10-K
1
f10k2020_kentuckyfirst.htm
ANNUAL REPORT
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
DC 20549
FORM
10-K
(Mark
One)
☒ ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For
the fiscal year ended June 30, 2020
or
☐ TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For
the transition period from to
Commission
file number 0-51176
KENTUCKY
FIRST FEDERAL BANCORP
(Exact
Name of Registrant as Specified in Its Charter)
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
(Address of Principal Executive Offices) (Zip Code)
Registrant’s
telephone number, including area code: (502) 223-1638
Securities
registered pursuant to Section 12(b) of the Act:
Title of each class Trading symbol(s) Name of each exchange on which registered
Common Stock, $0.01 par value per share KFFB The NASDAQ Stock Market LLC
Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No
☒
Indicate
by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐
No ☒
Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant
to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit such files). Yes ☒ No ☐
Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting
company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,”
“smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ Accelerated filer ☐
Non-accelerated filer ☒ Smaller reporting company ☒
Emerging growth company ☐
If
an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for
complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate
by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness
of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered
public accounting firm that prepared or issued its audit report. ☐
Indicate
by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The
aggregate market value of the common stock held by nonaffiliates was $23.7 million as of December 31, 2019.
Number
of shares of common stock outstanding as of September 24, 2020: 8,252,215
DOCUMENTS
INCORPORATED BY REFERENCE
The
following lists the documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated:
INDEX
PAGE
PART I 1
Item 1. Business 1
Item 1A. Risk Factors 19
Item 1B. Unresolved Staff Comments 26
Item 2. Properties 27
Item 3. Legal Proceedings 27
Item 4. Mine Safety Disclosures 27
Item 6. Selected Financial Data 29
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 29
Item 8. Financial Statements and Supplementary Data 29
Item 9A. Controls and Procedures 29
Item 9B. Other Information 31
PART III 32
Item 10. Directors, Executive Officers and Corporate Governance 32
Item 11. Executive Compensation 32
Item 14. Principal Accountant Fees and Services 33
Item 15. Exhibits and Financial Statement Schedules 34
SIGNATURES 36
i
PART
I
Item
1.Business.
Forward-Looking
Statements
Certain
statements contained in this report that are not historical facts are forward-looking statements that are subject to certain risks
and uncertainties. When used herein, the terms “anticipates,” “plans,” “expects,” “believes,”
and similar expressions as they relate to Kentucky First Federal Bancorp or its management are intended to identify such forward
looking statements. Kentucky First Federal Bancorp’s actual results, performance or achievements may materially differ from
those expressed or implied in the forward-looking statements. Risks and uncertainties that could cause or contribute to such material
differences include, but are not limited to, general economic conditions, prices for real estate in the Company’s market
areas, interest rate environment, competitive conditions in the financial services industry, changes in law, governmental policies
and regulations, rapidly changing technology affecting financial services, the potential effects of the COVID-19 pandemic on the
local and national economic environment, on our customers and on our operations (as well as any changes to federal, state and
local government laws, regulations and orders in connection with the pandemic), and the other matters mentioned in Item 1A of
this Annual Report on Form 10-K. Except as required by applicable law or regulation, the Company does not undertake the responsibility,
and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking
statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or
unanticipated events.
General
References
in this Annual Report on Form 10-K to “we,” “us” and “our” refer to Kentucky First, and where
appropriate, collectively to Kentucky First, First Federal of Hazard and First Federal of Kentucky.
Kentucky
First Federal Bancorp. Kentucky First Federal Bancorp (“Kentucky First” or the “Company”) was
incorporated as a mid-tier holding company under the laws of the United States on March 2, 2005 upon the completion of the reorganization
of First Federal Savings and Loan Association of Hazard (“First Federal of Hazard”) into a federal mutual holding
company form of organization (the “Reorganization”). On that date, Kentucky First also completed its minority stock
offering and its concurrent acquisition of Frankfort First Bancorp, Inc. (“Frankfort First Bancorp”) and its wholly
owned subsidiary First Federal Savings Bank of Kentucky, Frankfort, Kentucky (“First Federal of Kentucky”) (the “Merger”).
Following the Reorganization and Merger, the Company has operated First Federal of Hazard and First Federal of Kentucky (collectively,
the “Banks”) as two independent, community-oriented savings institutions.
On
December 31, 2012, Kentucky First acquired CFK Bancorp, Inc., the savings and loan holding company for Central Kentucky Federal
Savings Bank, a federally chartered savings bank located in Danville, Kentucky. Central Kentucky Federal Savings Bank was merged
into First Federal of Kentucky and now operates as a division of First Federal of Kentucky under the name “Central Kentucky
Federal Savings Bank” through its two offices in Danville, Kentucky and its Lancaster, Kentucky branch. With the acquisition,
the Company expanded its customer base in the central Kentucky area with an institution that shared its community banking orientation
and thrift heritage and enjoyed a favorable reputation within the new Danville-Lancaster market area.
Kentucky
First’s and First Federal of Hazard’s executive offices are located at 655 Main Street, Hazard, Kentucky, 41702 and
the telephone number for investor relations is (888) 818-3372.
At
June 30, 2020, Kentucky First had total assets of $321.1 million, deposits of $212.3 million and stockholders’ equity of
$51.9 million. The discussion in this Annual Report on Form 10-K relates primarily to the businesses of First Federal of Hazard
and First Federal of Kentucky, as Kentucky First’s operations consist primarily of operating the Banks and investing funds
retained in the Reorganization.
First
Federal of Hazard and First Federal of Kentucky are subject to examination and comprehensive regulation by the Office of the Comptroller
of the Currency and their savings deposits are insured up to applicable limits by the Deposit Insurance Fund, which is administered
by the Federal Deposit Insurance Corporation. Both of the Banks are members of the Federal Home Loan Bank of Cincinnati, which
is one of the 12 regional banks in the FHLB System. See “Regulation and Supervision.”
1
First
Federal Savings and Loan Association of Hazard. First Federal of Hazard was formed as a federally chartered mutual savings
and loan association in 1960. First Federal of Hazard operates from a single office located at 655 Main Street, Hazard, Kentucky
as a community-oriented savings and loan association offering traditional financial services to consumers in Perry and surrounding
counties in eastern Kentucky. It engages primarily in the business of attracting deposits from the general public and using such
funds to originate, when available, loans secured by first mortgages on owner-occupied, residential real estate and occasionally
other loans secured by real estate. To the extent there is insufficient loan demand in its market area, and where appropriate
under its investment policies, First Federal of Hazard has historically invested in mortgage-backed and investment securities,
although since the reorganization, First Federal of Hazard has been purchasing whole loans and participations in loans originated
at First Federal of Kentucky. At June 30, 2020, First Federal of Hazard had total assets of $82.1 million, net loans of $74.1
million, total mortgage-backed and other securities of $162,000, deposits of $47.9 million and total capital of $18.3 million.
First
Federal Savings Bank of Kentucky. First Federal of Kentucky is a federally chartered savings bank, which is primarily
engaged in the business of attracting deposits from the general public and originating primarily adjustable-rate loans secured
by first mortgages on owner-occupied and nonowner-occupied one- to four-family residences in Franklin, Boyle, Garrard and other
counties in Kentucky. First Federal of Kentucky also originates, to a lesser extent, home equity loans and loans secured by churches,
multi-family properties, professional office buildings and other types of property. At June 30, 2020, First Federal of Kentucky
had total assets of $241.7 million, net loans of $211.7 million, total mortgage-backed and other securities of $978,000, deposits
of $168.8 million and total capital of $30.8 million.
First
Federal of Kentucky’s main office is located at 216 W. Main Street, Frankfort, Kentucky 40602 and its main telephone number
is (502) 223-1638.
Market
Areas
First
Federal of Hazard and First Federal of Kentucky operate in three distinct market areas.
First
Federal of Hazard’s market area consists of Perry County, where the business office is located, as well as the surrounding
counties of Letcher, Knott, Breathitt, Leslie and Clay Counties in eastern Kentucky. The economy in its market area has been distressed
in recent years. The local economy depends on the coal industry and other industries, such as health care and manufacturing. Still,
the economy in First Federal of Hazard’s market area continues to lag behind the economies of Kentucky and the United States.
In the most recent available data, using information from the Commonwealth of Kentucky Economic Development and the United States
Bureau of Labor Statistics, per capita personal income in Perry County averaged $38,523 in 2018, compared to personal income of
$42,458 in Kentucky and $54,446 in the United States. Total population in Perry County has declined approximately 1,560 or 5.5%
over the last four years to approximately 26,000. However, as a regional economic center, Hazard tends to draw consumers and workers
who commute from surrounding counties. Employment in the market area, particularly in Perry County, consists primarily of education
and health services (26.0%), the trade, transportation and utilities industry (20.3%), professional and business services (7.8%),
and financial activities (2.8%). During the last five years, the unemployment rate (not seasonally adjusted) has been higher than
most regions, and in July 2020, was 9.8%, compared to 6.2% in Kentucky and 10.5% in the United States.
First
Federal of Kentucky’s primary lending area includes the Kentucky counties of Franklin, Boyle, Garrard and surrounding counties,
with the majority of lending originated on properties located in Franklin and Boyle Counties.
Franklin
County has a population of approximately 51,000, of which approximately 27,000 live within the city of Frankfort, which serves
as the capital of Kentucky. The primary employer in the area is government, which employs about 36.3% of the workforce followed
by the education and health services sector (9.9%), followed by the trade, transportation and utilities sector (9.7%), professional
and business services (9.4%), leisure and hospitality industries (8.6%), and manufacturing (8.4%.). The unemployment rate was
6.3% for July 2020 after having experienced an unemployment rate which had ranged from 4.4% to 9.0% in prior years. The per capita
income in Franklin County for 2018 averaged $41,760.
2
Boyle
County has a population of approximately 30,000. The education and health services sector, which employs about 21.7% of the work
force, is the largest employer, while the trade, transportation and utilities sector and manufacturing sector are the next largest
employers with approximately 18.6% and 13.3% of the workforce, respectively. Centre College is one of the larger employers in
the community. The unemployment rate was 7.5% in July 2020, while the per capita income in Boyle County for 2018 (the most recent
period for which information is available) averaged $37,780.
Lending
Activities
General.
Our loan portfolio consists primarily of one- to four-family residential mortgage loans. As opportunities arise, we also offer
loans secured by churches, commercial real estate, and multi-family real estate. We also offer loans secured by deposit accounts
and, through First Federal of Kentucky, home equity loans. Substantially all of our loans are made within the Banks’ respective
market areas.
Residential
Mortgage Loans. Our primary lending activity is the origination of mortgage loans to enable borrowers to purchase or refinance
existing homes in the Banks’ respective market areas. At June 30, 2020, residential mortgage loans totaled $238.9 million,
or 83.1%, of our total loan portfolio. We offer a mix of adjustable-rate and fixed-rate mortgage loans with terms up to 30 years.
Adjustable-rate loans have an initial fixed term of one, three, five or seven years. After the initial term, the rate adjustments
on most of First Federal of Kentucky’s adjustable-rate loans are indexed to the National Average Contract Interest Rate
for Major Lenders on the Purchase of Previously Occupied Homes. The interest rates on these mortgages are adjusted once a year,
with limitations on adjustments generally of one percentage point per adjustment period, and a lifetime cap of five percentage
points. We determine loan fees charged, interest rates and other provisions of mortgage loans on the basis of our own pricing
criteria and competitive market conditions. Some loans originated by the Banks have an additional advance clause which allows
the borrower to obtain additional funds at prevailing interest rates, subject to managements’ approval.
At
June 30, 2020, the Company’s loan portfolio included $208.6 million in adjustable-rate residential mortgage loans, or 72.6%,
of the Company’s residential mortgage loan portfolio.
The
retention of adjustable-rate loans in the portfolio helps reduce our exposure to increases in prevailing market interest rates.
However, there are unquantifiable credit risks resulting from potential increases in costs to borrowers in the event of upward
repricing of adjustable-rate loans. It is possible that during periods of rising interest rates, the risk of default on adjustable-rate
loans may increase due to increases in interest costs to borrowers. Further, although adjustable-rate loans allow us to increase
the sensitivity of our interest-earning assets to changes in interest rates, the extent of this interest sensitivity is limited
by the initial fixed-rate period before the first adjustment and the periodic and lifetime interest rate adjustment limitations.
Accordingly, there can be no assurance that yields on our adjustable-rate loans will fully adjust to compensate for increases
in our cost of funds. Finally, adjustable-rate loans may decrease at a pace faster than decreases in our cost of funds, resulting
in reduced net income.
While
one- to four-family residential real estate loans are normally originated with up to 30-year terms, such loans typically remain
outstanding for substantially shorter periods because borrowers often prepay their loans in full upon sale of the mortgaged property
or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase
and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans. As
interest rates declined and remained low over the past few years, we have experienced high levels of loan repayments and refinancings.
The
Banks offer various programs for the purchase and refinance of one- to four-family loans. Most of these loans have loan-to-value
ratios of 80% or less, based on an appraisal provided by a state licensed or certified appraiser. For owner-occupied properties,
the borrower may be able to borrow up to 95% of the value if they secure and pay for private mortgage insurance or they may be
able to obtain a second mortgage (at a higher interest rate) in which they borrow up to 90% of the value. The Boards of Directors
of the Banks may approve a loan above the 80% loan-to-value ratio without such enhancements.
3
Construction
Loans. We originate loans for a term of one year or less to individuals to finance the construction of residential dwellings
for personal use or for use as rental property. On a case-by-case basis we consider construction loans on other than owner-occupied,
residential property. At June 30, 2020, construction loans totaled $4.0 million, or 1.4%, of our total loan portfolio. Our construction
loans generally provide for the payment of interest only during the construction phase, which is usually less than one year. Loans
generally can be made with a maximum loan to value ratio of 80% of the appraised value. Funds are disbursed as progress is made
toward completion of the construction based on site inspections by qualified bank staff.
Construction
financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real
estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s
value at completion of construction or development and the estimated cost (including interest) of construction. During the construction
phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate,
we may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate
of value proves to be inaccurate, we may be confronted, at or before the maturity of the loan, with a project having a value which
is insufficient to assure full repayment. As a result of the foregoing, construction lending often involves the disbursement of
substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of the borrower
or guarantor to repay principal and interest. If we are forced to foreclose on a project before or at completion due to a default,
there can be no assurance that we will be able to recover the unpaid balance and accrued interest on the loan, as well as related
foreclosure and holding costs.
Multi-Family
Loans. We offer mortgage loans secured by multi-family property (residential real estate comprised of five or more units.)
At June 30, 2020, multi-family loans totaled $12.4 million, or 4.3%, of our total loan portfolio. We originate multi-family real
estate loans for terms of generally 25 years or less. Loan amounts generally do not exceed 80% of the appraised value and tend
to range much lower.
Nonresidential
Loans. As opportunities arise, we offer mortgage loans secured by nonresidential real estate, which is generally secured
by commercial office buildings, churches, and properties used for other purposes. At June 30, 2020, nonresidential totaled $36.6
million, or 12.8% of our total loan portfolio. We originate nonresidential real estate loans for terms of generally 25 years or
less and loan amounts generally do not exceed 80% of the appraised value and tend to range much lower.
Loans
secured by multi-family and nonresidential real estate generally have larger balances and involve a greater degree of risk than
one- to four-family residential mortgage loans. Of primary concern in multi-family and nonresidential real estate lending is the
borrower’s creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income
properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be
subject to a greater extent than residential real estate loans to adverse conditions in the real estate market or the economy.
To monitor cash flows on income properties, we require borrowers and/or loan guarantors to provide annual financial statements
on larger multi-family and commercial real estate loans. In reaching a decision on whether to make a multi-family or nonresidential
real estate loan, we consider the net cash flow of the project, the borrower’s expertise, credit history and the value of
the underlying property.
Commercial
Non-mortgage Loans. At June 30, 2020, commercial non-mortgage loans totaled $2.2 million, or 0.8%, of our total loan portfolio.
We do not emphasize commercial non-mortgage loans, which may be secured by vehicles used in business or by inventory and equipment
of the business or may be unsecured, although we do originate such loans on a limited basis and generally require a pre-existing
relationship with the Bank. These loans are made only to businesses in our local market and we generally require personal guarantees
of well-established individuals for these loans. Commercial loans involve an even greater degree of risk than real estate loans.
4
Consumer
Lending. Our consumer loans include home equity lines of credit, loans secured by savings deposits, automobile loans and
unsecured or personal loans. At June 30, 2020, our consumer loan balance totaled $9.6 million, or 3.3%, of our total loan portfolio.
Of the consumer loan balance at June 30, 2020, $7.6 million were home equity loans, $1.2 million were loans secured by savings
deposits and $710,000 were automobile or unsecured loans. Our home equity loans are made on the security of residential real estate
and have terms of up to 15 years. Most of our home equity loans are second mortgages subordinate only to first mortgages also
held by the bank and do not exceed 80% of the estimated value of the property, less the outstanding principal of the first mortgage,
although we do offer home equity loans up to 90% of the value less the balance of the first mortgage at a premium rate to qualified
borrowers. These loans are not secured by private mortgage insurance. Our home equity loans require the monthly payment of 1.0%
to 2% of the unpaid principal until maturity, when the remaining unpaid principal, if any, is due. Home equity loans bear variable
rates of interest indexed to the prime rate for loans with 80% or less loan-to-value ratio, and 2% above the prime rate for loans
with a loan-to-value ratio in excess of 80%. Interest rates on these loans can be adjusted monthly. At June 30, 2020, the total
outstanding home equity loans amounted to 2.7% of the Company’s total loan portfolio.
Loans
secured by savings are originated for up to 90% of the depositor’s savings account balance. The interest rate is varying
percentage points above the rate paid on the savings account, and the account must be pledged as collateral to secure the loan.
At June 30, 2020, loans on savings accounts totaled 0.4% of the Company’s total loan portfolio.
Consumer
loans generally entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured
or secured by rapidly depreciable assets. Automobile and unsecured loans at June 30, 2019, totaled 0.3% of the Company’s
total loan portfolio.
Loan
Originations, Purchases and Sales. Loan originations come from a number of sources. The primary source of loan originations
are our in-house loan originators, and to a lesser extent, advertising and referrals from customers and real estate agents. First
Federal of Kentucky sells fixed-rate loans with longer maturities to the Federal Home Loan Bank of Cincinnati (“FHLB-Cincinnati”).
We earn income on the loans sold through fees we charge on the origination, interest spread premiums earned when we sell the loans,
and loan servicing fees on an on-going basis, because servicing rights are retained on such loans. At June 30, 2020, $12.1 million
in loans were being serviced by First Federal of Kentucky for the FHLB-Cincinnati.
Loan
Approval Procedures and Authority. Our lending activities follow written, nondiscriminatory, underwriting standards and
loan origination procedures established by each Bank’s Board of Directors and management. Each Bank’s loan committee
can approve or deny loans on one- to four-family properties totaling $500,000 or less. First Federal of Hazard’s loan committee
consists of its two senior officers, while First Federal of Kentucky’s loan approval process allows for various combinations
of experienced bank officers to approve or deny loans which are one- to four-family properties. Loans that do not conform to this
criteria must be submitted to the Board of Directors or Loan Committee composed of at least three directors, for approval.
It
is the Company’s practice to record a lien on the real estate securing a loan. The Banks generally do not require title
insurance, although it may be required for loans made in certain programs. The Banks do require fire and casualty insurance on
all security properties and flood insurance when the collateral property is located in a designated flood hazard area.
Loans
to One Borrower. The maximum amount either Bank may lend to one borrower and the borrower’s related entities is
limited, by regulation, to generally 15% of that Bank’s stated capital and the allowance for loan losses. At June 30, 2020,
the regulatory limit on loans to one borrower was $4.6 million for First Federal of Hazard and $2.8 million for First Federal
of Kentucky. Neither of the banks had lending relationships in excess of their respective lending limits. However, loans or participations
in loans may be sold among the Banks, which may allow a borrower’s total loans with the Company to exceed the limit of either
individual bank.
5
Loan
Commitments. The Banks issue commitments for the funding of mortgage loans. Generally, these commitments exist from the
time the underwriting of the loan is completed and the closing of the loan. Generally, these commitments are for a maximum of
30 or 60 days but management routinely extends the commitment if circumstances delay the closing. Management reserves the right
to verify or re-evaluate the borrower’s qualifications and to change the rates and terms of the loan at that time.
If
conditions exist whereby either Bank experiences a significant increase in loans outstanding or commits to originate loans that
are riskier than a typical one- to four-family mortgage, management and the boards will consider reflecting the anticipated loss
exposure in a separate liability. As residential loans are approved in the normal course of business, and those loans are underwritten
to the standards of the Banks, management does not believe alteration of the allowance for loan losses is warranted. At June 30,
2020, no commitment losses were reflected in a separate liability.
Both
Banks offer construction loans that either have a separate construction period of one year or less, approved with a simultaneous
commitment for permanent financing, or a loan that has a construction phase of one year or less that is convertible to permanent
financing.
Interest
Rates and Loan Fees. Interest rates charged on mortgage loans are primarily determined by competitive loan rates offered
in our market areas and our yield objectives. Mortgage loan rates reflect factors such as prevailing market interest rate levels,
the supply of money available to the savings industry and the demand for such loans. These factors are in turn affected by general
economic conditions, the monetary policies of the federal government, including the Board of Governors of the Federal Reserve
System, the general supply of money in the economy, tax policies and governmental budget matters.
We
receive fees in connection with late payments on our loans. Depending on the type of loan and the competitive environment for
mortgage loans, we may charge an origination fee on all or some of the loans we originate. We may also offer a menu of loans whereby
the borrower may pay a higher fee to receive a lower rate or to pay a smaller or no fee for a higher rate.
Delinquencies.
When a borrower fails to make a required loan payment, we take a number of steps to have the borrower cure the delinquency
and restore the loan to current status. We make initial contact with the borrower when the loan becomes 15 days past due. Subsequently,
bank staff, under the direct supervision of senior management and with consultation by the Banks’ attorneys, attempt to
contact the borrower and determine their status and plans for resolving the delinquency. However, once a delinquency reaches 90
days, management considers foreclosure and, if the borrower has not provided a reasonable plan (such as selling the collateral,
securing a commitment from another lender to refinance the loan or submitting a plan to repay the delinquent principal, interest,
escrow, and late charges) the foreclosure suit may be initiated. In some cases, management may delay initiating the foreclosure
suit if, in management’s opinion, the Banks’ chance of loss is minimal (such as with loans where the estimated value
of the property greatly exceeds the amount of the loan) or if the original borrower is deceased or incapacitated. If a foreclosure
action is initiated and the loan is not brought current, paid in full, or refinanced with another lender before the foreclosure
sale, the real property securing the loan is sold at foreclosure. The Banks are represented at the foreclosure sale and in most
cases will bid an amount equal to the Banks’ investment (including interest, advances for taxes and insurance, foreclosure
costs, and attorney’s fees). If another bidder outbids the Bank, the Bank’s investment is received in full. If another
bidder does not outbid the Banks, the Banks acquire the property and attempt to sell it to recover their investment.
A
borrower’s filing for bankruptcy can alter the methods available to the Banks to seek collection. In such cases, the Banks
work closely with legal counsel to resolve the delinquency as quickly as possible.
We
may consider loan workout arrangements with certain borrowers under certain conditions. Management of each bank provides a report
to its board of directors on a monthly basis of all loans more than 60 days delinquent, including loans in foreclosure, and all
property acquired through foreclosure.
6
Investment
Activities
We
have legal authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal
agencies and state and municipal governments, mortgage-backed securities and certificates of deposit of federally insured institutions.
We also are required to maintain an investment in FHLB-Cincinnati stock, the level of which is largely dependent on our level
of borrowings from the FHLB.
At
June 30, 2020, our investment portfolio consisted of a single agency bond and mortgage-backed securities issued and guaranteed
by Fannie Mae, Freddie Mac and Ginnie Mae with stated final maturities of 30 years or less. The Company held no equity position
with Fannie Mae or Freddie Mac.
Our
investment objectives are to provide an alternate source of low-risk investments when loan demand is insufficient, to provide
and maintain liquidity, to maintain a balance of high quality, diversified investments to minimize risk, to provide collateral
for pledging requirements, to establish an acceptable level of interest rate risk, and to generate a favorable return. The Banks’
Board of Directors has the overall responsibility for each institution’s investment portfolio, including approval of investment
policies. The management of each Bank may authorize investments as prescribed in each of the Bank’s investment policies.
Bank
Owned Life Insurance
First
Federal of Kentucky owns several Bank Owned Life Insurance policies totaling $2.6 million at June 30, 2020. The purpose of these
policies is to offset future escalation of the costs of non-salary employee benefit plans such as First Federal of Kentucky’s
defined benefit retirement plan and First Federal of Kentucky’s health insurance plan. The lives of certain key Bank employees
are insured, and First Federal of Kentucky is the sole beneficiary and will receive any benefits upon the employee’s death.
The policies were purchased from four highly-rated life insurance companies. The design of the plan allows for the cash value
of the policy to be designated as an asset of First Federal of Kentucky. The asset’s value will increase by the crediting
rate, which is a rate set by each insurance company and is subject to change on an annual basis. The growth of the value of the
asset will be recorded as other operating income. Management does not foresee any expense associated with the plan. Because this
is a life insurance product, current federal tax laws exempt the income from federal income taxes.
Bank
owned life insurance is not secured by any government agency nor are the policies’ asset values or death benefits secured
specifically by tangible property. Great care was taken in selecting the insurance companies, and the bond ratings and financial
condition of these companies are monitored on a quarterly basis. The failure of one of these companies could result in a significant
loss to First Federal of Kentucky. Other risks include the possibility that the favorable tax treatment of the income could change,
that the crediting rate will not be increased in a manner comparable to market interest rates, or that this type of plan will
no longer be permitted by First Federal of Kentucky’s regulators. This asset is considered illiquid because, although First
Federal of Kentucky may terminate the policies and receive the original premium plus all earnings, such an action would require
the payment of federal income taxes on all earnings since the policies’ inception.
Deposit
Activities and Other Sources of Funds
General.
Deposits, loan repayments and maturities, redemptions, sales and repayments of investment and mortgage-backed securities are
the major sources of our funds for lending and other investment purposes. Loan repayments are a relatively stable source of funds,
while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market
conditions.
Deposit
Accounts. The vast majority of our depositors are residents of the Banks’ respective market areas. Deposits are
attracted from within our market areas through the offering of passbook savings and certificate accounts, and, at First Federal
of Kentucky, checking accounts and individual retirement accounts (“IRAs”). We do not utilize brokered funds. Deposit
account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest
rate, among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition,
profitability to us, asset liability management and customer preferences and concerns. We review our deposit mix and pricing on
an ongoing basis as needed.
7
Borrowings.
First Federal of Hazard and First Federal of Kentucky borrow from the FHLB-Cincinnati to supplement their supplies of investable
funds and to meet deposit withdrawal requirements. The Federal Home Loan Bank functions as a central reserve bank providing credit
for member financial institutions. As members, each Bank is required to own capital stock in the FHLB-Cincinnati and is authorized
to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities
which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been
met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending
on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth
or on the Federal Home Loan Bank’s assessment of the institution’s creditworthiness.
Subsidiary
Activities
The
Company has no other wholly owned subsidiaries other than First Federal of Hazard and Frankfort First Bancorp. Frankfort First
Bancorp has one subsidiary, First Federal of Kentucky.
As
federally chartered savings institutions, the Banks are permitted to invest an amount equal to 2% of assets in subsidiaries, with
an additional investment of 1% of assets where such investment serves primarily community, inner-city and community-development
purposes. Under such limitations, as of June 30, 2020, First Federal of Hazard and First Federal of Kentucky were authorized to
invest up to $2.5 million and $7.3 million, respectively, in the stock of or loans to subsidiaries, including the additional 1%
investment for community, inner-city and community development purposes.
Competition
We
face significant competition for the attraction of deposits and origination of loans. Our most direct competition for deposits
has historically come from the banks and credit unions operating in our market areas and, to a lesser extent, from other financial
services companies, such as investment brokerage firms. We also face competition for depositors’ funds from money market
funds and other corporate and government securities. Several of our competitors are significantly larger than us and, therefore,
have significantly greater resources. We expect competition to increase in the future as a result of legislative, regulatory and
technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for
example, have lowered the barriers to enter new market areas, allowed banks to expand their geographic reach by providing services
over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have
been provided by banks. Changes in federal law permit affiliation among banks, securities firms and insurance companies, which
promotes a competitive environment in the financial services industry. Competition for deposits and the origination of loans could
limit our growth in the future.
According
to the Federal Deposit Insurance Corporation (“FDIC”), at June 30, 2020, the latest date for which data is available,
First Federal of Hazard had a deposit market share of 8.3% in Perry County. Its largest competitors, Hazard Bancorp (Peoples Bank
& Trust Company of Hazard,) 1st Trust Bank, Inc., and Community Trust Bancorp, Inc. (Community Trust Bank, Inc.)
had Perry County deposit market shares of 37.2%, 28.4% and 24.8%, respectively. First Federal of Hazard’s competition for
loans comes primarily from financial institutions in its market area and, to a lesser extent, from other financial services providers,
such as mortgage companies and mortgage brokers. Competition for loans also comes from the increasing number of non-depository
financial services companies entering the mortgage market, such as insurance companies, securities companies and specialty finance
companies.
8
First
Federal of Kentucky’s principal competitors for deposits in its market area are other banking institutions, such as
commercial banks and credit unions, as well as mutual funds and other investments. First Federal of Kentucky principally
competes for deposits by offering a variety of deposit accounts, convenient business hours and branch locations, customer
service and a well-trained staff. According to the FDIC, at June 30, 2020, First Federal of Kentucky had deposit market share
of 8.5%, 7.4% and 18.1% for the Kentucky counties of Franklin, Boyle and Garrard. Its largest competitors for depositors are
the Boyle Bancorp, Inc. (The Farmers National Bank of Danville) at 23.9%, Wesbanco Bank, Inc. (Wesbanco) at 20.0% and
Community Trust Bancorp, Inc., (Community Trust Bank) at 7.5% market share in the three-county area. Wesbanco Bank, Inc.,
Boyle Bancorp, Inc., and Community Trust Bancorp, Inc. had assets at June 30, 2020, of $16.8 billion, $746.3 million and
$50.0 billion, respectively. The Bank also faces considerable competition from credit unions including the Commonwealth
Credit Union ($1.4 billion in assets) and the Kentucky Employees Credit Union ($81.2 million in assets). First Federal of
Kentucky competes for loans with other depository institutions, as well as specialty mortgage lenders and brokers and
consumer finance companies. First Federal of Kentucky principally competes for loans on the basis of interest rates and the
loan fees it charges, the types of loans it originates and the convenience and service it provides to borrowers. In addition,
First Federal of Kentucky believes it has developed strong relationships with the businesses, real estate agents, builders
and general public in its market area.
Personnel
At
June 30, 2020, we had 61 full-time employees and two part-time employees, none of whom was represented by a collective bargaining
unit. We believe our relationship with our employees is good.
Regulation
and Supervision
General.
First Federal of Hazard and First Federal of Kentucky are subject to extensive regulation, examination and supervision
by the Office of the Comptroller of the Currency, as their primary federal regulator, and the Federal Deposit Insurance Corporation,
as insurer of deposits. First Federal of Hazard and First Federal of Kentucky are each members of the Federal Home Loan Bank System
and their deposit accounts are insured up to applicable limits by the Deposit Insurance Fund managed by the Federal Deposit Insurance
Corporation. First Federal of Hazard and First Federal of Kentucky must each file reports with the Office of the Comptroller of
the Currency and the Federal Deposit Insurance Corporation concerning their activities and financial condition in addition to
obtaining regulatory approvals before entering into certain transactions such as mergers with, or acquisitions of, other financial
institutions. There are periodic examinations by the Office of the Comptroller of the Currency and, under certain circumstances,
the Federal Deposit Insurance Corporation to evaluate First Federal of Hazard’s and First Federal of Kentucky’s safety
and soundness and compliance with various regulatory requirements. This regulatory structure is intended primarily for the protection
of the insurance fund and depositors. The Federal Reserve Board, the agency that regulates and supervises bank holding companies,
now supervises and regulates Kentucky First Federal MHC. Kentucky First and First Federal MHC, as savings and loan holding companies,
are required to file certain reports with, and are subject to examination by, and otherwise are required to comply with the rules
and regulations of the Federal Reserve Board.
The
Dodd-Frank Act made extensive changes in the regulation of federal savings banks such as First Federal of Hazard and First Federal
of Kentucky. Under the Dodd-Frank Act, the Office of Thrift Supervision was eliminated and responsibility for the supervision
and regulation of federal savings banks was transferred to the Office of the Comptroller of the Currency, the agency that is primarily
responsible for the regulation and supervision of national banks, on July 21, 2011. The Office of the Comptroller of the Currency
assumed responsibility for implementing and enforcing many of the laws and regulations applicable to federal savings banks. Additionally,
the Dodd-Frank Act created a new Consumer Financial Protection Bureau as an independent bureau of the Federal Reserve Board. The
Consumer Financial Protection Bureau assumed responsibility for the implementation of the federal financial consumer protection
and fair lending laws and regulations and has authority to impose new requirements. However, institutions of less than $10 billion
in assets, such as First Federal of Hazard and First Federal of Kentucky, will continue to be examined for compliance with consumer
protection and fair lending laws and regulations by, and be subject to the enforcement authority of, their prudential regulator.
Many of the provisions of the Dodd-Frank Act require the issuance of regulations before their impact on operations can be fully
assessed by management. However, there is a significant possibility that the Dodd-Frank Act will, at a minimum, result in increased
regulatory burden and compliance for First Federal MHC, Kentucky First and each of the Banks.
9
In
May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act, was enacted to modify or remove certain financial
reform rules and regulations, including some of those implemented under the Dodd-Frank Act. While the Economic Growth, Regulatory
Relief and Consumer Protection Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain
aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and for large banks
with assets of more than $50 billion. Many of these changes could result in meaningful regulatory changes for community banks
such as the Bank, and their holding companies.
The
Economic Growth, Regulatory Relief and Consumer Protection Act, among other matters, expands the definition of qualified mortgages
which may be held by a financial institution and simplifies the regulatory capital rules for financial institutions and their
holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish
a single “Community Bank Leverage Ratio” of between 8 and 10 percent. Any qualifying depository institution or its
holding company that exceeds the “community bank leverage ratio” will be considered to have met generally applicable
leverage and risk-based regulatory capital requirements and any qualifying depository institution that exceeds the new ratio will
be considered to be “well capitalized” under the prompt corrective action rules. The Economic Growth, Regulatory Relief
and Consumer Protection Act also expands the category of holding companies that may rely on the “Small Bank Holding Company
and Savings and Loan Holding Company Policy Statement” by raising the maximum amount of assets a qualifying holding company
may have from $1 billion to $3 billion. A major effect of this change is to exclude such holding companies from the minimum capital
requirements of the Dodd-Frank Act. In addition, the Economic Growth, Regulatory Relief and Consumer Protection Act includes regulatory
relief for community banks regarding regulatory examination cycles, call reports, the Volcker Rule (proprietary trading prohibitions),
mortgage disclosures and risk weights for certain high-risk commercial real estate loans.
It
is difficult at this time to predict when or how any new standards under the Economic Growth, Regulatory Relief and Consumer Protection
Act will ultimately be applied to us or what specific impact and the yet-to-be-written implementing rules and regulations will
have on community banks.
Certain
of the regulatory requirements that are applicable to First Federal of Hazard, First Federal of Kentucky, Kentucky First and First
Federal MHC are described below. This discussion does not purport to be a complete description of the laws and regulations involved,
and is qualified in its entirety by the actual laws and regulations. Moreover, laws and regulations are subject to changes by
the U.S. Congress or the regulatory agencies as applicable.
Regulation
of Federal Savings Institutions
Business
Activities. Federal law and regulations, primarily the Home Owners’ Loan Act and the regulations of the Office of
the Comptroller of the Currency, govern the activities of federal savings institutions, such as First Federal of Hazard and First
Federal of Kentucky. These laws and regulations delineate the nature and extent of the activities in which federal savings banks
may engage. In particular, certain lending authority for federal savings institutions, e.g., commercial, nonresidential
real property loans and consumer loans, is limited to a specified percentage of the institution’s capital or assets.
Branching.
Federal savings institutions are authorized to establish branch offices in any state or states of the United States and
its territories, subject to the approval of the Office of the Comptroller of the Currency.
Capital
Requirements. In July 2013, the Federal Reserve Board and the OCC approved a new rule that implemented the Basel III regulatory
capital reforms. The capital regulations now require federal savings banks to meet four minimum capital standards: a 4.0% Tier
1 leverage ratio; a 4.5% common equity Tier 1 ratio; a 6.0% Tier 1 capital ratio; and an 8% Total capital ratio. In addition,
the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard. The
rules eliminated the inclusion of certain instruments, such as trust preferred securities, from Tier 1 capital. Instruments issued
before May 19, 2010 are grandfathered for companies with consolidated assets of $15 billion or less. The rules also established
a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist
entirely of common equity Tier 1 capital and would result in the following minimum ratios: (1) a common equity Tier 1 capital
ratio of 7.0%, (2) a Tier 1 capital ratio of 8.5%, and (3) a total capital ratio of 10.5%. The new capital conservation buffer
requirement was phased in beginning in January 2016 at 0.625% of risk-weighted assets and increased by that amount each year until
fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases
and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum
percentage of eligible retained income that could be utilized for such actions.
10