FIRST KEYSTONE CORPORATION This quarterly report contains certain forward-looking statements, which are included pursuant to the "safeharbor" provisions of the Private Securities Litigation Reform Act of 1995, and 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 Company'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.
CRITICAL ACCOUNTING ESTIMATES
The Company has chosen accounting policies that it believes are appropriate to
accurately and fairly report its operating results and financial position, and
the Company applies those accounting policies in a consistent manner. The
Significant Accounting Policies are summarized in Note 1 to the consolidated
financial statements included in the 2021 Annual Report on Form 10-K. There have
been no changes to the Critical Accounting Estimates since the Company filed its
Annual Report on Form 10-K for the year ended
RESULTS OF OPERATIONS
Quarter ended
On a per share basis, for the three months ended
NET INTEREST INCOME
The major source of operating income for the Company is net interest income,
defined as interest income less interest expense. In the three months ended
The Company's net interest margin for the three months ended
PROVISION FOR LOAN LOSSES
The provision for loan losses for the three months ended
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management's assessment of the continued credit risk associated with the
economic uncertainty surrounding the COVID-19 pandemic. Charge-off and recovery
activity in the allowance for loan losses resulted in net recoveries of
NON-INTEREST INCOME
Total non-interest income was
Net securities (losses) gains decreased
Service charges and fee income increased
(Losses) gains on sales of mortgage loans decreased
NON-INTEREST EXPENSE
Total non-interest expense was
Expenses associated with employees (salaries and employee benefits) continue to
be the largest category of non-interest expense. Salaries and benefits amounted
to
Net occupancy, furniture and equipment, and computer expense amounted to
ATM and debit card fees expense amounted to
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systems. Data processing expenses amounted to
Foreclosed assets held for resale expense decreased
Other non-interest expense amounted to
INCOME TAXES
Income tax expense amounted to
FINANCIAL CONDITION
SUMMARY
Total assets decreased to
Total debt securities available-for-sale decreased
Total loans increased
Total deposits decreased
The Company continues to maintain and manage its asset growth. The Company's
strong equity capital position provides an opportunity to further leverage its
asset growth. Total borrowings increased in the three months ended
Total stockholders' equity decreased to
SEGMENT REPORTING
Currently, management measures the performance and allocates the resources of the Company as a single segment.
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EARNING ASSETS
Earning assets are defined as those assets that produce interest income. By
maintaining a healthy asset utilization rate, i.e., the volume of earning assets
as a percentage of total assets, the Company maximizes income. The earning asset
ratio (average interest earning assets divided by average total assets) equaled
94.4% at
Our primary earning asset, total loans, increased to
In addition to loans, another primary earning asset is our overall securities
portfolio, which decreased in size from
Interest-bearing deposits in other banks decreased as of
LOANS
Total loans increased to
Steady demand for borrowing by businesses accounted for the 3.5% increase in the
loan portfolio from
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loan origination total), and regular principal payments and other typical
amortization in the
Management believes that the loan portfolio is well diversified. The total
commercial portfolio was
Overall, the portfolio risk profile as measured by loan grade is considered low
risk, as
Overall, non-pass grades decreased to
The Company continues to internally underwrite each of its loans to comply with prescribed policies and approval levels established by its Board of Directors.
Total Loans
(Dollars in thousands) March 31, December 31,
2022 2021
Commercial and Industrial $ 81,831 $ 82,526
Commercial Real Estate 549,921 521,654
Residential Real Estate 141,990 143,383
Consumer 5,286 5,278
Total Loans $ 779,028 $ 752,841
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses constitutes the amount available to absorb losses
within the loan portfolio. As of
Management performs a quarterly analysis to determine the adequacy of the allowance for loan losses. The methodology in determining adequacy incorporates specific and general allocations together with a risk/loss analysis on various segments of the portfolio according to an internal loan review process. This assessment results in an allocated
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allowance. Management maintains its loan review and loan classification standards consistent with those of its regulatory supervisory authority.
Management considers, based upon its methodology, that the allowance for loan
losses is adequate to cover foreseeable future losses. However, there can be no
assurance that the allowance for loan losses will be adequate to cover
significant losses, if any, that might be incurred in the future. On a quarterly
basis, management evaluates the qualitative factors utilized in the calculation
of the Company's allowance for loan losses and various adjustments are made to
these factors as deemed necessary at the time of evaluation. The economic impact
caused by the COVID-19 pandemic has played a large role in the qualitative
factor adjustments that have been implemented throughout 2021 and the first
quarter of 2022. Qualitative factors remained unchanged during the first quarter
of 2021, as the economy and unemployment levels showed marked improvement over
the prior quarter. During the second quarter of 2021, the qualitative factors
related to the local/regional economy were decreased by one basis point across
all loan segments, as the economy and job growth in the Company's market areas
demonstrated marked improvement over the prior quarter, and the qualitative
factor related to collateral values was increased by one basis point for both
the
The Analysis of Allowance for Loan Losses table contains an analysis of the
allowance for loan losses indicating charge-offs and recoveries for the three
months ended
For the three months ended
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Analysis of Allowance for Loan Losses
(Dollars in thousands) March 31, March 31,
2022 2021
Balance at beginning of period $ 8,680 $ 7,933
Charge-offs:
Commercial and Industrial - 13
Commercial Real Estate - -
Residential Real Estate - -
Consumer 2 10
2 23
Recoveries:
Commercial and Industrial 1 -
Commercial Real Estate 38 -
Residential Real Estate 1 -
Consumer - 2
40 2
Net (recoveries) charge-offs (38) 21
Additions charged to operations 219 135
Balance at end of period $ 8,937 $ 8,047
Ratio of net (recoveries) charge-offs during the
period to average loans outstanding during the (0.005) % 0.003 %
period
Allowance for loan losses to average loans 1.167 % 1.116 %
outstanding during the period
It is the policy of management and the Company's Board of Directors to make a provision for both identified and unidentified losses inherent in its loan portfolio. A provision for loan losses is charged to operations based upon an evaluation of the potential losses in the loan portfolio. This evaluation takes into account such factors as portfolio concentrations, delinquency trends, trends of non-accrual and classified loans, economic conditions, and other relevant factors.
The loan review process, which is conducted quarterly, is an integral part of the Bank's evaluation of the loan portfolio. A detailed quarterly analysis to determine the adequacy of the Company's allowance for loan losses is reviewed by the Board of Directors.
With the Bank's manageable level of net charge-offs and recoveries along with
the additions to the reserve from the provision out of operations, the allowance
for loan losses as a percentage of average loans amounted to 1.167% and 1.116%
at
NON-PERFORMING ASSETS
The table on page 45 details the Company's non-performing assets and impaired loans as of the dates indicated. 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 collectability of principal or interest. 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 current period income. A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession that the Company would not otherwise consider. Modifications to loans classified as TDRs generally include reductions in contractual interest rates, principal deferments and extensions of maturity dates at a stated interest rate lower than the current market for a new loan with similar risk characteristics. While unusual, there may be instances of loan principal forgiveness. Any loan modifications made in response to the COVID-19 pandemic
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are not considered TDRs as long as the criteria set forth in Section 4013 of the CARES Act are met. Foreclosed assets held for resale represent property acquired through foreclosure, or considered to be an in-substance foreclosure.
Total non-performing assets amounted to
Non-performing assets to total loans was 0.90% at
Performing substandard loans which are not deemed to be impaired have
characteristics that cause management to have doubts regarding the ability of
the borrower to perform under present loan repayment terms and which may result
in reporting these loans as non-performing loans in the future. Performing
substandard loans not deemed to be impaired amounted to
Impaired loans were
The Company estimates impairment based on its analysis of the cash flows or
collateral estimated at fair value less cost to sell. For collateral dependent
loans, the estimated appraisal or other qualitative adjustments and cost to
sell percentages are determined based on the market area in which the real
estate securing the loan is located, among other factors, and therefore, can
differ from one loan to another. Of the
The outstanding recorded investment of TDRs as of
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Commercial and Industrial portfolio, twenty-three loans were classified in the
At
One
The Company's non-accrual loan valuation procedure for any loans greater than
For non-accrual loans less than
Improving loan quality is a priority. The Company actively works with borrowers to resolve credit problems and will continue its close monitoring efforts in 2022. Excluding the assets disclosed in the Non-Performing Assets and Impaired Loans tables below and the Troubled Debt Restructurings section in Note 4 - Loans and Allowance for Loan Losses, management is not aware of any information about borrowers' possible credit problems which cause serious doubt as to their ability to comply with present loan repayment terms.
In addition, regulatory authorities, as an integral part of their examinations, periodically review the allowance for possible loan losses. They may require additions to allowances based upon their judgments about information available to them at the time of examination.
The economic climate remains uncertain at this time. The COVID-19 pandemic has caused much upheaval and uncertainty in the national and state economy and experts at all levels are attempting to calculate the intermediate or long term affects. The Company may experience difficulties collecting payments on time from its borrowers, and certain types of loans may need to be modified, which could cause a rise in the level of impaired loans, non-performing assets, charge-offs, and delinquencies. Should such metrics increase, additions to the balance of the Company's allowance for loan losses could be required. The extent of the impact of the COVID-19 pandemic on the Company's operational and financial performance will depend on certain developments including inflationary pressures, the labor force, supply bottlenecks, the government's ability to respond to foreign and domestic issues, and the effectiveness in controlling the lingering effects of the outbreak, etc. and any after-effects of these factors. These factors may not immediately impact the Company's operational and financial performance, as the effects of these factors may lag into the future. The Company is also susceptible to the impact of economic and fiscal policy factors that may evolve in the post-pandemic environment.
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A concentration of credit exists when the total amount of loans to borrowers,
who are engaged in similar activities that are similarly impacted by economic or
other conditions, exceed 10% of total loans. As of
Non-Performing Assets and Impaired Loans
(Dollars in thousands) March 31, December 31,
2022 2021
Non-performing assets
Non-accrual loans $ 7,018 $ 7,066
Foreclosed assets held for resale - -
Loans past-due 90 days or more and still accruing
interest - -
Total non-performing assets $ 7,018 $ 7,066
Impaired loans
Non-accrual loans $ 7,018 $ 7,066
Accruing TDRs 6,355 6,607
Total impaired loans 13,373 13,673
Allocated allowance for loan losses - -
Net investment in impaired loans $ 13,373 $ 13,673
Impaired loans with a valuation allowance $ - $ -
Impaired loans without a valuation allowance 13,373 13,673
Total impaired loans $ 13,373 $ 13,673 Allocated valuation allowance as a percent of impaired loans
- % - %
Impaired loans to total loans 1.72 % 1.81 %
Non-performing assets to total loans 0.90 % 0.94 %
Non-performing assets to total assets 0.54 % 0.54 %
Allowance for loan losses to impaired loans 66.83 % 63.48 %
Allowance for loan losses to total non-performing
assets 127.34 % 122.84 %
Real estate mortgages comprise 88.8% of the loan portfolio as of
DEPOSITS, OTHER BORROWED FUNDS AND SUBORDINATED DEBT
Consumer and commercial retail deposits are attracted primarily by the Bank's eighteen full service office locations, one loan production office and through its internet banking presence. The Bank offers a broad selection of deposit products and continually evaluates its interest rates and fees on deposit products. The Bank regularly reviews competing financial institutions' interest rates, especially when establishing interest rates on certificates of deposit.
Total deposits decreased
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short-term and long-term borrowings increased to
On
CAPITAL STRENGTH
Normal increases in capital are generated by net income, less dividends paid
out. During the three months ended
The Company held 231,611 shares of common stock as treasury stock at
Total stockholders' equity was
At
To Be Well
Capitalized
Under Prompt
March 31, December 31, Corrective Action
2022 2021 Regulations
Tier 1 leverage ratio (to average assets) 10.56 % 10.14 % 5.00 %
Common Equity Tier 1 capital ratio (to
risk-weighted assets) 15.40 % 15.52 % 6.50 %
Tier 1 risk-based capital ratio (to
risk-weighted assets) 15.40 % 15.52 % 8.00 %
Total risk-based capital ratio 16.44 % 16.57 % 10.00 %
Under the final capital rules that became effective on
The Corporation's capital ratios are not materially different than those of the Bank.
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LIQUIDITY
The Company's objective is to maintain adequate liquidity to meet funding needs at a reasonable cost and provide contingency plans to meet unanticipated funding needs or a loss of funding sources, while minimizing interest rate risk. Adequate liquidity is needed to provide the funding requirements of depositors' withdrawals, loan growth, and other operational needs.
Sources of liquidity are as follows:
? Growth in the core deposit base;
? Proceeds from sales or maturities of securities;
? Payments received on loans and mortgage-backed securities;
? Overnight correspondent bank borrowings on various credit lines, notes, etc.,
with various levels of capacity;
? Securities sold under agreements to repurchase; and
? Brokered CDs.
At
The Company enters into "Repurchase Agreements" in which it agrees to sell
securities subject to an obligation to repurchase the same or similar
securities. Because the agreement both entitles and obligates the Company to
repurchase the assets, the Company may transfer legal control of the securities
while still retaining effective control. As a result, the repurchase agreements
are accounted for as collateralized financing agreements (secured borrowings)
and act as an additional source of liquidity. Securities sold under agreements
to repurchase were
Asset liquidity is provided by securities maturing in one year or less, other short-term investments, federal funds sold, and cash and due from banks. The liquidity is augmented by repayment of loans and cash flows from mortgage-backed and asset-backed securities. Liability liquidity is accomplished primarily by maintaining a core deposit base, acquired by attracting new deposits and retaining maturing deposits. Also, short-term borrowings provide funds to meet liquidity needs.
Net cash flows provided by operating activities were
Investing activities used cash of
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Financing activities used cash of
Managing liquidity remains an important segment of asset/liability management. The overall liquidity position of the Company is maintained by an active asset/liability management committee. The Company believes that its core deposit base is stable even in periods of changing interest rates. Liquidity and funds management are governed by policies and are measured on a monthly basis. These measurements indicate that liquidity generally remains stable and exceeds the Company's minimum defined levels of adequacy. Other than the trends of continued competitive pressures and volatile interest rates, there are no known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way. Given our financial strength, we expect to be able to maintain adequate liquidity as we manage through the current environment, utilizing current funding options and possibly utilizing new options.
MARKET RISK
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. The Company's market risk is composed primarily of interest rate risk. The Company's interest rate risk results from timing differences in the repricing of assets, liabilities, off-balance sheet instruments, and changes in relationships between rate indices and the potential exercise of explicit or embedded options.
Increases in the level of interest rates also may adversely affect the fair
value of the Company's securities and other earning assets. Generally, the fair
value of fixed-rate instruments fluctuates inversely with changes in interest
rates. As a result, increases in interest rates could result in decreases in the
fair value of the Company's interest-earning assets, which could adversely
affect the Company's results of operations if sold, or, in the case of
interest-earning assets classified as available-for-sale, the Company's
stockholders' equity, if retained. Under FASB ASC 320-10, Investments -
Asset/Liability Management
The principal objective of asset/liability management is to manage the
sensitivity of the net interest margin to potential movements in interest rates
and to enhance profitability through returns from managed levels of interest
rate risk. The Company actively manages the interest rate sensitivity of its
assets and liabilities. Several techniques are used for measuring interest rate
sensitivity. Interest rate risk arises from the mismatches in the repricing of
assets and liabilities within a given time period, referred to as a rate
sensitivity gap. If more assets than liabilities mature or reprice within the
time frame, the Company is asset sensitive. This position would contribute
positively to net interest income in a rising rate environment. Conversely, if
more liabilities mature or reprice, the Company is liability sensitive. This
position would contribute positively to net interest income in a falling rate
environment. The Company's cumulative gap at one year indicates the Company is
liability sensitive at
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Earnings at Risk
The Bank's Asset/Liability Committee ("ALCO") is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to interest rate risk. The guidelines established by ALCO are reviewed by the Company's Board of Directors. The Company recognizes that more sophisticated tools exist for measuring the interest rate risk in the balance sheet beyond interest rate sensitivity gap. Although the Company continues to measure its interest rate sensitivity gap, the Company utilizes additional modeling for interest rate risk in the overall balance sheet. Earnings at risk and economic values at risk are analyzed.
Earnings simulation modeling addresses earnings at risk and net present value estimation addresses economic value at risk. While each of these interest rate risk measurements has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk to the Company.
Earnings Simulation Modeling
The Company's net income is affected by changes in the level of interest rates. Net income is also subject to changes in the shape of the yield curve. For example, a flattening of the yield curve would result in a decline in earnings due to the compression of earning asset yields and increased liability rates, while a steepening would result in increased earnings as earning asset and interest-bearing liability yields widen.
Earnings simulation modeling is the primary mechanism used in assessing the impact of changes in interest rates on net interest income. The model reflects management's assumptions related to asset yields and rates paid on liabilities, deposit sensitivity, size and composition of the balance sheet. The assumptions are based on what management believes at that time to be the most likely interest rate environment. Earnings at risk is the change in net interest income from a base case scenario under various scenarios of rate shock increases and decreases in the interest rate earnings simulation model.
The table on the next page presents an analysis of the changes in net interest income and net present value of the balance sheet resulting from various increases or decreases in the level of interest rates, such as two percentage points (200 basis points) in the level of interest rates. The calculated estimates of change in net interest income and net present value of the balance sheet are compared to current limits approved by ALCO and the Board of Directors. The earnings simulation model projects net interest income would decrease 7.63%, 14.22% and 20.45% in the 100, 200 and 300 basis point increasing rate scenarios presented. In addition, the earnings simulation model projects net interest income would decrease 0.05% and 4.99% in the 100 and 200 basis point decreasing rate scenarios presented. All of these forecasts are within the Company's one year policy guidelines.
The analysis and model used to quantify the sensitivity of net interest income
becomes less reliable in a decreasing rate scenario given the current
unprecedented low interest rate environment with federal funds trading in the 25
- 50 basis point range. Results of the decreasing basis point declining
scenarios are affected by the fact that many of the Company's interest-bearing
liabilities are at rates below 1% and therefore likely may not decline 100 or
more basis points. However, the Company's interest-sensitive assets are able to
decline by these amounts. For the three months ended
Net Present Value Estimation
The net present value measures economic value at risk and is used for helping to
determine levels of risk at a point in time present in the balance sheet that
might not be taken into account in the earnings simulation model. The net
present value of the balance sheet is defined as the discounted present value of
asset cash flows minus the discounted present value of liability cash flows. At
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The computation of the effects of hypothetical interest rate changes are based on many assumptions. They should not be relied upon solely as being indicative of actual results, since the computations do not account for actions management could undertake in response to changes in interest rates.
Effect of Change in Interest Rates
Projected Change
Effect on Net Interest Income
1-Year Net Income Simulation Projection
+300 bp Shock vs. Stable Rate (20.45) %
+200 bp Shock vs. Stable Rate (14.22) %
+100 bp Shock vs. Stable Rate (7.63) %
Flat rate
-100 bp Shock vs. Stable Rate (0.05) %
-200 bp Shock vs. Stable Rate (4.99) %
Effect on Net Present Value of Balance Sheet
Static Net Present Value Change
+300 bp Shock vs. Stable Rate 5.67 %
+200 bp Shock vs. Stable Rate 1.23 %
+100 bp Shock vs. Stable Rate 4.52 %
Flat rate
-100 bp Shock vs. Stable Rate (16.75) %
-200 bp Shock vs. Stable Rate (51.31) %© Edgar Online, source
