10-K 1 ffky10k02.txt FFKY FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 2002. OR [ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to ___________ Commission File Number: 0-18832 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) KENTUCKY 61-1168311 -------------------------------------------- ------------------- (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No.) 2323 RING ROAD, ELIZABETHTOWN, KENTUCKY 42701 ---------------------------------------- --------- (Address of principal executive offices) Zip Code Registrant's telephone number, including area code: (270) 765-2131 -------------- Securities registered pursuant to Section 12(b) of the Act: NONE ---- Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $1.00 PER SHARE (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days. Yes X No ___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the outstanding voting stock held by non-affiliates of the registrant, based on the closing sales price of the Registrant's Common Stock as quoted on The NASDAQ National Market on September 16, 2002, was $62,171,384. Solely for purposes of this calculation, the shares held by directors and executive officers of the registrant and by any stockholder beneficially owning more than 5% of the registrant's outstanding common stock are deemed to be shares held by affiliates. As of September 16, 2002, there were issued and outstanding 3,660,275 shares of the registrant's common stock, of which directors and executive officers held 634,839 shares and more than 5% beneficial owners held 199,464 shares. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Registrant's Definitive Proxy Statement for the 2002 Annual Meeting of Shareholders to be held November 13, 2002 are incorporated by reference into Part III. 1 PART I PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS Statements by First Federal Financial Corporation of Kentucky (the "Corporation") contained in "Item 1--Business," "Item 7--Management's Discussion and Analysis of Financial Condition and Results of Operations," and other sections of this report that are not statements of historical fact constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. In addition, the Corporation may make forward-looking statements in future filings with the Securities and Exchange Commission, in press releases, and in oral and written statements made by or with the approval of the Corporation. Forward-looking statements include, but are not limited to: (1) projections of revenues, income or loss, earnings or loss per share, capital structure and other financial items; (2) statements of plans and objectives of the Corporation or its management or Board of Directors; (3) statements regarding future events, actions or economic performance; and (4) statements of assumptions underlying such statements. Words such as "believes," "anticipates," "expects," "intends," "plans," "targeted," and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those indicated by the forword-looking statements. Some of the events or circumstances that could cause such difference include, but are not limited to, changes in economic conditions in the markets served by the Corporation, in Kentucky and the surrounding region, or in the nation as a whole; changes in interest rates; the impact of legislation and regulation; the Corporation's ability to offer competitive banking products and services; competition from other providers of financial services, the continued growth of the markets in which the Corporation operates; and the Corporation's ability to expand into new markets and to maintain profit margins in the face of pricing pressure. All of these events and circumstances are difficult to predict and many of them are beyond the Corporation's control. ITEM 1. BUSINESS THE CORPORATION First Federal Financial Corporation of Kentucky was incorporated in August 1989 under the laws of the Commonwealth of Kentucky for the purpose of becoming the holding company for First Federal Savings Bank of Elizabethtown ("First Federal" or the "Bank"), which became effective on June 1, 1990. Since that date, the Corporation has engaged in no significant activity other than holding the stock of First Federal and operating the business of a savings bank through First Federal. Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to First Federal and its subsidiaries. THE BANK First Federal is a federally chartered savings bank headquartered in Elizabethtown, Kentucky. The business of First Federal consists primarily of attracting deposits from the general public and originating mortgage loans on single-family residences, multi-family housing and commercial property. First Federal also makes home improvement loans, consumer loans, commercial business loans, FHA loans and through its subsidiaries offers insurance products and brokerage services to its customers and makes qualified VA loans for sale to investors on the secondary market. The principal sources of funds for First Federal's lending activities include deposits received from the general public, borrowings from the Federal Home Loan Bank ("FHLB") of Cincinnati, and loan repayments. First Federal's primary sources of income are interest and origination fees on loans and interest on investments such as various federal and government agency obligations and other investment securities permitted by applicable laws and regulations. First Federal's principal expenses are interest paid on deposit accounts and borrowed funds and operating expenses. First Federal was originally founded in 1923 as a state-chartered institution and became federally chartered in 1940. In 1987, the Bank converted to a federally chartered savings bank and converted from mutual to stock form. The Bank is a member of the FHLB of Cincinnati and is subject to regulation, examination and supervision by the Office of Thrift Supervision ("OTS"). The Bank's deposits are insured by the Savings Association Insurance Fund ("SAIF") and administered by the Federal Deposit Insurance Corporation ("FDIC"). 2 The Bank's primary market area consists of six counties in Central Kentucky: Hardin; Hart; Nelson; Bullitt; Meade; and Jefferson. The following table provides demographic and economic information by county:
AVERAGE MEDIAN MEDIAN % BELOW NUMBER UNEMPLOYMENT WEEKLY FAMILY HOME COUNTY POPULATION TREND POVERTY EMPLOYED RATE% TREND WAGE INCOME PRICE ------ ---------- ----- ------- -------- ------------ ----- ------- ------ ------ Hardin 95,070 1.0% 12.4 38,392 6.40 1.2% 527 48,100 86,000 Hart 17,383 (.4)% 22.2 4,317 5.70 1.1% 390 33,400 45,000 Nelson 38,592 3.0% 12.0 13,057 7.00 1.4% 485 48,100 71,375 Bullitt 63,043 3.0% 9.2 11,680 3.50 .5% 450 56,300 93,250 Meade 27,008 2.5% 10.3 3,833 5.00 .7% 473 40,200 70,100 Jefferson 692,910 (.4)% 12.0 438,853 4.00 .4% 642 56,300 102,650
The Bank continues to seek and evaluate additional expansion opportunities, either through the establishment of de novo banking centers and/ or through acquisitions of existing institutions in the financial services industry. The Bank intends to continue to consider various strategic acquisitions of banks or banking assets in those geographical areas that management believes would complement and increase the Bank's existing business lines, or expansion in new market areas or product lines that management determines would be in the best interest of the Bank and its shareholders. LENDING ACTIVITIES GENERAL. The principal lending activity of First Federal is the origination of conventional first mortgage loans secured by residential property. The Bank also engages in commercial real estate, consumer and commercial business lending. Residential mortgage loans made by First Federal are secured primarily by single-family homes and include construction loans. The majority of First Federal's mortgage loan portfolio is secured by real estate located in Hardin, Nelson, Hart, Meade, LaRue and Bullitt counties in the state of Kentucky. The following table presents a summary of the Bank's loan portfolio, net of deferred loan fees, by type for each of the last five years. The Bank has no foreign loans in its portfolio and other than the categories noted, there is no concentration of loans in any industry exceeding 10% of total loans.
JUNE 30, ----------------------------------------------------------------------------------------------- 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT % ------ - ------ - ------ - ------ - ------ - Type of Loan: Real Estate: Residential(1) $308,384 58.86% $328,297 63.12% $308,507 65.16% $297,574 73.94% $282,503 79.18% Construction 10,662 2.03 9,079 1.75 8,975 1.89 11,430 2.84 5,960 1.67 Commercial 112,528 21.48 88,938 17.10 64,828 13.69 32,729 8.13 22,169 6.21 Consumer and home equity 51,797 9.88 54,189 10.42 59,692 12.61 48,281 12.00 45,136 12.65 Indirect consumer 19,640 3.75 21,822 4.20 15,186 3.21 762 .19 - - Commercial, other 20,985 4.00 17,727 3.41 16,295 3.44 11,692 2.90 1,020 .29 -------- ------ ------- ------ -------- ------ -------- ------ -------- ------ Total loans $523,996 100.00% $520,052 100.00% $473,483 100.00% $402,468 100.00% $356,788 100.00% ======== ====== ======== ====== ======== ====== ======== ====== ======== ======
(1) Includes loans held for sale. 3 LOAN MATURITY SCHEDULE. The following table sets forth certain information at June 30, 2002, regarding the dollar amount of loans maturing in the Bank's loan portfolio based on their contractual terms to maturity.
DUE AFTER DUE DURING 1 THROUGH DUE AFTER 5 THE YEAR ENDED 5 YEARS AFTER YEARS AFTER JUNE 30, JUNE 30, JUNE 30, TOTAL 2003 2002 2002 LOANS ---- ---- ---- ----- (DOLLARS IN THOUSANDS) Residential mortgage (1) $ 3,685 $ 30,575 $274,124 $308,384 Real estate construction 8,102 1,300 1,260 10,662 Real estate commercial 12,515 72,969 27,044 112,528 Consumer, home equity and indirect consumer 5,626 65,041 770 71,437 Commercial, other 7,112 12,157 1,716 20,985 ------- -------- -------- -------- Total $37,040 $182,042 $304,914 $523,996 ======= ======== ======== ========
(1) Includes loans held for sale. The following table reflects a breakdown of loans maturing after one year, by fixed and adjustable rates. FLOATING OR FIXED RATES ADJUSTABLE RATES TOTAL ----------- ---------------- ----- (DOLLARS IN THOUSANDS) Residential mortgage (1) $242,725 $ 61,974 $304,699 Real estate construction 1,843 717 2,560 Real estate commercial 74,924 25,089 100,013 Consumer, home equity and indirect consumer 46,460 19,351 65,811 Commercial, other 12,135 1,738 13,873 -------- -------- -------- Total $378,087 $108,869 $486,956 ======== ======== ======== (1) Includes loans held for sale. RESIDENTIAL REAL ESTATE & CONSTRUCTION LENDING. The Bank's primary lending activity is the origination of loans on single-family residences, which consist of one-to-four individual dwelling units. Fixed rate residential real estate loans originated by the Bank have terms ranging from ten to thirty years. Interest rates are competitively priced within the primary geographic lending market, and vary according to the term for which they are fixed. In recent years, the Bank has emphasized the origination of adjustable-rate mortgage loans ("ARMs"). The Bank offers an ARM with an annual adjustment, which is tied to various national indices with a maximum adjustment of 2% annually, and a lifetime cap of 15%. As of June 30, 2002, approximately 20.3% of the Bank's residential real estate loans were adjustable rate loans with adjustment periods ranging from one to five years and balloon loans of seven years or less. The origination of these mortgage loans can be more difficult in a low interest rate environment where there is a significant demand for fixed rate mortgages. The Bank limits the maximum loan-to-value ratio on one-to-four-family residential first mortgages to 90% of the appraised value and generally limits the loan-to-value ratio on second mortgages on one-to-four-family dwellings to 90%. Construction loans involve additional risks as a result of the fact that loan funds are advanced upon the security of the project under construction, which is of uncertain value prior to the completion of construction. Moreover, because of the uncertainties inherent in estimating construction costs, delays arising from labor problems, material shortages, and other unpredictable contingencies, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, and related loan-to-value ratios. The analysis of prospective construction loan projects thus requires an expertise that varies in significant respects from that which is required for permanent residential mortgage lending. 4 The Bank's underwriting criteria is designed to evaluate and minimize the risks of each construction loan. Among other things, the Bank considers evidence of the availability of permanent financing or a takeout commitment to the borrower; the reputation of the borrower and his or her financial condition; the amount of the borrower's equity in the project; independent appraisals and cost estimates; pre-construction sale and leasing information; and cash flow projections of the borrower. COMMERCIAL REAL ESTATE LENDING. First Federal originates loans for small and medium-sized businesses from its various locations. Commercial loans are primarilly real estate secured and are generated at banking centers primarily in the Bank's market area. The Bank makes commercial loans to a variety of industries. Substantially all of the commercial real estate loans originated by First Federal have adjustable interest rates with maturities of 25 years or less or are loans with fixed interest rates and maturities of five years or less. At June 30, 2002, the Bank had $112.5 million outstanding in commercial real estate loans. The security for commercial real estate loans includes retail businesses, warehouses, churches, apartment buildings and motels. The largest commercial real estate loan originated during the June 30, 2002, fiscal year had a balance of $2.2 million. First Federal's commercial real estate lending activities include loans secured by multi-family residential property, consisting of properties with more than four separate dwelling units. These loans amounted to $15.1 million of the loan portfolio at June 30, 2002. First Federal generally does not lend above 75% of the appraised values of multi-family residences on first mortgage loans. The mortgage loans First Federal currently offers on multi-family dwellings are generally one or five year ARMs with maturities of 25 years or less. Commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers and may also involve higher loan principal amounts to collateral values as compared to loans secured by residential real estate. In addition, the payment experience of loans secured by income producing properties is typically dependent on the successful operation of the related real estate project and thus may be more vulnerable to adverse conditions in the real estate market or in the economy generally. CONSUMER LENDING. Federal regulations permit federally chartered thrift institutions to make secured and unsecured consumer loans of up to 35% of their assets. This limit may be exceeded for certain consumer loans, such as home equity loans, property improvement loans, mobile home loans and loans secured by savings accounts. The consumer loans granted by the Bank have included loans on automobiles, boats, recreational vehicles and other consumer goods, as well as loans secured by savings accounts, home improvement loans, and unsecured lines of credit. As of June 30, 2002, consumer loans outstanding were $71.4 million or approximately 13.6% of the Bank's total gross loan portfolio. These loans involve a higher risk of default than loans secured by one-to-four-family residential loans. The Bank believes, however, that the shorter term and the normally higher interest rates available on various types of consumer loans have been helpful in maintaining a profitable spread between the Bank's average loan yield and its cost of funds. The Bank offers a home equity line of credit, which is a revolving line of credit secured by the equity in a customer's home. As of June 30, 2002, these loans totaled $32.1 million. The Bank's underwriting standards reflect that consumer loans are considered to have greater risk of loan losses than residential real estate loans. Among other things, the capacity of individual borrowers to repay can change rapidly, particularly during an economic downturn, collection costs can be relatively higher for smaller loans, and the value of collateral may be more likely to depreciate. The Consumer Lending Policy establishes the appropriate consumer lending authority for all loan officers based on experience, training, and past performance for approving high quality loans. Loans beyond individual authorities must be approved by additional officers, the Executive Loan Committee or the Board of Directors, based on the size of the loan. The Bank requires detailed financial information and credit bureau reports for each consumer loan applicant to establish the applicant's credit history, the adequacy of income for debt retirement, and job stability based on the applicant's employment records. Co-signers are required on applications that are determined marginal for these standards, or that fail to qualify individually. Adequate collateral is required on the majority of consumer loans. The Executive Loan Committee monitors and evaluates unsecured lending activity by each loan officer. In 1999, the Bank developed an indirect consumer loan program. The indirect consumer loan portfolio is comprised of new and used automobile, motorcycle and all terrain vehicle loans originated on the behalf of the Bank by a select group of auto dealers within the service area. Indirect consumer loans are considered to have greater risk of loan losses than direct consumer loans due to, among other things: borrowers may have no existing relationship with the Bank; borrowers may not be residents of the lending area; less detailed financial statement information may be collected at application; collateral values can be more difficult to determine; and the condition of vehicles securing the loan can deteriorate rapidly. To address the additional risks associated with indirect consumer lending, the Executive Loan Committee continually evaluates data regarding the dealers enrolled in the program, including monitoring turn down 5 and delinquency rates. All applications are approved by specific lending officers, selected based on experience in this field, who obtain credit bureau reports on each application to assist in the decision. Aggressive collection procedures encourage more timely recovery of late payments. At June 30, 2002, total loans under the indirect consumer loan program totaled $19.6 million. COMMERCIAL BUSINESS LENDING. The Bank is permitted to make secured and unsecured loans for commercial, corporate, business, and agricultural purposes, including issuing letters of credit and engaging in inventory financing and commercial leasing activities. Commercial loans generally are made to small-to-medium size businesses located within the Bank's defined market area. Commercial loans are considered to involve a higher degree of risk than residential real estate loans. The risks associated with commercial business lending include potentially greater volatility in the value of the assigned collateral, the need for more technical analysis of the borrower's financial position, the potentially greater impact of changing economic conditions may have on the borrower's ability to retire debt, and the additional expertise required for commercial lending personnel. The Bank has developed a new commercial lending policy and hired a Chief Lending Officer to reduce these risks and coordinate the Bank's plans to increase its emphasis on commercial lending. The Chief Lending Officer has developed guidelines for the Bank's lending staff to assist this process. However, commercial loans generally carry a higher yield and are made for a shorter term than real estate loans. Commercial business loans outstanding at June 30, 2002 totaled $21.0 million INVESTMENT SECURITIES Interest on securities provides the largest source of interest income for First Federal after interest on loans, constituting 4.66% of the total interest income for fiscal year 2002. First Federal has the authority to invest in various types of liquid assets, including short-term United States Treasury obligations and securities of various federal agencies, certificates of deposit at insured savings and loans and banks, bankers' acceptances, and federal funds. The Bank may also invest a portion of its assets in certain commercial paper and corporate debt securities. First Federal is also authorized to invest in mutual funds and stocks whose assets conform to the investments that First Federal is authorized to make directly. Securities held-to-maturity decreased in fiscal year 2001 due to redemptions of bonds held in the Bank's investment portfolio. As interest rates declined, these bonds ceased to be an attractive funding vehicle for the issuer and were called for redemption in accordance with their terms. See Note 2 of Notes to Consolidated Financial Statements for further information concerning the Bank's investment portfolio. The following table sets forth the carrying value of the Bank's securities portfolio at the dates indicated. At June 30, 2002, the market value of the Bank's securities portfolio was $23.7 million. AT JUNE 30 ---------------------------------- 2002 2001 2000 ---- ---- ---- (DOLLARS IN THOUSANDS) Securities available-for-sale: Equity securities $ 930 $ 996 $ 1,105 Obligations of states and political Subdivisions 1,048 1,017 943 ----- ------- Total available-for-sale $ 1,978 $ 2,013 $ 2,048 ======= ======= ======= Securities held-to-maturity: U.S. Treasury and agencies $20,964 $19,917 $41,860 Mortgage-backed securities 751 1,004 1,274 ------- ------- ------- Total held-to-maturity $21,715 $20,921 $43,134 ======= ======= ======= The following table sets forth the scheduled maturities, amortized cost, fair value and weighted average yields for the Bank's securities at June 30, 2002. WEIGHTED AMORTIZED FAIR AVERAGE COST VALUE YIELD* ---- ----- ----- (DOLLARS IN THOUSANDS) Securities available-for-sale: Due after one year through five years $ 777 $ 810 4.39% Due after five years through ten years 233 238 4.46 Equity securities 385 930 3.57 ------ ------- Total available-for-sale $1,395 $ 1,978 ====== ======= 6 WEIGHTED AMORTIZED FAIR AVERAGE COST VALUE YIELD* (DOLLARS IN THOUSANDS) Securities held-to-maturity: Due in one year or less $ 1,964 $ 2,000 6.09% Due after one year through five years 15,000 15,020 4.49 Due after ten years 4,000 4,002 5.33 Mortgage-backed securities 751 728 5.24 ------- ------- Total held-to-maturity $21,715 $21,750 ======= ======= *The weighted average yields are calculated on amortized cost on a non tax-equivalent basis. DEPOSITS First Federal attracts both short-term and long-term deposits from the general public by offering a wide range of deposit accounts and interest rates. In recent years the Bank has been required by market conditions to rely increasingly on short-term certificate accounts and other deposit alternatives that are more responsive to market interest rates. The Bank uses forecasts based on interest rate risk simulations to assist management in monitoring the Bank's use of certificates of deposit and other deposit products as funding sources and the impact of their use on interest income and net interest margin in various rate environments. During the fiscal year ended June 30, 2001, the Bank relied on certificates of deposit for much of its funding needs. During that period, the stock market remained an attractive investment option for depositors, and rates being paid by competitors on deposit products had yet to decrease significantly in response to substantial interest rate reductions in 2001. During the fiscal year ended June 30, 2002, equity investments have become much less attractive, resulting in a substantial shift of investment funds from the stock market to deposit products, specifically savings and money market accounts. The steady decline in rates paid on certificates of deposit has led to increased balances for transactional and immediate availability products. To evaluate the funding needs of the Bank in light of deposit trends resulting from these changing conditions, management and Board committees evaluate simulated performance reports that forecast changes in margins. The Bank is offering attractive certificate rates for longer terms to allow the Bank to retain deposit customers and reduce interest rate risk during the current low-rate environment, while protecting the margin when interest rates increase as the economy recovers. First Federal offers statement and passbook savings accounts, NOW accounts, money market accounts and fixed and variable rate certificates with varying maturities. First Federal also offers tax-deferred individual retirement accounts. The flow of deposits is influenced significantly by general economic conditions, changes in interest rates and competition. The Bank relies primarily on customer service and long-standing relationships with customers to attract and retain these deposits; however, market interest rates and rates offered by competing financial institutions significantly affect the Bank's ability to attract and retain deposits. As of June 30, 2002, approximately 41.3% of the Bank's deposits consisted of various savings and demand deposit accounts from which customers are permitted to withdraw funds at any time without penalty. Interest earned on savings accounts is paid from the date of deposit to the date of withdrawal and compounded quarterly. Interest earned on NOW accounts is paid from the date of deposit to the date of withdrawal, compounded and credited monthly. Interest rates paid, maturity terms, service fees and withdrawal penalties are established by management on a periodic basis. First Federal also makes available to its depositors a number of certificates of deposit with various terms and interest rates to be competitive in its market area. These certificates have minimum deposit requirements as well. The variety of deposit accounts by First Federal has permitted it to be more competitive in obtaining funds and has allowed it to respond with more flexibility to the flow of funds away from depository institutions into direct investment vehicles such as government and corporate securities. However, the ability of the Bank to attract and maintain deposits and its cost of funds have been, and will continue to be, significantly affected by market conditions. The holders of the Bank's certificates of deposits in amounts of $100,000 or more are all non-brokered depositors, most of who reside within our service areas. The Bank does not accept brokered deposits, which are funds deposited by an investment dealer on behalf of a third-party investor. The Bank's policy is to maintain certificate of deposit accounts in amounts of $100,000 or more, to the extent practical, only when the depositor uses other bank products to increase the total customer relationship. The objective is to provide the Bank with a stable deposit base of large account balances while increasing the fee income and lower funding costs through other products and services. 7 The following table sets forth the breakdown of the Bank's deposits as of June 30, 2002. DOLLARS IN THOUSANDS PERCENT OF CATEGORY BALANCES DEPOSITS -------- -------- -------- Non-interest bearing demand accounts $ 28,341 5.35% NOW demand accounts 64,479 12.17 Savings accounts 78,143 14.75 Money market deposit accounts 47,936 9.05 Certificates of deposit 274,305 51.77 Individual Retirement Accounts 36,678 6.91 -------- ------ $529,882 100.00% ======== ======= The following table indicates at June 30, 2002 the amount of the Bank's certificates of deposit of $100,000 or more by time remaining until maturity. CERTIFICATES MATURITY PERIOD OF DEPOSIT --------------- ---------- (IN THOUSANDS) Three months or less $ 23,061 Three through six months 8,246 Six through twelve months 28,747 Over twelve months 40,015 -------- Total $100,069 ======== BORROWINGS Deposits are the primary source of funds for First Federal's lending and investment activities and for its general business purposes. The Bank can also use advances (borrowings) from the FHLB of Cincinnati to supplement its supply of lendable funds, meet deposit withdrawal requirements and to extend the term of its liabilities. Advances from the FHLB are secured by the Bank's stock in the FHLB and substantially all of the Bank's first mortgage loans. At June 30, 2002 First Federal had $77.8 million in advances outstanding from the FHLB and the capacity to increase its borrowings an additional $153.7 million. The FHLB of Cincinnati functions as a central reserve bank providing credit for savings banks and certain other member financial institutions. As a member, First Federal is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of its home mortgages and other assets (principally, securities which are obligations of, or guaranteed by, the United States) provided certain standards related to credit-worthiness have been met. For further information, see Note 6 of the Notes to Consolidated Financial Statements in the Annual Report. The following table sets forth certain information regarding the Bank's FHLB advances during the periods indicated. AT JUNE 30, ------------------------------------ 2002 2001 2000 ---- ---- ---- (DOLLARS IN THOUSANDS) Average balance outstanding $77,709 $91,418 $52,419 Maximum amount outstanding at any month-end during the period 80,377 111,026 80,339 Year end balance 77,778 77,298 80,339 Weighted average interest rate: At end of year 4.94% 4.97% 5.44% During the year 4.81% 5.80% 5.34% 8 SUBSIDIARY ACTIVITIES In 1978, the Bank formed First Service Corporation of Elizabethtown ("First Service"). First Service acts as a broker for the purpose of selling mortgage life, credit life and accident and disability insurance to the Bank's customers. In January 1999 First Service entered into a contract with Raymond James Financial Services, Inc. to provide investment services to the Bank's customers in the area of tax-deferred annuities, government securities and stocks and bonds. First Service employs four full-time employees to perform these services. This investment function operates under licenses held by First Service. The net income of First Service was $165,000 during fiscal year 2002. In July 1999, the Bank formed First Heartland Mortgage Company of Elizabethtown ("First Heartland") through which the secondary market lending department originates qualified VA loans on the behalf of the investors, thereby providing necessary liquidity to the Bank and needed loan products to the Bank's customers. The Bank has continued to experience good growth in the level of mortgages being processed by First Heartland. As of June 30, 2002, First Heartland originated $41.5 million in loans on the behalf of investors. The net income of First Heartland Mortgage was $91,000 during fiscal year 2002. COMPETITION First Federal experiences substantial competition both in attracting and retaining deposits and in the making of mortgage and other loans. Direct competition for deposits comes from other savings institutions, commercial banks, and credit unions located in north-central Kentucky. Additional significant competition for deposits comes from money market mutual funds and corporate and government debt securities. The primary factors in competing for loans are interest rates and loan origination fees and the range of services offered by the various financial institutions. Competition for origination of real estate loans normally comes from other savings institutions, commercial banks, mortgage bankers, mortgage brokers, and insurance companies. Retail establishments compete for loans by offering credit cards and retail installment contracts for the purchase of goods and merchandise. First Federal is able to compete effectively in its primary market area. First Federal has offices in nine cities in six contiguous counties. In addition to the financial institutions, which have offices in these counties, First Federal competes with several commercial banks and savings institutions in surrounding counties, many of which have assets substantially greater than First Federal. These competitors attempt to gain market share through their financial product mix, pricing strategies and banking center locations. In addition, Kentucky's interstate banking statute, which permits banks in all states to enter the Kentucky market if they have reciprocal interstate banking statutes, has further increased competition for the Bank. It is anticipated that competition from both bank and non-bank entities will continue to remain strong in the near future. The following table sets forth the Bank's market share and rank in terms of deposits in the Kentucky county where it has offices. The Bank has one office in Jefferson County, which is Louisville, Kentucky, with a population of more than 650,000. NUMBER OF COUNTY INSTITUTIONS FFKY MARKET SHARE % FFKY RANK ------ ------------ ------------------- --------- Hardin 14 18.45 1 Nelson 7 10.37 3 Hart 3 19.45 3 Bullitt 5 16.95 4 Meade 2 55.82 1 Jefferson 1 <1.00 N/M EMPLOYEES As of June 30, 2002, the Bank had 218 employees of which 200 were full-time and 18 part-time. None of the Bank's employees are subject to a collective bargaining agreement and the Bank believes that it enjoys good relations with its personnel. 9 REGULATION GENERAL. As a federally chartered savings association, First Federal is subject to extensive regulation by the OTS. The OTS periodically examines the Bank for compliance with various regulatory requirements and the FDIC also has the authority to conduct special examinations of institutions insured by the SAIF. The Bank must file reports, at least quarterly, with the OTS describing its activities and financial condition. The Bank is also subject to certain reserve requirements promulgated by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). This supervision and regulation is intended primarily for the protection of depositors. FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB System, which consists of 12 regional Federal Home Loan Banks subject to supervision and regulation by the Federal Housing Finance Board. The Federal Home Loan Banks provide a Central Credit facility primarily for member institutions. As a member of the FHLB, the Bank is required to acquire and hold shares of capital stock in the FHLB in an amount at least equal to 1% of the aggregate unpaid principal of its home mortgage loans, home purchase contracts, and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the FHLB, whichever is greater. First Federal was in compliance with this requirement with investment in the FHLB stock at June 30, 2002, of $6.2 million. The FHLB serves as a reserve or central bank for its member institutions within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes advances to members in accordance with policies and procedures established by the FHFB and the Board of Directors of the FHLB. As of June 30, 2002, First Federal had $77.8 million in advances outstanding from the FHLB. For further information regarding advances from the FHLB see Note 6 of the Notes to Consolidated Financial Statements in the Annual Report. QUALIFIED THRIFT LENDER TEST. The Bank is currently subject to the Home Owners' Loan Act, which uses the qualified thrift lender ("QTL") test to determine eligibility for Federal Home Loan Bank advances and for certain other purposes. To qualify as a QTL, a savings association must maintain at least 65% of its "portfolio" assets in qualified thrift investments. Portfolio assets are defined as total assets less goodwill and other intangibles, property used by a savings association in its business and liquidity investments in an amount not exceeding 20% of total assets. Qualified thrift investments consist of: (i) loans, equity positions, or securities related to domestic, residential real estate or manufactured housing, credit card and education loans; (ii) property used by the savings association in the conduct of its business; and (iii) stock in a Federal Home Loan Bank or the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation. Qualified thrift investments may also include liquidity investments and 50% of the dollar amount of residential mortgage loans subject to sale under certain conditions. To qualify as a QTL, a savings association must maintain its status as a QTL on a monthly basis in nine out of every 12 months. Failure to qualify as a QTL results in a number of sanctions, including the imposition of certain operating restrictions imposed on national banks and a restriction on obtaining additional advances from the Federal Home Loan Bank System. Upon failure to qualify as a QTL for two years, a savings association must convert to a commercial bank. At June 30, 2002, approximately 91.60% of the Bank's assets were invested in qualified thrift investments. LENDING LIMITS. Under regulations of the OTS, loans and extensions of credit to a person outstanding at one time and not fully secured cannot exceed 15% of capital and surplus. Loans and extensions of credit fully secured by readily marketable collateral (as defined) may comprise an additional 10% of capital and surplus. At June 30, 2002, the Bank complied with its regulatory lending limits. The aggregate amount of loans a federally chartered savings association may make on the security of liens on non-residential real property may not exceed 400% of the institution's capital, though the Director of OTS has the authority to permit savings associations to exceed the 400% of capital limit in certain circumstances. REGULATORY CAPITAL REQUIREMENTS. OTS regulations require savings associations to satisfy various different capital requirements. Specifically, savings associations must maintain a 6% Tier I leverage ratio, a 6% Tier I risk-based capital ratio and a 10% total risk-based capital ratio to be considered well capitalized. OTS regulations restrict savings associations that have capital below these amounts. As of June 30, 2002, the Bank's ratio of Total risk-based capital to total risk-weighted assets was 11.5%, Tier I capital to total risk-weighted assets was10.6%, and Tier I capital to total average assets was 7.4%. For additional information see Note 9 of the Notes to Consolidated Financial Statements in the Annual Report. For purposes of the OTS's regulatory capital regulations, Tier I capital is defined as common stockholders' equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, minority interests in the equity accounts of fully consolidated subsidiaries, certain nonwithdrawable accounts and pledged deposits and "qualifying supervisory goodwill." Tier I capital is generally reduced by the amount of the savings association's intangible assets for which no market exists. Limited exceptions to the deduction of intangible assets are provided for purchased mortgage servicing rights and qualifying supervisory goodwill held by an eligible savings association. 10 In determining compliance with the risk-based capital requirement, a savings association is allowed to use both Tier 1 capital and supplementary capital provided the amount of supplementary capital used does not exceed the savings association's Tier 1 capital. Supplementary capital is defined to include certain preferred stock issues, nonwithdrawable accounts and pledged deposits that do not qualify as Tier 1 capital; certain approved subordinated debt, certain other capital instruments and a portion of the savings association's general loss allowances. Total Tier 1 and supplementary capital are reduced by an amount equal to the savings association's high loan-to-value ratio land loans and non-residential construction loans and the amount of capital instruments held by other depository institutions pursuant to reciprocal arrangements as well as by an increasing percentage of the savings association's equity investments. The risk-based capital requirement is measured against risk-weighted assets, which equals the sum of each asset and the credit-equivalent amount of each off-balance sheet item after being multiplied by an assigned risk weight. Under the OTS risk-weighted system, one-to four-family first mortgages not more than 90 days past due with loan-to-value ratios under 80% are assigned a risk weight of 50%. Consumer and commercial loans are assigned a risk weight of 100%. Mortgage-backed securities issued, or fully guaranteed as to principal and interest, by the FNMA or FHLMC are assigned a 20% risk weight. Cash and U.S. Government securities backed by the full faith and credit of the U.S. Government are given a 0% risk weight. In determining compliance with capital standards, all of a savings association's investments in, and extensions of credit to, any subsidiary engaged in activities not permissible for a national bank are also to be deducted from the savings association's capital. Certain subsidiaries are exempted from this treatment, including any subsidiary engaged in impermissible activities solely as agent for its customers (unless the FDIC determined otherwise), subsidiaries engaged solely in mortgage banking, and depository institution subsidiaries acquired prior to May 1, 1989. In addition, the capital deduction is not applied to federal savings associations existing as of August 9, 1989 that were either chartered as a state savings bank or state cooperative bank prior to October 10, 1982 or that acquired their principal assets from such an association. At June 30, 2002, the Bank's investment in First Service, a wholly owned subsidiary of the Bank engaged in activities which are not permitted for a national bank, amounted to $788,000. Accordingly, on June 30, 2002, the Bank deducted 100% of this investment from its Tier1 and tangible capital. The OTS risk-based capital requirements require savings institutions with more than a "normal" level of interest rate risk to maintain additional total capital. A savings institution's interest rate risk is measured in terms of the sensitivity of its "net portfolio value" to changes in interest rates. Net portfolio value is defined, generally, as the present value of expected cash inflows from existing assets and off-balance sheet contracts less the present value of expected cash outflows from existing liabilities. A savings institution is considered to have a "normal" level of interest rate risk exposure if the decline in its net portfolio value after an immediate 200 basis point increase or decrease in market interest rates (whichever results in the greater decline) is less than two percent of the current estimated economic value of its assets. A savings institution with a greater than normal interest rate risk is required to deduct from total capital, for purposes of calculating its risk-based capital requirement, an amount (the "interest rate risk component") equal to one-half the difference between the institution's measured interest rate risk and the normal level of interest rate risk, multiplied by the economic value of its total assets. The OTS will calculate the sensitivity of a savings institution's net portfolio value ("NPV") based on data submitted by the institution in a schedule to its quarterly Thrift Financial Report and using the interest rate risk measurement model adopted by the OTS. The amount of the interest rate risk component, if any, for any quarter is based on the institution's Thrift Financial Report filed three quarters earlier. The Bank does not have more than a normal level of interest rate risk under the new rule and is not required to increase its total capital as a result of the rule. Presented below as of June 30, 2002 is an analysis of the Bank's interest rate risk ("IRR") as measured by changes in NPV for instantaneous and sustained parallel shifts of upward 300 basis points to downward 100 basis points in market interest rates. AS OF JUNE 30, 2002 ------------------- NET PORTFOLIO VALUE NPV AS % OF PV OF ASSETS ------------------- ------------------------ IN RATES $ AMOUNT $ CHANGE % CHANGE NPV RATIO CHANGE -------- -------- -------- -------- --------- ------ +300 bp 61,692 (19,365) (24) 9.22 (233 bp) +200 bp 69,604 (11,453) (14) 10.23 (133 bp) +100 bp 76,457 (4,600) (6) 11.05 (50 bp) 0 bp 81,056 11.55 -100 bp 81,635 579 1 11.53 (3 bp) 11 While the Bank complies with its currently applicable capital requirements and expects to continue to comply with the requirements, any failure to comply with the capital requirements in the future would result in severe penalties. In addition to requiring generally applicable capital standards for savings associations, applicable regulations authorize the Director of OTS to establish the minimum level of capital for a savings institution at such amount or at such ratio of capital-to-assets as the Director determines to be necessary or appropriate for such institution in light of the particular circumstances of the institution. The Director of OTS may treat the failure of any savings institution to maintain capital at or above such level as an unsafe or unsound practice and may issue a directive requiring any savings institution, which fails to maintain capital at or above the minimum level, required by the Director to submit and adhere to a plan for increasing capital. Such an order may be enforced in the same manner as an order issued by the FDIC. The OTS staff policies specify that savings institutions failing any one of their minimum regulatory capital requirements may not increase their total assets during any quarter in excess of an amount equal to net interest credited during the quarter. Under these policies, institutions that have submitted capital plans that are rejected by the District Director or that have had capital plans approved but do not meet the targets or requirements of the capital plan may not make any new loans or investments except with the prior written approval of the District Director. Such approval will only be granted when the proposed loan or investment is reasonable in the context of the institution's operations and does not significantly increase the risk profile of the savings institution. The Director of OTS must restrict the asset growth of savings associations not in regulatory capital compliance, subject to a limited exception for growth not exceeding interest credited. In addition, savings associations not in full compliance with applicable capital standards are subject to a capital directive, which may include such restrictions, including restrictions on the payment of dividends and on compensation, as deemed appropriate by the Director of OTS. The Director of OTS must treat as an unsafe and unsound practice any material failure by a savings association to comply with a capital plan or capital directive. The sanctions and penalties that could be imposed range from restrictions on branching or on the activities of the institution, to restrictions on the ability to obtain FHLB advances, to termination of insurance of accounts following appropriate proceedings, to the appointment of a conservator or receiver. PROMPT CORRECTIVE REGULATORY ACTION Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators must take prompt corrective action if an insured depository institution fails to satisfy certain minimum capital requirements. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying any management fees if the institution would thereafter fail to satisfy the minimum levels for any of its capital requirements. An institution that fails to meet the minimum level for any relevant capital measure (an "undercapitalized institution") may be: (i) subject to increased monitoring by the appropriate federal banking regulator; (ii) required to submit an acceptable capital restoration plan within 45 days; (iii) subject to asset growth limits; and (iv) required to obtain prior regulatory approval for acquisitions, branching and new lines of businesses. The capital restoration plan must include a guarantee by the institution's holding company that the institution will comply with the plan until it has been adequately capitalized on average for four consecutive quarters, under which the holding company would be liable up to the lesser of 5% of the institution's total assets or the amount necessary to bring the institution into capital compliance as of the date it failed to comply with its capital restoration plan. A "significantly undercapitalized" institution, as well as any undercapitalized institution that did not submit an acceptable capital restoration plan, may be subject to regulatory demands for recapitalization, broader application of restrictions on transactions with affiliates, limitations on interest rates paid on deposits, asset growth and other activities, possible replacement of directors and officers, and restrictions on capital distributions by any bank holding company controlling the institution. Any company controlling the institution could also be required to divest the institution or the institution could also be required to divest subsidiaries. The senior executive officers of a significantly undercapitalized institution may not receive bonuses or increases in compensation without prior approval and the institution is prohibited from making payments of principal or interest on its subordinated debt. In their discretion, the federal banking regulators may also impose the foregoing sanctions on an undercapitalized institution if the regulators determine that such actions are necessary to carry out the purposes of the prompt corrective action provisions. If an institution's ratio of tangible capital to total assets falls below a "critical capital level," the institution will be subject to conservatorship or receivership within 90 days unless periodic determinations are made that forbearance from such action would better protect the deposit insurance fund. Unless appropriate findings and certifications are made by the appropriate federal bank regulatory agencies, a critically undercapitalized institution must be placed in receivership if it remains critically undercapitalized on average during the calendar quarter beginning 270 days after the date it became critically undercapitalized. 12 Under FDICIA, regulations implementing the prompt corrective action provisions of a depository institution's capital adequacy is measured on the basis of the institution's total risk-based capital ratio (the ratio of its total capital to risk-weighted assets), Tier 1 capital ratio (the ratio of its Tier 1 capital to risk-weighted assets) and leverage ratio (the ratio of its core capital to adjusted total assets). Under the regulations, a savings association that is not subject to an order or written directive to meet or maintain a specific capital level will be deemed "well capitalized" if it also has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based capital ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0% or greater. An "adequately capitalized" savings association is a savings association that does not meet the definition of well capitalized and has: (i) a total risk-based capital ratio of 8.0% or greater; (ii) a Tier 1 capital risk-based ratio of 4.0% or greater; and (iii) a leverage ratio of 4.0% or greater (or 3.0% or greater if the savings association has a composite of 1 MACRO rating). An "undercapitalized institution" is a savings association that has (i) a total risk-based capital ratio less than 8.0%; or (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0% (or 3.0% if the association has a composite 1 MACRO rating). A "significantly undercapitalized" institution is defined as a savings association that has: (i) a total risk-based capital ratio of less than 6.0%; or (ii) a Tier 1 risk-based capital ratio of less than 3.0%; or (iii) a leverage ratio of less than 3.0%. A "critically undercapitalized" savings association defined as a savings association that has a ratio of core capital to total assets of less than 2.0%. The OTS may reclassify a well capitalized savings association as adequately capitalized and may require an adequately capitalized or undercapitalized association to comply with the supervisory actions applicable to associations in the next lower opportunity for a hearing, that the savings association is in an unsafe or unsound condition or that the association has received and not corrected a less-than-satisfactory rating for any MACRO rating category. First Federal is classified as "well capitalized" under these regulations. DEPOSIT INSURANCE Under FDICIA, the FDIC has established a risk-based assessment system for insured depository institutions. Under the system, the assessment rate for an insured depository institution depends on the assessment risk classification assigned to the institution by the FDIC, which will be determined by the institution's capital level and supervisory evaluations. Institutions are assigned to one of three capital groups; well capitalized, adequately capitalized or undercapitalized, based on the data reported to regulators for date closest to the last day of the seventh month preceding the semi-annual assessment period. Within each capital group, institutions are assigned to one of the three subgroups on the basis of supervisory evaluations by the institution's primary supervisory authority and such other information as the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance fund. Subgroup A consists of financially sound institutions with only a few minor weaknesses. Subgroup B consists of institutions that demonstrate weaknesses, which, if not corrected, could result in significant deterioration of the fund. Subgroup C consists of institutions that pose a substantial probability of loss to the deposit insurance fund unless effective corrective action is taken. FEDERAL RESERVE SYSTEM Pursuant to regulations of the Federal Reserve Board, a thrift institution must maintain average daily reserves equal to 3% on the first $51.9 million of transaction accounts, plus 10% on the remainder. This percentage is subject to adjustment by the Federal Reserve Board. Because required reserves must be maintained in the form of vault cash or in a non-interest bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution's interest-earning assets. As of June 30, 2002, a reserve of $5.1 million was required as deposits with the Federal Reserve or as cash on hand. SAVINGS AND LOAN HOLDING COMPANY REGULATIONS. The Corporation is a savings and loan holding company within the meaning of the Home Owners' Loan Act, as amended. As such, it is registered with the OTS and is subject to OTS regulations, examinations, supervision and reporting requirements. As a subsidiary of a savings and loan holding company, First Federal is subject to certain restrictions in its dealings with the Corporation and affiliates thereof. The Home Owners' Loan Act, as amended, generally prohibits a savings and loan holding company, without prior approval of the Director of OTS, from (i) acquiring control of any other savings institution or savings and loan holding company or controlling the assets thereof or (ii) acquiring or retaining more than 5% of the voting shares of a savings institution or holding company thereof which is not a subsidiary. 13 Additionally, under certain circumstances, a savings and loan holding company is permitted to acquire, with the approval of the Director of OTS, up to 15% of previously unissued voting shares of an under-capitalized savings association for cash without that savings association being deemed controlled by the holding company. Except with the prior approval of the Director of OTS, no director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than 25% of such company's stock may also acquire control of any savings institution, other than a subsidiary institution or any other savings and loan holding company. The Bank Holding Company Act of 1956 specifically authorizes the Federal Reserve Board and the Director of the OTS to approve an application by a bank holding company to acquire control of any savings institution. Pursuant to rules promulgated by the Federal Reserve Board, owning, controlling or operating a savings institution is a permissible activity for bank holding companies, if the savings institution engages only in deposit-taking activities and lending and other activities that are permissible for the bank holding companies. In approving such as application, the Federal Reserve Board may not impose any restriction on transaction between the savings institution and its holding company affiliates except as required by Sections 23A and 23B of the Federal Reserve Act. A bank holding company that controls a savings institution may merge or consolidate the assets and liabilities of the savings institution with, or transfer assets and liabilities to, any subsidiary bank, which is a member of the BIF with the approval of the appropriate federal banking agency and the Federal Reserve Board. The resulting bank will be required to continue to pay assessments to the SAIF at the rates prescribed for SAIF members on the deposits attributable to the merged savings institution plus an annual growth increment. Transactions between savings associations and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a savings association is any company or entity, which controls, is controlled by or is under common control with the savings association. In a holding company context, the parent holding company of a savings association (such as the Corporation) and any companies, which are controlled, by such parent holding company are affiliates of the savings association. Generally, Sections 23A and 23B (i) limit the extent to which the savings institution or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such institution's capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus and (ii) require that all such transactions be on terms substantially the same, or at least as favorable, to the institution or subsidiary as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and similar other types of transactions. In addition to the restrictions imposed by Sections 23A and 23B, no savings association may (i) loan or otherwise extend credit to an affiliate, except for any affiliate which engages only in activities which are permissible for bank holding companies, or (ii) purchase or invest in any stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the savings association. Savings associations are also subject to the restrictions contained in Section 22 (h) of the Federal Reserve Act on loans to executive officers, directors and principal shareholders. Under Section 22 (h), loans to an executive officer and to a greater than 10% shareholder of a savings association (18% in the case of institutions located in an area with less than 30,000 in population), and certain affiliated entities of either, may not exceed together with all other outstanding loans to such person and affiliated entities the association's loan to one borrower limit as established by FIRREA (generally equal to 15% of the institution's unimpaired capital and surplus, for loans fully secured by certain readily marketable collateral, an additional 10% of the institution's unimpaired capital and surplus). Section 22(h) also prohibits loans, above amounts prescribed by the appropriate federal banking agency, to directors, executive officers and greater than 10% shareholders of savings association, and their respective affiliates, unless such loan is approved in advance by a majority of the board of directors of the association with any "interested" director not participating in the voting. The Federal Reserve Board has prescribed the loan amount (which includes all other outstanding loans to such person), as to which such prior board of director approval if required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further, the Federal Reserve Board pursuant to Section 22(h) requires that loans to directors, executive officers and principal shareholders be made on terms substantially the same as offered in comparable transactions to other persons. The Board of Directors of the Corporation presently intends to operate the Corporation as a unitary savings and loan holding company. There are generally no restrictions on the activities of a unitary savings and loan company. However, if the Director of OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or 14 stability of its subsidiary savings association, the Director of OTS may impose such restrictions as deemed necessary to address such risk and limiting (i) payment of dividends by the savings association, (ii) transactions between the savings association and its affiliates, and (iii) any activities of the savings association that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings association. Notwithstanding the above rules as to permissible business activities of unitary savings and loan holding companies, if the savings association subsidiary of such a holding company fails to meet (in three out to every four quarters and two out of every three years) the QTL test, see "Qualified Thrift Lender Test" above, then such unitary holding company shall also become subject to the activities restrictions applicable to multiple holding companies (additional restrictions on securing advances from the FHLB also apply). If the Corporation were to acquire control of another savings institution other than through merger or other business combinations with First Federal, the Corporation would thereupon become a multiple savings and loan holding company. Except where such acquisition is pursuant to the authority to approve emergency thrift acquisitions and where each subsidiary savings institution meets the QTL test, the activities of the Corporation and any of its subsidiaries (other than First Federal or other subsidiary savings institutions) would thereafter be subject to further restrictions. The Home Owners' Loan Act, as amended, provides that, among other things, no multiple savings and loan holding company or subsidiary thereof which is not a savings institution shall commence or continue for more than a limited period of time after becoming a multiple savings and loan holding company or subsidiary thereof, any business activity other than (i) furnishing or performing management services for a subsidiary savings institution, (ii) conducting an insurance agency or escrow business, (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary savings institution, (iv) holding or managing properties used or occupied by a subsidiary savings institution, (v) acting as trustee under deeds of trust, (vi) those activities previously directly authorized by the FSLIC by regulations as of March 5, 1987 to be engaged in by multiple holding companies or (vii) those activities authorized by the Federal Reserve Board as permissible for bank holding companies, unless the Director of OTS by regulation prohibits or limits such activities for savings and loan holding companies. Those activities described in (vii) above must also be approved by the Director of OTS prior to being engaged in by a multiple holding company. The Director of OTS may only approve acquisitions resulting in the formation of a multiple savings and loan holding company which controls savings institutions in more than one state, if the multiple savings and loan holding company involved controls a savings institution which operated a home or branch office in the state of the institution to be acquired as of March 5, 1987, or if the laws of the state in which the institution to be acquired is located specifically permit institution to be acquired by state-chartered institutions or savings and loan holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings institutions). The Director of OTS may approve an acquisition resulting in a multiple savings and loan holding company controlling savings institutions in more than one state in the case of certain emergency thrift acquisitions. No subsidiary savings association of a savings and loan holding company may declare or pay a dividend on its permanent or nonwithdrawable stock unless it first gives the Director of OTS 30 day advance notice of such declaration and payment. Any dividend declared during such period or without the giving of such notice shall be invalid. FEDERAL AND STATE TAXATION The Corporation and the Bank currently file consolidated federal income tax returns based on a fiscal year ending June 30. Earnings appropriated to the Bank's bad debt reserve and claimed as a tax deduction will not be allowable for the payment of cash dividends or for distribution to shareholders (including distributions made on dissolution or liquidation), without payment of federal income taxes on such dividends or distributions by the Bank at the then current tax rates on the amount deemed removed to the Bank which would include not only the amount actually distributed, but would also be increased (subject to certain limitations) by the amount of the tax payable by reason of such distribution. The Commonwealth of Kentucky imposes no income tax on savings institutions. Nonetheless, First Federal must pay a Kentucky ad valorem tax. This tax is 1/10th of 1% of First Federals total savings accounts, common stock, capital and retained income with certain deductions for amounts borrowed by depositors and for securities guaranteed by the U.S. Government or certain of its agencies. The Bank's subsidiary must pay a state income tax, as well as a tax on capital. The tax on income is 4% for the first $25,000 of taxable income, 5% for the next $25,000, 6% for the next $50,000, 7% for the next $150,000 and 8.25% for all income over $250,000. The tax on capital is .0021 times the capital employed with a credit of .0014 times the first $350,000 of capital for those corporations with gross income of under $500,000. For information regarding federal income taxes, see Note 8 of the Notes to Consolidated Financial Statements in the Annual Report. 15 ITEM 2. PROPERTIES The Corporation's executive offices, principal support and operational functions are located at 2323 Ring Road in Elizabethtown, Kentucky. All of First Federal's banking centers are located in Kentucky. The location of the 13 banking centers, their form of occupancy and their respective approximate square footage is set forth in the following table. APPROXIMATE OWNED OR SQUARE BANKING CENTERS LEASED FOOTAGE ELIZABETHTOWN 2323 Ring Road Owned 55,000 325 West Dixie Avenue Owned 1,764 101 Wal-Mart Drive Leased 984 RADCLIFF, 475 West Lincoln Trail Owned 2,728 BARDSTOWN 401 East John Rowan Blvd. Leased 4,500 315 North Third Street Owned 1,271 MUNFORDVILLE, 925 Main Street Owned 2,928 SHEPHERDSVILLE, 395 N. Buckman Street Owned 7,600 MT. WASHINGTON, 279 Bardstown Road Owned 2,500 BRANDENBURG 416 East Broadway Leased 4,395 50 Old Mill Road Leased 575 FLAHERTY, 4055 Flaherty Road Leased 1,216 LOUISVILLE, 11901 Standiford Plaza Drive Leased 650 ITEM 3. LEGAL PROCEEDINGS Although the Bank is, from time to time, involved in various legal proceedings in the normal course of business, there are no material pending legal proceedings to which the Corporation, the Bank, or its subsidiaries is a party, or to which any of their property is subject. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended June 30, 2002. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information captioned "MARKET AND DIVIDEND INFORMATION" included in the Corporation's Annual Report to Shareholders for the fiscal year ended June 30, 2002 is incorporated on page 29 of the Form 10-K. The Common Stock of First Federal Financial Corporation of Kentucky is traded over the counter and quoted on The NASDAQ National Market under the symbol "FFKY. It is currently the policy of the Corporation's Board of Directors to continue to pay quarterly dividends, but any future dividends are subject to the Board's discretion based on its consideration of the Corporation's operating results, financial condition, capital, income tax considerations, regulatory restrictions and other factors. 16 ITEM 6. SELECTED FINANCIAL DATA The information captioned "Selected Consolidated Financial and Other Data" included in the Corporation's Annual Report to Shareholders for the fiscal year ended June 30, 2002 is incorporated on page 18 of the Form 10-K. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Corporation's Annual Report to Shareholders for the fiscal year ended June 30, 2002 is incorporated on pages 19-29 of the Form-10-K. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information included under the caption "ASSET/LIABILITY MANAGEMENT AND MARKET RISK" included in the Corporation's Annual Report to Shareholders for the fiscal year ended June 30, 2002 is incorporated on pages 27-28 of the Form 10-K. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY TABLE OF CONTENTS Selected Consolidated Financial and Other Data 18 Management Discussion & Analysis 19-29 Audited Consolidated Financial Statements: o Report of Independent Auditors 30 o Consolidated Statements of Financial Condition 31 o Consolidated Statements of Income 32 o Consolidated Statements of Comprehensive Income 33 o Consolidated Statements of Changes in Stockholders' Equity 34 o Consolidated Statements of Cash Flows 35 o Notes to Consolidated Financial Statements 36-53 17 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
AT JUNE 30, 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- FINANCIAL CONDITION DATA: (Dollars in thousands) Total assets $679,110 $606,726 $560,785 $488,304 $409,651 Net loans outstanding (1) 520,261 517,145 471,231 400,360 354,935 Interest bearing deposits 64,000 - - - - Investments 23,693 22,934 45,182 47,340 26,574 Deposits 529,882 468,825 423,759 399,443 306,703 Borrowings 87,493 77,298 80,339 25,894 43,249 Stockholders' equity 58,615 54,592 51,681 57,862 54,688 Number of: Real estate loans outstanding 7,577 7,618 7,154 6,968 6,709 Deposit accounts 49,726 49,615 47,238 45,425 37,764 Offices 13 13 13 12 8 Full time equivalent employees 227 203 170 155 110
YEAR ENDED JUNE 30, 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- OPERATIONS DATA: (Dollars in thousands) Interest income $44,100 $45,392 $38,542 $35,496 $31,182 Interest expense 21,426 27,429 20,873 18,481 16,059 Net interest income 22,674 17,963 17,669 17,015 15,123 Provision for loan losses 1,604 1,086 400 314 265 Non-interest income 5,398 5,145 3,877 3,954 2,860 Non-interest expense (2) 15,281 13,570 12,691 11,706 8,082 Income tax expense 3,729 2,803 2,792 2,970 3,302 Net income 7,458 5,649 5,663 5,979 6,334 Earnings per share: Basic 1.99 1.50 1.45 1.45 1.53 Diluted 1.98 1.50 1.44 1.44 1.52 Book value per share 15.72 14.53 13.76 14.04 13.24 Dividends paid per share 0.72 0.72 0.72 0.63 0.56 Dividend payout ratio 36% 48% 49% 43% 37% Return on average assets 1.19% .95% 1.08% 1.25% 1.60% Average equity to average assets 9.10% 8.97% 10.28% 11.85% 13.55% Return on average equity 13.08% 10.62% 10.52% 10.53% 11.81%
(1) Includes loans held for sale. (2) Non-interest expense in 1999 includes one time acquisition and conversion costs in the amount of $789,000, pretax. 18 MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CRITICAL ACCOUNTING POLICIES The accounting and reporting policies of First Federal Financial Corporation of Kentucky are in accordance with accounting principles generally accepted in the United State and conform to general practices within the banking industry. The accounting policy relating to the allowance for loan losses is critical to the understanding of the Corporation's results of operations since the application of this policy requires significant management assumptions and estimates that could result in materially different amounts to be reported if conditions or underlying circumstances were to change. See "ALLOWANCE AND PROVISION FOR LOAN LOSSES" herein for a complete discussion of the First Federal Financial Corporation's accounting methodologies related to the allowance. Also refer to Note 1 in the "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS" for details regarding all of the Corporation's critical and significant accounting policies. The following discussion and analysis covers the primary factors affecting the Corporation's performance and financial condition. It should be read in conjunction with the accompanying audited consolidated financial statements included in this report. OVERVIEW The Bank reported net income of $7.5 million during 2002 compared with $5.6 million for 2001, an increase of 32%. Diluted earnings per share also increased 32% from $1.50 during 2001 to $1.98 for 2002. The increase in earnings for 2002 was primarily attributable to increased net interest income, service charges on deposit accounts and gain on sale of mortgage loans. The Bank's 2001 restructuring of $75 million of its Federal Home Loan Bank advances from overnight to 10-year maturities at lower interest rates coupled with declines in interest rates will continue to have a positive impact on future earnings. The Bank's book value per common share increased from $14.53 at June 30, 2001 to $15.72 at June 30, 2002. Net income for 2002 generated return on average assets of 1.19% and return on average equity of 13.08%. These compare with return on average assets of .95% and return on average equity of 10.62% for the 2001 period. The Bank's total assets at June 30, 2002 grew to $679.1 million compared to $606.7 million at June 30, 2001. The increase in assets was due to the increase in the Bank's interest bearing deposits, a direct result of the growth in retail deposits. Net loans (including loans held for sale) increased $3.1 million from June 30, 2001 to $520.3 million at June 30, 2002. Residential mortgage loans decreased by $21.2 million during the 2002 period as declining market interest rates caused an increase in 1-4 family refinancing activity into fixed-rate, secondary market loan products. The commercial real estate portfolio remained strong, increasing by $23.6 million to $112.5 million at June 30, 2002. This growth is a result of the Bank's continued emphasis on the active pursuit of lending opportunities. Deposits increased by $61.1 million to $529.9 million at June 30, 2002 compared to $468.8 million at June 30, 2001. The growth in retail deposits was primarily in savings and money market accounts caused in part by a shift during recent quarters in funds from the stock market to more conservative investments such as bank deposits. FHLB advances increased from $77.3 million at June 30, 2001 to $77.8 million at June 30, 2002. On March 26, 2002, the Corporation issued $10.0 million of Trust Preferred Securities through First Federal Statutory Trust I, a subsidiary of the Corporation. The Corporation undertook the issuance of these securities to enhance its regulatory capital position. The Corporation intends to utilize the capital for general business purposes and to support the Bank's future opportunities for growth. The Bank experienced remarkable technological innovations during 2002 to improve operating efficiency and to enhance customer service. The Bank implemented a check imaging service for its customers. Imaged checks are also integrated with the Bank's internet banking service to allow customers the benefit of reviewing their canceled checks online. Customers also have the option of receiving their bank statements through e-mail, a service delivery improvement to the customer and an operational efficiency to the Bank. "Powerdraft", an overdraft privilege plan, was introduce in February 2002, and has been widely accepted by the Bank's retail customer base. 19 For the past four years, the Bank has implemented the strategic goal of transitioning to a commercial bank by making operational enhancements, expanding its product mix, and developing a sales-oriented culture. Total assets grew in response to increased commercial and consumer lending using a variety of new product lines. For fiscal year 2001, increased interest rates created margin decreases due to the Bank's substantial balances in fixed rate mortgages. Additional margin pressures resulted from increased deposit and wholesale funding rates. The restructuring of the Bank's loan portfolio had not yet positioned the Bank to absorb the higher rates. During the same period, new deposit products were developed to attract more transactional, low-cost customers. The Bank continued to offer higher certificate of deposit rates from time to time to retain deposits for funding loan growth and maintaining market share in our service areas. The Bank's strategy has been to offer higher rates on certificates of deposit as a means to cross-sell additional products and services that would eventually provide fee income and low yielding deposit accounts. RESULTS OF OPERATIONS NET INTEREST INCOME - The principal source of the Bank's revenue is net interest income. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities and the interest expense on liabilities used to fund those assets, such as interest-bearing deposits and borrowings. Net interest income is impacted by both changes in the amount and composition of interest-earning assets and interest-bearing liabilities as well as market interest rates. For 2002, net interest income was $22.7 million, up $4.7 million from the $18.0 million attained during 2001. The Bank was able to increase its net interest income through an improved interest rate margin compared to 2001. The Bank's net interest margin increased from 3.22% during 2001 to 3.83% for the 2002 period. The net interest rate spread increased from 2.81% during 2001 to 3.48% in 2002. The net interest spread and margin benefited from a significant decline in the Bank's cost of funds due to a reduction in short-term market interest rates by the Federal Reserve which occurred principally during calendar 2001. Substantially all categories of interest income and interest expense declined as a result, but more so with interest-bearing liabilities. During the 2002 period, average interest-earning assets were $593.4 million, an increase of $35.7 million over the same period in 2001. Total average interest bearing liabilities increased from $514.8 million during 2001 to $540.9 million for the same period in 2002. The 2002 period includes Trust Preferred Securities which were issued in March 2002. For 2001, net interest income increased by $293,000 to $18.0 million as compared to $17.7 million in 2000 in spite of a declining net interest margin. The Bank's net interest margin declined to 3.22% for the year ended June 30, 2001 compared to 3.61% for the 2000 period. An increase in the cost of funds over the past fiscal year, offset by an increase in the average earning assets of commercial real estate and residential mortgage loans, reduced the net interest margin. Average interest earning assets increased by $68.2 million from $489.5 million for the 2000 period to $557.7 million for the 2001 period due to the large growth of the Bank's loan portfolio. Average loans, which comprise 90% of the total interest earning assets, were $66.8 million higher and averaged $504.4 million during 2001, while the average yield on loans increased by 26 basis points to 8.33%. Average interest-bearing liabilities increased by $68.1 million to an average balance of $514.8 million for 2001. Customer deposits averaged $423.4 million during 2001, a $29.1 million increase from the 2000 average balance of $394.3 million. Average Federal Home Loan Bank advances increased $39.0 million for the 2001 period to fund the Bank's increased lending activity that exceeded its deposit growth during certain periods throughout the year. The Bank's cost of funds averaged 5.33% during 2001 which was an increase of 66 basis points from the 2000 average cost of funds of 4.67% due to higher rates paid on short-term customer deposits. 20 AVERAGE BALANCE SHEET The following table sets forth information relating to the Bank's average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated. Dividing income or expense by the average monthly balance of assets or liabilities, respectively, derives such yields and costs for the periods presented.
YEAR ENDED JUNE 30, ------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) 2002 2001 2000 ---- ---- ---- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE ASSETS BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST ------- -------- ---------- ------- -------- ---------- ------- -------- ---------- Interest earning assets: Equity securities $ 952 $ 34 3.57% $ 1,005 $ 34 3.38% $ 1,432 $ 43 3.00% State and political subdivision securities (1) 1,022 71 6.95 980 67 6.84 960 67 6.98 U.S. Treasury and agencies 10,741 589 5.48 37,207 2,552 6.86 41,507 2,711 6.53 Mortgage-backed securities 854 54 6.32 1,115 83 7.44 1,403 93 6.63 Loans receivable (2) (3) (4) 523,559 42,045 8.03 504,404 41,996 8.33 437,640 35,317 8.07 FHLB stock 5,995 325 5.42 5,257 385 7.32 3,354 237 7.07 Interest bearing deposits 50,260 1,006 2.00 7,736 297 3.84 3,221 97 3.01 ------- ------ ---- ------- ------ ---- ------- ------ ---- TOTAL INTEREST EARNING ASSETS 593,383 44,124 7.44 557,704 45,414 8.14 489,517 38,565 7.88 ------ ---- ------ ---- ------ ---- Less: Allowance for loan losses (3,273) (2,537) (2,221) Non-interest earning assets 36,371 37,457 36,383 -------- -------- -------- TOTAL ASSETS $626,481 $592,624 $523,679 ======== ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Interest bearing liabilities: Savings accounts $ 54,165 $ 1,190 2.20% $33,964 $ 925 2.72% $ 36,115 $ 1,047 2.90% NOW and money market accounts 97,339 1,764 1.81 79,792 2,161 2.71 78,222 1,871 2.39 Certificates of deposit and other time deposits 308,747 14,585 4.72 309,651 19,039 6.15 279,941 15,155 5.41 FHLB Advances 77,709 3,741 4.81 91,418 5,304 5.80 52,419 2,800 5.34 Trust Preferred Securities 2,987 146 4.89 - - - - - - ------- ----- ---- ------- ------ ---- ------- ------ ---- TOTAL INTEREST BEARING LIABILITIES 540,947 21,426 3.96 514,825 27,429 5.33 446,697 20,873 4.67 ------ ---- ------ ---- ------ ---- Non-interest bearing liabilities: Non-interest bearing deposits 22,996 18,427 16,896 Other liabilities 5,531 6,195 6,231 ------ ----- ----- TOTAL LIABILITIES 569,474 539,447 469,824 Stockholders' equity 57,007 53,177 53,855 ------- ------- ------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $626,481 $592,624 $523,679 ======= ======== ======== NET INTEREST INCOME $22,698 $17,985 $17,692 ======= ======= ======= NET INTEREST SPREAD 3.48% 2.81% 3.21% ===== ===== ===== NET INTEREST MARGIN 3.83% 3.22% 3.61% ===== ===== ===== Ratio of average interest earning assets to average interest bearing liabilities 109.69% 108.33% 109.59% ======= ======= =======
-------------------------------------------------- (1) Taxable equivalent yields are calculated assuming a 34% federal income tax rate. (2) Includes loan fees, immaterial in amount, in both interest income and the calculation of yield on loans. (3) Calculations include non-accruing loans in the average loan amounts outstanding. (4) Includes loans held for sale. 21 RATE/VOLUME ANALYSIS The table below sets forth certain information regarding changes in interest income and interest expense of the Bank for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (change in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.
YEAR ENDED JUNE 30, ---------------------------------------------------------------------------------------------- 2002 VS. 2001 2001 VS. 2000 2000 VS. 1999 INCREASE (DECREASE) INCREASE (DECREASE) INCREASE (DECREASE) DUE TO CHANGE IN DUE TO CHANGE IN DUE TO CHANGE IN NET NET NET RATE VOLUME CHANGE RATE VOLUME CHANGE RATE VOLUME CHANGE ---- ------ ------ ---- ------ ------ ---- ------ ------ (DOLLARS IN THOUSANDS) INTEREST INCOME: Equity securities $ 2 $ (2) $ - $ 5 $(14) $ (9) $ 26 $ (11) $ 15 State and political subdivision securities 1 3 4 (1) 1 - 1 (2) (1) U.S. Treasury and agencies (432) (1,531) (1,963) 131 (290) (159) (86) 67 (19) Mortgage-backed securities (11) (18) (29) 11 (21) (10) (5) (26) (31) Loans (1,517) 1,566 49 1,150 5,529 6,679 (750) 4,171 3,421 FHLB stock (109) 49 (60) 9 139 148 2 19 21 Interest bearing deposits (205) 914 709 33 167 200 (147) (213) (360) ------- ------ ------- ------ ------ ------ ------- ------ ------- TOTAL INTEREST EARNING ASSETS $(2,271) $ 981 $(1,290) $1,338 $5,511 $6,849 $ (959) $4,005 $3,046 ======= ====== ======= ====== ====== ====== ======= ====== ====== INTEREST EXPENSE: Savings accounts $ (205) $ 470 $ 265 $ (62) $ (60) $ (122) $ 126 $ (63) $ 63 NOW and money market accounts (809) 412 (397) 252 38 290 216 133 349 Certificates of deposit and other time deposits (4,399) (55) (4,454) 2,180 1,704 3,884 (246) 727 481 FHLB advances (831) (732) (1,563) 260 2,244 2,504 (44) 1,543 1,499 Trust preferred securities - 146 146 - - - - - - ------- ------ ------- ------ ------ ------ ---- ------ ------ TOTAL INTEREST BEARING LIABILITIES $(6,244) $ 241 $(6,003) $2,630 $3,926 $6,556 $ 52 $2,340 $2,392 ======= ====== ======= ====== ====== ====== ======= ====== ====== NET INTEREST INCOME $ 3,973 $ 740 $ 4,713 $(1,292) $1,585 $ 293 $(1,011) $1,665 $ 645 ======= ====== ======= ======= ====== ====== ======= ====== ======
NON-INTEREST INCOME - Non-interest income was $5.4 million during 2002, $5.1 million during 2001, and $3.9 million during 2000. The increased level of non-interest income during 2002 was primarily due to increased service fees on deposit accounts and to a lesser extent, gain on sale of mortgage loans. The increase from 2000 to 2001 occurred in all categories with the most significant increases in service fees on deposit accounts and gains from investment sales. Service charges on deposit accounts increased by $715,000 or 28% during 2002 due to growth in fee-related customer transactions and growth in deposits, a result of the general shift in funds from the stock market to bank deposits. Service charges on deposit accounts were positively affected by the Bank's new "Powerdraft" program. The "Powerdraft" program permits selected clients to overdraft their accounts up to $600 for the Bank's customary fee. At June 30, 2002, the Bank had nearly 14,000 accounts eligible for the "Powerdraft" program. 22 Gain on sale of mortgage loans increased by $125,000 or 24% for 2002 compared to 2001 as declining market interest rates prompted an increase in consumer refinance activity of 1-4 family fixed-rate residential loans, which the Bank sells into the secondary market through its subsidiary, First Heartland Mortgage Company. Mortgage banking income is dependent upon loan demand and refinance volume which management anticipates will continue at or near current levels for at least the next quarter. During 2002 the Bank did not report any gains from investment sales compared to reported gains of $696,000 for 2001. Income from brokerage commissions and insurance sales decreased $96,000 as a result of a decline in demand for these products. The increase in non-interest income from 2000 to 2001 was $1.3 million or 33%. Gains from investment sales were $696,000 in 2001 compared to $457,000 for 2000, an increase of $239,000. Gains on sale of mortgage loans increased by $172,000 or 48% during the fiscal year due to increased refinancing activity. Customer service fees charged on deposit accounts increased by $610,000 or 31% during 2001 due to several operational changes made by the Bank, the most significant of which was an increase in overdraft fees from $20 to $25 per occurrence. Commercial checking accounts became subject to fees assessed on the basis of account analysis. Insufficient funds, foreign ATM transactions, returned checks, and daily overdraft fees were all increased during 2001. Brokerage and insurance commissions increased by $175,000 or 38% during the 2001 period due as a result of increased demand and an improved emphasis on insurance sales within the Bank's lending area. Other sources of income such as trust, and other customer transaction fees also increased during the 2001 period by $104,000. NON-INTEREST EXPENSE - Non-interest expense increased by $1.7 million or 13% during 2002 compared to 2001. Significant factors impacting this increase included an increase in staffing levels, increased marketing efforts for the Bank's promotional products as well as increases in other expense. Non-interest expense increased from $12.7 million in 2000 to $13.6 million in 2001. The increase in 2001 was primarily attributable to compensation and employee benefits. Moderate increases in non-interest expense are likely to continue going forward as the Bank anticipates future remodeling and expansion of its banking centers. Non-interest expense levels are often measured using an efficiency ratio (non-interest expense divided by the sum of net interest income and non-interest income). A lower efficiency ration is indicative of higher bank performance. The Bank's efficiency ratio was 54% in 2002 compared to 59% in 2001 and 59% in 2000. Employee compensation and benefits increased $845,000 or 13% for 2002. The increase reflects growth in the overall staffing level from 203 full-time equivalent employees at June 30, 2001 to 227 at June 30, 2002. The Bank's continued emphasis on building its commercial and retail staff to reflect its commercial bank philosophy was the largest contributing factor. Marketing and advertising costs increased during 2002 by $107,000 or 21%. The increase is attributable to the Bank's television marketing campaign for the "Simply Free Checking" product, enhanced marketing for the Bank's new "Powerdraft" program and the Bank's commercial business campaign. Data processing costs increased during 2002 by $125,000 or 9%. The increase reflects the implementation of the Bank's cash management product, internet banking, the creation of the Bank's new imaging department and processor charges relating to an increase in the number of users. The remainder of non-interest expense categories increased by a net of $556,000 or 23% during 2002. The increase is primarily attributable to increases in costs associated with the new "Powerdraft" program, costs associated with postage, stationary and supplies and other customer account expenses. The increase in non-interest expense from 2000 to 2001 was primarily related to employee compensation and benefits. The increase includes inflationary salary adjustments and reflects growth in the overall staffing level from 170 at June 30, 2000, to 203 at June 30, 2001. Additional staffing was required to achieve a new strategic plan adopted by the Bank in 1999 to develop a bank-wide service and sales culture. The plan emphasizes expanding account relationships, which requires increasing the number of associates in banking centers, relationship bankers, business development officers, stockbrokers, and loan officers. The transition has been responsible for much of the renewed growth in lending and certificates of deposit. Office occupancy and equipment expense increased by $94,000 in 2001 compared to 2000 due to costs associated with the Bank's new Customer Service Center, which became operational in July 2000 and the second Bardstown, Kentucky banking center, which reopened in early 2000. 23 ALLOWANCE AND PROVISION FOR LOAN LOSSES The allowance for loan losses is evaluated quarterly by the Executive Loan Committee and maintained at a level that is considered sufficient to absorb probable incurred credit losses existing in the loan portfolio. Periodic provisions to the allowance are made as needed. An appropriate level of the general allowance is determined based on the application of loss percentages to graded loans by categories. In addition, specific reserves are established for individual loans when deemed necessary. The amount of the provision for loan losses necessary to maintain an adequate allowance is based upon an analysis of various factors, including changes in lending policies and procedures; underwriting standards; collection; charge-off and recovery history; changes in national and local economic business conditions and developments; changes in the characteristics of the portfolio; ability and depth of lending management and staff; changes in the trend of the volume and severity of past due, non-accrual and classified loans; troubled debt restructuring and other loan modifications; and results of regulatory examinations. The methodology for allocating the allowance for loan and lease losses has taken into account the Bank's strategic plan to increase its emphasis on commercial and consumer lending. The Bank has increased the amount of the reserve allocated to commercial in 2002 and consumer loans in 2001 in response to the growth of the commercial and consumer loan portfolios and management's recognition of the higher risks and loan losses in these lending areas. The indirect consumer loan program was a new product in 1999 and is comprised of new and used automobile, motorcycle and all terrain vehicle loans originated on the behalf of the Bank by a select group of auto dealers within the service area. The indirect loan program involves a greater degree of risk and is evaluated quarterly and monitored by the Board of Directors. In light of the greater charge-offs from indirect consumer loans compared to direct consumer loans, proportionally more of the allowance for consumer loans is allocated for indirect loans than direct loans. As the indirect loan program has evolved, dealer analysis and underwriting standards have been refined to improve the loan loss experience of the program. Estimating the reserve is a continuous process. In this regard, the Executive Loan Committee continues to monitor the performance of indirect consumer loans as well as the Bank's other loan products and updates its estimates as the evidence warrants. The following table sets forth an analysis of the Bank's loan loss experience for the periods indicated.
YEAR ENDED JUNE 30, (DOLLARS IN THOUSANDS) 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- Balance at beginning of period $2,906 $2,252 $2,108 $1,853 $1,715 ------ ------ ------ ------ ------ Loans charged-off: Real estate mortgage 25 2 36 42 16 Consumer 635 482 147 248 132 Commercial 256 15 82 - - --- --- --- --- --- Total charge-offs 916 499 265 290 148 --- --- --- --- --- Recoveries: Real estate mortgage 6 4 1 5 - Consumer 97 63 8 21 21 Commercial 38 - - - - Total recoveries 141 67 9 26 21 --- --- --- --- --- Net loans charged-off 775 432 256 264 127 --- --- --- ---- --- Acquired reserves - - - 205 - Provision for loan losses 1,604 1,086 400 314 265 ----- ----- --- --- --- Balance at end of period $3,735 $2,906 $2,252 $2,108 $1,853 ====== ====== ====== ====== ====== Allowance for loan losses to net loans .72% .56% .48% .52% .52% Net charge-offs to average loans outstanding .15% .09% .06% .07% .04% Allowance for loan losses to total non-performing loans 100% 88% 130% 68% 87%
24 The provision for loan losses was $1.6 million during 2002 compared to $1.1 million during 2001. The total allowance for loan losses increased $829,000 to $3.7 million from June 30, 2001 to June 30, 2002. Management increased the provision and allowance for loan losses due to the increase in non-performing loans and charge-offs for the period, continued strong growth in commercial real estate lending and the increase in charge-offs and non-performing loans which is commensurate with the generally recognized slowing in the U.S. economy. Net loan charge-offs increased $343,000 to $775,000 during 2002 compared to $432,000 during 2001. The increase in charge-offs is primarily related to charge-offs of indirect consumer loans and commercial real estate loans during the 2002 period. The following table shows management's allocation of the allowance for loan losses by loan type. Allowance funding and allocation is based on management's current evaluation of risk in each category, economic conditions, past loss experience, loan volume, past due history and other factors. Since these factors and management's assumptions are subject to change, the allocation is not necessarily predictive of future portfolio performance.
2002 2001 2000 ---- ---- ---- AMOUNT OF PERCENT OF AMOUNT OF PERCENT OF AMOUNT OF PERCENT OF ALLOWANCE TOTAL LOANS ALLOWANCE TOTAL LOANS ALLOWANCE TOTAL LOANS (DOLLARS IN THOUSANDS) Residential mortgage $ 738 61% $ 884 65% $1,116 67% Consumer 930 14 953 15 603 16 Commercial 2,067 25 1,069 20 533 17 ------ --- ------ --- ------ --- Total $3,735 100% $2,906 100% $2,252 100% ====== === ====== === ====== ===
Federal regulations require insured institutions to classify their own assets on a regular basis. The regulations provide for three categories of classified loans -- substandard, doubtful and loss. The regulations also contain a special mention and a specific allowance category. Special mention is defined as loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management's close attention. Specific allowance is defined as loans for which the Bank has designated specific reserves to cover specifically identified losses. Assets classified as substandard or doubtful require the institution to establish general allowances for loan losses. If an asset or portion thereof is classified as loss, the insured institution must either establish specified allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge off such amount. At June 30, 2002, on the basis of management's review of the Bank's loan portfolio, the Bank had $3.5 million of assets classified substandard, $206,000 classified as specific allowance, and $100,000 of assets classified as loss. There were no assets classified as doubtful. Classified loan ranges of estimated loss are as follows: Substandard-2.5% to 35%; Doubtful-5% to 50%; Loss-100%; Special Mention-2% to 6%; and Specific Allowance-50% to 100%. The Bank additionally provides a reserve estimate for incurred losses in non-classified loans ranging from .20% to 2.00%. Allowance estimates are developed by the Bank in consultation with regulatory authorities, actual loss experience and peer group loss experience and are adjusted for current economic conditions. Allowance estimates are considered a prudent measurement of the risk of the Bank's loan portfolio and are applied to individual loans based on loan type. NON-PERFORMING ASSETS Non-performing assets consist of loans on which interest is no longer accrued, real estate acquired through foreclosure and repossessed assets. The Bank does not have any loans greater than 90 days past due still on accrual. All loans considered impaired under SFAS 114 are included in non-performing loans. Loans are considered impaired if full principal or interest payments are not anticipated in accordance with the contractual loan terms. Impaired loans are carried at the present value of expected future cash flows discounted at the loans effective interest rate or at the fair value of the collateral if the loan is collateral dependent. 25 Loans are reviewed on a regular basis and normal collection procedures are implemented when a borrower fails to make a required payment on a loan. If the delinquency on a mortgage loan exceeds 90 days and is not cured through normal collection procedures or an acceptable arrangement is not worked out with the borrower, the Bank institutes measures to remedy the default, including commencing a foreclosure action. Consumer loans generally are charged off when a loan is deemed uncollectible by management and any available collateral has been disposed of. Commercial business and real estate loan delinquencies are handled on an individual basis by management with the advice of the Bank's legal counsel. The Bank anticipates that the increase in non-performing real estate loans will continue due to the growth of the Bank's loan portfolio. Interest income on loans is recognized on the accrual basis except for those loans in a nonaccrual of income status. The accrual of interest on impaired loans is discontinued when management believes, after consideration of economic and business conditions and collection efforts that the borrowers' financial condition is such that collection of interest is doubtful, typically after the loan becomes 90 days delinquent. When interest accrual is discontinued, interest income is subsequently recognized only to the extent cash payments are received. Real estate acquired by the Bank as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until such time as it is sold. When such property is acquired it is recorded at the lower of the unpaid principal balance of the related loan or its fair market value. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Subsequent gains and losses are included in non-interest income. The following table sets forth information with respect to the Bank's non-performing assets for the periods indicated.
AT JUNE 30 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- (DOLLARS IN THOUSANDS) Restructured $3,350 $ - $ - $ - $ - Past due 90 days still on accural - - - - - Loans on non-accrual status 386 3,309 1,728 3,082 2,128 ----- ----- ----- ----- ----- Total non-performing loans 3,736 3,309 1,728 3,082 2,128 Real estate acquired through foreclosure 660 296 - 109 134 Other repossessed assets 119 70 - - - ------ ------ ------ ------ ------ Total non-performing assets $4,515 $3,675 $1,728 $3,191 $2,262 ====== ====== ====== ====== ====== Interest income that would have been earned on non-accrual loans $ 300 $ 276 $ 139 $ 255 $ 182 Interest income recognized on non-accrual loans 32 26 7 29 16 Ratios: Non-performing loans to net loans .72% .64% .37% .77% .60% Non-performing assets to net loans .86% .71% .37% .80% .64%
LIQUIDITY The Bank maintains sufficient liquidity to fund loan demand and routine deposit withdrawal activity. Liquidity is managed by retaining sufficient liquid assets such as cash and cash equivalents, interest-bearing deposits, principal and interest payments from loans and securities. If large certificate depositors shift to the Bank's competitors or the stock market in response to interest rate changes, the Bank has the ability to replenish them through alternative funding sources. While the Bank utilizes numerous funding sources in order to meet liquidity requirements, FHLB borrowings remain a material component of management's balance sheet strategy. Also, the proceeds of trust preferred securities held by the Corporation are on deposit with a third party and available to the Corporation or Bank if needed. At June 30, 2002, the Bank had an unused approved line of credit in the amount of $45 million and sufficient collateral to borrow an additional $153.7 million in advances from the FHLB. 26 CAPITAL In November 2001 the Corporation's Board of Directors authorized the establishment of an additional stock repurchase program pursuant to which 10% of the Corporation's outstanding stock may be repurchased from time to time in the open market. The programs, which began in 1995, have repurchased a total of 645,321 shares. The Board will continue to evaluate earnings per share and monitor the success of the repurchase plan to maintain an attractive return to stockholders. The current plan expires in May 2003, when the Board will analyze the Bank's capital position and future earnings potential. On March 26, 2002, First Federal Statutory Trust I, a trust subsidiary of First Federal Financial Corporation of Kentucky (the "Corporation"), completed the private placement of 10,000 shares of cumulative trust preferred securities with a liquidation preference of $1,000 per security. The proceeds of the offering were loaned to the Corporation in exchange for floating rate junior subordinated deferrable interest debentures. Distributions on the securities are payable quarterly at a rate per annum equal to the 3-month LIBOR plus 3.60%. The Corporation undertook the issuance of these securities to enhance its regulatory capital position as they are considered as Tier I capital under current regulatory guidelines. The Corporation intends to utilize the proceeds for general business purposes and to support the Bank's future opportunities for growth. Regulatory agencies measure capital adequacy within a framework that makes capital requirements, in part, dependent on the individual risk profiles of financial institutions. The Corporation on a consolidated basis and the Bank continue to exceed the regulatory requirements for Tier I, Tier I leverage and total risk-based capital. Management intends to maintain a capital position that meets or exceeds the "well capitalized" requirements as defined by the FDIC. The Bank's average stockholders' equity to average assets ratio was 9.10% during 2002 compared to 8.97% during 2001. ASSET/LIABILITY MANAGEMENT AND MARKET RISK To minimize the volatility of net interest income and exposure to economic loss that may result from fluctuating interest rates, the Bank manages its exposure to adverse changes in interest rates through asset and liability management activities within guidelines established by its Asset Liability Committee ("ALCO"). The ALCO, which includes senior management representatives, has the responsibility for approving and ensuring compliance with asset/liability management polices of the Corporation. Interest rate risk is the exposure to adverse changes in the net interest income as a result of market fluctuations in interest rates. The ALCO, on an ongoing basis, monitors interest rate and liquidity risk in order to implement appropriate funding and balance sheet strategies. Management considers interest rate risk to be the Bank's most significant market risk. The Bank utilizes an earnings simulation model to analyze net interest income sensitivity. Potential changes in market interest rates and their subsequent effects on net interest income are then evaluated. The model projects the effect of instantaneous movements in interest rates of both 100 and 200 basis points. Assumptions based on the historical behavior of the Bank's deposit rates and balances in relation to changes in interest rates are also incorporated into the model. These assumptions are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model's simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies. The Bank's interest sensitivity profile remained liability sensitive from June 30, 2001 to June 30, 2002. Given a sustained 100 basis point downward shock to the yield curve used in the simulation model, the Bank's base net interest income would increase by an estimated .56% at June 30, 2002 compared to an increase of 3.92% at June 30, 2001. Given a 100 basis point increase in the yield curve the Bank's base net interest income would decrease by an estimated 4.89% at June 30, 2002 compared to a decrease of 4.30% at June 30, 2001. 27 The interest sensitivity of the Corporation at any point in time will be affected by a number of factors. These factors include the mix of interest sensitive assets and liabilities as well as their relative pricing schedules. It is also influenced by market interest rates, deposit growth, loan growth, and decay rates and prepayment speed assumptions. Based on simulations for the current balance sheet, the Bank continues to be liability sensitive. Savings products have increased dramatically over the past year due to the shift of funds from the stock market to immediate availability and re-pricing savings products. The Bank's loan portfolio retains a level of fixed rate products for both mortgages and commercial real estate that does not provide the corresponding movement in interest income as rates change. Strategic goals of moving to variable rate loan products and comparing wholesale funding with savings products will be the emphasis for management to accomplish a less liability sensitive balance sheet. The table below is representative only and is not a precise measurement of the effect of changing interest rates on the Corporation's net interest income in the future.
JUNE 30, 2002 DECREASE IN RATES INCREASE IN RATES ------------------ ----------------- 200 100 100 200 BASIS POINTS BASIS POINTS BASE BASIS POINTS BASIS POINTS (Dollars in thousands) PROJECTED INTEREST INCOME Loans $37,225 $38,685 $40,926 $40,881 $41,889 Investments 2,918 3,118 3,509 3,906 3,992 ------ ------ ------- ------ ------ TOTAL INTEREST INCOME 40,143 41,803 44,435 44,787 45,881 PROJECTED INTEREST EXPENSE Deposits 10,630 12,497 15,259 16,822 18,471 Borrowed funds 4,336 4,342 4,350 4,354 4,361 ------ ------ ------- ------ ------ TOTAL INTEREST EXPENSE 14,966 16,839 19,609 21,176 22,832 NET INTEREST INCOME $25,177 $24,964 $24,826 $23,611 $23,049 Change from base $351 $138 $(1,215) $(1,777) % Change from base 1.41% .56% (4.89)% (7.16)%
JUNE 30, 2001 DECREASE IN RATES INCREASE IN RATES ------------------ ----------------- 200 100 100 200 BASIS POINTS BASIS POINTS BASE BASIS POINTS BASIS POINTS (Dollars in thousands) PROJECTED INTEREST INCOME Loans $40,259 $41,873 $43,221 $44,342 $45,361 Investments 2,068 2,184 2,271 2,507 2,628 ------- ------- ------ ------ ------ TOTAL INTEREST INCOME 42,327 44,057 45,492 46,849 47,989 PROJECTED INTEREST EXPENSE Deposits 16,858 19,092 21,326 23,560 25,149 Borrowed funds 3,734 3,735 3,736 3,738 3,785 ------ ------ ------ ------ ------ TOTAL INTEREST EXPENSE 20,592 22,827 25,062 27,298 28,934 NET INTEREST INCOME $21,735 $21,230 $20,430 $19,551 $19,055 Change from base $1,305 $800 $(879) $(1,375) % Change from base 6.39% 3.92% (4.30)% (6.73)%
28 IMPACT OF INFLATION & CHANGING PRICES The financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The Bank has an asset and liability structure that is essentially monetary in nature. As a result interest rates have a more significant impact on the Bank's performance than the effects of general levels of inflation. Periods of high inflation are often accompanied by relatively higher interest rates and periods of low inflation are accompanied by relatively lower interest rates. As market interest rates rise or fall in relation to the rates earned on the Bank's loans and investments, the value of these assets decreases or increases respectively. MARKET AND DIVIDEND INFORMATION The Common Stock of the Corporation is traded on the Nasdaq National Market System (NASDAQ) under the symbol "FFKY". The following table sets forth the high and low closing prices of the Corporation's Common Stock and the dividends paid during the last two years. QUARTER ENDED FISCAL 2002: 9/30 12/31 3/31 6/30 ---- ----- ---- ---- High $ 18.50 $ 18.00 $ 20.50 $ 23.85 Low 14.95 16.10 17.25 20.25 Cash dividends 0.18 0.18 0.18 0.18 FISCAL 2001: 9/30 12/31 3/31 6/30 ---- ----- ---- ---- High $ 17.63 $ 16.50 $ 15.50 $ 18.25 Low 15.00 13.25 14.25 13.50 Cash dividends 0.18 0.18 0.18 0.18 It is currently the policy of the Corporation's Board of Directors to continue to pay quarterly dividends, but any future dividends are subject to the Board's discretion based on its consideration of the Corporation's operating results, financial condition, capital, income tax considerations, regulatory restrictions and other factors. 29 REPORT OF INDEPENDENT AUDITORS Board of Directors and Stockholders First Federal Financial Corporation of Kentucky Elizabethtown, Kentucky We have audited the accompanying consolidated statements of financial condition of First Federal Financial Corporation of Kentucky as of June 30, 2002 and 2001 and the related consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows for each of the three years in the period ending June 30, 2002. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Federal Financial Corporation of Kentucky as of June 30, 2002 and 2001 and the results of its operations and its cash flows for each of the three years in the period ending June 30, 2002 in conformity with accounting principles generally accepted in the United States of America. Crowe, Chizek and Company LLP Louisville, Kentucky July 19, 2002 30 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION JUNE 30, ASSETS 2002 2001 ---- ---- Cash and cash equivalents $ 40,016,230 $ 35,464,388 Interest bearing deposits 64,000,000 - Securities available-for-sale 1,977,794 2,013,107 Securities held-to-maturity: fair value of $21,750,149 (2002) and $20,954,198 (2001) 21,715,391 20,920,760 Loans held for sale 1,511,285 632,321 Loans receivable, less allowance for loan losses of $3,734,752 (2002) and $2,906,356 (2001) 518,749,701 516,512,836 Federal Home Loan Bank stock 6,169,600 5,845,000 Premises and equipment 11,486,617 11,453,601 Real estate owned: Acquired through foreclosure 659,966 295,989 Held for development 720,683 720,683 Other repossessed assets 119,504 70,050 Acquisition intangibles 8,383,574 9,215,373 Accrued interest receivable 1,925,331 2,024,554 Other assets 1,674,181 1,557,078 ------------ ------------ TOTAL ASSETS $679,109,857 $606,725,740 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Deposits: Non-interest bearing $ 28,340,904 $ 21,208,411 Interest bearing 501,541,338 447,616,786 ------------ ----------- Total Deposits 529,882,242 468,825,197 Advances from Federal Home Loan Bank 77,778,070 77,297,658 Trust Preferred Securities 9,714,500 - Accrued interest payable 516,122 1,969,545 Accounts payable and other liabilities 1,573,944 2,475,687 Deferred income taxes 1,030,424 1,565,376 ----------- ----------- TOTAL LIABILITIES 620,495,302 552,133,463 ----------- ----------- STOCKHOLDERS' EQUITY: Serial preferred stock, 5,000,000 shares authorized and unissued - - Common stock, $1 par value per share; authorized 10,000,000 shares; issued and outstanding, 3,729,400 shares in 2002 and 3,758,491 shares in 2001 3,729,400 3,758,491 Additional paid-in capital 18,015 20,527 Retained earnings 54,482,567 50,405,481 Accumulated other comprehensive income, net of tax 384,573 407,778 ---------- ------------ TOTAL STOCKHOLDERS' EQUITY 58,614,555 54,592,277 ---------- ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $679,109,857 $606,725,740 ============ ============ See notes to consolidated financial statements. 31 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED JUNE 30, --------------------------------------------- 2002 2001 2000 ---- ---- ---- INTEREST INCOME: Interest and fees on loans $42,044,646 $41,996,226 $35,316,819 Interest and dividends on investments and deposits 2,055,097 3,395,588 3,225,633 ---------- ----------- --------- Total interest income 44,099,743 45,391,814 38,542,452 ---------- ---------- ---------- INTEREST EXPENSE: Deposits 17,538,838 22,125,115 18,073,392 Federal Home Loan Bank advances 3,740,701 5,304,192 2,800,076 Trust Preferred Securities 146,284 - - ---------- ---------- ---------- Total interest expense 21,425,823 27,429,307 20,873,468 ---------- ---------- ---------- Net interest income 22,673,920 17,962,507 17,668,984 Provision for loan losses 1,603,887 1,086,100 399,500 ---------- ---------- ---------- Net interest income after provision for loan losses 21,070,033 16,876,407 17,269,484 ---------- ---------- ---------- NON-INTEREST INCOME: Customer service fees on deposit accounts 3,282,865 2,567,780 1,957,445 Gain on sale of mortgage loans 651,045 526,304 354,391 Gain on sale of investments - 696,041 456,926 Brokerage and insurance commissions 543,250 639,637 464,388 Other income 921,043 715,715 643,973 --------- --------- --------- Total non-interest income 5,398,203 5,145,477 3,877,123 --------- --------- --------- NON-INTEREST EXPENSE: Employee compensation and benefits 7,261,772 6,416,848 5,644,270 Office occupancy expense and equipment 1,487,896 1,456,721 1,362,424 FDIC insurance premiums 84,726 84,653 158,117 Marketing and advertising 612,496 505,418 524,349 Outside services and data processing 1,544,970 1,420,324 1,259,148 State franchise tax 472,016 424,663 403,869 Amortization of acquisition intangibles 831,799 831,799 831,799 Other expense 2,985,060 2,429,330 2,506,928 ---------- ---------- --------- Total non-interest expense 15,280,735 13,569,756 12,690,904 ---------- ---------- ---------- Income before income taxes 11,187,501 8,452,128 8,455,703 Income taxes 3,729,085 2,802,693 2,792,361 ---------- --------- --------- NET INCOME $7,458,416 $5,649,435 $5,663,342 ========== ========== ========== Earnings per share: Basic $ 1.99 $ 1.50 $ 1.45 Diluted $ 1.98 $ 1.50 $ 1.44
See notes to consolidated financial statements. 32 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEAR ENDED JUNE 30, 2002 2001 2000 ---- ---- ---- NET INCOME $7,458,416 $5,649,435 $5,663,342 Other comprehensive income (loss), net of tax: Change in unrealized gain (loss) on securities (23,205) 422,994 (352,242) Reclassification of realized amount - (459,387) (301,571) ---------- ----------- ---------- Net unrealized gain (loss) recognized in comprehensive income (23,205) (36,393) (653,813) ---------- ---------- ---------- COMPREHENSIVE INCOME $7,435,211 $5,613,042 $5,009,529 ========== ========== ==========
See notes to consolidated financial statements. 33 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDING JUNE 30, 2002, 2001, AND 2000
ACCUMULATED OTHER ADDITIONAL COMPREHENSIVE COMMON STOCK PAID - IN RETAINED INCOME, SHARES AMOUNT CAPITAL EARNINGS NET OF TAX TOTAL ------ ------ ------- -------- ---------- ----- BALANCE, JUNE 30, 1999 4,121,112 $4,121,112 $3,055,644 $49,587,422 $1,097,984 $57,862,162 Net income - - - 5,663,342 - 5,663,342 Exercise of stock options, net of redemptions 1,553 1,553 4,209 - - 5,762 Net change in unrealized gains (losses) on securities available- for-sale, net of tax - - - - (653,813) (653,813) Cash dividends declared ($.72 per share) - - - (2,802,833) - (2,802,833) Stock repurchased (366,904) (366,904) (3,059,853) (4,966,782) - (8,393,539) --------- --------- ---------- ---------- -------- ---------- BALANCE, JUNE 30, 2000 3,755,761 3,755,761 - 47,481,149 444,171 51,681,081 Net income - - - 5,649,435 - 5,649,435 Exercise of stock options 4,730 4,730 27,788 - - 32,518 Net change in unrealized gains (losses) on securities available- for-sale, net of tax - - - - (36,393) (36,393) Cash dividends declared ($.72 per share) - - - (2,704,364) - (2,704,364) Stock repurchased (2,000) (2,000) (7,261) (20,739) - (30,000) --------- --------- --------- ---------- --------- ---------- BALANCE, JUNE 30, 2001 3,758,491 3,758,491 20,527 50,405,481 407,778 54,592,277 Net income - - - 7,458,416 - 7,458,416 Exercise of stock options, net of redemptions 2,549 2,549 (2,512) - - 37 Net change in unrealized gains (losses) on securities available- for-sale, net of tax - - - - (23,205) (23,205) Cash dividends declared ($.72 per share) - - - (2,700,917) - (2,700,917) Stock repurchased (31,640) (31,640) - (680,413) - (712,053) --------- ---------- --------- ---------- ---------- ----------- BALANCE, JUNE 30, 2002 3,729,400 $3,729,400 $ 18,015 $ 54,482,567 $ 384,573 $58,614,555 ========= ========== ========= ============ ========== ===========
See notes to consolidated financial statements. 34 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED JUNE 30, 2002 2001 2000 ---- ---- ---- OPERATING ACTIVITIES: Net income $7,458,416 $5,649,435 $5,663,342 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,603,887 1,086,100 399,500 Depreciation on premises and equipment 1,052,329 1,136,143 1,022,327 Federal Home Loan Bank stock dividends (324,600) (384,600) (237,300) Amortization of acquired intangible assets 831,799 831,799 831,799 Net accretion (42,037) (71,922) (61,435) Gain on sale of investments available-for-sale - (696,041) (456,926) Gain on sale of mortgage loans (651,045) (526,304) (354,391) Origination of loans held for sale (41,461,141) (29,515,839) (23,607,548) Proceeds on sale of loans held for sale 41,233,222 30,150,248 24,610,167 Deferred taxes (522,998) (330,781) 353,014 Changes in: Interest receivable 99,223 7,323 (428,363) Other assets 379,841 (122,810) (197,941) Interest payable (1,453,423) 840,755 259,950 Accounts payable and other liabilities (901,743) 513,144 (373,960) ---------- --------- --------- Net cash provided by operating activities 7,301,730 8,566,650 7,422,235 ---------- --------- --------- INVESTING ACTIVITIES: Change in interest bearing deposits (64,000,000) - - Sales of securities available-for-sale - 707,607 461,782 Purchases of securities available-for-sale - (32,325) (107,300) Purchases of securities held-to-maturity (24,000,000) - (5,000,000) Maturities of securities held-to-maturity 23,263,876 22,285,284 6,332,014 Net increase in loans (4,751,127) (47,830,192) (71,810,035) Purchase of Federal Home Loan Bank stock - (1,379,600) (643,500) Net purchases of premises and equipment (1,085,345) (880,476) (1,137,226) Purchase of real estate held for development - (275,000) - ----------- ----------- ----------- Net cash used in investing activities (70,572,596) (27,404,702) (71,904,265) ----------- ----------- ----------- FINANCING ACTIVITIES: Net increase in deposits 61,057,045 45,066,242 24,315,516 Advances from Federal Home Loan Bank 723,712 76,090,434 79,647,360 Repayments to Federal Home Loan Bank (243,300) (79,131,326) (25,202,937) Proceeds from stock options exercised 37 32,518 5,762 Net proceeds from issuance of trust preferred securities 9,698,184 - - Dividends paid (2,700,917) (2,704,364) (2,802,833) Common stock repurchased (712,053) (30,000) (8,393,539) ---------- ---------- ---------- Net cash provided by financing activities 67,822,708 39,323,504 67,569,329 ---------- ---------- ---------- INCREASE IN CASH AND CASH EQUIVALENTS 4,551,842 20,485,452 3,087,299 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 35,464,388 14,978,936 11,891,637 ----------- ----------- ----------- CASH AND CASH EQUIVALENTS, END OF YEAR $40,016,230 $35,464,388 $14,978,936 =========== =========== ===========
See notes to consolidated financial statements. 35 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The following is a description of the significant accounting policies which First Federal Financial Corporation of Kentucky follows in preparing and presenting its consolidated financial statements: PRINCIPLES OF CONSOLIDATION AND BUSINESS - The consolidated financial statements include the accounts of First Federal Financial Corporation of Kentucky (the Corporation) and its wholly-owned subsidiaries, First Federal Savings Bank of Elizabethtown (the Bank) and First Federal Statutory Trust I. The Bank has two wholly-owned subsidiaries, First Service Corp. of Elizabethtown and First Heartland Mortgage. All significant intercompany transactions and balances have been eliminated. The business of the Bank consists primarily of attracting deposits from the general public and originating mortgage loans on single-family residences. To a lesser extent, the Bank also originates loans on multi-family housing and commercial property. The Bank also makes home improvement loans, consumer loans and commercial business loans. The Bank's primary lending area is a region within North Central Kentucky. The economy within this region is based on agriculture, a variety of manufacturing industries and Ft. Knox, a military installation. The principal sources of funds for the Bank's lending and investment activities are deposits, repayment of loans and Federal Home Loan Bank advances. The Bank's principal source of income is interest on loans. In addition, other income is derived from loan origination fees, service charges, returns on investment securities, secondary mortgage market fees, and trust department and brokerage services. ESTIMATES AND ASSUMPTIONS - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The allowance for loan losses and the fair value of financial instruments are particularly subject to change. CASH FLOWS - For purposes of the statement of cash flows, the Corporation considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents include cash on hand, amounts due from banks, and certain interest bearing deposits. Net cash flows are reported for loans and deposits. INTEREST BEARING DEPOSITS - Deposits with original maturities of greater than 90 days are reported separately. At June 30, 2002, interest-bearing deposits included time deposits with the Federal Home Loan Bank with original maturities of 60 to 180 days at rates of 1.65 % to 2.03%. SECURITIES - The Corporation classifies its investments into held-to-maturity and available-for-sale. Debt securities in which the Corporation has a positive intent and ability to hold are classified as held-to-maturity and are carried at cost adjusted for the amortization of premiums and discounts using the interest method over the terms of the securities. Debt and equity securities, which do not fall into this category, nor held for the purpose of selling in the near term, are classified as available-for-sale. Unrealized holding gains and losses, net of tax, on available-for-sale securities are reported as a net amount in a separate component of stockholders' equity until realized. 36 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED) LOANS RECEIVABLE - Loans receivable are stated at unpaid principal balances, less undistributed construction loans, net deferred loan origination fees and allowance for loan losses. The Bank defers loan origination fees and discounts net of certain direct origination costs. These net deferred fees are amortized using the level yield method on a loan-by-loan basis over the lives of the underlying loans. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management's periodic evaluation of the adequacy of the allowance is based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, and current economic conditions. Loans are considered impaired if full principal or interest payments are not anticipated in accordance with the contractual loan terms. Impaired loans are carried at the present value of expected future cash flows discounted at the loan's effective interest rate or at the fair value of the collateral if the loan is collateral dependent. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is less than the unpaid balance. If these allocations cause the allowance for loan losses to require an increase, such increase is reported in the provision for loan losses. Interest income on loans is recognized on the accrual basis except for those loans in nonaccrual status. The accrual of interest is discontinued when a loan becomes 90 or more days delinquent. When interest accrual is discontinued, interest income is subsequently recognized only to the extent cash payments are received. LOANS HELD FOR SALE - Loans held for sale include mortgage loans originated and intended for sale in the secondary market and are carried at the lower of aggregate cost or market value. The Corporation controls its interest rate risk with respect to mortgage loans held for sale and loan commitments expected to close by entering into "best efforts" forward sales contracts on a loan for loan basis. The aggregate market value of mortgage loans held for sale considers the sales prices of such agreements. The Corporation also provides for any losses on uncovered commitments to lend or sell. Gain on sale of loans is recognized when the loan is delivered to the investor and is sold with servicing released. FEDERAL HOME LOAN BANK STOCK - Investment in stock of Federal Home Loan Bank is carried at cost. PREMISES AND EQUIPMENT - Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed by the straight-line method for buildings and improvements and furniture and fixtures, over the estimated useful lives of the related assets. REAL ESTATE OWNED - Real estate properties acquired through foreclosure and in settlement of loans are stated at lower of cost or fair value less estimated selling costs at the date of foreclosure. The excess of cost over fair value less the estimated costs to sell at the time of foreclosure is charged to the allowance for loan losses. Costs relating to development and improvement of property are capitalized, whereas costs relating to holding property are not capitalized and are charged against operations in the current period. Real estate properties held for development and sale are carried at the lower of cost, including cost of development and improvement subsequent to acquisition, or fair value less estimated selling costs. The portion of interest costs relating to the development of real estate is capitalized. OTHER REPOSSESSED ASSETS - Consumer assets acquired through repossession and in settlement of loans, typically automobiles, are carried at lower of cost or fair value at the date of repossession. The excess cost over fair value at time of repossession is charged to the allowance for loan losses. 37 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED) BROKERAGE AND INSURANCE COMMISSIONS - Brokerage commissions are recognized as income on settlement date. Insurance commissions on loan products (credit life, mortgage life, accidental death, and guaranteed auto protection) are recognized as income over the life of the loan. STOCK OPTION PLANS - Employee compensation expense under stock option plans is reported if options are granted below market price at grant date. Pro-forma disclosures of net income and earnings per share are shown using the fair value method of SFAS No. 123 to measure expense, using an option pricing model to estimate fair value. INCOME TAXES - Deferred income tax assets and liabilities are determined using the liability method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the differences between the book and tax basis of the various balance sheet assets and liabilities. EARNINGS PER COMMON SHARE - Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits through the date of issuance of the financial statements. COMPREHENSIVE INCOME - Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available-for-sale, which are also recognized as a separate component of equity. NEW ACCOUNTING PRONOUNCEMENTS - A new accounting standard requires all business combinations to be recorded using the purchase method of accounting for any transaction initiated after June 30, 2001. Under the purchase method, all identifiable tangible and intangible assets and liabilities of the acquired company must be recorded at fair value at date of acquisition, and the excess of cost over fair value of net assets acquired is recorded as goodwill. Identifiable intangible assets must be separated from goodwill. Identifiable intangible assets with finite useful lives will be amortized under the new standard, whereas goodwill, both amounts previously recorded and future amounts purchased, will cease being amortized starting July 1, 2002. Annual impairment testing will be required for goodwill with impairment being recorded if the carrying amount of goodwill exceeds its implied fair value. As a result of adopting this standard, on July 1, 2002, the Corporation ceased annual amortization of $240,000 on remaining goodwill assets of $1.8 million. A separately identified core deposit intangible and other unidentified intangible assets of $6.6 million will continue to be amortized over their remaining lives. The new accounting standard requires the lives of existing intangibles be reevaluated upon adoption. Collectively, these amounts are reported together on the balance sheet as acquisition intangibles. INDUSTRY SEGMENTS - Segments are parts of a company evaluated by management with separate financial information. The Corporation's internal information is reported and evaluated in three lines of business-banking, mortgage banking, and brokerage and insurance. These segments are dominated by banking at a magnitude for which separate individual segment disclosures are not required. RECLASSIFICATIONS - Certain amounts for 2001 and 2000 have been reclassified to conform to the presentation for 2002. 38 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SECURITIES The amortized cost basis and fair values of securities at June 30 are as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE Securities available-for-sale: June 30, 2002: Equity securities $ 385,484 $ 544,607 $ - $ 930,091 Obligation of states and political subdivisions 1,009,619 38,084 - 1,047,703 ---------- --------- --------- ---------- Total available-for-sale $1,395,103 $ 582,691 $ - $1,977,794 ========== ========= ========= ========== June 30, 2001: Equity securities $ 385,484 $ 616,676 $ (5,625) $ 996,535 Obligation of states and political subdivisions 1,009,773 6,799 - 1,016,572 ---------- --------- -------- ---------- Total available-for-sale $1,395,257 $ 623,475 $ (5,625) $2,013,107 ========== ========= ======== ========== Securities held-to-maturity: June 30, 2002: U.S. Treasury and agencies $20,964,000 $ 58,060 $ - $21,022,060 Mortgage-backed securities 751,391 7,188 (30,490) 728,089 ----------- --------- --------- ----------- Total held-to-maturity securities $21,715,391 $ 65,248 $ (30,490) $21,750,149 =========== ========= ========= ========== June 30, 2001: U.S. Treasury and agencies $19,917,029 $ 150,470 $(103,869) $19,963,630 Mortgage-backed securities 1,003,731 4,235 (17,398) 990,568 ----------- ---------- --------- ----------- Total held-to-maturity securities $20,920,760 $ 154,705 $(121,267) $20,954,198 =========== ========= ========= ===========
The amortized cost and fair value of securities at June 30, 2002, by contractual maturity, are shown below.
AVAILABLE-FOR-SALE HELD-TO-MATURITY ---------------------------- ----------------------------- AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE Due in one year or less $ - $ - $ 1,964,000 $ 1,999,880 Due after one year through five years 776,365 809,628 15,000,000 15,020,300 Due after five years through ten years 233,254 238,075 - - Due after ten years - - 4,000,000 4,001,880 Mortgage-backed securities - - 751,391 728,089 Equity securities 385,484 930,091 - - ---------- ---------- ----------- ----------- $1,395,103 $1,977,794 $21,715,391 $21,750,149 ========== ========== =========== ===========
39 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SECURITIES - (CONTINUED) The following schedule sets forth the proceeds from sales of available-for-sale securities and the gross realized gains on those sales for the fiscal years ended June 30: 2002 2001 2000 ---- ---- ---- Proceeds from sales $ - $707,607 $461,782 Gross realized gains - 696,041 456,926 Investment securities having an amortized cost of $1,964,000 and fair value of $1,999,880 at June 30, 2002 were pledged to secure public deposits. 3. LOANS RECEIVABLE: Loans receivable at June 30 are summarized as follows: 2002 2001 ---- ---- Commercial $ 21,129,501 $ 17,843,459 Real estate commercial 112,528,113 88,937,849 Real estate construction 10,662,026 9,079,184 Residential mortgage 308,689,702 329,855,679 Consumer and home equity 51,796,395 54,189,225 Indirect consumer 19,640,208 21,822,325 ----------- ----------- 524,445,945 521,727,721 Less: Net deferred loan origination fees (1,961,492) (2,308,529) Allowance for loan losses (3,734,752) (2,906,356) ----------- ---------- (5,696,244) (5,214,885) ---------- ---------- Loans Receivable $518,749,701 $516,512,836 ============ ============ The Bank utilizes eligible real estate loans to collateralize advances and letters of credit from the Federal Home Loan Bank. At June 30, 2002 and 2001, the Bank had approximately $292 million and $313 million in one-to-four family residential mortgage loans pledged under this arrangement. The allowance for losses on loans is summarized as follows: YEAR ENDED JUNE 30, ------------------------------------------ 2002 2001 2000 ---- ---- ---- Balance, beginning of year $2,906,356 $2,252,062 $2,107,994 Provision for loan losses 1,603,887 1,086,100 399,500 Charge-offs (916,543) (498,796) (265,302) Recoveries 141,052 66,990 9,870 ---------- ---------- ---------- Balance, end of year $3,734,752 $2,906,356 $2,252,062 ========== ========== ========== 40 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. LOANS RECEIVABLE - (CONTINUED) Investment in impaired loans is summarized below. There were no impaired loans for the periods presented without an allowance allocation.
JUNE 30, ----------------------------------------- 2002 2001 2000 ---- ---- ---- Year-end impaired loans $3,736,000 $3,309,000 $1,728,000 Amount of allowance for loan loss allocated 511,000 324,000 117,000 Average impaired loans outstanding 3,507,000 2,499,000 2,688,000 Interest income recognized 201,000 93,000 111,000 Interest income received 201,000 93,000 111,000
4. PREMISES AND EQUIPMENT Premises and equipment consist of the following: JUNE 30, ------------------------------- 2002 2001 ---- ---- Land $ 953,765 $ 953,765 Buildings 10,205,523 10,055,266 Furniture, fixtures and equipment 6,854,502 5,924,356 --------- --------- 18,013,790 16,933,387 Less accumulated depreciation (6,527,173) (5,479,786) ---------- ---------- $11,486,617 $11,453,601 =========== =========== Certain premises are leased under various operating leases. Rental expense was $263,000, $256,000 and $259,600 for the years ended June 30, 2002, 2001, and 2000, respectively. Future minimum commitments under these leases are: YEAR ENDED JUNE 30 ------- 2003 $ 266,028 2004 269,228 2005 242,728 2006 242,728 Thereafter 1,224,017 --------- $2,244,729 ========== 5. DEPOSITS Time Deposits of $100,000 or more were $100,069,000 and $102,577,000 at June 30, 2002 and 2001, respectively. At June 30, 2002, scheduled maturities of time deposits are as follows: AMOUNT ------ 2003 $183,016,089 2004 80,040,668 2005 32,738,582 2006 4,451,563 Thereafter 9,782,100 ------------ $310,029,002 ============ 41 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. ADVANCES FROM FEDERAL HOME LOAN BANK Advances from the Federal Home Loan Bank (FHLB) of Cincinnati are collateralized by FHLB stock and a blanket pledge of one-to-four family residential mortgage loans equivalent to 125 percent of the outstanding advances and letters of credit. At June 30, 2002, the Bank has available collateral to borrow an additional $153.7 million from the FHLB. During January 2001, the Bank entered into $75 million in convertible fixed rate advances with a maturity of ten years. These advances are fixed for periods of two to three years. At the end of the fixed term and quarterly thereafter, the FHLB has the right to convert these advances to variable rate advances tied to the three-month LIBOR index. At June 30, 2002 and 2001, the Bank had $22,160,000 and $0 in letters of credit from the FHLB issued to collateralize public deposits. Advances from the FHLB at year-end are as follows:
JUNE 30, ------------------------------------------------------------- 2002 2001 ---- ---- WEIGHTED- WEIGHTED- AVERAGE RATE AMOUNT AVERAGE RATE AMOUNT ------------ ------ ------------ ------ Fixed rate advances: Mortgage matched advances with interest rates from 5.30% to 7.80% 6.36% 384,738 6.52% 559,864 Convertible fixed rate advances 4.92% 75,000,000 4.92% 75,000,000 Other fixed rate advances 5.45% 2,393,332 6.76% 1,737,794 --------- ----------- Total borrowings $77,778,070 $77,297,658 =========== ===========
The aggregate minimum annual repayments of borrowings as of June 30, 2002 is as follows: 2003 $ 448,495 2004 134,577 2005 138,928 2006 143,570 2007 144,710 Thereafter 76,767,790 ---------- $77,778,070 =========== 7. TRUST PREFERRED SECURITIES On March 26, 2002, the Corporation issued $10.0 million of Floating Rate Capital Securities (Trust Preferred Securities) through First Federal Statutory Trust I (Trust), a subsidiary of the Corporation. The proceeds of the offering were loaned by the Trust to the Corporation in exchange for subordinated debentures with terms that are similar to the Trust Preferred Securities and is the sole asset of the Trust. Issuance costs of $301,816 paid from the proceeds are being amortized to maturity. The Corporation has guaranteed that the Trust will make distributions to the holders of the Trust Preferred Securities if the Trust has available funds to make such distribution which is reflected as a liability on the balance sheet net of issuance costs. Distributions on the Trust Preferred Securities are payable quarterly in arrears at the annual rate (adjusted quarterly) of three-month LIBOR plus 3.60% (5.47% as of the last adjustment), and are included in interest expense. The annual rate cannot exceed 11% prior to March 26, 2007. 42 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. TRUST PREFERRED SECURITIES - (CONTINUED) The Trust Preferred Securities, which mature March 26, 2032, are subject to mandatory redemption, in whole or in part, upon repayment of the subordinated debentures at maturity or their earlier redemption at the liquidation preference. The subordinated debentures are redeemable prior to the maturity date at the option of the Corporation on or after March 26, 2007 at their principal amount plus accrued interest. The subordinated debentures are also redeemable in whole or in part from time to time, upon the occurrence of specific events defined within the trust debenture. The Corporation has the option to defer distributions on the subordinated debentures from time to time for a period not to exceed 20 consecutive quarters. Trust Preferred Securities are considered as Tier I capital for the Corporation under current regulatory guidelines. 8. INCOME TAXES The Corporation and its subsidiaries file a consolidated federal income tax return and income tax is apportioned among all companies based on their taxable income or loss. Provision for income taxes for the years ended June 30, are as follows: 2002 2001 2000 ---- ---- ---- Current $4,252,083 $3,133,474 $2,439,347 Deferred (522,998) (330,781) 353,014 ---------- ----------- ----------- Total income tax expense $3,729,085 $2,802,693 $2,792,361 ========== ========== ========== The provision for income taxes differs from the amount computed at the statutory rates as follows: 2002 2001 2000 ---- ---- ---- Federal statutory rate 34.0% 34.0% 34.0% Tax-exempt interest income (.2) (.2) (.2) Acquisition intangibles .7 1.0 1.0 Dividends to ESOP (.4) (.6) (.6) Other (.8) (1.0) (1.2) ----- ---- ----- Effective rate 33.3% 33.2% 33.0% ===== ===== ===== Temporary differences between the financial statements carrying amounts and tax bases of assets and liabilities that give rise to significant portions of deferred income taxes at June 30, relate to the following: 2002 2001 ---- ---- Deferred tax assets: Allowance for loan losses $ 966,137 $ 532,644 Investment securities 12,240 26,928 Accrued liabilities and other 284,468 262,244 --------- -------- 1,262,845 821,816 --------- -------- 43 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. INCOME TAXES - (CONTINUED) 2002 2001 ---- ---- Deferred tax liabilities: Depreciation $ 905,056 $ 872,006 Net unrealized gain on securities available-for-sale 198,118 210,072 Federal Home Loan Bank stock 955,283 844,919 Other 234,812 460,195 ---------- ---------- 2,293,269 2,387,192 ---------- ---------- Net deferred tax liability $1,030,424 $1,565,376 ========== ========== Federal income tax laws provided savings banks with additional bad debt deductions through 1987, totaling $9.3 million for the Bank. Accounting standards do not require a deferred tax liability to be recorded on this amount, which would otherwise total $3.2 million at June 30, 2002 and 2001. If the Bank was liquidated or otherwise ceased to be a bank or if tax laws were to change, the $3.2 million would be recorded as expense. 9. STOCKHOLDERS' EQUITY (A) LIQUIDATION ACCOUNT - In connection with the Bank's conversion from mutual to stock form of ownership during 1987, the Bank established a "liquidation account", currently in the amount of $728,208 for the purpose of granting to eligible deposit account holders a priority in the event of future liquidation. Only in such an event, an eligible account holder who continues to maintain a deposit account will be entitled to receive a distribution from the liquidation account. The total amount of the liquidation account decreases in an amount proportionately corresponding to decreases in the deposit account balances of the eligible account holders. (B) REGULATORY CAPITAL REQUIREMENTS - The Corporation and the Bank must meet various regulatory capital requirements. If a requirement is not met, regulatory authorities may take legal or administrative actions, including restrictions on growth or operations or, in extreme cases, seizure. As of June 30, 2002, both the Corporation on a consolidated basis and Bank were categorized as well capitalized. The actual and required capital amounts and ratios are presented below:
TO BE CONSIDERED WELL CAPITALIZED UNDER PROMPT FOR CAPITAL CORRECTION ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS ------------------------------------------------------------ --------- AS OF JUNE 30, 2002: AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------ ----- ------ ----- ------ ----- Total risk-based capital (to risk- weighted assets) Consolidated $62,770,000 13.5% $37,216,000 8.0% $46,520,000 10.0% Bank 53,049,000 11.5 37,012,000 8.0 46,265,000 10.0 Tier I capital (to risk-weighted assets) Consolidated 58,773,000 12.6 18,608,000 4.0 27,912,000 6.0 Bank 49,082,000 10.6 18,506,000 4.0 27,759,000 6.0 Tier I capital (to average assets) Consolidated 58,773,000 8.9 26,485,000 4.0 33,106,000 5.0 Bank 49,082,000 7.4 26,191,000 4.0 32,739,000 5.0
44 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. STOCKHOLDERS' EQUITY - (CONTINUED)
AS OF JUNE 30, 2001: Total risk-based capital (to risk- weighted assets) Consolidated $47,534,000 11.1% $34,334,000 8.0% $42,918,000 10.0% Bank 46,945,000 11.0 34,280,000 8.0 42,850,000 10.0 Tier I capital (to risk-weighted assets) Consolidated 44,347,000 10.3 17,167,000 4.0 25,751,000 6.0 Bank 43,722,000 10.2 17,140,000 4.0 25,710,000 6.0 Tier I capital (to average assets) Consolidated 44,347,000 7.3 24,168,000 4.0 30,210,000 5.0 Bank 43,722,000 7.3 23,925,000 4.0 29,907,000 5.0
(C) DIVIDEND RESTRICTIONS - Under OTS regulations, limitations have been imposed on all "capital distributions" by savings institutions, including cash dividends. The regulation establishes a three-tiered system of restrictions, with the greatest flexibility afforded to thrifts which are both well-capitalized and given favorable qualitative examination ratings by the OTS. For example, a thrift which is given one of the two highest examination ratings and has "capital" equal to its fully phased-in regulatory capital requirements (a "tier one institution") could, if a subsidiary of a holding company, after prior notice but without the prior approval of the OTS, make capital distributions in any year to the extent not in excess of its net income for the calendar year-to-date plus retained net income for the previous two calendar years (less any dividends previously paid), provided that the thrift remains adequately capitalized following the distribution. Other thrifts would be subject to more stringent procedural and substantive requirements, the most restrictive being prior OTS approval of any capital distribution. The Bank is a tier one institution. Under the most restrictive of the dividend limitations described above, at June 30, 2002, the Bank was able to declare $10.3 million in additional dividends to the holding company without obtaining the prior approval of the OTS. (D) QUALIFIED THRIFT LENDER - The Qualified Thrift Lender ("QTL") test requires that approximately 65% of assets be maintained in housing-related finance and other specified areas. If the QTL test is not met, limits are placed on growth, branching, new investments, FHLB advances and dividends, or the Bank must convert to a commercial bank charter. Management believes that the QTL test has been met. 45 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. EARNINGS PER SHARE The reconciliation of the numerators and denominators of the basic and diluted EPS is as follows: YEAR ENDED JUNE 30, 2002 2001 2000 ---- ---- ---- Net income available to common shareholders $7,458,416 $5,649,435 $5,663,342 ========== ========== ========== Basic EPS: Weighted average common shares 3,752,937 3,755,688 3,906,197 ========== ========= ========= Diluted EPS: Weighted average common shares 3,752,937 3,755,688 3,906,197 Dilutive effect of stock options 16,533 5,348 16,766 ---------- ---------- --------- Weighted average common and incremental shares 3,769,470 3,761,036 3,922,963 ========== ========= ========= Earnings Per Share: Basic $1.99 $1.50 $1.45 ========== ========= ========= Diluted $1.98 $1.50 $1.44 ========== ========= ========= Stock options for 60,000, 79,500, and 65,000 shares of common stock were not included in the 2002, 2001, and 2000 computation of diluted earning per share because their impact was anti-dilutive. 11. EMPLOYEE BENEFIT PLANS: (A) PENSION PLANS - The Bank is a participant in the Financial Institutions Retirement Fund, a multiple-employer defined benefit pension plan covering substantially all employees. Employees are 100% vested at the completion of five years of participation in the plan. The Bank's policy is to contribute annually the minimum funding amounts. Employer contributions and administrative expenses charged to operations for 2002, 2001 and 2000 totaled $6,501, $0, and $5,418, respectively. The Bank has a contributory thrift plan, which covers substantially all of the employees. Under the terms of the plan, voluntary employee contributions are matched by up to 6% of the employee base pay and employees are immediately vested. Employer contributions and administrative expenses charged to operations for 2002, 2001 and 2000 were $222,645, $184,331, and $166,577, respectively. (B) EMPLOYEE STOCK OWNERSHIP PLAN - The Corporation has a non-contributory employee stock ownership plan (ESOP) in which employees are eligible to participate upon completion of one year of service. Employees are vested in accordance with a schedule, which provides for 100% vesting upon completion of seven years of service. Shares of the Corporation's common stock are acquired in non-leveraged transactions. At the time of purchase, the shares are released and allocated to eligible employees determined by a formula specified in the plan agreement. Shares in the plan at June 30 and the fair value of shares released during the year charged to compensation expense were as follows: 2002 2001 2000 ---- ---- ---- ESOP shares 199,464 207,045 211,503 Compensation expense $54,000 $56,000 $66,000 46 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. EMPLOYEE BENEFIT PLANS - (CONTINUED) (C) STOCK OPTION PLAN - Under the 1998 Stock Option and Incentive Plan, the Corporation may grant either incentive or non-qualified stock options to key employees for an aggregate of 166,000 shares of the Corporation's common stock at not less than fair market value at the date such options are granted. The option to purchase shares vest over periods of one to five years and expire ten years after the date of grant. At June 30, 2002 options available for future grant under the 1998 Stock Option Plan totaled 79,000. Of the options outstanding at June 30, 2002, 18,000 were granted under a previous plan. A summary of option transactions is as follows:
JUNE 30, --------------------------------------------------------------------------- 2002 2001 2000 ---- ---- ---- WEIGHTED WEIGHTED WEIGHTED NUMBER AVERAGE NUMBER AVERAGE NUMBER AVERAGE OF EXERCISE OF EXERCISE OF EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE ------- ------- ------- ------- ------- -------- Outstanding, beginning of year 104,500 $19.18 102,230 $19.13 55,064 $15.52 Granted during year 10,000 16.23 12,000 17.00 52,500 22.53 Forfeited during year - - (5,000) 24.50 (500) 17.13 Exercised during the year (9,500) 14.32 (4,730) 6.88 (4,834) 15.10 ------- ------- ------- Outstanding, end of year 105,000 $19.34 104,500 $19.18 102,230 $19.13 ======= ======= ======= Eligible for exercise at year end 57,300 47,900 32,230 Weighted average fair value of options granted during the year $ 3.79 $ 4.71 $ 7.06
The following table summarizes information about stock options outstanding at June 30, 2002:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------- ------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE RANGE OF EXERCISE NUMBER REMAINING EXERCISE NUMBER EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE PRICE EXERCISABLE PRICE ------ ----------- ---------------- ----- ----------- ----- $12.50 20,000 1.2 years $12.50 20,000 $ 12.50 $16.00 to $17.00 25,000 8.1 16.57 7,800 16.62 $22.38 to $22.63 52,500 7.6 22.53 25,000 22.58 $24.50 7,500 6.8 24.50 4,500 24.50 ------- ------ 105,000 6.4 $19.34 57,300 $18.40 ======= ======
47 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. EMPLOYEE BENEFIT PLANS - (CONTINUED) The pro-forma effect on net income and earnings per share is as follows: YEAR ENDED JUNE 30, ------------------- 2002 2001 2000 ---- ---- ---- Net income: As reported $7,458,416 $5,649,435 $5,663,342 Pro-forma 7,340,473 5,544,858 5,600,975 Earnings per share: Basic As reported $ 1.99 $ 1.50 $ 1.45 Pro-forma 1.96 1.48 1.43 Diluted As reported $ 1.98 $ 1.50 $ 1.44 Pro-forma 1.95 1.47 1.43 The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions for grants in 2002: 1) expected dividend yields at 4.44%, 2) risk-free interest rates at 4.94%, 3) expected volatility at 28%, and 4) expected life of options at 10 years. Future pro-forma net income will be negatively impacted to the extent more options are granted. 12. CASH FLOW ACTIVITIES The following information is presented as supplemental disclosures to the statement of cash flows for the year ended June 30. (a) Cash paid for: 2002 2001 2000 ---- ---- ---- Interest expense $22,879,246 $26,588,552 $20,613,518 =========== =========== =========== Income taxes $ 4,257,000 $ 3,127,940 $ 2,973,347 =========== =========== =========== (b) Supplemental disclosure of non-cash activities: 2002 2001 2000 ---- ---- ---- Loans to facilitate sales of real estate owned $ 508,889 $120,766 $783,075 ========== ======== ======== Transfers from loans to real estate acquired through foreclosure and repossessed assets $1,419,264 $842,915 $674,465 ========== ======== ======== 48 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 13. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) The following condensed statements summarize the financial position, operating results and cash flows of First Federal Financial Corporation of Kentucky (Parent Company only). CONDENSED STATEMENTS OF FINANCIAL CONDITION JUNE 30, ---------------------- 2002 2001 ---- ---- ASSETS Cash and interest bearing deposits $ 9,363,205 $ 312,275 Investment in subsidiary 58,619,520 54,003,275 Securities available-for-sale 405,362 396,355 Receivable from Bank 266,241 260,426 Other assets 38,019 6,685 ----------- ----------- $68,692,347 $54,979,016 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Trust Preferred Securities $ 9,714,500 $ - Deferred income taxes 363,292 386,739 Stockholders' equity 58,614,555 54,592,277 ---------- ---------- $68,692,347 $54,979,016 =========== =========== CONDENSED STATEMENTS OF INCOME
YEAR ENDED JUNE 30, ---------------------------------------------- 2002 2001 2000 ---- ---- ---- Dividend from subsidiary $2,940,000 $4,900,000 $7,000,000 Interest income 69,733 20,916 52,695 Interest expense (146,284) - - Other expenses (197,360) (169,816) (164,893) --------- --------- ---------- Income before income tax benefit 2,666,089 4,751,100 6,887,802 Income tax benefit 146,932 104,764 93,942 --------- --------- ---------- Income before equity in undistributed net income of subsidiary 2,813,021 4,855,864 6,981,744 Equity in undistributed net income of subsidiary (distributions in excess of net income) 4,645,395 793,571 (1,318,402) ---------- ---------- ---------- Net income $7,458,416 $5,649,435 $5,663,342 ========== ========== ==========
49 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 13. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) - (CONTINUED) CONDENSED STATEMENTS OF CASH FLOWS
YEAR ENDED JUNE 30, ------------------------------------------------ 2002 2001 2000 ---- ---- ---- Operating Activities: Net income $7,458,416 $5,649,435 $5,663,342 Adjustments to reconcile net income to cash provided by operating activities: (Equity in undistributed net income from subsidiary) distributions in excess of net income (4,645,395) (793,571) 1,318,402 Amortization 16,316 - - Decrease (increase) in other assets (31,334) (25,252) 22,344 (Decrease) increase in deferred income taxes (26,509) 250,995 135,744 --------- --------- --------- Net cash provided by operating activities 2,771,494 5,081,607 7,139,832 --------- --------- --------- Investing Activities: Purchases of securities available-for-sale - (32,325) (107,300) Net change in receivable from Bank (5,815) - - -------- --------- --------- Net cash provided (used) by investing activities (5,815) (32,325) (107,300) -------- --------- --------- Financing Activities: Proceeds from stock options exercised 37 32,518 5,762 Net proceeds from issuance of Trust Preferred Securities 9,698,184 - - Dividends paid (2,700,917) (2,704,364) (2,802,833) Common stock repurchases (712,053) (30,000) (8,393,539) Net change in payable to Bank - (2,246,261) 3,773,540 -- ---------- ---------- Net cash used by financing activities 6,285,251 (4,948,107) (7,417,070) - --------- ---------- ---------- Net increase (decrease) in cash 9,050,930 101,175 (384,538) Cash and interest bearing deposits, beginning of year 312,275 211,100 595,638 ----- ------- ---------- ----------- Cash and interest bearing deposits, end of year $ 9,363,205 $ 312,275 $ 211,100 ============ ========== ===========
50 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value of the Corporation's financial instruments are as follows:
JUNE 30, 2002 JUNE 30, 2001 ------------------------------------------------------------------------------- CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE ----- ----- ----- ----- Financial assets: Cash and cash equivalents $ 40,016,230 $ 40,016,000 $ 35,464,388 $ 35,464,000 Interest bearing deposits 64,000,000 64,000,000 - - Investment securities: Securities available-for-sale 1,977,794 1,978,000 2,013,107 2,013,000 Securities held-to-maturity 21,715,391 21,750,000 20,920,760 20,954,000 Loans held for sale 1,511,285 1,534,000 632,321 642,000 Loans, net 518,749,701 533,665,000 516,512,836 526,238,000 Federal Home Loan Bank stock 6,169,600 6,170,000 5,845,000 5,845,000 Accrued interest receivable 1,925,331 1,925,000 2,024,554 2,025,000 Financial liabilities: Deposits (529,882,242) (535,586,000) (468,825,197) (469,719,000) Advances from Federal Home Loan Bank (77,778,070) (79,105,000) (77,297,658) (81,923,000) Trust Preferred Securities (9,714,500) (10,000,000) - - Accrued interest payable (516,122) (516,000) (1,969,545) (1,970,000)
The methods and assumptions used by the Corporation in estimating its fair value disclosures for financial instruments are presented below: Carrying amount is the estimated fair value for cash and cash equivalents, interest bearing deposits, Federal Home Loan Bank stock, accrued interest receivable and payable, demand deposits, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. The value of loans held for sale is based on the underlying sale commitments. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair values of advances from Federal Home Loan Bank is based on current rates for similar financing. The principal amount of the Trust Preferred Securities is the estimated fair value. The fair value of off-balance-sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements and is not material. 15. CONTINGENCIES In the normal course of business, there are various outstanding legal proceedings and claims. In the opinion of management, after consultation with legal counsel, the disposition of such legal proceedings and claims will not materially affect the Corporation's consolidated financial position, results of operations or liquidity. 51 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 16. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of the Bank's involvement in particular classes of financial instruments. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness. The amount of collateral obtained, if it is deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the counterparty. Commitments to make loans, excluding undisbursed portions of loans in process, at June 30 were as follows:
2002 2001 -------------------------- ---------------------------- FIXED VARIABLE FIXED VARIABLE RATE RATE RATE RATE ---- ---- ---- ---- Commitments to make loans $ 627,667 $ - $ 4,231,215 $ 389,500 Unused lines of credit - 45,108,356 - 38,257,649 Standby letters of credit - 4,791,802 - 3,846,000 --------- ----------- ----------- ----------- $ 627,667 $49,900,158 $ 4,231,215 $42,493,149 ========= =========== =========== ==========
Fixed rate loan commitments at June 30, 2002 were at current rates ranging from 7.25% to 7.75%, 4.50% to 17.90% for unused lines of credit and primarily at the national prime rate of interest plus 50 to 200 basis points for standby letters of credit. At June 30, 2002, a reserve of $5,138,000 was required as deposits with the Federal Reserve or as cash on hand. The reserves do not earn interest. At June 30, 2002 and 2001, the Bank had $22,160,000 and $0 in letters of credit from the Federal Home Loan Bank issued to collateralize public deposits. These letters of credit are secured by a blanket pledge of eligible one-to-four family residential mortgage loans. (For additional information see Note 3 on Loans Receivable and Note 6 on Advances from the Federal Home Loan Bank.) At June 30, 2002 and 2001, the Corporation's mortgage banking activities included commitments to extend credit, primarily representing fixed rate mortgage loans, totaling approximately $3.4 and $2.3 million. The commitments are generally for a period of 30 to 60 days and are at market rates. To deliver these loans to the secondary market, the Corporation has entered into "best efforts" forward sales contracts on a loan for loan basis. The Corporation provides for any losses on uncovered loans and commitments to lend or sell. For all periods presented, no such provisions were required. 52 FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 17. RELATED PARTY TRANSACTIONS Certain directors, executive officers and principal shareholders of the Company, including associates of such persons, are loan and deposit customers. Related party deposits at June 30, 2002 and 2001 were $2.9 million and $3.6 million. A summary of the related party loan activity, for loans aggregating $60,000 or more to any one related party, is as follows: JUNE 30, --------------------------------- 2002 2001 ---- ---- Beginning of year $1,389,460 $1,283,427 New loans 643,888 7,726 Repayments (548,452) (68,823) Other changes (294,085) 167,130 ---------- ---------- End of year $1,190,811 $1,389,460 ========== ========== Other changes include adjustments for loans applicable to one reporting period that are excludable from the other reporting period. These loans were made in the ordinary course of business at market interest rates and normal credit terms. 18. SUMMARY OF QUARTERLY FINANCIAL DATA - (UNAUDITED) (Dollars in thousands except per share data)
FISCAL 2002: SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30 ------------ ----------- -------- ------- Total interest income $11,486 $11,046 $10,735 $10,833 Total interest expense 6,166 5,368 4,883 5,009 Net interest income 5,320 5,678 5,852 5,824 Provision for loan losses 300 460 415 429 Non-interest income 1,234 1,407 1,328 1,429 Non-interest expense 3,623 3,657 3,913 4,088 Net income 1,752 1,978 1,925 1,803 Earnings per share: Basic 0.47 0.53 0.51 0.48 Diluted 0.47 0.53 0.51 0.47 FISCAL 2001: SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30 ------------ ----------- -------- ------- Total interest income $10,818 $11,301 $11,662 $11,611 Total interest expense 6,603 7,177 6,933 6,716 Net interest income 4,215 4,124 4,729 4,895 Provision for loan losses 195 306 285 300 Non-interest income 1,313 1,464 1,112 1,256 Non-interest expense 3,256 3,349 3,447 3,518 Net income 1,389 1,305 1,404 1,551 Earnings per share: Basic 0.37 0.35 0.37 0.41 Diluted 0.37 0.35 0.37 0.41
53 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information contained under the sections captioned "Proposal I - Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Corporation's definitive proxy statement for the Corporation's 2002 Annual Meeting of Shareholders (the "Proxy Statement") is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information contained under the sections captioned "Summary Compensation Table," "Option Exercises and Year-end Value Table," "Directors Compensation," and "Retirement Plan" in the Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a) Security Ownership of Certain Beneficial Owners Information required by this item is incorporated herein by reference to the section captioned "Voting Securities and Principal Holders Thereof" in the Proxy Statement (b) Security Ownership of Management Information required by this item is incorporated herein by reference to the sections captioned "Proposal I - Election of Directors" and "Voting Securities and Principal Holders Thereof" in the Proxy Statement. (c) Changes in Control Management of the Corporation knows of no arrangements, including any pledge by any person of securities of the Corporation, the operation of which may at a subsequent date result in a change of control of the Corporation. (d) Securities Authorized for Issuance Under Equity Compensation Plans
NUMBER OF SECURITIES NUMBER OF SECURITIES REMAINING AVAILABLE FOR TO BE ISSUED WEIGHTED-AVERAGE FUTURE ISSUANCE UNDER UPON EXERCISE OF EXERCISE PRICE OF EQUITY COMPENSATION PLANS OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (1)) ------------- ------------------- ------------------- ------------------------ Equity compensation plans approved by security holders 105,000 $19.34 79,000 Equity compensation plans not approved by security holders - - - ------- ------ ------ Total 105,000 $19.34 79,000 ======= ====== ======
Additional information required by this item is incorporated herein by reference to Note 11 of the Notes to Consolidated Financial Statements in the Annual Report. 54 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated herein by reference to the section captioned "Transactions with the Corporation and the Bank" in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 1. Financial Statements Filed (a) (1) Report of Independent Auditors-Crowe, Chizek and Company LLP (b) Consolidated Statements of Financial Condition at June 30, 2002 and 2001. (c) Consolidated Statements of Income for the years ended June 30, 2002, 2001, and 2000. (d) Consolidated Statements of Comprehensive Income for the years ended June 30, 2002, 2001, and 2000. (e) Consolidated Statements of Changes in Stockholders' Equity for the years ended June 30, 2002, 2001, and 2000. (f) Consolidated Statements of Cash Flows for the years ended June 30, 2002, 2001, and 2000. (g) Notes to Consolidated Financial Statements 2. All financial statement schedules have been omitted, as the required information is either inapplicable or included in the financial statements or related notes. 3. Exhibits (3)(a) Articles of Incorporation * (3)(b) Bylaws * (10)(b) First Federal Savings Bank of Elizabethtown Stock Option and Incentive Plan, as amended** (16) Letter re Change in Auditor*** (21) Subsidiaries of the Registrant (23)(a) Consent of Crowe, Chizek and Company LLP, Certified Public Accountants (99)(a) Certification of Principal Executive Officer and (99)(b) Principal Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act 4. The Registrant has filed no reports on Form 8-K for the quarter ending June 30, 2002. * Incorporated by reference to the Corporation's Form S-4 Registration Statement (No. 33-30582). ** Incorporated by reference to Exhibit 10(b) of the Corporation's 1998 definitive proxy statement. *** Incorporated by reference to the Corporation's Form 8-K filed April 20, 1999. 55 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY Date: 9/17/02 By: /s/ B. Keith JOHNSON ----------------------------- B. Keith Johnson President and Chief Executive Officer Duly Authorized Representative Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ B. Keith Johnson By: /s/ Bob Brown -------------------------- ----------------------- B. Keith Johnson Bob Brown Principal Executive Officer Director & Director Date: 9/17/02 Date: 9/17/02 By: /s/ Wreno M. Hall By: /s/ Diane E. Logsdon ------------------------ ----------------------- Wreno M. Hall Diane E. Logsdon Director Director Date: 9/17/02 Date: 9/17/02 By: /s/ J. Alton Rider By: /s/ John L. Newcomb, Jr. ----------------------- ------------------------ J. Alton Rider John L. Newcomb, Jr. Director Director Date: 9/17/02 Date: 9/17/02 By: /s/ Walter D. Huddleston By: /s/ Michael Thomas, DVM ------------------------ ------------------------ Walter D. Huddleston Michael Thomas, DVM Director Director Date: 9/17/02 Date: 9/17/02 By: /s/ Stephen Mouser By: /s/ Charles Chaney ------------------------ ------------------------ Stephen Mouser Charles Chaney Director Chief Operating Officer, Chief Financial Officer & Principal Accounting Officer Date: 9/17/02 Date: 9/17/02 56 CERTIFICATIONS Certification of Principal Executive Officer and Principal Financial Officer for 10-K for Fiscal Ending June 30, 2002 I, B. Keith Johnson, President & Chief Executive Officer of First Federal Financial Corporation of Kentucky, certify that: 1. I have reviewed this annual report on Form 10-K of First Federal Financial Corporation of Kentucky; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; Date: September 27, 2002 By: /s/ B. Keith Johnson ---------------------- B. Keith Johnson President and Chief Executive Officer I, Charles Chaney, Chief Operating Officer, Chief Financial Officer & Principal Accounting Officer of First Federal Financial Corporation of Kentucky, certify that: 1. I have reviewed this annual report on Form 10-K of First Federal Financial Corporation of Kentucky; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; Date: September 27, 2002 By: /s/ Charles Chaney ------------------------ Charles Chaney Chief Operating Officer, Chief Financial Officer & Principal Accounting Officer 57 INDEX TO EXHIBITS EXHIBIT NO. DESCRIPTION ----------- ----------- (3) (a) Articles of Incorporation * (3) (b) Bylaws* (10)(b) First Federal Savings Bank of Elizabethtown Stock Option and Incentive Plan, as amended ** (16) Letter re Change in Auditor*** (21) Subsidiaries of the Registrant (23)(a) Consent of Crowe, Chizek and Company LLP, Certified Public Accountants (99)(a) Certification of Principal Executive Officer and Principal (99)(b) Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act * Incorporated by reference to the Corporation's Form S-4 Registration Statement (No. 33-30582). ** Incorporated by reference to Exhibit 10(b) of the Corporation's 1998 definitive proxy statement. *** Incorporated by reference to the Corporation's Form 8-K filed April 20, 1999. 58 EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT PARENT ------ First Federal Financial Corporation of Kentucky STATE OF PERCENTAGE SUBSIDIARIES INCORPORATION OWNED ------------ ------------- ----------- First Federal Savings Bank United States 100% of Elizabethtown First Service Corporation Kentucky 100% of Elizabethtown (a) First Heartland Mortgage Kentucky 100% of Elizabethtown (a) (a) Wholly-owned subsidiaries of First Federal Savings Bank of Elizabethtown. 59 EXHIBIT 23(A) - CONSENT OF CROWE, CHIZEK AND COMPANY LLP We hereby consent to the incorporation by reference in the Form S-8 Registration Statement No. 33-30582 of First Federal Financial Corporation of Kentucky of our report dated July 19, 2002 on the consolidated financial statements of First Federal Financial Corporation of Kentucky as of June 30, 2002 and 2001 and for each of the three years in the period ending June 30, 2002 as included in the registrant's annual report on Form 10-K. Crowe, Chizek and Company LLP Louisville, Kentucky September 27, 2002 60 CERTIFICATIONS Certification of Principal Executive Officer and Principal Financial Officer I, B. Keith Johnson, certify that: 1. I have reviewed this annual report on Form 10-K of First Federal Financial Corporation of Kentucky; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of t he circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: September 27, 2002 By: /s/ B. Keith Johnson --------------------------- B. Keith Johnson President and Chief Executive Officer 61 CERTIFICATIONS Certification of Principal Executive Officer and Principal Financial Officer I, Charles Chaney, certify that: 1. I have reviewed this annual report on Form 10-K of First Federal Financial Corporation of Kentucky; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of t he circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: September 27, 2002 By: /s/ Charles Chaney ----------------------- Charles Chaney Chief Operating Officer, Chief Financial Officer & Principal Accounting Officer 62