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, 2007
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 8, 2007: 2,428,668
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, 2007 and September 30, 2006 1
Unaudited Consolidated Statements of Income for the Three
and Six Months Ended March 31, 2007 and 2006 2
Unaudited Consolidated Statement of Changes in
Stockholders' Equity for the Six Months Ended March 31,
2007 and 2006 3
Unaudited Consolidated Statements of Cash Flows for the Six
Months Ended March 31, 2007 and 2006 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 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,
2007 2006
--------- -------------
ASSETS
Cash and amounts due from depository institutions $ 8,822 $ 4,072
Interest-bearing deposits with depository institutions 25,601 8,715
-------- --------
Total cash and cash equivalents 34,423 12,787
Investment securities available for sale 28,230 33,386
Mortgage-related securities available for sale 73,926 70,030
Loans held for sale 392 1,334
Investment securities held to maturity - at amortized cost
(approximate fair value of $3,272 at March 31, 2007
and $3,268 at September 30, 2006) 3,257 3,257
Mortgage-related securities held to maturity - at amortized cost
(approximate fair value of $34,135 at March 31, 2007
and $37,163 at September 30, 2006) 35,031 38,355
Loans receivable (net of allowance for loan loss of $3,525 and $3,367
at March 31, 2007 and September 30, 2006, respectively) 311,505 323,220
Accrued interest receivable 2,674 2,667
Real estate owned -- 2,450
FHLBank stock, at cost 5,459 6,233
Office properties and equipment, net 4,477 4,643
Deferred income taxes 3,089 2,281
Cash surrender value of life insurance 16,918 16,624
Prepaid expenses and other assets 2,535 5,693
-------- --------
TOTAL ASSETS $521,916 $522,960
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Non-interest-bearing $ 17,666 $ 17,232
Interest-bearing 346,200 341,584
-------- --------
Total deposits 363,866 358,816
Advances from FHLBank and other borrowings 94,412 107,241
Junior subordinated debentures 21,465 21,483
Accrued interest payable 2,652 2,164
Advances from borrowers for taxes and insurance 2,045 866
Accounts payable and accrued expenses 2,753 3,731
-------- --------
Total liabilities 487,193 494,301
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 March 31, 2007 and September 30, 2006, 2,427,988
and 2,027,928 shares, respectively 27 27
Additional paid-in capital 12,605 12,974
Employee stock ownership plan (3,038) (3,089)
Treasury stock at cost: 284,568 shares at March 31, 2007 and 684,628 shares
at September 30, 2006 (4,321) (10,522)
Accumulated other comprehensive loss (861) (787)
Retained earnings - partially restricted 30,311 30,056
-------- --------
Total stockholders' equity 34,723 28,659
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $521,916 $522,960
======== ========
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,
------------------ -----------------
2007 2006 2007 2006
------ ------ ------- -------
INTEREST INCOME:
Interest and fees on loans $5,259 $4,821 $10,614 $ 9,520
Interest and dividends on:
Mortgage-related securities 1,209 1,276 2,416 2,476
Investment securities:
Taxable 315 296 625 592
Tax-exempt 145 187 296 374
Dividends 156 74 243 191
Interest-bearing deposits 114 42 177 92
------ ------ ------- -------
Total interest income 7,198 6,696 14,371 13,245
------ ------ ------- -------
INTEREST EXPENSE:
Interest on:
Deposits 2,838 1,958 5,542 3,827
FHLBank advances and other borrowings 1,242 1,425 2,747 2,854
Junior subordinated debentures 499 485 1,001 956
------ ------ ------- -------
Total interest expense 4,579 3,868 9,290 7,637
------ ------ ------- -------
NET INTEREST INCOME 2,619 2,828 5,081 5,608
PROVISION FOR LOAN LOSSES 100 525 175 570
------ ------ ------- -------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 2,519 2,303 4,906 5,038
------ ------ ------- -------
NON-INTEREST INCOME:
Service charges and other fees 410 360 797 739
Net gain on sales of:
Loans held for sale 8 17 124 142
Investment securities 120 -- 120 --
Real estate owned 61 158 61 158
Increase in cash surrender value of life insurance 147 144 294 297
Other income 107 121 204 237
------ ------ ------- -------
Total non-interest income 853 800 1,600 1,573
------ ------ ------- -------
NON-INTEREST EXPENSE:
Salaries and employee benefits 1,473 1,502 2,971 3,004
Occupancy and equipment 404 395 800 784
Professional fees 533 553 870 821
Federal deposit insurance premium 36 37 74 49
Data processing 140 131 278 251
Advertising 119 102 226 208
Deposit processing 142 155 296 310
Other 406 351 875 790
------ ------ ------- -------
Total non-interest expense 3,253 3,226 6,390 6,217
------ ------ ------- -------
INCOME (LOSS) BEFORE INCOME TAX BENEFIT 119 (123) 116 394
INCOME TAX BENEFIT (48) (142) (139) (70)
------ ------ ------- -------
NET INCOME $ 167 $ 19 $ 255 $ 464
====== ====== ======= =======
BASIC EARNINGS PER COMMON SHARE $ 0.07 $ 0.01 $ 0.12 $ 0.25
====== ====== ======= =======
DILUTED EARNINGS PER COMMON SHARE $ 0.07 $ 0.01 $ 0.12 $ 0.24
====== ====== ======= =======
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, 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
=== ======= ======= ======== ======= ======= =======
BALANCE AT OCTOBER 1, 2006 $27 $12,974 $(3,089) $(10,522) $ (787) $30,056 $28,659
Net income -- -- -- -- -- 255 255
Other comprehensive income, net of tax:
Net unrealized loss on securities
net of reclassification
adjustment(1) -- -- -- -- (74) -- (74)
--- ------- ------- -------- ------- ------- -------
Comprehensive income -- -- -- -- -- -- 181
--- ------- ------- -------- ------- ------- -------
ESOP shares committed to be released -- -- 51 -- -- -- 51
Share-based compensation -- 21 -- -- -- -- 21
Excess of fair value above cost of
ESOP shares committed to be released -- 22 -- -- -- -- 22
Exercise of stock options -- -- -- 1 -- -- 1
Release of treasury shares for
equity offering -- (412) -- 6,200 -- -- 5,788
--- ------- ------- -------- ------- ------- -------
BALANCE AT MARCH 31, 2007 $27 $12,605 $(3,038) $ (4,321) $ (861) $30,311 $34,723
=== ======= ======= ======== ======= ======= =======
(1) Disclosure of reclassification amount, net of tax:
March 31,
--------------
2007 2006
---- -------
Net unrealized appreciation (depreciation) arising during the period $ 5 $(1,221)
Less: reclassification adjustment for net gains included in net income
(net of tax of $41 and $0, respectively) 79 --
---- -------
Net unrealized loss on securities $(74) $(1,221)
==== =======
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,
-------------------
2007 2006
-------- --------
OPERATING ACTIVITIES:
Net income $ 255 $ 464
Adjustments to reconcile net income to net cash provided by (used
in) operating activities:
Provision for depreciation and amortization 272 266
Amortization of premiums and discounts 93 193
Increase in cash surrender value of life insurance (294) (297)
Gain on sales of:
Loans held for sale (124) (142)
Investment securities available for sale (120) --
Real estate owned (61) (158)
Provision for loan losses 175 570
Amortization of ESOP 73 74
Deferred income taxes (770) 250
Share-based compensation 21 13
Origination of loans held for sale (272) (4,347)
Proceeds from the sale of loans 1,214 4,388
Changes in assets and liabilities which provided (used) cash:
Accrued interest receivable (7) (61)
Prepaid expenses and other assets 3,158 4,750
Accrued interest payable 488 63
Accrued expenses (978) (398)
-------- --------
Net cash provided by operating activities 3,123 5,628
-------- --------
INVESTING ACTIVITIES:
Loans originated (54,827) (62,505)
Purchases of:
Mortgage-related securities available for sale (10,038) (16,381)
Investment securities available for sale (4,271) (240)
Mortgage-related securities held to maturity -- --
Redemption of FHLBank stock 774 3,326
Proceeds from sales of real estate owned 2,511 918
Proceeds from sales of investment securities available for sale 7,912 --
Principal collected on loans 66,477 54,857
Proceeds from maturities, calls, or repayments of:
Investment securities available for sale 1,058 590
Mortgage-related securities available for sale 6,559 6,673
Mortgage-related securities held to maturity 3,275 4,269
Investment securities held to maturity -- 1,000
Purchase of property and equipment (106) (192)
-------- --------
Net cash provided by (used in) investing activities 19,324 (7,685)
-------- --------
FINANCING ACTIVITIES:
Net increase in deposit accounts 5,050 13,016
Net decrease in FHLBank advances and other borrowings (12,829) (11,326)
Net increase in advances from borrowers for taxes and insurance 1,179 1,167
Exercise of stock options 1 5
Net proceeds from equity offering 5,788 --
Cash dividend -- (208)
-------- --------
Net cash (used in) provided by financing activities (811) 2,654
-------- --------
INCREASE IN CASH AND CASH EQUIVALENTS 21,636 597
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 12,787 16,155
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 34,423 $ 16,752
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW AND NON-CASH INFORMATION:
Cash payments for interest on deposits and borrowings $ 8,802 $ 7,574
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, 2007 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, at March 31, 2007, of
investment securities available for sale and held to maturity, by
contractual maturities, are as follows:
March 31, 2007
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
--------- ---------- ---------- -----------
Available for Sale:
U.S. Government and agency bonds:
1 to 5 years $ 2,000 $ -- $ (14) $ 1,986
Over 10 years 2,962 -- (22) 2,940
Municipal obligations:
5 to 10 years 130 -- -- 130
Over 10 years 1,000 -- (7) 993
Corporate bonds:
1 to 5 years 2,082 55 -- 2,137
Over 10 years 9,855 5 (210) 9,650
Mutual funds 9,455 -- (285) 9,170
Other equity investments 1,040 184 -- 1,224
------- ---- ----- -------
Total $28,524 $244 $(538) $28,230
======= ==== ===== =======
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 March 31,
2007.
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 $ 2,940 $(22) $ 1,986 $ (14) $ 4,926 $ (36)
Corporate bonds -- -- 8,569 (210) 8,569 (210)
Municipal bonds -- -- 993 (7) 993 (7)
Mutual funds -- -- 9,170 (285) 9,170 (285)
------- ---- ------- ----- ------- -----
Total $ 2,940 $(22) $20,718 $(516) $23,658 $(538)
======= ==== ======= ===== ======= =====
At March 31, 2007, investment securities in a gross unrealized loss
position for twelve months or longer consisted of eight securities and an
investment in two mutual funds having an aggregate depreciation of 2.4%
from the Company's amortized cost basis. Management believes that the
estimated fair value of the securities disclosed above is primarily
dependent upon the movement in market interest rates 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 consisted of two funds
primarily invested in asset-backed securities and had an aggregate
depreciation of 3.0%. Corporate bonds in an unrealized loss position for 12
months or longer consisted of six debt securities and had an aggregate
depreciation of 2.4%. 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,
2007 represents an other-than-temporary impairment.
The amortized cost and approximate fair value, at September 30, 2006, 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:
5 to 10 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)
Equity 56 (6) -- -- 56 (6)
Municipal bonds 348 -- 985 (15) 1,333 (15)
Mutual funds -- -- 8,952 (276) 8,592 (276)
------ ---- ------- ----- ------- -----
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, at March 31, 2007, are summarized as follows:
March 31, 2007
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gain Loss Fair Value
--------- ---------- ---------- -----------
Available for Sale:
FHLMC pass-through certificates $11,663 $ 4 $ (64) $11,603
FNMA pass-through certificates 27,359 52 (332) 27,079
GNMA pass-through certificates 2,603 5 (35) 2,573
Collateralized mortgage obligations 33,312 50 (691) 32,671
------- ---- ------- -------
Total $74,937 $111 $(1,122) $73,926
======= ==== ======= =======
Held to Maturity:
FHLMC pass-through certificates $13,255 $ 6 $ (350) $12,911
FNMA pass-through certificates 21,680 6 (558) 21,128
Collateralized mortgage obligations 96 -- -- 96
------- ---- ------- -------
Total $35,031 $ 12 $ (908) $34,135
======= ==== ======= =======
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, 2007.
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 $12,184 $(56) $55,510 $(1,283) $67,694 $(1,339)
Collateralized
mortgage
obligations -- -- 29,394 (691) 29,394 (691)
------- ---- ------- ------- ------- -------
Total $12,184 $(56) $84,904 $(1,974) $97,088 $(2,030)
======= ==== ======= ======= ======= =======
-7-
At March 31, 2007, mortgage-related securities in a gross unrealized loss
position for twelve months or longer consisted of fifty-five securities
that at such date had an aggregate depreciation of 2.3% from the Company's
amortized cost basis. Management does not believe any individual unrealized
loss as of March 31, 2007 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, at September 30, 2006, 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:
March 31, September 30,
2007 2006
--------- -------------
Real estate loans:
Single-family $141,588 $144,760
Construction and land 32,995 38,158
Multi-family and commercial 61,282 70,439
Home equity and lines of credit 58,629 59,319
Consumer loans 1,302 1,375
Commercial loans 26,476 24,474
-------- --------
Total loans 322,272 338,525
Loans in process (7,430) (12,081)
Allowance for loan losses (3,525) (3,367)
Deferred loan costs 188 143
-------- --------
Loans receivable - net $311,505 $323,220
======== ========
At March 31, 2007 and September 30, 2006, non-performing loans (which
include loans in excess of 90 days delinquent as to principal or interest)
amounted to approximately $2,581 and $277, respectively. At March 31, 2007,
non-performing loans primarily consisted of two single-family residential
mortgage loans aggregating $70, four commercial business loans aggregating
$1,175, three commercial real estate loans aggregating $1,293 and two
consumer home equity loans aggregating $43.
At March 31, 2007 and September 30, 2006, the Company had impaired loans
with a total recorded investment of $1,143 and $25, respectively. Interest
income of $27 was recognized on these impaired loans during the six months
ended March 31, 2007. Interest income of $15 was not recognized on these
impaired loans due to the non-accrual status of such loans for the six
months ended March 31, 2007.
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,
2007 2006
--------- -------------
Impaired loans with related allowance for loan losses
under SFAS No. 114 $ -- $--
Impaired loans with no related allowance for loan
losses under SFAS No. 114 1,143 25
------ ---
Total impaired loans $1,143 $25
====== ===
Valuation allowance related to impaired loans $ -- $--
====== ===
The following is an analysis of the allowance for loan losses:
Six Months Ended
March 31,
----------------
2007 2006
------ -------
Balance beginning of period $3,367 $ 3,475
Provisions charged to income 175 570
Charge-offs (43) (1,162)
Recoveries 26 10
------ -------
Total $3,525 $ 2,893
====== =======
-9-
5. DEPOSITS
Deposits consist of the following major classifications:
March 31, September 30,
2007 2006
------------------ ------------------
Amount Percent Amount Percent
-------- ------- -------- -------
Non-interest-bearing $ 17,666 4.8% $ 17,232 4.8%
NOW 77,350 21.3 73,356 20.5
Passbook 38,463 10.6 41,708 11.6
Money market demand 36,333 10.0 40,591 11.3
Certificates of deposit 194,054 53.3 185,929 51.8
-------- ----- -------- -----
Total $363,866 100.0% $358,816 100.0%
======== ===== ======== =====
6. EARNINGS PER SHARE
Basic earnings per share ("EPS") 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, 2007 and 2006, anti-dilutive shares
consisted of options covering 527 and 2,221 shares, respectively.
The calculated basic and diluted EPS is as follows:
For the Three Months For the Six Months
Ended March 31, Ended March 31,
----------------------- -----------------------
2007 2006 2007 2006
---------- ---------- ---------- ----------
Numerator - Net income $ 167 $ 19 $ 255 $ 464
Denominators:
Basic shares outstanding 2,303,333 1,890,608 2,146,185 1,889,463
Effect of dilutive securities 20,645 22,892 19,952 23,566
---------- ---------- ---------- ----------
Diluted shares outstanding 2,323,978 1,913,500 2,166,137 1,913,029
========== ========== ========== ==========
EPS:
Basic $ 0.07 $ 0.01 $ 0.12 $ 0.25
Diluted $ 0.07 $ 0.01 $ 0.12 $ 0.24
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
$21 compensation expense for the three and six month periods ended March
31, 2007, respectively. Compensation expense for the three and six month
periods ended March 31, 2006 was $6 and $13, respectively. There were no
new grants of stock options or other share-based payments during the six
months ended March 31, 2007 and, therefore, additional disclosures for
share-based compensation were omitted due to immateriality.
-10-
A summary of award activity under the stock option plans as of March 31,
2007 and changes during the nine month period is presented below:
Number of Weighted Average
Option Exercise Exercise Price
Shares Price Range per share
--------- -------------- ----------------
Outstanding at October 1, 2006 61,447 $10.13 - 21.89 $13.17
Granted -- -- --
Exercised (60) 10.13 - 10.13 10.13
Cancelled (1,694) 19.75 - 21.89 20.06
------
Outstanding at March 31, 2007 59,693 $10.13 - 21.89 $12.71
====== ============== ======
The weighted average remaining contractual term was approximately 3.0 years
for all options outstanding and approximately 2.8 years for 55,411 stock
options exercisable as of March 31, 2007.
As of March 31, 2007 there was approximately $12,900 of total unrecognized
compensation expense related to the unvested options granted under the
stock option plans. This expense is expected to be recognized over a
weighted average period of 0.5 years.
8. EQUITY OFFERING
In December 2006, 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 to below 50%. The Company is using 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 has filed
a registration statement with the Securities and Exchange Commission to
register such shares for resale.
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 March 31, 2007,
that the Bank meets all regulatory capital adequacy requirements to which
it is subject.
-11-
The Bank's actual capital amounts and ratios are presented in the following
table.
WELL
REQUIRED CAPITALIZED
FOR CAPITAL UNDER PROMPT
ADEQUACY CORRECTIVE
ACTUAL PURPOSE ACTION
--------------- --------------- ---------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ------- ----- ------- -----
At March 31, 2007:
Core Capital (to Adjusted Tangible Assets) $48,559 9.33% $20,827 4.0% $26,033 5.0%
Tier I Capital (to Risk-Weighted Assets) 48,559 14.75 N/A N/A 19,752 6.0
Total Capital (to Risk-Weighted Assets) 52,084 15.82 26,336 8.0 32,920 10.0
Tangible Capital (to Tangible Assets) 48,483 9.31 7,809 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 March 31, 2007, 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.
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, 2006 for the Company) and adoption did not have a material
impact on the Company's consolidated financial statements.
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.
-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.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities". This statement permits
entities to choose to measure many financial instruments and certain other
items at fair value. An entity shall report unrealized gains and losses on
items for which the fair value option has been elected in earnings at each
subsequent reporting date. This statement is effective as of the beginning
of an entity's first fiscal year that begins after November 15, 2007. Early
adoption is permitted as of the beginning of a fiscal year that begins on
or before November 15, 2007, provided the entity also elects to apply the
provisions of SFAS No.157. We are currently evaluating the potential
impact, if any, of the adoption of FASB Statement No. 159 on our
consolidated financial position or results of operations.
-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, 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 towards increased investment in 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, 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 (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 amounts or that
additional provisions for loan losses will not be required in future periods. In
addition, the Bank's
-14-
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 being required.
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 would not
take any regulatory action against the Bank provided it was in compliance with
the growth limitation as of September 30, 2006. The Bank has continued to comply
with the growth restriction as of each quarter since and including September 30,
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 hired a Chief Credit Officer, providing prior
notice to the OTS, in accordance with the requirements of the supervisory
agreement. 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 are being used to reduce the amount of its outstanding trust
preferred securities through the redemption of approximately $6.0 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 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.
-15-
COMPARISON OF FINANCIAL CONDITION AT MARCH 31, 2007 AND SEPTEMBER 30, 2006
Total assets of the Company decreased slightly by $1.0 million from $523.0
million at September 30, 2006 to $521.9 million at March 31, 2007. Cash and cash
equivalents increased by $21.6 million to $34.4 million at March 31, 2007 from
$12.8 million at September 30, 2006. The increase in cash and cash equivalents
was primarily due to cash flows generated by the sale of a large portion of the
Company's municipal bond portfolio, loan repayments and, to a lesser extent,
principal paydowns of mortgage-related securities. The sale of a substantial
portion of the Company's municipal bond portfolio which resulted in the $5.2
million decrease in investment securities available for sale was untaken as a
result of a change in the Company's tax strategy. Loans receivable decreased by
$11.7 million from $323.2 million at September 30, 2006 to $311.5 million at
March 31, 2007 as a modest increase in commercial business loans was outpaced by
repayments in all other loan categories. Total deposits increased $5.1 million,
or 1.4%, from $358.8 million at September 30, 2006 to $363.9 million at March
31, 2007, while borrowings decreased $12.9 million, or 12.0%, from $107.2
million at September 30, 2006. The increase in deposits resulted from an $8.1
million, or 4.4%, increase in certificates of deposit partially offset by a
decrease of $3.1 million, or 1.8%, in core deposits (which consist of passbook,
money market, NOW and non-interest bearing accounts).
Stockholders' equity increased $6.1 million to $34.7 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 AND SIX MONTHS ENDED MARCH 31,
2007 AND 2006
Net Income. Net income was $167,000, or $.07 per diluted share, for the quarter
ended March 31, 2007 as compared to $19,000, or $.01 per diluted share, for the
same period in 2006. Net income for the six months ended March 31, 2007 was
$255,000, or $.12 per diluted share, a decrease of $209,000, or 45.0%, as
compared to $464,000, or $.24 per diluted share, for the same period in 2006.
Net Interest Income. Net interest income decreased $209,000, or 7.4%, to $2.6
million and $527,000, or 9.4%, to $5.1 million for the three and six months
ended March 31, 2007 as compared to the same periods in 2006. Such decreases
were primarily due to increases in interest expense of $711,000, or 18.4%, and
$1.7 million, or 21.6%, for the three and six months ended March 31, 2007,
respectively, as compared to the same periods in 2006. The increases in interest
expense were partially offset by increases in interest income of $502,000 or
7.5% and $1.1 million or 8.5%, for the three and six months ended March 31,
2007, respectively, as compared to the same periods in 2006. The weighted
average yield earned on interest-earning assets for the three months ended March
31, 2007 increased 48 basis points to 6.08% compared to the same period in 2006
and 44 basis points to 6.01% for the six months ended March 31, 2007 compared to
the same period in 2006. For the three months ended March 31, 2007, the weighted
average rate paid on interest-bearing liabilities increased 68 basis points to
3.92% from 3.24% for the same period in the prior fiscal year and 70 basis
points to 3.91% for the six months ended March 31, 2007 as compared to 3.21% for
the six months ended March 31, 2006.
The interest rate spread and net interest margin were 2.16% and 2.21%,
respectively, for the three months ended March 31, 2007 as compared to 2.36% and
2.37%, respectively, for the same period in 2006.The interest rate spread and
net interest margin were 2.10% and 2.13%, respectively, for the six months ended
March 31, 2007 as compared to 2.36% and 2.36%, respectively, for the same period
in 2006. The declines in the interest rate spread and net interest margin were
the result of the Bank's interest-bearing liabilities repricing at a faster pace
than its 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 and six months ended March 31, 2007 and 2006.
FOR THE THREE MONTHS ENDED
-------------------------------------------------------------
MARCH 31, 2007 MARCH 31, 2006
----------------------------- -----------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Cost Balance Interest Cost
-------- -------- ------- -------- -------- -------
Interest-earning assets:
Loans receivable(1)(2) $314,315 $5,259 6.69% $308,208 $4,821 6.26%
Mortgage-related securities(2) 105,920 1,209 4.57 115,707 1,276 4.41
Investment securities(2) 41,133 616 5.99 46,518 557 4.79
Other interest-earning assets 12,449 114 3.65 7,591 42 2.21
-------- ------ -------- ------
Total interest-earning assets 473,817 $7,198 6.08 478,024 $6,696 5.60
-------- ------ ------ -------- ------ -----
Non-interest-earning assets 35,880 33,952
-------- --------
Total assets $509,697 $511,976
======== ========
Interest-bearing liabilities:
Deposits $355,649 $2,838 3.19 $349,151 $1,958 2.24
FHLB advances and other borrowings 90,469 1,242 5.49 106,869 1,425 5.33
Junior subordinated debentures 21,471 499 9.30 21,508 485 9.02
-------- ------ -------- ------
Total interest-bearing liabilities 467,589 4,579 3.92 477,528 3,868 3.24
------ ------ ------ ------
Interest rate spread 2.16% 2.36%
====== ======
Non-interest-bearing liabilities 7,691 6,429
-------- --------
Total liabilities 475,280 483,957
Stockholders' equity 34,417 28,019
-------- --------
Total liabilities and stockholders' equity $509,697 $511,976
======== ========
Net interest-earning assets $ 6,228 $ 496
======== ========
Net interest income $2,619 $2,828
====== ======
Net interest margin(3) 2.21% 2.37%
====== ======
Ratio of average interest-earning assets
to average interest-bearing liabilities 101.33% 100.10%
====== ======
- ----------
(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.
-17-
FOR THE SIX MONTHS ENDED
-------------------------------------------------------------
MARCH 31, 2007 MARCH 31, 2006
----------------------------- -----------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Cost Balance Interest Cost
-------- -------- ------- -------- -------- -------
Interest-earning assets:
Loans receivable(1)(2) $317,960 $10,614 6.68% $306,311 $ 9,520 6.22%
Mortgage-related securities(2) 106,332 2,416 4.54 114,108 2,476 4.34
Investment securities(2) 42,534 1,164 5.47 46,876 1,157 4.94
Other interest-earning assets 11,154 177 3.17 8,610 92 2.14
-------- ------- -------- -------
Total interest-earning assets 477,980 $14,371 6.01 475,905 $13,245 5.57
-------- ------- ------ -------- ------- -----
Non-interest-earning assets 35,837 34,238
-------- --------
Total assets $513,817 $510,143
======== ========
Interest-bearing liabilities:
Deposits $354,450 $ 5,542 3.13 $348,236 $ 3,827 2.20
FHLB advances and other borrowings 99,160 2,747 5.54 106,354 2,854 5.37
Junior subordinated debentures 21,476 1,001 9.32 21,512 956 8.89
-------- ------- -------- -------
Total interest-bearing liabilities 475,086 9,290 3.91 476,102 7,637 3.21
-------- ------- ------ -------- ------- -----
Interest rate spread 2.10% 2.36%
====== =====
Non-interest-bearing liabilities 7,112 6,054
-------- --------
Total liabilities 482,198 482,156
Stockholders' equity 31,619 27,987
-------- --------
Total liabilities and stockholders' equity $513,817 $510,143
======== ========
Net interest-earning assets (liabilities) $ 2,894 $ (197)
======== ========
Net interest income $ 5,081 $ 5,608
======= =======
Net interest margin(3) 2.13% 2.36%
====== =====
Ratio of average interest-earning assets
to average interest-bearing liabilities 100.61% 99.96%
====== =====
- ----------
(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.
-18-
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 March 31, 2007 and 2006, the provision for loan
losses amounted to $100,000 and $525,000, respectively. The provision for loan
losses in the 2006 period was substantially higher than the comparable 2007
period due to the amount of charge-offs taken in the 2006 period which required
the Company to make a greater than typical provision in order to maintain its
allowance for loan loss at an appropriate level. For the quarter ended March 31,
2007, 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 second
quarter of fiscal 2007 and the continual evaluation of the classified and pass
loan portfolios to bring the overall allowance for loan losses to a level deemed
appropriate.
At March 31, 2007, non-performing assets decreased $146,000 to $2.6
million, or 0.49%, of total assets, from $2.7 million at September 30, 2006. The
decrease in non-performing assets was primarily the result of a $2.5 million
decrease in real estate owned, partially offset by a $2.3 million increase to
$2.6 million in non-performing loans. The decrease in real estate owned
reflected the sale of a commercial real estate property consisting of a
restaurant in Chesapeake City, Maryland. The property was sold for $2.7 million,
resulting in a pre-tax gain of $61,000. The increase in non-performing loans was
primarily a result of a $1.1 million increase in non-accrual commercial real
estate loans combined with a $1.2 million increase in commercial business loans
that are 90 days past due and still accruing, which the Bank is in the process
of refinancing. The increase in non-accrual loans consisted of a bakery along
with rental units above the establishment located in center city Philadelphia,
Pennsylvania. The Company is continuing to aggressively pursue a workout
strategy with the borrower.
At March 31, 2007, the Bank had $17.7 million of classified assets compared
to $15.0 million at December 31, 2006. All the assets were classified as
substandard, consisting primarily of commercial business and commercial real
estate loans. Criticized assets at March 31, 2007 amounted to $12.8 million,
compared to $25.7 million at December 31, 2006.
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, 2007, non-interest
income increased $53,000 or 6.6% to $853,000 as compared to the same period in
2006. The increase for the three months ended March 31, 2007 was primarily due
to increases in the gain on sales of investment securities and service fee
income, partially offset by a decrease in gain from the sale of real estate
owned properties.
Non-interest income increased $27,000 to $1.6 million for the six months
ended March 31, 2007 by comparison to the same period last year. The increase
for the six months ended March 31, 2007 was primarily due to increases in gain
on sales of investment securities and service fee income. These increases were
partially offset by decreases in gain on the sale of real estate owned
properties, and, to a lesser extent, lower revenues generated in insurance
products.
Non-interest Expense. Non-interest expense increased $27,000, or 0.8%, during
the three months ended March 31, 2007 compared to the same period in 2006. The
increase for the quarter ended March 31, 2007 was primarily due to increases of
$55,000 and $17,000 in other non-interest expense and advertising, respectively,
partially offset by decreases of $29,000 and $20,000 in salaries and employee
benefits and professional fees, respectively.
For the six months ended March 31, 2007, non-interest expense increased by
$173,000, or 2.8%, primarily due to increases of $85,000, or 10.8%, $49,000, or
6.0% and $25,000, or 51.0% in other non-interest expense, professional fees and
federal deposit insurance premium, respectively. These increases were primarily
related to ongoing efforts to comply with the supervisory agreement. In
addition, the Company incurred increases of $27,000, $18,000 and $16,000 in data
processing, advertising and occupancy and equipment, respectively. The increases
in non-interest expense were partially offset by a $33,000, or 1.1%, decrease in
salaries and employee benefits compared to the same period in 2006.
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Income Tax Benefit. The Company recognized income tax benefits of $48,000 and
$139,000 for the three and six months ended March 31, 2007, respectively, as
compared to income tax benefits of $142,000 and $70,000 for the same periods in
2006. The recognition of the income tax benefits for the three and six months
ended March 31, 2007 was primarily related to the decline in taxable 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, 2007, the Company had short-term
borrowings (due within one year or currently callable by the FHLBank)
outstanding of $94.3 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 March 31, 2007, total approved
loan commitments outstanding amounted to $6.9 million, not including loans in
process. At the same date, commitments under unused lines of credit amounted to
$37.5 million. Certificates of deposit scheduled to mature in one year or less
at March 31, 2007 totaled $149.3 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, 2007, the
Bank had tangible capital and core capital equal to 9.3% of adjusted total
assets and total capital equal to 15.8% 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.
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 are being used to reduce the amount of its
outstanding trust preferred securities. The Company has given notice to redeem
approximately $6.0 million of its trust preferred securities in June 2007.
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, 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 March 31, 2007.
Net Portfolio Value
(Dollars in thousands)
- ------------------------------------------------------------------------
Changes in Net Portfolio
Rates in Dollar Percentage Value As
Basis Points Amount Change Change a % of Assets Change
- ------------ ------- -------- ---------- ------------- -------
300 $41,731 $(24,588) (37)% 8.23% (414)bp
200 50,818 (15,501) (23) 9.83 (254)bp
100 59,407 (6,912) (10) 11.28 (109)bp
0 66,319 -- -- 12.37 --
(100) 70,707 4,387 7 13.00 63bp
(200) 72,165 5,845 9 13.15 78bp
As of March 31, 2007 the Company's NPV was $66.3 million or 12.37% of the
market value of assets. Following a 200 basis point increase in interest rates,
the Company's "post shock" NPV was $50.8 million or 9.83% of the market value of
assets. The change in the NPV ratio, or the Company's sensitivity measure, was a
decline of 254 basis points.
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 was $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 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 Annual Report on Form 10-K
for the year ended September 30, 2006 ("Form 10-K").
Item 1A. Risk Factors
There have been no material changes from the risk factors disclosed in the
Company's Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) - (b) The information required by Item 2 was previously reported on a
Current Report 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
Information with regard to the results of the Company's annual meeting of
stockholders held on February 7, 2007 was reported in the Form 10-Q for the
quarter ended December 31, 2006.
Item 5. Other Information
(a) Not applicable
(b) There are no matters required to be reported under this item.
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.
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,*
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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 1 of Part
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 Code 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.
(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.
(*) 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, 2007 By: /s/ Thomas M. Kelly
------------------------------------
Thomas M. Kelly
President and Chief Executive
Officer
Date: May 15, 2007 By: /s/ Rose M. DiMarco
------------------------------------
Rose M. DiMarco
Chief Financial Officer
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