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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549



---



FORM 10-Q



(Mark One)



|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------



For the quarterly period ended June 30, 2003



OR



| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------



For the transition period from
 to



Commission file number: 333-105899



|KNBT Bancorp, Inc.                                            
|--------------------------------------------------------------
|(Exact Name of Registrant as Specified in Its Charter)        
|                                                              
|Pennsylvania                                                  
|(State or Other Jurisdiction of Incorporation or Organization)
|                                                              
|Route 512 and Highland Avenue                                 
|Bethlehem, Pennsylvania                                       
|(Address of Principal Executive Offices)                      
|                                                              
|(610) 861-5000                                                
|(Registrants Telephone Number, Including Area Code)          



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 ̈No x



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



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 September 25, 2003, no shares of the Registrants common stock were issued and outstanding. *

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|* |  | The issuer became subject to the filing requirements of Sections 13 and 15(d) when its Form S-1 was declared effective by the SEC on August 12, 2003.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

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                            |  | 18  
|                                                                                             | 
|Item 4Controls and Procedures                                                               |  | 18  
|                                                                                             | 
|PART IIOTHER INFORMATION                                                                    |  |     
|                                                                                             | 
|Item 1Legal Proceedings                                                                     |  | 18  
|                                                                                             | 
|Item 2Changes in Securities and Use of Proceeds                                             |  | 18  
|                                                                                             | 
|Item 3Defaults Upon Senior Securities                                                       |  | 18  
|                                                                                             | 
|Item 4Submission of Matters to a Vote of Security Holders                                   |  | 18  
|                                                                                             | 
|Item 5 Other Information                                                                    |  | 18  
|                                                                                             | 
|Item 6Exhibits and Reports on Form 8-K                                                      |  | 19  
|                                                                                             | 
|Signatures                                                                                   |  | 20  





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Keystone Savings Bank and Subsidiary



Consolidated Balance Sheet



June 30, 2003
(Unaudited) and December 31, 2002

(in thousands)



|                                                      |  | June 30, 2003 |           | December 31, 2002
|----------------------------------------------------- |  | ------------- | --------- | -----------------
|                                                      |  | (unaudited)   |           |                  
|ASSETS                                                |  |               |           |                  
|Cash and due from banks                               |  | $             | 12,448    |                  
|Interest-bearing deposits with banks                  |  |               | 39,169    |                  
|                                                      |  |               |           |                  
|Total cash and cash equivalents                       |  |               | 51,617    |                  
|Investment securities available for sale              |  |               | 390,422   |                  
|Federal Home Loan Bank of Pittsburgh stock            |  |               | 8,519     |                  
|Loans receivable, net                                 |  |               | 533,045   |                  
|Mortgage loans held for sale                          |  |               | 24,655    |                  
|Bank owned life insurance                             |  |               | 27,031    |                  
|Premises and equipment, net                           |  |               | 18,084    |                  
|Accrued interest receivable                           |  |               | 5,015     |                  
|Other assets                                          |  |               | 5,005     |                  
|                                                      |  |               |           |                  
|Total assets                                          |  | $             | 1,063,393 |                  
|                                                      |  |               |           |                  
|                                                      |  |              
|LIABILITIES AND RETAINED EARNINGS                     |  |               |           |                  
|Liabilities                                           |  |               |           |                  
|Deposits                                              |  | $             | 814,271   |                  
|Securities sold under agreements to repurchase        |  |               | 9,266     |                  
|Advances from the Federal Home Loan Bank              |  |               | 108,000   |                  
|Advance payments by borrowers for taxes and insurance |  |               | 2,688     |                  
|Accrued interest payable                              |  |               | 816       |                  
|Other liabilities                                     |  |               | 10,881    |                  
|                                                      |  |               |           |                  
|Total liabilities                                     |  |               | 945,922   |                  
|Retained earningssubstantially restricted            |  |               | 111,901   |                  
|Accumulated other comprehensive income                |  |               | 5,570     |                  
|                                                      |  |               |           |                  
|Total retained earnings                               |  |               | 117,471   |                  
|                                                      |  |               |           |                  
|Total liabilities and retained earnings               |  | $             | 1,063,393 |                  
|                                                      |  |               |           |                  





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Keystone Savings Bank and Subsidiary



Consolidated Statements of Income



Three and Six Months Ended June 30, 2003 and 2002

(in thousands)



|                                                               |  | Three Months Ended June 30, |        | Six Months Ended June 30, |     
|-------------------------------------------------------------- |  | --------------------------- | ------ | ------------------------- | ----
|                                                               |  | 2003                        |        |                           | 2002
|                                                               |  | (unaudited)                 |       
|Interest income                                                |  |                             |        |                           |     
|Loans receivable, including amortization of origination fees   |  | $                           | 9,526  |                           |     
|Investment securities                                          |  |                             | 4,005  |                           |     
|Other interest                                                 |  |                             | 47     |                           |     
|                                                               |  |                             |        |                           |     
|Total interest income                                          |  |                             | 13,578 |                           |     
|                                                               |  |                             |        |                           |     
|Interest expense                                               |  |                             |        |                           |     
|Deposits                                                       |  |                             | 3,809  |                           |     
|Advances from the Federal Home Loan Bank                       |  |                             | 1,154  |                           |     
|Other expense                                                  |  |                             | 28     |                           |     
|                                                               |  |                             |        |                           |     
|Total interest expense                                         |  |                             | 4,991  |                           |     
|                                                               |  |                             |        |                           |     
|Net interest income                                            |  |                             | 8,587  |                           |     
|Provision (recovery) for loan losses                           |  |                             | 326    |                           |     
|                                                               |  |                             |        |                           |     
|Net interest income after provision (recovery) for loan losses |  |                             | 8,261  |                           |     
|                                                               |  |                             |        |                           |     
|Noninterest income                                             |  |                             |        |                           |     
|Deposit charges and service fees                               |  |                             | 1,695  |                           |     
|Net gains on sales of investment securities                    |  |                             | 2      |                           |     
|Bank owned life insurance                                      |  |                             | 342    |                           |     
|Net gains (losses) on sales of residential mortgages           |  |                             | 376    |                           |     
|Net gains (losses) on sales of other real estate owned         |  |                             | (14    | )                         |     
|                                                               |  |                             |        |                           |     
|Total noninterest income                                       |  |                             | 2,401  |                           |     
|                                                               |  |                             |        |                           |     
|Noninterest expense                                            |  |                             |        |                           |     
|Compensation and employee benefits                             |  |                             | 3,723  |                           |     
|Occupancy expenses                                             |  |                             | 428    |                           |     
|FDIC insurance premiums                                        |  |                             | 31     |                           |     
|Advertising                                                    |  |                             | 209    |                           |     
|Data processing                                                |  |                             | 489    |                           |     
|Depreciation and amortization                                  |  |                             | 414    |                           |     
|Other                                                          |  |                             | 1,854  |                           |     
|                                                               |  |                             |        |                           |     
|Total noninterest expense                                      |  |                             | 7,148  |                           |     
|                                                               |  |                             |        |                           |     
|Income before income taxes                                     |  |                             | 3,514  |                           |     
|Income taxes                                                   |  |                             | 888    |                           |     
|                                                               |  |                             |        |                           |     
|Net income                                                     |  | $                           | 2,626  |                           |     
|                                                               |  |                             |        |                           |     



See accompanying notes
to consolidated financial statements.



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Keystone Savings Bank and Subsidiary



Consolidated Statement of Retained Earnings



Six Months Ended June 30, 2003 (Unaudited)

(in thousands)



|                                                                          |  | Retainedearnings |         | Accumulatedothercomprehensiveincome (loss) |   | Comprehensiveincome |  | Total
|------------------------------------------------------------------------- |  | ---------------- | ------- | ------------------------------------------ | - | ------------------- |  | -----
|Balance at December 31, 2002                                              |  | $                | 106,326 |                                            | $ | 4,723               |  |      
|Net income                                                                |  |                  | 5,575   |                                            |   |                    |  | $    
|Other comprehensive income, net of reclassification adjustments and taxes |  |                  |        |                                            |   | 847                 |  |      
|                                                                          |  |                  |         |                                            |   |                     |  |      
|Total comprehensive income                                                |  |                  |         |                                            |   |                     |  | $    
|                                                                          |  |                  |         |                                            |   |                     |  |      
|Balance at June 30, 2003                                                  |  | $                | 111,901 |                                            | $ | 5,570               |  |      
|                                                                          |  |                  |         |                                            |   |                     |  |      



See accompanying notes
to consolidated financial statements.



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Keystone Savings Bank and Subsidiary



Consolidated Statements of Cash Flows



Six Months Ended June 30, 2003 and 2002

(in thousands)



|                                                                                                     |  | Six Months Ended June 30, |         
|---------------------------------------------------------------------------------------------------- |  | ------------------------- | --------
|                                                                                                     |  | 2003                      |         
|                                                                                                     |  | (unaudited)               |         
|Operating activities                                                                                 |  |                           |         
|Net income                                                                                           |  |                           |         
|Adjustments to reconcile net income to net cash provided by (used in) operating activities           |  | $                         | 5,575   
|Depreciation and amortization                                                                        |  |                           | 795     
|Amortization of discounts on investment securities, net                                              |  |                           | 1,374   
|Provision for loan losses                                                                            |  |                           | 388     
|Mortgage loans originated for sale                                                                   |  |                           | 22,288  
|Mortgage loan sales                                                                                  |  |                           | (22,928 
|Changes in mortgages held for sale                                                                   |  |                           | (859    
|Net loss (gain) on sale of real estate owned                                                         |  |                           | 35      
|Net loss (gain) on sale investment securities                                                        |  |                           | (2      
|Increase/decrease in accrued interest receivable                                                     |  |                           | (748    
|Increase/decrease in other assets                                                                    |  |                           | (790    
|Increase/decrease in advance payments by borrowers for taxes and insurance                           |  |                           | 405     
|Increase/decrease in other liabilities and accrued interest payable                                  |  |                           | 3,352   
|                                                                                                     |  |                           |         
|Net cash provided by (used in) operating activities                                                  |  |                           | 8,885   
|                                                                                                     |  |                           |         
|Investing activities                                                                                 |  |                           |         
|Proceeds from sales of real estate owned                                                             |  |                           | 337     
|Proceeds from sales of investment securities available for sale                                      |  |                           | 3,050   
|Proceeds from maturities, calls and principal repayments of investment securities available for sale |  |                           | 118,303 
|Purchases of investment securities available for sale                                                |  |                           | (170,716
|Purchases of premises and equipment                                                                  |  |                           | (6,701  
|Purchases of Federal Home Loan Bank of Pittsburgh stock                                              |  |                           | (741    
|Redemption of Federal Home Loan Bank of Pittsburgh stock                                             |  |                           | 233     
|Net increase in loans                                                                                |  |                           | (24,636 
|Purchase of bank-owned life insurance                                                                |  |                           |        
|                                                                                                     |  |                           |         
|Net cash (used in) investing activities                                                              |  |                           | (80,871 
|                                                                                                     |  |                           |         
|Financing activities                                                                                 |  |                           |         
|Net increase in deposits                                                                             |  |                           | 42,448  
|Net increase in repurchase agreements                                                                |  |                           | 362     
|Net advances from (repayment to) the Federal Home Loan Bank                                          |  |                           | (5,500  
|                                                                                                     |  |                           |         
|Net cash provided by financing activities                                                            |  |                           | 37,310  
|                                                                                                     |  |                           |         
|Net increase (decrease) in cash and cash equivalents                                                 |  |                           | (34,676 
|Cash and cash equivalents at beginning of year                                                       |  |                           | 86,293  
|                                                                                                     |  |                           |         
|Cash and cash equivalents at end of year                                                             |  | $                         | 51,617  
|                                                                                                     |  |                           |         
|Supplemental disclosure of cash flow information:                                                    |  |                           |         
|Income Taxes                                                                                         |  | $                         | 2,095   
|                                                                                                     |  |                           |         
|Interest on deposits, advances and borrowed money                                                    |  | $                         | 10,189  
|                                                                                                     |  |                           |         
|Supplemental disclosure of noncash activities                                                        |  |                           |         
|Mortgage loan securitizations                                                                        |  | $                         | 47,251  
|                                                                                                     |  |                           |         
|Reclassifications of loans receivable to other real estate owned                                     |  | $                         | 337     
|                                                                                                     |  |                           |         

See accompanying notes to consolidated financial statements.



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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 is expected to be
consummated in October 2003, at which time the Company will become the holding company for the Bank and issue shares of its common stock to the general public. The Company will own all the outstanding common stock of the Bank upon completion of the
Conversion. Immediately after the completion of the Conversion, the Company expects to merge with First Colonial Group, Inc., the holding company for Nazareth National Bank and Trust Company, which will merge with the Bank. The Company filed a Form
S-1 with the Securities and Exchange Commission (SEC) on June 6, 2003, which, as amended, was declared effective by the SEC on August 12, 2003. The registrant is in organization and has engaged in no operations to date; 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 June 30, 2003 and for the three and six month periods ended June 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.



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KEYSTONE SAVINGS BANK AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(unaudited)



|3. |  | Investment Securities
|-- |  | ---------------------



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



|                                                 |  | June 30, 2003 (unaudited)
|------------------------------------------------ |  | -------------------------
|                                                 |  | Amortized Cost           
|                                                 |  | (in thousands)           
|Available for sale                               |  |                          
|U.S. Government and agencies                     |  | $                        
|Obligations of states and political subdivisions |  |                          
|Asset-managed funds                              |  |                          
|Adjusted rate mortgage portfolio                 |  |                          
|Mortgaged-backed securities:                     |  |                          
|GNMA                                             |  |                          
|FHLMC                                            |  |                          
|FNMA                                             |  |                          
|Other CMOs                                      |  |                          
|                                                 |  |                          
|                                                 |  |                          
|Corporate and other debt securities              |  |                          
|                                                 |  |                          
|                                                 |  | $                        
|                                                 |  |                          
|                                                 | 
|                                                 |  | December 31, 2002        
|                                                 |  | Amortized Cost           
|                                                 |  | (in thousands)           
|Available for sale                               |  |                          
|U.S. Government and agencies                     |  | $                        
|Obligations of states and political subdivisions |  |                          
|Asset-managed funds                              |  |                          
|Adjusted rate mortgage portfolio                 |  |                          
|Mortgaged-backed securities                      |  |                          
|GNMA                                             |  |                          
|FHLMC                                            |  |                          
|FNMA                                             |  |                          
|Other CMOs                                      |  |                          
|                                                 |  |                          
|                                                 |  |                          
|Corporate and other debt securities              |  |                          
|                                                 |  |                          
|                                                 |  | $                        
|                                                 |  |                          



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KEYSTONE SAVINGS BANK AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(unaudited)



|4. |  | Loan Portfolio Composition
|-- |  | --------------------------



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



|                                   |  | June 30,       |         |   | December 31, |  
|---------------------------------- |  | -------------- | ------- | - | ------------ | -
|                                   |  | 2003           |         |   | 2002         |  
|                                   |  | (in thousands) |        
|Real estate                        |  |                |         |   |              |  
|Mortgage                           |  | $              | 332,869 |   |              | $
|Construction                       |  |                | 77,675  |   |              |  
|                                   |  |                |         |   |              |  
|Total real estate loans            |  |                | 410,544 |   |              |  
|Commercial business loans          |  |                | 15,584  |   |              |  
|Consumer loans                     |  |                | 163,429 |   |              |  
|                                   |  |                |         |   |              |  
|Total loans                        |  |                | 589,557 |   |              |  
|Less: Mortgage Loans held for sale |  |                | (24,655 | ) |              |  
|Loans in process                   |  |                | (26,724 | ) |              |  
|Deferred fees                      |  |                | (2,319  | ) |              |  
|Allowance for loan losses          |  |                | (2,814  | ) |              |  
|                                   |  |                |         |   |              |  
|Net loans                          |  | $              | 533,045 |   |              | $
|                                   |  |                |         |   |              |  



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



|                                                 |  | Six Months Ended June 30, |      
|------------------------------------------------ |  | ------------------------- | -----
|                                                 |  | 2003                      |      
|                                                 |  | (in thousands)            |      
|Balance, beginning                               |  | $                         | 2,927
|Provisions charged (recovery made) to operations |  |                           | 388  
|Loans charged off                                |  |                           | (524 
|Recoveries of loans previously charged off       |  |                           | 23   
|                                                 |  |                           |      
|Balance, end                                     |  | $                         | 2,814
|                                                 |  |                           |      





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KEYSTONE SAVINGS BANK AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(unaudited)



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.



|                                                            |  | June 30, 2003          |       |   | December 31, 2002 |  
|----------------------------------------------------------- |  | ---------------------- | ----- | - | ----------------- | -
|                                                            |  | (Dollars in Thousands) |      
|Non-accruing loans:                                         |  |                        |      
|One- to four-family residential                             |  | $                      | 1,431 |   |                   | $
|Multi-family residential                                    |  |                        |      |   |                   |  
|Commercial real estate and land                             |  |                        |      |   |                   |  
|Construction and land development                           |  |                        |      |   |                   |  
|Commercial business                                         |  |                        |      |   |                   |  
|Consumer                                                    |  |                        | 157   |   |                   |  
|                                                            |  |                        |       |   |                   |  
|Total non-accruing loans                                    |  |                        | 1,588 |   |                   |  
|                                                            |  |                        |       |   |                   |  
|Accruing loans 90 days or more past due:                    |  |                        |       |   |                   |  
|One- to four-family residential                             |  |                        |      |   |                   |  
|Multi-family residential                                    |  |                        |      |   |                   |  
|Commercial real estate                                      |  |                        |      |   |                   |  
|Construction and land development                           |  |                        |      |   |                   |  
|Commercial business                                         |  |                        | 15    |   |                   |  
|Consumer                                                    |  |                        |      |   |                   |  
|                                                            |  |                        |       |   |                   |  
|Total accruing loans 90 days or more past due               |  |                        | 15    |   |                   |  
|                                                            |  |                        |       |   |                   |  
|Total non-performing loans(1)                               |  |                        | 1,603 |   |                   |  
|                                                            |  |                        |       |   |                   |  
|Real estate owned, net(2)                                   |  |                        | 400   |   |                   |  
|                                                            |  |                        |       |   |                   |  
|Total non-performing assets                                 |  | $                      | 2,003 |   |                   | $
|                                                            |  |                        |       |   |                   |  
|Total non-performing loans as a percentage of loans, net    |  |                        | 0.30  | % |                   |  
|                                                            |  |                        |       |   |                   |  
|Total non-performing loans as a percentage of total assets  |  |                        | 0.15  | % |                   |  
|                                                            |  |                        |       |   |                   |  
|Total non-performing assets as a percentage of total assets |  |                        | 0.19  | % |                   |  
|                                                            |  |                        |       |   |                   |  

---

|(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.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|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 or includes the conclusions reached by the 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



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KEYSTONE SAVINGS BANK AND SUBSIDIARY



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(unaudited)



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.





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KEYSTONE SAVINGS BANK AND SUBSIDIARY



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS



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.



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



Keystones total assets increased by $47.5 million, or 4.7% to $1.1 billion at June 30, 2003 compared to $1.0 billion at December 31, 2002. The increase in total assets was due primarily to an increase in investment securities which
was partially offset by decreases in cash and cash equivalents and net loans receivable. During the six-months ended June 30, 2003, Keystones investment securities increased by $96.3 million, or 32.7%, to $390.4 million at June 30, 2003
compared to $294.2 million at December 31, 2002. Keystones net loans receivable, including mortgage loans held for sale decreased by $21.6 million, or 3.7%, to $557.7 million at June 30, 2003 compared to $579.3 million at December 31,
2002. Such decrease 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 cash and cash equivalents amounted to $51.6 million at June 30, 2003, a $34.7 million, or 40.2%, decrease from $86.3 million of cash and cash equivalents at December 31,
2002. Such



12



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##### Table of Contents

KEYSTONE SAVINGS BANK AND SUBSIDIARY



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS(Continued)



decrease primarily reflects Keystones purchases of additional investment securities during the six-months ended June 30, 2003.



Keystones deposits increased by $42.4 million, or 5.5%, to $814.3
million at June 30, 2003 compared to December 31, 2002. Federal Home Loan Bank (FHLB) advances and other borrowings decreased by $5.1 million, or 4.2%, to $117.3 million at June 30, 2003 compared to $122.4 million at December 31, 2002.
Keystones retained earnings increased by $6.4 million, or 5.8%, to $117.5 million at June 30, 2003 compared to $111.0 million at December 31, 2002. Such increase in retained earnings was due primarily to $5.6 million in net income for the
six-months ended June 30, 2003.



Keystones net loans
receivable amounted to 52.4% of its total assets at June 30, 2003. At such date, its investment securities, all of which are classified as available for sale, constituted 36.7% of total assets. Keystones ratio of retained earnings to total
assets at June 30, 2003 amounted to 11.0%, and its ratio of total non-performing assets to total assets was 0.19%.



Comparison of Operating Results for the Three and Six Months Ended June 30, 2003 and 2002



General.Keystones net income for the three months ended June 30, 2003 was $2.6 million, relatively constant
with net income for the three months ended June 30, 2002. For the six months ended June 30, 2003, Keystones net income was $5.6 million, a $922,000 or 14.2% decrease from net income of $6.5 million for the six months ended June 30, 2002. The
primary reason for the decrease in the six-month period 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 increased by 14
basis points to 3.30% for the three months ended June 30, 2003 compared to 3.16% for the three months ended June 30, 2002. For the six-months ended June 30, 2003 and 2002, Keystones average interest rate spread was 3.36% and 3.17%,
respectively. The increases in Keystones average interest rate spread were due primarily to a decrease of 112 basis points in Keystones average cost of funds in the respective three-month and six-month periods over the prior year
comparable periods. Keystones net interest margin was 3.53% and 3.48% for the three months ended June 30, 2003 and 2002, respectively, and 3.61% and 3.50% for the six months ended June 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 six-month period ended June 30, 2003 over the prior year comparable periods.



Interest Income. Keystones total interest income was $13.6 million for the three months ended June 30, 2003
compared to $14.7 million for the three months ended June 30, 2002, a $1.1 million or 7.8% decline. For the six months ended June 30, 2003, total interest income was $27.7 million compared to $29.6 million for the six months ended June 30, 2002, a
$1.9 million or 6.5% 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 5.58%
and 5.74% for the three months and six months, respectively, ended June 30, 2003 compared to 6.56% and 6.67% for the respective comparable period in 2002.



Interest Expense. Keystones total interest expense was $5.0 million for the three months ended June 30, 2003 compared to $6.9 million for the
three months ended June 30, 2002, a decrease of $1.9 million or 27.9%. Total interest expense at Keystone was $10.3 million for the six months ended June 30, 2003 compared to $14.1 million for the six months ended June 30, 2002, a $3.8 million or
26.9% 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 2.28% for the three months
ended June 30, 2003 compared to 3.40% for the three months ended June 30, 2002. For the six months ended June 30, 2003, Keystones average rate paid on interest-bearing liabilities was 2.38% compared to 3.50% for the six months ended June 30,
2002.



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##### Table of Contents

KEYSTONE SAVINGS BANK AND SUBSIDIARY



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS(Continued)



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 June 30, |          
|----------------------------------------------------------------------- |  | --------------------------- | ---------
|                                                                        |  | 2003                        |          
|                                                                        |  | Average Balance             |          
|                                                                        |  | (Dollars in Thousands)      |          
|Interest-earning assets:                                                |  |                             |          
|Deposits at other institutions                                          |  | $                           | 45,347   
|Investment securities (1)                                               |  |                             | 387,782  
|Loans receivable (2)                                                    |  |                             | 540,820  
|                                                                        |  |                             |          
|Total interest-earning assets                                           |  |                             | 973,949  
|                                                                        |  |                             |          
|Non-interest-earning assets                                             |  |                             | 68,686   
|                                                                        |  |                             |          
|Total assets                                                            |  |                             | 1,042,635
|                                                                        |  |                             |          
|Interest-bearing liabilities:                                           |  |                             |          
|Deposits:                                                               |  |                             |          
|Savings accounts                                                        |  |                             | 125,966  
|Checking accounts (3)                                                   |  |                             | 91,649   
|Money market accounts                                                   |  |                             | 160,210  
|Certificate accounts                                                    |  |                             | 383,109  
|                                                                        |  |                             |          
|Total deposits                                                          |  |                             | 760,934  
|FHLB advances and other borrowings                                      |  |                             | 115,103  
|                                                                        |  |                             |          
|Total interest-bearing liabilities                                      |  |                             | 876,037  
|                                                                        |  |                             |          
|Non-interest-bearing liabilities:                                       |  |                             |          
|Deposits                                                                |  |                             | 40,538   
|Other                                                                   |  |                             | 9,045    
|                                                                        |  |                             |          
|Total liabilities                                                       |  |                             | 925,620  
|Retained earnings                                                       |  |                             | 117,015  
|                                                                        |  |                             |          
|Total liabilities and retained earnings                                 |  | $                           | 1,042,635
|                                                                        |  |                             |          
|Net interest-earning assets                                             |  | $                           | 97,912   
|                                                                        |  |                             |          
|Net interest income; average interest rate spread                       |  |                             |          
|                                                                        |  |                             |          
|Net interest margin (4)                                                 |  |                             |          
|                                                                        |  |                             |          
|Average interest-earning assets to average interest-bearing liabilities |  |                             |          
|                                                                        |  |                             |          



(Footnotes on next
page)



14



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##### Table of Contents

KEYSTONE SAVINGS BANK AND SUBSIDIARY



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS(Continued)



|                                                                        |  | Six Months Ended June 30, |          
|----------------------------------------------------------------------- |  | ------------------------- | ---------
|                                                                        |  | 2003                      |          
|                                                                        |  | Average Balance           |          
|                                                                        |  | (Dollars in Thousands)    |          
|Interest-earning assets:                                                |  |                           |          
|Deposits at other institutions                                          |  | $                         | 50,062   
|Investment securities (1)                                               |  |                           | 357,982  
|Loans receivable (2)                                                    |  |                           | 558,129  
|                                                                        |  |                           |          
|Total interest-earning assets                                           |  |                           | 966,173  
|                                                                        |  |                           |          
|Non-interest-earning assets                                             |  |                           | 59,460   
|                                                                        |  |                           |          
|Total assets                                                            |  |                           | 1,025,633
|                                                                        |  |                           |          
|Interest-bearing liabilities:                                           |  |                           |          
|Deposits:                                                               |  |                           |          
|Savings accounts                                                        |  |                           | 122,285  
|Checking accounts (3)                                                   |  |                           | 88,725   
|Money market accounts                                                   |  |                           | 156,724  
|Certificate accounts                                                    |  |                           | 385,181  
|                                                                        |  |                           |          
|Total deposits                                                          |  |                           | 752,915  
|FHLB advances and other borrowings                                      |  |                           | 112,972  
|                                                                        |  |                           |          
|Total interest-bearing liabilities                                      |  |                           | 865,887  
|                                                                        |  |                           |          
|Non-interest-bearing liabilities:                                       |  |                           |          
|Deposits                                                                |  |                           | 37,477   
|Other                                                                   |  |                           | 7,352    
|                                                                        |  |                           |          
|Total liabilities                                                       |  |                           | 910,716  
|Retained earnings                                                       |  |                           | 114,917  
|                                                                        |  |                           |          
|Total liabilities and retained Earnings                                 |  | $                         | 1,025,633
|                                                                        |  |                           |          
|Net interest-earning assets                                             |  | $                         | 100,286  
|                                                                        |  |                           |          
|Net interest income; average interest rate spread                       |  |                           |          
|                                                                        |  |                           |          
|Net interest margin (4)                                                 |  |                           |          
|                                                                        |  |                           |          
|Average interest-earning assets to average interest-bearing liabilities |  |                           |          
|                                                                        |  |                           |          

---

|(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.
|--- |  | ----------------------------------------------------------------------



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##### Table of Contents

KEYSTONE SAVINGS BANK AND SUBSIDIARY



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS(Continued)



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 June 30, 2003 vs. Three Months Ended June 30, 2002 |        |   | Six Months Ended June 30, 2003 vs. Six Months Ended June 30, 2002 |  
|------------------------------------------ |  | --------------------------------------------------------------------- | ------ | - | ----------------------------------------------------------------- | -
|                                           |  | Increase (Decrease) Due to                                            |        |   |                                                                   |  
|                                           |  |                                                                       | Total  |   |                                                                   |  
|                                           |  | Rate                                                                  |        |   | Volume                                                            |  
|                                           |  | (In Thousands)                                                        |       
|Interest income:                           |  |                                                                       |        |   |                                                                   |  
|Cash and cash equivalents                  |  | $                                                                     | (107   | ) |                                                                   | $
|Investment securities                      |  |                                                                       | (1,618 | ) |                                                                   |  
|Loans receivable, net                      |  |                                                                       | (354   | ) |                                                                   |  
|                                           |  |                                                                       |        |   |                                                                   |  
|Total interest-earning assets              |  |                                                                       | (2,079 | ) |                                                                   |  
|Interest expense:                          |  |                                                                       |        |   |                                                                   |  
|Savings accounts                           |  |                                                                       | (191   | ) |                                                                   |  
|Checking accounts                          |  |                                                                       | (66    | ) |                                                                   |  
|Money market accounts                      |  |                                                                       | (381   | ) |                                                                   |  
|Certificate accounts                       |  |                                                                       | (1,585 | ) |                                                                   |  
|                                           |  |                                                                       |        |   |                                                                   |  
|Total deposits                             |  |                                                                       | (2,223 | ) |                                                                   |  
|FHLB advances and other borrowings         |  |                                                                       | (75    | ) |                                                                   |  
|                                           |  |                                                                       |        |   |                                                                   |  
|Total interest-bearing liabilities         |  |                                                                       | (2,298 | ) |                                                                   |  
|                                           |  |                                                                       |        |   |                                                                   |  
|Increase (decrease) in net interest income |  | $                                                                     | 219    |   |                                                                   | $
|                                           |  |                                                                       |        |   |                                                                   |  



Provision for Loan
Losses. Keystone made provisions for loan losses of $326,000 for the three months ended June 30, 2003 compared to $197,000 for the three months ended June 30, 2002. For the six months ended June 30, 2003, Keystones provision for loan
losses was $388,000 compared to a $248,000 recovery for the six months ended June 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 June 30, 2003, Keystones total non-performing loans amounted to $1.6 million compared to $1.3 million in non-performing loans at June 30, 2002. Keystones allowance for loan losses was $2.8
million, or 177.2% of total non-performing loans, at June 30, 2003 compared to $2.9 million, or 226.3% of total non-performing loans, at June 30, 2002. Keystones net loan charge-offs amounted to $208,000 and $501,000 for the three months and
six months ended June 30, 2003, respectively, compared to $65,000 and $216,000 for the three months and six months ended June 30, 2002, respectively.





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##### Table of Contents

KEYSTONE SAVINGS BANK AND SUBSIDIARY



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS(Continued)



Other Income. Keystones total non-interest income amounted to $2.4 million for the three
months ended June 30, 2003 compared to $1.7 million for the three months ended June 30, 2002, a $738,000 or 44.4% increase. For the six months ended June 30, 2003, Keystones total non-interest income was $4.6 million compared to $4.3 million
for the six months ended, a $276,000 or 6.4% increase. 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 $7.1 million for the three months ended June 30, 2003 compared to $5.7 million for the three months ended June 30, 2002, a $1.4 million or 25.0% increase. For the six months ended June 30, 2003,
Keystones non-interest expense was $14.1 million compared to $10.9 million for the six months ended June 30, 2002, an increase of $3.2 million or 28.9%. The primary reasons for the increase in Keystones non-interest expenses in the 2003
periods were increases in employee compensation and benefits costs.



Income Tax Expense. Keystones income tax expense was $888,000 for the three months ended June 30, 2003 compared to $949,000 for the three months ended June 30, 2002. Such decrease in Keystones income tax expense reflects
its increased investment in tax advantaged municipal securities as well as increased BOLI income. For the six months ended June 30, 2003, Keystones income tax expense was $2.0 million compared to $2.7 million for the six months ended June 30,
2002. The decrease was due primarily to the decrease in net income as well as the effects of Keystones investments in municipal securities and BOLI.



17



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##### Table of Contents

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 March 31,
2003.



Item 4Controls and Procedures.



Our management evaluated, with the participation of our Senior Executive Vice President and Chief Operating Officer (who is also our acting principal executive officer and principal 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 Senior Executive Vice President and Chief Operating
Officer has 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 31,174,183 shares of common stock were registered solely for the account of the Company. The Conversion has not yet been completed and no
shares have been issued to date.
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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.



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##### Table of Contents

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 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 June 30, 2003.



19



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##### Table of Contents

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: September 25, 2003 |  |  |  | By:               
|                         |  |  |  |                   
|                         |  |  |  |                   





20