<PAGE> 1
FORM 10-QSB
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For Quarterly Period ended September 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from______________to_______________
Commission File Number: 0-25960
-------
THE BANK OF KENTUCKY FINANCIAL CORPORATION
-------------------------------------------
(Name of small business issuer in its charter)
Kentucky 61-1256535
------------------------------- ---------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1065 Burlington Pike, Florence, Kentucky 41042
---------------------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (606) 371-2340
--------------
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the issuer was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
As of November 8, 1999, the latest practicable date, 5,286,575 shares of the
Registrant's Common Stock, no par value, were issued and outstanding.
Transitional Small Business Disclosure Format Yes [ ] No [X]
<PAGE> 2
THE BANK OF KENTUCKY FINANCIAL CORPORATION
INDEX
FINANCIAL INFORMATION PAGE
The Bank of Kentucky Financial Corporation
Consolidated Statements of Financial Condition 1
The Bank of Kentucky Financial Corporation
Consolidated Statements of Income 2
The Bank of Kentucky Financial Corporation
Consolidated Statements of Changes
in Shareholders' Equity 3
The Bank of Kentucky Financial Corporation
Consolidated Statements of Cash Flows 4
The Bank of Kentucky Financial Corporation
Notes to Consolidated Financial Statements 5
The Bank of Kentucky Financial Corporation
Management's Discussion and Analysis of
Financial Condition and Results of Operations 6
The Bank of Kentucky Financial Corporation
Part II 10
The Bank of Kentucky Financial Corporation
Signatures 11
<PAGE> 3
THE BANK OF KENTUCKY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30 DECEMBER 31
1999 1998
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 12,785 $ 17,583
Interest bearing deposits with banks 0 422
Available-for-sale securities 21,631 18,028
Held-to-maturity securities 25,983 30,297
Loans held for sale 628 1,470
Total loans 233,843 206,365
Less: Allowances for loan losses 2,400 2,193
----------- -----------
Net loans 231,443 204,172
Premises and equipment, net 4,290 3,756
FHLB stock, at cost 2,135 2,026
Accrued interest receivable and other assets 3,966 3,013
----------- -----------
Total assets $ 302,861 $ 280,767
=========== ===========
LIABILITIES & SHAREHOLDERS' EQUITY
LIABILITIES
Deposits $ 247,821 $ 243,858
Short-term borrowings 25,329 10,398
Notes payable 509 526
Accrued interest payable & other liabilities 1,677 1,537
----------- -----------
Total liabilities 275,336 256,319
SHAREHOLDERS' EQUITY
Common stock 3,072 2,972
Additional paid-in capital 7,770 7,674
Retained earnings 16,812 13,774
Accumulated other comprehensive income (129) 28
----------- -----------
Total shareholders' equity 27,525 24,448
----------- -----------
Total liabilities and shareholders' equity $ 302,861 $ 280,767
=========== ===========
</TABLE>
See accompanying notes
<PAGE> 4
THE BANK OF KENTUCKY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30 September 30
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans, including related fees $ 4,999 $ 4,629 $ 14,325 $ 13,329
Securities and other 652 584 2,001 1,608
----------- ----------- ----------- -----------
Total interest income 5,651 5,212 16,326 14,937
----------- ----------- ----------- -----------
INTEREST EXPENSE
Deposits 2,380 2,401 6,991 6,811
Borrowings 223 114 592 468
----------- ----------- ----------- -----------
Total interest expense 2,603 2,515 7,583 7,279
----------- ----------- ----------- -----------
Net interest income 3,048 2,697 8,743 7,658
Provision for loan losses (182) (137) (414) (417)
----------- ----------- ----------- -----------
Net interest income after
Provision for loan losses 2,866 2,560 8,329 7,241
----------- ----------- ---------- ----------
NON-INTEREST INCOME
Service charges and fees 343 279 965 755
Gain/(loss) on securities 0 0 0 0
Gain on loans sold 61 152 314 557
Other 153 111 448 326
----------- ----------- ----------- -----------
Total non-interest income 557 542 1,727 1,638
NON-INTEREST EXPENSE
Salaries and benefits 862 741 2,461 2,161
Occupancy and equipment 362 315 1,091 891
Data processing 127 100 346 331
Advertising 78 56 204 145
Other 385 318 1,202 950
----------- ----------- ----------- -----------
Total non-interest expense 1,814 1,530 5,304 4,478
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 1,609 1,572 4,752 4,401
Less: income taxes (508) (510) (1,503) (1,443)
----------- ----------- ----------- -----------
NET INCOME $ 1,101 $ 1,062 $ 3,249 $ 2,958
=========== =========== =========== ===========
Earnings per share $ .21 $ .20 $ .62 $ .56
Earnings per share, assuming dilution $ .21 $ .20 $ .61 $ .56
Dividends per share $ 0 $ 0 $ .04 $ .03
</TABLE>
See accompanying notes
<PAGE> 5
THE BANK OF KENTUCKY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Balance January 1 $ 24,448 $ 20,327
----------- -----------
Comprehensive Income:
Net Income 3,249 2,958
Change in net unrealized Gain/Loss on
Available-for-sale Securities (157) 113
----------- -----------
TOTAL COMPREHENSIVE INCOME 3,092 3,071
Cash dividends paid (211) (176)
Exercise of stock options (including tax benefit of
$62 and $14) 196 120
----------- -----------
Balance September 30 $ 27,525 $ 23,342
=========== ===========
</TABLE>
See accompanying notes
<PAGE> 6
THE BANK OF KENTUCKY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30 1999 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 3,249 $ 2,958
Adjustments to reconcile net income to net cash
From operating activities 548
(233)
Net cash from operating activities 3,016 3,506
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in interest bearing deposits with banks 422 0
Proceeds from paydowns and maturities of
Held-to-maturity securities 6,625 14,522
Proceeds from paydowns and maturities of
Available-for-sale securities 4,159 8,072
Purchases of held-to-maturity securities (3,843) (13,114)
Purchases of available-for-sale securities (6,233) (12,733)
Net change in loans (26,844) (19,895)
Purchase stock in FHLB 0
0
Property and equipment expenditures (900) (119)
-------- --------
Net cash from investing activities (26,614) (23,267)
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 3,963 25,202
Net change in short-term borrowings 14,931 1,598
Proceeds from exercise of stock options 134 106
Cash dividends paid (211) (176)
Payments on note payable (17) (17)
-------- --------
Net cash from financing activities 18,800 26,713
-------- --------
Net change in cash and cash equivalents (4,798) 6,952
Cash and cash equivalents at beginning of period 17,583 10,125
-------- --------
Cash and cash equivalents at end of period $ 12,785 $ 17,077
======== ========
</TABLE>
See accompanying notes
<PAGE> 7
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
NOTE 1 - BASIS OF PRESENTATION:
- -------------------------------
The consolidated financial statements include the accounts of The Bank of
Kentucky Financial Corporation (the company) and its wholly owned subsidiary,
The Bank of Kentucky (the Bank). All significant intercompany accounts and
transactions have been eliminated.
NOTE 2 - GENERAL:
- -----------------
These financial statements were prepared in accordance with the instructions for
Form 10Q-SB and, therefore, do not include all of the disclosures necessary for
a complete presentation of financial position, results of operations and cash
flows in conformity with generally accepted accounting principles. Except for
the adoption of the required accounting changes described in Note 3, these
financial statements have been prepared on a basis consistent with the annual
financial statements and include, in the opinion of management, all adjustments,
consisting of only normal recurring adjustments, necessary for a fair
presentation of the results of operations and financial position at the end of
and for the periods presented.
NOTE 3 - EARNINGS PER SHARE:
- ----------------------------
Earnings per share have been computed based upon the weighted average number of
shares outstanding during the period. In the second quarter the Company declared
a three for two stock split resulting in there being 1,759,851 additional shares
outstanding. Per share data for the prior periods has been restated to reflect
the stock dividend. Earnings per share are computed based upon the weighted
average shares outstanding during the period. Diluted earnings per share further
assume that average stock options outstanding are exercised and the proceeds,
including the relevant tax benefit, are used entirely to reacquire shares at the
average price during the period. The following table presents weighted average
shares outstanding and the number of shares used to compute diluted earnings per
share:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30 September 30
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Weighted Average Shares Outstanding 5,284,138 5,269,170 5,280,373 5,264,459
Shares used to compute diluted
Earnings per share 5,338,192 5,298,473 5,324,733 5,278,920
</TABLE>
<PAGE> 8
THE BANK OF KENTUCKY FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND THE RESULTS OF OPERATIONS
SEPTEMBER 30, 1999
FINANCIAL CONDITION
Total assets at September 30, 1999 were $302,861,000 compared to $280,767,000 at
December 31, 1998, an increase of $22,094,000 (7.9%). This increase was
primarily due to an increase in loans of $27,478,000 (13.3%), from $206,365,000
at December 31, 1998 to $233,843,000 at September 30,1999. This growth was
funded by an increase in short-term borrowings of $14,931,000 (143.6%), from
$10,398,000 at December 31, 1998 to $25,329,000 at September 30,1999. Deposits
increased $3,963,000 (1.6%), from $243,858,000 at December 31, 1998 to
$247,821,000 at September 30,1999.
RESULTS OF OPERATIONS
GENERAL
Net income year to date increased from $2,958,000 in 1998 to $3,249,000 in 1999,
an increase of $291,000 (9.8%). Net income for the quarter ended September 30,
1999 was $1,101,000 ($.21 per share) compared to $1,062,000 ($.20 per share)
during the same period in 1998, an increase of $39,000 (3.7%). The increase in
earnings was driven by an increase in net interest income, primarily due to
increased volume.
NET INTEREST INCOME
Net interest income increased $351,000 (13.0%) in the third quarter of 1999 over
the same period in 1998, while the year to date total increased $1,085,000
(14.2%) from $7,658,000 in 1998 to $8,743,000 in 1999. The increase in net
interest income was driven by the continued growth in the loan portfolio.
PROVISION FOR LOAN LOSSES
The loan loss provision was $414,000 for the nine months ended September 30,1999
compared to $417,000 recorded in the same period in 1998 and $182,000 for the
third quarter compared to $137,000 in 1998. Non-performing loans at September
30, 1999 totaled $705,000 or .30% of total loans outstanding compared to .28% at
September 30, 1998. As a result of the continuing strong loan growth and to
maintain the loan loss reserve balance at a desired level, management.expects
the loan loss provision will remain higher through the remainder of the year.
Management is satisfied that the reserve is adequate at September 30, 1998.
NON INTEREST INCOME
Total non-interest income increased $89,000 (5.4%) to $1,727,000 through
September 30,1999, compared to $1,638,000 for the same period in 1998. Service
charges on deposits increased
<PAGE> 9
$64,000 (22.9%) in the third quarter, to $343,000 for the quarter ending
September 30,1999 compared to $279,000 for the same period in 1998. Transaction
growth and fee increases in the first quarter contributed to the continued
growth in deposit fees. Income from the sale of loans into the secondary market
decreased $243,000 (43.7%) to $314,000 through September 30, 1999, compared to
$557,000 for the same period in 1998. The Bank originates fixed rate first
mortgage loans and sells them, service released, into the secondary market. The
decrease in fee income is driven by decreased volume. Through September 30,
1999, 175 loans with a principal balance of $22.0 million were sold compared to
270 loans with a principal balance of $28.2 million during the same period in
1998. Loans held for sale at September 30, 1999 decreased to $628,000 from
$1,470,000 at December 31, 1998. These loans have been approved by the secondary
market buyer and closed by the Bank. The Bank is awaiting settlement but is not
exposed to significant interest rate or pricing risk during the period between
closing the loan and settlement. In addition, the Bank originates and sells,
servicing retained, SBA loans. SBA loan sale gains totaled $14,000 through
September 30, 1999 compared to $110,000 in 1998.
NON INTEREST EXPENSE
Non interest expense increased $284,000 (18.6%) in the third quarter of 1999,
with year to date expenses increasing $826,000 (18.4%) to $5,304,000 through
September 30, 1999 compared to $4,478,000 for the same period in 1998. Salaries
and employee benefits increased $300,000 (13.9%) to $2,461,000 through September
30,1999 compared to $2,161,000 for the same period in 1998. Staffing expenses
associated with an increase in operations staff and annual merit increases
accounted for most of the increase. Occupancy and equipment expense increased
$200,000 (22.5%) to $1,091,000 through September 30, 1999, compared to $891,000
for the same period in 1998. The increase was due to expenses associated with
the conversion of an existing branch to an operations center and the relocation
of that branch to a new facility in the first quarter of the year. Advertising
expense increased $59,000 (40.7%) through the first nine months of 1999 to
$204,000 from $145,000 for the same period last year. Other operating expenses
increased $252,000 (26.6%) through September 30, 1999 to $1,202,000 from
$950,000 for the same period in 1998. Expenses associated with the deployment of
six additional ATM machines increased ATM expenses by $63,000 (52.4%) to
$183,000 through September 30,1999 compared to $120,000 for the same period in
1998.
INCOME TAX EXPENSE
Income tax expense increased by $60,000 (4.2%) in the third quarter of 1999
compared to 1998. The increase was primarily due to higher income before tax as
the effective tax rate was fairly stable at 31.6% for 1999 versus 32.8% for
1998.
LIQUIDITY AND CAPITAL RESOURCES
The company achieves liquidity by maintaining an appropriate balance between its
sources and uses of funds to assure that sufficient funds are available to meet
loan demands and deposit fluctuations. The Bank has established a network of
community banks which will participate in loans to meet large loan request. In
addition, the Bank has the ability to draw funds from the
<PAGE> 10
Federal Home Loan Bank and two of its correspondent banks to meet liquidity
demands. Management is satisfied that BKFC's liquidity is sufficient at
September 30, 1999. For purposes of determining a bank's deposit insurance
assessment, the FDIC has issued regulations that define a "well capitalized "
bank as one with a leverage ratio of 5% or more and a total risk-based ratio of
10% or more. At September 30, 1999, the Bank's leverage and total risk-based
ratios were 9.31% and 11.07% respectively, which exceeds the well-capitalized
threshold.
YEAR 2000
Pursuant to the "Year 2000 Information and Readiness Disclosure Act", the
attached discussion of Year 2000 Issues is hereby designated a "Year 2000
Readiness Disclosure" by BKFC.
It is well documented that some data processing systems may experience
processing difficulties upon encountering the millenium. This "Year 2000
Problem" is believed to be material for virtually every public company. The
following section describes the steps, which BKFC is taking to handle this
serious matter. It should be noted that this section in particular, as well as
the "Management Discussion and Analysis" area in general, contains "forward
looking statements" which represent the opinions of management. Such
forward-looking statements are subject to numerous risks and uncertainties,
which obviously accompany any discussion of future actions, performances or
results. The reader of these discussions is hereby cautioned of the uncertain
nature of these discussions and is urged to use caution in relying on such
forward looking statements in forming any opinions concerning the financial
results, condition or operations of BKFC.
BKFC has conducted a formal review of its systems and system providers, due to
concerns regarding possible consequences that the year 2000 may pose to computer
and other operating systems utilized in its business activities. The review has
resulted in the identification of certain issues which require resolution,
management believes that appropriate plans are in place to resolve these issues
in a timely manner. A review of the service bureau supported data processing
system has been completed, with the major data systems already certified as Year
2000 compliant. The Company's major vendors have all been contacted, with
approximately 95 % reporting Year 2000 compliance for their product or service.
The customer contact group is currently in the process of evaluating responses
from major customers.
The contingency planning group has the task of working with all areas in order
to assure uninterrupted operations and to have plans available in the event that
mission critical vendors are not Year 2000 ready. BKFC's third party data
processing provider has developed a comprehensive year 2000 contingency plan
that provides for redundant systems and processes to insure business resumption
in the event of failure. BKFC has a written contingency plan, which addresses
several critical areas including data processing, data communications, voice
communications, liquidity, and environmental issues. The contingency plan
parallels our third party processor's plan to ensure a smooth transition for
business resumption in the event of a system or software failure. In addition,
the plan addresses liquidity issues resulting from year
<PAGE> 11
2000 readiness and provisions to establish lines of credit to cover anticipated
liquidity needs. The plan also provides for alternative and manual processes to
address communication and envoirmental issues. BKFC has written a validation
plan, which details the methods used to test viability of the bank's business
resumption contingency plan.
The principal expense factor in addressing the Year 2000 Issue has consisted of
employee time. Year 2000 tasks have been incorporated into the daily work
routine of the Company's employees, with only minimal interruption to work flow.
It is management's opinion that certain vendors will require additional
compensation for software upgrades that will need to be installed in certain
equipment in order to make such equipment Year 2000 compliant. It is
management's opinion that such additional expense will be nominal and will not
materially impact the Company's financial performance.
The risks for BKFC in the event that certain mission-critical systems are not
Year 2000 compliant are substantial. As a financial institution, the Company's
largest volume of transactions involve loan related matters (loan originations,
the acceptance of loan payments, escrow handling and so forth) and deposit
accounts (new account openings, additions and withdrawals from accounts,
interest crediting, checking account transactions and so forth). The inability
of the Company to process these transactions in an efficient and timely manner
would greatly impact the Company's operations. No estimate is available
concerning possible lost revenue in the event of a material Year 2000 problem.
However, such loss of revenue would likely be a material amount that could have
a serious negative impact on the Company's financial performance and operations.
<PAGE> 12
THE BANK OF KENTUCKY FINANCIAL CORPORATION
PART II
ITEM 1. Legal Proceedings
-----------------
Not applicable
ITEM 2. Changes in Securities
---------------------
Not applicable
ITEM 3. Defaults Upon Senior Securities
-------------------------------
Not applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
ITEM 6. Exhibits and Reports on Form 8 - K
----------------------------------
Exhibit 3.1 Articles of Incorporation of The Bank of
Kentucky Financial Corporation, as amended
(Incorporated by reference to the Form 8-A filed by
Registrant on April 28, 1995 the "8-A", Exhibits
2(a), 2(b), and 2(c).
Exhibit 3.2 By-Laws of The Bank of Kentucky Financial
Corporation (Incorporated by reference to the 8-A,
Exhibit 2(d).
Exhibit 27 Financial Data Schedule.
Exhibit 99 Safe Harbor under the Private Securities
Litigation Reform Act of 1995.
<PAGE> 13
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Date: November 8, 1999 /s/ Robert W. Zapp
---------------------------------- --------------------------
Robert W. Zapp
President
Date: November 8, 1999 /s/ Robert D. Fulkerson
---------------------------------- --------------------------
Robert D. Fulkerson
Treasurer (Chief Financial Officer)
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 12773
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 12
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 21631
<INVESTMENTS-CARRYING> 25983
<INVESTMENTS-MARKET> 25660
<LOANS> 233843
<ALLOWANCE> 2400
<TOTAL-ASSETS> 302861
<DEPOSITS> 247821
<SHORT-TERM> 25329
<LIABILITIES-OTHER> 1677
<LONG-TERM> 509
0
0
<COMMON> 3072
<OTHER-SE> 24453
<TOTAL-LIABILITIES-AND-EQUITY> 302861
<INTEREST-LOAN> 14325
<INTEREST-INVEST> 2001
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 16326
<INTEREST-DEPOSIT> 6991
<INTEREST-EXPENSE> 7583
<INTEREST-INCOME-NET> 8743
<LOAN-LOSSES> 414
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 5304
<INCOME-PRETAX> 4752
<INCOME-PRE-EXTRAORDINARY> 4752
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3249
<EPS-BASIC> .62
<EPS-DILUTED> .61
<YIELD-ACTUAL> 7.96
<LOANS-NON> 0
<LOANS-PAST> 705
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2193
<CHARGE-OFFS> 235
<RECOVERIES> 28
<ALLOWANCE-CLOSE> 2400
<ALLOWANCE-DOMESTIC> 2400
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
<PAGE> 1
EXHIBIT 99
----------
SAFE HARBOR UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
----------------------------------------------------------------------
The Private Securities Litigation Reform Act of 1995 (the "Act")
provides a "safe harbor" for forward-looking statements to encourage companies
to provide prospective information about their companies, so long as those
statements are identified as forward-looking and are accompanied by meaningful
cautionary statements identifying important factors that could cause actual
results to differ materially from those discussed in the statement. The Bank of
Kentucky Financial Corporation ("BKFC") desires to take advantage of the "safe
harbor" provisions of the Act. Certain information, particularly information
regarding future economic performance and finances and plans and objectives of
management, contained or incorporated by reference in BKFC's Annual Report on
Form 10-KSB for fiscal year 1996 is forward-looking. In some cases, information
regarding certain important factors that could cause actual results of
operations or outcomes of other events to differ materially from any such
forward-looking statement appears together with such statement. In addition,
forward-looking statements are subject to other risks and uncertainties
affecting the financial institutions industry, including, but not limited to,
the following:
Interest Rate Risk
- ------------------
BKFC's operating results are dependent to a significant degree on its
net interest income, which is the difference between interest income from loans,
investments and other interest-earning assets and interest expense on deposits,
borrowings and other interest-bearing liabilities. The interest income and
interest expense of BKFC change as the interest rates on interest-earning assets
and interest-bearing liabilities change. Interest rates may change because of
general economic conditions, the policies of various regulatory authorities and
other factors beyond BKFC's control. In a rising interest rate environment,
loans tend to prepay slowly and new loans at higher rates increase slowly, while
interest paid on deposits increases rapidly because the terms to maturity of
deposits tend to be shorter than the terms to maturity or prepayment of loans.
Such differences in the adjustment of interest rates on assets and liabilities
may negatively affect BKFC's income.
Possible Inadequacy of the Allowance for Loan Losses
- ----------------------------------------------------
BKFC maintains an allowance for loan losses based upon a number of
relevant factors, including, but not limited to, trends in the level of
nonperforming assets and classified loans, current and anticipated economic
conditions in the primary lending area, past loss experience, possible losses
arising from specific problem loans and changes in the composition of the loan
portfolio. While the Board of Directors of BKFC believes that it uses the best
information available to determine the allowance for loan losses, unforeseen
market conditions could result in material adjustments, and net earnings could
be significantly adversely affected if circumstances differ substantially from
the assumptions used in making the final determination.
Loans not secured by one- to four-family residential real estate are
generally considered to involve greater risk of loss than loans secured by one-
to four-family residential real estate due, in part, to the effects of general
economic conditions. The repayment of commercial loans and multifamily
residential and nonresidential real estate loans generally depends upon the cash
flow from the operation of the business or property, which may be negatively
affected by national and local economic conditions. Construction loans may also
be negatively affected by such economic conditions, particularly loans made to
developers who do not have a buyer for a property before the loan is made. The
risk of default on consumer loans increases during periods of recession, high
unemployment and other adverse economic conditions. When consumers have trouble
paying their bills, they are more likely to pay mortgage loans than consumer
loans. In addition, the collateral securing such loans, if any, may decrease in
value more rapidly than the outstanding balance of the loan.
<PAGE> 2
Competition
- -----------
The Bank of Kentucky, Inc. (the "Bank") competes for deposits with
other savings associations, commercial banks and credit unions and issuers of
commercial paper and other securities, such as shares in money market mutual
funds. The primary factors in competing for deposits are interest rates and
convenience of office location. In making loans, the Bank competes with other
commercial banks, savings and loan associations, savings banks, consumer finance
companies, credit unions, leasing companies, mortgage companies and other
lenders. Competition is affected by, among other things, the general
availability of lendable funds, general and local economic conditions, current
interest rate levels and other factors, which are not readily predictable. The
size of financial institutions competing with the Bank is likely to increase as
a result of changes in statutes and regulations eliminating various restrictions
on interstate and inter-industry branching and acquisitions. Such increased
competition may have an adverse effect upon the Bank.
Legislation and Regulation that may Adversely Affect BKFC's Earnings
- --------------------------------------------------------------------
The Bank is subject to regulation by the Department of Financial
Institutions of the Commonwealth of Kentucky and the Federal Deposit Insurance
Corporation (the "FDIC") and is periodically examined by such regulatory
agencies to test compliance with various regulatory requirements. As a savings
and loan holding company, BKFC is also subject to regulation and examination by
the Board of Governors of the Federal Reserve System. Such supervision and
regulation of the Bank and BKFC are intended primarily for the protection of
depositors and not for the maximization of shareholder value and may affect the
ability of the company to engage in various business activities. The
assessments, filing fees and other costs associated with reports, examinations
and other regulatory matters are significant and may have an adverse effect on
BKFC's net earnings.
The FDIC is authorized to establish separate annual assessment rates
for deposit insurance of members of the Bank Insurance fund (the "BIF") and the
Savings Association Insurance Fund (the "SAIF"). The FDIC has established a
risk-based assessment system for both SAIF and BIF members. Under such system,
assessments may vary depending on the risk the institution poses to its deposit
insurance fund. Such risk level is determined by reference to the institution's
capital level and the FDIC's level of supervisory concern about the institution.
Because the reserves of the BIF exceeded the statutorily set minimum,
assessments for healthy BIF institutions were significantly decreased in the
last half of 1995 and were reduced to $2,000 per year for well-capitalized,
well-managed banks, like the Bank, in 1996. Assessments paid by healthy
institutions on deposits in the SAIF exceed that paid by healthy banks by
approximately $.23 per $100 in deposits in 1996.
Federal legislation that was effective September 30, 1996, provided for
the recapitalization of the SAIF by means of a special assessment of $.657 per
$100 in deposits held at March 31, 1995, in order to increase SAIF reserves to
the level required by law. Certain banks were required to pay the special
assessment on only 80% of SAIF deposits held at that date. That legislation also
required that BIF members begin to share the cost of prior thrift failures. As a
result of the recapitalization of the SAIF and this cost sharing between BIF and
SAIF members, FDIC assessments for healthy institutions during 1997 have been
set at $.013 per $100 in BIF deposits and $.064 per $100 in SAIF deposits. The
recapitalization plan also provides of the merger of the BIF and the SAIF
effective January 1, 1999, assuming there are no savings associations under
federal law. Under separate proposed legislation, Congress is considering the
elimination of the federal thrift charter. BKFC cannot predict the impact of
such legislation and the merger of the BIF and the SAIF on BKFC or the Bank
until the legislation is enacted and the funds are merged.
