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, 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 February 9, 2007: 2,427,928
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, 2006 and September 30, 2006 1
Unaudited Consolidated Statements of Income for the Three
Months Ended December 31, 2006 and 2005 2
Unaudited Consolidated Statement of Changes in Stockholders'
Equity for the Three Months Ended December 31, 2006 3
Unaudited Consolidated Statements of Cash Flows for the
Three Months Ended December 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 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
Item 4. Controls and Procedures 20
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 23
SIGNATURES 25
-i-
FIRST KEYSTONE FINANCIAL, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands)
December 31, September 30,
2006 2006
------------ -------------
ASSETS
Cash and amounts due from depository institutions $ 6,371 $ 4,072
Interest-bearing deposits with depository institutions 14,562 8,715
-------- --------
Total cash and cash equivalents 20,933 12,787
Investment securities available for sale 32,994 33,386
Mortgage-related securities available for sale 68,991 70,030
Loans held for sale 387 1,334
Investment securities held to maturity - at amortized cost
(approximate fair value of $3,272 at December 31, 2006
and $3,268 at September 30, 2006) 3,257 3,257
Mortgage-related securities held to maturity - at amortized cost
(approximate fair value of $35,482 at December 31, 2006
and $37,163 at September 30, 2006) 36,549 38,355
Loans receivable (net of allowance for loan loss of $3,455 and $3,367
at December 31, 2006 and September 30, 2006, respectively) 316,999 323,220
Accrued interest receivable 2,542 2,667
Real estate owned 2,450 2,450
FHLBank stock, at cost 5,941 6,233
Office properties and equipment, net 4,519 4,643
Deferred income taxes 2,415 2,281
Cash surrender value of life insurance 16,771 16,624
Prepaid expenses and other assets 5,542 5,693
-------- --------
TOTAL ASSETS $520,290 $522,960
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Non-interest-bearing $ 18,265 $ 17,232
Interest-bearing 338,506 341,584
-------- --------
Total deposits 356,771 358,816
Advances from FHLBank and other borrowings 100,526 107,241
Junior subordinated debentures 21,474 21,483
Accrued interest payable 2,382 2,164
Advances from borrowers for taxes and insurance 1,899 866
Accounts payable and accrued expenses 2,914 3,731
-------- --------
Total liabilities 485,966 494,301
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, 2006 and September 30, 2006, 2,427,928
and 2,027,928 shares, respectively 27 27
Additional paid-in capital 12,587 12,974
Employee stock ownership plan (3,064) (3,089)
Treasury stock at cost: 284,628 shares at December 31, 2006 and 684,628 shares
at September 30, 2006 (4,322) (10,522)
Accumulated other comprehensive loss (1,048) (787)
Retained earnings - partially restricted 30,144 30,056
-------- --------
Total stockholders' equity 34,324 28,659
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $520,290 $522,960
======== ========
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,
-----------------------
2006 2005
---------- ----------
INTEREST INCOME:
Interest and fees on loans $ 5,355 $ 4,699
Interest and dividends on:
Mortgage-related securities 1,207 1,200
Investment securities:
Taxable 310 296
Tax-exempt 151 187
Dividends 87 117
Interest-bearing deposits 63 51
---------- ----------
Total interest income 7,173 6,550
---------- ----------
INTEREST EXPENSE:
Interest on:
Deposits 2,704 1,869
FHLBank advances and other borrowings 1,505 1,429
Junior subordinated debentures 502 472
---------- ----------
Total interest expense 4,711 3,770
---------- ----------
Net interest income 2,462 2,780
PROVISION FOR LOAN LOSSES 75 45
---------- ----------
Net interest income after provision for loan losses 2,387 2,735
---------- ----------
NON-INTEREST INCOME:
Service charges and other fees 387 380
Net gain on sales of loans held for sale 116 125
Increase in cash surrender value of life insurance 147 153
Other income 97 117
---------- ----------
Total non-interest income 747 775
---------- ----------
NON-INTEREST EXPENSE:
Salaries and employee benefits 1,498 1,502
Occupancy and equipment 396 389
Professional fees 337 268
Federal deposit insurance premium 38 12
Operations of real estate owned 50 2
Data processing 138 120
Advertising 107 106
Deposit processing 154 155
Other 419 439
---------- ----------
Total non-interest expense 3,137 2,993
---------- ----------
Income (loss) before income tax (benefit) expense (3) 517
Income tax (benefit) expense (91) 72
---------- ----------
Net income $ 88 $ 445
========== ==========
Earnings per common share:
Basic $ 0.04 $ 0.24
Diluted $ 0.04 $ 0.23
Weighted average shares - basic 1,992,453 1,888,344
Weighted average shares - diluted 2,011,731 1,915.801
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 (loss) restricted equity
------ ---------- --------- -------- ------------- ---------- -------------
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
=== ======= ======= ======== ======= ======= =======
BALANCE AT OCTOBER 1, 2006 $27 $12,974 $(3,089) $(10,522) $ (787) $30,056 $28,659
Net income -- -- -- -- -- 88 88
Other comprehensive income, net of tax:
Net unrealized loss on securities
net of reclassification adjustment(1) -- -- -- -- (261) -- (261)
--- ------- ------- -------- ------- ------- -------
Comprehensive loss -- -- -- -- -- -- (173)
--- ------- ------- -------- ------- ------- -------
ESOP shares committed to be released -- -- 25 -- -- -- 25
Share-based compensation -- 15 -- -- -- -- 15
Excess of fair value above cost of
ESOP shares committed to be released -- 10 -- -- -- -- 10
Release of treasury shares for
equity offering -- (412) -- 6,200 -- -- 5,788
--- ------- ------- -------- ------- ------- -------
BALANCE AT DECEMBER 31, 2006 $27 $12,587 $(3,064) $ (4,322) $(1,048) $30,144 $34,324
=== ======= ======= ======== ======= ======= =======
(1) Disclosure of reclassification amount, net of tax:
December 31,
---------------
2006 2005
------ ------
Net unrealized depreciation arising during the period $(261) $(587)
Less: reclassification adjustment for net gains included in net income
(net of tax) -- --
----- -----
Net unrealized loss on securities $(261) $(587)
===== =====
See notes to unaudited consolidated financial statements.
-3-
FIRST KEYSTONE FINANCIAL, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Three months ended
December 31,
-------------------
2006 2005
-------- --------
OPERATING ACTIVITIES:
Net income $ 88 $ 445
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Provision for depreciation and amortization 137 134
Amortization of premiums and discounts 59 100
Increase in cash surrender value of life insurance (147) (153)
Gain on sales of loans held for sale (116) (125)
Provision for loan losses 75 45
Amortization of ESOP 35 37
Share-based compensation 15 6
Changes in assets and liabilities which provided (used) cash:
Origination of loans held for sale (152) (3,312)
Proceeds from the sale of loans 1,099 3,142
Accrued interest receivable 125 116
Prepaid expenses and other assets 151 5,021
Accrued interest payable 218 261
Accrued expenses (817) (240)
-------- --------
Net cash provided by operating activities 770 5,477
-------- --------
INVESTING ACTIVITIES:
Loans originated (26,297) (33,712)
Purchases of:
Mortgage-related securities available for sale (2,026) (4,068)
Investment securities available for sale (113) (149)
Redemption of FHLBank stock 292 3,235
Principal collected on loans 32,545 29,330
Proceeds from maturities, calls, or repayments of:
Investment securities available for sale 55 590
Mortgage-related securities available for sale 3,092 3,636
Mortgage-related securities held to maturity 1,780 2,414
Purchase of property and equipment (13) (75)
-------- --------
Net cash provided by investing activities 9,315 1,201
-------- --------
FINANCING ACTIVITIES:
Net (decrease) increase in deposit accounts (2,045) 3,459
Net decrease in FHLBank advances and other borrowings (6,715) (7,513)
Net increase in advances from borrowers for taxes and insurance 1,033 1,069
Exercise of stock options -- 4
Net proceeds from equity offering 5,788 --
Cash dividend -- (208)
-------- --------
Net cash used in financing activities (1,939) (3,189)
-------- --------
INCREASE IN CASH AND CASH EQUIVALENTS 8,146 3,489
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 12,787 16,155
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 20,933 $ 19,644
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW AND NON-CASH INFORMATION:
Cash payments for interest on deposits and borrowings $ 4,493 $ 3,509
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,
2006 are not necessarily indicative of the results to be expected for the
fiscal year ending September 30, 2007 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, 2006.
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, 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 $ 2,000 $ -- $ (24) $ 1,976
Municipal obligations:
5 to 10 years 1,010 18 -- 1,028
Over 10 years 8,912 158 (12) 9,058
Corporate bonds:
1 to 5 years 1,000 33 -- 1,033
5 to 10 years 2,000 -- (162) 1,838
Over 10 years 7,869 11 (42) 7,838
Mutual funds 9,341 -- (295) 9,046
Other equity investments 1,040 137 -- 1,177
------- ---- ----- -------
Total $33,172 $357 $(535) $32,994
======= ==== ===== =======
Held to Maturity:
Municipal obligations:
5 to 10 years $ 3,257 $ 15 $ -- $ 3,272
======= ==== ===== =======
-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, 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 $ -- $ -- $ 1,976 $ (24) $ 1,976 $ (24)
Corporate bonds 2,013 (12) 6,574 (192) 8,587 (204)
Municipal bonds -- -- 988 (12) 988 (12)
Mutual fund -- -- 9,047 (295) 9,047 (295)
------ ---- ------- ----- ------- -----
Total $2,013 $(12) $18,585 $(523) $20,598 $(535)
====== ==== ======= ===== ======= =====
At December 31, 2006, investment securities in a gross unrealized loss position
for twelve months or longer consisted of eight securities having an aggregate
depreciation of 2.8% from the Company's amortized cost basis. Management
believes that the estimated fair value of the securities disclosed above is
primarily dependent upon the movement in market interest rates particularly
given the negligible inherent credit risk associated with these securities.
These investment securities are comprised of securities that are rated
investment grade by at least one bond credit rating service. Although the fair
value will fluctuate as the market interest rates move, management believes that
these fair values will recover as the underlying portfolios mature and are
reinvested in market rate yielding investments. Mutual funds in an unrealized
loss position for 12 months or longer consist of two funds primarily invested in
asset-backed securities and have an aggregate depreciation of 3.2%. Corporate
bonds in an unrealized loss position for 12 months or longer consist of four
debt securities and have an aggregate depreciation of 2.8%. The Company has the
ability and intent to hold all of 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, 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, 2006
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
--------- ---------- ---------- -----------
Available for Sale:
U.S. Government bonds:
1 to 5 years $ 2,000 $ -- $ (24) $ 1,976
Municipal obligations:
5 to 10 years 1,010 21 -- 1,031
Over 10 years 8,910 181 (15) 9,076
Corporate bonds:
1 to 5 years 1,000 39 -- 1,039
5 to 10 years 2,000 -- (183) 1,817
Over 10 years 7,941 11 (39) 7,913
Mutual funds 9,229 -- (276) 8,953
Other equity investments 1,040 547 (6) 1,581
------- ---- ----- -------
Total $33,130 $799 $(543) $33,386
======= ==== ===== =======
Held to Maturity:
Municipal obligations:
5 to 10 years $ 3,257 $ 11 $ -- $ 3,268
======= ==== ===== =======
-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,
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 $ -- $ -- $ 1,976 $ (24) $ 1,976 $ (24)
Corporate bonds 5,201 (18) 3,439 (204) 8,640 (222)
Municipal bonds 348 -- 985 (15) 1,333 (15)
Mutual fund -- -- 8,952 (276) 8,592 (276)
Equity 56 (6) -- -- 56 (6)
------ ---- ------- ----- ------- -----
Total $5,605 $(24) $15,352 $(519) $20,957 $(543)
====== ==== ======= ===== ======= =====
3. MORTGAGE-RELATED SECURITIES
Mortgage-related securities available for sale and mortgage-related
securities held to maturity are summarized as follows:
December 31, 2006
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
--------- ---------- ---------- -----------
Available for Sale:
FHLMC pass-through certificates $ 6,996 $ 1 $ (65) $ 6,932
FNMA pass-through certificates 28,794 38 (450) 28,382
GNMA pass-through certificates 2,773 5 (49) 2,729
Collateralized mortgage obligations 31,839 22 (913) 30,948
------- --- ------- -------
Total $70,402 $66 $(1,477) $68,991
======= === ======= =======
Held to Maturity:
FHLMC pass-through certificates $13,753 $ 6 $ (401) $13,358
FNMA pass-through certificates 22,672 4 (676) 22,000
Collateralized mortgage obligations 124 -- -- 124
------- --- ------- -------
Total $36,549 $10 $(1,077) $35,482
======= === ======= =======
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, 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 $11,008 $(94) $56,168 $(1,547) $67,176 $(1,641)
Collateralized
mortgage
obligations -- -- 30,604 (913) 30,604 (913)
------- ---- ------- ------- ------- -------
Total $11,008 $(94) $86,772 $(2,460) $97,780 $(2,554)
======= ==== ======= ======= ======= =======
-7-
At December 31, 2006, mortgage-related securities in a gross unrealized
loss position for twelve months or longer consisted of fifty-six securities
that at such date had an aggregate depreciation of 2.8% from the Company's
amortized cost basis. Management does not believe any individual unrealized
loss as of December 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 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, 2006
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
--------- ---------- ---------- -----------
Available for Sale:
FHLMC pass-through certificates $ 7,290 $ 1 $ (67) $ 7,224
FNMA pass-through certificates 28,037 34 (474) 27,597
GNMA pass-through certificates 2,966 4 (63) 2,907
Collateralized mortgage obligations 33,188 24 (910) 32,302
------- --- ------- -------
Total $71,481 $63 $(1,514) $70,030
======= === ======= =======
Held to Maturity:
FHLMC pass-through certificates $14,376 $ 6 $ (450) $13,932
FNMA pass-through certificates 23,826 3 (751) 23,078
Collateralized mortgage obligations 153 -- -- 153
------- --- ------- -------
Total $38,355 $ 9 $(1,201) $37,163
======= === ======= =======
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, 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 $14,955 $(104) $55,887 $(1,701) $ 70,842 $(1,805)
Collateralized
mortgage
obligations -- -- 31,965 (910) 31,965 (910)
------- ----- ------- ------- -------- -------
Total $14,955 $(104) $87,852 $(2,611) $102,807 $(2,715)
======= ===== ======= ======= ======== =======
-8-
4. LOANS RECEIVABLE
Loans receivable consist of the following:
December 31, September 30,
2006 2006
------------ -------------
Real estate loans:
Single-family $144,231 $144,760
Construction and land 35,427 38,158
Multi-family and commercial 65,350 70,439
Home equity and lines of credit 60,098 59,319
Consumer loans 1,386 1,375
Commercial loans 23,798 24,474
-------- --------
Total loans 330,290 338,525
Loans in process (9,996) (12,081)
Allowance for loan losses (3,455) (3,367)
Deferred loan costs 160 143
Loans receivable - net $316,999 $323,220
======== ========
At December 31, 2006 and September 30, 2006, non-performing loans (which
include loans in excess of 90 days delinquent) amounted to approximately
$1,428 and $277, respectively. At December 31, 2006, non-performing loans
primarily consisted of six single-family residential mortgage loans
aggregating $128, seven commercial business loans aggregating $1,276 and
nine consumer loans aggregating $24.
At December 31, 2006 and September 30, 2006, the Company had impaired loans
with a total recorded investment of $574 and $25, respectively. No interest
income was recognized on these impaired loans during the three months ended
December 31, 2006. Interest income of approximately $18 was not recognized
as interest income due to the non-accrual status of such loans for the
three months ended December 31, 2006.
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,
-------------
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. 114 574 897
---- ------
Total impaired loans $574 $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,
---------------
2006 2005
------ ------
Balance beginning of period $3,367 $3,475
Provisions charged to income 75 45
Charge-offs (12) (4)
Recoveries 25 9
------ ------
Total $3,455 $3,525
====== ======
-9-
5. DEPOSITS
Deposits consist of the following major classifications:
December 31, September 30,
2006 2006
------------------ ------------------
Amount Percent Amount Percent
-------- ------- -------- -------
Non-interest bearing $ 18,265 5.1% $ 17,232 4.8%
NOW 72,128 20.2 73,356 20.5
Passbook 39,882 11.2 41,708 11.6
Money market demand 40,017 11.2 40,591 11.3
Certificates of deposit 186,479 52.3 185,929 51.8
-------- ----- -------- -----
Total $356,771 100.0% $358,816 100.0%
======== ===== ======== =====
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, 2006 and 2005, anti-dilutive shares consisted of
options covering 2,221 shares.
The calculation of basic and diluted earnings per share ("EPS") is as
follows:
Three Months Ended
December 31,
-----------------------
2006 2005
---------- ----------
Numerator $ 88 $ 445
Denominators:
Basic shares outstanding 1,992,453 1,888,344
Effect of dilutive securities 19,278 27,457
---------- ----------
Dilutive shares outstanding 2,011,731 1,915,801
========== ==========
Earnings per share:
Basic $ 0.04 $ 0.24
Diluted $ 0.04 $ 0.23
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 $15
compensation expense for the three month period ended December 31, 2006.
There were no new grants of stock options or other share-based payments
during the three months ended December 31, 2006 and, therefore, additional
disclosures for share-based compensation were omitted due to immateriality.
At December 31, 2006, 61,447 stock options were outstanding with a weighted
average exercise price of $13.17. The weighted average remaining
contractual term was approximately 3.4 years for all options
outstanding and 4.0 years for the 56,492 options exercisable as of
December 31, 2006.
As of December 31, 2006 there was approximately $34 of total unrecognized
compensation cost related to the unvested options granted under the stock
option plans. That cost is expected to be recognized over a weighted
average period of 1.8 years.
-10-
8. EQUITY OFFERING
The Company conducted a private placement of 400,000 shares of common stock
resulting in gross proceeds of approximately $6.5 million. The offering was
undertaken by the Company to strengthen its capital position in accordance
with a capital plan designed to maintain the Company's capital at prudent
levels as well as reduce its debt-to-equity ratio below 50%. The Company
intends to use all of the net proceeds of $5.8 million to redeem a portion
of its outstanding trust preferred securities in June 2007. The capital
plan was adopted by the Company in April 2006 pursuant to a supervisory
agreement between the Company and the OTS in February 2006.
The shares sold in the private placement were offered to accredited
investors in reliance on an exemption from the registration requirements of
the Securities Act of 1933, as amended (the "Securities Act"). The shares
have not been registered under the Securities Act or any state securities
laws and the securities may not be offered or sold absent registration or
an applicable exemption from the registration requirements of the
Securities Act and applicable state securities laws. The Company intends
to file a registration statement with the Securities and Exchange
Commission to register such shares.
9. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum regulatory capital
requirements can result in certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a
direct material effect on the Company's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve
quantitative measures of the Bank's assets, liabilities, and certain
off-balance sheet items as calculated under regulatory accounting
practices. The Bank's capital amounts and classification are also subject
to qualitative judgments by regulators about components, risk weightings,
and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth below)
of tangible and core capital (as defined in the regulations) to adjusted
assets (as defined), and of Tier I and total capital (as defined) to
average assets (as defined). Management believes, as of December 31, 2006,
that the Bank meets all regulatory capital adequacy requirements to which
it is subject.
The Bank's actual capital amounts and ratios are presented in the following
table.
REQUIRED FOR WELL CAPITALIZED
CAPITAL ADEQUACY UNDER PROMPT
ACTUAL PURPOSE CORRECTIVE ACTION
--------------- ---------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- -------- ----- -------- ------
At December 31, 2006:
Core Capital (to Adjusted Tangible Assets) $48,151 9.27% $20,721 4.0% $25,974 5.0%
Tier I Capital (to Risk-Weighted Assets) 48,151 14.33 N/A N/A 20,168 6.0
Total Capital (to Risk-Weighted Assets) 51,606 15.35 26,890 8.0 33,613 10.0
Tangible Capital (to Tangible Assets) 48,074 9.26 7,791 1.5 N/A N/A
At September 30, 2006:
Core Capital (to Adjusted Tangible Assets) $47,771 9.15% $20,819 4.0% $26,096 5.0%
Tier I Capital (to Risk-Weighted Assets) 47,771 13.96 N/A N/A 20,539 6.0
Total Capital (to Risk-Weighted Assets) 51,138 14.94 27,385 8.0 34,231 10.0
Tangible Capital (to Tangible Assets) 47,771 9.15 7,829 1.5 N/A N/A
On February 13, 2006, the Bank entered into a supervisory agreement with
the OTS. The supervisory agreement requires the Bank, among other things,
to maintain minimum core capital and total risk-based capital ratios of
7.5% and 12.5%, respectively. At December 31, 2006, the Bank was in
compliance with such requirement. As a result of entering into and being
subject to a 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.
-11-
10. RECENT ACCOUNTING PRONOUNCEMENTS
In February 2006, the 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 (October 1, 2007 for the Company) and does not expect 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 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
adopted SFAS No. 156 for the fiscal year which began on October 1, 2006 and
the Company believes it will not have a material effect on the Company's
financial position or results of operations
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements".
SFAS No. 157 defines fair value, establishes a framework for measuring fair
value in GAAP, and expands disclosures about fair value measurements. SFAS
No. 157 does not require any new fair value measurements. The definition of
fair value retains the exchange price notion in earlier definitions of fair
value. SFAS No. 157 clarifies that the exchange price is the price in an
orderly transaction between market participants to sell the asset or
transfer the liability in the market in which the reporting entity would
transact for the asset or liability. The definition focuses on the price
that would be received to sell the asset or paid to transfer the liability
(an exit price), not the price that would be paid to acquire the asset or
received to assume the liability (an entry price). SFAS No. 157 emphasizes
that fair value is a market-based measurement, not an entity-specific
measurement. This Statement is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and interim periods
within those fiscal years. The Company is evaluating the impact of this
pronouncement but does not expect that the guidance will have a material
effect on the Company's financial position or results of operations.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Post-retirement Plans, an amendment of
FASB Statements No. 87, 88, 106 and 132(R)." For defined benefit
post-retirement plans, SFAS 158 requires that the funded status be
recognized in the statement of financial position, that assets and
obligations that determine funded status be measured as of the end of the
employer's fiscal year, and that changes in funded status be recognized in
comprehensive income in the year the changes occur. SFAS 158 does not
change the amount of net periodic benefit cost included in net income or
address measurement issues related to defined benefit post-retirement
plans. The requirement to recognize funded status is effective for fiscal
years ending after December 15, 2006. The requirement to measure assets and
obligations as of the end of the employer's fiscal year is effective for
fiscal years ending after December 15, 2008. The Company has determined
that the guidance provided by SFAS No. 158 does not have an impact on its
stockholders' equity or on the Company's financial position or results of
operations.
-12-
In June 2006, the FASB issued Interpretation No. 48 ("FIN 48"), "FASB
Interpretation No. 48 - Accounting for Uncertainty in Income Taxes - an
interpretation of FASB Statement No. 109". This Interpretation clarifies
the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with SFAS No. 109,
"Accounting for Income Taxes". This Interpretation prescribes a recognition
threshold and measurement attribute for the financial statement recognition
and measurement of a tax position taken or expected to be taken in a tax
return. This Interpretation also provides guidance on recognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition. FIN 48 is effective for fiscal years beginning
after December 15, 2006 or October 1, 2007 for the Company. The Company is
currently evaluating the impact of this pronouncement.
In September 2006, the SEC Staff issued Staff Accounting Bulletin No.108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in the Current Year Financial Statements" ("SAB No. 108").
SAB No. 108 requires the use of two alternative approaches in
quantitatively evaluating materiality of misstatements. If the misstatement
as quantified under either approach is material to the current year
financial statements, the misstatement must be corrected. If the effect of
correcting the prior year misstatements, if any, in the current year income
statement is material, the prior year financial statements should be
corrected. This guidance is effective for the fiscal year ending September
30, 2007. In the year of adoption, misstatements may be corrected by
treating the misstatement as an accounting change and adjusting retained
earnings rather than being included in the current year income statement.
The Company has determined that the guidance provided by SAB No. 108 does
not have a material effect on the current quarter's financial statements.
-13-
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
(special mention, 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, but at a minimum at least quarterly. 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
-14-
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.
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' reports of examination of the Company's and the Bank's operations
and financial condition conducted in 2005.
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 the Company complied with certain conditions. 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 ($0.11 per share) or 35% of its
consolidated net income (on an annualized basis), provided that the OTS, upon
review of prior notice from the Company of the proposed dividend, does not
object to payment.
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 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 compensatory arrangements with senior executive
officers and directors, subject to certain exceptions, without the prior
approval of the OTS. As a result of the growth restriction imposed on the Bank,
the Company's growth is currently and will continue to be substantially
constrained unless and until the supervisory agreements are terminated or
modified. As of March 31, 2006 and June 30, 2006, the Bank exceeded the growth
limitation contained in the supervisory agreement with the OTS described above.
Subsequent to June 30, 2006, the Bank reduced its assets sufficiently to be
below the June 30, 2006 limitation. The OTS advised the Bank that it will not
take any regulatory action against the Bank provided it will be in compliance
with the growth limitation as of September 30, 2006. The Bank complied with the
growth restriction at September 30, 2006 and December 31, 2006.
The Company recently underwent an examination by the OTS. In connection
with such examination, the OTS reviewed the Company's and the Bank's compliance
with the provisions of the supervisory agreements. Although the Company and the
Bank were determined to be in full or partial compliance with substantially all
of the provisions of the supervisory agreements, the examination did note a
number of areas for improvement with respect to the Bank's loan underwriting,
credit analysis and asset classification policies and procedures. In order to
strengthen these areas, the Bank intends to hire a Chief Credit Officer. The
Bank is aggressively addressing these areas for improvement in its lending
operations in order to be in full compliance with the terms of the supervisory
agreements as soon as possible. Except as described above, the Company believes
it and the Bank are in material compliance with the supervisory agreements.
The Company has submitted to and received from the OTS approval of a
capital plan, which plan calls for an equity infusion in order to reduce the
Company's debt-to-equity ratio below 50%. As part of its capital plan, the
Company conducted a private placement of 400,000 shares of common stock, raising
gross proceeds of approximately $6.5 million. The net proceeds of approximately
$5.8 million will be used to reduce the amount of its outstanding trust
preferred securities. The Company intends to use all of the net proceeds to
redeem approximately $5.8 million of its floating-rate trust preferred
securities in June 2007. As a result of such redemption, the Company's
debt-to-equity ratio will be less than 50%. The Company believes it will be able
to resume paying quarterly cash dividends in the quarter ending September 30,
2007. However, no assurances can be given that the Company will satisfy the
conditions necessary to resume paying dividends or that the OTS will not object
to the resumption of dividends or, if resumed, that the Company will be able to
pay dividends at the same rate that it has historically paid or be able to
continue to pay dividends. The Company and the Bank will make every effort to
have
-15-
both supervisory agreements terminated or the operating restrictions
substantially reduced by the end of 2007. However, no assurances can be given
that either of such events will occur.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2006 AND SEPTEMBER 30, 2006
Total assets of the Company decreased by $2.7 million from $523.0 million
at September 30, 2006 to $520.3 million at December 31, 2006. Cash and cash
equivalents increased by $8.1 million to $20.9 million at December 31, 2006 from
$12.8 million at September 30, 2006. The increase in cash and cash equivalents
was primarily due to cash flows generated by loan repayments and, to a lesser
extent, principal paydowns of mortgage-related securities. Loans receivable
decreased by $6.2 million from $323.2 million at September 30, 2006 to $317.0
million at December 31, 2006 primarily as a result of the Company experiencing
repayments within the commercial real estate loan portfolio. Deposits decreased
$2.0 million, or 0.6%, from $358.8 million at September 30, 2006 to $356.8
million at December 31, 2006. The decrease in deposits resulted from a $2.6
million, or 1.5%, decrease in core deposits (which consist of passbook, money
market, NOW and non-interest bearing accounts) partially offset by a $549,000,
or 0.3%, increase in certificates of deposit. The decline in core deposits
reflected the effects of competition as local competitors offered higher rates
on these products. In addition, borrowings decreased $6.7 million, or 6.3%, from
$107.2 million at September 30, 2006 as a result of excess cash flows reducing
overnight borrowings.
Stockholders' equity increased $5.7 million to $34.3 million primarily due
to the Company's completion of the private equity offering raising net proceeds
of approximately $5.8 million. See Note 8 of Notes to Unaudited Consolidated
Financial Statements. The Company released 400,000 shares of common stock from
the Company's treasury stock resulting in a reduction in treasury stock by $6.2
million.
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2006
AND 2005
Net Income. Net income was $88,000 for the three months ended December 31, 2006
as compared to $445,000 for the same period in 2005. The $357,000, or 80.2%,
decrease in net income for the three months ended December 31, 2006 was
primarily due to a $318,000 decrease in net interest income combined with a
$144,000 increase in non-interest expense partially offset by a $163,000
decrease in income tax expense.
Net Interest Income. Net interest income decreased $318,000, or 11.4%, to $2.5
million for the three months ended December 31, 2006 as compared to the same
period in 2005. The decrease was primarily due to a $941,000, or 25.0%, increase
in interest expense which was the result of a $10.1 million, or 2.1%, increase
in average interest-bearing liabilities combined with a 71 basis point increase
in the weighted average rate paid on interest-bearing liabilities for the three
months ended December 31, 2006 as compared to the same period in 2005. The
increase in interest expense was primarily due to an $835,000, or 44.7%,
increase in interest expense on deposits resulting from increases in market
rates of interest as well as intense competition for such deposits in the
Company's marketplace. Partially offsetting the increase in interest expense was
a $623,000, or 9.5%, increase in interest income which was primarily due to an
increase of $9.0 million, or 1.9%, in the average balance of interest-earning
assets, combined with a 40 basis point (on a fully tax-equivalent basis)
increase in weighted yield earned on interest-earning assets for the three
months ended December 31, 2006 as compared to the same period in 2005.
The interest rate spread and net interest margin, on a fully tax equivalent
basis, were 2.11% and 2.10%, respectively, for the three months ended December
31, 2006 as compared to 2.42% and 2.42%, respectively, for the same period in
2005. The decrease in the net interest margin was primarily due to the increase
in the cost of funds due to the continued rise of market rates of interest on
the short-term end of the yield curve which outpaced the increases in the yield
on interest-earning assets.
-16-
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, 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
-------------------------------------------------------------
DECEMBER 31, 2006 DECEMBER 31, 2005
----------------------------- -----------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
-------- -------- ------- -------- -------- -------
(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)(2) $321,525 $5,355 6.66% $304,455 $4,699 6.17%
Mortgage-related securities (2) 106,734 1,207 4.52 112,542 1,200 4.27
Investment securities (3) 43,904 617 5.62 47,226 686 5.81
Other interest-earning assets 10,658 63 2.37 9,624 51 2.12
-------- ------ -------- ------ -----
Total interest-earning assets (3) 482,821 7,242 6.00 473,847 6,636 5.60
-------- ------ -------- ------- -----
Non-interest-earning assets 37,911 34,642
-------- --------
Total assets $520,732 $508,489
======== ========
Interest-bearing liabilities:
Deposits $355,631 2,704 3.04 $347,338 $1,869 2.15
FHLBank advances and other borrowings 107,661 1,505 5.59 105,850 1,429 5.40
Junior subordinated debentures 21,480 502 9.35 21,517 472 8.77
-------- ------ -------- ------
Total interest-bearing liabilities 484,772 4,711 3.89 474,705 3,770 3.18
-------- ------ -------- ------
Interest rate spread (3) 2.11% 2.42%
===== =====
Non-interest-bearing liabilities 7,048 5,829
-------- --------
Total liabilities 491,820 480,534
Stockholders' equity 28,912 27,955
-------- --------
Total liabilities and stockholders' equity $520,732 $508,489
======== ========
Net interest-earning assets $ (1,951) $ (858)
======== ========
Net interest income (3) $2,530 $2,866
====== ======
Net interest margin (3)(4) 2.10% 2.42%
===== =====
Ratio of average interest-earning assets
to average interest-bearing liabilities 99.60% 99.82%
===== =====
- ----------
(1) Includes non-accrual loans.
(2) Includes assets classified as either available for sale or held for sale.
(3) Presented on a tax-equivalent basis.
(4) Net interest income divided by interest-earning assets.
-17-
Although management believes that the above mentioned non-GAAP financial
measure enhances investors' understanding of the Company's business and
performance, this non-GAAP financial measure should not be considered an
alternative to GAAP. The reconciliation of this non-GAAP financial measure from
GAAP to non-GAAP is presented below.
FOR THE THREE MONTHS ENDED
---------------------------------------------
DECEMBER 31, 2006 DECEMBER 31, 2005
--------------------- ---------------------
AVERAGE AVERAGE
INTEREST YIELD/COST INTEREST YIELD/COST
-------- ---------- -------- ----------
(Dollars in thousands)
Investment securities - nontaxable $ 548 4.99% $ 600 5.08%
Tax equivalent adjustments 69 86
------ ------
Investment securities - nontaxable to a
taxable equivalent yield $ 617 5.62% $ 686 5.81%
====== ======
Net interest income $2,461 $2,780
Tax equivalent adjustment 69 86
------ ------
Net interest income, tax equivalent $2,530 $2,866
====== ======
Net interest rate spread, no tax adjustment 2.05% 2.35%
Net interest margin, no tax adjustment 2.04% 2.35%
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 portfolio.
For the three months ended December 31, 2006 and 2005, the provision for loan
losses amounted to $75,000 and $45,000, respectively. 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, 2006, non-performing assets increased $1.2 million to $3.9
million, or 0.7%, of total assets, from $2.8 million at September 30, 2006. The
increase in non-performing assets was primarily the result of a $554,000
increase in nonaccrual commercial business loans. In addition, the increase was
due to a $702,000 increase in commercial loans that are 90 days past due and
still accruing which the Company is in the progress of refinancing. The coverage
ratio, which is the ratio of the allowance for loan losses to non-performing
loans, was 242.0% and 1,215.6% at December 31, 2006 and September 30, 2006,
respectively.
Included in non-performing assets was $2.4 million of real estate owned
consisting of a commercial real estate property. During the second quarter of
fiscal 2006, the Company transferred to real estate owned a restaurant located
in Chesapeake City, Maryland at its approximate fair value of $2.7 million
resulting in the Company's charging off $1.1 million against the allowance for
loan losses. Subsequent to December 31, 2006, the property was sold for $2.7
million which will result in the recognition of a pre-tax gain on the sale of
$61,000 during the quarter ending March 31, 2007.
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. Non-interest income decreased $28,000, or 3.6%, to $747,000
for the three months ended December 31, 2006 as compared to the same period in
2005. The decrease was primarily due to a $20,000, or 17.1%, decrease in other
income resulting from lower revenues generated in insurance products.
Non-interest Expense. Non-interest expense increased $144,000, or 4.8%, during
the three months ended December 31, 2006 compared to the same period in 2005.
The increase was primarily due to increases of $69,000 and $48,000 in
professional fees and real estate owned expenses, respectively. The increase in
professional fees was related to
-18-
ongoing efforts to comply with the supervisory agreement. The increase in real
estate owned expenses related to the maintenance of the commercial real estate
located in Chesapeake City, Maryland referenced above. In addition, the Company
incurred increases of $26,000 and $18,000 in federal deposit insurance premiums
and data processing expenses, respectively.
Income Tax Expense. The Company recognized an income tax benefit of $91,000 for
the three months ended December 31, 2006 as compared to recognition of income
tax expense of $72,000, or 13.9%, of pre-tax income for the same period in 2005.
The primary reason for the recognition of an income tax benefit for the three
months ended December 31, 2006 was the reduction in income before income taxes
combined with the effects of non-taxable earning assets.
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, 2006, the Company had short-term
borrowings (due within one year or currently callable by the FHLBank)
outstanding of $100.4 million, all of which consisted of advances from the
FHLBank 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, 2006, total approved
loan commitments outstanding amounted to $5.5 million, not including loans in
process. At the same date, commitments under unused lines of credit amounted to
$38.1 million. Certificates of deposit scheduled to mature in one year or less
at December 31, 2006 totaled $126.5 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 December 31, 2006, the
Bank had tangible capital and core capital equal to 9.3% 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 2 of Part I 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.
Under the terms of the supervisory agreement, the Company submitted a
capital plan to the OTS. As part of the capital plan, which was approved by the
OTS, the Company conducted a private placement of 400,000 shares of common
stock, raising gross proceeds of approximately $6.5 million. The net proceeds of
approximately $5.8 million will be used to reduce the amount of its outstanding
trust preferred securities. The Company intends to use all of the net proceeds
to redeem approximately $5.8 million of its trust preferred securities in June
2007.
-19-
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, 2006.
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, 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 $44,450 $(23,501) (35)% 8.76% (392)bp
200 53,200 (14,750) (22) 10.29 (239)bp
100 61,556 (6,394) (9) 11.69 (100)bp
0 67,950 -- -- 12.68 --
(100) 71,912 3,962 6 13.24 56 bp
(200) 73,282 5,332 8 13.36 68 bp
-20-
As of December 31, 2006, the Company's NPV was $68.0 million or 12.68% of
the market value of assets. Following a 200 basis point increase in interest
rates, the Company's "post shock" NPV would be $53.2 million or 10.29% of the
market value of assets. The change in the NPV ratio or the Company's sensitivity
measure was a decline of 239 basis points.
ITEM 4. CONTROLS AND PROCEDURES
Our management evaluated, with the participation of our Chief Executive
Officer and our 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 (i) recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
regulations and (ii) accumulated and communicated to management, including the
Chief Executive Officer and Chief Financial Officer, or persons performing
similar functions, as appropriate to allow timely decisions regarding required
disclosure and that such disclosure controls and procedures 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.
-21-
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,
2006.
Item 1A. Risk Factors
Not applicable
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) - (b) The information required by Item 2 was previously reported
on Form 8-K filed with the Commission on December 12, 2006 and Item 5
of the Company's Annual Report on Form 10-K for the year ended
September 30, 2006 filed with the Commission on December 29, 2006.
(c) Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
On February 7, 2007, the Annual Meeting of Stockholders of the
Company was held to obtain approval for two proxy proposals submitted
on behalf of the Company's Board of Directors: the election of three
nominees for directors and the ratification of the appointment of
Deloitte & Touche LLP as the Company's independent registered public
accounting firm. In addition, two nominees for director were
submitted by Lawrence Partners, LP and Lawrence Offshore Partners,
LLC (collectively, "Lawrence"). With respect to the election of
directors, the following directors were elected by the requisite
plurality of the votes cast at the Annual Meeting on the matter:
Votes
--------------------
Nominee For Withheld
- ------- --------- --------
Donald S. Guthrie 1,368,646 12,744
Edmund Jones 1,378,761 2,629
Jerry A. Naessens 1,367,846 13,544
With respect to the nominees submitted by Lawrence, the following
information is provided:
Votes
------------------
Nominee For Withheld
- ------- ------- --------
Lawrence Garshofsky 645,986 358
Jeffrey E. Susskind 645,986 358
The directors whose terms continued are: Bruce C. Hendrixson, Donald
G. Hosier, Jr., Thomas M. Kelly, William J. O'Donnell and Marshall J.
Soss.
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, 2007, the results were as follows:
2,022,993 votes for, 17,374 votes against and 1,965 votes abstaining.
Item 5. Other Information
(a) Not applicable
(b) No changes in procedures.
-22-
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. (12),
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), *
10.15 Confidentiality Agreement between First Keystone Bank and Marshall
Soss and KarMar Realty Group *
10.16 Letter dated December 11, 2006 with respect to appointment to Board
(9)
10.17 Form of Registration Rights Agreement
11 Statement re: computation of per share earnings. See Note 2 to the
Consolidated Financial Statements included in Item 8 hereof.
23 Consent of independent registered accounting firm.
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 (10)
99.2 Supervisory Agreement between First Keystone Financial, Inc. and the
Office of Thrift Supervision dated February 13, 2006. (11)
99.3 Supervisory Agreement between First Keystone Bank and the Office of
Thrift Supervision dated February 13, 2006. (11)
- ----------
(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.
-23-
(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 Exhibit 10.1 in the Form 8-K filed by the
Registrant with the SEC on December 20, 2006.
(10) Incorporated by reference from the Form 10-K filed by the Registrant with
the SEC on December 23, 2003.
(11) 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.
(12) Incorporated by reference from Exhibit 3.2 to the Form 10-K filed by the
registrant with the SEC on December 29, 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.
-24-
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, 2007 By: /s/ Thomas M. Kelly
------------------------------------
Thomas M. Kelly
President and Chief Executive
Officer
Date: February 14, 2007 By: /s/ Rose M. DiMarco
------------------------------------
Rose M. DiMarco
Chief Financial Officer
-25-