-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NENIWEOw80WXORgmfnw92pXQlCC8/NQAMNgM8UrzqF269Sp2BUG54W+GHOHAlN5j d4HzIHUtg9pQQiA4vbuYAQ== 0000717809-98-000004.txt : 19980401 0000717809-98-000004.hdr.sgml : 19980401 ACCESSION NUMBER: 0000717809-98-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: KEYSTONE FINANCIAL INC CENTRAL INDEX KEY: 0000717809 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 232289209 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-11460 FILM NUMBER: 98579911 BUSINESS ADDRESS: STREET 1: ONE KEYSTONE PLZ - FRONT & MARKET STS STREET 2: P O BOX 3660 CITY: HARRISBURG STATE: PA ZIP: 17105-3660 BUSINESS PHONE: 7172331555 MAIL ADDRESS: STREET 1: ONE KEYSTONE PLZ STREET 2: PO BOX 3660 CITY: HARRISBURG STATE: PA ZIP: 171053660 FORMER COMPANY: FORMER CONFORMED NAME: NCB FINANCIAL CORP DATE OF NAME CHANGE: 19850115 10-K 1 KEYSTONE FINANCIAL, INC. FORM 10-K FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (X) Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 1997 OR ( ) Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ________to_________ - -------------------------------------------------------------------------------- Commission File Number 0-11460 KEYSTONE FINANCIAL, INC. Pennsylvania 23-2289209 (State of Incorporation) (IRS Employer ID No.) P.O. Box 3660 One Keystone Plaza Front and Market Streets Harrisburg, PA 17105-3660 Telephone: (717) 233-1555 - -------------------------------------------------------------------------------- Securities registered pursuant to section 12(g) of the Act: Common Stock, $2.00 par value. 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. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant as of February 28, 1998: Common Stock $2.00 Par Value -- $1,969,986,000 The number of shares outstanding of the registrant's class of common stock as of February 28, 1998: Common Stock $2.00 Par Value -- 51,673,000. DOCUMENTS INCORPORATED BY REFERENCE Portions of the annual shareholder report for the year ended December 31, 1997, are incorporated by reference into Parts I and II and portions of the Proxy Statement of Keystone Financial, Inc. for the 1998 annual shareholders meeting are incorporated by reference into Part III. 1 FORM 10-K INDEX PART I PAGE - ---------- ------- Item 1 Business 3 Item 2 Properties 9 Item 3 Legal Proceedings 9 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 10 Item 6 Selected Financial Data 10 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 7A Quantitative and Qualitative Disclosures about Market Risk 10 Item 8 Financial Statements and Supplementary Data 10 Item 9 Changes in and Disagreements with Accountants on Not Accounting and Financial Disclosure Applicable PART III - ------------ Item 10 Directors and Executive Officers of the Registrant 10 Item 11 Executive Compensation 10 Item 12 Security Ownership of Certain Beneficial Owners and 10 Management Item 13 Certain Relationships and Related Transactions 10 PART IV - ----------- Item 14 Exhibits, Financial Statement Schedules and Reports 11 on Form 8-K 2 PART I ITEM 1 - BUSINESS Introduction Keystone Financial, Inc. (Keystone) was formed in 1984 as a result of mergers between predecessor bank holding companies. With assets of $6.8 billion, Keystone is the fourth largest banking corporation headquartered in the Commonwealth of Pennsylvania. Keystone is the parent of seven community banks and various nonbank subsidiaries. The subsidiary banks, which consist of American Trust Bank, N.A., Financial Trust Company, Keystone Bank, N.A., Keystone National Bank, Mid-State Bank and Trust Company, Northern Central Bank, and Pennsylvania National Bank and Trust Company, operate in thirty-one Pennsylvania counties, three Maryland counties and one county in West Virginia. Nonbank subsidiaries offer a variety of financial services including discount brokerage services, sales of mutual funds and annuities, asset management and investment advisory services, reinsurance, small equipment leasing, mortgage banking, and community development. None of the nonbank subsidiaries constitute a significant portion of Keystone's business. At December 31, 1997, Keystone and its subsidiaries had 3,126 full-time equivalent employees. Keystone and its subsidiaries do not have any portion of their business dependent upon a single or a limited number of customers, the loss of which would have a material adverse effect on their business; no substantial portion of their loans and investments are concentrated within a single industry or group of related industries. The businesses of Keystone are not seasonal in nature. For a further description of the nature of Keystone's business, refer to the section entitled "Nature of Operations" contained within Exhibit 13.1. Keystone's stock is traded on the NASDAQ Stock Market (servicemark) under the symbol of KSTN. During 1997, Keystone completed its merger with Financial Trust Corp, a bank holding company formerly headquartered in Carlisle, Pennsylvania, and its acquisition of First Financial Corporation of Western Maryland, a thrift holding company formerly based in Cumberland, Maryland. Refer to the Notes to the Financial Statements section under the caption "Mergers and Acquisitions" within Exhibit 13.1 for additional information. Legislation and Competition Changes in banking legislation since 1982 have increased the competition experienced by banks and bank holding companies and expanded the opportunities to grow geographically and offer new types of financial services. Beginning in 1982, amendments to the Pennsylvania Banking Code provided for the phased elimination of geographical branching restrictions on Pennsylvania banks and for the phased elimination of limitations on the number of Pennsylvania banks a bank holding company could own. Amendments in 1986 further provided for the phased implementation of interstate banking. Effective March 4, 1990, Pennsylvania state-chartered and national banks could establish or acquire branch offices anywhere in the state, there were no longer any limitations on the number of Pennsylvania banks a bank holding company could own and a bank holding company located in any state or the District of Columbia could, subject to a reciprocity requirement, acquire a Pennsylvania bank or bank holding company. 3 The Federal Interstate Banking and Branching Efficiency Act of 1994 has extended to a nationwide basis the process of removing the legal barriers to interstate banking which formerly existed under various state laws. Effective September 29, 1995, the Act permits bank holding companies in any state to acquire bank holding companies or banks located in any other state. Effective June 1, 1997, the Act permits a bank in one state to merge with a bank in another state as long as neither state had enacted legislation prior to that date to prohibit interstate branching. A bank may establish a de novo branch in another state or acquire a branch in another state without acquiring the entire bank only if expressly permitted by the law of the state where the new or acquired branch is located. Pennsylvania has enacted legislation to permit de novo interstate branching, subject to a reciprocity requirement. The result of these developments has been an increased volume of merger activity involving Pennsylvania banks and bank holding companies since 1982; larger banking organizations have sought to position themselves to enter into state-wide and inter-state banking; smaller banking organizations have sought to increase their size in order to remain competitive on a regional basis. At the same time, deregulation of the banking industry has increased the opportunities to offer new types of financial services and enhanced the potential for competition from savings and loan associations, insurance companies, brokerage firms, and other nonbank financial institutions. The market in which Keystone's banking subsidiaries operate is considered competitive. Banks and bank holding companies with significant operations in the Keystone market areas range in size from less than $100 million to over $50 billion in assets. In addition to commercial banks, competitors for loans, deposits, and other services include savings and loan associations, insurance companies, finance companies, credit unions, brokerage houses, direct lending by federal and state governments, and a proliferation of other types of financial institutions. Keystone differentiates itself from its financial institution competitors by focusing on the customers and delivering products customized to meet their financial needs. The operating banks of Keystone maintain local management presence to ensure close personal service and local decision-making on the issues which directly affect the customer. At the same time, this structure allows Keystone to standardize products and services and centralize a significant portion of operations, data processing, and other functions which are less directly related to customer contact. This approach enables Keystone to effect improved cost management through economies derived from standardization and centralization of these functions. In summary, Keystone believes that it derives a competitive advantage from this approach by providing personal, localized service in a cost efficient manner. Although Keystone expects that competition will increase as a result of the factors described herein, the effects thereof, if any, on Keystone are not readily ascertainable. Regulation and Supervision The business of Keystone and its subsidiaries is subject to extensive regulation and supervision under federal and state banking laws and other federal and state laws and regulations. In general, these laws and regulations are intended for the protection of the customers and depositors of Keystone's subsidiaries and not for the protection of Keystone or its shareholders. Set forth below are brief descriptions of selected laws and regulations applicable to Keystone and its subsidiaries. These descriptions are not intended to be a comprehensive description of all laws and regulations to which Keystone and its subsidiaries are subject or to be complete descriptions of the laws and regulations discussed. The descriptions of statutory and regulatory provisions are qualified in their entirety by reference to the particular statutes and regulations. Changes in applicable statutes, regulations or regulatory policy may have a material effect on Keystone and its business. 4 Regulation and Supervision of Bank Holding Companies Keystone is subject to regulation under the Bank Holding Company Act of 1956. A bank holding company is required to file annual reports and other information concerning its business operations and those of its subsidiaries with the Board of Governors of the Federal Reserve System (Federal Reserve Board). A bank holding company and each of its subsidiaries are also subject to examination by the Federal Reserve Board. The Bank Holding Company Act requires the prior approval of the Federal Reserve Board in any case where a bank holding company proposes to acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank (unless it already owns a majority of such bank's voting shares), to merge or consolidate with any other bank holding company or to acquire all or substantially all of the assets of any bank. The Act further provides that the Federal Reserve Board shall not approve any such acquisition of voting shares or assets or any such merger or consolidation: (i) that would result in a monopoly or would be in furtherance of any combination or conspiracy to monopolize or attempt to monopolize the business of banking in any part of the United States or (ii) the effect of which may be substantially to lessen competition or to tend to create a monopoly in any section of the country, or that in any other manner would be in restraint of trade, unless the anticompetitive effects of the proposed transaction are clearly outweighed in the public interest by the probable effect of the transaction in meeting the convenience and needs of the community to be served. The Bank Holding Company Act prohibits a bank holding company from engaging in, or from acquiring direct or indirect ownership or control of more than 5% of the voting shares of, any company engaged in nonbanking activities unless the Federal Reserve Board, by order or regulation, has found such activities to be so closely related to banking or to managing or controlling banks as to be a proper incident thereto. The Federal Reserve Board has by regulation determined that certain activities are so closely related to banking or to managing or controlling banks as to permit bank holding companies and subsidiaries formed for the purpose to engage in such activities, subject to Board approval in certain cases. These activities include operating a mortgage, consumer finance, credit card, or factoring company; servicing loans and other extensions of credit; providing certain investment and financial advice; leasing personal property; providing certain bookkeeping or financially-oriented data processing services; acting as an insurance agent for certain types of credit related insurance, and discount brokerage. Keystone Financial, Inc., is an affiliate of each of its subsidiary banks within the meaning of the Federal Reserve Act (Act). As an affiliate, Keystone is subject to certain restrictions imposed by the Act on extensions of credit by the banks to Keystone, on investment in the stock or other securities of Keystone by the banks and on the taking of such stock or securities as collateral for loans to any borrower. Further, under the Bank Holding Company Act, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of any property or the furnishing of services. The Federal Reserve Board has adopted capital adequacy guidelines under which it assesses the adequacy of capital in examining and supervising a bank holding company and in analyzing applications filed with the Board. In 1989, the Federal Reserve Board issued new risk-based capital adequacy guidelines that were fully phased-in at the end of 1992. Keystone is in compliance with all existing capital adequacy guidelines, including the risk-based guidelines. For a discussion of these capital adequacy guidelines and Keystone's capital position, reference is made to the caption "Shareholders' Equity", contained within the Financial Review section of Exhibit No. 13.1. Regulation and Supervision of Banks The banking subsidiaries of Keystone include both state-chartered banks (Financial Trust Company, Mid-State Bank and Trust Company and Northern Central Bank) and banks chartered under the laws of the United States (American Trust Bank, N.A., Keystone Bank, N.A., Keystone National Bank, and Pennsylvania National Bank and Trust Company). Keystone's state-chartered banks are under the supervision of the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation (FDIC) while the federally-chartered banks are supervised by the Office of the Comptroller of Currency (OCC). The supervisory agencies conduct regular examinations of the banks. Deposits in all of the Keystone banking subsidiaries are federally-insured by the FDIC. In addition, the banks are subject, in certain instances, to the regulation of the Federal Reserve 5 Board. The areas of operation of Keystone's subsidiary banks which are subject to regulation by federal and state laws, regulations and regulatory agencies include, among other things, reserves against deposits, maximum interest rates for specific classes of loans, truth-in-lending disclosure, permissible types of loans and investments, trust operations, issuance of securities, and payment of dividends. In addition, the FDIC and OCC have issued to state nonmember banks and national banks, respectively, capital adequacy and risk-based capital guidelines similar to those adopted by the Federal Reserve Board for bank holding companies, as referred to above. Keystone's subsidiary banks are in compliance with all such guidelines. As federally-insured banks, the state-chartered banks of Keystone must obtain the prior approval of the Pennsylvania Department of Banking and the FDIC before establishing any new branch banking office. The federally-chartered banks must obtain approval of the OCC. Mergers of banks or thrifts located in Pennsylvania, Maryland, and West Virginia are subject to the prior approval of one or more of the following: The applicable state department of banking, the FDIC, the Federal Reserve Board, the OCC, or the Office of Thrift Supervision. The approvals required depend upon several factors, including whether the merged institution is a federally-insured state bank or thrift institution, a member of the Federal Reserve System, a national bank or a federal savings bank. As affiliates of Keystone, the banks are subject to provisions of the Federal Reserve Act which restrict the ability of banks to extend credit to affiliates, to invest in the stock or securities thereof, or to take such stock or securities as collateral for loans to any borrower. The business and earnings of the banks are affected by the monetary policies of the Federal Reserve Board which regulate the money supply in order to influence rates of inflation and economic growth. Among the techniques used to implement these objectives are open market dealings in United States Government securities, changes in the discount rate for bank borrowings from the Federal Reserve Banks and changes in the reserve requirements against bank deposits and borrowings. Changes in these policies can influence to a significant degree the overall growth and distribution of bank loans, investments and deposits, the interest rates charged by banks on loans and the cost to banks of obtaining funds, as well as the ability of banks to compete for loans and for funds with other types of financial institutions. The Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) was signed into law in 1989. FIRREA primarily affects the regulation of savings associations (thrifts) and savings and loan holding companies, rather than the regulation of commercial banks and bank holding companies. However, FIRREA does contain a number of provisions affecting banks and bank holding companies, such as provisions affecting thrift acquisitions, liability of commonly controlled depository institutions, receivership and conservatorship rights and procedures, and substantially increased penalties for violation of banking statutes, regulations and orders. In 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act (FDICIA). This law has established a new framework for the relationship between insured depository institutions and the various regulatory bodies. For a discussion of FDICIA and associated regulations, reference is made to the caption "Regulatory Matters", contained within the Financial Review section of Exhibit No. 13.1. In 1994, Congress enacted the Riegle Community Development and Regulatory Improvement Act ("CDRIA"), a broad-based law primarily focused on ensuring that banks deliver services to financially underserved communities. In that connection, CDRIA established a fund to award financial grants to community development financial institutions and to promote their partnering with banks. Beyond community development, CDRIA made numerous changes to many provisions of federal banking law, for example, streamlining the bank holding company application process, liberalizing the makeup of national bank boards of directors, simplifying the establishment of bank service corporations, modifying management interlock rules, and tightening currency transaction reporting under the Bank Secrecy Act. CDRIA also amended an array of consumer protection laws, including the Truth in Lending Act, the Real Estate Settlement Procedures Act, The Fair Credit Reporting Act, the Consumer Leasing Act, and the Flood Disaster Protection Act. 6 Late in 1996, Congress enacted the Economic Growth and Regulatory Paperwork Reduction Act (EGARPRA), which, like CDRIA, amended a variety of banking laws, by relieving certain regulatory burdens on banks and bank holding companies. Among other things, EGARPRA eliminated per branch capital requirements for national banks, eliminated branch applications for automated teller machines, expedited procedures for bank holding companies to engage in permissible nonbanking activities, modified rules for qualification of bank directors, liberalized standards for loans to bank insiders, and streamlined the bank examination process. In addition, EGARPRA recapitalized the Savings Association Insurance Fund of FDIC through special assessments on banks and thrift institutions and prepared for the development of a common bank charter for all insured depository institutions. EGARPRA also amended the Fair Credit Reporting Act and the Home Mortgage Disclosure Act and freed banks from liability under certain circumstances for environmental cleanup of real estate taken as loan collateral. Changing conditions in the economy and in the financial industry can be expected to continue to result in changes in legislation and regulatory policies which will affect the business of banks and competition between banks and among banks and other types of financial institutions. Statistical Disclosure The consolidated statistical disclosures found in the sections of Exhibit No. 13.1 entitled, "Selected Financial Data", "Financial Review", and "Supplemental Financial Information", are incorporated herein by reference. Also incorporated herein by reference are the following consolidated statistical disclosures appearing in the Notes to Consolidated Financial Statements section of Exhibit No. 13.1: the discussion of "Interest and Fees on Loans" appearing in the note captioned "Summarized Accounting Policies", the note captioned "Investments", and the table of total nonaccrual and restructured loan balances and related annual interest data appearing in the note captioned "Loans and Leases". 7 Executive Officers of the Corporation Except as otherwise noted, each executive officer has held the position indicated for at least five years, serves at the pleasure of the Board of Directors and is not elected for any specific term of office. Name Age Office with Keystone and/or Subsidiary - ---------------- ----- ------------------------------------------- Carl L. Campbell 54 President, Chief Executive Officer and Director Mark L. Pulaski 44 Chief Operating Officer, Chief Financial Officer, and Vice Chairman From 1995 to November 1997, Mr. Pulaski was Senior Executive Vice President, Chief Financial Officer (CFO) and Chief Administrative Officer (CAO) of the Corporation; and prior to 1995, he served as Executive Vice President, CFO and CAO of the Corporation. Ben G. Rooke 48 Executive Vice President, Counsel and Secretary Ray L. Wolfe 59 Chairman of the Board (term expires at the annual meeting in the year 2000), President and Chief Executive Officer of Financial Trust Company. Prior to May 30, 1997, Mr. Wolfe was Chairman and Chief Executive Officer of Financial Trust Corp, which was acquired by the Corporation on that date. 8 ITEM 2 - PROPERTIES The headquarters of Keystone Financial, Inc., is located at One Keystone Plaza, Harrisburg, Pennsylvania. This office space is leased under an agreement scheduled to expire in 2002 with three consecutive renewal options each for five years. The main office of American Trust Bank, N.A. is located at 81 Baltimore Street in Cumberland, Maryland and is owned by American Trust Bank. Of the twenty-five community offices of American Trust Bank, twenty are owned and five are leased. American Trust Bank also owns the premises for KeyCall, an automated telephone banking center, located at 12400 Willowbrook Road in Cumberland, Maryland. Financial Trust Company owns its headquarters at 1415 Ritner Highway, Carlisle, Pennsylvania. It also operates a total of thirty-six offices, thirty of which are owned, with the remainder leased. Keystone Bank, N.A. is headquartered at 601 Dresher Road, Horsham, Pennsylvania in a facility which contains executive and administrative offices and a full-service banking center. Keystone Bank operates twenty-nine banking facilities of which twenty-two are leased, and seven are owned. Six of the leased facilities are owned by and leased from Key Trust Company, a wholly-owned subsidiary of Keystone. Keystone National Bank is headquartered at, and conducts limited banking operations from, its leased facility at 2270 Erin Court, Lancaster, Pennsylvania. This facility is also utilized as the headquarters of its wholly- owned subsidiary, Keystone Financial Mortgage Corporation. Mid-State Bank and Trust Co. owns its headquarters located at 1130 Twelfth Avenue, Altoona, Pennsylvania. The five-story building contains executive offices as well as a full-service banking facility. The bank also owns an operations center, which houses the primary data processing facility for Keystone, and is located in Bellwood, Pennsylvania. Mid-State Bank owns twenty-one of its twenty-eight banking offices, while the remaining seven offices are leased. In addition, Keystone and Mid-State lease office space for various administrative and back-office functions in three buildings in Altoona, including a building owned by a partnership in which a Keystone board member is a partner. The headquarters for Northern Central Bank is at 101 West Third Street, Williamsport, Pennsylvania, in a leased building which contains executive and administrative offices. An operations center is also located in Williamsport and is owned by Northern Central Bank. The bank owns a total of twenty-eight of its banking offices while the seven remaining offices are leased. Pennsylvania National Bank and Trust Company is headquartered at One South Centre Street in Pottsville, Pennsylvania, in a facility which contains executive and administrative offices as well as a full-service banking center. The Bank also owns an operations center located in St. Clair, Pennsylvania. In addition to the headquarters facility, the Bank operates twenty-eight banking offices of which twenty-one are owned by the Bank and seven are leased. Of the nonbanking subsidiaries, Keystone Financial Leasing Corporation, Keystone Financial Mortgage Corporation, Martindale Andres & Company and MMC&P are headquartered in leased facilities in Pennsylvania. All of the above-mentioned facilities are in good and usable condition. ITEM 3 - LEGAL PROCEEDINGS Keystone and its subsidiaries are involved as plaintiff or defendant in litigation matters that arise in the ordinary course of their business. In the opinion of management, none of the pending litigation matters, individually or in the aggregate, would have a material adverse effect on Keystone's results of operations. 9 PART II ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Information for this item is incorporated herein by reference to the section of Exhibit No. 13.1 entitled "Market Prices and Dividends". ITEM 6 - SELECTED FINANCIAL DATA The section entitled "Selected Financial Data" of Exhibit No. 13.1 is incorporated herein by reference. ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The section entitled "Financial Review" of Exhibit No. 13.1 is incorporated herein by reference. ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The following sections of Exhibit No. 13.1 are incorporated herein by reference: "Financial Review-Investments", "Financial Review - Asset/Liability Management and Market Risk", "Summarized Accounting Policies - Financial Derivatives and Other Hedging Activity", "Notes to Consolidated Financial Statements - Financial Derivatives, Hedging Activity, and Commitments". ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The sections of Exhibit No. 13.1 entitled "Report of Ernst & Young LLP, Independent Auditors", "Consolidated Financial Statements", and notes thereto, and "Quarterly Information - Income Performance" are incorporated herein by reference. PART III ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ITEM 11 - EXECUTIVE COMPENSATION ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Part III, Items 10 - 13, is incorporated herein by reference to the information appearing under the following captions in the Proxy Statement for Keystone's 1998 Annual Meeting of Shareholders: - -- Introduction - -- Proposals for Shareholders-Election of Directors - -- Executive Compensation - -- Other Information Concerning Directors and Executive Officers - -- 5% Beneficial Owners of Common Stock The other information appearing in such Proxy Statement, including without limitation that information appearing under the captions " Human Resources Committee 1997 Report on Executive Compensation" and "Stock Price Performance Graph", is not incorporated herein. 10 PART IV ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1)(2) The response to this portion of Item 14 is listed below. (a)(3) Listing of Exhibits - The exhibits are listed on the Exhibit Index beginning on page 14 of this Form 10-K. (b) Reports on Form 8-K are listed below. (c) Exhibits - The exhibits listed on the Exhibit Index beginning on page 14 of this Form 10-K are filed herewith or are incorporated by reference. (d) Schedules - listed under Item 14 (a)(1)(2) below. Item 14(a)(1)(2) List of Financial Statements and Financial Statement Schedules The following consolidated financial statements and report of independent auditors of Keystone Financial, Inc. and subsidiaries, included in the annual report of the registrant to its shareholders for the year ended December 31, 1997, are incorporated by reference in Item 8: Report of independent auditors Consolidated statements of condition - December 31, 1997, and 1996 Consolidated statements of income - Years ended December 31, 1997 , 1996, and 1995 Consolidated statements of changes in shareholders' equity -Years ended December 31, 1997, 1996, and 1995 Consolidated statements of cash flows - Years ended December 31, 1997, 1996, and 1995 Notes to consolidated financial statements Schedules to the consolidated financial statements as per Article 9 of Regulation S-X are not required under the related instructions or are inapplicable, and therefore have been omitted. The following report of other auditors required by Item 2-05 of Regulation S-X is filed herewith as a financial statement schedule: Report of Beard & Company, Inc. Item 14(b) Reports on Form 8-K During the quarter ended December 31, 1997, the registrant filed the following reports on Form 8-K: Date of Report Item Description - -------------------- ---------------------------------------------- October 17, 1997 5 Earnings release for the third quarter October 28, 1997 5 Press release announcing management changes November 21, 1997 5 Press release announcing increased dividend 11 INDEPENDENT AUDITOR'S REPORT Board of Directors and Shareholders Financial Trust Corp Carlisle, Pennsylvania We have audited the consolidated balance sheet of Financial Trust Corp and subsidiaries as of December 31, 1996, and the related consolidated statements of income, shareholders' equity and cash flows for the year then ended (not presented herein). These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. 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 1996 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Financial Trust Corp and subsidiaries as of December 31, 1996, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles. /s/ BEARD & COMPANY, INC. ------------------------- Reading, Pennsylvania February 28, 1997 12 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. (Registrant)Keystone Financial, Inc. By: /s/ Carl L. Campbell --------------------------- Chief Executive Officer Date: March 26, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on March 26, 1998, by the following persons on behalf of the registrant and in the capacities indicated. /s/ Carl L. Campbell /s/ Mark L. Pulaski - -------------------- ------------------- President, Chief Executive Vice Chairman and Chief Operating Officer Officer & Director & Director /s/ Ray L. Wolfe /s/ Donald F. Holt - -------------------- ------------------- Chairman Senior Vice President and Corporate Controller /s/ A. Joseph Antanavage, Jr /s/ June B. Barry - -------------------- ------------------- Director Director /s/ J. Glenn Beall, Jr. /s/ Paul I. Detwiler, Jr. - -------------------- ------------------- Director Director /s/ Donald Devorris /s/ Gerald E. Field - -------------------- ------------------- Director Director /s/ Walter W. Grant /s/ Philip C. Herr, II - -------------------- ------------------- Director Director /s/ Allan W. Holman, Jr. /s/ Richard G. King - -------------------- ------------------- Director Director /s/ Uzal H. Martz, Jr. /s/ Max A. Messenger - -------------------- ------------------- Director Director /s/ William L. Miller /s/ Don A. Rosini - -------------------- ------------------- Director Director /s/ F. Dale Schoeneman /s/ Ronald C. Unterberger - -------------------- ------------------- Director Director /s/ G. William Ward - -------------------- Director 13 EXHIBIT INDEX (Pursuant to Item 601 of Regulation S-K) Exhibit Description and Method No. of Filing - ------- ------------------------------------------------------------------------ 3.1 Restated Articles of Incorporation of Keystone Financial, Inc., as amended through July 29, 1996, incorporated by reference to Exhibit 4.1 of Form S-4 of Keystone Financial, Inc. (No. 333-20283) filed on January 23, 1997. 3.2 By-Laws of Keystone Financial, Inc., as amended November 21, 1996, incorporated by reference to Exhibit 3 of Form 10-Q of Keystone Financial, Inc. for the quarter ended September 30, 1997. 4.1 Keystone Financial, Inc. Series A Junior Participating Preferred Stock Purchase Rights Agreement dated January 25, 1990, incorporated by reference to Exhibit 1 to Form 8-A filed on February 9, 1990. 4.2 Amendment No. 1 to Series A Junior Participating Preferred Stock Purchase Rights Agreement dated December 20, 1990, incorporated by reference to Exhibit 2 to the Form 8 Amendment dated December 20, 1990. The registrant hereby agrees to furnish to the Commission upon request copies of the instruments defining the rights of the holders of the long-term debt of the registrant and its consolidated subsidiaries. 10.1* Keystone Financial, Inc., Corporate Directors Deferred Compensation Plans, incorporated herein by reference to Exhibit 10.1 of Form 10-K of Keystone Financial, Inc. for the year ended December 31, 1994. 10.2* Keystone Financial, Inc. 1988 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.2 of Form 10-K of Keystone Financial, Inc., for the year ended December 31, 1993. 14 Exhibit Description and Method No. of Filing - ------- ------------------------------------------------------------------------ 10.3* Keystone Financial, Inc. Management Incentive Compensation Plan as amended and restated, incorporated herein by reference to Exhibit 10.3 of Form 10-K of Keystone Financial, Inc., for the year ended December 31, 1993. 10.4* Form of employment agreement between Keystone Financial, Inc. and Executive Officer Campbell, incorporated herein by reference to Exhibit 10.4 of Form 10-K of Keystone Financial, Inc. for the year ended December 31, 1993. 10.5* Form of employment agreement between Keystone Financial, Inc. and Executive Officers, Pulaski, and Rooke, incorporated herein by reference to Exhibit 10.5 of Form 10-K of Keystone Financial, Inc. for the year ended December 31, 1993. 10.6* Keystone Financial, Inc. 1995 Management Stock Purchase Plan, incorporated herein by reference to Exhibit C of the Proxy Statement of Keystone Financial, Inc., dated April 7, 1995. 10.7* Keystone Financial, Inc. Savings Restoration Plan, as amended and restated effective January 1, 1994, and as corrected on June 14, 1994, incorporated herein by reference to Exhibit 10.7 of Form 10-K of Keystone Financial, Inc., for the year ended December 31, 1994. 10.8* Keystone Financial, Inc. Supplemental Retirement Income Plan, incorporated herein by reference to Exhibit 10.7 of Form 10-K of Keystone Financial, Inc., for the year ended December 31, 1993. 10.9* Keystone Financial, Inc. 1990 Non-Employee Directors' Stock Option Plan, as amended, incorporated herein by reference to Exhibit 10.8 of Form 10-K of Keystone Financial, Inc. for the year ended December 31, 1993. 15 Exhibit Description and Method No. of Filing - ------- ------------------------------------------------------------------------ 10.10* Keystone Financial, Inc. 1992 Stock Incentive Plan, filed herewith. 10.11* Keystone Financial, Inc. 1992 Director Fee Plan, as amended, incorporated herein by reference to Exhibit 10.11 of Form 10-K of Keystone Financial, Inc. for the year ended December 31, 1994. 10.12* Keystone Financial, Inc. form of Executive Split Dollar Agreements, Form A and Form B, incorporated herein by reference to Exhibit 10.1 of Form 10-K of Keystone Financial, Inc., for the year ended December 31, 1993. 10.13* Keystone Financial, Inc. 1995 Non-Employee Directors' Stock Option Plan, incorporated herein by reference to Exhibit B of the Proxy Statement of Keystone Financial, Inc., dated April 7, 1995. 10.14* Keystone Financial, Inc. Management Stock Ownership Program, incorporated herein by reference to Exhibit 10.15 of Form 10-K of Keystone Financial, Inc., for the year ended December 31, 1995. 10.15* Keystone Financial, Inc. 1996 Performance Unit Plan, incorporated herein by reference to Exhibit 99.16 of Amendment No. 1 to Form S-4 of Keystone Financial, Inc. (No. 333-20283), filed on March 10, 1997. 10.16* Keystone Financial, Inc. 1997 Stock Incentive Plan, incorporated herein by reference to Exhibit 99.17 of Amendment No.2 to form S-4 of Keystone Financial, Inc. (No. 333-20283), filed on March 27, 1997. 10.17* Separation Agreement and Release between Keystone Financial, Inc. and Executive Officer Groves dated November 21, 1997, filed herewith. 10.18* Employment agreement between Keystone Financial, Inc. and Officer Wolfe, incorporated herein by reference to Exhibit 99.9 of Form S-4 of Keystone Financial, Inc. (No. 333-20283), filed on January 23, 1997. 10.19* Keystone Financial, Inc. Supplemental Deferred Compensation Plan, as originally filed as exhibit 10.11 of Form 10-K of Keystone Financial, Inc. for the year ended December 31, 1992, filed herewith. 16 Exhibit Description and Method No. of Filing - ----- -------------------------------------------------------------------------- 11.1 The statement regarding computation of per share earnings required by this exhibit is contained in the note to the consolidated financial statements captioned "Earnings Per Share," filed as a part of Exhibit 13.1. 13.1 Portions of the Annual Report to Shareholders of Keystone Financial, Inc., for the year ended December 31, 1997, filed herewith. 21.1 Subsidiaries of Registrant, filed herewith. 23.1 Consent of Ernst & Young LLP, independent auditors, filed herewith. 23.2 Consent of Beard & Company, Inc., independent auditors, filed herewith. 27.1 Financial Data Schedule, filed herewith. 99.1 Reconciliation of previously reported quarterly information, filed herewith. *The exhibits marked by an asterisk (*) are management contracts or compensatory plans or arrangements. 17 EX-10 2 EXHIBIT 10.10 STOCK INCENTIVE PLAN EXHIBIT 10.10 KEYSTONE FINANCIAL, INC. 1992 STOCK INCENTIVE PLAN The purposes of the 1992 Stock Incentive Plan (the "Plan") are to encourage eligible employees of Keystone Financial, Inc. (the "Corporation") and its Subsidiaries to increase their efforts to make the Corporation and each Subsidiary more successful, to provide an additional inducement for such employees to remain with the Corporation or a Subsidiary, to reward such employees by providing an opportunity to acquire shares of the Common Stock, par value $2.00 per share, of the Corporation (the "Common Stock") on favorable terms and to provide a means through which the Corporation may attract able persons to enter the employ of the Corporation or one of its Subsidiaries. For the purposes of the Plan, the term "Subsidiary" means any corporation in an unbroken chain of corporations beginning with the Corporation, if each of the corporations other than the last corporation in the unbroken chain owns stock possessing at least fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in the chain. SECTION 1 Administration The Plan shall be administered by a Committee (the "Committee") appointed by the Board of Directors of the Corporation (the "Board") and consisting of not less than two members of the Board, each of whom at the time of appointment to the Committee and at all times during service as a member of the Committee shall be a "disinterested person" as then defined under Rule 16b-3 under the Securities Exchange Act of 1934, as amended (the "1934 Act") or any successor rule. The Committee shall interpret the Plan and prescribe such rules, regulations and procedures in connection with the operations of the Plan as it shall deem to be necessary and advisable for the administration of the Plan consistent with the purposes of the Plan. The Committee shall keep records of action taken at its meetings. A majority of the Committee shall constitute a quorum at any meeting, and the acts of a majority of the members present at any meeting at which a quorum is present, or acts approved in writing by a majority of the Committee, shall be the acts of the Committee. SECTION 2 Eligibility Those employees of the Corporation or any Subsidiary who share responsibility for the management, growth or protection of the business of the Corporation or any Subsidiary shall be eligible to be granted stock options (with or without reload option rights and/or cash payment rights) and to receive restricted share, performance unit or bonus share awards as described herein. Subject to the provisions of the Plan, the Committee shall have full and final authority, in its discretion, to grant stock options (with or without reload option rights and/or cash payment rights) and to award restricted shares, performance units and bonus shares as described herein and to determine the employees to whom any such grant or award shall be made and the number of shares or units to be covered thereby. In determining the eligibility of any employee, as well as in determining the number of shares or units covered by each grant or award of a stock option, restricted shares, performance units or bonus shares and whether reload option rights and/or cash payment rights shall be granted in conjunction with a stock option, the Committee shall consider the position and the responsibilities of the employee being considered, the nature and value to the Corporation or a Subsidiary of his or her services, his or her present and/or potential contribution to the success of the Corporation or a Subsidiary and such other factors as the Committee may deem relevant. SECTION 3 Shares Available under the Plan The aggregate number of shares of the Common Stock which may be issued and as to which grants or awards of stock options (including reload options), restricted shares, performance units or bonus shares may be made under the Plan is 1,250,000 shares, subject to adjustment and substitution as set forth in Section 7. If any stock option granted under the Plan is cancelled by mutual consent or terminates or expires for any reason without having been exercised in full, the number of shares subject thereto shall again be available for purposes of the Plan. If shares of Common Stock are forfeited to the Corporation pursuant to the restrictions applicable to restricted shares awarded under the Plan, the shares so forfeited shall not again be available for purposes of the Plan unless during the period such shares were outstanding the grantee received no dividends or other "benefits of ownership" from such shares. To the extent any award of performance units is not earned or is paid in cash rather than shares, the number of shares covered thereby shall again be available for purposes of the Plan. The shares which may be issued under the Plan may be either authorized but unissued shares or treasury shares or partly each, as shall be determined from time to time by the Board. SECTION 4 Grant of Stock Options, Reload Options and Cash Payment Rights and Awards of Restricted Shares, Performance Units and Bonus Shares The Committee shall have authority, in its discretion, (a) to grant "incentive stock options" pursuant to Section 422 of the Internal Revenue Code of 1986 (the "Code"), to grant "nonstatutory stock options" (i.e., stock options which do not qualify under Sections 422 or 423 of the Code) or to grant both types of stock options (but not in tandem), (b) to award restricted shares, (c) to award performance units and (d) to award bonus shares. The Committee also shall have the authority, in its discretion, to grant reload option rights in conjunction with incentive stock options or nonstatutory stock options with the effect provided in Section 5(D) and to grant cash payment rights in conjunction with nonstatutory stock options with the effect provided in Section 5(E). Reload option rights granted in conjunction with an incentive stock option may only be granted at the time the incentive stock option is granted. Cash payment rights may not be granted in conjunction with incentive stock options. Reload option rights and/or cash payment rights granted in conjunction with a nonstatutory stock option may be granted either at the time the stock option is granted or at any time thereafter during the term of the stock option. Notwithstanding any other provision contained in the Plan or in any stock option agreement, but subject to the possible exercise of the Committee's discretion contemplated in the last sentence of this Section 4, the aggregate fair market value, determined as provided in Section 5(I) on the date of grant, of the shares with respect to which incentive stock options are exercisable for the first time by an employee during any calendar year under all plans of the corporation employing such employee, any parent or subsidiary corporation of such corporation and any predecessor corporation of any such corporation shall not exceed $100,000. If the date on which one or more of such incentive stock options could first be exercised would be accelerated pursuant to any provision of the Plan or any stock option agreement, and the acceleration of such exercise date would result in a violation of the restriction set forth in the preceding sentence, then, notwithstanding any such provision, but subject to the provisions of the next succeeding sentence, the exercise dates of such incentive stock options shall be accelerated only to the date or dates, if any, that do not result in a violation of such restriction and, in such event, the exercise dates of the incentive stock options with the lowest option prices shall be accelerated to the earliest such dates. The Committee may, in its discretion, authorize the acceleration of the exercise date of one or more incentive stock options even if such acceleration would violate the $100,000 restriction set forth in the first sentence of this paragraph and even if such incentive stock options are thereby converted in whole or in part to nonstatutory stock options. SECTION 5 Terms and Conditions of Stock Options, Reload Option Rights and Cash Payment Rights Stock options, reload option rights and cash payment rights granted under the Plan shall be subject to the following terms and conditions: (A) The purchase price at which each stock option may be exercised (the "option price") shall be such price as the Committee, in its discretion, shall determine but shall not be less than one hundred percent (100%) of the fair market value per share of the Common Stock covered by the stock option on the date of grant, except that in the case of an incentive stock option granted to an employee who, immediately prior to such grant, owns stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Corporation or any Subsidiary (a "Ten Percent Employee"), the option price shall not be less than one hundred ten percent (110%) of such fair market value on the date of grant. For purposes of this Section 5(A), the fair market value of the Common Stock shall be determined as provided in Section 5(I). For purposes of this Section 5(A), an individual (i) shall be considered as owning not only shares of stock owned individually but also all shares of stock that are at the time owned, directly or indirectly, by or for the spouse, ancestors, lineal descendants and brothers and sisters (whether by the whole or half blood) of such individual and (ii) shall be considered as owning proportionately any shares owned, directly or indirectly, by or for any corporation, partnership, estate or trust in which such individual is a shareholder, partner or beneficiary. (B) The option price for each stock option shall be paid in full upon exercise and shall be payable in cash in United States dollars (including check, bank draft or money order), which may include cash forwarded through a broker or other agent-sponsored exercise or financing program; provided, however, that in lieu of such cash the person exercising the stock option may (if authorized by the Committee at the time of grant in the case of an incentive stock option, or at any time in the case of a nonstatutory stock option) pay the option price in whole or in part by delivering to the Corporation shares of the Common Stock having a fair market value on the date of exercise of the stock option, determined as provided in Section 5(I), equal to the option price for the shares being purchased; except that (i) any portion of the option price representing a fraction of a share shall in any event be paid in cash and (ii) no shares of the Common Stock which have been held for less than six months may be delivered in payment of the option price of a stock option. If the person exercising a stock option participates in a broker or other agent-sponsored exercise or financing program, the Corporation will cooperate with all reasonable procedures of the broker or other agent to permit participation by the person exercising the stock option in the exercise or financing program. Notwithstanding any procedure of the broker or other agent-sponsored exercise or financing program, if the option price is paid in cash, the exercise of the stock option shall not be deemed to occur and no shares of the Common Stock will be issued until the Corporation has received full payment in cash (including check, bank draft or money order) for the option price from the broker or other agent. The date of exercise of a stock option shall be determined under procedures established by the Committee, and as of the date of exercise the person exercising the stock option shall be considered for all purposes to be the owner of the shares with respect to which the stock option has been exercised. Payment of the option price with shares shall not increase the number of shares of the Common Stock which may be issued under the Plan as provided in Section 3. (C) No stock option shall be exercisable by a grantee during employment during the first six months of its term, except that this limitation on exercise shall not apply if Section 8(B) becomes applicable. No stock option shall be exercisable after the expiration of ten years (five years in the case of an incentive stock option granted to a Ten Percent Employee) from the date of grant. A stock option to the extent exercisable at any time may be exercised in whole or in part. (D) Reload option rights granted in conjunction with a stock option shall entitle the original grantee of the stock option (and unless otherwise determined by the Committee, in its discretion, only such original grantee), upon exercise of the stock option or any portion thereof through delivery of previously owned shares of Common Stock, to automatically be granted on the date of such exercise a new nonstatutory stock option (a "reload option") (i) for a number of shares of Common Stock not exceeding the number of shares delivered in payment of the option price of the original option, (ii) having an option price not less than one hundred percent (100%) of the fair market value per share of the Common Stock covered by the reload option on such date of grant, (iii) having an expiration date not later than the expiration date of the stock option so exercised and (iv) otherwise having terms permissible for an original grant of a stock option under the Plan. Subject to the preceding sentence and the other provisions of the Plan, reload option rights and reload options granted thereunder shall have such terms and be subject to such restrictions and conditions, if any, as shall be determined, in its discretion, by the Committee and set forth in the agreement referred to in Section 5(H) relating to the original option with respect to which the reload option rights were granted or, for reload option rights and reload options not granted in conjunction with an incentive stock option, in an amendment to such agreement or in the agreement relating to the reload option or an amendment thereto. In granting reload option rights, the Committee, may, in its discretion, provide for successive reload option grants upon the exercise of reload options granted thereunder. Unless otherwise determined, in its discretion, by the Committee, reload option rights shall entitle the grantee to be granted reload options only if the underlying option to which they relate is exercised by the grantee during employment with the Corporation or a Subsidiary. Notwithstanding any provision of the Plan or any stock option agreement, no holder of reload option rights may be granted a reload option covering a number of shares in excess of the number of shares then remaining available under the Plan. Except as otherwise specifically provided herein or required by the context, the term "stock option" as used in this Plan shall include reload options granted hereunder. For the purposes of this Section 5(D), the fair market value of the Common Stock shall be determined as provided in Section 5(I). (E) Cash payment rights granted in conjunction with a nonstatutory stock option shall entitle the person who is entitled to exercise the stock option, upon exercise of the stock option or any portion thereof, to receive cash from the Corporation (in addition to the shares to be received upon exercise of the stock option) equal to such percentage as the Committee, in its discretion, shall determine not greater than one hundred percent (100%) of the excess of the fair market value of a share of the Common Stock on the date of exercise of the stock option over the option price per share of the stock option times the number of shares covered by the stock option, or portion thereof, which is exercised. Payment of the cash provided for in this Section 5(E) shall be made by the Corporation as soon as practicable after the time the amount payable is determined. The Committee may, in its discretion, provide for the grant of cash payment rights in connection with reload options. For purposes of this Section 5(E), the fair market value of the Common Stock shall be determined as provided in Section 5(I). (F) No stock option shall be transferable by the grantee otherwise than by Will, or if the grantee dies intestate, by the laws of descent and distribution of the state of domicile of the grantee at the time of death. All stock options shall be exercisable during the lifetime of the grantee only by the grantee. (G) Subject to the provisions of Section 4 in the case of incentive stock options, unless the Committee, in its discretion, shall otherwise determine: (i) If the employment of a grantee who is not disabled within the meaning of Section 422(c)(6) of the Code (a "Disabled Grantee") is voluntarily terminated with the consent of the Corporation or a Subsidiary or a grantee retires under any retirement plan of the Corporation or a Subsidiary, any then outstanding incentive stock option held by such grantee shall be exercisable by the grantee (but only to the extent exercisable by the grantee immediately prior to the termination of employment) at any time prior to the expiration date of such incentive stock option or within three months after the date of termination of employment, whichever is the shorter period; (ii) If the employment of a grantee who is not a Disabled Grantee is voluntarily terminated with the consent of the Corporation or a Subsidiary or a grantee retires under any retirement plan of the Corporation or a Subsidiary, any then outstanding nonstatutory stock option held by such grantee shall be exercisable by the grantee (but only to the extent exercisable by the grantee immediately prior to the termination of employment) at any time prior to the expiration date of such nonstatutory stock option or within one year after the date of termination of employment, whichever is the shorter period; (iii) If the employment of a grantee who is a Disabled Grantee is voluntarily terminated with the consent of the Corporation or a Subsidiary, any then outstanding stock option held by such grantee shall be exercisable by the grantee in full (whether or not so exercisable by the grantee immediately prior to the termination of employment) by the grantee at any time prior to the expiration date of such stock option or within one year after the date of termination of employment, whichever is the shorter period; (iv) Following the death of a grantee during employment, any outstanding stock option held by the grantee at the time of death shall be exercisable in full (whether or not so exercisable by the grantee immediately prior to the death of the grantee) by the person entitled to do so under the Will of the grantee, or, if the grantee shall fail to make testamentary disposition of the stock option or shall die intestate, by the legal representative of the grantee at any time prior to the expiration date of such stock option or within one year after the date of death, whichever is the shorter period; (v) Following the death of a grantee after termination of employment during a period when a stock option is exercisable, any outstanding stock option held by the grantee at the time of death shall be exercisable by such person entitled to do so under the Will of the grantee or by such legal representative (but only to the extent the stock option was exercisable by the grantee immediately prior to the death of the grantee) at any time prior to the expiration date of such stock option or within one year after the date of death, whichever is the shorter period; and (vi) Unless the exercise period of a stock option following termination of employment has been extended as provided in Section 8(C), if the employment of a grantee terminates for any reason other than voluntary termination with the consent of the Corporation or a Subsidiary, retirement under any retirement plan of the Corporation or a Subsidiary or death, all outstanding stock options held by the grantee at the time of such termination of employment shall automatically terminate. Whether termination of employment is a voluntary termination with the consent of the Corporation or a Subsidiary and whether a grantee is a Disabled Grantee shall be determined in each case, in its discretion, by the Committee and any such determination by the Committee shall be final and binding. If a grantee of a stock option, reload option rights, restricted shares or performance units engages in the operation or management of a business (whether as owner, partner, officer, director, employee or otherwise and whether during or after termination of employment) which is in competition with the Corporation or any of its Subsidiaries, the Committee may immediately terminate all outstanding stock options held by the grantee, declare forfeited all restricted shares held by the grantee as to which the restrictions have not yet lapsed and terminate all outstanding performance unit awards held by the grantee for which the applicable Performance Period has not been completed; provided, however, that this sentence shall not apply if the exercise period of a stock option following termination of employment has been extended as provided in Section 8(C), if the lapse of the restrictions applicable to restricted shares has been accelerated as provided in Section 8(D) or if a performance unit has been deemed to have been earned as provided in Section 8(E). Whether a grantee has engaged in the operation or management of a business which is in competition with the Corporation or any of its Subsidiaries shall also be determined, in its discretion, by the Committee, and any such determination by the Committee shall be final and binding. (H) All stock options, reload option rights and cash payment rights shall be confirmed by an agreement, or an amendment thereto, which shall be executed on behalf of the Corporation by the Chief Executive Officer (if other than the President), the President or any Vice President and by the grantee. (I) Fair market value of the Common Stock shall be the mean between the following prices, as applicable, for the date as of which fair market value is to be determined as quoted in The Wall Street Journal (or in such other reliable publication as the Committee, in its discretion, may determine to rely upon): (a) if the Common Stock is listed on the New York Stock Exchange, the highest and lowest sales prices per share of the Common Stock as quoted in the NYSE-Composite Transactions listing for such date, (b) if the Common Stock is not listed on such exchange, the highest and lowest sales prices per share of Common Stock for such date on (or on any composite index including) the principal United States securities exchange registered under the 1934 Act on which the Common Stock is listed, or (c) if the Common Stock is not listed on any such exchange, the highest and lowest sales prices per share of the Common Stock for such date on the National Association of Securities Dealers Automated Quotations System or any successor system then in use ("NASDAQ"). If there are no such sale price quotations for the date as of which fair market value is to be determined but there are such sale price quotations within a reasonable period both before and after such date, then fair market value shall be determined by taking a weighted average of the means between the highest and lowest sales prices per share of the Common Stock as so quoted on the nearest date before and the nearest date after the date as of which fair market value is to be determined. The average should be weighted inversely by the respective numbers of trading days between the selling dates and the date as of which fair market value is to be determined. If there are no such sale price quotations on or within a reasonable period both before and after the date as of which fair market value is to be determined, then fair market value of the Common Stock shall be the mean between the bona fide bid and asked prices per share of Common Stock as so quoted for such date on NASDAQ, or if none, the weighted average of the means between such bona fide bid and asked prices on the nearest trading date before and the nearest trading date after the date as of which fair market value is to be determined, if both such dates are within a reasonable period. The average is to be determined in the manner described above in this Section 5(I). If the fair market value of the Common Stock cannot be determined on the basis previously set forth in this Section 5(I) on the date as of which fair market value is to be determined, the Committee shall in good faith determine the fair market value of the Common Stock on such date. Fair market value shall be determined without regard to any restriction other than a restriction which, by its terms, will never lapse. (J) The obligation of the Corporation to issue shares of the Common Stock under the Plan shall be subject to (i) the effectiveness of a registration statement under the Securities Act of 1933, as amended, with respect to such shares, if deemed necessary or appropriate by counsel for the Corporation, (ii) the condition that the shares shall have been listed (or authorized for listing upon official notice of issuance) upon each stock exchange, if any, on which the Common Stock shares may then be listed and (iii) all other applicable laws, regulations, rules and orders which may then be in effect. Subject to the foregoing provisions of this Section and the other provisions of the Plan, any stock option granted under the Plan may be exercised at such times and in such amounts and be subject to such restrictions and other terms and conditions, if any, as shall be determined, in its discretion, by the Committee and set forth in the agreement referred to in Section 5(H), or an amendment thereto. SECTION 6 Terms and Conditions of Restricted Share, Performance Unit and Bonus Share Awards (A) Restricted Shares. Restricted share awards shall be evidenced by a written agreement in the form prescribed by the Committee in its discretion, which shall set forth the number of shares of the Common Stock awarded, the restrictions imposed thereon (including, without limitation, restrictions on the right of the grantee to sell, assign, transfer or encumber such shares while such shares are subject to other restrictions imposed under this Section 6), the duration of such restrictions, events (which may, in the discretion of the Committee, include performance-based events) the occurrence of which would cause a forfeiture of the restricted shares and such other terms and conditions as the Committee in its discretion deems appropriate. Restricted share awards shall be effective only upon execution of the applicable restricted share agreement on behalf of the Corporation by the Chief Executive Officer (if other than the President), the President or any Vice President, and by the grantee. Following a restricted share award and prior to the lapse or termination of the applicable restrictions, the Committee shall deposit share certificates for such restricted shares in escrow. Upon the lapse or termination of the applicable restrictions (and not before such time), the grantee shall be issued or transferred share certificates for such restricted shares. From the date a restricted share award is effective, the grantee shall be a shareholder with respect to all the shares represented by such certificates and shall have all the rights of a shareholder with respect to all such shares, including the right to vote such shares and to receive all dividends and other distributions paid with respect to such shares, subject only to the restrictions imposed by the Committee. (B) Performance Units. The Committee may award performance units which shall be earned by an awardee based on the level of performance over a specified period of time by the Corporation, a Subsidiary or Subsidiaries, any branch, department or other portion thereof or the awardee individually, as determined by the Committee. For the purposes of the grant of performance units, the following definitions shall apply: (i) "performance unit" shall mean an award, expressed in dollars or shares of Common Stock, granted to an awardee with respect to a Performance Period. Awards expressed in dollars may be established as fixed dollar amounts, as a percentage of salary, as a percentage of a pool based on earnings of the Corporation, a Subsidiary or Subsidiaries or any branch, department or other portion thereof or in any other manner determined by the Committee in its discretion, provided that the amount thereof shall be capable of being determined as a fixed dollar amount as of the close of the Performance Period. (ii) "Performance Period" shall mean an accounting period of the Corporation or a Subsidiary of not less than one year, as determined by the Committee in its discretion. (iii) "Performance Target" shall mean that level of performance established by the Committee which must be met in order for the performance unit to be fully earned. The Performance Target may be expressed in terms of earnings per share, return on assets, asset growth, ratio of capital to assets or such other level or levels of accomplishment by the Corporation, a Subsidiary or Subsidiaries, any branch, department or other portion thereof or the awardee individually as may be established or revised from time to time by the Committee. (iv) "Minimum Target" shall mean a minimal level of performance established by the Committee which must be met before any part of the performance unit is earned. The Minimum Target may be the same as or less than the Performance Target in the discretion of the Committee. (v) "performance shares" shall mean shares of Common Stock issued in payment of earned performance units. An awardee shall earn the performance unit in full by meeting the Performance Target for the Performance Period. If the Minimum Target has not been attained at the end of the Performance Period, no part of the performance unit shall have been earned by the awardee. If the Minimum Target is attained but the Performance Target is not attained, the portion of the performance unit earned by the awardee shall be determined on the basis of a formula established by the Committee. At any time prior to the end of a Performance Period, the Committee may adjust downward (but not upward) the Performance Target and/or the Minimum Target as a result of major events unforseen at the time of the performance unit award, such as changes in the economy, the industry, laws affecting the operations of the Corporation or a Subsidiary or any other event the Committee determines would have a significant impact upon the probability of attaining the previously established Performance Target. Payment of earned performance units shall be made to awardees following the close of the Performance Period as soon as practicable after the time the amount payable is determined by the Committee. Payment in respect of earned performance units, whether expressed in dollars or shares, may be made in cash, in shares of Common Stock, or partly in cash and partly in shares of Common Stock, as determined by the Committee at the time of payment. For this purpose, performance units expressed in dollars shall be converted to shares, and performance units expressed in shares shall be converted to dollars, based on the fair market value of the Common Stock, determined as provided in Section 5(I), as of the date the amount payable is determined by the Committee. If prior to the close of the Performance Period the employment of an awardee of performance units is voluntarily terminated with the consent of the Corporation or a Subsidiary or the awardee retires under any retirement plan of the Corporation or a Subsidiary or the awardee dies during employment, the Committee may in its absolute discretion determine to pay all or any part of the performance unit based upon the extent to which the Committee determines the Performance Target or Minimum Target has been achieved as of the date of termination of employment, retirement or death, the period of time remaining until the close of the Performance Period and/or such other factors as the Committee may deem relevant. If the Committee in its discretion determines that all or any part of the performance unit shall be paid, payment shall be made to the awardee or his or her estate as promptly as practicable following such determination and may be made in cash, in shares of Common Stock, or partly in cash and partly in shares of Common Stock, as determined by the Committee at the time of payment. For this purpose, performance units expressed in dollars shall be converted to shares, and performance units expressed in shares shall be converted to dollars, based on the fair market value of the Common Stock, determined as provided in Section 5(I), as of the date the amount payable is determined by the Committee. Except as otherwise provided in Section 8(E), if the employment of an awardee of performance units terminates prior to the close of a Performance Period for any reason other than voluntary termination with the consent of the Corporation or a Subsidiary, retirement under any retirement plan of the Corporation or a Subsidiary or death, the performance units of the awardee shall be deemed not to have been earned, and no portion of such performance units may be paid. Whether termination of employment is a voluntary termination with the consent of the Corporation or a Subsidiary shall be determined, in its discretion, by the Committee. Any determination by the Committee on any matter with respect to performance units shall be final and binding on both the Corporation and the awardee. Performance unit awards shall be evidenced by a written agreement in the form prescribed by the Committee which shall set forth the amount or manner of determining the amount of the performance unit, the Performance Period, the Performance Target and any Minimum Target and such other terms and conditions as the Committee in its discretion deems appropriate. Performance unit awards shall be effective only upon execution of the applicable performance unit agreement on behalf of the Corporation by the Chief Executive Officer (if other than the President), the President or any Vice President, and by the awardee. (C) Bonus Shares. The Committee shall have the authority in its discretion to award bonus shares of Common Stock to eligible employees from time to time in recognition of the contribution of the awardee to the performance of the Corporation, a Subsidiary or Subsidiaries, or any branch, department or other portion thereof, in recognition of the awardee's individual performance or on the basis of such other factors as the Committee may deem relevant. SECTION 7 Adjustment and Substitution of Shares If a dividend or other distribution shall be declared upon the Common Stock payable in shares of the Common Stock, the number of shares of the Common Stock then subject to any outstanding stock options or performance unit awards and the number of shares of the Common Stock which may be issued under the Plan but are not then subject to outstanding stock options or awards shall be adjusted by adding thereto the number of shares of the Common Stock which would have been distributable thereon if such shares had been outstanding on the date fixed for determining the shareholders entitled to receive such stock dividend or distribution. Shares of Common Stock so distributed with respect to any restricted shares held in escrow shall also be held by the Corporation in escrow and shall be subject to the same restrictions as are applicable to the restricted shares on which they were distributed. If the outstanding shares of the Common Stock shall be changed into or exchangeable for a different number or kind of shares of stock or other securities of the Corporation or another corporation, whether through reorganization, reclassification, recapitalization, stock split-up, combination of shares, merger or consolidation, then there shall be substituted for each share of the Common Stock subject to any then outstanding stock option or performance unit award, and for each share of the Common Stock which may be issued under the Plan but which is not then subject to any outstanding stock option or award, the number and kind of shares of stock or other securities into which each outstanding share of the Common Stock shall be so changed or for which each such share shall be exchangeable. Unless otherwise determined by the Committee in its discretion, any such stock or securities, as well as any cash or other property, into or for which any restricted shares held in escrow shall be changed or exchangeable in any such transaction shall also be held by the Corporation in escrow and shall be subject to the same restrictions as are applicable to the restricted shares in respect of which such stock, securities, cash or other property was issued or distributed. In case of any adjustment or substitution as provided for in this Section 7, the aggregate option price for all shares subject to each then outstanding stock option prior to such adjustment or substitution shall be the aggregate option price for all shares of stock or other securities (including any fraction) to which such shares shall have been adjusted or which shall have been substituted for such shares. Any new option price per share shall be carried to at least three decimal places with the last decimal place rounded upwards to the nearest whole number. No adjustment or substitution provided for in this Section 7 shall require the Corporation to issue or sell a fraction of a share or other security. Accordingly, all fractional shares or other securities which result from any such adjustment or substitution shall be eliminated and not carried forward to any subsequent adjustment or substitution. Owners of restricted shares held in escrow shall be treated in the same manner as owners of Common Stock not held in escrow with respect to fractional shares created by an adjustment or substitution of shares, except that, unless otherwise determined by the Committee in its discretion, any cash or other property paid in lieu of a fractional share shall be subject to restrictions similar to those applicable to the restricted shares exchanged therefor. If any such adjustment or substitution provided for in this Section 7 requires the approval of shareholders in order to enable the Corporation to grant incentive stock options, then no such adjustment or substitution shall be made without the required shareholder approval. Notwithstanding the foregoing, in the case of incentive stock options, if the effect of any such adjustment or substitution would be to cause the stock option to fail to continue to qualify as an incentive stock option or to cause a modification, extension or renewal of such stock option within the meaning of Section 424 of the Code, the Committee may elect that such adjustment or substitution not be made but rather shall use reasonable efforts to effect such other adjustment of each then outstanding stock option as the Committee, in its discretion, shall deem equitable and which will not result in any disqualification, modification, extension or renewal (within the meaning of Section 424 of the Code) of such incentive stock option. SECTION 8 Additional Rights in Certain Events (A) Definitions. For purposes of this Section 8, the following terms shall have the following meanings: (1) The term "Person" shall be used as that term is used in Sections 13(d) and 14(d) of the 1934 Act. (2) Beneficial Ownership shall be determined as provided in Rule 13d-3 under the 1934 Act as in effect on the effective date of the Plan. (3) "Voting Shares" shall mean all securities of a company entitling the holders thereof to vote in an annual election of Directors (without consideration of the rights of any class of stock other than the Common Stock to elect Directors by a separate class vote); and a specified percentage of "Voting Power" of a company shall mean such number of the Voting Shares as shall enable the holders thereof to cast such percentage of all the votes which could be cast in an annual election of directors (without consideration of the rights of any class of stock other than the Common Stock to elect Directors by a separate class vote). (4) "Tender Offer" shall mean a tender offer or exchange offer to acquire securities of the Corporation (other than such an offer made by the Corporation or any Subsidiary), whether or not such offer is approved or opposed by the Board. (5) "Section 8 Event" shall mean the date upon which any of the following events occurs: (a) The Corporation acquires actual knowledge that any Person other than the Corporation, a Subsidiary or any employee benefit plan(s) sponsored by the Corporation has acquired the Beneficial Ownership, directly or indirectly, of securities of the Corporation entitling such Person to 10% or more of the Voting Power of the Corporation; (b) A Tender Offer is made to acquire securities of the Corporation entitling the holders thereof to 20% or more of the Voting Power of the Corporation; or (c) A solicitation subject to Rule 14a-11 under the 1934 Act (or any successor Rule) relating to the election or removal of 50% or more of the members of any class of the Board shall be made by any person other than the Corporation; or (d) The shareholders of the Corporation shall approve a merger, consolidation, share exchange, division or sale or other disposition of assets of the Corporation as a result of which the shareholders of the Corporation immediately prior to such transaction shall not hold, directly or indirectly, immediately following such transaction a majority of the Voting Power of (i) in the case of a merger or consolidation, the surviving or resulting corporation, (ii) in the case of a share exchange, the acquiring corporation or (iii) in the case of a division or a sale or other disposition of assets, each surviving, resulting or acquiring corporation which, immediately following the transaction, holds more than 10% of the consolidated assets of the Corporation immediately prior to the transaction; provided, however, that (i) if securities beneficially owned by a grantee are included in determining the Beneficial Ownership of a Person referred to in paragraph 5(a), (ii) a grantee is required to be named pursuant Item 2 of the Schedule 14D-1 (or any similar successor filing requirement) required to be filed by the bidder making a Tender Offer referred to in paragraph 5(b) or (iii) if a grantee is a "participant" as defined in 14a-11 under the 1934 Act (or any successor Rule) in a solicitation (other than a solicitation by the Corporation) referred to in paragraph 5(c), then no Section 8 Event with respect to such grantee shall be deemed to have occurred by reason of such event. (B) Acceleration of the Exercise Date of Stock Options. Subject to the provisions of Section 4 in the case of incentive stock options, unless the agreement referred to in Section 5(H), or an amendment thereto, shall otherwise provide, notwithstanding any other provision contained in the Plan, in case any "Section 8 Event" occurs all outstanding stock options (other than those held by a person referred to in the proviso to Section 8(a)(5)) shall become immediately and fully exercisable whether or not otherwise exercisable by their terms. (C) Extension of the Expiration Date of Stock Options. Subject to the provisions of Section 4 in the case of incentive stock options, unless the agreement referred to in Section 5(H), or an amendment thereto, shall otherwise provide, notwithstanding any other provision contained in the Plan, all stock options held by a grantee (other a grantee referred to in the proviso to Section 8(a)(5)) whose employment with the Corporation or a Subsidiary terminates within one year of any Section 8 Event for any reason other than voluntary termination with the consent of the Corporation or a Subsidiary, retirement under any retirement plan of the Corporation or a Subsidiary or death shall be exercisable for a period of three months from the date of such termination of employment, but in no event after the expiration date of the stock option. (D) Lapse of Restrictions on Restricted Share Awards. If any "Section 8 Event" occurs prior to the scheduled lapse of all restrictions applicable to restricted share awards under the Plan (other than those held by a person referred to in the proviso to Section 8(a)(5)), all such restrictions shall lapse upon the occurrence of any such "Section 8 Event" regardless of the scheduled lapse of such restrictions. (E) Payment of Performance Units. If any "Section 8 Event" occurs prior to the end of any Performance Period, all performance units awarded with respect to such Performance Period (other than those held by a person referred to in the proviso to Section 8(a)(5)) shall be deemed to have been fully earned as of the date of such Section 8 Event, regardless of the attainment or nonattainment of the Performance Target or any Minimum Target, and shall be paid to the awardees thereof as promptly as practicable thereafter. If the performance unit is not expressed as a fixed amount in dollars or shares, the Committee may provide in the performance unit agreement for the amount to be paid in the case of a Section 8 Event. SECTION 9 Effect of the Plan on the Rights of Employees and Employer Neither the adoption of the Plan nor any action of the Board or the Committee pursuant to the Plan shall be deemed to give any employee any right to be granted a stock option (with or without reload option rights and/or cash payment rights) or to be awarded restricted shares, performance units or bonus shares under the Plan. Nothing in the Plan, in any stock option, reload option rights or cash payment rights granted under the Plan, in any restricted share, performance unit or bonus share award under the Plan or in any agreement providing for any of the foregoing shall confer any right to any employee to continue in the employ of the Corporation or any Subsidiary or interfere in any way with the rights of the Corporation or any Subsidiary to terminate the employment of any employee at any time. SECTION 10 Amendment The right to alter and amend the Plan at any time and from time to time and the right to revoke or terminate the Plan are hereby specifically reserved to the Board; provided that no such alteration or amendment of the Plan shall, without shareholder approval (a) increase by more than 10% the total number of shares which may be issued under the Plan to persons subject to Section 16 under the 1934 Act ("Section 16 Persons"), (b) materially increase the benefits accruing under the Plan to Section 16 Persons, (c) materially modify the requirements as to eligibility for participation in the Plan by Section 16 Persons, (d) make any changes in the class of employees eligible to receive incentive stock options under the Plan or (e) increase the number of shares with respect to which incentive stock options may be granted under the Plan. No alteration, amendment, revocation or termination of the Plan shall, without the written consent of the holder of a stock option, reload option rights, cash payment rights, restricted shares, performance units or bonus shares theretofore awarded under the Plan, adversely affect the rights of such holder with respect thereto. SECTION 11 Effective Date and Duration of Plan The effective date and date of adoption of the Plan shall be March 26, 1992, the date of adoption of the Plan by the Board, provided that such adoption of the Plan by the Board is approved by a majority of the votes cast at a duly held meeting of shareholders held on or prior to March 25, 1993 at which a quorum representing a majority of the outstanding voting stock of the Corporation is, either in person or by proxy, present and voting. No stock option granted under the Plan may be exercised and no restricted shares, bonus shares or performance units payable in performance shares may be awarded until after such approval. No stock option, reload option rights or cash payment rights may be granted, and no restricted shares, bonus shares or performance units payable in performance shares may be awarded under the Plan subsequent to March 25, 2002, except that reload options and associated cash payment rights may be granted pursuant to reload option rights then outstanding. EX-10 3 EXHIBIT 10.17-SEPARATION AGREEMENT & RELEASE SEPARATION AGREEMENT AND RELEASE THIS SEPARATION AGREEMENT AND RELEASE (the "Agreement") is entered into this 21st day of November, 1997 but is effective for all purposes hereunder as of October 22, 1997 (the "Effective Date"), by and between KEYSTONE FINANCIAL, INC., a Pennsylvania corporation ("Keystone") and GEORGE H. GROVES ("Groves"). WHEREAS, Groves was employed by Keystone as Senior Executive Vice President and Chief Banking Officer; and WHEREAS, by letter dated October 24, 1997, Groves tendered to Keystone his resignation from all positions and directorships held by him with Keystone and with any and all of Keystone's subsidiaries and affiliates, such resignation to be effective as of the Effective Date; and WHEREAS, Groves resignation was accepted by and was done with the consent of Keystone; and WHEREAS, both parties desire to achieve an amicable separation to fully and finally resolve and/or avoid any existing or other potential disputes between them. NOW, THEREFORE, in consideration of the mutual covenants contained herein and intending to be legally bound, Keystone and Groves agree as follows: 1. PURPOSE OF AGREEMENT. The purpose of this Agreement is to confirm and memorialize the termination of the employment relationship between Keystone and Groves, to resolve fully and finally and/or avoid any and all existing or potential disputes arising from the employment relationship and the termination thereof without admission of any liability on the part of either party. To that end, the parties acknowledge that this Agreement resolves any and all claims either may have against the other with respect to Grove's employment and/or the termination of such employment. For the purpose of this Agreement, the term "Keystone" includes not only Keystone Financial, Inc. and its employee welfare benefit, pension, fringe benefit or compensation plans, but also all other entities affiliated with Keystone Financial, Inc. 2. TERMINATION OF EMPLOYMENT. Groves hereby acknowledges and agrees that his employment with Keystone as Senior Executive Vice President and Chief Banking Officer and any and all officer positions and directorships terminated as of the Effective Date. 3. CONSIDERATION. Groves acknowledges and confirms that the only consideration for his executing this Agreement is set forth herein, that no other promises or agreements of any kind, save for those set forth in this Agreement, have been made to him by any person or entity whatsoever to cause him to sign this Agreement and that he fully understands the meaning and intent of this Agreement. 4. SEPARATION PAYMENTS. In consideration of the promises set forth in this Agreement, Keystone and Groves agree that Groves shall receive the separation payments and other benefits set forth in Exhibit A, which is attached hereto and incorporated herein. Keystone and Groves further agree that the separation payments and benefits set forth in Exhibit A constitute all of the payments and benefits which Groves shall receive due to the termination of his employment with Keystone. 5. NONDISCLOSURE OF INFORMATION. Groves acknowledges that as an employee, officer and director of Keystone, he had access to extensive confidential and/or proprietary information. Groves agrees that he shall not, without the written consent of a duly authorized executive officer of Keystone, disclose to any person any material confidential information obtained by him while in the employ of Keystone with respect to any of the services, products, improvements, formulas, designs or styles, processes, customers, methods of distribution or business practices, the disclosure of which reasonably would be expected to materially damage Keystone; provided, however, that for purposes of this Agreement, confidential information shall not include any information known generally to the public (other than as a result of unauthorized disclosure by Groves) or any information of a type not otherwise considered confidential by persons engaged in the same business or a business similar to that conducted by Keystone. Provided, further, that this section shall not apply to any disclosure that may be required by Groves by law, regulation or court order, but only after Groves notifies an executive officer of Keystone of such demand for disclosure and Keystone has a reasonable opportunity to respond to such demand. Any breach of this Nondisclosure of Information provision shall be deemed a material breach of this Agreement. 6. RETURN OF PROPERTY. Groves represents that he has surrendered to Keystone any and all materials in Groves' possession, or elsewhere, whether or not said materials are proprietary in nature, relating to the business of Keystone including, but not limited to, data, documents, reports, programs, diskettes, computer printouts, program listings, computer hardware and/or software specifications, client lists, client information, and any and all similar information without regard to form of representation, including all copies thereof. Groves acknowledges that all such materials are the sole property of Keystone and that Groves has no right, title or other interest in or to such materials. These materials are included in the Nondisclosure of Information provision contained in Section 5. Further, any breach of this Return of Property provision shall be deemed a material breach of this Agreement. 7. NO ACCESS. The parties acknowledge that Groves' office at Keystone was fully equipped with a computer system and other equipment. In addition to the return to Keystone of all of its property and any copies thereof as required in Section 6 above, Groves agrees never to access Keystone's computer system for any purpose whatsoever. Groves acknowledges and agrees that any such access constitutes an illegal act and would cause irreparable damage and liability to Keystone. Any breach of this No Access provision shall be deemed a material breach of this Agreement. 8. NO SOLICITATION. Groves agrees that he shall not entice or solicit, directly or indirectly, any other executives or key management personnel of Keystone to leave the employ of Keystone to work with Groves or any entity with which Groves has affiliated for a period of one (1) year from the Effective Date. Groves acknowledges and agrees that any breach of the restrictions set forth in this Section 8 will result in irreparable injury to Keystone for which it may have no meaningful remedy in law and Keystone shall be entitled to injunctive relief in order to enforce the provisions hereof. Upon obtaining such injunction, Keystone shall be entitled to pursue reimbursement from Groves and/or Groves' employer of costs incurred in securing a qualified replacement for any employee enticed away from Keystone by Groves. Further, Keystone shall be entitled to set off against or obtain reimbursement from Groves of any payments owed or made to Groves by Keystone hereunder. Any breach of this No Solicitation provision shall be deemed a material breach of this Agreement. 9. NONCOMPETITION. In consideration for the separation payments and other benefits extended to Groves under this Agreement, Groves agrees that he shall not, directly or indirectly, within the marketing area of Keystone (defined for purposes of this Section 9 as all areas within one hundred (100) miles of the work location to which Groves was assigned for the majority of the time during the twelve (12) months preceding the Effective Date where Keystone has established an active and material market presence) enter into or engage generally in direct or indirect competition with Keystone in the business of banking or any banking or trust related business, either directly or indirectly as an individual on his own or as a partner or joint venturer, or as a director, officer, shareholder (except as an incidental shareholder), employee or agent for any person, for a period of one (1) year from the Effective Date. The existence of any material claim or cause of action of Groves against Keystone, whether predicated on this Agreement or otherwise, shall not constitute a defense to the enforcement by Keystone of this provision. In the event that this Section 9 shall be determined by any court of competent jurisdiction to be unenforceable in part by reason of being too great a period of time or covering too great a geographical area, it shall be in full force and effect as to that period of time or geographical area determined to be reasonable by the court. Any breach of this Noncompetition provision shall be deemed a material breach of this Agreement. 10. NO DISPARAGEMENT. Groves agrees not to make disparaging remarks about Keystone or its operations, its employees, or any other aspect of its operation, and Keystone agrees not to make disparaging remarks about Groves. Any breach by either party of this No Disparagement provision shall be deemed a material breach of this Agreement. 11. GENERAL RELEASE. In consideration for the separation payments and other benefits extended to Groves under this Agreement, Groves, for himself, his heirs, executors, administrators, successors and assigns, forever releases and discharges Keystone, its board and their successors and assigns, officers, agents, contractors, consultants and employees, past and present, collectively or individually, from any and all claims, demands, causes of action, losses and expenses of every nature whatsoever, known or unknown, that Groves ever had, now has or hereafter may have, arising out of or in conjunction with his employment with Keystone or the termination thereof, including, but not limited to, breach of contract (express or implied), infliction of emotional harm, defamation, wrongful discharge or any other tort, the Age Discrimination in Employment Act (29 U.S.C. ss.621 et seq.), the Pennsylvania Human Relations Act, or any other federal, state or municipal statute or ordinance including, but not limited to, those relating to employment, labor relations or wages. It is expressly agreed and understood that this Agreement is a general release. In consideration of the foregoing release, and the covenants set forth therein, Keystone, for itself, its agents, employees, successors and assigns, releases Groves, his heirs, executors, administrators and assigns from any and all claims, demands, causes of action, losses and expenses of every nature whatsoever, known or unknown, that Keystone ever had, now has, or hereafter may have, arising out of or in conjunction with Groves' employment by Keystone or the termination thereof; provided, however, that Keystone expressly does not release Groves with respect to any acts of gross negligence or any intentional acts by Groves that are or were materially injurious to or which may contribute or has contributed to the material detriment of Keystone. Nothing herein shall act as a release of Groves from complying with this Agreement. 12. COVENANT NOT TO SUE. Groves agrees that he will not bring any action, suit or administrative proceeding or request contesting the validity of this Agreement or attempting to negate, modify or reform it, nor will he sue Keystone and its successors and assigns, agents, contractors, consultants or employees, past and present, individually or collectively, for any reason arising out of Groves' employment or termination thereof. Any breach of this Covenant Not To Sue shall be deemed a material breach of this Agreement requiring Groves to tender back to Keystone any and all payments paid to him thereunder, including the value of any benefits provided by Keystone. 13. INDEMNIFICATION. Except as prohibited by law, Keystone agrees to defend and indemnify Groves against expenses and any liability paid or incurred by Groves in connection with any actual or threatened claim, cause of action, suit or proceeding, civil or administrative, brought by any third party against Groves by reason of Groves having been an officer of Keystone; provided, however, Keystone does not agree to so indemnify Groves for any acts of gross negligence or any intentional acts by Groves that are or were materially injurious to or which may contribute or has contributed to the material detriment of Keystone. If Groves obtains knowledge of: (a) facts that would give rise to a right of defense or indemnification; or (b) commencement of an action that may require defense or indemnification, Groves shall give written notice to Keystone as promptly as practicable after his receipt of that knowledge. Following receipt of such notice, Keystone shall be entitled to participate in the defense of such claim, and upon notice delivered promptly to Groves, to assume the defense thereof, with counsel reasonably satisfactory to Groves. Within a reasonable period following the assumption of such defense by Keystone, Groves shall be permitted to participate in the defense of such claim and may retain additional counsel of his choice at his own expense. As an additional condition to Keystone's obligation to defend and indemnify Groves under this paragraph, Groves shall make himself available upon reasonable notice to testify in any suit or proceeding which relates to Groves' duties as an officer of Keystone. 14. CONFIDENTIALITY. The parties agree that the terms and existence of this Agreement shall remain confidential. The parties agree further not to disclose any information concerning this Agreement to any agency or person, including but not limited to past, present and future employees of Keystone, except where such disclosure is required by law or is necessary to carry out the terms of this Agreement. Any breach of this Confidentiality provision shall be regarded as a material breach of this Agreement. There is specifically excepted from the foregoing the right of Groves to disclose information concerning this Agreement to his family, financial advisors and attorneys, but Groves shall assume responsibility for the failure of such persons to comply with the terms of this Confidentiality provision. 15. ENFORCEMENT. In the event of an actual or threatened breach by Groves of the provisions of Sections 5, 6, 7, 8 or 9, Keystone shall be entitled to injunctive relief restraining Groves and any other so engaged from such violation for the entire period set forth in the applicable section(s); provided, however, that said period shall be extended by the time which may have elapsed between the time Groves is notified of such violation and an injunction issues restraining Groves from such violation. Nothing herein shall be construed as prohibiting Keystone from pursuing any other remedies available for such breach or threatened breach including, but not limited to, the recovery of damages, reasonable fees of counsel and costs from Groves. 16. DAMAGES. Should suit be necessary to enforce either parties' rights in this Agreement, the party determined in such suit to have breached this Agreement shall pay damages, reasonable fees of counsel and costs incurred by the other party enforcing its rights under this Agreement. The parties acknowledge, however, that any damages to Keystone that may result from a breach of the provisions of Sections 5, 6, 7, 8 or 9 of this Agreement by Groves are not readily ascertainable. Accordingly, in the event of a breach of the provisions of Sections 5, 6, 7, 8 or 9 of this Agreement by Groves, the parties agree that Groves shall be required to pay to Keystone, as liquidated damages, the sum of Four Hundred Thousand Dollars ($400,000.00), plus reasonable fees of counsel and costs. Nothing herein shall, however, be construed as prohibiting Keystone from pursuing injunctive relief restraining Groves and any other as provided in Section 15 of this Agreement. 17. REFERENCES. All requests for references about Groves by potential future employers shall be directed to the Senior Vice President, Human Resources, who will provide such information as Groves and Keystone mutually determine. The parties may prepare a summary of such information which shall be either attached to this Agreement as Exhibit B or, if prepared after the execution of this Agreement, shall reference this Agreement and be signed by the parties. 18. GOVERNING LAW. This Agreement shall be construed in accordance with and be governed by the laws of the Commonwealth of Pennsylvania. 19. SEVERABILITY. Groves and Keystone acknowledge that any restrictions contained in this Agreement are reasonable and that consideration for this Agreement has been exchanged. In the event that any provision of this Agreement shall be held to be void, voidable or unenforceable, the remaining portions hereof shall remain in full force and effect; provided, that in the event that a court shall determine that any provision is inequitably broad, it is the intention of the parties that the court adjust such obligations of Groves rather than eliminating such obligations entirely. 20. EXECUTIVE EMPLOYMENT AGREEMENT. Groves and Keystone hereby acknowledge that by executing this Agreement, the Executive Employment Agreement between Groves and Keystone dated January 27, 1994 and as modified pursuant to a memorandum to Groves from G. E. Aumiller dated March 11, 1994 and a letter to Groves from Carl L. Campbell dated September 29, 1994 (the "Employment Agreement") has been terminated and its terms thereby rendered null and void. Groves hereby specifically acknowledges that he has no rights or claims to any compensation or benefits pursuant to the terms of the Employment Agreement, including, but not limited to, the right to arbitration and/or the payment of attorneys fees and administrative court costs by Keystone pursuant to Section 19 of the Employment Agreement. 21. OTHER AGREEMENTS. This Agreement supersedes all other agreements, if any, oral or written, heretofore made with respect to the subject matter hereof and contains the entire agreement of the parties. This Agreement cannot be amended or modified, except in writing signed by Groves and an agent of Keystone specifically authorized to sign on behalf of Keystone in this matter. 22. ACKNOWLEDGMENT. Groves acknowledges and represents to Keystone as follows: a. He has had ample time (up to 21 days) to review all of the provisions of this Agreement and fully understands it and the choices with respect to the advisability of making the settlement and release provided herein. b. He acknowledges that, because of the consideration promised in return, he has entered into this Agreement by his free will and choice without any compulsion, duress or undue influence from anyone. c. He acknowledges that he has been advised to seek independent legal counsel regarding his rights and the advisability of entering into this Agreement. d. He acknowledges that he has been advised and understands that once executed, he shall have up to seven (7) days thereafter to revoke this Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement the day and year first above written. WITNESS: /s/ Craig A. Golfieri /s/ George H. Groves - --------------------- -------------------- ATTEST: KEYSTONE FINANCIAL, INC. /s/ George R. Barr By Carl L. Campbell - --------------------- -------------------- EXHIBIT A SCHEDULE OF SEPARATION PAYMENTS AND BENEFITS I. SEPARATION PAYMENTS A. SEPARATION PAYMENTS. 1. Groves shall receive separation payments in an amount equal to Four Hundred Fifty Thousand Dollars ($450,000.00) payable in accordance with subsections 2 and 3 below. 2. Groves shall receive a separation payment in an amount equal to the balance of his Annual Salary (as such term is defined in the Employment Agreement) for 1997 under the terms of the Employment Agreement had he remained an employee of Keystone for the remainder of 1997. The separation payment shall be made immediately following the expiration of the statutory revocation period referenced in Section 22(d) of the Agreement. Groves shall receive a separation payment equal to the balance of the Four Hundred Fifty Thousand Dollars ($450,000.00) referenced in subsection 1 above on January 2, 1998 (or on such other date as is mutually agreed to by Keystone and Groves.) In the event of Groves' death prior to January 2, 1998, his heirs shall receive the separation payment. 4. Groves hereby acknowledges that the separation payments referenced above include payment for any vacation, personal days, sick days, short-term disability and holidays to which Groves may have otherwise been entitled and that such separation payments represent complete satisfaction of any such obligations. B. SEPARATION PAYMENTS IN LIEU OF BENEFITS. 1. Groves shall receive an additional separation payment of Two Hundred Thousand Dollars ($200,000.00) on January 2, 1998 (or on such other date as is mutually agreed to by Keystone and Groves). In the event of Groves' death prior to January 2, 1998, his heirs shall receive the separation payment. 2. Groves hereby acknowledges that the payment of this Two Hundred Thousand Dollars ($200,000.00) is in lieu of any welfare, fringe benefit or other incentive compensation benefits to which Groves may have been entitled including, but not limited to, medical, dental, accidental death and dismemberment, long-term disability, life, payments pursuant to the Management Incentive Compensation Plan (MICP) for 1997, payments pursuant to the Performance Unit Plan (PUP) for the current performance period, any phone/secretarial support, tax consulting services, automobile allowance and/or club memberships and that such separation payment represents complete satisfaction of any such obligations. C. SEPARATION PAYMENTS FOR RETIREMENT BENEFIT PURPOSES. W-2 wages are generally included in the calculation of retirement benefits under the qualified and nonqualified retirement programs maintained by Keystone. Employment contract buyout payments (such as the separation payments provided herein) are specifically excluded from the calculation of retirement benefits under the qualified and nonqualified retirement programs maintained by Keystone. II. BENEFITS A. SPLIT DOLLAR LIFE INSURANCE. 1. Keystone shall continue to maintain the split dollar life insurance policy with a death benefit of Six Hundred Thousand Dollars ($600,000.00) (Metropolitan Life Insurance Policy No. 947590025U) on the life of Groves (the "Policy") for a period of eighteen (18) months from the Effective Date, such maintenance period to end on April 22, 1999. 2. In the event of Groves' death prior to April 22, 1999, Groves' designated beneficiaries shall receive the death benefits under the terms of the Policy and Keystone shall receive a repayment of the premium payments that are owed by Groves to Keystone. 3. On April 22, 1999, the Policy shall be transferred to Groves and Groves shall not be required to repay the premium payments that would have otherwise been owed by Groves to Keystone in the amount of approximately One Hundred Thirty Thousand Five Hundred Forty-Four Dollars ($130,544.00). B. QUALIFIED PENSION PLANS. Any retirement benefits to which Groves is enti- tled under the terms of the Keystone Financial Pension Plan and/or the Keystone Financial 401(k) Savings Plan shall be paid in accordance with the terms of such plans. C. NONQUALIFIED RETIREMENT BENEFITS. Any benefits to which Groves may be enti- tled under the terms of the Supplemental Retirement Income Plan and/or the Savings Restoration Plan shall be paid in accordance with the terms of such plans. D. STOCK OPTIONS. 1. Groves acknowledges that he is not eligible to receive any further grants of stock options pursuant to any program maintained by Keystone. 2. Outstanding vested incentive stock options held by Groves must be exercised no later than the earlier of (i) three months from the Effective Date or (ii) the scheduled expiration of the exercise period of such options. 3. Outstanding vested nonqualified stock options must be exercised no later than the earlier of (i) one year from the Effective Date or (ii) the scheduled expiration of the exercise period of such stock options. 4. All nonvested incentive stock options and nonvested nonqualified stock options have lapsed as of the Effective Date. E. MANAGEMENT STOCK OWNERSHIP PROGRAM. In accordance with the terms of the MSOP and the underlying loan documents, Groves shall be required to repay the outstanding loan balance within ninety (90) days from the Effective Date. F. EMPLOYEE STOCK PURCHASE PLAN. Groves' account balance (plus accrued interest) shall be distributed to Groves pursuant to the terms of the Plan. G. PERFORMANCE UNIT PLAN AND MANAGEMENT INCENTIVE COMPENSATION PLAN. Groves thereby acknowledges that the separation payment made pursuant to Section I.B.2 hereof represents complete satisfaction of any amounts to which Groves may have been entitled pursuant to the terms of the PUP and MICP. H. COBRA. Groves shall be provided with a notice of his right to COBRA continuation coverage. If Groves elects COBRA continuation coverage, the cost of such coverage shall be paid exclusively by Groves. III. TAX WITHHOLDING All separation payments and benefits hereunder are subject to all applicable federal, state and local taxes and reporting requirements. EX-10 4 EX. 10.19-SUPPLEMENTAL DEFERRED COMPENSATION PLAN KEYSTONE FINANCIAL, INC. SUPPLEMENTAL DEFERRED COMPENSATION PLAN I. Purpose of the Plan. The Keystone Financial, Inc. Supplemental Deferred Compensation Plan ("Plan") is an unfunded deferred compensation arrangement to provide supplemental post-employment or retirement benefits solely for a select group of management or highly compensated employees employed by Keystone Financial, Inc. ("KFI"), its subsidiaries and affiliated corporations ("Employers"). II. Administration of the Plan. (a) The Plan shall be administered by the Human Resources Department of KFI ("Human Resources Department"). (b) Decisions and determinations by the Human Resources Department concerning the Plan shall be final and binding upon all parties. The Human Resources Department shall have the authority to interpret the Plan, to make all determinations reserved hereunder to the Employers, to establish and revise rules and regulations relating to the Plan, and to make any other determinations that are authorized herein or that it believes are necessary or advisable for the administration of the Plan. III. Participation The Human Resources Committee of the Keystone Financial, Inc. Board of Directors or such person or persons as the Committee shall designate (the "Selection Committee") shall have the exclusive power to select solely from the management and highly compensated employees of the Employers the individual participants to receive benefits under the Plan. The Selection Committee shall complete a separate Benefit Schedule in the form attached hereto as Appendix "A" for each employee selected to be a participant in the Plan. IV. Amount of Benefit. The Selection Committee shall have the exclusive power to determine the benefit to be paid by any Employer to a participant under the Plan. The benefit of each participant under the Plan shall be set forth on the Benefit Schedule. The Benefit Schedule must be completed by the Human Resources Department and made a part of this Plan before any benefit under the Plan may be paid to such participant. V. Time and Terms of Payment. The Selection Committee shall have the exclusive power to determine the time when payment of any benefit under the Plan shall commence, the manner in which such benefit shall be paid and the terms or conditions which must be met in order for the participant to qualify for such benefit. The time, terms and conditions of payment shall be set forth on the Benefit Schedule which is completed by the Human Resources Department and made part of this Plan. VI. Survivor Benefits. The Plan is for the exclusive benefit of the participants selected to receive benefits under the Plan pursuant to Article III hereof. No other person, including the participant's surviving spouse, his surviving children, or his estate, shall have any interest in any benefit under the Plan except to the extent specifically provided in the Benefit Schedule prepared with respect to the participant by the Human Resources Department and made a part of this Plan. VII. Non-Competition. If the Benefit Schedule with respect to the individual participant incorporates by reference this noncompetition provision, and if, without the written consent of the Human Resources Department, the participant at any time after his termination of employment with the Employers, and prior to the time he has received all of any benefit due hereunder engages in or becomes associated with, directly or indirectly, either the stockholder, director, officer, partner, proprietor, employee, agent, advisor or consultant, any business which in the opinion of the Human Resources Department competes in any way with the business of the Employers (as such businesses were conducted at the time the participant's termination of employment occurred), the Employers shall be relieved of all further obligations hereunder and all amounts then remaining unpaid under the Plan shall be forfeited. The Human Resources Department shall provide written notice of this determination to the participant. However, nothing herein shall prevent the participant from investing in the securities of any competing company which are publicly traded so long as the participant's investment does not give him or her any voice in the management or conduct of the affairs of such company. VIII. Forfeiture for Fraud. Notwithstanding anything herein to the contrary, if the participant shall be discharged or he resigns due to an act of fraud, theft, embezzlement or misrepresentation affecting the finances of the Employers, all amounts to be paid to such participant under the Plan shall be forfeited and the Employers shall be relieved of any and all obligations hereunder. IX. Failure to Locate. If the Human Resources Department shall be unable, within one year after any benefit becomes payable to any person under the Plan, to make distribution to such person because of the Human Resources Department's inability to ascertain his or her whereabouts by mailing to the last-known address of such person on the records of the Employers and such person has not made written claim thereof before the expiration of the one-year period, then the Human Resources Department shall declare all rights of such person under the Plan to be forfeited as of such date as the Human Resources Department shall determine. X. Relation to Other Plans. The benefit of the participant under the Plan shall be in addition to any benefits paid or payable to or on account of the participant under any other pension, disability, equity, annuity or retirement plan or policy whatsoever. Nothing herein contained shall in any manner modify, impair or affect any existing or future rights of the participant to receive any employee benefits to which he would otherwise be entitled or to participate in any current or future pension plan of the Employers or any other supplemental arrangement which constitutes a part of the participant's regular compensation structure. However, any benefits credited under the Plan shall not be deemed part of the participant's total compensation for the purpose of computing benefits to which he may be entitled under any pension plan or other supplemental compensation arrangement, unless such plan or arrangement specifically provides to the contrary. XI. Prohibition Against Funding. Should the Employers elect to acquire any investment in connection with the liabilities assumed under the Plan or to establish any reserves on its books, it is expressly understood and agreed that the participant shall not have any right with respect to, or claim against, any such asset or reserve nor shall any acquisition of an asset or establishment of a reserve create a trust of any kind or any fiduciary relationship between the Employers and the participant, his heirs personal representatives or assigns. Any such assets shall be and remain a part of the general, unpledged and unrestricted assets of the Employers subject to the claims of its general creditors. The participant shall be required to look to the provisions of the Plan and to the Employers for enforcement of any and all benefits due under the Plan and to the extent any person acquires a right to receive any payments under the Plan, such right shall be no greater than the right of any unsecured, general creditor of the Employers. XII. General Provisions. (a) No benefit or payment under the Plan shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance or charge, whether voluntary or involuntary, and no attempt to anticipate, alienate, sell, transfer, assign, pledge, encumber or charge the same shall be valid. Nor shall any such benefit or payment be in any way liable for or subject to the debts, contracts, liabilities, engagements or torts of any person entitled to such benefit or payment, except to such extent as may be required by law. If any person entitled to a benefit or payment under the Plan becomes bankrupt or attempts to anticipate, alienate, sell , transfer, assign, pledge, encumber or charge any benefit or payment under the Plan, in whole or in part, or if any attempt is made to subject any such benefit or payment, in whole or in part, to the debts, contracts, liabilities, engagements or torts of the person entitled to any such benefit or payment, then such benefit or payment, in the discretion of the Human Resources Department shall cease and terminate with respect to such person, and the Human Resources Department in such case shall hold or apply the same or any part thereof for the benefit of any dependent, relative or beneficiary of such person, in such manner and proportion as the Human Resources Department shall deem proper. (b) The establishment of the Plan shall not be construed to confer upon the participant the legal right to be retained in the employ of the Employers or give the participant, or any other person, any right to any payment whatsoever, except to the extent of the benefit provided for hereunder. The participant shall remain subject to discharge to the same extent as if the Plan had never been adopted. (c) If the Human Resources Department determines that any person to whom a benefit is payable under the Plan is incompetent by reason of age or physical or metal disability, the Human Resources Department shall have the power to cause the payments becoming due to such person to be made to another for his benefit without any responsibility to see to the application of such payments. Any payment made pursuant to such power shall, as to the amount of such payment, operate as a complete discharge of the Employers. (d) If at any time any doubt exists as to the identity of any person entitled to any payment hereunder or the amount or time of such payment, the Human Resources Department shall be entitled to hold such sum as a segregated amount in trust until such identity, amount or time is determined or until an order of a court of competent jurisdiction is obtained. The Human Resources Department shall also be entitled to pay such sum into court in accordance with the appropriate rules of law. (e) No liability shall attach to or be incurred by any officer, director or employee of the Employers under or by reason of the terms, conditions and provisions contained in the Plan, or for the acts or decisions taken or made thereunder or in connection therewith; and as a condition precedent to the establishment of the Plan or the receipt of benefits thereunder, or both, such liability, if any, is expressly waived and released by the participant and by any and all persons claiming under or through the participant or any other person. Such waiver and release shall be conclusively evidenced by any act of participation in or the acceptance of benefits under the Plan. (f) Any notices required or permitted to be given under the Plan shall be sufficient if in writing and if sent by registered or certified mail to the last-known address of the participant as shown on records of the Human Resources Department as the case may be. (g) The Plan shall be governed by and construed and administered under the laws of the Commonwealth of Pennsylvania. (h) The Plan shall be binding upon the parties hereto, their heirs, executors, administrators, successors and assigns. In the event of a merger, consolidation, or reorganization involving the Employers, the Plan shall continue in force and become an obligation of the successor or successors of KFI, its subsidiaries or affiliated corporations. (i) If any provision of the Plan is held invalid or unenforceable, its invalidity or unenforceability shall not affect any other provisions of the Plan, and the Plan shall be construed and enforced as if such provision had not been included therein. (j) The Article headings contained herein are inserted only as a matter of convenience and for reference and in no way define, limit, enlarge or describe the scope or intent of the Plan nor in any way shall they affect the Plan or the construction of any provision thereof. (k) The Plan shall be evidenced by this document and the separate Benefit Schedule executed by each participant which together shall set forth the full extent of any obligation of the Employers to such participant. TO RECORD the adoption of the Plan, Keystone Financial, Inc. on behalf of the Employers has caused this instrument to be executed on this _____ day of December, 1991. ATTEST: KEYSTONE FINANCIAL, INC. ____________________________________ By_______________________________ APPENDIX A BENEFIT SCHEDULE TO THE KEYSTONE FINANCIAL, INC. SUPPLEMENTAL DEFERRED COMPENSATION PLAN Participant Information: Name _________________________________________________________________ Social Security Number _______________________________________________ Home Address _________________________________________________________ ______________________________________________________________________ Employer _____________________________________________________________ Position _____________________________________________________________ Annual Total Compensation ____________________________________________ Date of Retirement ___________________________________________________ Amount of Benefit: _____________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ Time and Terms of Payment: _____________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ Survivor Benefits: _____________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ Non-Competition Requirements: __________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ Acceptance by Participant: By executing this Benefit Schedule, the undersigned acknowledges that the preceding description of benefits represents his of her entire agreement with KFI for supplemental post-employment or retirement benefits in accordance with the terms of the Keystone Financial, Inc. Supplemental Deferred Compensation Plan, which terms are incorporated herein by reference. Participant --------------------------- Date: ______________________ Accepted by Human Resources - -------------------------------------- Date _________________________________ EX-13 5 EXHIBIT 13.1 - PORTIONS OF THE ANNUAL REPORT Selected Financial Data
(in thousands except per share data) Year Ended December 31, 1997 1996 1995 1994 1993 - --------------------------- ---------- ----------- ----------- ----------- ----------- Operations: - --------------------------- ---------- ----------- ----------- ----------- ----------- Interest income $510,738 $473,420 $446,786 $386,894 $378,403 Interest expense 232,494 211,301 200,775 152,463 151,943 - --------------------------- ---------- ----------- ----------- ----------- ----------- Net interest income 278,244 262,119 246,011 234,431 226,460 Provision for credit losses 15,316 10,713 8,568 10,324 11,580 Noninterest income 89,932 71,525 58,137 51,921 52,684 Noninterest expense 225,990 196,245 182,130 182,333 176,034 Income tax expense 38,953 37,180 34,001 25,907 25,846 - --------------------------- ---------- ----------- ----------- ----------- ----------- Net Income $87,917 $89,506 $79,449 $67,788 $65,684 - --------------------------- ---------- ----------- ----------- ----------- ----------- Pre-tax security gains, included above $6,071 $871 $1,789 $978 $1,707 Net interest spread 3.87% 3.87% 3.90% 4.11% 4.19% Impact of noninterest funds .72 .74 .71 .57 .55 - --------------------------- ---------- ----------- ----------- ----------- ----------- Net interest margin 4.59% 4.61% 4.61% 4.68% 4.74% - --------------------------- ---------- ----------- ----------- ----------- ----------- Per Share: - --------------------------- ---------- ----------- ----------- ----------- ----------- Net income: Basic $1.70 $1.72 $1.60 $1.38 $1.34 Diluted 1.68 1.70 1.59 1.37 1.33 Dividends 1.06 0.98 0.93 0.86 0.79 Dividend payout ratio 63.65% 56.98% 58.13% 54.85% 44.67% Average shares outstanding 51,692,534 52,118,819 49,557,082 49,188,961 49,036,666 Balances at December 31: - --------------------------- ---------- ----------- ----------- ----------- ----------- Loans & leases $4,712,566 $4,336,470 $4,096,866 $3,900,900 $3,440,210 Allowance for credit losses (65,091) (56,256) (55,415) (53,708) (51,084) Total assets 6,841,337 6,450,579 6,213,222 5,796,576 5,414,897 Deposits 5,233,165 5,059,721 4,993,608 4,726,842 4,419,421 FHLB borrowings & long-term debt 349,943 226,776 168,564 155,752 136,605 Shareholders' equity 685,485 660,406 621,766 533,643 527,617 Ratios: - --------------------------- ---------- ----------- ----------- ----------- ----------- Return on average assets 1.33% 1.44% 1.35% 1.23% 1.24% Return on average equity 13.27 14.09 14.00 12.90 13.01 Equity to assets, average 9.99 10.19 9.66 9.53 9.51 Risk adjusted capital ratios: Leverage ratio 9.15% 10.03% 10.12% 9.59% 9.74% "Tier 1" 12.50 14.43 14.48 13.75 13.95 "Total" capital 13.75 15.66 15.67 15.00 15.20 Loans to deposits, year-end 90.05% 85.71% 82.04% 82.53% 77.84% Allowance for credit losses to loans 1.38 1.30 1.35 1.38 1.48 Nonperforming assets to loans 0.55% 0.65% 0.72% 0.87% 1.21% Loans 90 days past due 0.70 0.46 0.41 0.25 0.16 - --------------------------- ---------- ----------- ----------- ----------- ----------- Total risk elements to loans 1.25% 1.11% 1.13% 1.12% 1.37% - --------------------------- ---------- ----------- ----------- ----------- -----------
2 Financial Review This review has been provided to present information needed to fully understand the financial condition and the results of operations of Keystone Financial Inc., (Keystone). In May of 1997, Keystone consummated the merger of Financial Trust Corp(FTC), a bank holding company with $1.2 billion in assets, and the acquisition of First Financial Corporation of Western Maryland (FFWM), a thrift institution with $355 million in assets. The merger of FTC was accounted for as a pooling of interests and all prior periods have been restated. The thrift institution acquired through the FFWM transaction was merged into an existing Keystone bank and was accounted for under the purchase method of accounting. Accordingly, the acquired assets and liabilities and results of operations of FFWM were included in combined results from May 29, 1997 and reflected approximately half of the growth in average earning assets and the majority of the increase in total deposits. Throughout this review net interest income and yield on earning assets are presented on a fully taxable-equivalent basis. Additionally, balances represent average daily balances unless otherwise indicated. 1997 Summary Performance Results Performance during 1997 was significantly influenced by the expansion of Keystone's franchise during the year. The merger of FTC added another strategic partner in Keystone's expanding financial services marketplace while the acquisition of FFWM added important market share to Keystone's existing franchise in Maryland and West Virginia. Net income, which was affected by special charges incurred in connection with the FTC merger, was $87.9 million in 1997 versus $89.5 million in 1996, a decrease of 1.8%. Special charges, which included pre-tax merger expenses of $11.4 million as well as certain portfolio restructuring charges, reduced net income by $8.6 million, or $.17 per basic share. Excluding special charges, net income in 1997 was $96.5 million or $1.87 per basic share, compared to $89.5 million and $1.72 in 1996, an 8.7% improvement in basic earnings per share. Keystone's return on average assets (ROA)and return on average equity (ROE), the most commonly used measures of financial institution performance, were 1.33% and 13.27%, respectively, versus 1.44% and 14.09%, in the prior year. Excluding the effect of the special charges, ROA and ROE were 1.46% and 14.54% in 1997. Comparable ratios for Keystone's peer group of financial institutions with assets of $5 billion to $10 billion, as compiled by Keefe, Bruyette & Woods, Inc. for 1997, were 1.39% and 16.03%, respectively. Core operating performance in 1997 was marked by an increase in net interest income, substantial growth in fee-based revenues, prudent credit risk management, and expense growth which accompanied revenue expansion. Total revenues, excluding security gains, grew 8.6%, including a 5.9% increase in net interest income and 18.7% growth in noninterest revenues. The growth in net interest income was stimulated by both increased loan volume and improvement in the proportionate mix of earnings assets. The growth rate of noninterest revenues continued to be driven by new and expanded asset management activities, strength in mortgage banking performance and successful electronic banking initiatives. Keystone continues to execute a strategic diversification of its revenue stream by expanding its menu of financial services. The introduction of KeyPremier Funds, Keystone's own proprietary mutual funds, and the acquisition of MMC&P, a retirement benefit services firm, reflected Keystone's commitment to meeting the expanding needs of its financial services customers. Consumer credit concerns were an integral component of asset quality issues on a national level, particularly in the area of credit card debt. Though Keystone had eliminated its credit card operations prior to 1996, increased consumer delinquencies and rising levels of personal bankruptcies did impact consumer loan charge-offs levels during 1997. Though improvements in credit quality were experienced through the course of the year, Keystone prudently increased its provision for credit losses and sustained a strong ratio of allowance to loans of 1.38% at December 31, 1997. 3 Growth in operating expenses was influenced by expenses associated with the 1997 merger activity, by investments in activities connected with the growth in fee income, and by ongoing improvement in Keystone's financial services delivery system. During 1997, Keystone completed an aggressive effort to expand its banking franchise and, at the same time, continued its expansion of financial services capabilities. These efforts, combined with a prudent strategy to evolve Keystone's delivery system, were critical to the overall expansion of the revenue base. Strategic Focus Keystone has always been driven by its fundamental goal of increasing shareholder value through continuous performance improvement. Managerial focus on this goal has shaped Keystone's competitive market strategy, which is designed to provide value to customers through local delivery of superior financial services. This has led to the development of Keystone's operating structure, now commonly described as "Super Community Banking". During 1997, Keystone executed strategies in six major areas, which influenced 1997 performance and provided a foundation for improved performance in 1998 and beyond. These six areas include relationship banking, marketing, asset management, delivery systems, overhead expense management and franchise expansion. Strategic focus within Keystone begins with relationship banking, a business approach executed to deliver a value proposition that is customer-focused. The execution of relationship banking began with the formation of market teams composed of competent, well-trained financial professionals capable of delivering both customary and specialized financial services within specified geographic regions. These teams focus on the delivery of financial solutions built upon, simplified customer access to services that is distinguishable from competitors' product-focused strategies. Successful execution requires investment in Keystone's human capital, including targeted selection of new associates, combined with training, skill development and performance-driven variable compensation for Keystone's existing employee base. Keystone's second strategic focus involves its approach to marketing efforts. Keystone's customer-focused approach to the delivery of financial services has dramatically influenced its overall marketing execution. Marketing begins with life cycle segmentation, a process which allows Keystone to understand the financial needs of its customer base by understanding the financial profile of its individual customer segments. This understanding shapes Keystone's marketing philosophy by reducing mass marketing initiatives and delivering a targeted service delivery approach. Keystone's asset management capabilities have had a dramatic impact on its organizational evolution and performance. Over the last several years, Keystone augmented existing financial products and services with more integrated financial solutions. Keystone is now able to more effectively compete with both financial institutions and other financial service providers. Prior to 1997, Keystone acquired Martindale Andres & Company, a registered investment advisory firm that provided expanded revenues, improved trust-related performance and, in late 1996, introduced KeyPremier mutual funds. Keystone continued its expansion of financial service capabilities in August of 1997, with the acquisition of MMC&P, a retirement benefit services consulting firm specializing in retirement plan recordkeeping and plan management for employee benefit programs. Additionally, Keystone's asset management capabilities were extended to the retail sector through Keystone Investor Services, a newly-formed subsidiary specializing in the delivery of brokerage and annuity products. Effective integration of financial services would not be complete without an ongoing evaluation of the service delivery system. During 1997, Keystone evolved its multi-channel service delivery system by transforming its community office network and by expanding its alternate channel capabilities through ATMs and telephone banking. Constant evaluation and modification of the service delivery network is necessary to ensure a competitive advantage in the financial services industry. 4 Overhead expense management requires multi-skilled job training, continuing investment in technology, evaluation of outsourcing alternatives, and development of specialized expertise. An important gauge of management's effectiveness in this area involves merger integration efforts and the realization of anticipated efficiencies. The extent of merger integration made necessary by Keystone's market and product expansion activities presented special challenges during 1997. Keystone's demonstrated skill in directing this effort has provided a strong foundation that will effectively accommodate future growth. Keystone's final key strategy involves franchise expansion. The year 1997 has been pivotal to Keystone as it grows into an increasingly important regional franchise in the mid-Atlantic states. Franchise expansion includes achievement of performance gains from both the banking business as well as specialty offerings necessary for a fully-developed financial services company. Successful achievement of improved shareholder value through "Super Community Banking" has been driven by aligning the needs of Keystone's customers with the skills of its professional workforce, engaging the customer base with a shared objective of improving the customer's financial position, and delivering financial products and services consistent with Keystone's value proposition. Economic Trends & Interest Rates The financial services industry is constantly influenced by a multitude of factors, not the least of which are overall economic trends and the interest rate environment. Through the third quarter of 1997, virtually all critical indicators of economic activity suggested that the economy was operating near peak performance levels. Low interest rates, record-high employment, and virtually nonexistent inflationary concerns created conditions wherein the economic expansion was expected to continue unabated. The U.S. economy, in particular, continued along a record-setting period of economic expansion. The optimism born of a strong economy influenced stock market valuations as the Dow Jones industrial average increased 23% during the year to 7908. Entering the fourth quarter, emerging trends were observed which raised concerns over the long-term sustainability of the robust economy. Global economic developments, particularly the turmoil in Asian markets, caused speculation on the impact of a crisis in that region and the potential ripple effect on the U.S. economy. Interest rate conditions, which have been characterized by a relatively flat yield curve throughout 1997, exhibited the potential for further flattening that could compress net interest income by reducing traditional spreads between long and short term rates. Despite these concerns, however, the overall economic picture remained the most optimistic in a generation and fueled the third largest economic expansion in history. The confidence born of a fundamentally strong U.S. economy continues to heighten expectations for 1998. The economic and interest rate conditions present during 1997 provided special challenges for financial institutions. On the asset generation side, Keystone has been responsive to strong consumer credit demand through its product development and management effort, best exemplified by the Personal Financial Analysis (PFA) program. This program is a unique financial service designed to blend credit and debt consolidation needs with an effective investment or savings plan. Demand for an expanded array of financial products also led to the introduction of Keystone's family of KeyPremier mutual funds that are managed by Keystone's nationally-recognized fund managers, Martindale Andres & Co. Expanding consumer demand for enhanced retirement plan services influenced Keystone's acquisition of MMC&P, thus improving its ability to provide a complete package of retirement plan services. Performance beyond 1997 will continue to depend largely on Keystone's ability to deliver products and services which meet the changing financial needs of its customers. Forward-Looking Statements From time to time, Keystone has and will continue to make statements which may include "forward-looking" information. Keystone cautions that "forward-looking" information disseminated through financial presentations should not be construed as guarantees of future performance. Furthermore, actual results may differ from expectations contained in such "forward-looking" information as a result of factors which are not predictable. Financial institution performance can be affected by any number of factors, many of which are outside of management's direct control. Examples include, but are not limited to, the effect of prevailing economic conditions; the overall direction of government policies; unforseen changes in the general interest rate environment; the actions and policy directives of the Federal Reserve Board; competitive factors in the 5 marketplace, and business risk associated with the management of the credit extension function and fiduciary activities. Each of these factors could affect estimates, assumptions, uncertainties, and risks considered in the development of "forward-looking" information, and could cause actual results to differ materially from management's expectations regarding future performance. 6 NET INTEREST INCOME Keystone derives revenue from both intermediation activities, the results of which are reflected in net interest income, and from fee and service based income, which is included in noninterest income performance. Net interest income continues to be the most significant component of revenue, comprising over 77% of total revenues. Net interest income is defined as the difference between interest income on earning assets and interest expense on deposits and borrowed funds. Net interest margin provides a relative measure of a financial institution's ability to efficiently deliver net interest income from a given level of average earning assets. Both net interest income and net interest margin are influenced by interest rate changes, changes in the relationships between rates, and changes in the composition or absolute volumes of earning assets and liabilities. The following table compares net interest income and net interest margin components between 1997 and 1996 (in thousands): 1997 1996 Change - ----------------------- -------------------- -------------------- -------------------- Yield/ Yield/ Yield/ Amount Rate Amount Rate Amount Rate ======================= ========== ========= ========== ========= =========== ======== Interest income $519,598 8.32% $482,393 8.20% $37,205 0.12 Interest expense 232,494 4.45 211,301 4.33 21,193 (0.12) - ----------------------- ---------- --------- ---------- --------- ----------- -------- Net interest income $287,104 $271,092 $16,012* ======================= ========== ========= ========== ========= =========== ======== Interest spread 3.87% 3.87% ----- Impact of noninterest funds 0.72 0.74 (0.02) - ----------------------- ---------- --------- ---------- --------- ----------- -------- Net interest margin 4.59% 4.61% (0.02) ======================= ========== ========= ========== ========= =========== ======== *The change in net interest income consisted of a favorable volume variance of $24.2 million, offset by an unfavorable rate variance of $8.2 million.
Interest Rates The interest rate environment, combined with Keystone's management of pricing, product mix, and execution of relationship banking, influenced the rate of growth in net interest income. The interest rate environment has remained remarkably constant through the last three years, and rates throughout 1997 were only slightly above the rates that existed throughout 1996. These slightly higher rates influenced both a rise in earning asset yield and an increase in the cost of funding sources. By the end of 1997, rates began to slide toward historic lows and included an overall flattening of the yield curve. Continuation of this trend on an extended basis would reduce the opportunity to extend asset maturities to improve yields and would compress the natural spread between long-term asset yields and short-term funding sources. The following is a comparison of the average yield curve for U.S. Treasury instruments for specific intervals between three months and thirty years, which serves as an illustration of the relative comparability of interest rate trends between 1997 and 1996.
Three Six One Two Three Five Ten Thirty Months Months Year Years Years Years Years Years - ------ --------- --------- --------- --------- --------- --------- --------- --------- 1997 5.18% 5.37% 5.60% 5.96% 6.07% 6.21% 6.34% 6.60% 1996 5.14% 5.28% 5.49% 5.83% 5.97% 6.17% 6.43% 5.70%
7 The similarity of performance in net interest margin belies the fact that Keystone has continued to actively manage the development, the delivery, and pricing of products in response to changes in customer preferences. Keystone's relationship banking focus remains at the core of loan and deposit product innovations, including the Personal Financial Analysis (PFA) lending product and the highly regarded variable-rate CD. Successful management of both net interest income and net interest margin is a function of proactively fulfilling customer needs and preferences in a manner which is considerate of the changing interest rate environment. Interest Income/Earning Assets Interest income grew 7.7% on the strength of slightly higher interest rates and steady growth in loans, driving an improved earning asset mix. Interest income grew to $520 million in 1997 from $482 million in 1996 an increase of $38 million. Generation of increased levels of interest income is influenced by the evolution of relationship banking, overall trends in interest rates, dynamic changes in rate relationships, and overall liquidity management. The credit component of Keystone's relationship banking strategy has affected both growth in earning assets and earning asset mix trends. Relationship banking, which focuses primarily on middle market businesses and retail customers, has fostered significant growth of both commercial real estate loans and direct consumer credits, which grew 23% and 27%, respectively, during 1997 and have become increasing components of Keystone's earning asset mix. At the same time, customers are demanding products which are more responsive to interest rate changes. Increasing components of both earning assets and funding sources are now more sensitive to changes in interest rates, particularly specific maturity points along the Treasury curve. By balancing customer needs with a successful pricing strategy, Keystone has attempted to more effectively insulate net interest income performance from interest rate risk. Growth in loans was also affected by balance sheet management and liquidity strategies. For example, a sale of approximately $259 million of mortgage loans was executed as a strategic component of Keystone's acquisition of FFWM. Keystone's ongoing mortgage banking operations and the strategic curtailment of the indirect automobile lending business preserved funding capacity for relationship banking and eliminated the need to aggressively price deposits to fund commodity-based activities. Keystone's on-going execution of its mortgage banking operations, which includes both the sale and service components, has preserved customer affinity and permitted consistent customer access to a full menu of mortgage products under various interest rate conditions. Keystone's focus on relationship banking, responsiveness to interest rates, and prudent liquidity management have enabled it to achieve an increase in earning asset yields at 8.32% verses 8.20% in 1996. The 12 basis point improvement in yields, combined with a 6% increase in earning assets, allowed Keystone to sustain steady revenue growth. Interest Expense/Funding Sources Improvement in net interest income must include increased levels of interest income combined with prudent management of both funding cost and capacity. Financial institutions have been consistently challenged to achieve revenue improvement despite an erosion of the funding base as customers seek increased investment returns. Successful integration of relationship banking requires innovative and responsive product management in terms of both deposit product lines and asset management offerings. As competitive pressures constrain deposit growth, deposit-gathering strategies have been augmented by self-funding securitization activities as well as prudent use of credit markets, most notably FHLB advances. Keystone's funding approach resulted in an increase in the overall funding costs from 4.33% in 1996 to 4.45% in 1997, a 12 basis point increase which was equal to the improvement in asset yield. 8 Net Interest Spread and Net Interest Margin Combining the impact of both yield on earning assets with the cost of funding sources results in interest spread, a measure of a financial institution's ability to effectively blend the impact of changing rates, shifting interest rate indexes, and earning assets and funding mix changes with evolving consumer needs. Net interest margin combines the impact of interest spread with both the investment of noninterest funding sources and the level of nonearning assets. In 1997, Keystone successfully sustained both its overall interest spread and its net interest margin, rising to the challenges of an increasingly competitive marketplace for financial services. Interest spread was 3.87% in both 1997 and 1996. Similarly, net interest margin remained constant at 4.59% compared to 4.61% in 1996, reflecting little change in either interest spread or the net impact of noninterest funding sources and nonearning assets. Quarterly Performance The following table provides a comparative summary of earning asset yields, funding costs, and other information for each of the four quarters of 1997 and 1996 (in thousands):
1997 - ------------------------------ -------------------------------------------- Fourth Third Second First Quarter Quarter Quarter Quarter ============================== =========== ========== ========== ========== Asset yield 8.38% 8.38% 8.33% 8.20% Funding cost 4.55 4.47 4.44 4.36 - ------------------------------ ----------- ---------- ---------- ---------- Interest spread 3.83% 3.91% 3.89% 3.84% - ------------------------------ ----------- ---------- ---------- ---------- Net interest margin 4.56% 4.62% 4.63% 4.56% - ------------------------------ ----------- ---------- ---------- ---------- Net interest income $72,788 $74,087 $71,687 $68,542 ============================== =========== ========== ========== ========== 1996 - ------------------------------ -------------------------------------------- Fourth Third Second First Quarter Quarter Quarter Quarter ============================== =========== ========== ========== ========== Asset yield 8.20% 8.11% 8.20% 8.26% Funding cost 4.36 4.35 4.24 4.35 - ------------------------------ ----------- ---------- ---------- ---------- Interest spread 3.84% 3.76% 3.96% 3.91% - ------------------------------ ----------- ---------- ---------- ---------- Net interest margin 4.58% 4.50% 4.68% 4.63% - ------------------------------ ----------- ---------- ---------- ---------- Net interest income $69,012 $67,228 $67,532 $67,320 ============================== =========== ========== ========== ==========
Quarterly performance throughout 1997 and 1996 was marked by the consistency of yields and cost of funds, reflecting similar interest rate conditions throughout those periods. Factors influencing both net interest spread and net interest margin performances gave rise to a relatively constant band of conditions and consistent quarter-to-quarter performance. PROVISION FOR CREDIT LOSSES The provision for credit losses grew by 43% during the year from $10.7 million in 1996 to $15.3 million in 1997. The provision was influenced by higher levels of consumer charge-offs and the changing risk characteristics of Keystone's credit portfolio. Charge-offs were primarily affected by the evolving risk characteristics of consumer debt as reflected in higher levels of defaults and personal bankruptcy trends. Since the end of 1996, the allowance for credit losses expressed as a percentage of loans grew from 1.30% to 1.38%. In addition, the allowance expressed as a percentage of nonperforming loans increased from 285% at the end of 1996 to 310% at the end of 1997, reflecting Keystone's commitment to maintaining appropriate coverage of risk elements within its loan portfolio. See the Allowance for Credit Losses and Asset Quality section of this review for additional information. 9 NONINTEREST INCOME Revenue stream diversification has been directly influenced by Keystone's commitment to enhance its position as the "financial services provider of choice" in the market in which it operates. This focus has manifested itself in an increasing relative contribution of noninterest revenues to the overall revenue stream. During 1997, noninterest revenues (excluding security transactions) accounted for 22.6% of aggregate revenues versus 20.7% in 1996. In total, noninterest revenues grew 18.7% over 1996 performance. Keystone's commitment to the expansion and diversification of the revenue stream was exemplified not only by the growth of noninterest revenues but also by its corporate acquisition and product development strategies. In prior years, Keystone successfully integrated both Martindale Andres & Co. and Keystone Financial Mortgage Corporation into its traditional banking franchise and also expanded its cutting-edge electronic delivery of financial services. During 1997, Keystone's roll-out of KeyPremier, its proprietary family of mutual funds, and the acquisition of MMC&P, a retirement benefit services firm, provided additional complimentary financial services capabilities geared toward customer needs. These services are particularly relevant in today's increasingly competitive marketplace, reflecting the trend toward personal responsibility for retirement planning efforts. This trend, exemplified by the growth in 401(K) plans and self-directed IRA products, has created a need for responsive retirement plan counseling, monitored investment performance, and enhanced record-keeping capabilities for employers, employees, and individual consumers. Trust and investment advisory services, the largest single source of fee-base revenues within Keystone, was a major driver of the improved revenues and reflected 21% growth over 1996 performance. Assets under management within Keystone now exceed $3.5 billion, growth of nearly 10% since 1996. Such growth has been influenced by the emergence of Martindale Andres & Co., now nationally recognized as one of the top portfolio managers of its class in the country. Expansion of revenue sources is also expected to continue through the acquisition of MMC&P. Keystone has been equally successful in evolving its mortgage banking strategy through leveraging its traditional banking network as a source of mortgage originations. The specialized expertise provided through Keystone Financial Mortgage Corporation has been successfully integrated within Keystone's banking network, providing seamless access to a full complement of mortgage products and consistent delivery of this core component of the consumer relationship. Keystone has demonstrated an ability to provide both a high level of service and a competitive product menu under a variety of interest rate or market conditions. Originations during 1997 approached $300 million, reflecting a 5% increase over 1996. Residential mortgage loans serviced at the end of 1997 grew to nearly $1.9 billion. As a result of the growth in originations and loans serviced, mortgage banking revenues grew 31% during 1997. During the third quarter of 1997, Keystone began a deliberate curtailment of activities related to the indirect financing of automobiles through its automobile dealer network in an attempt to focus on more relationship-oriented lines of business. Execution of this strategic decision was completed by year-end. Despite the reduction in indirect lending, both automobile dealer floor plan financing and other more direct forms of automobile lending to consumers remain vital and profitable elements of Keystone's product delivery strategy that will continue to be explored and enhanced. Deposit account service charges in 1997 were flat as compared to the prior year. In late 1996, Keystone had introduced "KeyFree", its free checking option which served as a vehicle to introduce consumers to the various financial services available through Keystone including credit products, deposit services and alternative investment products. This strategic initiative, which provided Keystone with a competitive position in its marketplace, has constrained the rate of growth in deposit fee income. 10 Similar to the strategies employed within both asset management and mortgage banking, Keystone has successfully leveraged its impressive electronic banking configuration to improve related fee income growth. Growing demand for access to funds and technological innovations contributed to a $2.3 million increase in ATM and debit card fees. Keystone has consistently made strategic alliances and prudent investments in ATM technology to improve its fee generation capabilities. Keystone's joint ventures to place ATMs in convenience stores; the expansion of KeyCheck, Keystone's ATM/debit card product; and the investment in advanced function ATMs have all provided Keystone with a competitive advantage in serving customers and generating fee income. Keystone now has an expansive network of over 450 ATMs including both traditional and expanded service ATMs. The investment in ATMs has allowed Keystone to become one of the 40 largest ATM networks in the United States. Keystone remains committed to ATM network expansion which will include partnerships with other convenience stores and retail outlets. Aggregate ATM transaction activity grew 33% from 1996 and debit card activity rose 63% over the same period, convincing evidence of Keystone's successful execution of its electronic banking initiatives. Surcharge fees, which enable Keystone to charge noncustomers who access their bank through Keystone's ATM network, also have strategic relevance for improved fee generation. These factors combined with other fee-based initiatives to grow aggregate fee income by 26.5%. Keystone has developed an effective distribution channel analysis model which provides a framework to constantly evaluate Keystone's various delivery channel networks. This model has been used to evaluate current and prospective networks, including the most visible distribution channel, the community office. With a current network of nearly 200 offices, Keystone must constantly evaluate a number of factors, including demographic trends and market share, to maximize its return on investment. Decisions regarding this investment are subjected to thorough analysis. During 1997, Keystone sold nine offices resulting in gains of $4.5 million, which are reflected in other income. This strategy has allowed Keystone to increase investments in those markets which provide acceptable profit contributions and explore alternative delivery options in other markets. NONINTEREST EXPENSE Noninterest expenses, exclusive of the special charges associated with the merger of FTC, rose to $214.6 million from $196.2 million, an increase of $18.4 million or 9.3%. Of the overall increase, approximately 26% was attributed to the absorption of the expense structures in both the FFWM and MMC&P acquisitions, both of which were accounted for under the purchase method of accounting. Core operating expenses, excluding the impact of acquisitions, grew approximately 7%, resulting in an efficiency ratio of 57.8% for 1997, virtually unchanged from the previous year. Special charges in connection with the merger of FTC totaled $11.4 million and included professional fees, integration and conversion expenses, and costs of various separation plans directly related to the merger. The most significant individual component of noninterest expense involves salary-related expenses. Traditionally, salary and benefit expenses approximate 50% of total operating expense of a financial institution and this pattern remained constant during 1997. Salary expenses grew to $92.6 million versus $81.9 million in 1996, an increase of 13.1%. A portion of this increase was related to personnel additions from the FFWM and MMC&P transactions. On average, the number of full time equivalent employees grew only 3% from 1996 to 1997, reflecting efficiency gains which offset employees added in the acquisitions. Several additional factors influenced the growth in salary expenses, including average salary increases approximating 4%. Effective in 1997, Keystone executed a comprehensive sales compensation program that has been coordinated with corporate efforts to improve revenue performance. This program resulted in higher levels of variable compensation correlated to improved market revenue performance, increased mortgage banking revenues and enhanced asset management fees. This program was designed to provide additional incentive opportunities and manage compensation expenses at levels commensurate with revenue improvement. Over the last several years, Keystone has demonstrated an ability to control the pace of growth in employee benefits, a significant component of which is linked to the cost of providing employee health care. Consistent with national health care trends, the cost control features of managed care have constrained the growth in these expenses while providing high quality health care services. Further, Keystone's ability to efficiently and effectively absorb employees through its merger and acquisition strategies has enabled it to leverage its health care structure over a more substantial employee base. 11 The evaluation and constant evolution of delivery channels in the financial services industry continues to affect changes in the related expense structure. During 1997, Keystone expanded the use of technology-related delivery channels while, at the same time, subjecting its more traditional community office network to analysis which quantified the effectiveness and efficiency of product and service delivery. Technology investment in delivery channels included the expanded ATM network and Keystone's automated telephone banking network. The telephone banking network facilitates increased sales and services to new and existing customers through this convenient delivery channel. The investment in this program will also support more aggressive inbound and outbound sales initiatives, providing enterprise-wide sales support and focused telemarketing capabilities. Keystone will also continue to explore other, less traditional delivery channels, such as PC and internet banking, as customer affinity for these channels increases. The reconfiguration of delivery channels has also affected the most traditional and visible financial services outlet, the community banking office, and the occupancy expenses related thereto. During 1997, Keystone modified its delivery approach to certain markets by selling offices in these markets and relying on more effective and efficient alternative channels of delivery for providing products and services to customers within these markets. This strategy will enable Keystone to make incremental investments in markets more closely aligned with the changing flow of economic commerce. Keystone will continue to pursue strategic initiatives through its on-going analysis of markets and market potential. Through effective use of these analyses, Keystone will continue to prudently manage the rate of growth in occupancy-focused expenses. Other expenses grew to $68.7 million, or 6.1% compared with 1996 and were also affected by the impact of the purchase accounting for the FFWM and MMC&P transactions. Exclusive of the impact of the absorption of these expense structures, increases in specific categories included merchant banking expenses, postage and communication-related costs, each of which were influenced by revenue-related activities or expansions of customer-focused product or service capabilities. Year 2000 Much has been written about the approach of the Year 2000 and the widespread concern over its potential impact on computer systems. Historically, most computer programs were written with two digits, rather than four, to designate the applicable year. Accordingly, it is anticipated that most systems may recognize a date using "00" as the year "1900" rather than "2000", thus increasing the possibility of computer system failures, miscalculations, and disruption of normal business operations. Issues surrounding the concern over the approach of the Year 2000, particularly as it would affect the financial services industry, have been the subject of intense management focus. Prior to 1997, Keystone began a planning effort designed to ensure identification of Year 2000 business issues and develop a strategic response to those issues. The resulting business plan was designed to achieve substantial implementation of its Year 2000 compliance program by the end of 1998 in order to provide sufficient time and resources for testing and resolution of unforeseen complexities that may arise prior to final implementation in 1999. It is difficult to isolate the incremental cost of this effort given that it primarily impacts technical manpower already in place and modestly accelerates already planned technological investments. Costs incurred to execute this plan have been reflected in Keystone's operating expenses in both 1996 and 1997 and will continue to affect expense levels through the Year 2000 and beyond. Keystone currently projects that it will incur capital investment and period expenses in excess of $9 million over the course of program implementation, inclusive of nearly $1 million that has been expensed through the end of 1997. Period expense should aggregate approximately $3 to $4 million in 1998 and 1999, with an additional $4 to $5 million of investments in software and system replacements which will be capitalized and amortized over a three to five year period. These forward-looking cost estimates may be influenced by any number of factors and risks including, but not limited to, the availability and cost of properly trained programmers, the ability to identify all possible issues, the timely availability of compliant software, and other uncertainties. 12 Keystone also continues to analyze and discuss these issues with its vendors, service partners, and customer base to determine the extent to which Keystone is vulnerable to those third parties' failure to remediate their own Year 2000 issues. The projected costs include the estimated time and costs associated with the impact of third party issues. While Keystone has taken and will continue to take appropriate actions to mitigate the risk of adverse consequences associated with the failure of a third party to address these issues, there can be no guarantee that the systems of third parties will be timely converted and will not have an adverse effect on Keystone. Income Taxes Income tax expense reached $39 million in 1997 versus $37 million in 1996, reflecting effective tax rates of 30.7% and 29.3% respectively. 13 BALANCE SHEET OVERVIEW At the end of 1997, Keystone's total assets reached $6.8 billion versus $6.4 billion at December 31, 1996. Approximately $355 million of assets were acquired in connection with the acquisition of FFWM. During 1997, Keystone executed certain asset sales, including the restructuring of its mortgage loan portfolio in connection with the FFWM acquisition, which constrained asset growth. However, this strategy precluded the need for aggressive acquisition pricing for deposit funding to support increased strategic lending activities. Average loans grew 9% to $4.6 billion at the end of 1997 versus $4.2 billion in 1996. Deposit acquisition continued to be less than robust though growth did occur in both variable rate CD's and the insured money market product lines. LOANS Keystone experienced solid growth in its loan portfolio as well as changes in the loan mix consistent with its relationship banking focus. Loans grew 9.1%, including increases in commercial real estate and direct consumer loans of 23% and 27%, respectively. The absolute level of loan growth was offset by runoff in indirect automobile loans and consumer mortgages, influenced largely by Keystone's securitization strategies. The following is a summary of various lending categories within Keystone between 1996 and 1997.
1997 1996 Change - ------------------------ ------------------ ----------------- ------------------ Amount % Amount % Amount % - ------------------------ ---------- ------- ---------- ------ ----------- ------ Commercial $622,569 14% $558,276 13% $ 64,293 12 % Floor plan financing 186,737 4 150,052 4 36,685 24 Commercial-real estate secured 1,294,933 28 1,055,688 25 239,245 23 Consumer mortgages 944,731 21 1,153,491 28 (208,760) (18) Direct consumer 856,225 19 675,783 16 180,442 27 Indirect consumer 293,013 6 330,463 8 (37,450) (11) Lease financing 374,421 8 265,416 6 109,005 41 - ------------------------ ---------- ------- ---------- ------ ----------- ------ $4,572,629 100% $4,189,169 100% $383,460 9 % - ------------------------ ---------- ------- ---------- ------ ----------- ------
Keystone's focus on relationship banking has manifested itself in the pace of growth in both commercial real estate and commercial lending. This improvement demonstrated Keystone's commitment to meeting the credit needs of these critical segments of Keystone's market. Keystone's emphasis on meeting the needs of both middle market and smaller business customers requires skillful execution and understanding of real estate-based lending issues. The delivery of products and services which are adaptable to individual business situations has been a hallmark of Keystone's focus on relationship banking. One of the more specialized business segments that remains important to Keystone's strategic execution of its lending strategy involves automobile dealer floor plan financing. Keystone's commitment to this and other facets of automobile dealer financial needs remains a natural extension of its overall relationship banking focus for business customers. Similarly, Keystone's emphasis on direct consumer lending, combined with its ability to develop, deliver, and manage products for that important segment, has influenced the growth in various forms of consumer lending. Traditional home equity lending, including credit products growing out of PFA efforts, contributed to the substantial increase in lending to this market sector. Additionally, growth in lease financing, primarily automobile financing, has evidenced Keystone's attention to providing competitive products that are responsive to consumer needs. Keystone's array of consumer credit products is undergoing continuous improvement in order to facilitate service to this important market segment. 14 Keystone experienced runoff of various degrees in mortgages and indirect lending. With respect to mortgages, Keystone has executed a strategy of providing competitive mortgage products with an emphasis on service delivery. Keystone established Keystone Financial Mortgage Corporation (KFMC) to facilitate delivery of specialized services to its consumer base and to ensure consistent access to competitive products. KFMC's expertise in product delivery, combined with its ability to access the secondary market via securitization, continues to provide a competitive advantage throughout Keystone's market. During 1996, Keystone had executed a similar securitization strategy to accommodate consumer financing needs through its automobile dealer network. The indirect securitization programs provided automobile financing to customers of automobile dealers on a self-funding basis, thus preserving core funding for core relationship activities. In 1997, Keystone evaluated the profitability and alignment of its indirect automobile lending business with its overall relationship banking strategy and elected to curtail this activity. Keystone will continue to explore opportunities designed to expand automobile financing activities into more comprehensive retail relationships. 15 ALLOWANCE FOR CREDIT LOSSES AND ASSET QUALITY Keystone's ratio of the allowance for credit losses to loans reached 1.38% at December 31, 1997 versus 1.30% at the end of 1996. The absolute level of the allowance reached $65.1 million at the end of 1997 compared to $56.3 million at the end of the previous year. The following table sets forth five years of activity within the allowance for loan losses beginning January 1, 1993 (in thousands):
1997 1996 1995 1994 1993 ============================= ========== ========= ================================ Balance at January 1, $56,256 $55,415 $53,708 $51,084 $46,405 Allowance obtained through acquisitions 8,311 ----- 935 2,096 ----- Loans charged off: Commercial (1,930) (1,936) (874) (4,417) (2,871) Real estate-secured: Commercial (1,234) (1,646) (1,971) (4,265) (2,834) Consumer (1,116) (651) (708) (638) (470) Consumer (10,010) (6,702) (5,498) (2,932) (3,704) Lease financing (2,987) (1,330) (786) (198) (238) - ----------------------------- ---------- --------- -------------------------------- Total loans charged off (17,277) (12,265) (9,837) (12,450) (10,117) - ----------------------------- ---------- --------- -------------------------------- Recoveries: Commercial 501 461 281 528 1,743 Real estate-secured: Commercial 410 465 538 849 359 Consumer 219 152 164 280 73 Consumer 1,104 1,138 900 968 997 Lease financing 251 177 158 29 44 - ----------------------------- ---------- --------- -------------------------------- Total recoveries 2,485 2,393 2,041 2,654 3,216 - ----------------------------- ---------- --------- -------------------------------- Net loans charged off (14,792) (9,872) (7,796) (9,796) (6,901) Provision charged to operations 15,316 10,713 8,568 10,324 11,580 - ----------------------------- ---------- --------- -------------------------------- Balance at December 31, $65,091 $56,256 $55,415 $53,708 $51,084 ============================= ========== ========= ================================ Ratio of allowance to year-end loans 1.38% 1.30% 1.35% 1.38% 1.48% ============================= ========== ========= ================================
The following statistics are relevant to activity that has occurred within the allowance for credit losses during the most recent five year period:
1997 1996 1995 1994 1993 - --------------------------------- -------- ------- -------- ------- -------- Ratio to Average Loans: Provision .33% .26% .21% .29% .34% Net charge-offs .32% .24% .20% .27% .20%
Traditionally, Keystone has reflected a loan loss provision in excess of the level of net charge-offs, a pattern which was sustained over the most recent five year period. During that time, trends have emerged which reflect the underlying risk characteristics and the changing composition of Keystone's loan portfolio. 16 While commercial credits have experienced less significant charge-off activity, consumer credit charge-offs have grown substantially. This shift was affected by both Keystone's strategic emphasis on consumer lending and by national trends associated with higher levels of consumer defaults and personal bankruptcies. Keystone will continue to manage its exposure to credit risk as it relates to its strategic focus on relationship banking, with particular emphasis on the consumer sector. Risk Elements As a means of assessing the risk profile of its loan portfolio, Keystone has monitored the level of aggregate risk elements which include the following: nonaccrual loans, nonperforming assets (NPA's)and loans past due more than 90 days. Keystone will also review trends with respect to less severe categories of past due loans, including loans which are 30 to 60 days past due and 60 to 90 days past due. Nonperforming assets include nonaccrual loans, restructurings, and other real estate (ORE). Nonaccrual loans are loans for which interest income is not accrued due to concerns about the collection of interest and/or principal. Restructured loans may involve renegotiated interest rates, repayment terms, or both, because of a deterioration in the financial condition of the borrower. ORE activity in 1997 reflected no unusual or significant fluctuations in balances. The following table provides a comparative summary of nonperforming assets and total risk elements at the end of each of the last five years (in thousands):
1997 1996 1995 1994 1993 - ----------------------------- --------- ---------- ---------- ---------- ---------- Nonaccrual loans $20,520 $19,350 $19,142 $26,701 $26,571 Restructurings 489 393 503 144 5,508 - ----------------------------- --------- ---------- ---------- ---------- ---------- Nonperforming loans 21,009 19,743 19,645 26,845 32,079 Other real estate 5,028 8,305 9,777 7,028 9,505 - ----------------------------- --------- ---------- ---------- ---------- ---------- Nonperforming assets 26,037 28,048 29,422 33,873 41,584 Loans past due 90 days or more 33,062 20,141 16,798 10,062 5,771 - ----------------------------- --------- ---------- ---------- ---------- ---------- Total risk elements $59,099 $48,189 $46,220 $43,935 $47,355 - ----------------------------- --------- ---------- ---------- ---------- ----------
Substantially all of the loans in the nonaccrual category at December 31, 1997, were contractually past due as to principal or interest. The relationships of nonperforming assets and total risk elements to total loans and to the allowance for credit losses provide important measures of asset quality. The allowance for credit losses must be adequate to absorb credit risk in these categories and in the remainder of the loan portfolio. The following table summarizes the total risk element components expressed as a percentage of year-end loans and relevant coverage provided by the allowance for credit losses.
1997 1996 1995 1994 1993 - ------------------------------------------- ------- ------- ------- ------- ------- Ratio to Year-End Loans: Nonperforming assets 0.55% 0.65% 0.72% 0.87% 1.21% 90 days past due 0.70 0.46 0.41 0.25 0.16 - ------------------------------------------- ------- ------- ------- ------- ------- Total risk elements 1.25% 1.11% 1.13% 1.12% 1.37% - ------------------------------------------- ------- ------- ------- ------- ------- Coverage Ratios: Ending allowance to nonperforming loans 310% 285% 282% 200% 159% Ending allowance to risk elements* 120% 141% 152% 146% 135% Ending allowance to net charge-offs 4.4x 5.7x 7.1x 5.5x 7.4x - ------------------------------------------- ------- ------- ------- ------- ------- * Excludes ORE.
While the level of nonperforming assets has continued to decline, loans 90 days past due as a percent of loans have increased over the last few years. As a result, total risk elements expressed as a percent of loans increased from 1.11% at December 31, 1996 to 1.25% at December 31, 1997. The increase was due to the migration of a single credit of approximately $5.7 million into loans 90 days past due as well as an increase in consumer loan delinquencies. Management will continue to closely monitor these and other components of risk elements and manage the level of adversely classified assets. Coverage ratios, which measure the capacity of the allowance to absorb the impact of possible collectability problems, remained at strong levels. Credit risk associated with nonperforming assets also can be measured in terms of exposure to specific categories of loans. The following table provides the components of nonperforming assets, detailed by loan categories, at the end of each of the past five years, (in thousands):
- ------------------------------- --------------------------------------------------- 1997 1996 1995 1994 1993 - ------------------------------- ---------- --------- ---------- --------- --------- Commercial $4,550 $4,340 $4,833 $5,651 $8,762 Commercial real estate: Construction and development 220 764 1,951 5,690 6,007 Permanent 11,960 12,196 10,919 10,597 12,871 Residential real estate 1,465 1,014 1,173 4,486 3,443 Consumer 2,814 1,429 769 421 996 - ------------------------------- ---------- --------- ---------- --------- --------- Nonperforming loans 21,009 19,743 19,645 26,845 32,079 Other real estate 5,028 8,305 9,777 7,028 9,505 - ------------------------------- ---------- --------- ---------- --------- --------- Total nonperforming assets $26,037 $28,048 $29,422 $33,873 $41,584 - ------------------------------- ---------- --------- ---------- --------- ---------
The following is a comparative summary of past due loans at the end of 1997 and 1996 (in thousands):
% of Total % of Total 1997 Loans 1996 Loans - ------------------ ---------- ------------ ----------- -------------- 30-59 days $53,320 1.1% $47,135 1.1% 60-89 days 15,807 0.3 16,421 0.4 Over 90 days 33,062 0.8 20,141 0.4 - ------------------ ---------- ------------ ----------- -------------- $102,189 2.2% $83,697 1.9% - ------------------ ---------- ------------ ----------- --------------
The level of past due credits in the over 90-days category increased as a result of the aforementioned $5.7 million credit and higher consumer delinquencies brought about by the stress of high debt levels on consumer credit. Management has identified approximately $8.3 million of loans outstanding at December 31, 1997 where concern exists as to the potential for future classification into one of the risk element categories. Substantially all of these loans were current at the end of 1997. Such loans totaled $9.1 million at December 31, 1996. Overall Assessment Keystone has assessed all of the above factors in the establishment of the allowance for credit losses. The determination as to the adequacy of the allowance reflects management's judgment, and was based upon collateral, various estimates, local market conditions, and other information that requires 17 subjective analysis. These factors, which are prone to change, are monitored by management to evaluate their potential impact on management's assessment of the adequacy of the allowance. Based on its evaluation of loan quality, management believes that the allowance for credit losses at December 31, 1997 was adequate to absorb potential losses within the loan portfolio. INVESTMENTS Keystone has established corporate investment policies that address various aspects of portfolio management including, but not limited to, quality standards, liquidity and maturity limits, investment concentrations, and regulatory guidelines. Compliance with these policies is reported regularly to the Board of Directors. Keystone's objectives with respect to investment management include maintenance of appropriate asset liquidity, facilitation of asset/liability management strategies, and maximization of return. At December 31, 1997, Keystone's investments represented 23.7% of total assets. The following is a summary of the carrying values of investments at December 31, 1997 and 1996 (in thousands): 1997 1996 - --------------------------- ------------------------- ------------------------- Available Held to Available Held to for Sale Maturity for Sale Maturity - --------------------------- ------------ ------------ ------------ ------------ Negotiable money market investments $178,404 $----- $194,566 $ ----- U.S. Treasury securities 194,120 ----- 244,542 ----- U.S. Government agency obligations 503,078 366,238 559,438 230,402 Obligations of states and political subdivisions 74,171 143,910 103,520 134,194 Corporate and other 141,627 18,240 108,028 15,362 - --------------------------- ------------ ------------ ------------ ------------ $1,091,400 $528,388 $1,210,094 $379,958 =========================== ============ ============ ============ ============ FASB Statement No. 119, "Disclosures About Derivative Financial Instruments and the Fair Value of Financial Instruments" defined two distinct types of off- balance sheet derivative activities: "trading" activities and "end-user" activities. Keystone does not engage in derivatives trading activities and has made only limited use, as an end-user, of interest rate swaps. These swaps, together with other strategies, have been used to manage Keystone's overall exposure to the effect of changes in interest rates. Keystone has also made use of forward mortgage commitments as well as put options and short sales of U.S. Treasury securities. These instruments were executed to reduce the market risk associated with interest rate fluctuations in fixed consumer mortgages and the indirect automobile loans held for sale. Further disclosures of these activities are included in the footnotes of the financial statements. Both the FASB and SEC have issued pronouncements concerning the derivatives, hedging activities and overall market risk. The FASB Exposure Draft on accounting for derivatives, which has undergone considerable revision, continues to be deliberated and a final standard is expected in 1998. Key elements of the expected standard include provisions to measure derivatives at fair value as assets or liabilities as well as establishment of more specific criteria for hedge accounting treatment. Currently, these proposed changes are not expected to have a material impact on Keystone's future financial statement presentations. A broader definition of derivatives would include any financial instrument which derives its value or contractual cash flows from the price of some other security or index. Keystone's investment policy governs the nature and extent of on- balance sheet financial derivative holdings, which currently include both collateralized mortgage obligations and structured notes. This policy limits Keystone's exposure to derivatives risk by defining restrictions on the amount of credit, prepayment, extension, and interest-rate risk associated with derivative financial instruments. Keystone's aggregate investment in this form of financial derivative holdings is substantially composed of U.S. Government 18 Agency holdings. The weighted average life of Keystone's fixed rate investments was 4.16 years at December 31, 1997. Ratings for state and municipal, and corporate issues are provided by major rating agencies, principally Moody's and Standard & Poor's. At the end of 1997, the portion of all state and municipal holdings rated "AAA" was 90.0% and the portion of all corporate issues rated "A" or better was 98.5%. The relationship of market value to the amortized cost of investments at December 31, 1997, was 101.4% compared to 100.6% at the end of 1996. At December 31, 1997, investments "held-to-maturity", which are carried at amortized cost, contained gross unrealized gains and losses of $10 million and $173,000, respectively. Unrealized gains and losses included in the carrying value of the "available-for-sale" investments of $15 million and $2 million, respectively, were reflected, on a net of tax basis, as an adjustment to shareholders' equity. Keystone holds no concentration of corporate or municipal investment securities of any single issuer which exceeds 10% of shareholders' equity. DEPOSITS Customer deposits remained the primary source of funding for traditional banking activities. Keystone has actively responded to competitive pressures which have the potential to contribute to the erosion of this important funding base. During 1997, Keystone experienced growth of 3% in overall deposit funding due primarily to the late May acquisition of FFWM, summarized as follows (in thousands): Change ========== 1997 1996 Amount % ============================== ============= ============ ============== ====== Noninterest-bearing demand $606,907 $604,536 $2,371 --% NOW 330,514 532,480 (201,966) (38) Savings 600,759 569,814 30,945 5 Money market 650,082 536,237 113,845 21 Variable-rate CD 575,025 415,812 159,213 38 Other time deposits less than $100,000 2,114,231 2,055,888 58,343 3 Time deposits $100,000 or more 278,181 288,273 (10,092) (4) - ------------------------------ ------------- ------------ -------------- ------ $5,155,699 $5,003,040 $152,659 3% ============================== ============= ============ ============== ====== Keystone's retail customers continued to express a preference for competitive deposit products which are responsive both to individual liquidity needs and competitive investment returns. Both the indexed money market account (IMMA), which is included in the money market category, and the variable rate certificate of deposit have been developed in response to these customer preferences. The IMMA, whose rate is pegged to the Treasury Bill, has provided customers with a market-based rate of return combined with the liquidity features of a more traditional money market account. Of the total growth of $114 million in money market deposits, approximately $71 million was attributed to growth in the IMMA accounts. Similarly, the variable-rate CD has provided Keystone with a significant competitive advantage in retaining and growing its certificate of deposit funding. Consumer access to variable-rate deposits has furnished a viable alternative, blending the security of deposit insurance with the flexibility to achieve higher returns. Keystone experienced some erosion of its traditional NOW deposits, which was partially attributable to growth in these other, more innovative product lines. NOW deposits were also impacted by the introduction of a sweep account product now provided to retail customers. As a consequence of these various initiatives, Keystone has been able to grow these competitive deposit products and sustain its critical funding composition. 19 BORROWED FUNDS While deposits remain the most significant bank funding source, Keystone has consistently accessed other funding sources critical to its overall funding strategy. The following table provides a summary of the various components of borrowed funds(in thousands):
Change ------ 1997 1996 Amount % - ---------------------------- ----------- ----------- ------------- ---------- Short-term borrowings $371,645 $323,938 $47,707 15% FHLB borrowings 240,533 159,503 81,030 51 Long-term debt 64,016 3,569 60,447 100+ - ---------------------------- ----------- ----------- ------------- ---------- $676,194 $487,010 $189,184 39% - ---------------------------- ----------- ----------- ------------- ----------
Growth in Keystone's lending and strategic acquisition efforts has influenced the volume and composition of nondeposit funding sources. The most common form of these funding sources, short-term borrowings, are obtained to meet both the short-term funding needs and the short-term investment requirements of primarily commercial and governmental entities. FHLB borrowings, which are collateralized by Keystone's mortgage portfolio, reflect a variety of credit products available to Keystone through the membership of its banks in the Federal Home Loan Bank. These borrowings consist primarily of fixed-rate borrowings with various maturities, primarily in the one to five year time frames. In May of 1997, Keystone issued $100 million of senior medium-term notes at a coupon rate of 7.30%, with a maturity date of 2004 under a $400 million shelf registration. The proceeds were used primarily to fund the acquisition of FFWM. From time to time, Keystone expects to access this funding source for general corporate purposes as the need arises. SHAREHOLDERS' EQUITY The changing nature of the financial services industry, including the expansion of fee-based activities such as asset management services and mortgage banking, requires a proactive view of capital management. Maintenance of appropriate levels of capital is subjected to constraints and restrictions imposed by regulatory authorities, dividend requirements, and acquisition opportunities. Keystone's capital management policies have been designed to ensure maintenance of appropriate levels of capital under a variety of economic conditions. At the end of 1997, shareholders' equity reached $685 million versus $660 million at December 31, 1996 resulting in an equity to assets ratio of 10.02%. The principal source of new capital for Keystone is earnings retention, which is a function of its return on beginning equity and the dividends paid to shareholders. Keystone, in its capital management policies, has set forth specific guidelines to ensure a favorable, consistent, and sustainable pattern of dividend payments. Dividend declarations during 1997 equated to an 8% payout on year-end 1996 book value. Many financial institutions, including Keystone, continued to generate earnings retention levels in excess of asset growth rates which has resulted in increased relative levels of capital. Under guidelines set forth in its capital management policies, Keystone has sought to execute strategies and tactics which would moderate capital growth and increase the level of earning assets, thus improving the leverage of its capital base. The acquisition of treasury stock reissued in the acquisition of FFWM and the annual dividend to shareholders were influenced by Keystone's capital management strategies. Despite these efforts, the ability to manage capital levels continues to be constrained by external factors. Among these factors are the desire to preserve pooling-of-interests accounting treatment for future merger opportunities as well as Keystone's objective to preserve "well- capitalized" ratings for its member banks. Bank regulators have set forth requirements for risk-based capital, which resulted in the establishment of international capital standards for banks. These requirements set forth minimum "leverage", "Tier 1" and "Total" capital 20 ratios in order to provide measures of capital adequacy that are more risk responsive than previous regulatory guidelines. Risk-based capital standards included the establishment of ranges of capital adequacy which extend from "significantly undercapitalized" to "well-capitalized". These assessments of capital adequacy directly influence the focus of regulatory oversight, including the premium rates charged for deposit insurance. Regulators, including both the Federal Reserve Board and the Office of the Comptroller of the Currency, now operate under a risk-based supervisory approach designed to encourage management focus on the most effective use of limited capital and the generation of the highest possible returns with the least amount of associated risk. With regulatory oversight increasingly focused on capital issues, Keystone and other financial institutions have been challenged to develop a capital measurement system that will ensure effective management of capital levels and associated business risk. Keystone will continue to be responsive to the need to balance both capital adequacy levels and business risk issues. The following table provides Keystone's risk-based capital position at the end of 1997 and a comparison to the various regulatory capital requirements.
"Well Minimum Keystone Capitalized" Requirements - ------------------------- ------------- --------------- --------------- Leverage ratio 9.15% 5.00% 4.00% "Tier 1" capital ratio 12.50% 6.00% 4.00% "Total" capital ratio 13.75% 10.00% 8.00% - ------------------------- ------------- --------------- ---------------
Failure to meet any one of the minimum capital ratios would result in an institution being classified as "undercapitalized" or "significantly undercapitalized". Such classifications could disrupt dividends, capital distributions, or affiliate management fees. In addition, other restrictions, prohibitions, and related supervisory actions would be likely depending upon the overall level of capital. Keystone anticipates no significant problems in meeting the current or future capital standards. Intangible assets, consisting primarily of core deposit intangibles and goodwill, totaled $63 million at December 31, 1997 or 10% of "Tier 1" capital. ASSET/LIABILITY MANAGEMENT AND MARKET RISK The process by which financial institutions manage earning assets and funding sources under different interest rate environments is called asset/liability management. The primary goal of asset/liability management is to increase net interest income within an acceptable range of overall risk tolerance. Two important performance barometers are net interest margin and liquidity. Net interest margin is increased by widening interest spread while controlling interest rate sensitivity. The adequacy of liquidity is determined by the ability to meet the cash flow requirements of both depositors and customers requesting bank credit. Asset/liability management within Keystone is the primary responsibility of the Asset/Liability Management Committee (ALCO) whose representation includes both bank and holding company personnel. Interest Rate Risk Interest rate risk, which is the single most significant market risk within Keystone, can be quantified by measuring the change in net interest margin relative to changes in market interest rates. Risk is identified by reviewing repricing characteristics of interest-earning assets and interest-bearing liabilities. Keystone's asset/liability management policy sets forth guidelines that limit the level of interest rate risk within specified tolerance ranges. Keystone and its subsidiary banks utilize a variety of techniques to measure and monitor interest rate risk, including the use of simulation analysis. In order to quantify the impact of changes in interest rates on net interest income, Keystone conducts quarterly interest rate shock simulations which quantify the impact of interest rate changes over periods up to two years. These simulations are used to determine whether corrective action may be warranted or required in order to adjust the overall interest rate risk profile of Keystone or its banks. Keystone's asset/liability management policy limits interest rate risk exposure to 5% of net interest income for the succeeding twelve-month period and 8% for the succeeding twenty-four-month period. Simulations prepared as of December 31, 21 1997 for the ensuing twelve month and twenty-four month periods have measured potential reductions in net interest income of approximately 1% and 2%, respectively, well within Keystone's defined tolerance levels. Current simulations are prepared under the assumption that rates will increase 200 basis points or decrease 100 basis points over a three month period and then stabilize. Simulation results are influenced by a number of estimates and assumptions with regard to embedded options, prepayment behaviors, pricing strategies, cashflows, and others. Such assumptions and estimates are inherently uncertain and, as a consequence, results will neither precisely estimate net interest income nor precisely measure the impact of higher or lower interest rates on net interest income. The results of these simulations are reported to Keystone's Board of Directors on a quarterly basis. Management has determined that Keystone maintained a level of interest rate risk within its asset/liability management policy limits at December 31, 1997. Management augments rate shock simulations with GAP interest rate sensitivity analysis and with market value of portfolio equity (MVPE) computations. GAP is defined as the volume difference between interest rate-sensitive assets and liabilities. GAP is used by management to assist in evaluating the results of rate shock simulations, to identify areas that may warrant corrective action, and to identify interest rate risk exposure for periods beyond one year. By utilizing GAP to monitor longer term interest rate risk, Keystone attempts to minimize fluctuations in net interest margin and thereby achieve consistent net interest income growth during periods of changing interest rates. MVPE is a more comprehensive measure that attempts to quantify the impact of aggregate interest rate risk exposure on the intrinsic value of financial institutions, and is particularly useful in quantifying the impact of changing interest rates on that intrinsic value. Analyses similar to those conducted for interest rate shock simulations are conducted for MVPE computations, with policy guidelines on the acceptable reduction in Keystone's intrinsic value under defined interest rate conditions. Under current guidelines, intrinsic value must exceed regulatory capital requirements for "well capitalized" institutions. Computations of Keystone's MVPE yielded intrinsic values well in excess of these limits, under both a 200 basis points increase or 100 basis points decrease in overall interest rates. This measurement tool, while valuable as a gauge of longer-term interest rate risk, is less useful as a tool to provide strategic solutions to the management of that risk. The following table provides an analysis of Keystone's interest rate sensitivity as measured under GAP at December 31, 1997 compared to 1996 (dollars in thousands): December 31, December 31, 1997 1996 - -------------------------------------------------------------------------------- 1 month 3 months 6 months 1 year 1 year - -------------------------------------------------------------------------------- Assets $1,684,979 $1,978,390 $2,342,271 $3,017,875 $2,988,260 Liabilities 1,408,717 2,398,355 2,794,965 3,313,948 2,996,283 Cumulative GAP 276,262 (419,965) (452,694) (296,073) (8,023) As a percent of total assets 4.04% (6.14)% (6.62)% (4.33)% (0.12)% Gap ratio 1.20 0.82 0.84 0.91 1.00 - -------------------------------------------------------------------------------- While rate shock simulations, GAP analysis, and MVPE computations provide measures of interest rate risk, such presentations cannot accurately reflect all actual repricing opportunities which will occur within loan and deposit categories. The information provided by these analyses, however, provides some indication of the potential for interest rate adjustment, but does not necessarily mean that the rate adjustment will occur, or that it will occur in accordance with the assumptions. Despite these inherent limitations, Keystone believes that the tools used to manage its level of interest rate risk provide an appropriate measure of market risk exposure. 22 Liquidity Liquidity is defined as Keystone's ability to meet maturing obligations and customers' demand for funds on a continuous basis. Liquidity is sustained by stable core deposits, a diversified mix of liabilities, strong credit perception, and the maintenance of sufficient assets convertible to cash without material loss or disruption of normal operations. Keystone monitors liquidity through regular computations of prescribed liquidity ratios at each of the affiliate banks. Banks which fail to meet the prescribed minimum standards for these ratios must set forth tactics to promptly comply with policy guidelines and provide mandatory progress reports to Keystone's ALCO and to Keystone's Board of Directors. Keystone actively manages liquidity within a defined range and has developed reasonable liquidity contingency plans, including ensuring availability of alternate funding sources to maintain adequate liquidity under a variety of business conditions. Keystone's primary sources of liquidity are funds derived through earnings and deposit balances. Liquidity is also provided by scheduled maturities of loans and investment securities, as well as the early payoff of customer loan balances. Liquidity may also be influenced by the volume and timing of securitizations, particularly mortgage loans. Consideration is given to the maturity of assets and expected future growth/funding needs when developing investment strategies. These liquidity sources may also be augmented by other forms of liability liquidity, such as FHLB borrowings. Various funding sources have been used to support increases in overall earning asset balances during the year. Keystone's operating, investing, and financing activities are conducted within the overall constraints of Keystone's liquidity management policy. Parent company liquidity represents another important aspect of liquidity management. Within Keystone, the parent company relies on the banking subsidiaries to provide funding for dividends to shareholders and unallocated corporate expenses. The amount of dividends from bank subsidiaries to the parent company is constrained by both state and federal regulations, which have not historically limited Keystone's practices. Periodically, the parent company may also access other forms of funding such as medium-term notes to facilitate strategic corporate initiatives. Based upon the inherent strength and profitability of the Keystone banks, holding company liquidity is deemed adequate. REGULATORY MATTERS Keystone and its banking affiliates are subject to periodic examinations by one or more of the various regulatory agencies. During 1997, examinations were conducted at the holding company and at Keystone's various banking and nonbanking subsidiaries. These examinations included, but were not limited to, procedures designed to review lending practices, credit quality, liquidity, compliance, and capital adequacy of Keystone and its subsidiaries. No comments were received from the various regulatory bodies which would have a material effect on Keystone's liquidity, capital resources, or operations. The Federal Deposit Insurance Corporation Improvement Act (FDICIA), established a new framework for the relationship between insured depository institutions and the various regulatory bodies. FDICIA regulations, which addressed capital adequacy, brokered deposits, annual audits, expanded regulatory requirements, audit committee composition, and truth in savings provisions have been implemented throughout Keystone. INFLATION Keystone's ability to cope with the impact of inflation is best determined by an analysis of its ability to respond to changing interest rates and manage noninterest income and expense. As discussed in the asset/liability management section of this review, Keystone manages the mix of interest rate-sensitive assets and liabilities in order to limit the impact of changing interest rates on net interest income. Inflation also has a direct impact on noninterest income and expense, such as service fees, salary expense and benefits, and other overhead expenses. Inflationary pressure over the last several years has been modest, although concern exists over the sustained strength of the economy and the potential impact on inflationary pressure. Management will continue to monitor the impact of these pressures on the pricing of its products and services and on the control of overhead expenses. 23 SEGMENT REPORTING In 1997, the FASB issued a new accounting pronouncement, Statement of Financial Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and Related Information". This new Standard will be effective for 1998 and will require disclosure of financial information on the basis of operating segments used by management for decision-making and performance assessment. Keystone's super community banking operating structure and relationship banking philosophy will influence the manner in which Keystone defines it operating segments. Keystone currently provides traditional commercial and retail banking services to both middle market business and retail customers. Keystone also provides substantial asset management and mortgage banking services, as well as other related financial services to its customer base. Keystone will consider these factors in assessing the impact of the new accounting Standard and will comply with the reporting requirements for the year ended December 31, 1998. 24 1996 VS 1995 Summary Keystone's financial performance for 1996 reflected continued improvement as net income reached a record high of $89.5 million, a 12.6% improvement over 1995 net income of $79.4 million. Basic earnings per share also grew to $1.72 in 1996, a 7.5% improvement over the 1995 performance of $1.60. Keystone recorded strong performance in both ROA and ROE, which were 1.44% and 14.09%, respectively in 1996, a slight improvement over the comparable measures of 1.35% and 14.00% in 1995. During the fourth quarter of 1995, Keystone completed mergers of two Pennsylvania bank holding companies, Shawnee Financial Services Corporation (Shawnee) and National American Bancorp (NAB); and the acquisition of Martindale Andres & Company, a Philadelphia-based asset management firm. The bank subsidiaries of both Shawnee and NAB were merged into existing Keystone affiliated banks and the mergers were accounted for under the pooling-of-interests method of accounting. Due to the immaterial impact of both transactions to Keystone's financial position and results of operation, prior periods were not restated. Consolidated results of Keystone included Shawnee's and NAB's results of operations from the consummation dates of October 10, 1995, and December 29, 1995, respectively. Total assets added through these three transactions approximated $230 million. Revenue expansion efforts were the primary focus of Keystone's profit improvement initiatives during 1996. Total revenues, consisting of both net interest income and noninterest income, grew 9% from 1995 to 1996, including a 6% increase in net interest income and a 23% increase in revenue from noninterest sources. Net interest income growth was stimulated primarily by loan growth, including loans added in the late 1995 bank mergers, as net interest margin was constant from 1995 to 1996. Under the direction of Martindale Andres & Company, assets under management continued to grow, translating to improvement in trust and investment advisory fees. Keystone's ratio of noninterest expense to revenues of 57.42% for 1996 reflected improvement over the ratio of 58.44% for 1995, as growth in noninterest expenses was 8%. Additional expense added from the late 1995 mergers was partially offset by the benefit of a full-year reduction in the FDIC insurance premium. Finally, Keystone continued to sustain solid asset quality in its investment and loan portfolios, including a low level of nonperforming loans. Interest Income Interest income reached $482 million in 1996, compared to $456 million in 1995, an increase of 6%. The improvement was driven by loan growth of 5%, as the total yield on earning assets actually declined slightly from 8.23% for 1995 to 8.20% for 1996. The most notable loan growth occurred in the categories of commercial, direct consumer and leases. The 5% growth was achieved despite the securitization and sale of indirect loans and fixed rate consumer mortgages in the secondary market. Interest Expense While the overall cost of funds remained stable at 4.33% for 1995 and 1996, interest expense increased 5% from $201 million in 1995 to $211 million in 1996. This increase was driven by a 5% increase in deposits, including the impact of deposits acquired in acquisitions. Net Interest Income Net interest income grew $16 million or 6% to reach $271 million for 1996. Both the yield on earning assets and cost of funds were relatively constant between 1996 and 1995, resulting in little change in interest spread. Net interest margin also remained stable at 4.61% for both years. Provision for Credit Losses The provision for credit losses increased from $8.6 million in 1995 to $10.7 million in 1996, as a direct response to increased charge-offs and a decrease in the allowance for loan losses expressed as a percentage of loans from 1.35% at the end of 1995 to 1.30% at December 31, 1996. 25 Noninterest Income Keystone's total noninterest revenue increased $13 million or 23% in 1996. Areas of continued focus and strength included trust and investment management fees, service charges on deposits, electronic banking fees, and income from loan servicing. Trust and investment management fees increased 19% in 1996, and were benefitted by the late 1995 acquisition of Martindale Andres & Company and an overall increase in assets under management. Revenues from these activities were positively influenced by both expanded product offerings and intensified marketing efforts to customers, including the introduction of KeyPremier funds late in the year. Service charges on deposits and fee income consisting primarily of ATM and debit card fees and revenue from merchant banking activities increased 11% and 16%, respectively, from 1995 to 1996, and were benefitted by late 1995 acquisitions. In addition, towards the later part of 1996, Keystone significantly expanded its ATM network through contracts with convenience stores to provide ATM's at their locations. During 1996, Keystone became more active in the securitization and sale of indirect loans and consumer mortgages in the secondary market as a strategy to provide liquidity for "relationship banking" activities. As a result of this increased sale and servicing activity, mortgage banking and other secondary market income increased by $3 million or 39% in 1996. As a result of Keystone's 1996 acquisition of KeyInvestor Services, a distributor of investment products, revenue from annuity sales increased notably in 1996. This improvement, together with a gain recognized on the sale of its credit card portfolio, led to a $4 million increase in other income from 1995. Noninterest Expense Noninterest expenses increased from $182 million in 1995 to $196 million in 1996, an increase of 8%. While overhead expenses were impacted favorably by the full-year reduction in FDIC insurance premiums, the late 1995 bank mergers and acquisitions of Martindale Andres and KeyInvestor resulted in increases in the various other categories of noninterest expense. Salary and benefit expenses increased a total of $10 million, or 11%, from 1995 to 1996. Merger and acquisition activity drove a 5% increase in the average number of full-time equivalent employees. This increase, combined with Keystone's emphasis on performance-based incentive programs and an overall average merit increase of 5%, led to higher salary and benefit expenses. Office reconfiguration, including the expansion of delivery channels and continued technological investments, attributed to growth in occupancy expenses of 7% and furniture and equipment expenses of 13% in 1996. Efforts included the expansion of the ATM network into convenience stores and the start-up of KeyCall telephone center. During the third quarter of 1995, the FDIC announced that the Bank Insurance Fund reached its recapitalization level, and enacted a significant reduction to insurance premiums, particularly for "well-capitalized" institutions. As a result, Keystone's deposit insurance expense decreased $5 million in 1996. Conversely, in 1996, a one-time premium was levied on thrifts and banks which had acquired thrift deposits to boost the undercapitalized Savings Association Insurance Fund. This one-time charge resulted in an increase of nearly $2 million to the "other" category of noninterest expense in 1996. The remaining increase of approximately $4.5 million was related to the late 1995 mergers and acquisitions as well as expenses associated with revenue expansion activities. Income Taxes Keystone's recorded tax expense reached $37 million for 1996 versus $34 million in 1995. Expressed as a percentage of income before taxes, the effective tax rate decreased slightly from 30.0% in 1995 to 29.3% in 1996. 26 Report of Ernst & Young LLP, Independent Auditors Shareholders and Board of Directors Keystone Financial, Inc. We have audited the accompanying consolidated statements of condition of Keystone Financial, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the management of Keystone Financial, Inc. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1996 financial statements of Financial Trust Corp, a wholly owned subsidiary, which statements reflect total assets constituting 19% as of December 31, 1996, and net interest income constituting 20% of the related consolidated totals for the year ended December 31, 1996. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for Financial Trust Corp, is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. 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 audits provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Keystone Financial, Inc. and subsidiaries at December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ Ernst & Young, LLP ---------------------- Pittsburgh, Pennsylvania January 30, 1998 27 Consolidated Statements of Condition December 31, (in thousands, except share data) 1997 1996 - ------------------------------------------------ -------------- ------------- ASSETS - ------------------------------------------------ -------------- ------------- Cash and due from banks $206,223 $206,972 Federal funds sold 25,300 44,500 Interest-bearing deposits with banks 1,928 36,913 Investment securities available for sale 1,091,400 1,210,094 Investment securities held to maturity (market values 1997 - $538,218; 1996 - $383,526) 528,388 379,958 Loans held for resale 43,055 51,225 Loans and leases 4,712,566 4,336,470 Allowance for credit losses (65,091) (56,256) - ------------------------------------------------ -------------- ------------- Net loans 4,647,475 4,280,214 Premises and equipment 116,615 97,932 Other assets 180,953 142,771 - ------------------------------------------------ -------------- ------------- TOTAL ASSETS $6,841,337 $6,450,579 - ------------------------------------------------ -------------- ------------- LIABILITIES - ------------------------------------------------ -------------- ------------- Noninterest-bearing deposits $637,164 $625,536 Interest-bearing deposits 4,596,001 4,434,185 - ------------------------------------------------ -------------- ------------- Total deposits 5,233,165 5,059,721 Federal funds purchased and security repurchase agreements 399,730 368,886 Other short-term borrowings 26,160 29,078 - ------------------------------------------------ -------------- ------------- Total short-term borrowings 425,890 397,964 FHLB borrowings 248,150 224,203 Long-term debt 101,793 2,573 Other liabilities 146,854 105,712 - ------------------------------------------------ -------------- ------------- TOTAL LIABILITIES 6,155,852 5,790,173 - ------------------------------------------------ -------------- ------------- SHAREHOLDERS' EQUITY - ------------------------------------------------ -------------- ------------- Preferred stock; $1.00 par value, authorized 8,000,000 shares; none issued or outstanding ----- ----- Common stock: $2.00 par value, authorized 100,000,000 shares; issued 52,029,017 - 1997 and 52,320,142 - 1996 104,058 104,640 Surplus 155,430 139,213 Retained earnings 418,605 422,018 Deferred KSOP benefit expense (1,150) (1,249) Treasury stock; 1996 - 333,966 shares at cost ----- (8,412) Net unrealized securities gains, net of tax 8,542 4,196 - ------------------------------------------------ -------------- ------------- TOTAL SHAREHOLDERS' EQUITY 685,485 660,406 - ------------------------------------------------ -------------- ------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $6,841,337 $6,450,579 - ------------------------------------------------ -------------- ------------- The accompanying notes are an integral part of the consolidated financial statements. 28 Consolidated Statements of Income
Year Ended December 31, (in thousands except per share data) 1997 1996 1995 - --------------------------------------- ------------- ------------ ------------- INTEREST INCOME - --------------------------------------- ------------- ------------ ------------- Loans and fees on loans $404,096 $370,364 $353,025 Investments - taxable 82,664 79,977 69,957 Investments - tax-exempt 12,230 12,723 13,105 Federal funds sold and other 5,340 5,668 9,063 Loans held for resale 6,408 4,688 1,636 - --------------------------------------- ------------- ------------ ------------- 510,738 473,420 446,786 - --------------------------------------- ------------- ------------ ------------- INTEREST EXPENSE - --------------------------------------- ------------- ------------ ------------- Deposits 194,898 186,257 176,571 Short-term borrowings 18,134 14,506 12,747 FHLB borrowings 14,677 10,175 10,955 Long-term debt 4,785 363 502 - --------------------------------------- ------------- ------------ ------------- 232,494 211,301 200,775 - --------------------------------------- ------------- ------------ ------------- NET INTEREST INCOME 278,244 262,119 246,011 Provision for credit losses 15,316 10,713 8,568 - --------------------------------------- ------------- ------------ ------------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 262,928 251,406 237,443 - --------------------------------------- ------------- ------------ ------------- NONINTEREST INCOME - --------------------------------------- ------------- ------------ ------------- Trust and investment advisory fees 21,291 17,597 14,843 Service charges on deposit accounts 17,356 17,234 15,497 Fee income 20,029 15,840 13,651 Mortgage banking income 9,633 7,334 6,130 Other secondary market income 2,477 3,607 1,728 Reinsurance income 3,512 2,864 2,577 Other income 9,563 6,178 1,922 Net gains - equity securities 5,754 529 755 Net gains - debt securities 317 342 1,034 - --------------------------------------- ------------- ------------ ------------- 89,932 71,525 58,137 - --------------------------------------- ------------- ------------ ------------- NONINTEREST EXPENSE - --------------------------------------- ------------- ------------ ------------- Salaries 92,650 81,894 73,852 Employee benefits 17,311 16,508 14,683 Occupancy expense, net 16,407 15,916 14,894 Furniture and equipment expense 18,732 16,156 14,324 Special charges 11,410 ----- ----- Deposit insurance 778 1,014 6,195 Other expense 68,702 64,757 58,182 - --------------------------------------- ------------- ------------ ------------- 225,990 196,245 182,130 - --------------------------------------- ------------- ------------ ------------- Income before income taxes 126,870 126,686 113,450 Income tax expense 38,953 37,180 34,001 - --------------------------------------- ------------- ------------ ------------- NET INCOME $87,917 $89,506 $79,449 - --------------------------------------- ------------- ------------ ------------- PER SHARE DATA - --------------------------------------- ------------- ------------ ------------- Net income: Basic $1.70 $1.72 $1.60 Diluted 1.68 1.70 1.59 - --------------------------------------- ------------- ------------ ------------- Dividends $1.06 $0.98 $0.93 - --------------------------------------- ------------- ------------ ------------- The accompanying notes are an integral part of the consolidated financial statements.
29
Consolidated Statements of Changes in Shareholders' Equity Issued and Deferred Net Unrealized Outstanding KSOP Securities (in thousands) Common Common Retained Benefit Treasury Gains(Losses), Shareholders' Shares Stock Surplus Earnings Expense Stock Net of Tax Equity - ------------------------------------------------------------------------------------------------------------------------------------ JANUARY 1, 1995 36,175 $73,730 $153,558 $344,487 ($2,250) ($20,576) ($15,306) $533,643 - ------------------------------------------------------------------------------------------------------------------------------------ 1995 Net Income - - - 79,449 - - - 79,449 Dividends - - - (39,875) - - - (39,875) Stock issued: Benefit plans 276 552 4,686 - - - - 5,238 KSOP 21 42 571 - - - - 613 Dividend reinvestment 89 176 2,480 - - - - 2,656 Deferred KSOP benefit expense - - - - 500 - - 500 Acquisition of treasury stock (229) - - - - (6,649) - (6,649) Reissuance of treasury stock 17 - (29) - - 286 - 257 Shares issued in acquisitions 1,721 1,640 (21,372) 17,387 - 26,939 - 24,594 Other (1) (1) (8) - - - - (9) Change in unrealized gain on available-for-sale securities - - - - - - 21,349 21,349 - ------------------------------------------------------------------------------------------------------------------------------------ BALANCES AT DECEMBER 31, 1995 38,069 $76,139 $139,886 $401,448 ($1,750) $- $6,043 $621,766 - ------------------------------------------------------------------------------------------------------------------------------------ 1996 Net Income - - - 89,506 - - - 89,506 Dividends - - - (46,998) - - - (46,998) Stock issued: Stock split/dividend 14,004 28,009 (6,170) (21,938) - - - (99) Benefit plans 137 273 2,561 - - - - 2,834 KSOP 12 24 278 - - - - 302 Dividend reinvestment 98 195 2,696 - - - - 2,891 Deferred KSOP benefit expense - - - - 501 - - 501 Acquisition of treasury stock (424) - - - - (9,915) - (9,915) Reissuance of treasury stock 90 - (38) - - 1,503 - 1,465 Change in unrealized gain on available-for-sale securities - - - - - - (1,847) (1,847) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCES AT DECEMBER 31, 1996 51,986 $104,640 $139,213 $422,018 ($1,249) ($8,412) $4,196 $660,406 - ------------------------------------------------------------------------------------------------------------------------------------ 1997 Net Income - - - 87,917 - - - 87,917 Dividends - - - (55,964) - - - (55,964) Stock issued: Benefit plans 524 1,048 8,178 - - - - 9,226 KSOP 28 56 763 - - - - 819 Dividend reinvestment 130 260 3,422 - - - - 3,682 Deferred KSOP benefit expense - - - - 523 - - 523 Acquisition of treasury stock (2,318) - - - - (72,586) - (72,586) Reissuance of treasury stock 7 - - - - 182 - 182 Retirement of treasury stock - (2,290) (3,312) (35,366) - 40,931 - (37) Shares issued in acquisitions 1,672 344 7,166 - (424) 39,885 - 46,971 Change in unrealized gain on available-for-sale securities - - - - - - 4,346 4,346 - ------------------------------------------------------------------------------------------------------------------------------------ BALANCES AT DECEMBER 31, 1997 52,029 $104,058 $155,430 $418,605 ($1,150) $- $8,542 $685,485 ==================================================================================================================================== The accompanying notes are an integral part of the consolidated financial statements.
30 Consolidated Statements of Cash Flows
Year Ended December 31, (in thousands) 1997 1996 1995 - ------------------------------------------------ -------------- ----------- ---------- OPERATING ACTIVITIES: Net income $87,917 $89,506 $79,449 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for credit losses 15,316 10,713 8,568 Provision for depreciation and amortization 18,062 15,840 14,830 Deferred income taxes 14,537 14,880 11,219 Sale of loans held for resale 203,887 441,716 157,803 Origination of loans held for resale (385,458) (466,469) (162,678) Increase in interest receivable (4,459) (3,964) (1,690) Increase (decrease) in interest payable (567) (1) 3,299 Other 20,660 (6,391) (25,987) - ------------------------------------------------ -------------- ----------- ---------- NET CASH PROVIDED BY(USED IN) OPERATING ACTIVITIES (30,105) 95,830 84,813 - ------------------------------------------------ -------------- ----------- ---------- INVESTING ACTIVITIES: Net cash received in bank acquisitions 35,646 ----- 49,639 Net increase in interest-earning deposits (25,363) (3,121) (6,922) Available for sale securities: Sales 176,606 98,724 116,880 Maturities 855,464 1,208,804 701,267 Purchases (891,694) (1,368,734) (847,228) Held to maturity securities: Maturities 91,370 108,438 103,343 Purchases (192,900) (103,268) (55,258) Net increase in loans (198,217) (265,833) (145,153) Proceeds from sales of loans 302,840 52,013 34,305 Purchases of loans (11,947) (1,986) (15,869) Purchases of premises and equipment (23,641) (16,870) (19,050) Other (6,404) (1,025) (1,619) - ------------------------------------------------ -------------- ----------- ---------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 111,760 (292,858) (85,665) - ------------------------------------------------ -------------- ----------- ---------- FINANCING ACTIVITIES: Net increase (decrease) in deposits (99,242) 66,113 74,606 Net increase in short-term borrowings 27,926 64,593 23,499 Proceeds from FHLB borrowings 242,313 420,892 138,352 Repayments of FHLB borrowings (253,418) (360,715) (129,973) Issuance of long-term debt 100,000 ---- ---- Repayment of long-term debt (780) (1,962) (2,068) Acquisition of treasury stock (72,586) (9,915) (6,649) Cash dividends (55,964) (46,998) (39,875) Other 10,147 7,894 8,755 - ------------------------------------------------ -------------- ----------- ---------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (101,604) 139,902 66,647 - ------------------------------------------------ -------------- ----------- ---------- INCREASE (DECREASE) IN CASH & CASH EQUIVALENTS (19,949) (57,126) 65,795 Cash and cash equivalents at beginning of year 251,472 308,598 242,803 - ------------------------------------------------ -------------- ----------- ---------- CASH AND CASH EQUIVALENTS AT END OF YEAR $231,523 $251,472 $308,598 - ------------------------------------------------ -------------- ----------- ---------- The accompanying notes are an integral part of the consolidated financial statements.
31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Summarized Accounting Policies The accounting policies discussed below are followed consistently by Keystone Financial, Inc., and its subsidiaries (Keystone). These policies are in accordance with generally accepted accounting principles and conform to common practices in the banking industry. On May 30, 1997, Keystone acquired Financial Trust Corp in a transaction accounted for under the pooling of interests method of accounting. As such, all periods presented include the consolidated accounts of Financial Trust Corp. Nature of Operations: Keystone provides a wide range of financial services to a diverse client base through its banking subsidiaries. The client base includes individual, business, public, and institutional customers primarily located in Pennsylvania, Maryland, and West Virginia. Lending services include secured and unsecured commercial loans, residential and commercial mortgages, installment loans, revolving consumer loans and lease financing. Deposit services include a variety of checking, savings, time, money market, and individual retirement accounts. Money management services are available to customers through a variety of techniques, all of which are designed to improve cash flow, control disbursements, and increase return on investments. A full spectrum of asset management services is offered by specialists, including administration of trusts and estates, investment management, administration of retirement and employee benefit plans, and other fiduciary responsibilities. Keystone's nonbanking subsidiaries perform specialized services including mortgage banking, small-ticket equipment leasing, discount brokerage services, investment advisor services, and reinsurance. Keystone is subject to the regulations of certain federal and state agencies and undergoes periodic examinations by certain regulatory authorities. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from the estimates, and such difference may be material to the financial statements. Principles of Consolidation: The consolidated financial statements include the accounts of: Keystone Financial, Inc., the parent company; its wholly-owned banking subsidiaries consisting of: American Trust Bank, N.A., and its subsidiaries, ATB Real Estate Investment Trust, Inc., Keystone Brokerage, Inc., and Key Investor Services, Inc.; Financial Trust Company; Keystone Bank, N.A., and its subsidiary, Keystone Financial Leasing Corporation; Keystone National Bank and its subsidiary, Keystone Financial Mortgage Corporation; Mid-State Bank and Trust Company; Northern Central Bank; Pennsylvania National Bank and Trust Company; and other nonbanking subsidiaries of Keystone consisting of Financial Trust Services Company, Key Trust Company, Keystone Financial Mid-Atlantic Funding Corp., Keystone Financial Unlimited, Inc., Keystone Investment Services, Inc., Keystone Life Insurance Company, Martindale Andres & Co., MMC&P and two community development corporations. All significant intercompany accounts have been eliminated in consolidation. Trading Account Assets: Securities classified as trading account assets are held for resale in anticipation of short-term market movements and are carried at fair value with market adjustments recorded against income. Keystone has made limited use of trading account portfolios. 32 Investments: Keystone classifies its securities as either "held-to-maturity" or "available-for-sale" at the time of purchase. Debt securities are classified as held-to-maturity based upon management's positive ability and intent to hold such securities to maturity. Held-to-maturity securities are stated at cost, adjusted for amortization of premiums and accretion of discounts (amortized cost). Debt securities not classified as trading or held-to-maturity and marketable equity securities not classified as trading are classified as available-for-sale. Available-for-sale securities are stated at fair value, with unrealized gains and losses, net of tax, reported as a component of shareholders' equity. The cost of debt securities classified as held-to-maturity or available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of a mortgage-backed security, over the estimated life of the security. Such amortization/accretion, as well as interest and dividends, is included in interest income from investments. Realized gains and losses and declines in value judged to be other than temporary are included in net securities gains (losses). The cost of securities sold is based on the specific identification method, and sales are reported as of the trade date. Loans Held for Resale: Loans held for resale, primarily consisting of fixed-rate consumer mortgages, are valued at the lower of cost or market, determined on an aggregate basis. Mortgage Servicing Rights: An asset is recognized for mortgage servicing rights acquired through purchase or origination. If mortgage loans are sold or securitized with servicing retained, the total cost of the mortgage loans is allocated to the loans and the servicing rights based on their relative fair values. Keystone performs a periodic review for impairment in the fair value of recorded mortgage servicing rights. Interest and Fees on Loans: Interest income on loans is accrued based upon the principal amount outstanding using methods that produce level yields. Loan origination fees and certain direct loan origination costs have been deferred and the net amount amortized as an adjustment of the related loan yield over the estimated contractual life of the related loans. Keystone places loans and leases on nonaccrual when collection of principal is in doubt, or when interest is 90 days past due, unless the loan is well-secured and in the process of collection. Classification of a loan as nonaccrual is also considered when the financial condition of the borrower is in a state of significant deterioration. When loans are placed on nonaccrual, including those identified as impaired, loan interest receivable is reversed. Interest payments received on these loans and leases are applied as a reduction of the principal balance when concern exists as to the ultimate collectability of principal; otherwise such payments are recognized as interest income. Loans and leases are removed from nonaccrual when they have performed in accordance with contract terms for a reasonable period of time and when concern no longer exists as to their collectability. Impaired Loans: Impaired loans are defined as those loans for which it is probable that contractual amounts due will not be received. Impaired loans are reported at the present value of expected future cash flows using the loan's effective interest rate, or as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The determination of impairment requires judgement including estimates of the amount and timing of cash flows. Loans included as components of risk elements are not deemed to be impaired when it is probable that contractual amounts due will be received through the normal collection process. Identification of impaired loans is the primary obligation of the credit extension function and is augmented by the normal loan review process. Factors which are considered in the identification of impaired loans include, but are not limited to: classification into nonaccrual or workout status; a history of 33 payment delinquency; adverse industry trends; and a general understanding of a customer's financial status. An insignificant delay or payment shortfall, such as those attributable to seasonal payment waivers, would not necessarily require treatment as an impaired loan when other factors make it probable that contractual amounts will be received. The majority of loans classified as impaired on an individual basis are commercial loans and commercial loans secured by real estate. Other loans, such as residential real estate and consumer loans and leases are aggregated for the purpose of measuring impairment due to their homogeneous risk characteristics and their predilection for statistically valid historical analysis. Loans, including impaired loans, are charged-off when they are deemed to be substantially uncollectible. Direct Lease Financing: Financing of equipment, principally consisting of automobiles and business equipment, is provided to customers under lease arrangements accounted for as direct financing leases. These leases are reported in the consolidated statements of condition under the loan caption as a net amount, consisting of the aggregate of lease payments receivable and estimated residual values, less unearned income. Income is recognized in a manner which results in an approximate level yield over the lease term. Allowance for Credit Losses: The allowance for credit losses is maintained at a level believed adequate by management to absorb potential loan and lease losses. Management's determination of the adequacy of the allowance is based on periodic evaluation of the risk characteristics of the loans and leases, credit loss experience, economic conditions, appraisals, valuation estimates, and such other relevant factors which, in management's judgment, deserve recognition. This evaluation is inherently subjective as it requires material estimates including the amount and timing of expected future cash flows on impaired loans, which might be susceptible to significant change. Financial Derivatives and other Hedging Activity: Interest rate swap contracts have been utilized to hedge specific credit and/or funding activities, and the differential of interest paid or received is reflected on the accrual method in interest income or expense. The fair values of these swap contracts have been appropriately disclosed in a footnote to these financial statements and have not been recognized in the financial statements. Forward mortgage commitments, as well as put options and short sales of U.S. Treasury securities, have been used to reduce the market risk associated with interest rate fluctuations of fixed-rate consumer mortgages and the indirect automobile loans held for sale. Changes in the market value of the forward mortgage commitments, as well as the securities underlying the put options and short sales, are recognized in income when the related changes in the fair values of the loans being hedged are recognized. Transfers and Servicing of Financial Assets and Extinguishments of Liabilities: In June 1996, the Financial Accounting Standards Board issued Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". This statement provided new accounting and reporting standards for sales, securitizations, and servicing of receivables and other financial assets, for certain secured borrowing and collateral transactions, and for extinguishment of liabilities. Provisions of this standard, which became effective in 1997 or will become effective in 1998, have not had a significant impact on Keystone's financial condition or results of operations. Premises and Equipment: Bank premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is computed generally on the straight-line method over the estimated useful lives of the related assets. Intangible Assets: Intangible assets, consisting primarily of goodwill and core deposit intangibles, are stated at cost, less accumulated amortization. Amortization of goodwill is generally recognized on the straight-line method over periods ranging from 15-25 years. Amortization of core deposit intangibles is recognized on an accelerated basis, generally over a ten-year period. 34 Other Real Estate: Other real estate is comprised of property acquired through a foreclosure proceeding or an acceptance of a deed in lieu of foreclosure. Balances are carried at the lower of the related loan balance or estimated fair value less estimated disposition costs. Any losses realized upon disposition of the property, and holding costs prior thereto, are charged against income. Trust Assets and Income: Assets held in a fiduciary capacity are not assets of the company and are therefore not included in the consolidated financial statements. Stock Based Compensation: Stock options and shares issued under the Employee Stock Purchase Plan are accounted for under Accounting Principles Board Opinion (APB) No. 25. Stock options are granted at exercise prices not less than the fair value of the common stock on the date of grant. Under APB 25, no compensation expense is recognized related to these plans. The pro forma impact to net income and earnings per share that would occur if compensation expense was recognized based on the estimated fair value of the options and purchase rights on the date of the grant is disclosed in the notes to the consolidated financial statements. Pensions: The provision for pension expense was actuarially determined using the projected unit credit actuarial cost method. The funding policy is to contribute an amount sufficient to meet the requirements of ERISA, subject to Internal Revenue Code contribution limitations. Income Taxes: The provision for income taxes is based on the results of operations and the impact of tax rate changes on the carrying amount of deferred tax assets and liabilities. In computing the tax liability, the results of operations are adjusted principally for the tax effect of tax-exempt income. Comprehensive Income: In June of 1997, the Financial Accounting Standards Board (FASB) issued Statement 130, "Reporting Comprehensive Income", which will be effective for fiscal years beginning after December 15, 1997, and will require reclassification of financial statements for earlier periods. This Statement sets forth guidance regarding the reporting and prominent display of comprehensive income and its components in the financial statements. The adoption of this statement is not expected to have a significant impact on Keystone's financial statements. Per Share Information: During 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share", which requires dual presentation of basic and diluted earnings per share. This statement was adopted in 1997 and required restatement of all prior-period earnings per share data. Basic earnings per share is calculated by dividing net income by the weighted average number of shares of common stock outstanding during each period. Diluted earnings per share is calculated by increasing the denominator for the assumed conversion of all potentially dilutive securities. Keystone's dilutive securities are limited to stock options granted under various incentive plans. Historical shares outstanding and per share data have been restated to reflect the 1996 three-for-two stock split. Treasury Stock: The acquisition of treasury stock is recorded under the cost method. The subsequent disposition or sale of the treasury stock is recorded using the average cost inventory method. Segment Reporting: In June 1997, the Financial Accounting Standards Board issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information", which is effective for years beginning after December 15, 1997. This statement establishes standards for reporting information about operating 35 segments and related disclosures about products and services, geographic areas, and major customers. Keystone will adopt the new requirements beginning with its annual report for the year ended December 31, 1998. Cash Flow Information: Keystone considers cash and due from banks and federal funds sold as cash and cash equivalents. Interest paid on deposits and other borrowings aggregated $233,061,000, $211,302,000, and $196,293,000 in 1997, 1996, and 1995, respectively. Cash payments for income taxes approximated $19,253,000, $23,898,000, and $22,983,000 for 1997, 1996, and 1995, respectively. 36 Investments The amortized cost, related fair value, and unrealized gains and losses for investment securities classified as available-for-sale or held-to-maturity were as follows at December 31 (in thousands):
- -------------------------------------- ------------ ---------------------- ------------ 1997 Available-for-Sale - -------------------------------------- ------------ ---------------------- ------------ Amortized Unrealized Fair Value Cost Gains Losses - -------------------------------------- ------------ ---------------------- ------------ Negotiable money market investments $178,455 $18 $69 $178,404 U.S. Treasury securities 193,099 1,063 42 194,120 U.S. Government agency obligations 502,483 2,363 1,768 503,078 Obligations of states and political subdivisions 72,487 1,688 4 74,171 Corporate and other securities 131,735 9,918 26 141,627 - -------------------------------------- ------------ ---------------------- ------------ Total $1,078,259 $15,050 $1,909 $1,091,400 - -------------------------------------- ------------ ---------- ----------- ------------ 1997 Held-to-Maturity - -------------------------------------- ------------------------------------------------ Amortized Unrealized Fair Value Cost Gains Losses - -------------------------------------- ------------ ---------------------- ------------ U.S. Government agency obligations $366,238 $4,928 $150 $371,016 Obligations of states and political subdivisions 143,910 4,845 5 148,750 Corporate and other securities 18,240 230 18 18,452 - -------------------------------------- ------------ ---------------------- ------------ Total $528,388 $10,003 $173 $538,218 - -------------------------------------- ------------ ---------- ----------- ------------
37
- --------------------------------------- ------------- -------------------------------- 1996 Available-for-Sale - --------------------------------------- ------------- -------------------------------- Amortized Unrealized Fair Value Cost Gains Losses - --------------------------------------- ------------- -------------------------------- Negotiable money market investments $194,566 $15 $15 $194,566 U.S. Treasury securities 244,010 1,083 551 244,542 U.S. Government agency obligations 561,245 2,817 4,624 559,438 Obligations of states and political subdivisions 101,992 1,669 141 103,520 Corporate and other securities 101,846 6,324 142 108,028 - --------------------------------------- ------------- -------------------------------- Total $1,203,659 $11,908 $5,473 $1,210,094 - --------------------------------------- ------------- --------- ---------------------- 1996 Held-to-Maturity - --------------------------------------- ---------------------------------------------- Amortized Unrealized Fair Value Cost Gains Losses - --------------------------------------- ------------- -------------------------------- U.S. Government agency obligations $230,402 $1,997 $1,680 $230,719 Obligations of states and political subdivisions 134,194 3,308 135 137,367 Corporate and other securities 15,362 156 78 15,440 - --------------------------------------- ------------- -------------------------------- Total $379,958 $5,461 $1,893 $383,526 - --------------------------------------- ------------- --------- ---------------------- 1995 Available-for-Sale - --------------------------------------- ------------- -------------------------------- Amortized Unrealized Fair Value Cost Gains Losses - -------------------------------------- ------------- --------------------- ------------ Negotiable money market investments $237,107 $11 $16 $237,102 U.S. Treasury securities 327,338 2,137 434 329,041 U.S. Government agency obligations 380,533 2,199 1,236 381,496 Obligations of states and political 107,723 1,763 190 109,296 subdivisions Corporate and other securities 92,890 5,565 651 97,804 - --------------------------------------- ------------- -------------------------------- Total $1,145,591 $11,675 $2,527 $1,154,739 - -------------------------------------- ------------- ----------- --------- ------------ 1995 Held-to-Maturity - -------------------------------------- ------------------------------------------------ Amortized Unrealized Fair Value Cost Gains Losses - -------------------------------------- ------------- --------------------- ------------ U.S. Government agency obligations $237,122 $4,423 $338 $241,207 Obligations of states and political subdivisions 132,541 4,242 102 136,681 Corporate and other securities 15,599 367 19 15,947 - --------------------------------------- ------------- -------------------------------- Total $385,262 $9,032 $459 $393,835 - -------------------------------------- ------------- ----------- --------- ------------
Investment securities having a carrying value of $717,785,000 at December 31, 1997, were pledged to secure public and trust deposits and security repurchase agreements. 38 Security gains and losses included in operating results from 1995 through 1997 were as follows (in thousands):
1997 1996 1995 - -------------------- --------------- -------------- --------------- Gains $6,847 $980 $1,800 Losses (776) (109) (11) - -------------------- --------------- -------------- --------------- Net $6,071 $871 $1,789 - -------------------- --------------- -------------- ---------------
39 The following tables display at December 31, 1997, the amortized cost, related fair values, and the weighted average yield (tax-equivalent basis) available thereon of investment securities maturing at various intervals (in thousands):
- ------------------------------------------------------------------------------------------------------------------------------------ Available for Sale - ----------------------------------------------------------------------------------------------------------------------------------- After One, After Five, Within One Year But Within Five Years But Within Ten Years After Ten Years - ----------------------------------------------------------------------------------------------------------------------------------- Amortized Fair Amortized Fair Amortized Fair Amortized Fair Cost Value Yield Cost Value Yield Cost Value Yield Cost Value Yield - ----------------------------------------------------------------------------------------------------------------------------------- Negotiable money market investments $ 178,455 $178,404 5.54% $- $- - % $ - $- - % $- $- - % U.S. Treasury securities 125,202 125,442 5.96 67,897 68,678 6.37 - - - - - - Government agency obligations 56,919 56,935 5.70 346,198 345,840 6.28 81,389 82,171 7.42 17,978 18,132 7.28 Obligations of states and political subdivisions 3,675 3,704 5.47 28,399 28,957 4.90 28,899 29,679 5.06 11,514 11,832 5.38 Corporate and other securities 8,664 8,677 6.63 54,753 54,976 6.46 400 400 7.68 67,918 77,573 8.12 - ----------------------------------------------------------------------------------------------------------------------------------- Total $ 372,915 $373,162 5.68% $497,247 $498,451 5.94% $110,688 $112,250 5.46% $97,410 $107,537 7.08% - ----------------------------------------------------------------------------------------------------------------------------------- Held to Maturity ----------------------------------------------------------------------------------------------------------------------------------- After One, After Five, Within One Year But Within Five Years But Within Ten Years After Ten Years - ----------------------------------------------------------------------------------------------------------------------------------- Amortized Fair Amortized Fair Amortized Fair Amortized Fair Cost Value Yield Cost Value Yield Cost Value Yield Cost Value Yield - ----------------------------------------------------------------------------------------------------------------------------------- Government agency obligations $ 2,172 $ 2,170 3.58% $109,589 $110,813 6.67% $135,956 $137,211 6.97% $118,521 $120,822 7.07% Obligations of states and political subdivisions 9,060 9,209 6.53 20,675 21,524 5.87 14,496 15,067 5.46 99,679 102,950 5.52 Corporate and other securities - - - 16,964 17,148 6.53 1,276 1,304 7.27 - - - - ----------------------------------------------------------------------------------------------------------------------------------- Total $11,232 $11,379 5.96% $147,228 $149,485 6.54% $151,728 $153,582 6.83% $218,200 $223,772 6.36% - -----------------------------------------------------------------------------------------------------------------------------------
40 Loans and Leases The composition of loans and leases was as follows at December 31, (in thousands):
1997 1996 - ------------------------------------------------- ------------ - ------------ Consumer financings: Consumer loans $1,218,730 $978,157 Net investment in direct lease financing receivables 335,017 301,483 - ------------------------------------------------- ------------ - ------------ 1,553,747 1,279,640 Loans secured by real estate: Consumer 862,227 1,186,663 Commercial 1,384,923 1,077,017 - ------------------------------------------------- ------------ - ------------ 2,247,150 2,263,680 Commercial 911,669 793,150 - ------------------------------------------------- ------------ - ------------ Total $4,712,566 $4,336,470 ================================================= ============ = ============
At December 31, 1997, substantially all of the consumer real estate loans outstanding were pledged under blanket collateral agreements to secure outstanding Federal Home Loan Bank borrowings. No industry-related concentrations are deemed to exist. Activity within the allowance for credit losses was summarized as follows (in thousands):
1997 1996 1995 ======================================== =========== = ========= = =========== Balance at January 1 $56,256 $55,415 $53,708 Allowance obtained through acquisitions 8,311 ----- 935 Recoveries on loans previously charged off 2,485 2,393 2,041 Loans charged off (17,277) (12,265) (9,837) - ------------------------------------------------- ------------ - ------------ Net loans charged off (14,792) (9,872) (7,796) Provision charged to operations 15,316 10,713 8,568 - ------------------------------------------------- ------------ - ------------ Balance at December 31 $65,091 $56,256 $55,415 ========================================= ========== = ========== = ==========
41 Total nonaccrual and restructured loan balances and related annual interest data were as follows (in thousands):
1997 1996 1995 - ------------------------------------- ---------- - --------- - ---------- Nonaccrual $20,520 $19,350 $19,142 Restructured 489 393 503 - ------------------------------------- ---------- - --------- - ---------- Total $21,009 $19,743 $19,645 - ------------------------------------- ---------- - --------- - ---------- Interest computed at original terms $2,144 $1,896 $2,045 Interest recognized 473 598 623 - ------------------------------------- ---------- - --------- - ----------
At December 31, 1997, there were no significant commitments to lend additional funds on these loans. The following is a summary presentation of loans that are considered to be impaired as defined under FASB Statement No. 114:
- ---------------------------------------------------------------------- --------- At December 31, 1997 1996 - ---------------------------------------------------------------------- --------- Recorded investment in impaired loans $12,805 $7,375 Amount of allowance for loan losses specifically allocated to impaired loans 1,540 1,560 - ---------------------------------------------------------------------- --------- For the years ended December 31, 1997 1996 1995 - ---------------------------------------------------------------------- --------- Average recorded investment in impaired loans 13,305 9,212 10,414 Interest income recognized on impaired loans 153 326 361 - ---------------------------------------------------------------------- ---------
Certain directors and executive officers of Keystone and its subsidiaries, and their associates, were indebted to the bank subsidiaries during 1997. Such loans were made in the ordinary course of business and on customary terms. Loan activity during 1997 with these related parties was as follows (in thousands): Beginning Balance Additions Repayments Ending Balance - --------------------- ------------------ ----------------- ----------------- $116,066 $102,287 $93,504 $124,849 Financial Derivatives, Hedging Activity, and Commitments Keystone engages in activities associated with the use of off-balance sheet derivative financial instruments (derivatives) and hedges to manage its exposure to changes in interest rates. Activities have included limited interest rate swap activity, forward commitments for mortgage banking inventory management, the use of short sales and put options to hedge against the potential deterioration in the value of indirect auto financings held for sale, loan commitments and standby letters of credit made in the ordinary course of its banking business. At December 31, 1997, outstanding hedging activity was limited to forward mortgage commitments related to management of its mortgage banking inventory. Under the terms of these commitments, Keystone agreed to deliver a specified volume of mortgage loans with a specified portfolio yield, and received a pre-established price commitment pursuant to timely delivery of the mortgage loans. The purpose of these arrangements is to manage the effect of interest rate changes on these loans between the date of the original loan commitment and the date of delivery for sale into the secondary market. At December 31, 1997, 42 Keystone had entered into commitments to deliver approximately $44,721,000 of mortgage loans for sale into the secondary market. The delivery dates for these commitments are short-term in nature and will expire at various dates in the first half of 1998. Keystone is a party to financial instruments with off-balance sheet risk used in the normal course of business to meet the financing needs of its customers. These financial instruments include loan commitments and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. Keystone's maximum exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for the loan commitments and standby letters of credit is the contractual or notional amount of those instruments. Keystone uses the same policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount and nature of collateral obtained, if deemed necessary, is based on management's credit evaluation of the couterparty. Standby letters of credit are agreements used by Keystone's customers as a means of improving their credit standings in dealing with others. Under these agreements, Keystone guarantees certain financial commitments of its customers. At December 31, 1997, outstanding commitments for loans and standby letters of credit were as follows (in thousands): Loan commitments $75,574 --------------------------- ------------ Standby letters of credit $1,027,782 --------------------------- ------------ Premises and Equipment The following summarizes premises and equipment at December 31, (in thousands): 1997 1996 - ---------------------------------------------- ----------- ------------ Land $12,801 $12,333 Buildings 97,298 84,085 Equipment 108,169 99,000 Leasehold improvements 15,741 14,676 - ---------------------------------------------- ----------- ------------ 234,009 210,094 Accumulated depreciation and amortization (117,394) (112,162) - ---------------------------------------------- ----------- ------------ Total $116,615 $97,932 - ---------------------------------------------- ----------- ------------ Depreciation and amortization expense amounted to $14,554,000 in 1997, $13,058,000 in 1996, and $11,616,000 in 1995. Keystone and its subsidiaries lease various equipment and buildings under operating lease agreements. In 1997, 1996, and 1995, total rent expense amounted to $7,377,000, $7,956,000, and $7,715,000, respectively. Future annual minimum lease payments do not significantly exceed historic levels. 43 Federal Home Loan Bank Borrowings The subsidiary banks of Keystone are members of a Federal Home Loan Bank (FHLB) and, as such, can take advantage of the FHLB program for overnight and term advances at published daily rates, which are advantageous to members as compared to issuing notes directly in the market. Under the terms of a blanket collateral agreement, advances from the FHLB are collateralized by first mortgage loans and securities. Advances available under this agreement are limited by available and qualifying collateral and the amount of FHLB stock held by the borrower. At December 31, 1997, Keystone member banks could borrow an additional $836,265,000 based on qualifying collateral. Such additional borrowing would require that the banks increase their investment in FHLB stock by $83,941,200. Outstanding borrowings from the Federal Home Loan Bank are summarized as follows (in thousands): - --------------------------------------------------------------- December 31, 1997 1996 - ---------------------------------------------------------------- Due 1997, 5.48% to 7.04% $------ $67,420 Due 1998, 5.45% to 7.71% 57,957 48,848 Due 1999, 4.75% to 6.51% 49,286 30,786 Due 2000, 5.54% to 6.51% 70,830 2,500 Due 2001, 4.92% to 6.80% 6,000 71,000 Due 2002, 5.25% to 6.08% 60,550 ------ Due After 2002, 4.75% to 7.23% 3,527 3,649 - ------------------------------------ -------------- ----------- $248,150 $224,203 - ------------------------------------ -------------- ------------ Of the December 31, 1997 outstanding balance, $164,900,000 was either adjustable, variable, or subject to conversion. Of the $164,900,000, $10,000,000 was variable with Prime and $13,500,000 was adjustable with LIBOR. The remaining $141,400,000 are advances which are subject to conversion to adjustable rates at the option of the FHLB at various dates in 1998 and 1999. In the event the FHLB elects to convert these advances to adjustable rates, Keystone has the option to prepay the borrowings without penalty. Long-term Debt Long-term debt at December 31 consisted of the following (in thousands): 1997 1996 - ----------------------------------------------- ----------- ----------- Medium-term notes, interest at 7.3% $99,777 $----- Other 2,016 2,573 - ----------------------------------------------- ----------- ----------- Total $101,793 $2,573 - ----------------------------------------------- ----------- ----------- On May 15, 1997, Keystone Financial Mid-Atlantic Funding Corp., a wholly-owned funding subsidiary of Keystone, issued $100 million of senior medium term notes under a $400 million shelf registration statement. The notes, which mature on May 15, 2004, provide for semi-annual interest payments at a fixed rate of 7.3%, and are unconditionally guaranteed by Keystone. The proceeds from the issuance of the notes were used primarily to finance the acquisition of First Financial of Western Maryland (see Mergers and Acquisitions footnote). 44 Shareholders' Equity Series A Junior Participating Preferred Stock (Preferred Stock) (par value $1.00 per share, with voting powers and dividends and liquidation rights per share equal to 187.5 times that of the current common stock) has been established in connection with the adoption of a Shareholders' Rights Plan (Rights Plan). Under the Rights Plan, 200,000 shares of Preferred Stock are reserved for issuance on the exercise of rights attached to the outstanding common stock. The rights are exercisable only if a person or group acquires or announces a tender or exchange offer to acquire 20% or more of Keystone's common stock. In the event a person or group acquires a 20% position, each right not owned by the person or group will entitle its holder to purchase at the exercise price of $70.00, a number of shares of common stock, 5.333 one-thousandths (0.005333) of a share of Preferred Stock, or other securities or assets of Keystone or common shares of the acquiring company having a market value equal to twice the exercise price. At any time after a person or group acquires 20% or more (but less than 50%) of the outstanding common stock, the Board of Directors may exchange part or all of the rights (other than the rights held by the person or group) for shares of common or 5.333 one-thousandths of a share of Preferred Stock on a one-for-one basis. The Board of Directors is entitled to redeem the rights at any time before a 20% position has been acquired. Unless extended, the rights will expire on February 8, 2000. Stock-based Compensation Keystone provides eligible employees and directors with various stock option and stock purchasing plans which are more fully described below. Keystone has adopted the disclosure only provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation", and accordingly, continues to account for its plans in accordance with APB Opinion No. 25 and related interpretations. As such, no compensation expense has been recognized for its stock option plans and employee stock purchase plan. Keystone has an employee "Stock Incentive Plan" and a "Nonemployee Directors' Stock Option Plan." Under the terms of these plans, Keystone has reserved for issuance a total of 2,875,000 shares of common stock for qualifying employees and nonemployee directors, of which approximately 2,836,000 are available for future grants. The plans provide for the issuance of nonqualified options and, under the employee plan, incentive stock options. Options are granted at an exercise price not less than the fair market value of Keystone common stock on the date of grant, vest in two years, and expire approximately ten years after the grant date. Keystone also has outstanding options pursuant to predecessor plans and plans of acquired banks. The following table provides a summary of options outstanding under the "Stock Incentive Plan," the "Nonemployee Directors' Stock Option Plan", and other predecessor or acquired plans. 45 Weighted Average Exercise Common Price Shares - ---------------------------- ------------ ------------ January 1, 1995 $16.63 1,954,121 Granted $20.70 201,645 Exercised $9.59 (279,300) Terminated $20.08 (50,830) - ---------------------------- ------------ ------------ December 31, 1995 $17.92 1,825,636 - ---------------------------- ------------ ------------ Granted $21.09 312,636 Exercised $10.60 (83,966) Terminated $20.88 (51,146) - ---------------------------- ------------ ------------ December 31, 1996 $18.62 2,003,160 - ---------------------------- ------------ ------------ Granted $25.40 307,339 Exercised $16.30 (443,815) Terminated $23.16 (21,926) - ---------------------------- ------------ ------------ December 31, 1997 $19.61 1,844,758 - ---------------------------- ------------ ------------ The following table summarizes information about stock options outstanding at December 31, 1997: - ------------------------------------------------------- --------------------- Options Outstanding Options Exercisable - ------------------------------------------------------- --------------------- Weighted- Average Weighted- Weighted- Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life (years) Price Exercisable Price - ---------------------------------------------- --------------------------------- $4.95 - $10.50 226,944 3.03 $8.95 226,944 $8.95 $11.13 - $15.98 225,007 3.35 $14.42 218,245 $14.39 $16.46 - $20.92 478,224 6.83 $19.79 244,590 $19.53 $21.08 - $26.31 912,763 6.81 $23.41 502,878 $22.22 $36.00 - $39.94 1,820 4.80 $37.73 ----- ----- - -------------------------------------------------------------------------------- $4.95 - $39.94 1,844,758 5.93 $19.61 1,192,657 $17.71 - -------------------------------------------------------------------------------- Options exercisable at the end of 1996 and 1995 were 1,333,422 and 883,029, respectively. Under the "Employee Stock Purchase Plan", eligible employees are provided an opportunity to purchase Keystone common stock at a discount from market price. The Plan provides for the purchase of stock through payroll deductions at a price which is the lesser of 85% of the fair market value of the common stock as of the first or last day of the annual purchase period. The purchase period commences on July 1 and ends on June 30. Through modifications made to the plan in 1995, Keystone reserved 750,000 shares of common stock, of which 559,000 remain available for future purchases. The amount of common shares issued under this program in 1997, 1996, and 1995 were as follows: 46 Price Per Shares Share Issued - -------------------------- ----------- ---------- 1997 $19.20 94,195 1996 $15.79 97,196 1995 $15.90 74,249 The following pro forma amounts indicate the net income and earnings per share that would have resulted if compensation expense for the stock option plans and employee stock purchase plan was determined under the recognition provisions of Statement No. 123 using the fair value of the awards at the grant date. 1997 1996 1995 - ----------------------- ------------- ------------- ------------ ------------- Net Income As reported $87,917 $89,506 $79,449 (in thousands) Pro forma 86,457 88,348 78,876 Diluted earnings per As reported $1.68 $1.70 $1.59 share Pro forma 1.65 1.68 1.58 The pro forma effect is not fully reflected in 1995 since Statement No. 123 is applicable only to options granted subsequent to December 31, 1994, and Keystone's options have a two-year vesting period. Information regarding the weighted-average grant-date fair values for stock options and purchase rights granted in 1997, 1996, and 1995 were as follows: Assumptions ------------------------------------ Grant Date Dividend Expected Interest Fair Value Yield Volatility Rate Life (Per Option /Share) - ------------------------------ ------------------------------------------------- Stock option plans: 1997 $4.20 4.2% 15% 6.37% 7yrs 1996 $3.01 4.6% 15% 5.50% 7yrs 1995 $3.34 4.3% 15% 7.88% 7yrs Employee stock purchase plan: 1997 $6.30 4.5% 15% 5.63% 1yr 1996 $4.28 4.1% 12% 5.75% 1yr 1995 $3.50 4.8% 13% 5.64% 1yr - ------------------------------ ------------------------------------------------- The fair values were estimated using the Black-Scholes model. This model is predominantly used to value traded options, which differ from Keystone's options, and requires the use of numerous assumptions, many of which are subjective in nature. Therefore, the pro forma results are estimates of the impact to operations if compensation expense had been recognized for all stock based compensation plans and are not indicative of the impact on future periods. Keystone also has a Management Stock Ownership Program (the "Program") which is intended, among other things, to promote alignment of management and shareholder interests and to encourage management to focus on value creation. To accomplish these purposes, the Program establishes stock ownership goals for executive and senior officers of the Corporation to be achieved over a five-year period. In order to assist the officers in attaining their stock ownership goals, a related plan provides for nonrecourse, noninterest-bearing loans, in amounts not to 47 exceed 50% of the officer's stock ownership goal, to be used to purchase shares of Keystone common stock at fair market value. The loans are secured by collateral having an initial value of 120% of the loan amount and consisting of the shares of Keystone stock purchased with the loan plus additional shares of stock or other acceptable collateral owned by the executive. The aggregate number of shares which may be issued and sold pursuant to the Program is limited to 750,000 shares of Common Stock, subject to proportionate adjustment in the event of stock splits and similar events. At December 31, 1997, approximately 650,000 shares remain available for future issuances. During 1997, 1996 and 1995, 6,000, 19,000 and 72,000 shares, respectively, were issued under the Program. At December 31, 1997 and 1996, the amount executives participating in the Program owed Keystone for financed purchases totaled $1,709,000 and $1,786,000, respectively. Keystone has a dividend reinvestment plan for shareholders under which additional shares of Keystone common stock may be purchased at market value with reinvested dividends and voluntary cash payments. Keystone has reserved 900,000 shares of common stock for this Plan, and approximately 336,000 shares remain unissued. The following number of shares of Keystone common stock were purchased pursuant to this plan: 130,000 in 1997, 98,000 in 1996, and 89,000 in 1995. Employee Benefit Plans Keystone provides a noncontributory defined benefit pension plan covering substantially all full-time employees. Plan benefits are based on years of service and qualifying compensation during the final years of employment. A summary of the components of net periodic pension expense for Keystone's defined benefit plan was as follows for the years ended December 31 (in thousands):
1997 1996 1995 - -------------------------------------------------- ---------- ---------- ----------- Service cost benefits earned during the period $2,907 $2,793 $2,648 Interest cost on projected benefit obligation 5,458 5,166 4,547 Actual return on plan assets (20,922) (9,802) (13,590) Net amortization and deferral 12,940 2,377 7,189 - -------------------------------------------------- ---------- ---------- ----------- Pension expense $383 $534 $794 ================================================== ========== ========== ===========
The following table sets forth the funded status and amounts recognized in Keystone's consolidated statement of condition as of December 31, (in thousands): 1997 1996 - -------------------------------------------------------- ---------- ----------- Actuarial present value of the accumulated benefit obligation, including vested benefits of $66,042 in 1997 and $59,432 in 1996 $66,789 $59,964 - -------------------------------------------------------- ----------- ----------- Actuarial present value of projected benefit obligation for service rendered to date (84,890) $(75,060) Fair value of plan assets 106,239 89,560 - -------------------------------------------------------- ----------- ----------- Plan assets in excess of projected benefit obligation 21,349 14,500 Unrecognized net assets at transition (3,137) (3,862) Unrecognized net gain (12,839) (5,181) Unrecognized prior service cost (1,497) (1,501) - -------------------------------------------------------- ---------- ----------- Prepaid pension expense, included in other assets $3,876 $3,956 ======================================================== =========== =========== 48 Actuarial assumptions used in the determination of the projected benefit obligation were as follows: 1997 1996 1995 - --------------------------------------------------- -------- -------- ------- Rate of increase in future compensation levels 5.50% 5.50% 5.50% Expected long-term rate of return on plan assets 8.50 8.50 8.00 Weighted average discount rate 7.00 7.50 7.50 - --------------------------------------------------- -------- -------- ------- The unrecognized net assets at transition and the unrecognized prior service costs are being amortized over the expected service lives of eligible employees, which approximate 15 years. Trusteed pension plan assets consist primarily of equity and fixed income securities and short-term investments. A 401(k) deferred savings plan covers eligible employees of Keystone. The plan provides for a matching employer contribution equal to 60% of the employee contribution. While empolyees can contribute up to 15% of their compensation, the employer match is limited to 5% of employee compensation. Matching contributions are paid entirely in Keystone stock. In July 1992, Keystone established a leveraged KSOP and borrowed $3,500,000 for the purpose of acquiring 186,000 shares of Keystone stock. The shares purchased by the KSOP are used to meet matching contribution requirements of the 401(k) plan. Dividends received on shares held by the KSOP are used to service the principal and interest payments on the borrowing. Debt service is also provided by matching cash contributions required under the original 401(k) plan. Benefit expense is recognized based on a percentage of total debt service for the current year to total debt service over the life of the borrowing. Group-based incentive plans include both long-term and annual incentive programs designed to focus management and employee efforts on profit performance objectives and revenue growth targets. Employees earn awards under these programs based on the profitability of their operating unit and/or Keystone or based on achievement of revenue-driven sales objectives. Expenses for these plans, a predecessor profit sharing plan, and the above-mentioned 401(k) plan totaled $9,160,000 in 1997, $6,640,000 in 1996, and $6,467,000 in 1995. 49 Income Taxes Deferred income taxes reflect the tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred tax assets and liabilities are as follows (in thousands): December 31, - ----------------------------------------- ------------------------- Deferred tax assets: 1997 1996 - ----------------------------------------- ------------ ------------ Allowance for credit losses $20,717 $16,388 Deferred liabilities 1,879 945 Compensation accruals 3,229 2,599 - ----------------------------------------- ------------ ------------ Deferred tax liabilities: - ----------------------------------------- ------------ ------------ Lease financing activities (47,672) (33,950) Net unrealized gains on securities available-for-sale (4,600) (2,465) Premises and equipment (3,862) (2,542) Intangible assets (4,044) (1,494) Other 287 (1,086) - ----------------------------------------- ------------ ------------ Net deferred tax liability ($34,066) $(21,605) - ----------------------------------------- ------------ ------------ The provision for income taxes consisted of the following components (in thousands): 1997 1996 1995 - --------------------------------- --------- ---- ----------- --- ---------- Deferred provision $14,537 $14,880 $11,219 Current provision: Federal taxes 23,229 21,441 22,217 State taxes 1,187 859 565 - --------------------------------- --------- ---- ----------- --- ---------- Total $38,953 $37,180 $34,001 - --------------------------------- --------- ---- ---------- ---- ---------- A reconciliation of income tax expense and the amounts which would have been recorded based upon statutory rates (35%) was as follows (in thousands): 1997 1996 1995 - ------------------------------------ ---------- ---- ---------- ---- ---------- Provision on pre-tax income at statutory rates $44,405 $44,340 $39,708 Tax exempt interest income (5,089) (6,212) (6,863) Other (363) (948) 1,156 - ----------------------------------- ---------- ---- ---------- ---- ----------- Total $38,953 $37,180 $34,001 - ------------------------------------ ---------- ---- ---------- ---- ---------- Effective Rate 30.7% 29.3% 30.0% ==================================== ========== ==== ========== ==== ========== Income taxes attributable to investment security gains were $2,125,000 in 1997, $305,000 in 1996, and $626,000 in 1995. 50 Earnings Per Share Effective December 31, 1997, Keystone adopted Statement of Financial Accounting Standards No.128, "Earnings Per Share." This statement requires the dual presentation of basic and diluted earnings per share, and requires the restatement of all prior period earnings per share amounts. The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations (in thousands, except per share data): 1997 1996 1995 - -------------------------------- --------------- -------------- -------------- Numerator $87,917 $89,506 $79,449 Denominators: Basic shares outstanding 51,693 52,119 49,557 Dilutive option effect 627 362 289 - -------------------------------- --------------- -------------- -------------- Dilutive shares outstanding 52,320 52,481 49,846 - -------------------------------- --------------- -------------- -------------- EPS: Basic $1.70 $1.72 $1.60 Diluted $1.68 $1.70 $1.59 - -------------------------------- --------------- -------------- -------------- Regulatory Capital Requirements Bank regulators have set forth requirements for risk-based capital, which resulted in the establishment of international capital standards for banks. The following table provides Keystone's risk-based capital position at the end of 1997 and 1996 and a comparison to the various regulatory capital requirements (in thousands):
1997 1996 Well- ---- ---- Capitalized Minimum Amount Ratio Amount Ratio Ratio Ratio - --------------------- -------- ------- --------- -------- ------------- -------- Total capital (to risk-weighted assets) $675,575 13.75% $688,794 15.66% 10% 8% Tier 1 capital (to risk-weighted assets) 614,172 12.50 634,590 14.43 6 4 Tier 1 capital (to average assets) 614,172 9.15 634,590 10.03 5 4 - --------------------- -------- -------- --------- -------- ------------ --------
At December 31, 1997 and 1996, each significant subsidiary of Keystone had capital at or above the "well-capitalized" level for each of the three ratios. Failure to meet any one of the minimum capital ratios would result in an institution being classified as "undercapitalized" or "significantly undercapitalized". Such classifications could disrupt dividends, capital distributions, or affiliate management fees. In addition, other restrictions, prohibitions, and related supervisory actions would be likely depending upon the overall level of capital. Keystone anticipates no problems in meeting the current or future capital standards. As of December 31, 1997, each subsidiary bank had been categorized as "well-capitalized" by its primary regulator at its most recent examination. 51 Restrictions Under Federal Reserve regulations, depository institutions must maintain reserves in the form of cash or amounts on deposit with Federal Reserve Banks. For the year ended December 31, 1997, Keystone's bank subsidiaries maintained average reserve balances of approximately $53,252,000 in compliance therewith. Dividends that may be paid to Keystone by the subsidiary banks are limited by state and federal regulations. The related amount available for dividends aggregated $222,000,000 at December 31, 1997. Federal Reserve regulations also limit each subsidiary bank as to the amount it may loan its affiliates, including Keystone. At December 31, 1997, the maximum amount available for loans to affiliates approximated 10% of consolidated net assets. Fair Value of Financial Instruments FASB Statement No. 107 requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair value is based on estimates using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison with independent markets, and, in many cases, could not be realized in immediate settlement of the instrument. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of Keystone Financial, Inc. 52 The following schedule displays at December 31, the carrying values and related estimated fair values for financial instruments (in thousands): 1997 1996 ------------------------------------------- ----------------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value - ------------------------------------------- ------------------------------------ Financial Assets: Cash and due from banks $206,223 $206,223 $206,972 $206,972 Federal funds sold and other 27,228 27,228 81,413 81,413 Investment securities available for sale 1,091,400 1,091,400 1,210,094 1,210,094 Investment securities held to maturity 528,388 538,218 379,958 383,526 Loans held for resale 43,055 43,055 51,225 51,225 Loans, net of allowance for credit losses 4,275,218 4,447,413 3,948,949 3,996,601 Leases 372,257 380,855 331,265 336,101 - ------------------------------------------- ------------------------------------ Financial Liabilities: Time deposits $3,023,702 $3,048,175 $2,842,032 $2,848,996 Other deposits 2,209,463 2,209,463 2,217,689 2,217,689 Short-term borrowings 425,890 425,890 397,964 397,964 FHLB borrowings 248,150 249,629 224,203 222,349 Long-term debt 101,793 101,793 2,573 2,573 - ------------------------------------------- ------------------------------------ Off-Balance Sheet Instruments: Lending commitments and letters of credit $----- $(684) $----- $(2,625) All other $----- $(217) $----- $(79) - ------------------------------------------- ------------------------------------ The following methods and assumptions were used to estimate fair market value disclosures for financial instruments: Cash and short-term instruments: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets' fair values. Investment securities (including mortgage-backed securities): Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Loans receivable: For variable-rate loans that reprice frequently and have no significant changes in credit risk, fair values are based on carrying values. The fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of comparable credit quality. The carrying amount of accrued interest approximates its fair value. Deposit liabilities: The fair values disclosed for demand deposits (e.g., interest and noninterest checking, savings, and certain types of money market accounts) are reported at a value equal to the amount payable on demand at the reporting date. The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair market value at the reporting date. Fair values for fixed-rate certificates of deposit are estimated 53 using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities. Short-term borrowings: The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings approximate their fair values. FHLB and long-term borrowings: The fair values of Keystone's FHLB and long-term borrowings are estimated using discounted cash flow analyses, based on Keystone's current incremental borrowing rates for similar types of borrowings. Unfunded lending commitments and letters of credit: Fair values for Keystone's unfunded lending commitments and letters of credit 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. Other off-balance sheet instruments: Fair values for off-balance sheet instruments including interest rate swaps, forward mortgage commitments, and securities underlying put options and short sales are based on dealer quotes and current trading prices. The fair values represent the estimated amounts that Keystone would receive or pay to terminate the contracts, taking into account current interest rates. Mergers and Acquisitions On May 30, 1997 Keystone completed the merger of Financial Trust Corp (Financial Trust), a financial institution with $1.2 billion of assets headquartered in Carlisle, Pennsylvania. Under the terms of the agreement, each Financial Trust shareholder received Keystone common stock at a fixed exchange ratio of 1.65 shares for each Financial Trust share, resulting in the issuance of 14.2 million shares of Keystone stock. The merger was accounted for under the pooling-of-interests method of accounting, and, as such, all prior period information has been restated. During the second quarter of 1997, Keystone recorded previously announced special charges associated with the merger of Financial Trust. These charges, which totaled $11.4 million, included the estimated expenses for professional services, employment matters, system conversions and occupancy and equipment. The following summarizes the activity in the special charge accrual (in thousands): Paid Balance at Initial During December 31, Accrual 1997 1997 - ---------------------------- -------------- ---------------- -------------- Professional $2,400 $2,197 $203 Employment matters 1,700 1,002 698 Integration and conversion 2,785 2,646 139 Net occupancy and equipment 2,575 1,114 1,461 Other 1,950 1,145 805 - ---------------------------- -------------- ---------------- -------------- $11,410 $8,104 $3,306 - ---------------------------- -------------- ---------------- -------------- The majority of the remaining expenses will be paid during 1998. 54 The results of operations and financial condition of Financial Trust were combined with Keystone as follows (in thousands): Financial Consolidated For the year ended: Keystone Trust Keystone - ---------------------------- --------------- ----------------- ---------------- 1996: Net interest income $209,763 $52,356 $262,119 Net income 69,475 20,031 89,506 1995: Net interest income $197,352 $48,659 $246,011 Net income 61,314 18,135 79,449 - ---------------------------- --------------- ----------------- ---------------- December 31, 1996: - ---------------------------- --------------- ----------------- ---------------- Assets $5,231,268 $1,219,311 $6,450,579 Liabilities 4,723,961 1,066,212 5,790,173 Shareholders' equity 507,307 153,099 660,406 - ---------------------------- --------------- ----------------- ---------------- Financial data for Keystone and Financial Trust from the beginning of 1997 to the date of consummation, May 30, 1997, is presented below: Financial Consolidated Keystone Trust Keystone - ------------------------ ----------------- ------------------ ---------------- Net interest income $89,411 $22,623 $112,034 Net income 28,773 9,225 37,998 Dividends declared 23,120 4,796 27,916 - ------------------------ ----------------- ------------------ ---------------- On May 29, Keystone completed the acquisition of First Financial Corporation of Western Maryland (FFWM), a thrift holding company with assets approximating $355 million based in Cumberland, Maryland. Under the terms of the agreement with FFWM, each of its shareholders received Keystone common stock at a fixed exchange ratio of 1.29 shares of Keystone for each FFWM share, or cash. The issuance of 1.6 million Keystone shares amounted to 60% of the total consideration of $76 million and, accordingly, the transaction was accounted for as a purchase. The transaction resulted in the recognition of goodwill and core deposit intangibles totaling approximately $34 million and $6 million, respectively, which will be amortized over 25 and 10-year periods. The results of FFWM have been included herein from the consummation date of May 29, 1997. Pro forma results of operations as though FFWM had been combined with Keystone at the beginning of the periods presented do not differ materially from consolidated results presented herein. During 1995, Keystone completed mergers of two Pennsylvania bank holding companies, Shawnee Financial Services Corporation (Shawnee) and National American Bancorp (NAB); and the acquisition of Martindale Andres & Company (Martindale), a Philadelphia-based asset management firm. The Shawnee and NAB mergers resulted in the issuance of 501,000 and 1,158,000 shares, respectively, of Keystone stock in exchange for 80,200 and 579,000 shares of Shawnee and NAB, respectively. The bank subsidiaries of both Shawnee and NAB were merged into existing Keystone affiliated banks and the mergers were accounted for under the pooling of interests method of accounting. Due to the immaterial impact of both 55 transactions to Keystone's financial position and results of operation, prior periods were not restated. Consolidated results of Keystone include Shawnee's and NAB's results of operations from the consummation dates of October 10, 1995 and December 29, 1995, respectively. The acquisition of Martindale Andres, which occurred on November 30, 1995 was accounted for under the purchase method of accounting and, accordingly, the results of Martindale's operations were included in Keystone's consolidated results beginning December 1, 1995. Pro forma results of operations of Keystone as though Martindale had been acquired as of January 1 of the respective periods would not have been materially different from the consolidated results presented herein. The purchase price, consisting of both cash and shares of Keystone common stock, was not significant to Keystone's financial condition. 56 Parent Company Financial Statements The following parent company condensed statements reflect the financial condition and results of operations of Keystone (in thousands): Statements of Condition December 31, 1997 1996 - ----------------------------------------------- ------------ ------------ Assets: Cash $1,489 $1,027 Investment securities 65,024 22,383 Investments in: Subsidiary banks 630,102 591,786 Other subsidiaries 115,624 54,362 Other assets 889 9,911 - ----------------------------------------------- ------------ ------------ TOTAL ASSETS $813,128 $679,469 - ----------------------------------------------- ------------ ------------ Liabilities: Long-term debt $100,106 $1,669 Other liabilities 27,537 17,394 - ----------------------------------------------- ------------ ------------ TOTAL LIABILITIES 127,643 19,063 Shareholders' Equity 685,485 660,406 - ----------------------------------------------- ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $813,128 $679,469 - ----------------------------------------------- ------------ ------------ Statements of Income Year Ended December 31, 1997 1996 1995 - -------------------------------------------- ---------- ----------- ----------- Income: Dividends from subsidiaries: Bank subsidiaries $67,305 $71,891 $48,363 Other subsidiaries ---- 134 30 Expenses 11,627 2,934 6,889 - -------------------------------------------- ---------- ----------- ----------- Income before taxes and undistributed earnings of subsidiaries 55,678 69,091 41,504 Income taxes (benefit) (3,712) (799) (2,630) Equity in undistributed earnings of subsidiaries 28,527 19,616 35,315 - --------------------------------------------- ---------- ----------- ---------- NET INCOME $87,917 $89,506 $79,449 - -------------------------------------------- ---------- ----------- ----------- 57 Statements of Cash Flows Year Ended December 31, 1997 1996 1995 - ------------------------------------------ ----------- ----------- ----------- OPERATING ACTIVITIES: Net income $87,917 $89,506 $79,449 Equity in undistributed earnings (28,527) (19,616) (35,315) Other 14,729 1,042 (10,842) - ------------------------------------------ ----------- ----------- ----------- NET CASH PROVIDED BY OPERATING ACTIVITIES 74,119 70,932 33,292 - ------------------------------------------ ----------- ----------- ----------- INVESTING ACTIVITIES: Net (increase) decrease in investments (38,529) (13,030) 9,147 Investments in subsidiaries (24,459) (8,451) (4,042) - ------------------------------------------ ----------- ----------- ----------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (62,988) (21,481) 5,105 - ------------------------------------------ ----------- ----------- ----------- FINANCING ACTIVITIES: Cash dividends declared (55,964) (46,998) (39,875) KSOP activity: Common stock proceeds 819 302 613 Payment of debt (523) (569) (562) Proceeds of long-term debt 98,960 --- --- Acquisition of treasury stock (72,586) (9,915) (6,649) Proceeds from issuance of common stock under benefits plans 12,908 7,190 8,151 Other 5,717 34 573 - ------------------------------------------ ----------- ----------- ----------- NET CASH USED IN FINANCING ACTIVITIES (10,669) (49,956) (37,749) - ------------------------------------------ ----------- ----------- ----------- Increase (decrease) in cash 462 (505) 648 Cash at beginning of year 1,027 1,532 884 - ------------------------------------------ ----------- ----------- ----------- CASH AT END OF YEAR $1,489 $1,027 $1,532 - ------------------------------------------ ----------- ----------- ----------- 58 Net Interest Income Keystone's largest source of revenue is net interest income, which is the difference between interest on earning assets and interest expense on deposits and other borrowed funds. The following table provides a summary of net interest income performance for the three years ended December 31, 1997:
1997 1996 1995 --------------------------- --------------------------- -------------------------- (in thousands) Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate - ----------------------------------------- ---------- -------- ----- --------- -------- ----- --------- -------- ---- ASSETS Federal funds sold and other $84,032 $5,340 6.35% $106,374 $5,668 5.33% $153,528 $9,063 5.90% Investment securities: Negotiable money market investments 108,278 6,155 5.68 153,631 8,583 5.59 98,541 5,773 5.86 Taxable investment securities 1,174,674 77,034 6.56 1,143,073 71,458 6.25 1,060,838 64,230 6.05 Nontaxable investment securities(1) 225,384 17,557 7.79 235,731 18,953 8.04 223,046 19,525 8.75 Loans held for resale 77,330 6,408 8.29 53,656 4,688 8.74 21,378 1,636 7.65 Consumer loans (2) (3) 1,523,659 136,257 8.94 1,271,662 113,377 8.92 1,159,363 103,071 8.89 Real estate loans (1) (2) (3) 2,239,664 196,964 8.79 2,209,179 196,152 8.88 2,187,063 193,349 8.84 Commercial loans (1) (2) (3) 809,306 73,883 9.13 708,328 63,514 8.97 640,408 59,457 9.28 - ----------------------------------------- ---------- -------- ----- --------- -------- ----- --------- -------- ---- Total earning assets 6,242,327 $519,598 8.32% 5,881,634 $482,393 8.20% 5,544,165 $456,104 8.23% - ----------------------------------------- ---------- -------- ----- --------- -------- ----- --------- -------- ---- Allowance for credit losses (61,800) (56,211) (55,324) Other assets 449,475 407,225 382,395 - ----------------------------------------- ---------- -------- ----- --------- -------- ----- --------- -------- ---- Total Assets $6,630,002 $6,232,648 $5,871,236 - ----------------------------------------- ---------- -------- ----- --------- -------- ----- --------- -------- ---- LIABILITIES AND SHAREHOLDERS' EQUITY NOW deposits $330,514 $4,865 1.47% $532,480 $7,889 1.48% $586,576 $10,614 1.81% Savings deposits 600,759 11,065 1.84 569,814 12,515 2.20 603,918 13,826 2.29 Money market deposits 650,082 16,306 2.51 536,237 12,732 2.37 501,709 12,929 2.58 Time deposits 2,967,437 162,662 5.48 2,759,973 153,121 5.55 2,501,740 139,202 5.56 Short-term borrowings 371,645 18,134 4.88 323,938 14,506 4.48 257,113 12,747 4.96 FHLB borrowings 240,533 14,677 6.10 159,503 10,175 6.38 178,791 10,955 6.13 Long-term debt 64,016 4,785 7.47 3,569 363 10.17 5,574 502 9.01 - ----------------------------------------- ---------- -------- ----- --------- -------- ----- --------- -------- ---- Total interest-bearing liabilities 5,224,986 $232,494 4.59% 4,885,514 $211,301 4.33% 4,635,421 $200,775 4.33% - ----------------------------------------- ---------- -------- ----- --------- -------- ----- --------- -------- ---- Demand deposits 606,907 604,536 576,445 Other liabilities 135,789 107,247 92,008 Shareholders' equity 662,320 635,351 567,362 - ----------------------------------------- ---------- -------- ----- --------- -------- ----- --------- -------- ---- Total Liabilities and Equity $6,630,002 $6,232,648 $5,871,236 - ----------------------------------------- ---------- -------- ----- --------- -------- ----- --------- -------- ---- Interest rate spread 3.87% 3.87% 3.90% - ----------------------------------------- ---------- -------- ----- --------- -------- ----- --------- -------- ---- Net interest income and net interest margin $287,104 4.59% $271,092 4.61% $255,329 4.61% Tax-equivalent adjustment (8,860) (8,973) (9,318) - ----------------------------------------- ---------- -------- ----- --------- -------- ----- --------- -------- ---- Net interest income $278,244 $262,119 $246,011 - ----------------------------------------- ---------- -------- ----- --------- -------- ----- --------- -------- ----
59 The following table sets forth for the periods indicated a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates (in thousands):
1997 change from 1996 1996 change from 1995 --------------------------- -------------------------- Total Change due to(4) Total Change due to(4) Change Volume Rate Change Volume Rate ------ ------ ---- ------ ------ ---- Interest income on: Federal funds sold and other ($328) ($1,400) $1,072 ($3,395) ($2,606) ($789) Investment securities(1) 1,752 (156) 1,908 9,466 9,697 (231) Loans held for resale 1,720 1,973 (253) 3,052 2,790 262 Loans and leases (1)(2)(3) 34,061 39,782 (5,721) 17,166 17,844 (678) - --------------------------------------------------------------------------------------------------------------- 37,205 40,199 (2,994) 26,289 27,725 (1,436) - --------------------------------------------------------------------------------------------------------------- Interest expense on: NOW deposits 3,024 2,973 51 2,725 919 1,806 Savings deposits 1,450 (652) 2,102 1,311 762 549 Money market deposits (3,574) (3,968) 394 197 (1,641) 1,838 Time deposits (9,541) (2,623) (6,918) (13,919) (13,452) (467) Short-term borrowings (3,628) (2,255) (1,373) (1,759) (3,079) 1,320 FHLB borrowings (4,502) (4,962) 460 780 1,217 (437) Long-term debt (4,422) (4,543) 121 139 198 (59) - --------------------------------------------------------------------------------------------------------------- (21,193) (16,030) (5,163) (10,526) (15,076) 4,550 - --------------------------------------------------------------------------------------------------------------- Net Interest Income Change - Tax Equivalent $16,012 $24,169 ($8,157) $15,763 $12,649 $3,114 - --------------------------------------------------------------------------------------------------------------- (1) Interest income and yields are adjusted to a fully taxable-equivalent basis using a 35% tax rate. (2) Non-performing loans are included in the average balances. (3) Interest on loans includes fees on loans of $6,523,000 in 1997, $5,954,000 in 1996, and $3,696,000 in 1995. (4) The change in interest due to both rate and volume has been allocated to the volume and rate changes in proportion to the absolute dollar amounts of each change. 60
GAP Interest rate sensitivity is evidenced by the changes in net interest income and net interest margin relative to changes in market interest rates. One indicator of interest rate sensitivity is GAP, which measures the volume difference between interest rate sensitive assets and liabilities. The following table apportions the balance sheet at December 31, 1997, into rate sensitive periods based on the repricing or maturity dates of the various cash-flow streams (in thousands). 61
Rate-Sensitive - --------------------------------------------------------------------------------------------------------------------- 1 to 90 91 to 180 181 to 360 1 to 2 Beyond Days Days Days Years 2 Years Total - --------------------------------------------------------------------------------------------------------------------- Federal funds sold and other $ 27,228 $ - $ - $ - $ - $ 27,228 Investment securities 300,189 50,838 132,199 159,565 976,997 1,619,788 Loans held for resale 16,134 3,193 21,833 1,895 - 43,055 Consumer loans 360,682 119,823 220,418 350,150 502,674 1,553,747 Consumer mortgages 112,868 110,925 162,332 72,512 403,590 862,227 Commercial real estate loans 507,991 57,788 116,623 142,936 559,585 1,384,923 Commercial loans 653,298 21,314 22,199 34,920 179,938 911,669 - --------------------------------------------------------------------------------------------------------------------- Total earning assets 1,978,390 363,881 675,604 761,978 2,622,784 6,402,637 - --------------------------------------------------------------------------------------------------------------------- Other assets - - - - 438,700 438,700 - --------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $1,978,390 $ 363,881 $ 675,604 $ 761,978 $3,061,484 $6,841,337 - --------------------------------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY NOW deposits $ 226,385 $ - $ - $ - $ 385,465 $ 611,850 Savings deposits 69,230 - - - 169,492 238,722 Money market deposits 366,772 9,839 9,839 - 335,277 721,727 Time deposits 1,218,939 359,177 465,119 603,034 377,433 3,023,702 Short-term borrowings 404,915 200 100 20,675 - 425,890 FHLB borrowings 110,142 27,350 43,925 43,689 23,044 248,150 Long-term debt 1,972 44 - - 99,777 101,793 - --------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 2,398,355 396,610 518,983 667,398 1,390,488 5,371,834 - --------------------------------------------------------------------------------------------------------------------- Demand deposits - - - - 637,164 637,164 Other liabilities - - - - 146,854 146,854 Shareholders' equity - - - - 685,485 685,485 - --------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $2,398,355 $ 396,610 $ 518,983 $ 667,398 $2,859,991 $6,841,337 - --------------------------------------------------------------------------------------------------------------------- Interest Rate Sensitivity $ (419,965) $ (32,729) $ 156,621 $ 94,580 $ 201,493 Cumulative GAP $ (419,965) $(452,694) $ (296,073) $ (201,493) - ---------------------------------------------------------------------------------------------------------------------
62 Other Liquidity Elements The predominant source of income from earning assets is derived from the loan portfolio. Commercial loans and commercial loans secured by real estate comprise 49% of total loans and are closely monitored in terms of the volume of loans which are sensitive to changes in interest rates. The following table shows the maturity of commercial loans and commercial loans secured by real estate as of December 31, 1997(in thousands):
After One But Within After Within Five Five One Year Years Years Total - ------------------------------------ ----------- ---------- ----------- ------------ Commercial $485,357 $265,354 $160,958 $911,669 Commercial real estate 273,842 431,993 679,088 1,384,923 - ------------------------------------ ----------- ---------- ----------- ------------ $759,199 $697,347 $840,046 $2,296,592 - ------------------------------------ ----------- ---------- ----------- ------------ Loans maturing after one year with: Fixed interest rates: Commercial $137,266 $69,143 Commercial real estate 208,622 347,346 Variable interest rates: Commercial 128,088 91,815 Commercial real estate 223,371 331,742 - ------------------------------------ ----------- ---------- ----------- ------------ Total $697,347 $840,046 - ------------------------------------ ----------- ---------- ----------- ------------
Deposits with balances exceeding $100,000 and short-term borrowings are not considered core funding sources because they are generally short-term in nature and are subject to competitive bids. The following is a maturity summary of deposits of $100,000 or more at December 31, 1997 (in thousands): Certificates of Other Time Deposit of Deposits of $100,000 or more $100,000 or more - ----------------------------------- ------------------ ------------------ 3 months or less $139,618 $4,473 Over 3 months through 6 months 57,530 3,881 Over 6 months through 12 months 45,997 5,969 Over 12 months 83,824 24,109 - ----------------------------------- ------------------ ------------------ Total $326,969 $38,432 - ----------------------------------- ------------------ ------------------ 63 The following table presents the amounts and interest rates for federal funds purchased and security repurchase agreements for each of the last three years (in thousands):
1997 1996 1995 - ---------------------------------------------- ------------ ----------- ------------ Balance at December 31, $399,730 $368,886 $312,494 Weighted average interest rate at year end 4.75% 4.75% 4.52% Maximum amount outstanding at any month end $405,268 $377,727 $322,256 Average amount outstanding during the year $367,102 $307,225 $246,357 Weighted average interest rate during the year 4.78% 4.58% 5.00% - ---------------------------------------------- ------------ ----------- ------------
Investment Portfolio Analysis Keystone's investment policy specifically addresses the use of derivatives and other hedging activities and provides for specific restrictions on the type and extent of Keystone's exposure. A narrow definition of financial derivatives includes off-balance sheet instruments such as futures, forwards, swaps, and options which are designed to manage various types of business risks. Keystone has historically made limited use of the off-balance sheet derivatives known as "interest rate swaps" as a means to manage the income exposure associated with changes in interest rates, as well as forward commitments, put options, and short sales to manage exposure to market risk. A broader definition of derivatives would include any financial instrument which derives its value, or contractually required cash flows, from the price of some other security or index. Keystone's investment in this form of financial derivatives is limited to some forms of collateralized mortgage obligations (CMO's) and structured notes. The following is a brief description of both "on" and "off"-balance sheet derivatives and other hedging activity utilized by Keystone. Interest Rate Swaps Interest rate swaps are "off"-balance sheet instruments which provide for the exchange of interest payments on a specified principal amount (notional amount) for a specified period of time. Investment policy requires that Keystone may execute a swap contract only as a hedge of an interest rate position and not for the purpose of speculation or trading. That policy further requires that swap contracts must be approved in advance by the affiliate banks' president and parent company executives, and that swap counterparties must be reviewed for credit-worthiness on at least an annual basis. Keystone's policy also sets forth specific limitations on exposure to a single counterparty and sets an aggregate limit on the notional value of interest rate swaps at 50% of capital. Other Hedging Activity Forward mortgage commitments, as well as put options and short sales of U.S. Treasury securities, have been used to reduce the market risk, associated with interest rate fluctuations, of fixed-rate consumer mortgages and indirect automobile loans held for sale. In accordance with Keystone's written policy, such transactions must be ratified by the Board of Directors and can only be executed as a hedge of market risk and not for the purpose of speculation or trading. Such activity is self-limited by the level of loan production. CMO's Purchases of CMO's are restricted principally to U.S. Government issues that have passed various regulatory standards associated with mortgage extension or prepayment risk. All Keystone CMO holdings can be disaggregated into groupings which more accurately define the extent of mortgage extension or prepayment risk, and include PAC's (planned amortization class), VADM's (very accurately 64 defined maturity), TAC's (targeted amortization class) and others. All CMO's are subject to at least annual examination to ensure compliance with regulatory standards. CMO's which fail to meet these standards are disclosed to the Board of Directors and are subjected to special review and monitoring procedures. Other more volatile forms of CMO's include interest-only, principal-only, and inverse floating bonds, which are subject to even more stringent limits set forth in Keystone's investment policy. At December 31, 1997, Keystone had none of these volatile forms of CMO's in its investment portfolio. An even higher-risk form of CMO's, known as CMO residuals, are specifically designated as prohibited investments under Keystone's investment policy. Structured Notes A structured note is a debt security whose cash flow characteristics, including coupon rate, redemption amount or redemption rate may be dependent on one or more indices or future cash flow adjustment. Keystone's activity in structured notes has been limited to U.S. Government Agency index amortization notes (IANs), whereby the principal balance amortizes according to the prepayments on a specific collateral pool of mortgage-backed securities. Keystone's investment in structured notes is also limited by investment policy guidelines and aggregated $9,968,000 at the end of 1997. The following presentation provides an analysis of the composition of investments included in both investments available-for-sale and investments held-to-maturity. This comparison includes a detailed presentation of derivative financial instruments included in the U.S. Government agency category (in thousands): December 31, 1997 - -------------------------------------- ---------------------------------------- Amortized Market Unrealized Cost Value Gain/(Loss) - -------------------------------------- ------------- ------------ ------------- U.S. Government Agency Obligations: Conventional $671,826 $674,358 $2,532 Mortgage-backed 125,450 127,693 2,243 CMO's: PAC's(1) 21,611 21,610 (1) VADM's (2) 10,966 11,023 57 TAC's (3) 6,190 6,179 (11) Other 22,710 23,131 421 Structured notes 9,968 10,100 132 - -------------------------------------- ------------- ------------ ------------- Subtotal 868,721 874,094 5,373 - -------------------------------------- ------------- ------------ ------------- Negotiable money market instruments 178,455 178,404 (51) U.S. Treasury securities 193,099 194,120 1,021 State and political subdivision obligations 216,397 222,921 6,524 Corporate and other 149,975 160,079 10,104 - -------------------------------------- ------------- ------------ ------------- Total $1,606,647 $1,629,618 $22,971 - -------------------------------------- ------------- ------------ ------------- (1) A PAC(planned amortization class) has a principal payment schedule that is guaranteed within a predetermined range of mortgage prepayment rates, i.e. has built-in call protection, lower prepayment risk and lower average life variability. (2) A VADM(very accurately defined maturity) has a stated final payment date which provides protection from mortgage payment extension risk. (3) A TAC(targeted amortization class) has a payment schedule that offers some call protection if mortgage prepayments increase, but little to no extension protection if prepayments slow down. 65 Credit Risk and Loan Portfolio Analysis Keystone's objective as a lending institution is to profitably meet the credit needs of customers within the communities in which it operates. Credit risk and lending practices are governed by written policies and procedures which have been designed to provide for an acceptable level of risk and compensating return. These policies have also established requirements for lending authority, underwriting practices, collateral standards, lending concentrations, geographic limits, and other important elements of the credit process. Significant policies are reviewed, at a minimum, on an annual basis. Keystone maintains a corporate loan review function which is independent of the underwriting and administrative process. Loan review performs continuous reviews to determine adherence to credit policies, assess the effectiveness of the credit process, and objectively evaluate the quality of the loan portfolio. In connection with these reviews, adversely classified credits within the portfolio are identified and included on a classified loan report, which is reviewed by management on a monthly basis. Loan Composition Keystone maintains a diverse loan portfolio. The composition of Keystone's loan portfolio is illustrated in the following comparison of loan balances at the end of each of the last five years (in thousands): 1997 1996 1995 1994 1993 - ---------------- ----------- ----------- ------------ ------------ ------------- Commercial: Commercial and industrial $637,617 $547,153 $487,843 $426,434 $404,171 Floor plan financing 203,189 172,248 167,504 150,066 118,362 Obligations of political subdivisions 70,863 73,749 64,677 60,160 58,915 - ---------------- ----------- ----------- ------------ ------------ ------------- 911,669 793,150 720,024 636,660 581,448 - ---------------- ----------- ----------- ------------ ------------ ------------- Commercial Real Estate: Commercial and industrial 1,080,776 843,746 828,508 840,910 799,614 Multi-family residential 130,148 99,074 92,544 84,548 91,288 Obligations of political subdivisions 40,930 29,686 33,010 31,023 27,037 Construction and land development 117,503 91,755 86,983 68,652 63,074 Agricultural 15,566 12,756 13,363 14,364 14,424 - ---------------- ----------- ----------- ------------ ------------ ------------- 1,384,923 1,077,017 1,054,408 1,039,497 995,437 - ---------------- ----------- ----------- ------------ ------------ ------------- Consumer: Real estate 862,227 1,186,663 1,206,547 1,184,346 1,042,375 Installment 704,242 626,573 631,584 655,163 550,152 Home equity 473,365 311,086 256,505 227,110 185,083 Personal lines of credit 41,123 40,498 43,244 46,392 30,645 Leases 335,017 301,483 184,554 111,732 55,070 - ---------------- ----------- ----------- ------------ ------------ ------------- 2,415,974 2,466,303 2,322,434 2,224,743 1,863,325 - ---------------- ----------- ----------- ------------ ------------ ------------- Total $4,712,566 $4,336,470 $4,096,866 $3,900,900 $3,440,210 - ---------------- ----------- ----------- ------------ ------------ ------------- 66 Concentration Risk The diversity of Keystone's loan portfolio is directly influenced by Keystone's efforts to manage credit risk. Keystone's credit policy has established specific limits on the level of credit to a borrower or single group of borrowers, which serve to reduce concentration risk. This diversity is evidenced by the absence of industry and customer concentrations. o The largest group of customers in a single industry to whom Keystone provides credit extensions is automobile dealers. At December 31, 1997 credit extensions totaling $258,547,000 were outstanding, and consisted of floor plan and related commercial loans and mortgages. o Keystone has no dependence on a single customer. The top ten credit relationships account for only 4% of the total loans outstanding at the end of 1997. Geographic Risk In addition to industry or customer concentrations, credit risk is also affected by the geographic characteristics of the loan portfolio. The credit risk profile of Keystone's portfolio is enhanced by the stable economic climate and the industry diversification of Keystone's-defined market. o The overwhelming majority of Keystone's lending activities are conducted within its own defined market. o Keystone has no loan exposure in foreign countries. Categories of Exposure Keystone's loan portfolio can be evaluated in terms of its exposure to certain types of loans which are presumed to exhibit a higher degree of credit risk. Examples include credit extensions for highly leveraged transactions, speculative real estate ventures, or certain commercial real estate loans. These types of loans may subject a lender to a higher level of loss from economic downturns, dramatic changes in interest rates, or depressed real estate markets. The following comments provide insight into this aspect of Keystone's loan profile. o Keystone has not been active in the organization, syndication, or purchase of highly leveraged transactions. o Keystone's commercial real estate lending practice requires an evaluation of the borrower's ability to repay debt from cash flow provided through operations. The underlying value of real estate is viewed as a secondary source of repayment. In addition, Keystone's lending practices generally require guarantees, endorsements, and other forms of recourse which provide additional security for such credits. Keystone has examined its exposure to commercial and commercial real estate loans. This examination included a review of all customer account relationships and classification of credits into risk-related categories. The following table summarizes the commercial and commercial real estate segments of the portfolio (in thousands): December 31, 1997 - ----------------------------------------------------------- Average Balance Relationship - ----------------------------- ------------ - -------------- Commercial loans $911,669 Commercial real estate 1,384,923 - ----------------------------- ------------ - -------------- $2,296,592 $121 - ----------------------------- ------------ - -------------- At December 31, 1997, approximately 37% of the balance of commercial real estate was nonowner occupied. Individual categories of nonowner-occupied in excess of $75 million were office buildings and apartment/rental units which totaled $123,356,000 and $129,773,000, respectively. 67 Secondary Market Activity Keystone sells a significant portion of its fixed consumer mortgages to secondary market investors. Keystone recognizes an income stream from the servicing of these loans subsequent to the sale. The sale of these loans enables mortgage loans to be self-funding. Allocation of Allowance The allowance for credit losses is maintained at a level adequate to absorb losses associated with credit risk. Management exercises its judgment to allocate the allowance to specific categories of loans. The following table summarizes the allocation of the allowance for credit losses at December 31, (in thousands): 1997 1996 1995 1994 1993 - -------------------------- --------- ---------- --------- ---------- ---------- Commercial $11,266 $9,944 $11,450 $11,168 $11,564 Real estate secured: Commercial 12,630 11,922 11,969 12,104 13,338 Consumer 1,849 2,324 2,251 2,563 2,957 Consumer 16,844 12,693 7,724 7,036 6,854 General risk 22,502 19,373 22,021 20,837 16,371 - -------------------------- --------- ---------- --------- ---------- ---------- $65,091 $56,256 $55,415 $53,708 $51,084 - -------------------------- --------- ---------- --------- ---------- ---------- While management has apportioned the allowance to the different loan categories, the allowance is general in nature and is available for the loan portfolio in its entirety. Keystone assesses the reasonableness of the allocation of the allowance by preparing a percentage-based comparison of the allocated allowance to the actual loan portfolio. At December 31, the following comparison is provided: 1997 1996 1995 1994 1993 - ---------------------------- ---------- ---------- --------- ---------- -------- Commercial: % of Total loans 19% 18% 18% 16% 17% % Allocation of allowance 17% 18% 21% 21% 23% Commercial real estate: % of Total loans 29% 25% 26% 27% 29% % Allocation of allowance 19% 21% 22% 23% 26% Consumer real estate: % of Total loans 18% 27% 29% 30% 30% % Allocation of allowance 3% 4% 4% 5% 6% Consumer: % of Total loans 34% 30% 27% 27% 24% % Allocation of allowance 26% 23% 14% 13% 13% General Risk: % Allocation of allowance 35% 34% 39% 38% 32% - ---------------------------- ---------- ---------- --------- ---------- -------- Total loans 100% 100% 100% 100% 100% - ---------------------------- ---------- ---------- --------- ---------- -------- Allocation of allowance 100% 100% 100% 100% 100% - ---------------------------- ---------- ---------- --------- ---------- -------- 68 Quarterly Information Income Performance 1997 - -------------------------------------------------------------------------------- (in thousands, except per Fourth Third Second First share data Quarter Quarter Quarter Quarter - ------------------------- -------------- ------------- ------------ ------------ Interest income $131,273 $132,215 $126,804 $120,446 Interest expense 60,650 60,446 57,341 54,057 - ------------------------- -------------- ------------- ------------ ------------ Net interest income 70,623 71,769 69,463 66,389 Provision for credit losses 3,544 4,319 3,659 3,794 - ------------------------ -------------- ------------- ------------- ------------ Net interest income after provision 67,079 67,450 65,804 62,595 Noninterest income 21,681 20,825 20,429 20,926 Security transactions 2,842 3,524 (444) 149 Noninterest expense 55,329 55,531 63,768 51,362 - ------------------------ -------------- ------------- ------------- ------------ Income before income taxes 36,273 36,268 22,021 32,308 Income taxes 10,709 11,668 7,039 9,537 - ------------------------ -------------- ------------- ------------- ------------ Net income $25,564 $24,600 $14,982 $22,771 - ------------------------ -------------- ------------- ------------- ------------ Tax effect of security transactions $995 $1,233 ($155) $52 - ------------------------ -------------- ------------- ------------- ------------ Earnings per share: Basic $0.49 $0.48 $0.29 $0.44 Diluted 0.49 0.47 0.29 0.43 Dividends per share $0.28 $0.26 $0.26 $0.26 Average shares outstanding 51,979,519 51,834,406 51,320,373 51,630,443 - ------------------------ -------------- ------------- ------------- ------------ 1996 - -------------------------------------------------------------------------------- (in thousands, except per Fourth Third Second First share data) Quarter Quarter Quarter Quarter - ------------------------ -------------- ------------- ------------- ------------ Interest income $120,864 $119,070 $116,634 $116,852 Interest expense 54,470 53,955 51,139 51,737 - ------------------------ -------------- ------------- ------------- ------------ Net interest expense 66,394 65,115 65,495 65,115 Provision for credit losses 3,778 2,494 2,307 2,134 - ------------------------ -------------- ------------- ------------- ------------ Net interest income after provision 62,616 62,621 63,188 62,981 Noninterest income 18,727 17,861 16,814 17,252 Security transactions (2) 29 314 530 Noninterest expense 49,475 49,716 47,650 49,404 - ------------------------ -------------- ------------- ------------- ------------ Income before income taxes 31,866 30,795 32,666 31,359 Income Taxes 9,077 8,508 9,897 9,698 - ------------------------ -------------- ------------- ------------- ------------ Net income $22,789 $22,287 $22,769 $21,661 - ------------------------ -------------- ------------- ------------- ------------ Tax effect of security transactions $(1) $10 $110 $186 - ------------------------ -------------- ------------- ------------- ------------ Earnings per share: Basic $0.44 $0.43 $0.43 $0.42 Diluted 0.44 0.42 0.43 0.41 Dividends per share $ 0.26 $0.24 $0.24 $0.24 Average shares outstanding 52,134,311 52,243,456 52,116,068 52,041,141 - ------------------------ -------------- ------------- ------------- ------------ 69 STOCK INFORMATION Market Prices and Dividends The common stock of Keystone Financial, Inc. trades on The Nasdaq Stock MarketSM under the symbol KSTN. The Nasdaq Stock MarketSM, which began operation in 1971, is the world's first electronic securities market and the fastest growing stock market in the U.S. Nasdaq utilizes today's information technologies-computers and telecommunications-to unite its participants in a screen-based, floorless market. This competitive marketplace, along with the many products and services available to issuers and their shareholders, attracts today's largest and fastest growing companies to Nasdaq. More domestic and foreign companies list on Nasdaq than on all other U.S. stock markets combined. At the close of business on January 30, 1998, there were approximately 15,056 shareholders of record. The table below sets forth the quarterly range of high and low closing sales prices for Keystone common stock as reported by NASDAQ and dividends declared per common share. Quarterly Closing Dividends Sales Price Range Declared - -------------------- ------------ ------------ ------------ High Low - -------------------- ------------ ------------ ------------ 1997 - -------------------- ------------ ------------ ------------ I $28.00 $24.88 $0.26 II 33.25 24.50 0.26 III 38.88 30.56 0.26 IV 41.00 34.00 0.28 - -------------------- ------------ ------------ ------------ $1.06 ==================== ============ ============ ============ 1996 - -------------------- ------------ ------------ ------------ I $22.83 $19.83 $0.24 II 22.75 20.75 0.24 III 25.33 21.67 0.24 IV 27.75 24.50 0.26 - -------------------- ------------ ------------ ------------ $0.98 ==================== ============ ============ ============ While Keystone is not obligated to pay cash dividends, the Board of Directors presently intends to continue the policy of paying quarterly dividends. Future dividends will depend, in part, upon the earnings and financial condition of Keystone. The payment of dividends is subject to applicable regulatory rules and policies. See the dividend and loan restriction information listed in the notes to the consolidated financial statements. 70 EX-21 6 JURISDICTION OF INCORPORATION Exhibit 21.1 Jurisdiction of Incorporation ------------------ First Tier Subsidiaries of Registrant: American Trust Bank, N.A. United States Financial Trust Company Pennsylvania Keystone Bank, N.A. United States Keystone National Bank United States Mid-State Bank and Trust Company Pennsylvania Northern Central Bank Pennsylvania Pennsylvania National Bank and Trust Company United States Keystone Financial Unlimited, Inc. Pennsylvania Key Trust Company Pennsylvania Keystone CDC, Inc. Pennsylvania Keystone Financial Community Development Corporation Pennsylvania Keystone Financial Life Insurance Company Arizona Keystone Financial Mid-Atlantic Funding Corporation Pennsylvania Keystone Investment Services, Inc. Delaware Martindale Andres & Company Pennsylvania MMC&P, Inc. Pennsylvania Second Tier Subsidiaries of Registrant: Keystone Financial Leasing Corporation Pennsylvania Keystone Financial Mortgage Corporation Pennsylvania Keystone Brokerage, Inc. Pennsylvania Key Investor Services, Inc. Maryland Key Investor Services, Inc. Pennsylvania Key Investor Services, Inc. West Virginia ATB Holding Company, Inc. Delaware ATB Real Estate Investment Trust, Inc. Maryland Financial Trust Services Company Pennsylvania Financial Trust Life Insurance Company Arizona EX-23 7 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Exhibit 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Regarding: 1) Registration Statement on Form S-8 relating to the 1988 Stock Incentive Plan (File #33-38427). 2) Registration Statement on Form S-3 relating to the Dividend Reinvestment Plan (File #333-02063). 3) Registration Statement on Form S-8 relating to the 1992 Director Fee Plan (File #33-48031). 4) Registration Statement on Form S-3 relating to the Main Line Bancshares, Inc. Stock Option Agreements (File #33-50526). 5) Registration Statement on Form S-8 relating to the 1990 Non- Employee Directors' Stock Option Plan (File #33-59372). 6) Registration Statement on Form S-8 relating to the 1992 Stock Incentive Plan (File #33-68800). 7) Registration Statement on Form S-8 relating to the Elmwood Bancorp, Inc. Key Employee Stock Compensation Program (File #33-77358) 8) Registration Statement on Form S-8 relating to the Amended and Restated Nonqualified Stock Option Agreement with Donald E. Stone (File #33-77354). 9) Registration Statement on Form S-8 relating to The Frankford Corporation 1983 Incentive Stock Option Plan (File #33-82088). 10) Registration Statement on Form S-8 relating to the 1995 Employee Stock Purchase Plan (File #33-91572). 11) Registration Statement on Form S-8 relating to the 1995 Management Stock Purchase Plan (File #33-91574). 12) Registration Statement on Form S-8 relating to the National American Bancorp, Inc. 1994 Employee Stock Option Plan (File #333-02065). 13) Registration Statement on Form S-8 relating to the 1995 Non-Employee Director's Stock Option Plan (File # 333-04281). 14) Registration Statement on Form S-3 relating to the Senior/ Subordinated Medium-Term Notes (File #333-25393). We consent to the incorporation by reference in the above listed Registration Statements of our report dated, January 30, 1998, with respect to the consolidated financial statements of Keystone Financial, Inc. and subsidiaries incorporated by reference in this Annual Report (Form 10-K) for the year ended December 31, 1997. /s/ ERNST & YOUNG LLP ---------------------- Pittsburgh, Pennsylvania March 27 , 1998 EX-23 8 CONSENT OF BEARD & COMPANY, INC., INDEPENDENT AUD. Exhibit 23.2 CONSENT OF BEARD & COMPANY, INC., INDEPENDENT AUDITORS Regarding: 1) Registration Statement on Form S-8 relating to the 1988 Stock Incentive Plan (File #33-38427). 2) Registration Statement on Form S-3 relating to the Dividend Reinvest ment Plan (File #333-02063). 3) Registration Statement on Form S-8 relating to the 1992 Director Fee Plan (File #33-48031). 4) Registration Statement on Form S-3 relating to the Main Line Bancshares, Inc. Stock Option Agreements (File #33-50526). 5) Registration Statement on Form S-8 relating to the 1990 Non-Employee Directors' Stock Option Plan (File #33-59372). 6) Registration Statement on Form S-8 relating to the 1992 Stock Incentive Plan (File #33-68800). 7) Registration Statement on Form S-8 relating to the Elmwood Bancorp, Inc. Key Employee Stock Compensation Program (File #33-77358). 8) Registration Statement on Form S-8 relating to the Amended and Restated Nonqualified Stock Option Agreement with Donald E. Stone (File #33-77354). 9) Registration Statement on Form S-8 relating to The Frankford Corporation 1983 Incentive Stock Option Plan (File #33-82088). 10) Registration Statement on Form S-8 relating to the 1995 Employee Stock Purchase Plan (File #33-91572). 11) Registration Statement on Form S-8 relating to the 1995 Management Stock Purchase Plan (File #33-91574). 12) Registration Statement on Form S-8 relating to the National American Bancorp, Inc. 1994 Employee Stock Option Plan (File # 333-02065). 13) Registration Statement on Form S-8 relating to the 1995 Non-Employee Director's Stock Option Plan (File # 333-04281). 14) Registration Statement on Form S-3 relating to the Senior/ Subordinated Medium-Term Notes (File #333-25393). We consent to the incorporation by reference in the above listed Registration Statements of our report dated, February 28, 1997, with respect to the consolidated financial statements of Financial Trust Corp and subsidiaries for the year ended December 31, 1996, included in this Annual Report (Form 10-K) of Keystone Financial, Inc. for the year ended December 31, 1997. /s/ BEARD & COMPANY, INC ------------------------ Reading, Pennsylvania March 25, 1998 EX-27 9 EXHIBIT 27.1 - FINANCIAL DATA SCHEDULE
9 This schedule contains summary financial information extracted from the financial statements and statistical disclosures referenced within item 14(a)(1)(2) and item 1 of the Form 10-K and is qualified in its entirety by reference to such financial statements and statistical disclosures. 1,000 12-MOS DEC-31-1997 DEC-31-1997 206,223 1,928 25,300 0 1,091,400 528,388 538,218 4,712,566 65,091 6,841,337 5,233,165 425,890 146,854 349,943 0 0 104,058 581,427 6,841,337 404,096 94,894 11,748 510,738 194,898 232,494 278,244 15,316 6,071 225,990 126,870 87,917 0 0 87,917 1.70 1.68 3.87 20,520 33,062 489 8,347 56,256 17,277 2,485 65,091 65,091 0 0
EX-99.1 10 RECON OF PREV. REPORTED QTRLY INFO Exhibit 99.1 Reconciliation of Previously Reported Quarterly Information On May 30, 1997, Financial Trust Corp was merged into Keystone, resulting in the termination of the separate legal existence of Financial Trust Corp. The merger was accounted for under the pooling-of-interests method of accounting and, accordingly, the consolidated financial statements were restated. Columns one and two of the following presentation represent amounts previously reported by the individual entities. Column three, which represents total combined Keystone as reported in the 1997 Annual Report to Shareholders, is the sum of columns one and two with the exception of earnings per share amounts, which are calculated based on total average shares of the combined entity after giving effect to the issuance of shares resulting from the merger. Historical Combined Keystone Financial Trust Keystone -------- --------------- -------- For the quarter ended: March 31, 1996 Net Interest Income $52,591 $12,524 $65,115 Net Income 16,857 4,804 21,661 Basic Earnings per Share $ 0.44 $0.56 $0.42 June 30, 1996 Net Interest Income $52,435 $13,060 $65,495 Net Income 17,733 5,036 22,769 Basic Earnings per Share $ 0.47 $0.59 $0.43 September 30, 1996 Net Interest Income $51,899 $13,216 $65,115 Net Income 17,025 5,262 22,287 Basic Earnings per Share $0.45 $0.62 $0.43 December 31, 1996 Net Interest Income $52,838 $13,556 $66,394 Net Income 17,860 4,929 22,789 Basic Earnings per Share $0.47 $0.58 $0.44 March 31, 1997 Net Interest Income $53,012 $13,377 $66,389 Net Income 17,129 5,642 22,771 Basic Earnings per Share $0.46 $0.66 $0.44 ========================= ============= ============== ============== -----END PRIVACY-ENHANCED MESSAGE-----