UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the quarterly period ended
September 30, 2007
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the transition period from
_________ to _________
Commission File Number: 2-88927
FIRST KEYSTONE CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2249083
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification No.)
111 West Front Street, Berwick, PA 18603
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (570) 752-3671
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements
for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See
definition of "accelerated filer and large accelerated filer" in
Rule 12b-2 of the Exchange Act). (Check one):
Large accelerated filer [ ] Accelerated Filer [X]
Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
On October 31, 2007 there were 4,518,873 shares of the Registrant's
common stock outstanding.
PART I. - FINANCIAL INFORMATION
Item. 1 Financial Statements
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
September December
2007 2006
(Unaudited)
ASSETS
Cash and due from banks $ 6,330 $ 5,881
Interest bearing deposits
in other banks 8 4,307
Investment securities, available-
for-sale securities carried at
estimated fair value 248,730 237,009
Investment securities, held-to-
maturity securities, estimated
fair value of $4,534 and $6,908 4,542 6,929
Loans, net of unearned income 267,883 251,757
Allowance for loan losses (3,796) (3,671)
________ ________
Net loans $264,087 $248,086
________ ________
Premises and equipment-net 4,983 5,016
Accrued interest receivable 3,404 2,686
Cash surrender value of bank
owned life insurance 13,346 11,942
Goodwill 1,224 1,224
Other assets 4,885 2,840
________ ________
TOTAL ASSETS $551,539 $525,920
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
Non-interest bearing $ 42,143 $ 41,361
Interest bearing 350,765 342,659
________ ________
TOTAL DEPOSITS $392,908 $384,020
Short-term borrowings 45,246 28,179
Long-term borrowings 57,280 57,535
Accrued interest and other
expenses 2,965 2,581
Other liabilities 208 218
________ ________
TOTAL LIABILITIES $498,607 $472,533
________ ________
STOCKHOLDERS' EQUITY
Common stock, par value
$2 per share $ 9,511 $ 9,511
Surplus 16,119 16,119
Retained earnings 35,170 33,793
Accumulated other comprehensive
income (1,813) (126)
Less treasury stock at cost
236,691 shares in 2007 and
228,900 in 2006 (6,055) (5,910)
________ ________
TOTAL STOCKHOLDERS' EQUITY $ 52,932 $ 53,387
________ ________
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $551,539 $525,920
======== ========
See Accompanying Notes to Consolidated Financial Statements
1
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(Unaudited)
(Amounts in thousands except per share data)
2007 2006
INTEREST INCOME
Interest and fees on loans $4,525 $4,223
Interest and dividend income
on securities 3,303 3,012
Deposits in banks 2 1
______ ______
TOTAL INTEREST INCOME $7,830 $7,236
______ ______
INTEREST EXPENSE
Deposits $3,328 $2,951
Short-term borrowings 439 250
Long-term borrowings 702 709
______ ______
TOTAL INTEREST EXPENSE $4,469 $3,910
______ ______
Net interest income $3,361 $3,326
Provision for loan losses 25 100
______ ______
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES $3,336 $3,226
______ ______
NON-INTEREST INCOME
Trust department $ 137 $ 122
Service charges and fees 518 537
Bank owned life insurance income 144 121
Gain on sale of loans 14 10
Investment securities gains
(losses) - net 72 74
Other 88 88
______ ______
TOTAL NON-INTEREST INCOME $ 973 $ 952
______ ______
NON-INTEREST EXPENSES
Salaries and employee benefits $1,316 $1,279
Occupancy, net 171 154
Furniture and equipment 182 187
Professional services 70 115
State shares tax 138 131
Other 553 514
______ ______
TOTAL NON-INTEREST EXPENSES $2,430 $2,380
______ ______
Income before income taxes $1,879 $1,798
Income tax expense 338 295
______ ______
Net Income $1,541 $1,503
______ ______
PER SHARE DATA
Basic $ .34 $ .33
Diluted .34 .33
Cash dividends per share .22 .21
See Accompanying Notes to Consolidated Financial Statements
Adjusted to reflect a 5% stock dividend declared October 24, 2006, to
shareholders of record November 14, 2006, payable December 5, 2006.
2
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(Unaudited)
(Amounts in thousands except per share data)
2007 2006
INTEREST INCOME
Interest and fees on loans $13,215 $12,171
Interest and dividend income
on securities 9,508 8,968
Deposits in banks 64 6
_______ _______
TOTAL INTEREST INCOME $22,787 $21,145
_______ _______
INTEREST EXPENSE
Deposits $ 9,803 $ 8,028
Short-term borrowings 849 684
Long-term borrowings 2,078 2,167
_______ _______
TOTAL INTEREST EXPENSE $12,730 $10,879
_______ _______
Net interest income $10,057 $10,266
Provision for loan losses 150 400
_______ _______
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES $ 9,907 $ 9,866
_______ _______
NON-INTEREST INCOME
Trust department $ 443 $ 385
Service charges and fees 1,489 1,538
Bank owned life insurance income 404 347
Gain on sale of loans 61 13
Investment securities gains
(losses) - net 339 269
Other 232 168
_______ _______
TOTAL NON-INTEREST INCOME $ 2,968 $ 2,720
_______ _______
NON-INTEREST EXPENSE
Salaries and employee benefits $ 3,961 $ 3,955
Occupancy, net 512 452
Furniture and equipment 544 561
Professional services 342 298
State shares tax 411 389
Other 1,820 1,580
_______ _______
TOTAL NON-INTEREST EXPENSES $ 7,590 $ 7,235
_______ _______
Income before income taxes $ 5,285 $ 5,351
Income tax expense 926 823
_______ _______
Net Income $ 4,359 $ 4,528
======= =======
PER SHARE DATA
Basic $ .96 $ .99
Diluted .96 .99
Cash Dividends .66 .63
See Accompanying Notes to Consolidated Financial Statements
Adjusted to reflect a 5% stock dividend declared October 24, 2006, to
shareholders of record November 14, 2006, payable December 5, 2006.
3
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED September 30, 2007 AND 2006
(Unaudited)
(Amounts in thousands)
2007 2006
OPERATING ACTIVITIES
Net income $ 4,359 $ 4,528
Adjustments to reconcile net
income to net cash provided
by operating activities:
Provision for loan losses 150 400
Stock option expense 0 8
Provision for depreciation
and amortization 400 404
Premium amortization on
investment securities 59 125
Accretion of core deposit net
discount 12 1
Discount accretion on
investment securities (382) (379)
Gain on sale of mortgage loans (61) (13)
Proceeds from sale of mortgage
loans 5,640 5,658
Originations of mortgage loans
for resale (3,225) (3,713)
Loss on sale of foreclosed
real estate 0 13
Gain on sales of investment
securities (339) (269)
Deferred income tax (benefit) (111) (216)
Increase in interest receivable
and other assets (1,360) (609)
Increase in cash surrender value
of bank owned life insurance (1,404) (347)
Increase in interest payable,
accrued expenses and other
liabilities 518 216
Loss from sale of premises and
equipment 3 0
_________ ________
Net Cash Provided by Operating
Activities $ 4,259 $ 5,807
_________ ________
INVESTING ACTIVITIES
Purchases of investment
securities available-for-sale $(113,271) $(64,345)
Purchase of investment securities
held-to-maturity 0 (2,005)
Purchase of investment in real
estate ventures (489) 0
Proceeds from sales of investment
securities available-for-sale 85,188 52,266
Proceeds from maturities and
redemptions of investment
securities available-for-sale 14,404 21,790
Proceeds from maturities and
redemption of investment
securities held-to-maturity 2,385 308
Net (increase) in loans (18,505) (19,078)
Purchase of premises and equipment (438) (147)
Proceeds from sale of foreclosed
assets 41 198
Proceeds from sale of premises
and equipment 2 0
_________ ________
Net Cash Used by Investing
Activities $ (30,683) $(11,013)
FINANCING ACTIVITIES
Net increase in deposits $ 8,888 $ 23,574
Net increase (decrease) in
short-term borrowings 17,068 (9,640)
Net decrease in long-term
borrowings (255) (5,000)
Acquisition of treasury stock (145) (1,255)
Proceeds from sale of
treasury stock 0 69
Cash dividends (2,982) (2,877)
_________ ________
Net Cash Provided by Financing
Activities $ 22,574 $ 4,871
_________ ________
Decrease in Cash and Cash
Equivalents (3,850) (335)
Cash and Cash Equivalents,
Beginning 10,188 7,156
_________ ________
Cash and Cash Equivalents, Ending $ 6,338 $ 6,821
========= ========
SUPPLEMENTAL DISCLOSURE OF
CASH FLOW INFORMATION
Cash paid during period for:
Interest $ 12,571 $ 10,890
Income Taxes 1,021 1,065
See Accompanying Notes to Consolidated Financial Statements
4
FIRST KEYSTONE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting policies of First Keystone Corporation and
Subsidiary (the "Corporation") are in accordance with accounting
principles generally accepted in the United States of America and
conform to common practices within the banking industry. The more
significant policies follow:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of
First Keystone Corporation and its wholly owned Subsidiary, First
Keystone National Bank (the "Bank"). All significant inter company
balances and transactions have been eliminated in consolidation.
NATURE OF OPERATIONS
The Corporation, headquartered in Berwick, Pennsylvania,
provides a full range of banking, trust and related services through
its wholly owned Bank subsidiary and is subject to competition from
other financial institutions in connection with these services. The
Bank serves a customer base which includes individuals, businesses,
public and institutional customers primarily located in the
Northeast Region of Pennsylvania. The Bank has 10 full service
offices and 12 ATMs located in Columbia, Luzerne and Montour
Counties. The Corporation and its subsidiary must also adhere to
certain federal banking laws and regulations and are subject to
periodic examinations made by various federal agencies.
SEGMENT REPORTING
The Corporation's banking subsidiary acts as an independent
community financial services provider, and offers traditional
banking and related financial services to individual, business and
government customers. Through its branch and automated teller
machine network, the Bank offers a full array of commercial and
retail financial services, including the taking of time, savings and
demand deposits; the making of commercial, consumer and mortgage
loans; and the providing of other financial services. The Bank also
performs personal, corporate, pension and fiduciary services through
its Trust Department.
Management does not separately allocate expenses, including the
cost of funding loan demand, between the commercial, retail, trust
and mortgage banking operations of the Corporation. Currently,
management measures the performance and allocates the resources of
First Keystone Corporation as a single segment.
USE OF ESTIMATES
The preparation of these consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America, requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of these consolidated financial statements and the reported
amounts of income and expenses during the reporting periods. Actual
results could differ from those estimates.
5
INVESTMENT SECURITIES
The Corporation classifies its investment securities as either
"Held to Maturity" or "Available for Sale" at the time of purchase.
Debt securities are classified as Held to Maturity when the
Corporation has the ability and positive intent to hold the
securities to maturity. Investment securities Held to Maturity are
carried at cost adjusted for amortization of premium and accretion
of discount to maturity.
Debt securities not classified as Held to Maturity and equity
securities are included in the Available for Sale category and are
carried at fair value. The amount of any unrealized gain or loss,
net of the effect of deferred income taxes, is reported as other
comprehensive income (loss) in the Consolidated Statement of Changes
in Stockholders' Equity. Management's decision to sell Available for
Sale securities is based on changes in economic conditions
controlling the sources and applications of funds, terms,
availability of and yield of alternative investments, interest rate
risk and the need for liquidity.
The cost of debt securities classified as Held to Maturity or
Available for Sale is adjusted for amortization of premiums and
accretion of discounts to expected maturity. Such amortization and
accretion, as well as interest and dividends is included in interest
income from investments. Realized gains and losses are included in
net investment securities gains and losses.
The cost of investment securities sold, redeemed or matured is
based on the specific identification method.
LOANS
Loans are stated at their outstanding unpaid principal
balances, net of deferred fees or costs, unearned income and the
allowance for loan losses. Interest on installment loans is
recognized as income over the term of each loan, generally, by the
actuarial method. Interest on all other loans is primarily
recognized based upon the principal amount outstanding on an actual
day basis. Loan origination fees and certain direct loan origination
costs have been deferred with the net amount amortized using the
interest method over the contractual life of the related loans as an
interest yield adjustment.
Mortgage loans held for resale are carried at the lower of cost
or market on an aggregate basis. These loans are sold without
recourse to the Corporation.
Past-Due Loans - Generally, a loan is considered to be past due when
scheduled loan payments are in arrears 15 days or more. Delinquent
notices are generated automatically when a loan is 15 days past due,
depending on the type of loan. Collection efforts continue on loans
past due beyond 60 days that have not been satisfied, when it is
believed that some chance exists for improvement in the status of
the loan. Past due loans are continually evaluated with the
determination for charge-off being made when no reasonable chance
remains that the status of the loan can be improved.
Non-Accrual Loans - Generally, a loan is classified as non accrual
and the accrual of interest on such a loan is discontinued when the
contractual payment of principal or interest has become 90 days past
due or management has serious doubts about further collectibility of
principal or interest, even though the loan currently is performing.
A loan may remain on accrual status if it is in the process of
collection and is either guaranteed or well secured. When a loan is
placed on non-accrual status, unpaid interest credited to income in
the current year is reversed and unpaid interest accrued in prior
years is charged against the allowance for loan losses. Certain non
accrual loans may continue to perform, that is, payments are still
being received. Generally, the payments are applied to principal.
These loans remain under constant scrutiny and if performance
continues, interest income may be recorded on a cash basis based on
management's judgement as to collectibility of principal.
6
Allowance for Loan Losses - The allowance for loan losses is
established through provisions for loan losses charged against
income. Loans deemed to be uncollectible are charged against the
allowance for loan losses and subsequent recoveries, if any, are
credited to the allowance.
A principal factor in estimating the allowance for loan losses
is the measurement of impaired loans. A loan is considered impaired
when, based on current information and events, it is probable that
the Corporation will be unable to collect all amounts due according
to the contractual terms of the loan agreement. Under current
accounting standards, the allowance for loan losses related to
impaired loans is based on discounted cash flows using the effective
interest rate of the loan or the fair value of the collateral for
certain collateral dependent loans.
The allowance for loan losses is maintained at a level
estimated by management to be adequate to absorb potential loan
losses. Management's periodic evaluation of the adequacy of the
allowance for loan losses is based on the Corporation's past loan
loss experience, known and inherent risks in the portfolio, adverse
situations that may affect the borrower's ability to repay
(including the timing of future payments), the estimated value of
any underlying collateral, composition of the loan portfolio,
current economic conditions, and other relevant factors. This
evaluation is inherently subjective as it requires material
estimates including the amounts and timing of future cash flows
expected to be received on impaired loans that may be susceptible to
significant change.
DERIVATIVES
The Bank has outstanding loan commitments that relate to the
origination of mortgage loans that will be held for resale.
Pursuant to Statement of Financial Accounting Standards (SFAS) No.
133, "Accounting for Derivative Instruments and Hedging Activities"
as amended by SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities" and the guidance
contained within the Derivatives Implementation Group Statement 133
Implementation Issue No. C 13, the Bank has accounted for such loan
commitments as derivative instruments. The outstanding loan
commitments in this category did not give rise to any losses for the
nine months ended September 30, 2007 and the year ended December 31,
2006, as the fair market value of each outstanding loan commitment
exceeded the Bank's cost basis in each outstanding loan commitment.
PREMISES AND EQUIPMENT
Premises, improvements and equipment are stated at cost less
accumulated depreciation computed principally on the straight line
method over the estimated useful lives of the assets. Long lived
assets are reviewed for impairment whenever events or changes in
business circumstances indicate that the carrying value may not be
recovered. Maintenance and minor repairs are charged to operations
as incurred. The cost and accumulated depreciation of the premises
and equipment retired or sold are eliminated from the property
accounts at the time of retirement or sale, and the resulting gain
or loss is reflected in current operations.
MORTGAGE SERVICING RIGHTS
The Corporation originates and sells real estate loans to
investors in the secondary mortgage market. After the sale, the
Corporation may retain the right to service these loans. When
originated mortgage loans are sold and servicing is retained, a
servicing asset is capitalized based on relative fair value at the
date of sale. Servicing assets are amortized as an offset to other
fees in proportion to, and over the period of, estimated net
servicing income. The unamortized cost is included in other assets
in the accompanying consolidated balance sheet. The servicing rights
are periodically evaluated for impairment based on their relative
fair value.
FORECLOSED REAL ESTATE
Real estate properties acquired through, or in lieu of, loan
foreclosure are held for sale and are initially recorded at fair
value on the date of foreclosure establishing a new cost basis.
After foreclosure, valuations are periodically performed by
management and the real estate is carried at the lower of carrying
amount or fair value less cost to sell and is included in other
assets. Revenues derived from and costs to maintain the assets and
7
subsequent gains and losses on sales are included in other non
interest income and expense. The total of foreclosed real estate
properties included in other assets amounted to $0 at September 30,
2007 and $41,000 at December 31, 2006.
BANK OWNED LIFE INSURANCE
The Corporation invests in Bank Owned Life Insurance (BOLI)
with split dollar life provisions. Purchase of BOLI provides life
insurance coverage on certain employees with the Corporation being
owner and beneficiary of the policies.
INVESTMENTS IN REAL ESTATE VENTURES
The Bank is a limited partner in real estate ventures that own
and operate affordable residential low-income housing apartment
buildings for elderly residents. The investments are accounted for
under the effective yield method under the Emerging Issues Task
Force (EITF) 94-1, "Accounting for Tax Benefits Resulting from
Investments in Affordable Housing Projects". Under the effective
yield method, the Bank recognizes tax credits as they are allocated
and amortizes the initial cost of the investment to provide a
constant effective yield over the period that the tax credits are
allocated to the Bank. Under this method, the tax credits
allocated, net of any amortization of the investment in the limited
partnerships, are recognized in the consolidated statements of
income as a component of income tax expense. The amount of tax
credits allocated to the Bank were $128,000 in 2006, 2005 and 2004.
The amortization of the investments in the limited partnerships were
$78,000 and $75,000 for the nine months ended September 30, 2007 and
2006, respectively. In June of 2007 the Bank acquired a limited
partnership interest in a real estate venture in the amount of
$489,000. It is anticipated the venture will become operational by
the end of 2007. The carrying value of the investments as of
September 30, 2007 and December 31, 2006, was $1,005,000 and
$595,000, respectively, and is included in other assets in the
accompanying consolidated balance sheets.
INCOME TAXES
The provision for income taxes is based on the results of
operations, adjusted primarily for tax exempt income. Certain items
of income and expense are reported in different periods for
financial reporting and tax return purposes. Deferred tax assets and
liabilities are determined based on the differences between the
consolidated financial statement and income tax bases of assets and
liabilities measured by using the enacted tax rates and laws
expected to be in effect when the timing differences are expected to
reverse. Deferred tax expense or benefit is based on the difference
between deferred tax asset or liability from period to period.
GOODWILL, OTHER INTANGIBLE ASSETS, AND PREMIUM DISCOUNT
Goodwill resulted from the acquisition of certain fixed and
operating assets acquired and deposit liabilities assumed of the
branch of another financial institution in Danville, Pennsylvania,
in January 2004. Such goodwill represents the excess cost of the
acquired assets relative to the assets fair value at the date of
acquisition. The Corporation accounts for goodwill pursuant to the
Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Intangible Assets". SFAS No. 142 includes
requirements to test goodwill for impairments rather than to
amortize goodwill. The Corporation has tested the goodwill included
in its consolidated balance sheet at December 31, 2006, and has
determined there was no impairment as of that date.
Intangible assets are comprised of core deposit intangibles and
premium discount (negative premium) on certificates of deposit
acquired in January 2004 when the Bank assumed deposit accounts of
the branch of another financial institution. The core deposit
intangible is being amortized over the average life of the deposits
acquired as determined by an independent third party. Premium
discount (negative premium) on acquired certificates of deposit
resulted from the valuation of certificate of deposit accounts by an
independent third party which were part of the
8
deposit accounts assumed of the branch by another financial
institution. The book value of certificates of deposit acquired was
greater than their fair value at the date of acquisition which
resulted in a negative premium due to higher cost of the
certificates of deposit compared to the cost of similar term
financing.
STOCK BASED COMPENSATION
The Corporation sponsors a stock option plan. Prior to January
1, 2006 the Corporation had accounted for this Plan under the fair
value recognition and measurement provisions of Statement of
Financial Accounting Standards (SFAS) 123, "Accounting for Stock
Based Compensation". Effective January 1, 2006 the Corporation
adopted SFAS 123 (revised 2004), "Share Based Payment", using the
modified prospective application method. Based on the terms of the
Plan, the Corporation did not have a cumulative effect related to
the Plan. Since the fair value recognition provisions of SFAS 123
and SFAS 123R are essentially the same as they relate to the
Corporation's Plan, the adoption of SFAS 123R did not and will not
have a material impact on the Corporation's consolidated financial
condition, results of operations or liquidity. The fair values of
the stock awards are determined using the estimated expected life.
The Corporation recognized stock based compensation expense on the
straight line basis over the period the stock award is earned by the
employee.
PER SHARE DATA
Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings Per Share", requires dual presentation of basic and fully
diluted earnings per share. Basic earnings per share is calculated
by dividing net income by the weighted average number of shares of
common stock outstanding at the end of each period. Diluted earnings
per share is calculated by increasing the denominator for the
assumed conversion of all potentially dilutive securities. The
Corporation's dilutive securities are limited to stock options.
CASH FLOW INFORMATION
For purposes of reporting consolidated cash flows, cash and
cash equivalents include cash on hand and due from other banks and
interest bearing deposits in other banks. The Corporation considers
cash classified as interest bearing deposits with other banks as a
cash equivalent since they are represented by cash accounts
essentially on a demand basis.
TRUST ASSETS AND INCOME
Property held by the Corporation in a fiduciary or agency
capacity for its customers is not included in the accompanying
consolidated financial statements since such items are not assets of
the Corporation. Trust Department income is generally recognized on
a cash basis and is not materially different than if it were
reported on an accrual basis.
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards (SFAS) 158
"Employers' Accounting for Defined Benefit Pension and Other Post
Retirement Plans", which requires the Corporation to recognize the
funded status of a benefit plan as either assets or liabilities in
the consolidated balance sheet and to recognize as a component of
other comprehensive income, net of tax, unrecognized actuarial gains
or losses, prior service costs and transition obligations that arise
during the period. The adoption of SFAS 158 for year ended December
31, 2006 did not have a material impact on the Corporation's
consolidated financial position, results of operations, or
liquidity.
In September 2006, the FASB issued Statement of Financial
Accounting Standards (SFAS) 157, "Fair Value Measurements", which
upon adoption will replace various definitions of fair value in
existing accounting literature with a single definition, will
establish a framework for measuring fair value, and will require
additional disclosures about fair value measurements. The statement
clarifies that fair value is the price that would be received to
sell an asset or the price paid to transfer a liability in the most
advantageous market available to the entity and emphasizes that fair
value is a market based measurement and should be based on the
assumptions market participants would use. The statement
9
also creates a three level hierarchy under which individual fair
value estimates are to be ranked based on the relative reliability
of the inputs used in the valuation. This hierarchy is the basis for
the disclosure requirements, with fair value estimates based on the
least reliable inputs requiring more extensive disclosures about the
valuation method used and the gains and losses associated with those
estimates. SFAS 157 is required to be applied whenever another
financial accounting standard requires or permits an asset or
liability to be measured at fair value. The statement does not
expand the use of fair value to any new circumstances. The
Corporation will be required to apply the new guidance beginning
January 1, 2008, and does not expect it to have a material impact on
the Corporation's consolidated financial condition, results of
operations, or liquidity.
In July 2006, the FASB issued FASB Staff Position (FSP) 13-2,
"Accounting for a Change or Projected Change in the Timing of Cash
Flows Related to Income Taxes Generated by a Leveraged Lease
Transaction". This FSP amends SFAS 13, "Accounting for Leases", to
require a lessor in a leveraged lease transaction to recalculate the
leveraged lease for the effects of a change or projected change in
the timing of cash flows relating to income taxes that are generated
by the leveraged lease. The guidance in FSP 13-2 is required to be
applied to fiscal years beginning after December 15, 2006. The
application of this FSP is not expected to have a material impact on
the Corporation's consolidated financial condition, results of
operations, or liquidity.
In June 2006, the FASB issued Interpretation No. 48 (FIN 48),
"Accounting for Uncertainty in Income Taxes", an interpretation of
SFAS 109, "Accounting for Income Taxes". FIN 48 prescribes a
comprehensive model for how companies should recognize, measure,
present, and disclose in their financial statements uncertain tax
positions taken or expected to be taken on a tax return. Under FIN
48, tax positions shall initially be recognized in the financial
statements when it is more likely than not the position will be
sustained upon examination by the tax authorities. Such tax
positions shall initially and subsequently be measured as the
largest amount of tax benefit that is greater than 50% likely of
being realized upon ultimate settlement with the tax authority
assuming full knowledge of the position and all relevant facts. FIN
48 also revises disclosure requirements to include an annual tabular
roll-forward of unrecognized tax benefits. The provisions of this
interpretation are required to be adopted for fiscal periods
beginning after December 15, 2006. The Corporation will be required
to apply the provisions of FIN 48 to all tax positions upon initial
adoption with any cumulative effect adjustment to be recognized as
an adjustment to retained earnings. The adoption of FIN 48 is not
expected to have a material impact on the Corporation's consolidated
financial condition, result of operations, or liquidity.
In March 2006, the FASB issued Statement of Financial
Accounting Standards (SFAS) 156, "Accounting for Servicing of
Financial Assets", an amendment of SFAS 140. This standard requires
entities to separately recognize a servicing asset or liability
whenever it undertakes an obligation to service financial assets and
also requires all separately recognized servicing assets or
liabilities to be initially measured at fair value. Additionally,
this standard permits entities to choose among two alternatives, the
amortization method or fair value measurement method, for the
subsequent measurement of each class of separately recognized
servicing assets and liabilities. Under the amortization method, an
entity shall amortize the value of servicing assets or liabilities
in proportion to and over the period of estimated net servicing
income or net servicing loss and assess servicing assets or
liabilities for impairment or increased obligation based on fair
value at each reporting date. Under the fair value measurement
method, an entity shall measure servicing assets or liabilities at
fair value at each reporting date and report changes in fair value
in earnings in the period in which the changes occur.
Effective January 1, 2006, the Corporation adopted this
statement by electing amortization method as the measurement method
for residential real estate mortgage servicing rights (MSRs).
In February 2006, the FASB issued Statement of Financial
Accounting Standards (SFAS) 155, "Accounting for Certain Hybrid
Financial Instruments", which amends SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities", and SFAS 140,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". SFAS 155 requires entities to
evaluate and identify whether interests in securitized financial
assets are freestanding derivatives, hybrid financial instruments
that contain an embedded derivative requiring bifurcation, or hybrid
financial instruments that contain embedded derivatives that do not
require bifurcation. SFAS 155 also permits fair value measurement
for any hybrid financial instrument that contains an embedded
derivative that otherwise would
10
require bifurcation. This statement will be effective for all
financial instruments acquired or issued by the Corporation on or
after January 1, 2007 and is not expected to have a material impact
on the Corporation's consolidated financial condition, results of
operations, or liquidity.
In November 2005, the Financial Accounting Standards Board
(FASB) issued FASB Staff Position (FSP) 115 - "The Meaning of Other
Than Temporary Impairment and Its Application to Certain
Investments". This FSP provides additional guidance on when an
investment in a debt or equity security should be considered
impaired and when that impairment should be considered other than
temporary and recognized as a loss in the consolidated statement of
income. Specifically, this guidance clarifies that an investor
should recognize an impairment loss no later than when an impairment
is deemed other than temporary, even if the decision to sell has not
been made. The FSP also requires certain disclosures about
unrealized losses that have not been recognized as other than
temporary impairments. The Corporation has followed the guidance of
this FSP in 2005, 2006 and 2007.
In May 2005, the FASB issued Statement of Financial Accounting
Standards (SFAS) 154, "Accounting Charges and Error Corrections",
which modifies the accounting for and reporting of a change in an
accounting principle. This statement applies to all voluntary
changes in accounting principles and changes required by an
accounting pronouncement in the unusual instance that the
pronouncement does not include specified transition provisions. This
statement also requires retrospective application to prior period
financial statements of changes in accounting principles, unless it
is impractical to determine either the period specific or cumulative
effects of the accounting change. SFAS 154 is effective for
accounting changes made in fiscal years beginning after December 15,
2005. The adoption of SFAS 154 is not expected to have a material
impact on the Corporation's consolidated financial condition,
results of operations, or liquidity.
In December 2004, the FASB issued Statement of Financial
Accounting Standards (SFAS) 153, "Exchanges of Nonmonetary Assets",
which amends APB Opinion No. 29, "Accounting for Nonmonetary
Transactions". SFAS 153 eliminates the exception from fair value
measurement for nonmonetary exchanges of similar productive assets
in Opinion No. 29 and replaces it with an exception for exchanges
that do not have commercial substance. SFAS 153 specifies that a
nonmonetary exchange has commercial substance if the future cash
flows of the entity are expected to change significantly as a result
of the exchange. SFAS 153 is effective for nonmonetary exchanges
occurring in fiscal periods beginning after June 15, 2005. The
adoption of SFAS No. 153 is not expected to have a material impact
on the Corporation's consolidated financial condition, results of
operations, or liquidity.
In December 2004, the FASB issued Statement of Financial
Accounting Standards (SFAS) 123 (revised 2004), "Share-Based
Payment". This Statement is a revision of SFAS 123, "Accounting for
Stock-Based Compensation", and supercedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees", and its related
guidance. SFAS 123 (revised 2004) established standards for the
accounting for transactions in which an entity exchanges its equity
instruments for goods and services. This Statement requires that
the cost resulting from all share based payment transactions be
recognized in the financial statements. This Statement establishes
fair value as the measurement objective in accounting for share
based payment arrangements and requires all entities to apply a fair
value based measurement method in accounting for share based payment
transactions with employees, except for equity instruments held by
employee share ownership plans.
In addition, this statement amends SFAS 95, "Statement of Cash
Flows", to require that excess tax benefits be reported as financing
cash inflow rather than as a reduction of taxes paid. The
Corporation has adopted these statements as of January 1, 2006.
SFAS 123R requires the Corporation to change its method of
accounting for share based awards to include estimated forfeitures
in the initial estimate of compensation expense and to accelerate
the recognition of compensation expense for retiree eligible
employees. The adoption of these standards did not have a material
effect on the Corporation's consolidated financial condition,
results of operations, or liquidity.
ADVERTISING COSTS
It is the Corporation's policy to expense advertising costs in
the period in which they are incurred. Advertising expense for the
nine month periods ended September 30, 2007 and 2006 was
approximately $285,000 and $193,000, respectively.
11
RECLASSIFICATIONS
Certain amounts in the consolidated financial statements of
prior periods have been reclassified to conform with presentation
used in the 2007 consolidated financial statements. Such
reclassifications have no effect on the Corporation's consolidated
financial condition or net income.
Note 2. ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses for the periods ended
September 30, 2007, and September 30, 2006, were as follows:
(amounts in thousands)
2007 2006
____ ____
Balance, January 1 $3,671 $3,676
Provision charged to operations 150 400
Loans charged off (127) (492)
Recoveries 102 38
______ ______
Balance, September 30 $3,796 $3,622
====== ======
At September 30, 2007, the total recorded investment in loans
that are considered to be impaired as defined by SFAS No. 114 was
$1,335,000. No additional charge to operations was required to
provide for the impaired loans since the total allowance for loan
losses is estimated by management to be adequate to provide for the
loan loss allowance required by SFAS No. 114 along with any other
potential losses.
At September 30, 2007, there were no significant commitments to
lend additional funds with respect to non accrual and restructured
loans.
Non accrual loans at September 30, 2007 and December 31, 2006
were $1,335,000 and $1,704,000, respectively, all of which were
considered impaired.
Loans past due 90 days or more and still accruing interest
amounted to $391,000 and $1,135,000 on September 30, 2007 and
December 31, 2006, respectively.
Note 3. SHORT-TERM BORROWINGS
Federal funds purchased, securities sold under agreements to
repurchase and Federal Home Loan Bank advances generally represent
overnight or less than 30 day borrowings. U.S. Treasury tax and loan
notes for collections made by the Bank are payable on demand.
Note 4. LONG-TERM BORROWINGS
Long term borrowings are comprised of advances from the
Federal Home Loan Bank. Under terms of a blanket agreement,
collateral for the loans are secured by certain qualifying assets of
the Corporation's banking subsidiary which consist principally of
first mortgage loans and certain investment securities.
12
Note 5. FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET
RISK AND CONCENTRATIONS OF CREDIT RISK
The Corporation is a party to financial instruments with off
balance sheet risk in the normal course of business to meet the
financing needs of its customers. These financial instruments
include commitments to extend credit and standby letters of credit.
Those instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the
consolidated balance sheets. The contract or notional amounts of
those instruments reflect the extent of involvement the Corporation
has in particular classes of financial instruments. The Corporation
does not engage in trading activities with respect to any of its
financial instruments with off balance sheet risk.
The Corporation's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for
commitments to extend credit and standby letters of credit is
represented by the contractual notional amount of those instruments.
The Corporation uses the same credit policies in making
commitments and conditional obligations as it does for on balance
sheet instruments.
The Corporation may require collateral or other security to
support financial instruments with off balance sheet credit risk.
The contract or notional amounts at September 30, 2007 and December
31, 2006 were as follows:
(amounts in thousands)
September 30, December 31,
2007 2006
____ ____
Financial instruments whose
contract amounts represent
credit risk:
Commitments to extend credit $26,230 $33,811
Financial standby letters
of credit 1,379 1,160
Performance standby letters
of credit 1,152 2,155
Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition
established in the contract. Commitments generally have fixed
expiration dates or other termination clauses that may require
payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Corporation
evaluates each customer's creditworthiness on a case by case basis.
The amount of collateral obtained, if deemed necessary by the
Corporation upon extension of credit, is based on management's
credit evaluation of the counter party. Collateral held varies but
may include accounts receivable, inventory, property, plant and
equipment, and income producing commercial properties.
Standby letters of credit are conditional commitments issued by
the Corporation to guarantee the performance of a customer to a
third party. The credit risk involved in issuing letters of credit
is essentially the same as that involved in extending loan
facilities to customers. The Corporation may hold collateral to
support standby letters of credit for which collateral is deemed
necessary.
The Corporation grants commercial, agricultural, real estate
mortgage and consumer loans to customers primarily in the counties
of Columbia, Luzerne, and Montour, Pennsylvania. It is management's
opinion that the loan portfolio was well balanced and diversified at
September 30, 2007, to the extent necessary to avoid any significant
concentration of credit risk. However, its debtors ability to honor
their contracts may be influenced by the region's economy.
13
Note 6. STOCKHOLDERS' EQUITY
Changes in Stockholders' Equity for the period ended September
30, 2007, were are follows:
(Amounts in thousands, except common share data)
Common Common
Shares Stock Surplus
______ ______ _______
Balance at January 1, 2007 4,755,564 $9,511 $16,119
Comprehensive Income:
Net Income
Change in unrealized
gain (loss) on
investment securities
available-for-sale,
net of reclassification
adjustment and tax
effects
Total Comprehensive
income (loss)
Purchase of 7,791
shares of treasury stock
Cash dividends -
$.66 per share
_________ ______ _______
Balance at September 30, 2007 4,755,564 $9,511 $16,119
========= ====== =======
(Amounts in thousands, except common share data)
Accumulated
Compre- Other
hensive Retained Comprehensive
Income Earnings Income (Loss)
______ ______ __________
Balance at January 1, 2007 $33,793 $ (126)
Comprehensive Income:
Net Income $4,359 4,359
Change in unrealized
gain (loss) on
investment securities
available-for-sale,
net of reclassification
adjustment and tax
effects (1,687) (1,687)
______
Total Comprehensive
income (loss) $2,671
======
Purchase of 7,791
shares of treasury stock
Cash dividends -
$.66 per share (2,982)
_______ _______
Balance at September 30, 2007 $35,170 $(1,813)
======= =======
(Amounts in thousands, except common share data)
Treasury
Stock Total
_____ _____
Balance at January 1, 2007 $(5,910) $53,387
Comprehensive Income:
Net Income 4,359
Change in unrealized
gain (loss) on
investment securities
available-for-sale,
net of reclassification
adjustment and tax
effects (1,687)
Total Comprehensive
income (loss)
Purchase of 7,791
shares of treasury stock (145) (145)
Cash dividends -
$.66 per share (2,982)
_______ _______
Balance at June 30, 2007 $(6,055) $52,932
======= =======
On October 24, 2006 the Corporation declared a 5% stock
dividend to shareholders of record on November 14, 2006, payable on
December 5, 2006.
NOTE 7. MANAGEMENT'S ASSERTIONS AND COMMENTS
REQUIRED TO BE PROVIDED WITH FORM 10Q FILING
In management's opinion, the consolidated interim financial
statements reflect fair presentation of the consolidated financial
position of First Keystone Corporation and Subsidiary, and the
results of their operations and their cash flows for the interim
periods presented. Further, the consolidated interim financial
statements are unaudited; however they reflect all adjustments,
which are in the opinion of management, necessary to present fairly
the consolidated financial condition and consolidated results of
operations and cash flows for the interim periods presented and that
all such adjustments to the consolidated financial statements are of
a normal recurring nature. The independent accountants, J. H.
Williams & Co., LLP, reviewed these consolidated financial
statements as stated in their accompanying review report.
The results of operations for the nine month period ended
September 30, 2007, are not necessarily indicative of the results to
be expected for the full year.
These consolidated interim financial statements have been
prepared in accordance with requirements of Form 10Q and therefore
do not include all disclosures normally required by generally
accepted accounting principles applicable to financial institutions
as included with consolidated financial statements included in the
Corporation's annual Form 10K filing. The reader of these
consolidated interim financial statements may wish to refer to the
Corporation's annual report or Form 10K for the period ended
December 31, 2006, filed with the Securities and Exchange
Commission.
14
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders of First Keystone Corporation:
We have reviewed the accompanying consolidated balance sheet of
First Keystone Corporation and Subsidiary as of September 30, 2007,
and the related consolidated statements of income for the three and
nine month periods ended September 30, 2007 and 2006 and cash flows
for the nine month periods ended September 30, 2007, and 2006.
These consolidated interim financial statements are the
responsibility of the management of First Keystone Corporation and
Subsidiary.
We conducted our reviews in accordance with the standards of the
Public Company Accounting Oversight Board (United States). A review
of interim financial information consists principally of applying
analytical procedures and making inquiries of persons responsible
for financial and accounting matters. It is substantially less in
scope than an audit conducted in accordance with the standards of
the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our reviews, we are not aware of any material modifications
that should be made to the consolidated interim financial statements
referred to above for them to be in conformity with accounting
principles generally accepted in the United States of America.
We have previously audited, in accordance with the auditing
standards of the Public Company Accounting Oversight Board (United
States), the consolidated balance sheet of First Keystone
Corporation and Subsidiary as of December 31, 2006, and the related
consolidated statements of income, changes in stockholders' equity,
and cash flows for the year then ended (not presented herein); and
in our report dated February 28, 2007, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying consolidated balance
sheet as of December 31, 2006, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which
it has been derived.
/s/ J.H. Williams & Co., LLP
J. H. Williams & Co., LLP
Kingston, Pennsylvania
November 7, 2007
15
Item 2. First Keystone Corporation Management's Discussion
and Analysis of Financial Condition and
Results of Operation as of September 30, 2007
This quarterly report contains certain forward looking
statements (as defined in the Private Securities Litigation Reform
Act of 1995), which reflect management's beliefs and expectations
based on information currently available. These forward looking
statements are inherently subject to significant risks and
uncertainties, including changes in general economic and financial
market conditions, the Corporation's ability to effectively carry
out its business plans and changes in regulatory or legislative
requirements. Other factors that could cause or contribute to such
differences are changes in competitive conditions, and pending or
threatened litigation. Although management believes the expectations
reflected in such forward looking statements are reasonable, actual
results may differ materially.
RESULTS OF OPERATIONS
First Keystone Corporation realized earnings for the third
quarter of 2007 of $1,541,000, an increase of $38,000 or 2.5% from
the third quarter of 2006. Nine months net income for the period
ended September 30, 2007, amounted to $4,359,000, a decrease of 3.7%
from the $4,528,000 net income reported September 30, 2006. Net
interest income increased in the third quarter of 2007, but declined
for the first nine months of 2007 when compared to the same period
in 2006. The higher net interest income in the third quarter of
2007 was due to a steepening yield curve and some expansion of our
net interest margin. Earnings were positively affected by a lower
loan loss provision, increased non interest income, and continued
excellent control over non interest expense. On a per share basis,
net income per share was $.96 for the nine months of 2007, as
compared to $.99 for the first nine months of 2006, while dividends
increased to $.66 per share up from $.63 in 2006, or an increase of
4.8%.
Year-to-date net income annualized amounts to a return on
average common equity of 12.38% and a return on assets of 1.09%.
For the nine months ended September 30, 2006, these measures were
11.54% and 1.16%, respectively on an annualized basis.
NET INTEREST INCOME
The major source of operating income for the Corporation is net
interest income, defined as interest income less interest expense.
In the third quarter of 2007, interest income amounted to
$7,830,000, an increase of $594,000 or 8.2% from the third quarter
of 2006. Interest expense amounted to $4,469,000 in the third
quarter of 2007, an increase of $559,000 or 14.3% over the third
quarter of 2006. Accordingly, net interest income amounted to
$3,361,000 in the third quarter of 2007, an increase of $35,000, or
1.1% from the third quarter of 2006. Year to date for the nine
months ended September 30, 2007, total interest income increased
$1,642,000, or 7.8% to $22,787,000 from $21,145,000 in the first
nine months of 2006. Total interest expense increased $1,851,000,
or 17.0% to $12,730,000 for the first nine months of 2007 from
$10,879,000 in the first nine months of 2006. This resulted in net
interest income decreasing $209,000 to $10,057,000 as of September
30, 2007 from $10,266,000 as of September 30, 2006.
Our net interest margin for the quarter ended September 30,
2007, was 2.97% compared to 3.08% for the quarter ended September
30, 2006. For the nine months ended September 30, 2007, our net
interest margin was 2.94% compared to 3.17% for the first nine
months of 2006.
16
PROVISION FOR LOAN LOSSES
The provision for loan losses for the quarter ended September
30, 2007, was $25,000 compared to $100,000 for the third quarter of
2006. Year to date, the provision for loan losses amounts to
$150,000 in 2007 as compared to the $400,000 provision for the
period ended September 30, 2006. Net charge offs amounted to
$25,000 for the nine months ended September 30, 2007, as compared to
$454,000 for the first nine months of 2006.
The allowance for loan losses as a percentage of loans, net of
unearned interest was 1.42% as of September 30, 2007, and 1.46% as
of December 31, 2006.
NON-INTEREST INCOME
Total non interest or other income was $973,000 for the quarter
ended September 30, 2007, as compared to $952,000 for the quarter
ended September 30, 2006. Excluding investment security gains and
losses, non interest income was $901,000 for the third quarter of
2007, as compared to $878,000 in the third quarter of 2006, an
increase of 2.6%. For the nine months ended September 30, 2007,
total non interest income was $2,968,000, as compared to $2,720,000,
or a 9.1% increase from the first nine months of 2006. In both the
third quarter of 2007 and for the nine months ended September 30,
2007, the increase in non-interest income was primarily the result
of an increase in trust department revenue, an increase in bank
owned life insurance income, an increase on gains on sale of loans,
and an increase in other non interest income.
NON-INTEREST EXPENSES
Total non interest, or other expenses, was $2,430,000 for the
quarter ended September 30, 2007, as compared to $2,380,000 for the
quarter ended September 30, 2006, an increase of $50,000 or 2.1%.
For the nine months ended September 30, 2007, total non
interest expense was $7,590,000, an increase of $355,000, or 4.9%
over the first nine months of 2006. Expenses associated with
employees (salaries and employee benefits) continue to be the
largest category of non-interest expenses. Salaries and benefits
amount to 52.2% of total non interest expense for the nine months
ended September 30, 2007, as compared to 54.7% for the first nine
months of 2006. Salaries and benefits amounted to $3,961,000 for
the nine months ended September 30, 2007, an increase of $6,000, or
0.2% over the first nine months of 2006. Net occupancy expense,
including furniture and equipment, amounted to $1,056,000 for the
nine months ended September 30, 2007, an increase od $43,000, or
4.2% from 2006. Because of additional legal expenses, professional
services increased $44,000 or 14.8% from the first nine months of
2006. State shares tax increased by $22,000 or 5.7% over the first
nine months of 2006. Other non-interest expenses amounted to
$1,820,000 for the nine months ended September 30, 2007, an increase
of $240,000, or 15.2% from the first nine months of 2006. Even with
the increase in non interest expenses in 2007, our overall non
interest expense continues at less than 2.0% of average assets on an
annualized basis. This places us among the leaders of our peer
financial institutions at controlling non interest expense.
INCOME TAXES
Effective tax planning has helped produce favorable net income.
The effective total income tax rate was 18.0% for the third quarter
of 2007 as compared to 16.4% for the third quarter of 2006. For the
nine months ended September 30, 2007, our tax liability amounted to
$926,000 for an effective tax rate of 17.5% as compared to an
effective tax rate of 15.4% for the first nine months of 2006.
17
ANALYSIS OF FINANCIAL CONDITION
ASSETS
Total assets increased to $551,539,000 as of September 30,
2007, an increase of $25,619,000, or 4.9% over year end 2006. Total
deposits increased to $392,908,000 as of September 30, 2007, an
increase of $8,888,000, or 2.3% over year end 2006.
The Corporation used the increase in total deposits to fund
primarily an increase in loans. Total borrowings increased
$16,812,000 from December 31, 2006. Short term borrowings increased
to $45,246,000 as of September 30, 2007, up from $28,179,000 at year
end 2006. Long term borrowings decreased slightly to $57,280,000 as
of September 30, 2007, down $255,000 from $57,535,000 at year end
2006.
EARNING ASSETS
Our primary earning asset, loans, net of unearned income
increased to $267,883,000 as of September 30, 2007, an increase of
$16,126,000, or 6.4% from year end 2006. The loan portfolio is well
diversified and the increases in the portfolio has been primarily
from increased originations of commercial real estate loans.
In addition to loans, another primary earning asset is our
investment portfolio which has increased in size from December 31,
2006, to September 30, 2007. Available for sale securities amounted
to $248,730,000 as of September 30, 2007, an increase of
$11,721,000, or 4.9% from year-end 2006. However, held to maturity
securities decreased to $4,542,000 as of September 30, 2007, a
decrease of $2,387,000, or 34.4% since year end 2006. Interest
bearing deposits with banks decreased to $8,000 on September 30,
2007, as compared to $4,307,000 as of December 31, 2006.
ALLOWANCE FOR LOAN LOSSES
Management performs a quarterly analysis to determine the
adequacy of the allowance for loan losses. The methodology in
determining adequacy incorporates specific allocations together with
a risk/loss analysis on various segments of the portfolio according
to an internal loan review process. Management maintains its loan
review and loan classification standards consistent with those of
its regulatory supervisory authority. Management feels, considering
the conservative portfolio composition, which is largely composed of
small retail loans (mortgages and installments) with minimal
classified assets, low delinquencies, and favorable loss history,
that the allowance for loan loss is adequate to cover foreseeable
future losses.
Any loans classified for regulatory purposes as loss, doubtful,
substandard, or special mention that have not been disclosed under
Industry Guide 3 do not (i) represent or result from trends or
uncertainties which management reasonably expects will materially
impact future operating results, liquidity, or capital resources, or
(ii) represent material credits about which management is aware of
any information which causes management to have serious doubts as to
the ability of such borrowers to comply with the loan repayment
terms.
The company was required to adopt Financial Accounting
Standards Board Statement No. 114, "Accounting by Creditors for
Impairment of a Loan" - Refer to Note 2 above for details.
18
NON-PERFORMING ASSETS
Non performing assets consist of non accrual and restructured
loans, other real estate and foreclosed assets, together with the
loans past due 90 days or more and still accruing. As of September
30, 2007, total non performing assets were $1,726,000 as compared to
$2,880,000 on December 31, 2006. Non performing assets to total
loans and foreclosed assets was 0.64% as of September 30, 2007, and
1.14% as of December 31, 2006.
Interest income received on non performing loans as of
September 30, 2007, was $0 compared to $14,000 as of December 31,
2006. Interest income, which would have been recorded on these
loans under the original terms as of September 30, 2007, and
December 31, 2006, was $77,000 and $133,000, respectively. As of
September 30, 2007 and December 31, 2006, there was no outstanding
commitments to advance additional funds with respect to these
non-performing loans.
DEPOSITS AND OTHER BORROWED FUNDS
As indicated previously, total deposits increased by $8,888,000
as non interest bearing deposits increased by $782,000 and interest
bearing deposits increased by $8,106,000 as of September 30, 2007,
from year end 2006. Total short term and long term borrowings
increased by $16,812,000 from year end 2006.
CAPITAL STRENGTH
Normal increases in capital are generated by net income, less
cash dividends paid out. Also, accumulated other comprehensive
income derived from unrealized gains on investment securities
available for sale decreased shareholders' equity, or capital net of
taxes, by $1,813,000 as of September 30, 2007, and $126,000 as of
December 31, 2006. Our stock repurchase plan repurchased 236,691
shares as treasury stock as of September 30, 2007 and 228,900 shares
as treasury stock as of December 31, 2006. This had an effect of
our reducing our total stockholders' equity by $6,055,000 on
September 30, 2007, and $5,910,000 as of December 31, 2006.
Total stockholders' equity was $52,932,000 as of September 30,
2007, and $53,387,000 as of December 31, 2006. Leverage ratio and
risk based capital ratios remain very strong. As of September 30,
2007, our leverage ratio was 9.95% compared to 9.94% as of December
31, 2006. In addition, Tier I risk based capital and total risk
based capital ratio as of September 30, 2007, were 16.16% and
17.35%, respectively. The same ratios as of December 31, 2006, were
17.45% and 18.82%, respectively.
LIQUIDITY
The liquidity position of the Corporation remains adequate to
meet customer loan demand and deposit fluctuation. Managing
liquidity remains an important segment of asset liability
management. Our overall liquidity position is maintained by an
active asset liability management committee.
Management feels its current liquidity position is
satisfactorily given a very stable core deposit base which has
increased annually. Secondly, our loan payments and principal
paydowns on our mortgage backed securities provide a steady source
of funds. Also, short term investments and maturing investment
securities represent additional sources of liquidity. Finally,
short term borrowings are readily accessible at the Federal Reserve
Bank discount window, Atlantic Central Bankers Bank, or the Federal
Home Loan Bank.
19
COMMITMENTS
On November 1, 2007, First Keystone Corporation completed the
acquisition of Pocono Community Bank ("Pocono") through the merger
of Pocono with and into First Keystone National Bank pursuant to the
Agreement and Plan of Merger dated as of May 10, 2007 (the "Merger
Agreement") between First Keystone Corporation, First Keystone
National Bank and Pocono. The three Pocono branches acquired will
operate under the name "Pocono Community Bank, a division of First
Keystone National Bank."
In the merger, Pocono shareholders received either 0.8944
shares of First Keystone Corporation common stock for each share of
Pocono common stock or $ 16.10 in cash for each share held,
depending on shareholder elections and subject to the allocation
provisions of the Merger Agreement. All outstanding options and
warrants were cashed out and cancelled. In connection with the
Merger, First Keystone Corporation paid to the former shareholders
of Pocono, in the aggregate, $11,327,927 million in cash and issued
to the former shareholders of Pocono, in the aggregate, 932,203
shares of First Keystone's common stock.
ITEM 3. Quantitative and Qualitative Disclosures
About Market Risk
There have been no material changes in the Company's
quantitative and qualitative market risks since December 31, 2006.
The composition of rate sensitive assets and rate sensitive
liabilities as of September 30, 2007 is very similar to December 31,
2006.
ITEM 4. Controls and Procedures
a) Evaluation of disclosure controls and procedures. The
company maintains controls and procedures designed to ensure that
information required to be disclosed in the reports that the company
files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods
specified in the rules and forms of the Securities and Exchange
Commission. Based upon their evaluation of those controls and
procedures performed within 90 days of the filing date of this
report, the chief executive and chief financial officers of the
company concluded that the company's disclosure controls and
procedures were adequate.
b) Changes in internal controls. The Company made no
significant changes in its internal controls or in other factors
that could significantly affect these controls subsequent to the
date of the evaluation of the controls by the Chief Executive and
Chief Financial officers.
20
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 1A. There have been no material changes in our "Risk
Factors" as previously disclosed in our Annual Report
on Form 10K for the year ended December 31, 2006.
Item 2. Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities
Total
Number Maximum
of Shares Number of
Purchased Shares That
as Part of May Yet Be
Total Publicly Purchased
Number Average Announced Under the
of Shares Price Paid Plans or Plans or
Period Purchased per Share Programs Programs
______ _________ _________ ________ ________
July 1 -
July 31,
2007 ---- ---- ---- 123,098
August 1 -
August 31,
2007 ---- ---- ---- 123,098
Sept. 1 -
Sept. 30,
2007 ---- ---- ---- 123,098
Total ---- ---- ---- 123,098
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
Annual Meeting of Shareholders of First Keystone
Corporation held on Tuesday, April 17, 2007 at 10:00
a.m.
Votes Votes
Directors Elected Votes For Against Withheld
_________________ _________ ______ _______
John E. Arndt 3,123,686 65,263 0
J. Gerald Bazewicz 3,108,986 79,963 0
Robert E. Bull 3,107,141 81,808 0
Broker
Directors Elected Abstentions Non-Votes
_________________ ___________ _________
John E. Arndt 0 0
J. Gerald Bazewicz 0 0
Robert E. Bull 0 0
21
Directors Continuing:
____________________
Don E. Bower, term expires in 2008
Robert A. Bull, term expires in 2008
Dudley P. Cooley, term expires in 2008
Jerome F. Fabian, term expires in 2009
David R. Saracino, term expires in 2009
Robert J. Wise, term expires in 2009
Matters Voted Upon:
------------------
Selection of J. H. Williams & Co. LLP, as auditors for the
Corporation.
Votes For - 3,065,673
Votes Against - 1,201
Votes Withheld - 0
Abstentions - 2,282
Broker Non-Votes - 0
Item 5. Other Information
The Company made no material changes to the procedures
by which shareholders may recommend nominees to the
Company's Board of Directors.
22
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits required by Item 601 Regulation S-K
Exhibit Number Description of Exhibit
______________ ______________________
3i Articles of Incorporation, as amended
(Incorporated by reference to Exhibit 3(i) to
the Registrant's Report on Form 10Q for the
quarter ended March 31, 2006).
3ii By-Laws, as amended (Incorporated by reference
to Exhibit 3(ii) to the Registrant's Report on
Form 10Q for the quarter ended March 31, 2006).
10.1 Supplemental Employee Retirement Plan
(Incorporated by reference to Exhibit 10 to the
Registrant's Report on Form 10Q for the quarter
ended September 30, 2005).
10.2 Management Incentive Compensation Plan
(Incorporated by reference to Exhibit 10 to the
Registrant's Report on Form 10Q for the quarter
ended September 30, 2006).
10.3 Profit Sharing Plan (Incorporated by reference
to Exhibit 10 to the Registrant's Report on Form
10Q for the quarter ended September 30, 2006).
10.4 First Keystone Corporation 1998 Stock Incentive
Plan (Incorporated by reference to Exhibit 10 to
the Registrant's Report on Form 10Q for the
quarter ended September 30, 2006).
14 Code of Ethics (Incorporated by reference to
Exhibit 14 to the Registrant's Report on Form 8K
dated January 9, 2007).
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief
Executive Officer.
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief
Financial Officer.
32.1 Section 1350 Certification of Chief Executive
Officer.
32.2 Section 1350 Certification of Chief Financial
Officer.
(b) During the quarter ended September 30, 2007, the
registrant filed the following reports on Form 8-K:
Date of Report Item Description
______________ ____ ___________
August 1, 2007 2.02 On July 31, 2006, the Registrant
issued a press release announcing its
earnings for the quarter ended
September 30, 2007.
August 31, 2007 8.01 On August 31, 2007, the Registrant
issued a press release announcing the
declaration of it's third quarter
dividend.
23
FIRST KEYSTONE CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly cause this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FIRST KEYSTONE CORPORATION
Registrant
November 8, 2007 /s/ J. Gerald Bazewicz
J. Gerald Bazewicz
President and
Chief Executive Officer
(Principal Executive Officer)
November 8, 2007 /s/ Diane C.A. Rosler
Diane C.A. Rosler
Chief Financial Officer
(Principal Accounting Officer)
24
INDEX TO EXHIBITS
Exhibit Description
_______ ___________
3i Articles of Incorporation, as amended (Incorporated
by reference to Exhibit 3(i) to the Registrant's
Report on Form 10Q for the quarter ended March 31,
2006).
3ii By-Laws, as amended (Incorporated by reference to
Exhibit 3(ii) to the Registrant's Report on Form
10Q for the quarter ended March 31, 2006).
10.1 Supplemental Employee Retirement Plan (Incorporated
by reference to Exhibit 10 to the Registrant's
Report on Form 10Q for the quarter ended September
30, 2005).
10.2 Management Incentive Compensation Plan
(Incorporated by reference to Exhibit 10 to the
Registrant's Report on Form 10Q for the quarter
ended September 30, 2006).
10.3 Profit Sharing Plan (Incorporated by reference to
Exhibit 10 to the Registrant's Report on Form 10Q
for the quarter ended September 30, 2006).
10.4 First Keystone Corporation 1998 Stock Incentive
Plan (Incorporated by reference to Exhibit 10 to
the Registrant's Report on Form 10Q for the quarter
ended September 30, 2006).
14 Code of Ethics (Incorporated by reference to
Exhibit 14 to the Registrant's Report on Form 8K
dated January 9, 2007).
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief
Executive Officer.
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief
Financial Officer.
32.1 Section 1350 Certification of Chief Executive
Officer.
32.2 Section 1350 Certification of Chief Financial
Officer.
25