Item 1A. Risk Factors 17
Item 1B. Unresolved Staff Comments 24
Item 2. Properties 24
Item 3. Legal Proceedings 25
Item 4. Mine Safety Disclosures 25
Item 6. [Reserved] 27
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 27
Item 8. Financial Statements and Supplementary Data 27
Item 9A. Controls and Procedures 27
Item 9B. Other Information 29
Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections 29
PART III 30
Item 10. Directors, Executive Officers and Corporate Governance 30
Item 11. Executive Compensation 30
Item 14. Principal Accountant Fees and Services 31
Item 15. Exhibits and Financial Statement Schedules 32
SIGNATURES 34
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, 2021, Kentucky First had total assets of $338.1 million, deposits of $226.8 million and stockholders’ equity of $52.3
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 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, 2021, First Federal of Hazard
had total assets of $90.8 million, net loans of $83.7 million, total mortgage-backed and other securities of $145,000, deposits of $48.5
million and total capital of $18.4 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, 2021, First Federal of Kentucky had total assets of $249.8 million, net loans
of $214.1 million, total mortgage-backed and other securities of $350,000, deposits of $183.8 million and total capital of $31.2 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,
median household income in Perry County averaged $33,640 compared to personal income of $50,589 in Kentucky and $62,843 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 2021, was 6.5%, compared to 4.7% in Kentucky and 5.7% 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 52,000, 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 4.5% for July 2021 after having
experienced an unemployment rate which had ranged from 4.4% to 9.0% in prior years. The median household income in Franklin County averaged
$56,274.
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 5.0% in July 2021, while the per capita income in Boyle County for 2019 (the most recent period for which information
is available) averaged $46,382.
2
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, 2021, residential mortgage loans totaled $249.3 million, or 83.2%,
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, 2021, the Company’s loan portfolio included $241.9 million in adjustable-rate residential mortgage loans, or 97.0%, 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.
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, 2021, construction loans totaled $5.4 million, or 1.8%, 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.
3
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, 2021, multi-family loans totaled $19.8 million, or 6.6%, 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, 2021, nonresidential real estate loans totaled $35.5
million, or 11.9% 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, 2021, commercial non-mortgage loans totaled $2.3 million, or 0.7%, 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.
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, 2021, our consumer loan balance totaled $8.9 million, or 3.0%, of our total loan portfolio. Of the consumer
loan balance at June 30, 2021, $7.2 million were home equity loans, $1.1 million were loans secured by savings deposits and $628,000
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 2.0% 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, 2021, the total outstanding home equity loans amounted to 2.4% of the Company’s
total loan portfolio.
4
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, 2021,
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, 2021, totaled 0.2% 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, 2021, $18.3 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, 2021, the regulatory
limit on loans to one borrower was $4.5 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.
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, 2021, 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.
5
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.
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, 2021, our investment portfolio consisted of 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 $2.7 million at June 30, 2021. 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.
6
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.
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, 2021, First Federal of Hazard and First Federal of Kentucky were authorized to invest up to $2.7
million and $7.5 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.
7
According
to the Federal Deposit Insurance Corporation (“FDIC”), at June 30, 2021, the latest date for which data is available, First
Federal of Hazard had a deposit market share of 7.5% 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 36.8%, 26.1% and 27.2%, respectively. First Federal of Hazard’s competition for loans comes primarily
from financial institutions in its market area and, to a lesser extent, from other financial services providers, such as mortgage companies
and mortgage brokers. Competition for loans also comes from the increasing number of non-depository financial services companies entering
the mortgage market, such as insurance companies, securities companies and specialty finance companies.
First
Federal of 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, 2021, First Federal of Kentucky had deposit market share of 8.5%, 7.6% and 17.5% 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 23.2%, Wesbanco Bank, Inc. (Wesbanco) at 18.1% and Community Trust Bancorp, Inc., (Community Trust
Bank) at 6.9% market share in the three-county area. Wesbanco Bank, Inc., Boyle Bancorp, Inc., and Community Trust Bancorp, Inc. had
assets at June 30, 2021, of $17.0 billion, $791.2 million and $5.5 billion, respectively. The Bank also faces considerable
competition from credit unions including the Commonwealth Credit Union ($1.7 billion in assets) and the Kentucky Employees Credit
Union ($92.0 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 31, 2021, we had 59 full-time employees and three 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 (OCC), as their primary federal regulator, and the Federal Deposit Insurance Corporation (FDIC),
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 (DIF) of the FDIC. First Federal of Hazard and
First Federal of Kentucky must each file reports with the OCC and the FDIC 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 OCC and, under certain circumstances, the FDIC to evaluate First Federal of Hazard’s
and First Federal of Kentucky’s safety and soundness and compliance with various regulatory requirements. The Board of Governors
of the Federal Reserve System (Federal Reserve Board), the agency that regulates and supervises bank and savings and loan holding companies,
supervises and regulates Kentucky First and 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. This regulatory structure is intended primarily for the protection of the DIF and depositors.
The
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) significantly changed the financial regulatory regime
in the United States. Since the enactment of the Dodd-Frank Act, U.S. banks and financial services firms have been subject to enhanced
regulation and oversight. Several provisions of the Dodd-Frank Act remain subject to further rulemaking, guidance, and interpretation
by the federal banking agencies.
8
Enacted
in 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (EGRRCPA) amended certain provisions of the Dodd-Frank
Act. EGRRCPA provides limited regulatory relief to certain financial institutions, while preserving the existing framework under which
U.S. financial institutions are regulated. In addition to amending the Dodd-Frank Act, EGRRCPA also includes several provisions that
positively affect smaller banking institutions (e.g., those with less than $10 billion in assets) like the Banks. Specific provisions
of the EGRRCPA that benefit smaller banks include modifications to the “qualified mortgage” criteria under the “ability
to repay” rules for certain mortgages that are held and maintained on the Bank’s retained portfolio as well as relief from
certain capital requirements with the creation of a “community bank leverage ratio.” See “Federal Savings Association
Regulation – Capital Requirements.”
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 Associations
Business
Activities. Federal law and regulations, primarily the Home Owners’ Loan Act and the regulations of the OCC, govern the
activities of federal savings associations, 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 associations may engage. In particular, certain lending authority
for federal savings associations (e.g., commercial, nonresidential real property loans and consumer loans) is limited to a specified
percentage of the association’s capital or assets.
Branching.
Federal savings associations are authorized to establish branch offices in any state or states of the United States and its territories,
subject to the approval of the OCC.
Capital
Requirements. Federal regulations require insured depository institutions, including federal savings associations 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 to risk-weighted assets
ratio; and an 8% Total capital to risk-weighted assets ratio. These requirements were effective January 1, 2015, and are the result of
a final rule implementing recommendations of the Basel Committee on Banking Supervision (Basel III) and certain requirements of the Dodd
Frank Act. The regulations also include a “capital conservation buffer” of 2.5% above the regulatory minimum capital requirements,
which must consist entirely of common equity Tier 1 capital and 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 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.
Tier
1 capital is generally defined as common stockholders’ equity (including retained earnings), certain non-cumulative perpetual preferred
stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain
mortgage servicing rights and credit card relationships. The regulations eliminate 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 components of Tier 2 capital currently include cumulative preferred stock, long-term perpetual preferred
stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with
readily determinable fair market values. Overall, the amount of Tier 2 capital included as part of total capital cannot exceed 100% of
core capital. Total capital is defined as core capital and supplementary capital, less certain specified deductions from total capital
such as reciprocal holdings of depository institution capital, instruments and equity investments. For purposes of determining the amount
of risk-weighted assets, all assets, including certain off-balance sheet assets, recourse obligations, residual interests and direct
credit substitutes, are multiplied by a risk-weight factor of 0% to 150%, as assigned by the capital regulation based on the risks believed
inherent in the type of asset.
9
The
EGRRCPA required the federal banking agencies, including the OCC, to establish a “community bank leverage ratio” (CBLR) for
qualifying community banking organizations having less than $10 billion in average total consolidated assets and a leverage ratio of
greater than 9%. The CBLR is an alternative framework that permits qualifying institutions to calculate a leverage ratio to measure capital
adequacy. Institutions opting into the CBLR framework are not be required to calculate or report risk-based capital and are deemed to
have met the “well capitalized” ratio requirements and be in compliance with the generally applicable capital rule if they
meet the CBLR ratio. The CBLR ratio is the ratio of a banking organization’s Tier 1 capital to its average total consolidated assets
as reported on the banking organization’s applicable regulatory filings. The federal agencies a final rule, effective January 1,
2020, that set the CBLR at 9%. The CARES Act directed the federal banking agencies to issue an interim rule temporarily lowering the
CBLR ratio to 8% which the agencies did with a transition back to 9% by year-ended 2021. The Banks elected to use the CBLR framework
effective for the quarter ended March 31, 2020. As of June 30, 2021, the capital levels of First Federal of Hazard and First Federal
of Kentucky exceed the minimum required capital amounts for capital adequacy. See Note K-Stockholders’ Equity and Regulatory Capital
in notes to financial statements.
Prompt
Corrective Regulatory Action. Federal law requires the federal banking agencies to take “prompt corrective action”
should an insured depository institution fail to meet certain capital adequacy standards. Prompt corrective action regulations provide
five capital classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval
is required to accept broker deposits. The OCC is required to take certain supervisory actions against undercapitalized federal savings
associations, the severity of which depends upon the association’s degree of undercapitalization. In addition, numerous mandatory
supervisory actions become immediately applicable to an undercapitalized association, including, but not limited to, increased monitoring
by regulators and restrictions on growth, capital distributions and expansion. The OCC could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Significantly
and undercapitalized associations are subject to additional mandatory and discretionary measures.
Loans
to One Borrower. Federal law provides that federal savings associations are generally subject to the limits on loans to one borrower
applicable to national banks. Subject to certain exceptions, a federal savings association may not make a loan or extend credit to a
single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal
to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral.
Standards
for Safety and Soundness. As required by statute, the federal banking agencies have adopted Interagency Guidelines prescribing
Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use
to identify and address problems at insured depository institutions before capital becomes impaired. If the OCC determines that a federal
savings association fails to meet any standard prescribed by the guidelines, the OCC may require the institution to submit an acceptable
plan to achieve compliance with the standard.
Limitation
on Capital Distributions. OCC regulations impose limitations upon all capital distributions by a federal savings association,
including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger.
Under the regulations, an application to and the prior approval of the OCC is required before any capital distribution if, among other
circumstances the association will not remain an “eligible” savings association (i.e., generally, well capitalized
and with examination and Community Reinvestment Act ratings in the two top categories), the total capital distributions for the calendar
year exceed net income for that year plus the amount of retained net income for the preceding two years, Federal savings association
is directly or indirectly controlled by a mutual savings and loan holding company or the distribution would otherwise be contrary to
a statute, regulation or agreement with the. In addition, the federal savings association must provide 30 days prior notice to the Federal
Reserve Board of the capital distribution if, like First Federal of Hazard and First Federal of Kentucky, it is a subsidiary of a holding
company. If First Federal of Hazard’s or First Federal of Kentucky’s capital were ever to fall below its regulatory requirements
or the OCC notified it that it was in need of increased supervision, its ability to make capital distributions could be restricted. In
addition, the OCC could prohibit a proposed capital distribution that would otherwise be permitted by the regulation, if the agency determines
that such distribution would constitute an unsafe or unsound practice.
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Qualified
Thrift Lender Test. Federal law requires federal savings associations to meet a qualified thrift lender test. Under the test,
a federal savings association is required to either qualify as a “domestic building and loan association” under the Internal
Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to 20%
of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain “qualified
thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities, education
loans, credit card loans and small business loans) in at least 9 months out of each 12-month period.
A
savings association that fails the qualified thrift lender test is immediately subject to certain operating restrictions, including restrictions
on new activities, branching and the payment of dividends. The Dodd-Frank Act also specifies that failing the qualified thrift lender
test is a violation of law that could result in an enforcement action. Failure to correct the violation within 12 months will cause the
association’s savings and loan holding company to register as and be deemed a bank holding company. At June 30, 2021, First Federal
of Hazard and First Federal of Kentucky were in compliance with the qualified thrift lender test in each of the prior 12 months.
Transactions
with Related Parties. Federal law limits the authority of First Federal of Hazard and First Federal of Kentucky to lend to, and
engage in certain other transactions (collectively, “covered transactions”), with “affiliates” (e.g.,
any company that controls or is under common control with an insured depository institution, including Kentucky First, First Federal
MHC and their non-savings institution subsidiaries). The aggregate amount of covered transactions with any individual affiliate is limited
to 10% of the capital and surplus of the savings association. The aggregate amount of covered transactions with all affiliates is limited
to 20% of the savings association’s capital and surplus. Loans and other specified transactions with affiliates are required to
be secured by collateral in an amount and of a type described in federal law. The purchase of low-quality assets from affiliates is generally
prohibited. Transactions with affiliates must be on terms and under circumstances that are at least as favorable to the association as
those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings associations are prohibited
from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no federal savings
association may purchase the securities of any affiliate other than a subsidiary. Transactions between sister depository institutions
that are 80% or more owned by the same holding company are exempt from the quantitative limits and collateral requirements.
The
Sarbanes-Oxley Act of 2002 generally prohibits a company from making loans to its executive officers and directors. However, that law
contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal
banking laws. Under such laws, First Federal of Hazard’s and First Federal of Kentucky’s authority to extend credit to executive
officers, directors and 10% shareholders (“insiders”), as well as entities such persons control, is limited. The law restricts
both the individual and aggregate amount of loans First Federal of Hazard and First Federal of Kentucky may make to insiders based, in
part, on First Federal of Hazard’s and First Federal of Kentucky’s respective capital positions and requires certain board
approval procedures to be followed. Such loans must be made on terms, including rates and collateral, substantially the same as, and
follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated
persons and that do not involve more than the normal risk of repayment or any other unfavorable features. There are additional restrictions
applicable to loans to executive officers.
Enforcement.
The OCC has primary enforcement responsibility over federal savings associations and has the authority to bring actions against
the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly
or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement actions may
range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to appointment of a
receiver or conservator or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000
per day, or even $1 million per day in especially egregious cases. The FDIC has authority to recommend to the OCC that enforcement action
to be taken with respect to a particular savings association. If action is not taken by the OCC, the FDIC has authority to take such
action under certain circumstances. Federal law also establishes criminal penalties for certain violations of law.
Assessments.
Federal savings associations pay assessments to the OCC to fund its operations. The general assessments, paid on a semi-annual
basis, are based upon the savings association’s total assets, including consolidated subsidiaries, its financial condition and
the complexity of its portfolio.
11
Insurance
of Deposit Accounts. The deposits of both First Federal of Hazard and First Federal of Kentucky are insured up to applicable
limits by the DIF administered by the FDIC. Deposit insurance per account owner is currently $250,000. Under the FDIC’s risk-based
assessment system, insured depository are assigned a risk category based on supervisory evaluations, regulatory capital levels and certain
other factors. An institution’s assessment rate depends upon the category to which it is assigned, and certain adjustments specified
by FDIC regulations. Institutions deemed less risky pay lower assessments. The FDIC may adjust the scale uniformly, except that no adjustment
can deviate more than two basis points from the base scale without notice and comment. No institution may pay a dividend if in default
of the federal deposit insurance assessment. Assessment rates currently range from 1.5 to 30 basis points of total average assets (excluding
PPP loans) less average tangible equity.
The
FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect
on the operating expenses and results of operations of the Banks. Management cannot predict what insurance assessment rates will be in