UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2007
- OR -
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-25328
FIRST KEYSTONE FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2576479
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
22 WEST STATE STREET, MEDIA, PENNSYLVANIA 19063
(Address of principal executive office) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (610) 565-6210
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
COMMON STOCK (PAR VALUE $0.01 PER SHARE) THE NASDAQ STOCK MARKET
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. YES [ ] NO [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. YES [ ] NO [X]
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
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 check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant based on the closing price of $19.70 on March 30, 2007, the last
business day of the Registrant's second quarter was $30.5 million (2,432,998
shares outstanding less 886,063 shares held by affiliates at $19.70 per share).
Although directors and executive officers of the Registrant and certain employee
benefit plans were assumed to be "affiliates" of the Registrant for purposes of
the calculation, the classification is not to be interpreted as an admission of
such status.
Number of shares of Common Stock outstanding as of December 19, 2007: 2,432,998
DOCUMENTS INCORPORATED BY REFERENCE
Listed hereunder are the documents incorporated by reference and the Part of the
Form 10-K into which the document is incorporated:
(1) Portions of the definitive proxy statement for the 2008 Annual Meeting of
Stockholders are incorporated into Part III.
FIRST KEYSTONE FINANCIAL, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2007
INDEX
Page
----
PART I
Item 1. Business 1
Item 1A. Risk Factors 36
Item 1B. Unresolved Staff Comments 38
Item 2. Properties 39
Item 3. Legal Proceedings 40
Item 4. Submission of Matters to a Vote of Security Holders 40
PART II
Item 5. Market for Registrant's Common Stock, Related Stockholder Matters 40
and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data 42
Item 7. Management's Discussion and Analysis of Financial Condition and Results of 44
Operations
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 58
Item 8. Financial Statements and Supplementary Data 59
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial 90
Disclosures
Item 9A. Controls and Procedures 90
Item 9B. Other Information 90
PART III
Item 10. Directors and Executive Officers of the Registrant 90
Item 11. Executive Compensation 90
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related 91
Stockholder Matters
Item 13. Certain Relationships and Related Transactions 91
Item 14. Principal Accounting Fees and Services 91
PART IV
Item 15. Exhibits, Financial Statement Schedules 91
SIGNATURES 94
[This page left blank intentionally]
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995
relating to, without limitation, our future economic performance, plans and
objectives for future operations, and projections of revenues and other
financial items that are based on our beliefs, as well as assumptions made by
and information currently available to us. The words "may," "will,"
"anticipate," "should," "would," "believe," "contemplate," "could," "project,"
"predict," "expect," "estimate," "continue," and "intend," as well as other
similar words and expressions of the future, are intended to identify
forward-looking statements. Our actual results, performance, or achievements may
differ materially from the results expressed or implied by our forward-looking
statements.
The factors set forth under "Risk Factors" and other cautionary statements
made in this Annual Report should be read and understood as being applicable to
all related forward-looking statements wherever they appear in this Annual
Report on Form 10-K. In addition to the risks discussed in the "Risk Factors"
section of this Annual Report, factors that could have a material adverse effect
on our operations and future prospects include, but are not limited to, the
following: (1) changes in the interest rate environment; (2) changes in deposit
flows, loan demand or real estate values; (3) changes in accounting principles,
policies or guidelines; (4) legislation or regulatory changes; (5) changes in
loan delinquency rates or in our levels of non-performing assets; (6) changes in
the economic climate in the market areas in which we operate; (7) the economic
impact of any future terrorist threats and attacks, acts of war or threats
thereof and the response of the United States to any such threats and attacks;
(8) the effects of the supervisory agreements entered into by each of the
Company and the Bank with the Office of Thrift Supervision ("OTS"); and (9)
other factors, if any, referenced in this Annual Report or the documents
incorporated by reference.
These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be placed on such
statements. The forward-looking statements included in this Annual Report are
made only as of the date of this Annual Report. We disclaim any obligation to
update any such factors or to publicly announce the results of any revisions to
any of the forward-looking statements contained herein to reflect future events
or developments.
Any forward-looking earnings estimates included in this Annual Report have
not been examined or compiled by our independent registered public accounting
firm, nor has our independent registered public accounting firm applied any
procedures to our estimates. Accordingly, our accountants do not express an
opinion or any other form of assurance on them. Further information concerning
our business, including additional factors that could materially affect our
financial results, is included in our filings with the Securities and Exchange
Commission ("SEC").
PART I
ITEM 1. BUSINESS.
GENERAL
First Keystone Financial, Inc. (the "Company") is a Pennsylvania
corporation and the sole shareholder of First Keystone Bank, a federally
chartered stock savings bank (the "Bank"), which converted to the stock form of
organization in January 1995. The only significant assets of the Company are the
capital stock of the Bank, the Company's loan to its employee stock ownership
plan, and various equity and other investments. See Note 17 of the Notes to
Consolidated Financial Statements for the fiscal year ended September 30, 2007
set forth in Item 8 hereof, "Financial Statements and Supplementary Data." The
primary business of the Company consists of operating the Bank.
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.
1
BUSINESS STRATEGY
Although the future growth of the Company and the Bank currently is
restricted by the provisions contained in the supervisory agreements described
below, the Company intends to continue executing its strategy to transform
itself from a traditional thrift into a locally-based community bank. The
principal components of the Company's strategy include:
- Expanding commercial and construction lending infrastructure.
During fiscal 2007, the Company employed many resources to
strengthen both its credit review process as well as its
administrative procedures in the commercial lending area. With
the infrastructure in place in support of its commercial business
and commercial and multi-family real estate lending activities,
the Bank intends to hire additional seasoned commercial and
construction lending officers in order to expand its operations
in these areas. The Bank plans to continue improving the
integration of its business development officers and branch
managers with the operations of its lending department. The
Bank's expanded commercial credit administration function is
instrumental in developing and implementing more rigorous and
extensive oversight of the Bank's commercial lending activities
to, among other things, reduce the likelihood of credit quality
issues.
- Continuing expansion of product offerings. To assist its
commercial customers and to attract new business deposits, the
Bank created a Cash Management Division which provides extensive
support services, including ACH activity, wire transfers,
automated interest-earning clearing accounts and other cash
management products. In fiscal 2007, the Bank began offering
remote deposit capture to its commercial customers enabling them
to scan and process their deposits directly from their offices.
The Bank has also expanded its electronic delivery systems in
recent years, including both commercial and retail bill paying
services. Commercial business and commercial and multi-family
loans grew to $79.1 million, or 26.2% of the total loan
portfolio, at September 30, 2007 compared to $69.2 million, or
23.1% of the total loan portfolio, at September 30, 2003. This
service also enhances the Bank's ability to attract and retain
commercial customers who are not located in close proximity to
the branch network. In addition to the remote deposit product,
the Bank expects to introduce its relationship banking product,
which will reward customers for bundling services, allow more
competitive pricing.
- Increasing the amount of lower costing deposits. The Bank
continues to emphasize the generation of core deposits, in
particular non-interest-bearing checking accounts, targeted to
commercial customers. As of September 30, 2003, time deposits
accounted for 49.2% of total deposits, while transaction, savings
and MMDA accounts constituted 22.4%, 13.0% and 15.4% of total
deposits, respectively. As of September 30, 2007, the Company's
time deposits increased to 53.2% of total deposits, with
low-cost transaction accounts increasing to 26.4% of total
deposits and savings and MMDA accounts comprising 10.6% and 9.7%,
respectively, of total deposits. Although, time deposits
increased, in particular during fiscal 2006, and to a lesser
extent during fiscal 2007, reflecting the Company's
determination to utilize time deposits as a lower cost
alternative to borrowings as a source of funding for the
Company's operations. In addition, with the recent competitive
pressures in 2007, the Bank, like many other financial
institutions, has found customers moving funds to time deposits
due to their generally higher rates.
- Establishing branches in desirable locations. The Company seeks
to open additional full-service branches in attractive suburban
communities with growing populations and significant numbers of
small and medium-sized businesses in Delaware and Chester
Counties. The Bank opened its last branch office in Aston,
Pennsylvania in October 2004 which generated deposits of $21.7
million as of September 30, 2007. The Bank's goal is to open one
new branch office approximately every 24 months, subject to the
availability of attractive locations at reasonable prices, the
proper demographic mix and receipt of regulatory approval.
2
MARKET AREA AND COMPETITION
The Bank's primary market area is Delaware and Chester Counties, which are
located in the southeastern corner of Pennsylvania between two prominent
metropolitan areas - Philadelphia, Pennsylvania and Wilmington, Delaware. There
is easy access to I-95, the Philadelphia International Airport and the Delaware
River, and the Bank is fortunate to be located in such a desirable geographic
area. New York City is just 92 miles away from the Bank's headquarters in Media,
Pennsylvania, while Baltimore, Maryland and Washington, DC are only 80 miles and
127 miles away, respectively.
Through an extensive highway network, the economies of Delaware and Chester
Counties are knitted tightly into a regional economy of more than 2.5 million
workers. Delaware and Chester Counties have a large, well-educated, and skilled
labor force, with nearly one quarter of the counties' population having earned a
four-year college degree. The median household income of Delaware and Chester
Counties in 2005 was approximately $55,630 and $72,690, respectively, as
compared to approximately $48,500 for Pennsylvania as a whole. In addition,
Philadelphia's central location in the Northeast corridor, infrastructure, and
other factors have made the Bank's primary market area attractive to many large
corporate employers, including Comcast, Boeing, State Farm Insurance, United
Parcel Service, PECO Energy, SAP America, Inc. and Wawa.
The Philadelphia area economy is typical of many large northeastern cities
where the traditional manufacturing-based economy has declined and been replaced
by the service sector, including the health care market. Crozer/Keystone Health
System, Mercy Health Corp., and Astra-Zeneca are among the larger health care
employers within the Bank's market area. According to the Delaware County
Chamber of Commerce, there are more than 65 degree-granting institutions in the
Delaware Valley region, representing a higher density of colleges and
universities than any other area in the United States. Delaware County also has
one of the nation's lowest unemployment rates and one of the most active Chamber
of Commerce Offices in the Commonwealth. The Delaware County Chamber of Commerce
has been recognized by the U.S. Small Business Administration (Philadelphia
District Office) for its accomplishments several times within the past few
years.
The population of Delaware County is reported at over half a million
residents and is the fifth most populated county in the Commonwealth of
Pennsylvania. Much of the growth and development continues to be in the western
part of the county and adjacent Chester County. At the end of the third calendar
quarter of 2007, unemployment in Chester County was extremely low - at 3.1% -
compared to the rest of the Commonwealth, which was at 4.1%. Chester County's
growth rate is expected to increase even further in the next decade, and some of
the communities in Chester County that are experiencing the most rapid growth -
East Marlborough Township, New Garden Township and East Goshen - surround the
Bank's Chester County branch.
The Bank experiences strong competition for real estate loans, principally
from other savings associations, commercial banks, and mortgage-banking
companies. The Bank competes for these and other loans primarily through the
interest rates and loan fees it charges, the efficiency and quality of the
services it provides borrowers, and the convenient locations of its branch
office network.
The Bank faces strong competition, both in attracting deposits and making
real estate and commercial loans. Its most direct competition for deposits has
historically come from other savings associations, credit unions, and commercial
banks located in its market area. This includes many large regional financial
institutions which have even greater financial and marketing resources available
to them. The ability of the Bank to attract and retain core deposits depends on
its ability to provide a competitive rate of return, liquidity, and service
convenience comparable to those offered by competing investment opportunities.
The Bank's management remains focused on attracting core deposits through its
branch network, business development efforts, and commercial business
relationships.
The Bank maintains seven branch offices in Delaware County with deposits
totaling $334.3 million at September 30, 2007 and one branch office in Chester
County with deposits totaling $19.4 million at September 30, 2007. Based on
deposits as of June 30, 2007 (the most recent data used by the FDIC), the Bank's
market share in Delaware and Chester Counties was 3.4% and 0.7%, respectively.
The Bank believes it has the opportunity to expand its deposit market share in
the future.
3
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 such payment.
The Company has submitted to and received from the OTS approval of a
capital plan, which 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. In June 2007, the net proceeds of
approximately $5.8 million were used to reduce the amount of its outstanding
debt through the redemption of $6.2 million of its junior subordinated
debentures. As a result of such redemption, the Company's debt-to-equity ratio
is less than 50%. Although the Company's debt-to-equity ratio is below 50%, it
does not anticipate resuming the payment of dividends until such time as the
Company's operating results improve.
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.
As a result of the supervisory agreement, the Bank hired a Chief Credit
Officer ("CCO") and, under the direction of the Board and the CCO, enhanced its
credit review analysis, developed administrative procedures and adopted an asset
classification system. The Bank continues to address these areas and to reduce
the level of classified assets in order to be in full compliance with the terms
of the supervisory agreements. At September 30, 2007, the Company believes it
and the Bank are in full compliance with all the provisions of the supervisory
agreements.
4
LENDING ACTIVITIES
Loan Portfolio Composition. The following table sets forth the composition
of the Bank's loan portfolio by type of loan at the dates indicated (excluding
loans held for sale).
SEPTEMBER 30,
----------------------------------------------------------------------------------------
2007 2006 2005 2004 2003
---------------- ---------------- ---------------- ---------------- ----------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
(Dollars in thousands)
Real estate loans:
Single-family $139,888 46.40% $144,760 42.76% $149,237 46.64% $163,907 50.87% $166,042 55.51%
Multi-family and commercial 60,026 19.91 70,439 20.81 69,704 21.78 64,509 20.02 59,022 19.73
Construction and land 23,501 7.80 38,158 11.27 36,828 11.51 38,078 11.82 28.975 9.69
Home equity loans and lines of credit 57,808 19.17 59,319 17.52 46,748 14.61 43,621 13.54 33,459 11.19
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 281,223 93.28 312,676 92.36 302,517 94.54 310,115 96.25 287,498 96.12
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer:
Deposit 142 .05 170 .05 112 .04 133 .04 112 .04
Unsecured personal loans 460 .15 538 .16 641 .20 629 .20 547 .18
Other (1) 602 .20 667 .20 623 .19 709 .21 779 .26
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans 1,204 .40 1,375 .41 1,376 .43 1,471 .45 1,438 .48
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial business loans 19,044 6.32 24,474 7.23 16,085 5.03 10,624 3.30 10,161 3.40
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans receivable(2) 301,471 100.00% 338,525 100.00% 319,978 100.00% 322,210 100.00% 299,097 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Loans in process 6,008 12,081 14,614 15,807 10,655
Deferred loan origination fees and
discounts (277) (143) (90) 116 35
Allowance for loan losses 3,322 3,367 3,475 2,039 1,986
-------- -------- -------- -------- --------
Total loans receivable, net $292,418 $323,220 $301,979 $304,248 $286,421
======== ======== ======== ======== ========
- ----------
(1) Consists primarily of credit card loans.
(2) Does not include $0, $1.3 million, $41,000, $172,000 and $4.5 million of
loans held for sale at September 30, 2007, 2006, 2005, 2004 and 2003,
respectively.
5
Contractual Principal Repayments. The following table sets forth the
scheduled contractual principal repayments of the Bank's loans held to maturity
at September 30, 2007. Demand loans, loans having no stated schedule of
repayments and no stated maturity and overdraft loans are reported as due in one
year or less. The amounts shown for each period do not take into account loan
prepayments of the Bank's loan portfolio held to maturity.
REAL ESTATE LOANS
---------------------------------------------------
MULTI-FAMILY CONSUMER AND
SINGLE- AND CONSTRUCTION COMMERCIAL
FAMILY (1) COMMERCIAL AND LAND TOTAL BUSINESS LOANS TOTAL
---------- ------------ ------------ -------- -------------- --------
(Dollars in thousands)
Amounts due in:
One year or less $ 12,279 $ 7,688 $23,501 $ 43,468 $ 9,774 $ 53,242
After one year through three years 27,534 9,375 -- 36,909 2,209 39,118
After three years through five years 30,367 6,707 -- 37,074 3,413 40,487
After five years through ten years 69,490 15,762 -- 85,252 2,005 87,257
After ten years through fifteen years 24,735 9,641 -- 34,376 1,454 35,830
Over fifteen years 33,291 10,853 -- 44,144 1,393 45,537
-------- ------- ------- -------- ------- --------
Total (2) $197,696 $60,026 $23,501 $281,223 $20,248 $301,471
======== ======= ======= ======== ======= ========
Interest rate terms on amounts due after one year:
Fixed $160,704 $ 5,246 $165,950
Adjustable 77,051 5,228 82,279
-------- ------- --------
Total (2) $237,755 $10,474 $248,229
======== ======= ========
- ----------
(1) Includes home equity loans and lines of credit.
(2) Does not include adjustments relating to loans in process, allowances for
loan losses and deferred fee income and discounts.
6
Scheduled contractual amortization of loans does not reflect the expected
term of the Bank's loan portfolio. The average life of loans is substantially
less than their contractual terms because of prepayments and due-on-sale clauses
which give the Bank the right to declare a conventional loan immediately due and
payable in the event, among other things, that the borrower sells the real
property subject to the mortgage and the loan is not repaid. The average life of
mortgage loans tends to increase when current mortgage loan rates are higher
than rates on existing mortgage loans and, conversely, decrease when current
mortgage loan rates are lower than rates on existing mortgage loans, due to
refinancings of adjustable-rate and fixed-rate loans at lower rates. Under the
latter circumstances, the weighted average yield on loans decreases as higher
yielding loans are repaid or refinanced at lower rates.
Loan Origination, Purchase and Sale Activity. The following table shows the
loan origination, purchase and sale activity of the Bank during the periods
indicated.
YEAR ENDED SEPTEMBER 30,
---------------------------------
2007 2006 2005
--------- --------- ---------
(Dollars in thousands)
Gross loans at beginning of period(1) $ 339,859 $ 320,019 $ 322,382
--------- --------- ---------
Loan originations for investment:
Real estate:
Residential 16,838 16,799 11,235
Commercial and multi-family 6,679 23,068 31,689
Construction 11,366 21,743 23,876
Home equity and lines of credit 30,106 41,592 33,033
--------- --------- ---------
Total real estate loans originated for investment 64,989 103,202 99,833
Consumer 1,953 3,265 3,458
Commercial business 18,979 32,424 26,281
--------- --------- ---------
Total loans originated for investment 85,921 138,891 129,572
Loans originated for resale 271 6,063 13,620
--------- --------- ---------
Total originations 86,192 144,954 143,192
--------- --------- ---------
Deduct:
Principal loan repayments and prepayments (122,505) (116,316) (131,460)
Transferred to real estate owned -- (2,700) --
Charge-offs (470) (1,328) (344)
Loans sold in secondary market (1,605) (4,770) (13,751)
--------- --------- ---------
Subtotal (124,580) (125,114) (145,555)
--------- --------- ---------
Net (decrease) increase in loans(1) (38,388) 19,840 (2,363)
--------- --------- ---------
Gross loans at end of period(1) $ 301,471 $ 339,859 $ 320,019
========= ========= =========
- ----------
(1) Includes loans held for sale of $0, $1.3 million, and $41,000 at September
30, 2007, 2006, and 2005, respectively.
The residential lending activities of the Bank are subject to written
underwriting standards and loan origination procedures established by the Bank's
Board of Directors and management. Loan applications may be taken at all of the
Bank's branch offices by the branch manager or other designated loan officers.
Applications for single-family residential mortgage loans for portfolio
retention are obtained predominately through loan originators who are employees
of the Bank. The Bank's residential loan originators will take loan applications
outside of the Bank's offices at the customer's convenience and are compensated
on a commission basis. The Residential Lending Department supervises the process
of obtaining credit reports, appraisals and other documentation involved with
the origination of a loan. In most cases, the Bank requires that a property
appraisal be obtained in connection with all new first mortgage loans.
Generally, appraisals are not required on home equity loans below $250,000
because alternative means of valuation are used (i.e., tax assessments, home
value estimators). Property appraisals generally are performed by an independent
appraiser selected from a list approved by the Bank's Board of Directors. The
Bank requires that title insurance (other than with respect to home equity
loans) and hazard insurance be maintained on all security properties and that
flood insurance be maintained if the property is within a designated flood
plain.
7
Residential mortgage loan applications are primarily developed from
referrals from real estate brokers and builders, existing customers and walk-in
customers. Commercial and multi-family real estate loan applications are
obtained primarily from previous borrowers, direct solicitations by Bank
personnel, as well as referrals. Consumer loans originated by the Bank are
obtained primarily through existing and walk-in customers who have been made
aware of the Bank's programs by advertising and other means.
Applications for single-family residential mortgage loans which may be
originated for resale in the secondary market or loans designated for portfolio
retention that conform to the requirements for resale into the secondary market
and do not exceed Fannie Mae ("FNMA") or Freddie Mac ("FHLMC") limits are
approved by at least one of the following: the Bank's Chief Credit Officer, the
Senior Mortgage Loan Underwriter or the Loan Committee (a committee comprised of
four directors and the Chief Credit Officer). Residential mortgage loans in
excess of FNMA/FHLMC maximum amounts (currently $417,000 for single-family
properties) but less than $1.0 million must be approved by the Loan Committee.
Commercial and multi-family residential real estate mortgage loans in excess of
$250,000 and all construction loans must be approved by the Loan Committee. All
mortgage loans in excess of $1.0 million must be approved by the Bank's Board of
Directors or the Executive Committee thereof. All mortgage loans which do not
require approval by the Board of Directors are submitted to the Board at its
next meeting for review and ratification. Home equity loans and lines of credit
up to $250,000 can be approved by the Chief Credit Officer, the Vice President
of Construction Loans or the Administrative Vice President of Residential
Lending. Loans in excess of such amount must be approved by the Loan Committee.
Single-Family Residential Loans. Substantially all of the Bank's
single-family residential mortgage loans consist of conventional loans.
Conventional loans are loans that are neither insured by the Federal Housing
Administration nor partially guaranteed by the Department of Veterans Affairs.
The vast majority of the Bank's single-family residential mortgage loans are
secured by properties located in Pennsylvania, primarily in Delaware and Chester
Counties, and are originated under terms and documentation which permit their
sale to FHLMC or FNMA. During fiscal 2007, due to the inverted yield curve,
continuing interest rate margin compression, and the unappealing spreads on
mortgage-backed securities, the Bank elected to retain all of its newly
originated 30-year term fixed-rate residential mortgage loans in its portfolio.
The Bank will also continue to retain its adjustable-rate mortgage loans and
shorter term fixed-rate residential mortgage loans. See "- Mortgage-Banking
Activities."
The single-family residential mortgage loans offered by the Bank currently
consist of fixed-rate loans, including bi-weekly and balloon loans and
adjustable-rate loans. Fixed-rate loans generally have maturities ranging from
15 to 30 years and are fully amortized with monthly loan payments sufficient to
repay the total amount of the loan with interest by the end of the loan term.
The Bank's fixed-rate loans are originated under terms, conditions and
documentation which permit them to be sold to U.S. Government-sponsored
agencies, such as FHLMC or FNMA, and other purchasers in the secondary mortgage
market. The Bank also offers bi-weekly loans under the terms of which the
borrower makes payments every two weeks. Although such loans have a 30-year
amortization schedule, due to the bi-weekly payment schedule, such loans repay
substantially more rapidly than a standard monthly amortizing 30-year fixed-rate
loan. The Bank also offers five and seven year balloon loans which provide that
the borrower can conditionally renew the loan at the fifth or seventh year at a
then to-be-determined interest rate for the remaining 25 or 23 years,
respectively, of the amortization period. At September 30, 2007, $123.1 million,
or 88.0% of the Bank's single-family residential mortgage loans held in
portfolio were fixed-rate loans, including $7.8 million of bi-weekly, fixed-rate
residential mortgage loans.
The adjustable-rate loans currently offered by the Bank have interest rates
which adjust every one, three or five years in accordance with a designated
index, such as U.S. Treasury obligations, adjusted to a constant maturity
("CMT"), plus a stipulated margin. The Bank's adjustable-rate single-family
residential real estate loans generally have a cap of 2% on any increase or
decrease in the interest rate at any adjustment date, and a maximum adjustment
limit of 6% on any such increase or decrease over the life of the loan. In order
to increase the originations of adjustable-rate loans, the Bank has been
originating loans which bear a fixed interest rate for a period of three to five
years after which they convert to one-year adjustable-rate loans. The Bank's
adjustable-rate loans require that any payment adjustment resulting from a
change in the interest rate of an adjustable-rate loan be sufficient to result
in full amortization of the loan by the end of the loan term and, thus, do not
permit any of the increased payment to be added to the principal amount of the
loan, creating negative amortization. Although the Bank does offer
adjustable-rate loans with initial rates below the fully indexed rate, loans
tied to the one-year CMT are underwritten using methods approved by FHLMC or
FNMA which require borrowers to be qualified at 2% above the discounted loan
rate under certain conditions. The Bank has taken steps to increase the amount
of such loans originated in recent years, but with limited success due to
limited interest by
8
consumers due to the low interest rate environment that existed prior to fiscal
2006. At September 30, 2007, $16.8 million, or 12.0%, of the Bank's
single-family residential mortgage loans held for portfolio were adjustable-rate
loans.
Adjustable-rate loans decrease the Bank's risk associated with changes in
interest rates but involve other risks. In the event interest rates increase,
the loan payment by the borrower also increases to the extent permitted by the
terms of the loan, thereby increasing the potential for default. In addition,
adjustable-rate loans tend to prepay and convert to fixed rates when the overall
interest rate environment is low. Moreover, as with fixed-rate loans, as
interest rates increase, the marketability of the underlying collateral property
may be adversely affected by higher interest rates. The Bank believes that these
risks, which have not had a material adverse effect on the Bank to date,
generally are less than the risks associated with holding fixed-rate loans in
portfolio in an increasing interest rate environment.
For conventional residential mortgage loans held in portfolio and also for
those loans originated for sale in the secondary market, the Bank's maximum
loan-to-value ("LTV") ratio is 97%, and is based on the lesser of sales price or
appraised value. On loans with a LTV ratio of over 80%, private mortgage
insurance may be required to be obtained or the Bank, on occasion, may lend the
excess as a home equity loan.
Commercial and Multi-Family Residential Real Estate Loans. During fiscal
2007, the Bank decreased its investment in commercial and multi-family
residential loans due to the Company's self-imposed curtailment of such lending
activity while implementing substantially enhanced credit review and
administration infrastructure. The limited amount of such loans being originated
during fiscal 2007 was being made primarily to small- and medium-sized
businesses located in the Bank's primary market area, a segment of the market
that the Bank believes has continued to be underserved in recent years. Loans
secured by commercial and multi-family residential real estate amounted to $60.0
million, or 19.9%, of the Bank's total loan portfolio, at September 30, 2007.
The Bank's commercial and multi-family residential real estate loans are secured
primarily by professional office buildings, small retail establishments,
warehouses and apartment buildings (with 36 units or less) located in the Bank's
primary market area.
The Bank's adjustable-rate multi-family residential and commercial real
estate loans generally are either three or five-year adjustable-rate loans
indexed to the CMT plus a margin. In addition, depending on collateral value and
strength of the borrower, fixed-rate balloon loans and longer term fixed-rate
loans may be originated. Generally, fees of up to 1% of the principal loan
balance are charged to the borrower upon closing. Although terms for
multi-family residential and commercial real estate loans may vary, the Bank's
underwriting standards generally provide for terms of up to 20 years with
amortization of the principal over the term of the loan and LTV ratios of not
more than 75%. Generally, the Bank obtains personal guarantees of the principals
of the borrower as additional security for any commercial real estate and
multi-family residential loan and requires that the borrower have at least a 25%
equity investment in the property which is the subject of the loan.
The Bank evaluates various aspects of commercial and multi-family
residential real estate loan transactions in an effort to mitigate risk to the
extent possible. In underwriting these loans, consideration is given to the
stability of the property's cash flow history, future operating projections,
current and projected occupancy, position in the market, location and physical
condition. In recent periods, the Bank has generally imposed a debt coverage
ratio (the ratio of net cash from operations before payment of debt service to
debt service) of not less than 110%. The underwriting analysis also includes
credit checks and a review of the financial condition of the borrower and
guarantor, if applicable. An appraisal report is prepared by a state-licensed
and certified appraiser (generally an appraiser who is qualified as a Member of
the Appraisal Institute ("MAI")) commissioned by the Bank to substantiate
property values for every commercial real estate and multi-family loan
transaction. All appraisal reports are reviewed by the commercial loan
underwriter prior to the closing of the loan.
Multi-family residential and commercial real estate lending entails
different and significant risks when compared to single-family residential
lending because such loans often involve large loan balances to single borrowers
and because the payment experience on such loans is typically dependent on the
successful operation of the project or the borrower's business. These risks also
can be significantly affected by supply and demand conditions in the local
market for apartments, offices, warehouses or other commercial space. The Bank
attempts to minimize its risk exposure by limiting such lending to proven
owners, only considering properties with existing operating performance which
can be analyzed, requiring conservative debt coverage ratios, and periodically
monitoring the operation and physical condition of the collateral. See "-Asset
Quality - Non-performing Assets" for further discussion of the Bank's
non-performing loans.
Construction Loans. Substantially all of the Bank's construction loans
consist of loans for acquisition and development of properties to construct
single-family properties extended either to individuals or to selected
developers with whom the Bank is familiar to build such properties on a pre-sold
or limited speculative basis.
9
To a lesser extent, the Bank provides financing for construction to
permanent commercial real estate properties. Commercial construction loans have
a maximum term of 24 months during the construction period with interest based
upon the prime rate published in the Wall Street Journal ("Prime Rate") plus a
margin and have LTV ratios of 80% or less of the appraised value of the project
upon completion. The loans convert to permanent commercial real estate loans
upon completion of construction. With respect to construction loans to
individuals, such loans have a maximum term of 12 months, have variable rates of
interest based upon the Prime Rate plus a margin and have LTV ratios of 80% or
less of the appraised value of the property upon completion and generally do not
require the amortization of principal during the term. Upon completion of
construction, the borrower is required to refinance the loan although the Bank
may be the lender of the permanent loan secured by the property.
The Bank also provides construction loans (including acquisition and
development loans) and revolving lines of credit to developers. The majority of
construction loans consists of loans to selected local developers with whom the
Bank is familiar and who build single-family dwellings on a pre-sold or, to a
significantly lesser extent, on a speculative basis. The Bank generally limits
to two the number of unsold units that a developer may have under construction
in a project. Such loans generally have terms of 36 months or less, generally
have a maximum LTV ratio of 75% of the appraised value of the property upon
completion and do not require the amortization of the principal during the term.
The loans are made with variable rates of interest based on the Prime Rate plus
a margin adjusted on a monthly basis. The Bank also receives origination fees
that generally range from 0.5% to 3.0% of the amount of the loan commitment. The
borrower is required to fund a portion of the project's costs, the exact amount
being determined on a case-by-case basis but usually not less than 25%. Loan
proceeds are disbursed by percentage of completion of the cost of the project
after inspections indicate that such disbursements are for costs already
incurred and which have added to the value of the project. Only interest
payments are due during the construction phase and the Bank may provide the
borrower with an interest reserve from which it can pay the stated interest due
thereon.
At September 30, 2007, residential construction loans totaled $8.7 million,
or 2.9%, of the total loan portfolio, primarily consisting of construction loans
to developers. At September 30, 2007, commercial construction loans totaled
$919,000, or 0.30%, of the total loan portfolio.
The Bank also originates ground or land loans to individuals to purchase a
property on which they intend to build their primary residences, as well as to
developers to purchase lots to build speculative homes at a later date. Such
loans have terms of 36 months or less with a maximum LTV ratio of 75% of the
lower of appraised value or sale price. The loans are made with variable rates
based on the Prime Rate plus a margin. The Bank also receives origination fees,
which generally range between 1.0% and 3.0% of the loan amount. At September 30,
2007, land loans (including loans to acquire and develop land) totaled $13.8
million, or 4.6%, of the total loan portfolio.
Loans to developers include both secured and unsecured lines of credit
(which are classified as commercial business loans) with outstanding commitments
totaling $730,000. All have personal guarantees of the principals and are
cross-collateralized with existing loans. At September 30, 2007, loans
outstanding under builder lines of credit totaled $704,000, all of which were
unsecured. Such loans are only given to the Bank's most creditworthy long
standing customers.
Prior to making a commitment to fund a construction loan, the Bank requires
an appraisal of the property by an appraiser approved by the Board of Directors.
In addition, during the term of the construction loan, the project is inspected
by an independent inspector.
Construction financing generally is considered to involve a higher degree
of risk of loss than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development and the estimated cost (including interest) of
construction. During the construction phase, a number of factors could result in
delays and cost overruns. If the estimate of value proves to be inaccurate, the
Bank may be confronted, at or prior to the maturity of the loan, with a project,
when completed, having a value which is insufficient to assure full repayment.
Loans on lots may run the risk of adverse zoning changes as well as
environmental or other restrictions on future use.
10
Home Equity Loans and Lines of Credit. Home equity loans and home equity
lines of credit are secured by the underlying equity in the borrower's primary
residence or, occasionally, other types of real estate. Home equity loans are
amortizing loans with fixed interest rates with a maximum term of 15 years while
equity lines of credit have adjustable interest rates indexed to the Prime Rate
with a term of 10 years and interest-only payments. Generally home equity loans
or home equity lines of credit do not exceed $100,000. The Bank's home equity
loans and lines of credit generally require combined LTV ratios of 80% or less.
Loans with higher LTV ratios are available but with higher interest rates and
stricter credit standards. At September 30, 2007, home equity loans and lines of
credit amounted to $57.8 million, or 19.2%, of the Bank's total loan portfolio.
Commercial Business Loans. The Bank's strategic plan focuses the growth of
its commercial business loan portfolio by granting such loans directly to
business enterprises that are located in its market area. The majority of such
loans are for less than $1.0 million. The Bank actively targets and markets this
product to small-and medium-sized businesses. Applications for commercial
business loans are obtained from existing commercial customers, branch and
customer referrals, direct inquiry and those that are obtained by our commercial
lending officers. As of September 30, 2007, commercial business loans amounted
to $19.0 million, or 6.3%, of the Bank's total loan portfolio. The commercial
business loans consist of a limited number of commercial lines of credit secured
by equipment and securities, some working capital financings secured by accounts
receivable and inventory and, to a limited extent, unsecured lines of credit.
Commercial business loans originated by the Bank ordinarily have terms of five
years or less and fixed rates or adjustable rates tied to the Prime Rate plus a
margin.
Although commercial business loans generally are considered to involve
greater credit risk than certain other types of loans, management intends to
continue to offer commercial business loans to small- and medium-sized
businesses in an effort to better serve our community's needs, obtain core
non-interest-bearing deposits and increase the Bank's interest rate spread and
improve interest rate sensitivity. See " -Asset Quality" for discussion of the
Bank's non-performing and classified assets.
In the latter part of fiscal 2005, the Bank began to market loans
guaranteed by the Small Business Administration. During fiscal 2006, the Bank
was approved as an SBA Preferred Lender. As an SBA Preferred Lender, the Bank
has been granted the ability to approve SBA Loans without requesting the
approval of the SBA prior to closing the loan. All SBA policies and procedures
must be followed by the Bank to maintain its Preferred Lender Status. As part of
the Company's asset liability strategy, the Bank intends to sell the guaranteed
portion of the loan upon loan settlement. In fiscal 2007, the Bank recognized
$163,000 from the sale of SBA loans compared to $132,000 in 2006.
Consumer Lending Activities. The Bank also offers a variety of consumer
loans in order to provide a full range of retail financial services to its
customers. At September 30, 2007, $1.2 million, or 0.4%, of the Bank's total
loan portfolio was comprised of consumer loans. The Bank originates
substantially all of such loans in its market area. At September 30, 2007, the
Bank's consumer loan portfolio was comprised of credit card, deposit,
automobile, unsecured personal loans and other consumer loans. The Bank's credit
card program is primarily offered to only the Bank's most creditworthy
customers. At September 30, 2007, these loans totaled $568,000, or 0.19%, of the
total loan portfolio. Another component of the consumer loan portfolio is
unsecured loans amounting to $460,000, or 0.15%, of the Bank's loan portfolio at
September 30, 2007.
Consumer loans generally have shorter terms and higher interest rates than
mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral.
Mortgage-Banking Activities. Due to customer preference for fixed-rate
loans, the Bank has continued to originate fixed-rate loans. Long-term
(generally 30 years) fixed-rate loans not taken into portfolio for
asset/liability purposes are sold into the secondary market. The Bank's net gain
on sales of single-family residential loans amounted to $0, $24,000 and $93,000
during the fiscal years ended September 30, 2007, 2006 and 2005, respectively.
The decrease in net gain on sales for mortgage loans in fiscal 2007 was a result
from the Bank's decision to retain 30-year single-family residential loans into
its loan portfolio as part of the Bank's asset/liability strategy. The Bank did
not have any single-family residential loans held for sale at September 30, 2007
and 2006.
11
The Bank's conforming mortgage loans sold to others are sold, generally
with servicing retained, on a loan-by-loan basis primarily to FHLMC or FNMA. A
period of less than five days generally elapses between the closing of the loan
by the Bank and its purchase by the investor. Mortgages with established
interest rates generally will decrease in value during periods of increasing
interest rates. Accordingly, fluctuations in prevailing interest rates may
result in a gain or loss to the Bank as a result of adjustments to the carrying
value of loans held for sale or upon sale of loans. The Bank attempts to protect
itself from these market fluctuations through the use of forward commitments
entered into at the same time of the commitment by the Bank of a loan rate to
the borrower. These commitments are mandatory delivery contracts with the
purchaser, generally FHLMC or FNMA, within a certain time frame and within
certain dollar amounts by a price determined at the commitment date. Market risk
does exist as non-refundable points paid by the borrower may not be sufficient
to offset fees associated with closing the forward commitment contract.
Loan Origination Fees and Servicing. Borrowers may be charged an
origination fee, which is a percentage of the principal balance of the loan. In
accordance with the provisions of Statement of Financial Accounting Standards
("SFAS") No. 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases," the various
fees, net of costs, received by the Bank in connection with the origination of
loans are deferred and amortized as a yield adjustment over the lives of the
related loans using the interest method. However, when such loans are sold, the
remaining unamortized fees (which are all or substantially all of such fees due
to the relatively short period during which such loans are held) are recognized
as income on the sale of loans held for sale.
The Bank, for conforming loan products, generally retains the servicing on
all loans sold to others. In addition, the Bank services substantially all of
the loans that it retains in its portfolio. Loan servicing includes collecting
and remitting loan payments, accounting for principal and interest, making
advances to cover delinquent payments, making inspections as required of
mortgaged premises, contacting delinquent mortgagors, supervising foreclosures
and property dispositions in the event of unremedied defaults and generally
administering the loans. Funds that have been escrowed by borrowers for the
payment of mortgage-related expenses, such as property taxes and hazard and
mortgage insurance premiums, are maintained in non-interest-bearing accounts at
the Bank.
The following table presents information regarding the loans serviced by
the Bank for others at the dates indicated. Substantially all the loans were
secured by properties in Pennsylvania. A small percentage of the loans are
secured by properties located in Delaware, Maryland or New Jersey.
SEPTEMBER 30,
---------------------------
2007 2006 2005
------- ------- -------
(Dollars in thousands)
Loans originated by the Bank and serviced for:
FNMA $ 491 $ 544 $ 595
FHLMC 46,193 50,290 54,457
Others 295 311 326
------- ------- -------
Total loans serviced for others $46,979 $51,145 $55,378
======= ======= =======
The Bank receives fees for servicing mortgage loans, which generally amount
to 0.25% per annum on the declining principal balance of mortgage loans. Such
fees serve to compensate the Bank for the costs of performing the servicing
function. Other sources of loan servicing revenues include late charges. The
Bank retains a portion of funds received from borrowers on the loans it services
for others in payment of its servicing fees received on loans serviced for
others. For fiscal years ended September 30, 2007, 2006 and 2005, the Bank
earned gross fees of $124,000, $139,000 and $133,000, respectively, from loan
servicing.
Loans-to-One Borrower Limitations. Regulations impose limitations on the
aggregate amount of loans that a savings institution could make to any one
borrower, including related entities. Under such regulations, the permissible
amount of loans-to-one borrower follows the national bank standard for all loans
made by savings institutions, which generally does not permit loans-to-one
borrower to exceed 15% of unimpaired capital and surplus. Loans in an amount
equal to an additional 10% of unimpaired capital and surplus also may be made to
a borrower if the loans are fully secured by readily marketable securities. At
September 30, 2007, the Bank's five largest loans or groups of loans-to-one
borrower, including related entities, ranged from an aggregate of $3.5 million
to $6.4 million. The Bank's loans-to-one borrower limit was $7.8 million at such
date.
12
ASSET QUALITY
General. As a part of the Bank's ongoing efforts to improve its asset
quality, it has developed and implemented an asset classification system. All of
the Bank's assets are subject to review under the classification system, but
particular emphasis is placed on the review of multi-family residential and
commercial real estate loans, construction loans and commercial business loans.
All assets of the Bank are periodically reviewed and the classification
recommendations submitted to the Asset Quality Review Committee. The Asset
Quality Review Committee is composed of the President and Chief Executive
Officer, the Chief Financial Officer, Chief Credit Officer, the Vice President
of Loan Administration, the Internal Auditor and the Vice President of
Construction Lending and meets at least monthly. All assets are placed into one
of the five following categories: pass, special mention, substandard, doubtful
and loss. A rating system was implemented which provides for the grading of
assets as follows: 1-6 as pass, 7 as special mention and 8, 9 and 10 as an
adverse classification (substandard, doubtful and loss, respectively). Loans
classified as "pass" are then placed into one of the six grades based on
objective underwriting criteria. See "- Non-Performing Assets" and "- Other
Classified Assets" for a discussion of certain of the Bank's assets which have
been classified as substandard and regulatory classification standards
generally.
When a borrower fails to make a required payment on a loan, the Bank
attempts to cure the deficiency by contacting the borrower and requesting
payment. Contact is generally made after the expiration of the grace period
(usually fifteen days) in the form of telephone calls and/or correspondence. In
most cases, deficiencies are cured promptly. If the delinquency increases, the
Bank will initiate foreclosure actions or legal collection actions if a borrower
fails to enter into satisfactory repayment arrangements. Such actions generally
commence at sixty to ninety days of delinquency.
Loans are placed on non-accrual status when, in the judgment of management,
the probability of collection of interest is deemed to be insufficient to
warrant further accrual. When a loan is placed on non-accrual status, previously
accrued but unpaid interest is deducted from interest income. As a matter of
policy, the Bank generally does not accrue interest on loans past due 90 days or
more. See Note 2 of the Notes to Consolidated Financial Statements set forth in
Item 8 hereof.
Real estate acquired by the Bank as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold. Real
estate owned is initially recorded at the lower of fair value less estimated
costs to sell the property, or cost (generally the balance of the loan on the
property at the date of acquisition). After the date of acquisition, all costs
incurred in maintaining the property are expensed and costs incurred for the
improvement or development of such property are capitalized up to the extent of
their net realizable value.
Under accounting principles generally accepted in the United States of
America ("GAAP"), the Bank is required to account for certain loan modifications
or restructurings as "troubled debt restructurings" under SFAS No. 15. In
general, the modification or restructuring of a debt constitutes a troubled debt
restructuring if the Bank, for economic or legal reasons related to the
borrower's financial difficulties, grants a concession to the borrower that the
Bank would not otherwise consider under current market conditions. Debt
restructuring or loan modifications for a borrower do not necessarily always
constitute troubled debt restructuring, however, and troubled debt restructuring
does not necessarily result in non-accrual loans.
Delinquent Loans. The following table sets forth information concerning
delinquent loans at the dates indicated, in dollar amounts and as a percentage
of each category of the Bank's loan portfolio. The amounts presented represent
the total outstanding principal balances of the related loans, rather than the
actual payment amounts which are past due.
AT SEPTEMBER 30, 2007 AT SEPTEMBER 30, 2006
----------------------------- -----------------------------
30 TO 59 DAYS 60 TO 89 DAYS 30 TO 59 DAYS 60 TO 89 DAYS
------------- ------------- ------------- -------------
Real estate loans:
Single-family residential $ 159 $ -- $ -- $ 3
Commercial and multi-family 220 -- -- --
Home equity 227 -- 362 29
Consumer loans 5 17 33 3
Commercial business loans 881 1,261 927 98
------ ------ ------ ----
Total $1,492 $1,278 $1,322 $133
====== ====== ====== ====
13
Non-performing Assets. The following table sets forth the amounts and
categories of the Bank's non-performing assets at the dates indicated.
SEPTEMBER 30,
--------------------------------------------
2007 2006 2005 2004 2003
------ ------ ------ ------ ------
(Dollars in thousands)
Non-performing loans:
Single-family residential $ 174 $ 189 $ 378 $ 623 $ 688
Commercial and multi-family(1) 1,148 -- 3,337(2) -- 381
Construction(3) -- -- -- 770 --
Home equity and lines of credit 274 47 60 243 --
Consumer -- 4 5 6 16
Commercial business 26 26 500(2) -- 268
------ ------ ------ ------ ------
Total non-accrual loans 1,622 266 4,280 1,642 1,353
------ ------ ------ ------ ------
Accruing loans more than 90 days delinquent (4) 3,063 11 772 391 203
------ ------ ------ ------ ------
Total non-performing loans 4,685 277 5,052 2,033 1,556
------ ------ ------ ------ ------
Real estate owned -- 2,450 760 1,229 1,420
------ ------ ------ ------ ------
Total non-performing assets $4,685 $2,727 $5,812 $3,262 $2,976
====== ====== ====== ====== ======
Total non-performing loans
as a percentage of gross loans receivable(5) 1.55% 0.08% 1.65% 0.66% 0.53%
====== ====== ====== ====== ======
Total non-performing assets
as a percentage of total assets 0.89% 0.52% 1.12% 0.57% 0.53%
====== ====== ====== ====== ======
- ----------
(1) Consisted of two loans to the same borrower at September 30, 2007, one loan
at September 30, 2005 which became real estate owned during fiscal 2006 and
one loan at September 30, 2003. The loans to the same borrower as of
September 30, 2007 are discussed below and were repaid in full subsequent
to September 30, 2007.
(2) Loans extended to the same borrower. The commercial business loan to the
borrower was charged off in full in connection with the transfer to real
estate owned of the property in 2006.
(3) Consisted of one single-family residential construction loan at September
30, 2004.
(4) Consisted of 11 loans at September 30, 2007 (see below), three credit card
accounts at September 30, 2006, four loans at September 30, 2005 of which a
$770,000 construction loan returned to current status subsequent to
September 30, 2005, six loans at September 30, 2004 and two loans at
September 30, 2003.
(5) Includes loans receivable and loans held for sale, less construction and
land loans in process and deferred loan origination fees and discounts.
The $174,000 of non-performing single-family residential loans at September
30, 2007 consisted of two loans with principal balances ranging from $60,000 to
$114,000, with an average balance of approximately $87,000. Included within the
two loans is one loan of $60,000 to a credit impaired borrower.
The $1.1 million of non-performing commercial and multi-family loans
consisted of two loans to the same borrower. The commercial property consists of
a bakery along with rental units above the establishment located in center city
Philadelphia, Pennsylvania. Subsequent to fiscal year end, the property was sold
and settled. The loans were repaid in full with the proceeds of the sale.
The $274,000 of non-performing home equity and lines of credit at September
30, 2007 consisted of three loans with principal balances ranging from $17,000
to $210,000, with an average balance of approximately $91,000.
14
Loans 90 days or more past maturity which continued to make payments on a
basis consistent with the original repayment schedule amounted to $3.1 million
and $11,000 at September 30, 2007 and 2006, respectively. The increase in 90
days delinquent and still accruing primarily consisted of one $488,000
construction loan, two commercial real estate loans totaling $718,000, and seven
commercial loans totaling $1.9 million. All these loans went past their
contractual maturity and continue to pay in accordance with their terms
otherwise. The principal balance of the loans is included in the accruing loans
past due 90 days or more category of non-performing assets.
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 $2.5 million, resulting in a pre-tax gain of $71,000.
Other Classified Assets. Federal banking regulations require that each
insured savings association classify its assets on a regular basis. In addition,
in connection with examinations of insured institutions, federal examiners have
authority to identify problem assets and, if appropriate, classify them. There
are four classifications for problem assets: "substandard," "doubtful," "loss"
and "special mention." Substandard assets have one or more defined weaknesses
and are characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not corrected. Doubtful assets
have the weaknesses of substandard assets with the additional characteristic
that the weaknesses make collection or liquidation in full, on the basis of
currently existing facts, conditions and values questionable, and there is a
high possibility of loss. An asset classified loss is considered uncollectible
and of such little value that continuance as an asset of the institution is not
warranted.
In connection with the OTS examination in the fall of 2006, the Company
reviewed its asset classifications resulting in a substantial increase in its
criticized and classified assets. At September 30, 2007, the Bank had $12.0
million of assets classified as substandard, no assets classified as either
doubtful or loss, and $1.6 million identified as special mention. A substantial
majority of the assets classified as substandard consists of commercial business
and commercial real estate loans. Furthermore, criticized assets decreased by
$6.6 million, or 65.5%, from September 30, 2006.
Allowance for Loan Losses. The Bank's policy is to establish reserves for
estimated losses on delinquent loans when it determines that losses are
probable. The allowance for losses on loans is maintained at a level believed by
management to cover all known and inherent losses in its loan portfolio.
Management's analysis of the adequacy of the allowance is based on an evaluation
of the loan portfolio, past loss experience, current economic conditions,
volume, growth and composition of the portfolio, and other relevant factors. The
allowance is increased by provisions for loan losses which are charged against
income. The level of allowance for loan losses decreased slightly in fiscal 2007
due to the Bank's evaluation of its estimate including, among other things, an
analysis of delinquency trends, non-performing loan trends, the levels of
charge-offs and recoveries, the decreased level of special mention assets, prior
loss experience, the decreased amount of total loans outstanding, the reduced
volume of loan originations in construction, commercial real estate and business
loans, the value and the nature of the collateral securing loans, the number of
loans requiring heightened management oversight, general economic conditions,
particularly as they relate to the Company's primary market area and trends in
market rates of interest. The Company's primary banking regulator periodically
reviews the Company's allowance for loan losses as an integral part of the
examination. As shown in the table below, at September 30, 2007, the Bank's
allowance for loan losses amounted to 70.9% and 1.1 % of the Bank's
non-performing loans and gross loans receivable, respectively.
15
Management of the Company presently believes that its allowance for loan
losses is adequate to cover all known and inherent losses that are both probable
and reasonably estimable in the Bank's loan portfolio. However, future
adjustments to this allowance may be necessary, and the Company's results of
operations could be adversely affected if circumstances differ substantially
from the assumptions used by management in making its determinations in this
regard. The following table provides information regarding the changes in the
allowance for loan losses and other selected statistics for the periods
presented.
YEAR ENDING SEPTEMBER 30,
---------------------------------------------------
2007 2006 2005 2004 2003
------- --------- ------ ------- -------
(Dollars in thousands)
Allowance for loan losses, beginning of period $ 3,367 $ 3,475 $2,039 $ 1,986 $ 2,358
Charged-off loans:
Single-family residential (21) (50) (26) -- (50)
Multi-family and commercial -- (637)(1) -- (62) (941)
Consumer and commercial business (449) (641)(1) (318) (259) (111)
------- --------- ------ ------- -------
Total charged-off loans (470) (1,328) (344) (321) (1,102)
------- --------- ------ ------- -------
Recoveries on loans previously charged-off:
Single-family residential 20 -- -- 35 4
Multi-family and commercial -- 3 -- 32 --
Consumer and commercial business 30 11 -- 7 11
------- --------- ------ ------- -------
Total recoveries 50 14 -- 74 15
------- --------- ------ ------- -------
Net loans charged-off (420) (1,314) (344) (247) (1,087)
Provision for loan losses 375 1,206 1,780 300 715
------- --------- ------ ------- -------
Allowance for loan losses, end of period $ 3,322 $ 3,367 $3,475 $ 2,039 $ 1,986
======= ========= ====== ======= =======
Net loans charged-off to average loans outstanding(2) 0.13% 0.42% 0.11% 0.08% 0.37%
======= ========= ====== ======= =======
Allowance for loan losses to gross loans receivable(2) 1.12% 1.03% 1.14% 0.67% 0.68%
======= ========= ====== ======= =======
Allowance for loan losses to total non-performing loans 70.91% 1,215.61% 68.79% 100.30% 127.63%
======= ========= ====== ======= =======
Net loans charged-off to allowance for loan losses 12.64% 39.03% 9.90% 12.11% 54.73%
======= ========= ====== ======= =======
Recoveries to charge-offs 10.64% 1.05% 0.00% 23.05% 1.36%
======= ========= ====== ======= =======
- ----------
(1) The charge-off in multi-family and commercial loans as well as a $500,000
charge-off in consumer and commercial business loans was related to the
commercial property transferred to real estate owned discussed above.
(2) Gross loans receivable and average loans outstanding include loans
receivable as well as loans held for sale, less construction and land loans
in process and deferred loan origination fees and discounts.
16
The following table presents the Bank's allocation of the allowance for
loan losses to the total amount of loans in each category listed at the dates
indicated:
SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------
2007 2006 2005 2004 2003
------------------- ------------------- ------------------- ------------------- -------------------
% OF LOANS
IN EACH % OF LOANS % OF LOANS % OF LOANS % OF LOANS
CATEGORY IN EACH IN EACH IN EACH IN EACH
TO CATEGORY TO CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
Single-family
residential $ 329 46.40% $ 326 42.76% $ 695 46.64% $ 700 50.87% $ 733 55.51%
Commercial and multi-
family residential 1,441 19.91 1,346 20.81 1,888 21.78 446 20.02 317 19.73
Construction and land 104 7.80 129 11.27 383 11.51 467 11.82 329 9.69
Home equity 216 19.17 122 17.52 62 14.61 57 13.54 34 11.19
Consumer 85 .40 85 .41 10 .43 11 .45 10 .48
Commercial business 861 6.32 1,072 7.23 370 5.03 70 3.30 132 3.40
Unallocated 286 -- 287 -- 67 -- 288 -- 431 --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance for
loan losses $3,322 100.00% $3,367 100.00% $3,475 100.00% $2,039 100.00% $1.986 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
17
MORTGAGE-RELATED AND INVESTMENT SECURITIES
Mortgage-Related Securities. Federally chartered savings institutions have
authority to invest in various types of liquid assets, including U.S. Treasury
obligations, securities of various federal agencies and of state and municipal
governments, certificates of deposit at federally insured banks and savings
associations, certain bankers' acceptances and federal funds. Subject to various
restrictions, federally chartered savings institutions also may invest a portion
of their assets in commercial paper, corporate debt securities and mutual funds,
the assets of which conform to the investments that federally chartered savings
institutions are otherwise authorized to make directly.
The Bank maintains a significant portfolio of mortgage-related securities
(including mortgage-backed securities and collateralized mortgage obligations
("CMOs") as a means of investing in housing-related mortgage instruments without
the costs associated with originating mortgage loans for portfolio retention and
with limited credit risk of default which arises in holding a portfolio of loans
to maturity. Mortgage-backed securities (which also are known as mortgage
participation certificates or pass-through certificates) represent a
participation interest in a pool of single-family or multi-family residential
mortgages. The principal and interest payments on mortgage-backed securities are
passed from the mortgage originators, as servicer, through intermediaries
(generally U.S. Government agencies and government-sponsored enterprises) that
pool and repackage the participation interests in the form of securities, to
investors such as the Bank. Such U.S. Government agencies and
government-sponsored enterprises, which guarantee the payment of principal and
interest to investors, primarily include FHLMC, FNMA and the Government National
Mortgage Association ("GNMA"). The Bank also invests in certain privately
issued, credit enhanced mortgage-related securities rated AAA by national
securities rating agencies.
FHLMC is a public corporation chartered by the U.S. Government. FHLMC
issues participation certificates backed principally by conventional mortgage
loans. FHLMC guarantees the timely payment of interest and the ultimate return
of principal on participation certificates. FNMA is a private corporation
chartered by the U.S. Congress with a mandate to establish a secondary market
for mortgage loans. FNMA guarantees the timely payment of principal and interest
on FNMA securities. FHLMC and FNMA securities are not backed by the full faith
and credit of the United States, but because FHLMC and FNMA are U.S.
Government-sponsored enterprises, these securities are considered to be among
the highest quality investments with minimal credit risks. GNMA is a government
agency within the Department of Housing and Urban Development which is intended
to help finance government-assisted housing programs. GNMA securities are backed
by Federal Housing Administration ("FHA") insured and the Department of Veterans
Affairs ("VA") guaranteed loans, and the timely payment of principal and
interest on GNMA securities are guaranteed by the GNMA and backed by the full
faith and credit of the U.S. Government. Because FHLMC, FNMA and GNMA were
established to provide support for low- and middle-income housing, there are
limits to the maximum size of loans that qualify for these programs which is
currently $417,000 (for single-family dwellings).
Mortgage-related securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
underlying pool of mortgages can be composed of either fixed-rate or
adjustable-rate loans. As a result, the risk characteristics of the underlying
pool of mortgages (i.e., fixed-rate or adjustable rate) as well as prepayment
risk, are passed on to the certificate holder. Thus, the life of a
mortgage-backed pass-through security approximates the life of the underlying
mortgages.
The Bank's mortgage-related securities include regular interests in CMOs.
CMOs were developed in response to investor concerns regarding the uncertainty
of cash flows associated with the prepayment option of the underlying mortgagor
and are typically issued by governmental agencies, governmental sponsored
enterprises and special purpose entities, such as trusts, corporations or
partnerships, established by financial institutions or other similar
institutions. A CMO can be (but is not required to be) collateralized by loans
or securities which are insured or guaranteed by FNMA, FHLMC or the GNMA. In
contrast to pass-through mortgage-related securities, in which cash flow is
received pro rata by all security holders, the cash flow from the mortgages
underlying a CMO is segmented and paid in accordance with a predetermined
priority to investors holding various CMO classes. By allocating the principal
and interest cash flows from the underlying collateral among the separate CMO
classes, different classes of bonds are created, each with its own stated
maturity, estimated average life, coupon rate and prepayment characteristics.
18
The short-term classes of a CMO usually carry a lower coupon rate than the
longer term classes and, therefore, the interest differential cash flow on a
residual interest is greatest in the early years of the CMO. As the early coupon
classes are extinguished, the residual income declines. Thus, the longer the
lower coupon classes remain outstanding, the greater the cash flow accruing to
CMO residuals. As interest rates decline, prepayments accelerate, the interest
differential narrows, and the cash flow from the CMO declines. Conversely, as
interest rates increase, prepayments decrease, generating a larger cash flow to
residuals.
A senior-subordinated structure often is used with CMOs to provide credit
enhancement for securities which are backed by collateral which is not
guaranteed by FNMA, FHLMC or the GNMA. These structures divide mortgage pools
into various risk classes: a senior class and one or more subordinated classes.
The subordinated classes provide protection to the senior class. When cash flow
is impaired, debt service goes first to the holders of senior classes. In
addition, incoming cash flows also may go into a reserve fund to meet any future
shortfalls of cash flow to holders of senior classes. The holders of
subordinated classes may not receive any funds until the holders of senior
classes have been paid and, when appropriate, until a specified level of funds
has been contributed to the reserve fund.
Mortgage-related securities generally bear yields which are less than those
of the loans which underlie such securities because of their payment guarantees
or credit enhancements which reduce credit risk to nominal levels. However,
mortgage-related securities are more liquid than individual mortgage loans and
may be used to collateralize certain obligations of the Bank. At September 30,
2007, $24.5 million of the Bank's mortgage-related securities were pledged to
secure various obligations of the Bank, treasury tax and loan processing and as
collateral for certain municipal deposits.
The Bank's mortgage-related securities are classified as either "held to
maturity" or "available for sale" based upon the Bank's intent and ability to
hold such securities to maturity at the time of purchase, in accordance with
GAAP. As of September 30, 2007, the Bank had an aggregate of $110.5 million, or
21.0%, of total assets invested in mortgage-related securities, net, of which
$31.3 million was held to maturity and $79.2 million was available for sale. The
Company's investment strategy is to maintain the portfolio to complement the
asset-liability structure of the Company. The Company's strategy during fiscal
2007 was to reinvest its cash flows from held to maturity portfolio into its
available for sale portfolio in order to provide flexibility and liquidity in
the Company as part of its asset-liability management. The mortgage-related
securities of the Bank which are held to maturity are carried at cost, adjusted
for the amortization of premiums and the accretion of discounts using a level
yield method, while mortgage-related securities available for sale are carried
at the current fair value. See Notes 2 and 4 of the Notes to Consolidated
Financial Statements set forth in Item 8 hereof.
19
The following table sets forth the composition of the Bank's available for
sale (at fair value) and held to maturity (at amortized cost) mortgage-related
securities portfolios at the dates indicated.
SEPTEMBER 30,
-------------------------------
2007 2006 2005
------- ------- -------
(Dollars in thousands)
Available for sale:
Mortgage-backed securities:
FHLMC $15,511 $ 7,224 $ 53
FNMA 31,504 27,597 23,180
GNMA 2,181 2,906 3,920
------- ------- -------
Total mortgage-backed securities 49,196 37,727 27,153
------- ------- -------
Collateralized mortgage obligations:
FHLMC 4,703 5,582 3,514
FNMA 2,709 3,231 3,951
Other 22,570(1) 23,490(2) 32,909(3)
------- ------- -------
Total collateralized mortgage obligations 29,982 32,303 40,374
------- ------- -------
Total mortgage-related securities $79,178 $70,030 $67,527
======= ======= =======
Held to maturity:
Mortgage-backed securities:
FHLMC $11,957 $14,376 $17,267
FNMA 19,289 23,826 29,084
------- ------- -------
Total mortgage-backed securities 31,246 38,202 46,351
------- ------- -------
Collateralized mortgage obligations:
FNMA 48 153 303
------- ------- -------
Total collateralized mortgage obligations 48 153 303
------- ------- -------
Total mortgage-related securities, amortized cost $31,294 $38,355 $46,654
======= ======= =======
Total fair value(4) $30,511 $37,163 $45,679
======= ======= =======
- ----------
(1) Includes "AAA" rated securities of AMAC, Bank of America, Countrywide Home
Loans, Credit Suisse First Boston, First Horizon Securities, GSR,
MastrAsset, Structured Asset Securities, Washington Mutual and Wells Fargo
with book values of $3.0 million, $312,000, $2.2 million, $1.3 million,
$2.8 million, $1.0 million, $1.6 million, $463,000, $3.9 million and $6.5
million, respectively, and fair values of $2.9 million, $311,000, $2.1
million, $1.2 million, $2.8 million, $988,000, $1.6 million, $465,000, $3.8
million and $6.4 million, respectively, as of September 30, 2007.
(2) Includes "AAA" rated securities of AMAC, Bank of America, Countrywide Home
Loans, Credit Suisse First Boston, GSR, MastrAsset, Structured Asset
Securities, Washington Mutual and Wells Fargo with book values of $3.6
million, $429,000, $2.6 million, $1.4 million, $1.2 million, $2.0 million,
$604,000, $4.7 million and $7.5 million, respectively, and fair values of
$3.5 million, $426,000, $2.5 million, $1.4 million, $1.2 million, $1.9
million, $602,000, $4.6 million and $7.3 million, respectively, as of
September 30, 2006.
(3) Includes "AAA" rated securities of AMAC, Credit Suisse First Boston,
Countrywide Home Loans, First Horizon, GSR, MastrAsset, Washington Mutual
and Wells Fargo with book values of $4.3 million, $1.7 million, $2.9
million, $4.4 million, $1.3 million, $3.1 million, $5.4 million, and $8.2
million, respectively, and fair values of $4.3 million, $1.6 million, $3.0
million, $4.3 million, $1.3 million, $3.1 million, $5.5 million, and $8.4
million, respectively, as of September 30, 2005.
(4) See Note 4 of the Notes to Consolidated Financial Statements set forth in
Item 8 hereof.
20
The following table sets forth the purchases, sales and principal
repayments of the Bank's mortgage-related securities for the periods indicated.
YEAR ENDED SEPTEMBER 30,
------------------------------
2007 2006 2005
-------- -------- --------
(Dollars in thousands)
Mortgage-related securities, beginning of period(1)(2) $108,385 $114,181 $134,983
-------- -------- --------
Purchases:
Mortgage-backed securities - available for sale 18,934 18,353 23,532
Mortgage-backed securities - held to maturity -- -- 18,591
CMOs - available for sale 2,979 -- 18,402
Sales:
Mortgage-backed securities - available for sale -- -- (31,758)
CMOs - available for sale -- (1,709) (10,806)
Repayments and prepayments:
Mortgage-backed securities (14,506) (15,510) (22,802)
CMOs (5,563) (6,410) (14,314)
Decrease in net premium (120) (241) (643)
Change in net unrealized loss on mortgage-related
securities available for sale 363 (279) (1,004)
-------- -------- --------
Net increase (decrease) in mortgage-related securities 2,087 (5,796) (20,802)
-------- -------- --------
Mortgage-related securities, end of period(1)(2) $110,472 $108,385 $114,181
======== ======== ========
- ----------
(1) Includes both mortgage-related securities available for sale and held to
maturity.
(2) Calculated at amortized cost for securities held to maturity and at fair
value for securities available for sale.
At September 30, 2007, the estimated weighted average maturity of the
Bank's fixed-rate mortgage-related securities was approximately 4.0 years. The
actual maturity of a mortgage-backed security is generally less than its stated
maturity due to prepayments of the underlying mortgages. Prepayments that are
faster than anticipated may shorten the life of the security and adversely
affect its yield to maturity. The yield is based upon the interest income and
the amortization of any premium or discount related to the mortgage-backed
security. In accordance with GAAP, premiums and discounts are amortized over the
estimated lives of the securities, which decrease and increase interest income,
respectively. The prepayment assumptions used to determine the amortization
period for premiums and discounts can significantly affect the yield of the
mortgage-backed security, and these assumptions are reviewed periodically to
reflect actual prepayments. Although prepayments of underlying mortgages depend
on many factors, including the type of mortgages, the coupon rate, the age of
mortgages, the geographical location of the underlying real estate
collateralizing the mortgages and general levels of market interest rates, the
difference between the interest rates on the underlying mortgages and the
prevailing mortgage interest rates generally is the most significant determinant
of the rate of prepayments. During periods of declining mortgage interest rates,
if the coupon rates of the underlying mortgages exceed the prevailing market
interest rates offered for mortgage loans, refinancings generally increase and
accelerate the prepayment rate of the underlying mortgages and the related
securities. Conversely, during periods of increasing mortgage interest rates, if
the coupon rates of the underlying mortgages are less than the prevailing market
interest rates offered for mortgage loans, refinancings generally decrease and
decrease the prepayment rate of the underlying mortgages and the related
securities. During fiscal 2007 and 2006, the Company experienced lower
prepayment speeds and refinancing activity as interest rates offered for
mortgage loans in the marketplace increased during these time periods.
21
Investment Securities. The following table sets forth information regarding
the carrying and fair value of the Company's investment securities, both held to
maturity and available for sale, at the dates indicated.
AT SEPTEMBER 30,
------------------------------------------------------------
2007 2006 2005
------------------ ------------------ ------------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE VALUE VALUE
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
FHLB stock $ 6,338 $ 6,338 $ 6,233 $ 6,233 $ 9,499 $ 9,499
U.S. Government and agency
obligations
1 to 5 years 2,000 2,000 1,976 1,976 -- --
5 to 10 years 3,951 3,951 -- -- 1,979 1,979
Municipal obligations 4,372 4,382 13,365 13,376 16,502 16,530
Corporate bonds 11,237 11,237 10,769 10,769 12,036 12,032
Mutual funds 9,888 9,888 8,952 8,952 8,593 8,593
Asset-backed securities -- -- -- -- 593 593
Other equity investments 1,092 1,092 1,581 1,581 1,582 1,582
------- ------- ------- ------- ------- -------
Total $38,878 $38,888 $42,876 $42,887 $50,784 $50,808
======= ======= ======= ======= ======= =======
At September 30, 2007, the Company had an aggregate of $38.9 million, or
7.4 %, of its total assets invested in investment securities, of which $6.3
million consisted of FHLB stock, $29.3 million was investment securities
available for sale and $3.3 million was investment securities held to maturity.
Included in U.S. Government and agency obligations are four callable bonds with
an average remaining term of approximately nine years. The Bank's investment
securities (excluding mutual funds, equity securities and FHLB stock) had a
weighted average maturity to the call date of 3.1 years and a weighted average
yield of 5.98%.
SOURCES OF FUNDS
General. The Bank's principal source of funds for use in lending and for
other general business purposes has traditionally come from deposits obtained
through the Bank's branch offices. The Bank also derives funds from contractual
payments and prepayments of outstanding loans and mortgage-related securities,
from sales of loans, from maturing investment securities and from advances from
the FHLBank Pittsburgh and other borrowings. Loan repayments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by general interest rates and money market conditions. The Bank uses
borrowings to supplement its deposits as a source of funds.
Deposits. The Bank's current deposit products include passbook accounts,
NOW accounts, MMDAs, certificates of deposit ranging in terms from 30 days to
five years and non-interest-bearing personal and business checking accounts. The
Bank's deposit products also include Individual Retirement Account ("IRA")
certificates and Keogh accounts.
The Bank's deposits are obtained primarily from residents in Delaware and
Chester Counties in southeastern Pennsylvania. The Bank attracts local deposit
accounts by offering a wide variety of accounts, competitive interest rates, and
convenient branch office locations and service hours. The Bank utilizes
traditional marketing methods to attract new customers and savings deposits,
including print media, radio advertising and direct mailings. However, the Bank
does not solicit funds through deposit brokers nor does it pay any brokerage
fees if it accepts such deposits.
22
The Bank has been competitive in the types of accounts and interest rates
it has offered on its deposit products but does not necessarily seek to match
the highest rates paid by competing institutions. During fiscal 2007, the Bank's
deposits decreased $5.1 million, or 1.4%, from $358.8 million at September 30,
2006 to $353.7 million at September 30, 2007. The decrease in deposits resulted
from a $7.7 million, or 4.4%, decrease in core deposits (which consist of
passbook, money market, NOW and non-interest bearing accounts) partially offset
by a $2.6 million, or 1.4%, increase in certificates of deposit. Core deposits
amounted to $165.2 million or 46.7% of the Bank's total deposits at September
30, 2007.
I The following table shows the distribution of, and certain information
relating to, the Bank's deposits by type of deposit as of the dates indicated.
SEPTEMBER 30,
------------------------------------------------------------
2007 2006 2005
------------------ ------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
Passbook $ 37,369 10.57% $ 41,708 11.62% $ 47,139 13.48%
MMDA 34,252 9.68 40,591 11.31 45,753 13.08
NOW 75,194 21.26 73,356 20.45 65,688 18.79
Certificates of deposit 188,489 53.29 185,929 51.82 173,113 49.50
Non-interest-bearing 18,404 5.20 17,232 4.80 18,001 5.15
-------- ------ -------- ------ -------- ------
Total deposits $353,708 100.00% $358,816 100.00% $349,694 100.00%
======== ====== ======== ====== ======== ======
The following table sets forth the net savings flows of the Bank during the
periods indicated.
YEAR ENDED SEPTEMBER 30,
--------------------------
2007 2006 2005
-------- ------ ------
(Dollars in thousands)
(Decrease) increase before interest credited $(15,633) $1,134 $ (650)
Interest credited 10,525 7,988 5,464
-------- ------ ------
Net savings increase (decrease) $ (5,108) $9,122 $4,814
======== ====== ======
The following table sets forth maturities of the Bank's certificates of
deposit of $100,000 or more at September 30, 2007 and 2006 by time remaining to
maturity (amounts in thousands).
SEPTEMBER 30,
-----------------
2007 2006
------- -------
Three months or less $29,590 $24,188
Over three months through six months 12,424 6,089
Over six months through twelve months 13,542 12,424
Over twelve months 5,062 17,376
------- -------
$60,618 $60,077
======= =======
23
The following table presents, by various interest rate categories, the
amount of certificates of deposit at September 30, 2007 and 2006 and the amounts
at September 30, 2007 which mature during the periods indicated.
AMOUNTS AT SEPTEMBER 30, 2007
SEPTEMBER 30, MATURING WITHIN
------------------- -----------------------------------------------
Certificates of Deposit 2007 2006 ONE YEAR TWO YEARS THREE YEARS THEREAFTER
-------- -------- -------- --------- ----------- ----------
(Dollars in thousands)
2.0% or less $ 2 $ 174 $ 1 $ 1 $ -- $ --
2.01% to 3.0% 516 11,571 516 -- -- --
3.01% to 4.0% 43,602 62,755 26,881 12,934 3,278 509
4.01% to 5.0% 105,961 64,366 98,467 2,794 935 3,765
5.01% to 6.0% 38,408 47,063 38,335 -- -- 73
-------- -------- -------- ------- ------ ------
Total certificate accounts $188,489 $185,929 $164,200 $15,729 $4,213 $4,347
======== ======== ======== ======= ====== ======
The following table presents the average balance of each deposit type and
the average rate paid on each deposit type for the periods indicated.
SEPTEMBER 30,
------------------------------------------------------------
2007 2006 2005
------------------ ------------------ ------------------
AVERAGE AVERAGE AVERAGE
AVERAGE RATE AVERAGE RATE AVERAGE RATE
BALANCE PAID BALANCE PAID BALANCE PAID
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
Passbook accounts $ 39,078 0.93% $ 45,673 0.94% $ 50,574 0.94%
MMDA accounts 37,288 2.90 42,966 2.13 51,284 1.49
Certificates of deposit 190,098 4.58 178,878 3.66 166,179 2.81
NOW accounts 72,983 1.39 67,254 1.03 61,051 0.65
Non-interest-bearing deposits 15,496 -- 17,600 -- 19,988 --
-------- -------- --------
Total deposits $354,943 3.16% $352,371 2.43% $349,076 1.80%
======== ==== ======== ==== ======== ====
24
Borrowings. The Bank may obtain advances from the FHLBank Pittsburgh upon
the security of the common stock it owns in the FHLB and certain of its
residential mortgage loans and securities held to maturity, provided certain
standards related to creditworthiness have been met. Such advances are made
pursuant to several credit programs, each of which has its own interest rate and
range of maturities. At September 30, 2007, the Bank had $115.4 million in
outstanding FHLB advances and overnight borrowings. The FHLB advances have
certain call features whereby the FHLBank Pittsburgh can call the borrowings
after the expiration of certain time frames. The time frames on the callable
borrowings are within 12 months. Note 9 of the Notes to Consolidated Financial
Statements set forth in Item 8 hereof.
The following table sets forth certain information regarding the Bank's
FHLB advances for the periods indicated.
SEPTEMBER 30,
-------------------
2007 2006
-------- --------
(Dollars in thousands)
FHLB advances
Average balance outstanding for the period $ 93,182 $108,247
Maximum outstanding at any month end 115,334 116,457
Balance outstanding at end of the period 115,334 107,153
Average interest rate for the period 5.49% 5.46%
Interest rate at the end of the period 5.40% 5.46%
In addition, the Company participated in junior subordinated debentures
aggregating $15.3 million at September 30, 2007 held by statutory trusts that
issued trust preferred securities comprised of $13.2 million in fixed-rate
preferred securities and $2.1 million in floating-rate preferred securities. On
June 8, 2007, the Company utilized proceeds from the private placement offering
to reduce its balance of junior subordinated debentures. Funds received by the
statutory trust were used to redeem $6.0 million of its floating-rate trust
preferred securities. See Note 16 of the Notes to Consolidated Financial
Statements set forth in Item 8 hereof.
SUBSIDIARIES
The Bank is permitted to invest up to 2% of its assets in the capital stock
of, or secured or unsecured loans to, service corporations, with an additional
investment of 1% of assets when such additional investment is utilized primarily
for community development purposes. It may invest essentially unlimited amounts
in subsidiaries deemed operating subsidiaries that can only engage in activities
that the Bank is permitted to engage in. Under such limitations, as of September
30, 2007, the Bank was authorized to invest up to approximately $10.5 million in
the stock of, or loans to, service corporations. As of September 30, 2007, the
net book value of the Bank's investment in stock, unsecured loans, and
conforming loans to its service corporations was $52,000.
At September 30, 2007, in addition to the Bank, the Company has four
indirect active subsidiaries: FKF Management Corp., Inc., State Street Services
Corp., First Chester Services, Inc., and First Pointe, Inc.
FKF Management Corp., Inc., a Delaware corporation, is a wholly owned
operating subsidiary of the Bank established in 1997 for the purpose of managing
certain assets of the Bank. Assets under management totaled $90.6 million at
September 30, 2007 and were comprised principally of investment and
mortgage-related securities.
State Street Services Corp. is a wholly owned subsidiary of the Bank
established in 1999 for the purpose of offering a full array of insurance
products through its ownership of a 51% interest in First Keystone Insurance
Services, LLC ("First Keystone Insurance"). First Keystone Insurance's financial
data is consolidated into the Company's financial statements. Total assets for
First Keystone Insurance were $213,000 and $134,000 at September 30, 2007 and
2006, respectively. Total liabilities for First Keystone Insurance were $28,000
and $32,000 at September 30, 2007 and 2006, respectively. Net income for the
years ending September 30, 2007 and 2006 was $83,000 and $69,000, respectively.
First Chester Services, Inc. and First Pointe, Inc. are wholly owned
subsidiaries which were reactivated to manage a real estate owned parcel and
other assets related to the real estate owned parcel.
25
EMPLOYEES
The Bank had 95 full-time employees and 15 part-time employees as of
September 30, 2007. None of these employees is represented by a collective
bargaining agreement. The Bank believes that it enjoys excellent relations with
its personnel.
REGULATION
General. Set forth below is a brief description of certain laws and
regulations which are applicable to the Company and the Bank. The description of
these laws and regulations, as well as descriptions of laws and regulations
contained elsewhere herein, do not purport to be complete and is qualified in
its entirety by reference to the applicable laws and regulations.
The Company. The Company, as a savings and loan holding company within the
meaning of the Home Owners' Loan Act, as amended ("HOLA"), is registered as such
with the OTS and is subject to OTS regulations, examination, supervision and
reporting requirements. As a subsidiary of a savings and loan holding company,
the Bank is subject to certain restrictions in its dealings with the Company and
affiliates thereof.
Federal Activities Restrictions. The Company operates as a unitary savings
and loan holding company. Generally, there are only limited restrictions on the
activities of a unitary savings and loan holding company such as the Company
which applied to become or was a unitary savings and loan holding company prior
to May 4, 1999 and its non-savings institution subsidiaries. Under the
Gramm-Leach-Bliley Act of 1999 (the "GLBA"), companies which apply to the OTS to
become unitary savings and loan holding companies are restricted to only
engaging in those activities traditionally permitted to multiple savings and
loan holding companies. However, if the Director of the OTS determines that
there is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings association, the
Director may impose such restrictions as deemed necessary to address such risk,
including limiting (i) payment of dividends by the savings association; (ii)
transactions between the savings association and its affiliates; and (iii) any
activities of the savings association that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings association. Notwithstanding the above rules regarding permissible
business activities of grandfathered unitary savings and loan holding companies
under the GLBA, if the savings association subsidiary of such a holding company
fails to meet the Qualified Thrift Lender ("QTL") test, then such unitary
holding company also shall become subject to the activities restrictions
applicable to multiple savings and loan holding companies and, unless the
savings association qualifies as a QTL within one year thereafter, shall
register as, and become subject to the restrictions applicable to, a bank
holding company.
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company and
would thereafter be subject to further restrictions on its activities.
The GLBA also imposes financial privacy obligations and reporting
requirements on all financial institutions. The privacy regulations require,
among other things, that financial institutions establish privacy policies and
disclose such policies to its customers at the commencement of a customer
relationship and annually thereafter. In addition, financial institutions are
required to permit customers to opt out of the financial institution's
disclosure of the customer's financial information to non-affiliated third
parties.
The HOLA requires every savings institution subsidiary of a savings and
loan holding company to give the OTS at least 30 days' advance notice of any
proposed dividends to be made on its guarantee, permanent or other
nonwithdrawable stock, or else such capital distribution will be invalid. See "-
The Bank - Capital Distributions."
Limitations on Transactions with Affiliates. Except for certain exceptions
set forth in the regulations of the OTS, transactions between savings
associations and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act ("FRA") and Regulation W in which implements those statutory
provisions and OTS regulations issued in connection therewith. Affiliates of a
savings institution include, among other entities, the savings institution's
holding company and companies that are controlled by or under common control
with the savings institution. Generally, Sections 23A and 23B (i) limit the
extent to which the savings association or its subsidiaries may engage in
"covered transactions" with any one affiliate to an amount equal to 10% of such
association's capital stock and surplus, and contain an aggregate limit on all
such transactions with all affiliates to an amount equal to 20% of such capital
stock and surplus and (ii) require that all
26
such transactions be on terms substantially the same, or at least as favorable,
to the association or subsidiary as those provided to a non-affiliate. The term
"covered transaction" includes, among other things, the making of loans or
extension of credit to an affiliate, purchase of assets, issuance of a guarantee
and similar transactions. In addition to the restrictions imposed by Sections
23A and 23B, under OTS regulations no savings association may (i) loan or
otherwise extend credit to an affiliate, except for any affiliate which engages
only in activities which are permissible for bank holding companies, (ii) a
savings association may not purchase or invest in securities of an affiliate
other than shares of a subsidiary; (iii) a savings association and its
subsidiaries may not purchase a low-quality asset from an affiliate; (iv) and
covered transactions and certain other transactions between a savings
association or its subsidiaries and an affiliate must be on terms and conditions
that are consistent with safe and sound banking practices. With certain
exceptions, each extension of credit by a savings association to an affiliate
must be secured by collateral with a market value ranging from 100% to 130%
(depending on the type of collateral) of the amount of the loan or extension of
credit.
OTS regulations generally exclude all non-bank and non-savings association
subsidiaries of savings associations from treatment as affiliates, except to the
extent that the OTS or the Federal Reserve Board ("FRB") decides to treat such
subsidiaries as affiliates. The regulations also require savings associations to
make and retain records that reflect affiliate transactions in reasonable
detail, and provide that certain classes of savings associations may be required
to give the OTS prior notice of affiliate transactions.
Restrictions on Acquisitions. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior approval
of the OTS, (i) control of any other savings association or savings and loan
holding company or substantially all of the assets thereof; (ii) more than 5% of
the voting shares of a savings association or holding company thereof which is
not a subsidiary; (iii) acquiring through a merger, consolidation or purchase of
assets of another savings institution (or holding company thereof) or acquiring
all or substantially all of the assets of another savings institution (or
holding company thereof); or (iv) acquiring control of an uninsured institution.
No director or officer of a savings and loan holding company or person owning or
controlling by proxy or otherwise more than 25% of such company's stock, may
acquire control of any savings association, other than a subsidiary savings
association, or of any other savings and loan holding company.
The OTS may not approve any acquisition that would result in a multiple
savings and loan holding company controlling savings institutions in more than
one state, subject to two exceptions: (i) the approval of interstate supervisory
acquisitions by savings and loan holding companies; and (ii) the acquisition of
a savings institution in another state if the laws of the state of the target
savings institution specifically permit such acquisitions. The states vary in
the extent to which they permit interstate savings and loan holding company
acquisitions.
Federal Securities Laws. The Company's Common Stock is registered with the
SEC under the Securities Exchange Act of 1934, as amended ("Exchange Act"). The
Company is subject to the information, proxy solicitation, insider trading
restrictions and other requirements of the Exchange Act.
Sarbanes-Oxley Act of 2002. As a public company, the Company is subject to
the Sarbanes-Oxley Act of 2002 (the "Act"), which implements a broad range of
corporate governance and accounting measures for public companies designed to
promote honesty and transparency in corporate America and better protect
investors from corporate wrongdoing. The Act's principal legislation and the
derivative regulation and rule making promulgated by the SEC includes:
- the creation of an independent accounting oversight board;
- auditor independence provisions that restrict non-audit services that
accountants may provide to their audit clients;
- additional corporate governance and responsibility measures, including
the requirement that the chief executive officer and chief financial
officer certify financial statements;
- a requirement that companies establish and maintain a system of
internal control over financial reporting and that a company's
management provide an annual report regarding its assessment of the
effectiveness of such internal control over financial reporting to the
company's independent accountants and that such accountants provide an
attestation report with respect to management's assessment of the
effectiveness of the company's internal control over financial
reporting;
27
- the forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer's securities by directors and
senior officers in the twelve month period following initial
publication of any financial statements that later require
restatement;
- an increase in the oversight of, and enhancement of certain
requirements relating to audit committees of public companies and how
they interact with the company's independent auditors;
- the requirement that audit committee members must be independent and
are absolutely barred from accepting consulting, advisory or other
compensatory fees from the issuer;
- the requirement that companies disclose whether at least one member of
the committee is a "financial expert" (as such term is defined by the
securities and exchange commission) and if not, why not;
- expanded disclosure requirements for corporate insiders, including
accelerated reporting of stock transactions by insiders and a
prohibition on insider trading during pension blackout periods;
- a prohibition on personal loans to directors and officers, except
certain loans made by insured financial institutions;
- disclosure of a code of ethics and the requirement of filing of a Form
8-K for a change or waiver of such code;
- mandatory disclosure by analysts of potential conflicts of interest;
and
- a range of enhanced penalties for fraud and other violations.
Although the Company anticipates that it will incur additional expense in
complying with the provisions of the Act and the regulations resulting
therefrom, management does not expect that such compliance will have a material
impact on its results of operations or financial condition.
The Bank. The OTS has extensive regulatory authority over the operations of
savings associations such as the Bank. As part of this authority, savings
associations are required to file periodic reports with the OTS and are subject
to periodic examinations by the OTS. The investment and lending authority of
savings associations are prescribed by federal laws and regulations and they are
prohibited from engaging in any activities not permitted by such laws and
regulations. Those laws and regulations generally are applicable to all
federally chartered savings associations and may also apply to state-chartered
savings associations. Such regulation and supervision is primarily intended for
the protection of depositors.
The OTS' enforcement authority over all savings institutions and their
holding companies includes, among other things, the ability to assess civil
money penalties, to issue cease and desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices, other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS.
Insurance of Accounts. The deposits of the Bank are insured to the maximum
extent permitted by the Deposit Insurance Fund, which is administered by the
Federal Deposit Insurance Corporation ("FDIC"), and are backed by the full faith
and credit of the U. S. Government. As insurer, the FDIC is authorized to
conduct examinations of, and to require reporting by, FDIC-insured institutions.
It also may prohibit any FDIC-insured institution from engaging in any activity
the FDIC determines by regulation or order to pose a serious threat to the FDIC.
The FDIC also has the authority to initiate enforcement actions against savings
associations, after giving the OTS an opportunity to take such action.
Each FDIC insured institution is assigned to one of three capital groups
which are based solely on the level of an institution's capital - "well
capitalized," "adequately capitalized" and "undercapitalized" - which are
defined in the same manner as the regulations establishing the prompt corrective
action system discussed below. These three groups are then divided into three
subgroups which reflect varying levels of supervisory concern, from those which
are considered to be healthy to those which are considered to be of substantial
supervisory concern. The matrix so created results in nine assessment risk
classifications, with rates during the first six months of 2006 ranging from
zero for well capitalized, healthy institutions, to 27 basis points for
undercapitalized institutions with substantial supervisory concerns.
28
In addition, all institutions with deposits insured by the FDIC are
required to pay assessments to fund interest payments on bonds issued by the
Financing Corporation, a mixed-ownership government corporation established to
recapitalize the predecessor to the SAIF. The assessment rate for the third
quarter of 2007 was .1114% of insured deposits and is adjusted quarterly. These
assessments will continue until the Financing Corporation bonds mature in 2019.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is not aware of any existing circumstances which could
result in termination of the Bank's deposit insurance.
DEPOSIT INSURANCE REFORM. On February 8, 2006, President George W. Bush
signed into law legislation that merged the Bank Insurance Fund and the Savings
Association Insurance Fund to form the Deposit Insurance Fund, eliminated any
disparities in bank and thrift risk-based premium assessments, reduced the
administrative burden of maintaining and operating two separate funds and
established certain new insurance coverage limits and a mechanism for possible
periodic increases. The legislation also gave the FDIC greater discretion to
identify the relative risks all institutions present to the Deposit Insurance
Fund and set risk-based premiums.
Major provisions in the legislation include:
- merging the Savings Association Insurance Fund and Bank Insurance
Fund, which became effective March 31, 2006;
- maintaining basic deposit and municipal account insurance coverage at
$100,000 but providing for a new basic insurance coverage for
retirement accounts of $250,000. Insurance coverage for basic deposit
and retirement accounts could be increased for inflation every five
years in $10,000 increments beginning in 2011;
- providing the FDIC with the ability to set the designated reserve
ratio within a range between 1.15% and 1.50%, rather than maintaining
1.25% at all times regardless of prevailing economic conditions;
- providing a one-time assessment credit of $4.7 billion to banks and
savings associations in existence on December 31, 1996, which may be
used to offset future premiums with certain limitations; and
- requiring the payment of dividends of 100% of the amount that the
insurance fund exceeds 1.5% of the estimated insured deposits and the
payment of 50% of the amount that the insurance fund exceeds 1.35% of
the estimated insured deposits (when the reserve is greater than 1.35%
but no more than 1.5%).
Pursuant to the Reform Act, the FDIC has determined to maintain the
designated reserve ratio at its current 1.25% which will be reviewed annually.
The FDIC has also adopted a new risk-based premium system that provides for
quarterly assessments based on an insured institution's ranking in one of four
risk categories based upon supervisory and capital evaluations. Beginning in
2007, well-capitalized institutions (generally those with CAMELS composite
ratings of 1 or 2) will be grouped in Risk Category I and will be assessed for
deposit insurance at an annual rate of between five and seven basis points. The
assessment rate for an individual institution is determined according to a
formula based on a weighted average of the institution's individual CAMELS
component ratings plus either five financial ratios or, in the case of an
institution with assets of $10.0 billion or more, the average ratings of its
long-term debt. Institutions in Risk Categories II, III and IV will be assessed
at annual rates of 10, 28 and 43 basis points, respectively.
29
Regulatory Capital Requirements. The OTS capital requirements consist of a
"tangible capital requirement," a "leverage capital requirement" and a
"risk-based capital requirement." The OTS is authorized to impose capital
requirements in excess of those standards on individual institutions on a
case-by-case basis. Under these requirements, savings associations must maintain
"tangible" capital equal to 1.5% of adjusted total assets, "core" capital equal
to 4% (3% if the association receives the OTS's highest rating) of adjusted
total assets and "total" capital (a combination of core and "supplementary"
capital) equal to 8.0% of "risk-weighted" assets. For purposes of the
regulation, core capital generally consists of common stockholders' equity
(including retained earnings), noncumulative perpetual preferred stock and
related surplus, minority interests in the equity accounts of fully consolidated
subsidiaries, certain nonwithdrawable accounts and pledged deposits and
"qualifying supervisory goodwill." Tangible capital is given the same definition
as core capital but does not include qualifying supervisory goodwill and is
reduced by the amount of all the savings association's intangible assets, with
only a limited exception for purchased mortgage servicing rights ("PMSRs"). Both
core and tangible capital are further reduced by an amount equal to a savings
association's debt and equity investments in subsidiaries engaged in activities
not permissible for national banks (other than subsidiaries engaged in
activities undertaken as agent for customers or in mortgage banking activities
and subsidiary depository institutions or their holding companies). In addition,
under the Prompt Corrective Action provisions of the OTS regulations, all but
the most highly rated institutions must maintain a minimum leverage ratio of 4%
in order to be adequately capitalized. See "- Prompt Corrective Action." At
September 30, 2007, the Bank did not have any investment in subsidiaries engaged
in impermissible activities and required to be deducted from its capital
calculation.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital does not exceed the savings association's core capital. Supplementary
capital generally consists of hybrid capital instruments; perpetual preferred
stock which is not eligible to be included as core capital; subordinated debt
and intermediate-term preferred stock; and, subject to limitations, general
allowances for loan losses. Assets are adjusted under the risk-based guidelines
to take into account different risk characteristics, with the categories ranging
from 0% (requiring no additional capital) for assets such as cash to 100% for
repossessed assets or loans more than 90 days past due. Single-family
residential real estate loans which are not past-due or non-performing and which
have been made in accordance with prudent underwriting standards are assigned a
50% level in the risk-weighing system, as are certain privately-issued
mortgage-backed securities representing indirect ownership of such loans.
Off-balance sheet items also are adjusted to take into account certain risk
characteristics.
Certain exclusions from capital and assets are required for the purpose of
calculating total capital, in addition to adjustments required for calculating
core capital. Such exclusions consist of equity investments (as defined by
regulation) and that portion of land loans and non-residential construction
loans in excess of an 80% loan-to-value ratio and reciprocal holdings of
qualifying capital instruments. However, in calculating regulatory capital,
institutions must exclude unrealized losses and gains on securities available
for sale, net of taxes, reported as a separate component of capital calculated
according to generally accepted accounting principles.
The OTS and the FDIC generally are authorized to take enforcement action
against a savings association that fails to meet its capital requirements, which
action may include restrictions on operations and banking activities, the
imposition of a capital directive, a cease-and-desist order, civil money
penalties or harsher measures such as the appointment of a receiver or
conservator or a forced merger into another institution. In addition, under
current regulatory policy, an association that fails to meet its capital
requirements is prohibited from making any capital distributions.
30
The following is a reconciliation of the Bank's equity determined in
accordance with GAAP to regulatory tangible, core and risk-based capital at
September 30, 2007, 2006 and 2005.
SEPTEMBER 30, 2007 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------------------- ------------------------------- -------------------------------
TANGIBLE CORE RISK-BASED TANGIBLE CORE RISK-BASED TANGIBLE CORE RISK-BASED
CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL
-------- ------- ---------- -------- ------- ---------- -------- ------- ----------
(Dollars in thousands)
GAAP equity $49,126 $49,207 $49,207 $47,771 $47,771 $47,771 $45,606 $45,606 $45,606
General valuation allowances -- -- 3,322 -- -- 3,367 -- -- 3,202
------- ------- ------- ------- ------- ------- ------- ------- -------
Total regulatory capital 49,126 49,207 52,529 47,771 47,771 51,138 45,606 45,606 48,808
Minimum capital requirement 7,864 20,975 25,491 7,829 20,819 27,385 7,732 20,619 25,800
------- ------- ------- ------- ------- ------- ------- ------- -------
Excess $41,262 $28,232 $27,038 $39,942 $26,952 $23,753 $37,874 $24,987 $23,008
======= ======= ======= ======= ======= ======= ======= ======= =======
These capital requirements are viewed as minimum standards by the OTS, and
most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings association's capital, upon a determination that
circumstances exist that higher individual minimum capital requirements may be
appropriate. In February 2006, the OTS imposed minimum core capital and total
risk-based capital ratios of 7.5% and 12.5%, respectively. As of September 30,
2007, the Bank's regulatory capital was in excess of all regulatory capital
requirements, including those imposed by the supervisory agreement. See
"Supervisory Agreements" and Note 11 to the Notes to Consolidated Financial
Statements included set forth in Item 8 hereof.
31
Prompt Corrective Action. Under the prompt corrective action regulations of
the OTS, an institution shall be deemed to be (i) "well capitalized" if it has
total risk-based capital of 10% or more, has a Tier I risk-based capital ratio
of 6% or more, has a Tier I leverage capital ratio of 5% or more and is not
subject to any order or final capital directive to meet and maintain a specific
capital level for any capital measure, (ii) "adequately capitalized" if it has a
total risk-based capital ratio of 8% or more, a Tier I risk-based capital ratio
of 4% or more and a Tier I leverage capital ratio of 4% or more (3% under
certain circumstances) and does not meet the definition of "well capitalized,"
(iii) "undercapitalized" if it has a total risk-based capital ratio that is less
than 8%, a Tier I risk-based capital ratio that is less than 4% or a Tier I
leverage capital ratio that is less than 4% (3% under certain circumstances),
(iv) "significantly undercapitalized" if it has a total risk-based capital ratio
that is less than 6%, a Tier I risk-based capital ratio that is less than 3% or
a Tier I leverage capital ratio that is less than 3%, and (v) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2%. Under specified circumstances, the OTS may reclassify
a "well capitalized" institution as "adequately capitalized" and may require an
"adequately capitalized" institution or an "undercapitalized" institution to
comply with supervisory actions as if it were in the next lower category (except
that the FDIC may not reclassify a significantly undercapitalized institution as
critically "undercapitalized"). At September 30, 2007, the Bank's regulatory
capital is in excess of all regulatory capital requirements, including those
imposed by the supervisory agreement. However, under the terms of the
supervisory agreement, the Bank is required to observe certain requirements
regarding limits on asset growth, adoption of revised policies and procedures
governing commercial lending, conduct periodic internal loan reviews and its
commercial loan department, adoption of a revised asset classification policy
and not amend, renew or enter into compensatory arrangements with senior
executive officers and directors, subject to certain exceptions, without the
prior approval of the OTS.
In February 2006, the Company entered into a Supervisory Agreement with the
OTS. Under the terms of the supervisory agreement, the Company agreed to, among
other things, (i) develop and implement a three-year capital plan designed to
support the Company's efforts to maintain prudent levels of capital and to
reduce its debt-to-equity ratio below 50%; (ii) not incur any additional debt
without the prior written approval of the OTS; and (iii) not repurchase any
shares of or pay any cash dividends on its common stock until certain conditions
were complied with; provided, however, that upon reducing its debt-to-equity
below 50%, the Company may resume the payment of quarterly cash dividends at the
lesser of the dividend rate in effect immediately prior to entering into the
supervisory agreement or 35% of its consolidated net income (on an annualized
basis), provided that the OTS does not object to the payment of such dividend
pursuant to a required prior notice of the Company's intent to declare such
quarterly dividend. The Company has filed and received OTS approval of its
capital plan.
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 Company used all of the net proceeds of $5.8 million to reduce the
balance of its junior subordinated debentures in June 2007. As a result of such
redemption, the Company's debt-to-equity ratio as of September 30, 2007 is less
than 50%.
Qualified Thrift Lender Test (the "QTL"). A savings association can comply
with the QTL test by either meeting the QTL test set forth in the HOLA and the
implementing regulations or qualifying as a domestic building and loan
association as defined in Section 7701(a)(19) of the Internal Revenue Code of
1986, as amended ("Code"). Currently, the portion of the QTL test that is based
on the HOLA rather than the Code requires that 65% of an institution's
"portfolio assets" (as defined) consist of certain housing and consumer-related
assets on a monthly average basis in nine out of every 12 months. Assets that
qualify without limit for inclusion as part of the 65% requirement are loans
made to purchase, refinance, construct, improve or repair domestic residential
housing and manufactured housing, home equity loans, mortgage-backed securities
(where the mortgages are secured by domestic residential housing or manufactured
housing), stock issued by the FHLBank Pittsburgh, and direct or indirect
obligations of the FDIC. In addition, small business loans, credit card loans,
student loans and loans for personal, family and household purposes are allowed
to be included without limitation as qualified investments. The following
assets, among others, also may be included in meeting the test subject to an
overall limit of 20% of the savings institution's portfolio assets: 50% of
residential mortgage loans originated and sold within 90 days of origination,
100% loans for personal, family and household purposes (other than credit card
loans and education loans) (limited to 10% of total portfolio assets) and stock
issued by FHLMC or FNMA. Portfolio assets consist of total assets minus the sum
of (i) goodwill and other intangible assets, (ii) property used by the savings
institution to conduct its business, and (iii) liquid assets up to 20% of the
institution's total assets.
32
A savings institution that does not comply with the QTL test must either
convert to a bank charter or comply with the following restrictions on its
operations: (i) the institution may not engage in any new activity or make any
new investment, directly or indirectly, unless such activity or investment is
permissible for a national bank; (ii) the branching powers of the institution
shall be restricted to those of a national bank; (iii) the institution shall not
be eligible to obtain any new advances from its Federal Home Loan Bank, other
than special liquidity advances with the approval of the Office of Thrift
Supervision; and (iv) payment of dividends by the institution shall be subject
to the rules regarding payment of dividends by a national bank. Upon the
expiration of three years from the date the association ceases to be a QTL, it
must cease any activity and not retain any investment not permissible for a
national bank and immediately repay any outstanding FHLB advances (subject to
safety and soundness considerations).
At September 30, 2007, approximately 84.5% of the Bank's assets were
invested in qualified thrift investments which were in excess of the percentage
required to qualify the Bank under the QTL test in effect at that time.
Capital Distribution. OTS regulations govern capital distributions by
savings institutions which include cash dividends, stock repurchases and other
transactions charged to the capital account of a savings institution to make
capital distributions. A savings institution must file an application for OTS
approval of the capital distribution if any of the following occur or would
occur as a result of the capital distribution (1) the total capital
distributions for the applicable calendar year exceed the sum of the
institution's net income for that year to date plus the institution's retained
net income for the preceding two years, (2) the institution would not be at
least adequately capitalized following the distribution, (3) the distribution
would violate any applicable statute, regulation, agreement or OTS-imposed
condition, or (4) the institution is not eligible for expedited treatment of its
filings. If an application is not required to be filed, savings institutions
which are a subsidiary of a holding company (as well as certain other
institutions) must still file a notice with the OTS at least 30 days before the
Board of Directors declares a dividend or approves a capital distribution. OTS
regulations also prohibit the Bank from declaring or paying any dividends or
from repurchasing any of its stock if, as a result, the regulatory (or total)
capital of the Bank would be reduced below the amount required to be maintained
for the liquidation account established by it for certain depositors in
connection with its conversion from mutual to stock form. At September 30, 2007,
the Company is currently not permitted to pay dividends to its stockholders
under the terms of the supervisory agreement until certain conditions are
satisfied, including the receipt of the non-objection of the OTS.
Community Reinvestment Act and the Fair Lending Laws. Under the Community
Reinvestment Act of 1977, as amended ("CRA"), as implemented by OTS regulations,
a savings association has a continuing and affirmative obligation consistent
with its safe and sound operation to help meet the credit needs of its entire
community, including low and moderate income neighborhoods. The CRA does not
establish specific lending requirements or programs for financial institutions
nor does it limit an institution's discretion to develop the types of products
and services that it believes are best suited to its particular community,
consistent with the CRA. The Bank received a satisfactory CRA rating as a result
of its last OTS evaluation. In addition, the Equal Credit Opportunity Act and
the Fair Housing Act prohibit lenders from discriminating in their lending
practices on the basis of characteristics specified in those statutes. An
institution's failure to comply with the provisions of the CRA could, at a
minimum, result in regulatory restrictions on its activities, and failure to
comply with the fair lending laws could result in enforcement actions by the
OTS, as well as other federal regulatory agencies and the Department of Justice.
Branching by Federal Saving Institutions. OTS policy permits interstate
branching to the full extent permitted by statute (which is essentially
unlimited). Generally, federal law prohibits federal savings institutions from
establishing, retaining or operating a branch outside the state in which the
federal institution has its home office unless the institution meets the IRS'
domestic building and loan test (generally, 60% of a thrift's assets must be
housing-related) ("IRS Test"). The IRS Test requirement does not apply if: (a)
the branch(es) result(s) from an emergency acquisition of a troubled savings
institution (however, if the troubled savings institution acquired by a bank
holding company does not have its home office in the state of the bank holding
company bank subsidiary and does not qualify under the IRS Test, its branching
is limited to the branching laws for state-chartered banks in the state where
the savings institution is located); (b) the law of the state where the branch
would be located would permit the branch to be established if the federal
savings institution were chartered by the state in which its home office is
located; or (c) the branch was operated lawfully as a branch under state law
prior to the savings institution's reorganization to a federal charter.
33
Furthermore, the OTS will evaluate a branching applicant's record of CRA
compliance. An unsatisfactory CRA record may be the basis for denial of a
branching application.
Federal Home Loan Bank System. The Bank is a member of the FHLBank
Pittsburgh, which is one of 12 regional FHLBs that administers the home
financing credit function of savings associations. Each FHLB serves as a reserve
or central bank for its members within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures established by the Board of Directors of the FHLBank. As
of September 30, 2007, the Bank has overnight borrowings and advances
aggregating $115.3 million from the FHLBank or 23.5% of its total liabilities.
The Bank currently has the ability to obtain up to $177.3 million of additional
advances from the FHLBank Pittsburgh.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Pittsburgh in an amount equal to at least 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year or 5% of its advances from the FHLBank Pittsburgh,
whichever is greater. At September 30, 2007, the Bank had $6.3 million in FHLB
stock which was in compliance with this requirement.
The FHLBs are required to provide funds for the resolution of troubled
savings institutions and to contribute to affordable housing programs through
direct loans or interest subsidies on advances targeted for community investment
and low- and moderate-income housing projects. These contributions have
adversely affected the level of FHLB dividends paid and could continue to do so
in the future and could also result in the FHLBs imposing higher interest rates
on advances to members. These contributions also could have an adverse effect on
the value of FHLB stock in the future.
Federal Reserve System. FRB requires all depository institutions to
maintain reserves against their transaction accounts (primarily NOW and Super
NOW checking accounts) and non-personal time deposits. At September 30, 2007,
the Bank was in compliance with applicable requirements. However, because
required reserves must be maintained in the form of vault cash or a
non-interest-bearing account at a FRB, the effect of this reserve requirement is
to reduce an institution's earning assets.
Savings institutions are authorized to borrow from a Federal Reserve Bank
"discount window," but FRB regulations require savings banks to exhaust other
reasonable alternative sources of funds, including FHLB advances, before
borrowing from a Federal Reserve Bank.
Safety and Soundness Guidelines. The OTS and the other federal banking
agencies have established guidelines for safety and soundness, addressing
operational and managerial, as well as compensation matters for insured
financial institutions. Institutions failing to meet these standards are
required to submit compliance plans to their appropriate federal regulators. The
OTS and the other agencies have also established guidelines regarding asset
quality and earnings standards for insured institutions. See "Supervisory
Agreements."
FEDERAL AND STATE TAXATION
General. The Company and the Bank are subject to the corporate tax
provisions of the Internal Revenue Code ("Code"), as well as certain additional
provisions of the Code which apply to thrift and other types of financial
institutions. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to the Company and the Bank.
Fiscal Year. The Company and the Bank and the Bank's subsidiaries file a
consolidated federal income tax return on a fiscal year basis ending September
30.
Method of Accounting. The Bank maintains its books and records for federal
income tax purposes using the accrual method of accounting. The accrual method
of accounting generally requires that items of income be recognized when all
events have occurred that establish the right to receive the income and the
amount of income can be determined with reasonable accuracy, and that items of
expense be deducted at the later of (i) the time when all events have occurred
that establish the liability to pay the expense and the amount of such liability
can be determined with reasonable accuracy or (ii) the time when economic
performance with respect to the item of expense has occurred.
34
Bad Debt Reserves. The Small Business Job Protection Act of 1996 eliminated
the use of the reserve method of accounting for bad debt reserves by savings
institutions, effective for taxable years beginning after 1995. Prior to that
time, the Company was permitted to establish a reserve for bad debts and to make
additions to the reserve. These additions could, within specified formula
limits, be deducted in arriving at taxable income. As a result of the Small
Business Job Protection Act, savings institutions must use the specific
charge-off method in computing their bad debt deduction beginning with their
1996 federal tax return.
Prior to the Small Business Protection Act of 1996, bad debt reserves
created prior to January 1, 1988 were subject to recapture into taxable income
if the Bank failed to meet certain thrift asset and definitional tests. New
federal legislation eliminated these thrift-related recapture rules. However, to
the extent that the Bank makes "non-dividend distributions" that are considered
as made (i) from the reserve for losses on qualifying real property loans or
(ii) from the supplemental reserve for losses on loans, then an amount based on
the amount distributed will be included in its taxable income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, distributions in redemption of stock, and
distributions in partial or complete liquidation. Dividends paid out of the
Bank's current or accumulated earnings and profits, as calculated for federal
income tax purposes, will not be considered to result in a distribution from our
bad debt reserve. As a result, any dividends that would reduce amounts
appropriated to bad debt reserve and deducted for federal income tax purposes
would create a tax liability for the Bank.
Minimum Tax. The Code imposes an alternative minimum tax ("AMT") at a rate
of 20% on a base of regular taxable income plus certain tax preferences
("alternative minimum taxable income" or "AMTI"). The alternative minimum tax is
payable to the extent such AMTI is in excess of an exemption amount and the AMT
exceeds the regular income tax. Net operating losses can offset no more than 90%
of AMTI. Certain payments of alternative minimum tax may be used as credits
against regular tax liabilities in future years. At September 30, 2007, the
Company has approximately $182,000 of AMT credit carryforwards.
Net Operating Loss Carryovers. For net operating losses in years beginning
after August 5, 1997, net operating losses can be carried back to the two years
preceding the loss year and forward to the 20 years following the loss year. At
September 30, 2007, the Company had approximately $1.8 million of net operating
loss carryforwards which would expire in tax years 2025 and 2026. Audit by IRS.
The Bank's consolidated federal income tax returns for taxable years through
September 30, 1998 have been closed for the purpose of examination by the IRS.
STATE TAXATION
The Company and the Bank's subsidiaries are subject to the Pennsylvania
Corporate Net Income Tax and Capital Stock and Franchise Tax. The Corporate Net
Income Tax rate for fiscal 2007 is 9.99% and is imposed on the Company's
unconsolidated taxable income for federal purposes with certain adjustments. In
general, the Capital Stock and Franchise Tax is a property tax imposed at the
rate of 0.489% of a corporation's capital stock value, which is determined in
accordance with a fixed formula.
The Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax Act
(the ("MTIT"), as amended to include thrift institutions having capital stock.
Pursuant to the MTIT, the Bank's tax rate is 11.5%. The MTIT exempts the Bank
from all other taxes imposed by the Commonwealth of Pennsylvania for state
income tax purposes and from all local taxation imposed by political
subdivisions, except taxes on real estate and real estate transfers. The MTIT is
a tax upon net earnings, determined in accordance with GAAP with certain
adjustments. The MTIT, in computing GAAP income, allows for the deduction of
interest earned on state and federal securities, while disallowing a percentage
of the thrift's interest expense deduction in the proportion of interest income
on those securities to the overall interest income of the Bank. Net operating
losses, if any, thereafter can be carried forward three years for MTIT purposes.
35
ITEM 1A. RISK FACTORS.
OUR OPERATIONS ARE SUBJECT TO INTEREST RATE RISK AND VARIATIONS IN INTEREST
RATES MAY NEGATIVELY AFFECT FINANCIAL PERFORMANCE.
Our earnings and cash flows are largely dependent upon our net interest
income. Net interest income is the difference between interest income earned on
interest-earning assets such as loans and securities and interest expense paid
on interest-bearing liabilities such as deposits and borrowed money. Changes in
the general level of interest rates may have an adverse effect on our business,
financial condition and result of operations. Interest rates are highly
sensitive to many factors that are beyond our control, including general
economic conditions and policies of various governmental and regulatory agencies
and, in particular, the FRB. Changes in monetary policy, including changes in
interest rates, influence the amount of interest income that we receive on loans
and securities and the amount of interest that we pay on deposits and
borrowings. Changes in monetary policy and interest rates also can adversely
affect:
- our ability to originate loans and obtain deposits;
- the fair value of our financial assets and liabilities; and
- the average duration of our securities portfolio.
If the interest rates paid on deposits and other borrowings increase at a
faster rate than the interest rates received on loans and other investments, our
net interest income, and therefore earnings, could be adversely affected.
Earnings could also be adversely affected if the interest rates received on
loans and other investments fall more quickly than the interest rates paid on
deposits and other borrowings.
THE OPERATING RESTRICTIONS IMPOSED BY THE OTS IN THE SUPERVISORY AGREEMENTS
LIMIT OUR ABILITY TO GROW, WHICH MAY ADVERSELY AFFECT OUR ABILITY TO
SUCCESSFULLY IMPLEMENT OUR BUSINESS STRATEGY.
In February 2006, the Company and the Bank each entered into supervisory
agreements with the OTS. The supervisory agreements provide for a number of
restrictions on the operations of the Company and the Bank, including the
requirement for the Company to cease paying dividends and to not repurchase any
shares of its common stock and for the Bank to not grow in any quarter in excess
of the greater of its net interest credited or 3% (on an annualized basis). For
further information, see Item 1, "Business - Supervisory Agreements." If the
restrictions imposed by the supervisory agreements are not removed or reduced,
it may adversely affect our ability to successfully implement our business
strategy and thus may also adversely affect our financial condition and results
of operations. As a result of the supervisory agreements, the Company submitted
a capital plan to the OTS. The Company's capital plan, which has been approved
by the OTS, calls for, among other things, an equity infusion in order to reduce
the Company's debt-to-equity ratio below 50%. A private placement was undertaken
in order to comply with the Company's capital plan. The net proceeds from this
private placement both increased the Company's capital as well as reduced its
debt-to-equity ratio.
WE MAY BE UNABLE TO SUCCESSFULLY IMPLEMENT OUR BUSINESS STRATEGY.
Implementation of our business strategy is dependent on (i) the termination
of the supervisory agreements we entered into in February 2006 with the OTS or
the elimination of, or substantial reduction in, the operating restrictions
imposed by such agreements, in particular the restriction limiting our asset
growth, which likely will depend, in part, on our ability to comply with the
provisions of our capital plan which was approved by the OTS in May 2006; (ii)
our ability to attract sufficient low cost retail and commercial deposits; (iii)
maintaining existing and attracting new business banking relationships; (iv)
expanding our commercial business and commercial real estate lending portfolios;
(v) attracting and retaining experienced commercial lenders and other key
managerial employees; and (vi) expanding our branch network in Delaware and
Chester Counties, Pennsylvania. The failure to achieve these strategic goals
could adversely affect our ability to successfully implement our business
strategy and thus our financial condition and results of operations.
WE ARE SUBJECT TO LENDING RISK AND COULD SUFFER LOSSES IN OUR LOAN PORTFOLIO
DESPITE OUR UNDERWRITING PRACTICES.
There are inherent risks associated with our lending activities. There are
risks inherent in making any loan, including those related to dealing with
individual borrowers, nonpayment, uncertainties as to the future value of
collateral and changes in economic and industry conditions. We attempt to
closely manage our credit risk through loan underwriting and application
approval procedures, monitoring of large loan relationships and periodic
independent reviews of outstanding loans by our lending department and third
party loan review specialists. We cannot assure that such approval and
monitoring procedures will reduce these credit risks.
36
OUR LOAN PORTFOLIO INCLUDES COMMERCIAL AND MULTI-FAMILY REAL ESTATE, COMMERCIAL
BUSINESS AND CONSTRUCTION LOANS WHICH HAVE A GENERALLY HIGHER RISK OF LOSS THAN
SINGLE-FAMILY RESIDENTIAL LOANS.
As of September 30, 2007, approximately 34.0% of our loan portfolio
consisted of commercial business, construction and land development and
commercial and multi-family real estate loans. We are focused on increasing
these types of loans in the future. These types of loans involve increased risks
because the borrower's ability to repay the loan typically depends on the
successful operation of the business or the property securing the loan.
Additionally, these loans are made to small or middle-market business customers
who may be more vulnerable to economic conditions and who may not have
experienced a complete business or economic cycle. These types of loans are also
typically larger than single-family residential mortgage loans or consumer
loans. Furthermore, since these types of loans frequently have relatively large
balances, the deterioration of one or more of these loans could cause a
significant increase in non-performing loans and/or non-performing assets. An
increase in non-performing loans would result in a reduction in interest income
recognized on loans. An increase in non-performing loans also could require us
to increase the provision for losses on loans and increase loan charge-offs,
both of which would reduce our net income. All of these could have a material
adverse effect on our financial condition and results of operations. As of
September 30, 2007, the Bank had $12.0 million of classified assets consisting
of $10.5 million in commercial loans. See "Business - Asset Quality."
ADVERSE ECONOMIC AND BUSINESS CONDITIONS IN OUR PRIMARY MARKET AREA COULD CAUSE
AN INCREASE IN LOAN DELINQUENCIES AND NON-PERFORMING ASSETS WHICH COULD
ADVERSELY AFFECT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The substantial majority of our real estate loans are secured by properties
located in Delaware and Chester Counties, Pennsylvania, our primary market area.
Furthermore, at September 30, 2007, approximately 34.0% of our loan portfolio
consisted of commercial business, construction and land development and
commercial and multi-family real estate loans. The Company's results of
operations and financial condition may be adversely affected by changes in
prevailing economic conditions, particularly in the Philadelphia metropolitan
area, including decreases in real estate values, adverse local employment
conditions, and other significant local events. Any deterioration in the local
economy could result in borrowers not being able to repay their loans, the value
of the collateral securing the Company's loans to borrowers declining and the
quality of the loan portfolio deteriorating. This could result in an increase in
delinquencies and non-performing assets or require the Company to record loan
charge-offs and/or increase the Company's provisions for loan losses, which
would reduce the Company's earnings.
OUR ALLOWANCE FOR LOSSES ON LOANS MAY BE INSUFFICIENT TO COVER ACTUAL LOSSES ON
LOANS.
We maintain an allowance for losses on loans at a level believed adequate
by us to absorb credit losses inherent in the loan portfolio. The allowance for
losses on loans is a reserve established through a provision for losses on loans
charged to expense that represents our estimate of probable incurred losses
within the loan portfolio at each statement of condition date and is based on
the review of available and relevant information. The level of the allowance for
losses on loans reflects, among other things, our consideration of the Company's
historical experience, levels of and trends in delinquencies, the amount of
classified assets, the volume and type of lending, and current and anticipated
economic conditions, especially as they relate to the Company's primary market
area. The determination of the appropriate level of the allowance for losses on
loans inherently involves a high degree of subjectivity and requires us to make
significant estimates of current credit risks and future trends. Our allowance
for loan losses may be insufficient to cover actual losses experienced on loans.
Changes in economic conditions affecting borrowers, new information regarding
existing loans, identification of additional problem loans and other factors,
both within and outside of our control, may require an increase in the allowance
for losses on loans. In addition, bank regulatory agencies periodically review
our allowance for losses on loans and may require an increase in the provision
for losses on loans or the recognition of further loan charge offs, based on
judgments different from ours. Also, if charge offs in future periods exceed the
allowance for losses on loans, we will need additional provisions to increase
our allowance for losses on loans. Any increases in the allowance for losses on
loans will result in a decrease in net income and possibly capital, and may have
a material adverse effect on our financial condition and results of operations.
37
WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY AND MARKET AREA WITH OTHER FINANCIAL
INSTITUTIONS OFFERING PRODUCTS AND SERVICES SIMILAR TO THOSE WE OFFER.
We compete with savings associations, national banks, regional banks and
other community banks in making loans, attracting deposits and recruiting and
retaining talented employees, many of which have greater financial and technical
resources than us. Currently, there are more than 30 competing financial
institutions in Delaware and Chester Counties, our principal market area. We
also compete with securities and brokerage companies, mortgage companies,
insurance companies, finance companies, money market mutual funds, credit unions
and other non-bank financial service providers. Many of these competitors are
not subject to the same regulatory restrictions to which we are subject, yet are
able to provide customers with a feasible alternative to traditional banking
services. The competition in our market for making commercial and construction
loans has resulted in more competitive pricing as well as intense competition
for skilled commercial lending officers. These trends could have a material
adverse effect on our ability to grow (irrespective of the limitations imposed
by the supervisory agreements) and remain profitable. In addition, if we
experience an inability to recruit and retain skilled commercial lending
officers, including experienced construction lenders, it could pose a
significant barrier to retaining and growing our customer base. The competition
in our market for attracting deposits also has resulted in more competitive
pricing.
WE ARE SUBJECT TO EXTENSIVE GOVERNMENT REGULATION AND SUPERVISION WHICH COULD
ADVERSELY AFFECT OUR OPERATIONS.
We are subject to extensive federal and state regulations and supervision.
Banking regulations are primarily intended to protect depositors' funds, federal
deposit insurance funds and the banking system as a whole, not stockholders.
These regulations affect our lending practices, capital structure, investment
practices, dividend policy and growth, among other things. Congress and federal
agencies continually review banking laws, regulations and policies for possible
changes. Changes to statutes, regulations or regulatory policies, including
changes in interpretation or implementation of statutes, regulations or
policies, could affect us in substantial and unpredictable ways. Such changes
could subject us to additional costs, limit the types of financial services and
products we may offer and/or increase the ability of non-banks to offer
competing financial services and products, among other things. Failure to comply
with law, regulations or policies could result in sanctions by regulatory
agencies, civil money penalties and/or reputation damage, which could have a
material adverse effect on our business, financial condition and results of
operations.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
NOT APPLICABLE.
38
ITEM 2. PROPERTIES.
At September 30, 2007, the Bank conducted business from its executive
offices located in Media, Pennsylvania and seven full-service offices located in
Delaware and Chester Counties, Pennsylvania. See also Note 7 of the Notes to
Consolidated Financial Statements set forth in Item 8 hereof.
The following table sets forth certain information with respect to the
Bank's offices at September 30, 2007.
Net Book Value Amount of
Description/Address Leased/Owned of Property Deposits
- ----------------------------------- ------------ -------------- ---------
(Dollars in thousands)
Executive Offices:
22 West State Street
Media, Pennsylvania 19063 Owned(1) $1,695 $83,604
Branch Offices:
3218 Edgmont Avenue
Brookhaven, Pennsylvania 19015 Owned 237 72,179
Routes 1 and 100
Chadds Ford, Pennsylvania 19317 Leased(2) 28 26,606
23 East Fifth Street
Chester, Pennsylvania 19013 Leased(3) 35 29,961
31 Baltimore Pike
Chester Heights, Pennsylvania 19017 Leased(4) 442 42,901
106 East Street Road
Kennett Square, Pennsylvania 19348 Leased(5) 396 19,401
5000 Pennell Road
Aston, Pennsylvania 19014 Leased(6) 736 21,426
330 Dartmouth Avenue
Swarthmore, Pennsylvania 19081 Owned 99 57,630
------ --------
Total $3,668 $353,708
====== ========
- ----------
(1) Also a branch office.
(2) Lease expiration date is September 30, 2010. The Bank has one five-year
renewal option.
(3) Lease expiration date is December 31, 2015.
(4) Lease expiration date is December 31, 2028. The Bank has options to cancel
on the 15th, 20th and 25th year of the lease.
(5) Lease expiration date is September 30, 2034. The Bank has one six-year
renewal option followed by a five-year renewal option.
(6) Lease expiration date is December 31, 2033. The Bank has options to cancel
on the 15th, 20th and 25th year of the lease.
39
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in routine legal proceedings occurring in the
ordinary course of business which, in the aggregate, are believed by management
to be immaterial to the financial condition and operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) As of September 30, 2007, there were 2,432,998 shares of common stock
outstanding. As of September 30, 2007, the Company had 391 stockholders of
record not including the number of persons or entities holding stock in nominee
or street name through various brokers and banks.
The following table sets forth the quarterly high and low trading stock
prices of the Company's common stock as reported by the Nasdaq Stock Market
under the symbol "FKFS". Price information appears in a major newspaper under
the symbol "FstKeyst".
YEAR ENDED
---------------------------------------
SEPTEMBER 30, 2007 SEPTEMBER 30, 2006
------------------ ------------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First Quarter $19.75 $18.48 $22.00 $19.27
Second Quarter $20.61 $19.00 $20.30 $19.01
Third Quarter $20.25 $18.87 $21.25 $18.01
Fourth Quarter $19.90 $12.55 $19.73 $16.47
The following schedule summarizes the cash dividends per share of common
stock paid by the Company during the periods indicated.
YEAR ENDED SEPTEMBER 30,
------------------------
2007 2006
---- -----
First Quarter $-- $0.11
Second Quarter -- 0.11
Third Quarter -- --
Fourth Quarter -- --
Pursuant to the terms of the supervisory agreement between the Company and
the OTS, the Company is not permitted to pay dividends until the Company meets
certain limitations. See Item 1, "Business - Supervisory Agreements" and Note 11
of the "Notes to Consolidated Financial Statements" set forth in Item 8 hereof
for discussion of restrictions on the Company's and the Bank's ability to pay
dividends. Also see "Business - Regulation-Capital Distributions" for a
discussion of restrictions on the Bank's ability to pay dividends to the
Company.
The information for all equity based and individual compensation
arrangements is incorporated by reference from Item 12 hereof.
(b) As previously disclosed, the Company completed a private placement of
400,000 shares of Common Stock on December 11, 2006, resulting in gross proceeds
of approximately $6.5 million and net proceeds of approximately $5.8 million.
Included in the expenses were placement agent fees paid to Sandler O'Neill &
Partners, LP totaling approximately $393,000. The net proceeds of the offering
were used to redeem approximately the same amount of trust preferred securities
in June 2007.
(c) As previously disclosed, the Company does not have a repurchase program
currently in effect. In addition, pursuant to the terms of the supervisory
agreement between the Company and the OTS, the Company is not permitted to
repurchase shares of common stock. See Item 1, "Business -- Supervisory
Agreements."
40
(d) The following graph compares the cumulative total return on the Common
Stock since September 30, 2002 with (i) the yearly cumulative total return on
the stocks included in the Russell 2000 Index; (ii) the yearly cumulative total
return on the stocks included in the Nasdaq Bank Index; and (iii) the yearly
cumulative total return on the stocks indexed in the S&P Bank Index. All of
these cumulative returns are computed assuming the reinvestment of dividends at
the frequency with which dividends were paid during the applicable years. The
graph represents $100 invested in the Company's Common Stock at $15.50 per share
on September 30, 2002.
[PERFORMANCE GRAPH]
Index 09/30/02 09/30/03 09/30/04 09/30/05 09/30/06 09/30/07
- ------------------------------------- -------- -------- -------- -------- -------- --------
First Keystone Financial, Inc. (FKFS) $100.00 $167.26 $144.78 $145.90 $133.04 $ 95.22
Russell 2000 Index (RTY) 100.00 134.62 158.15 184.34 200.29 222.33
Nasdaq Bank Index (BANK) 100.00 117.85 135.29 137.62 148.88 137.26
S&P Bank Index (BIX) 100.00 111.64 130.48 123.42 144.15 131.45
41
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial and other data of the Company set forth
below does not purport to be complete and should be read in conjunction with,
and is qualified in its entirety by, the more detailed information, including
the Consolidated Financial Statements and related Notes, set forth in Item 8
hereof.
AT OR FOR THE YEAR ENDED SEPTEMBER 30,
----------------------------------------------------
2007 2006 2005 2004 2003
-------- -------- -------- -------- --------
(Dollars in thousands, except per share data)
SELECTED FINANCIAL DATA:
Total assets $524,881 $522,960 $518,124 $571,919 $559,612
Loans receivable, net 292,418 323,220 301,979 304,248 286,421
Mortgage-related securities held to maturity 31,294 38,355 46,654 37,363 3,487
Investment securities held to maturity 3,256 3,257 4,267 5,287 6,315
Assets held for sale:
Mortgage-related securities 79,178 70,030 67,527 97,620 124,656
Investment securities 29,284 33,386 37,019 63,615 77,700
Loans -- 1,334 41 172 4,498
Real estate owned -- 2,450 760 1,229 1,420
Deposits 353,708 358,816 349,694 344,880 362,605
Borrowings 115,384 107,241 113,303 171,149 136,272
Junior subordinated debentures 15,264 21,483 21,520 21,557 21,593
Stockholders' equity 34,694 28,659 28,193 29,698 32,388
Non-performing assets 4,685 2,727 5,812 3,262 2,976
SELECTED OPERATIONS DATA:
Interest income $ 28,381 $ 27,493 $ 27,076 $ 26,143 $ 27,212
Interest expense 18,225 16,415 15,768 14,712 16,012
-------- -------- -------- -------- --------
Net interest income 10,156 11,078 11,308 11,431 11,200
Provision for loan losses 375 1,206 1,780 300 715
-------- -------- -------- -------- --------
Net interest income
after provision for loan losses 9,781 9,872 9,528 11,131 10,485
Service charges and other fees 1,661 1,560 1,577 1,235 1,013
Net gain on sales of interest-earning assets 283 338 802 968 1,010
Other non-interest income 1,069 1,614 1,210 1,696 1,263
Non-interest expense 12,549 12,708 12,820 12,501 10,400
-------- -------- -------- -------- --------
Income before income taxes 245 676 297 2,529 3,371
Income tax (benefit) expense (220) (359) (313) 326 632
-------- -------- -------- -------- --------
Net income $ 465 $ 1,035 $ 610 $ 2,203 $ 2,739
======== ======== ======== ======== ========
PER SHARE DATA:
Basic earnings per share $ 0.21 $ 0.55 $ 0.33 $ 1.21 $ 1.44
Diluted earnings per share 0.21 0.54 0.33 1.14 1.35
Cash dividends per share -- 0.11 0.44 0.44 0.40
42
AT OR FOR THE YEAR ENDED SEPTEMBER 30,
--------------------------------------------
2007 2006 2005 2004 2003
------ -------- ------ ------ ------
(Dollars in thousands, except per share data)
SELECTED OPERATING RATIOS:
Average yield earned on interest-earning assets 6.01% 5.72% 5.06% 4.94% 5.40%
Average rate paid on interest-bearing
liabilities 3.90 3.40 2.96 2.80 3.22
Average interest rate spread 2.11 2.32 2.10 2.14 2.18
Net interest margin 2.15 2.30 2.11 2.16 2.22
Ratio of interest-earning assets to interest-
bearing liabilities 101.05 99.67 100.52 100.69 101.44
Efficiency ratio (1) 95.29 87.10 86.06 81.55 64.50
Non-interest expense as a percent
of average assets 2.47 2.46 2.26 2.23 1.95
Return on average assets 0.09 0.20 0.11 0.39 0.51
Return on average equity 1.40 3.73 2.08 7.13 8.39
Ratio of average equity to average assets 6.53 5.37 5.18 5.50 6.12
Full-service offices at end of period 8 8 8 7 7
ASSET QUALITY RATIOS:(2)
Non-performing loans as a
percent of gross loans receivable 1.55% 0.08% 1.65% 0.66% 0.53%
Non-performing assets as a
percent of total assets 0.89 0.52 1.12 0.57 0.53
Allowance for loan losses as a
percent of gross loans receivable 1.12 1.03 1.14 0.67 0.68
Allowance for loan losses as a
percent of non-performing loans 70.91 1,215.61 68.79 100.29 127.63
Net loans charged-off to average
loans receivable 0.13 0.42 0.11 0.08 0.37
CAPITAL RATIOS:(2) (3)
Tangible capital ratio 9.37% 9.15% 8.85% 8.21% 7.98%
Core capital ratio 9.38 9.15 8.85 8.21 7.98
Risk-based capital ratio 16.49 14.94 15.13 14.56 14.97
(1) Reflects non-interest expense as a percent of the aggregate of net interest
income and non-interest income.
(2) Asset Quality Ratios and Capital Ratios are end of period ratios except for
the ratio of loan charge-offs to average loans. With the exception of end
of period ratios, all ratios are based on average daily balances during the
indicated periods. Gross loans receivable are net of loans in process.
(3) Reflects regulatory capital ratios of the Company's wholly owned
subsidiary, First Keystone Bank.
43
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
First Keystone Financial, Inc. (the "Company") is the holding company for
its wholly owned subsidiary, First Keystone Bank (the "Bank"). For purposes of
this discussion, references to the Company will include its wholly owned
subsidiaries, unless otherwise indicated. The Company is a community-oriented
banking organization that focuses on providing customer and business services
within its primary market area, consisting primarily of Delaware and Chester
Counties in southeastern Pennsylvania.
The following discussion should be read in conjunction with the Company's
consolidated financial statements presented in Item 8 of this Annual Report on
Form 10-K. The primary asset of the Company is its investment in the Bank and,
accordingly, the discussion below with respect to results of operations relates
primarily to the operations of the Bank.
The Company's results of operations depend primarily on its net interest
income which is the difference between interest income on interest-earning
assets, which principally consist of loans, mortgage-related securities and
investment securities, and interest expense on interest-bearing liabilities,
which principally consist of deposits and Federal Home Loan Bank ("FHLB")
advances. The Company's results of operations also are affected by the provision
for loan losses (the amount of which reflects management's assessment of the
known and inherent losses in its loan portfolio that are both probable and
reasonably estimable), the level of its non-interest income, including service
charges and other fees as well as gains and losses from the sale of certain
assets, the level of its operating expenses, and the amount of income tax
expense or benefit.
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 all 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 loans (special mention) 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 determination as to the amount of its allowance for loan
losses is subject to review by its primary federal banking regulator, the OTS,
as part of its examination process, which may result in additional allowances
based upon the judgment and review of the OTS. See "- Provision for Loan
Losses."
44
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 written notice from the Company of the proposed dividend, does
not object to such payment.
The Company has submitted to and received from the OTS approval of a
capital plan, which 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. In June 2007, the net proceeds of
approximately $5.8 million were used to reduce the amount of its outstanding
debt through the redemption of $6.2 million of its junior subordinated
debentures. As a result of such redemption, the Company's debt-to-equity ratio
is less than 50%. Although the Company's debt-to-equity ratio is below 50%, it
does not anticipate resuming the payment of dividends until such time as the
Company's operating results improve.
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.
As a result of the supervisory agreement, the Bank hired a Chief Credit
Officer ("CCO") who, under the direction of the Board and the CEO, has taken
steps to enhance the Bank's credit review analysis, develop loan administrative
procedures and adopt an asset classification system. The Bank continues to
address these areas and to reduce the level of classified and criticized assets
in order to be in full compliance with the terms of the supervisory agreements.
At September 30, 2007, the Company believes it and the Bank are in compliance
with all the operative provisions of the supervisory agreements.
45
ASSET AND LIABILITY MANAGEMENT
The principal objectives of the Company's asset and liability management
are to (i) evaluate the interest rate risk existing in certain assets and
liabilities, (ii) determine the appropriate level of risk given the Company's
business focus, operating environment, capital and liquidity requirements and
performance objectives, (iii) establish prudent asset and liability
compositions, and (iv) manage the assessed risk consistent with Board approved
guidelines. Through asset and liability management, the Company seeks to reduce
both the vulnerability and volatility of its operations to changes in interest
rates and to manage the ratio of interest-rate sensitive assets to interest-rate
sensitive liabilities within specified maturities or repricing periods. The
Company's actions in this regard are taken under the guidance of the
Asset/Liability Committee ("ALCO"), which is chaired by the Chief Financial
Officer and comprised of members of the Company's senior management. The ALCO
meets no less than quarterly to review, among other things, liquidity and cash
flow needs, current market conditions and the interest rate environment, the
sensitivity to changes in interest rates of the Company's assets and
liabilities, the historical and market values of assets and liabilities,
unrealized gains and losses, and the repricing and maturity characteristics of
loans, investment securities, deposits and borrowings. The ALCO reports to the
Company's Board of Directors no less than once a quarter. In addition,
management reviews at least weekly the pricing of the Company's commercial loans
and retail deposits. The pricing of residential loans, including those being
originated for sale in the secondary market, is reviewed daily.
The Company's primary asset/liability monitoring tools consist of various
asset/liability simulation models which are prepared on a quarterly basis. The
models are designed to capture the dynamics of the balance sheet as well as rate
and spread movements and to quantify variations in net interest income under
different interest rate scenarios.
One of the models consists of an analysis of the extent to which assets and
liabilities are interest rate sensitive and measures an institution's interest
rate sensitivity gap. An asset or liability is said to be interest rate
sensitive within a specific time period if it will mature or reprice within that
time period. An institution's interest rate sensitivity gap is defined as the
difference between interest-earning assets and interest-bearing liabilities
maturing or repricing within a given time period. A gap is considered positive
when the amount of interest rate sensitive assets exceeds the amount of interest
rate sensitive liabilities and is considered negative when the amount of
interest rate sensitive liabilities exceeds interest rate sensitive assets.
During a period of falling interest rates, a negative gap would tend to result
in an increase in net interest income, while a positive gap would tend to result
in a decline in net interest income. Conversely, during a period of rising
interest rates, a negative gap would tend to result in a decline in net interest
income, while a positive gap would tend to result in an increase in net interest
income.
The Bank's passbook, statement savings, MMDA and NOW accounts are generally
subject to immediate withdrawal. However, management considers a portion of
these deposits to be core deposits (which consists of passbook, statement
saving, MMDA and NOW accounts) having significantly longer effective maturities
based upon the Bank's experience in retaining such deposits in changing interest
rate environments. Borrowed funds are included in the period in which they can
be called or when they mature.
Management believes that the assumptions used to evaluate the vulnerability
of the Bank's operations to changes in interest rates are considered reasonable.
However, certain shortcomings are inherent in the method of analysis presented
in the table below. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates, while interest rates on other types
may lag behind changes in market rates. Additionally, certain assets, such as
adjustable-rate loans, have features which restrict changes in market rates both
on a short-term and over the life of the asset. Further, in the event of a
material change in interest rates, prepayments and early withdrawal levels would
likely deviate significantly from those assumed in calculating the table.
46
The following table summarizes the Company's interest-earning assets and
interest-bearing liabilities as of September 30, 2007 based on certain
assumptions management has made that affect the rate at which loans will prepay
and the duration of core deposits.
More Than More Than
Within Six to One Year Three Over
Six Twelve to Three Years to Five
Months Months Years Five Years Years Total
-------- -------- --------- ---------- ------- --------
(Dollars in thousands)
Interest-earning assets:
Loans receivable, net(1) $ 73,899 $ 25,349 $ 71,560 $ 54,659 $65,329 $290,796
Mortgage-related securities 39,001 35,105 29,818 5,323 1,225 110,472
Investment securities(2) 23,823 -- 4,724 1,074 9,257 38,878
Interest-earning deposits
48,293 -- -- -- -- 48,293
-------- -------- -------- -------- ------- --------
Total interest-earning assets $185,016 $ 60,454 $106,102 $ 61,056 $75,811 $488,439
-------- -------- -------- -------- ------- --------
Interest-bearing liabilities:
Deposits $144,634 $ 67,665 $ 77,110 $ 53,610 $10,689 $353,708
Borrowed funds 29,178 5,515 25,041 55,514 136 115,384
Junior subordinated debentures
2,062 -- -- -- 13,202 15,264
-------- -------- -------- -------- ------- --------
Total interest-bearing liabilities $175,874 $ 73,180 $102,151 $109,124 $24,027 $484,356
-------- -------- -------- -------- ------- --------
Excess (deficiency) of interest-earning
assets over interest-bearing liabilities $ 9,142 $(12,726) $ 3,951 $(48,068) $51,784 $ 4,083
======== ======== ======== ======== ======= ========
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities $ 9,142 $ (3,584) $ 367 $(47,701) $ 4,083
======== ======== ======== ======== =======
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities as a
percentage of total assets 1.74% (0.68)% 0.07% (9.09)% 0.78%
======== ======== ======== ======== =======
- ----------
(1) Balances have been reduced for non-accruing loans, which amounted to $1.6
million at September 30, 2007.
(2) Balance includes FHLB stock.
Although an analysis of the interest rate sensitivity gap measure may be
useful, it is limited in its ability to predict trends in future earnings. It
makes no presumptions about changes in prepayment tendencies, deposit or loan
maturity preferences or repricing time lags that may occur in response to a
change in the interest rate environment. As a consequence, the Company also
utilizes an analysis of the market value of portfolio equity, which addresses
the estimated change in the value of the Bank's equity arising from movements in
interest rates. The market value of portfolio equity is estimated by valuing the
Bank's assets and liabilities under different interest rate scenarios. The
extent to which assets gain or lose value in relation to gains or losses of
liabilities as interest rates increase or decrease determines the appreciation
or depreciation in equity on a market value basis. Market value analysis is
intended to evaluate the impact of immediate and sustained shifts of the current
yield curve upon the market value of the Bank's current balance sheet.
The Company utilizes reports prepared by the OTS to measure interest rate
risk. Using data submitted by the Bank, the OTS performs scenario analysis to
estimate the net portfolio value ("NPV") of the Bank over a variety of interest
rate scenarios. The NPV is defined as the present value of expected cash flows
from existing assets less the present value of expected cash flows from existing
liabilities plus the present value of net expected cash inflows from existing
off-balance sheet contracts.
47
The table below sets forth the Bank's NPV assuming an immediate change in
interest rates of up to 300 basis points and a decline of up to 200 basis
points. Due to the prevailing interest rate environment, the OTS did not provide
a calculation for the minus 300 basis point change in rates. Dollar amounts are
expressed in thousands as of September 30, 2007.
NET PORTFOLIO VALUE
NET PORTFOLIO VALUE AS A % OF ASSETS
-----------------------------------------------------
CHANGES IN RATES DOLLAR PERCENTAGE NPV
IN BASIS POINTS AMOUNT CHANGE CHANGE RATIO CHANGE
- ---------------- ------- -------- ---------- ------ ---------
300 $45,826 $(20,353) (31)% 8.91% (336) bp
200 52,138 (14,040) (21) 10.00 (227)
100 57,918 (8,260) (12) 10.95 (132)
50 62,341 (3,838) (6) 11.67 (60)
0 66,178 -- -- 12.27 --
(50) 67,845 1,667 3 12.51 24
(100) 70,241 4,062 6 12.86 59
(200) 71,484 5,305 8 12.98 71
As is the case with interest rate sensitivity gap, certain shortcomings are
inherent in the methodology used in the above interest rate risk measurements.
Modeling changes in NPV require the making of certain assumptions which may or
may not reflect the manner in which actual yields and costs respond to changes
in market interest rates. In this regard, the NPV model presented assumes that
the composition of the Bank's interest sensitive assets and liabilities existing
at the beginning of a period remains constant over the period being measured and
also assumes that a particular change in interest rates is reflected uniformly
across the yield curve regardless of the duration to maturity or repricing of
specific assets and liabilities. Although the NPV measurements and net interest
income models provide an indication of the Bank's interest rate risk exposure at
a particular point in time, such measurements are not intended to and do not
provide a precise forecast of the effect of changes in market interest rates on
the Bank's net interest income and may differ from actual results.
The Company is aware of its interest rate risk exposure in the event of
rapidly rising rates. During fiscal 2007 and 2006, due to the inverted yield
curve, continuing interest rate margin compression, and the unappealing spreads
on mortgage-backed securities, the Bank decided to retain all of its newly
originated 30-year term fixed-rate residential mortgage loans in its portfolio.
In addition, in recent years, the Company has emphasized the origination of home
equity, construction and land, multi-family and commercial real estate and
business loans which generally have either adjustable interest rates and/or
shorter contractual terms than single-family residential loans. However, during
fiscal 2007, the Company determined to curtail the origination of commercial
loans in order to strengthen its credit and administration procedures. Since the
Company has the infrastructure in place, the Company plans to gradually expand
the origination of commercial real estate and business loans.
Derivative financial instruments include futures, forwards, interest rate
swaps, option contracts, and other financial instruments with similar
characteristics. The Company currently does not enter into futures, forwards,
swaps or options. However, the Company is party to financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of our customers. These financial instruments include commitments to
extend credit. These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the consolidated
statements of financial condition. Commitments generally have fixed expiration
dates and may require additional collateral from the borrower if deemed
necessary. Commitments to extend credit are not recorded as an asset or
liability until the instruments are exercised.
The Company is subject to certain market risks and interest rate risks from
the time a commitment is issued to originate new loans. In an effort to protect
the Company against adverse interest rate movements, at the time an application
is taken for a fixed-rate, single-family residential loan, the Company typically
enters into an agreement to sell such loan upon closing, or another loan which
bears an interest rate within the same interest-rate range, into the secondary
market. This is known as a "matched sale" approach and reduces interest-rate
risk with respect to these loans. There is still some portion of these loans
which may never close for various reasons. However, the agencies the Company
sells loans to permit some flexibility in delivering loan product to them. In
certain instances, if the loans delivered for sale do not match the
characteristics outlined in the forward sale commitments, the gain on sale may
be reduced.
48
CHANGES IN FINANCIAL CONDITION
GENERAL. Total assets of the Company increased $1.9 million from $523.0
million at September 30, 2006 to $524.9 million at September 30, 2007. The
slight increase was the result of increased cash balances on hand partially
offset by the decrease in loans receivable. The Company experienced significant
levels of repayments within the construction and commercial real estate loan
portfolio while only originating a limited amount of such loans. This resulted
from the Company's self-imposed curtailment of such lending activity while
implementing substantially enhanced credit review and administration
infrastructure.
CASH AND CASH EQUIVALENTS. Cash and cash equivalents, which consists of
cash on hand and deposited in other banks in interest-earning and
non-interest-earning accounts, increased by $40.1 million to $52.9 million at
September 30, 2007 from $12.8 million at September 30, 2006. The increase in
cash and cash equivalents was primarily due to increased cash balances on hand,
and, to a lesser extent, loan repayments.
INVESTMENT SECURITIES HELD TO MATURITY AND INVESTMENT SECURITIES AVAILABLE
FOR SALE. Total investment securities decreased in the aggregate by $4.1
million, or 11.2%, from $36.6 million at September 30, 2006 to $32.5 million at
September 30, 2007. The decrease in investment securities available for sale
resulted from the sale of $7.9 million of the Company's municipal bond portfolio
which was undertaken as a result of a change in the Company's tax strategy and
was partially offset by reinvesting a portion of the proceeds in long-term
investment securities.
MORTGAGE-RELATED SECURITIES HELD TO MATURITY AND MORTGAGE-RELATED
SECURITIES AVAILABLE FOR SALE. Mortgage-related securities held to maturity and
available for sale increased in the aggregate by $2.1 million, or 1.9%, to
$110.5 million at September 30, 2007 compared to $108.4 million at September 30,
2006. The available for sale portfolio increased $9.1 million, or 13.1%, as part
of the Company's asset-liability strategy to reinvest the cashflows from the
held to maturity portfolio, and to a lesser extent, from the reinvestment of
loan repayments into the available for sale portfolio. As a result of this
strategy, the held to maturity portfolio decreased $7.1 million, or 18.4%.
LOANS HELD FOR SALE. At September 30, 2007, there were no loans held for
sale compared to $1.3 million of commercial business loans held for sale at
September 30, 2006. These commercial business loans were originated through a
program sponsored by the Small Business Administration. During fiscal year 2007,
the Company originated $271,000 of loans for sale and sold $1.6 million of
loans.
LOANS RECEIVABLE, NET. Total loans receivable, net, decreased $30.8
million, or 9.5%, to $292.4 million at September 30, 2007 compared to $323.2
million at September 30, 2006. The decrease in loans receivable was primarily
due to a $14.7 million, or 38.4%, decrease in construction loans, a $10.5
million, or 14.9%, decrease in commercial real estate loans and $5.5 million, or
22.4%, decrease in commercial business loans. The decrease in the construction
loan portfolio was primarily due to developers repaying their existing loans and
delaying new projects due to the turmoil in the housing markets. The decrease in
the commercial real estate and business loan portfolios was primarily due to
loan repayments and, to a lesser extent, the Company's workout strategy to exit
certain loans as well as the Company's decision to curtail such lending for a
limited amount of time in order to enhance its credit review and commercial
lending infrastructure.
NON-PERFORMING ASSETS. The Company's total non-performing loans and real
estate owned increased to $4.7 million, or 0.9% of total assets, at September
30, 2007 compared to $2.7 million, or 0.5% of total assets, at the end of the
prior fiscal year. The increase in non-performing assets in fiscal 2007 was
attributable to a $4.4 million increase to $4.7 million in non-performing loans
partially offset by a $2.4 million decrease in real estate owned. The increase
in non-performing loans was primarily due a $1.3 million increase in non-accrual
loans as a result of a $1.1 million non-accrual commercial real estate loan. The
commercial property consists of a bakery along with rental units above the
establishment located in Center City Philadelphia, Pennsylvania. Subsequent to
September 30, 2007, the commercial property was sold and the proceeds from the
sale were used to repay the loans in full. In addition, loans that are 90 days
delinquent and still accruing increased $3.1 million. The increase in loans 90
days delinquent and still accruing primarily consisted of commercial loans which
were not repaid in full as of their contractual maturity. The loans continue to
pay in accordance with their terms otherwise. Offsetting the increase in
non-performing assets, the Company's only real estate owned, which consisted of
a restaurant located in Chesapeake City, Maryland, was sold for $2.5 million
resulting in a pre-tax gain on the sale of $71,000. See Item 1 "Business - Asset
Quality."
49
DEPOSITS. Deposits decreased by $5.1 million, or 1.4%, from $358.8 million
at September 30, 2006 to $353.7 million at September 30, 2007. The decrease in
deposits resulted from a $7.7 million, or 4.4%, decrease in core deposits (which
consist of passbook, money market, NOW and non-interest bearing accounts)
partially offset by a $2.6 million, or 1.4%, increase in certificates of
deposit. The decrease in deposits was due to the competitive pricing of the
Company's core deposits, in particular money market, compared to those paid by
the competition.
BORROWINGS. The Company's total borrowings, which primarily consist of
advances from the FHLB, increased to $115.4 million at September 30, 2007 from
$107.2 million at September 30, 2006 as part of the Company's asset-liability
strategy. Borrowings had a weighted average interest rate of 5.4% at September
30, 2007 as compared to 5.5% at September 30, 2006. See Note 9 to the
Consolidated Financial Statements set forth in Item 8 hereof for further
information.
JUNIOR SUBORDINATED DEBENTURES. On August 21, 1997, the Company issued
$16.7 million of junior subordinated debentures to First Keystone Capital Trust
I (the "Trust"). The Trust issued preferred securities at an interest rate of
9.7%, with a scheduled maturity of August 15, 2027. In addition, the Company
issued $8.2 million of Junior Subordinated Debentures to First Keystone Capital
Trust II (the "Trust II"). The Trust issued preferred securities in a pooled
securities offering at a floating rate of 375 basis points over the six month
LIBOR with a maturity date of December 8, 2031. The Company owns all the common
stock of both trusts. Junior subordinated debentures decreased $6.2 million to
$15.3 million at September 30, 2007 as a result of the Company utilizing the
proceeds from the private placement offering to reduce its outstanding balance.
See Note 16 to the Consolidated Financial Statements set forth in Item 8 hereof
for further information.
EQUITY. At September 30, 2007, total stockholders' equity was $34.7
million, or 6.6% of total assets, compared to $28.7 million, or 5.5% of total
assets, at September 30, 2006. The increase in stockholders' equity was due to
the Company's completion of the private equity offering which raised net
proceeds of approximately $5.8 million. The Company issued 400,000 shares of
common stock from treasury resulting in a reduction in treasury stock by $6.2
million. In addition, net income of $465,000 for the fiscal year ended September
30, 2007 contributed to the increase in stockholders' equity, offsetting an
increase in other comprehensive loss of $436,000 primarily due to increases in
market rates of interest during fiscal 2007.
50
AVERAGE BALANCES, NET INTEREST INCOME AND YIELDS EARNED AND RATES PAID. The
following table sets forth, for the periods indicated, information regarding (i)
the total dollar amount of interest income of the Company from interest-earning
assets and the resultant average yields; (ii) the total dollar amount of
interest expense on interest-bearing liabilities and the resultant average rate;
(iii) net interest income; (iv) interest rate spread; and (v) net interest
margin. Information is based on average daily balances during the indicated
periods.
YEAR ENDED SEPTEMBER 30,
------------------------------------------------------------------------------------------------
YIELD/ 2007 2006 2005
COST --------------------------- --------------------------- ---------------------------
AT AVERAGE AVERAGE AVERAGE
SEPT. 30, AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
2007 BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
--------- -------- -------- ------- -------- -------- ------- -------- -------- -------
(Dollars in thousands)
Interest-earning assets:
Loans receivable(1) (2)(3) 6.51% $310,318 $20,674 6.66% $312,778 $19,956 6.38% $304,367 $17,926 5.89%
Mortgage-related securities(3) 4.81 107,913 4,989 4.62 113,995 5,054 4.43 155,292 6,223 4.01
Investment securities(3) 5.44 39,786 2,185 5.49 45,478 2,286 5.03 63,505 2,760 4.35
Other interest-earning assets 4.93 14,528 533 3.67 8,632 197 2.28 11,602 167 1.44
-------- ------- -------- ------- -------- -------
Total interest-earning
assets 5.88 472,545 28,381 6.01 480,883 27,493 5.72 534,766 27,076 5.06
---- -------- ----- -------- ----- -------- ------- ------
Non-interest-earning assets 35,751 35,885 32,543
-------- -------- --------
Total assets $508,296 $516,768 $567,309
======== ======== ========
Interest-bearing liabilities:
Deposits 3.08 $354,943 11,208 3.16 $352,371 8,547 2.43 $349,076 6,280 1.80
FHLB advances and other
borrowings 5.42 93,190 5,189 5.57 108,603 5,914 5.45 161,382 7,694 4.77
Junior subordinated debentures 9.63 19,518 1,828 9.37 21,503 1,954 9.09 21,540 1,794 8.33
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities 3.84 467,651 18,225 3.90 482,477 16,415 3.40 531,998 15,768 2.96
---- -------- ------- ----- -------- ------- ----- -------- ------- ------
Interest rate spread 2.04% 2.11% 2.32% 2.10%
==== ====== ===== ======
Non-interest-bearing liabilities 7,444 6,517 5,918
-------- -------- --------
Total liabilities 475,095 488,994 537,916
Stockholders' equity 33,201 27,774 29,393
-------- -------- --------
Total liabilities and
stockholders' equity $508,296 $516,768 $567,309
======== ======== ========
Net interest-earning assets
(liabilities) $ 4,894 $ (1,594) $ 2,768
======== ======== ========
Net interest income $10,156 $11,078 $11,308
======= ======= =======
Net interest margin(4) 2.15% 2.30% 2.11%
====== ===== ======
Ratio of average interest-earning
assets to average interest-
bearing liabilities 101.05% 99.67% 100.52%
====== ===== ======
- ----------
(1) Includes non-accrual loans.
(2) Loan fees are included in interest income and the amounts are not material
for this analysis.
(3) Includes assets classified as either available for sale or held for sale.
(4) Net interest income divided by interest-earning assets.
51
RATE/VOLUME ANALYSIS. The following table describes the extent to which
changes in interest rates and changes in the volume of interest-related assets
and liabilities have affected the Company's interest income and expense during
the periods indicated. For each category of interest-earning asset and
interest-bearing liability, information is provided on changes attributable to
(i) changes in volume (change in volume multiplied by prior year rate), (ii)
changes in rate (change in rate multiplied by prior year volume), and (iii)
total change in rate and volume. The combined effect of changes in both rate and
volume has been allocated proportionately to the change due to rate and the
change due to volume.
YEAR ENDED SEPTEMBER 30,
--------------------------------------------------------------
2007 VS. 2006 2006 VS. 2005
------------------------------ -----------------------------
INCREASE(DECREASE) DUE TO INCREASE (DECREASE) DUE TO
------------------------------ -----------------------------
TOTAL TOTAL
INCREASE INCREASE
RATE VOLUME (DECREASE) RATE VOLUME (DECREASE)
-------- ------ ---------- ------ ------- ----------
Interest-earnings assets:
Loans receivable(1) $ 873 $(155) $ 718 $1,525 $ 505 $ 2,030
Mortgage-related securities(1) 265 (330) (65) 779 (1,948) (1,169)
Investment securities(1) 285 (386) (101) 583 (1,057) (474)
Other interest-earning assets 159 177 336 53 (23) 30
------- ----- ------ ------ ------- -------
Total interest-earning assets 1,582 (694) 888 2,940 (2,523) 417
------- ----- ------ ------ ------- -------
Interest-bearing liabilities:
Deposits 2,599 62 2,661 2,207 60 2,267
FHLB advances and other borrowings 137 (862) (725) 1,369 (3,149) (1,780)
Junior subordinated debentures 63 (189) (126) 163 (3) 160
------- ----- ------ ------ ------- -------
Total interest-bearing liabilities 2,799 (989) 1,810 3,739 (3,092) 647
------- ----- ------ ------ ------- -------
Decrease in net interest income $(1,217) $ 295 $ (922) $ (799) $ 569 $ (230)
======= ===== ====== ====== ======= =======
- ----------
(1) Includes assets classified as either available for sale or held for sale.
RESULTS OF OPERATIONS
GENERAL. The Company reported net income of $465,000, $1.0 million, and
$610,000 for the years ended September 30, 2007, 2006 and 2005, respectively.
The $570,000 decrease in net income for the year ended September 30, 2007
compared to the year ended September 30, 2006 was primarily due to a $922,000
decrease in net interest income and a $499,000 decrease in non-interest income
partially offset by a decrease of $831,000 in the provision for loan losses and
a $159,000 decrease in non-interest expense.
The $425,000 increase in net income for the year ended September 30, 2006
compared to the year ended September 30, 2005 was primarily due to a $574,000,
or 32.3%, decrease in the provision for loan losses combined with a $132,000, or
1.0%, decrease in non-interest expense and an increase of $46,000, or 14.7%, in
income tax benefit partially offset by a $230,000, or 2.0%, decrease in net
interest income and a $97,000, or 2.7%, decrease in non-interest income.
NET INTEREST INCOME. Net interest income is determined by the interest rate
spread (the difference between the yields earned on interest-earning assets and
the rates paid on interest-bearing liabilities) and the relative amounts of
interest-earning assets and interest-bearing liabilities. The Company's average
interest-rate spread was 2.11%, 2.32 % and 2.10% for the years ended September
30, 2007, 2006, and 2005, respectively. The Company's interest-rate spread was
2.04% at September 30, 2007. The Company's net interest margin (net interest
income as a percentage of average interest-earning assets) was 2.15%, 2.30% and
2.11% for the years ended September 30, 2007, 2006 and 2005, respectively.
During fiscal 2007, the interest rate compression experienced by the Company
reflected the impact on increases in the rates paid on the Company's
interest-bearing liabilities consisting primarily of deposits, due to repricing
upward of liabilities due to market rates of interest as well as the flat yield
curve experienced for most of the 2007 period. Conversely, during 2006, the
improvement in the Company's net interest margin was a result of the
implementation in the fourth quarter of fiscal 2005 of a de-leveraging strategy
involving the sale of $47.5 million of various low-yielding securities, using
the proceeds to repay $46.0 million in FHLB convertible advances and overnight
borrowings.
52
For the year ended September 30, 2007, net interest income decreased to
$10.2 million as compared to $11.1 million in fiscal 2006. The $922,000, or
8.3%, decrease reflected the effect of a $1.8 million, or 11.0%, increase in
interest expense partially offset by an $888,000, or 3.2%, increase in interest
income. The decrease in net interest income was primarily due to the flat yield
curve remaining with higher short-term interest rates during fiscal 2007
impacting the rates paid on the Company's interest-bearing core deposits,
certificates of deposit and floating-rate borrowings more rapidly than the
yields earned on its interest-earning assets.
Net interest income decreased to $11.1 million in fiscal 2006 as compared
to $11.3 million in fiscal 2005. The $230,000, or 2.0%, decrease came as a
result of a $647,000, or 4.1%, decrease in interest expense partially offset by
a $417,000, or 1.5%, increase in interest income. The decrease in net interest
income was primarily due to the increase in the cost of funds due to the
increase 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.
INTEREST INCOME. The $888,000, or 3.2%, increase in total interest income
during the year ended September 30, 2007 as compared to fiscal 2006 was
primarily due to a $718,000, or 3.6%, increase in interest income on loans due
to a 28 basis point increase in the average yield earned. Additionally, the
increase in interest income was due to a $336,000, or 170.6%, increase in
interest income from interest-bearing deposits due to a $5.9 million, or 68.3%,
increase in the average balance combined with a 139 basis point increase in the
average yield earned. The increase in interest income was offset, in part, by a
$101,000, or 4.4%, decrease in interest income from investment securities as a
result of a $5.7 million, or 12.5%, decrease in the average balance of the
investments securities portfolio offset, in part, by a 46 basis point increase
in the yield earned. The increase in interest income was also offset, in part,
by a $65,000, or 1.3%, decrease in interest income on mortgage-related
securities as a result of a $6.1 million, or 5.3%, decrease in the average
balance offset, in part, by a 19 basis point increase in the yield earned on
such assets. The increase in interest income was primarily due to the increase
in the overall yield earned on interest-earning assets resulting from the
repricing of assets during the latter part of fiscal 2006 and fiscal 2007 as a
result of increased market rates of interest.
The $417,000, or 1.5%, increase in total interest income during the year
ended September 30, 2006 as compared to fiscal 2005 was primarily due to a $2.0
million, or 11.3%, increase in interest income on loans due to an $8.4 million,
or 2.8%, increase in the average balance of the loan portfolio combined with a
49 basis point increase in the average yield earned. The increase in interest
income was offset, in part, by a $1.2 million, or 18.8%, decrease in interest
income from mortgage-related securities as a result of a $41.3 million, or
26.6%, decrease in the average balance of the mortgage-related securities
portfolio offset, in part, by a 42 basis point increase in the yield earned.
Additionally, the increase in interest income was offset, in part, by a
$474,000, or 17.2%, decrease in interest income on investment securities as a
result of an $18.0 million, or 28.4%, decrease in the average balance offset, in
part, by an 87 basis point increase in the yield earned on such assets. The
increase in interest income was primarily the result of the de-leveraging
strategy implemented in the fourth quarter of fiscal 2005 combined with the cash
flows from the mortgage-related and investment portfolios being reinvested at
higher market interest rates.
INTEREST EXPENSE. Total interest expense amounted to $18.2 million for the
year ended September 30, 2007 as compared to $16.4 million for fiscal 2006. The
$1.8 million, or 11.0%, increase in fiscal 2007 compared to fiscal 2006
reflected a $2.7 million, or 31.1%, increase in interest expense on deposits was
due primarily to a 73 basis point increase in the average rate paid thereon and,
to a lesser degree, a $2.9 million increase in the average balance of deposits.
Offsetting the increase in interest expense was a $725,000, or 12.3%, decrease
in interest expense on borrowings primarily due to a $15.4 million, or 14.2%,
decrease in the average balance reflecting the impact of utilizing the proceeds
from the equity offering in fiscal 2007 to redeem $6.2 million of the junior
subordinated debentures in June 2007. However, the decrease in interest expense
on borrowings was partially offset by a 12 basis point increase in the average
rate paid reflecting higher current market rates of interest. Additionally, the
decrease in interest expense on junior subordinated debentures was due to a $2.0
million, or 9.2%, decrease in the average balance partially offset by a 28 basis
point increase in the average rate paid. During fiscal 2007, the Company
redeemed $6.0 million of the floating junior subordinated debentures with the
proceeds raised by the private equity offering completed in December 2006. The
increase in the overall cost of funds was primarily a result of competitive
pressures on pricing of deposits as well as increases to floating-rate debt as a
result of increases in market rates of interest.
53
Total interest expense amounted to $16.4 million for the year ended
September 30, 2006 as compared to $15.8 million for fiscal 2005. The $647,000,
or 4.1%, increase in fiscal 2006 compared to fiscal 2005 reflected a $2.3
million, or 36.1%, increase in interest expense on deposits combined with a
$160,000, or 8.9%, increase in interest expense on junior subordinated
debentures. The increase in interest expense on deposits was due primarily to a
63 basis point increase in the average rate paid thereon and, to a lesser
degree, a $3.3 million increase in the average balance of deposits. The increase
in interest expense on junior subordinated debentures was due to a 76 basis
point increase in the average rate paid due to the repricing of $8.0 million of
junior subordinated debentures to 9.2%. Offsetting the increase in interest
expense was a $1.8 million, or 23.1%, decrease in interest expense on borrowings
primarily due to a $52.8 million, or 32.7%, decrease in the average balance
reflecting the effects of the de-leveraging strategy. However, the decrease in
interest expense on borrowings was partially offset by a 68 basis point increase
in the average rate paid reflecting higher current market rates of interest. The
increase in the overall cost of funds was primarily a result of the upward
repricing of deposits and floating-rate debt due to increases in market rates of
interest.
PROVISIONS FOR LOAN LOSSES. The Company establishes provisions for loan
losses, which are charges to its operating results, in order to maintain a level
of total allowance for losses that management believes covers all known and
inherent losses that are both probable and reasonably estimable at each
reporting date. Management performs reviews generally on a monthly basis, but at
a minimum at least quarterly, in order to identify these known and inherent
losses and to assess the overall collection probability for the loan portfolio.
Management's reviews consist of a quantitative analysis by loan category, using
historical loss experience, and consideration of a series of qualitative loss
factors. For each primary type of loan, management establishes a loss factor
reflecting our estimate of the known and inherent losses in each loan type using
both the quantitative analysis as well as consideration of the qualitative
factors. Management's evaluation process includes, among other things, an
analysis of delinquency trends, non-performing loan trends, the levels of
charge-offs and recoveries, the levels of classified and special mention assets,
prior loss experience, total loans outstanding, the volume of loan originations,
the type, average size, terms and geographic location and concentration of loans
held by the Company, the value and the nature of the collateral securing loans,
the number of loans requiring heightened management oversight, general economic
conditions, particularly as they relate to the Company's primary market area,
and trends in market rates of interest. The amount of the allowance for loan
losses is an estimate and actual losses may vary from these estimates.
Furthermore, the Company's primary banking regulator periodically reviews the
Company's allowance for loan losses as an integral part of the examination
process. Such agency may require the Company to make additional provisions for
estimated loan losses based upon judgments that differ from those of management.
For the years ended September 30, 2007, 2006 and 2005, the provisions for
loan losses were $375,000, $1.2 million and $1.8 million, respectively. For the
year ended September 30, 2007, the provision for loan losses decreased $831,000,
or 68.9%, to $375,000 compared to fiscal 2006. The $375,000 provision reflected
management's assessment upon the Company's review of the credit quality of its
loan portfolio, the level of net charge-offs during fiscal 2007 and the
continual evaluation of the classified and pass loan portfolios to maintain the
overall allowance for loan losses at a level deemed appropriate. At September
30, 2007, the Bank had $13.6 million of criticized and classified assets of
which $12.0 million was classified as substandard. No assets were classified as
doubtful or loss. The Company charged off $470,000 in fiscal 2007 compared to
$1.3 million in the prior fiscal year. See Item 1, "Business - Asset Quality."
At September 30, 2007 the Company's allowance for loan losses totaled $3.3
million which amounted to 70.9% of total non-performing loans and 1.12% of gross
loans receivable. The secondary mortgage market has been adversely impacted
during the third and fourth quarters of fiscal 2007 and through the filing date
of this Form 10-K by deteriorating investor demand for mortgage loan products,
particularly with regard to subprime products, as investors are tightening
credit standards and offering less favorable pricing. The Company does not have
a program for originating subprime loans. At September 30, 2007, the Company had
a minimal amount of real estate loans that would be considered subprime loans in
the mortgage loan portfolio.
For the year ended September 30, 2006, the provision for loan losses
decreased $574,000, or 32.2%, to $1.2 million compared to fiscal 2005. The $1.2
million provision reflected management's assessment of a number of factors
including the implementation of refinements to its rating system, the increased
level of classified and criticized assets, continued growth of the commercial
and multi-family real estate and commercial business loan portfolio as well as
extensive discussions with the OTS examination staff in connection with their
examination in fiscal 2006. At September 30, 2006, the Bank had $19.9 million of
criticized and classified assets of which $11.7 million was classified as
substandard. No assets were classified as doubtful or loss. The Company charged
off $1.3 million during fiscal 2006 primarily related to the write down to fair
value of a property securing a $3.3 million commercial real estate loan and a
54
related $500,000 commercial business loan compared to $344,000 in the prior
fiscal year. See Item 1, "Business - Asset Quality." At September 30, 2006, the
Company's allowance for loan losses totaled $3.4 million which amounted to
1215.6% of total non-performing loans and 1.03% of gross loans receivable.
NON-INTEREST INCOME. For the year ended September 30, 2007, the Company
reported non-interest income of $3.0 million compared to $3.5 million for the
year ended September 30, 2006, a $499,000, or 14.2%, decrease. Non-interest
income in fiscal 2006 included the receipt of death proceeds of $567,000 from
bank owned life insurance ("BOLI"). In addition, during fiscal 2007, the Company
experienced a decrease of $107,000 on the gain on sale of its real estate owned
property compared to the prior year. Other income also decreased $59,000, or
13.2%, due to lower revenues generated from the sale of insurance products. The
decrease in non-interest income was partially offset by an increase of $117,000
in net gains on sale of investment securities as a result of the Company's tax
strategy and a $101,000, or 6.5%, increase in service charges and other fees.
Non-interest income decreased $97,000, or 2.7% for the year ended September
30, 2006, compared to the year ended September 30, 2005. The decrease in
non-interest income was primarily due to the Company experiencing only a $3,000
gain on sales of investment and mortgage-related securities in the 2006 period
as compared to $709,000 for fiscal 2005. In addition, the increase in cash
surrender value of the bank owned life insurance experienced a slower rate of
appreciation, decreasing $229,000 in fiscal 2006. The decrease in non-interest
income was partially offset by the receipt of death-benefit proceeds from the
BOLI program. In addition, the Company recognized an increase of $158,000 on the
sale of real estate owned properties.
NON-INTEREST EXPENSE. Non-interest expense includes salaries and employee
benefits, occupancy and equipment expense, Federal Deposit Insurance Corporation
("FDIC") deposit insurance premiums, professional fees, data processing expense,
advertising, deposit processing and other items.
Non-interest expense decreased $159,000, or 1.3%, for the year ended
September 30, 2007 compared to the year ended September 30, 2006. The Company
experienced decreases of $169,000, or 10.5%, and $95,000, or 1.6%, in
professional fees and salaries and employee benefits, respectively. The higher
level of professional fees in 2006 was primarily due to costs related to
foreclosure proceedings incurred from a non-performing commercial loan. However,
the decline in professional fees in 2007 was offset partially by increases in
legal and consultant fees as a result of compliance with the terms of the
supervisory agreement. Salaries and employee benefits decreased primarily due to
a reduction in pension expense and the number of employees employed by the Bank
offset partially by higher medical insurance benefit premiums. In addition,
non-interest expense decreased $90,000 due to expenditures in fiscal 2006
related to real estate operations that were not incurred in fiscal 2007 due to
the sale of the commercial real estate in fiscal 2006 to which such costs
related. During fiscal 2007, the Company experienced increases of $95,000 and
$87,000 in deposit insurance premiums and other non-interest expense,
respectively. The higher premium was related to the Bank's characterization as
an institution with increased supervisory oversight due to the supervisory
agreement and its examination classification.
Non-interest expense decreased $132,000, or 1.0%, for the year ended
September 30, 2006 compared to the year ended September 30, 2005. Non-interest
expense decreased in fiscal 2006 primarily due to the non-recurring pre-tax
charge of $486,000 experienced in fiscal 2005 incurred as a result of the
retirement of FHLB advances as part of the de-leveraging strategy. In addition,
the Company experienced decreases of $131,000, or 2.2%, and $269,000, or 14.1%,
in salaries and employee benefits and other non-interest expense, respectively.
The decrease in other non-interest expense was primarily due to the completion
of a bank-wide customer service training program during the fourth quarter of
fiscal 2005. The decrease in non-interest expense was partially offset by a
$457,000, or 39.4%, increase in professional fees due to professional costs
incurred relating to the foreclosure proceedings of a non-performing commercial
loan (see Item 1, "Business - Asset Quality") as well as additional auditing and
legal fees incurred as a result of the supervisory agreement. During fiscal
2006, expenses incurred in connection with real estate operations increased
$156,000 as a result of maintenance of a real estate owned property. In
addition, the Company incurred increases of $77,000, and $62,000 in deposit
insurance premiums and occupancy and equipment, respectively.
INCOME TAXES. The Company recognized income tax benefits of $220,000,
$359,000 and $313,000 for the years ended September 30, 2007, 2006 and 2005. The
primary reason for the recognition of income tax benefits for fiscal 2007, 2006
and 2005 was the reduction in income before income taxes combined with the level
of non-taxable income. The income tax benefit in fiscal 2006 was much higher
since a substantial portion of the Company's income consisted of insurance
proceeds from the BOLI program which were not taxable.
55
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity, represented by cash and cash equivalents, is a
product of its operating, investing and financing activities. The Company's
primary sources of funds are deposits, amortization, prepayments and maturities
of outstanding loans and mortgage-related securities, sales of loans, maturities
of investment securities and other short-term investments, borrowings and funds
provided from operations. While scheduled payments from the amortization of
loans and mortgage-related securities and maturing investment securities and
short-term investments are relatively predictable sources of funds, deposit
flows and loan and mortgage-related securities prepayments are greatly
influenced by general interest rates, economic conditions and competition. In
addition, the Company invests excess funds in overnight deposits and other
short-term interest-earning assets which provide liquidity to meet lending
requirements. The Company has the ability to obtain advances from the FHLBank
Pittsburgh through several credit programs with the FHLB in amounts not to
exceed the Bank's maximum borrowing capacity and subject to certain conditions,
including holding a predetermined amount of FHLB stock as collateral. As an
additional source of funds, the Company has access to the FRB discount window,
but only after it has exhausted its access to the FHLB. At September 30, 2007,
the Company had $86.3 million of outstanding advances and $29.0 million of
overnight borrowings from the FHLBank Pittsburgh. The Bank currently has the
ability to obtain up to $177.3 million of additional 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 and mortgage-related
securities. The Company uses its sources of funds primarily to meet its ongoing
commitments, to pay maturing savings certificates and savings withdrawals, fund
loan commitments and maintain a portfolio of mortgage related and investment
securities. At September 30, 2007, the total of approved loan commitments
outstanding amounted to $3.0 million. At the same date, commitments under unused
lines of credit and loans in process on construction loans amounted to an
aggregate of $39.9 million. Certificates of deposit scheduled to mature in one
year or less at September 30, 2007 totaled $164.2 million. Based upon its
historical experience, management believes that a majority of maturing deposits
will remain with the Company.
The OTS requires that the Bank meet minimum regulatory tangible, core,
tier-1 risk-based and total risk-based capital requirements. At September 30,
2007, the Bank exceeded all regulatory capital requirements and met the capital
requirements for regulatory purposes to be deemed "well-capitalized." However,
as a result of the supervisory agreement, it is subject to a number of
restrictions including, but not limited, requiring prior approval to appoint new
senior officers and directors and pay dividends. See Note 11 to the Consolidated
Financial Statements set forth in Item 8 hereof.
The Company's assets consist primarily of its investment in the Bank and
investments in various corporate debt and equity instruments. Its only material
source of income consists of earnings from its investment in the Bank and
interest and dividends earned on other investments. The Company, as a separately
incorporated holding company, has no significant operations other than serving
as the sole stockholder of the Bank and paying interest to its subsidiaries,
First Keystone Capital Trust I and II, for junior subordinated debt issued in
conjunction with the issuance of trust preferred securities. See Note 16 to the
Consolidated Financial Statements set forth in Item 8 hereof. On an
unconsolidated basis, the Company has no paid employees. The expenses primarily
incurred by the Company relate to its reporting obligations under the Securities
Exchange Act of 1934, related expenses incurred as a publicly traded company,
and expenses relating to the issuance of the trust preferred securities and the
junior subordinated debentures issued in connection therewith. Management
believes that the Company has adequate liquidity available to respond to its
liquidity demands. Under applicable federal regulations, the Bank may pay
dividends to the Company (its sole stockholder) within certain limits after
obtaining the approval of the OTS. See Note 11 of the Consolidated Financial
Statements set forth in Item 8 hereof.
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 were utilized to fund, in part, the redemption of
$6.2 million of its junior subordinated debentures in June 2007.
56
DERIVATIVE FINANCIAL INSTRUMENTS, CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
The Company has not used, and has no intention to use, any significant
off-balance sheet financing arrangements for liquidity purposes. The Company's
primary financial instruments with off-balance sheet risk are limited to loan
servicing for others, its obligations to fund loans to customers pursuant to
existing commitments and commitments to purchase and sell mortgage loans. In
addition, the Company has not had, and has no intention to have, any significant
transactions, arrangements or other relationships with any unconsolidated,
limited purpose entities that could materially affect its liquidity or capital
resources. The Company has not, and does not intend to, trade in commodity
contracts.
We anticipate that we will continue to have sufficient funds and
alternative funding sources to meet our current commitments.
The Company's contractual cash obligations as of September 30, 2007 are as
follows:
PAYMENTS DUE BY PERIOD:
----------------------------------------------------------
LESS THAN MORE THAN 5
TOTAL YEAR 1-3 YEARS 3-5 YEARS YEARS
-------- --------- --------- --------- -----------
(DOLLARS IN THOUSANDS)
FHLB borrowings $115,835 $35,173 $25,018 $55,521 $ 123
Junior subordinated debentures 16,011 747 -- -- 15,264
Operating leases 3,500 343 659 292 2,206
-------- ------- ------- ------- -------
Total obligations $135,346 $36,263 $25,677 $55,813 $17,593
======== ======= ======= ======= =======
OFF-BALANCE-SHEET OBLIGATIONS
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and letters of
credit. Those instruments involve, to varying degrees, elements of credit risk
in excess of the amount recognized in the balance sheet. The Company's exposure
to credit loss in the event of non-performance by the other party to the
financial instrument for commitments to extend credit and letters of credit is
represented by the contractual notional amount of those instruments. The Company
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance-sheet instruments (see Note 1 of the Consolidated
Financial Statements set forth in Item 8 hereof).
The Company's outstanding commitments to originate loans and to advance
additional amounts pursuant to outstanding letters of credit, lines of credit
and undisbursed portions of construction loans as of September 30, 2007 are as
follows:
LESS THAN MORE THAN 5
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS YEARS
------- --------- --------- ---------- -----------
(DOLLARS IN THOUSANDS)
Lines of credit(1) $33,917 $ 9,108 $ 478 $3,369 $20,962
Letters of credit 849 30 -- -- 819
Other commitments to originate loans 3,015 3,015 -- -- --
Undisbursed portions of construction loans 5,983 2,800 3,183 -- --
------- ------- ------ ------ -------
Total $43,764 $14,953 $3,661 $3,369 $21,781
======= ======= ====== ====== =======
- ----------
(1) Includes lines of credit for commercial real estate, commercial loans and
home equity loans.
RECENT ACCOUNTING PRONOUNCEMENTS
For discussion of recent accounting pronouncements, see Note 2 of the
Consolidated Financial Statements set forth in Item 8 hereof.
57
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements of the Company and related notes
presented herein have been prepared in accordance with accounting principles
generally accepted in the United States of America which require the measurement
of financial position and operating results in terms of historical dollars,
without considering changes in the relative purchasing power of money over time
due to inflation.
Unlike most industrial companies, substantially all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or in the same magnitude as the
prices of goods and services, since such prices are affected by inflation to a
larger extent than interest rates. In the current interest rate environment,
liquidity and the maturity structure and repricing characteristics of the
Company's assets and liabilities are critical to the maintenance of acceptable
performance levels.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required herein is incorporated by reference to "Asset and
Liability Management" set forth in Item 7 above.
58
[SNODGRASS LOGO]
CERTIFIED PUBLIC ACCOUNTANT AND CONSULTANTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
BOARD OF DIRECTORS
FIRST KEYSTONE FINANCIAL, INC.
We have audited the consolidated statement of financial condition of First
Keystone Financial, Inc. and subsidiary (the "Company") as of September 30,
2007, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for the year then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit. The accompanying consolidated financial
statements of First Keystone Financial, Inc. and subsidiary as of September 30,
2006, and for each of the years in the two-year period ended September 30, 2006,
were audited by other auditors whose report thereon dated December 28, 2006,
expressed an unqualified opinion on those statements.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of First
Keystone Financial, Inc. and subsidiary as of September 30, 2007, and the
consolidated results of their operations and their cash flows for the year then
ended in conformity with U.S. generally accepted accounting principles.
S.R. Snodgrass, A. C.
Wexford, PA
December 27, 2007
59
[DELOITTE LOGO]
Deloitte Touche LLp
1700 Market Street
Philiadelphia, PA 19103-3984
Tel: 215-246-2300
Fax: 215-569-2441
www.deloitte.com
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF FIRST KEYSTONE FINANCIAL, INC. AND
SUBSIDIARIES - MEDIA, PENNSYLVANIA:
We have audited the accompanying consolidated statements of financial condition
of First Keystone Financial, Inc. and Subsidiaries (the "Company") as of
September 30, 2006, and the related consolidated statements of operations,
changes in stockholders' equity, and cash flows for each of the two years in the
period ended September 30, 2006. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of their internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of First Keystone Financial, Inc. and
Subsidiaries as of September 30, 2006, and the results of their operations and
their cash flows for each of the two years in the period ended September 30,
2006, in conformity with accounting principles generally accepted in the United
States of America.
Deloitte & Touche LLP
December 28, 2006
Member of
DELOITTE TOUCHE TOHMATSU
60
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
SEPTEMBER 30,
-------------------
2007 2006
-------- --------
ASSETS
Cash and amounts due from depository institutions $ 4,642 $ 4,072
Interest-bearing deposits with depository institutions 48,293 8,715
-------- --------
Total cash and cash equivalents 52,935 12,787
Investment securities available for sale 29,284 33,386
Mortgage-related securities available for sale 79,178 70,030
Loans held for sale -- 1,334
Investment securities held to maturity - at amortized cost (approximate fair
value of $3,266 and $3,268 at September 30, 2007 and 2006, respectively) 3,256 3,257
Mortgage-related securities held to maturity - at amortized cost
(approximate fair value of $30,511 and $37,163 at September 30, 2007
and 2006, respectively) 31,294 38,355
Loans receivable (net of allowance for loan losses of $3,322 and $3,367
at September 30, 2007 and 2006, respectively) 292,418 323,220
Accrued interest receivable 2,702 2,667
Real estate owned -- 2,450
FHLBank stock, at cost 6,338 6,233
Office properties and equipment, net 4,762 4,643
Deferred income taxes 2,505 2,281
Cash surrender value of life insurance 17,234 16,624
Prepaid expenses and other assets 2,975 5,693
-------- --------
Total Assets $524,881 $522,960
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits
Non-interest-bearing $ 18,404 $ 17,232
Interest-bearing 335,304 341,584
-------- --------
Total deposits 353,708 358,816
Advances from FHLBank and other borrowings 115,384 107,241
Junior subordinated debentures 15,264 21,483
Accrued interest payable 2,324 2,164
Advances from borrowers for taxes and insurance 870 866
Accounts payable and accrued expenses 2,637 3,731
-------- --------
Total liabilities 490,187 494,301
-------- --------
Commitments and contingencies (see Note 13) -- --
Stockholders' Equity:
Preferred stock, $.01 par value, 10,000,000 shares authorized; none issued
Common stock, $.01 par value, 20,000,000 shares authorized; issued 2,712,556
shares; outstanding at September 30, 2007 and 2006, 2,432,998
and 2,027,928 shares, respectively 27 27
Additional paid-in capital 12,598 12,974
Employee stock ownership plan (2,985) (3,089)
Treasury stock at cost: 279,558 and 684,628 shares at September 30, 2007
and 2006, respectively (4,244) (10,522)
Accumulated other comprehensive loss (1,223) (787)
Retained earnings-partially restricted 30,521 30,056
-------- --------
Total stockholders' equity 34,694 28,659
-------- --------
Total Liabilities and Stockholders' Equity $524,881 $522,960
======== ========
See notes to consolidated financial statements.
61
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED SEPTEMBER 30,
------------------------------------
2007 2006 2005
---------- ---------- ----------
INTEREST INCOME:
Interest and fees on loans $ 20,674 $ 19,956 $ 17,926
Interest and dividends on:
Mortgage-related securities 4,989 5,054 6,223
Investment securities:
Taxable 1,394 1,196 1,491
Tax-exempt 386 711 755
Dividends 405 379 514
Interest-bearing deposits 533 197 167
---------- ---------- ----------
Total interest income 28,381 27,493 27,076
---------- ---------- ----------
INTEREST EXPENSE:
Interest on:
Deposits 11,208 8,547 6,280
FHLBank advances and other borrowings 5,189 5,914 7,694
Junior subordinated debentures 1,828 1,954 1,794
---------- ---------- ----------
Total interest expense 18,225 16,415 15,768
---------- ---------- ----------
Net interest income 10,156 11,078 11,308
Provision for loan losses 375 1,206 1,780
---------- ---------- ----------
Net interest income after provision for loan losses 9,781 9,872 9,528
---------- ---------- ----------
NON-INTEREST INCOME:
Service charges and other fees 1,661 1,560 1,577
Net gain on sale of:
Investments and mortgage-related securities 120 3 709
Loans held for sale 163 157 93
Real estate owned 71 178 20
Proceeds from life insurance -- 567 --
Increase in cash surrender value of life insurance 610 600 725
Other income 388 447 485
---------- ---------- ----------
Total non-interest income 3,013 3,512 3,609
---------- ---------- ----------
NON-INTEREST EXPENSE:
Salaries and employee benefits 5,865 5,960 6,091
Occupancy and equipment 1,623 1,624 1,562
Professional fees 1,447 1,616 1,159
Federal deposit insurance premium 220 125 48
Operations of real estate owned 72 162 6
Data processing 564 533 526
Advertising 440 444 413
Deposit processing 589 602 638
Prepayment penalty on FHLB advances -- -- 486
Other 1,729 1,642 1,911
---------- ---------- ----------
Total non-interest expense 12,549 12,708 12,840
---------- ---------- ----------
Income before income tax benefit 245 676 297
Income tax benefit (220) (359) (313)
---------- ---------- ----------
Net income $ 465 $ 1,035 $ 610
========== ========== ==========
Earnings per common share:
Basic $ 0.21 $ 0.55 $ 0.33
Diluted $ 0.21 $ 0.54 $ 0.33
Weighted average shares - basic 2,228,400 1,892,510 1,842,434
Weighted average shares - diluted 2,241,779 1,912,282 1,871,401
Dividends per share $ -- $ 0.11 $ 0.44
See notes to consolidated financial statements.
62
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
(DOLLARS IN THOUSANDS)
EMPLOYEE ACCUMULATED RETAINED
ADDITIONAL STOCK OTHER EARNINGS- TOTAL
COMMON PAID-IN OWNERSHIP TREASURY COMPREHENSIVE PARTIALLY STOCKHOLDERS'
STOCK CAPITAL PLAN STOCK INCOME (LOSS) RESTRICTED EQUITY
------ ---------- --------- -------- ------------- ---------- -------------
Balance at October 1, 2004 $27 $13,609 $(3,189) $(11,913) $ 1,734 $29,430 $29,698
Comprehensive income:
Net income -- -- -- -- -- 610 610
Other comprehensive income, net of tax:
Net unrealized loss on securities
Net of reclassification adjustment(1) -- -- -- -- (1,943) -- (1,943)
--- ------- ------- -------- ------- ------- -------
Comprehensive income -- -- -- -- -- -- (1,333)
--- ------- ------- -------- ------- ------- -------
ESOP stock committed to be released -- -- 76 -- -- -- 76
Common stock acquired by stock benefit plan -- -- (72) -- -- -- (72)
Excess of fair value above cost of ESOP
shares committed to be released -- 88 -- -- -- -- 88
Exercise of stock options -- (777) -- 1,433 -- -- 656
Purchase of treasury stock -- -- -- (110) -- -- (110)
Dividends paid -- -- -- -- -- (810) (810)
--- ------- ------- -------- ------- ------- -------
Balance at September 30, 2005 $27 $12,920 $(3,185) $(10,590) $ (209) $29,230 $28,193
=== ======= ======= ======== ======= ======= =======
Comprehensive income:
Net income -- -- -- -- -- 1,035 1,035
Other comprehensive income, net of tax:
Net unrealized loss on securities
Net of reclassification adjustment(1) -- -- -- -- (578) -- (578)
--- ------- ------- -------- ------- ------- -------
Comprehensive loss -- -- -- -- -- -- 457
--- ------- ------- -------- ------- ------- -------
ESOP stock committed to be released -- -- 96 -- -- -- 96
Excess of fair value above cost of ESOP
shares committed to be released -- 50 -- -- -- -- 50
Exercise of stock options -- (21) -- 68 -- -- 47
Share-based compensation -- 25 -- -- -- -- 25
Dividends paid -- -- -- -- -- (209) (209)
--- ------- ------- -------- ------- ------- -------
Balance at September 30, 2006 $27 $12,974 $(3,089) $(10,522) $ (787) $30,056 $28,659
=== ======= ======= ======== ======= ======= =======
Comprehensive income:
Net income -- -- -- -- -- 465 465
Other comprehensive income, net of tax:
Net unrealized loss on securities
Net of reclassification adjustment(1) -- -- -- -- (436) -- (436)
--- ------- ------- -------- ------- ------- -------
Comprehensive income -- -- -- -- -- -- 29
--- ------- ------- -------- ------- ------- -------
ESOP stock committed to be released -- -- 104 -- -- -- 104
Excess of fair value above cost of ESOP
shares committed to be released -- 38 -- -- -- -- 38
Exercise of stock options -- (16) -- 78 -- -- 62
Share-based compensation -- 33 -- -- -- -- 33
Release of treasury shares for equity offering -- (431) -- 6,200 -- -- 5,769
--- ------- ------- -------- ------- ------- -------
Balance at September 30, 2007 $27 $12,598 $(2,985) $ (4,244) $(1,223) $30,521 $34,694
=== ======= ======= ======== ======= ======= =======
(1) Disclosure of reclassification amount, net of tax for the years ended: 2007 2006 2005
----- ----- -------
Net unrealized depreciation arising during the year $(515) $(580) $(2,411)
Less: reclassification adjustment for net gains included in net income
(net of tax $41, $1 and $241, respectively) 79 2 468
----- ----- -------
Net unrealized loss on securities $(436) $(578) $(1,943)
===== ===== =======
See notes to consolidated financial statements.
63
FIRST KEYSTONE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30,
--------------------------------
2007 2006 2005
-------- --------- ---------
OPERATING ACTIVITIES:
Net income $ 465 $ 1,035 $ 610
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for depreciation and amortization 557 535 534
Amortization of premiums and discounts 159 310 582
Increase in cash surrender value of life insurance (610) (600) (725)
(Gain) loss on sales of:
Loans held for sale (163) (157) (93)
Investment securities available for sale (120) (46) (1,499)
Mortgage-related securities available for sale -- 43 790
Real estate owned (71) (178) (20)
Provision for loan losses 375 1,206 1,780
Amortization of ESOP 142 146 164
Deferred income taxes -- 25 (81)
Share-based compensation 33 25 --
Insurance proceeds on real estate owned -- -- 29
Changes in assets and liabilities which provided (used) cash:
Origination of loans held for sale (271) (6,063) (13,620)
Loans sold in the secondary market 1,605 4,770 13,751
Accrued interest receivable (35) (232) 142
Prepaid expenses and other assets 2,529 2,470 2,532
Accrued interest payable 160 294 87
Accrued expenses (1,094) 1,026 668
-------- --------- ---------
Net cash provided by operating activities 3,661 4,609 5,631
-------- --------- ---------
INVESTING ACTIVITIES:
Loans originated (91,913) (141,352) (130,133)
Purchases of:
Investment securities available for sale (6,005) (444) (9,700)
Mortgage-related securities available for sale (21,913) (18,353) (41,934)
Mortgage-related securities held to maturity -- -- (18,591)
(Purchase) redemption of FHLB stock (105) 3,266 328
Proceeds from life insurance -- 811 --
Proceeds from sales of investment and mortgage-related securities
available for sale 7,912 4,559 74,056
Proceeds from sales of real estate owned 2,521 1,188 435
Return of investment in First Keystone Capital Trust II 189 -- --
Principal collected on loans 122,505 116,309 130,830
Proceeds from maturities, calls or repayments of:
Investment securities available for sale 1,218 590 3,527
Investment securities held to maturity -- 1,000 1,000
Mortgage-related securities available for sale 13,101 13,760 28,006
Mortgage-related securities held to maturity 6,969 8,160 9,110
Purchase of property and equipment (676) (396) (1,041)
-------- --------- ---------
Net cash provided by (used in) investing activities 33,803 (10,902) 45,893
-------- --------- ---------
FINANCING ACTIVITIES:
Net increase (decrease) in deposit accounts (5,108) 9,122 4,814
Net (decrease) increase in FHLB advances and other borrowings 8,143 (6,062) (57,846)
Net increase in advances from borrowers for taxes and insurance 4 27 24
Common stock acquired by ESOP -- -- (72)
Proceeds from exercise of stock options 62 47 656
Net proceeds from equity offering 5,769 -- --
Retirement of junior subordinated debentures (6,186) -- --
Purchase of treasury stock -- -- (110)
Cash dividends -- (209) (810)
-------- --------- ---------
Net cash provided by (used in) financing activities 2,684 2,925 (53,344)
-------- --------- ---------
Increase (decrease) in cash and cash equivalents 40,148 (3,368) (1,820)
Cash and cash equivalents at beginning of year 12,787 16,155 17,975
-------- --------- ---------
Cash and cash equivalents at end of year $ 52,935 $ 12,787 $ 16,155
======== ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW AND NON-CASH INFORMATION:
Cash payments for interest on deposits and borrowings $ 18,065 $ 16,121 $ 15,681
Cash (refunds) payments of income taxes -- (374) 654
Transfers of loans receivable into real estate owned -- 2,700 --
See notes to consolidated financial statements.
64
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. NATURE OF OPERATIONS AND ORGANIZATION STRUCTURE
The primary business of First Keystone Financial, Inc. (the "Company") is
to act as the holding company for its principal wholly owned subsidiary, First
Keystone Bank (the "Bank"), a federally chartered stock savings association
founded in 1934. The Bank has the following four wholly owned subsidiaries: FKF
Management Corp., Inc. which manages investment securities, First Chester
Services, Inc. and First Pointe, Inc. which acquire certain loans, real estate
and other assets in satisfaction of debts previously contracted by the Bank, and
State Street Services Corporation, which holds a 51% interest in First Keystone
Insurance Services, LLC ("First Keystone Insurance"), an insurance agency, which
is consolidated into the Company's financial statements. The Company's capital
trusts, First Keystone Capital Trust I and First Keystone Capital Trust II,
collectively, the ("Issuer Trusts") are not consolidated with the accounts of
the Company as discussed in Note 2. The Issuer Trusts were formed in connection
with the issuance of trust preferred securities.
The primary business of the Bank is to offer a wide variety of commercial
and retail products through its branch system located in Delaware and Chester
Counties in Pennsylvania. The Company and the Bank are primarily supervised and
regulated by the Office of Thrift Supervision ("OTS").
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company, the Bank and the Company's and the Bank's wholly owned
subsidiaries. In addition, the Company consolidates First Keystone Insurance,
LLC in which one of the Bank's subsidiaries holds a 51% ownership interest.
In 2004, upon adoption of Financial Accounting Standards Board ("FASB")
Interpretation ("FIN") No. 46 and FIN 46(R), the Issuer Trusts are not
consolidated with the accounts of the Company.
Intercompany accounts and transactions have been eliminated in
consolidation.
SEGMENT ACCOUNTING
The Company evaluated Statement of Financial Accounting Standards ("SFAS")
No. 131, "Disclosure about Segments of an Enterprise and Related Information,"
and determined the Company operates in two segments: Banking and Insurance
Services. Results are presented on a combined basis because insurance services
do not meet quantitative thresholds for separate disclosure.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the dates of the consolidated financial statements and the
reported amounts of income and expense during the reporting periods. Actual
results could differ from those estimates.
SECURITIES HELD TO MATURITY AND SECURITIES AVAILABLE FOR SALE
Securities held to maturity are carried at amortized cost. Securities are
designated as held to maturity only if the Company has the positive intent and
ability to hold these securities to maturity. Securities available for sale are
carried at fair value with the resulting unrealized gains or losses recorded in
stockholders' equity, net of tax. Premiums are amortized and discounts are
accreted using the interest method over the estimated remaining term of the
underlying security. For the years ended September 30, 2007 and 2006, the
Company did not maintain a trading portfolio.
65
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
OTHER-THAN-TEMPORARY IMPAIRMENT OF SECURITIES
Securities are evaluated on at least a quarterly basis and more frequently
when economic or market conditions warrant such an evaluation to determine
whether a decline in their value is other than temporary. Management utilizes
criteria such as the magnitude and duration of the decline and the intent and
ability of the Company to retain its investment in the issues for a period of
time sufficient to allow for an anticipated recovery in fair value, in addition
to the reasons underlying the decline, to determine whether the loss in value is
other than temporary. Once a decline in value is determined to be other than
temporary, the value of the security is reduced and a corresponding charge to
earnings is recognized.
On November 3, 2005, the FASB issued FASB Staff Position ("FSP") Nos. FAS
115-1 and FAS 124-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments." This FSP addresses the determination as to
when an investment is considered impaired, whether that impairment is other than
temporary, and the measurement of an impairment loss. This FSP also includes
accounting considerations subsequent to the recognition of an
other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. This FSP nullifies certain requirements of Emerging Issues Task
Force ("EITF") Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments", and supersedes EITF Topic No. D-44,
"Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a
Security Whose Cost Exceeds Fair Value." The guidance in this FSP amends SFAS
Statement No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." The FSP is effective for reporting periods beginning after December
15, 2005. The Company adopted this guidance on January 1, 2006 and the adoption
did not have a significant impact on the Company's consolidated financial
statements.
ALLOWANCE FOR LOAN LOSSES
An allowance for loan losses is maintained at a level that management
considers adequate to provide for probable losses based upon an evaluation of
known and inherent losses in the loan portfolio that are both probable and
reasonably estimated. The Company is constantly reviewing the methodology,
conducting assessments and redefining the process to determine the appropriate
level of allowance for loan losses. In establishing the allowance for loan
losses, management must use a large degree of judgment in (i) assigning
individual loans to specific risk levels (pass, special mention, substandard,
doubtful and loss), (ii) valuing the underlying collateral securing the loans,
(iii) determining the appropriate reserve factor to be applied to specific risk
levels for criticized and classified loans (special mention, substandard,
doubtful and loss), and (iv) determining reserve factors to be applied to pass
loans based upon loan type. Management reviews the allowance for loan losses
generally on a monthly basis, but at a minimum at least quarterly. To the extent
that loans change risk levels, collateral values change or reserve factors
change, the Company may need to adjust its provision for loan losses which would
impact earnings. In this framework, a series of qualitative factors are used in
a methodology as a measurement of how current circumstances are affecting the
loan portfolio. Included, among other things, in these qualitative factors are
past loss experience, the type and volume of loans, changes in lending policies
and procedures, underwriting standards, collections, charge-offs and recoveries,
national and local economic conditions, concentrations of credit, and the effect
of external factors on the level of estimated credit losses in the current
portfolio. While management uses the best information available to make such
evaluation, future adjustments to the allowance may be necessary if conditions
differ substantially from the assumptions used in making the evaluations.
Impaired loans are predominantly measured based on the fair value of the
collateral. The provision for loan losses charged to expense is based upon past
loan loss experience and an evaluation of probable losses and impairment
existing in the current loan portfolio. A loan is considered to be impaired
when, based upon current information and events, it is probable that the Company
will be unable to collect all amounts due in accordance with the original
contractual terms of the loan. An insignificant delay or insignificant shortfall
in amounts of payments does not necessarily result in the loan being identified
as impaired. For this purpose, delays of less than 90 days are considered to be
insignificant. Large groups of smaller balance homogeneous loans, including
residential real estate and consumer loans, are collectively evaluated for
impairment, except for loans restructured pursuant to a troubled debt
restructuring.
66
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Loans secured by residential real estate, including home equity and home
equity lines of credit, are classified as nonaccrual at 90 days past due. Loans
other than consumer loans are charged-off based on the facts and circumstances
of the individual loan. Consumer loans are generally charged-off in the month
they become 180 days past due.
MORTGAGE BANKING ACTIVITIES
The Company originates mortgage loans held for investment and for sale. At
origination, the mortgage loan is identified as either held for sale or for
investment. Mortgage loans held for sale are carried at the lower of cost or
forward committed contracts (which approximates fair value).
At September 30, 2007, 2006 and 2005, loans serviced for others totaled
approximately $46,979, $51,145 and $55,378, respectively. Servicing loans for
others consists of collecting mortgage payments, maintaining escrow accounts,
disbursing payments to investors, and processing foreclosures. Loan servicing
income is recorded when earned and includes servicing fees from investors and
certain charges collected from borrowers, such as late payment fees. The Company
has fiduciary responsibility for related escrow and custodial funds aggregating
approximately $290 and $345 at September 30, 2007 and 2006, respectively.
The Company assesses the retained interest in the servicing asset or
liability associated with the sold loans based on the relative fair values. The
servicing asset or liability is amortized in proportion to and over the period
during which estimated net servicing income or net servicing loss, as
appropriate, will be received. Assessment of the fair value of the retained
interest is performed on a quarterly basis. At September 30, 2007 and 2006,
mortgage servicing rights totaling $339 and $314, respectively, were included in
other assets.
TRANSFERS OF FINANCIAL ASSETS
Transfers of financial assets are accounted for as sales when control over
the assets has been surrendered. Control is surrendered when (1) the assets have
been isolated from the Company, (2) the transferee obtains the right (free of
conditions that constrain it from taking advantage of that right) to pledge or
exchange the transferred assets, and (3) the Company does not maintain effective
control over the transferred assets through an agreement to repurchase them
before their maturity.
INCOME RECOGNITION ON LOANS
Interest on loans is credited to income when earned. Accrual of loan
interest is discontinued and a reserve established through a charge to interest
income on existing accruals if management believes after considering, among
other things, economic and business conditions and collection efforts, that the
borrower's financial condition is such that collection of interest is doubtful.
Such interest ultimately collected is credited to income when collection of
principal and interest is no longer in doubt.
REAL ESTATE OWNED
Real estate owned consists of properties acquired by foreclosure or deed
in-lieu of foreclosure. These assets are initially recorded at the lower of
carrying value of the loan or estimated fair value less selling costs at the
time of foreclosure and at the lower of the new cost basis or net realizable
value thereafter. The amounts recoverable from real estate owned could differ
materially from the amounts used in arriving at the net carrying value of the
assets at the time of foreclosure because of future market factors beyond the
control of the Company. Costs relating to the development and improvement of
real estate owned properties are capitalized and those relating to holding the
property are charged to expense.
OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are recorded at cost. Depreciation is
computed using the straight-line method over the expected useful lives of the
assets which range from two to 40 years. The costs of maintenance and repairs
are expensed as they are incurred, and renewals and betterments are capitalized.
67
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
CASH SURRENDER VALUE OF LIFE INSURANCE
The Bank funded the purchase of insurance policies on the lives of certain
officers and employees of the Bank. The Bank has recognized any increase in cash
surrender value of life insurance, net of insurance costs, in the consolidated
statements of operations. The cash surrender value of the insurance policies is
recorded as an asset in the statements of financial condition. For the year
ended September 30, 2006, the Company recognized the receipt of death-benefit
proceeds of $567 from the bank owned life insurance policies.
INTEREST RATE RISK
At September 30, 2007 and 2006, the Company's assets consisted of assets
earning interest at either adjustable or fixed rates, with the majority having
long-term average lives. At September 30, 2007, the Bank had interest-earning
assets of approximately $472.5 million having a weighted average effective yield
of 6.01% and interest-bearing liabilities of approximately $468.0 million with a
weighted average cost of 3.90%. These assets were funded primarily with shorter
term liabilities that have interest rates which vary over time with market rates
and, in some cases, certain call features that are affected by changes in market
rates of interest. The shorter duration of the interest-sensitive liabilities
indicates that the Company is exposed to interest rate risk because, in a rising
rate environment, liabilities will be repricing faster at higher interest rates,
thereby reducing the market value of long-term assets and net interest income.
EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed based on the weighted average
number of shares of common stock outstanding. Diluted earnings per common share
is computed based on the weighted average number of shares of common stock
outstanding increased by the number of common shares that are assumed to have
been purchased with the proceeds from the exercise of stock options. Weighted
average shares used in the computation of earnings per share were as follows:
YEAR ENDED SEPTEMBER 30,
---------------------------------
2007 2006 2005
--------- --------- ---------
Average common shares outstanding 2,228,400 1,892,510 1,842,434
Increase in shares due to dilutive options 13,379 19,772 28,967
--------- --------- ---------
Adjusted shares outstanding - diluted 2,241,779 1,912,282 1,871,401
========= ========= =========
For the years ended September 30, 2007 and 2006, 11,466 and 2,221
outstanding options, respectively, were anti-dilutive. For the year ended
September 30, 2005, there were no outstanding options that were anti-dilutive.
INCOME TAXES
Deferred income taxes are recognized for the tax consequences of temporary
differences by applying enacted statutory tax rates applicable to future years
to differences between the financial statement carrying amounts and the tax
bases of existing assets and liabilities. The effect on deferred taxes of a
change in tax rates is recognized in income in the period that includes the
enactment date.
ACCOUNTING FOR STOCK OPTIONS
On October 1, 2005, the Company adopted SFAS No. 123 (Revised 2004),
"Share-Based Payment" (SFAS No. 123(R)) using the modified prospective
application transition method. This Statement requires an entity to recognize
the cost of employee services received in exchange for an award of equity
investment based on grant-date fair value of the award. That cost will be
recognized over the period during which an employee is required to provide
service in exchange for the award. Upon adoption of SFAS No. 123R, the Company
was required to recognize compensation expense for the fair value of stock
options that are granted or vested after that date. The revised Statement
generally requires that an entity account for those transactions using the
fair-value based method and eliminates an entity's ability to account for
share-based compensation transactions using the intrinsic value method of
accounting provided in Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," which was permitted under SFAS No.
123, as originally issued. Prior to October 1, 2005, the Company did not
recognize employee equity-based compensation costs in net income.
68
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The adoption of SFAS No. 123R had the following impact on reported amounts
compared with amounts that would have been reported using the intrinsic value
method under previous accounting:
YEAR ENDED SEPTEMBER 30,
------------------------
2007 2006 2005
----- ------ -----
Net income, as reported $ 465 $1,035 $ 610
Add: Total stock-based employee compensation expense
included in reported net income (net of tax) 22 17 --
Deduct: Total stock-based employee compensation expense
determined under fair value method (net of tax) (22) (17) (17)
----- ------ -----
Pro forma net income $ 465 $1,035 $ 593
===== ====== =====
Net income per common and common equivalent share:
Earnings per common share - diluted
- As reported $0.21 $ 0.54 $0.33
- Pro forma 0.21 0.54 0.33
Weighted average fair value of options granted during the period N/A N/A $7.30
The binomial option-pricing model was used to determine the fair value of
options at the grant date. No grants were made in fiscal 2007 and 2006.
Significant assumptions used to calculate the above fair value of the awards are
as follows:
SEPTEMBER 30,
------------------
2007 2006 2005
---- ---- ----
Risk-free interest rate of return N/A N/A 4.04%
Expected option life (months) N/A N/A 120
Expected volatility N/A N/A 34%
Expected dividends N/A N/A 2.2%
The total intrinsic value of options outstanding and exercisable was
$286 and $280, respectively, at September 30, 2007.
OTHER COMPREHENSIVE INCOME
The Company presents as a component of comprehensive income the amounts
from transactions and other events which currently are excluded from the
statements of operations and are recorded directly as an adjustment to
stockholders' equity.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS
In April 2004, the FASB issued SFAS Statement No.149, "Amendment of
Statement No.133 on Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments,
including derivatives embedded in other contracts and hedging activities. SFAS
No. 133 "Accounting for Derivative Instruments and Hedging Activities," as
amended by SFAS Nos. 137 and 138 and interpreted by the FASB and the Derivative
Implementation Group through Statement 133 Implementation Issues, requires that
an entity recognize all derivatives as either assets or liabilities in the
statement of financial condition and measure those instruments at fair value. In
accordance with SFAS No. 149 and SFAS No. 133, the accounting for changes in the
fair value of a derivative depends on the intended use of the derivative and the
resulting designation. The Company's derivative instruments outstanding during
fiscal years ended September 30, 2007 and 2006 included commitments to fund
loans held-for-sale and forward loan sale agreements. At September 30, 2007 and
2006, the Company did not have any embedded derivatives and did not employ
hedging activities.
69
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include
cash and amounts due from depository institutions and interest-bearing deposits
with depository institutions. The Company is required to maintain certain
balances at the Federal Reserve Bank of Philadelphia which amounted to $167 and
$520 at September 30, 2007 and 2006, respectively.
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.
This statement is effective for all financial instruments that the Company
acquires or issues after October 1, 2007 and the 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.
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 is assessing SFAS
No. 158 and its impact on stockholders' equity, if any, and on the Company's
financial position or results of operations.
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.
70
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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. The adoption of FIN 48 will
not have a material impact on the Company's consolidated financial position or
results of operations.
RECLASSIFICATIONS
Certain reclassifications have been made to the September 30, 2006 and 2005
consolidated financial statements to conform to the September 30, 2007
presentation. Such reclassifications had no impact on the reported net income.
71
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
3. INVESTMENT SECURITIES
The amortized cost and approximate fair value of investment securities
available for sale and held to maturity, by contractual maturities, are as
follows:
SEPTEMBER 30, 2007
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED APPROXIMATE
COST GAIN LOSS FAIR VALUE
--------- ---------- ---------- -----------
Available for Sale:
U.S. Government bonds
1 to 5 years $ 2,000 $ -- $ -- $ 2,000
Over 10 years 3,950 10 (9) 3,951
Municipal obligations
5 to 10 years 1,130 -- (14) 1,116
Corporate bonds
1 to 5 years 2,074 50 -- 2,124
5 to 10 years 2,000 -- (560) 1,440
Over 10 years 7,654 61 (42) 7,673
Mutual funds 10,203 7 (322) 9,888
Other equity investments 1,040 60 (8) 1,092
------- ---- ----- -------
Total $30,051 $188 $(955) $29,284
======= ==== ===== =======
Held to Maturity:
Municipal obligations
5 to 10 years $ 3,256 $ 10 $ -- $ 3,266
======= ==== ===== =======
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,
2007.
LOSS POSITION LOSS POSITION
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
------------------------ ------------------------ ------------------------
APPROXIMATE UNREALIZED APPROXIMATE UNREALIZED APPROXIMATE UNREALIZED
FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
----------- ---------- ----------- ---------- ----------- ----------
U.S. Government bonds $2,954 $ (9) $ -- $ -- $ 2,954 $ (9)
Corporate bonds -- -- 3,420 (602) 3,420 (602)
Municipal obligations -- -- 986 (14) 986 (14)
Mutual funds -- -- 9,374 (322) 9,374 (322)
Other equity investments 327 (8) -- -- 327 (8)
------ ---- ------- ----- ------- -----
Total $3,281 $(17) $13,780 $(938) $17,061 $(955)
====== ==== ======= ===== ======= =====
At September 30, 2007, investment securities in a gross unrealized loss
position for twelve months or longer consist of four securities and investments
in two mutual funds having an aggregate depreciation of 6.4% 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
72
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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 3.3%. Corporate bonds in an unrealized loss position
for 12 months or longer consisted of three debt securities and had an aggregate
depreciation of 15.0%. The Company has the ability and intent to hold these
securities until such time as the value recovers. Management does not believe
any individual unrealized loss as of September 30, 2007 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
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
------- ---- ----- -------
Total $ 3,257 $ 11 $ -- $ 3,268
======= ==== ===== =======
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
------------------------ ------------------------ ------------------------
APPROXIMATE UNREALIZED APPROXIMATE UNREALIZED APPROXIMATE UNREALIZED
FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
----------- ---------- ----------- ---------- ----------- ----------
U.S. Government bonds $ -- $ -- $ 1,976 $ (24) $ 1,976 $ (24)
Corporate bonds 5,201 (18) 3,439 (204) 8,640 (222)
Municipal obligations 348 -- 985 (15) 1,333 (15)
Mutual funds -- -- 8,952 (276) 8,952 (276)
Other equity investments 56 (6) -- -- 56 (6)
------ ---- ------- ----- ------- -----
Total $5,605 $(24) $15,352 $(519) $20,957 $(543)
====== ==== ======= ===== ======= =====
73
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
For the years ended September 30, 2007, 2006 and 2005, proceeds from sales
of investment securities available for sale amounted to $7,912, $2,893 and
$32,282, respectively. For such periods, gross realized gains on sales amounted
to $120, $46 and, $1,957, respectively, while gross realized losses amounted to
$0, $0 and $458, respectively. The tax provision applicable to these net
realized gains amounted to $41, $16 and $510, respectively. Gains are realized
and recorded on the specific identification method.
4. MORTGAGE-RELATED SECURITIES
Mortgage-related securities available for sale and held to maturity are
summarized as follows:
SEPTEMBER 30, 2007
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED APPROXIMATE
COST GAIN LOSS FAIR VALUE
--------- ---------- ---------- -----------
Available for Sale:
FHLMC pass-through certificates $15,647 $ 1 $ (137) $15,511
FNMA pass-through certificates 31,744 80 (320) 31,504
GNMA pass-through certificates 2,185 3 (7) 2,181
Collateralized mortgage obligations 30,689 19 (726) 29,982
------- ---- ------- -------
Total $80,265 $103 $(1,190) $79,178
======= ==== ======= =======
Held to Maturity:
FHLMC pass-through certificates $11,957 $ 5 $ (316) $11,646
FNMA pass-through certificates 19,289 4 (476) 18,817
Collateralized mortgage obligations 48 -- -- 48
------- ---- ------- -------
Total $31,294 $ 9 $ (792) $30,511
======= ==== ======= =======
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, 2007.
LOSS POSITION LOSS POSITION
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
------------------------ ------------------------ ------------------------
APPROXIMATE UNREALIZED APPROXIMATE UNREALIZED APPROXIMATE UNREALIZED
FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
----------- ---------- ----------- ---------- ----------- ----------
Pass-through certificates $21,075 $(176) $47,185 $(1,080) $68,260 $(1,256)
Collateralized mortgage
obligations 2,754 (20) 26,392 (706) 29,146 (726)
------- ----- ------- ------- ------- -------
Total $23,829 $(196) $73,577 $(1,786) $97,406 $(1,982)
======= ===== ======= ======= ======= =======
At September 30, 2007, mortgage-related securities in a gross unrealized
loss position for twelve months or longer consist of 51 securities having an
aggregate depreciation of 2.4% from the Company's amortized cost basis.
Management does not believe any individual unrealized loss as of September 30,
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 private institutions. Management believes that market value
fluctuations in these securities are dependent upon the movement in market
interest rates, particularly given the negligible inherent credit risk
associated with these securities, rather than from the deterioration of the
creditworthiness of the issuer. Accordingly, management does not believe that
any individual unrealized loss as of September 30, 2007 represents an
other-than-temporary impairment. The Company has the ability and intent to hold
these securities until the anticipated recovery of fair value occurs or until
the securities mature.
74
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Mortgage-related securities available for sale and 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
------------------------ ------------------------ ------------------------
APPROXIMATE UNREALIZED APPROXIMATE UNREALIZED APPROXIMATE 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)
======= ===== ======= ======= ======== =======
The collateralized mortgage obligations contain both fixed and
adjustable-rate classes of securities which are repaid in accordance with a
predetermined priority. The underlying collateral of the securities consisted of
loans which are primarily guaranteed by FHLMC, FNMA and GNMA.
For the years ended September 30, 2007, 2006 and 2005, proceeds from sales
of mortgage-related securities available for sale amounted to $0, $1,666 and
$41,774, respectively. There were no gross realized gains for the years ended
September 30, 2007, 2006 and 2005, respectively. Gross realized losses amounted
to $0, $43 and $790 for the years ended September 30, 2007, 2006 and 2005,
respectively. The tax benefit applicable to these net realized gains and losses
amounted to $0, $(15) and $(269) for the years ended September 30, 2007, 2006
and 2005, respectively. Gains and losses are realized and recorded on the
specific identification method.
Mortgage-related securities with aggregate carrying values of $24,778 and
$22,224 were pledged as collateral at September 30, 2007 and 2006, respectively,
for municipal deposits and financings (see Note 8).
75
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
5. ACCRUED INTEREST RECEIVABLE
The following is a summary of accrued interest receivable by category:
SEPTEMBER 30,
---------------
2007 2006
------ ------
Loans $1,701 $1,816
Mortgage-related securities 450 426
Investment securities 551 425
------ ------
Total $2,702 $2,667
====== ======
6. LOANS RECEIVABLE
Loans receivable consist of the following:
SEPTEMBER 30,
-------------------
2007 2006
-------- --------
Single-family $139,888 $144,760
Construction and land 23,501 38,158
Multi-family and commercial 60,026 70,439
Home equity and lines of credit 57,808 59,319
Consumer loans 1,204 1,375
Commercial loans 19,044 24,474
-------- --------
Total loans 301,471 338,525
Loans in process (6,008) (12,081)
Allowance for loan losses (3,322) (3,367)
Deferred loan costs 277 143
-------- --------
Loans receivable net $292,418 $323,220
======== ========
The Company originates loans primarily in its local market area of Delaware
and Chester Counties, Pennsylvania to borrowers that share similar attributes.
This geographic concentration of credit exposes the Company to a higher degree
of risk associated with this economic region.
The Company participates in the origination and sale of fixed-rate
single-family residential loans and Small Business Administration-guaranteed
loans in the secondary market. The Company recognized gains on sale of loans
held for sale of $163, $157 and $93 for fiscal years ended September 30, 2007,
2006 and 2005, respectively.
The Company offers loans to its directors and senior officers on terms
permitted by Regulation O promulgated by the Board of Governors of the Federal
Reserve System. There were approximately $5,179, $4,267 and $4,374 of loans
outstanding to senior officers and directors as of September 30, 2007, 2006 and
2005, respectively. The amount of repayments during the years ended September
30, 2007, 2006 and 2005, totaled $2,368, $112 and $737, respectively. There were
$4,519, $5 and $1,300 of new loans granted during fiscal years 2007, 2006 and
2005, respectively.
The Company had undisbursed portions under consumer and commercial lines of
credit as of September 30, 2007 and 2006 of $33,917 and $37,266, respectively.
76
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The Company originates both adjustable and fixed interest rate loans and
purchases mortgage-related securities in the secondary market. The originated
adjustable-rate loans have annual and lifetime interest rate adjustment
limitations and are generally indexed to U.S. Treasury securities plus a fixed
margin. Future market factors may affect the correlation of the interest rate
adjustment with rates the Company pays on the short-term deposits that have been
the primary funding source for these loans. The adjustable-rate mortgage-related
securities adjust to various national indices plus a fixed margin. At September
30, 2007, the composition of these loans and mortgage-related securities was as
follows:
FIXED-RATE
- --------------------------------
TERM TO MATURITY BOOK VALUE
- ------------------- ----------
1 month to 1 year $ 13,487
1 year to 3 years 13,695
3 years to 5 years 22,185
5 years to 10 years 49,384
Over 10 years 188,024
--------
Total $286,775
========
ADJUSTABLE-RATE
- ------------------------------------
TERM TO RATE ADJUSTMENT BOOK VALUE
- ----------------------- ----------
1 month to 1 year $ 57,152
1 year to 3 years 31,281
3 years to 5 years 25,935
5 years to 10 years 5,069
--------
Total $119,437
========
The following is an analysis of the allowance for loan losses:
YEAR ENDED
SEPTEMBER 30,
-------------------------
2007 2006 2005
------ ------- ------
Beginning balance $3,367 $ 3,475 $2,039
Provisions charged to income 375 1,206 1,780
Charge-offs (470) (1,328) (344)
Recoveries 50 14 --
------ ------- ------
Total $3,322 $ 3,367 $3,475
====== ======= ======
At September 30, 2007 and 2006, non-performing loans (which include loans
in excess of 90 days delinquent) amounted to approximately $4,685 and $277,
respectively. At September 30, 2007, non-performing loans consisted of loans
that were both individually and collectively evaluated for impairment.
Loans collectively evaluated for impairment include residential real
estate, home equity (including lines of credit) and consumer loans and are not
included in the data that follow:
SEPTEMBER 30,
-------------
2007 2006
------ ----
Impaired loans with related allowance for loan losses $1,148 $--
under SFAS No. 114
Impaired loans with no related allowance for loan losses
under SFAS No. 114 25 25
------ ---
Total impaired loans $1,173 $25
====== ===
Valuation allowance related to impaired loans $ 271 $--
====== ===
77
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
At September 30, 2007 and 2006, the Company had impaired loans with a total
recorded investment of $1,173 and $25, respectively, and an average recorded
investment of $933 and $1,727, respectively. There was $1, $1 and $39 of
interest income recognized on these impaired loans during the years ended
September 30, 2007, 2006 and 2005, respectively. Interest income of
approximately $83, $1 and $338, respectively, was not recognized as interest
income due to the non-accrual status of loans during fiscal 2007, 2006 and 2005.
7. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are summarized by major classification as
follows:
SEPTEMBER 30,
-----------------
2007 2006
------- -------
Land and buildings $ 7,875 $ 7,423
Furniture, fixtures and equipment 3,965 3,797
------- -------
Total 11,840 11,220
Accumulated depreciation and amortization (7,078) (6,577)
------- -------
Net $ 4,762 $ 4,643
======= =======
The future minimum rental payments required under operating leases that
have initial or remaining non-cancelable lease terms in excess of one year as of
September 30, 2007 are as follows:
September 30,
2008 $ 343
2009 343
2010 316
2011 143
2012 149
Thereafter 2,206
------
Total minimum future rental payments $3,500
======
Leasehold expense was approximately $533, $532 and $502 for the years ended
September 30, 2007, 2006 and 2005, respectively.
Depreciation expense amounted to $557, $535 and $534 for the years ended
September 30, 2007, 2006 and 2005, respectively.
8. DEPOSITS
Deposits consist of the following major classifications:
SEPTEMBER 30,
---------------------------------------
2007 2006
------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- -------
Non-interest-bearing $ 18,404 5.2% $ 17,232 4.8%
NOW 75,194 21.2 73,356 20.5
Passbook 37,369 10.6 41,708 11.6
Money market 34,252 9.7 40,591 11.3
Certificates of deposit 188,489 53.3 185,929 51.8
-------- ----- -------- -----
Total $353,708 100.0% $358,816 100.0%
======== ===== ======== =====
The weighted average interest rates paid on deposits were 3.16% and 2.43%
for the years ended September 30, 2007 and 2006, respectively.
78
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Included in deposits as of September 30, 2007 and 2006 were deposits
greater than $100 totaling approximately $126,369 and $123,651, respectively.
Basic deposits and retirement accounts in excess of $100 and $250, respectively,
are generally not federally insured.
At September 30, 2007 and 2006, the Company had pledged certain
mortgage-related securities aggregating $24,778 and $19,259, respectively, as
collateral for municipal deposits and financings.
A summary of scheduled maturities of certificates is as follows:
SEPTEMBER 30,
-------------------
2007 2006
-------- --------
Within one year $164,200 $118,779
One to two years 15,729 53,852
Two to three years 4,213 5,666
Thereafter 4,347 7,632
-------- --------
Total $188,489 $185,929
======== =======
A summary of interest expense on deposits is as follows:
YEAR ENDED SEPTEMBER 30,
-------------------------
2007 2006 2005
------- ------ ------
NOW $ 1,016 $ 693 $ 399
Passbook 365 429 475
Money market 1,082 914 762
Certificates of deposit 8,745 6,511 4,644
------- ------ ------
Total $11,208 $8,547 $6,280
======= ====== ======
9. BORROWINGS
A summary of borrowings is as follows:
SEPTEMBER 30,
------------------
2007 2006
-------- --------
FHLB advances $ 86,334 $ 86,353
FHLB overnight borrowings 29,000 20,800
Other 50 88
-------- --------
Total borrowings $115,384 $107,241
======== ========
Advances from the FHLB bear fixed interest rates with remaining periods
until maturity, summarized as follows:
SEPTEMBER 30,
------------------
2007 2006
------- -------
Within one year $ 5,672 $ --
Over one year through five years 80,539 86,175
Over five years through ten years 123 178
Over 10 years -- --
------- -------
$86,334 $86,353
======= =======
Included in the table above at September 30, 2007 and 2006 are $86,334 and
$86,353, respectively, of FHLB advances whereby the FHLB has the option at
predetermined times to convert the fixed interest rate to an adjustable rate
tied to the London Interbank Offered Rate (LIBOR). At September 30, 2007,
substantially all the FHLB advances with the convertible feature are subject to
conversion in fiscal 2008. The Company then has the option to prepay these
advances if the FHLB converts the interest rate. These advances are included in
the periods in which they mature rather
79
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
than the period in which they can be converted. The average balance of FHLB
advances and overnight borrowings was $93,182 with an average cost of 5.56% for
the year ended September 30, 2007.
Advances from the FHLB are collateralized by all FHLB stock, which is
carried at cost, owned by the Bank in addition to a blanket pledge of eligible
assets in an amount required to be maintained so that the estimated fair value
of such eligible assets exceeds, at all times, 110% of the outstanding advances.
10. INCOME TAXES
The Company and its subsidiaries file a consolidated federal income tax
return. The Company uses the specific charge-off method for computing reserves
for bad debts. The bad debt deduction allowable under this method is available
to large banks with assets of greater than $500 million. Generally, this method
allows the Company to deduct an annual addition to the reserve for bad debts
equal to its net charge-offs.
Retained earnings at September 30, 2007 and 2006 included approximately
$2,500 representing bad debt deductions for which no income tax has been
provided.
Income tax (benefit) expense is comprised of the following:
YEAR ENDED SEPTEMBER 30,
------------------------
2007 2006 2005
----- ----- -----
Federal:
Current $(220) $(384) $(232)
Deferred -- 25 (81)
State -- -- --
----- ----- -----
Total $(220) $(359) $(313)
===== ===== =====
The tax effect of temporary differences that give rise to significant
portions of the deferred tax accounts, calculated at 34%, is as follows:
SEPTEMBER 30,
---------------
2007 2006
------ ------
Deferred tax assets:
Accelerated depreciation $ 496 $ 475
Allowance for loan losses 1,129 1,145
Unrealized loss on available for sale securities 630 406
Accrued expenses 627 608
------ ------
Total deferred tax assets $2,882 $2,634
====== ======
Deferred tax liabilities:
Deferred loan fees (311) (274)
Other (66) (79)
------ ------
Total deferred tax liabilities (377) (353)
------ ------
Net deferred tax assets $2,505 $2,281
====== ======
From time to time, the Company may be subject to examination by various tax
authorities in jurisdictions in which the Company has its business operations.
The Company regularly assesses the likelihood of additional assessments in each
of the tax jurisdictions resulting from these examinations. Tax reserves have
been established which the Company believes to be adequate in relation to the
potential for additional assessments. Once established, reserves are adjusted as
information becomes available or when an event requiring a change to the reserve
occurs. The resolution of tax matters could have an impact on the Company's
effective tax rate.
80
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The Company's effective tax rate is less than the statutory federal income
tax rate for the following reasons:
YEAR ENDED SEPTEMBER 30,
---------------------------------------------------------------
2007 2006 2005
------------------- ------------------- -------------------
PERCENTAGE PERCENTAGE PERCENTAGE
OF PRETAX OF PRETAX OF PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
------ ---------- ------ ---------- ------ ----------
Tax at statutory rate $ 83 34.0% $ 238 34.0% $ 101 34.0%
Decrease (increase) in taxes resulting from:
Tax exempt interest, net (119) (48.6) (222) (31.7) (231) (77.8)
Increase in cash surrender value (193) (78.8) (383) (54.8) (194) (65.3)
Dividend received deduction (7) (2.9) (19) (2.7) (50) (16.8)
Other 16 6.5 27 3.9 61 20.5
----- ----- ----- ----- ----- ------
Total $(220) (89.8)% $(359) (51.3)% $(313) (105.4)%
===== ===== ===== ===== ==== ======
11. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum regulatory capital
requirements can result in certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth below) of
tangible and core capital (as defined in the regulations) to adjusted assets (as
defined), and of Tier I and total capital (as defined) to average assets (as
defined). Management believes, as of September 30, 2007, that the Bank met 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 PERCENTAGE AMOUNT PERCENTAGE AMOUNT PERCENTAGE
------- ---------- ------- ---------- ------- ----------
At September 30, 2007:
Core Capital (to Adjusted Tangible Assets) $49,207 9.38% $20,975 4.0% $26,219 5.0%
Tier I Capital (to Risk-Weighted Assets) 49,207 15.44 N/A N/A 19,118 6.0
Total Capital (to Risk-Weighted Assets) 52,529 16.49 25,491 8.0 31,864 10.0
Tangible Capital (to Tangible Assets) 49,126 9.37 7,864 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
81
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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 a minimum core capital and total risk-based capital ratios of 7.5% and
12.5%, respectively. At September 30, 2007, the Bank was in compliance with such
requirement.
The Company's capital at September 30, 2007 and 2006 for financial
statement purposes differs from tangible, core (leverage), and Tier-1 risk-based
capital amounts by approximately $14,513 and $18,150, respectively, representing
the inclusion for regulatory capital purposes of unrealized losses on securities
available for sale and a portion of capital securities (see Note 16) that
qualifies as regulatory capital as well as adjustments to the Bank's capital
that do not affect the parent company.
At September 30, 2007 and 2006, total risk-based capital, for regulatory
requirements, was increased by $3,322 and $3,367, respectively, of general loan
loss reserves, for a total of $52,529 and $51,138, respectively.
At the date of the Bank's conversion from the mutual to stock form in
January 1995 (the "Conversion"), the Bank established a liquidation account in
an amount equal to its retained income as of August 31, 1994. The liquidation
account is maintained for the benefit of eligible account holders and
supplemental eligible account holders (as such terms are defined in the Bank's
plan of conversion) who continue to maintain their accounts at the Bank after
the Conversion. The liquidation account is reduced annually to the extent that
eligible account holders and supplemental eligible account holders have reduced
their qualifying deposits as of each anniversary date. Subsequent increases in
such balances will not restore an eligible account holder's or supplemental
eligible account holder's interest in the liquidation account. In the event of a
complete liquidation of the Bank, each eligible account holder and supplemental
eligible account holder will be entitled to receive a distribution from the
liquidation account in an amount proportionate to the current adjusted
qualifying balances for accounts then held.
The principal source of cash flow for the Company is dividends from the
Bank. Various federal banking regulations and capital guidelines limit the
amount of dividends that may be paid to the Company by the Bank. Future payment
of dividends by the Bank is dependent on individual regulatory capital
requirements, levels of profitability, and safety and soundness concerns. Under
current regulatory requirements of the OTS, the Bank is required to apply for
approval to dividend funds to the Company. No assurances can be given that such
approval, if requested, would be granted. In addition, loans or advances made by
the Bank to the Company are generally limited to 10 percent of the Bank's
capital stock and surplus on a secured basis, subject to compliance with various
collateral and other requirements. Accordingly, at September 30, 2007, funds
potentially available for loans or advances by the Bank to the Company amounted
to $4,816.
12. EMPLOYEE BENEFITS
401(K) PROFIT SHARING PLAN
The Bank's 401(k) profit sharing plan covers substantially all full-time
employees of the Company and provides for pre-tax contributions by the employees
with matching contributions at the discretion of the Board of Directors
determined at the beginning of the calendar year. All amounts are fully vested.
For calendar years 2007, 2006 and 2005, the Company matched twenty-five cents
for every dollar contributed up to 5% of a participant's salary. The profit
sharing expense for the plan was $35, $36 and $38 for the years ended September
30, 2007, 2006 and 2005, respectively.
82
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
EMPLOYEE STOCK OWNERSHIP PLAN
In connection with the Conversion, the Company established an employee
stock ownership plan ("ESOP") for the benefit of eligible employees. The Company
accounts for its ESOP in accordance with AICPA Statement of Position 93-6,
"Employers Accounting for Employee Stock Ownership Plans," which requires the
Company to recognize compensation expense equal to the fair value of the ESOP
shares during the periods in which they become committed to be released. To the
extent that the fair value of the ESOP shares released differs from the cost of
such shares, this difference is charged or credited to equity as additional
paid-in capital. Management expects the recorded amount of expense in any given
period to fluctuate from period to period as continuing adjustments are made to
reflect changes in the fair value of the ESOP shares. The Company's ESOP, which
is internally leveraged, does not report the loans receivable extended to the
ESOP as assets and does not report the ESOP debt due the Company. At September
30, 2007, 219,846 shares were committed to be released, of which 6,516 shares
have not yet been allocated to participant accounts. The fair value of
unreleased ESOP shares was $1,581 at September 30, 2007. The Company recorded
compensation and employee benefit expense related to the ESOP of $159, $183 and
$219 for the years ended September 30, 2007, 2006 and 2005, respectively.
RECOGNITION AND RETENTION PLAN
Under the 1995 Recognition and Retention Plan and Trust (the "RRP"), there
are 81,600 shares authorized to be issued pursuant to grants under the RRP. At
September 30, 2006, the Company had awarded 81,600 shares to the Company's
non-employee directors and executive officers subject to vesting and other
provisions of the RRP. At September 30, 2007, 80,248 shares granted to the plan
participants had vested and been distributed.
STOCK OPTION PLANS
Under the 1995 Stock Option Plan (the "Option Plan"), common stock totaling
272,000 shares was reserved for issuance pursuant to the exercise of options.
The Option Plan expired by its terms in July 2005. Options granted pursuant to
the Option Plan, prior to its expiration, remain exercisable according to the
terms of their issuance. During fiscal year 1999, stockholders approved the
adoption of the 1998 Stock Option Plan ("1998 Option Plan") (collectively with
the Option Plan, the "Plans") pursuant to which an additional 111,200 shares of
common stock were reserved for issuance of which 29,623 were available for
future grant at September 30, 2007. Options covering an aggregate of 353,577
shares have been granted to the Company's executive officers, non-employee
directors and other key employees, subject to vesting and other provisions of
the Plans. At September 30, 2007, 2006 and 2005, the number of shares covered by
options exercisable at such dates was 50,356, 55,810 and 56,836, respectively,
and the weighted average exercise price of those options was $12.85, $12.76 and
$12.38, respectively.
The following table summarizes transactions regarding the stock option
plans:
WEIGHTED
NUMBER OF EXERCISE AVERAGE
OPTION PRICE EXERCISE PRICE
SHARES RANGE PER SHARE
--------- -------------- ---------------
Outstanding at October 1, 2004 186,102 $ 7.50 - 16.15 $10.26
Granted 2,221 19.75 - 21.89 20.14
Exercised (116,396) 7.50 - 16.15 8.69
Cancelled (5,750) 12.13 - 14.25 14.17
--------
Outstanding at September 30, 2005 66,177 $ 7.50 - 21.89 $13.01
-------- -------------- ------
Granted -- -- --
Exercised (4,730) 8.50 - 12.38 10.95
Cancelled
-- -- --
--------
Outstanding at September 30, 2006 61,447 $10.13 - 21.89 $13.17
-------- -------------- ------
Granted -- -- --
Exercised (5,070) 10.13 - 14.25 12.25
Cancelled (1,694) 19.75 - 21.89 20.06
Forfeited (3,727) 14.25 - 21.89 15.12
--------
Outstanding at September 30, 2007 50,956 $10.13 - 16.15 $12.89
======== ============== ======
83
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
A summary of the range of exercise prices of outstanding options at
September 30, 2007 is as follows:
WEIGHTED AVERAGE WEIGHTED
NUMBER OF EXERCISE PRICE REMAINING AVERAGE EXERCISE
OPTION SHARES RANGE CONTRACTUAL LIFE PRICE PER SHARE
- ------------- -------------- ---------------- ----------------
3,000 $10.13 - 10.13 3.00 $10.13
47,956 12.13 - 16.15 2.66 13.06
------
50,956 $10.13 - 16.15 2.68 $12.89
====== ============== ==== ======
SUPPLEMENTAL RETIREMENT BENEFITS
The Bank maintains a defined contribution supplemental executive retirement
plan (the "SERP") covering certain senior executive officers of the Bank. For
the initial year of the SERP, the crediting rate on the amounts contributed was
established at 5.0% and will remain in effect until such time that the Company's
Compensation Committee administering the SERP determines to change it. Upon
retirement of a participant, he or she will receive his or her account balance
paid out in equal annual payments for a period not to exceed 15 years provided
that a participant did not make a prior election to receive his or her
distribution in a lump sum. The SERP also provides for the payment of benefits
in the event of the death of the participant or the termination of the
employment of the participant subsequent to a change in control of the Company.
In March 2005, the Company entered into a Transition, Consulting,
Noncompetition and Retirement Agreement with the Company's previous President
(the "Agreement"). The Agreement provides for a consulting fee for five years
and for payments for a period of ten years beginning upon the commencement of
the retirement phase of the Agreement. The Agreement provides for full payments
in the event of a change in control of the Company. For the fiscal years ended
September 30, 2007, 2006 and 2005, the pension expense relating to supplemental
retirement benefits was approximately $175, $254 and $261, respectively.
The Bank also provides supplemental retirement benefits to certain
directors and Advisory Board members. The expense relating to these arrangements
was approximately $105, $114 and $119 for the years ended September 30, 2007,
2006 and 2005, respectively.
13. COMMITMENTS AND CONTINGENCIES
The Bank has outstanding commitments to originate loans, excluding
undisbursed portion of loans in process and equity lines of credit, of
approximately $1,939 and $4,637 as of September 30, 2007 and 2006, respectively,
all of which are expected to be funded within four months. Of these commitments
outstanding, the breakdown between fixed and adjustable-rate loans is as
follows:
SEPTEMBER 30,
---------------
2007 2006
------ ------
Fixed-rate (ranging from 5.88% to 7.75%) $1,275 $3,662
Adjustable-rate 664 975
------ ------
Total $1,939 $4,637
====== ======
Depending on cash flow, interest rate, risk management and other
considerations, longer term fixed-rate residential loans originated prior to
February 2006 were sold in the secondary market. Currently, the Bank sells
participations in SBA loans to the secondary market. There were an aggregate of
approximately $0 and $1,099 in outstanding commitments to sell SBA
participations at September 30, 2007 and 2006, respectively.
84
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The Bank issues letters of credit to its commercial customers which are
commitments to guarantee the performance of the customer to a third party. There
were $849 and $367 outstanding letters of credit at September 30, 2007 and 2006,
respectively. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Bank currently has the ability to obtain up to $177,294 in additional
advances from the FHLBank Pittsburgh.
The Bank also purchased letters of credit from the FHLBank Pittsburgh,
which totaled $0 and $4,136 at September 30, 2007 and 2006, respectively.
There may be various claims and pending actions against the Company and its
subsidiaries arising out of the conduct of its business. In the opinion of the
Company's management and based upon advice of legal counsel, the resolution of
these matters is not expected to have a material adverse impact on the
consolidated financial position, the results of operations or the cash flows of
the Company and its subsidiaries.
14. RELATED PARTY TRANSACTIONS
The Company retains the services of a law firm in which one of the
Company's directors is a member. In addition to providing general legal counsel
to the Company, the firm also prepares mortgage documents and attends loan
closings for which it is paid directly by the borrower.
The Company utilizes two of the Company's directors as consultants on
various real estate and general business matters. In addition, one of the
Company's board members has an interest in an insurance agency, First Keystone
Insurance, LLC in which one of the Bank's subsidiaries has a 51% ownership
interest.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies. However,
considerable judgment is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
SEPTEMBER 30,
------------------------ --------------------
2007 2006
--------------------- ---------------------
CARRYING/ ESTIMATED CARRYING/ ESTIMATED
NOTIONAL FAIR NOTIONAL FAIR
AMOUNT VALUE AMOUNT VALUE
--------- --------- --------- ---------
Assets:
Cash and cash equivalents $ 52,935 $ 52,935 $ 12,787 $ 12,787
Investment securities 32,540 32,550 36,643 36,654
Loans 292,418 283,255 323,220 321,939
Loans held for sale -- -- 1,334 1,334
Mortgage-related securities 110,472 109,689 108,385 107,193
FHLB stock 6,338 6,338 6,233 6,233
Liabilities:
Passbook deposits 37,369 37,369 41,708 41,708
NOW and money market deposits 127,850 127,850 131,179 131,179
Certificates of deposit 188,489 188,880 185,929 183,629
Borrowings 115,384 117,974 107,241 106,127
85
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The fair value of cash and cash equivalents is their carrying value due to
their short-term nature. The fair value of investment and mortgage-related
securities is based on quoted market prices, dealer quotes, and prices obtained
from independent pricing services. The fair value of loans is estimated, based
on present values using approximate current entry value interest rates,
applicable to each category of such financial instruments. The fair value of
FHLB stock approximates its carrying amount.
The fair value of NOW deposits, money market deposits and passbook deposits
is the amount reported in the financial statements. The fair value of
certificates of deposit and borrowings is based on a present value estimate,
using rates currently offered for deposits and borrowings of similar remaining
maturity. The fair value for accrued interest receivable and payable, the cash
surrender value of life insurance, and subordinated debentures approximates
their carrying value at September 30, 2007.
Fair values for off-balance sheet commitments are based on fees currently
charged to enter into similar agreements, taking into account the remaining
terms of the agreements and the counterparties credit standings.
No adjustment was made to the entry-value interest rates for changes in
credit performing commercial real estate and business loans, construction loans,
and land loans for which there are no known credit concerns. Management believes
that the risk factor embedded in the entry-value interest rates, along with the
general reserves applicable to the performing commercial, construction, and land
loan portfolios for which there are no known credit concerns, result in a fair
valuation of such loans on an entry-value basis. The fair value of
non-performing loans, with a recorded book value of approximately $1,622 and
$277 (which are collateralized by real estate properties with property values in
excess of carrying amounts) as of September 30, 2007 and 2006, respectively, was
not estimated because it is not practicable to reasonably assess the credit
adjustment that would be applied in the marketplace for such loans. The fair
value estimates presented herein are based on pertinent information available to
management as of September 30, 2007 and 2006. Although management is not aware
of any factors that would significantly affect the estimated fair value amounts,
such amounts have not been comprehensively revalued for purposes of these
financial statements since September 30, 2007 and 2006 and, therefore, current
estimates of fair value may differ significantly from the amounts presented
herein.
16. CAPITAL SECURITIES
On August 21, 1997, First Keystone Capital Trust I (the "Trust"), a trust
formed under Delaware law, that is a subsidiary of the Company, issued $16.2
million of preferred securities (the "Preferred Securities") at an interest rate
of 9.7%, with a scheduled maturity of August 15, 2027. The Company owns all the
common stock of the Trust. The proceeds from the issue were invested in junior
subordinated debentures (the "Debentures") issued by the Company. The Debentures
are unsecured and rank subordinate and junior in right of payment to all
indebtedness, liabilities and obligations of the Company. On November 15, 2001,
the Company purchased $3.5 million of the Preferred Securities. Debentures
represent the sole assets of the Trust. Interest on the Preferred Securities is
cumulative and payable semiannually in arrears. The Company has the option,
subject to required regulatory approval, if any, to prepay the securities
beginning August 15, 2007. The Company has, under the terms of the Debentures
and the related Indenture as well as the other operative corporate documents,
agreed to irrevocably and unconditionally guarantee the Trust's obligations
under the Debentures. In 1997, the Company made a capital contribution of
approximately $6.0 million to the Bank using a portion of the net proceeds from
the issuance of the Debentures to support the Bank's lending activities.
On November 28, 2001, First Keystone Capital Trust II (the "Trust II"), a
trust formed under Delaware law, that is a subsidiary of the Company, issued
$8.0 million of securities ("Preferred Securities II") in a pooled securities
offering at a floating rate of 375 basis points over the six month LIBOR with a
maturity date of December 8, 2031. The Company owns all the common stock of
Trust II. The proceeds from the issue were invested in junior subordinated
debentures (the "Debentures II") issued by the Company. The Debentures II are
unsecured and rank subordinate and junior in right of payment to all
indebtedness, liabilities and obligations of the Company. The Debentures II
represent the sole assets of the Trust II. Interest on the Preferred Securities
II is cumulative and payable semi-annually in arrears. The Company has the
option, subject to required regulatory approval, if any, to redeem, in whole or
in part, the securities beginning December 8, 2006 and every six months
thereafter. In June 2007, with the net proceeds from the private placement
offering, the Trust II redeemed $6.0 million of Preferred Securities II.
86
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The Company had previously established Issuer Trusts that issued guaranteed
preferred beneficial interests in the Company's junior subordinated debentures.
Prior to FIN 46 and FIN 46 (R), the Company classified its Issuer Trusts after
total liabilities and before shareholders' equity on its consolidated statements
of financial condition under the caption "Guaranteed Preferred Beneficial
Interest in Company's Subordinated Debt" and the retained common capital
securities of the Issuer Trusts were eliminated against the Company's investment
in the Issuer Trusts. Distributions on the preferred securities were recorded as
non-interest expense on the consolidated statements of operations.
As a result of the adoption of FIN 46 and FIN 46 (R), the Company
deconsolidated all the Issuer Trusts. As a result, the junior subordinated
debentures issued by the Company to the Issuer Trusts, totaling $15.3 million
and $21.5 million, are reflected in the Company's consolidated statements of
financial condition in the liabilities section at September 30, 2007 and 2006,
respectively, under the caption "Junior Subordinated Debentures." The Company
records interest expense on the corresponding debentures in its consolidated
statements of operations. The Company also recorded the common capital
securities issued by the Issuer Trusts in "Prepaid expenses and other assets" in
its consolidated statements of financial condition at September 30, 2007 and
2006.
17. PARENT COMPANY ONLY FINANCIAL INFORMATION
Condensed financial statements of First Keystone Financial, Inc. are as
follows:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30,
-----------------
2007 2006
------- -------
Assets:
Interest-bearing deposits $ 541 $ 1,802
Investment securities available for sale 1,092 1,581
Investment in subsidiaries 49,048 47,853
Other assets 146 277
------- -------
Total assets $50,827 $51,513
======= =======
Liabilities and Stockholders' Equity:
Junior subordinated debentures $15,264 $21,483
Other liabilities 869 1,371
------- -------
Total liabilities 16,133 22,854
Stockholders' equity 34,694 28,659
------- -------
Total liabilities and stockholders' equity $50,827 $51,513
======= =======
CONDENSED STATEMENTS OF OPERATIONS
YEAR ENDED SEPTEMBER 30,
------------------------
2007 2006 2005
------ ------ ------
Interest and dividend income:
Dividends from subsidiary $ 12 $ 14 $ 11
Loans to ESOP 226 233 192
Interest and dividends on investments 208 125 280
Interest on deposits 17 25 13
------ ------ ------
Total interest and dividend income 463 397 496
Interest on debt and other borrowed money 1,828 1,954 1,794
Other income 7 -- 1,256
Operating expenses 189 211 183
Equity in earnings of subsidiaries 1,497 2,213 770
------ ------ ------
(Loss) income before income taxes (50) 445 545
Income tax benefit (515) (590) (65)
------ ------ ------
Net income $ 465 $1,035 $ 610
====== ====== ======
87
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
CONDENSED STATEMENTS OF CASH FLOWS
YEAR ENDED SEPTEMBER 30,
---------------------------
2007 2006 2005
------- ------- -------
Cash flows from operating activities:
Net income $ 465 $ 1,035 $ 610
Adjustment to reconcile net income to cash used in operations:
Equity in earnings of subsidiaries (1,497) (2,213) (770)
Shared-based compensation 33 25 --
Amortization of ESOP 142 146 164
Gain on sales of investment securities available for sale -- -- (1,133)
Amortization of premium (33) (37) (37)
(Increase) decrease in other assets 131 1,034 (897)
(Decrease) increase in other liabilities (336) (62) 660
------- ------- -------
Net cash used in operating activities (1,095) (72) (1,403)
------- ------- -------
Cash flows from investing activities:
Purchase of investments available for sale -- (62) --
Dividend from subsidiary -- -- 1,500
Return of investment in First Keystone Capital Trust II 189 -- --
Proceeds from sale of investments available for sale -- -- 1,911
------- ------- -------
Net cash provided by (used in) investing activities 189 (62) 3,411
------- ------- -------
Cash flows from financing activities:
Purchase of treasury stock -- -- (110)
Common stock acquired by ESOP -- -- (72)
Dividends paid -- (209) (810)
Net proceeds from equity offering 5,769 -- --
Retirement of junior subordinated debentures (6,186) -- --
Proceeds from exercise of stock options 62 47 656
------- ------- -------
Net cash used in financing activities (355) (162) (336)
------- ------- -------
(Decrease) increase in cash (1,261) (296) 1,672
Cash at beginning of year 1,802 2,098 426
------- ------- -------
Cash at end of year $ 541 $ 1,802 $ 2,098
======= ======= =======
88
FIRST KEYSTONE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
18. QUARTERLY FINANCIAL DATA (UNAUDITED)
Unaudited quarterly financial data for the years ended September 30, 2007
and 2006 is as follows:
2007 2006
-------------------------------- ---------------------------------
1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
QTR QTR QTR QTR QTR QTR QTR QTR
------ ------ ------ ------ ------ ------ ------ ------
Interest income $7,173 $7,198 $7,045 $6,967 $6,550 $6,696 $7,064 $7,183
Interest expense 4,711 4,579 4,540 4,396 3,770 3,868 4,222 4,555
------ ------ ------ ------ ------ ------ ------ ------
Net interest income 2,462 2,619 2,505 2,571 2,780 2,828 2,842 2,628
Provision for loan losses
75 100 100 100 45 525 81 555
------ ------ ------ ------ ------ ------ ------ ------
Net income after
provision for loan losses 2,387 2,519 2,405 2,471 2,735 2,303 2,761 2,073
Non-interest income 747 853 726 687 775 800 668 1,269
Non-interest expense 3,137 3,253 3,046 3,113 2,993 3,226 3,181 3,308
------ ------ ------ ------ ------ ------ ------ ------
Income (loss) before income
taxes (3) 119 85 45 517 (123) 248 34
Income tax expense (benefit)
(91) (48) (30) (50) 72 (142) (19) (270)
------ ------ ------ ------ ------ ------ ------ ------
Net income $ 88 $ 167 $ 115 $ 95 $ 445 $ 19 $ 267 $ 304
====== ====== ===== ==== ====== ==== ====== ======
Per Share:
Earnings per share - basic $0.04 $0.07 $0.05 $0.04 $ 0.24 $ 0.01 $ 0.14 $ 0.16
Earnings per share - diluted $0.04 $0.07 $0.05 $0.04 $ 0.23 $ 0.01 $ 0.14 $ 0.16
Dividend per share -- -- -- -- $ 0.11 $ -- $ -- $ --
Earnings per share are computed independently for each period presented.
Consequently, the sum of the quarters may not equal the total earnings per share
for the year.
****
89
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES.
Not applicable.
ITEM 9-A. CONTROLS AND PROCEDURES.
Under the supervision and with the participation of the Company's
management, including its Chief Executive Officer and Chief Financial Officer,
the Company has evaluated the effectiveness of the design and operation of its
disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e)
under the Exchange Act) as of September 30, 2007. Based on such evaluation, the
Company's Chief Executive Officer and Chief Financial Officer have concluded
that these controls and procedures are designed to ensure that the information
required to be disclosed by the Company in reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the SEC's rules and regulations and are operating
in an effective manner.
No change in the Company's internal control over financial reporting (as
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during
the fourth fiscal quarter of fiscal 2007 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
ITEM 9-B. OTHER INFORMATION.
There is no information to be reported on Form 8-K during the fourth
quarter of fiscal 2007 that has not already been reported pursuant thereto.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERANCE.
The information required herein with respect to directors and executive
officers of the Company is incorporated by reference from the information
contained in the sections captioned "Information with Respect to Nominees for
Director, Continuing Directors and Executive Officers" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Company's definitive Proxy
Statement for the Annual Meeting of Stockholders currently expected (as of the
date hereof) to be held on February 6, 2008 (the "Proxy Statement"), a copy of
which will be filed with the SEC within 120 days of the end of the Company's
fiscal year.
The Company has adopted a Code of Conduct and Ethics that applies to its
Principal Executive Officer and Principal Financial Officer, Principal
Accounting Officer as well as other officers and employees of the Company and
the Bank. A copy of the Code of Ethics was included as Exhibit 99.1 to the
Annual Report on Form 10-K for the year ended September 30, 2003 filed with the
SEC.
ITEM 11. EXECUTIVE COMPENSATION.
The information required herein is incorporated by reference from the
information contained in the sections captioned "Management Compensation",
"Compensation Committee Report" and "Compensation Committee Interlocks and
Insider Participation" in the Registrant's Proxy Statement. The report of the
Compensation Committee included in the Registrant's Proxy Statement should not
be deemed filed or incorporated into this filing or any other filing by the
Company under the Exchange Act or the Securities Act of 1933 except to the
extent the Company specifically incorporates said report herein or therein by
reference thereto.
90
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The
information required herein is incorporated by reference from the information
contained in the section captioned "Beneficial Ownership of Common Stock by
Certain Beneficial Owners and Management" in the Registrant's Proxy Statement.
EQUITY COMPENSATION PLAN INFORMATION. The following table sets forth
certain information for all equity compensation plans and individual
compensation arrangements (whether with employees or non-employees, such as
directors) in effect as of September 30, 2007.
Number of Shares Remaining
Number of Shares to be Issued Available
Upon the Exercise of Weighted Average for Future Issuance (Excluding
Outstanding Options, Exercise Price of Shares
Plan Category Warrants and Rights Outstanding Options Reflected in the First Column)
- ------------------------------- ----------------------------- ------------------- -------------------------------
Equity Compensation Plans
Approved by Security 50,956(1) $12.89(1) 29,623
Holders
Equity Compensation Plans Not
Approved by Security Holders -- -- --
------ ------ ------
Total 50,956 $12.89 29,623
====== ====== ======
- ----------
(1) Excludes 600 shares subject to restricted stock grants which were not
vested as of September 30, 2007.
ITEM 13. CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.
The information required herein is incorporated by reference from the
information contained in the section captioned "Management Compensation -
Indebtedness of Management and Related Party Transactions" and "Information with
Respect to Nominees for Director, Continuing Directors and Executive Officers"
in the Registrant's Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The information required herein is incorporated by reference from the
information contained in the section captioned "Ratification of Appointment of
Independent Registered Public Accounting Firm- Audit Fees" in the Registrant's
Proxy Statement.
PART IV.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a) Documents filed as part of this Report.
(1) The following documents are filed as part of this report and are
incorporated herein by reference from Item 8 hereof.
Reports of Independent Registered Public Accounting Firm
Consolidated Statements of Financial Condition at September 30,
2007 and 2006.
Consolidated Statements of Operations for the Years Ended
September 30, 2007, 2006 and 2005.
91
Consolidated Statements of Changes in Stockholders' Equity for
the Years Ended September 30, 2007, 2006 and 2005.
Consolidated Statements of Cash Flows for the Years Ended
September 30, 2007, 2006 and 2005.
Notes to the Consolidated Financial Statements.
(2) All schedules for which provision is made in the applicable
accounting regulation of the SEC are omitted because they are not
applicable or the required information is included in the
Consolidated Financial Statements or notes thereto.
(3) The following exhibits are filed as part of this Form 10-K, and
this list includes the Exhibit Index.
No Description
- ----- ------------------------------------------------------------------------
3.1 Amended and Restated Articles of Incorporation of First Keystone
Financial, Inc. 1
3.2 Amended and Restated Bylaws of First Keystone Financial, Inc.
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 Carol
Walsh dated December 1, 2004 2,*
10.3 1995 Stock Option Plan 3, *
10.4 1995 Recognition and Retention Plan and Trust Agreement 4,*
10.5 1998 Stock Option Plan 4, *
10.6 Employment Agreement between First Keystone Bank and Thomas M. Kelly
dated December 1, 2004 2, *
10.7 Severance Agreement between First Keystone Bank and Carol Walsh dated
December 1, 2004 2, *
10.8 First Keystone Bank Supplemental Executive Retirement Plan 5,*
10.9 Amendment No. 1 to the Employment Agreement between First Keystone
Financial, Inc. and Thomas M. Kelly 6,*
10.10 Amendment No. 1 to the Employment Agreement between First Keystone Bank
and Thomas M. Kelly 6,*
10.11 Transition, Consulting, Noncompetition and Retirement Agreement by and
between First Keystone Financial, Inc., First Keystone Bank and Donald
S. Guthrie 7,*
10.12 Letter dated December 11, 2006 with respect to appointment to Board 8
10.13 Form of Registration Rights Agreement 11
11 Statement re: computation of per share earnings. See Note 2 to the
Consolidated Financial Statements included in Item 8 hereof.
23.1 Consent of S.R. Snodgrass, A.C.
23.2 Consent of Deloitte & Touche LLP
31.1 Section 302 Certification of Chief Executive Officer
31.2 Section 302 Certification of Chief Financial Officer
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.1 Codes of Ethics 9
99.2 Supervisory Agreement between First Keystone Financial, Inc. and the
Office of Thrift Supervision dated February 13, 2006. 10
99.3 Supervisory Agreement between First Keystone Bank and the Office of
Thrift Supervision dated February 13, 2006. 10
92
- ----------
(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, 10.8, 10.14, 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 Exhibits 10.19 and 10.20, respectively, in
the Form 8-K filed by the Registrant with the SEC on March 29, 2005.
(7) Incorporated by reference from Exhibit 10.21 in the Form 8-K filed by the
Registrant with the SEC on March 29, 2005.
(8) Incorporated by reference from Exhibit 10.1 in the Form 8-K filed by the
Registrant with the SEC on December 20, 2006.
(9) Incorporated by reference from the Form 10-K filed by the Registrant with
the SEC on December 23, 2003.
(10) Incorporated by reference from the Form 10-Q for the quarter ended December
31, 2005 filed by the Registrant with the SEC on February 14, 2006.
(11) Incorporated by reference from 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.
(b) Exhibits
The exhibits listed under (a)(3) of this Item 15 are filed herewith.
(c) Reference is made to (a)(2) of this Item 15.
93
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST KEYSTONE FINANCIAL, INC.
By: /s/ Thomas M. Kelly
---------------------------------
Thomas M. Kelly
President and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report had been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Donald S. Guthrie December 28, 2007
- -------------------------------------------------
Donald S. Guthrie
Chairman of the Board
/s/ Thomas M. Kelly December 28, 2007
- -------------------------------------------------
Thomas M. Kelly
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Edmund Jones December 28, 2007
- -------------------------------------------------
Edmund Jones
Director
/s/ Donald G. Hosier, Jr. December 28, 2007
- -------------------------------------------------
Donald G. Hosier, Jr.
Director
/s/ Marshall J. Soss December 28, 2007
- -------------------------------------------------
Marshall J. Soss
Director
/s/ William J. O'Donnell December 28, 2007
- -------------------------------------------------
William J. O'Donnell
Director
/s/ Bruce C. Hendrixson December 28, 2007
- -------------------------------------------------
Bruce C. Hendrixson
Director
/s/ Jerry A. Naessens December 28, 2007
- -------------------------------------------------
Jerry A. Naessens
Director
/s/ Nedret E. Vidinli December 28, 2007
- -------------------------------------------------
Nedret E. Vidinli
Director
/s/ Rose M. DiMarco December 28, 2007
- -------------------------------------------------
Rose M. DiMarco
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
94