SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the Fiscal Year Ended June 30, 1998.
[ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from____________to____________
Commission File Number: 0-18832
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Kentucky 61-1168311
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
2323 Ring Road, Elizabethtown, Kentucky 42701
(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code: (502) 765-2131
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
(Title of Class)
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 ninety days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the outstanding voting stock held by
non-affiliates of the registrant, based on the closing sales price of the
Registrant's Common Stock as quoted on the National Association of Securities
Dealers, Inc. Automated Quotation National Market System on September 15, 1998,
was $97,045,882. Solely for purposes of this calculation, the shares held by
directors and executive officers of the registrant and by any stockholder
beneficially owning more than 5% of the registrant's outstanding common stock
are deemed to be shares held by affiliates.
As of September 15, 1998, there were issued and outstanding 4,129,612
shares of the registrant's common stock, of which directors and executive
officers held 432,079 shares and more than 5% beneficial owners held 230,213
shares.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Proxy Statement for the 1998 Annual Meeting of
Stockholders. (Part III)
PART I
ITEM 1. BUSINESS
The Corporation
First Federal Financial Corporation of Kentucky (the "Corporation") was
incorporated in August 1989 under the laws of the Commonwealth of Kentucky for
the purpose of becoming the holding company for First Federal Savings Bank of
Elizabethtown ("First Federal" or the "Bank") pursuant to the Bank's
reorganization into the holding company form of ownership, which was consummated
on June 1, 1990. Prior to its acquisition of all the outstanding stock of the
Bank in connection with the Bank's holding company reorganization, the
Corporation had no assets or liabilities and engaged in no business activities.
Since its acquisition of First Federal, the Corporation has engaged in no
significant activity other than holding the stock of First Federal and operating
the business of a savings bank through First Federal. Accordingly, the
information set forth in this report, including financial statements and related
data, relates primarily to First Federal and its subsidiary.
The Corporation's executive offices are located at 2323 Ring Road,
Elizabethtown, Kentucky. Its telephone number is (502) 765-2131.
The Bank
First Federal is a federally-chartered savings bank headquartered in
Elizabethtown, Kentucky. The business of First Federal consists primarily of
attracting deposits from the general public and originating mortgage loans on
single family residences, and to a lesser extent on multi-family housing and
commercial property. First Federal also makes home improvement loans, consumer
loans and commercial business loans and through its subsidiary offers insurance
products and brokerage services to its customers. In April 1993 the Bank
established a full service trust department to serve the fiduciary needs of its
customers. The principal sources of funds for First Federal's lending activities
include deposits received from the general public, borrowings from the Federal
Home Loan Bank of Cincinnati, principal amortization and prepayment of loans.
First Federal's primary sources of income are interest and origination fees on
loans and interest on investments. First Federal also invests in various federal
and government agency obligations and other investment securities permitted by
applicable laws and regulations. First Federal's principal expenses are interest
paid on deposit accounts and operating expenses.
First Federal was originally founded in 1923 as a state-chartered
institution and became federally-chartered in 1940. In 1987, the Bank converted
to a federally-chartered savings bank and converted from mutual to stock form.
The Bank is a member of the Federal Home Loan Bank ("FHLB") of
Cincinnati and is subject to regulation, examination and supervision by the
Office of Thrift Supervision ("OTS"). The Bank's deposits are insured by the
Savings Association Insurance Fund ("SAIF") administered by the Federal Deposit
Insurance Corporation("FDIC").
LENDING ACTIVITIES
GENERAL. The principal lending activity of First Federal is the origination
origination of conventional first mortgage loans secured by residential
property. Residential mortgage loans are generally underwritten according to
Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage
Corporation (FHLMC) guidelines. To a lesser extent the Bank engages in
commercial real estate, consumer and commercial business lending. Residential
1
mortgage loans made by First Federal are secured primarily by single family
homes and include construction loans. The majority of First Federal's mortgage
loan portfolio is secured by real estate located in Hardin, Nelson, Hart, Meade,
LaRue, and Bullitt counties in the state of Kentucky.
LOAN UNDERWRITING POLICIES. During the loan approval process, First
Federal assesses both the borrower's ability to repay the loan and the adequacy
of the underlying security. Potential residential borrowers complete an
application which is submitted to a salaried loan officer. As part of the loan
application process, qualified fee appraisers inspect and appraise the property
which is offered to secure the loan. The Bank also obtains information
concerning the income, financial condition, employment and credit history of the
applicant. First Federal's loan committee, consisting of certain officers of the
Bank, analyzes the loan application and the property to be used as collateral
and subsequently approves or denies the loan request. If the mortgage loan
amount is less than $250,000, it must be approved by a loan committee consisting
of certain members of management. The Board of Directors must approve all
mortgage loans in excess of $250,000. All consumer loans under $25,000 may be
approved by authorized loan officers under Board approved lines of authority and
all loans under $100,000 may be approved by an officer loan committee. Consumer
loans in excess of $100,000 must be approved by the President. In connection
with the origination of single family residential adjustable rate mortgage
loans, borrowers are qualified at a rate of interest equal to the fully accrued
index rate. It is the policy of management to make loans to borrowers who not
only qualify at the low initial rate of interest, but who would also qualify
following an upward interest rate adjustment.
2
LOAN PORTFOLIO ANALYSIS. Set forth below is selected data relating to the
composition of the Bank's loan portfolio by type of loan and type of security on
the date indicated.
June 30,
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
Amount % Amount % Amount % Amount % Amount %
-------- --- ------- --- -------- --- -------- --- -------- ---
(Dollars in thousands)
TYPE OF LOAN:
Conventional real estate
loans:
Interim construction
loans .......................... $ 16,435 4.63% $ 15,444 4.71% $ 15,766 5.21% $ 8,159 2.88% $ 7,007 3.03%
Loans on existing
property........................ 231,071 65.03 217,759 66.43 204,301 67.57 195,424 69.06 146,228 63.35
Loans refinanced.................. 77,809 21.90 67,693 20.65 65,681 21.72 60,765 21.48 62,724 27.17
Commercial loans secured by
real estate...................... 3,254 .92 2,246 .69 2,406 .79 2,004 .71 3,234 1.40
Commercial lines of credit......... 1,116 .31 1,953 .60 1,785 .59 1,138 .40 721 .31
Home equity loans.................. 16,271 4.57 10,377 3.16 4,959 1.64 3,802 1.35 3,675 1.59
Consumer loans:
Mobile home loans................ 12 .01 18 .01 49 .02 51 .02 47 .02
Savings account loans............ 1,809 .51 1,667 .51 1,597 .52 1,357 .48 823 .35
Home improvement loans........... 0 .00 2 .00 108 .04 44 .01 107 .04
Automobile, boat and
recreational vehicle
loans.......................... 95 .03 338 .10 805 .27 980 .35 1,019 .44
Other........................... 22,639 6.37 22,390 6.83 19,649 6.50 19,504 6.89 14,298 6.19
Accrued interest
receivable..................... 241 .07 179 .05 187 .06 146 .05 133 .05
Less:
Loans in process................ 9,729 2.74 7,098 2.17 10,156 3.36 5,671 2.00 5,503 2.38
Discounts and other............. 12 .01 61 .02 184 .06 272 .10 285 .12
Loan loss reserve............... 1,853 .52 1,715 .52 1,613 .53 1,661 .59 1,406 .61
Deferred loan fees.............. 3,026 .85 2,672 .81 2,329 .77 2,052 .72 1,804 .78
Escrow deposits................. 760 .21 683 .21 618 .20 730 .26 225 .10
Interest reserves (91 days
or more delinquent)........... 66 .02 46 .01 30 .01 34 .01 13 .01
------- ------ ------- ------ -------- ------ ------- ------ -------- ------
Total.................... $355,306 100.00% $327,791 100.00% $302,363 100.00% $282,954 100.00% $230,793 100.00%
======= ====== ======= ====== ======== ====== ======== ====== ======== ======
3
June 30,
1998 1997 1996 1995 1994
---------------- ----------------- ------------------ ------------------ ----------------
Amount % Amount % Amount % Amount % Amount %
-------- ----- -------- ----- -------- ------ -------- ----- -------- -----
(Dollars in thousands)
TYPE OF SECURITY:
Residential
Single family............$283,591 79.82% $267,839 81.71% $249,161 82.40% $230,672 81.52% $188,559 81.70%
2-to-4 family............ 4,060 1.14 5,983 1.82 6,554 2.17 6,296 2.22 5,662 2.45
Commercial or industrial... 33,810 9.51 24,482 7.47 30,169 9.98 25,570 9.03 21,768 9.43
Home equity................ 16,271 4.57 10,377 3.16 4,959 1.64 3,802 1.35 3,675 1.59
Savings Accounts........... 1,809 .51 1,667 .51 1,597 .52 1,357 .48 823 .36
Mobile Homes............... 12 .01 18 .01 49 .02 51 .02 47 .02
Automobile, boats and
Recreational vehicles.... 95 .03 338 .10 805 .27 980 .35 1,019 .44
Other...................... 23,777 6.69 23,128 7.06 17,480 5.78 18,654 6.59 13,075 5.67
Accrued interest
receivable................. 241 .07 179 .05 187 .06 146 .05 133 .06
Less:
Loans in process......... 9,729 2.74 7,098 2.17 10,156 3.36 5,671 2.00 5,503 2.38
Discounts and other...... 12 .01 61 .02 184 .06 272 .10 285 .12
Loan loss reserve........ 1,853 .52 1,715 .52 1,613 .53 1,661 .59 1,406 .61
Deferred loan fees....... 3,026 .85 2,672 .81 2,329 .77 2,052 .72 1,804 .78
Escrow deposits.......... 760 .21 683 .21 618 .20 730 .26 225 .10
Interest Reserves (91
days or more delinquent) 66 .02 46 .01 30 .01 34 .01 13 .01
------- ------ ------- ------ -------- ------ -------- ------ -------- ------
Total.............. $355,306 100.00% $327,791 100.00% $302,363 100.00% $282,954 100.00% $230,793 100.00%
======= ====== ======= ====== ======== ====== ======== ====== ======== ======
LOAN MATURITY SCHEDULE. The following table sets forth certain
information at June 30, 1998, regarding the dollar amount of loans
maturing in the Bank's loan portfolio based on their contractual terms
to maturity.
Due after
Due During 1 through Due after 5
The year ended 5 years after Years after
June 30, June 30, June 30,
1999 1998 1998
-------------- ------------- -----------
(Dollars in thousands)
Real estate mortgage............................... $ 2,515 $ 10,637 $295,347
Real estate construction (1)....................... 0 0 7,452
Installment........................................ 55 179 4
Commercial, financial and
Agricultural.................................... 7,787 34,985 2,062
------ ------- -------
Total........................................ $ 10,357 $ 45,801 $304,865
======== ======== ========
<FN>
(1) These loans will become permanent real estate loans upon completion of
construction.
</FN>
4
The following table reflects a breakdown of loans maturing after one
year, by predetermined rates and adjustable rates.
Floating or
Predetermined Adjustable
Rates Rates Total
------------- ----------- -----
(Dollars in thousands)
Real estate mortgage $213,928 $ 92,056 $305,984
Real Estate Construction 5,477 1,975 7,452
Installment 183 0 183
Commercial, consumer and
agricultural 19,021 18,026 37,047
------- ------- --------
Total $238,609 $112,057 $350,666
======= ======= ========
RESIDENTIAL REAL ESTATE LENDING. The Bank's primary lending activity
is the origination of loans on single family residential units, which are units
consisting of one-to-four individual dwelling units. Fixed rate residential real
estate loans originated by the Bank have terms ranging from ten to thirty years.
Interest rates are competitively priced within the primary geographic lending
market, and vary according to the term for which they are fixed.
In recent years, the Bank has emphasized the origination of
adjustable-rate mortgage loans ("ARMs"). The Bank offers an ARM with an annual
adjustment which is tied to various national indeces with a maximum adjustment
of 2% annually and a lifetime cap of 15%. As of June 30, 1998, approximately 30%
of the Bank's real estate loans were adjustable rate loans with adjustment
periods ranging from one to five years and balloon loans of seven years or less.
The Bank limits the maximum loan-to-value ratio on one-to-four-family
residential first mortgages to 80% of the appraised value and 95% on certain
mortgages, with the requirement that private mortgage insurance be obtained for
loans with loan-to-value ratios in excess of 80%. The Bank generally limits the
loan-to-value ratio to 80% on second mortgages on one-to-four-family dwellings.
First Federal's residential lending activities also include loans
secured by multi-family residential property, consisting of properties with more
than four separate dwelling units. These loans amounted to $7.1 million or 2.3%
of the loan portfolio at June 30, 1998. First Federal generally does not lend
above 75% of the appraised values of multi-family residences on first mortgage
loans. The mortgage loans First Federal currently offers on multi-family
dwellings are generally one or five year ARMs with maturities of 25 years or
less.
The Bank maintains a secondary mortgage operation designed to make
qualified VA and FHA loans for sale to investors, thereby providing necessary
liquidity to the Bank and needed loan products to the Bank's customers. During
fiscal 1998, the Bank's secondary mortgage operations originated $31.3 million
in loans for sale to investors. Conventional mortgage loans originated by the
Bank do not meet certain guidelines, therefore, they do not qualify for sale on
the secondary market.
CONSTRUCTION AND COMMERCIAL REAL ESTATE LENDING. First Federal
originates loans secured by existing commercial properties and construction
loans primarily on residential real estate. The loans are secured by real estate
located in Kentucky. Substantially all of the commercial real estate loans
originated by First Federal have adjustable interest rates with maturities of 25
years or less or are loans with fixed interest rates and maturities of five
years or less. At June 30, 1998, the Bank had $16.4 million in outstanding
interim construction loans. The security for commercial real estate loans
includes retail businesses, warehouses and motels. Commercial real estate loans
originated by the Bank range in size from $65,000 to $2,750,000.
5
Commercial real estate loans typically involve large loan balances to
single borrowers or groups of related borrowers and may also involve higher loan
principal amount to security property appraisal value ratios as compared to
loans secured by residential real estate. In addition, the payment experience of
loans secured by income producing properties is typically dependent on the
successful operation of the related real estate project and thus may be more
vulnerable to adverse conditions in the real estate market or in the economy
generally. Construction loans involve additional risks as a result of the fact
that loan funds are advanced upon the security of the project under
construction, which is of uncertain value prior to the completion of
construction. Moreover, because of the uncertainties inherent in estimating
construction costs, delays arising from labor problems, material shortages, and
other unpredictable contingencies, it is relatively difficult to evaluate
accurately the total loan funds required to complete a project, and related
loan-to-value ratios. The analysis of prospective construction loan projects
thus requires an expertise that varies in significant respects from that which
is required for residential mortgage lending.
The Bank's underwriting criteria are designed to evaluate and minimize
the risks of each construction loan. Among other things, the Bank considers
evidence of the availability of permanent financing or a takeout commitment to
the borrower; the reputation of the borrower and his or her financial condition;
the amount of the borrower's equity in the project; independent appraisals and
cost estimates; preconstruction sale and leasing information; and cash flow
projections of the borrower.
CONSUMER LOANS. Federal regulations permit federally chartered thrift
institutions to make secured and unsecured consumer loans of up to 30% of their
assets. This limit may be exceeded for certain consumer loans, such as home
equity loans, property improvement loans, mobile home loans and loans secured by
savings accounts. The consumer loans granted by the Bank have included loans on
automobiles, boats, recreational vehicles and other consumer goods, as well as
education loans, loans secured by savings accounts, home improvement loans, and
unsecured lines of credit. As of June 30, 1998, consumer loans outstanding were
$45.0 million or approximately 12.6% of the Bank's total gross loan portfolio.
These loans involved a higher risk of default than loans secured by one-to-four-
family residential loans. The Bank believes, however, that the shorter term and
the normally higher interest rates available on various types of consumer loans
have been helpful in maintaining a profitable spread between the Bank's average
loan yield and its cost of funds.
In view of the riskier nature of consumer lending, the Bank has
developed what management believes are conservative underwriting standards. In
applying these standards, the Bank obtains detailed financial information and
credit bureau reports concerning each applicant. In addition, the relationship
of the loans to the value of the collateral is considered.
The Bank offers a home equity line of credit, which is a revolving line
of credit secured by the equity in a customer's home. As of June 30, 1998, these
loans totaled $16.3 million which is a 57% increase over the prior fiscal year.
COMMERCIAL BUSINESS LENDING. The Bank is permitted to make secured and
unsecured loans for commercial, corporate, business, and agricultural purposes,
including issuing letters of credit and engaging in inventory financing and
commercial leasing activities. First Federal has offered business loans secured
by real estate since 1982 and it has not been a material part of the Bank's
activities to date. The Bank may become more active in this type of lending in
the future.
6
The Bank offers a commercial line of credit, which is a revolving line
of credit secured by the equity in the property, primarily real estate, of a
business. As of June 30, 1998, these loans totaled approximately $1.1 million.
ORIGINATION, PURCHASES AND SALES. Historically, all residential and
commercial real estate loans have been originated directly by the Bank through
salaried loan officers. Residential loan originations are generally attributable
to referrals from real estate brokers and builders, depositors and walk-in
customers. Commercial real estate and construction loan origination have been
obtained by direct solicitation, and consumer loan origination by walk-in
customers in response to the Bank's advertising, as well as by direct
solicitation.
The following table shows loans originated and sold during the periods
indicated. No loans were purchased by the Bank during the last five fiscal
years.
Year Ended June 30,
1998 1997 1996 1995 1994
------- ------ ----- ------ -----
(Dollars in thousands)
Loans originated:
Conventional real estate
loans:
Construction loans $ 18,648 $ 16,664 $ 16,078 $12,632 $15,093
Loans on existing property 73,581 47,256 61,349 38,235 33,216
Loans refinanced 33,249 15,846 16,436 5,271 17,923
Insured and quaranteed loans 2,355 2,286 2,472 1,936 1,705
Commercial loans 2,655 2,769 3,267 2,331 5,129
Consumer loans 35,463 29,440 21,071 18,548 14,199
------- ------- ------- ------- -------
Total Loans Originated $165,951 $114,261 $120,673 $78,953 $87,265
======= ======= ======= ======= =======
Total Loans Sold $ 29,814 $ 16,199 $ 23,178 $ 8,822 $ 4,121
======= ======= ======== ======= =======
LOAN COMMITMENTS. Conventional loan commitments by the Bank are
granted for periods of 30 days. The total amount of the Bank's outstanding
commitments to originate real estate loans at June 30, 1998, was approximately
$6.6 million. It has been the Bank's experience that few commitments expire
unfunded.
LOAN FEES. In addition to interest earned on loans, certain fees are
received for committing to and ultimately originating loans. The Bank also
receives other fees and charges relating to existing loans, which include
prepayment penalties, late charges and fees for loan modifications. Management
believes that these fees and charges do not materially affect operating results.
NON-PERFORMING LOANS AND ASSET CLASSIFICATION. Loans are reviewed on
a regular basis and normal collection procedures are implemented when a borrower
fails to make a required payment on a loan. If the delinquency on a mortgage
loan exceeds 90 days and is not cured through normal collection procedures or an
acceptable arrangement is not worked out with the borrower, the Bank institutes
measures to remedy the default, including commencing a foreclosure action.
Consumer loans generally are charged off when a loan is deemed uncollectible by
management and any available collateral has been disposed of. Commercial
business and real estate loan delinquencies are handled on an individual basis
by management with the advice of the Bank's legal counsel. The Bank anticipates
that the increase in non-performing real estate loans will continue due to the
growth of the Bank's loan portfolio.
7
Real estate acquired by the Bank as a result of foreclosure or by deed
in lieu of foreclosure is classified as real estate owned until such time as it
is sold. When such property is acquired it is recorded at the lower of the
unpaid principal balance of the related loan or its fair market value. Any
write-down of the property is charged to the allowance for loan losses.
The following table sets forth information with respect to the Bank's
non-performing assets for the periods indicated. During the periods shown, the
Bank had no restructured loans within the meaning of Statement of Financial
Accounting Standards No. 15.
At June 30,
1998 1997 1996 1995 1994
------ ------ ------- ------ -----
(Dollars in thousands)
Non-Performing loans which are
contractually past due
90 days or more:
Real Estate:
Residential..................... $ 1,487 $ 1,172 $ 940 $ 649 $ 254
Commercial...................... -- -- -- -- --
Consumer.......................... 566 378 312 512 333
------ ------ ------- ------- -------
Total....................... $ 2,053 $ 1,550 $ 1,252 $ 1,161 $ 587
======= ======= ======= ======= =======
Total 90 days past
due loans................ $ 2,053 $ 1,550 $ 1,252 $ 1,161 $ 587
======= ======= ======= ======= =======
Percentage of Total Loans............... 0.58% 0.47% 0.41% 0.41% 0.25%
Other Non-Performing Assets $ 134 $ 184 $ 375 $ 260 $ 267
======= ======= ======= ======= =======
(1).....................................
<FN>
(1) Other non-performing assets represents property acquired by the Bank
through foreclosure or repossession. This property is carried at the
lower of its fair value or the principal balance of the related loan.
</FN>
8
The following table sets forth an analysis of the Bank's allowance for
possible loan losses for the periods indicated.
Year Ended June 30,
1998 1997 1996 1995 1994
------ ------ ------ ------ -----
(Dollars in thousands)
Balance at Beginning of Period............... $1,715 $1,613 $1,662 $1,406 $1,415
------ ------ ------ ------ ------
Loans Charged-Off:
Real Estate--Mortgage:
Residential.............................. 16 17 0 14 0
Commercial............................... 0 0 0 16 10
Commercial Business........................ 0 0 24 0 0
Consumer................................... 132 114 50 21 35
------- ------ ------ ------ ------
Total Charge-Offs............................ 148 131 74 51 45
------ ------ ------ ------ ------
Recoveries:
Real Estate-Mortgage:
Residential.............................. 0 0 1 0 0
Commercial............................... 0 0 23 16 0
Consumer................................... 21 33 1 6 6
------ ------ ------ ------ ------
Total Recoveries............................. 21 33 25 22 6
------ ------ ------ ------ ------
Net Loans Charged-Off........................ 127 98 49 29 39
------ ------ ------ ------ ------
Reserve associated with loans
acquired in merger........................... -- -- -- 185 --
Provision for Possible Loan
Losses....................................... 265 200 0 100 30
------ ------ ------ ------ ------
Balance at End of Period..................... $1,853 $1,715 $1,613 $1,662 $1,406
====== ====== ====== ====== ======
Ratio of Net Charge-Offs to
Average Loans Outstanding
During the Period.......................... 0.037% 0.031% 0.017% 0.010% 0.017%
The following table sets forth the breakdown of the allowance for loan
losses by loan category for the periods indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. The
allocation of the allowance to each category is not necessarily indicative of
further losses and does not restrict the use of the allowance to absorb losses
in any category.
At June 30,
1998 1997 1996 1995 1994
------ ------ ------ ------ -----
(Dollars in thousands)
Real estate loans:
Residential Loans............. $1,234 $1,178 $1,277 $1,289 $1,043
Commercial Loans.............. 168 146 142 128 103
Non-real estate loans............ 451 391 194 245 260
------ ------ ------ ------ ------
Total allowance for
possible loan
losses......................... $1,853 $1,715 $1,613 $1,662 $1,406
====== ====== ====== ====== ======
It is management's policy to provide for estimated losses on loans and
investments in real estate when it determines that losses are expected to be
incurred on the underlying assets. Management also establishes general
allowances based on the amount and types of loans in the Bank's portfolio.
Subsequent adjustments to allowances are made if current circumstances differ
substantially from the assumptions used in making the initial estimates.
9
At June 30, 1998, there were no concentrations of loans in any types of
industry which exceeded 10% of total loans that were not otherwise disclosed as
a loan category above. In addition, there were no loans which were not
classified as non-accrual or restructured at June 30, 1998 which may be so
classified in the near future because of management concerns as to the ability
of the borrowers to comply with repayment terms.
Federal regulations require insured institutions to classify their own
assets on a regular basis. In addition, in connection with examinations of
insured institutions, OTS examiners have authority to identify problem assets
and, if appropriate, classify them. The regulations provide for three
classifications of asset categories -- substandard, doubtful and loss. The
regulations also contain a special mention category, defined as assets which do
not currently expose an insured institution to a sufficient degree of risk to
warrant classification but do possess credit deficiencies or potential
weaknesses deserving management's close attention. Assets classified as
substandard or doubtful require the institution to establish general allowances
for loan losses. If an asset or portion thereof is classified as loss, the
insured institution must either establish specified allowances for loan losses
in the amount of 100% of the portion of the asset classified loss, or charge off
such amount.
At June 30, 1998, on the basis of management's review of the Bank's loan
portfolio, the Bank had $1.9 million of assets classified substandard, $185,000
of assets classified doubtful, and no assets classified as loss.
INVESTMENT ACTIVITIES
Interest on investment securities provides the largest source of income
for First Federal after interest on loans, constituting 5.9% of the total
interest income for fiscal year 1998. First Federal maintains its liquid assets
above the minimum requirements imposed by regulation at a level believed
adequate to meet requirements of normal banking activities and potential savings
outflows. Cash flow projections are regularly reviewed and updated to assure
that adequate liquidity is provided. As of June 30, 1998, First Federal's
liquidity ratio (liquid assets as a percentage of net withdrawable savings and
current borrowings) was 9.17%.
First Federal has the authority to invest in various types of liquid
assets, including short-term United States Treasury obligations and securities
of various federal agencies, certificates of deposit at insured savings and
loans and banks, bankers' acceptances, and federal funds. The Bank may also
invest a portion of its assets in certain commercial paper and corporate debt
securities. First Federal is also authorized to invest in mutual funds and
stocks whose assets conform to the investments that First Federal is authorized
to make directly. See Note 3 of Notes to Consolidated Financial Statements for
further information concerning the Bank's investment portfolio.
As a member of the Federal Home Loan Bank System, First Federal must
maintain minimum levels of liquid assets specified by the OTS which vary from
time to time. See "Regulation - Federal Home Loan Bank System." Liquidity may
increase or decrease depending upon the availability of funds and comparative
yields on investments in relation to return on loans.
The table on the following page sets forth the carrying value of the
Bank's investment securities portfolio at the dates indicated. At June 30, 1998,
the market value of the Bank's investment securities portfolio was $26.9
million.
10
At June 30,
1998 1997 1996
-------- -------- -------
(Dollars in thousands)
Held-to-maturity securities:
U.S. Treasury and agencies.............. $22,693 $15,335 $ 9,225
Mortgage-backed securities.............. $ 1,946 $ 2,149 $ 2,769
-------- ------- -------
Total held-to-maturity
securities............................. $24,639 $17,484 $11,994
======= ======= =======
Securities available-for-sale:
Equity securities....................... $ 1,934 $ 5,192 $ 4,748
====== ======= =======
The following table sets forth the scheduled maturities, amortized
cost, and average yields for the Bank's debt securities at June 30, 1998,
all of which were classified as held-to-maturity.
Amortized Average
Cost Yield
(Dollars in thousands)
Debt securities:
Due in one year or less $ 984 6.36%
Due after one year through five years 12,718 6.61
Due after five years through ten years - -
Due after ten years 8,991 7.00
Mortgage-backed securities 1,946 6.99
-------
$24,639
=======
11
SOURCES OF FUNDS
GENERAL. Savings accounts and other types of deposits have traditionally
been an important source of the Bank's funds for use in lending and for other
general business purposes. In addition to deposit accounts, the Bank derives
funds from loan repayments, FHLB advances, other borrowings and operations.
Borrowings may be used on a short-term basis to compensate for reductions in
deposits or deposit inflows at less than projected levels and may be used on a
longer term basis to support expanded lending activities.
DEPOSITS. First Federal attracts both short-term and long-term deposits
from the general public by offering a wide range of deposit accounts and
interest rates. In recent years the Bank has been required by market conditions
to rely increasingly on short-term certificate accounts and other deposit
alternatives that are more responsive to market interest rates. First Federal
offers regular passbook accounts, NOW accounts, money market accounts and
fixed-interest-rate certificates with varying maturities. First Federal also
offers tax-deferred individual retirement accounts.
As of June 30, 1998, approximately 28.1% of First Federal's deposits
consisted of various savings and demand deposit accounts from which customers
are permitted to withdraw funds at any time without penalty.
Interest earned on passbook accounts is paid from the date of deposit to
the date of withdrawal and compounded quarterly. Interest earned on NOW accounts
is paid from the date of deposit to the date of withdrawal, compounded and
credited monthly. The interest rate on these accounts is established by First
Federal's management.
First Federal also makes available to its depositors a number of
certificates of deposit with various terms and interest rates to be competitive
in its market area. These certificates have minimum deposit requirements as
well.
12
The following table sets forth the change in dollar amount of savings deposits
in the various types of savings accounts offered by the Bank between the dates
indicated.
Balance Balance Balance Balance
June 30, % of Increase June 30, % of Increase June 30, % of Increase June 30, % of
1998 Deposits (Decrease) 1997 Deposits (Decrease) 1996 Deposits (Decrease) 1995 Deposits
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Passbook and
Regular Savings.........$ 30,182 9.84% $(1,004) $ 31,186 11.08% $ (112) $ 31,298 11.81% $ (2,340) $ 33,638 12.91%
NOW commercial
accounts................ 9,196 3.00 (617) 9,813 3.49 833 8,980 3.39 1,447 7,533 2.89
NOW Demand Accounts..... 37,015 12.07 3,875 33,140 11.78 2,702 30,438 11.49 735 29,703 11.40
Money Market
deposit accounts........ 9,856 3.21 (604) 10,460 3.72 191 10,269 3.88 1,629 8,640 3.32
Three month CD's........ 925 .30 (108) 1,033 .37 (64) 1,097 .41 (253) 1,350 .52
Six month CD's.......... 25,696 8.38 13,297 12,399 4.41 (5,132) 17,531 6.62 2,051 15,480 5.94
Fixed rate CD's
- 12 months.......... 41,007 13.37 (12,706) 53,713 19.09 5,140 48,573 18.33 9,394 39,179 15.04
Variable rate CD's
- 12 months.......... 2,448 .80 (671) 3,119 1.11 (1,205) 4,324 1.63 (814) 5,138 1.97
Fixed Rate CD's
- 18 months.......... 38,138 12.43 2,635 35,503 12.62 27,905 7.598 2.87 (6,929) 14,527 5.58
Fixed Rate CD's
- 24 months.......... 53,684 17.50 28,699 24,985 8.88 (8,673) 33,658 12.70 5,004 28,654 11.00
Fixed Rate CD's
- 30 months.......... 2,095 .68 (1,075) 3,170 1.13 (605) 3,775 1.42 (3,861) 7,636 2.93
Fixed Rate CD's
- 36 months.......... 8,201 2.67 (3,501) 11,702 4.16 (26) 11,728 4.43 (1,473) 13,201 5.07
Fixed Rate CD's
- 48 months.......... 12,348 4.03 (4,448) 16,796 5.97 (5,502) 22,298 8.42 (1,278) 23,576 9.05
Variable Rate CD's
- 48 months.......... 7 .01 (21) 28 .01 (7) 35 .01 (20) 55 .02
IRA accounts............ 24,438 7.97 1,392 23,046 8.19 1,242 21,804 8.23 1,267 20,537 7.88
Other accounts -
6 to 8 year CD's..... 11,467 3.74 218 11,249 3.99 (291) 11,540 4.36 (116) 11,656 4.48
------- ------ ------ ------- ------ ------- -------- ------ ------- -------- ------
Total............$306,703 100.00% $ 25,361 $281,342 100.00% $16,396 $264,946 100.00% $ 4,443 $260,503 100.00%
======= ====== ======= ======== ====== ======= ======== ====== ======= ======== ======
13
The variety of deposit account offered by First Federal has permitted
it to be more competitive in obtaining funds and has allowed it to respond with
more flexibility to disintermediation (the flow of funds away from depository
institutions such as savings institutions into direct investment vehicles such
as government and corporate securities). However, the ability of the Bank to
attract and maintain deposits and its cost of funds have been, and will continue
to be, significantly affected by money market conditions.
The following table sets forth the amount of deposits as of June 30,
1998 by various interest rate categories.
Weighted
Average Percent
Interest Minimum Minimum of Total
Rate Term Category Amount Balances(1) Savings
-------- ------- -------- ------- ---------- -------
2.65% NONE Passbook Savings Account $ 1 $ 30,182 9.84%
.10 NONE NOW Commercial Accounts 300 9,196 3.00
1.52 NONE NOW Demand Accounts 1,000 37,015 12.07
3.31 NONE Money Market Deposit Accounts 500 9,856 3.21
3.61 91 days 3 Month Certificate 500 925 0.30
5.27 182 days 6 Month Certificate 500 25,696 8.38
5.58 12 months Fixed Rate 500 41,007 13.37
5.14 12 months Variable Rate 500 2,448 .80
6.11 18 months Fixed Rate 500 38,138 12.43
5.89 24 months Fixed Rate 500 53,684 17.50
5.63 30 months Fixed Rate 500 2,095 .68
5.61 36 months Fixed Rate 500 8,201 2.67
5.97 48 months Fixed Rate 500 12,348 4.03
5.39 48 months Variable Rate 500 7 .01
5.82 18 months Individual Retirement Accounts 500 23,438 7.97
6.11 6-8 years Other Certificates 500 11,467 3.74
------- ------
$306,703 100.00%
======= =======
(1) Dollars in thousands.
14
The following table indicates at June 30, 1998 the amount of the Bank's
certificates of deposit of $100,000 or more by time remaining until maturity.
Maturity Period Certificates
of Deposit
(In Thousands)
Three months or less.................................... $ 5,863
Three through six months................................ 11,753
Six through twelve months............................... 17,598
Over twelve months...................................... 19,118
------
Total............................................... $54,332
======
The following table sets forth the average balances and interest rates
based on month-end balances for various deposit categories during the periods
indicated.
Year Ended June 30,
1998 1997 1996
--------------- --------------- ---------------
Average Average Average
Average Rate Average Rate Average Rate
Balance Paid Balance Paid Balance Paid
(Dollars in thousands)
Non interest-bearing
accounts................ $ 9,743 --% $ 9,104 --% $ 8,376 --%
Interest-bearing
demand deposits......... 46,141 1.59 42,343 1.70 37,489 1.65
Savings deposits.......... 30,696 2.64 31,259 2.62 31,885 2.65
Certificates of
deposit................ 207,333 5.78 187,974 5.52 180,959 5.68
BORROWINGS. Savings deposits are the primary source of funds for First
Federal's lending and investment activities and for its general business
purposes. The Bank can also use advances (borrowings) from the FHLB of
Cincinnati to supplement its supply of lendable funds, meet deposit withdrawal
requirements and to extend the term of its liabilities. Advances from the FHLB
are typically secured by the Bank's stock in the FHLB and a portion of the
Bank's first mortgage loans. At June 30, 1998 First Federal had $43.2 million in
advances outstanding from the FHLB of Cincinnati.
The FHLB of Cincinnati functions as a central reserve bank providing
credit for savings banks and certain other member financial institutions. As a
member, First Federal is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its home mortgages and other assets (principally, securities which are
obligations of, or guaranteed by, the United States) provided certain standards
related to credit- worthiness have been met.
The following table sets forth certain information regarding the Bank's
FHLB advances during the periods indicated.
At June 30,
1998 1997 1996
-------- -------- ------
(Dollars in thousands)
Average balance outstanding............... $41,990 $41,482 $31,825
Maximum amount outstanding at
any month-end during the
period ................................... 43,441 47,716 35,051
Year end balance.......................... 43,249 41,514 34,979
Weighted average interest rate:
At end of year ....................... 5.39% 5.62% 5.54%
During the year........................ 5.63% 5.61% 5.73%
15
AVERAGE BALANCE SHEET
The following table sets forth information relating to the Bank's
average balance sheet and reflects the average yield on assets and
average cost of liabilities for the periods indicated. Such yields and
costs are derived by dividing income or expense by the average monthly
balance of assets or liabilities, respectively, for the periods
presented.
Year Ended June 30,
1998 1997 1996
---------------------------- ----------------------------------- ---------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- -------- --------- -------- -------- ------- -------- ------
(Dollars in thousands)
Interest-earning assets:
Loans-receivable, net........... $343,822 $ 29,339 8.53% $317,565 $ 26,945 8.48% $295,657 $ 25,173 8.51%
Debt securities................... 16,475 1,058 6.42 15,133 976 6.45 8,011 527 6.25
Equity securities................ 2,492 73 2.93 4,856 228 4.70 4,536 225 4.96
Mortgage-backed securities........ 2,090 147 7.03 2,514 178 7.08 3,042 222 7.30
FHLB stock........................ 2,875 207 7.20 2,674 188 7.03 2,495 174 6.97
Interest-bearing deposits......... 2,968 221 7.45 1,805 98 5.43 9,981 605 6.06
------- -------- ------ ------- ------- ------ ------ -------- ------
Total interest-earning
assets...................... 370,723 31,045 8.37 344,548 28,613 8.30 323,722 26,926 8.32
Non-interest-earning assets..... 23,279 21,981 18,906
------- ------- --------
Total assets....................$394,002 $366,529 $342,628
======= ======= ========
Interest-bearing liabilities:
Passbook accounts................$ 30,696 $ 809 2.64% $ 31,259 $ 818 2.62% $ 31,885 $ 846 2.65%
NOW and money market accounts..... 55,884 887 1.59 51,447 875 1.70 45,865 759 1.65
Certificate accounts..............207,333 11,980 5.78 187,974 10,377 5.52 180,959 10,271 5.68
FHLB advances..................... 41,990 2,383 5.68 41,482 2,306 5.56 31,825 1,800 5.66
------- ------- ------- ------- ------- ------- -------- -------- ------
Total interest-bearing
liabilities....................335,903 16,059 4.78 312,162 14,376 4.61 290,534 13,676 4.71
------- ------- --------
Non-interest-bearing liabilities.... 4,697 3,879 3,198
------- ------- --------
Total liabilities............... 340,600 316,041 293,732
Stockholders' equity................ 53,402 50,488 48,896
------- ------- --------
Total liabilities and
stockholders' equity $394,002 $366,529 $342,628
======= ======= ========
Net interest income................. $ 14,986 $ 14,237 $ 13,250
======= ======= ========
Interest rate spread................ 3.59% 3.70% 3.61%
======= ====== ======
Net yield on interest-earning
assets............................ 4.04% 4.13% 4.09%
======= ====== ======
Ratio of average interest-
earning assets to average
interest-bearing liabilities....... 110.37% 110.37% 111.42%
======= ====== ======
16
RATE/VOLUME ANALYSIS
The table below sets forth certain information regarding changes in
interest income and interest expense of the Bank for the periods
indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes
attributable to (1) changes in rate (change in rate multiplied by old
volume);(2) changes in volume (change in volume multiplied by old rate);
and (3) changes in rate-volume (change in rate multiplied by change in
volume). Changes in rate-volume are proportionately allocated between
rate and volume variance.
Year Ended June 30,
1998 vs. 1997 1997 vs. 1996 1996 vs. 1995
--------------------------- --------------------------- ----------------------------
Increase (Decrease) Increase (Decrease) Increase (Decrease)
Due to Due to Due to
Rate Volume Total Rate Volume Total Rate Volume Total
------ ------ ------- ------ ------ ------- ------ ------ -------
(Dollars in Thousands)
Interest income:
Loans-receivable, net...... $ 159 $ 2,235 $ 2,394 $ (89) $ 1,860 $ 1,771 $ 578 $ 3,308 $ 3,886
Debt securities.............. (5) 87 82 (11) 460 449 (67) 96 29
Equity securities............ (104) (135) (239) (15) 12 (3) 40 12 52
Mortgaged-backed
securities.................. (1) (30) (32) (7) (39) (46) 18 97 115
FHLB stock................... 5 14 19 2 12 14 13 24 37
Interest-bearing deposits.... 45 78 123 (57) (450) (507) (18) 134 116
------- ----- ------ ------ -------- -------- -------- ------- --------
Total interest-earning
assets.................... .$ 99 $ 2,249 $ 2,347 $ (177) $ 1,855 $ 1,678 $ 564 $ 3,671 $ 4,235
======= ======= ======= ====== ======= ======== ======== ======= ========
Interest expense:
Passbook accounts.......... $ 7 $ (14) $ (7) $ (9) $ (15) $ (24) $ 20 $ 18 $ 38
Now & money market
accounts.................... (77) 48 (29) 16 100 116 29 103 132
Certificate accounts......... 503 1,100 1,603 (756) (70) (826) 811 1,274 2,085
FHLB advances................ 52 29 81 (32) 538 506 (24) 930 906
----- ----- ------ ------ ------ ------- -------- ------- -------
Total interest-bearing
liabilities................ $ 485 $ 1,163 $ 1,648 $ (781) $ 553 $ (228) $ 836 $ 2,325 $ 3,161
===== ======= ======== ====== ======= ======= ======== ======= ========
17
SUBSIDIARY ACTIVITIES
As a federally-chartered savings bank, the Bank is permitted to invest
an amount equal to 2% of its assets in subsidiaries with an additional
investment of 1% of assets where such investment serves primarily community,
intercity, and community development purposes. Under such limitations, on June
30, 1998, the Bank was authorized to invest up to approximately $12.3 million in
the stock of or loans to subsidiaries. In addition, institutions meeting
regulatory capital requirements, which the Bank does, may invest up to 50% of
their regulatory capital in conforming first mortgage loans to subsidiaries in
which they own 10% or more of the capital stock. As of June 30, 1998, the Bank's
investment in and loans to its subsidiaries was approximately $810,484
consisting of investment in common stock and earnings.
In 1978, the Bank formed First Service Corporation of Elizabethtown
("First Service") which holds an equity interest in Intrieve, Inc.,the company
performing the Bank's data processing. First Service also acts as a broker for
the purpose of selling mortgage life, credit life and accident and disability
insurance to the Bank's customers.
In March, 1998 First Service entered into a contract with Robert Thomas
Securities, Inc. to provide investment services to the Bank's customers in the
area of tax deferred annuities, government securities and stocks and bonds.
First Service employs three full-time employees to perform these services. This
investment function operates under licenses held by First Service. The net
earnings of First Service was $112,588 during fiscal year 1998.
Savings associations, in determining compliance with capital
requirements, are required to deduct from capital an increasing percentage of
their debt and equity investments in, and extensions of credit to, service
corporations in activities not permissible for a national bank. Certain
activities of the Bank's service corporations are not permissible for national
banks. Accordingly, on June 30, 1998, the Bank deducted 100% of its investment
in its service corporation from its core and tangible capital. See "Regulation
- -- Regulatory Capital Requirements." Because the Bank's investment in its
subsidiary is insignificant, management does not believe that the required
deductions from capital will have a material effect on the Bank's regulatory
capital position.
COMPETITION
First Federal experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans. Direct
competition for savings deposits comes from other savings institutions,
commercial banks, and credit unions located in north-central Kentucky.
Additional significant competition for savings deposits comes from money market
mutual funds and corporate and government debt securities.
The primary factors in competing for loans are interest rates and loan
origination fees and the range of services offered by the various financial
institutions. Competition for origination of real estate loans normally comes
from other savings institutions, commercial banks, mortgage bankers, mortgage
brokers, and insurance companies. First Federal is able to compete effectively
in its primary market area.
First Federal has offices in six cities in four contiguous counties. In
addition to the financial institutions which have offices in these counties,
First Federal competes with several commercial banks and savings institutions in
surrounding counties, many of which have assets which are substantially larger
18
than First Federal's. In addition, Kentucky's interstate banking statute, which
permits banks in all states to enter the Kentucky market if they have reciprocal
interstate banking statutes, has further increased competition for the Bank.
EMPLOYEES
The Corporation and subsidiaries had 100 full-time employees and 15
part-time employees as of June 30, 1998. None of these employees is represented
by a collective bargaining agreement and the Corporation believes that it enjoys
good relations with its personnel.
REGULATION
GENERAL. As a federally chartered savings association, First Federal is
subject to extensive regulation by the OTS. The lending activities and other
investments of the Bank must comply with various federal regulatory
requirements. The OTS periodically examines the Bank for compliance with various
regulatory requirements and the FDIC also has the authority to conduct special
examinations of institutions insured by the SAIF. The Bank must file reports
with the OTS describing its activities and financial condition. The Bank is also
subject to certain reserve requirements promulgated by the Board of Governors of
the Federal Reserve System (the "Federal Reserve Board"). This supervision and
regulation is intended primarily for the protection of depositors. As a savings
and loan holding company, the Corporation is subject to the OTS' regulation,
examination, supervision and reporting requirements.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB System,
which consists of 12 regional Federal Home Loan Banks subject to supervision and
regulation by the Federal Housing Finance Board ("FHLB"). The Federal Home Loan
Banks provide a Central Credit facility primarily for member institutions. As a
member of the FHLB of Cincinnati, the Bank is required to acquire and hold
shares of capital stock in the FHLB of Cincinnati in an amount at least equal to
1% of the aggregate unpaid principal of its home mortgage loans, home purchase
contracts, and similar obligations at the beginning of each year, or 1/20 of its
advances (borrowings) from the FHLB of Cincinnati, whichever is greater. First
Federal was in compliance with this requirement with investment in the FHLB of
Cincinnati stock at June 30, 1998, of $3.0 million.
The FHLB of Cincinnati serves as a reserve or central bank for its
member institutions within its assigned region. It is funded primarily from
proceeds derived from the sale of consolidated obligations of the FHLB System.
It makes advances to members in accordance with policies and procedures
established by the FHFB and the Board of Directors of the FHLB of Cincinnati. As
of June 30, 1998, First Federal had $43.2 million in advances outstanding from
the FHLB of Cincinnati. See "Business - Sources of Funds - Borrowings."
LIQUIDITY REQUIREMENTS. As a member of the FHLB System, the Bank has
been required to maintain average daily balances of liquid assets (cash,
deposits maintained pursuant to Federal Reserve Board requirements, time and
savings deposits in certain institutions, obligations of states and political
subdivisions thereof, shares in mutual funds with certain restricted investment
policies, highly rated corporate debt, and mortgage loans and mortgage-related
securities with less than one year to maturity or subject to purchase within one
year) equal to the monthly average of not less than a specified percentage of
its net withdrawable savings deposits plus short-term borrowings. This liquidity
requirement, which is currently 5%, may be changed from time to time by the OTS
to any amount within the range of 4% to 10% depending upon economic conditions
and the savings flows of member institutions. Member institutions have also been
19
required to maintain average daily balances of short-term liquid assets at a
specified percentage (currently 1%) of the total of their net withdrawable
savings accounts and borrowings payable in one year or less. Monetary penalties
may be imposed for failure to meet liquidity requirements. The average liquidity
and short-term liquidity ratios of First Federal for June 1998 were 9.81% and
9.17%, respectively.
QUALIFIED THRIFT LENDER TEST. The Bank is currently subject to OTS
regulations which use the concept of a qualified thrift lender ("QTL") to
determine eligibility for Federal Home Loan Bank advances and for certain other
purposes. To qualify as a QTL, a savings association must maintain at least 65%
of its "portfolio" assets in qualified thrift investments. Portfolio assets are
defined as total assets less intangibles, property used by a savings association
in its business and liquidity investments in an amount not exceeding 20% of
assets. Qualified thrift investments consist of: (i) loans, equity positions, or
securities related to domestic, residential real estate or manufactured housing,
credit card and education loans; (ii) property used by the savings association
in the conduct of its business; and (iii) stock in a Federal Home Loan Bank or
the Federal National Mortgage Association or the Federal Home Loan Mortgage
Corporation. Qualified thrift investments may also include liquidity investments
and 50% of the dollar amount of residential mortgage loans subject to sale under
certain conditions. To qualify as a QTL, a savings association must maintain its
status as a QTL on a monthly basis in nine out of every 12 months. Failure to
qualify as a QTL results in a number of sanctions, including the imposition of
certain operating restrictions imposed on national banks and a restriction on
obtaining additional advances from the Federal Home Loan Bank System. Upon
failure to qualify as a QTL for two years, a savings association must convert to
a commercial bank. At June 30, 1998, approximately 97.53% of the Bank's assets
were invested in qualified thrift investments.
LENDING LIMITS. Under regulations of the OTS, loans and extensions of
credit to a person outstanding at one time and not fully secured shall not
exceed 15% of the unimpaired capital, surplus and the loan loss allowance of the
savings association. Loans and extensions of credit fully secured by readily
marketable collateral (as defined) may comprise an additional 10% of unimpaired
capital and surplus. At June 30, 1998, the Bank complied with its regulatory
lending limits.
The aggregate amount of loans which a federally chartered savings
association may make on the security of liens on non-residential real property
may not exceed 400% of the institution's capital, though the Director of OTS has
the authority to permit savings associations to exceed the 400% of capital limit
in certain circumstances.
REGULATORY CAPITAL REQUIREMENTS. OTS regulations require savings
associations to satisfy three different capital requirements. Specifically,
savings associations must maintain "tangible" capital equal to 1.5% of adjusted
total assets, "core" capital equal to 3% of adjusted total assets and a
combination of core and "supplementary" capital equal to 8.0% of "risk-weighted"
assets. OTS regulations impose certain restrictions on savings associations that
have a total risk-based capital ratio that is less than 8.0%, a ratio of Tier 1
capital to risk-weighted assets of less than 4.0% or a ratio of Tier 1 capital
to adjusted total assets of less than 4.0% (or 3.0% if the institution is rated
composite 1 under the OTS examination rating system). For purposes of these
regulations, Tier 1 capital has the same definitions as core capital. See "--
Prompt Corrective Regulatory Action."
For purposes of the OTS's regulatory capital regulations, core capital
is defined as common stockholders' equity (including retained earnings),
noncumulative perpetual preferred stock and related surplus, minority interests
20
in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Core capital is generally reduced by the amount of the savings
association's intangible assets for which no market exists. Limited exceptions
to the deduction of intangible assets are provided for purchased mortgage
servicing rights and qualifying supervisory goodwill held by an eligible savings
associating. Tangible capital is given the same definition as core capital but
does not include qualifying supervisory goodwill and is reduced by the amount of
all the savings association's intangible assets with only a limited exception
for purchased mortgage servicing rights.
Adjusted total assets are a savings association's total assets as
determined under generally accepted accounting principles, adjusted for certain
goodwill amounts, and increased by a pro rata portion of the assets of
subsidiaries in which the savings association holds a minority interest and
which are not engaged in activities for which the capital rules require the
savings association to net its debt and equity investments against capital, as
well as a pro rata portion of the assets of other subsidiaries for which netting
is not fully required under the phase-in rules. Adjusted total assets are
reduced by the amount of assets that have been deducted from capital, the
portion of savings association's investments in subsidiaries that must be netted
against capital under the capital rules and, for purposes of the core capital
requirement, qualifying supervisory goodwill.
In determining compliance with the risk-based capital requirement, a
savings association is allowed to use both core capital and supplementary
capital provided the amount of supplementary capital used does not exceed the
savings association's core capital. Supplementary capital is defined to include
certain preferred stock issues, nonwithdrawable accounts and pledged deposits
that do not qualify as core capital, certain approved subordinated debt, certain
other capital instruments and a portion of the savings association's general
loss allowances. Total core and supplementary capital are reduced by an amount
equal to the savings association's high loan-to-value ratio land loans and
non-residential construction loans and the amount of capital instruments held by
other depository institutions pursuant to reciprocal arrangements as well as by
an increasing percentage of the savings association's equity investments.
The risk-based capital requirement is measured against risk-weighted
assets which equals the sum of each asset and the credit-equivalent amount of
each off- balance sheet item after being multiplied by an assigned risk weight.
Under the OTS risk-weighted system, one-to four-family first mortgages not more
than 90 days past due with loan-to-value ratios under 80% are assigned a risk
weight of 50%. Consumer loans are assigned a risk weight of 100%.
Mortgage-backed securities issued, or fully guaranteed as to principal and
interest, by the FNMA or FHLMC are assigned a 20% risk weight. Cash and U.S.
Government securities backed by the full faith and credit of the U.S. Government
are given a 0% risk weight. The risk-based capital requirement is 8% of
risk-weighted assets.
In determining compliance with capital standards, all of a savings
association's investments in, and extensions of credit to, any subsidiary
engaged in activities not permissible for a national bank are also to be
deducted from the savings association's capital. Certain subsidiaries are
exempted from this treatment, including any subsidiary engaged in impermissible
activities solely as agent for its customers (unless the FDIC determined
otherwise), subsidiaries engaged solely in mortgage banking, and depository
institution subsidiaries acquired prior to May 1, 1989. In addition, the capital
deduction is not applied to federal savings associations existing as of August
9, 1989 that were either chartered as a state savings bank or state cooperative
bank prior to October 10, 1982 or that acquired their principal assets from such
an association. The required reduction of capital for this purpose is being
phased in over a period of approximately five years. At June 30, 1998, the
Bank's investment in First Service, a wholly owned subsidiary of the Bank
engaged in activities which are not permitted for a national bank, amounted to
$810,484. Accordingly, on June 30, 1998, the Bank deducted 100% of this
investment from its core and tangible capital.
21
The tables below present the Bank's capital position relative to its
various minimum regulatory capital requirements at June 30, 1998.
June 30, 1998
Percent of
Amount Assets (1)
------ ----------
(Dollars in thousands)
Tangible capital...................... $ 48,243 11.9%
Tangible capital requirement.......... 6,081 1.5
-------- ---
Excess................................ $ 42,162 10.4%
======== ====
Tier 1/Core capital................... $ 48,243 11.9%
Tier 1/Core capital
requirement.......................... 16,215 3.0
-------- ---
Excess................................ $ 32,028 8.9%
======== ====
Tier 1/Risk-based capital............. $ 48,243 17.9%
Tier 1/Risk-based capital
requirement.......................... 10,829 4.0
-------- ----
Excess................................ $ 37,414 13.9%
======== ====
Risk-based capital.................... $ 50,096 18.5%
Risk-based capital
requirement.......................... 21,658 8.0
-------- ----
Excess................................ $ 28,438 10.5%
======== ====
<FN>
(1) Based upon adjusted total assets for purposes of the tangible capital
and core capital requirements, and risk-weighted assets for purposes of
the risk-based capital requirements.
</FN>
The OTS risk-based capital requirements require savings institutions
with more than a "normal" level of interest rate risk to maintain additional
total capital. A savings institution's interest rate risk is measured in terms
of the sensitivity of its "net portfolio value" to changes in interest rates.
Net portfolio value is defined, generally, as the present value of expected cash
inflows from existing assets and off-balance sheet contracts less the present
value of expected cash outflows from existing liabilities. A savings institution
is considered to have a "normal" level of interest rate risk exposure if the
decline in its net portfolio value after an immediate 200 basis point increase
or decrease in market interest rates (whichever results in the greater decline)
is less than two percent of the current estimated economic value of its assets.
A savings institution with a greater than normal interest rate risk is required
to deduct from total capital, for purposes of calculating its risk-based capital
requirement, an amount (the "interest rate risk component") equal to one-half
the difference between the institution's measured interest rate risk and the
normal level of interest rate risk, multiplied by the economic value of its
total assets.
22
The OTS will calculate the sensitivity of a savings institution's net
portfolio value based on data submitted by the institution in a schedule to its
quarterly Thrift Financial Report and using the interest rate risk measurement
model adopted by the OTS. The amount of the interest rate risk component, if
any, for any quarter is based on the institution's Thrift Financial Report filed
three quarters earlier. The Bank does not have more than a normal level of
interest rate risk under the new rule and is not required to increase its total
capital as a result of the rule.
Presented below as of June 30, 1998 is an analysis of the Bank's
interest rate risk ("IRR") as measured by changes in NPV for instantaneous and
sustained parallel shifts of 100 basis points in market interest rates.
As of June 30, 1998
-------------------
Net Portfolio Value NPV as % of PV of Assets
------------------- ------------------------
Change
In Rates $ Amount $ Change % Change NPV Ratio Change
-------- -------- -------- -------- --------- ------
+400 bp $40,100 (27,721) -41% 10.42% -567 bp
+300 bp 47,718 (20,103) -30% 12.09% -399 bp
+200 bp 55,246 (12,575) -19% 13.67% -242 bp
+100 bp 62,237 (5,584) -8% 15.05% -104 bp
0 bp 67,821 16.09%
-100 bp 71,556 3,736 +6% 16.72% +63 bp
-200 bp 73,709 5,888 +9% 17.02% +94 bp
-300 bp 76,656 8,835 +13% 17.46% +138 bp
-400 bp 80,610 12,790 +19% 18.07% +198 bp
While the Bank complies with its currently applicable capital
requirements and expects to continue to comply with the requirements, any
failure to comply with the capital requirements in the future would result in
severe penalties. In addition to requiring generally applicable capital
standards for savings associations, applicable regulations authorize the
Director of OTS to establish the minimum level of capital for a savings
institution at such amount or at such ratio of capital-to-assets as the Director
determines to be necessary or appropriate for such institution in light of the
particular circumstances of the institution. The Director of OTS may treat the
failure of any savings institution to maintain capital at or above such level as
an unsafe or unsound practice and may issue a directive requiring any savings
institution which fails to maintain capital at or above the minimum level
required by the Director to submit and adhere to a plan for increasing capital.
Such an order may be enforced in the same manner as an order issued by the FDIC.
The OTS staff policies specify that savings institutions failing any one
of their minimum regulatory capital requirements may not increase their total
assets during any quarter in excess of an amount equal to net interest credited
during the quarter. Under these policies, institutions that have submitted
capital plans that are rejected by the District Director or that have had
capital plans approved but do not meet the targets or requirements of the
capital plan may not make any new loans or investments except with the prior
written approval of the District Director. Such approval will only be granted
when the proposed loan or investment is reasonable in the context of the
institution's operations and does not significantly increase the risk profile of
the savings institution.
The Director of OTS must restrict the asset growth of savings
associations not in regulatory capital compliance, subject to a limited
exception for growth not exceeding interest credited. In addition, savings
associations not in full compliance with applicable capital standards are
subject to a capital directive which may include such restrictions, including
restrictions on the payment of dividends and on compensation, as deemed
appropriate by the Director of OTS. The Director of OTS is directed to treat as
an unsafe and unsound practice any material failure by a savings association to
comply with a capital plan or capital directive. The sanctions and penalties
that could be imposed range from restrictions on branching or on the activities
of the institution, to restrictions on the ability to obtain FHLB advances, to
termination of insurance of accounts following appropriate proceedings, to the
appointment of a conservator or receiver.
23
PROMPT CORRECTIVE REGULATORY ACTION
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), the federal banking regulators are required to take prompt
corrective action if an insured depository institution fails to satisfy certain
minimum capital requirements. All institutions, regardless of their capital
levels, are restricted from making any capital distribution or paying any
management fees if the institution would thereafter fail to satisfy the minimum
levels for any of its capital requirements. An institution that fails to meet
the minimum level for any relevant capital measure (an "undercapitalized
institution") may be: (i) subject to increased monitoring by the appropriate
federal banking regulator; (ii) required to submit an acceptable capital
restoration plan within 45 days; (iii) subject to asset growth limits; and (iv)
required to obtain prior regulatory approval for acquisitions, branching and new
lines of businesses. The capital restoration plan must include a guarantee by
the institution's holding company that the institution will comply with the plan
until it has been adequately capitalized on average for four consecutive
quarters, under which the holding company would be liable up to the lesser of 5%
of the institution's total assets or the amount necessary to bring the
institution into capital compliance as of the date it failed to comply with its
capital restoration plan. A "significantly undercapitalized" institution, as
well as any undercapitalized institution that did not submit an acceptable
capital restoration plan, may be subject to regulatory demands for
recapitalization, broader application of restrictions on transactions with
affiliates, limitations on interest rates paid on deposits, asset growth and
other activities, possible replacement of directors and officers, and
restrictions on capital distributions by any bank holding company controlling
the institution. Any company controlling the institution could also be required
to divest the institution or the institution could also be requird to divest
subsidiaries. The senior executive officers of a significantly undercapitalized
institution may not receive bonuses or increases in compensation without prior
approval and the institution is prohibited from making payments of principal or
interest on its subordinated debt. In their discretion, the federal banking
regulators may also impose the foregoing sanctions on an undercapitalized
institution if the regulators determine that such actions are necessary to carry
out the purposes of the prompt corrective action provisions. If an institution's
ratio of tangible capital to total assets falls below a "critical capital
level," the institution will be subject to conservatorship or receivership
within 90 days unless periodic determinations are made that forbearance from
such action would better protect the deposit insurance fund. Unless appropriate
findings and certifications are made by the appropriate federal bank regulatory
agencies, a critically undercapitalized institution must be placed in
receivership if it remains critically undercapitalized on average during the
calendar quarter beginning 270 days after the date it became critically
undercapitalized. If a savings association is in compliance with an approved
capital plan on the date of enactment of FDICIA, however, it will not be
required to submit a capital restoration plan if it is undercapitalized or
become subject to the statutory prompt corrective action provisions applicable
to significantly and critically undercapitalized institutions prior to July 1,
1995.
Under FDICIA, regulations implementing the prompt corrective action
provisions of a depository institution's capital adequacy is measured on the
basis of the institution's total risk-based capital ratio (the ratio of its
total capital to risk-weighted assets), Tier 1 risk-based capital ratio (the
ratio of its core capital to risk-weighted assets) and leverage ratio (the ratio
of its core capital to adjusted total assets). Under the regulations, a savings
association that is not subject to an order or written directive to meet or
maintain a specific capital level will be deemed "well capitalized" if it also
has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-
based capital ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0% or
greater. An "adequately capitalized" savings association is a savings
association that does not meet the definition of well capitalized and has: (i) a
total risk- based capital ratio of 8.0% or greater; (ii) a Tier 1 capital
risk-based ratio of 4.0% or greater; and (iii) a leverage ratio of 4.0% or
greater (or 3.0% or greater if the savings association has a composite of 1
MACRO rating). An "undercapitalized institution" is a savings association that
has (i) a total risk- based capital ratio less than 8.0%; or (ii) a Tier 1
risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less
than 4.0% (or 3.0% if the association has a composite 1 MACRO rating). A
"significantly undercapitalized" institution is defined as a savings association
that has: (i) a total risk-based capital ratio of less than 6.0%; or (ii) a Tier
1 risk-based capital ratio of less than 3.0%; or (iii) a leverage ratio of less
than 3.0%. A "critically undercapitalized" savings association defined as a
savings association that has a ratio of core capital to total assets of less
than 2.0%. The OTS may reclassify a well capitalized savings association as
adequately capitalized and may require an adequately capitalized or
undercapitalized association to comply with the supervisory actions applicable
to associations in the next lower opportunity for a hearing, that the savings
association is in an unsafe or unsound condition or that the association has
received and not corrected a less-than-satisfactory rating for any MACRO rating
category. First Federal is classified as "well capitalized" under the new
regulations.
24
DEPOSIT INSURANCE
Under FDICIA, the FDIC has established a risk-based assessment system
for insured depository institutions. Under the system, the assessment rate for
an insured depository institution depends on the assessment risk classification
assigned to the institution by the FDIC which will be determined by the
institution's capital level and supervisory evaluations. Institutions are
assigned to one of three capital groups -- well capitalized, adequately
capitalized or undercapitalized -- based on the data reported to regulators for
date closest to the last day of the seventh month preceding the semi-annual
assessment period. Well capitalized institutions are institutions satisfying the
following capital ratio standards; (i) total risk-based capital ratio of 10.0%
or greater; (ii) Tier 1 risk-based capital ratio of 6.0% or greater; and (iii)
Tier 1 leverage ratio of 5.0% or greater. Adequately capitalized institutions
are institutions that do not meet the standards for well capitalized
institutions but which satisfy the following capital ratio standards: (i) total
risk-based capital ratio of 8.0% or greater; (ii) Tier 1 risk-based capital
ratio of 4.0% or greater; and (iii) Tier 1 leverage ratio of 4.0% or greater.
Undercapitalized institutions consist of institutions that do not qualify as
either "well capitalized" or "adequately capitalized." Within each capital
group, institutions are assigned to one of the three subgroups on the basis of
supervisory evaluations by the institution's primary supervisory authority and
such other information as the FDIC determines to be relevant to the
institution's financial condition and the risk posed to the deposit insurance
fund. Subgroup A consists of financially sound institutions with only a few
minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the fund. Subgroup C consists of institutions that pose a substantial
probability of loss to the deposit insurance fund unless effective corrective
action is taken.
The Bank insures its customers' deposits through the Savings Association
Insurance Fund ("SAIF"). On September 30, 1996, Federal Deposit Insurance
Corporation ("FDIC") legislation was signed into law to recapitalize the SAIF
due to a substantial disparity that existed between the premiums assessed by the
SAIF as compared to premiums assessed to commercial banks. All SAIF-insured
savings institutions were required to pay a one-time special assessment of $.657
for every $100 of customer deposits held as of March 31, 1995. This has resulted
in a charge to earnings of $1,095,000, net of tax, during the first quarter of
fiscal 1997. On January 1, 1997, the Bank began paying insurance premiums of
$.064 per $100 of deposits as compared to a previous premium of $.23 per $100 of
deposits.
FEDERAL RESERVE SYSTEM
Pursuant to regulations of the Federal Reserve Board, a thrift
institution must maintain average daily reserves equal to 3% on the first $51.9
million of transaction accounts, plus 10% on the remainder. This percentage is
subject to adjustment by the Federal Reserve Board. Because required reserves
must be maintained in the form of vault cash or in a non-interest bearing
account at a Federal Reserve Bank, the effect of the reserve requirement is to
reduce the amount of the institution's interest-earning assets. As of June 30,
1998, the Bank met its reserve requirements.
25
SAVINGS AND LOAN HOLDING COMPANY REGULATIONS. The Corporation is a
savings and loan holding company within the meaning of the Home Owners' Loan
Act, as amended. As such, it is registered with the OTS and is subject to OTS
regulations, examinations, supervision and reporting requirements. As a
subsidiary of a savings and loan holding company, First Federal is subject to
certain restrictions in its dealings with the Corporation and affiliates
thereof.
The Home Owners' Loan Act, as amended, generally prohibits a savings and
loan holding company, without prior approval of the Director of OTS, from (i)
acquiring control of any other savings institution or savings and loan holding
company or controlling the assets thereof or (ii) acquiring or retaining more
than 5% of the voting shares of a savings institution or holding company thereof
which is not a subsidiary. Additionally, under certain circumstances, a savings
and loan holding company is permitted to acquire, with the approval of the
Director of OTS, up to 15% of previously unissued voting shares of an
under-capitalized savings association for cash without that savings association
being deemed controlled by the holding company. Except with the prior approval
of the Director of OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock may also acquire control of any savings institution, other
than a subsidiary institution or any other savings and loan holding company.
The Bank Holding Company Act of 1956 specifically authorizes the Federal
Reserve Board and the Director of the OTS to approve an application by a bank
holding company to acquire control of any savings institution. Pursuant to rules
promulgated by the Federal Reserve Board, owning, controlling or operating a
savings institution is a permissible activity for bank holding companies, if the
savings institution engages only in deposit-taking activities and lending and
other activities that are permissible for the bank holding companies. In
approving such as application, the Federal Reserve Board may not impose any
restriction on transaction between the savings institution and its holding
company affiliates except as required by Sections 23A and 23B of the Federal
Reserve Act.
A bank holding company that controls a savings institution may merge or
consolidate the assets and liabilities of the savings institution with, or
transfer assets and liabilities to, any subsidiary bank which is a member of the
BIF with the approval of the appropriate federal banking agency and the Federal
Reserve Board. The resulting bank will be required to continue to pay
assessments to the SAIF at the rates prescribed for SAIF members on the deposits
attributable to the merged savings institution plus an annual growth increment.
Transactions between savings associations and any affiliate are governed
by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a savings
association is any company or entity which controls, is controlled by or is
under common control with the savings association. In a holding company context,
the parent holding company of a savings association (such as the Corporation)
and any companies which are controlled by such parent holding company are
affiliates of the savings association. Generally, Sections 23A and 23B (i) limit
the extent to which the savings institution or its subsidiaries may engage in
"covered transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus, and contain an aggregate limit on all
such transactions with all affiliates to an amount equal to 20% of such capital
stock and surplus and (ii) require that all such transactions be on terms
substantially the same, or at least as favorable, to the institution or
subsidiary as those provided to a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
similar other types of transactions. Additionally, in addition to the
restrictions imposed by Sections 23A and 23B, no savings association may (i)
loan or otherwise extend credit to an affiliate, except for any affiliate which
engages only in activities which are permissible for bank holding companies, or
(ii) purchase or invest in any stocks, bonds, debentures, notes or similar
obligations of any affiliate, except for affiliates which are subsidiaries of
the savings association.
26
Savings associations are also subject to the restrictions contained in
Section 22 (h) of the Federal Reserve Act on loans to executive officers,
directors and principal shareholders. Under Section 22 (h), loans to an
executive officer and to a greater than 10% shareholder of a savings association
(18% in the case of institutions located in an area with less than 30,000 in
population), and certain affiliated entities of either, may not exceed together
with all other outstanding loans to such person and affiliated entities the
association's loan to one borrower limit as established by FIRREA (generally
equal to 15% of the institution's unimpaired capital and surplus, for loans
fully secured by certain readily marketable collateral, an additional 10% of the
institution's unimpaired capital and surplus). Section 22(h) also prohibits
loans, above amounts prescribed by the appropriate federal banking agency, to
directors, executive officers and greater than 10% shareholders of savings
association, and their respective affiliates, unless such loan is approved in
advance by a majority of the board of directors of the association with any
"interested" director not participating in the voting. The Federal Reserve Board
has prescribed the loan amount (which includes all other outstanding loans to
such person), as to which such prior board of director approval if required, as
being the greater of $25,000 or 5% of capital and surplus (up to $500,000).
Further, the Federal Reserve Board pursuant to Section 22(h) requires that loans
to directors, executive officers and principal shareholders be made on terms
substantially the same as offered in comparable transactions to other persons.
The Board of Directors of the Corporation presently intends to operate
the Corporation as a unitary savings and loan holding company. There are
generally no restrictions on the activities of a unitary savings and loan
company. However, if the director of OTS determines that there is reasonable
cause to believe that the continuation by a savings and loan holding company of
an activity constitutes a serious risk to the financial safety, soundness or
stability of its subsidiary savings association, the Director of OTS may impose
such restrictions as deemed necessary to address such risk and limiting (i)
payment of dividends by the savings association, (ii) transactions between the
savings association and its affiliates, and (iii) any activities of the savings
association that might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings association.
Notwithstanding the above rules as to permissible business activities of
unitary savings and loan holding companies, if the savings association
subsidiary of such a holding company fails to meet (in three out to every four
quarters and two out of every three years) the QTL test, see "Qualified Thrift
Lender Test" above, then such unitary holding company shall also become subject
to the activities restrictions applicable to multiple holding companies
(additional restrictions on securing advances from the FHLB also apply).
If the Corporation were to acquire control of another savings
institution other than through merger or other business combinations with First
Federal, the Corporation would thereupon become a multiple savings and loan
holding company. Except where such acquisition is pursuant to the authority to
approve emergency thrift acquisitions and where each subsidiary savings
institution meets the QTL test, the activities of the Corporation and any of its
subsidiaries (other than First Federal or other subsidiary savings institutions)
would thereafter be subject to further restrictions. The Home Owners' Loan Act,
as amended, provides that, among other things, no multiple savings and loan
holding company or subsidiary thereof which is not a savings institution shall
commence or continue for more than a limited period of time after becoming a
multiple savings and loan holding company or subsidiary thereof, any business
activity other than (i) furnishing or performing management services for a
subsidiary savings institution, (ii) conducting an insurance agency or escrow
business, (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary savings institution, (iv) holding or managing properties used
or occupied by a subsidiary savings institution, (v) acting as trustee under
deeds of trust, (vi) those activities previously directly authorized by the
FSLIC by regulations as of March 5, 1987 to be engaged in by multiple holding
companies or (vii) those activities authorized by the Federal Reserve Board as
permissible for bank holding companies, unless the Director of OTS by regulation
prohibits or limits such activities for savings and loan holding companies.
Those activities described in (vii) above must also be approved by the Director
of OTS prior to being engaged in by a multiple holding company.
27
The Director of OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state, if the multiple savings and loan holding
company involved controls a savings institution which operated a home or branch
office in the state of the institution to be acquired as of March 5, 1987, or if
the laws of the state in which the institution to be acquired is located
specifically permit institution to be acquired by state-chartered institutions
or savings and loan holding companies located in the state where the acquiring
entity is located (or by a holding company that controls such state-chartered
savings institutions). The Director of OTS may approve an acquisition resulting
in a multiple savings and loan holding company controlling savings institutions
in more than one state in the case of certain emergency thrift acquisitions.
No subsidiary savings association of a savings and loan holding company
may declare or pay a dividend on its permanent or nonwithdrawable stock unless
it first gives the Director of OTS 30 day advance notice of such declaration and
payment. Any dividend declared during such period or without the giving of such
notice shall be invalid.
FEDERAL AND STATE TAXATION
The Corporation and the Bank currently file consolidated federal income
tax returns based on a fiscal year ending June 30.
The Small Business Job Protection Act passed by Congress in August 1996
included a provision that repealed the percentage of taxable income bad debt
deduction for federal income tax purposes. The Bank used this method to
determine its bad debt deduction when computing federal taxes in applicable
years. This new legislation also requires recapture of the excess of bad debt
reserves over the base year reserve as of December 31, 1987. For years
subsequent to the base year, deferred taxes have been recorded; thus, no
additional tax provision is required as a result of this legislation. Under the
new legislation, the Bank is required to use the specific charge-off method to
calculate the bad debt deduction for federal income tax purposes. The new
legislation is effective for tax years beginning after December 31, 1995.
Earnings appropriated to the Bank's bad debt reserve and claimed as a
tax deduction will not be allowable for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
liquidation), without payment of federal income taxes on such dividends or
distributions by the Bank at the then current tax rates on the amount deemed
removed to the Bank would include not only the amount actually distributed, but
would also be increased (subject to certain limitations) by the amount of the
tax payable by reason of such distribution.
The Corporation adopted Statement of Financial Accounting Standard No.
109 (SFAS No. 109), "Accounting for Income Taxes," on July 1, 1993.
SFAS No. 109 calculates taxes on the liability method, thus requiring the
recognition of current and deferred tax liabilities and assets for the expected
future tax consequences of events that have been recognized in the financial
statements or tax return. This statement's emphasis on the balance sheet is
consistent with SFAS No. 96 but is a change from APB No. 11's emphasis on the
expense calculation. Under SFAS No. 109, the tax expense or benefit in the
statement of operations will be the current tax liability plus the change in the
deferred tax liabilities and assets occurring during the year. SFAS No. 109
changes the treatment of loan loss provisions in the calculation of taxes. Tax
bad debt reserves that arose prior to 1988 will require recognition of deferred
tax liabilities only if it becomes apparent that those temporary differences
will reverse in the foreseeable future. Other differences between financial and
tax reserves will create temporary differences for which deferred tax assets or
liabilities will be computed.
28
The Commonwealth of Kentucky imposes no income tax on savings
institutions. Nonetheless, First Federal must pay a Kentucky ad valorem tax.
This tax is 1/10th of 1% of First Federal's total savings accounts, common
stock, capital and retained income with certain deductions for amounts borrowed
by depositors and for securities guaranteed by the U.S. Government or certain of
its agencies. The Bank's subsidiary must pay a state income tax, as well as a
tax on capital. The tax on income is 4% for the first $25,000 of taxable income,
5% for the next $25,000, 6% for the next $50,000, 7% for the next $150,000 and
8.25% for all income over $250,000. The tax on capital is .0021 times the
capital employed with a credit of .0014 times the first $350,000 of capital for
those corporations with gross income of under $500,000.
For information regarding federal income taxes, see Note 7 of the Notes
to Consolidated Financial Statements in the Annual Report.
29
ITEM 2. PROPERTIES
The following table sets forth the location of the Bank's offices, as
well as certain additional information relating to these offices at June 30,
1998. All of the properties are owned by the Bank.
Year Approximate
Facility Square
Office Location Opened Net Book Value Footage
- --------------- -------- -------------- -----------
(Dollars in thousands)
Home Office 1993 $6,369 55,000
2323 Ring Road
Elizabethtown, Kentucky
Radcliff Office 1975 561 2,728
475 West Lincoln Trail
Radcliff, Kentucky
Bardstown Office (1) 1997 1,275 4,500
315 North Third Street
Bardstown, Kentucky
Munfordville Office 1976 255 2,928
925 Main Street
Munfordville, Kentucky
Elizabethtown Office 1985 267 1,764
325 West Dixie Avenue
Elizabethtown, Kentucky
Shepherdsville Office 1995 1,105 7,600
395 North Buckman Street
Shepherdsville, Kentucky
Mt. Washington Office 1995 620 2,500
279 Bardstown Road
Mt. Washington, Kentucky
Wal-Mart Office (1) 1996 295 984
101 Wal-Mart Drive
Elizabethtown, Kentucky
<FN>
(1) In February 1996, the Bank leased office space for its Wal-Mart location
under a five year operating lease agreement with options to extend the terms of
the lease at the end of the original lease period. In August 1996, the Bank
leased land under a five-year operating lease agreement for its Bardstown
office. This lease contains options to renew the terms of the lease for an
additional forty-five years.
</FN>
As of June 30, 1998, the net book value of office properties and
equipment owned by the Bank and its subsidiaries was $10.7 million. For further
information, see Note 4 of the Notes to Consolidated Financial Statements in the
Annual Report.
The Bank utilizes the services of an outside data processing center
for most of its savings and loan operations. All accounting and internal record
keeping functions are handled by the Bank's in-house computer system.
30
ITEM 3. LEGAL PROCEEDINGS
Although the Bank is, from time to time, involved in various legal
proceedings in the normal course of business, there are no material pending
legal proceedings to which the Corporation, the Bank, or its subsidiary is a
party, or to which any of their property is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended June 30, 1998.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Quarterly Stock Prices Two
Quarter Ended Months Ended
Fiscal 1998: 9/30 12/31 3/31 6/30 8/31/98
---- ----- ---- ---- -------
High $23.25 $22.75 $23.00 $28.75 $28.50
Low $21.00 $22.00 $20.50 $21.50 $24.25
Cash dividends $ 0.14 $ 0.14 $ 0.14 $ 0.14
Fiscal 1997:
High $21.25 $21.25 $21.00 $20.25
Low $19.75 $18.75 $19.75 $18.00
Cash dividends $ 0.12 $0.12 $ 0.13 $ 0.13
31
ITEM 6. SELECTED FINANCIAL DATA
At June 30,
Financial Condition Data: 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in Thousands)
Total assets $409,651 $377,380 $352,671 $331,375 $262,457
Interest bearing deposits 4,157 481 7,753 6,601 11,001
Net loans outstanding 355,306 327,791 302,363 282,954 230,792
Investments 26,811 22,677 16,742 17,068 7,058
Savings deposits 306,703 281,342 264,946 260,503 197,143
Borrowings 43,249 41,514 34,979 21,238 16,126
Net worth, substantially
restricted 54,688 51,665 49,946 47,310 47,119
------ ------ ------ ------ ------
Number of:
Real estate loans
outstanding 6,709 6,380 5,914 5,858 4,525
Deposits accounts 37,764 36,378 35,140 35,933 26,436
Offices 8 8 8 7 5
Year Ended June 30,
Operations Data: 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in Thousands)
Interest income $31,182 $28,782 $26,926 $22,635 $20,017
Interest expense (16,059) (14,375) (13,676) (10,515) (8,168)
------- ------- ------- ------- -------
Net interest income 15,123 14,407 13,250 12,120 11,849
Provision for loan losses (265) (200) 0 (100) (30)
Other income 2,860 2,468 2,648 2,464 1,213
General and administrative
expense (1) (8,082) (9,472) (7,547) (6,428) (5,145)
Income tax expense (3,302) (2,429) (2,864) (2,626) (2,518)
------- ------- ------- ------- -------
Net income $ 6,334 $ 4,774 $ 5,487 $ 5,430 $ 5,369
======= ======= ======= ======= =======
Earnings per share** $ 1.53 $ 1.14 $ 1.30 $ 1.24 $ 1.22
Book value per share** $ 13.24 $ 12.39 $ 11.87 $ 11.17 $ 10.65
Dividends paid per share** $ .56 $ .50 $ .46 $ .41 $ .39
Return payout ratio per
share** 37% 44% 35% 33% 30%
Return on average assets 1.60% 1.30% 1.60% 1.85% 2.11%
Average equity to average
assets 13.55% 13.77% 14.27% 16.37% 17.80%
Return on average equity 11.81% 9.46% 11.22% 11.30% 11.87%
<FN>
(1) 1997 general and administrative expenses include the non-recurring special
assessment paid to the FDIC in the amount of $1.7 million.
</FN>
**All per share information has been adjusted for a 2-for-1 stock split which
was effective June 10, 1996.
Financial data for 1994 and six months of 1995 do not reflect results of
operations from Shepherdsville and Mt. Washington offices.
32
Quarterly Financial Data
(Unaudited) (Dollars in thousands except per share data)
Fiscal 1998: September 30 December 31 March 31 June 30
------------ ----------- -------- -------
Total interest income $7,522 $7,693 $7,889 $8,078
Total interest expense 3,829 3,993 4,047 4,190
Net interest income 3,693 3,700 3,842 3,888
Provision for loan
losses 60 30 30 145
Net income 1,604 1,452 1,650 1,628
Earnings per share $ 0.39 $ 0.35 $ 0.40 $ 0.39
Fiscal 1997:
Total interest income $6,953 $7,133 $7,250 $7,446
Total interest expense 3,484 3,582 3,595 3,714
Net interest income 3,469 3,551 3,655 3,732
Provision for loan
losses 200 0 0 0
Net income 287 1,387 1,528 1,572
Earnings per share $ 0.07 $ 0.33 $ 0.37 $ 0.37
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL INFORMATION
The management of First Federal Financial Corporation of Kentucky is responsible
for the preparation of the financial statements and all other information in the
Annual Report. The financial statements were prepared in accordance with
generally accepted accounting principles appropriate to our circumstances.
The accounting system and internal accounting controls in use are designed to
provide reasonable assurance that the financial records are reliable for
preparing financial statements and maintaining accounting for assets, and that
assets are safeguarded against loss from unauthorized use or disposition.
To be reasonably certain that policies are followed and internal accounting
controls are maintained, the Internal Audit Department monitors activities and
procedures throughout the year. Findings and recommendations are reported to the
Audit Committee of the Corporation. The Audit Committee is composed of directors
who are not employees.
33
MANAGEMENT DISCUSSION & ANALYSIS OF
FINANCIAL CONDITION & RESULTS OF OPERATIONS
GENERAL
First Federal Financial Corporation of Kentucky is the parent to its wholly
owned subsidiary, First Federal Savings Bank of Elizabethtown. The Corporation
has no other material income other than that generated by the Bank.
RESULTS OF OPERATIONS
Net income was $6,334,000, or $1.53 per share in 1998, compared with $4,774,000,
or $1.14 per share in 1997. During the quarter ended September 30, 1996, net
income was affected by a one-time special assessment of $1.7 million ($1.1
million, net of tax) paid to the FDIC to recapitalize the Savings Association
Insurance Fund ("SAIF"). Net earnings for the 1997 period would have been
approximately $5.87 million or $1.40 per share had it not been for the special
assessment. See further discussion under "Regulatory Matters."
In addition to the higher net income the 9% increase in net income per share was
also attributable to the Corporation's stock repurchase plans which have reduced
the weighted average number of shares outstanding from 4,182,060 for the 1997
period to 4,145,039 for 1998.
Net Interest Income - Net interest income increased by $716,000 during 1998 to
$15,123,000 as compared to $14,407,000 in 1997 in spite of the declining net
interest margin. The Bank's net interest margin decreased from 4.13% for the
1997 period to 4.04% for the 1998 period.
Average loan balances, which comprise 93% of the total interest-earning assets,
were $343.8 million during 1998 as compared to $317.6 million during 1997, or an
increase of $26.2 million. The average yield on loans increased by 5 basis
points to 8.53% during 1998 as compared to 8.48% during 1997, resulting in a
$2.4 million growth in loan interest income.
34
Customer deposit balances averaged $293.9 million during 1998, a $23 million
increase from the 1997 average balance of $270.7 million. The cost of funds on
these deposits averaged 4.66% during 1998, which was an increase of 20 basis
points from the 1997 average cost of funds of 4.46%. This increase was
attributable to higher rates paid on short-term customer deposits.
Provision for Loan Losses - Management periodically evaluates the adequacy of
the allowance for loan losses based on the Bank's past loan loss experience,
known and inherent risks in the portfolio, adverse situations that may affect
the borrower's ability to repay and other factors.
The provision for loan losses was $265,000 for 1998. Net charge-offs were
$126,936 during 1998 as compared to $98,115 during 1997. The Bank's allowance
for loan losses was $1.9 million or .52% of loans outstanding at June 30, 1998
compared to $1.7 million or .52% of loans outstanding at June 30, 1997.
Nonperforming loans represented .58% of the loans outstanding at June 30, 1998.
As demonstrated in the summary table below, 68% of the Bank's non-performing
assets are collateralized by one-to-four family residential mortgages on real
estate located in central Kentucky. Management chose not to add to the reserve
during 1996 due to their assessment as to its adequacy.
YEAR ENDED JUNE 30,
1998 1997 1996
---- ---- ----
(Dollars in thousands)
Allowance for loan losses:
Balance, July 1 $ 1,715 $ 1,613 $ 1,662
Provision for loan losses 265 200 -
Charge-offs (148) (131) (74)
Recoveries 21 33 25
------ ------ ------
Balance, June 30 $ 1,853 $ 1,715 $ 1,613
====== ====== ======
Net loans outstanding at year end $355,306 $327,791 $302,363
Nonperforming loans at year end:
Collateralized by one-to-four
family homes $ 1,487 $ 1,172 $ 940
Other non-performing loans $ 566 $ 378 $ 312
Ratios: Non-performing loans to
total loans 0.58% 0.47% 0.41%
Allowance for loan losses
to non-performing loans 90% 111% 128%
Allowance for loan losses to
net loans 0.52% 0.52% 0.53%
Non-performing assets to
total assets 0.53% 0.46% 0.46%
35
Non-Interest Income and Expense - Non-interest income was $2,860,000 in 1998, an
increase of $392,000 over 1997. Customer service fees increased by $43,000
during the 1998 period due to a growth in customer checking accounts. Gains
reported from investment sales were $375,000 in 1998 as compared to $317,000
reported in the 1997 period. Income from government lending operations increased
by $172,000 from $314,000 in 1997 to $486,000 in 1998 due to a growth in VA and
FHA loans. Other sources of non-interest income, such as brokerage commissions,
loan fees, and other customer transaction fees increased by $119,000 due to
growth in deposit relationships with existing customers.
Non-interest expense was $8,082,000 in 1998, compared to $9,472,000 in 1997. If
it had not been for the SAIF special assessment of $1,685,000 recorded in the
first quarter of 1997, non-interest expense would have been approximately
$7,787,000 for the 1997 period.
Compensation and benefits increased by $184,000 or 5.2% in 1998 as compared to
1997, due to routine inflationary salary raises and new associate positions
required to service the normal customer growth of the Bank.
Office occupancy and equipment expenses increased by $36,000 or 4% in 1998 as
compared to 1997 due to inflationary increases in other occupancy and equipment
related expenses.
Due to the SAIF recapitalization, on January 1, 1997, the Bank began paying
federal insurance premiums of $.064 per $100 of deposits as compared to a
previous premium of $.23 per $100 of deposits, resulting in a $210,000 decrease
in federal insurance premiums exclusive of special assessments. See further
discussion under "Regulatory Matters."
All other expenses increased by $285,000 in 1998 as compared to 1997. Expenses
directly related to customer checking accounts increased due to a higher volume
of accounts. Expenses directly related to postage, telephone, data processing
costs, marketing, and supplies increased due to asset growth, new services
provided by the Bank, and general inflation.
LIQUIDITY AND CAPITAL RESOURCES
The Bank is required to maintain levels of liquid assets as defined by the
Office of Thrift Supervision regulations. This requirement is based on a
percentage of deposits and short-term borrowings and is currently 4%. The Bank's
liquidity ratio was 9.17% at June 30, 1998.
The Bank's primary source of funds for meeting its liquidity needs are customer
deposits, borrowings from the Federal Home Loan Bank of Cincinnati, principal
and interest payments from loans and mortgage-backed securities, and earnings
from operations retained by the Corporation. The Bank also has a significant
investment portfolio to meet liquidity should the need arise.
At June 30, 1998, the Bank had outstanding loan commitments, including
undisbursed portions of loans in process, standby letters of credit and lines of
credit in the amount of $29.4 million. It is anticipated that these demands on
liquidity will be net through growth in customer deposits and additional
borrowings from the Federal Home Loan Bank of Cincinnati.
36
The Office of Thrift Supervision's capital regulations require savings
institutions to meet three capital standards: a 1.5% tangible capital standard;
a 3% leverage (core capital) ratio; and an 8% risk-based capital standard. As of
June 30, 1998, the Bank's actual capital percentages for tangible capital of
11.9%, core capital of 11.9%, and current risk-based capital of 18.5%,
significantly exceed the regulatory requirement for each category.
IMPACT OF INFLATION & CHANGING PRICES
The financial statements and related data presented herein have been prepared in
accordance with generally accepted accounting principles, which require the
measurement of financial position and operating results in historical dollars
without considering changes in the relative purchasing power of money over time
due to inflation.
The Bank has an asset and liability structure that is essentially monetary in
nature. As a result interest rates have a more significant impact on the Bank's
performance than the effects of general levels of inflation. Periods of high
inflation are often accompanied by relatively higher interest rates and periods
of low inflation are accompanied by relatively lower interest rates. As market
interest rates rise or fall in relation to the rates earned on the Bank's loans
and investments, the value of these assets decreases or increases respectively.
REGULATORY MATTERS
The Bank insures its customers' deposits through the Savings Association
Insurance Fund ("SAIF"). On September 30, 1996, Federal Deposit Insurance
Corporation ("FDIC") legislation was signed into law to recapitalize the SAIF.
As was anticipated, all SAIF- insured savings institutions were required to pay
a one-time special assessment of $.657 for every $100 of customer deposits. This
has resulted in a charge to earning of $1,095,000, net of tax, during the first
quarter of 1997. On January 1, 1997, the Bank began paying insurance premiums of
$.064 per $100 of deposits as compared to a previous premium of $.23 per $100 of
deposits.
ACQUISITION
In March 1998, the Bank entered into an agreement to acquire three banking
centers of Bank One Corporation located in Meade County, Kentucky. Two of the
banking centers are located in Brandenburg, Kentucky and the third banking
center is in Flaherty, Kentucky. On July 24, 1998, the Bank completed its
acquisition of the three offices.
In the transaction, the Bank acquired certain assets and assumed certain
liabilities associated with the Meade County banking centers, including deposit
liabilities, certain loans, real estate leases, furniture, fixtures, equipment,
and other assets totaling approximately $72.5 million. The consideration paid
for the assets totaled approximately $20.5 million, which was determined based
on a premium for the core deposits of the acquired banking centers plus the book
or cash value of certain other transferred assets. The acquisition was funded by
reducing the cash associated with the transferred deposits by the amount of the
purchase price. This acquisition will expand the Bank's market share to 53% of
the total deposits in Meade County. The Bank plans to operate the acquired
banking centers as branch offices.
YEAR 2000
Recognizing the need to ensure its operations will not be adversely impacted by
Y2K failures, the Bank has developed a proactive plan for minimizing its risk
and updating a majority of its computer hardware and software systems in the
process. The Bank has entered into agreements with hardware and software vendors
to systematically replace all non-Y2K compliant hardware and software by March
1999. An equally important objective of the complete overhaul of the systems is
to enhance the Bank's technological capabilities. The anticipated benefits of
the new systems include faster customer service, the flexibility to offer a
wider range of new products and services and the capability to offer electronic
banking services in the future. Communication systems will be converted to a
fully integrated wide area network, thereby connecting all banking centers
electronically to one another. Although the Bank anticipates a $400,000 after
tax charge against operations during the quarter ended September 30, 1998,
future technology costs are expected not to differ materially from those
incurred in prior periods.
37
NEW ACCOUNTING PRONOUNCEMENT
Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Comprehensive
Income," was issued in June 1997 and becomes effective for fiscal periods
beginning after December 15, 1997. SFAS 130 requires reclassification of earlier
financial statements for comparative purposes. SFAS 130 requires that changes in
the amounts of certain items, including foreign currency translation adjustments
and gains and losses on certain securities be shown in the financial statements.
SFAS 130 does not require a specific format for the financial statement in which
comprehensive income is reported, but does require that an amount representing
total comprehensive income be reported in that statement. Management has
determined that the adoption of SFAS 130 will not have a material effect on the
consolidated financial statements.
COMPARISON OF FISCAL 1997 TO 1996
Net income for the fiscal year ended June 30, 1997, was $4,774,000, or $1.14 per
share, as compared to net income of $5,487,000 or $1.30 per share for the same
period in 1996. The decrease in earnings is attributable to the one-time special
assessment of $1.7 million ($1.1 million, net of tax) to recapitalize the
Savings Association Insurance Fund ("SAIF") and a $200,000 addition to provision
for loan losses. Net earnings for the period would have been approximately $5.87
million or $1.40 per share had it not been for the special assessment. See
further discussion under "Regulatory Matters".
Total interest income increased by $1,856,000 from fiscal 1996 to 1997, due to
the strong growth of the Bank's loan portfolio. Interest income on loans
accounts for a majority of the Bank's interest income as average loan balances,
which comprise 92% of the total interest-earning assets, were $317.6 million
during 1997 as compared to $295.7 million during 1996, or an increase of $21.9
million. The average yield on loans decreased by 3 basis points to 8.48% during
1997 as compared to 8.51% during 1996. The growth in volume of loans exceeds the
impact of a decrease in yield thus resulting in a $1.8 million growth in loan
interest income.
Total interest expense increased by $700,000 from fiscal 1996 to 1997. The
weighted average interest rate paid on customer deposits averaged 4.46% during
1997, which was a decrease of 13 basis points from the 1996 average cost of
funds of 4.59%. This decrease was primarily attributable to customers'
transferring deposits from long-term to short-term maturities. Customer deposit
balances averaged $270.7 million during 1997, a $12 million increase from the
1996 average balance of $258.7 million. Interest expense paid on deposits
increased by $194,000 while interest expense paid on Federal Home Loan Bank
advances increased by $506,000.
As a result of the foregoing discussion, net interest income increased by
$1,157,000 to $14,407,000 in 1997 from $13,250,000 in 1996.
Management periodically evaluates the adequacy of the reserve for loan losses
based on the Bank's past loan loss experience, known and inherent risks in the
portfolio, adverse situations that may affect the borrower's ability to repay
and other factors. During fiscal 1997, the Bank's provision for loan losses was
$200,000. The allowance for loan losses was $1.7 million or .52% of loans
outstanding at June 30, 1997, compared to $1.6 million or .53% of loans
outstanding at June 30, 1996. During fiscal 1996, management chose not to add to
the reserve based on their assessment as to its adequacy. Net loan charge-offs
have been $98,115 and $49,054 for fiscal 1997 and 1996, respectively.
Other income was $2,468,000 in 1997, a decrease of $180,000 from 1996. The
decrease in income is due to reduced sales of available-for-sale securities. In
1997, the Bank reported gains from investment sales of $317,000 as compared to
$754,000 in 1996. Service fees charged on customer checking accounts increased
by $170,000 or 16% from 1996 to 1997, due to a growth in customer checking
accounts and an increase in customer service fees. Other sources of
miscellaneous income, such as safety deposit box rental, loan fees, and other
customer transaction fees increased by $88,000 due to growth in deposit
relationships with existing customers.
Other expense was $9,472,000 for the 1997 period as compared to $7,547,000 for
the 1996 period, an increase of $1,925,000. The increase is a result of the SAIF
special assessment recorded in the first quarter of 1997, resulting in a
$1,685,000 charge against earnings. Associate compensation and benefits
increased by $217,000 or 6.6% in 1997 as compared to 1996 due to the addition of
new associates required to offer expanded services to the Bank's customers.
Office occupancy and equipment expenses increased by $56,000 or 6.6% in 1997 as
compared to 1996 due to costs attributable to the opening of a new banking
center in the Elizabethtown Wal-Mart Supercenter and inflationary increases in
other occupancy and equipment related expenses. Due to the SAIF
recapitalization, on January 1, 1997, the Bank began paying federal insurance
premiums of $.064 per $100 of deposits as compared to a previous premium of $.23
per $100 of deposits, resulting in a $230,000 decrease in federal insurance
premiums exclusive of special assessments. All other expenses increased by
$224,000 in 1997 as compared to 1996 due to a higher volume of accounts, asset
growth, general inflation, and expanded services offered to customers.
38
ITEM 7A. DISCLOSURES ABOUT MARKET RISK
To minimize the volatility of net interest income and exposure to
economic loss that may result from fluctuating interest rates, the Bank manages
its exposure to adverse changes in interest rates through asset and liability
management activities within guidelines established by its Asset Liability
Committee ("ALOC"). The ALCO, which includes senior management representatives,
has the responsibility for approving and ensuring compliance with
asset/liability management policies of the Corporation, which include managing
the sensitivity repricing characteristics of the balance sheet components
consistent with maintaining acceptable levels of changes in net portfolio value
("NPV") and net interest income. A primary purpose of the Corporation's ALCO is
to manage interest rate risk to effectively invest the Corporation's capital and
to preserve the value created by its core business operations. As such, certain
management monitoring processes are designed to minimize the impact of sudden
and sustained changes in interest rates on NPV and net interest income.
The Corporation's exposure to interest rate risk is reviewed on at least
a quarterly basis by the Board of Directors and the ALCO. Interest rate risk
exposure is measured using interest rate sensitivity analysis to determine the
Corporation's change in NPV in the event of hypothetical changes in interest
rates and interest rate sensitivity gap analysis is used to determine the
repricing characteristics of the Bank's assets and liabilities. The table,
presented on page 23, under Item 1 "Regulatory Capital Requirements", presents
the Corporation's projected change in NPV for the various rate shock levels as
of June 30, 1998. All market risk sensitive instruments presented in this table
are held to maturity or available for sale. The Corporation has no trading
securities.
NPV is calculated by the Corporation pursuant to guidelines estimated by
the OTS. The calculation is based on the net present value of estimated
discounted cash flows utilizing market prepayment assumptions and market rates
of interest provided by independent broker quotations and other public sources
as of June 30, 1998, with adjustments made to reflect the shift in the Treasury
yield curve as appropriate. Computation of prospective effects of hypothetical
interest rate changes are based on numerous assumptions, including relative
levels of market interest rates, loan prepayments, and deposits decay, and
should not be relied upon as indicative of actual results. Further, the
computations do not contemplate any actions the ALCO could undertake in response
to changes in interest rates.
Certain shortcomings are inherent in the method of analysis presented in
the computation of NPV. Actual values may differ from those projections
presented, should market conditions vary from assumptions used in the
calculation of the NPV. Certain assets, such as adjustable rate loans, which
represent one of the Corporation's primary loan products, have features which
restrict changes in interest rates on a short-term basis and over the life of
the assets. In addition, the proportion of adjustable rate loans in the
Corporation's portfolio could decrease in future periods if market interest
rates remain at or decrease below current levels due to refinance activity.
Further, in the event of a change in interest rates, prepayment and early
withdrawal levels would likely deviate significantly from those assumed in the
NPV. Finally, the ability of many borrowers to repay their adjustable-rate
mortgage loans may decrease in the event of interest rate increases.
Another tool of evaluating the institution's sensitivity to net interest
income to changes in interest rates is to examine the extent to which its assets
and liabilities are "interest rate sensitive" and by monitoring an institution's
interest rate sensitivity "gap". An asset or liability is said to be interest
rate sensitive within a specific time period if it will mature or reprice within
that time period. The interest rate sensitivity gap is defined as the difference
between the amount of interest-earning assets maturing or repricing within a
specific time period and the amount of interest-bearing liabilities maturing or
repricing within that same time period.
39
The following interest rate sensitivity table sets forth the Bank's
interest-earning assets and interest-bearing liabilities at June 30, 1998, which
are anticipated to reprice or mature in each of the future time periods shown.
Interest Rate Sensitivity (Gap Analysis)
As of June 30, 1998
(Dollars in thousands)
0 - 3 4 - 6 7 - 12 1 - 3 3 - 5 Over 5
Total Months Months Months Years Years Years
----- ------ ------ ------ ----- ----- -----
Interest-Earning Assets:
Loans $358,547 $35,752 $26,163 $44,166 $107,997 $42,724 $101,744
Debt and equity securities 25,653 2,984 -- 1,000 1,000 11,669 9,000
Mortgage-backed securities 1,970 69 66 126 423 322 964
------- ------- ------- ------- -------- ------ --------
Total rate sensitive assets 386,170 38,805 26,229 45,292 109,420 54,715 111,708
------- ------- ------- ------- -------- ------ --------
Interest-Bearing Liabilities:
Money market deposits 9,856 939 850 1,464 3,639 1,634 1,330
Passbook accounts 30,928 2,146 1,997 3,588 10,148 5,708 7,340
Demand deposit accounts 32,714 2,270 2,113 3,796 10,734 6,038 7,763
Certificates of deposit 220,454 27,233 45,727 68,113 70,860 8,521 --
Borrowed funds 44,521 21,272 -- -- -- -- 23,249
------ ------ ------ ------ ------ ----- ------
Total rate sensitive
liabilities 338,473 53,860 50,686 76,961 95,382 21,901 39,682
------- ------ ------ ------ ------ ------ ------
Interest sensitivity gap $ 47,697 (15,055) (24,458) (31,669) 14,038 32,814 72,026
====== ====== ====== ====== ====== ====== ======
Cumulative interest
sensitivity gap $(15,055) $(39,513) $(71,182) $(57,143) $(24,329) $47,697
======= ====== ====== ====== ====== ======
Cumulative interest
sensitivity gap as a
percentage of total assets -3.67% -9.63% -17.36% -13.93% -5.93% 11.64%
===== ===== ====== ====== ===== =====
As the preceding table indicates, the Bank has a moderate negative
cumulative gap for assets and liabilities maturing or repricing within one year
in the amount of $(71,182) million or 17.38 percent of total assets. Thus,
decreases in interest rates during this time period would generally increase net
interest income, while increases in interest rates would generally decrease net
interest income. However, even though the periodic gap analysis provides
management with a method of measuring current interest rate risk, it only
measures rate sensitivity at a specific point in time. Gap analysis does not
take into consideration that assets and liabilities with similar repricing
characteristics may not reprice at the same time or to the same degree and,
therefore, does not necessarily predict the impact of changes in general levels
of interest rates on net interest income. Additionally, certain assets such as
adjustable rate mortgage loans have features which restrict changes in interest
rates on a short-term basis and over the life of the asset. Further, in the
event of changes in interest rates, prepayment and decay rates may deviate
significantly from those assumed in calculating the table. Finally, the ability
of many borrowers to afford the payments on their adjustable rate mortgage loans
may decrease in the event of an interest rate increase.
40
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
Board of Directors
First Federal Financial Corporation
of Kentucky
Elizabethtown, Kentucky
We have audited the accompanying consolidated statements of financial condition
of First Federal Financial Corporation of Kentucky and Subsidiaries as of June
30, 1998 and 1997, and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the three years in the period
ended June 30, 1998. These financial statements are the responsibility of the
Bank's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of First Federal Financial
Corporation of Kentucky and Subsidiaries as of June 30, 1998 and 1997, and the
results of its operations and its cash flows for each of the three years in the
period ended June 30, 1998, in conformity with generally accepted accounting
principles.
/s/ Whelan, Doerr & Pike, PSC
Elizabethtown, Kentucky
August 17, 1998
41
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30,
--------------------------
1998 1997
------------ ----------
ASSETS
Cash and cash equivalents $ 4,992,588 $ 8,694,283
Interest bearing deposits 4,157,124 481,430
Securities held-to-maturity (fair value approximates
$24,935,000 and $17,800,000 at June 30, 1998 and
1997, respectively) 24,639,484 17,484,427
Securities available-for-sale, at fair value 1,934,412 5,192,323
Loans receivable, net 355,306,342 327,791,495
Real estate owned:
Acquired through foreclosure 133,584 183,569
Held for development 642,491 687,261
Investment in Federal Home Loan Bank stock 2,983,800 2,777,200
Premises and equipment 10,747,145 10,221,228
Other assets 1,329,890 842,656
Excess of cost over net assets of affiliates
purchased 2,784,409 3,024,481
--------- ---------
TOTAL ASSETS $409,651,269 $377,380,353
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Savings deposits $306,702,649 $281,342,174
Advances from Federal Home Loan Bank 43,248,855 41,514,194
Accrued interest payable 358,435 202,982
Accounts payable and other liabilities 2,576,839 706,892
Deferred income taxes 2,076,104 1,949,361
TOTAL LIABILITIES 354,962,882 325,715,603
----------- -----------
COMMITMENTS - -
STOCKHOLDERS' EQUITY:
Serial preferred stock, 5,000,000 shares
authorized and unissued - -
Common stock, $1 par value per share;
authorized 10,000,000 shares; issued and
outstanding, 4,129,612 shares in 1998 and
4,170,003 shares in 1997 4,129,612 4,170,003
Additional paid-in capital 3,253,664 4,330,548
Retained earnings-substantially restricted 46,208,807 42,193,609
Net unrealized holding gain on securities
available-for-sale, net of tax 1,096,304 970,590
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 54,688,387 51,664,750
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $409,651,269 $377,380,353
=========== ===========
See notes to consolidated financial statements.
42
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year Ended June 30,
1998 1997 1996
----------- ---------- ----------
Interest income:
Interest on loans $29,338,526 $26,944,715 $25,173,320
Interest and dividends on investments and deposits 1,843,413 1,837,661 1,752,590
---------- ---------- ----------
Total interest income 31,181,939 28,782,376 26,925,910
Interest expense:
Savings deposits 13,676,525 12,069,782 11,875,423
Federal Home Loan Bank advances 2,382,084 2,305,725 1,800,194
---------- ---------- ----------
Total interest expense 16,058,609 14,375,507 13,675,617
---------- ---------- ----------
Net interest income 15,123,330 14,406,869 13,250,293
Provision for loan losses 265,000 200,000 -
---------- ---------- ----------
Net interest income after provision for loan losses 14,858,330 14,206,869 13,250,293
---------- ---------- ----------
Noninterest income:
Customer service fees on deposit accounts 1,274,298 1,231,149 1,061,102
Other income 1,210,716 919,943 832,381
Gain on sale of investments 375,356 316,927 754,409
---------- ---------- ---------
Total other income 2,860,370 2,468,019 2,647,892
---------- ---------- ---------
Noninterest expense:
Employee compensation and benefits 3,706,255 3,522,340 3,305,384
Office occupancy expense and equipment 935,972 899,855 843,969
Federal insurance premiums 178,476 2,014,218 586,428
Marketing and advertising 377,135 373,117 342,710
Outside services and data processing 663,442 600,167 609,906
State franchise tax 308,691 292,880 279,914
Other expense 1,912,515 1,769,357 1,579,128
---------- --------- ---------
Total other expense 8,082,486 9,471,934 7,547,439
---------- ---------- ---------
Income before income taxes 9,636,214 7,202,954 8,350,746
Income taxes 3,301,997 2,428,892 2,864,122
---------- ---------- ---------
Net income $ 6,334,217 $4,774,062 $5,486,624
========== ========== =========
Earnings per share:
Basic $ 1.53 $ 1.14 $ 1.30
========== ========== =========
Diluted $ 1.52 $ 1.13 $ 1.29
========== ========== =========
See notes to consolidated financial statements.
43
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Net Unrealized
Holding Gains
Common Additional on Securities
Stock Common Paid-in Retained Available-
Shares Stock Capital Earnings for-sale Total
------- ------ ---------- -------- -------------- -----
BALANCE, June 30, 1995 2,118,898 $2,118,898 $8,194,890 $35,965,471 $1,031,099 $47,310,358
Net earnings - - - 5,486,624 - 5,486,624
Exercise of stock
options 8,950 8,950 102,398 - - 111,348
Stock tendered as payment
for options excercised (2,655) (2,655) (79,821) - - (82,476)
Change in unrealized holding
gains on securities avail-
able-for-sale, net of tax - - - - 228,877 228,877
Gain realized on the sale
of securities available-
for-sale - - - - (497,910) (497,910)
Cash dividends declared - - - (1,942,906) - (1,942,906)
Stock repurchased (20,898) (20,898) (646,572) - - (667,470)
2-for-1 stock split 2,104,195 2,104,195 (2,104,195)
--------- --------- --------- ---------- --------- ----------
BALANCE, June 30, 1996 4,208,490 4,208,490 5,466,700 39,509,189 762,066 49,946,445
Net earnings - - - 4,774,062 - 4,774,062
Exercise of stock
options 26,930 26,930 92,576 - - 119,506
Stock tendered as payment
for options exercised (3,018) (3,018) (55,937) - - (58,955)
Change in unrealized holding
gains on securities avail-
able-for-sale, net of tax - - - - 417,696 417,696
Gain realized on the sale
of securities available-
for-sale - - - - (209,172) (209,172)
Cash dividends declared - - - (2,089,642) - (2,089,642)
Stock repurchased (62,399) (62,399) (1,172,791) - - (1,235,190)
--------- --------- --------- ---------- --------- ----------
BALANCE, June 30, 1997 4,170,003 4,170,003 4,330,548 42,193,609 970,590 51,664,750
Net earnings - - - 6,334,217 - 6,334,217
Exercise of stock
options 21,000 21,000 220,875 - - 241,875
Stock tendered as payment
for options exercised (10,994) (10,994) (230,841) - - (241,835)
Change in unrealized holding
gains on securities avail-
able-for-sale, net of tax - - - - 373,449 373,449
Gain realized on the sale
of securities available-
for-sale - - - - (247,735) (247,735)
Cash dividends declared - - - (2,319,019) - (2,319,019)
Stock repurchased (50,397) (50,397) (1,066,918) - - (1,117,315)
--------- --------- --------- ---------- --------- ----------
BALANCE, June 30, 1998 4,129,612 $4,129,612 $3,253,664 $46,208,807 $1,096,304 $54,688,387
========= ========= ========= ========== ========= ==========
See notes to consolidated financial statements.
44
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended June 30,
1998 1997 1996
----------- ----------- -----------
Operating Activities:
Net income $ 6,334,217 $ 4,774,062 $ 5,486,624
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses and real estate
owned 265,000 200,000 -
Provision for depreciation 605,955 550,488 462,621
Net change in deferred loan fees and costs 195,066 178,756 164,059
Federal Home Loan Bank stock dividends (206,600) (187,300) (173,700)
Amortization of acquired intangible assets 240,072 240,072 240,072
Amortization of discounts on securities
held-to-maturity (147,972) (151,218) (125,833)
Gain on sale of investments available-for-sale (375,356) (316,927) (754,409)
(Decrease) increase in interest payable 155,453 (15,302) (30,533)
Decrease (increase) in other assets (498,363) 143,604 45,245
Increase in accounts payable and other
liabilities 1,996,690 74,490 507,652
--------- --------- ---------
Net cash provided by operating activities 8,564,162 5,490,725 5,821,798
--------- --------- ---------
Investing Activities:
Sales of securities available-for-sale 3,808,207 455,831 793,308
Purchases of securities available-for-sale (36,082) (221,543) (495,960)
Purchases of securities held-to-maturity (14,000,000) (5,993,995) (5,000,000)
Principal collections on securities held-to-
maturity 6,979,771 654,582 5,499,137
Net increase in loans to customers (27,924,928) (25,753,189) (19,729,353)
Purchases of premises and equipment (1,131,872) (1,087,549) (346,653)
Decrease (increase) in real estate held for
development 44,770 (182,000) (12,102)
----------- ----------- -----------
Net cash used in investing activities (32,260,134) (32,127,863) (19,291,623)
----------- ----------- -----------
Financing Activities:
Advances from Federal Home Loan Bank 1,734,661 6,535,115 13,740,731
Net increase in customer savings deposits 25,360,475 16,396,430 4,442,692
Proceeds from stock options exercised 40 60,551 28,872
Dividends paid (2,319,019) (2,089,642) (1,942,906)
Common stock repurchased (1,117,315) (1,235,190) (667,470)
Collection on advance to ESOP 11,129 - 163,677
Advance to ESOP - (14,685) -
----------- ----------- ----------
Net cash provided by financing activities 23,669,971 19,652,579 15,765,596
----------- ----------- ----------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (26,001) (6,984,559) 2,295,771
CASH AND CASH EQUIVALENTS, beginning of year 9,175,713 16,160,272 13,864,501
----------- ----------- ----------
CASH AND CASH EQUIVALENTS, end of year $ 9,149,712 $ 9,175,713 $16,160,272
=========== =========== ==========
See notes to consolidated financial statements.
45
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a description of the more significant accounting policies which
First Federal Financial Corporation of Kentucky follows in preparing and
presenting its consolidated financial statements:
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the
accounts of First Federal Financial Corporation of Kentucky (the Corporation)
and its wholly-owned subsidiary, First Federal Savings Bank of Elizabethtown
(the Bank), and its wholly-owned subsidiary, First Service Corp. of
Elizabethtown. All significant intercompany transactions and balances have been
eliminated.
SECURITIES - The Corporation records securities under Statement of Financial
Accounting Standards No. 115 (SFAS No. 115) "Accounting for Certain Investments
in Debt and Equity Securities", which requires the classification of securities
into three categories: held-to-maturity, available-for-sale, or trading. Based
upon a periodic review of the investment portfolio, debt securities in which the
Corporation has a positive intent and ability to hold are classified as
held-to-maturity and are carried at cost adjusted for the amortization of
premiums and discounts using the interest method over the terms of the
securities.
Debt and equity securities which do not fall into this category, nor held for
the purpose of selling in the near term are classified as available-for-sale.
Unrealized holding gains and losses, net of income tax, on available-for-sale
securities are reported as a net amount in a separate component of stockholders'
equity until realized.
FEDERAL HOME LOAN BANK STOCK - Investment in stock of Federal Home Loan Bank is
required by law of every federally insured savings and loan or savings bank. The
investment is carried at cost. No ready market exists for the stock, and it has
no quoted market value.
REAL ESTATE OWNED - Real estate properties acquired through foreclosure and in
settlement of loans are stated at the lower of cost or fair value less estimated
selling costs at the date of foreclosure. The excess of cost over fair value
less the estimated costs to sell at the time of foreclosure is charged to the
allowance for loan losses. Costs relating to development and improvement of
property are capitalized, whereas costs relating to holding property are not
capitalized and are charged against operations in the current period.
Real estate properties held for development and sale are carried at the lower of
cost, including cost of development and improvement subsequent to acquisition,
or fair value less estimated selling costs. The portion of interest costs
relating to the development of real estate is capitalized.
PREMISES AND EQUIPMENT - Premises and equipment are stated at cost less
accumulated depreciation. Depreciation is computed by the straight-line method
for buildings and improvements and furniture and fixtures, over the estimated
useful lives of the related assets.
INCOME TAXES - Deferred income tax assets and liabilities are determined using
the liability method. Under this method, the net deferred tax asset or liability
is determined based on the tax effects of the differences between the book and
tax basis of the various balance sheet assets and liabilities.
46
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)
LOANS RECEIVABLE - Loans receivable are stated at unpaid principal balances,
less the allowance for loan losses, net deferred loan origination fees and
unearned discounts. The Bank defers loan origination fees and discounts net of
certain direct origination costs. These net deferred fees are amortized using
the level yield method on a loan-by-loan basis over the lives of the underlying
loans. Unearned discounts on consumer loans are recognized over the lives of the
loans using methods that approximate the interest method.
The allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries). Management's periodic evaluation of the
adequacy of the allowance is based on the Bank's past loan loss experience,
known and inherent risks in the portfolio, adverse situations that may affect
the borrower's ability to repay, estimated value of any underlying collateral,
and current economic conditions.
Uncollectible interest on loans that are contractually past due is charged off
or an allowance is established based on management's periodic evaluation. The
allowance is established by a charge to interest income equal to all interest
previously accrued, and income is subsequently recognized only to the extent
cash payments are received until, in management's judgement, the borrower's
ability to make periodic interest and principal payments is back to normal, in
which case the loan is returned to accrual status.
The Bank's primary lending area is a region within north central Kentucky. The
economy within this region is based on agriculture, a variety of manufacturing
industries and Ft. Knox, a military installation. The Bank's primary lending
activity is the origination of residential real estate loans secured by first
mortgage for the purpose of acquisition or construction of one-to-four family
residential properties.
CASH FLOWS - For purposes of the statement of cash flows, the Corporation
considers all highly liquid debt instruments purchased with a maturity of three
months or less to be cash equivalents. Cash and cash equivalents include cash on
hand and amounts due from banks.
ESTIMATES AND ASSUMPTIONS - The preparation of consolidated financial statements
in conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
ADVERTISING COSTS - The Corporation expenses all advertising costs when they are
incurred.
RECLASSIFICATIONS - Certain amounts for 1997 and 1996 have been reclassified to
conform to the presentation for 1998.
47
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2.SECURITIES
The amortized cost basis and fair values of securities at June 30 are as
follows:
Amortized Gross Gross
Cost Unrealized Unrealized Fair
Basis Gains Losses Value
--------- ---------- ---------- -----
Securities held-to-maturity:
June 30, 1998:
U.S. Treasury and agencies $22,693,407 $ 229,673 $ - $22,923,080
Mortgage-backed securities 1,946,077 66,004 - 2,012,081
---------- -------- ------- ----------
Total held-to-maturity securities $24,639,484 $ 295,677 $ - $24,935,161
========== ======== ======= ==========
June 30, 1997:
U.S. Treasury and agencies $15,335,411 $ 234,624 $ - $15,570,035
Mortgage-backed securities 2,149,016 80,972 - 2,229,988
---------- ------- ------- ----------
Total held-to-maturity securities $17,484,427 $ 315,596 $ - $17,800,023
========== ======= ======= ==========
Securities available-for-sale:
June 30, 1998:
Equity securities $ 273,341 $1,688,883 $(27,812) $ 1,934,412
========== ========= ======= ==========
June 30, 1997:
Equity securities $ 3,721,730 $1,479,974 $ (9,381) $ 5,192,323
========== ========= ======= =========
The amortized cost and fair value of debt securities held-to-maturity at June
30, 1998, by contractual maturity, are shown below.
Amortized Market
Cost Value
Due in one year or less $ 983,932 $ 999,370
Due after one year through five years 12,718,642 13,008,000
Due after five years through ten years --
Due after ten years 8,990,833 8,915,710
Mortgage backed securities 1,946,077 2,012,081
---------- ----------
$24,639,484 $24,835,161
========== ==========
The following schedule sets forth the proceeds from sales of available-for-sale
securities and the gross realized gains on those sales for the fiscal years
ended June 30:
1998 1997 1996
---- ---- ----
Proceeds from sales $3,808,207 $455,831 $793,308
Gross realized gains $ 375,356 $316,927 $754,409
Realized gains, net of tax $ 247,735 $209,172 $518,430
Change in net unrealized holding gains $ 565,832 $632,873 $346,783
48
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2.SECURITIES - (Continued)
The average cost method was used for determining the basis of the securities in
computing the realized gains. Investment securities of $4,356,362 at June 30,
1998 were pledged to secure public deposits.
3. LOANS RECEIVABLE:
Loans receivable at June 30 are summarized as follows:
1998 1997
----------- ----------
Commercial $ 4,274,499 $ 4,310,725
Real estate construction 16,435,042 15,444,350
Residential real estate 307,405,412 284,145,699
Consumer 42,636,990 36,164,536
----------- -----------
370,751,943 340,065,310
----------- -----------
Less:
Loans in process 9,728,902 7,097,807
Net deferred loan origination fees 3,026,307 2,672,040
Escrow deposits 760,090 683,258
Unearned discounts 11,859 60,521
Interest reserves 65,867 45,677
Allowance for loan losses 1,852,576 1,714,512
----------- -----------
15,445,601 12,273,815
----------- -----------
$355,306,342 $327,791,495
=========== ===========
The Bank did not materially participate in the servicing of loans for others on
any of the dates presented in these financial statements.
The allowance for losses on loans is summarized as follows:
Year Ended June 30,
1998 1997 1996
---------- ---------- ---------
Balance, beginning of year $1,714,512 $1,612,627 $1,661,681
Provision charged to operations 265,000 200,000 -
Charge-offs (147,985) (131,132) (74,018)
Recoveries 21,049 33,017 24,964
--------- --------- ---------
Balance, end of year $1,852,576 $1,714,512 $1,612,627
========= ========= =========
49
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3. LOANS RECEIVABLE - (Continued)
The Bank records impaired loans under Statement of Financial Accounting
Standards No. 114 (SFAS No. 114) "Accounting by Creditors for Impairment of a
Loan", as amended by SFAS No. 118. SFAS No. 114 defines a loan as impaired when
it is probable that a creditor will be unable to collect all amounts due
according to the contractual terms of the loan agreement. Management has defined
its population of impaired loans as residential mortgage, consumer and
commercial real estate loans which are classified as substandard, doubtful, or
loss, as defined by Office of Thrift Supervision (OTS) regulations. Interest
income is recognized on an impaired loan when earned.
Investment in impaired loans is summarized as follows:
June 30,
1998 1997
---- ----
Impaired loans with no related allowances $2,128,000 $1,739,000
Impaired loans with related allowances - -
--------- ---------
Total impaired loans $2,128,000 $1,739,000
========= =========
Average impaired loans outstanding $1,934,000 $1,983,000
Interest income recognized $ 157,000 $ 163,000
Interest income received $ 157,000 $ 163,000
At June 30, 1998, the Bank had loan commitments of approximately $6,586,069,
excluding undisbursed portions of loans in process. Commitments to fund fixed
rate loans included in the above amount were $4,182,800 with interest rates
ranging from 6.75% to 9.50%. The Bank also had standby letters of credit
totaling $694,640 and undisbursed lines of credit of $12,389,690 at June 30,
1998.
Non-performing loans were $2,057,000 and $1,540,000 at June 30, 1998 and 1997,
respectively. Interest income in the amount of $94,390 and $60,486 for 1998 and
1997, respectively, would have been recorded on non-performing loans if they had
been performing in accordance with their contractual terms.
4. PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
June 30,
1998 1997
---- ----
Land $ 816,266 $ 816,266
Buildings 8,805,668 8,205,723
Furniture, fixtures and equipment 4,680,069 4,172,502
---------- ----------
14,302,003 13,194,491
Less accumulated depreciation 3,554,858 2,973,263
---------- ----------
$10,747,145 $10,221,228
========== ==========
50
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
4. PREMISES AND EQUIPMENT - (Continued)
Certain premises and equipment are leased under various operating leases. Rental
expense was $63,200, $65,458 and $-0- for the years ended June 30, 1998, 1997
and 1996, respectively. Future minimum commitments under these leases are:
Year Ended
June 30
----------
1999 $ 63,200
2000 63,200
2001 51,533
2002 2,350
-------
$180,283
=======
5. SAVINGS DEPOSITS
Deposits at June 30 are summarized as follows:
Weighted-
Average Rate 1998 1997
1998 1997 Amount Percent Amount Percent
----- ----- ------------ ------- ----------- -------
NOW Accounts 1.52% 1.51% $ 46,211,024 15.07 $ 42,952,707 15.27
Money Market 3.31% 3.38% 9,856,242 3.21 10,460,267 3.72
Passbook Savings 2.65% 2.65% 30,181,812 9.84 31,185,601 11.08
----------- ----- ---------- -----
86,249,078 28.12 84,598,575 30.07
Certificates of
Deposit:
0.00% - 4.00% 884,495 .29 1,128,044 .40
4.01% - 6.00% 149,186,507 48.64 143,982,629 51.18
6.01% - 8.00% 70,382,569 22.95 51,632,926 18.35
8.01% - 10.00% - - - -
----------- ------ ----------- -----
220,453,571 71.88 196,743,599 69.93
----------- ------ ----------- -----
$306,702,649 100.00 $281,342,174 100.00
=========== ====== =========== ======
At June 30, 1998, scheduled maturities of certificates of deposit are as
follows:
Average
Amount Rate Percent
------ ------- -------
1999 $141,072,560 5.71% 63.99
2000 64,239,488 5.87% 29.14
2001 6,620,146 5.82% 3.00
2002 4,227,988 5.99% 1.92
Thereafter 4,293,389 6.20% 1.95
----------- -----
$220,453,571 100.00
=========== ======
51
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
5. SAVINGS DEPOSITS - (Continued):
The average interest rate on the savings deposit portfolio, computed without
effect of compounding daily interest, at June 30, 1998 and 1997 is 4.76% and
4.54%, respectively.
The Bank had certificates of deposit with balances of $100,000 or more of
$54,332,191 and $43,925,939 at June 30, 1998 and 1997, respectively.
A summary of interest expense on deposits is as follows:
Year Ended
June 30,
1998 1997 1996
--------- --------- ---------
Savings accounts $ 809,108 $ 818,414 $ 845,727
Money Market and NOW
accounts 887,153 874,464 759,117
Certificates of deposit 11,980,264 10,376,904 10,270,579
---------- ---------- ----------
$13,676,525 $12,069,782 $11,875,423
========== ========== ==========
6.ADVANCES FROM FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank of Cincinnati are collateralized by
Federal Home Loan Bank stock and a blanket pledge of one-to-four family
residential mortgage loans equivalent to 150 percent of the outstanding
advances.
June 30,
1998 1997
------------------ --------------------
Weighted- Weighted-
Average Average
Rate Amount Rate Amount
Short-term borrowings from
Federal Home Loan Bank:
Variable rate advances 5.59% $20,000,000 5.58 $40,000,000
Fixed rate advances 5.09% 22,000,000 - -
Long-term borrowings from
Federal Home Loan Bank:
Mortgage matched advances
payable monthly through
May, 2009 with interest
rates from 5.30% to 7.80% 6.72% 1,248,855 6.75% 1,514,194
---------- ----------
Total long-term borrowings 1,248,855 1,514,194
---------- ----------
Total borrowings $43,248,855 $41,514,194
========== ==========
52
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
6.ADVANCES FROM FEDERAL HOME LOAN BANK - (Continued)
The aggregate minimum annual repayments of long-term borrowings as of June 30,
1998 is as follows:
1998 $ 95,013
1999 101,643
2000 108,744
2001 116,352
2002 124,503
Thereafter 702,600
---------
$1,248,855
=========
7.INCOME TAXES
The Corporation and its subsidiaries file a consolidated federal income tax
return and income tax is apportioned among all companies based on their taxable
income or loss.
Provision for income taxes for the years ended June 30, are as follows:
1998 1997 1996
--------- -------- ---------
Current $3,198,763 $2,321,803 $2,369,470
Deferred 103,234 107,089 494,652
--------- --------- ---------
Total income tax expense $3,301,997 $2,428,892 $2,864,122
========= ========= =========
Temporary differences between the financial statements carrying amounts and tax
bases of assets and liabilities that give rise to significant portions of
deferred income taxes at June 30, relate to the following:
1998 1997
Deferred tax assets:
Loan fees deferred for financial
reporting purpose $ 229,679 $ 344,518
Accrued liabilities and other 108,612 44,855
Assets acquired, purchase price adjustments 149,937 251,368
------- -------
488,228 640,741
------- -------
Deferred tax liabilities:
Depreciation differences 762,591 705,697
Basis difference in real estate 48,514 48,514
Difference in bad debt reserve 619,159 842,979
Unrealized appreciation on securities
available-for-sale 574,103 503,191
Basis difference in Federal Home Loan
Bank stock 559,965 489,721
------- -------
2,564,332 2,590,102
--------- ---------
Net deferred tax liability $2,076,104 $1,949,361
========= =========
53
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
7.INCOME TAXES - (Continued)
Included in retained earnings at June 30, 1998, is approximately $11,437,000 in
bad debt reserves for which no deferred federal income tax liability has been
recorded. These amounts represent allocations of income to bad debt deductions
for tax purposes only. Reduction of these reserves for purposes other than tax
bad-debt losses would create income for tax purposes, which would be subject to
the then-current corporate income tax rate. The unrecorded deferred liability on
these amounts was approximately $3,888,600.
8.STOCKHOLDERS' EQUITY
(a) LIQUIDATION ACCOUNT - In connection with the Bank's conversion from mutual
to stock form of ownership during 1987, the Bank established a "liquidation
account", currently in the amount of $1,641,000 for the purpose of granting to
eligible savings account holders a priority in the event of future liquidation.
Only in such an event, an eligible account holder who continues to maintain a
savings account will be entitled to receive a distribution from the liquidation
account. The total amount of the liquidation account decreases in an amount
proportionately corresponding to decreases in the savings account balances of
the eligible account holders.
(b) DIVIDEND RESTRICTIONS - The Bank is subject to certain restrictions on the
amount of dividends that it may declare without prior regulatory approval. Based
upon these restrictions, the Bank could have declared dividends for 1998 of
$10,240,000 without prior regulatory approval.
(c) EARNINGS PER SHARE - On December 15, 1997, the Bank adopted Statement of
Financial Accounting Standards No. 128 (SFAS No. 128) "Earnings per Share,"
which establishes new standards for computing and presenting earnings per share
("EPS"). Specifically, SFAS 128 replaces the presentation of primary EPS with a
presentation of basic EPS, requires dual presentation of basic and diluted EPS
on the face of the income statement for all entities with complex capital
structures and requires a reconciliation of the numerator and denominator of the
basic EPS computation to the numerator and denominator of the diluted EPS
computation.
The reconciliation of the numerators and denominators of the basic and
diluted EPS is as follows:
Year Ended June 30,
1998 1997 1996
---------- ---------- ----------
Net income available to common
shareholders $6,334,217 $4,774,062 $5,486,624
========= ========= =========
Basic EPS:
Weighted average common shares 4,145,039 4,182,060 4,222,788
========= ========= =========
Diluted EPS:
Weighted average common shares 4,145,039 4,182,060 4,222,788
Dilutive effect of stock options 29,114 46,456 46,830
--------- --------- ---------
Weighted average common and
incremental shares 4,174,153 4,228,516 4,269,618
========= ========= =========
Earnings Per Share:
Basic $1.53 $1.14 $1.30
==== ==== ====
Diluted $1.52 $1.13 $1.29
==== ==== ====
54
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
8.STOCKHOLDERS' EQUITY - (Continued)
(d) REGULATORY CAPITAL REQUIREMENTS - The Bank is subject to various regulatory
capital requirements administered by the OTS. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary, actions by the OTS that, if undertaken, could have a direct
material effect on the Corporation's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action, a
bank must meet specific capital guidelines that involve quantitative measures of
a bank's assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The amounts and classification of a
bank's capital are also subject to qualitative judgments by the OTS about
components, risk weightings, and other factors. Qualitative measures established
by regulation to ensure capital adequacy and to be classified as "well
capitalized" require the Bank to maintain minimum amounts and ratios of Total,
Tier I, Core and Tangible capital as set forth in the following table. In their
evaluation of capital adequacy, the regulators assess exposure to declines in
the economic value of the Bank's capital adequacy, as well as exposure to
declines in the economic value of capital due to changes in interest rates. As
of June 30, 1998, the most recent notification from the OTS categorized the Bank
as "well capitalized" under the regulatory framework for prompt corrective
action. There are no conditions or events since that notification that
management believes have changed the Bank's category.
To Be Considered
Well Capitalized
Under Prompt
For Capital Correction
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
AS OF JUNE 30, 1998:
Total risk-based capital (to risk-
weighted assets) $50,096,000 18.5% $21,658,000 8.0% $27,073,000 10.0%
Tier I capital (to risk-weighted
assets) $48,243,000 17.9% $ n/a n/a $16,244,000 6.0%
Core capital (to adjusted tangible
assets) $48,243,000 11.9% $16,215,000 3.0% $20,269,000 5.0%
Tangible capital (to tangible
assets) $48,243,000 11.9% $ 6,081,000 1.5% n/a n/a
AS OF JUNE 30, 1997:
Total risk-based capital (to risk-
weighted assets) $47,532,000 19.6% $19,423,000 8.0% $24,279,000 10.0%
Tier I capital (to risk-weighted
assets) $45,817,000 18.9% $ n/a n/a $14,567,000 6.0%
Core capital (to adjusted tangible
assets) $45,817,000 12.3% $11,197,000 3.0% $18,662,000 5.0%
Tangible capital (to tangible
assets) $45,817,000 12.3% $ 5,599,000 1.5% n/a n/a
9. EMPLOYEE BENEFIT PLANS:
(A) PENSION PLANS - The Bank is a participant in the Financial Institutions
Retirement Fund, a multiple-employer defined benefit pension plan covering
substantially all employees. Employees are 100% vested at the completion of five
years of participation in the plan. The Bank's policy is to contribute annually
the minimum funding amounts. Employer contributions charged to operations for
1998, 1997 and 1996 were $4,438, $56,475, and $113,584, respectively.
55
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9.EMPLOYEE BENEFIT PLANS - (Continued):
(a) PENSION PLANS - (CONTINUED) - The Bank has a contributory thrift plan which
covers substantially all of the employees. Under the terms of the plan,
voluntary employee contributions are matched by up to 6% of the employee base
pay and employees are immediately vested. Employer contributions charged to
operations for 1998, 1997 and 1996 were $116,367, $114,939 and $103,107,
respectively.
(b) EMPLOYEE STOCK OWNERSHIP PLAN - The Corporation has a non-contributory
employee stock ownership plan (ESOP) in which employees are eligible to
participate upon completion of one year of service. Employees are vested in
accordance with a schedule which provides for 100% vesting upon completion of
seven years of service.
Shares of the Corporation's common stock were acquired in a leveraged
transaction, and were initially held in an unallocated stock account. Annually,
the aggregate number of shares released and allocated to eligible employees is
determined by a formula specified in the plan agreement, based on the total debt
service for the year made on the ESOP indebtedness. The indebtedness is repaid
by the ESOP from Bank contributions and dividends on the allocated and
unallocated stock held by the ESOP. The number of shares allocated and
unallocated at June 30 is as follows:
1998 1997 1996
---- ---- ----
Allocated 230,213 307,595 321,504
Unallocated - - 860
------- ------- -------
Total shares held by ESOP 230,213 307,595 322,364
======= ======= =======
The Corporation has elected not to adopt the accounting guidelines of AICPA
Statement of Position 93-6 "Employers Accounting for Employee Stock Ownership
Plans" (SOP 93-6), since all of the ESOP shares were acquired prior to the
transition date of December 31, 1992. Bank contributions charged to employee
compensation costs during the year ended June 30, 1998, 1997, and 1996 were
$30,000, $30,000, and $30,000, respectively.
(c) STOCK OPTION PLAN - Under the 1987 Stock Option and Incentive Plan, the
Corporation may grant either incentive or non-qualified stock options to key
employees for an aggregate of 423,200 shares of the Corporation's common stock
at not less than fair market value at the date such options are granted. The
option to purchase shares expires ten years after the date of grant. A summary
of option transactions, which has been adjusted to reflect the 2-for-1 stock
split on June 10, 1996, is as follows:
June 30,
1998 1997 1996
------------------- ------------------- ------------------
Weighted Weighted Weighted
Average Average Average
Number of Excercise Number of Exercise Number of Exercise
Options Price Options Price Options Price
Outstanding, beginning of year 71,314 $12.77 98,244 $10.49 106,044 $ 9.42
Granted during year - - - - 10,000 14.25
Forfeited during year (7,750) 15.60 - - - -
Exercised during the year (21,000) 11.52 (26,930) 4.44 (17,800) 6.25
------ ------ ------
Outstanding, end of year 42,564 12.88 71,314 12.77 98,244 10.49
====== ====== ======
Eligible for exercise at year end 26,564 42,564 61,244
====== ====== ======
Weighted average fair value of
options granted during the year $ n/a $ n/a $ 8.88
====== ====== ======
56
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9.EMPLOYEE BENEFIT PLANS - (Continued)
The Corporation applies APB Opinion No. 25, "Accounting for Stock Issued to
Employees". Accordingly, no compensation cost has been recognized for its plan.
Had compensation cost for the Corporation's Stock Option Plan been determined
based on the fair value at the grant dates for awards under the plan consistent
with the method of SFAS No. 123, "Accounting for Stock-Based Compensation", the
Corporation's net income and earnings per share would have been restated to the
pro-forma amounts indicated below:
Years Ended
June 30,
1998 1997 1996
---- ---- ----
Net income: As reported $6,334,217 $4,774,062 $5,486,624
Pro-forma $6,332,502 $4,762,347 $5,480,429
Earnings per share: As reported $ 1.53 $ 1.14 $ 1.30
Pro-forma $ 1.53 $ 1.14 $ 1.30
The following table summarizes information about stock options outstanding at
June 30, 1998:
Options Outstanding Options Exercisable
---------------------------------------- ---------------------
Weighted Average Average Average
Range of Number Remaining Exercise Number Exercise
Exercise Prices Outstanding Contractual Life Price Exercisable Price
$ 6.88 5,564 3.4 years $ 6.88 5,564 $ 6.88
$12.50 25,000 5.7 $12.50 20,000 $12.50
$16.00 to $17.13 12,000 6.6 $16.45 1,000 $17.13
------ ------
42,564 5.5 $12.88 26,564 $11.49
====== ======
The fair value of each stock option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions for
grants in 1996: 1) expected dividend yields at 2.5%, 2) risk-free interest rates
at 7.5%, 3) expected volatility at 6%, and 4) expected life of options at 5
years.
10. CASH FLOW ACTIVITIES
The following information is presented as supplemental disclosures to the
statement of cash flows, as required by Statement of Financial Accounting
Standards No. 95.
(a)Cash paid during the year ended June 30 for:
1998 1997 1996
----------- ---------- ----------
Interest expense $15,903,156 $14,390,809 $13,706,150
========== ========== ==========
Income taxes $ 1,461,000 $ 2,482,000 $ 2,370,201
========== ========== ==========
57
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10. CASH FLOW ACTIVITIES - (Continued)
(b)Supplemental disclosure of non-cash activities:
1998 1997 1996
---- ---- ----
Loans to facilitate sales of real estate owned $716,448 $698,405 $103,000
======= ======= =======
Transfers from loans to real estate acquired
through foreclosure $666,463 $505,579 $216,484
======= ======= =======
Change in unrealized gains on securities
available-for-sale, net of tax $125,714 $208,524 $(269,033)
======= ======= =======
11.CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)
The following condensed statements summarize the financial position, operating
results and cash flows of First Federal Financial Corporation of Kentucky
(Parent Company only).
CONDENSED STATEMENTS OF FINANCIAL CONDITION
June 30,
1998 1997
ASSETS
Cash and interest bearing deposits $ 92,006 $ 169,661
Investment in subsidiary 52,978,174 50,584,319
Securities available-for-sale 209,995 228,082
Other assets 1,408,212 734,308
---------- ----------
$54,688,387 $51,716,370
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ - $ 51,620
Stockholders' equity 54,688,387 51,664,750
---------- ----------
$54,688,387 $51,716,370
========== ==========
CONDENSED STATEMENTS OF INCOME
Year Ended June 30,
1998 1997 1996
---------- ----------- ---------
Interest income $ 35,188 $ 57,162 $ 68,183
Gain on sale of investments 51,620 25,344 -
Other expenses (65,329) (47,044) (44,731)
--------- --------- ---------
Net income before income tax benefit 21,479 35,462 23,452
Income tax benefit 56,535 39,635 20,480
--------- --------- ---------
Income before equity in undistributed
net income of subsidiaries 78,014 75,097 43,932
Equity in undistributed net income (excess
of dividends distributed) of subsidiaries 6,256,203 4,698,965 5,494,311
--------- --------- ---------
Net income $6,334,217 $4,774,062 $5,538,243
========= ========= =========
58
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11.CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) - (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended June 30,
1998 1997 1996
Operating Activities:
Net income $ 6,334,217 $ 4,774,062 $ 5,538,243
Adjustments to reconcile net income to
cash provided by operating activities:
Earnings from investment in subsidiary (6,256,203) (4,698,965) (5,494,311)
Gain on sale of investments available-
for-sale (51,620) (25,344) -
Decreaes (increase) in other assets (26,691) 51,531 (153,217)
(Decrease) increase in other
liabilities (51,620) (57,080) 37,550
---------- ---------- ----------
Net cash provided (used) by operating
activities (51,917) 44,204 (71,735)
---------- ---------- ----------
Investing Activities:
Sale of securities available-for-sale - 152,064 -
Purchases of securities available-for-sale - (17,463) (301,400)
Collections on note receivable from
subsidiary 3,399,427 3,029,780 2,851,275
---------- ---------- ----------
Net cash provided by investing
activities 3,399,427 3,164,381 2,549,875
---------- ---------- ----------
Financing Activities:
Proceeds from stock options exercised 40 60,551 28,872
Dividends paid (2,319,019) (2,089,642) (1,942,906)
Common stock repurchases (1,117,315) (1,235,190) (667,470)
Collection on advance to ESOP 11,129 - 163,677
Advance to ESOP - (14,685) -
---------- --------- ---------
Net cash used by financing activities (3,425,165) (3,278,966) (2,417,827)
---------- ---------- ----------
Net (decrease) increase in cash (77,655) (70,381) 60,313
Cash, beginning of year 169,661 240,042 179,729
--------- ---------- ----------
Cash, end of year $ 92,006 $ 169,661 $ 240,042
========= ========== ==========
12.FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments", requires disclosure of fair value information
about financial instruments, whether or not recognized in the balance sheet, for
which it is practicable to estimate that value. In cases where quoted market
prices are not available, fair values are based on estimates using present value
or other valuation techniques. Those techniques are significantly affected by
the assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases could not be realized in
immediate settlement of the instrument. Accordingly, the aggregate fair value
amounts presented are not intended to represent the underlying value of the
Corporation.
59
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
12.FAIR VALUE OF FINANCIAL INSTRUMENTS - (Continued)
The methods and assumptions used by the Corporation in estimating its fair value
disclosures for financial instruments are presented below:
CASH AND INTEREST BEARING DEPOSITS - The carrying amounts for cash and interest
bearing deposits approximates their fair values.
INVESTMENT SECURITIES - Fair values for investment securities are based upon
quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments.
LOANS, NET - For variable rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying amounts.
The fair values of other types of loans are estimated by discounting the future
cash flows using current interest rates at which similar loans would be made to
borrowers with similar credit quality and for the same remaining maturities.
DEPOSITS - The fair values for demand deposits, savings accounts and certain
money market deposits are the amounts payable on demand at the reporting date.
The carrying amounts for variable-rate, money market accounts and certificates
of deposit approximate their fair values at the reporting date. Fair values for
fixed-rate certificates of deposit are estimated using a discounted cash flow
calculation that applies interest rates currently being offered on certificates
to a schedule of aggregated expected monthly maturities on time deposits.
ADVANCES FROM FEDERAL HOME LOAN BANK - The fair values for long-term debt are
estimated using discounted cash flow analyses, based on the Corporation's
current incremental borrowing rates for similar types of borrowing arrangements.
COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT - The fair values of
commitments to extend credit is estimated using fees currently charged to enter
into similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the customer. For fixed-rate loan
commitments, fair value also considers the difference between current levels of
interest rates and the committed rates. The fair values of standby letters of
credit are based on fees currently charged for similar agreements or on the
estimated cost to terminate them or otherwise settle the obligations with the
counter parties at the reporting date. The value of these financial instruments
was not material at June 30, 1998 and 1997.
The estimated fair values of the Corporation's financial instruments are as
follows:
June 30, 1998 June 30, 1997
----------------------------- ----------------------------
Carrying Fair Carrying Fair
Value Value Value Value
Financial assets:
Cash and interest bearing deposits $ 9,149,712 $ 9,149,000 $ 9,175,713 $ 9,175,000
Investment securities:
Securities held-to-maturity $ 24,639,484 $ 24,935,000 $ 17,484,427 $ 17,800,000
Securities available-for-sale $ 1,934,412 $ 1,934,000 $ 5,192,323 $ 5,192,000
Loans, net $355,306,342 $352,805,000 $327,791,495 $329,094,000
Financial liabilities:
Deposits $306,702,649 $309,326,000 $281,342,174 $283,863,000
Advances from Federal Home Loan Bank $ 43,248,855 $ 42,317,000 $ 41,514,194 $ 41,630,000
60
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
13. CONTINGENCIES
In the normal course of business, there are various outstanding legal
proceedings and claims. In the opinion of management, after consultation with
legal counsel, the disposition of such legal proceedings and claims will not
materially affect the Corporation's consolidated financial position, results of
operations or liquidity.
14. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Bank is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit. Those instruments
involve, to varying degrees, elements of credit and interest-rate risk in excess
of the amount recognized in the balance sheet. The contract or notional amounts
of those instruments reflect the extent of the Bank's involvement in particular
classes of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments. The Bank
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's credit
worthiness. The amount of collateral obtained, if it is deemed necessary by the
Bank upon extension of credit, is based on management's credit evaluation of the
counterpart.
The Bank's only financial instruments with off-balance-sheet risk at June 30,
1998 and 1997 are outlined in Note 3.
15. SUBSEQUENT EVENTS
In July, 1998, the Bank acquired certain assets and assumed certain liabilities
associated with the acquisition of Meade County banking centers. The transaction
resulted in recording of assets of $11,870,000, liabilities of $72,500,000 and
core deposit intangibles of approximately $8,670,000. The acquisition was funded
by reducing proceeds due for the net liability amount assumed.
In July, 1998, the Bank received final regulatory approval for its plan to
address Year 2000 related data processing concerns. The plan includes converting
data processing centers and replacing non Year 2000 compliant software and
hardware. The plan will result in an after tax charge to operations of
approximately $400,000.
61
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information concerning the Board of Directors of the Corporation,
the information contained under the section captioned "Proposal I -- Election of
Directors" in the Corporation's definitive proxy statement for the Corporation's
1998 Annual Meeting of Stockholders (the "Proxy Statement") is incorporated
herein by reference.
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
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by
reference to the section captioned "Voting Securities and
Principal Holders Thereof" in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by
reference to the sections captioned "Proposal I -- Election of
Directors" and "Voting Securities and Principal Holders Thereof"
in the Proxy Statement.
(c) Changes in Control
Management of the Corporation knows of no arrangements, including
any pledge by any person of securities of the Corporation, the
operation of which may at a subsequent date result in a change of
control of the Corporation.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by
reference to the section captioned "Proposal I -- Election of Directors" in the
Proxy Statement.
62
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
1. Financial Statements Filed
(a) Report of Independent Certified Public Accountants
(b) Consolidated Statements of Financial Condition at June 30,
1998 and 1997.
(c) Consolidated Statements of Earnings for the Years ended
June 30, 1998, 1997, and 1996.
(d) Consolidated Statements of Stockholders' Equity for the
Years ended June 30, 1998, 1997, and 1996.
(e) Consolidated Statements of Cash Flows for the Years ended
June 30, 1998, 1997, and 1996.
(f) Notes to Consolidated Financial Statements
2. All financial statement schedules have been omitted as the
required information is either inapplicable or included in the
financial statements or related notes.
3. Exhibits
(3) (a) Articles of Incorporation **
(3) (b) Bylaws **
10 (b) First Federal Savings Bank of Elizabethtown
Stock Option and Incentive Plan, as amended***
(21) Subsidiaries of the Registrant
(99) Undertakings
(23) Consent of Whelan, Doerr, & Pike, PSC, Certified
Public Accountants
4. No reports on Form 8-K have been filed during the last quarter of
the fiscal year covered by this report.
** Incorporated by reference to the Corporation's Form S-4
Registration Statement (No. 33-30582)
*** Incorporated by reference to Exhibit 10(b) of the Corporation's Form
10-K for the fiscal year ended June 30, 1994.
63
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.
FIRST FEDERAL FINANCIAL CORPORATION
OF KENTUCKY
Date: 9/15/98 By: /s/ B. Keith Johnson
------------------------------
B. Keith Johnson
President and Chief Executive Officer
Duly Authorized Representative
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By: /s/ B. Keith Johnson By: /s/ Irene B. Lewis
--------------------- --------------------
B. Keith Johnson Irene B. Lewis
Principal Executive Officer Director
and Director
Date: 9/15/98 Date: 9/15/98
By: /s/ Wreno M. Hall By: /s/ Bob Brown
--------------------- --------------------
Wreno M. Hall Bob Brown
Director Director
Date: 9/15/98 Date: 9/15/98
By: /s/ J. Alton Rider By: /s/ Kennard Peden
--------------------- --------------------
J. Alton Rider Kennard Peden
Director Director
Date: 9/15/98 Date: 9/15/98
By: /s/ Burlyn Pike By: /s/ Steven Mouser
--------------------- --------------------
Burlyn Pike Steven Mouser
Director Director
Date: 9/15/98 Date: 9/15/98
By: /s/ Walter D. Huddleston By: /s/ Richard L. Muse
------------------------- --------------------
Walter D. Huddleston Richard L. Muse
Director Chief Financial Officer
and Comptroller
Date: 9/15/98 Date: 9/15/98
By: /s/ Michael Thomas
-------------------------
Michael Thomas, DVM
Director
Date: 9/15/98
64
INDEX TO EXHIBITS
Exhibit No. Description
(3) (a) Articles of Incorporation *
(3) (b) Bylaws*
(10)(b) First Federal Savings Bank of Elizabethtown Stock Option and
Incentive Plan, as amended **
(21) Subsidiaries of the Registrant
(99) Undertakings
(23) Consent of Whelan, Doerr, & Pike, PSC, Certified Public
Accountants
(27) Financial Data Schedule
* Incorporated by reference to the Corporation's Form S-4 Registration
Statement (No. 33-30582)
** Incorporated by reference to Exhibit 10(b) of the Corporation's Form
10-K for the fiscal year ended June 30, 1994.
65
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Parent
First Federal Financial Corporation of Kentucky
State of Percentage
Subsidiaries Incorporation Owned
First Federal Savings Bank United States 100%
of Elizabethtown
First Federal Service Corporation Kentucky 100%
of Elizabethtown (a)
(a) Wholly-owned subsidiary of First Federal Savings Bank of Elizabethtown.
66
EXHIBIT 99
EXHIBIT 99 - UNDERTAKINGS
(a) The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to its Form S-8 registration
statement No. 33- 30582
(i) To include any prospectus required by section 10(a)(3) of
the Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or
the most recent post-effective amendment thereof) which,
individually or in the aggregate, represents a fundamental
change in the information set forth in the registration
statement;
(iii) To include any material information with respect to the
plan of distribution not previously disclosed in the
registration statement or any material change to such
information in the registration statements;
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall
be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering
thereof.
(3) To remove from registration by means of a post-effective
amendment any of the securities being registered which remain
unsold at the termination of the offering.
(b) The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing
of the Registrant's Annual Report pursuant to section 13(a) or section
15(d) of the Securities Exchange Act of 1934 (and, where applicable,
each filing of an employee benefit plan's annual report pursuant to
section 15(d) of the Securities Exchange of 1934) that is incorporated
by reference in the registration statement relating to the securities
offered therein, and the offering of such securities at that time shall
be deemed to be the initial bona fide offering thereof.
(h) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or
otherwise, the registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against
public policy as expressed in the Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities
(other than the payment by the registrant of expenses incurred or paid
by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, the registrant will, unless in the opinion
of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act
and will be governed by the final adjudication of such issue.
67
EXHIBIT 23
EXHIBIT 23 - Consent of Whelan, Doerr, & Pike, P.S.C.
The Board of Directors
First Federal Financial Corporation of Kentucky
We consent to incorporation by reference in the Registration Statement No.
33-30582 on Form S-8 of First Federal Financial Corporation of Kentucky of our
report dated August 17, 1998, relating to the consolidated balance sheets of
First Federal Financial Corporation of Kentucky and Subsidiaries as of June 30,
1998 and 1997, and related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the years in the three-year
period ended June 30, 1998, which reports appear in the June 30, 1998 annual
report on Form 10-K of First Federal Financial Corporations of Kentucky.
Whelan, Doerr, & Pike, P.S.C.
/s/ Whelan, Doerr, & Pike, P.S.C.
Elizabethtown, Kentucky 42701
September 25, 1998
68