SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended December 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number: 000-25328
FIRST KEYSTONE FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-0469351
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
22 West State Street
Media, Pennsylvania 19063
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (610) 565-6210
Indicate by check mark whether the Registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
----- -----
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by checkmark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
----- -----
Number of shares of Common Stock outstanding as of February 9, 2006: 2,023,874
Transitional Small Business Disclosure Format Yes No X
----- -----
FIRST KEYSTONE FINANCIAL, INC.
CONTENTS
PAGE
----
PART I FINANCIAL INFORMATION:
Item 1. Financial Statements
Unaudited Consolidated Statements of Financial Condition as
of December 31, 2005 and September 30, 2005 1
Unaudited Consolidated Statements of Income for the Three
Months Ended December 31, 2005 and 2004 2
Unaudited Consolidated Statement of Changes in Stockholders'
Equity for the Three Months Ended December 31, 2005 3
Unaudited Consolidated Statements of Cash Flows for the
Three Months Ended December 31, 2005 and 2004 4
Notes to Unaudited Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 17
Item 4. Controls and Procedures 18
PART II OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 1A Risk Factors 19
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 19
Item 3. Defaults Upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits 20
SIGNATURES 22
-i-
FIRST KEYSTONE FINANCIAL, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands)
December 31 September 30
2005 2005
----------- ------------
ASSETS
Cash and amounts due from depository institutions $ 10,391 $ 8,321
Interest-bearing deposits with depository institutions 9,253 7,834
-------- --------
Total cash and cash equivalents 19,644 16,155
Investment securities available for sale 36,153 37,019
Mortgage-related securities available for sale 67,444 67,527
Loans held for sale 211 41
Investment securities held to maturity - at amortized cost
(approximate fair value of $4,246 at December 31, 2005
and $4,290 at September 30, 2005) 4,262 4,267
Mortgage-related securities held to maturity - at amortized cost
(approximate fair value of $42,921 at December 31, 2005
and $45,679 at September 30, 2005) 44,196 46,654
Loans receivable (net of allowance for loan loss of $3,525 and $3,475
at December 31, 2005 and September 30, 2005, respectively) 306,432 301,979
Accrued interest receivable 2,319 2,435
Real estate owned 760 760
Federal Home Loan Bank stock, at cost 6,264 9,499
Office properties and equipment, net 4,723 4,782
Deferred income taxes 2,310 2,008
Cash surrender value of life insurance 16,988 16,835
Prepaid expenses and other assets 3,142 8,163
-------- --------
TOTAL ASSETS $514,848 $518,124
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Non-interest-bearing $ 18,987 $ 18,001
Interest-bearing 334,166 331,693
-------- --------
Total deposits 353,153 349,694
Advances from Federal Home Loan Bank and other borrowings 105,790 113,303
Junior subordinated debentures 21,511 21,520
Accrued interest payable 2,131 1,870
Advances from borrowers for taxes and insurance 1,908 839
Accounts payable and accrued expenses 2,465 2,705
-------- --------
Total liabilities 486,958 489,931
Commitments and contingencies
Stockholders' Equity:
Preferred stock, $.01 par value, 10,000,000 shares authorized;
none issued
Common stock, $.01 par value, 20,000,000 shares authorized;
issued 2,712,556 shares; outstanding at December 31, 2005 and
September 30, 2005, 2,023,874 and 2,023,534 shares, respectively 27 27
Additional paid-in capital 12,939 12,920
Employee stock ownership plan (3,162) (3,185)
Treasury stock at cost: 688,682 shares at December 31, 2005 and
689,022 shares at September 30, 2005 (10,585) (10,590)
Accumulated other comprehensive loss (796) (209)
Retained earnings - partially restricted 29,467 29,230
-------- --------
Total stockholders' equity 27,890 28,193
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $514,848 $518,124
======== ========
See notes to unaudited consolidated financial statements.
-1-
FIRST KEYSTONE FINANCIAL, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data)
Three months ended
December 31
-----------------------
2005 2004
---------- ----------
INTEREST INCOME:
Interest and fees on loans $ 4,699 $ 4,463
Interest and dividends on:
Mortgage-related securities 1,200 1,402
Investment securities:
Taxable 296 435
Tax-exempt 187 208
Dividends 117 86
Interest-bearing deposits 51 41
---------- ----------
Total interest income 6,550 6,635
---------- ----------
INTEREST EXPENSE:
Interest on:
Deposits 1,869 1,453
Federal Home Loan Bank advances and other borrowings 1,429 1,928
Junior subordinated debentures 472 434
---------- ----------
Total interest expense 3,770 3,815
---------- ----------
Net interest income 2,780 2,820
PROVISION FOR LOAN LOSSES 45 45
---------- ----------
Net interest income after provision for loan losses 2,735 2,775
---------- ----------
NON-INTEREST INCOME:
Service charges and other fees 380 420
Net gain on sales of:
Loans held for sale 125 19
Investment securities -- 75
Increase in cash surrender value 153 260
Other income 117 125
---------- ----------
Total non-interest income 775 899
---------- ----------
NON-INTEREST EXPENSE:
Salaries and employee benefits 1,502 1,530
Occupancy and equipment 389 362
Professional fees 268 245
Federal deposit insurance premium 12 13
Data processing 120 128
Advertising 106 96
Deposit processing 155 162
Other 441 510
---------- ----------
Total non-interest expense 2,993 3,046
---------- ----------
Income before income tax expense 517 628
Income tax expense 72 105
---------- ----------
Net income $ 445 $ 523
========== ==========
Earnings per common share:
Basic $ 0.24 $ 0.29
Diluted $ 0.23 $ 0.28
Weighted average shares - basic 1,888,344 1,785,415
Weighted average shares - diluted 1,915,801 1,890,068
See notes to unaudited consolidated financial statements.
-2-
FIRST KEYSTONE FINANCIAL, INC.
UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(dollars in thousands)
Employee Accumulated Retained
Additional stock other earnings- Total
Common paid-in ownership Treasury comprehensive partially stockholders'
stock capital plan stock income (loss) restricted equity
------ ---------- --------- -------- ------------- ---------- -------------
BALANCE AT OCTOBER 1, 2004 $27 $13,609 $(3,189) $(11,913) $1,734 $29,430 $29,698
Net income -- -- -- -- -- 523 523
Other comprehensive income, net of tax:
Net unrealized loss on securities
net of reclassification
adjustment(1) -- -- -- -- (345) -- (345)
--- ------- ------- -------- ------ ------- -------
Comprehensive income -- -- -- -- -- -- 178
--- ------- ------- -------- ------ ------- -------
ESOP shares committed to be released -- -- 7 -- -- -- 7
Common stock acquired by stock benefit
plan -- -- (72) -- -- -- (72)
Excess of fair value above cost of
ESOP shares committed to be released -- 9 -- -- -- -- 9
Exercise of stock options -- (10) -- 46 -- -- 36
Dividends paid -- -- -- -- -- (195) (195)
--- ------- ------- -------- ------ ------- -------
BALANCE AT DECEMBER 31, 2004 $27 $13,608 $(3,254) $(11,867) $1,389 $29,758 $29,661
=== ======= ======= ======== ====== ======= =======
BALANCE AT OCTOBER 1, 2005 $27 $12,920 $(3,185) $(10,590) $(209) $29,230 $28,193
Net income -- -- -- -- -- 445 445
Other comprehensive income, net of tax:
Net unrealized loss on securities
net of reclassification
adjustment(1) -- -- -- -- (587) -- (587)
--- ------- ------- -------- ------ ------- -------
Comprehensive loss -- -- -- -- -- -- (142)
--- ------- ------- -------- ------ ------- -------
ESOP shares committed to be released -- -- 23 -- -- -- 23
Share-based compensation -- 6 -- -- -- -- 6
Excess of fair value above cost of
ESOP shares committed to be released -- 14 -- -- -- -- 14
Exercise of stock options -- (1) -- 5 -- -- 4
Dividends paid -- -- -- -- -- (208) (208)
--- ------- ------- -------- ------ ------- -------
BALANCE AT DECEMBER 31, 2005 $27 $12,939 $(3,162) $(10,585) $(796) $29,467 $27,890
=== ======= ======= ======== ====== ======= =======
(1) Disclosure of reclassification amount, net of tax:
December 31,
-------------
2005 2004
----- -----
Net unrealized depreciation arising during the period $(587) $(395)
Less: reclassification adjustment for net gains included in net income
(net of tax of $0 and $25, respectively) 0 50
----- -----
Net unrealized loss on securities $(587) $(345)
===== =====
See notes to unaudited consolidated financial statements.
-3-
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands)
Three months ended
December 31
-------------------
2005 2004
-------- --------
OPERATING ACTIVITIES:
Net income $ 445 $ 523
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Provision for depreciation and amortization 134 125
Amortization of premiums and discounts 100 75
Increase in cash surrender value of life insurance (153) (260)
Gain on sales of:
Loans held for sale (125) (19)
Investment securities available for sale -- (75)
Provision for loan losses 45 45
Amortization of ESOP 37 16
Share-based compensation 6 --
Insurance proceeds on real estate owned -- 29
Changes in assets and liabilities which provided (used) cash:
Origination of loans held for sale (3,312) (2,722)
Proceeds from the sale of loans 3,142 2,894
Accrued interest receivable 116 114
Prepaid expenses and other assets 5,021 8,423
Accrued interest payable 261 (24)
Accrued expenses (240) 617
-------- --------
Net cash provided by operating activities 5,477 9,761
-------- --------
INVESTING ACTIVITIES:
Loans originated (33,712) (28,351)
Purchases of:
Mortgage-related securities available for sale (4,068) (8,256)
Investment securities available for sale (149) (1,673)
Mortgage-related securities held to maturity -- (18,591)
Redemption (purchase) of FHLB stock 3,235 (53)
Proceeds from sales of investment securities available for sale -- 16,075
Principal collected on loans 29,330 28,183
Proceeds from maturities, calls, or repayments of:
Investment securities available for sale 590 201
Mortgage-related securities available for sale 3,636 6,072
Mortgage-related securities held to maturity 2,414 1,417
Purchase of property and equipment (75) (855)
------- -------
Net cash provided by (used in) investing activities 1,201 (5,831)
------- --------
FINANCING ACTIVITIES:
Net increase (decrease) in deposit accounts 3,459 (1,866)
Net decrease in FHLB advances and other borrowings (7,513) (2,806)
Net increase in advances from borrowers for taxes and insurance 1,069 1,088
Exercise of stock options 4 36
Common stock acquired by ESOP -- (72)
Cash dividend (208) (195)
-------- --------
Net cash used in financing activities (3,189) (3,815)
-------- --------
INCREASE IN CASH AND CASH EQUIVALENTS 3,489 115
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 16,155 17,975
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 19,644 $ 18,090
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW AND NON-CASH INFORMATION:
Cash payments for interest on deposits and borrowings $ 3,509 $ 3,546
Cash refund of income taxes -- (255)
See notes to unaudited consolidated financial statements.
-4-
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with instructions to Form 10-Q. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. However, such information reflects all adjustments
(consisting solely of normal recurring adjustments) which are, in the
opinion of management, necessary for a fair statement of results for the
periods.
The results of operations for the three month period ended December 31,
2005 are not necessarily indicative of the results to be expected for the
fiscal year ending September 30, 2006 or any other period. The consolidated
financial statements presented herein should be read in conjunction with
the audited consolidated financial statements and related notes thereto
included in the First Keystone Financial, Inc. (the "Company") Annual
Report on Form 10-K for the year ended September 30, 2005.
2. INVESTMENT SECURITIES
The amortized cost and approximate fair value of investment securities
available for sale and held to maturity, by contractual maturities, are as
follows:
December 31, 2005
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
--------- ---------- ---------- -----------
Available for Sale:
U.S. Government and agency bonds:
5 to 10 years $ 1,999 $ -- $ (32) $ 1,967
Municipal obligations:
5 to 10 years 130 3 -- 133
Over 10 years 12,633 408 (27) 13,014
Corporate bonds:
1 to 5 years 1,000 60 -- 1,060
5 to 10 years 2,000 -- (119) 1,881
Over 10 years 7,978 1 (61) 7,918
Mutual funds 8,933 -- (274) 8,659
Other equity investments 1,040 502 (21) 1,521
------- ---- ----- -------
Total $35,713 $974 $(534) $36,153
======= ==== ===== =======
Held to Maturity:
Municipal obligations:
5 to 10 years $ 3,258 $ 4 $ (8) $ 3,254
Corporate bonds:
Less than 1 year 1,004 -- (12) 992
------- ---- ----- -------
Total $ 4,262 $ 4 $ (20) $ 4,246
======= ==== ===== =======
-5-
Provided below is a summary of investment securities available for sale and held
to maturity which were in an unrealized loss position at December 31, 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 $ 1,967 $ (32) $ -- $ -- $ 1,967 $ (32)
Corporate bonds 4,712 (43) 2,966 (149) 7,678 (192)
Municipal bonds 2,999 (35) -- -- 2,999 (35)
Mutual fund -- -- 8,659 (274) 8,659 (274)
Equity securities 556 (21) -- -- 556 (21)
------- ----- ------- ----- ------- -----
Total $10,234 $(131) $11,625 $(423) $21,859 $(554)
======= ===== ======= ===== ======= =====
At December 31, 2005, investment securities in a gross unrealized loss position
for twelve months or longer consisted of four securities having an aggregate
depreciation of 3.6% 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 3.1%. Corporate
bonds in an unrealized loss position for 12 months or longer consist of two debt
securities and have an aggregate depreciation of 5.0%. 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 December 31, 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, 2005
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair 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
======= ====== ===== =======
-6-
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)
====== ==== ======= ===== ======= =====
3. MORTGAGE-RELATED SECURITIES
Mortgage-related securities available for sale and mortgage-related
securities held to maturity are summarized as follows:
December 31, 2005
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
--------- ---------- ---------- -----------
Available for Sale:
FHLMC pass-through certificates $ 4,058 $ 2 $ (27) $ 4,033
FNMA pass-through certificates 22,236 43 (491) 21,788
GNMA pass-through certificates 3,551 5 (63) 3,493
Collateralized mortgage obligations 39,246 24 (1,140) 38,130
------- --- ------- -------
Total $69,091 $74 $(1,721) $67,444
======= === ======= =======
Held to Maturity:
FHLMC pass-through certificates $16,442 $ 6 $ (491) $15,957
FNMA pass-through certificates 27,495 5 (791) 26,709
Collateralized mortgage obligations 259 -- (4) 255
------- --- ------- -------
Total $44,196 $11 $(1,286) $42,921
======= === ======= =======
Provided below is a summary of mortgage-related securities available for
sale and held to maturity which were in an unrealized loss position at
December 31, 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
---------- ---------- ---------- ---------- ---------- ----------
Pass-through certificates $30,827 $ (589) $38,544 $(1,274) $ 69,371 $ (1,863)
Collateralized mortgage obligations 25,960 (619) 11,866 (525) 37,826 (1,144)
------- ------- ------- ------- -------- -------
Total $56,787 $(1,208) $50,410 $(1,799) $107,197 $(3,007)
======= ======= ======= ======= ======== =======
-7-
At December 31, 2005, mortgage-related securities in a gross unrealized
loss position for twelve months or longer consisted of thirty securities
that at such date had an aggregate depreciation of 3.5% from the Company's
amortized cost basis. Management does not believe any individual unrealized
loss as of December 31, 2005 represents an other-than-temporary impairment.
The unrealized losses reported for mortgage-related securities relate
primarily to securities issued by the Federal National Mortgage
Association, the Federal Home Loan Mortgage Corporation and private
institutions. The majority of the unrealized losses associated with
mortgage-related securities are primarily attributable to changes in
interest rates and not due to the deterioration of the creditworthiness of
the issuer. The Company has the ability and intent to hold these securities
until the securities mature or recover in value.
Mortgage-related securities available for sale and mortgage-related
securities held to maturity are summarized as follows:
September 30, 2005
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair 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
======= === ======= =======
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
----------------------- ----------------------- -----------------------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair 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)
======= ======= ======= ===== ======== =======
-8-
4. LOANS RECEIVABLE
Loans receivable consist of the following:
December 31 September 30
2005 2005
----------- ------------
Real estate loans:
Single-family $146,287 $ 149,237
Construction and land 37,468 36,828
Multi-family and commercial 69,376 69,704
Home equity and lines of credit 49,598 46,748
Consumer loans 1,451 1,376
Commercial loans 18,039 16,085
-------- ---------
Total loans 322,219 319,978
Loans in process (12,360) (14,614)
Allowance for loan losses (3,525) (3,475)
Deferred loan costs 98 90
-------- ---------
Loans receivable - net $306,432 $ 301,979
======== =========
At December 31, 2005 and September 30, 2005, non-performing loans (which
include loans in excess of 90 days delinquent) amounted to approximately
$4,215 and $5,052, respectively. At December 31, 2005, non-performing loans
primarily consisted of single-family residential mortgage loans aggregating
$173, one commercial real estate loan in the amount of $3,337 and
commercial business loans aggregating $505.
At December 31, 2005 and September 30, 2005, the Company had impaired loans
with a total recorded investment of $4,734 and $3,837, respectively.
Interest income of $17 was recognized on these impaired loans during the
three months ended December 31, 2005. Interest income of approximately $115
was not recognized as interest income due to the non-accrual status of
loans for the three months ended December 31, 2005.
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:
December 31,
-------------
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. 114 897 --
------ ---
Total impaired loans $4,734 $--
====== ===
Valuation allowance related to impaired loans $ 959 $--
====== ===
The following is an analysis of the allowance for loan losses:
Three Months Ended
December 31
------------------
2005 2004
------ ------
Balance beginning of period $3,475 $2,039
Provisions charged to income 45 45
Charge-offs (4) (21)
Recoveries 9 --
------ ------
Total $3,525 $2,063
====== ======
The Company has identified the evaluation of the allowance for loan losses
as a critical accounting estimate where amounts are sensitive to material
variation. The Company is constantly challenging the methodology,
conducting assessments and redefining the process to determine the
appropriate level of allowance for loan losses. Critical accounting
estimates are significantly affected by management's judgment and
uncertainties and there is a likelihood that materially different amounts
would be reported
-9-
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 a minimum of 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, 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
its 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.
5. DEPOSITS
Deposits consist of the following major classifications:
December 31 2005 September 30 2005
------------------ ------------------
Amount Percent Amount Percent
-------- ------- -------- -------
Non-interest bearing $ 18,987 5.4% $ 18,001 5.1%
NOW 65,115 18.4 65,688 18.8
Passbook 45,996 13.0 47,139 13.5
Money market demand 44,833 12.7 45,753 13.1
Certificates of deposit 178,222 50.5 173,113 49.5
-------- ----- -------- -----
Total $353,153 100.0% $349,694 100.0%
======== ===== ======== =====
6. EARNINGS PER SHARE
Basic net income per share is based upon the weighted average number of
common shares outstanding, while diluted net income per share is based upon
the weighted average number of common shares outstanding and common share
equivalents that would arise from the exercise of dilutive securities. All
dilutive shares consist of options the exercise price of which is lower
than the market price of the common stock covered thereby at the dates
presented. At December 31, 2005, anti-dilutive shares consisted of options
covering 2,221 shares. No anti-dilutive shares existed at December 31,
2004.
-10-
The calculated basic and diluted earnings per share ("EPS") is as follows:
Three Months Ended
December 31
-----------------------
2005 2004
---------- ----------
Numerator $ 445 $ 523
Denominators:
Basic shares outstanding 1,888,344 1,785,415
Effect of dilutive securities 27,457 104,653
---------- ----------
Dilutive shares outstanding 1,915,801 1,890,068
========== ==========
Earnings per share:
Basic $ 0.24 $ 0.29
Diluted $ 0.23 $ 0.28
7. SHARE-BASED COMPENSATION
Effective October 1, 2005, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 123 (Revised 2004), "Share-Based Payment"
(SFAS No. 123(R)) using the modified prospective application transition
method. The adoption of SFAS No.123(R) resulted in approximately $6
compensation expense for the three-month period ended December 31, 2005.
Proforma compensation expense for the three-month period ended December 31,
2004 was $4. There were no new grants of stock options or other share-based
payments during the three months ended December 31, 2005 and therefore
additional disclosures for share-based compensation were omitted due to
immateriality.
8. SUBSEQUENT EVENT
On February 13, 2006, the Company and the Bank entered into separate
supervisory agreements with the OTS governing a number of operational
matters including, among other things, the requirement to (i) adopt a
capital plan designed to maintain the Company's capital at prudent levels
as well as reduce its debt-to-equity ratio below 50%; (ii) cease the
repurchase of and payment of cash dividends on its common stock unless
certain conditions are met; (iii) maintain the Bank's core and total
risk-based capital in excess of 7.5% and 12.5%, respectively; (iv) not grow
the Bank in any given quarter in excess of the greater of 3% of assets (on
an annualized basis) or net interest credited for such quarter; and (v)
adopt various revised lending policies and procedures. For more
information, see Item 5(a) of Part II hereof.
-11-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In addition to historical information, this Quarterly Report on Form 10-Q
includes certain "forward-looking statements" based on management's current
expectations. The Company's actual results could differ materially, as such term
is defined in the Securities Act of 1933 and the Securities Exchange Act of
1934, from management's expectations. Such forward-looking statements include
statements regarding management's current intentions, beliefs or expectations as
well as the assumptions on which such statements are based. These
forward-looking statements are subject to significant business, economic and
competitive uncertainties and contingencies, many of which are not subject to
the Company's control. Stockholders and potential stockholders are cautioned
that any such forward-looking statements are not guarantees of future
performance and involve risks and uncertainties, and that actual results may
differ materially from those contemplated by such forward-looking statements.
Factors that could cause future results to vary from current management
expectations include, but are not limited to, general economic conditions,
legislative and regulatory changes, monetary and fiscal policies of the federal
government, changes in tax policies, rates and regulations of federal, state and
local tax authorities, changes in interest rates, deposit flows, the cost of
funds, demand for loan products, demand for financial services, competition,
changes in the quality or composition of the Company's loan and investment
portfolios, changes in accounting principles, policies or guidelines,
availability and cost of energy resources and other economic, competitive,
governmental and technological factors affecting the Company's operations,
markets, products, services and fees.
The Company undertakes no obligation to update or revise any forward-looking
statements to reflect changed assumptions, the occurrence of unanticipated
events or changes to future operating results that occur subsequent to the date
such forward-looking statements are made.
GENERAL
The Company is a Pennsylvania corporation and sole stockholder of First Keystone
Bank, a federally chartered stock savings bank (the "Bank"), which converted to
the stock form of organization in January 1995. The Bank is a community-oriented
bank emphasizing customer service and convenience. The Bank's primary business
is attracting deposits from the general public and using those funds together
with other available sources of funds, primarily borrowings, to originate loans.
The Bank's management remains focused on its long-term strategic plan to
continue to shift the Bank's loan composition toward commercial business,
construction and home equity loans and lines of credit in order to provide a
higher yielding loan portfolio with generally shorter contractual terms.
CRITICAL ACCOUNTING POLICIES.
Accounting policies involving significant judgments and assumptions by
management, which have, or could have, a material impact on the carrying value
of certain assets or comprehensive income, are considered critical accounting
policies. In management's opinion, the most critical accounting policy affecting
the Company's financial statements is the evaluation of the allowance for loan
losses. The Company maintains an allowance for loan losses at a level management
believes is sufficient to provide for known and inherent losses in the loan
portfolio that were both probable and reasonable to estimate. 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, 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
(substandard, doubtful and loss) and (iv) determining reserve factors to be
applied to pass loans based upon loan type. Accordingly, there is a likelihood
that materially different amounts would be reported under different, but
reasonably plausible conditions or assumptions.
-12-
The determination of the allowance for loan losses requires management to make
significant estimates with respect to the amounts and timing of losses and
market and economic conditions. Accordingly, a decline in the economy could
increase loan delinquencies, foreclosures or repossessions resulting in
increased charge-off amounts and the need for additional loan loss allowances in
future periods. The Bank will continue to monitor and adjust its allowance for
loan losses through the provision for loan losses as economic conditions and
other factors dictate. Management reviews the allowance for loan losses
generally on a monthly basis. Although the Bank maintains its allowance for loan
losses at levels considered adequate to provide for the inherent risk of loss in
its loan portfolio, there can be no assurance that future losses will not exceed
estimated amounts or that additional provisions for loan losses will not be
required in future periods. In addition, the Bank's determination as to the
amount of its allowance for loan losses is subject to review by its primary
regulator, the OTS, as part of its examination process, which may result in
additional allowances based upon the judgment and review of the OTS.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2005 AND SEPTEMBER 30, 2005
Total assets of the Company decreased by $3.3 million from $518.1 million at
September 30, 2005 to $514.8 million at December 31, 2005. Loans receivable
increased slightly to $306.4 million at December 31, 2005 as the Company
continued to modestly increase the percentage of its portfolio consisting of
commercial, construction and home equity and lines of credit, partially offset
by a decrease in single-family residential loans. Prepaid expenses and other
assets decreased $5.0 million due to funds received for settlement of securities
sales. Deposits increased $3.5 million, or 1.0%, from $349.7 million at
September 30, 2005 to $353.2 million at December 31, 2005, while borrowings
decreased $7.5 million, or 6.6%, from $113.3 million at September 30, 2005. The
increase in deposits resulted from a $5.1 million, or 3.0% increase in
certificates of deposit partially offset by decreases of $1.7 million, or 0.9%,
in core deposits (which consist of passbook, money market, NOW and non-interest
bearing accounts). The decline in core deposits reflected the effects of
competition as local competitors offered higher rates on these products.
Stockholders' equity decreased $303,000 to $27.9 million primarily due to the
decrease of $587,000 in the amount of accumulated other comprehensive income
combined with dividend payments totaling $208,000, partially offset by net
income of $445,000.
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2005
AND 2004
NET INCOME.
Net income was $445,000 for the three months ended December 31, 2005 as compared
to $523,000 for the same period in 2004. The $78,000, or 14.9%, decrease in net
income for the three months ended December 31, 2005 was primarily due to a
$40,000 decrease in net interest income, a $124,000 decrease in non-interest
income partially offset by a $53,000 decrease in non-interest expense combined
with a $33,000 decrease in income tax expense.
NET INTEREST INCOME.
Net interest income decreased $40,000, or 1.4%, to $2.8 million for the three
months ended December 31, 2005 as compared to the same period in 2004. The
decrease was primarily due to a $85,000, or 1.3%, decrease in interest income
which was primarily due to a decrease of $64.0 million, or 11.9%, in the average
balance of interest-earning assets for the three months ended December 31, 2005
as compared to the same period in 2004. In the fourth quarter of fiscal 2005,
the Company implemented a deleveraging strategy involving the sale of $47.5
million of various low-yielding securities and the repayment of $46.0 million in
FHLB convertible advances and overnight borrowings. The decline in the average
balance of interest-earning assets was a result of this strategy partially
offset by a 60 basis point (on a fully tax-equivalent basis) increase in the
weighted yield earned on the Company's interest-earning assets. However, the
decrease in interest income was partially offset by a $45,000, or 1.2%, decrease
in interest expense which was primarily due to a decrease of $61.1 million, or
11.4%, in the average balance of such liabilities for the three months ended
December 31, 2005 as compared to the same period in 2004 partially offset by a
33 basis point (on a fully tax-equivalent basis) increase in the weighted
average rate paid on interest-bearing liabilities.
-13-
The interest rate spread and net interest margin, on a fully tax equivalent
basis, were 2.42% and 2.42%, respectively, for the three months ended December
31, 2005 as compared to 2.15% and 2.16%, respectively, for the same period in
2004. As a result of the deleveraging strategy, the Company improved its
interest rate margin because the yields on interest-earning assets increased to
a greater degree than the rates paid on interest-bearing liabilities. However,
the continued rise in short-term interest rates could negatively impact the
Company's interest rate margin as shorter term interest-bearing liabilities will
reprice faster than the Company's longer term interest-earning assets.
The following table presents the average balances for various categories of
assets and liabilities, and income and expense related to those assets and
liabilities for the three months ended December 31, 2005 and 2004. The
adjustment of tax exempt securities to a tax equivalent yield in the table below
may be considered to include non-GAAP financial information. Management believes
that it is a 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.
FOR THE THREE MONTHS ENDED
-------------------------------------------------------------
DECEMBER 31, 2005 DECEMBER 31, 2004
-------------------------------------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Cost(4) Balance Interest Cost(4)
-------- -------- ------- -------- -------- -------
Interest-earning assets:
Loans receivable(1) (2) $304,455 $4,699 6.17% $306,002 $4,463 5.83%
Mortgage-related securities(2) 112,542 1,200 4.27 142,387 1,402 3.94
Investment securities(4) 47,226 686 5.81 75,389 813 4.31
Other interest-earning assets 9,624 51 2.12 14,037 41 1.17
-------- ------ -------- ------
Total interest-earning assets 473,847 6,636 5.60 537,815 6,719 5.00
-------- ------ -------- ------
Non-interest-earning assets 34,642 32,471
-------- --------
Total assets $508,489 $570,286
======== ========
Interest-bearing liabilities:
Deposits $347,338 1,869 2.15 $343,454 $1,453 1.69
FHLB advances and other borrowings 105,850 1,429 5.40 170,770 1,928 4.52
Junior subordinated debentures 21,517 472 8.77 21,553 434 8.05
-------- ------ -------- ------
Total interest-bearing
liabilities 474,705 3,770 3.18 535,777 3,815 2.85
-------- ------ -------- ------
Interest rate spread 2.42% 2.15%
===== ======
Non-interest-bearing liabilities 5,829 4,903
-------- --------
Total liabilities 480,534 540,680
Stockholders' equity 27,955 29,606
-------- --------
Total liabilities and stockholders'
equity $508,489 $570,286
======== ========
Net interest-earning assets $ (858) $ 2,038
======== ========
Net interest income(4) $2,866 $2,904
====== ======
Net interest margin(3) 2.42% 2.16%
===== ======
Ratio of average interest-earning
assets to average interest-bearing
liabilities 99.82% 100.38%
===== ======
- ----------
(1) Includes non-accrual loans.
(2) Includes assets classified as either available for sale or held for sale.
(3) Net interest income divided by interest-earning assets.
(4) Presented on a tax-equivalent basis.
-14-
Although management believes that the above mentioned non-GAAP financial
measures enhance investor's understanding of the Company's business and
performance, these non-GAAP financials measures should not be considered an
alternative to GAAP. The reconciliation of these non-GAAP financials measures
from GAAP to non-GAAP is presented below.
FOR THE THREE MONTHS ENDED
---------------------------------------------
DECEMBER 31, 2005 DECEMBER 31, 2004
--------------------- ---------------------
AVERAGE AVERAGE
INTEREST YIELD/COST INTEREST YIELD/COST
-------- ---------- -------- ----------
(Dollars in thousands)
Investment securities - nontaxable $ 600 5.08% $ 729 3.87%
Tax equivalent adjustments 86 84
------ ------
Investment securities - nontaxable to
a taxable equivalent yield $ 686 5.81% $ 813 4.31%
====== ======
Net interest income $2,780 $2,820
Tax equivalent adjustment 86 84
------ ------
Net interest income, tax equivalent $2,866 $2,904
====== ======
Net interest rate spread, no tax adjustment 2.35% 2.09%
Net interest margin, no tax adjustment 2.35% 2.10%
PROVISION FOR LOAN LOSSES.
Provisions for loan losses are charged to earnings to maintain the total
allowance for loan losses at a level believed by management sufficient to cover
all known and inherent losses in the loan portfolio which are both probable and
reasonably estimable. Management's analysis includes consideration of the
Company's historical experience, the volume and type of lending conducted by the
Company, the amount of the Company's classified assets, the status of past due
principal and interest payments, general economic conditions, particularly as
they relate to the Company's primary market area, and other factors related to
the collectibility of the Company's loan and loans held for sale portfolios. For
the three months ended December 31, 2005 and 2004, the provision for loan losses
amounted to $45,000 for each respective quarter. The provision for loan loss was
based on the Company's monthly review of the credit quality of its loan
portfolio, the net charge-offs during the first quarter of fiscal 2006 and other
factors.
At December 31, 2005, non-performing assets decreased $837,000 to $5.0 million,
or 1.0%, of total assets, from $5.8 million at September 30, 2005. The decrease
in non-performing assets was primarily the result of a $770,000 construction
loan returning to current status. The coverage ratio, which is the ratio of the
allowance for loan losses to non-performing loans, was 86.6% and 68.8% at
December 31, 2005 and September 30, 2005, respectively.
Included in non-performing assets was $760,000 of real estate owned which
consisted primarily of a commercial real estate property. The Bank owns a 25%
participation interest in an 18-hole golf course and a golf house located in
Avondale, Pennsylvania. Subsequent to December 31, 2005, the property was sold
and will result in the recognition of a pre-tax gain on sale of $158,000 for the
quarter ended March 31, 2006.
Included in non-performing loans at December 31, 2005 was a $3.8 million
commercial loan relationship comprised of a $3.3 million non-accrual commercial
real estate loan and a $500,000 non-accrual commercial business loan. The loans
are secured by a restaurant in Chesapeake City, Maryland. Although the Company
received an updated appraisal of the property during fiscal 2005, upon review of
the appraisal, a number of factors concerning the loans and the unique nature of
the property as well as the results of the recent examination by the OTS,
significant issues as to the collectibility of the loans were deemed to exist.
As a result, the Company determined to classify these loans as "doubtful" and
establish a significant reserve related to them. Subsequent to December 31,
2005, the restaurant ceased operations. The borrower has filed for bankruptcy
and, as part of those proceedings, the property will be sold at auction.
Management continues to review its loan portfolio to determine the extent, if
any, to which further additional loss provisions may be deemed necessary. There
can be no assurance that the allowance for losses will be adequate to cover
losses which may in fact be realized in the future and that additional
provisions for losses will not be required.
-15-
NON-INTEREST INCOME.
Non-interest income decreased $124,000 or 13.8% to $775,000 for the three months
ended December 31, 2005 as compared to the same period in 2004. The decrease for
the three months ended December 31, 2005 was primarily due to a slower
appreciation rate during the 2005 period in the cash surrender value of certain
insurance policies held by the Bank to fund certain supplemental retirement
benefits resulting in a decrease of $107,000 compared to the same period in
2004. In addition, the Company did not experience any gain on sale of investment
securities as compared to $75,000 in gain on sale of investment securities in
the first quarter of fiscal 2005 resulting from the implementation of certain
asset/liability strategies in fiscal year 2005. In addition, the $40,000
decrease in the service charges and other fees was mainly due to a decrease in
fee-based deposit transactions. The decrease in non-interest income was
partially offset by a $106,000 increase in the gain on sale of commercial
business loans through the Small Business Administration Program.
NON-INTEREST EXPENSE.
Non-interest expense decreased $53,000 or 1.7% during the three months ended
December 31, 2005 compared to the same period in 2004. The decrease was
primarily due to decreases of $69,000 and $28,000 in other non-interest expense
and salaries and employee benefits, respectively, partially offset by a $27,000
increase in occupancy and equipment expense. Other non-interest expense
decreased primarily due to the completion of a bankwide customer service
training program in October 2005. The increase in occupancy and equipment was
related to the branch expansion which occurred in the fourth quarter of 2004.
The decrease in non-interest expense was partially offset by increases of
$23,000 and $10,000 in professional fees and advertising expenses, respectively.
INCOME TAX EXPENSE.
Income tax expense decreased $33,000 to $72,000 during the three months ended
December 31, 2005 as compared to the same period in 2004. The decrease reflected
the decrease in income before income taxes as compared to the same period in
2004. The effective tax rate decreased to 13.9% for the three months ended
December 31, 2005 from 16.7% for the same period in 2004 due to the effect of
tax-free investments.
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, prepayment and maturities of
outstanding loans and mortgage-related securities, sales of loans, maturities of
investment securities and other short-term investments, borrowing and funds
provided from operations. While scheduled payments from the amortization of
loans and mortgage-related securities and maturing investment securities and
short-term investments are relatively predictable sources of funds, deposit
flows and loan prepayments are greatly influenced by general interest rates,
economic conditions and competition. In addition, the Company invests excess
funds in overnight deposits and other short-term interest-earning assets which
provide liquidity to meet lending requirements. The Company has been able to
generate sufficient cash through its deposits as well as borrowings to satisfy
its funding commitments. At December 31, 2005, the Company had short-term
borrowings (due within one year or currently callable by the FHLB) outstanding
of $105.7 million, all of which consisted of advances 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, mortgage-related securities
and investment securities. The Company uses its sources of funds primarily to
meet its ongoing commitments, to fund maturing certificates of deposit and
savings withdrawals, fund loan commitments and maintain a portfolio of
mortgage-related and investment securities. At December 31, 2005, total approved
loan commitments outstanding amounted to $14.5 million, not including loans in
process. At the same date, commitments under unused lines of credit amounted to
$36.5 million. Certificates of deposit scheduled to mature in one year or less
at December 31, 2005 totaled $111.9 million. Based upon the Company's historical
experience, management believes that a significant portion of maturing deposits
will remain with the Company.
-16-
The Bank is required under applicable federal banking regulations to maintain
tangible capital equal to at least 1.5% of its adjusted total assets, core
capital equal to at least 4.0% of its adjusted total assets and total capital to
at least 8.0% of its risk-weighted assets. At December 31, 2005, the Bank had
tangible capital and core capital equal to 9.0% of adjusted total assets and
total capital equal to 15.4% of risk-weighted assets. However, as a result of
the supervisory agreement discussed in Item 5(a) of Part II hereof, the Bank is
required to maintain core and risk-based capital in excess of 7.5% and 12.5%,
respectively. The Bank is in compliance with such requirements imposed by the
supervisory agreement. In addition, as a result of entering into such agreement,
the Bank is no longer deemed to be "well-capitalized" for purposes of the prompt
corrective action regulations of the OTS.
IMPACT OF INFLATION AND CHANGING PRICES.
The Consolidated Financial Statements of the Company and related notes presented
herein have been prepared in accordance with generally accepted accounting
principles which requires the measurement of financial position and operating
results in terms of historical dollars, without considering changes in the
relative purchasing power of money over time due to inflation.
Unlike most industrial companies, substantially all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or in the same magnitude as the price
of goods and services, since such prices are affected by inflation to a larger
extent than interest rates. In the current interest rate environment, liquidity
and the maturity structure of the Company's assets and liabilities are critical
to the maintenance of acceptable performance levels.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For a discussion of the Company's asset and liability management policies, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operation" in the Company's Annual Report for the year ended September 30, 2005.
The Company utilizes reports prepared by the OTS to measure interest rate risk.
Using data from the Bank's quarterly thrift financial reports, the OTS models
the net portfolio value ("NPV") of the Bank over a variety of interest rate
scenarios. The NPV is defined as the present value of expected cash flows from
existing assets less the present value of expected cash flows from existing
liabilities plus the present value of net expected cash inflows from existing
off-balance sheet contracts. The model assumes instantaneous, parallel shifts in
the U.S. Treasury Securities yield curve up to 300 basis points, and a decline
of 200 basis points.
The interest rate risk measures used by the OTS include an "Exposure Measure" or
"Post-Shock" NPV ratio and a "Sensitivity Measure". The "Post-Shock" NPV ratio
is the net present value as a percentage of assets over the various yield curve
shifts. A low "Post-Shock" NPV ratio indicates greater exposure to interest rate
risk and can result from a low initial NPV ratio or high sensitivity to changes
in interest rates. The "Sensitivity Measure" is the decline in the NPV ratio, in
basis points, caused by a 2% increase or decrease in rates, whichever produces a
larger decline. The following sets forth the Bank's NPV as of December 31, 2005.
Net Portfolio Value
(Dollars in thousands)
- ------------------------------------------------------------------------------
Changes in Net
Rates in Dollar Percentage Portfolio Value As
Basis Points Amount Change Change a % of Assets Change
- ------------ ------- -------- ---------- ------------------ --------
300 $43,558 $(21,840) (33)% 8.71% (363) bp
200 51,816 (13,582) (21) 10.16 (218) bp
100 59,420 (5,979) (9) 11.43 (92) bp
0 65,398 -- -- 12.35 --
(100) 68,084 2,686 4 12.67 33 bp
(200) 67,008 (1,610) 2 12.37 3 bp
-17-
As of December 31, 2005, the Company's NPV was $65.4 million or 12.35% of the
market value of assets. Following a 200 basis point increase in interest rates,
the Company's "post shock" NPV was $51.8 million or 10.16% of the market value
of assets. The change in the NPV ratio or the Company's sensitivity measure was
(2.18)%.
ITEM 4. CONTROLS AND PROCEDURES
Our management evaluated, with the participation of our Chief Executive Officer
and Chief Financial Officer, the effectiveness of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934) as of the end of the period covered by this report. Based on such
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures are designed to ensure
that information required to be disclosed by us in the reports that we file or
submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
regulations and are operating in an effective manner.
No change in our internal control over financial reporting (as defined in Rule
13a-15(f) under the Securities Exchange Act of 1934) occurred during the most
recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
-18-
PART II
Item 1. Legal Proceedings
No material changes in the legal proceedings previously disclosed in Item 3
of the Company's Form 10-K for the year ended September 30, 2005.
Item 1A. Risk Factors
Not applicable
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) - (b) Not applicable
(c) Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
On January 25, 2006, the Annual Meeting of Stockholders of the Company was
held to elect management's nominees for director and to ratify the
appointment of Deloitte & Touche LLP as the Company's independent
registered public accounting firm. No other nominations for directors were
submitted. With respect to the election of directors, the results were as
follows:
Votes
--------------------
Nominee For Withheld
------- --------- --------
Edward Calderoni 1,465,190 370,716
William J. O' Donnell 1,468,788 367,118
With respect to the ratification of Deloitte & Touche LLP as the Company's
independent registered public accounting firm for the fiscal year ending
September 30, 2006, the results were as follows: 1,835,455 votes for, 217
votes against and 234 votes abstaining.
Item 5. Other Information
(a) On February 13, 2006, the Company and the Bank each entered into
supervisory agreements with the OTS which primarily addressed issues
identified in the OTS' most recent reports of examination of the
Company's and the Bank's operations and financial condition.
Under the terms of the supervisory agreement between the Company and
the OTS, the Company agreed to, among other things, (i) develop and
implement a three-year capital plan designed to support the Company's
efforts to maintain prudent levels of capital and to reduce its
debt-to-equity ratio below 50%; (ii) not incur any additional debt
without the prior written approval of the OTS; and (iii) not
repurchase any shares of or pay any cash dividends on its common stock
until certain conditions were complied with; provided, however, that
upon reducing its debt-to-equity below 50%, the Company may resume the
payment of quarterly cash dividends at the lesser of the dividend rate
in effect immediately prior to entering into the supervisory agreement
or 35% of its consolidated net income (on an annualized basis),
provided that the OTS does not object to the payment of such dividend
pursuant to a required prior notice of the Company's intent to declare
such quarterly dividend. In order to comply with the debt-to-equity
ratio requirement, the Company is considering various alternatives
which may include raising additional equity capital combined with the
redemption in the future of a portion of its outstanding subordinated
debt.
Under the terms of the supervisory agreement between the Bank and the
OTS, the Bank agreed to, among other things, (i) not grow in any
quarter in excess of the greater of 3% of total assets (on an
annualized basis) or net interest credited on deposit liabilities
during such quarter; (ii) maintain its core capital and total
risk-based capital ratios in excess of 7.5% and 12.5%, respectively;
(iii) adopt revised
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policies and procedures governing commercial lending; (iv) conduct
periodic reviews of its commercial loan department; (v) conduct
periodic internal loan reviews; (vi) adopt a revised asset
classification policy and (vii) not amend, renew or enter into
compensatory arrangements with senior executive officers and
directors, subject to certain exceptions, without the prior approval
of the OTS.
The Company and the Bank have already taken a number of steps which
they believe will render them in substantial compliance with a
majority of the terms of the supervisory agreements. In addition, the
Company is working with its advisors to address the capital plan
requirements.
As a result of the supervisory agreement, even though the Bank's
regulatory capital is in excess of all regulatory capital
requirements, the Bank will not be deemed to be "well-capitalized" for
purposes of the prompt corrective action regulations of the OTS.
The supervisory agreements are filed herewith as Exhibits 99.2 and
99.3 and are incorporated by reference herein. The foregoing
description of the supervisory agreements is qualified in its entirety
by reference to the text of the supervisory agreements.
(b) No changes in procedures.
Item 6. Exhibits
List of Exhibits
Exhibit
No Description
- ------- -----------
3.1 Amended and Restated Articles of Incorporation of First Keystone
Financial, Inc. (1)
3.2 Amended and Restated Bylaws of First Keystone Financial, Inc. (1)
4.1 Specimen Stock Certificate of First Keystone Financial, Inc. (1)
4.2 Instrument defining the rights of security holders **
10.1 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 6 to the
Unaudited Consolidated Financial Statements included in Item 1 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
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32.2 Certification of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
99.1 Codes of Ethics (9)
99.2 Supervisory Agreement between First Keystone Financial, Inc. and the
Office of Thrift Supervision dated February 13, 2006.
99.3 Supervisory Agreement between First Keystone Bank and the Office of
Thrift Supervision dated February 13, 2006.
- ----------
(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).
(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.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST KEYSTONE FINANCIAL, INC.
Date: February 14, 2006 By: /s/ Thomas M. Kelly
----------------------------------------
Thomas M. Kelly
President and Chief Executive Officer
Date: February 14, 2006 By: /s/ Rose M. DiMarco
----------------------------------------
Rose M. DiMarco
Chief Financial Officer
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