<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, 1999
[_] 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, 1999, the aggregate market value of the 1,135,293 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $17.0 million based on the closing sales price of
$15.00 per share of the registrant's Common Stock on September 15, 1999 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, 1999:
1,483,411
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,
1999. (Parts I and II)
2. Portions of Proxy Statement for the 1999 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,
1999, the Company had total assets of $140.3 million, deposits of $86.3 million
and shareholder's equity of $21.3 million.
The Bank. First Federal was originally chartered in 1934 as a Kentucky-
chartered building and loan association known as "Greater Frankfort Building and
Loan Association" and was rechartered in 1938 as First Federal Savings and Loan
Association of Frankfort. First Federal has been a member of the Federal Home
Loan Bank ("FHLB") of Cincinnati and its deposits have been federally insured
since 1938. In 1989, First Federal became a federal mutual savings bank and
adopted its current name. First Federal currently operates through three banking
offices located in Frankfort, Kentucky.
First Federal is primarily engaged in the business of attracting deposits
from the general public and originating loans secured by first mortgages on one-
to four-family residences in First Federal's market area. First Federal also
originates, to a lesser extent, church loans, home equity loans and other loans.
As a federally chartered savings institution, First Federal is subject to
extensive regulation by the 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 January 6, 1999,
legislation was reintroduced in the U.S. House of Representatives which calls
for the modernization of the banking system and which would significantly affect
the operations and regulatory structure of the financial services industry,
including savings institutions like us. At this time, management does not know
what form final legislation might take, but if enacted into law, the legislation
could affect the Corporation's competitive environment as well as its business
and operations. See " -- Regulation -- Proposed Legislative and Regulatory
Changes."
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
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<PAGE>
of Franklin, Anderson, Scott, Shelby and Woodford. 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, 1999, First Federal had no concentrations of
loans exceeding 10% of total loans that are not otherwise disclosed below.
<TABLE>
<CAPTION>
At June 30,
---------------------------------------------------------------------------------------
1999 1998 1997 1996
----------------- ----------------- ----------------- -----------------
Amount % Amount % Amount % Amount %
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Type of Loan:
- -------------
Real estate loans --
Construction loans................. $ 808 0.61% $ 1,270 1.00% $ 1,060 0.87% $ 672 .6%
One- to four-family residential.... 124,081 93.74 118,899 93.47 113,549 93.14 103,944 93.7
Multi-family residential........... 78 0.06 80 0.06 58 0.05 123 .1
Other loans (1).................... 1,756 1.33 1,704 1.34 1,830 1.50 1,450 1.3
Consumer loans --
Savings account loans.............. 935 0.71 545 0.43 672 0.55 547 .5
Home equity lines of credit........ 4,705 3.55 4,713 3.70 4,742 3.89 4,182 3.8
-------- -------- -------- ------ -------- ------ --------- ------
132,363 100.00% 127,211 100.00% 121,911 100.00% 110,918 100.00%
======== ======== ======== ====== ======== ====== ========= ======
Less:
Loans in process................... 246 572 824 392
Discounts, deferred loan fees and
other.............................. 378 211 99 100
Loan loss reserve.................. 100 100 100 95
-------- -------- -------- ---------
Total............................. $131,639 $126,328 $120,888 $ 110,331
======== ======== ======== =========
--------------------------
1995
----------------
Amount %
------ -----
<S> <C> <C>
Type of Loan:
- -------------
Real estate loans --
Construction loans................. $ 270 .3%
One- to four-family residential.... 94,816 94.0
Multi-family residential........... 134 .1
Other loans (1).................... 1,549 1.6
Consumer loans --
Savings account loans.............. 618 .6
Home equity lines of credit........ 3,449 3.4
------- ------
100,836 100.00%
======= ======
Less:
Loans in process................... 123
Discounts, deferred loan fees and 28
other.............................. 83
Loan loss reserve.................. --------
$100,602
Total............................. ========
</TABLE>
__________________
(1) Represents primarily church loans.
4
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The following table sets forth certain information at June 30, 1999
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, 1999 June 30, 1999 June 30, 1999 Total
-------------- ------------- ------------- --------
<S> <C> <C> <C> <C>
(In thousands)
Real estate loans:
Construction loans........... $ 808 $ -- $ -- $ 808
One- to four-family.......... 4,109 18,503 101,469 124,081
Multi-family residential..... 3 13 62 78
Other loans................... 58 261 1,437 1,756
Consumer loans:
Savings account loans........ 935 -- -- 935
Home equity lines of credit.. 711 291 3,703 4,705
--------- ---------- ---------- ---------
Total....................... $ 6,624 $ 19,068 $ 106,671 $ 132,363
========= ========== ========== =========
</TABLE>
The following table sets forth at June 30, 1999, the dollar amount of all
loans due more than one year after June 30, 1999 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....... $ 40,649 $ 79,323
Multi-family residential.............. -- 75
Other loans........................... 480 1,218
Consumer loans:
Home equity lines of credit........... -- 3,994
Savings account loans................. -- --
----------- ----------
Total.............................. $ 41,129 $ 84,610
=========== ==========
</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
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Originations of Loans. The following table sets forth certain information
with respect to First Federal's loan originations during the periods indicated.
Year Ended June 30,
---------------------------------
1999 1998 1997
------- ------- -------
(In thousands)
Originations
Real estate loans:
One- to four-family......... $35,353 $31,786 $27,878
Multi-family................ 64 82 --
Other....................... 20 161 575
Construction loans.......... 1,363 1,445 1,604
Consumer loans:
Home equity line of credit.. 3,181 2,702 2,899
Savings account loans....... 912 406 524
------- ------- -------
Total...................... $40,893 $36,582 $33,480
======= ======= =======
Other than two loan participations purchased and having a balance totalling
$77,000 at June 30, 1999, 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, although it may continue to purchase loan participations.
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, 1999, approximately $124.1 million, or 93.7%, of the Bank's
loan portfolio consisted of loans secured by one- to four-family residential
properties which were primarily owner-occupied, single family residences.
First Federal began originating adjustable rate residential mortgage loans
in the early 1980s. Since that time, most one- to four-family mortgage loans
originated by the Bank have been adjustable rate loans with an initial fixed
term of one, three, or five years. After the initial term, the rate adjustments
on the Bank's adjustable rate loans are indexed to the National Average Contract
Interest Rate for Major Lenders on the Purchase of Previously Occupied Homes
("NACR"). The interest rates on these mortgages are adjusted once a year, with
limitations on adjustments of one percentage point per adjustment period, and a
lifetime cap of five percentage points.
At June 30, 1999, the Bank's loan portfolio included $82.0 million in
adjustable rate one- to four-family residential mortgage loans, or 66.1% of the
Bank's one- to four-family residential mortgage 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%.
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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. The Bank has
been offering second mortgages up to an overall 90% loan-to-value ratio at a
premium rate to qualified borrowers. These loans have a term of seven years and
are not covered by private mortgage insurance. At June 30, 1999, the outstanding
balance of these loans totaled $50,000.
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, 1999, the Bank had 16 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, 1999, single-family
residential construction loans constituted $808,000, or 0.6%, of First Federal's
total loans. First Federal limits its construction lending to loans to
individuals building their primary residences. These loans generally have rates
that are fixed for six months and are underwritten in accordance with the same
standards as First Federal's mortgages on existing properties, except the loans
generally provide for disbursement in stages during a construction period of up
to six months, during which period the borrower is required to make monthly
payments of accrued interest on the outstanding loan balance. Construction loans
have a maximum loan-to-value ratio of 80%. Borrowers must satisfy all credit
requirements which would apply to First Federal's permanent mortgage loan
financing for the subject property. The Bank's construction loans may be
refinanced into permanent loans upon completion of the construction.
Construction financing is considered to involve a higher degree of risk of
loss than long-term financing on improved, occupied real estate. Risk of loss on
a construction loan is dependent largely upon the accuracy of the initial
estimate of the property's value at completion of construction and the estimated
cost (including interest) thereof. During the construction phase, a number of
factors could result in delays and cost overruns. If the estimate of
construction costs proves to be inaccurate, First Federal may be required to
advance funds beyond the amount originally committed to permit completion of the
project. If the estimate of value proves to be inaccurate, First Federal may be
confronted, at or prior to the maturity of the loan, with a project having a
value which is insufficient to assure full repayment. First Federal has sought
to minimize this risk by limiting construction lending to qualified borrowers in
Franklin County and by limiting the number of outstanding construction loans.
Consumer Lending. The consumer loans originated by the Bank include home
equity lines of credit, and loans secured by savings deposits.
At June 30, 1999, the Bank's consumer loan balance totaled $5.6 million, or
4.3% of its total loan portfolio. Of the consumer loan balance at June 30, 1999,
83.4% were home equity loans and 16.6% 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
7
<PAGE>
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, 1999, the total outstanding
home equity loans amounted to $4.7 million, or 3.6%, of the Bank's total loan
portfolio.
The Bank makes savings account loans for up to 90% of the depositor's
savings account balance. The interest rate is normally 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, 1999, loans on savings accounts
totaled $935,000, or 0.7%, 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 documentation is requested 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
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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 $3.4 million at June 30, 1999. 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, 1999, First Federal had no assets
classified as loss or doubtful and $179,000 of assets classified as
substandard. At June 30, 1999, assets designated as special mention totaled
$64,000.
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.
Year Ended June 30,
---------------------------------
1999 1998 1997 1996 1995
----- ----- ----- ----- -----
(In thousands)
Balance at beginning of period.. $ 100 $ 100 $ 95 $ 83 $ 71
Provision for loan losses....... -- -- 5 12 12
----- ----- ----- ----- -----
Balance at end of period........ $ 100 $ 100 $ 100 $ 95 $ 83
===== ===== ----- ===== =====
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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,
------------------------------------------------------------------------------
1999 1998 1997
---------------------- ---------------------- ------------------------
Percent of Percent of Percent of
Loans in Loans in Loans in
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
-------- ----------- -------- ----------- -------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate - mortgage:
Residential............... $ 94 93.8% $ 94 93.5% $ 93 93.2%
Commercial................ 2 1.3 1 1.2 2 1.5
Real estate - construction.. -- 0.6 1 1.2 1 0.9
Consumer.................... 4 4.3 4 4.1 4 4.4
----- ------ ----- ------ ----- -----
Total allowance for loan
losses.................... $ 100 100.00% $ 100 100.00% $ 100 100.0%
===== ====== ===== ====== ===== =====
<CAPTION>
---------------------------------------------------
1996 1995
---------------------- ----------------------
Percent of Percent of
Loans in Loans in
Category to Category to
Amount Total Loans Amount Total Loans
-------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Real estate - mortgage:
Residential............... $89 93.8% $78 94.1%
Commercial................ 1 1.3 2 1.6
Real estate - construction.. 1 0.6 -- 0.3
Consumer.................... 4 4.3 3 4.0
--- ----- --- -----
Total allowance for loan
losses.................... $95 100.0% $83 100.0%
=== ===== === =====
</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,
--------------------------------------
1999 1998 1997 1996 1995
------ ------ ------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Accruing loans which are contractually
past due 90 days or more.............. $ 188 $ 363 $ 116 $ 118 $ 34
Percentage of total loans............... 0.14% 0.29% .10% .11% .03%
Percentage of total assets.............. 0.13% 0.27% .09% .09% .02%
</TABLE>
At June 30, 1999, 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
deposit 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>
June 30,
------------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Investment securities:
U.S. Government agency issues........................ $ 2,004 $ 2,996 $ 4,750
State and municipal obligations...................... -- -- 100
Interest-earning deposits and certificates of deposit.. 1,800 1,320 2,790
FHLB stock............................................. 1,621 1,494 1,156
-------- -------- --------
Total investments................................. $ 5,425 $ 5,810 $ 8,796
======== ======== ========
</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, 1999.
<TABLE>
<CAPTION>
At June 30, 1999
-----------------------------------------------------------------------------------
One Year or Less One to Five Years Five to Ten Years
----------------------- ----------------------- -----------------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- -------- -------- -------- ---------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Investment securities:
Federal agency issued bonds.......... $ 2,004 5.22% $ -- --% $ -- --%
Interest-earning deposits
and certificates of deposit.......... 1,600 4.53 200 4.84 -- --
-------- -------- ----------
Total............................. $ 3,604 $ 200 $ --
====== ======== ==========
<CAPTION>
--------------------------------------------------------------------
More than Ten Years Total Investment Portfolio
----------------------- --------------------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
-------- -------- -------- ------ --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Investment securities:
Federal agency issued bonds.......... $ -- --% $ 2,004 $1,999 5.22%
Interest-earning deposits
and certificates of deposit.......... -- -- 1,800 1,800 4.57
-------- -------- ------
Total............................. $ -- $ 3,804 $3,799
======== ======== ======
</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, 1999 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 $10,223 11.85%
3.00 None Christmas Savings N/A 162 0.19
3.00 None NOW 300 1,661 1.93
3.00 None Home Equity & Construction N/A 3 0.00
3.10 None Golden 50 300 1,818 2.11
3.10 None Super NOW 1,000 2,728 3.16
3.23 None MMDA 1,000 4,447 5.16
-- None Noninterest-bearing 300 347 0.40
------- ------
21,389 24.80
Certificates of Deposit
-----------------------
4.05% 91-Days Fixed Term, Fixed Rate 500 1,334 1.55
4.34 182-Days Fixed-Term, Fixed Rate 500 5,468 6.34
4.54 9-month Fixed-Term, Fixed Rate 5,000 1,604 1.86
4.82 12-month Fixed-Term, Fixed Rate 500 14,004 16.24
5.63 15-month Fixed-Term, Fixed Rate 500 4,380 5.08
5.30 18-month Fixed-Term, Fixed Rate 500 8,111 9.40
4.96 24-month Fixed-Term, Fixed Rate 500 4,505 5.22
5.70 30-month Fixed-Term, Fixed Rate 500 6,989 8.10
5.34 36-month Fixed-Term, Fixed Rate 500 4,055 4.70
5.99 60-month Fixed-Term, Fixed Rate 500 3,241 3.76
5.64 72-month Fixed-Term, Fixed Rate 500 296 0.34
4.82 12-month Variable IRA 100 4,745 5.50
4.65 12-month Fixed-Term, Variable Rate 500 643 0.75
5.02 24-month Fixed Term, Variable Rate (2) 500 5,454 6.32
3.00 Varies Other N/A 36 0.04
------- ------
64,865 75.20
------- ------
$86,254 100.00%
======= ======
</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
1999 Deposits (Decrease) 1998 Deposits (Decrease) 1997 Deposits
-------- -------- --------- -------- -------- ---------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Passbook.............................. $10,223 11.85% $ 79 $10,144 12.39% $ (247) $10,391 12.08%
Christmas savings..................... 162 0.19 (22) 184 0.22 (12) 196 0.23
NOW................................... 1,661 1.93 30 1,631 1.99 5 1,626 1.89
Home equity........................... 3 0.00 3 -- -- -- -- --
Golden 50............................. 1,818 2.11 212 1,606 1.96 127 1,479 1.72
Super Now............................. 2,728 3.16 2,249 479 0.58 (196) 675 0.79
MMDA.................................. 4,447 5.16 (85) 4,532 5.53 (1,649) 6,181 7.19
Noninterest-bearing................... 347 0.40 34 313 0.40 133 180 0.21
------- ------ ------- ------- ------ ------- ------- ------
21,389 24.80 2,500 18,889 23.07 (1,839) 20,728 24.11
Certificates of Deposit
- -----------------------
Fixed-Term, Fixed-Rate:
91-days............................. 1,334 1.55 (80) 1,414 1.73 (535) 1,949 2.27
182-days............................ 5,468 6.34 (169) 5,637 6.88 (1,403) 7,040 8.19
7-month............................. 0 0.00 (3,231) 3,231 3.95 3,231 -- --
9-month............................. 1,604 1.86 1,266 338 0.41 (1,373) 1,711 1.99
12-month............................ 14,004 16.24 5,296 8,708 10.63 (119) 8,827 10.26
15-month............................ 4,380 5.08 (6,442) 10,822 13.22 (379) 11,201 13.03
18-month............................ 8,111 9.40 8,011 100 0.12 -- 100 0.12
24-month............................ 4,505 5.22 (692) 5,197 6.35 (2,901) 8,098 9.42
30-month............................ 6,989 8.10 1,382 5,607 6.85 2,439 3,168 3.69
36-month............................ 4,055 4.70 (1,186) 5,241 6.40 (253) 5,494 6.39
60-month............................ 3,241 3.76 (738) 3,979 4.86 (240) 4,219 4.91
72-month............................ 296 0.34 (17) 313 0.38 (38) 351 0.41
Variable IRA (12-month)............... 4,745 5.50 114 4,631 5.66 (662) 5,293 6.16
Fixed-Term, Variable-Rate (12 month).. 643 0.75 (314) 957 1.17 (200) 1,157 1.35
Fixed-Term, Variable-Rate (24 month).. 5,454 6.32 (1,306) 6,760 8.25 265 6,495 7.55
Other................................. 36 0.04 (31) 67 0.07 (59) 126 0.15
------- ------ ------- ------- ------ ------- ------- ------
64,865 75.20 1,863 63,002 76.93 (2,227) 65,229 75.89
------- ------ ------- ------- ------ ------- ------- ------
Total............................. $86,254 100.00% $ 4,363 $81,891 100.00% $(4,066) $85,957 100.00%
======= ====== ======= ======= ====== ======= ======= ======
</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,
--------------------------------------------------------------------
1999 1998 1997
---------------------- --------------------- --------------------
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............................. $ 8,945 $ 63,692 $ 9,204 $ 63,761 $ 9,770 $ 65,296
Average rate................................ 3.17% 5.21% 3.10% 5.33% 3.33% 5.44%
</TABLE>
The following table sets forth the time deposits in First Federal
classified by rates at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
----------------------------
1999 1998 1997
------- ------- -------
(In thousands)
<S> <C> <C> <C>
2 - 3.99%.................. $ 178 $ 90 $ 152
4 - 5.99%.................. 62,114 58,966 54,461
6 - 7.99%.................. 2,573 3,944 10,530
8 - 9.99%.................. -- 2 86
------- ------- -------
$64,865 $63,002 $65,229
======= ======= =======
</TABLE>
The following table sets forth the amount and maturities of time deposits
in First Federal at June 30, 1999.
<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%......... $ 157 $ -- $ 21 $ -- $ 178
4 - 5.99%......... 47,964 10,137 3,275 738 62,114
6 - 7.99%......... 360 242 976 995 2,573
-------- -------- ------- ------- --------
$ 48,481 $ 10,379 $ 4,272 $ 1,733 $ 64,865
======== ======== ======= ======= ========
</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,
1999.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- ------------
(In thousands)
<S> <C>
Three months or less........................... $ 2,204
More than three through six months............. 1,159
More than six through 12 months................ 3,023
Over 12 months................................. 2,600
-------
Total.................................... $ 8,986
=======
</TABLE>
The following table sets forth the deposit activities of First Federal for
the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------
1999 1998 1997
-------- ------- --------
(In thousands)
<S> <C> <C> <C>
Beginning balance................................. $ 81,891 $ 85,957 $ 87,777
Deposits.......................................... 56,813 57,438 64,175
Withdrawals....................................... 56,378 65,540 69,224
-------- -------- --------
Net increase (decrease) before interest credited.. 435 (8,102) (5,049)
Interest credited................................. 3,928 4,036 3,229
-------- -------- --------
Net increase (decrease) in deposits............... 4,363 (4,066) (1,820)
-------- -------- --------
Ending balance.................................... $ 86,254 $ 81,891 $ 85,957
======== ======== ========
</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, 1999, First Federal had $30.9 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,
--------------------------
1999 1998
------- ---------
(Dollars in thousands)
<S> <C> <C>
Amounts outstanding at end of period:
FHLB advances........................................ $ 30,878 $ 28,260
Other loans.......................................... 284 --
-------- --------
Total............................................. 31,162 28,260
Weighted average rate paid on:
FHLB advances........................................ 5.50% 6.07%
Other loans.......................................... 7.50% --%
</TABLE>
<TABLE>
<CAPTION>
For the Year
Ended June 30,
------------------------
1999 1998
------- -------
(Dollars in thousands)
<S> <C> <C>
Maximum amount of borrowings outstanding
at any month end:
FHLB advances........................................ $ 31,640 $ 29,068
Other loans.......................................... 284 2,000
</TABLE>
<TABLE>
<CAPTION>
For the Year
Ended June 30,
-------------------------
1999 1998
------- --------
(Dollars in thousands)
<S> <C> <C>
Approximate average short-term borrowings outstanding
with respect to:
FHLB advances........................................ $ 3,211 $ 5,750
Other loans.......................................... 33 1,923
Approximate weighted average rate paid on: (1)
FHLB advances........................................ 5.73% 6.32%
Other loans.......................................... 7.50% 8.50%
</TABLE>
- ----------------
(1) Weighted average computed by dividing total interest paid by average
balance outstanding.
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, 1999, First Federal had 25 full-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.
Proposed Legislative and Regulatory Changes. The U.S. Congress is in the
process of drafting legislation which may have a profound effect on the
financial services industry. In January 1999 legislation restructuring the
activities and regulations oversight of the financial services industry was
reintroduced in both houses of the U.S. Congress. The stated purposes of the
House bill ("H.R. 10") 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 would permit affiliations between commercial
banks, securities firms, insurance companies and, subject to certain
limitations, other commercial enterprises allowing holding companies to offer
new services and products. In particular, H.R. 10 repeals the Glass-Steagall Act
prohibitions on bank affiliating with securities firms and thereby allow holding
companies to engage in securities underwriting and dealing without limits and to
sponsor and act as distributor for mutual funds and also removes the Bank
Holding Company Act's prohibitions on insurance underwriting allowing holding
companies to underwrite and broker any type of insurance product. H.R. 10 also
calls for a new regulatory framework for financial institutions and their
holding companies. The legislation preserves the thrift charter and all existing
thrift powers, but would restrict the activities of new unitary thrift holding
companies. In May 1999, the Senate passed a version of financial services
modernization which differs from H.R. 10. In July 1999, the House passed H.R.
10, which will now go to the Senate to be reconciled with its version. At this
time, it is unknown how the legislation will be modified, or if enacted, what
form the final version of the legislation might take and how it will affect the
Corporation's and the Bank's business and operations and competitive
environment.
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 4% (or 3.0% if the association is rated
composite 1 CAMELS under the OTS examination rating system) 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, 1999, 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
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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 and up to 45% of unrealized gains
on equity securities. Total core and supplementary capital are reduced by the
amount of capital instruments held by other depository institutions pursuant to
reciprocal arrangements all equity investments and that portion of true
associations land loans and non-residential construction loans in excess of an
80% loan-to-value ratio. At June 30, 1999, 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.
The table below presents the Bank's capital position relative to its
various regulatory capital requirements at June 30, 1999.
<TABLE>
<CAPTION>
Percent of
Amount Assets (1)
------ -----------
(Dollars in thousands)
<S> <C> <C>
Tangible capital................ $ 22,513 16.1%
Tangible capital requirement.... 2,102 1.5
-------- ----
Excess........................ $ 20,411 14.6%
======== ====
Core capital.................... $ 22,513 16.1%
Core capital requirement........ 4,204 3.0
-------- ----
Excess........................ $ 18,309 13.1%
======== ====
Risk-based capital.............. $ 22,613 31.3%
Risk-based capital requirement.. 5,773 8.0
-------- ----
Excess........................ $ 16,840 23.3%
======== ====
</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
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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
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.
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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 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 1999 was 5.43%.
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
26
<PAGE>
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,
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, 1999, approximately 99.2% 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.
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.
OTS regulations require that savings institutions submit notice to the OTS
prior to making a capital distribution if (a) they would not be well-capitalized
after the distribution, (b) the distribution would result in the retirement of
any of the institution's common or preferred stock or debt counted as its
regulatory capital, or (c) the institution is a subsidiary of a holding company.
A savings institution must make application to the OTS to pay a capital
distribution if (x) the institution would not be adequately capitalized
following the distribution, (y) the institution's total distributions for the
calendar year exceeds the institution's net income for the calendar year to date
plus its net income (less distributions) for the preceding two years, or (z) the
distribution would otherwise violate applicable law or regulation or an
agreement with or condition imposed by the OTS. If neither the savings
institution nor the proposed capital distribution meet any of the foregoing
criteria, then no notice or application is required to be filed with the OTS
before making a capital distribution. The OTS may disapprove or deny a capital
distribution if in the view of the OTS, the capital distribution would
constitute an unsafe or unsound practice.
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
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<PAGE>
account factors such as comparable compensation practices at comparable
institutions. If the OTS determines that a savings institution is not in
compliance with the safety and soundness guidelines, it may require the
institution to submit an acceptable plan to achieve compliance with the
guidelines. A savings institution must submit an acceptable compliance plan to
the OTS within 30 days of receipt of a request for such a plan. Failure to
submit or implement a compliance plan may subject the institution to regulatory
sanctions. Management believes that the Bank already meets substantially all the
standards adopted in the interagency guidelines, and therefore does not believe
that implementation of these regulatory standards has materially affected the
Bank's operations.
Additionally under FDICIA, as amended by the CDRI Act, the Federal banking
agencies were required to establish standards relating to the asset quality and
earnings that the agencies determine to be appropriate. On July 10, 1995, the
Federal banking agencies, including the OTS, issued proposed guidelines relating
to asset quality and earnings. Under the proposed guidelines, a savings
institution should maintain systems, commensurate with its size and the nature
and scope of its operations, to identify problem assets and prevent
deterioration in those assets as well as to evaluate and monitor earnings and
ensure that earnings are sufficient to maintain adequate capital and reserves.
Management believes that the asset quality and earnings standards, in the form
proposed by the banking agencies, would not have a material effect on the Bank's
operations.
The federal banking agencies have also established Year 2000 readiness
safety and soundness guidelines requiring all insured depository institutions to
implement procedures by specified key dates to ensure the institution can
continue business operations after January 1, 2000. Every institution must
identify its internal and external "mission-critical" systems (i.e., those
systems vital to the continuance of a core business activity) and develop a
written plan establishing priorities, oversight and reasonable deadlines to
complete the testing and renovation of mission-critical systems. In addition,
an institution must prepare a written business resumption contingency plan that
(i) defines scenarios where mission-critical systems might fail, (ii) evaluates
contingency options to keep business operations going, and (iii) provides for
testing of the contingency plan by an independent party. Every depository
institution must also identify among its customers those persons that represent
a material risk to the institution in the event the customer is not Year 2000
compliant and implement appropriate risks controls to manage and mitigate the
customer's Year 2000 risk to the institution. The federal banking agencies will
examine the institution's overall progress in meeting the Year 2000 readiness
guidelines. In the event an institution has failed to renovate its mission-
critical systems or is not on schedule with key dates, the institution must
draft a remediation contingency plan outlining alternative strategies to comply
with the guidelines and locate available third party providers. The agencies,
in their sole discretion, may take actions under the FDICIA, the safety and
soundness guidelines or any other action available to them, including
enforcement action, to ensure an institution's Year 2000 readiness. For
additional information, see "Year 2000 Readiness Disclosure" in the Annual
Report.
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
28
<PAGE>
institutions with only a few minor weaknesses. Subgroup B consists of
institutions that demonstrate weaknesses which, if not corrected, could result
in significant deterioration of the institution and increased risk of loss to
the deposit insurance fund. Subgroup C consists of institutions that pose a
substantial probability of loss to the deposit insurance fund unless effective
corrective action is taken. The Bank is a Subgroup A institution, and therefore
currently pays assessments to the FDIC at the rate of $0.5920 per $100 of
insured deposits.
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,
1999, of $1.6 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,
1999, the Bank had $30.9 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
transaction accounts of between $4.9 million and $46.5 million, 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, 1999, 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 1999.
Thrift institutions are subject to the provisions of the Internal Revenue
Code of 1986, as amended (the "Code") in the same general manner as other
corporations. Prior to recent legislation, institutions such as First Federal
which met certain definitional tests and other conditions prescribed by the Code
benefitted from certain favorable provisions regarding their deductions from
taxable income for annual additions to their bad debt reserve. For purposes of
the bad debt reserve deduction, loans were separated into "qualifying real
property loans," which generally are loans secured by interests in certain real
property, and nonqualifying loans, which are all other loans. The bad debt
reserve deduction with respect to nonqualifying loans was based on actual loss
experience, however, the amount of the bad debt reserve deduction with respect
to qualifying real property loans could be based upon actual loss experience
(the "experience method") or a percentage of taxable income determined without
regard to such deduction (the "percentage of taxable income method").
First Federal historically elected to use the percentage of taxable income
method. Under such method, the bad debt reserve deduction for qualifying real
property loans was computed as a percentage of taxable income, with certain
adjustments, effective for taxable years beginning after 1986. The allowable
deduction under the percentage of taxable income method (the "percentage bad
debt deduction") for taxable years beginning before 1987 was scaled downward in
the event that less than 82% of the total dollar amount of the assets of an
association were within certain designated categories. When the percentage
method bad debt deduction was lowered to 8%, the 82% qualifying assets
requirement was lowered to 60%. For all taxable years, no deduction was
permitted in the event that less than 60% of the total dollar amount of the
assets of an association fell within such categories.
29
<PAGE>
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.
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.
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.
30
<PAGE>
<TABLE>
<CAPTION>
Age at
June 30,
Name 1999 Title
- ------------------ --------- ----------------------------
<S> <C> <C>
Don Jennings (1) 34 Vice President and Treasurer
Joyce Jennings 62 Vice President
</TABLE>
- -------------------------
(1) Don Jennings 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.
Item 2. Properties
- -------------------
The following table sets forth information regarding First Federal's
offices at June 30, 1999.
<TABLE>
<CAPTION>
Book Value Deposits at
Year Owned or at June 30, Approximate June 30,
Opened Leased 1999 Square Footage 1999
------ -------- ----------- -------------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Main Office:
216 West Main Street 1989 Owned $1,120 14,400 $45,574
Frankfort, Kentucky 40601
Branch Offices:
East Branch 1971 Owned 98 1,800 23,485
1980 Versailles Road
Frankfort, Kentucky 40601
West Branch 1975 Owned 103 2,480 17,195
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, 1999 was $25,000. 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, 1999.
31
<PAGE>
Item 3. Legal Proceedings.
- -------------------------
From time to time, First Federal is a party to various legal
proceedings incident to its business. At June 30, 1999, 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, 1999.
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.
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.
32
<PAGE>
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 1999 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.
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:
33
<PAGE>
Independent Auditors' Report
Consolidated Statements of Financial Condition as of June 30, 1999 and
1998
Consolidated Statements of Operations for the years ended June 30,
1999, 1998, and 1997
Consolidated Statements of Shareholders' Equity for the years ended
June 30, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the years ended June 30,
1999, 1998 and 1997
Notes to Consolidated Financial Statements for the years ended June
30, 1999, 1998 and 1997
(2) Financial Statement Schedules. All schedules for which provision is
made in the applicable accounting regulations of the Securities and Exchange
Commission are omitted because of the absence of conditions under which they are
required or because the required information is included in the consolidated
financial statements and related notes thereto.
(3) Exhibits. The following is a list of exhibits filed as part of this
Annual Report on Form 10-K and is also the Exhibit Index.
<TABLE>
<CAPTION>
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. * +
10.3(c) 1999 Employment Agreements and Guaranty Agreements with First
Federal Savings Bank of Frankfort
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 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.
34
<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 14, 1999 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 14, 1999
- ------------------------------------------
William C. Jennings
President and Chief Executive Officer
(Principal Executive Officer and Principal
Financial and Accounting Officer)
/s/ Danny A. Garland September 14, 1999
- ------------------------------------------
Danny A. Garland
Vice President and Director
/s/ Charles A. Cotton, III September 14, 1999
- ------------------------------------------
Charles A. Cotton, III
Director
/s/ David Eddins September 14, 1999
- ------------------------------------------
David Eddins
Director
/s/ William M. Johnson September 14, 1999
- ------------------------------------------
William M. Johnson
Director
/s/ Frank McGrath September 14, 1999
- ------------------------------------------
Frank McGrath
Director
/s/ Herman D. Regan, Jr. September 20, 1999
- ------------------------------------------
Herman D. Regan, Jr.
Director
/s/ C. Michael Davenport September 22, 1999
- ------------------------------------------
C. Michael Davenport
Director
<PAGE>
Exhibit 10.3(c)
FIRST FEDERAL SAVINGS BANK OF FRANKFORT
---------------------------------------------
Employment Agreement with
Daniel A. Garland
---------------------------------------------
AGREEMENT entered into and effective this 1st day of July, 1999, by and
between First Federal Savings Bank of Frankfort (the "Bank") and Danny A.
Garland (the "Employee").
WHEREAS, the Employee has heretofore been employed by First Federal Savings
Bank of Frankfort as its President and Chief Executive Officer and is
experienced in all phases of the business of the Bank; and
WHEREAS, the Board of Directors (the "Board") of the Bank believes it is in
the best interests of the Bank to enter into this Agreement with the Employee in
order to assure continuity of management of the Bank and to reinforce and
encourage the continued attention and dedication of the Employee to his assigned
duties; and
WHEREAS, the parties desire by this writing to set forth the continuing
employment relationship of the Bank and the Employee.
NOW, THEREFORE, it is AGREED as follows:
1. Defined Terms
-------------
When used anywhere in this Agreement, the following terms shall have the
meaning set forth herein.
(a) "Change in Control" shall mean any one of the following events:
(1) the acquisition of ownership, holding or power to vote more than 25% of the
voting stock of Frankfort First Bancorp, Inc. (the "Company") or the Bank, (2)
the acquisition of the ability to control the election of a majority of the
Bank's or the Company's directors, (3) the acquisition of a controlling
influence over the management or policies of the Bank or the Company by any
person or by persons acting as a "group" (within the meaning of Section 13(d) of
the Securities Exchange Act of 1934), (4) the acquisition of control of the Bank
or the Company within the meaning of 12 C.F.R. Part 574 or its applicable
equivalent (except in the case of (1), (2), (3) and (4) hereof, ownership or
control of the Bank by the Company itself shall not constitute a "change in
control"), or (5) during any period of two consecutive years, individuals who at
the beginning of such period constitute the Board of Directors of the Company or
the Bank (the "Existing Board") (the "Continuing Directors") cease for any
reason to constitute at least a majority thereof, provided that any individual
whose election or nomination for election as a member of the Existing Board was
approved by a vote of at least a majority of the Continuing Directors then in
office shall be considered a Continuing Director. For purposes of this
subparagraph only, the term "person" refers to an individual or a corporation,
partnership, trust, association, joint venture, pool, syndicate, sole
proprietorship, unincorporated organization or any other form of entity not
specifically listed herein.
<PAGE>
(b) "Code" shall mean the Internal Revenue Code of 1986, as amended
from time to time, and as interpreted through applicable rulings and regulations
in effect from time to time.
(c) "Code ss 280G Maximum" shall mean the product of 2.99 and the
Employee's "base amount" as defined in Code ss 280G(b)(3).
(d) "Disability" shall mean a physical or mental infirmity which
impairs the Employee's ability to substantially perform his duties under this
Agreement and which results in the Employee becoming eligible for long-term
disability benefits under the Bank's long-term disability plan (or, if the Bank
has no such plan in effect, which impairs the Employee's ability to
substantially perform his duties under this Agreement for a period of 180
consecutive days).
(e) "Effective Date" shall mean the date referenced in the opening
paragraph of this Agreement.
(f) "Good Reason" shall mean any of the following events, which has
not been consented to in advance by the Employee in writing: (i) the requirement
that the Employee move his personal residence, or perform his principal
executive functions, more than 30 miles from his primary office as of the later
of the Effective Date and the most recent voluntary relocation by the Employee;
(ii) a material reduction in the Employee's base compensation under this
Agreement as the same may be increased from time to time; (iii) the failure by
the Bank or the Company to continue to provide the Employee with compensation
and benefits provided under this Agreement as the same may be increased from
time to time, or with benefits substantially similar to those provided to him
under any of the employee benefit plans in which the Employee now or hereafter
becomes a participant, or the taking of any action by the Bank or the Company
which would directly or indirectly reduce any of such benefits or deprive the
Employee of any material fringe benefit enjoyed by him under this Agreement;
(iv) the assignment to the Employee of duties and responsibilities materially
different from those normally associated with his position; (v) a failure to
reelect the Employee to the Board of Directors of the Bank or the Company, if
the Employee has served on such Board at any time during the term of the
Agreement; or (vi) a material diminution or reduction in the Employee's
responsibilities or authority (including reporting responsibilities) in
connection with his employment with the Bank.
(g) "Just Cause" shall mean, in the good faith determination of the
Bank's Board of Directors, the Employee's personal dishonesty, incompetence,
willful misconduct, breach of fiduciary duty involving personal profit,
intentional failure to perform stated duties, willful violation of any law, rule
or regulation (other than traffic violations or similar offenses) or final
cease-and-desist order, or material breach of any provision of this Agreement.
The Employee shall have no right to receive compensation or other benefits for
any period after termination for Just Cause. No act, or failure to act, on the
Employee's part shall be considered "willful" unless he has acted, or failed to
act, with an absence of good faith and without a reasonable belief that his
action or failure to act was in the best interest of the Bank and the Company.
2
<PAGE>
(h) "Protected Period" shall mean the period that begins on the date
six months before a Change in Control and ends on the later of the second annual
anniversary of the Change in Control or the expiration date of this Agreement.
(i) "Trust" shall mean a grantor trust that is designed in accordance
with Revenue Procedure 92-64 and has a trustee independent of the Bank and the
Company.
2. Employment. The Employee is employed as the President and Chief
----------
Executive Officer of the Bank. The Employee shall render such administrative
and management services for the Bank as are currently rendered and as are
customarily performed by persons situated in a similar executive capacity. The
Employee shall also promote, by entertainment or otherwise, as and to the extent
permitted by law, the business of the Bank. The Employee's other duties shall
be such as the Board may from time to time reasonably direct, including normal
duties as an officer of the Bank.
3. Base Compensation. The Bank agrees to pay the Employee during the term
-----------------
of this Agreement a salary at the rate of $73,500 per annum, payable in cash not
less frequently than monthly. The Board shall review, not less often than
annually, the rate of the Employee's salary, and in its sole discretion may
decide to increase his salary.
4. Discretionary Bonuses. The Employee shall participate in an equitable
---------------------
manner with all other senior management employees of the Bank in discretionary
bonuses that the Board may award from time to time to the Bank's senior
management employees. No other compensation provided for in this Agreement
shall be deemed a substitute for the Employee's right to participate in such
discretionary bonuses.
5. Participation in Retirement, Medical and Other Plans.
----------------------------------------------------
(a) The Employee shall be eligible to participate in any of the
following plans or programs that the Bank may now or in the future maintain:
group hospitalization, disability, health, dental, sick leave, life insurance,
travel and/or accident insurance, auto allowance/auto lease, retirement,
pension, and/or other present or future qualified or nonqualified plans provided
by the Bank, generally which benefits, taken as a whole, must be at least as
favorable as those in effect on the Effective Date.
(b) The Employee shall also be eligible to participate in any fringe
benefits which are or may become available to the Bank's senior management
employees, including for example: any stock option or incentive compensation
plans, and any other benefits which are commensurate with the responsibilities
and functions to be performed by the Employee under this Agreement. The
Employee shall be reimbursed for all reasonable out-of-pocket business expenses
which he shall incur in connection with his services under this Agreement upon
substantiation of such expenses in accordance with the policies of the Bank.
6. Term. The Bank hereby employs the Employee, and the Employee hereby
----
accepts such employment under this Agreement, for the period commencing on the
Effective Date and ending 36 months thereafter (or such earlier date as is
determined in accordance with Section 10 or 12 hereof). Additionally, on each
3
<PAGE>
annual anniversary date from the Effective Date, the Employee's term of
employment shall be extended for an additional one-year period beyond the then
effective expiration date, provided the Board determines in a duly adopted
resolution that the performance of the Employee has met the Board's requirements
and standards, and that this Agreement shall be extended. Only those members of
the Board of Directors who have no personal interest in this Employment
Agreement shall discuss and vote on the approval and subsequent review of this
Agreement.
7. Loyalty; Noncompetition.
-----------------------
(a) During the period of his employment hereunder and except for
illnesses, reasonable vacation periods, and reasonable leaves of absence, the
Employee shall devote all his full business time, attention, skill, and efforts
to the faithful performance of his duties hereunder; provided, however, from
time to time, the Employee may serve on the boards of directors of, and hold any
other offices or positions in, companies or organizations, which will not
present any conflict of interest with the Bank or any of its subsidiaries or
affiliates, or unfavorably affect the performance of the Employee's duties
pursuant to this Agreement, or will not violate any applicable statute or
regulation. "Full business time" is hereby defined as that amount of time
usually devoted to like companies by similarly situated executive officers.
During the term of his employment under this Agreement, the Employee shall not
engage in any business or activity contrary to the business affairs or interests
of the Bank.
(b) Nothing contained in this Section shall be deemed to prevent or
limit the Employee's right to invest in the capital stock or other securities of
any business dissimilar from that of the Bank, or, solely as a passive or
minority investor, in any business.
8. Standards. The Employee shall perform his duties under this Agreement
---------
in accordance with such reasonable standards as the Board may establish from
time to time. The Bank will provide the Employee with the working facilities
and staff customary for similar executives and necessary for him to perform his
duties.
9. Vacation and Sick Leave. At such reasonable times as the Board shall
-----------------------
in its discretion permit, the Employee shall be entitled, without loss of pay,
to absent himself voluntarily from the performance of his employment under this
Agreement, all such voluntary absences to count as vacation time, provided that:
(a) The Employee shall be entitled to an annual vacation in accordance
with the policies that the Board periodically establishes for senior management
employees of the Bank.
(b) The Employee shall accumulate any unused vacation and/or sick
leave from one fiscal year to the next, in either case to the extent authorized
by the Board, provided that the Board shall not reduce previously accumulated
vacation or sick leave.
4
<PAGE>
(c) In addition to the aforesaid paid vacations, the Employee shall be
entitled without loss of pay, to absent himself voluntarily from the performance
of his employment with the Bank for such additional periods of time and for such
valid and legitimate reasons as the Board may in its discretion determine.
Further, the Board may grant to the Employee a leave or leaves of absence, with
or without pay, at such time or times and upon such terms and conditions as such
Board in its discretion may determine.
(d) In addition, the Employee shall be entitled to an annual sick
leave benefit as established by the Board.
10. Termination and Termination Pay. Subject to Section 12 hereof, the
-------------------------------
Employee's employment hereunder may be terminated under the following
circumstances:
(a) Death. The Employee's employment under this Agreement shall
terminate upon his death during the term of this Agreement, in which event the
Employee's estate shall be entitled to receive the compensation due the Employee
through the last day of the calendar month in which his death occurred.
(b) Disability. (1) The Bank may terminate the Employee's employment
after having established the Employee's Disability, in which event the Employee
shall be entitled to the compensation and benefits provided for under this
Agreement for (i) any period during the term of this Agreement and prior to the
establishment of the Employee's Disability during which the Employee is unable
to work due to the physical or mental infirmity, and (ii) any period of
Disability which is prior to the Employee's termination of employment pursuant
to this Section 10(b); provided that any benefits paid pursuant to the Bank's
long term disability plan will continue as provided in such plan without
-------
reduction for payments made pursuant to this Agreement. (2) During any period
that the Employee shall receive disability benefits and to the extent that the
Employee shall be physically and mentally able to do so, he shall furnish such
information, assistance and documents so as to assist in the continued ongoing
business of the Bank and, if able, shall make himself available to the Bank to
undertake reasonable assignments consistent with his prior position and his
physical and mental health. The Bank shall pay all reasonable expenses incident
to the performance of any assignment given to the Employee during the disability
period.
(c) Just Cause. The Board may, by written notice to the Employee,
immediately terminate his employment at any time, for Just Cause. The Employee
shall have no right to receive compensation or other benefits for any period
after termination for Just Cause.
(d) Without Just Cause; Constructive Discharge. The Board may, by
written notice to the Employee, immediately terminate his employment at any time
for a reason other than his Disability or Just Cause, in which event the
Employee shall be entitled to receive the following compensation and benefits
(unless such termination occurs during the Protected Period, in which event the
benefits and compensation provided for in Section 12 shall apply):
5
<PAGE>
(i) the salary provided pursuant to Section 3 hereof, up to the
expiration date of this Agreement, including any renewal term (the
"Expiration Date"), plus said salary for an additional 12-month
period, and
(ii) cash in an amount equal to the cost to the Employee of
obtaining all health, life, disability and other benefits which the
Employee would have been eligible to participate in through the
Expiration Date based upon the benefit levels substantially equal to
those that the Bank provided for the Employee at the date of
termination of employment.
All amounts payable to the Employee shall be paid, at the option of the
Employee, in one lump sum within ten days of such termination.
(e) Good Reason. The Employee shall be entitled to receive the
compensation and benefits payable under subsection 10(d) hereof in the event
that the Employee voluntarily terminates employment within 90 days of an event
that constitutes Good Reason, (unless such voluntary termination occurs during
the Protected Period, in which event the benefits and compensation provided for
in Section 12 shall apply).
(f) Termination or Suspension Under Federal Law. (1) If the Employee
is removed and/or permanently prohibited from participating in the conduct of
the Bank's affairs by an order issued under Sections 8(e)(4) or 8(g)(1) of the
Federal Deposit Insurance Act ("FDIA") (12 U.S.C. 1818(e)(4) and (g)(1)), all
obligations of the Bank under this Agreement shall terminate, as of the
effective date of the order, but vested rights of the parties shall not be
affected. (2) If the Bank is in default (as defined in Section 3(x)(1) of
FDIA), all obligations under this Agreement shall terminate as of the date of
default; however, this Paragraph shall not affect the vested rights of the
parties. (3) If a notice served under Section 8(e)(3) or (g)(1) of the FDIA
(12 U.S.C.1818(e)(3) or (g)(1)) suspends and/or temporarily prohibits the
Employee from participating in the conduct of the Bank's affairs, the Bank's
obligations under this Agreement shall be suspended as of the date of such
service, unless stayed by appropriate proceedings. If the charges in the notice
are dismissed, the Bank may in its discretion (i) pay the Employee all or part
of the compensation withheld while its contract obligations were suspended, and
(ii) reinstate (in whole or in part) any of its obligations which were
suspended. (4) All obligations under this Agreement shall terminate, except to
the extent determined that continuation of this Agreement is necessary for the
continued operation of the Association: (i) by the Director of the Office of
Thrift Supervision ("Director of OTS"), or his or her designee, at the time that
the Federal Deposit Insurance Corporation ("FDIC") or the Resolution Trust
Corporation enters into an agreement to provide assistance to or on behalf of
the Association under the authority contained in Section 13(c) of FDIA; or (ii)
by the Director of the OTS, or his or her designee, at the time that the
Director of the OTS, or his or her designee, approves a supervisory merger to
resolve problems related to operation of the Association or when the Association
is determined by the Director of the OTS to be in an unsafe or unsound
condition. Such action shall not affect any vested rights of the parties. (5)
Any payments made to the Employee pursuant to this Agreement, or otherwise, are
subject to and conditioned upon their compliance with both 12 U.S.C. Section
----
1828(k) and any regulations promulgated thereunder, and Regulatory Bulletin 27A,
---
but only to the extent required thereunder on the date any payment is required
pursuant to this Agreement.
6
<PAGE>
(g) Voluntary Termination by Employee. Subject to Section 12 hereof,
the Employee may voluntarily terminate employment with the Bank during the term
of this Agreement, upon at least 90 days' prior written notice to the Board of
Directors, in which case the Employee shall receive only his compensation,
vested rights and employee benefits up to the date of his termination (unless
such termination occurs pursuant to Section 10(d) hereof or within the Protected
Period, in Section 12(a) hereof, in which event the benefits and compensation
provided for in Sections 10(d) or 12, as applicable, shall apply).
11. No Mitigation. The Employee shall not be required to mitigate the
-------------
amount of any payment provided for in this Agreement by seeking other employment
or otherwise and no such payment shall be offset or reduced by the amount of any
compensation or benefits provided to the Employee in any subsequent employment.
12. Change in Control.
-----------------
(a) Trigger Events. The Employee shall be entitled to collect the
severance benefits set forth in Subsection (b) hereof in the event that either
(i) the Employee voluntarily terminates employment for any reason within the 30-
day period beginning on the date of a Change in Control, (ii) the Employee
voluntarily terminates employment within 90 days of an event that both occurs
during the Protected Period and constitutes Good Reason, or (iii) the Bank or
the Company or their successor(s) in interest terminate the Employee's
employment without his written consent and for any reason other than Just Cause
during the Protected Period.
(b) Amount of Severance Benefit. If the Employee becomes entitled to
collect severance benefits pursuant to Section 12(a) hereof, the Bank shall pay
the Employee a severance benefit equal to the difference between the Code ss
280G Maximum and the sum of any other "parachute payments" as defined under Code
ss 280G(b)(2) that the Employee receives on account of the Change in Control.
The amount payable under this Section 12(b) shall be paid in one lump sum
within ten days of the later of the date of the Change in Control and the
Employee's last day of employment with the Bank or the Company.
7
<PAGE>
In the event that the Employee, the Bank, and the Company jointly agree
that the Employee has collected an amount exceeding the Code ss 280G Maximum,
the parties may agree in writing that such excess shall be treated as a loan ab
--
initio, which the Employee shall repay to the Bank, on terms and conditions
- ------
mutually agreeable to the parties, together with interest at 120% of the
applicable federal rate compounded semiannually provided for in Section
7872(f)(2)(B) of the Code.
13. Indemnification. The Bank and the Company agree that their respective
---------------
Bylaws shall continue to provide for indemnification of directors, officers,
employees and agents of the Bank and the Company, including the Employee during
the full term of this Agreement, and to at all times provide adequate insurance
for such purposes.
14. Reimbursement of Employee for Enforcement Proceedings. In the event
-----------------------------------------------------
that any dispute arises between the Employee and the Bank as to the terms or
interpretation of this Agreement, whether instituted by formal legal proceedings
or otherwise, including any action that the Employee takes to defend against any
action taken by the Bank or the Company, the Employee shall be reimbursed for
all costs and expenses, including reasonable attorneys' fees, arising from such
dispute, proceedings or actions, provided that the Employee obtains either a
written settlement or a final judgement by a court of competent jurisdiction
substantially in his favor. Such reimbursement shall be paid within ten days of
the Employee's furnishing to the Bank written evidence, which may be in the
form, among other things, of a canceled check or receipt, of any costs or
expenses incurred by the Employee.
15. Federal Income Tax Withholding. The Bank may withhold all federal and
------------------------------
state income or other taxes from any benefit payable under this Agreement as
shall be required pursuant to any law or government regulation or ruling.
16. Successors and Assigns.
----------------------
(a) Bank. This Agreement shall not be assignable by the Bank,
provided that this Agreement shall inure to the benefit of and be binding upon
any corporate or other successor of the Bank which shall acquire, directly or
indirectly, by merger, consolidation, purchase or otherwise, all or
substantially all of the assets or stock of the Bank.
(b) Employee. Since the Bank is contracting for the unique and
personal skills of the Employee, the Employee shall be precluded from assigning
or delegating his rights or duties hereunder without first obtaining the written
consent of the Bank; provided, however, that nothing in this paragraph shall
preclude (i) the Employee from designating a beneficiary to receive any benefit
payable hereunder upon his death, or (ii) the executors, administrators, or
other legal representatives of the Employee or his estate from assigning any
rights hereunder to the person or persons entitled thereunto.
8
<PAGE>
(c) Attachment. Except as required by law, no right to receive
payments under this Agreement shall be subject to anticipation, commutation,
alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation or
to exclusion, attachment, levy or similar process or assignment by operation of
law, and any attempt, voluntary or involuntary, to effect any such action shall
be null, void and of no effect.
17. Amendments. No amendments or additions to this Agreement shall be
----------
binding unless made in writing and signed by all of the parties, except as
herein otherwise specifically provided.
18. Applicable Law. Except to the extent preempted by Federal law, the
--------------
laws of the Commonwealth of Kentucky shall govern this Agreement in all
respects, whether as to its validity, construction, capacity, performance or
otherwise.
19. Severability. The provisions of this Agreement shall be deemed
------------
severable and the invalidity or unenforceability of any provision shall not
affect the validity or enforceability of the other provisions hereof.
20. Entire Agreement. This Agreement, together with any understanding or
----------------
modifications thereof as agreed to in writing by the parties, shall constitute
the entire agreement between the parties hereto and shall supersede any prior
agreement between the parties.
IN WITNESS WHEREOF, the parties have executed this Agreement on the day and
year first hereinabove written.
ATTEST: FIRST FEDERAL SAVINGS BANK OF FRANKFORT
By: /s/ William C. Jennings
- --------------------------- -----------------------------------
Secretary Its Chairman of the Board
WITNESS:
/s/ Danny A. Garland
- --------------------------- -----------------------------------
Daniel A. Garland
9
<PAGE>
FRANKFORT FIRST BANCORP, INC.
__________________________
Guaranty Agreement
__________________________
THIS AGREEMENT is entered into this 1st day of July, 1999 (the "Effective
Date"), by and between Frankfort First Bancorp, Inc. (the "Company") and Daniel
A. Garland (the "Employee").
WHEREAS, the Employee has heretofore been employed by First Federal Savings
Bank of Frankfort (the "Bank") as its President and Chief Executive Officer, and
has entered into an agreement (the "Bank Agreement") dated July 1, 1999, with
the Employee; and
WHEREAS, the Board of Directors (the "Board") of the Company believes it is
in the best interests of the Company to enter into this Agreement with the
Employee in order to assure continuity of management of the Bank and to
reinforce and encourage the long-term retention of the Employee; and
WHEREAS, the parties desire by this writing to set forth the Company's
commitment to guarantee the Bank's obligations under the Bank Agreement with the
Employee.
NOW, THEREFORE, it is AGREED as follows:
1. Consideration from Company: Joint and Several Liability. The Company
-------------------------------------------------------
hereby agrees that to the extent permitted by law, it shall be jointly and
severally liable with the Bank for the payment of all amounts due under the Bank
Agreement, provided that the paragraphs of the Bank Agreement that appear under
the heading "Termination or Suspension under Federal Law" shall be inapplicable
to this Agreement. The Board may in its discretion at any time during the term
of this Agreement agree to pay the Employee a base salary for the remaining term
of this Agreement. If the Board agrees to pay such salary, the Board shall
thereafter review, not less often than annually, the rate of the Employee's
salary, and in its sole discretion may decide to increase his salary.
2. Discretionary Bonuses; Participation in Retirement, Medical and Other
---------------------------------------------------------------------
Plans. The Employee shall participate in an equitable manner with all other
- -----
senior management employees of the Company in discretionary bonuses that the
Board may award from time to time to the Company's senior management employees,
as well as in (i) any of the following plans or programs that the Company may
now or in the future maintain: group hospitalization, disability, health,
dental, sick leave, life insurance, travel and/or accident insurance, auto
allowance/auto lease, retirement, pension, and/or other present or future
qualified plans provided by the Company, generally which benefits, taken as a
whole, must be at least as favorable as those in effect on the Effective Date;
<PAGE>
and (ii) any fringe benefits which are or may become available to the Company's
senior management employees, including for example: any stock option or
incentive compensation plans, and any other benefits which are commensurate with
the responsibilities and functions to be performed by the Employee under this
Agreement.
3. Indemnification. The Company agrees that its Bylaws shall continue to
---------------
provide for indemnification of directors, officers, employees and agents of the
Company, including the Employee, during the full term of this Agreement, and to
at all times provide adequate insurance for such purposes.
4. Successors and Assigns.
----------------------
(a) Company. This Agreement shall inure to the benefit of and be
binding upon any corporate or other successor of the Company which shall
acquire, directly or indirectly, by merger, consolidation, purchase or
otherwise, all or substantially all of the assets or stock of the Company.
(b) Attachment. Except as required by law, no right to receive
payments under this Agreement shall be subject to anticipation, commutation,
alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation or
to exclusion, attachment, levy or similar process or assignment by operation of
law, and any attempt, voluntary or involuntary, to effect any such action shall
be null, void and of no effect.
5. Amendments. No amendments or additions to this Agreement shall be
----------
binding unless made in writing and signed by all of the parties, except as
herein otherwise specifically provided.
6. Applicable Law. Except to the extent preempted by Federal law, the
--------------
laws of the Commonwealth of Kentucky shall govern this Agreement in all
respects, whether as to its validity, construction, capacity, performance or
otherwise.
7. Severability. The provisions of this Agreement shall be deemed
------------
severable and the invalidity or unenforceability of any provision shall not
affect the validity or enforceability of the other provisions hereof.
8. Entire Agreement. This Agreement, together with any understanding or
----------------
modifications thereof as agreed to in writing by the parties, shall constitute
the entire agreement between the parties hereto.
-2-
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement on the day and
year first hereinabove written.
ATTEST: FRANKFORT FIRST BANCORP, INC.
By /s/ William C. Jennings
- ----------------------------- -----------------------------
Secretary Its Chairman of the Board
WITNESS:
/s/ Danny A. Garland
- ----------------------------- -----------------------------
Daniel A. Garland
-3-
<PAGE>
Exhibit 13
================================================================================
Frankfort First Bancorp, Inc.
Annual Report
1999
================================================================================
Parent Company of
First Federal Savings Bank of Frankfort
216 West Main Street
P.O. Box 535
Frankfort, KY 40602
<PAGE>
TABLE OF CONTENTS
================================================================================
President's Message........................................................ 1
Frankfort First Bancorp, Inc. ............................................. 2
First Federal Savings Bank of Frankfort.................................... 2
Market Information......................................................... 2
Selected Consolidated Financial and Other Data............................. 3
Management's Discussion and Analysis of
Financial Condition and Results of Operations............................ 5
Independent Auditors' 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 Flow..................................... 21
Notes to Consolidated Financial Statements............................... 22
Corporate Information...................................................... 45
<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, 1999. We believe that this
has been a successful year in which we have built on the foundation of our
restructuring plan completed in 1997.
Our net earnings for the year were approximately $1.7 million or $1.06 per
share, a significant improvement over the previous year despite a heavy
period of mortgage refinancing to lower rates during the last part of
calendar 1998 and the early part of calendar 1999. Return on assets for
the year was 1.21% which is well above industry averages. Our return on
equity increased by about 14% to 7.62%, as a result of an increase in net
earnings and the reduction of capital through our stock repurchase program.
During the year we have acquired over 120,000 shares or approximately 7% of
our outstanding shares.
As with last year, our ratio of operating expenses to average assets at
1.20% was very low by industry standards. Our Board also increased the
dividend paid during the past year from $0.20 to $0.22 per quarter
beginning with the dividend paid on January 15, 1999, and again increased
the dividend to $0.24 per quarter beginning with the dividend to be paid on
October 15, 1999. These actions result in one of the highest dividend
yields in the industry.
Our primary operational concern during this year was preparing for possible
Year 2000 computer failures. Our staff devoted many hours to testing our
critical computer systems and in developing contingency plans to cope with
a variety of eventualities. We are pleased to report that all of our
testing was successful and that we believe that we have met all milestones
established by our federal regulators to ensure compliance. If you have
any concerns about this issue either as a shareholder or a customer of our
Bank, we urge you to contact Danny Garland or Don Jennings or to visit one
of our Y2K information centers located at each office.
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,
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 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, 1999, the Company had total assets of
$140.3 million, deposits of $86.3 million and shareholders' equity of $21.3
million.
As approved by the shareholders at the Company's 1997 Annual Meeting of
Shareholders, the Company effected a one-for two reverse stock split on December
1, 1997. Consequently, all stock information in this report has been adjusted
to reflect the reverse 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 1,483,411 shares of the
Common Stock outstanding. The number of registered holders of Common Stock on
September 15, 1999, was 591.
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, 1999
and 1998.
<TABLE>
<CAPTION>
Fiscal 1998 Dividends
Quarter ended High Low Declared
------------- ---- --- ---------
<S> <C> <C> <C>
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
<CAPTION>
Fiscal 1999
Quarter ended
-------------
<S> <C> <C> <C>
September 30, 1998 $15.875 $13.625 $0.20
December 31, 1998 16.500 13.500 0.22
March 31, 1999 15.625 14.375 0.22
June 30, 1999 15.000 14.625 0.22
</TABLE>
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,
------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total amount of:
Assets............................. $140,322 $134,485 $132,038 $128,513 $142,772
Loans receivable, net.............. 131,639 126,328 120,888 110,331 100,602
Cash and investment securities..... 4,795 4,517 7,801 14,889 38,918
Deposits........................... 86,254 81,891 85,957 87,777 119,041
Advances from FHLB................. 30,878 28,260 9,006 4,998 4,416
Shareholders' equity--substantially
restricted (1)................... 21,266 22,706 22,345 34,265 18,604
Number of:
Real estate loans outstanding...... 2,772 2,814 2,732 2,685 2,582
Deposits accounts.................. 7,523 7,671 8,032 8,397 8,500
Offices............................ 3 3 3 3 3
</TABLE>
- ---------------
(1) Consisted solely or retained earnings at June 30, 1995.
3
<PAGE>
Summary of Operations
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Interest income................................. $9,691 $9,751 $9,226 $9,699 $7,809
Interest expense................................ 5,595 5,685 4,685 4,585 4,234
------ ------ ------ ------ ------
Net interest income............................. 4,096 4,066 4,541 5,114 3,575
Provision for loan losses....................... -- -- 5 12 12
Other income.................................... 41 60 61 54 50
General, administrative and other expense....... 1,636 1,732 4,474 2,669 2,270
------ ------ ------ ------ ------
Earnings before federal income taxes............ 2,501 2,394 123 2,487 1,343
Federal income taxes............................ 851 814 491 827 454
------ ------ ------ ------ ------
Net earnings (loss)............................. $1,650 $1,580 $ (368) $1,660 $ 889
====== ====== ====== ====== ======
Earnings (loss) per share:
Basic......................................... $ 1.06 $1.00 $(0.23) $ 1.04 $ n/a
Diluted....................................... $ 1.05 $0.96 $ n/a $ 1.04 $ n/a
</TABLE>
Key Operating Ratios
<TABLE>
<CAPTION>
At or for the Year Ended June 30,
---------------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Performance Ratios
Return on assets (net earnings (loss) divided by
average total assets)................................... 1.21% 1.18% (0.28%)
Return on equity (net earnings (loss) divided by
average equity)......................................... 7.62% 6.58% (1.11%)
Equity to assets ratio (average equity divided by
average total assets)................................... 16.10% 17.93% 25.49%
Interest rate spread for the period....................... 2.26% 2.20% 2.34%
Net interest margin for the period........................ 3.04% 3.11% 3.58%
Operating expenses to average assets...................... 1.20% 1.29% 3.45%
Ratio of average interest-earning assets to average
interest-bearing liabilities............................ 118.78% 120.92% 133.50%
Regulatory Capital Ratios
Tangible capital as a percent of assets................... 16.06% 17.40% 25.86%
Core capital as a percent of assets....................... 16.06% 17.40% 25.86%
Risk-based capital as a percent of risk-weighted assets... 31.34% 33.68% 50.80%
Asset Quality Ratio
Non-performing assets to total assets..................... 0.13% 0.27% 0.09%
Loan loss allowance to total assets....................... 0.07% 0.07% 0.08%
Loan loss allowance to total non-performing assets........ 53.19% 27.50% 86.21%
</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 which
includes federal agency debt instruments, FHLB stock, and 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, which was effected in December
1997. The special cash distribution of $8.00 was paid on June 24, 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 an increase in
operating expenses. At June 30, 1999, first mortgage loans with adjustable
rates represented 65.8% 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 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 3% increases and decreases in market
interest rates.
5
<PAGE>
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 tables set forth the interest rate sensitivity of the Bank's
NPV as of June 30, 1999 and 1998 in the event of 1%, 2%, and 3% instantaneous
and permanent increases and decreases in market interest rates, respectively.
Although the table setting forth the interest rate sensitivity of the Bank's NPV
as of June 30, 1998 includes a 4% change in rate, the OTS no longer uses that
level of change in its calculations. All market risk-sensitive instruments
presented in these tables are held to maturity. The Company has no trading
securities or securities available for sale.
<TABLE>
<CAPTION>
June 30, 1999
Board of
Director
Net Portfolio Value NPV as % of Portfolio Value of Assets Limits
Change ----------------------------- ------------------------------------- --------
in Rates Amount $ Change % Change NPV Ratio Basis Point Changes % Change
-------- ------ -------- -------- --------- ------------------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
+300 bp $19,496 $(5,814) (23%) 14.96% -308 bp 35%
+200 bp 21,946 (3,364) (13%) 16.37% -167 bp 25
+100 bp 24,008 (1,301) (5%) 17.46% -58 bp 10
0 bp 25,309 18.04% --
-100 bp 25,703 393 +2% 18.06% +2 bp 10
-200 bp 25,545 235 +1% 17.76% -28 bp 25
-300 bp 25,385 75 0% 17.44% -60 bp 35
<CAPTION>
June 30, 1999
Board of
Director
Net Portfolio Value NPV as % of Portfolio Value of Assets Limits
Change ----------------------------- ------------------------------------- --------
in Rates Amount $ Change % Change NPV Ratio Basis Point Changes % Change
-------- ------ -------- -------- --------- ------------------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
+400 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
+100 bp 25,324 233 1% 18.93% +48 bp 10
0 bp 25,091 18.44% --
-100 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>
The preceding table indicates that at June 30, 1999, in the event of a
sudden and sustained increase in prevailing market interest rates, the Company's
NPV would be expected to decrease, and that in the event of a sudden and
sustained decrease in prevailing interest rates, the Company's NPV would be
expected to increase. At June 30, 1999 and 1998, the Company's estimated
changes in NPV were within the targets established by the Board of Directors.
6
<PAGE>
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.
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,
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, 1999, 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, 1999 and 1998 given a hypothetical 200 basis point rate
change in market interest rate.
<TABLE>
<CAPTION>
At At
June 30, June 30,
1999 1998
<S> <C> <C>
Pre-Shock NPV Ratio: NPV as % of Portfolio Value of Assets 18.04% 18.44%
Exposure Measure: Post-Shock NPV Ratio 16.37% 16.21%
Sensitivity Measure: Change in NPV Ratio (167 bp) (224 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,
---------------------------------------------------------------------------------------
1999 1998 1997
-------------------------- ---------------------------- -------------------------
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....................... $129,398 $9,388 7.26% $124,319 $9,331 7.51% $115,690 $8,579 7.42%
Investment securities (1).............. 5,201 303 5.83% 6,325 420 6.64% 11,026 647 5.87%
-------- ------ -------- ------ -------- ------
Total interest-earning assets........ 134,599 9,691 7.20% 130,644 9,751 7.46% 126,716 9,226 7.28%
Non-interest-earning assets.............. 2,188 3,255 2,867
-------- -------- --------
Total assets......................... $136,787 $133,899 $129,583
======== ======== ========
Interest bearing liabilities:
Deposits............................... $ 83,499 3,915 4.69% $ 83,493 4,000 4.79% $ 86,826 4,196 4.83%
Borrowings............................. 29,822 1,680 5.63% 24,552 1,685 6.86% 8,094 489 6.04%
-------- ------ -------- ------ -------- ------
Total interest-bearing liabilities... 113,321 5,595 4.94% 108,045 5,685 5.26% 94,920 4,685 4.94%
------ ------ ------
Non-interest-bearing liabilities......... 1,801 1,849 1,638
-------- -------- --------
Total liabilities.................... 115,122 109,894 96,558
Shareholders' equity..................... 21,664 24,005 33,025
-------- -------- --------
Total liabilities and shareholders'
equity............................. $136,787 $133,899 $129,583
======== ======== ========
Net interest income...................... $4,096 $4,066 $4,541
====== ====== ======
Interest rate spread..................... 2.26% 2.20% 2.34%
====== ====== ======
Net interest margin...................... 3.04% 3.11% 3.58%
====== ====== ======
Average interest-earning assets as
a percentage of average interest-
bearing liabilities.................... 118.78% 120.92% 133.50%
====== ====== ======
</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,
-----------------------------------------------------------
1999 vs. 1998 1998 vs. 1997
------------------------- ----------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------- ----------------------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loan portfolio....................... $ 310 $(253) $ 57 $ 647 $105 $ 752
Investment securities (1)............ (70) (47) (117) (328) 101 (227)
----- ----- ----- ------ ---- ------
Total interest-earning assets...... 240 (300) (60) 319 206 525
Interest expense:
Savings deposits..................... -- (85) (85) (169) (27) (196)
FHLB Advances........................ (30) 25 (5) 1,190 6 1,196
----- ----- ----- ------ ---- ------
Total interest-bearing
liabilities...................... (30) (60) (90) 1,021 (21) 1,000
----- ----- ----- ------ ---- ------
Change in net interest income.......... $ 270 $(240) $ 30 $ (702) $227 $ (475)
===== ===== ===== ====== ==== ======
</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 local
and national economy, as well as changes in the general level of interest rates.
Comparison of Financial Condition at June 30, 1999 and 1998
Assets: The Company's total assets increased from $134.5 million at June
30, 1998 to $140.3 million at June 30, 1999, an increase of $5.8 million or
4.3%. The increase is due primarily to an increase in net loans receivable
which rose from $126.3 million at June 30, 1998, to $131.6 million at June 30,
1999, an increase of $5.3 million or 4.2%. Also contributing to the increase in
total assets was an increase in cash and cash equivalents which rose from $1.3
million at June 30, 1998, to $2.6 million at June 30, 1999, an increase of $1.3
million, or 96.1%. Offsetting the increases in net loans receivable and cash
and cash equivalents was a decrease in investment securities from $3.0 million
at June 30, 1998 to $2.0 million at June 30, 1999, a decrease of $992,000 or
33.1%.
Loan disbursements for the year ended June 30, 1999, totaled $40.9 million
and were partially offset by principal repayments of $35.7 million and
amortization of deferred loan origination fees and costs of $61,000. At June
30, 1999 and 1998, the Company's allowance for loan losses totaled $100,000.
That allowance represents approximately 0.07% of total assets and 53.2% of
nonperforming assets at June 30, 1999. Nonperforming assets at June 30, 1999
and 1998 were $188,000 and $363,000, 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, 1999 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 $111.8 million
at June 30, 1998 to $119.1 million at June 30, 1999, an increase of $7.3 million
or 6.5%. The increase is attributed primarily to a net increase in deposits of
$4.4 million. Deposits rose from $81.9 million at June 30, 1998 to $86.3
million at June 30, 1999, an increase of $4.4 million or 5.3%. The balance at
June 30, 1999, included approximately $2.2 million deposited just prior to the
end of the fiscal year and withdrawn within a few days after the end of the
fiscal year. Also contributing to the increase in total liabilities was an
increase in advances from the FHLB. Advances rose from $28.3 million at June
30, 1998, to $30.9 million at June 30, 1999, an increase of $2.6 million or
9.3%. Other borrowings increased by $284,000.
Shareholders' Equity: Shareholders' equity decreased from $22.7 million at
June 30, 1998 to $21.3 million at June 30, 1999, a decrease of $1.4 million or
6.3%. This reduction is a result of net earnings of $1.7 million for the year
ended June 30, 1999, less $1.3 million returned to the shareholders in the form
of dividends and the repurchase of approximately 120,637 common shares for $1.8
million. At June 30, 1999, the Company's book value per share was $14.19
compared to $14.02 at June 30, 1998.
Comparison of Operating Results for the Years Ended June 30, 1999 and 1998
Net Earnings: Net earnings increased from $1.6 million for the year ended
June 30, 1998, to a total of $1.7 million for the year ended June 30, 1999, an
increase of $70,000 or 4.4%. The increase is primarily attributable to a
decrease in general, administrative and other expense of $96,000, and supported
by a $30,000 increase in net interest income. Offsetting these advances was an
increase in total federal income taxes of $37,000.
Net Interest Income: Net interest income increased $30,000, or 0.7%, and
totaled $4.1 million for the years ended June 30, 1999 and 1998. A decrease in
interest income of $60,000 was more than offset by a decrease in interest
expense of $90,000.
10
<PAGE>
Interest Income: Interest income decreased from $9.8 million for the year
ended June 30, 1998 to $9.7 million for the year ended June 30, 1999, a decrease
of $60,000 or 0.6%. The decrease is related primarily to a decrease in interest
income from investment securities which declined from $220,000 for the year
ended June 30, 1998 to $99,000 for the year ended June 30, 1999, a decrease of
$121,000 or 55.0%. Offsetting the decrease in interest income from investment
securities were increases in interest income from loans and interest-bearing
deposits and other of $57,000 and $4,000, respectively. As interest rates in
the economy generally declined during the year, the Company's average coupon
rate earned on invested assets also declined. Management believes that
generally rates paid on short-term investments and deposits are less than the
rates that can be earned on mortgage loans, and prefers to use excess funds to
either make new loans or reduce advances. As such, the investment emphasis
during the year ended June 30, 1999, has been on loans and management expects
that emphasis to continue. While the Company experienced a net increase in
interest income from loans, the net increase is attributed to increased volume
rather than an increase in the weighted average interest rate earned on the loan
portfolio. The Company's weighted average interest rate earned on the loan
portfolio has decreased as a result of refinancing of mortgages and the downward
adjustment of adjustable rate mortgages in the portfolio. The decrease in
interest income from the investment portfolio is a result of both a decline in
the average rate paid by the market as well as management's intentional shift in
the composition of the interest-earning assets of the Company from investment
securities toward those earning higher rates.
In the latter part of the 1999 fiscal year, rates in general had increased.
If this trend continues, the weighted average rate on the Bank's asset portfolio
is expected to increase. This increase is caused by both the origination of new
loans at higher rates and the contractual increase in the coupon rate of the
Bank's adjustable rate mortgages (although such increases only occur annually
and are limited by a 1% cap). However, in times of increasing rates, generally
the level of new originations declines and consumer preference tends to shift
toward the adjustable rate mortgages which usually have an initial coupon rate
that is less than the rates offered on fixed rate mortgages. These two factors
tend to offset the expected increase in returns on the assets and could result
in a short-term decline in the weighted average rate of the Bank's assets.
Interest Expense: Interest expense decreased from $5.7 million for the
year ended June 30, 1998 to $5.6 million for the year ended June 30, 1999, a
decrease of $90,000 or 1.6%. The decrease was due primarily to a decrease in
the interest paid on deposits which declined from $4.0 million for the year
ended June 30, 1998 to $3.9 million for the year ended June 30, 1999, a decrease
of $85,000, or 2.1%. Interest expense from the Company's borrowings remained
relatively constant at $1.7 million for the years ended June 30, 1999 and 1998,
decreasing only $5,000, or 0.3%. 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. Management believes that, when compared to
other sources of funds, FHLB advances offer plans and terms that can be more
easily matched to characteristics of the Company's interest-earning assets.
As discussed above, near the end of the 1999 fiscal year, interest rates in
general had increased. During a period of increasing rates, the cost of
liabilities is expected to increase as well. Management cannot predict whether
the cost of liabilities will increase at a faster pace than the increase in the
Bank's income generated by the loan and investment portfolio.
Management has also taken steps to prepare for possible customer
withdrawals over concerns about Year 2000 computer failures (see "Other Matters-
- -Year 2000 Compliance"). Primarily, the Bank's plans are to replace such
withdrawals with funds borrowed from the FHLB. If significant demands are made
on the country's money supply during this period, the cost of such funds may
increase greatly. While management cannot predict the impact of such an event,
management does expect if such an outflow of funds occurs, it will be reversed
in the early 2000 calendar year.
Provision for Loan Losses: The Company's provision for loan losses
remained constant with no provision for either of the years ended June 30, 1999
or 1998. Management believed, on the basis of its analysis of the risk profile
of the Company's assets, that it was appropriate to maintain the allowance for
loan losses at $100,000, a level which had been reached previously. In
determining the appropriate provision, management considers a number of factors,
including specific loans in the Company's portfolio, real estate market trends
in the Company's market area, economic conditions, interest rates, and other
conditions that may affect a borrower's ability to comply with repayment terms.
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.
Other Operating Income: Other operating income decreased from $60,000 for
the year ended June 30, 1998 to $41,000 for the year ended June 30, 1999, a
decrease of $19,000 or 31.7%. Other operating income is generally comprised of
service charges and fees charged on loan and deposit accounts. However, the
Company realized a gain on the sale of property and equipment of $8,000 during
the fiscal year ended June 30, 1998. The nonrecurrance of this sale and a
decline in charges and fees assessed on loan and deposit accounts of $11,000 are
responsible for the overall decrease in other operating income.
11
<PAGE>
General, Administrative and Other Expense: General, administrative and
other expense decreased $96,000 or 5.5% from $1.7 million for the year ended
June 30, 1998 to $1.6 million for the year ended June 30, 1999. The decrease
was due primarily to a $73,000, or 19.2% decrease in other operating expense and
a $57,000, or 6.2%, decrease in employee compensation and benefits. Other
operating expenses declined from $380,000 for the fiscal year ended June 30,
1998, to $307,000 for the fiscal year ended June 30, 1999, while employee
compensation and benefits decreased from $919,000 for the year ended June 30,
1998 to $862,000 for the year ended June 30, 1999. Offsetting somewhat the
decreases in other operating expense and employee compensation and benefits were
increases in data processing expense and franchise and other taxes. Data
processing expense increased $20,000, or 14.7%, from $136,000 for the year ended
June 30, 1998, to $156,000 for the year ended June 30, 1999. The increase in
data processing expense is primarily related to Year 2000 readiness preparations
(See "Other Matters -- Year 2000 Readiness Disclosure"). Franchise and other
taxes increased $19,000, or 20.4%, from $93,000 for the year ended June 30,
1998, to $112,000 for the year ended June 30, 1999. This increase is due
primarily to an overpayment of the Delaware franchise tax recognized in the year
ended June 30, 1998, which did not reoccur in the year ended June 30, 1999.
Income tax: The effective income tax rate for the years ended June 30,
1999 and 1998 was 34.0%.
Dividends: On December 9, 1998, the Company announced a dividend policy
whereby it will pay a quarterly cash dividend of $0.22 per share, per quarter,
payable on the 15th day of the month following the end of each quarter, to
shareholders of record as of the last business day of each quarter. This
represented an increase from the previous quarterly dividend of $0.20 per share.
On September 15, 1999, the Company announced another dividend policy change
whereby it will pay a quarterly cash dividend of $0.24 per share, per quarter,
payable on the 15th day of the month following the end of each quarter, to
shareholders of record as of the last business day of each quarter. The Board
of Directors determined in both instances that the increase in the amount of the
dividend was appropriate in light of the Company's earnings, capital position
and financial condition. Although the Board of Directors has adopted this
policy, the future payment of dividends is dependent upon the Company's
financial condition, earnings, equity structure, capital needs, regulatory
requirements, and economic conditions. At June 30, 1999 the Company had
recorded dividends payable of $330,000 for the payment of a dividend on July 15,
1999, which was the last dividend paid by the Company.
Stock Repurchase: On August 12, 1998, the Company announced a plan to
purchase up to 81,000 shares of the Company's common stock, which represented
approximately 5% of the outstanding common stock at that time. This specific
program was concluded on March 24, 1999 when the Company announced that it had
acquired 76,900 shares at an average price of $14.42 per share. At the same
time it was announced that the Company's Board of Directors had authorized a new
program for the purchase of up to 77,000 or approximately 5% of the remaining
outstanding shares of common stock. At September 15, 1999, 58,837 shares had
been repurchased at an average price of $14.90 per share. The program is
dependent upon market conditions and there is no guarantee as to the exact
number of shares to be repurchased by the Company. Management believes that the
repurchase should be completed within nine months of commencement. The Board of
Directors considers the Company's common stock to be an attractive investment,
and the repurchase program may improve liquidity in the market for the common
stock and result in increased per share earnings and book value.
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 a total of $1.6 million for the year ended June 30,
1998. The increase was 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.
12
<PAGE>
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 was 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 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 remained
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%. At June 30, 1997, the Company owed $13.0 million to another
financial institution. The Company's borrowings were primarily composed of FHLB
advances during the year ended June 30, 1998. The increase in interest expense
on borrowings was partially offset by 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 in
June 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.
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.
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 was 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.
13
<PAGE>
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, 1999, the Bank exceeded all regulatory minimum capital
requirements.
The Bank's primary sources of funds are (i) cash generated from
operations, (ii) deposits, (iii) principal repayments on loans, and (iv)
advances from the FHLB of Cincinnati. As reflected in the Consolidated
Statements of Cash Flows, net cash flow provided by operating activities for
fiscal years 1999, 1998, and 1997 was $1.3 million, $1.5 million, and $2.0
million, respectively.
Net cash used in investing activities for fiscal years 1999, 1998, and 1997
was $4.2 million, $3.8 million, and $6.6 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 $4.2 million, $929,000 and
$1.6 million for fiscal years 1999, 1998 and 1997, respectively.
The primary investing activity of the Bank is the origination of mortgage
loans. During the years ended June 30, 1999, 1998 and 1997, the Bank originated
loans of $40.9 million, $36.6 million, and $33.5 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 ratio at
June 30, 1999 and 1998 was 4.0%. The Bank's average daily liquidity during June
1999, 1998, and 1997 was 5.43%, 6.07% and 7.77%, 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 net earnings in future
periods. See "---Comparison of Financial Condition at June 30, 1999 and 1998."
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, 1999, 1998 and
1997, cash and cash equivalents totaled $2.6 million, $1.3 million, and $2.8
million, respectively.
Management believes that the Bank will have sufficient funds available to
meet its current commitments. At June 30, 1999, the Bank had commitments to
originate loans of $2.0 million. Additionally, the Bank was obligated under
unused lines of credit totaling $5.1 million. Certificates of deposit which
were scheduled to mature in less than one year at June 30, 1999, totaled $48.5
million. On the basis of historical experience, management believes that a
significant portion of such deposits will remain with the Bank.
14
<PAGE>
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
Reporting Comprehensive Income. In June 1997, the FASB issued SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 established 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. 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. Management
adopted SFAS No. 130 effective July 1, 1998, as required, without material
impact on the Company's financial statements. The Company has no items of other
comprehensive income as defined, therefore net earnings are equal to other
comprehensive income for the years ended June 30, 1999, 1998 and 1997.
Disclosure about Segments of an Enterprise. 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 established 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. Management adopted SFAS No. 131 effective July 1, 1998,
as required, without material impact on the Company's financial statements.
Accounting for Derivative Instruments and Hedging Activities. In June,
1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," which requires entities to recognize all derivatives in
their financial statements as either assets or liabilities measured at fair
value. SFAS No. 133 also specifies new methods of accounting for hedging
transactions, prescribes the items and transactions that may be hedged, and
specifies detailed criteria to be met to qualify for hedge accounting.
The definition of a derivative financial instrument is complex, but in
general, it is an instrument with one or more underlyings, such as an interest
rate or foreign exchange rate, that is applied to a notional amount, such as an
amount of currency, to determine the settlement amount(s). It generally
requires no significant initial investment and can be settled net or by delivery
of an asset that is readily convertible to cash. SFAS No. 133 applies to
derivatives embedded in other contracts, unless the underlying of the embedded
derivative is clearly and closely related to the host contract.
SFAS No. 133, as amended by SFAS No. 137, is effective for fiscal years
beginning after June 15, 2000. On adoption, entities are permitted to transfer
held-to-maturity debt securities to the available-for-sale or trading category
without calling into question their intent to hold other debt securities to
maturity in the future. SFAS No. 133 is not expected to have a material impact
on the Company's financial statements.
15
<PAGE>
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 has addressed 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 has
completed the process of 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 BISYS , 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. The Bank
has completed a comprehensive testing program of the BISYS system. During the
test, the Bank used the same hardware and software that it will use on and after
January 1, 2000. Test data was extracted from the Bank's data files. Testing
involved aging the test data to certain key dates associated with the new
millenium and running various transactions against the aged data. No
substantive processing difficulties were identified. Under its contingency plan
of operation, the Bank also has procedures in place to address short-term
unavailability of the BISYS system.
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. 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
$30,000 and $10,000 were incurred during the fiscal years ended June 30, 1999
and 1998, respectively. Management expects to incur a cost of approximately
$30,000 in the fiscal year ending June 30, 2000, with the remainder to be
incurred in subsequent fiscal years as hardware is depreciated--at a cost of
$8,000 to $10,000 per year. These totals do not include time devoted by staff
for planning, testing, and implementing year 2000 related activities. 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 condition 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 made up of one- to four-family residential
mortgages. Likewise, it is possible that the Bank could incur losses if its
level of deposits decreases 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.
The Bank has taken steps to ensure that it has adequate liquidity and cash on
hand to meet unusually high demand. These steps, as they are outside the Bank's
normal operations, will result in some cost to the Bank. Management expects
such costs to total less than $20,000, but the cost is highly dependant on
market conditions and could fluctuate.
16
<PAGE>
[GRANT THORNTON LETTERHEAD]
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, 1999 and 1998, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the years ended June 30, 1999, 1998 and 1997. 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, 1999 and 1998, and the consolidated results of its
operations and its consolidated cash flows for each of the years ended June 30,
1999, 1998 and 1997, in conformity with generally accepted accounting
principles.
/s/ Grant Thornton LLP
Cincinnati, Ohio
July 30, 1999
17
<PAGE>
Frankfort First Bancorp, Inc.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30,
(In thousands, except share data)
<TABLE>
<CAPTION>
ASSETS 1999 1998
<S> <C> <C>
Cash and due from banks $ 991 $ 201
Interest-bearing deposits in other financial institutions 1,600 1,120
-------- --------
Cash and cash equivalents 2,591 1,321
Certificates of deposit in other financial institutions 200 200
Investment securities held to maturity - at amortized cost, approximate market
value of $1,999 and $2,995 as of June 30, 1999 and 1998 2,004 2,996
Loans receivable - net 131,639 126,328
Office premises and equipment - at depreciated cost 1,477 1,503
Federal Home Loan Bank stock - at cost 1,621 1,494
Accrued interest receivable on loans 367 342
Accrued interest receivable on investments and
interest-bearing deposits 39 58
Prepaid expenses and other assets 127 90
Prepaid federal income taxes 170 97
Deferred federal income taxes 87 56
-------- --------
Total assets $140,322 $134,485
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ 86,254 $ 81,891
Advances from the Federal Home Loan Bank 30,878 28,260
Other borrowed money 284 -
Advances by borrowers for taxes and insurance 308 305
Accrued interest payable 79 85
Other liabilities 1,253 1,238
-------- --------
Total liabilities 119,056 111,779
Commitments - -
Shareholders' equity
Preferred stock, 500,000 shares authorized, $.01 par value;
no shares issued - -
Common stock, 3,750,000 shares authorized, $.01 par value;
1,672,451 and 1,672,473 shares issued at June 30, 1999 and 1998 17 17
Additional paid-in capital 5,876 5,876
Retained earnings - restricted 18,166 17,846
Less 173,940 and 53,303 shares of treasury stock - at cost (2,793) (1,033)
-------- --------
Total shareholders' equity 21,266 22,706
-------- --------
Total liabilities and shareholders' equity $140,322 $134,485
======== ========
</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>
1999 1998 1997
<S> <C> <C> <C>
Interest income
Loans $9,388 $9,331 $8,579
Investment securities 99 220 379
Interest-bearing deposits and other 204 200 268
------ ------ ------
Total interest income 9,691 9,751 9,226
Interest expense
Deposits 3,915 4,000 4,196
Borrowings 1,680 1,685 489
------ ------ ------
Total interest expense 5,595 5,685 4,685
------ ------ ------
Net interest income 4,096 4,066 4,541
Provision for losses on loans - - 5
------ ------ ------
Net interest income after provision
for losses on loans 4,096 4,066 4,536
Other operating income 41 60 61
General, administrative and other expense
Employee compensation and benefits 862 919 2,869
Occupancy and equipment 149 150 162
Federal deposit insurance premiums 50 54 725
Franchise and other taxes 112 93 149
Data processing 156 136 126
Other operating 307 380 443
------ ------ ------
Total general, administrative and other expense 1,636 1,732 4,474
------ ------ ------
Earnings before income taxes 2,501 2,394 123
Federal income taxes
Current 882 740 579
Deferred (31) 74 (88)
------ ------ ------
Total federal income taxes 851 814 491
------ ------ ------
NET EARNINGS (LOSS) $1,650 $1,580 $ (368)
====== ====== ======
EARNINGS (LOSS) PER SHARE
Basic $1.06 $1.00 $(.23)
====== ====== ======
Diluted $1.05 $.96 N/A
====== ====== ======
</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, 1999, 1998 and 1997
(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, 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
Cash dividends of $.78 per common share - - (1,266) - - (1,266)
------ -------- ------- ------------- -------- --------
Balance at June 30, 1998 17 5,876 17,846 - (1,033) 22,706
Net earnings for the year ended June 30, 1999 - - 1,650 - - 1,650
Cash dividends of $.86 per common share - - (1,330) - - (1,330)
Acquisition of treasury stock - - - - (1,760) (1,760)
------ -------- ------- ------------- -------- --------
Balance at June 30, 1999 $ 17 $ 5,876 $18,166 $ - $(2,793) $ 21,266
====== ======== ======= ============= ======== ========
</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>
1999 1998 1997
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss) for the year $ 1,650 $ 1,580 $ (368)
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 (2) 4 22
Amortization of deferred loan origination fees (61) (11) (21)
Depreciation and amortization 72 78 89
Loans originated for sale (80) - -
Provision for losses on loans - - 5
Amortization of expense related to stock benefit plans - 47 1,605
Federal Home Loan Bank stock dividends (108) (92) (78)
Increase (decrease) in cash due to changes in:
Accrued interest receivable (6) (5) 25
Prepaid expenses and other assets (37) 5 31
Other liabilities 9 32 585
Federal income taxes
Current (73) (238) 162
Deferred (31) 74 (88)
-------- -------- --------
Net cash provided by operating activities 1,333 1,474 1,969
Cash flows provided by (used in) investing activities:
Purchase of investment securities designated as held to maturity (3,006) (4,000) -
Proceeds from maturity of investment securities 4,000 5,850 4,000
Purchase of Federal Home Loan Bank stock (19) (246) -
Loan principal repayments 35,723 31,153 22,939
Loan disbursements (40,893) (36,582) (33,480)
Purchase of office premises and equipment (46) (8) (56)
-------- -------- --------
Net cash used in investing activities (4,241) (3,833) (6,597)
Cash flows provided by (used in) financing activities:
Net increase (decrease) in deposit accounts 4,363 (4,066) (1,820)
Proceeds from Federal Home Loan Bank advances 17,250 32,500 4,500
Repayment of Federal Home Loan Bank advances (14,632) (13,246) (492)
Proceeds from other borrowed money 288 - 13,000
Repayment of other borrowed money (4) (13,000) (500)
Advances by borrowers for taxes and insurance 3 7 31
Principal repayments on ESOP loan in conjunction with pending
termination of the plan - net - - 2,269
Capital distributions paid on common stock (1,330) (1,266) (14,760)
Acquisition of treasury stock (1,760) - (666)
-------- -------- --------
Net cash provided by financing activities 4,178 929 1,562
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 1,270 (1,430) (3,066)
Cash and cash equivalents at beginning of year 1,321 2,751 5,817
-------- -------- --------
Cash and cash equivalents at end of year $ 2,591 $ 1,321 $ 2,751
======== ======== ========
</TABLE>
21
<PAGE>
Frankfort First Bancorp, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Federal income taxes $ 925 $1,040 $ 405
====== ====== ======
Interest on deposits and borrowings $5,601 $5,729 $4,694
====== ====== ======
Transfer of loans from held for sale classification to
loans receivable - net $ 80 $ - $ -
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
22
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Frankfort First Bancorp, Inc. (the "Corporation") is a savings and loan
holding company whose activities are primarily limited to holding the stock of
First Federal Savings Bank of Frankfort (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.
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, 1999 and 1998, the Corporation had
designated all investment securities as held-to-maturity.
23
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
2. Investment Securities (continued)
---------------------
Realized gains and 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.
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).
24
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
5. Allowance for Losses on Loans (continued)
-----------------------------
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, 1999 and 1998, the Savings Bank had no loans that would be defined
as impaired under SFAS No. 114.
6. Office Premises and Equipment
-----------------------------
Office premises and equipment are carried at cost and include expenditures
which extend the useful lives of existing assets. Maintenance, repairs and
minor renewals are expensed as incurred. For financial reporting,
depreciation and amortization are provided on the straight-line and
accelerated methods over the useful lives of the assets, estimated to be forty
years for buildings, ten to forty years for building improvements, and five to
ten years for furniture and equipment. An accelerated method is used for tax
reporting purposes.
25
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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 the
recapture of 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
-------------------------------------
The Corporation had 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. During the fiscal year
ended June 30, 1997, the Board of Directors elected to terminate the ESOP and
had filed with the Internal Revenue Service for a favorable determination
letter in this 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.
26
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
8. Retirement and Employee Benefit Plans (continued)
-------------------------------------
The Corporation also had a Management Recognition Plan ("MRP"). The MRP
purchased 68,460 shares of the Corporation's common stock in the open market
during fiscal 1996. 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 related to the MRP was charged to expense for
the fiscal year ended June 30, 1997. 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 1999 and 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 for the
fiscal year ended June 30, 1997, while no such expense was recorded during
fiscal year ended June 30, 1999 and 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 and 125,339
weighted-average unallocated shares held by the ESOP for the fiscal years
ended June 30, 1998 and 1997, respectively, totaled 1,561,656, 1,572,379 and
1,583,196 for the fiscal years ended June 30, 1999, 1998 and 1997,
respectively.
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
1,578,313 and 1,640,817 for the fiscal years ended June 30, 1999 and 1998,
respectively. Incremental shares related to the assumed exercise of stock
options included in the computation of diluted earnings per share totaled
16,657 and 68,438 for the fiscal years ended June 30, 1999 and 1998,
respectively. Options to purchase 4,747 shares of common stock with an
exercise price of $14.91 were outstanding at June 30, 1999, but were excluded
from the computation of diluted earnings per share because the exercise price
was greater than the average market price of the common shares.
27
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
9. Earnings Per Share and Dividends Per Share (continued)
------------------------------------------
During the fiscal year ended June 30, 1997, the Corporation declared dividends
of $8.72 (adjusted) per common share. Of this amount, $8.00 per share was
paid in June 1997 from funds retained by the Corporation in the conversion to
stock form and were deemed by management to constitute a return of excess
capital. Accordingly, the Corporation charged such capital distribution to
additional paid-in-capital. Management had obtained a Private Letter Ruling
from the Internal Revenue Service which stated that the Corporation's dividend
payments in excess of accumulated earnings and profits were considered a tax-
free return of capital for federal income tax purposes. As a result,
management determined that $7.20 of the distributions paid during the fiscal
year ended June 30, 1997, 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.
The following methods and assumptions were used by the Corporation in
estimating its fair value disclosures for financial instruments at June 30,
1999 and 1998:
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.
28
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
10. Fair Value of Financial Instruments (continued)
-----------------------------------
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.
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, 1999 and 1998, was not material.
29
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
10. Fair Value of Financial Instruments (continued)
-----------------------------------
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>
1999 1998
Carrying Fair Carrying Fair
value value value value
(In thousands)
<S> <C> <C> <C> <C>
Financial assets
Cash and cash equivalents $ 2,591 $ 2,591 $ 1,321 $ 1,321
Certificates of deposit in other financial
institutions 200 200 200 200
Investment securities 2,004 1,999 2,996 2,995
Loans receivable 131,639 130,681 126,328 128,760
Stock in Federal Home Loan Bank 1,621 1,621 1,494 1,494
-------- -------- -------- --------
$138,055 $137,092 $132,339 $134,770
======== ======== ======== ========
Financial liabilities
Deposits $ 86,254 $ 86,763 $ 81,891 $ 82,058
Advances from the Federal Home Loan Bank 30,878 30,525 28,260 28,269
Other borrowed money 284 284 - -
Advances by borrowers for taxes and insurance 308 308 305 305
-------- -------- -------- --------
$117,724 $117,880 $110,456 $110,632
======== ======== ======== ========
</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.
12. Comprehensive Income
--------------------
The Corporation adopted SFAS No. 130, "Reporting Comprehensive Income," as of
July 1, 1998. SFAS No. 130 established standards for reporting and
presentation of comprehensive income and its components in a full set of
general-purpose financial statements. It 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 presented
with the same prominence as other financial statements. SFAS No. 130 requires
that companies (i) classify items of other comprehensive income by their
nature in a financial statement and (ii) display the accumulated balance of
other comprehensive income separately from retained earnings. The Corporation
had no components of other comprehensive income for the fiscal years ended
June 30, 1999 and 1998.
13. Reclassifications
-----------------
Certain prior year amounts have been reclassified to conform to the 1999
consolidated financial statement presentation.
30
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
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>
1999 1998
Estimated Estimated
Amortized fair Amortized fair
cost value cost value
(In thousands)
<S> <C> <C> <C> <C>
U.S. Government agency
obligations $2,004 $1,999 $2,996 $2,995
====== ========= ========= =========
</TABLE>
At June 30, 1999 and 1998, the carrying value of the Corporation's investment
securities exceeded the estimated fair value by $5,000 and $1,000,
respectively, consisting solely of gross unrealized losses.
The amortized cost and estimated fair value of U.S. Government agency
obligations designated as held to maturity, by contractual term to maturity at
June 30 are shown below:
<TABLE>
<CAPTION>
1999 1998
Estimated Estimated
Amortized fair Amortized fair
cost value cost value
(In thousands)
<S> <C> <C> <C> <C>
Due within one year $2,004 $1,999 $2,000 $1,999
Due after five years through ten years - - 996 996
------ --------- ------ ---------
$2,004 $1,999 $2,996 $2,995
====== ========= ====== =========
</TABLE>
NOTE C - LOANS RECEIVABLE
The composition of the loan portfolio at June 30 is as follows:
<TABLE>
<CAPTION>
1999 1998
(In thousands)
<S> <C> <C>
Residential real estate
One-to-four family $124,081 $118,899
Multi-family 78 80
Construction 808 1,270
Nonresidential real estate and land 1,756 1,704
Consumer and other 5,640 5,258
-------- --------
132,363 127,211
Less:
Undisbursed portion of loans in process (246) (572)
Deferred loan origination fees (378) (211)
Allowance for loan losses (100) (100)
-------- --------
$131,639 $126,328
======== ========
</TABLE>
31
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE C - LOANS RECEIVABLE (continued)
The Savings Bank's lending efforts have historically focused on one-to-four
family and multi-family residential real estate loans, which comprise
approximately $124.7 million, or 95%, of the total loan portfolio at June 30,
1999, and $119.7 million, or 95%, of the total loan portfolio at June 30,
1998. 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 $911,000 and $477,000 at June 30, 1999 and 1998, respectively.
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>
1999 1998 1997
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 100 $ 100 $ 95
Provision for loan losses - - 5
----- ----- -----
Balance at end of year $ 100 $ 100 $ 100
===== ===== =====
</TABLE>
As of June 30, 1999, 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 $188,000, $363,000 and $116,000 at
June 30, 1999, 1998 and 1997, respectively. The Savings Bank did not incur
any reduction in interest income related to such nonperforming loans during
the respective periods.
32
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE E - OFFICE PREMISES AND EQUIPMENT
Office premises and equipment at June 30 are comprised of the following:
<TABLE>
<CAPTION>
1999 1998
(In thousands)
<S> <C> <C>
Land and improvements $ 187 $ 187
Office buildings and improvements 1,728 1,720
Furniture, fixtures and equipment 774 737
------ ------
2,689 2,644
Less accumulated depreciation and
amortization 1,212 1,141
------ ------
$1,477 $1,503
====== ======
</TABLE>
33
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE F - DEPOSITS
Deposits consist of the following major classifications at June 30:
<TABLE>
<CAPTION>
Deposit type and weighted-
average interest rate 1999 1998
(In thousands)
<S> <C> <C>
NOW accounts
1999 - 3.09% $ 3,622
1998 - 3.05% $ 3,716
Passbook
1999 - 2.94% 10,563
1998 - 2.91% 10,641
Money market deposit accounts
1999 - 3.08% 7,204
1998 - 3.33% 4,532
------ -------
Total demand, transaction and
passbook deposits 21,389 18,889
Certificates of deposit
Original maturities of:
Less than 12 months
1999 - 4.33% 8,442
1998 - 4.81% 10,620
12 months to 24 months
1999 - 5.04% 41,842
1998 - 5.27% 37,242
30 months to 36 months
1999 - 5.70% 6,989
1998 - 5.75% 10,848
More than 36 months
1999 - 5.63% 7,592
1998 - 5.85% 4,292
------- -------
Total certificates of deposit 64,865 63,002
------- -------
Total deposit accounts $86,254 $81,891
======= =======
</TABLE>
At June 30, 1999 and 1998, the Savings Bank had certificate of deposit accounts
with balances in excess of $100,000 totaling approximately $9.0 million and $7.1
million, respectively.
34
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE F - DEPOSITS (continued)
Maturities of outstanding certificates of deposit at June 30 are summarized as
follows:
<TABLE>
<CAPTION>
1999 1998
(In thousands)
<S> <C> <C>
Less than one year $48,481 $44,775
One to three years 14,651 15,453
Over three years 1,733 2,774
------- -------
$64,865 $63,002
======= =======
</TABLE>
NOTE G - ADVANCES FROM THE FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank, collateralized at June 30, 1999 by
pledges of certain residential mortgage loans totaling $46.6 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, 1999 1998
(Dollars in thousands)
<S> <C> <C> <C>
5.84% 2000 $ 500 $ 8,000
6.45% - 6.95% 2004 409 563
6.45% - 6.75% 2007 1,567 1,956
5.31% - 6.40% 2008 8,653 10,891
4.22% - 7.35% 2009 16,366 2,786
6.90% 2012 452 475
5.75% 2013 750 986
6.15% - 6.95% 2016 824 852
6.30% - 6.35% 2017 594 768
6.20% 2018 763 983
------- -------
$30,878 $28,260
======= =======
Weighted-average interest rate 5.50% 6.07%
======= =======
</TABLE>
NOTE H - OTHER BORROWED MONEY
Other borrowed money consisted of a $1.0 million variable-rate, unsecured line
of credit with an outstanding balance of $284,000 and an interest rate of
7.50% at June 30, 1999.
35
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE I - FEDERAL INCOME TAXES
Federal income taxes differ from the amounts computed at the statutory
corporate tax rate for the years ended June 30 as follows:
<TABLE>
<CAPTION>
1999 1998 1997
(In thousands)
<S> <C> <C> <C>
Federal income taxes computed at
statutory rate $ 850 $ 814 $ 42
Increase (decrease) in taxes resulting from:
Interest on municipal securities - (1) (2)
Nondeductible ESOP compensation expense - - 451
Other 1 1 -
----- ----- -----
Federal income tax provision per consolidated
statements of earnings $ 851 $ 814 $ 491
===== ===== =====
</TABLE>
The composition of the Corporation's net deferred tax asset at June 30 is as
follows:
<TABLE>
<CAPTION>
1999 1998
(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 129 72
Deferred compensation 67 64
Book/tax depreciation 15 15
----- -----
Total deferred tax assets 245 185
Deferred tax liabilities:
Percentage of earnings bad debt deductions (39) (47)
Federal Home Loan Bank stock dividends (119) (82)
----- -----
Total deferred tax liabilities (158) (129)
----- -----
Net deferred tax asset $ 87 $ 56
===== =====
</TABLE>
36
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
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, 1999 include
approximately $5.3 million for which federal income taxes have not been
provided. The amount of unrecognized deferred tax liability relating to the
cumulative bad debt deduction was approximately $1.8 million at June 30, 1999.
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, 1999, the Savings Bank had outstanding commitments of
approximately $1.7 million to originate loans. Additionally, the Savings Bank
was obligated under unused lines of credit totaling $5.1 million. In the
opinion of management all loan commitments equaled or exceeded prevalent
market interest rates as of June 30, 1999, and will be funded from normal cash
flow from operations.
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.
37
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE K - REGULATORY CAPITAL (continued)
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, 1999 and 1998, management believes that the Savings Bank met
all capital adequacy requirements to which it was subject.
<TABLE>
<CAPTION>
As of June 30, 1999
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 $22,513 16.1% greater than greater than greater than greater than
or equal to $2,102 or equal to 1.5% or equal to $7,007 or equal to 5.0%
Core capital $22,513 16.1% greater than greater than greater than greater than
or equal to $4,204 or equal to 3.0% or equal to $8,408 or equal to 6.0%
Risk-based capital $22,613 31.3% greater than greater than greater than greater than
or equal to $5,773 or equal to 8.0% or equal to $7,216 or equal to 10.0%
<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 greater than
or equal to $2,014 or equal to 1.5% or equal to $6,714 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 greater than
or equal to $5,557 or equal to 8.0% or equal to $6,947 or equal to 10.0%
</TABLE>
38
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE K - REGULATORY CAPITAL (continued)
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 MATTERS
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.
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.
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 amortize the recapture of the bad debt reserve in
taxable income over a six year period, which commenced in fiscal 1998.
39
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
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, 1999 and 1998, and the results
of its operations and its cash flows for the fiscal years ended June 30, 1999,
1998 and 1997.
Frankfort First Bancorp, Inc.
STATEMENTS OF FINANCIAL CONDITION
June 30,
(In thousands)
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
ASSETS
Interest-bearing deposits in First Federal Savings Bank
of Frankfort $ 29 $ 358
Investment in First Federal Savings Bank of Frankfort 22,513 23,299
Prepaid expenses and other 285 213
------- -------
Total assets $22,827 $23,870
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Other borrowed money $ 284 $ -
Dividends payable 330 324
Deferred compensation 813 813
Other liabilities 134 27
------- -------
1,561 1,164
Shareholders' equity
Common stock 17 17
Additional paid-in capital 5,876 5,876
Retained earnings 18,166 17,846
Treasury stock - at cost (2,793) (1,033)
------- -------
Total shareholders' equity 21,266 22,706
------- -------
Total liabilities and shareholders' equity $22,827 $23,870
======= =======
</TABLE>
40
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE M - CONDENSED FINANCIAL STATEMENTS OF FRANKFORT FIRST BANCORP, INC.
(continued)
Frankfort First Bancorp, Inc.
STATEMENTS OF OPERATIONS
Years ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Revenue
Interest income $ 15 $ 27 $ 204
Equity in earnings of First Federal Savings Bank of Frankfort 1,760 1,849 1,004
------ ------ ------
Total revenue 1,775 1,876 1,208
General and administrative expenses 181 435 1,667
------ ------ ------
Earnings (loss) before income tax credits 1,594 1,441 (459)
Federal income tax credits (56) (139) (91)
------ ------ ------
NET EARNINGS (LOSS) $1,650 $1,580 $ (368)
====== ====== ======
</TABLE>
Frankfort First Bancorp, Inc.
STATEMENTS OF CASH FLOWS
Years ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Cash from operating activities:
Net earnings (loss) for the year $1,650 $ 1,580 $ (368)
Adjustments to reconcile net earnings (loss) to net
cash provided by (used in) operating activities
Excess distributions from consolidated subsidiary 786 10,836 1,996
Increase (decrease) in cash due to changes in:
Prepaid expenses and other assets (72) (85) (66)
Other liabilities 113 119 866
------ ------- ------
Net cash provided by operating activities 2,477 12,450 2,428
Cash flows provided by investing activities:
Proceeds from repayment of loan to ESOP - - 2,511
------ ------- ------
Net cash provided by operating and investing
activities (balance carried forward) 2,477 12,450 4,939
------ ------- ------
</TABLE>
41
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE M - CONDENSED FINANCIAL STATEMENTS OF FRANKFORT FIRST BANCORP, INC.
(continued)
Frankfort First Bancorp, Inc.
STATEMENTS OF CASH FLOWS (CONTINUED)
Years ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Net cash provided by operating and investing
activities (balance brought forward) $ 2,477 $ 12,450 $ 4,939
Cash flows provided by (used in) financing activities:
Proceeds from other borrowed money 288 - 13,000
Repayments of other borrowed money (4) (13,000) (500)
Capital distributions on common stock (1,330) (1,266) (14,759)
Purchase of treasury stock (1,760) - (666)
------- -------- --------
Net cash used in financing activities (2,806) (14,266) (2,925)
------- -------- --------
Net increase (decrease) in cash and cash equivalents (329) (1,816) 2,014
Cash and cash equivalents at beginning of year 358 2,174 160
------- -------- --------
Cash and cash equivalents at end of year $ 29 $ 358 $ 2,174
======= ======== ========
</TABLE>
The Savings Bank is subject to regulations imposed by the OTS regarding the
amount of capital distributions payable by the Savings Bank to the
Corporation. Generally, the Savings Bank's payment of dividends is limited,
without prior OTS approval, to net income for the current calendar year plus
the two preceding calendar years, less capital distributions paid over the
comparable time period. Insured institutions are required to file an
application with the OTS for capital distributions in excess of this
limitation. During fiscal 1999, the Savings Bank received OTS approval to
make up to $4.1 million in capital distributions during fiscal 2000.
42
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE N - 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
251,860 (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 adjusted such fair value to $13.80 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, 1999, none of the stock options
granted had been exercised.
The Corporation accounts for the Plan in accordance with 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 APB 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:
<TABLE>
<CAPTION>
1999 1998 1997
(Earnings in thousands)
<S> <C> <C> <C> <C>
Net earnings As reported $1,650 $1,580 $(368)
====== ====== =====
Pro-forma $1,650 $1,580 $(373)
====== ====== =====
Earnings per share
Basic As reported $ 1.06 $ 1.00 $(.23)
====== ====== =====
Pro-forma $ 1.06 $ 1.00 $(.24)
====== ====== =====
Diluted As reported $ 1.05 $ .96 N/A
====== ====== =====
Pro-forma $ 1.05 $ .96 N/A
====== ====== =====
</TABLE>
43
<PAGE>
Frankfort First Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE N - STOCK OPTION PLAN (continued)
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: 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,
1999, 1998 and 1997, and changes during the periods ending on those dates is
presented below:
<TABLE>
<CAPTION>
1999 1998 1997
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 251,860 $13.82 251,860 $13.82 247,113 $13.80
Granted - - - - 4,747 14.91
Exercised - - - - - -
Forfeited (12,368) - - - - -
------- ------ ------- --------- ------- ------
Outstanding at end of year 239,492 $13.82 251,860 $13.82 251,860 $13.82
======= ====== ======= ========= ======= ======
Options exercisable at year-end 142,740 $13.81 107,211 $13.81 59,316 $13.80
======= ====== ======= ========= ======= ======
Weighted-average fair value of
options granted during the year N/A N/A $ 1.66
====== ========= ======
</TABLE>
The following information applies to options outstanding at June 30, 1999:
<TABLE>
<CAPTION>
<S> <C>
Number outstanding 239,492
Range of exercise prices $13.80 - $14.91
Weighted-average exercise price $13.82
Weighted-average remaining contractual life 6.5 years
</TABLE>
<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
HEADQUARTERS: BRANCH OFFICES:
216 West Main Street East Branch West Branch
P.O. Box 535 1980 Versailles Road 1220 US 127 South
Frankfort, Kentucky 40602 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 9, 1999 at ANNUAL REPORT ON FORM
Cincinnati, OH 45202-4181 4:30 p.m. at First Federal Savings 10-K FOR THE YEAR ENDED
Bank of Frankfort JUNE 30, 1999, AS FILED WITH
THE SECURITIES AND EX-
SPECIAL COUNSEL TRANSFER AGENT AND REGISTRAR CHANGE COMMISSION WILL
Housley, Kantarian & Bronstein, P.C. Illinois Stock Transfer Company BE FURNISHED WITHOUT
1220 19th Street N.W. Suite 700 209 W Jackson Blvd, Suite 903 CHARGE TO SHAREHOLDERS
Washington, D.C. 20036 Chicago, Illinois 60606-6905 AS OF THE RECORD DATE
FOR THE NOVEMBER 9, 1999
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
[Grant Thornton Letterhead]
September 23, 1999
ACCOUNTANT'S CONSENT
We have issued our report dated July 30, 1999, 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,
1999. 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 22, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> JUN-30-1999
<CASH> 991
<INT-BEARING-DEPOSITS> 1,600
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 2,204
<INVESTMENTS-MARKET> 2,199
<LOANS> 131,739
<ALLOWANCE> 100
<TOTAL-ASSETS> 140,322
<DEPOSITS> 86,254
<SHORT-TERM> 284
<LIABILITIES-OTHER> 1,640
<LONG-TERM> 30,878
0
0
<COMMON> 17
<OTHER-SE> 21,249
<TOTAL-LIABILITIES-AND-EQUITY> 140,322
<INTEREST-LOAN> 9,388
<INTEREST-INVEST> 99
<INTEREST-OTHER> 204
<INTEREST-TOTAL> 9,691
<INTEREST-DEPOSIT> 3,915
<INTEREST-EXPENSE> 5,595
<INTEREST-INCOME-NET> 4,096
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1,636
<INCOME-PRETAX> 2,501
<INCOME-PRE-EXTRAORDINARY> 1,650
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,650
<EPS-BASIC> 1.06
<EPS-DILUTED> 1.05
<YIELD-ACTUAL> 3.04
<LOANS-NON> 0
<LOANS-PAST> 188
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 100
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 100
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 100
</TABLE>
