Unassociated Document
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
DC 20549
FORM
10-K
(Mark
One)
x
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ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For the
fiscal year ended June 30, 2010
OR
¨
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For the
transition period from
to
Commission
file number 0-51176
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KENTUCKY FIRST FEDERAL
BANCORP
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(Exact
name of registrant as specified in its charter)
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United States
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61-1484858
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(State
or other jurisdiction of
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(I.R.S.
Employer
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incorporation
or organization)
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Identification
No.)
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479 Main Street, Hazard,
Kentucky
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41702
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(Address
of principal executive offices)
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(Zip
Code)
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Registrant’s
telephone number, including area code:
(502)
223-1638
Securities
registered pursuant to Section 12(b) of the Act:
Common Stock (par value $0.01 per
share)
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Nasdaq Stock Market, LLC
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(Title
of each class)
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(Name
of each exchange on which registered)
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Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by check mark whether the registrant is a well-known seasoned issuer, as defined
in Rule 405 of the Securities Act. Yes ¨ No
x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes ¨ No
x
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days. Yes x No ¨
Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such
files. Yes ¨ No ¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):
Large
accelerated filer ¨
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Accelerated
filer ¨
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Non-accelerated
filer ¨
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Smaller Reporting Company
x
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(Do
not check if smaller reporting company)
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Indicate by a check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes ¨ No x
The
aggregate market value of the common stock held by nonaffiliates was $24.9
million as of June 30, 2010.
Number of
shares of common stock outstanding as of September 20,
2010: 7,789,689
DOCUMENTS
INCORPORATED BY REFERENCE
The
following lists the documents incorporated by reference and the Part of the Form
10-K into which the document is incorporated:
1. Portions
of the Annual Report to Stockholders for the fiscal year ended June 30, 2010.
(Part II)
2. Portions
of Proxy Statement for the 2010 Annual Meeting of Stockholders. (Part
III)
INDEX
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PAGE
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PART
I
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Item
1.
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Business
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1
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Item
1A.
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Risk
Factors
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17
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Item
1B.
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Unresolved
Staff Comments
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21
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Item
2.
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Properties
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21
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Item
3.
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Legal
Proceedings
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21
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Item
4.
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[Removed
and reserved]
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21
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PART
II
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Item
5.
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Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
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22
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Item
6.
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Selected
Financial Data
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22
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Item
7.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operation
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22
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Item
7A.
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Quantitative
and Qualitative Disclosures About Market Risk
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22
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Item
8.
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Financial
Statements and Supplementary Data
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22
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Item
9.
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Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
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23
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Item
9A.
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Controls
and Procedures
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23
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Item
9B.
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Other
Information
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24
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PART
III
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Item
10.
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Directors,
Executive Officers and Corporate Governance
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24
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Item
11.
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Executive
Compensation
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24
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Item
12.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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24
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Item
13.
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Certain
Relationships and Related Transactions, and Director
Independence
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25
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Item
14.
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Principal
Accountant Fees and Services
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25
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PART
IV
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Item
15.
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Exhibits
and Financial Statement Schedules
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26
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SIGNATURES
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28
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PART
I
Item
1.
Business
Forward-looking
Statements
This
report contains certain “forward-looking statements” within the meaning of the
federal securities laws. These statements are not historical facts, rather
statements based on Kentucky First Federal Bancorp’s current expectations
regarding its business strategies, intended results and future
performance. Forward-looking statements are preceded by terms such as
“expects,” “believes,” “anticipates,” “intends” and similar
expressions.
Management’s ability to predict results
or the effect of future plans or strategies is inherently uncertain.
Factors which could affect actual results include the following: interest
rate trends; the general economic climate in the market areas in which Kentucky
First Federal Bancorp operates, as well as nationwide; Kentucky First Federal
Bancorp’s ability to control costs and expenses; competitive products and
pricing; loan delinquency rates; and changes in federal and state legislation
and regulation. These factors should be considered in evaluating the
forward-looking statements and undue reliance should not be placed on such
statements. Kentucky First Federal Bancorp assumes no obligation to update
any forward-looking statements.
General
References in this Annual Report on
Form 10-K to “we,” “us” and “our” refer to Kentucky First, and where
appropriate, collectively to Kentucky First, First Federal of Hazard and First
Federal of Frankfort.
Kentucky First
Federal Bancorp. Kentucky First Federal Bancorp (“Kentucky First”
or the “Company”) was incorporated as a mid-tier holding company under the laws
of the United States on March 2, 2005 upon the completion of the reorganization
of First Federal Savings and Loan Association of Hazard (“First Federal of
Hazard”) into a federal mutual holding company form of organization (the
“Reorganization”). On that date, Kentucky First completed its minority
stock offering and issued a total of 8,596,064 shares of common stock, of which
4,727,938 shares, or 55%, were issued to First Federal MHC, a federally
chartered mutual holding company formed in connection with the Reorganization,
in exchange for the transfer of all of First Federal of Hazard’s capital stock,
and 2,127,572 shares were sold at a cash price of $10.00 per share. Also
on March 2, 2005, Kentucky First completed its acquisition of Frankfort First
Bancorp, Inc. (“Frankfort First Bancorp”) and its wholly owned subsidiary First
Federal Savings Bank of Frankfort, Frankfort, Kentucky (“First Federal of
Frankfort”) (the “Merger”). Under the terms of the agreement of merger,
shareholders of Frankfort First Bancorp received approximately 1,740,554 shares
of Kentucky First’s common stock and approximately $13.7 million in cash
(including payments to holders of Frankfort First stock options).
Following the Reorganization and Merger, the Company retained Frankfort First
Bancorp as a wholly owned subsidiary and holds all of the capital stock of First
Federal of Hazard and First Federal of Frankfort. The Company is operating
First Federal of Hazard and First Federal of Frankfort as two independent,
community-oriented savings institutions.
Kentucky
First’s and First Federal of Hazard’s executive offices are located at 479 Main Street, Hazard,
Kentucky, 41702 and the telephone number for investor relations is (888)
818-3372.
At June
30, 2010, Kentucky First had total assets of $236.9 million, deposits of $145.0
million and stockholders’ equity of $57.7 million. The discussion in this
Annual Report on Form 10-K relates primarily to the businesses of First Federal
of Hazard and First Federal of Frankfort (collectively, the “Banks”), as
Kentucky First’s operations consist primarily of operating the Banks and
investing funds retained in the Reorganization.
First
Federal of Hazard and First Federal of Frankfort are subject to examination and
comprehensive regulation by the Office of Thrift Supervision and their savings
deposits are insured up to applicable limits by the Deposit Insurance Fund,
which is administered by the Federal Deposit Insurance Corporation. Both
of the Banks are members of the Federal Home Loan Bank of Cincinnati, which is
one of the 12 regional banks in the FHLB System. See “Regulation and
Supervision.”
First Federal
Savings and Loan Association of Hazard. First Federal of Hazard
was formed as a federally chartered mutual savings and loan association in
1960. First Federal of Hazard operates from a single office in Hazard,
Kentucky as a community-oriented savings and loan association offering
traditional financial services to consumers in Perry and surrounding counties in
eastern Kentucky. It engages primarily in the business of attracting
deposits from the general public and using such funds to originate, when
available, loans secured by first mortgages on owner-occupied, residential real
estate and occasionally other loans secured by real estate. To the extent
there is insufficient loan demand in its market area, and where appropriate
under its investment policies, First Federal of Hazard has historically invested
in mortgage-backed and investment securities, although since the reorganization,
First Federal of Hazard has been purchasing whole loans and participations in
loans originated at First Federal of Frankfort. At June 30, 2010, First
Federal of Hazard had total assets of $105.9 million, net loans of $77.9
million, total mortgage-backed and other securities of $9.4 million, deposits of
$77.2 million and total capital of $18.6 million.
First Federal
Savings Bank of Frankfort. First Federal of Frankfort is a
federally chartered savings bank, which is primarily engaged in the business of
attracting deposits from the general public and originating primarily
adjustable-rate loans secured by first mortgages on owner-occupied and
nonowner-occupied one- to four-family residences in Franklin, Anderson, Scott,
Shelby, Woodford and other counties in Kentucky. First Federal of
Frankfort also originates, to a lesser extent, home equity loans and loans
secured by churches, multi-family properties, professional office buildings and
other types of property. At June 30, 2010, First Federal of Frankfort had
total assets of $138.6 million, net loans of $110.6 million, deposits of $79.6
million and total capital of $32.4 million.
First
Federal of Frankfort’s main office is located at 216 W. Main Street, Frankfort,
Kentucky 40602 and its main telephone number is (502) 223-1638.
Market
Areas
First
Federal of Hazard and First Federal of Frankfort operate in two distinct market
areas.
First
Federal of Hazard’s market area consists of Perry County, where the business
office is located, as well as the surrounding counties of Letcher, Knott,
Breathitt, Leslie and Clay Counties in eastern Kentucky. The economy in
its market area has been distressed in recent years. The local
economy depends on the coal industry and other industries, such as health care
and manufacturing. Still, the economy in First Federal of Hazard’s market
area continues to lag behind the economies of Kentucky and the United
States. In the most recent available data, using information from the
State of Kentucky Economic Development Information System
(www.thinkkentucky.com), per capita personal income in Perry County averaged
$28,023 in 2008, compared to personal income of $31,936 in Kentucky and $40,166
in the United States. Total population in Perry County has remained stable
over the last five years at approximately 30,000. However, as a regional
economic center, Hazard tends to draw consumers and workers who commute from
surrounding counties. Employment in the market area, particularly in Perry
County, consists primarily of the trade, transportation and utilities industry
(18.4%), the mining industry (16.0%), and the services sector, including health
care (15.7%). During the last five years, the unemployment rate has
been 6.8% or higher, and in June 2010, was 10.9%, compared to 10.0% in Kentucky
and 9.5% in the United States.
First
Federal of Frankfort’s primary lending area includes the Kentucky counties of
Franklin, Anderson, Scott, Shelby and Woodford, with the majority of lending
originated on properties located in Franklin County. Franklin County has a
population of approximately 49,000, of which approximately 27,000 live within
the city of Frankfort, which serves as the capital of Kentucky. The
primary employer in the area is the state government, which employs about 47% of
the work force. In addition, there are several large industrial, financial
and government employers in the community. Despite this large, relatively
stable source of employment, the unemployment rate was 8.7% in June 2010 after
having experienced an unemployment rate which had ranged from 4.7 to 9% in prior
years.
Lending
Activities
General. Our loan portfolio
consists primarily of one- to four-family residential mortgage loans. As
opportunities arise, we also offer loans secured by churches, commercial real
estate, and multi-family real estate. We also offer loans secured by
deposit accounts and, through First Federal of Frankfort, home equity
loans. Substantially all of our loans are made within the Banks’
respective market areas.
Residential
Mortgage Loans. Our primary lending
activity is the origination of mortgage loans to enable borrowers to purchase or
refinance existing homes in the Banks’ respective market areas. At June
30, 2010, residential mortgage loans totaled $174.4 million, or 90.4% of our
total loan portfolio. We offer a mix of adjustable-rate and fixed-rate
mortgage loans with terms up to 40 years. Adjustable-rate loans have an
initial fixed term of one, three, five or seven years. After the initial
term, the rate adjustments on First Federal of Frankfort’s adjustable-rate loans
are indexed to the National Average Contract Interest Rate for Major Lenders on
the Purchase of Previously Occupied Homes. The interest rates on these
mortgages are adjusted once a year, with limitations on adjustments of one
percentage point per adjustment period, and a lifetime cap of five percentage
points. We determine loan fees charged, interest rates and other provisions of
mortgage loans on the basis of our own pricing criteria and competitive market
conditions. Some loans originated by the Banks have an additional advance
clause which allows the borrower to obtain additional funds at prevailing
interest rates, subject to managements’ approval.
At June 30, 2010, the Company’s loan
portfolio included $114.5 million in adjustable-rate one- to four-family
residential mortgage loans, or 69.0%, of the Company’s one- to four-family
residential mortgage loan portfolio.
The retention of adjustable-rate loans
in the portfolio helps reduce our exposure to increases in prevailing market
interest rates. However, there are unquantifiable credit risks resulting
from potential increases in costs to borrowers in the event of upward repricing
of adjustable-rate loans. It is possible that during periods of rising
interest rates, the risk of default on adjustable-rate loans may increase due to
increases in interest costs to borrowers. However, despite their
popularity in some parts of the country, neither bank offers adjustable-rate
loans that contractually allow for negative amortization. Such loans,
under some circumstances, can cause the balance of a closed-end loan to exceed
the original balance and perhaps surpass the value of the collateral.
Further, although adjustable-rate loans allow us to increase the sensitivity of
our interest-earning assets to changes in interest rates, the extent of this
interest sensitivity is limited by the initial fixed-rate period before the
first adjustment and the periodic and lifetime interest rate adjustment
limitations. Accordingly, there can be no assurance that yields on our
adjustable-rate loans will fully adjust to compensate for increases in our cost
of funds. Finally, adjustable-rate loans may decrease at a pace faster
than decreases in our cost of funds, resulting in reduced net
income.
While one- to four-family residential
real estate loans are normally originated with up to 30-year terms, (with terms
up to 40 years available for some products) such loans typically remain
outstanding for substantially shorter periods because borrowers often prepay
their loans in full upon sale of the mortgaged property or upon refinancing the
original loan. Therefore, average loan maturity is a function of, among
other factors, the level of purchase and sale activity in the real estate
market, prevailing interest rates and the interest rates payable on outstanding
loans. As interest rates declined and remained low over the past few
years, we have experienced high levels of loan repayments and
refinancings.
The Banks offer various programs for
the purchase and refinance of one- to four-family loans. Most of these
loans have loan-to-value ratios of 80% or less, based on an appraisal provided
by a state licensed or certified appraiser. For owner-occupied properties,
the borrower may be able to borrow up to 95% of the value if they secure and pay
for private mortgage insurance or they may be able to obtain a second mortgage
(at a higher interest rate) in which they borrow up to 90% of the value.
On a rare case-by-case basis, the Boards of Directors of the Banks may approve a
loan above the 80% loan-to-value ratio without such
enhancements.
Construction
Loans. We
originate loans to individuals to finance the construction of residential
dwellings for personal use or for use as rental property. On limited
occasions we have made construction loans to builders for the construction of a
single-family residence for subsequent sale. At June 30, 2010,
construction loans totaled $1.9 million, or 0.9%, of our total loan
portfolio. Our construction loans generally provide for the payment of
interest only during the construction phase, which is usually less than one
year. Loans generally can be made with a maximum loan to value ratio of
80% of the appraised value. Funds are disbursed as progress is made toward
completion of the construction based on site inspections by qualified bank
staff.
Construction financing is generally
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
depends 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, we 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, we may be
confronted, at or before the maturity of the loan, with a project having a value
which is insufficient to assure full repayment. As a result of the
foregoing, construction lending often involves the disbursement of substantial
funds with repayment dependent, in part, on the success of the ultimate project
rather than the ability of the borrower or guarantor to repay principal and
interest. If we are forced to foreclose on a project before or at
completion due to a default, there can be no assurance that we will be able to
recover the unpaid balance and accrued interest on the loan, as well as related
foreclosure and holding costs.
Multi-Family and
Nonresidential Loans. As opportunities
arise, we offer mortgage loans secured by multi-family (residential property
comprised of five or more units) or nonresidential real estate, which is
generally secured by commercial office buildings, churches, condominiums and
properties used for other purposes. At June 30, 2010, multi-family and
nonresidential loans totaled $6.7 million and $10.9 million, respectively, or
3.5% and 5.7%, respectively, of our total loan portfolio. We originate
multi-family and nonresidential real estate loans for terms of generally 25
years or less. Loan amounts generally do not exceed 80% of the appraised
value and tend to range much lower.
Loans secured by multi-family and
commercial real estate generally have larger balances and involve a greater
degree of risk than one- to four-family residential mortgage loans. Of
primary concern in multi-family and commercial real estate lending is the
borrower’s creditworthiness and the feasibility and cash flow potential of the
project. Payments on loans secured by income properties often depend on
successful operation and management of the properties. As a result,
repayment of such loans may be subject to a greater extent than residential real
estate loans to adverse conditions in the real estate market or the
economy. To monitor cash flows on income properties, we require borrowers
and/or loan guarantors to provide annual financial statements on larger
multi-family and commercial real estate loans. In reaching a decision on
whether to make a multi-family or commercial real estate loan, we consider the
net cash flow of the project, the borrower’s expertise, credit history and the
value of the underlying property.
Consumer
Lending. Our consumer loans include home equity lines of credit and
loans secured by savings deposits. At June 30, 2010, our consumer loan
balance totaled $7.6 million, or 3.9%, of our total loan portfolio. Of the
consumer loan balance at June 30, 2010, $4.8 million were home equity loans and
$2.8 million were loans secured by savings deposits.
Our home equity loans are made at First
Federal of Frankfort and are made on the security of residential real estate and
have terms of up to 10 years. Most of First Federal of Frankfort’s home
equity loans are second mortgages subordinate only to first mortgages also held
by the bank and do not exceed 80% of the estimated value of the property, less
the outstanding principal of the first mortgage. First Federal of
Frankfort does offer home equity loans up to 90% of the value less the balance
of the first mortgage at a premium rate to qualified borrowers. These
loans are not secured by private mortgage insurance. First Federal of
Frankfort’s home equity loans require the monthly payment of 2% of the unpaid
principal until maturity, when the remaining unpaid principal, if any, is
due. First Federal of Frankfort’s home equity loans bear variable rates of
interest indexed to the prime rate for loans with 80% or less loan-to-value
ratio, and 2% above the prime rate for loans with a loan-to-value ratio in
excess of 80%. Interest rates on these loans can be adjusted
monthly. At June 30, 2010, the total outstanding home equity loans
amounted to 2.5% of the Company’s total loan portfolio.
Loans secured by savings are originated
for up to 90% of the depositor’s savings account balance. The interest
rate is normally two percentage points above the rate paid on the savings
account, and the account must be pledged as collateral to secure the loan.
At June 30, 2010, loans on savings accounts totaled 1.4% of the Company’s total
loan portfolio.
Consumer loans generally entail greater
risk than do residential mortgage loans, particularly in the case of consumer
loans which are unsecured or secured by rapidly depreciable assets. However,
these risks are considerably reduced in our case, since all of our consumer
loans are secured loans.
Loan
Originations, Purchases and Sales. Loan originations come
from a number of sources. The primary source of loan originations are our
in-house loan originators, and to a lesser extent, advertising and referrals
from customers and real estate agents. We currently do not purchase
loans. First Federal of Frankfort sells fixed-rate loans with longer
maturities to the Federal Home Loan Bank of Cincinnati
(“FHLB-Cincinnati”). We earn income on the loans sold through fees we
charge on the origination, interest spread premiums earned when we sell the
loans, and loan servicing fees on an on-going basis, because servicing rights
are retained on such loans. At June 30, 2010, $12.8 million in loans were
being serviced by First Federal of Frankfort for the
FHLB-Cincinnati.
Loan Approval
Procedures and Authority. Our lending activities
follow written, nondiscriminatory, underwriting standards and loan origination
procedures established by each Bank’s Board of Directors and management.
First Federal of Hazard’s loan committee, consisting of its two senior officers,
has authority to approve loans of up to $275,000. Loans above this amount
and loans with non-standard terms such as longer repayment terms or high
loan-to-value ratios, must be approved by our Board of Directors. First
Federal of Frankfort’s loan approval process allows for various combinations of
experienced bank officers to approve or deny loans which are one- to four-family
properties totaling $275,000 or less, church loans of under $150,000, home
equity lines of credit of $100,000 or less and loans to individuals whose
aggregate borrowings with the Bank is less than $500,000. Loans that do not
conform to these criteria must be submitted to the Board of Directors or
Executive Committee composed of at least three directors, for
approval.
It is the Company’s practice to record
a lien on the real estate securing a loan. The Banks generally do not
require title insurance, although it may be required for loans made in certain
programs. The Banks do require fire and casualty insurance on all security
properties and flood insurance when the collateral property is located in a
designated flood hazard area. First Federal of Frankfort also requires an
earthquake provision in all policies for new loans.
Loans to One
Borrower.
The maximum amount either Bank may lend to one borrower and the borrower’s
related entities is limited, by regulation, to generally 15% of that Bank’s
stated capital and the allowance for loan losses. At June 30, 2010, the
regulatory limit on loans to one borrower was $2.9 million for First Federal of
Hazard and $2.7 million for First Federal of Frankfort. Neither of the
banks had lending relationships in excess of their respective lending
limits. However, loans or participations in loans may be sold among the
Banks, which may allow a borrower’s total loans with the Company to exceed the
limit of either individual bank.
Loan
Commitments. The Banks issue
commitments for the funding of mortgage loans. Generally, these
commitments exist from the time the underwriting of the loan is completed and
the closing of the loan. Generally, these commitments are for a maximum of
30 or 60 days but management routinely extends the commitment if circumstances
delay the closing. Management reserves the right to verify or re-evaluate
the borrower’s qualifications and to change the rates and terms of the loan at
that time.
If conditions exist whereby either Bank
experiences a significant increase in loans outstanding or commits to originate
loans that are riskier than a typical one- to four-family mortgage, management
and the boards will consider reflecting the anticipated loss exposure in a
separate liability. As residential loans are approved in the normal course
of business, and those loans are underwritten to the standards of the Banks,
management does not believe alteration of the allowance for loan losses is
warranted. At June 30, 2010, no commitment losses were reflected in a
separate liability.
First Federal of Frankfort offers
construction loans in which the borrower obtains the loan for a short term, less
than one year, and simultaneously extends a commitment for permanent
financing. First Federal of Hazard offers a construction loan that is
convertible to permanent financing, thus no additional commitment is
made.
Interest Rates
and Loan Fees. Interest rates charged on mortgage loans are
primarily determined by competitive loan rates offered in our market areas and
our yield objectives. Mortgage loan rates reflect factors such as
prevailing market interest rate levels, the supply of money available to the
savings industry and the demand for such loans. These factors are in turn
affected by general economic conditions, the monetary policies of the federal
government, including the Board of Governors of the Federal Reserve System, the
general supply of money in the economy, tax policies and governmental budget
matters.
We receive fees in connection with late
payments on our loans. Depending on the type of loan and the competitive
environment for mortgage loans, we may charge an origination fee on all or some
of the loans we originate. We may also offer a menu of loans whereby the
borrower may pay a higher fee to receive a lower rate or to pay a smaller or no
fee for a higher rate.
Delinquencies. When a borrower fails
to make a required loan payment, we take a number of steps to have the borrower
cure the delinquency and restore the loan to current status. We make
initial contact with the borrower when the loan becomes 15 days past due.
Subsequently, bank staff under the direct supervision of senior management and
with consultation by the Banks’ attorneys, attempt to contact the borrower and
determine their status and plans for resolving the delinquency. However,
once a delinquency reaches 90 days, management considers foreclosure and, if the
borrower has not provided a reasonable plan (such as selling the collateral, a
commitment from another lender to refinance the loan or a plan to repay the
delinquent principal, interest, escrow, and late charges) the foreclosure suit
may be initiated. In some cases, management may delay initiating the
foreclosure suit if, in management’s opinion, the Banks’ chance of loss is
minimal (such as with loans where the estimated value of the property greatly
exceeds the amount of the loan) or if the original borrower is deceased or
incapacitated. If a foreclosure action is initiated and the loan is not
brought current, paid in full, or refinanced with another lender before the
foreclosure sale, the real property securing the loan is sold at
foreclosure. The Banks are represented at the foreclosure sale and in most
cases will bid an amount equal to the Banks’ investment (including interest,
advances for taxes and insurance, foreclosure costs, and attorney’s fees).
If another bidder outbids the Bank, the Bank’s investment is received in
full. If another bidder does not outbid the Banks, the Banks acquire the
property and attempt to sell it to recover their investment.
A borrower’s filing for bankruptcy can
alter the methods available to the Banks to seek collection. In such
cases, the Banks work closely with legal counsel to resolve the delinquency as
quickly as possible.
We may consider loan workout
arrangements with certain borrowers under certain conditions. Management
of each bank provides a report to its board of directors on a monthly basis of
all loans more than 60 days delinquent, including loans in foreclosure, and all
property acquired through foreclosure.
Investment
Activities
We have legal authority to invest in
various types of liquid assets, including U.S. Treasury obligations, securities
of various federal agencies and state and municipal governments, mortgage-backed
securities and certificates of deposit of federally insured institutions.
We also are required to maintain an investment in FHLB-Cincinnati stock, the
level of which is largely dependent on our level of borrowings from the
FHLB.
At June 30, 2010, our investment
portfolio consisted primarily of residential mortgage-backed securities issued
and guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae with stated final
maturities of 30 years or less. The Company held no equity position with
Fannie Mae or Freddie Mac.
Our investment objectives are to
provide an alternate source of low-risk investments when loan demand is
insufficient, to provide and maintain liquidity, to maintain a balance of high
quality, diversified investments to minimize risk, to provide collateral for
pledging requirements, to establish an acceptable level of interest rate risk,
and to generate a favorable return. The Banks’ Board of Directors has the
overall responsibility for each institution’s investment portfolio, including
approval of investment policies. The management of each
Bank may authorize investments as prescribed in each of the Bank’s investment
policies.
Bank
Owned Life Insurance
First
Federal of Frankfort owns several Bank Owned Life Insurance policies totaling
$2.5 million at June 30, 2010. The purpose of these policies is to offset
future escalation of the costs of non-salary employee benefit plans such as
First Federal of Frankfort’s defined benefit retirement plan and First Federal
of Frankfort’s health insurance plan. The lives of certain key Bank
employees are insured, and First Federal of Frankfort is the sole beneficiary
and will receive any benefits upon the employee’s death. The policies were
purchased from four highly-rated life insurance companies. The design of
the plan allows for the cash value of the policy to be designated as an asset of
First Federal of Frankfort. The asset’s value will increase by the
crediting rate, which is a rate set by each insurance company and is subject to
change on an annual basis. The growth of the value of the asset will be
recorded as other operating income. Management does not foresee any
expense associated with the plan. Because this is a life insurance
product, current federal tax laws exempt the income from federal income
taxes.
Bank owned life insurance is not
secured by any government agency nor are the policies’ asset values or death
benefits secured specifically by tangible property. Great care was taken
in selecting the insurance companies, and the bond ratings and financial
condition of these companies are monitored on a quarterly basis. The
failure of one of these companies could result in a significant loss to First
Federal of Frankfort. Other risks include the possibility that the
favorable tax treatment of the income could change, that the crediting rate will
not be increased in a manner comparable to market interest rates, or that this
type of plan will no longer be permitted by First Federal of Frankfort’s
regulators. This asset is considered illiquid because, although First
Federal of Frankfort may terminate the policies and receive the original premium
plus all earnings, such an action would require the payment of federal income
taxes on all earnings since the policies’ inception.
Deposit
Activities and Other Sources of Funds
General. Deposits, loan
repayments and maturities, redemptions, sales and repayments of investment and
mortgage-backed securities are the major sources of our funds for lending and
other investment purposes. Loan repayments are a relatively stable source
of funds, while deposit inflows and outflows and loan prepayments are
significantly influenced by general interest rates and money market
conditions.
Deposit
Accounts.
The vast majority of our depositors are residents of the Banks’ respective
market areas. Deposits are attracted from within our market areas through
the offering of passbook savings and certificate accounts, and, at First Federal
of Frankfort, checking accounts and individual retirement accounts
(“IRAs”). We do not utilize brokered funds. Deposit account terms
vary according to the minimum balance required, the time periods the funds must
remain on deposit and the interest rate, among other factors. In
determining the terms of our deposit accounts, we consider the rates offered by
our competition, profitability to us, asset liability management and customer
preferences and concerns. We review our deposit mix and pricing on an
ongoing basis as needed.
Borrowings. First Federal of
Hazard and First Federal of Frankfort borrow from the FHLB-Cincinnati to
supplement their supplies of investable funds and to meet deposit withdrawal
requirements. The Federal Home Loan Bank functions as a central reserve
bank providing credit for member financial institutions. As members, each
Bank is required to own capital stock in the FHLB-Cincinnati and is authorized
to apply for advances on the security of such stock and certain of our mortgage
loans and other assets (principally securities which are obligations of, or
guaranteed by, the United States), provided certain standards related to
creditworthiness have been met. Advances are made under several different
programs, each having its own interest rate and range of maturities.
Depending on the program, limitations on the amount of advances are based either
on a fixed percentage of an institution’s net worth or on the Federal Home Loan
Bank’s assessment of the institution’s creditworthiness.
Subsidiary
Activities
The
Company has no other wholly owned subsidiaries other than First Federal of
Hazard and Frankfort First Bancorp. Frankfort First Bancorp
has one subsidiary, First Federal of Frankfort.
As
federally chartered savings institutions, the Banks are permitted to invest an
amount equal to 2% of 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,
2010, First Federal of Hazard and First Federal of Frankfort were authorized to
invest up to $3.2 million and $4.2 million, respectively, in the stock of or
loans to subsidiaries, including the additional 1% investment for community,
inner-city and community development purposes.
Competition
We face significant competition for the
attraction of deposits and origination of loans. Our most direct
competition for deposits has historically come from the banks and credit unions
operating in our market areas and, to a lesser extent, from other financial
services companies, such as investment brokerage firms. We also face
competition for depositors’ funds from money market funds and other corporate
and government securities. Several of our competitors are significantly
larger than us and, therefore, have significantly greater resources. We
expect competition to increase in the future as a result of legislative,
regulatory and technological changes and the continuing trend of consolidation
in the financial services industry. Technological advances, for example,
have lowered the barriers to enter new market areas, allowed banks to expand
their geographic reach by providing services over the Internet and made it
possible for non-depository institutions to offer products and services that
traditionally have been provided by banks. Changes in federal law permit
affiliation among banks, securities firms and insurance companies, which
promotes a competitive environment in the financial services industry.
Competition for deposits and the origination of loans could limit our growth in
the future.
According
to the Federal Deposit Insurance Corporation (“FDIC”), at June 30, 2009, First
Federal of Hazard had a deposit market share of 13.8% in Perry County. Its
largest competitors, Peoples Bank & Trust Company of Hazard (approximately
$282.3 million in assets), Community Trust Bank, Inc. (approximately $3.2
billion in assets) and 1st Trust
Bank (approximately $115.5 million in assets), have Perry County deposit market
shares of 43.6%, 17.1% and 15.5%, respectively. First Federal of Hazard’s
competition for loans comes primarily from financial institutions in its market
area and, to a lesser extent, from other financial services providers, such as
mortgage companies and mortgage brokers. Competition for loans also comes
from the increasing number of non-depository financial services companies
entering the mortgage market, such as insurance companies, securities companies
and specialty finance companies.
First Federal of Frankfort’s principal
competitors for deposits in its market area are other banking institutions, such
as commercial banks and credit unions, as well as mutual funds and other
investments. First Federal of Frankfort principally competes for deposits
by offering a variety of deposit accounts, convenient business hours and branch
locations, customer service and a well-trained staff. According to the
FDIC, at June 30, 2009, First Federal of Frankfort had a deposit market share of
7.4%. Its largest competitors for depositors are the Farmers Bank and
Capital Trust ($828.1 million in assets) at a 49.0% market share, Mainsource
Bank ($2.8 billion in assets) at 9.2%, Whitaker Bank ($1.6 billion in assets) at
13.2%, Fifth Third Bank ($110.0 billion in assets) at 6.2%, and Republic Bank
($3.0 billion in assets) at 5.1%. The Bank also faces considerable
competition from credit unions including the Commonwealth Credit Union ($898
million in assets) and the Kentucky Employees Credit Union ($56 million in
assets). First Federal of Frankfort competes for loans with other
depository institutions, as well as specialty mortgage lenders and brokers and
consumer finance companies. First Federal of Frankfort principally
competes for loans on the basis of interest rates and the loan fees it charges,
the types of loans it originates and the convenience and service it provides to
borrowers. In addition, First Federal of Frankfort believes it has
developed strong relationships with the businesses, real estate agents, builders
and general public in its market area. Despite First Federal of
Frankfort’s small size relative to the many and various other depository and
lending institutions in its market area, First Federal of Frankfort usually
ranks first with respect to the origination of single-family purchase mortgages
made on properties located in Franklin County. Nevertheless, the level of
competition in First Federal of Frankfort’s market area has limited, to a
certain extent, the lending opportunities in its market area.
Personnel
At June 30, 2010, we had 38 full-time
employees and two part-time employees, none of whom is represented by a
collective bargaining unit. We believe our relationship with our employees
is good.
Regulation
and Supervision
General.
First Federal of Hazard and First Federal of Frankfort are subject to extensive
regulation, examination and supervision by the Office of Thrift Supervision, as
their primary federal regulator, and the Federal Deposit Insurance Corporation,
as insurer of deposits. First Federal of Hazard and First Federal of
Frankfort are each members of the Federal Home Loan Bank System and their
deposit accounts are insured up to applicable limits by the Deposit Insurance
Fund managed by the Federal Deposit Insurance Corporation. First Federal
of Hazard and First Federal of Frankfort must each file reports with the Office
of Thrift Supervision and the Federal Deposit Insurance Corporation concerning
their activities and financial condition in addition to obtaining regulatory
approvals before entering into certain transactions such as mergers with, or
acquisitions of, other financial institutions. There are periodic
examinations by the Office of Thrift Supervision and, under certain
circumstances, the Federal Deposit Insurance Corporation to evaluate First
Federal of Hazard’s and First Federal of Frankfort’s safety and soundness and
compliance with various regulatory requirements. This regulatory structure
is intended primarily for the protection of the insurance fund and
depositors.
Kentucky
First and First Federal MHC, as savings and loan holding companies, are required
to file certain reports with, and are subject to examination by, and otherwise
are required to comply with the rules and regulations of the Office of Thrift
Supervision.
The Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (the “Dodd-Frank Act’) makes extensive changes
in the regulation of federal savings banks such as First Federal of Hazard and
First Federal of Frankfort. Under the Dodd-Frank Act, the Office of Thrift
Supervision will be eliminated. Responsibility for the supervision and
regulation of federal savings banks will be transferred to the Office of the
Comptroller of the Currency, which is the agency that is currently primarily
responsible for the regulation and supervision of national banks. The
Office of the Comptroller of the Currency will assume responsibility for
implementing and enforcing many of the laws and regulations applicable to
federal savings banks. The transfer of regulatory functions will take place over
a transition period of up to one year from the enactment date of July 21, 2010
(subject to a possible six month extension). Over the same transition
period, responsibility for the regulation and supervision of savings and loan
holding companies will be transferred to the Federal Reserve Board, which
currently supervises bank holding companies. Additionally, the Dodd-Frank
Act creates a new Consumer Financial Protection Bureau as an independent bureau
of the Federal Reserve Board. The Consumer Financial Protection Bureau
will assume responsibility for the implementation of the federal financial
consumer protection and fair lending laws and regulations, a function currently
assigned to prudential regulators, and will have authority to impose new
requirements. However, institutions of less than $10 billion in assets,
such as First Federal of Hazard and First Federal of Frankfort, will continue to
be examined for compliance with consumer protection and fair lending laws and
regulations by, and be subject to the enforcement authority of, their prudential
regulator.
As part
of the Dodd-Frank Act regulatory restructuring, the Office of Thrift
Supervision’s authority over savings and loan holding companies, such as
Kentucky First and First Federal MHC, will be transferred to the Federal Reserve
Board, which is the agency that regulates and supervises bank holding
companies.
Certain
of the regulatory requirements that are applicable to First Federal of Hazard,
First Federal of Frankfort, Kentucky First and First Federal MHC are described
below. This discussion does not purport to be a complete description of
the laws and regulations involved, and is qualified in its entirety by the
actual laws and regulations. Moreover, laws and regulations are subject to
changes by the U.S. Congress or the regulatory agencies as
applicable.
Regulation
of Federal Savings Institutions
Business
Activities. Federal law and regulations, primarily the Home Owners’
Loan Act and the regulations of the Office of Thrift Supervision, govern the
activities of federal savings institutions, such as First Federal of Hazard and
First Federal of Frankfort. These laws and regulations delineate the
nature and extent of the activities in which federal savings banks may
engage. In particular, certain lending authority for federal savings
institutions, e.g.,
commercial, nonresidential real property loans and consumer loans, is limited to
a specified percentage of the institution’s capital or assets.
Branching.
Federal savings institutions are authorized to establish branch offices in any
state or states of the United States and its territories, subject to the
approval of the Office of Thrift Supervision.
Capital
Requirements. The
Office of Thrift Supervision’s capital regulations require federal savings
institutions to meet three minimum capital standards: a 1.5% tangible
capital to total assets ratio, a 4% leverage ratio (3% for institutions
receiving the highest examination rating under the Office of Thrift
Supervision’s examination rating system) and an 8% risk-based capital
ratio. In addition, the prompt corrective action standards discussed below
also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage
ratio (3% for institutions receiving the highest examination rating) and,
together with the risk-based capital standard itself, a 4% Tier 1 risk-based
capital standard. The Office of Thrift Supervision regulations also
require that, in meeting the tangible, leverage and risk-based capital
standards, institutions must generally deduct investments in and loans to
subsidiaries engaged in activities as principal that are not permissible for a
national bank.
The risk-based capital standard
requires federal savings institutions to maintain Tier 1 (core) and total
capital (which is defined as core capital and supplementary capital) to
risk-weighted assets of at least 4% and 8%, respectively. In determining
the amount of risk-weighted assets, all assets, including certain off-balance
sheet assets, recourse obligations, residual interests and direct credit
substitutes, are multiplied by a risk-weight factor assigned by the Office of
Thrift Supervision capital regulation based on the risks believed inherent in
the type of asset. Core (Tier 1) capital is defined as common
stockholders’ equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus and minority interests in equity
accounts of consolidated subsidiaries, less intangibles other than certain
mortgage servicing rights and credit card relationships. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock, the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets and up to 45% of
unrealized gains on available-for-sale equity securities with readily
determinable fair market values. Overall, the amount of supplementary
capital included as part of total capital cannot exceed 100% of core
capital.
The Office of Thrift Supervision also
has authority to establish individual minimum capital requirements in
appropriate cases upon a determination that an institution’s capital level is or
may become inadequate in light of the particular circumstances. At June
30, 2010, First Federal of Hazard and First Federal of Frankfort each met each
of these capital requirements.
Prompt Corrective
Regulatory Action. The Office of Thrift
Supervision is required to take certain supervisory actions against
undercapitalized institutions, the severity of which depends upon the
institution’s degree of undercapitalization. Generally, a savings
institution that has a ratio of total capital to risk weighted assets of less
than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than
4% or a ratio of core capital to total assets of less than 4% (3% or less for
institutions with the highest examination rating) is considered to be
“under-capitalized.” A savings institution that has a total risk-based
capital ratio of less than 6%, a Tier 1 capital ratio of less than 3% or a
leverage ratio that is less than 3% is considered to be “significantly
undercapitalized” and a savings institution that has a tangible capital to
assets ratio equal to or less than 2% is deemed to be “critically
undercapitalized.” Subject to a narrow exception, the Office of Thrift
Supervision is required to appoint a receiver or conservator within specified
time frames for an institution that is “critically undercapitalized.” An
institution must file a capital restoration plan with the Office of Thrift
Supervision within 45 days of the date it receives notice that it is
“undercapitalized,” “significantly undercapitalized,” or “critically
undercapitalized.” Compliance with the plan must be guaranteed by any
parent holding company. In addition, numerous mandatory supervisory
actions become immediately applicable to an undercapitalized institution,
including, but not limited to, increased monitoring by regulators and
restrictions on growth, capital distributions and expansion.
“Significantly undercapitalized” and “critically undercapitalized” institutions
are subject to more extensive mandatory regulatory actions. The Office of
Thrift Supervision could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
Loans to One
Borrower. Federal law provides that savings institutions are
generally subject to the limits on loans to one borrower applicable to national
banks. A savings institution may not make a loan or extend credit to a
single or related group of borrowers in excess of 15% of its unimpaired capital
and surplus. An additional amount may be lent, equal to 10% of unimpaired
capital and surplus, if secured by specified readily-marketable
collateral.
Standards for
Safety and Soundness. As required by statute, the federal banking
agencies have adopted Interagency Guidelines prescribing Standards for Safety
and Soundness. The guidelines set forth the safety and soundness standards
that the federal banking agencies use to identify and address problems at
insured depository institutions before capital becomes impaired. If the
Office of Thrift Supervision determines that a savings institution fails to meet
any standard prescribed by the guidelines, the Office of Thrift Supervision may
require the institution to submit an acceptable plan to achieve compliance with
the standard.
Limitation on
Capital Distributions. Office of Thrift Supervision regulations
impose limitations upon all capital distributions by a savings institution,
including cash dividends, payments to repurchase its shares and payments to
shareholders of another institution in a cash-out merger. Under the
regulations, an application to and the prior approval of the Office of Thrift
Supervision is required before any capital distribution if the institution does
not meet the criteria for “expedited treatment” of applications under Office of
Thrift Supervision regulations (i.e., generally, examination
and Community Reinvestment Act ratings in the two top categories), the total
capital distributions for the calendar year exceed net income for that year plus
the amount of retained net income for the preceding two years, the institution
would be undercapitalized following the distribution or the distribution would
otherwise be contrary to a statute, regulation or agreement with the Office of
Thrift Supervision. If an application is not required, the institution
must still provide prior notice to the Office of Thrift Supervision of the
capital distribution if, like First Federal of Hazard and First Federal of
Frankfort, it is a subsidiary of a holding company. If First Federal of
Hazard’s or First Federal of Frankfort’s capital were ever to fall below its
regulatory requirements or the Office of Thrift Supervision notified it that it
was in need of increased supervision, its ability to make capital distributions
could be restricted. In addition, the Office of Thrift Supervision could
prohibit a proposed capital distribution that would otherwise be permitted by
the regulation, if the agency determines that such distribution would constitute
an unsafe or unsound practice.
Qualified Thrift
Lender Test. Federal law requires savings institutions to meet a
qualified thrift lender test. Under the test, a savings association is
required to either qualify as a “domestic building and loan association” under
the Internal Revenue Code or maintain at least 65% of its “portfolio assets”
(total assets less: (i) specified liquid assets up to 20% of total assets; (ii)
intangibles, including goodwill; and (iii) the value of property used to conduct
business) in certain “qualified thrift investments” (primarily residential
mortgages and related investments, including certain mortgage-backed securities)
in at least 9 months out of each 12-month period.
A savings institution that fails the
qualified thrift lender test is subject to certain operating restrictions.
The Dodd-Frank Act subjects violations of the qualified thrift lender test
requirements to possible enforcement action for violation of law.
At June 30, 2010, First Federal of
Hazard and First Federal of Frankfort each met the qualified thrift lender
test.
Transactions with
Related Parties. Federal law limits the authority of First Federal
of Hazard and First Federal of Frankfort to lend to, and engage in certain other
transactions with (collectively, “covered transactions”), “affiliates” (e.g., any company that
controls or is under common control with an institution, including Kentucky
First, First Federal MHC and their non-savings institution subsidiaries).
The aggregate amount of covered transactions with any individual affiliate is
limited to 10% of the capital and surplus of the savings institution. The
aggregate amount of covered transactions with all affiliates is limited to 20%
of the savings institution’s capital and surplus. Loans and other
specified transactions with affiliates are required to be secured by collateral
in an amount and of a type described in federal law. The purchase of low
quality assets from affiliates is generally prohibited. Transactions with
affiliates must be on terms and under circumstances that are at least as
favorable to the institution as those prevailing at the time for comparable
transactions with non-affiliated companies. In addition, savings
institutions are prohibited from lending to any affiliate that is engaged in
activities that are not permissible for bank holding companies and no savings
institution may purchase the securities of any affiliate other than a
subsidiary. Transactions between sister depository institutions that are
80% or more owned by the same holding company are exempt from the quantitative
limits and collateral requirements.
The Sarbanes-Oxley Act of 2002
generally prohibits a company from making loans to its executive officers and
directors. However, that act contains a specific exception for loans by a
depository institution to its executive officers and directors in compliance
with federal banking laws. Under such laws, First Federal of Hazard’s and
First Federal of Frankfort’s authority to extend credit to executive officers,
directors and 10% shareholders (“insiders”), as well as entities such persons
control, is limited. The law restricts both the individual and aggregate
amount of loans First Federal of Hazard and First Federal of Frankfort may make
to insiders based, in part, on First Federal of Hazard’s and First Federal of
Frankfort’s respective capital positions and requires certain board approval
procedures to be followed. Such loans must be made on terms, including
rates and collateral, substantially the same as those offered to unaffiliated
individuals prevailing at the time for comparable loans with persons not related
to the lender and not involve more than the normal risk of repayment.
There are additional restrictions applicable to loans to executive
officers.
Enforcement.
The Office of Thrift Supervision has primary enforcement responsibility over
federal savings institutions and has the authority to bring actions against the
institution and all institution-affiliated parties, including stockholders, and
any attorneys, appraisers and accountants who knowingly or recklessly
participate in wrongful action likely to have an adverse effect on an insured
institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order to removal of officers and/or
directors to appointment of a receiver or conservator or termination of deposit
insurance. Civil penalties cover a wide range of violations and can amount
to $25,000 per day, or even $1 million per day in especially egregious
cases. The Federal Deposit Insurance Corporation has authority to
recommend to the Director of the Office of Thrift Supervision that enforcement
action to be taken with respect to a particular savings institution. If
action is not taken by the Director, the Federal Deposit Insurance Corporation
has authority to take such action under certain circumstances. Federal law
also establishes criminal penalties for certain violations. The Office of
the Comptroller of the Currency will assume the Office of Thrift Supervision’s
enforcement authority over federal savings banks as part of the Dodd-Frank Act
regulatory restructuring.
Assessments.
Federal savings banks are required to pay assessments to the Office of Thrift
Supervision to fund its operations. The general assessments, paid on a
semi-annual basis, are based upon the savings institution’s total assets,
including consolidated subsidiaries, as reported in the institution’s latest
quarterly thrift financial report, its financial condition and the complexity of
its portfolio. The Office of the Comptroller of the Currency similarly
assesses its regulated institutions to fund its operations.
Insurance of
Deposit Accounts.
Insurance of
Deposit Accounts. The deposits of both First Federal of Hazard and
First Federal of Frankfort are insured up to applicable limits by the Deposit
Insurance Fund of the Federal Deposit Insurance Corporation’s. Under the Federal
Deposit Insurance Corporation’s risk-based assessment system, insured
institutions are assigned to one of four risk categories based on supervisory
evaluations, regulatory capital levels and certain other factors, with less
risky institutions paying lower assessments. An institution’s assessment rate
depends upon the category to which it is assigned. Effective April 1, 2009,
assessment rates range from seven to 77.5 basis points. The Dodd-Frank Act
requires the FDIC to amend its procedures to base assessments on total assets
less tangible equity rather than deposits. It is uncertain how quickly
that will occur. No institution may pay a dividend if in default of the
federal deposit insurance assessment.
The FDIC
imposed on all insured institutions a special emergency assessment of five basis
points of total assets minus Tier 1 capital, as of June 30, 2009 (capped at
ten basis points of an institution’s deposit assessment base), in order to cover
losses to the Deposit Insurance Fund. That special assessment was collected on
September 30, 2009. The FDIC provided for similar assessments during
the final two quarters of calendar year 2009, if deemed necessary. However, in
lieu of further special assessments, the Federal Deposit Insurance Corporation
required insured institutions to prepay estimated quarterly risk-based
assessments for the fourth quarter of 2009 through the fourth quarter of 2012.
The estimated assessments, which include an assumed annual assessment base
increase of 5%, were recorded as a prepaid expense asset as of December 30,
2009. As of December 31, 2009, and each quarter thereafter, a charge to earnings
will be recorded for each regular assessment with an offsetting credit to the
prepaid asset.
Due to
the recent difficult economic conditions, deposit insurance per account owner
has been raised to $250,000 for all types of accounts. That coverage was made
permanent by the Dodd-Frank Act. In addition, the Federal Deposit
Insurance Corporation adopted an optional Temporary Liquidity Guarantee Program
by which, for a fee, noninterest bearing transaction accounts would receive
unlimited insurance coverage until June 30, 2010, subsequently extended to
December 31, 2010, and certain senior unsecured debt issued by institutions and
their holding companies between October 13, 2008 and December 31, 2009
would be guaranteed by the Federal Deposit Insurance Corporation through
June 30, 2012, or in some cases, December 31, 2012. The Bank and
the Company made the business decision to decline participation in both
programs. The Dodd-Frank Act adopted unlimited coverage for certain
non-interest bearing transactions accounts for January 1, 2011 through December
31, 2012, with no apparent opt out option.
In
addition to the assessment for deposit insurance, institutions are required to
make payments on bonds issued in the late 1980s by the Financing Corporation to
recapitalize a predecessor deposit insurance fund. That payment is established
quarterly and during the four quarters ended June 30, 2010 averaged 1.04 basis
points of assessable deposits.
The
Dodd-Frank Act increased the minimum target Deposit Insurance Fund ratio from
1.15% of estimated insured deposits to 1.35% of estimated insured
deposits. The FDIC must seek to achieve the 1.35% ratio by September 30,
2020. Insured institutions with assets of $10 billion or more are supposed
to fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund
ratio, instead leaving it to the discretion of the FDIC.
The FDIC
has authority to increase insurance assessments. A significant increase in
insurance premiums would likely have an adverse effect on the operating expenses
and results of operations of the Banks. Management cannot predict what insurance
assessment rates will be in the future.
Insurance
of deposits may be terminated by the Federal Deposit Insurance Corporation upon
a finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the Federal
Deposit Insurance Corporation or the Office of Thrift Supervision (or the Office
of the Comptroller of the Currency after the Dodd-Frank Act regulatory
restructuring). Management does not know of any practice, condition or
violation that might lead to termination of deposit insurance.
Federal Home Loan
Bank System. First Federal of Hazard and First Federal of Frankfort
are members of the Federal Home Loan Bank System, which consists of 12 regional
Federal Home Loan Banks. The Federal Home Loan Bank provides a central
credit facility primarily for member institutions. As members of the
Federal Home Loan Bank of Cincinnati, First Federal of Hazard and First Federal
of Frankfort are each required to acquire and hold shares of capital stock in
that Federal Home Loan Bank. First Federal of Hazard and First Federal of
Frankfort were in compliance with this requirement with investments in Federal
Home Loan Bank of Cincinnati stock at June 30, 2010, of $2.1 million and $3.5
million, respectively.
Community
Reinvestment Act. Under the Community
Reinvestment Act, as implemented by Office of Thrift Supervision regulations, a
savings institution has a continuing and affirmative obligation consistent with
its safe and sound operation to help meet the credit needs of its entire
community, including low and moderate income neighborhoods. The Community
Reinvestment Act does not establish specific lending requirements or programs
for financial institutions nor does it limit an institution’s discretion to
develop the types of products and services that it believes are best suited to
its particular community, consistent with the Community Reinvestment Act.
The Community Reinvestment Act requires the Office of Thrift Supervision, in
connection with its examination of a savings association, to assess the
institution’s record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications by such
institution.
The Community Reinvestment Act requires
public disclosure of an institution’s rating and requires the Office of Thrift
Supervision to provide a written evaluation of an institution’s Community
Reinvestment Act performance utilizing a four-tiered descriptive rating
system. First Federal of Hazard and First Federal of Frankfort each
received a “Satisfactory” rating as a result of their most recent Community
Reinvestment Act assessments.
Holding
Company Regulation
General.
Kentucky First and First Federal MHC are savings and loan holding
companies within the meaning of federal law. As such, they are registered
with the Office of Thrift Supervision and are subject to Office of Thrift
Supervision regulations, examinations, supervision, reporting requirements and
regulations concerning corporate governance and activities. In addition,
the Office of Thrift Supervision has enforcement authority over Kentucky First
and First Federal MHC and their non-savings institution subsidiaries.
Among other things, this authority permits the Office of Thrift Supervision to
restrict or prohibit activities that are determined to be a serious risk to
First Federal of Hazard and/or First Federal of Frankfort.
As part of the Dodd-Frank Act
regulatory restructuring, the responsibility for regulating and supervising
savings and loan holding companies will be transferred to the Federal Reserve
Board.
Restrictions
Applicable to Mutual Holding Companies. According to federal law
and Office of Thrift Supervision regulations, a mutual holding company, such as
First Federal MHC, may generally engage in the following activities: (1)
investing in the stock of insured depository institutions and acquiring them by
means of a merger or acquisition; (2) investing in a corporation the capital
stock of which may be lawfully purchased by a savings association under federal
law; (3) furnishing or performing management services for a savings association
subsidiary of a savings and loan holding company; (4) conducting an insurance
agency or escrow business; (5) holding, managing or liquidating assets
owned or acquired from a savings association subsidiary of the savings and loan
holding company; (6) holding or managing properties used or occupied by a
savings association subsidiary of the savings and loan holding company; (7)
acting as trustee under deed or trust; (8) any activity permitted for multiple
savings and loan holding companies by Office of Thrift Supervision regulations;
(9) any activity permitted by the Board of Governors of the Federal Reserve
System for bank holding companies and financial holding companies; and (10) any
activity permissible for service corporations. Legislation, which
authorized mutual holding companies to engage in activities permitted for
financial holding companies, expanded the authorized activities. Financial
holding companies may engage in a broad array of financial services activities,
including insurance and securities.
Federal law prohibits a savings and
loan holding company, including a federal mutual holding company, from directly
or indirectly, or through one or more subsidiaries, acquiring more than 5% of
the voting stock of another savings institution, or its holding company, without
prior written approval of the Office of Thrift Supervision. Federal law
also prohibits a savings and loan holding company from acquiring or retaining
control of a depository institution that is not insured by the Federal Deposit
Insurance Corporation. In evaluating applications by holding companies to
acquire savings institutions, the Office of Thrift Supervision must consider the
financial and managerial resources and future prospects of the company and
institution involved, the effect of the acquisition on the risk to the insurance
funds, the convenience and needs of the community and competitive
factors.
The Office of Thrift Supervision is
prohibited from approving any acquisition that would result in a multiple
savings and loan holding company controlling savings institutions in more than
one state, except: (1) the approval of interstate supervisory
acquisitions by savings and loan holding companies, and (2) the acquisition
of a savings institution in another state if the laws of the state of the target
savings institution specifically permit such acquisitions. The states vary
in the extent to which they permit interstate savings and loan holding company
acquisitions.
Capital
Requirements. Savings and loan holding companies are not currently
subject to specific regulatory capital requirements. The Dodd-Frank Act,
however, requires the Federal Reserve Board to promulgate consolidated capital
requirements for depository institution holding companies that are no less
stringent, both quantitatively and in terms of components of capital, than those
applicable to institutions themselves. There is a five year transition
period from the July 21, 2010 date of enactment of the Dodd-Frank Act before the
capital requirements will apply to savings and loan holding
companies.
Stock Holding
Company Subsidiary Regulation. The Office of Thrift Supervision has
adopted regulations governing the two-tier mutual holding company form of
organization and subsidiary stock holding companies that are controlled by
mutual holding companies. Kentucky First is the stock holding company
subsidiary of First Federal MHC. Kentucky First is only permitted to
engage in activities that are permitted for First Federal MHC subject to the
same restrictions and conditions.
Waivers of
Dividends by First Federal MHC. Office of Thrift
Supervision regulations require First Federal MHC to notify the Office of Thrift
Supervision if it proposes to waive receipt of our dividends from Kentucky
First. The Office of Thrift Supervision reviews dividend waiver notices on
a case-by-case basis, and, in general, does not object to any such waiver if:
(i) the waiver would not be detrimental to the safe and sound operation of the
savings association; and (ii) the mutual holding company’s board of directors
determines that such waiver is consistent with such directors’ fiduciary duties
to the mutual holding company’s members. The Office of Thrift Supervision will
not consider the amount of dividends waived by the mutual holding company in
determining an appropriate exchange ratio in the event of a full conversion to
stock form. Kentucky First has been granted such a waiver. Dividends
paid to shareholders on November 23, 2009, February 22, May 24 and August 23,
2010 were waived by First Federal MHC.
The Dodd-Frank Act addresses the issue
of dividend waivers in the context of the transfer of the supervision of savings
and loan holding companies to the Federal Reserve Board. The Dodd-Frank
Act specified that dividends may be waived if certain conditions are met,
including that the Federal Reserve Board does not object after being given
written notice of the dividend and proposed waiver. The Dodd-Frank Act
indicates that the Federal Reserve Board may not object to such a waiver (i) if
the mutual holding company involved has, prior to December 1, 2009, reorganized
into a mutual holding company structure, engaged in a minority stock offering
and waived dividends; (ii) the board of directors of the mutual holding company
expressly determines that a waiver of the dividend is consistent with its
fiduciary duties to members and (iii) the waiver would not be detrimental to the
safe and sound operation of the savings association subsidiaries of the holding
company. The Federal Reserve has not previously permitted dividend waivers
by mutual bank holding companies and may object to dividend waivers involving
mutual savings and loan holding companies, notwithstanding the referenced
language in the Dodd-Frank Act.
Conversion of
First Federal MHC to Stock Form. Office of Thrift Supervision
regulations permit First Federal MHC to convert from the mutual form of
organization to the capital stock form of organization. In a conversion
transaction, a new holding company would be formed as successor to First Federal
MHC, its corporate existence would end, and certain depositors would receive the
right to subscribe for additional shares of the new holding company. In a
conversion transaction, each share of common stock held by stockholders other
than First Federal MHC would be automatically converted into a number of shares
of common stock of the new holding company based on an exchange ratio determined
at the time of conversion that ensures that stockholders other than First
Federal MHC own the same percentage of common stock in the new holding company
as they owned in us immediately before conversion. Under Office of Thrift
Supervision regulations, stockholders other than First Federal MHC would not be
diluted because of any dividends waived by First Federal MHC (and waived
dividends would not be considered in determining an appropriate exchange ratio),
in the event First Federal MHC converts to stock form. The total number of
shares held by stockholders other than First Federal MHC after a conversion
transaction also would be increased by any purchases by stockholders other than
First Federal MHC in the stock offering conducted as part of the conversion
transaction.
The Dodd-Frank Act provides that waived
dividends will also not be considered in determining the appropriate exchange
ratio after the transfer of responsibilities to the Federal Reserve Board for
provided that the mutual holding company involved was formed, engaged in a
minority offering and waived dividends prior to December 1, 2009. First
Federal MHC was formed, engaged, in a minority stock offering and waived
dividends prior to December 1, 2009.
Acquisition of
Control. Under the federal Change in Bank Control Act, a notice
must be submitted to the Office of Thrift Supervision if any person (including a
company), or group acting in concert, seeks to acquire “control” of a savings
and loan holding company or savings association. An acquisition of
“control” can occur upon the acquisition of 10% or more of the voting stock of a
savings and loan holding company or savings institution or as otherwise defined
by the Office of Thrift Supervision. Under the Change in Bank Control Act,
the Office of Thrift Supervision has 60 days from the filing of a complete
notice to act, taking into consideration certain factors, including the
financial and managerial resources of the acquirer and the anti-trust effects of
the acquisition. Any company that so acquires control would then be
subject to regulation as a savings and loan holding company.
Financial Reform
Legislation. On July 21, 2010, President Obama signed the
Dodd-Frank Act. In addition to eliminating the Office of Thrift
Supervision and creating the Consumer Financial Protection Bureau, the
Dodd-Frank Act, among other things, requires changes in the way that
institutions are assessed for deposit insurance, mandates the imposition of
consolidated capital requirements on savings and loan holding companies,
requires that originators of securitized loans retain a percentage of the risk
for the transferred loans, reduces the federal preemption afforded to federal
savings associations and contains a number of reforms related to mortgage
origination. Many of the provisions of the Dodd-Frank Act require the
issuance of regulations before their impact on operations can be assessed by
management. However, there is a significant possibility that the
Dodd-Frank Act will, at a minimum, result in increased regulatory burden and
compliance costs for the Banks and the Company.
Federal
and State Taxation
General.
We report our income on a fiscal year basis using the accrual method of
accounting.
Federal
Taxation. The federal income tax laws apply to us in the same
manner as to other corporations with some exceptions, including particularly the
reserve for bad debts discussed below. The following discussion of tax matters
is intended only as a summary and does not purport to be a comprehensive
description of the tax rules applicable to us. Our federal income tax
returns are being examined for the tax year ended June 30, 2006 (tax year 2005)
and are subject to examination for years 2005 and later. For the
2010 fiscal year, First Federal of Hazard’s and Frankfort First’s maximum
federal income tax rate was 34.0%.
For fiscal years beginning before
June 30, 1996, thrift institutions that qualified under certain
definitional tests and other conditions of the Internal Revenue Code were
permitted to use certain favorable provisions to calculate their deductions from
taxable income for annual additions to their bad debt reserve. A reserve could
be established for bad debts on qualifying real property loans, generally
secured by interests in real property improved or to be improved, under the
percentage of taxable income method or the experience method. The reserve for
nonqualifying loans was computed using the experience method. Federal
legislation enacted in 1996 repealed the reserve method of accounting for bad
debts and the percentage of taxable income method for tax years beginning after
1995 and require savings institutions to recapture or take into income certain
portions of their accumulated bad debt reserves. First Federal of Hazard
did not qualify for such favorable tax treatment for any years through
1996. Approximately $5.2 million of First Federal of Frankfort First’s
accumulated bad debt reserves would not be recaptured into taxable income unless
Frankfort First makes a “non-dividend distribution” to Kentucky First as
described below.
If First Federal of Hazard or First
Federal of Frankfort makes “non-dividend distributions” to us, the distributions
will be considered to have been made from First Federal of Hazard’s and First
Federal of Frankfort’s unrecaptured tax bad debt reserves, including the balance
of their reserves as of December 31, 1987, to the extent of the
“non-dividend distributions,” and then from First Federal of Frankfort’s
supplemental reserve for losses on loans, to the extent of those reserves, and
an amount based on the amount distributed, but not more than the amount of those
reserves, will be included in First Federal of Frankfort’s taxable income.
Non-dividend distributions include distributions in excess of First Federal of
Frankfort’s current and accumulated earnings and profits, as calculated for
federal income tax purposes, distributions in redemption of stock, and
distributions in partial or complete liquidation. Dividends paid out of
First Federal of Frankfort’s current or accumulated earnings and profits will
not be so included in First Federal of Frankfort’s taxable income.
The
amount of additional taxable income triggered by a non-dividend distribution is
an amount that, when reduced by the tax attributable to the income, is equal to
the amount of the distribution. Therefore, if First Federal of Frankfort makes a
non-dividend distribution to us, approximately one and one-half times the amount
of the distribution not in excess of the amount of the reserves would be
includable in income for federal income tax purposes, assuming a 34% federal
corporate income tax rate. First Federal of Frankfort inadvertently made such a
distribution in fiscal 2009, but does not intend to pay dividends in the future
that would result in a recapture of any portion of its bad debt
reserves.
State
Taxation. Although First Federal
MHC and Kentucky First are subject to the Kentucky corporation income tax and
state corporation license tax (franchise tax), the corporation license tax is
repealed effective for tax periods ending on or after December 31, 2005.
Gross income of corporations subject to Kentucky income tax is similar to income
reported for federal income tax purposes except that dividend income, among
other income items, is exempt from taxation. For First Federal MHC and
Kentucky First tax years beginning July 1, 2005, the corporations are subject to
an alternative minimum income tax. Corporations must pay the greater of
the income tax, the alternative tax or $175. The corporations can choose
between two methods to calculate the alternative minimum; 9.5 cents per $100 of
the corporation’s gross receipts, or 75 cents per $100 of the corporation’s
Kentucky gross profits. Kentucky gross profits means Kentucky gross
receipts reduced by returns and allowances attributable to Kentucky gross
receipts, less Kentucky cost of goods sold. The corporations, in their
capacity as holding companies for financial institutions, do not have a material
amount of cost of good sold. Although the corporate license tax rate is
0.21% of total capital employed in Kentucky, a bank holding company, as defined
in Kentucky Revised Statutes 287.900, is allowed to deduct from its taxable
capital, the book value of its investment in the stock or securities of
subsidiaries that are subject to the bank franchise tax.
First Federal of Hazard and First
Federal of Frankfort are exempt from both the Kentucky corporation income tax
and corporation license tax. However, both institutions are instead
subject to the bank franchise tax, an annual tax imposed on federally or state
chartered savings and loan associations, savings banks and other similar
institutions operating in Kentucky. The tax is 0.1% of taxable capital
stock held as of January 1 each year. Taxable capital stock includes
an institution’s undivided profits, surplus and general reserves plus savings
accounts and paid-up stock less deductible items. Deductible items include
certain exempt federal obligations and Kentucky municipal bonds. Financial
institutions which are subject to tax both within and without Kentucky must
apportion their net capital.
Item 1A. Risk
Factors
We may not be able to achieve
sufficient growth in our retail franchise to allow us to achieve the anticipated
benefits of our merger with Frankfort First Bancorp.
We intend to efficiently utilize excess
liquidity at either Bank or Kentucky First by buying and selling whole loans or
participations in loans between First Federal of Hazard and First Federal of
Frankfort, with the originating bank retaining servicing of any loans sold, or
by making deposits into accounts at either bank, subject to regulatory
limitations, in order to maximize the potential earnings of each bank.
This strategy will not succeed if we do not maintain sufficient loan demand at
First Federal of Frankfort or sufficient deposit growth and retention at First
Federal of Hazard. At June 30, 2010, Frankfort First had total real estate
loans of $105.6 million, compared to $98.5 million at June 30, 2009, an increase
of approximately $7.1 million, or 7.2%. Loans sold by First Federal of
Frankfort to First Federal of Hazard were $53.2 million and $62.2 million at
June 30, 2010 and 2009, respectively. At June 30, 2010, First Federal of
Hazard had total deposits of $77.2 million, compared to total deposits of $77.7
million at June 30, 2009, a decrease of $500,000, or 0.6%. There can be no
assurance as to if or when this strategy can be accomplished. In an
attempt to increase the overall interest rate spread of the combined company,
management may adopt strategies that result in decreases in the assets and/or
liabilities of either or both Banks.
Rising interest rates may hurt our
profits and asset values.
If interest rates rise, our net
interest income would likely decline in the short term since, due to the
generally shorter terms of interest-bearing liabilities, interest expense paid
on interest-bearing liabilities, increases more quickly than interest
income earned on interest-earning assets, such as loans and investments.
In addition, a
continuation of rising interest rates may hurt our income because of reduced
demand for new loans, the demand for refinancing loans and the interest and fee
income earned on new loans and refinancings. At June 30, 2010, in the
event of an instantaneous and permanent 200 basis point increase in interest
rates, our net portfolio value, which represents the discounted present value of
the difference between incoming cash flows on interest-earning and other assets
and outgoing cash flows on interest-bearing liabilities, would be expected to
increase by approximately 2%. While we believe that modest interest rate
increases will not significantly hurt our interest rate spread over the long
term due to our high level of liquidity and the presence of a significant amount
of adjustable-rate mortgage loans in our loan portfolio, interest rate increases
may initially reduce our interest rate spread until such time as our loans and
investments reprice to higher levels.
Changes in interest rates also affect
the value of our interest-earning assets, and in particular our securities
portfolio. Generally, the value of fixed-rate securities fluctuates
inversely with changes in interest rates. Unrealized gains and losses on
securities available for sale are reported as separate components of
equity. Decreases in the fair value of securities available for sale
resulting from increases in interest rates therefore could have an adverse
effect on stockholders’ equity.
Future
FDIC assessments will hurt our earnings.
FDIC insurance assessments increased
significantly during the fiscal year ended June 30, 2010, and we expect to pay
higher FDIC premiums in the future. See “Insurance of Deposit
Accounts.” Higher recurring premiums assessed by the FDIC and any
additional emergency special assessments imposed by the FDIC will further hurt
the Company's earnings.
A
larger percentage of our loans are collateralized by real estate and further
disruptions in the real estate market may result in losses and hurt our
earnings.
Approximately 96.1% of our loan
portfolio at June 30, 2010 was comprised of loans collateralized by real
estate. The declining economic conditions have caused a decrease in demand
for real estate, which has resulted in an erosion of some real estate values in
our markets. Further disruptions in the real estate market could
significantly impair the value of our collateral and our ability to sell the
collateral upon foreclosure. The real estate collateral in each case
provides an alternate source of repayment in the event of default by the
borrower and may deteriorate in value during the time the credit is
extended. If real estate values decline further, it will become more
likely that we would be required to increase our allowance for loan
losses. If during a period of reduced real estate values, we are required
to liquidate the collateral securing a loan to satisfy the debt or to increase
our allowance for loan losses, it could materially reduce our profitability and
adversely affect our financial condition.
Strong
competition within our market area could hurt our profits and slow
growth.
Although we consider ourselves
competitive in our market areas, we face intense competition both in making
loans and attracting deposits. Price competition for loans and deposits
might result in our earning less on our loans and paying more on our deposits,
which reduces net interest income. Some of the institutions with which we
compete have substantially greater resources than we have and may offer services
that we do not provide. We expect competition to increase in the future as
a result of legislative, regulatory and technological changes and the continuing
trend of consolidation in the financial services industry. Our
profitability will depend upon our continued ability to compete successfully in
our market areas.
The
distressed economy in First Federal of Hazard’s market area could hurt our
profits and slow our growth.
First Federal of Hazard’s market area
consists of Perry and surrounding counties in eastern Kentucky. The
economy in this market area has been distressed in recent years due to the
decline in the coal industry on which the economy has been dependent.
While there has been improvement in the economy from the influx of other
industries, such as health care and manufacturing, and there may be signs that
the coal industry is improving with the rising costs of petroleum, the economy
in First Federal of Hazard’s market area continues to lag behind the economies
of Kentucky and the United States. As a result, First Federal of Hazard
has experienced insufficient loan demand in its market area. While First
Federal of Hazard will seek to use excess funds to purchase loans from First
Federal of Frankfort, we expect the redeployment of funds from securities into
loans to take several years. Moreover, the slow economy in First Federal
of Hazard’s market area will limit our ability to grow our asset base in that
market.
Recently
enacted regulatory reform may have a material impact on our
operations.
On July 21, 2010, the President signed
into law The Dodd-Frank Wall Street Reform and Consumer Protection Act (the
“Dodd-Frank Act”). The Dodd-Frank Act restructures the regulation of
depository institutions. Under the Dodd-Frank Act, the Office of Thrift
Supervision will be merged into the Office of the Comptroller of the Currency,
which regulates national banks. Savings and loan holding companies will be
regulated by the Federal Reserve Board. The Dodd-Frank Act contains
various provisions designed to enhance the regulation of depository institutions
and prevent the recurrence of a financial crisis such as occurred in
2008-2009. Also included is the creation of a new federal agency to
administer and enforce consumer and fair lending laws, a function that is now
performed by the depository institution regulators. The federal preemption
of state laws currently accorded federally chartered depository institutions
will be reduced as well. The Dodd-Frank Act also will impose consolidated
capital requirements on savings and loan holding companies effective in five
years, which will limit our ability to borrow at the holding company and invest
the proceeds from such borrowings as capital in First Federal of Hazard or First
Federal of Frankfort that could be leveraged to support additional growth.
The full impact of the Dodd-Frank Act on our business and operations will not be
known for years until regulations implementing the statute are written and
adopted. The Dodd-Frank Act may have a material impact on our operations,
particularly through increased compliance costs resulting from possible future
consumer and fair lending regulations.
We
expect that our return on equity will be low compared to other companies as a
result of our high level of capital.
Return on average equity, which equals
net income divided by average equity, is a ratio used by many investors to
compare the performance of a particular company with other companies. For the
year ended June 30, 2010, our return on average equity was 0.73%. We also
intend to continue managing excess capital through our stock repurchase program,
which has been successful, given relatively low market prices of the Company’s
common stock. However, this program could be curtailed or rendered less
effective if the market price of our stock increases, or if the Company’s liquid
funds are deployed elsewhere. Our goal of generating a return on average
equity that is competitive with other publicly-held subsidiaries of mutual
holding companies, by increasing earnings per share and book value per share,
without assuming undue risk, could take a number of years to achieve, and we
cannot assure that our goal will be attained. Consequently, you should not
expect a competitive return on average equity in the near future. Failure
to achieve a competitive return on average equity might make an investment in
our common stock unattractive to some investors and might cause our common stock
to trade at lower prices than comparable companies with higher returns on
average equity.
Additional annual employee
compensation and benefit expenses may reduce our profitability and stockholders’
equity.
We will continue to recognize employee
compensation and benefit expenses for employees and executives under our benefit
plans. With regard to the employee stock ownership plan, applicable
accounting practices require that the expense be based on the fair market value
of the shares of common stock at specific points in the future, therefore we
will recognize expenses for our employee stock ownership plan when shares are
committed to be released to participants’ accounts. We will also recognize
expenses for restricted stock awards and options over the vesting periods of
those awards. In addition, employees of both subsidiary Banks participate
in a defined-benefit plan through Pentegra. Costs associated with the
defined-benefit plans could increase or legislation could be enacted that would
increase the Banks’ obligations under the plan or change the methods the Banks
use in accounting for the plans. Those changes could adversely affect
personnel expense and the Company’s balance sheet.
First
Federal MHC owns a majority of our common stock and is able to exercise voting
control over most matters put to a vote of stockholders, including preventing
sale or merger transactions you may like or a second-step conversion by First
Federal MHC.
First Federal MHC owns a majority of
our common stock and, through its Board of Directors, is able to exercise voting
control over most matters put to a vote of stockholders. As a federally
chartered mutual holding company, the board of directors of First Federal MHC
must ensure that the interests of depositors of First Federal of Hazard are
represented and considered in matters put to a vote of stockholders of Kentucky
First. Therefore, the votes cast by First Federal MHC may not be in your
personal best interests as a stockholder. For example, First Federal MHC
may exercise its voting control to prevent a sale or merger transaction in which
stockholders could receive a premium for their shares, prevent a second-step
conversion transaction by First Federal MHC or defeat a stockholder nominee for
election to the Board of Directors of Kentucky First. However,
implementation of a stock-based incentive plan will require approval of Kentucky
First’s stockholders other than First Federal MHC. Office of Thrift
Supervision regulations would likely prevent an acquisition of Kentucky First
other than by another mutual holding company or a mutual
institution.
There
may be a limited market for our common stock which may lower our stock
price.
Although
our shares of common stock are listed on the Nasdaq Global Market, there is no
guarantee that the shares will be regularly traded. If an active trading
market for our common stock does not develop, you may not be able to sell all of
your shares of common stock on short notice and the sale of a large number of
shares at one time could temporarily depress the market price.
Item 1B. Unresolved
Staff Comments
None.
Item
2.
Properties
We conduct our business through four
offices. The following table sets forth certain information relating to
our offices at June 30, 2010.
|
|
Year
Opened/Acquired
|
|
|
Owned or
Leased
|
|
|
Net
Book Value at
June 30,
2010
|
|
|
Approximate
Square Footage
|
|
|
|
(Dollars in thousands)
|
|
First
Federal of Hazard
Main
Office:
|
|
1960
|
|
|
Owned
|
|
|
$ |
172 |
|
|
15,000
|
|
479
Main Street
Hazard,
Kentucky 41701
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
Federal of Frankfort
Main
Office:
216
West Main Street
Frankfort,
Kentucky 40601
|
|
2005
|
|
|
Owned
|
|
|
|
1,273 |
|
|
14,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
East
Branch
1980
Versailles Road
Frankfort,
Kentucky 40601
|
|
2005
|
|
|
Owned
|
|
|
|
516 |
|
|
1,800
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
West
Branch
1220
US 127 South
Frankfort,
Kentucky 40601
|
|
2005
|
|
|
Owned
|
|
|
|
509 |
|
|
2,480
|
|
The net
book value of our investment in premises and equipment was $2.7 million at June
30, 2010. See Note E of Notes to Consolidated Financial
Statements.
Item 3. Legal
Proceedings
From time to time, we may be defendants
in claims and lawsuits against us, such as claims to enforce liens, condemnation
proceedings on properties in which we hold security interests, claims involving
the making and servicing of real property loans and other issues incident to our
business. We are not a party to any pending legal proceedings that we
believe could have a material adverse effect on our financial condition, results
of operations or cash flows.
Item
4.
[Removed
and reserved]
Not
applicable.
PART
II
Item
5.
Market
for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
(a) The information
contained under the sections captioned “Market Information” in the Company’s
Annual Report to Stockholders for the Fiscal Year Ended June 30, 2010 (the
“Annual Report”) filed as Exhibit 13 hereto is incorporated herein by
reference.
(b) Not
applicable.
(c) The Company
repurchased the following equity securities registered under the Securities
Exchange Act of 1934, as amended, during the fourth quarter of the fiscal year
ended June 30, 2010.
Period
|
|
(a)
Total
Number of
Shares
Purchased
|
|
|
(b)
Average
Price Paid
per Share
|
|
|
(c)
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
|
|
|
(d)
Maximum
Number of Shares
That May Yet Be
Purchased Under
the Plans or
Programs (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
April
2010
Beginning
date: April 1
Ending
date: April 30
|
|
|
— |
|
|
$ |
— |
|
|
|
— |
|
|
|
20,900 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
May
2010
Beginning
date: May 1
Ending
date: May 31
|
|
|
10,000 |
|
|
$ |
9.86 |
|
|
|
10,000 |
|
|
|
10,900 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June
2010
Beginning
date: June 1
Ending
date: June 30
|
|
|
32,500 |
|
|
$ |
9.56 |
|
|
|
32,500 |
|
|
|
117,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
42,500 |
|
|
$ |
9.63 |
|
|
|
42,500 |
|
|
|
|
|
|
(1)
|
On
May 14, 2010, the Company announced a program (its seventh) to repurchase
up to 150,000 shares of its Common Stock. It is estimated that this
program will be completed within one
year.
|
Item
6.
Selected
Financial Data
This item is not applicable, as the
Company is a smaller reporting company.
Item
7.
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
The
information contained in the section captioned “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” in the Annual Report
is incorporated herein by reference.
Item
7A.
Quantitative
and Qualitative Disclosures About Market Risk
This item is not applicable, as the
Company is a smaller reporting company.
Item
8.
Financial
Statements and Supplementary Data
The
Consolidated Financial Statements, Notes to Consolidated Financial Statements,
Report of Independent Registered Public Accounting Firm and Selected Financial
Data, which are listed under Item 15 herein, are included in the Annual Report
and are incorporated herein by reference.
Item
9.
Changes
in and Disagreements With Accountants on Accounting and Financial
Disclosure
None.
Item 9A. Controls and
Procedures
Management
is responsible for establishing and maintaining effective disclosure controls
and procedures as defined under Rules 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934. As of June 30, 2010, an evaluation was performed
under the supervision and with the participation of management, including the
Chief Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on
that evaluation, management concluded that disclosure controls and procedures as
of June 30, 2010, were not effective in ensuring material information required
to be disclosed in this Annual Report on Form 10-K was recorded, processed,
summarized, and reported on a timely basis.
Management’s
responsibilities related to establishing and maintaining effective disclosure
controls and procedures including maintaining effective internal controls over
financial reporting that are designed to produce reliable financial statements
in accordance with accounting principles generally accepted in the United
States. As disclosed in the Report on Management’s Assessment of Internal
Control Over Financial Reporting of this Annual Report, we assessed our system
of internal control over financial reporting as of June 30, 2010, in relation to
criteria for effective internal control over financial reporting as described in
“Internal Control-Integrated Framework,” issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, we
believe that, as of June 30, 2010, our system of internal control over financial
reporting was not operating effectively as it relates to certain internal
controls related to the income tax function.
We have a
matter that has been classified as a material weakness in internal control over
financial reporting as of June 30, 2010.
The
Public Accounting Oversight Board’s Auditing Standard No. 5 has defined a
material weakness as “a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected.
During
the conduct of our annual audit, Crowe Horwath LLP (“Crowe”), our registered
independent public accounting firm, identified a matter as they conducted audit
work. This matter related to the accuracy of our deferred income tax
assets and liabilities. Based on the evaluation by our Chief Executive
Officer and our Chief Financial Officer, they concluded that our disclosure
controls and procedures related to income tax were not effective as of June 30,
2010. Specifically, at issue was the carrying amount of the deferred tax
liability and the distribution of dividends from one of the Company’s thrift
subsidiaries to its parent in excess of accumulated earnings and profits, which
resulted in distribution of thrift reserves, which is a taxable event. The
issues were identified after discussions with Crowe and resulted in the
restatement of retained earnings at July 1, 2007, and the restatement of net
income for the fiscal year ended June 30, 2009. Retained earnings was
increased by $224,000 at July 1, 2007, while net income for the fiscal year
ended June 30, 2009, was reduced by $80,000, the additional tax resulting from
the excess distribution of thrift reserves.
This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial
reporting. Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to the exemption provided
to issuers that are not “large accelerated filers” or “accelerated filers” under
the Dodd-Frank Wall Street Reform and Consumer Protection Act.
To
remediate the material weakness described above and enhance our internal
controls over financial reporting, management has initiated the following
significant changes:
|
·
|
Revised
our procedures related to income tax preparation and financial reporting
to include updating a schedule of accumulated earnings and
profits.
|
Notwithstanding
the evaluation and initiation of these remediation actions, the identified
significant material weakness in our internal controls over financial reporting
will not be considered remediated until the new controls are fully implemented,
in operation for a sufficient period of time, tested, and concluded by
management to be operating effectively.
Item 9B. Other
Information
Not
Applicable.
PART
III
Item
10.
Directors,
Executive Officers, and Corporate Governance
Directors
The
information contained under the section captioned “Proposal I — Election of
Directors” in the Company’s definitive proxy statement for the Company’s 2010
Annual Meeting of Stockholders (the “Proxy Statement”) is incorporated herein by
reference.
Executive
Officers
The
information regarding the Company’s executive officers is incorporated herein by
reference to “Proposal I –
Election of Directors” in the Proxy Statement.
Corporate
Governance
Information
regarding the Company’s Audit Committee and Audit Committee financial expert is
incorporated herein by reference to the section captioned “Proposal I ─ Election of Directors
─ Committees of the Board of Directors” in the Proxy
Statement.
Compliance
with Section 16(a) of the Exchange Act
Information
regarding compliance with Section 16(a) of the Exchange Act is incorporated by
reference to section captioned “Section 16(a) Beneficial Ownership
Reporting Compliance” in the Proxy Statement.
Disclosure
of Code of Ethics
Kentucky First has adopted a Code of
Ethics and Business Conduct that applies to all of its directors, officers and
employees. To obtain a copy of this document at no charge, please write to
Kentucky First Federal Bancorp, P.O. Box 535, Frankfort, Kentucky 40602-0535, or
call toll-free (888) 818-3372 and ask for Investor Relations.
Item
11.
Executive
Compensation
The
information contained under the section captioned “Executive Compensation” in
the Proxy Statement is incorporated herein by reference.
Item
12.
Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
|
(a)
|
Security Ownership of Certain
Beneficial Owners. Information required by this item is
incorporated herein by reference to the section captioned “Voting
Securities and Security Ownership” in the Proxy
Statement.
|
|
(b)
|
Security Ownership of
Management. Information required by this item is incorporated
herein by reference to the sections captioned “Voting Securities and
Security Ownership” in the Proxy
Statement.
|
|
(c)
|
Changes in Control.
Management of the Company knows of no arrangements, including any
pledge by any person of securities of the Company, the operation of which
may at a subsequent date result in a change in control of the
Company.
|
|
(d)
|
Equity Compensation
Plans. The following table sets forth certain information
with respect to the Company’s equity compensation plans as of June 30,
2010.
|
|
|
(a)
|
|
|
(b)
|
|
|
(c)
|
|
|
|
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights
|
|
|
Weighted-average
exercise price of
outstanding options,
warrants and rights
|
|
|
Number of securities
remaining available
for future issuance
under equity compensation
plans (excluding securities
reflected in column (a))
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
compensation plans approved by security holders
|
|
|
325,800 |
|
|
$ |
10.10 |
|
|
|
95,416 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
compensation plans not approved by security holders
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
325,800 |
|
|
$ |
10.10 |
|
|
|
95,416 |
|
Item
13.
Certain
Relationships and Related Transactions, and Director
Independence
Certain
Relationships and Related Transactions
The
information required by this item is incorporated herein by reference to the
section captioned “Transactions with Related
Persons” in the Proxy Statement.
Corporate
Governance
For information regarding director
independence, the section captioned “Proposal I – Election of
Directors” is incorporated herein by reference.
Item 14. Principal
Accountant Fees and Services
The information required by this item
is incorporated herein by reference to the section captioned “Audit and Other Fees Paid to
Independent Accountant” in the Proxy Statement.
PART
IV
Item
15.
Exhibits
and Financial Statement Schedules
(a)
List of Documents
Filed as Part of This Report
|
(1)
|
Financial
Statements. The following
consolidated financial statements are incorporated by reference from Item
8 hereof (see Exhibit 13):
|
Report of Independent Registered Public
Accounting Firm
Consolidated Balance Sheets as of June
30, 2010 and 2009
Consolidated Statements of Income for
the Years Ended June 30, 2010 and 2009
Consolidated Statements of
Comprehensive Income for the Years Ended
June
30, 2010 and 2009
Consolidated Statements of
Shareholders’ Equity for the Years Ended
June
30, 2010 and 2009
Consolidated Statements of Cash Flows
for the Years Ended June 30, 2010 and 2009
Notes to Consolidated Financial
Statements
|
(2)
|
Financial
Statement Schedules. All
schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are omitted because
of the absence of conditions under which they are required or because the
required information is included in the consolidated financial statements
and related notes thereto.
|
|
(3)
|
Exhibits. The
following is a list of exhibits filed as part of this Annual Report on
Form 10-K and is also the Exhibit
Index.
|
No.
|
|
Description
|
3.11
|
|
Charter
of Kentucky First Federal Bancorp
|
3.21
|
|
Bylaws
of Kentucky First Federal Bancorp
|
4.11
|
|
Specimen
Stock Certificate of Kentucky First Federal Bancorp
|
10.12
|
|
Employment
Agreement between Kentucky First Federal Bancorp and Tony D. Whitaker, as
amended†
|
10.22
|
|
Employment
Agreement between First Federal Savings and Loan Association of Hazard and
Tony D. Whitaker, as amended†
|
10.32
|
|
Employment
Agreement between Kentucky First Federal Bancorp and Don D. Jennings, as
amended†
|
10.42
|
|
Employment
Agreement between First Federal Savings Bank of Frankfort and Don D.
Jennings, as amended†
|
10.52
|
|
Employment
Agreement between Kentucky First Federal Bancorp and R. Clay Hulette, as
amended†
|
10.62
|
|
Employment
Agreement between First Federal Savings Bank of Frankfort and R. Clay
Hulette, as amended†
|
10.72
|
|
Employment
Agreement between First Federal Savings Bank of Frankfort and Teresa Kuhl,
as amended†
|
10.82
|
|
Amended
and Restated First Federal Savings and Loan Association of Hazard Change
in Control Severance Compensation Plan†
|
10.92
|
|
Amended
and Restated First Federal Savings Bank of Frankfort Change in Control
Severance Compensation Plan†
|
10.102
|
|
Amended
and Restated First Federal Savings and Loan Association Supplemental
Executive Retirement Plan†
|
10.113
|
|
Kentucky
First Federal Bancorp 2005 Equity Incentive Plan†
|
10.124
|
|
Form
of Restricted Stock Award Agreement†
|
10.134
|
|
Form
of Incentive Stock Option Award Agreement†
|
10.144
|
|
Form
of Non-Statutory Option Award
Agreement†
|
13
|
|
Annual
Report to Stockholders for the year ended June 30, 2010
|
21
|
|
Subsidiaries
|
23.1
|
|
Consent
of Crowe Horwath LLP
|
23.2
|
|
Consent
of BKD LLP
|
31.1
|
|
Rule
13a-14(a) Certification of Chief Executive Officer
|
31.2
|
|
Rule
13a-14(a) Certification of Chief Financial Officer
|
32
|
|
Section
1350 Certifications
|
|
†
|
Management
contract or compensation plan or
arrangement.
|
|
(1)
|
Incorporated
herein by reference to the Company’s Registration Statement on Form S-1
(File No. 333-119041).
|
|
(2)
|
Incorporated
herein by reference to the Company’s Quarterly Report on Form 10-Q for the
quarter ended December 31, 2008 (File No.
0-51176).
|
|
(3)
|
Incorporated
herein by reference to the Company’s definitive additional proxy
solicitation materials filed with the Securities and Exchange Commission
on October 24, 2005.
|
|
(4)
|
Incorporated
herein by reference to the Company’s Registration Statement on Form S-8
(File No. 333-130243).
|
(b)
|
Exhibits. The
exhibits required by Item 601 of Regulation S-K are either filed as part
of this Annual Report on Form 10-K or incorporated by reference
herein.
|
(c)
|
Financial
Statements and Schedules Excluded from Annual Report. There are
no other financial statements and financial statement schedules which were
excluded from the Annual Report to Stockholders pursuant to Rule 14a-3(b)
which are required to be included
herein.
|
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 FEDERAL BANCORP
|
|
|
October
6, 2010
|
By:
|
/s/ Tony D. Whitaker
|
|
|
|
Tony
D. Whitaker
|
|
|
Chief
Executive Officer
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
/s/ Tony D. Whitaker
|
|
October
6, 2010
|
Tony
D. Whitaker
|
|
|
Chairman
of the Board and Chief Executive Officer
|
|
|
(Principal
Executive Officer)
|
|
|
|
|
|
/s/ R. Clay Hulette
|
|
October
6, 2010
|
R.
Clay Hulette
|
|
|
Vice
President, Chief Financial Officer and Treasurer
|
|
|
(Principal
Financial and Accounting Officer)
|
|
|
|
|
|
/s/ Don D. Jennings
|
|
October
6, 2010
|
Don
D. Jennings
|
|
|
Director
|
|
|
|
|
|
/s/ Stephen G. Barker
|
|
October
6, 2010
|
Stephen
G. Barker
|
|
|
Director
|
|
|
|
|
|
/s/ William D. Gorman
|
|
October
6, 2010
|
William
D. Gorman
|
|
|
Director
|
|
|
|
|
|
/s/ Walter G. Ecton, Jr.
|
|
October
6, 2010
|
Walter
G. Ecton, Jr.
|
|
|
Director
|
|
|
|
|
|
/s/ David R. Harrod
|
|
October
6, 2010
|
David
R. Harrod
|
|
|
Director
|
|
|
|
|
|
/s/ Herman D. Regan, Jr.
|
|
October
6, 2010
|
Herman
D. Regan, Jr.
|
|
|
Director
|
|
|