<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 1998
[_] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
Commission File No. 0-26360
FRANKFORT FIRST BANCORP, INC.
------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 61-1271129
------------------------------- -------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
216 W. MAIN STREET, FRANKFORT, KENTUCKY 40601
- ---------------------------------------- -------------------
(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
--------------------------------------
(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
----- -----
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. [_]
As of September 15, 1998, the aggregate market value of the 1,350,889 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $18.9 million based on the closing sales price of
$14.00 per share of the registrant's Common Stock on September 15, 1998 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 15, 1998:
1,596,448
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, 1998. (Parts I and II)
2. Portions of Proxy Statement for the 1998 Annual Meeting of Stockholders.
(Part III)
<PAGE>
PART I
ITEM 1. BUSINESS
- -----------------
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 1,725,000 (as adjusted) 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. The Company's principal business is the business of First Federal. At
June 30, 1998, the Company had total assets of $134.5 million, deposits of $81.9
million and shareholder's equity of $22.7 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 Office of Thrift Supervision ("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 40601, and their main telephone number is
(502) 223-1638.
RECENT DEVELOPMENTS
PROPOSED REGULATORY AND LEGISLATIVE CHANGES. On May 13, 1998, the U.S.
House of Representatives passed H.R. 10 (the "Act"), the "Financial Services
Competition Act of 1998," which calls for a sweeping modernization of the
banking system that would permit affiliations between commercial banks,
securities firms, insurance companies and, subject to certain limitations, other
commercial enterprises. The stated purposes of the Act are to enhance consumer
choice in the financial services marketplace, level the playing field among
providers of financial services and increase competition.
H.R. 10 removes the restrictions contained in the Glass-Steagall Act of
1933 and the Bank Holding Company Act of 1956, thereby allowing qualified
financial holding companies to control banks, securities firms, insurance
companies, and other financial firms. Conversely, securities firms, insurance
companies and financial firms would be allowed to own or affiliate with a
commercial bank. Under the new framework, the Federal Reserve would serve as
2
<PAGE>
an umbrella regulator to oversee the new financial holding company structure.
Securities affiliates would be required to comply with all applicable federal
securities laws, including registration and other requirements applicable to
broker-dealers. The Act also provides that insurance affiliates be subject to
applicable state insurance regulations and supervision. The Act preserves the
thrift charter and all existing thrift powers, but restricts the activities of
new unitary thrift holding companies.
The Senate is now considering the legislation but may further modify the
Act. At this time, it is unknown whether the Act will be enacted, or if
enacted, what form the final version of such legislation might take.
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 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. The Bank also offers fixed-rate
financing, but generally funds all or part of such loans with long-term, fixed-
rate advances from the FHLB of Cincinnati.
3
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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, 1998, First Federal had no concentrations of
loans exceeding 10% of total loans that are not otherwise disclosed below.
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------- ---------------- ----------------- --------------- ----------------
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................. $ 1,270 1.00% $ 1,060 0.87% $ 672 .6% $ 270 .3% $ 568 .6%
One- to four-family residential.... 118,899 93.47 113,549 93.14 103,944 93.7 94,816 94.0 92,861 94.0
Multi-family residential........... 80 0.06 58 0.05 123 .1 134 .1 148 .2
Other loans (1).................... 1,704 1.34 1,830 1.50 1,450 1.3 1,549 1.6 1,580 1.6
Consumer loans --
Savings account loans.............. 545 0.43 672 0.55 547 .5 618 .6 584 .6
Home equity lines of credit........ 4,713 3.70 4,742 3.89 4,182 3.8 3,449 3.4 3,044 3.0
-------- ------ -------- ------ -------- ------ -------- ------ ------- ------
127,211 100.00% 121,911 100.00% 110,918 100.00% 100,836 100.00% 98,785 100.00%
====== ====== ====== ====== ======
Less:
Loans in process................... 572 824 392 123 448
Discounts, deferred loan fees and
other............................. 211 99 100 28 38
Loan loss reserve.................. 100 100 95 83 71
-------- -------- -------- -------- -------
Total........................... $126,328 $120,888 $110,331 $100,602 $98,228
======== ======== ======== ======== =======
- -------------------------
</TABLE>
(1) Represents primarily church loans.
4
<PAGE>
The following table sets forth certain information at June 30, 1998
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 Within 1 Through Due After
One Year After 5 Years After 5 Years After
June 30, 1998 June 30, 1998 June 30, 1998 Total
-------------- ------------- ------------- --------
(In thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Construction loans........... $1,270 $ -- $ -- $ 1,270
One- to four-family.......... 3,925 17,598 97,376 118,899
Multi-family residential..... 2 9 69 80
Other loans.................... 139 587 978 1,704
Consumer loans:
Savings account loans........ 545 -- -- 545
Home equity lines of credit.. 106 1,240 3,367 4,713
------ ------- -------- --------
Total...................... $5,987 $19,434 $101,790 $127,211
====== ======= ======== ========
</TABLE>
The following table sets forth at June 30, 1998, the dollar amount of all
loans due more than one year after June 30, 1998 which have predetermined
interest rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates
------------- ----------------
(In thousands)
<S> <C> <C>
Real estate loans:
One- to four-family residential.. $ 27,595 $ 87,364
Multi-family residential......... -- 78
Other loans...................... -- 1,580
Consumer loans:
Home equity lines of credit...... -- 4,607
Savings account loans............ -- --
------------- ------------
Total........................... $ 27,595 $ 93,629
============= ============
</TABLE>
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.
5
<PAGE>
Originations of Loans. The following table sets forth certain information
with respect to First Federal's loan originations during the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------
1998 1997 1996
-------- ------- -------
<S> <C> <C> <C>
(In thousands)
Originations
Real estate loans:
One- to four-family......... $31,786 $27,878 $27,903
Multi-family................ 82 -- --
Other....................... 161 575 190
Construction loans.......... 1,445 1,604 915
Consumer loans:
Home equity line of credit.. 2,702 2,899 2,844
Savings account loans....... 406 524 361
------- ------- -------
Total...................... $36,582 $33,480 $32,213
======= ======= =======
</TABLE>
The Bank has not in recent years purchased or sold any loans. 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 loans secured by
owner occupied, one- to four-family residential properties located in its market
area. At June 30, 1998, approximately $118.9 million, or 93.5%, 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, 1998, the Bank's loan portfolio included $92.0 million in
adjustable rate one- to four-family residential mortgage loans, or 72.3% 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 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 may offset this effect.
In general, First Federal originates residential mortgage loans with loan-
to-value ratios of up to 95%, with private mortgage insurance required for loans
with loan-to-value ratios greater than 80%.
6
<PAGE>
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 a maximum loan-to-value ratio of 75%, and
are originated under the same terms as the Bank's one- to four-family real
estate mortgage loans. At June 30, 1998, the Bank had 18 church loans
aggregating approximately $1.7 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.
Construction Lending. The Bank offers single family residential
construction loans to qualified borrowers for construction of single-family
owner occupied residences in Franklin County. At June 30, 1998, single-family
residential construction loans constituted $1.3 million, or 1.0%, 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, 1998, the Bank's consumer loan balance totaled $5.3 million, or
4.1% of its total loan portfolio. Of the consumer loan balance at June 30,
1998, 89.6% were home equity loans and 10.4% were loans secured by savings
deposits at the Bank.
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. The Bank does offer 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, 1998, the total outstanding home equity loans amounted to $4.7 million, or
3.7%, of the Bank's total loan portfolio.
7
<PAGE>
The Bank makes savings account loans for up to 90% of the depositor's
savings account balance. The interest rate is normally two percentage points
above the rate paid on the savings account, and the account must be pledged as
collateral to secure the loan. At June 30, 1998, loans on savings accounts
totaled $545,000, or 0.4%, 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. However, 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 real estate agents,
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 real estate agents. 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. For
adjustable rate loans, the rate is guaranteed for the period of 14 days
following approval. The Bank will make a similar guarantee for fixed-rate
loans for a fee. 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.
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 when 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.
8
<PAGE>
Loans to One Borrower. Under applicable law, with certain limited
exceptions, loans and extensions of credit by a savings institution to a person
outstanding at one time shall not exceed 15% of the institution'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,
by order of the Director of OTS, 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 regulatory capital requirements, (3) the
loans comply with applicable loan-to-value requirements, and (4) the aggregate
amount of loans made under this authority does not exceed 150% of the
institution's unimpaired capital and surplus. Under these limits, the Bank's
loans to one borrower were limited to $3.5 million at June 30, 1998. 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 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, 1998, First Federal had no assets
classified as loss, no assets classified as doubtful and $94,000 of assets
classified as substandard. At June 30, 1998, assets designated as special
mention totaled $262,000.
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 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
9
<PAGE>
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.
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,
---------------------------------
1998 1997 1996 1995 1994
----- ----- ----- ----- -----
(In thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period.. $ 100 $ 95 $ 83 $ 71 $ 59
Provision for loan losses....... -- 5 12 12 12
----- ----- ----- ----- -----
Balance at end of period $ 100 $ 100 $ 95 $ 83 $ 71
===== ----- ===== ===== =====
</TABLE>
10
<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,
-------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------- ------------------- ------------------- ------------------- -------------------
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............ $ 94 93.5% $ 93 93.2% $ 89 93.8% $78 94.1% $ 67 94.2%
Commercial............. 1.4 1.2 2 1.5 1 1.3 2 1.6 1 1.6
Real estate -
construction............ 1.0 1.2 1 0.9 1 0.6 -- 0.3 1 0.6
Consumer................. 4 4.1 4 4.4 4 4.3 3 4.0 2 3.6
----- ------ ---- ----- ----- ----- --- ----- ----- -----
Total allowance for
loan losses............. $ 100 100.00% $100 100.0% $ 95 100.0% $83 100.0% $ 71 100.0%
===== ====== ---- ===== ===== ===== === ===== ===== =====
</TABLE>
11
<PAGE>
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,
--------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Accruing loans which are contractually
past due 90 days or more............... $ 363 $ 116 $ 118 $ 34 $ 213
Percentage of total loans............... 0.29% .10% .11% .03% .20%
Percentage of total assets.............. 0.27% .09% .09% .02% .19%
</TABLE>
At June 30, 1998, 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
institutions are required to maintain. For additional information, see " --
Regulation of the Bank -- Liquidity Requirements."
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, Federal 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.
12
<PAGE>
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,
-----------------------
1998 1997 1996
------ ------ -------
(In thousands)
<S> <C> <C> <C>
Investment securities:
U.S. Government agency issues......................... $2,996 $4,750 $ 8,772
State and municipal obligations....................... -- 100 100
Interest-earning deposits and certificates of deposit.. 1,320 2,790 5,873
FHLB stock............................................. 1,494 1,156 1,078
------ ------ -------
Total investments.................................... $5,810 $8,796 $15,823
====== ====== =======
</TABLE>
13
<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, 1998.
<TABLE>
<CAPTION>
At June 30, 1998
---------------------------------------------------------------------------------------------------------
One Year or Less One to Five Years Five to Ten Years More than Ten Years Total Investment Portfolio
------------------- ----------------- ----------------- ------------------- --------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Market Average
Value Yield Value Yield Value Yield Value Yield Value Value Yield
--------- -------- -------- ------- -------- -------- ---------- ------- --------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Investment securities:
Federal agency issued
bonds................... $2,000 5.96% -- -- 996 6.60 -- -- 2,996 2,995 6.17
Interest-earning deposits
and certificates of
deposit................... 1,320 5.89 -- -- -- -- -- -- 1,320 1,320 5.89
------ -------- -------- -------- -------- ------
Total.................. $3,320 $ -- $ 996 $ -- $ 4,316 $4,315
====== ======== ======== ======== ======== ======
</TABLE>
For additional information, see Notes A2 and B of the Notes to Consolidated
Financial Statements included in the Annual Report.
14
<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 borrowings from the FHLB of Cincinnati, loan principal
repayments, interest payments and maturing investments. FHLB advances are
generally more costly than deposits but provide greater flexibility in terms and
are more easily matched to the life of assets in the Bank's portfolio. 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.
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, 1998 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
- -------- ----------- ----------------------------- ---------- ---------- --------------
<S> <C> <C> <C> <C> <C>
3.00% None Passbook $ 100 $10,144 12.39%
3.00 None Christmas Savings N/A 184 0.22
3.00 None NOW 300 1,631 1.99
3.10 None Golden 50 300 1,606 1.96
3.07 None Super NOW 1,000 479 0.58
3.33 None MMDA 1,000 4,532 5.53
-- None Noninterest-bearing 300 313 0.40
------- ------
18,889 23.07
Certificates of Deposit
-----------------------
4.25% 91-Days Fixed Term, Fixed Rate 500 1,414 1.73
4.70 182-Days Fixed-Term, Fixed Rate 500 5,637 6.88
5.26 7-month Fixed-Term, Fixed Rate 500 3,231 3.95
4.75 9-month Fixed-Term, Fixed Rate 100 338 0.41
4.94 12-month Fixed-Term, Fixed Rate 500 8,708 10.63
5.62 15-month Fixed-Term, Fixed Rate 500 10,822 13.22
6.15 18-month Fixed-Term, Fixed Rate 500 100 0.12
5.08 24-month Fixed-Term, Fixed Rate 500 5,197 6.35
5.87 30-month Fixed-Term, Fixed Rate 500 5,607 6.85
5.62 36-month Fixed-Term, Fixed Rate 500 5,241 6.40
5.86 60-month Fixed-Term, Fixed Rate 500 3,979 4.86
5.70 72-month Fixed-Term, Fixed Rate 500 313 0.38
4.91 12-month Variable IRA 100 4,631 5.66
4.97 12-month Fixed-Term, Variable Rate 500 957 1.17
5.53 24-month Fixed Term, Variable Rate (2) 500 6,760 8.25
3.00 Varies Other N/A 67 0.07
------- ------
63,002 76.93
------- ------
$81,891 100.00%
======= ======
</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.
15
<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
1998 Deposits (Decrease) 1997 Deposits (Decrease) 1996 Deposits
---------- ----------- ----------- -------- --------- ---------- -------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Passbook.............................. $10,144 12.39% $ (247) $10,391 12.08% $ (774) $11,165 12.72%
Statement savings..................... -- -- -- -- -- -- -- --
Christmas savings..................... 184 0.22 (12) 196 0.23 (13) 209 0.24
NOW 1,631 1.99 5 1,626 1.89 181 1,445 1.65
Golden 50............................. 1,606 1.96 127 1,479 1.72 42 1,437 1.64
Super Now............................. 479 0.58 (196) 675 0.79 (68) 743 0.85
MMDA 4,532 5.53 (1,649) 6,181 7.19 (4) 6,185 7.05
Noninterest-bearing................... 313 0.40 133 180 0.21 (199) 379 0.43
------- ------ ------- ------- ------ ------- ------- ------
18,889 23.07 (1,839) 20,728 24.11 (835) 21,563 24.58
Certificates of Deposit
- --------------------------------------
Fixed-Term, Fixed-Rate:
91-days............................. 1,414 1.73 (535) 1,949 2.27 (72) 2,021 2.30
182-days............................ 5,637 6.88 (1,403) 7,040 8.19 (1,745) 8,785 10.01
7-month............................. 3,231 3.95 3,231 -- -- -- -- --
9-month............................. 338 0.41 (1,373) 1,711 1.99 665 1,046 1.19
12-month............................ 8,708 10.63 (119) 8,827 10.26 (3,943) 12,770 14.55
15-month............................ 10,822 13.22 (379) 11,201 13.03 11,201 -- --
18-month............................ 100 0.12 -- 100 0.12 (1,244) 1,344 1.53
24-month............................ 5,197 6.35 (2,901) 8,098 9.42 98 8,000 9.11
30-month............................ 5,607 6.85 2,439 3,168 3.69 2,563 605 0.69
36-month............................ 5,241 6.40 (253) 5,494 6.39 (2,150) 7,644 8.71
60-month............................ 3,979 4.86 (240) 4,219 4.91 1,183 3,036 3.46
72-month............................ 313 0.38 (38) 351 0.41 (48) 399 0.45
Variable IRA (12-month)............... 4,631 5.66 (662) 5,293 6.16 (1,056) 6,349 7.23
Fixed-Term, Variable-Rate (12 month).. 957 1.17 (200) 1,157 1.35 (147) 1,304 1.49
Fixed-Term, Variable-Rate (24 month).. 6,760 8.25 265 6,495 7.55 (6,272) 12,767 14.54
Other................................. 67 0.07 (59) 126 0.15 (18) 144 0.16
------- ------ ------- ------- ------ ------- ------- ------
63,002 76.93 (2,227) 65,229 75.89 (985) 66,214 75.42
------- ------ ------- ------- ------ ------- ------- ------
Total............................. $81,891 100.00% $(4,066) $85,957 100.00% $(1,820) $87,777 100.00%
======= ====== ======= ======= ====== ======= ======= ======
</TABLE>
16
<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,
-------------------------------------------------------------------
1998 1997 1996
---------------------- -------------------- --------------------
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.............................. $18,857 $63,761 $9,770 $65,296 $13,805 $63,656
Average rate................................. 3.10% 5.33% 3.33% 5.44% 3.06% 5.64%
</TABLE>
The following table sets forth the time deposits in First Federal classified by
rates at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
-----------------------------------
1998 1997 1996
---------- ------- -------
(In thousands)
<S> <C> <C> <C>
2 - 3.99%........ $ 90 $ 152 $ 135
4 - 5.99%........ 58,966 54,461 46,122
6 - 7.99%........ 3,944 10,530 19,795
8 - 9.99%........ 2 86 162
10.00 - 11.99%... -- -- --
------- ------- -------
$63,002 $65,229 $66,214
======= ======= =======
</TABLE>
The following table sets forth the amoun t and maturities of time deposits in
First Federal at June 30, 1998.
<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%......... $ 62 $ 8 $ -- $ 20 $ 90
4 - 5.99%......... 43,499 12,806 2,030 631 58,966
6 - 7.99%......... 1,212 346 263 2,123 3,944
8 - 9.99%......... 2 -- -- -- 2
------- ------- -------- ------- --------
$44,775 $13,160 $ 2,293 $ 2,774 $63,002
======= ======= ======== ======= ========
</TABLE>
17
<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,
1998.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- --------------
(In thousands)
<S> <C>
Three months or less................ $1,536
More than three through six months.. 957
More than six through 12 months..... 1,817
Over 12 months...................... 2,817
------
Total............................... $7,127
======
</TABLE>
The following table sets forth the deposit activities of First Federal for
the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------
1998 1997 1996
-------- -------- ---------
(In thousands)
<S> <C> <C> <C>
Beginning balance...................... $85,957 $87,777 $119,041
Deposits............................... 57,438 64,175 62,402
Withdrawals............................ 65,540 69,224 96,507
------- ------- --------
Net decrease before interest credited.. (8,102) (5,049) (34,105)
Interest credited...................... 4,036 3,229 2,841
------- ------- --------
Net decrease in deposits............... (4,066) (1,820) (31,264)
------- ------- --------
Ending balance......................... $81,891 $85,957 $ 87,777
======= ======= ========
</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, 1998, First Federal had $28.3 million in advances
outstanding from the FHLB of Cincinnati.
18
<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,
----------------------
1998 1997
---------- ---------
(Dollars in thousands)
<S> <C> <C>
Amounts outstanding at end of period:
FHLB advances......................................... $28,260 $ 9,006
Other loans........................................... -- 13,000
------- -------
Total................................................ 28,260 22,006
Weighted average rate paid on:
FHLB advances......................................... 6.07% 6.44%
Other loans........................................... -- % 8.50%
</TABLE>
<TABLE>
<CAPTION>
For the Year
Ended June 30,
----------------------
1998 1997
---------- ---------
(Dollars in thousands)
<S> <C> <C>
Maximum amount of borrowings outstanding
at any month end:
FHLB advances......................................... $29,068 $ 9,006
Other loans........................................... 2,000 13,000
</TABLE>
<TABLE>
<CAPTION>
For the Year
Ended June 30,
----------------------
1998 1997
---------- ---------
(Dollars in thousands)
<S> <C> <C>
Approximate average short-term borrowings outstanding
with respect to:
FHLB advances......................................... $ 5,750 $ --
Other loans (2)....................................... 1,923 1,083
Approximate weighted average rate paid on: (1)
FHLB advances......................................... 6.32% 6.04%
Other loans (2)....................................... 8.50% 8.50%
- -------------------------
</TABLE>
(1) Weighted average computed by dividing total interest paid by average
balance outstanding.
(2) Consists solely of a $13.0 million note originated on June 24, 1997, and
was repaid during the fiscal year ended June 30, 1998.
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.
19
<PAGE>
Franklin County has a population of approximately 46,000, of which
approximately 29,000 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 2-3% in recent years.
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, real estate agents, 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, 1998, First Federal had 24 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 institution, 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 ("QTL") Test, then within one year after the institution ceased to
be a QTL, such unitary savings and loan holding company shall register as and be
deemed to be a bank holding company and will become subject to the activities
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 institution,
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 subsidiaries (other
20
<PAGE>
than the Bank or other subsidiary savings institutions) would thereafter be
subject to further restrictions. The HOLA provides that, 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 authorized by regulation as of March 5, 1987 to be
directly engaged in by multiple savings and loan 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 savings and loan 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. Section 106 of the Bank
Holding Company Act of 1956, as amended ("BHCA") which also applies to the Bank,
prohibits the Bank from extending credit to or offering any other services, or
fixing or varying the consideration for such extension of credit or service, on
condition that the customer obtain some additional services from the institution
or certain of its affiliates or not obtain services of a competitor of the
institution, subject to certain exceptions.
Savings institutions are also subject to the restrictions contained in
Section 22(h) and Section 22(g) of the Federal Reserve Act on loans to executive
officers, directors and principal stockholders. Under Section 22(h), loans to a
director, executive officer or to a greater than 10% stockholder of a savings
institution, and certain affiliated entities of the foregoing, 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 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.
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
21
<PAGE>
type, amount and terms of credits to such officers. In addition, Section 106 of
the BHCA 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, without prior approval of the Director of OTS, from
acquiring (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 laws 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).
OTS regulations permit federal savings institutions 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 savings institution may not establish an out-of-
state branch unless (i) the institution qualifies as a QTL or 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 institution in the state would
qualify such branches taken as a whole for treatment as a QTL or 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
institution subsidiaries of banking holding companies. Federal savings
institutions generally may not establish new branches unless the institution
meets or exceeds minimum regulatory capital requirements. The OTS will also
consider the institution's record of compliance with the Community Reinvestment
Act of 1977 in connection with any branch application.
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 Bank must file reports with the OTS
describing its activities and financial condition. The FDIC also has the
authority to conduct special examinations of the Bank because its deposits are
insured by the SAIF. The Bank is also subject to certain reserve requirements
promulgated by the Federal Reserve Board. This supervision and regulation is
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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 regulatory capital
requirements, savings institutions must maintain "tangible" capital equal to
1.5% of adjusted total assets, "core" capital equal to 3% of adjusted total
assets and a combination of core and "supplementary" capital equal to 8% of
"risk-weighted" assets. In addition, the OTS regulations impose certain
restrictions on savings institutions that have a total risk-based capital ratio
that is less than 8%, a ratio of Tier 1 capital to risk-weighted assets of less
than 4% or a ratio of Tier 1 capital to adjusted total assets of less than 4%
(or 3% if the institution is rated composite 1 CAMELS under the OTS examination
rating system). See "-- Prompt Corrective Regulatory Action." For purposes of
these regulations, Tier 1 capital has the same definition as core capital. Core
capital 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
institution'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. Both core and tangible capital are further reduced
by an amount equal to the savings institution'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, 1998, First Federal had no such investments.
Adjusted total assets are a savings institution'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
unconsolidated includable subsidiaries in which the savings institution holds a
minority interest. Adjusted total assets are reduced by the amount of assets
that have been deducted from capital, the portion of the savings institution's
investments in unconsolidated includable subsidiaries and, for purposes of the
core capital requirement, qualifying supervisory goodwill.
In determining compliance with the risk-based capital requirement, a
savings institution is allowed to use both core capital and supplementary
capital in its total capital provided the amount of supplementary capital
included does not exceed the savings institution'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 institution'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 by that portion
of the savings institution's land loans and non-residential construction loans
in excess of 80% loan-to-value ratio and all equity investments, other than
those deducted from core and tangible capital. At June 30, 1998, the Bank had
no high ratio land or nonresidential construction loans and had no equity
investments for which OTS regulations require a 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 FNMA or 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.
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The table below presents the Bank's capital position relative to its
various regulatory capital requirements at June 30, 1998.
<TABLE>
<CAPTION>
Percent of
Amount Assets (1)
------- ----------
(Dollars in thousands)
<S> <C> <C>
Tangible capital....................... $23,299 17.4%
Tangible capital requirement........... 2,014 1.5
------- ----
Excess............................... $21,285 15.9%
======= ====
Core capital........................... $23,299 17.4%
Core capital requirement............... 4,028 3.0
------- ----
Excess............................... $19,271 14.4%
======= ====
Risk-based capital..................... $23,399 33.7%
Risk-based capital requirement......... 5,557 8.0
------- ----
Excess............................... $17,842 25.7%
======= ====
Tier 1 capital......................... $23,299 17.4%
Tier 1 capital requirement............. 5,377 4.0
------- ----
Excess............................... $17,922 13.4%
======= ====
Tier 1 capital......................... $23,299 33.5%
Tier 1 risk-based capital requirement.. 2,779 4.0
------- ----
Excess............................... $20,520 29.5%
======= ====
- -------------------------
</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.
The OTS' risk-based capital requirements require 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 is 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 requires 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
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<PAGE>
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 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. Such circumstances
would include a high degree of exposure of interest rate risk, prepayment risk,
credit risk and concentration of credit risk and certain risks arising from non-
traditional activities. 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,
including the OTS, 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 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.
Under regulations jointly adopted by the federal banking regulators,
including the OTS, a depository institution's capital adequacy for purposes of
the prompt corrective action rules is determined 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% or greater; and (iii) a leverage ratio of 5% 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% or greater; (ii) a Tier 1 capital risk-based ratio of 4% or
greater; and (iii) a leverage
25
<PAGE>
ratio of 4% or greater (or 3% or greater if the savings institution has a
composite 1 CAMELS rating). An "undercapitalized institution" is a savings
institution that has (i) a total risk-based capital ratio less than 8%; or (ii)
a Tier 1 risk-based capital ratio of less than 4%; or (iii) a leverage ratio of
less than 4% (or 3% if the institution has a composite 1 CAMELS rating). A
"significantly undercapitalized" institution is defined as a savings institution
that has: (i) a total risk-based capital ratio of less than 6%; or (ii) a Tier 1
risk-based capital ratio of less than 3%; or (iii) a leverage ratio of less than
3%. 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%. 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 CAMELS rating category. The Bank is
classified as "well capitalized" under these regulations.
LIQUIDITY REQUIREMENTS. As a member of the FHLB System, the Bank is
required to maintain average daily balances of liquid assets (cash, deposits
maintained pursuant to Federal Reserve Board requirements, time and savings
deposits in certain institutions, obligations of states and political
subdivisions thereof, shares in mutual funds with certain restricted investment
policies, highly rated corporate debt, and mortgage loans and mortgage-related
securities with less than one year to maturity or subject to purchase within one
year) equal to the monthly average of not less than a specified percentage
(currently 4%) of its net withdrawable savings deposits plus short-term
borrowings. Monetary penalties may be imposed for failure to meet liquidity
requirements. The average daily ratio of the Bank for June 1998 was 6.07%.
QUALIFIED THRIFT LENDER TEST. The Bank is currently subject to OTS
regulations which use the concept of a qualified thrift lender ("QTL") to
determine eligibility for Federal Home Loan Bank advances and for certain other
purposes. A savings institution that does not meet the 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 both a national bank and a savings institution; (ii) the
branching powers of the institution are restricted to those of a national bank
located in the institution's home state; (iii) the institution shall not be
eligible to obtain any advances from its Federal Home Loan Bank; and (iv)
payment of dividends by the institution shall be subject to the rules regarding
payment of dividends by a national bank. In addition, any company that controls
a savings institution that fails to qualify as a QTL will be required to
register as and be deemed a bank holding company subject to all of the
provisions of the BHCA and other statutes applicable to bank holding companies.
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 both a national bank and a savings institution and immediately repay any
outstanding Federal Home Loan Bank advances (subject to safety and soundness
considerations).
To qualify as a QTL, a savings institution must either qualify as a
"domestic building and loan association" under the Internal Revenue Code or
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. All of the following may be included as Qualified
Thrift Investments: investments in mortgage-backed securities, residential
mortgages, home equity loans, loans made for educational purposes, small
business loans, credit card loans and shares of stock issued by a Federal Home
Loan Bank. Subject to a 20% of portfolio assets limit, savings institutions are
also able to treat the following as Qualified Thrift Investments: (i) 50% of the
dollar amount of residential mortgage loans subject to sale under certain
conditions, (ii) investments, both debt and equity, in the capital stock or
obligations of and any other security issued by a service corporation or
operating subsidiary, provided that such subsidiary derives at least 80% of its
annual gross revenues from activities directly related to purchasing,
refinancing, constructing, improving or repairing domestic residential housing
or manufactured housing, (iii) 200% of their investments in loans to finance
"starter homes" and loans for construction,
26
<PAGE>
development or improvement of housing and community service facilities or for
financing small businesses in "credit-needy" areas, (iv) loans for the purchase,
construction, development or improvement of community service facilities, and
(v) loans for personal, family, household or educational purposes, provided that
the dollar amount treated as Qualified Thrift Investments may not exceed 10% of
the savings institution's portfolio assets.
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
QTL 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. At June 30, 1998, approximately 98.7% of
the Bank's "portfolio" assets were invested in Qualified Thrift Investments, as
currently defined.
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 the ratio of its fully phased-in capital requirement to its assets 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%; (ii) a Tier 1 risk-based capital ratio of less than 4%; or (iii) a
leverage ratio of less than 4%. 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 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
27
<PAGE>
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.
Historically, institutions with SAIF-assessable deposits, like the Bank,
were required to pay higher deposit insurance premiums than institutions with
deposits insured by the Bank Insurance Fund ("BIF") also administered by the
FDIC. In order to recapitalize the SAIF and address the premium disparity, in
November 1996 the FDIC imposed a one-time special assessment on institutions
with SAIF-assessable deposits based on the amount determined by the FDIC to be
necessary to increase the reserve levels of the SAIF to the designated reserve
ratio of 1.25% of insured deposits. Institutions were assessed at the rate of
65.7 basis points based on the amount of their SAIF-assessable deposits as of
March 31, 1995. As a result of the special assessment, the Bank incurred a pre-
tax expense of $567,000 during fiscal 1997.
The special assessment recapitalized the SAIF, and as a result, the FDIC
lowered the SAIF deposit insurance assessment rates to zero for well capitalized
institutions with the highest supervisory ratings and 0.31% of insured deposits
for institutions in the highest risk-based premium category. Since the BIF is
above its designated reserve ratio of 1.25% of insured deposits, "well-
capitalized" institutions in Subgroup A, numbering 95% of BIF-insured
institutions, pay no federal deposit insurance premiums, with the remaining 5%
of institutions paying a graduated range of rates up
28
<PAGE>
to 0.27% of insured deposits for the highest risk-based premium category. Until
December 31, 1999, SAIF-insured institutions will be required to pay assessments
to the FDIC at the rate of 6.5 basis points to help fund interest payments on
certain bonds issued by the Financing Corporation ("FICO"), an agency of the
federal government established to finance takeovers of insolvent thrifts.
During this period, BIF members will be assessed for these obligations at the
rate of 1.3 basis points. After December 31, 1999, both BIF and SAIF members
will be assessed at the same rate for FICO payments.
Since the SAIF now meets its designated reserve ratio as a result of the
special assessment, SAIF members are now permitted to convert to the status of
members of the BIF and may merge with or transfer assets to a BIF member.
However, substantial entrance and exit fees apply to conversions from SAIF to
BIF insurance and such fees may make a SAIF to BIF conversion prohibitively
expensive. In the past, the substantial disparity existing between deposit
insurance premiums paid by BIF and SAIF members gave BIF-insured institutions a
competitive advantage over SAIF-insured institutions like the Bank. The
reduction of the SAIF deposit insurance premiums effectively eliminated this
disparity and could have the effect of increasing the net income of the Bank and
restoring the competitive equality between BIF-insured and SAIF-insured
institutions.
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,
1998, of $1.5 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,
1998, the Bank had $28.3 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 $47.8 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, 1998, 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 1998.
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").
29
<PAGE>
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
liquidation), unless such amount was included in taxable income, along with the
amount deemed necessary to pay the resulting federal income tax.
Legislation enacted in 1996 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 loans 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. Under such
legislation, the Bank is required to recapture approximately $140,000 of its bad
debt reserve. 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.
30
<PAGE>
STATE INCOME TAXATION
The Commonwealth of Kentucky imposes an annual franchise tax on financial
institutions regularly engaged in business in Kentucky at any time during the
calendar year. This tax is 1.1% of First Federal's net capital. For purposes
of this tax, net capital is defined as the aggregate of the Bank's capital
stock, paid-in capital, retained earnings and net unrealized gains or losses on
securities designated as available for sale less an amount equal to the five
year average of the percentage that the book value of any United States
obligations held by the Bank bears to the book value of the Bank's total assets.
Financial institutions which are subject to tax both within and without Kentucky
must apportion their net capital.
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.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The following table sets forth information regarding the executive officers
of the Company who do not serve on the Board of Directors.
<TABLE>
<CAPTION>
AGE AT
JUNE 30,
NAME 1998 TITLE
- ---- -------- -----
<S> <C> <C>
Don Jennings (1) 33 Vice President and Treasurer
Joyce Jennings 61 Vice President
</TABLE>
- -------------------------
(1) Don Jennings was appointed Vice President in January 1998. He is the son
of Joyce Jennings, Vice President of the Company and William C. Jennings,
President of the Company.
DON JENNINGS has been employed by the Bank since 1991. He currently serves
as Executive Vice President and Secretary of the Bank. He serves as Treasurer
of Frankfort/Franklin County CrimeStoppers and as a Board member of the Kentucky
Education Alliance.
JOYCE H. JENNINGS has been an employee of First Federal since 1955. She
has served as Vice President of the Bank since 1983 and Vice President 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 her son, Don Jennings, is Vice President of the Company.
31
<PAGE>
ITEM 2. PROPERTIES
- -------------------
The following table sets forth information regarding First Federal's
offices at June 30, 1998.
<TABLE>
<CAPTION>
Book Value Deposits at
Year Owned or at June 30, Approximate June 30,
Opened Leased 1998 Square Footage 1998
------ ---------- ----------- -------------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
MAIN OFFICE:
216 West Main Street 1989 Owned $1,281 14,400 $44,169
Frankfort, Kentucky 40601
BRANCH OFFICES:
East Branch 1971 Owned 142 1,800 21,446
1980 Versailles Road
Frankfort, Kentucky 40601
West Branch 1975 Owned 196 2,480 16,276
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, 1998 was $27,000. 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 $1.5 million at June 30, 1998.
ITEM 3. LEGAL PROCEEDINGS.
- -------------------------
From time to time, First Federal is a party to various legal proceedings
incident to its business. At June 30, 1998, 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, 1998.
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 attached as
Exhibit 13 hereto.
32
<PAGE>
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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------
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
- --------------------
None.
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 1998 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference.
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."
For more information concerning compliance with Section 16(a) of the
Securities Exchange Act of 1934, as amended, the information contained under the
section captioned "Section 16(a) Beneficial Ownership Reporting Compliance" is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
The information required by this item is incorporated by reference to
"Executive Compensation" in the Proxy Statement.
33
<PAGE>
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, 1998 and
1997
Consolidated Statements of Operations for the years ended June 30,
1998, 1997, and 1996
Consolidated Statements of Shareholders' Equity for the years ended
June 30, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended June 30,
1998, 1997 and 1996
Notes to Consolidated Financial Statements for the years ended June
30, 1998, 1997 and 1996
(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.
34
<PAGE>
(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>
No. Description
--- -----------
<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 * +
10.3(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.
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. None.
-------------------
(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.
35
<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 22, 1998 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 22, 1998
- ----------------------------------------------
William C. Jennings
President and Chief Executive Officer
(Principal Executive Officer and Principal
Financial and Accounting Officer)
/s/ Danny A. Garland September 22, 1998
- ----------------------------------------------
Danny A. Garland
Vice President and Director
/s/ Charles A. Cotton, III September 22, 1998
- ----------------------------------------------
Charles A. Cotton, III
Director
/s/ David Eddins September 22, 1998
- ----------------------------------------------
David Eddins
Director
/s/ William M. Johnson September 22, 1998
- ----------------------------------------------
William M. Johnson
Director
/s/ Frank McGrath September 22, 1998
- ----------------------------------------------
Frank McGrath
Director
/s/ Herman D. Regan, Jr. September 22, 1998
- ----------------------------------------------
Herman D. Regan, Jr.
Director
<PAGE>
EXHIBIT 13
==============================================
FRANKFORT FIRST BANCORP, INC.
ANNUAL REPORT
1998
==============================================
Parent Company of
First Federal Savings Bank of Frankfort
216 West Main Street
P.O. Box 535
Frankfort, KY 40602
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
President's Message.......................................................... 1
Frankfort First Bancorp, Inc................................................. 2
First Federal Savings Bank of Frankfort...................................... 2
Market Information........................................................... 2
Selected Consolidated Financial Information.................................. 3
Management's Discussion and Analysis of
Financial Condition and Results of Operations.............................. 5
Independent Auditor's Report................................................. 17
Consolidated Financial Statements:
Consolidated Statements of Financial Condition.............................. 18
Consolidated Statements of Operations....................................... 19
Consolidated Statements of Shareholders' Equity............................. 20
Consolidated Statements of Cash Flows....................................... 21
Notes to Consolidated Financial Statements.................................. 23
Corporate Information....................................................... 46
</TABLE>
<PAGE>
Frankfort First Bancorp, Inc.
Parent Company of First Federal Savings Bank of Frankfort
President's Message
Dear Shareholder:
We are very happy to present Frankfort First Bancorp's Annual Report to
Shareholders for the fiscal year ended June 30, 1998. This was the first full
year after the restructuring plan we announced in June, 1997, and management and
the Board of Directors are pleased with the results which are especially
evidenced by the improvements made in net earnings, return on equity, and the
ratio of operating expenses to average assets.
Our net earnings for the year were approximately $1.6 million--which is not
quite on pace with our record 1996 fiscal year earnings (earnings of $1.7
million) but was earned on a much smaller capital base. For this reason, our
management believes that return on equity is the best indication of the
improvements we have made. Our return on equity for the past fiscal year was
6.58% compared to 3.64% in fiscal 1996 and 4.90% in fiscal 1995 (the year prior
to our stock conversion). This ratio was negative in fiscal 1997 due to charges
resulting from the restructuring plan.
The ratio of operating expenses to average assets was 1.29% in fiscal 1998
compared to 3.45% in fiscal 1997 (a number inflated by the one-time charges of
the restructuring plan) and 1.93% in fiscal 1996. We believe this ratio to be
very low when compared to other financial institutions and represents general
efficiency in our operation and our staff.
Our Board also increased the dividend paid during the past year from $0.18 to
$0.20 per adjusted share per quarter beginning with the dividend paid on January
15, 1998. This increase reflects both an increase in earnings per share and an
ongoing effort to effectively manage the Company's capital. At current price
levels, this represents a dividend yield of better than 5%.
Despite these increased efficiencies in our operations, our stock price has
dropped considerably during the year--a trend prevalent in most small bank
stocks. Our response includes the commencement of a stock repurchase program
announced on August 11, 1998 whereby we intend to purchase up to 81,000 shares
or 5% of our outstanding shares. We believe our stock is an attractive
investment and its repurchase can provide significant value to our investors.
On a personal note, during the past fiscal year my wife Joyce and I retired from
the day-to-day operations of the Bank--myself after 35 years of service and
Joyce after 43 years--although both of us have stayed involved in the operations
of the Company. It has been an honor and a privilege for us to be associated
with First Federal Savings Bank of Frankfort for all these years and we have
every confidence in Danny Garland and the other members of the Bank's management
and staff.
We look forward to seeing you at our annual meeting and encourage you to give us
a call if at any time you have any questions or concerns.
Sincerely,
/s/ William C. Jennings
William C. Jennings
President
1
<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 1,725,000 (as
adjusted) shares of its common stock, par value $0.01 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. The Company's principal
business is the business of First Federal. At June 30, 1998, the Company had
total assets of $134.5 million, deposits of $81.9 million and shareholders'
equity of $22.7 million.
In June 1997, the Company's Board of Directors proposed a one-for-two
reverse stock split which was approved by the shareholders at the Company's 1997
Annual Meeting of Shareholders. The reverse stock split was effective December
1, 1997. Consequently, all stock information in this report has been adjusted
to reflect the split.
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 Office of Thrift Supervision ("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 Federal
Deposit Insurance Corporation ("FDIC") also has 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 40601, 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 1,596,448 shares of the
Common Stock outstanding. The number of registered holders of Common Stock on
September 15, 1998, was 549.
2
<PAGE>
The following table shows the high and low stock prices for the Common Stock and
dividends declared on a quarterly basis for the fiscal years ended June 30, 1998
and 1997.
<TABLE>
<CAPTION>
Fiscal 1997 Dividends
Quarter ended High Low Declared
------------- ---- --- --------
<S> <C> <C> <C>
September 30, 1996 $24.500 $19.500 $0.18
December 31, 1996 24.250 21.000 0.18
March 31, 1997 22.750 19.500 0.18
June 30, 1997 25.500 16.000 8.18 (1)
Fiscal 1998
Quarter ended
-------------
September 30, 1997 $23.000 $16.250 $0.18
December 31, 1997 23.250 17.500 0.20
March 31, 1998 17.750 15.750 0.20
June 30, 1998 17.750 14.750 0.20
</TABLE>
--------------------
(1) Includes $7.20 deemed to constitute a tax-free return of excess
capital.
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,
-----------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total amount of:
Assets................................ $ 134,485 $ 132,038 $ 128,513 $ 142,772 $ 111,955
Loans receivable, net................. 126,328 120,888 110,331 100,602 98,228
Cash and investment securities........ 4,317 7,601 14,889 38,918 11,027
Deposits.............................. 81,891 85,957 87,777 119,041 89,115
Advances from FHLB.................... 28,260 9,006 4,998 4,416 4,652
Shareholders' equity--substantially
restricted (1)...................... 22,706 22,345 34,265 18,604 17,715
Number of:
Real estate loans outstanding......... 2,814 2,732 2,685 2,582 2,585
Deposit accounts...................... 7,671 8,032 8,397 8,500 8,586
Offices............................... 3 3 3 3 3
</TABLE>
- ----------------------------------------
(1) Consisted solely of retained earnings at June 30, 1994 through June 30, 1995
inclusive.
3
<PAGE>
SUMMARY OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Interest income................................. $ 9,751 $ 9,226 $ 9,699 $ 7,809 $ 7,434
Interest expense................................ 5,685 4,685 4,585 4,234 3,754
---------- -------- -------- -------- ---------
Net interest income............................. 4,066 4,541 5,114 3,575 3,680
Provision for loan losses....................... -- 5 12 12 12
Other income.................................... 60 61 54 50 58
General, administrative and other expense....... 1,732 4,474 2,669 2,270 1,899
---------- -------- -------- -------- ---------
Earnings before federal income taxes............ 2,394 123 2,487 1,343 1,827
Federal income taxes............................ 814 491 827 454 618
Cumulative effect of change in
accounting principle.......................... -- -- -- -- (37)
---------- -------- -------- -------- ---------
Net earnings (loss)............................. $ 1,580 $ 368 $ 1,660 $ 889 $ 1,172
========== ======== ======== ======== =========
Earnings (loss) per share:
Basic........................................ $ 1.00 $ (0.23) $ 1.04 $ n/a $ n/a
Diluted...................................... $ 0.96 $ n/a $ 1.04 $ n/a $ n/a
</TABLE>
<TABLE>
<CAPTION>
At or for the Year Ended June 30,
-----------------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
PERFORMANCE RATIOS
Return on assets (net earnings (loss) divided by
average total assets)....................................... 1.18% (0.28%) 1.20%
Return on equity (net earnings (loss) divided by
average equity)............................................. 6.58% (1.11%) 3.64%
Equity to assets ratio (average equity divided by
average total assets)....................................... 17.93% 25.49% 33.00%
Interest rate spread for the period.......................... 2.20% 2.34% 2.12%
Net interest margin for the period........................... 3.11% 3.58% 3.76%
Operating expenses to average assets......................... 1.29% 3.45% 1.93%
Ratio of average interest-earning assets to average
interest-bearing liabilities............................... 120.92% 133.50% 148.78%
REGULATORY CAPITAL RATIOS
Tangible capital as a percent of assets...................... 17.40% 25.86% 25.20%
Core capital as a percent of assets.......................... 17.40% 25.86% 25.20%
Risk-based capital as a percent of risk-weighted assets...... 33.68% 50.80% 51.65%
ASSET QUALITY RATIO
Non-performing assets to total assets........................ 0.27% 0.09% 0.09%
Loan loss allowance to total assets.......................... 0.07% 0.08% 0.07%
Loan loss allowance to total non-performing assets........... 27.50% 86.21% 80.51%
</TABLE>
4
<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. 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 Federal agency debt instruments and FHLB stock. Also
included in the investment portfolio are certificates of deposit at the FHLB and
other federally insured financial 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. In addition to net interest
income, net earnings are also affected by the level of general, administrative
and other expenses. Also impacting net earnings are competitive conditions in
the Bank's market area.
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.
RESTRUCTURING PLAN
In June 1997, the Company's Board of Directors approved a plan
designed to improve the Company's profitability through a series of actions
consisting of a special cash distribution of $8.00 per share (adjusted),
termination of the Company's employee stock ownership plan ("ESOP") and
management recognition plan ("MRP") and a one-for-two reverse stock split. The
special cash distribution of $8.00 was paid on June 24, 1997 and the reverse
stock split was effected on December 31, 1997.
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 with
those of its liabilities. 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"). The Bank also offers fixed-rate mortgages which are fully or
partially funded with long-term advances from the FHLB of Cincinnati.
Management believes that advances allow the Bank to respond to customer demand
without incurring undue interest rate or credit risk and without increase in
operating expenses. At June 30, 1998, first mortgage loans with adjustable
rates represented 73.7% 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. In a rising interest rate
environment these caps may restrict the interest rates from increasing at the
same pace that the Bank's cost of funds also increase. In addition, some of the
rates on adjustable rate mortgages may already be at their lifetime caps or
lifetime floors. The Bank currently expects to fund future loan growth from
working capital, FHLB advances, and proceeds from deposit growth.
The Bank's Asset/Liability management program primarily involves
monitoring of Net Present Value ("NPV") through interest rate sensitivity
analysis. NPV represents the market value of portfolio equity and is equal to
the market value of assets minus the market value of liabilities, with
adjustments made for off-balance sheet
5
<PAGE>
items. Management monitors and considers methods of managing the rate
sensitivity and repricing characteristics of balance sheet components in an
effort to maintain acceptable levels of change in NPV and net interest income in
the event of changes in prevailing market interest rates. Interest rate
sensitivity analysis is used to measure the Company's interest rate risk by
computing estimated changes in NPV that are a result of changes in the net
present value of its cash flows from assets, liabilities, and off-balance sheet
items. These changes in cash flow are estimated based on hypothetical
instantaneous and permanent 1% through 4% increases and decreases in market
interest rates.
As part of the Bank's interest rate risk policy, the Board of
Directors establishes maximum decreases in NPV given these assumed instantaneous
changes in interest rates. The Company's exposure to interest rate risk is
reviewed on a quarterly basis by the Board of Directors. If estimated changes
to NPV are not within the limits established by the Board, the Board may direct
management to adjust its asset and liability mix to bring interest rate risk
within Board-approved limits.
The following table sets forth the interest rate sensitivity of the
Bank's NPV as of June 30, 1998 in the event of 1%, 2%, 3%, and 4% instantaneous
and permanent increases and decreases in market interest rates, respectively.
All market risk-sensitive instruments presented in this table are held to
maturity. The Company has no trading securities or securities available for
sale.
<TABLE>
<CAPTION>
Board of
NPV as % of Portfolio Director
Change Net Portfolio Value Value of Assets Limits
---------------------------------- ---------------------------- ---------
in Rates Amount $ Change % Change NPV Ratio Basis Point Changes % Change
- -------- ------ -------- --------- --------- ------------------- ----------
<S> <C> <C> <C> <C> <C> <C>
+40O bp $ 21,989 $ (3,102) (12%) 17.72% -72 bp 50 %
+300 bp 23,564 (1,527) (6%) 18.46% +2 bp 35
+200 bp 24,748 (343) (1%) 18.90% +46 bp 25
+l00 bp 25,324 233 1% 18.93% +48 bp 10
0 bp 25,091 18.44% --
- -l00 bp 24,109 (982) (4%) 17.50% -94 bp 10
- -200 bp 22,561 (2,530) (10%) 16.21% -224 bp 25
- -300 bp 20,961 (4,130) (16%) 14.88% -356 bp 35
- -400 bp 19,374 (5,717) (23%) 13.57% -487 bp 50
</TABLE>
NPV is calculated by the OTS using information provided by the
Company. The calculation is based on the net present value of discounted cash
flows utilizing market prepayment assumptions and market rates of interest.
Computations or 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. These computations 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.
The preceding table indicates that at June 30, 1998, in the event of a
sudden and sustained increase or decrease in prevailing market interest rates,
the Company's NPV would generally be expected to decrease. At June 30, 1998 the
Company's estimated changes in NPV were within the targets established by the
Board of Directors.
Certain shortcomings are inherent in this method of computing NPV. 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,
6
<PAGE>
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 portfolio 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.
The OTS's risk-based capital rules incorporate an interest rate risk
("IRR") component. The IRR component is a dollar amount that is 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 requires 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 requires any exempt
savings institution that it determines may have a high level of interest rate
risk exposure to file such a schedule on a quarterly basis. Based on the Bank's
asset size and capital ratio at June 30, 1998, it was not subject to any
increased capital requirements in connection with its level of interest rate
risk.
The following table sets forth the interest rate risk capital
component for the Bank at June 30, 1998 and 1997 given a hypothetical 200 basis
point rate change in market interest rate.
<TABLE>
<CAPTION>
At At
June 30 June 30
1998 1997
<S> <C> <C>
Pre-Shock NPV Ratio: NPV as % of Portfolio Value of Assets 18.44% 26.98%
Exposure Measure: Post-Shock NPV Ratio 16.21% 25.65%
Sensitivity Measure: Change in NPV Ratio (224 bp) (179 bp)
Interest Rate Risk Capital Component ($000) -- --
</TABLE>
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 an 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 represents 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.
7
<PAGE>
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------------------------------------------------------------------
1998 1997 1996
----------------------------- ----------------------------- ----------------------------
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..................... $124,319 $ 9,331 7.51% $115,690 $ 8,579 7.42% $104,602 $ 7,880 7.53%
Investment securities (1)............ 6,325 420 6.64% 11,026 647 5.87% 31,488 1,819 5.78%
-------- -------- -------- -------- -------- --------
Total interest-earning assets...... 130,644 9,751 7.46% 126,716 9,226 7.28% 136,090 9,699 7.13%
Non-interest-earning assets............ 3,255 2,867 2,030
-------- -------- --------
Total assets....................... $133,899 $129,583 $138,120
======== ======== ========
Interest bearing liabilities:
Deposits............................. $ 83,493 4,000 4.79% $ 86,826 4,196 4.83% $ 86,886 4,296 4.94%
Borrowings........................... 24,552 1,685 6.86% 8,094 489 6.04% 4,586 289 6.30%
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities. 108,045 5,685 5.26% 94,920 4,685 4.94% 91,472 4,585 5.01%
-------- -------- --------
Non-interest-bearing liabilities....... 1,849 1,638 1,074
-------- -------- --------
Total liabilities.................. 109,894 96,558 92,546
Shareholders' equity................... 24,005 33,025 45,574
-------- -------- --------
Total liabilities and shareholders'
equity........................... $133,899 $ 4,066 $129,583 $ 4,541 $138,120 $ 5,114
======== ======== ======== ======== ======== ========
Net yield on interest-earning assets... 2.20% 2.34% 2.12%
======= ======= =======
Interest rate spread................... 3.11% 3.58% 3.76%
======= ======= =======
Net interest margin....................
Average interest-earning assets as
a percentage of average interest-
bearing liabilities.................. 120.92% 133.50% 148.78%
======= ======= =======
</TABLE>
_____________________________________________
(1) Includes interest bearing deposits at other financial institutions.
8
<PAGE>
RATE/VOLUME ANALYSIS
The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
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,
--------------------------------------------------------------------------
1998 vs. 1997 1997 vs. 1996
Increase (Decrease) Increase (Decrease)
------------------------------ -----------------------------
Due to Due to
------------------------------ -----------------------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loan portfolio................. $ 647 $ 105 $ 752 $ 825 $ (126) $ 699
Investment securities (1)...... (328) 101 (227) (1,200) 28 (1,172)
------- ------ ------- ------- ------ -------
Total interest-earning assets. 319 206 525 (375) (98) (473)
Interest expense:
Savings deposits............... (169) (27) (196) (3) (97) (100)
FHLB Advances.................. 1,190 6 1,196 212 (12) 200
------- ------ ------- ------- ------ -------
Total interest-bearing
liabilities................... 1,021 (21) 1,000 209 (109) 100
------- ------ ------- ------- ------ -------
Change in net interest income..... $ (702) $ 227 $ (475) $ (584) $ 11 $ (573)
======= ====== ======= ======= ====== =======
</TABLE>
- --------------------
(1) Includes interest-bearing deposits at other financial institutions.
9
<PAGE>
NOTE REGARDING FORWARD-LOOKING STATEMENTS
In addition to historical information contained herein, the following
discussion contains forward-looking statements that involve risk and
uncertainties. Economic circumstances, the Company's operations and the
Company's actual results could differ significantly from those discussed in the
forward-looking statements. Some of the factors that could cause or contribute
to such differences are discussed herein but also include changes in the economy
and interest rates in the nation and the Company's market area generally.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 1998 AND 1997
ASSETS: The Company's total assets increased from $132.0 million at
June 30, 1997 to $134.5 million at June 30, 1998, an increase of $2.5 million or
1.9%. The increase is due primarily to an increase in net loans receivable
which rose from $120.9 million at June 30, 1997, to $126.3 million at June 30,
1998, an increase of $5.4 million or 4.5%. Offsetting the increase in net loans
receivable were a decrease in cash and cash equivalents of $1.4 million and a
decrease in investment securities of $1.9 million. Cash and cash equivalents
decreased from $2.8 million at June 30, 1997 to $1.3 million at June 30, 1998, a
decrease of 52.0%. Investment securities decreased from $4.9 million at June
30, 1997 to $3.0 million at June 30, 1998, a decrease of 38.2%.
Loan disbursements for the year ended June 30, 1998, totaled $36.6
million and were partially offset by principal repayments of $31.2 million and
amortization of deferred loan origination fees and costs of $11,000. At June
30, 1998 and 1997, the Company's allowance for loan losses totaled $100,000.
That allowance represents approximately 0.07% of total assets and 37.04% of
nonperforming assets at June 30, 1998. Nonperforming assets at June 30, 1998
and 1997 were $270,000 and $116,000, respectively, and consisted solely of loans
past due 90 days or more but still accruing. While management believes that the
allowance for loan losses at June 30, 1998 was adequate under the circumstances,
there can be no assurance that unforeseen additions to this allowance will not
be necessary. Such additions could adversely affect the Company's results of
operations.
LIABILITIES: The Company's total liabilities increased from $109.7
million at June 30, 1997 to $111.8 million at June 30, 1998, an increase of $2.1
million or 1.9%. The increase is attributed primarily to a net increase in
borrowings of $6.3 million. Advances from the FHLB increased by $19.3 million
during the fiscal year while other borrowings decreased by $13.0 million. The
funds generated from the increase in borrowings were used to fund loan growth
and to replace lost deposits. Deposits fell from $86.0 million at June 30, 1997
to $81.9 million at June 30, 1998, a decrease of $4.1 million or 4.7%.
At June 30, 1997, the Company had borrowed $13.0 million from a
commercial bank to fund the $8.00 per share (adjusted) return of capital
distribution to shareholders on June 24, 1997. During the year ended June 30,
1998, the Company repaid the loan with proceeds from various FHLB advances.
Management believes that, when compared to other sources of funds, FHLB advances
offer plans and terms that can be more easily matched to the characteristics of
the Company's interest-earning assets.
SHAREHOLDERS' EQUITY: Shareholders' equity increased from $22.3
million at June 30, 1997 to $22.7 million at June 30, 1998, an increase of
$361,000 or 1.6%. The net increase to retained earnings was $314,000 or 1.8%.
This increase consists of the $1.6 million in net earnings for the year ended
June 30, 1998, less the $1.3 million returned to the shareholders in the form of
dividends. Other items impacting shareholders' equity include final
distribution of the Company's stock benefit plans and the associated acquisition
of some of its outstanding common shares. The distribution of shares acquired
by the Company's stock benefit plans resulted in an increase in shareholders'
equity of $414,000. The Company acquired approximately 21,000 of its common
shares resulting in an increase in treasury stock of $367,000. At June 30,
1998, the Company's book value per share was $14.02 compared to $13.88 at June
30, 1997 (adjusted).
10
<PAGE>
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED JUNE 30, 1998 AND 1997
NET EARNINGS: Net earnings increased from a net loss of $368,000 for
the year ended June 30, 1997 to $1.6 million for the year ended June 30, 1998.
The increase is primarily attributable to a decrease in general, administrative
and other expense of $2.7 million, which was partially offset by a $475,000
decrease in net interest income and a $323,000 increase in total federal income
taxes.
NET INTEREST INCOME: Net interest income decreased from $4.5 million
for the year ended June 30, 1997 to $4.1 million for the year ended June 30,
1998, a decrease of $475,000 or 10.5%. An increase in interest expense of $1.0
million was partially offset by an increase in interest income of $525,000.
INTEREST INCOME: Interest income increased from $9.2 million for the
year ended June 30, 1997 to $9.8 million for the year ended June 30, 1998, an
increase of $525,000 or 5.7%. The increase is related primarily to an increase
in interest income from loans which rose from $8.6 million for the year ended
June 30, 1997 to $9.3 million for the year ended June 30, 1998, an increase of
$752,000 or 8.8%. Offsetting the increase in interest income from loans was a
decrease in interest income from investment securities and interest-bearing
deposits and other of $159,000 and $68,000, respectively. The decrease in the
investment portfolio represents management's intentional shift in the
composition of the interest-earning assets of the Company. While the average
yield on both loans receivable and investment securities increased from the year
ended June 30, 1997 to the year ended June 30, 1998, the average yield on loans
receivable remains higher than that of investment securities. Consequently,
management has sought to maximize interest income by shifting resources to loans
receivable during the year ended June 30, 1998, as interest rates in the economy
overall were generally decreasing.
INTEREST EXPENSE: Interest expense increased from $4.7 million for
the year ended June 30, 1997 to $5.7 million for the year ended June 30, 1998,
an increase of $1.0 million or 21.3%. The increase was due primarily to an
increase in the level of borrowings which rose from $22.0 million at June 30,
1997 to $28.3 million at June 30, 1998. The associated interest expense from
the Company's borrowings increased from $489,000 for the year ended June 30,
1997 to $1.7 million for the year ended June 30, 1998, an increase of $1.2
million or 244.6%. Although at June 30, 1997 the Company owed $13.0 million to
another financial institution, the Company's borrowings were primarily composed
of FHLB advances for the year ended June 30, 1998. Offsetting somewhat the
increase in interest expense on borrowings was a decrease in interest expense on
deposits. Interest expense on deposits decreased from $4.2 million for the year
ended June 30, 1997 to $4.0 million for the year ended June 30, 1998, a decrease
of $196,000 or 4.7%. Management expected interest expense to increase during
the fiscal year ended June 30, 1998, due to the borrowing of $13.0 million to
fund the special $8.00 per share (adjusted) distribution paid to shareholders on
June 24, 1997. Management expects that the proportion of interest expense
attributable to FHLB advances will continue to grow as advances are used to fund
loan growth. In general, rates paid on FHLB advances are greater than rates
paid on deposits (see "Comparison of Financial Condition--Liabilities").
PROVISION FOR LOAN LOSSES: The Company's provision for loan losses
decreased from $5,000 for the year ended June 30, 1997 to no provision for the
year ended June 30, 1998. While there can be no assurance that the allowance
for loan losses (see "Comparison of Financial Condition--Assets") will be
adequate to cover losses on nonperforming assets in the future, management
believes that the allowance for loan losses was sufficient at June 30, 1998 and,
consequently, made no provision for the year then ended.
OTHER OPERATING INCOME: Other operating income decreased from $61,000
for the year ended June 30, 1997 to $60,000 for the year ended June 30, 1998, a
decrease of $1,000 or 1.6%. Other operating income is generally comprised of
service charges and fees charged on loan and deposit accounts.
GENERAL, ADMINISTRATIVE AND OTHER EXPENSE: General, administrative
and other expense decreased 61.3% from $4.5 million for the year ended June 30,
1997 to $1.7 million for the year ended June 30, 1998. While the Company
experienced decreases in nearly every expense category in this area compared to
the prior year, decreases in employee compensation and benefits and Federal
deposit insurance premiums were primarily responsible for the overall reduction
in expense.
11
<PAGE>
Employee compensation and benefits decreased from $2.9 million for the
year ended June 30, 1997 to $919,000 for the year ended June 30, 1998, a
decrease of $2.0 million or 68.0%. The primary reason for the decrease in
employee compensation and benefits was the termination of the Company's MRP and
ESOP.
The FDIC premiums paid by the Company for the year ended June 30,
1997, included a one-time special assessment of $567,000 to recapitalize the
Savings Association Insurance Fund ("SAIF"). Accordingly, Federal deposit
insurance premiums decreased from $725,000 for the year ended June 30, 1997 to
$54,000 for the year ended June 30, 1998, a decrease of $671,000 or 92.6%.
Management expects the lower level of insurance expense to continue into the
foreseeable future.
Franchise and other taxes decreased from $149,000 for the year ended
June 30, 1997 to $93,000 for the year ended June 30, 1998, a decrease of $56,000
or 37.6%. This decrease is due primarily to an overpayment of the Delaware
franchise tax in the year ended June 30, 1997.
INCOME TAX: The effective income tax rate for the years ended June
30, 1998 and 1997 was 34.0%. Although the Company experienced a net loss for
the year ended June 30, 1997, a provision of $491,000 was made for federal
income taxes for that year. The charge was due primarily to the
nondeductibility of expenses associated with the termination of the ESOP for
income tax purposes.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED JUNE 30, 1997 AND 1996
NET EARNINGS: Net earnings decreased from a total of $1.7 million for
the year ended June 30, 1996 to a net loss of $368,000 for the year ended June
30, 1997, a difference of $2.0 million. The primary reason for the decline in
earnings was the one-time charge to terminate the Company's MRP and ESOP plans.
Other factors included the decrease in net interest income caused by the
decrease in interest-earning assets as a result of the $8 per share (adjusted)
special distribution paid to shareholders on June 3, 1996 and the one-time
assessment of $567,000 to recapitalize the Savings Association Insurance Fund
("SAIF").
NET INTEREST INCOME: Net interest income decreased from $5.1 million
for the year ended June 30, 1996 to $4.5 million for the year ended June 30,
1997, a decrease of $573,000 or 11.2%. The primary reason for the decrease was
the $473,000 decrease in interest income.
INTEREST INCOME: Interest income decreased from $9.7 million for the
year ended June 30, 1996 to $9.2 million for the year ended June 30, 1997, a
decrease of $473,000 or 4.9%. The primary reason for this decrease was the $9.4
million decrease in average interest-earning assets that resulted from the
special distribution paid to shareholders on June 3, 1996 in the amount of $13.8
million. Average interest-earning assets decreased from $136.1 million for the
year ended June 30, 1996 to $126.7 million for the year ended June 30, 1997.
INTEREST EXPENSE: Interest expense increased from $4.6 million for
the year ended June 30, 1996 to $4.7 million for the year ended June 30, 1997,
an increase of $100,000 or 2.2%. The increase was due to the $3.5 million
increase in the level of average FHLB advances outstanding, which was partially
offset by a slight decrease in the average rate paid on deposits. Management
expects interest expense to increase in future periods due to the borrowing of
$13.0 million to fund the special $8 per share (adjusted) distribution paid to
shareholders on June 24, 1997.
PROVISION FOR LOAN LOSSES: The Company's provision for losses on
loans for the year ended June 30, 1997 was $5,000 compared to $12,000 for the
year ended June 30, 1996. The Board of Directors periodically reviews the
allowance for loan losses and has 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 cover losses on nonperforming
assets in the future.
OTHER OPERATING INCOME: Other operating income increased from $54,000
for the year ended June 30, 1996 to $61,000 for the year ended June 30, 1997.
Other operating income is generally comprised of service charges and fees on
loan and deposit accounts.
12
<PAGE>
GENERAL, ADMINISTRATIVE, AND OTHER EXPENSE: General, administrative,
and other expense increased from $2.7 million for the year ended June 30, 1996
to $4.5 million for the year ended June 30, 1997, an increase of $1.8 million or
67.6%. Expense for employee compensation and benefits increased by $1.3
million, which primarily relates to the termination of the MRP and ESOP,
although approximately $100,000 of this increase represented the payment
required under the MRP to the estate of Director Joseph R. Johnson subsequent to
his death. Management fully expects that expense for compensation and benefits
will be significantly reduced in future periods due to the elimination of the
ongoing expense of these two plans. Also, the termination of the plans
eliminates potential unexpected expenses associated with the plans such as
payments to participants who die or become disabled or increased expenses due to
increases in the market value of the Company's stock.
The expense for FDIC premiums increased by $494,000 from the year
ended June 30, 1996 to the year ended June 30, 1997. This increase was caused
by the one-time charge of $567,000 to recapitalize the SAIF. Insurance premiums
in the periods subsequent to the recapitalization have been substantially less
than in previous periods, and management expects the lower premiums to continue
into the foreseeable future. There was relatively little change in the other
expense categories that make up general, administrative, and other expenses.
INCOME TAX: The effective tax rate for the year ended June 30, 1996
was 33.3%. Although the Company experienced a net loss in the year ended June
30, 1997, the Company did provide for $491,000 in federal income taxes due to
the fact that most of the expense involved with the termination of the ESOP was
not deductible for income tax purposes.
LIQUIDITY AND CAPITAL RESOURCES
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 dividends that may be paid from the
Bank to the Company will provide sufficient funds for its future operations,
including the servicing of any debt which may exist. The Company's primary
sources of liquidity are dividends paid by the Bank. The Bank is subject to
certain regulatory limitations with respect to the payment of dividends to the
Company. At June 30, 1998, the Bank exceeded all regulatory minimum capital
requirements.
The Bank's primary sources of funds are (i) cash generated from
operations, (ii) deposits, and (iii) principal repayments on loans, and (iv)
advances from the FHLB of Cincinnati. As reflected in the Consolidated
Statements of Cash Flows, net cash flow provided by operating activities for
fiscal years 1998, 1997, and 1996 was $1.5 million, $2.0 million and $2.6
million, respectively.
Net cash used in investing activities for fiscal years 1998, 1997, and
1996 was $3.8 million, $6.6 million and $18.9 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 provided by financing activities was $929,000 and $1.6
million for fiscal years 1998 and 1997. Net cash used in financing activities
was $16.5 million for fiscal year 1996.
The primary investing activity of the Bank is the origination of
mortgage loans. During the years ended June 30, 1998, 1997 and 1996, the Bank
originated loans of $36.6 million, $33.5 million and $32.2 million,
respectively. Other investing activities include investment in Federal agency
issues, FHLB certificates of deposit and insured certificates of deposit 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
the competitive conditions in First Federal's market area.
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 are 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 ratios at June 30, 1998 and 1997 were 4.0% and 5.0%, respectively. The
Bank's average daily liquidity during June 1998, 1997, and
13
<PAGE>
1996 was 6.07%, 7.8% and 10.4%, respectively. Historically, management 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. The result of such action could adversely affect neat earnings in future
periods. See "---Comparison of Financial Condition at June 30, 1998 and 1997."
The Bank's most liquid asset is cash held in an interest-bearing
demand and overnight deposit accounts at the FHLB of Cincinnati. The level of
cash available at any point in time is dependent on the Bank's operating,
financing and investing activities during any given period. At June 30, 1998,
1997, and 1996, cash and cash equivalents totaled $1.3 million, $2.8 million and
$5.8 million, respectively.
Management believes that the Bank will have sufficient funds available
to meet its current commitments. At June 30, 1998, the Bank had commitments to
originate loans of $2.0 million. Additionally, the bank was obligated under
unused lines of credit totaling $5.0 million. Certificates of deposit which
were scheduled to mature in less than one year at June 30, 1998, totaled $44.8
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 required 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 costs
of the Company's operations. Unlike most industrial companies, nearly all of
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
In June 1996, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 125. "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments 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.
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.
14
<PAGE>
SFAS No. 125 is effective for transfers and servicing of financial
assets and extinguishment of liabilities occurring after December 31, 1997 and
is to be applied prospectively. Earlier or retroactive application is not
permitted. The Company adopted SFAS No. 125 effective January 1, 1998, as
required, without material effect on the consolidated financial position or
results of operations.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains, and losses)
in a full set of general-purpose financial statements. SFAS No. 130 requires
that all items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. It does not
require a specific format for that financial statement but requires that an
enterprise display an amount representing total comprehensive income for the
period in that financial statement.
SFAS No. 130 requires that an enterprise (a) classify items of other
comprehensive income by their nature in a financial statement and (b) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position. SFAS No. 130 is effective for fiscal years beginning after
December 15, 1997. Reclassification of financial statements for earlier
periods provided for comparative purposes is required. SFAS No. 130 is not
expected to have a material impact on the Company's financial statements.
In June, 1997, the FASB issued SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information." SFAS No. 131 significantly
changes the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about reportable segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. SFAS No. 131 uses a "management approach" to disclose financial and
descriptive information about the way that management organizes the segments
within the enterprise for making operating decisions and assessing performance.
For many enterprises, the management approach will likely result in more
segments being reported. In addition, SFAS No. 131 requires significantly more
information to be disclosed for each reportable segment than is presently being
reported in annual financial statements and also requires that selected
information be reported in interim financial statements. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997. SFAS No. 131 is
not expected to have a material impact on the Company's financial statements.
OTHER MATTERS -- YEAR 2000 COMPLIANCE
As with all providers of financial services, the Bank's operations are
heavily dependent on information technology systems. The Bank is addressing the
potential problems associated with the possibility that the computers that
control or operate the Bank's information technology system and infrastructure
may not be programmed to read four-digit date codes and, upon arrival of the
year 2000, may recognize the two-digit code "00" as the year 1900, causing
systems to fail to function or to generate erroneous data. The Bank is working
with the companies that supply or service its information technology systems to
identify and remedy any year 2000 related problems.
The Bank is particularly dependent upon The BISYS Group, Inc.
("BISYS"), a provider of information processing systems to banks. Through
BISYS, the Bank processes all of its daily transactions and keeps records of all
loan and deposit accounts, as well as other functions. The Bank's management
has been working closely with BISYS to monitor their efforts to renovate their
systems. In November, 1998, the Bank will begin a comprehensive testing program
through BISYS. During the test, the Bank will use the same hardware and
software that it will use after the year 2000. BISYS is making available a set
of data extracted from the Bank's data files. The data will be aged to certain
key dates associated with year 2000 compliance for the purposes of testing.
Testing is expected to conclude in March, 1999. Procedures are in place to
notify BISYS of any processing errors found during testing. In the event that
the Bank determines that the BISYS system is not capable of processing data
after the year 2000 and that the system cannot be properly renovated, the Bank
has the option of switching to another BISYS software system that was designed
to be year 2000 compliant. There would be no charge from BISYS to make this
switch; however, the Bank may incur significant costs in training its employees
on this new system. The Bank also has procedures in place to address short-term
unavailability of the BISYS system.
15
<PAGE>
The Company expects that there will be some expense incurred as a
result of preparing for the year 2000. The Bank has decided to replace some
older computer hardware which is at or near the end of its useful life. The new
equipment will be year 2000 compliant and will have sufficient capacity to run
BISYS's year 2000 compliant software. Management has assessed the impact of
such cost on the Company's net earnings in future periods. Generally,
management expects that the Bank will spend approximately $80,000 on hardware,
software, the testing program, and other year 2000 related expenses. Of this
amount, approximately $10,000 was incurred during the year ended June 30, 1998.
Management expects a cost of $30,000 to $40,000 to be incurred in the fiscal
year ending June 30, 1999, with the remainder to be incurred in subsequent
fiscal years as hardware is depreciated--at a cost of $6,000 to $10,000 per
year. At the present time, management believes that these costs are an accurate
reflection of the Bank's needs in order to establish year 2000 readiness;
however, if the Bank is ultimately required to purchase replacement computer
systems, programs, and equipment or incur substantial unforeseen expense to make
the Bank's current systems, programs, and equipment year 2000 compliant, the
Company's net earnings and financial condition could be adversely affected.
In addition to BISYS, the Bank is dependent on numerous other
providers of services ranging from specific bank-related services (such as check
processing and ATM operations) to general environmental and administrative
support services such as electrical power and telephone service. The Bank has
attempted to identify such services on which it is most dependent and to contact
each provider to determine their level of year 2000 readiness. In most cases,
the Bank is unable to independently verify that such services are or will be
year 2000 compliant. The Bank may or may not have the option of switching to
other service providers. The Bank's management is working to establish
contingency plans as to how it may best respond to the inability to utilize
these services. In most cases, management does not foresee a substantial impact
on its financial condition and future earnings. However, it is possible that
situations could occur that are beyond the Bank's control that would have
significant impact on its financial conditions and earnings--such as widespread
electrical power failure.
While it is possible that the Bank could incur losses if loan payments
are delayed due to year 2000 problems affecting its borrowers, management
believes that such losses are unlikely given the composition of the Bank's loan
portfolio, which is primarily composed of 1-4 family residential mortgages.
Likewise, it is possible that the Bank could incur losses if its level of
deposits decreased due to withdrawals from depositors in anticipation of or in
response to problems with their access to funds from other sources, such as the
delay or incapacity of their employers' payroll processing systems.
16
<PAGE>
[LETTERHEAD OF GRANT THORNTON LLP APPEARS HERE]
Report of Independent Certified Public Accountants
--------------------------------------------------
Board of Directors
Frankfort First Bancorp, Inc.
We have audited the accompanying consolidated statements of financial condition
of Frankfort First Bancorp, Inc. as of June 30, 1998 and 1997, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
the years ended June 30, 1998, 1997 and 1996. 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 audits.
We conducted our audits 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 audits provide 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, 1998 and 1997, and the consolidated results of its
operations and its consolidated cash flows for each of the years ended June 30,
1998, 1997 and 1996, in conformity with generally accepted accounting
principles.
/s/ Grant Thornton LLP
- ----------------------
Cincinnati, Ohio
August 28, 1998
17
<PAGE>
FRANKFORT FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30,
(In thousands, except share data)
<TABLE>
<CAPTION>
ASSETS 1998 1997
<S> <C> <C>
Cash and due from banks $ 201 $ 161
Interest-bearing deposits in other financial institutions 1,120 2,590
-------- --------
Cash and cash equivalents 1,321 2,751
Certificates of deposit in other financial institutions 200 200
Investment securities held to maturity - at amortized cost, approximate market value
of $2,995 and $4,819 as of June 30, 1998 and 1997 2,996 4,850
Loans receivable - net 126,328 120,888
Office premises and equipment - at depreciated cost 1,503 1,573
Federal Home Loan Bank stock - at cost 1,494 1,156
Accrued interest receivable on loans 342 316
Accrued interest receivable on investments and
interest-bearing deposits 58 79
Prepaid expenses and other assets 90 95
Prepaid federal income taxes 97 -
Deferred federal income taxes 56 130
-------- --------
Total assets $134,485 $132,038
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ 81,891 $ 85,957
Advances from the Federal Home Loan Bank 28,260 9,006
Other borrowed money - 13,000
Advances by borrowers for taxes and insurance 305 298
Accrued interest payable 85 129
Other liabilities 1,238 1,162
Accrued federal income taxes - 141
-------- --------
Total liabilities 111,779 109,693
Commitments - -
Shareholders' equity
Preferred stock, 5,000,000 shares authorized, $.01 par value;
no shares issued - -
Common stock, 3,750,000 and 7,500,000 shares authorized, $.01 par value;
1,672,473 and 3,344,996 shares issued 17 33
Additional paid-in capital 5,876 5,860
Retained earnings - restricted 17,846 17,532
Shares acquired by stock benefit plans - (414)
Less 53,325 and 32,500 shares of treasury stock - at cost (1,033) (666)
-------- --------
Total shareholders' equity 22,706 22,345
-------- --------
Total liabilities and shareholders' equity $134,485 $132,038
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
18
<PAGE>
FRANKFORT FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the year ended June 30,
(In thousands, except share data)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Interest income
Loans $9,331 $8,579 $7,880
Investment securities 220 379 486
Interest-bearing deposits and other 200 268 1,333
------ ------ ------
Total interest income 9,751 9,226 9,699
Interest expense
Deposits 4,000 4,196 4,296
Borrowings 1,685 489 289
------ ------ ------
Total interest expense 5,685 4,685 4,585
------ ------ ------
Net interest income 4,066 4,541 5,114
Provision for losses on loans - 5 12
------ ------ ------
Net interest income after provision
for losses on loans 4,066 4,536 5,102
Other operating income 60 61 54
General, administrative and other expense
Employee compensation and benefits 919 2,869 1,522
Occupancy and equipment 150 162 167
Federal deposit insurance premiums 54 725 231
Franchise and other taxes 93 149 149
Data processing 136 126 123
Other operating 380 443 477
------ ------ ------
Total general, administrative and other expense 1,732 4,474 2,669
------ ------ ------
Earnings before income taxes 2,394 123 2,487
Federal income taxes
Current 740 579 857
Deferred 74 (88) (30)
------ ------ ------
Total federal income taxes 814 491 827
------ ------ ------
NET EARNINGS (LOSS) $1,580 $ (368) $1,660
====== ====== ======
EARNINGS (LOSS) PER SHARE
Basic $1.00 $(.23) $1.04
====== ====== ======
Diluted $.96 N/A $1.04
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
19
<PAGE>
FRANKFORT FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended June 30, 1998, 1997 and 1996
(In thousands, except share data)
<TABLE>
<CAPTION>
SHARES
ADDITIONAL ACQUIRED
COMMON PAID-IN RETAINED BY STOCK TREASURY
STOCK CAPITAL EARNINGS BENEFIT PLANS STOCK TOTAL
<S> <C> <C> <C> <C> <C> <C>
Balance at July 1, 1995 $ - $ - $18,604 $ - $ - $ 18,604
Net proceeds from issuance of common stock 35 33,355 - (2,710) - 30,680
Shares acquired by stock benefit plans - - - (1,974) - (1,974)
Principal repayments on loan to ESOP and amortization of
expense related to stock benefit plans - 40 - 199 - 239
Net earnings for the year ended June 30, 1996 - - 1,660 - - 1,660
Capital distributions of $8.72 per common share - (13,800) (1,144) - - (14,944)
---- -------- ------- ------- ------- --------
Balance at June 30, 1996 35 19,595 19,120 (4,485) - 34,265
Purchase of treasury shares - - - - (666) (666)
Principal repayments on loan to ESOP in conjunction
with pending termination of the plan - (197) - 4,071 - 3,874
Net loss for the year ended June 30, 1997 - - (368) - - (368)
Capital distributions of $8.72 per common share - (13,540) (1,220) - - (14,760)
Retirement of common shares held in MRP (2) 2 - - - -
---- -------- ------- ------- ------- --------
Balance at June 30, 1997 33 5,860 17,532 (414) (666) 22,345
Effect of 2 for 1 reverse stock split (16) 16 - - - -
Amortization expense related to stock benefit plans - - - 414 (367) 47
Net earnings for the year ended June 30, 1998 - - 1,580 - - 1,580
Capital distributions of $.78 per common share - - (1,266) - - (1,266)
---- -------- ------- ------- ------- --------
Balance at June 30, 1998 $ 17 $ 5,876 $17,846 $ - $(1,033) $ 22,706
==== ======== ======= ======= ======= ========
</TABLE>
The accompanying notes are an integral part of these statements.
20
<PAGE>
FRANKFORT FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss) for the year $ 1,580 $ (368) $ 1,660
Adjustments to reconcile net earnings (loss) to net cash
provided by (used in) operating activities:
Amortization of discounts and premiums on loans,
investments and mortgage-backed securities - net 4 22 5
Amortization of deferred loan origination fees (11) (21) (11)
Depreciation and amortization 78 89 93
Provision for losses on loans - 5 12
Amortization of expense related to stock benefit plans 47 1,605 239
Federal Home Loan Bank stock dividends (92) (78) (88)
Increase (decrease) in cash due to changes in:
Accrued interest receivable (5) 25 (208)
Prepaid expenses and other assets 5 31 569
Other liabilities 32 585 315
Federal income taxes
Current (238) 162 1
Deferred 74 (88) (30)
-------- -------- --------
Net cash provided by operating activities 1,474 1,969 2,557
Cash flows provided by (used in) investing activities:
Purchase of investment securities designated as held to maturity (4,000) - (12,776)
Proceeds from maturity of investment securities 5,850 4,000 4,000
Purchase of Federal Home Loan Bank stock (246) - -
Loan principal repayments 31,153 22,939 22,483
Loan disbursements (36,582) (33,480) (32,213)
Purchase of office premises and equipment (8) (56) (378)
-------- -------- --------
Net cash used in investing activities (3,833) (6,597) (18,884)
Cash flows provided by (used in) financing activities:
Net decrease in deposit accounts (4,066) (1,820) (31,264)
Proceeds from Federal Home Loan Bank advances 32,500 4,500 904
Repayment of Federal Home Loan Bank advances (13,246) (492) (322)
Proceeds from other borrowed money - 13,000 500
Repayment of other borrowed money (13,000) (500) -
Advances by borrowers for taxes and insurance 7 31 (53)
Net proceeds from the issuance of common stock - - 30,680
Purchase of shares for stock benefit plans - - (1,974)
Principal repayments on ESOP loan in conjunction with pending
termination of the plan - net - 2,269 -
Capital distributions paid on common stock (1,266) (14,760) (14,944)
Acquisition of treasury stock - (666) -
-------- -------- --------
Net cash provided by (used in) financing activities 929 1,562 (16,473)
-------- -------- --------
Net decrease in cash and cash equivalents (1,430) (3,066) (32,800)
Cash and cash equivalents at beginning of year 2,751 5,817 38,617
-------- -------- --------
Cash and cash equivalents at end of year $ 1,321 $ 2,751 $ 5,817
======== ======== ========
</TABLE>
21
<PAGE>
Frankfort First Bancorp, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Federal income taxes $1,040 $ 405 $ 909
====== ====== ======
Interest on deposits and borrowings $5,729 $4,694 $4,613
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
22
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998, 1997 and 1996
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 1,7250,000 (as adjusted) common shares. Condensed financial
statements of the Corporation as of and for the periods ended June 30, 1998
and 1997 are presented in Note M. 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.
23
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
2. Investment Securities
---------------------
The Corporation accounts for investment securities in accordance with
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. At June 30, 1998 and 1997, the Corporation had
designated 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.
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.
24
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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).
The Savings Bank accounts for impaired loans in accordance with SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan," which 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.
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 multi-family and nonresidential loans, and its evaluation
of impairment thereof, such loans are collateral dependent and, as a result,
are carried as a practical expedient at the lower of cost or fair value.
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, 1998 and 1997, the Savings Bank had no loans that would be defined
as impaired under SFAS No. 114.
25
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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.
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 provided retirement benefits for
substantially all employees who had completed one year of service and had
attained the age of 21. Expense recognized related to the ESOP totaled
approximately $238,000 for the year ended June 30, 1996. During the fiscal
year ended June 30, 1997, the Board elected to terminate the ESOP and had
filed with the Internal Revenue Service for a favorable determination letter
in this
26
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
8. Retirement and Employee Benefit Plans (continued)
-------------------------------------
regard. Payment of the fiscal 1997 scheduled ESOP loan installment, coupled
with accelerated principal payments related to the pending plan termination,
resulted in 102,364 (adjusted) common shares being committed for release to
participants with a corresponding $1.5 million charge to compensation expense
during the fiscal year ended June 30, 1997. The Corporation recognized
approximately $47,000 in expense upon final termination of the ESOP during the
fiscal year ended June 30, 1998. References to share totals have been
adjusted to reflect the Corporation's reverse two-for-one stock split effected
during fiscal 1998.
The Corporation also had a Management Recognition Plan ("MRP"). Subsequent to
the Conversion the MRP purchased 68,460 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 MRP. Common stock granted under the MRP vested
over a five year period at twenty percent per year, commencing in January
1996. A provision of $52,000 and $178,000 related to the MRP was charged to
expense for the fiscal years ended June 30, 1997 and 1996. During fiscal
1997, the Board of Directors terminated the MRP. In conjunction therewith,
the Corporation received cash of $900,000 and 52,524 common shares at fair
value from the MRP. The common shares received upon termination of the MRP
were placed in treasury and simultaneously deemed retired. Coincident with
termination of the MRP, the Corporation established a deferred unfunded
compensation plan liability for the benefit of management and the directors.
The Corporation recognized $63,800 in expense under this plan for the fiscal
year ended June 30, 1998, while no expense was recognized for fiscal 1997.
During fiscal 1995, the Savings Bank transferred its defined benefit funds
into a multiemployer defined benefit pension plan. All employees over 21
years of age enter this plan at the first entrance date after completing one
year of service. The Savings Bank recorded expense totaling $72,000 and
$88,000 for the fiscal years ended June 30, 1997 and 1996, respectively, while
no such expense was recorded during fiscal year ended June 30, 1998.
9. Earnings Per Share and Dividends Per Share
------------------------------------------
Basic earnings per share is computed based upon the weighted-average shares
outstanding during the period 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 46,732, 125,339 and 125,555
weighted-average unallocated shares held by the ESOP, totaled 1,572,379,
1,583,196 and 1,599,445 for the fiscal years ended June 30, 1998, 1997 and
1996, respectively.
27
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
9. Earnings Per Share and Dividends Per Share (continued)
------------------------------------------
Diluted earnings per share is computed taking into consideration common shares
outstanding and dilutive potential common shares to be issued under the
Corporation's stock option plan. Weighted-average common shares deemed
outstanding for purposes of computing diluted earnings per share totaled
1,640,817 and 1,601,086 for the fiscal years ended June 30, 1998 and 1996,
respectively.
Effective during the fiscal year ended June 30, 1998, the Corporation began
presenting earnings per share pursuant to the provisions of SFAS No. 128,
"Earnings per Share." Accordingly, the fiscal 1997 and 1996 earnings per
share presentation has been revised to conform to SFAS No. 128.
During each of the fiscal years ended June 30, 1997 and 1996, the Corporation
declared dividends of $8.72 (adjusted) per common share. Of this amount,
$8.00 per share was paid in June 1997, and $8.00 per share was paid in June
1996, from funds retained by the Corporation in the Conversion and were deemed
by management to constitute a return of excess capital. Accordingly, the
Corporation charged each of these capital distributions to additional paid-in-
capital. Management had 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 $7.20 and $8.24 of the distributions paid during the fiscal years ended
June 30, 1997 and 1996, respectively, constituted a tax-free return of
capital.
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.
28
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
10. Fair Value of Financial Instruments (continued)
-----------------------------------
The following methods and assumptions were used by the Corporation in
estimating its fair value disclosures for financial instruments at June 30,
1998 and 1997:
Cash and cash equivalents: The carrying amounts presented in the
-------------------------
consolidated statements 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 statements 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 statements 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.
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.
29
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
10. Fair Value of Financial Instruments (continued)
-----------------------------------
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, 1998 and 1997, 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 are as follows:
<TABLE>
<CAPTION>
1998 1997
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
(In thousands)
<S> <C> <C> <C> <C>
Financial assets
Cash and cash equivalents $ 1,321 $ 1,321 $ 2,751 $ 2,751
Certificates of deposit in other financial
institutions 200 200 200 200
Investment securities 2,996 2,995 4,850 4,819
Loans receivable 126,328 128,760 120,888 116,380
Stock in Federal Home Loan Bank 1,494 1,494 1,156 1,156
-------- -------- -------- --------
$132,339 $134,770 $129,845 $125,306
======== ======== ======== ========
Financial liabilities
Deposits $ 81,891 $ 82,058 $ 85,957 $ 86,078
Advances from the Federal Home Loan Bank 28,260 28,269 9,006 8,923
Other borrowed money - - 13,000 13,000
Advances by borrowers for taxes and insurance 305 305 298 298
-------- -------- -------- --------
$110,456 $110,632 $108,261 $108,299
======== ======== ======== ========
</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.
30
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
12. Reclassifications
-----------------
Certain prior year amounts have been reclassified to conform to the 1998
consolidated financial statement presentation.
NOTE B - INVESTMENT SECURITIES
The amortized cost and estimated fair values of investment securities held to
maturity at June 30 are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
(In thousands)
<S> <C> <C> <C> <C>
U.S. Government agency
obligations $2,996 $2,995 $4,750 $4,719
Municipal securities - - 100 100
------ ------ ------ ------
$2,996 $2,995 $4,850 $4,819
====== ====== ====== ======
</TABLE>
At June 30, 1998, the carrying value of the Corporation's investment
securities exceeded the estimated fair value by $1,000, consisting solely of
gross unrealized losses. At June 30, 1997, the carrying value of the
Corporation's investment securities exceeded the estimated fair value by
$31,000, consisting of $3,000 in gross unrealized gains and $34,000 in gross
unrealized losses.
The amortized cost and estimated fair 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>
1998 1997
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
(In thousands)
<S> <C> <C> <C> <C>
Due within one year $2,000 $1,999 $1,856 $1,859
Due after one year through five years - - 1,998 1,999
Due after five years through ten years 996 996 996 961
------ ------ ------ ------
$2,996 $2,995 $4,850 $4,819
====== ====== ====== ======
</TABLE>
31
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE C - LOANS RECEIVABLE
The composition of the loan portfolio at June 30 is as follows:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Residential real estate
One-to-four family $118,899 $113,549
Multi-family 80 58
Construction 1,270 1,060
Nonresidential real estate and land 1,704 1,830
Consumer and other 5,258 5,414
-------- --------
127,211 121,911
Less:
Undisbursed portion of loans in process (572) (824)
Deferred loan origination fees (211) (99)
Allowance for loan losses (100) (100)
-------- --------
$126,328 $120,888
======== ========
</TABLE>
The Savings Bank's lending efforts have historically focused on one-to-four
family and multi-family residential real estate loans, which comprise
approximately $119.7 million, or 95%, of the total loan portfolio at June 30,
1998, and $113.8 million, or 94%, of the total loan portfolio at June 30,
1997. 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 $477,000 and $563,000 at June 30, 1998 and 1997, respectively.
32
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE D - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is summarized as follows for the
years ended June 30:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 100 $ 95 $ 83
Provision for loan losses - 5 12
----- ----- -----
Balance at end of year $ 100 $ 100 $ 95
===== ===== =====
</TABLE>
As of June 30, 1998, 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 $363,000, $116,000 and $118,000 at
June 30, 1998, 1997 and 1996, respectively. The Savings Bank did not incur
any reduction in interest income related to such nonperforming loans during
the respective periods.
NOTE E - OFFICE PREMISES AND EQUIPMENT
Office premises and equipment at June 30 are comprised of the following:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Land and improvements $ 187 $ 187
Office buildings and improvements 1,720 1,716
Furniture, fixtures and equipment 737 758
------ ------
2,644 2,661
Less accumulated depreciation and
amortization 1,141 1,088
------ ------
$1,503 $1,573
====== ======
</TABLE>
33
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE F - DEPOSITS
Deposits consist of the following major classifications at June 30:
<TABLE>
<CAPTION>
DEPOSIT TYPE AND WEIGHTED-
AVERAGE INTEREST RATE 1998 1997
(In thousands)
<S> <C> <C>
NOW accounts
1998 - 3.05% $ 3,716
1997 - 2.92% $ 3,960
Passbook
1998 - 2.91% 10,641
1997 - 3.00% 10,587
Money market deposit accounts
1998 - 3.33% 4,532
1997 - 3.64% 6,181
------- -------
Total demand, transaction and
passbook deposits 18,889 20,728
Certificates of deposit
Original maturities of:
Less than 12 months
1998 - 4.81% 10,620
1997 - 4.81% 10,826
12 months to 24 months
1998 - 5.27% 37,242
1997 - 5.36% 41,171
30 months to 36 months
1998 - 5.75% 10,848
1997 - 5.64 % 8,662
More than 36 months
1998 - 5.85% 4,292
1997 - 5.72% 4,570
------- -------
Total certificates of deposit 63,002 65,229
------- -------
Total deposit accounts $81,891 $85,957
======= =======
</TABLE>
At June 30, 1998 and 1997, the Savings Bank had certificates of deposit with
balances in excess of $100,000 totaling approximately $7.1 million and $7.6
million, respectively.
34
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE F - DEPOSITS (continued)
Maturities of outstanding certificates of deposit at June 30 are summarized as
follows:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Less than one year $44,775 $43,538
One to three years 15,453 19,877
Over three years 2,774 1,814
------- -------
$63,002 $65,229
======= =======
</TABLE>
NOTE G - ADVANCES FROM THE FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank, collateralized at June 30, 1998 by
pledges of certain residential mortgage loans totaling $42.7 million, and the
Savings Bank's investment in Federal Home Loan Bank stock, are summarized as
follows:
<TABLE>
<CAPTION>
MATURING
YEAR ENDING
INTEREST RATE JUNE 30, 1998 1997
(In thousands)
<S> <C> <C> <C>
5.84% 2000 $ 8,000 $ -
6.45% - 6.95% 2004 563 693
6.15% - 6.55% 2006 360 1,412
6.45% - 6.75% 2007 1,956 1,488
5.31% - 6.40% 2008 10,891 -
5.55% - 7.35% 2009 2,786 3,060
6.90% 2012 475 494
5.75% 2013 986 -
6.44% - 6.95% 2016 492 1,859
6.30% - 6.35% 2017 768 -
6.30% - 6.35% 2018 983 -
------- ------
$28,260 $9,006
======= ======
Weighted-average interest rate 6.07% 6.44%
==== =======
</TABLE>
35
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE H - OTHER BORROWED MONEY
At June 30, 1997, other borrowed money consisted of a variable rate bank note
totaling $13.0 million, with an interest rate of 8.50%. This borrowing was
collateralized by 100,000 shares of First Federal Savings Bank of Frankfort
stock, and was repaid during the fiscal year ended June 30, 1998.
NOTE I - FEDERAL INCOME TAXES
Federal income taxes differ from the amounts computed at the statutory
corporate tax rate as follows:
<TABLE>
<CAPTION>
JUNE 30,
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Federal income taxes computed at
statutory rate $ 814 $ 42 $ 846
Increase (decrease) in taxes resulting from:
Interest on municipal securities (1) (2) (2)
Nondeductible ESOP compensation expense - 451 -
Other 1 - (17)
----- ----- -----
Federal income tax provision per consolidated
statements of earnings $ 814 $ 491 $ 827
===== ===== =====
</TABLE>
The composition of the Corporation's net deferred tax asset at June 30 is as
follows:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Taxes (payable) refundable on temporary
differences at estimated corporate tax rate:
Deferred tax assets:
General loan loss allowance $ 34 $ 34
Deferred loan origination fees 72 34
Deferred compensation 64 149
Book/tax depreciation 15 10
----- -----
Total deferred tax assets 185 227
Deferred tax liabilities:
Percentage of earnings bad debt deductions (47) (47)
Federal Home Loan Bank stock dividends (82) (50)
----- -----
Total deferred tax liabilities (129) (97)
----- -----
Net deferred tax asset $ 56 $ 130
===== =====
</TABLE>
36
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE I - FEDERAL INCOME TAXES (continued)
The Savings Bank was 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, 1998 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, 1998. See Note L for additional information regarding the Savings
Bank's future 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 its
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 consolidated statements 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, 1998, the Savings Bank had outstanding commitments of
approximately $2.0 million to originate loans. Additionally, the Savings Bank
was obligated under unused lines of credit totaling $5.0 million. In the
opinion of management all loan commitments equaled or exceeded prevalent
market interest rates as of June 30, 1998, and will be funded from normal cash
flow from operations.
37
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE K - REGULATORY CAPITAL
The Savings Bank is subject to minimum regulatory capital standards promulgated
by the Office of Thrift Supervision (the "OTS"). Failure to meet minimum
capital requirements can initiate certain mandatory -- and possibly additional
discretionary -- actions by regulators that, if undertaken, could have a direct
material effect on the consolidated financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Savings Bank must meet specific capital guidelines that involve
quantitative measures of the Savings Bank's assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices.
The Savings Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.
The minimum capital standards of the OTS 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) equal to
3.0% of adjusted total assets. An OTS proposal, if adopted in present form,
would increase the core capital requirement to a range of 4.0% - 5.0% of
adjusted total assets for substantially all savings associations. Management
anticipates no material change to the Savings Bank's excess regulatory capital
position as a result of this proposed change in the regulatory capital
requirement. The risk-based capital requirement currently 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, 1998 and 1997, management believes that the Savings Bank met all
capital adequacy requirements to which it is subject.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1998
TO BE "WELL-
CAPITALIZED" UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
--------------- ------------------------------------- -------------------------------------
Amount Ratio Amount Ratio Amount Ratio
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tangible capital $23,299 17.4% greater than greater than greater than $6,714 greater than
or equal to $2,014 or equal to 1.5% or equal to or equal to 5.0%
Core capital $23,299 17.4% greater than greater than greater than greater than
or equal to $4,028 or equal to 3.0% or equal to $8,056 or equal to 6.0%
Risk-based capital $23,399 33.7% greater than greater than greater than $6,947 greater than
or equal to $5,557 or equal to 8.0% or equal to or equal to 10.0%
</TABLE>
38
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
<TABLE>
<CAPTION>
NOTE K - REGULATORY CAPITAL (continued)
AS OF JUNE 30, 1997
TO BE "WELL-
CAPITALIZED" UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------- ---------------------------------- ------------------------------------
Amount Ratio Amount Ratio Amount Ratio
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tangible capital $34,135 25.9% greater than greater than greater than greater than
or equal to $1,980 or equal to 1.5% or equal to $6,599 or equal to 5.0%
Core capital $34,135 25.9% greater than greater than greater than greater than
or equal to $3,959 or equal to 3.0% or equal to $7,919 or equal to 6.0%
Risk-based capital $34,235 50.8% greater than greater than greater than greater than
or equal to $5,393 or equal to 8.0% or equal to $6,741 or equal to 10.0%
</TABLE>
The Savings Bank's management believes that, under the current regulatory
capital regulations, the Savings Bank will continue to meet its minimum capital
requirements in the foreseeable future. However, events beyond the control of
the Savings Bank, such as increased interest rates or a downturn in the economy
in the Savings Bank's market area, could adversely affect future earnings and,
consequently, the ability to meet future minimum regulatory capital
requirements.
NOTE L - LEGISLATIVE DEVELOPMENTS
The deposit accounts of the Savings Bank and of other savings associations are
insured by the Federal Deposit Insurance Corporation ("FDIC") through the
Savings Association Insurance Fund ("SAIF"). The reserves of the SAIF were
below the level required by law, because a significant portion of the
assessments paid into the fund were used to pay the cost of prior thrift
failures. The deposit accounts of commercial banks are insured by the FDIC
through 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 fiscal 1996 and 1997, no BIF assessments were required for healthy
commercial banks except for a $2,000 minimum fee.
Legislation was enacted to recapitalize the SAIF that provided for a special
assessment totaling $.657 per $100 of SAIF deposits held at March 31, 1995, in
order to increase SAIF reserves to the level required by law. The Savings Bank
held $86.3 million in deposits at March 31, 1995, resulting in an assessment of
approximately $567,000, or $374,000 after-tax, which was charged to operations
in fiscal 1997.
A component of the recapitalization plan provided for the merger of the SAIF
and BIF on January 1, 1999. 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
39
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE L - LEGISLATIVE DEVELOPMENTS (continued)
merger of the deposit insurance funds. As a result, the Savings Bank would be
regulated as a bank under federal laws which would subject it to the more
restrictive activity limits imposed on national banks. In the opinion of
management, such activity limit restrictions would not have a material effect
on the Corporation's financial position or results of operations.
Under separate legislation related to the recapitalization plan, the Savings
Bank is required to recapture as taxable income approximately $140,000 of its
tax 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
bad debt deduction in the future. The Savings Bank has provided deferred taxes
for this amount and will be permitted to amortize the recapture of the bad debt
reserve in taxable income over six years.
NOTE M - 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, 1998 and 1997, and the results
of its operations and its cash flows for the fiscal years ended June 30, 1998,
1997 and 1996.
FRANKFORT FIRST BANCORP, INC.
STATEMENTS OF FINANCIAL CONDITION
June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
ASSETS
Interest-bearing deposits in First Federal Savings Bank
of Frankfort $ 358 $ 2,174
Investment in First Federal Savings Bank of Frankfort 23,299 34,135
Prepaid expenses and other 213 128
------- -------
Total assets $23,870 $36,437
======= =======
</TABLE>
40
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE M - CONDENSED FINANCIAL STATEMENTS OF FRANKFORT FIRST BANCORP, INC.
(continued)
<TABLE>
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Other borrowed money $ - $13,000
Dividends payable 324 295
Deferred compensation 813 750
Other liabilities 27 47
------- -------
1,164 14,092
Shareholders' equity
Common stock 17 33
Additional paid-in capital 5,876 5,860
Retained earnings 17,846 17,532
Shares acquired by stock benefit plans - (414)
Treasury stock - at cost (1,033) (666)
------- -------
Total shareholders' equity 22,706 22,345
------- -------
Total liabilities and shareholders' equity $23,870 $36,437
======= =======
</TABLE>
FRANKFORT FIRST BANCORP, INC.
STATEMENTS OF EARNINGS
Years ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Revenue
Interest income $ 27 $ 204 $ 632
Equity in earnings of First Federal Savings Bank of Frankfort 1,849 1,004 1,519
------ ------ ------
Total revenue 1,876 1,208 2,151
General and administrative expenses 435 1,667 405
------ ------ ------
Earnings (loss) before income taxes (credits) 1,441 (459) 1,746
Federal income taxes (credits) (139) (91) 86
------ ------ ------
NET EARNINGS (LOSS) $1,580 $ (368) $1,660
====== ====== ======
</TABLE>
41
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE M - CONDENSED FINANCIAL STATEMENTS OF FRANKFORT FIRST BANCORP, INC.
(continued)
FRANKFORT FIRST BANCORP, INC.
STATEMENTS OF CASH FLOWS
Years ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Cash from operating activities:
Net earnings (loss) for the year $ 1,580 $ (368) $ 1,660
Adjustments to reconcile net earnings (loss) to net
cash provided by (used in) operating activities
(Undistributed earnings of) excess distributions from
consolidated subsidiary 10,836 1,996 (1,519)
Increase (decrease) in cash due to changes in:
Prepaid expenses and other assets (85) (66) (62)
Other liabilities 119 866 341
-------- -------- --------
Net cash provided by operating activities 12,450 2,428 420
Cash flows provided by (used in) investing activities:
Issuance of loan to ESOP - - (2,760)
Purchase of investment in First Federal Savings Bank of Frankfort - - (16,695)
Proceeds from repayment of loan to ESOP - 2,511 249
-------- -------- --------
Net cash provided by (used in) investing activities - 2,511 (19,206)
-------- -------- --------
Net cash provided by (used in) operating and investing
activities (balance brought forward) $ 12,450 $ 4,939 $(18,786)
Cash flows provided by (used in) financing activities:
Proceeds from other borrowed money - 13,000 500
Repayments of other borrowed money (13,000) (500) -
Proceeds from issuance of common stock - - 33,390
Capital distributions on common stock (1,266) (14,759) (14,944)
Purchase of treasury stock - (666) -
-------- -------- --------
Net cash provided by (used in) financing activities (14,266) (2,925) 18,946
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (1,816) 2,014 160
Cash and cash equivalents at beginning of year 2,174 160 -
-------- -------- --------
Cash and cash equivalents at end of year $ 358 $ 2,174 $ 160
======== ======== ========
</TABLE>
42
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE M - CONDENSED FINANCIAL STATEMENTS OF FRANKFORT FIRST BANCORP, INC.
(continued)
As a condition to regulatory approval of the stock conversion and
reorganization to the holding company form of ownership, the Savings Bank
agreed to limit the amount of dividends payable to the Corporation.
Regulations of the Office of Thrift Supervision (OTS) impose limitations on the
payment of dividends and other capital distributions by savings associations.
Under such regulations, a savings association 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 requirement is generally
permitted without OTS approval (but subsequent to 30 days prior notice to the
OTS of the planned dividend) to make capital distributions during a calendar
year in the amount of up to the greater of (i) 100% of its net earnings to date
during the year plus an amount equal to one-half of the amount by which its
total capital-to-assets ratio exceeded its fully phased-in capital-to-assets
ratio at the beginning of the year or (ii) 75% of its net earnings for the most
recent four quarters. Pursuant to such OTS dividend regulations, the Savings
Bank had the ability to pay dividends of approximately $5.3 million to the
Corporation at June 30, 1998.
NOTE N - CORPORATE REORGANIZATION AND CONVERSION TO STOCK FORM
On July 26, 1994, the Savings Bank's Board of Directors adopted a plan of
conversion (the "Plan") whereby the Savings Bank would convert to the stock
form of ownership, followed by the issuance of all of the Savings Bank's
outstanding stock to a newly formed holding company, Frankfort First Bancorp,
Inc. Pursuant to the Plan, the Corporation offered for sale up to 1,725,000
(adjusted) common shares. The stock offering was completed on July 7, 1995,
culminating in the sale of 1,725,000 (adjusted) common shares which, after
consideration of offering expenses totaling $1.1 million, and shares acquired
by the ESOP totaling $2.7 million, resulted in the receipt of $30.7 million of
net equity capital.
At the completion of the conversion to stock form, the Savings Bank established
a liquidation account in an amount equal to retained earnings contained in the
final offering circular. The liquidation account will be maintained for the
benefit of eligible savings account holders who maintain deposit accounts in
the Savings Bank after conversion.
In the event of a complete liquidation (and only in such event), each eligible
savings account holder will be entitled to receive a liquidation distribution
from the liquidation account in the amount of the then current adjusted balance
of deposit accounts held, before any liquidation distribution may be made with
respect to common stock. Except for the repurchase of stock and payment of
dividends by the Savings Bank, the existence of the liquidation account will
not restrict the use or application of such retained earnings. The Savings Bank
may not declare, pay a cash dividend on, or repurchase any of its common stock,
if the effect thereof would cause retained earnings to be reduced below either
the amount required for the liquidation account or the regulatory capital
requirements for SAIF insured institutions.
43
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE O - STOCK OPTION PLAN
The Board of Directors adopted the Frankfort First Bancorp, Inc. 1995 Stock
Option and Incentive Plan (the "Plan") that provided for the issuance of
175,778 (adjusted) shares of authorized, but unissued shares of common stock at
fair value at the date of grant. The Corporation had initially granted options
to purchase shares at the adjusted fair value of $18.96 per share. The
Corporation anticipates such fair value to be adjusted to $10.96 to give effect
to the return of capital distributions (Note A-9) paid by the Corporation in
fiscal 1997, 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, 1998, none of the stock
options granted had been exercised.
In 1996, the Corporation adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," which contains a fair value-based method for valuing stock-based
compensation that entities may use, which measures compensation cost at the
grant date based on the fair value of the award. Compensation is then
recognized over the service period, which is usually the vesting period.
Alternatively, SFAS No. 123 permits entities to continue to account for stock
options and similar equity instruments under Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." Entities
that continue to account for stock options using APB Opinion No. 25 are
required to make pro forma disclosures of net earnings and earnings per share,
as if the fair value-based method of accounting defined in SFAS No. 123 had
been applied.
The Corporation applies Accounting Principles Board Opinion No. 25 and related
Interpretations in accounting for its stock option plan. Accordingly, no
compensation cost has been recognized with respect to the Plan. Had
compensation cost for the Corporation's stock option plan been determined based
on the fair value at the grant date in a manner consistent with the accounting
method utilized in SFAS No. 123, then the Corporation's net earnings and
earnings per share would have been reduced to the pro forma amounts indicated
below:
44
<PAGE>
FRANKFORT FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE O - STOCK OPTION PLAN (continued)
<TABLE>
<CAPTION>
1998 1997 1996
(Earnings in thousands)
<S> <C> <C> <C> <C>
Net earnings As reported $1,580 $(368) $1,660
====== ===== ======
Pro-forma $1,580 $(373) $1,433
====== ===== ======
Earnings per share
Basic As reported $ 1.00 $(.22) $ 1.04
====== ===== ======
Pro-forma $ 1.00 $(.24) $ .90
====== ===== ======
Diluted As reported $ .96 N/A $ 1.04
====== ===== ======
Pro-forma $ .96 N/A $ .90
====== ===== ======
</TABLE>
The fair value of each option grant is estimated on the date of grant using the
modified Black-Scholes options-pricing model with the following weighted-
average assumptions used for grants in fiscal 1997 and 1996: dividend yield of
5.0%, expected volatility of 20.0%, a risk-free interest rate of 6.5% and an
expected life of ten years.
A summary of the status of the Corporation's stock option plan as of June 30,
1998, 1997 and 1996, and changes during the periods ending on those dates is
presented below:
<TABLE>
<CAPTION>
1998 1997 1996
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 175,778 $10.99 172,328 $10.96 - $ -
Granted - - 3,450 12.50 172,328 10.96
Exercised - - - - - -
Forfeited - - - - - -
------- ------ ------- --------- --------------- ---------
Outstanding at end of year 175,778 $10.99 175,778 $10.99 172,328 $10.96
======= ====== ======= ========= =============== =========
Options exercisable at year-end 74,796 $10.96 41,366 $10.96 - $ -
======= ====== ======= ========= =============== =========
Weighted-average fair value of
options granted during the year N/A $ 2.28 $ 2.00
====== ========= =========
The following information applies to options outstanding
at June 30, 1998:
Number outstanding 175,778
Range of exercise prices $10.96 - $12.50
Weighted-average exercise price $10.99
Weighted-average remaining contractual life 7.5 years
</TABLE>
45
<PAGE>
<TABLE>
<S> <C> <C>
BOARD OF DIRECTORS
WILLIAM C. JENNINGS CHARLES A. COTTON III DAVID G. EDDINS
President and Chairman of the Board Commissioner of the Department Certified Public Accountant
of the Company of Housing, Building and
Construction,
Commonwealth of Kentucky
DANNY A. GARLAND HERMAN D. REGAN, JR. WILLIAM M. JOHNSON
President of the Bank and Vice Retired Chairman of the Board Attorney
President and Secretary of the and President of
Company Kenvirons, Inc.
FRANK McGRATH C. MICHAEL DAVENPORT
President President
Frankfort Lumber Company C. Michael Davenport, Inc., and
Davenport Broadcasting, Inc.
EXECUTIVE OFFICERS
WILLIAM C. JENNINGS DANNY A. GARLAND JOYCE H. JENNINGS
President and Chairman of the Board Vice President and Secretary Vice President
Don D. Jennings
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
Grant Thornton, LLP The Annual Meeting of Share- AVAILABILITY OF 10-K REPORT
Suite 900 holders will be held on A COPY OF The COMPANY'S
625 Eden Park Drive November 10, 1998, at 4:30 p.m. ANNUAL REPORT ON FORM
Cincinnati, Ohio 45202-4181 at First Federal Savings Bank of 10-K FOR THE YEAR ENDED
Frankfort JUNE 30, 1998, AS FILED
WITH THE SECURITIES AND
SPECIAL COUNSEL TRANSFER AGENT AND REGISTRAR EXCHANGE COMMISSION
Housley, Kantarian & Bronstein, P.C. Illinois Stock Transfer Company WILL BE FURNISHED
1220 19th Street, N.W. Suite 700 209 W. Jackson Blvd, Suite 903 WITHOUT CHARGE TO
Washington, D.C. 20036 Chicago, Illinois 60606-6905 SHAREHOLDERS AS OF
THE RECORD DATE FOR
THE NOVEMBER 10, 1998
ANNUAL MEETING UPON
WRITTEN REQUEST TO
INVESTOR RELATIONS,
FRANKFORT FIRST BANCORP,
INC., P.O. BOX 535
FRANKFORT, KY 40602
</TABLE>
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Parent
- ------
Frankfort First Bancorp, Inc.
<TABLE>
<CAPTION>
State or
Percentage Other Jurisdiction
Subsidiaries (1) Ownership of Incorporation
- ---------------- --------- ------------------
<S> <C> <C>
First Federal Savings Bank of Frankfort 100% United States
</TABLE>
- -------------------------
(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>
EXHIBIT 23.1
ACCOUNTANT'S CONSENT
We have issued our report dated August 28, 1998, 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, 1998. We
hereby consent to the incorporation by reference of said report in the
Corporation's Form S-8.
/s/ Grant Thornton, LLP
- -----------------------
Cincinnati, Ohio
September 21, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> JUN-30-1998
<CASH> 201
<INT-BEARING-DEPOSITS> 1,320
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 2,996
<INVESTMENTS-MARKET> 2,995
<LOANS> 126,428
<ALLOWANCE> 100
<TOTAL-ASSETS> 134,485
<DEPOSITS> 81,891
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1,628
<LONG-TERM> 28,260
0
0
<COMMON> 17
<OTHER-SE> 22,689
<TOTAL-LIABILITIES-AND-EQUITY> 134,485
<INTEREST-LOAN> 9,331
<INTEREST-INVEST> 420
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 9,751
<INTEREST-DEPOSIT> 4,000
<INTEREST-EXPENSE> 5,685
<INTEREST-INCOME-NET> 4,066
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1,672
<INCOME-PRETAX> 2,394
<INCOME-PRE-EXTRAORDINARY> 1,580
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,580
<EPS-PRIMARY> 1.00
<EPS-DILUTED> 0.96
<YIELD-ACTUAL> 2.34
<LOANS-NON> 0
<LOANS-PAST> 363
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 100
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 100
<ALLOWANCE-DOMESTIC> 100
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
