-----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, PzCSQe12XIA/anSoL2hg3eVTFJAjkHmmh9Zc0uOxuK3Ltx27PpnZxTPg58h91JLq EanUUyX8r+J9VmmYqIAP8Q== 0000737875-98-000007.txt : 19980401 0000737875-98-000007.hdr.sgml : 19980401 ACCESSION NUMBER: 0000737875-98-000007 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST KEYSTONE CORP CENTRAL INDEX KEY: 0000737875 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 232249083 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-21344 FILM NUMBER: 98580533 BUSINESS ADDRESS: STREET 1: 111 W FRONT ST CITY: BERWICK STATE: PA ZIP: 18603 BUSINESS PHONE: 717-752-36 MAIL ADDRESS: STREET 1: 111 WEST FRONT STREET CITY: BERWICK 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [x] ANNUAL REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 Or [ ] TRANSITION REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to ________________ Commission file Number: 2-88927 FIRST KEYSTONE CORPORATION (Name of small business issuer in its charter) PENNSYLVANIA 23-2249083 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 111 West Front Street, 18603 Berwick, Pennsylvania (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (717) 752-3671 Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $2.00 per share Securities registered pursuant to Section 12(g) of the Act: Not Applicable Indicate by check mark whether the Registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non- affiliates on the Registrant based on the closing price as of March 10, 1998, was approximately $60,033,324. The number of shares outstanding of the issuer's Common Stock, as of March 10, 1998, was 2,933,727 shares of Common Stock, par value $2.00 per share. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's 1998 definitive Proxy Statement are incorporated by reference in Part III of this Annual Report. In addition, portions of the Annual Report to stockholders of the Registrant for the year ended December 31, 1997, are incorporated by reference in Part II of this Annual Report. FIRST KEYSTONE CORPORATION FORM 10-K Table of Contents Part I Page Item 1. Business 1 Item 2. Properties 12 Item 3. Legal Proceedings 13 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 13 Item 6. Selected Financial Data 15 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 8. Financial Statements and Supplementary Data 15 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not Applicable Part III Item 10. Directors and Executive Officers of the Registrant 15 Item 11. Executive Compensation 15 Item 12. Security Ownership of Certain Beneficial Owners and Management 16 Item 13. Certain Relationships and Related Transactions 16 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 16 i FIRST KEYSTONE CORPORATION FORM 10-K PART I ITEM 1. BUSINESS First Keystone Corporation (the "Corporation"), a Pennsylvania business corporation, is a bank holding company, registered with and supervised by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). The Corporation was incorporated on July 6, 1983, and commenced operations on July 2, 1984, upon consummation of the acquisition of all of the outstanding stock of The First National Bank of Berwick (the "Bank"). Since commencing operations, the Corporation's business has consisted primarily of managing and supervising the Bank, and its principal source of income has been dividends paid by the Bank. The Corporation has one wholly- owned subsidiary, the Bank. At December 31, 1997, the Corporation had total consolidated assets, deposits and stockholders' equity of approximately $267.4 million, $217.6 million and $31.8 million, respectively. The Bank was organized in 1864. The Bank is a national banking association that is a member of the Federal Reserve System and the deposits of which are insured by the Federal Deposit Insurance Corporation (the "FDIC"). The Bank, having six branch locations (three branches within Columbia County and three branches within Luzerne County, Pennsylvania), is a full service commercial bank providing a wide range of services to individuals and small to medium sized businesses in its Northeastern Pennsylvania market area, including accepting time, demand, and savings deposits and making secured and unsecured commercial, real estate and consumer loans. Additionally, the Bank also provides personal and corporate trust and agency services to individuals, corporations, and others, including trust investment accounts, investment advisory services, mutual funds, estate planning, and management of pension and profit sharing plans. FKC Realty Corporation commenced operations July 2, 1984. It's major asset is a parcel of real estate currently utilized for parking located in Berwick, Pennsylvania and its only source of income is parking fees. On December 29, 1995, FKC Realty, Inc., a wholly owned realty subsidiary of the Corporation, was liquidated. Transfer of assets in liquidation were at book value to the Corporation and bank subsidiary. No gain or loss is recognized in these consolidated financial statements. Supervision and Regulation - Corporation The Corporation is subject to the jurisdiction of the Securities and Exchange Commission ("SEC") and of state securities laws for matters relating to the offering and sale of its securities. The Corporation is currently subject to the SEC's rules and regulations relating to periodic reporting in accordance with Section 13 of the Securities Exchange Act of 1934. The Bank is subject to regulation by the Pennsylvania Department of Banking and the FDIC, but, as a national bank, is regulated and examined by the Office of the Comptroller of the Currency. The Corporation is also subject to the provisions of the Bank Holding Company Act of 1956, as amended ("Bank Holding Company Act"), and to supervision by the Federal Reserve Board. The Bank Holding Company Act requires the Corporation to secure the prior approval of the Federal Reserve Board before it owns or controls, directly or indirectly, more than 5% of the voting shares of substantially all of the assets of any institution, including another bank. The Bank Holding Company 1 Act prohibits acquisition by the Corporation of more than 5% of the voting shares of, or interest in, or substantially all the assets of, any bank located outside Pennsylvania unless such an acquisition is specifically authorized by laws of the state in which such bank is located. A bank holding company is prohibited from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in non-banking activities unless the Federal Reserve Board, by order or regulation, has found such activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In making this determination, the Federal Reserve Board considers whether the performance of these activities by a bank holding company would offer benefits to the public that outweigh possible adverse effects. The Bank Holding Company Act also prohibits acquisitions of control of a bank holding company, such as the Corporation, without prior notice to the Federal Reserve Board. Control is defined for this purpose as the power, directly or indirectly, to direct the management or policies of a bank holding company or to vote twenty- five percent (25%) (or ten percent (10%), if no other person or persons acting on concert, holds a greater percentage of the Common Stock) or more of the Corporation's Common Stock. The Corporation is required to file an annual report with the Federal Reserve Board and any additional information that the Federal Reserve Board may require pursuant to the Bank Holding Company Act. The Federal Reserve Board may also make examinations of the Corporation and any or all of its subsidiaries. Further, under Section 106 of the 1970 amendments to the Bank Holding Company Act and the Federal Reserve Board's regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or provision of credit or provision of any property or services. The so-called "Anti-tie-in" provisions state generally that a bank may not extend credit, lease, sell property or furnish any service to a customer on the condition that the customer provide additional credit or service to the bank, to its bank holding company or to any other subsidiary of its bank holding company or on the condition that the customer not obtain other credit or service from a competitor of the bank, its bank holding company or any subsidiary of its bank holding company. Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or any of its subsidiaries, on investments in the stock or other securities of the bank holding company and on taking of such stock or securities as collateral for loans to any borrower. Permitted Non-Banking Activities The Federal Reserve Board permits bank holding companies to engage in non-banking activities so closely related to banking, managing or controlling banks as to be a proper incident thereto. The Corporation does not at this time engage in any of these non-banking activities, nor does the Corporation have any current plans to engage in any other permissible activities in the foreseeable future. Legislation and Regulatory Changes From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial institutions are frequently made in Congress, and before various bank regulatory agencies. No prediction can be made as to the likelihood of any major changes or the impact such changes might have on the 2 Corporation and its subsidiary bank. Certain changes of potential significance to the Corporation which have been enacted recently and others which are currently under consideration by Congress or various regulatory agencies are discussed below. Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") On August 9, 1989, major reform and financing legislation, i.e., FIRREA, was enacted into law in order to restructure the regulation of the thrift industry, to address the financial condition of the Federal Savings and Loan Insurance Corporation and to enhance the supervisory and enforcement powers of the Federal bank and thrift regulatory agencies. The Office of the Comptroller of the Currency ("OCC"), as the primary Federal regulator of the Bank, is primarily responsible for supervision of the Bank. The OCC and FDIC have far greater flexibility to impose supervisory agreements on an institution that fails to comply with its regulatory requirements, particularly with respect to the capital requirements. Possible enforcement actions include the imposition of a capital plan, termination of deposit insurance and removal or temporary suspension of an officer, director or other institution-affiliated party. Under FIRREA, civil penalties are classified into three levels, with amounts increasing with the severity of the violation. The first tier provides for civil penalties of up to $5,000 per day for any violation of law or regulation. A civil penalty of up to $25,000 per day may be assessed if more than a minimal loss or a pattern of misconduct is involved. Finally, a civil penalty of up to $1.0 million per day may be assessed for knowingly or recklessly causing a substantial loss to an institution or taking action that results in a substantial pecuniary gain or other benefit. Criminal penalties are increased to $1.0 million per violation, up to $5.0 million for continuing violations or for the actual amount of gain or loss. These monetary penalties may be combined with prison sentences for up to five years. Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") In 1991, the Federal Deposit Insurance Corporation Improvement Act ("FDICIA") was signed into law. FDICIA established five different levels of capitalization of financial institutions, with "prompt corrective actions" and significant operational restrictions imposed of institutions that are capital deficient under the categories. The five categories are: Well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. To be considered well capitalized, an institution must have a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 6%, a leverage capital ratio of 5%, and must not be subject to any order or directive requiring the institution to improve its capital level. An institution falls within the adequately capitalized category if it has a total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 4%, and a leverage capital ratio of at least 4%. Institutions with lower capital levels are deemed to be undercapitalized, significantly undercapitalized or critically undercapitalized, depending on their actual capital levels. In addition, the appropriate federal regulatory agency may downgrade an institution to the next lower capital category upon a determination that the institution is in an unsafe or unsound condition, or is engaged in an unsafe or unsound practice. Institutions are required under FDICIA to closely monitor their capital levels and to notify their appropriate regulatory agency of any basis for a change in capital category. On December 31, 1997, the Corporation and the Bank exceeded the minimum capital levels of the well capitalized category. Regulatory oversight of an institution becomes more stringent with each lower capital category, with certain "prompt corrective actions" imposed depending on the level of capital deficiency. 3 Other Provisions of FDICIA Each depository institution must submit audited financial statements to its primary regulator and the FDIC, which reports are made publicly available. In addition, the audit committee of each depository institution must consist of outside directors and the audit committee at "large institutions" (as defined by FDIC regulation) must include members with banking or financial management expertise. The audit committee at "large institutions" must also have access to independent outside counsel. In addition, an institution must notify the FDIC and the institution's primary regulator of any change in the institutions independent auditor, and annual management letters must be provided to the FDIC and the depository institution's primary regulator. The regulations define a "large institution" as one with over $500 million in assets, which does not include the Bank. Also, under the rule, an institution's independent auditor must examine the institution's internal controls over financial reporting and perform agreed-upon procedures to test compliance with laws and regulations concerning safety and soundness. Under FDICIA, each federal banking agency must prescribe certain safety and soundness standards for depository institutions and their holding companies. Three types of standards must be prescribed: Asset quality and earnings, operational and managerial, and compensation. Such standards would include a ratio of classified assets to capital, minimum earnings, and, to the extent feasible, a minimum ratio of market value to book value for publicly traded securities of such institutions and holding companies. Operational and managerial standards must relate to: (i) internal controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) interest rate exposure, (v) asset growth, and (vi) compensation, fees and benefits. In November, 1993, the federal banking agencies released proposed rules setting forth some of the required safety and soundness standards. Under such proposed rules, if the primary federal regulator determines that any standard has not been met, the regulator can require the institution to submit a compliance plan that describes the steps the institution will take to eradicate the deficiency. Failure to adopt or implement a compliance plan could lead to further sanctions by the responsible regulator. Pursuant to the Riegle Community Development and Regulatory Improvement Act of 1994, federal banking agencies have been given the discretion to adopt safety and soundness guidelines rather than regulations. Provisions of FDICIA relax certain requirements for mergers and acquisitions among financial institutions, including authorization of mergers of insured institutions that are not members of the same insurance fund, and provide specific authorization for a federally chartered savings association or national bank to be acquired by an insured depository institution. Under FDICIA, all depository institutions must provide 90 days notice to their primary federal regulator of branch closings, and penalties are imposed for false reports by financial institutions. Depository institutions with assets in excess of $250 million must be examined on-sit annually by their primary federal or state regulator of the FDIC. FDICIA also sets forth Truth in Savings disclosure and advertising requirements applicable to all depository institutions. Real Estate Lending Standards. Pursuant to the FDICIA, the OCC and other federal banking agencies adopted real estate lending guidelines which would set loan-to-value ("LTV") ratios for different types of real estate loans. A LTV ratio is generally defined as the total loan amount divided by the appraised value of the property at the time the loan is originated. If the institution does not hold a first lien position, the total loan amount would be combined with the amount of all senior liens when calculating the ratio. In addition to establishing the LTV ratios, the guidelines require all real estate loans to be based upon proper loan documentation and a recent appraisal of the property. 4 Bank Enterprise Act of 1991. Within the overall FDICIA is a separate subtitle called the "Bank Enterprise Act of 1991." The purpose of this Act is to encourage banking institutions to establish "basic transaction services for consumers" or so-called "lifeline accounts." The FDIC assessment rate is reduced for all lifeline depository accounts. This Act establishes ten (10) factors which are the minimum requirements to qualify as a lifeline depository account. Some of these factors relate to minimum opening and balance amounts, minimum number of monthly withdrawals, the absence of discriminatory practices against low-income individuals and minimum service charges and fees. Moreover, the Housing and Community Development Act of 1972 requires that the FDIC's risk-based assessment system include provisions regarding life-line accounts. Assessment rates applicable to life-line accounts are to be established by FDIC rule. Truth in Savings Act. The FDICIA also contains the Truth in Savings Act ("TSA"). The Federal Reserve Board has adopted regulations ("Regulation DD") under the TSA. The purpose of TSA is to require the clear and uniform disclosure of the rates of interest which are payable on deposit accounts by depository institutions and the fees that are assessable against deposit accounts, so that consumers can make a meaningful comparison between the competing claims of banks with regard to deposit accounts and products. In addition to disclosures to be provided when a customer establishes a deposit account, TSA requires the depository institution to include, in a clear and conspicuous manner, the following information with each periodic statement of a deposit account: (1) the annual percentage yield earned, (2) the amount of interest earned, (3) the amount of any fees and charges imposed and (4) the number of days in the reporting period. TSA allows for civil lawsuits to be initiated by customers if the depository institution violates any provision or regulation under TSA. FDIC Insurance Assessments The FDIC has implemented a risk-related premium schedule for all insured depository institutions that results in the assessment of premiums based on capital and supervisory measures. Under the risk-related premium schedule, the FDIC, on a semiannual basis, assigns, each institution to one of three capital groups (well capitalized, adequately capitalized or under capitalized) and further assigns such institution to one of three subgroups within a capital group corresponding to the FDIC's judgment of the institution's strength based on supervisory evaluations, including examination reports, statistical analysis and other information relevant to gauging the risk posed by the institution. Only institutions with a total capital to risk-adjusted assets ratio of 10.0% or greater, a Tier 1 capital to risk-adjusted assets ratio of 6.0% or greater and a Tier 1 leverage ratio of 5.0% or greater, are assigned to the well-capitalized group. Over the last two years, FDIC insurance assessments have seen several changes for both the Bank Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF") institutions. The most recent change occurred on September 30, 1996, when the President signed into law a bill designed to remedy the disparity between BIF and SAIF deposit premiums. The first part of the bill called for the SAIF to be capitalized by a one-time assessment on all SAIF insured deposits held as of March 31, 1995. This assessment, which was 65.7 cents per $100 in deposits, raised approximately $4.7 billion to bring the SAIF up to its required 1.25 reserve ratio. This special assessment, paid in 1996, had no effect on the Bank. The second part of the bill remedied the future anticipated shortfall with respect to the payment of Financing Corporation ("FICO") interest. For 1997 through 1999, the banking industry will help pay the FICO interest payments at an assessment rate that is one-fifth the rate paid by thrifts. The FICO assessment on BIF insured deposits is 1.29 cents per $100 in deposits; for SAIF insured deposits it is 6.44 cents per $100 in deposits. Beginning January 1, 2000, the FICO interest payments will be paid pro-rata by banks and thrifts based on deposits. 5 Regulatory Capital Requirements
The following table presents the Corporation's capital ratios at December 31, 1997: (In Thousands) Tier I Capital $ 29,589 Tier II Capital 29,589 Total Capital 31,499 Adjusted Total Average Assets 263,525 Total Adjusted Risk-Weighted Assets 152,323 Tier I Risk-Based Capital Ratio 19.43% Required Tier I Risk-Based Capital Ratio 4.00% Excess Tier I Risk-Based Capital Ratio 15.43% Total Risk-Based Capital Ratio 20.68% Required Total Risk-Based Capital Ratio 8.00% Excess Total Risk-Based Capital Ratio 12.68% Tier I Leverage Ratio 11.23% Required Tier I Leverage Ratio 3.00% Excess Tier I Leverage Ratio 8.23% ______________________________ Includes off-balance sheet items at credit-equivalent values less intangible assets. Tier I Risk-Based Capital Ratio is defined as the ratio of Tier I Capital to Total Adjusted Risk-Weighted Assets. Total Risk-Based Capital Ratio is defined as the ratio of Tier I and Tier II Capital to Total Adjusted Risk-Weighted Assets. Tier I Leverage Ratio is defined as the ratio of Tier I Capital to Adjusted Total Average Assets.
The Corporation's ability to maintain the required levels of capital is substantially dependent upon the success of Corporation's capital and business plans; the impact of future economic events on the Corporation's loan customers; and the Corporation's ability to manage its interest rate risk and investment portfolio and control its growth and other operating expenses. Effect of Government Monetary Policies The earnings of the Corporation are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The monetary policies of the Federal Reserve Board have had, and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order to, among other things, curb inflation or combat a recession. The Federal Reserve Board has a major effect upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulations of, among other things, the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies. 6 Environmental Regulation There are several federal and state statutes that regulate the obligations and liabilities of financial institutions pertaining to environmental issues. In addition to the potential for attachment of liability resulting from its own actions, a bank may be held liable, under certain circumstances, for the actions of its borrowers, or third parties, when such actions result in environmental problems on properties that collateralize loans held by the bank. Further, the liability has the potential to far exceed the original amount of the loan issued by the Bank. Currently, neither the Corporation nor the Bank is a party to any pending legal proceeding pursuant to any environmental statute, nor are the Corporation and the Bank aware of any circumstances that may give rise to liability under any such statute. History and Business - Bank The Bank's legal headquarters are located at 111 West Front Street, Berwick, Pennsylvania. As of December 31, 1997, the Bank had total assets of $265,829,051, total shareholders' equity of $30,022,204 and total deposits and other liabilities of $235,806,847. The Bank engages in a full-service commercial banking business, including accepting time and demand deposits, and making secured and unsecured commercial and consumer loans. The Bank's business is not seasonal in nature. Its deposits are insured by the FDIC to the extent provided by law. At December 31, 1997, the Bank had eighty-three (83) full-time employees and thirty-one (31) part-time employees. In the opinion of management, the Bank enjoys a satisfactory relationship with its employees. The Bank is not a party to any collective bargaining agreement. Competition - Bank The Bank competes actively with other area commercial banks and savings and loan associations, many of which are larger than the Bank, as well as with major regional banking and financial institutions. The Bank's major competitors in the county of Columbia and the county of Luzerne are: First Columbia Bank & Trust Co. of Bloomsburg, PNC Bank, N.A., Columbia County Farmers National Bank of Bloomsburg, Franklin First Savings Bank of Wilkes-Barre, FNB Bank of Danville and First National Trust Bank of Sunbury. The Bank is generally competitive with all competing financial institutions in its service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans. Supervision and Regulation - Bank The operations of the Bank are subject to federal and state statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System and to banks whose deposits are insured by the FDIC. Bank operations are also subject to regulations of the OCC, the Federal Reserve Board and the FDIC. The primary supervisory authority of the Bank is the OCC, which regulates and examines the Bank. The OCC has the authority under the Financial Institutions Supervisory Act to prevent a national bank from engaging in an unsafe or unsound practice in conducting its business. Federal and state banking laws and regulations govern, among other things, the scope of a bank's business, the investments a bank may make, the reserves against deposits a bank must 7 maintain, loans a bank makes and collateral it takes, and the activities of a bank with respect to mergers and consolidations and the establishment of branches. As a subsidiary of a bank holding company, the Bank is subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or its subsidiaries, on investments in the stock or other securities of the bank holding company or its subsidiaries and on taking such stock or securities as collateral for loans. The Federal Reserve Act and Federal Reserve Board regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship. From time to time, various types of federal and state legislation have been proposed that could result in additional regulations of, and restrictions on, the business of the Bank. It cannot be predicted whether any such legislation will be adopted or how such legislation would affect the business of the Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, the Bank's business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business. Under the Federal Deposit Insurance Act ("FDIA"), the OCC possesses the power to prohibit institutions regulated by it (such as the Bank) from engaging in any activity that would be an unsafe or unsound banking practice or would otherwise be in violation of the law. Moreover, the Financial Institutions Regulatory and Interest Rate Control Act of 1978 ("FIRA") generally expanded the circumstances under which officers or directors of a bank may be removed by the institution's federal supervisory agency, restricts lending by a bank to its executive officers, directors, principal shareholders or related interests thereof and restricts management personnel of a bank from serving as directors or in other management positions with certain depository institutions whose assets exceed a specified amount or which have an office within a specified geographic area, and restricts the relationships of management personnel of a bank with securities companies and securities dealers. Additionally, FIRA requires that no person may acquire control of a bank unless the appropriate federal supervisory agency has given sixty (60) days prior written notice and within that time has not disapproved the acquisition or otherwise extended the period for disapproval. Control for purposes of FIRA means the power to direct, either directly or indirectly, the management or policies or to vote twenty-five percent (25%) or more of any class of outstanding stock of a financial institution or its respective holding company. A person or group holding revocable proxies to vote twenty-five percent (25%) or more of the outstanding common stock of a financial institution or holding company would presumably be deemed to control the institution for purposes of FIRA. Under the Bank Secrecy Act ("BSA"), the Bank is required to report to the Internal Revenue Service currency transactions of more than $10,000 or multiple transactions of which the Bank is aware in any one day that aggregate in excess of $10,000. Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information required by the BSA or for filing a false or fraudulent report. The Garn-St Germain Depository Institutions Act of 1982 ("1982 Act"), removes certain restrictions on the lending powers and liberalizes the depository abilities of the Bank. The 1982 Act also amends FIRA (see above) by eliminating certain statutory limits on lending of a bank to its executive officers, directors, principal shareholders or related interests thereof and by relaxing certain reporting requirements. However, the 1982 Act strengthened FIRA provisions respecting management interlocks and correspondent bank relationships by management personnel. 8 Community Reinvestment Act The Community Reinvestment Act of 1977, as amended (the "CRA"), and the regulations promulgated to implement the CRA are designed to create a system for bank regulatory agencies to evaluate a depository institution's record in meeting the credit needs of its community. Until May 1995, a depository institution was evaluated for CRA compliance based upon 12 assessment factors. The CRA regulations were completely revised as of May 4, 1995, to establish new performance-based standard for use in examining a depository institution's compliance with the CRA (the "revised CRA regulations"). The revised CRA regulations establish new tests for evaluating both small and large depository institutions investment in the community. A "small bank" is defined as a bank which has total assets of less than $250 million and is independent or is an affiliate of a holding company with less than $1 billion in assets., Pursuant to the revised CRA regulations, a depository institution which qualifies as a "small bank" will be examined under a streamlined procedure which emphasizes lending activities. The streamlined examination procedures for a small bank became effective on January 1, 1996. A large retail institution is one which does not meet the "small bank" definition above. A large retail institution can be evaluated under one of two tests: (1) a three-part test evaluating the institution's lending, service and investment performance: or (2) a "Strategic Plan"; designed by the institution with community involvement and approved by the appropriate federal bank regulator. A large institution must choose one of these options prior to July 1997, but may opt to be examined under one of these two options prior to that time. Effective January 1, 1996, a large retail institution that opts to be examined pursuant to a strategic plan may submit its strategic plan to the bank regulators for approval. In addition, the revised CRA regulations include separate rules regarding the manner in which "wholesale banks" and "limited purpose banks" will be evaluated for compliance. The new CRA regulations will be phased in over a two-year period, beginning July 1, 1995, with a final effective date of July 1, 1997. Until the applicable test is phased in, institutions may be examined under the prior CRA regulations. On December 27, 1995, the federal banking regulators issued a joint final rule containing technical amendments to the revised CRA regulations. Specifically, the recent technical amendments clarify the various effective dates in the revised CRA regulations, correct certain cross references and state that once an institution becomes subject to the requirements of the revised CRA regulations, it must comply with all aspects of the revised CRA regulations, regardless of the effective date of certain provisions. Similarly, once an institution is subject to the revised CRA regulations, the prior CRA regulations do not apply to that institution. For the purposes of the revised CRA regulations, the Bank is deemed to be a small depository institution, based upon financial information as of December 31, 1997. Therefore, the Bank will be evaluated for CRA compliance using the streamlined procedures for a small bank. The Bank received a "satisfactory" rating in 1996. Concentration The Corporation and the Bank are not dependent for deposits nor exposed by loan concentrations to a single customer or to a small group of customers the loss of any one or more of whom would have a materially adverse effect on the financial condition of the Corporation or the Bank. 9 New Legislation The Deposit Insurance Funds Act of 1996 was a part of the larger Economic Growth and Regulatory Paperwork Reduction Act of 1996 "EGRPRA"). EGRPRA is a lengthy Act that amends many different bank regulatory and consumer protection statutes. While EGRPRA does not contain any major changes to banking law (except for the FDIC and FICO assessments discussed above), it does contain a number of smaller provisions that are beneficial to the banking industry. In particular, certain routine regulatory application requirements and procedures have been reduced or eliminated, making it easier and less expensive for banks to comply with regulatory requirements. While the changes effected by EGRPRA are welcome, the direct effect on the Company and the Bank are expected to be minimal. Proposed legislation is introduced in almost every legislative session that would dramatically affect the regulation of the banking industry. Whether or not such legislation will ever be enacted and what effect if may have on the Company and the Bank cannot be estimated at this time. Pennsylvania Banking Law Under the Pennsylvania Banking Code of 1965, as amended (the "Code"), the Corporation is permitted to control an unlimited number of banks. However, the Corporation would be required, under the Bank Holding Company Act, to obtain the prior approval of the Federal Reserve Board before it could acquire all or substantially all of the assets of any bank, or acquire ownership or control of any voting shares of any bank other than the Bank, if, after such acquisition, it would own or control more than five percent (5%) of the voting shares of such bank. Interstate Banking Prior to the passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Banking Act"), the BHCA prohibited a bank holding company located in one state from acquiring a bank located in another state, unless such an acquisition by an out-of-state bank holding company was specifically authorized by the law of the state where the bank to be acquired was located. Similarly, interstate branching by a single bank was generally prohibited by the McFadden Act. The Interstate Banking Act permits an adequately capitalized and adequately managed bank holding company to acquire a bank in another state whether or not the law of that other state permits the acquisition, subject to certain deposit concentration caps and approval by the Federal Reserve Board. In addition, beginning on June 1, 1997, under the Interstate Banking Act, a bank can engage in interstate expansion by merging with a bank in another state, unless the other state affirmatively opts out of the legislation before that date. A state may also opt into the legislation earlier than June 1, 1997 if it wishes to do so. The Interstate Banking Act also permits de novo interstate branching as of June 1, 1997, but only if a state affirmatively opts in by adopting appropriate legislation. Pennsylvania, Delaware, Maryland, and New Jersey, as well as other states, adopted "opt in" legislation which allows such transactions prior to the June 1, 1997 federal effective date. 10 Foreign Operations The Corporation does not depend on foreign sources for funds, nor does the Corporation make foreign loans. Year 2000 Compliance The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Corporation's computer programs that have date- sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, or a temporary inability to engage in normal business activities. First Keystone Corporation is in the process of becoming Year 2000 compliant. The expenses for maintenance or modification of software associated with the Year 2000 will be expensed as incurred. The costs of new software will be capitalized and amortized over the software's useful life. The cost of becoming 2000 compliant is not material. The amount expensed in 1997 was immaterial and the Corporation does not expect the amounts required to be expensed in 1998 and 1999 to have a material effect on its financial position or results of operation. The Corporation has also initiated formal communications with all of its significant suppliers and large customers to determine the extent to which the Corporation is vulnerable to those third parties' failure to remediate their own Year 2000 issue. However, failures of third parties or other companies, on which the Corporation systems rely to be 2000 compliant could have an adverse effect on the Corporation's systems. The Corporation plans to complete the Year 2000 project by December 31, 1998. The costs of the project and the date on which the Corporation plans to complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those plans. 11 ITEM 2. DESCRIPTION OF PROPERTIES The Corporation owns no property other than through its subsidiary. These are:
Type of Square Location Ownership Footage Use Columbia County, PA 111 W. Front Street, Berwick Owned 12,500 Administrative office, banking and trust services and computer department. 2nd & Market Streets, Owned Land Area No buildings, Berwick 1.45 Acres held for possible expansion. Present use, parking. 701 Freas Avenue, Berwick Owned 3,744 Banking services. 2401 New Berwick Highway, Bloomsburg Leased 2,000 Banking services. Annual Rental $21,800 U.S. Route 11 & Owned Land Area No buildings, Central Road, 1.11 Acres held for expansion. Bloomsburg Present use, rental. Third & Race Streets, Owned 2,500 Banking services. Mifflinville Luzerne County, PA Salem Township Owned 3,700 Banking services. Post Office Address - 400 Fowler Avenue, Berwick West Third Street, Leased 2,300 Banking services. Nescopeck Annual Rental $8,400 1540 Sans Souci Highway Owned 4,000 Banking services. Wilkes-Barre
12 It is Management's opinion that the facilities currently utilized are suitable and adequate for the Corporation's current and immediate future purposes. ITEM 3. LEGAL PROCEEDINGS The Corporation and/or the Bank are defendants in various legal proceedings arising in the course of their business. However, in the opinion of management of the Corporation and the Bank, there are no proceedings pending to which the Corporation and the Bank is a party or to which their property is subject, which, if determined adversely to the Corporation and the Bank, would be material in relation to the Corporation's and Bank's individual profits or financial condition, nor are there any proceedings pending other than ordinary routine litigation incident to the business of the Corporation and the Bank. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Corporation and the Bank by government authorities or others. 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 The Corporation's Common Stock is traded in the over-the-counter market on the OTC Bulletin Board under the symbol "FKYS". The following table sets forth: (1) the quarterly high and low prices for a share of the Corporation's Common Stock during the periods indicated as reported by the management of the Corporation and (2) quarterly dividends on a share of the Common Stock with respect to each quarter since January 1, 1996. The following quotations represent prices between buyers and sellers and do not include retail markup, markdown or commission, and may not necessarily reflect actual transactions.
Stock Prices Dividends High Low Declared 1996: First quarter $11.21 $10.19 $.094 Second quarter $11.21 $11.21 $.094 Third quarter $11.21 $11.21 $.094 Fourth quarter $11.21 $11.21 $.106 1997: First quarter $11.21 $10.74 $.106 Second quarter $14.33 $10.92 $.117 Third quarter $14.33 $14.33 $.117 Fourth quarter $19.08 $16.63 $.133
As of December 31, 1997, the Corporation had approximately 524 shareholders of record. 13 The Corporation has paid dividends since commencement of business in 1984. It is the present intention of the Corporation's Board of Directors to continue the dividend payment policy; however, further dividends must necessarily depend upon earnings, financial condition, appropriate legal restrictions and other factors relevant at the time the Board of Directors of the Corporation considers dividend policy. Cash available for dividend distributions to shareholders of the Corporation must initially come from dividends paid by the Bank to the Corporation. Therefore, the restrictions on the Bank's dividend payments are directly applicable to the Corporation. Dividend Restrictions on the Bank The OCC has issued rules governing the payment of dividends by national banks. Consequently, the Bank, which is subject to these rules, may not pay dividends from capital (unimpaired common and preferred stock outstanding) but only from retained earnings after deducting losses and bad debts therefrom. "Bad debts" are defined as matured obligations in which interest is past due and unpaid for ninety (90) days, but do not include well-secured obligations that are in the process of collection. Previously, the Bank was permitted to add the balances in its allowance for loan and lease losses in determining retained earnings, but the OCC's regulations now prohibit that practice. However, to the extent that (1) the Bank has capital surplus in an amount in excess of common capital and (2) the Bank can prove that such surplus resulted from prior period earnings, the Bank, upon approval of the OCC, may transfer earned surplus to retained earnings and thereby increase its dividend capacity. If, however, the Bank has insufficient retained earnings to pay a dividend, the OCC's regulations allow the Bank to reduce its capital to a specified level and to pay dividends upon receipt of the approval of the OCC, as well as the approval of the holders of two-thirds of the outstanding shares of the Corporation's Common Stock. The Bank is allowed to pay dividends no more frequently than quarterly. Moreover, the Bank must obtain the OCC's approval before paying a dividend, if the total of all dividends declared by the Bank in any calendar year would exceed the total of (1) the Bank's net profits for that year plus (2) its retained net profits for the preceding two years less (3) any required transfers to surplus or to a fund for the retirement of preferred stock. The Bank may not pay any dividends on its capital stock during a period in which it may be in default in the payment of its assessment for a deposit insurance premium due to the FDIC, nor may it pay dividends on Common Stock until any cumulative dividends on the Bank's preferred stock (if any) have been paid in full. The Bank has never been in default in the payments of its assessments to the FDIC; and the Bank has no outstanding preferred stock. In addition, under the Federal Deposit Insurance Act (912 U.S.C. Section 1818), dividends cannot be declared and paid if the OCC obtains a cease and desist order because, in the opinion of the OCC, such payment would constitute an unsafe and unsound banking practice. As of December 31, 1997, there was $6,141,195 in unrestricted retained earnings and net income available at the Bank that could be paid as a dividend to the Corporation under the current OCC regulations. Dividend Restrictions on the Corporation Under the Pennsylvania Business Corporation Law of 1988, as amended (the "BCL"), the Corporation may not pay a dividend if, after giving effect thereto, either (a) the Corporation would be unable to pay its debts as they become due in the usual course of business or (b) the Corporation's total assets would be less than its total liabilities. The determination of total assets and liabilities may be based upon: (i) financial statements prepared on the basis of generally accepted accounting principles, (ii) financial statements that are prepared on the basis of other accounting practices and principles that are reasonable under the circumstances, or (iii) a fair valuation or other method that is reasonable under the circumstances. 14 ITEM 6. SELECTED FINANCIAL DATA The information under the caption "Summary of Selected Financial Data" appearing on page 2 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1997, which page is included in Exhibit 11 hereto, is incorporated in its entirety by reference in response to this Item 6. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing on pages 25 through 39 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1997, which pages are included in Exhibit 13 hereto, is incorporated in its entirety by reference in response to this Item 7. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Corporation's Consolidated Financial Statements and notes thereto appearing on pages 4 through 23 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1997, which pages are included in Exhibit 13 hereto, are incorporated in their entirety by reference in response to this Item 8. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information under the captions "Information As To Nominees, Directors and Executive Officers," "Section 16(A) Beneficial Ownership Reporting Compliance," "Principal Officers of the Corporation," and "Principal Officers of the Bank" appearing on pages 5, 6, 7, 12, and 13, respectively in the Corporation's Definitive Proxy Statement, filed at Exhibit 99 hereto, are incorporated in their entirety by reference in response to this Item 10. ITEM 11. EXECUTIVE COMPENSATION The information under the caption "Executive Compensation" appearing on pages 8 through 10 of the Corporation's Definitive Proxy Statement, filed as Exhibit 99 hereto, is incorporated in its entirety by reference in response to this Item 11. 15 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information under the caption "Principal Beneficial Owners of the Corporation's Stock" appearing on pages 2 through 4 of the Corporation's Definitive Proxy Statement, filed as Exhibit 99 hereto, is incorporated in its entirety by reference in response to this Item 12. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information under the caption "Certain Transactions" appearing on page 12 of the Corporation's Definitive Proxy Statement, filed as Exhibit 99 hereto, is incorporated in its entirety by reference in response to this Item 13. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. The Registrant's consolidated financial statements and notes thereto as well as the applicable reports of the independent certified public accountants are filed at Exhibit 13 hereto and are incorporated in their entirety by reference under this Item 14(a)1. 2. All schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. 3. The exhibits required by Item 601 of the Regulation S-K are included under Item 14(c) hereto. (b) The Corporation filed no reports on Form 8-K during the last quarter of the year ended December 31, 1997. (c) Exhibits required by Item 601 of Regulation S-:: Exhibit Number Referred to Item 601 of Regulation S-K Description of Exhibit 2 None. 3i Articles of Incorporation, as amended (Incorporated by reference to Exhibit 3(i) to the Registrant's Annual Report on Form 10-KSB for the year ended December 31, 1996). 3ii By-Laws, as amended (Incorporated by reference to Exhibit 3(ii) to the Registrant's Annual Report on Form 10-KSB for the year ended December 31, 1996). 4 None. 9 None. 16 Exhibit Number Referred to Item 601 of Regulation S-K Description of Exhibit 10 None. 11 Computation of Earnings Per Share incorporated by reference to Exhibit 11 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1997. 12 None. 13 Excerpt from Annual Report to Shareholders for Fiscal Year Ended December 31, 1997. 16 None. 18 None. 21 List of Subsidiaries of the Corporation (Incorporated by reference to Exhibit 22 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1997. 22 None. 23 Consent of Independent Auditors. 24 None. 27 Financial Data Schedule. 99 Definitive Proxy Statement, Notice of Annual Meeting and Form of Proxy for the Annual Meeting of Shareholders to be held April 21, 1998. 17 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST KEYSTONE CORPORATION (Issuer) By: /s/ J. Gerald Bazewicz J. Gerald Bazewicz President and Chief Executive Officer Date: March 24, 1998 In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ John L. Coates John L. Coates Secretary and Director Date: March 24, 1998 By: /s/ J. Gerald Bazewicz J. Gerald Bazewicz President, Chief Executive Officer and Director (Chief Executive Officer and Principal Financial Officer) Date: March 24, 1998 18 By: /s/ John E. Arndt John E. Arndt Director Date: March 24, 1998 By: /s/ Budd L. Beyer Budd L. Beyer Director Date: March 24, 1998 By: /s/ Robert E. Bull Robert E. Bull Chairman of the Board and Director Date: March 24, 1998 By: /s/ Dudley P. Cooley Dudley P. Cooley Director Date: March 24, 1998 By: /s/ Frederick E. Crispin, Jr. Frederick E. Crispin, Jr. Director Date: March 24, 1998 By: Stanley E. Oberrender Director Date: March 24, 1998 19 By: /s/ David R. Saracino David R. Saracino Treasurer and Assistant Secretary (Principal Accounting Officer) Date: March 24, 1998 By: /s/ Robert J. Wise Robert J. Wise Vice Chairman of the Board and Director Date: March 24, 1998 20 EX-11 2 EXHIBIT 11 FIRST KEYSTONE CORPORATION COMPUTATION OF EARNINGS PER COMMON SHARE Year Ended December 31,
(Dollars in Thousands) 1997 1996 1995 Primary Net Income $ 4,660 $ 4,130 $ 3,486 Shares Weighted average number of common shares outstanding 2,933,727 2,933,727 2,933,727 Adjustments - increases or decreases None None None Weighted average number of common shares outstanding as adjusted 2,933,727 2,933,727 2,933,727 Basic earnings per common share $ 1.59 $ 1.41 $ 1.19 Assuming full dilution Net Income $ 4,660 $ 4,130 $ 3,486 Shares Weighted average number of common shares outstanding 2,933,727 2,933,727 2,933,727 Adjustments - increases or decreases None None None Weighted average number of common shares outstanding as adjusted 2,933,727 2,933,727 2,933,727 Earnings per common share assuming full dilution $ 1.59 $ 1.41 $ 1.19 See Notes 1 to the consolidated financial statements appearing on page 8 more fully described in the Corporation's Annual Report to Shareholders for the year ended December 31, 1997, which page is included in Exhibit 13 hereto.
21 EXHIBIT 11 SUMMARY OF SELECTED FINANCIAL DATA
(Amounts in thousands, except per share) 1997 1996 1995 1994 1993 SUMMARY OF OPERATIONS Interest income $ 19,345 $ 17,786 $ 16,637 $ 13,731 $ 13,734 Interest expense 9,381 8,667 8,271 6,353 6,519 Net interest income 9,964 9,119 8,366 7,378 7,215 Provision for loan losses 325 517 372 31 518 Investment securities gains (losses) 68 (38) 5 180 70 Net income $ 4,660 $ 4,130 $ 3,486 $ 3,115 $ 3,101 PER COMMON SHARE Net income $ 1.59 $ 1.41 $ 1.19 $ 1.07 $ 1.07 Cash dividends .47 .39 .33 .31 .26 BALANCE SHEET DATA Assets $267,399 $242,557 $226,033 $206,864 $201,270 Investment securities 98,459 101,225 88,125 79,946 86,054 Net loans 149,780 130,994 126,046 116,383 106,500 Deposits 217,647 198,546 187,320 172,280 165,731 Stockholders' equity 31,818 27,473 25,399 20,788 18,577 PERFORMANCE RATIOS Return on average assets 1.83% 1.75% 1.58% 1.54% 1.58% Return on average equity 15.92% 15.98% 15.24% 15.34% 17.56% Dividend payout ratio 29.76% 27.56% 27.36% 28.55% 24.79% Average equity to average assets ratio 11.49% 11.05% 10.36% 10.05% 9.02% Reflects adjustment for stock dividends more fully described in Note 1.
2 First Keystone Corporation EX-13 3 EXHIBIT 13 EXCERPT FROM ANNUAL REPORT TO SHAREHOLDERS FOR FISCAL YEAR ENDED DECEMBER 31, 1997 22 FIRST KEYSTONE CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 and 1996
1997 1996 ASSETS Cash and due from banks $ 6,400,261 $ 5,147,438 Interest-bearing deposits in other banks 7,083,684 32,093 Investment securities available for sale 81,650,689 81,145,934 Investment securities held to maturity (estimated fair value 1997 $16,833,038; 1996 $19,954,360) 16,808,625 20,079,559 Loans, net of unearned income 152,150,843 133,260,961 Allowance for loan losses (2,371,194) (2,266,983) Net loans $149,779,649 $130,993,978 Premises and equipment 3,435,689 2,881,176 Other real estate owned 0 46,184 Accrued interest receivable 1,997,936 1,958,882 Other assets 242,053 271,906 TOTAL ASSETS $267,398,586 $242,557,150 LIABILITIES Deposits: Non-interest bearing $ 18,397,819 $ 17,804,634 Interest bearing 199,249,365 180,741,149 Total Deposits $217,647,184 $198,545,783 Short-term borrowings 6,102,160 5,121,367 Long-term borrowings 9,000,000 10,000,000 Accrued interest and other expenses 1,521,832 1,128,034 Other liabilities 1,309,343 288,971 TOTAL LIABILITIES $235,580,519 $215,084,155 STOCKHOLDERS' EQUITY Preferred stock, par value $10.00 per share; authorized 500,000 shares; no shares issued $ - $ - Common stock, par value $2.00 per share; authorized 3,000,000 shares; issued 977,909 shares 1997 and 889,147 shares 1996 1,955,818 1,778,294 Surplus 9,761,066 6,654,396 Retained earnings 17,873,418 17,889,923 Net unrealized securities gains, net of tax 2,227,765 1,150,382 TOTAL STOCKHOLDERS' EQUITY $ 31,818,067 $ 27,472,995 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $267,398,586 $242,557,150 The accompanying notes are an integral part of these consolidated financial statements.
4 First Keystone Corporation FIRST KEYSTONE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, and 1995
1997 1996 INTEREST INCOME Loans, including fees: Taxable $12,785,688 $11,193,303 Tax exempt 137,869 212,206 Interest and dividends on investment securities: Taxable 3,727,915 3,856,431 Tax exempt 2,288,362 2,317,029 Dividends 140,973 115,054 Deposits in banks 264,015 91,782 Total interest income $19,344,822 $17,785,805 INTEREST EXPENSE Deposits $ 8,437,271 $ 7,864,665 Short-term borrowings 230,071 261,458 Long-term borrowings 713,710 541,243 Total interest expense $ 9,381,052 $ 8,667,366 Net interest income $ 9,963,770 $ 9,118,439 Provision for loan losses 325,000 516,584 Net interest income after provision for loan losses $ 9,638,770 $ 8,601,855 NON-INTEREST INCOME Trust Department $456,880 $424,740 Service charges and fees 669,252 616,487 Other 33,855 48,936 Gain on sale of mortgage loans 34,107 - Investment securities gains (losses) - net 67,957 (37,729) Total non-interest income $ 1,262,051 $ 1,052,434 NON-INTEREST EXPENSE Salaries and employee benefits $ 2,626,752 $ 2,448,234 Occupancy, net 331,962 281,222 Furniture and equipment 487,683 467,973 FDIC insurance 24,795 2,000 Other 1,461,953 1,341,236 Total non-interest expense $ 4,933,145 $ 4,540,665 Income before income taxes $ 5,967,676 $ 5,113,624 Income tax expense 1,307,436 983,339 NET INCOME $ 4,660,240 $ 4,130,285 PER SHARE DATA Net income $ 1.59 $ 1.41 Cash dividends $ .47 $ .39 Weighted average shares outstanding 2,933,727 2,933,727 1995 INTEREST INCOME Loans, including fees: Taxable $10,569,702 Tax exempt 290,578 Interest and dividends on investment securities: Taxable 3,887,673 Tax exempt 1,631,495 Dividends 107,443 Deposits in banks 149,793 Total interest income $16,636,684 INTEREST EXPENSE Deposits $ 7,450,453 Short-term borrowings 236,928 Long-term borrowings 583,469 Total interest expense $ 8,270,850 Net interest income $ 8,365,834 Provision for loan losses 372,448 Net interest income after provision for loan losses $ 7,993,386 NON-INTEREST INCOME Trust Department $ 349,809 Service charges and fees 572,535 Other 41,825 Gain on sale of mortgage loans - Investment securities gains (losses) - net 4,841 Total non-interest income $ 969,010 NON-INTEREST EXPENSE Salaries and employee benefits $ 2,262,650 Occupancy, net 292,731 Furniture and equipment 456,013 FDIC insurance 199,953 Other 1,345,098 Total non-interest expense $ 4,556,445 Income before income taxes $ 4,405,951 Income tax expense 919,758 NET INCOME $ 3,486,193 PER SHARE DATA Net income $ 1.19 Cash dividends $ .33 Weighted average shares outstanding 2,933,727 Reflects adjustment for stock dividends more fully described in Note 1. The accompanying notes are an integral part of these consolidated financial statements.
1997 Annual Report 5 FIRST KEYSTONE CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, and 1995
Common Retained Stock Surplus Earnings BALANCE AT DECEMBER 31, 1994 $1,616,858 $3,829,266 $15,356,687 Net Income $ - $ - $ 3,486,193 Cash Dividends - $.33 per share - - (953,946) Change in unrealized gain on securities, net of tax - - - BALANCE AT DECEMBER 31, 1995 $1,616,858 $3,829,266 $17,888,934 Net Unrealized Gain (Loss) On Investment Securities Treasury Available Stock For Sale Total BALANCE AT DECEMBER 31, 1994 $ - $ (14,740) $20,788,071 Net Income $ - $ - $ 3,486,193 Cash Dividends - $.33 per share - - (953,946) Change in unrealized gain on securities, net of tax - 2,079,143 2,079,143 BALANCE AT DECEMBER 31, 1995 $ - $2,064,403 $25,399,461 Common Retained Stock Surplus Earnings Net Income $ - $ - $ 4,130,285 10% Stock Dividend 161,436 2,825,130 (2,986,566) Dividends paid in lieu of fractional shares - - (4,622) Cash Dividends - $.39 per share - - (1,138,108) Change in unrealized gain on securities, net of tax - - - BALANCE AT DECEMBER 31, 1996 $1,778,294 $6,654,396 $17,889,923 Net Unrealized Gain (Loss) On Investment Securities Treasury Available Stock For Sale Total Net Income $ - $ - $ 4,130,285 10% Stock Dividend - - - Dividends paid in lieu of fractional shares - - (4,622) Cash Dividends - $.39 per share - - (1,138,108) Change in unrealized gain on securities, net of tax - (914,021) (914,021) BALANCE AT DECEMBER 31, 1996 $ - $1,150,382 $27,472,995 Common Retained Stock Surplus Earnings Net Income $ - $ - $ 4,660,240 10% Stock Dividend 177,524 3,106,670 (3,284,194) Dividends paid in lieu of fractional shares - - (5,650) Cash Dividends - $.47 per share - - (1,386,901) Change in unrealized gain on securities, net of tax - - - BALANCE AT DECEMBER 31, 1997 $1,955,818 $9,761,066 $17,873,418 Net Unrealized Gain (Loss) On Investment Securities Treasury Available Stock For Sale Total Net Income $ - $ - $ 4,660,240 10% Stock Dividend - - - Dividends paid in lieu of fractional shares - - (5,650) Cash Dividends - $.47 per share - - (1,386,901) Change in unrealized gain on securities, net of tax - 1,077,383 1,077,383 BALANCE AT DECEMBER 31, 1997 $ - $2,227,765 $31,818,067 Reflects adjustment for stock dividends more fully described in Note 1. The accompanying notes are an integral part of these consolidated financial statements.
6 First Keystone Corporation FIRST KEYSTONE CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 and 1995 1997 1996 OPERATING ACTIVITIES Net income $ 4,660,240 $ 4,130,285 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 325,000 516,584 Depreciation 304,134 299,274 Premium amortization on investment securities 132,361 158,011 Discount accretion on investment securities (131,988) (86,481) Deferred income taxes (benefit) 18,645 (32,241) Gain on sale of mortgage loans (34,107) - Proceeds from sale of mortgage loans 765,019 65,000 Originations of mortgage loans held for resale (1,675,406) (1,087,313) (Gain) loss on sales of investment securities (67,958) 37,729 Gain on sale of premises and equipment (67) (804) (Gain) loss on sale of other real estate owned (816) - (Increase) decrease in accrued interest receivable (39,054) (83,514) (Increase) decrease in other assets - net 65,704 28,687 Increase (decrease) in accrued interest and other expenses 393,798 (52,076) Increase (decrease) in other liabilities - net 406,418 (301) NET CASH PROVIDED BY OPERATING ACTIVITIES $ 5,121,923 $ 3,892,840 INVESTING ACTIVITIES Proceeds from sales of investment securities available for sale $ 18,369,369 $ 20,076,003 Proceeds from maturities and redemptions of investment securities available for sale 5,119,885 3,998,416 Purchases of investment securities available for sale (21,757,280) (40,909,754) Purchases of investment securities held to maturity - (996,170) Proceeds from maturities and redemption of investment securities held to maturity 2,774,482 3,254,532 Net increase in loans (18,202,028) (4,488,234) Proceeds from sale of premises and equipment 2,001 1,200 Purchases of premises and equipment (860,581) (114,846) Proceeds from sale of other real estate owned 47,000 - NET CASH USED IN INVESTING ACTIVITIES $(14,507,152) $(19,178,853) FINANCING ACTIVITIES Net increase in deposits $ 19,101,401 $ 11,225,696 Net increase (decrease) in short-term borrowings 980,793 762,766 Proceeds from long-term borrowings 12,000,000 12,000,000 Repayment of long-term borrowings (13,000,000) (9,000,000) Cash dividends paid (1,386,901) (1,138,108) Dividends paid in lieu of fractional shares (5,650) (4,622) NET CASH PROVIDED BY FINANCING ACTIVITIES $ 17,689,643 $ 13,845,732 Increase (decrease) in cash and cash equivalents $ 8,304,414 $ (1,440,281) Cash and cash equivalents at beginning of year 5,179,531 6,619,812 CASH AND CASH EQUIVALENTS AT END OF YEAR $ 13,483,945 $ 5,179,531 The accompanying notes are an integral part of these consolidated financial statements. 1995 OPERATING ACTIVITIES Net income $ 3,486,193 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 372,448 Depreciation 311,636 Premium amortization on investment securities 254,510 Discount accretion on investment securities (141,052) Deferred income taxes (benefit) (29,421) Gain on sale of mortgage loans - Proceeds from sale of mortgage loans 182,500 Originations of mortgage loans held for resale (286,400) (Gain) loss on sales of investment securities (4,841) Gain on sale of premises and equipment (2,342) (Gain) loss on sale of other real estate owned 37,155 (Increase) decrease in accrued interest receivable (602,849) (Increase) decrease in other assets - net 100,671 Increase (decrease) in accrued interest and other expenses 398,383 Increase (decrease) in other liabilities - net (7,395) NET CASH PROVIDED BY OPERATING ACTIVITIES $ 4,069,196 INVESTING ACTIVITIES Proceeds from sales of investment securities available for sale $ 22,461,737 Proceeds from maturities and redemptions of investment securities available for sale 6,424,757 Purchases of investment securities available for sale (36,711,805) Purchases of investment securities held to maturity (5,608,356) Proceeds from maturities and redemption of investment securities held to maturity 8,307,905 Net increase in loans (9,932,144) Proceeds from sale of premises and equipment 3,000 Purchases of premises and equipment (348,965) Proceeds from sale of other real estate owned 197,845 NET CASH USED IN INVESTING ACTIVITIES $(15,206,026) FINANCING ACTIVITIES Net increase in deposits $15,040,312 Net increase (decrease) in short-term borrowings (1,126,013) Proceeds from long-term borrowings 1,000,000 Repayment of long-term borrowings (1,500,000) Cash dividends paid (953,946) Dividends paid in lieu of fractional shares - NET CASH PROVIDED BY FINANCING ACTIVITIES $ 12,460,353 Increase (decrease) in cash and cash equivalents $ 1,323,523 Cash and cash equivalents at beginning of year 5,296,289 CASH AND CASH EQUIVALENTS AT END OF YEAR $ 6,619,812 The accompanying notes are an integral part of these consolidated financial statements. 1997 Annual Report 7 FIRST KEYSTONE CORPORATION AND SUBSIDIARY Notes to Consolidated Financial Statements for Years Ended December 31, 1997, 1996, and 1995 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. All significant inter-company balances and transactions have been eliminated in consolidation. On December 29, 1995, FKC Realty, Inc., a wholly owned realty subsidiary of the Corporation, was liquidated. Transfer of assets in liquidation were at book value to the Corporation and bank subsidiary. No gain or loss is recognized in these consolidated financial statements. Nature of Operations The Corporation provides full banking services, including trust services, through its subsidiary, The First National Bank of Berwick, to individuals and corporate customers. The Bank has seven full service offices and nine ATMs in Columbia and Lower Luzerne Counties. The Corporation and its banking subsidiary are subject to regulation of the Office of the Comptroller of the Currency, The Federal Deposit Insurance Corporation, and the Federal Reserve Bank of Philadelphia. 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 is reported as a separate component of Stockholders' Equity net of the effect of deferred income tax. Management's 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 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 and 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. These loans are sold without recourse to the Corporation. 8 First Keystone Corporation Non-Accrual Loans - Generally, a loan (including a loan impaired under Statement of Financial Accounting Standards No. 114) is classified as non-accrual and the accrual of interest on such 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. As of January 1, 1995, the Corporation adopted Statement of Financial Accounting Standards No.114, "Accounting by Creditors for Impairment of a Loan" as amended by Statement of Financial Accounting Standards No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure." Under these standards, the allowance for loan losses related to loans that are identified for evaluation in accordance with Statement No. 114 is based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. Prior to 1995, the allowance for loan losses related to these loans was based on undiscounted cash flows or the fair value of the collateral for collateral dependent loans. Statement No. 118 allows the continued use of existing methods for income recognition on impaired loans and amends disclosure requirements to require information about the recorded investment in certain impaired loans and related income recognition on those 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. Mortgage Servicing Rights In accordance with Statement of Financial Accounting Standards No. 125, the Corporation records a separate asset or liability representing the right of obligation, respectively, to service mortgage loans for others. A servicing asset is determined by allocating the loans' previous carrying amount between the servicing asset and the loans that were sold, based on their relative fair values at the date of sale. Servicing liabilities are recorded at their fair value as a reduction of the sale proceeds. Servicing assets and liabilities are amortized in proportion to, and over the period of, estimated net servicing income. In addition, the mortgage servicing rights must be periodically evaluated for impairment based on their fair value. Other Real Estate Owned Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value at 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. Further, the Statement requires that a valuation allowance be provided in an amount sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. 1997 Annual Report 9 Per Share Data Net income and cash dividends per share is calculated by dividing net income and dividends by the weighted average number of shares outstanding during each year presented adjusted retroactively for stock splits and dividends. Adjustments resulted from the following: a 10% stock dividend distributed on February 6, 1996, to shareholder of record January 4, 1996, a 10% stock dividend distributed May 16, 1997, to shareholders of record May 2, 1997, and an event subsequent to December 31, 1997, in that on January 27, 1998, the Board of Directors approved a 3 for 1 stock split issued in the form of a 200% stock dividend to be distributed March 2, 1998, to shareholders of record on February 10, 1998. Cash Flow Information For purposes of reporting 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. Interest paid on deposits and other borrowings was $9,275,057, $8,682,349, and $7,994,087 in 1997, 1996 and 1995, respectively. Cash payments for income taxes were $1,257,115, $1,125,251, and $902,567 for 1997, 1996, and 1995, respectively. The Corporation transferred loans to other real estate owned in the amounts of $46,184 in 1996. Derivative Financial Instruments The Corporation has no derivative financial instruments requiring disclosure under Statement of Financial Accounting Standards No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments." 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. Transfers and Servicing of Financial Assets and Extinguishment of Liabilities In June 1996, The Financial Accounting Standards Board (FASB) issued Statement 125, "Accounting for Transfers and Servicing of Financial Assets and Extinquishments of Liabilities." This Statement provides new accounting and reporting standards for sales, securitizations and servicing of receivables and other financial assets, for certain secured borrowing and collateral transactions and extinquishments of liabilities. Implementation of certain transfer provisions of FASB 125 was delayed by FASB 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement 125." For repurchase agreements, dollar roll, securities lending and similar transactions, the FASB 125 transfer provisions and related disclosures are effective for those transactions occurring after December 31, 1997, and adoption f this segment of the standard is not expected to have a material impact on the consolidated financial statements. For securitizations, servicing of assets and extinquishments of liabilities the FASB 125 provisions are effective for transactions occurring after December 31, 1996, and were implemented by the Corporation where applicable with no material impact on these consolidated financial statements. Reporting Comprehensive Income In June 1997, The Financial Accounting Standards Board (FASB) issued Statement 130 "Reporting Comprehensive Income." FASB 130 establishes standards for reporting and display of comprehensive income and its components (income, expenses, gains and losses) in a full set of general-purpose financial statements. FASB 130 is effective for fiscal years beginning after December 15, 1997. The Corporation has determined that the impact of adopting the standard will not be material to the financial position or results of operations. Reporting Format Certain amounts in the financial statements of prior periods have been reclassified to conform with presentation used in the 1996 financial statements. Such reclassifications have no effect on the Corporation's consolidated financial condition or net income. NOTE 2. RESTRICTED CASH BALANCES Regulations of the Board of Governors of the Federal Reserve System impose uniform reserve requirements on all member depository institutions. The Corporation's banking subsidiary was required to have aggregate cash reserves of $3,105,000 and $1,949,000 at December 31, 1997, and 1996, respectively. The Corporation's banking subsidiary also, from time to time, maintains deposits with the Federal Reserve Bank and other banks for various services such as check clearing and charge card processing. Balances maintained for this purpose were $1,284,001 at December 31, 1997. 10 First Keystone Corporation NOTE 3. INVESTMENT SECURITIES The amortized cost, related estimated 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, 1997, and 1996:
Available For Sale Securities Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value December 31, 1997: U.S. Treasury securities $10,321,983 $ 119,830 $ - $10,441,813 Obligations of U.S. Government Corporations and Agencies: Mortgage-backed 17,196,705 237,966 32,030 17,402,641 Other 16,754,705 120,138 25,000 16,849,843 Obligations of state and political subdivisions 31,782,785 2,213,179 - 33,995,964 Equity securities 2,136,832 823,596 - 2,960,428 Total $78,193,010 $3,514,709 $57,030 $81,650,689
Held to Maturity Securities Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value December 31, 1997: Obligations of U.S. Government Corporations and Agencies, Mortgage-backed $13,611,707 $ - $66,466 $13,545,241 Obligations of state and political subdivisions 3,196,918 90,879 - 3,287,797 Total $16,808,625 $90,879 $66,466 $16,833,038
Available For Sale Securities Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value December 31, 1996: U.S. Treasury securities $ 3,294,242 $ 46,430 $ - $ 3,340,672 Obligations of U.S. Government Corporations and Agencies: Mortgage-backed 18,874,935 - 62,810 18,812,125 Other 17,748,918 - 221,778 17,527,140 Obligations of state and political subdivisions 35,971,566 1,630,009 - 37,601,575 Corporate debt securities, Mortgage-backed 1,292,934 - 27,116 1,265,818 Equity securities 2,178,352 420,252 - 2,598,604 Total $79,360,947 $2,096,691 $311,704 $81,145,934
Held to Maturity Securities Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value December 31, 1996: Obligations of U.S. Government Corporations and Agencies, Mortgage-backed $16,786,482 $ - $173,419 $16,613,063 Obligations of state and political subdivisions 3,293,077 48,220 - 3,341,297 Total $20,079,559 $48,220 $173,419 $19,954,360
1997 Annual Report 11 Securities available for sale with an aggregate fair value of $29,864,796 in 1997; $23,005,146 in 1996 and securities held to maturity with an aggregate unamortized cost of $13,611,707 in 1997; $16,786,482 in 1996, respectively, were pledged to secure public funds, trust funds, securities sold under agreements to repurchase and other balances of $35,175,394 in 1997 and $25,362,784 in 1996 as required by law. The amortized cost, estimated fair value and weighted average yield of debt securities, by contractual maturity, are shown below at December 31, 1997. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
December 31, 1997 U.S. Government Obligations U.S. Agency & of State Treasury Corporation & Political Securities Obligations Subdivisions Available For Sale: Within 1 Year: Amortized Cost $ 1,992,647 $ - $ - Estimated Fair Value 1,997,813 - - Weighted average yield 6.54% - - 1 - 5 Years: Amortized cost 8,329,336 3,010,728 2,340,163 Estimated fair value 8,444,000 3,024,688 2,581,550 Weighted average yield 6.45% 6.49% 10.95% 5 - 10 Years: Amortized cost - 7,792,321 485,672 Estimated Fair value - 7,868,682 536,065 Weighted average yield - 7.31% 11.70% After 10 Years: Amortized cost - 23,148,361 28,956,950 Estimated fair value - 23,359,114 30,878,349 Weighted average yield - 7.28% 9.01% Total: Amortized cost $10,321,983 $33,951,410 $31,782,785 Estimated fair value 10,441,813 34,252,484 33,995,964 Weighted average yield 6.47% 7.28% 9.20% December 31, 1997 Marketable Other Equity Securties Securities Available For Sale: Amortized Cost $ - $ - Estimated Fair Value - - Weighted average yield - - 1 - 5 Years: Amortized cost - - Estimated fair value - - Weighted average yield - - 5 - 10 Years: Amortized cost - - Estimated Fair value - - Weighted average yield - - After 10 Years: Amortized cost 1,387,150 749,682 Estimated fair value 1,387,150 1,573,278 Weighted average yield 6.29% 5.33% Total: Amortized cost $1,387,150 $ 749,682 Estimated fair value 1,387,150 1,573,278 Weighted average yield 6.29% 5.33% _______________________ Average yields on tax-exempt obligations of state and political subdivisions have been computed on a tax-equivalent basis using a 34% tax rate. Other securities and marketable equity securities are not considered to have defined maturities and are included in the after ten year category.
12 First Keystone Corporation
December 31, 1997 U.S. Government Obligations U.S. Agency & of State Treasury Corporation & Political Securities Obligations Subdivisions Held To Maturity: Within 1 Year: Amortized Cost $ - $ - $ - Estimated fair value - - - Weighted average yield - - - 1 - 5 Years: Amortized cost - - 205,000 Estimated fair value - - 205,267 Weighted average yield - - 7.42% 5 - 10 Years: Amortized cost - - 779,173 Estimated Fair value - - 782,188 Weighted average yield - - 7.74% After 10 Years: Amortized cost - 13,611,707 2,212,745 Estimated fair value - 13,545,241 2,300,342 Weighted average yield - 6.76% 8.87% Total: Amortized cost $ - $13,611,707 $3,196,918 Estimated fair value - 13,545,241 3,287,797 Weighted average yield - 6.76% 8.50% December 31, 1997 Marketable Other Equity Securties Securities Held To Maturity: Within 1 Year: Amortized Cost $ - $ - Estimated fair value - - Weighted average yield - - 1 - 5 Years: Amortized cost - - Estimated fair value - - Weighted average yield - - 5 - 10 Years: Amortized cost - - Estimated Fair value - - Weighted average yield - - After 10 Years: Amortized cost - - Estimated fair value - - Weighted average yield - - Total: Amortized cost $ - $ - Estimated fair value - - Weighted average yield - - _______________________ Average yields on tax-exempt obligations of state and political subdivisions have been computed on a tax-equivalent basis using a 34% tax rate. Other securities and marketable equity securities are not considered to have defined maturities and are included in the after ten year category.
There were no aggregate investments with a single issuer (excluding U.S. Government and its agencies) which exceeded ten percent of consolidated shareholders' equity at December 31, 1997. The quality rating of all obligations of state and political subdivisions are "A" or higher, as rated by Moody's or Standard and Poors. The only exceptions are local issues which are not rated, but are secured by the full faith and credit obligations of the communities that issued these securities. All of the state and political subdivision investments are actively traded in a liquid market. Proceeds from sale of investments in debt and equity securities during 1997, 1996 and 1995 were $18,369,369, $20,076,003, and $22,461,737, respectively. Gross gains realized on these sales were $309,956, $414,239, and $350,410, respectively. Gross losses on these sales were $241,999, $451,968, and $345,569, respectively. Net unrealized gains on securities available for sale included as a separate component of consolidated stockholders' equity net of tax was $2,227,765, $1,150,382, and $2,064,403 in 1997, 1996, and 1995, respectively. NOTE 4. LOANS Major classifications of loans at December 31, 1997 and 1996 consisted of:
1997 1996 Commercial, Financial, and Agricultural $ 17,240,808 $ 13,573,843 Tax exempt 2,565,607 2,263,116 Real estate mortgage 114,467,096 98,248,599 Consumer 22,009,000 23,026,816 Gross loans $156,282,511 $137,112,374 Less: Unearned discount 3,864,710 3,544,417 Unamortized loan fees net of costs 266,958 306,996 Loans, net of unearned income $152,150,843 $133,260,961
1997 Annual Report 13 Mortgage loans held for sale included in loans were $2,070,707 and $1,126,213 at December 31, 1997, and 1996, respectively. Changes in the allowance for loan losses for the years ended December 31, 1997, 1996, and 1995, were as follows:
1997 1996 1995 Balance, January 1 $2,266,983 $2,015,236 $1,801,517 Provision charged to operations 325,000 516,584 372,448 Loans charged off (271,406) (302,480) (185,643) Recoveries 50,617 37,643 26,914 Balance, December 31 $2,371,194 $2,266,983 $2,015,236
Non-accrual loans at December 31, 1997, 1996 and 1995 were approximately $320,700, $267,445, and $556,533, respectively. The gross interest that would have been recorded if these loans had been current in accordance with their original terms and the amounts actually recorded in income were as follows:
1997 1996 1995 Gross interest due under terms $30,027 $46,924 $53,224 Amount included in income 7,006 3,048 2,700 Interest income not recognized $23,021 $43,876 $50,524
At December 31, 1997 and 1996 the recorded investment in loans that are considered to be impaired as defined by Statement No. 114 was $45,531 and $108,749, respectively. 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 Statement No. 114 along with any other potential losses. The average recorded investment in impaired loans during the year ended December 31, 1997 and 1996 was approximately $84,901 and $126,641, respectively. At December 31, 1997, there were no significant commitments to lend additional funds with respect to non-accrual and restructured loans. NOTE 5. PREMISES AND EQUIPMENT A summary of premises and equipment at December 31, 1997 and 1996 follows:
1997 1996 Land $ 876,526 $ 840,288 Buildings and improvements 2,773,148 2,386,788 Equipment 3,389,465 2,953,482 $7,039,139 $6,180,558 Less: Accumulated depreciation 3,603,450 3,299,382 Total $3,435,689 $2,881,176
Depreciation amounted to $304,134 for 1997, $299,274 for 1996, and $311,636 for 1995. NOTE 6. MORTGAGE SERVICING RIGHTS The Corporation's banking subsidiary entered into mortgage servicing in 1997. Mortgage loans serviced for others are not included in the accompanying Consolidated Statements of Financial Condition. The unpaid principal balances of mortgage loans serviced for others was $704,673 at December 31, 1997. Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in demand deposits, was approximately $777 at December 31, 1997. Mortgage servicing rights of $7,048 were capitalized in 1997. Amortization of mortgage servicing rights was $16 in 1997. 14 First Keystone Corporation Changes in the balances of servicing assets for the year ended December 31, 1997, are as follows:
Servicing Assets Balance at January 1, 1997 $ 0 Servicing asset additions 7,048 Amortization 16 Balance at December 31, 1997 $7,032
There was no valuation allowance on servicing assets as of December 31, 1997. Additionally, there were no unrecognized servicing assets or liabilities, or, servicing assets or liabilities for which it is not practicable to estimate fair value. Mortgage servicing rights in the Consolidated Balance Sheet are included in other assets at December 31, 1997. NOTE 7. DEPOSITS Major classifications of deposits at December 31, 1997 and 1996 consisted of:
1997 1996 Demand - non-interest bearing $ 18,397,819 $ 17,804,634 Demand - interest bearing 51,654,338 42,838,638 Savings 41,651,109 40,405,703 Time, $100,000 and over 25,245,346 21,053,285 Other time 80,698,572 76,443,523 Total deposits $217,647,184 $198,545,783
The following is a schedule reflecting classification and remaining maturities of time deposits of $100,000 and over at December 31, 1997:
1998 $21,489,432 1999 2,586,625 2000 1,005,293 2001 163,996 $25,245,346
Interest expense related to time deposits of $100,000 or more was $1,241,486 in 1997, $1,066,135 in 1996, and $1,156,943 in 1995. NOTE 8. 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. Short- term borrowings consisted of the following at December 31, 1997, and 1996:
1997 Maximum Month Ending Average End Average Balance Balance Balance Rate Federal funds purchased and securities sold under agreements to repurchase $4,602,160 $3,992,063 $4,728,459 4.15% Federal Home Loan Bank 0 456,411 2,275,000 6.50% U.S. Treasury tax and loan notes 1,500,000 663,378 1,888,686 5.19% Total $6,102,160 $5,111,852 $8,892,145 5.75% 1996 Maximum Month Ending Average End Average Balance Balance Balance Rate Federal funds purchased and securities sold under agreements to repurchase $3,388,466 $3,767,724 $ 4,095,918 4.28% Federal Home Loan Bank 500,000 1,088,209 5,775,000 6.52% U.S. Treasury tax and loan notes 1,232,901 570,705 1,506,241 5.11% Total $5,121,367 $5,426,638 $11,377,159 6.03%
1997 Annual Report 15 NOTE 9. 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. A schedule of long-term borrowings by maturity as of December 31, 1997, and 1996 follows:
1997 1996 Due 1997, 5.50% to 5.73% $ - $ 7,000,000 Due 1998, 5.56% 1,000,000 1,000,000 Due 1999, 6.38% 1,000,000 - Due 2000, 6.73% 2,000,000 - Due 2001, 4.97% to 5.80% 1,000,000 1,000,000 Due 2002, 5.48% to 7.77% 4,000,000 1,000,000 $9,000,000 $10,000,000
NOTE 10. INCOME TAXES The current and deferred components of the income tax provision (benefit) consisted of the following:
1997 1996 1995 Federal Current $1,278,515 $1,013,777 $947,026 Deferred (benefit) 18,645 (32,241) (28,711) $1,297,160 $ 981,536 $918,315 State Current (benefit) $ 10,276 $ 1,803 $ 2,153 Deferred (benefit) - - (710) $ 10,276 $ 1,803 $ 1,443 Total provision for income taxes $1,307,436 $ 983,339 $919,758
The following is a reconciliation between the actual provision for federal income taxes and the amount of federal income taxes which would have been provided at the statutory rate of 34%:
1997 Amount Rate Provision at statutory rate $2,029,010 34.0% Tax exempt income (824,918) (13.8) Non-deductible expenses 106,425 1.8 Other, net (13,357) (.3) Applicable federal income tax and rate $1,297,160 21.7% 1996 Amount Rate Provision at statutory rate $1,738,632 34.0% Tax exempt income (859,940) (16.8) Non-deductible expenses 112,022 2.2 Other, net (9,178) (.2) Applicable federal income tax and rate $ 981,536 19.2% 1995 Amount Rate Provision at statutory rate $1,498,023 34.0% Tax exempt income (653,505) (14.8) Non-deductible expenses 83,110 1.9 Other, net (9,313) (.3) Applicable federal income tax and rate $ 918,315 20.8%
Total federal income tax (benefit) attributable to realized security gains and losses was $29,888 in 1997, ($12,828) in 1996, and $2,833 in 1995. The deferred tax assets and liabilities resulting from temporary timing differences have been netted to reflect a net deferred tax liability included in other liabilities in these consolidated financial statements. The components of the net deferred tax liability at December 31, 1997, 1996, and 1995, are as follows: 16 First Keystone Corporation
1997 1996 1995 Deferred Tax Assets: Loan loss Reserve $ 659,302 $ 623,870 $ 538,276 Deferred Compensation 20,432 - - Contributions - - 4,454 Total $ 679,734 $ 623,870 $ 542,730 Deferred Tax Liabilities: Loan origination fees and costs $ (118,427) $ (64,371) $ (30,176) Accretion (41,836) (24,302) (11,622) Unrealized investment securities gains (1,229,914) (634,604) (1,088,095) Depreciation (170,361) (167,442) (165,418) Total $(1,560,538) $(890,719) $(1,295,311) Net Deferred Tax Asset (Liability) $ (880,804) $(266,849) $ (752,581)
It is anticipated that all deferred tax assets are to be realized, accordingly no valuation allowance has been provided. NOTE 11. EMPLOYEE BENEFIT PLANS AND DEFERRED COMPENSATION AGREEMENTS The Corporation maintains a 401K Plan which has a combined tax qualified savings feature and profit sharing feature for the benefit of its employees. Under the savings feature, the Corporation contributes 100% of the employee contribution up to 3% of compensation which amounted to $59,395, $52,892, and $46,306 in 1997, 1996, and 1995, respectively. Under the profit sharing feature, contributions at the discretion of the Board of Directors, funded currently, amounted to $151,574, $138,818, and $195,291 in 1997, 1996, and 1995, respectively. The Bank also has non-qualified deferred compensation agreements with three of its officers. These agreements are essentially unsecured promises by the Bank to make monthly payments to the officers over a twenty year period. Payments begin based upon specific criteria generally, when the officer retires. To account for the cost of payments yet to be made in the future, the Bank recognizes an accrued liability in years prior to when payments begin based on the present value of those future payments. The Bank's accrued liability for these deferred compensation agreements as of December 31, 1997 and 1996, was $60,093 and $0, respectively. NOTE 12. LEASE COMMITMENTS AND CONTINGENCIES The Corporation's banking subsidiary leases two branch bank buildings under operating leases. Rent expense for the year ended December 31, 1997, 1996, and 1995 was $49,905, $48,180, and $45,997, respectively. The lease commitments, including a new lease entered into in January 1998 for additional office space adjoining the main bank building with a base annual rental by $30,000 adjusted annually for inflation, is: 1998 - $74,725, 1999 - $77,087, 2000 - $72,577, and 2001 - $18,130. In the normal course of business, there are various pending legal actions and proceedings that are not reflected in the Consolidated Financial Statements. Management does not believe the outcome of these actions and proceedings will have a material effect on the consolidated financial position of the Corporation. NOTE 13. RELATED PARTY TRANSACTIONS Certain directors and executive officers of First Keystone Corporation and its Subsidiary and companies in which they are principal owners (i.e., at least 10%) were indebted to the Corporation at December 31, 1997, 1996 and 1995. These loans were made on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated parties. The loans do not involve more than the normal risk of collectibility nor present other unfavorable features. A summary of the activity on the related party loans, comprised of 5 directors and 4 executive officers, consists of the following for the years ended December 31, 1997, 1996, and 1995:
1997 1996 1995 Balance at January 1 $2,553,945 $3,090,030 $3,410,457 Additions 284,044 224,885 1,513,122 Deductions (757,026) (760,970) (1,833,549) Balance at December 31 $2,080,963 $2,553,945 $3,090,030
1997 Annual Report 17 NOTE 14. REGULATORY MATTERS Dividends are paid by the Corporation to shareholders from its assets which are mainly provided by dividends from the Bank. However, national banking laws place certain restrictions on the amount of cash dividends allowed to be paid by the Bank to the Corporation. Generally, the limitation provides that dividend payments may not exceed the Bank's current year's retained income plus retained net income for the preceding two years. Accordingly, in 1998, without prior regulatory approval, the Bank may declare dividends to the Corporation in the amount of $6,141,195 plus additional amounts equal to the net income earned in 1998 for the period January 1, 1998, through the date of declaration, less any dividends which may have already been paid in 1998. Regulations also limit the amount of loans and advances from the Bank to the Corporation to 10% of consolidated net assets. The Corporation is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet specific capital guidelines that involve quantitative measures of the Corporation's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Corporation's capital amounts and classification are also subject to qualitative judgements by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set fourth in the table below) of Total and Tier I Capital (as defined in the regulations) to Risk-Weighted Assets (as defined), and of Tier I Capital (as defined) to Average Assets (as defined). As of December 31, 1997, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as Well Capitalized under the regulatory framework for prompt corrective action. To be categorized as Well Capitalized, the Bank must maintain minimum Total Risk-Based, Tier I Risked-Based, and Tier I Leverage Ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category.
(Amounts in thousands) Actual Amount Ratio As of December 31, 1997: Total Capital (to Risk Weighted Assets) $30,073 21.01% Tier I Capital (to Risk Weighted Assets) 28,277 19.75% Tier I Capital (to Average Assets) 28,277 10.79% As of December 31, 1996: Total Capital (to Risk Weighted Assets) $26,741 20.45% Tier I Capital (to Risk Weighted Assets) 25,099 19.29% Tier I Capital (to Average Assets) 25,099 10.42% For Capital (Amounts in thousands) Adequacy Purposes Amount Ratio As of December 31, 1997: Total Capital (to Risk Weighted Assets) $11,450 8.00% Tier I Capital (to Risk Weighted Assets) 5,727 4.00% Tier I Capital (to Average Assets) 10,483 4.00% As of December 31, 1996: Total Capital (to Risk Weighted Assets) $10,461 8.00% Tier I Capital (to Risk Weighted Assets) 5,204 4.00% Tier I Capital (to Average Assets) 9,635 4.00% To Be Well Capitalized Under Prompt Corrective (Amounts in thousands) Action Provisions Amount Ratio As of December 31, 1997: Total Capital (to Risk Weighted Assets) $14,314 10.00% Tier I Capital (to Risk Weighted Assets) 8,590 6.00% Tier I Capital (to Average Assets) 13,103 5.00% As of December 31, 1996: Total Capital (to Risk Weighted Assets) $31,076 10.00% Tier I Capital (to Risk Weighted Assets) 7,807 6.00% Tier I Capital (to Average Assets) 12,044 5.00%
The Corporation's capital ratios are not materially different from those of the Bank. NOTE 15. 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. 18 First Keystone Corporation The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Corporation may require collateral or other security to support financial instruments with off-balance sheet credit risk. The contract or notional amounts at December 31, 1997, and 1996 were as follows:
1997 1996 Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $15,524,491 $17,675,879 Standby letters of credit $ 522,080 $ 1,331,233
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. However, at December 31, 1997, all standby letters of credit are generally unsecured. 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 December 31, 1997, to the extent necessary to avoid any significant concentration of credit risk. NOTE 16. STOCKHOLDERS' EQUITY On January 4, 1996, the Board of Directors declared a 10% stock dividend paid February 16, 1996, to shareholders of record January 4, 1996. A total of 80,718 shares were issued as a result of this stock dividend with a total value transferred from retained earnings of $2,991,188, including cash in lieu of fractional shares. On April 15, 1997, the Board of Directors declared a 10% stock dividend paid May 16, 1997, to shareholders of record May 2, 1997. A total of 88,762 shares were issued as a result of this stock dividend with a total value transferred from retained earnings of $3,289,844, including cash in lieu of fractional shares. On January 27, 1998, the Board of Directors approved a 3 for 1 stock split issued in the form of a 200% stock dividend to be paid March 2, 1998, to shareholders of record February 10, 1998. It is expected that 1,955,818 shares will be issued as a result of this transaction. All data with respect to shares, net income and cash dividends per share, and weighted average number of shares outstanding was retroactively adjusted to reflect the additional shares issued. NOTE 17. FAIR VALUES OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards Board Statement No. 107, "Disclosures about Fair Value of Financial Instruments", requires disclosure of fair value information about financial instruments, whether or not required to be recognized in the consolidated balance sheet, for which it is practicable to estimate such fair value. In cases where quoted market prices are not available, fair values are 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. Fair value estimates derived through these techniques cannot be substantiated by comparison to 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 the Corporation. The following methods and assumptions were used by the Corporation in estimating its fair value disclosures for financial instruments: Cash and Due From Banks, Short-Term Investments, Accrued Interest Receivable and Accrued Interest Payable The fair values are equal to the current carrying values. 1997 Annual Report 19 Investment Securities The fair value of investment securities which include mortgage backed securities, except certain state and municipal securities, is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, thus fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued. Loans Fair values are estimated for categories of loans with similar financial characteristics. Loans were segregated by type such as commercial, tax exempt, real estate mortgages and consumer. For estimation purposes each loan category was further segmented into fixed and adjustable rate interest terms and also into performing and non-performing classifications. The fair value of each category of performing loans is calculated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Fair value for non-performing loans is based on managements' estimate of future cash flows discounted using a rate commensurate with the risk associated with the estimated future cash flows. The assumptions used by management are judgmentally determined using specific borrower information. Deposits Under Statement No. 107, the fair value of deposits with no stated maturity, such as Demand Deposits, Savings Accounts and Money Market Accounts is equal to the amount payable on demand at December 31, 1997, and 1996. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. Short-Term and Long-Term Borrowings The fair values of short-term and long-term borrowings are estimated using discounted cash flow analyses based on the Corporation's incremental borrowing rate for similar instruments. Commitments to Extend Credit and Stand-By Letters of Credit Management estimates that there are no material differences between the notional amount and the estimated fair value of those off- balance sheet items since they are primarily composed of unfunded loan commitments which are generally priced at market at the time of funding. At December 31, 1997 and 1996, the carrying values and estimated fair values of financial instruments of the Corporation are presented in the table below:
1997 Carrying Estimated Amount Fair Value FINANCIAL ASSETS: Cash and due from banks $ 6,400,261 $ 6,400,261 Short-term investments 7,083,684 7,083,684 Investment securities 98,459,314 98,483,727 Net loans 149,779,649 151,403,927 Accrued interest receivable 1,997,936 1,997,936 FINANCIAL LIABILITIES: Deposits 217,647,184 218,366,085 Short-term borrowings 6,102,160 6,104,781 Long-term borrowings 9,000,000 9,042,986 Accrued interest payable 991,403 991,403 OFF-BALANCE SHEET FINANCIAL INSTRUMENTS: Commitments to extend credit 15,524,491 Standby letters of credit 522,080 1996 Carrying Estimated Amount Fair Value FINANCIAL ASSETS: Cash and due from banks $ 5,147,438 $ 5,147,438 Short-term investments 32,093 32,093 Investment securities 101,225,493 100,100,294 Net loans 130,933,978 132,207,197 Accrued interest receivable 1,958,882 1,958,882 FINANCIAL LIABILITIES: Deposits 198,545,783 198,681,259 Short-term borrowings 5,121,367 5,122,376 Long-term borrowings 10,000,000 10,041,133 Accrued interest payable 900,396 900,396 OFF-BALANCE SHEET FINANCIAL INSTRUMENTS: Commitments to extend credit 17,675,879 Standby letters of credit 1,331,233
20 First Keystone Corporation NOTE 18. PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for First Keystone Corporation (parent company only) was as follows:
BALANCE SHEETS December 31 1997 1996 ASSETS Cash in subsidiary bank $ 593,598 $ 468,854 Investment in subsidiary bank 30,022,204 26,000,323 Investment in other equity securities 1,573,278 1,170,554 Prepayments and other assets - 11,400 TOTAL ASSETS $32,189,080 $27,651,131 LIABILITIES Payable to subsidiary bank $ 3,742 $ 6,745 Accrued expenses and other liabilities 367,271 171,391 TOTAL LIABILITIES $ 371,013 $ 178,136 STOCKHOLDERS' EQUITY Preferred stock $ - $ - Common stock 1,955,818 1,778,294 Surplus 9,761,066 6,654,396 Retained earnings 17,873,418 17,889,923 Net unrealized securities gains 2,227,765 1,150,382 TOTAL STOCKHOLDERS' EQUITY $31,818,067 $27,472,995 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $32,189,080 $27,651,131
INCOME STATEMENTS Year Ended December 31 1997 1996 1995 INCOME Dividends from subsidiary bank $1,386,901 $1,138,110 $ 953,945 Dividends - other 40,173 34,818 26,553 Securities gains 103,145 - 21,760 Interest 16,650 28,810 15,372 TOTAL INCOME $1,546,869 $1,201,738 $1,017,630 Operating Expenses 28,984 21,212 27,102 Income Before Taxes and Equity in Undistributed Net Income of Subsidiary $1,517,885 $1,180,526 $ 990,528 Income tax expense 41,756 7,325 7,305 Income Before Equity in Undistributed Net Income of Subsidiary $1,476,129 $1,173,201 $ 983,223 Equity in undistributed income of Subsidiary 3,184,111 2,957,084 2,502,970 NET INCOME $4,660,240 $4,130,285 $3,486,193
1997 Annual Report 21
STATEMENTS OF CASH FLOWS Year Ended December 31 1997 1996 1995 OPERATING ACTIVITIES Net income $ 4,660,240 $ 4,130,285 $3,486,193 Adjustments to reconcile net income to net cash provided by operating activities: Securities gains (103,145) - (21,760) Equity in undistributed net income of Subsidiary (3,184,111) (2,957,084) (2,502,970) (Increase) decrease in receivables from Subsidiary - 54,681 (53,325) (Increase) decrease in prepaid expenses and other assets 11,400 70,994 (245) Increase (decrease) in advances payable to Subsidiary (3,003) 6,745 (56,093) Increase (decrease) in accrued expenses and other liabilities 32,149 (97,721) 45,900 NET CASH PROVIDED BY OPERATING ACTIVITIES $ 1,413,530 $ 1,207,900 $ 897,700 INVESTING ACTIVITIES Purchase of equity securities $ (59,431) $ (41,628) $ (166,253) Sale of equity securities 163,196 - 56,438 Dissolution of non-bank subsidiary - - 12,851 NET CASH PROVIDED (USED) IN INVESTING ACTIVITIES $ 103,765 $ (41,628) $ (96,964) FINANCING ACTIVITIES Cash dividends paid $(1,386,901) $(1,138,108) $ (953,946) Dividends paid in lieu of fractional shares (5,650) (4,622) - NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES $(1,392,551) $(1,142,730) $ (953,946) Increase (Decrease) in Cash and Cash Equivalents $ 124,744 $ 23,542 $ (153,210) Cash and Cash Equivalents at Beginning of Year 468,854 445,312 598,522 CASH AND CASH EQUIVALENTS AT END OF YEAR $ 593,598 $ 468,854 $ 445,312
22 First Keystone Corporation REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors and Stockholders of First Keystone Corporation: We have audited the accompanying consolidated balance sheets of First Keystone Corporation and Subsidiary as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Keystone Corporation and Subsidiary as of 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/ J. H. Williams & Co., LLP J. H. Williams & Co., LLP Kingston, Pennsylvania January 9, 1998 1997 Annual Report 23 Management's Discussion and Analysis MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE RESULTS OF OPERATIONS AND FINANCIAL CONDITION PURPOSE The purpose of the Management Discussion and Analysis of First Keystone Corporation, a bank holding company (the Corporation), and its wholly owned subsidiary, The First National Bank of Berwick (the Bank), is to assist the reader in reviewing the financial information presented and should be read in conjunction with the consolidated financial statements and other financial data contained herein. RESULTS OF OPERATIONS First Keystone Corporation realized record earnings in 1997 with reported net income of $4,660,240. The net income for 1997 marked the 15th consecutive year that earnings and earnings per share have increased. Earnings per share for 1997 were $1.59 as compared to $1.41 and $1.19 in 1996 and 1995, respectively (adjusted for a 10% stock dividend paid in May 1997 and a 3 for 1 stock split in the form of a 200% stock dividend paid in March 1998). The Corporation's return on average assets improved to 1.83% in 1997 from 1.75% in 1996 and 1.58% in 1995. Likewise, the Corporation's return on average equity remained strong at 15.92% in 1997, compared to 15.98% in 1996 and 15.24% in 1995. Average earning assets increased $18,347,624, or 8.1% during 1997, while average interest bearing liabilities grew $14,504,523, or 7.6%. The average yield on earning assets decreased to 8.37% in 1997 from 8.38% in 1996 while the rate paid on interest bearing liabilities increased to 4.56% in 1997 from 4.53% in 1996. As a result, the Corporation's net interest income on a fully taxable equivalent basis increased 7.6% in 1997 after increasing 11.4% in 1996. NET INTEREST INCOME The major source of operating income for the Corporation is net interest income, defined as interest income less interest expense. The amount of interest income is dependent upon both the volume of earning assets and the level of interest rates. In addition, the volume of non-performing loans affects interest income. The amount of interest expense varies with the amount of funds needed to support earnings assets, interest rates paid on deposits and borrowed funds, and finally, the level of interest free deposits. Table 1 indicates the amount of net interest income in each of the past-three years and the increase or decrease in each of the components. With interest income increasing more than interest expense, net interest income on a fully tax equivalent basis increased $793,000 in 1997 as compared to an increase of $1,065,000 in 1996. Table 2 on the following page provides a breakdown of average balances with corresponding revenues and expense resulting in average yield or rates paid. The yield on earning assets was 8.37% in 1997, 8.38% in 1996, and 8.27% in 1995. The rate paid on interest bearing liabilities increased to 4.56% after decreasing to 4.53% in 1996 from 4.60% in 1995. A 1 basis point decline in the yield on earning assets, together with a 3 basis increase on the rate paid on interest bearing liabilities in 1997 put slight pressure on the net interest margin. The effect was a decrease in our net interest margin to 4.56% in 1997 as compared to 4.58% in 1996 and 4.39% in 1995. The continued maintenance of an adequate net interest margin is a primary concern being addressed by management on an ongoing basis. Table 1 - Net Interest Income
(Amounts in thousands) 1997/1996 Increase/(Decrease) 1997 Amount % 1996 Interest Income $19,345 $1,559 8.8 $17,786 Interest Expense 9,381 714 8.2 8,667 Net Interest Income 9,964 845 9.3 9,119 Tax Equivalent Adjustment 1,250 (52) (4.0) 1,302 Net Interest Income (fully tax equivalent) $11,214 $ 793 7.6 $10,421 1996/1995 Increase/(Decrease) 1996 Amount % 1995 Interest Income $17,786 $1,149 6.9 $16,637 Interest Expense 8,667 396 4.8 8,271 Net Interest Income 9,119 753 9.0 8,366 Tax Equivalent Adjustment 1,302 312 31.5 990 Net Interest Income (fully tax equivalent) $10,421 $1,065 11.4 $ 9,356
1997 Annual Report 25 Management's Discussion and Analysis Table 2 Distribution of Assets, Liabilities and Stockholders' Equity
1997 Avg. Balance Revenue/ Yield/ Expense Rate Interest Earning Assets: Loans: Commercial $ 18,047,317 $ 1,534,446 8.50% Real Estate 109,683,131 9,412,077 8.58% Installment Loans, Net 17,344,819 2,124,094 12.25% Fees on Loans 0 (76,037) 0% Total Loans (Including Fees) $145,075,267 $12,994,580 8.96% Investment Securities: Taxable $ 57,852,149 $ 3,868,888 6.69% Tax Exempt 38,362,932 3,467,215 9.04% Total Investment Securities $ 96,215,081 $ 7,336,103 7.62% Interest Bearing Deposits in Banks 4,776,405 264,015 5.53% Total Interest-Earning Assets $246,066,753 $20,594,698 8.37% Non-Interest Earning Assets: Cash and Due From Banks $ 5,378,688 Allowance for Loan Losses (2,295,089) Premises and Equipment 3,161,431 Other Real Estate Owned 47,946 Other Assets 2,240,113 Total Non-Interest Earning Assets 8,533,089 Total Assets $254,599,842 Interest-Bearing Liabilities: Savings, NOW Accounts, and Money Markets $ 89,137,426 $ 2,853,898 3.20% Time Deposits 100,012,779 5,583,373 5.58% Short-Term Borrowings 1,119,789 64,408 5.75% Long-Term Borrowings 11,646,849 713,710 6.13% Securities Sold U/A to Repurchase 3,992,063 165,663 4.15% Total Interest-Bearing Liabilities $205,908,906 $ 9,381,052 4.56% Non-Interest Bearing Liabilities: Demand Deposits $ 17,712,235 Other Liabilities 1,712,920 Stockholders' Equity 29,265,781 Total Liabilities/ Stockholders' Equity $254,599,842 Net Interest Income Tax Equivalent $11,213,646 Margin Analysis: Interest Income/Earning Assets 8.37% Interest Expense/Earning Assets 3.81% Net Interest Income/ Earning Assets 4.56% 26 First Keystone Corporation Management's Discussion and Analysis 1996 Avg. Balance Revenue/ Yield/ Expense Rate Interest Earning Assets: Loans: Commercial $ 15,770,100 $ 1,542,429 9.78% Real Estate 93,136,506 8,008,957 8.60% Installment Loans, Net 19,832,168 1,986,279 10.02% Fees on Loans 0 (22,838) 0% Total Loans (Including Fees) $128,738,774 $11,514,827 8.94% Investment Securities: Taxable $ 58,566,185 $ 3,971,485 6.78% Tax Exempt 38,724,074 3,510,650 9.07% Total Investment Securities $ 97,290,259 $ 7,482,135 7.69% Interest Bearing Deposits in Banks 1,690,096 91,782 5.43% Total Interest - Earning Assets $227,719,129 $19,088,744 8.38% Non-Interest Earning Assets: Cash and Due From Banks $ 4,589,473 Allowance for Loan Losses (1,956,549) Premises and Equipment 2,957,176 Other Real Estate Owned 51,253 Other Assets 2,245,001 Total Non-Interest Earning Assets 7,886,354 Total Assets $235,605,483 Interest-Bearing Liabilities: Savings, NOW Accounts, and Money Markets $ 84,434,401 $ 2,601,722 3.08% Time Deposits 93,521,485 5,262,943 5.63% Short-Term Borrowings 1,658,914 100,183 6.04% Long-Term Borrowings 8,021,858 541,243 6.75% Securities Sold U/A to Repurchase 3,767,725 161,275 4.28% Total Interest-Bearing Liabilities $191,404,383 $ 8,667,366 4.53% Non-Interest Bearing Liabilities: Demand Deposits $ 16,664,535 Other Liabilities 1,506,985 Stockholders' Equity 26,029,580 Total Liabilities/ Stockholders' Equity $235,605,483 Net Interest Income $10,421,378 Margin Analysis: Interest Income/Earning Assets 8.38% Interest Expense/Earning Assets 3.81% Net Interest Income/ Earning Assets 4.58% 1995 Avg. Balance Revenue/ Yield/ Expense Rate Interest Earning Assets Loans: Commercial $ 20,081,671 $ 1,810,582 9.02% Real Estate 84,960,257 7,367,400 8.67% Installment Loans, Net 17,105,408 1,880,933 11.00% Fees on Loans 0 (48,943) 0% Total Loans (Including Fees) $122,147,336 $11,009,972 9.01% Investment Securities: Taxable $ 62,270,253 $ 3,995,116 6.42% Tax Exempt 26,120,515 2,471,962 9.46% Total Investment Securities $ 88,390,768 $ 6,467,078 7.32% Interest Bearing Deposits in Banks 2,559,912 149,793 5.85% Total Interest-Earning Assets $213,098,016 $17,626,843 8.27% Non-Interest Earning Assets: Cash and Due From Banks $ 4,138,600 Allowance for Loan Losses (1,823,528) Premises and Equipment 3,034,903 Other Real Estate Owned 71,370 Other Assets 2,328,407 Total Non-Interest Earning Assets 7,749,752 Total Assets $220,847,768 Interest-Bearing Liabilities: Savings, NOW Accounts, and Money Markets $ 79,045,538 $ 2,502,194 3.17% Time Deposits 87,133,168 4,948,259 5.68% Short-Term Borrowings 1,008,574 57,590 5.71% Long-Term Borrowings 8,478,003 583,469 6.88% Securities Sold U/A to Repurchase 3,994,576 179,338 4.49% Total Interest-Bearing Liabilities $179,659,859 $ 8,270,850 4.60% Non-Interest Bearing Liabilities: Demand Deposits $ 16,910,070 Other Liabilities 1,408,712 Stockholders' Equity 22,869,127 Total Liabilities/ Stockholders' Equity $220,847,768 Net Interest Income $ 9,355,993 Margin Analysis: Interest Income/Earning Assets 8.27% Interest Expense/Earning Assets 3.88% Net Interest Income/Earning Assets 4.39% ______________________ Tax-exempt income has been adjusted to a tax equivalent basis using an incremental rate of 34%. Installment loans are stated net of unearned interest. Average loan balances include non-accrual loans. Interest income on non- accrual loans is not included.
1997 Annual Report 27 Management's Discussion and Analysis Table 3 analyzes the changes attributable to the volume and rate components of net interest income on a fully tax equivalent basis. In 1997, the increase in net interest income of $793,000 resulted from a change in volume of $816,000 and a decrease of $23,000 due to changes in rate. In 1996, there was an increase in net interest income of $1,065,000 due to changes in volume of $969,000 and an increase of $96,000 due to changes in rate. Table 3 - Changes in Income and Expense, 1997 and 1996
(Amounts in thousands) 1997 COMPARED TO 1996 VOLUME RATE NET Interest Income: Loans, Net $1,461 $ 19 $1,480 Taxable Investment Securities (49) (54) (103) Tax-Exempt Investment Securities (33) (11) (44) Other Short-Term Investments 168 5 173 Total Interest Income $1,547 $ (41) $1,506 Interest Expense: Savings, Now, and Money Markets $ 145 $ 107 $ 252 Time Deposits 365 (45) 320 Short-Term Borrowings (33) (3) (36) Long-Term Borrowings 245 (72) 173 Securities Sold U/A to Repurchase 9 (5) 4 Total Interest Expense $ 731 (18) $ 713 Net Interest Income $ 816 $ (23) $ 793 (Amounts in thousands) 1996 COMPARED TO 1995 VOLUME RATE NET Interest Income: Loans, Net $ 594 $ (89) $ 505 Taxable Investment Securities (238) 214 (24) Tax-Exempt Investment Securities 1,193 (154) 1,039 Other Short-Term Investments (51) (7) (58) Total Interest Income $1,498 $ (36) $1,462 Interest Expense: Savings, Now, and Money Markets $ 170 $ (71) $ 99 Time Deposits 363 (48) 315 Short-Term Borrowings 37 6 43 Long-Term Borrowings (31) (11) (42) Securities Sold U/A to Repurchase (10) (8) (18) Total Interest Expense $ 529 $(132) $ 397 Net Interest Income $ 969 $ 96 $1,065 ________________________ The change in interest due to both volume and yield/rate has been allocated to change due to volume and change due to yield/rate in proportion to the absolute value of the change in each. Balance on non-accrual loans are included for computational purposes. Interest income on non-accrual loans is not included. Interest income exempt from federal tax was $2,426,231 in 1997, $2,529,235 in 1996 and $1,922,073 in 1995. Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental rate of 34%.
NON INTEREST INCOME Total non-interest income increased $210,000, or 20.0% in 1997 as compared to an increase of $82,000, or 8.5% in 1996 as illustrated in Table 5. Excluding investment securities gains, non-interest income in 1997 increased $104,000, or 9.5% as compared to 1996 when non-interest income increased by $125,000, or 13.0%. Income from the trust department which consists of fees generated from individual and corporate accounts, increased in 1997 by $32,000 after increasing by $75,000 in 1996. Increased income from the trust department was due to a larger overall number of accounts in 1997. Also, in 1997 more accounts were moved to a quarterly fee assessment as opposed to annual. Assets under management by our Trust Department continue to increase as illustrated in Table 4. Table 4 - Assets Under Management by Trust Department
(Amounts in thousands) 1997 1996 1995 1994 1993 Individual Trusts $109,788 $ 91,256 $83,886 $72,027 $70,300 Corporate Trusts 9,535 10,004 7,676 3,569 3,887 Total Trust Department $119,323 $101,260 $91,562 $75,596 $74,187
28 First Keystone Corporation Management's Discussion and Analysis Service charges and fees, consisting primarily of service charges on deposit accounts, was the largest source of non-interest income in 1997. Service charges increased by $53,000, or 8.6% in 1997 compared to an increase of $43,000, or 7.5% in 1996. Other income decreased by $15,000, or 30.6% in 1997 compared with an increase of $7,000, or 16.7% in 1996. In 1997 for the first time, a gain on the sale of mortgage loans of $34,000 was recognized. It is anticipated that some mortgages will continue to be originated for sale in the secondary market. The servicing of those mortgages will provide additional fee income. The table below illustrates the change in non-interest income by category for the years ended December 31, 1997, 1996, and 1995. Table 5 - Non-Interest Income
(Amounts in thousands) 1997/1996 Increase/(Decrease) 1997 Amount % 1996 Trust Department $ 457 $ 32 7.5 $ 425 Service Charges and Fees 669 53 8.6 616 Other 34 (15) (30.6) 49 Gain on Sale of Mortgages 34 34 0 0 Subtotal $1,194 104 9.5 $1,090 Investment Securities Gains 68 106 278.9 (38) Total $1,262 $210 20.0 $1,052 1996/1995 Increase/(Decrease) 1996 Amount % 1995 Trust Department $ 425 $ 75 21.4 $350 Service Charges and Fees 616 43 7.5 573 Other 49 7 16.7 42 Gain on Sale of Mortgages 0 0 0 0 Subtotal $1,090 $125 13.0 $965 Investment Securities Gains (38) (43) (860.0) 5 Total $1,052 $ 82 8.5 $970
PROVISION FOR LOAN LOSSES The provision for loan losses for the year-ended December 31, 1997, was $325,000 compared to $516,584 and $372,448 for the years ended December 31, 1996, and 1995, respectively. The provision for possible loan losses declined in 1997 primarily because net charge- offs fell in 1997 as compared to 1996. Net charge-offs totaled $221,000 in 1997, $265,000 in 1996, and $159,000 in 1995, respectfully. Our manageable net charge-offs and reduced non- performing assets indicate good overall asset quality. Non-performing assets, consisting of non-performing loans and foreclosed assets, were $350,000, $351,000, and $557,000 at December 31, 1997, 1996, and 1995, respectively, representing .23%, .26%, and .44%, respectively, of loans net of unearned income and foreclosed assets. The allowance for loan losses as a percentage of loans, net of unearned interest, was 1.56% at December 31, 1997, 1.70% at December 31, 1996, and 1.57% at December 31, 1995. The allowance for loan losses as a percentage of non-performing assets and loans past-due 90 or more days remain strong at 345.7%, 369.2%, and 322.4% at year-end 1997, 1996, and 1995, respectively. Loans past-due 90 or more days and still accruing interest increased to $336,000 in 1997 from $263,000 and $68,000 in 1996 and 1995, respectively. With the increase in our allowance for loan losses and our continued collection efforts, the increase in loans past-due 90 or more days does not represent a concern. NON-INTEREST EXPENSES Total non-interest expense increased by $392,000, or 8.6% in 1997 compared to a decrease of $15,000, or 0.3% in 1996 as illustrated in Table 6. Expenses associated with employees (salaries and employee benefits) continue to be the largest category of non-interest expense. Salaries and employee benefits amounted to 53.3% of total non- interest expense in 1997 and 53.9% in 1996. Salaries and employee benefits increased $179,000, or 7.3% in 1997 and $185,000, or 8.2% in 1996. The increases in 1997 and 1996 were due to an increased number of employees plus normal salary adjustments and increased benefit costs. Full-time equivalent employees totaled 98 at December 31, 1997, compared to 91 in 1996 and 89 at year-end 1995. Based upon our total deposits and total assets, our number of employees compares favorably against peer financial institutions. Net occupancy expense increased $51,000, or 18.1% in 1997 as compared to a decrease of $11,000, or 3.8% in 1996. The increase in 1997 relates primarily to the opening of a new branch office. Furniture and equipment expense increased $20,000, or 4.3% in 1997 compared to an increase of $12,000, or 2.6% in 1996. The increases in 1997 and 1996 relate directly to higher depreciation associated with computer processing and related equipment. 1997 Annual Report 29 Management's Discussion and Analysis Due to the reestablishment of the payment of FDIC premiums, the Corporation paid $25,000 in 1997 after paying the minimum annual assessment rate of $2,000 in 1996. This represented an increase of $23,000 in FDIC insurance expense from 1996. Other operating expenses increased by $119,000, or 8.9% in 1997 after a $3,000 decrease, or 0.2% in 1996. The increase in other operating expenses in 1997 was because of higher expenses associated with professional fees, postage, printing supplies, insurance, marketing, and advertising over 1996. Our overall non-interest expense of less than 2% of average assets in 1997 and 1996, places us among the leaders of our peer financial institutions in controlling non-interest expense. Table 6 - Non-Interest Expense
(Amounts in thousands) 1997/1996 Increase/(Decrease) 1997 Amount % 1996 Salaries and Employee Benefits $2,627 $179 7.3 $2,448 Occupancy, Net 332 51 18.1 281 Furniture and Equipment 488 20 4.3 468 FDIC Insurance 25 23 1150.0 2 Other 1,461 119 8.9 1,342 Total $4,933 $392 8.6 $4,541 1996/1995 Increase/(Decrease) 1996 Amount % 1995 Salaries and Employee Benefits $2,448 $ 185 8.2 $2,263 Net Occupancy Expense 281 (11) (3.8) 292 Furniture and Equipment Expense 468 12 2.6 456 FDIC Insurance 2 (198) (99.0) 200 Other Operating Expenses 1,342 (3) (0.2) 1,345 Total $4,541 $ (15) (0.3) $4,556
INCOME TAXES Effective tax planning has helped produce favorable net income in each of the past three years. In 1997, net income before taxes increased $854,052. In 1996, income before income taxes increased $707,673 over 1995, while our income tax liability increased $324,097 and $63,581 in 1997 and 1996, respectively. The effective total income tax rate was 21.9% in 1997, 19.2% in 1996, and 20.8% in 1995. The increase in our tax liability rate in 1997 was due primarily to the limited purchases of municipal (tax-free investments) securities at attractive interest rates. ANALYSIS OF FINANCIAL CONDITION ASSETS Total assets increased to $267,398,586, an increase of 10.2% over year-end 1996. Total deposits increased to $217,647,184, or 9.6%. Assets at December 31, 1996, were up 7.3% to $242,557,150, while total deposits were up 6.0% to $198,545,783 compared to 1995. The Corporation has used borrowed funds in previous years to support asset growth not provided by deposit growth. Deposit growth in 1997 was $19,101,401 as compared to 1996 deposit growth of $11,225,696. With conventional deposit growth increasing in 1997, as compared to 1996, the Corporation's short-term borrowings and long- term borrowings remained stable at $15,102,160 in 1997 as compared to $15,121,367 in 1996. Borrowings were not reduced in 1997 because of strong loan demand which is discussed under Earning Assets and illustrated in Table 7 - Loans Outstanding, Net of Unearned Income. The Corporation continues to maintain and manage its asset growth. Our strong equity capital position has put us in a position where we can leverage our asset growth. Depending upon interest rates in 1998, the Corporation may borrow additional funds to leverage its balance sheet if net income can be incrementally increased without incurring an excessive amount of interest rate risk. The capital ratios, as illustrated in Table 12 - Capital Ratios for the Corporation and the Bank, continue to exceed all minimum capital ratio requirements. EARNING ASSETS Earning assets are defined as those assets that produce interest income. By maintaining a healthy asset utilization rate, i.e., the volume of earning assets as a percentage of total assets, the Corporation maximizes income. The earning asset ratio equaled 96.4% as of December 31, 1997, compared to 96.7% at December 31, 1996, and 96.5% as of December 31, 1995. This indicates that the management of earning assets is a priority and non-earning assets, primarily cash and due from banks, fixed assets and other assets, are maintained at minimal levels. The primary earning assets are loans and investment securities. Loans, as illustrated in Table 7 - Loans Outstanding, have steadily increased. Total loans, net of unearned income, increased $18,890,000, or 14.2% in 1997 to a level of $152,151,000. This compares to an increase in loans of $5,200,000, or 4.1% in 1996 and $9,877,000, or 8.4% in 1995. The loan portfolio is well diversified, and increases in the portfolio have primarily been from real estate loans and commercial loans secured by real estate. A pool of 30 First Keystone Corporation Management's Discussion and Analysis residential mortgage loans was sold in the secondary market during 1997. The Corporation will continue to originate and market residential mortgage loans which conform to secondary market requirements. The Corporation derives ongoing income from the servicing of mortgages. Table 7 - Loans Outstanding, Net of Unearned Income
(Amounts in thousands) December 31, 1997 1996 1995 Commercial, financial and agricultural: Commercial secured by real estate $ 41,566 $ 33,103 $ 28,846 Commercial - other 17,241 13,574 17,563 Tax exempt 2,566 2,263 3,602 Real estate (primarily residential mortgage loans) 72,901 65,145 58,438 Consumer loans 22,009 23,027 23,681 Total Gross Loans $156,283 $137,112 $132,130 Less: Unearned income and unamortized loan fees net of costs 4,132 3,851 4,069 Total Loans, net of unearned income $152,151 $133,261 $128,061 December 31, 1994 1993 Commercial, financial and agricultural: Commercial secured by real estate $ 30,127 $ 30,097 Commercial - other 16,285 14,005 Tax exempt 3,754 2,717 Real estate (primarily residential mortgage loans) 52,389 47,867 Consumer loans 19,370 17,156 Total Gross Loans $121,925 $111,842 Less: Unearned income and unamortized loan fees net of costs 3,741 3,498 Total Loans, net of unearned income $118,184 $108,344
The investment portfolio has been allocated between securities available for sale and securities held to maturity. No investment securities were established in a trading account. Available for sale securities increased $505,000 to $81,651,000 in 1997, while held to maturity securities decreased $3,271,000 to $16,809,000, as illustrated in Table 8. The vast majority of investment security purchases are allocated as available for sale. This provides the Corporation with increased flexibility should there be a need or desire to liquidate an investment security. The investment portfolio includes short-term investments, U.S. Treasury Securities, U.S. Government Agencies, corporate obligations, mortgage backed securities, state and municipal securities, and other debt securities. In addition, the investment portfolio includes equity securities consisting of common stock investments in other bank holding companies and commercial banks. During 1997, interest bearing deposits in other banks increased to $7,083,684 from $32,093 in 1996, as funds were kept short-term for liquidity purposes and to fund additional loan commitments. Table 8 - Carrying Value of Investment Securities
(Amounts in thousands) December 31, 1997 Available Held to for Sale Maturity U.S. Treasury $10,442 $ 0 U. S. Government Corporations and Agencies 34,253 13,612 State and Municipal 33,996 3,197 Other Securities 0 0 Equity Securities 2,960 0 Total Investment Securities $81,651 $16,809 December 31, 1996 Available Held to for Sale Maturity U.S. Treasury $ 3,341 $ 0 U. S. Government Corporations and Agencies 36,339 16,787 State and Municipal 37,602 3,293 Other Securities 1,266 0 Equity Securities 2,598 0 Total Investment Securities $81,146 $20,080 December 31, 1995 Available Held to for Sale Maturity U.S. Treasury $ 5,176 $ 0 U. S. Government Corporations and Agencies 22,358 20,130 State and Municipal 32,105 3,291 Other Securities 2,900 0 Equity Securities 2,165 0 Total Investment Securities $64,704 $23,421
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 losses 1997 Annual Report 31 Management's Discussion and Analysis is adequate to cover foreseeable future losses. Table 9 contains an analysis of our Allowance for Loan Losses indicating charge-offs and recoveries by the year. In 1997, net charge-offs as a percentage of average loans were .15% compared to .21% in 1996 and .13% in 1995. Net charge-offs amounted to $221,000 in 1997 as compared to $265,000 and $159,000 in 1996 and 1995, respectively. The increased number of bankruptcy filings in 1997 and 1996 largely account for the increased net charge-offs. With our manageable level of net charge-offs and the additions to the reserve from our provision out of operations, the allowance for loan losses as a percentage of average loans amounted to 1.63% in 1997, 1.76% in 1996, and 1.65% in 1995. Table 9 - Analysis of Allowance for Loan Losses
(Amounts in thousands) Years Ended December 31, 1997 1996 1995 Balance at beginning of period $2,267 $2,015 $1,802 Charge-offs: Commercial, financial, and agricultural 107 214 18 Real estate - mortgage 54 0 118 Installment loans to individuals 111 88 50 272 302 186 Recoveries: Commercial, financial, and agricultural 7 12 6 Real estate - mortgage 17 8 2 Installment loans to individuals 27 17 19 51 37 27 Net charge-offs 221 265 159 Additions charged to operations 325 517 372 Balance at end of period $2,371 $2,267 $2,015 Ratio of net charge-offs during the period to average loans outstanding during the period .15% .21% .13% Allowance for loan losses to average loans outstanding during the period 1.63% 1.76% 1.65% (Amounts in thousands) Years Ended December 31, 1994 1993 Balance at beginning of period $1,844 $1,366 Charge-offs: Commercial, financial, and agricultural 80 54 Real estate - mortgage 29 9 Installment loans to individuals 72 86 181 149 Recoveries: Commercial, financial, and agricultural 81 0 Real estate - mortgage 6 3 Installment loans to individuals 21 106 108 109 Net charge-offs 73 40 Additions charged to operations 31 518 Balance at end of period $1,802 $1,844 Ratio of net charge-offs during the period to average loans outstanding during the period .07% .04% Allowance for loan losses to average loans outstanding during the period 1.61% 1.75%
The Bank's actual provision for loan losses and its allowance for loan losses are based upon an active loan review procedure. A loan review is conducted quarterly to assess loan quality, analyze delinquencies, identify and evaluate potential problem loans (classified loans), and review general economic conditions. The quarterly review includes a determination of the adequacy of the Bank's loan loss reserves. The allowance for loan losses was allocated to specific categories as illustrated in Table 10. Table 10 - Allocation of Allowance for Loan Losses
December 31, 1997 % Commercial, financial, and agricultural $ 271 12.1 Real estate - mortgage 1,135 73.9 Installments to individuals 241 14.0 Unallocated 724 N/A $2,371 100.0 December 31, 1996 % 1995 % Commercial, financial, and agricultural $ 303 10.7 $ 344 17.4 Real estate - mortgage 1,088 72.5 663 66.1 Installments to individuals 203 16.8 443 16.5 Unallocated 673 N/A 565 N/A $2,267 100.0 $2,015 100.0 December 31, 1994 % 1993 % Commercial, financial, and agricultural $ 253 15.2 $ 262 13.4 Real estate - mortgage 985 68.9 1,077 71.3 Installments to individuals 153 15.9 174 15.3 Unallocated 411 N/A 331 N/A $1,802 100.0 $1,844 100.0 ______________________ Percentage of loans in each category to total loans.
32 First Keystone Corporation Management's Discussion and Analysis NON-PERFORMING ASSETS Table 11 reflects non-performing assets for the past five years. Non-accrual loans are generally delinquent on which principal or interest is past-due approximately 90 days or more, depending upon the type of credit and the collateral. When a loan is placed on non-accrual status, any unpaid interest is charged against income. Restructured loans are loans where the borrower has been granted a concession in the interest rate or payment amount because of financial problems. Other real estate owned/foreclosed assets represents property acquired through foreclosure, or considered to be an in-substance foreclosure. The total of non-performing assets has declined annually after peaking in 1993. The current level of non-performing assets of $350,000 and loans past-due 90 days or more are considered manageable. Loans which are past-due 90 days or more as to interest or principal and still accruing did increase to $336,000 in 1997 from $263,000 in 1996. With a full-time loan review officer, loan quality is monitored closely, and we actively attempt to work with borrowers to resolve credit problems. Excluding the assets disclosed in Table 11, management is not aware of any information about borrowers' possible credit problems, which cause serious doubt as to their ability to comply with present loan repayment terms. Should the economic climate no longer continue to be stable or begin to deteriorate, borrowers may experience difficulty, and the level of non-performing loans and assets, charge-offs and delinquencies could rise and possibly require additional increases in our allowance for loan losses. In addition, regulatory authorities, as an integral part of their examinations, periodically review the allowance for possible loan and lease losses. They may require additions to allowances based upon their judgements about information available to them at the time of examination. Interest income received on non-performing loans in 1997 and 1996 was $7,006 and $3,048, respectively. Interest income, which would have been recorded on these loans under the original terms in 1997 and 1996 was $30,027 and $46,924, respectively. At December 31, 1997, the Corporation had no outstanding commitments to advance additional funds with respect to these non-performing loans. A concentration of credit exists when the total amount of loans to borrowers, who are engaged in similar activities that are similarly impacted by economic or other conditions, exceed 10% of total loans. As of December 31, 1997, 1996, and 1995, management is of the opinion that there were no loan concentrations exceeding 10% of total loans. There is a concentration of real estate mortgage loans in the loan portfolio. Real estate mortgages comprise 73.2% of the loan portfolio as of December 31, 1997, up from 71.7% in 1996. Real estate mortgages consist of both residential and commercial real estate loans. The real estate loan portfolio is well diversified in terms of borrowers and collateral. Also, the real estate loan portfolio has a mix of both fixed rate and adjustable rate mortgages. The real estate loans are concentrated primarily in our marketing area and are subject to risks associated with the local economy. Table 11 - Non-Performing Assets
(Amounts in thousands) December 31, 1997 1996 1995 1994 1993 Non-accrual and restructured loans $321 $267 $557 $620 $1,431 Other real estate/ foreclosed assets 29 84 0 235 5 Total non-performing assets $350 $351 $557 $855 $1,436 Non-performing assets to period-end loans and foreclosed assets .23% .26% .44% .73% 1.35% Loans past-due 90 or more days and still accruing $336 $263 $68 $49 $27
DEPOSITS AND OTHER BORROWED FUNDS Deposit growth amounted to $19,101,401, or a 9.6% increase when comparing December 31, 1997, to December 31, 1996. This increase compares to deposit increases of 6.0% in 1996 and 8.7% in 1995. First Keystone's subsidiary bank, opened its seventh full service office in Hanover Township, Wilkes-Barre, Pennsylvania, in the fourth quarter of 1997. This office helped account for some of the deposit growth in 1997. We expect the office to not only provide a basis for deposits, but also be an active lender in the area. During 1997, the Corporation experienced a vast majority of its deposit growth in interest bearing deposits. In particular, interest bearing demand deposits increased in 1997. Also, certificates of deposit under $100,000 and time deposits of $100,000 or more both increased in 1997. Short-term borrowings and long-term borrowings remained relatively stable in 1997, while declining only $19,207 after increasing $3,762,766 in 1996. 1997 Annual Report 33 Management's Discussion and Analysis CAPITAL STRENGTH Normal increases in capital are generated by net income, less cash dividends paid out. Also, the net unrealized gains on investment securities available for sale increased shareholders' equity or capital in both 1997 and 1996. The net increase in capital was $4,345,072 in 1997 and $2,073,534 in 1996. The unrealized gain on investment securities available-for-sale net of taxes which increased to $2,227,765 in 1997, accounts for part of the net increase in capital in 1997. Return on equity (ROE) is computed by dividing net income by average stockholders' equity. This ratio was 15.92% for 1997, 15.98% for 1996, and 15.24% for 1995. Refer to Performance Ratios on Page 2 - Summary of Selected Financial Data for a more expanded listing of the ROE. Adequate capitalization of banks and bank holding companies is required and monitored by regulatory authorities. Table 12 reflects risk-based capital ratios and the leverage ratio for our Corporation and Bank. The Corporation's leverage ratio was 11.23% at December 31, 1997, and 10.87% as of December 31, 1996. The risk-based capital ratios also increased in 1997 from 1996 for both the Corporation and the Bank. The risk-based capital calculation assigns various levels of risk to different categories of bank assets, requiring higher levels of capital for assets with more risk. Also measured in the risk-based capital ratio is credit risk exposure associated with off-balance sheet contracts and commitments. The following table indicates capital ratios as of December 31, 1997, and December 31, 1996, for the Corporation and the Bank. Table 12 - Capital Ratios
December 31, 1997 Corporation Bank Risk-Based Capital: Tier I risk-based capital ratio 19.43% 19.75% Total risk-based capital ratio (Tier 1 and Tier 2) 20.68% 21.01% Leverage Ratio: Tier I capital to average assets 11.23% 10.79% December 31, 1996 Corporation Bank Risk-Based Capital: Tier I risk-based capital ratio 19.29% 18.83% Total risk-based capital ratio (Tier 1 and Tier 2) 20.55% 20.08% Leverage Ratio: Tier I capital to average assets 10.87% 10.42%
LIQUIDITY MANAGEMENT Effective liquidity management ensures that the cash flow requirements of depositors and borrowers, as well as the operating cash needs of the Corporation, are met. Liquidity is needed to provide the funding requirements of depositors withdrawals, loan growth, and other operational needs. Asset liquidity is provided by investment securities maturing in one year or less, other short-term investments, federal funds sold, and cash and due from banks. Additionally, maturing loans and repayment of loans are another source of asset liquidity. Liability liquidity is accomplished by maintaining a core deposit base, acquired by attracting new deposits and retaining maturing deposits. Also, short-term borrowings provide funds to meet liquidity. Management feels its current liquidity position is satisfactory given the factors that the Corporation has 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 investments 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. Finally, the Corporation does have access to funds on a short- term basis from the Federal Reserve Bank discount window. Fed funds can be purchased by means of a borrowing line at the Atlantic Central Bankers Bank. The Corporation has indirect access to the capital markets through its membership in the Federal Home Loan Bank. Advances, both short-term and long-term, are available to help address any liquidity needs. 34 First Keystone Corporation Management's Discussion and Analysis Table 13 - Loan Maturities and Interest Sensitivity
(Amounts in thousands) December 31, 1997 One year One thru Over five or less five years years Total Commercial, Financial and Agricultural Fixed interest rate $ 2,707 $ 7,025 $6,598 $16,330 Variable interest rate 30,379 14,107 1,632 46,118 Total $33,086 $21,132 $8,230 $62,448 Real Estate Construction Fixed interest rate $ 0 $ 0 $ 0 $ 0 Variable interest rate $ 0 $ 0 $ 0 $ 0 __________________________ Excludes residential mortgages and consumer loans.
MARKET RISK MANAGEMENT Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. First Keystone Corporation's market risk is composed primarily of interest rate risk. Increases in the level of interest rates also may adversely affect the fair value of the Corporation's securities and other earning assets. Generally, the fair value of fixed-rate instruments fluctuates inversely with changes in interest rates. As a result, increases in interest rates could result in decreases in the fair value of the Corporation's interest-earning assets, which could adversely affect the Corporation's results of operations if sold, or, in the case of interest earning assets classified as available for sale, the Corporation's stockholders' equity, if retained. Under The Financial Accounting Standards Board (FASB) Statement 115, changes in the unrealized gains and losses, net of taxes, on securities classified as available for sale will be reflected in the Corporation's stockholders' equity. As of December 31, 1997, the Corporation's securities portfolio included $81,650,689 in securities classified as available for sale. Accordingly, with the magnitude of the Corporation's holdings of securities available for sale, changes in interest rates could produce significant changes in the value of such securities and could produce significant fluctuations in the stockholders' equity of the Corporation. The Corporation does not own any trading assets. The Bank's Asset/Liability Committee (ALCO) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to interest rate risk. The guidelines established by ALCO are reviewed by the Corporation's Board of Directors. Table 14 presents an analysis of the changes in net-interest income and net present value of the balance sheet resulting from an increase or decrease of two percentage points (200 basis points) in the level of interest rates. The calculated estimates of change in net interest income and net present value of the balance sheet are compared to current limits approved by ALCO and the Board of Directors. The earnings simulation model projects net-interest income would increase by approximately 7.6% if rates fell gradually by two percentage points over one year. It projects a decrease of approximately 7.8% in net-interest income if rates rise gradually by two percentage points over one year. While this does indicate a liability sensitive risk position, both of these forecasts are within the one year policy guidelines of 10%. The net present value of the balance sheet is defined as the discounted present value of asset cash flows minus the discounted present value of liability cash flows. At year-end, a 200 basis point immediate decrease in rates is estimated to increase net present value by 39.4%. Additionally, net present value is projected to decrease by 36.1% if rates increase immediately by 200 basis points, both within policy limits restricting these amounts to 50%. The computation of the effects of hypothetical interest rate changes are based on many assumptions. They should not be relied upon solely as being indicative of actual results, since the computations do not contemplate actions management could undertake in response to changes in interest rates. 1997 Annual Report 35 Management's Discussion and Analysis Table 14 - Effect of Change in Interest Rates
Projected ALCO Change Guidelines Effect on Net Interest Income 1-year Net Income simulation Projection -200 bp Ramp vs Stable Rate 7.6% (10%) +200 bp Ramp vs Stable Rate (7.8%) (10%) Effect on Net Present Value of Balance Sheet Static Net Present Value Change -200 bp Shock vs Stable Rate 39.4% (50%) +200 bp Shock vs Stable Rate (36.1%) (50%)
ASSET/LIABILITY MANAGEMENT The principal objective of asset liability management is to manage the sensitivity of the net interest margin to potential movements in interest rates and to enhance profitability through returns from managed levels of interest rate risk. The Corporation actively manages the interest rate sensitivity of its assets and liabilities. Several techniques are used for measuring interest rate sensitivity. The traditional maturity "gap" analysis, which reflects the volume difference between interest rate sensitive assets and liabilities during a given time period, is reviewed regularly by management. A positive gap occurs when the amount of interest sensitive assets exceeds interest sensitive liabilities. This position would contribute positively to net-interest income in a rising interest rate environment. Conversely, if the balance sheet has more liabilities repricing than assets, the balance sheet is liability sensitive or negatively gapped. In our current sensitivity position, management continues to monitor sensitivity so we do not become overexposed in a rising interest rate environment. Limitations of gap analysis as illustrated in Table 15 include: a) assets and liabilities which contractually reprice within the same period may not, in fact, reprice at the same time or to the same extent; b) changes in market interest rates do not affect all assets and liabilities to the same extent or at the same time, and c) interest rate gaps reflect the Corporation's position on a single day (December 31, 1997 in the case of the following schedule) while the Corporation continually adjusts its interest sensitivity throughout the year. Another way management reviews its interest sensitivity position is through dynamic income simulation. A dynamic income simulation model is the primary mechanism used in assessing the impact of changes in interest rates on net interest income. The model reflects management's assumptions related to asset yields and rates paid on liabilities, deposit sensitivity, size and composition of the balance sheet. The assumptions are based on what management believes at that time to be the most likely interest rate environment. Management also evaluates the impact of higher and lower interest rates. Management cannot predict the direction of interest rates or how the mix of assets and liabilities will change. The use of this information will help formulate strategies to minimize the unfavorable effect on net interest income caused by interest rate changes. In Table 15, the Corporation has elected to incorporate interest bearing demand deposits and savings deposits as rate sensitive in the three months or less time frame. The result is a negative gap in that time frame of $61,964,000. However, much of our interest bearing demand deposits and savings deposits are considered core deposits and are not rate sensitive, especially in the three months or less time frame. Accordingly, the Corporation feels it is only slightly negatively gapped with exposure to an increase in interest rates limited within policy guidelines. As discussed previously, a negative gap will decrease net interest income should interest rates rise. Despite the Corporation's negative gap position, the impact of a rapid rise in interest rates as occurred in 1994, did not have a significant effect on our net interest income. Accordingly, even though there are some inherent limitations to gap analysis and dynamic income simulation, the Corporation believes that the tools used to manage its interest rate sensitivity provide an appropriate reflection of interest rate risk exposure. 36 First Keystone Corporation Management's Discussion and Analysis Table 15 - Interest Rate Sensitivity Analysis
(Amounts in thousands) December 31, 1997 3 Months 3 - 12 1 - 5 or Less Months Years Rate Sensitive Assets: Cash and cash equivalent $ 7,084 $ 0 $ 0 Loans 38,122 25,694 51,955 Investments 21,062 10,405 26,121 Total Rate Sensitive Assets $ 66,268 $ 36,099 $78,076 Rate Sensitive Liabilities: Deposits: Interest-bearing demand /savings $ 93,317 $ 0 $ 0 Time 29,215 46,429 29,943 Short-term borrowings 5,700 402 0 Long-term borrowings 0 1,000 8,000 Total Rate Sensitive Liabilities $128,232 $ 47,831 $37,943 Interest Rate Sensitivity: Current period $(61,964) $(11,732) $40,133 Cumulative gap (61,964) (73,696) (33,563) Cumulative gap to total assets (23.17%) (27.56%) (12.55%) December 31, 1997 Over 5 Years Total Rate Sensitive Assets: Cash and cash equivalent $ 0 $ 7,084 Loans 36,380 152,151 Investments 39,298 96,886 Total Rate Sensitive Assets $75,678 $256,121 Rate Sensitive Liabilities: Deposits: Interest-bearing demand /savings $ 0 $ 93,317 Time 0 105,587 Short-term borrowings 0 6,102 Long-term borrowings 0 9,000 Total Rate Sensitive Liabilities $ 0 $214,006 Interest Rate Sensitivity: Current period $75,678 $ 42,115 Cumulative gap 42,115 Cumulative gap to total assets 15.75%
EFFECT OF INFLATION Although inflation was not significant in 1997, the potential for increased inflation must be kept in mind. The impact of inflation on a financial institution can be difficult to measure. Inflation affects asset growth due to inflated borrowing requests, which in turn requires a bank to increase its equity capital to maintain an appropriate capital base. Additionally, overall increases in inflation tend to increase medium to long-term interest rates and consequently reduce the market value of investment securities, residential mortgage loans, and other fixed-rate, long-term assets. Management believes that it can cope with the impact of inflation by managing the mix of interest rate sensitive assets and liabilities in order to reduce the impact of changing interest rates on net interest income. Also, inflation has a direct impact on non-interest income and expense. Management attempts to offset the effect of inflation by reviewing the prices of its products and services regularly, and by controlling overhead expenses. Management believes inflation is another risk associated with the business of providing financial services. Continuing effective management practices will be a key, as with other risks to future success. Planning, monitoring, and revising our short-range and long- range plans will provide results needed to attain our goals. FORWARD OUTLOOK AND YEAR 2000 Management and the Board of Directors of the Corporation continually evaluate its operating procedures and practices. Additionally, bank regulators often make observations and recommendations regarding such procedures and practices as a result of their examinations. Those observations and recommendations are promptly considered by management and actions are taken as warranted. Financial indicators are mixed on whether continued economic expansion will take place in 1998. We are optimistic that loan growth will continue in 1998. Although it is anticipated that the majority of the loan growth in 1998 will be in the residential mortgage area and home equity loans, any deposit increases in excess of loan demand will be primarily directed to the investment securities portfolio. We will continue to give careful attention to the pricing of loans and deposits, such that our net interest margin is not adversely affected. Increasing non-interest income and controlling non-interest expense in 1998 and beyond will continue to be a priority. The Corporation, as part of its strategic plan, will continue to investigate expansion. The Corporation will explore market possibilities for future branch locations. We will maintain a delivery system and practices which maximize convenience and offer comprehensive user-friendly service to the market. 1997 Annual Report 37 Management's Discussion and Analysis First Keystone Corporation is in the process of becoming Year 2000 compliant. The expenses for maintenance or modification of software associated with the Year 2000 will be expensed as incurred. The costs of new software will be capitalized and amortized over the software's useful life. The cost of becoming 2000 compliant is not material. The amount expensed in 1997 was immaterial and the Corporation does not expect the amounts required to be expensed in 1998 and 1999 to have a material effect on its financial position or results of operation. However, failures of third parties or other companies, on which the Corporation systems rely to be 2000 compliant could have an adverse effect on the Corporation's systems. MARKET PRICE/DIVIDEND HISTORY First Keystone Corporation's common stock is quoted on the Over The Counter (OTC) Bulletin Board under the symbol "FKYS." The following have indicated that they are market makers in our stock: Ryan, Beck and Company, 150 Monument Road, Suite 106, Bala Cynwyd, PA 19004 (800-223-8969); Janney Montgomery Scott, Inc., 1801 Market Street, Philadelphia, PA 19103 (800-526-6397); and Hopper Soliday & Co., 1703 Oregon Pike, Lancaster, PA 17601 (800-646-8647). The table below reports the highest and lowest per share prices known to the Corporation and the dividends paid during the periods indicated. All amounts are restated to reflect a 10% stock dividend paid in February 1996, May 1997, and a 3 for 1 split in the form of a 200% dividend paid in March 1998. These prices do not necessarily reflect any dealer or retail markup, markdown or commission. Table 16 - Market Price/Dividend History
1997 Common Stock Dividends High/Low Paid First Quarter $11.21/$10.74 $.106 Second Quarter $14.33/$10.92 .117 Third Quarter $14.33/$14.33 .117 Fourth Quarter $19.08/$16.63 .133 1996 Common Stock Dividends High/Low Paid First Quarter $11.21/$10.19 $.094 Second Quarter $11.21/$11.21 .094 Third Quarter $11.21/$11.21 .094 Fourth Quarter $11.21/$11.21 .106 1995 Common Stock Dividends High/Low Paid First Quarter $ 9.64/$ 9.64 $.081 Second Quarter $ 9.64/$ 9.64 .081 Third Quarter $10.19/$ 9.64 .081 Fourth Quarter $10.19/$10.19 .085 Reflects adjustment for stock dividends more fully described in Note 1.
38 First Keystone Corporation Management's Discussion and Analysis Table 17 - Quarterly Results of Operations (Unaudited)
(Amounts in thousands, except per share) Three Months Ended 1997 March June September December 31 30 30 31 Interest income $4,608 $4,745 $4,948 $5,044 Interest expense 2,237 2,276 2,417 2,451 Net interest income $2,371 $2,469 $2,531 $2,593 Provision for loan losses 50 100 50 125 Other non-interest income 291 273 286 412 Non-interest expense 1,215 1,186 1,223 1,309 Income before income taxes $1,397 $1,456 $1,544 $1,570 Income taxes 274 309 359 365 Net income $1,123 $1,147 $1,185 $1,205 Per share $ .38 $ .39 $ .40 $ .41 Three Months Ended 1996 March June September December 31 30 30 31 Interest income $4,253 $4,390 $4,542 $4,601 Interest expense 2,129 2,152 2,158 2,228 Net interest income $2,124 $2,238 $2,384 $2,373 Provision for loan losses 25 65 45 382 Other non-interest income 240 275 262 275 Non-interest expense 1,155 1,081 1,095 1,210 Income before income taxes $1,184 $1,367 $1,506 $1,056 Income taxes 216 274 314 179 Net income $ 968 $1,093 $1,192 $ 877 Per share $ .33 $ .37 $ .41 $ .30 Reflects adjustment for stock dividends more fully described in Note 1. 1997 Annual Report 39
EX-21 4 EXHIBIT 21 LIST OF SUBSIDIARIES OF THE ISSUER Direct Subsidiary: The First National Bank of Berwick, chartered under the laws of the United States of America, a national banking association. 23 EX-23 5 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report on Form 10-K of First Keystone Corporation of our report dated January 9, 1998, included in the 1997 Annual Report to Stockholders of First Keystone Corporation. /s/ J. H. Williams & Co., LLP March 24, 1998 J. H. Williams & Co., LLP Kingston, Pennsylvania Certified Public Accountants 24 EX-27 6
9 1,000 12-MOS DEC-31-1997 DEC-31-1997 6,400 7,084 0 0 81,651 16,809 16,833 152,151 2,371 267,399 217,647 6,102 2,831 9,000 0 0 1,956 29,862 267,399 12,924 6,157 264 19,345 8,437 944 9,964 325 68 4,933 5,968 0 0 0 4,660 1.59 0 4.49 320 336 0 3,775 2,267 271 50 2,371 2,371 0 724
EX-99 7 EXHIBIT 99 DEFINITIVE PROXY STATEMENT, NOTICE OF ANNUAL MEETING AND FORM OF PROXY FOR THE ANNUAL MEETING OF SHAREHOLDERS TO BE HELD APRIL 21, 1998 26 First Keystone Corporation 111 West Front Street Berwick, Pennsylvania 18603 March 27, 1998 DEAR SHAREHOLDER: It is my pleasure to invite you to attend the 1998 Annual Meeting of Shareholders of First Keystone Corporation to be held on Tuesday, April 21, 1998, at 9:00 a.m., prevailing time. The Annual Meeting this year will be held at the main office of The First National Bank of Berwick, 111 West Front Street, Berwick, Pennsylvania, 18603. The Notice of the Annual Meeting and the Proxy Statement on the following pages address the formal business of the meeting. The formal business schedule includes: the election of three (3) Class B Directors, the proposal to amend Article 5 of the Articles of Incorporation to increase the number of authorized shares of common stock, the proposal to adopt the First Keystone Corporation 1998 Stock Incentive Plan and the ratification of the selection of the independent auditors for 1998. At the meeting, members of the Corporation's management will review the Corporation's operations during the past year and be available to respond to questions. We strongly encourage you to vote your shares, whether or not you plan to attend the meeting. It is very important that you sign, date and return the accompanying Proxy as soon as possible, in the postage prepaid envelope. If you do attend the meeting and wish to vote in person, you must give written notice thereof to the Secretary of the Corporation so that your Proxy will be superseded by any ballot that you submit at the meeting. Sincerely, /s/ J. Gerald Bazewicz J. Gerald Bazewicz President FIRST KEYSTONE CORPORATION NOTICE OF ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON APRIL 21, 1998 TO THE SHAREHOLDERS OF FIRST KEYSTONE CORPORATION: Notice is hereby given that the Annual Meeting of Shareholders of FIRST KEYSTONE CORPORATION (the "Corporation") will be held at 9:00 a.m., prevailing time, on Tuesday, April 21, 1998, at the main office of The First National Bank of Berwick, 111 West Front Street, Berwick, Pennsylvania 18603, for the following purposes: 1. To elect three (3) Class B Directors to serve for a three-year term and until their successors are elected and qualified; 2. To consider and act upon a proposal to amend Article 5 of the Articles of Incorporation to increase the number of authorized shares of common stock from three million to ten million shares; 3. To consider and act upon a proposal to approve the First Keystone Corporation 1998 Stock Incentive Plan, as described in the accompanying Proxy Statement; 4. To ratify the selection of J. H. Williams & Co. as the independent auditors for the Corporation for the year ending December 31, 1998; and 5. To transact such other business as may properly come before the Annual Meeting and any adjournment or postponement thereof. In accordance with the By-laws of the Corporation and action of the Board of Directors, only those shareholders of record at the close of business on March 10, 1998 will be entitled to notice of and to vote at the Annual Meeting and any adjournment or postponement thereof. A copy of the Corporation's Annual Report for the fiscal year ended December 31, 1997 is being mailed with this Notice. Copies of the Corporation's Annual Report for the 1996 fiscal year may be obtained at no cost by contacting J. Gerald Bazewicz, President, 111 West Front Street, Berwick, Pennsylvania, 18603, telephone: (717) 752-3671. You are urged to mark, sign, date and promptly return your Proxy in the enclosed envelope so that your shares may be voted in accordance with your wishes and in order that the presence of a quorum may be assured. The prompt return of your signed Proxy, regardless of the number of shares you hold, will aid the Corporation in reducing the expense of additional proxy solicitation. The giving of such Proxy does not affect your right to vote in person if you attend the meeting and give written notice to the Secretary of the Corporation. By Order of the Board of Directors, /s/ J. Gerald Bazewicz J. Gerald Bazewicz, President March 27, 1998 PROXY STATEMENT FOR THE ANNUAL MEETING OF SHAREHOLDERS OF FIRST KEYSTONE CORPORATION TO BE HELD ON APRIL 21, 1998 GENERAL Introduction, Date, Time and Place of Annual Meeting This Proxy Statement is being furnished in connection with the solicitation by the Board of Directors of FIRST KEYSTONE CORPORATION (the "Corporation"), a Pennsylvania business corporation, of proxies to be voted at the Annual Meeting of Shareholders of the Corporation to be held on Tuesday, April 21, 1998, at 9:00 a.m., prevailing time, at the main office of The First National Bank of Berwick, 111 West Front Street, Berwick, Pennsylvania, 18603, and at any adjournment or postponement of the Annual Meeting. The principal executive office of the Corporation is located at The First National Bank of Berwick (the "Bank"), 111 West Front Street, Berwick, Pennsylvania, 18603. The telephone number for the Corporation is (717) 752-3671. All inquiries should be directed to J. Gerald Bazewicz, President of the Corporation. The Bank is a wholly-owned subsidiary of the Corporation. Solicitation and Voting of Proxies This Proxy Statement and the enclosed form of proxy (the "Proxy") are first being sent to shareholders of the Corporation on or about March 27, 1998. Shares represented by proxies on the accompanying Proxy, if properly signed and returned, will be voted in accordance with the specifications made thereon by the shareholders. Any Proxy not specifying to the contrary will be voted FOR the election of the nominees for Class B Director named below, FOR the proposal to amend Article 5 of the Articles of Incorporation to increase the number of authorized shares of common stock, FOR the proposal to adopt the First Keystone Corporation 1998 Stock Incentive Plan (the Plan ) and FOR the ratification of the selection of J. H. Williams & Co. as the independent auditors for the Corporation for the year ending December 31, 1998. Execution and return of the enclosed Proxy will not affect a shareholder's right to attend the Annual Meeting and vote in person, after giving written notice to the Secretary of the Corporation. The cost of preparing, assembling, printing, mailing and soliciting proxies, and any additional material which the Corporation may furnish shareholders in connection with the Annual Meeting, will be borne by the Corporation. In addition to the use of the mails, certain directors, officers and employees of the Corporation and the Bank may solicit proxies personally, by telephone, telegraph and telecopier. Arrangements will be made with brokerage houses and other custodians, nominees and fiduciaries to forward proxy solicitation material to the beneficial owners of stock held of record by these persons, and, upon request therefor, the Corporation will reimburse them for their reasonable forwarding expenses. Revocability of Proxy A shareholder who returns a Proxy may revoke the Proxy at any time before it is voted only: (1) by giving written notice of revocation to John L. Coates, Secretary of First Keystone Corporation, at 111 West Front Street, Berwick, Pennsylvania, 18603; (2) by executing a later-dated proxy and giving written notice thereof to the Secretary of the Corporation; or (3) by voting in person after giving written notice to the Secretary of the Corporation. Proxy Statement Page 1 Voting Securities, Record Date and Quorum At the close of business on March 10, 1998, the Corporation had outstanding 2,933,727 shares of common stock, par value $2.00 per share, the only issued and outstanding class of stock (the "Common Stock"). The Corporation has 500,000 shares of preferred stock, par value $10.00 per share, authorized. As of March 10, 1998, none of the shares of preferred stock were issued. Only holders of Common Stock of record at the close of business on March 10, 1998, will be entitled to notice of and to vote at the Annual Meeting. Cumulative voting rights do not exist with respect to the election of directors. On all matters to come before the Annual Meeting, each shareholder is entitled to one vote for each share of Common Stock outstanding on the record date. Under Pennsylvania law and the By-laws of the Corporation, the presence of a quorum is required for each matter to be acted upon at the Annual Meeting. Pursuant to Article 3, Section 3.1, of the By-laws of the Corporation, the presence, in person or by proxy, of shareholders entitled to cast at least a majority of the votes which all shareholders are entitled to cast shall constitute a quorum for the transaction of business at the Annual Meeting. Votes withheld and abstentions will be counted in determining the presence of a quorum for the particular matter. Broker non-votes will not be counted in determining the presence of a quorum for the particular matter as to which the broker withheld authority. Assuming the presence of a quorum, the three nominees for director receiving the highest number of votes cast by shareholders entitled to vote for the election of directors shall be elected. Votes withheld from a nominee and broker non-votes will not be cast for such nominee. Assuming the presence of a quorum, the affirmative vote of a majority of all votes cast by shareholders on such matter is required for the approval and adoption of the amendment to Article 5 of the Articles of Incorporation, for the approval and adoption of the Plan and for the ratification of the selection of independent auditors. Abstentions and broker non-votes are not votes cast and therefore do not count either for or against the approval and adoption or ratification. Abstentions and broker non-votes, however, have the practical effect of reducing the number of affirmative votes required to achieve a majority for each matter by reducing the total number of shares voted from which the majority is calculated. PRINCIPAL BENEFICIAL OWNERS OF THE CORPORATION'S STOCK Principal Owners The following table sets forth, as of March 10, 1998, the name and address of each person who owns of record or who is known by the Board of Directors to be the beneficial owner of more than five percent (5%) of the Corporation's outstanding Common Stock, the number of shares beneficially owned by such person and the percentage of the Corporation's outstanding Common Stock so owned. The footnotes to this table follow the "Beneficial Ownership by Officers, Directors and Nominees" table, found immediately hereafter. Page 2 Proxy Statement
Shares Percent of Outstanding Beneficially Common Stock Name and Address Owned Beneficially Owned Robert J. Wise 197,082 6.72% 115 West Third Street Berwick, PA 18603 Berbank 295,929 10.09% First National Bank of Berwick Trust Department Robert E. Bull 206,433 7.04% 323 West Fourth Street Nescopeck, PA 18635 Frederick E. Crispin, Jr. 148,617 5.07% 3 Cedarbrook Terrace Princeton, NJ 08540
Beneficial Ownership by Officers, Directors and Nominees The following table sets forth as of March 10, 1998, the amount and percentage of the Common Stock beneficially owned by each director, each nominee and all officers, directors and nominees of the Corporation as a group. All shares are individually owned by the reporting person unless otherwise indicated.
Name of Individual Amount and Nature of Percent or Identity of Group Beneficial Ownership of Class Nominee for Class B Directors (to serve until 2001) And a Current Class B Director John Arndt 4,836 -- J. Gerald Bazewicz 10,848 -- Robert E. Bull 206,433 7.04% Class C Directors (to serve until 1999) John L. Coates 7,029 -- Dudley P. Cooley 3,993 -- Stanley E. Oberrender 4,791 -- Class A Directors (to serve until 2000) Budd L. Beyer 37,932 1.29% Frederick E. Crispin, Jr. 148,617 5.07% Robert J. Wise 197,082 6.72% All Officers, Directors and 624,753 21.29% Nominees as a Group (10 Persons in Total) Proxy Statement Page 3 The securities "beneficially owned" by an individual are determined in accordance with the definitions of "beneficial ownership" set forth in the General Rules and Regulations of the Securities and Exchange Commission and may include securities owned by or for the individual's spouse and minor children and any other relative who has the same home, as well as securities to which the individual has or shares voting or investment power or has the right to acquire beneficial ownership within 60 days after March 10, 1998. Beneficial ownership may be disclaimed as to certain of the securities. Does not include Common Stock held in fiduciary accounts under the control of the Bank's Trust Department. Information furnished by the directors and the Corporation. Includes 177,321 shares held individually by Mr. Wise and 19,761 shares held jointly with his spouse. Nominee registration for the Common Stock held by the Trust Department of the Bank on behalf of various trusts, estates and other accounts for which the Bank acts as fiduciary with sole voting and dispositive power over 248,421 shares and as fiduciary with shared voting and dispositive power over 47,508 shares. Total does not include 29,886 shares held by the Trust Department of the Bank for which the Bank does not have sole voting or dispositive power. The Trust Department intends to cast all shares under its voting power FOR the election of the nominees for director named below FOR the proposal to amend Article 5 of the Articles of Incorporation to increase the number of authorized shares of common stock, FOR the proposal to adopt the First Keystone Corporation 1998 Stock Incentive Plan ( the Plan ) and FOR the ratification of J. H. Williams & Co. as the independent auditors of the Corporation. Includes 145,857 shares held individually by Mr. Bull, 9,981 shares held by Bull, Bull & Knecht, a law firm of which Mr. Bull is a partner, and 50,595 shares held by the Sara Bull Trust. Less than one percent (1%) unless otherwise indicated. Includes 15,972 shares held individually by Mr. Crispin, 7,986 shares held individually by his spouse and 124,659 shares held by Frederick E. Crispin Trust in which Mr. Crispin is trustee. Includes 3,159 shares held individually by Mr. Arndt, 357 shares held individually by his spouse, and 1,320 shares held by Arndt Insurance Profit Sharing. Includes 7,329 shares held individually by Mr. Bazewicz, 2,055 shares held jointly with his spouse, 474 shares held individually by his spouse, 660 shares held jointly with his children and 330 shares held as Custodian for the benefit of his children. Includes 5,433 shares held individually by Mr. Coates and 1,596 shares held jointly with his spouse.
ELECTION OF DIRECTORS The By-laws of the Corporation provide that the Corporation's business shall be managed by its Board of Directors. Section 10.2 of the By-laws provides that the number of directors that shall constitute the whole Board of Directors shall not be less than seven nor more than twenty-five and that the Board of Directors shall be classified into three classes, each class to be elected for a term of three years. Within the foregoing limits, the Board of Directors may, from time to time, fix the number of directors and their respective classifications. No person shall serve as a director after he or she has attained the age of seventy (70) years, with the exception of Messrs. Beyer, Bull, Crispin, and Wise. Pursuant to Section 11.1 of the By-laws, vacancies on the Board of Directors, including vacancies resulting from an increase in the number of directors, shall be filled by the Page 4 Proxy Statement appointment of a replacement by a majority of the remaining members of the Board of Directors, though less than a quorum, and each person so appointed shall be a director until the expiration of the term of office of the class of directors to which he or she was appointed. In accordance with Section 10.3 of the By-laws, at the 1998 Annual Meeting of Shareholders, three (3) Class B Directors shall be elected to serve for a three-year term and until their successors are elected and qualified. Therefore, the By-laws provide for a classified Board of Directors with staggered three-year terms of office. Unless otherwise instructed, the Proxyholders will vote the Proxies received by them for the election of the three nominees named below. If any nominee should become unavailable for any reason, Proxies will be voted in favor of a substitute nominee as the Board of Directors of the Corporation shall determine. The Board of Directors has no reason to believe that the nominees named will be unable to serve, if elected. Any vacancy occurring on the Board of Directors of the Corporation for any reason may be filled by the appointment of a replacement by a majority of the directors then in office and the replacement shall serve until the expiration of the term of the vacancy. There is no cumulative voting for the election of directors. Each shareholder is entitled to one vote for each share of Common Stock outstanding on the record date. For example, if a shareholder owns ten shares of Common Stock, he or she may cast up to ten votes for each of the three directors in the class to be elected. INFORMATION AS TO NOMINEES, DIRECTORS AND EXECUTIVE OFFICERS The following table contains certain information with respect to the executive officers, nominees for Class B Director whose term expires in 2001 and the current Class B Directors whose term expires in 1998, and the Class C Directors and Class A Directors whose terms expire in 1999 and 2000, respectively:
Principal Occupation for Past Five Years Director Name and Age as of and Position Held Since Current March 10, with Corporation Corporation Committees 1998 and Bank /Bank NOMINEES FOR CLASS B DIRECTOR WHOSE TERM EXPIRES IN 2001 AND CURRENT CLASS B DIRECTORS WHOSE TERM EXPIRES IN 1998 John Arndt 36 Owner of Arndt 1995/1995 Committees 2,3,4,7,8 Insurance Agency (General insurance) J. Gerald Bazewicz 49 President of the Committees 1,2,3,4, Corporation 1986/1986 5,7,8 and the Bank Robert E. Bull 75 Attorney, Bull, 1983/1956 Committees 1,3,4,5, Bull & Knecht; 6,7,8 Chairman of the Corporation and the Bank Proxy Statement Page 5 CLASS C DIRECTORS WHOSE TERM EXPIRES IN 1999 John L. Coates 61 Owner, Tri-County 1987/1987 Committees 1,3,5,6 True Value Hardware and Tri-County True Value Lumber Secretary of the Corporation and the Bank Dudley P. Cooley 59 Personal Financial 1987/1987 Committees 3,6,7 Consultant; Former Controller, Wise Foods, Borden, Inc. (Snack food processor) Stanley E. Oberrender 56 Owner, Suntex 1987/1987 Committees 3,4,6,7,8 (Dry cleaning) CLASS A DIRECTORS WHOSE TERM EXPIRES IN 2000 Budd L. Beyer 70 Investor; Former 1983/1976 Committees 1,2,4,5,7 President, Sunshine Textiles Service, Inc. (Dry Cleaning, Laundry and Linen Rental) Frederick E. Crispin, Jr. 66 Financial Consultant, 1983/1964 Committees 1,3,4,5,6 F.E. Crispin & Associates Robert J. Wise 68 Retired, former investor 1983/1967 Committees 1,2,4,5,7,8 investor Vice Chairman of the Corporation and the Bank Committee 1 - Executive Committee This committee exercises the authority of the Board of Directors in the management of the business of the Bank between the dates of regular meetings of the Board of Directors. This committee did not meet in 1997. Committee 2 - Trust Committee This committee ensures that all trust activities of the Bank are performed in a manner that is consistent with the legal instrument governing the account, prudent trust administration practices, and approved trust policy. This committee met twelve (12) times in 1997. Committee 3 - Asset/Liability Committee This committee reviews asset/liability committee reports and provides support and discretion in managing the Bank's net interest income, liquidity, and gap positions. This committee met four (4) times in 1997. Committee 4 - Marketing Committee This committee provides guidance to management in formulating marketing and sales plans and programs and to assist in evaluating the performance of the Bank relative to plans. This committee met four (4) times in 1997. Committee 5 - Loan Administration Committee This committee monitors loan review and compliance activities. Also, the committee ensures that loans are made and administered in accordance with the Loan Policy. This committee met four (4) times in 1997. Page 6 Proxy Statement Committee 6 - Audit Committee This committee recommends the appointment of the independent certified public accountant to examine the affairs of the Bank. Also, the committee reviews findings of the auditor and ensures an independent, effective audit function. This committee met two (2) times in 1997. Committee 7 - Human Resources Committee This committee helps ensure that a sound human resources management system is developed and maintained. This committee also acts as the Compensation Committee for the Bank and related Corporation officers. This committee met one (1) time in 1997. Committee 8 - Building Committee This committee makes recommendations to the Board relating to the Bank's physical assets, including both current and proposed physical assets. This committee met two (2) times in 1997.
The aforementioned committees are committees of the Bank and not of the Corporation. During 1997, the Bank's Board of Directors held twenty-seven (27) meetings and the Corporation's Board of Directors held five (5) meetings. Each of the Directors attended at least 75% of the combined total number of meetings of the Corporation's and the Bank's Board of Directors and the committees of which he is a member. The Board of Directors of the Corporation has at present no standing committees. The Corporation does not have a nominating committee. A shareholder who desires to propose an individual for consideration by the Board of Directors as a nominee for director should submit a proposal in writing to the Secretary of the Corporation in accordance with Section 10.1 of the Corporation's By-laws. Any shareholder who intends to nominate any candidate for election to the Board of Directors must notify the Secretary of the Corporation in writing not less than forty-five (45) days prior to the date of any meeting of shareholders called for the election of directors. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Corporation's officers and directors, and persons who own more than ten percent (10%) of the registered class of the Corporation's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission ( SEC ). Officers, directors and greater than ten percent (10%) shareholders are required by SEC regulation to furnish the Corporation with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no Forms 5 were required for those persons, the Corporation believes that during the period January 1, 1997, through December 31, 1997, its officers and directors were in compliance with all filing requirements applicable to them. COMPENSATION COMMITTEE REPORT OF EXECUTIVE COMPENSATION The Corporation s Executive Compensation Policy is to provide executives of First Keystone Corporation's subsidiary, The First National Bank of Berwick, with a competitive compensation package that attracts and retains qualified executives while placing a portion of total pay at risk. The at risk portion is paid as a cash bonus and is earned through the achievement of overall annual earnings objectives. This helps align executive management's interest with those of shareholders since generally, the higher the net income for the year, the larger the bonuses paid to executive management. Proxy Statement Page 7 Compensation for executive officers of The First National Bank of Berwick is determined by the Board of Directors. With regard to the compensation paid to executive officers other than the Chief Executive Officer, the Board of Directors considers information provided by the Chief Executive Officer as to each executive officer's level of individual performance, contribution to the organization, and salary history. With regard to the compensation paid to the Chief Executive Officer, the Board of Directors, with Mr. Bazewicz not being present, considers his performance level, the results of management decisions made by him, and the earnings of the organization. No particular weight is assigned to any of the foregoing individual performance factors. The executive compensation established by the Board of Directors is based on its overall subjective assessment of the value of the services provided by each executive officer with consideration to the performance factors discussed in this paragraph and peer group compensation information. The peer group of banks chosen by the Board of Directors for purposes of making a comparative analysis of executive compensation does not include all of the same banks incorporated in the peer group established to compare shareholder returns as indicated in the Performance Graph included in this proxy statement. The Board of Directors uses data from compensation surveys of the banking industry to assist in determining executive pay. This group of Pennsylvania banking organizations bears no direct relationship to those banking organizations represented in the Performance Graph. The Board of Directors believes Plan to be voted on by shareholders will provide a long-term incentive program to further link compensation and performance of First Keystone Corporation employees. The Board of Directors believes that stock option awards provide a vehicle for long-term incentive compensation through financial rewards dependent on future increases in the market value of the Corporation's stock. Thus, executive officers are encouraged to manage the Corporation with a view toward maximizing long-term shareholder value. BOARD OF DIRECTORS Robert E. Bull, Chairman Budd L. Beyer Robert J. Wise, Vice Chairman Dudley P. Cooley J. Gerald Bazewicz, President Frederick E. Crispin, Jr. John L. Coates, Secretary Stanley E. Oberrender John E. Arndt EXECUTIVE COMPENSATION Shown below is information concerning the annual compensation for services rendered in all capacities to the Corporation and the Bank for the fiscal years ended December 31, 1997, 1996 and 1995 of those persons who were ( i ) the Chief Executive Officer during 1997, and (ii) the other four most highly compensated executive officers of the Corporation and the Bank to the extent such persons' total annual salary and bonus exceeded $100,000 at December 31, 1997. Page 8 Proxy Statement SUMMARY COMPENSATION TABLE
Annual Compensation (a) (b) (c) (d) (e) Other Annual Name and Compen- Principal Salary Bonus sation Position Year ($) ($) ($) J. Gerald Bazewicz 1997 126,800 27,972 0 President and Chief 1996 116,800 35,397 0 Executive Officer 1995 108,100 22,553 0 of the Corporation and the Bank Long-Term Compensation Awards Payouts (f) (g) (h) (i) Restricted All Other Name and Stock Options/ LTIP Compen- Principal Award(s) SARs Payouts sation Position ($) (#) ($) ($) J. Gerald Bazewicz 0 0 0 40,003 President and Chief 0 0 0 13,701 Executive Officer 0 0 0 17,274 of the Corporation and the Bank Amounts shown consist of base salary and fees for attendance at Board of Directors meetings of $9,800 in 1997, $9,800 in 1996, and $8,100 in 1995. Bonus information is reported by the year in which earned. Amounts shown include contributions to the Bank's 401(K) Plan of $15,872 for 1997, $13,701 for 1996, and $17,274 for 1995. The amount for 1997 includes the first year accrual to the Bank's Supplemental Employee Retirement Plan ( SERP ) of $22,803 and the premiums on term life insurance relative to the SERP of $1,328 in 1997. See Other Executive Benefits on next page.
Retirement Plan The Corporation does not have a retirement or pension plan. The Bank maintains a 401(K) Plan which has a combined tax qualified savings feature and profit sharing feature (the "Plan"). The Plan provides benefits to employees who have completed at least one year of service and are at least 21 years of age. The Plan agreement provides that the Bank will match employee deferrals to the Plan not to exceed 3% of their respective eligible compensations. Additionally, the Bank may make a discretionary contribution annually to the Plan, which when combined with the employee's deferral and Bank's matching contributions, cannot exceed 15% of total eligible compensation. Contributions made by the Bank to the Plan are allocated to participants in the same portions that each participant's compensation bears to the aggregate compensation of all participants. Each participant in the Plan is one hundred percent (100%) vested at all times. Benefits are payable under the Plan upon termination of employment, disability, death, or retirement. Contributions reflected as expense under this Plan in 1997 and 1996 were:
1996 1995 Matching contribution to savings plan $ 59,395 $ 52,892 Contribution to profit sharing plan 151,575 138,818 Total Expense $210,970 $191,710
Proxy Statement Page 9 Of the $210,970 total expenses during 1997, $41,633 was credited among the individual accounts of the most highly compensated executive officers of the Bank. Of the $41,633, Mr. Bazewicz was credited with $15,872 and has been a member of the Plan for twelve years. Other Executive Benefits A Supplemental Employee Retirement Plan ( SERP ) was approved and became effective January 7, 1997, covering three of the Bank's executive officers, Mr. Bazewicz, Mr. Saracino, and Mr. Bodle. The SERP, which is a salary continuation agreement, provides that if the executive officer continues to serve as an officer of the Bank until he attains sixty (60) years of age, the Bank will pay him 240 guaranteed consecutive monthly payments commencing on the first day of the month following the officer's 60th birthday in the amounts indicated below. The salary continuation agreement allows the executive officers to achieve a retirement income percentage that is more consistent with their experience and years of service to the Bank. The plan objective is to provide the executive officers with a final wage replacement ratio of 75% of projected final salary including projected benefits from the Bank 401K, social security, and salary continuation provided through the agreement. The retirement benefit under the salary continuation plan for Messrs. Bazewicz, Saracino, and Bodle will be $3,750 per month, $2,333 per month, and $1,750 per month, respectively. If the executive officer attains sixty (60) years of age, but dies before receiving all of the guaranteed monthly payments, then the Bank will make the remaining payments to the officer's beneficiary. In the event the officer dies while serving as an officer, prior to age sixty (60), then the Bank will remit the guaranteed monthly payment to the officer's beneficiary commencing the month following the Executive's death. In the event of a change of control and the termination of the officer's employment, the guaranteed monthly payments will commence the month following the Executive's termination of service. No benefit shall be paid if the executive officer voluntarily terminates his employment prior to the age of sixty (60). The Bank has obtained term life insurance (designating the Bank as the beneficiary) on the life of each participating executive officer in an amount which is intended to cover the Bank's obligation until the expense for the plan is fully accrued, based upon certain actuarial assumptions. In 1997, the Bank expensed $60,093 for the first year accrual of the salary continuation plan for the three executive officers. In addition, $5,474 was paid to cover the first year's premium on the term insurance policies. Compensation of Directors During 1997, the Corporation's Board of Directors received Three Hundred Fifty Dollars ($350.00) for each Director's attendance at the Annual Meeting. Other Corporate Board meetings met concurrently with the Bank's Board and there was no additional compensation paid to Directors. The Bank's Directors received Three Hundred Fifty Dollars ($350.00) for each Directors' meeting attended. Non-employee Directors received a Four Thousand Dollar ($4,000.00) retainer and One Hundred Seventy-Five Dollars ($175.00) for each committee meeting attended. All Directors received a bonus of One Thousand Dollars ($1,000.00). In addition, Chairman Bull received an annual stipend of One Thousand Dollars ($1,000.00) and Vice Chairman Wise and Secretary Coates each received an annual stipend of Seven Hundred Fifty Dollars ($750.00). In the aggregate, the Board of Directors received $158,375.00 for all Board of Directors' meetings and committee meetings attended in 1997, including all fees, bonuses, and stipends paid to all Directors in 1997. Page 10 Proxy Statement PERFORMANCE GRAPH The following graph and table compare the cumulative total shareholder return on the Corporation's Common Stock during the period December 31, 1992, through and including December 31, 1997, with (i) the cumulative total return on the SNL Securities Corporate Performance Index for banks with less than $500 million in total assets in the Middle Atlantic area , and (ii) the cumulative total return for all United States stocks traded on the NASDAQ Stock Market. The comparison assumes $100 was invested on December 31, 1992, in the Corporation's Common Stock and in each of the indices below and assumes further the reinvestment of dividends into the applicable securities. The shareholder return shown on the graph and table below is not necessarily indicative of future performance. (Performance Graph omitted) (The following is a description of the performance graph in tabular format) FIRST KEYSTONE CORPORATION Total Return Performance Period Ending 12/31/92 12/31/93 12/31/94 First Keystone Corporation 100.00 102.54 116.56 NASDAQ - Total US 100.00 114.80 112.21 SNL <$500M Bank Index 100.00 130.56 140.42 Period Ending 12/31/95 12/31/96 12/31/97 First Keystone Corporation 128.24 168.76 318.33 NASDAQ - Total US 158.70 195.19 239.53 SNL <$500M Bank Index 192.09 247.24 421.47 [FN] SNL Securities is a research and publishing firm specializing in the collection and dissemination of data on the banking, thrift and financial services industries. The Middle Atlantic area comprises the states of Delaware, Pennsylvania, Maryland, New Jersey, New York, the District of Columbia and Puerto Rico. Proxy Statement Page 11 CERTAIN TRANSACTIONS Other than described below, there have been no material transactions between the Corporation and the Bank, nor any material transactions proposed, with any director or executive officer of the Corporation and the Bank, or any associate of the foregoing persons. The Corporation and the Bank have engaged in and intend to continue to engage in banking and financial transactions in the ordinary course of business with directors and officers of the Corporation and the Bank and their associates on comparable terms and with similar interest rates as those prevailing from time to time for other customers of the Corporation and the Bank. Total loans outstanding from the Corporation and the Bank at December 31, 1997, to the Corporation's and the Bank's officers and directors as a group and members of their immediate families and companies in which they had an ownership interest of 10% or more was $2,080,963 or approximately 6.54% of the total equity capital of the Bank. Loans to such persons were made in the ordinary course of business, were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal risk of collectibility or present other unfavorable features. All loans are current and being paid as agreed. The largest aggregate amount of indebtedness outstanding at any time during fiscal year 1997 to officers and directors of the Corporation and the Bank as a group was $2,244,288. The aggregate amount of indebtedness outstanding as of the latest practicable date, February 2, 1998, to the above described group was $2,025,362. PRINCIPAL OFFICERS OF THE CORPORATION The following table sets forth selected information about the principal officers of the Corporation, each of whom is elected by the Board of Directors and each of whom holds office at the discretion of the Board of Directors:
Age Number as of Corporation of Shares March Held Employee Beneficially 10, Name and Position Since Since Owned 1998 Robert E. Bull 1983 206,433 75 Chairman of the Board Robert J. Wise 1996 197,082 68 Vice Chairman of the Board J. Gerald Bazewicz 1987 1973 10,848 49 President John L. Coates 1995 7,029 61 Secretary David R. Saracino 1983 1972 3,192 53 Treasurer Messrs. Bull, Wise, and Coates are not employees of the Corporation. Includes 2,394 shares of Common Stock held individually by Mr. Saracino and 798 shares of Common Stock held jointly with his spouse.
Page 12 Proxy Statement PRINCIPAL OFFICERS OF THE BANK The following table sets forth selected information about the principal officers of the Bank, each of whom is elected by the Board of Directors and each of whom holds office at the discretion of the Board of Directors:
Office and Position Held Name with the Bank Since Robert E. Bull Chairman of the Board 1983 Robert J. Wise Vice Chairman 1996 of the Board J. Gerald Bazewicz President and CEO 1987 John L. Coates Secretary 1995 David R. Saracino Vice President, 1983 Cashier and Assistant Secretary Leslie W. Bodle Vice President and 1985 Trust Officer Sally A. Rishkofski Assistant Vice President 1997 Bank Number of Age as of Employee Shares Bene- March 10, Name Since ficially Owned 1998 Robert E. Bull 206,433 75 Robert J. Wise 197,082 68 J. Gerald Bazewicz 1973 10,848 49 John L. Coates 7,029 61 David R. Saracino 1972 3,192 53 Leslie W. Bodle 1985 3,495 50 Sally A. Rishkofski 1964 435 58 Messrs. Bull, Wise, and Coates are not employees of the Bank. <2> Includes 1,242 shares of Common Stock held individually by Mr. Bodle, 1,113 shares of Common Stock held jointly with his spouse, and 1,140 shares of Common Stock held jointly with his daughter.
PROPOSAL TO APPROVE AND ADOPT AN AMENDMENT TO ARTICLE 5 OF THE ARTICLES OF INCORPORATION OF THE CORPORATION, AS AMENDED TO INCREASE THE NUMBER OF AUTHORIZED SHARES OF THE CORPORATION The Articles of Incorporation of the Corporation, as amended, currently authorize three million (3,000,000) shares of Common Stock, par value $2.00 per share. As of March 10, 1998, there were 2,933,727 shares of Common Stock issued and outstanding. The Corporation thus has only a limited number of authorized but unissued shares of Common Stock available for issuance from time to time as may be necessary in connection with future financings , investment opportunities, acquisitions of other companies, the declaration of stock dividends, stock splits or other distributions, or for other corporate purposes. Accordingly, on January 27, 1998, the Board of Directors of the Corporation approved and adopted resolutions to amend Article 5 of the Corporation's amended Articles of Incorporation to increase the number of authorized shares of Common Stock from 3,000,000 shares to 10,000,000 shares. The increase in the number of authorized shares of Common Stock requires that the shareholders approve and adopt the proposed Proxy Statement Page 13 amendment to the Corporation s amended Articles of Incorporation. A true and correct copy of the proposed amendment to Article 5 of the Corporation's amended Articles of Incorporation and the resolutions approved and adopted by the Board of Directors and as proposed to the shareholders are set forth below: RESOLUTION OF BOARD OF DIRECTORS FIRST KEYSTONE CORPORATION WHEREAS, the Board of Directors desires and finds that it is in the best interests of the Corporation and its shareholders to increase the number of authorized shares of the Corporation's Common Stock, par value $2.00 per share, from 3,000,000 shares to 10,000,000, in order to provide the Corporation with as much flexibility as possible to issue additional shares of Common Stock for proper corporate purposes, including financing, acquisitions, stock splits, stock dividends, employee incentive plans, and other similar purposes; and NOW, THEREFORE, BE IT RESOLVED, that in accordance with Sections 1911, 1912, 1914, 1915 and 1916 of the Business Corporation Law of 1988, as amended, the Board of Directors hereby approves and adopts the following proposed amendment to the Corporation's Articles of Incorporation, as amended, and hereby directs that the following proposed amendment to the Articles of Incorporation, as amended, of this Corporation be submitted to the shareholders of the Corporation for their approval and adoption at the 1998 Annual Meeting of Shareholders of the Corporation to be held on April 21, 1998, at 9:00 a.m., prevailing time, at 111 West Front Street, Berwick, Pennsylvania 18603 to wit: Article 5 of the Articles of Incorporation, as amended, of First Keystone Corporation is amended and restated to read in full and in its entirety as follows: The aggregate number of shares which the Corporation shall have authority to issue is 10,000,000 shares of Common Stock of the par value $2.00 per share (the "Common Stock"). BE IT FURTHER RESOLVED, that the Board of Directors establishes and fixes Tuesday, March 10, 1998, at the close of business as the record date and time to determine those shareholders entitled to notice of and to vote at the 1998 Annual Meeting of Shareholders to be held on Tuesday, April 21, 1998; RESOLVED, that the Board of Directors directs and orders that the President and Secretary, or a Vice President and an Assistant Secretary, of the Corporation shall cause to be prepared proxy solicitation materials for the 1998 Annual Meeting of Shareholders to solicit proxies for approval and adoption of the aforesaid amendment by the shareholders of the Corporation and further directs and orders that said proxy solicitation materials be mailed to the shareholders of record, on March 30, 1998, or as soon as practicable thereafter; and BE IT FURTHER RESOLVED, that after approval and adoption of the aforesaid amendment of the Articles of Incorporation of the Corporation by the shareholders of the Corporation at the 1998 Annual Meeting of Shareholders, the President and Secretary, or a Vice President and an Assistant Secretary, of the Corporation are hereby authorized, empowered and directed to execute and file Articles of Amendment containing and amendment with the Commonwealth of Pennsylvania, Department of State, Corporation Bureau, and upon such filing said amendment shall be effective. Except as described in this section of the Proxy Statement, the Corporation has no present plans, understandings or arrangements for issuing the additional shares of Common Stock to be authorized by the proposed amendment. The Board of Directors believes that it is advisable to have authorization for such additional shares of Common Stock in order to enable the Corporation, as the need may arise, to take prompt advantage of market conditions and the availability of favorable opportunities for the acquisition of other companies without the delay and expense incident to the holding of a special meeting of stockholders of the Corporation. The future issuance by the Corporation of shares of Common Stock may dilute the present equity ownership position of current holders of the Common Stock. The proposed amendment is not intended to have Page 14 Proxy Statement an anti-takeover effect. The issuance, however, of any of the shares proposed to be authorized as well as currently authorized but unissued shares, may potentially have an anti-takeover effect by making it more difficult to obtain shareholder approval of actions such as certain business combinations or removal of management. The proposed amendment, if adopted by the shareholders, would increase the number of authorized but unissued shares of Common Stock of the Corporation from 3,000,000 shares, par value $2.00 per share, to 10,000,000 shares, par value $2.00 per share. The unissued shares of Common Stock will he available for issuance at the discretion of the Board of Directors from time to time for any proper corporate purposes generally without further action of the shareholders upon the affirmative vote of a majority of the members of the Board of Directors. If the proposed amendment is adopted by the shareholders, the Board of Directors is not likely to solicit shareholder approval to issue the additional authorized shares, except to the extent that such approval may be required by law, regulation or any agreement governing the trading of the Corporation's stock. As a result, the Board of Directors proposes that Article 5 of the Corporation's amended Articles of Incorporation be amended and restated to read in full and in its entirety as set forth above and that the shareholders approve and adopt the following resolution: RESOLVED, that the proposed amendment to Article S of the amended Articles of Incorporation of the Corporation, as set forth in its entirely above, be and hereby is, approved, adopted, ratified and confirmed. The affirmative vote of at least a majority of the issued and outstanding shares of Common Stock of the Corporation entitled to vote at the Annual Meeting is required to approve and adopt this amendment to Article 5 of the Articles of Incorporation of the Corporation, as amended. THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE FOR THE PROPOSAL TO AMEND THE CORPORATION'S ARTICLES OF INCORPORATION TO INCREASE THE NUMBER OF AUTHORIZED SHARES OF COMMON STOCK FROM THREE MILLION SHARES, PAR VALUE $2.00 PER SHARE, TO TEN MILLION SHARES, PAR VALUE $2.00 PER SHARE. PROPOSAL TO APPROVE AND ADOPT THE FIRST KEYSTONE CORPORATION 1998 STOCK INCENTIVE PLAN On February 10, 1998, the Board of Directors adopted the First Keystone 1998 Stock Incentive Plan (the "Plan") and reserved 100,000 shares of Common Stock for issuance under the Plan. The purpose of the Plan is to advance the development, growth and financial condition of the Corporation and its subsidiaries by providing incentives through participation in the appreciation of capital stock of the Corporation in order to secure, retain and motivate personnel responsible for the operation and management of the Corporation and its subsidiaries. The Plan is designed to attract and retain individuals of outstanding ability as employees of the Corporation and its subsidiaries, to encourage employees to acquire a proprietary interest in the Corporation, to continue their employment with the Corporation and its subsidiaries and to render superior performance during such employment. The Plan became effective as of the date it was adopted by the Corporation's Board of Directors, subject to the approval of the shareholders of the Corporation. Any and all options and rights awarded under the Plan before its approval by the shareholders are conditioned upon and may not be exercised before receipt of shareholder approval. If the shareholders approve the Plan, the Plan will continue in effect until all awards under the Plan either have lapsed, been exercised, satisfied or canceled according to the terms under the Plan. The shares of stock that may be issued under the Plan shall not exceed, in the aggregate, 100,000 shares of Common Stock as may be adjusted from time to time due to stock splits, payments of stock dividends, or other changes in the structure of the Corporation's capital. Proxy Statement Page 15 The Plan will be administered by a committee consisting of two or more directors (the Committee"). Persons eligible to receive awards under the Plan are those key officers and other management employees of the Corporation and its subsidiaries as determined by the Committee. Awards Awards made under the Plan may be in the form of: (i) options to purchase stock intended to qualify as incentive stock options under Sections 421 and 422 of the Code (referred to herein as "Qualified Options") and (ii) options which do not so qualify (referred to herein as "Non-Qualified Options"). Generally, awards may be exercised in whole or in part. Funds received by the Corporation from the exercise of any award shall be used for its general corporate purposes. The Committee may permit an acceleration of previously established exercise terms of any award as, when, under such facts and circumstances, and subject to such other or further requirements and conditions as the Committee may deem necessary or appropriate, including, but not limited to upon a change of control of the Corporation (as defined in the Plan). Qualified Options Qualified Options may not be awarded under the Plan more than ten (10) years after the earlier of the date the Plan is adopted by the Board of Directors or the date on which the Plan is approved by the shareholders are only exercisable upon the expiration of six months after the date of the award and may not continue beyond the expiration often (10) years beyond the date of the award. The purchase price of the stock subject to any Qualified Option, as determined by the Committee, may not be less than the stock's fair market value (as defined in the Plan) at the time the option is awarded or less than its par value. If the recipient of a Qualified Option ceases to be employed by the Corporation, or subsidiary thereof, the Committee may permit the recipient to exercise such option during its remaining term for a period of not more than three (3) months. This period may be extended to a 12 month period if such employment cessation was due to the recipient's disability, as defined in the Plan. If the recipient ceases to be employed by the Corporation, or subsidiary thereof, due to his or her death, the committee may permit the recipient's qualified personal representatives, or any persons who acquire the options pursuant to his or her will or the laws of descent and distribution, to exercise such option during its remaining term for a period not to exceed 12 months after the recipient's death to the extent that the option was then and remains exercisable. Qualified Options are not transferrable except by will or by the laws of descent and distribution. Non-Qualified Options Similar to Qualified Options, Non-Qualified Options are only exercisable upon the expiration of six (6) months after the date of the award and shall not continue beyond the expiration of ten (10) years beyond the date of the award. If a recipient of a Non-Qualified Option ceases to be eligible under the Plan before the option lapses or before it is fully exercised, the Committee may permit the recipient to exercise the option during its remaining term, to the extent that the option was then and remains exercisable, for such time period and under such terms and conditions as may be prescribed by the Committee. The purchase price of a share of stock pursuant to a Non- Qualified Option, as determined by the Committee, shall not be less than the stock's par value (as defined in the Plan) at the time such option is awarded. Except as otherwise provided by the Committee, Non- Qualified Stock Options are not transferable except as designated by the participant by will and the laws of descent and distribution. Federal Tax Consequences An employee who receives Qualified Options will not recognize taxable income on the grant or the exercise of the option. If the stock acquired by the exercise of a Qualified Option is held until the later of: (i) two (2) years from the date of the grant; and (ii) one (1) year from the date of exercise, any gain (or loss) recognized on the sale or exchange of the stock will he treated as long-term capital gain (or loss), and the Page 16 Proxy Statement Corporation will not be entitled to any income tax deduction. If stock acquired on exercise of a Qualified Option is sold or exchanged before the expiration of the required holding period, the employee will recognize ordinary income in the year of disposition in an amount equal to the difference between the option price and the lesser of the fair market value of the stock on the date of exercise, or the setting price. In the event of a disqualifying disposition, the Corporation will be entitled to an income tax deduction in the year of such disposition in an amount equal to the amount of ordinary income recognized by the employee. An employee who receives a Non-Qualified Option will not recognize taxable income on the grant of the option, however, upon exercise, he or she will recognize ordinary income in an amount equal to the excess of the fair market value of the stock on the date that the option is exercised over the purchase price paid for the stock. The Corporation will be entitled to an income tax deduction in the year of exercise in an amount equal the amount of income recognized by the employee. The foregoing tax discussion is intended as a summary only, and the federal income tax consequences to any person who participates in the Plan and to the Corporation may vary from those described above depending upon individual actions and circumstances. As of February 10, 1998, four (4) executive officers were eligible to participate in the Plan. The size and type of awards are generally to be determined by the Committee in its discretion. Such future grants are not presently determinable, and it is not possible to predict the benefits or amounts that will be received by or allocated to particular individuals or groups for 1998. The following table sets forth the benefits that would have been granted under the Plan had it been in effect during 1997. The table assumes that the grants would have been made on December 31, 1997. On that date, the approximate fair market value of the Corporation's Common Stock was $55,985,290. Currently, the Corporation has definitive plans to issue any benefits under the Plan.
New Plan Benefits Name and Position Dollar Value ($) Number of Units J. Gerald Bazewicz, CEO 114,500 2,000 Executive Group 171,750 3,000 Non-Executive Director Group 0 0 Non-Executive Officer 114,500 2,000 Employee Group 11,450 200
The foregoing discussion of the Plan consists of only a summary and is qualified in its entirety by reference to the full text of the Plan attached as Exhibit "A" to this Proxy Statement. Exhibit "A" is deemed to be an integral part of this Proxy Statement and incorporated in its entirety by reference. The Board of Directors recommends a vote FOR the following resolution which will be presented at the Annual Meeting: RESOLVED, that the First Keystone Corporation 1998 Stock Incentive Plan, the text of which is set forth in full and in its entirety in the Proxy Statement for the 1998 Annual Meeting of Shareholders as Exhibit "A" is hereby approved, adopted, ratified and confirmed by the shareholders of the Corporation. The approval and adoption of the Plan requires the affirmative vote of a majority of all votes cast by all shareholders entitled to vote thereon. Proxies solicited by the Board of Directors will be voted for the foregoing resolution unless shareholders specify to the contrary on their proxies. THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE RESOLUTION APPROVING AND ADOPTING THE FIRST KEYSTONE CORPORATION 1998 STOCK INCENTIVE PLAN. Proxy Statement Page 17 RATIFICATION OF INDEPENDENT AUDITORS Unless instructed to the contrary, it is intended that votes will be cast pursuant to the proxies for the ratification of the selection of J. H. Williams & Co. as the Corporation's independent auditors for its 1998 fiscal year. The Corporation has been advised by J. H. Williams & Co. that none of its members has any financial interest in the Corporation. Ratification of J. H. Williams & Co. will require the affirmative vote of a majority of the shares of Common Stock represented in person or by proxy at the Annual Meeting. J. H. Williams & Co. served as the Corporation's independent auditors for the 1997 fiscal year, assisted the Corporation and the Bank with preparation of their federal and state tax returns, and provided assistance in connection with regulatory matters, charging the Bank for such services at its customary hourly billing rates. These non- audit services were approved by the Corporation's and the Bank's Board of Directors after due consideration of the effect of the performance thereof on the independence of the auditors and after the conclusion by the Corporation's and the Bank's Board of Directors that there was no effect on the independence of the auditors. In the event that the shareholders do not ratify the selection of J. H. Williams & Co. as the Corporation's independent auditors for the 1998 fiscal year, another accounting firm may be chosen to provide independent audit services for the 1998 fiscal year. The Board of Directors recommends that the shareholders vote FOR the ratification of the selection of J. H. Williams & Co. as the independent auditors for the Corporation for the year ending December 31, 1998. ANNUAL REPORT A copy of the Corporation's Annual Report for its fiscal year ended December 31, 1997 is enclosed with this Proxy Statement. A representative of J. H. Williams & Co., the accounting firm which examined the financial statements in the Annual Report, will attend the meeting. The representative will have the opportunity to make a statement, if he desires to do so, and will be available to respond to any appropriate questions concerning the Annual Report presented by shareholders at the Annual Meeting. SHAREHOLDER PROPOSALS Any shareholder who, in accordance with and subject to the provisions of the proxy rules of the Securities and Exchange Commission, wishes to submit a proposal for inclusion in the Corporation's Proxy Statement for its 1999 Annual Meeting of Shareholders must deliver such proposal in writing to the President of First Keystone Corporation at its principal executive offices, 111 West Front Street, Berwick, Pennsylvania, 18603, not later than Monday, November 23, 1998. OTHER MATTERS The Board of Directors does not know of any matters to be presented for consideration other than the matters described in the accompanying Notice of Annual Meeting of Shareholders, but if any matters are properly presented, it is the intention of the persons named in the accompanying Proxy to vote on such matters in accordance with their best judgment. Page 18 Proxy Statement ADDITIONAL INFORMATION UPON WRITTEN REQUEST OF ANY SHAREHOLDER, A COPY OF THE CORPORATION'S REPORT ON FORM 10-K FOR ITS FISCAL YEAR ENDED DECEMBER 31, 1997, INCLUDING THE FINANCIAL STATEMENTS AND THE SCHEDULES THERETO, REQUIRED TO BE FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 13a-1 UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, MAY BE OBTAINED, WITHOUT CHARGE, FROM DAVID R. SARACINO, TREASURER, FIRST KEYSTONE CORPORATION, 111 WEST FRONT STREET, BERWICK, PENNSYLVANIA 18603. Proxy Statement Page 19 EXHIBIT A FIRST KEYSTONE CORPORATION 1998 STOCK INCENTIVE PLAN 1. Purpose. The purpose of this Stock Incentive Plan (the "Plan") is to advance the development, growth and financial condition of First Keystone Corporation (the "Corporation") and each subsidiary thereof, as defined in Section 424 of the Internal Revenue Code of 1986, as amended (the "Code"), by providing incentives through participation in the appreciation of the common stock of the Corporation to secure, retain and motivate personnel who may be responsible for the operation and for management of the affairs of the Corporation and any subsidiary now or hereafter existing ("Subsidiary"). 2. Term. The Plan shall become effective as of the date it is adopted by the Corporation's Board of Directors (the "Board"), and shall be presented for approval at the next meeting of the Corporation's shareholders. Any and all options and rights awarded under the Plan (the "Awards") before it is approved by the Corporation's shareholders shall be conditioned upon and may not be exercised before receipt of shareholder approval, and shall lapse upon failure to receive such approval. If the Plan is approved, it shall continue in effect until all Awards either have lapsed or been exercised, satisfied or canceled according to their terms under the Plan. 3. Stock. Shares of the Corporation s common stock, par value $2.00 per share (the "Stock"), that may be issued under the Plan shall not exceed, in the aggregate, 100,000 shares, as may be adjusted pursuant to paragraph 16 hereof. Shares may be either authorized and unissued shares, or authorized shares, issued by and subsequently reacquired by the Corporation as treasury stock. Under no circumstances shall any fractional shares be awarded under the Plan. Except as may be otherwise provided in the Plan, any Stock subject to an Award that, for any reason, lapses or terminates prior to exercise, shall again become available for grant under the Plan. While the Plan is in effect, the Corporation shall reserve and keep available the number of shares of Stock needed to satisfy the requirements of the Plan. The Corporation shall apply for any requisite governmental authority to issue shares under the Plan. The Corporation's failure to obtain any such governmental authority, deemed necessary by the Corporation's legal counsel for the lawful issuance and sale of Stock under the Plan, shall relieve the Corporation of any duty, or liability for the failure to issue or sell the Stock. 4. Administration. The ability to control and manage the operation and administration of the Plan shall be vested in the Board or in a committee of two or more members of the Board, selected by the Board (the Committee ). The Committee shall have the authority and discretion to interpret the Plan, to establish, amend and rescind any rules and regulations relating to the Plan, to determine the terms and provisions of any agreements made pursuant to the Plan, and to make any and all determinations that may be necessary or advisable for the administration of the Plan. Any interpretation of the Plan by the Committee and any decision made by the Committee under the Plan is final and binding. The Committee shall be responsible and shall have full, absolute and final power of authority to determine what, to whom, when and under what facts and circumstances Awards shall be made, and the form, number, terms, conditions and duration thereof, including but not limited to when exercisable, the number of shares of Stock subject thereto, and the stock option exercise prices. The Committee shall make all other determinations and decisions, take all actions and do all things necessary or appropriate in and for the administration of the Plan. No member of the Committee or of the Board shall be liable for any decision, determination or action made or taken in good faith by such person under or with respect to the Plan or its administration. Page 20 Proxy Statement 5. Awards. Awards may be made under the Plan in the form of: (a) "Qualified Options" to purchase Stock, which are intended to qualify for certain tax treatment as incentive stock options under Sections 421 and 422 of the Code, or (b) "Non-Qualified Options" to purchase Stock, which are not intended to qualify under Sections 421 through 424 of the Code. More than one Award may be granted to an eligible person, and the grant of any Award shall not prohibit the grant another Award, either to the same person or otherwise, or impose any obligation to exercise on the participant. All Awards and the terms and conditions thereof shall be set forth in written agreements, in such form and content as approved by the Committee from time to time, and shall be subject to the provisions of the Plan whether or not contained in such agreements. Multiple Awards for a particular person may be set forth in a single written agreement or in multiple agreements, as determined by the Committee, but in all cases each agreement for one or more Awards shall identify each of the Awards thereby represented as a Qualified Option or Non- Qualified Option, as the case may be. 6. Eligibility. Persons eligible to receive Awards shall be those key officers and other employees of the Corporation and each Subsidiary, as determined by the Committee. A person's eligibility to receive an Award shall not confer upon him or her any right to receive an Award. Except as otherwise provided, a person's eligibility to receive, or actual receipt of an Award under the Plan shall not limit or affect his or her benefits under or eligibility to participate in any other incentive or benefit plan or program of the Corporation or of its affiliates. 7. Qualified Options. In addition to other applicable provisions of the Plan, all Qualified Options and Awards thereof shall be under and subject to the following terms and conditions: (a) No Qualified Option shall be awarded more than ten (10) years after the date the Plan is adopted by the Board or the date the Plan is approved by the Corporation's shareholders, whichever is earlier; (b) The time period during which any Qualified Option is exercisable, as determined by the Committee, shall not commence before the expiration of six (6) months or continue beyond the expiration of ten (10) years after the date the Qualified Option is awarded; (c) If a participant, who was awarded a Qualified Option, ceases to be employed by the Corporation or any Subsidiary for any reason other than his or her death, the Committee may permit the participant thereafter to exercise the option during its remaining term for a period of not more than three (3) months after cessation of employment to the extent that the Qualified Option was then and remains exercisable, unless such employment cessation was due to the participant's disability, as defined in Section 22(e)(3) of the Code, in which case the three (3) month period shall be twelve (12) months; if the participant dies while employed by the Corporation or a Subsidiary, the Committee may permit the participant's qualified personal representatives, or any persons who acquire the Qualified Option pursuant to his or her Will or laws of descent and distribution, to exercise the Qualified Option during its remaining term for a period of not more than twelve (12) months after the participant's death to the extent that the Qualified Option was then and remains exercisable; the Committee may impose terms and conditions upon and for the exercise of a Qualified Option after the cessation of the participant's employment or his or her death; (d) The purchase price of Stock subject to any Qualified Option shall not be less than the Stock's fair market value at the time the Qualified Option is awarded or less than the Stock's par value; and (e) Qualified Options may not be sold, transferred or assigned by the participant except by will or the laws of descent and distribution. Proxy Statement Page 21 8. Non-Qualified Options. In addition to other applicable provisions of the Plan, all Non-Qualified Options and Awards thereof shall be under and subject to the following terms and conditions: (a) The time period during which any Non-Qualified Option is exercisable shall not commence before the expiration of six (6) months or continue beyond the expiration of ten (10) years after the date the Non-Qualified Option is awarded; (b) If a participant, who was awarded a Non-Qualified Option, ceases to be eligible under the Plan, before lapse or full exercise of the option, the Committee may permit the participant to exercise the option during its remaining term, to the extent that the option was then and remains exercisable, or for such time period and under such terms and conditions as may be prescribed by the Committee; (c) The purchase price of a share of Stock subject to any Non- Qualified Option shall not be less than the Stock's par value; and (d) Except as otherwise provided by the Committee, Non- Qualified Stock Options granted under the Plan are not transferable except as designated by the participant by Will and the laws of descent and distribution. 9. Exercise. Except as otherwise provided in the Plan, Awards may be exercised in whole or in part by giving written notice thereof to the Secretary of the Corporation, or his or her designee, identifying the Award to be exercised, the number of shares of Stock with respect thereto, and other information pertinent to exercise of the Award. The purchase price of the shares of Stock with respect to which an Award is exercised shall be paid with the written notice of exercise, either in cash or in Stock at its then current fair market value, or it any combination thereof, as the Committee shall determine. Funds received by the Corporation from the exercise of any Award shall be used for its general corporate purposes. The Committee may permit an acceleration of previously established exercise terms of any Awards as, when, under such facts and circumstances, and subject to such other or further requirements and conditions as the Committee may deem necessary or appropriate. In addition: (a) if the Corporation or its shareholders execute an agreement to dispose of all or substantially all of the Corporation's assets or stock by means of sale, merger, consolidation, reorganization, liquidation or otherwise, as a result of which the Corporation's shareholders, immediately before the transaction, will not own at least fifty percent (50%) of the total combined voting power of all classes of voting stock of the surviving entity (be it the Corporation or otherwise) immediately after the consummation of the transaction, then any and all outstanding Awards shall immediately become and remain exercisable or, if the transaction is not consummated, until the agreement relating to the transaction expires or is terminated, in which case, all Awards shall be treated as if the agreement was never executed; (b) if there is an actual, attempted or threatened change in the ownership of at least twenty-five percent (25%) of all classes of voting stock of the Corporation through the acquisition of, or an offer to acquire such percentage of the Corporation's voting stock by any person or entity, or persons or entities acting in concert or as a group, and the acquisition or offer has not been duly approved by the Board; or Page 22 Proxy Statement (c) if during any period of two (2) consecutive years, the individuals who at the beginning of such period constituted the Board cease, for any reason, to constitute at least a majority of the Board, (unless the election of each director of the Board, who was not a director of the Board at the beginning of such period, was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of such period) thereupon any and all Awards immediately shall become and remain exercisable. 10. Withholding. When a participant exercises a stock option awarded under the Plan, the Corporation, in its discretion and as required by law, may require the participant to remit to the Corporation an amount sufficient to satisfy fully any federal, state and other jurisdictions' income and other tax withholding requirements prior to the delivery of any certificates for shares of Stock. 11. Value. Where used in the Plan, the "fair market value" of Stock or any options or rights with respect thereto, including Awards, shall mean and be determined by (a) the average of the highest and lowest reported sales prices thereof on the principal established domestic securities exchange on which listed, and if not listed, then (b) the average of the dealer "bid" and "ask" prices thereof on the New York over-the-counter market, as reported by the National Association of Securities Dealers, Inc., in either case as of the specified or otherwise required or relevant time, or if not traded as of such specified, required or relevant time, then based upon such reported sales or "bid" and "ask" prices before and/or after such time in accordance with pertinent provisions of and principles under the Code and the regulations promulgated thereunder. 12. Amendment. To the extent permitted by applicable law, the Board may amend, suspend, or terminate the Plan at any time. The amendment or termination of this Plan shall not, without the consent of the participants, alter or impair any rights or obligations under any Award previously granted hereunder. From time to time, the Committee may rescind, revise and add to any of the terms, conditions and provisions of the Plan or of an Award as necessary or appropriate to have the Plan and any Awards be or remain qualified and in compliance with all applicable laws, rules and regulations, and the Committee may delete, omit or waive any of the terms conditions or provisions that are no longer required by reason of changes of applicable laws, rules or regulations, but not limited to, the provisions of Sections 421 and 422 of the Code, Section 16 of the Securities Exchange Act of 1934, as amended, (the 1934 Act ) and Rule 16b-3 promulgated by the Securities and Exchange Commission. Without limiting the generality of the preceding sentence, each Qualified Option shall be subject to such other and additional terms, conditions and provisions as the Committee may deem necessary or appropriate in order to qualify as a Qualified Option under Section 422 of the Code, including, but not limited to, the following provisions: (a) At the time a Qualified Option is awarded, the aggregate fair market value of the Stock subject thereto and of any Stock or other capital stock with respect to which incentive stock options qualifying under Sections 421 and 422 of the Code are exercisable for the first time by the participant during any calendar year under the Plan and any other plans of the Corporation or its affiliates, shall not exceed $100,000.00; and (b) No Qualified Option, shall be awarded to any person if, at the time of the Award, the person owns shares of the stock of the Corporation possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Corporation or its affiliates, unless, at the time the Qualified Option is awarded, the exercise price of the Qualified Option is at least one hundred and ten percent (110%) of the fair market value of the Stock on the date of grant and the option, by its terms, is not exercisable after the expiration of five (5) years from the date it is awarded. Proxy Statement Page 23 13. Continued Employment. Nothing in the Plan or any Award shall confer upon any participant or other persons any right to continue in the employ of, or maintain any particular relationship with, the Corporation or its affiliates, or limit or affect any rights, powers or privileges that the Corporation or its affiliates may have to supervise, discipline and terminate the participant. However, the Committee may require, as a condition of making and/or exercising any Award, that a participant agree to, and in fact provide services, either as an employee or in another capacity, to or for the Corporation or any Subsidiary for such time period as the Committee may prescribe. The immediately preceding sentence shall not apply to any Qualified Option, to the extent such application would result in disqualification of the option under Sections 421 and 422 of the Code. 14. General Restrictions. If the Committee or Board determines that it is necessary or desirable to: (a) list, register or qualify the Stock subject to the Award, or the Award itself, upon any securities exchange or under any federal or state securities or other laws, (b) obtain the approval of any governmental authority, or (c) enter into an agreement with the participant with respect to disposition of any Stock (including, without limitation, an agreement that, at the time of the participant's exercise of the Award, any Stock thereby acquired is and will be acquired solely for investment purposes and without any intention to sell or distribute the Stock), then such Award shall not be consummated in whole or in part unless the listing, registration, qualification, approval or agreement, as the case may be, shall have been appropriately effected or obtained to the satisfaction of the Committee and legal counsel for the Corporation. 15. Rights. Except as otherwise provided in the Plan, participants shall have no rights as a holder of the Stock unless and until one or more certificates for the shares of Stock are issued and delivered to the participant. 16. Adjustments. In the event that the shares of common stock of the Corporation, as presently constituted, shall be changed into or exchanged for a different number or kind of shares of common stock or other securities of the Corporation or of other securities of the Corporation or of another corporation (whether by reason of merger, consolidation, recapitalization, reclassification, split-up, combination of shares or otherwise) or if the number of such shares of common stock shall be increased through the payment of a stock dividend, stock split or similar transaction, then, there shall be substituted for or added to each share of common stock of the Corporation that was theretofore appropriated, or which thereafter may become subject to an option under the Plan, the number and kind of shares of common stock or other securities into which each outstanding share of the common stock of the Corporation shall be so changed or for which each such share shall be exchanged or to which each such shares shall be entitled, as the case may be. Each outstanding Award shall be appropriately amended as to price and other terms, as may be necessary to reflect the foregoing events. If there shall be any other change in the number or kind of the outstanding shares of the common stock of the Corporation, or of any common stock or other securities in which such common stock shall have been changed, or for which it shall have been exchanged, and if a majority of the disinterested members of the Committee shall, in its sole discretion, determine that such change equitably requires an adjustment in any Award that was theretofore granted or that may thereafter be granted under the Plan, then such adjustment shall be made in accordance with such determination. The grant of an Award under the Plan shall not affect in any way the right or power of the Corporation to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge, to consolidate, to dissolve, to liquidate or to sell or transfer all or any part of its business or assets. Fractional shares resulting from any adjustment in Awards pursuant to this paragraph 16 may be settled as a majority of the disinterested members of the Board of Directors or of the Committee, as the case may be, shall determine. Page 24 Proxy Statement To the extent that the foregoing adjustments relate to common stock or securities of the Corporation, such adjustments shall be made by a majority of the members of the Board, whose determination in that respect shall be final, binding and conclusive. Notice of any adjustment shall be given by the Corporation to each holder of an Award that is so adjusted. 17. Forfeiture. Notwithstanding anything to the contrary in this Plan, if the Committee finds, after full consideration of the facts presented on behalf of the Corporation and the involved participant, that he or she has been engaged in fraud, embezzlement, theft, commission of a felony, or dishonesty in the course of his or her employment by the Corporation or by any Subsidiary and such action has damaged the Corporation or the Subsidiary, as the case may be, or that the participant has disclosed trade secrets of the Corporation or its affiliates, the participant shall forfeit all rights under and to all unexercised Awards, and under and to all exercised Awards under which the Corporation has not yet delivered payment or certificates for shares of Stock (as the case may be), all of which Awards and rights shall be automatically canceled. The decision of the Committee as to the cause of the participant's discharge from employment with the Corporation or any Subsidiary and the damage thereby suffered shall be final for purposes of the Plan, but shall not affect the finality of the participant's discharge by the Corporation or Subsidiary for any other purposes. The preceding provisions of this paragraph shall not apply to any Qualified Option to the extent such application would result in disqualification of the option as an incentive stock option under Sections 421 and 422 of the Code. 18. Indemnification. In and with respect to the administration of the Plan, the Corporation shall indemnify each member of the Committee and/or of the Board, each of whom shall be entitled, without further action on his or her part, to indemnification from the Corporation for all damages, losses, judgments, settlement amounts, punitive damages, excise taxes, fines, penalties, costs and expenses (including without limitation attorneys' fees and disbursements) incurred by the member in connection with any threatened, pending or completed action, suit or other proceedings of any nature, whether civil, administrative, investigative or criminal, whether formal or informal, and whether by or in the right or name of the Corporation, any class of its security holders, or otherwise, in which the member may be or may have been involved, as a party or otherwise, by reason of his or her being or having been a member of the Committee and/or of the Board, whether or not he or she continues to be a member of the Committee or of the Board. The provisions, protection and benefits of this paragraph shall apply and exist to the fullest extent permitted by applicable law to and for the benefit of all present and future members of the Committee and/or of the Board and their respective heirs, personal and legal representatives, successors and assigns, in addition to all other rights that they may have as a matter of law, by contract, or otherwise, except (a) to the extent there is entitlement to insurance proceeds under insurance coverages provided by the Corporation on account of the same matter or proceeding for which indemnification hereunder is claimed, or (b) to the extent there is entitlement to indemnification from the Corporation, other than under this paragraph, on account of the same matter or proceeding for which indemnification hereunder is claimed. 19. Miscellaneous. (a) Any reference contained in this Plan to particular section or provision of law, rule or regulation, including but not limited to the Code and the 1934 Act, shall include any subsequently enacted or promulgated section or provision of law, rule or regulation, as the case may be. With respect to persons subject to Section 16 of the 1934 Act, transactions under this Plan are intended to comply with all applicable conditions of Rule 16b-3 or any successor rule that may be promulgated by the Securities and Exchange Commission, and to the extent any provision of this Plan or action by the Committee fails to so comply, it shall be deemed null and void, to the extent permitted by applicable law and deemed advisable by the Committee. Proxy Statement Page 25 (b) Where used in this Plan: the plural shall include the singular, and unless the context otherwise clearly requires, the singular shall include the plural; and the term "affiliates" shall mean each and every Subsidiary and any parent of the Corporation. (c) The captions of the numbered paragraphs contained in this Plan are for convenience only, and shall not limit or affect the meaning, interpretation or construction of any of the provisions of the Plan. Page 26 Proxy Statement FIRST KEYSTONE CORPORATION PROXY ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON APRIL 21, 1998 THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS The undersigned hereby constitutes and appoints Paul Klinger and William Selden, Jr. and each or any of them, proxies of the undersigned, with full power of substitution, to vote all of the shares of First Keystone Corporation (the "Corporation") that the undersigned may be entitled to vote at the Annual Meeting of Shareholders of the Corporation to be held at the main office of The First National Bank of Berwick, 111 West Front Street, Berwick, Pennsylvania 18603 on Tuesday, April 21, 1998, at 9:00 a.m., prevailing time, and at any adjournment or postponement thereof as follows: 1. ELECTION OF CLASS B DIRECTORS TO SERVE FOR A THREE-YEAR TERM John Arndt J. Gerald Bazewicz Robert E. Bull [ ] FOR all nominees listed [ ] WITHHOLD AUTHORITY above (except as marked to vote for all to the contrary below) nominees listed above (INSTRUCTION: TO WITHHOLD AUTHORITY FROM THE PROXYHOLDERS TO VOTE FOR ANY INDIVIDUAL NOMINEE, WRITE THAT NOMINEE'S NAME FOR WHOM YOU DO NOT WISH THE PROXYHOLDERS TO VOTE FOR ON THE SPACE PROVIDED BELOW.) __________________________________________________________________ 2. PROPOSAL #1: PROPOSAL TO AMEND ARTICLE 5 OF THE ARTICLES OF INCORPORATION TO INCREASE THE NUMBER AUTHORIZED SHARES OF COMMON STOCK FROM THREE MILLION TO TEN MILLION SHARES. [ ] FOR [ ] AGAINST [ ] ABSTAIN The Board of Directors recommends a vote FOR this proposal. 3. PROPOSAL #2: PROPOSAL TO APPROVE THE FIRST KEYSTONE CORPORATION 1998 STOCK INCENTIVE PLAN. [ ] FOR [ ] AGAINST [ ] ABSTAIN The Board of Directors recommends a vote FOR this proposal. 4. PROPOSAL #3: PROPOSAL TO RATIFY THE SELECTION OF J. H. WILLIAMS & CO. AS THE INDEPENDENT AUDITORS FOR THE CORPORATION FOR THE YEAR ENDING DECEMBER 31, 1998. [ ] FOR [ ] AGAINST [ ] ABSTAIN The Board of Directors recommends a vote FOR this proposal. 5. In their discretion, the proxies are authorized to vote upon such other business as may properly come before the meeting and any adjournment or postponement thereof. THIS PROXY, WHEN PROPERLY SIGNED, WILL BE VOTED IN THE MANNER DIRECTED HEREIN BY THE UNDERSIGNED SHAREHOLDER. IF NO DIRECTION IS MADE, THIS PROXY WILL BE VOTED FOR ALL NOMINEES LISTED ABOVE AND FOR PROPOSAL 1, PROPOSAL 2, AND PROPOSAL 3. __________________________, 1998 Number of Shares Held of ________________________________ Record on March 10, 1998: ________________________________ ________________________________ Signature(s) (Seal) THIS PROXY MUST BE DATED, SIGNED BY THE SHAREHOLDER AND RETURNED PROMPTLY TO THE CORPORATION IN THE ENCLOSED ENVELOPE. WHEN SIGNING AS ATTORNEY, EXECUTOR, ADMINISTRATOR, TRUSTEE OR GUARDIAN, PLEASE GIVE FULL TITLE. IF MORE THAN ONE TRUSTEE, ALL SHOULD SIGN. IF STOCK IS HELD JOINTLY, EACH OWNER SHOULD SIGN. -----END PRIVACY-ENHANCED MESSAGE-----