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, 2008
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 November 6, 2008 there were 5,440,126 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
2008 2007
(Unaudited)
ASSETS
Cash and due from banks $ 7,421 $ 9,886
Interest-bearing deposits in
other banks 18 89
Investment securities available-
for-sale carried at estimated
fair value 244,995 241,521
Investment securities, held-
to-maturity securities,
estimated fair value of
$2,958 and $4,553 2,994 4,538
Loans, net of unearned income 398,377 376,603
Allowance for loan losses (5,233) (5,046)
________ ________
Net loans $393,144 $371,557
Premises and equipment - Net 8,342 8,486
Accrued interest receivable 3,579 3,241
Cash surrender value of bank
owned life insurance 16,968 16,450
Goodwill 19,133 18,981
Other assets 9,507 6,458
________ ________
TOTAL ASSETS $706,101 $681,207
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
Non-interest bearing $ 59,428 $ 58,844
Interest bearing 454,438 434,197
________ ________
TOTAL DEPOSITS $513,866 $493,041
Short-term borrowings 47,633 47,349
Long-term borrowings 72,084 66,175
Accrued interest and other expenses 3,153 3,454
Other liabilities 2,093 264
________ ________
TOTAL LIABILITIES $638,829 $610,283
======== ========
STOCKHOLDERS' EQUITY
Common stock, par value $2
per share $ 11,375 $ 11,375
Surplus 30,269 30,252
Retained earnings 37,950 35,705
Accumulated other
comprehensive (loss) (6,082) (166)
Less treasury stock at cost
247,641 shares in 2008
and 247,691 shares in 2007 (6,240) (6,242)
________ ________
TOTAL STOCKHOLDERS' EQUITY $ 67,272 $ 70,924
________ ________
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $706,101 $681,207
======== ========
See Accompanying Notes to Consolidated Financial Statements
1
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(Unaudited)
(Amounts in thousands except per share data)
2008 2007
INTEREST INCOME
Interest and fees on loans $6,401 $4,525
Interest and dividend income
on securities 3,078 3,303
Deposits in banks 12 2
______ ______
TOTAL INTEREST INCOME $9,491 $7,830
______ ______
INTEREST EXPENSE
Deposits $3,374 $3,328
Short-term borrowings 164 439
Long-term borrowings 861 702
______ ______
TOTAL INTEREST EXPENSE $4,399 $4,469
______ ______
Net interest income $5,092 $3,361
Provision for loan losses 75 25
______ ______
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES $5,017 $3,336
______ ______
NON-INTEREST INCOME
Trust department $ 134 $ 137
Service charges and fees 644 518
Bank owned life insurance income 177 144
Gain on sale of loans 46 14
Investment securities gains
(losses) - net 11 72
Other 118 88
______ ______
TOTAL NON-INTEREST INCOME $1,130 $ 973
______ ______
NON-INTEREST EXPENSES
Salaries and employee benefits $1,816 $1,316
Occupancy, net 262 171
Furniture and equipment 237 182
Professional services 101 70
State shares tax 171 138
Other 859 553
______ ______
TOTAL NON-INTEREST EXPENSES $3,446 $2,430
______ ______
Income before income taxes $2,701 $1,879
Income tax expense 474 338
______ ______
Net Income $2,227 $1,541
====== ======
PER SHARE DATA
Basic $ .41 $ .34
Diluted .41 .34
Cash dividends per share .22 .22
See Accompanying Notes to Consolidated Financial Statements
2
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(Unaudited)
(Amounts in thousands except per share data)
2008 2007
INTEREST INCOME
Interest and fees on loans $19,079 $13,215
Interest and dividend income
on securities 8,938 9,508
Deposits in banks 78 64
Interest on fed funds sold 14 0
_______ _______
TOTAL INTEREST INCOME $28,109 $22,787
_______ _______
INTEREST EXPENSE
Deposits $10,719 $ 9,803
Short-term borrowings 490 849
Long-term borrowings 2,589 2,078
_______ _______
TOTAL INTEREST EXPENSE $13,798 $12,730
_______ _______
Net interest income $14,311 $10,057
Provision for loan losses 200 150
_______ _______
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES $14,111 $ 9,907
_______ _______
NON-INTEREST INCOME
Trust department $ 418 $ 443
Service charges and fees 1,830 1,489
Bank owned life insurance income 518 404
Gain on sale of loans 88 61
Investment securities gains
(losses) - net 134 339
Other 245 232
_______ _______
TOTAL NON-INTEREST INCOME $ 3,233 $ 2,968
_______ _______
NON-INTEREST EXPENSE
Salaries and employee benefits $ 5,469 $ 3,961
Occupancy, net 798 512
Furniture and equipment 682 544
Professional services 297 342
State shares tax 511 411
Other 2,487 1,820
_______ _______
TOTAL NON-INTEREST EXPENSES $10,244 $ 7,590
Income before income taxes $ 7,100 $ 5,285
Income tax expense 1,265 926
_______ _______
Net Income $ 5,835 $ 4,359
======= =======
PER SHARE DATA
Basic $ 1.07 $ .96
Diluted 1.07 .96
Cash Dividends .66 .66
See Accompanying Notes to Consolidated Financial Statements
3
FIRST KEYSTONE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED September 30, 2008 AND 2007
(Unaudited)
(Amounts in thousands)
2008 2007
OPERATING ACTIVITIES
Net income $ 5,835 $ 4,359
Adjustments to reconcile net
income to net cash provided
by operating activities:
Provision for loan losses 200 150
Stock option expense 18 0
Provision for depreciation
and amortization 733 400
Premium amortization on
investment securities 84 59
Accretion of core deposit
net discount 82 12
Discount accretion on
investment securities (496) (382)
Gain on sale of mortgage loans (88) (61)
Proceeds from sale of
mortgage loans 5,602 5,640
Originations of mortgage
loans for resale (10,096) (3,225)
Gain on sale of foreclosed
real estate (30) 0
Gain on sales of investment
securities (66) (339)
Deferred income tax (benefit) (167) (111)
Increase in interest
receivable and other assets (467) (1,360)
Increase in cash surrender
value of bank owned
life insurance (518) (1,404)
Increase in interest payable,
accrued expenses and
other liabilities (339) 518
Loss from sale of premises
and equipment 0 3
_______ _________
Net Cash Provided by
Operating Activities $ 287 $ 4,259
_______ _________
INVESTING ACTIVITIES
Purchases of investment
securities available-
for-sale $(75,513) $(113,271)
Purchase of investment
securities held-to-maturity (467) 0
Purchase of investment in
real estate ventures 0 (489)
Proceeds from sales of
investment securities
available-for-sale 32,579 85,188
Proceeds from maturities
and redemptions of
investment securities
available-for-sale 32,899 14,404
Proceeds from maturities
and redemption of
investment securities
held-to-maturity 2,011 2,385
Net (increase) in loans (17,448) (18,505)
Purchase of premises
and equipment (461) (438)
Proceeds from sale of
foreclosed assets 337 41
Proceeds from sale of
premises and equipment 0 2
Decrease in other liabilities
related to acquisition (133) 0
________ _________
Net Cash Used by Investing
Activities $(26,196) $ (30,683)
________ _________
FINANCING ACTIVITIES
Net increase in deposits $ 20,743 $ 8,888
Net increase in short-term
borrowings 284 17,068
Net increase (decrease) in
long-term borrowings 5,935 (255)
Acquisition of treasury stock 0 (145)
Proceeds from sale of
treasury stock 1 0
Cash dividends (3,590) (2,982)
________ _________
Net Cash Provided by
Financing Activities $ 23,373 $ 22,574
Decrease in Cash and Cash
Equivalents (2,536) (3,850)
Cash and Cash Equivalents,
Beginning 9,975 10,188
________ _________
Cash and Cash Equivalents,
Ending $ 7,439 $ 6,338
________ _________
SUPPLEMENTAL DISCLOSURE OF
CASH FLOW INFORMATION
Cash paid during period for:
Interest $ 14,060 $ 12,571
Income Taxes 1,202 1,021
See Accompanying Notes to Consolidated Financial Statements
4
FIRST KEYSTONE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(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 14 full service
offices and 16 ATMs located in Columbia, Luzerne, Montour and Monroe
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.
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.
5
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.
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.
6
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
period ended September 30, 2008 and December 31, 2007, 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
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 $47,000 and $65,000
at September 30, 2008 and December 31, 2007, respectively.
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.
7
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 $151,000 in 2007 and $128,000 in
2006, and the amortization of the investments in the limited
partnerships were $111,000 and $78,000 for the nine months ended
September 30, 2008 and 2007, respectively. The carrying value of
the investments as of September 30, 2008 and December 31, 2007 was
$881,000 and $975,000, 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 the Pocono Community
Bank in November 2007 and 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 dates of acquisition. The
Corporation accounts for goodwill pursuant to the Statement of
Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Intangible Assets". During the first quarter of 2008, $152,000 of
liabilities were recorded related to the Pocono acquisition as a
purchase accounting adjustment, resulting in an increase in excess
purchase price. The amount was comprised of the finalization of
severance agreements and contract terminations related to the
acquisition. 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, 2007, 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. 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. 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.
8
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 December 2007, the Financial Accounting Standards Board
(FASB) issued State of Financial Accounting Standards SFAS 141,
"Business Combinations". SFAS 141 will significantly change how
entities apply the acquisition method to business combinations. The
most significant changes affecting how the Corporation will account
for business combinations under this Statement include: the
acquisition date will be the date the acquirer obtains control; all
(and only) identifiable assets acquired, liabilities assumed, and
noncontrolling interests in the acquiree will be stated at fair
value on the acquisition date; assets or liabilities arising from
noncontractual contingencies will be measured at their acquisition
date fair value only if it is more likely than not that they meet
the definition of an asset or liability on the acquisition date;
adjustments subsequently made to the provisional amounts recorded on
the acquisition date will be made retroactively during a measurement
period not to exceed one year; acquisition related restructuring
costs that do not meet the criteria in SFAS 146, "Accounting for
Costs Associated with Exit or Disposal Activities", will be expensed
as incurred; transaction costs will be expensed as incurred;
reversals of deferred income tax valuation allowances and income tax
contingencies will be recognized in earnings subsequent to the
measurement period; and the allowance for loan losses of an acquiree
will not be permitted to be recognized by the acquirer.
Additionally, SFAS 141 will require new and modified disclosures
surrounding subsequent changes to acquisition related contingencies,
contingent consideration, noncontrolling interests, acquisition
related transaction costs, fair values and cash flows not expected
to be collected for acquired loans, and an enhanced goodwill
rollforward.
The Corporation will be required to prospectively apply SFAS
141 to all business combinations completed on or after January 1,
2009. Early adoption is not permitted. For business combinations in
which the acquisition date was before the effective date, the
provisions of SFAS 141 will apply to the subsequent accounting for
deferred income tax valuation allowances and income tax
contingencies and will require any changes in those amounts to be
recorded in earnings. Management is currently evaluating the effects
that SFAS 141 will have on the financial condition, results of
operations, liquidity, and the disclosures that will be presented in
the consolidated financial statements.
In December 2007, the FASB issued Statement of Financial
Accounting Standards SFAS 160, "Noncontrolling Interests in
Consolidated Financial Statements, an Amendment of ARB 51". SFAS 160
establishes new accounting and reporting standards for
noncontrolling interests in a subsidiary and for the deconsolidation
of a subsidiary. SFAS 160 will require entities to classify
noncontrolling interests as a component of stockholders' equity and
will require subsequent changes in ownership interest in a
subsidiary to be accounted for as an equity transaction.
Additionally, SFAS 160 will require entities to recognize a gain or
loss upon the loss of control of a subsidiary and to remeasure any
ownership interest retained at fair value on that date. This
statement also requires expanded disclosures that clearly identify
and distinguish between the interests of the parent and the
interests of the noncontrolling owners. SFAS 160 is effective on a
prospective
9
basis for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008, except for the
presentation and disclosure requirements, which are required to be
applied retrospectively. Early adoption is not permitted. The
adoption of this standard is not expected to have a material impact
on the Corporation's consolidated financial condition, results of
operations or liquidity.
EITF 06-4, "Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split Dollar Life
Insurance Arrangements", was issued in September 2006 and is
effective for fiscal years beginning after December 15, 2007 with
earlier application permitted. EITF 06-4 requires that, for split
dollar life insurance arrangements that provide a benefit to an
employee that extends to postretirement periods, an employer should
recognize a liability for future benefits in accordance with SFAS
No. 106. EITF 06-4 requires that recognition of the effects of
adoption should be either by (a) a change in accounting principle
through a cumulative effect adjustment to retained earnings as of
the beginning of the year of adoption or (b) a change in accounting
principle through retrospective application to all prior periods.
The Corporation adopted this standard as of January 1, 2007 through
a cumulative effect adjustment to beginning retained earnings. This
adjustment represented a decrease of $36,000 to retained earnings.
In November 2007, the Securities and Exchange Commission issued
Staff Accounting Bulletin (SAB) No. 109, which addresses the
valuation of written loan commitments accounted for a fair value
through earnings. The guidance in SAB 109 expresses the staff's view
that the measurement of fair value for a written loan commitment
accounted for at fair value through earnings should incorporate the
expected net future cash flows related to the associated servicing
of the loan. Previously under SAB 105, Application of Accounting
Principles to Loan Commitments, this component of value was not
incorporated into the fair value of the loan commitment. The
Corporation does not account for any written loan commitments at
fair value through earnings.
In June 2007, the FASB ratified the consensus reached in EITF
06-11, "Accounting for Income Tax Benefits of Dividends on Share
Based Payment Awards". EITF 06-11 applies to entities that have
share-based payment arrangements that entitle employees to receive
dividends or dividend equivalents on equity classified nonvested
shares when those dividends or dividend equivalents are charged to
retained earnings and result in an income tax deduction. Entities
that have share based payment arrangements that fall within the
scope of EITF 06-11 will be required to increase capital surplus for
any realized income tax benefit associated with dividends or
dividend equivalents paid to employees for equity classified
nonvested equity awards. Any increase recorded to capital surplus is
required to be included in any entity's pool of excess tax benefits
that are available to absorb potential future tax deficiencies on
share based payment awards. The Corporation will adopt EITF 06-11 on
January 1, 2008 for dividends declared on share based payment awards
subsequent to this date. The impact of adoption is not expected to
have a material impact on financial condition, results of
operations, or liquidity.
In April 2007, the FASB issued FSP 39-1, "Amendments of FASB
Interpretation No. 39. Offsetting of Amounts Related to Certain
Contracts". FSP 39-1 permits entities to offset fair value amounts
recognized for multiple derivative instruments executed with the
same counterparty under a master netting agreement. FSP 39-1
clarifies that the fair value amounts recognized for the right to
reclaim cash collateral, or the obligation to return cash
collateral, arising from the same master netting arrangement, should
also be offset against the fair value of the related derivative
instruments.
Effective January 1, 2008, the Corporation adopted a net
presentation for derivative positions and related collateral entered
into under master netting agreements pursuant to the guidance in FIN
39 and FSP 39-1. The adoption of this guidance would result in
balance sheet reclassifications of certain cash collateral based
short term investments against the related derivative liabilities
and certain deposit liability balances against the related fair
values of derivative assets. The effects of these reclassifications
will fluctuate based on the fair values of derivative contracts but
overall would not have a material impact on either total assets or
total liabilities. The adoption of these standards will not have an
impact on the Corporations consolidated financial condition, results
of operations or liquidity.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value
Option for Financial Assets and Liabilities". The statement allows
an entity to elect to measure certain financial assets and
liabilities at fair value with changes in fair value recognized in
the income statement each period. The statement also requires
additional disclosures to identify the effects of an entity's fair
value election on its earnings. The election is irrevocable. The
Corporation is currently assessing whether it will elect to adopt
SFAS 159.
10
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, 2007 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 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 was adopted by the
Corporation on January 1, 2007. 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 were adopted by the Corporation on January 1, 2007.
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.
11
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 require bifurcation. This statement
was effective for all financial instruments acquired or issued by
the Corporation on or after January 1, 2007 and the adoption of SFAS
155 did not have a material impact 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 period ended September 30, 2008 and 2007, was
approximately $239,000 and $285,000, respectively.
RECLASSIFICATIONS
Certain amounts in the consolidated financial statements of
prior periods have been reclassified to conform with presentation
used in the 2008 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, 2008, and September 30, 2007, were as follows:
(amounts in thousands)
2008 2007
____ ____
Balance, January 1 $5,047 $3,671
Provision charged to operations 200 150
Loans charged off (194) (127)
Recoveries 186 102
______ ______
Balance, September 30 $5,239 $3,796
====== ======
At September 30, 2008, the total recorded investment in loans
that are considered to be impaired as defined by SFAS No. 114 was
$5,372,000. 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, 2008, there were no significant commitments to
lend additional funds with respect to non accrual and restructured
loans.
Non-accrual loans at September 30, 2008 and December 31, 2007
were $3,227,000 and $3,208,000, respectively, all of which were
considered impaired.
Loans past-due 90 days or more and still accruing interest
amounted to $156,000 and $185,000 on September 30, 2008 and December
31, 2007, respectively.
12
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.
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, 2008 and December
31, 2007 were as follows:
(amounts in thousands)
September 30, December 31,
2008 2007
____ ____
Financial instruments whose
contract amounts
represent credit risk:
Commitments to extend credit $52,481 $42,776
Financial standby letters
of credit 1,131 1,744
Performance standby letters
of credit 7,574 2,471
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.
13
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.
Note 6. STOCKHOLDERS' EQUITY
Changes in Stockholders' Equity for the period ended September
30, 2008, were are follows:
(Amounts in thousands, except common share data)
Common Common
Shares Stock Surplus
______ ______ _______
Balance at January 1, 2008 5,687,767 $11,375 $30,252
Comprehensive Income:
Net Income
Change in unrealized
gain (loss) on
investment securities
available-for-sale,
net of reclassification
adjustment and tax
effects
Total Comprehensive
(loss)
Recognition of stock
option expense 18
Issuance of 50 shares of
treasury stock upon
exercise of employee
stock options (1)
Cash dividends -
$.66 per share
_________ _______ _______
Balance at September 30, 2008 5,687,767 $11,375 $30,269
========= ======= =======
(Amounts in thousands, except common share data)
Accumulated
Compre- Other
hensive Retained Comprehensive
Income Earnings Income (Loss)
______ ______ __________
Balance at January 1, 2008 $35,705 $ (166)
Comprehensive Income:
Net Income $5,835 5,835
Change in unrealized
gain (loss) on
investment securities
available-for-sale,
net of reclassification
adjustment and tax
effects (5,916) (5,916)
______
Total Comprehensive
(loss) $ (81)
======
Recognition of stock
option expense
Issuance of 50 shares of
treasury stock upon
exercise of employee
stock options
Cash dividends -
$.66 per share (3,590)
_______ _______
Balance at September 30, 2008 $37,950 $(6,082)
======= =======
(Amounts in thousands, except common share data)
Treasury
Stock Total
_____ _____
Balance at January 1, 2008 $(6,242) $70,924
Comprehensive Income:
Net Income 5,835
Change in unrealized
gain (loss) on
investment securities
available-for-sale,
net of reclassification
adjustment and tax
effects (5,916)
Total Comprehensive
(loss)
Recognition of stock
option expense 18
Issuance of 50 shares of
treasury stock upon
exercise of employee
stock options 2 1
Cash dividends -
$.66 per share (3,590)
______ _______
Balance at September 30, 2008 $(6,240) $67,272
======= =======
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.
14
The results of operations for the nine month period ended
September 30, 2008, 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, 2007, filed with the Securities and Exchange
Commission.
15
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, 2008,
and the related consolidated statements of income for the three and
nine month periods ended September 30, 2008 and 2007 and cash flows
for the nine month periods ended September 30, 2008, and 2007.
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, 2007, 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 March 11, 2008, 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, 2007, 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 6, 2008
16
Item 2. First Keystone Corporation Management's Discussion
and Analysis of Financial Condition and
Results of Operation as of September 30, 2008
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.
The Corporation acquired Pocono Community Bank, Stroudsburg,
Pennsylvania, in the fourth quarter of 2007. Period to period
comparisons and the Management's Discussion are impacted by this
acquisition when 2008 results are compared to 2007.
RESULTS OF OPERATIONS
First Keystone Corporation realized earnings for the third
quarter of 2008 of $2,227,000, an increase of $686,000 or 44.5% from
the third quarter of 2007. Nine months net income for the period
ended September 30, 2008, amounted to $5,835,000, an increase of
33.9% from the $4,359,000 net income reported September 30, 2007.
Net interest income increased in both the third quarter of 2008 and
for the first nine months of 2008 when compared to the same period
in 2007. The higher net interest income in 2008 was due to a
positively sloped yield curve and an expansion of our net interest
margin. Earnings were also positively affected by increased non
interest income and continued excellent control over non interest
expense. On a per share basis, net income per share was $1.07 for
the first nine months of 2008, as compared to $.96 for the first
nine months of 2008, while dividends remained at $.66 per share, the
same as last year at the end of three quarters.
Year-to-date net income annualized amounts to a return on
average common equity of 11.26% and a return on assets of 1.12%.
For the nine months ended September 30, 2007, these measures were
12.38% and 1.09%, 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 2008, interest income amounted to
$9,491,000, an increase of $1,661,000 or 21.2% from the third
quarter of 2007. Interest expense amounted to $4,399,000 in the
third quarter of 2008, a decrease of $70,000 or 1.6% over the third
quarter of 2007. Accordingly, net interest income amounted to
$5,092,000 in the third quarter of 2008, an increase of $1,731,000,
or 51.5% from the third quarter of 2007. Year to date for the nine
months ended September 30, 2008, total interest income increased
$5,322,000, or 23.4% to $28,109,000 from $22,787,000 in the first
nine months of 2007. Total interest expense increased $1,068,000,
or 8.4% to $13,798,000 for the first nine months of 2007 from
$12,730,000 in the first nine months of 2007. This resulted in net
interest income increasing $4,254,000 to $14,311,000 as of September
30, 2008 from $10,057,000 as of September 30, 2007, an increase of
42.3%.
Our net interest margin for the quarter ended September 30,
2008, was 3.49% compared to 2.97% for the quarter ended September
30, 2007. For the nine months ended September 30, 2008, our net
interest margin was 3.30% compared to 2.94% for the first nine
months of 2007.
17
PROVISION FOR LOAN LOSSES
The provision for loan losses for the quarter ended September
30, 2008, was $75,000 compared to $25,000 for the third quarter of
2007. Year to date, the provision for loan losses amounts to
$200,000 in 2008 as compared to the $150,000 provision for the
period ended September 30, 2007. Net charge offs amounted to $8,000
for the nine months ended September 30, 2008, as compared to $25,000
for the first nine months of 2007.
The allowance for loan losses as a percentage of loans, net of
unearned interest was 1.31% as of September 30, 2008, and 1.34% as
of December 31, 2007.
NON-INTEREST INCOME
Total non interest or other income was $1,130,000 for the
quarter ended September 30, 2008, as compared to $973,000 for the
quarter ended September 30, 2007. Excluding investment security
gains and losses, non interest income was $1,119,000 for the third
quarter of 2008, as compared to $901,000 in the third quarter of
2007, an increase of 24.2%. For the nine months ended September 30,
2008, total non interest income was $3,233,000, as compared to
$2,968,000, or a 8.9% increase from the first nine months of 2007.
In both the third quarter of 2008 and for the nine months ended
September 30, 2008, the increase in non interest income was
primarily the result of an increase in service charges and fees, 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 $3,446,000 for the
quarter ended September 30, 2008, as compared to $2,430,000 for the
quarter ended September 30, 2007, an increase of $1,016,000 or
41.8%. The majority of in increases in non interest expenses in
both the third quarters of 2008 and the first nine months of 2008
reflect the acquisition of Pocono Community Bank completed in
November 2007.
For the nine months ended September 30, 2008, total non
interest expense was $10,244,000, an increase of $2,654,000, or
35.0% over the first nine months of 2007. Expenses associated with
employees (salaries and employee benefits) continue to be the
largest category of non interest expenses. Salaries and benefits
amount to 53.4% of total non-interest expense for the nine months
ended September 30, 2008, as compared to 52.2% for the first nine
months of 2007. Salaries and benefits amounted to $5,469,000 for
the nine months ended September 30, 2008, an increase of $1,508,000,
or 38.1% over the first nine months of 2007. Net occupancy expense,
including furniture and equipment, amounted to $1,480,000 for the
nine months ended September 30, 2008, an increase of $424,000, or
40.2% from 2007. Because of reduced legal expenses, professional
services decreased $45,000 or 13.2% from the first nine months of
2007. State shares tax increased by $100,000 or 24.3% over the
first nine months of 2007. Other non interest expenses amounted to
$2,487,000 for the nine months ended September 30, 2008, an increase
of $667,000, or 36.6% from the first nine months of 2007. Even with
the increase in non interest expenses in 2008, 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 17.5% for the third quarter
of 2008 as compared to 18.0% for the third quarter of 2007. For the
nine months ended September 30, 2008, our tax expense amounted to
$1,265,000 for an effective tax rate of 17.8% as compared to an
effective tax rate of 17.5% for the first nine months of 2007.
18
ANALYSIS OF FINANCIAL CONDITION
ASSETS
Total assets increased to $706,101,000 as of September 30,
2008, an increase of $24,894,000, or 3.7% over year end 2007. Total
deposits increased to $513,866,000 as of September 30, 2008, an
increase of $20,825,000, or 4.2% over year end 2007.
The Corporation used the increase in total deposits to fund
primarily an increase in loans. Total borrowings also helped to
fund loan growth and increased $6,193,000 from December 31, 2007.
Short term borrowings increased slightly to $47,633,000 as of
September 30, 2008, up from $47,349,000 at year end 2007. Long term
borrowings increased to $72,084,000 as of September 30, 2008, up
$5,909,000 from $66,175,000 at year end 2007.
EARNING ASSETS
Our primary earning asset, loans, net of unearned income
increased to $398,377,000 as of September 30, 2008, an increase of
$21,774,000, or 5.8% from year end 2007. 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,
2007, to September 30, 2008. Available for sale securities amounted
to $244,995,000 as of September 30, 2008, an increase of $3,474,000,
or 1.4% from year end 2007. However, held to maturity securities
decreased to $2,994,000 as of September 30, 2008, a decrease of
$1,544,000, or 34.0% since year end 2007. Interest bearing deposits
with banks decreased to $18,000 on September 30, 2008, as compared
to $89,000 as of December 31, 2007.
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.
19
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, 2008, total non performing assets were $3,430,000 as compared to
$3,458,000 on December 31, 2007. Non performing assets to total
loans and foreclosed assets was .86% as of September 30, 2008, and
..92% as of December 31, 2007.
Interest income received on non performing loans as of
September 30, 2008, was $70,000 compared to $144,000 as of December
31, 2007. Interest income, which would have been recorded on these
loans under the original terms as of September 30, 2008, and
December 31, 2007, was $321,000 and $175,000, respectively. As of
September 30, 2008 and December 31, 2007, 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
$20,825,000 as non interest bearing deposits increased by $584,000
and interest bearing deposits increased by $20,241,000 as of
September 30, 2008, from year end 2007. Total short term and long
term borrowings increased by $6,193,000 from year end 2007.
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 $6,082,000 as of September 30, 2008, and $166,000 as of
December 31, 2007. Our stock repurchase plan repurchased 247,641
shares as treasury stock as of September 30, 2008 and 247,691 shares
as treasury stock as of December 31, 2007. This had an effect of
our reducing our total stockholders' equity by $6,240,000 on
September 30, 2008, and $6,242,000 as of December 31, 2007.
Total stockholders' equity was $67,272,000 as of September 30,
2008, and $70,924,000 as of December 31, 2007. Leverage ratio and
risk based capital ratios remain very strong. As of September 30,
2008, our leverage ratio was 7.64% compared to 7.96% as of December
31, 2007. In addition, Tier I risk based capital and total risk
based capital ratio as of September 30, 2008, were 11.52% and
12.68%, respectively. The same ratios as of December 31, 2007, were
11.86% and 13.06%, 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.
20
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, 2007.
The composition of rate sensitive assets and rate sensitive
liabilities as of September 30, 2008 is very similar to December 31,
2007.
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 75 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.
21
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, 2007.
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,
2008 ---- ---- ---- 112,098
August 1 -
August 31,
2008 ---- ---- ---- 112,098
Sept. 1 -
Sept. 30,
2008 ---- ---- ---- 112,098
Total ---- ---- ---- 112,098
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, May 6, 2008 at 10:00 a.m.
Votes Votes
Directors Elected Votes For Against Withheld
_________________ _________ ______ _______
Don E. Bower 4,523,664 13,301 0
Robert A. Bull 4,342,535 194,430 0
Dudley P. Cooley 4,522,664 14,301 0
Broker
Directors Elected Abstentions Non-Votes
_________________ ___________ _________
Don E. Bower 0 0
Robert A. Bull 0 0
Dudley P. Cooley 0 0
22
Directors Continuing:
____________________
Jerome F. Fabian, term expires in 2009
David R. Saracino, term expires in 2009
Robert J. Wise, term expires in 2009
John E. Arndt, term expires in 2010
J. Gerald Bazewicz, term expires in 2010
Robert E. Bull, term expires in 2010
Matters Voted Upon:
__________________
Selection of J. H. Williams & Co. LLP, as auditors for the
Corporation.
Votes For - 4,496,980
Votes Against - 5,408
Votes Withheld - 0
Abstentions - 34,577
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.
23
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, 2008, the
registrant filed the following reports on Form 8-K:
Date of Report Item Description
______________ ____ ___________
July 31, 2008 2.02 On July 31, 2008, the Registrant issued
a press release announcing its earnings
for the quarter ended June 30, 2008.
August 27, 2008 8.01 On August 27, 2008, the Registrant
issued a press release announcing the
declaration of it's third quarter
dividend.
24
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 7, 2008 /s/ J. Gerald Bazewicz
J. Gerald Bazewicz
President and
Chief Executive Officer
(Principal Executive Officer)
November 7, 2008 /s/ Diane C.A. Rosler
Diane C.A. Rosler
Chief Financial Officer
(Principal Accounting Officer)
25
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.
26