10-Q 1 form10q302.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10Q Quarterly Report Pursuant to Section 13 OR 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2002 Commission File Number: 2-88927 FIRST KEYSTONE CORPORATION (Exact name of registrant as specified in its charter) Pennsylvania 23-2249083 (I.R.S. Employer incorporation or organization) identification No.) 111 West Front Street, Berwick, PA 18603 (Address of principal executive (Zip Code) offices) 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date: Common Stock, $2 Par Value, 2,833,727 shares as of March 31, 2002. PART I. - FINANCIAL INFORMATION Item. 1 Financial Statements FIRST KEYSTONE CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except per share data) March December 2002 2001 (Unaudited) ASSETS Cash and due from banks $ 6,469 $ 6,500 Interest bearing deposits with banks 4 50 Available-for-sale securities carried at estimated fair value 174,397 178,099 Investment securities, held-to- maturity securities, estimated fair value of $6,679 and $5,986 6,728 6,009 Loans, net of unearned income 202,707 198,224 Allowance for loan losses 3,040 2,922 ________ ________ Net loans $199,667 $195,302 Bank premises and equipment 3,229 3,275 Accrued interest receivable 2,907 2,994 Other assets 1,879 1,243 ________ ________ Total Assets $395,280 $393,472 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non-interest bearing $ 26,068 $ 25,576 Interest bearing 271,104 269,105 ________ ________ Total deposits $297,172 $294,681 Short-term borrowings 10,555 11,566 Long-term borrowings 45,250 45,250 Accrued interest and other expenses 2,214 2,083 Other liabilities 59 196 ________ ________ Total Liabilities $355,250 $353,776 STOCKHOLDERS' EQUITY Common stock, par value $2 per share 5,867 5,867 Surplus 9,761 9,761 Retained earnings 27,527 26,450 Accumulated other comprehensive income (loss) (28) 715 Less treasury stock at cost 100,000 shares in 2001 and 2000 (3,097) (3,097) ________ ________ Total Stockholders' Equity $ 40,030 $ 39,696 ________ ________ Total Liabilities and Stockholders' Equity $395,280 $393,472 ======== ======== See Accompanying Notes to Consolidated Financial Statements

1 FIRST KEYSTONE CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS ENDED March 31, 2002 AND 2001 (Unaudited)

(Amounts in thousands except per share data) 2002 2001 INTEREST INCOME Interest and fees on loans $ 3,715 $ 3,949 Interest and dividend income on securities 2,676 2,647 Interest on deposits in banks 1 101 _________ _________ Total Interest Income $ 6,392 $ 6,697 INTEREST EXPENSE Interest on deposits $ 2,050 $ 3,176 Interest on short-term borrowings 48 112 Interest on long-term borrowings 614 592 _________ _________ Total Interest Expense $ 2,712 $ 3,880 Net interest income $ 3,680 $ 2,817 Provision for loan losses 175 100 _________ _________ Net Interest Income After Provision for Loan Losses $ 3,505 $ 2,717 OTHER INCOME Service charges on deposit accounts $ 261 $ 268 Other non-interest income 149 200 Investment securities gains (losses) net 105 13 _________ _________ Total Other Income $ 515 $ 481 OTHER EXPENSES Salaries and employee benefits $ 1,027 $ 956 Net occupancy and fixed asset expense 248 262 Other non-interest expense 541 483 _________ _________ Total Other Expenses $ 1,816 $ 1,701 Income before income taxes $ 2,204 $ 1,497 Applicable income tax (benefit) 532 294 Net Income $ 1,672 $ 1,203 PER SHARE DATA Net Income $ .59 $ .42 Cash Dividends .21 .20 Weighted Average Shares Outstanding 2,833,727 2,833,727 See Accompanying Notes to Consolidated Financial Statements

2 FIRST KEYSTONE CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED March 31, 2002 AND 2001 (Unaudited)

(Amounts in thousands) 2002 2001 OPERATING ACTIVITIES Net income $ 1,672 $ 1,203 Adjustments to reconcile net income to net cash provided (used) by operating activities: Provision for loan losses 175 100 Provision for depreciation and amortization 91 107 Premium amortization on investment securities 111 39 Discount accretion on investment securities (205) (284) Gain on sale of mortgage loans 0 (47) Proceeds from sale of mortgage loans 0 3,949 Originations of mortgage loans for resale (3,022) (692) (Gain) loss on sales of investment securities (105) (13) (Gain) loss on sale of other real estate owned 0 0 Deferred income tax (benefit) (51) (28) (Increase) decrease in interest receivable and other assets (188) (489) Increase (decrease) in interest payable, accrued expenses and other liabilities (5) 95 ________ ________ NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES $ (1,527) $ 3,940 INVESTING ACTIVITIES Purchases of investment securities available-for-sale $(17,509) $(32,782) Purchases of investment securities held-to-maturity (983) 0 Proceeds from sales of investment securities available-for-sale 15,780 14,156 Proceeds from maturities and redemptions of investment securities available for sale 4,508 4,569 Proceeds from maturities and redemption of investment securities held-to-maturity 257 2,272 Net (increase) decrease in loans (1,518) (1,758) Purchase of premises and equipment (45) (15) Proceeds from sale of other real estate owned 75 0 ________ ________ NET CASH (USED) BY INVESTING ACTIVITIES $ 565 $(13,558) FINANCING ACTIVITIES Net increase (decrease) in deposits $ 2,491 $ 18,678 Net increase (decrease) in short-term borrowings (1,011) 327 Net increase (decrease)in long-term borrowings 0 (1,000) Cash dividends (595) (567) ________ ________ NET CASH PROVIDED BY FINANCING ACTIVITIES $ 885 $ 17,438 INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ (77) $ 7,820 CASH AND CASH EQUIVALENTS, BEGINNING 6,550 9,161 ________ ________ CASH AND CASH EQUIVALENTS, ENDING $ 6,473 $ 16,981 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during period for Interest $ 2,859 $ 3,980 Income Taxes 144 11 See Accompanying Notes to Consolidated Financial Statements

3 FIRST KEYSTONE CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 2002 (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, The First National Bank of Berwick (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 nine full service offices and 12 ATMs located in Columbia, Luzerne and Montour Counties. The Corporation and its subsidiary must also adhere to certain federal banking laws and regulations and are subject to periodic examinations made by various federal agencies. SEGMENT REPORTING The Corporation's banking subsidiary acts as an independent community financial services provider, and offers traditional banking and related financial services to individual, business and government customers. Through its branch and automated teller machine network, the Bank offers a full array of commercial and retail financial services, including the taking of time, savings and demand deposits; the making of commercial, consumer and mortgage loans; and the providing of other financial services. The Bank also performs personal, corporate, pension and fiduciary services through its Trust Department. Management does not separately allocate expenses, including the cost of funding loan demand, between the commercial, retail, trust and mortgage banking operations of the Corporation. Currently, management measures the performance and allocates the resources of First Keystone Corporation as a single segment. USE OF ESTIMATES The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of these consolidated financial statements and the reported amounts of income and expenses during the reporting periods. Actual results could differ from those estimates. INVESTMENT SECURITIES The Corporation classifies its investment securities as either "Held-to-Maturity" or "Available-for-Sale" at the time of purchase. Debt securities are classified as Held-to-Maturity when the Corporation has the ability and positive intent to hold the securities to maturity. Investment securities Held-to-Maturity are carried at cost adjusted for amortization of premium and accretion of discount to maturity. Debt securities not classified as Held-to-Maturity and equity securities are included in the Available-for-Sale category and are carried at fair value. The amount of any unrealized gain or loss, net of the effect of deferred income taxes, is reported as other comprehensive income (loss) in the Consolidated Statement of 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. 4 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 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. 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. 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. 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. 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. PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation computed principally on the straight-line method over the estimated useful lives of the assets. 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 retains 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. 5 FORECLOSED ASSETS HELD FOR SALE 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. INVESTMENT IN REAL ESTATE VENTURE In October of 2000, the Bank became a limited partner in a real estate venture that owns and operates an affordable residential low-income housing apartment building for elderly residents. The investment is 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". The carrying value of the investment as of March 31, 2002, and December 31, 2001, was $603,395 and $617,284, respectively, and is carried in Other Assets in the accompanying consolidated balance sheet. 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. STOCK BASED COMPENSATION The Corporation accounts for stock options and shares issued under the Stock Option Incentive Plan in accordance with Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees". Under this method no compensation expense is recognized for stock options when the exercise price equals the fair value of the options at the grant date. Under provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock Based Compensation", the fair value of a stock option is required to be recognized as compensation expense over the service period (generally the vesting period). As permitted under SFAS No. 123 the Corporation has elected to continue to account for its stock option plan in accordance with APB No. 25. 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 which currently have no effect on earnings per share since the market price per share historically has not been greater than the lowest stock option exercise price. Per share data has been adjusted retroactively for stock splits and stock dividends. 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. 6 RECENT ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards (SFAS) No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities", is generally effective for transactions occurring after March 31, 2001. For recognition and reclassification of collateral and for disclosure related to securitization transactions and collateral, the effective date is for fiscal years ending after December 15, 2000. SFAS No. 140 replaces SFAS No. 125 and provides revisions to the standards for accounting and requirements for certain disclosures relating to securitzations and other transfers of financial assets. The standard does not have any impact on the Corporation's consolidated financial condition or results of operations. REPORTING FORMAT Certain amounts in the consolidated financial statements of prior periods have been reclassified to conform with presentation used in the 2002 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 March 31, 2002, and March 31, 2001, were as follows:

(amounts in thousands) 2002 2001 Balance, January 1 $2,922 $2,702 Provision charged to operations 175 100 Loans charged off (62) (165) Recoveries 5 11 ______ ______ Balance, March 31 $3,040 $2,648 ====== ======

At March 31, 2002, the recorded investment in loans that are considered to be impaired as defined by SFAS No. 114 was $148,389. 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 March 31, 2002, there were no significant commitments to lend additional funds with respect to non-accrual and restructured loans. 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 (FHLB). 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. 7 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 March 31, 2002, and December 31, 2001, were as follows:

(amounts in thousands) March 31, December 31, 2002 2001 _______ _________ Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $22,363 $21,853 Standby letters of credit 2,584 2,589

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses that may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management's credit evaluation of the counter-party. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation may hold collateral to support standby letters of credit for which collateral is deemed necessary. The Corporation grants commercial, agricultural, real estate mortgage and consumer loans to customers primarily in the counties of Columbia, Luzerne and Montour, Pennsylvania. It is management's opinion that the loan portfolio was well balanced and diversified at March 31, 2002, 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. 8 (Amounts in thousands, except common share data) Common Common Shares Stock Surplus ______ ______ _______ Balance at January 1, 2002 2,933,727 $5,867 $9,761 Comprehensive Income: Net Income Change in unrealized gain (loss) on investment securities available-for-sale, net of reclassification adjustment and tax effects Total Comprehensive income (loss) Cash dividends - $.21 per share _________ ______ ______ Balance at March 31, 2002 2,933,727 $5,867 $9,761 (Amounts in thousands, except common share data) Accumulated Compre- Other hensive Retained Comprehensive Income Earnings Income (Loss) ________ ________ _____________ Balance at January 1, 2002 $26,450 $ 715 Comprehensive Income: Net Income $1,672 1,672 Change in unrealized gain (loss) on investment securities available-for-sale, net of reclassification adjustment and tax effects (743) (743) ______ Total Comprehensive income (loss) $ 929 ====== Cash dividends - $.21 per share (595) _______ _____ Balance at March 31, 2002 $27,527 $ (28) (Amounts in thousands, except common share data) Treasury Stock Total ______ _____ Balance at January 1, 2002 $(3,097) $39,696 Comprehensive Income: Net Income 1,672 Change in unrealized gain (loss) on investment securities available-for-sale, net of reclassification adjustment and tax effects (743) Total Comprehensive income (loss) Cash dividends - $.21 per share (595) _______ _______ Balance at March 31, 2002 $(3,097) $40,030 NOTE 7. MANAGEMENT'S ASSERTIONS AND COMMENTS REQUIRED TO BE PROVIDED WITH FORM 10Q FILING In management's opinion, the consolidated interim financial statements reflect fair presentation of the consolidated financial position of First Keystone Corporation and Subsidiary, and the results of their operations and their cash flows for the interim periods presented. Further, the consolidated interim financial statements are unaudited; however they reflect all adjustments, which are in the opinion of management, necessary to present fairly the consolidated financial condition and consolidated results of operations and cash flows for the interim periods presented and that all such adjustments to the consolidated financial statements are of a normal recurring nature. The independent accountants, J. H. Williams & Co., LLP, reviewed these consolidated financial statements as stated in their accompanying review report. The results of operations for the three-month period ended March 31, 2002, 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, 2001, filed with the Securities and Exchange Commission. 9 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 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 March 31, 2002, and the related consolidated statements of income and cash flows for the three-month periods ended March 31, 2002, and 2001. These consolidated financial statements are the responsibility of the management of First Keystone Corporation and Subsidiary. We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, 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 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 auditing standards generally accepted in the United States of America, the consolidated balance sheet of First Keystone Corporation and Subsidiary as of December 31, 2001, and the related consolidated statements of income, stockholders' equity, and cash flows for the year then ended (not presented herein); and in our report dated January 10, 2002, 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, 2001, 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 April 23, 2002 10 Item 2. First Keystone Corporation Management's Discussion and Analysis of Financial Condition and Results of Operation as of March 31, 2002 This quarterly report contains certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995), which reflect management's beliefs and expectations based on information currently available. These forward-looking statements are inherently subject to significant risks and uncertainties, including changes in general economic and financial market conditions, the Corporation's ability to effectively carry out its business plans and changes in regulatory or legislative requirements. Other factors that could cause or contribute to such differences are changes in competitive conditions, and pending or threatened litigation. Although management believes the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially. RESULTS OF OPERATIONS First Keystone Corporation realized earnings for the first quarter of 2002 of $1,672,000, an increase of $469,000, or 39.0% over the first quarter of 2001. The increase in net income for the first quarter of 2002 was primarily the result of an increase of $863,000, or 30.6% in net-interest income from reduced deposit costs and an increase in total other income of $34,000, or 7.1%. The widening of our net interest margin resulted in increased net interest income. On a per share basis, net income per share increased to $.59 for the first three months of 2002 compared to $.42 for the first three months of 2001, while dividends increased to $.21 per share up from $.20 in 2001, or an increase of 5.0%. Year-to-date net income annualized amounts to a return on average common equity of 16.21% and a return on assets of 1.70%. For the three months ended March 31, 2001, these measures were 12.87% and 1.30%, 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 first quarter of 2002, interest income amounted to $6,392,000, a decrease of $305,000 or 4.6% over the first quarter of 2001, while interest expense amounted to $2,712,000 in the first quarter of 2002, a decrease of $1,168,000, or 30.1% over the first quarter of 2001. As a result, net interest income increased $863,000, or 30.6% over the first quarter of 2001. Our net interest margin for the quarter ended March 31, 2002, was 4.17% compared to 3.48% for the quarter ended March 31, 2001. PROVISION FOR LOAN LOSSES The provision for loan losses for the quarter ended March 31, 2002, was $175,000, compared to the $100,000 provision for the first quarter of 2001. Net charge-offs totaled $57,000 for the three months ended March 31, 2002, as compared to $154,000 for the first three months of 2001. The allowance for loan losses as a percentage of loans, net of unearned interest, was 1.50% as of March 31, 2002, as compared to 1.47% as of December 31, 2001. NON-INTEREST INCOME Total non-interest income or other income was $515,000 for the quarter ended March 31, 2002, as compared to $481,000 for the quarter ended March 31, 2001, an increase of $34,000, or 7.1%. Excluding investment security gains and losses, non-interest income was $410,000 for the first quarter of 2002, a decrease of $58,000 over the first quarter of 2001. A decrease in service charges on deposit accounts and a decrease in other non-interest income, were the primary reasons for the decrease in non-interest income before security gains. 11 NON-INTEREST EXPENSES Total non-interest expenses, or other expenses, was $1,816,000 for the quarter ended March 31, 2002, as compared to $1,701,000 for the quarter ended March 31, 2001. The increase of $115,000, or 6.8% is comprised of salary and benefits increasing $71,000, occupancy expense decreasing $14,000, and other non-interest expense increasing $58,000. Expenses associated with employees (salaries and employee benefits) continue to be the largest category of non-interest expenses. Salaries and benefits amounted to $1,027,000, or 56.6% of total non-interest expense for the three months ended March 31, 2002, as compared to 56.2% for the first three months of 2001. Other non-interest expenses amounted to $541,000 for the three months ended March 31, 2002, an increase of $58,000, or 12.0% over the first three months of 2001. Even with the increase in our non-interest expense in the first quarter, our overall non-interest expense is less than 2% of average assets on an annualized basis, which places us among the leaders of our peer financial institutions at controlling total non-interest expense. INCOME TAXES Effective tax planning has helped produce favorable net income. The effective total income tax rate was 24.1% for the first quarter of 2002 as compared to 19.6% for the first quarter of 2001. The increase in our effective tax rate in the first quarter of 2002 was due primarily to the limited opportunities to purchase municipal (tax-free investments) securities at relatively attractive interest rates. ANALYSIS OF FINANCIAL CONDITION ASSETS Total assets increased to $395,280,000 as of March 31, 2002, an increase of $1,808,000, or 0.5% over year-end 2001. Total deposits increased to $297,172,000 as of March 31, 2002, an increase of $2,491,000, or 0.8% over year-end 2001. With the increase in total deposits, the Corporation did not increase borrowed funds. Short-term borrowings decreased to $10,555,000 as of March 31, 2002, as compared to $11,566,000 as of December 31, 2001. Long-term borrowings were unchanged from year-end 2001. EARNING ASSETS Our primary earning asset, loans, net of unearned income increased to $202,707,000 as of March 31, 2002, up $4,483,000, or 2.3% since year-end 2001. The loan portfolio continues to be well diversified and overall asset quality remains strong with past-due loans and non-performing assets remaining relatively stable. Our investment portfolio decreased in size from December 31, 2001, to March 31, 2002. Held-to-maturity securities amounted to $6,728,000 as of March 31, 2002, an increase of $219,000 from December 31, 2001. However, available-for-sale securities amounted to $174,397,000 as of March 31, 2002, a decrease of $3,702,000, or 2.1% from year-end 2001. Cash and due from banks, along with interest bearing deposits with banks remained stable as of March 31, 2002, with little change from year-end. 12 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 and general 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 Corporation was required to adopt Financial Accounting Standards Board Statement No. 114, "Accounting by Creditors for Impairment of a Loan" - Refer to Note 5 above for details. NON-PERFORMING ASSETS Non-performing assets consist of non-accrual and restructured loans, other real estate and foreclosed assets, together with loans past-due 90 days or more and still accruing. As of March 31, 2002, total non-performing assets were $1,456,000 as compared to $1,394,000 on December 31, 2001. Non-performing assets to total loans and foreclosed assets was .73% as of March 31, 2002, and .70% as of December 31, 2001. Interest income received on non-performing loans as of March 31, 2002, was $749 compared to $72,382 as of December 31, 2001. Interest income, which would have been recorded on these loans under the original terms as of March 31, 2002, and December 31, 2001, were $28,534 and $93,258, respectively. As of March 31, 2002 and December 31, 2001, 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 $2,491,000 as non-interest bearing deposits increased by $492,000 and interest bearing deposits increased by $1,999,000 as of March 31, 2002, from year-end 2001. Total short-term and long-term borrowings declined by $1,011,000 from year-end 2001. CAPITAL STRENGTH Normal increases in capital are generated by net income, less cash dividends paid out. Also, accumulated other comprehensive income derived from net unrealized losses on investment securities available-for-sale decreased shareholders' equity, or capital, net of taxes by $28,000 as of March 31, 2002. Net unrealized gains on investment securities available for sale increased shareholders' equity by $715,000 as of December 31, 2001. Our stock repurchase plan indicates 100,000 shares being repurchased as of March 31, 2002 and December 31, 2001. This had an effect of our reducing our total stockholders' equity by $3,097,000 as of both March 31, 2002 and December 31, 2001. Total stockholders' equity was $40,030,000 as of March 31, 2002, compared to $39,696,000 as of December 31, 2001. 13 Leverage ratio and risk based capital ratios remain very strong. As of March 31, 2002, our leverage ratio was 10.03% as compared to 9.79% as of December 31, 2001. In addition, Tier 1 risk based capital and total risk based capital ratio as of March 31, 2002, were 15.46% and 16.76%, respectively. The same ratios as of December 31, 2001, were 15.01% and 16.26%, 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, Atlantic Central Bankers Bank, or the Federal Home Loan Bank. 14 PART II - OTHER INFORMATION Item 1. Legal Proceedings None. Item 2. Changes in Securities None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders Annual Meeting of Shareholders of First Keystone Corporation held on Tuesday, April 16, 2002, at 10:00 a.m.

Votes Votes Directors Elected Votes For Against Withheld _________________ _________ ______ _______ Don E. Bower 2,106,444 25,588 0 John L. Coates 2,102,800 29,232 0 Dudley P. Cooley 2,105,869 26,163 0

Broker Directors Elected Abstentions Non-Votes _________________ ___________ _________ Don E. Bower 0 0 John L. Coates 0 0 Dudley P. Cooley 0 0

Directors Continuing: ____________________ Budd L. Beyer, term expires in 2003 Frederick E. Crispin, Jr., term expires in 2003 Jerome F. Fabian, term expires in 2003 Robert J. Wise, term expires in 2003 John Arndt, term expires in 2004 J. Gerald Bazewicz, term expires in 2004 Robert E. Bull, term expires in 2004 Matters Voted Upon: __________________ Selection of J. H. Williams & Co. LLP, as auditors for the Corporation. Votes For - 2,095,838 Votes Against - 26,766 Votes Withheld - 0 Abstentions - 9,428 Broker Non-Votes - 0 Item 5. Other Information None. 15 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 10-Q for the quarter ended March 31, 2001) 3ii By-Laws, as amended (Incorporated by reference to Exhibit 3(ii) to the Registrant's Report on Form 10-Q for the quarter ended March 31, 2001) 10.1 Supplemental Employee Retirement Plan (Incorporated by reference to Exhibit 10 to Registrant's Annual Report on Form 10-K for the year ended December 31, 2000) 10.2 Management Incentive Compensation Plan (Incorporated by reference to Exhibit 10 to Registrant's Report on Form 10-Q for the quarter ended September 30, 2001) 10.3 Profit Sharing Plan (Incorporated by reference to Exhibit 10 to Registrant's Report on Form 10-Q for the quarter ended September 30, 2001) 10.4 First Keystone Corporation 1998 Stock Incentive Plan (Incorporated by reference to Exhibit 10 to Registrant's Report on Form 10-Q for the quarter ended September 30, 2001) 11 Statement RE: Computation of Earnings Per Share. (b) During the quarter ended March 30, 2002, the registrant filed the following reports on Form 8-K: Date of Report Item Description ______________ ____ ___________ April 30, 2002 5 Press release announcing First Quarter Earnings 16 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 May 8, 2002 /s/ J. Gerald Bazewicz J. Gerald Bazewicz President and Chief Executive Officer (Principal Executive Officer) May 8, 2002 /s/ David R. Saracino David R. Saracino Treasurer/Assistant Secretary (Principal Accounting Officer) 17 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 10-Q for the quarter ended March 31, 2001) 3ii By-Laws, as amended (Incorporated by reference to Exhibit 3(ii) to the Registrant's Report on Form 10-Q for the quarter ended March 31, 2001) 9 None. 10.1 Supplemental Employee Retirement Plan (Incorporated by reference to Exhibit 10 to Registrant's Annual Report on Form 10-K for the year ended December 31, 2000) 10.2 Management Incentive Compensation Plan (Incorporated by reference to Exhibit 10 to Registrant's Report on Form 10-Q for the quarter ended September 30, 2001) 10.3 Profit Sharing Plan (Incorporated by reference to Exhibit 10 to Registrant's Report on Form 10-Q for the quarter ended September 30, 2001) 10.4 First Keystone Corporation 1998 Stock Incentive Plan (Incorporated by reference to Exhibit 10 to Registrant's Report on Form 10-Q for the quarter ended September 30, 2001) 11 Compensation of Earning Per Share 18