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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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(Mark One) FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended June 30, 1996
[_] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ______________ to _______________
Commission File No. 0-26360
FRANKFORT FIRST BANCORP, INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 61-1271129
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
216 W. MAIN STREET, FRANKFORT, KENTUCKY 40602
- ---------------------------------------- ---------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (502) 223-1638
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $.01 per share
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or 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 _____
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
As of September 17, 1996, the aggregate market value of the 2,445,557 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $25.1 million based on the closing sales price of
$10.25 per share of the registrant's Common Stock on September 17, 1996 as
reported on the National Association of Securities Dealers Automated Quotation
National Market. For purposes of this calculation, it is assumed that
directors, officers and beneficial owners of more than 5% of the registrant's
outstanding voting stock are affiliates.
Number of shares of Common Stock outstanding as of September 17, 1996:
3,450,000
DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and the Part of the
Form 10-K into which the document is incorporated:
1. Portions of Annual Report to Stockholders for the Fiscal Year Ended June
30, 1996. (Parts I and II)
2. Portions of Proxy Statement for the 1996 Annual Meeting of Stockholders.
(Part III)
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PART I
ITEM 1. BUSINESS
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GENERAL
THE COMPANY. Frankfort First Bancorp, Inc. (the "Company") was
incorporated under the laws of the State of Delaware in August 1994 at the
direction of the Board of Directors of First Federal Savings Bank of Frankfort
("First Federal" or the "Bank") for the purpose of serving as a savings
institution holding company of First Federal upon the acquisition of all of the
capital stock issued by First Federal upon its conversion from mutual to stock
form (the "Conversion"). The Conversion was completed July 7, 1995, with the
Company issuing 3,450,000 shares of its common stock, par value $.01 per share
(the "Common Stock") to the public, and the Bank issuing all of its issued and
outstanding common stock to the Company. Prior to and since the Conversion, the
Company had not engaged in any material operations. The Company has no
significant assets other than the outstanding capital stock of First Federal,
and a note receivable from the Employee Stock Ownership Plan of the Bank (the
"ESOP"). The Company's principal business is the business of First Federal. At
June 30, 1996, the Company had total assets of $128.5 million, deposits of $87.8
million and shareholder's equity of $34.3 million.
THE BANK. First Federal was originally chartered in 1934 as a Kentucky
chartered building and loan association known as "Greater Frankfort Building and
Loan Association" and was rechartered in 1938 as First Federal Savings and Loan
Association of Frankfort. First Federal has been a member of the Federal Home
Loan Bank ("FHLB") of Cincinnati and its deposits have been federally insured
since 1938. In 1989, First Federal became a federal mutual savings bank and
adopted its current name. First Federal currently operates through three banking
offices located in Frankfort, Kentucky.
First Federal is primarily engaged in the business of attracting
deposits from the general public and originating loans secured by first
mortgages on one-to four-family residences in First Federal's market area. First
Federal also originates, to a lesser extent, church loans, home equity loans and
other loans.
As a federally chartered savings institution, First Federal is subject
to extensive regulation by the OTS. The lending activities and other investments
of First Federal must comply with various federal regulatory requirements, and
the OTS periodically examines First Federal for compliance with various
regulatory requirements. The FDIC also has the authority to conduct special
examinations. First Federal must file reports with the OTS describing its
activities and financial condition and is also subject to certain reserve
requirements promulgated by the Federal Reserve Board. For additional
information, see " -- Regulation of the Bank."
Both the Company's and First Federal's executive offices are located at 216
W. Main Street, Frankfort, Kentucky 40602, and their main telephone number is
(502) 223-1638.
RECENT DEVELOPMENTS
SAIF PREMIUM DISPARITY. The Bank's savings deposits are insured by the
Savings Association Insurance Fund ("SAIF"), which is administered by the
Federal Deposit Insurance Corporation ("FDIC"). The assessment rate currently
ranges from 0.23% of deposits for well capitalized institutions to 0.31% of
deposits for undercapitalized institutions.
The FDIC also administers the Bank Insurance Fund ("BIF"), which has the
same designated reserve ratio as the SAIF. On August 8, 1995, the FDIC adopted
an amendment to the BIF risk-based assessment schedule which lowered the deposit
insurance assessment rate for most commercial banks and other depository
institutions with deposits insured by the BIF to a range of from 0.31% of
insured deposits for undercapitalized BIF-insured institutions to 0.04% of
deposits for well-capitalized institutions, which constitute over 90% of BIF-
insured institutions. The FDIC amendment became effective September 30, 1995. On
November 14, 1995, the BIF assessment rate schedule
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was further revised to a statutory minimum of $2,000 annually for well
capitalized institutions to 0.27% of deposits for undercapitalized institutions.
These revisions to the BIF assessment rate schedule created a substantial
disparity in the deposit insurance premiums paid by BIF and SAIF members and
placed SAIF-insured savings institutions such as the Bank at a significant
competitive disadvantage to BIF-insured institutions.
A number of proposals have been considered to recapitalize the SAIF in
order to eliminate the premium disparity. The Senate and the House of
Representatives have both, as part of a budget reconciliation package to balance
the federal budget, approved legislation requiring a one time assessment of an
amount sufficient to bring the SAIF to a level equal to 1.25% of insured
deposits (originally estimated to be up to approximately 0.85% of insured
deposits) to be imposed on all SAIF-insured deposits held as of March 31, 1995.
This assessment was originally scheduled to be payable during the first quarter
of 1996. It is unknown whether this legislation will be enacted, or if enacted,
the amount of such special assessment. It is currently estimated that a special
assessment of between 67 and 71 basis points would be required to fully
recapitalize the SAIF. If a special assessment equal to 71 basis points were to
be required, it would result in a one-time after-tax charge of up to
approximately $410,000. Such assessment would have the effect of reducing the
Bank's tangible and core capital to $32.0 million, or 25.0%, of adjusted total
assets, and risk-based capital to $32.1 million, or 51.0%, of risk-weighted
assets as of June 30, 1996. If such a special assessment were required and the
SAIF as a result was fully recapitalized, it could have the effect of reducing
the Bank's deposit insurance premiums to the SAIF, thereby increasing net
earnings in future periods.
BAD DEBT RECAPTURE. On August 20, 1996, the President signed into law
the Small Business Jobs Protection Act. Included within this act were provisions
repealing the percentage of taxable income method of calculating a thrift's bad
debt reserve for tax purposes. This method had permitted thrift institutions,
such as the Bank, who satisfied certain definitional tests and other conditions
prescribed by the Internal Revenue Code to deduct an annual addition to their
bad debt reserve calculated as a percentage of taxable income. Other financial
institutions generally were required to calculate their bad debt deduction based
upon actual loss experience (the "experience method"). As a result of the
elimination of the percentage of taxable income method, institutions that have
utilized such method will be required to recapture into taxable income post-1987
reserves in excess of the reserves calculated under the experience method, over
a period of six years commencing in the first taxable year beginning after
December 31, 1995. An institution will be able to defer recapture until up to
the third taxable year after December 31, 1995 if the dollar amount of the
institution's residential loan originations in each year is not less than the
average dollar amount of residential loan originations originated in each of the
six most recent years disregarding the years with the highest and lowest
originations during such period. For purposes of this test, residential loan
originations would not include refinancings and home equity loans.
Beginning with the first taxable year beginning after December 31,
1995, savings institutions, such as the Bank, will be treated the same as
commercial banks. Institutions with $500 million or more in assets will only be
able to take a tax deduction when a loan is actually charged off. Institutions
with less than $500 million in assets will still be permitted to make deductible
bad debt additions to reserves, but only using the experience method. The Bank
has provided deferred taxes on its post-1987 additions to the bad debt reserve
and, and a result, management does not expect that the recapture of the Bank's
post-1987 reserves will have a material adverse effect on the Bank's operations.
LENDING ACTIVITIES
General. First Federal's principal lending activity consists of the
origination of loans secured by first mortgages on owner occupied one- to four-
family residences in the Bank's lending area, which is limited to the Kentucky
Counties of Franklin, Anderson, Scott, Shelby and Woodford. First Federal
formerly made loans secured by property in Owen and Henry Counties, but has
since discontinued such lending unless the loan-to-value ratio of the loan is
50% or less. First Federal also originates loans secured by nonowner occupied
one- to four-family homes, loans secured by churches, home equity lines of
credit, second mortgages and share loans. Additionally, First Federal
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offers financing for the construction of single family, owner occupied homes in
Franklin County. Such financing is available only for, and made directly to, the
homeowners.
Beginning in the early 1980s management of the Bank has sought to
build a rate sensitive loan portfolio and to manage First Federal's interest
rate risk by emphasizing the origination of adjustable rate mortgage loans with
an initial fixed term of one, three or five years. During the period from 1983
to 1993, the Bank offered only adjustable rate mortgages. Beginning in September
1993, the Bank began offering fixed-rate mortgages, some of which are fully or
partially funded with advances from the FHLB of Cincinnati with similar
maturities. Management believes that the yields and fees provided by these loan
products are greater than what the Bank could earn on investment securities with
similar risks and maturities purchased in the market.
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Loan Portfolio Composition. The following table sets forth selected
data relating to the composition of First Federal's loan portfolio by type of
loan at the dates indicated. At June 30, 1996, First Federal had no
concentrations of loans exceeding 10% of total loans that are not otherwise
disclosed below.
<TABLE>
<CAPTION>
At June 30,
------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
----------------- ----------------- ---------------- ---------------- ----------------
Amount % Amount % Amount % Amount % Amount %
-------- ------- -------- ------- ------- ------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Type of Loan:
- ------------
Real estate loans --
Construction loans............... $ 672 .6% $ 270 .3% $ 568 .6% $ 45 .1% $ -- -- %
One- to four-family residential.. 103,944 93.7 94,816 94.0 92,861 94.0 87,450 94.1 82,280 93.7
Multi-family residential......... 123 .1 134 .1 148 .2 342 .3 669 .8
Other loans (1).................. 1,450 1.3 1,549 1.6 1,580 1.6 1,322 1.4 1,082 1.2
Consumer loans --
Savings account loans............ 547 .5 618 .6 584 .6 635 .7 679 .8
Home equity lines of credit...... 4,182 3.8 3,449 3.4 3,044 3.0 3,161 3.4 3,066 3.5
-------- ------ -------- ------ ------- ------ ------- ------ ------- ------
110,918 100.00% 100,836 100.00% 98,785 100.00% 92,955 100.00% 87,776 100.00%
====== ====== ====== ====== ======
Less:
Loans in process................. 392 123 448 -- --
Discounts, deferred loan fees
and other...................... 100 28 38 57 52
Loan loss reserve................ 95 83 71 59 47
-------- -------- ------- ------- -------
Total......................... $110,331 $100,602 $98,228 $92,839 $87,677
======== ======== ======= ======= =======
</TABLE>
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(1) Represents primarily church loans.
5
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The following table sets forth certain information at June 30, 1996
regarding the dollar amount of loans maturing in the Bank's portfolio based on
their contractual terms to maturity. Demand loans, loans having no stated
schedule of repayments and no stated maturity, and overdrafts are reported as
due in one year or less.
<TABLE>
<CAPTION>
Due after Due after Due after
3 through 5 through 10 through Due after 15
Due during the year ending 5 years after 10 years after 15 years after years after
June 30, June 30, June 30, June 30, June 30,
--------------------------
1997 1998 1999 1996 1996 1996 1996 Total
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<S> <C> <C> <C> <C> <C> <C> <C> <C>
(In thousands)
Real estate loans:
Construction loans........ $ 672 $ -- $ -- $ -- $ -- $ -- $ -- $ 672
One- to four-family....... 3,863 3,989 4,088 8,647 24,482 25,425 33,450 103,944
Multi-family residential.. 12 13 14 31 53 -- -- 123
Other loans................ 105 111 116 225 431 336 126 1,450
Consumer loans:
Savings account loans..... 547 -- -- -- -- -- -- 547
Home equity lines of
credit................... -- 28 231 661 3,262 -- -- 4,182
------ ------ ------ ------ ------- ------- --------- --------
Total.................... $5,199 $4,141 $4,449 $9,564 $28,228 $25,761 $33,576 $110,918
====== ====== ====== ====== ======= ======= ========= ========
</TABLE>
The following table sets forth at June 30, 1996, the dollar amount of
all loans due more than one year after June 30, 1996 which have predetermined
interest rates and have floating or adjustable interest rates.
Predetermined Floating or
Rate Adjustable Rates
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(In thousands)
Real estate loans:
One- to four-family residential.. $13,277 $86,804
Multi-family residential......... -- 111
Other loans...................... 268 1,077
Consumer loans:
Home equity lines of credit...... -- 4,182
Savings account loans............ -- --
------- -------
Total........................... $13,545 $92,174
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Scheduled contractual principal repayments of loans do not necessarily
reflect the actual life of such assets. The average life of long-term loans is
substantially less than their contractual terms, due to prepayments. The average
life of mortgage loans tends to increase when current mortgage loan market rates
are substantially higher than rates on existing mortgage loans and tends to
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.
Originations of Loans. The following table sets forth certain
information with respect to First Federal's loan originations during the periods
indicated. The increase in loans originated in fiscal 1996 was primarily the
result of lower prevailing interest rates during the period and the Bank's
consistent offering of fixed-rate mortgages.
Year Ended June 30,
-----------------------------------
1996 1995 1994
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(In thousands)
Originations
Real estate loans:
One- to four-family........... $27,903 $15,655 $28,349
Multi-family.................. -- -- 20
Other......................... 190 163 493
Construction loans............ 915 1,109 885
Consumer loans:
Home equity line of credit.... 2,844 2,619 1,887
Savings account loans......... 361 497 605
------- ------- -------
Total........................ $32,213 $20,043 $32,239
======= ======= =======
The Bank has not in recent years purchased or sold any loans, with the
exception of one participation interest in a single family home in the Bank's
market area. The Bank does not expect to make any purchases or sales of loans
in the foreseeable future.
One- to Four-Family Residential Lending and Second Mortgage Loans.
The Bank historically has been and continues to be an originator of owner
occupied, one- to four-family residential properties located in its market area.
At June 30, 1996, approximately $103.9 million, or 93.7% of the Bank's loan
portfolio consisted of loans secured by one- to four-family residential
properties which were primarily owner-occupied, single family residences.
First Federal began originating adjustable rate residential mortgage
loans in the early 1980s. Since that time, most one- to four-family mortgage
loans originated by the Bank have been adjustable rate loans with an initial
fixed term of one, three, or five years. After the initial term, the rate
adjustments on the Bank's adjustable rate loans are indexed to the National
Average Contract Interest Rate for Major Lenders on the Purchase of Previously
Occupied Homes ("NACR"). The interest rates on these mortgages are adjusted
once a year, with limitations on adjustments of one percentage point per
adjustment period, and a lifetime cap of five percentage points.
At June 30, 1996, the Bank's loan portfolio included $89.9 million in
adjustable rate one- to four-family residential mortgage loans, or 81.1% of the
Bank's loan portfolio.
The retention of adjustable rate loans in First Federal's portfolio
helps reduce First Federal's exposure to increases in prevailing market interest
rates. However, there are unquantifiable credit risks resulting from potential
increases in costs to borrowers in the event of upward repricing of adjustable
rate loans. It is possible that during periods of rising interest rates, the
risk of default on adjustable rate loans may increase due to increases in
interest costs to borrowers. Further, although adjustable rate loans allow
First Federal to increase the sensitivity of its interest-earning assets to
changes in interest rates, the extent of this interest sensitivity is limited by
the initial fixed rate period before the first adjustment and the periodic and
lifetime interest rate adjustment limitations. Accordingly, there can be no
assurance that yields on First Federal's adjustable rate loans will fully adjust
to compensate for
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increases in First Federal's cost of funds. Finally, adjustable rate loans
increase First Federal's exposure to decreases in prevailing market interest
rates, although decreases in First Federal's cost of funds tend to offset this
effect.
In general, First Federal originates residential mortgage loans with
loan-to-value ratios of up to 90%, with private mortgage insurance required for
loans with loan-to-value ratios greater than 80%. In March 1993, the Bank
established a low down payment program pursuant to which it now offers financing
for the purchase of single-family owner occupied homes with loan-to-value ratios
of up to 95%. These loans, however, are limited to properties located in
Franklin County and to homes with sales prices of $80,000 or less.
The Bank also originates second mortgage loans if the Bank holds the
first mortgage on the property. Although these loans are secured by a lien on
the borrower's primary residence, they differ from the Bank's traditional first
mortgage loans in that the terms of these loans are substantially shorter than
25 years (generally 120 months or less). All of such loans are underwritten to
a maximum of 80% loan to value ratio and all are fully amortizing.
Church and Other Nonresidential Real Estate Lending. First Federal
has also been active in originating loans secured by churches located in the
Bank's primary market area. These loans have loan-to-value ratios of 75%, and
are originated as adjustable rate loans based on the same index as the Bank's
one-to-four family real estate mortgage loans. At June 30, 1996, the Bank had
16 church loans aggregating approximately $1.4 million. In the past the Bank
offered small commercial loans secured by property located in its market area.
The Bank has been inactive in this type of lending in recent years and at June
30, 1996 had approximately $25,000 of these loans still outstanding.
Construction Lending. In October 1992 First Federal began to offer
single family residential construction loans to qualified borrowers for
construction of single-family owner occupied residences in Franklin County. At
June 30, 1996, single-family residential construction loans constituted
$672,000, or 0.6%, of First Federal's total loans. First Federal limits its
construction lending to loans to individuals building their primary residences.
These loans generally have rates that are fixed for six months and are
underwritten in accordance with the same standards as First Federal's mortgages
on existing properties, except the loans generally provide for disbursement in
stages during a construction period of up to six months, during which period the
borrower is required to make monthly payments of accrued interest on the
outstanding loan balance. Construction loans have a maximum loan-to-value ratio
of 80%. Borrowers must satisfy all credit requirements which would apply to
First Federal's permanent mortgage loan financing for the subject property. The
Bank's construction loans may be refinanced into permanent loans upon completion
of the construction.
Construction financing is considered to involve a higher degree of
risk of loss than long-term financing on improved, occupied real estate. Risk
of loss on a construction loan is dependent largely upon the accuracy of the
initial estimate of the property's value at completion of construction and the
estimated cost (including interest) thereof. During the construction phase, a
number of factors could result in delays and cost overruns. If the estimate of
construction costs proves to be inaccurate, First Federal may be required to
advance funds beyond the amount originally committed to permit completion of the
project. If the estimate of value proves to be inaccurate, First Federal may be
confronted, at or prior to the maturity of the loan, with a project having a
value which is insufficient to assure full repayment. First Federal has sought
to minimize this risk by limiting construction lending to qualified borrowers in
Franklin County and by limiting the number of outstanding construction loans.
Consumer Lending. The consumer loans originated by the Bank include
home equity lines of credit, and loans secured by savings deposits.
At June 30, 1996, the Bank's consumer loan balance totaled $4.7
million, or 4.3% of its total loan portfolio. Of the consumer loan balance at
June 30, 1996, 88.4% were home equity loans and 11.6% were loans secured by
savings deposits at the Bank.
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The Bank's home equity loans are made on the security of residential
real estate which have terms of up to 10 years. Most of the Bank's home equity
loans do not exceed 80% of the estimated value of the property, less the
outstanding principal of the first mortgage. In May 1995, the Bank began
offering home equity loans up to 90% of the value, less the balance of the first
mortgage. The amount of the principal of the loan above 80% of the estimated
value of the property is not insured by private mortgage insurance. The Bank's
home equity loans require the monthly payment of 2% of the unpaid principal
until maturity, when the remaining unpaid principal, if any, is due. The Bank's
home equity loans bear variable rates of interest indexed to the prime rate for
loans with 80% or less loan to value ratio, and 2% above the prime rate for
loans with a loan to value ratio in excess of 80%. Interest rates on these
loans can be adjusted monthly. At June 30, 1996, the total outstanding home
equity loans amounted to $4.2 million, or 3.8% of the Bank's total loan
portfolio.
The Bank makes savings account loans for up to 90% of the depositor's
savings account balance. The interest rate is normally one percentage point
above the rate paid on the savings account, and the account must be pledged as
collateral to secure the loan. At June 30, 1996, loans on savings accounts
totalled $547,000, or 0.5% of the Bank's total loan portfolio.
Consumer loans generally entail greater risk than do residential
mortgage loans, particularly in the case of consumer loans which are unsecured
or secured by rapidly depreciable assets. These risks are considerably reduced
in the case of First Federal, since all of the Bank's consumer loans are home
equity lines of credit or savings account loans.
Loan Solicitation and Processing. First Federal's loan originations
are derived from a number of sources, including referrals by realtors,
depositors and borrowers, as well as walk-in customers. First Federal's
solicitation programs consist of advertisements in local media, in addition to
occasional participation in home buying seminars and open house events sponsored
by local realtors. Real estate loans are originated by First Federal's salaried
staff loan officers.
Upon receipt of a loan application from a prospective borrower, a
credit report and verifications are ordered to verify specific information
relating to the loan applicant's employment, income credit standing and any
deposit to be used for a down payment. It is First Federal's policy to obtain
an appraisal of the real estate intended to secure a proposed mortgage loan from
an independent fee appraiser approved by First Federal. Appraisals are
generally required on all purchase loans, all loans to refinance another lender,
all loans to refinance First Federal's loans when the existing appraisal is more
than five years old and the loan amount does not exceed regulatory limits, and
other loans at the loan committee's discretion. A panel of qualified appraisers
are approved by the Board annually, and management selects appraisers for
specific jobs. Certain Bank employees perform inspections for construction
financing and for transactions that do not require a full appraisal. Except
when First Federal becomes aware of a particular risk of environmental
contamination, First Federal generally does not obtain a formal environmental
report on the real estate at the time a loan is made.
The Bank makes a 30-day loan commitment for each loan approved. The
rate is guaranteed for the period of 14 days following approval. If the borrower
desires a longer commitment, the commitment may be extended at a cost of 0.1% of
the loan balance per month for up to three months. The rate is subject to
change during this extended commitment. In the case of construction loans, a
commitment is also made for the permanent financing to be funded no later than
182 days from the date of the closing of the construction loan. The interest
rate on permanent financing is not guaranteed until closing of the permanent
loan.
The Bank's loan committee analyzes a completed application and may
approve or deny the loan if the loan is $150,000 or less and the property is a
one or two family dwelling. Loans that do not conform to these criteria must be
submitted to the Board of Directors for approval.
9
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It is First Federal's policy to record a lien on the real estate
securing a loan. The Bank does not require title insurance unless the attorney
who provides the title opinion cannot or will not certify the title as clear and
marketable. The Bank requires fire and casualty insurance on all security
properties and flood insurance where the collateral property is located in a
designated flood hazard area. The Bank also requires an earthquake provision in
all policies for new loans. A Bank employee is designated to constantly review
and update insurance files.
Loans to One Borrower. Under applicable law, with certain limited
exceptions, loans and extensions of credit by a savings association to a person
outstanding at one time shall not exceed 15% of the association's unimpaired
capital and surplus. Loans and extensions of credit fully secured by readily
marketable collateral may comprise an additional 10% of unimpaired capital and
surplus. Applicable law additionally authorizes savings institutions to make
loans to one borrower, for any purpose, in an amount not to exceed $500,000 or
in an amount not to exceed the lesser of $30,000,000 or 30% of unimpaired
capital and surplus to develop residential housing, provided (1) the purchase
price of each single-family dwelling in the development does not exceed
$500,000, (2) the savings institution is and continues to be in compliance with
its fully phased-in regulatory capital requirements, (3) the loans comply with
applicable loan-to-value requirements, (4) the aggregate amount of loans made
under this authority does not exceed 150% of unimpaired capital and surplus, and
(5) the Director of OTS, by order, permits the savings association to avail
itself of this higher limit. Under these limits, the Bank's loans to one
borrower were limited to $4.9 million at June 30, 1996, though the Bank's Board-
imposed internal limit is $1.0 million. At that date, the Bank had no lending
relationships in excess of the OTS's loans-to-one-borrower limit.
Interest Rates and Loan Fees. Interest rates charged by First Federal
on mortgage loans are primarily determined by competitive loan rates offered in
its market area and First Federal's yield objectives. Mortgage loan rates
reflect factors such as prevailing market interest rate levels, the supply of
money available to the savings industry and the demand for such loans. These
factors are in turn affected by general economic conditions, the monetary
policies of the federal government, including the Board of Governors of the
Federal Reserve System (the "Federal Reserve Board"), the general supply of
money in the economy, tax policies and governmental budget matters.
First Federal receives fees in connection with late payments and for
miscellaneous services related to its loans. First Federal typically receives
fees of one point (one point being equivalent to 1% of the principal amount of
the loan) in connection with the origination of construction loans. Depending
on the type of loan produced and the competitive environment for mortgage loans,
the Bank may charge an origination fee on all or some of the loans it
originates.
Asset Classification, Allowances for Losses and Non-Performing Assets.
Federal regulations require savings institutions to classify their assets on the
basis of quality on a regular basis. An asset is classified as substandard if
it is determined to be inadequately protected by the current net worth and
paying capacity of the obligor or of the collateral pledged, if any. An asset
is classified as doubtful if full collection is highly questionable or
improbable. An asset is classified as loss if it is considered uncollectible,
even if a partial recovery could be expected in the future. The regulations
also provide for a special mention designation, described as assets which do not
currently expose a savings institution to a sufficient degree of risk to warrant
classification but do possess credit deficiencies or potential weaknesses
deserving management's close attention. Assets classified as substandard or
doubtful require a savings institution to establish general allowances for loan
losses. If an asset or portion thereof is classified loss, a savings
institution must either establish a specific allowance for loss in the amount of
the portion of the asset classified loss, or charge off such amount. Federal
examiners may disagree with a savings institution's classifications. If a
savings institution does not agree with an examiner's classification of an
asset, it may appeal this determination to the OTS Regional Director. First
Federal regularly reviews its assets to determine whether any assets require
classification or re-classification. The Board of Directors reviews and
approves all classifications. At June 30, 1996, First Federal had no assets
classified as loss, doubtful or substandard. At June 30, 1996, assets
designated as special mention totalled $99,000.
Management will continue to actively monitor First Federal's asset
quality and will establish loan loss reserves and will charge off loans and
properties acquired in settlement of loans against the allowances for losses
10
<PAGE>
on such loans and such properties when appropriate and will provide specific
loss allowances when necessary. Although management believes it uses the best
information available to make determinations with respect to the allowances for
losses, future adjustments may be necessary if economic conditions differ
substantially from the economic conditions in the assumptions used in making the
initial determinations.
First Federal's methodology for establishing the allowance for losses
takes into consideration probable losses that have been identified in connection
with specific assets as well as losses that have not been identified but can be
expected to occur. Management conducts regular reviews of First Federal's
assets and evaluates the need to establish allowances on the basis of this
review. Allowances are established by the Board of Directors on a quarterly
basis based on an assessment of risk in First Federal's assets taking into
consideration the composition and quality of the portfolio, delinquency trends,
current charge-offs and loss experience, the state of the real estate market,
regulatory reviews conducted in the regulatory examination process and economic
conditions generally. Allowances will be provided for individual assets, or
portions of assets, when ultimate collection is considered improbable by
management based on the current payment status of the assets and the fair value
or net realizable value of the security. At the date of foreclosure or other
repossession, First Federal would transfer the property to real estate acquired
in settlement of loans at the lower of cost or fair value. Any portion of the
outstanding loan balance in excess of fair value would be charged off against
the allowance for loan losses. If, upon ultimate disposition of the property,
net sales proceeds exceed the net carrying value of the property, a gain on sale
of real estate would be recorded. Any losses realized on sale would be charged
to the allowance for loan losses on real estate acquired through foreclosure.
The Bank has not experienced any such losses in recent years.
Historically, management has emphasized the Bank's loss experience
over other factors in establishing a provision for loan losses. The Bank has
had no non-accruing loans and no loans charged off during the last five years.
Further, in the last five years, the Bank has not experienced a loss on the
disposition of foreclosed property. During the fiscal year ended June 30, 1992,
management determined, in accordance with its discussions with regulatory
examiners, that factors in addition to historical loan experience should be
considered in determining reasonably estimable loan losses. Accordingly, the
Bank established a provision for loan losses in the amount of $47,000 in that
year, and added $12,000 to its allowance in fiscal years 1993, 1994, 1995 and
1996.
In December 1993 the banking regulatory agencies, including the OTS,
adopted a policy statement regarding maintenance of an adequate allowance for
loan and lease losses and an effective loan review system. This policy includes
an arithmetic formula for checking the reasonableness of an institution's
allowance for loan loss estimate compared to the average loss experience of the
industry as a whole. Examiners will review an institution's allowance for loan
losses and compare it against the sum of (i) 50% of the portfolio that is
classified doubtful; (ii) 15% of the portfolio that is classified as
substandard; and (iii) for the portions of the portfolio that have not been
classified (including those loans designated as special mention), estimated
credit losses over the upcoming twelve months given the facts and circumstances
as of the evaluation date. This amount is considered neither a "floor" nor a
"safe harbor" of the level of allowance for loan losses an institution should
maintain, but examiners will view a shortfall relative to the amount as an
indication that they should review management's policy on allocating these
allowances to determine whether it is reasonable based on all relevant factors.
The following table sets forth an analysis of First Federal's
allowance for loan losses for the periods indicated. As indicated above, First
Federal has had no loans charged off during these periods.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period............. $ 83 $ 71 $ 59 $ 47 $ --
Provision for loan losses.................. 12 12 12 12 47
----- ----- ----- ----- -----
Balance at end of period................... $ 95 $ 83 $ 71 $ 59 $ 47
===== ===== ===== ===== =====
</TABLE>
11
<PAGE>
The following table allocates the allowance for loan losses by asset
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
June 30,
--------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
--------------------- ------------------- -------------------- ------------------- ---------------------
Percent of Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in Loans in
Category to Category to Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans
-------- ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate - mortgage:
Residential.............. $89 93.8% $78 94.1% $67 94.2% $56 94.4% $44 94.5%
Commercial............... 1 1.3 2 1.6 1 1.6 1 1.4 1 1.2
Real estate - construction. 1 0.6 -- 0.3 1 .6 -- .1 -- --
Consumer................... 4 4.3 3 4.0 2 3.6 2 4.1 2 4.3
--- ----- --- ----- --- ----- --- ----- --- -----
Total allowance for loan
losses.................... $95 100.0% $83 100.0% $71 100.0% $59 100.0% $47 100.0%
=== ===== === ===== === ===== === ===== === =====
</TABLE>
12
<PAGE>
Numerous financial institutions throughout the United States have incurred
losses in recent years due to significant increases in loss provisions and
charge-offs resulting largely from higher levels of loan delinquencies and
foreclosures. Depressed real estate market conditions have adversely affected
the economies of various regions and have had a severe impact on the financial
condition and businesses of many of the financial institutions doing business in
these areas. Considerable uncertainty exists as to the future improvement or
deterioration of the real estate markets in these regions, or of its ultimate
impact on these financial institutions.
As a result of declines in real estate market values and significant losses
experienced by many financial institutions, there has been a greater level of
scrutiny by regulatory authorities of the loan portfolios of financial
institutions undertaken as part of examinations of such institutions by the
FDIC, OTS or other federal or state regulators. Results of recent examinations
indicate that these regulators may be applying more conservative criteria in
evaluating real estate market values, requiring significantly increased
provisions for losses on loans and real estate acquired in settlement of such
loans. While management believes First Federal has established its existing loan
loss allowances in accordance with generally accepted accounting principles,
there can be no assurance that regulators, in reviewing First Federal's assets,
will not make First Federal increase its loan loss allowance, thereby negatively
affecting First Federal's reported financial condition and results of
operations.
The following table sets forth information with respect to First Federal's
non-performing assets at the dates indicated. At these dates, First Federal did
not have any non-accrual loans or any restructured loans within the meaning of
SFAS No. 15. All loans 90 days or more past due are secured by residential
property for all periods in the table below.
<TABLE>
<CAPTION>
At June 30,
----------------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Accruing loans which are contractually
past due 90 days or more.............. $ 118 $ 34 $ 213 $ 272 $ 568
Percentage of total loans............... .11% .03% .20% .30% .70%
Percentage of total assets.............. .09% .02% .19% .26% .55%
</TABLE>
At June 30, 1996, the Bank had no loans which were not already classified
as non-accrual, 90 days past due or restructured where known information about
possible credit problems of borrowers caused management to have serious concerns
as to the ability of the borrowers to comply with present loan repayment terms.
INVESTMENT ACTIVITIES
First Federal is permitted under federal law to make certain investments,
including investments in securities issued by various federal agencies and state
and municipal governments, deposits at the FHLB of Cincinnati, certificates of
deposits in federally insured institutions, certain bankers' acceptances and
federal funds. First Federal may also invest, subject to certain limitations, in
commercial paper having one of the two highest investment ratings of a
nationally recognized credit rating agency, and certain other types of corporate
debt securities and mutual funds. Federal regulations require First Federal to
maintain an investment in FHLB of Cincinnati stock and a minimum amount of
liquid assets which may be invested in cash and specified securities. From time
to time, the OTS adjusts the percentage of liquid assets which savings
associations are required to maintain. For additional information, see " --
Regulation of the Bank -- Liquidity Requirements."
13
<PAGE>
First Federal makes investments in order to diversify its assets, manage
cash flow, obtain yield and maintain the minimum levels of liquid assets
required by regulatory authorities. The Bank currently maintains an investment
portfolio consisting primarily of deposits in other financial institutions and
U.S. Government agency issues. Investment decisions generally are made by First
Federal's Investment Committee and approved by the Board of Directors. In the
future, the Investment Committee may consider other investment options and
investment strategies, including but not limited to FHLB Certificates of
Deposit, U.S. Treasury issues, U.S. Government agency issues, and mortgage-
backed securities.
First Federal has the ability and it is management's intention to hold the
Bank's investment securities to maturity. Therefore, First Federal carries these
securities at cost, adjusted for amortization of premiums and accretion of
discounts on a method which approximates the interest method over the term of
the security.
The following table sets forth the carrying value of the First Federal's
investment portfolio and FHLB stock at the dates indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------------------
1996 1995 1994
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Investment securities:
State and municipal obligations...................... $ 100 $ 101 $ 101
Interest-earning deposits and certificates of deposit.. 5,873 38,680 10,929
U.S. Government agency issues.......................... 8,772 -- --
FHLB stock............................................. 1,078 990 994
-------- -------- --------
Total investments................................. $ 15,823 $ 39,771 $ 12,024
======== ======== ========
</TABLE>
14
<PAGE>
The following table sets forth information regarding the scheduled
maturities, market value and weighted average yields for First Federal's
investments, excluding FHLB stock, at June 30, 1996.
<TABLE>
<CAPTION>
At June 30, 1996
---------------------------------------------------------------
One Year or Less One to Five Years Five to Ten Years
------------------- ------------------- -------------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Investment securities:
State and municipal
obligations.................... $ -- -- % $ 100 6.24% $ -- -- %
U.S. Government agency
issues......................... 3,005 5.79 4,772 5.69 995 6.64
Interest-earning deposits
and certificates of deposit....... 5,873 5.12 -- -- -- --
-------- -------- --------
Total.......................... $ 8,878 $ 4,872 $ 995
======== ======== ========
<CAPTION>
------------------------------------------------------
More than Ten Years Total Investment Portfolio
------------------- ------------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
-------- ------- -------- ------ -------
<S> <C> <C> <C> <C> <C>
Investment securities:
State and municipal
obligations.................... $ -- -- % $ 100 $ 100 6.24%
U.S. Government agency
issues......................... -- -- 8,772 8,711 5.83
Interest-earning deposits
and certificates of deposit....... -- -- 5,873 5,873 5.12
-------- -------- -------
Total..........................
$ -- $ 14,745 $14,684
======== ======== =======
</TABLE>
For additional information, see Note A-2 of the Notes to Consolidated
Financial Statements included in the Company's 1996 Annual Report to
Stockholders (the "Annual Report") which is attached as Exhibit 13 hereto.
15
<PAGE>
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
General. Deposits are the primary source of First Federal's funds for
lending and other investment purposes. In addition to deposits, First Federal
derives funds from loan principal repayments, interest payments and maturing
investments. Loan repayments and interest payments are a relatively stable
source of funds, while deposit inflows and outflows are significantly influenced
by prevailing market interest rates and money market conditions. Borrowings may
be used to supplement First Federal's available funds, and from time to time
First Federal has borrowed funds from the FHLB of Cincinnati.
Deposits. First Federal attracts deposits principally from within its
market area by offering a variety of deposit instruments, including passbook
accounts, money market accounts, retirement savings accounts, checking accounts
and certificates of deposit which range in term from three to 120 months.
Deposit terms vary, principally on the basis of the minimum balance required,
the length of time the funds must remain on deposit and the interest rate.
First Federal's policies are designed primarily to attract deposits from
local residents through First Federal's branch network rather than from outside
First Federal's market area. First Federal does not accept deposits from brokers
due to their rate sensitivity. First Federal's interest rates, maturities,
service fees and withdrawal penalties on deposits are established by management
on a periodic basis. Management determines deposit interest rates and maturities
based on First Federal's liquidity requirements, the rates paid by First
Federal's competitors, First Federal's growth goals and applicable regulatory
restrictions and requirements.
Savings deposits in First Federal at June 30, 1996 were represented by the
various types of savings programs described below.
<TABLE>
<CAPTION>
Interest Minimum Minimum Balance in Percentage of
Rate (1) Term Category Amount Thousands Total Savings
- -------- ------- -------- ------- ---------- -------------
<C> <S> <C> <C> <C> <C>
3.00% None Passbook $ 100 $ 11,165 12.72%
3.00 None Christmas Savings N/A 209 0.24
2.87 None NOW 300 1,445 1.65
3.10 None Golden 50 300 1,437 1.64
3.08 None SuperNOW 1,000 743 0.85
3.48 None MMDA 1,000 6,185 7.05
-- None Non Interest-Bearing 300 379 0.43
------- ------
21,563 24.58
Certificates of Deposit
-----------------------
4.13 91-Days Fixed Term, Fixed Rate 500 2,021 2.30
4.89 182-Days Fixed-Term, Fixed Rate 500 8,785 10.01
5.39 9-month Fixed-Term, Fixed Rate 100 1,046 1.19
5.36 12-month Fixed-Term, Fixed Rate 500 12,770 14.55
6.83 18-month Fixed-Term, Fixed Rate 500 1,344 1.53
5.72 24-month Fixed-Term, Fixed Rate 500 8,000 9.11
6.16 30-month Fixed-Term, Fixed Rate 500 605 0.69
5.26 36-month Fixed-Term, Fixed Rate 500 7,644 8.71
5.44 60-month Fixed-Term, Fixed Rate 500 3,036 3.46
6.80 72-month Fixed-Term, Fixed Rate 500 399 0.45
5.38 12-month Variable IRA 100 6,349 7.23
4.85 12-month Fixed-Term, Variable Rate 500 1,304 1.49
6.62 24-month(2) Fixed Term, Variable Rate 500 12,767 14.54
3.40 Varies Other N/A 144 0.16
------- ------
66,214 75.42
------- ------
$87,777 100.00%
======= ======
</TABLE>
_________________
(1) Represents weighted average interest rate.
(2) Account holder has a one-time option to increase the interest rate to the
rate offered by the Bank on a new 24-month Certificate of Deposit.
16
<PAGE>
The following table sets forth the change in dollar amount of deposits in
the various types of accounts offered by First Federal between the dates
indicated.
<TABLE>
<CAPTION>
Balance at Balance at Balance at
June 30, % of Increase June 30, % of Increase June 30, % of
1996 Deposits (Decrease) 1995 Deposits (Decrease) 1994 Deposits
--------- -------- ---------- ---------- -------- ---------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Passbook................... $ 11,165 12.72% $ (35,007)(1) $ 46,172 38.79% $ 30,972(2) $ 15,200 17.06%
Statement savings.......... -- -- (88) 88 0.07 (85) 173 0.19
Christmas savings.......... 209 0.24 (16) 225 0.19 (7) 232 0.26
NOW........................ 1,445 1.65 41 1,404 1.18 371 1,033 1.16
Golden 50.................. 1,437 1.64 163 1,274 1.07 (716) 1,990 2.23
SuperNOW................... 743 0.85 263 480 0.40 (374) 854 0.96
MMDA....................... 6,185 7.05 (26) 6,211 5.22 (1,610) 7,821 8.78
Non interest-bearing....... 379 0.43 340 39 0.03 12 27 0.03
--------- ------ ---------- ---------- ------ ------- --------- -------
21,563 24.58 (34,330) 55,893 46.95 28,563 27,330 30.67
Certificates of Deposit
- -----------------------
Fixed-Term, Fixed-Rate:
91-days................... 2,021 2.30 (974) 2,995 2.52 1,021 1,974 2.22
182-days.................. 8,785 10.01 465 8,320 6.99 (2,212) 10,532 11.82
9-month................... 1,046 1.19 1,046 -- -- -- -- --
12-month.................. 12,770 14.55 1,197 11,573 9.72 (3,569) 15,142 16.99
18-month.................. 1,344 1.53 71 1,273 1.07 1,273 -- --
24-month.................. 8,000 9.11 56 7,944 6.67 (2,330) 10,274 11.53
30-month.................. 605 0.69 (33) 638 0.54 638 -- --
36-month.................. 7,644 8.71 414 7,230 6.07 (1,506) 8,736 9.80
60-month.................. 3,036 3.46 163 2,873 2.41 (159) 3,032 3.40
72-month.................. 399 0.45 (107) 506 0.43 (948) 1,454 1.63
Variable IRA (12-month).... 6,349 7.23 216 6,133 5.15 (1,600) 7,733 8.68
Fixed-Term, Variable-Rate
(12 month)................ 1,304 1.49 (461) 1,765 1.48 (803) 2,568 2.88
Fixed-Term, Variable-Rate
(24 month)................ 12,767 14.54 1,088 11,679 9.81 11,679 -- --
IRA fixed rate (30 month).. -- -- -- -- -- (24) 24 0.03
Fixed-Term, Fixed-Rate
(8-year).................. -- -- (5) 5 0.01 (122) 127 0.14
Fixed-Term, Fixed-Rate
(4-year).................. -- -- (15) 15 0.01 (174) 189 0.21
Other...................... 144 0.16 (55) 199 0.17 199 -- --
--------- ------ ---------- ---------- ------ ------- --------- -------
66,214 75.42 3,066 63,148 53.05 1,363 61,785 69.33
--------- ------ ---------- ---------- ------ ------- --------- -------
Total.................... $ 87,777 100.00% $ 31,264 $ 119,041 100.00% $29,926 $ 89,115 100.00%
========= ====== ========== ========== ====== ======= ========= =======
</TABLE>
____________________
(1) Decrease represents in part funds used for purchase of shares in the
Conversion.
(2) Increase represents in part funds received for purchase of shares in the
Conversion.
17
<PAGE>
The following table sets forth the average balances and interest rates
based on month-end balances for interest-bearing demand deposits and time
deposits as of the dates indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------------------------------------------
1996 1995 1994
--------------------- --------------------- ---------------------
Interest- Interest- Interest-
Bearing Bearing Bearing
Demand Time Demand Time Demand Time
Deposits Deposits Deposits Deposits Deposits Deposits
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Average balance.......... $ 13,805 $ 63,656 $ 10,455 $ 62,184 $ 10,984 $ 63,108
Average rate............. 3.06% 5.64% 3.16% 4.96% 3.26% 4.51%
</TABLE>
The following table sets forth the time deposits in First Federal
classified by rates at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
-----------------------------
1996 1995 1994
------ ------ ------
(In thousands)
<S> <C> <C> <C>
2 - 3.99%............... $ 135 $ 217 $20,725
4 - 5.99%............... 46,122 41,111 37,605
6 - 7.99%............... 19,795 21,447 2,152
8 - 9.99%............... 162 319 983
10.00 - 11.99%.......... -- 54 320
------- ------- -------
$66,214 $63,148 $61,785
======= ======= =======
</TABLE>
The following table sets forth the amount and maturities of time deposits
in First Federal at June 30, 1996.
<TABLE>
<CAPTION>
Amount Due
-------------------------------------------------
Less Than After
Rate One Year 1-2 Years 2-3 Years 3 Years Total
- ---- --------- --------- --------- ------- -------
(In thousands)
<S> <C> <C> <C> <C> <C>
2 - 3.99%........ $ -- $ -- $ 85 $ 50 $ 135
4 - 5.99%........ 36,502 6,113 3,101 406 46,122
6 - 7.99%........ 15,867 2,661 893 374 19,795
8 - 9.99%........ 82 78 2 -- 162
--------- --------- --------- ------- -------
$ 52,451 $ 8,852 $ 4,081 $ 830 $66,214
========= ========= ========= ======= =======
</TABLE>
18
<PAGE>
The following table indicates the amount of the certificates of deposit of
$100,000 or more in First Federal by time remaining until maturity at June 30,
1996.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- ------------
(In thousands)
<S> <C>
Three months or less................ $ 646
More than three through six months.. 612
More than six through 12 months..... 2,889
Over 12 months...................... 1,578
------
Total......................... $5,725
======
</TABLE>
The following table sets forth the deposit activities of First Federal for
the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------
1996 1995 1994
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Beginning balance........................ $119,041 $ 89,115 $ 88,736
Deposits................................. 62,402 74,935 36,097
Withdrawals.............................. 96,507 47,920 38,358
-------- -------- --------
Net increase (decrease) before interest
credited............................... (34,105) 27,015 (2,261)
Interest credited........................ 2,841 2,911 2,640
-------- -------- --------
Net increase (decrease) in deposits...... (31,264) 29,926 379
-------- -------- --------
Ending balance........................... $ 87,777 $119,041 $ 89,115
======== ======== ========
</TABLE>
Borrowings. Savings deposits historically have been the primary source of
funds for First Federal's lending, investment and general operating activities.
First Federal is authorized, however, to use advances from the FHLB of
Cincinnati to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. The FHLB of Cincinnati functions as a central reserve
bank providing credit for savings institutions and certain other member
financial institutions. As a member of the FHLB system, First Federal is
required to own stock in the FHLB of Cincinnati and is authorized to apply for
advances. Advances are made pursuant to several different programs, each of
which has its own interest rate and range of maturities. Advances from the FHLB
of Cincinnati are secured by a portion of First Federal's mortgage loan
portfolio. At June 30, 1996, First Federal had $5.0 million in advances
outstanding from the FHLB of Cincinnati. In recent years First Federal has not
utilized borrowings from the FHLB of Cincinnati, except for occasional FHLB
short-term advances to ensure compliance with liquidity requirements. However,
in connection with its decision to originate fixed rate mortgage loans in 1993,
First Federal began to obtain advances from the FHLB in order to fund such
loans. The advances from the FHLB have interest rates ranging from 6.16% to
6.69%, and have maturity dates between fiscal years 2004 and 2016.
On May 31, 1996, the Company borrowed $500,000 from the Farmers Bank of
Frankfort, Kentucky. These funds were used for general corporate purposes
including the payment of dividends. The loan was repaid in full on July 23,
1996.
19
<PAGE>
The following table sets forth certain information regarding the borrowings
outstanding of the Company and the Bank at the dates and for the periods
indicated.
<TABLE>
<CAPTION>
At or for the
Year Ended June 30,
-------------------------
1996 1995
-------- --------
(Dollars in thousands)
<S> <C> <C>
Amounts outstanding at end of period:
FHLB advances......................................... $ 4,998 $ 4,416
Other loans........................................... 500 --
-------- --------
Total................................................ 5,498 4,416
Weighted average rate paid on:
FHLB advances......................................... 6.33% 6.28%
Other loans........................................... 8.25% -- %
</TABLE>
<TABLE>
<CAPTION>
At or for the
Year Ended June 30,
-------------------------
1996 1995
-------- --------
(Dollars in thousands)
<S> <C> <C>
Maximum amount of borrowings outstanding
at any month end:
FHLB advances......................................... $ 5,044 $ 4,716
Other loans........................................... 500 --
</TABLE>
<TABLE>
<CAPTION>
For the
Year Ended June 30,
-------------------------
1996 1995
-------- --------
(Dollars in thousands)
<S> <C> <C>
Approximate average short-term borrowings outstanding
with respect to:
FHLB advances......................................... $ -- $ --
Other loans........................................... 42 --
Approximate weighted average rate paid on: (1)
FHLB advances......................................... 6.23% 6.32%
Other loans........................................... 8.25% --
</TABLE>
_______________________
(1) Weighted average computed by dividing total interest paid by average
balance outstanding.
As of June 30, 1996, First Federal could borrow up to an additional $27.1
million from the FHLB of Cincinnati. As of June 30, 1996, the Bank had $5.0
million in advances outstanding. Further asset growth may be funded through
additional advances.
20
<PAGE>
MARKET AREA
First Federal currently conducts its business through three banking offices
located in the City of Frankfort, Kentucky, which is located in the bluegrass
region of central Kentucky in Franklin County and which is about 50 miles east
of Louisville and 30 miles west of Lexington. The Bank's primary lending area
includes the Kentucky Counties of Franklin, Anderson, Scott, Shelby and
Woodford, with the majority of lending being originated on properties located in
Franklin County.
Based on the 1990 census, Franklin County has a population of approximately
44,000, of which approximately 26,000 live within the city of Frankfort, which
serves as the capital of Kentucky. The primary employer in the area is the state
government, which employs about 30% of the work force. In addition, there are
several large industrial, financial and government employers in the community.
Due to this large, relatively stable source of employment, there has been little
fluctuation in the unemployment rate of about 4% in recent years, which has been
consistently among the lowest in Kentucky.
COMPETITION
First Federal faces strong competition for deposits and loans. First
Federal's principal competitors for deposits are other banking institutions,
such as commercial banks and credit unions, as well as mutual funds and other
investments. First Federal principally competes for deposits by offering a
variety of deposit accounts, convenient business hours and branch locations,
customer service and a well trained staff. First Federal competes for loans with
other depository institutions, as well as specialty mortgage lenders and brokers
and consumer finance companies. First Federal principally competes for loans on
the basis of interest rates and the loan fees it charges, the types of loans it
originates and the convenience and service it provides to borrowers. In
addition, First Federal believes it has developed strong relationships with the
businesses, realtors, builders and general public in its market area. Despite
First Federal's small size relative to the many and various other depository and
lending institutions in its market area, First Federal usually ranks first with
respect to the origination of single family purchase mortgages made on
properties located in Franklin County. Nevertheless, the level of competition in
the Bank's market area has limited to a certain extent the lending opportunities
in the area.
EMPLOYEES
As of June 30, 1996, First Federal had 25 full-time and no part-time
employees, none of whom was represented by a collective bargaining agreement.
REGULATION OF THE COMPANY
GENERAL. The Company is registered as a savings and loan holding company
within the meaning of the Home Owners' Loan Act, as amended ("HOLA") with the
OTS and subject to OTS regulations, examinations, supervision and reporting
requirements. As a subsidiary of a savings and loan holding company, the Bank is
subject to certain restrictions in its dealings with the Company and affiliates
thereof.
ACTIVITIES RESTRICTIONS. The Board of Directors of the Company presently
operates the Company as a unitary savings and loan holding company. There are
generally no restrictions on the activities of a unitary savings and loan
holding company. However, if the Director of OTS determines that there is
reasonable cause to believe that the continuation by a savings and loan holding
company of an activity constitutes a serious risk to the financial safety,
soundness, or stability of its subsidiary savings association, the Director of
OTS may impose such restrictions as deemed necessary to address such risk
including limiting: (i) payment of dividends by the savings institution, (ii)
transactions between the savings institution and its affiliates; and (iii) any
activities of the savings institution that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings institution. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
institution subsidiary of such a holding company fails to meet the Qualified
Thrift Lender
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("QTL") Test, then such unitary holding company shall also presently become
subject to the activities restrictions applicable to multiple holding companies
and unless the savings association requalifies as a QTL within one year
thereafter, register as, and become subject to, the restrictions applicable to a
bank holding company. See "Regulation of the Bank -- Qualified Thrift Lender
Test."
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
Test, the activities of the Company and any of its subsidi aries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings institution may commence or
continue for a limited period of time after becoming a multiple savings and loan
holding company or subsidiary thereof, any business activity, upon prior notice
to, and no objection by the OTS, other than (i) furnishing or performing
management services for a subsidiary savings institution, (ii) conducting an
insurance agency or escrow business, (iii) holding, managing, or liquidating
assets owned by or acquired from a subsidiary savings institution, (iv) holding
or managing properties used or occupied by a subsidiary savings institution, (v)
acting as trustee under deeds of trust, (vi) those activities previously
directly authorized by regulation as of March 5, 1987 to be engaged in by
multiple holding companies or (vii) those activities authorized by the Federal
Reserve Board as permissible for bank holding companies, unless the Director of
OTS by regulation prohibits or limits such activities for savings and loan
holding companies. Those activities described in (vii) above must also be
approved by the Director of OTS prior to being engaged in by a multiple holding
company.
TRANSACTIONS WITH AFFILIATES. Transactions between savings institutions
and any affiliate are governed by Sections 23A and 23B of the Federal Reserve
Act. An affiliate of a savings institution is any company or entity which
controls, is controlled by or is under common control with the savings
institution. In a holding company context, the parent holding company of a
savings institution (such as the Company) and any companies which are controlled
by such parent holding company are affiliates of the savings institution.
Generally, Sections 23A and 23B (i) limit the extent to which the savings
institution or its subsidiaries may engage in "covered transactions" with any
one affiliate to an amount equal to 10% of such institution's capital stock and
surplus, and contain an aggregate limit on all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus, and (ii)
require that all such transactions be on terms substantially the same, or at
least as favorable, to the institution or subsidiary as those provided to a non-
affiliate. The term "covered transaction" includes the making of loans, purchase
of assets, issuance of a guarantee and similar other types of transactions. In
addition to the restrictions imposed by Sections 23A and 23B, no savings
institution may (i) loan or otherwise extend credit to an affiliate, except for
any affiliate which engages only in activities which are permissible for bank
holding companies, or (ii) purchase or invest in any stocks, bonds, debentures,
notes or similar obligations of any affiliate, except for affiliates which are
subsidiaries of the savings institution.
Savings institutions are also subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act on loans to executive officers,
directors and principal stockholders. Under Section 22(h), loans to an executive
officer and to a greater than 10% stockholder of a savings institution, and
certain affiliated entities of either, may not exceed, together with all other
outstanding loans to such person and affiliated entities the institution's loan
to one borrower limit (generally equal to 15% of the institution's unimpaired
capital and surplus and an additional 10% of such capital and surplus for loans
fully secured by certain readily marketable collateral). Section 22(h) also
prohibits loans, above amounts prescribed by the appropriate federal banking
agency, to directors, executive officers and greater than 10% stockholders of a
savings institution, and their respective affiliates, unless such loan is
approved in advance by a majority of the board of directors of the institution
with any "interested" director not participating in the voting. The Federal
Reserve Board has prescribed the loan amount (which includes all other
outstanding loans to such person), as to which such prior board of director
approval is required, as being the greater of $25,000 or 5% of capital and
surplus (up to $500,000). Further, the Federal Reserve Board pursuant to Section
22(h) requires that loans to directors, executive officers and principal
stockholders be made on terms substantially the same as offered
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in comparable transactions to other persons. Section 22(h) also generally
prohibits a depository institution from paying the overdrafts of any of its
executive officers or directors.
Savings institutions are also subject to the requirements and restrictions
of Section 22(g) of the Federal Reserve Act and Regulation O on loans to
executive officers and the restrictions of 12 U.S.C. (S) 1972 on certain tying
arrangements and extensions of credit by correspondent banks. Section 22(g) of
the Federal Reserve Act requires that loans to executive officers of depository
institutions not be made on terms more favorable than those afforded to other
borrowers, requires approval for such extensions of credit by the board of
directors of the institution, and imposes reporting requirements for and
additional restrictions on the type, amount and terms of credits to such
officers. Section 1972 prohibits (i) a depository institution from extending
credit to or offering any other services, or fixing or varying the consideration
for such extension of credit or service, on the condition that the customer
obtain some additional service from the institution or certain of its affiliates
or not obtain services of a competitor of the institution, subject to certain
exceptions, and (ii) extensions of credit to executive officers, directors, and
greater than 10% stockholders of a depository institution by any other
institution which has a correspondent banking relationship with the institution,
unless such extension of credit is on substantially the same terms as those
prevailing at the time for comparable transactions with other persons and does
not involve more than the normal risk of repayment or present other unfavorable
features.
RESTRICTIONS ON ACQUISITIONS. The HOLA generally prohibits savings and
loan holding companies from acquiring, without prior approval of the Director of
OTS, (i) control of any other savings institution or savings and loan holding
company or substantially all the assets thereof, or (ii) more than 5% of the
voting shares of a savings institution or holding company thereof which is not a
subsidiary. Under certain circumstances, a registered savings and loan holding
company is permitted to acquire, with the approval of the Director of OTS, up to
15% of the voting shares of an under-capitalized savings institution pursuant to
a "qualified stock issuance" without that savings institution being deemed
controlled by the holding company. In order for the shares acquired to
constitute a "qualified stock issuance," the shares must consist of previously
unissued stock or treasury shares, the shares must be acquired for cash, the
savings and loan holding company's other subsidiaries must have tangible capital
of at least 6-1/2% of total assets, there must not be more than one common
director or officer between the savings and loan holding company and the issuing
savings institution and transactions between the savings institution and the
savings and loan holding company and any of its affiliates must conform to
Sections 23A and 23B of the Federal Reserve Act. Except with the prior approval
of the Director of OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may also acquire control of any savings institution, other
than a subsidiary savings institution, or of any other savings and loan holding
company.
The Director of OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if: (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office in the state of the institution to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by state-chartered institutions or savings and loan holding companies
located in the state where the acquiring entity is located (or by a holding
company that controls such state-chartered savings institutions).
The OTS regulations permit federal associations to branch in any state or
states of the United States and its territories. Except in supervisory cases or
when interstate branching is otherwise permitted by state law or other statutory
provision, a federal association may not establish an out-of-state branch unless
(i) the federal association qualifies as a "domestic building and loan
association" under (S)7701(a)(19) of the Code and the total assets attributable
to all branches of the association in the state would qualify such branches
taken as a whole for treatment as a domestic building and loan association and
(ii) such branch would not result in (a) formation of a prohibited multi-state
multiple savings and loan holding company or (b) a violation of certain
statutory restrictions on branching by savings association subsidiaries of
banking holding companies. Federal associations generally may not establish
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new branches unless the association meets or exceeds minimum regulatory capital
requirements. The OTS will also consider the association's record of compliance
with the Community Reinvestment Act of 1977 in connection with any branch
application.
Under the Bank Holding Company Act of 1956, bank holding companies are
specifically authorized to acquire control of any savings association. Pursuant
to rules promulgated by the Federal Reserve Board, owning, controlling or
operating a savings institution is a permissible activity for bank holding
companies, if the savings institution engages only in deposit-taking activities
and lending and other activities that are permissible for bank holding
companies. A bank holding company that controls a savings institution may merge
or consolidate the assets and liabilities of the savings institution with, or
transfer assets and liabilities to, any subsidiary bank which is a member of the
BIF with the approval of the appropriate federal banking agency and the Federal
Reserve Board. The resulting bank will be required to continue to pay
assessments to the SAIF at the rates prescribed for SAIF members on the deposits
attributable to the merged savings institution plus an annual growth increment.
In addition, the transaction must comply with the restrictions on interstate
acquisitions of commercial banks under the Bank Holding Company Act.
REGULATION OF THE BANK
GENERAL. As a federally chartered savings institution, First Federal is
subject to extensive regulation by the OTS. The lending activities and other
investments of First Federal must comply with various state and federal
regulatory requirements. The OTS periodically examines the Bank for compliance
with various regulatory requirements. The FDIC also has the authority to conduct
special examinations of the Bank because its deposits are insured by the SAIF.
The Bank must file reports with these agencies describing its activities and
financial condition. The Bank is also subject to certain reserve requirements
promulgated by the Federal Reserve Board. This supervision and regulation is
intended primarily for the protection of depositors. Certain of these regulatory
requirements are referred to below or appear elsewhere herein.
REGULATORY CAPITAL REQUIREMENTS. Under OTS capital standards, savings
associations must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3.0% of adjusted total assets and a combination
of core and "supplementary" capital equal to 8.0% of "risk-weighted" assets. In
addition, the OTS has recently adopted regulations which impose certain
restrictions on savings associations that have a total risk-based capital ratio
that is less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of
less than 4.0% or a ratio of Tier 1 capital to adjusted total assets of less
than 4.0% (or 3.0% if the institution is rated Composite 1 under the OTS
examination rating system). See "-- Prompt Corrective Regulatory Action." For
purposes of this regulation, Tier 1 capital has the same definition as core
capital which is defined as common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Core capital is generally reduced by the amount of the savings
association's intangible assets for which no market exists. Limited exceptions
to the deduction of intangible assets are provided for purchased mortgage
servicing rights and qualifying supervisory goodwill. Tangible capital is given
the same definition as core capital but does not include an exception for
qualifying supervisory goodwill and is reduced by the amount of all the savings
association's intangible assets with only a limited exception for purchased
mortgage servicing rights and purchased credit card relationships. Both core and
tangible capital are further reduced by an amount equal to a gradually
increasing percentage of the savings association's debt and equity investments
in subsidiaries engaged in activities not permissible to national banks other
than subsidiaries engaged in activities undertaken as agent for customers or in
mortgage banking activities and subsidiary depository institutions or their
holding companies. At June 30, 1996, First Federal had no such investments.
Adjusted total assets are a savings association's total assets as
determined under generally accepted accounting principles, adjusted for certain
goodwill amounts and increased by a pro rated portion of the assets of
subsidiaries in which the savings association holds a minority interest and
which are not engaged in activities for which the capital rules require
deduction of its debt and equity investments as well as a pro rated portion of
the
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assets of other subsidiaries for which deduction is not fully required under
phase-in rules. Adjusted total assets are reduced by the amount of assets that
have been deducted from capital, the portion of the savings association's
investments in subsidiaries that must be netted against capital under the
capital rules and, for purposes of the core capital requirement, qualifying
supervisory goodwill.
In determining compliance with the risk-based capital requirement, a
savings association is allowed to use both core capital and supplementary
capital provided the amount of supplementary capital used does not exceed the
savings association's core capital. Supplementary capital is defined to include
certain preferred stock issues, nonwithdrawable accounts and pledged deposits
that do not qualify as core capital, certain approved subordinated debt, certain
other capital instruments and a portion of the savings association's general
loss allowances. Total core and supplementary capital are reduced by the amount
of capital instruments held by other depository institutions pursuant to
reciprocal arrangements and, after July 1, 1990, by an increasing percentage of
the savings association's high loan-to-value ratio land loans and nonresidential
construction loans and equity investments other than those deducted from core
and tangible capital. At June 30, 1996, the Bank had no high ratio land or
nonresidential construction loans and had no equity investments for which OTS
regulations require deduction from total capital.
The risk-based capital requirement is measured against risk-weighted assets
which equal the sum of each asset and the credit-equivalent amount of each off-
balance sheet item after being multiplied by an assigned risk weight. Under the
OTS risk-weighting system, one- to four-family first mortgages not more than 90
days past due with loan-to-value ratios under 80% are assigned a risk weight of
50%. Consumer and residential construction loans are assigned a risk weight of
100%. Mortgage-backed securities issued, or fully guaranteed as to principal and
interest, by the FHLMC are assigned a 20% risk weight. Cash and U.S. Government
securities backed by the full faith and credit of the U.S. Government are given
a 0% risk weight.
The table below presents the Bank's capital position relative to its
various regulatory capital requirements at June 30, 1996.
<TABLE>
<CAPTION>
Percent of
Amount Assets (1)
--------- ------------
(Dollars in thousands)
<S> <C> <C>
Tangible capital....................... $32,373 25.20%
Tangible capital requirement........... 1,927 1.50
------- -----
Excess............................... $30,446 23.70%
======= =====
Core capital........................... $32,373 25.20%
Core capital requirement............... 3,854 3.00
------- -----
Excess............................... $28,519 22.20%
======= =====
Risk-based capital..................... $32,468 51.62%
Risk-based capital requirement......... 5,032 8.00
------- -----
Excess............................... $27,436 43.62%
======= =====
Tier 1 capital......................... $32,373 25.20%
Tier 1 capital requirement............. 5,138 4.00
------- -----
Excess............................... $27,235 21.20%
======= =====
Tier 1 risk-based capital.............. $32,468 51.62%
Tier 1 risk-based capital requirement.. 2,516 4.00
------- -----
Excess............................... $29,952 47.62%
======= =====
</TABLE>
- --------------------
(1) Based upon adjusted total assets for purposes of the tangible, core and
Tier 1 capital requirements, and risk-weighted assets for purposes of the
risk-based capital requirements.
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The OTS has adopted an amendment to its risk-based capital requirements
that requires savings institutions with more than a "normal" level of interest
rate risk to maintain additional total capital. A savings institution's
interest rate risk is measured in terms of the sensitivity of its "net portfolio
value" to changes in interest rates. Net portfolio value is defined, generally,
as the present value of expected cash inflows from existing assets and off-
balance sheet contracts less the present value of expected cash outflows from
existing liabilities. A savings institution will be considered to have a
"normal" level of interest rate risk exposure if the decline in its net
portfolio value after an immediate 200 basis point increase or decrease in
market interest rates (whichever results in the greater decline) is less than
two percent of the current estimated economic value of its assets. A savings
institution with a greater than normal interest rate risk is required to deduct
from total capital, for purposes of calculating its risk-based capital
requirement, an amount (the "interest rate risk component") equal to one-half
the difference between the institution's measured interest rate risk and the
normal level of interest rate risk, multiplied by the economic value of its
total assets.
The OTS calculates the sensitivity of a savings institution's net portfolio
value based on data submitted by the institution in a schedule to its quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS. The amount of the interest rate risk component, if any, to
be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier. Savings
institutions with less than $300 million in assets and a risk-based capital
ratio above 12% are generally exempt from filing the interest rate risk schedule
with their Thrift Financial Reports. However, the OTS will require any exempt
savings institution that it determines may have a high level of interest rate
risk exposure to file such schedule on a quarterly basis. The Bank has
determined that, on the basis of current financial data, it will not be deemed
to have more than normal level of interest rate risk under the new rule and
believes that it will not be required to increase its total capital as a result
of the rule.
In addition to requiring generally applicable capital standards for savings
institutions, the OTS is authorized to establish the minimum level of capital
for a savings institution at such amount or at such ratio of capital-to-assets
as the OTS determines to be necessary or appropriate for such institution in
light of the particular circumstances of the institution. The OTS may treat the
failure of any savings institution to maintain capital at or above such level as
an unsafe or unsound practice and may issue a directive requiring any savings
institution which fails to maintain capital at or above the minimum level
required by the OTS to submit and adhere to a plan for increasing capital. Such
an order may be enforced in the same manner as an order issued by the FDIC.
PROMPT CORRECTIVE REGULATORY ACTION. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action if an insured depository
institution fails to satisfy certain minimum capital requirements. All
institutions, regardless of their capital levels, are restricted from making any
capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of businesses. The capital
restoration plan must include a guarantee by the institution's holding company
that the institution will comply with the plan until it has been adequately
capitalized on average for four consecutive quarters, under which the holding
company would be liable up to the lesser of 5% of the institution's total assets
or the amount necessary to bring the institution into capital compliance as of
the date it failed to comply with its capital restoration plan. A
"significantly undercapitalized" institution, as well as any undercapitalized
institution that did not submit an acceptable capital restoration plan, may be
subject to regulatory demands for recapitalization, broader application of
restrictions on transactions with affiliates, limitations on interest rates paid
on deposits, asset growth and other activities, possible replacement of
directors and officers, and restrictions on capital distributions by any bank
holding company controlling the institution. Any company controlling the
institution could also be required to divest the institution or the institution
could be required to divest subsidiaries. The senior executive officers of a
significantly undercapitalized institution may not receive bonuses or increases
in compensation without prior approval and the institution is prohibited from
making payments of
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<PAGE>
principal or interest on its subordinated debt. In their discretion, the
federal banking regulators may also impose the foregoing sanctions on an
undercapitalized institution if the regulators determine that such actions are
necessary to carry out the purposes of the prompt corrective action provisions.
If an institution's ratio of tangible capital to total assets falls below a
"critical capital level," the institution will be subject to conservatorship or
receivership within 90 days unless periodic determinations are made that
forbearance from such action would better protect the deposit insurance fund.
Unless appropriate findings and certifications are made by the appropriate
federal bank regulatory agencies, a critically undercapitalized institution must
be placed in receivership if it remains critically undercapitalized on average
during the calendar quarter beginning 270 days after the date it became
critically undercapitalized. If a savings institution is in compliance with an
approved capital plan on the date of enactment of FDICIA, however, it will not
be required to submit a capital restoration plan if it is undercapitalized or
become subject to the statutory prompt corrective action provisions applicable
to significantly and critically undercapitalized institutions prior to July 1,
1994.
Effective December 19, 1992, the federal banking regulators, including the
OTS, adopted regulations implementing the prompt corrective action provisions of
FDICIA. Under these regulations, the federal banking regulators will generally
measure a depository institution's capital adequacy on the basis of the
institution's total risk-based capital ratio (the ratio of its total capital to
risk-weighted assets), Tier 1 risk-based capital ratio (the ratio of its core
capital to risk-weighted assets) and leverage ratio (the ratio of its core
capital to adjusted total assets). Under the regulations, a savings institution
that is not subject to an order or written directive to meet or maintain a
specific capital level will be deemed "well capitalized" if it also has: (i) a
total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based
capital ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0% or greater.
An "adequately capitalized" savings institution is a savings institution that
does not meet the definition of well capitalized and has: (i) a total risk-based
capital ratio of 8.0% or greater; (ii) a Tier 1 capital risk-based ratio of 4.0%
or greater; and (iii) a leverage ratio of 4.0% or greater (or 3.0% or greater if
the savings institution has a composite 1 CAMEL rating). An "undercapitalized
institution" is a savings institution that has (i) a total risk-based capital
ratio less than 8.0%; or (ii) a Tier 1 risk-based capital ratio of less than
4.0%; or (iii) a leverage ratio of less than 4.0% (or 3.0% if the institution
has a composite 1 CAMEL rating). A "significantly undercapitalized" institution
is defined as a savings institution that has: (i) a total risk-based capital
ratio of less than 6.0%; or (ii) a Tier 1 risk-based capital ratio of less than
3.0%; or (iii) a leverage ratio of less than 3.0%. A "critically
undercapitalized" savings institution is defined as a savings institution that
has a ratio of "tangible equity" to total assets of less than 2.0%. Tangible
equity is defined as core capital plus cumulative perpetual preferred stock (and
related surplus) less all intangibles other than qualifying supervisory goodwill
and certain purchased mortgage servicing rights. The OTS may reclassify a well
capitalized savings institution as adequately capitalized and may require an
adequately capitalized or undercapitalized institution to comply with the
supervisory actions applicable to institutions in the next lower capital
category (but may not reclassify a significantly undercapitalized institution as
critically under-capitalized) if the OTS determines, after notice and an
opportunity for a hearing, that the savings institution is in an unsafe or
unsound condition or that the institution has received and not corrected a less-
than-satisfactory rating for any CAMEL rating category. The Bank is classified
as "well capitalized" under these regulations.
QUALIFIED THRIFT LENDER TEST. A savings institution that does not meet the
Qualified Thrift Lender test ("QTL Test") must either convert to a bank charter
or comply with the following restrictions on its operations: (i) the institution
may not engage in any new activity or make any new investment, directly or
indirectly, unless such activity or investment is permissible for a national
bank; (ii) the branching powers of the institution shall be restricted to those
of a national bank; (iii) the institution shall not be eligible to obtain any
advances from its FHLB; and (iv) payment of dividends by the institution shall
be subject to the rules regarding payment of dividends by a national bank. Upon
the expiration of three years from the date the institution ceases to be a QTL,
it must cease any activity, and not retain any investment not permissible for a
national bank and immediately repay any outstanding FHLB advances (subject to
safety and soundness considerations).
To qualify as a QTL, a savings institution must maintain at least 65% of
its "portfolio" assets in Qualified Thrift Investments. Portfolio assets are
defined as total assets less intangibles, property used by a savings institution
in its business and liquidity investments in an amount not exceeding 20% of
assets. Qualified Thrift Investments
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<PAGE>
consist of: (i) loans, equity positions, or securities related to domestic,
residential real estate or manufactured housing; (ii) 50% of the dollar amount
of residential mortgage loans subject to sale under certain conditions but do
not include any intangible assets. Subject to a 20% of portfolio assets limit,
however, savings institutions are able to treat as Qualified Thrift Investments
200% of their investments in loans to finance "starter homes" and loans for
construction, development or improvement of housing and community service
facilities or for financing small businesses in "credit-needy" areas.
In addition, a savings institution must maintain its status as a QTL on a
monthly basis in nine out of every 12 months. A savings institution that fails
to maintain Qualified Thrift Lender status will be permitted to requalify once,
and if it fails the QTL Test a second time, it will become immediately subject
to all penalties as if all time limits on such penalties had expired. Failure
to qualify as a QTL results in a number of sanctions, including the imposition
of certain operating restrictions imposed on national banks and a restriction on
obtaining additional advances from the Federal Home Loan Bank System. Upon
failure to qualify as a QTL for two years, a savings association must convert to
a commercial bank. At June 30, 1996, approximately 97% of the Bank's
"portfolio" assets were invested in Qualified Thrift Investments.
DIVIDEND LIMITATIONS. Under OTS regulations, the Bank is not permitted to
pay dividends on its capital stock if its regulatory capital would thereby be
reduced below the amount then required for the liquidation account established
for the benefit of certain depositors of the Bank at the time of its conversion
to stock form. In addition, savings institution subsidiaries of savings and
loan holding companies are required to give the OTS 30 days' prior notice of any
proposed declaration of dividends to the holding company.
Federal regulations impose limitations on the payment of dividends and
other capital distributions (including stock repurchases and cash mergers) by
the Bank. Under these regulations, a savings institution that, immediately
prior to, and on a pro forma basis after giving effect to, a proposed capital
distribution, has total capital (as defined by OTS regulation) that is equal to
or greater than the amount of its fully phased-in capital requirements (a "Tier
1 Association") is generally permitted without OTS approval, after notice, to
make capital distributions during a calendar year in the amount equal to the
greater of (i) 75% of net income for the previous four quarters or (ii) up to
100% of its net income to date during the calendar year plus an amount that
would reduce by one-half the amount by which its capital-to-assets ratio
exceeded its fully phased-in capital requirement to assets ratio at the
beginning of the calendar year. A savings institution with total capital in
excess of current minimum capital requirements but not in excess of the fully
phased-in requirements (a "Tier 2 Association") is permitted, after notice, to
make capital distributions without OTS approval of up to 75% of its net income
for the previous four quarters, less dividends already paid for such period. A
savings institution that fails to meet current minimum capital requirements (a
"Tier 3 Association") is prohibited from making any capital distributions
without the prior approval of the OTS. Tier 1 Associations that have been
notified by the OTS that they are in need of more than normal supervision will
be treated as either a Tier 2 or Tier 3 Association. Unless the OTS determines
that the Bank is an institution requiring more than normal supervision, the Bank
is authorized to pay dividends in accordance with the provisions of the OTS
regulations discussed above as a Tier 1 Association.
Under the OTS' prompt corrective action regulations, the Bank is also
prohibited from making any capital distributions if after making the
distribution, the Bank would have: (i) a total risk-based capital ratio of less
than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a
leverage ratio of less than 4.0%. The OTS, after consultation with the FDIC,
however, may permit an otherwise prohibited stock repurchase if made in
connection with the issuance of additional shares in an equivalent amount and
the repurchase will reduce the institution's financial obligations or otherwise
improve the institution's financial condition.
SAFETY AND SOUNDNESS STANDARDS. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each Federal banking agency is required to establish safety and soundness
standards for institutions under its authority. The final rule and the
guidelines became effective on August 9, 1995. The guidelines require savings
institutions to maintain internal controls and information systems and internal
audit systems that are appropriate for the size, nature and scope of the
institution's business. The
28
<PAGE>
guidelines also establish certain basic standards for loan documentation, credit
underwriting, interest rate risk exposure, and asset growth. The guidelines
further provide that savings institutions should maintain safeguards to prevent
the payment of compensation, fees and benefits that are excessive or that could
lead to material financial loss, and should take into account factors such as
comparable compensation practices at comparable institutions. If the OTS
determines that a savings institution is not in compliance with the safety and
soundness guidelines, it may require the institution to submit an acceptable
plan to achieve compliance with the guidelines. A savings institution must
submit an acceptable compliance plan to the OTS within 30 days of receipt of a
request for such a plan. Failure to submit or implement a compliance plan may
subject the institution to regulatory sanctions. Management believes that the
Bank already meets substantially all the standards adopted in the interagency
guidelines, and therefore does not believe that implementation of these
regulatory standards has materially affected the Bank's operations.
Additionally under FDICIA, as amended by the CDRI Act, the Federal banking
agencies were required to establish standards relating to the asset quality and
earnings that the agencies determine to be appropriate. On July 10, 1995, the
Federal banking agencies, including the OTS, issued proposed guidelines relating
to asset quality and earnings. Under the proposed guidelines, a savings
institution should maintain systems, commensurate with its size and the nature
and scope of its operations, to identify problem assets and prevent
deterioration in those assets as well as to evaluate and monitor earnings and
ensure that earnings are sufficient to maintain adequate capital and reserves.
Management believes that the asset quality and earnings standards, in the form
proposed by the banking agencies, would not have a material effect on the Bank's
operations.
DEPOSIT INSURANCE. The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the FDIC through the SAIF. Under the Federal Deposit Insurance Act, the FDIC is
required to set semi-annual assessments for SAIF-insured institutions at a level
necessary to maintain the designated reserve ratio of the SAIF at 1.25% of
estimated insured deposits or at a higher percentage of estimated insured
deposits that the FDIC determines to be justified for that year by circumstances
indicating a significant risk of substantial future losses to the SAIF.
Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as under the prompt
corrective action regulations. See " -- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken. The
assessment rate currently ranges from 0.23% of deposits for well capitalized
institutions in Subgroup A to 0.31% of deposits for undercapitalized
institutions in Subgroup C.
SAIF members are generally prohibited from converting to the BIF, also
administered by the FDIC, or merging with or transferring assets to a BIF member
before the later of August 9, 1994 or the date on which the SAIF first meets or
exceeds the designated reserve ratio of 1.25% of insured deposits. The FDIC,
however, may approve such a transaction in the case of a SAIF member in default
or if the transaction involves an insubstantial portion of the deposits of each
participant. In addition, mergers, transfers of assets and assumptions of
liabilities may be approved by the appropriate bank regulator so long as deposit
insurance premiums continue to be paid to the SAIF for deposits attributable to
the SAIF members plus an adjustment for the annual rate of growth of deposits in
the surviving bank without regard to subsequent acquisitions. Each depository
institution participating in a SAIF-to-BIF
29
<PAGE>
conversion transaction is required to pay an exit fee to SAIF and an entrance
fee to BIF. A savings institution is not prohibited from adopting a commercial
bank or savings bank charter if the resulting bank remains a SAIF member.
The FDIC has adopted a regulation which provides that any insured
depository institution with a ratio of Tier 1 capital to total assets of less
than 2% will be deemed to be operating in an unsafe or unsound condition, which
would constitute grounds for the initiation of termination of deposit insurance
proceedings. The FDIC, however, will not initiate termination of insurance
proceedings if the depository institution has entered into and is in compliance
with a written agreement with its primary regulator, and the FDIC is a party to
the agreement, to increase its Tier 1 capital to such level as the FDIC deems
appropriate. Tier 1 capital is defined as the sum of common stockholders'
equity, noncumulative perpetual preferred stock (including any related surplus)
and minority interests in consolidated subsidiaries, minus all intangible assets
other than certain purchased servicing rights and purchased credit card
receivables and qualifying supervisory goodwill eligible for inclusion in core
capital under OTS regulations and minus identified losses and investments in
certain securities subsidiaries. Insured depository institutions with Tier 1
capital equal to or greater than 2% of total assets may also be deemed to be
operating in an unsafe or unsound condition notwithstanding such capital level.
The regulation further provides that in considering applications that must be
submitted to it by savings institutions, the FDIC will take into account whether
the savings association is meeting the Tier 1 capital requirement for state non-
member banks of 4% of total assets.
On August 8, 1995, the FDIC adopted an amendment to the BIF risk-based
assessment schedule which lowered the deposit insurance assessment rate for most
commercial banks and other depository institutions with deposits insured by the
BIF to a range of from 0.31% of insured deposits for undercapitalized BIF-
insured institutions to 0.04% of deposits for well-capitalized institutions,
which constitute over 90% of BIF-insured institutions. The FDIC amendment
becomes effective September 30, 1995. Subsequently, the FDIC reduced the
premium rate to a range of from the statutory minimum of $1,000 per semi-annual
period for the most highly-rated BIF institutions to 0.27% of insured deposits
for undercapitalized institutions. These amendments created a substantial
disparity in the deposit insurance premiums paid by BIF and SAIF members and
could place SAIF-insured savings institutions at a significant competitive
disadvantage to BIF-insured institutions.
A number of proposals have been considered to recapitalize the SAIF in
order to eliminate the premium disparity. The Senate and the House of
Representatives have both, as part of a budget reconciliation package to balance
the federal budget, approved legislation requiring a one time assessment of an
amount sufficient to bring the SAIF to a level equal to 1.25% of insured
deposits (originally estimated to be up to approximately 0.85% of insured
deposits) to be imposed on all SAIF-insured deposits held as of March 31, 1995.
This assessment was originally scheduled to be payable during the first quarter
of 1996. This legislation was subsequently vetoed by the President. It is
unknown whether legislation of this type will be enacted, or if enacted, the
amount of such special assessment. It is currently estimated that a special
assessment of between 67 and 71 basis points would be required to fully
recapitalize the SAIF. If a special assessment equal to 71 basis points were to
be required, it would result in a one-time after-tax charge of up to
approximately $410,000. Such assessment would have the effect of reducing the
Bank's tangible and core capital to $32.0 million, or 25.0%, of adjusted total
assets, and risk-based capital to $32.1 million, or 51.0%, of risk-weighted
assets as of June 30, 1996. If such a special assessment were required and the
SAIF as a result was fully recapitalized, it could have the effect of reducing
the Bank's deposit insurance premiums to the SAIF, thereby increasing net
earnings in future periods.
LIQUIDITY REQUIREMENTS. The Bank is required to maintain average daily
balances of liquid assets (cash, certain time deposits, bankers' acceptances,
highly rated corporate debt and commercial paper, securities of certain mutual
funds, and specified United States government, state or federal agency
obligations) equal to the monthly average of not less than a specified
percentage (currently 5%) of its net withdrawable savings deposits plus short-
term
30
<PAGE>
borrowings. The Bank is also required to maintain average daily balances of
short-term liquid assets at a specified percentage (currently 1%) of the total
of its net withdrawable savings accounts and borrowings payable in one year or
less. Monetary penalties may be imposed for failure to meet liquidity
requirements. The average daily and short-term liquidity ratios of the Bank at
June 30, 1996, were 10.4% and 10.4%, respectively.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB, which
consists of 12 Federal Home Loan Banks subject to supervision and regulation by
the Federal Housing Finance Board ("FHFB"). The Federal Home Loan Banks provide
a central credit facility primarily for member institutions. As a member of the
FHLB of Cincinnati, the Bank is required to acquire and hold shares of capital
stock in the FHLB of Cincinnati in an amount at least equal to 1% of the
aggregate unpaid principal of its home mortgage loans, home purchase contracts,
and similar obligations at the beginning of each year, or 1/20 of its advances
from the FHLB of Cincinnati, whichever is greater. The Bank was in compliance
with this requirement with investment in FHLB of Cincinnati stock at June 30,
1996, of $1.1 million. The FHLB of Cincinnati is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System. It makes
advances to members in accordance with policies and procedures established by
the FHFB and the Board of Directors of the FHLB of Cincinnati. As of June 30,
1996, the Bank had $5.0 million in advances and other borrowings from the FHLB
of Cincinnati. See " -- Deposit Activity and Other Sources of Funds --
Borrowings."
FEDERAL RESERVE SYSTEM. Pursuant to regulations of the Federal Reserve
Board, a thrift institution must maintain average daily reserves equal to 3% on
the first $52.0 million of transaction accounts, plus 10% on the remainder.
This percentage is subject to adjustment by the Federal Reserve Board. Because
required reserves must be maintained in the form of vault cash or in a non-
interest bearing account at a Federal Reserve Bank, the effect of the reserve
requirement is to reduce the amount of the institution's interest-earning
assets. As of June 30, 1996, the Bank met its reserve requirements.
TAXATION
First Federal files its tax return based on a fiscal year ending June 30.
The Company and the Bank will file separate tax returns for fiscal 1996.
Thrift institutions are subject to the provisions of the Internal Revenue
Code of 1986, as amended (the "Code") in the same general manner as other
corporations. Prior to recent legislation, institutions such as First Federal
which met certain definitional tests and other conditions prescribed by the Code
benefitted from certain favorable provisions regarding their deductions from
taxable income for annual additions to their bad debt reserve. For purposes of
the bad debt reserve deduction, loans were separated into "qualifying real
property loans," which generally are loans secured by interests in certain real
property, and nonqualifying loans, which are all other loans. The bad debt
reserve deduction with respect to nonqualifying loans was based on actual loss
experience, however, the amount of the bad debt reserve deduction with respect
to qualifying real property loans could be based upon actual loss experience
(the "experience method") or a percentage of taxable income determined without
regard to such deduction (the "percentage of taxable income method").
First Federal historically elected to use the percentage of taxable income
method. Under such method, the bad debt reserve deduction for qualifying real
property loans was computed as a percentage of taxable income, with certain
adjustments, effective for taxable years beginning after 1986. The allowable
deduction under the percentage of taxable income method (the "percentage bad
debt deduction") for taxable years beginning before 1987 was scaled downward in
the event that less than 82% of the total dollar amount of the assets of an
association were within certain designated categories. When the percentage
method bad debt deduction was lowered to 8%, the 82% qualifying assets
requirement was lowered to 60%. For all taxable years, no deduction was
permitted in the event that less than 60% of the total dollar amount of the
assets of an association fell within such categories.
Earnings appropriated to an institution's bad debt reserve and claimed as a
tax deduction were not available for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
31
<PAGE>
liquidation), unless such amount was included in taxable income, along with the
amount deemed necessary to pay the resulting federal income tax.
Legislation recently signed by the President repealed the percentage of
taxable income method of calculating the bad debt reserve. Savings
associations, like the Bank, which have previously used that method are required
to recapture into taxable income post-1987 reserves in excess of the reserves
calculated under the experience method over a six-year period beginning with the
first taxable year beginning after December 31, 1995. The start of such
recapture may be delayed until the third taxable year beginning after December
31, 1995 if the dollar amount of the institution's residential loan originations
in each year is not less than the average dollar amount of residential loan
originated in each of the six most recent years disregarding the years with the
highest and lowest originations during such period. For purposes of this test,
residential loan originations would not include refinancings and home equity
loans. The Bank has provided deferred taxes on its post-1987 additions to its
bad debt reserves and, as a result, the recapture provisions will have no effect
on the Bank's results of operations.
Beginning with the first taxable year beginning after December 31, 1995,
savings institutions, such as the Bank, will be treated the same as commercial
banks. Institutions with $500 million or more in assets will only be able to
take a tax deduction when a loan is actually charged off. Institutions with
less than $500 million in assets will still be permitted to make deductible bad
debt additions to reserves, but only using the experience method.
First Federal's federal corporate income tax returns have not been audited
in the last five years.
Under provisions of the Revenue Reconciliation Act of 1993 ("RRA"), enacted
on August 10, 1993, the maximum federal corporate income tax rate was increased
from 34% to 35% for taxable income over $10.0 million, with a 3% surtax imposed
on taxable income over $15.0 million. Also under provisions of RRA, a separate
depreciation calculation requirement has been eliminated in the determination of
adjusted current earnings for purposes of determining alternative minimum
taxable income, rules relating to payment of estimated corporate income taxes
were revised, and certain acquired intangible assets such as goodwill and
customer-based intangibles were allowed a 15-year amortization period.
Beginning with tax years ending on or after January 1, 1993, RRA also provides
that securities dealers must use mark-to-market accounting and generally reflect
changes in value during the year or upon sale as taxable gains or losses. The
IRS has indicated that financial institutions which originate and sell loans
will be subject to the new rule.
STATE INCOME TAXATION
The Commonwealth of Kentucky imposes no income or franchise taxes on
savings institutions. First Federal is subject to an annual Kentucky ad valorem
tax. This tax is 0.1% of First Federal's savings accounts, common stock,
capital and retained income with certain deductions allowed for amounts borrowed
by depositors and for securities guaranteed by the U.S. Government or certain of
its agencies. For the year ended June 30, 1996, the amount of such expense for
First Federal was $100,000.
Shareholders of the Company who are residents of the Commonwealth of
Kentucky may be subject to a Kentucky tax on intangible property, defined for
this purpose to include shares of stock in a corporation. The tax is an ad
valorem tax based upon the fair market value of the shares held by the
individual, and is assessed at a rate of $.25 per $100 in value.
32
<PAGE>
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The following table sets forth information regarding the executive officer
of the Company who does not serve on the Board of Directors.
<TABLE>
<CAPTION>
AGE AT
JUNE 30,
NAME 1996 TITLE
- ---- ---------- -----
<S> <C> <C>
Joyce H. Jennings (1) 59 Vice President and Treasurer
</TABLE>
_______________
(1) Mrs. Jennings is the wife of William C. Jennings, Chairman of the Board and
President of the Company and the Bank and the mother of Donald Jennings,
Vice President of the Bank.
JOYCE H. JENNINGS has been an employee of First Federal since 1955. She
has served as Vice President and Treasurer of the Bank since 1983 and Treasurer
of the Company since its inception. Mrs. Jennings has been active in
philanthropy and civic activities in the Frankfort area, and holds several
offices in her church. She currently serves on the Board of the Franklin County
Council on Aging. Her husband, William C. Jennings, is President and Chairman
of the Board of the Company and First Federal and her son, Donald Jennings, is
Vice President of the Bank.
ITEM 2. PROPERTIES
- -------------------
The following table sets forth information regarding First Federal's
offices at June 30, 1996.
<TABLE>
<CAPTION>
Book Value Deposits at
Year Owned or at June 30, Approximate June 30,
Opened Leased 1996 Square Footage 1996
------ -------- ----------- -------------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
MAIN OFFICE:
216 West Main Street 1989 Owned $ 1,257 14,400 $ 49,003
Frankfort, Kentucky 40601
BRANCH OFFICES:
East Branch 1971 Owned 162 1,800 22,538
1980 Versailles Road
Frankfort, Kentucky 40601
West Branch 1975 Owned 157 2,480 16,236
1220 US 127 South
Frankfort, Kentucky 40601
</TABLE>
The net book value of the Automatic Teller Machines buildings located at
the East and West Branches at June 30, 1996 was $30,000. First Federal owns a
small parcel of land to the rear of the East Branch which is rented to a local
business for parking.
The book value of First Federal's investment in premises and equipment
totaled $1.6 million at June 30, 1996.
33
<PAGE>
ITEM 3. LEGAL PROCEEDINGS.
- -------------------------
From time to time, First Federal is a party to various legal proceedings
incident to its business. At June 30, 1996, there were no legal proceedings to
which the Company or First Federal was a party, or to which any of their
property was subject, which were expected by management to result in a material
loss to the Company or the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
There were no matters submitted to a vote of security holders during the
fourth quarter of the fiscal year ended June 30, 1996.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS'
- ----------------------------------------------------------------------------
MATTERS
- -------
The information required by this Item is incorporated by reference to
"Market Information" contained in the Company's Annual Report.
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
The information contained in the table captioned "Selected Consolidated
Financial and Other Data" in the Annual Report is incorporated herein by
reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
The information required by this item is incorporated by reference to
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Annual Report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
The financial statements required by this item are incorporated by
reference to the consolidated financial statements, notes to consolidated
financial statements and independent auditors' report in the Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
The information required by this Item is incorporated by reference to the
Company's Current Report on Form 8-K dated April 2, 1996 and filed on April 2,
1996 and the Company's Current Report on Form 8-K/A dated April 2, 1996 and
filed on April 9, 1996.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
For information concerning the Board of Directors and executive officers of
the Company, the information contained under the section captioned "Proposal I
- -- Election of Directors" in the Company's definitive proxy statement for the
Company's 1996 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference.
34
<PAGE>
For certain information regarding the one executive officer of the Company
who is not a director, see "Item 1. Description of Business -- Executive
Officers Who Are Not Directors."
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
The information required by this item is incorporated by reference to
"Executive Compensation" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference
to the section captioned "Voting Securities and Principal Holders
Thereof" in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference
to the sections captioned "Voting Securities and Principal Holders
Thereof" and "Proposal I -- Election of Directors" in the Proxy
Statement.
(c) Changes in Control
Management of the Company knows of no arrangements, including any
pledge by any person of securities of the Company, the operation of
which may at a subsequent date result in a change in control of the
registrant.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Proposal I -- Election of Directors -- Transactions
with Management" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
- -------------------------------------------------------------------------
(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
----------------------------------------------
(1) Financial Statements. The following consolidated financial statements
are incorporated by reference from Item 8 hereof:
Independent Auditors' Report
Consolidated Statements of Financial Condition as of June 30, 1996 and
1995
Consolidated Statements of Earnings for the years ended June 30, 1996,
1995, and 1994
Consolidated Statements of Shareholders' Equity for the years ended
June 30, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the years ended June 30,
1996, 1995 and 1994
Notes to Consolidated Financial Statements for the years ended June
30, 1996, 1995 and 1994
35
<PAGE>
(2) Financial Statement Schedules. All schedules for which provision is
made in the applicable accounting regulations of the Securities and Exchange
Commission are omitted because of the absence of conditions under which they are
required or because the required information is included in the consolidated
financial statements and related notes thereto.
(3) Exhibits. The following is a list of exhibits filed as part of this
Annual Report on Form 10-K and is also the Exhibit Index.
<TABLE>
<CAPTION>
Page in
Sequentially
No. Description Numbered Copy
--- ----------- -------------
<S> <C> <C>
3.1 Certificate of Incorporation of Frankfort First Bancorp, Inc. *
3.2 Bylaws of Frankfort First Bancorp, Inc. *
4 Form of Stock Certificate of Frankfort First Bancorp, Inc. *
10.1 Stock Option and Incentive Plan * +
10.2 Management Recognition Plan * +
10.3(a) Employment Agreements with First Federal Savings Bank of Frankfort * +
10.3(b) Employment Agreements with Frankfort First Bancorp, Inc. * +
10.4 Deferred Compensation Plan * +
10.5 Trust Agreement Relating to Employment Agreements and Deferred ** +
Compensation Plan
13 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23.1 Consent of Grant Thornton L.L.P.
23.2 Consent of Butler & Associates, P.S.C.
27 Financial Data Schedule
</TABLE>
- --------------------
(*) Incorporated herein by reference from Registration Statement on Form S-1
filed (File No. 33-83968).
(**) Incorporated herein by reference from the Company's Annual Report on Form
10-K for the fiscal year ended June 30, 1995.
(+) Management contract or compensatory plan or arrangement.
(B) REPORTS ON FORM 8-K. A Current Report on Form 8-K dated April 2, 1996
-------------------
and filed on April 2, 1996 and a Current Report on Form 8-K/A filed on April 9,
1996 amending such report were filed by the Company during the last quarter
ended June 30, 1996 to report under Item 4 a change in the Company's certifying
accountant. The Company also filed a Current Report on Form 8-K dated April 23,
1996 to report the declaration of a special dividend.
(C) EXHIBITS. The exhibits required by Item 601 of Regulation S-K are
--------
either filed as part of this Annual Report on Form 10-K or incorporated by
reference herein.
(D) FINANCIAL STATEMENTS AND SCHEDULES EXCLUDED FROM ANNUAL REPORT.
--------------------------------------------------------------
There are no other financial statements and financial statement schedules which
were excluded from the Annual Report to Stockholders pursuant to Rule 14a-
3(b)(1) which are required to be included herein.
36
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
FRANKFORT FIRST BANCORP, INC.
September 10, 1996 By: /s/ William C. Jennings
---------------------------------------
William C. Jennings
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ William C. Jennings September 10, 1996
- ------------------------------------------
William C. Jennings
President and Chief Executive Officer
(Principal Executive Officer and Principal
Financial and Accounting Officer)
/s/ Danny A. Garland September 10, 1996
- ------------------------------------------
Danny A. Garland
Vice President and Director
/s/ Charles A. Cotton, III September 10, 1996
- ------------------------------------------
Charles A. Cotton, III
Director
/s/ David Eddins September 10, 1996
- ------------------------------------------
David Eddins
Director
/s/ William M. Johnson September 10, 1996
- ------------------------------------------
William M. Johnson
Director
/s/ Frank McGrath September 10, 1996
- ------------------------------------------
Frank McGrath
Director
/s/ Herman D. Regan, Jr. September 10, 1996
- ------------------------------------------
Herman D. Regan, Jr.
Director
<PAGE>
- -------------------------------------------------------------------------------
Frankfort First Bancorp, Inc.
Annual Report
1996
- -------------------------------------------------------------------------------
Parent Company of
First Federal Savings Bank of Frankfort
216 West Main Street
P.O. Box 535
Frankfort, KY 40602
<PAGE>
PRESIDENT'S MESSAGE
Dear Stockholder:
It is with great pleasure that we present Frankfort First Bancorp's Annual
Report to Shareholders for the fiscal year ended June 30, 1996. It has been an
extremely busy year as management and the directorate of your Corporation and
its First Federal Savings Bank subsidiary adjusted to life as a public company.
The completion of our initial public offering in July 1995 paved the way for a
record earnings performance in the current fiscal year. Net earnings for fiscal
1996 totaled $1.7 million or $.52 per share, representing an increase of
$771,000 or 86.7% over our fiscal 1995 earnings of $889,000. The enhanced
earnings in fiscal 1996 were primarily attributable to a $1.5 million or 43.1%
increase in net interest income. Shareholders' equity also increased to $34.3
million at June 30, 1996 representing 26.7% to total assets at that date.
The overwhelming public response to our initial public offering has presented a
challenge to your Board and management. Specifically, optimal deployment of
capital has become one of our Corporation's primary areas of strategic focus.
Toward this end, we undertook two significant initiatives during fiscal 1996.
First, we made every attempt to internally leverage the capital base through
growth in the loan portfolio with strong, safe, profitable loans. Loans
receivable increased during the year by $9.7 million or 9.7%. The increase in
loans, representing the highest level of growth in our history, was accomplished
through expansion of our loan product line as well as aggressive marketing
efforts in our primary banking area.
Secondly, we implemented an innovative capital deployment strategy that enabled
us to return $4.18 of our $10.00 initial offering price to shareholders through
our quarterly dividends paid in January and April and a one-time special
dividend paid in June. Of this amount, $4.12 will be considered a tax-free
return of capital, which reduced a shareholder's basis in the stock. The
remaining $.06 is viewed as a taxable dividend. We believe the long-term
benefits of this strategy to our charter shareholders (e.g., a 59% ratio of
remaining investment to book value at June 30, 1996, and an increased current
annual dividend rate of 6% of the remaining investment) more than offset the
short-term loss of earnings as a result of the distribution. Please be assured
that your management is keenly aware of the need to manage our return on equity
and will continue to closely monitor our progress in this regard.
On a sad note, the Corporation lost one of its directors on July 17, 1996, with
the passing of Joe R. Johnson. Joe had been a director of First Federal since
1978. His vision, knowledge, and leadership will be greatly missed.
The Corporation's Board of Directors has appointed C. Michael Davenport to fill
the vacancy left by Joe and to stand for election at the Corporation's upcoming
annual meeting. Mike has been a very active force in the Frankfort community in
recent years, and has long been a supporter of First Federal. We look forward
to Mike's contributions to our Board.
In conclusion, we wish to thank all of you for your support of Frankfort First
Bancorp over its first year of operations as a public company. We look forward
to fiscal 1997 with cautious optimism and remain ever-committed to maximizing
the value of your investment in our Corporation.
Sincerely,
FRANKFORT FIRST BANCORP, INC.
/s/ William C. Jennings
William C. Jennings
President and Chief Executive Officer
<PAGE>
FRANKFORT FIRST BANCORP, INC.
Frankfort First Bancorp, Inc. (the "Company") was incorporated under the
laws of the State of Delaware in August 1994 at the direction of the Board of
Directors of First Federal Savings Bank of Frankfort ("First Federal" or the
"Bank") for the purpose of serving as a savings institution holding company of
First Federal upon the acquisition of all of the capital stock issued by First
Federal upon its conversion from mutual to stock form (the "Conversion"). The
Conversion was completed July 7, 1995, with the Company issuing 3,450,000 shares
of its common stock, par value $.01 per share (the "Common Stock") to the
public, and the Bank issuing all of its outstanding common stock to the Company.
Prior to and since the Conversion, the Company had not engaged in any material
operations. The Company has no significant assets other than the outstanding
capital stock of First Federal and a note receivable from the Employee Stock
Ownership Plan of the Bank (the "ESOP"). The Company's principal business is
the business of First Federal. At June 30, 1996, the Company had total assets
of $128.5 million, deposits of $87.8 million and shareholders' equity of $34.3
million.
FIRST FEDERAL SAVINGS BANK OF FRANKFORT
First Federal was originally chartered in 1934 as a Kentucky-chartered
building and loan association known as "Greater Frankfort Building and Loan
Association" and was rechartered in 1938 as First Federal Savings and Loan
Association of Frankfort. First Federal has been a member of the Federal Home
Loan Bank ("FHLB") of Cincinnati and its deposits have been federally insured
since 1938. In 1989, First Federal became a federal mutual savings bank and
adopted its current name. First Federal currently operates through three
banking offices located in Frankfort, Kentucky.
First Federal is primarily engaged in the business of attracting deposits
from the general public and originating loans secured by first mortgages on one-
to four-family residences in First Federal's market area. First Federal also
originates, to a lesser extent, church loans, home equity loans and other loans.
As a federally chartered savings institution, First Federal is subject to
extensive regulation by the OTS. The lending activities and other investments
of First Federal must comply with various federal regulatory requirements, and
the OTS periodically examines First Federal for compliance with various
regulatory requirements. The FDIC also has the authority to conduct special
examinations. First Federal must file reports with the OTS describing its
activities and financial condition and is also subject to certain reserve
requirements promulgated by the Federal Reserve Board.
Both the Company's and First Federal's executive offices are located at 216
W. Main Street, Frankfort, Kentucky 40602, and their main telephone number is
(502) 223-1638.
MARKET INFORMATION
The Common Stock began trading under the symbol "FKKY" on the Nasdaq
National Market on July 10, 1995. There are currently 3,450,000 shares of the
Common Stock outstanding. The number of registered holders of Common Stock on
September 17, 1996 was 666.
The following table shows the high and low stock prices for the Common
Stock on July 10, 1996 and dividends declared on a quarterly basis since the
Common Stock began trading on the Nasdaq National Market through June 30, 1996.
<TABLE>
<CAPTION>
Quarter Dividends
Ended High Low Declared
----- ---- --- ---------
<S> <C> <C> <C>
September 30, 1995 $12.875 $11.625 $0.09
December 31, 1995 13.250 12.250 0.09
March 31, 1996 15.250 12.750 0.09 (1)
June 30, 1996 16.250 10.750 4.09 (2)
</TABLE>
__________________
(1) Includes $0.08 deemed to constitute a return of excess capital.
(2) Includes $4.04 deemed to constitute a return on excess capital.
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The following summary of selected consolidated financial information and
other data does not purport to be complete and is qualified in its entirety by
reference to the detailed information and consolidated financial statements and
accompanying notes appearing elsewhere herein.
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
<TABLE>
<CAPTION>
At June 30,
----------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total amount of:
Assets.............................. $128,513 $142,772 $111,955 $105,801 $103,336
Loans receivable, net............... 110,331 100,602 98,228 92,839 87,677
Cash and investment securities...... 14,889 38,918 11,027 10,283 12,946
Deposits............................ 87,777 119,041 89,115 88,736 87,657
Advances from FHLB.................. 4,998 4,416 4,652 -- --
Shareholders' equity-substantially
restricted (1).................... 34,265 18,604 17,715 16,493 15,073
Number of:
Real estate loans outstanding....... 2,685 2,582 2,585 2,586 2,620
Savings accounts.................... 8,397 8,500 8,586 8,865 9,854
Offices............................. 3 3 3 3 3
</TABLE>
- --------------------
(1) Consisted solely of retained earnings for June 30, 1992 through June 30,
1995 inclusive.
SUMMARY OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Interest income.................................. $ 9,699 $ 7,809 $ 7,434 $ 7,961 $ 9,187
Interest expense................................. 4,585 4,234 3,754 4,108 5,579
-------- -------- -------- -------- --------
Net interest income.............................. 5,114 3,575 3,680 3,853 3,608
Provision for loan losses........................ 12 12 12 12 47
Other income..................................... 54 50 58 94 114
General, administrative and other expense........ 2,669 2,270 1,899 1,859 1,758
-------- -------- -------- -------- --------
Earnings before federal income taxes............. 2,487 1,343 1,827 2,076 1,917
Federal income taxes............................. 827 454 618 705 650
Cumulative effect of change in
accounting principle............................ -- -- (37) -- --
-------- -------- -------- -------- --------
Net earnings..................................... $ 1,660 $ 889 $ 1,172 $ 1,371 $ 1,267
======== ======== ======== ======== ========
Earnings per share............................... $ .52 n/a n/a n/a n/a
======== ======== ======== ======== ========
</TABLE>
2
<PAGE>
KEY OPERATING RATIOS
<TABLE>
<CAPTION>
At or for the Year Ended June 30,
------------------------------------------------------
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
PERFORMANCE RATIOS:
Return on assets (net earnings divided by average
total assets)........................................... 1.20% 0.79% 1.08%
Return on equity (net earnings divided by
average equity)......................................... 3.64% 4.90% 6.84%
Equity-to-assets ratio (average equity divided by
average total assets)................................... 33.00% 16.04% 15.83%
Interest rate spread for the period...................... 2.12% 2.59% 2.87%
Net interest margin for the period....................... 3.76% 3.24% 3.47%
Operating expenses to average assets..................... 1.93% 2.01% 1.75%
Ratio of average interest-earning assets to average
interest-bearing liabilities............................ 148.78% 117.00% 117.06%
REGULATORY CAPITAL RATIOS:
Tangible capital as a percent of assets.................. 25.20% 13.03% 15.82%
Core capital as a percent of assets...................... 25.20% 13.03% 15.82%
Risk-based capital as a percent of risk-weighted assets.. 51.65% 32.34% 34.31%
ASSET QUALITY RATIOS:
Non-performing assets to total assets.................... 0.09% 0.02% 0.19%
Loan loss allowance to total assets...................... 0.07% 0.06% 0.06%
Loan loss allowance to total non-performing assets....... 80.51% 244.12% 33.33%
</TABLE>
3
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company's principal business, since July 7, 1995, has been that of
First Federal. Prior to July 7, 1995, the Company engaged in no business and,
accordingly, had no results of operations at June 30, 1995. As such, this
discussion relates primarily to First Federal. The principal business of the
Bank consists of accepting deposits from the general public and investing these
funds in loans secured by one- to four-family owner-occupied residential
properties in the Bank's primary market area. The Bank also invests in loans
secured by non-owner occupied one-to-four family residential properties and some
churches located in the Bank's primary market area. The Bank also maintains an
investment portfolio, most of which is in the form of U.S. Government agency
issues, FHLB stock, FHLB certificates of deposit, and insured deposit accounts
held at other institutions.
The Bank's net earnings are dependent primarily on its net interest income,
which is the difference between interest income earned on its loan and
investment portfolio and interest paid on interest-bearing liabilities. To a
lesser extent, the Bank's net earnings are also affected by the level of other
income, such as service charges and other fees. For the year ended June 30,
1996, net interest income amounted to $5.1 million, and other income amounted to
$54,000. In addition, net earnings are affected by the level of general,
administrative and other expenses. First Federal's net earnings are also
affected by competitive conditions in the Bank's market area. Due to significant
competition from other institutions, and given the relative lack of diversity in
the Bank's lending and investment portfolios, the yields on the Bank's assets
are somewhat below average. Further, First Federal's sources of fee income and
other non-interest income are relatively limited. Thus, the Bank's net earnings
are limited by a relatively low net interest margin and relatively low levels of
non-interest income. First Federal's significant investment in adjustable rate
mortgage loans has in some cases further served to limit the Bank's earnings
potential.
The operations of First Federal and the entire thrift industry's earnings
are significantly affected by prevailing economic conditions, competition, and
the monetary and fiscal policies of governmental agencies. Lending activities
are influenced by the demand for and supply of housing, competition among
lenders, the level of interest rates, and the availability of funds. The Bank's
deposit flows and costs of funds are influenced by prevailing market rates of
interest - primarily on competing investments, account maturities, and the
levels of personal income and savings in the Bank's market area.
ASSET/LIABILITY MANAGEMENT
Net interest income, the primary component of the Bank's net earnings, is
derived from the difference or "spread" between the yield on interest-earning
assets and the cost of interest-bearing liabilities. First Federal has sought to
reduce its exposure to changes in interest rates by matching the effective
maturities or repricing characteristics of its interest-sensitive assets and
liabilities. In accordance with the Bank's interest rate risk policy, management
has emphasized the origination of adjustable rate mortgages with rate
adjustments indexed to the National Average Contract Interest Rate for Major
Lenders on the Purchase of Previously Occupied Homes ("NACR"). Beginning in
September 1993, the Bank began offering fixed-rate mortgages, some of which are
fully or partially funded with advances with similar maturities from the Federal
Home Loan Bank of Cincinnati. Management believes that these fixed rate loan
originations are beneficial in that they allow the Bank to respond to customer
demand without incurring undue interest rate or credit risk and without an
increase in operating expenses. At June 30, 1996, mortgage loans with adjustable
rates represented 81.1% of the Bank's mortgage loan portfolio. Nearly all of the
Bank's adjustable rate mortgage loans have an annual adjustment cap of one
percent and a lifetime cap of five percent. These caps may restrict the interest
rates from increasing at the same pace that the Bank's cost of funds increase.
In addition, some of the rates on adjustable rate mortgages may already be at
their lifetime cap or lifetime floor, which would also restrict future
adjustments. The Bank currently expects to fund future loan growth from working
capital, proceeds from deposit growth and FHLB advances.
4
<PAGE>
INTEREST RATE SENSITIVITY ANALYSIS
The OTS requires the computation of amounts by which the net present value
of an institution's cash flows from assets, liabilities and off balance sheet
items (the institution's net portfolio value, or "NPV") would change in the
event of a range of assumed changes in market interest rates. The OTS also
requires the computation of estimated changes in net interest income over a
four-quarter period. These computations estimate the effect on an institution's
NPV and net interest income of instantaneous and permanent 1% to 4% increases
and decreases in market interest rates. In the Bank's interest rate risk policy,
the Board of Directors has established a maximum decrease in net interest income
and maximum decreases in NPV given these instantaneous changes in interest
rates.
The following table sets forth the interest rate sensitivity of the Bank's
net portfolio value as of June 30, 1996 in the event of 1%, 2%, 3% and 4%
instantaneous and permanent increases and decreases in market interest rates,
respectively.
<TABLE>
<CAPTION>
Board of
Director
Change Net Portfolio Value NPV as % of Portfolio Value of Assets Limits
---------------------------------------- ------------------------------------- --------
in Rates Amount $ Change % Change NPV Ratio Basis Point Changes % Change
- -------- ------ -------- -------- --------- ------------------- --------
<S> <C> <C> <C> <C> <C> <C>
+400 bp $ 24,785 $ (8,264) (25%) 21.09% (459 bp) 50%
+300 bp 27,221 (5,828) (18%) 22.57 (311 bp) 35
+200 bp 29,541 (3,508) (11%) 23.89 (179 bp) 25
+100 bp 31,522 (1,527) (5%) 24.94 (74 bp) 10
0 bp 33,049 -- -- 25.68 -- --
- -100 bp 33,997 948 3% 26.05 37 bp 10
- -200 bp 34,472 1,423 4% 26.14 46 bp 25
- -300 bp 34,861 1,812 5% 26.15 48 bp 35
- -400 bp 35,365 2,316 7% 26.22 54 bp 50
</TABLE>
The OTS adopted a final rule in August of 1993 incorporating an interest
rate risk ("IRR") component into the risk-based capital rules. The new rule
became effective January 1, 1994, with institutions first required to meet the
new standards at July 1, 1994. The IRR component is a dollar amount that will
be deducted from total capital for the purpose of calculating an institution's
risk-based capital requirement and is measured in terms of the sensitivity of
its NPV to changes in interest rates. An institution's IRR is measured as the
change to its NPV as a result of a hypothetical 200 basis point change in market
interest rates. A resulting change in NPV of more than 2% of the estimated
market value of its assets will require the institution to deduct from its
capital 50% of that excess change. Under the rule, the OTS calculates the IRR
component quarterly for each institution with information as of the preceding
quarter end. Savings institutions with less than $300 million in assets and a
risk-based capital ratio above 12% are generally exempt from filing the interest
rate risk schedule with their Thrift Financial Reports. However, the OTS will
require any exempt savings institution that it determines may have a high level
of interest rate risk exposure to file such schedule on a quarterly basis.
Based on the Bank's asset size and capital ratio at June 30, 1996, it was not
subject to any increased capital requirements in connection with its level of
interest rate risk.
At June 30, 1996, the Bank's Board of Directors had adopted interest rate
risk target limits which established maximum potential decreases in the Bank's
NPV of 10%, 25%, 35% and 50% in the event of 1%, 2%, 3% and 4% immediate and
sustained increases and decreases in market interest rates, respectively. The
Bank's interest risk target limits are reviewed by the Board of Directors
regularly and may be adjusted in light of market conditions and other factors.
5
<PAGE>
The following table sets forth the interest rate risk capital component for
the Bank at June 30, 1996 and 1995 given a hypothetical 200 basis point rate
change in market interest rates.
<TABLE>
<CAPTION>
At At
June 30, June 30,
1996 1995
--------- ---------
<S> <C> <C>
Pre-Shock NPV Ratio: NPV as % of Portfolio Value of Assets.. 25.68% 15.16%
Exposure Measure: Post-Shock NPV Ratio...................... 23.89% 14.26%
Sensitivity Measure: Change in NPV Ratio.................... (179 bp) (91 bp)
Change in NPV as % of Portfolio Value of Assets.............. (2.73)% (0.83)%
Interest Rate Risk Capital Component ($000).................. -- --
</TABLE>
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit run-offs, and should not be relied upon as
indicative of actual results. Further, the computations do not contemplate any
actions the Bank may undertake in response to changes in interest rates.
Certain shortcomings are inherent in the method of analysis presented in
both the computation of NPV and in the analysis presented in prior tables
setting forth the maturing and repricing of interest-earning assets and
interest-bearing liabilities. For example, although certain assets and
liabilities may have similar maturities or periods to repricing, they may react
in differing degrees to changes in market interest rates. The interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market rates. Additionally, certain assets, such as adjustable rate
loans, which represent the Bank's primary loan product, have features which
restrict changes in interest rates on a short-term basis and over the life of
the asset. In addition, the proportion of adjustable rate loans in the Bank's
portfolios could decrease in future periods if market interest rates remain at
or decrease below current levels due to refinance activity. Further, in the
event of a change in interest rates, prepayment and early withdrawal levels
would likely deviate significantly from those assumed in the tables. Finally,
the ability of many borrowers to service their adjustable-rate debt may decrease
in the event of an interest rate increase.
AVERAGE BALANCE, INTEREST AND AVERAGE YIELDS AND RATES
The following table sets forth certain information relating to the Bank's
average balance sheet and reflects the average yield on assets and average cost
of liabilities for the periods indicated and the average yields earned and rates
paid for the periods indicated. Such yields and costs are derived by dividing
income or expense by the average monthly balance of assets or liabilities,
respectively, for the periods presented. Average balances are derived from
monthly balances. Management does not believe that the use of monthly balances
instead of daily balances has caused any material difference in the information
presented.
The table also presents information for the periods indicated with respect
to the difference between the weighted average yield earned on interest-earning
assets and weighted average rate paid on interest-bearing liabilities, or
"interest rate spread," which savings institutions have traditionally used as an
indicator of profitability. Another indicator of an institution's net interest
income is its "net interest margin." Net interest income is affected by the
interest rate spread and by the relative amounts of interest-earning assets and
interest-bearing liabilities. When interest-earning assets approximate or
exceed interest-bearing liabilities, any positive interest rate spread will
generate net interest income.
6
<PAGE>
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------------------------------------------------------
1996 1995 1994
---------------------------- ---------------------------- ----------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- -------- ------- -------- -------- ------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable....................... $104,602 $ 7,880 7.53% $101,227 $ 7,340 7.25% $ 95,198 $ 7,047 7.40%
Investment securities (1).............. 31,488 1,819 5.78 8,996 469 5.21 10,765 387 3.59
-------- -------- -------- -------- -------- --------
Total interest-earning assets....... 136,090 9,699 7.13 110,223 7,809 7.08 105,963 7,434 7.02
Non-interest-earning assets.............. 2,030 2,974 2,356
-------- -------- --------
Total assets........................ $138,120 $113,197 $108,319
======== ======== ========
Interest-bearing liabilities:
Deposits............................... $ 86,886 $ 4,296 4.94 $ 89,647 $ 3,946 4.40 $ 88,007 3,610 4.10
Borrowings............................. 4,586 289 6.30 4,559 288 6.32 2,511 144 5.73
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities... 91,472 4,585 5.01 94,206 4,234 4.49 90,518 3,754 4.15
-------- ---- -------- ------- -------- -------
Non-interest-bearing liabilities......... 1,074 832 656
-------- -------- --------
Total liabilities.................... 92,546 95,038 91,174
Shareholders' equity (2)................. 45,574 18,159 17,145
-------- -------- --------
Total liabilities and shareholders'
equity............................ $138,120 $113,197 $108,319
======== ======== ========
Net yield on interest-earning assets..... $ 5,114 $ 3,575 $ 3,680
====== ======== ========
Interest rate spread..................... 2.12% 2.59% 2.87%
====== ======== =======
Net interest margin...................... 3.76% 3.24% 3.47%
====== ======== =======
Average interest-earning assets as
a percentage of average interest-
bearing liabilities.................... 148.78% 117.00% 117.06%
====== ======== ========
</TABLE>
______________________
(1) Includes cash and cash equivalents and interest bearing deposits at other
financial institutions.
(2) Consisted solely of retained earnings for the fiscal years ended June 30,
1995 and 1994.
7
<PAGE>
RATE/VOLUME ANALYSIS
The table below sets forth certain information regarding changes in
interest income and interest expense of the Bank for the periods indicated. For
each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by old rate), (ii) changes in rates (change in
rate multiplied by old volume), and (iii) total change. Changes in rate-volume
(changes in rate multiplied by changes in volume) are allocated proportionately
between changes in rate and changes in volume.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------------------------------------
1996 vs. 1995 1995 vs. 1994
---------------------------- -----------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
---------------------------- -----------------------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loan portfolio......................... $ 247 $ 293 $ 540 $ 430 $ (137) $ 293
Investment securities (1).............. 1,179 171 1,350 (66) 148 82
------ ------ ------ ------ ------ ------
Total interest-earning assets........ 1,426 464 1,890 364 11 375
Interest expense:
Savings deposits....................... (141) 491 350 265 71 336
FHLB advances.......................... 2 (1) 1 25 119 144
------ ------ ------ ------ ------ ------
Total interest-bearing
liabilities....................... (139) 490 351 290 190 480
------ ------ ------ ------ ------ ------
Change in net interest income............ $1,565 $ (26) $1,539 $ 74 $ (179) $ (105)
====== ====== ====== ====== ====== ======
</TABLE>
__________________
(1) Includes cash and cash equivalents and interest-bearing deposits at other
financial institutions.
8
<PAGE>
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 1996 AND 1995
ASSETS. The Company's total assets decreased from $142.8 million at June
30, 1995 to $128.5 million at June 30, 1996, a decrease of $14.3 million or
10.0%. This decrease was due primarily to the $13.8 million return of capital
which was paid to shareholders on June 3, 1996 and reduced cash and cash
equivalents by this amount. Total assets at June 30, 1995 also included
approximately $5.0 million that was returned to subscribers whose orders were
not filled in the Bank's conversion which was completed on July 7, 1995. During
the fiscal year ended June 30, 1996, the Company deployed conversion proceeds
primarily into loans receivable (which increased by $9.7 million during the
year) and investment securities (which increased by $8.8 million during the
year). The Company purchased a total of $12.8 million in investment securities
during fiscal 1996, of which $4.0 million matured or were called. The
investments purchased were intermediate-term U.S. Government agency bonds.
Loan disbursements totaled $32.2 million in fiscal 1996 and were partially
offset by principal repayments of $22.5 million. Disbursements during the
current year exceeded those of fiscal 1995 by $12.2 million or 60.7%. At June
30, 1996, the Company's allowance for loan losses totaled $95,000, representing
approximately 0.1% of total loans and 80.5% of nonperforming loans (loans past
due 90 days or more but still accruing). This allowance totaled $83,000 at June
30, 1995. Nonperforming loans totaled $118,000 and $34,000 at June 30, 1996 and
1995 respectively, or 0.11% and 0.03% of total loans at these respective dates.
At both dates, the percentage of nonperforming loans to total loans was far
below industry averages. Although management believes that its allowance for
loan losses at June 30, 1996, was adequate based upon facts and circumstances
available, there can be no assurance that unanticipated additions to such
allowance will not be necessary in future periods, which could adversely affect
the Company's results of operations.
LIABILITIES. Deposits decreased during the year from $119.0 million at
June 30, 1995 to $87.8 million at June 30, 1996, a decrease of $31.2 million or
26.3%. Total deposits at June 30, 1995, however, had included approximately
$36.7 million in stock subscriptions of which $31.7 million was used to purchase
stock in the conversion and $5.0 million was returned to subscribers whose
orders were not filled. After consideration of these stock subscription
proceeds, deposits increased during fiscal 1996 by $5.4 million or 6.6%, due
primarily to management's continuing efforts to maintain a consistent level of
deposits through marketing and pricing strategies.
SHAREHOLDERS' EQUITY. Shareholders' equity increased from the Bank's
retained earnings of $18.6 million at June 30, 1995 to $34.3 million at June 30,
1996, an increase of $15.7 million or 84.2%. The increase was due to the
capital raised in the stock conversion and the Company's net earnings during the
year, less the $13.8 million return of capital and $1.2 million in regular
dividends paid or accrued. At June 30, 1996, shareholders' equity per share
totaled $9.93.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED JUNE 30, 1996 AND 1995
NET EARNINGS. Net earnings increased from $889,000 for the year ended June
30, 1995 to $1.7 million for the year ended June 30, 1996, an increase of
$771,000 or 86.7%. The primary reason for the increase is the increase in
interest-earning assets purchased with proceeds from the conversion.
Shareholders should note that at on June 3, 1996, the Company's capital was
reduced by $13.8 million due to the return of capital. Future net earnings are
likely to decline as a consequence of this reduction in interest-earning assets.
NET INTEREST INCOME. Net interest income increased from $3.6 million for
the fiscal year ended June 30, 1995 to $5.1 million for the fiscal year ended
June 30, 1996, an increase of $1.5 million or 43.0%. The primary reason for the
increase was the $25.9 million or 23.5% increase in interest-earning assets
purchased with proceeds from the Company's stock offering.
INTEREST INCOME. Interest income increased from $7.8 million for the
fiscal year ended June 30, 1995 to $9.7 million for the fiscal year ended June
30, 1996 for an increase of $1.9 million or 24.2%. The primary reason for the
increase is the increase in interest-earning assets purchased with proceeds from
the Conversion. These assets
9
<PAGE>
include residential mortgage loans, investment securities, and deposits in
interest-bearing bank accounts. As mentioned above, as of June 3, 1996 the
Company returned $13.8 million to the shareholders, thus reducing the Bank's
interest-earning assets. Primarily, the $13.8 million had been held in short-
term interest-bearing accounts.
INTEREST EXPENSE. Interest expense increased from $4.2 million for the
year ended June 30, 1995 to $4.6 million for the year ended June 30, 1996, an
increase of $351,000 or 8.3%. This increase is due primarily to higher
prevailing interest rates in the earlier part of this fiscal year. In addition,
a portion of the Bank's certificates of deposits reflect the higher interest
rates experienced in fiscal 1995.
PROVISION FOR LOSSES ON LOANS. The Company's provision for losses on loans
for the year ended June 30, 1996 was $12,000. The Board of Directors
periodically reviews the allowance for loan losses and determined that, based on
a variety of factors, this allowance was adequate. There can be no assurance
that the allowance for loan losses will be adequate to absorb losses on known
nonperforming assets or that the allowance will be adequate to cover losses on
nonperforming assets in the future.
OTHER OPERATING INCOME. Other operating income was virtually the same for
fiscal years 1995 and 1996. Other operating income is generally comprised of
service charges and fees on loan and deposit accounts.
GENERAL, ADMINISTRATIVE AND OTHER EXPENSE. General, administrative, and
other expense increased from $2.3 million for the year ended June 30, 1995 to
$2.7 million for the year ended June 30, 1996, an increase of $399,000 or 17.6%.
This increase includes an increase in employee compensation and benefits of
$209,000 or 15.9% which is primarily a result of the costs attendant to the
Company's Employee Stock Ownership Plan as implemented in connection with the
Conversion and the accruals for the Company's Management Recognition Plan
("MRP") as approved at the Annual Meeting of Shareholders on January 16, 1996.
Management anticipates that the overall expense of the MRP will be greater for
the year ended June 30, 1997 since the Company only began accruing for this
expense after the MRP's approval in January 1996. The Company will also have an
expense of approximately $100,000 during the year ended June 30, 1997 to provide
for the acceleration of the vesting of the MRP for Joe R. Johnson, a director of
the Company who died in July 1996. This one-time expense will, however, reduce
MRP expense during future years.
Other increases in expenses during the year ended June 30, 1996 include an
increase of $167,000 or 53.9% in other operating expenses which includes
professional fees, annual meeting expenses, and transfer services which are
essential for a publicly traded company. Also, franchise and other taxes, which
includes Kentucky income tax on the Company's earnings and Delaware franchise
taxes, increased by $49,000 or 49.0%.
INCOME TAX. The effective tax rate for the year ended June 30, 1996 was
33.3% compared to 33.8% for the year ended June 30, 1995. Overall expense
increased from $454,000 for the year ended June 30, 1995 to $827,000 for the
year ended June 30, 1996. The increase was due to the Company's $1.1 million or
85.2% increase in pretax earnings.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED JUNE 30, 1995 AND 1994
NET EARNINGS. Net earnings decreased from $1.2 million for the fiscal year
ended June 30, 1994 to $889,000 for the fiscal year ended June 30, 1995, a
decrease of $283,000 or 24.1%. This decrease is attributable to a number of
factors which include a decrease in net interest income of $105,000 and a
$371,000 increase in general, administrative and other expenses, which were
partially offset by a $201,000 decrease in the provision for federal income
taxes.
NET INTEREST INCOME. Net interest income decreased from $3.7 million for
the fiscal year ended June 30, 1994 to $3.6 million for the fiscal year ended
June 30, 1995, a decrease of $105,000 or 2.9%. This decrease was primarily
attributable to an increase in interest expense, which was offset in part by a
smaller increase in interest
10
<PAGE>
income. The decrease in net interest income is reflected in the fact that the
interest rate spread decreased from 2.87% for the fiscal year ended June 30,
1994 to 2.59% for the fiscal year ended June 30, 1995.
INTEREST INCOME. Interest income for the year ended June 30, 1995
increased to $7.8 million from $7.4 million for the fiscal year ended June 30,
1994, an increase of $375,000, or 5.0%. This increase was primarily due to a
$4.3 million or 4.0% increase in average interest earning assets. Other reasons
for the increase include the fact that rates on new loans originated were
generally higher than in the previous fiscal year, the Bank's loans receivable
were slightly more than in the previous year, and rates paid to the Bank on its
interest-bearing deposits were generally higher than in the previous year.
Although the Bank experienced an increase of $27.9 million in cash, cash
equivalents, and interest-bearing deposits from the fiscal year before, these
funds were only on deposit for a short time and did not significantly affect
interest income.
INTEREST EXPENSE. Interest expense increased from $3.8 million for the
year ended June 30, 1994 to $4.2 million for the year ended June 30, 1995, an
increase of $480,000 or 12.8%. The increase was due primarily to higher
interest rates during the year ended June 30, 1995 which caused the Bank to
offer higher rates of interest to maintain its deposit level. While the Bank's
deposit balance at June 30, 1995 had increased by $29.9 million from the year
before, these funds were only on deposit for a short time and did not
significantly affect interest expense.
PROVISIONS FOR LOSSES ON LOANS. The Bank's provision for losses on loans
for the year ended June 30, 1995 was $12,000. The Bank's Board of Directors
periodically reviewed this provision and determined that based on a variety of
factors, this loan loss provision was adequate.
OTHER OPERATING INCOME. Other operating income, which is principally made
up of service charges and fees on loan and deposit accounts, comprises a
relatively small portion of the Bank's total income. Other operating income
decreased from $58,000 for the year ended June 30, 1994 to $50,000 for the year
ended June 30, 1995.
GENERAL, ADMINISTRATIVE AND OTHER EXPENSE. General, administrative and
other expense increased from $1.9 million for the year ended June 30, 1994 to
$2.3 million for the year ended June 30, 1995, an increase of $371,000 or 19.5%.
This increase was primarily the result of an increase in compensation and
benefits of approximately $341,000, or 35.1%, which includes normal increases in
salaries, an increase in the number of employees, and a $50,000 contribution to
the Company's Employee Stock Ownership Plan. The federal deposit insurance
premium also increased by approximately $21,000 or 9.0%, which was caused in
part by the Bank's increased level of deposits year-to-year.
FEDERAL INCOME TAX. The effective tax rate for the year ended June 30,
1995 was 33.8%, which was the same as for the year ended June 30, 1994. Income
tax expense decreased approximately $164,000 or 26.5% from $618,000 for the year
ended June 30, 1994 to $454,000 for the year ended June 30, 1995. The decrease
in expense was due to a $484,000 or 26.5% decline in the Bank's pre-tax
earnings.
LIQUIDITY AND CAPITAL RESOURCES
The Company conducted no business at June 30, 1995. Since July 7, 1995,
the Company has had no business other than that of the Bank and investment of
the portion of the net Conversion proceeds retained by the Company. Management
believes that the net Conversion proceeds retained by the Company, together with
dividends that may be paid from the Bank to the Company, provides sufficient
funds for its operations. The Company's primary sources of liquidity are
dividends paid by the Bank and earnings on that portion of the net Conversion
proceeds retained by the Company. The Bank is subject to certain regulatory
limitations with respect to the payment of dividends to the Company. The
Company loaned a portion of the net proceeds retained from the Conversion to the
ESOP to permit its purchase of Common Stock in the Conversion. At June 30,
1996, the Bank exceeded all regulatory minimum capital requirements.
11
<PAGE>
The Bank's primary sources of funds are (i) cash generated from operations,
(ii) deposits, (iii) principal repayments on loans, and (iv) advances from the
FHLB of Cincinnati. As reflected in the Statement of Cash Flows, net cash flows
provided by operating activities for fiscal years 1996, 1995 and 1994 were $2.6
million, $651,000 and $1.2 million, respectively.
Net cash used in investing activities for fiscal years 1996, 1995, and 1994
were $18.9 million, $489,000 and $7.7 million, respectively. Amounts fluctuate
from period to period primarily as a result of the volume of principal
repayments on loans and loan disbursements.
Net cash used in financing activities was $16.5 million for fiscal 1996.
Net cash provided by financing activities for fiscal years 1995 and 1994 were
$29.7 million and $5.0 million, respectively. The increase in cash provided in
financing activities for fiscal year 1995 was primarily due to the increase in
deposits to be used for the purchase of stock in the Conversion.
The primary investing activity of the Bank is the origination of mortgage
loans. During the years ended June 30, 1996, 1995, and 1994, the Bank
originated mortgage loans in the amounts of $32.2 million, $20.0 million and
$32.2 million, respectively. Prevailing lower interest rates had increased the
amount of loan originations in fiscal 1994 as compared to previous years.
However, in fiscal year 1995, prevailing interest rates increased and the Bank
originated fewer loans. Also, due to periods of low levels of liquidity during
the year, the Bank sought to minimize mortgage lending for a time by increasing
interest rates and origination fees. Beginning on July 7, 1995, the Bank had
access to proceeds from the Conversion and utilized these proceeds in the
origination of mortgage loans to the greatest extent possible, within the Bank's
range of products and underwriting standards. Due to generally lower interest
rates and the consistent offering of fixed rate loans, the Bank has increased
its net loans by $9.7 million during fiscal 1996. Other investing activities
include investment in U.S. Government agency issues, FHLB certificates of
deposit, and insured certificates of deposits in other institutions. The Bank
may in the future consider other investing activities that may provide higher
yields. The primary financing activity of the Bank is the attraction of savings
deposits, though the Bank has somewhat reduced its reliance on deposits as a
source of funds in recent periods due to competitive conditions in First
Federal's market area. Deposits decreased $31.3 million during the year ended
June 30, 1996 after increases of $29.9 million in the year ended June 30, 1995
and $379,000 in the year ended June 30, 1994. For an explanation of the large
decrease in deposits in fiscal 1996, see "--Comparison of Financial Condition at
June 30, 1996 and June 30, 1995."
Another source of liquidity is the Bank's ability to obtain advances from
the FHLB of Cincinnati. In addition, the Bank maintains a portion of its
investments in FHLB overnight funds that will be available when needed.
The Bank is required to maintain minimum levels of liquid assets as defined
by OTS regulations. This requirement, which may be changed at the direction of
the OTS depending upon economic conditions and deposit flows, is based upon a
percentage of deposits and short-term borrowings. The required minimum ratio is
currently 5.0%. The Bank's liquidity ratios were 10.4%, 24.2% and 12.5% at June
30, 1996, 1995, and 1994, respectively. Historically, management of the Bank
has sought to maintain a relatively high level of liquidity in order to retain
flexibility in terms of investment opportunities and deposit pricing. If
necessary, the Bank could elect to increase its borrowings from the FHLB of
Cincinnati or increase its rates on deposits in order to generate additional
funds, and net earnings in future periods could be adversely affected as a
result. See " -- Comparison of Financial Condition at June 30, 1996 and 1995."
The Bank's most liquid asset is cash held in an interest-bearing overnight
interest account at the FHLB of Cincinnati. The level of cash is dependent on
the Bank's operating, financing and investing activities during any given
period. At June 30, 1996, 1995 and 1994, cash totaled $5.8 million, $38.6
million and $8.7 million, respectively.
12
<PAGE>
Management believes that the Bank will have sufficient funds available to
meet its current commitments. At June 30, 1996, the Bank had commitments to
originate loans of $1.7 million. Additionally, the Bank was obligated under
unused lines of credit totaling $3.8 million Certificates of deposit which were
scheduled to mature in less than one year at June 30, 1996, totaled $52.5
million. On the basis of historical experience, management believes that a
significant portion of such deposits will remain with the Bank.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements of the Company and notes thereto,
presented elsewhere herein, have been prepared in accordance with generally
accepted accounting principles, which require the measurement of financial
position and operating results in terms of historical dollars without
considering the change in the relative purchasing power of money over time and
due to inflation. The impact of inflation is reflected in the increased cost of
the Company's operations. Unlike most industrial companies, nearly all the
assets and liabilities of the Company are monetary. As a result, interest rates
have a greater impact on the Company's performance than do the effects of
general levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the price of goods and services.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
Disclosures of Fair Value of Financial Instruments. In December 1991, the
Financial Accounting Standards Board (the "FASB") issued Statement of Financial
Accounting Standards ("SFAS") No. 107, "Disclosures about Fair Value of
Financial Instruments." SFAS No. 107 requires the Company to disclose the fair
value of its financial instruments, which will include the majority of its
balance sheet accounts in addition to selected off-balance sheet items. SFAS
No. 107 became effective for the Company in fiscal 1996 because the Company has
less than $150 million in total assets. Earlier adoption was required for
entities with assets in excess of $150 million. SFAS No. 107 focuses only on
disclosure of fair values in the financial statements and, therefore, has no
effect on consolidated financial position and results of operations.
Accounting for Impaired Loans. In September 1993, the FASB issued SFAS No.
114, "Accounting by Creditors for Impairment of a Loan." SFAS No. 114 specifies
that allowances for loan losses on impaired loans should be determined using the
present value of estimated future cash flows of the loan, discounted at the
loan's effective interest rate. A loan is impaired when it is probable that all
principal and interest amounts will not be collected according to the loan
contract. SFAS No. 114 is effective for fiscal years beginning after December
15, 1994, which for the Company is the 1996 fiscal year. Management adopted
SFAS No. 114 on July 1, 1995, without material impact on consolidated financial
position or results of operations. In October 1994, the FASB amended certain of
the revenue recognition provisions of SFAS No. 114 by the issuance of SFAS No.
118. Such revisions similarly had no material effect on the consolidated
financial condition or results of operations of the Company.
Derivative Financial Instruments. In October 1994, the FASB issued SFAS
No. 119, "Disclosure About Derivative Financial Instruments and Fair Value of
Financial Instruments." SFAS No. 119 requires financial statement disclosure of
certain derivative financial instruments, defined as futures, forwards, swaps,
option contracts, or other financial instruments with similar characteristics.
In the opinion of management, the disclosure requirements of SFAS No. 119 will
not have a material effect on the Company's consolidated financial condition or
results of operations, as the Company does not invest in derivative financial
instruments, as defined in SFAS No. 119. As a result, the applicability of SFAS
No. 119 relates solely to disclosure requirements pertaining to fixed-rate and
adjustable-rate loan commitments.
Accounting for ESOP. The Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants ("AcSEC") has issued
Statement of Position ("SOP 93-6") on "Employers' Accounting for Employee Stock
Ownership Plans" ("ESOP"). SOP 93-6, among other things, changes the measure of
compensation expense recorded by employers from the cost of ESOP shares to the
fair value of ESOP shares. To
13
<PAGE>
the extent that fair value of the Company's ESOP shares differs from the cost of
such shares, compensation expense must be recorded in the Company's financial
statements for the fair value of ESOP shares allocated to participants for a
reporting period. SOP 93-6 was adopted by the Company during fiscal 1995,
without material financial statement effect.
Accounting for Mortgage Servicing. In May 1995, the FASB issued SFAS No.
122, "Accounting for Mortgage Servicing Rights." SFAS No. 122 requires that the
Company recognizes as separate assets rights to service mortgage loans for
others, regardless of how those servicing rights were acquired. An institution
that acquires mortgage servicing rights through either the purchase or
origination of mortgage loans and sells those loans with servicing rights
retained would allocate some of the cost of the loans to the mortgage servicing
rights. SFAS No. 122 also requires that an enterprise allocate the cost of
purchasing or originating the mortgage loans between the mortgage servicing
rights and the loans when mortgage loans are securitized, if it is practicable
to estimate the fair value of mortgage servicing rights. Additionally, SFAS No.
122 requires that capitalized mortgage servicing rights and capitalized excess
servicing receivables be assessed for impairment. Impairment would be measured
based on fair value. SFAS No. 122 is to be applied prospectively to the
Company's fiscal year beginning July 1, 1996, to transactions in which an entity
acquires mortgage servicing rights and to impairment evaluations of all
capitalized mortgage servicing rights and capitalized excess servicing
receivables whenever acquired. Retroactive application is prohibited. Management
adopted SFAS No. 122 on July 1, 1996, as required, without material effect on
the Company's consolidated financial position or results of operations.
Accounting for Stock-Based Compensation. In October 1994, the FASB issued
SFAS No. 123 entitled "Accounting for Stock Based Compensation." SFAS No. 123
establishes a fair value based method of accounting for stock-based compensation
paid to employees. SFAS No. 123 recognizes the fair value of an award of stock
or stock options on the grant date and is effective for transactions occurring
after December 1995. Companies are allowed to continue to measure compensation
cost for those plans using the intrinsic value based method of accounting, which
generally does not result in compensation expense recognition for most plans.
Companies that elect to remain with the existing accounting are required to
disclose in a footnote to the financial statements pro forma net earnings and,
if presented, earnings per share, as if SFAS No. 123 had been adopted.
Management has determined that the Company will continue to account for stock-
based compensation pursuant to Accounting Principles Board Opinion No. 25, and
therefore adoption of SFAS No. 123 will not have a material effect on the
Company's consolidated financial condition or results of operations.
Accounting for Transfers of Financial Assets. In June 1996, the FASB issued
SFAS No. 125, "Accounting for Transfers of Financial Assets, Servicing Rights,
and Extinguishment of Liabilities," that provides accounting guidance on
transfers of financial assets, servicing of financial assets, and extinguishment
of liabilities. SFAS No. 125 introduces an approach to accounting for transfers
of financial assets that provides a means of dealing with more complex
transactions in which the seller disposes of only a partial interest in the
assets, retains rights or obligations, makes use of special purpose entities in
the transaction, or otherwise has continuing involvement with the transferred
assets. The new accounting method, the financial components approach, provides
that the carrying amount of the financial assets transferred be allocated to
components of the transaction based on their relative fair values. SFAS No. 125
provides criteria for determining whether control of assets has been
relinquished and whether a sale has occurred. If the transfer does not qualify
as a sale, it is accounted for as a secured borrowing. Transactions subject to
the provisions of SFAS No. 125 include, among others, transfers involving
repurchase agreements, securitizations of financial assets, loan participations,
factoring arrangements, and transfers of receivables with recourse.
An entity that undertakes an obligation to service financial assets
recognizes either a servicing asset or liability for the servicing contract
(unless related to a securitization of assets, and all the securitized assets
are retained and classified as held-to-maturity). A servicing asset or
liability that is purchased or assumed is initially recognized at its fair
value. Servicing assets and liabilities are amortized in proportion to and over
the period of estimated net servicing income or net servicing loss and are
subject to subsequent assessments for impairment based on fair value.
14
<PAGE>
SFAS No. 125 provides that a liability is removed from the balance sheet
only if the debtor either pays the creditor and is relieved of its obligation
for the liability or is legally released from being the primary obligor.
SFAS No. 125 is effective for transfers and servicing of financial assets
and extinguishment of liabilities occurring after December 31, 1996, and is to
be applied prospectively. Earlier or retroactive application is not permitted.
Management does not believe that adoption of SFAS No. 125 will have a material
adverse effect on the Company's consolidated financial position or results of
operations.
OTHER DEVELOPMENTS -- BIF-SAIF PREMIUM DISPARITY; DEPOSIT INSURANCE ASSESSMENT
The Bank's savings deposits are insured by the Savings Association
Insurance Fund ("SAIF"), which is administered by the Federal Deposit Insurance
Corporation ("FDIC"). The assessment rate currently ranges from 0.23% of
deposits for well capitalized institutions to 0.31% of deposits for
undercapitalized institutions.
The FDIC also administers the Bank Insurance Fund ("BIF"), which has the
same designated reserve ratio as the SAIF. On August 8, 1995, the FDIC adopted
an amendment to the BIF risk-based assessment schedule which lowered the deposit
insurance assessment rate for most commercial banks and other depository
institutions with deposits insured by the BIF to a range of from 0.31% of
insured deposits for undercapitalized BIF-insured institutions to 0.04% of
deposits for well-capitalized institutions, which constitute over 90% of BIF-
insured institutions. The FDIC amendment became effective September 30, 1995.
On November 14, 1995, the BIF assessment rate schedule was further revised to a
statutory minimum of $2,000 annually for well capitalized institutions to 0.27%
of deposits for undercapitalized institutions. These revisions to the BIF
assessment rate schedule created a substantial disparity in the deposit
insurance premiums paid by BIF and SAIF members and placed SAIF-insured savings
institutions such as the Bank at a significant competitive disadvantage to BIF-
insured institutions.
A number of proposals have been considered to recapitalize the SAIF in
order to eliminate the premium disparity. The Senate and the House of
Representatives have both, as part of a budget reconciliation package to balance
the federal budget, approved legislation requiring a one time assessment of an
amount sufficient to bring the SAIF to a level equal to 1.25% of insured
deposits (originally estimated to be up to approximately 0.85% of insured
deposits) to be imposed on all SAIF-insured deposits held as of March 31, 1995.
This assessment was originally scheduled to be payable during the first quarter
of 1996. It is unknown whether this legislation will be enacted, or if enacted,
the amount of such special assessment. It is currently estimated that a special
assessment of between 67 and 71 basis points would be required to fully
recapitalize the SAIF. If a special assessment equal to 71 basis points were to
be required, it would result in a one-time after-tax charge of up to
approximately $410,000. Such assessment would have the effect of reducing the
Bank's tangible and core capital to $32.0 million, or 25.0%, of adjusted total
assets, and risk-based capital to $32.1 million, or 51.0%, of risk-weighted
assets as of June 30, 1996. If such a special assessment were required and the
SAIF as a result was fully recapitalized, it could have the effect of reducing
the Bank's deposit insurance premiums to the SAIF, thereby increasing net
earnings in future periods.
15
<PAGE>
[LETTERHEAD OF GRANT THORNTON LLP]
Report of Independent Certified Public Accountants
--------------------------------------------------
Board of Directors
Frankfort First Bancorp, Inc.
We have audited the accompanying consolidated statement of financial condition
of Frankfort First Bancorp, Inc. (the holding company for First Federal Savings
Bank of Frankfort) as of June 30, 1996, and the related consolidated statements
of earnings, shareholders' equity, and cash flows for the year then ended.
These consolidated financial statements are the responsibility of the
Corporation's management. Our responsibility is to express an opinion on these
financial statements based on our audit. The financial statements as of June
30, 1995, and for the years ended June 30, 1995 and 1994, were audited by other
auditors, whose report thereon dated July 20, 1995, expressed an unqualified
opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Frankfort First
Bancorp, Inc. as of June 30, 1996, and the consolidated results of its
operations and its consolidated cash flows for the year then ended, in
conformity with generally accepted accounting principles.
/s/ Grant Thornton LLP
Cincinnati, Ohio
August 23, 1996
16
<PAGE>
FRANKFORT FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30,
(In thousands, except share data)
<TABLE>
<CAPTION>
ASSETS 1996 1995
<S> <C> <C>
Cash and due from banks $ 144 $ 137
Interest-bearing deposits in other financial institutions 5,673 38,480
-------- --------
Cash and cash equivalents 5,817 38,617
Certificates of deposit in other financial institutions 200 200
Investment securities - at amortized cost, approximate
market value of $8,811 and $100 as of
June 30, 1996 and 1995 8,872 101
Loans receivable - net 110,331 100,602
Office premises and equipment - at depreciated cost 1,606 1,321
Federal Home Loan Bank stock - at cost 1,078 990
Accrued interest receivable on loans 264 177
Accrued interest receivable on investments and
interest-bearing deposits 156 35
Prepaid expenses and other assets 126 695
Prepaid federal income taxes 21 22
Deferred federal income taxes 42 12
-------- --------
Total assets $128,513 $142,772
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ 87,777 $119,041
Advances from the Federal Home Loan Bank 4,998 4,416
Other borrowed money 500 -
Advances by borrowers for taxes and insurance 267 320
Accrued interest payable 138 166
Other liabilities 568 225
-------- --------
Total liabilities 94,248 124,168
Commitments - -
Shareholders' equity
Preferred stock, 5,000,000 shares authorized, $.01 par value;
no shares issued - -
Common stock, 7,500,000 shares authorized, $.01 par value;
3,450,000 shares issued and outstanding at June 30, 1996 35 -
Additional paid-in capital 19,595 -
Retained earnings - restricted 19,120 18,604
Shares acquired by employee stock benefit plans (4,485) -
-------- --------
Total shareholders' equity 34,265 18,604
-------- -------
Total liabilities and shareholders' equity $128,513 $142,772
======== =======
</TABLE>
The accompanying notes are an integral part of these statements.
17
<PAGE>
FRANKFORT FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
For the year ended June 30,
(In thousands, except share data)
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Interest income
Loans $7,880 $7,340 $7,047
Investment securities 486 74 51
Interest-bearing deposits and other 1,333 395 336
------ ------ ------
Total interest income 9,699 7,809 7,434
Interest expense
Deposits 4,296 3,946 3,610
Borrowings 289 288 144
------ ------ ------
Total interest expense 4,585 4,234 3,754
------ ------ ------
Net interest income 5,114 3,575 3,680
Provision for losses on loans 12 12 12
------ ------ ------
Net interest income after provision
for losses on loans 5,102 3,563 3,668
Other operating income 54 50 58
General, administrative and other expense
Employee compensation and benefits 1,522 1,313 972
Occupancy and equipment 167 165 170
Federal deposit insurance premiums 231 255 234
Franchise and other taxes 149 100 102
Data processing 123 127 122
Other operating 477 310 299
------ ------ ------
Total general, administrative and other expense 2,669 2,270 1,899
------ ------ ------
Earnings before income taxes 2,487 1,343 1,827
Federal income taxes
Current 857 502 556
Deferred (30) (48) 62
------ ------ ------
Total federal income taxes 827 454 618
------ ------ ------
Net earnings before cumulative effect of
change in accounting principle 1,660 889 1,209
Cumulative effect of change in method of accounting for
income taxes - - (37)
------ ------ ------
NET EARNINGS $1,660 $ 889 $1,172
====== ====== ======
EARNINGS PER SHARE $.52 N/A N/A
=== === ===
</TABLE>
The accompanying notes are an integral part of these statements.
18
<PAGE>
FRANKFORT FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended June 30, 1996, 1995 and 1994
(In thousands, except share data)
<TABLE>
<CAPTION>
SHARES
ADDITIONAL ACQUIRED
COMMON PAID-IN RETAINED BY EMPLOYEE
STOCK CAPITAL EARNINGS BENEFIT PLANS TOTAL
<S> <C> <C> <C> <C> <C>
Balance at July 1, 1993 $ - $ - $16,543 $ - $ 16,543
Net earnings for the year ended June 30, 1994 - - 1,172 - 1,172
------ ---------- ------ ------------ --------
Balance at June 30, 1994 - - 17,715 - 17,715
Net earnings for the year ended June 30, 1995 - - 889 - 889
------ ---------- ------ ------------ --------
Balance at June 30, 1995 - - 18,604 - 18,604
Net proceeds from issuance of common stock 35 33,355 - (2,710) 30,680
Shares acquired by employee stock benefit plans - - - (1,974) (1,974)
Principal repayments on loan to ESOP and amortization of
expense related to employee benefit plans - 40 - 199 239
Net earnings for the year ended June 30, 1996 - - 1,660 - 1,660
Dividends of $4.36 per common share - (13,800) (1,144) - (14,944)
------ ------ ------ ------------ ------
Balance at June 30, 1996 $ 35 $ 19,595 $19,120 $(4,485) $ 34,265
====== ========= ======= ============= ========
</TABLE>
The accompanying notes are an integral part of these statements.
19
<PAGE>
FRANKFORT FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings for the year $ 1,660 $ 889 $ 1,172
Adjustments to reconcile net earnings to net cash
provided by (used in) operating activities:
Amortization of discounts and premiums on loans,
investments and mortgage-backed securities - net 5 - -
Amortization of deferred loan origination fees (11) (10) (18)
Depreciation and amortization 93 98 95
Provision for losses on loans 12 12 12
Amortization expense of expense related to employee stock benefit plans 239 - -
Federal Home Loan Bank stock dividends (88) (63) (44)
Increase (decrease) in cash due to changes in:
Accrued interest receivable (208) (23) (85)
Prepaid expenses and other assets 569 (430) 140
Other liabilities 315 236 (160)
Federal income taxes
Current 1 (10) (53)
Deferred (30) (48) 99
-------- -------- --------
Net cash provided by operating activities 2,557 651 1,158
Cash flows provided by (used in) investing activities:
Purchase of investment securities designated as held to maturity (12,776) - -
Proceeds from maturity of investment securities 4,000 - -
Loan principal repayments 22,483 17,667 26,856
Loan disbursements (32,213) (20,043) (32,239)
Purchase of office premises and equipment (378) (113) (73)
Increase in deposits in other financial institutions - 2,000 (2,200)
-------- -------- --------
Net cash used in investing activities (18,884) (489) (7,656)
Cash flows provided by (used in) financing activities:
Net increase (decrease) in deposit accounts (31,264) 29,926 379
Net proceeds from the issuance of common stock 30,680 - -
Purchase of shares for employee stock benefit plans (1,974) - -
Proceeds from Federal Home Loan Bank advances 904 - 4,652
Repayment of Federal Home Loan Bank advances (322) (236) -
Proceeds from other borrowed money 500 - -
Advances by borrowers for taxes and insurance (53) 26 14
Dividends on common stock (14,944) - -
------- -------- --------
Net cash provided by (used in) financing activities (16,473) 29,716 5,045
------- -------- --------
Net increase (decrease) in cash and cash equivalents (32,800) 29,878 (1,453)
Cash and cash equivalents at beginning of year 38,617 8,739 10,192
-------- -------- --------
Cash and cash equivalents at end of year $ 5,817 $ 38,617 $ 8,739
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Federal income taxes $ 909 $ 512 $ 610
======== ======= ========
Interest on deposits and borrowings $ 4,613 $ 4,190 $ 3,678
======= ======= ========
</TABLE>
The accompanying notes are an integral part of these statements.
20
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
On July 26, 1994, the Board of Directors of First Federal Savings Bank of
Frankfort (the Savings Bank) adopted a Plan of Conversion whereby the Savings
Bank would convert to the stock form of ownership (the conversion), followed
by the issuance of all of the Savings Bank's outstanding stock to a newly
formed holding company, Frankfort First Bancorp, Inc. (the Corporation), and
the issuance of common shares of the Corporation to subscribing members of the
Savings Bank. The conversion to the stock form of ownership was completed on
July 7, 1995, culminating in the Corporation's issuance of 3,450,000 common
shares. Condensed financial statements of the Corporation as of and for the
period ended June 30, 1996 are presented in Note L. Future references are
made to either the Corporation or the Savings Bank as applicable.
The Corporation is a savings and loan holding company whose activities are
primarily limited to holding the stock of the Savings Bank. The Savings Bank
conducts a general banking business in central Kentucky which primarily
consists of attracting deposits from the general public and applying those
funds to the origination of loans for residential, consumer and nonresidential
purposes. The Savings Bank's profitability is significantly dependent on net
interest income which is the difference between interest income generated from
interest-earning assets (i.e. loans and investments) and the interest expense
paid on interest-bearing liabilities (i.e. customer deposits and borrowed
funds). Net interest income is affected by the relative amount of interest-
earning assets and interest-bearing liabilities and the interest received or
paid on these balances. The level of interest rates paid or received by the
Savings Bank can be significantly influenced by a number of environmental
factors, such as governmental monetary policy, that are outside of
management's control.
The consolidated financial information presented herein has been prepared in
accordance with generally accepted accounting principles (GAAP) and general
accounting practices within the financial services industry. In preparing
consolidated financial statements in accordance with GAAP, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements and revenues and expenses during the
reporting period. Actual results could differ from such estimates.
The following is a summary of the Corporation's significant accounting
policies which have been consistently applied in the preparation of the
accompanying consolidated financial statements.
1. Principles of Consolidation
---------------------------
The consolidated financial statements include the accounts of the Corporation
and the Savings Bank. All significant intercompany balances and transactions
have been eliminated.
21
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
2. Investment Securities
---------------------
Prior to July 1, 1994, investment securities were carried at cost, adjusted
for amortization of premiums and accretion of discounts. The investment
securities were carried at cost, as it was management's intent and the Savings
Bank had the ability to hold the securities until maturity. Investment
securities held for indefinite periods of time, or which management utilized
as part of its asset/liability management strategy, or that would be sold in
response to changes in interest rates, prepayment risk, or the perceived need
to increase regulatory capital were classified as held for sale at the point
of purchase and carried at the lower of cost or market.
In 1993, the Financial Accounting Standards Board (the FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 115 "Accounting for Certain
Investments in Debt and Equity Securities". SFAS No. 115 requires that
investments in debt and equity securities be categorized as held-to-maturity,
trading, or available for sale. Securities classified as held-to-maturity are
to be carried at cost only if the Corporation has the positive intent and
ability to hold these securities to maturity. Trading securities and
securities designated as available for sale are carried at fair value with
resulting unrealized gains or losses recorded to operations or shareholders'
equity, respectively. The Savings Bank adopted SFAS No. 115 for the fiscal
year beginning July 1, 1994, by designating all investment securities as held-
to-maturity. At June 30, 1996 and 1995, the Corporation continued to
designate all investment securities as held-to-maturity.
Realized gains or losses on sales of securities are recognized using the
specific identification method.
3. Loans Receivable
----------------
Loans receivable are stated at the principal amount outstanding, adjusted for
deferred loan origination fees and the allowance for loan losses. Interest is
accrued as earned unless the collectibility of the loan is in doubt. Interest
on loans that are contractually past due is charged off, or an allowance is
established based on management's periodic evaluation. The allowance is
established by a charge to interest income equal to all interest previously
accrued, and income is subsequently recognized only to the extent that cash
payments are received until, in management's judgment, the borrower's ability
to make periodic interest and principal payments has returned to normal, in
which case the loan is returned to accrual status. If the ultimate
collectibility of the loan is in doubt, in whole or in part, all payments
received on nonaccrual loans are applied to reduce principal until such doubt
is eliminated.
22
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
4. Loan Origination Fees
---------------------
The Savings Bank accounts for loan origination fees in accordance with SFAS
No. 91 "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Cost of Leases". Pursuant
to the provisions of SFAS No. 91, origination fees received from loans, net of
direct origination costs, are deferred and amortized to interest income using
the level-yield method, giving effect to actual loan prepayments.
Additionally, SFAS No. 91 generally limits the definition of loan origination
costs to the direct costs attributable to originating a loan, i.e.,
principally actual personnel costs. Fees received for loan commitments that
are expected to be drawn upon, based on the Savings Bank's experience with
similar commitments, are deferred and amortized over the life of the loan
using the level-yield method. Fees for other loan commitments are deferred
and amortized over the loan commitment period on a straight-line basis.
5. Allowance for Losses on Loans
-----------------------------
It is the Savings Bank's policy to provide valuation allowances for estimated
losses on loans based on past loss experience, trends in the level of
delinquent and problem loans, adverse situations that may affect the
borrower's ability to repay, the estimated value of any underlying collateral
and current and anticipated economic conditions in the primary lending area.
When the collection of a loan becomes doubtful, or otherwise troubled, the
Savings Bank records a loan charge-off equal to the difference between the
fair value of the property securing the loan and the loan's carrying value.
Lending areas are reviewed periodically to determine potential problems at an
early date. The allowance for loan losses is increased by charges to earnings
and decreased by charge-offs (net of recoveries).
In June 1993, the FASB issued SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan". This promulgation, which was amended by SFAS No. 118
as to certain income recognition and disclosure provisions and was effective
as to the Corporation in fiscal 1996, requires that impaired loans be measured
based upon the present value of expected future cash flows discounted at the
loan's effective interest rate or, as an alternative, at the loan's observable
market price or fair value of the collateral. The Savings Bank's current
procedures for evaluating impaired loans result in carrying such loans at the
lower of cost or fair value.
The Savings Bank adopted SFAS No. 114, as subsequently amended, on July 1,
1995, without material effect on consolidated financial condition or results
of operations.
A loan is defined under SFAS No. 114 as impaired when, based on current
information and events, it is probable that a creditor will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. In applying the provisions of SFAS No. 114, the Savings Bank
considers its investment in one-to-four family residential loans and consumer
installment loans to be homogeneous and therefore excluded from separate
identification for evaluation of impairment. With respect to the Savings
Bank's investment in impaired multi-family and nonresidential loans, such
loans are collateral dependent and, as a result, are carried as a practical
expedient at the lower of cost or fair value.
23
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
5. Allowance for Losses on Loans (continued)
-----------------------------
Collateral dependent loans which are more than ninety days delinquent are
considered to constitute more than a minimum delay in repayment and are
evaluated for impairment under SFAS No. 114 at that time.
At June 30, 1996, the Savings Bank had no loans that would be defined as
impaired under SFAS No. 114.
6. Office Premises and Equipment
-----------------------------
Office premises and equipment are carried at cost and include expenditures
which extend the useful lives of existing assets. Maintenance, repairs and
minor renewals are expensed as incurred. For financial reporting,
depreciation and amortization are provided on the straight-line and
accelerated methods over the useful lives of the assets, estimated to be forty
years for buildings, ten to forty years for building improvements, and five to
ten years for furniture and equipment. An accelerated method is used for tax
reporting purposes.
7. Federal Income Taxes
--------------------
The Corporation accounts for federal income taxes in accordance with the
provisions of SFAS No. 109, "Accounting for Income Taxes". SFAS No. 109
established financial accounting and reporting standards for the effects of
income taxes that result from the Corporation's activities within the current
and previous years. Pursuant to the provisions of SFAS No. 109, a deferred
tax liability or deferred tax asset is computed by applying the current
statutory tax rates to net taxable or deductible differences between the tax
basis of an asset or liability and its reported amount in the financial
statements that will result in taxable or deductible amounts in future
periods. Deferred tax assets are recorded only to the extent that the amount
of net deductible temporary differences or carryforward attributes may be
utilized against current period earnings, carried back against prior years
earnings, offset against taxable temporary differences reversing in future
periods, or utilized to the extent of management's estimate of future taxable
income. A valuation allowance is provided for deferred tax assets to the
extent that the value of net deductible temporary differences and carryforward
attributes exceeds management's estimates of taxes payable on future taxable
income. Deferred tax liabilities are provided on the total amount of net
temporary differences taxable in the future.
24
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
7. Federal Income Taxes (continued)
--------------------
The Corporation's principal temporary differences between pretax financial
income and taxable income result from different methods of accounting for
deferred loan origination fees and costs, Federal Home Loan Bank stock
dividends, the general loan loss allowance, deferred compensation, and
percentage of earnings bad debt deductions. Additional temporary differences
result from depreciation computed using accelerated methods for tax purposes.
8. Retirement and Employee Benefit Plans
-------------------------------------
In conjunction with the conversion, the Corporation implemented an Employee
Stock Ownership Plan (ESOP). The ESOP provides retirement benefits for
substantially all employees who have completed one year of service and have
attained the age of 21. Expense recognized related to the ESOP totaled
approximately $238,000 for the year ended June 30, 1996.
The Corporation accounts for expense under the ESOP in accordance with
Statement of Position 93-6, "Employers' Accounting for Employee Stock
Ownership Plans" (SOP 93-6). SOP 93-6 changed the measure of compensation
expense recorded by employers from the cost of allocated ESOP shares to the
fair value of ESOP shares allocated to participants during a fiscal year.
Utilization of SOP 93-6 resulted in a $40,000 increase in compensation expense
recorded for the fiscal year ended June 30, 1996 from the amount which would
be computed under the prior accounting literature.
The Corporation also has a Management Recognition Plan (MRP). Subsequent to
the conversion the MRP purchased 136,920 shares of common stock in the open
market. All of the shares available under the MRP were granted to executive
officers, directors and employees of the Savings Bank upon receipt of
shareholder approval of the Plan. Common stock granted under the MRP vests
over a five year period at twenty percent per year, commencing in January
1996. A provision of $178,000 related to the MRP was charged to expense for
the year ended June 30, 1996.
Also, the Board of Directors adopted the Frankfort First Bancorp, Inc. 1995
Stock Option and Incentive Plan (the Plan) that provided for the issuance of
345,000 shares of authorized, but unissued shares of common stock at fair
market value at the date of grant. The Corporation has granted options to
purchase shares at the fair value of $13.00 per share. Such fair value will
be adjusted in the subsequent period to give effect to the $4.00 return of
capital dividend (Note A-9) paid by the Corporation in fiscal 1996, in order
to place option holders in an economically equivalent position post-dividend.
The Plan provides for one-fifth of the shares granted to be exercisable on
each of the first five anniversaries of the date of the Plan, commencing in
January 1996. As of June 30, 1996, none of the stock options granted had been
exercised.
25
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
8. Retirement and Employee Benefit Plans (continued)
-------------------------------------
During fiscal 1995, the Savings Bank transferred its defined benefit funds
into a multiemployer defined benefit pension plan. Essentially all of the
former plan provisions were transferred to the new plan. All employees over
21 years of age enter the plan at the first entrance date after completing one
year of service. The transfer of funds to this multiemployer plan effectively
terminated the old plan. With the plan termination, the 1994 prepaid pension
costs of $127,710 were expensed in the fiscal year ended June 30, 1995. For
the fiscal years ended June 30, 1996 and 1995, the Savings Bank recorded
expense totaling $88,000 and $96,000 in pension costs.
For the year ended June 30, 1994, the Savings Bank had a qualified,
noncontributory defined-benefit retirement plan covering substantially all of
its employees. The benefits were based on each employee's years of service up
to a maximum of 30 years, and the average of the highest five consecutive
annual salaries of the ten years prior to retirement. An employee became
fully vested upon completion of seven years of qualifying service. Financial
statement presentation uses actuarial cost method as required by SFAS No. 87.
It was the policy of the Savings Bank to fund the maximum amount that can be
deducted for federal income tax purposes.
Funding of the plan was achieved through contributions made to an irrevocable
trust fund. At June 30, 1994, all fund assets were invested in certificates
of deposit of the Savings Bank. Contributions were determined in accordance
with the Frozen Initial Liability Cost Method, an acceptable funding method
under the Employee Retirement Income Security Act (ERISA) of 1974.
The following table sets forth the plan's funded status and amounts recognized
in the Savings Bank's statement of financial condition as of June 30, 1994.
(In thousands)
1. Vested Benefit Obligation $(788)
2. Accumulated Benefit Obligation (795)
3. Projected Benefit Obligation (971)
4. Plan assets at market value 813
5. Funded Status = (3) + (4) (158)
6. Unrecognized net obligation 183
7. Unrecognized prior service cost -
8. Unrecognized net (gain) or loss 103
9. Adjustment required to recognize minimum liability -
10. Prepaid pension cost = (5) + (6) + (7) + (8) + (9) 128
26
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
8. Retirement and Employee Benefit Plans (continued)
-------------------------------------
The components of net pension expense for the year ended June 30, 1994 are as
follows:
(In thousands)
Service cost-benefits earned during the period $ 61
Interest cost on projected benefit obligation 70
Actual return on plan assets (25)
Net amortization and deferral 2
----
Net pension expense $108
====
Assumptions used to develop the net periodic pension cost were:
Discount rate (compounded annually) 7%
Expected long-term rate of return on assets (compounded annually) 7%
Rate of increase in compensation levels 6%
The Savings Bank also offered a thrift savings plan [401(k)] to its employees
with at least one year of service. Participants could designate up to 15% of
their annual compensation as their contribution to the plan. The Savings Bank
did not match any contribution under the plan. Management terminated the plan
during the fiscal year ending June 30, 1995. Funds in this account were
transferred to self-directed individual retirement accounts.
9. Earnings Per Share and Dividends Per Share
------------------------------------------
Earnings per share for the year ended June 30, 1996 is based upon the
weighted-average shares outstanding during the period plus those stock options
that are dilutive, less shares in the ESOP that are unallocated and not
committed to be released. Weighted-average common shares deemed outstanding,
which gives effect to a reduction for 251,110 unallocated shares held by the
ESOP, totaled 3,198,890 for the fiscal year ended June 30, 1996. There is no
dilutive effect attendant to the Corporation's stock option plan.
The provisions of Accounting Principles Board Opinion No. 15 "Earnings Per
Share" are not applicable to the fiscal years ended June 30, 1995 and 1994, as
the Corporation had not issued any common stock prior to July 1995.
During fiscal 1996, the Corporation declared dividends of $4.36 per common
share. Of this amount, $4.00 per share was paid in June 1996 from funds
retained by the Corporation in the conversion and was deemed by management to
constitute a return of excess capital. Accordingly, the Corporation charged
the return of capital dividend to additional paid-in-capital. Management has
obtained a Private Letter Ruling from the Internal Revenue Service which
states that the Corporation's dividend payments in excess of accumulated
earnings and profits are considered a tax-free return of capital for federal
income tax purposes. As a result, management believes that approximately
$4.12 of the current fiscal year dividends constitute a tax-free return of
capital.
27
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
10. Fair Value of Financial Instruments
-----------------------------------
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments",
requires disclosure of the fair value of financial instruments, both assets
and liabilities whether or not recognized in the consolidated statement of
financial condition, for which it is practicable to estimate that value. For
financial instruments where quoted market prices are not available, fair
values are based on estimates using present value and other valuation methods.
The methods used are greatly affected by the assumptions applied, including
the discount rate and estimates of future cash flows. Therefore, the fair
values presented may not represent amounts that could be realized in an
exchange for certain financial instruments.
The following methods and assumptions were used by the Corporation in
estimating its fair value disclosures for financial instruments at June 30,
1996:
Cash and cash equivalents: The carrying amounts presented in the
-------------------------
consolidated statement of financial condition for cash and cash
equivalents are deemed to approximate fair value.
Certificates of deposit in other financial institutions: The carrying
-------------------------------------------------------
amounts presented in the consolidated statement of financial condition
for certificates of deposit in other financial institutions are deemed
to approximate fair value.
Investment securities: For investment securities, fair value is
---------------------
deemed to equal the quoted market price.
Loans receivable: The loan portfolio has been segregated into
----------------
categories with similar characteristics, such as one-to-four family
residential, multi-family residential and nonresidential real estate.
These loan categories were further delineated into fixed-rate and
adjustable-rate loans. The fair values for the resultant loan
categories were computed via discounted cash flow analysis, using
current interest rates offered for loans with similar terms to
borrowers of similar credit quality. For loans on deposit accounts
and consumer and other loans, fair values were deemed to equal the
historic carrying values. The historical carrying amount of accrued
interest on loans is deemed to approximate fair value.
Federal Home Loan Bank stock: The carrying amount presented in the
----------------------------
consolidated statement of financial condition is deemed to
approximate fair value.
Deposits: The fair value of NOW accounts, passbook accounts, money
--------
market deposits and advances by borrowers for taxes and insurance are
deemed to approximate the amount payable on demand. Fair values for
fixed-rate certificates of deposit have been estimated using a
discounted cash flow calculation using the interest rates currently
offered for deposits of similar remaining maturities.
28
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
10. Fair Value of Financial Instruments (continued)
-----------------------------------
Advances from the Federal Home Loan Bank: The fair value of these
----------------------------------------
advances is estimated using the rates currently offered for similar
advances of similar remaining maturities or, when available, quoted
market prices.
Other borrowed money: The fair value of other borrowed money is
--------------------
estimated using rates currently offered for similar borrowings of
similar remaining maturities or, when available, quoted market prices.
Commitments to extend credit: For fixed-rate and adjustable-rate loan
----------------------------
commitments, the fair value estimate considers the difference between
current levels of interest rates and committed rates. The difference
between the fair value and notional amount of outstanding loan
commitments at June 30, 1996, was not material.
Based on the foregoing methods and assumptions, the carrying value and fair
value of the Corporation's financial instruments at June 30, 1996, are as
follows:
<TABLE>
<CAPTION>
CARRYING FAIR
VALUE VALUE
<S> <C> <C>
(In thousands)
Financial assets
Cash and cash equivalents $ 5,817 $ 5,817
Certificates of deposit in other financial
institutions 200 200
Investment securities 8,872 8,811
Loans receivable 110,331 107,945
Stock in Federal Home Loan Bank 1,078 1,078
-------- --------
$126,298 $123,851
======== ========
Financial liabilities
Deposits $ 87,777 $ 88,459
Advances from the Federal Home Loan Bank 4,998 4,998
Other borrowed money 500 500
Advances by borrowers for taxes and insurance 267 267
-------- --------
$ 93,542 $ 94,224
======== ========
</TABLE>
11. Cash and Cash Equivalents
-------------------------
For purposes of reporting cash flows, cash and cash equivalents include cash
and due from banks and interest-bearing deposits in other financial
institutions with original maturities of less than ninety days.
29
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
12. Reclassifications
-----------------
Certain prior year amounts have been reclassified to conform to the 1996
consolidated financial statement presentation.
NOTE B - INVESTMENTS
Carrying values and approximate market values of investment securities held to
maturity at June 30 are summarized as follows:
<TABLE>
<CAPTION>
1996 1995
CARRYING MARKET CARRYING MARKET
VALUE VALUE VALUE VALUE
(In thousands)
<S> <C> <C> <C> <C>
U.S. Government agency
obligations $8,772 $8,711 $- $-
Municipal securities 100 100 101 100
------ ------ ---- ----
$8,872 $8,811 $101 $100
====== ====== ==== ====
</TABLE>
At June 30, 1996, the carrying value of the Corporation's investment
securities exceeded market value by $61,000, consisting of $5,000 in gross
unrealized gains and $66,000 in gross unrealized losses. At June 30, 1995,
the carrying value of the Corporation's investment securities exceeded market
value by $1,000, consisting solely of gross unrealized losses.
The amortized cost and market value of U.S. Government agency obligations and
municipal securities designated as held to maturity, by contractual term to
maturity at June 30 are shown below:
<TABLE>
<CAPTION>
1996 1995
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
(In thousands)
<S> <C> <C> <C> <C>
Due in three years or less $7,872 $7,864 $101 $100
Due after five years 1,000 947 - -
------ ------ ---- ----
$8,872 $8,811 $101 $100
====== ====== ==== ====
</TABLE>
30
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE C - LOANS RECEIVABLE
The composition of the loan portfolio at June 30 is as follows:
1996 1995
(In thousands)
Residential real estate
One-to-four family $108,126 $98,265
Multi-family 123 134
Construction 672 270
Nonresidential real estate and land 1,450 1,549
Consumer and other 547 618
-------- -------
110,918 100,836
Less:
Undisbursed portion of loans in process (392) (123)
Deferred loan origination fees (100) (28)
Allowance for loan losses (95) (83)
-------- -------
$110,331 $100,602
======= =======
The Savings Bank's lending efforts have historically focused on one-to-four
family and multi-family residential real estate loans, which comprise
approximately $108.5 million, or 98%, of the total loan portfolio at June 30,
1996, and $98.4 million, or 98%, of the total loan portfolio at June 30, 1995.
Generally, such loans have been underwritten on the basis of no more than an
80% loan-to-value ratio, which has historically provided the Savings Bank with
adequate collateral coverage in the event of default. Nevertheless, the
Savings Bank, as with any lending institution, is subject to the risk that
real estate values could deteriorate in its primary lending area of central
Kentucky, thereby impairing collateral values. However, management is of the
belief that residential real estate values in the Savings Bank's primary
lending area are presently stable.
In the normal course of business, the Savings Bank has made loans to some of
its directors, officers and employees. Related party loans are made on
substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with unrelated
persons and do not involve more than the normal risk of collectibility. The
aggregate dollar amount of loans outstanding to directors and officers totaled
approximately $289,000 and $256,000 at June 30, 1996 and 1995, respectively.
31
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE D - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is summarized as follows for the
years ended June 30:
1996 1995 1994
(In thousands)
Balance at beginning of year $83 $71 $59
Provision for loan losses 12 12 12
--- --- ---
Balance at end of year $95 $83 $71
=== === ===
As of June 30, 1996, the Savings Bank's allowance for loan losses was solely
general in nature, and is includible as a component of regulatory risk-based
capital, subject to certain percentage limitations.
Nonperforming loans totaled approximately $118,000, $34,000 and $213,000 at
June 30, 1996, 1995 and 1994, respectively, and did not result in any
reduction in interest income during the respective periods.
NOTE E - OFFICE PREMISES AND EQUIPMENT
Office premises and equipment at June 30 are comprised of the following:
1996 1995
(In thousands)
Land and improvements $ 187 $ 187
Office buildings and improvements 1,685 1,334
Furniture, fixtures and equipment 733 706
------ ------
2,605 2,227
Less accumulated depreciation and
amortization 999 906
------ ------
$1,606 $1,321
====== ======
32
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE F - DEPOSITS
Deposits consist of the following major classifications at June 30:
<TABLE>
<CAPTION>
DEPOSIT TYPE AND WEIGHTED-
AVERAGE INTEREST RATE 1996 1995
(In thousands)
<S> <C> <C>
NOW accounts
1996 - 2.73% $ 4,004
1995 - 3.08% $ 3,197
Passbook
1996 - 3.00% 11,374
1995 - 3.83% 46,485
Money market deposit accounts
1996 - 3.48% 6,185
1995 - 3.26% 6,211
Total demand, transaction and -------- --------
passbook deposits
21,563 55,893
Certificates of deposit
Original maturities of:
Less than 12 months
1996 - 4.81% 11,852
1995 - 5.27% 11,315
12 months to 24 months
1996 - 5.84% 42,534
1995 - 5.79% 40,367
30 months to 36 months
1996 - 5.33% 8,249
1995 - 5.09% 7,868
More than 36 months
1996 - 5.51% 3,579
1995 - 5.55% 3,598
------- --------
Total certificates of deposit 66,214 63,148
------- --------
Total deposit accounts $87,777 $119,041
======= ========
</TABLE>
33
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE F - DEPOSITS (continued)
Maturities of outstanding certificates of deposit at June 30 are summarized as
follows:
1996 1995
(In thousands)
Less than one year $52,451 $37,751
One to three years 12,933 23,401
Over three years 830 1,996
------- -------
$66,214 $63,148
======= =======
NOTE G - ADVANCES FROM THE FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank, collateralized at June 30, 1996 by
pledges of certain residential mortgage loans totaling $7.5 million, and the
Savings Bank's investment in Federal Home Loan Bank stock, are summarized as
follows:
MATURING
YEAR ENDING
INTEREST RATE JUNE 30, 1996 1995
(In thousands)
6.69% 2004 $ 807 $ 911
6.16% 2009 3,293 3,505
6.61% 2016 898 -
------ ------
$4,998 $4,416
====== ======
NOTE H - OTHER BORROWED MONEY
At June 30, 1996, other borrowed money consisted of an unsecured fixed-rate
bank note, bearing interest at a rate of 8.25%, which matured in July 1996.
34
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE I - FEDERAL INCOME TAXES
Federal income taxes differ from the amounts computed at the statutory
corporate tax rate as follows:
JUNE 30,
1996 1995 1994
(In thousands)
Federal income taxes computed at
statutory rate $ 846 $ 457 $ 621
Decrease in taxes resulting from:
Interest on municipal securities (2) (2) (2)
Other (17) (1) (1)
----- ----- -----
Federal income tax provision per consolidated
statements of earnings $ 827 $ 454 $ 618
===== ===== =====
The composition of the Corporation's net deferred tax asset at June 30 is as
follows:
1996 1995
(In thousands)
Taxes (payable) refundable on temporary
differences at estimated corporate tax rate:
Deferred tax assets:
General loan loss allowance $ 32 $ 28
Deferred loan origination fees 6 10
Deferred compensation 61 -
Book/tax depreciation 14 11
---- ----
Total deferred tax assets 113 49
Deferred tax liabilities:
Percentage of earnings bad debt deductions (47) (37)
Federal Home Loan Bank stock dividends (24) -
---- ----
Total deferred tax liabilities (71) (37)
---- ----
Net deferred tax asset $ 42 $ 12
==== ====
35
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE I - FEDERAL INCOME TAXES (continued)
The Savings Bank is allowed a special bad debt deduction, generally limited to
8% of otherwise taxable income, and subject to certain limitations based on
aggregate loans and deposit account balances at the end of the year. If the
amounts that qualify as deductions for federal income taxes are later used for
purposes other than bad debt losses, including distributions in liquidation,
such distributions will be subject to federal income taxes at the then current
corporate income tax rate. Retained earnings at June 30, 1996 include
approximately $5.3 million for which federal income taxes have not been
provided. The approximate amount of unrecognized deferred tax liability
relating to the cumulative bad debt deduction was approximately $1.8 million
at June 30, 1996. See Note K for additional information regarding the Savings
Bank's percentage of earnings bad debt deductions.
NOTE J - LOAN COMMITMENTS
The Savings Bank is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of their
customers including commitments to extend credit. Such commitments involve,
to varying degrees, elements of credit and interest-rate risk in excess of the
amount recognized in the statement of financial condition. The contract or
notional amounts of the commitments reflect the extent of the Savings Bank's
involvement in such financial instruments.
The Savings Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit
is represented by the contractual notional amount of those instruments. The
Savings Bank uses the same credit policies in making commitments and
conditional obligations as those utilized for on-balance-sheet instruments.
At June 30, 1996, the Savings Bank had outstanding commitments of
approximately $1.7 million to originate loans. Additionally, the Savings Bank
was obligated under unused lines of credit totaling $3.8 million. In the
opinion of management all loan commitments equaled or exceeded prevalent
market interest rates as of June 30, 1996, and will be funded from normal cash
flow from operations.
36
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE K - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL
The Savings Bank is subject to minimum regulatory capital requirements
promulgated by the Office of Thrift Supervision (OTS). Such minimum capital
standards generally require the maintenance of regulatory capital sufficient
to meet each of three tests, hereinafter described as the tangible capital
requirement, the core capital requirement and the risk-based capital
requirement. The tangible capital requirement provides for minimum tangible
capital (defined as shareholders' equity less all intangible assets) equal to
1.5% of adjusted total assets. The core capital requirement provides for
minimum core capital (tangible capital plus certain forms of supervisory
goodwill and other qualifying intangible assets such as capitalized mortgage
servicing rights) equal to 3.0% of adjusted total assets. A recent OTS
proposal, if adopted in present form, would increase the core capital
requirement to a range of 4% - 5% of adjusted total assets for substantially
all savings institutions. Management anticipates no material change to the
Savings Bank's present excess regulatory capital position as a result of this
change in the regulatory capital requirement. The risk-based capital
requirement provides for the maintenance of core capital plus general loss
allowances equal to 8.0% of risk-weighted assets. In computing risk-weighted
assets, the Savings Bank multiplies the value of each asset on its statement
of financial condition by a defined risk-weighting factor, e.g., one-to-four
family residential loans carry a risk-weighted factor of 50%.
As of June 30, 1996, the Savings Bank's regulatory capital exceeded all
minimum regulatory capital requirements as shown in the following table:
<TABLE>
<CAPTION>
REGULATORY CAPITAL
TANGIBLE CORE RISK-BASED
CAPITAL PERCENT CAPITAL PERCENT CAPITAL PERCENT
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Capital under generally accepted
accounting principles $32,373 $32,373 $32,373
Additional capital items
General valuation
allowances - - 95
------- ------- -------
Regulatory capital computed 32,373 25.2 32,373 25.2 32,468 51.6
Minimum capital requirement 1,927 1.5 3,854 3.0 5,032 8.0
------- ---- ------- ---- ------- ----
Regulatory capital - excess $30,446 23.7 $28,519 22.2 $27,436 43.6
======= ==== ======= ==== ======= ====
</TABLE>
The deposit accounts of the Savings Bank and of other savings associations are
insured by the FDIC in the Savings Association Insurance Fund ("SAIF"). The
reserves of the SAIF are below the level required by law, because a
significant portion of the assessments paid into the fund are used to pay the
cost of prior thrift failures. The deposit accounts of commercial banks are
insured by the FDIC in the Bank Insurance Fund ("BIF"), except to the extent
such banks have acquired SAIF deposits. The reserves of the BIF met the level
required by law in May 1995. As a result of the respective reserve levels of
the funds, deposit insurance assessments paid by healthy savings associations
exceeded those paid by healthy commercial banks by approximately $.19 per $100
in deposits in 1995. In 1996, no BIF assessments will be required for healthy
commercial banks except for a $2,000 minimum fee. A continuation of this
premium disparity could have a negative competitive impact on the Savings Bank
and other institutions with SAIF deposits.
37
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE K - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL (continued)
Congress is considering legislation to recapitalize the SAIF and eliminate the
significant premium disparity. Currently, that recapitalization plan provides
for a special assessment ranging from approximately $.69 to $.71 per $100 of
SAIF deposits held at March 31, 1995, in order to increase SAIF reserves to
the level required by law. In addition, the cost of prior thrift failures
would be shared by both the SAIF and the BIF. This would likely increase BIF
assessments by $.02 to $.025 per $100 in deposits. SAIF assessments would
initially be set at the same level as BIF assessments and could never be
reduced below the level for BIF assessments. These projected assessment
levels may change if commercial banks holding SAIF deposits are provided some
relief from the special assessment or are allowed to transfer SAIF deposits to
the BIF.
A component of the recapitalization plan provides for the merger of the SAIF
and BIF on January 1, 1998. However, the SAIF recapitalization legislation
currently provides for an elimination of the thrift charter or of the separate
federal regulation of thrifts prior to the merger of the deposit insurance
funds. As a result, the Savings Bank will be regulated as a bank under
federal laws which would subject it to the more restrictive activity limits
imposed on national banks. Under separate legislation recently enacted into
law, the Savings Bank is required to recapture, as taxable income,
approximately $139,000 of its bad debt reserve, which represents the post-1987
additions to the reserve, and will be unable to utilize the percentage of
earnings method to compute its reserve in the future. The Savings Bank will
be permitted by such legislation to amortize the recapture of its bad debt
reserve into taxable income over six years. The Savings Bank has previously
provided deferred taxes on the amount of the bad debt reserve subject to
recapture.
The Savings Bank had $86.8 million in deposits at March 31, 1995. If the
special assessment level is finalized at $.71 per $100 in deposits, the
Savings Bank will pay an assessment of approximately $620,000. This
assessment will be tax deductible, but will reduce earnings and capital for
the quarter in which the legislation is finalized.
No assurances can be given that the SAIF recapitalization plan will be enacted
into law or in what form it may be enacted. In addition, the Savings Bank can
give no assurances that the disparity between BIF and SAIF assessments will be
eliminated and cannot predict the impact of being regulated as a bank, until
the legislation requiring such change is enacted.
38
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE L - CONDENSED FINANCIAL STATEMENTS OF FRANKFORT FIRST BANCORP, INC.
The following condensed financial statements summarize the financial position
of Frankfort First Bancorp, Inc. as of June 30, 1996, and the results of its
operations for the period then ended.
FRANKFORT FIRST BANCORP, INC.
STATEMENT OF FINANCIAL CONDITION
June 30, 1996
(In thousands)
ASSETS
Interest-bearing deposits in First Federal Savings Bank
of Frankfort $ 160
Loan receivable from ESOP 2,511
Investment in First Federal Savings Bank of Frankfort 32,373
Prepaid expenses and other 62
-------
Total assets $35,106
=======
LIABILITIES AND SHAREHOLDERS' EQUITY
Other borrowed money $ 500
Dividends payable 311
Other liabilities 31
-------
842
Shareholders' equity
Common stock 35
Additional paid-in capital 38,715
Retained earnings -
Shares acquired by employee stock benefit plans (4,485)
-------
Total shareholders' equity 34,265
-------
Total liabilities and shareholders' equity $35,106
=======
FRANKFORT FIRST BANCORP, INC.
STATEMENT OF EARNINGS
Period ended June 30, 1996
(In thousands)
Revenue
Interest income $ 632
Equity in earnings of First Federal Savings Bank of Frankfort 1,519
------
Total revenue 2,151
General and administrative expenses 405
------
Earnings before income taxes 1,746
Federal income taxes 86
------
NET EARNINGS $1,660
======
39
<PAGE>
<TABLE>
<CAPTION>
BOARD OF DIRECTORS
<S> <C> <C>
WILLIAM C. JENNINGS CHARLES A. COTTON, III DAVID EDDINS
President and Chairman of the Board of Commissioner of the Department Certified Public Accountant
the Bank and the Company of Housing, Building and
Construction
Commonwealth of Kentucky
DANNY A. GARLAND HERMAN D. REGAN, JR. WILLIAM M. JOHNSON
Vice President and Secretary of the Bank Retired Chairman of the Board Attorney
and the Company and President
Kenvirons, Inc.
FRANK MCGRATH C. MICHAEL DAVENPORT
President President
Frankfort Lumber Company C. Michael Davenport, Inc.
EXECUTIVE OFFICERS
WILLIAM C. JENNINGS DANNY A. GARLAND JOYCE H. JENNINGS
President and Chairman of the Board Vice President and Secretary Vice President and Treasurer
OFFICE LOCATIONS
MAIN OFFICE AND CORPORATE BRANCH OFFICES:
HEADQUARTERS: East Branch West Branch
216 West Main Street 1980 Versailles Road 1220 US 127 South
Frankfort, Kentucky 40601 Frankfort, Kentucky 40601 Frankfort, Kentucky 40601
(502) 223-1638
GENERAL INFORMATION
INDEPENDENT AUDITORS ANNUAL MEETING SHAREHOLDER INQUIRIES AND AVAILABILITY
Grant Thornton LLP The Annual Meeting of Share- OF 10-K REPORT
Suite 900 holders will be held on A COPY OF THE COMPANY'S
625 Eden Park Drive November 12, 1996 at 4:30 p.m. ANNUAL REPORT ON FORM 10-K
Cincinnati, Ohio 45202-4181 at First Federal Savings Bank of FOR THE FISCAL YEAR ENDED
Frankfort JUNE 30, 1996 AS FILED WITH
SPECIAL COUNSEL 216 W. Main Street THE SECURITIES AND
Housley Kantarian & Bronstein, P.C. Frankfort, Kentucky 40601 EXCHANGE COMMISSION WILL
1220 19th Street, N.W. Suite 700 BE FURNISHED WITHOUT
Washington, D.C. 20036 TRANSFER AGENT AND REGISTRAR CHARGE TO SHAREHOLDERS AS
Illinois Stock Transfer OF THE RECORD DATE FOR THE
223 W. Jackson Blvd., Suite NOVEMBER 12, 1996 ANNUAL
1210 MEETING UPON WRITTEN
Chicago, Illinois 60606 REQUEST TO INVESTOR
RELATIONS, FRANKFORT FIRST
BANCORP, INC., 216 W. MAIN
STREET, FRANKFORT,
KENTUCKY 40601.
</TABLE>
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Parent
- ------
Frankfort First Bancorp, Inc.
State or Other
Jurisdiction of Percentage
Subsidiaries (1) Incorporation Ownership
- ---------------- ------------- ---------
First Federal Savings Bank of Frankfort United States 100%
_________________
(1) The assets, liabilities and operations of the subsidiaries are included in
the consolidated financial statements contained in the Annual Report to
Stockholders attached hereto as an exhibit.
<PAGE>
[LETTERHEAD OF GRANT THORNTON LLP]
ACCOUNTANTS' CONSENT
We have issued our report dated August 23, 1996, accompanying the
consolidated financial statements of Frankfort First Bancorp, Inc. which are
incorporated within the Annual Report on Form 10-K for the year ended June 30,
1996. We hereby consent to the incorporation by reference of said report in
Frankfort First Bancorp, Inc.'s Form S-8.
/s/ GRANT THORNTON LLP
Cincinnati, Ohio
September 25, 1996
<PAGE>
[LETTERHEAD OF BUTLER & ASSOCIATES, P.S.C]
CONSENT OF INDEPENDENT AUDITORS
-------------------------------
We consent to the incorporation by reference in the registration
statement of Frankfort First Bancorp, Inc. and Subsidiary on Form S-8 (as filed
with the Commission on January 17, 1996) of our report dated July 20, 1995 and
the related statements of financial condition, income, retained earnings and
cash flows for First Federal Savings Bank of Frankfort as of June 30, 1995 and
1994 which are included in the consolidated financial statements of Frankfort
First Bancorp,, Inc. and subsidiary and which report is incorporated by
reference in this Annual Report on Form 10-K.
/s/Butler & Associates, P.S.C.
September 26, 1996
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1996
<PERIOD-START> JUL-1-1995
<PERIOD-END> JUN-30-1996
<CASH> 144
<INT-BEARING-DEPOSITS> 5,673
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 9,072
<INVESTMENTS-MARKET> 9,011
<LOANS> 110,331
<ALLOWANCE> 95
<TOTAL-ASSETS> 128,513
<DEPOSITS> 87,777
<SHORT-TERM> 500
<LIABILITIES-OTHER> 974
<LONG-TERM> 4,998
0
0
<COMMON> 35
<OTHER-SE> 34,230
<TOTAL-LIABILITIES-AND-EQUITY> 128,513
<INTEREST-LOAN> 7,880
<INTEREST-INVEST> 486
<INTEREST-OTHER> 1,333
<INTEREST-TOTAL> 9,699
<INTEREST-DEPOSIT> 4,296
<INTEREST-EXPENSE> 4,585
<INTEREST-INCOME-NET> 5,114
<LOAN-LOSSES> 12
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 2,669
<INCOME-PRETAX> 2,487
<INCOME-PRE-EXTRAORDINARY> 1,660
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,660
<EPS-PRIMARY> .52
<EPS-DILUTED> .52
<YIELD-ACTUAL> 7.13
<LOANS-NON> 0
<LOANS-PAST> 118
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 99
<ALLOWANCE-OPEN> 83
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 95
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 95
</TABLE>
