10-Q 1 e10q0900b.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10Q Quarterly Report Pursuant to Section 13 OR 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2000 Commission File Number: 2-88927 FIRST KEYSTONE CORPORATION (Exact name of registrant as specified in its charter) Pennsylvania 23-2249083 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) identification No.) 111 West Front Street, Berwick, PA 18603 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (570) 752-3671 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date: Common Stock, $2 Par Value, 2,833,727 shares as of September 30, 2000. PART I. - FINANCIAL INFORMATION Item. 1 Financial Statements FIRST KEYSTONE CORPORATION BALANCE SHEETS (Unaudited)
(Amounts in thousands, except per share data) September December 2000 1999 ASSETS Cash and due from banks $ 5,968 $ 6,884 Interest bearing deposits with banks 47 80 Available-for-sale securities carried at estimated fair value 143,042 123,468 Investment securities, held to maturity securities, estimated fair value of $8,794 and $11,335 8,975 11,563 Loans, net of unearned income 186,797 185,231 Allowance for loan losses (2,576) (2,600) ________ ________ Net loans $184,221 $182,631 ________ ________ Bank premises and equipment 3,668 3,881 Other real estate owned 13 85 Interest receivable 2,440 2,239 Other assets 1,814 2,685 ________ ________ Total Assets $350,188 $333,516 LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits Non-interest bearing $ 24,538 $ 20,919 Interest bearing 235,265 223,761 ________ ________ Total deposits $259,803 $244,680 Short-term borrowings 23,359 31,594 Long-term borrowings 31,250 26,000 Accrued expenses and other liabilities 2,360 1,884 ________ ________ Total Liabilities $316,772 $304,158 STOCKHOLDERS' EQUITY Common stock, par value $2 per share $ 5,867 $ 5,867 Surplus 9,761 9,761 Retained earnings 22,514 20,285 Accumulated other comprehensive income (loss) (1,630) (3,459) Treasury stock at cost 100,000 shares in 2000 and 100,000 in 1999 (3,096) (3,096) ________ _______ Total Stockholders' Equity $ 33,416 $ 29,358 ________ ________ Total Liabilities and Stockholders' Equity $350,188 $333,516 See Accompanying Notes to Financial Statements
1 FIRST KEYSTONE CORPORATION STATEMENTS OF INCOME FOR THE THREE MONTHS ENDED September 30, 2000 AND 1999 (Unaudited)
(Amounts in thousands except per share data) 2000 1999 INTEREST INCOME Interest and fees on loans $ 4,031 $ 3,706 Interest and dividend income on securities 2,520 2,182 Interest on deposits in banks 1 12 _________ _________ Total Interest Income $ 6,552 $ 5,900 INTEREST EXPENSE Interest on deposits $ 2,786 $ 2,356 Interest on short-term borrowings 384 395 Interest on long-term borrowings 479 279 _________ _________ Total Interest Expense $ 3,649 $ 3,030 Net interest income $ 2,903 $ 2,870 Provision for loan losses 75 50 _________ _________ Net Interest Income After Provision for Loan Losses $ 2,828 $ 2,820 OTHER INCOME Service charges on deposit accounts $ 264 $ 227 Other non-interest income 191 157 Investment securities gains (losses) net 70 77 _________ _________ Total Other Income $ 525 $ 461 OTHER EXPENSES Salaries and employee benefits $ 938 $ 884 Net occupancy and fixed asset expense 273 234 Other non-interest expense 451 470 _________ _________ Total Other Expenses $ 1,662 $ 1,588 Income before income taxes $ 1,691 $ 1,693 Applicable income tax (benefit) 328 338 _________ _________ Net Income $ 1,363 $ 1,355 Per Share Data Net Income $ .48 $ .47 Cash dividends .19 .17 Weighted average shares outstanding 2,833,727 2,872,718 See Accompanying Notes to Financial Statements
2 FIRST KEYSTONE CORPORATION STATEMENTS OF INCOME FOR THE NINE MONTHS ENDED September 30, 2000 AND 1999 (Unaudited)
(Amounts in thousands except per share data) 2000 1999 INTEREST INCOME Interest and fees on loans $ 11,809 $ 10,728 Interest and dividend income on securities 7,022 6,207 Interest on deposits in banks 4 165 _________ _________ Total Interest Income $ 18,835 $ 17,100 INTEREST EXPENSE Interest on deposits $ 8,045 $ 7,082 Interest on short-term borrowings 1,021 989 Interest on long-term borrowings 1,142 698 _________ _________ Total Interest Expense $ 10,208 $ 8,769 Net interest income $ 8,627 $ 8,331 Provision for loan losses 235 225 _________ _________ Net Interest Income After Provision for Loan Losses $ 8,392 $ 8,106 OTHER INCOME Service charges on deposit accounts $ 719 $ 645 Other non-interest income 490 485 Investment securities gains (losses) net 123 173 _________ _________ Total Other Income $ 1,332 $ 1,303 OTHER EXPENSES Salaries and employee benefits $ 2,833 $ 2,501 Net occupancy and fixed asset expense 758 717 Other non-interest expense 1,479 1,378 _________ _________ Total Other Expenses $ 5,070 $ 4,596 Income before income taxes $ 4,654 $ 4,813 Applicable income tax (benefit) 810 935 _________ _________ Net Income $ 3,844 $ 3,878 Per Share Data Net Income $ 1.36 $ 1.35 Cash dividends .57 .51 Weighted average shares outstanding 2,833,727 2,872,718 See Accompanying Notes to Financial Statements
3 FIRST KEYSTONE CORPORATION STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED September 30, 2000 AND 1999 (Unaudited)
(Amounts in thousands) 2000 1999 OPERATING ACTIVITIES Net income $ 3,844 $ 3,878 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 235 225 Provision for depreciation and amortization 302 301 Premium amortization on investment securities 76 197 Discount accretion on investment securities (647) (142) Gain on sale of mortgage loans (19) (9) Proceeds from sale of mortgage loans 1,812 4,016 Originations of mortgage loans for resale (2,441) (6,341) (Gain) loss on sales of investment securities (123) (77) (Gain) loss on sales of other real estate owned 36 0 Deferred income tax (benefit) (27) (44) (Increase) decrease in interest receivable and other assets (195) (452) Increase (decrease) in interest payable, accrued expenses and other liabilities 476 251 ________ ________ Net Cash Provided by Operating Activities $ 3,329 $ 1,803 INVESTING ACTIVITIES Purchases of investment securities available-for-sale $(54,755) $(55,358) Proceeds from sales of investment securities available for sale 34,718 24,124 Proceeds from maturities and redemptions of investment securities available for sale 3,166 12,942 Purchase of investment securities held-to-maturity 0 0 Proceeds from maturities and redemption of investment securities held to maturity 3,314 1,858 Net (increase) decrease in loans (1,273) (16,781) Purchase of premises and equipment (89) (431) Proceeds from sale of other real estate owned 118 0 ________ ________ Net Cash Used by Investing Activities $(14,801) $(33,646) FINANCING ACTIVITIES Net increase (decrease) in deposits $ 15,123 $ 2,885 Net increase (decrease) in short-term borrowings (8,235) 23,789 Net increase (decrease) in long-term borrowings 5,250 9,000 Acquisition of treasury stock 0 (1,906) Cash dividends (1,615) (1,461) ________ ________ Net Cash Provided by Financing Activities $ 10,523 $ 32,307 Increase (Decrease) in Cash and Cash Equivalent (949) $464 Cash and Cash Equivalents, Beginning 6,964 7,055 ________ ________ Cash and Cash Equivalents, Ending $ 6,015 $ 7,519 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during period for Interest $ 10,029 $ 8,707 Income Taxes 695 923 See Accompanying Notes to Financial Statements
4 FIRST KEYSTONE CORPORATION CONSOLIDATED NOTES TO FINANCIAL STATEMENTS September 30, 2000 (Unaudited) Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting policies of First Keystone Corporation and Subsidiary (the "Corporation") are in accordance with generally accepted accounting principles and conform to common practices within the banking industry. The more significant policies follow: PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of First Keystone Corporation and its wholly-owned Subsidiary, The First National Bank of Berwick (the "Bank"). All significant inter-company balances and transactions have been eliminated in consolidation. NATURE OF OPERATIONS The Corporation, headquartered in Berwick, Pennsylvania, provides a full range of banking, trust and related services through its wholly owned Bank subsidiary and is subject to competition from other financial institutions in connection with these services. The Bank serves a customer base which includes individuals, businesses, public and institutional customers primarily located in the Northeast Region of Pennsylvania. The Bank has nine full service offices and 12 ATMs located in Columbia, Luzerne and Montour Counties. The Corporation and its subsidiary must also adhere to certain federal banking laws and regulations and are subject to periodic examinations made by various federal agencies. The Corporation has a commercial banking operation and trust department as its major lines of business. The commercial banking operation includes a commercial services and retail services area and has historically constituted over 90% of the Corporation's revenue and profit and is the only reportable segment. Commercial services includes lending and related financial services to small and medium sized corporations and other business entities. The retail services includes sales and distribution (direct lending, deposit gathering, and retail mortgage lending) primarily to individuals. The trust department includes investment management, estate planning, employee benefit administration, and personal trust services which produce fee based income. The business units are identified by the products or services offered by the business unit and the channel through which the product or service is delivered. The accounting policies of the individual business units are the same as those of the Corporation. USE OF ESTIMATES The preparation of these consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of these consolidated financial statements and the reported amounts of income and expenses during the reporting periods. Actual results could differ from those estimates. INVESTMENT SECURITIES The Corporation classifies its investment securities as either "Held-to-Maturity" or "Available-for-Sale" at the time of purchase. Debt securities are classified as held-to-maturity when the Corporation has the ability and positive intent to hold the securities to maturity. Investment securities Held-to-Maturity are carried at cost adjusted for amortization of premium and accretion of discount to maturity. Debt securities not classified as Held-to-Maturity and equity securities are included in the Available-for-Sale category and are carried at fair value. The amount of any unrealized gain or loss, net of the effect of deferred income taxes, is reported as other comprehensive income as a component of Stockholders' Equity. Management's 5 decision to sell available-for-sale securities is based on changes in economic conditions controlling the sources and applications of funds, terms, availability of and yield of alternative investments, interest rate risk and the need for liquidity. 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. Such amortization and accretion, as well as interest and dividends is included in interest income from investments. Realized gains and losses are included in net investment securities gains. The cost of investment securities sold, redeemed or matured is based on the specific identification method. LOANS Loans are stated at their outstanding unpaid principal balances, net of deferred fees or costs, unearned income and the allowance for loan losses. Interest on installment loans is recognized as income over the term of each loan, generally, by the "actuarial method". Interest on all other loans is primarily recognized based upon the principal amount outstanding. Loan origination fees and certain direct loan origination costs have been deferred with the net amount amortized using the interest method over the contractual life of the related loans as an interest yield adjustment. Mortgage loans held for resale are carried at the lower of cost or market on an aggregate basis. These loans are sold without recourse to the Corporation. Non-Accrual Loans - Generally, a loan is classified as non-accrual and the accrual of interest on such a loan is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan currently is performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. Certain non-accrual loans may continue to perform, that is, payments are still being received. Generally, the payments are applied to principal. These loans remain under constant scrutiny and if performance continues, interest income may be recorded on a cash basis based on management's judgement as to collectibility of principal. Allowance for Loan Losses - The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses and subsequent recoveries, if any, are credited to the allowance. A principal factor in estimating the allowance for loan losses is the measurement of impaired loans. A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. Under current accounting standards, the allowance for loan losses related to impaired loans is based on discounted cash flows using the effective interest rate of the loan or the fair value of the collateral for certain collateral dependent loans. The allowance for loan losses is maintained at a level estimated by management to be adequate to absorb potential loan losses. Management's periodic evaluation of the adequacy of the allowance for loan losses is based on the Corporation's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation computed principally on the straight-line method over the estimated useful lives of the assets. Maintenance and minor repairs are charged to operations as incurred. The cost and accumulated depreciation of the premises and equipment retired or sold are eliminated from the property accounts at the time of retirement or sale, and the resulting gain or loss is reflected in current operations. 6 MORTGAGE SERVICING RIGHTS The Corporation originates and sells real estate loans to investors in the secondary mortgage market. After the sale, the Corporation retains the right to service certain loans. When originated mortgage loans are sold and servicing is retained, a servicing asset is capitalized based on relative fair value at the date of sale. Servicing assets are amortized as an offset to other fees in proportion to, and over the period of, estimated net servicing income. The unamortized cost is included in other assets in the accompanying consolidated balance sheet. The servicing rights are periodically evaluated for impairment based on their relative fair value. OTHER REAL ESTATE OWNED Real estate properties acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value on the date of foreclosure establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of carrying amount or fair value less cost to sell. Revenues derived from and costs to maintain the assets and subsequent gains and losses on sales are included in other non-interest income and expense. INCOME TAXES The provision for income taxes is based on the results of operations, adjusted primarily for tax-exempt income. Certain items of income and expense are reported in different periods for financial reporting and tax return purposes. Deferred tax assets and liabilities are determined based on the differences between the consolidated financial statement and income tax bases of assets and liabilities measured by using the enacted tax rates and laws expected to be in effect when the timing differences are expected to reverse. Deferred tax expense or benefit is based on the difference between deferred tax asset or liability from period to period. PER SHARE DATA Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share, requires dual presentation of basic and fully diluted earnings per share. Basic earnings per share is calculated by dividing net income by the weighted average number of shares of common stock outstanding at the end of each period. Fully diluted earnings per share is calculated by increasing the denominator for the assumed conversion of all potentially dilutive securities. The Corporation's dilutive securities are limited to stock options which currently have no effect on earnings per share since the market price per share historically has not been greater than the lowest stock option exercise price. Per share data has been adjusted retroactively for stock splits and stock dividends. CASH FLOW INFORMATION For purposes of reporting consolidated cash flows, cash and cash equivalents include cash on hand and due from other banks and interest bearing deposits in other banks. The Corporation considers cash classified as interest bearing deposits with other banks as a cash equivalent since they are represented by cash accounts essentially on a demand basis. TRUST ASSETS AND INCOME Property held by the Corporation in a fiduciary or agency capacity for its customers is not included in the accompanying consolidated financial statements since such items are not assets of the Corporation. Trust Department income is recognized on a cash basis and is not materially different than if it were reported on an accrual basis. NEW ACCOUNTING STANDARDS Statement of Financial Accounting Standards (SFAS) No. 133 (as amended by SFAS No. 137), "Accounting for Derivative Instruments and Hedging Activities", becomes effective for financial reporting periods beginning after June 15, 2000. SFAS 133 requires fair value accounting for all stand-alone derivatives and many derivatives embedded in other instruments and contracts. Since the Corporation does not enter into transactions involving derivatives described in the standard and does not engage in hedging activities, the standard is not expected to have a significant impact on the Corporation's consolidated financial condition or results of operations. 7 Note 2. ALLOWANCE FOR LOAN LOSSES Changes in the allowance for loan losses for the periods ended September 30, 2000, and September 30, 1999, were as follows:
(amounts in thousands) 2000 1999 Balance, January 1 $2,600 $2,421 Provision charged to operations 235 225 Loans charged off (274) (154) Recoveries 15 80 ______ ______ Balance, September 30 $2,576 $2,572
At September 30, 2000, the recorded investment in loans that are considered to be impaired as defined by SFAS No. 114 was $71,935. No additional charge to operations was required to provide for the impaired loans since the total allowance for loan losses is estimated by management to be adequate to provide for the loan loss allowance required by SFAS No. 114 along with any other potential losses. At September 30, 2000, there were no significant commitments to lend additional funds with respect to non-accrual and restructured loans. Note 3. SHORT-TERM BORROWINGS Federal funds purchased, securities sold under agreements to repurchase and Federal Home Loan Bank advances generally represent overnight or less than 30-day borrowings. U.S. Treasury tax and loan notes for collections made by the Bank are payable on demand. Note 4. LONG-TERM BORROWINGS Long-term borrowings are comprised of advances from the Federal Home Loan Bank (FHLB). Under terms of a blanket agreement, collateral for the loans are secured by certain qualifying assets of the Corporation's banking subsidiary which consist principally of first mortgage loans. Note 5. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF CREDIT RISK The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments. The Corporation does not engage in trading activities with respect to any of its financial instruments with off-balance sheet risk. The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. 8 The Corporation may require collateral or other security to support financial instruments with off-balance sheet credit risk. The contract or notional amounts at September 30, 2000, and December 31, 1999, were as follows:
(amounts in thousands) September 30, December 31, 2000 1999 Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $14,748 $17,348 Standby letters of credit $ 993 $ 633
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 that may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management's credit evaluation of the counter-party. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation may hold collateral to support standby letters of credit for which collateral is deemed necessary. The Corporation grants commercial, agribusiness and residential loans to customers within the state. It is management's opinion that the loan portfolio was balanced and diversified at September 30, 2000, to the extent necessary to avoid any significant concentration of credit risk. Note 6. STOCKHOLDERS' EQUITY Changes in Stockholders' Equity for the period ended September 30, 2000, were are follows:
(Amounts in thousands, except common share data) Common Common Shares Stock Surplus ______ ______ _______ Balance at January 1, 2000 2,933,727 $5,867 $9,761 Comprehensive Income: Net Income Change in unrealized gain (loss) on investment securities available-for-sale, net of reclassification adjustment and tax effects Total Comprehensive income (loss) Cash dividends - $.57 per share _________ ______ ______ Balance at September 30, 2000 2,933,727 $5,867 $9,761 (Amounts in thousands, except common share data) Compre- Other hensive Retained Comprehensive Income Earnings Income ________ ________ _____________ Balance at January 1, 2000 $20,285 $(3,459) Comprehensive Income: Net Income 3,844 3,844 Change in unrealized gain (loss) on investment securities available-for-sale, net of reclassification adjustment and tax effects 1,829 1,829 _____ Total Comprehensive income (loss) 5,673 Cash dividends - $.57 per share (1,615) _______ _______ Balance at September 30, 2000 $22,514 $(1,630) (Amounts in thousands, except common share data) Treasury Stock Total ______ _____ Balance at January 1, 2000 $(3,096) $29,358 Comprehensive Income: Net Income 3,844 Change in unrealized gain (loss) on investment securities available-for-sale, net of reclassification adjustment and tax effects 1,829 Total Comprehensive income (loss) Cash dividends - $.57 per share (1,615) _______ _______ Balance at September 30, 2000 $(3,096) $33,416
9 Note 7. MANAGEMENT'S ASSERTIONS AND COMMENTS REQUIRED TO BE PROVIDED WITH FORM 10Q FILING In management's opinion, the consolidated interim financial statements reflect fair presentation of the consolidated financial position of First Keystone Corporation and Subsidiary, and the results of their operations and their cash flows for the interim periods presented. Further, the consolidated interim financial statements reflect all adjustments, which are in the opinion of management, necessary to present fairly the consolidated financial condition and consolidated results of operations and cash flows for the interim period presented and that all such adjustments to the consolidated financial statements are of a normal recurring nature. The results of operations for the nine-month period ended September 30, 2000, are not necessarily indicative of the results to be expected for the full year. These consolidated interim financial statements have been prepared in accordance with requirements of Form 10Q and therefore do not include all disclosures normally required by generally accepted accounting principles applicable to financial institutions as included with consolidated financial statements included in the Corporation's annual Form 10K filing. The reader of these consolidated interim financial statements may wish to refer to the Corporation's annual report or Form 10K for the period ended December 31, 1999, filed with the Securities and Exchange Commission. Note 8. AMENDMENT OF RULE 10-01 OF REGULATION S-X REQUIRING REVIEWED QUARTERLY FINANCIAL STATEMENTS In accordance with the new amendment effective for the period ended March 31, 2000, the accompanying consolidated financial statements have been reviewed by Independent Certified Public Accountants whose report is being submitted as an integral part of this Form 10Q filing. 10 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTS Board of Directors and Stockholders of First Keystone Corporation: We have reviewed the accompanying consolidated balance sheet of First Keystone Corporation and Subsidiary as of September 30, 2000, and the related consolidated statements of income and cash flows for the three and nine-month periods then ended. These consolidated financial statements are the responsibility of the management of First Keystone Corporation and Subsidiary. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the September 30, 2000, financial statements for them to be in conformity with generally accepted accounting principles. The accompanying balance sheet of First Keystone Corporation and Subsidiary for the year ended December 31, 1999, was audited by us as part of our audit of the financial statements for the year ended December 31, 1999, taken as a whole and we expressed an unqualified opinion on them in our report dated January 10, 2000, but we have not performed any auditing procedures since that date. The accompanying statements of income and cash flows of First Keystone Corporation and Subsidiary for the three and nine-month periods ended September 30, 1999, were not audited by us and, accordingly, we do not express an opinion on them. /s/ J. H. Williams & Co., LLP J. H. Williams & Co., LLP Kingston, Pennsylvania October 26, 2000 11 Item 2. First Keystone Corporation Management's Discussion and Analysis of Financial Condition and Results of Operation as of September 30, 2000 RESULTS OF OPERATIONS First Keystone Corporation realized earnings for the third quarter of 2000 of $1,363,000, an increase of $8,000, or 0.6% over the third quarter of 1999. Nine months net income for the period ended September 30, 2000, amounted to $3,844,000, a decrease of 0.9% over the $3,878,000 net income reported September 30, 1999. On a per share basis net income per share increased to $1.36 for the nine months of 2000 compared to $1.35 for the first nine months of 1999, while dividends increased to $.57 per share up from $.51 in 1999, an increase of 11.8%. Year-to-date net income annualized amounts to a return on average common equity of 1.51% and a return on assets of 16.76%. For the nine months ended September 30, 1999, these measures were 1.59% and 15.79%, respectively on an annualized basis. NET INTEREST INCOME The major source of operating income for the Corporation is net interest income, defined as interest income less interest expense. In the third quarter of 2000, interest income amounted to $6,552,000, an increase of $652,000 or 11.1% over the third quarter of 1999. Interest expense amounted to $3,649,000 in the third quarter of 2000, an increase of $619,000, or 20.4% over the third quarter of 1999. Accordingly, net interest income amounted to $2,903,000 in the third quarter of 2000, an increase of $33,000, or 1.1% over the third quarter of 1999. Year-to-date for the nine months ended September 30, 2000, total interest income increased $1,735,000, or 10.1% over the first nine months of 1999. Total interest expense increased $1,439,000, or 16.4% for the first nine months of 2000 over 1999. This resulted in net interest income increasing $296,000, or 3.6% for the nine months ended September 30, 2000, over 1999. Our net interest margin for the quarter ended September 30, 2000, was 3.94% compared to 3.91% for the quarter ended September 30, 1999. For the nine months ended September 30, 2000, our net interest margin was 4.10% compared to 3.98% for the first nine months of 1999. PROVISION FOR LOAN LOSSES The provision for loan losses for the quarter ended September 30, 2000, was $75,000 compared to $50,000 for the third quarter of 1999. Year-to-date, the provision for loan losses amounts to $235,000 in 2000 as compared to the $225,000 provision for the period ended September 30, 1999. The provision for possible loan losses increased in 2000. Our allowance for loan losses of $2,576,000 as of September 30, 2000, is down slightly compared to our allowance for loan losses of $2,600,000 as of December 31, 1999. Net charge-offs totaled $259,000 for the nine months ended September 30, 2000, as compared to $74,000 for the first nine months of 1999. The allowance for loan losses as a percentage of loans, net of unearned interest was 1.38% as of September 30, 2000, and 1.40% as of December 30, 1999. 12 NON-INTEREST INCOME Total non-interest or other income was $525,000 for the quarter ended September 30, 2000, as compared to $461,000 for the quarter ended September 30, 1999. Excluding investment security gains and losses, non-interest income was $455,000 for the third quarter of 2000, an increase of $71,000 over the third quarter of 1999. For the nine months ended September 30, 2000, total non-interest income was $1,332,000, an increase of $29,000, or 2.2% over the first nine months of 1999. An increase in service charges on deposit accounts, was the primary reason for the gain in non-interest income year-to-date in 2000. NON-INTEREST EXPENSES Total non-interest, or other expenses, was $1,662,000 for the quarter ended September 30, 2000, as compared to $1,588,000 for the quarter ended September 30, 1999. The increase of $74,000 is comprised of salary and benefits increasing $54,000, occupancy expense increasing $39,000, and other non-interest expense decreasing $19,000. For the nine months ended September 30, 2000, total non-interest expense was $5,070,000, an increase of $474,000, or 10.3% over the first nine months of 1999. Expenses associated with employee expense and benefits continues to be the largest category of non-interest expenses. Salaries and benefits amount to 55.9% of total non-interest expense for the nine months ended September 30, 2000, as compared to 54.4% for the first nine months of 1999. Salaries and benefits amounted to $2,833,000 for the nine months ended September 30, 2000, an increase of $332,000, or 13.3% over the first nine months of 1999. The increase was a result of normal salary adjustments, higher employee benefit costs and an increased number of employees. Net occupancy expense amounted to $758,000 for the nine months ended September 30, 2000, an increase of $41,000, or 5.7% over 1999. Other non-interest expenses amounted to $1,479,000 for the nine months ended September 30, 2000, an increase of $101,000, or 7.3% over the first nine months of 1999. Our overall non-interest expense of less than 2% of average assets on an annualized basis for 2000 and 1999, places us among the leaders of our peer financial institutions at controlling total non-interest expense. INCOME TAXES Effective tax planning has helped produce favorable net income. The effective total income tax rate was 19.4% for the third quarter of 2000 as compared to 20.0% for the third quarter of 1999. For the nine months ended September 30, 2000, our tax liability amounted to $810,000, a decrease of $125,000 over 1999. Our effective tax rate of 17.4% as of September 30, 2000, compared to an effective tax rate of 19.4% for the first nine months of 1999. ANALYSIS OF FINANCIAL CONDITION ASSETS Total assets increased to $350,188,000 as of September 30, 2000, an increase of $16,672,000, or 5.0% over year-end 1999. Total deposits increased to $259,803,000 as of September 30, 2000, an increase of $15,123,000, or 6.2% over year-end 1999. The Corporation was able to reduce borrowed funds with the increase in total deposits. Short-term borrowings decreased to $23,359,000, a decrease of $8,235,000 over December 31, 1999. Long-term borrowings increased in to $31,250,000 as of September 30, 2000, up from $26,000,000 at year-end 1999. Accordingly, total borrowings amounted to $54,609,000 as of September 30, 2000, as compared to $57,594,000 as of December 31, 1999, a decrease of $2,985,000. 13 EARNING ASSETS Our primary earning asset, loans, net of unearned income increased to $186,797,000 as of September 30, 1999, up $1,566,000, or 0.8% since year-end 1999. The loan portfolio is well diversified and increases in the portfolio have been primarily from increased originations of residential real estate loans and commercial real estate loans. In addition to loans, our investment portfolio, another earning asset, increased in size from December 31, 1999, to September 30, 2000. Held-to-maturity securities amounted to $8,975,000 as of September 30, 2000, a decrease of $2,588,000 since year-end 1999. However, available-for-sale securities increased to $143,042,000 as of September 30, 2000, an increase of $19,574,000, or 15.9% from year-end 1999. Interest bearing deposits with banks amounted to $47,000 on September 30, 2000, as compared to $80,000 as of December 31, 1999. ALLOWANCE FOR LOAN LOSSES Management performs a quarterly analysis to determine the adequacy of the allowance for loan losses. The methodology in determining adequacy incorporates specific and general allocations together with a risk/loss analysis on various segments of the portfolio according to an internal loan review process. Management maintains its loan review and loan classification standards consistent with those of its regulatory supervisory authority. Management feels, considering the conservative portfolio composition, which is largely composed of small retail loans (mortgages and installments) with minimal classified assets, low delinquencies, and favorable loss history, that the allowance for loan loss is adequate to cover foreseeable future losses. Any loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been disclosed under Industry Guide 3 do not (i) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (ii) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms. The company was required to adopt Financial Accounting Standards Board Statement No. 114, "Accounting by Creditors for Impairment of a Loan" - Refer to Note 5 above for details. NON-PERFORMING ASSETS Non-performing assets consist of non-accrual and restructured loans, other real estate and foreclosed assets, together with the loans past-due 90 days or more and still accruing. As of September 30, 2000, total non-performing assets were $1,142 as compared to $750,000 on December 31, 1999. Non-performing assets to total loans and foreclosed assets was .61% as of September 30, 2000, and .40% as of December 31, 1999. Interest income received on non-performing loans as of September 30, 2000, was $19,904 compared to $6,380 as of December 31, 1999. Interest income, which would have been recorded on these loans under the original terms as of September 30, 2000, and December 31, 1999, was $65,306 and $68,569, respectively. As of September 30, 2000 and December 31, 1999, there was no outstanding commitments to advance additional funds with respect to these non-performing loans. 14 DEPOSITS AND OTHER BORROWED FUNDS As indicated previously, deposit growth amounted to $15,123,000 as total deposits increased to $259,803,000 as of September 30, 2000, up from $244,680,000 as of year-end 1999. During 2000, the Corporation has experienced deposit growth in both non-interest bearing deposits and interest bearing deposits. Total short-term and long-term borrowings decreased by $2,985,000 from year-end 1999. CAPITAL STRENGTH Normal increases in capital are generated by net income, less cash dividends paid out. Also, net unrealized losses on investment securities available-for-sale decreased shareholders' equity, or capital by $1,630,000 as of September 30, 2000, and $3,459,000 as of December 31, 1999. Our stock repurchase plan had repurchased 100,000 shares as of September 30, 2000 and December 31, 1999. This had an effect of our reducing our total stockholders' equity by $3,096,000. Total stockholders' equity was $33,416,000 as of September 30, 2000, and $29,358,000 as of December 31, 2000. Leverage ratio and risk based capital ratios remain very strong. As of September 30, 2000, our leverage ratio was 10.09% compared to 10.02% as of December 31, 1999. In addition, Tier I risk based capital and total risk based capital ratio as of September 30, 2000, were 16.53% and 17.82%, respectively. The same ratios as of December 31, 1999, were 16.43% and 17.85%, respectively. LIQUIDITY The liquidity position of the Corporation remains adequate to meet customer loan demand and deposit fluctuation. Managing liquidity remains an important segment of asset liability management. Our overall liquidity position is maintained by an active asset liability management committee. Management feels its current liquidity position is satisfactorily given a very stable core deposit base which has increased annually. Secondly, our loan payments and principal paydowns on our mortgage backed securities provide a steady source of funds. Also, short-term investments and maturing investment securities represent additional sources of liquidity. Finally, short-term borrowings are readily accessible at the Federal Reserve Bank discount window, Atlantic Central Bankers Bank, or the Federal Home Loan Bank. YEAR 2000 COMPLIANCE During 1999, management completed the process of preparing its computer systems and applications for the Year 2000. The process involves identifying and remediating date recognition problems in computer systems and software and other operating equipment that could be caused by the date change from December 31, 1999, to January 1, 2000. In addition, the process involved working with third parties to address their year 2000 issues and developing contingency plans to address potential risks in the event of Year 2000 failures. To date, First Keystone Corporation has successfully managed the transition into the Year 2000. Unanticipated problems associated with non-compliance by third parties and disruptions to the economy in general resulting from Year 2000 issues could still have a negative impact on First Keystone Corporation. Management will continue to monitor all business processes, including interaction with customers, vendors, and other third parties throughout 2000 to address any issues and insure all processes and systems continue to function properly. 15 Through 1999, the Corporation estimates that its total Year 2000 project cost did not exceed $100,000. The expenses for maintenance or modification of software associated with the Year 2000 were expensed as incurred. The costs of new software were capitalized and amortized over the software's useful life. The aforementioned Year 2000 project cost may change as the Corporation progresses through 2000. Some additional project costs are expected to be incurred in 2000 for ongoing monitoring and support activities. These costs will be expensed as incurred and are estimated not to exceed $25,000. Management believes it has an effective plan in place to address the Year 2000 issues in a timely manner and, thus far, activities have tracked in accordance with the original plan. 16 PART II - OTHER INFORMATION Item 1. Legal Proceedings None. Item 2. Changes in Securities None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders Annual Meeting of Shareholders of First Keystone Corporation held on Tuesday, April 18, 2000, at 10:00 a.m.
Votes Votes Directors Elected Votes For Against Withheld _________________ _________ ______ _______ Budd L. Beyer 2,404,890 4,268 0 Frederick E. Crispin, Jr. 2,404,890 4,268 0 Jerome F. Fabian 2,406,188 2,970 0 Robert J. Wise 2,405,140 4,018 0 Broker Directors Elected Abstentions Non-Votes _________________ ___________ _________ Budd L. Beyer 0 0 Frederick E. Crispin, Jr. 0 0 Jerome F. Fabian 0 0 Robert J. Wise 0 0
Directors Continuing: John L. Coates, term expires in 2002 Dudley P. Cooley, term expires in 2002 Stanley E. Oberrender, term expires in 2002 John E. Arndt, term expires in 2001 J. Gerald Bazewicz, term expires in 2001 Robert E. Bull, term expires in 2001 Matters Voted Upon: Selection of J. H. Williams & Co. LLP, as auditors for the Corporation. Votes For - 2,406,872 Votes Against - 1,204 Votes Withheld - 0 Abstentions - 1,082 Broker Non-Votes - 0 Item 5. Other Information None. 17 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits required by Item 601 Regulation S-K Exhibit Number Description of Exhibit 3(i) Articles of Incorporation, as amended (Incorporated by reference to Exhibit 3(i) to Registrant's Form 10Q for the Quarter Ended June 30, 1998 and Exhibit 3(i) to Registrant's Annual Report on Form 10-KSB for the year ended December 31, 1996.) 3(ii) Bylaws, as amended (Incorporated by reference to Exhibit 3(ii) to Registrant's Annual Report on Form 10-KSB for the year ended December 31, 1996.) 10 Material Contracts (Incorporated by reference to Exhibit 10 to Registrant's Form 10Q for the quarter ended June 30, 1997) 11 Statement RE: Computation of Earnings Per Share. 27 Financial Data Schedule. (b) The Registrant has filed no reports on Form 8-K for this quarter. 18 FIRST KEYSTONE CORPORATION SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly cause this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST KEYSTONE CORPORATION Registrant November 8, 2000 /s/ J. Gerald Bazewicz J. Gerald Bazewicz President and Chief Executive Officer (Principal Executive Officer) November 8, 2000 /s/ David R. Saracino David R. Saracino Treasurer/Assistant Secretary (Principal Accounting Officer) 19 INDEX TO EXHIBITS Exhibit Description 10 Material Contracts Profit Sharing Plan Summary (Incorporated by reference to Exhibit 10 (Page 16) to Registrant's Form 10Q for the quarter ended June 30, 1997) Deferred Compensation (Incorporated by reference to Exhibit 10 (Page 17) to Registrant's Form 10Q for the quarter ended June 30, 1997) Other Executive Benefits (Incorporated by reference to Exhibit 99 (Page 9) of the Corporation's Annual Report on Form 10-KSB for the year ended December 31, 1996) Management Incentive Compensation Plan (Incorporated by reference to Exhibit 10 (Page 18) to Registrant's Form 10Q for the quarter ended June 30, 1997) 11 Computation of Earnings Per Share 27 Financial Data Schedule 20