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 March 31, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission File Number: 000-25328
FIRST KEYSTONE FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2576479
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
22 West State Street
Media, Pennsylvania 19063
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (610) 565-6210
Indicate by check mark whether the Registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
----- -----
Indicate by check mark whether the Registrant is 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 May 9, 2006: 2,023,974
FIRST KEYSTONE FINANCIAL, INC.
CONTENTS
PAGE
----
PART I CONDENSED FINANCIAL INFORMATION:
Item 1. Financial Statements
Unaudited Consolidated Statements of Financial Condition as of
March 31, 2006 and September 30, 2005 1
Unaudited Consolidated Statements of Income for the Three and Six
Months Ended March 31, 2006 and 2005 2
Unaudited Consolidated Statement of Changes in Stockholders' Equity
for the Six Months Ended March 31, 2006 and 2005 3
Unaudited Consolidated Statements of Cash Flows for the Six Months
Ended March 31, 2006 and 2005 4
Notes to Unaudited Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21
Item 4. Controls and Procedures 21
PART II OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 1A. Risk Factors 22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 22
Item 3. Defaults Upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits 22
SIGNATURES 24
FIRST KEYSTONE FINANCIAL, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands)
March 31, September 30,
2006 2005
--------- -------------
ASSETS
Cash and amounts due from depository institutions $ 4,395 $ 8,321
Interest-bearing deposits with depository institutions 12,357 7,834
-------- --------
Total cash and cash equivalents 16,752 16,155
Investment securities available for sale 36,039 37,019
Mortgage-related securities available for sale 75,926 67,527
Loans held for sale -- 41
Investment securities held to maturity - at amortized cost
(approximate fair value of $3,234 at March 31, 2006
and $4,290 at September 30, 2005) 3,258 4,267
Mortgage-related securities held to maturity - at amortized cost
(approximate fair value of $40,547 at March 31, 2006
and $45,679 at September 30, 2005) 42,306 46,654
Loans receivable (net of allowance for loan loss of $2,893 and $3,475
at March 31, 2006 and September 30, 2005, respectively) 306,465 301,979
Accrued interest receivable 2,496 2,435
Real estate owned 2,700 760
Federal Home Loan Bank stock, at cost 6,173 9,499
Office properties and equipment, net 4,708 4,782
Deferred income taxes 2,387 2,008
Cash surrender value of life insurance 17,132 16,835
Prepaid expenses and other assets 3,413 8,163
-------- --------
TOTAL ASSETS $519,755 $518,124
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Non-interest-bearing $ 16,816 $ 18,001
Interest-bearing 345,894 331,693
-------- --------
Total deposits 362,710 349,694
Advances from Federal Home Loan Bank and other borrowings 101,977 113,303
Junior subordinated debentures 21,502 21,520
Accrued interest payable 1,933 1,870
Advances from borrowers for taxes and insurance 2,006 839
Accounts payable and accrued expenses 2,307 2,705
-------- --------
Total liabilities 492,435 489,931
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 March 31 2006 and September 30, 2005, 2,023,974
and 2,023,534 shares, respectively 27 27
Additional paid-in capital 12,958 12,920
Employee stock ownership plan (3,138) (3,185)
Treasury stock at cost: 688,582 shares at March 31, 2006 and 689,022 shares
at September 30, 2005 (10,583) (10,590)
Accumulated other comprehensive loss (1,430) (209)
Retained earnings - partially restricted 29,486 29,230
-------- --------
Total stockholders' equity 27,320 28,193
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $519,755 $518,124
======== ========
See notes to unaudited consolidated financial statements.
FIRST KEYSTONE FINANCIAL, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data)
Three months
ended Six months ended
March 31, March 31,
--------------- -----------------
2006 2005 2006 2005
------ ------ ------- -------
INTEREST INCOME:
Interest and fees on loans $4,821 $4,408 $ 9,520 $ 8,871
Interest and dividends on:
Mortgage-related securities 1,276 1,552 2,476 2,953
Investment securities:
Taxable 296 321 592 771
Tax-exempt 187 187 374 380
Dividends 74 271 191 357
Interest-bearing deposits 42 40 92 81
------ ------ ------- -------
Total interest income 6,696 6,779 13,245 13,413
------ ------ ------- -------
INTEREST EXPENSE:
Interest on:
Deposits 1,958 1,474 3,827 2,926
Federal Home Loan Bank advances and other borrowings 1,425 1,900 2,854 3,828
Junior subordinated debentures 485 444 956 878
------ ------ ------- -------
Total interest expense 3,868 3,818 7,637 7,632
------ ------ ------- -------
NET INTEREST INCOME 2,828 2,961 5,608 5,781
PROVISION FOR LOAN LOSSES 525 45 570 90
------ ------ ------- -------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 2,303 2,916 5,038 5,691
------ ------ ------- -------
NON-INTEREST INCOME:
Service charges and other fees 360 378 739 798
Net gain on sales of:
Loans held for sale 17 18 142 37
Investment and mortgage-related securities -- 449 -- 524
Real estate owned 158 -- 158 --
Increase in cash surrender value of life insurance 144 151 297 411
Other income 121 105 237 230
------ ------ ------- -------
Total non-interest income 800 1,101 1,573 2,000
------ ------ ------- -------
NON-INTEREST EXPENSE:
Salaries and employee benefits 1,502 1,711 3,004 3,241
Occupancy and equipment 395 383 784 745
Professional fees 553 284 821 528
Federal deposit insurance premium 37 12 49 25
Data processing 131 136 251 264
Advertising 102 86 208 182
Net cost of operation of other real estate -- 3 -- 5
Deposit processing 155 154 310 316
Other 351 435 790 944
------ ------ ------- -------
Total non-interest expense 3,226 3,204 6,217 6,250
------ ------ ------- -------
INCOME (LOSS) BEFORE INCOME TAX (BENEFIT) EXPENSE (123) 813 394 1,441
INCOME TAX (BENEFIT) EXPENSE (142) 175 (70) 280
------ ------ ------- -------
NET INCOME $ 19 $ 638 $ 464 $ 1,161
====== ====== ======= =======
BASIC EARNINGS PER COMMON SHARE $ 0.01 $ 0.35 $ 0.25 $ 0.64
====== ====== ======= =======
DILUTED EARNINGS PER COMMON SHARE $ 0.01 $ 0.34 $ 0.24 $ 0.63
====== ====== ======= =======
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 -- -- -- -- -- 1,161 1,161
Other comprehensive income, net of tax:
Net unrealized loss on securities
net of reclassification adjustment(1) -- -- -- -- (1,620) -- (1,620)
--- ------- ------- -------- ------- ------- -------
Comprehensive loss -- -- -- -- -- -- (459)
--- ------- ------- -------- ------- ------- -------
Common stock acquired by stock benefit plans -- -- (72) -- -- -- (72)
ESOP shares committed to be released -- -- 30 -- -- -- 30
Excess of fair value above cost of
ESOP shares committed to be released -- 29 -- -- -- -- 29
Purchase of treasury stock -- -- -- (110) -- -- (110)
Exercise of stock options -- (671) -- 1,101 -- -- 430
Dividends - paid -- -- -- -- -- (397) (397)
--- ------- ------- -------- ------- ------- -------
BALANCE AT MARCH 31, 2005 $27 $12,967 $(3,231) $(10,922) $ 114 $30,194 $29,149
=== ======= ======= ======== ======= ======= =======
BALANCE AT OCTOBER 1, 2005 $27 $12,920 $(3,185) $(10,590) $ (209) $29,230 $28,193
Net income -- -- -- -- -- 464 464
Other comprehensive income, net of tax:
Net unrealized loss on securities
net of reclassification adjustment(1) -- -- -- -- (1,221) -- (1,221)
--- ------- ------- -------- ------- ------- -------
Comprehensive loss -- -- -- -- -- -- (757)
--- ------- ------- -------- ------- ------- -------
ESOP shares committed to be released -- -- 47 -- -- -- 47
Share-based compensation -- 13 -- -- -- -- 13
Excess of fair value above cost of
ESOP shares committed to be released -- 27 -- -- -- -- 27
Exercise of stock options -- (2) -- 7 -- -- 5
Dividends paid -- -- -- -- -- (208) (208)
--- ------- ------- -------- ------- ------- -------
BALANCE AT MARCH 31, 2006 $27 $12,958 $(3,138) $(10,583) $(1,430) $29,486 $27,320
=== ======= ======= ======== ======= ======= =======
(1) Disclosure of reclassification amount, net of tax:
March 31,
-----------------
2006 2005
------- -------
Net unrealized depreciation arising during the period $(1,221) $(1,966)
Less: reclassification adjustment for net gains included in net income
(net of tax of $0 and $178, respectively) -- 346
------- -------
Net unrealized loss on securities $(1,221) $(1,620)
======= =======
See notes to unaudited consolidated financial statements.
-3-
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) (dollars in thousands)
Six months ended
March 31,
-------------------
2006 2005
-------- --------
OPERATING ACTIVITIES:
Net income $ 464 $ 1,161
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Provision for depreciation and amortization 266 261
Amortization of premiums and discounts 193 244
Increase in cash surrender value of life insurance (297) (411)
Gain on sales of:
Loans held for sale (142) (37)
Investment securities available for sale -- (524)
Real estate owned (158) --
Provision for loan losses 570 90
Amortization of ESOP 74 59
Deferred income taxes 250 --
Share-based compensation 13 --
Insurance proceeds on real estate owned -- 29
Changes in assets and liabilities which provided (used) cash:
Origination of loans held for sale (4,347) (6,041)
Proceeds from the sale of loans 4,388 5,717
Accrued interest receivable (61) 41
Prepaid expenses and other assets 4,750 8,396
Accrued interest payable 63 63
Accrued expenses (398) 688
-------- --------
Net cash provided by operating activities 5,628 9,736
-------- --------
INVESTING ACTIVITIES:
Loans originated (62,505) (64,493)
Purchases of:
Mortgage-related securities available for sale (16,381) (30,955)
Investment securities available for sale (240) (2,673)
Mortgage-related securities held to maturity -- (18,591)
Redemption of FHLB stock 3,326 850
Proceeds from sales of real estate owned 918 250
Proceeds from sales of investment securities available for sale -- 25,508
Principal collected on loans 54,857 63,108
Proceeds from maturities, calls, or repayments of:
Investment securities available for sale 590 324
Mortgage-related securities available for sale 6,673 11,816
Mortgage-related securities held to maturity 4,269 3,717
Investment securities held to maturity 1,000 1,000
Purchase of property and equipment (192) (954)
-------- --------
Net cash used in investing activities (7,685) (11,093)
-------- --------
FINANCING ACTIVITIES:
Net increase in deposit accounts 13,016 10,248
Net decrease in FHLB advances and other borrowings (11,326) (7,457)
Net increase in advances from borrowers for taxes and insurance 1,167 1,133
Exercise of stock options 5 430
Common stock acquired by ESOP -- (72)
Purchase of treasury stock -- (110)
Cash dividend (208) (397)
-------- --------
Net cash provided by financing activities 2,654 3,775
-------- --------
INCREASE IN CASH AND CASH EQUIVALENTS 597 2,418
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 16,155 17,975
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 16,752 $ 20,393
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW AND NON-CASH INFORMATION:
Cash payments for interest on deposits and borrowings $ 7,574 $ 7,544
Transfers of loans receivable into real estate owned 3,337 --
See notes to unaudited consolidated financial statements.
-4-
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with instructions to Form 10-Q. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. However, such information reflects all adjustments
(consisting solely of normal recurring adjustments) which are, in the
opinion of management, necessary for a fair statement of results for the
periods.
The results of operations for the three and six month periods ended March
31, 2006 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:
March 31, 2006
-------------------------------------------------
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 $ -- $ (44) $ 1,955
Municipal obligations:
5 to 10 years 130 2 -- 132
Over 10 years 12,634 325 (36) 12,923
Corporate bonds:
1 to 5 years 1,000 45 -- 1,045
5 to 10 years 2,000 -- (145) 1,855
Over 10 years 7,966 1 (66) 7,901
Mutual funds 9,025 -- (302) 8,723
Other equity investments 1,040 500 (35) 1,505
------- ---- ----- -------
Total $35,794 $873 $(628) $36,039
======= ==== ===== =======
Held to Maturity:
Municipal obligations:
5 to 10 years $ 3,258 $ -- $ (24) $ 3,234
------- ---- ----- -------
Total $ 3,258 $ -- $ (24) $ 3,234
======= ==== ===== =======
-5-
Provided below is a summary of investment securities available for sale and
held to maturity which were in an unrealized loss position at March 31,
2006.
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 $ 1,955 $ (44) $ -- $ -- $ 1,955 $ (44)
Corporate bonds 5,734 (39) 2,939 (172) 8,673 (211)
Municipal bonds 4,199 (60) -- -- 4,199 (60)
Mutual fund -- -- 8,693 (302) 8,693 (302)
Equity securities 605 (35) -- -- 605 (35)
------- ----- ------- ----- ------- -----
Total $12,493 $(178) $11,632 $(474) $24,125 $(652)
======= ===== ======= ===== ======= =====
At March 31, 2006, investment securities in a gross unrealized loss
position for twelve months or longer consisted of four securities having an
aggregate depreciation of 3.9% 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 limited 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
consisted of two funds primarily invested in asset-backed securities and
had an aggregate depreciation of 3.3%. Corporate bonds in an unrealized
loss position for 12 months or longer consisted of two debt securities and
had an aggregate depreciation of 5.5%. 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 March 31, 2006 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:
March 31, 2006
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
--------- ---------- ---------- -----------
Available for Sale:
FHLMC pass-through certificates $ 8,052 $ 1 $ (156) $ 7,897
FNMA pass-through certificates 29,191 31 (758) 28,464
GNMA pass-through certificates 3,301 4 (77) 3,228
Collateralized mortgage obligations 37,794 25 (1,482) 36,337
------- --- ------- -------
Total $78,338 $61 $(2,473) $75,926
======= === ======= =======
Held to Maturity:
FHLMC pass-through certificates $15,801 $ 4 $ (678) $15,127
FNMA pass-through certificates 26,285 3 (1,086) 25,202
Collateralized mortgage obligations 220 -- (2) 218
------- --- ------- -------
Total $42,306 $ 7 $(1,766) $40,547
======= === ======= =======
Provided below is a summary of mortgage-related securities available for
sale and held to maturity which were in an unrealized loss position at
March 31, 2006.
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 $28,799 $ (613) $49,026 $(2,141) $ 77,825 $(2,754)
Collateralized
mortgage
obligations 15,619 (550) 20,398 (935) 36,017 (1,485)
------- ------- ------- ------- -------- -------
Total $44,418 $(1,163) $69,424 $(3,076) $113,842 $(4,239)
======= ======= ======= ======= ======== =======
-7-
At March 31, 2006, mortgage-related securities in a gross unrealized loss
position for twelve months or longer consisted of 42 securities that at
such date had an aggregate depreciation of 4.2% from the Company's
amortized cost basis. Management does not believe any individual unrealized
loss as of March 31, 2006 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 various private
issuers. 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 23 (856) 40,374
------- --- ------- -------
Total $68,697 $89 $(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:
March 31, September 30,
2006 2005
---------- -------------
Real estate loans:
Single-family $143,538 $149,237
Construction and land 37,805 36,828
Multi-family and commercial 67,768 69,704
Home equity and lines of credit 52,764 46,748
Consumer loans 1,461 1,376
Commercial loans 19,030 16,085
-------- --------
Total loans 322,366 319,978
Loans in process (13,123) (14,614)
Allowance for loan losses (2,893) (3,475)
Deferred loan costs 115 90
-------- --------
Loans receivable - net $306,465 $301,979
======== ========
At March 31, 2006 and September 30, 2005, non-performing loans (which
include loans in excess of 90 days delinquent) amounted to approximately
$811 and $5,052, respectively. At March 31, 2006, non-performing loans
primarily consisted of single-family residential mortgage loans aggregating
$472 and consumer lines of credit aggregating $202.
At March 31, 2006 and September 30, 2005, the Company had impaired loans
with a total recorded investment of $995 and $3,837, respectively, and an
average recorded investment of $3,727 and $1,279, respectively. Interest
income of $34 and $39 was recognized on these impaired loans during the six
months ended March 31, 2006 and the year ended September 30, 2005,
respectively.
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:
March 31, September 30,
2006 2005
--------- -------------
Impaired loans with related allowance for loan losses
under SFAS No. 114 $ -- $3,837
Impaired loans with no related allowance for loan losses
under SFAS No. 114 955 --
---- ------
Total impaired loans $955 $3,837
==== ======
Valuation allowance related to impaired loans $ -- $ 959
==== ======
The following is an analysis of the allowance for loan losses:
Six Months Ended
March 31,
------------------
2006 2005
------- --------
Balance beginning of period $ 3,475 $2,039
Provisions charged to income 570 45
Charge-offs (1,162) (21)
Recoveries 10 --
------- ------
Total $ 2,893 $2,063
======= ======
As of March 31, 2006, the Company transferred to real estate owned property
located in Chesapeake City, Maryland that secured a $3,337 commercial real
estate loan and a $500 commercial business loan as a result of the Company
taking possession of the property. In connection with the property's
transfer to real estate owned, the Company recorded the property at its
approximate fair value of $2,700 resulting in a charge-off of $1,137
against the allowance for loan losses.
-9-
The Company has identified the evaluation of the allowance for loan losses
as a critical accounting estimate where amounts are sensitive to material
variation. The Company is constantly challenging the methodology,
conducting assessments and redefining the process to determine the
appropriate level of allowance for loan losses. Critical accounting
estimates are significantly affected by management's judgment and
uncertainties and there is a likelihood that materially different amounts
would be reported under different, but reasonable, conditions or
assumptions. The allowance for loan losses is considered a critical
accounting estimate because there is a large degree of judgment in (i)
assigning individual loans to specific risk levels (pass, special mention,
substandard, doubtful and loss), (ii) valuing the underlying collateral
securing the loans, (iii) determining the appropriate reserve factor to be
applied to specific risk levels for criticized and classified loans
(special mention, substandard, doubtful and loss) and (iv) determining
reserve factors to be applied to pass loans based upon loan type.
Management reviews the allowance for loan losses generally on a monthly
basis, but at a minimum 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 federal banking 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:
March 31, September 30,
2006 2005
------------------ ------------------
Amount Percent Amount Percent
-------- ------- -------- -------
Non-interest bearing $ 16,816 4.6% $ 18,001 5.1%
NOW 72,036 19.9 65,688 18.8
Passbook 48,074 13.3 47,139 13.5
Money market demand 43,929 12.1 45,753 13.1
Certificates of deposit 181,855 50.1 173,113 49.5
-------- ----- -------- -----
Total $362,710 100.0% $349,694 100.0%
======== ===== ======== =====
-10-
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 March 31, 2006 and 2005, anti-dilutive shares consisted of
options covering 2,221 and 408 shares, respectively.
The calculated basic and diluted earnings per share ("EPS") is as follows:
For the Three Months For the Six Months
Ended March 31, Ended March 31,
----------------------- -----------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------
Numerator - Net income $ 19 $ 638 $ 464 $ 627
Denominators:
Basic shares outstanding 1,890,608 1,824,419 1,889,463 1,826,967
Effect of dilutive securities 22,892 49,486 23,566 124,393
---------- ---------- ---------- ----------
Diluted shares outstanding 1,913,500 1,873,905 1,913,029 1,951,360
========== ========== ========== ==========
EPS:
Basic $ 0.01 $ 0.35 $ 0.25 $ 0.34
Diluted $ 0.01 $ 0.34 $ 0.24 $ 0.32
7. SHARE-BASED COMPENSATION
Effective October 1, 2005, the Company adopted Statement of Financial
Accounting Standard ("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 and $13
compensation expense for the three and six month periods ended March 31,
2006, respectively. Pro forma compensation expense for the three and six
month periods ended March 31, 2005 was $4 and $8, respectively. There were
no new grants of stock options or other share-based payments during the six
months ended March 31, 2006 and, therefore, additional disclosures for
share-based compensation were omitted due to immateriality.
8. RECENT ACCOUNTING PRONOUNCEMENTS
In February 2006, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments-an
amendment of FASB Statements No. 133 and 140" ("SFAS No. 155.") SFAS No.
155 amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," to permit fair value remeasurement for any hybrid financial
instrument with an embedded derivative that otherwise would require
bifurcation, provided that the whole instrument is accounted for on a fair
value basis. SFAS No. 155 amends SFAS No. 140, "Accounting for the
Impairment or Disposal of Long-Lived Assets", to allow a qualifying
special-purpose entity to hold a derivative financial instrument that
pertains to a beneficial interest other than another derivative financial
instrument. SFAS No. 155 is effective for all financial instruments
acquired or issued after the beginning of an entity's first fiscal year
beginning after September 15, 2006 and is not expected to have a material
impact on the Company's consolidated financial statements.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets-an amendment of FASB Statement No. 140," ("SFAS No. 156").
SFAS No. 156 amends SFAS No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities," with respect to
the accounting for separately recognized servicing assets and servicing
liabilities. SFAS No. 156 requires an entity to recognize a servicing asset
or servicing liability each time it undertakes an obligation to service a
financial asset by entering into a servicing contract in certain situations
prescribed by SFAS No. 156. All separately recognized servicing assets and
servicing liabilities are to be initially measured at fair value, if
practicable, and SFAS No. 156 permits an entity to choose either the
amortization method or
-11-
fair value measurement method for subsequent measurement methods for each
class of separately recognized servicing assets and servicing liabilities.
SFAS No. 156 is effective as of the beginning of an entity's first fiscal
year that begins after September 15, 2006. The requirements for recognition
and initial measurement of servicing assets and servicing liabilities
should be applied prospectively to all transactions after the effective
date of this statement. The Company's management is evaluating the impact
of adopting SFAS No. 156 on the Company's financial statements.
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 adopted this guidance on January 1,
2006 and it did not have a significant impact on the Company's interim
financial statements.
9. SUPERVISORY AGREEMENTS
On February 13, 2006, the Company and the Bank each entered into a
supervisory agreement 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 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.
As noted above, the Company is not permitted to pay dividends to its
stockholders under the terms of the supervisory agreement until certain
conditions are satisfied. Currently, the Company does not believe dividends
will be able to be resumed until at least the quarter ended March 31, 2007.
As a result of the supervisory agreement, the Bank is not deemed to be
"well-capitalized" for purposes of the prompt corrective action regulations
of the OTS even though the Bank's regulatory capital is in excess of all
regulatory capital requirements.
-12-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In addition to historical information, this Quarterly Report on Form 10-Q
includes certain "forward-looking statements" based on management's current
expectations. The 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, the effects of the supervisory
agreements entered into by the Company and First Keystone Bank (the "Bank") with
the Office of Thrift Supervision (the "OTS"), 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 the Bank, a
federally chartered stock savings 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.
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
-13-
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 federal banking regulator, the OTS, as part of its
examination process, which may result in additional allowances based upon the
judgment and review of the OTS. See "- Provision for Loan Losses."
SUPERVISORY AGREEMENTS.
On February 13, 2006, the Company and the Bank each entered into a supervisory
agreement 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 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.
As noted above, the Company is not permitted to pay dividends to its
stockholders under the terms of the supervisory agreement until certain
conditions are satisfied. Currently, the Company does not believe dividends will
be able to be resumed until at least the quarter ended March 31, 2007.
As a result of the supervisory agreement, the Bank is not deemed to be
"well-capitalized" for purposes of the prompt corrective action regulations of
the OTS even though the Bank's regulatory capital is in excess of all regulatory
capital requirements.
COMPARISON OF FINANCIAL CONDITION AT MARCH 31, 2006 AND SEPTEMBER 30, 2005
Total assets of the Company increased by $1.6 million from $518.1 million at
September 30, 2005 to $519.8 million at March 31, 2006. Loans receivable
increased slightly to $306.5 million at March 31, 2006 as the Company continued
to modestly increase the percentage of its portfolio consisting of commercial
real estate loans, construction loans, home equity and lines of credit and
commercial business loans, partially offset by a decrease in single-family
residential loans. Prepaid expenses and other assets decreased $4.7 million due
to funds received for settlement of securities sales. Total deposits increased
$13.0 million, or 3.7%, from $349.7 million at September 30, 2005 to $362.7
million at March 31, 2006, while borrowings decreased $11.3 million, or 10.0%,
from $113.3 million at September 30, 2005. The increase in deposits resulted
from an $8.7 million, or 5.0%, increase in certificates of deposit combined with
an increase of $4.3 million, or 2.4%, in core deposits (which consist of
passbook, money market, NOW and non-interest bearing accounts).
Stockholders' equity decreased $873,000 to $27.3 million primarily due to a $1.2
million decline in the amount of accumulated other comprehensive loss combined
with dividend payments in the first quarter of fiscal 2006 totaling $208,000,
partially offset by net income of $464,000 for the six months ended March 31,
2006.
-14-
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED MARCH 31,
2006 AND 2005
NET INCOME.
Net income was $19,000, or $.01 per diluted share, for the quarter ended March
31, 2006 as compared to $638,000, or $.34 per diluted share, for the same period
in 2005. Net income for the six months ended March 31, 2006 was $464,000, or
$.24 per diluted share, a decrease of $697,000, or 60.0%, as compared to $1.2
million, or $.63 per diluted share, for the same period in 2005.
NET INTEREST INCOME.
Net interest income decreased $133,000, or 4.5%, to $2.8 million and $173,000,
or 3.0%, to $5.6 million for the three and six months ended March 31, 2006 as
compared to the same period in 2005. Such decreases were primarily due to
decreases in interest income of $83,000, or 1.2%, and $168,000, or 1.3%, for the
three and six months ended March 31, 2006, respectively. The average balance of
interest-earning assets decreased $54.8 million and $59.5 million for the three
and six months ended March 31, 2006, respectively, as compared to the same
periods in 2005. The significant decline in the average balances was the result
of the Company implementing a deleveraging strategy in the fourth quarter of
fiscal 2005 involving the sale of $47.5 million of various low-yielding
securities and the repayment of $46.0 million in FHLB convertible advances.
Calculated on a tax-equivalent basis, the weighted average yield earned on
interest-earning assets for the three months ended March 31, 2006 increased 53
basis points to 5.68% compared to the same period in 2005 and 57 basis points to
5.64% for the six months ended March 31, 2006 compared to the same period in
2005. Net interest income was also affected by a $50,000, or 1.3%, and $5,000,
or 0.07%, increase in interest expense for the three and six months ended March
31, 2006, respectively, as compared to the same periods in 2005. For the three
months ended March 31, 2006, the weighted average rate paid on such liabilities
increased 36 basis points to 3.24% from 2.88% for the same period in the prior
fiscal year and 34 basis points to 3.21% for the six months ended March 31, 2006
as compared to 2.87% for the six months ended March 31, 2005.
The interest rate spread and net interest margin, on a fully tax-equivalent
basis, were 2.43% and 2.43%, respectively, for the six months ended March 31,
2006 as compared to 2.21% and 2.22%, respectively, for the same period in 2005.
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.
-15-
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 and six months ended March 31, 2006 and 2005.
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
-------------------------------------------------------------
MARCH 31, 2006 MARCH 31, 2005
----------------------------- -----------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Cost(4) Balance Interest Cost(4)
-------- -------- ------- -------- -------- -------
Interest-earning assets:
Loans receivable(1) (2) $308,208 $4,821 6.26% $306,418 $4,408 5.75%
Mortgage-related securities(2) 115,707 1,276 4.41 156,053 1,552 3.98
Investment securities(2) 46,518 643 5.53 60,138 863 5.74
Other interest-earning assets 7,591 42 2.21 10,256 40 1.56
-------- ------ -------- ------
Total interest-earning assets 478,024 $6,782 5.68 532,865 $6,863 5.15
-------- ------ ------ -------- ------ ------
Non-interest-earning assets 33,952 32,861
-------- --------
Total assets $511,976 $565,726
======== ========
Interest-bearing liabilities:
Deposits $349,151 $1,958 2.24 $344,275 $1,474 1.71
FHLB advances and other borrowings 106,869 1,425 5.33 163,856 1,900 4.64
Junior subordinated debentures 21,508 485 9.02 21,544 444 8.24
-------- ------ -------- ------
Total interest-bearing liabilities 477,528 3,868 3.24 529,675 3,818 2.88
------ ------ -------- ------ ------
Interest rate spread 2.44% 2.27%
====== ======
Non-interest-bearing liabilities 6,429 6,050
-------- --------
Total liabilities 483,957 535,725
Stockholders' equity 28,019 30,001
-------- --------
Total liabilities and stockholders' equity $511,976 $565,726
======== ========
Net interest-earning assets $ 496 $ 3,190
======== ========
Net interest income $2,914 $3,045
====== ======
Net interest margin(3) 2.44% 2.29%
====== ======
Ratio of average interest-earning assets
to average interest-bearing liabilities 100.10% 100.60%
====== ======
- ----------
(1) Includes non-accrual loans.
(2) Includes assets classified as either available for sale or held for sale.
(3) Net interest income divided by interest-earning assets.
(4) Presented on a tax-equivalent basis.
-16-
FOR THE SIX MONTHS ENDED
-------------------------------------------------------------
MARCH 31, 2006 MARCH 31, 2005
----------------------------- -----------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Cost(4) Balance Interest Cost(4)
-------- -------- ------- -------- -------- -------
Interest-earning assets:
Loans receivable(1) (2) $306,311 $ 9,520 6.22% $306,207 $ 8,871 5.79%
Mortgage-related securities(2) 114,108 2,476 4.34 149,144 2,953 3.96
Investment securities(2) 46,876 1,330 5.67 67,848 1,677 4.94
Other interest-earning assets 8,610 92 2.14 12,167 81 1.33
-------- ------- -------- -------
Total interest-earning assets 475,905 $13,418 5.64 535,366 $13,582 5.07
-------- ------- ----- -------- ------- ------
Non-interest-earning assets 34,238 32,742
-------- --------
Total assets $510,143 $568,108
======== ========
Interest-bearing liabilities:
Deposits $348,236 $ 3,827 2.20 $343,860 $ 2,926 1.70
FHLB advances and other borrowings 106,354 2,854 5.37 167,351 3,828 4.57
Junior subordinated debentures 21,512 956 8.89 21,549 878 8.15
-------- ------- -------- -------
Total interest-bearing liabilities 476,102 7,637 3.21 532,760 7,632 2.87
-------- ------- ----- -------- ------- ------
Interest rate spread 2.43% 2.21%
===== ======
Non-interest-bearing liabilities 6,054 5,546
-------- --------
Total liabilities 482,156 538,306
Stockholders' equity 27,987 29,802
-------- --------
Total liabilities and stockholders' equity $510,143 $568,108
======== ========
Net interest-earning assets (liabilities) $ (197) $ 2,606
======== ========
Net interest income $ 5,781 $ 5,950
======= =======
Net interest margin(3) 2.43% 2.22%
===== ======
Ratio of average interest-earning assets
to average interest-bearing liabilities 99.96% 100.49%
===== ======
- ----------
(1) Includes non-accrual loans.
(2) Includes assets classified as either available for sale or held for sale.
(3) Net interest income divided by interest-earning assets.
(4) Presented on a tax-equivalent basis.
-17-
Although management believes that the above mentioned non-GAAP financial
measures enhance investor's understanding of the Company's business and
performance, these non-GAAP financial measures should not be considered an
alternative to GAAP. The reconciliation of these non-GAAP financial
measures from GAAP to non-GAAP is presented below.
FOR THE THREE MONTHS ENDED
---------------------------------------------
MARCH 31, 2006 MARCH 31, 2005
--------------------- ---------------------
AVERAGE AVERAGE
(Dollars in thousands) INTEREST YIELD/COST INTEREST YIELD/COST
-------- ---------- -------- ----------
Investment securities - nontaxable $ 557 4.79% $ 779 5.18%
Tax equivalent adjustments 86 84
------ ------
Investment securities - nontaxable to a
taxable equivalent yield $ 643 5.53% $ 863 5.74%
====== ======
Net interest income $2,828 $2,961
Tax equivalent adjustment 86 84
------ ------
Net interest income, tax equivalent $2,914 $3,045
====== ======
Net interest rate spread, no tax adjustment 2.36% 2.21%
Net interest margin, no tax adjustment 2.37% 2.22%
FOR THE SIX MONTHS ENDED
---------------------------------------------
MARCH 31, 2006 MARCH 31, 2005
--------------------- ---------------------
AVERAGE AVERAGE
(Dollars in thousands) INTEREST YIELD/COST INTEREST YIELD/COST
-------- ---------- -------- ----------
Investment securities - nontaxable $1,157 4.94% $1,508 4.45%
Tax equivalent adjustments 173 169
------ ------
Investment securities - nontaxable to a
taxable equivalent yield $1,330 5.67% $1,677 4.94%
====== ======
Net interest income $5,608 $5,781
Tax equivalent adjustment 173 169
------ ------
Net interest income, tax equivalent $5,781 $5,950
====== ======
Net interest rate spread, no tax adjustment 2.36% 2.15%
Net interest margin, no tax adjustment 2.36% 2.16%
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 March 31, 2006 and 2005, the provision for loan losses amounted to
$525,000 and $45,000, respectively. The increase of $480,000 in the
provision for loan losses was due to an additional reserve of $180,000
related to the write down to fair value of the property securing a $3.3
million commercial real estate loan and a related $500,000 commercial
business loan based on the current assessment of the property's fair value
as well as a determination that an additional provision of $345,000 was
required as result of the continual evaluation of the classified and pass
loan portfolios to bring the overall allowance for loan losses to a level
deemed appropriate. As further discussed below, during the three months
ended March, 31, 2006, the $3.3 million
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commercial real estate loan was transferred to real estate owned. For the
six months ended March 31, 2006 and 2005, the provision for loan losses
amounted to $570,000 and $90,000, respectively. The coverage ratio, which
is the ratio of the allowance for loan losses to non-performing loans, was
356.74% and 68.8% at March 31, 2006 and September 30, 2005, respectively.
At March 31, 2006, non-performing assets decreased $2.3 million to $3.5
million, or 0.68%, of total assets, from $5.8 million at September 30,
2005. The decrease in non-performing assets was primarily the result of a
$4.2 million decrease to $811,000 in nonperforming loans partially offset
by a $1.9 million increase to $2.7 million in real estate owned. The
decrease in non-performing loans was primarily due to the transfer of a
$3.3 million commercial real estate loan to real estate owned and a
charge-off of $500,000 for a related commercial business loan combined with
the repayment in full of a $770,000 residential construction loan. As of
March 31, 2006, the Company transferred to real estate owned property
located in Chesapeake City, Maryland that secured a $3.3 million commercial
real estate loan as a result of the Company taking possession of the
property. The Company also had a $500,000 commercial business loan
outstanding in connection with this loan relationship. The Company
previously allocated reserves of $959,000 as of the quarter ended June 30,
2005. In connection with the Company's review of the fair value of the
collateral supporting the loans, the Company recognized an additional
reserve of $178,000 in the three months ended March 31, 2006, increasing
the total reserve for the loan to approximately $1.1 million. In connection
with the property's transfer to real estate owned, the Company recorded the
property at its approximate fair value of $2.7 million. As a result of the
transfer of the property to real estate owned and the charge-off of the
commercial business loan, the Company charged-off $1.1 million against the
allowance for loan losses in the quarter ended March 31, 2006. Offsetting,
in part, the increase in real estate owned was the sale during the quarter
of a commercial property in which the Company held a 25% participation
interest in a golf facility. The sale of the property, which was carried at
a value of $760,000, resulted in a pre-tax gain of $158,000 which was
included in non-interest income.
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.
NON-INTEREST INCOME.
For the three months ended March 31, 2006, non-interest income decreased
$301,000 or 27.3% to $800,000 as compared to the same period in 2005. The
decrease for the three months ended March 31, 2006 was primarily due to the
Company's not experiencing any gain on sales of investment securities in
the 2006 period as compared to $449,000 in gain on sales of investment and
mortgage-related securities in the second quarter of fiscal 2005. The
decrease in non-interest income was partially offset by the $158,000
pre-tax gain on the sale of a real estate owned property referenced above.
Non-interest income decreased $427,000 to $1.6 million for the six months
ended March 31, 2006 by comparison to the same period last year. The
decrease for the six months ended March 31, 2006 was primarily due to the
Company's not experiencing any gain on sales of investment securities in
the 2006 period as compared to $524,000 for the same period in 2005. To a
lesser extent, non-interest income decreased due to a slower appreciation
rate during the first quarter of fiscal 2006 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 $114,000
compared to the same period in 2005. In addition, the $59,000 decrease in
the service charges and other fees was mainly due to a decrease in usage of
a deposit service provided to the Bank's checking accounts. The decreases
in non-interest income were partially offset by a $105,000 increase in the
gain on sale of loans of commercial business loans through the Small
Business Administration.
NON-INTEREST EXPENSE.
Non-interest expense increased $22,000 or 0.7% during the three months
ended March 31, 2006 compared to the same period in 2005. The increase for
the quarter ended March 31, 2006 was primarily due to increases of $269,000
and $25,000 in professional fees and federal insurance premiums,
respectively, partially offset by decreases of $209,000 and $84,000 in
salaries and employee benefits and other non-interest expense,
respectively. Professional fees were substantially higher in the 2006
period due to expenses incurred in connection with the foreclosure of a
$3.8 million non-performing commercial real estate loan. Salaries and
employee benefits costs were higher in the 2005 period due to certain
benefits incurred as part of a retirement package as well as accruals for
certain incentive programs. Other non-interest expense decreased due to the
completion of a bank-wide customer service training program in October 2005
as well as decreases in general administrative expenses.
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For the six months ended March 31, 2006, non-interest expense decreased by
$33,000, or 0.5%, primarily due to decreases of $237,000, or 7.3%, in
salary and employee benefits and $154,000, or 16.3%, in other non-interest
expenses, respectively, partially offset by a $293,000, or 55.5%, increase
in professional fees compared to the same period in 2005 for the reasons
described above.
INCOME TAX (BENEFIT) EXPENSE.
The Company recognized income tax benefits of $142,000 and $70,000 for the
three and six months ended March 31, 2006, respectively as compared to
income tax expenses of $175,000 and $280,000 for the same periods in 2005.
The recognition of the income tax benefits for the three and six months
ended March 31, 2006 was primarily related to the decline in pre-tax income
for such periods.
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 March 31, 2006, the Company had
short-term borrowings (due within one year or currently callable by the
FHLB) outstanding of $101.5 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 March 31, 2006, total approved loan commitments outstanding
amounted to $15.8 million, not including loans in process. At the same
date, commitments under unused lines of credit amounted to $39.6 million.
Certificates of deposit scheduled to mature in one year or less at March
31, 2006 totaled $124.9 million. Based upon the Company's historical
experience, management believes that a significant portion of maturing
deposits will remain with the Company.
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 March
31, 2006, the Bank had tangible capital and core capital equal to 9.0% of
adjusted total assets and total capital equal to 15.1% of risk-weighted
assets. However, as a result of the supervisory agreement discussed above
in "Supervisory Agreements," 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.
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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 March 31, 2006.
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 $42,072 $(24,300) (37)% 8.34% (408)bp
200 50,880 (15,492) (23) 9.89 (253)bp
100 59,352 (7,020) (11) 11.32 (110)bp
0 66,372 -- -- 12.42 --
(100) 70,685 4,313 6 13.02 60bp
(200) 70,958 4,586 7 12.95 53bp
As of March 31, 2006, the Company's NPV was $66.4 million or 12.42% of the
market value of assets. Following a 200 basis point increase in interest
rates, the Company's "post shock" NPV was $50.9 million or 9.89% of the
market value of assets. The change in the NPV ratio or the Company's
sensitivity measure was (2.53)%.
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.
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PART II
Item 1. Legal Proceedings
No material changes have occurred with respect to 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) The Company does not have a repurchase program currently in effect. In
addition, pursuant to the terms of the supervisory agreement between
the Company and the OTS, the Company is not permitted to pay dividends
until the Company meets certain limitations. See " - Supervisory
Agreements."
Item 3. Defaults Upon Senior Securities
(a) - (b) Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
(a) - (b) Not applicable
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, *
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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
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 10
99.3 Supervisory Agreement between First Keystone Bank and the Office of
Thrift Supervision dated February 13, 2006 10
- ----------
(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 for the year
ended September 30, 1995 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 for the
quarter ended March 31, 2004 filed by the Registrant with the SEC on May
17, 2004.
(6) Incorporated by reference from Exhibit 10.18 in the Form 10-K for the year
ended September 30, 2004 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 for the year ended September
30, 2004 filed by the Registrant with the SEC on December 23, 2004.
(10) Incorporated by reference from the Form 10-Q for the quarter ended December
31, 2005 filed by the Registrant with the SEC on February 14, 2006.
(*) 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: May 15, 2006 By: /s/ Thomas M. Kelly
-------------------------------------
Thomas M. Kelly
President and Chief Executive Officer
Date: May 15, 2006 By: /s/ Rose M. DiMarco
-------------------------------------
Rose M. DiMarco
Chief Financial Officer
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