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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE YEAR ENDED SEPTEMBER 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-25328
FIRST KEYSTONE FINANCIAL, INC.
--------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-0469351
--------------------------------- ----------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
22 West State Street
Media, Pennsylvania 19063
--------------------------------------- ----------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (610) 565-6210
Securities registered pursuant to Section 12(b) of the Act:
NOT APPLICABLE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK (PAR VALUE $.01 PER SHARE)
Indicate by check mark whether the Registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
--------
As of December 21, 2001 the aggregate value of the 1,668,912 shares of Common
Stock of the Registrant issued and outstanding on such date, which excludes
368,603 shares held by all directors and officers of the Registrant as a group,
was approximately $23.2 million. This figure is based on the closing price of
$13.81 per share of the Registrant's Common stock on December 21, 2001.
Number of shares of Common Stock outstanding as of December 21, 2001: 2,037,515
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents incorporated by reference and the Part of
the Form 10-K into which the document is incorporated:
(1) Portions of the Annual Report to Stockholders for the fiscal year ended
September 30, 2001 are incorporated into Parts II and III.
(2) Portions of the definitive proxy statement for the 2002 Annual Meeting
of Stockholders are incorporated into Part III.
PART I.
Item 1. BUSINESS
GENERAL
First Keystone Financial, Inc. (the "Company") is a Pennsylvania
corporation and sole shareholder of First Keystone Federal Savings Bank, a
federally chartered stock savings bank (the "Bank") which, converted to the
stock form of organization in January 1995. The only significant assets of the
Company are the capital stock of the Bank, the Company's loans to its employee
stock ownership plan, and various equity and other investments. See Note 18 of
the Notes to Consolidated Financial Statements in the Annual Report to
Stockholders for the fiscal year ended September 30, 2001 set forth as Exhibit
13 hereto ("Annual Report"). The business of the Company primarily consists of
the business of the Bank.
The Bank is a traditional, community oriented bank emphasizing customer
service and convenience. The Bank's primary business is to attract deposits from
the general public and invest those funds together with other available sources
of funds, primarily borrowings, to originate loans. A substantial portion of the
Bank's deposits are comprised of core deposits consisting of passbook, money
market ("MMDA"), NOW and non-interest-bearing accounts. Core deposits amounted
to $129.4 million or 41.5% of the Bank's total deposits at September 30, 2001.
The Bank's primary lending emphasis is the origination of loans secured by first
and second liens on single-family (one-to-four units) residences located in
Delaware and Chester Counties, Pennsylvania and to a lesser degree, Montgomery
County, Pennsylvania and New Castle County, Delaware. The Bank originates
residential first mortgage loans with either fixed and/or adjustable rates.
Adjustable rate loans are retained for the Bank's portfolio while fixed-rate
loans may be sold in the secondary market depending on the Bank's
asset/liability strategy, cash flow needs and current market conditions. The
Bank also originates for portfolio, due to their generally shorter terms,
adjustable or variable interest rates and generally higher yields, loans secured
by commercial and multi-family residential real estate properties as well as
residential and commercial construction loans secured by properties located in
the Bank's market area. The level of the Bank's originations of commercial,
construction and multi-family residential loans has remained strong as a direct
result of the Bank's continued emphasis on developing business loan products.
Multi-family residential and commercial real estate loans amounted to $43.5
million or 16.2% of the total loan portfolio at September 30, 2001 as compared
to $37.9 million or 15.5% at September 30, 2000. In addition, the Bank
originates for sale in the secondary market, servicing released, non-conforming
loans in excess of Fannie Mae ("FNMA") and Freddie Mac ("FHLMC") limits. The
Bank has on occasions purchased loan participation interests in both residential
and commercial loans depending on market conditions and portfolio needs.
To a lesser extent, the Bank also originates consumer loans (consisting
almost entirely of home equity loans and lines of credit) and other mortgage
loans.
In addition to its deposit gathering and lending activities, the Bank
invests in mortgage-related securities, which are issued or guaranteed by U.S.
Government agencies and government sponsored or private enterprises, as well as
U.S. Treasury and federal government agency obligations, corporate bonds and
municipal obligations. At September 30, 2001, the Bank's mortgage-related
securities (including mortgage-related securities available for sale) amounted
to $129.1 million, or 26.4% of the Company's total assets, and investment
securities available for sale amounted to $62.6 million, or 12.8% of total
assets.
MARKET AREA AND COMPETITION
The Bank's primary market area consists of Delaware and Southern
Chester Counties and to a lesser extent the contiguous counties of Montgomery
and Northern Chester Counties, Pennsylvania and New Castle County, Delaware.
Delaware County is part of the Philadelphia Primary Metropolitan Statistical
Area ("PMSA") which includes besides Delaware County, Bucks, Chester, Montgomery
and Philadelphia Counties (as well as four counties in New Jersey). The
Philadelphia area economy is typical of many large Northeastern and Midwestern
cities where the traditional manufacturing based economy has declined to a
certain degree and has been replaced by growth of the service sector. As a
result of such growth, the Philadelphia PMSA's economic diversity has broadened
and employment in the area is derived from a number of different employment
sectors. In particular, Delaware County has experienced the development of
companies providing products and services for the health care market such as
Crozer/Keystone Health System, Wyeth-Ayerst Labs, Inc. and Mercy Health Corp.
Philadelphia's central location in the Northeast corridor, its
well-educated and skilled population base, infrastructure and other factors has
made the Bank's market area attractive to many large corporate employers. Such
employers include Comcast Corp., Boeing, State Farm Insurance, Unisys Corp.,
PECO Energy, SAP America, Inc., and many others. There are over seventy-five
Fortune 1,000 companies maintaining a presence in this area and approximately
twenty Fortune 500 companies headquartered in the region surrounding the
Philadelphia PMSA including CIGNA Corp., E.I. duPont de Nemours, Bethlehem
Steel, Ikon Office Solutions, Sun Company, Crown Cork & Seal and others.
Delaware County has experienced slower population growth than the
Philadelphia PMSA, although the growth rates in the outlying areas of Delaware
County have exceeded that of the Philadelphia PMSA. Since 1990, there has been
minimal population growth in Delaware County and it is expected to decrease
slightly over the next 20 years. Chester County, on the other hand, has grown
over 15% since 1990 and expected to increase further in the next decade.
The Bank faces strong competition both in attracting deposits and
making real estate loans. Its most direct competition for deposits has
historically come from other savings associations, credit unions and commercial
banks located in its market area including many large financial institutions
which have greater financial and marketing resources available to them. In
addition, during times of high interest rates, the Bank has faced additional
significant competition for investors' funds from short-term money market
securities, mutual funds and other corporate and government securities. The
ability of the Bank to attract and retain savings deposits depends on its
ability to generally provide a rate of return, liquidity and risk comparable to
that offered by competing investment opportunities.
The Bank experiences strong competition for real estate loans
principally from other savings associations, commercial banks and
mortgage-banking companies. The Bank competes for loans principally through the
interest rates and loan fees it charges, the efficiency and quality of the
services it provides borrowers and the convenient locations of its branch office
network. Competition may increase as a result of the continuing reduction of
restrictions on the interstate operations of financial institutions.
2
Lending Activities
Loan Portfolio Composition. The following table sets forth the composition
of the Bank's loan portfolio by type of loan at the dates indicated (excluding
loans held for sale).
September 30,
---------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Amount % Amount % Amount % Amount % Amount %
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
(Dollars in thousands)
Real estate loans:
Single-family $160,289 59.81% $160,143 65.54% $166,802 69.82% $148,088 71.34% $135,168 68.53%
Multi-family and commercial 43,472 16.22 37,870 15.50 31,188 13.05 20,563 9.91 18,305 9.28
Construction and land 29,117 10.86 17,905 7.33 18,426 7.71 15,858 7.64 16,400 8.31
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 232,878 86.89 215,918 88.37 216,416 90.58 184,509 88.89 169,873 86.12
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer:
Home equity loans and
lines of credit 25,847 9.65 22,597 9.25 18,624 7.80 19,609 9.45 22,964 11.64
Deposit 232 .09 251 .10 243 .10 181 .09 348 .18
Education 285 .12 365 .15 449 .21 365 .19
Other(1) 893 .33 807 .33 1,080 .45 1,429 .69 1,690 .86
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans 26,972 10.07 23,940 9.80 20,312 8.50 21,668 10.44 25,367 12.87
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial business loans 8,158 3.04 4,475 1.83 2,190 .92 1,390 .67 2,000 1.01
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans receivable(2) 268,008 100.00% 244,333 100.00% 238,918 100.00% 207,567 100.00% 197,240 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Loans in process
(construction and land) 17,016 10,330 9,005 5,781 5,670
Deferred loan origination
fees and discounts 1,147 1,298 1,610 1,705 1,653
Allowance for loan losses 2,181 2,019 1,928 1,738 1,628
-------- -------- -------- -------- --------
20,344 13,647 12,543 9,224 8,951
-------- -------- -------- -------- --------
Total loans receivable,
net $247,664 $230,686 $226,375 $198,343 $188,289
======== ======== ======== ======== ========
- ----------
(1) Consists primarily of credit card loans.
(2) Does not include $225,000, $3.1 million, $1.8 million, $2.8 million,
and $4.6 million of loans held for sale at September 30, 2001, 2000,
1999, 1998 and 1997, respectively.
3
Contractual Principal Repayments. The following table sets forth the
scheduled contractual maturities of the Bank's loans held to maturity at
September 30, 2001. Demand loans, loans having no stated schedule of repayments
and no stated maturity and overdraft loans are reported as due in one year or
less. The amounts shown for each period do not take into account loan
prepayments and normal amortization of the Bank's loan portfolio held to
maturity.
Real Estate Loans
----------------------------------------------------
Multi-family Consumer and
and Construction Commercial
Single-family Commercial and Land Total Business Loans Total
------------- ---------- -------- ----- -------------- -----
(Dollars in thousands)
Amounts due in:
One year or less $ 5,923 $ 993 $29,117 $ 36,033 $11,509 $ 47,542
After one year through three years 12,243 14,696 26,939 5,189 32,128
After three years through five years 14,725 7,525 22,250 4,304 26,554
After five years through ten years 35,513 9,818 45,331 9,613 54,944
After ten years through fifteen years 32,395 5,120 37,515 3,640 41,155
Over fifteen years 59,490 5,320 64,810 875 65,685
-------- ------- ------- -------- -------- --------
Total(1) $160,289 $43,472 $29,117 $232,878 $35,130 $268,008
======== ======= ======= ======== ======== ========
Interest rate terms on amounts due
after one year:
Fixed $122,431 $19,061 $141,492
Adjustable 74,414 4,560 78,974
-------- ------- --------
Total(1) $196,845 $23,621 $220,466
======== ======= ========
- ----------
(1) Does not include adjustments relating to loans in process, allowances
for loan losses and deferred fee income.
4
Scheduled contractual amortization of loans does not reflect the
expected term of the Bank's loan portfolio. The average life of loans is
substantially less than their contractual terms because of prepayments and
due-on-sale clauses, which give the Bank the right to declare a conventional
loan immediately due and payable in the event, among other things, that the
borrower sells the real property subject to the mortgage and the loan is not
repaid. The average life of mortgage loans tends to increase when current
mortgage loan rates are higher than rates on existing mortgage loans and,
conversely, decrease when rates on existing mortgage loans are lower than
current mortgage loan rates (due to refinancings of adjustable-rate and
fixed-rate loans at lower rates). Under the latter circumstances, the weighted
average yield on loans decreases as higher yielding loans are repaid or
refinanced at lower rates.
Loan Origination, Purchase and Sales Activity. The following table
shows the loan origination, purchase and sale activity of the Bank during the
periods indicated.
Year Ended September 30,
---------------------------------------------
2001 2000 1999
(In thousands)
Gross loans at beginning of period(1) $ 247,532 $ 240,710 $ 210,366
--------- --------- ---------
Loan originations for investment:
Real estate:
Residential 25,889 20,002 49,970
Commercial and multi-family 11,265 10,704 16,070
Construction 18,503 15,470 22,313
--------- --------- ---------
Total real estate loans originated for investment 55,657 46,176 88,353
Consumer 11,650 10,045 7,309
Commercial business 12,102 4,443 3,594
--------- --------- ---------
Total loans originated for investment 80,533 61,017 101,217
Participations purchased(2) 1,124 353 1,961
Loans originated for resale 20,685 39,531 46,199
--------- --------- ---------
Total originations 101,218 100,548 147,416
--------- --------- ---------
Deduct:
Principal loan repayments and prepayments (56,086) (54,325) (68,549)
Transferred to real estate owned (872) (1,177) (1,317)
Loans sold in secondary market (23,559) (38,224) (47,206)
--------- --------- ---------
Subtotal (80,517) 93,726 117,072
--------- --------- ---------
Net increase in loans(1) 20,701 6,822 30,344
--------- --------- ---------
Gross loans at end of period(1) $ 268,233 $ 247,532 $ 240,710
========= ========= =========
- ----------
(1) Includes loans held for sale of $225,000, $3.1 million, and $1.8
million at September 30, 2001, 2000 and 1999, respectively.
(2) Consist of commercial real estate loans.
5
The lending activities of the Bank are subject to written underwriting
standards and loan origination procedures established by the Bank's Board of
Directors and management. Applications for all types of loans may be taken at
all of the Bank's branch offices by the branch manager or other designated loan
officers. Applications for single-family residential mortgage loans for
portfolio retention also are obtained through loan originators who are employees
of the Bank. The Bank's loan originators will take loan applications outside of
the Bank's offices at the customer's convenience and are compensated on a
commission basis. The Mortgage Lending Department supervises the process of
obtaining credit reports, appraisals and other documentation involved with a
loan. In most cases, the Bank requires that a property appraisal be obtained in
connection with all new first mortgage loans. Generally, appraisals are not
required on home equity loans because alternative means of valuation are used
(i.e. tax assessments). Property appraisals generally are performed by an
independent appraiser from a list approved by the Bank's Board of Directors. The
Bank requires that title insurance (other than with respect to home equity
loans) and hazard insurance be maintained on all security properties and that
flood insurance be maintained if the property is within a designated flood
plain.
Residential mortgage loan applications are primarily developed from
referrals from real estate brokers and builders, existing customers and walk-in
customers. Residential mortgage loans also are originated through
correspondents. Commercial and multi-family real estate loan applications are
obtained primarily from previous borrowers, direct solicitations by Bank
personnel, as well as referrals. Consumer loans originated by the Bank are
obtained primarily through existing and walk-in customers who have been made
aware of the Bank's programs by advertising and other means.
Applications for single-family residential mortgage loans which are
originated for resale in the secondary market or loans designated for portfolio
retention that conform to the requirements for resale into the secondary market
and do not exceed FNMA/FHLMC limits are approved by the Bank's Chief Lending
Officer or in his absence, by the Vice President of Mortgage Lending or the Loan
Committee (a committee comprised of four directors and the Bank's Chief Lending
Officer). All other mortgage loans (commercial and multi-family residential real
estate and construction loans) and residential mortgage loans in excess of
FNMA/FHLMC maximum amounts (currently $300,700) but less than $1.0 million must
be approved by the Loan Committee. All mortgage loans in excess of $1.0 million
must be approved by the Bank's Board of Directors or the Executive Committee
thereof. All mortgage loans which do not require approval by the Board of
Directors are submitted to the Board at its next meeting for review and
ratification. Home equity loans and lines of credit up to $100,000 can be
approved by the Chief Lending Officer, the Vice President of Construction Loans
or the Vice President of Mortgage Lending. Loans in excess of such amount must
be approved by the Loan Committee.
Single-Family Residential Loans. Substantially all of the Bank's
single-family residential mortgage loans consist of conventional loans.
Conventional loans are loans that are neither insured by the Federal Housing
Administration or partially guaranteed by the Department of Veterans Affairs.
The vast majority of the Bank's single-family residential mortgage loans are
secured by properties located in Pennsylvania, primarily in Delaware and Chester
Counties, and are originated under terms and documentation which permit their
sale to the FHLMC or FNMA. The Bank, consistent with its asset/liability
management strategies, sells some of its newly originated longer term fixed-rate
residential mortgage loans and to a limited degree, existing longer term
fixed-rate residential mortgage loans while retaining adjustable-rate mortgage
loans and shorter term fixed-rate residential mortgage loans. See
"-Mortgage-Banking Activities."
The single-family residential mortgage loans offered by the Bank
currently consist of fixed-rate loans, including bi-weekly, balloon and
adjustable-rate loans. Fixed-rate loans generally have maturities ranging from
15 to 30 years and are fully amortizing with monthly loan payments sufficient to
repay the total amount of the loan with interest by the end of the loan term.
The Bank's fixed-rate loans are originated under terms, conditions and
documentation which permit them to be sold to U.S. Government-sponsored
agencies, such as FHLMC and FNMA, and other purchasers in the secondary mortgage
market. The Bank also offers bi-weekly loans under the terms of which the
borrower makes payments every two weeks. Although such loans have a 30 year
amortization schedule, due to the bi-weekly payment schedule, such loans repay
substantially more rapidly than a standard monthly amortizing 30-year fixed-rate
loan. The Bank also offers five and seven year balloon loans which provide that
the borrower can conditionally renew the loan at the fifth or seventh year at a
then to-be-determined rate for the remaining 25 or 23 years, respectively, of
the amortization period. At September 30, 2001, $125.0 million, or 78.0%, of the
Bank's single-family residential mortgage
6
loans held in portfolio were fixed-rate loans, including $25.3 million of
bi-weekly fixed-rate residential mortgage loans.
The adjustable-rate loans currently offered by the Bank have interest
rates which adjust every one, three or five years in accordance with a
designated index, such as U.S. Treasury obligations, adjusted to a constant
maturity ("CMT"), plus a stipulated margin. The Bank's adjustable-rate
single-family residential real estate loans generally have a cap of 2% on any
increase or decrease in the interest rate at any adjustment date, and a cap and
floor of 6% on any such increase or decrease over the life of the loan. In order
to increase the originations of adjustable-rate loans, the Bank recently has
been originating loans which bear a fixed interest rate for a period of three to
five years after which they convert to one-year adjustable-rate loans. The
Bank's adjustable-rate loans require that any payment adjustment resulting from
a change in the interest rate of an adjustable-rate loan be sufficient to result
in full amortization of the loan by the end of the loan term and, thus, do not
permit any of the increased payment to be added to the principal amount of the
loan, creating negative amortization. Although the Bank does offer
adjustable-rate loans with initial rates below the fully indexed rate, such
loans are underwritten using methods approved by FHLMC and FNMA which require
borrowers to be qualified at 2% above the discounted loan rate under certain
conditions. At September 30, 2001, $35.3 million, or 22.0%, of the Bank's
single-family residential mortgage loans held for portfolio were adjustable-rate
loans.
Adjustable-rate loans decrease the risks associated with changes in
interest rates but involve other risks, primarily because in the event interest
rates increase, the loan payment by the borrower also increases to the extent
permitted by the terms of the loan, thereby increasing the potential for
default. In addition, adjustable rate loans tend to prepay and convert to fixed
rates when the overall interest rate environment is low. Moreover, as with
fixed-rate loans, as interest rates increase, the marketability of the
underlying collateral property may be adversely affected by higher interest
rates. The Bank believes that these risks, which have not had a material adverse
effect on the Bank to date, generally are less than the risks associated with
holding fixed-rate loans in an increasing interest rate environment.
For conventional residential mortgage loans held in portfolio and also
for those loans originated for sale in the secondary market, the Bank's maximum
loan-to-value ("LTV") ratio is 97%, and is based on the lesser of sales price or
appraised value. On most loans with a LTV ratio of over 80%, private mortgage
insurance is required to be obtained.
Commercial and Multi-Family Residential Real Estate Loans. The Bank has
moderately increased its investment in commercial and multi-family residential
lending. Such loans are being made primarily to small- and medium-sized
businesses located in the Bank's primary market area, a portion of the market
that the Bank believes has been underserved in recent years. Loans secured by
commercial and multi-family residential real estate amounted to $43.5 million,
or 16.2%, of the Bank's total loan portfolio, at September 30, 2001. The Bank's
commercial and multi-family residential real estate loans are secured primarily
by professional office buildings, small retail establishments, warehouses and
apartment buildings (with 36 units or less) located in the Bank's primary market
area.
The Bank's adjustable-rate multi-family residential and commercial real
estate loans generally are either three or five-year adjustable-rate loans
indexed to the CMT plus a margin. In addition, depending on collateral value and
strength of the borrower, fixed-rate balloon loans and longer term fixed-rate
loans may be originated. Generally, fees of 1% to 3% of the principal loan
balance are charged to the borrower upon closing. Although terms for
multi-family residential and commercial real estate loans may vary, the Bank's
underwriting standards generally provide for terms of up to 25 years with
amortization of principal over the term of the loan and LTV ratios of not more
than 75%. Generally, the Bank obtains personal guarantees of the principals of
the borrower as additional security for any commercial real estate and
multi-family residential loans and requires that the borrower have at least a
25% equity investment in any such property.
The Bank evaluates various aspects of commercial and multi-family
residential real estate loan transactions in an effort to mitigate risk to the
extent possible. In underwriting these loans, consideration is given to the
stability of the property's cash flow history, future operating projections,
current and projected occupancy, position in the market, location and physical
condition. In recent periods, the Bank has generally imposed a debt coverage
ratio (the ratio of net cash from operations before payment of debt service to
debt service) of not less than 110%. The underwriting analysis also includes
credit checks and a review of the financial condition of the borrower and
guarantor, if applicable. An appraisal report is prepared by a state-licensed
and certified appraiser (generally an appraiser who is qualified as a Member of
the Appraisal Institute ("MAI")) commissioned by the Bank to substantiate
property values for every
7
commercial real estate and multi-family loan transaction. All appraisal reports
are reviewed by the commercial loan underwriter prior to the closing of the
loan.
Multi-family residential and commercial real estate lending entails
different and significant risks when compared to single-family residential
lending because such loans often involve large loan balances to single borrowers
and because the payment experience on such loans is typically dependent on the
successful operation of the project or the borrower's business. These risks also
can be significantly affected by supply and demand conditions in the local
market for apartments, offices, warehouses or other commercial space. The Bank
attempts to minimize its risk exposure by limiting such lending to proven
developers/owners, only considering properties with existing operating
performance which can be analyzed, requiring conservative debt coverage ratios,
and periodically monitoring the operation and physical condition of the
collateral.
Construction Loans. Substantially all of the Bank's construction loans
consist of loans to construct single-family properties extended either to
individuals or to selected developers with whom the Bank is familiar to build
such properties on a pre-sold or limited speculative basis.
To a lesser extent, the Bank provides financing for construction to
permanent commercial loan properties. Commercial construction loans have a
maximum term of 24 months during the construction period with interest based
upon the prime rate published in the Wall Street Journal ("Prime Rate") plus a
margin and have LTV ratios of 80% or less of the appraised value upon
completion. The loans convert to permanent commercial term loans upon completion
of construction. With respect to construction loans to individuals, such loans
have a maximum term of 12 months, have variable rates of interest based upon the
Prime Rate plus a margin and have LTV ratios of 80% or less of the appraised
value of the property upon completion and generally do not require the
amortization of principal during the term. Upon completion of construction, the
borrower is required to refinance the loan although the Bank may be the lender
of the permanent loan secured by the property.
The Bank also provides construction loans and lines of credit to
developers. The majority of construction loans consist of loans to selected
local developers with whom the Bank is familiar and who build single-family
dwellings on a pre-sold or, to a significantly lesser extent, on a speculative
basis. The Bank generally limits to two the number of unsold units that a
developer may have under construction in a project. Such loans generally have
terms of 24 to 36 months or less, have maximum LTV ratios of 75% of the
appraised value of the property upon completion and generally do not require the
amortization of the principal during the term. The loans are made with variable
rates of interest based on the Prime Rate plus a margin adjusted on a monthly
basis. The Bank also receives origination fees that generally range from .5% to
3.0% of the loan commitment. The borrower is required to fund a portion of the
project's costs, the exact amount being determined on a case-by-case basis. Loan
proceeds are disbursed by percentage of completion of the cost of the project
after inspections indicate that such disbursements are for costs already
incurred and which have added to the value of the project. Only interest
payments are due during the construction phase and the Bank may provide the
borrower with an interest reserve from which it can pay the stated interest due
thereon. The Bank's construction loans include a small number of loans to
developers to acquire the land, develop the site and construct the residential
units ("ADC loans").
At September 30, 2001, residential construction loans totaled $21.0
million, or 7.8%, of the total loan portfolio, primarily consisting of
construction loans to developers. At September 30, 2001, commercial construction
loans totaled $1.6 million, or .60%, of the total loan portfolio.
The Bank also originates ground or land loans to individuals to
purchase a property on which he intends to build his primary residence, as well
as to developers to purchase lots to build speculative homes at a later date.
Such loans have terms of 36 months or less with a maximum LTV ratio of 75% of
the lower of appraised value or sale price. The loans are made with variable
rates based on the Prime Rate plus a margin. The Bank also receives origination
fees, which generally range between 1.0% and 3.0% of the loan amount. At
September 30, 2001, land loans (including loans to acquire and develop land)
totaled $6.5 million, or 2.4%, of the total loan portfolio.
Loans to developers include both secured and unsecured lines of credit
(which are classified as a commercial loans) with outstanding commitments
totaling $1.7 million. All have personal guaranties of the principals and are
cross- collateralized with existing loans. At September 30, 2001, loans
outstanding under builder lines of credit totaled $1.4
8
million, or .52%, of the total loan portfolio, of which $683,800 were unsecured
and given only to the Bank's most creditworthy long standing customers.
Prior to making a commitment to fund a construction loan, the Bank
requires an appraisal of the property by a MAI appraiser approved by the Board
of Directors. In addition, during the term of the construction loan, the project
is inspected by an independent inspector.
Construction financing generally is considered to involve a higher
degree of risk of loss than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development and the estimated cost (including interest) of
construction. During the construction phase, a number of factors could result in
delays and cost overruns. If the estimate of value proves to be inaccurate, the
Bank may be confronted, at or prior to the maturity of the loan, with a project,
when completed, having a value which is insufficient to assure full repayment.
Loans on lots may run the risk of adverse zoning changes as well as
environmental or other restrictions on future use.
Consumer Lending Activities. The Bank offers consumer loans in order to
provide a full range of retail financial services to its customers. At September
30, 2001, $27.0 million, or 10.1 %, of the Bank's total loan portfolio was
comprised of consumer loans. The Bank originates substantially all of such loans
in its primary market area.
The largest component of the Bank's consumer loan portfolio consists of
home equity loans and home equity lines of credit, both of which are secured by
the underlying equity in the borrower's primary residence or, occasionally,
other types of real estate. Home equity loans are amortizing loans with fixed
interest rates and maximum terms of 15 years while equity lines of credit have
adjustable interest rates indexed to the Prime Rate. Generally home equity loans
or home equity lines of credit do not exceed $100,000. The Bank's home equity
loans and lines of credit generally require combined LTV ratios of 80% or less.
Loans with higher LTV ratios are available but with higher interest rates and
stricter credit standards. At September 30, 2001, home equity loans and lines of
credit amounted to $25.8 million, or 9.7%, of the Bank's total loan portfolio.
At September 30, 2001, the remaining portion of the Bank's consumer
loan portfolio was comprised of credit card, deposit and other consumer loans.
Credit cards, deposit loans and other consumer loans totaled $1.1 million, or
.4%, of the Bank's total loan portfolio at September 30, 2001. The Bank's credit
card program is primarily offered to only the Bank's most creditworthy
customers. At September 30, 2001, these loans totaled $618,000, or .2%, of the
total loan portfolio.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. These risks are not as prevalent in the Bank's consumer
loan portfolio, however, because a high percentage of the portfolio is comprised
of home equity loans and lines of credit that are secured by real estate and
underwritten in a manner such that they result in a lending risk that is
substantially similar to single-family residential loans.
Commercial Business Loans. The Bank grants commercial business loans
directly to business enterprises that are located in its market area. The
majority of such loans are for less than $1.0 million. The Bank actively targets
and markets to small- and medium-sized businesses. Applications for commercial
business loans are obtained from existing commercial customers, branch and
customer referrals, direct inquiry and those that are obtained by our commercial
lending officers. As of September 30, 2001, commercial business loans amounted
to $8.2 million, or 3.0%, of the Bank's total loan portfolio.
9
The commercial business loans consist of a limited number of commercial
lines of credit secured by real estate, securities, some working capital
financings secured by accounts receivable and inventory and, to a limited
extent, unsecured lines of credit. Commercial business loans originated by the
Bank ordinarily have terms of five years or less and fixed rates or adjustable
rates tied to the Prime Rate plus a margin.
Although commercial business loans generally are considered to involve
greater credit risk than other certain types of loans, management intends to
offer commercial business loans to small- and medium-sized businesses in an
effort to better serve our community's needs, obtain core noninterest-bearing
deposits and increase the Bank's interest rate spread.
Mortgage-Banking Activities. Due to customer preference for fixed-rate
loans, the Bank has continued to originate fixed-rate loans. Long-term
(generally 30 years) fixed-rate loans not taken into portfolio for
asset/liability purposes are sold into the secondary market. In addition, the
Bank has developed for sale in the secondary market non-conforming loans (loans
not conforming to FHLMC/FNMA underwriting guidelines). The Bank's net gain on
sales of mortgage loans amounted to $122,000, $206,000, and $325,000 during the
fiscal years ended September 30, 2001, 2000 and 1999, respectively. Profits from
sales of loans held for sale have declined due to declining profitability on
subprime lending and the Bank's decision in fiscal 2001 to exit the subprime
line of business. The Bank had $225,000 and $3.1 million of mortgage loans held
for sale at September 30, 2001 and 2000, respectively.
The Bank's conforming mortgage loans sold to others are sold, generally
with servicing retained, on a loan-by-loan basis primarily to FHLMC and FNMA. A
period of less than five days generally elapses between the closing of the loan
by the Bank and its purchase by the investor. Mortgages with established
interest rates generally will decrease in value during periods of increasing
interest rates. Accordingly, fluctuations in prevailing interest rates may
result in a gain or loss to the Bank as a result of adjustments to the carrying
value of loans held for sale or upon sale of loans. The Bank attempts to protect
itself from these market fluctuations through the use of forward commitments at
the time of the commitment by the Bank of a loan rate to the borrower. These
commitments are mandatory delivery contracts with FHLMC and FNMA within a
certain time frame and within certain dollar amounts by a price determined at
the commitment date. Market risk does exist as non-refundable points paid by the
borrower may not be sufficient to offset fees associated with closing the
forward commitment contract.
Loan Origination Fees and Servicing. Borrowers are generally charged an
origination fee, which is a percentage of the principal balance of the loan. In
accordance with the provisions of Statement of Financial Accounting Standards
("SFAS") No. 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases," the various
fees received by the Bank in connection with the origination of loans are
deferred and amortized as a yield adjustment over the lives of the related loans
using the interest method. However, when such loans are sold, the remaining
unamortized fees (which is all or substantially all of such fees due to the
relatively short period during which such loans are held) are recognized as
income on the sale of loans held for sale.
The Bank, for conforming loan products, generally retains the servicing
on all loans sold to others. In addition, the Bank services substantially all of
the loans that it retains in its portfolio. Loan servicing includes collecting
and remitting loan payments, accounting for principal and interest, making
advances to cover delinquent payments, making inspections as required of
mortgaged premises, contacting delinquent mortgagors, supervising foreclosures
and property dispositions in the event of unremedied defaults and generally
administering the loans. Funds that have been escrowed by borrowers for the
payment of mortgage-related expenses, such as property taxes and hazard and
mortgage insurance premiums, are maintained in noninterest-bearing accounts at
the Bank.
The following table presents information regarding the loans serviced
by the Bank for others at the dates indicated. Substantially all the loans were
secured by properties in Pennsylvania. A small percentage of the loans are
secured by properties located in Delaware, Maryland or New Jersey.
10
September 30,
-------------------------------------
2001 2000 1999
---- ---- ----
(In thousands)
Loans originated by the Bank and serviced for:
FNMA $ 1,726 $ 2,140 $ 2,752
FHLMC 64,195 67,858 74,031
Others 380 392 403
------- ------- -------
Total loans serviced for others $66,301 $70,390 $77,186
======= ======= =======
The Bank receives fees for servicing mortgage loans, which generally
amount to 0.25% per annum on the declining principal balance of mortgage loans.
Such fees serve to compensate the Bank for the costs of performing the servicing
function. Other sources of loan servicing revenues include late charges. For
fiscal years ended September 30, 2001, 2000 and 1999, the Bank earned gross fees
of $148,000, $150,000 and $205,000, respectively, from loan servicing. The Bank
retains a portion of funds received from borrowers on the loans it services for
others in payment of its servicing fees received on loans serviced for others.
Loans-to-One Borrower Limitations. Regulations impose limitations on
the aggregate amount of loans that a savings institution could make to any one
borrower, including related entities. Under such regulations, the permissible
amount of loans-to-one borrower follows the national bank standard for all loans
made by savings institutions, which generally does not permit loans-to-one
borrower to exceed 15% of unimpaired capital and surplus. Loans in an amount
equal to an additional 10% of unimpaired capital and surplus also may be made to
a borrower if the loans are fully secured by readily marketable securities. At
September 30, 2001, the Bank's five largest loans or groups of loans-to-one
borrower, including related entities, ranged from an aggregate of $3.7 million
to $5.4 million. The Bank's loans-to-one borrower limit was $5.9 million at such
date.
ASSET QUALITY
General. As a part of the Bank's efforts to improve its asset quality,
it has developed and implemented an asset classification system. All of the
Bank's assets are subject to review under the classification system, but
particular emphasis is placed on the review of multi-family residential and
commercial real estate loans, construction loans and commercial business loans.
All assets of the Bank are periodically reviewed and the classification
recommendations submitted to the Asset Classification Committee at least
monthly. The Asset Classification Committee is composed of the President and
Chief Executive Officer, the Chief Financial Officer, the Vice President of Loan
Administration, the Internal Auditor and the Vice President of Construction
Lending. All assets are placed into one of the four following categories: Pass,
Substandard, Doubtful and Loss. The criteria used to review and establish each
asset's classification are substantially identical to the asset classification
system used by the Office of Thrift Supervision (the "OTS") in connection with
the examination process. As of September 30, 2001, the Bank did not have any
assets which it had classified as doubtful or loss. See "- Non-Performing
Assets" and "- Other Classified Assets" for a discussion of certain of the
Bank's assets which have been classified as substandard and regulatory
classification standards generally.
11
When a borrower fails to make a required payment on a loan, the Bank
attempts to cure the deficiency by contacting the borrower and seeking payment.
Contacts are generally made 30 days after a payment is due. In most cases,
deficiencies are cured promptly. If a delinquency continues, late charges are
assessed and additional efforts are made to collect the loan. While the Bank
generally prefers to work with borrowers to resolve such problems, when the
account becomes 90 days delinquent, the Bank institutes foreclosure or other
proceedings, as necessary, to minimize any potential loss.
Loans are placed on non-accrual status when, in the judgment of
management, the probability of collection of interest is deemed to be
insufficient to warrant further accrual. When a loan is placed on non-accrual
status, previously accrued but unpaid interest is deducted from interest income.
As a matter of policy, the Bank does not accrue interest on loans past due 90
days or more. See Note 2 of the Notes to Consolidated Financial Statements
included in the Company's Annual Report.
Real estate acquired by the Bank as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold. Real
estate owned is initially recorded at the lower of fair value less estimated
costs to sell the property, or cost (generally the balance of the loan on the
property at the date of acquisition). After the date of acquisition, all costs
incurred in maintaining the property are expenses and costs incurred for the
improvement or development of such property are capitalized up to the extent of
their net realizable value.
Under accounting principles generally accepted in the United States of
America ("GAAP"), the Bank is required to account for certain loan modifications
or restructurings as "troubled debt restructurings." In general, the
modification or restructuring of a debt constitutes a troubled debt
restructuring if the Bank, for economic or legal reasons related to the
borrower's financial difficulties, grants a concession to the borrower that the
Bank would not otherwise consider under current market conditions. Debt
restructuring or loan modifications for a borrower do not necessarily always
constitute troubled debt restructuring, however, and troubled debt restructuring
does not necessarily result in non-accrual loans.
12
Delinquent Loans. The following table sets forth information concerning
delinquent loans at the dates indicated, in dollar amounts and as a percentage
of each category of the Bank's loan portfolio. The amounts presented represent
the total outstanding principal balances of the related loans, rather than the
actual payment amounts which are past due.
September 30, 2001 September 30, 2000
------------------------------------------- -------------------------------------------
30-59 Days 60-89 Days 30-59 Days 60-89 Days
-------------------- ------------------- ------------------- -------------------
Percent Percent Percent Percent
of of of of
Loan Loan Loan Loan
Amount Category Amount Category Amount Category Amount Category
------ -------- ------ -------- ------ -------- ------ --------
(Dollars in thousands)
Real estate loans:
Single-family
residential $526 .33% $ 80 .05% $752 .46% $148 .09%
Construction
Consumer loans 204 .76 46 .17 13 .05 24 .10
Commercial
business loans
---- ---- ---- ----
Total $730 .27% $126 .05% $765 .31% $172 .07%
==== === ==== === ==== === ==== ===
13
Non-Performing Assets. The following table sets forth the amounts and
categories of the Bank's non-performing assets and troubled debt restructurings
at the dates indicated.
September 30,
--------------------------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(Dollars in thousands)
Non-performing loans:
Single-family residential $1,924 $2,109 $2,312 $2,341 $1,661
Commercial and multi-
family(1) 33 289 323 22
Construction(2) 556 895 275
Consumer 314 48 16 43 14
Commercial business 3 6 83 100
------ ------ ------ ------ ------
Total non-performing loans 2,271 2,160 3,179 3,685 2,072
------ ------ ------ ------ ------
Accruing loans more than
90 days delinquent 31 355 1 19 5
------ ------ ------ ------ ------
Total non-performing loans 2,302 2,515 3,180 3,704 2,077
------ ------ ------ ------ ------
Real estate owned 887 947 297 1,663 1,672
------ ------ ------ ------ ------
Total non-performing assets $3,189 $3,462 $3,477 $5,367 $3,749
====== ====== ====== ====== ======
Troubled debt restructurings(3) $ $ $ 24 $ 46 $ 384
====== ====== ====== ====== ======
Total non-performing loans and
troubled debt restructurings
as a percentage of gross loans
receivable(4) .92% 1.07% 1.39% 1.85% 1.29%
====== ====== ====== ====== ======
Total non-performing assets
as a percentage of total assets .65% .75% .77% 1.29% 1.00%
====== ====== ====== ====== ======
Total non-performing assets and
troubled debt restructurings as
percentage of total assets .65% .75% .78% 1.30% 1.11%
====== ====== ====== ====== ======
- ----------
(1) Consists of two loans at September 30, 1999, 1998 and 1996 and one loan
at September 30, 2001 and 1997.
(2) Consists of three loans made to two borrowers at September 30, 1999,
six loans made to three borrowers at September 30, 1998 and two loans
at September 30, 1997.
(3) Consists of lease financing receivables at September 30, 1999, 1998 and
1997 from the Bennett Funding Group of Syracuse, New York ("Bennett
Funding"). The troubled debt restructurings entered into in 1997
performed in accordance with the terms of the agreements since the
restructurings.
(4) Includes loans receivable and loans held for sale, less construction
and land loans in process and deferred loan origination fees and
discounts.
14
The $1.9 million of single-family residential loans at September 30,
2001 consisted of 32 loans with principal balances ranging from $1,000 to
$219,000, with an average balance of approximately $60,200. Included within the
32 loans, are 9 loans aggregating $1.0 million to credit impaired borrowers.
At September 30, 2001, the $887,000 of real estate owned consisted of
12 single-family residential properties, with an average carrying value of
$74,000 with the largest having a carrying value of $270,000.
Other Classified Assets. Federal banking regulations require that each
insured savings association classify its assets on a regular basis. In addition,
in connection with examinations of insured institutions, federal examiners have
authority to identify problem assets and, if appropriate, classify them. There
are three classifications for problem assets: "substandard," "doubtful" and
"loss." Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full, on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified loss is considered uncollectible and of
such little value that continuance as an asset of the institution is not
warranted.
At September 30, 2001, the Bank had $3.5 million of assets classified
as substandard, and no assets classified as doubtful or loss. Substantially all
classified assets consist of non-performing assets.
Allowance for Loan Losses. The Bank's policy is to establish reserves
for estimated losses on delinquent loans when it determines that losses are
probable. The allowance for losses on loans is maintained at a level believed
adequate by management to absorb probable losses in its portfolio. Management's
determination of the adequacy of the allowance is based on an evaluation of the
portfolio, past loss experience, current economic conditions, volume, growth and
composition of the portfolio, and other relevant factors. The allowance is
increased by provisions for loan losses which are charged against income. The
level of provisions increased in fiscal 2001 and 2000 due to the Bank's
increasing originations of commercial and consumer loans which have a greater
inherent degree of credit risk. As shown in the table below, at September 30,
2001, the Bank's allowance for loan losses amounted to 94.74% and .87% of the
Bank's non-performing loans and gross loans receivable, respectively.
On July 6, 2001, the Securities and Exchange Commission (the "SEC")
issued Staff Accounting Bulletin ("SAB") No. 102, Selected Loan Loss Allowance
Methodology and Documentation Issues. The guidance contained in the SAB was
effective immediately. This SAB expresses the views of the SEC staff regarding a
registrant's development, documentation, and application of a systematic
methodology for determining the allowance for loan and lease losses, as required
by SEC Financial Reporting Release No. 28. The guidance in SAB No. 102 focuses
on the documentation the SEC staff normally expects registrants to prepare and
maintain in support of the allowance for loans and lease losses.
Concurrent with the SEC's issuance of SAB No. 102, the federal banking
agencies (the Federal Deposit Insurance Corporation (the "FDIC"), the Board of
Governors of the Federal Reserve System, the Office of the Comptroller of the
Currency and the Office of Thrift Supervision (the "OTS")) represented by the
Federal Financial Institutions Examination Council issued an interagency policy
statement entitled Allowance for Loan and Lease Losses Methodologies and
Documentation for Banks and Savings Institutions (the "Policy Statement"). SAB
No. 102 and the Policy Statement were the result of an agreement between the SEC
and the federal banking agencies in March 1999 to provide guidance on allowance
for loan and lease methodologies and supporting documentation.
The guidance contained in SAB No. 102 does not prescribe specific
allowance estimation methodologies registrants should employ in estimating their
allowance for loan and lease losses, but rather emphasizes the need for a
systematic methodology that is properly designed and implemented by registrants.
Management of the Bank presently believes that its allowance for loan
losses is adequate to cover any probable losses in the Bank's loan portfolio.
However, future adjustments to this allowance may be necessary, and the Bank's
results of operations could be adversely affected if circumstances differ
substantially from the assumptions used by management in making its
determinations in this regard.
15
The following table provides information regarding the changes in the
allowance for loan losses and other selected statistics for the periods
presented.
Year Ending September 30,
------------------------------------------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(Dollars in thousands)
Allowance for loan losses, beginning of
period $ 2,019 $ 1,928 $ 1,738 $ 1,628 $ 2,624
Charged-off loans:
Single-family residential (492) (182) (12) (86) (119)
Construction (117)
Commercial leases(1) (956)
Consumer and commercial business (40) (64) (60) (28) (177)
------- ------- ------- ------- -------
Total charged-off loans (532) (363) (72) (114) (1,252)
------- ------- ------- ------- -------
Recoveries on loans previously charged off:
Single-family residential 11 2 22 7
Construction 14 10
Commercial leases(1) 134 33
Consumer and commercial business 9 1 1 2
------- ------- ------- ------- -------
Total recoveries 154 34 3 38 17
------- ------- ------- ------- -------
Net loans charged-off (378) (329) (69) (76) (1,235)
Provision for loan losses 540 420 259 186 239
------- ------- ------- ------- -------
Allowance for loan losses, end of period $ 2,181 $ 2,019 $ 1,928 $ 1,738 $ 1,628
======= ======= ======= ======= =======
Net loans charged-off to average
loans outstanding(2) .16% .14% .03% .04% .68%
======= ======= ======= ======= =======
Allowance for loan losses
to gross loans receivable(2) .87% .86% .84% .86% .86%
======= ======= ======= ======= =======
Allowance for loan losses
to total non-performing loans 94.74% 80.28% 60.63% 46.92% 78.38%
======= ======= ======= ======= =======
Net loans charged-off to
allowance for loan losses 17.33% 16.30% 3.58% 4.37% 75.86%
======= ======= ======= ======= =======
Recoveries to charge-offs 28.95% 9.37% 4.17% 33.33% 1.36%
======= ======= ======= ======= =======
- ----------
(1) Relate to commercial lease purchases in prior years.
(2) Gross loans receivable and average loans outstanding include loans
receivable and loans held for sale, less construction and land loans in
process and deferred loan origination fees and discounts.
16
The following table presents the Bank's allocation of the allowance for
loan losses to the total amount of loans in each category listed at the dates
indicated.
September 30,
------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
----------------- ------------------ ------------------ ------------------ ------------------
% % % % %
of Loans of Loans of Loans of Loans of Loans
in Each in Each in Each in Each in Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Single-family residential $ 615 59.81% $1,098 65.54% $ 572 69.82% $ 446 71.34% $ 439 68.53%
Commercial and multi-
family residential 566 16.22 198 15.50 166 13.05 109 9.91 77 9.28
Construction 249 10.86 171 7.33 320 7.71 382 7.64 300 8.31
Consumer 70 10.07 49 9.80 42 8.50 63 10.44 67 12.87
Commercial business 87 3.04 60 1.83 14 .92 20 .67 31 1.01
Unallocated 594 443 814 718 714
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance for
loan losses $2,181 100.00% $2,019 100.00% $1,928 100.00% $1,738 100.00% $1,628 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
17
MORTGAGE-RELATED SECURITIES AND INVESTMENT SECURITIES
Mortgage-Related Securities. Federally chartered savings institutions
have authority to invest in various types of liquid assets, including U.S.
Treasury obligations, securities of various federal agencies and of state and
municipal governments, certificates of deposit at federally insured banks and
savings and loan associations, certain bankers' acceptances and federal funds.
Subject to various restrictions, federally chartered savings institutions also
may invest a portion of their assets in commercial paper, corporate debt
securities and mutual funds, the assets of which conform to the investments that
federally chartered savings institutions are otherwise authorized to make
directly.
The Bank maintains a significant portfolio of mortgage-related
securities (including mortgage-backed securities and collateralized mortgage
obligations ("CMOs")) as a means of investing in housing-related mortgage
instruments without the costs associated with originating mortgage loans for
portfolio retention and with limited credit risk of default which arises in
holding a portfolio of loans to maturity. Mortgage-backed securities (which also
are known as mortgage participation certificates or pass-through certificates)
represent a participation interest in a pool of single-family or multi-family
residential mortgages. The principal and interest payments on mortgage-backed
securities are passed from the mortgage originators, as servicer, through
intermediaries (generally U.S. Government agencies and government-sponsored
enterprises) that pool and repackage the participation interests in the form of
securities, to investors such as the Bank. Such U.S. Government agencies and
government sponsored enterprises, which guarantee the payment of principal and
interest to investors, primarily include FHLMC, FNMA and the Government National
Mortgage Association ("GNMA"). The Bank also invests in certain privately
issued, credit enhanced mortgage-related securities rated AAA by national
securities rating agencies.
FHLMC is a public corporation chartered by the U.S. Government. FHLMC
issues participation certificates backed principally by conventional mortgage
loans. FHLMC guarantees the timely payment of interest and the ultimate return
of principal on participation certificates. FNMA is a private corporation
chartered by the U.S. Congress with a mandate to establish a secondary market
for mortgage loans. FNMA guarantees the timely payment of principal and interest
on FNMA securities. FHLMC and FNMA securities are not backed by the full faith
and credit of the United States, but because FHLMC and FNMA are U.S.
Government-sponsored enterprises, these securities are considered to be among
the highest quality investments with minimal credit risks. GNMA is a government
agency within the Department of Housing and Urban Development which is intended
to help finance government-assisted housing programs. GNMA securities are backed
by Federal Housing Administration ("FHA") insured and the Department of Veterans
Affairs ("VA") guaranteed loans, and the timely payment of principal and
interest on GNMA securities are guaranteed by the GNMA and backed by the full
faith and credit of the U.S. Government. Because FHLMC, FNMA and GNMA were
established to provide support for low- and middle-income housing, there are
limits to the maximum size of loans that qualify for these programs which is
currently $300,700.
Mortgage-related securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
underlying pool of mortgages can be composed of either fixed-rate or
adjustable-rate loans. As a result, the risk characteristics of the underlying
pool of mortgages (i.e., fixed-rate or adjustable rate) as well as prepayment
risk, are passed on to the certificate holder. Thus, the life of a
mortgage-backed pass-through security thus approximates the life of the
underlying mortgages.
The Bank's mortgage-related securities include regular interests in
CMOs. CMOs were developed in response to investor concerns regarding the
uncertainty of cash flows associated with the prepayment option of the
underlying mortgagor and are typically issued by governmental agencies,
governmental sponsored enterprises and special purpose entities, such as trusts,
corporations or partnerships, established by financial institutions or other
similar institutions. A CMO can be (but is not required to be) collateralized by
loans or securities which are insured or guaranteed by FNMA, FHLMC or the GNMA.
In contrast to pass-through mortgage-related securities, in which cash flow is
received pro rata by all security holders, the cash flow from the mortgages
underlying a CMO is segmented and paid in accordance with a predetermined
priority to investors holding various CMO classes. By allocating the principal
and interest cash flows from the underlying collateral among the separate CMO
classes, different classes of bonds are created, each with its own stated
maturity, estimated average life, coupon rate and prepayment characteristics.
18
The short-term classes of a CMO usually carry a lower coupon rate than
the longer term classes and, therefore, the interest differential cash flow on a
residual interest is greatest in the early years of the CMO. As the early coupon
classes are extinguished, the residual income declines. Thus, the longer the
lower coupon classes remain outstanding, the greater the cash flow accruing to
CMO residuals. As interest rates decline, prepayments accelerate, the interest
differential narrows, and the cash flow from the CMO declines. Conversely, as
interest rates increase, prepayments decrease, generating a larger cash flow to
residuals.
A senior-subordinated structure often is used with CMOs to provide
credit enhancement for securities which are backed by collateral which is not
guaranteed by FNMA, FHLMC or the GNMA. These structures divide mortgage pools
into various risk classes: a senior class and one or more subordinated classes.
The subordinated classes provide protection to the senior class. When cash flow
is impaired, debt service goes first to the holders of senior classes. In
addition, incoming cash flows also may go into a reserve fund to meet any future
shortfalls of cash flow to holders of senior classes. The holders of
subordinated classes may not receive any funds until the holders of senior
classes have been paid and, when appropriate, until a specified level of funds
has been contributed to the reserve fund.
Mortgage-related securities generally bear yields which are less than
those of the loans which underlie such securities because of their payment
guarantees or credit enhancements which reduce credit risk to nominal levels. In
addition, mortgage-related securities are more liquid than individual mortgage
loans and may be used to collateralize certain obligations of the Bank. At
September 30, 2001, $19.9 million of the Bank's mortgage-related securities were
pledged to secure various obligations of the Bank, including reverse repurchase
agreements, treasury tax and loan processing, and as collateral for certain
government deposits.
The Bank's mortgage-related securities are classified as either "held
to maturity" or "available for sale" based upon the Bank's intent and ability to
hold such securities to maturity at the time of purchase, in accordance with
GAAP. As of September 30, 2001, the Bank had an aggregate of $129.1 million, or
26.4%, of total assets invested in mortgage-related securities, net, of which
$11.5 million was held to maturity and $117.6 million was available for sale.
The mortgage-related securities of the Bank which are held to maturity are
carried at cost, adjusted for the amortization of premiums and the accretion of
discounts using a method which approximates a level yield, while
mortgage-related securities available for sale are carried at the current fair
value. See Notes 2 and 4 of the Notes to Consolidated Financial Statements in
the Annual Report.
19
The following table sets forth the composition of the Bank's available
for sale (at fair value) and held to maturity (at amortized cost) of the
mortgage-related securities portfolios at the dates indicated.
September 30,
------------------------------------------
2001 2000 1999
---- ---- ----
Available for sale: (In thousands)
Mortgage-backed securities:
FHLMC $ 9,175 $ 5,771 $ 11,834
FNMA 15,056 23,546 31,955
GNMA 43,907 38,421 33,959
-------- ------- --------
Total mortgage-backed securities 68,138 67,738 77,748
-------- ------- --------
Collateralized mortgage obligations:
FHLMC 10,994 9,117 6,283
FNMA 6,215 6,905 9,115
GNMA 17 309 549
Other 32,244(1) 12,188 19,351
-------- ------- --------
Total collateralized mortgage obligations 49,470 28,519 35,298
-------- ------- --------
Total mortgage-related securities $117,608 $96,257 $113,046
======== ======= ========
Held to maturity:
Mortgage-backed securities:
FHLMC $ 2,285 $ 2,898 $ 3,156
FNMA 4,684 5,674 6,832
-------- ------- --------
Total mortgage-backed securities 6,969 8,572 9,988
-------- ------- --------
Collateralized mortgage obligations:
FHLMC 25
FNMA 4,485 4,484 4,484
-------- ------- --------
Total collateralized mortgage obligations 4,485 4,484 4,509
-------- ------- --------
Total mortgage-related securities, amortized cost $ 11,454 $13,056 $ 14,497
======== ======= ========
Total fair value(2) $ 11,550 $12,580 $ 14,100
======== ======= ========
- ----------
(1) Includes "AAA" rated securities of Northwest Asset Securities
Corporation, Chase Mortgage Services, Washington Mutual and Countrywide
Home Loans with book values of $5.5 million, $3.1 million, $4.2 million
and $5.0 million, respectively, and fair values of $5.7 million, $3.1
million, $4.3 million and $5.0 million, respectively.
(2) See Note 4 of the Notes to Consolidated Financial Statements in the
Annual Report.
20
The following table sets forth the purchases, sales and principal repayments of
the Bank's mortgage-related securities for the periods indicated.
Year Ended September 30,
---------------------------------------------
2001 2000 1999
---- ---- ----
(In thousands)
Mortgage-related securities, beginning of period(1)(2) $ 109,313 $ 127,543 $ 134,255
--------- --------- ---------
Purchases:
Mortgage-backed securities - available for sale 24,501 11,873 21,210
CMOs - available for sale 34,162 3,965 24,685
Sales:
Mortgage-backed securities - available for sale (6,888) (13,407)
CMOs - available for sale (5,132)
Repayments and prepayments:
Mortgage-backed securities (21,568) (10,410) (22,759)
CMOs (14,808) (5,675) (25,493)
Decrease in net premium (145) (62) (469)
Change in net unrealized gain (loss) on mortgage-related securities
available for sale 4,495 618 (3,886)
--------- --------- ---------
Net increase (decrease) in mortgage-related securities 19,749 (18,230) (6,712)
--------- --------- ---------
Mortgage-related securities, end of period(1) $ 129,062 $ 109,313 $ 127,543
========= ========= =========
- ----------
(1) Includes both mortgage-related securities available for sale and held
to maturity.
(2) Calculated at amortized cost for securities held to maturity and at
fair value for securities available for sale.
At September 30, 2001, the estimated weighted average maturity of the
Bank's fixed-rate mortgage-related securities was approximately 3.6 years. The
actual maturity of a mortgage-backed security is less than its stated maturity
due to prepayments of the underlying mortgages. Prepayments that are faster than
anticipated may shorten the life of the security and adversely affect its yield
to maturity. The yield is based upon the interest income and the amortization of
any premium or discount related to the mortgage-backed security. In accordance
with GAAP, premiums and discounts are amortized over the estimated lives of the
securities, which decrease and increase interest income, respectively. The
prepayment assumptions used to determine the amortization period for premiums
and discounts can significantly affect the yield of the mortgage-backed
security, and these assumptions are reviewed periodically to reflect actual
prepayments. Although prepayments of underlying mortgages depend on many
factors, including the type of mortgages, the coupon rate, the age of mortgages,
the geographical location of the underlying real estate collateralizing the
mortgages and general levels of market interest rates, the difference between
the interest rates on the underlying mortgages and the prevailing mortgage
interest rates generally is the most significant determinant of the rate of
prepayments. During periods of declining mortgage interest rates, such as the
Bank experienced during most of fiscal 2001, if the coupon rates of the
underlying mortgages exceed the prevailing market interest rates offered for
mortgage loans, refinancings generally increase and accelerate the prepayment
rate of the underlying mortgages and the related securities. Conversely, during
periods of increasing mortgage interest rates, if the coupon rates of the
underlying mortgages are less than the prevailing market interest rates offered
for mortgage loans, refinancings generally decrease and decrease the prepayment
rate of the underlying mortgages and the related securities. As a result, in a
declining interest rate environment, the Bank may be subject to reinvestment
risk because to the extent that the Bank's mortgage-related securities amortize
or prepay faster than anticipated, the Bank may not be able to reinvest the
proceeds of such repayments and prepayments at a comparable yield.
21
Investment Securities. The following table sets forth information regarding
the carrying and fair value of the Company's investment securities, both held to
maturity and available for sale, at the dates indicated.
At September 30,
-----------------------------------------------------------------------------------
2001 2000 1999
----------------------- ---------------------- -----------------------
Carrying Fair Carrying Fair Carrying Fair
Value Value Value Value Value Value
----- ----- ----- ----- ----- -----
(In thousands)
FHLB stock $ 6,917 $ 6,917 $ 6,672 $ 6,672 $ 6,157 $ 6,157
U.S. Government and agency
obligations
1 to 5 years 2,961 3,133 2,936 2,970 5,746 5,652
5 to 10 years 1,843 2,050 6,997 6,745 6,994 6,780
Municipal securities 21,890 22,626 18,930 18,153 18,924 17,873
Corporate bonds 14,333 14,087 4,910 4,596 4,909 4,639
Mutual funds 5,009 5,004 2,000 1,970 2,000 1,972
Asset backed securities 2,986 2,970
Preferred stocks 9,474 9,197 5,528 4,732 5,534 5,248
Other equity investments 2,778 3,497 2,778 3,049 2,390 2,151
------- ------- ------- ------- ------- -------
Total $68,191 $69,481 $50,751 $48,887 $52,654 $50,472
======= ======= ======= ======= ======= =======
At September 30, 2001, the Company had an aggregate of $69.5 million,
or 14.2%, of its total assets invested in investment securities, of which $6.9
million consisted of FHLB stock and $62.6 million was investment securities
available for sale. Included in U.S. Government and agency obligations is a
callable bond with a remaining term of approximately two years. The Bank's
investment securities (excluding equity securities and FHLB stock) had a
weighted average maturity to the call date of 6.1 years and a weighted average
yield of 6.57% (adjusted to a fully taxable equivalent yield).
SOURCES OF FUNDS
General. The Bank's principal source of funds for use in lending and
for other general business purposes has traditionally come from deposits
obtained through the Bank's branch offices. The Bank also derives funds from
contractual payments and prepayments of outstanding loans and mortgage-related
securities, from sales of loans, from maturing investment securities and from
advances from the FHLB of Pittsburgh and other borrowings. Loan repayments are a
relatively stable source of funds, while deposits inflows and outflows are
significantly influenced by general interest rates and money market conditions.
The Bank uses borrowings to supplement its deposits as a source of funds.
Deposits. The Bank's current deposit products include passbook
accounts, NOW accounts, MMDA, certificates of deposit ranging in terms from 30
days to five years and noninterest-bearing personal and business checking
accounts. The Bank's deposit products also include Individual Retirement Account
("IRA") certificates and Keogh accounts.
The Bank's deposits are obtained primarily from residents in Delaware
and Chester Counties in southeastern Pennsylvania. The Bank attracts local
deposit accounts by offering a wide variety of accounts, competitive interest
rates, and convenient branch office locations and service hours. The Bank
utilizes traditional marketing methods to attract new customers and savings
deposits, including print media, radio advertising and direct mailings. However,
the Bank does not solicit funds through deposit brokers nor does it pay any
brokerage fees if it accepts such deposits.
22
The Bank has been competitive in the types of accounts and interest
rates it has offered on its deposit products but does not necessarily seek to
match the highest rates paid by competing institutions. Even with the
significant decline in interest rates paid on deposit products in fiscal 2001,
due to generally declining returns on competing investment opportunities as well
as the effects of the stock market decline, the Bank did not experience
disintermediation of deposits into competing investment products in fiscal 2001.
The following table shows the distribution of, and certain information
relating to, the Bank's deposits by type of deposit as of the dates indicated.
September 30,
--------------------------------------------------------------------------------------
2001 2000 1999
------------------------ ------------------------ ------------------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
(Dollars in thousands)
Passbook $ 37,806 12.13% $ 37,861 13.89% $ 40,324 15.46%
MMDA 40,781 13.09 23,583 8.65 19,417 7.45
NOW 45,161 14.49 38,898 14.27 33,412 12.81
Certificates of deposit 182,155 58.46 165,456 60.71 159,761 61.25
Noninterest-bearing 5,698 1.83 6,764 2.48 7,912 3.03
-------- -------- -------- -------- -------- --------
Total deposits $311,601 100.00% $272,562 100.00% $260,826 100.00%
======== ======== ======== ======== ======== ========
The following table sets forth the net savings flows of the Bank during
the periods indicated.
Year Ended September 30,
-------------------------------------
2001 2000 1999
---- ---- ----
(In thousands)
Increase before interest credited $27,876 $ 1,894 $ 4,336
Interest credited 11,163 9,842 9,179
------- ------- -------
Net savings increase $39,039 $11,736 $13,515
======= ======= =======
The following table sets forth maturities of the Bank's certificates of
deposit of $100,000 or more at September 30, 2001 by time remaining to maturity.
Amounts in
Thousands
---------
Three months or less $12,688
Over three months through six months 7,624
Over six months through twelve months 5,782
Over twelve months 4,685
-------
$30,779
=======
23
The following table presents, by various interest rate categories, the
amount of certificates of deposit at September 30, 2001 and 2000 and the amounts
at September 30, 2001 which mature during the periods indicated.
Amounts at September 30, 2001
September 30, Maturing Within
------------------------ ------------------------------------------------------
Certificates of
Deposit 2001 2000 One Year Two Years Three Years Thereafter
------- ---- ---- -------- --------- ----------- ----------
(Dollars in thousands)
3.0% or less $ 3,694 $ 1,886 $ 1,808
3.01% to 4.0% 23,209 $ 386 19,250 1,496 $ 803 $1,660
4.01% to 5.0% 45,287 24,013 38,240 3,826 1,799 1,422
5.01% to 6.0% 26,107 39,929 16,270 3,511 717 5,609
6.01% to 7.0% 83,858 101,128 74,262 106 9,267 223
-------- -------- -------- ------- ------- ------
Total certificate accounts $182,155 $165,456 $149,908 $10,747 $12,586 $8,914
======== ======== ======== ======= ======= ======
The following table presents the average balance of each deposit type
and the average rate paid on each deposit type for the periods indicated.
September 30,
-------------------------------------------------------------------------------------------
2001 2000 1999
------------------------- -------------------------- --------------------------
Average Average Average
Average Rate Average Rate Average Rate
Balance Paid Balance Paid Balance Paid
------- ---- ------- ---- ------- ----
(Dollars in thousands)
Passbook accounts $ 37,661 2.41% $ 39,498 2.41% $ 39,625 2.41%
MMDA accounts 31,645 3.86 17,345 3.44 17,833 2.82
Certificates of deposit 177,086 5.87 164,783 5.61 157,134 5.33
NOW accounts 40,681 1.32 39,918 1.40 34,581 1.27
Noninterest-bearing deposits 7,658 6,613 6,360
-------- -------- --------
Total deposits $294,731 4.43% $268,157 4.23% $255,533 4.02%
======== ==== ======== ==== ======== ====
24
Borrowings. The Bank may obtain advances from the FHLB of Pittsburgh
upon the security of the common stock it owns in the FHLB and certain of its
residential mortgage loans and securities held to maturity, provided certain
standards related to creditworthiness have been met. Such advances are made
pursuant to several credit programs, each of which has its own interest rate and
range of maturities. During fiscal 2001, deposit increases exceeded asset growth
which allowed the Bank to repay some of the existing FHLB advances. The Bank,
during fiscal 2000 and 1999, increased its FHLB borrowings to fund asset growth.
At September 30, 2001, the Bank had $126.1 million in outstanding FHLB advances.
See Note 9 of the Notes to Consolidated Financial Statements in the Annual
Report for additional information.
The Bank has entered into agreements to sell securities under terms
which require it to repurchase the same or substantially similar securities by a
specified date. Repurchase agreements are considered borrowings which are
secured by the sold securities. At September 30, 2000, the Bank had $10.0
million of repurchase agreements outstanding callable within one year. There
were no outstanding repurchase agreements during the year ended September 30,
2001. See Note 10 of the Notes to Consolidated Financial Statements in the
Annual Report.
Both the FHLB advances and the repurchase agreements have certain call
features whereby the issuer can call the borrowings after the expiration of
certain time frames. The time frames on the callable borrowings range from three
months to seven years.
SUBSIDIARIES
The Bank is permitted to invest up to 2% of its assets in the capital
stock of, or secured or unsecured loans to, service corporations, with an
additional investment of 1% of assets when such additional investment is
utilized primarily for community development purposes. It may invest essentially
unlimited amounts in subsidiaries deemed operating subsidiaries that can only
engage in activities that the Bank is permitted to engage in. Under such
limitations, as of September 30, 2001, the Bank was authorized to invest up to
approximately $9.6 million in the stock of, or loans to, service corporations.
As of September 30, 2001, the net book value of the Bank's investment in stock,
unsecured loans, and conforming loans to its service corporations was $39,600.
At September 30, 2001, in addition to the Bank, the Company has five
direct or indirect subsidiaries: First Keystone Capital Trust I, FKF Management
Corp., Inc., State Street Services Corp., First Pointe, Inc., and First Chester
Services, Inc.
First Keystone Capital Trust I (the "Trust") is a Delaware statutory
business trust wholly owned by the Company formed in 1997 for the purpose of
issuing trust preferred securities and investing the proceeds therefrom in
Junior Subordinated Debentures issued by the Company. See Note 17 of the Notes
to Consolidated Financial Statements in the Annual Report for further discussion
regarding the issuance of trust preferred securities.
25
FKF Management Corp., Inc., a Delaware corporation, is a wholly owned
operating subsidiary of the Bank established in 1997 for the purpose of managing
assets of the Bank. Assets under management totaled $145.6 million at September
30, 2001 and were comprised principally of investment and mortgage-related
securities.
State Street Services Corp. is a wholly owned subsidiary of the Bank
established in 1999 for the purpose of offering a full array of insurance
products through its ownership of a 51% interest in First Keystone Insurance
Services, LLC. In addition, it holds a 10% equity position in a title company
which offers title services.
First Pointe, Inc. is a wholly owned subsidiary of the Bank which was
formed for the purpose of developing a real estate parcel received in a
deed-in-lieu of foreclosure action. At September 30, 2000, all of the townhouses
had been completed and sold.
The Bank has one remaining subsidiary, First Chester Services, Inc.,
which was involved in real estate management but is now inactive.
EMPLOYEES
The Bank had 78 full-time employees and 8 part-time employees as of
September 30, 2001. None of these employees is represented by a collective
bargaining agreement. The Bank believes that it enjoys excellent relations with
its personnel.
26
REGULATION
The Company. The Company as a savings and loan holding company within
the meaning of the Home Owners' Loan Act, as amended ("HOLA"), is registered as
such with the OTS and is subject to OTS regulations, examinations, supervision
and reporting requirements. As a subsidiary of a savings and loan holding
company, the Bank is subject to certain restrictions in its dealings with the
Company and affiliates thereof.
Federal Activities Restrictions. The Company operates as a unitary
savings and loan holding company. Generally, there are only limited restrictions
on the activities of a unitary savings and loan holding company which applied to
become or were a unitary saving and loan holding company prior to May 4, 1999
and its non-savings institution subsidiaries. Under the enacted
Gramm-Leach-Bliley Act of 1999 (the "GLBA"), companies which apply to the OTS to
become unitary savings and loan holding companies will be restricted to only
engaging in those activities traditionally permitted to multiple saving and loan
holding companies. However, if the Director of the OTS determines that there is
reasonable cause to believe that the continuation by a savings and loan holding
company of an activity constitutes a serious risk to the financial safety,
soundness or stability of its subsidiary savings association, the Director may
impose such restrictions as deemed necessary to address such risk, including
limiting (i) payment of dividends by the savings association; (ii) transactions
between the savings association and its affiliates; and (iii) any activities of
the savings association that might create a serious risk that the liabilities of
the holding company and its affiliates may be imposed on the savings
association. Notwithstanding the above rules as to permissible business
activities of grandfathered unitary savings and loan holding companies under the
GBLA (such as the Company), if the savings association subsidiary of such a
holding company fails to meet a Qualified Thrift Lender ("QTL") test, then such
unitary holding company also shall become subject to the activities restrictions
applicable to multiple savings and loan holding companies and, unless the
savings association qualifies as a QTL within one year thereafter, shall
register as, and become subject to the restrictions applicable to, a bank
holding company. See "- The Bank - Qualified Thrift Lender Test."
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company and
would thereafter be subject to further restrictions on its activities.
The GLBA also imposed new financial privacy obligations and reporting
requirements on all financial institutions. The privacy regulations require,
among other things, that financial institutions establish privacy policies and
disclose such policies to its customers at the commencement of a customer
relationship and annually thereafter. In addition, financial institutions are
required to permit customers to opt out of the financial institution's
disclosure of the customer's financial information to non-affiliated third
parties. Such regulations become mandatory as of July 1, 2001.
The HOLA requires every savings institution subsidiary of a savings and
loan holding company to give the OTS at least 30 days' advance notice of any
proposed dividends to be made on its guarantee, permanent or other
nonwithdrawable stock, or else such dividend will be invalid. See "- The Bank -
Restrictions on Capital Distributions."
Limitations on Transactions with Affiliates. Transactions between
savings associations and any affiliate are governed by Sections 23A and 23B of
the Federal Reserve Act ("FRA") and OTS regulations issued in connection
therewith. Affiliates of a savings institution include, among other entities,
the savings institution's holding company and companies that are controlled by
or under common control with the savings institution. Generally, Sections 23A
and 23B (i) limit the extent to which the savings association or its
subsidiaries may engage in "covered transactions" with any one affiliate to an
amount equal to 10% of such association's capital stock and surplus, and contain
an aggregate limit on all such transactions with all affiliates to an amount
equal to 20% of such capital stock and surplus and (ii) require that all such
transactions be on terms substantially the same, or at least as favorable, to
the association or subsidiary as those provided to a non-affiliate. The term
"covered transaction" includes, among other things, the making of loans or
extension of credit to an affiliate, purchase of assets, issuance of a guarantee
and similar transactions. In addition to the restrictions imposed by Sections
23A and 23B, under OTS regulations no savings association may (i) loan or
otherwise extend credit to an affiliate, except for any affiliate which engages
only in activities which are permissible for bank holding companies, (ii) a
savings association may not purchase or invest in securities of an affiliate
other than shares of a subsidiary; (iii) a savings association and its
subsidiaries may not purchase a low-quality asset
27
from an affiliate; (iv) and covered transactions and certain other transactions
between a savings association or its subsidiaries and an affiliate must be on
terms and conditions that are consistent with safe and sound banking practices.
With certain exceptions, each extension of credit by a savings association to an
affiliate must be secured by collateral with a market value ranging from 100% to
130% (depending on the type of collateral) of the amount of the loan or
extension of credit.
OTS regulations generally exclude all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve Board decides to treat
such subsidiaries as affiliates. The regulations also require savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail, and provide that certain classes of savings associations may
be required to give the OTS prior notice of affiliate transactions.
Restrictions on Acquisitions. Except under limited circumstances,
savings and loan holding companies are prohibited from acquiring, without prior
approval of the Director of the OTS, (i) control of any other savings
association or savings and loan holding company or substantially all the assets
thereof or (ii) more than 5% of the voting shares of a savings association or
holding company thereof which is not a subsidiary. Except with the prior
approval of the Director of the OTS, no director or officer of a savings and
loan holding company or person owning or controlling by proxy or otherwise more
than 25% of such company's stock, may acquire control of any savings
association, other than a subsidiary savings association, or of any other
savings and loan holding company.
Federal Securities Laws. The Company's Common Stock is registered with
the SEC under the Securities Exchange Act of 1934, as amended ("Exchange Act").
The Company is subject to the information, proxy solicitation, insider trading
restrictions and other requirements under the Exchange Act.
Shares of Common Stock owned by an affiliate of the Company are subject
to the resale restrictions of Rule 144 under the Securities Act of 1933, as
amended ("Securities Act"). If the Company meets the current public information
requirements of Rule 144 under the Securities Act, each affiliate of the Company
who complies with the other conditions of Rule 144 (including those that require
the affiliate's sale to be aggregated with those of certain other persons)
generally is able to sell in the public market, without registration, a number
of shares not to exceed, in any three-month period, the greater of (i) 1% of the
outstanding shares of the Company or (ii) the average weekly volume of trading
in such shares during the preceding four calendar weeks.
The Bank. The OTS has extensive regulatory authority over the
operations of savings associations. As part of this authority, savings
associations are required to file periodic reports with the OTS and are subject
to periodic examinations by the OTS. The investment and lending authority of
savings associations are prescribed by federal laws and regulations and they are
prohibited from engaging in any activities not permitted by such laws and
regulations. Those laws and regulations generally are applicable to all
federally chartered savings associations and may also apply to state-chartered
savings associations. Such regulation and supervision is primarily intended for
the protection of depositors.
Insurance of Accounts. The deposits of the Bank are insured to the
maximum extent permitted by the SAIF, which is administered by the FDIC, and are
backed by the full faith and credit of the U. S. Government. As insurer, the
FDIC is authorized to conduct examinations of, and to require reporting by,
FDIC-insured institutions. It also may prohibit any FDIC-insured institution
from engaging in any activity the FDIC determines by regulation or order to pose
a serious threat to the FDIC. The FDIC also has the authority to initiate
enforcement actions against savings associations, after giving the OTS an
opportunity to take such action.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is not aware of any existing circumstances which could
result in termination of the Bank's deposit insurance.
28
Capital requirements. Current OTS capital standards require savings
associations to satisfy three different capital requirements. Under these
standards, savings associations must maintain "tangible" capital equal to 1.5%
of adjusted total assets, "core" capital equal to 4% (3% if the association
receives the OTS' highest rating) of adjusted total assets and "total" capital
(a combination of core and "supplementary" capital) equal to 8.0% of
"risk-weighted" assets. For purposes of the regulation, core capital generally
consists of common stockholders' equity (including retained earnings),
noncumulative perpetual preferred stock and related surplus, minority interests
in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Tangible capital is given the same definition as core capital but
does not include qualifying supervisory goodwill and is reduced by the amount of
all the savings association's intangible assets, with only a limited exception
for purchased mortgage servicing rights ("PMSRs"). Both core and tangible
capital are further reduced by an amount equal to a savings association's debt
and equity investments in subsidiaries engaged in activities not permissible for
national banks (other than subsidiaries engaged in activities undertaken as
agent for customers or in mortgage banking activities and subsidiary depository
institutions or their holding companies). In addition, under the Prompt
Corrective Action provisions of the OTS regulations, all but the most highly
rated institutions must maintain a minimum leverage ratio of 4% in order to be
adequately capitalized. See "- Prompt Corrective Action." At September 30,
2001, the Bank did not have any investment in subsidiaries engaged in
impermissible activities and required to be deducted from its capital
calculation.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") granted the OTS the authority to prescribe rules for the amount of
PMSRs that may be included in a savings association's regulatory capital and
required that the value of readily marketable PMSRs included in the calculation
of a savings association's regulatory capital not exceed 90% of fair market
value and that such value be determined at least quarterly. Under OTS
regulations, (i) PMSRs do not have to be deducted from tangible and core
regulatory capital, provided that they do not exceed 50% of core capital, (ii)
savings associations are required to determine the fair market value and to
review the book value of their PMSRs at least quarterly and to obtain an
independent valuation of PMSRs annually, (iii) savings associations that desire
to include PMSRs in regulatory capital may not carry them at a book value under
GAAP that exceeds the discounted value of their future net income stream and
(iv) for purposes of calculating regulatory capital, the amount of PMSRs
reported as balance sheet assets should amount to the lesser of 90% of their
fair market value, 90% of their original purchase price or 100% of their
remaining unamortized book value. At September 30, 2001, the Bank had PMSRs
totalling $45,500.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital does not exceed the savings association's core capital. Supplementary
capital generally consists of hybrid capital instruments; perpetual preferred
stock which is not eligible to be included as core capital; subordinated debt
and intermediate-term preferred stock; and, subject to limitations, general
allowances for loan losses. Assets are adjusted under the risk-based guidelines
to take into account different risk characteristics, with the categories ranging
from 0% (requiring no additional capital) for assets such as cash to 100% for
repossessed assets or loans more than 90 days past due. Single-family
residential real estate loans which are not past-due or non-performing and which
have been made in accordance with prudent underwriting standards are assigned a
50% level in the risk-weighing system, as are certain privately-issued
mortgage-backed securities representing indirect ownership of such loans.
Off-balance sheet items also are adjusted to take into account certain risk
characteristics.
The OTS amended its risk-based capital requirements that would require
institutions with an "above normal" level of interest rate risk to maintain
additional capital. A savings association is considered to have a "normal" level
of interest rate risk if the decline in the market value of its portfolio equity
after an immediate 200 basis point increase or decrease in market interest rates
(whichever leads to the greater decline) is less than two percent of the current
estimated market value of its assets. The market value of portfolio equity is
defined as the net present value of expected cash inflows and outflows from an
association's assets, liabilities, and off-balance sheet items. The amount of
additional capital, that an institution with an above normal interest rate risk
is required to maintain (the "interest rate risk component") equals one-half of
the dollar amount by which its measured interest rate risk exceeds the normal
level of interest rate risk. The interest rate risk component is in addition to
the capital otherwise required to satisfy the risk-based capital requirement.
Implementation of this component has been postponed by the OTS. The final rule
was to be effective as of January 1,
29
1994, subject however to a three quarter lag time in implementation. However,
because of continuing delays by the OTS, the interest rate risk component has
never been operative.
At September 30, 2001, the Bank exceeded all of its regulatory capital
requirements, with tangible, core and risk-based capital ratios of 7.8%, 7.8%,
and 16.8%, respectively. See Note 12 to the Notes to Consolidated Financial
Statements included in the Annual Report.
The OTS and the FDIC generally are authorized to take enforcement
action against a savings association that fails to meet its capital
requirements, which action may include restrictions on operations and banking
activities, the imposition of a capital directive, a cease-and-desist order,
civil money penalties or harsher measures such as the appointment of a receiver
or conservator or a forced merger into another institution. In addition, under
current regulatory policy, an association that fails to meet its capital
requirements is prohibited from paying any dividends.
30
The following is a reconciliation of the Bank's equity determined in
accordance with GAAP to regulatory tangible, core and risk-based capital at
September 30, 2001, 2000 and 1999.
September 30, 2001 September 30, 2000 September 30, 1999
-------------------------------- ----------------------------- ------------------------------
Tangible Core Risk-based Tangible Core Risk-based Tangible Core Risk-based
Capital Capital Capital Capital Capital Capital Capital Capital Capital
------- ------- ------- ------- ------- ------- ------- ------- -------
(In thousands)
GAAP equity $ 37,211 $37,211 $37,211 $38,127 $38,127 $38,127 $36,467 $36,467 $36,467
Assets required to be deducted(1) (511)
General valuation allowances 1,883 1,667 1,813
-------- ------- ------- ------- ------- ------- ------- ------- -------
Total regulatory capital 37,211 37,211 39,094 38,127 38,127 39,283 36,467 36,467 38,280
Minimum capital requirement per
FIRREA published guidelines 7,189 19,172 18,602 6,874 18,332 17,782 6,696 17,586 16,294
-------- ------- ------- ------- ------- ------- ------- ------- -------
Excess $ 30,022 $18,039 $20,492 $31,253 $19,795 $21,501 $29,771 $18,881 $21,986
======== ======= ======= ======= ======= ======= ======= ======= =======
- ----------
(1) Consists of equity investment non-includable in regulatory capital.
These capital requirements are viewed as minimum standards by the OTS,
and most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings association's capital, upon a determination that
circumstances exist that higher individual minimum capital requirements may be
appropriate.
31
Prompt Corrective Action. Under the prompt corrective action
regulations of the OTS, an institution shall be deemed to be (i) "well
capitalized" if it has total risk-based capital of 10% or more, has a Tier I
risk-based capital ratio of 6% or more, has a Tier I leverage capital ratio of
5% or more and is not subject to any order or final capital directive to meet
and maintain a specific capital level for any capital measure, (ii) "adequately
capitalized" if it has a total risk-based capital ratio of 8% or more, a Tier I
risk-based capital ratio of 4% or more and a Tier I leverage capital ratio of 4%
or more (3% under certain circumstances) and does not meet the definition of
"well capitalized," (iii) "undercapitalized" if it has a total risk-based
capital ratio that is less than 8%, a Tier I risk-based capital ratio that is
less than 4% or a Tier I leverage capital ratio that is less than 4% (3% under
certain circumstances), (iv) "significantly undercapitalized" if it has a total
risk-based capital ratio that is less than 6%, a Tier I risk-based capital ratio
that is less than 3% or a Tier I leverage capital ratio that is less than 3%,
and (v) "critically undercapitalized" if it has a ratio of tangible equity to
total assets that is equal to or less than 2%. Under specified circumstances,
the OTS may reclassify a well capitalized institution as adequately capitalized
and may require an adequately capitalized institution or an undercapitalized
institution to comply with supervisory actions as if it were in the next lower
category (except that the FDIC may not reclassify a significantly
undercapitalized institution as critically undercapitalized). At September 30,
2001, the Bank met the requirements of a "well capitalized" institution under
OTS regulations.
Liquidity Requirements. All savings institutions were previously
required to maintain an average daily balance of liquid assets equal to a
certain percentage of the sum of its average daily balance of net withdrawable
deposit accounts and borrowings payable in one year or less. The liquidity
requirement varied from time to time (between 4% and 10%) depending upon
economic conditions and savings flows of all savings institutions. During 2000,
the required minimum liquid asset ratio was 4%. This regulation was discontinued
by the OTS effective in 2001.
Qualified Thrift Lender Test. A savings association can comply with the
QTL test by either meeting the QTL test set forth in the HOLA and the
implementing regulations or qualifying as a domestic building and loan
association as defined in Section 7701(a)(19) of the Internal Revenue Code of
1986, as amended ("Code"). Currently, the portion of the QTL test that is based
on the HOLA rather than the Code requires that 65% of an institution's
"portfolio assets" (as defined) consist of certain housing and consumer-related
assets on a monthly average basis in nine out of every 12 months. Assets that
qualify without limit for inclusion as part of the 65% requirement are loans
made to purchase, refinance, construct, improve or repair domestic residential
housing and manufactured housing, home equity loans, mortgage-backed securities
(where the mortgages are secured by domestic residential housing or manufactured
housing), stock issued by the FHLB, and direct or indirect obligations of the
FDIC. In addition, small business loans, credit card loans, student loans and
loans for personal, family and household purposes are allowed to be included
without limitation as qualified investments. The following assets, among others,
also may be included in meeting the test subject to an overall limit of 20% of
the savings institution's portfolio assets: 50% of residential mortgage loans
originated and sold within 90 days of origination, 100% of consumer and
educational loans (limited to 10% of total portfolio assets) and stock issued by
FHLMC or FNMA. Portfolio assets consist of total assets minus the sum of (i)
goodwill and other intangible assets, (ii) property used by the savings
institution to conduct its business, and (iii) liquid assets up to 20% of the
institution's total assets.
A savings institution that does not comply with the QTL test must
either convert to a bank charter or comply with certain restrictions on its
operations. Upon the expiration of three years from the date the association
ceases to be a QTL, it must cease any activity and not retain any investment not
permissible for a national bank and immediately repay any outstanding FHLB
advances (subject to safety and soundness considerations).
At September 30, 2001, approximately 78.08% of the Bank's assets were
invested in qualified thrift investments, which was in excess of the percentage
required to qualify the Bank under the QTL test in effect at that time.
32
Restrictions on Capital Distributions. OTS regulations govern capital
distributions by savings associations, which include cash dividends, stock
redemptions or repurchases, cash-out mergers, interest payments on certain
convertible debt and other transactions charged to the capital account of a
savings association to make capital distributions. Generally, the regulation
creates a safe harbor for specified levels of capital distributions (as a
percentage of income) from associations meeting at least their minimum capital
requirements, so long as such associations notify the OTS and receive no
objection to the distribution from the OTS. Savings institutions and
distributions that do not qualify for the safe harbor are required to obtain
prior OTS approval before making any capital distributions.
Generally, savings associations such as the Bank can, upon 30 days
prior notice, distribute during each calendar year an amount equal to or less
than its net income for the year to date plus retained net income (which takes
into account distributions in such periods) for the preceding two years. Amounts
in excess of this must be approved by the OTS.
OTS regulations also prohibit the Bank from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
(or total) capital of the Bank would be reduced below the amount required to be
maintained for the liquidation account established by it for certain depositors
in connection with its conversion from mutual to stock form.
Community Reinvestment. Under the Community Reinvestment Act of 1977,
as amended ("CRA"), as implemented by OTS regulations, a savings association has
a continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with the CRA.
The Bank received a satisfactory rating as a result of its last OTS evaluation.
Policy Statement on Nationwide Branching. OTS policy on branching by
federally chartered savings associations permits nationwide branching to the
extent allowed by federal statute. Current OTS policy generally permits a
federally chartered savings association to establish branch offices outside of
its home state if the association meets the domestic building and loan test in
Section 7701(a)(19) of the Code or the asset composition test of subparagraph
(c) of that section, and if, with respect to each state outside of its home
state where the association has established branches, the branches, taken alone,
also satisfy one of the two tax tests. An association seeking to take advantage
of this authority would have to have a branching application approved by the
OTS, which would consider the regulatory capital of the association and its
record under the CRA, as amended, among other things.
Federal Home Loan Bank System. The Bank is a member of the FHLB of
Pittsburgh, which is one of 12 regional FHLBs that administers the home
financing credit function of savings associations. Each FHLB serves as a reserve
or central bank for its members within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures established by the Board of Directors of the FHLB.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Pittsburgh in an amount equal to at least 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year or 5% of its advances from the FHLB of Pittsburgh,
whichever is greater. At September 30, 2001, the Bank had $6.9 million in FHLB
stock, which was in compliance with this requirement.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest on
advances to their members. For the years ended September 30, 2001, 2000 and
1999, dividends from the FHLB to the Bank amounted to approximately $471,000,
$428,000 and $375,000, respectively. If dividends were reduced, the Bank's net
interest income would likely also be
33
reduced. Further, there can be no assurance that the impact of recent or future
legislation on the FHLBs will not also cause a decrease in the value of FHLB
stock held by the Bank, if any.
Federal Reserve System. The Board of Governors of The Federal Reserve
System ("FRB") requires all depository institutions to maintain reserves against
their transaction accounts (primarily NOW and Super NOW checking accounts) and
non-personal time deposits. At September 30, 2001, the Bank was in compliance
with applicable requirements. However, because required reserves must be
maintained in the form of vault cash or a noninterest-bearing account at a FRB,
the effect of this reserve requirement is to reduce an institution's earning
assets.
Safety and Soundness Guidelines. The OTS and the other federal banking
agencies have established guidelines for safety and soundness, addressing
operational and managerial, as well as compensation matters for insured
financial institutions. Institutions failing to meet these standards are
required to submit compliance plans to their appropriate federal regulators. The
OTS and the other agencies have also established guidelines regarding asset
quality and earnings standards for insured institutions.
34
FEDERAL AND STATE TAXATION
General. The Company and the Bank are subject to the corporate tax
provisions of the Code, as well as certain additional provisions of the Code
which apply to thrift and other types of financial institutions. The following
discussion of tax matters is intended only as a summary and does not purport to
be a comprehensive description of the tax rules applicable to the Company and
the Bank.
Fiscal Year. The Company and the Bank and its subsidiaries file a
consolidated federal income tax return on a fiscal year basis ending September
30.
Method of Accounting. The Bank maintains its books and records for
federal income tax purposes using the accrual method of accounting. The accrual
method of accounting generally requires that items of income be recognized when
all events have occurred that establish the right to receive the income and the
amount of income can be determined with reasonable accuracy, and that items of
expense be deducted at the later of (i) the time when all events have occurred
that establish the liability to pay the expense and the amount of such liability
can be determined with reasonable accuracy or (ii) the time when economic
performance with respect to the item of expense has occurred.
Bad Debt Reserves. The Bank is permitted to establish reserves for bad
debts and to make annual additions thereto which qualify as deductions from
taxable income. The Company, as of October 1, 1996, changed its method of
computing reserves for bad debts to the experience method (the "Experience
Method"). The bad debt deduction allowable under this method is available to
small banks with assets less than $500 million. Generally, this method will
allow the Company to deduct an annual addition to the reserve for bad debts
equal to the increase in the balance of the Company's reserve for bad debts at
the end of the year to an amount equal to the percentage of total loans at the
end of the year, computed using the ratio of the previous six years net charge
offs divided by the sum of the previous six years total outstanding loans at
year end.
The Bank treated such change as a change in a method of accounting
determined solely with respect to the "applicable excess reserves" of the
institution. The amount of the applicable excess reserves will be taken into
account ratably over a six-taxable year period, beginning with the first taxable
year beginning after December 31, 1995. The timing of the recapture may be
delayed for a two-year period provided certain residential lending requirements
are met. For financial reporting purposes, the Company will not incur any
additional tax expense. At September 30, 1997, under SFAS No. 109, deferred
taxes were provided on the difference between the book reserve at September 30,
1997 and the applicable excess reserve in an amount equal to the Bank's increase
in the tax reserve from December 31, 1987 to September 30, 1997.
Distributions. While the Bank maintains a bad debt reserve, if it were
to distribute cash or property to its sole stockholder having a total fair
market value in excess of its accumulated tax-paid earnings and profits, or were
to distribute cash or property to its stockholder in redemption of its stock,
the Bank would generally be required to recognize as income an amount which,
when reduced by the amount of federal income tax that would be attributable to
the inclusion of such amount in income, is equal to the lesser of: (i) the
amount of the distribution or (ii) the sum of (a) the amount of the accumulated
bad debt reserve of the Bank with respect to qualifying real property loans (to
the extent that additions to such reserve exceed the additions that would be
permitted under the experience method) and (b) the amount of the Bank's
supplemental bad debt reserve.
Minimum Tax. The Code imposes an alternative minimum tax at a rate of
20% on a base of regular taxable income plus certain tax preferences
("alternative minimum taxable income" or "AMTI"). The alternative minimum tax is
payable to the extent such AMTI is in excess of an exemption amount. The Code
provides that an item of tax preference is the excess of the bad debt deduction
allowable for a taxable year pursuant to the percentage of taxable income method
over the amount allowable under the experience method. The other items of tax
preference that constitute AMTI include (a) tax-exempt interest on newly-issued
(generally, issued on or after August 8, 1986) private activity bonds other than
certain qualified bonds and (b) for taxable years beginning after 1989, 75% of
the excess (if any) of (i) adjusted current
35
earnings as defined in the Code, over (ii) AMTI (determined without regard to
this preference and prior to reduction by net operating losses). Net operating
losses can offset no more than 90% of AMTI. Certain payments of alternative
minimum tax may be used as credits against regular tax liabilities in future
years.
Audit by IRS. The Bank's consolidated federal income tax returns for
taxable years through September 30, 1998 have been closed for the purpose of
examination by the IRS.
STATE TAXATION
The Company and the Bank's subsidiaries are subject to the Pennsylvania
Corporate Net Income Tax and Capital Stock and Franchise Tax. The Corporate Net
Income Tax rate for fiscal 2001 is 9.99% and is imposed on the Company's
unconsolidated taxable income for federal purposes with certain adjustments. In
general, the Capital Stock Tax is a property tax imposed at the rate of 1.1% of
a corporation's capital stock value, which is determined in accordance with a
fixed formula.
The Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax
Act (the ("MTIT"), as amended to include thrift institutions having capital
stock. Pursuant to the MTIT, the Bank's tax rate is 11.5%. The MTIT exempts the
Bank from all other taxes imposed by the Commonwealth of Pennsylvania for state
income tax purposes and from all local taxation imposed by political
subdivisions, except taxes on real estate and real estate transfers. The MTIT is
a tax upon net earnings, determined in accordance with GAAP with certain
adjustments. The MTIT, in computing GAAP income, allows for the deduction of
interest earned on state and federal securities, while disallowing a percentage
of a thrift's interest expense deduction in the proportion of interest income on
those securities to the overall interest income of the Bank. Net operating
losses, if any, thereafter can be carried forward three years for MTIT purposes.
36
ITEM 2. PROPERTIES
At September 30, 2001, the Bank conducted business from its
executive offices located in Media, Pennsylvania and six full-service
offices located in Delaware and Chester Counties, Pennsylvania. See
also Note 7 of the Notes to Consolidated Financial Statements in the
Annual Report.
The following table sets forth certain information with
respect to the Bank's offices at September 30, 2001.
Net Book Value Amount of
Description/Address Leased/Owned of Property Deposits
------------------- ------------ ----------- --------
(In thousands)
Executive Offices:
22 West State Street
Media, Pennsylvania 19063 Owned(1) $1,252 $ 90,735
Branch Offices:
3218 Edgmont Avenue
Brookhaven, Pennsylvania 19015 Owned 451 85,766
Routes 1 and 100
Chadds Ford, Pennsylvania 19318 Leased(2) 92 24,536
23 East Fifth Street
Chester, Pennsylvania 19013 Leased(3) 152 24,297
31 Baltimore Pike
Chester Heights, Pennsylvania 19017 Leased(4) 668 21,229
Route 82 and 926
Kennett Square, Pennsylvania 19348 Leased(5) 43 9,558
330 Dartmouth Avenue
Swarthmore, Pennsylvania 19081 Owned 111 55,480
------ --------
$2,769 $311,601
====== ========
- ----------
(1) Also a branch office.
(2) Lease expiration date is September 30, 2005. The Bank has one five-year
renewal option.
(3) Lease expiration date is December 31, 2005. The Bank has one ten-year
renewal option.
(4) Lease expiration date is December 31, 2028. The Bank has options to
cancel on the 15th, 20th and 25th year of the lease.
(5) Lease expiration date is September 30, 2006. The Bank has three
five-year renewal options.
37
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in routine legal proceedings occurring
in the ordinary course of business which, in the aggregate, are
believed by management to be immaterial to the financial condition of
the Company.
In late September 2001, the Company was served in the
following action: Aurora Loan Services, Inc. v. First Keystone Federal
Savings Bank, Civil Action No. 01-CV-4774 (United States District Court
for the Eastern District of Pennsylvania). This is a civil action
arising out of five residential mortgage loans that Aurora holds in its
portfolio. Aurora alleges that it suffered losses in connection with
these loans (all of which were purchased by Aurora from the Bank more
than 18 months prior hereto) and that the Bank is required to purchase
the loans or compensate Aurora for its alleged losses. The Complaint
asserts claims for breach of contract (Count One), violation of the New
York Consumer Protection Law (Count Two) and Unjust Enrichment (Count
Three). The Bank denies that any of its actions breached any contract
between it and Aurora. Moreover, the Bank denies that Aurora can, as a
matter of law, assert claims under the New York Consumer Protection Law
or for unjust enrichment. The Bank has filed a motion to dismiss Counts
Two and Three of the Complaint because they fail to state a claim as a
matter of law. The Bank plans to assert all other available defenses to
Aurora's claims. No discovery has been taken in this civil action and
no trial date has been set. In the opinion of the Company's management
and based upon advice of legal counsel, the resolution of this action
will not have a material adverse impact on the consolidated financial
position or the results of operations of the Company and its
subsidiaries.
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 information required herein is incorporated by reference
on page 39 of the Registrant's Annual Report.
ITEM 6. SELECTED FINANCIAL DATA.
The information required herein is incorporated by reference
from pages 7 to 8 of the Registrant's Annual Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
The information required herein is incorporated by reference
from pages 9 to 17 of the Registrant's Annual Report.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company's balance sheet consists of interest-earning
assets and interest-bearing liabilities, and thus, the Company is
therefore exposed to interest rate risk. The following additional
information is being provided regarding the exposure to this interest
rate risk.
The Company utilizes reports prepared by the OTS to measure
interest rate risk. Using data from the Bank's quarterly thrift
financial reports, the OTS models the net portfolio value ("NPV") of
the Bank over a variety of interest rate scenarios. The NPV is defined
as the present value of expected cash flows from existing assets less
the present value of expected cash flows from existing liabilities plus
the present value of net expected cash inflows from existing
off-balance sheet contracts. The model assumes instantaneous, parallel
shifts in the U.S. Treasury Securities yield curve of 100 to 300 basis
points, where applicable, either up or down, and in 100 basis point
increments.
38
The interest rate risk measures used by the OTS include an
"Exposure Measure" or "Post-Shock" NPV ratio and a "Sensitivity
Measure". The "Post-Shock" NPV ratio is the net present value as a
percentage of assets over the various yield curve shifts. A low
"Post-Shock" NPV ratio indicates greater exposure to interest rate risk
and can result from a low initial NPV ratio or high sensitivity to
changes in interest rates. The "Sensitivity Measure" is the decline in
the NPV ratio, in basis points, caused by a 2% increase or decrease in
rates, whichever produces a larger decline. The following sets forth
the Bank's NPV as of September 30, 2001.
Net Portfolio Value
------------------------------------------------------------------------------------------------------
Changes in
Rates in Dollar Percentage Net Portfolio Value As Change in
Basis Points Amount Change Change a % of Assets Percentage(1)
------------ ------ ------ ------ ------------- --------------
(Dollars in thousands)
300 $16,868 $(15,598) (48.04)% 3.69% (43.58)%
200 25,613 (6,853) (21.11) 5.46 (16.51)
100 34,002 1,536 4.73 7.05 7.80
0 32,466 6.54
(100) 41,805 9,339 28.77 8.30 26.91
(200) 40,078 7,612 73.44 7.84 19.88
(1) Based on the portfolio value of the Bank's assets in the base case
scenario.
Certain shortcomings are inherent in the methodology used in
the above interest rate risk measurements. Modeling changes in NPV
require the making of certain assumptions which may or may not reflect
the manner in which actual yields and costs respond to changes in
market interest rates. In this regard, the NPV table presented assumes
that the composition of the Bank's interest sensitive assets and
liabilities existing at the beginning of a period remains constant over
the period being measured and also assumes that a particular change in
interest rates is reflected uniformly across the yield curve regardless
of the duration to maturity or repricing of specific assets and
liabilities. Also, the model does not take into account the Bank's
business or strategic plans. Accordingly, although the NPV table
provides an indication of the Bank's interest rate risk exposure at a
particular point in time, such measurements are not intended to and do
not provide a precise forecast of the effect of changes in market
interest rates on the Bank's net interest income and may differ from
actual results. See also the discussion on pages 9 to 10 of the Annual
Report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements and supplementary data required
herein are incorporated by reference from pages 19 to 38 of the Annual
Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required herein is incorporated by reference
from pages 2 to 6 and page 15 of the Registrant's Proxy Statement dated
December 26, 2001 ("Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION.
The information required herein is incorporated by reference
from pages 9 to 14 of the Registrant's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required herein is incorporated by reference
from pages 7 to 9 of the Registrant's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required herein is incorporated by reference
from page 15 of the Registrant's Proxy Statement.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this Report.
(1) The following documents are filed as part of this
report and are incorporated herein by reference from
the Registrant's Annual Report.
Report of Independent Auditors.
Consolidated Statements of Financial Condition at
September 30, 2001 and 2000.
Consolidated Statements of Income for the Years Ended
September 30, 2001, 2000 and 1999.
Consolidated Statements of Changes in Stockholders'
Equity for the Years Ended September 30, 2001, 2000
and 1999.
Consolidated Statements of Cash Flows for the Years
Ended September 30, 2001, 2000 and 1999.
Notes to the Consolidated Financial Statements.
(2) All schedules for which provision is made in the
applicable accounting regulation of the SEC are
omitted because they are not applicable or the
required information is included in the Consolidated
Financial Statements or notes thereto.
(3) The following exhibits are filed as part of this Form
10-K, and this list includes the Exhibit Index.
40
No Description
- -- -----------
3.1 Amended and Restated Articles of Incorporation of First Keystone
Financial, Inc. *
3.2 Amended and Restated Bylaws of First Keystone Financial, Inc. *
4 Specimen Stock Certificate of First Keystone Financial, Inc. *
10.1 Employee Stock Ownership Plan and Trust of First Keystone Financial,
Inc. *
10.2 401(K)/Profit-sharing Plan of First Keystone Federal Savings Bank. *
10.3 Employment Agreement between First Keystone Financial, Inc. and Donald
S. Guthrie dated May 26, 1999. **
10.4 Employment Agreement between First Keystone Financial, Inc. and Stephen
J. Henderson dated May 26, 1999. **
10.5 Employment Agreement between First Keystone Financial, Inc. and Thomas
M. Kelly dated May 26, 1999. **
10.6 Form of Severance Agreement between First Keystone Financial, Inc. and
Elizabeth M. Mulcahy dated May 26, 1999. **
10.8 Form of Severance Agreement between First Keystone Financial, Inc. and
Carol Walsh dated May 26, 1999. **
10.9 1995 Stock Option Plan.***
41
10.10 1995 Recognition and Retention Plan and Trust Agreement. ***
10.11 1998 Stock Option Plan. ****
10.12 Employment Agreement between First Keystone Federal Savings Bank and
Donald S. Guthrie dated May 26, 1999. **
10.13 Employment Agreement between First Keystone Federal Savings Bank and
Stephen J. Henderson dated May 26, 1999. **
10.14 Employment Agreement between First Keystone Federal Savings Bank and
Thomas M. Kelly dated May 26, 1999. **
10.15 Form of Severance Agreement between First Keystone Federal Savings Bank
and Elizabeth M. Mulcahy dated May 26, 1999. **
10.16 Form of Severance Agreement between First Keystone Federal Savings Bank
and Carol Walsh dated May 26, 1999. **
11 Statement re: computation of per share earnings. See Note 2 to the
Consolidated Financial Statements included in the Annual Report set
forth as Exhibit 13 hereto.
13 Annual Report to Stockholders.
21 Subsidiaries of the Registrant - Reference is made to Item 1
"Business," for the required information.
23 Consent of Deloitte & Touche LLP.
- ----------
(*) Incorporated by reference from the Registration Statement Form S-1
(Registration No. 33-84824) filed by the Registrant with the SEC on
October 6, 1994, as amended.
(**) Incorporated by reference from the Form 10-K filed by the Registrant
with the SEC on December 29, 1999.
(***) Incorporated by reference from the 10-K filed by the Registrant with
SEC on December 29, 1995.
(****) Incorporated from Appendix A of the Registrant's definitive proxy
statement dated December 24, 1998.
(b) Reports filed on Form 8-K.
None.
42
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST KEYSTONE FINANCIAL, INC.
By: /s/ Donald S. Guthrie
--------------------------------
Donald S. Guthrie
President and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report had been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.
/s/ Donald S. Guthrie December 21, 2001
- -----------------------------------------------
Donald S. Guthrie
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Thomas M. Kelly December 21, 2001
- -----------------------------------------------
Thomas M. Kelly
Executive Vice-President and Chief
Financial Officer
(Principal Financial and Accounting Officer)
/s/ Donald A. Purdy December 21, 2001
- -----------------------------------------------
Donald A. Purdy
Chairman of the Board
/s/ Edward Calderoni December 21, 2001
- -----------------------------------------------
Edward Calderoni
Director
/s/ Edmund Jones December 21, 2001
- -----------------------------------------------
Edmund Jones
Director
/s/ Donald G. Hosier, Jr. December 21, 2001
- ----------------------------------------------
Donald G. Hosier, Jr.
Director
/s/ Marshall J. Soss December 21, 2001
- -----------------------------------------------
Marshall J. Soss
Director
43