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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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(Mark One) FORM 10-KSB
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 1998
[_] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
Commission File No. 1-13904
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KENTUCKY FIRST BANCORP, INC.
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(NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
Delaware 61-1281483
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(State or other jurisdiction (I.R.S. employer
of incorporation or organization) identification no.)
306 North Main Street, Cynthiana, Kentucky 41031-1210
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(Address of principal executive offices) (Zip Code)
ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE: (606) 234-1440
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE AMERICAN STOCK EXCHANGE
- -------------------------------------- -----------------------------
(Title of Class) (Name of Exchange on Which
Registered)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NOT APPLICABLE
Check whether the issuer: (1) filed all reports required by Section 13 or 15(d)
of the Exchange Act during the preceding 12 months (or such shorter period that
the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No _______
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Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will 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-KSB or any
amendment to this Form 10-KSB. [ ]
Registrant's revenues for the fiscal year ended June 30, 1998: $6,423,000
As of September 10, 1998, the aggregate market value of the 1,004,664 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $13,939,713 based on the closing sales price of
$13.875 per share of the registrant's Common Stock on September 10, 1998 as
listed on the American Stock Exchange. For purposes of this calculation, it is
assumed that directors, executive 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 10, 1998:
1,212,005
Transitional Small Business Disclosure Format Yes ________ No X
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DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and the Part of the
Form 10-KSB into which the document is incorporated:
1. Portions of Proxy Statement for the 1998 Annual Meeting of
Stockholders. (Part III)
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
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GENERAL
The Company. Kentucky First Bancorp, Inc. (the "Company"), a Delaware
corporation, was organized at the direction of the Board of Directors of First
Federal Savings Bank, Cynthiana, Kentucky ("First Federal" or the "Bank") in
April 1995 to acquire all of the capital stock to be issued by the Bank in its
conversion from mutual to stock form (the "Conversion"). The Conversion was
completed August 28, 1995, with the Company issuing 1,388,625 shares of its
common stock, par value $0.01 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 the Conversion, the Company did not engage in any material operations.
The Company does not have any significant assets other than the outstanding
capital stock of the Bank, cash and investment securities and a note receivable
from the ESOP. The Company's principal business is the business of the Bank.
At June 30, 1998, the Company had total assets of $82.0 million, deposits of
$56.6 million, net loans receivable of $48.8 million and shareholders' equity of
$14.4 million.
The Bank. First Federal was formed in 1888 under the name of Cynthiana
Building & Saving Association. In 1966 the Bank converted to a federally-
chartered savings and loan association and adopted the name of First Federal
Savings and Loan Association of Cynthiana. The Bank converted to a federally
chartered savings bank under the name of First Federal Savings Bank in January
1988. The Bank operates two offices in Cynthiana, Kentucky. The Bank is
principally engaged in the business of accepting deposits from the general
public through a variety of deposit programs and investing these funds by
originating and purchasing loans secured by one- to four-family residential
properties located in its market area, construction loans, commercial and multi-
family mortgage loans, agricultural loans, commercial business loans and
consumer loans.
First Federal's business strategy is to operate a well capitalized,
profitable community savings association dedicated to financing home ownership
in its market area and providing quality service to its customers. The Bank's
deposits are insured by the Federal Deposit Insurance Corporation ("FDIC") up to
applicable limits for each depositor. The Bank is a member of the Federal Home
Loan Bank ("FHLB") of Cincinnati, which is one of the 12 district banks
comprising the FHLB System. The Bank is subject to comprehensive examination,
supervision and regulation by the OTS and the FDIC. Such regulation is intended
primarily for the protection of depositors.
Both the Company's and First Federal's executive offices are located at 306
North Main Street, Cynthiana, Kentucky 41031-1210, and its telephone number is
(606) 234-1440.
MARKET AREA
The Bank considers its primary market area to consist of the eight counties
of Harrison, Pendleton, Scott, Grant, Robertson, Nicholas, Bourbon and Fayette
Counties, Kentucky. Management believes that most of the Bank's depositors and
borrowers are residents of these counties. The City of Cynthiana is located in
Harrison County which is the economic hub of the seven-county area, excluding
Fayette. Cynthiana is located 26 miles north of Lexington, Kentucky, 100 miles
east of Louisville, Kentucky and 80 miles south of Cincinnati, Ohio. Based upon
the 1990 population census, Cynthiana had a population of 6,100 and
approximately 16,000 persons lived in Harrison County.
The economy in the Bank's market area is based on a mixture of
manufacturing and agriculture. Other employment is provided by a variety of
professionals, service employers, manufacturing industries, wholesale/retail
trade employers including 3M, Grede Perm Cast (a division of Grede Foundries),
Bullard Manufacturing, Bundy Tubing, Southland Container Concept Packaging
Group, Trinity Industries, TR Technologies, FICO and SNAPCO. The Licking Valley
Center of Maysville Community College is also located in Cynthiana with an
enrollment of approximately 300 students.
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According to the US Bureau of Labor Statistics, the unemployment rate in
Harrison County as of June 30, 1998 was 3.4% as compared to 4.5% for the
Commonwealth of Kentucky.
LENDING ACTIVITIES
General. First Federal's primary lending activity is the origination and
purchase of conventional mortgage loans for the purpose of constructing,
purchasing or refinancing one- to four-family residential properties in its
primary market area. The Bank also makes construction loans and originates
loans secured by multi-family properties, commercial properties and originates
commercial, farm and consumer loans. In recent years, the Bank has purchased
whole loans and participation interests in loans secured by one- to four-family
properties and commercial and multi-family real estate. Such loans are
originated and serviced by an unaffiliated mortgage broker.
Savings institutions generally are subject to the lending limits applicable
to national banks. With certain limited exceptions, the maximum amount that a
savings institution or a national bank may lend to any borrower (including
certain related entities of the borrower) at one time may not exceed 15% of the
unimpaired capital and surplus of the institution, plus an additional 10% of
unimpaired capital and surplus for loans fully secured by readily marketable
collateral. Savings institutions are additionally authorized 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:
(i) the purchase price of each single-family dwelling in the development does
not exceed $500,000; (ii) the savings institution is in compliance with its
fully phased-in capital requirements; (iii) the loans comply with applicable
loan-to-value requirements, and; (iv) the aggregate amount of loans made under
this authority does not exceed 15% of unimpaired capital and surplus.
At June 30, 1998, the maximum amount that the Bank could have loaned to any
one borrower without prior OTS approval was $1.9 million. At such date, the
largest aggregate amount of loans that the Bank had outstanding to any one
borrower was approximately $1.6 million.
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Loan Portfolio Composition. The following table sets forth selected data
relating to the composition of the Bank's loan portfolio by type of loan at the
dates indicated. At June 30, 1998, the Bank had no concentrations of loans
exceeding 10% of total loans that are not otherwise disclosed below.
<TABLE>
<CAPTION>
At June 30,
----------------------------------
1998 1997
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Amount % Amount %
------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Type of Loan:
- ------------
Real estate loans:
One- to four-family residential and construction (1).. $27,827 56.18% $27,052 54.56%
Multi-family residential.............................. 5,332 10.75 5,972 12.04
Agricultural.......................................... 5,631 11.37 5,726 11.55
Commercial............................................ 6,276 12.67 5,829 11.75
------- ------ ------- ------
Total real estate loans............................ 45,066 90.97 44,579 89.90
Commercial loans........................................ 915 1.85 1,069 2.16
Agricultural operating loans............................ 908 1.83 1,025 2.06
Consumer loans:
Automobiles........................................... 373 .75 296 .60
Mobile home........................................... 150 .30 196 .40
Savings account....................................... 1,043 2.11 947 1.91
Other................................................. 1,073 2.19 1,471 2.97
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Total consumer loans............................... 2,639 5.35 2,910 5.88
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Total loans........................................ 49,528 100.00% 49,583 100.00%
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Less:
Loans in process...................................... 232 143
Deferred loan fees.................................... 86 94
Unearned discount..................................... 25 54
Allowance for loan losses............................. 384 372
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Loans receivable, net.............................. $48,801 $48,920
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</TABLE>
__________________________
(1) At June 30, 1998, constructions loans amounted to $1.2 million and
represented 2.5% of total gross loans.
Loan Maturity Schedule. The following table sets forth certain information
at June 30, 1998 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, including scheduled
repayments of principal. 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 Within Due 1-5
1 Year Years Due After 5
After After Years After
6/30/98 6/30/98 6/30/98 Total
-------- -------- -------- -------
(In thousands)
<S> <C> <C> <C> <C>
Real estate mortgage.. $ 615 $ 2,150 $ 42,301 $45,066
Consumer.............. 2,305 276 58 2,639
Commercial............ 1,821 2 -- 1,823
-------- -------- -------- -------
Total............ $ 4,741 $ 2,428 $ 42,359 $49,528
======== ======== ======== =======
</TABLE>
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The following table sets forth at June 30, 1998, the dollar amount of
all loans due one year or more after June 30, 1998 which have (i) predetermined
interest rates and (ii) floating or adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rates Adjustable Rates
------------- ----------------
(In thousands)
<S> <C> <C>
Real estate mortgage.. $25,485 $18,966
Consumer.............. 334 --
Commercial............ 2 --
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Total............... $25,821 $18,966
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</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. In
addition, the Bank's mortgage loans generally give First Federal the right to
declare a loan due and payable in the event, among other things, that a borrower
sells the real property subject to the mortgage and the loan is not repaid.
One- to Four-Family Real Estate Loans. The primary emphasis of the
Bank's lending activity is the origination of loans secured by first mortgages
on one- to four-family residential properties. At June 30, 1998, $27.8 million,
or 56.2% of the Bank's gross loan portfolio consisted of loans secured by one-
to four-family residential real properties primarily located in the Bank's
market area.
The Bank originates both fixed rate and adjustable rate mortgage loans
("ARMs") with terms of up to 30 years. In late March 1995, the Bank changed the
index used to the weekly average yield on U.S. Treasury Securities adjusted to a
Constant Maturity of One Year. The interest rates on these mortgages are
adjusted annually with a limitation of two percentage points per adjustment and
six percentage points over the life of the loan. The minimum rate on such loans
is 5%. Prior to March 1995, some of First Federal's adjustable rate loans were
indexed to the National Monthly cost of funds rate to SAIF-Insured Institutions.
The Bank's lending policies generally limit the maximum loan-to-value
ratio on mortgage loans to 85% of the lesser of the appraised value or purchase
price of the property. The Bank recently began offering mortgage loans up to
95% of the appraised value of the underlying property for single and two family
dwellings only that are located in Harrison County. Private mortgage insurance
is required.
The retention of ARMs in the portfolio helps reduce First Federal's
exposure to increases in interest rates. However, there are unquantifiable
credit risks resulting from potential increased costs to the borrower as a
result of repricing of ARMs. It is possible that during periods of rising
interest rates, the risk of default on ARMs may increase due to the upward
adjustment of interest costs to the borrower. Although ARMs allow First Federal
to increase the sensitivity of its asset base to changes in interest rates, the
extent of this interest sensitivity is limited by the periodic and lifetime
interest rate ceiling contained in ARM contracts. Accordingly, there can be no
assurance that yields on First Federal's ARM's will adjust sufficiently to
compensate for increases in its cost of funds.
Multi-family and Commercial Real Estate Loans. The Bank has been
active in the origination and purchase of loans secured by commercial real
estate and multi-family properties. At June 30, 1998, multi-family and
commercial real estate loans totaled $5.3 million and $6.3 million,
respectively, and represented 10.8% and 12.7%, respectively, of the Bank's gross
loan portfolio.
Multi-family and commercial real estate loans are made in amounts of
up to 80% of the appraised value of the property and may be on a fixed or
adjustable rate basis for terms of up to 30 years. Prior to committing to make
a multi-family or commercial real estate loan, the Bank requires that the
prospective borrower provide a cash flow statement
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indicating sufficient cash flow from the property to service the loan. The Bank
reviews any tenant leases and requires that the payments under such leases be
assigned to the Bank.
The Bank's multi-family real estate loans consist primarily of loans
secured by apartment buildings which are primarily located in the Bank's market
area. Generally, these apartment buildings are small with an average of eight
to twelve units. The Bank's largest multi-family property loan amounted to
$724,000 at June 30, 1998 and was secured by 10 triplex/duplex units.
The Bank's commercial real estate portfolio consists of loans secured
by office buildings, nursing homes, warehouse properties and churches. The
Bank's largest commercial real estate loan is secured by a nursing home located
in Butler, Kentucky. Such loan had a balance of $631,000 at June 30, 1998.
Multi-family and commercial real estate lending entails significant
additional risks as compared to one-to four-family residential lending. Such
loans typically involve large loans to single borrowers or related borrowers.
At June 30, 1998, the average size of the Bank's multi-family and commercial
real estate loans was $151,000 as compared to the average size of residential
real estate loans which was $41,000. Such loans also involve a greater
repayment risk as repayment is typically dependent on the successful operation
of the project such that the income generated by the project is sufficient to
cover operating expenses and debt service, and these risks can be significantly
affected by the supply and demand conditions in the market for commercial
property and multi-family residential units. In addition, commercial real
estate is more likely to be subject to some form of environmental contamination.
The Bank is now pricing multi-family and commercial loans it originates 60 to
100 basis points above the single-family loan rate to compensate the Bank for
these additional risks.
Construction Loans. First Federal engages in construction lending
involving loans to qualified borrowers for construction of one- to four-family
residential properties. Such loans convert to permanent financing upon
completion of construction. These properties are primarily located in the
Bank's market area. At June 30, 1998, the Bank's loan portfolio included $1.2
million of loans secured by properties under construction. All construction
loans are secured by a first lien on the property under construction. Loan
proceeds are disbursed in three increments as construction progresses and as
inspections warrant. Construction/permanent loans may have either an adjustable
or fixed rate and are underwritten in accordance with the same terms and
requirements as the Bank's permanent mortgages, except the loans generally
provide for disbursement in stages during a construction period of up to six
months. Interest is billed monthly during the construction phase. Monthly
principal and interest payments commence when the loan is converted to permanent
financing. Borrowers must satisfy all credit requirements which would apply to
the Bank's permanent mortgage loan financing for the subject property.
Construction financing generally 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 or development and the estimated cost (including interest) of
construction. 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, the Bank may be required to advance funds beyond the amount
originally committed to permit completion of the development. If the estimate
of value proves to be inaccurate, the Bank may be confronted, at or prior to the
maturity of the loan, with collateral having a value which is insufficient to
assure full repayment. The Bank has sought to minimize this risk by limiting
construction lending to qualified borrowers (i.e., borrowers who satisfy all
credit requirements and whose loans satisfy all other underwriting standards
which would apply to the Bank's permanent mortgage loan financing for the
subject property) in the Bank's market area.
The Bank makes a limited number of construction loans to contractors
to finance the construction of residential properties on a speculative basis.
The largest such loan had an outstanding balance of $571,000 as of June 30, 1998
and was secured by seven single family homes with an aggregate appraised value
of $784,000. Terms of such loans provide that the Bank receives sufficient
proceeds from the sale of individual properties in the project to satisfy the
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mortgage on that particular property. Certain of these construction loans were
originated by an outside broker and purchased by the Bank. The broker continues
to service the loans for the Bank including performing inspections and
authorizing all draws under the construction loan.
The Bank also makes a limited number of construction loans to finance
the construction of commercial and multi-family real estate.
Consumer Loans. The consumer loans originated by the Bank include
automobile loans, savings account loans and unsecured loans. The Bank's loan
portfolio includes loans secured by mobile homes although the Bank no longer
originates such loans. The Bank's automobile loans are generally underwritten
in amounts up to 80% of the lesser of the purchase price of the automobile or
the loan value as published by the National Automobile Dealers Association. The
terms of such loans do not exceed 60 months. The Bank requires that the
vehicles be insured and the Bank be listed as loss payee on the insurance
policy. The Bank makes savings account loans for terms of up to the lesser of
six months or the maturity date of the certificate, securing the loan for up to
100% of the face amount of the certificate or the balance in the savings
account. The interest rate charged on these loans is normally two percentage
points above the rate paid on the certificate account and the account must be
pledged as collateral to secure the loan. At June 30, 1998, the Bank's consumer
loans totaled $2.6 million, or 5.4% of the Bank's gross loan portfolio.
Consumer loans tend to be originated at higher interest rates than
mortgage loans and for shorter terms. However, consumer loans generally involve
more risk than one- to four-family residential real estate loans. Repossessed
collateral for a defaulted loan may not provide an adequate source of repayment
of the outstanding loan balance as a result of damage, loss or depreciation, and
the remaining deficiency often does not warrant further substantial collection
efforts against the borrower. In addition, loan collections are dependent on
the borrower's continuing financial stability, and thus are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Further, the application of various state and federal laws, including federal
and state bankruptcy and insolvency law, may limit the amount which may be
recovered. In underwriting consumer loans, the Bank considers the borrower's
credit history, an analysis of the borrower's income and ability to repay the
loan, and the value of the collateral. The Bank's risks associated with
consumer loans have been further limited by the modest amount of consumer loans
made by the Bank.
Agricultural Loans. The Bank originates agricultural loans both for
the purchase or refinance of agriculture-related real estate and for operating
purposes. At June 30, 1998, the Bank had $5.6 million in agricultural real
estate loans, or 11.7% of its gross loan portfolio, and $908,000 in agricultural
operating loans, or 1.8% of the Bank's gross loan portfolio.
Agricultural real estate loans are primarily secured by first liens on
farmland or buildings thereon located in the Bank's market area. Loans are
generally underwritten in amounts of up to 65% of the lesser of the appraised
value or the fair market value of the property on loans secured by farm land and
80% of the lesser of the appraised or fair market value on loans secured by farm
buildings. Such loans may be underwritten on either a fixed rate or an
adjustable rate basis with a term of up to 30 years. In originating an
agricultural real estate loan, the Bank considers the debt service coverage of
the borrower's cash flow and the appraised value of the underlying property.
The average size of an agricultural real estate loan originated by the Bank is
approximately $52,000.
Agricultural operating loans are made to finance the acquisition of
farm equipment, seed, fertilizer, cattle feed and other operating expenses of a
farm over the course of a year. As with agricultural real estate loans, the
Bank has been making these types of loans to satisfy the demand in its market
area. Because such loans are made to finance a farm's annual operations, the
terms of agricultural operating loans do not exceed one year and are at a fixed
rate. Interest payments are made at least semi-annually and the rate may be
changed semi-annually in accordance with market rates.
In underwriting agricultural operating loans, the Bank considers the
cash flow of the borrower based upon the farm's income stream as well as the
value of collateral used to secure the loan. Collateral generally consists of
the cash crops produced by the farm, predominantly tobacco in the Bank's market
area, and cattle. The Bank requires that the
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borrowers provide evidence of hazard insurance on any equipment that will be
collateral. Representatives of the Bank inspect such collateral on a periodic
basis. In certain instances, the Bank may also take a lien on real estate as
additional collateral for an agricultural operating loan. In such instances, the
Bank generally requires that an appraisal of the real estate by a certified
appraiser be performed, if the loan is in excess of $100,000. For loans of less
than $100,000, as circumstances warrant, the appraisal may be performed by the
Executive Committee.
Agricultural real estate and operating loans involve a greater degree
of risk as payments on such loans depend, to a large degree, on the results of
operation of the related farm. In addition, agricultural operating loans are
generally made at the beginning of the growing season and are secured by the
crops, primarily tobacco, not yet grown. The ultimate value of the collateral
depends on the grade of tobacco produced and the prevailing price for that grade
at the time the tobacco is sold. As neither the grade of the tobacco nor the
market price to be obtained at the time of sale can be determined with certainty
at the inception of the loan, there is a risk that the ultimate value of the
collateral securing an agricultural operating loan may be significantly less
than the principal balance owed.
Commercial Loans. The Bank originates a limited amount of commercial
loans to small and medium sized businesses located in its market area. At June
30, 1998, the Bank's commercial business loans amounted to $915,000, or 1.9% of
the Bank's gross loan portfolio.
Commercial loans are generally made to finance the purchase of
inventory, equipment and for short-term working capital. Such loans are
generally secured, although loans are sometimes granted on an unsecured basis.
Commercial business loans are generally written for a term of one year or less
although may be renewed by the Bank at maturity. Interest payments are made at
least semi-annually and the rate may be changed semi-annually in accordance with
market rates.
Commercial loans involve a greater degree of risk than other types of
lending as payments on such loans are often dependent on successful operation of
the business involved which may be subject to a greater extent to adverse
conditions in the economy. The Bank seeks to minimize this risk through its
underwriting guidelines, which require that the loan be supported by adequate
cash flow of the borrower, profitability of the business and collateral.
Loan Solicitation and Processing. Loan originations are derived from
a number of sources, including walk-in customers and referrals by realtors,
depositors and borrowers.
Upon receipt of a loan application from a prospective borrower, a
credit report and employment and other verifications are ordered to verify
specific information relating to the loan applicant's employment, income and
credit standing. An appraisal of the real estate intended to secure the
proposed loan is undertaken by an independent, state certified, appraiser
approved by the Bank's Board of Directors for loans in excess of $100,000. For
loans of $100,000 and less, as circumstances warrant, an evaluation may be
performed by the Executive Committee of the Bank's Board of Directors.
Typically, an independent appraiser is utilized.
All one- to four-family mortgage loans in excess of $125,000 are
subject to the approval of a majority of the Bank's Board of Directors. Loans
on this type of property in an amount of $125,000 or less may be approved by a
Bank loan officer. Approval authority limits for each loan officer are
determined by the Bank's Board of Directors for each type of loan.
Commercial real estate loans over $100,000 must be approved by a
majority of the Bank's Board of Directors. Loans of $100,000 and less may be
approved by a majority of the Executive Committee of the Board of Directors or a
loan officer with that approval authority.
Secured business loans (other than real estate) require the approval
of a majority of the Board of Directors for loan amounts in excess of $150,000.
Loans in excess of $40,000 up to $150,000 may be approved by a majority of the
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Executive Committee. Loans of $40,000 and less may be approved by certain Bank
Loan Officers as authorized by the Board of Directors.
Unsecured loans in an amount exceeding $40,000 must be approved by a
majority of the Board of Directors. Loans in excess of $10,000 up to $40,000
may be approved by a majority of the Executive Committee. Loans of $10,000 and
less may be approved by certain Bank loan officers as authorized by the Board of
Directors.
Secured consumer loans in excess of $150,000 require the approval of a
majority of the Board of Directors. Loans in excess of $40,000 up to $150,000
may be approved by the Executive Committee. Loans of $40,000 and less may be
approved by certain Bank loan officers as authorized by the Board of Directors.
Home equity lines of credit require the approval of a majority of the
Board of Directors for loan amounts in excess of $125,000. Loans for $125,000
and less may be approved by a majority of the Executive Committee or certain
loan officers as authorized by the Board of Directors.
Fire and casualty and earthquake insurance, as well as flood
insurance, are required for all loans as appropriate, and a title opinion is
required for loans secured by real estate.
Originations and Purchases of Loans. The Bank's loans are primarily
originated by salaried loan officers of the Bank. In addition, the Bank has
purchased one-to four-family mortgage loans from various sources in the Bank's
market area and has purchased a number of whole loans and participation
interests in loans from an established mortgage broker headquartered in
Lexington, Kentucky. Historically, the Bank has not originated any loans for
sale in the secondary market. The Bank expects to apply to become an eligible
seller/servicer. There can be no guarantee, however, that the Bank will be
approved.
The Bank purchases loans to supplement its lending activities during
periods of low loan demand. The Bank has purchased one- to four-family loans
from various institutions and an unaffiliated mortgage broker, located in
Lexington, Kentucky. These loans are primarily secured by real estate located
in and around Lexington, Kentucky and continue to be serviced by the sellers.
In addition, the Bank has purchased whole loans and a limited number of
participation interests in a variety of commercial real estate and multi-family
real estate loans. These loans are originated by the unaffiliated mortgage
broker headquartered in Lexington, Kentucky and are secured by properties which
are primarily located in and around Lexington Kentucky. The mortgage broker
does not retain any ownership interest in the loans purchased by the Bank,
although the broker receives a fee for servicing the loans. As of June 30,
1998, the Bank had purchased from this broker participation interests in four
loans with outstanding balances as of that date totaling $1.8 million, or 3.7%
of total gross loans and had purchased whole loans totaling $4.1 million, or
8.4% of total gross loans. Thirteen of these loans or participation interests
aggregating $3.4 million, or 7.0% of total gross loans at June 30, 1998, were
secured by commercial or multi-family real estate. The Bank has also purchased
some participation loans from a local financial institution. These
participation loans are in an aggregate amount of $1.3 million or 2.7% of total
gross loans at June 30, 1998. These participation loans were secured by
duplexes and triplexes.
With respect to purchased multi-family and commercial loans, the Bank
reviews certain financial and property information provided to the Bank by the
broker prior to determining to approve the loan. Generally, the Bank's
Executive Committee also visits the property which will secure the loan. In the
case of purchased construction loans, a representative of the broker performs
inspections on the property and informs the Bank when additional advances are
warranted.
Generally, in addition to the risks associated with the specific type
of loan purchased, the purchase of loans involves certain additional risks
resulting from the Bank's lower level of control over the origination and
subsequent administration of the loans. In addition, certain of the loans
purchased by the Bank in the past do not conform to the Bank's current
underwriting standards. In January, 1995, the Bank implemented a policy (and
informed the mortgage broker in this regard) that prior to its consideration of
any future loan purchases, the Bank will require a detailed
9
<PAGE>
description of the proposed terms of the loan, copies of all applicable
financial statements, tax returns and credit reports, a current appraisal on the
property securing the proposed loan, occupancy information and copies of all
underlying leases, if applicable, and a signed application. If the proposed loan
is to be a construction loan, the Bank will also require all cost estimates and
must receive inspection certificates and lien waivers prior to making any
disbursements under the loan. The Bank will also require updated financial
information at least annually on all outstanding commercial and multi-family
real estate loans or participations.
Interest Rates and Loan Fees. Interest rates charged by the Bank on
mortgage loans are primarily determined by competitive loan rates offered in its
market area. Mortgage loan rates reflect factors such as general 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.
In addition to the interest earned on loans, the Bank receives fees in
connection with loan commitments and originations, late payments and fees for
miscellaneous services related to its loans. The Bank charges an origination
fee for its adjustable rate mortgage loans and fixed rate mortgage loans.
Asset Classification and Allowance for Loan Losses. Federal
regulations require savings associations to review their assets on a regular
basis and to classify them as "substandard," "doubtful" or "loss," if warranted.
Assets classified as substandard or doubtful require the institution to
establish general allowances for loan losses. If an asset or portion thereof is
classified loss, the insured institution must either establish specified
allowances for loan losses in the amount of 100% of the portion of the asset
classified loss, or charge off such amount. An asset which does not currently
warrant classification but which possesses weaknesses or deficiencies deserving
close attention is required to be designated as "special mention." Currently,
general loss allowances established to cover possible losses related to assets
classified substandard or doubtful may be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses do not qualify as regulatory capital. See "Regulation of the Bank --
Regulatory Capital Requirements." OTS examiners may disagree with the insured
institution's classifications and amounts reserved. If an institution does not
agree with an examiner's classification of an asset, it may appeal this
determination to the OTS. Management of the Bank reviews assets on a quarterly
basis, and at the end of each quarter prepares an asset classification listing
in conformity with the OTS regulations, which is reviewed by the Board of
Directors. The Bank also makes quarterly inspections of all property securing
delinquent loans. At June 30, 1998 the Bank had $40,000 and $176,000 in assets
classified as special mention and substandard, respectively, $5,000 in assets
classified as doubtful, and had no assets classified as loss.
Included in the balance of substandard loans was a loan to an
individual secured by a commercial property which had a balance of $31,000 as of
June 30, 1998. Payments on this loan are approximately 17 months delinquent
although the Bank has received sporadic payments.
The remaining substandard loans consist primarily of loans secured by
one-to four-family properties.
In originating loans, the Bank recognizes that credit losses will be
experienced and that the risk of loss will vary with, among other things, the
type of loan being made, the creditworthiness of the borrower over the term of
the loan, general economic conditions and, in the case of a secured loan, the
quality of the security for the loan. It is management's policy to maintain an
adequate allowance for loan losses based on, among other things, the Bank's and
the industry's historical loan loss experience, evaluation of economic
conditions and regular reviews of delinquencies and loan portfolio quality. The
Bank increases its allowance for loan losses by charging provisions for loan
losses against the Bank's earnings.
General allowances are made pursuant to management's assessment of
risk in the Bank's loan portfolio as a whole. Specific allowances are provided
for individual loans when ultimate collection is considered questionable by
10
<PAGE>
management after reviewing the current status of loans which are contractually
past due and considering the net realizable value of the security for the loan.
Management also reviews individual loans for which full collectibility may not
be reasonably assured and evaluates among other things the net realizable value
of the underlying collateral. General allowances are included in calculating
the Bank's risk-based capital, while specific allowances are not so included.
Management continues to actively monitor the Bank's asset quality and to charge
off loans against the allowance for loan losses when appropriate or to provide
specific loss reserves when necessary. As of June 30, 1998, the Bank's
allowance for loan losses did not include any specific loss reserves.
The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------
1998 1997
---------- ---------
(In thousands)
<S> <C> <C>
Balance at beginning of period............. $ 372 $ 367
Charge-offs:
Real estate loans:
One- to four-family residential........ -- --
Multi-family residential............... -- --
Agricultural........................... -- --
Commercial and other................... -- --
Construction........................... -- --
Commercial loans......................... -- --
Agricultural operating loans............. -- --
Consumer loans:
Automobile............................. -- --
Savings account........................ -- --
Other consumer......................... 18 12
----- -----
Total:............................... 18 12
----- -----
Recoveries:
One- to four-family residential........ -- --
Multi-family residential............... -- --
Agricultural........................... -- --
Commercial and other................... -- --
Construction........................... -- --
Commercial loans......................... -- --
Agricultural operating loans............. -- --
Consumer loans:
Automobile............................. -- --
Savings account........................ -- --
Other consumer......................... -- 2
----- -----
Total:............................... -- 2
Net charge-offs............................ 18 10
----- -----
Provision for losses on loans.............. 30 15
----- -----
Balance at end of period................... $ 384 $ 372
===== =====
Ratio of net charge-offs to average loans
outstanding during the period............ .04% .02%
===== =====
</TABLE>
11
<PAGE>
The following table sets forth the breakdown of the allowance for loan
losses by loan category at the dates indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. 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>
At June 30,
----------------------------------------------
1998 1997
---------------------- ----------------------
Percent of Percent of
Loans in Each Loans in Each
Category to Category to
Amount Total Loans Amount Total Loans
------ -------------- ------ --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate - mortgage:
One- to four-family residential and construction.. $151 56.17% $151 53.42%
Multi-family residential.......................... -- 10.76 -- 12.04
Agricultural...................................... -- 11.34 -- 11.55
Commercial........................................ 176 12.27 176 11.69
Commercial loans.................................... 6 1.85 6 3.47
Agricultural operating loans........................ 31 1.86 31 2.06
Consumer loans:
Automobiles....................................... -- 0.75 -- 0.59
Mobile homes...................................... -- 0.30 -- 0.34
Savings account................................... -- 2.11 -- 1.91
Other consumer loans.............................. 20 2.19 8 2.93
---- ------ ---- ------
Total allowance for loan losses................. $384 100.00% $372 100.00%
==== ====== ==== ======
</TABLE>
Non-Performing Loans and Other Problem Assets. Management reviews the
Bank's loans on a regular basis. Loans are placed on a non-accrual status when,
in the opinion of management, the collection of additional interest is doubtful.
Real estate acquired by the Bank as a result of foreclosure is
classified as real estate owned until such time as it is sold. When such
property is acquired, it is recorded at its fair value less estimated costs of
sale. Any required write-down of the loan to its appraised fair market value
upon foreclosure is charged against the allowance for loan losses. Subsequent
to foreclosure, in accordance with generally accepted accounting principles, a
valuation allowance is established if the carrying value of the property exceeds
its fair value net of related selling expenses.
12
<PAGE>
The following table sets forth information with respect to the Bank's
non-performing assets at the dates indicated. No loans were recorded as
restructured loans within the meaning of Statement of Financial Accounting
Standard ("SFAS") No. 114 at the dates indicated. In addition, the Bank had no
real estate acquired as a result of foreclosure.
<TABLE>
<CAPTION>
At June 30,
-----------------------
1998 1997
-------- --------
(Dollars in thousands)
<S> <C> <C>
Loans accounted for on a non-accrual basis: (1)
Real Estate:
One- to four-family residential and construction.. $ -- $ --
Multi-family residential.......................... -- --
Agricultural...................................... -- --
Commercial........................................ 31 34
Commercial loans.................................... -- --
Agricultural operating loans........................ -- --
Consumer............................................ -- --
----- -----
Total............................................ 31 34
----- -----
Accruing loans which are contractually past due
90 days or more:
Real estate:
One- to four-family residential and construction.. 104 25
Multi-family residential.......................... -- --
Agricultural...................................... -- --
Commercial........................................ -- --
Commercial loans.................................... -- --
Agricultural operating loans........................ -- --
Consumer............................................ 6 --
----- -----
Total............................................ 110 25
----- -----
Total non-performing loans............................ $ 141 $ 59
===== =====
Total non-performing loans as a percentage
of total net loans.................................. .29% .12%
===== =====
Total non-performing assets as a percentage
of total assets..................................... .17% .07%
===== =====
</TABLE>
- -------------------------
(1) Non-accrual status denotes loans on which, in the opinion of management,
the collection of additional interest is unlikely. Payments received on a
non-accrual loan are either applied to the outstanding principal balance
or recorded as interest income, depending on assessment of the
collectibility of the loan.
Loans generally are placed on non-accrual status when they become 90 days
past due unless they are well secured and in the process of collection. During
the year ended June 30, 1998, gross interest income of $3,000 would have been
recorded on loans accounted for on a non-accrual basis if the loans had been
current throughout the respective periods. Interest income recognized on such
loans during the year ended June 30, 1998, totaled approximately $2,323.
Accruing loans which were contractually past due 90 days or more at June 30,
1998 totaled $110,000 and consisted primarily of one- to four-family real
estate loans at June 30, 1998. See " -- Asset Classification and Allowance for
Loan Losses."
13
<PAGE>
At June 30, 1998, the Bank did not have any loans not classified as on-
accrual, 90 days past due or restructured but 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
and may result in disclosure as non-accrual, 90 days past due or restructured.
INVESTMENT ACTIVITIES
First Federal is permitted under federal law to make certain investments,
including investments in securities issued by various federal agencies and state
and municipal governments, deposits at the FHLB of Cincinnati, certificates of
deposits in federally insured institutions, certain bankers' acceptances and
federal funds. The Bank 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 the Bank 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."
The Bank invests in investment securities in order to diversify its assets,
manage cash flow, obtain yield and maintain the minimum levels of liquid assets
required by regulatory authorities. The investment activities of the Bank
consist primarily of investments in mortgage-backed and related securities and
other investment securities, consisting primarily of securities issued or
guaranteed by the U.S. Government or agencies thereof. The Bank's investment
securities include obligations of the Commonwealth of Kentucky and political
subdivisions thereof. The Bank generally does not invest in obligations of
states other than Kentucky. Such municipal securities are not guaranteed by any
third party. The Bank has also invested in structured notes issued by the FHLB,
as discussed below. Investment decisions generally are made by the Investment
Committee consisting of three directors of the Bank and later ratified by the
full Board of Directors.
Mortgage-Related Securities. The Company invests in mortgage-related
securities such as collateralized mortgage obligations ("CMOs") and real estate
mortgage investment conduits ("REMICs"), primarily as an alternative to mortgage
loans or mortgage-backed securities. CMOs and REMICs are typically issued by a
special purpose entity, which may be organized in a variety of legal forms, such
as a trust, a corporation or a partnership. The entity aggregates pools of
pass-through securities, which are used to collateralize the mortgage-related
securities. Once combined, the cash flows can be divided into "tranches" or
"classes" of individual securities, thereby creating more predictable average
lives for each security than the underlying pass-through pools. Accordingly,
under this security structure, all principal paydowns from the various mortgage
pools are allocated to a mortgage-related securities' class or classes
structured to have priority until it has been paid off.
Some mortgage-related securities instruments are like traditional debt
instruments due to their stated principal amounts and traditionally defined
interest rate terms. Purchasers of certain other mortgage-related securities
instruments are entitled to the excess, if any, of the issuer's cash inflows.
These mortgage-related securities instruments may include instruments designated
as residual interest and are riskier in that they could result in the loss of a
portion of the original investment. Cash flows from residual interests are very
sensitive to prepayments and, thus, contain a high degree of interest rate risk.
The Bank does not purchase residual interests in mortgage-related securities.
At June 30, 1998, the Bank had $5.0 million in CMOs and REMICs, which
amounted to 6.1% of total assets. All of the CMOs and REMICs owned by the Bank
are insured or guaranteed either directly or indirectly through mortgage-backed
securities underlying the obligations of either FNMA or FHLMC. The CMOs and
REMICs owned by the Bank include both fixed and floating rate instruments.
Prepayments in the Bank's mortgage-related securities portfolio may be
affected by declining and rising interest rate environments. In a low and
declining interest rate environment, prepayments would be expected to increase.
In
14
<PAGE>
such an event, the Bank's fixed-rate CMOs and REMICs purchased at a premium
price could result in actual yields to the Bank that are lower than anticipated
yields. The Bank's floating rate CMOs and REMICs would be expected to generate
lower yields as a result of the effect of falling interest rates on the indexes
for determining payment of interest. Additionally, the increased principal
payments received may be subject to reinvestment at lower rates. Conversely, in
a period of rising rates, prepayments would be expected to decrease, which would
make less principal available for reinvestment at higher rates. In a rising
rate environment, floating rate instruments would generate higher yields to the
extent that the indexes for determining payment of interest did not exceed the
life-time interest rate caps. Such prepayment may subject the Bank's CMOs and
REMICs to yield and price volatility.
Mortgage-Backed Securities. The Company also invests in traditional
mortgage-backed securities. Mortgage-backed securities represent a
participation interest in a pool of single-family or multi-family mortgages, the
principal and interest payments on which are passed from the mortgage
originators through intermediaries that pool and repackage the participation
interest in the form of securities to investors such as the Bank. Such
intermediaries may include quasi-governmental agencies such as FHLMC, FNMA and
GNMA which guarantee the payment of principal and interest to investors.
Mortgage-backed securities generally increase the quality of the Company's
assets by virtue of the guarantees that back them, are more liquid than
individual mortgage loans and may be used to collateralize borrowings or other
obligations of the Bank.
Mortgage-backed securities typically are issued with stated principal
amounts and the securities are backed by pools of mortgages that have loans with
interest rates that are within a range and have similar maturities. The
underlying pool of mortgages can be composed of either fixed-rate or adjustable-
rate mortgage loans. Mortgage-backed securities generally are referred to as
mortgage participation certificates or pass-through certificates. As a result,
the interest rate risk characteristics of the underlying pool of mortgages,
i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are passed on
to the certificate holder. The life of a mortgage-backed pass-through security
is equal to the life of the underlying mortgages.
The actual maturity of a mortgage-backed security varies, depending on when
the mortgagors prepay or repay the underlying mortgages. Prepayments of the
underlying mortgages may shorten the life of the investment, thereby adversely
affecting its yield to maturity and the related market value of the mortgage-
backed security. The yield is based upon the interest income and the
amortization of the premium or accretion of the discount related to the
mortgage-backed security. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security, and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayments of the
underlying mortgages depend on many factors, including the type of mortgage, the
coupon rate, the age of the mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates. The difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates is an important
determinant in the rate of prepayments. During periods of falling mortgage
interest rates, prepayments generally increase, and, conversely, during periods
of rising mortgage interest rates, prepayments generally decrease. If the
coupon rate of the underlying mortgage significantly exceeds the prevailing
market interest rates offered for mortgage loans, refinancing generally
increases and accelerates the prepayment of the underlying mortgages.
Prepayment experience is more difficult to estimate for adjustable-rate
mortgage-backed securities.
The Company's mortgage-backed securities portfolio consists primarily of
seasoned fixed-rate mortgage-backed securities. At June 30, 1998, the Bank had
$17.9 million in mortgage-backed securities (representing 100% of the Bank's
gross mortgage-backed securities portfolio, or 21.8% of total assets), insured
or guaranteed by FNMA, FHLMC or GNMA.
Structured Notes. The Company has also invested in structured notes issued
by the FHLBs. These securities represent obligations of the FHLBs to repay
principal with interest that is either fixed or fluctuates in accordance with an
interest formula tied to various indices. Certain of these securities involve
certain risks not associated with investments in a conventional debt security.
If the interest rate on a note is indexed, the change in the interest rate may
15
<PAGE>
result in an interest rate that is less than that payable on a conventional
fixed rate debt security issued at the same time. Moreover, the secondary
market for such notes is affected by factors independent of the creditworthiness
of the issuer and the value of the index, including other interest rates, the
volatility of the index to which interest on the notes is tied, time remaining
to maturity, and the amount of such notes outstanding. The Company has
purchased its structured notes in an effort to increase the yield in its
investment portfolio.
The following table sets forth the carrying value of the Company's
investments at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
--------------------
1998 1997
------- --------
(In thousands)
<S> <C> <C>
Investment securities held to maturity:
U.S. government obligations............................ $ -- $ --
FHLB obligations....................................... 1,387 4,886
FHLMC notes............................................ 2,115 3,611
FNMA notes............................................. -- 996
Municipal obligations.................................. 1,660 2,240
------- -------
Total investment securities held to maturity........ 5,162 11,733
------- -------
Investment securities available for sale:
Tennessee Valley Authority bonds....................... -- 153
FHLB obligations....................................... 994 1,945
FHLMC notes............................................ 1,001 --
FNMA notes............................................. 501 --
Municipal obligations.................................. 2,111 104
------- -------
Total investment securities available for sale....... 4,607 2,202
------- -------
Total investment securities........................ $ 9,769 $13,935
======= =======
Mortgage-backed securities held to maturity:
FHLMC participation certificates....................... $ 1,287 $ 2,104
GNMA participation certificates........................ 1,527 2,043
FNMA participation certificates........................ 11,866 13,675
------- -------
Total mortgage-backed securities held
to maturity........................................ 14,680 17,822
------- -------
Mortgage-backed securities available for sale:
FHLMC participation certificates....................... 3,213 3,348
------- -------
Total mortgage-backed securities available for sale.. 3,213 3,348
------- -------
Total mortgage-backed securities..................... 17,893 21,170
Interest-earning deposits and certificates............... 1,435 762
------- -------
Total investments and mortgage-backed
securities:...................................... $29,097 $35,867
======= =======
</TABLE>
16
<PAGE>
The following table sets forth the scheduled maturities, carrying values,
market values and average yields for the Company's investment and mortgage-
backed securities, including those designated as available for sale at June 30,
1998.
<TABLE>
<CAPTION>
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:
U.S. obligations................... $ -- -- % $ -- -- % $ -- --%
FHLB obligations................. 391 5.52 984 5.62 995 6.55
FHLMC Notes...................... -- -- -- -- 2,115 7.04
FNMA notes....................... -- -- -- -- 500 6.58
State and municipal obligations.. 135 4.92 434 5.32 1,963 4.72
Mortgage-backed securities....... 3 11.75 252 6.56 3,336 6.58
Interest-earning deposits and
certificates of deposits....... 1,435 5.18 -- -- -- --
------ ------ ------
Total........................ $1,964 $1,670 $8,909
====== ====== ======
<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:
U.S. obligations................... $ -- -- $ -- $-- -- %
FHLB obligations................. -- -- 2,370 2,382 5.99
FHLMC Notes...................... 1,000 7.00 3,115 3,127 7.03
FNMA notes....................... -- -- 500 501 6.58
State and municipal obligations.. 1,222 5.92 3,754 3,808 5.19
Mortgage-backed securities....... 14,302 6.78 17,893 18,010 6.74
Interest-earning deposits and
certificates of deposits....... -- 1,435 1,435 5.18
Total........................ ------- ------- -------
$16,524 $29,067 $29,263
======= ======= =======
</TABLE>
17
<PAGE>
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
General. Deposits are the primary source of the Bank's funds for lending and
other investment purposes. In addition to deposits, First Federal derives funds
primarily from loan principal repayments, maturing investment securities, and
interest payments. Loan repayments and interest payments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by general interest rates and money market conditions.
Deposits. Deposits are attracted principally from within the Bank's primary
market area through the offering of a variety of deposit instruments, including
passbook and statement accounts and certificates of deposit currently ranging in
term from 91 days to five years. Deposit account terms vary, principally on the
basis of the minimum balance required, the time periods the funds must remain on
deposit and the interest rate. The Bank also offers individual retirement
accounts ("IRAs").
The Bank's policies are designed primarily to attract deposits from local
residents rather than to solicit deposits from areas outside its primary market.
Interest rates paid, maturity terms, service fees and withdrawal penalties are
established by the Bank on a periodic basis. Determination of rates and terms
are predicated upon funds acquisition and liquidity requirements, rates paid by
competitors, growth goals and federal regulations.
Certificates of deposit in amounts of $100,000 or more ("Jumbos"), totaled
$2.1 million, or 4.0% of the Bank's total savings portfolio at June 30, 1998.
The majority of these Jumbos represent deposits by individuals. This large
amount of Jumbos as a percentage of total deposits makes the Bank susceptible to
large deposit withdrawals if one or more depositors withdraw deposits from the
Bank. Such withdrawals may adversely affect the Bank's liquidity and funds
available for lending if the Bank was unable to obtain funds from alternative
sources. However, First Federal has no brokered funds, nor do these Jumbos
represent brokered funds.
Savings deposits in the Bank as of June 30, 1998 were represented by the
various types of savings programs described below.
<TABLE>
<CAPTION>
June 30, 1998
Interest Minimum Minimum Balance in Percentage of
Rate Term Category Amount Thousands Total Savings
- --------- --------- -------- --------- ------------ --------------
<S> <C> <C> <C> <C> <C>
2.97% None Passbook Savings $ 50 $ 6,034 10.67%
0.66 None Demand Checking 200 836 1.48
2.01 None NOW Accounts 400 4,511 7.97
2.10 None Super NOW Accounts 1,000 3,264 5.77
2.94 None Money Market Deposit Accounts 2,500 2,828 5.00
* 4.05 None First Money MMDA Accounts 10,000 1,419 2.51
2.96 None Christmas Clubs -- 55 .10
Certificates of Deposit
-----------------------
* 4.54 91 days 91-day Fixed Term, Fixed Rate 1,000 657 1.16
* 5.06 6 months 6 Month Fixed Term, Fixed Rate 1,000 5,443 9.62
* 5.47 1 year 1 Year, Fixed Term, Fixed Rate 1,000 10,960 19.38
* 5.71 18 months 18 Month Fixed Term, Fixed Rate 1,000 6,756 11.94
* 5.57 18 months IRA 18 Month Fixed Term, Fixed Rate 500 3,380 5.97
* 5.60 24 months 24 Month "Bump" ** 5,000 2,249 3.98
* 5.38 30 months 30 Month Fixed Term, Fixed Rate 1,000 432 .76
* 5.73 36 months 36 Month Fixed Term, Fixed Rate 1,000 3,066 5.42
* 5.75 36 months IRA 36 Month Fixed Term, Fixed Rate 500 95 .17
* 5.74 5 years 5 Year Fixed Term, Fixed Rate 1,000 4,082 7.22
* 6.00 5 years IRA 5 Year, Fixed Term, Fixed Rate 500 499 .88
------- ------
$56,566 100.00%
======= ======
</TABLE>
- -------------------------
* Represents weighted average interest rate.
** Certificate holder has option at any time during term of certificate to
request a one-time increase to then-prevailing 24 month certificate of
deposit rate.
18
<PAGE>
The following table sets forth, for the periods indicated, the average
balances and interest rates based on month-end balances for interest-bearing
demand deposits and time deposits.
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------------------------
1998 1997
---------------------------- ----------------------------
Interest-Bearing Interest-Bearing
Demand and Time Demand and Time
Savings Deposits Deposits Savings Deposits Deposits
----------------- --------- ----------------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Average balance.. $19,012 $36,468 $19,242 $35,785
Average rate..... 2.53% 5.44% 2.17% 5.20%
</TABLE>
The following table indicates the amount of the Bank's certificates of
deposit of $100,000 or more by time remaining until maturity as of June 30,
1998.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- --------------
(In thousands)
<S> <C>
Three months or less................ $ 857
More than three through six months.. 360
More than six through 12 months..... 258
Over 12 months...................... 601
------
Total......................... $2,076
======
</TABLE>
Borrowings. Savings deposits historically have been the primary source of
funds for the Bank's lending and investment activities and for its general
business activities. The Bank is authorized, however, to use advances from the
FHLB of Cincinnati to supplement its supply of lendable funds and to meet
deposit withdrawal requirements. Advances from the FHLB are secured by the
Bank's one-to-four-family mortgage loans.
The FHLB of Cincinnati functions as a central reserve bank providing credit
for savings institutions and certain other member financial institutions. As a
member, First Federal is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its home mortgages and other assets (principally, securities which are
obligations of, or guaranteed by, the United States) provided certain standards
related to creditworthiness have been met. See "Regulation of the Bank --
Federal Home Loan Bank System."
19
<PAGE>
The following table sets forth certain information regarding the Company's
FHLB advances and other borrowed money at the dates and for the periods
indicated.
<TABLE>
<CAPTION>
At or for the
Year Ended June 30,
------------------------
1998 1997
-------------- --------
<S> <C> <C>
(Dollars in thousands)
Amounts outstanding at end of period:
FHLB advances.................................. $10,412 $17,970
Weighted average rate paid on:
FHLB advances.................................. 5.85% 5.40%
<CAPTION>
For the Year
Ended June 30,
--------------------
1998 1997
------- -------
<S> <C> <C>
(Dollars in thousands)
Maximum amount of borrowings outstanding
at any month end:
FHLB advances and other borrowed money......... $18,669 $19,923
<CAPTION>
For the Year
Ended June 30,
---------------------
1998 1997
------- -------
<S> <C> <C>
(Dollars in thousands)
Approximate average borrowings outstanding
with respect to:
FHLB advances and other borrowed money......... $14,860 $18,043
Approximate weighted average rate paid on: (1)
FHLB advances and other borrowed money......... 5.71% 5.27%
</TABLE>
__________________
(1) Weighted average computed by dividing total interest paid by average
balance outstanding.
As of June 30, 1998, the Bank had $10.4 million in advances outstanding.
Further asset growth may be funded through additional advances.
SUBSIDIARY ACTIVITIES
As a federally chartered savings bank, the Bank is permitted to invest an
amount equal to 2% of its assets in subsidiaries, with an additional investment
of 1% of assets where such investment serves primarily community, inner-city and
community-development purposes. Under such limitations, as of June 30, 1998,
the Bank was authorized to invest up to $2.5 million in the stock of or loans to
subsidiaries, including the additional 1.0% investment for community inner-city
and community development purposes. The Bank has one wholly owned subsidiary:
Cynthiana Service Corporation, a Kentucky corporation, formed for the purpose of
holding the Bank's investments in data processing operations. At June 30, 1998,
the Bank's total investment in the subsidiary was $15,000. The operations of
Cynthiana Service Corporation are not consolidated with the operations of the
Bank as the subsidiary's operations were immaterial.
20
<PAGE>
PERFORMANCE RATIOS
The table below sets forth certain performance ratios of the Company at or
for the years indicated.
<TABLE>
<CAPTION>
At or for the
Year Ended June 30,
-----------------------
1998 1997
-------- --------
<S> <C> <C>
Return on assets (net earnings divided by
average total assets).............................. 1.07% 0.86%
Return on average stockholders' equity (net earnings
divided by average stockholders' equity)........... 6.35 5.15
Dividend payout ratio (dividends declared per share
divided by net earnings per share)................. 64.94 583.00 (1)
Interest rate spread (combined weighted average
interest rate earned less combined weighted
average interest rate cost)........................ 2.79 2.96
Ratio of average interest-earning assets to
average interest-bearing liabilities............... 118.15 116.83
Ratio of noninterest expense to average total assets.. 2.07 2.38
</TABLE>
___________
(1) During fiscal 1997 the Company paid a $3.00 per share return of capital
distribution.
COMPETITION
The Company experiences competition both in attracting and retaining savings
deposits and in the making of mortgage and other loans. Direct competition for
savings deposits and loans in Harrison County and the other counties in the
Company's market area comes from other savings institutions, credit unions,
commercial banks, money market mutual funds, brokerage firms and insurance
companies. Within Harrison County, the Bank is the only thrift institution
although there are branches of commercial banks and one loan production office
of a commercial bank. Although the Bank believes it ranks second in Harrison
County in terms of total deposits, one of its primary competitors may have
resources substantially greater than that of the Bank and can offer a wide
variety of deposit and loan products. The primary factors in competing for
loans are interest rates and loan origination fees and the range of services
offered by various financial institutions.
EMPLOYEES
As of June 30, 1998, the Company had 19 full-time employees, none of whom was
represented by a collective bargaining agreement. The Company believes that it
enjoys good relations with its personnel.
EXECUTIVE OFFICERS
The following sets forth information with respect to the executive officers of
the Company who do not serve on the Board of Directors.
<TABLE>
<CAPTION>
Age at
June 30,
Name 1998 Title
---- ------- -----
<S> <C> <C>
Russell Brooks 47 Executive Vice President
Kevin R. Tolle 41 Vice President, Secretary/Treasurer
Robbie G. Cox 51 Vice President and Financial Officer
</TABLE>
21
<PAGE>
RUSSELL M. BROOKS is Executive Vice President of the Company and the Bank.
Mr. Brooks assumed the positions in June, 1998. Prior to joining the Company,
he served as Vice President of Kentucky Bank, Paris, Kentucky from 1996 to 1998
and served as Chief Executive Officer of Jessamine First Federal Savings and
Loan, Nicholasville, Kentucky from 1989 until its acquisition by Kentucky Bank
in 1996. From 1984 to 1989, Mr. Brooks served as Chief Executive Officer of
Harlan Federal Savings and Loan.
KEVIN R. TOLLE is Vice President and Secretary/Treasurer of the Company and
Vice President and Secretary of the Bank. Mr. Tolle joined the Bank in 1975 as
a teller and was promoted to his current position in 1994. He has served as a
mortgage loan officer of the Bank since 1986. He is a member of the New
Friendship Baptist Church in Harrison County. He is a past member of the
Harrison County Habitat for Humanity, Cynthiana-Harrison County Jaycees, and the
Harrison County United Fund Board.
ROBBIE G. COX is Vice President and Financial Officer of the Company and
Vice President of the Bank, a position he has held since joining the Bank in
December 1986. From September 1992 to December 31, 1993 he also served as Chief
Executive Officer of the Bank and served as President and Chief Executive
Officer of the Bank from January 1994 to May 1994. Mr. Cox is a member and past
president of the Cynthiana Lions Club and Deacon at Cynthiana Christian Church.
REGULATION OF THE COMPANY
GENERAL. The Company is a savings and loan holding company within the
meaning of the Home Owners' Loan Act, as amended ("HOLA"). As such the Company
is registered with the OTS and is subject to OTS regulations, examinations,
supervision and reporting requirements. As a subsidiary of a savings and loan
holding company, the Bank is subject to certain restrictions in its dealings
with the Company and affiliates thereof.
ACTIVITIES RESTRICTIONS. The Board of Directors of the Company presently
operates the Company as a unitary savings and loan holding company. There are
generally no restrictions on the activities of a unitary savings and loan
holding company. However, if the Director of OTS determines that there is
reasonable cause to believe that the continuation by a savings and loan holding
company of an activity constitutes a serious risk to the financial safety,
soundness, or stability of its subsidiary savings association, the Director of
OTS may impose such restrictions as deemed necessary to address such risk
including limiting: (i) payment of dividends by the savings institution, (ii)
transactions between the savings institution and its affiliates; and (iii) any
activities of the savings institution that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings institution. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
institution subsidiary of such a holding company fails to meet the Qualified
Thrift Lender ("QTL") Test, then such unitary holding company shall also
presently become subject to the activities restrictions applicable to multiple
holding companies and unless the savings association requalifies as a QTL within
one year thereafter, register as, and become subject to, the restrictions
applicable to a bank holding company. See "Regulation of the Bank -- Qualified
Thrift Lender Test."
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
Test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings institution may commence or
continue for a limited period of time after becoming a multiple savings and loan
holding company or subsidiary thereof, any business activity, upon prior notice
to, and no objection by the OTS, other than (i) furnishing or performing
management services for a subsidiary savings institution, (ii) conducting an
insurance agency or escrow business, (iii) holding, managing, or liquidating
assets owned by or acquired from a subsidiary savings institution, (iv) holding
or managing properties used or occupied by a subsidiary savings institution, (v)
acting as trustee under deeds
22
<PAGE>
of trust, (vi) those activities previously directly authorized by regulation as
of March 5, 1987 to be engaged in by multiple holding companies or (vii) those
activities authorized by the Federal Reserve Board as permissible for bank
holding companies, unless the Director of OTS by regulation prohibits or limits
such activities for savings and loan holding companies. Those activities
described in (vii) above must also be approved by the Director of OTS prior to
being engaged in by a multiple holding company.
TRANSACTIONS WITH AFFILIATES. Transactions between savings institutions
and any affiliate are governed by Sections 23A and 23B of the Federal Reserve
Act. An affiliate of a savings institution is any company or entity which
controls, is controlled by or is under common control with the savings
institution. In a holding company context, the parent holding company of a
savings institution (such as the Company) and any companies which are controlled
by such parent holding company are affiliates of the savings institution.
Generally, Sections 23A and 23B (i) limit the extent to which the savings
institution or its subsidiaries may engage in "covered transactions" with any
one affiliate to an amount equal to 10% of such institution's capital stock and
surplus, and contain an aggregate limit on all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus, and (ii)
require that all such transactions be on terms substantially the same, or at
least as favorable, to the institution or subsidiary as those provided to a non-
affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings institution may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities which are permissible
for bank holding companies, or (ii) purchase or invest in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings institution. Savings associations are
also subject to the anti-tying provisions of Section 106(b) of the Bank Holding
Company Act of 1956 ("BHCA") which prohibits a depository institution from
extending credit to or offering any other services, or fixing or varying the
consideration for such extension of credit or service, on the condition that the
customer obtain some additional service from the institution or certain of its
affiliates or not obtain services of a competitor of the institution, subject to
certain exceptions.
Savings institutions are also subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act on loans to executive officers,
directors and principal stockholders. Under Section 22(h), loans to an executive
officer and to a greater than 10% stockholder of a savings institution, and
certain affiliated entities of either, may not exceed, together with all other
outstanding loans to such person and affiliated entities the institution's loan
to one borrower limit (generally equal to 15% of the institution's unimpaired
capital and surplus and an additional 10% of such capital and surplus for loans
fully secured by certain readily marketable collateral) and all loans to such
persons may not exceed the institution's unimpaired capital and unimpaired
surplus unless the institution has less than $100 million in deposits in which
case the aggregate limit may be increased to no more than two times unimpaired
capital and surplus. 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 unless the loan is
made pursuant to a benefit or compensation plan that is widely available to
other employees and does not give preference to insiders. Section 22(h) also
generally prohibits a depository institution from paying the overdrafts of any
of its executive officers or directors.
Savings institutions are also subject to the requirements and restrictions
of Section 22(g) of the Federal Reserve Act and Regulation on loans to executive
officers and the restrictions of 12 U.S.C. (S) 1972 on certain tying
arrangements and extensions of credit by correspondent banks. Section 22(g) of
the Federal Reserve Act requires that loans to executive officers of depository
institutions not be made on terms more favorable than those afforded to other
borrowers, requires approval for such extensions of credit by the board of
directors of the institution, and imposes reporting requirements for and
additional restrictions on the type, amount and terms of credits to such
officers. Section 1972
23
<PAGE>
prohibits (i) a depository institution from extending credit to or offering any
other services, or fixing or varying the consideration for such extension of
credit or service, on the condition that the customer obtain some additional
service from the institution or certain of its affiliates or not obtain services
of a competitor of the institution, subject to certain exceptions, and (ii)
extensions of credit to executive officers, directors, and greater than 10%
stockholders of a depository institution by any other institution which has a
correspondent banking relationship with the institution, unless such extension
of credit is on substantially the same terms as those prevailing at the time for
comparable transactions with other persons and does not involve more than the
normal risk of repayment or present other unfavorable features.
RESTRICTIONS ON ACQUISITIONS. The HOLA generally prohibits savings and loan
holding companies from acquiring, without prior approval of the Director of OTS,
(i) control of any other savings institution or savings and loan holding company
or substantially all the assets thereof, or (ii) more than 5% of the voting
shares of a savings institution or holding company thereof which is not a
subsidiary. Under certain circumstances, a registered savings and loan holding
company is permitted to acquire, with the approval of the Director of OTS, up to
15% of the voting shares of an under-capitalized savings institution pursuant to
a "qualified stock issuance" without that savings institution being deemed
controlled by the holding company. In order for the shares acquired to
constitute a "qualified stock issuance," the shares must consist of previously
unissued stock or treasury shares, the shares must be acquired for cash, the
savings and loan holding company's other subsidiaries must have tangible capital
of at least 6-1/2% of total assets, there must not be more than one common
director or officer between the savings and loan holding company and the issuing
savings institution and transactions between the savings institution and the
savings and loan holding company and any of its affiliates must conform to
Sections 23A and 23B of the Federal Reserve Act. Except with the prior approval
of the Director of OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may also acquire control of any savings institution, other
than a subsidiary savings institution, or of any other savings and loan holding
company.
The Director of OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if: (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office in the state of the institution to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by state-chartered institutions or savings and loan holding companies
located in the state where the acquiring entity is located (or by a holding
company that controls such state-chartered savings institutions).
The OTS regulations permit federal associations to branch in any state or
states of the United States and its territories. Except in supervisory cases or
when interstate branching is otherwise permitted by state law or other statutory
provision, a federal association may not establish an out-of-state branch unless
(i) the federal association qualifies as a "domestic building and loan
association" under (S)7701(a)(19) of the Code and the total assets attributable
to all branches of the association in the state would qualify such branches
taken as a whole for treatment as a domestic building and loan association and
(ii) such branch would not result in (a) formation of a prohibited multi-state
multiple savings and loan holding company or (b) a violation of certain
statutory restrictions on branching by savings association subsidiaries of
banking holding companies. Federal associations generally may not establish new
branches unless the association meets or exceeds minimum regulatory capital
requirements. The OTS will also consider the association's record of compliance
with the Community Reinvestment Act of 1977 in connection with any branch
application.
Under the BHCA, bank holding companies are specifically authorized to
acquire control of any savings association. Pursuant to rules promulgated by
the Federal Reserve Board, owning, controlling or operating a savings
institution is a permissible activity for bank holding companies, if the savings
institution engages only in deposit-taking activities and lending and other
activities that are permissible for bank holding companies. A bank holding
company that controls a savings institution may merge or consolidate the assets
and liabilities of the savings institution with, or transfer assets and
liabilities to, any subsidiary bank which is a member of the BIF with the
approval of the appropriate federal banking agency and the Federal Reserve
Board. The resulting bank will be required to continue to pay
24
<PAGE>
assessments to the SAIF at the rates prescribed for SAIF members on the deposits
attributable to the merged savings institution plus an annual growth increment.
In addition, the transaction must comply with the restrictions on interstate
acquisitions of commercial banks under the BHCA.
REGULATION OF THE BANK
GENERAL. As a federally chartered savings institution, First Federal is
subject to extensive regulation by the OTS. The lending activities and other
investments of First Federal must comply with various state and federal
regulatory requirements. The OTS periodically examines the Bank for compliance
with various regulatory requirements. The FDIC also has the authority to
conduct special examinations of the Bank because its deposits are insured by
SAIF. The Bank must file reports with these agencies describing its activities
and financial condition. The Bank is also subject to certain reserve
requirements promulgated by the Federal Reserve Board. This supervision and
regulation is intended primarily for the protection of depositors. Certain of
these regulatory requirements are referred to below or appear elsewhere herein.
REGULATORY CAPITAL REQUIREMENTS. Under OTS capital standards, savings
associations must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3.0% of adjusted total assets and a combination
of core and "supplementary" capital equal to 8.0% of "risk-weighted" assets. In
addition, the OTS has recently adopted regulations which impose certain
restrictions on savings associations that have a total risk-based capital ratio
that is less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of
less than 4.0% or a ratio of Tier 1 capital to adjusted total assets of less
than 4.0% (or 3.0% if the institution is rated Composite 1 under the OTS
examination rating system). See "-- Prompt Corrective Regulatory Action." For
purposes of this regulation, Tier 1 capital has the same definition as core
capital which is defined as common shareholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Core capital is generally reduced by the amount of the savings
association's intangible assets for which no market exists. Limited exceptions
to the deduction of intangible assets are provided for purchased mortgage
servicing rights and qualifying supervisory goodwill. Tangible capital is given
the same definition as core capital but does not include an exception for
qualifying supervisory goodwill and is reduced by the amount of all the savings
association's intangible assets with only a limited exception for purchased
mortgage servicing rights and purchased credit card relationships. Both core
and tangible capital are further reduced by an amount equal to the savings
association's debt and equity investments in subsidiaries engaged in activities
not permissible to national banks other than subsidiaries engaged in activities
undertaken solely as an agent for customers or in mortgage banking activities
and subsidiary depository institutions or their holding companies. At June 30,
1998, First Federal had no such investments.
Adjusted total assets are a savings association's total assets as
determined under generally accepted accounting principles, adjusted for certain
goodwill amounts and increased by a pro rated portion of the assets of
subsidiaries in which the savings association holds a minority interest and
which are not engaged in activities for which the capital rules require
deduction of its debt and equity investments. Adjusted total assets are reduced
by the amount of assets that have been deducted from capital, the portion of the
savings association's investments in subsidiaries that must be netted against
capital under the capital rules and, for purposes of the core capital
requirement, qualifying supervisory goodwill.
In determining compliance with the risk-based capital requirement, a
savings association is allowed to use both core capital and supplementary
capital provided the amount of supplementary capital used does not exceed the
savings association's core capital. Supplementary capital is defined to include
certain preferred stock issues, nonwithdrawable accounts and pledged deposits
that do not qualify as core capital, certain approved subordinated debt, certain
other capital instruments and a portion of the savings association's general
loss allowances. Total core and supplementary capital are reduced by the amount
of capital instruments held by other depository institutions pursuant to
reciprocal arrangements and by the savings association's high loan-to-value
ratio land loans and non-residential construction loans and equity investments
other than those deducted from core and tangible capital. At June 30, 1998, the
Bank had no
25
<PAGE>
high ratio land or nonresidential construction loans and had no equity
investments for which OTS regulations require deduction from total capital.
The risk-based capital requirement is measured against risk-weighted assets
which equal the sum of each asset and the credit-equivalent amount of each off-
balance sheet item after being multiplied by an assigned risk weight. Under the
OTS risk-weighting system, one- to four-family first mortgages not more than 90
days past due with loan-to-value ratios under 80% are assigned a risk weight of
50%. Consumer and residential construction loans are assigned a risk weight of
100%. Mortgage-backed securities issued, or fully guaranteed as to principal and
interest, by FNMA and the FHLMC are assigned a 20% risk weight. Cash and U.S.
Government securities backed by the full faith and credit of the U.S. Government
are given a 0% risk weight. As of June 30, 1998, the Bank's risk-weighted assets
were approximately $46.6 million.
The table below presents the Bank's capital position relative to its
various regulatory capital requirements at June 30, 1998.
<TABLE>
<CAPTION>
Percent of
Amount Assets(1)
--------- --------------
(Dollars in Thousands)
<S> <C> <C>
Tangible capital...................................... $12,328 15.1%
Tangible capital requirement.......................... 1,223 1.5
------- ----
Excess.............................................. $11,105 13.6%
======= ====
Core capital.......................................... $12,328 15.1%
Core capital requirement (2).......................... 3,261 4.0
------- ----
Excess.............................................. $ 9,067 11.1%
======= ====
Total capital (i.e., core and supplementary capital).. $12,712 27.3%
Risk-based capital requirement........................ 3,729 8.0
------- ----
Excess.............................................. $ 8,983 19.3%
======= ====
</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.
(2) Reflects the capital requirement which must be satisfied to avoid
regulatory restrictions that would be imposed pursuant to prompt corrective
action regulations.
OTS regulations 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 will be considered to
have a "normal" level of interest rate risk exposure if the decline in its net
portfolio value after an immediate 200 basis point increase or decrease in
market interest rates (whichever results in the greater decline) is less than
two percent of the current estimated economic value of its assets. A savings
institution with a greater than normal interest rate risk is required to deduct
from total capital, for purposes of calculating its risk-based capital
requirement, an amount (the "interest rate risk component") equal to one-half
the difference between the institution's measured interest rate risk and the
normal level of interest rate risk, multiplied by the economic value of its
total assets.
The OTS calculates the sensitivity of a savings institution's net portfolio
value based on data submitted by the institution in a schedule to its quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS. The amount of the interest rate risk component, if any, to
be deducted from a savings institution's
26
<PAGE>
total capital is based on the institution's Thrift Financial Report filed two
quarters earlier. Savings institutions with less than $300 million in assets and
a risk-based capital ratio above 12% are generally exempt from filing the
interest rate risk schedule with their Thrift Financial Reports. However, the
OTS will require any exempt savings institution that it determines may have a
high level of interest rate risk exposure to file such schedule on a quarterly
basis. The OTS has not yet implemented these requirements. The Bank has
determined that, on the basis of current financial data, it will not be deemed
to have more than normal level of interest rate risk under the new rule and does
not expect that it will be required to increase its total capital as a result of
the rule upon its implementation.
In addition to requiring generally applicable capital standards for savings
institutions, the OTS is authorized to establish the minimum level of capital
for a savings institution at such amount or at such ratio of capital-to-assets
as the OTS determines to be necessary or appropriate for such institution in
light of the particular circumstances of the institution. The OTS may treat the
failure of any savings institution to maintain capital at or above such level as
an unsafe or unsound practice and may issue a directive requiring any savings
institution which fails to maintain capital at or above the minimum level
required by the OTS to submit and adhere to a plan for increasing capital. Such
an order may be enforced in the same manner as an order issued by the FDIC.
PROMPT CORRECTIVE REGULATORY ACTION. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action if an insured depository
institution fails to satisfy certain minimum capital requirements. All
institutions, regardless of their capital levels, are restricted from making any
capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of businesses. The capital
restoration plan must include a guarantee by the institution's holding company
that the institution will comply with the plan until it has been adequately
capitalized on average for four consecutive quarters, under which the holding
company would be liable up to the lesser of 5% of the institution's total assets
or the amount necessary to bring the institution into capital compliance as of
the date it failed to comply with its capital restoration plan. A
"significantly undercapitalized" institution, as well as any undercapitalized
institution that did not submit an acceptable capital restoration plan, may be
subject to regulatory demands for recapitalization, broader application of
restrictions on transactions with affiliates, limitations on interest rates paid
on deposits, asset growth and other activities, possible replacement of
directors and officers, and restrictions on capital distributions by any bank
holding company controlling the institution. Any company controlling the
institution could also be required to divest the institution or the institution
could be required to divest subsidiaries. The senior executive officers of a
significantly undercapitalized institution may not receive bonuses or increases
in compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total
assets falls below a "critical capital level," the institution will be subject
to conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized. If a savings institution is in
compliance with an approved capital plan on the date of enactment of FDICIA,
however, it will not be required to submit a capital restoration plan if it is
undercapitalized or become subject to the statutory prompt corrective action
provisions applicable to significantly and critically undercapitalized
institutions prior to July 1, 1994.
The federal banking regulators, including the OTS, generally measure a
depository institution's capital adequacy on the basis of the institution's
total risk-based capital ratio (the ratio of its total capital to risk-weighted
assets), Tier 1 risk-based capital ratio (the ratio
27
<PAGE>
of its core capital to risk-weighted assets) and leverage ratio (the ratio of
its core capital to adjusted total assets). Under the regulations, a savings
institution that is not subject to an order or written directive to meet or
maintain a specific capital level will be deemed "well capitalized" if it also
has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-
based capital ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0% or
greater. An "adequately capitalized" savings institution is a savings
institution that does not meet the definition of well capitalized and has: (i) a
total risk-based capital ratio of 8.0% or greater; (ii) a Tier 1 capital risk-
based ratio of 4.0% or greater; and (iii) a leverage ratio of 4.0% or greater
(or 3.0% or greater if the savings institution has a composite 1 CAMELS rating).
An "undercapitalized institution" is a savings institution that has (i) a total
risk-based capital ratio less than 8.0%; or (ii) a Tier 1 risk-based capital
ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0% (or 3.0% if
the institution has a composite 1 CAMELS rating). A "significantly
undercapitalized" institution is defined as a savings institution that has: (i)
a total risk-based capital ratio of less than 6.0%; or (ii) a Tier 1 risk-based
capital ratio of less than 3.0%; or (iii) a leverage ratio of less than 3.0%. A
"critically undercapitalized" savings institution is defined as a savings
institution that has a ratio of "tangible equity" to total assets of less than
2.0%. Tangible equity is defined as core capital plus cumulative perpetual
preferred stock (and related surplus) less all intangibles other than qualifying
supervisory goodwill and certain purchased mortgage servicing rights. The OTS
may reclassify a well capitalized savings institution as adequately capitalized
and may require an adequately capitalized or undercapitalized institution to
comply with the supervisory actions applicable to institutions in the next lower
capital category (but may not reclassify a significantly undercapitalized
institution as critically under-capitalized) if the OTS determines, after notice
and an opportunity for a hearing, that the savings institution is in an unsafe
or unsound condition or that the institution has received and not corrected a
less-than-satisfactory rating for any CAMELS rating category. The Bank is
classified as "well capitalized" under these regulations.
QUALIFIED THRIFT LENDER TEST. A savings institution that does not meet the
Qualified Thrift Lender test ("QTL Test") must either convert to a bank charter
or comply with the following restrictions on its operations: (i) the institution
may not engage in any new activity or make any new investment, directly or
indirectly, unless such activity or investment is permissible for a national
bank; (ii) the branching powers of the institution shall be restricted to those
of a national bank; (iii) the institution shall not be eligible to obtain any
advances from its FHLB; and (iv) payment of dividends by the institution shall
be subject to the rules regarding payment of dividends by a national bank. Upon
the expiration of three years from the date the institution ceases to be a QTL,
it must cease any activity, and not retain any investment not permissible for a
national bank and immediately repay any outstanding FHLB advances (subject to
safety and soundness considerations).
To qualify as a QTL, a savings institution must maintain at least 65% of
its "portfolio" assets in Qualified Thrift Investments. Portfolio assets are
defined as total assets less intangibles, property used by a savings institution
in its business and liquidity investments in an amount not exceeding 20% of
assets. Qualified Thrift Investments consist of: (i) loans, equity positions,
or securities related to domestic, residential real estate or manufactured
housing, and educational, small business and credit card loans; (ii) shares of
stock issued by an FHLB. Subject to a 20% of portfolio assets limit, however,
savings institutions are 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 but do not include any intangible assets; (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, (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 association's portfolio assets; and (vi) shares of
stock issued by FNMA or FHLMC.
A savings institution must maintain its status as a QTL on a monthly basis
in nine out of every 12 months. A savings institution that fails to maintain
Qualified Thrift Lender status will be permitted to requalify once, and if it
fails the QTL Test a second time, it will become immediately subject to all
penalties as if all time limits on such penalties
28
<PAGE>
had expired. Failure to qualify as a QTL results in a number of sanctions,
including the imposition of certain operating restrictions imposed on national
banks and a restriction on obtaining additional advances from the FHLB System.
Upon failure to qualify as a QTL for two years, a savings association must
convert to a commercial bank. At June 30, 1998, approximately 75.9% of the
Bank's assets were invested in Qualified Thrift Investments.
DIVIDEND LIMITATIONS. Under OTS regulations, the Bank is not permitted to
pay dividends on its capital stock if its regulatory capital would thereby be
reduced below the amount then required for the liquidation account established
for the benefit of certain depositors of the Bank at the time of its conversion
to stock form. In addition, savings institution subsidiaries of savings and
loan holding companies are required to give the OTS 30 days' prior notice of any
proposed declaration of dividends to the holding company.
Federal regulations impose limitations on the payment of dividends and
other capital distributions (including stock repurchases and cash mergers) by
the Bank. Under these regulations, a savings institution that, immediately
prior to, and on a pro forma basis after giving effect to, a proposed capital
distribution, has total capital (as defined by OTS regulation) that is equal to
or greater than the amount of its fully phased-in capital requirements (a "Tier
1 Association") is generally permitted without OTS approval, after notice, to
make capital distributions during a calendar year in the amount equal to the
greater of (i) 75% of net income for the previous four quarters or (ii) up to
100% of its net income to date during the calendar year plus an amount that
would reduce by one-half the amount by which its capital-to-assets ratio
exceeded its fully phased-in capital requirement to assets ratio at the
beginning of the calendar year. A savings institution with total capital in
excess of current minimum capital requirements but not in excess of the fully
phased-in requirements (a "Tier 2 Association") is permitted, after notice, to
make capital distributions without OTS approval of up to 75% of its net income
for the previous four quarters, less dividends already paid for such period. A
savings institution that fails to meet current minimum capital requirements (a
"Tier 3 Association") is prohibited from making any capital distributions
without the prior approval of the OTS. Tier 1 Associations that have been
notified by the OTS that they are in need of more than normal supervision will
be treated as either a Tier 2 or Tier 3 Association. Unless the OTS determines
that the Bank is an institution requiring more than normal supervision, the Bank
is authorized to pay dividends in accordance with the provisions of the OTS
regulations discussed above as a Tier 1 Association.
Under the OTS' prompt corrective action regulations, the Bank is also
prohibited from making any capital distributions if after making the
distribution, the Bank would have: (i) a total risk-based capital ratio of less
than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a
leverage ratio of less than 4.0%. The OTS, after consultation with the FDIC,
however, may permit an otherwise prohibited stock repurchase if made in
connection with the issuance of additional shares in an equivalent amount and
the repurchase will reduce the institution's financial obligations or otherwise
improve the institution's financial condition.
SAFETY AND SOUNDNESS STANDARDS. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each Federal banking agency is required to establish safety and soundness
standards for institutions under its authority. The final rule and the
guidelines went into effect on August 9, 1995. The guidelines require savings
institutions to maintain internal controls and information systems and internal
audit systems that are appropriate for the size, nature and scope of the
institution's business. The guidelines also establish certain basic standards
for loan documentation, credit underwriting, interest rate risk exposure, and
asset growth. The guidelines further provide that savings institutions should
maintain safeguards to prevent the payment of compensation, fees and benefits
that are excessive or that could lead to material financial loss, and should
take into account factors such as comparable compensation practices at
comparable institutions. If the OTS determines that a 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 will materially affect
the Bank's operations.
29
<PAGE>
Additionally, under FDICIA, as amended by the CDRI Act, the Federal banking
agencies are required to establish standards relating to the asset quality and
earnings that the agencies determine to be appropriate. On July 10, 1995, the
federal banking agencies, including the OTS, issued proposed guidelines relating
to asset quality and earnings. Under the proposed guidelines, a savings
institution should maintain systems, commensurate with its size and the nature
and scope of its operations, to identify problem assets and prevent
deterioration in those assets as well as to evaluate and monitor earnings and
ensure that earnings are sufficient to maintain adequate capital and reserves.
Management believes that the asset quality and earnings standards, in the form
proposed by the banking agencies, would not have a material effect on the Bank's
operations.
DEPOSIT INSURANCE. The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the FDIC through the SAIF. Under the Federal Deposit Insurance Act, the FDIC is
required to set semi-annual assessments for SAIF-insured institutions at a level
necessary to maintain the designated reserve ratio of the SAIF at 1.25% of
estimated insured deposits or at a higher percentage of estimated insured
deposits that the FDIC determines to be justified for that year by circumstances
indicating a significant risk of substantial future losses to the SAIF.
Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as under the prompt
corrective action regulations. See " -- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund.
The FDIC has adopted a new assessment schedule for SAIF deposit insurance
pursuant to which the assessment rate for well-capitalized institutions with the
highest supervisory ratings has been reduced to zero and institutions in the
lowest risk assessment classification will be assessed at the rate of 0.27% of
insured deposits. Until December 31, 1999, however, SAIF-insured institutions,
will be required to pay assessments to the FDIC at the rate of 6.5 basis points
to help fund interest payments on certain bonds issued by the Financing
Corporation ("FICO") an agency of the federal government established to finance
takeovers of insolvent thrifts. During this period, BIF members will be assessed
for these obligations at the rate of 1.3 basis points. After December 31, 1999,
both BIF and SAIF members will be assessed at the same rate for FICO payments.
The FDIC has adopted a regulation which provides that any insured
depository institution with a ratio of Tier 1 capital to total assets of less
than 2% will be deemed to be operating in an unsafe or unsound condition, which
would constitute grounds for the initiation of termination of deposit insurance
proceedings. The FDIC, however, will not initiate termination of insurance
proceedings if the depository institution has entered into and is in compliance
with a written agreement with its primary regulator, and the FDIC is a party to
the agreement, to increase its Tier 1 capital to such level as the FDIC deems
appropriate. Tier 1 capital is defined as the sum of common stockholders'
equity, noncumulative perpetual preferred stock (including any related surplus)
and minority interests in consolidated subsidiaries, minus all intangible assets
other than certain purchased servicing rights and purchased credit card
receivables and qualifying supervisory goodwill eligible for inclusion in core
capital under OTS regulations and minus identified losses and investments in
certain securities subsidiaries. Insured depository institutions with Tier 1
capital equal to or greater than 2% of total assets may also be deemed to be
operating in an unsafe or unsound condition notwithstanding such capital level.
The regulation further provides that in considering applications that must be
submitted to it by savings institutions, the FDIC will take into account whether
the savings association is meeting the Tier 1 capital requirement for state non-
member banks of 4% of total assets.
30
<PAGE>
LIQUIDITY REQUIREMENTS. The Bank is required to maintain average daily
balances of liquid assets (cash, certain time deposits, bankers' acceptances,
highly rated corporate debt and commercial paper, securities of certain mutual
funds, and specified United States government, state or federal agency
obligations) equal to the monthly average of not less than a specified
percentage (currently 4%) of its net withdrawable savings deposits plus short-
term borrowings. The Bank is also required to maintain average daily balances of
short-term liquid assets at a specified percentage (currently 1%) of the total
of its net withdrawable savings accounts and borrowings payable in one year or
less. Monetary penalties may be imposed for failure to meet liquidity
requirements. The average daily liquidity ratio of the Bank for the month of
June 1998, was 5.45%.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB, which
consists of 12 Federal Home Loan Banks subject to supervision and regulation by
the Federal Housing Finance Board ("FHFB"). The Federal Home Loan Banks provide
a central credit facility primarily for member institutions. As a member of the
FHLB of Cincinnati, the Bank is required to acquire and hold shares of capital
stock in the FHLB of Cincinnati in an amount at least equal to 1% of the
aggregate unpaid principal of its home mortgage loans, home purchase contracts,
and similar obligations at the beginning of each year, or 1/20 of its advances
from the FHLB of Cincinnati, whichever is greater. The Bank was in compliance
with this requirement with investment in FHLB of Cincinnati stock at June 30,
1998, of $1.1 million. The FHLB of Cincinnati is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System. It makes
advances to members in accordance with policies and procedures established by
the FHFB and the Board of Directors of the FHLB of Cincinnati. As of June 30,
1998, the Bank had $10.4 million in advances and other borrowings from the FHLB
of Cincinnati. See "Deposit Activity and Other Sources of Funds -- Borrowings."
FEDERAL RESERVE SYSTEM. Pursuant to regulations of the Federal Reserve
Board, a thrift institution must maintain average daily reserves equal to 3% on
the first $47.3 million of transaction accounts, plus 10% on the remainder. This
percentage is subject to adjustment by the Federal Reserve Board. Because
required reserves must be maintained in the form of vault cash or in a non-
interest bearing account at a Federal Reserve Bank, the effect of the reserve
requirement is to reduce the amount of the institution's interest-earning
assets. As of June 30, 1998, the Bank met its reserve requirements.
TAXATION
The Company and First Federal file separate federal income tax returns.
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.
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<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 signed by the President 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 loan originated in each
of the six most recent years disregarding the years with the highest and lowest
originations during such period. For purposes of this test, residential loan
originations would not include refinancings and home equity loans. Under such
legislation, the Bank is required to recapture approximately $70,000 of its tax
bad debt reserve. The Bank has provided deferred taxes for the amount of the
recapture.
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.
Neither the Company nor First Federal's federal corporate income tax
returns have 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 rule.
STATE INCOME TAXATION
The Commonwealth of Kentucky imposes no income or franchise taxes on
savings institutions. The Bank is subject to an annual Kentucky ad valorem tax.
This tax is 0.1% of the Bank's savings accounts, common stock, capital and
retained income with certain deductions allowed for amounts borrowed by
depositors and for securities guaranteed by the U.S. Government or certain of
its agencies. For the fiscal year ended June 30, 1998, the amount of such
expense for First Federal was $55,000.
32
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTY
- ---------------------------------
The following table sets forth the location and certain additional
information regarding the Bank's two offices at June 30, 1998.
<TABLE>
<CAPTION>
Book Value
Year Owned or at June 30, Approximate
Opened Leased 1998 Square Footage
------ -------- ----------- --------------
<S> <C> <C> <C> <C>
306 North Main Street 1975 Owned $239,000 4,278
Cynthiana, Kentucky
100 Ladish Road
Cynthiana, Kentucky 1994 Owned $887,000 2,500
</TABLE>
ITEM 3. LEGAL PROCEEDINGS.
- ---------------------------
Although First Federal, from time to time, is involved in various legal
proceedings in the normal course of business, there are no material legal
proceedings to which the Company or First Federal is a party or to which any of
its property is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -------------------------------------------------------------
There were no matters submitted to a vote of the security holders during
the fourth quarter of fiscal year 1998.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS'
- ----------------------------------------------------------------------------
MATTERS
- -------
The Common Stock began trading under the symbol "KYF" on the American Stock
Exchange on August 29, 1995. There are currently 1,212,005 shares of the Common
Stock outstanding. The number of registered holders of Common Stock on September
10, 1998 was 359.
The following table shows the high and low stock prices for the Common
Stock and dividends declared on a quarterly basis for the past two fiscal years.
<TABLE>
<CAPTION>
Quarter Dividends
Ended High Low Declared
----- ---- --- --------
<S> <C> <C> <C>
September 30,1996 $13.6250 $13.6250 $0.125
December 31, 1996 $11.0000 $10.8750 $3.125(1)
March 31, 1997 $11.5000 $11.5000 $0.125
June 30, 1997 $10.7500 $10.6250 $0.125
September 30, 1997 $14.2500 $10.6250 $0.125
December 31, 1997 $15.0000 $13.3125 $0.125
March 31, 1998 $15.0000 $13.7500 $0.125
June 30, 1998 $16.0000 $14.0000 $0.125
</TABLE>
- ---------------------------
(1) In November 1996, the Company paid a $3.00 per share return of capital
distribution.
33
<PAGE>
The income of the Company consists of interest on investment and related
securities and dividends which may periodically be declared and paid by the
Board of Directors of the Bank on the common shares of the Bank held by the
Company.
In addition to certain federal income tax considerations, OTS regulations
impose limitations on the payment of dividends and other capital distributions
by savings associations. Under OTS regulations applicable to converted savings
associations, the Bank is not permitted to pay a cash dividend on its common
shares if the Bank's regulatory capital would, as a result of the payment of
such dividend, be reduced below the amount required for the liquidation account
established in connection with the Conversion or applicable regulatory capital
requirements prescribed by the OTS.
OTS regulations applicable to all savings associations provide that a
savings association which immediately prior to, and on a pro forma basis after
giving effect to, a proposed capital distribution (including a dividend) has
total capital (as defined by OTS regulations) that is equal to or greater than
the amount of its capital requirements is generally permitted without OTS
approval (but subsequent to 30 days' prior notice to the OTS) to make capital
distributions, including dividends, during a calendar year in an amount not to
exceed the greater of (1) 100% of its net earnings to date during the calendar
year, plus an amount equal to one-half the amount by which its total capital to
asset ratio exceeded its required capital to asset ratio at the beginning of the
calendar year, or (2) 75% of its net earnings for the most recent four-quarter
period. Savings associations with total capital in excess of the capital
requirements that have been notified by the OTS that they are in need of more
than normal supervision will be subject to restrictions on dividends. A savings
association that fails to meet current minimum capital requirements is
prohibited from making any capital distributions without the prior approval of
the OTS.
The Bank currently meets all of its regulatory requirements and, unless the
OTS determines that the Bank is an institution requiring more than normal
supervision, the Bank may pay dividends in accordance with the foregoing
provisions of the OTS regulations.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
- -------------------------------------------------------------------
FORWARD-LOOKING STATEMENTS
In addition to historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. Economic circumstances, the Company's operations and the
Company's actual results could differ significantly from those discussed in the
forward-looking statements. Some of the factors that could cause or contribute
to such differences are discussed herein but also include changes in the economy
and interest rates in the nation and the Company's market area generally.
Some of the forward-looking statements included herein are the statements
regarding management's determination of the amount and adequacy of the allowance
for losses on loans, the effect of certain recent accounting pronouncements and
the Company's projected effects related to the year 2000 compliance issue.
GENERAL
The Company's principal business since August 28, 1995 has been that of the
Bank. Therefore, this discussion relates primarily to the Bank. Historically,
the Bank has functioned as a financial intermediary, attracting deposits from
the general public and using such deposits to make and purchase mortgage and
other loans and, to a lesser extent, to purchase investment and mortgage-backed
securities. As such, its earnings have depended primarily on its net interest
income, or "spread," which is the difference between the amount it receives from
interest earned on loans and investments ("interest-earning assets") and the
amount it pays in interest on its deposits and borrowings ("interest-
34
<PAGE>
bearing liabilities"). Results of operations are also dependent upon the level
of the Bank's other income, including fee income and service charges and by the
level of its general, administrative and other expense, including SAIF deposit
insurance premiums, employee compensation and benefits, occupancy and equipment
expense and other operating expenses.
The operations of the Bank are significantly affected by prevailing
economic conditions and the monetary, fiscal and regulatory 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. Deposit flows and costs of funds are likewise heavily
influenced by prevailing market rates of interest on competing investment
alternatives, account maturities and the levels of personal income and savings
in the Bank's market areas.
ASSET/LIABILITY MANAGEMENT
Net interest income, the primary component of First Federal's net earnings,
is determined by the difference, or "spread," between the yield earned on the
Bank's interest-earning assets and the rates paid on its interest-bearing
liabilities and the relative amounts of such assets and liabilities. Key
components of a successful asset/liability strategy are the monitoring and
managing of interest rate sensitivity of both the interest-earning asset and
interest-bearing liability portfolios. First Federal has employed various
strategies intended to minimize the adverse effect of interest rate risk on
future operations by providing a better match between the interest rate
sensitivity of its assets and liabilities. Such strategies include the
origination and purchase of adjustable-rate mortgage loans secured by one- to
four-family residential real estate, multi-family and commercial real estate
loans. The Bank's loan pricing strategies are designed to encourage customers to
choose adjustable rate, rather than fixed rate, mortgage loans; however, the
fixed rates offered have been reduced recently to become more competitive with
the rates offered by competitors in the Bank's lending areas.
INTEREST RATE SENSITIVITY ANALYSIS AND NET PORTFOLIO VALUE
In recent years, the Bank has measured its interest rate sensitivity by
computing the "gap" between the assets and liabilities which were expected to
mature or reprice within certain periods, based on assumptions regarding loan
prepayment and deposit decay rates formerly provided by the OTS. However, the
OTS now requires the computation of amounts by which the net present value of an
institution's cash flows from assets, liabilities and off balance sheet items
(the institution's net portfolio value, or "NPV") would change in the event of a
range of assumed changes in market interest rates. The OTS also requires the
computation of estimated changes in net interest income over a four-quarter
period. These computations estimate the effect on an institution's NPV and net
interest income of an instantaneous and permanent 1% to 4% increase and decrease
in market interest rates.
35
<PAGE>
The following table sets forth the interest rate sensitivity of the Bank's
and net portfolio value as of June 30, 1998, in the event of 1%, 2%, 3% and 4%
instantaneous and permanent increases and decreases in market interest rates,
respectively.
<TABLE>
<CAPTION>
Change Net Portfolio Value NPV as % of Portfolio Value of Assets
-------------------------------------- -------------------------------------
in Rates Amount $ Change % Change NPV Ratio Basis Point Changes
-------- ------ -------- -------- --------- -------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
+400 bp $ 7,522 $(5,942) (44)% 9.96% (630) bp
+300 bp 9,094 (4,370) (32) 11.75 (451) bp
+200 bp 10,668 (2,796) (21) 13.45 (281) bp
+100 bp 12,150 (1,314) (10) 14.98 (128) bp
0 bp 13,464 16.26
-100 bp 14,400 936 7 17.11 85 bp
-200 bp 15,215 1,751 13 17.82 156 bp
-300 bp 16,376 2,912 22 18.83 257 bp
-400 bp 17,737 4,273 32 19.98 372 bp
</TABLE>
Certain shortcomings are inherent in the method of analysis presented in
the computation of 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 have features
which restrict changes in interest rates on a short-term basis and over the life
of the asset. In addition, the proportion of adjustable rate loans in the Bank's
portfolios could decrease in future periods if market interest rates remain at
or decrease below current levels due to refinance activity. Further, in the
event of a change in interest rates, prepayment and early withdrawal levels
would likely deviate significantly from those assumed in the tables.
Finally, the ability of many borrowers to service their adjustable-rate
debt may decrease in the event of an interest rate increase. The retention of
adjustable-rate mortgage and commercial loans in the Bank's portfolio helps
reduce the Bank's exposure to changes in interest rates. However, there are
unquantifiable credit risks resulting from potential increased costs to
borrowers as a result of repricing of adjustable-rate mortgage loans. It is
possible that during periods of rising interest rates, the risk of default on
adjustable-rate mortgage loans may increase due to the upward adjustment of
interest cost to the borrower.
36
<PAGE>
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS
Net interest income is affected by (i) the difference between rates of
interest earned on interest-earning assets and rates of interest paid on
interest-bearing liabilities ("interest rate spread") and (ii) 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. Savings
institutions have traditionally used interest rate spreads as a measure of net
interest income. Another indication of an institution's net interest income is
its "net yield on interest-earning assets" which is net interest income divided
by average interest-earning assets. The following table sets forth certain
information relating to the Bank's average interest-earning assets and interest-
bearing liabilities and reflects the average yield on assets and average cost of
liabilities 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. During the periods
indicated, nonaccruing loans are included in the net loan category. Average
balances are derived from month-end average balances. Management does not
believe that the use of month-end average balances instead of average daily
balances has caused any material difference in the information presented.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------------------------------------------------------------
1998 1997 1996
--------------------------- --------------------------- ---------------------------
Average Average Average
Yield/ Yield/ 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, net (1).................. $49,732 $4,080 8.20% $49,693 $3,837 7.72% $42,544 $3,265 7.67%
Mortgage-backed securities................. 19,509 1,312 6.73 21,161 1,438 6.80 12,094 864 7.14
Investment securities...................... 11,937 746 6.25 12,970 927 7.15 12,421 962 7.74
Other interest-earning assets.............. 1,930 99 5.13 1,547 97 6.27 4,827 266 5.51
------- ------ ------- ------ ------- ------
Total interest-earning assets............ 83,108 6,237 7.50 85,371 6,299 7.38 71,886 5,357 7.45
Non-interest-earning assets.................. 2,482 3,286 3,003
------- ------- -------
Total assets............................. $85,590 $88,657 $74,889
======= ======= =======
Interest-bearing liabilities:
Deposits................................... $55,480 $2,467 4.45 $55,027 2,280 4.14 $51,547 2,305 4.47
Borrowings................................. 14,860 849 5.71 18,043 951 5.27 6,234 316 5.07
------- ------ ------- ------ ------- ------
Total interest-bearing liabilities...... 70,340 3,316 4.71 73,070 3,231 4.42 57,781 2,621 4.54
------ ------ ------ ------ ------ ------
Non-interest-bearing liabilities............. 808 777 478
------- ------- -------
Total liabilities....................... 71,148 73,847 58,259
Shareholders' equity......................... 14,442 14,810 16,630
------- ------- -------
Total liabilities and
shareholders' equity.................. $85,590 $88,657 $74,889
======= ======= =======
Net interest income.......................... $2,921 $3,068 $2,736
====== ====== ======
Interest rate spread (2)..................... 2.79% 2.96% 2.91%
====== ====== ======
Net yield on interest-earning assets (3)..... 3.51% 3.59% 3.81%
====== ====== ======
Ratio of average interest-earning assets to
average interest-bearing liabilities....... 118.15% 116.83% 124.41%
====== ====== ======
</TABLE>
_________________________
(1) Includes non-accrual loans.
(2) Represents the difference between the average yield on interest-earning
assets and the average cost of interest-bearing liabilities.
(3) Represents net interest income as a percentage of the average balance of
interest-earning assets for the same period.
37
<PAGE>
RATE/VOLUME ANALYSIS
The table below sets forth certain information regarding changes in
interest income and interest expense of the Bank for the periods indicated. For
each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by old rate); and (ii) changes in rates (change in
rate multiplied by old volume). Changes in rate-volume (changes in rate
multiplied by the changes in volume) are allocated proportionately between
changes in rate and changes in volume.
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------------------------
1998 vs. 1997 1997 vs. 1996
------------------------ ------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------- ------------------------
Rate Volume Total Rate Volume Total
----- ------ ----- ----- ------ -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest Income:
Loans............................... $ 240 $ 3 $ 243 $ 21 $ 551 $ 572
Investment securities (1)........... (110) (71) (181) (76) 41 (35)
Mortgage-backed securities (1)...... (14) (112) (126) (44) 618 574
Other interest-earning assets....... (20) 22 2 33 (202) (169)
----- ----- ----- ----- ------ -----
Total interest-earning assets.... 96 (158) (62) (66) 1,008 942
----- ----- ----- ----- ------ -----
Interest expense:
Deposits............................ 170 17 187 (176) 151 (25)
Borrowings.......................... 83 (185) (102) 12 623 635
----- ----- ----- ----- ------ -----
Total interest-bearing
liabilities................... 253 (168) 85 (164) 774 610
----- ----- ----- ----- ------ -----
Increase (decrease) in net interest
income.............................. $(147) $ 332
===== =====
</TABLE>
- --------------------
(1) Includes securities designated as available for sale.
COMPARISON OF FINANCIAL CONDITION AS OF JUNE 30, 1998 AND 1997
At June 30, 1998, the Company's consolidated total assets amounted to $82.0
million, a decrease of $6.8 million, or 7.7%, from the total at June 30, 1997.
The decrease in assets resulted primarily from a decrease of $7.6 million in
advances from the FHLB and a decline in shareholders' equity of $319,000, which
were partially offset by an increase in deposits of $1.1 million.
Liquid assets (i.e. cash, interest-bearing deposits and investment
securities) decreased by $3.5 million to a total of $11.7 million at June 30,
1998. Investment securities totaling $7.8 million matured during the period and
were partially offset by purchases of $3.6 million. Mortgage-backed securities
totaled $17.9 million at June 30, 1998, a decrease of $3.3 million, or 15.5%,
from June 30, 1997 levels. The decrease resulted primarily from principal
repayments of $3.4 million during the period. Excess liquid assets and proceeds
from maturities of investment and mortgage-backed securities were partially used
to fund repayments of FHLB advances. Regulatory liquidity amounted to 5.99%, at
June 30, 1998.
Loans receivable decreased by $119,000, or .2%, during the period, to a
total of $48.8 million at June 30, 1998. Loan disbursements amounting to $11.8
million were exceeded by principal repayments of $12.8 million. The allowance
for loan losses totaled $384,000 at June 30, 1998, as compared to $372,000 at
June 30, 1997. Nonperforming
38
<PAGE>
loans totaled $141,000 at June 30, 1998, as compared to $59,000 at June 30,
1997. The allowance for loan losses represented 272% of nonperforming loans as
of June 30, 1998 and 631% at June 30, 1997. Although management believes that
its allowance for loan losses at June 30, 1998, is adequate based upon the
available facts and circumstances, there can be no assurance that additions to
such allowance will not be necessary in future periods, which could adversely
affect the Company's results of operations.
Deposits totaled $56.6 million at June 30, 1998, an increase of $1.1
million, or 2.0%, over June 30, 1997 levels. During the current period,
management has not attempted to match premium deposit rates offered by certain
competitors and has instead continued its conservative pricing strategy with
respect to deposit accounts during the current interest rate environment.
Advances from the FHLB totaled $10.4 million at June 30, 1998, a decrease
of $7.6 million, or 42.1%, from the total at June 30, 1997, as proceeds from
maturities of investment and mortgage-backed securities were utilized to repay
such advances.
The Company's shareholders' equity amounted to $14.4 million at June 30,
1998, a decrease of $319,000, or 2.2%, from June 30, 1997 levels. The decrease
resulted primarily from dividends paid on common stock totaling $598,000 and
purchases of treasury stock totaling $1.1 million, which were partially offset
by 1998 period net earnings of $917,000 and a $96,000 increase in unrealized
gains on securities designated as available for sale.
COMPARISON OF RESULTS OF OPERATIONS FOR THE FISCAL YEARS ENDED JUNE 30, 1998 AND
1997
GENERAL. Net earnings amounted to $917,000 for the fiscal year ended June
30, 1998, an increase of $155,000, or 20.3%, over the $762,000 of net earnings
reported in fiscal 1997. Net earnings during the fiscal 1997 period reflected a
$351,000 one-time special assessment recorded in the first quarter of fiscal
1997 to recapitalize the SAIF. The increase in net earnings in the current
period was also due to a $30,000 increase in other income, which was partially
offset by a $147,000 decrease in net interest income, a $13,000 increase in
general, administrative and other expense (excluding the effects of the SAIF
recapitalization assessment) and a $51,000 increase in the provision for federal
income taxes.
NET INTEREST INCOME. Interest income totaled $6.2 million for the fiscal
year ended June 30, 1998, a decrease of $62,000, or 1.0%, from the $6.3 million
of total interest income reported in fiscal 1997. The decrease resulted
primarily from a $2.3 million, or 2.7%, decrease in the weighted-average balance
of interest earning assets outstanding, partially offset by a twelve basis point
increase in the average yield, to 7.50% in fiscal 1998. Interest income on
loans increased by $243,000, or 6.3%, due primarily to a 48 basis point increase
in yield, to 8.20% for fiscal 1998. Interest income on mortgage-backed
securities decreased by $126,000, or 8.8%, due primarily to a $1.7 million, or
7.8%, decrease in the weighted-average balance outstanding. Interest income on
investment securities and interest-bearing deposits decreased by $179,000, or
17.5%, due primarily to a decline in the average yields available on short-term
deposits.
Interest expense on deposits increased by $187,000, or 8.2%, due primarily
to a 31 basis point increase in the cost of deposits year to year, from 4.14% in
fiscal 1997 to 4.45% in fiscal 1998. Interest expense on borrowings decreased
by $102,000, or 10.7%, during the current period, due primarily to a $3.2
million decrease in the weighted-average balance of advances outstanding from
the FHLB, which was partially offset by a 44 basis point increase in the average
rate on such advances, to 5.71% for fiscal 1998.
As a result of the foregoing changes in interest income and interest
expense, net interest income decreased by $147,000, or 4.8%, to a total of $2.9
million for the fiscal year ended June 30, 1998, as compared to fiscal 1997.
The interest rate spread amounted to approximately 2.79% and 2.96% during the
respective fiscal 1998 and 1997 periods, while the net interest margin amounted
to approximately 3.51% in fiscal 1998 and 3.59% in fiscal 1997.
39
<PAGE>
PROVISION FOR LOSSES ON LOANS. A provision for losses on loans is charged
to earnings to bring the total allowance for loan losses to a level considered
appropriate by management based on historical experience, the volume and type of
lending conducted by the Bank, the status of past due principal and interest
payments, general economic conditions, particularly as such conditions relate to
the Bank's market area, and other factors related to the collectibility of the
Bank's loan portfolio. As a result of such analysis, management recorded a
$30,000 provision for losses on loans during the fiscal year ended June 30,
1998, compared to a $15,000 provision for the comparable period in 1997. There
can be no assurance that the loan loss allowance of the Bank will be adequate to
cover losses on nonperforming assets in the future.
OTHER INCOME. Other income increased by $30,000, or 19.2%, for the fiscal
year ended June 30, 1998, compared to fiscal 1997, due primarily to a $16,000
gain on investment securities transactions, coupled with a $20,000, or 18.3%,
increase in service charges and fees on loans and deposits.
GENERAL, ADMINISTRATIVE AND OTHER EXPENSE. General, administrative and
other expense totaled $1.8 million for the fiscal year ended June 30, 1998, a
decrease of $338,000, or 16.0%, from fiscal 1997. This decrease resulted
primarily from the $351,000 charge recorded in the first quarter of fiscal 1997
attendant to the aforementioned SAIF recapitalization. Excluding the effects of
this recapitalization assessment, general, administrative and other expense
increased by $13,000, or .7%, due primarily to a $99,000, or 10.3%, increase in
employee compensation and benefits and a $19,000, or 17.8%, increase in data
processing, which were partially offset by a $35,000, or 50.7%, decrease in
federal deposit insurance premiums and a $77,000, or 15.9%, decrease in other
operating expense.
The decrease in federal deposit insurance premiums resulted from the
decline in premium rates following the recapitalization of the SAIF. The
decline in other operating expense reflects the absence of professional costs
related to the Company's return of capital distribution paid in November 1996.
The increase in employee compensation and benefits was due to the combined
effects of the costs associated with the acceleration of vesting of certain
stock awards resulting from the death of a director, increased expenses relating
to the Company's employee stock ownership plan reflecting the increased market
price of the Kentucky First Bancorp, Inc. common stock and an increase in cash
bonuses paid in lieu of annual salary increases.
FEDERAL INCOME TAXES. The provision for federal income taxes totaled
$386,000 for the fiscal year ended June 30, 1998, an increase of $51,000, or
15.2%, over fiscal 1997. This increase resulted primarily from the increase in
net earnings before taxes of $206,000, or 18.8%. The effective tax rates were
29.6% and 30.5% for the fiscal years ended June 30, 1998 and 1997, respectively.
COMPARISON OF RESULTS OF OPERATIONS FOR THE FISCAL YEARS ENDED JUNE 30, 1997 AND
1996
GENERAL. Net earnings for the year ended June 30, 1997, totaled $762,000,
a decrease of $87,000, or 10.2%, from the $849,000 in net earnings recorded for
the year ended June 30, 1996. This net decrease was attributable to an increase
in general, administrative and other expenses of $507,000, which was
attributable primarily to a $301,000 increase in federal deposit insurance
premiums resulting from the one-time SAIF recapitalization assessment of
$351,000, as well as a $119,000, or 14.1%, increase in employee compensation and
benefits and a $75,000, or 18.4%, increase in other expense. This increase was
partially offset by an increase in net interest income of $332,000, an increase
in other income of $38,000 and a decrease in the provision for federal income
taxes of $50,000.
NET INTEREST INCOME. Net interest income increased by $332,000, or 12.1%,
for the year ended June 30, 1997, compared to fiscal 1996. Interest income on
loans increased by $572,000, or 17.5%, for the year ended June 30, 1997, due
primarily to a $7.1 million, or 16.8%, increase in the weighted-average balance
outstanding. Interest income on mortgage-backed securities increased by
$574,000, or 66.4%, due primarily to a $9.1 million increase in the weighted-
average portfolio balance, which was partially offset by a 34 basis point
decline in yield, to 6.80% in fiscal 1997. Interest income on investment
securities and interest-bearing deposits declined by $204,000, or 16.6%, due
primarily to a $2.7 million, or 15.8%, decline in the weighted-average balance
of such assets.
40
<PAGE>
Interest expense on deposits totaled $2.3 million for the fiscal year ended
June 30, 1997, a decrease of $25,000, or 1.1%, from fiscal 1996. The decrease
resulted primarily from a 33 basis point decline in the average cost of
deposits, to 4.14%, which was partially offset by a $3.5 million increase in the
weighted-average balance outstanding year to year. Interest expense on
borrowings increased by $635,000, or 200.9%, during fiscal 1997, as compared to
fiscal 1996, due primarily to an $11.8 million, or 189.4%, increase in the
weighted-average balance outstanding.
As a result of the foregoing changes in interest income and interest
expense, net interest income increased by $332,000, or 12.1%, to a total of $3.1
million in fiscal 1997. The interest rate spread increased by five basis
points, from 2.91% in fiscal 1996 to 2.96% in fiscal 1997, while the net
interest margin declined by 22 basis points, from 3.81% in fiscal 1996 to 3.59%
in fiscal 1997.
PROVISION FOR LOSSES ON LOANS. A provision for losses on loans is charged
to earnings to bring the total allowance for loan losses to a level considered
appropriate by management based on historical experience, the volume and type of
lending conducted by the Bank, the status of past due principal and interest
payments, general economic conditions, particularly as such conditions relate to
the Bank's market area, and other factors related to the collectibility of the
Bank's loan portfolio. As a result of such analysis, management recorded a
$15,000 provision for losses on loans during each of the fiscal years ended June
30, 1997 and 1996. There can be no assurance that the loan loss allowance of
the Bank will be adequate to cover losses on nonperforming assets in the future.
OTHER INCOME. Other income totaled $156,000 for the year ended June 30,
1997, an increase of $38,000, or 32.2%, over fiscal 1996. The increase in other
income was attributable primarily to an increase in service charges on deposit
accounts due to overall growth in the portfolio.
GENERAL, ADMINISTRATIVE AND OTHER EXPENSE. General, administrative and
other expense totaled $2.1 million for the year ended June 30, 1997, an increase
of $507,000, or 31.6%, over the $1.6 million recorded in fiscal 1996. The
increase in fiscal 1997 was attributable primarily to a $301,000 increase in
federal deposit insurance premiums resulting from the one-time SAIF
recapitalization assessment of $351,000, as well as a $119,000, or 14.1%,
increase in employee compensation and benefits and a $75,000, or 18.4%, increase
in other expense. The increase in employee compensation and benefits resulted
primarily from an increase in costs related to stock benefit plans, coupled with
normal merit increases year to year. The increase in other expenses included
increases in advertising, office supplies, telephone and postage costs and other
operating expenses due to the Company's overall growth year to year.
FEDERAL INCOME TAXES. The provision for federal income taxes amounted to
$335,000 and $385,000 for the years ended June 30, 1997 and 1996, respectively,
a decrease of $50,000, or 13.0%. The decrease in income tax expense was
primarily due to the decline in earnings before income taxes. The effective tax
rate on earnings before income taxes was 30.5% and 31.2% for the years ended
June 30, 1997 and 1996, respectively.
YEAR 2000
As with all providers of financial services, the Bank's operations are
heavily dependent on information technology systems. The Bank is addressing the
potential problems associated with the possibility that the computers that
control or operate the Bank's information technology system and infrastructure
may not be programmed to read four-digit date codes and, upon arrival of the
year 2000, may recognize the two-digit code "00" as the year 1900, causing
systems to fail to function or to generate erroneous data. The Bank is working
with the companies that supply or service its information technology systems to
identify and remedy any year 2000 related problems.
The Bank's mission-critical systems are provided by a third party. This
service provider is converting its hardware to a new year 2000 compliant system.
The Bank anticipates that its conversion to this new system will be completed by
October 31, 1998 with testing to commence in November 1998. The Bank is also in
the process of developing a contingency plan in the event its efforts to become
year 2000 compliant are not successful and anticipates that such contingency
plan will be completed by September 30, 1998.
41
<PAGE>
Management of the Bank has developed an estimate of expenses that are
reasonably likely to be incurred by the Bank in connection with this issue,
however the Bank does not expect to incur significant expense to implement the
necessary corrective measures. No assurance can be given, however, that
significant expense will not be incurred in future periods. In the event that
the Bank is ultimately required to purchase replacement computer systems,
programs and equipment, or incur substantial expense to make the Bank's current
systems, programs and equipment year 2000 compliant, the Bank's net earnings and
financial condition could be adversely affected.
In addition to possible expense related to its own systems, the Bank could
incur losses if loan payments are delayed due to year 2000 problems affecting
any major borrowers in the Bank's primary market area. Because the Bank's loan
portfolio is highly diversified with regard to individual borrowers and types of
businesses and the Bank's primary market area is not significantly dependent
upon one employer or industry, the Bank does not expect any significant or
prolonged difficulties that will affect net earnings or cash flow.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of liquidity is dividends paid by the Bank.
The Bank, as a stock savings institution, is subject to certain regulatory
limitations with respect to the payment of dividends to the Company.
First Federal's capital ratios are substantially in excess of current
regulatory capital requirements. At June 30, 1998, the Bank's tangible and core
capital amounted to 15.1% of adjusted total assets, or 13.6% and 12.1%,
respectively, in excess of the Bank's current 1.5% tangible and 3.0% core
capital requirements. Additionally, the Bank's risk-based capital ratio was
27.3% at June 30, 1998, or 19.3% in excess of the Bank's 8.0% risk-based capital
requirement.
First Federal's principal sources of funds for operations are deposits from
its primary market area, principal and interest payments on loans and proceeds
from maturing investment securities. In addition, as a member of the FHLB of
Cincinnati, the Bank is eligible to borrow funds from the FHLB of Cincinnati in
the form of advances.
First Federal is required by OTS regulations to maintain minimum levels of
specified liquid assets which are currently equal to 4% of deposits and
borrowings. First Federal's daily average liquidity ratio for the month of June
1998 was 5.45%. Management seeks to maintain a liquidity ratio at or near the
regulatory minimum as a means of improving the return on the investment of the
Bank's assets.
The Bank's regulatory liquid assets consist of cash and cash equivalents
and certain of the Bank's investment and mortgage-backed securities with
original maturities of less than five years. The level of liquid assets is
dependent on the Bank's operating, financing and investing activities during any
given period. At June 30, 1998, the Bank's regulatory liquidity totaled
approximately $3.8 million.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements, and notes thereto, presented herein
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars without considering the changes in the relative
purchasing power of money over time due to inflation. The impact of inflation
is reflected in the increased cost of the Bank's operations. Unlike most
industrial companies, nearly all the assets and liabilities of the Bank are
monetary in nature. As a result, interest rates have a greater impact on the
Bank'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
Accounting for Transfers of Financial Assets. In June 1996, the FASB
issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities," that provides accounting guidance on
transfers of financial assets, servicing of financial assets, and extinguishment
of liabilities. SFAS No. 125 introduces
42
<PAGE>
an approach to accounting for transfers of financial assets that provides a
means of dealing with more complex transactions in which the seller disposes of
only a partial interest in the assets, retains rights or obligations, makes use
of special purpose entities in the transaction, or otherwise has continuing
involvement with the transferred assets. The new accounting method, the
financial components approach, provides that the carrying amount of the
financial assets transferred be allocated to components of the transaction based
on their relative fair values. SFAS No. 125 provides criteria for determining
whether control of assets has been relinquished and whether a sale has occurred.
If the transfer does not qualify as a sale, it is accounted for as a secured
borrowing. Transactions subject to the provisions of SFAS No. 125 include, among
others, transfers involving repurchase agreements, securitizations of financial
assets, loan participations, factoring arrangements, and transfers of
receivables with recourse.
An entity that undertakes an obligation to service financial assets
recognizes either a servicing asset or liability for the servicing contract
(unless related to a securitization of assets, and all the securitized assets
are retained and classified as held-to-maturity). A servicing asset or
liability that is purchased or assumed is initially recognized at its fair
value. Servicing assets and liabilities are amortized in proportion to and over
the period of estimated net servicing income or net servicing loss and are
subject to subsequent assessments for impairment based on fair value.
SFAS No. 125 provides that a liability is removed from the balance sheet
only if the debtor either pays the creditor and is relieved of its obligations
for the liability or is legally released from being the primary obligor. SFAS
No. 125 is effective for transfers and servicing of financial assets and
extinguishment of liabilities occurring after December 31, 1997 and is to be
applied prospectively. Earlier or retroactive application is not permitted.
Management adopted SFAS No. 125 during fiscal 1998, as required, without
material effect on the Company's consolidated financial position or results of
operations.
Comprehensive Income. In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains and losses) in a full set of general-purpose financial
statements. SFAS No. 130 requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. It does not require a specific format for that
financial statement but requires that an enterprise display an amount
representing total comprehensive income for the period in that financial
statement.
SFAS No. 130 requires that an enterprise (a) classify items of other
comprehensive income by their nature in a financial statement and (b) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial condition. SFAS No. 130 is effective for fiscal years beginning after
December 15, 1997. Reclassification of financial statements for earlier periods
provided for comparative purposes is required. SFAS No. 130 is not expected to
have a material impact on the Company's financial statements.
Business Segments. In June 1997, the FASB issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 significantly changes the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about reportable segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. SFAS No. 131 uses a "management approach" to disclose financial and
descriptive information about the way that management organizes the segments
within the enterprise for making operating decisions and assessing performance.
For many enterprises, the management approach will likely result in more
segments being reported. In addition, SFAS No. 131 requires significantly more
information to be disclosed for each reportable segment than is presently being
reported in annual financial statements and also requires that selected
information be reported in interim financial statements. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997. SFAS No. 131 is
not expected to have a material impact on the Company's financial statements.
43
<PAGE>
Derivatives 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 is effective for fiscal years beginning after June 15, 1999.
On adoption, entities are permitted to transfer held-to-maturity debt securities
to the available-for-sale category 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.
44
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
- -----------------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Certified Public Accountants 46
Consolidated Statements of Financial Condition as of
June 30, 1998 and 1997 47
Consolidated Statements of Earnings for the Years Ended
June 30, 1998, 1997 and 1996 48
Consolidated Statements of Shareholders' Equity for the Years Ended
June 30, 1998, 1997 and 1996 49
Consolidated Statements of Cash Flows for the Years Ended
June 30, 1998, 1997 and 1996 50
Notes to Consolidated Financial Statements 52
</TABLE>
45
<PAGE>
[Letterhead of Grant Thornton LLP]
Report of Independent Certified Public Accountants
--------------------------------------------------
Board of Directors
Kentucky First Bancorp, Inc.
We have audited the accompanying consolidated statements of financial condition
of Kentucky First Bancorp, Inc. as of June 30, 1998 and 1997, and the related
consolidated statements of earnings, shareholders' equity, and cash flows for
the years ended June 30, 1998, 1997 and 1996. These consolidated financial
statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these consolidated 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 Kentucky First
Bancorp, Inc. as of June 30, 1998 and 1997, and the consolidated results of its
operations and its cash flows for the years ended June 30, 1998, 1997 and 1996,
in conformity with generally accepted accounting principles.
/s/ Grant Thornton LLP
Cincinnati, Ohio
August 28, 1998
46
<PAGE>
KENTUCKY FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30,
(In thousands, except share data)
<TABLE>
<CAPTION>
ASSETS 1998 1997
<S> <C> <C>
Cash and due from banks $ 522 $ 505
Interest-bearing deposits in other financial institutions 1,435 762
------- -------
Cash and cash equivalents 1,957 1,267
Investment securities available for sale - at market 4,607 2,202
Investment securities held to maturity - at amortized cost, approximate
market value of $5,211 and $11,589 as of
June 30, 1998 and 1997 5,162 11,733
Mortgage-backed securities available for sale - at market 3,213 3,348
Mortgage-backed securities held to maturity - at cost, approximate market
value of $14,797 and $17,483 as of June 30, 1998 and 1997 14,680 17,822
Loans receivable - net 48,801 48,920
Office premises and equipment - at depreciated cost 1,356 1,397
Federal Home Loan Bank stock - at cost 1,130 1,052
Accrued interest receivable 492 574
Prepaid expenses and other assets 460 415
Prepaid federal income taxes 144 32
Deferred federal income taxes 44 94
------- -------
Total assets $82,046 $88,856
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $56,566 $55,443
Advances from the Federal Home Loan Bank 10,412 17,970
Accrued interest payable 117 148
Other liabilities 543 568
------- -------
Total liabilities 67,638 74,129
Commitments - -
Shareholders' equity
Preferred stock - authorized 500,000 shares of $.01 par value;
no shares issued - -
Common stock, authorized 3,000,000 shares of $.01 par value;
1,388,625 shares issued at June 30, 1998 and 1997 14 14
Additional paid-in capital 9,291 9,220
Retained earnings - restricted 8,144 7,825
Less shares acquired by stock benefit plans (1,249) (1,509)
Less 147,520 and 69,431 shares of treasury stock - at cost (1,883) (818)
Unrealized gains (losses) on securities designated as available for sale,
net of related tax effects 91 (5)
------- -------
Total shareholders' equity 14,408 14,727
------- -------
Total liabilities and shareholders' equity $82,046 $88,856
======= =======
</TABLE>
The accompanying notes are an integral part of these statements.
47
<PAGE>
KENTUCKY FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
For the year ended June 30,
(In thousands, except share data)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Interest income
Loans $4,080 $3,837 $3,265
Mortgage-backed securities 1,312 1,438 864
Investment securities 746 927 962
Interest-bearing deposits and other 99 97 266
------ ------ ------
Total interest income 6,237 6,299 5,357
Interest expense
Deposits 2,467 2,280 2,305
Borrowings 849 951 316
------ ------ ------
Total interest expense 3,316 3,231 2,621
------ ------ ------
Net interest income 2,921 3,068 2,736
Provision for losses on loans 30 15 15
------ ------ ------
Net interest income after provision
for losses on loans 2,891 3,053 2,721
Other income
Gain on investment securities transactions 16 - -
Service charges 129 109 82
Other operating 41 47 36
------ ------ ------
Total other income 186 156 118
General, administrative and other expense
Employee compensation and benefits 1,059 960 841
Occupancy and equipment 149 142 138
Federal deposit insurance premiums 34 420 119
Data processing 126 107 99
Other operating 406 483 408
------ ------ ------
Total general, administrative and other expense 1,774 2,112 1,605
------ ------ ------
Earnings before income taxes 1,303 1,097 1,234
Federal income taxes
Current 385 373 403
Deferred 1 (38) (18)
------ ------ ------
Total federal income taxes 386 335 385
------ ------ ------
NET EARNINGS $ 917 $ 762 $ 849
====== ====== ======
EARNINGS PER SHARE
Basic $.77 $.60 $.66
====== ====== ======
Diluted $.75 $.59 $.65
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
48
<PAGE>
KENTUCKY FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended June 30, 1998, 1997 and 1996
(In thousands, except share data)
<TABLE>
<CAPTION>
UNREALIZED
GAINS (LOSSES)
SHARES ON SECURITIES
ADDITIONAL ACQUIRED DESIGNATED
COMMON PAID-IN RETAINED BY STOCK TREASURY AS AVAILABLE
STOCK CAPITAL EARNINGS BENEFIT PLANS STOCK FOR SALE TOTAL
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at July 1, 1995 $ - $ - $7,159 $ - $ - $ - $ 7,159
Net proceeds from issuance of common stock 14 13,316 - (1,111) - - 12,219
Purchase of shares for management
recognition plan - - - (730) - - (730)
Amortization expense of stock benefit plans - 35 - 93 - - 128
Net earnings for the year ended June 30, 1996 - - 849 - - - 849
Cash dividends of $.25 per share - - (319) - - - (319)
Unrealized losses on securities designated
as available
for sale, net of related tax effects - - - - - (50) (50)
------ ------- ------ ------- -------- ------------- -------
Balance at June 30, 1996 14 13,351 7,689 (1,748) - (50) 19,256
Purchase of treasury stock - - - - (818) - (818)
Amortization expense of stock benefit plans - 35 - 239 - - 274
Net earnings for the year ended June 30, 1997 - - 762 - - - 762
Cash dividends of $.50 per share - - (626) - - - (626)
Capital distribution of $3.00 per share - (4,166) - - - - (4,166)
Unrealized gains on securities designated as
available for sale, net of related tax
effects - - - - - 45 45
------ ------- ------ ------- -------- ------------- -------
Balance at June 30, 1997 14 9,220 7,825 (1,509) (818) (5) 14,727
Purchase of treasury stock - - - - (1,124) - (1,124)
Amortization expense of stock benefit plans - 37 - 260 - - 297
Net earnings for the year ended June 30, 1998 - - 917 - - - 917
Cash dividends of $.50 per share - - (598) - - - (598)
Issuance of shares under stock option plan - 34 - - 59 - 93
Unrealized gains on securities designated as
available for sale, net of related tax
effects - - - - - 96 96
------ ------- ------ ------- -------- ------------- -------
Balance at June 30, 1998 $14 $ 9,291 $8,144 $(1,249) $(1,883) $ 91 $14,408
====== ======= ====== ======= ======== ============= =======
</TABLE>
The accompanying notes are an integral part of these statements.
49
<PAGE>
KENTUCKY FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings for the year $ 917 $ 762 $ 849
Adjustments to reconcile net earnings to net cash
provided by (used in) operating activities:
Amortization of discounts and premiums on loans,
investments and mortgage-backed securities - net (14) (19) (8)
Amortization of deferred loan origination fees (36) (44) (14)
Depreciation and amortization 67 64 50
Provision for losses on loans 30 15 15
Amortization of expense related to stock benefit plans 297 274 128
Gain on investment securities transactions (16) - -
Federal Home Loan Bank stock dividends (78) (65) (30)
Increase (decrease) in cash due to changes in:
Accrued interest receivable 82 (57) (74)
Prepaid expenses and other assets (45) (69) 56
Accrued interest payable (31) 77 (12)
Other liabilities (25) 66 253
Federal income taxes
Current (112) (194) 222
Deferred 1 (38) (18)
-------- -------- --------
Net cash provided by operating activities 1,037 772 1,417
Cash flows provided by (used in) investing activities:
Proceeds from maturity of investment securities 7,811 2,440 10,628
Purchase of investment securities designated as held to maturity - (701) (14,305)
Purchase of investment securities designated as available for sale (3,580) (100) -
Purchase of mortgage-backed securities designated as available for sale - - (3,088)
Purchase of mortgage-backed securities designated as held to maturity - - (15,253)
Principal repayments on mortgage-backed securities 3,387 2,053 1,189
Purchase of loans (783) (1,654) (779)
Loan principal repayments 12,756 11,140 8,137
Loan disbursements (11,848) (15,357) (10,288)
Purchase of office premises and equipment (26) (100) (43)
Proceeds from sale of office equipment - - 10
Purchase of Federal Home Loan Bank stock - (249) (405)
-------- -------- --------
Net cash provided by (used in) investing activities 7,717 (2,528) (24,197)
-------- -------- --------
Net cash provided by (used in) operating and investing
activities (subtotal carried forward) 8,754 (1,756) (22,780)
-------- -------- --------
</TABLE>
50
<PAGE>
KENTUCKY FIRST BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the year ended June 30,
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Net cash provided by (used in) operating and investing
activities (subtotal brought forward) $ 8,754 $ (1,756) $(22,780)
Cash flows provided by (used in) financing activities:
Net increase (decrease) in deposits 1,123 3,665 (1,327)
Proceeds from Federal Home Loan Bank advances 28,700 19,250 16,606
Repayment of Federal Home Loan Bank advances (36,258) (15,808) (4,157)
Proceeds from note payable - 2,000 -
Repayment of note payable - (2,000) -
Net proceeds from the issuance of common stock - - 12,219
Purchase of treasury stock (1,124) (818) -
Proceeds from issuance of shares under stock option plan 93 - -
Shares acquired by management recognition plan - - (730)
Dividends and capital distributions on common stock (598) (4,792) (319)
-------- -------- --------
Net cash provided by (used in) financing activities (8,064) 1,497 22,292
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 690 (259) (488)
Cash and cash equivalents at beginning of year 1,267 1,526 2,014
-------- -------- --------
Cash and cash equivalents at end of year $ 1,957 $ 1,267 $ 1,526
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Federal income taxes $ 466 $ 350 $ 197
======== ======== ========
Interest on deposits and borrowings $ 3,347 $ 3,154 $ 2,633
======== ======== ========
Supplemental disclosure of noncash investing activities:
Transfers of investment and mortgage-backed securities
to an available for sale classification $ - $ - $ 4,301
======== ======== ========
Unrealized gains (losses) on securities designated as available
for sale, net of related tax effects $ 96 $ 45 $ (50)
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
51
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
During fiscal 1995, the Board of Directors of First Federal Savings Bank (the
"Savings Bank") adopted a plan of conversion (the "Plan") whereby the Savings
Bank would convert to the stock form of ownership (the "Conversion"), followed
by the issuance of all of the Savings Bank's outstanding stock to a newly
formed holding company, Kentucky First Bancorp, Inc. (the "Corporation"), and
the issuance of common shares of the Corporation to subscribing members of the
Savings Bank. The conversion to the stock form of ownership was completed on
August 28, 1995, culminating in the Corporation's issuance of 1,388,625 common
shares. Condensed financial statements of the Corporation are presented in
Note N. Future references are made to either the Corporation or the Savings
Bank as applicable.
The Corporation is a savings and loan holding company whose activities are
primarily limited to holding the common stock of the Savings Bank. The
Savings Bank conducts a general banking business in central Kentucky which
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 its
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.
52
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
2. Investment Securities and Mortgage-Backed Securities
----------------------------------------------------
The Corporation accounts for investment and mortgage-backed 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 the resulting unrealized gains or losses recorded to operations or
shareholders' equity, respectively.
In November 1995, the FASB issued a Special Report on Implementation of SFAS
No. 115 (the "Special Report"), which provided for the reclassification of
securities between the held-to-maturity, available for sale and trading
portfolios during a forty-five day period, without calling into question
management's prior intent with respect to such securities. Management elected
to restructure the Corporation's securities portfolio pursuant to the Special
Report, and transferred approximately $4.3 million of investment and mortgage-
backed securities from the held-to-maturity portfolio to an available for sale
portfolio. At June 30, 1998 and 1997, the Corporation's shareholders' equity
reflected a respective net unrealized gain and loss on securities designated
as available for sale totaling $91,000 and $5,000.
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.
53
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
4. Loan Origination Fees
---------------------
The Savings Bank accounts for loan origination fees in accordance with SFAS
No. 91 "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs 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.
Major loans (including development projects) and major lending areas are
reviewed periodically to determine potential problems at an early date. The
allowance for loan losses is increased by charges to earnings and decreased by
charge-offs (net of recoveries).
The Savings Bank accounts for impaired loans in accordance with SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan," which requires that
impaired loans be measured based upon the present value of expected future
cash flows discounted at the loan's effective interest rate or, as an
alternative, at the loan's observable market price or fair value of the
collateral. The Savings Bank's current procedures for evaluating impaired
loans result in carrying such loans at the lower of cost or fair value.
A loan is defined under SFAS No. 114 as impaired when, based on current
information and events, it is probable that a creditor will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. In applying the provisions of SFAS No. 114, the Savings Bank
considers its investment in one-to-four family residential loans and consumer
installment loans to be homogeneous and therefore excluded from separate
identification for evaluation of impairment. With respect to the Savings
Bank's investment in multi-family and nonresidential loans, and its evaluation
of impairment thereof, such loans are collateral dependent and as a result are
carried as a practical expedient at the lower of cost or fair value.
54
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
5. Allowance for Losses on Loans (continued)
-----------------------------
It is the Savings Bank's general policy to charge off unsecured credits that
are more than ninety days delinquent. Similarly, collateral dependent loans
which are more than ninety days delinquent are considered to constitute more
than a minimum delay in repayment and are evaluated for impairment under SFAS
No. 114 at that time.
At June 30, 1998 and 1997, the Savings Bank had no loans that would be defined
as impaired under SFAS No. 114.
6. Office Premises and Equipment
-----------------------------
Office premises and equipment are carried at cost and include expenditures
which extend the useful lives of existing assets. Maintenance, repairs and
minor renewals are expensed as incurred. For financial reporting,
depreciation and amortization are provided on the straight-line and
accelerated methods over the useful lives of the assets, estimated to be forty
years for buildings, ten to forty years for building improvements, and five to
ten years for furniture and equipment. An accelerated method is used for tax
reporting purposes.
7. Real Estate Acquired Through Foreclosure
----------------------------------------
Real estate acquired through foreclosure is carried at the lower of the loan's
unpaid principal balance (cost) or fair value less estimated selling expenses
at the date of acquisition. Real estate loss provisions are recorded if the
properties' fair value subsequently declines below the amount determined at
the recording date. In determining the lower of cost or fair value at
acquisition, costs relating to development and improvement of property are
capitalized. Costs relating to holding real estate acquired through
foreclosure, net of rental income, are charged against earnings as incurred.
8. Federal Income Taxes
--------------------
The Corporation accounts for federal income taxes in accordance with the
provisions of SFAS No. 109, "Accounting for Income Taxes". 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 consolidated 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
55
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
8. Federal Income Taxes (continued)
--------------------
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, certain
components of benefit plans and percentage of earnings bad debt deductions.
Additional temporary differences result from depreciation computed using
accelerated methods for tax purposes.
9. Benefit Plans
--------------
In conjunction with the common stock offering, the Corporation adopted the
Kentucky First Bancorp, Inc. Employee Stock Ownership Plan ("ESOP"). The ESOP
provides retirement benefits for substantially all employees who have
completed one year of service and have attained the age of 21. Expense
recognized related to the ESOP totaled approximately $158,000 for the fiscal
year ended June 30, 1998, and $128,000 for each of the fiscal years ended June
30, 1997 and 1996.
In connection with the Conversion, the Corporation also adopted the Kentucky
First Bancorp, Inc. Management Recognition Plan ("MRP"). Subsequent to
adoption, the MRP purchased 55,545 shares of common stock in the open market.
All of the shares available under the MRP were granted to executive officers,
directors and employees of the Savings Bank upon receipt of shareholder
approval. The MRP provides that common stock granted under the MRP vests
ratably over a five year period. A provision of $186,000, $146,000 and
$29,000 related to the MRP was charged to expense for the fiscal years ended
June 30, 1998, 1997 and 1996, respectively.
56
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
10. Earnings and Dividends Per Share
--------------------------------
Basic earnings per share for the years ended June 30, 1998, 1997 and 1996, 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
92,574, 101,832 and 110,090 unallocated ESOP shares), totaled 1,188,719,
1,264,832 and 1,278,535 for the years ended June 30, 1998, 1997 and 1996,
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
1,230,251, 1,294,928 and 1,315,184 for the fiscal years ended June 30, 1998,
1997 and 1996, respectively.
Effective for the fiscal year ending June 30, 1998, the Corporation began
presenting earnings per share pursuant to the provisions of SFAS No. 128,
"Earnings Per Share." Accordingly, the fiscal 1997 and 1996 earnings per
share presentation has been revised to conform to SFAS No. 128.
During fiscal 1997, the Corporation paid cash distributions of $3.50 per
share. Of these distributions, management deemed $3.00 per share as a return
of capital charging such amount to additional paid-in capital in the 1997
consolidated financial statements.
11. Investment in Subsidiary
------------------------
The Savings Bank has a wholly-owned subsidiary, Cynthiana Service Corporation,
which was incorporated for the sole purpose of owning stock in the Savings
Bank's data processor. The subsidiary's assets at June 30, 1998 and 1997 are
limited to a $15,000 investment in such stock. As a result, the subsidiary
has not been consolidated based on materiality.
12. 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.
57
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
12. Fair Value of Financial Instruments (continued)
-----------------------------------
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,
1998 and 1997:
Cash and cash equivalents: The carrying amounts presented in the
-------------------------
consolidated statements of financial condition for cash and cash
equivalents are deemed to approximate fair value.
Investment and mortgage-backed securities: For investments and
-----------------------------------------
mortgage-backed securities, fair value is deemed to equal the quoted
market price.
Loans receivable: The loan portfolio has been segregated into
----------------
categories with similar characteristics, such as one-to-four family
residential, multi-family residential and nonresidential real estate.
These loan categories were further delineated into fixed-rate and
adjustable-rate loans. The fair values for the resultant loan
categories were computed via discounted cash flow analysis, using
current interest rates offered for loans with similar terms to
borrowers of similar credit quality. For loans on deposit accounts
and consumer and other loans, fair values were deemed to equal the
historic carrying values. The historical carrying amount of accrued
interest on loans is deemed to approximate fair value.
Federal Home Loan Bank stock: The carrying amount presented in the
----------------------------
consolidated statements of financial condition is deemed to
approximate fair value.
Deposits: The fair value of NOW accounts, passbook accounts and money
--------
market deposits is 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 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.
Commitments to extend credit: For fixed-rate and adjustable-rate loan
----------------------------
commitments, the fair value estimate considers the difference between
current levels of interest rates and committed rates. The difference
between the fair value and notional amount of outstanding loan
commitments at June 30, 1998 and 1997 was not material.
58
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
12. 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>
1998 1997
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
(In thousands)
<S> <C> <C> <C> <C>
Financial assets
Cash and cash equivalents $ 1,957 $ 1,957 $ 1,267 $ 1,267
Investment securities 9,769 9,818 13,935 13,791
Mortgage-backed securities 17,893 18,010 21,170 20,831
Loans receivable 48,801 50,265 48,920 50,615
Federal Home Loan Bank stock 1,130 1,130 1,052 1,052
------- ------- ------- -------
$79,550 $81,180 $86,344 $87,556
======= ======= ======= =======
Financial liabilities
Deposits $56,566 $56,613 $55,443 $55,455
Advances from the Federal Home Loan Bank 10,412 10,396 17,970 17,906
------- ------- ------- -------
$66,978 $67,009 $73,413 $73,361
======= ======= ======= =======
</TABLE>
13. Cash and Cash Equivalents
-------------------------
For purposes of reporting cash flows, cash and cash equivalents include cash
and due from banks and interest-bearing deposits due from other financial
institutions with original maturities of less than ninety days.
14. Reclassifications
-----------------
Certain prior year amounts have been reclassified to conform to the 1998
consolidated financial statement presentation.
59
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE B - INVESTMENTS AND MORTGAGE-BACKED SECURITIES
The amortized cost and estimated fair values of investment securities held to
maturity at June 30 are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
(In thousands)
<S> <C> <C> <C> <C>
U. S. Government
agency obligations $3,502 $3,514 $ 9,493 $ 9,319
Municipal obligations 1,660 1,697 2,240 2,270
------ ------ ------- ---------
$5,162 $5,211 $11,733 $11,589
====== ====== ======= =========
</TABLE>
At June 30, 1998, the estimated fair value of the Corporation's investment
securities exceeded the carrying value of such securities by $49,000,
consisting solely of gross unrealized gains. At June 30, 1997, the carrying
value of the Corporation's investment securities exceeded the estimated fair
value of such securities by $144,000, consisting of $30,000 in gross
unrealized gains and $174,000 in gross unrealized losses.
The amortized cost and estimated fair value of U.S. Government agency and
municipal obligations designated as held to maturity at June 30, by
contractual term to maturity, are shown below:
<TABLE>
<CAPTION>
1998 1997
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
(In thousands)
<S> <C> <C> <C> <C>
Due in three years or less $ 957 $ 962 $ 2,792 $ 2,795
Due after three years through
five years 135 145 160 170
Due after five years 4,070 4,104 8,781 8,624
------ ------ ------- -------
$5,162 $5,211 $11,733 $11,589
====== ====== ======= =======
</TABLE>
At June 30, 1997, investment securities totaling $2.0 million were pledged to
secure deposits.
60
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE B - INVESTMENTS AND MORTGAGE-BACKED SECURITIES (continued)
The amortized cost, gross unrealized gains, gross unrealized losses, and
estimated fair values of investment securities designated as available for
sale at June 30, 1998 and 1997, are summarized as follows:
<TABLE>
<CAPTION>
JUNE 30, 1998
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(In thousands)
<S> <C> <C> <C> <C>
U.S. Government agency obligations:
Due in three years or less $ 990 $ 4 $ - $ 994
Due after five years 1,500 1 - 1,501
Municipal obligations:
Due after five years 2,105 9 (2) 2,112
------ --- ---------- ------
$4,595 $14 $ (2) $4,607
====== === ========== ======
JUNE 30, 1997
Gross Gross Estimated
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(In thousands)
U.S. Government agency obligations:
Due in three years or less $1,984 $ - $(39) $1,945
Due after three years through five years 149 4 - 153
Municipal obligations:
Due after five years 100 4 - 104
------ --- ---------- ------
$2,233 $ 8 $(39) $2,202
====== === ========== ======
</TABLE>
The amortized cost, gross unrealized gains, gross unrealized losses and
estimated fair values of mortgage-backed securities at June 30, 1998 and 1997
(including those designated as available for sale) are summarized as follows:
<TABLE>
<CAPTION>
1998
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(In thousands)
<S> <C> <C> <C> <C>
HELD TO MATURITY:
Federal Home Loan Mortgage
Corporation participation certificates $ 1,786 $ 20 $(19) $ 1,787
Government National Mortgage
Association participation certificates 1,527 57 - 1,584
Federal National Mortgage Association
participation certificates 11,367 62 (3) 11,426
------- ---- ---- -------
14,680 139 (22) 14,797
Total mortgage-backed securities held to maturity
AVAILABLE FOR SALE:
Federal Home Loan Mortgage
Corporation participation certificates 3,088 125 - 3,213
------- ---- ---- -------
$17,768 $264 $(22) $18,010
======= ==== ==== =======
Total mortgage-backed securities
</TABLE>
61
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE B - INVESTMENTS AND MORTGAGE-BACKED SECURITIES (continued)
<TABLE>
<CAPTION>
1997
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(Inn thousands)
<S> <C> <C> <C> <C>
HELD TO MATURITY:
Federal Home Loan Mortgage
Corporation participation certificates $ 2,104 $ 6 $ (56) $ 2,054
Government National Mortgage
Association participation certificates 2,043 54 (9) 2,088
Federal National Mortgage Association
participation certificates 13,675 - (334) 13,341
------- --- ----- -------
17,822 60 (399) 17,483
Total mortgage-backed securities held to maturity
AVAILABLE FOR SALE:
Federal Home Loan Mortgage
Corporation participation certificates 3,325 23 - 3,348
------- --- ----- -------
$21,147 $83 $(399) $20,831
======= === ===== =======
Total mortgage-backed securities
</TABLE>
The amortized cost of mortgage-backed securities, by contractual terms to
maturity, are shown below. Based on materiality, contractual maturities of
mortgage-backed securities designated as available for sale have been combined
with those designated as held to maturity. Expected maturities will differ
from contractual maturities because borrowers may generally prepay obligations
without prepayment penalties.
<TABLE>
<CAPTION>
JUNE 30,
1998 1997
(In thousands)
<S> <C> <C>
Due within three years $ 249 $ 375
Due in three to five years 7 5
Due in five to ten years 815 539
Due in ten to twenty years 11,814 13,868
Due after twenty years 4,883 6,360
------- -------
$17,768 $21,147
======= =======
</TABLE>
62
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE C - LOANS RECEIVABLE
The composition of the loan portfolio at June 30 is as follows:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Residential real estate
One-to-four family $27,174 $26,922
Multi-family 5,322 5,972
Construction 1,220 130
Nonresidential real estate and land 11,350 11,555
Consumer and other 4,462 5,004
------- -------
49,528 49,583
Less:
Undisbursed portion of loans in process 232 143
Deferred loan origination fees 86 94
Unearned discount 25 54
Allowance for loan losses 384 372
------- -------
$48,801 $48,920
======= =======
</TABLE>
The Savings Bank's lending efforts have historically focused on one-to-four
family and multi-family residential real estate loans, which comprise
approximately $33.5 million, or 69%, of the total loan portfolio at June 30,
1998, and $32.9 million, or 67%, of the total loan portfolio at June 30, 1997.
Generally, such loans have been underwritten on the basis of no more than an
85% 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 $199,000 and $212,000 at June 30, 1998 and 1997, respectively.
63
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE D - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is summarized as follows for the
years ended June 30:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 372 $ 367 $ 352
Provision for loan losses 30 15 15
Charge-offs, net of recoveries (18) (10) -
----- ----- -----
Balance at end of year $ 384 $ 372 $ 367
===== ===== =====
</TABLE>
As of June 30, 1998, the Savings Bank's allowance for loan losses was solely
general in nature, and is includible as a component of regulatory risk-based
capital, subject to certain percentage limitations.
Nonperforming and nonaccrual loans totaled approximately $141,000, $59,000 and
$122,000 at June 30, 1998, 1997 and 1996, respectively.
During each of the years ended June 30, 1998, 1997 and 1996, interest income
of approximately $3,000 would have been recognized had such loans been
performing in accordance with contractual terms.
NOTE E - OFFICE PREMISES AND EQUIPMENT
Office premises and equipment at June 30 are comprised of the following:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Land and improvements $ 477 $ 477
Office buildings and improvements 953 946
Furniture, fixtures and equipment 388 369
------ ------
1,818 1,792
Less accumulated depreciation and
amortization 462 395
------ ------
$1,356 $1,397
====== ======
</TABLE>
64
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE F - DEPOSITS
Deposits consist of the following major classifications at June 30:
<TABLE>
<CAPTION>
DEPOSIT TYPE AND WEIGHTED-
AVERAGE INTEREST RATE 1998 1997
(In thousands)
<S> <C> <C>
NOW accounts
1998 - 1.90% $ 8,610
1997 - 1.89% $10,095
Passbook
1998 - 2.97% 6,090
1997 - 2.97% 6,206
Money market deposit accounts
1998 - 3.31% 4,248
1997 - 3.29% 3,525
------- -------
Total demand, transaction and
passbook deposits 18,948 19,826
Certificates of deposit
Original maturities of:
Less than 12 months
1998 - 5.00% 6,101
1997 - 5.01% 5,871
12 months to 24 months
1998 - 5.57% 19,965
1997 - 5.49% 18,373
30 months to 36 months
1998 - 5.69% 3,497
1997 - 5.70% 3,809
More than 36 months
1998 - 5.74% 4,082
1997 - 5.46% 3,948
Individual retirement accounts
1998 - 5.63% 3,973
1997 - 5.42% 3,616
------- -------
Total certificates of deposit 37,618 35,617
------- -------
Total deposit accounts $56,566 $55,443
======= =======
</TABLE>
At June 30, 1998 and 1997, the Savings Bank had certificate of deposit accounts
with balances in excess of $100,000 totaling $2.1 million and $3.5 million,
respectively.
65
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE F - DEPOSITS (continued)
Interest expense on deposits for the year ended June 30 is summarized as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Passbook $ 180 $ 180 $ 185
NOW and money market deposit
accounts 302 267 264
Certificates of deposit 1,985 1,833 1,856
------ ------- -------
$2,467 $ 2,280 $ 2,305
====== ======= =======
</TABLE>
Maturities of outstanding certificates of deposit at June 30 are summarized as
follows:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Less than one year $27,219 $24,126
One to three years 7,510 9,955
Over three years 2,889 1,536
------- -------
$37,618 $35,617
======= =======
</TABLE>
NOTE G - ADVANCES FROM THE FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank, collateralized at June 30, 1998 by
pledges of certain residential mortgage loans and securities totaling $15.6
million and the Savings Bank's investment in Federal Home Loan Bank stock, are
summarized as follows:
<TABLE>
<CAPTION>
MATURING
YEAR ENDING JUNE 30,
INTEREST RATE JUNE 30, 1998 1997
(Dollars in thousands)
<S> <C> <C> <C>
5.40% - 6.65% 1998 $ - $14,450
6.45% 1999 6,900 -
5.71% - 5.74% 2006 3,100 3,100
4.00% 2025 311 317
4.00% 2026 101 103
------- -------
$10,412 $17,970
======= =======
Weighted-average interest rate 6.12% 5.40%
======= =======
</TABLE>
66
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE H - FEDERAL INCOME TAXES
Federal income taxes differ from the amounts computed at the statutory
corporate tax rate as follows:
<TABLE>
<CAPTION>
JUNE 30,
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Federal income taxes computed at
statutory rate $ 443 $ 373 $ 420
Increase (decrease) in taxes resulting from:
Municipal interest income (57) (43) (39)
Other - 5 4
----- ----- -----
Federal income tax provision per consolidated
statements of earnings $ 386 $ 335 $ 385
===== ===== =====
</TABLE>
The composition of the Corporation's net deferred tax asset at June 30 is as
follows:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Taxes (payable) refundable on temporary
differences at estimated corporate tax rate:
Deferred tax assets:
General loan loss allowance $ 131 $ 127
Deferred loan origination fees 5 13
Deferred compensation 92 86
Retirement plans 70 65
Unrealized losses on securities designated as
available for sale - 3
----- -----
Total deferred tax assets 298 294
Deferred tax liabilities:
Percentage of earnings bad debt deduction (16) (24)
Book/tax depreciation (42) (34)
Federal Home Loan Bank stock dividends (69) (43)
Accrual vs. cash basis of accounting (74) (99)
Unrealized gains on securities designated
as available for sale (46) -
Other (7) -
----- -----
Total deferred tax liabilities (254) (200)
Net deferred tax asset $ 44 $ 94
===== =====
</TABLE>
67
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE H - FEDERAL INCOME TAXES (continued)
The Savings Bank was allowed a special bad debt deduction, generally limited
to 8% of otherwise taxable income, and subject to certain limitations based on
aggregate loans and deposit account balances at the end of the year. If the
amounts that qualify as deductions for federal income taxes are later used for
purposes other than bad debt losses, including distributions in liquidation,
such distributions will be subject to federal income taxes at the then current
corporate income tax rate. Retained earnings at June 30, 1998 include
approximately $1.6 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 $520,000 at June 30, 1998.
See Note L for additional information regarding the Savings Bank's future
percentage of earnings bad debt deductions.
NOTE I - 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 statement of financial condition. The
contract or notional amounts of the commitments reflect the extent of the
Savings Bank's involvement in such financial instruments.
The Savings Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit
is represented by the contractual notional amount of those instruments. The
Savings Bank uses the same credit policies in making commitments and
conditional obligations as those utilized for on-balance-sheet instruments.
At June 30, 1998, the Savings Bank had outstanding commitments of
approximately $410,000 to originate loans. In the opinion of management all
loan commitments equaled or exceeded prevailing market interest rates as of
June 30, 1998, and will be funded from normal cash flow from operations.
68
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE J - 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 classifications are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.
The minimum capital standards of the OTS generally require the maintenance of
regulatory capital sufficient to meet each of three tests, hereinafter
described as the tangible capital requirement, the core capital requirement
and the risk-based capital requirement. The tangible capital requirement
provides for minimum tangible capital (defined as shareholders' equity less
all intangible assets) equal to 1.5% of adjusted total assets. The core
capital requirement provides for minimum core capital (tangible capital plus
certain forms of supervisory goodwill and other qualifying intangible assets)
equal to 3.0% of adjusted total assets. An OTS proposal, if adopted in present
form, would increase the core capital requirement to a range of 4.0% - 5.0% of
adjusted total assets for substantially all savings associations. Management
anticipates no material change to the Savings Bank's excess regulatory capital
position as a result of this proposed change in the regulatory capital
requirement. The risk-based capital requirement currently provides for the
maintenance of core capital plus general loss allowances equal to 8.0% of
risk-weighted assets. In computing risk-weighted assets, the Savings Bank
multiplies the value of each asset on its statement of financial condition by
a defined risk-weighting factor, e.g., one- to four-family residential loans
carry a risk-weighted factor of 50%.
As of June 30, 1998 and 1997, management believes that the Savings Bank met
all capital adequacy requirements to which it is subject.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1998
TO BE "WELL-
CAPITALIZED" UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------- ----------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tangible capital $12,328 15.1% *$1,223 *1.5% *$4,076 *5.0%
Core capital $12,328 15.1% *$2,446 *3.0% *$4,892 *6.0%
Risk-based capital $12,712 27.3% *$3,729 *8.0% *$4,662 *10.0%
</TABLE>
* Greater than or Equal to.
69
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE J - REGULATORY CAPITAL (continued)
<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
TO BE "WELL-
CAPITALIZED" UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
-------------- ------------------ ------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tangible capital $13,022 14.7% *$1,326 *1.5% *$4,420 *5.0%
Core capital $13,022 14.7% *$2,652 *3.0% *$5,304 *6.0%
Risk-based capital $13,394 27.8% *$3,849 *8.0% *$4,811 *10.0%
</TABLE>
* Greater than or Equal to
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 K - STOCK OPTION PLAN
In fiscal 1996 the Board of Directors adopted the Kentucky First Bancorp, Inc.
Stock Option and Incentive Plan (the "Plan") which provided for the issuance
of 173,579 shares (adjusted for the fiscal 1997 return of capital
distribution) of authorized, but unissued shares of common stock at fair value
at the date of grant. The Corporation immediately granted options to purchase
138,862 shares at a return of capital adjusted fair value of $9.74 per share.
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
November 1995.
Also in fiscal 1996, the Corporation adopted SFAS No. 123, "Accounting for
Stock-Based Compensation," which contains a fair value-based method for
valuing stock-based compensation that entities may use, which measures
compensation cost at the grant date based on the fair value of the award.
Compensation is then recognized over the service period, which is usually the
vesting period. Alternatively, SFAS No. 123 permits entities to continue to
account for stock options and similar equity instruments under Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees." Entities that continue to account for stock options using APB
Opinion No. 25 are required to make pro forma disclosures of net earnings and
earnings per share, as if the fair value-based method of accounting defined in
SFAS No. 123 had been applied.
70
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE K - STOCK OPTION PLAN (continued)
The Corporation applies Accounting Principles Board Opinion No. 25 and related
Interpretations in accounting for its stock option plan. Accordingly, no
compensation cost has been recognized with respect to the Plan. Had
compensation cost for the Corporation's stock option plan been determined
based on the fair value at the grant date in a manner consistent with the
accounting method utilized in SFAS No. 123, then the Corporation's net
earnings and earnings per share would have been reduced to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
(Earnings in thousands)
<S> <C> <C> <C> <C>
Net earnings As reported $ 917 $ 762 $ 849
===== ===== =====
Pro-forma $ 917 $ 762 $ 834
===== ===== =====
Earnings per share
Basic As reported $ .77 $ .60 $ .66
===== ===== =====
Pro-forma $ .77 $ .60 $ .65
===== ===== =====
Diluted As reported $ .75 $ .59 $ .65
===== ===== =====
Pro-forma $ .75 $ .59 $ .63
===== ===== =====
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the modified Black-Scholes options-pricing model with the following weighted-
average assumptions used for grants in fiscal 1996: dividend yield of 5.5%,
expected volatility of 20.0%, a risk-free interest rate of 6.5% and an
expected life of ten years.
A summary of the status of the Corporation's stock option plan as of June 30,
1998, 1997 and 1996, and changes during the periods ending on those dates is
presented below:
<TABLE>
<CAPTION>
1998 1997 1996
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 173,579 $9.7375 138,862 $12.1875 - $ -
Adjustments for return of capital
distribution - - 34,717 (2.4500) - -
Granted - - - - 138,862 12.1875
Exercised 4,970 9.7375 - - - -
Forfeited - - - - - -
------- ------- ------- -------- ------- ---------
Outstanding at end of year 168,609 $9.7375 173,579 $ 9.7375 138,862 $12.1875
======= ======= ======= ======== ======= =========
Options exercisable at year-end 64,462 $9.7375 86,790 $ 9.7375 - $ -
======= ======= ======= ======== ======= =========
Weighted-average fair value of
options granted during the year N/A N/A $ 1.98
======= ======== =========
</TABLE>
71
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE K - STOCK OPTION PLAN (continued)
The following information applies to options outstanding at June 30, 1998:
<TABLE>
<S> <C>
Number outstanding 168,609
Range of exercise prices $ 9.7375
Weighted-average exercise price $ 9.7375
Weighted-average remaining contractual life 7.4 years
</TABLE>
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. In fiscal 1996 and 1997, no BIF assessments were required
for healthy commercial banks except for a $2,000 minimum fee.
Legislation which was enacted during fiscal 1997 to recapitalize the SAIF
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 $53.6 million in deposits at March 31,
1995, resulting in an approximate $351,000, or $232,000 after-tax, charge to
operations in fiscal 1997.
A component of the recapitalization plan provided for the merger of the SAIF
and BIF on January 1, 1999. However, the SAIF recapitalization legislation
currently provides for an elimination of the thrift charter or of the separate
federal regulation of thrifts prior to the merger of the deposit insurance
funds. As a result, the Savings Bank would be regulated as a bank under
federal laws which would subject it to the more restrictive activity limits
imposed on national banks. In the opinion of management, such activity limit
restrictions would not have a material effect on the Corporation's financial
position or results of operations.
Under separate legislation related to the recapitalization plan, the Savings
Bank is required to recapture as taxable income approximately $70,000 of its
tax bad debt reserve, which represents the post-1987 additions to the reserve,
and will be unable to utilize the percentage of earnings method to compute its
bad debt deduction in the future. The Savings Bank has provided deferred taxes
for this amount and will be permitted to amortize the recapture of the bad
debt reserve in taxable income over six years.
72
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE M - CORPORATE REORGANIZATION AND CONVERSION TO STOCK FORM
During fiscal 1995, the Savings Bank's Board of Directors adopted a plan of
conversion (the "Plan") whereby the Savings Bank would convert to the stock
form of ownership, followed by the issuance of all of the Savings Bank's
outstanding stock to a newly formed holding company, Kentucky First Bancorp,
Inc. Pursuant to the Plan, the Savings Bank offered for sale up to 1.4
million common shares to its depositors. The stock offering was completed on
August 28, 1995, culminating in the sale of 1,388,625 common shares and the
receipt of $12.2 million of net equity capital after consideration of offering
expenses and shares acquired by the ESOP.
At the completion of the conversion to stock form, the Savings Bank
established a liquidation account in an amount equal to retained earnings
contained in the final offering circular. The liquidation account will be
maintained for the benefit of eligible savings account holders who maintain
deposit accounts in the Savings Bank after conversion.
In the event of a complete liquidation (and only in such event), each eligible
savings account holder will be entitled to receive a liquidation distribution
from the liquidation account in the amount of the then current adjusted
balance of deposit accounts held, before any liquidation distribution may be
made with respect to common stock. Except for the repurchase of stock and
payment of dividends by the Savings Bank, the existence of the liquidation
account will not restrict the use or application of such retained earnings.
The Savings Bank may not declare, pay a cash dividend on, or repurchase any of
its common stock, if the effect thereof would cause retained earnings to be
reduced below either the amount required for the liquidation account or the
regulatory capital requirements for SAIF insured institutions.
73
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE N - CONDENSED FINANCIAL STATEMENTS OF KENTUCKY FIRST BANCORP, INC.
The following condensed financial statements summarize the financial position
of Kentucky First Bancorp, Inc. as of June 30, 1998 and 1997, and the results
of its operations and its cash flows for the years ended June 30, 1998, 1997
and 1996.
KENTUCKY FIRST BANCORP, INC.
STATEMENTS OF FINANCIAL CONDITION
June 30,
(In thousands)
<TABLE>
<CAPTION>
ASSETS 1998 1997
<S> <C> <C>
Deposits in First Federal Savings Bank $ 90 $ 56
Interest-bearing deposits in other financial institutions 385 202
Investment securities - 501
Loan receivable from ESOP 833 926
Investment in First Federal Savings Bank 12,419 13,022
Prepaid expenses and other assets 631 14
Prepaid federal income taxes 51 31
------- -------
Total assets $14,409 $14,752
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Accounts payable and other liabilities $ 1 $ 25
Shareholders' equity
Common stock and additional paid-in capital 9,305 9,234
Retained earnings 8,144 7,825
Less treasury stock (1,883) (818)
Less shares acquired by stock benefit plans (1,249) (1,509)
Unrealized gains (losses) on securities designated as available for sale,
net of related tax effects 91 (5)
------- -------
Total shareholders' equity 14,408 14,727
------- -------
Total liabilities and shareholders' equity $14,409 $14,752
======= =======
</TABLE>
KENTUCKY FIRST BANCORP, INC.
STATEMENTS OF EARNINGS
Years ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
Revenue
<S> <C> <C> <C>
Interest income $ 55 $ 106 $ 171
Equity in earnings of First Federal Savings Bank 964 822 780
------ ----- -----
Total revenue 1,019 928 951
General, administrative and other expense 126 197 173
------ ----- -----
Earnings before income tax credits 893 731 778
Federal income tax credits (24) (31) -
------ ----- -----
NET EARNINGS $ 917 $ 762 $ 778
====== ===== =====
</TABLE>
74
<PAGE>
KENTUCKY FIRST BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE N - CONDENSED FINANCIAL STATEMENTS OF KENTUCKY FIRST BANCORP, INC.
(continued)
KENTUCKY FIRST BANCORP, INC.
STATEMENTS OF CASH FLOWS
Year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Cash provided by (used in) operating activities:
Net earnings for the year $ 917 $ 762 $ 778
Adjustments to reconcile net earnings to net cash
provided by (used in)
operating activities
(Undistributed earnings of) excess of distributions
from
consolidated subsidiary 996 2,878 (780)
Increase (decrease) in cash due to changes in:
Prepaid expenses and other assets (617) 7 104
Prepaid federal income taxes (20) (31) -
Accounts payable and other liabilities (24) 25 -
------- ------- --------
Net cash provided by operating activities 1,252 3,641 102
Cash flows provided by (used in) investing activities:
Purchase of investment in First Federal Savings Bank - - (8,348)
Loan disbursements - - (1,018)
Proceeds from repayment of loan 93 92 -
Proceeds from maturities of investment securities 501 2,200 -
Purchase of investment securities - (701) (2,000)
------- ------- --------
Net cash provided by (used in) investing activities 594 1,591 (11,366)
Cash flows provided by (used in) financing activities:
Net proceeds from issuance of common stock - - 12,219
Proceeds from note payable - 2,000 -
Repayment of note payable - (2,000) -
Payment of dividends on common stock (598) (4,792) (319)
Proceeds from exercise of stock options 93 - -
Purchase of treasury stock (1,124) (818) -
------- ------- --------
Net cash provided by (used in) financing activities (1,629) (5,610) 11,900
------- ------- --------
Net increase (decrease) in cash and cash equivalents 217 (378) 636
Cash and cash equivalents at beginning of year 258 636 -
------- ------- --------
Cash and cash equivalents at end of year $ 475 $ 258 $ 636
======= ======= =======
</TABLE>
75
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
- -----------------------------------------------------------------------
The information required by this item is incorporated by reference to
"Proposal I -- Election of Directors" in the Proxy Statement.
For certain information regarding the non-director executive officers of
the Company, see "Item 1. Description of Business -- Executive Officers."
ITEM 10. EXECUTIVE COMPENSATION
- --------------------------------
The information required by this item is incorporated by reference to
"Executive Compensation" in the Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
The information required by this item is incorporated by reference to
"Voting Securities and Principal Holders Thereof" and "Proposal I -- Election of
Directors" in the Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Transactions with Management" in the Proxy Statement.
PART IV
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K.
- -------------------------------------------------
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
----------------------------------------------
(1) Financial Statements. The following financial statements are
incorporated by reference from Item 7:
Independent Auditors' Report
Consolidated Statements of Financial Condition as of June 30, 1998 and
1997
Consolidated Statements of Earnings for Each of the Years in the
Three-Year Period Ended June 30, 1998
Consolidated Statements of Shareholders' Equity for Each of the Years
in the Three-Year Period Ended June 30, 1998
Consolidated Statements of Cash Flows for Each of the Years in the
Three-Year Period Ended June 30, 1998
Notes to Consolidated Financial Statements
76
<PAGE>
(2) Exhibits. The following is a list of exhibits filed as part of this
Annual Report on Form 10-KSB and is also the Exhibit Index.
<TABLE>
<CAPTION>
Page in
Sequentially
No. Description Numbered Copy
--- ----------- -------------
<S> <C> <C>
3.1 Certificate of Incorporation of Kentucky First Bancorp, Inc. *
3.2 Bylaws of Kentucky First Bancorp, Inc. *
4 Form of Common Stock Certificate of Kentucky First Bancorp, Inc. *
10.1 First Federal Savings Bank Incentive Compensation Plan *+
10.2 Kentucky First Bancorp, Inc. Stock Option and Incentive Plan
10.3 Kentucky First Bancorp, Inc. Management Recognition Plans *+
10.4 Deferred Compensation Agreements, as amended
10.5 First Federal Savings Bank Retirement Plan for Non-Employee Directors *+
10.6 Supplemental Executive Retirement Agreement between First Federal
Savings Bank and Betty J. Long *+
10.7 Employment Agreements between First Federal Savings Bank and Betty J.
Long and Kevin R. Tolle *+
10.8 Employment Agreements between Kentucky First Bancorp, Inc. and Betty
J. Long and Kevin R. Tolle *
21 Subsidiaries of the Registrant
23.1 Consent of Grant Thornton L.L.P.
27 Financial Data Schedule (EDGAR only)
</TABLE>
- -------------------------
(*) Incorporated herein by reference from Registration Statement on Form S-1
filed (File No. 33-91134).
(+) Management contract or compensatory plan or arrangement.
(B) REPORTS ON FORM 8-K. There were no Current Reports on Form 8-K filed
-------------------
by the Company during the fourth quarter of fiscal year 1998.
77
<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.
KENTUCKY FIRST BANCORP, INC.
September 23, 1998 By: /s/ Betty J. Long
------------------------------------
Betty J. Long
President and Chief Executive Officer
(Duly Authorized Representative)
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/ Betty J. Long September 23, 1998
- --------------------------------------------
Betty J. Long
President and Chief Executive Officer
(Director and Principal Executive Officer)
/s/ William D. Morris September 23, 1998
- --------------------------------------------
William D. Morris
Chairman of the Board
(Director)
/s/ Luther O. Beckett September 23, 1998
- --------------------------------------------
Luther O. Beckett
Vice Chairman of the Board
(Director)
/s/ Milton G. Rees September 23, 1998
- --------------------------------------------
Milton G. Rees
(Director)
/s Diane Ritchie September 23, 1998
- --------------------------------------------
Diane Ritchie
(Director)
/s/ John Swinford September 23, 1998
- --------------------------------------------
John Swinford
(Director)
/s/ Wilbur H. Wilson September 23, 1998
- --------------------------------------------
Wilbur H. Wilson
(Director)
/s/ Russell M. Brooks September 23, 1998
- --------------------------------------------
Russell M. Brooks
Executive Vice President
(Principal Accounting and Financial Officer)
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Parent
- ------
Kentucky First Bancorp, Inc.
<TABLE>
<CAPTION>
State or Other Percentage
Subsidiaries (1) Jurisdiction of Incorporation Ownership
- ---------------- ----------------------------- -----------
<S> <C> <C>
First Federal Savings Bank United States 100%
Cynthiana Service Corporation (2) Kentucky 100%
</TABLE>
- -------------------------
(1) The assets, liabilities and operations of the subsidiaries are included in
the consolidated financial statements contained in the financial statements
attached hereto as an exhibit.
(2) Wholly owned subsidiary of First Federal Savings Bank.
<PAGE>
EXHIBIT 23.1
ACCOUNTANTS' CONSENT
We have issued our report dated August 28, 1998, accompanying the consolidated
financial statements of Kentucky First Bancorp, Inc. which are incorporated
within the Annual Report on Form 10-KSB for the year ended June 30, 1998. We
hereby consent to the incorporation by reference of said report in the
Corporation's Form S-8.
/s/ Grant Thornton LLP
Cincinnati, Ohio
September 21, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> JUN-30-1998
<CASH> 522
<INT-BEARING-DEPOSITS> 1,435
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 7,820
<INVESTMENTS-CARRYING> 19,842
<INVESTMENTS-MARKET> 20,008
<LOANS> 48,801
<ALLOWANCE> 384
<TOTAL-ASSETS> 82,046
<DEPOSITS> 56,566
<SHORT-TERM> 0
<LIABILITIES-OTHER> 660
<LONG-TERM> 10,412
0
0
<COMMON> 14
<OTHER-SE> 14,394
<TOTAL-LIABILITIES-AND-EQUITY> 82,046
<INTEREST-LOAN> 4,080
<INTEREST-INVEST> 2,058
<INTEREST-OTHER> 99
<INTEREST-TOTAL> 6,237
<INTEREST-DEPOSIT> 2,467
<INTEREST-EXPENSE> 3,316
<INTEREST-INCOME-NET> 2,921
<LOAN-LOSSES> 30
<SECURITIES-GAINS> 16
<EXPENSE-OTHER> 1,774
<INCOME-PRETAX> 1,303
<INCOME-PRE-EXTRAORDINARY> 917
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 917
<EPS-PRIMARY> .77
<EPS-DILUTED> .75
<YIELD-ACTUAL> 3.51
<LOANS-NON> 31
<LOANS-PAST> 110
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 372
<CHARGE-OFFS> 18
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 384
<ALLOWANCE-DOMESTIC> 384
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
