UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

 

 

FORM 10-Q

 

 

KNBT Bancorp, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

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 o       No ý

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).   Yes o   No ý

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  As of November 11, 2003, 30,363,138 shares of the Registrant’s common stock were issued and outstanding.

 

 

PART I - FINANCIAL INFORMATION

 

Interim financial information required by Rule 10-01 of Regulation S-X and Item 303 of Regulation S-K is included in this Form 10-Q as referenced below.

 

		Page
Item 1 -	Financial Statements	3
Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3 -	Quantitative and Qualitative Disclosures About Market Risk	20
Item 4 -	Controls and Procedures	20
PART II - OTHER INFORMATION
Item 1 -	Legal Proceedings	20
Item 2 -	Changes in Securities and Use of Proceeds	20
Item 3 -	Defaults Upon Senior Securities	21
Item 4 -	Submission of Matters to a Vote of Security Holders	21
Item 5 -	Other Information	21
Item 6 -	Exhibits and Reports on Form 8-K	21
Signatures		22

 

2

 

Keystone Savings Bank and Subsidiary
Consolidated Balance Sheet
September 30, 2003 (Unaudited) and December 31, 2002
(in thousands)

 

		September 30, 2003			December 31, 2002
		(unaudited)
ASSETS
Cash and due from banks		$	13,326		$	33,535
Interest-bearing deposits with banks		364,619			52,758
Total cash and cash equivalents		377,945			86,293
Investment securities available for sale		337,980			294,150
Federal Home Loan Bank of Pittsburgh stock		8,889			8,011
Loans receivable, net		572,847			555,526
Mortgage loans held for sale		10,617			23,796
Bank owned life insurance		27,374			26,334
Premises and equipment, net		17,700			12,178
Accrued interest receivable		4,826			4,964
Other assets		9,867			4,654
Total assets		$	1,368,045		$	1,015,906
LIABILITIES AND RETAINED EARNINGS
Liabilities
Deposits		$	819,347		$	771,825
Securities sold under agreements to repurchase		11,034			8,904
Advances from the Federal Home Loan Bank		106,000			113,500
Advance payments by borrowers for taxes and insurance		993			2,283
Accrued interest payable		781			711
Stock subscription escrow		304,477			—
Other liabilities		7,360			7,634
Total liabilities		1,249,992			904,857
Retained earnings - substantially restricted		113,657			106,326
Accumulated other comprehensive income		4,396			4,723
Total retained earnings		118,053			111,049
Total liabilities and retained earnings		$	1,368,045		$	1,015,906

 

See accompanying notes to consolidated financial statements.

 

3

 

Keystone Savings Bank and Subsidiary

Consolidated Statements of Income

Three and Nine Months Ended September 30, 2003 and 2002

(in thousands)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2003			2002			2003			2002
		(unaudited)
Interest income
Loans receivable, including amortization of origination fees		$	9,745		$	10,716		$	29,404		$	33,361
Investment securities		3,403			4,398			11,346			11,283
Other interest		45			50			160			168
Total interest income		13,193			15,164			40,910			44,812
Interest expense
Deposits		3,452			5,540			11,424			18,329
Advances from the Federal Home Loan Bank		1,177			937			3,439			2,154
Other expense		28			44			88			112
Total interest expense		4,657			6,521			14,951			20,595
Net interest income		8,536			8,643			25,959			24,217
Provision for loan losses		468			301			856			53
Net interest income after provision for loan losses		8,068			8,342			25,103			24,164
Noninterest income
Deposit charges and service fees		1,789			1,437			5,068			3,618
Net gains on sales of investment securities		—			—			2			1,202
Bank owned life insurance		344			364			1,041			1,069
Net gains (losses) on sales of residential mortgages		(127		)	205			513			392
Net gains (losses) on sales of other real estate owned		12			(42		)	(23		)	(10		)
Total noninterest income		2,018			1,964			6,601			6,271
Noninterest expense
Compensation and employee benefits		4,333			3,187			11,791			9,521
Occupancy expenses		487			330			1,385			955
FDIC insurance premiums		32			33			95			101
Advertising		77			156			593			542
Data processing		514			437			1,434			1,342
Depreciation and amortization		435			338			1,230			960
Other		1,974			1,598			5,378			3,559
Total noninterest expense		7,852			6,079			21,906			16,980
Income before income taxes		2,234			4,227			9,798			13,455
Income taxes		478			1,210			2,467			3,941
Net income		$	1,756		$	3,017		$	7,331		$	9,514

 

See accompanying notes to consolidated financial statements.

 

4

 

Keystone Savings Bank and Subsidiary

Consolidated Statement of Retained Earnings

Nine Months Ended September 30, 2003 (Unaudited)

(in thousands)

 

		Retained earnings			Accumulated other comprehensive income (loss)			Comprehensive income			Total
Balance at December 31, 2002		$	106,326		$	4,723					$	111,049
Net income		7,331			—			$	7,331		7,331
Other comprehensive (loss), net of reclassification adjustments and taxes		—			(327		)	(327		)	(327		)
Total comprehensive income								$	7,004
Balance at September 30, 2003		$	113,657		$	4,396					$	118,053

 

See accompanying notes to consolidated financial statements.

 

5

 

Keystone Savings Bank and Subsidiary

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2003 and 2002

(in thousands)

 

		Nine Months Ended September 30,
		2003			2002
		(unaudited)
Operating activities
Net income
Adjustments to reconcile net income to net cash provided by (used in) operating activities		$	7,331		$	9,514
Depreciation and amortization		1,230			960
Amortization of discounts on investment securities, net		(2,477		)	(196		)
Provision for loan losses		856			53
Mortgage loans originated for sale		45,514			22,855
Mortgage loan sales		(46,027		)	(23,247		)
Changes in mortgages held for sale		13,179			(18,723		)
Net loss (gain) on sale of real estate owned		23			10
Net loss (gain) on sale investment securities		(2		)	(1,202		)
Increase/decrease in accrued interest receivable		(902		)	(1,928		)
Increase/decrease in other assets		(5,381		)	(3,139		)
Increase/decrease in advance payments by borrowers for taxes and insurance		(1,290		)	(1,232		)
Increase/decrease in other liabilities and accrued interest payable		(204		)	4,163
Net cash provided by (used in) operating activities		11,850			(12,112		)
Investing activities
Proceeds from sales of real estate owned		740			705
Proceeds from sales of investment securities available for sale		3,051			63,844
Proceeds from maturities, calls and principal repayments of investment securities available for sale		217,427			53,235
Purchases of investment securities available for sale		(214,987		)	(158,470		)
Purchases of premises and equipment		(6,752		)	(1,697		)
Purchases of Federal Home Loan Bank of Pittsburgh stock		(1,111		)	(84		)
Redemption of Federal Home Loan Bank of Pittsburgh stock		233			—
Net increase in loans		(65,428		)	(20,951		)
Purchase of bank-owned life insurance		—			(4,000		)
Net cash (used in) investing activities		(66,827		)	(67,418		)
Financing activities
Net increase (decrease) in deposits		47,522			(3,219		)
Net increase in repurchase agreements		2,130			2,477
Net advances from (repayment to) the Federal Home Loan Bank		(7,500		)	53,500
Increase in Stock Escrow Funds		304,477			—
Net cash provided by financing activities		346,629			52,758
Net increase (decrease) in cash and cash equivalents		291,652			(26,772		)
Cash and cash equivalents at beginning of year		86,293			51,844
Cash and cash equivalents at end of year		$	377,945		$	25,072
Supplemental disclosure of cash flow information:
Income Taxes		$	3,195		$	3,075
Interest on deposits, advances and borrowed money		$	14,882		$	20,399
Supplemental disclosure of noncash activities
Mortgage loan securitizations		$	47,251		$	115,336
Reclassifications of loans receivable to other real estate owned		$	1,367		$	813

 

See accompanying notes to consolidated financial statements.

 

6

 

Keystone Savings Bank and Subsidiary
Notes to Consolidated Financial Statements
(unaudited)

 

1.                                      Basis of Presentation.

 

On May 22, 2003, Keystone Savings Bank (the “Bank” or “Keystone”) incorporated KNBT Bancorp, Inc., a Pennsylvania corporation (the “Company” or “registrant”) to facilitate the conversion of the Bank from a Pennsylvania chartered mutual savings bank to a Pennsylvania chartered stock savings bank (the “Conversion”).  The Conversion was consummated on October 31, 2003, at which time the Company became the holding company for the Bank and issued shares of its common stock to the general public.  The Company owns all the outstanding common stock of the Bank which was issued upon completion of the Conversion.  Immediately after the completion of the Conversion, the Company completed its merger with First Colonial Group, Inc. (“First Colonial”), the holding company for Nazareth National Bank and Trust Company (“Nazareth National”), which was then merged with the Bank.  Prior to October 31, 2003, the registrant was in organization and had not yet engaged in any operations; accordingly, no financial statements of the Company have been included herein.

 

References in this document to “we,” “our” or “us” refer to the Company together with the Bank, unless the context requires otherwise.

 

2.                                      Basis of Consolidation

 

The consolidated financial statements include the accounts of the Bank and its wholly owned subsidiary, KLVI, Inc. (“KLVI”).  KLVI was formed in 1997 to hold and manage certain securities investments.

 

The accompanying unaudited consolidated financial statements as of September 30, 2003, and for the three and nine month periods ended September 30, 2003 and 2002 have been prepared in accordance with the instructions to Form 10-Q and therefore do not include all information and notes necessary for complete financial statements in conformity with accounting principles generally accepted in the United States of America.  All significant intercompany accounts and transactions have been eliminated in consolidation.  In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation.  The results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year.  These interim financial statements should be read in conjunction with the Company’s consolidated audited financial statements and the notes thereto contained in the Company’s prospectus dated August 12, 2003 and filed with the Securities and Exchange Commission (“SEC”) as a part of its registration statement on Form S-1 (File No. 333-105899).

 

7

 

3.                                      Investment Securities

 

Investment securities at September 30, 2003 and December 31, 2002 are summarized below:

 

		September 30, 2003 (unaudited)
		Amortized Cost			Gross unrealized gains			Gross unrealized losses			Fair Value
		(in thousands)
Available for sale
U.S. Government and agencies		$	19,633		$	114		$	(21	)	$	19,726
Obligations of states and political subdivisions		56,631			3,149			(175		)	59,605
Asset-managed funds
Adjusted rate mortgage portfolio		4,939			—			(59		)	4,880
Mortgaged-backed securities:
GNMA		2,331			17			—			2,348
FHLMC		17,188			209			(85		)	17,312
FNMA		76,112			2,364			(37		)	78,439
Other CMO’s		132,923			1,047			(733		)	133,237
		228,554			3,637			(855		)	231,336
Corporate and other debt securities		21,563			870			—			22,433
		$	331,320		$	7,770		$	(1,110	)	$	337,980

 

		December 31, 2002
		Amortized Cost			Gross unrealized gains			Gross unrealized losses			Fair Value
		(in thousands)
Available for sale
U.S. Government and agencies		$	30,677		$	398		$	—		$	31,075
Obligations of states and political subdivisions		38,935			2,148			(44		)	41,039
Asset-managed funds
Adjusted rate mortgage portfolio		4,939			—			(25		)	4,914
Mortgaged-backed securities
GNMA		3,234			93			—			3,327
FHLMC		17,963			390			(5		)	18,348
FNMA		73,743			2,382			(24		)	76,101
Other CMO’s		83,449			862			(137		)	84,174
		178,389			3,727			(166		)	181,950
Corporate and other debt securities		34,053			1,132			(13		)	35,172
		$	286,993		$	7,405		$	(248	)	$	294,150

 

8

 

4.                                      Loan Portfolio Composition

 

Loans receivable at September 30, 2003 and December 31, 2002 are summarized below.

 

		September 30, 2003			December 31, 2002
		(in thousands)
Real estate
Mortgage		$	329,945		$	396,604
Construction		98,668			59,363
Total real estate loans		428,613			455,967
Commercial business loans		17,124			10,050
Consumer loans		168,441			143,731
Total loans		614,178			609,748
Less:
Mortgage Loans held for sale		(10,617		)	(23,796		)
Loans in process		(25,894		)	(24,263		)
Deferred fees		(1,879		)	(3,236		)
Allowance for loan losses		(2,941		)	(2,927		)
Net loans		$	572,847		$	555,526

 

The following table sets forth the activity in the Bank’s allowance for loan losses during the periods indicated.

 

		Nine Months Ended September 30,
		2003			2002
		(in thousands)
Balance, beginning		$	2,927		$	3,386
Provisions charged to operations		856			53
Loans charged off		(886		)	(456		)
Recoveries of loans previously charged off		44			13
Balance, end		$	2,941		$	2,996

 

9

 

The following table shows the amounts of non-performing assets, defined as non-accruing loans, accruing loans 90 days or more past due and real estate owned, at the dates indicated.  Keystone did not have troubled debt restructurings at any of the dates indicated.

 

		September 30, 2003			December 31, 2002
		(Dollars in Thousands)
Non-accruing loans:
One- to four-family residential		$	1,474		$	2,023
Multi-family residential		—			—
Commercial real estate and land		—			—
Construction and land development		—			—
Commercial business		—			—
Consumer		183			174
Total non-accruing loans		1,657			2,197
Accruing loans 90 days or more past due:
One- to four-family residential		50			283
Multi-family residential		—			—
Commercial real estate		—			—
Construction and land development		—			—
Commercial business		14			15
Consumer		—			—
Total accruing loans 90 days or more  past due		64			298
Total non-performing loans(1)		1,721			2,495
Real estate owned, net(2)		56			115
Total non-performing assets		$	1,777		$	2,610
Total non-performing loans as a percentage of loans, net		0.30		%	0.45		%
Total non-performing loans as a percentage of total assets		0.13		%	0.25		%
Total non-performing assets as a percentage of total assets		0.13		%	0.26		%

 

(1)                                  Non-performing loans consist of non-accruing loans plus accruing loans 90 days or more past due.

 

(2)                                  Real estate owned balances are shown net of related loss allowances and include both real property and other repossessed collateral consisting primarily of automobiles.

 

10

 

5.                                      Recent Accounting Pronouncements

 

The Company adopted Statement of Financial Accounting Standards No. 149 (SFAS No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging Activities, on July 1, 2003.  SFAS No. 149 clarifies and amends SFAS No. 133 for implementation issues raised by constituents and includes the conclusions reached by the Financial Accounting Standards Board (“FASB”) on certain FASB Staff Implementation Issues.  Statement 149 also amends SFAS No. 133 to require a lender to account for loan commitments related to mortgage loans that will be held for sale as derivatives.  SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003.  The Company periodically enters into commitments with its customers, which it intends to sell in the future.  Management does not anticipate the adoption of SFAS No. 149 to have a material impact on the Company’s financial position or results of operations.

 

The FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, on May 15, 2003.  SFAS No. 150 changes the classification in the statement of financial position of certain common financial instruments from either equity or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in fair value or redemption amount, as applicable, in earnings.  SFAS No. 150 is effective for public companies for financial instruments entered into or modified after May 13, 2003 and is effective at the beginning of the first interim period beginning after June 15, 2003.  Management has not entered into any financial instruments that would qualify under SFAS No. 150.

 

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”).  On October 31, 2003, the FASB issued an Exposure Draft related to the consolidation of Variable Interest Entities, and the interpretation of FIN 46 (“FIN 46 Interpretation”).  The consolidation requirements, as amended by FASB Staff Position (FSP) 46-6, “Effective Date of FIN 46,” apply to existing entities in the first fiscal year or interim period beginning after December 15, 2003.  Management does not anticipate that FIN 46 or FIN 46, Interpretation will have material impact on the Company’s financial position or results of operations.

 

11

 

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains certain forward-looking statements and information relating to the Company and the Bank that are based on the beliefs of management as well as assumptions made by and information currently available to management.  In addition, in portions of this document the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “should” and similar expressions, or the negative thereof, as they relate to the Company or the Bank or their management, are intended to identify forward-looking statements.  Such statements reflect the current views of the Company and/or the Bank with respect to forward-looking events and are subject to certain risks, uncertainties and assumptions.  Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended.  The Company does not intend to update these forward-looking statements.

 

General

 

The Company was formed by the Bank in connection with the Bank’s conversion and has not yet commenced operations. The Company’s results of operations initially will be primarily dependent on the results of the Bank, which will be a wholly owned subsidiary upon completion of the conversion.  The Bank’s results of operations depend, to a large extent, on net interest income, which is the difference between the income earned on its loan and investment portfolios and the cost of funds, consisting of the interest paid on deposits and borrowings.  Results of operations are also affected by provisions for loan losses, loan sale activities and loan servicing.  Non-interest expense principally consists of compensation and employee benefits, office occupancy and equipment expense, data processing, advertising and business promotion and other expense.  Our results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities.  Future changes in applicable law, regulations or government policies may materially impact our financial conditions and results of operations.

 

Critical Accounting Policies

 

Keystone has identified the calculation of the allowance for loan losses as a critical accounting policy, due to the higher degree of judgment and complexity than its other significant accounting policies.  Provisions for loan losses will continue to be based upon management’s periodic valuation and assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions and other relevant factors in order to maintain the allowance for loan losses at a level believed by management to be sufficient to absorb estimated, probable losses.  Although management uses the best information available, the level of the allowance for loan losses remains an estimate which is subject to significant judgment and short-term change.

 

12

 

Comparison of Financial Condition at September 30, 2003 and December 31, 2002

 

Keystone’s total assets increased by $352.1 million, or 34.7%, to $1.4 billion at September 30, 2003 compared to $1.0 billion at December 31, 2002.  The increase in total assets was due primarily to a $291.7 million increase in cash and cash equivalents primarily as a result of funds received for subscription orders in Keystone’s recently completed subscription offering conducted in connection with Keystone’s mutual-to-stock conversion (the “Conversion”).  Keystone also reported increases in investment securities, net loans receivable, premises and equipment and other assets at September 30, 2003 compared to December 31, 2002.  During the nine-months ended September 30, 2003, Keystone’s investment securities increased by $43.8 million, or 14.9%, to $338.0 million at September 30, 2003 compared to $294.2 million at December 31, 2002.  At September 30, 2003, Keystone’s net loans receivable amounted to $572.8 million compared to $555.5 million at December 31, 2003, an increase of $17.3 million or 3.1%. During the nine months ended September 30, 2003, Keystone’s construction loans increased by $39.3 million, or 66.2%, its commercial business loans increased $7.1 million, or 70.4%, and its consumer loans increased $24.7 million, or 17.2%.  The increases in construction loans, commercial business loans and consumer loans more than offset a $66.7 million, or 16.8%, decrease in Keystone’s real estate mortgage loans during the nine months ended September 30, 2003.  The decrease in Keystone’s residential mortgage loans during the first nine months of 2003 reflects the continuing high prepayment levels of mortgage loans, as customers continue to take advantage of the low market rates of interest to refinance mortgage loans, as well as Keystone’s securitization of $47.3 million in residential mortgage loans in the first quarter of 2003.  Keystone’s loan portfolio growth during the nine months ended September 30, 2003, shows, in part, its efforts to increase originations of relatively higher yielding construction, commercial business and consumer loans.  Keystone’s growth in consumer loans during 2003 has been due primarily to increases in home equity loans and lines of credit and automobile loans. At September 30, 2003, Keystone’s home equity loans and lines of credit amounted to $107.5 million compared to $102.3 million at December 31, 2002.  Keystone’s automobile loans amounted to $52.8 million at September 30, 2003 compared to $32.0 million at December 31, 2002.  In addition to its portfolio of net loans receivable, Keystone held $10.6 million of mortgage loans for sale at September 30, 2003 compared to $23.8 million at December 31, 2002. During 2003, Keystone’s general policy has been to sell into the secondary market [all] of its newly originated, agency eligible long-term, fixed rate single-family residential mortgage loans.  Keystone’s net premises and equipment increased by $5.5 million to $17.7 million at September 30, 2003 compared to $12.2 million at December 31, 2002 primarily as a result of a $5.0 million purchase of a building to house Keystone’s operations departments.

 

Keystone’s total liabilities amounted to $1.2 billion at September 30, 2003, an increase of $345.1 million, or 38.1%, compared to total liabilities at December 31, 2002.  The primary reason for the increase in liabilities was $304.5 million of stock subscription funds held in escrow by Keystone at September 30, 2003.  Keystone’s deposits increased by $47.5 million, or 6.2%, to $819.3 million at September 30, 2003 compared to December 31, 2002.  Federal Home Loan Bank (“FHLB”) advances and other borrowings decreased by an aggregate of $5.4 million, or 4.4%, to $117.0 million at September 30, 2003 compared to $122.4 million at December 31, 2002.  Keystone’s total retained earnings increased by $7.0 million, or 6.3%, to $118.1 million at

 

13

 

September 30, 2003 compared to $111.0 million at December 31, 2002.  Such increase in retained earnings was due primarily to $7.3 million in net income for the nine-months ended September 30, 2003.

 

Keystone’s net loans receivable amounted to 41.9% of its total assets at September 30, 2003.  At such date, its investment securities, all of which are classified as available for sale, constituted 24.7% of total assets.  Keystone’s ratio of retained earnings to total assets at September 30, 2003 amounted to 8.6%, and its ratio of total non-performing assets to total assets was 0.13%.

 

Comparison of Operating Results for the Three and Nine Months Ended September 30, 2003 and 2002

 

General.  Keystone’s net income for the three months ended September 30, 2003 was $1.8 million, a $1.3 million, or 41.8%, decrease compared to $3.0 million of net income for the three months ended September 30, 2002.  For the nine months ended September 30, 2003, Keystone’s net income was $7.3 million, a $2.2 million, or 23.0%, decrease from net income of $9.5 million for the nine months ended September 30, 2002.  The primary reason for the decrease in the three-month and nine-month periods in 2003 was an increase in Keystone’s non-interest expenses which more than offset an increase in its net interest income.  Keystone’s average interest rate spread decreased by 47 basis points to 2.97% for the three months ended September 30, 2003 compared to 3.44% for the three months ended September 30, 2002.  For the nine-months ended September 30, 2003 and 2002, Keystone’s average interest rate spread was 3.30% and 3.26%, respectively.  The decreases in Keystone’s average interest rate spread were due primarily to decreases of 148 basis points and 104 basis points, respectively, in the average yield earned by Keystone on its interest-earning assets in the respective three-month and nine-month periods over the prior year comparable periods.  Keystone’s net interest margin was 3.29% and 3.74% for the three months ended September 30, 2003 and 2002, respectively, and 3.55% and 3.58% for the nine months ended September 30, 2003 and 2002, respectively.  Keystone’s ratio of average interest-earning assets to average interest-bearing liabilities increased in both the three-month and nine-month period ended September 30, 2003 over the prior year comparable periods.

 

Interest Income.  Keystone’s total interest income was $13.2 million for the three months ended September 30, 2003 compared to $15.2 million for the three months ended September 30, 2002, a $2.0 million or 13.0% decline.  For the nine months ended September 30, 2003, total interest income was $40.9 million compared to $44.8 million for the nine months ended September 30, 2002, a $3.9 million or 8.7% decrease.  The primary reason for the decrease in total interest income in the 2003 periods was the continuing effects of the low market rates of interest.  The average yield on Keystone’s interest-earning assets was 5.08% and 5.59% for the three months and nine months, respectively, ended September 30, 2003 compared to 6.56% and 6.63% for the respective comparable period in 2002.  Such decreases in the average yields earned on Keystone’s interest-earning assets more than offset increases of 12.4% and 8.2%, respectively, in the average balance of Keystone’s interest-earning assets during the respective three-months and nine months ended September 30, 2003 compared to the similar periods in 2002.

 

14

 

Interest Expense.  Keystone’s total interest expense was $4.7 million for the three months ended September 30, 2003 compared to $6.5 million for the three months ended September 30, 2002, a decrease of $1.9 million or 28.6%.  Total interest expense at Keystone was $15.0 million for the nine months ended September 30, 2003 compared to $20.6 million for the nine months ended September 30, 2002, a $5.6 million or 27.4% decline.  Such reductions reflect the lower average rates of interest paid by Keystone on both its deposits and its borrowings in the 2003 periods.  Keystone’s average rate paid on interest-bearing liabilities was 2.11% for the three months ended September 30, 2003 compared to 3.12% for the three months ended September 30, 2002.  For the nine months ended September 30, 2003, Keystone’s average rate paid on interest-bearing liabilities was 2.29% compared to 3.37% for the nine months ended September 30, 2002.

 

15

 

Average Balances, Net Interest Income, and Yields Earned and Rates Paid. The following table shows for the periods indicated the total dollar amount of interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin.  Tax-exempt income and yields have not been adjusted to a tax-equivalent basis. All average balances are based on monthly balances. Management does not believe that the monthly averages differ significantly from what the daily averages would be.

 

 

		Three Months Ended September 30,
		2003								2002
		Average Balance			Interest			Average Yield/Rate		Average Balance			Interest			Average Yield/Rate
		(Dollars in Thousands)
Interest-earning assets:
Deposits at other institutions		$	89,131		$	176		0.79	%	$	15,194		$	43		1.13	%
Investment securities (1)		370,758			3,272			3.53		319,941			4,405			5.51
Loans receivable (2)		578,414			9,745			6.74		589,068			10,716			7.28
Total interest-earning assets		1,038,303			13,193			5.08		924,203			15,164			6.56
Non-interest-earning assets		64,594								56,712
Total assets		1,102,897								980,915
Interest-bearing liabilities:
Deposits:
Savings accounts		130,135			201			0.62	%	114,067			433			1.52	%
Checking accounts (3)		93,482			56			0.24		82,256			120			0.58
Money market accounts		168,822			480			1.14		136,343			696			2.04
Certificate accounts		374,247			2,715			2.90		411,225			4,291			4.17
Total deposits		766,686			3,452			1.80		743,891			5,540			2.98
FHLB advances and other borrowings		116,928			1,205			4.13		92,332			981			4.25
Total interest-bearing liabilities		883,614			4,657			2.11		836,223			6,521			3.12
Non-interest-bearing liabilities:
Deposits		45,920								29,526
Other		57,560								7,253
Total liabilities		987,094								873,002
Retained earnings		115,803								107,913
Total liabilities and retained earnings		$	1,102,897							$	980,915
Net interest-earning assets		$	154,689							$	87,980
Net interest income; average interest rate spread					$	8,537		2.97	%				$	8,643		3.44	%
Net interest margin (4)								3.29	%							3.74	%
Average interest-earning assets to average interest-bearing liabilities								117.51	%							110.52	%

 

(Footnotes on next page)

 

16

 

		Nine Months Ended September 30,
		2003								2002
		Average Balance			Interest			Average Yield/ Rate(1)		Average Balance			Interest			Average Yield/ Rate
		(Dollars in Thousands)
Interest-earning assets:
Deposits at other institutions		$	63,085		$	417		0.88	%	$	30,094		$	327		1.45	%
Investment securities (1)		347,126			11,089			4.26		263,251			11,124			5.63
Loans receivable (2)		564,867			29,404			6.94		607,550			33,361			7.32
Total interest-earning assets		975,078			40,910			5.59		900,895			44,812			6.63
Non-interest-earning assets		76,309								52,490
Total assets		1,051,387								953,385
Interest-bearing liabilities:
Deposits:
Savings accounts		124,902			798			0.85	%	110,673			1,245			1.50	%
Checking accounts (3)		90,311			236			0.35		81,165			349			0.57
Money market accounts		160,757			1,634			1.36		131,348			2,077			2.11
Certificate accounts		381,536			8,756			3.06		425,361			14,658			4.59
Total deposits		757,506			11,424			2.01		748,547			18,329			3.26
FHLB advances and other borrowings		114,291			3,527			4.12		66,675			2,266			4.53
Total interest-bearing liabilities		871,797			14,951			2.29		815,222			20,595			3.37
Non-interest-bearing liabilities:
Deposits		40,291								27,817
Other		24,087								7,323
Total liabilities		936,175								850,362
Retained earnings		115,212								103,023
Total liabilities and retained Earnings		$	1,051,387							$	953,385
Net interest-earning assets		$	103,281							$	85,673
Net interest income; average interest rate spread					$	25,959		3.30	%				$	24,217		3.26	%
Net interest margin (4)								3.55	%							3.58	%
Average interest-earning assets to average interest-bearing liabilities								111.85	%							110.51	%

 

(1)                                  Includes securities available-for-sale and held-to-maturity.  Investment securities also include Federal Home Loan Bank stock.

 

(2)                                  Includes nonaccrual loans during the respective periods.  Calculated net of deferred fees and discounts, loans in process and allowance for loan losses.

 

(3)                                  Includes non-interest-bearing checking accounts.

 

(4)                                  Equals net interest income divided by average interest-earning assets.

 

17

 

Rate/Volume Analysis.  The following table shows the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities affected Keystone’s interest income and expense during the periods indicated.  For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate, which is the change in rate multiplied by prior year volume, and (2) changes in volume, which is the change in volume multiplied by prior year rate.  The combined effect of changes in both rate and volume has been allocated proportionately to the change due to rate and the change due to volume.

 

		Three Months Ended September 30, 2003 vs. Three Months Ended September 30, 2002									Nine Months Ended September 30, 2003 vs. Nine Months Ended September 30, 2002
		Increase (Decrease) Due to						Total Increase (Decrease)			Increase (Decrease) Due to						Total Increase (Decrease)
		Rate			Volume						Increase (Decrease)			Volume
		(In Thousands)
Interest income:
Cash and cash equivalents		$	(9	)	$	142		$	133		$	(50	)	$	140		$	90
Investment securities		(1,833		)	700			(1,133		)	(3,579		)	3,544			(35		)
Loans receivable, net		(779		)	(191		)	(970		)	(1,683		)	(2,274		)	(3,957		)
Total interest-earning assets		(2,621		)	651			(1,970		)	(5,312		)	1,410			(3,902		)
Interest expense:
Savings accounts		(304		)	72			(232		)	(636		)	189			(447		)
Checking accounts		(83		)	19			(64		)	(159		)	46			(113		)
Money market accounts		(467		)	251			(216		)	(1,187		)	744			(443		)
Certificate accounts		(1,219		)	(359		)	(1,578		)	(4,511		)	(1,394		)	(5,905		)
Total deposits		(2,073		)	(17		)	(2,090		)	(6,493		)	(415		)	(6,908		)
FHLB advances and other borrowings		(26		)	253			227			(184		)	1,448			1,264
Total interest-bearing liabilities		(2,099		)	236			(1,863		)	(6,677		)	1,033			(5,644		)
Increase (decrease) in net interest income		$	522		$	415		$	(107	)	$	1,365		$	377		$	1,742

 

Provision for Loan Losses.  Keystone made provisions for loan losses of $468,000 for the three months ended September 30, 2003 compared to $301,000 for the three months ended September 30, 2002.  For the nine months ended September 30, 2003, Keystone’s provision for loan losses was $856,000 compared to $53,000 for the nine months ended September 30, 2002.  During the first quarter of 2002, Keystone made a recovery of $445,000 on its loan loss allowance, primarily reflecting its securitizations of $115.3 million of mortgage loans during the quarter.  At September 30, 2003, Keystone’s total non-performing loans amounted to $1.7 million compared to $1.9 million in non-performing loans at September 30, 2002.  Keystone’s allowance for loan losses was $2.9 million, or 170.9% of total non-performing loans, at September 30, 2003 compared to $3.0 million, or 158.8% of total non-performing loans, at September 30, 2002.  Keystone’s net loan charge-offs amounted to $341,000 and $886,000 for the three months and nine months ended September 30, 2003, respectively, compared to $227,000 and $456,000 for the three months and nine months ended September 30, 2002, respectively.

 

Other Income.  Keystone’s total non-interest income amounted to $2.0 million for both of the three month periods ended September 30, 2003 and 2002.  For the nine months ended September 30, 2003, Keystone’s total non-interest income was $6.6 million compared to $6.3 million for the nine months ended, a $330,000 or 5.3% increase.  Keystone’s non-interest income during 2003 reflects increased fee income from transaction accounts.  Deposit charges increased

 

18

 

by $352,000 and $1.5 million, respectively, in the three-months and nine month periods ended September 30, 2003 compared to the same periods in 2002.  Such increases were partially offset by the absence of $1.2 million in net gains on the sale of investment securities recognized in the first quarter of 2002.  In addition, Keystone recognized a $127,000 loss on the sale of residential mortgage loans in the quarter ended September 30, 2003 compared to a $205,000 gain in the quarter ended September 30, 2002.  The primary reasons for Keystone’s increases in non-interest income in the 2003 periods were increased fee income from transaction accounts as well as increased income from bank owned life insurance (“BOLI”).

 

Other Expense.  Keystone’s non-interest expense was $7.9 million for the three months ended September 30, 2003 compared to $6.1 million for the three months ended September 30, 2002, a $1.8 million or 29.2% increase.  For the nine months ended September 30, 2003, Keystone’s non-interest expense was $21.9 million compared to $17.0 million for the nine months ended September 30, 2002, an increase of $4.9 million or 29.0%.  The primary reasons for the increase in Keystone’s non-interest expenses in the 2003 periods were increases in employee compensation and benefits costs.  Compensation and employee benefits costs increased by $1.1 million and $2.3 million, respectively, in the three-months and nine-months ended September 30, 2003 compared to the prior comparable periods in 2002.  The increases in compensation and employee benefits costs were due primarily to an increase in the number of employees, certain additional compensation costs incurred as a result of the proposed merger with First Colonial as well as increased health care costs.  Other non-interest expenses increased by $376,000 and $1.8 million in the three months and nine months ended September 30, 2003 compared to the prior year comparable period due primarily to certain planning costs related to Keystone’s proposed merger with First Colonial as well as increased loan origination costs incurred as a result of higher loan origination volumes in the 2003 periods.

 

Income Tax Expense.  Keystone’s income tax expense was $478,000 for the three months ended September 30, 2003 compared to $1.2 million for the three months ended September 30, 2002.  For the nine months ended September 30, 2003, Keystone’s income tax expense was $2.5 million compared to $3.9 million for the nine months ended September 30, 2002.  The decreases were due primarily to the decreases in net income as well as the effects of Keystone’s investments in municipal securities.

 

19

 

Item 3 - Quantitative and Qualitative Disclosures About Market Risk.

 

For a discussion of the Bank’s asset and liability management policies as well as the methods used to manage its exposure to the risk of loss from adverse changes in market prices and rates market, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations of Keystone – How Keystone Manages Market Risk” and – “Quantitative and Qualitative Disclosures About Market Risk” in the Company’s prospectus dated August 12, 2003.  There has been no material change in the Bank’s asset and liability position or the market value of the Bank’s equity since June 30, 2003.

 

Item 4 - Controls and Procedures.

 

Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report.  Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations and are operating in an effective manner.

 

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15(d)-15(f) under the Securities Exchange Act of 1934) occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 1 - Legal Proceedings.

 

There are no matters required to be reported under this item.

 

Item 2 - Changes in Securities and Use of Proceeds.

 

(a), (b) and (c) Not applicable.

 

(d)                                 The Company’s Form S-1 (File No. 333-105899) was declared effective by the SEC on August 12, 2003.  The offering commenced on August 22, 2003, and the offering subscription period ended September 15, 2003.  Sandler O’Neill & Partners, L.P. was the underwriter.  A total of 20,201,188 shares of common stock were sold at $10.00 per share in the subscription offering, which was consummated on October 31, 2003.  The gross offering proceeds were $202,011,880 and net proceeds are estimated to be approximately $198,083,371.  In addition, 8,527,264 shares were issued to former shareholders of First Colonial

 

20

 

in exchange for their shares of common stock of First Colonial (based upon an exchange ration of 3.7:1) and 1,616,095 shares of the Company’s common stock were contributed to the Keystone Nazareth Charitable Foundation.

 

Item 3 - Defaults Upon Senior Securities.

 

There are no matters required to be reported under this item.

 

Item 4 - Submission of Matters to a Vote of Security Holders.

 

There are no matters required to be reported under this item.

 

Item 5 - Other Information.

 

There are no matters required to be reported under this item.

 

Item 6 - Exhibits and Reports on Form 8-K.

 

(a)                                  List of exhibits: (filed herewith unless otherwise noted)

 

2.1                                 Plan of Conversion*

2.2                                 Agreement and Plan of Merger between Keystone Savings Bank and First Colonial Group, Inc. (without exhibits)*

3.1                                 Articles of Incorporation of KNBT Bancorp, Inc.*

3.2                                 Bylaws of KNBT Bancorp, Inc.*

4.0                                 Form of Stock Certificate of KNBT Bancorp, Inc.*

10.1                           Employment Agreement between Keystone Savings Bank, KNBT Bancorp and Scott V. Fainor*

10.2                           Employment Agreement between Keystone Savings Bank, KNBT Bancorp and Eugene T. Sobol*

10.3                           Letter Agreement between Keystone Savings Bank and Eugene T. Sobol*

10.4                           Retirement Agreement  between Keystone Savings Bank and Frederick E. Kutteroff*

10.5                           Supplemental Executive Retirement Plan*

10.6                           Performance Unit Plan*

10.7                           Senior Management Variable Compensation Program*

10.8                           Severance Agreement between Keystone Savings Bank and Richard L. Meares*

31.1                           Section 302 Certification of the Chief Executive Officer

31.2                           Section 302 Certification of the Chief Operating Officer

31.3                           Section 302 Certification of the Chief Financial Officer

32.1                           Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

*                                         Incorporated by reference from the Company’s Registration Statement on Form S-1, filed on June 6, 2003, as amended, and declared effective on August 12, 2003 (File No. 333-105899).

 

(b)                                 Reports on Form 8-K:

 

No reports on Form 8-K were filed by the Registrant during the quarter ended September 30, 2003.

 

21

 

SIGNATURES

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

			KNBT BANCORP, INC.
Date:	November 12, 2003	By:	/s/ Scott V. Fainor
			Scott V. Fainor
			President and Chief Executive Officer
Date:	November 12, 2003	By:	/s/ Eugene T. Sobol
			Eugene T. Sobol
			Senior Executive Vice President and Chief Operating Officer
Date:	November 12, 2003	By:	/s/ Reid L. Heeren
			Reid L. Heeren
			Executive Vice President and Chief Financial Officer

 

22