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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 September 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 October 31, 2003
----- ----------------------------------
Common Stock 3,722,438 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) September 30, December 31,
2003 2002
---- ----
ASSETS:
Cash and due from banks $ 22,771 $ 31,776
Federal funds sold 55,000 60,000
------ ------
Cash and cash equivalents 77,771 91,776
Securities available-for-sale 3,737 1,999
Securities held-to-maturity: fair value of $21,161
(Sept) and $16,655 (Dec) 2002 21,346 16,576
Loans held for sale 2,054 3,676
Loans receivable, less allowance for loan losses
of $5,243 (Sept) and $4,576 (Dec) 2002 528,166 524,859
Federal Home Loan Bank stock 6,505 6,314
Cash surrender value of life insurance 3,500 -
Premises and equipment 14,617 11,672
Real estate owned:
Acquired through foreclosure 446 510
Held for development 549 721
Other repossessed assets 94 119
Goodwill 8,384 8,384
Accrued interest receivable 1,663 1,742
Other assets 1,926 2,108
----- -----
TOTAL ASSETS $670,758 $670,456
======== ========
LIABILITIES:
Deposits:
Non-interest bearing $ 34,205 $ 32,391
Interest bearing 491,640 488,730
Total deposits 525,845 521,121
Advances from Federal Home Loan Bank 77,643 77,683
Trust Preferred Securities 9,736 9,728
Accrued interest payable 436 504
Accounts payable and other liabilities 2,010 1,773
----- -----
TOTAL LIABILITIES 615,670 610,809
------- -------
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, 3,721,878 shares in September
and 3,643,706 shares in December 3,722 3,644
Additional paid-in capital 10,435 -
Retained earnings 40,313 55,605
Accumulated other comprehensive
income, net of tax 618 398
--- ---
TOTAL STOCKHOLDERS' EQUITY 55,088 59,647
------ ------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $670,758 $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 Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
Interest Income:
Interest and fees on loans $ 9,272 $10,217 $28,361 $30,705
Interest and dividends on investments and deposits 473 648 1,480 1,727
--- --- ----- -----
Total interest income 9,745 10,865 29,841 32,432
----- ------ ------ ------
Interest Expense:
Deposits 2,924 3,738 9,282 11,626
Federal Home Loan Bank advances 942 944 2,797 2,801
Trust Preferred Securities 122 148 379 295
--- --- --- ---
Total interest expense 3,988 4,830 12,458 14,722
----- ----- ------ ------
Net interest income 5,757 6,035 17,383 17,710
Provision for loan losses 438 726 1,187 1,569
--- --- ----- -----
Net interest income after provision for loan losses 5,319 5,309 16,196 16,141
----- ----- ------ ------
Non-interest Income:
Customer service fees on deposit accounts 1,142 1,041 3,275 2,896
Gain on sale of mortgage loans 473 225 1,311 522
Brokerage and insurance commissions 81 128 278 405
Other income 278 138 710 465
--- --- --- ---
Total non-interest income 1,974 1,532 5,574 4,288
----- ----- ----- -----
Non-interest Expense:
Employee compensation and benefits 2,347 1,978 7,016 5,776
Office occupancy expense and equipment 396 357 1,144 1,099
Marketing and advertising 150 143 448 494
Outside services and data processing 458 371 1,389 1,164
State franchise tax 141 129 423 388
Goodwill amortization - - - 416
Other expense 913 631 2,363 2,273
--- --- ----- -----
Total non-interest expense 4,405 3,609 12,783 11,610
----- ----- ------ ------
Income before income taxes 2,888 3,232 8,987 8,819
Income taxes 967 1,078 2,994 2,938
--- ----- ----- -----
Net income $1,921 $2,154 $5,993 $5,881
====== ====== ====== ======
Earnings per share
Basic $ 0.52 $ 0.53 $ 1.58 $ 1.44
Diluted $ 0.51 $ 0.53 $ 1.56 $ 1.43
See notes to consolidated financial statements.
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
Consolidated Statements of Comprehensive Income
(Unaudited)
(Dollars in thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
Net Income $1,921 $2,154 $5,993 $5,881
Other comprehensive income (loss):
Change in unrealized gain (loss)
on securities 114 (5) 333 9
Reclassification of realized amount - - - -
------ ----- ------ ------
Net unrealized gain (loss) recognized in
comprehensive income 114 (5) 333 9
Tax effect (39) 2 (113) (3)
--- - ---- --
Total other comprehensive income 75 (3) 220 6
-- -- --- ---
Comprehensive Income $1,996 $2,151 $6,213 $5,887
====== ====== ====== ======
See notes to consolidated financial statements.
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
Consolidated Statements of Changes in Stockholders' Equity
(Unaudited)
Nine Months Ended September 30, 2003
Accumulated Other
Additional Comprehensive
Common Stock Paid - in Retained Income,
Shares Amount Capital Earnings Net of Tax Total
------ ------ ------- -------- ---------- -----
Balance, January 1, 2003 3,644 $ 3,644 $ - $55,605 $ 398 $59,647
Net income - - - 5,993 - 5,993
Stock dividend-10% 337 337 10,213 (10,550) - -
Exercise of stock
options, net of redemptions 28 28 222 - - 250
Net change in unrealized
gains (losses) on
securities available-
for-sale, net of tax - - - - 220 220
Cash dividends declared
($.54 per share) - - - (1,991) - (1,991)
Stock repurchased (287) (287) - (8,744) - (9,031
---- ---- ------ ------ --- ------
Balance, September 30, 2003 3,722 $ 3,722 $10,435 $40,313 $ 618 $55,088
===== ======= ======= ======= ====== =======
See notes to consolidated financial statements.
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)
Nine Months Ended
September 30,
-------------
Operating Activities: 2003 2002
---- ----
Net income $ 5,993 $ 5,881
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 1,187 1,569
Depreciation of premises and equipment 740 743
Federal Home Loan Bank stock dividends (191) (212)
Goodwill amortization - 416
Net amortization (accretion) (204) 23
Gain on sale of mortgage loans (1,311) (522)
Origination of loans held for sale (76,128) (32,004)
Proceeds on sale of loans held for sale 79,061 32,797
Changes in:
Interest receivable 79 (196)
Other assets 355 482
Interest payable (68) (301)
Accounts payable and other liabilities 123 363
--- ---
Net cash from operating activities 9,636 9,039
----- -----
Investing Activities:
Change in interest bearing deposits - (51,000)
Purchases of securities available-for-sale (1,415) -
Purchases of securities held-to-maturity (29,978) (38,000)
Maturities of securities held-to-maturity 25,431 22,217
Investment in cash surrender value of life insurance (3,500) -
Net change in loans (4,406) 1,510
Net purchases of premises and equipment (3,685) (907)
------ ----
Net cash from investing activities (17,553) (66,180)
------- -------
Financing Activities:
Net increase in deposits 4,724 42,005
Advances from Federal Home Loan Bank 132 726
Repayments to Federal Home Loan Bank (172) (194)
Proceeds from stock options exercised 250 37
Net proceeds from issuance of trust preferred securities - 9,699
Dividends paid (1,991) (2,007)
Common stock repurchased (9,031) (2,395)
------ ------
Net cash from financing activities (6,088) 47,871
------ ------
Decrease in cash and cash equivalents (14,005) (9,270)
Cash and cash equivalents, beginning of period 91,776 47,880
------ ------
Cash and cash equivalents, end of period $77,771 $38,610
======= =======
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 nine month period ending September 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 to its shareholders of record as of April
28, 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 Nine Months Ended
except per share data) September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
Net income:
As reported $1,921 $2,154 $5,993 $5,881
Pro-forma 1,894 2,129 5,912 5,798
Earnings per share:
Basic As reported $ 0.52 $ 0.53 $ 1.58 $ 1.44
Pro-forma 0.51 0.52 1.56 1.42
Diluted As reported $ 0.51 $ 0.53 $ 1.56 $ 1.43
Pro-forma 0.51 0.52 1.55 1.41
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 pre-tax income of ceasing goodwill amortization for the three months and nine months
ended September 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 Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
Reported net income $ 1,921 $ 2,154 $ 5,993 $ 5,881
Add back: goodwill amortization
(net of tax) - - - 316
--------- ----------- -------- --------
Adjusted net income $ 1,921 $ 2,154 $ 5,993 $ 6,197
========= =========== ======== ========
Basic earnings per share:
Reported net income $ 0.52 $ 0.53 $ 1.58 $ 1.44
Goodwill amortization - - - .08
--------- ----------- -------- --------
Adjusted net income $ 0.52 $ 0.53 $ 1.58 $ 1.52
========= =========== ======== ========
Diluted earnings per share:
Reported net income $ 0.51 $ 0.53 $ 1.56 $ 1.43
Goodwill amortization - - - .08
--------- ---------- -------- --------
Adjusted net income $ 0.51 $ 0.53 $ 1.56 $ 1.51
========= ========== ======== ========
Recently Adopted Accounting Standards - On January 1, 2003, the Corporation adopted Interpretation 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees. On July 1, 2003, the Corporation adopted 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. On October 1, 2003, the Corporation adopted
Interpretation 46, Consolidation of Variable Interest Entities. Adoption of the new standards did not materially affect the
Corporation's operating results or 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:
September 30, 2003:
Equity securities $ 1,874 $ 822 $ (39) $ 2,657
State and municipal 999 81 - 1,080
--- -- -----
Total available-for-sale $ 2,873 $ 903 $ (39) $ 3,737
======= ====== ======= =======
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:
September 30, 2003:
U.S. Treasury and agencies $ 9,999 $ 50 $ - $10,049
Corporate Bond 2,000 - 2,000
Mortgage-backed securites 9,347 9 (244) 9,112
----- - ---- -----
Total held-to-maturity $21,346 $ 59 $ (244) $21,161
======= ====== ======= =======
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:
September 30, December 31,
(Dollars in thousands) 2003 2002
---- ----
Commercial $ 27,879 $ 29,024
Real estate commercial 184,692 135,191
Real estate construction 14,672 12,674
Residential mortgage 227,718 282,437
Consumer and home equity 53,291 51,215
Indirect consumer 26,644 20,594
------ ------
Total loans 534,896 531,135
------- -------
Less:
Net deferred loan origination fees (1,487) (1,700)
Allowance for loan losses (5,243) (4,576)
------ ------
(6,730) (6,276)
------ ------
Loans Receivable $528,166 $524,859
======== ========
The allowance for losses on loans is summarized as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in thousands)
Allowance for loan losses:
Balance, beginning of period $ 4,935 $ 3,735 $ 4,576 $ 3,284
Provision for loan losses 438 726 1,187 1,569
Charge-offs (188) (165) (672) (654)
Recoveries 58 57 152 154
-- -- --- ---
Balance, end of period $ 5,243 $ 4,353 $ 5,243 $ 4,353
======= ======= ======= =======
Investment in impaired loans is summarized below. There were no impaired loans for the periods presented without an
allowance allocation.
September 30, December 31,
(Dollars in thousands) 2003 2002
---- ----
End of period impaired loans $4,449 $4,584
Amount of allowance for loan
loss allocated 886 751
Non-performing loans were as follows:
September 30, December 31,
(Dollars in thousands) 2003 2002
---- ----
Restructured $3,064 $3,325
Loans past due over 90 days still
on accrual - -
Non accrual loans 1,385 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 Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in thousands) (In thousands)
Net income available
to common shareholders $1,921 $2,154 $5,993 $5,881
====== ====== ====== ======
Basic EPS:
Weighted average common shares 3,710 4,049 3,799 4,095
===== ===== ===== =====
Diluted EPS:
Weighted average common shares 3,710 4,049 3,799 4,095
Dilutive effect of stock options 39 20 37 15
-- -- -- --
Weighted average common and
incremental shares 3,749 4,069 3,836 4,138
===== ===== ===== =====
Earnings Per Share:
Basic $0.52 $0.53 $1.58 $1.44
===== ===== ===== =====
Diluted $0.51 $0.53 $1.56 $1.43
===== ===== ===== =====
Stock options for 7,500 and 8,050 shares of common stock were not included in the three-month and nine-month periods ended
September 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 and nine-month periods ending, September 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.
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 related
to the change in charter have been met and approved by the FDIC and the Federal Reserve. As part of its charter conversion, the Bank
formed a new subsidiary, First Federal Office Park, LLC to sell its commercial lots held for development.
On 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 identifies 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 comprise 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.
Net income for the quarter ended September 30, 2003 was $1.9 million or $0.51 per share diluted compared to $2.1 million or $0.53 per
share diluted for the same period in 2002. Net income for the nine months ended September 30, 2003 was $6.0 million or $1.56 per
share diluted compared to $5.9 million or $1.43 per share diluted for the same period in 2002. The increase in earnings for the
nine-month period was primarily attributable to an absence of goodwill amortization and an increase in gain on sale of mortgage
loans, offset by a decrease in net interest income. The Bank's book value per common share increased from $14.52 at September 30,
2002 to $14.80 at September 30, 2003. Annualized net income for 2003 generated a return on average assets of 1.18% and a return on
average equity of 14.32%. These compare with a return on average assets of 1.20% and a return on average equity of 13.48% for the
2002 period also annualized.
The Bank's total assets at September 30, 2003 remained relatively constant at $670.7 million compared to $670.5 million at December
31, 2002. The available-for-sale and held-to-maturity investment portfolios increased during the nine month period ended September
30, 2003 due to investments in equity securities and two mortgage-backed securities with fixed rate terms of five and seven years.
Also, during the 2003 quarter, the Bank invested $3.5 million in bank owned life insurance. Net loans increased $3.3 million from
December 31, 2002 to $528.2 million at September 30, 2003. Residential mortgage loans decreased by $54.7 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 $49.5 million to $184.7 million at
September 30, 2003. This growth is a result of the Bank's continued emphasis on the active pursuit of lending opportunities that
meet its lending risk criteria. In addition, the Bank has hired an automotive dealer loan specialist to expand its dealer loan
program, which increased $6.1 million to $26.6 million at September 30, 2003, and is expected to continue to increase.
Premises and equipment increased by $2.9 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. The Bank is
currently constructing two traditional banking centers on these lots. The banking centers are anticipated to be operational during
the March 2004 quarter. The Bank has developed a unique building design for all future banking centers to brand its image.
Deposits increased by $4.7 million to $525.8 million at September 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 Corporation's accounting and reporting policies conform to accounting principles generally accepted in the United States of
America and to general practices within the banking industry. The accounting principles relating to the allowance for loan losses is
critical to the understanding of the Corporation's results of operations since the application of these principles 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 September 30, 2003, net interest income declined to $5.8 million compared to $6.0 million for the 2002 quarter
due to a narrowing net interest margin. The Bank's net interest margin declined on an annualized basis from 3.79% during the 2002
quarter to 3.64% for the 2003 period. The Bank's yield on interest earning assets declined by 67 basis points while the cost of funds
declined by 57 basis points, resulting in a net reduction to the net interest margin of 15 basis points. The declining yield on
interest earning assets was the cumulative result of the heavier refinancing of residential mortgage loans. 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 June 2003 quarter, the net interest margin experienced no further decline.
Net interest income for the nine months ended September 30, 2003 also declined to $17.4 million compared to $17.7 million for the
2002 period. On an annualized basis, the net interest margin decreased from 3.83% for 2002 to 3.63% for 2003. The net interest rate
spread on an annualized basis decreased from 3.52% during 2002 to 3.39% 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, heavy
volumes of residential mortgage loans were refinanced into the secondary market, reducing the Bank's residential mortgage loan
portfolio. During the 2003 nine-month period, residential mortgage loans held in the Bank's portfolio decreased by $54.7 million as
a majority of the new and refinanced residential mortgage loan originations were sold during 2003. The substitution of residential
mortgage loans for commercial and commercial real estate loans has resulted in a declining yield on the Bank's loan portfolio.
However, one of the underlying benefits of this strategy is to substantially reduce the Bank's interest rate risk in the event of a
rising rate environment. (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 September 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 $ 2,568 $ 33 5.14% $ 919 $ 7 3.05%
State and political subdivision
securities (1) 1,084 17 6.27 1,058 17 6.43
U.S. Treasury and agencies 11,000 75 2.73 17,978 147 3.27
Corporate Bond 2,000 15 3.00 2,000 16 3.20
Mortgage-backed securities 9,963 96 3.85 684 9 5.26
Loans receivable (2) (3) (4) 528,183 9,272 7.02 523,048 10,217 7.81
FHLB stock 6,456 65 4.03 6,188 74 4.78
Interest bearing deposits and
Federal funds 72,610 179 0.99 85,804 384 1.79
------ --- ---- ------ --- ----
Total interest earning assets 633,864 9,752 6.15 637,679 10,871 6.82
----- ---- ------ ----
Less: Allowance for loan losses (5,120) (3,972)
Non-interest earning assets 44,610 38,534
------ ------
Total assets $673,354 $672,241
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
Savings accounts $75,365 $ 176 0.93% $78,969 $ 319 1.62%
NOW and money market
Accounts 117,049 223 0.76 111,981 462 1.65
Certificates of deposit and
other time deposits 300,154 2,525 3.36 302,890 2,957 3.91
FHLB Advances 77,668 942 4.85 77,761 944 4.86
Trust Preferred Securities 9,735 122 5.01 9,722 148 6.09
----- --- ---- ----- --- ----
Total interest bearing
liabilities 579,971 3,988 2.75 581,323 4,830 3.32
Non-interest bearing liabilities: ----- ---- ----- ----
Non-interest bearing deposits 35,665 28,444
Other liabilities 3,246 4,104
----- -----
Total liabilities 618,882 613,871
Stockholders' equity 54,472 58,370
------ ------
Total liabilities and
stockholders' equity $673,354 $672,241
======== ========
Net interest income $5,764 $6,041
====== ======
Net interest spread 3.40% 3.50%
==== ====
Net interest margin 3.64% 3.79%
==== ====
- -----------------------------------------------------
(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.
Nine Months Ended September 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 $ 1,870 $ 59 4.21% $ 932 $ 24 3.43%
State and political subdivision
securities (1) 1,085 51 6.27 1,032 53 6.85
U.S. Treasury and agencies 11,596 257 2.95 13,082 421 4.29
Corporate Bond 2,000 49 3.27 600 16 3.56
Mortgage-backed securities 6,357 181 3.80 751 31 5.50
Loans receivable (2) (3) (4) 526,908 28,362 7.18 521,750 30,706 7.85
FHLB stock 6,390 191 3.99 6,114 213 4.65
Interest bearing deposits and
Federal funds 82,265 709 1.15 73,258 987 1.80
------ --- ---- ------ --- ----
Total interest earning assets 638,471 29,859 6.24 617,519 32,451 7.01
------ ---- ------ ----
Less: Allowance for loan losses (4,873) (3,659)
Non-interest earning assets 42,295 37,007
------ ------
Total assets $675,893 $650,867
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
Savings accounts $76,974 $ 599 1.04% $73,425 $1,086 1.97%
NOW and money market
Accounts 114,338 735 0.86 104,521 1,209 1.54
Certificates of deposit and
other time deposits 303,549 7,948 3.49 300,693 9,331 4.14
FHLB Advances 77,695 2,797 4.80 77,678 2,801 4.81
Trust Preferred Securities 9,732 379 5.19 6,800 295 5.78
----- --- ---- ----- --- ----
Total interest bearing
liabilities 582,288 12,458 2.85 563,117 14,722 3.49
------ ---- ------ ----
Non-interest bearing liabilities:
Non-interest bearing deposits 34,188 25,105
Other liabilities 3,619 4,486
----- -----
Total liabilities 620,095 592,708
Stockholders' equity 55,798 58,159
------ ------
Total liabilities and
stockholders' equity $675,893 $650,867
======== ========
Net interest income $17,401 $17,729
======= =======
Net interest spread 3.39% 3.52%
==== ====
Net interest margin 3.63% 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 Nine Months Ended
September 30, September 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 $ 7 $ 19 $ 26 $ 7 $ 29 $35
State and political subdivision
securities (1) 1 - (5) 3 (2)
U.S. Treasury and agencies (21) (51) (72) (121) (44) (164)
Corporate bond (1) - (1) 33 - 33
Mortgage-backed securities (3) 90 87 (13) 163 150
Loans (1,045) 100 (945) (2,645) 301 (2,344)
FHLB stock (12) 3 (9) (31) 9 (22)
Interest bearing deposits and
federal funds (153) (52) (205) (388) 110 (278)
---- --- ---- ---- --- ----
Net Change in Interest Income (1,229) 110 (1,119) (3,163) 571 (2,592)
------ --- ------ ------ --- ------
Interest expense:
Savings accounts (129) (14) (143) (537) 50 (487)
NOW and money market accounts (259) 20 (239) (579) 105 (474)
Certificates of deposit and other
time deposits (405) (27) (432) (1,471) 88 (1,383)
FHLB advances (1) (1) (2) (5) 1 (4)
Trust preferred securities (26) - (26) (43) 127 84
--- --- --- --- --- -----
Net Change in Interest Expense (820) (22) (842) (2,635) 371 (2,264)
---- --- ---- ------ --- ------
Decrease in net interest income $(409) $132 $(277) $ (528) $ 200 $ (328)
===== ==== ===== ====== ===== ======
Non-Interest Income-Non-interest income was $2.0 million for the quarter ended September 30, 2003, as compared to $1.5 million for
the 2002 period, an increase of $442,000 or 29%. 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, service fees on deposit accounts and other income. Offsetting these
increases were decreases in brokerage and insurance commissions. Gain on sale of mortgage loans increased by $248,000 to $473,000 for
2003 compared to 2002 as declining market interest rates encouraged 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 income increased by $194,000 or 15% during the 2003 quarter compared to the 2002 quarter,
attributable to a wide variety of customer service fees resulting from the growth in loans and deposits.
Non-interest income was $5.6 million for the nine months ended September 30, 2003, as compared to $4.3 million for the same period
last year. Customer service fees on deposit accounts increased by $379,000 or 13% during 2003 due to growth in customer deposits,
overdraft fee income on retail checking accounts and the sale of fee based products. The Bank continues to increase its customer base
through cross-selling opportunities as well as through marketing initiatives and promotions. Gain on sale of mortgage loans
increased by $789,000 to $1.3 million for 2003 compared to 2002 due to the high level of refinancing activity. Income from brokerage
commissions and insurance sales decreased $127,000 as a result of a decline in demand for these products. Other income increased
during the 2003 period by $245,000 primarily due to growth in other loan and deposit fees and 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 in which the Bank holds a 48% interest. The new LLC generated $107,000 in income for the nine months
ended September 30, 2003.
Non-Interest Expense- Non-interest expense increased during the quarter and nine-month period ended September 30, 2003 compared to
the same period in 2002. The most significant factors impacting the increase in non-interest expense for the quarter and nine-months
ended September 30, 2003 include an increase in staffing levels and 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 higher growth market areas in
Louisville, Kentucky. These banking centers are expected 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% and 53% for the nine month periods ended September 30, 2003 and 2002.
Employee compensation and benefits, the largest component of non-interest expense, increased $369,000 for the 2003 quarter compared
to the 2002 quarter, and $1.2 million for the nine months ended September 30, 2003 compared to September 30, 2002. The increase in
employee compensation reflects higher incentive bonuses and Bank profitability, coupled with growth in the overall staffing level
from 235 full-time equivalent employees at September 30, 2002 to 258 full-time equivalent employees at September 30, 2003. New
positions were added in most areas of the Bank reflecting the Bank's continued emphasis on building its commercial and retail staff
to reflect its commercial bank strategy. The increase in employee benefits for the 2003 nine 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 nine months ended
September 30, 2002 was $416,000. However, goodwill amortization had no effect during the September quarter on a comparative basis.
All other non-interest expenses increased $349,000 to $5.8 million during the 2003 nine month period compared to the 2002 period.
ALLOWANCE AND PROVISIONS FOR LOAN LOSSES
The allowance for loan losses is evaluated quarterly by the Bank's 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 Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in thousands)
Balance-beginning of period $4,935 $3,735 $4,576 $3,284
------ ------ ------ ------
Loans charged-off:
Real estate mortgage - - (45) (25)
Consumer (183) (165) (554) (521)
Commercial (5) - (73) (108)
-- ---- --- ----
Total charge-offs (188) (165) (672) (654)
---- ---- ---- ----
Recoveries:
Real estate mortgage - - - 2
Consumer 58 27 152 92
Commercial - 30 - 60
-- -- --- ---
Total recoveries 58 57 152 154
-- -- --- ---
Net loans charged-off (130) (108) (520) (500)
---- ---- ---- ----
Provision for loan losses 438 726 1,187 1,569
--- --- ----- -----
Balance-end of period $5,243 $4,353 $5,243 $4,353
====== ====== ====== ======
Net charge-offs to average
loans outstanding .10% .09%
Allowance for loan losses to
total non-performing loans 118% 105%
Allowance for loan losses
to net loans outstanding .99% .84%
The provision for loan losses decreased to $438,000 for the quarter ended September 30, 2003 compared to $726,000 for the 2002
quarter. The provision also decreased for the nine-month period ended September 30, 2003 to $1.2 million compared to $1.6 million
for the 2002 period. The provision decreased for the 2003 quarter due to a change in the loan classification and charge-off
estimates which occurred during the September 2002 quarter. The provision also decreased for the 2003 nine-month period due to a
change in the non-classified commercial real estate estimated loss percentage, which increased .20% during the March 2002 quarter.
The total allowance for loan losses increased $890,000 to $5.2 million from September 30, 2002 to September 30, 2003. Management
increased the allowance for loan losses due to the continued strong growth in commercial real estate lending and changes in the
product mix within the loan portfolios. Net loan charge-offs increased $22,000 to $130,000 for the quarter ended September 30, 2003
compared to $108,000 for the same period in 2002 and increased $20,000 for the September 30 nine-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 September 30, 2003, on the basis of
management's review of the Bank's loan portfolio, the Bank had $5.6 million of assets classified substandard, $1.0 million classified
as doubtful, $0 classified as specific allowance, $6.5 million classified as special mention and $60,000 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 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.
September 30, December 31,
2003 2002
---- ----
(Dollars in thousands)
Restructured $ 3,064 $3,325
Past due 90 days still on accural - -
Loans on non-accrual status 1,385 1,259
----- -----
Total non-performing loans 4,449 4,584
Real estate acquired
through foreclosure 446 510
Other repossessed assets 94 119
-- ---
Total non-performing assets $4,989 $5,213
====== ======
Interest income that would have
been earned on non-performing loans $ 189 $ 177
Interest income recognized
on non-performing loans 182 158
Ratios: Non-performing loans
to net loans .84% .87%
Non-performing assets
to net loans .94% .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 in the form of cash and cash equivalents and core deposits to meet demand. Funding and cash flows
can also be realized by the sale of securities in the available-for-sale portion of the investment portfolio, principal paydowns on
loans and mortgage-backed securities and proceeds realized from loans held for sale. 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. Traditionally, the Bank has
also utilized borrowings from the FHLB to supplement its funding requirements. At September 30, 2003, the Bank had an unused
approved line of credit in the amount of $78.1 million and sufficient collateral available to borrow, approximately, an additional
$63.3 million in advances from the FHLB.
CAPITAL
During the nine-month period ended September 30, 2003, the Corporation purchased 287,343 shares of its own common stock. As a
result, total capital decreased by $9.0 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 8.26% year to date September 30, 2003 compared to 8.94% on September 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 September 30, 2003: Amount Ratio Amount Ratio Amount Ratio
Total risk-based capital (to risk-
weighted assets)
Consolidated $61,261 12.1% $40,381 8.0% $50,476 10.0%
Bank 59,339 11.8 40,198 8.0 50,248 10.0
Tier I capital (to risk-weighted
assets)
Consolidated 55,820 11.1 20,190 4.0 30,285 6.0
Bank 53,898 10.7 20,099 4.0 30,149 6.0
Tier I capital (to average assets)
Consolidated 55,820 8.4 26,599 4.0 33,249 5.0
Bank 53,898 8.1 26,599 4.0 33,249 5.0
On March 26, 2002, a trust subsidiary of 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.
Kentucky banking laws limit the amount of dividends that may be paid to the Corporation by the Bank without prior approval of the
KDFI. Under these laws, the amount of dividends that may be paid in any calendar year is limited to current year's net income, as
defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those
periods. At September 30, 2003, the Bank had approximately $15.4 million of retained earnings that could be utilized for payment of
dividends if authorized by its board of directors without prior regulatory approval.
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 September 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 5.10% at September
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 3.55% at September 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 without these growth estimates.
As demonstrated by the September 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 change in the current reporting period 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 September 30, 2003 and December 31, 2002
annualized to a one year period.
Interest Rate Sensitivity Table
September 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 $32,148 $34,159 $36,014 $37,701 $39,278
Investments 1,085 1,141 2,160 3,026 3,899
----- ----- ----- ----- -----
Total interest income 33,233 35,300 38,174 40,727 43,177
Projected interest expense
Deposits 7,432 8,620 10,199 11,828 13,458
Borrowed funds 3,957 4,036 4,114 4,192 4,271
----- ----- ----- ----- -----
Total interest expense 11,389 12,656 14,313 16,020 17,729
Net interest income $21,844 $22,644 $23,861 $24,707 $25,448
Change from base $(2,017) $(1,217) $846 $1,587
% Change from base (8.45)% (5.10)% 3.55% 6.65%
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
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 23 to
25 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
Not Applicable
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 July 29, 2003 under Item 9. Regulation FD Disclosure
announcing its second quarter ended June 30, 2003 earnings. The Corporation filed another
8-K on August 1, 2003 containing a financial presentation to a Keefe, Bruette & Woods, Inc.
Community Bank Investor Conference.
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: November 13, 2003 BY: (S) B. Keith Johnson
----------------------
B. Keith Johnson
President and Chief Executive Officer
DATE: November 13, 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 to 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 the end of
the period covered by 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: November 13, 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 the end of
the period covered by 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: November 13, 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 September 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: November 13, 2003 By: /s/ B. Keith Johnson
--------------------
B. Keith Johnson
President and Chief Executive Officer
Date: November 13, 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.