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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
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 (IRS Employer Identification No.)
of incorporation or organization)
2323 Ring Road
Elizabethtown, Kentucky 42701
-----------------------------
(Address of principal executive offices)
(Zip Code)
(270) 765-2131
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
---
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes X No
---
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class Outstanding as of July 31, 2003
----- -------------------------------
Common Stock 3,699,878 shares
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. -Consolidated Financial Statements and Notes to Consolidated
Financial Statements
Item 2. -Management's Discussion and Analysis of the Consolidated
Statements of Financial Condition and Results of Operations
Item 3. -Quantitative and Qualitative Disclosures about Market Risk
Item 4. -Controls and Procedures
PART II - OTHER INFORMATION
SIGNATURES
CERTIFICATIONS
Item 1.
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
Consolidated Statements of Financial Condition
(Unaudited)
(Dollars in thousands, except share data) June 30, December 31,
2003 2002
ASSETS: ---- ----
Cash and due from banks $ 41,317 $ 31,776
Federal funds sold 52,000 60,000
------ ------
Cash and cash equivalents 93,317 91,776
Securities available-for-sale 3,623 1,999
Securities held-to-maturity: fair value of $24,631
(June) and $16,655 (Dec.) 2002 24,532 16,576
Loans held for sale 5,107 3,676
Loans receivable, less allowance for loan losses
of $4,935 (June) and $4,576 (Dec.) 2002 513,988 524,859
Federal Home Loan Bank stock 6,440 6,314
Premises and equipment 13,859 11,672
Real estate owned:
Acquired through foreclosure 596 510
Held for development 549 721
Other repossessed assets 90 119
Goodwill 8,384 8,384
Accrued interest receivable 1,809 1,742
Other assets 1,506 2,108
----- -----
TOTAL ASSETS $673,800 $670,456
======== ========
LIABILITIES:
Deposits:
Non-interest bearing $ 37,126 $ 32,391
Interest bearing 493,344 488,730
------- -------
Total deposits 530,470 521,121
Advances from Federal Home Loan Bank 77,687 77,683
Trust Preferred Securities 9,734 9,728
Accrued interest payable 481 504
Accounts payable and other liabilities 1,917 1,773
----- -----
TOTAL LIABILITIES 620,289 610,809
------- -------
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, 3,696,691 shares in June
and 3,643,706 shares in December 3,697 3,644
Additional paid-in capital 10,212 -
Retained earnings 39,059 55,605
Accumulated other comprehensive
income, net of tax 543 398
--- ---
TOTAL STOCKHOLDERS' EQUITY 53,511 59,647
------ ------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $673,800 $670,456
======== ========
See notes to consolidated financial statements.
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
Consolidated Statements of Income
(Unaudited)
(Dollars in thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
Interest Income: ---- ---- ---- ----
Interest and fees on loans $ 9,451 $10,157 $19,089 $20,489
Interest and dividends on investments and deposits 520 675 1,006 1,078
--- --- ----- -----
Total interest income 9,971 10,832 20,095 21,567
----- ------ ------ ------
Interest Expense:
Deposits 3,113 3,929 6,358 7,889
Federal Home Loan Bank advances 932 935 1,855 1,857
Trust Preferred Securities 129 146 257 146
--- --- --- ---
Total interest expense 4,174 5,010 8,470 9,892
----- ----- ----- -----
Net interest income 5,797 5,822 11,625 11,675
Provision for loan losses 420 428 749 844
--- --- --- ---
Net interest income after provision for loan losses 5,377 5,394 10,876 10,831
----- ----- ------ ------
Non-interest Income:
Customer service fees on deposit accounts 1,133 1,006 2,133 1,855
Gain on sale of mortgage loans 431 140 838 297
Brokerage and insurance commissions 101 136 197 277
Other income 217 146 432 327
--- --- --- ---
Total non-interest income 1,882 1,428 3,600 2,756
----- ----- ----- -----
Non-interest Expense:
Employee compensation and benefits 2,433 1,925 4,669 3,798
Office occupancy expense and equipment 379 375 747 742
Marketing and advertising 150 187 298 350
Outside services and data processing 464 403 931 793
State franchise tax 141 129 282 259
Goodwill amortization - 208 - 416
Other expense 766 859 1,450 1,642
--- --- ----- -----
Total non-interest expense 4,333 4,086 8,377 8,000
----- ----- ----- -----
Income before income taxes 2,926 2,736 6,099 5,587
Income taxes 976 933 2,027 1,859
--- --- ----- -----
Net income $1,950 $1,803 $4,072 $3,728
====== ====== ====== ======
Earnings per share:
Basic $ 0.52 $ 0.44 $ 1.06 $ 0.90
Diluted $ 0.52 $ 0.44 $ 1.05 $ 0.90
See notes to consolidated financial statements.
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
Consolidated Statements of Comprehensive Income
(Unaudited)
(Dollars in thousands)
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
Net Income $1,950 $1,803 $4,072 $3,728
Other comprehensive income (loss):
Change in unrealized gain (loss)
on securities 226 33 220 14
Reclassification of realized amount - - - -
----- ----- ----- -----
Net unrealized gain (loss) recognized in
comprehensive income 226 33 220 14
Tax effect (77) (11) (75) (5)
----- ----- ----- -----
Total other comprehensive income 149 22 145 9
----- ----- ----- -----
Comprehensive Income $2,099 $1,825 $4,217 $3,737
====== ====== ====== ======
See notes to consolidated financial statements.
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
Consolidated Statements of Changes in Stockholders' Equity
(Unaudited)
Accumulated Other
Additional Comprehensive
Paid - in Retained Income,
Shares Amount Capital Earnings Net of Tax Total
------ ------ ------- -------- ---------- -----
Balance, January 1, 2003 3,644 $ 3,644 $ - $55,605 $ 398 $59,647
Net income - - - 4,072 - 4,072
Stock dividend-10% 338 338 10,212 (10,550) - -
Exercise of stock
options, net of redemptions 3 3 - (3) -
Net change in unrealized
gains (losses) on
securities available-
for-sale, net of tax - - - - 145 145
Cash dividends declared
($.36 per share) - - - (1,321) - (1,321)
Stock repurchased (288) (288) - (8,744) - (9,032)
----- ------- ------- ------- ------ -------
Balance, June 30, 2003 3,697 $ 3,697 $10,212 $39,059 $ 543 $53,511
===== ======= ======= ======= ====== =======
See notes to consolidated financial statements.
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)
Six Months Ended
June 30,
2003 2002
Operating Activities: ---- ----
Net income $ 4,072 $ 3,728
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 749 844
Depreciation of premises and equipment 496 517
Federal Home Loan Bank stock dividends (126) (139)
Goodwill amortization - 416
Net amortization (accretion) (219) (10)
Gain on sale of mortgage loans (838) (297)
Origination of loans held for sale (49,991) (18,369)
Proceeds on sale of loans held for sale 49,398 20,070
Changes in:
Interest receivable (67) (409)
Other assets 774 (429)
Interest payable (23) (277)
Accounts payable and other liabilities 70 (507)
----- -----
Net cash from operating activities 4,295 5,138
----- -----
Investing Activities:
Change in interest bearing deposits - (64,000)
Purchases of securities available-for-sale (1,415) -
Purchases of securities held-to-maturity (29,978) (19,000)
Maturities of securities held-to-maturity 22,257 5,121
Net change in loans 10,065 (230)
Net purchases of premises and equipment (2,683) (529)
------ ------
Net cash from investing activities (1,754) (78,638)
------ ------
Financing Activities:
Net increase in deposits 9,349 57,390
Advances from Federal Home Loan Bank 132 726
Repayments to Federal Home Loan Bank (128) (156)
Proceeds from stock options exercised - 37
Net proceeds from issuance of trust preferred securities - 9,699
Dividends paid (1,321) (1,348)
Common stock repurchased (9,032) (712)
------ ------
Net cash from financing activities (1,000) 65,636
------ ------
Increase in cash and cash equivalents 1,541 (7,864)
Cash and cash equivalents, beginning of period 91,776 47,880
------ ------
Cash and cash equivalents, end of period $93,317 $40,016
======= =======
See notes to consolidated financial statements.
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
Notes to Consolidated Financial Statements
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - 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 or First
Federal), and First Federal Statutory Trust I. The Bank has three wholly owned subsidiaries, First Service Corporation of
Elizabethtown, First Heartland Mortgage Company and First Federal Office Park, LLC. All significant intercompany
transactions and balances have been eliminated.
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q
and Rule 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the six-month period ending June 30, 2003 are not necessarily indicative of the results
that may be expected for the year ended December 31, 2003. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Corporation's annual report on Form 10-K for the six-month transitional
period ended December 31, 2002.
On January 8, 2003, the Bank converted from a federal savings bank, regulated by the Office of Thrift Supervision (OTS), to
a commercial bank chartered under Kentucky banking laws regulated by the Federal Deposit Insurance Corporation (FDIC) and
the Kentucky Department of Financial Institutions (KDFI). At the same time, the Corporation became a bank holding company
regulated by the Federal Reserve and changed its fiscal year from June 30 to December 31.
Stock Dividend - The Corporation declared a 10% stock dividend on April 16, 2003, payable on May 14, 2003. The payment of
this dividend is in addition to the regular quarterly cash dividends. Per share amounts have been restated for the impact
of the stock dividend.
Stock Option Plans - Employee compensation expense under stock option plans is reported using the intrinsic value method.
No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to the
market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and
earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting
for Stock-Based Compensation.
(Dollars in thousands Three Months Ended Six Months Ended
except per share data) June 30, June 30,
2003 2002 2003 2002
Net income: ---- ---- ---- ----
As reported $1,950 $1,803 $4,072 $3,728
Pro-forma 1,923 1,774 4,016 3,670
Earnings per share:
Basic As reported $ 0.52 $ 0.44 $1.06 $ 0.90
Pro-forma 0.52 0.43 1.05 0.89
Diluted As reported $ 0.52 $ 0.44 $1.05 $0.90
Pro-forma 0.51 0.43 1.04 0.89
New Accounting Pronouncements - On October 1, 2002, new guidance was issued on the accounting for financial institution
acquisitions. Under this new guidance, if certain criteria are met, the amount of the unidentifiable intangible asset
resulting from prior acquisitions is to be reclassified to goodwill commensurate with the previously adopted business
combination standards. Accordingly, the Corporation reclassified $6.6 million of previously recognized unidentifiable
intangible assets to goodwill effective July 1, 2002. Thus, the acquisition intangibles consist solely of goodwill, which
is no longer amortized. The effect on net income of ceasing goodwill amortization for the three months and six months ended
June 30, 2003 was $208,000 and $416,000 and will be $832,000 on an annual basis.
The effect of not amortizing goodwill, net of tax effects, is summarized as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
Reported net income $ 1,950 $ 1,925 $ 4,072 $ 3,728
Add back: goodwill amortization
(net of tax) - 158 - 316
--------- ----------- -------- --------
Adjusted net income $ 1,950 $ 2,083 $ 4,072 $ 4,044
========= =========== ======== ========
Basic earnings per share:
Reported net income $ 0.52 $ 0.44 $ 1.06 $ 0.90
Goodwill amortization - .04 - .08
--------- ----------- -------- --------
Adjusted net income $ 0.52 $ 0.48 $ 1.06 $ 0.98
========= =========== ======== ========
Diluted earnings per share:
Reported net income $ 0.52 $ 0.44 $ 1.05 $ 0.90
Goodwill amortization - .04 - .08
--------- ----------- -------- --------
Adjusted net income $ 0.52 $ 0.48 $ 1.05 $ 0.98
========= =========== ======== ========
Newly Issued But Not Yet Effective Accounting Standards - The Financial Accounting Standards Board (FASB) recently issued
two new accounting standards, Statement 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities,
and Statement 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equities, both
of which generally become effective in the quarter beginning July 1, 2003. Management determined that, upon adopting the
new standards, they will not materially affect the Corporation's operating results of financial condition.
Reclassifications - Certain amounts have been reclassified in the prior period financial statements to conform to the
current period classifications.
2. SECURITIES
The amortized cost basis and fair values of securities are as follows:
Gross Gross
(Dollars in thousands) Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
Securities available-for-sale: ---- ----- ------ ----------
June 30, 2003:
Equity securities $ 1,874 $ 664 $ - $ 2,538
State and municipal 999 86 - 1,085
------- ------ ----- -------
Total available-for-sale $ 2,873 $ 750 $ - $ 3,623
======= ====== ===== =======
December 31, 2002:
Equity securities $ 385 $ 532 $ (3) $ 914
State and municipal 1,010 75 - 1,085
------- ------ ----- -------
Total available-for-sale $ 1,395 $ 607 $ (3) $ 1,999
======= ====== ===== =======
Gross Gross
(Dollars in thousands) Amortized Unrecognized Unrecognized
Cost Gains Losses Fair Value
Securities held-to-maturity: ---- ----- ------ ----------
June 30, 2003:
U.S. Treasury and agencies $12,000 $ 62 $ - $12,062
Corporate Bond 2,000 - 2,000
Mortgage-backed securites 10,532 37 - 10,569
------- ------ ----- -------
Total held-to-maturity $24,532 $ 99 $ - $24,631
======= ====== ===== =======
December 31, 2002:
U.S. Treasury and agencies $13,986 $ 65 $ - $14,051
Corporate Bond 2,000 - - 2,000
Mortgage-backed securities 590 14 - 604
------- ------ ----- -------
Total held-to-maturity $16,576 $ 79 $ - $16,655
======= ====== ===== =======
3. LOANS RECEIVABLE
Loans receivable are summarized as follows:
June 30, December 31,
(Dollars in thousands) 2003 2002
---- ----
Commercial $ 26,458 $ 29,024
Real estate commercial 157,216 135,191
Real estate construction 15,765 12,674
Residential mortgage 244,569 282,437
Consumer and home equity 51,770 51,215
Indirect consumer 24,678 20,594
------ ------
Total loans 520,456 531,135
------- -------
Less:
Net deferred loan origination fees (1,533) (1,700)
Allowance for loan losses (4,935) (4,576)
------ ------
(6,468) (6,276)
------- -------
Loans Receivable $513,988 $524,859
======== ========
The allowance for losses on loans is summarized as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in thousands)
Allowance for loan losses:
Balance, beginning of period $ 4,679 $ 3,497 $ 4,576 $ 3,284
Provision for loan losses 420 428 749 844
Charge-offs (224) (226) (483) (490)
Recoveries 60 36 93 97
------- ------- ------- -------
Balance, end of period $ 4,935 $ 3,735 $ 4,935 $ 3,735
======= ======= ======= =======
Investment in impaired loans is summarized below. There were no impaired loans for the periods presented without an
allowance allocation.
June 30, December 31,
(Dollars in 2003 2002
thousands) ---- ----
End of period impaired loans $4,674 $4,584
Amount of allowance for loan
loss allocated 864 751
Non-performing loans were as follows:
June 30, December 31,
(Dollars in thousands) 2003 2002
---- ----
Restructured $3,257 $3,325
Loans past due over 90 days still
on accrual - -
Non accrual loans 1,417 1,259
4. EARNINGS PER SHARE
The reconciliation of the numerators and denominators of the basic and diluted EPS is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in thousands) (In thousands)
Net income available
to common shareholders $1,950 $1,803 $4,072 $3,728
====== ====== ====== ======
Basic EPS:
Weighted average common shares 3,710 4,114 3,835 4,123
===== ===== ===== =====
Diluted EPS:
Weighted average common shares 3,710 4,114 3,835 4,123
Dilutive effect of stock options 44 14 42 15
Weighted average common and ----- ----- ----- -----
incremental shares 3,754 4,128 3,877 4,138
===== ===== ===== =====
Earnings Per Share:
Basic $0.52 $0.44 $1.06 $0.90
===== ===== ===== =====
Diluted $0.52 $0.44 $1.05 $0.90
===== ===== ===== =====
Stock options for 7,500 and 6,050 shares of common stock were not included in the three-month and six-month periods ended
June 30, 2002 computations of diluted earnings per share because their impact was anti-dilutive.
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Statements contained in 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.
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 forward-looking statements. Some of the events or circumstances that could cause such difference include the following: changes
in general economic conditions and economic conditions in Kentucky and the markets served by the Corporation any of which may affect,
among other things, the level of non-performing assets, charge-offs, and provision expense; changes in the interest rate environment
which may reduce interest margins and impact funding sources; changes in market rates and prices which may adversely impact the value
of financial products including securities, loans and deposit; changes in tax laws, rules and regulations; various monetary and
fiscal policies and regulations, including those determined by the Federal Reserve Board, the Federal Deposit Insurance Corporation
and the Kentucky Department of Financial Institutions; competition with other local and regional commercial banks, savings banks,
credit unions and other non-bank financial institutions; ability to grow core businesses; ability to develop and introduce new
banking-related products, services and enhancements and gain market acceptance of such products; and management's ability to manage
these and other risks.
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
The Corporation, through its banking subsidiary, First Federal, conducts operations in the Kentucky communities of Elizabethtown,
Radcliff, Bardstown, Munfordville, Shepherdsville, Mt. Washington, Brandenburg, Flaherty, and Hillview. The Bank offers a wide range
of financial products and services, including checking, savings and time deposit accounts; real estate, commercial and consumer
loans, and investment and trust services.
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. The amount and composition of interest-earning assets and interest-bearing liabilities,
changes in market interest rates, and the Bank's ability to manage the sensitivity of its interest-earning assets and
interest-bearing liabilities to changing rates can all have a material effect on net income. Management considers interest rate risk
to be the Bank's most significant market risk.
The Corporation's and the Bank's activities are subject to supervision and examination by federal and state bank regulatory
agencies. The Bank's capital position is directly related to its capacity to make loans, its assets that earn the highest interest
rates. The Bank must remain "well capitalized" in accordance with regulatory standards to offer some specific lending and financial
services.
Loan quality directly affects the Bank's financial results, as loan losses reduce net interest income and capital. The Bank maintains
rigorous underwriting policies and procedures in originating loans, regularly monitors the performance and risk elements of its loan
portfolio, and maintains a loan loss allowance at a level deemed sufficient to absorb probable credit losses in the loan portfolio.
See "Allowance and Provision for Loan Losses" and "Non-Performing Assets."
The Bank's conversion to a state-chartered commercial bank in January 2003 is part of its strategic plan to increase the financial
products and services it offers to small business and retail customers and to expand into growing markets in its region. Management
believes the transition has been responsible for the renewed growth in lending and certificates of deposit. An important element of
this strategy has been to develop a bank-wide service and sales culture emphasizing expanded account relationships. To achieve this
goal, the Bank has increased the number of associates in banking centers, relationship bankers, business development officers,
stockbrokers, and loan officers with experience in commercial lending. The strategy also involves greater emphasis on originating
commercial and consumer loans, which generally earn higher rates of interest and have shorter terms than residential mortgage loans.
The Bank has adjusted its lending practices and risk management policies to reflect the greater risk involved with commercial and
consumer lending.
This discussion and analysis covers material changes in the financial condition since December 31, 2002 and material changes in the
results of operations for the three-month period ending, June 30, 2003. It should be read in conjunction with "Management Discussion
and Analysis of Financial Condition and Results of Operations" included in the Annual Report on Form 10-K for the six-month
transitional period ended December 31, 2002.
RECENT DEVELOPMENTS
Effective July 1, 2003, the Corporation joined the Russell 3000 Index and will remain in place for one year in the small-cap Russell
2000 Index. Annual reconstitution of the Russell indexes captures the 3,000 largest U.S. stocks as of the end of May, ranking them
by total market capitalization to create the Russell 3000. The largest 1,000 companies in the ranking compromise the Russell 1000
Index while the remaining 2,000 companies become the widely used Russell 2000 Index. Membership in Russell's 21 U.S. equity indexes
is determined primarily by market capitalization rankings and style attributes. Russell indexes are widely used by managers for
index funds and as benchmarks for both passive and active investment strategies.
OVERVIEW
On January 8, 2003, the Bank converted from a federal savings bank, regulated by the Office of Thrift Supervision (OTS), to a
commercial bank chartered under Kentucky banking laws regulated by the Federal Deposit Insurance Corporation (FDIC) and the Kentucky
Department of Financial Institutions (KDFI). At the same time, the Corporation became a bank holding company regulated by the
Federal Reserve and changed its fiscal year from June 30 to December 31. All regulatory filing and compliance requirements have been
met and approved by the FDIC and the Federal Reserve. The creation of a subsidiary of the Bank, First Federal Office Park, LLC was a
result of the charter conversion. The subsidiary represents a means by which the Bank will complete the liquidation of commercial
lots adjacent to the Ring Road Home Office location in Elizabethtown.
Net income for the quarter ended June 30, 2003 was $1.9 million or $0.52 per share diluted compared to $1.8 million or $0.44 per
share diluted for the same period in 2002. In addition to the higher net income, the 18% increase in diluted earnings per share was
also attributable to the Corporation's stock repurchase plans which have reduced the weighted average number of shares outstanding
from 4,114,396 for the 2002 period to 3,710,469 for 2003.
Net income for the six months ended June 30, 2003 was $4.1 million or $1.05 per share diluted compared to $3.7 million or $0.90 per
share diluted for the same period in 2002. The increase in earnings for 2003 was primarily attributable to an absence of goodwill
amortization and an increase in gain on sale of mortgage loans. The Bank's book value per common share increased from $14.29 at June
30, 2002 to $14.48 at June 30, 2003. Annualized net income for 2003 generated a return on average assets of 1.20% and a return on
average equity of 14.48%. These compare with a return on average assets of 1.16% and a return on average equity of 12.83% for the
2002 period also annualized.
The Bank's total assets at June 30, 2003 increased to $673.8 million compared to $670.5 million at December 31, 2002. The increase
in assets resulted from an increase in the Bank's available-for-sale and held-to-maturity investment portfolio, a direct result of
the increase in retail deposits, offset by a decrease in net loans. During the quarter ended June 30, 2003, the Bank invested in two
mortgage-backed securities with fixed rate terms of five and seven years. Net loans decreased $10.9 million from December 31, 2002
to $514.0 million at June 30, 2003. Residential mortgage loans decreased by $37.9 million during the 2003 period as declining market
interest rates caused an increase in 1-4 family refinancing activity into fixed-rate, secondary market loan products. The growth in
the commercial real estate portfolios remained strong, increasing by $22.0 million to $157.2 million at June 30, 2003. This growth
is a result of the Bank's continued emphasis on the active pursuit of lending opportunities that meet its lending criteria. In
addition, the Bank has hired a dealer loan specialist to expand its dealer loan program, which increased $4.1 million to $24.7
million at June 30, 2003, and is expected to continue to increase.
Premises and equipment increased by $2.2 million due to the purchase of three lots and the reclassification of land previously
classified as held for development. Two of the lots are located in high-growth market areas in Louisville, Kentucky. Currently
under construction on these lots are two traditional banking centers. The banking centers are anticipated to be operational during
the March 2004 quarter. A unique building design has been developed for all future banking centers for the purpose of branding our
image.
Deposits increased by $9.3 million to $530.5 million at June 30, 2003 compared to $521.1 million at December 31, 2002. The increase
in retail deposits was primarily non-interest bearing demand deposits and savings and money market accounts caused in part by a shift
in funds from the stock market to more conservative investments such as bank deposits. 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, to enhance its
regulatory capital position.
APPLICATION OF 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 States of America 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 "Note to Consolidated Financial Statements" in the 2002 10-K for details -regarding all of the Corporation's
critical and significant accounting policies.
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 the quarter ended June 30, 2003, net interest income remained constant at $5.8 million compared to $5.8 million for the 2002
quarter. The Bank's net interest margin declined on an annualized basis from 3.71% during the 2002 quarter to 3.63% for the 2003
period. Reductions in the federal discount rate by the Federal Reserve tightened the margin during the past twelve months as customer
deposit interest rates could not adjust downward in a corresponding relationship to the declining interest yields on loans and
investments. However, on a comparative basis to the March 2003 quarter, the net interest margin experienced no further decline.
Net interest income for the six months ended June 30, 2003 also remained relatively constant at $11.6 million compared to $11.7
million for the 2002 period. On an annualized basis, the net interest margin decreased from 3.83% for 2002 to 3.64% for 2003. The
net interest rate spread on an annualized basis decreased from 3.52% during 2002 to 3.38% in 2003. The net interest margin declined
due to a reduction in short-term market interest rates by the Federal Reserve, which occurred in November 2002. Customer deposit
interest rates could not adjust downward in a corresponding relationship to the falling interest yields on loans and investments.
Additionally, a heavy volume of residential mortgage loans were refinanced into the secondary market reducing the Bank's residential
mortgage loan portfolio by $37.9 million. Although the Bank grew commercial real estate loans by $22.0 million, the remaining
decline in the Bank's loan portfolio, coupled with a growth in customer deposits, resulted in a $10 million increase in the Bank's
investment portfolio. Management believes the investment in two mortgage-backed securities will have a positive impact on the Bank's
net interest margin in the future. (For additional analysis on the effect of increasing and decreasing interest rates on the
Corporation's net interest margin, see the interest rate sensitivity model under "Asset/Liability Management and Market Risk.")
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.
Quarter Ended June 30,
----------------------------------------------------------------------------------------
2003 2002
Average Average Average Average
Balance Interest Yield/Cost (5) Balance Interest Yield/Cost (5)
------- -------- -------------- ------- -------- --------------
ASSETS (Dollars in thousands)
Interest earning assets:
Equity securities $ 2,056 $ 18 3.50% $ 932 $ 10 4.29%
State and political subdivision
securities (1) 1,086 16 5.89 1,022 18 7.05
U.S. Treasury and agencies 12,999 81 2.49 15,743 202 5.13
Corporate Bond 2,000 16 3.20 - - -
Mortgage-backed securities 8,126 80 3.94 762 11 5.78
Loans receivable (2) (3) (4) 524,656 9,452 7.21 520,812 10,157 7.80
FHLB stock 6,392 64 4.01 6,115 72 4.71
Interest bearing deposits and
Federal funds 82,055 250 1.22 82,453 369 1.79
------- ----- ---- ------- ------ ----
Total interest earning assets 639,370 9,977 6.24 627,839 10,839 6.91
Less: Allowance for loan losses (4,830) (3,622)
Non-interest earning assets 43,038 37,898
------- -------
Total assets $677,578 $662,115
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
Savings accounts $78,642 $ 205 1.04% $73,288 $ 399 2.18%
NOW and money market
Accounts 113,071 253 0.90 108,469 387 1.43
Certificates of deposit and
other time deposits 305,419 2,655 3.48 304,716 3,143 4.13
FHLB Advances 77,710 933 4.80 77,806 935 4.81
Trust Preferred Securities 9,732 128 5.26 9,707 146 6.02
------- ----- ---- ------- ----- ----
Total interest bearing 584,574 4,174 2.86 573,986 5,010 3.49
liabilities
Non-interest bearing liabilities:
Non-interest bearing deposits 35,985 25,503
Other liabilities 3,768 4,153
------- -------
Total liabilities 624,327 603,642
Stockholders' equity 53,251 58,473
------- -------
Total liabilities and
stockholders' equity $677,578 $662,115
======== ========
Net interest income $5,803 $5,829
====== ======
Net interest spread 3.38% 3.42%
==== ====
Net interest margin 3.63% 3.71%
==== ====
- -----------------------------------------------------
(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.
(5) Annualized
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.
Six Months Ended June 30,
-----------------------------------------------------------------------------------------
2003 2002
Average Average Average Average
Balance Interest Yield/Cost (5) Balance Interest Yield/Cost (5)
------- -------- ------------- ------- -------- -------------
ASSETS (Dollars in thousands)
Interest earning assets:
Equity securities $ 1,567 $ 26 3.32% $ 939 $ 17 3.62%
State and political subdivision
securities (1) 1,086 33 6.08 1,019 36 7.07
U.S. Treasury and agencies 11,995 182 3.03 11,130 274 4.92
Corporate Bond 2,000 34 3.40 - - -
Mortgage-backed securities 4,893 86 3.52 785 22 5.61
Loans receivable (2) (3) (4) 525,768 19,090 7.26 521,330 20,489 7.86
FHLB stock 6,359 126 3.96 6,079 139 4.57
Interest bearing deposits and
Federal funds 86,406 530 1.23 68,582 603 1.76
------- ------ ---- ------- ------ ----
Total interest earning assets 640,074 20,107 6.28 609,864 21,580 7.08
Less: Allowance for loan losses (4,740) (3,491)
Non-interest earning assets 41,710 36,316
-------- --------
Total assets $677,044 $642,689
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
Savings accounts $77,808 $ 423 1.09% $67,882 $ 768 2.26%
NOW and money market
Accounts 112,607 512 0.91 104,572 747 1.43
Certificates of deposit and
other time deposits 305,539 5,423 3.55 300,771 6,374 4.24
FHLB Advances 77,709 1,855 4.77 77,646 1,858 4.79
Trust Preferred Securities 9,731 257 5.28 5,547 146 5.26
------- ----- ---- ------- ----- ----
Total interest bearing 583,394 8,470 2.90 556,418 9,893 3.56
liabilities
Non-interest bearing liabilities:
Non-interest bearing deposits 33,764 23,659
Other liabilities 3,657 4,509
------- -------
Total liabilities 620,815 584,586
Stockholders' equity 56,229 58,103
Total liabilities and ------- -------
stockholders' equity $677,044 $642,689
======== ========
Net interest income $11,637 $11,687
======= =======
Net interest spread 3.38% 3.52%
==== ====
Net interest margin 3.64% 3.83%
==== ====
- ---------------------------------------------------
(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.
(5) Annualized
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.
Three Months Ended Six Months Ended
June 30, June 30,
2003 vs. 2002 2003 vs. 2002
------------- -------------
Increase (decrease) Increase (decrease)
Due to change in Due to change in
(Dollars in thousands)
Net Net
Rate Volume Change Rate Volume Change
---- ------ ------ ---- ------ ------
Interest income:
Equity securities $ (2) $ 10 $ 8 $ (2) $ 11 $ 9
State and political subdivision
securities (3) 1 (2) (6) 3 (3)
U.S. Treasury and agencies (90) (31) (121) (112) 20 (92)
Corporate bond 12 4 16 17 17 34
Mortgage-backed securities (5) 74 69 (11) 75 64
Loans (780) 75 (705) (1,572) 173 (1,399)
FHLB stock (11) 3 (8) (19) 6 (13)
Interest bearing deposits and
federal funds (117) (2) (119) (208) 135 (73)
---- -- ---- ---- --- ---
Net Change in Interest Income (996) 134 (862) (1,913) 440 (1,473)
---- --- ---- ------ --- ------
Interest expense:
Savings accounts (221) 27 (194) (445) 100 (345)
NOW and money market accounts (150) 16 (134) (289) 54 (235)
Certificates of deposit and other
time deposits (495) 7 (488) (1,051) 100 (951)
FHLB advances (1) (1) (2) (5) 2 (3)
Trust preferred securities (19) 1 (18) (9) 120 111
--- - --- -- --- ---
Net Change in Interest Expense (886) 50 (836) (1,799) 376 (1,423)
---- -- ---- ------ --- ------
Decrease in net interest income $ (110) $ 84 $ (26) $ (114) $ 64 $ (50)
====== ==== ===== ======= ==== =======
Non-Interest Income-Non-interest income was $1.9 million for the quarter ended June 30, 2003, as compared to $1.4 million for the
2002 period, an increase of $454,000 or 32%. The increased level of non-interest income during 2003 was primarily due to increased
gains on sale of mortgage loans and to a lesser extent, other income. Offsetting these increases were decreases in brokerage and
insurance commissions. Gain on sale of mortgage loans increased by $291,000 to $431,000 for 2003 compared to 2002 as declining market
interest rates continued 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. All other non-interest increased by $163,000 or
13% during the 2003 quarter compared to the 2002 quarter, resulting from the growth in customer deposits and the sale of fee based
products.
Non-interest income was $3.6 million for the six months ended June 30, 2003, as compared to $2.8 million for the same period last
year. Customer service fees on deposit accounts increased by $278,000 or 15% during 2003 due to growth in customer deposits,
overdraft fee income on retail checking accounts and the sale of fee based products. Gain on sale of mortgage loans increased by
$541,000 to $838,000 for 2003 compared to 2002 due to the high level of refinancing activity. Income from brokerage commissions and
insurance sales decreased $80,000 as a result of a decline in demand for these products. Other income increased during the 2003
period by $105,000 primarily due to the creation of First Heartland Title, LLC, a subsidiary of the Bank that provides title
insurance coverage for mortgage borrowers. The subsidiary is a joint venture with a local title insurance company with the Bank
retaining a 48% ownership. The new LLC generated $60,000 in income for the six months ended June 30, 2003.
Non-Interest Expense- Non-interest expense increased during the quarter and six-month period ended June 30, 2003 compared to the same
period in 2002. The most significant factors impacting the increase in non-interest expense for the quarter and six-months ended
June 30, 2003 include an increase in staffing levels, employee benefits expense and a change in accounting rules in which goodwill
amortization expense from acquisitions is no longer recorded. Moderate increases in non-interest expense are likely going forward as
the Bank broke ground during May 2003 on two traditional banking centers in high-growth market areas in Louisville, Kentucky. These
banking centers are anticipated to be operational during the March 2004 quarter. The Bank intends to close its existing supermarket
banking center located within one-half mile of the southern Louisville banking center currently under construction. 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 ratio is indicative of higher bank performance. The Bank's efficiency ratio was 56% for
the quarter in both 2003 and 2002.
Employee compensation and benefits, the largest component of non-interest expense, increased $508,000 for the 2003 quarter compared
to the 2002 quarter, and $871,000 for the six months ended June 30, 2003 compared to June 30, 2002. The increase in employee
compensation reflects higher incentive bonuses for performance and Bank profitability coupled with growth in the overall staffing
level from 227 full-time equivalent employees at June 30, 2002 to 259 full-time equivalent employees at June 30, 2003. The Bank's
continued emphasis on building its commercial and retail staff to reflect its commercial bank strategy was the largest contributing
factor. The increase in employee benefits for the 2003 six month period compared to the 2002 period of $154,000 reflects the
increased cost for the defined benefit plan. Although the plan was frozen as of March 2003, continuing plan contributions may be
required based on economic conditions in the stock and bond markets.
As a result of adopting new accounting standards on July 1, 2002, the Corporation ceased annual amortization of $832,000 on remaining
goodwill assets of $8.4 million. Annual impairment testing will be required for goodwill with impairment being recorded if the
carrying amount of goodwill exceeds its implied fair value. Goodwill amortization expense reported for the quarter and six months
ended June 30, 2002 was $208,000 and $416,000. All other non-interest expenses declined $53,000 to $1.9 million during the 2003
quarter compared to the 2002 quarter.
ALLOWANCE AND PROVISIONS 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. 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 increased the amount of the allowance allocated to commercial loans and
consumer loans 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 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. In addition, the Bank has hired a dealer loan specialist to expand its dealer loan program. Estimating the allowance 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.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in thousands)
Balance-beginning of period $4,679 $3,497 $4,576 $3,284
------ ------ ------ ------
Loans charged-off:
Real estate mortgage (44) (25) (45) (25)
Consumer (180) (201) (370) (357)
Commercial - - (68) (108)
---- ---- ---- ----
Total charge-offs (224) (226) (483) (490)
---- ---- ---- ----
Recoveries:
Real estate mortgage - 1 - 2
Consumer 60 34 93 65
Commercial - 1 - 30
---- ---- ---- ----
Total recoveries 60 36 93 97
----- ----- ----- -----
Net loans charged-off (164) (190) (390) (393)
----- ----- ----- -----
Provision for loan losses 420 428 749 844
------ ------ ------ ------
Balance-end of period $4,935 $3,735 $4,935 $3,735
====== ====== ====== ======
Net charge-offs to average
loans outstanding .15% .15%
Allowance for loan losses to
total non-performing loans 106 % 100%
Allowance for loan losses
to net loans outstanding .96% .72%
The provision for loan losses decreased to $420,000 for the quarter ended June 30, 2003 compared to $428,000 for the 2002 quarter.
The provision also decreased for the six-month period ended June 30, 2003 to $749,000 compared to $843,000 for the 2002 period. The
total allowance for loan losses increased $1.2 million to $4.9 million from June 30, 2002 to June 30, 2003. Management increased the
allowance for loan losses due to changes in loan classifications and charge-off estimates, the increase in non-performing loans,
which reflect the generally recognized slowing in the U.S. economy, and continued strong growth in commercial real estate lending.
The provision decreased for the 2003 six-month period due to a change in the non-classified commercial real estate estimated loss
percentage, which increased .20% during the March 2002 quarter. Net loan charge-offs decreased $26,000 to $164,000 for the quarter
ended June 30, 2003 compared to $190,000 for the same period in 2002 and remained relatively constant for the June 30 six-month
period.
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, 2003, on the basis of
management's review of the Bank's loan portfolio, the Bank had $5.5 million of assets classified substandard, $1.0 million classified
as doubtful, $0 classified as specific allowance, $7.8 million classified as special mention and $76,000 of assets classified as
loss.
Classified loan ranges of estimated loss are as follows: Substandard-2.5% to 35%; Doubtful-5% to 50%; Loss-100%; Special Mention-2%
to 10%; and Specific Allowance-100%. The Bank additionally provides a reserve estimate for incurred losses in non-classified loans
ranging from .20% to 3.50%. Allowance estimates are developed by the Bank in consultation with regulatory authorities, actual 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 certain restructured loans where interest rate or other terms have been renegotiated, 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. Loans, including impaired loans under SFAS 114, are placed on non-accrual status
when they become past due 90 days or more as to principal or interest, unless they are adequately secured and in the process of
collection. 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.
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 the volume of 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. New and used automobile, motorcycle and all terrain vehicles acquired by the Bank as a result of
foreclosure are classified as repossessed assets until they are 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 and non-interest
expense.
The following table sets forth information with respect to the Bank's non-performing assets for the periods indicated.
June 30, December 31,
2003 2002
---- ----
(Dollars in thousands)
Restructured $3,257 $3,325
Past due 90 days still on accural - -
Loans on non-accrual status 1,417 1,259
----- -----
Total non-performing loans 4,674 4,584
Real estate acquired
through foreclosure 596 510
Other repossessed assets 90 119
------ ------
Total non-performing assets $5,360 $5,213
====== ======
Interest income that would have
been earned on non-performing loans $ 170 $ 177
Interest income recognized
on non-performing loans 130 158
Ratios: Non-performing loans
to net loans .91% .87%
Non-performing assets
to net loans 1.04% .99%
During the quarter ended June 30, 2002, the Bank restructured approximately $3.3 million in commercial and residential mortgage
loans. The terms of these loans were renegotiated to reduce the rate of interest and extend the term thus reducing the amount of
cash flow required from the borrower to service the loan. The new terms of the restructured loans are currently being met.
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, and principal and interest payments from loans and securities.
The Corporation's banking centers also provide access to retail deposit markets. 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 can use a number of funding sources in order to meet liquidity requirements, FHLB borrowings remain
a material component of management's balance sheet strategy. At June 30, 2003, the Bank had an unused approved line of credit in the
amount of $65.1 million and sufficient collateral to borrow an additional $76.4 million in advances from the FHLB.
CAPITAL
During the six-month period ended June 30, 2003, the Corporation purchased 287,343 shares of its own common stock. As a result,
total capital decreased by $8.5 million, which in turn reduced consolidated regulatory capital. The Corporation and the Bank
continued to be well capitalized after the transaction. The Corporation's stock repurchase programs have generally authorized the
repurchase of up to 10% of the Corporation's outstanding stock from time to time in the open market or private transactions during an
18-month period. Management considers repurchasing shares when the financial and other terms of the purchase and its impact on
earnings per share and other financial measures offer an attractive return to stockholders. The Corporation adopted its most recent
plan on March 18, 2003.
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 declined to 8.31% year to date June 30, 2003 compared to 9.04% on June 30, 2002 due principally to stock repurchases.
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, 2003: Amount Ratio Amount Ratio Amount Ratio
Total risk-based capital (to risk- ------ ----- ------ ----- ------ -----
weighted assets)
Consolidated $59,645 12.3% $38,804 8.0% $48,505 10.0%
Bank 57,309 11.9 38,626 8.0 48,282 10.0
Tier I capital (to risk-weighted
assets)
Consolidated 54,522 11.2 19,402 4.0 29,103 6.0
Bank 52,186 10.8 19,313 4.0 28,969 6.0
Tier I capital (to average assets)
Consolidated 54,522 8.1 26,746 4.0 33,433 5.0
Bank 52,186 7.8 26,690 4.0 33,363 5.0
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.
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 was more asset sensitive at June 30, 2003 compared to December 31, 2002. Given a sustained
100 basis point decrease in rates, the Bank's base net interest income would decrease by an estimated 4.67% at June 30, 2003 compared
to a decrease of 2.83% at December 31, 2002. Given a 100 basis point increase in interest rates the Bank's base net interest income
would increase by an estimated 3.11% at June 30, 2003 compared to an increase of 1.70% at December 31, 2002.
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, decay rates and prepayment speed assumptions. Our previous disclosures of sensitivity included growth rates for
loans and deposits. To provide improved period-to-period comparisons, the tables are now presented absent these growth estimates.
As demonstrated by the June 30, 2003 and December 31, 2002 sensitivity tables presented below, the bank is transitioning away from a
liability sensitive institution to a more asset sensitive institution. The current reporting period improvement in the bank's asset
sensitivity is a result of changes in the loan portfolio to a greater extent than the investment portfolio. While lending practices
have shifted to shorter term, variable rate commercial and consumer loans, that impact will be evidenced in smaller degrees over time.
The Corporation's sensitivity to interest rate changes is presented based on data as of June 30, 2003 and December 31, 2002
annualized to a one year period.
Interest Rate Sensitivity Table
June 30, 2003
Decrease in Rates Increase in Rates
200 100 100 200
(Dollars in thousands) Basis Points Basis Points Base Basis Points Basis Points
Projected interest income
Loans $32,931 $34,711 $36,319 $37,730 $39,029
Investments 1,154 1,233 2,292 3,294 4,246
----- ----- ----- ----- -----
Total interest income 34,085 35,944 38,611 41,024 43,275
Projected interest expense
Deposits 7,846 8,951 10,419 12,008 13,597
Borrowed funds 4,057 4,135 4,213 4,291 4,369
----- ----- ----- ----- -----
Total interest expense 11,903 13,086 14,632 16,299 17,966
Net interest income $22,182 $22,858 $23,979 $24,725 $25,309
Change from base $(1,797) $(1,121) $746 $1,330
% Change from base (7.49)% (4.67)% 3.11% 5.55%
Interest Rate Sensitivity Table
December 31, 2002
Decrease in Rates Increase in Rates
200 100 100 200
(Dollars in Thousands) Basis Points Basis Points Base Basis Points Basis Points
Projected interest income (Dollars in thousands)
Loans $35,590 $37,261 $38,733 $39,982 $41,111
Investments 704 1,309 2,331 3,326 4,324
--- ----- ----- ----- -----
Total interest income 36,294 38,570 41,064 43,308 45,435
Projected interest expense
Deposits 8,149 9,453 11,081 12,830 14,583
Borrowed funds 4,033 4,130 4,267 4,325 4,422
----- ----- ----- ----- -----
Total interest expense 12,182 13,583 15,348 17,155 19,005
Net interest income $24,112 $24,987 $25,716 $26,153 $26,430
Change from base $(1,604) $(729) $437 $714
% Change from base (6.24) (2.83)% 1.70% 2.78%
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The information for this item is incorporated by reference to the Asset/Liability Management and Market Risks section on pages 22 and
23 of Part I, Item 2., Management's Discussion and Analysis of Financial Condition and Results of Operations, of this report.
Item 4. Controls and Procedures
As of the end of the period covered by this report, the Corporation carried out an evaluation, under the supervision and with the
participation of the Corporation's management, including the Corporation's Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the design and operation of the Corporation's disclosure controls and procedures. Based on the foregoing, the
Corporation's Chief Executive Officer and Chief Financial Officer concluded that the Corporation's disclosure controls and procedures
were effective, in all material respects, to ensure that information required to be disclosed in the reports the Corporation files
and submits under the Exchange Act is recorded, processed, summarized and reported as and when required.
The Corporation also conducted an evaluation of internal control over financial reporting to determine whether any changes occurred
during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the
Corporation's internal control over financial reporting. Based on this evaluation, there has been no such change during the quarter
covered by this report.
Part II - Other Information
Item 1. 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 2. Changes in Securities
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
The Corporation's 2003 Annual Meeting of Shareholders was held on May 14, 2003. At the meeting, the directors
listed below were elected as directors of the Corporation for terms expiring at the annual meeting in the year
set forth to each of their names. The voting results for the matters brought before the 2003 Annual Meeting
are as follows:
1. Election of Directors. Cumulative voting applied in the election of directors.
Name Term Expires Votes For Abstentions
---- ------------ --------- -----------
B. Keith Johnson 2006 2,776,267 23,940
Diane E. Logsdon 2006 2,740,037 23,940
John L. Newcomb, Jr. 2006 2,675,379 23,940
In addition, the following directors will continue in office until the annual meeting of the
year set forth beside each of their names.
Name Term Expires
---- ------------
Robert M. Brown 2004
Wreno M. Hall 2005
Walter D. Huddleston 2005
J. Stephen Mouser 2005
Gail L. Schomp 2004
J. Alton Rider 2004
Michael L. Thomas 2005
Item 5. Other Information
None
Item 6. Exhibits:
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act
32 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350(As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)
Reports on Form 8-K:
The Corporation filed a Form 8-K on April 17, 2003 under Item 9. Regulation FD Disclosure
for the announcement of a 10% stock dividend payable to its shareholders on May 14, 2003, and to announce the
adoption of a Shareholder Rights Plan. The Corporation filed another 8-K on April 29, 2003 containing its press
release announcing its first quarter earnings. The last 8-K filing for the June 2003 quarter was on May 19,
2003 disclosing the Corporation's financial presentation to its shareholders at its May 14, 2003 annual meeting.
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
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.
DATE: August 14, 2003 BY: (S) B. Keith Johnson
-------------------
B. Keith Johnson
President and Chief Executive Officer
DATE: August 14, 2003 BY: (S) Charles E. Chaney
--------------------
Charles E. Chaney
Chief Operating Officer
Chief Financial Officer &
Principal Accounting Officer
INDEX TO EXHIBITS
Exhibit No. Description
- ----------- -----------
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act
32 Certification of Chief Executive Officer and Chief Financial Officer Pursuant 18 U.S.C.
Section 1350 (As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)
EXHIBIT 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT
I, B. Keith Johnson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of First Federal Financial Corporation of Kentucky;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be
designed under our supervision, 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 report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this
report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date
within 90 days before the filing of this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially affect, the registrant's
internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of
directors:
(a) all significant deficiencies in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report
financial data; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: August 14, 2003 By: /s/ B. Keith Johnson
---------------------
B. Keith Johnson
President and Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF
SARBANES-OXLEY ACT
I, Charles Chaney, certify that:
1. I have reviewed this quarterly report on Form 10-Q of First Federal Financial Corporation of Kentucky;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be
designed under our supervision, 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 report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this
report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date
within 90 days before the filing of this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal control over financial reporting that
occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the
case of an annual report) that has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of
directors:
(a) all significant deficiencies in the design or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and
report financial data; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: August 14, 2003 By: /s/ Charles Chaney
------------------
Charles Chaney
Chief Operating Officer, Chief Financial Officer &
Principal Accounting Officer
EXHIBIT 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350
(AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002)
In connection with the Quarterly Report of First Federal Financial Corporation of Kentucky (the "Corporation") on Form 10-Q for the
period ended June 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned,
the Chief Executive Officer and Chief Financial Officer of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, that:
1. The Report fully complies with the requirements of section 13 (a) or 15(d) of the Securities Exchange Act of 1934
and;
2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of
operations of the Corporation;
Date: August 14, 2003 By: /s/ B. Keith Johnson
--------------------
B. Keith Johnson
President and Chief Executive Officer
Date: August 14, 2003 By: /s/ Charles Chaney
------------------
Charles Chaney
Chief Operating Officer
Chief Financial Officer &
Principal Accounting Officer
A signed original of this written statement required by Section 906 has been provided to the Corporation and will be retained by the
Corporation and furnished to the Securities and Exchange Commission or its staff upon request.