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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, 2003
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. [X]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 126-2).
Yes [ ] No [X]
The aggregate market value of the shares of Common Stock of the Registrant
issued and outstanding on December 10, 2003, which excludes 369,970 shares held
by all directors and officers of the Registrant as a group, was approximately
$31.8 million. This figure is based on the closing price of $20.98 per share of
the Registrant's Common stock on March 31, 2003, the last business day of the
Registrant's second fiscal quarter.
Number of shares of Common Stock outstanding as of December 10, 2003: 1,886,897
DOCUMENTS INCORPORATED BY REFERENCE
Listed hereunder are the documents incorporated by reference and the Part of the
Form 10-K into which the document is incorporated:
(1) Portions of the definitive proxy statement for the 2003 Annual Meeting of
Stockholders are incorporated into Part III.
FIRST KEYSTONE FINANCIAL, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2003
INDEX
Page
----
PART I
Item 1. Business 1
Item 2. Properties 37
Item 3. Legal Proceedings 38
Item 4. Submission of Matters to a Vote of Security Holders 38
PART II
Item 5. Market for Registrant's Common Stock and Related
Stockholder Matters 38
Item 6. Selected Financial Data 40
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations 42
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 54
Item 8. Financial Statements and Supplementary Data 55
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosures 82
Item 9A. Control and Procedures 82
PART III
Item 10. Directors and Executive Officers of the Registrant 82
Item 11. Executive Compensation 82
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters 83
Item 13. Certain Relationships and Related Transactions 83
Item 14. Principal Accounting Fees and Services 83
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports of Form 8-K 83
SIGNATURES 86
[This page left blank intentionally]
PART I.
ITEM 1. BUSINESS.
GENERAL
First Keystone Financial, Inc. (the "Company") is a Pennsylvania
corporation and sole shareholder of First Keystone Bank, a federally chartered
stock savings bank (the "Bank"), which converted to the stock form of
organization in January 1995. The only significant assets of the Company are the
capital stock of the Bank, the Company's loan to its employee stock ownership
plan, and various equity and other investments. See Note 18 of the Notes to
Consolidated Financial Statements for the fiscal year ended September 30, 2003
set forth in Item 8, "Financial Statements and Supplementary Data." The business
of the Company primarily consists of the business of the Bank.
The Bank is a community oriented bank emphasizing customer service and
convenience. The Bank's primary business is attracting deposits from the general
public and using those funds together with other available sources of funds,
primarily borrowings, to originate loans. A substantial portion of the Bank's
deposits are comprised of core deposits consisting of NOW, non-interest-bearing
accounts, money market ("MMDA") and passbook. Core deposits amounted to $184.1
million or 50.8% of the Bank's total deposits at September 30, 2003. 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
Bank's management, however, remains focused on its long-term strategic plan to
continue to shift to its loan composition toward commercial business,
construction and home equity loans and lines of credit in order to provide a
higher yielding portfolio with generally shorter terms. This effort to keep
shorter term loans in portfolio resulted in a $5.9 million increase in
outstanding balances in home equity loans and equity lines of credit at fiscal
year end, representing a 21.3% increase in this category compared to the
previous fiscal year. Multi-family residential and commercial real estate loans
amounted to $59.0 million or 19.7% of the total loan portfolio at September 30,
2003 as compared to $60.4 million or 19.9% at September 30, 2002. The Bank has
on occasion purchased loan participation interests in both residential and
commercial real estate loans depending on market conditions and portfolio needs,
although no such purchases were made during the fiscal year ended September 30,
2003.
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, 2003, the Bank's mortgage-related
securities (both available for sale and held to maturity) amounted to $128.2
million, or 22.9% of the Company's total assets, and investment securities (both
available for sale and held to maturity) amounted to $84.0 million, or 15.0% of
total assets.
1
MARKET AREA AND COMPETITION
The Bank's primary market area is in Delaware and Chester Counties,
which is located in the southeastern corner of Pennsylvania between two
metropolitan areas, Philadelphia, Pennsylvania and Wilmington, Delaware. There
is easy access to I-95, the Philadelphia International Airport and the Delaware
River. The Bank is fortunate to be located in such a desirable geographic area.
New York City is just 92 miles away from the Bank's headquarters in Media,
Pennsylvania, Baltimore, Maryland is only 80 miles away, and the distance to
Washington, DC is just 127 miles.
Through an extensive highway and telecommunications network, the
Delaware County's economy is knitted tightly into a regional economy of more
than 2.5 million workers. Census 2000 lists Delaware County as having 14,394
business establishments with the number of jobs in the County (258,922) at an
all time high. Most of the businesses are in corporate and professional
services, distributive services and the manufacturing sector. Census 2000 shows
Delaware County has a large, well-educated, and skilled local labor force of
258,782. Nearly one quarter of the County's population is 25 years or older and
has earned a four-year college degree. The total number of people employed as
executives, managers, professionals, and technicians is 101,646. Philadelphia's
central location in the Northeast corridor, infrastructure and other factors has
made the Bank's market area attractive to many large corporate employers
including Comcast Corp., Boeing, State Farm Insurance, United Parcel Service,
PECO Energy, SAP America, Inc., Wawa and many others.
The Philadelphia area economy is typical of many large Northeastern
cities where the traditional manufacturing based economy has declined and has
been replaced by the service sector including the health care market.
Crozer/Keystone Health System and Mercy Health Corp are amongst the larger
employers within the Bank's market area. According to the Delaware County
Chamber of Commerce, there are 82 degree-granting institutions and 47,000
graduates annually in the region, representing more colleges and universities
than any other area in the United States. Delaware County also has one of the
nation's lowest unemployment rates and one of the most active Chamber of
Commerce Offices in the State. The U.S. Small Business Administration,
Philadelphia District Office, named the Delaware County Chamber the Eastern
Region Chamber of the Year in 2001. This is the second time the Chamber received
this level of recognition.
According to the 2000 Census, the population of Delaware County is
550,864, a modest 0.6% increase since 1990. During the year 2000, Delaware
County Planning Commission reviewed proposals for almost twice as many
residential units compared to 1997. Due to the availability of land still
suitable for development, the majority of this growth has occurred in the
western part of Delaware County, and its contiguous neighbor Chester County. The
Bank had benefited from this growth with the opening of its Chester Heights
office in December 1999 which has exceeded the Company's deposit and consumer
loan projections. Chester County's continual growth is expected to increase
further in the next decade. The communities in Chester County that are
experiencing growth are East Marlborough Township, New Garden Township and East
Goshen which surround the Bank's Chester County office. As a result of the
continual anticipated growth, the Bank is expanding its Willowdale Branch,
Chester County to a full-service free-standing office to be completed in fiscal
2004.
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 regional financial
institutions which have greater financial and marketing resources available to
them. The ability of the Bank to attract and retain core deposits depends on its
ability to provide a competitive rate of return, liquidity and 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. Recognizing
that convenience, as it relates to branch locations, is still a primary
motivator in attracting new deposits, the Bank is undergoing construction of a
new full-service free-standing branch on a corner property in Aston Township,
Delaware County, a densely populated area in the heart of the Bank's
marketplace.
2
FORWARD LOOKING STATEMENTS
In this Annual Report on Form 10-K, the Company has included certain
forward-looking statements concerning the future operations of the Company. It
is management's desire to take advantage of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. This statement is for the
express purpose of availing the Company of the protections of such safe harbor
with respect to all forward-looking statements contained in this Annual Report.
Such forward-looking statements are subject to risks and uncertainties which
could cause actual results to differ materially from those currently anticipated
due to a number of factors. Such forward-looking statements may be identified by
the use of words such as believe, expect, should, estimated, potential and
similar expressions. Examples of forward-looking statements include, but are not
limited to, estimates with respect to the financial condition, business
strategy, expected or anticipated revenue, results of operations and the
business of the Company that are subject to various factors which could cause
actual results to differ materially from these estimates. Factors that could
affect results include interest rate trends, deposit flows, competition, the
general economic climate in Delaware and Chester counties, the mid-Atlantic
region and the United States as a whole, loan demand, real estate values, loan
delinquency rates, levels of non-performing assets, changes in federal and state
regulation, changes in accounting policies and practices and other uncertainties
described in the Company's filings with the Securities and Exchange Commission,
including its Form 10-K for the year ended September 30, 2003. These factors
should be considered in evaluating the forward-looking statements, and undue
reliance should not be placed on such statements. The Company assumes no
obligation to update or revise forward-looking statements to reflect any changed
assumptions, any unanticipated events or any changes in the future.
3
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,
--------------------------------------------------------------
2003 2002 2001
------------------ ------------------ ------------------
Amount % Amount % Amount %
------------------ ------------------ ------------------
(Dollars in thousands)
Real estate loans:
Single-family $166,042 55.51% $173,736 57.32% $160,289 59.81%
Multi-family and commercial 59,022 19.73 60,379 19.92 43,472 16.22
Construction and land 28,975 9.69 28,292 9.33 29,117 10.86
Home equity loans and lines of credit 33,459 11.19 27,595 9.10 25,847 9.65
-------- ------- -------- ------- -------- -------
Total real estate loans 287,498 96.12 290,002 95.67 258,725 96.54
-------- ------- -------- ------- -------- -------
Consumer:
Deposit 112 .04 144 .05 232 .09
Education -- -- -- -- -- --
Unsecured personal loans 547 .18 322 .11 133 .05
Other(1) 779 .26 736 .24 760 .28
-------- ------- -------- ------- -------- -------
Total consumer loans 1,438 .48 1,202 .40 1,125 .42
-------- ------- -------- ------- -------- -------
Commercial business loans 10,161 3.40 11,919 3.93 8,158 3.04
-------- ------- -------- ------- -------- -------
Total loans receivable(2) 299,097 100.00% 303,123 100.00% 268,008 100.00%
-------- ======= -------- ======= -------- =======
Less:
Loans in process (construction and
land) 10,655 11,384 17,016
Deferred loan origination fees and
discounts 35 605 1,147
Allowance for loan losses 1,986 2,358 2,181
-------- -------- --------
Total loans receivable, net $286,421 $288,776 $247,664
======== ======== ========
September 30,
----------------------------------------
2000 1999
------------------ ------------------
Amount % Amount %
------------------ ------------------
(Dollars in thousands)
Real estate loans:
Single-family $160,143 65.54% $166,802 69.82%
Multi-family and commercial 37,870 15.50 31,188 13.05
Construction and land 17,905 7.33 18,426 7.71
Home equity loans and lines of credit 22,597 9.25 18,624 7.80
-------- ------- -------- -------
Total real estate loans 238,515 97.62 235,040 98.38
-------- ------- -------- -------
Consumer:
Deposit 251 .10 243 .10
Education 285 .12 365 .15
Unsecured personal loans -- -- -- --
Other(1) 807 .33 1,080 .45
-------- ------- -------- -------
Total consumer loans 1,343 .55 1,688 .70
-------- ------- -------- -------
Commercial business loans 4,475 1.83 2,190 .92
-------- ------- -------- -------
Total loans receivable(2) 244,333 100.00% 238,918 100.00%
-------- ======= -------- =======
Less:
Loans in process (construction and
land) 10,330 9,005
Deferred loan origination fees and
discounts 1,298 1,610
Allowance for loan losses 2,019 1,928
-------- --------
Total loans receivable, net $230,686 $226,375
======== ========
- -----------------------------
(1) Consists primarily of credit card loans.
(2) Does not include $4.5 million, $501,000, $225,000, $3.1 million and
$1.8 million of loans held for sale at September 30, 2003, 2002, 2001,
2000 and 1999, respectively.
4
Contractual Principal Repayments. The following table sets forth the
scheduled contractual maturities of the Bank's loans held to maturity at
September 30, 2003. 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
Single-family and Construction Commercial
(1) Commercial and Land Total Business Loans Total
------------- ------------ ------------ --------- --------------- ---------
(Dollars in thousands)
Amounts due in:
One year or less $ 9,970 $ 6,597 $ 28,975 $ 45,542 $ 10,839 $ 56,381
After one year through three years 19,971 8,601 -- 28,572 335 28,907
After three years through five years 24,808 10,308 -- 35,116 160 35,276
After five years through ten years 74,564 12,913 -- 87,477 97 87,574
After ten years through fifteen years 43,070 9,619 -- 52,689 23 52,712
Over fifteen years 27,118 10,984 -- 38,102 145 38,247
------------ ------------ ------------ --------- --------------- ---------
Total(2) $ 199,501 $ 59,022 $ 28,975 $ 287,498 $ 11,599 $ 299,097
============ ============ ============ ========= =============== =========
Interest rate terms on amounts due after
one year:
Fixed $ 156,927 $ 463 $ 157,390
Adjustable 85,029 297 85,326
--------- --------------- ---------
Total(2) $ 241,956 $ 760 $ 242,716
========= =============== =========
- ----------------------------
(1) Includes home equity loans and lines of credit.
(2) Does not include adjustments relating to loans in process, allowances
for loan losses and deferred fee income.
5
Scheduled contractual amortization of loans does not reflect the
expected term of the Bank's loan portfolio. The average life of loans is
substantially less than their contractual terms because of prepayments and
due-on-sale clauses, which give the Bank the right to declare a conventional
loan immediately due and payable in the event, among other things, that the
borrower sells the real property subject to the mortgage and the loan is not
repaid. The average life of mortgage loans tends to increase when current
mortgage loan rates are higher than rates on existing mortgage loans and,
conversely, decrease when current mortgage loan rates are lower than rates on
existing mortgage loans (due to refinancings of adjustable-rate and fixed-rate
loans at lower rates). Under the latter circumstances, the weighted average
yield on loans decreases as higher yielding loans are repaid or refinanced at
lower rates.
Loan Origination, Purchase and Sale Activity. The following table shows
the loan origination, purchase and sale activity of the Bank during the periods
indicated.
Year Ended September 30,
--------------------------------------
2003 2002 2001
---------- ---------- ----------
(Dollars in thousands)
Gross loans at beginning of period(1) $ 303,624 $ 268,233 $ 247,532
---------- ---------- ----------
Loan originations for investment:
Real estate:
Residential 80,722 60,719 25,889
Commercial and multi-family 13,890 31,300 11,265
Construction 24,578 28,741 18,503
Home equity and lines of credit 29,920 21,710 10,363
---------- ---------- ----------
Total real estate loans originated for investment 149,110 142,470 66,020
Consumer 2,927 2,825 1,287
Commercial business 17,548 21,555 12,102
---------- ---------- ----------
Total loans originated for investment 169,585 166,850 79,409
Participations purchased(2) -- -- 1,124
Loans originated for resale 30,995 3,712 20,685
---------- ---------- ----------
Total originations 200,580 170,562 101,218
---------- ---------- ----------
Deduct:
Principal loan repayments and prepayments (171,489) (131,374) (56,086)
Transferred to real estate owned (2,122) (361) (872)
Loans sold in secondary market (26,998) (3,436) (23,559)
---------- ---------- ----------
Subtotal (200,609) (135,171) (80,517)
---------- ---------- ----------
Net (decrease) increase in loans(1) (29) 35,391 20,701
---------- ---------- ----------
Gross loans at end of period(1) $ 303,595 $ 303,624 $ 268,233
========== ========== ==========
- -------------------
(1) Includes loans held for sale of $4.5 million, $501,000 and $225,000 at
September 30, 2003, 2002 and 2001, respectively.
(2) Consist of commercial real estate loans.
6
The residential lending activities of the Bank are subject to written
underwriting standards and loan origination procedures established by the Bank's
Board of Directors and management. Loan applications may be taken at all of the
Bank's branch offices by the branch manager or other designated loan officers.
Applications for single-family residential mortgage loans for portfolio
retention are obtained predominately through loan originators who are employees
of the Bank. The Bank's residential loan originators will take loan applications
outside of the Bank's offices at the customer's convenience and are compensated
on a commission basis. The Residential Lending Department supervises the process
of obtaining credit reports, appraisals and other documentation involved with 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. 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 Fannie Mae ("FNMA") or Freddie Mac ("FHLMC") limits are
approved by at least one of the following: the Bank's Senior Vice President of
Residential Lending, the Vice President of Residential Lending, the Senior
Mortgage Loan underwriter or the Loan Committee (a committee comprised of four
directors and the Vice President of Residential Lending). Residential mortgage
loans in excess of FNMA/FHLMC maximum amounts (currently $322,700) 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. Commercial and multi-family residential real estate
loans in excess of $200,000 and construction loans must be approved by the Board
of Directors. 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 $150,000 can be
approved by the Vice President of Residential Lending, the Vice President of
Construction Loans, the Vice President of Residential Lending or the Senior
Mortgage Loan Underwriter. 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 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 and balloon loans 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 or FNMA, and other purchasers in the secondary mortgage
market. The Bank also offers bi-weekly loans under the terms of which the
borrower makes payments every two weeks. Although such loans have a 30 year
amortization schedule, due to the bi-weekly payment schedule, such loans repay
substantially more rapidly than a standard monthly amortizing 30-year fixed-rate
loan. The Bank also offers five and seven year balloon loans which provide that
the borrower can conditionally renew the loan at the fifth or seventh year at a
then to-be-determined interest rate for the remaining 25 or 23 years,
respectively, of the amortization period. At September 30, 2003, $147.8 million,
or 89.0% of the Bank's single-family residential mortgage loans held in
portfolio were fixed-rate loans, including $12.4 million of bi-weekly,
fixed-rate residential mortgage loans.
7
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 has been
originating loans which bear a fixed interest rate for a period of three to five
years after which they convert to one-year adjustable-rate loans. The Bank's
adjustable-rate loans require that any payment adjustment resulting from a
change in the interest rate of an adjustable-rate loan be sufficient to result
in full amortization of the loan by the end of the loan term and, thus, do not
permit any of the increased payment to be added to the principal amount of the
loan, creating negative amortization. Although the Bank does offer
adjustable-rate loans with initial rates below the fully indexed rate, loans
tied to the one-year CMT are underwritten using methods approved by FHLMC or
FNMA which require borrowers to be qualified at 2% above the discounted loan
rate under certain conditions. At September 30, 2003, $18.2 million, or 11.0%,
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 loans with a LTV ratio of over 80%, private mortgage
insurance may be required to be obtained or the Bank may lend the excess as a
home equity loan.
Commercial and Multi-Family Residential Real Estate Loans. In fiscal
2003, the Bank has maintained its increased 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 segment
of the market that the Bank believes continues to be under served in recent
years. Loans secured by commercial and multi-family residential real estate
amounted to $59.0 million, or 19.7%, of the Bank's total loan portfolio, at
September 30, 2003. 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 the principal over the term of the loan and LTV ratios of not
more than 75%. Generally, the Bank obtains personal guarantees of the principals
of the borrower as additional security for any commercial real estate and
multi-family residential loans and requires that the borrower have at least a
25% equity investment in any such property.
8
The Bank evaluates various aspects of commercial and multi-family
residential real estate loan transactions in an effort to mitigate risk to the
extent possible. In underwriting these loans, consideration is given to the
stability of the property's cash flow history, future operating projections,
current and projected occupancy, position in the market, location and physical
condition. In recent periods, the Bank has generally imposed a debt coverage
ratio (the ratio of net cash from operations before payment of debt service to
debt service) of not less than 110%. The underwriting analysis also includes
credit checks and a review of the financial condition of the borrower and
guarantor, if applicable. An appraisal report is prepared by a state-licensed
and certified appraiser (generally an appraiser who is qualified as a Member of
the Appraisal Institute ("MAI")) commissioned by the Bank to substantiate
property values for every commercial real estate and multi-family loan
transaction. All appraisal reports are reviewed by the commercial loan
underwriter prior to the closing of the loan.
Multi-family residential and commercial real estate lending entails
different and significant risks when compared to single-family residential
lending because such loans often involve large loan balances to single borrowers
and because the payment experience on such loans is typically dependent on the
successful operation of the project or the borrower's business. These risks also
can be significantly affected by supply and demand conditions in the local
market for apartments, offices, warehouses or other commercial space. The Bank
attempts to minimize its risk exposure by limiting such lending to proven
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. During fiscal 2003, the Bank continued to experience difficulties
with two borrowers in its commercial real estate loan portfolio which has
increased non-performing assets. See "-Non-performing Assets" for further
discussion of these non-performing loans.
Construction Loans. Substantially all of the Bank's construction loans
consist of loans for acquisition and development of properties to construct
single-family properties extended either to individuals or to selected
developers with whom the Bank is familiar to build such properties on a pre-sold
or limited speculative basis.
To a lesser extent, the Bank provides financing for construction to
permanent commercial real estate properties. Commercial construction loans have
a maximum term of 24 months during the construction period with interest based
upon the prime rate published in the Wall Street Journal ("Prime Rate") plus a
margin and have LTV ratios of 80% or less of the appraised value upon
completion. The loans convert to permanent commercial real estate loans upon
completion of construction. With respect to construction loans to individuals,
such loans have a maximum term of 12 months, have variable rates of interest
based upon the Prime Rate plus a margin and have LTV ratios of 80% or less of
the appraised value of the property upon completion and generally do not require
the amortization of principal during the term. Upon completion of construction,
the borrower is required to refinance the loan although the Bank may be the
lender of the permanent loan secured by the property.
The Bank also provides construction loans (including acquisition and
development) and revolving 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 36 months or less, have
generally a maximum LTV ratios of 75% of the appraised value of the property
upon completion and do not require the amortization of the principal during the
term. The loans are made with variable rates of interest based on the Prime Rate
plus a margin adjusted on a monthly basis. The Bank also receives origination
fees that generally range from .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.
At September 30, 2003, residential construction loans totaled $16.4
million, or 5.5%, of the total loan portfolio, primarily consisting of
construction loans to developers. At September 30, 2003, commercial construction
loans totaled $2.1 million, or .71%, of the total loan portfolio.
9
The Bank also originates ground or land loans to individuals to
purchase a property on which they intend to build their primary residences, as
well as to developers to purchase lots to build speculative homes at a later
date. Such loans have terms of 36 months or less with a maximum LTV ratio of 75%
of the lower of appraised value or sale price. The loans are made with variable
rates based on the Prime Rate plus a margin. The Bank also receives origination
fees, which generally range between 1.0% and 3.0% of the loan amount. At
September 30, 2003, land loans (including loans to acquire and develop land)
totaled $10.4 million, or 3.5%, of the total loan portfolio.
Loans to developers include both secured and unsecured lines of credit
(which are classified as commercial business loans) with outstanding commitments
totaling $2.2 million. All have personal guaranties of the principals and are
cross-collateralized with existing loans. At September 30, 2003, loans
outstanding under builder lines of credit totaled $1.4 million, or .47%, of the
total loan portfolio, of which $788,000 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 an appraiser approved by the Board of
Directors. In addition, during the term of the construction loan, the project is
inspected by an independent inspector.
Construction financing generally is considered to involve a higher
degree of risk of loss than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development and the estimated cost (including interest) of
construction. During the construction phase, a number of factors could result in
delays and cost overruns. If the estimate of value proves to be inaccurate, the
Bank may be confronted, at or prior to the maturity of the loan, with a project,
when completed, having a value which is insufficient to assure full repayment.
Loans on lots may run the risk of adverse zoning changes as well as
environmental or other restrictions on future use.
Home Equity Loans and Lines of Credit. Home equity loans and home
equity lines of credit are secured by the underlying equity in the borrower's
primary residence or, occasionally, other types of real estate. Home equity
loans are amortizing loans with fixed interest rates and generally 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, 2003, home equity loans and lines of credit amounted to $33.5
million, or 11.2%, of the Bank's total loan portfolio.
Consumer Lending Activities. The Bank also offers a variety of consumer
loans in order to provide a full range of retail financial services to its
customers. At September 30, 2003, $1.4 million, or .5 %, of the Bank's total
loan portfolio was comprised of consumer loans. The Bank originates
substantially all of such loans in its market area. At September 30, 2003, the
Bank's consumer loan portfolio was comprised of credit card, deposit, unsecured
personal loans and other consumer loans. The Bank's credit card program is
primarily offered to only the Bank's most creditworthy customers. At September
30, 2003, these loans totaled $620,000, or .2%, of the total loan portfolio.
Another component of the consumer loan portfolio is unsecured loans amounting to
$547,000, or .2%, of the Bank's loan portfolio at September 30, 2003.
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.
Commercial Business Loans. The Bank has also emphasized the growth in
commercial business loans by granting such loans directly to business
enterprises that are located in its market area. The majority of such loans are
for less than $1.0 million. The Bank actively targets and markets 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, 2003, commercial business loans amounted to $10.2 million, or
3.4%, of the Bank's total loan portfolio.
10
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
continue to offer commercial business loans to small- and medium-sized
businesses in an effort to better serve our community's needs, obtain core
non-interest-bearing deposits and increase the Bank's interest rate spread.
Mortgage-Banking Activities. Due to customer preference for fixed-rate
loans, the Bank has continued to originate fixed-rate loans. Long-term
(generally 30 years) fixed-rate loans not taken into portfolio for
asset/liability purposes are sold into the secondary market. The Bank's net gain
on sales of mortgage loans amounted to $410,000, $84,000, and $122,000 during
the fiscal years ended September 30, 2003, 2002 and 2001, respectively. Profits
from sales of loans held for sale significantly increased due to the increased
originations in 30-year loans resulting from the low interest rate environment.
The Bank had $4.5 million and $501,000 of mortgage loans held for sale at
September 30, 2003 and 2002, respectively. Subsequent to fiscal year end,
management determined, based on its asset liability position, to retain a
substantial portion of such loans in its loan portfolio.
The Bank's conforming mortgage loans sold to others are sold, generally
with servicing retained, on a loan-by-loan basis primarily to FHLMC or FNMA. A
period of less than five days generally elapses between the closing of the loan
by the Bank and its purchase by the investor. Mortgages with established
interest rates generally will decrease in value during periods of increasing
interest rates. Accordingly, fluctuations in prevailing interest rates may
result in a gain or loss to the Bank as a result of adjustments to the carrying
value of loans held for sale or upon sale of loans. The Bank attempts to protect
itself from these market fluctuations through the use of forward commitments
entered into at the same time of the commitment by the Bank of a loan rate to
the borrower. These commitments are mandatory delivery contracts with FHLMC or
FNMA within a certain time frame and within certain dollar amounts by a price
determined at the commitment date. Market risk does exist as non-refundable
points paid by the borrower may not be sufficient to offset fees associated with
closing the forward commitment contract. See Note 13 of the Notes to
Consolidated Financial Statements set forth in Item 8 hereof.
Loan Origination Fees and Servicing. Borrowers may be charged an
origination fee, which is a percentage of the principal balance of the loan. In
accordance with the provisions of Statement of Financial Accounting Standards
("SFAS") No. 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases," the various
fees 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.
11
The following table presents information regarding the loans serviced
by the Bank for others at the dates indicated. Substantially all the loans were
secured by properties in Pennsylvania. A small percentage of the loans are
secured by properties located in Delaware, Maryland or New Jersey.
SEPTEMBER 30,
----------------------------------
2003 2002 2001
----------------------------------
(Dollars in thousands)
Loans originated by the Bank and serviced for:
FNMA $ 822 $ 1,054 $ 1,726
FHLMC 50,373 50,405 64,195
Others 352 367 380
------- ------- ------
Total loans serviced for others $ 51,547 $ 51,826 $66,301
======= ======= ======
The Bank receives fees for servicing mortgage loans, which generally
amount to 0.25% per annum on the declining principal balance of mortgage loans.
Such fees serve to compensate the Bank for the costs of performing the servicing
function. Other sources of loan servicing revenues include late charges. The
Bank retains a portion of funds received from borrowers on the loans it services
for others in payment of its servicing fees received on loans serviced for
others. For fiscal years ended September 30, 2003, 2002 and 2001, the Bank
earned gross fees of $140,000, $160,000 and $191,000, respectively, from loan
servicing.
Loans-to-One Borrower Limitations. Regulations impose limitations on
the aggregate amount of loans that a savings institution could make to any one
borrower, including related entities. Under such regulations, the permissible
amount of loans-to-one borrower follows the national bank standard for all loans
made by savings institutions, which generally does not permit loans-to-one
borrower to exceed 15% of unimpaired capital and surplus. Loans in an amount
equal to an additional 10% of unimpaired capital and surplus also may be made to
a borrower if the loans are fully secured by readily marketable securities. At
September 30, 2003, the Bank's six largest loans or groups of loans-to-one
borrower, including related entities, ranged from an aggregate of $4.3 million
to $5.8 million. The Bank's loans-to-one borrower limit was $6.8 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, 2003, 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.
12
When a borrower fails to make a required payment on a loan, the Bank
attempts to cure the deficiency by contacting the borrower and requesting
payment. Contact is generally made after the expiration of the grace period
(usually fifteen days) in the form of telephone calls and/or correspondence. In
most cases, deficiencies are cured promptly. If the delinquency increases, the
Bank will initiate foreclosure actions or legal collection actions if a borrower
fails to enter into satisfactory repayment arrangements. Such actions generally
commence at sixty to ninety days of delinquency.
Loans are placed on non-accrual status when, in the judgment of
management, the probability of collection of interest is deemed to be
insufficient to warrant further accrual. When a loan is placed on non-accrual
status, previously accrued but unpaid interest is deducted from interest income.
As a matter of policy, the Bank does not accrue interest on loans past due 90
days or more. See Note 2 of the Notes to Consolidated Financial Statements set
forth in Item 8 hereof.
Real estate acquired by the Bank as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold. Real
estate owned is initially recorded at the lower of fair value less estimated
costs to sell the property, or cost (generally the balance of the loan on the
property at the date of acquisition). After the date of acquisition, all costs
incurred in maintaining the property are 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" under SFAS No. 15. In
general, the modification or restructuring of a debt constitutes a troubled debt
restructuring if the Bank, for economic or legal reasons related to the
borrower's financial difficulties, grants a concession to the borrower that the
Bank would not otherwise consider under current market conditions. Debt
restructuring or loan modifications for a borrower do not necessarily always
constitute troubled debt restructuring, however, and troubled debt restructuring
does not necessarily result in non-accrual loans.
13
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, 2003 September 30, 2002
----------------------------------------------------------------------
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 $ 84 .05% $127 .08% $ -- --% $405 .23%
Multi-family and commercial 531 .90 -- -- 246 .41 -- --
Home equity 64 .19 167 .50 -- -- 35 .13
Consumer loans 12 .83 1 .07 18 1.50 23 1.91
Commercial business loans 60 .59 -- -- 33 .28 -- --
---- ---- ---- ----
Total $751 .25% $295 .10% $297 .10% $463 .15%
==== ==== ==== ====
14
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,
------------------------------------------
2003 2002 2001 2000 1999
------------------------------------------
(Dollars in thousands)
Non-performing loans:
Single-family residential $ 688 $1,237 $1,924 $2,109 $2,312
Commercial and multi-family(1) 381 2,386 33 -- 289
Construction(2) -- -- -- -- 556
Consumer 16 19 314 48 16
Commercial business 268 138 -- 3 6
------ ------ ------ ------ ------
Total non-performing loans 1,353 3,780 2,271 2,160 3,179
------ ------ ------ ------ ------
Accruing loans more than 90 days delinquent (3) 203 1,358 31 355 1
------ ------ ------ ------ ------
Total non-performing loans 1,556 5,138 2,302 2,515 3,180
------ ------ ------ ------ ------
Real estate owned 1,420 248 887 947 297
------ ------ ------ ------ ------
Total non-performing assets $2,976 $5,386 $3,189 $3,462 $3,477
====== ====== ====== ====== ======
Troubled debt restructurings (4) $ -- $ -- $ -- $ -- $ 24
====== ====== ====== ====== ======
Total non-performing loans and
troubled debt restructurings
as a percentage of gross loans
receivable(5) 0.53% 1.76% 0.92% 1.07% 1.39%
====== ====== ====== ====== ======
Total non-performing assets
as a percentage of total assets 0.53% 1.04% 0.65% 0.75% 0.77%
====== ====== ====== ====== ======
Total non-performing assets and
troubled debt restructurings as
percentage of total assets 0.53% 1.04% 0.65% 0.75% 0.78%
====== ====== ====== ====== ======
- ------------------------
(1) Consists of one loan at September 30, 2003, three loans at September 30,
2002, one loan at September 30, 2001 and two loans at September 30, 1999.
(2) Consists of three loans made to two borrowers at September 30, 1999.
(3) Consists of one commercial real estate loan of $1.3 million which returned
to current status subsequent to September 30, 2002
(4) Consists of lease financing receivables at September 30, 1999 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.
(5) Includes loans receivable and loans held for sale, less construction and
land loans in process and deferred loan origination fees and discounts.
15
The $688,000 of non-performing single-family residential loans at
September 30, 2003 consisted of 16 loans with principal balances ranging from
$2,700 to $164,000, with an average balance of approximately $43,000. Included
within the 16 loans are four loans aggregating $291,000 to credit impaired
borrowers.
At September 30, 2003, non-performing commercial real estate loans were
comprised of two commercial real estate loans totaling $381,000 with the largest
of the two having a carrying value of $320,000. The Bank owns a 25%
participation interest in this loan which is secured by a partially completed
storage facility in Clifton Heights, Pennsylvania. Subsequent to fiscal year
end, the loan was paid off.
Non-performing commercial business loans comprised of four loans with
an average balance of approximately $67,000 and the largest loan having a
carrying value of $125,000.
At September 30, 2003, the $1.4 million of real estate owned (including
in-substance foreclosure) consisted of two single-family residential properties
with an average carrying value of $167,600 and a $1.1 million commercial real
estate property. The commercial real estate property is an 18-hole golf course
and golf house, located in Avondale, Pennsylvania. The golf facility is fully
operational and continues to generate revenues. Foreclosure is expected to occur
in December 2003 and the property is currently being marketed. During fiscal
2003, the Bank incurred expenses in the amount of $299,000 relating to the
workout of these loans. Management expects the costs associated with these loans
to continue into the next fiscal year.
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, 2003, the Bank had $3.1 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 by
management to cover all known and inherent losses in its loan portfolio.
Management's analysis of the adequacy of the allowance is based on an evaluation
of the loan portfolio, past loss experience, current economic conditions,
volume, growth and composition of the portfolio, and other relevant factors. The
allowance is increased by provisions for loan losses which are charged against
income. The level of provisions increased in fiscal 2002 compared, to a large
part, to the nonperforming commercial assets aggregating $1.5 million as
discussed above. As shown in the table below, at September 30, 2003, the Bank's
allowance for loan losses amounted to 127.63% and .68% of the Bank's
non-performing loans and gross loans receivable, respectively.
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.
16
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,
-----------------------------------------------
2003 2002 2001 2000 1999
-----------------------------------------------
(Dollars in thousands)
Allowance for loan losses, beginning of period $ 2,358 $ 2,181 $ 2,019 $ 1,928 $ 1,738
Charged-off loans:
Single-family residential (50) (317) (492) (182) (12)
Multi-family and commercial (941) -- -- -- --
Construction -- -- -- (117) --
Consumer and commercial business (111) (56) (40) (64) (60)
------- ------- ------- ------- -------
Total charged-off loans (1,102) (373) (532) (363) (72)
------- ------- ------- ------- -------
Recoveries on loans previously charged off:
Single-family residential 4 1 11 -- 2
Commercial leases (1) -- -- 134 33 --
Consumer and commercial business 11 9 9 1 1
------- ------- ------- ------- -------
Total recoveries 15 10 154 34 3
------- ------- ------- ------- -------
Net loans charged-off (1,087) (363) (378) (329) (69)
Provision for loan losses 715 540 540 420 259
------- ------- ------- ------- -------
Allowance for loan losses, end of period $ 1,986 $ 2,358 $ 2,181 $ 2,019 $ 1,928
======= ======= ======= ======= =======
Net loans charged-off to average loans outstanding(2) 0.37% 0.13% 0.16% 0.14% 0.03%
======= ======= ======= ======= =======
Allowance for loan losses to gross loans receivable(2) 0.68% 0.81% 0.87% 0.86% 0.84%
======= ======= ======= ======= =======
Allowance for loan losses to total non-performing loans 127.63% 45.89% 94.74% 80.28% 60.63%
======= ======= ======= ======= =======
Net loans charged-off to allowance for loan losses 54.73% 15.39% 17.33% 16.30% 3.58%
======= ======= ======= ======= =======
Recoveries to charge-offs 1.36% 2.68% 28.95% 9.37% 4.17%
======= ======= ======= ======= =======
(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.
17
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,
-------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------- ------------------- ------------------- ------------------- -------------------
% OF LOANS % OF LOANS % OF LOANS % OF LOANS % OF LOANS
IN EACH IN EACH IN EACH IN EACH IN EACH
CATEGORY TO CATEGORY TO CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
Single-family residential $ 733 55.51% $ 815 57.32% $ 615 59.81% $1,098 65.54% $ 572 69.82%
Commercial and multi-
family residential 317 19.73 767 19.92 566 16.22 198 15.50 166 13.05
Construction 329 9.69 304 9.33 249 10.86 171 7.33 320 7.71
Home equity 34 11.19 40 9.10 59 9.65 41 9.25 34 7.80
Consumer 10 .48 10 .40 11 .42 8 .55 8 .70
Commercial business 132 3.40 86 3.93 87 3.04 60 1.83 14 .92
Unallocated 431 -- 336 -- 594 -- 443 -- 814 --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance for
loan losses $1,986 100.00% $2,358 100.00% $2,181 100.00% $2,019 100.00% $1,928 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
18
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 $322,700.
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
19
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.
The short-term classes of a CMO usually carry a lower coupon rate than
the longer term classes and, therefore, the interest differential cash flow on a
residual interest is greatest in the early years of the CMO. As the early coupon
classes are extinguished, the residual income declines. Thus, the longer the
lower coupon classes remain outstanding, the greater the cash flow accruing to
CMO residuals. As interest rates decline, prepayments accelerate, the interest
differential narrows, and the cash flow from the CMO declines. Conversely, as
interest rates increase, prepayments decrease, generating a larger cash flow to
residuals.
A senior-subordinated structure often is used with CMOs to provide
credit enhancement for securities which are backed by collateral which is not
guaranteed by FNMA, FHLMC or the GNMA. These structures divide mortgage pools
into various risk classes: a senior class and one or more subordinated classes.
The subordinated classes provide protection to the senior class. When cash flow
is impaired, debt service goes first to the holders of senior classes. In
addition, incoming cash flows also may go into a reserve fund to meet any future
shortfalls of cash flow to holders of senior classes. The holders of
subordinated classes may not receive any funds until the holders of senior
classes have been paid and, when appropriate, until a specified level of funds
has been contributed to the reserve fund.
Mortgage-related securities generally bear yields which are less than
those of the loans which underlie such securities because of their payment
guarantees or credit enhancements which reduce credit risk to nominal levels.
However, mortgage-related securities are more liquid than individual mortgage
loans and may be used to collateralize certain obligations of the Bank. At
September 30, 2003, $13.1 million of the Bank's mortgage-related securities were
pledged to secure various obligations of the Bank, treasury tax and loan
processing and as collateral for certain municipal deposits.
The Bank's mortgage-related securities are classified as either "held
to maturity" or "available for sale" based upon the Bank's intent and ability to
hold such securities to maturity at the time of purchase, in accordance with
GAAP. As of September 30, 2003, the Bank had an aggregate of $128.1 million, or
22.9%, of total assets invested in mortgage-related securities, net, of which
$3.5 million was held to maturity and $124.6 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 set
forth in Item 8 hereof.
20
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,
---------------------------------------
2003 2002 2001
---------------------------------------
(Dollars in thousands)
Available for sale:
Mortgage-backed securities:
FHLMC $ 6,950 $ 5,261 $ 9,175
FNMA 46,030 13,463 15,056
GNMA 13,639 33,621 43,907
-------- -------- --------
Total mortgage-backed securities 66,619 52,345 68,138
-------- -------- --------
Collateralized mortgage obligations:
FHLMC 20,239 9,509 10,994
FNMA 5,381 3,751 6,215
GNMA -- -- 17
Other 32,417(1) 20,069(2) 32,244(3)
-------- -------- --------
Total collateralized mortgage obligations 58,037 33,329 49,470
-------- -------- --------
Total mortgage-related securities $124,656 $ 85,674 $117,608
======== ======== ========
Held to maturity:
Mortgage-backed securities:
FHLMC $ 478 $ 1,433 $ 2,285
FNMA 2,123 3,574 4,684
-------- -------- --------
Total mortgage-backed securities 2,601 5,007 6,969
-------- -------- --------
Collateralized mortgage obligations:
FNMA 886 3,848 4,485
-------- -------- --------
Total collateralized mortgage obligations 886 3,848 4,485
-------- -------- --------
Total mortgage-related securities, amortized cost $ 3,487 $ 8,855 $ 11,454
======== ======== ========
Total fair value(4) $ 3,560 $ 9,090 $ 11,550
======== ======== ========
(1) Includes "AAA" rated securities of Countrywide Home Loans, Washington
Mutual, AMAC and First Horizon with book values of $6.5 million, $6.8
million, $4.7 million and $ 3.6 million, respectively, and fair values
of $6.4 million, $6.7 million, $4.8 million and $3.5 million.
(2) Includes "AAA" rated securities of Northwest Asset Securities
Corporation, Credit Suisse First Boston, Washington Mutual and
Countrywide Home Loans with book values of $2.9 million, $4.1 million,
$5.1 million and $2.7 million, respectively, and fair value of $3.0
million, $4.1 million, $5.1 million and $2.8 million, respectively.
(3) 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.
(4) See Note 4 of the Notes to Consolidated Financial Statements set forth
in Item 8 hereof.
21
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,
------------------------------------
2003 2002 2001
------------------------------------
(Dollars in thousands)
Mortgage-related securities, beginning of period(1)(2) $ 94,529 $ 129,062 $ 109,313
--------- --------- ---------
Purchases:
Mortgage-backed securities - available for sale 50,199 9,280 24,501
CMOs - available for sale 81,942 18,231 34,162
Sales:
Mortgage-backed securities - available for sale (4,493) -- (6,888)
CMOs - available for sale (3,064) -- --
Repayments and prepayments:
Mortgage-backed securities (32,563) (26,820) (21,568)
CMOs (55,941) (34,554) (14,808)
Decrease in net premium (1,128) (315) (145)
Change in net unrealized (loss) gain on mortgage-related
securities available for sale (1,338) (355) 4,495
--------- --------- ---------
Net increase (decrease) in mortgage-related securities 33,614 (34,533) 19,749
--------- --------- ---------
Mortgage-related securities, end of period(1) (2) $ 128,143 $ 94,529 $ 129,062
========= ========= =========
(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, 2003, the estimated weighted average maturity of the
Bank's fixed-rate mortgage-related securities was approximately 3.27 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 fiscal 2003 and 2002, 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 of the
declining interest rate environment, the Bank experienced high levels of
repayments and accelerated prepayments, and consequently, the Bank reinvested
the proceeds of such repayments and prepayments at a lower yield.
22
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,
----------------------------------------------------------
2003 2002 2001
----------------------------------------------------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE VALUE VALUE
----------------------------------------------------------
(Dollars in thousands)
FHLB stock $ 8,294 $ 8,294 $ 6,571 $ 6,571 $ 6,917 $ 6,917
U.S. Government and agency
obligations
1 to 5 years 13,020 13,004 11,986 12,114 2,961 3,133
5 to 10 years 4,880 4,988 1,861 2,071 1,843 2,050
Municipal obligations 17,373 17,895 19,012 19,800 21,890 22,626
Corporate bonds 20,621 21,693 14,299 14,720 14,333 14,087
Mutual funds 14,009 13,952 14,009 14,045 5,009 5,004
Asset backed securities 1,911 1,922 2,837 2,853 2,986 2,970
Preferred stocks 5,474 4,984 10,682 10,751 9,474 9,197
Other equity investments 3,126 5,712 3,476 4,269 2,778 3,497
------- ------- ------- ------- ------- -------
Total $88,708 $92,444 $84,733 $87,194 $68,191 $69,481
======= ======= ======= ======= ======= =======
At September 30, 2003, the Company had an aggregate of $92.4 million,
or 16.5%, of its total assets invested in investment securities, of which $8.3
million consisted of FHLB stock, $77.7 million was investment securities
available for sale and $6.5 million held to maturity. Included in U.S.
Government and agency obligations are callable bonds with a remaining term of
approximately four years. The Bank's investment securities (excluding mutual
funds, equity securities and FHLB stock) had a weighted average maturity to the
call date of 6.0 years and a weighted average yield of 6.1% (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 non-interest-bearing personal and business checking
accounts. The Bank's deposit products also include Individual Retirement Account
("IRA") certificates and Keogh accounts.
The Bank's deposits are obtained primarily from residents in Delaware
and Chester counties in southeastern Pennsylvania. The Bank attracts local
deposit accounts by offering a wide variety of accounts, competitive interest
rates, and convenient branch office locations and service hours. The Bank
utilizes traditional marketing methods to attract new customers and savings
deposits, including print media, radio advertising and direct mailings. However,
the Bank does not solicit funds through deposit brokers nor does it pay any
brokerage fees if it accepts such deposits.
23
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 2003
and 2002, 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 2003 and 2002.
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,
------------------------------------------------------------
2003 2002 2001
------------------------------------------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------------------------------------------------------------
(Dollars in thousands)
Passbook $ 47,089 12.99% $ 41,659 12.60% $ 37,806 12.13%
MMDA 55,889 15.41 48,721 14.73 40,781 13.09
NOW 60,221 16.61 48,803 14.75 45,161 14.49
Certificates of deposit 178,489 49.22 176,242 53.28 182,155 58.46
Non-interest-bearing 20,917 5.77 15,340 4.64 5,698 1.83
-------- ------ -------- ------ -------- ------
Total deposits $362,605 100.00% $330,765 100.00% $311,601 100.00%
======== ====== ======== ====== ======== ======
The following table sets forth the net savings flows of the Bank during
the periods indicated.
YEAR ENDED SEPTEMBER 30,
---------------------------
2003 2002 2001
---------------------------
(Dollars in thousands)
Increase before interest credited $25,633 $10,477 $27,876
Interest credited 6,207 8,687 11,163
------- ------- -------
Net savings increase $31,840 $19,164 $39,039
======= ======= =======
The following table sets forth maturities of the Bank's certificates of
deposit of $100,000 or more at September 30, 2003 and 2002 by time remaining to
maturity (amounts in thousands).
SEPTEMBER 30
-----------------
2003 2002
-----------------
Three months or less $11,724 $10,764
Over three months through six months 6,581 5,509
Over six months through twelve months 5,984 6,679
Over twelve months 9,889 9,618
------- -------
$34,178 $32,570
======= =======
24
The following table presents, by various interest rate categories, the
amount of certificates of deposit at September 30, 2003 and 2002 and the amounts
at September 30, 2003 which mature during the periods indicated.
AMOUNTS AT SEPTEMBER 30, 2003
SEPTEMBER 30, MATURING WITHIN
-------------------- ----------------------------------------------
Certificates of Deposit 2003 2002 ONE YEAR TWO YEARS THREE YEARS THEREAFTER
-------------------- ----------------------------------------------
(Dollars in thousands)
2.0% or less $ 61,363 $ 3,475 $ 49,859 $ 11,504 $ -- $ --
2.01% to 3.0% 39,394 63,429 19,527 16,497 2,703 667
3.01% to 4.0% 42,191 66,834 25,240 4,271 788 11,892
4.01% to 5.0% 19,694 23,064 1,882 7,335 1,214 9,263
5.01% to 6.0% 6,219 9,717 713 2,244 3,257 5
6.01% to 7.0% 9,628 9,723 9,410 218 -- --
-------- -------- -------- -------- -------- --------
Total certificate accounts $178,489 $176,242 $106,631 $ 42,069 $ 7,962 $ 21,827
======== ======== ======== ======== ======== ========
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,
---------------------------------------------------------
2003 2002 2001
---------------------------------------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE RATE AVERAGE RATE AVERAGE RATE
BALANCE PAID BALANCE PAID BALANCE PAID
---------------------------------------------------------
(Dollars in thousands)
Passbook accounts $ 44,105 1.20% $ 40,300 1.86% $ 37,661 2.41%
MMDA accounts 51,756 1.42 47,245 2.19 31,645 3.86
Certificates of deposit 178,097 3.24 174,844 4.24 177,086 5.87
NOW accounts 55,496 .57 49,235 .81 40,681 1.32
Non-interest-bearing deposits 14,272 -- 7,720 -- 7,658 --
-------- -------- --------
Total deposits $343,726 2.14% $319,344 3.01% $294,731 4.43%
======== ==== ======== ==== ======== ====
25
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 2003, the Company funded a portion of its
asset growth with overnight borrowings from FHLB. However, during fiscal 2002,
the increase in core deposits funded asset growth, therefore borrowing from the
FHLB was not necessary. At September 30, 2003, the Bank had $126.4 million in
outstanding FHLB advances. The FHLB advances have certain call features whereby
the FHLB of Pittsburgh 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. See Note 9 of the Notes to Consolidated Financial Statements set
forth in Item 8 hereof.
SUBSIDIARIES
The Bank is permitted to invest up to 2% of its assets in the capital
stock of, or secured or unsecured loans to, service corporations, with an
additional investment of 1% of assets when such additional investment is
utilized primarily for community development purposes. It may invest essentially
unlimited amounts in subsidiaries deemed operating subsidiaries that can only
engage in activities that the Bank is permitted to engage in. Under such
limitations, as of September 30, 2003, the Bank was authorized to invest up to
approximately $11.0 million in the stock of, or loans to, service corporations.
As of September 30, 2003, the net book value of the Bank's investment in stock,
unsecured loans, and conforming loans to its service corporations was $38,100.
At September 30, 2003, in addition to the Bank, the Company has six
direct or indirect subsidiaries: First Keystone Capital Trust I, First Keystone
Capital Trust II, 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 there from in
Junior Subordinated Debentures issued by the Company. See Note 17 of the Notes
to Consolidated Financial set forth in Item 8 hereof for further discussion
regarding the issuance of trust preferred securities.
First Keystone Capital Trust II (the "Trust II") is a Delaware
statutory business trust wholly owned by the Company formed in 2001 for the
purpose of issuing trust preferred securities and investing the proceeds in
Junior Subordinated Debentures issued by the Company. See Note 17 of the Notes
to the Consolidated Financial Statements set forth in Item 8 hereof for further
discussion regarding the issuance of trust preferred securities.
FKF Management Corp., Inc., a Delaware corporation, is a wholly owned
operating subsidiary of the Bank established in 1997 for the purpose of managing
certain assets of the Bank. Assets under management totaled $150.5 million at
September 30, 2003 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.
The Bank has two remaining subsidiaries, First Chester Services, Inc.
and First Pointe, Inc., which were both involved in real estate management but
are now inactive.
EMPLOYEES
The Bank had 88 full-time employees and 15 part-time employees as of
September 30, 2003. 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, examination, supervision
and reporting requirements. As a subsidiary of a savings and loan holding
company, the Bank is subject to certain restrictions in its dealings with the
Company and affiliates thereof.
Federal Activities Restrictions. The Company operates as a unitary
savings and loan holding company. Generally, there are only limited restrictions
on the activities of a unitary savings and loan holding company which applied to
become or was a unitary saving and loan holding company prior to May 4, 1999 and
its non-savings institution subsidiaries. Under the Gramm-Leach-Bliley Act of
1999 (the "GLBA"), companies which apply to the OTS to become unitary savings
and loan holding companies 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 regarding permissible business
activities of grandfathered unitary savings and loan holding companies under the
GLBA (such as the Company), if the savings association subsidiary of such a
holding company fails to meet the Qualified Thrift Lender ("QTL") test, then
such unitary holding company also shall become subject to the activities
restrictions applicable to multiple savings and loan holding companies and,
unless the savings association qualifies as a QTL within one year thereafter,
shall register as, and become subject to the restrictions applicable to, a bank
holding company.
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company and
would thereafter be subject to further restrictions on its activities.
The GLBA also imposes financial privacy obligations and reporting
requirements on all financial institutions. The privacy regulations require,
among other things, that financial institutions establish privacy policies and
disclose such policies to its customers at the commencement of a customer
relationship and annually thereafter. In addition, financial institutions are
required to permit customers to opt out of the financial institution's
disclosure of the customer's financial information to non-affiliated third
parties.
The HOLA requires every savings institution subsidiary of a savings and
loan holding company to give the OTS at least 30 days' advance notice of any
proposed dividends to be made on its guarantee, permanent or other
nonwithdrawable stock, or else such 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 from an affiliate; (iv) and
covered transactions and certain other transactions between a savings
association or its subsidiaries and an affiliate must
27
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