10-K: First Keystone Corporation Reports Lower Net Income in 2023 Amidst Rising Interest Rates

First Keystone Corporation experienced a significant decrease in net income for 2023, primarily due to increased interest expenses and a contraction in net interest margin.

Summary

• First Keystone Corporation's net income decreased by 60.4% to $5.56 million in 2023, compared to $14.024 million in 2022.
• Earnings per share also saw a substantial drop, falling to $0.91 from $2.35 in the previous year.
• The corporation's return on average assets decreased to 0.42% in 2023 from 1.07% in 2022, and return on average equity fell to 4.55% from 10.75%.
• Total interest income increased by 22.8% to $56.988 million, driven by higher interest rates and loan growth, but this was offset by a 212.7% increase in interest expense to $27.872 million.
• The net interest margin decreased to 2.38% in 2023 from 3.19% in 2022, primarily due to increased yields on deposits and borrowings.
• The allowance for credit losses decreased to $6.925 million at the end of 2023, representing 0.79% of average total loans, mainly due to the adoption of the CECL model.
• Total assets increased by 6.5% to $1.415 billion, while total deposits decreased by 1.3% to $980.439 million.
• The corporation's loan portfolio increased by 6.3% to $904.153 million, with growth primarily in commercial real estate and commercial and industrial loans.

Sentiment

Score: 4

Explanation: The document presents a mixed picture with some positive aspects like loan growth and increased interest income, but the significant decrease in net income and earnings per share, along with the identified material weakness in internal controls, weighs heavily on the overall sentiment. The outlook is cautious, with management acknowledging the challenges of the current economic environment.

Positives

• Total interest income increased by 22.8% to $56.988 million, driven by higher interest rates and loan growth.
• The corporation's loan portfolio increased by 6.3% to $904.153 million, with growth primarily in commercial real estate and commercial and industrial loans.
• The Corporation maintains capital ratios above the required capital conservation buffer.
• The Corporation has implemented a new control requiring that the remaining life calculations are run on a quarterly basis in order to recalculate the annual attrition rate.

Negatives

• Net income decreased by 60.4% to $5.56 million in 2023, compared to $14.024 million in 2022.
• Earnings per share dropped to $0.91 in 2023, a 61.3% decrease from $2.35 in 2022.
• Total interest expense rose by 212.7% to $27.872 million.
• The net interest margin decreased to 2.38% in 2023 from 3.19% in 2022.
• Total deposits decreased by 1.3% to $980.439 million.
• Management identified a material weakness in internal controls relating to the failure to properly review and update remaining life calculations and the qualitative factors grid related to the allowance for credit losses calculations under the Corporations CECL model.

Risks

• The Corporation is subject to interest rate risk, which could adversely affect its earnings and cash flows.
• Lending risk, particularly with a significant portion of the loan portfolio secured by commercial real estate, could lead to increased non-performing loans and credit losses.
• The Corporation's communication, information, and technology systems are vulnerable to interruptions or security breaches.
• Severe weather, natural disasters, disease pandemics, acts of war or terrorism, and other external events could significantly impact the Corporation's business.
• The Corporation operates in a highly competitive industry, facing competition from various financial institutions and non-bank firms.
• The Basel III capital requirements may require the Corporation to maintain higher levels of capital, which could reduce its profitability.
• Past and future bank failures may adversely affect the national, regional, and local business environment, results of operation, and capital.
• Changes in control of the United States government and issues relating to debt and the deficit may adversely affect the Corporation.
• The Corporation's profitability depends significantly on economic conditions in the Commonwealth of Pennsylvania.
• The Corporation may not be able to attract and retain skilled people.
• The Corporation is subject to claims and litigation pertaining to fiduciary responsibility.
• The trading volume in the Corporation's common stock is less than that of other larger financial services companies.
• The Corporation's controls and procedures may fail or be circumvented.
• The Corporation continually encounters technological change.
• The Corporation may need or be compelled to raise additional capital in the future, but that capital may not be available when it is needed and on terms favorable to current shareholders.
• The Corporation is subject to environmental liability risk associated with lending activities.
• The Corporation's ability to pay dividends is subject to limitations.
• Pennsylvania Business Corporation Law and various anti-takeover provisions under its Articles of Incorporation and Bylaws could impede the takeover of the Corporation.
• The Corporation's banking subsidiary may be required to pay higher FDIC insurance premiums or special assessments which may adversely affect its earnings.
• The increasing use of social media platforms presents new risks and challenges and our inability or failure to recognize, respond to and effectively manage the accelerated impact of social media could materially adversely impact our business.

Future Outlook

The Corporation will continue to evaluate the potential impact of short-term rate fluctuations in 2024, as well as the slope and position of the yield curve. The Corporation is actively monitoring and restructuring its portfolios to become more asset sensitive, which will allow for better performance in a static or rates-up environment. The Corporation will continue to focus on attracting organic loan growth and core deposits such as checking, savings, and money market accounts, thereby further reducing its dependence on higher priced certificates of deposit and short-term borrowings.

Management Comments

• Management believes the loan portfolio is well diversified.
• Management considers, based upon its methodology, that the allowance for credit losses is adequate to cover foreseeable future losses.
• Management expects that one result of bank failures is that FDIC assessments will more likely than not increase as a cost of doing business to the Bank.
• Management believes the Corporation meets the conditions of the Federal Reserves small bank holding company policy statement and is therefore excluded from consolidated capital requirements at December 31, 2023; however, the Bank remains subject to regulatory capital requirements administered by the federal banking agencies.

Industry Context

The decrease in net income and net interest margin reflects a broader trend in the banking industry, where rising interest rates have increased funding costs and compressed margins. The Corporation is actively monitoring and restructuring its portfolios to become more asset sensitive, which will allow for better performance in a static or rates-up environment.

Comparison to Industry Standards

• The Corporation's total non-interest expense was 2.21% of average assets in 2023 and 2.04% in 2022, which places the Corporation among the leaders in its peer financial institution categories in controlling non-interest expense.
• The Corporation is generally competitive with national, regional and community banking financial institutions and credit unions in its service area, with respect to interest rates paid on time, savings and interest-bearing checking deposits, service charges assessed and interest rates charged on loans.
• The Bank ranks a commanding first in deposit market share in the Berwick market with 64.5% of deposits as of June 30, 2023, based on data compiled annually by the FDIC.
• As of June 30, 2023, the FDIC Summary of Deposits report market share data ranked the Bank 8th in the deposit market share out of the top 25 banks in the principal five-county deposit market, with 4.7% of deposits.

Related Party Transactions

• Certain directors, executive officers and immediate family members of First Keystone Corporation and its subsidiary, and companies in which they are principal owners (i.e., at least 10% ownership), were indebted to the Corporation at December 31, 2023 and 2022.
• The loans do not involve more than the normal risk of collectability nor present other unfavorable features.
• Deposits from certain officers, directors and immediate family members and/or their related companies held by the Bank amounted to $26,988,000 and $27,248,000 at December 31, 2023 and 2022, respectively.

Stakeholder Impact

• Shareholders will experience a decrease in earnings per share and a lower return on equity.
• Employees may be affected by the company's efforts to control costs.
• Customers may see changes in interest rates and fees on deposit and loan products.
• Creditors may be concerned about the company's ability to repay its debts given the decrease in net income.

Next Steps

• The Corporation will continue to monitor its allowance for credit losses and make future adjustments to the allowance through the provision for credit losses as conditions warrant.
• The Corporation will continue to evaluate the potential impact of short-term rate fluctuations in 2024, as well as the slope and position of the yield curve.
• The Corporation will continue to focus on attracting organic loan growth and core deposits such as checking, savings, and money market accounts, thereby further reducing its dependence on higher priced certificates of deposit and short-term borrowings.
• Management has instituted a new control requiring that the remaining life calculations are run on a quarterly basis in order to recalculate the annual attrition rate.
• Management has introduced several refinements in its qualitative factors grid utilized in the calculation of the allowance for credit losses and eliminated duplicative and overlapping values when defining the ranges used to determine the magnitude of qualitative adjustments.

Key Dates

Keywords

net income, interest rates, loan portfolio, credit losses, deposits, capital, financial performance, risk management, banking, financial services