as a whole, loan demand, real estate values, loan
delinquency rates, levels of non-performing assets, changes in federal and state
regulation, changes in accounting policies and practices and other uncertainties
described in the Company's filings with the Securities and Exchange Commission,
including the Form 10-K. These factors should be considered in evaluating the
forward-looking statements, and undue reliance should not be placed on such
statements. The Company assumes no obligation to update or revise
forward-looking statements to reflect any changed assumptions, any unanticipated
events or any changes in the future.
3
LENDING ACTIVITIES
Loan Portfolio Composition. The following table sets forth the composition
of the Bank's loan portfolio by type of loan at the dates indicated (excluding
loans held for sale).
SEPTEMBER 30,
----------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
---------------- ---------------- ---------------- ---------------- ----------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
(Dollars in thousands)
Real estate loans:
Single-family $146,745 45.85% $163,907 50.87% $166,042 55.51% $173,736 57.32% $160,289 59.81%
Multi-family and commercial 72,376 22.61 64,509 20.02 59,022 19.73 60,379 19.92 43,472 16.22
Construction and land 36,828 11.50 38,078 11.82 28,975 9.69 28,292 9.33 29,117 10.86
Home equity loans and lines of credit 46,748 14.60 43,621 13.54 33,459 11.19 27,595 9.10 25,847 9.65
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 302,697 94.56 310,115 96.25 287,498 96.12 290,002 95.67 258,725 96.54
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer:
Deposit 112 .03 133 .04 112 .04 144 .05 232 .09
Unsecured personal loans 641 .20 629 .20 547 .18 322 .11 133 .05
Other (1) 623 .19 709 .21 779 .26 736 .24 760 .28
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans 1,376 .42 1,471 .45 1,438 .48 1,202 .40 1,125 .42
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial business loans 16,085 5.02 10,624 3.30 10,161 3.40 11,919 3.93 8,158 3.04
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans receivable (2) 320,158 100.00% 322,210 100.00% 299,097 100.00% 303,123 100.00% 268,008 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Loans in process 14,614 15,807 10,655 11,384 17,016
Deferred loan origination fees and
discounts 90 116 35 605 1,147
Allowance for loan losses 3,475 2,039 1,986 2,358 2,181
-------- -------- -------- -------- --------
Total loans receivable, net $301,979 $304,248 $286,421 $288,776 $247,664
======== ======== ======== ======== ========
- ----------
(1) Consists primarily of credit card loans.
(2) Does not include $41,000, $172,000, $4.5 million, $501,000, and $225,000 of
loans held for sale at September 30, 2005, 2004, 2003, 2002 and 2001,
respectively.
4
Contractual Principal Repayments. The following table sets forth the
scheduled contractual maturities of the Bank's loans held to maturity at
September 30, 2005. Demand loans, loans having no stated schedule of repayments
and no stated maturity and overdraft loans are reported as due in one year or
less. The amounts shown for each period do not take into account loan
prepayments and normal amortization of the Bank's loan portfolio held to
maturity.
REAL ESTATE LOANS
----------------------------------------------------------
MULTI-FAMILY CONSUMER AND
AND CONSTRUCTION COMMERCIAL
SINGLE-FAMILY (1) COMMERCIAL AND LAND TOTAL BUSINESS LOANS TOTAL
----------------- ------------ ------------ -------- -------------------------
(Dollars in thousands)
Amounts due in:
One year or less $ 11,548 $ 5,127 $36,828 $ 53,503 $ 9,496 $ 62,999
After one year through three years 22,235 10,529 -- 32,764 3,399 36,163
After three years through five years 27,656 12,576 -- 40,232 1,445 41,677
After five years through ten years 79,308 17,956 -- 97,264 937 98,201
After ten years through fifteen years 30,345 11,409 -- 41,754 732 42,486
Over fifteen years 22,401 14,779 -- 37,180 1,452 38,632
-------- ------- ------- -------- ------- --------
Total (2) $193,493 $72,376 $36,828 $302,697 $17,461 $320,158
======== ======= ======= ======== ======= ========
Interest rate terms on amounts due after
one year:
Fixed $159,630 $ 2,275 $161,905
Adjustable 89,564 5,690 95,254
-------- ------- --------
Total (2) $249,194 $ 7,965 $257,159
======== ======= ========
- ----------
(1) Includes home equity loans and lines of credit.
(2) Does not include adjustments relating to loans in process, allowances for
loan losses and deferred fee income and discounts.
5
Scheduled contractual amortization of loans does not reflect the expected
term of the Bank's loan portfolio. The average life of loans is substantially
less than their contractual terms because of prepayments and due-on-sale clauses
which give the Bank the right to declare a conventional loan immediately due and
payable in the event, among other things, that the borrower sells the real
property subject to the mortgage and the loan is not repaid. The average life of
mortgage loans tends to increase when current mortgage loan rates are higher
than rates on existing mortgage loans and, conversely, decrease when current
mortgage loan rates are lower than rates on existing mortgage loans, due to
refinancings of adjustable-rate and fixed-rate loans at lower rates. Under the
latter circumstances, the weighted average yield on loans decreases as higher
yielding loans are repaid or refinanced at lower rates.
Loan Origination, Purchase and Sale Activity. The following table shows the
loan origination, purchase and sale activity of the Bank during the periods
indicated.
YEAR ENDED SEPTEMBER 30,
---------------------------------
2005 2004 2003
--------- --------- ---------
(Dollars in thousands)
Gross loans at beginning of period(1) $ 322,382 $ 303,595 $ 303,624
--------- --------- ---------
Loan originations for investment:
Real estate:
Residential 11,235 35,214 80,722
Commercial and multi-family 31,689 26,560 13,890
Construction 23,876 28,816 24,578
Home equity and lines of credit 33,033 29,133 29,920
--------- --------- ---------
Total real estate loans originated for investment 99,833 119,723 149,110
Consumer 3,458 2,695 2,927
Commercial business 26,281 13,734 17,548
--------- --------- ---------
Total loans originated for investment 129,572 136,152 169,585
Loans originated for resale 13,620 9,671 30,995
--------- --------- ---------
Total originations 143,192 145,823 200,580
--------- --------- ---------
Deduct:
Principal loan repayments and prepayments (131,624) (117,069) (171,489)
Transferred to real estate owned -- (153) (2,122)
Loans sold in secondary market (13,751) (9,814) (26,998)
--------- --------- ---------
Subtotal (145,375) (127,036) (200,609)
--------- --------- ---------
Net (decrease) increase in loans(1) (2,183) 18,787 (29)
--------- --------- ---------
Gross loans at end of period(1) $ 320,199 $ 322,382 $ 303,595
========= ========= =========
- ----------
(1) Includes loans held for sale of $41,000, $172,000 and $4.5 million at
September 30, 2005, 2004 and 2003, respectively.
The residential lending activities of the Bank are subject to written
underwriting standards and loan origination procedures established by the Bank's
Board of Directors and management. Loan applications may be taken at all of the
Bank's branch offices by the branch manager or other designated loan officers.
Applications for single-family residential mortgage loans for portfolio
retention are obtained predominately through loan originators who are employees
of the Bank. The Bank's residential loan originators will take loan applications
outside of the Bank's offices at the customer's convenience and are compensated
on a commission basis. The Residential Lending Department supervises the process
of obtaining credit reports, appraisals and other documentation involved with
the adjustment of a loan. In most cases, the Bank requires that a property
appraisal be obtained in connection with all new first mortgage loans.
Generally, appraisals are not required on home equity loans below $250,000
because alternative means of valuation are used (i.e. tax assessments, home
value estimators). Property appraisals generally are performed by an independent
appraiser selected from a list approved by the Bank's Board of Directors. The
Bank requires that title insurance (other than with respect to home equity
loans) and hazard insurance be maintained on all security properties and that
flood insurance be maintained if the property is within a designated flood
plain.
6
Residential mortgage loan applications are primarily developed from
referrals from real estate brokers and builders, existing customers and walk-in
customers. Commercial and multi-family real estate loan applications are
obtained primarily from previous borrowers, direct solicitations by Bank
personnel, as well as referrals. Consumer loans originated by the Bank are
obtained primarily through existing and walk-in customers who have been made
aware of the Bank's programs by advertising and other means.
Applications for single-family residential mortgage loans which are
originated for resale in the secondary market or loans designated for portfolio
retention that conform to the requirements for resale into the secondary market
and do not exceed Fannie Mae ("FNMA") or Freddie Mac ("FHLMC") limits are
approved by at least one of the following: the Bank's Director of Lending, the
Senior Mortgage Loan underwriter or the Loan Committee (a committee comprised of
four directors and the Director of Lending). Residential mortgage loans in
excess of FNMA/FHLMC maximum amounts (currently $359,650 for single-family
properties) but less than $1.0 million must be approved by the Loan Committee.
All mortgage loans in excess of $1.0 million must be approved by the Bank's
Board of Directors or the Executive Committee thereof. Commercial and
multi-family residential real estate loans in excess of $250,000 and
construction loans must be approved by the Loan Committee. All mortgage loans
which do not require approval by the Board of Directors are submitted to the
Board at its next meeting for review and ratification. Home equity loans and
lines of credit up to $250,000 can be approved by the Director of Lending, the
Vice President of Construction Loans, the Vice President of Residential Lending
or the Senior Mortgage Loan Underwriter. Loans in excess of such amount must be
approved by the Loan Committee.
Single-Family Residential Loans. Substantially all of the Bank's
single-family residential mortgage loans consist of conventional loans.
Conventional loans are loans that are neither insured by the Federal Housing
Administration nor partially guaranteed by the Department of Veterans Affairs.
The vast majority of the Bank's single-family residential mortgage loans are
secured by properties located in Pennsylvania, primarily in Delaware and Chester
Counties, and are originated under terms and documentation which permit their
sale to FHLMC or FNMA. The Bank, consistent with its asset/liability management
strategies, sells some of its newly originated 30-year term fixed-rate
residential mortgage loans and to a limited degree, existing longer term
fixed-rate residential mortgage loans while retaining adjustable-rate mortgage
loans and shorter term fixed-rate residential mortgage loans. See "-
Mortgage-Banking Activities."
The single-family residential mortgage loans offered by the Bank currently
consist of fixed-rate loans, including bi-weekly and balloon loans and
adjustable-rate loans. Fixed-rate loans generally have maturities ranging from
15 to 30 years and are fully amortizing with monthly loan payments sufficient to
repay the total amount of the loan with interest by the end of the loan term.
The Bank's fixed-rate loans are originated under terms, conditions and
documentation which permit them to be sold to U.S. Government-sponsored
agencies, such as FHLMC or FNMA, and other purchasers in the secondary mortgage
market. The Bank also offers bi-weekly loans under the terms of which the
borrower makes payments every two weeks. Although such loans have a 30-year
amortization schedule, due to the bi-weekly payment schedule, such loans repay
substantially more rapidly than a standard monthly amortizing 30-year fixed-rate
loan. The Bank also offers five and seven year balloon loans which provide that
the borrower can conditionally renew the loan at the fifth or seventh year at a
then to-be-determined interest rate for the remaining 25 or 23 years,
respectively, of the amortization period. At September 30, 2005, $127.5 million,
or 86.9% of the Bank's single-family residential mortgage loans held in
portfolio were fixed-rate loans, including $9.0 million of bi-weekly, fixed-rate
residential mortgage loans.
The adjustable-rate loans currently offered by the Bank have interest rates
which adjust every one, three or five years in accordance with a designated
index, such as U.S. Treasury obligations, adjusted to a constant maturity
("CMT"), plus a stipulated margin. The Bank's adjustable-rate single-family
residential real estate loans generally have a cap of 2% on any increase or
decrease in the interest rate at any adjustment date, and a maximum adjustment
limit of 6% on any such increase or decrease over the life of the loan. In order
to increase the originations of adjustable-rate loans, the Bank has been
originating loans which bear a fixed interest rate for a period of three to five
years after which they convert to one-year adjustable-rate loans. The Bank's
adjustable-rate loans require that any payment adjustment resulting from a
change in the interest rate of an adjustable-rate loan be sufficient to result
in full amortization of the loan by the end of the loan term and, thus, do not
permit any of the increased payment to be added to the principal amount of the
loan, creating negative amortization. Although the Bank does offer
adjustable-rate loans with initial rates below the fully indexed rate, loans
tied to the one-year CMT are underwritten using methods approved by FHLMC or
FNMA which require borrowers to be qualified at 2% above the discounted loan
rate under certain conditions. The Bank has taken steps to increase such loans
in recent years, but with limited interest. However, with the anticipated rise
in long-term interest rates, the Bank expects the volume of adjustable-rate
loans to increase. At September 30, 2005, $19.2 million, or 13.1%, of the Bank's
single-family residential mortgage loans held for portfolio were adjustable-rate
loans.
7
Adjustable-rate loans decrease the risks associated with changes in
interest rates but involve other risks. In the event interest rates increase,
the loan payment by the borrower also increases to the extent permitted by the
terms of the loan, thereby increasing the potential for default. In addition,
adjustable-rate loans tend to prepay and convert to fixed rates when the overall
interest rate environment is low. Moreover, as with fixed-rate loans, as
interest rates increase, the marketability of the underlying collateral property
may be adversely affected by higher interest rates. The Bank believes that these
risks, which have not had a material adverse effect on the Bank to date,
generally are less than the risks associated with holding fixed-rate loans in an
increasing interest rate environment.
For conventional residential mortgage loans held in portfolio and also for
those loans originated for sale in the secondary market, the Bank's maximum
loan-to-value ("LTV") ratio is 97%, and is based on the lesser of sales price or
appraised value. On loans with a LTV ratio of over 80%, private mortgage
insurance may be required to be obtained or the Bank, on occasion, may lend the
excess as a home equity loan.
Commercial and Multi-Family Residential Real Estate Loans. During fiscal
2005, the Bank moderately increased its investment in commercial and
multi-family residential loans. Such loans are being made primarily to small-
and medium-sized businesses located in the Bank's primary market area, a segment
of the market that the Bank believes has continued to be underserved in recent
years. Loans secured by commercial and multi-family residential real estate
amounted to $72.4 million, or 22.6%, of the Bank's total loan portfolio, at
September 30, 2005. The Bank's commercial and multi-family residential real
estate loans are secured primarily by professional office buildings, small
retail establishments, warehouses and apartment buildings (with 36 units or
less) located in the Bank's primary market area.
The Bank's adjustable-rate multi-family residential and commercial real
estate loans generally are either three or five-year adjustable-rate loans
indexed to the CMT plus a margin. In addition, depending on collateral value and
strength of the borrower, fixed-rate balloon loans and longer term fixed-rate
loans may be originated. Generally, fees of up to 1% of the principal loan
balance are charged to the borrower upon closing. Although terms for
multi-family residential and commercial real estate loans may vary, the Bank's
underwriting standards generally provide for terms of up to 20 years with
amortization of the principal over the term of the loan and LTV ratios of not
more than 75%. Generally, the Bank obtains personal guarantees of the principals
of the borrower as additional security for any commercial real estate and
multi-family residential loans and requires that the borrower have at least a
25% equity investment in any such property.
The Bank evaluates various aspects of commercial and multi-family
residential real estate loan transactions in an effort to mitigate risk to the
extent possible. In underwriting these loans, consideration is given to the
stability of the property's cash flow history, future operating projections,
current and projected occupancy, position in the market, location and physical
condition. In recent periods, the Bank has generally imposed a debt coverage
ratio (the ratio of net cash from operations before payment of debt service to
debt service) of not less than 110%. The underwriting analysis also includes
credit checks and a review of the financial condition of the borrower and
guarantor, if applicable. An appraisal report is prepared by a state-licensed
and certified appraiser (generally an appraiser who is qualified as a Member of
the Appraisal Institute ("MAI")) commissioned by the Bank to substantiate
property values for every commercial real estate and multi-family loan
transaction. All appraisal reports are reviewed by the commercial loan
underwriter prior to the closing of the loan.
Multi-family residential and commercial real estate lending entails
different and significant risks when compared to single-family residential
lending because such loans often involve large loan balances to single borrowers
and because the payment experience on such loans is typically dependent on the
successful operation of the project or the borrower's business. These risks also
can be significantly affected by supply and demand conditions in the local
market for apartments, offices, warehouses or other commercial space. The Bank
attempts to minimize its risk exposure by limiting such lending to proven
owners, only considering properties with existing operating performance which
can be analyzed, requiring conservative debt coverage ratios, and periodically
monitoring the operation and physical condition of the collateral See
"-Non-performing Assets" for further discussion of the Bank's non-performing
loans.
Construction Loans. Substantially all of the Bank's construction loans
consist of loans for acquisition and development of properties to construct
single-family properties extended either to individuals or to selected
developers with whom the Bank is familiar to build such properties on a pre-sold
or limited speculative basis.
8
To a lesser extent, the Bank provides financing for construction to
permanent commercial real estate properties. Commercial construction loans have
a maximum term of 24 months during the construction period with interest based
upon the prime rate published in the Wall Street Journal ("Prime Rate") plus a
margin and have LTV ratios of 80% or less of the appraised value upon
completion. The loans convert to permanent commercial real estate loans upon
completion of construction. With respect to construction loans to individuals,
such loans have a maximum term of 12 months, have variable rates of interest
based upon the Prime Rate plus a margin and have LTV ratios of 80% or less of
the appraised value of the property upon completion and generally do not require
the amortization of principal during the term. Upon completion of construction,
the borrower is required to refinance the loan although the Bank may be the
lender of the permanent loan secured by the property.
The Bank also provides construction loans (including acquisition and
development loans) and revolving lines of credit to developers. The majority of
construction loans consist of loans to selected local developers with whom the
Bank is familiar and who build single-family dwellings on a pre-sold or, to a
significantly lesser extent, on a speculative basis. The Bank generally limits
to two the number of unsold units that a developer may have under construction
in a project. Such loans generally have terms of 36 months or less, generally
have a maximum LTV ratio of 75% of the appraised value of the property upon
completion and do not require the amortization of the principal during the term.
The loans are made with variable rates of interest based on the Prime Rate plus
a margin adjusted on a monthly basis. The Bank also receives origination fees
that generally range from 0.5% to 3.0% of the amount of the loan commitment. The
borrower is required to fund a portion of the project's costs, the exact amount
being determined on a case-by-case basis but usually not less than 25%. Loan
proceeds are disbursed by percentage of completion of the cost of the project
after inspections indicate that such disbursements are for costs already
incurred and which have added to the value of the project. Only interest
payments are due during the construction phase and the Bank may provide the
borrower with an interest reserve from which it can pay the stated interest due
thereon.
At September 30, 2005, residential construction loans totaled $23.4
million, or 7.3%, of the total loan portfolio, primarily consisting of
construction loans to developers. At September 30, 2005, commercial construction
loans totaled $1.2 million, or 0.37%, of the total loan portfolio.
The Bank also originates ground or land loans to individuals to purchase a
property on which they intend to build their primary residences, as well as to
developers to purchase lots to build speculative homes at a later date. Such
loans have terms of 36 months or less with a maximum LTV ratio of 75% of the
lower of appraised value or sale price. The loans are made with variable rates
based on the Prime Rate plus a margin. The Bank also receives origination fees,
which generally range between 1.0% and 3.0% of the loan amount. At September 30,
2005, land loans (including loans to acquire and develop land) totaled $22.6
million, or 7.0%, of the total loan portfolio.
Loans to developers include both secured and unsecured lines of credit
(which are classified as commercial business loans) with outstanding commitments
totaling $1.2 million. All have personal guaranties of the principals and are
cross-collateralized with existing loans. At September 30, 2005, loans
outstanding under builder lines of credit totaled $548,000, of which $455,000
was unsecured. Such loans are only given to the Bank's most creditworthy long
standing customers.
Prior to making a commitment to fund a construction loan, the Bank requires
an appraisal of the property by an appraiser approved by the Board of Directors.
In addition, during the term of the construction loan, the project is inspected
by an independent inspector.
Construction financing generally is considered to involve a higher degree
of risk of loss than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development and the estimated cost (including interest) of
construction. During the construction phase, a number of factors could result in
delays and cost overruns. If the estimate of value proves to be inaccurate, the
Bank may be confronted, at or prior to the maturity of the loan, with a project,
when completed, having a value which is insufficient to assure full repayment.
Loans on lots may run the risk of adverse zoning changes as well as
environmental or other restrictions on future use.
Home Equity Loans and Lines of Credit. Home equity loans and home equity
lines of credit are secured by the underlying equity in the borrower's primary
residence or, occasionally, other types of real estate. Home equity loans are
amortizing loans with fixed interest rates and generally maximum terms of 15
years while equity lines of credit have adjustable interest rates indexed to the
Prime Rate. Generally home equity loans or home equity lines of credit do not
exceed $100,000. The Bank's home equity loans and lines of credit generally
require combined LTV ratios of 80% or
9
less. Loans with higher LTV ratios are available but with higher interest rates
and stricter credit standards. At September 30, 2005, home equity loans and
lines of credit amounted to $46.7 million, or 14.6%, of the Bank's total loan
portfolio.
Commercial Business Loans. The Bank has also emphasized in recent periods
the growth of its commercial business loan portfolio by granting such loans
directly to business enterprises that are located in its market area. The
majority of such loans are for less than $1.0 million. The Bank actively targets
and markets this product to small-and medium-sized businesses. Applications for
commercial business loans are obtained from existing commercial customers,
branch and customer referrals, direct inquiry and those that are obtained by our
commercial lending officers. As of September 30, 2005, commercial business loans
amounted to $16.1 million, or 5.0%, of the Bank's total loan portfolio. The
commercial business loans consist of a limited number of commercial lines of
credit secured by equipment and securities, some working capital financings
secured by accounts receivable and inventory and, to a limited extent, unsecured
lines of credit. Commercial business loans originated by the Bank ordinarily
have terms of five years or less and fixed rates or adjustable rates tied to the
Prime Rate plus a margin.
Although commercial business loans generally are considered to involve
greater credit risk than certain other types of loans, management intends to
continue to offer commercial business loans to small- and medium-sized
businesses in an effort to better serve our community's needs, obtain core
non-interest-bearing deposits and increase the Bank's interest rate spread and
improve interest rate sensitivity.
In the fourth quarter of fiscal 2005, the Bank began to market loans
guaranteed by the Small Business Administration. Experienced professionals are
employed by the Bank with extensive knowledge of lending via the Small Business
Administration. Such experience will continue to be leveraged to grow this
business line. As part of the Company's asset liability strategy, the Bank
intends to sell the guaranteed portion of the loan upon loan settlement.
Consumer Lending Activities. The Bank also offers a variety of consumer
loans in order to provide a full range of retail financial services to its
customers. At September 30, 2005, $1.4 million, or 0.42%, of the Bank's total
loan portfolio was comprised of consumer loans. The Bank originates
substantially all of such loans in its market area. At September 30, 2005, the
Bank's consumer loan portfolio was comprised of credit card, deposit, unsecured
personal loans and other consumer loans. The Bank's credit card program is
primarily offered to only the Bank's most creditworthy customers. At September
30, 2005, these loans totaled $623,000, or 0.19%, of the total loan portfolio.
Another component of the consumer loan portfolio is unsecured loans amounting to
$456,000, or 0.14%, of the Bank's loan portfolio at September 30, 2005.
Consumer loans generally have shorter terms and higher interest rates than
mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral.
Mortgage-Banking Activities. Due to customer preference for fixed-rate
loans, the Bank has continued to originate fixed-rate loans. Long-term
(generally 30 years) fixed-rate loans not taken into portfolio for
asset/liability purposes are sold into the secondary market. The Bank's net gain
on sales of mortgage loans amounted to $93,000, $54,000 and $410,000, during the
fiscal years ended September 30, 2005, 2004 and 2003, respectively. Profits from
sales of loans held for sale slightly increased in fiscal 2005; however, the
Bank continued to experience a slowdown in the refinancing market in 30-year
loans resulting from increases in long-term interest rates. The Bank had $41,000
and $172,000 of mortgage loans held for sale at September 30, 2005 and 2004,
respectively.
The Bank's conforming mortgage loans sold to others are sold, generally
with servicing retained, on a loan-by-loan basis primarily to FHLMC or FNMA. A
period of less than five days generally elapses between the closing of the loan
by the Bank and its purchase by the investor. Mortgages with established
interest rates generally will decrease in value during periods of increasing
interest rates. Accordingly, fluctuations in prevailing interest rates may
result in a gain or loss to the Bank as a result of adjustments to the carrying
value of loans held for sale or upon sale of loans. The Bank attempts to protect
itself from these market fluctuations through the use of forward commitments
entered into at the same time of the commitment by the Bank of a loan rate to
the borrower. These commitments are mandatory delivery contracts with the
purchaser, generally FHLMC or FNMA, within a certain time frame and within
certain dollar amounts by a price determined at the commitment date. Market risk
does exist as non-refundable points paid by the borrower may not be sufficient
to offset fees associated with closing the forward commitment contract. See Note
13 of the Notes to Consolidated Financial Statements set forth in Item 8 hereof.
10
Loan Origination Fees and Servicing. Borrowers may be charged an
origination fee, which is a percentage of the principal balance of the loan. In
accordance with the provisions of Statement of Financial Accounting Standards
("SFAS") No. 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases," the various
fees, net of costs, received by the Bank in connection with the origination of
loans are deferred and amortized as a yield adjustment over the lives of the
related loans using the interest method. However, when such loans are sold, the
remaining unamortized fees (which is all or substantially all of such fees due
to the relatively short period during which such loans are held) are recognized
as income on the sale of loans held for sale.
The Bank, for conforming loan products, generally retains the servicing on
all loans sold to others. In addition, the Bank services substantially all of
the loans that it retains in its portfolio. Loan servicing includes collecting
and remitting loan payments, accounting for principal and interest, making
advances to cover delinquent payments, making inspections as required of
mortgaged premises, contacting delinquent mortgagors, supervising foreclosures
and property dispositions in the event of unremedied defaults and generally
administering the loans. Funds that have been escrowed by borrowers for the
payment of mortgage-related expenses, such as property taxes and hazard and
mortgage insurance premiums, are maintained in non-interest-bearing accounts at
the Bank.
The following table presents information regarding the loans serviced by
the Bank for others at the dates indicated. Substantially all the loans were
secured by properties in Pennsylvania. A small percentage of the loans are
secured by properties located in Delaware, Maryland or New Jersey.
SEPTEMBER 30,
---------------------------
2005 2004 2003
------- ------- -------
(Dollars in thousands)
Loans originated by the Bank and serviced for:
FNMA $ 595 $ 673 $ 822
FHLMC 54,457 49,849 50,373
Others 326 340 352
------- ------- -------
Total loans serviced for others $55,378 $50,862 $51,547
======= ======= =======
The Bank receives fees for servicing mortgage loans, which generally amount
to 0.25% per annum on the declining principal balance of mortgage loans. Such
fees serve to compensate the Bank for the costs of performing the servicing
function. Other sources of loan servicing revenues include late charges. The
Bank retains a portion of funds received from borrowers on the loans it services
for others in payment of its servicing fees received on loans serviced for
others. For fiscal years ended September 30, 2005, 2004 and 2003, the Bank
earned gross fees of $133,000, $132,000 and $140,000, respectively, from loan
servicing.
Loans-to-One Borrower Limitations. Regulations impose limitations on the
aggregate amount of loans that a savings institution could make to any one
borrower, including related entities. Under such regulations, the permissible
amount of loans-to-one borrower follows the national bank standard for all loans
made by savings institutions, which generally does not permit loans-to-one
borrower to exceed 15% of unimpaired capital and surplus. Loans in an amount
equal to an additional 10% of unimpaired capital and surplus also may be made to
a borrower if the loans are fully secured by readily marketable securities. At
September 30, 2005, the Bank's five largest loans or groups of loans-to-one
borrower, including related entities, ranged from an aggregate of $4.0 million
to $7.0 million. The Bank's loans-to-one borrower limit was $7.4 million at such
date.
ASSET QUALITY
General. As a part of the Bank's ongoing efforts to improve its asset
quality, it has developed and implemented an asset classification system. All of
the Bank's assets are subject to review under the classification system, but
particular emphasis is placed on the review of multi-family residential and
commercial real estate loans, construction loans and commercial business loans.
All assets of the Bank are periodically reviewed and the classification
recommendations submitted to the Asset Quality Review Committee. The Asset
Quality Review Committee is composed of the President and Chief Executive
Officer, the Director of Lending, the Vice President of Loan Administration, the
Internal Auditor and the Vice President of Construction Lending and meets at
least monthly. All assets are placed into one of the five following categories:
pass, special mention, substandard, doubtful and loss. As a result of the most
recent OTS examination, the Bank revised its classification process and created
a rating system to include a grading of 1-6 as pass, 7 as special mention and 8,
9 and 10 as an adverse classification (substandard, doubtful and loss). Loans
classified as
11
"pass" are then placed into one of the six grades based on objective criteria of
credit underwriting. See "- Non-Performing Assets" and "- Other Classified
Assets" for a discussion of certain of the Bank's assets which have been
classified as substandard and doubtful and regulatory classification standards
generally.
When a borrower fails to make a required payment on a loan, the Bank
attempts to cure the deficiency by contacting the borrower and requesting
payment. Contact is generally made after the expiration of the grace period
(usually fifteen days) in the form of telephone calls and/or correspondence. In
most cases, deficiencies are cured promptly. If the delinquency increases, the
Bank will initiate foreclosure actions or legal collection actions if a borrower
fails to enter into satisfactory repayment arrangements. Such actions generally
commence at sixty to ninety days of delinquency.
Loans are placed on non-accrual status when, in the judgment of management,
the probability of collection of interest is deemed to be insufficient to
warrant further accrual. When a loan is placed on non-accrual status, previously
accrued but unpaid interest is deducted from interest income. As a matter of
policy, the Bank generally does not accrue interest on loans past due 90 days or
more. See Note 2 of the Notes to Consolidated Financial Statements set forth in
Item 8 hereof.
Real estate acquired by the Bank as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold. Real
estate owned is initially recorded at the lower of fair value less estimated
costs to sell the property, or cost (generally the balance of the loan on the
property at the date of acquisition). After the date of acquisition, all costs
incurred in maintaining the property are expensed and costs incurred for the
improvement or development of such property are capitalized up to the extent of
their net realizable value.
Under accounting principles generally accepted in the United States of
America ("GAAP"), the Bank is required to account for certain loan modifications
or restructurings as "troubled debt restructurings" under SFAS No. 15. In
general, the modification or restructuring of a debt constitutes a troubled debt
restructuring if the Bank, for economic or legal reasons related to the
borrower's financial difficulties, grants a concession to the borrower that the
Bank would not otherwise consider under current market conditions. Debt
restructuring or loan modifications for a borrower do not necessarily always
constitute troubled debt restructuring, however, and troubled debt restructuring
does not necessarily result in non-accrual loans.
Delinquent Loans. The following table sets forth information concerning
delinquent loans at the dates indicated, in dollar amounts and as a percentage
of each category of the Bank's loan portfolio. The amounts presented represent
the total outstanding principal balances of the related loans, rather than the
actual payment amounts which are past due.
AT SEPTEMBER 30, 2005 AT SEPTEMBER 30, 2004
----------------------------- -----------------------------
30 TO 59 DAYS 60 TO 89 DAYS 30 TO 59 DAYS 60 TO 89 DAYS
------------- ------------- ------------- -------------
Real estate loans:
Single-family residential $ -- $435 $-- $ 277
Multi-family and commercial -- -- -- 3,357(1)
Construction loans 22 -- -- ------
Home equity 189 5 -- 116
Consumer loans 8 6 5 7
Commercial business loans 676 19 -- 100
---- -- --- ------
Total $895 $465 $ 5 $3,857
==== ==== === ======
- ----------
(1) Consists of one commercial real estate loan. (See "Other Classified
Assets")
12
Non-performing Assets. The following table sets forth the amounts and
categories of the Bank's non-performing assets at the dates indicated.
SEPTEMBER 30,
----------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(Dollars in thousands)
Non-performing loans:
Single-family residential $ 378 $ 623 $ 688 $1,237 $1,924
Commercial and multi-family(1) 3,337(2) -- 381 2,386 33
Construction(3) -- 770 -- -- --
Home equity and lines of credit 60 243 -- -- --
Consumer 5 6 16 19 314
Commercial business 500(2) -- 268 138 --
------ ------ ------ ------ ------
Total non-accrual loans 4,280 1,642 1,353 3,780 2,271
------ ------ ------ ------ ------
Accruing loans more than 90 days delinquent 772(4) 391(4) 203(4) 1,358(4) 31
Total non-performing loans 5,052 2,033 1,556 5,138 2,302
------ ------ ------ ------ ------
Real estate owned 760 1,229 1,420 248 887
Total non-performing assets $5,812 $3,262 $2,976 $5,386 $3,189
====== ====== ====== ====== ======
Total non-performing loans as a percentage of
gross loans receivable(5) 1.65% 0.66% 0.53% 1.76% 0.92%
====== ====== ====== ====== ======
Total non-performing assets
as a percentage of total assets 1.12% 0.57% 0.53% 1.04% 0.65%
====== ====== ====== ====== ======
- ----------
(1) Consists of one loan at September 30, 2005, one loan at September 30, 2003,
three loans at September 30, 2002 (all of which became real estate owned
during fiscal 2003), and one loan at September 30, 2001.
(2) Loans extended to the same borrower.
(3) Consists of one single-family residential construction loan at September
30, 2004.
(4) Consists of four loans at September 30, 2005 of which a $770,000
construction loan returned to current status subsequent to September 30,
2005, six loans at September 30, 2004, two loans at September 30, 2003, and
one commercial real estate loan at September 30, 2002 which returned to
current status subsequent to September 30, 2002.
(5) Includes loans receivable and loans held for sale, less construction and
land loans in process and deferred loan origination fees and discounts.
The $378,000 of non-performing single-family residential loans at September
30, 2005 consisted of seven loans with principal balances ranging from $4,000 to
$162,000, with an average balance of approximately $54,100. Included within the
seven loans are two loans aggregating $223,000 to credit impaired borrowers.
The $60,000 of non-performing home equity and lines of credit at September
30, 2005 consisted of two loans, with an average balance of approximately
$30,000, with the largest having a balance of approximately $60,000.
13
Included in non-performing loans at September 30, 2005, was a $3.8 million
commercial borrower comprising of a $3.3 million non-accrual commercial real
estate loan and a $500,000 non-accrual commercial business loan raised
significant issues as to the collectibility of the loan. As a consequence, the
loans are secured by a restaurant in Chesapeake City, Maryland, and were one of
the primary reasons for the substantial increase in the provision for loan
losses for the third quarter of fiscal 2005. Although the Company received an
updated appraisal of the property during the quarter ended June 30, 2005, upon
review of the appraisal, a number of factors concerning the loans and the unique
nature of the property as well as a result of the recent examination by the OTS,
the Company determined to classify theses loans as "doubtful" and establish a
significant reserve related to them. The borrower has filed for bankruptcy and
foreclosure proceedings have been stayed until the borrower is released from
bankruptcy.
Loans 90 days or more past maturity which continued to make payments on a
basis consistent with the original repayment schedule amounted to $772,000 and
$391,000 at September 30, 2005 and 2004, respectively. The Company is working
with the borrowers to refinance or extend the term of such loans.
At September 30, 2005, the $760,000 of real estate owned consisted of a
commercial real estate property. The Bank owns a 25% participation interest in
an 18-hole golf course and golf house, located in Avondale, Pennsylvania. The
golf facility is fully operational and continues to generate revenues. No
operating expenses were incurred during fiscal 2005. However, in connection with
the operation of the facility during 2004, the Company incurred its
representative share of expenses totaling approximately $147,000 for the year
ended September 30, 2004. The prospective buyer could not obtain financing to
purchase the golf course. As a result, the property has been placed on the
market for sale. In December 2005, the golf course was closed for the winter.
Management anticipates that the Bank will incur a modest level of operational
costs in connection with winterizing the facility.
Other Classified Assets. Federal banking regulations require that each
insured savings association classify its assets on a regular basis. In addition,
in connection with examinations of insured institutions, federal examiners have
authority to identify problem assets and, if appropriate, classify them. There
are four classifications for problem assets: "substandard," "doubtful", "loss"
and "special mention." Substandard assets have one or more defined weaknesses
and are characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not corrected. Doubtful assets
have the weaknesses of substandard assets with the additional characteristic
that the weaknesses make collection or liquidation in full, on the basis of
currently existing facts, conditions and values questionable, and there is a
high possibility of loss. An asset classified loss is considered uncollectible
and of such little value that continuance as an asset of the institution is not
warranted.
At September 30, 2005, the Bank had $2.8 million of assets classified as
substandard, $3.8 million classified as doubtful, and no assets classified as
loss as well as $5.9 million identified as special mention. A substantial
majority of all assets classified as substandard or doubtful consist of
non-performing assets.
Allowance for Loan Losses. The Bank's policy is to establish reserves for
estimated losses on delinquent loans when it determines that losses are
probable. The allowance for losses on loans is maintained at a level believed by
management to cover all known and inherent losses in its loan portfolio.
Management's analysis of the adequacy of the allowance is based on an evaluation
of the loan portfolio, past loss experience, current economic conditions,
volume, growth and composition of the portfolio, and other relevant factors. The
allowance is increased by provisions for loan losses which are charged against
income. However, in fiscal 2005, the level of provisions increased due to the
Bank's evaluation of its estimate including, 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. Furthermore, the Company's primary
banking regulator periodically reviews the Company's allowance for loan losses
as an integral part of the examination. As shown in the table below, at
September 30, 2005, the Bank's allowance for loan losses amounted to 68.8% and
1.1 % of the Bank's non-performing loans and gross loans receivable,
respectively.
Management of the Company presently believes that its allowance for loan
losses is adequate to cover all known and inherent losses that are both probable
and reasonably estimable in the Bank's loan portfolio. However, future
adjustments to this allowance may be necessary, and the Company's results of
operations could be adversely affected if circumstances differ substantially
from the assumptions used by management in making its determinations in this
regard.
14
The following table provides information regarding the changes in the
allowance for loan losses and other selected statistics for the periods
presented.
YEAR ENDING SEPTEMBER 30,
--------------------------------------------
2005 2004 2003 2002 2001
------ ------- ------- ------ ------
(Dollars in thousands)
Allowance for loan losses, beginning of period $2,039 $ 1,986 $ 2,358 $2,181 $2,019
Charged-off loans:
Single-family residential (26) -- (50) (317) (492)
Multi-family and commercial -- (62) (941) -- --
Consumer and commercial business (318) (259) (111) (56) (40)
------ ------- ------- ------ ------
Total charged-off loans (344) (321) (1,102) (373) (532)
------ ------- ------- ------ ------
Recoveries on loans previously charged off:
Single-family residential -- 35 4 1 11
Commercial leases (1) -- -- -- -- 134
Multi-family and commercial -- 32 -- -- --
Consumer and commercial business -- 7 11 9 9
------ ------- ------- ------ ------
Total recoveries -- 74 15 10 154
------ ------- ------- ------ ------
Net loans charged-off (344) (247) (1,087) (363) (378)
Provision for loan losses 1,780 300 715 540 540
------ ------- ------- ------ ------
Allowance for loan losses, end of period $3,475 $ 2,039 $ 1,986 $2,358 $2,181
====== ======= ======= ====== ======
Net loans charged-off to average loans outstanding(2) 0.11% 0.08% 0.37% 0.13% 0.16%
====== ======= ======= ====== ======
Allowance for loan losses to gross loans receivable(2) 1.14% 0.67% 0.68% 0.81% 0.87%
====== ======= ======= ====== ======
Allowance for loan losses to total non-performing loans 68.79% 100.30% 127.63% 45.89% 94.74%
====== ======= ======= ====== ======
Net loans charged-off to allowance for loan losses 9.90% 12.11% 54.73% 15.39% 17.33%
====== ======= ======= ====== ======
Recoveries to charge-offs 0.00% 23.05% 1.36% 2.68% 28.95%
====== ======= ======= ====== ======
(1) Relates to commercial leases purchased in prior years.
(2) Gross loans receivable and average loans outstanding include loans
receivable as well as loans held for sale, less construction and land loans
in process and deferred loan origination fees and discounts.
15
The following table presents the Bank's allocation of the allowance for
loan losses to the total amount of loans in each category listed at the dates
indicated.
SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
------------------- ------------------- ------------------- ------------------- -------------------
% OF LOANS % OF LOANS % OF LOANS % OF LOANS % OF LOANS
IN EACH IN EACH IN EACH IN EACH IN EACH
CATEGORY TO CATEGORY TO CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
Single-family residential $ 695 45.85% $ 700 50.87% $ 733 55.51% $ 815 57.32% $ 615 59.81%
Commercial and multi-family
residential 1,888 22.61 446 20.02 317 19.73 767 19.92 566 16.22
Construction and land 383 11.50 467 11.82 329 9.69 304 9.33 249 10.86
Home equity 62 14.60 57 13.54 34 11.19 40 9.10 59 9.65
Consumer 10 .42 11 .46 10 .48 10 .40 11 .42
Commercial business 370 5.02 70 3.29 132 3.40 86 3.93 87 3.04
Unallocated 67 -- 288 -- 431 -- 336 -- 594 --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance for loan
losses $3,475 100.00% $2,039 100.00% $1,986 100.00% $2,358 100.00% $2,181 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
16
MORTGAGE-RELATED AND INVESTMENT SECURITIES
Mortgage-Related Securities. Federally chartered savings institutions have
authority to invest in various types of liquid assets, including U.S. Treasury
obligations, securities of various federal agencies and of state and municipal
governments, certificates of deposit at federally insured banks and savings
associations, certain bankers' acceptances and federal funds. Subject to various
restrictions, federally chartered savings institutions also may invest a portion
of their assets in commercial paper, corporate debt securities and mutual funds,
the assets of which conform to the investments that federally chartered savings
institutions are otherwise authorized to make directly.
The Bank maintains a significant portfolio of mortgage-related securities
(including mortgage-backed securities and collateralized mortgage obligations
("CMOs") as a means of investing in housing-related mortgage instruments without
the costs associated with originating mortgage loans for portfolio retention and
with limited credit risk of default which arises in holding a portfolio of loans
to maturity. Mortgage-backed securities (which also are known as mortgage
participation certificates or pass-through certificates) represent a
participation interest in a pool of single-family or multi-family residential
mortgages. The principal and interest payments on mortgage-backed securities are
passed from the mortgage originators, as servicer, through intermediaries
(generally U.S. Government agencies and government-sponsored enterprises) that
pool and repackage the participation interests in the form of securities, to
investors such as the Bank. Such U.S. Government agencies and
government-sponsored enterprises, which guarantee the payment of principal and
interest to investors, primarily include FHLMC, FNMA and the Government National
Mortgage Association ("GNMA"). The Bank also invests in certain privately
issued, credit enhanced mortgage-related securities rated AAA by national
securities rating agencies.
FHLMC is a public corporation chartered by the U.S. Government. FHLMC
issues participation certificates backed principally by conventional mortgage
loans. FHLMC guarantees the timely payment of interest and the ultimate return
of principal on participation certificates. FNMA is a private corporation
chartered by the U.S. Congress with a mandate to establish a secondary market
for mortgage loans. FNMA guarantees the timely payment of principal and interest
on FNMA securities. FHLMC and FNMA securities are not backed by the full faith
and credit of the United States, but because FHLMC and FNMA are U.S.
Government-sponsored enterprises, these securities are considered to be among
the highest quality investments with minimal credit risks. GNMA is a government
agency within the Department of Housing and Urban Development which is intended
to help finance government-assisted housing programs. GNMA securities are backed
by Federal Housing Administration ("FHA") insured and the Department of Veterans
Affairs ("VA") guaranteed loans, and the timely payment of principal and
interest on GNMA securities are guaranteed by the GNMA and backed by the full
faith and credit of the U.S. Government. Because FHLMC, FNMA and GNMA were
established to provide support for low- and middle-income housing, there are
limits to the maximum size of loans that qualify for these programs which is
currently $359,650 (for single family dwellings).
Mortgage-related securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
underlying pool of mortgages can be composed of either fixed-rate or
adjustable-rate loans. As a result, the risk characteristics of the underlying
pool of mortgages (i.e., fixed-rate or adjustable rate) as well as prepayment
risk, are passed on to the certificate holder. Thus, the life of a
mortgage-backed pass-through security approximates the life of the underlying
mortgages.
The Bank's mortgage-related securities include regular interests in CMOs.
CMOs were developed in response to investor concerns regarding the uncertainty
of cash flows associated with the prepayment option of the underlying mortgagor
and are typically issued by governmental agencies, governmental sponsored
enterprises and special purpose entities, such as trusts, corporations or
partnerships, established by financial institutions or other similar
institutions. A CMO can be (but is not required to be) collateralized by loans
or securities which are insured or guaranteed by FNMA, FHLMC or the GNMA. In
contrast to pass-through mortgage-related securities, in which cash flow is
received pro rata by all security holders, the cash flow from the mortgages
underlying a CMO is segmented and paid in accordance with a predetermined
priority to investors holding various CMO classes. By allocating the principal
and interest cash flows from the underlying collateral among
17
the separate CMO classes, different classes of bonds are created, each with its
own stated maturity, estimated average life, coupon rate and prepayment
characteristics.
The short-term classes of a CMO usually carry a lower coupon rate than the
longer term classes and, therefore, the interest differential cash flow on a
residual interest is greatest in the early years of the CMO. As the early coupon
classes are extinguished, the residual income declines. Thus, the longer the
lower coupon classes remain outstanding, the greater the cash flow accruing to
CMO residuals. As interest rates decline, prepayments accelerate, the interest
differential narrows, and the cash flow from the CMO declines. Conversely, as
interest rates increase, prepayments decrease, generating a larger cash flow to
residuals.
A senior-subordinated structure often is used with CMOs to provide credit
enhancement for securities which are backed by collateral which is not
guaranteed by FNMA, FHLMC or the GNMA. These structures divide mortgage pools
into various risk classes: a senior class and one or more subordinated classes.
The subordinated classes provide protection to the senior class. When cash flow
is impaired, debt service goes first to the holders of senior classes. In
addition, incoming cash flows also may go into a reserve fund to meet any future
shortfalls of cash flow to holders of senior classes. The holders of
subordinated classes may not receive any funds until the holders of senior
classes have been paid and, when appropriate, until a specified level of funds
has been contributed to the reserve fund.
Mortgage-related securities generally bear yields which are less than those
of the loans which underlie such securities because of their payment guarantees
or credit enhancements which reduce credit risk to nominal levels. However,
mortgage-related securities are more liquid than individual mortgage loans and
may be used to collateralize certain obligations of the Bank. At September 30,
2005, $15.6 million of the Bank's mortgage-related securities were pledged to
secure various obligations of the Bank, treasury tax and loan processing and as
collateral for certain municipal deposits.
The Bank's mortgage-related securities are classified as either "held to
maturity" or "available for sale" based upon the Bank's intent and ability to
hold such securities to maturity at the time of purchase, in accordance with
GAAP. As of September 30, 2005, the Bank had an aggregate of $114.2 million, or
22.0%, of total assets invested in mortgage-related securities, net, of which
$46.7 million was held to maturity and $67.5 million was available for sale. The
Company's investment strategy is to maintain the portfolio to complement the
asset-liability structure of the Company. To reduce the volatility of the
Company's equity, due to adjustments required to be made to equity reflecting
the changes in gains or losses on securities available for sale, the Company's
strategy during the first six months of fiscal 2005 was to increase the held to
maturity portfolio. The mortgage-related securities of the Bank which are held
to maturity are carried at cost, adjusted for the amortization of premiums and
the accretion of discounts using a level yield method, while mortgage-related
securities available for sale are carried at the current fair value. See Notes 2
and 4 of the Notes to Consolidated Financial Statements set forth in Item 8
hereof.
18
The following table sets forth the composition of the Bank's available for
sale (at fair value) and held to maturity (at amortized cost) mortgage-related
securities portfolios at the dates indicated.
SEPTEMBER 30,
-------------------------------
2005 2004 2003
------- -------- --------
(Dollars in thousands)
Available for sale:
Mortgage-backed securities:
FHLMC $ 53 $ 5,811 $ 6,950
FNMA 23,180 42,861 46,030
GNMA 3,920 1,270 13,639
------- ------- --------
Total mortgage-backed securities 27,153 49,942 66,619
------- ------- --------
Collateralized mortgage obligations:
FHLMC 3,514 15,649 20,239
FNMA 3,951 6,543 5,381
GNMA -- -- --
Other 32,909(1) 25,486(2) 32,417(3)
------- ------- --------
Total collateralized mortgage obligations 40,374 47,678 58,037
------- ------- --------
Total mortgage-related securities $67,527 $97,620 $124,656
======= ======= ========
Held to maturity:
Mortgage-backed securities:
FHLMC $17,267 $16,226 $ 478
FNMA 29,084 20,613 2,123
------- ------- --------
Total mortgage-backed securities 46,351 36,839 2,601
------- ------- --------
Collateralized mortgage obligations:
FNMA 303 524 886
------- ------- --------
Total collateralized mortgage obligations 303 524 886
------- ------- --------
Total mortgage-related securities, amortized cost $46,654 $37,363 $ 3,487
======= ======= ========
Total fair value(4) $45,679 $37,312 $ 3,560
======= ======= ========
- ----------
(1) Includes "AAA" rated securities of AMAC, Credit Suisse First Boston,
Countrywide Home Loans, First Horizon, GSR, MastrAsset, Washington Mutual
and Wells Fargo with book values of $4.3 million, $1.7 million, $2.9
million, $4.4 million, $1.3 million, $3.1 million, $5.4 million, and $8.2
million, respectively, and fair values of $4.3 million, $1.6 million, $3.0
million, $4.3 million, $1.3 million, $3.1 million, $5.5 million, and $8.4
million, respectively.
(2) Includes "AAA" rated securities of Countrywide Home Loans, Washington
Mutual, AMAC, First Horizon and Mastr Asset with book values of $5.2
million, $4.7 million, $2.0 million, $ 4.9 million and $4.0 million,
respectively, and fair values of $5.2 million, $4.7 million, $1.9 million,
$4.9 million and $4.1 million, respectively.
(3) Includes "AAA" rated securities of Countrywide Home Loans, Washington
Mutual, AMAC and First Horizon with book values of $6.5 million, $6.8
million, $4.7 million and $ 3.6 million, respectively, and fair values of
$6.4 million, $6.7 million, $4.8 million and $3.5 million, respectively.
(4) See Note 4 of the Notes to Consolidated Financial Statements set forth in
Item 8 hereof.
19
The following table sets forth the purchases, sales and principal
repayments of the Bank's mortgage-related securities for the periods indicated.
YEAR ENDED SEPTEMBER 30,
------------------------------
2005 2004 2003
-------- -------- --------
(Dollars in thousands)
Mortgage-related securities, beginning of period(1)(2) $134,983 $128,143 $ 94,529
-------- -------- --------
Purchases:
Mortgage-backed securities - available for sale 23,532 11,106 50,199
Mortgage-backed securities - held to maturity 18,591 37,856 --
CMOs - available for sale 18,402 11,222 81,942
Sales:
Mortgage-backed securities - available for sale (31,758) (7,073) (4,493)
CMOs - available for sale (10,806) -- (3,064)
Repayments and prepayments:
Mortgage-backed securities (22,802) (23,006) (32,563)
CMOs (14,314) (21,262) (55,941)
Decrease in net premium (643) (787) (1,128)
Change in net unrealized loss on mortgage-related
securities available for sale (1,004) (1,216) (1,338)
-------- -------- --------
Net increase (decrease) in mortgage-related securities (20,802) 6,840 33,614
-------- -------- --------
Mortgage-related securities, end of period(1)(2) $114,181 $134,983 $128,143
======== ======== ========
- ----------
(1) Includes both mortgage-related securities available for sale and held to
maturity.
(2) Calculated at amortized cost for securities held to maturity and at fair
value for securities available for sale.
At September 30, 2005, the estimated weighted average maturity of the
Bank's fixed-rate mortgage-related securities was approximately 3.4 years. The
actual maturity of a mortgage-backed security is less than its stated maturity
due to prepayments of the underlying mortgages. Prepayments that are faster than
anticipated may shorten the life of the security and adversely affect its yield
to maturity. The yield is based upon the interest income and the amortization of
any premium or discount related to the mortgage-backed security. In accordance
with GAAP, premiums and discounts are amortized over the estimated lives of the
securities, which decrease and increase interest income, respectively. The
prepayment assumptions used to determine the amortization period for premiums
and discounts can significantly affect the yield of the mortgage-backed
security, and these assumptions are reviewed periodically to reflect actual
prepayments. Although prepayments of underlying mortgages depend on many
factors, including the type of mortgages, the coupon rate, the age of mortgages,
the geographical location of the underlying real estate collateralizing the
mortgages and general levels of market interest rates, the difference between
the interest rates on the underlying mortgages and the prevailing mortgage
interest rates generally is the most significant determinant of the rate of
prepayments. During periods of declining mortgage interest rates, such as the
Bank experienced during fiscal 2004 and 2003, if the coupon rates of the
underlying mortgages exceed the prevailing market interest rates offered for
mortgage loans, refinancings generally increase and accelerate the prepayment
rate of the underlying mortgages and the related securities. Conversely, during
periods of increasing mortgage interest rates, if the coupon rates of the
underlying mortgages are less than the prevailing market interest rates offered
for mortgage loans, refinancings generally decrease and decrease the prepayment
rate of the underlying mortgages and the related securities. As a result of the
declining interest rate environment, the Bank experienced high levels of
repayments and accelerated prepayments, and consequently, the Bank reinvested
the proceeds of such repayments and prepayments at lower yields. During fiscal
2005, the Company experienced lower prepayment speeds and refinancing activity
as interest rates offered for mortgage loans in the marketplace increased toward
the latter part of the year.
20
Investment Securities. The following table sets forth information
regarding the carrying and fair value of the Company's investment securities,
both held to maturity and available for sale, at the dates indicated.
AT SEPTEMBER 30,
------------------------------------------------------------
2005 2004 2003
------------------ ------------------ ------------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE VALUE VALUE
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
FHLB stock $ 9,499 $ 9,499 $ 9,827 $ 9,827 $ 8,294 $ 8,294
U.S. Government and agency obligations
1 to 5 years -- -- 14,694 14,495 13,020 13,004
5 to 10 years 1,997 1,979 -- -- 4,880 4,988
Municipal obligations 16,022 16,530 15,223 15,691 17,373 17,895
Corporate bonds 11,998 12,032 15,336 16,134 20,621 21,693
Mutual funds 8,846 8,593 14,009 13,804 14,009 13,952
Asset-backed securities 590 593 1,189 1,197 1,911 1,922
Preferred stocks -- -- 3,900 3,900 5,474 4,984
Other equity investments 978 1,582 1,755 3,764 3,126 5,712
------- ------- ------- ------- ------- -------
Total $49,930 $50,808 $75,933 $78,812 $88,708 $92,444
======= ======= ======= ======= ======= =======
At September 30, 2005, the Company had an aggregate of $50.8 million, or
9.8 %, of its total assets invested in investment securities, of which $9.5
million consisted of FHLB stock, $37.0 million was investment securities
available for sale and $4.3 million investment securities held to maturity.
Included in U.S. Government and agency obligations is a callable bond with a
remaining term of approximately six years. The Bank's investment securities
(excluding mutual funds, equity securities and FHLB stock) had a weighted
average maturity to the call date of 4.53 years and a weighted average yield of
6.26% (adjusted to a fully taxable equivalent yield).
SOURCES OF FUNDS
General. The Bank's principal source of funds for use in lending and for
other general business purposes has traditionally come from deposits obtained
through the Bank's branch offices. The Bank also derives funds from contractual
payments and prepayments of outstanding loans and mortgage-related securities,
from sales of loans, from maturing investment securities and from advances from
the FHLB of Pittsburgh and other borrowings. Loan repayments are a relatively
stable source of funds, while deposits inflows and outflows are significantly
influenced by general interest rates and money market conditions. The Bank uses
borrowings to supplement its deposits as a source of funds.
Deposits. The Bank's current deposit products include passbook accounts,
NOW accounts, MMDAs, certificates of deposit ranging in terms from 30 days to
five years and non-interest-bearing personal and business checking accounts. The
Bank's deposit products also include Individual Retirement Account ("IRA")
certificates and Keogh accounts.
The Bank's deposits are obtained primarily from residents in Delaware and
Chester Counties in southeastern Pennsylvania. The Bank attracts local deposit
accounts by offering a wide variety of accounts, competitive interest rates, and
convenient branch office locations and service hours. The Bank utilizes
traditional marketing methods to attract new customers and savings deposits,
including print media, radio advertising and direct mailings. However, the Bank
does not solicit funds through deposit brokers nor does it pay any brokerage
fees if it accepts such deposits.
21
The Bank has been competitive in the types of accounts and interest rates
it has offered on its deposit products but does not necessarily seek to match
the highest rates paid by competing institutions. During fiscal 2005, the Bank
slightly increased deposits, primarily in certificate of deposits, due to
competitively pricing its jumbo certificates of deposit causing a decline in its
core deposits driven by the increases in short-term interest rates. Core
deposits amounted to $176.6 million or 50.5% of the Bank's total deposits at
September 30, 2005. However, in fiscal 2004, as a result of not offering the
highest rate for certificates of deposit, the Bank experienced a decline in
overall deposits. As a result of the significant decline in interest rates paid
on deposit products in fiscal 2004 and 2003, due to generally declining returns
on competing investment opportunities as well as the effects of the decline of
the equities markets, the Bank did not experience disintermediation of deposits
into competing investment products in fiscal 2004 and 2003.
The following table shows the distribution of, and certain information
relating to, the Bank's deposits by type of deposit as of the dates indicated.
SEPTEMBER 30,
------------------------------------------------------------
2005 2004 2003
------------------ ------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
Passbook $ 47,139 13.48% $ 51,371 14.90% $ 47,089 12.99%
MMDA 45,753 13.08 51,682 14.98 55,889 15.41
NOW 65,688 18.79 55,864 16.20 60,221 16.61
Certificates of deposit 173,113 49.50 164,917 47.82 178,489 49.22
Non-interest-bearing 18,001 5.15 21,046 6.10 20,917 5.77
-------- ------ -------- ------ -------- ------
Total deposits $349,694 100.00% $344,880 100.00% $362,605 100.00%
======== ====== ======== ====== ======== ======
The following table sets forth the net savings flows of the Bank during the
periods indicated.
YEAR ENDED SEPTEMBER 30,
----------------------------
2005 2004 2003
------ --------- -------
(Dollars in thousands)
(Decrease) increase before interest credited $ (650) $(22,744) $25,633
Interest credited 5,464 5,019 6,207
------ -------- -------
Net savings increase (decrease) $4,814 $(17,725) $31,840
====== ======== =======
The following table sets forth maturities of the Bank's certificates of
deposit of $100,000 or more at September 30, 2005 and 2004 by time remaining to
maturity (amounts in thousands).
SEPTEMBER 30,
-----------------
2005 2004
------- -------
Three months or less $13,484 $19,770
Over three months through six months 7,916 5,144
Over six months through twelve months 9,748 1,370
Over twelve months 18,927 5,830
------- -------
$50,075 $32,114
======= =======
22
The following table presents, by various interest rate categories, the
amount of certificates of deposit at September 30, 2005 and 2004 and the amounts
at September 30, 2005 which mature during the periods indicated.
AMOUNTS AT SEPTEMBER 30, 2005
SEPTEMBER 30, MATURING WITHIN
------------------- -----------------------------------------------
Certificates of Deposit 2005 2004 ONE YEAR TWO YEARS THREE YEARS THEREAFTER
- ----------------------- -------- -------- -------- --------- ----------- ----------
(Dollars in thousands)
2.0% or less $ 18,651 $ 67,053 $18,584 $ 67 $ -- $ --
2.01% to 3.0% 44,489 33,906 37,087 6,354 1,048 --
3.01% to 4.0% 91,595 41,147 32,619 32,769 11,829 14,378
4.01% to 5.0% 15,262 17,139 3,253 11,269 707 33
5.01% to 6.0% 3,116 5,491 3,110 6 -- --
6.01% to 7.0% -- 181 -- -- -- --
-------- -------- ------- ------- ------- -------
Total certificate accounts $173,113 $164,917 $94,653 $50,465 $13,584 $14,411
======== ======== ======= ======= ======= =======
The following table presents the average balance of each deposit type and
the average rate paid on each deposit type for the periods indicated.
SEPTEMBER 30,
------------------------------------------------------------
2005 2004 2003
------------------ ------------------ ------------------
AVERAGE AVERAGE AVERAGE
AVERAGE RATE AVERAGE RATE AVERAGE RATE
BALANCE PAID BALANCE PAID BALANCE PAID
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
Passbook accounts $ 50,574 .94% $ 50,206 .94% $ 44,105 1.20%
MMDA accounts 51,284 1.49 53,054 1.14 51,756 1.42
Certificates of deposit 166,179 2.81 169,834 2.68 178,097 3.24
NOW accounts 61,051 .65 55,115 .52 55,496 .57
Non-interest-bearing deposits 19,988 -- 19,598 -- 14,272 --
-------- ---- -------- ---- -------- ----
Total deposits $349,076 1.81% $347,807 1.70% $343,726 2.14%
======== ==== ======== ==== ======== ====
23
Borrowings. The Bank may obtain advances from the FHLB of Pittsburgh upon
the security of the common stock it owns in the FHLB and certain of its
residential mortgage loans and securities held to maturity, provided certain
standards related to creditworthiness have been met. Such advances are made
pursuant to several credit programs, each of which has its own interest rate and
range of maturities. At September 30, 2005, the Bank had $169.9 million in
outstanding FHLB advances and overnight borrowings. The FHLB advances have
certain call features whereby the FHLB of Pittsburgh can call the borrowings
after the expiration of certain time frames. The time frames on the callable
borrowings are within 12 months. Note 9 of the Notes to Consolidated Financial
Statements set forth in Item 8 hereof.
The following table sets forth certain information regarding our outside
borrowings for the periods indicated.
SEPTEMBER 30,
-------------------
2005 2004
-------- --------
(Dollars in
thousands)
FHLB advances
Average balance outstanding for the period $160,265 $152,656
Maximum outstanding at any month end 167,886 169,890
Balance outstanding at end of the period 113,170 169,887
Average interest rate for the period 4.79% 4.66%
Interest rate at the end of the period 5.19% 4.39%
In addition, the Company participated in junior subordinated debentures
aggregating $21.5 million at September 30, 2005 held by statuary trusts that
issued trust preferred securities. See Note 17 of the Notes to Consolidated
Financial Statements set forth in Item 8 hereof.
SUBSIDIARIES
The Bank is permitted to invest up to 2% of its assets in the capital stock
of, or secured or unsecured loans to, service corporations, with an additional
investment of 1% of assets when such additional investment is utilized primarily
for community development purposes. It may invest essentially unlimited amounts
in subsidiaries deemed operating subsidiaries that can only engage in activities
that the Bank is permitted to engage in. Under such limitations, as of September
30, 2005, the Bank was authorized to invest up to approximately $10.3 million in
the stock of, or loans to, service corporations. As of September 30, 2005, the
net book value of the Bank's investment in stock, unsecured loans, and
conforming loans to its service corporations was $40,000.
At September 30, 2005, in addition to the Bank, the Company has two
indirect subsidiaries: FKF Management Corp., Inc. and State Street Services
Corp.
FKF Management Corp., Inc., a Delaware corporation, is a wholly owned
operating subsidiary of the Bank established in 1997 for the purpose of managing
certain assets of the Bank. Assets under management totaled $155.5 million at
September 30, 2005 and were comprised principally of investment and
mortgage-related securities.
State Street Services Corp. is a wholly owned subsidiary of the Bank
established in 1999 for the purpose of offering a full array of insurance
products through its ownership of a 51% interest in First Keystone Insurance
Services, LLC ("First Keystone Insurance"), and therefore, First Keystone
Insurance is consolidated into the Company's financial statements. In addition,
State Street Services Corp. holds a 10% equity position in a title company which
offers title services.
EMPLOYEES
The Bank had 94 full-time employees and 18 part-time employees as of
September 30, 2005. None of these employees is represented by a collective
bargaining agreement. The Bank believes that it enjoys excellent relations with
its personnel.
24
REGULATION
General. Set forth below is a brief description of certain laws and
regulations, which are applicable to the Company and the Bank. The description
of these laws and regulations, as well as descriptions of laws and regulations
contained elsewhere herein, do not purport to be complete and is qualified in
its entirety by reference to the applicable laws and regulations.
The Company. The Company as a savings and loan holding company within the
meaning of the Home Owners' Loan Act, as amended ("HOLA"), is registered as such
with the OTS and is subject to OTS regulations, examination, supervision and
reporting requirements. As a subsidiary of a savings and loan holding company,
the Bank is subject to certain restrictions in its dealings with the Company and
affiliates thereof.
Federal Activities Restrictions. The Company operates as a unitary savings
and loan holding company. Generally, there are only limited restrictions on the
activities of a unitary savings and loan holding company which applied to become
or was a unitary saving and loan holding company prior to May 4, 1999 and its
non-savings institution subsidiaries. Under the Gramm-Leach-Bliley Act of 1999
(the "GLBA"), companies which apply to the OTS to become unitary savings and
loan holding companies are restricted to only engaging in those activities
traditionally permitted to multiple saving and loan holding companies. However,
if the Director of the OTS determines that there is reasonable cause to believe
that the continuation by a savings and loan holding company of an activity
constitutes a serious risk to the financial safety, soundness or stability of
its subsidiary savings association, the Director may impose such restrictions as
deemed necessary to address such risk, including limiting (i) payment of
dividends by the savings association; (ii) transactions between the savings
association and its affiliates; and (iii) any activities of the savings
association that might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings association.
Notwithstanding the above rules regarding permissible business activities of
grandfathered unitary savings and loan holding companies under the GLBA (such as
the Company), if the savings association subsidiary of such a holding company
fails to meet the Qualified Thrift Lender ("QTL") test, then such unitary
holding company also shall become subject to the activities restrictions
applicable to multiple savings and loan holding companies and, unless the
savings association qualifies as a QTL within one year thereafter, shall
register as, and become subject to the restrictions applicable to, a bank
holding company.
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company and
would thereafter be subject to further restrictions on its activities.
The GLBA also imposes financial privacy obligations and reporting
requirements on all financial institutions. The privacy regulations require,
among other things, that financial institutions establish privacy policies and
disclose such policies to its customers at the commencement of a customer
relationship and annually thereafter. In addition, financial institutions are
required to permit customers to opt out of the financial institution's
disclosure of the customer's financial information to non-affiliated third
parties.
The HOLA requires every savings institution subsidiary of a savings and
loan holding company to give the OTS at least 30 days' advance notice of any
proposed dividends to be made on its guarantee, permanent or other
nonwithdrawable stock, or else such capital distribution will be invalid. See "-
The Bank - Capital Distributions."
Limitations on Transactions with Affiliates. Transactions between savings
associations and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act ("FRA") and OTS regulations issued in connection therewith.
Affiliates of a savings institution include, among other entities, the savings
institution's holding company and companies that are controlled by or under
common control with the savings institution. Generally, Sections 23A and 23B (i)
limit the extent to which the savings association or its subsidiaries may engage
in "covered transactions" with any one affiliate to an amount equal to10% of
such association's capital stock and surplus, and contain an aggregate limit on
all such transactions with all affiliates to an amount equal to 20% of such
capital stock and surplus and (ii) require that all such transactions be on
terms substantially the same, or at least as favorable, to the association or
subsidiary as those provided to a non-affiliate. The term "covered transaction"
includes, among other things, the making of loans or extension of credit to an
affiliate, purchase of assets, issuance of a guarantee and similar transactions.
In addition to the restrictions imposed by Sections 23A and 23B, under OTS
regulations no savings association may (i) loan or otherwise extend credit to an
affiliate, except for any affiliate which engages only in activities which are
permissible for bank holding companies, (ii) a savings association may not
purchase or invest in securities of an affiliate other than shares of a
subsidiary; (iii) a savings association and its subsidiaries may not purchase a
low-quality asset from an affiliate; (iv) and
25
covered transactions and certain other transactions between a savings
association or its subsidiaries and an affiliate must be on terms and conditions
that are consistent with safe and sound banking practices. With certain
exceptions, each extension of credit by a savings association to an affiliate
must be secured by collateral with a market value ranging from 100% to 130%
(depending on the type of collateral) of the amount of the loan or extension of
credit.
OTS regulations generally exclude all non-bank and non-savings association
subsidiaries of savings associations from treatment as affiliates, except to the
extent that the OTS or the Federal Reserve Board ("FRB") decides to treat such
subsidiaries as affiliates. The regulations also require savings associations to
make and retain records that reflect affiliate transactions in reasonable
detail, and provide that certain classes of savings associations may be required
to give the OTS prior notice of affiliate transactions.
Restrictions on Acquisitions. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior approval
of the Director of the OTS, (i) control of any other savings association or
savings and loan holding company or substantially all of the assets thereof;
(ii) more than 5% of the voting shares of a savings association or holding
company thereof which is not a subsidiary; (iii) acquiring through a merger,
consolidation or purchase of assets of another savings institution (or holding
company thereof) or acquiring all or substantially all of the assets of another
savings institution (or holding company thereof) without prior OTS approval; or
(iv) acquiring control of an uninsured institution except with the prior
approval of the Director of the OTS, no director or officer of a savings and
loan holding company or person owning or controlling by proxy or otherwise more
than 25% of such company's stock, may acquire control of any savings
association, other than a subsidiary savings association, or of any other
savings and loan holding company.
Federal Securities Laws. The Company's Common Stock is registered with the
SEC under the Securities Exchange Act of 1934, as amended ("Exchange Act"). The
Company is subject to the information, proxy solicitation, insider trading
restrictions and other requirements of the Exchange Act.
Sarbanes-Oxley Act of 2002. On July 30, 2002, the President signed into law
the Sarbanes-Oxley Act of 2002 (the "Act") implementing legislative reforms
intended to address corporate and accounting fraud. In addition to the
establishment of a new accounting oversight board which will enforce auditing,
quality control and independence standards and will be funded by fees from all
publicly traded companies, the bill restricts provision of both auditing and
consulting services by accounting firms. To ensure auditor independence, any
non-audit services being provided to an audit client will require preapproval by
the company's audit committee members. In addition, the audit partners must be
rotated. The Act requires chief executive officers and chief financial officers,
or their equivalent, to certify to the accuracy of periodic reports filed with
the SEC, subject to civil and criminal penalties if they knowingly or willfully
violate this certification requirement. In addition, under the Act, counsel are
required to report evidence of a material violation of the securities laws or a
breach of fiduciary duty by a company to its chief executive officer or its
chief legal officer, and, if such officer does not appropriately respond, to
report such evidence to the audit committee or other similar committee of the
board of directors or the board itself.
Longer prison terms and increased penalties will also be applied to
corporate executives who violate federal securities laws, the period during
which certain types of suits can be brought against a company or its officers
has been extended, and bonuses issued to top executives prior to restatement of
a company's financial statements are now subject to disgorgement if such
restatement was due to corporate misconduct. Executives are also prohibited from
insider trading during retirement plan "blackout" periods, and loans to company
executives are restricted. In addition, a provision directs that civil penalties
levied by the SEC as a result of any judicial or administrative action under the
Act be deposited to a fund for the benefit of harmed investors. The Federal
Accounts for Investor Restitution ("FAIR") provision also requires the SEC to
develop methods of improving collection rates. The legislation accelerates the
time frame for disclosures by public companies, as they must immediately
disclose any material changes in their financial condition or operations.
Directors and executive officers must also provide information for most changes
in ownership in a company's securities within two business days of the change.
26
The Act also increases the oversight of, and codifies certain requirements
relating to audit committees of public companies and how they interact with the
company's "registered public accounting firm" ("RPAF"). Audit committee members
must be independent and are barred from accepting consulting, advisory or other
compensatory fees from the issuer. In addition, companies must disclose whether
at least one member of the committee is a "financial expert" (as such term is
defined by the SEC in regulations promulgated thereby) and if not, why not.
Under the Act, a RPAF is prohibited from performing statutorily mandated audit
services for a company if such company's chief executive officer, chief
financial officer, comptroller, chief accounting officer or any person serving
in equivalent positions has been employed by such firm and participated in the
audit of such company during the one-year period preceding the audit initiation
date. The Act also prohibits any officer or director of a company or any other
person acting under their direction from taking any action to fraudulently
influence, coerce, manipulate or mislead any independent public or certified
accountant engaged in the audit of the company's financial statements for the
purpose of rendering the financial statement's materially misleading. The Act
also requires the SEC to prescribe rules requiring inclusion of an internal
control report and assessment by management in the annual report to stockholders
which will become effective for the fiscal year ended September 30, 2007. The
Act requires the RPAF that issues the audit report to attest to and report on
management's assessment of the company's internal controls. In addition, the Act
requires that each financial report required to be prepared in accordance with
(or reconciled to) accounting principles generally accepted in the United States
of America and filed with the SEC reflect all material correcting adjustments
that are identified by a RPAF in accordance with accounting principles generally
accepted in the United States of America and the rules and regulations of the
SEC.
The Bank. The OTS has extensive regulatory authority over the operations of
savings associations such as the Bank. As part of this authority, savings
associations are required to file periodic reports with the OTS and are subject
to periodic examinations by the OTS. The investment and lending authority of
savings associations are prescribed by federal laws and regulations and they are
prohibited from engaging in any activities not permitted by such laws and
regulations. Those laws and regulations generally are applicable to all
federally chartered savings associations and may also apply to state-chartered
savings associations. Such regulation and supervision is primarily intended for
the protection of depositors.
Insurance of Accounts. The deposits of the Bank are insured to the maximum
extent permitted by the Savings Association Insurance Fun ("SAIF"), which is
administered by the Federal Deposit Insurance Corporation ("FDIC"), and are
backed by the full faith and credit of the U. S. Government. As insurer, the
FDIC is authorized to conduct examinations of, and to require reporting by,
FDIC-insured institutions. It also may prohibit any FDIC-insured institution
from engaging in any activity the FDIC determines by regulation or order to pose
a serious threat to the FDIC. The FDIC also has the authority to initiate
enforcement actions against savings associations, after giving the OTS an
opportunity to take such action.
Under current FDIC regulations, SAIF insured institutions are assigned to
one of three capital groups which are based solely on the level of an
institution's capital - "well capitalized," "adequately capitalized" and
"undercapitalized" - which are defined in the same manner as the regulations
establishing the prompt corrective action system discussed below. These three
groups are then divided into three subgroups which reflect varying levels of
supervisory concern, from those which are considered to be healthy to those
which are considered to be of substantial supervisory concern. The matrix so
created results in nine assessment risk classifications, with rates during the
first six months of 2005 ranging from zero for well capitalized, healthy
institutions, such as the Bank, to 27 basis points for undercapitalized
institutions with substantial supervisory concerns.
In addition, all institutions with deposits insured by the FDIC are
required to pay assessments to fund interest payments on bonds issued by the
Financing Corporation, a mixed-ownership government corporation established to
recapitalize the predecessor to the SAIF. The assessment rate for the third
quarter of 2005 was .0148% of insured deposits and is adjusted quarterly. These
assessments will continue until the Financing Corporation bonds mature in 2019.
27
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is not aware of any existing circumstances which could
result in termination of the Bank's deposit insurance.
Capital requirements. The OTS capital requirements consist of a "tangible
capital requirement," a "leverage capital requirement" and a "risk-based capital
requirement." The Office of Thrift Supervision is authorized to impose capital
requirements in excess of those standards on individual institutions on a
case-by-case basis. Under these requirements, savings associations must maintain
"tangible" capital equal to 1.5% of adjusted total assets, "core" capital equal
to 4% (3% if the association receives the OTS's highest rating) of adjusted
total assets and "total" capital (a combination of core and "supplementary"
capital) equal to 8.0% of "risk-weighted" assets. For purposes of the
regulation, core capital generally consists of common stockholders' equity
(including retained earnings), noncumulative perpetual preferred stock and
related surplus, minority interests in the equity accounts of fully consolidated
subsidiaries, certain nonwithdrawable accounts and pledged deposits and
"qualifying supervisory goodwill." Tangible capital is given the same definition
as core capital but does not include qualifying supervisory goodwill and is
reduced by the amount of all the savings association's intangible assets, with
only a limited exception for purchased mortgage servicing rights ("PMSRs"). Both
core and tangible capital are further reduced by an amount equal to a savings
association's debt and equity investments in subsidiaries engaged in activities
not permissible for national banks (other than subsidiaries engaged in
activities undertaken as agent for customers or in mortgage banking activities
and subsidiary depository institutions or their holding companies). In addition,
under the Prompt Corrective Action provisions of the OTS regulations, all but
the most highly rated institutions must maintain a minimum leverage ratio of 4%
in order to be adequately capitalized. See "- Prompt Corrective Action." At
September 30, 2005, the Bank did not have any investment in subsidiaries engaged
in impermissible activities and required to be deducted from its capital
calculation.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") granted the OTS the authority to prescribe rules for the amount of
PMSRs that may be included in a savings association's regulatory capital and
required that the value of readily marketable PMSRs included in the calculation
of a savings association's regulatory capital not exceed 90% of fair market
value and that such value be determined at least quarterly. Under OTS
regulations, (i) PMSRs do not have to be deducted from tangible and core
regulatory capital, provided that they do not exceed 50% of core capital, (ii)
savings associations are required to determine the fair market value and to
review the book value of their PMSRs at least quarterly and to obtain an
independent valuation of PMSRs annually, (iii) savings associations that desire
to include PMSRs in regulatory capital may not carry them at a book value under
GAAP that exceeds the discounted value of their future net income stream and
(iv) for purposes of calculating regulatory capital, the amount of PMSRs
reported as balance sheet assets should amount to the lesser of 90% of their
fair market value, 90% of their original purchase price or 100% of their
remaining unamortized book value. At September 30, 2005, the Bank did not have
any PMSRs.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital does not exceed the savings association's core capital. Supplementary
capital generally consists of hybrid capital instruments; perpetual preferred
stock which is not eligible to be included as core capital; subordinated debt
and intermediate-term preferred stock; and, subject to limitations, general
allowances for loan losses. Assets are adjusted under the risk-based guidelines
to take into account different risk characteristics, with the categories ranging
from 0% (requiring no additional capital) for assets such as cash to 100% for
repossessed assets or loans more than 90 days past due. Single-family
residential real estate loans which are not past-due or non-performing and which
have been made in accordance with prudent underwriting standards are assigned a
50% level in the risk-weighing system, as are certain privately-issued
mortgage-backed securities representing indirect ownership of such loans.
Off-balance sheet items also are adjusted to take into account certain risk
characteristics.
28
Certain exclusions from capital and assets are required for the purpose of
calculating total capital, in addition to the adjustments required for
calculating core capital. Such exclusions consist of equity investments (as
defined by regulation) and that portion of land loans and non-residential
construction loans in excess of an 80% loan-to-value ratio and reciprocal
holdings of qualifying capital instruments. However, in calculating regulatory
capital, institutions must exclude unrealized losses and gains on securities
available for sale, net of taxes, reported as a separate component of capital
calculated according to generally accepted accounting principles.
At September 30, 2005, the Bank exceeded all of its regulatory capital
requirements, with tangible, core and risk-based capital ratios of 8.9%, 8.9%
and 15.1%, respectively. See Note 11 to the Notes to Consolidated Financial
Statements included set forth in Item 8 hereof.
The OTS and the FDIC generally are authorized to take enforcement action
against a savings association that fails to meet its capital requirements, which
action may include restrictions on operations and banking activities, the
imposition of a capital directive, a cease-and-desist order, civil money
penalties or harsher measures such as the appointment of a receiver or
conservator or a forced merger into another institution. In addition, under
current regulatory policy, an association that fails to meet its capital
requirements is prohibited from making any capital distributions.
29
The following is a reconciliation of the Bank's equity determined in
accordance with GAAP to regulatory tangible, core and risk-based capital at
September 30, 2005, 2004 and 2003.
SEPTEMBER 30, 2005 SEPTEMBER 30, 2004 SEPTEMBER 30, 2003
----------------------------- ----------------------------- -----------------------------
TANGIBLE CORE RISK-BASED TANGIBLE CORE RISK-BASED TANGIBLE CORE RISK-BASED
CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL
-------- ------- ---------- -------- ------- ---------- -------- ------- ----------
(Dollars in thousands)
GAAP equity $45,606 $45,606 $45,606 $46,535 $46,535 $46,535 $43,852 $43,852 $43,852
General valuation allowances -- -- 3,202 -- -- 1,765 -- -- 1,712
------- ------- ------- ------- ------- ------- ------- ------- -------
Total regulatory capital 46,606 45,606 48,808 46,535 46,535 48,300 43,852 43,852 45,564
Minimum capital requirement 7,732 20,619 25,800 8,500 22,667 26,540 8,240 21,972 24,357
------- ------- ------- ------- ------- ------- ------- ------- -------
Excess $37,874 $24,987 $23,008 $38,035 $23,868 $21,760 $35,612 $21,880 $21,207
======= ======= ======= ======= ======= ======= ======= ======= =======
These capital requirements are viewed as minimum standards by the OTS, and
most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings association's capital, upon a determination that
circumstances exist that higher individual minimum capital requirements may be
appropriate.
30
Prompt Corrective Action. Under the prompt corrective action regulations of
the OTS, an institution shall be deemed to be (i) "well capitalized" if it has
total risk-based capital of 10% or more, has a Tier I risk-based capital ratio
of 6% or more, has a Tier I leverage capital ratio of 5% or more and is not
subject to any order or final capital directive to meet and maintain a specific
capital level for any capital measure, (ii) "adequately capitalized" if it has a
total risk-based capital ratio of 8% or more, a Tier I risk-based capital ratio
of 4% or more and a Tier I leverage capital ratio of 4% or more (3% under
certain circumstances) and does not meet the definition of "well capitalized,"
(iii) "undercapitalized" if it has a total risk-based capital ratio that is less
than 8%, a Tier I risk-based capital ratio that is less than 4% or a Tier I
leverage capital ratio that is less than 4% (3% under certain circumstances),
(iv) "significantly undercapitalized" if it has a total risk-based capital ratio
that is less than 6%, a Tier I risk-based capital ratio that is less than 3% or
a Tier I leverage capital ratio that is less than 3%, and (v) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2%. Under specified circumstances, the OTS may reclassify
a well capitalized institution as adequately capitalized and may require an
adequately capitalized institution or an undercapitalized institution to comply
with supervisory actions as if it were in the next lower category (except that
the FDIC may not reclassify a significantly undercapitalized institution as
critically undercapitalized). At September 30, 2005, the Bank met the capital
requirements of a "well capitalized" institution under OTS regulations.
Qualified Thrift Lender Test (the "QTL"). A savings association can comply
with the QTL test by either meeting the QTL test set forth in the HOLA and the
implementing regulations or qualifying as a domestic building and loan
association as defined in Section 7701(a)(19) of the Internal Revenue Code of
1986, as amended ("Code"). Currently, the portion of the QTL test that is based
on the HOLA rather than the Code requires that 65% of an institution's
"portfolio assets" (as defined) consist of certain housing and consumer-related
assets on a monthly average basis in nine out of every 12 months. Assets that
qualify without limit for inclusion as part of the 65% requirement are loans
made to purchase, refinance, construct, improve or repair domestic residential
housing and manufactured housing, home equity loans, mortgage-backed securities
(where the mortgages are secured by domestic residential housing or manufactured
housing), stock issued by the FHLB of Pittsburgh, and direct or indirect
obligations of the FDIC. In addition, small business loans, credit card loans,
student loans and loans for personal, family and household purposes are allowed
to be included without limitation as qualified investments. The following
assets, among others, also may be included in meeting the test subject to an
overall limit of 20% of the savings institution's portfolio assets: 50% of
residential mortgage loans originated and sold within 90 days of origination,
100% loans for personal, family and household purposes (other then credit card
loans and education loans) (limited to 10% of total portfolio assets) and stock
issued by FHLMC or FNMA. Portfolio assets consist of total assets minus the sum
of (i) goodwill and other intangible assets, (ii) property used by the savings
institution to conduct its business, and (iii) liquid assets up to 20% of the
institution's total assets.
A savings institution that does not comply with the QTL test must either
convert to a bank charter or comply with the following restrictions on its
operations: (i) the institution may not engage in any new activity or make any
new investment, directly or indirectly, unless such activity or investment is
permissible for a national bank; (ii) the branching powers of the institution
shall be restricted to those of a national bank; (iii) the institution shall not
be eligible to obtain any new advances from its Federal Home Loan Bank, other
than special liquidity advances with the approval of the Office of Thrift
Supervision; and (iv) payment of dividends by the institution shall be subject
to the rules regarding payment of dividends by a national bank. Upon the
expiration of three years from the date the association ceases to be a QTL, it
must cease any activity and not retain any investment not permissible for a
national bank and immediately repay any outstanding FHLB advances (subject to
safety and soundness considerations).
At September 30, 2005, approximately 70.3% of the Bank's assets were
invested in qualified thrift investments, which was in excess of the percentage
required to qualify the Bank under the QTL test in effect at that time.
31
Capital Distribution. OTS regulations govern capital distributions by
savings institutions, which include cash dividends, stock repurchases and other
transactions charged to the capital account of a savings institution to make
capital distributions. A savings institution must file an application for OTS
approval of the capital distribution if any of the following occur or would
occur as a result of the capital distribution (1) the total capital
distributions for the applicable calendar year exceed the sum of the
institution's net income for that year to date plus the institution's retained
net income for the preceding two years, (2) the institution would not be at
least adequately capitalized following the distribution, (3) the distribution
would violate any applicable statute, regulation, agreement or OTS-imposed
condition, or (4) the institution is not eligible for expedited treatment of its
filings. If an application is not required to be filed, savings institutions
which are a subsidiary of a holding company (as well as certain other
institutions) must still file a notice with the OTS at least 30 days before the
Board of Directors declares a dividend or approves a capital distribution.
OTS regulations also prohibit the Bank from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
(or total) capital of the Bank would be reduced below the amount required to be
maintained for the liquidation account established by it for certain depositors
in connection with its conversion from mutual to stock form.
Community Reinvestment Act and the Fair Lending Laws. Under the Community
Reinvestment Act of 1977, as amended ("CRA"), as implemented by OTS regulations,
a savings association has a continuing and affirmative obligation consistent
with its safe and sound operation to help meet the credit needs of its entire
community, including low and moderate income neighborhoods. The CRA does not
establish specific lending requirements or programs for financial institutions
nor does it limit an institution's discretion to develop the types of products
and services that it believes are best suited to its particular community,
consistent with the CRA. The Bank received a satisfactory CRA rating as a result
of its last OTS evaluation. In addition, the Equal Credit Opportunity Act and
the Fair Housing Act prohibit lenders from discriminating in their lending
practices on the basis of characteristics specified in those statutes. An
institution's failure to comply with the provisions of the CRA could, at a
minimum, result in regulatory restrictions on its activities, and failure to
comply with the fair lending laws could result in enforcement actions by the
OTS, as well as other federal regulatory agencies and the Department of Justice.
Branching by Federal Saving Institutions. OTS policy permits interstate
branching to the full extent permitted by statute (which is essentially
unlimited). Generally, federal law prohibits federal savings institutions from
establishing, retaining or operating a branch outside the state in which the
federal institution has its home office unless the institution meets the IRS'
domestic building and loan test (generally, 60% of a thrift's assets must be
housing-related) ("IRS Test"). The IRS Test requirement does not apply if: (a)
the branch(es) result(s) from an emergency acquisition of a troubled savings
institution (however, if the troubled savings institution is acquired by a bank
holding company, does not have its home office in the state of the bank holding
company bank subsidiary and does not qualify under the IRS Test, its branching
is limited to the branching laws for state-chartered banks in the state where
the savings institution is located); (b) the law of the state where the branch
would be located would permit the branch to be established if the federal
savings institution were chartered by the state in which its home office is
located; or (c) the branch was operated lawfully as a branch under state law
prior to the savings institution's reorganization to a federal charter.
Furthermore, the OTS will evaluate a branching applicant's record of CRA
compliance. An unsatisfactory CRA record may be the basis for denial of a
branching application.
Federal Home Loan Bank System. The Bank is a member of the FHLB of
Pittsburgh, which is one of 12 regional FHLBs that administers the home
financing credit function of savings associations. Each FHLB serves as a reserve
or central bank for its members within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures established by the Board of Directors of the FHLB. As of
September 30, 2005, the Bank has overnight borrowings and advances aggregating
$113.2 million from the FHLB or 23.1% of its total liabilities. The Bank
currently has the ability to obtain up to $345.0 million additional advances
from FHLB of Pittsburgh.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Pittsburgh in an amount equal to at least 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year or 5% of its advances from the FHLB of Pittsburgh,
whichever is greater. At September 30, 2005, the Bank had $9.5 million in FHLB
stock, which was in compliance with this requirement.
32
The FHLBs are required to provide funds for the resolution of troubled
savings institutions and to contribute to affordable housing programs through
direct loans or interest subsidies on advances targeted for community investment
and low- and moderate-income housing projects. These contributions have
adversely affected the level of FHLB dividends paid and could continue to do so
in the future and could also result in the FHLBs imposing higher interest rates
on advances to members. These contributions also could have an adverse effect on
the value of FHLB stock in the future.
Federal Reserve System. FRB requires all depository institutions to
maintain reserves against their transaction accounts (primarily NOW and Super
NOW checking accounts) and non-personal time deposits. At September 30, 2005,
the Bank was in compliance with applicable requirements. However, because
required reserves must be maintained in the form of vault cash or a
non-interest-bearing account at a FRB, the effect of this reserve requirement is
to reduce an institution's earning assets.
Savings institutions are authorized to borrow from a Federal Reserve Bank
"discount window," but FRB regulations require savings banks to exhaust other
reasonable alternative sources of funds, including FHLB advances, before
borrowing from a Federal Reserve Bank.
Safety and Soundness Guidelines. The OTS and the other federal banking
agencies have established guidelines for safety and soundness, addressing
operational and managerial, as well as compensation matters for insured
financial institutions. Institutions failing to meet these standards are
required to submit compliance plans to their appropriate federal regulators. The
OTS and the other agencies have also established guidelines regarding asset
quality and earnings standards for insured institutions.
FEDERAL AND STATE TAXATION
General. The Company and the Bank are subject to the corporate tax
provisions of the Code, as well as certain additional provisions of the Code
which apply to thrift and other types of financial institutions. The following
discussion of tax matters is intended only as a summary and does not purport to
be a comprehensive description of the tax rules applicable to the Company and
the Bank.
Fiscal Year. The Company and the Bank and the Bank's subsidiaries file a
consolidated federal income tax return on a fiscal year basis ending September
30.
Method of Accounting. The Bank maintains its books and records for federal
income tax purposes using the accrual method of accounting. The accrual method
of accounting generally requires that items of income be recognized when all
events have occurred that establish the right to receive the income and the
amount of income can be determined with reasonable accuracy, and that items of
expense be deducted at the later of (i) the time when all events have occurred
that establish the liability to pay the expense and the amount of such liability
can be determined with reasonable accuracy or (ii) the time when economic
performance with respect to the item of expense has occurred.
Bad Debt Reserves. The Bank is permitted to establish reserves for bad
debts and to make annual additions thereto which qualify as deductions from
taxable income. The Company, as of October 1, 1996, used the experience method
in computing reserves for bad debts (the "Experience Method"). The bad debt
deduction allowable under this method is available to small banks with assets
less than $500 million. Beginning October 1, 2002, the Company changed its
method of computing reserves for bad debts to the specific charge-off method.
The bad debt deduction allowable under this method is available to large banks
with assets greater than $500 million. Generally, this method allows the Company
to deduct an annual addition to the reserve for bad debts equal to it its net
charge-offs.
The Bank treated such change as a change in a method of accounting
determined solely with respect to the "applicable excess reserves" of the
institution. The amount of applicable excess reserves is taken into account
ratably over a six taxable-year period, beginning with the first taxable year
beginning after December 31, 1995. For financial reporting purposes, the Company
has not incurred any additional tax expense. Amounts that had been previously
deferred will be reversed for financial reporting purposes and will be included
in the income tax return of the Company, increasing income tax payable. The
change from the experience method to the specific charge-off method did not
result in a recapture of bad debt reserves for tax purposes in the current year.
33
Prior to the Small Business Protection Act of 1996, bad debt reserves
created prior to January 1, 1988 were subject to recapture into taxable income
if the Bank failed to meet certain thrift asset and definitional tests. New
federal legislation eliminated these thrift-related recapture rules. However, to
the extent that the Bank makes "non-dividend distributions" that are considered
as made (i) from the reserve for losses on qualifying real property loans or
(ii) from the supplemental reserve for losses on loans, then an amount based on
the amount distributed will be included in its taxable income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, distributions in redemption of stock, and
distributions in partial or complete liquidation. Dividends paid out of the
Bank's current or accumulated earnings and profits, as calculated for federal
income tax purposes, will not be considered to result in a distribution from our
bad debt reserve. As a result, any dividends that would reduce amounts
appropriated to bad debt reserve and deducted for federal income tax purposes
would create a tax liability for the Bank.
Minimum Tax. The Code imposes an alternative minimum tax at a rate of 20%
on a base of regular taxable income plus certain tax preferences ("alternative
minimum taxable income" or "AMTI"). The alternative minimum tax is payable to
the extent such AMTI is in excess of an exemption amount. The Code provides that
an item of tax preference is the excess of the bad debt deduction allowable for
a taxable year pursuant to the percentage of taxable income method over the
amount allowable under the experience method. The other items of tax preference
that constitute AMTI include (a) tax-exempt interest on newly-issued (generally,
issued on or after August 8, 1986) private activity bonds other than certain
qualified bonds and (b) for taxable years beginning after 1989, 75% of the
excess (if any) of (i) adjusted current earnings as defined in the Code, over
(ii) AMTI (determined without regard to this preference and prior to reduction
by net operating losses). Net operating losses can offset no more than 90% of
AMTI. Certain payments of alternative minimum tax may be used as credits against
regular tax liabilities in future years.
Audit by IRS. The Bank's consolidated federal income tax returns for
taxable years through September 30, 1998 have been closed for the purpose of
examination by the IRS.
STATE TAXATION
The Company and the Bank's subsidiaries are subject to the Pennsylvania
Corporate Net Income Tax and Capital Stock and Franchise Tax. The Corporate Net
Income Tax rate for fiscal 2005 is 9.9 % and is imposed on the Company's
unconsolidated taxable income for federal purposes with certain adjustments. In
general, the Capital Stock and Franchise Tax is a property tax imposed at the
rate of 0.72% of a corporation's capital stock value, which is determined in
accordance with a fixed formula.
The Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax Act
(the ("MTIT"), as amended to include thrift institutions having capital stock.
Pursuant to the MTIT, the Bank's tax rate is 11.5%. The MTIT exempts the Bank
from all other taxes imposed by the Commonwealth of Pennsylvania for state
income tax purposes and from all local taxation imposed by political
subdivisions, except taxes on real estate and real estate transfers. The MTIT is
a tax upon net earnings, determined in accordance with GAAP with certain
adjustments. The MTIT, in computing GAAP income, allows for the deduction of
interest earned on state and federal securities, while disallowing a percentage
of a thrift's interest expense deduction in the proportion of interest income on
those securities to the overall interest income of the Bank. Net operating
losses, if any, thereafter can be carried forward three years for MTIT purposes.
34
ITEM 2. PROPERTIES.
At September 30, 2005, the Bank conducted business from its executive
offices located in Media, Pennsylvania and six full-service offices located in
Delaware and Chester Counties, Pennsylvania. See also Note 7 of the Notes to
Consolidated Financial Statements set forth in Item 8 hereof.
The following table sets forth certain information with respect to the
Bank's offices at September 30, 2005.
Net Book Value Amount of
Description/Address Leased/Owned of Property Deposits
- ----------------------------------- ------------ -------------- ---------
(Dollar in thousands)
Executive Offices:
22 West State Street
Media, Pennsylvania 19063 Owned(1) $1,717 $ 91,316
Branch Offices:
3218 Edgmont Avenue
Brookhaven, Pennsylvania 19015 Owned 346 74,667
Routes 1 and 100
Chadds Ford, Pennsylvania 19317 Leased(2) 69 27,582
23 East Fifth Street
Chester, Pennsylvania 19013 Leased(3) 75 29,459
31 Baltimore Pike
Chester Heights, Pennsylvania 19017 Leased(4) 664 42,391
106 East Street Road
Kennett Square, Pennsylvania 19348 Leased(5) 690 17,761
5000 Pennell Road
Aston, Pennsylvania 19014 Leased(6) 1,038 8,242
330 Dartmouth Avenue
Swarthmore, Pennsylvania 19081 Owned 183 58,276
------ --------
Total $4,782 $349,694
====== ========
- ----------
(1) Also a branch office.
(2) Lease expiration date is September 30, 2010. The Bank has one five-year
renewal option.
(3) Lease expiration date is December 31, 2015.
(4) Lease expiration date is December 31, 2028. The Bank has options to cancel
on the 15th, 20th and 25th year of the lease.
(5) Lease expiration date is September 30, 2034. The Bank has one six-year
followed by a five-year renewal option.
(6) Branch opened in November 2005. Lease expiration date is December 31, 2033.
The Bank has options to cancel on the 15th, 20th and 25th year of the
lease.
35
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in routine legal proceedings occurring in the
ordinary course of business which, in the aggregate, are believed by management
to be immaterial to the financial condition and operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) On January 25, 1995 the conversion and reorganization of the Bank and
its holding company parent was completed. In connection with the consummation of
the Conversion, the Holding Company issued 2,720,000 shares of common stock. As
of September 30, 2005, there were 2,023,534 shares of common stock outstanding.
As of September 16, 2005, the Holding Company had 411 stockholders of record not
including the number of persons or entities holding stock in nominee or street
name through various brokers and banks.
The following table sets forth the high and low closing stock prices of the
Holding Company's common stock as reported by the Nasdaq Stock Market under the
symbol "FKFS" during the periods presented. Price information appears in a major
newspaper under the symbol "FstKeyst".
YEAR ENDED
---------------------------------------
SEPTEMBER 30, 2005 SEPTEMBER 30, 2004
------------------ ------------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First Quarter $23.60 $21.67 $27.45 $26.00
Second Quarter $24.70 $21.23 $29.00 $26.59
Third Quarter $21.34 $16.50 $28.99 $23.50
Fourth Quarter $22.00 $18.25 $24.50 $21.40
The following schedule summarizes the cash dividends per share of common
stock paid by the Holding Company during the periods indicated.
YEAR ENDED SEPTEMBER 30,
------------------------
2005 2004
----- -----
First Quarter $0.11 $0.10
Second Quarter 0.11 0.11
Third Quarter 0.11 0.11
Fourth Quarter 0.11 0.11
On November 22, 2005, the Board of Directors declared a quarterly cash
dividend of $0.11 per share of common stock, payable on January 2, 2006, to
stockholders of record at the close of business on December 16, 2006. See
"Liquidity, Capital Resources and Commitments" set forth in Item 7 hereof and
Notes 11 of the "Notes to Consolidated Financial Statements" set forth in Item 8
hereof for discussion of restrictions on the Holding Company's and the Bank's
ability to pay dividends. Also see "Regulation-Capital Distributions" for a
discussion of restrictions on the Bank's ability to pay dividends to the Holding
Company.
The information for all equity based and individual compensation
arrangements is incorporated by reference from Item 12 hereof.
(b) Not applicable.
(c) Not applicable. As previously disclosed, the Company in the fourth
quarter of fiscal 2005 terminated its publicly announced repurchase
program to purchase shares of its common stock on the open market. No
shares were purchased pursuant to this plan in the fourth quarter of
fiscal 2005 prior to its termination. In addition, no shares were
repurchased by the Company during the fourth quarter of fiscal 2005
through any other plan or arrangement.
36
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial and other data of the Company set forth
below does not purport to be complete and should be read in conjunction with,
and is qualified in its entirety by, the more detailed information, including
the Consolidated Financial Statements and related Notes, set forth in Item 8
hereof.
AT OR FOR THE YEAR ENDED SEPTEMBER 30,
----------------------------------------------------
2005 2004 2003 2002 2001
-------- -------- -------- -------- --------
(Dollars in thousands, except per share data)
SELECTED FINANCIAL DATA:
Total assets $518,124 $571,919 $559,612 $519,259 $489,680
Loans receivable, net 301,979 304,248 286,421 288,776 247,664
Mortgage-related securities held to maturity 46,654 37,363 3,487 8,855 11,454
Investment securities held to maturity 4,267 5,287 6,315 -- --
Assets held for sale:
Mortgage-related securities 67,527 97,620 124,656 85,674 117,608
Investment securities 37,019 63,615 77,700 80,624 62,564
Loans 41 172 4,498 501 225
Real estate owned 760 1,229 1,420 248 887
Deposits 349,694 344,880 362,605 330,765 311,601
Borrowings 113,303 171,149 136,272 126,237 126,234
Junior subordinated debentures 21,520 21,557 21,593 21,629 16,702
Stockholders' equity 28,193 29,698 32,388 32,795 30,621
Non-performing assets 5,812 3,262 2,976 5,386 3,189
SELECTED OPERATIONS DATA:
Interest income $ 27,076 $ 26,143 $ 27,212 $ 30,121 $ 31,860
Interest expense 15,768 14,712 16,012 18,250 21,964
-------- -------- -------- -------- --------
Net interest income 11,308 11,431 11,200 11,871 9,896
Provision for loan losses 1,780 300 715 540 540
-------- -------- -------- -------- --------
Net interest income
after provision for loan losses 9,528 11,131 10,485 11,331 9,356
Service charges and other fees 1,577 1,235 1,013 1,000 952
Net gain on sales of interest-earning assets 802 968 1,010 415 174
Other non-interest income 1,210 1,696 1,263 848 820
Non-interest expense 12,820 12,501 10,400 10,441 8,388
-------- -------- -------- -------- --------
Income before income taxes 297 2,529 3,371 3,153 2,914
Income tax (benefit) expense (313) 326 632 427 443
-------- -------- -------- -------- --------
Net income $ 610 $ 2,203 $ 2,739 $ 2,726 $ 2,471
======== ======== ======== ======== ========
PER SHARE DATA:
Basic earnings per share $ 0.33 $ 1.21 $ 1.44 $ 1.42 $ 1.22
Diluted earnings per share 0.33 1.14 1.35 1.34 1.18
Cash dividends per share 0.44 0.44 0.40 0.36 0.32
37
AT OR FOR THE YEAR ENDED SEPTEMBER 30,
------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(Dollars in thousands, except per share data)
SELECTED OPERATING RATIOS:
Average yield earned on interest-earning assets (1) 5.12% 5.01% 5.48% 6.42% 7.25%
Average rate paid on interest-bearing liabilities 2.96 2.80 3.23 3.91 5.02
Average interest rate spread (1) 2.16 2.21 2.26 2.52 2.23
Net interest margin (1) 2.18 2.23 2.30 2.59 2.32
Ratio of interest-earning assets to interest-
bearing liabilities 100.52 100.69 101.44 101.83 101.83
Efficiency ratio (2) 86.06 81.55 64.50 66.07 62.46
Non-interest expense as a percent of average assets 2.26 2.23 1.95 2.07 1.78
Return on average assets 0.11 0.39 0.51 0.54 0.52
Return on average equity 2.08 7.13 8.39 8.77 8.42
Ratio of average equity to average assets 5.18 5.50 6.12 6.17 6.22
Full-service offices at end of period 8 7 7 7 7
ASSET QUALITY RATIOS:(3)
Non-performing loans as a percent of gross loans
receivable 1.65% 0.66% 0.53% 1.76% 0.92%
Non-performing assets as a percent of total assets 1.12 0.57 0.53 1.04 0.65
Allowance for loan losses as a percent of gross
loans receivable 1.14 0.67 0.68 0.81 0.87
Allowance for loan losses as a percent of non-
performing loans 68.79 100.29 127.63 45.89 94.74
Net loans charged-off to average loans receivable 0.11 0.08 0.37 0.13 0.16
CAPITAL RATIOS:(3) (4)
Tangible capital ratio 8.85% 8.21% 7.98% 8.07% 7.76%
Core capital ratio 8.85 8.21 7.98 8.07 7.76
Risk-based capital ratio 15.13 14.56 14.97 16.17 16.81
(1) Adjusted for the effects of tax-free investments. See presentation of
reconciliation of tax-free investments in Item 7, "Management's Discussion
and Analysis - Average Balances, Net Interest Income and Yield Earned and
Rates Paid."
(2) Reflects non-interest expense as a percent of the aggregate of net interest
income and non-interest income.
(3) Asset Quality Ratios and Capital Ratios are end of period ratios except for
the ratio of loan charge-offs to average loans. With the exception of end
of period ratios, all ratios are based on average daily balances during the
indicated periods. Gross loans receivable are net of loans in process.
(4) Reflects regulatory capital ratios of the Holding Company's wholly owned
subsidiary, First Keystone Bank.
38
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
GENERAL
First Keystone Financial, Inc. (the "Company") is the holding company for
its wholly owned subsidiary, First Keystone Bank (the "Bank"). For purposes of
this discussion, references to the Company will include its wholly owned
subsidiaries, unless otherwise indicated. The Company is a community-oriented
banking organization that focuses on providing customer and business services
within its primary market area, consisting primarily of Delaware and Chester
Counties in southeastern Pennsylvania.
The following discussion should be read in conjunction with the Company's
consolidated financial statements presented in Item 8 of this Annual Report on
Form 10-K. The primary asset of the Company is its investment in the Bank and,
accordingly, the discussion below with respect to results of operations relates
primarily to the operations of the Bank.
The Company's results of operations depend primarily on its net interest
income which is the difference between interest income on interest-earning
assets, which principally consist of loans, mortgage-related securities and
investment securities, and interest expense on interest-bearing liabilities,
which principally consist of deposits and FHLB advances. The Company's results
of operations also are affected by the provision for loan losses (the amount of
which reflects management's assessment of the known and inherent losses in its
loan portfolio that are both probable and reasonably estimable), the level of
its non-interest income, including service charges and other fees as well as
gains and losses from the sale of certain assets, the level of its operating
expenses, and income tax expense.
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 its
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 provisions to the loan
loss allowance 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 which is both probable
and reasonably estimable, 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.
39
ASSET AND LIABILITY MANAGEMENT
The principal objectives of the Company's asset and liability management
are to (i) evaluate the interest rate risk existing in certain assets and
liabilities, (ii) determine the appropriate level of risk given the Company's
business focus, operating environment, capital and liquidity requirements and
performance objectives, (iii) establish prudent asset and liability
compositions, and (iv) manage the assessed risk consistent with Board approved
guidelines. Through asset and liability management, the Company seeks to reduce
both the vulnerability and volatility of its operations to changes in interest
rates and to manage the ratio of interest-rate sensitive assets to interest-rate
sensitive liabilities within specified maturities or repricing periods. The
Company's actions in this regard are taken under the guidance of the
Asset/Liability Committee ("ALCO"), which is chaired by the Chief Financial
Officer and comprised of members of the Company's senior management. The ALCO
meets no less than quarterly to review, among other things, liquidity and cash
flow needs, current market conditions and the interest rate environment, the
sensitivity to changes in interest rates of the Company's assets and
liabilities, the historical and market values of assets and liabilities,
unrealized gains and losses, and the repricing and maturity characteristics of
loans, investment securities, deposits and borrowings. The ALCO reports to the
Company's Board of Directors no less than once a quarter. In addition,
management reviews at least weekly the pricing of the Company's commercial loans
and retail deposits. The pricing of residential loans, including those being
originated for sale in the secondary market, is reviewed daily.
The Company's primary asset/liability monitoring tools consist of various
asset/liability simulation models which are prepared on a quarterly basis. The
models are designed to capture the dynamics of the balance sheet as well as rate
and spread movements and to quantify variations in net interest income under
different interest rate scenarios.
One of the models consists of an analysis of the extent to which assets and
liabilities are interest rate sensitive and measures an institution's interest
rate sensitivity gap. An asset or liability is said to be interest rate
sensitive within a specific time period if it will mature or reprice within that
time period. An institution's interest rate sensitivity gap is defined as the
difference between interest-earning assets and interest-bearing liabilities
maturing or repricing within a given time period. A gap is considered positive
when the amount of interest rate sensitive assets exceeds the amount of interest
rate sensitive liabilities and is considered negative when the amount of
interest rate sensitive liabilities exceeds interest rate sensitive assets.
During a period of falling interest rates, a negative gap would tend to result
in an increase in net interest income, while a positive gap would tend to result
in a decline in net interest income. Conversely, during a period of rising
interest rates, a negative gap would tend to result in a decline in net interest
income, while a positive gap would tend to result in an increase in net interest
income.
The Bank's passbook, statement savings, MMDA and NOW accounts are generally
subject to immediate withdrawal. However, management considers a portion of
these deposits to be core deposits (which consists of passbook, statement
saving, MMDA and NOW accounts) having significantly longer effective maturities
based upon the Bank's experience in retaining such deposits in changing interest
rate environments. Borrowed funds are included in the period in which they can
be called or when they mature.
Management believes that the assumptions used to evaluate the vulnerability
of the Bank's operations to changes in interest rates are considered reasonable.
However, certain shortcomings are inherent in the method of analysis presented
in the table below. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates, while interest rates on other types
may lag behind changes in market rates. Additionally, certain assets, such as
adjustable-rate loans, have features which restrict changes in market rates both
on a short-term and over the life of the asset. Further, in the event of a
change in interest rates, prepayments and early withdrawal levels would likely
deviate significantly from those assumed in calculating the table.
40
The following table summarizes the Company's interest-earning assets and
interest-bearing liabilities as of September 30, 2005 based on certain
assumptions management has made that affect the rate at which loans will prepay
and the duration of core deposits.
More Than More Than
Within Six to One Year Three
Six Twelve to Three Years to Over Five
Months Months Years Five Years Years Total
-------- -------- --------- ---------- --------- ---------
(Dollars in thousands)
Interest-earning assets:
Loans receivable, net(1) $ 84,251 $ 34,084 $ 65,718 $ 60,609 $ 53,036 $297,698
Mortgage-related securities 11,788 12,937 39,263 24,043 26,150 114,181
Loans held for sale 41 -- -- -- -- 41
Investment securities(2) 14,724 -- 9,012 5,748 21,301 50,785
Interest-earning deposits 7,834 -- -- -- -- 7,834
-------- -------- -------- -------- -------- --------
Total interest-earning assets $118,638 $ 47,021 $113,993 $ 90,400 $100,487 $470,539
-------- -------- -------- -------- -------- --------
Interest-bearing liabilities:
Deposits $ 82,087 $ 61,871 $126,703 $ 65,553 $ 13,480 $349,694
Borrowed funds 16,807 7 5,711 35,026 55,752 113,303
Junior subordinated debentures -- -- -- -- 21,520 21,520
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities $ 98,894 $ 61,878 $132,414 $100,579 $ 90,752 $484,517
-------- -------- -------- -------- -------- --------
Excess (deficiency) of interest-earning assets
over interest-bearing liabilities $ 19,744 $(14,857) $(18,421) $(10,179) $ 9,735 $(13,978)
======== ======== ======== ======== ======== ========
Cumulative excess (deficiency) of interest-earning
assets over interest-bearing liabilities $ 19,744 $ 4,887 $(13,534) $(23,713) $(13,978)
======== ======== ======== ======== ========
Cumulative excess (deficiency) of interest-earning
assets over interest-bearing liabilities as a
percentage of total assets 3.81% 0.94% (2.6)% (4.58)% (2.70)%
======== ======== ======== ======== ========
- ----------
(1) Balances have been reduced for non-accruing loans, which amounted to $4.3
million at September 30, 2005.
(2) Balance includes Federal Home Loan Bank stock.
Although an analysis of the interest rate sensitivity gap measure may be
useful, it is limited in its ability to predict trends in future earnings. It
makes no presumptions about changes in prepayment tendencies, deposit or loan
maturity preferences or repricing time lags that may occur in response to a
change in the interest rate environment. As a consequence, the Company also
utilizes an analysis of the market value of portfolio equity, which addresses
the estimated change in the value of the Bank's equity arising from movements in
interest rates. The market value of portfolio equity is estimated by valuing the
Bank's assets and liabilities under different interest rate scenarios. The
extent to which assets gain or lose value in relation to gains or losses of
liabilities as interest rates increase or decrease determines the appreciation
or depreciation in equity on a market value basis. Market value analysis is
intended to evaluate the impact of immediate and sustained shifts of the current
yield curve upon the market value of the Bank's current balance sheet.
The Company utilizes reports prepared by the OTS to measure interest rate
risk. Using data submitted by the Bank, the OTS performs scenario analysis to
estimate 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.
41
The table below sets forth the Bank's NPV assuming an immediate change in
interest rates of up to 300 basis points and a decline of 100 basis points. Due
to the low prevailing interest rate environment, the OTS did not provide a
calculation for the minus 300 basis point change in rates. Dollar amounts are
expressed in thousands as of September 30, 2005.
NET PORTFOLIO VALUE
NET PORTFOLIO VALUE AS A % OF ASSETS
-------------------------------- -------------------
CHANGES IN RATES DOLLAR PERCENTAGE NPV
IN BASIS POINTS AMOUNT CHANGE CHANGE RATIO CHANGE
- ---------------- -------- -------- ---------- ----- ------
300 $44,099 $(20,482) (32)% 8.76% (336)bp
200 51,985 (12,596) (20) 10.13 (199)
100 59,101 (5,480) (8) 11.29 (82)
0 64,581 -- -- 12.12 --
(100) 66,186 1,605 2 12.26 15
(200) 64,021 (560) (1) 11.78 (33)
(300) N/A N/A N/A N/A N/A
As is the case with interest rate sensitivity gap, certain shortcomings are
inherent in the methodology used in the above interest rate risk measurements.
Modeling changes in NPV require the making of certain assumptions which may or
may not reflect the manner in which actual yields and costs respond to changes
in market interest rates. In this regard, the NPV model presented assumes that
the composition of the Bank's interest sensitive assets and liabilities existing
at the beginning of a period remains constant over the period being measured and
also assumes that a particular change in interest rates is reflected uniformly
across the yield curve regardless of the duration to maturity or repricing of
specific assets and liabilities. Although the NPV measurements and net interest
income models provide an indication of the Bank's interest rate risk exposure at
a particular point in time, such measurements are not intended to and do not
provide a precise forecast of the effect of changes in market interest rates on
the Bank's net interest income and may differ from actual results.
The Company is aware of its interest rate risk exposure in the event of
rapidly rising rates. Due to the Company's recognition of the need to control
interest rate exposure, the Company's current policy is to sell new 30-year
fixed-rate single-family residential mortgage loans into the secondary market.
In addition, in recent years, the Company has emphasized the origination of
construction and land, multi-family and commercial real estate and consumer
loans which generally have either adjustable interest rates and/or shorter
contractual terms than single-family residential loans. The Company plans to
continue these lending strategies.
Derivative financial instruments include futures, forwards, interest rate
swaps, option contracts, and other financial instruments with similar
characteristics. The Company currently does not enter into futures, forwards,
swaps or options. However, the Company is party to financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of our customers. These financial instruments include commitments to
extend credit. These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the consolidated
statements of financial condition. Commitments generally have fixed expiration
dates and may require additional collateral from the borrower if deemed
necessary. Commitments to extend credit are not recorded as an asset or
liability until the instruments are exercised.
The Company is subject to certain market risks and interest rate risks from
the time a commitment is issued to originate new loans. In an effort to protect
the Company against adverse interest rate movements, at the time an application
is taken for a fixed-rate, single-family residential loan, the Company typically
enters into an agreement to sell such loan upon closing, or another loan which
bears an interest rate within the same interest-rate range, into the secondary
market. This is known as a "matched sale" approach and reduces interest-rate
risk with respect to these loans. There is still some portion of these loans
which may never close for various reasons. However, the agencies the Company
sells loans to permit some flexibility in delivering loan product to them. In
certain instances, if the loans delivered for sale do not match the
characteristics outlined in the forward sale commitments, the gain on sale may
be reduced.
42
CHANGES IN FINANCIAL CONDITION
GENERAL. Total assets of the Company decreased by $53.8 million, or 9.4%,
from $571.9 million at September 30, 2004 to $518.1 million at September 30,
2005. The decrease was primarily due to the deleveraging strategy employed in
the fourth quarter of fiscal 2005. The deleveraging strategy resulted in an
aggregate reduction in investment and mortgage-related securities available for
sale of $56.7 million. The proceeds from the sales of securities from the
available for sale portfolios were used to reduce the level of borrowings from
the FHLB from $171.1 million at September 30, 2004 to $113.3 million at
September 30, 2005.
CASH AND CASH EQUIVALENTS. Cash and cash equivalents, which consists of
cash on hand and deposited in other banks in interest-earning and
non-interest-earning accounts, amounted to $16.2 million and $18.0 million at
September 30, 2005 and 2004, respectively. The $1.8 million, or 10.1%, decrease
in cash and cash equivalents was primarily due to general cash overflows in
excess of inflows impacted by borrowings as well as the funds being utilized to
repay FHLB borrowings.
INVESTMENT SECURITIES HELD TO MATURITY AND INVESTMENT SECURITIES AVAILABLE
FOR SALE. Total investment securities decreased in the aggregate by $27.6
million, or 40.1%, from $68.9 million at September 30, 2004 to $41.3 million at
September 30, 2005. The decrease in investment securities resulted from the sale
of $30.8 million in investment securities available for sale. The majority of
sales represented $19.9 million relating to the Company's asset liability
strategy of selling low yielding, fixed-rate investment securities and
reinvesting the proceeds into mortgage-related securities. The deleveraging
strategy involved the sale of $7.9 million in investment securities available
for sale. To a lesser extent, the decrease in investment securities was also due
to U.S. agency, municipal and corporate bonds maturing or being called.
MORTGAGE-RELATED SECURITIES HELD TO MATURITY AND MORTGAGE-RELATED
SECURITIES AVAILABLE FOR SALE. Mortgage-related securities held to maturity and
mortgage-related securities available for sale decreased in the aggregate by
$20.8 million, or 15.4%, to $114.2 million at September 30, 2005 compared to
$135.0 million at September 30, 2004. The available for sale portfolio decreased
by $30.1 million, or 30.8%, as part of the Company's deleveraging strategy which
involved the sale of $39.1 million in low yielding mortgage-related securities
with average lives of 2.4 years in order to mitigate margin compression. The
held to maturity portfolio increased $9.3 million, or 24.9%, as part of the
Company's investment strategy to reinvest the cash flows from the available for
sale portfolio into the held to maturity portfolio minimizing the effect of
price volatility to the Company's equity as interest rates increase.
LOANS HELD FOR SALE. At September 30, 2005, $41,000 of commercial business
loans were classified as held for sale. At September 30, 2005, there were no
fixed-rate single-family residential family loans held for sale compared to
$172,000 at September 30, 2004. The decrease reflected the reduction in loan
refinancings with the increase in interest rates during the fiscal year. During
fiscal year 2005, the Company originated $13.6 million and sold $13.8 million of
such loans.
LOANS RECEIVABLE, NET. Total loans receivable, net, decreased to $302.0
million at September 30, 2005 compared to $304.2 million at September 30, 2004.
The decrease was primarily due to a $17.2 million, or 10.5%, decrease in
single-family residential loans partially offset by a $13.3 million, or 17.7%,
increase in commercial real estate and business loans and $3.1 million, or 7.2%,
increase in home equity loans and lines of credit. The Company has continued to
sell 30-year fixed-rate mortgages bearing low interest rates into the secondary
market in order to minimize interest rate risk in a rising interest rate
environment.
NON-PERFORMING ASSETS. The Company's total non-performing loans and real
estate owned increased to $5.8 million, or 1.1% of total assets, at September
30, 2005 compared to $3.3 million, or 0.57% of total assets, at the end of the
prior fiscal year. The increase in non-performing assets in fiscal 2005 was
attributable to an increase of $3.1 million and $376,000 in non-performing
commercial real estate loans and commercial business loans, respectively,
partially offset by a decrease of $245,000 and $183,000 in single-family
residential and home equity loans, respectively, along with a $469,000 decrease
in real estate owned. See Item 1 Business "-Asset Quality."
DEPOSITS. Deposits increased by $4.8 million, or 1.4%, from $344.9 million
at September 30, 2004 to $349.7 million at September 30, 2005. Certificates of
deposit increased by $8.2 million, or 5.0%, to $173.1 million representing 49.5%
of total deposits at September 30, 2005 from $164.9 million, or 47.8%, of total
deposits at September 30, 2004. The increase was partially offset by a $3.4
million, or 1.9%, decrease in the Company's core accounts (non-interest-bearing,
NOW, passbook, and MMDA accounts). The increase in certificates of deposit was
due to the competitive pricing of the Company's certificates, in particular
jumbo certificates, compared to those paid by the competition.
43
BORROWINGS. The Company's total borrowings, which primarily consist of
advances from the FHLB, decreased to $113.3 million at September 30, 2005 from
$171.1 million at September 30, 2004 primarily as the result of the deleveraging
strategy pursuant to which the Company used the proceeds from the sale of
investment and mortgage-related securities to repay overnight borrowings and
term advances in the fourth quarter of 2005. Borrowings had a weighted average
interest rate of 5.2% at September 30, 2005 as compared to 4.4% at September 30,
2004. See Note 9 to the Consolidated Financial Statements set forth in Item 8
hereof for further information.
EQUITY. At September 30, 2005, total stockholders' equity was $28.2
million, or 5.4% of total assets, compared to $29.7 million, or 5.2% of total
assets, at September 30, 2004. The decrease was due to a decline in other
comprehensive income of $1.9 million primarily due to increases in market rates
of interest combined with dividend payments totaling $810,000 partially offset
by net income of $610,000 for the fiscal year ended September 30, 2005.
AVERAGE BALANCES, NET INTEREST INCOME AND YIELDS EARNED AND RATES PAID. The
following table sets forth, for the periods indicated, information regarding (i)
the total dollar amount of interest income of the Company from interest-earning
assets and the resultant average yields; (ii) the total dollar amount of
interest expense on interest-bearing liabilities and the resultant average rate;
(iii) net interest income; (iv) interest rate spread; and (v) net interest
margin. Information is based on average daily balances during the indicated
periods; yields were adjusted for the effects of tax-free investments using the
statutory tax rate.
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 common practice 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 also is included below.
YEAR ENDED SEPTEMBER 30,
------------------------------------------------------------------------------------------------
YIELD/ 2005 2004 2003
COST --------------------------- --------------------------- ---------------------------
AT AVERAGE AVERAGE AVERAGE
SEPT. 30, AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
2005 BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
--------- -------- -------- ------- -------- -------- ------- -------- -------- -------
(Dollars in thousands)
Interest-earning assets:
Loans receivable(1)(2)(3) 6.09% $304,367 $17,926 5.89% $295,701 $17,529 5.93% $290,357 $18,937 6.52%
Mortgage-related securities(3) 4.38 155,292 6,223 4.01 137,256 5,298 3.86 114,833 4,464 3.89
Investment securities(3) 5.03 63,505 3,099 4.88 83,911 3,597 4.29 84,038 4,094 4.87
Other interest-earning assets 3.68 11,602 167 1.44 12,056 76 0.63 14,390 120 0.83
-------- ------- -------- ------- -------- -------
Total interest-earning
assets 5.54 534,766 27,415 5.12 528,924 26,500 5.01 503,618 27,615 5.48
-------- -------- ------- -------- -------
Non-interest-earning assets 32,543 32,847 30,411
-------- -------- --------
Total assets $567,309 $561,771 $534,029
======== ======== ========
Interest-bearing liabilities:
Deposits 2.07 $349,076 6,280 1.80 $347,807 5,910 1.70 $343,727 7,353 2.14
FHLB advances and other
borrowings 5.19 161,382 7,694 4.77 155,932 7,126 4.57 131,136 6,983 5.33
Junior subordinated debentures 8.81 21,540 1,794 8.33 21,576 1,676 7.77 21,613 1,677 7.76
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities 3.10 531,998 15,768 2.96 525,315 14,712 2.80 496,476 16,013 3.22
-------- ------- -------- ------- -------- -------
Interest rate spread 2.44% 2.16% 2.21% 2.26%
==== ====== ====== ======
Non-interest-bearing liabilities 5,918 5,565 4,889
-------- -------- --------
Total liabilities 537,916 530,880 501,365
Stockholders' equity 29,393 30,891 32,664
-------- -------- --------
Total liabilities and
stockholders' equity $567,309 $561,771 $534,029
======== ======== ========
Net interest-earning assets $ 2,768 $ 3,609 $ 7,142
======== ======== ========
Net interest income $11,647 $11,788 $11,602
======= ======= =======
Net interest margin(4) 2.18% 2.23% 2.30%
====== ====== ======
Ratio of average interest-earning
assets to average
interest-bearing liabilities 100.52% 100.69% 101.44%
====== ====== ======
- ----------
(1) Includes non-accrual loans.
(2) Loan fees are included in interest income and the amount is not material
for this analysis.
(3) Includes assets classified as either available for sale or held for sale.
(4) Net interest income divided by interest-earning assets.
44
Although management believes that the above mentioned non-GAAP financial
measures enhance an investor's understanding of the Company's business and
performance, these non-GAAP financials measures should not be considered an
alternative to GAAP. The reconciliation of these non-GAAP financials measures
from GAAP to non-GAAP is presented below.
FOR THE YEAR ENDED SEPTEMBER 30,
----------------------------------------------------------------
2005 2004 2003
-------------------- -------------------- --------------------
AVERAGE AVERAGE AVERAGE
INTEREST YIELD/COST INTEREST YIELD/COST INTEREST YIELD/COST
-------- ---------- -------- ---------- -------- ----------
(Dollars in thousands)
Investment securities - nontaxable $ 2,760 4.35% $ 3,240 3.86% $ 3,691 4.39%
Tax equivalent adjustments 339 357 403
------- ------- -------
Investment securities - nontaxable to a
taxable equivalent yield $ 3,099 4.88% $ 3,597 4.29% $ 4,094 4.87%
======= ======= =======
Net interest income $11,308 $11,431 $11,199
Tax equivalent adjustment 339 357 403
------- ------- -------
Net interest income, tax equivalent $11,647 $11,788 $11,602
======= ======= =======
Net interest rate spread, no tax
adjustment 2.10% 2.14% 2.18%
Net interest margin, no tax adjustment 2.11% 2.16% 2.22%
RATE/VOLUME ANALYSIS. The following table describes the extent to which
changes in interest rates and changes in the volume of interest-related assets
and liabilities have affected the Company's interest income and expense during
the periods indicated. For each category of interest-earning asset and
interest-bearing liability, information is provided on changes attributable to
(i) changes in volume (change in volume multiplied by prior year rate), (ii)
changes in rate (change in rate multiplied by prior year volume), and (iii)
total change in rate and volume. The combined effect of changes in both rate and
volume has been allocated proportionately to the change due to rate and the
change due to volume. The table below has been prepared on a tax-equivalent
basis.
YEAR ENDED SEPTEMBER 30,
------------------------------------------------------------
2005 VS. 2004 2004 VS. 2003
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
---------------------------- -----------------------------
TOTAL TOTAL
INCREASE INCREASE
RATE VOLUME (DECREASE) RATE VOLUME (DECREASE)
----- ------- ---------- ------- ------ ----------
Interest-earnings assets:
Loans receivable(1) $(112) $ 509 $ 397 $(1,765) 357 $(1,408)
Mortgage-related securities(1) 208 717 925 (32) 866 834
Investment securities(1) (2) 658 (1,156) (498) (491) (6) (497)
Other interest-earning assets 94 (3) 91 (26) (18) (44)
----- ------- ------ ------- ----- -------
Total interest-earning assets 848 67 915 (2,314) 1,199 (1,115)
----- ------- ------ ------- ----- -------
Interest-bearing liabilities:
Deposits 348 22 370 (1,531) 88 (1,443)
Junior subordinated debentures 121 (3) 118 2 (3) (1)
FHLB advances and other borrowings 314 254 568 (429) 572 143
----- ------- ------ ------- ----- -------
Total interest-bearing liabilities 783 273 1,056 (1,958) 657 1,301
----- ------- ------ ------- ----- -------
Increase (decrease) in net interest income $ 65 $ (206) $ (141) $ (356) 542 $ 186
===== ======= ====== ======= ===== =======
- ----------
(1) Includes assets classified as either available for sale or held for sale.
(2) Total decrease in investment securities on a nontaxable equivalent basis
would be $(480) and $(451) for the 2005 and the 2004 comparisons,
respectively, resulting in a (decrease) increase in net interest income of
$(123) and $232, respectively.
45
RESULTS OF OPERATIONS
GENERAL. The Company reported net income of $610,000, $2.2 million and $2.7
million for the years ended September 30, 2005, 2004 and 2003, respectively.
The $1.6 million decrease in net income for the year ended September 30,
2005 compared to the year ended September 30, 2004 was primarily due to a $1.5
million increase in the provision for loan losses partially offset by a decrease
of $639,000 in income tax expense. In addition, the decrease also reflected the
effects of a $123,000, or 1.1%, decrease in net interest income combined with a
$319,000, or 2.6%, increase in non-interest expense combined with a $310,000, or
8.0%, decrease in non-interest income.
The $536,000 decrease in net income for the year ended September 30, 2004
compared to the year ended September 30, 2003 was primarily due to a $2.1
million, or 20.2%, increase in non-interest expense partially offset a $613,000,
or 18.7%, increase in non-interest income, a $646,000, or 6.2%, increase in net
interest income after provision for loan loss combined with a $306,000, or
48.4%, decrease in income tax expense.
NET INTEREST INCOME. Net interest income is determined by the interest rate
spread (the difference between the yields earned on interest-earning assets and
the rates paid on interest-bearing liabilities) and the relative amounts of
interest-earning assets and interest-bearing liabilities. All yields are
reported on a fully tax-equivalent basis (see the tables on the prior page for a
recalculation of such percentages in accordance with GAAP). The Company's
average interest-rate spread was 2.16%, 2.21% and 2.26% for the years ended
September 30, 2005, 2004, and 2003, respectively. The Company's interest-rate
spread was 2.44% at September 30, 2005. The Company's net interest margin (net
interest income as a percentage of average interest-earning assets) was 2.18%,
2.23% and 2.30% for the years ended September 30, 2005, 2004 and 2003,
respectively. During fiscal 2005, the interest rate compression experienced by
the Company reflected the impact on the rates paid there on the Company's
interest-bearing liabilities as a result of the increases in short-term interest
rates. However, during fiscal 2004, the Company's margin compression primarily
reflected the effects of the accelerated rate of repayments and prepayments of
loans and mortgage-related securities experienced by the Company requiring it to
reinvest the resulting proceeds at then current lower market rates of interest
without a corresponding decrease in the rates paid on deposits and borrowings.
Market rates of interest did not start to increase until the summer of 2004.
Thus the full effect of the rise in interest rates was not experienced until
fiscal 2005.
Net interest income decreased to $11.3 million in fiscal 2005 as compared
to $11.4 million in fiscal 2004. The $123,000, or 1.1%, decrease came as a
result of a $1.1 million, or 7.2%, increase in interest expense partially offset
by a $933,000, or 3.6%, increase in interest income. The increase in net
interest income was primarily due to the increase in short-term interest rates
impacting the rates paid on the Company's interest-bearing core deposits,
certificates of deposit and floating-rate borrowings more rapidly than its
interest-earning assets.
For the year ended September 30, 2004, net interest income increased to
$11.4 million as compared to $11.2 million in fiscal 2003. The $231,000, or
2.1%, increase came as a result of a $1.3 million, or 8.1%, decrease in interest
expense partially offset by a $1.1 million, or 3.9%, decrease in interest
income. The increase in net interest income was primarily due to the
historically low interest rate environment impacting the rates paid on the
Company's interest-bearing core deposits and certificates of deposit which
repriced downward to a greater degree than its interest-earning assets.
INTEREST INCOME. The $933,000, or 3.6%, increase in total interest income
during the year ended September 30, 2005 as compared to fiscal 2004 was
primarily due to a $925,000, or 17.5%, increase in interest income from
mortgage-related securities as a result of a $18.0 million, or 13.1%, increase
in the average balance of the mortgage-related securities portfolio combined
with a 15 basis point increase in the yield earned. Additionally, interest
income on loans increased $397,000, or 2.3%, due to an $8.7 million, or 2.9%,
increase in the average balance of the loan portfolio offset partially by a 4
basis point decrease in the average yield earned. The increase in interest
income was offset, in part, by a $480,000, or 14.8%, decrease in interest income
on investment securities as a result of a $20.4 million, or 24.3%, increase in
the average balance offset, in part, by a 59 basis point increase in the yield
earned on such assets. The increase in interest income was primarily due to the
increase in the overall yield earned on investment and mortgage-related
securities resulting from the slowdown of prepayments and the reinvestment of
proceeds being reinvested at higher market interest rates.
46
The $1.1 million, or 3.9%, decrease in total interest income during the
year ended September 30, 2004 as compared to fiscal 2003 was primarily due to a
$1.4 million, or 7.4%, decrease in interest on loans reflecting in large part
the 59 basis point decrease in the average yield earned offset partially by a
$5.3 million, or 1.8%, increase in the average balance of the loan portfolio.
The decline in yield was due to the continued low interest rate environment
experienced in fiscal 2004 causing repayments of loans with the proceeds being
reinvested in lower yielding assets. Additionally, interest income on investment
securities and interest-bearing deposits decreased $495,000, or 13.0%, due to a
45 basis point decrease in the weighted average yield earned combined with a
$2.5 million, or 2.5%, decrease in the average balance. The decline in the yield
was primarily due to the low interest rate environment resulting in the
acceleration of repayment and prepayment of such securities, the proceeds were
being reinvested in lower yielding assets. The decrease was offset, in part, by
an increase in interest income on mortgage-related securities as a result of a
$22.4 million, or 19.5%, increase in the average balance offset by a 3 basis
point decrease in the yield earned on such assets.
INTEREST EXPENSE. Total interest expense amounted to $15.8 million for the
year ended September 30, 2005 as compared to $14.7 million for fiscal 2004. The
$1.1 million, or 7.2%, increase in fiscal 2005 compared to fiscal 2004 reflected
a $568,000, or 8.0%, increase in interest expense on borrowings combined with a
$370,000, or 6.3%, and $118,000, or 7.0% increase in interest expense on
deposits and junior subordinated debentures, respectively. The increase in
interest expense on borrowings was due to a $5.5 million increase in the average
balance of borrowings along with a 20 basis point increase in the average rate
paid. The increase in interest expense on deposits was due primarily to a 10
basis point increase in the average rate paid thereon and, to a lesser degree, a
$1.3 million increase in the average balance of deposits. The increase in
interest expense on junior subordinated debentures was due to a 56 basis point
increase in the average rate paid. The increase in the overall cost of funds was
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.
Total interest expense amounted to $14.7 million for the year ended
September 30, 2004 as compared to $16.0 million for fiscal 2003. Total interest
expense decreased by $1.3 million, or 8.1%, during the year ended September 30,
2004 compared to fiscal 2003 due to a $1.4 million decrease in interest expense
on deposits partially offset by a $143,000 increase in interest expense on
borrowings. The decrease in interest expense on deposits was due to a 44 basis
point decrease in the average rate paid thereon partially offset by a $4.1
million increase in the average balance of deposits. The increase in interest
expense on borrowings was due to a $24.8 million increase in the average balance
of borrowings offset by a 76 basis point decrease in the average rate paid. The
decrease in the rates paid on deposits and borrowings was due to declining
interest rates experienced during the first three quarters of fiscal year 2004.
PROVISIONS 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 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.
47
For the years ended September 30, 2005, 2004 and 2003, the provisions for
loan losses were $1.8 million, $300,000 and $715,000, respectively. During
fiscal 2005, the Company significantly increased its provision for loan losses
which 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 fiscal
2005 period, 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
September 30, 2005, the Bank had $2.8 million of assets classified as
substandard, $3.8 million classified as doubtful, and no assets classified as
loss as well as $5.9 million identified as special mention. The Company charged
off $344,000 in fiscal 2005 compared to $321,000 in the prior fiscal year. At
September 30, 2005, the Company's allowance for loan losses totaled $3.5 million
which amounted to 68.8% of total non-performing loans and 1.14% of gross loans
receivable. During fiscal 2004, the Company lowered its provision for loan
losses primarily due to its assessment of the amount of losses and charge-offs
it would incur with respect to non-performing commercial real estate loans. The
Company charged off $321,000 in fiscal 2004 compared to $1.1 million in the
prior fiscal year. During fiscal 2003, the Company increased its provision for
loan losses as compared to fiscal 2002 primarily due to its assessment of the
amount of losses it would incur with respect to non-performing commercial real
estate loans.
NON-INTEREST INCOME. For the year ended September 30, 2005, the Company
reported non-interest income of $3.6 million compared to $3.9 million for the
year ended September 30, 2004, a $310,000 or 8.0% decrease. Non-interest income
in fiscal 2004 included a one-time recognition of $550,000 related to a
non-recurring real estate fee. In addition, during fiscal 2005, realized gains
on sale of securities declined due to market opportunities which existed in
fiscal 2004 but not in fiscal 2005 partially offset by an increase in service
charges and other fees.
For the fiscal year ended September 30, 2005, the net gains on sale of
investment and mortgage-related securities decreased $205,000 resulting from the
reduction in gains due primarily to the rising interest rate environment
existing throughout fiscal 2005. This was partially offset by a $342,000, or
27.7%, increase in service charges due to the implementation of additional
fee-based deposit services in fiscal 2004. The full effect was not experienced
until fiscal 2005.
During fiscal 2004, service charges increased $222,000, or 21.9%, as
compared to fiscal 2003, primarily as a result of the implementation of
additional fee-based deposit services in the fourth quarter of fiscal 2004. For
the fiscal year ended September 30, 2004, the net gains on sale of investment
and mortgage-related securities increased $314,000 as compared to fiscal 2003
resulting from realized gains of $2.0 million on securities partially offset by
a $1.1 million pre-tax other-than-temporary impairment of a perpetual preferred
security. The increase in non-interest income during fiscal 2004 was also due to
a recognition of $550,000 non-recurring real estate fee in connection with a
repayment of a commercial real estate loan. Under the terms of the loan, certain
additional contingent payments were due upon repayment of the loan in full. The
rise in mortgage rates experienced during the last quarter of fiscal 2004
reduced the volume of mortgage refinance activity as compared to fiscal 2003
resulting in a decrease of $356,000 in the gain on sale of loans. The reduced
level of mortgage refinance activity also resulted in reduced mortgage broker
activity and reduced gains on sale of loans held for sale. In addition, the
increase in cash surrender value experienced a slower appreciation decreased
$229,000 primarily due to certain insurance policies held by the Bank to fund
certain supplemental retirement benefits in the underlying investment of equity
securities compared to the same period last year.
NON-INTEREST EXPENSE. Non-interest expense include salaries and employee
benefits, occupancy and equipment expense, Federal Deposit Insurance Corporation
(FDIC) deposit insurance premiums, professional fees, data processing expense,
advertising, deposit processing and other items.
Non-interest expense increased $319,000, or 2.6%, for the year ended
September 30, 2005 compared to the year ended September 30, 2004 and was
primarily due to a $486,000 prepayment penalty charge resulting from the
retirement of certain FHLB convertible advances as part of the Company's
deleveraging strategy. In addition, the Company experienced increases of
$309,000, or 24.7%, $292,000, or 33.7%, and $105,000, or 5.8%, in occupancy and
equipment, professional fees and other non-interest expense, respectively. The
increase in occupancy and equipment expense was related to implementation of the
Company's branch expansion plans in fiscal 2005. The increase in professional
fees was due to the additional auditing and legal fees incurred as a result of
complying with additional regulatory requirements combined with professional
costs incurred in connection with a non-performing loan. See Item 1 "-Asset
Quality." Other non-interest expense increased due to the implementation of a
training program as well as increased general
48
administrative expenses. The increase in non-interest expense was partially
offset by $716,000, or 10.5%, decrease in compensation and employee benefit
expense. During fiscal 2004, the Company funded a non-qualified supplemental
retirement plan for certain executive officers of the original ESOP loan through
the prepayment of the last installment due on such loan. In addition, during
fiscal 2005, expenses incurred in connection real estate operations decreased
$200,000. In fiscal 2004, the Company was required to fund a portion of the
operations related to a non-performing loan.
Non-interest expense increased $2.1 million, or 20.2%, for the year ended
September 30, 2004 compared to the year ended September 30, 2003 and was
primarily due to a $1.4 million, or 27.0%, increase in compensation and employee
benefit expense. The increase in compensation and employee benefit expense was
attributable to an additional $598,000 expense relating to the funding of a
non-qualified supplemental retirement plan for certain executive officers.
Additionally, the increase also reflected a $334,000, or 64.7%, increase in the
ESOP expense related to the appreciation of the Company's stock value as well as
the prepayment of the outstanding loan balance on the original loan. In
addition, the Company experienced an increase of $463,000 in compensation and
benefit expense due to the hiring of additional personnel to staff a new branch
as well as to expand the operations of certain lending areas, provide for merit
increases and to fund increased medical insurance premiums. In addition, the
increase in non-interest expense for fiscal 2004 was due to increases of
$148,000, $188,000 and $204,000 in real estate operations, professional fees and
other non-interest expenses, respectively.
INCOME TAXES. The Company recognized income tax benefit of $313,000, for
the year ended September 30, 2005, compared to recognition of income tax expense
of $326,000, or 12.9%, of pre-tax income, for the year ended September 30, 2004.
The Company recognized income tax expense of $632,000, or 18.7%, of pre-tax
income for fiscal 2003. The primary reason for the recognition of an income tax
benefit for fiscal 2005 was the reduction in income before income taxes combined
with the effects of non-taxable earning assets. Comparing fiscal years 2004 and
2003, the primary reason for the decrease in income tax expense was the reduced
level of income.
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, amortization, prepayments and maturities
of outstanding loans and mortgage-related securities, sales of loans, maturities
of investment securities and other short-term investments, borrowings 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 and mortgage-related securities 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 the ability to obtain advances from the FHLB of
Pittsburgh through several credit programs with the FHLB in amounts not to
exceed the Bank's maximum borrowing capacity and subject to certain conditions,
including holding a predetermined amount of FHLB stock as collateral. As an
additional source of funds, the Company has access to the Federal Reserve
discount window, but only after it has exhausted its access to the FHLB of
Pittsburgh. At September 30, 2005, the Company had $96.5 million of outstanding
advances and $16.8 million of overnight borrowings from the FHLB 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 and mortgage-related
securities. The Company uses its sources of funds primarily to meet its ongoing
commitments, to pay maturing savings certificates and savings withdrawals, fund
loan commitments and maintain a portfolio of mortgage related and investment
securities. At September 30, 2005, the total of approved loan commitments
outstanding amounted to $12.7 million. At the same date, commitments under
unused lines of credit and loans in process on construction loans amounted to an
aggregate of $49.9 million. Certificates of deposit scheduled to mature in one
year or less at September 30, 2005 totaled $94.7 million. Based upon its
historical experience, management believes that a significant portion of
maturing deposits will remain with the Company.
The OTS requires that the Bank meet minimum regulatory tangible, core,
tier-1 risk-based and total risk-based capital requirements. At September 30,
2005, the Bank exceeded all regulatory capital requirements and met the capital
requirements for regulatory purposes. See Note 11 to the Consolidated Financial
Statements set forth in Item 8 hereof.
49
The Company's assets consist primarily of its investment in the Bank and
investments in various corporate debt and equity instruments. Its only material
source of income consists of earnings from its investment in the Bank and
interest and dividends earned on other investments. The Company, as a separately
incorporated holding company, has no significant operations other than serving
as the sole stockholder of the Bank and paying interest to its subsidiaries,
First Keystone Capital Trust I and II, for junior subordinated debt issued in
conjunction with the issuance of trust preferred securities. See Note 17 to the
Consolidated Financial Statements set forth in Item 8 hereof. On an
unconsolidated basis, the Company has no paid employees. The expenses primarily
incurred by the Company relate to its reporting obligations under the Securities
Exchange Act of 1934, related expenses incurred as a publicly traded company,
and expenses relating to the issuance of the trust preferred securities and the
junior subordinated debentures issued in connection therewith. Management
believes that the Company has adequate liquidity available to respond to its
liquidity demands. Under applicable federal regulations, the Bank may pay
dividends to the Company (its sole stockholder) within certain limits after
obtaining the approval of the OTS. See Note 11 of the Consolidated Financial
Statements set forth in Item 8 hereof.
DERIVATIVE FINANCIAL INSTRUMENTS, CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
The Company has not used, and has no intention to use, any significant
off-balance sheet financing arrangements for liquidity purposes. The Company's
primary financial instruments with off-balance sheet risk are limited to loan
servicing for others, its obligations to fund loans to customers pursuant to
existing commitments and commitments to purchase and sell mortgage loans. In
addition, the Company has not had, and has no intention to have, any significant
transactions, arrangements or other relationships with any unconsolidated,
limited purpose entities that could materially affect its liquidity or capital
resources. The Company has not, and does not intend to, trade in commodity
contracts.
We anticipate that we will continue to have sufficient funds and
alternative funding sources to meet our current commitments.
The Company's contractual cash obligations as of September 30, 2005 are as
follows:
PAYMENTS DUE BY PERIOD:
--------------------------------------------------------
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
-------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
FHLB borrowings $113,171 $16,818 $5,700 $35,030 $55,623
Junior subordinated debentures 21,520 -- -- -- 21,520
Operating leases 3,598 282 591 523 2,202
-------- ------- ------ ------- -------
Total obligations $138,289 $17,100 $6,291 $35,553 $79,345
======== ======= ====== ======= =======
OFF-BALANCE-SHEET OBLIGATIONS
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Those instruments involve, to varying degrees, elements of
credit risk in excess of the amount recognized in the balance sheet. The
Company's exposure to credit loss in the event of non-performance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual notional amount of those
instruments. The Company uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments (see Note 1
of the Consolidated Financial Statements set forth in Item 8 hereof).
50
The Company's contingent liabilities and commitments as of September 30,
2005 are as follows:
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Line of credit(1) $34,452 $ 6,835 $ 903 $2,242 $24,472
Standby letters of credit 1,539 1,486 53 -- --
Other commitments to make loans 9,585 9,585 -- -- --
Undisbursed funds on previous disbursed loans 13,933 1,464 11,672 797 --
------- ------- ------- ------ -------
Total $59,509 $19,370 $12,628 $3,039 $24,472
======= ======= ======= ====== =======
- ----------
(1) Includes lines of credit for commercial real estate, commercial loans and
home equity loans.
INVESTMENT AND MORTGAGE-RELATED SECURITIES
The Company reviews the investment and mortgage-related securities
portfolios on a periodic basis to specifically review individual securities for
any meaningful decline in market value below amortized cost. The analysis
addresses all securities whose fair value is significantly below amortized cost
at the time of the analysis, with additional emphasis placed on securities whose
fair value has been below amortized cost for an extended period of time. As part
of the periodic review process, the Company utilizes the expertise of outside
professional asset managers who provide an updated assessment of each issuer's
current credit situation based on recent issuer activities, such as quarterly
earnings announcements or other pertinent financial news for the issuer, recent
developments in a particular industry, economic outlook for a particular
industry and rating agency actions.
In addition to issuer-specific financial information and general economic
data, the Company also considers the ability and intent of its operations to
hold a particular security to maturity or until the market value of the security
recovers to a level in excess of the carrying value.
At September 30, 2005, the net unrealized loss on its investment and
mortgage-related securities was $1.3 million, or 1.2% of the amortized cost
basis. The net unrealized gain on its investment assets at September 30, 2004
was $2.7 million, or 1.3% of the amortized cost basis. At September 30, 2005,
the net unrealized loss included gross unrealized gains of $1.3 million and
gross unrealized losses of $2.6 million. Of the securities in an unrealized loss
position, the unrealized loss position longer than 12 months represents $1.2
million, or 3.2% of its amortized cost. Securities with an unrealized loss
longer than 12 months have a fair value of $35.3 million, of which $24.8 million
are mortgage-related.
For all securities that are in an unrealized loss position for an extended
period of time, an evaluation is performed of the specific events attributable
to the decline in the market value of the security. Factors that are considered
are the length of time and extent to which the security's market value has been
below cost as well as the general market conditions, industry characteristics
and the fundamental operating results of the issuer to determine if the decline
is due to changes in interest rates, changes relating to a decline in credit
quality of the issuer, or general market conditions. An additional part of the
evaluation is the Company's intent and ability to hold the security until its
market value has recovered to a level at least equal to the amortized cost. If
the security's unrealized loss is other than temporary, a realized loss is
recognized in the period in which the decline in value is determined to be other
than temporary.
Based on our evaluation as of September 30, 2005, the Company does not
believe any individual unrealized loss represents an other-than-temporary
impairment. In fiscal 2004, the Company recognized a pre-tax
other-than-temporary impairment of $1.1 million with respect to one perpetual
preferred security. A number of factors, including the magnitude of the drop in
the market value of the security below the Company's cost and that recovery was
not expected in a reasonable amount of time, resulted in management's
determination that the decline in value was other-than-temporary. During fiscal
2005, the perpetual preferred security was sold at a pre-tax realized gain of
$250,000.
RECENT ACCOUNTING PRONOUNCEMENTS
For discussion of recent accounting pronouncements, see Note 2 of the
Consolidated Financial Statements set forth in Item 8 hereof.
51
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements of the Company and related notes
presented herein have been prepared in accordance with accounting principles
generally accepted in the United States of America which require 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
prices 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 and repricing characteristics of the
Company's assets and liabilities are critical to the maintenance of acceptable
performance levels.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required herein is incorporated by reference to "Asset and
Liability Management" set forth in Item 7 above.
52
(DELOITTE(R) LOGO) Deloitte Touche LLP
22nd Floor
1700 Market Street
Philadelphia, PA 19103-3984
Tel: 215-246-2300
Fax: 215-569-2441
www.deloitte.com
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF FIRST KEYSTONE FINANCIAL, INC. AND
SUBSIDIARIES - MEDIA, PENNSYLVANIA:
We have audited the accompanying consolidated statements of financial condition
of First Keystone Financial, Inc. and Subsidiaries (the "Company") as of
September 30, 2005 and 2004, and the related consolidated statements of
operations, comprehensive income, stockholders' equity, and cash flows for each
of the three years in the period ended September 30, 2005. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of their internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of First Keystone Financial, Inc. and
Subsidiaries as of September 30, 2005 and 2004, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 2005, in conformity with accounting principles generally accepted
in the United States of America.
As discussed in Note 2, in 2004, the Company applied the provisions of Financial
Accounting Standards Board Interpretation No. 46(R).
Deloitte Touche LLP
- -------------------------------------
Philadelphia, Pennsylvania
December 20, 2005
Member of
Deloitte Touche Tohmatsu
53
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
SEPTEMBER 30,
---------------------
2005 2004
--------- ---------
ASSETS
Cash and amounts due from depository institutions $ 8,321 $ 5,185
Interest-bearing deposits with depository institutions 7,834 12,790
-------- --------
Total cash and cash equivalents 16,155 17,975
Investment securities available for sale 37,019 63,615
Mortgage-related securities available for sale 67,527 97,620
Loans held for sale 41 172
Investment securities held to maturity - at amortized cost (approximate fair
value of $4,290 and $5,370 September 30, 2005 and 2004, respectively) 4,267 5,287
Mortgage-related securities held to maturity - at amortized cost
(approximate fair value of $45,679 and $37,312 at September 30, 2005
and 2004, respectively) 46,654 37,363
Loans receivable (net of allowance for loan losses of $3,475 and $2,039
at September 30, 2005 and 2004, respectively) 301,979 304,248
Accrued interest receivable 2,435 2,577
Real estate owned 760 1,229
Federal Home Loan Bank stock, at cost 9,499 9,827
Office properties and equipment, net 4,782 4,275
Deferred income taxes 2,008 657
Cash surrender value of life insurance 16,835 16,110
Prepaid expenses and other assets 8,163 10,964
-------- --------
Total Assets $518,124 $571,919
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits
Non-interest-bearing $ 18,001 $ 21,046
Interest-bearing 331,693 323,834
-------- --------
Total deposits 349,694 344,880
Advances from Federal Home Loan Bank and other borrowings 113,303 171,149
Junior subordinated debentures 21,520 21,557
Accrued interest payable 1,870 1,783
Advances from borrowers for taxes and insurance 839 815
Accounts payable and accrued expenses 2,705 2,037
-------- --------
Total liabilities 489,931 542,221
-------- --------
Commitments and contingencies (see Note 13 and 14)
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 September 30, 2005 and 2004, 2,023,534
and 1,927,744 shares, respectively 27 27
Additional paid-in capital 12,920 13,609
Employee stock ownership plan (3,185) (3,189)
Treasury stock at cost: 689,022 and 784,812 shares at September 30, 2005
and 2004, respectively (10,590) (11,913)
Accumulated other comprehensive (loss) income (209) 1,734
Retained earnings-partially restricted 29,230 29,430
-------- --------
Total stockholders' equity 28,193 29,698
-------- --------
Total Liabilities and Stockholders' Equity $518,124 $571,919
======== ========
See notes to consolidated financial statements.
54
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED SEPTEMBER 30,
------------------------------------
2005 2004 2003
---------- ---------- ----------
INTEREST INCOME:
Interest and fees on loans $ 17,926 $ 17,529 $ 18,937
Interest and dividends on:
Mortgage-related securities 6,223 5,298 4,464
Investment securities:
Taxable 1,491 2,127 2,295
Tax-exempt 755 842 1,040
Dividends 514 271 356
Interest-bearing deposits 167 76 120
---------- ---------- ----------
Total interest income 27,076 26,143 27,212
---------- ---------- ----------
INTEREST EXPENSE:
Interest on:
Deposits 6,280 5,910 7,352
Federal Home Loan Bank advances and other borrowings 7,694 7,126 6,983
Junior subordinated debentures 1,794 1,676 1,677
---------- ---------- ----------
Total interest expense 15,768 14,712 16,012
---------- ---------- ----------
Net interest income 11,308 11,431 11,200
Provision for loan losses 1,780 300 715
---------- ---------- ----------
Net interest income after provision for loan losses 9,528 11,131 10,485
---------- ---------- ----------
NON-INTEREST INCOME:
Service charges and other fees 1,577 1,235 1,013
Net gain on sale of:
Investments and mortgage-related securities 709 914 600
Loans held for sale 93 54 410
Increase in cash surrender value 725 731 960
Other real estate fees -- 550 --
Other income 485 415 303
---------- ---------- ----------
Total non-interest income 3,589 3,899 3,286
---------- ---------- ----------
NON-INTEREST EXPENSE:
Salaries and employee benefits 6,091 6,807 5,358
Occupancy and equipment 1,562 1,253 1,242
Professional fees 1,159 867 679
Federal deposit insurance premium 48 53 55
Operations of real estate owned (14) 186 38
Data processing 526 478 467
Advertising 413 423 397
Deposit processing 638 628 562
Prepayment penalty on FHLB advances 486 -- --
Other 1,911 1,806 1,602
---------- ---------- ----------
Total non-interest expense 12,820 12,501 10,400
---------- ---------- ----------
Income before income tax (benefit) expense 297 2,529 3,371
Income tax (benefit) expense (313) 326 632
---------- ---------- ----------
Net income $ 610 $ 2,203 $ 2,739
========== ========== ==========
Earnings per common share:
Basic $ 0.33 $ 1.21 $ 1.44
Diluted $ 0.33 $ 1.14 $ 1.35
Weighted average shares - basic 1,842,434 1,820,137 1,901,682
Weighted average shares - diluted 1,871,401 1,937,612 2,028,992
See notes to consolidated financial statements.
55
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
(DOLLARS IN THOUSANDS)
ACCUMULATED RETAINED
ADDITIONAL OTHER EARNINGS- TOTAL
COMMON PAID-IN EMPLOYEE STOCK TREASURY COMPREHENSIVE PARTIALLY STOCKHOLDERS'
STOCK CAPITAL OWNERSHIP PLAN STOCK INCOME (LOSS) RESTRICTED EQUITY
------ ---------- -------------- -------- ------------- ---------- -------------
Balance at October 1, 2002 $27 $13,609 $ (995) $ (9,175) $ 3,200 $26,129 $32,795
--- ------- ------- -------- ------- ------- -------
Comprehensive income:
Net income -- -- -- -- -- 2,739 2,739
Other comprehensive income, net of tax:
Net unrealized loss on securities
net of reclassification adjustment(1) -- -- -- -- (131) -- (131)
--- ------- ------- -------- ------- ------- -------
Comprehensive income -- -- -- -- -- -- 2,608
--- ------- ------- -------- ------- ------- -------
ESOP stock committed to be released -- -- 165 -- -- -- 165
Excess of fair value above cost of ESOP
shares committed to be released -- 231 -- -- -- -- 231
Exercise of stock options -- (410) -- 783 -- -- 373
Purchase of treasury stock -- -- -- (2,986) -- -- (2,986)
Dividends paid -- -- -- -- -- (798) (798)
--- ------- ------- -------- ------- ------- -------
Balance at September 30, 2003 $27 $13,430 $ (830) $(11,378) $ 3,069 $28,070 $32,388
=== ======= ======= ======== ======= ======= =======
Comprehensive income:
Net income -- -- -- -- -- 2,203 2,203
Other comprehensive income, net of tax:
Net unrealized loss on securities
Net of reclassification adjustment(1) -- -- -- -- (1,335) -- (1,335)
--- ------- ------- -------- ------- ------- -------
Comprehensive income -- -- -- -- -- -- 868
--- ------- ------- -------- ------- ------- -------
ESOP stock committed to be released -- -- 220 -- -- -- 220
Common stock acquired by stock benefit plan -- -- (2,579) -- -- -- (2,579)
Excess of fair value above cost of ESOP
shares committed to be released -- 417 -- -- -- -- 417
Exercise of stock options -- (238) -- 804 -- -- 566
Purchase of treasury stock -- -- -- (1,339) -- -- (1,339)
Dividends paid -- -- -- -- -- (843) (843)
--- ------- ------- -------- ------- ------- -------
Balance at September 30, 2004 $27 $13,609 $(3,189) $(11,913) $ 1,734 $29,430 $29,698
=== ======= ======= ======== ======= ======= =======
Comprehensive income:
Net income -- -- -- -- -- 610 610
Other comprehensive income, net of tax:
Net unrealized loss on securities
Net of reclassification adjustment(1) -- -- -- -- (1,943) -- (1,943)
--- ------- ------- -------- ------- ------- -------
Comprehensive loss -- -- -- -- -- -- (1,333)
--- ------- ------- -------- ------- ------- -------
ESOP stock committed to be released -- -- 76 -- -- -- 76
Common stock acquired by stock benefit plan -- -- (72) -- -- -- (72)
Excess of fair value above cost of ESOP
shares committed to be released -- 88 -- -- -- -- 88
Exercise of stock options -- (777) -- 1,433 -- -- 656
Purchase of treasury stock -- -- -- (110) -- -- (110)
Dividends paid -- -- -- -- -- (810) (810)
--- ------- ------- -------- ------- ------- -------
Balance at September 30, 2005 $27 $12,920 $(3,185) $(10,590) $ (209) $29,230 $28,193
=== ======= ======= ======== ======= ======= =======
(1) Disclosure of reclassification amount, net of tax for the years ended:
2005 2004 2003
------- ------- -----
Net unrealized (depreciation) appreciation arising during the year $(2,411) $(1,938) $ 265
Less: reclassification adjustment for net gains included in net income
(net of tax $241, $311 and $204, respectively) 468 603 396
------- ------- -----
Net unrealized loss on securities $(1,943) $(1,335) $(131)
======= ======= =====
See notes to consolidated financial statements.
56
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30,
---------------------------------
2005 2004 2003
--------- --------- ---------
OPERATING ACTIVITIES:
Net income $ 610 $ 2,203 $ 2,739
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Provision for depreciation and amortization 534 473 426
Amortization of premiums and discounts 582 540 1,203
Increase in cash surrender value of life insurance (725) (745) (1,003)
(Gain) loss on sales of:
Loans held for sale (93) (54) (410)
Investment securities available for sale (1,499) (619) (660)
Mortgage-related securities available for sale 790 (295) 60
Real estate owned (20) -- 1
Provision for loan losses 1,780 300 715
Amortization of ESOP 164 637 396
Deferred income taxes (81) (550) 225
Insurance proceeds on real estate owned 29 -- --
Changes in assets and liabilities which provided (used) cash:
Origination of loans held for sale (13,620) (9,671) (30,995)
Loans sold in the secondary market 13,751 9,814 26,998
Accrued interest receivable 142 77 317
Prepaid expenses and other assets 2,532 (6,779) (1,622)
Accrued interest payable 87 (16) (138)
Accrued expenses 668 (1,379) (1,224)
--------- --------- ---------
Net cash provided by (used in) operating activities 5,631 (6,064) (2,972)
--------- --------- ---------
INVESTING ACTIVITIES:
Loans originated (130,133) (130,824) (174,407)
Purchases of:
Investment securities available for sale (9,700) (8,579) (23,334)
Investment securities held to maturity -- -- (6,329)
Mortgage-related securities available for sale (41,934) (22,329) (132,141)
Mortgage-related securities held to maturity (18,591) (37,856) --
Redemption (purchase) of FHLB stock 328 (1,533) (1,723)
Proceeds from sales of investment and mortgage-related securities available
for sale 74,056 16,485 14,600
Proceeds from sales of real estate owned 435 376 150
Principal collected on loans 130,830 116,894 175,198
Proceeds from maturities, calls or repayments of:
Investment securities available for sale 3,527 13,454 20,793
Investment securities held to maturity 1,000 1,000 --
Mortgage-related securities available for sale 28,006 40,344 83,135
Mortgage-related securities held to maturity 9,110 3,924 5,369
Purchase of property and equipment (1,041) (1,321) (362)
--------- --------- ---------
Net cash provided by (used in) investing activities 45,893 (9,965) (39,051)
--------- --------- ---------
FINANCING ACTIVITIES:
Net increase (decrease) in deposit accounts 4,814 (17,725) 31,840
Net (decrease) increase in FHLB advances and other borrowings (57,846) 34,877 10,035
Net increase (decrease) in advances from borrowers for taxes and insurance 24 (143) 126
Common stock acquired by ESOP (72) (2,579) --
Proceeds from exercise of stock options 656 566 373
Purchase of treasury stock (110) (1,339) (2,986)
Cash dividends (810) (843) (798)
--------- --------- ---------
Net cash (used in) provided by financing activities (53,344) 12,814 38,590
--------- --------- ---------
Decrease in cash and cash equivalents (1,820) (3,215) (3,433)
Cash and cash equivalents at beginning of year 17,975 21,190 24,623
--------- --------- ---------
Cash and cash equivalents at end of year $ 16,155 $ 17,975 $ 21,190
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW AND NON-CASH INFORMATION:
Cash payments for interest on deposits and borrowings $ 15,681 $ 14,362 $ 16,174
Cash payments of income taxes 654 959 800
Fair value adjustment to investments available for sale -- 1,074 --
Transfer of loans held for sale to loan portfolio -- 4,186 --
Transfers of loans receivable into real estate owned -- 153 2,122
See notes to consolidated financial statements.
57
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. NATURE OF OPERATIONS AND ORGANIZATION STRUCTURE
The primary business of First Keystone Financial, Inc. (the "Company") is
to act as the holding company for its principal wholly owned subsidiary, First
Keystone Bank (the "Bank"), a federally chartered stock savings association
founded in 1934. The Bank has two active subsidiaries, FKF Management Corp.,
Inc. which manages investment securities, and State Street Services Corporation,
which holds an ownership interest in a title company as well as a 51% interest
in First Keystone Insurance Services ("First Keystone Insurance"), an insurance
agency, which is consolidated into the Company's financial statements. Effective
with the adoption of Financial Accounting Standards Board ("FASB")
Interpretation ("FIN") No. 46 and FIN 46(R) (see "Recent Accounting
Pronouncements", below), on December 31, 2003, the Company deconsolidated First
Keystone Capital Trust I and First Keystone Capital Trust II, (collectively the
"Issuer Trusts"). The Issuer Trusts were formed in connection with the issuance
of trust preferred securities.
The primary business of the Bank is to offer a wide variety of commercial
and retail products through its branch system located in Delaware and Chester
counties in Pennsylvania. The Bank is primarily supervised and regulated by the
Office of Thrift Supervision ("OTS").
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company, the Bank and the Company's and the Bank's wholly owned
subsidiaries. In addition, the Company consolidates First Keystone Insurance in
which one of the Bank's subsidiaries holds a 51% ownership interest. The Company
evaluated Statement of Financial Accounting Standards ("SFAS") No. 131,
"Disclosure about Segments of an Enterprise and Related Information," and
determined the Company operates in one segment and that is Banking. Intercompany
accounts and transactions have been eliminated in consolidation.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the dates of the consolidated financial statements and the
reported amounts of income and expense during the reporting periods. Actual
results could differ from those estimates.
SECURITIES HELD TO MATURITY AND SECURITIES AVAILABLE FOR SALE
Securities held to maturity are carried at amortized cost. Securities are
designated as held to maturity only if the Company has the positive intent and
ability to hold these securities to maturity. Securities available for sale are
carried at fair value with the resulting unrealized gains or losses recorded in
equity, net of tax. Premiums are amortized and discounts are accreted using the
interest method over the estimated remaining term of the underlying security.
For the years ended September 30, 2005 and 2004, the Company did not maintain a
trading portfolio.
OTHER-THAN-TEMPORARY IMPAIRMENT OF SECURITIES
Securities are evaluated on at least a quarterly basis and more frequently
when economic or market conditions warrant such an evaluation to determine
whether a decline in their value is other than temporary. Management utilizes
criteria such as the magnitude and duration of the decline and the intent and
ability of the Company to retain its investment in the issues for a period of
time sufficient to allow for an anticipated recovery in fair value, in addition
to the reasons underlying the decline, to determine whether the loss in value is
other than temporary. The term "other than temporary" is not intended to
indicate that the decline is permanent, but indicates that the prospects for a
near-term recovery of value is not necessarily favorable, or that there is a
lack of evidence to support a realizable value equal to or greater than carrying
value of the investment. Once a decline in value is determined to be other than
temporary, the value of the security is reduced and a corresponding charge to
earnings is recognized.
58
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
ALLOWANCE FOR LOAN LOSSES
An allowance for loan losses is maintained at a level that management
considers adequate to provide for probable losses based upon an evaluation of
known and inherent losses in the loan portfolio that are both probable and
reasonably estimated. The Company is constantly challenging the methodology,
conducting assessments and redefining the process to determine the appropriate
level of allowance for loan losses. In establishing the allowance for loan
losses, management must use 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. While management uses the best information available to make such
evaluation, future adjustments to the allowance may be necessary if conditions
differ substantially from the assumptions used in making the evaluations.
Impaired loans are predominantly measured based on the fair value of the
collateral. The provision for loan losses charged to expense is based upon past
loan loss experience and an evaluation of probable losses and impairment
existing in the current loan portfolio. A loan is considered to be impaired
when, based upon current information and events, it is probable that the Company
will be unable to collect all amounts due in accordance with the original
contractual terms of the loan. An insignificant delay or insignificant shortfall
in amounts of payments does not necessarily result in the loan being identified
as impaired. For this purpose, delays of less than 90 days are considered to be
insignificant. Large groups of smaller balance homogeneous loans, including
residential real estate and consumer loans, are collectively evaluated for
impairment, except for loans restructured pursuant to a troubled debt
restructuring.
Loans secured by residential real estate, including home equity and home
equity lines of credit, are classified as nonaccrual at 90 days past due, and
are recorded at cost. Loans other than consumer loans are charged-off based on
the facts and circumstances of the individual loan. Consumer loans are generally
charged-off in the month they become 180 days past due.
MORTGAGE BANKING ACTIVITIES
The Company originates mortgage loans held for investment and for sale. At
origination, the mortgage loan is identified as either held for sale or for
investment. Mortgage loans held for sale are carried at the lower of cost or
forward committed contracts (which approximates market).
At September 30, 2005, 2004 and 2003, loans serviced for others totaled
approximately $55,378, $50,862 and $51,547, respectively. Servicing loans for
others consists of collecting mortgage payments, maintaining escrow accounts,
disbursing payments to investors, and processing foreclosures. Loan servicing
income is recorded when earned and includes servicing fees from investors and
certain charges collected from borrowers, such as late payment fees. The Company
has fiduciary responsibility for related escrow and custodial funds aggregating
approximately $451 and $318 at September 30, 2005 and 2004, respectively.
The Company assesses the retained interest in the servicing asset or
liability associated with the sold loans based on the relative fair values. The
servicing asset or liability is amortized in proportion to and over the period
during which estimated net servicing income or net servicing loss, as
appropriate, will be received. Assessment of the fair value of the retained
interest is performed on a quarterly basis. At September 30, 2005 and 2004,
mortgage servicing rights totaling $288 and $240, respectively, were included in
other assets.
59
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
TRANSFERS OF FINANCIAL ASSETS
Transfers of financial assets are accounted for as sales when control over
the assets has been surrendered. Control is surrendered when (1) the assets have
been isolated from the Company, (2) the transferee obtains the right (free of
conditions that constrain it from taking advantage of that right) to pledge or
exchange the transferred assets, and (3) the Company does not maintain effective
control over the transferred assets through an agreement to repurchase them
before their maturity.
INCOME RECOGNITION ON LOANS
Interest on loans is credited to income when earned. Accrual of loan
interest is discontinued and a reserve established through a charge to interest
income on existing accruals if management believes after considering, among
other things, economic and business conditions and collection efforts, that the
borrowers' financial condition is such that collection of interest is doubtful.
Such interest ultimately collected is credited to income when collection of
principal and interest is no longer in doubt.
REAL ESTATE OWNED
Real estate owned consists of properties acquired by foreclosure or deed
in-lieu of foreclosure. These assets are initially recorded at the lower of
carrying value of the loan or estimated fair value less selling costs at the
time of foreclosure and at the lower of the new cost basis or net realizable
value thereafter. The amounts recoverable from real estate owned could differ
materially from the amounts used in arriving at the net carrying value of the
assets at the time of foreclosure because of future market factors beyond the
control of the Company. Costs relating to the development and improvement of
real estate owned properties are capitalized and those relating to holding the
property are charged to expense.
OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are recorded at cost. Depreciation is
computed using the straight-line method over the expected useful lives of the
assets which range from two to 40 years. The costs of maintenance and repairs
are expensed as they are incurred, and renewals and betterments are capitalized.
CASH SURRENDER VALUE OF LIFE INSURANCE
The Bank funded the purchase of insurance policies on the lives of certain
officers and employees of the Bank. The Bank has recognized any increase in cash
surrender value of life insurance, net of insurance costs in the consolidated
statements of income. The cash surrender value of the insurance policies is
recorded as an asset in the statements of financial condition.
INTEREST RATE RISK
At September 30, 2005 and 2004, the Company's assets consisted primarily of
assets that earned interest at either adjustable or fixed interest rates and the
average life of which is longer term. At September 30, 2005, the Bank had
interest-earning assets of approximately $468.3 million having a weighted
average effective yield of 5.54% and interest-bearing liabilities of
approximately $484.5 million with a weighted average cost of 3.10%. These assets
were funded primarily with shorter term liabilities that have interest rates
which vary over time with market rates and, in some cases, certain call features
that are affected by changes in market rates of interest. The shorter duration
of the interest-sensitive liabilities indicates that the Company is exposed to
interest rate risk because, in a rising rate environment, liabilities will be
repricing faster at higher interest rates, thereby reducing the market value of
long-term assets and net interest income.
60
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed based on the weighted average
number of shares of common stock outstanding. Diluted earnings per common share
is computed based on the weighted average number of shares of common stock
outstanding increased by the number of common shares that are assumed to have
been purchased with the proceeds from the exercise of stock options. Weighted
average shares used in the computation of earnings per share were as follows:
YEAR ENDED SEPTEMBER 30,
---------------------------------
2005 2004 2003
--------- --------- ---------
Average common shares outstanding 1,842,434 1,820,137 1,901,682
Increase in shares due to options 28,967 117,475 127,310
--------- --------- ---------
Adjusted shares outstanding - diluted 1,871,401 1,937,612 2,028,992
========= ========= =========
For the years ended September 30, 2005, 2004 and 2003, there were no
outstanding options that were antidilutive.
INCOME TAXES
Deferred income taxes are recognized for the tax consequences of temporary
differences by applying enacted statutory tax rates applicable to future years
to differences between the financial statement carrying amounts and the tax
bases of existing assets and liabilities. The effect on deferred taxes of a
change in tax rates is recognized in income in the period that includes the
enactment date.
ACCOUNTING FOR STOCK OPTIONS
The Company accounts for stock options in accordance with SFAS No. 123,
"Accounting for Stock-Based Compensation," which allows an entity to choose
between the intrinsic value method, as defined in Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," or the fair
value method of accounting for stock-based compensation described in SFAS No.
123. An entity using the intrinsic value method must disclose pro forma net
income and earnings per share as if stock-based compensation was accounted for
using the fair value method. The Company continues to account for stock-based
compensation using the intrinsic value method and, accordingly, has not
recognized compensation expense under this method.
In December 2002, FASB issued SFAS" No. 148, "Accounting for Stock-Based
Compensation --Transition and Disclosure, an amendment of FASB Statement No.
123." SFAS No. 148 amends SFAS No. 123 to provide alternative methods of
transition in connection with a voluntary change to the fair value based method
of accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results.
Had the Company determined compensation expense based on the fair value at
the grant date for its stock options under SFAS No. 123, the Company's net
income and income per share would have been reduced to the pro forma amounts
indicated below:
YEAR ENDED SEPTEMBER 30,
------------------------
2005 2004 2003
----- ------ ------
Net income, as reported $610 $2,203 $2,739
Add: Total stock-based employee compensation expense
included in reported net income (net of tax) -- -- --
Deduct: Total stock-based employee compensation expense
determined under fair value method (net of tax) (17) (20) (74)
---- ------ ------
Pro forma net income $593 $2,183 $2,665
==== ====== ======
61
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income:
As reported $ 610 $2,203 $2,739
Pro forma 593 2,183 2,665
Net income per common and common equivalent share:
Earnings per common share - diluted
- As reported $0.33 $ 1.14 $ 1.35
- Pro forma 0.33 1.13 1.31
Weighted average fair value of options granted during
the period $7.30 N/A $ 4.83
The binomial option-pricing model was used to determine the fair value of
options at the grant date. Significant assumptions used to calculate the above
fair value of the awards are as follows:
SEPTEMBER 30,
------------------
2005 2004 2003
---- ---- ----
Risk-free interest rate of return 4.04% N/A 3.03%
Expected option life (months) 120 N/A 100
Expected volatility 34% N/A 27%
Expected dividends 2.2% N/A 1.8%
In December 2004, the FASB issued SFAS No. 123 (Revised 2004), "Share-Based
Payment" (SFAS No. 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 No. 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 No. 123(R) becomes effective at the
beginning of the fiscal year that begins after June 15, 2005. Accordingly, the
Company adopted SFAS No. 123(R) on October 1, 2005 and will use the modified
prospective method. In management's opinion, the impact of adopting SFAS No.
123(R) will be generally consistent with the impact disclosed above pursuant to
the pro forma disclosure requirements of SFAS No. 123.
OTHER COMPREHENSIVE INCOME
The Company presents as a component of comprehensive income the amounts
from transactions and other events which currently are excluded from the
statement of income and are recorded directly as an adjustment to stockholders'
equity.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS
In April 2004, the FASB issued SFAS Statement No.149, "Amendment of
Statement No.133 on Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments,
including derivatives imbedded in other contracts and hedging activities. SFAS
No. 133 "Accounting for Derivative Instruments and Hedging Activities," as
amended by SFAS Nos. 137 and 138 and interpreted by the FASB and the Derivative
Implementation Group through Statement 133 Implementation Issues, requires that
an entity recognize all derivatives as either assets or liabilities in the
statement of financial condition and measure those instruments at fair value. In
accordance with SFAS No. 149 and SFAS No. 133, the accounting for changes in the
fair value of a derivative depends on the intended use of the derivative and the
resulting designation. The Company's derivative instruments outstanding during
fiscal year end September 30, 2005 include commitments to fund loans
held-for-sale and forward loan sale agreements. Currently, the Company does not
have any embedded derivatives and does not employ hedging activities.
62
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include
cash and amounts due from depository institutions and interest-bearing deposits
with depository institutions. The Company is required to maintain certain
balances at Federal Reserve Bank which amounted to $1,176.
RECENT ACCOUNTING PRONOUNCEMENTS
On November 3, 2005, the FASB issued FASB Staff Position ("FSP") Nos. FAS
115-1 and FAS 124-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments." This FSP addresses the determination as to
when an investment is considered impaired, whether that impairment is other than
temporary, and the measurement of an impairment loss. This FSP also includes
accounting considerations subsequent to the recognition of an
other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. This FSP nullifies certain requirements of EITF Issue 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments", and supersedes EITF Topic No. D-44, "Recognition of
Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost
Exceeds Fair Value." The guidance in this FSP amends SFAS Statement No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." The FSP is
effective for reporting periods beginning after December 15, 2005. The Company
intends to adopt this guidance on January 1, 2006.
"In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections- a replacement of APB Opinion No. 20 and FASB Statement No. 3". SFAS
No. 154 replaces APB Opinion No. 20, "Accounting Changes," and FASB Statement
No. 3, "Reporting Accounting Changes in Interim Financial Statements," and
changes the accounting and reporting requirements for a change in accounting
principle. SFAS No. 154 applies to all voluntary changes in an accounting
principle, as well as to changes required by a new accounting pronouncement in
the unusual instance that the pronouncement does not include specific transition
provisions. SFAS No. 154 is effective for accounting changes and error
corrections made in fiscal years beginning after December 15, 2005 and requires
retrospective application to prior periods' financial statements for most
voluntary changes in an accounting principle, unless it is impracticable to do
so. The Company does not anticipate any material impact to its financial
condition or results of operations as a result of the adoption of SFAS No. 154.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." In December 2003, the FASB issued a revision of FIN 46 (FIN
46(R)). The Interpretation clarifies the application of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," to certain entities in
which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. The Company has participated in the issue of trust preferred
securities through trusts established for such purpose. These trusts are subject
to the requirements of FIN No. 46 and FIN No. 46(R). Effective December 31,
2003, the Company adopted FIN No. 46(R). requiring the Company to deconsolidate
the trust preferred security trusts. The Company previously classified its trust
preferred securities after total liabilities and before stockholders' equity on
the Consolidated Statements of Financial Condition. Under the provisions of FIN
No. 46(R), these securities were reclassified as borrowed funds effective
December 31, 2003. Additionally, the related dividends were reclassified from
non-interest expense and included in interest expense in the consolidated
statements of income. Reclassifications of prior period amounts were made to
conform to this presentation. The Company is not a party to any other variable
interest entities covered by FIN No. 46(R). The adoption of FIN No. 46(R) did
not have a material impact on the Company's financial statements.
RECLASSIFICATIONS
Certain reclassifications have been made to the September 30, 2004 and 2003
consolidated financial statements to conform to the September 30, 2005
presentation. Such reclassifications had no impact on the reported net income.
63
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
3. 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:
SEPTEMBER 30, 2005
-------------------------------------------------
GROSS GROSS APPROXIMATE
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
--------- ---------- ---------- -----------
Available for Sale:
U.S. Government bonds
5 to 10 years $ 1,997 $ -- $ (18) $ 1,979
Municipal obligations
5 to 10 years 130 4 -- 134
Over 10 years 12,633 494 (18) 13,109
Corporate bonds
1 to 5 years 1,000 71 -- 1,071
5 to 10 years 2,000 -- (47) 1,953
Over 10 years 7,990 34 (19) 8,005
Asset-backed securities
1 to 5 years 590 3 -- 593
Mutual funds 8,846 -- (253) 8,593
Other equity investments 978 604 -- 1,582
------- ------ ----- -------
Total $36,164 $1,210 $(355) $37,019
------- ------ ----- -------
Held to Maturity:
Municipal obligations
5 to 10 years $ 3,259 $ 28 $ -- $ 3,287
Corporate bonds
Less than 1 year 1,008 -- (5) 1,003
------- ------ ----- -------
Total $ 4,267 $ 28 $ (5) $ 4,290
======= ====== ===== =======
Provided below is a summary of investment securities available for sale and
held to maturity which were in an unrealized loss position at September 30,
2005.
LOSS POSITION LOSS POSITION
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
----------------------- ----------------------- -----------------------
UNREALIZED UNREALIZED UNREALIZED
FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
---------- ---------- ---------- ---------- ---------- ----------
U.S. Government and agency bonds $1,979 $(18) $ -- $ -- $ 1,979 $ (18)
Corporate bonds 2,642 (24) 1,953 (47) 4,595 (71)
Municipal bonds 983 (18) -- -- 983 (18)
Mutual fund -- -- 8,593 (253) 8,593 (253)
------ ---- ------- ----- ------- -----
Total $5,604 $(60) $10,546 $(300) $16,150 $(360)
====== ==== ======= ===== ======= =====
64
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
At September 30, 2005, investment securities in a gross unrealized loss
position for twelve months or longer consist of three securities having an
aggregate depreciation of 2.8% 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
particularly given the negligible inherent credit risk associated with these
securities. These investment securities are comprised of securities that are
rated investment grade by at least one bond credit rating service. Although the
fair value will fluctuate as the market interest rates move, management believes
that these fair values will recover as the underlying portfolios mature and are
reinvested in market rate yielding investments. Mutual funds in an unrealized
loss position for 12 months or longer consist of two funds primarily invested in
asset-backed securities and have an aggregate depreciation of 2.9%. The Company
has the ability and intent to hold these securities until such time as the value
recovers or the securities mature. Management does not believe any individual
unrealized loss as of September 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 APPROXIMATE
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS 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
Mutual funds 14,009 -- (205) 13,804
Asset-backed securities
1 to 5 years 1,189 8 -- 1,197
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
======= ====== ===== =======
65
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Provided below is a summary of investment securities available for sale and
held to maturity which were in an unrealized loss position at September 30,
2004.
LOSS POSITION LOSS POSITION
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
----------------------- ----------------------- -----------------------
UNREALIZED UNREALIZED UNREALIZED
FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
---------- ---------- ---------- ---------- ---------- ----------
U.S. Government and agency bonds $12,544 $(150) $ 1,951 $ (49) $14,495 $(199)
Corporate bonds 1,995 (5) -- -- 1,995 (5)
Mutual fund -- -- 13,804 (205) 13,804 (205)
------- ----- ------- ----- ------- -----
Total $14,539 $(155) $15,755 $(254) $30,294 $(409)
======= ===== ======= ===== ======= =====
Based on management's evaluation in fiscal year 2004, the Company
recognized a pre-tax other-than-temporary impairment charge of $1,074 resulting
from a determination that a $4,974 investment available for sale in Federal Home
Loan Mortgage Corporation ("FHLMC") floating rate perpetual preferred stock was
impaired due to its decline in value and a determination that it was not
expected to recover in the near future. Such loss was included as a component of
net gain on sale of investment and mortgage-related securities in the
consolidated statements of operations. The FHLMC preferred stock was rated AA-
and was fully performing. During fiscal 2005, the security was sold at a pre-tax
realized gain of $250.
For the years ended September 30, 2005, 2004 and 2003, proceeds from sales
of investment securities available for sale amounted to $32,282, $9,986 and
$7,309, respectively. For such periods, gross realized gains on sales amounted
to $1,957, $1,754 and $660, respectively, while gross realized losses amounted
to $458, $61 and $0, respectively. The tax provision applicable to these net
realized gains amounted to $510, $576 and $224, respectively. Gains are realized
and recorded on the specific identification method.
Investment securities with an aggregate carrying value of $0 and $4,906
were pledged as collateral at September 30, 2005 and 2004, respectively, for
financings.
4. MORTGAGE-RELATED SECURITIES
Mortgage-related securities available for sale and held to maturity are
summarized as follows:
SEPTEMBER 30, 2005
-------------------------------------------------
GROSS GROSS APPROXIMATE
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
--------- ---------- ---------- -----------
Available for Sale:
FHLMC pass-through certificates $ 50 $ 3 $ -- $ 53
FNMA pass-through certificates 23,493 51 (364) 23,180
GNMA pass-through certificates 3,947 12 (39) 3,920
Collateralized mortgage obligations 41,207 3 (856) 40,374
------- --- ------- -------
Total $68,697 $69 $(1,259) $67,527
======= === ======= =======
Held to Maturity:
FHLMC pass-through certificates $17,267 $ 9 $ (371) $16,905
FNMA pass-through certificates 29,084 9 (619) 28,474
Collateralized mortgage obligations 303 -- (3) 300
------- --- ------- -------
Total $46,654 $18 $ (993) $45,679
======= === ======= =======
66
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Provided below is a summary of mortgage-related securities available for
sale and held to maturity which were in an unrealized loss position at September
30, 2005.
LOSS POSITION LOSS POSITION
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
-------------------- -------------------- ---------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
------- ---------- ------- ---------- -------- ----------
Pass-through certificates $54,321 $ (916) $14,893 $(477) $ 69,214 $(1,393)
Collateralized mortgage
obligations 30,206 (485) 9,873 (374) 40,079 (859)
------- ------- ------- ----- -------- -------
Total $84,527 $(1,401) $24,766 $(851) $109,293 $(2,252)
======= ======= ======= ===== ======== =======
At September 30, 2005, mortgage-related securities in a gross unrealized
loss position for twelve months or longer consist of fifteen securities having
an aggregate depreciation of 3.3% from the Company's amortized cost basis.
Management does not believe any individual unrealized loss as of September 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. Management believes that market value
fluctuations in these securities are dependent upon the movement in market
interest rates, particularly given the negligible inherent credit risk
associated with these securities, rather than from the deterioration of the
creditworthiness of the issuer. Accordingly, management does not believe that
any individual unrealized loss as of September 30, 2005 represents an
other-than-temporary impairment. The Company has the ability and intent to hold
these securities until the anticipated recovery of fair value occurs or until
the securities mature.
Mortgage-related securities available for sale and 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
======= ==== ===== =======
67
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Provided below is a summary of mortgage-related securities available for
sale and held to maturity which were in an unrealized loss position at September
30, 2004.
LOSS POSITION LOSS POSITION
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
-------------------- -------------------- --------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
------- ---------- ------- ---------- ------- ----------
Pass-through certificates $30,639 $(285) $ 6,859 $(167) $37,498 $(452)
Collateralized mortgage
obligations 26,003 (233) 6,344 (128) 32,347 (361)
------- ----- ------- ----- ------- -----
Total $56,642 $(518) $13,203 $(295) $69,845 $(813)
======= ===== ======= ===== ======= =====
The collateralized mortgage obligations contain both fixed and
adjustable-rate classes of securities which are repaid in accordance with a
predetermined priority. The underlying collateral of the securities consisted of
loans which are primarily guaranteed by FHLMC, FNMA and GNMA.
For the years ended September 30, 2005, 2004 and 2003, proceeds from sales
of mortgage-related securities available for sale amounted to $41,774, $7,174
and $7,485, respectively. Gross realized gains amounted to $0, $299 and $39 for
the years ended September 30, 2005, 2004 and 2003, respectively. Gross realized
losses amounted to $790, $4, and $99 for the years ended September 30, 2005,
2004 and 2003 respectively. The tax provision (benefit) applicable to these net
realized gains and losses amounted to $(269), $100 and $(20) for the years ended
September 30, 2005, 2004 and 2003, respectively. Gains are realized and recorded
on the specific identification method.
Mortgage-related securities with aggregate carrying values of $15,626 and
$17,064 were pledged as collateral at September 30, 2005 and 2004, respectively,
for municipal deposits, treasury tax, loan processing and financings (see Note
8).
5. ACCRUED INTEREST RECEIVABLE
The following is a summary of accrued interest receivable by category:
SEPTEMBER 30,
---------------
2005 2004
------ ------
Loans $1,456 $1,401
Mortgage-related securities 448 524
Investment securities 531 652
------ ------
Total $2,435 $2,577
====== ======
68
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
6. LOANS RECEIVABLE
Loans receivable consist of the following:
SEPTEMBER 30,
-------------------
2005 2004
-------- --------
Single-family $146,745 $163,907
Construction and land 36,828 38,078
Multi-family and commercial 72,376 64,509
Home equity and lines of credit 46,748 43,621
Consumer loans 1,376 1,471
Commercial loans 16,085 10,624
-------- --------
Total loans 320,158 322,210
Loans in process (14,614) (15,807)
Allowance for loan losses (3,475) (2,039)
Deferred loan fees (90) (116)
-------- --------
Loans receivable net $301,979 $304,248
======== ========
The Company originates loans primarily in its local market area of Delaware
and Chester Counties, Pennsylvania to borrowers that share similar attributes.
This geographic concentration of credit exposes the Company to a higher degree
of risk associated with this economic region.
The Company participates in the origination and sale of fixed-rate
single-family residential loans in the secondary market. The Company recognized
gains on sale of conforming agency loans held for sale of $93, $54 and $410 for
fiscal years ended September 30, 2005, 2004 and 2003, respectively.
The Company offers loans to its directors and senior officers on terms
permitted by Regulation O. There were approximately $4,374, $3,812 and $2,597 of
loans outstanding to senior officers and directors as of September 30, 2005,
2004 and 2003, respectively. The amount of repayments during the years ended
September 30, 2005, 2004 and 2003, totaled $737, $400 and $838, respectively.
There were $1,300, $1,614 and $1,380 of new loans granted during fiscal years
2005, 2004 and 2003, respectively.
The Company had undisbursed portions under consumer and commercial lines of
credit as of September 30, 2005 of $26,253 and $9,062, respectively.
69
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The Company originates both adjustable and fixed interest rate loans and
purchases mortgage-related securities in the secondary market. The originated
adjustable-rate loans have annual and lifetime interest rate adjustment
limitations and are generally indexed to U.S. Treasury securities plus a fixed
margin. Future market factors may affect the correlation of the interest rate
adjustment with rates the Company pays on the short-term deposits that have been
the primary funding source for these loans. The adjustable-rate mortgage-related
securities adjust to various national indices plus a fixed margin. At September
30, 2005, the composition of these loans and mortgage-related securities was as
follows:
FIXED-RATE
TERM TO MATURITY BOOK VALUE
- ------------------- ----------
1 month to 1 year $ 2,080
1 year to 3 years 10,396
3 years to 5 years 22,691
5 years to 10 years 57,369
Over 10 years 174,169
--------
Total $266,705
========
ADJUSTABLE-RATE
TERM TO RATE ADJUSTMENT BOOK VALUE
- ----------------------- ----------
1 month to 1 year $ 62,888
1 year to 3 years 44,654
3 years to 5 years 45,478
--------
Total $153,020
========
The following is an analysis of the allowance for loan losses:
YEAR ENDED
SEPTEMBER 30,
-------------------------
2005 2004 2003
------ ------ -------
Beginning balance $2,039 $1,986 $ 2,358
Provisions charged to income 1,780 300 715
Charge-offs (344) (321) (1,102)
Recoveries -- 74 15
------ ------ -------
Total $3,475 $2,039 $ 1,986
====== ====== =======
At September 30, 2005 and 2004, non-performing loans (which include loans
in excess of 90 days delinquent) amounted to approximately $5,052 and $2,033,
respectively. At September 30, 2005, non-performing loans consisted of loans
that were both individually and collectively evaluated for impairment.
Loans collectively evaluated for impairment include residential real
estate, home equity (including lines of credit) and consumer loans and are not
included in the data that follow:
SEPTEMBER 30,
-------------
2005 2004
------ ----
Impaired loans with related allowance for loan losses $3,837 $--
under SFAS No. 114
Impaired loans with no related allowance for loan losses
under SFAS No. 114 -- --
------ ---
Total impaired loans $3,837 $--
====== ===
Valuation allowance related to impaired loans $ 959 $--
====== ===
70
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
At September 30, 2005 and 2004, the Company had impaired loans with a total
recorded investment of $3,837 and $0, respectively, and an average recorded
investment of $1,279 and $85, respectively. There was $39 and $0 of interest
income recognized on these impaired loans during the years ended September 30,
2005 and 2004, respectively. Interest income of approximately $338, $8 and $168,
respectively, was not recognized as interest income due to the non-accrual
status of loans during fiscal 2005, 2004 and 2003.
7. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are summarized by major classification as
follows:
SEPTEMBER 30,
-----------------
2005 2004
------- -------
Land and buildings $ 7,372 $ 7,038
Furniture, fixtures and equipment 3,529 4,921
------- -------
Total 10,901 11,959
Accumulated depreciation and amortization (6,119) (7,684)
------- -------
Net $ 4,782 $ 4,275
======= =======
The future minimum rental payments required under operating leases that
have initial or remaining non-cancelable lease terms in excess of one year as of
September 30, 2005 are as follows:
September 30,
- -------------
2006 $ 282,441
2007 287,762
2008 303,279
2009 309,312
2010 214,062
Thereafter 2,201,431
----------
Total minimum future rental payments $3,598,287
==========
Leasehold expense was approximately $502, $356 and $375 for the years ended
September 30, 2005, 2004 and 2003, respectively.
Depreciation expense amounted to $534, $473 and $426 for the years ended
September 30, 2005, 2004 and 2003, respectively.
8. DEPOSITS
Deposits consist of the following major classifications:
SEPTEMBER 30,
---------------------------------------
2005 2004
------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- -------
Non-interest-bearing $ 18,001 5.1% $ 21,046 6.1%
NOW 65,688 18.8 55,864 16.2
Passbook 47,139 13.5 51,371 14.9
Money market 45,753 13.1 51,682 15.0
Certificates of deposit 173,113 49.5 164,917 47.8
-------- ----- -------- -----
Total $349,694 100.0% $344,880 100.0%
======== ===== ======== =====
The weighted average interest rates paid on deposits were 2.07% and 1.66%
at September 30, 2005 and 2004, respectively.
71
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Included in deposits as of September 30, 2005 and 2004 were deposits
greater than $100 totaling approximately $112,950 and $96,891, respectively.
Deposits in excess of $100 are not federally insured.
At September 30, 2005 and 2004, the Company had pledged certain
mortgage-related securities aggregating $15,626 and $17,064, respectively, as
collateral for municipal deposits.
A summary of scheduled maturities of certificates is as follows:
SEPTEMBER 30,
-------------------
2005 2004
-------- --------
Within one year $ 94,653 $ 97,389
One to two years 50,465 32,530
Two to three years 13,584 10,455
Thereafter 14,411 24,543
-------- --------
Total $173,113 $164,917
======== ========
A summary of interest expense on deposits is as follows:
YEAR ENDED SEPTEMBER 30,
------------------------
2005 2004 2003
------ ------ ------
NOW $ 399 $ 287 $ 316
Passbook 475 473 530
Money market 762 606 736
Certificates of deposit 4,644 4,544 5,770
------ ------ ------
Total $6,280 $5,910 $7,352
====== ====== ======
9. BORROWINGS
A summary of borrowings is as follows:
SEPTEMBER 30,
-------------------
2005 2004
-------- --------
FHLB advances $ 96,371 $166,387
Repurchase agreements -- 1,110
FHLB overnight borrowings 16,800 3,500
Other 132 152
-------- --------
Total borrowings $113,303 $171,149
======== ========
Advances from the FHLB bear fixed interest rates with remaining periods
until maturity, summarized as follows:
SEPTEMBER 30,
------------------
2005 2004
------- --------
Over one year through five years $40,685 $ 80,695
Over five years through ten years 55,500 85,499
Over 10 years 186 193
------- --------
$96,371 $166,387
======= ========
Included in the table above at September 30, 2005 and 2004 are FHLB
advances whereby the FHLB has the option at predetermined times to convert the
fixed interest rate to an adjustable rate tied to the London Interbank Offered
Rate (LIBOR). At September 30, 2005, substantially all the FHLB advances with
the convertible feature are subject to conversion in fiscal 2006. The Company
then has the option to prepay these advances if the FHLB converts the interest
rate. These advances are included in the periods in which they mature. The
average balance of FHLB advances and overnight borrowings was $160,265 with an
average cost of 4.79% for the year ended September 30, 2005.
72
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Advances from the FHLB are collateralized by all FHLB stock, which is
carried at cost, owned by the Bank in addition to a blanket pledge of eligible
assets in an amount required to be maintained so that the estimated fair value
of such eligible assets exceeds, at all times, 110% of the outstanding advances.
The Company enters into sales of securities under agreements to repurchase.
These agreements are recorded as financing transactions, and the obligation to
repurchase is reflected as a liability in the consolidated statements of
financial condition. The Company retains the right of substitution of collateral
throughout the terms of the agreement.
At September 30, 2005, there were no outstanding repurchase agreements. The
average balance of repurchase agreements during the year ended September 30,
2005 was $255 with an average cost of 1.26%. The maximum amount outstanding at
any month end during the year ended September 30, 2005 was $1,110.
At September 20, 2004, outstanding repurchase agreements were secured by
U.S. Government securities. The average balance of repurchase agreements during
the year ended September 30, 2004 was $2,327 with an average cost of 27 basis
points. The maximum amount outstanding at any month end during the year ended
September 30, 2004 was $2,884.
10. INCOME TAXES
The Company and its subsidiaries file a consolidated federal income tax
return. The Company uses the specific charge-off method for computing reserves
for bad debts. The bad debt deduction allowable under this method is available
to large banks with assets of greater than $500 million. Generally, this method
allows the Company to deduct an annual addition to the reserve for bad debts
equal to its net charge-offs.
Retained earnings at September 30, 2005 and 2004 included approximately
$2,500 representing bad debt deductions for which no income tax has been
provided.
Income tax (benefit) expense is comprised of the following:
YEAR ENDED
SEPTEMBER 30,
--------------------
2005 2004 2003
----- ----- ----
Federal:
Current $(232) $ 876 $407
Deferred (81) (550) 225
State -- -- --
----- ----- ----
Total $(313) $ 326 $632
===== ===== ====
The tax effect of temporary differences that give rise to significant
portions of the deferred tax accounts, calculated at 34%, is as follows:
SEPTEMBER 30,
----------------
2005 2004
------ -------
Deferred tax assets:
Accelerated depreciation $ 471 $ 402
Allowance for loan losses 1,182 695
Loss on available for sale securities -- 374
Unrealized loss on available for sale securities 108 --
Accrued expenses 569 507
------ -------
Total deferred tax assets $2,330 $ 1,978
====== =======
Deferred tax liabilities:
Deferred loan fees (253) (303)
Unrealized gain on available for sale securities -- (893)
Other (69) (125)
------ -------
Total deferred tax liabilities (322) (1,321)
------ -------
Net deferred income taxes $2,008 $ 657
====== =======
73
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
From time to time, the Company may be subject to examination by various tax
authorities. in jurisdictions in which the Company has its business operations.
The Company regularly assesses the likelihood of additional assessments in each
of the tax jurisdictions resulting from these examinations. Tax reserves have
been established, which the Company believes to be adequate in relation to the
potential for additional assessments. Once established, reserves are adjusted as
information becomes available or when an event requiring a change to the reserve
occurs. The resolution of tax matters could have an impact on the Company's
effective tax rate.
The Company's effective tax rate is less than the statutory federal income
tax rate for the following reasons:
YEAR ENDED SEPTEMBER 30,
---------------------------------------------------------------
2005 2004 2003
------------------- ------------------- -------------------
PERCENTAGE PERCENTAGE PERCENTAGE
OF PRETAX OF PRETAX OF PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
------ ---------- ------ ---------- ------ ----------
Tax at statutory rate $ 101 34.0% $ 860 34.0% $1,146 34.0%
Decrease in taxes resulting from:
Tax exempt interest, net (231) (77.8) (246) (9.7) (274) (8.2)
Increase in cash surrender value (194) (65.3) (206) (8.2) (223) (6.6)
Dividend received deduction (50) (16.8) (49) (1.9) (45) (1.3)
Other 61 20.5 (33) (1.3) 28 0.8
----- ------ ----- ---- ------ ----
Total $(313) (105.4)% $ 326 12.9% $ 632 18.7%
===== ====== ===== ==== ====== ====
11. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum regulatory capital
requirements can result in certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth below) of
tangible and core capital (as defined in the regulations) to adjusted assets (as
defined), and of Tier I and total capital (as defined) to average assets (as
defined). Management believes, as of September 30, 2005, that the Bank meets all
regulatory capital adequacy requirements to which it is subject.
As of September 30, 2005, the Bank met the capital requirements considered
well capitalized under the regulatory framework for prompt corrective action. To
be considered as well capitalized, the Bank must maintain minimum total
risk-based, Tier-1 risk-based, and Tier-1 core capital ratios as set forth in
the table below. There are no conditions or events since that notification that
management believes have changed the institution's category.
WELL CAPITALIZED
REQUIRED FOR CAPITAL UNDER PROMPT
ACTUAL ADEQUACY PURPOSE CORRECTIVE ACTION
-------------------- -------------------- --------------------
AMOUNT PERCENTAGE AMOUNT PERCENTAGE AMOUNT PERCENTAGE
------- ---------- ------- ---------- ------- ----------
At September 30, 2005:
Core Capital (to Adjusted Tangible Assets) $45,606 8.85% $20,619 4.0% $25,774 5.0%
Tier I Capital (to Risk-Weighted Assets) 45,606 14.14 N/A N/A 19,350 6.0
Total Capital (to Risk-Weighted Assets) 48,808 15.13 25,800 8.0 32,250 10.0
Tangible Capital (to Tangible Assets) 45,606 8.85 7,732 1.5 N/A N/A
74
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
At September 30, 2004:
Core Capital (to Adjusted Tangible Assets) $46,535 8.21% $22,667 4.0% $28,334 5.0%
Tier I Capital (to Risk-Weighted Assets) 46,535 14.03 N/A N/A 19,905 6.0
Total Capital (to Risk-Weighted Assets) 48,300 14.56 26,540 8.0 33,175 10.0
Tangible Capital (to Tangible Assets) 46,535 8.21 8,500 1.5 N/A N/A
The Company's capital at September 30, 2005 and 2004 for financial
statement purposes differs from tangible, core (leverage), and Tier-1 risk-based
capital amounts by $16,973 and $16,767, respectively, representing the inclusion
for regulatory capital purposes of unrealized losses on securities available for
sale and a portion of capital securities (see Note 17) that qualifies as
regulatory capital as well as adjustments to the Bank's capital that do not
affect the parent company.
At September 30, 2005 and 2004, total risk-based capital, for regulatory
requirements, was increased by $3,202 and $1,765, respectively, of general loan
loss reserves, for a total of $48,800 and $48,300, respectively.
At the date of the Bank's conversion from the mutual to stock form in
January 1995 (the "Conversion"), the Bank established a liquidation account in
an amount equal to its retained income as of August 31, 1994. The liquidation
account is maintained for the benefit of eligible account holders and
supplemental eligible account holders (as such terms are defined in the Bank's
plan of conversion) who continue to maintain their accounts at the Bank after
the Conversion. The liquidation account is reduced annually to the extent that
eligible account holders and supplemental eligible account holders have reduced
their qualifying deposits as of each anniversary date. Subsequent increases in
such balances will not restore an eligible account holder's or supplemental
eligible account holder's interest in the liquidation account. In the event of a
complete liquidation of the Bank, each eligible account holder and supplemental
eligible account holder will be entitled to receive a distribution from the
liquidation account in an amount proportionate to the current adjusted
qualifying balances for accounts then held.
The principal source of cash flow for the Company is dividends from the
Bank. Various federal banking regulations and capital guidelines limit the
amount of dividends that may be paid to the Company by the Bank. Future payment
of dividends by the Bank is dependent on individual regulatory capital
requirements, levels of profitability, and safety and soundness concerns. Under
current regulatory requirements of the OTS, the Bank is required to apply for
approval to dividend funds to the Company. No assurances can be given that such
approval, if requested, would be granted. In addition, loans or advances made by
the Bank to the Company are generally limited to 10 percent of the Bank's
capital stock and surplus on a secured basis, subject to compliance with various
collateral and other requirements. Accordingly, at September 30, 2005, funds
potentially available for loans or advances by the Bank to the Company amounted
to $4,517.
12. EMPLOYEE BENEFITS
401(K) PROFIT SHARING PLAN
The Bank's 401(k) profit sharing plan covers substantially all full-time
employees of the Company and provides for pre-tax contributions by the employees
with matching contributions at the discretion of the Board of Directors
determined at the beginning of the calendar year. All amounts are fully vested.
For calendar years 2005, 2004 and 2003, the Company matched twenty-five cents
for every dollar contributed up to 5% of a participant's salary. The profit
sharing expense for the plan was $38, $37 and $38 for the years ended September
30, 2005, 2004 and 2003, respectively.
75
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
EMPLOYEE STOCK OWNERSHIP PLAN
In connection with the Conversion, the Company established an employee
stock ownership plan ("ESOP") for the benefit of eligible employees. The Company
accounts for its ESOP in accordance with AICPA Statement of Position 93-6,
"Employers Accounting for Employee Stock Ownership Plans," which requires the
Company to recognize compensation expense equal to the fair value of the ESOP
shares during the periods in which they become committed to be released. To the
extent that the fair value of the ESOP shares released differs from the cost of
such shares, this difference is charged or credited to equity as additional
paid-in capital. Management expects the recorded amount of expense in any given
period to fluctuate from period to period as continuing adjustments are made to
reflect changes in the fair value of the ESOP shares. The Company's ESOP, which
is internally leveraged, does not report the loans receivable extended to the
ESOP as assets and does not report the ESOP debt due the Company. At September
30, 2005, 250,582 shares were committed to be released, of which 6,516 shares
have not yet been allocated to participant accounts. The Company recorded
compensation and employee benefit expense related to the ESOP of $219, $850 and
$516 for the years ended September 30, 2005, 2004 and 2003, respectively.
RECOGNITION AND RETENTION PLAN
Under the 1995 Recognition and Retention Plan and Trust (the "RRP"), there
are 81,600 shares authorized under the RRP. At September 30, 2005, the Company
had awarded 81,600 shares to the Company's non-employee directors and executive
officers subject to vesting and other provisions of the RRP. At September 30,
2005, 79,350 shares granted to the plan participants had vested and been
distributed.
STOCK OPTION PLANS
Under the 1995 Stock Option Plan (the "Option Plan"), common stock totaling
272,000 shares was reserved for issuance pursuant to the exercise of options.
During fiscal year 1999, stockholders approved the adoption of the 1998 Stock
Option Plan ("1998 Option Plan") (collectively with the Option Plan, the
"Plans") which pursuant to which an additional 111,200 shares of common stock
were reserved for issuance of which 26,886 were available for future grants at
September 30, 2005. Options covering an aggregate of 356,314 shares have been
granted to the Company's executive officers, nonemployee directors and other key
employees, subject to vesting and other provisions of the Plans. At September
30, 2005, 2004 and 2003, the number of shares exercisable was 67,523, 181,023
and 210,209, respectively, and the weighted average exercise price of those
options was $12.47, $9.84 and $9.19, respectively.
The following table summarizes transactions regarding the stock option
plans:
WEIGHTED AVERAGE
NUMBER OF EXERCISE EXERCISE
OPTION SHARES PRICE RANGE PRICE PER SHARE
------------- -------------- ----------------
Outstanding at October 1, 2002 300,416 $ 7.50 - 16.15 $ 9.56
Granted 3,000 16.15 - 16.15 16.15
Exercised (62,678) 7.50 - 14.25 8.79
-------- -------------- ------
Outstanding at September 30, 2003 240,738 $ 7.50 - 16.15 $ 9.81
Granted -- -- --
Exercised (54,436) 7.50 - 14.25 8.39
-------- -------------- ------
Outstanding at September 30, 2004 186,302 $ 7.50 - 16.15 $10.26
Granted 2,221 19.75 - 21.89 20.14
Exercised (108,646) 7.50 - 16.15 8.45
Cancelled (3,013) 12.13 - 14.25 12.95
-------- -------------- ------
Outstanding at September 30, 2005 76,864 $ 7.50 - 21.89 $13.01
======== ============== ======
76
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
A summary of the exercise price range at September 30, 2005 is as follows:
WEIGHTED AVERAGE WEIGHTED AVERAGE
NUMBER OF EXERCISE REMAINING EXERCISE
OPTION SHARES PRICE RANGE CONTRACTUAL LIFE PRICE PER SHARE
- ------------- -------------- ---------------- ----------------
5,820 $ 7.50 - 10.13 4.07 $ 9.74
68,823 12.13 - 16.15 4.38 13.05
2,221 19.75 - 21.89 9.66 20.14
------ --------------
76,864 $ 7.50 - 21.89 4.51 $13.01
====== ============== ==== ======
SUPPLEMENTAL RETIREMENT BENEFITS
During fiscal 2004, the Bank implemented a defined contribution
supplemental executive retirement plan (the "SERP") covering certain senior
executive officers of the Bank. For the initial year of the SERP, the crediting
rate on the amounts contributed was established at 5.0% and will remain in
effect until such time that the Company's Compensation Committee administering
the SERP determines to change it. Upon retirement of a participant, he or she
will receive his or her account balance paid out in equal annual payments for a
period not to exceed 15 years provided that a participant did not make a prior
election to receive his or her distribution in a lump sum. The SERP also
provides for the payment of benefits in the event of the death of the
participant or the termination of the employment of the participant subsequent
to a change in control of the Company.
In addition, the Bank previously maintained split dollar insurance
arrangements with certain senior executive officers. Such arrangements were
terminated in December 2003. In March 2005, the Company entered into a
Transition, Consulting, Noncompetition and Retirement Agreement with the
Company's previous President (the "Agreement"). The Agreement provides for a
consulting fee for five years and for payments for a period of ten years
beginning upon the commencement of the retirement phase of the agreement. The
Agreement provides for full payments in the event of a change in control of the
Company. For the fiscal years ended September 30, 2005, 2004 and 2003, the
pension expense relating to supplemental retirement benefits was approximately
$261, $837 and $444, respectively.
The Bank also provides supplemental retirement benefits to certain
directors and Advisory Board members. The expense relating to these arrangements
was approximately $119, $88 and $65 for the years ended September 30, 2005, 2004
and 2003, respectively.
13. DERIVATIVE FINANCIAL INSTRUMENTS
The Company concurrently adopted the provisions of SFAS No. 133, and SFAS
No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities -- an amendment of FASB Statement No. 133" on October 1, 2000. The
Company adopted the provisions of SFAS No. 149 effective July 1, 2004. The
Company's derivative instruments outstanding during fiscal year end September
30, 2005 include commitments to fund loans held-for-sale and forward loan sale
agreements.
The Company adopted new accounting requirements relating to SFAS No. 149
which requires that mortgage loan commitments related to loans originated for
sale be accounted for as derivative instruments. In accordance with SFAS No. 133
and SFAS No. 149, derivative instruments are recognized in the statement of
financial condition at fair value and changes in the fair value thereof are
recognized in the statement of operations. The Company originates single-family
residential loans for sale pursuant to programs with FHLMC. Under the structure
of the programs, at the time the Company initially issues a loan commitment in
connection with such programs, it does not lock in a specific interest rate. At
the time the interest rate is locked in by the borrower, the Company
concurrently enters into a forward loan sale agreement with respect to the sale
of such loan at a set price in an effort to manage the interest rate risk
inherent in the locked loan commitment. The forward loan sale agreement also
meets the definition of a derivative instrument under SFAS No. 133. Any change
in the fair value of the loan commitment after the borrower locks in the
interest rate is
77
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
substantially offset by the corresponding change in the fair value of the
forward loan sale agreement related to such loan. The period from the time the
borrower locks in the interest rate to the time the Company funds the loan and
sells it to FHLMC is generally 60 days. The fair value of each instrument will
rise or fall in response to changes in market interest rates subsequent to the
dates the interest rate locks and forward loan sale agreements are entered into.
In the event that interest rates rise after the Company enters into an interest
rate lock, the fair value of the loan commitment will decline. However, the fair
value of the forward loan sale agreement related to such loan commitment should
increase by substantially the same amount, effectively eliminating the Company's
interest rate and price risk.
At September 30, 2005, the Company had $315 of loan commitments outstanding
related to loans being originated for sale which were subject to interest rate
locks. At September 30, 2005, the Company had $315 of forward loan sale
agreements. The Company concluded that the fair value of these derivative
instruments involving loan commitments was not material to the consolidated
statements of the financial condition and operations of the Company as of and
for the year ended September 30, 2005.
14. COMMITMENTS AND CONTINGENCIES
The Company has outstanding loan commitments, excluding undisbursed portion
of loans in process and equity lines of credit, of approximately $12,742 and
$2,239 as of September 30, 2005 and 2004, respectively, all of which are
expected to be funded within four months. Of these commitments outstanding, the
breakdown between fixed and adjustable-rate loans is as follows:
SEPTEMBER 30,
----------------
2005 2004
------- ------
Fixed-rate (ranging from 5.24% to 8.20%) $ 2,721 $1,924
Adjustable-rate 10,021 315
------- ------
Total $12,742 $2,239
======= ======
Depending on cash flow, interest rate, risk management and other
considerations, longer term fixed-rate residential loans are sold in the
secondary market. There were approximately $315 and $1,256 in outstanding
commitments to sell loans at September 30, 2005 and 2004, respectively.
The Bank currently has the ability to obtain up to $345.0 million
additional advances from FHLB of Pittsburgh.
There may be various claims and pending actions against the Company and its
subsidiaries arising out of the conduct of its business. In the opinion of the
Company's management and based upon advice of legal counsel, the resolution of
these matters is not expected to have a material adverse impact on the
consolidated financial position or the results of operations of the Company and
its subsidiaries.
15. RELATED PARTY TRANSACTIONS
The Company retains the services of a law firm in which one of the
Company's directors is a member. In addition to providing general legal counsel
to the Company, the firm also prepares mortgage documents and attends loan
closings for which it is paid directly by the borrower.
The Company utilizes two of the Company's directors as consultants on
various real estate and general business matters. In addition, one of the
Company's board members has an interest in an insurance agency, First Keystone
Insurance Services, LLC, in which one of the Bank's subsidiaries has a 51%
ownership interest.
78
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies. However,
considerable judgment is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
SEPTEMBER 30,
---------------------------------------------
2005 2004
--------------------- ---------------------
CARRYING/ ESTIMATED CARRYING/ ESTIMATED
NOTIONAL FAIR NOTIONAL FAIR
AMOUNT VALUE AMOUNT VALUE
--------- --------- --------- ---------
Assets:
Cash and cash equivalents $ 16,155 $ 16,155 $ 17,975 $ 17,975
Investment securities 41,286 41,309 68,902 68,985
Loans 301,979 298,228 304,248 299,287
Loans held for sale 41 41 172 172
Mortgage-related securities 114,181 113,206 134,983 134,932
FHLB stock 9,499 9,499 9,827 9,827
Liabilities:
Passbook deposits 47,139 47,139 51,371 51,371
NOW and money market deposits 111,441 111,441 107,546 107,546
Certificates of deposit 173,113 169,801 164,917 163,801
Borrowings 113,303 112,827 171,149 171,416
Off balance sheet commitments 62,671 62,671 51,921 51,921
The fair value of cash and cash equivalents is their carrying value due
to their short-term nature. The fair value of investment and mortgage-related
securities is based on quoted market prices, dealer quotes, and prices obtained
from independent pricing services. The fair value of loans is estimated, based
on present values using approximate current entry value interest rates,
applicable to each category of such financial instruments. The fair value of
FHLB stock approximates its carrying amount.
The fair value of NOW deposits, money market deposits and passbook
deposits is the amount reported in the financial statements. The fair value of
certificates of deposit and FHLB advances is based on a present value estimate,
using rates currently offered for deposits and borrowings of similar remaining
maturity.
Fair values for off-balance sheet commitments are based on fees currently
charged to enter into similar agreements, taking into account the remaining
terms of the agreements and the counterparties credit standings.
No adjustment was made to the entry-value interest rates for changes in
credit performing commercial real estate and business loans, construction loans,
and land loans for which there are no known credit concerns. Management believes
that the risk factor embedded in the entry-value interest rates, along with the
general reserves applicable to the performing commercial, construction, and land
loan portfolios for which there are no known credit concerns, result in a fair
valuation of such loans on an entry-value basis. The fair value of
non-performing loans, with a recorded book value of approximately $5,052 and
$2,033 (which are collateralized by real estate properties with property values
in excess of carrying amounts) as of September 30, 2005 and 2004, respectively,
was not estimated because it is not practicable to reasonably assess the credit
adjustment that would be applied in the marketplace for such loans. The fair
value estimates presented herein are based on pertinent information available to
management as of September 30, 2005 and 2004. Although management is not aware
of any factors that would significantly affect the estimated fair value amounts,
such amounts have not been comprehensively revalued for purposes of these
financial statements since September 30, 2005 and 2004 and, therefore, current
estimates of fair value may differ significantly from the amounts presented
herein.
79
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Dollars in thousands, except per share data)
17. CAPITAL SECURITIES
On August 21, 1997, First Keystone Capital Trust I (the "Trust"), a trust
formed under Delaware law, that is a subsidiary of the Company, issued $16.2
million of preferred securities (the "Preferred Securities") at an interest rate
of 9.7%, with a scheduled maturity of August 15, 2027. The Company owns all the
common stock of the Trust. The proceeds from the issue were invested in Junior
Subordinated Debentures (the "Debentures") issued by the Company. The Debentures
are unsecured and rank subordinate and junior in right of payment to all
indebtedness, liabilities and obligations of the Company. On November 15, 2001,
the Company purchased $3.5 million of the Preferred Securities. Debentures
represent the sole assets of the Trust. Interest on the Preferred Securities is
cumulative and payable semiannually in arrears. The Company has the option,
subject to required regulatory approval, if any, to prepay the securities
beginning August 15, 2007. The Company has, under the terms of the Debentures
and the related Indenture as well as the other operative corporate documents,
agreed to irrevocably and unconditionally guarantee the Trust's obligations
under the Debentures. The Company made a capital contribution of approximately
$6.0 million of the net proceeds to the Bank to support the Bank's lending
activities.
On November 28, 2001, First Keystone Capital Trust II (the "Trust II"), a
trust formed under Delaware law, that is a subsidiary of the Company, issued
$8.0 million of securities ("Preferred Securities II") in a pooled securities
offering at a floating rate of 375 basis over the six month LIBOR with a
maturity date of December 8, 2031. The Company owns all the common stock of the
Trust II. The proceeds from the issue were invested in Junior Subordinated
Debentures (the "Debentures II") issued by the Company. The Debentures II are
unsecured and rank subordinate and junior in right of payment to all
indebtedness, liabilities and obligations of the Company. The Debentures II
represent the sole assets of the Trust II. Interest on the Preferred Securities
II is cumulative and payable semi-annually in arrears. The Company has the
option, subject to required regulatory approval, if any, to prepay the
securities beginning December 8, 2006.
The Company had previously established Issuer Trusts that issued guaranteed
preferred beneficial interests in the Company's junior subordinated debentures.
Prior to FIN 46 and FIN 46 (R), the Company classified its Issuer Trusts after
total liabilities and before shareholders' equity on its consolidated statements
of financial condition under the caption "Guaranteed Preferred Beneficial
Interest in Company's Subordinated Debt" and the retained common capital
securities of the Issuer Trusts were eliminated against the Company's investment
in the Issuer Trusts. Distributions on the preferred securities were recorded as
non-interest expense on the consolidated statements of operations.
As a result of the adoption of FIN 46 and FIN 46 (R), the Company
deconsolidated all the Issuer Trusts. As a result, the junior subordinated
debentures issued by the Company to the Issuer Trusts, totaling $21.5 million,
are reflected in the Company's consolidated statements of financial condition in
the liabilities section at September 30, 2005, under the caption "Junior
Subordinated Debentures." The Company records interest expense on the
corresponding debentures in its consolidated statements of operations. The
Company also recorded the common capital securities issued by the Issuer Trusts
in "Prepaid expenses and other assets" in its consolidated statements of
financial condition at September 30, 2005.
80
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Dollars in thousands, except per share data)
18. PARENT COMPANY ONLY FINANCIAL INFORMATION
Condensed financial statements of First Keystone Financial, Inc. are as
follows:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30,
-----------------
2005 2004
------- -------
Assets:
Interest-bearing deposits $ 2,098 $ 426
Investment securities available for sale 1,582 3,764
Investment in subsidiaries 46,177 47,921
Other assets 1,311 414
------- -------
Total assets $51,168 $52,525
======= =======
Liabilities and Stockholders' Equity:
Junior subordinated debentures $21,520 $21,557
Other liabilities 1,455 1,270
------- -------
Total liabilities 22,975 22,827
Stockholders' equity 28,193 29,698
------- -------
Total liabilities and stockholders' equity $51,168 $52,525
======= =======
CONDENSED STATEMENTS OF OPERATIONS
YEAR ENDED SEPTEMBER 30,
------------------------
2005 2004 2003
------ ------ ------
Interest and dividend income:
Dividends from subsidiary $ 11 $ 9 $ 9
Loan to ESOP 192 59 79
Interest and dividends on investments 280 173 286
Interest on deposits 13 17 50
------ ------ ------
Total interest and dividend income 496 258 424
Interest on debt and other borrowed money 1,794 1,676 1,677
Other income 1,256 1,393 241
Operating expenses 183 210 194
Equity in earnings of subsidiaries 770 2,369 3,543
------ ------ ------
Income before income taxes 545 2,134 2,337
Income tax benefit (65) (69) (402)
------ ------ ------
Net income $ 610 $2,203 $2,739
====== ====== ======
81
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Dollars in thousands, except per share data)
CONDENSED STATEMENTS OF CASH FLOWS
YEAR ENDED SEPTEMBER 30,
---------------------------
2005 2004 2003
------- ------- -------
Cash flows from operating activities:
Net income $ 610 $ 2,203 $ 2,739
Adjustment to reconcile net income to cash provided by
(used in) operations:
Equity in earnings of subsidiaries (770) (2,369) (3,543)
Amortization of common stock acquired by stock benefit plans 164 637 396
Gain on sales of investment securities available for sale (1,133) (1,390) (241)
Amortization of premium (37) (37) 26
(Increase) decrease in other assets (897) 675 709
Decrease (increase) in other liabilities 660 (159) 165
------- ------- -------
Net cash (used in) provided by operating activities (1,403) (440) 251
------- ------- -------
Cash flows from investing activities:
Purchase of investments available for sale -- (578) --
Dividend from subsidiary 1,500 -- --
Proceeds from calls or repayments of investment securities -- 500 1,100
Proceeds from sale of investments available for sale 1,911 3,339 1,591
------- ------- -------
Net cash provided by investing activities 3,411 3,261 2,691
------- ------- -------
Cash flows from financing activities:
Purchase of treasury stock (110) (1,339) (2,986)
Common stock acquired by ESOP (72) (2,579) --
Dividends paid (810) (843) (798)
Proceeds from exercise of stock options 656 566 373
------- ------- -------
Net cash used in financing activities (336) (4,195) (3,411)
------- ------- -------
Increase (decrease) in cash 1,672 (1,374) (469)
Cash at beginning of year 426 1,800 2,269
------- ------- -------
Cash at end of year $ 2,098 $ 426 $ 1,800
======= ======= =======
82
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Dollars in thousands, except per share data)
19. QUARTERLY FINANCIAL DATA (UNAUDITED)
Unaudited quarterly financial data for the years ended September 30, 2005
and 2004 is as follows:
2005 2004
----------------------------------- ---------------------------------
1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
QTR QTR QTR QTR QTR QTR QTR QTR
------ ------ ------- ------- ------ ------ ------ ------
Interest income $6,635 $6,779 $ 6,788 $ 6,875 $6,636 $6,439 $6,505 $6,563
Interest expense 3,815 3,818 3,963 4,173 3,740 3,666 3,586 3,720
------ ------ ------- ------- ------ ------ ------ ------
Net interest income 2,820 2,961 2,825 2,702 2,896 2,773 2,919 2,843
Provision for loan losses 45 45 1,645 45 75 75 75 75
------ ------ ------- ------- ------ ------ ------ ------
Net income after
provision for loan losses 2,775 2,916 1,180 2,657 2,821 2,698 2,844 2,768
Non-interest income 899 1,101 683 906 1,064 2,169 575 91
Non-interest expense 3,046 3,204 2,946 3,624(1) 2,933 4,094 2,646 2,827
------ ------ ------- ------- ------ ------ ------ ------
Income (loss) before income taxes 628 813 (1,083) (61) 952 773 773 32
Income tax expense (benefit) 105 175 (470) (123) 209 146 146 (175)
------ ------ ------- ------- ------ ------ ------ ------
Net income (loss) $ 523 $ 638 $ (613) $ 62 $ 743 $ 627 $ 627 $ 207
====== ====== ======= ======= ====== ====== ====== ======
Per Share:
Earnings per share - basic $ 0.29 $ 0.35 $(0.33) $ 0.03 $ 0.40 $ 0.34 $ 0.34 $ 0.12
Earnings per share - diluted $ 0.28 $ 0.34 $(0.32) $ 0.03 $ 0.37 $ 0.32 $ 0.32 $ 0.11
Dividend per share $ 0.11 $ 0.11 $ 0.11 $ 0.11 $ 0.11 $ 0.11 $ 0.11 $ 0.11
- ----------
(1) As part of the deleveraging strategy, the Company repaid certain FHLB
advances resulting in a pre-tax prepayment penalty of $468.
Earnings per share are computed independently for each period presented.
Consequently, the sum of the quarters may not equal the total earnings per share
for the year.
Certain reclassifications have been made to the quarters presented to conform to
the presentation. Such reclassifications had no impact on the reported net
income.
****
83
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
ITEM 9-A. CONTROLS AND PROCEDURES.
Under the supervision and with the participation of the Company's
management, including its chief executive officer and chief financial officer,
the Company has evaluated the effectiveness of the design and operation of its
disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e)
under the Exchange Act) as of September 30, 2005. Based on such evaluation, the
Company's chief executive officer and chief financial officer have concluded
that these controls and procedures are designed to ensure that the information
required to be disclosed by the Company in reports that it files or submits
under the Exchange Act 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 the Company's internal control over financial reporting (as
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during
the fourth fiscal quarter of fiscal 2005 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
ITEM 9-B. OTHER INFORMATION.
There is no information to be reported on Form 8-K that has not already
been reported pursuant thereto.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required herein with respect to directors and executive
officers of the Company is incorporated by reference from the information
contained in the sections captioned "Information with Respect to Nominees for
Director, Directors Whose Terms Continue and Executive Officers" and "Section
16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive
Proxy Statement for the Annual Meeting of Stockholders to be held on January 25,
2006 (the "Proxy Statement"), a copy of which will be filed with the SEC within
120 days of the end of the Company's fiscal year.
The Company has adopted a Code of Conduct and Ethics that applies to its
principal executive officer and principal financial officer, as well as other
officers and employees of the Company and the Bank. A copy of the Code of Ethics
was included as Exhibit 99.1 to the Annual Report on Form 10-K for the year
ended September 30, 2004 filed with the SEC.
ITEM 11. EXECUTIVE COMPENSATION.
The information required herein is incorporated by reference from the
information contained in the section captioned "Executive Compensation" in of
the Registrant's Proxy Statement. The reports of the Audit Committee and the
Compensation Committee included in the Registrant's Proxy Statement should not
be deemed filed or incorporated into this filing or any other filing by the
Company under the Exchange Act or the Securities Act of 1933 except to the
extent the Company specifically incorporates said reports herein or therein by
reference thereto.
84
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The information required herein is incorporated by reference from the
information contained in the section captioned "Beneficial Ownership of Common
Stock by Certain Beneficial Owners and Management" in the Registrant's Proxy
Statement.
EQUITY COMPENSATION PLAN INFORMATION. The following table sets forth
certain information for all equity compensation plans and individual
compensation arrangements (whether with employees or non-employees, such as
directors) in effect as of September 30, 2005.
Number of Shares to be Issued Upon Weighted Average Number of Shares Remaining Available
the Exercise of Outstanding Options, Exercise Price of for Future Issuance (Excluding Shares
Plan Category Warrants and Rights Outstanding Options Reflected in the First Column)
- ------------------------------- ------------------------------------ ------------------- -------------------------------------
Equity Compensation Plans
Approved by Security Holders 76,864 $13.01 26,886
Equity Compensation Plans Not
Approved by Security Holders -- -- --
------ ------ ------
Total 76,864 $13.01 26,886
====== ====== ======
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required herein is incorporated by reference from the
information contained in the section captioned "Transactions with Certain
Related Persons" in the Registrant's Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The information required herein is incorporated by reference from the
information contained in the section captioned "Ratification of Appointment of
Auditors" in the Registrant's Proxy Statement.
PART IV.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a) Documents filed as part of this Report.
(1) The following documents are filed as part of this report and are
incorporated herein by reference from Item 8 hereof.
Report of Independent Registered Public Accounting Firm.
Consolidated Statements of Financial Condition at September 30, 2005
and 2004.
Consolidated Statements of Operations for the Years Ended September
30, 2005, 2004 and 2003.
Consolidated Statements of Changes in Stockholders' Equity for the
Years Ended September 30, 2005, 2004 and 2003.
Consolidated Statements of Cash Flows for the Years Ended September
30, 2005, 2004 and 2003.
Notes to the Consolidated Financial Statements.
85
(2) All schedules for which provision is made in the applicable accounting
regulation of the SEC are omitted because they are not applicable or
the required information is included in the Consolidated Financial
Statements or notes thereto.
(3) The following exhibits are filed as part of this Form 10-K, and this
list includes the Exhibit Index.
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 Employment Agreement between First Keystone Financial, Inc. and Thomas
M. Kelly dated December 1, 2004. 2,*
10.2 Severance Agreement between First Keystone Financial, Inc. and Elizabeth
M. Mulcahy dated December 1, 2004. 2,*
10.3 Severance Agreement between First Keystone Financial, Inc. and Carol
Walsh dated December 1, 2004. 2,*
10.4 1995 Stock Option Plan. 3, *
10.5 1995 Recognition and Retention Plan and Trust Agreement 4,*
10.6 1998 Stock Option Plan 4, *
10.7 Employment Agreement between First Keystone Bank and Thomas M. Kelly
dated December 1, 2004 2, *
10.8 Severance Agreement between First Keystone Bank and Elizabeth M. Mulcahy
dated December 1, 2004 2, *
10.9 Severance Agreement between First Keystone Bank and Carol Walsh dated
December 1, 2004 2, *
10.10 First Keystone Bank Supplemental Executive Retirement Plan 5,*
10.11 Consulting Agreement between First Keystone Bank and Edmund Jones 6,*
10.12 Amendment No. 1 to the Employment Agreement between First Keystone
Financial, Inc. and Thomas M. Kelly. 7,*
10.13 Amendment No. 1 to the Employment Agreement between First Keystone Bank
and Thomas M. Kelly. 7,*
10.14 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 on 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 Exhibits 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).
86
(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 Exhibits 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.
(9) Incorporated by reference from the Form 10-K filed by the Registrant with
the SEC on December 23, 2004.
(*) 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.
Not applicable.
87
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST KEYSTONE FINANCIAL, INC.
By: /s/ Thomas M. Kelly
------------------------------------
Thomas M. Kelly
President and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report had been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Donald S. Guthrie December 27, 2005
- -------------------------------------
Donald S. Guthrie
Chairman of the Board
/s/ Thomas M. Kelly December 27, 2005
- -------------------------------------
Thomas M. Kelly
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Edward Calderoni December 27, 2005
- -------------------------------------
Edward Calderoni
Director
/s/ Edmund Jones December 27, 2005
- -------------------------------------
Edmund Jones
Director
/s/ Donald G. Hosier, Jr. December 27, 2005
- -------------------------------------
Donald G. Hosier, Jr.
Director
/s/ Marshall J. Soss December 27, 2005
- -------------------------------------
Marshall J. Soss
Director
/s/ William J. O'Donnell December 27, 2005
- -------------------------------------
William J. O'Donnell
Director
/s/ Bruce C. Hendrixson December 27, 2005
- -------------------------------------
Bruce C. Hendrixson
Director
/s/ Jerry A. Naessens December 27, 2005
- -------------------------------------
Jerry A. Naessens
Director
/s/ Rose M. DiMarco December 27, 2005
- -------------------------------------
Rose M. DiMarco
Senior Vice President and Chief
Financial Officer
(Principal Financial and Accounting
Officer)
88